On Friday of last week, the SEC announced that it had filed a complaint charging AT&T, Inc. and three of its Investor Relations executives with violations of Reg FD as a result of one-on-one disclosures of AT&T's "projected and actual financial results" to a number of Wall Street research analysts by the three executives. In March 2016, the SEC alleges, AT&T learned that, as a result of a "steeper-than-expected decline in smartphone sales," AT&T's first quarter revenues would fall short of analysts' estimates by over a $1 billion. The three IR executives were then asked to contact the analysts whose estimates were too high to "walk" them down. This case illustrates the tightrope that IR personnel walk when talking one-on-one with analysts in the context of Reg FD.
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Under Reg FD, if a senior official of the company (or other person who regularly communicates with investors and analysts) intentionally discloses material nonpublic information to a person in one of the specified categories, including analysts, broker/dealers, investment advisers, investment companies or securityholders, the company is required to simultaneously disseminate the information publicly. Disclosure is considered intentional if the person making the disclosure either knew (or was reckless in not knowing) that the information was both material and nonpublic. In the event that a company unintentionally discloses material nonpublic information on a selective basis, then that information must be publicly disseminated promptly (within the later of 24 hours or the commencement of the next day's trading) after a senior official of the company knows (or is reckless in not knowing) that the information selectively disclosed was both material and nonpublic.
The SEC has indicated that Reg FD is not intended to discourage analysts from "sifting through and extracting information" that would not be significant to the ordinary investor in reaching material conclusions. In addition, a company "is not prohibited from disclosing a non-material piece of information to an analyst, even if, unbeknownst to the issuer, that piece helps the analyst complete a 'mosaic' of information that, taken together, is material." As stated in SEC v. Bausch & Lomb, Inc., the "SEC, of course, does not maintain that the securities laws prohibit all disclosures of internal corporate information. The Commission itself has recognized that corporate management may reveal to securities analysts or other inquirers non-public information that merely fills 'interstices in analysis.'"
Information is considered "material" if there is "a substantial likelihood that a reasonable investor would consider the information important in making an investment decision or if the information would significantly alter the total mix of available information." And that's where the thorny part comes in. Judgments about materiality of disclosures are often complicated and muddy and frequently made in real time. When is information disclosed just filling in the interstices or providing immaterial fragments of a mosaic, and, as a result, not viewed as MNPI, and when is it material information disclosure of which could violate Reg FD? It's a line that's not always easy to discern. What's more, whatever line-drawing takes place, it will always be evaluated by regulators with the benefit of hindsight.
And one-on-one conversations with analysts can be especially fraught with peril, as the SEC explicitly noted in the release adopting Reg FD:
"When an issuer official engages in a private discussion with an analyst who is seeking guidance about earnings estimates, he or she takes on a high degree of risk under Regulation FD. If the issuer official communicates selectively to the analyst nonpublic information that the company's anticipated earnings will be higher than, lower than, or even the same as what analysts have been forecasting, the issuer likely will have violated Regulation FD. This is true whether the information about earnings is communicated expressly or through indirect 'guidance,' the meaning of which is apparent though implied. Similarly, an issuer cannot render material information immaterial simply by breaking it into ostensibly non-material pieces."
According to the complaint, AT&T had been experiencing a decline in smartphone sales for a couple of years as a result of a number of factors, including termination of customer subsidies for purchases, fewer model changes and more direct sales by phone manufacturers. In the fourth quarter of 2015, the company's revenue had substantially missed analysts' estimates, leading the CFO to emphasize these trends on an earnings call with analysts in January 2016 and to "telegraph[] the likelihood that these impacts would persist into future quarters." In early March 2016, AT&T became aware of a steep decline in smartphone sales, including a potentially record low rate at which existing customers purchased new smartphones. Consequently, the company projected that its gross revenues would be over $1 billion below the consensus estimate-not a particularly good place to be, especially since it would have been the company's third consecutive quarterly miss.
The SEC alleges that the company decided to make a public disclosure "to manage market expectations" and, after ruling out issuance of an 8-K, decided that the company's CFO should discuss the issue at a scheduled investor conference on March 9, 2016. At the conference, the CFO "referred back to his comments from AT&T's 4Q15 earnings release regarding the decline in wireless equipment revenue and stated that he 'would not be surprised' to see that trend continue," but did not provide any quantitative guidance for Q1, stating that he could "only talk about up through the fourth quarter."
Those remarks were not enough, however, to induce analysts to lower the consensus revenue estimates sufficiently to be in line with AT&T's internal estimates. To that end, the company's IR Department developed a plan to reach out to individual analysts, and, the SEC alleges, the plan was understood to be "a top priority at the company." The CFO instructed IR to be sure that the team was "'working the analysts who still have equipment revenue too high,'" and the Director of IR "took steps to ensure that the IR team prioritized this analyst outreach and its objectives," directing the three executives "to speak to analysts privately on a one-by-one basis about their estimates in order to 'walk the analysts down.'" As directed, the SEC alleges, the three executives made calls to about 20 analysts, disclosing specific information about Q1 such as "AT&T's projected or actual equipment upgrade rate, its projected or actual wireless equipment revenue amount (presented as a percentage decrease compared with the first quarter of 2015), or both." On some of the calls, one of the executives allegedly knowingly or recklessly "misrepresented" to analysts that the estimates he was providing to them were "publicly available consensus estimates, when in fact he was providing AT&T's own internal projected or actual results."
According to the complaint, following the calls, each of the 20 analysts revised their research reports to reduce their revenue estimates, and "almost all of them cited a record low upgrade rate and reduced wireless equipment revenue as the primary reasons, typically reducing their estimates of those metrics to the level AT&T was internally forecasting or knew it would report. Most of the analysts specifically cited an expected upgrade rate of 5%." Consequently, the SEC alleges, the day before the company released its Q1 2016 earnings, the consensus estimate had dipped just below the revenues that the company would report.
Importantly, the SEC alleges that all three executives "knew or recklessly disregarded that the internal data they communicated was material nonpublic information when they selectively disclosed that information in one-on-one calls with the analyst firms." According to the complaint, all three executives participated in periodic Reg FD training, which used materials that "specifically informed the IR Department personnel that AT&T's revenue and sales of smartphones were types of information generally considered 'material' to AT&T investors," and prohibited from selective disclosure under Reg FD. In addition, the SEC charges, they disclosed this information expecting the analysts to reduce their estimates. Moreover, the misrepresentation by one of the executives to disguise the internal information he was presenting as the analysts' "consensus" also, in the view of the SEC, supports the charge of knowing or reckless misconduct.
In addition, according to the SEC, the mere timing and subject matter of the calls implicitly conveyed MNPI. All three executives "knew or recklessly disregarded that the timing of the calls (i.e., near and after the quarter's end) and the subject matter discussed (i.e., AT&T's wireless equipment revenue and/or upgrade rate) also independently conveyed, apart from the specific details that were discussed on a given call, material nonpublic information to the analysts-that their revenue and related estimates were higher than AT&T's expected results."
The SEC charged the company with repeated selective disclosures in violation of Reg FD and the three executives with aiding and abetting AT&T's violations. Neither the CFO nor the Director of IR were charged. The SEC is seeking an injunction and monetary penalties.
In response to the charges, AT&T issued a statement characterizing the three IR executives as "mid-level investor relations employees" and the SEC's charges as "a significant departure from the SEC's own long-standing Regulation FD enforcement policy." The company also charged that the SEC's allegations were "inconsistent with the testimony of all who participated in these conversations. Tellingly, after spending four years investigating this matter, the SEC does not cite a single witness involved in any of these analyst calls who believes that material nonpublic information was conveyed to them."
According to AT&T, no MNPI was disclosed on the calls. AT&T contends that, in providing the information to analysts, the three IR employees were just filling in the interstices with respect to a matter that was widely known or had already been fully disclosed or was otherwise just not material:
"The information discussed during these March and April 2016 conversations concerned the widely reported, industry-wide phase-out of subsidy programs for new smartphone purchases and the impact of this trend on smartphone upgrade rates and equipment revenue. Not surprisingly, without device subsidies, customers upgraded their smartphones less frequently, leading to a reduction in equipment revenue. Not only did AT&T publicly disclose this trend on multiple occasions before the analyst calls in question, but AT&T also made clear that the declining phone sales had no material impact on its earnings. Analysts and the news media frequently wrote about this trend and investors understood that AT&T's core business was selling connectivity (i.e., wireless service plans), not devices, and that smartphone sales were immaterial to the company's earnings. The evidence could not be clearer-and the lack of any market reaction to AT&T's first quarter 2016 results confirms-there was no disclosure of material nonpublic information and no violation of Regulation FD."
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Interestingly, some of the reporting seems to suggest a milder take on the facts than the SEC details in the complaint. In a 2016 article, the WSJ reported that, prior to "AT&T's announcement, investor-relations employees at the telecommunications giant encouraged analysts to look back at comments made by [the CFO] in early March, say analysts who spoke with the company. He had implied some customers were waiting longer to upgrade their mobile phones, an important revenue source." As noted above, the SEC charged that the discussions went well beyond references to the CFO's remarks, providing more explicit information about the relative decline in smartphone revenue and upgrade rate for Q1. Would the SEC's hackles still have been raised had the three IR executives referred only to the CFO's prior public comments without more? Perhaps not so much, but keep in mind that the SEC considered the timing and subject matter of the calls themselves to implicitly convey MNPI.
In addition, in recent reporting on the complaint, the WSJ seems to confirm the AT&T statement that none of analysts thought they had received MNPI, reporting that "[a]nalysts interviewed by the SEC as part of the investigation told regulators they didn't believe the metrics were material, and thus didn't report the communication from AT&T to their own compliance experts, a person familiar with the matter said."
In its statement, AT&T observed that the case "will only create a climate of uncertainty among public companies and the analysts who cover them." The company, the statement concluded, is looking forward to its "day in court." Given how infrequently the SEC brings cases under Reg FD-is this only the second case in eight years?-we are certainly looking forward to the proceedings and the outcome. Stay tuned.
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