SEC Signals Heightened Scrutiny of Issuer/Analyst Communications and More Reg FD Enforcement

On March 5, 2021, the U.S. Securities and Exchange Commission filed an enforcement action in the U.S. District Court for the Southern District of New York charging AT&T with repeated violations of Section 13 of the Securities Exchange Act and Regulation FD (Fair Disclosure), and charging three AT&T Investor Relations (IR) mid-level employees with aiding and abetting those violations.^[1] The SEC alleges that AT&T selectively disclosed material nonpublic information about its revenue expectations to certain analysts in an effort to manipulate analyst consensus revenue expectations in advance of earnings disclosures, and did not fairly disclose the same information to the public. Without AT&T’s efforts to manage market expectations, the SEC alleges that AT&T’s reported revenue for the first quarter of 2016 would have been $1 billion below the consensus, rather than $100 million over the lower, revised consensus. AT&T denies the charges, and asserts that the information discussed with analysts was in fact public, “widely reported” market trends and the impacts of those trends.^[2]

The enforcement action against AT&T is only the second action taken by the SEC concerning Regulation FD since 2013. The charges follow a four-year investigation and could signal a new focus by the SEC on scrutinizing regular communications between an issuer and analysts to ensure compliance with fair disclosure requirements. In a press release announcing the charges, the SEC stated that “selective disclosure of material information in private phone calls with analysts is precisely the type of conduct Regulation FD was designed to prevent.” The SEC further noted that it is “committed to assuring an even playing field by taking appropriate action, including litigation when necessary, against public companies and their executives who selectively disclose material nonpublic information.” This enforcement action raises important questions about when discussions concerning market trends cross the line into discussion of material nonpublic information, and suggests that the SEC may be more actively looking at issuer communications with research analysts.

The AT&T Communications at Issue

The charges in the enforcement action relate to calls between three mid-level employees in AT&T’s IR group and approximately 20 research analysts covering AT&T between March 9 and April 7, 2016. The SEC alleges that the calls occurred before AT&T disclosed its Q1/16 results, but after AT&T had significant nonpublic knowledge about its quarterly performance. According to the SEC, AT&T disclosed material nonpublic information regarding the company’s Q1/16 sales of cell phones during these analyst calls.

AT&T regularly disclosed information about sales of cell phones to its cellular subscribers as part of its quarterly and annual reporting, including wireless equipment revenue, a comparison showing the increase or decrease in that revenue from the same quarter in the prior year, and the rate at which subscribers upgraded their mobile devices. In 2015, AT&T — like other carriers — experienced a decline in the sales of cell phones. This trend was attributable to several factors: AT&T started charging customers full price for phones instead of subsidizing the purchase; the newest version of phones released in late 2015 were not significant upgrades or changes over the prior version, making upgrades less attractive; and phone manufacturers began offering leasing and other installment purchase plans that moved sales away from the carriers and to the manufacturers.

The 2015 disclosures to analysts failed to move the consensus revenue estimates closer to AT&T’s own internal projections, and AT&T’s reported revenues in Q4/15 fell short of the consensus expectations by $600 million. Most of this shortfall was attributed to the overestimation of cell phone sales revenue. During the earnings call in late January 2016, the CFO discussed the trends slowing revenue from cell phone sales. At a March 9, 2016 conference, the CFO stated that he “would not be surprised” if the downward trend in cellphone sales continued into 2016, but no other public disclosures were made by the company about equipment sales.

In fact, cell phone sales did continue to decline in Q1/16 and by early March, AT&T’s internal information showed that the decline in sales was steeper than initially expected, causing AT&T to reduce its internal forecast. The SEC alleges that AT&T’s CFO and director of IR were concerned that analysts covering AT&T still did not appreciate the significance of the trends in mobile device sales and that, as a result, the analyst consensus overestimated revenue and cell phone sales for Q1/16. According to the SEC, without any adjustment to the consensus estimate, AT&T would have missed expectations by $1 billion. The SEC alleges that it was a “top priority” to avoid such a shortfall by convincing analysts to adjust their revenue estimates prior to the earnings release.

To do so, the SEC alleges that AT&T’s director of IR instructed the three individual defendants “to speak to analysts privately on a one-by-one basis about their estimates in order to ‘walk the analysts down.’” Over the course of several weeks between March 9 and April 7, 2016, the individual defendants spoke with 20 analysts. Following these calls, each of the 20 analysts significantly reduced their guidance on AT&T’s overall revenue and the revenue attributable to cell phone sales.

According to the SEC, these calls violated Regulation FD because AT&T allegedly shared with the analysts material nonpublic information that was not publicly disclosed until the earnings release later in April. According to the SEC this material non-public information included:

• That AT&T expected record low upgrade rates for Q1/16, and in some instances indicating that the upgrade rates would be at or below 5%;
• That AT&T would have a year-over-year decline in cell phone revenue that was somewhere in the high teens to 20%; and
• Telling analysts that consensus was a 5% upgrade rate and an 18% year-over-year decline in cell phone sales revenue, which was not actually the consensus but was instead AT&T’s internal forecast based on knowledge of actual performance.

Following the discussions with the 20 analysts, each of the analysts lowered their revenue estimates by considerable amounts prior to the Q1/16 earnings release. When AT&T reported earnings in late April, the earnings beat the revised, lowered consensus estimates by approximately $100M.

Notably, the SEC complaint does not quote any statement or testimony from participants in the calls between AT&T and the analysts. Instead, the allegations rely primarily on the fact that the revised analyst expectations of upgrade rate, cell phone sales revenue, and total revenue very closely mirrored AT&T’s own internal forecasts that the individual defendants had at the time of the calls. The government also alleges that some analyst’s emails with coworkers following the calls with AT&T noted the trends in cell phone sales.

Considerations Going Forward

Given the signal that the SEC intends to focus on issuer communications with analysts, issuers should, among other things, consider the following:

• Carefully assess whether market trend information is material and nonpublic. Issuers should carefully consider whether communications concerning market trends are conveying information that is already widely disseminated, or whether communications about trends become so intertwined with the issuer’s own operations that they convey material nonpublic information about the issuers’ operational or financial performance. Although it remains to be seen how the courts treat the allegations in this case, the SEC’s complaint argues that a post-communication realignment of analyst expectations that much more closely mirrors internal forecasts is sufficient to show that a discussion of market trends crossed the line into material nonpublic information about how the trends impact the issuer’s performance. What remains unclear, however, is how much circumstantial evidence the SEC believes is needed to pursue enforcement action. For example, it is unclear if the SEC would take this same position if there were fewer analyst calls, fewer adjustments made by analysts, if the adjustments were of a smaller magnitude, or if the adjustments were not so closely aligned with the internal forecast. For now, issuers should carefully consider how to draw the line between information concerning general, publicly known market trends and the implications of market trends on the issuer’s performance.
  
  
• Timing of discussions may be important. In addition to the factors discussed above, it is also unclear how the timing of the discussions impacted the SEC’s decision to pursue an enforcement action against AT&T. The discussions at issue in the enforcement action all took place close to quarter end, when AT&T allegedly had significant internal reporting on the quarterly results but before any public disclosure of those results. Communications when the IR team has some initial indication of results or other material nonpublic information may draw a higher level of scrutiny than, for example, communications that take place early in a quarter or reporting period.
  
  
• SEC’s targeting of mid-level employees. Notably, the SEC’s complaint includes allegations that AT&T’s desire to move the consensus estimate originated in the C-suite, specifically identifying the CFO and director of IR. Neither was named in the enforcement action however, with the SEC instead targeting mid-level employees in the IR department. This focus on lower level employees suggests that issuers should ensure that all employees in the IR, corporate communications, and similar groups are adequately trained on the fair disclosure requirements in the securities laws. Issuers may also want to update written guidance on Regulation FD compliance, and offer refresher trainings on compliance on a regular basis.
  
  
• Assess written training materials on Regulation FD Compliance. Notably, the SEC used AT&T’s Regulation FD training materials against the company and the individuals named in the charges. The SEC specifically alleged that the individuals involved in the analyst calls all received regular training on Reg FD, and that these training materials specifically called out that revenues and cell phone sales were material information. While regular, written training of employees in IR and corporate communications roles is important, issuers should be aware that the SEC may seek to review such training materials in the course of an investigation and should be careful to regularly update the content of those training materials.

^[1]Securities and Exchange Commission v. AT&T, Inc., et. al., Case No. 1:21-cv-01951 (S.D.N.Y.). See also SEC Release No. 2021-43, SEC Charges AT&T and Three Executives with Selectively Providing Information to Wall Street Analysts (Mar. 5, 2021).
^[2]Press Release, AT&T Inc., AT&T Disputes SEC Allegations (Mar. 5, 2021) (https://www.prnewswire.com/news-releases/att-disputes-sec-allegations-301241737.html).