Reg FD Action Headed for Trial Where IR Department Alleged to Have “Walked Down” Consensus

For the first time, a Regulation Fair Disclosure (Reg FD) case may be headed to trial. On September 8, 2022, the Federal District Court for the Southern District of New York denied cross-motions for summary judgment in a case brought by the Securities and Exchange Commission (SEC) against AT&T, Inc. and three individuals who worked in the company’s Investor Relations (IR) Department. SEC v. AT&T, et al., Opinion and Order, 21 Civ. 1951 (PAE) (SDNY Sept. 8, 2022) (Order). Reg FD prohibits public companies from selectively disclosing material nonpublic information (MNPI) to certain individuals or entities—including Wall Street analysts. The SEC has alleged that, in early 2016, members of AT&T’s IR Department systematically leaked MNPI to analysts in an effort to have those analysts reduce their estimates of AT&T’s Q1 2016 revenue. The Court’s analysis—particularly when rejecting defendants’ request for summary judgment on the issue of materiality—provides some important takeaways for issuers to consider.

Background on Reg FD

Promulgated in 2000, Reg FD was intended to prevent selective disclosure of MNPI, which “leads to a loss of investor confidence in the integrity of our capital markets.” Final Rule: Selective Disclosure and Insider Trading, SEC Release No. 7881, 2000 WL 12011556, at *2 (Aug. 15, 2000) (“Adopting Release”). Reg FD was adopted to ensure that all investors have equal access to a company’s material disclosures at the same time.   

Neither Reg FD nor its Adopting Release defines “material nonpublic information,” but instead “relies on existing definitions of these terms established in the caselaw.” Adopting Release, 2000 WL 1201556, at *9. Under those precedents, information is material where there is “a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of available information.” Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 (1988). The Adopting Release contains an enumerated (albeit non-exhaustive) list of information likely to be material, including “earnings information.”  While the Adopting Release notes that issuers “will not be second-guessed on close materiality judgments,” Adopting Release at *6, SEC assessments of materiality often reflect hindsight.  Summary judgment on issues of materiality is only appropriate where the information is “so obviously important to the investor, that reasonable minds cannot differ on the question of materiality.”  Order at 91.

The Decision

The Court’s 129-page decision painstakingly details the evidence regarding the specific disclosures made by AT&T to analysts during the relevant period. Briefly, in late 2015 and early 2016, AT&T had been experiencing a decline in sales due, in part, to the low rate at which existing customers purchased smartphone upgrades. The company considered disclosing this trend in an early March 2016 Form 8-K, but instead decided that the CFO would address it at an investor conference. During his remarks, the CFO referred to the decline in wireless equipment revenue reported in Q4 2015, and stated that he “would not be surprised” to see that trend continue. Importantly, he did not disclose any specific figures.  

Upon release of analysts’ estimates in the wake of that conference, it became apparent that the CFO’s remarks had not had the desired effect: consensus revenue estimates were not in line with AT&T’s internal figures, and AT&T was in danger of missing consensus revenue estimates for the third quarter in a row. As a result, AT&T allegedly orchestrated a campaign whereby the CFO and IR director instructed the defendant IR employees to selectively disclose MNPI to analysts at 20 Wall Street firms. The company’s alleged goal was to convince those analysts to reduce their estimates of AT&T’s Q1 2016 total revenue so that AT&T could beat the consensus revenue estimates for the quarter. As detailed in the opinion, the defendants would call an analyst, and within the next day or two, that analyst would update their estimate to match almost exactly the numbers internally circulated at AT&T. According to the SEC, the scheme worked:  AT&T’s announced total revenue exceeded analysts’ final consensus estimate by 0.1%.

The issues before the Court on the summary judgment motions included whether there was sufficient evidence from which a jury could find the information disclosed to the analysts was (1) material, (2) nonpublic, and (3) selectively disclosed with the requisite scienter.[1] 

Materiality

With respect to materiality, the SEC argued that the information was material because it (i) enabled AT&T to meet (and exceed) analysts’ consensus expectations for Q1 2016 and (ii) disclosed in advance to analysts that three important performance metrics (consolidated total revenue, wireless equipment revenue, and wireless upgrade rates) were all unexpectedly low for that quarter. The Court found ample evidence to show the jury that these selective disclosures were material.  The following takeaways can be drawn from the Court’s discussion of materiality:

• Motive matters: The Court noted that the equipment revenue and upgrade rates were “idiosyncratic and narrow such that they ordinarily would not form the basis of a finding of materiality.” The Court further detailed defendants’ argument that these metrics were quantitatively insignificant because (among other things) the information implicated less than 5% of AT&T’s earnings. However, in finding the evidence sufficient to enable a jury to find these metrics material, the Court emphasized it was clear that the intention of the disclosures was to “walk down” analysts’ estimates and to bring them in line with actual financial metrics. The Court repeatedly noted that the disclosures were part of a “campaign” orchestrated by the company specifically to lower consensus.  In short, if the purpose of the disclosure is to get analysts to lower consensus, a Court will be highly skeptical of a claim that the disclosed information is immaterial.
• If it’s important to the company, it’s likely important to investors: The Court also highlighted the significance that AT&T attached to equipment revenue and upgrade rates in its earnings calls, quarterly filings, investor presentations, and internal discussions, including the fact that concern about equipment and upgrade rates was elevated to the Company’s board. The Court found this bolstered the SEC’s claim that the metrics were material.      
• Revenue impact may be material even if it has no impact on earnings: The Court also addressed defendants’ argument that wireless equipment revenue was immaterial because it was profit neutral (because, if wireless equipment revenue was down, the cost of equipment would decrease by a similar amount and there would be no change to earnings). The Court rejected this argument and said a jury could find the wireless equipment revenue metric material even if that metric did not influence earnings.  Order at 107.

Nonpublic

The Court also described the “overwhelming” evidence on which a jury could find that the defendants selectively disclosed nonpublic information to analysts. Order at 109. Although the defendants argued that the disclosed information could have been extrapolated from public information, the Court found that argument to be at odds with the analysts’ behavior. Specifically, the analysts’ estimates were higher until the conversations with the defendants, after which they adjusted their estimates to be nearly identical to AT&T’s internal numbers.

Scienter

“Unlike the preceding two elements, as to which the evidence lopsidedly support[ed] the SEC’s claims,” the Court found substantial evidence supporting both sides’ scienter arguments. Order at 119. Scienter in this case turned on “whether the IR defendants knew, or were reckless in not knowing” that the information they disclosed was MNPI. As support for the SEC’s claim, the Court highlighted the number, duration, and persistence of disclosures over the relevant period, the data disclosed, and the Reg FD training the defendants had received, which expressly instructed them not to provide analysts with nonpublic metrics regardless of materiality. However, the Court also credited defendants’ uniform testimony that they had not appreciated that they were disclosing MNPI at the time. And even more telling, the frequent discussions about the campaign involving numerous persons at the company—including the director of IR and the CFO—failed to raise any alarms.  Similarly, a jury might credit the fact that no analyst questioned whether the disclosures violated Reg FD. “The wholesale lack of expressed concern or alarm . . . would support that any violations of Reg FD here were non-obvious.”  Order at 125.

Steps to Consider

The AT&T decision highlights the potential for Reg FD pitfalls.  Below are a few practices for companies to consider in light of the decision:

• Policies and procedures alone may not be enough:  At AT&T, the relevant policies, procedures, and training expressly prohibited the disclosures at issue. Nevertheless, the IR defendants and executives involved apparently understood that their actions did not violate Reg FD. Companies should consider whether changes or updates are warranted in their compliance programs to help mitigate the risk of unintended Reg FD violations.  Such changes could include additional targeted trainings for those employees who communicate directly with analysts.
• Timing: One way that companies can reduce the risk of possible Reg FD violations is to impose a “quiet period” late in the quarter during which company employees to whom Reg FD applies are prohibited from speaking with investors and analysts.
• Utilize scripts: Where IR professionals speak with analysts, they should consider using scripts to guide their conversations. Such scripts can be reviewed by counsel and senior leadership to help ensure compliance with Reg FD.

[1] The Court also analyzed various other issues, including the constitutionality of Reg FD. With respect to defendants’ First Amendment challenge, the Court found that Reg FD “satisfies intermediate scrutiny—the most rigorous level potentially applicable to it”—because Reg FD does not substantially burden more speech than necessary to further the government’s substantial, legitimate interest in protecting market integrity. The Court also dismissed the defendants’ challenges under the due process clause of the Fifth Amendment claiming that Reg FD “as well as the SEC’s conflicting public positions failed to provide AT&T with fair notice of what conduct is actually prohibited.” The Court found that Reg FD “in fact, is short and exceedingly clear: It requires covered entities to promptly disclose material, nonpublic communications that it disclosed on a selective basis.” The Court also found that the SEC had the statutory authority to promulgate Reg FD and rejected defendants’ arguments to the contrary.