When Disclosure Is the Better Part of Valor: Lessons From the AT&T Regulation FD Enforcement Action
[This piece was posted on the Harvard Law School Forum on Corporate Governance on April 18, 2021]
On March 5, 2021, the US Securities and Exchange Commission (SEC) announced that it had charged AT&T, Inc. with “repeatedly violating” Regulation Fair Disclosure (Reg FD) in 2016. In addition to charges against the company, the SEC charged three members of AT&T’s investor relations (IR) department with “aiding and abetting” the alleged Reg FD violations.
The SEC enacted Reg FD in 2000 to prohibit selective disclosure of material nonpublic information to securities analysts, investors, and others who are likely to act on the information. Since then, the SEC has made infrequent enforcement actions, with each one giving corporate lawyers and IR professionals another datapoint to guide company communications with the investor community in what remain gray areas.
In March 2016, the company saw that a steeper-than-expected decline in its Q1 smartphone sales would cause revenues to fall well short of analysts’ Q1 revenue estimates.
To avoid missing the “consensus” estimate, the company’s CFO directed the IR department to “work the analysts who still have equipment revenue too high.”
At the instruction of the director of IR, three IR officers made private, one-on-one phone calls to approximately 20 sell-side analysts, disclosing internal smartphone sales data and the impact those data would have on internal revenue metrics.
The company’s Reg FD training materials had specifically informed the IR department that smartphone revenues and sales were types of information generally considered “material” and therefore prohibited from selective disclosure under Reg FD.
According to the company’s March 5, 2021 press release, “The information discussed [on those calls] 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… [W]ithout device subsidies, customers upgraded their smartphones less frequently, leading to a reduction in equipment revenue.”
The director of IR had his team track (a) each analyst’s original Q1 projection, (b) who was assigned to call each analyst, and (c) any adjustments each analyst made to its projection after the call. The IR director held weekly internal meetings to discuss the effect of the outreach on bringing down estimates.
Promptly after those calls, every one of the analysts that the IR department called substantially reduced its revenue forecast, resulting in the consensus estimate falling to just below the level that the company ultimately reported to the public in its Q1 earnings release.
Given the infrequency of enforcement actions for violations of Reg FD, it is critical for IR officers and their advisers to carefully examine the AT&T fact pattern and the SEC’s allegations. Here are a few key lessons:
1. Why not just publicly disclose? If you are planning to call a select group of analysts out of the ordinary course because you think their estimates are wrong and could be revised after you help them understand, strongly consider making a public explanation instead. What is the potential downside, and is that worse than the risk of a SEC enforcement action?
2. Work together with the legal team. One notable absence from the SEC’s complaint and AT&T’s press release is any mention of IR consulting with the company’s legal department or outside counsel. Many IR teams receive Reg FD training from their lawyers and then rely mostly on self-policing. This case shows the risks of that approach, especially in an era when the work of in-house IR and corporate legal teams should be more closely integrated on many of fronts.
3. What is “material” may not be in the eye of the recipient. AT&T says in its press release, “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.” And yet, the SEC still brought the case. Materiality for purposes of securities law is judged on an objective, “reasonable shareholder” standard. Even if the recipients say the information was not material to them, that in and of itself is not dispositive.
4. Do not attempt to convey indirectly what you know would be wrong to say explicitly. In 2010, the SEC charged Office Depot, its CEO, and its CFO with violating Reg FD through a coordinated effort where the IR team made private, one-on-one calls to 18 analysts late in the quarter, resulting in the earnings estimates being lowered after those calls. While the Office Depot IR team did not explicitly tell analysts that their estimates were too high, they were able to convey the message by pointing to other information, much of which was public, to remind the analysts to consider economic conditions and other “head winds.”
The lesson from the Office Depot case was that privately giving “indirect” guidance or “signaling” to analysts that their estimates are too high can run afoul of Reg FD. While AT&T claims that the information they conveyed in their 2016 calls was “widely reported,” the SEC is likely to analogize the company’s actions to what took place in the Office Depot case.
5. Protect your team. In the Office Depot case, the CEO and CFO were both penalized for the company’s actions. However, in the case of AT&T, neither the CFO nor the director of IR was charged with Reg FD violations, even though internal emails show them instructing their subordinates to find a way to get the consensus revenue estimate up to where they needed it to be. Instead, three AT&T IR officers, whom the company refers to as “mid-level investor relations employees,” may be facing civil monetary penalties and unqualifiable career reputational damage.
The AT&T enforcement action shows that the SEC continues to examine corporate strategies to deftly influence securities analysts’ quarterly estimates. In this case, mid-level IR professionals may end up taking the fall for those who ordered and oversaw the execution of a plan that they believed would not involve selective disclosure of material non-public information. Executives and IR professionals should be extremely cautious to go down this path when public disclosure may be the better part of valor. Corporate insiders have the tendency to rationalize non-disclosure after internal discussions where they are able to “get comfortable” that the information in question is probably not material. However, many experienced securities lawyers tell their clients, “If you have to ask whether something is material, you probably already know the answer and should just disclose it.”