Before you respond to that Wells notice…

A few considerations are at play before responding to a SEC Wells notice, which warns of impeding regulatory action, least of which the possibility your ‘Wells submission’ jeopardizes the firm’s defense strategy. 

Fenway Partners appears to be the latest victim in the SEC’s crackdown on fees, as first reported by the Wall Street Journal earlier this month. The rumor circling the air is that the Wells notice sent to Fenway was one of several recently sent to investment advisers, which would make sense if we believe former and current SEC officials like Bruce Karpati, who have said (in so many words) that enforcement action is the logical follow-up to troublesome exam findings.

To date, the much-feared wave of enforcement action hasn’t materialized yet – save for a few fee-related splashes on Lincolnshire and, more notably, KKR – but the caveat is that cases take years to build. The SEC only just ended its exam initiative on private equity late last year, so let’s assume more Wells notices are in fact coming: how should a firm respond?

An SEC Wells notice is a warning of impeding enforcement action, and gives the person or firm a chance to tell their side of the story before formal charges are filed. Working with outside counsel, a “Wells submission” provides the firm a valuable opportunity to begin mounting their defense. However, legal sources speaking to pfm about the best defense strategy here advise a few preliminary steps first. 

For starters, it should be considered if a submission should even be filed. Any submission “is admissible against the firm should litigation ensue and can help provide the SEC with a blueprint of the manager’s anticipated defense strategy,” warns Gibson Dunn attorney Marc Fagel. It’s also questionable whether or not enforcement staff would be willing to change course if they’ve already reached the point of sending a notice. The WSJ recently found that about one in five Wells notices do not ultimately result in a suit, but the study was limited to individuals (not firms). More importantly, it’s unknown if the cases were dropped because of a successful submission, or based off the SEC’s own volition (a FOIA request was submitted by pfm in an attempt to find out, but the SEC has yet to respond).

In an ideal scenario, the question of responding can be avoided entirely with a “pre-Wells meeting.” As an investigation is drawing to a close, and it seems that charges are imminent, the GP, alongside legal counsel, can and should request an early sit-down with enforcement staff to lay out their defense. It’s possible the charges will be reduced or a settlement will be reached before the notice is sent, saving the firm from reputational damage. And if the notice is sent, the same opportunity exists to request a meeting (within a two-week window), which can be used to learn more about the case before preparing a formal response. 

To be clear: a submission is likely the correct course of action for firms unfortunate enough to receive a Wells notice in the coming months and years (a position Fagel shares). It represents the firm’s last opportunity to prevent SEC staff from pursuing enforcement action. But the decision to submit a formal defense should be preceded by a few action steps that counsel should bring to the firm’s attention early on.