A Difficult Choice: “To Disclose Or Not To Disclose” an SEC Investigation
On August 17, 2006, Dell disclosed an informal SEC inquiry into its stock option practices which began about one year ago. It stated that, as a result of the inquiry, an internal investigation has turned up some difficulties, which the company does not believe are material. When questioned why it had not disclosed the SEC inquiry sooner, Dell stated that it has no legal obligation to do so and that the inquiry was informal. Now some people question the reason Dell chose not to disclose the SEC inquiry initially. Others question the reason Dell chose to disclose the inquiry now, along with the results to date of its inquiry. Dell’s situation highlights the difficult issue companies face when deciding whether to disclose an SEC investigation.No doubt Dell was right about the law. There is no legal duty to disclose an SEC investigation. It is axiomatic that disclosure is not required unless there is a duty, regardless of whether the information is, in fact, material. A duty to disclose can arise from a specific legal requirement, such as an SEC regulation. While the SEC has specific regulations governing the disclosure of litigation, there is no rule requiring a company to disclose an SEC investigation. In fact unlike in a DOJ inquiry, a company cannot disclose that it is the target or subject of an SEC investigation because the SEC’s position is that its investigations do not have targets or subjects.
Following this rule, traditionally many companies have chosen not to disclose the existence of an SEC inquiry, formal or informal. There are good reasons for this approach. If, for example, the investigation is informal, the SEC staff is not obligated to notify the company if it chooses to terminate its investigation. In contrast, when the SEC terminates a formal inquiry, it must provide notice that it is closing the investigation. Thus, if the informal inquiry ends with no enforcement action, the company may not be in a position to tell the market because it may not have confirmation that the inquiry has ended. This is particularly troublesome because typically the price of the company’s stock goes down after the announcement of an investigation and up upon news that it has concluded.
Even if a formal investigation is being conducted, there may be reasons not to disclose. By disclosing, the company may assume a duty to update that disclosure. Thus, when a material event occurs, such as the issuance of a Wells notice or an agreement in principle with the staff to resolve the investigation, additional disclosure may be necessary. A press release announcing either of these events may have a severe impact on the company’s share price. Yet following a Wells notice, the SEC may decline to bring an enforcement action and may even terminate the investigation. Similarly, an agreement with the staff is not a settlement with the SEC and there is no assurance that the Commission will accept the proposed settlement.
Nevertheless in the wake of recent scandals and SOX, many companies have chosen to disclose that they are under investigation. For example, a number of companies have disclosed investigations concerning their stock option practices, while others have issued press releases indicating that they are conducting similar internal investigations. Some companies have gone one step further and disclosed that they may have a problem even before the government began any inquiry. A few issuers have even disclosed that they conduced an inquiry and determined they do not have a stock option backdating problem. Disclosure, of course, promotes transparency and can boost investor confidence. At the same time, given the current business and regulatory environment, many companies may believe that they have little choice but to disclose. One may also wonder whether disclosing each step in a government or self-conducted inquiry is not in fact over kill which dilutes the disclosure of important facts by burying them in less significant material.
The bottom line is that the disclosure issue faced by Dell was not an easy one. This is particularly true because the environment has changed since the company made its initial decision before the current stock option scandal broke and the ensuing media frenzy about the issue. Careful consideration has to be given not only to the legal implications but also to the practical impact of disclosing or not disclosing an SEC inquiry in the context of the existing environment. The conflicting threads of this are in some ways characterized by the conflicting positions currently being asserted on this issue. On one side there has been a call for a rule mandating that companies disclose the receipt of a Wells notice. Such a rule, of course, could trigger a continuing disclosure obligtion which would include any subsequent settlement discussions with the staff. The SEC, which as a matter of policy declines to comment on the existence of an investigation, has urged companies to disclose an investigation, presumably as a sign of cooperation. On the other hand, in February SEC Commissioner Atkins decried the practice of disclosing the status of settlement negotiations with the staff noting, “[i]t has become a common occurrence lately that I see public companies disclosing an agreement, or settlement, “in principle” with the SEC. I can’t tell you how frustrated this makes me.” http://www.sec.gov/news/speech/spch021606psa.htm Clearly, there is no easy “one size fits all” answer to resolving these conflicting ideas or answering the question of whether to disclosue an SEC investigation. But as Dell recently learned, sometimes no matter what you do it is impossible to avoid criticism.