United States: AT&T Settles Reg FD Charges For Record Penalty

Yesterday, the SEC announced that it had settled charges against AT&T for alleged violations of Reg FD for $6.25 million, an amount that it characterized as a "record penalty"—the "largest ever in a Reg FD case." The case involved allegations of one-on-one disclosures by three company executives of AT&T's "projected and actual financial results" to a number of Wall Street research analysts in violation of Reg FD and Exchange Act 13(a). (See this PubCo post.) The three executives agreed to pay $25,000 each to settle charges. After the federal district court for the SDNY denied summary judgment for both sides in September (see this PubCo post), the case appeared to be on its way to trial, but that was headed off by this new settlement. According to Gurbir Grewal, Director of Enforcement, the "actions allegedly taken by AT&T executives to avoid falling short of analysts' projections are precisely the type of conduct Regulation FD was designed to prevent....Compliance with Regulation FD ensures that issuers publicly disclose material information to the entire market and not just to select analysts."

The SEC alleged that, in March 2016, 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. Given that AT&T had missed consensus revenue estimates in two of the three preceding quarters, AT&T, it was alleged, embarked on a "campaign" to beat consensus revenue estimates for Q1: the three defendant IR executives were asked by the CFO and IR Director to contact the analysts whose estimates were too high to "walk" them down. As part of that campaign, the SEC alleged, they selectively disclosed the company's "projected or actual total revenue, and internal metrics bearing on total revenue, including wireless equipment revenue and wireless equipment upgrade rates." The campaign worked. But—and it's a big but—it also led the SEC to bring claims against AT&T for violating Reg FD, and against the three IR employees for aiding and abetting that violation. This case illustrates the tightrope that IR personnel walk when talking one-on-one with analysts in the context of Reg FD.

SideBar

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:

According to the SEC's 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 alleged that the company decided to make a public disclosure "to manage market expectations" and, after ruling out issuance of an 8-K, concluded 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 SEC alleged, the company's IR Department developed a plan to reach out to individual analysts, and the plan was understood to be "a top priority at the company." The SEC charged that 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 alleged, 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 alleged, 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 alleged 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 charged, 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, supported 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."

On motions for summary judgment, the parties' dispute centered on the elements of materiality, selective disclosure of nonpublic information and scienter. The defendants contended that the information disclosed was not material because, previously, missed consensus estimates had not appreciably moved the stock price. But the Court concluded that, under the case law, that is "rarely dispositive of materiality." In addition, the SEC observed that there was contemporaneous evidence that favorable news in the same announcement countered the bad news. The Court concluded that the evidence supporting the materiality of the disclosed information was "overwhelming." With regard to selective disclosure of MNPI, the Defendants argued that analysts and investors could have extrapolated the information from public information. The Court, however, viewed that claim as "at odds with the evidence of the analysts' behavior. The evidence does not reflect that any analyst, or other AT&T outsider, had performed such an exercise and arrived at this result." The Court considered the evidence that the IR defendants selectively disclosed MNPI to analysts to be likewise "overwhelming."

The rub came in determining the issue of scienter. The Court said that scienter here "turns on whether the IR defendants knew, or were reckless in not knowing, that the data about AT&T's Q1 2016 performance... was both material and nonpublic." Although there were many facts identified by the Court in support of a finding of scienter, "the showing as to the defendants' states of mind required of the SEC here, while short of criminal intent, is formidable....On multiple grounds, a jury here could find this state of mind not established."

The Court denied both motions for summary judgment. As to AT&T and the other defendants, the Court was not persuaded by their arguments that there was insufficient evidence to support the SEC's claims of a Reg FD violation, nor did the Court agree that Reg FD was "invalid" under the First Amendment. And, as to the SEC, while the Court viewed as "formidable" the evidence showing that the information at issue was material, nonpublic and selectively disclosed, the question of scienter was a closer one, and there was "substantial evidence on which a jury could find for either side as to the scienter element."

After these motions were denied, it certainly appeared that the case was on its way to trial. Instead, the parties reached a settlement and trial was avoided.

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