Rare Court Decision in Regulation FD
Litigation Highlights Risks of Calls with Analysts
Posted by Ning Chiu, Robert A. Cohen, and
Michael Kaplan, Davis Polk & Wardwell LLP, on Saturday, November 12,
A federal district court decision involving alleged Regulation FD violations
highlighted analysis of key elements governing the regulation relating to
whether information is material and nonpublic, and provides multiple takeaways
on evaluating the risk of one-on-one calls with analysts.
On September 8, Judge Engelmayer of the Southern District of New York denied
motions for summary judgment filed by both the SEC and the defendants in
litigation alleging Regulation FD violations. The defendants included AT&T and
three individuals who worked in the company’s investor relations department. The
decision puts the case on a path toward trial (absent settlements).
Regulation FD prohibits a company from selectively disclosing material,
nonpublic information (MNPI) to certain securities professionals or others
likely to use the information to trade, such as analysts and investors, unless
the company also discloses the information to the public. Although the court
found the evidence overwhelmingly supported the SEC’s claims that the
information at issue was both nonpublic and material, it determined that a
reasonable jury could find for either side on the third element, scienter.
Because most Regulation FD cases brought by the SEC are settled, the court’s
evaluation of the claims and defenses provides insight for companies deciding
whether certain communications with analysts might violate Regulation FD.
Materiality of information conveyed to analysts
At the time in question, most of AT&T’s revenues were derived from providing
services rather than equipment upgrades, and it generally did not make money on
equipment upgrades so that revenues from such upgrades had a very minor bottom
line impact. In both Q3 and Q4 of 2015, AT&T had failed to meet analysts’
consensus estimates for revenue, and in the months leading up to the
announcement of Q1 2016 results, executives and employees were sensitive to
avoiding another revenue miss. The court noted that internal documents and
emails demonstrated a concerted effort to “walk down analysts’ estimates” for
AT&T was facing reduced wireless equipment upgrade rates and decreased equipment
revenue because of changes in its reliance on charging customers for new phones
up front and because customers were more reluctant to upgrade to new versions.
This development was highlighted by two executives, including the CFO, at public
conferences in March, and the CFO at the conference strongly hinted that this
trend would continue, but many analysts did not revise their estimates as a
result. The Company then followed up with calls to analysts, and they provided
specific data points for metrics documenting the downward trend on these private
The defendants argued that the upgrade rate and equipment revenue metrics were
quantitatively insignificant, because wireless equipment revenue had amounted to
less than 10% of the total revenue, and the information shared with analysts
would only impact total revenue by less than 5%. Additionally, defendants argued
that while earnings results were material, total revenue was not material
because of the inconsistent impact on earnings and that equipment revenue had a
very small bottom line impact.
The court disagreed and found that the three metrics that were communicated in
private calls to analysts were material despite the minor effect these metrics
have on earnings. The court focused on the emphasis placed by AT&T in its prior
public statements about these metrics, as well as the numerous records
demonstrating internal concern surrounding missing analyst expectations due to
these metrics. In particular, the court noted that “[m]issing consensus can
cause concern among investors,” and is therefore often material.
Whether the information conveyed
AT&T did not dispute that the values of the metrics themselves were not publicly
available, but argued that at least the upgrade rate could be extrapolated by
both investors and analysts using public information. Defendants posited that
the downward trends in wireless upgrade rates and wireless equipment revenue
reflected industry trends that were well-known, and that applying the same
percentage reduction in these metrics that had occurred year-over-year would
allow the analysts to separately derive the same upgrade rate decline that was
communicated to them by the defendants.
The court focused instead on the use of nonpublic information by the defendants
when they spoke to analysts and the analysts’ subsequent behavior after those
conversations. The AT&T employees conveyed nonpublic quarterly financial
information, and analysts “repeatedly adjusted their estimates downward”
promptly after phone calls with AT&T, which supported the conclusion that the
information they heard during the calls was new.
The company further argued that the information was public because AT&T
executives, including the CFO, had shared the same information previously at two
Regulation FD-compliant conferences in early March. The court disagreed, noting
that the executives clearly had not disclosed the quarterly results that the
company’s investor personnel disclosed when they called the analysts, and
instead spoke only to general trends and the prior quarter’s results rather than
provide data about the most recent quarter. When one executive did address the
declines in upgrade rates and equipment revenue, and was asked to provide
specific data, he responded that “it’s not something we publicly disclose” and
referred again to the general trend.
Additionally, these conferences occurred much earlier in the quarter than the
subsequent calls made to analysts and investors, which continued in an attempt
to adjust or keep down consensus, right up until the day before quarterly
results were released. While consensus estimates were initially adjusted
somewhat following the CFO’s comments at one of the conferences, defendants were
unsuccessful in arguing that analysts understood the magnitude of these trends
based solely on the CFO’s comments because estimates were adjusted even further
by analysts, and at times more meaningfully, following the private calls.
Scienter remains in doubt
Regulation FD requires that “the individual making the disclosure must know (or
be reckless in not knowing) that he or she would be communicating information
that was both material and nonpublic.” The court cited the multiple points of
evidence in support of scienter, including the number of analyst calls in which
defendants disclosed confidential information; the variety of internal data that
the defendants disclosed; the sustained duration (six weeks) of these
disclosures and the general internal concern and persistence until the earnings
estimates were brought down.
But the court explained that a jury could find the defendants had only acted
negligently because of the lack of direct evidence of defendants or supervisors
expressing a conscious disregard for securities laws or company policies. The
court also said that it was possible that a jury could believe that they had not
appreciated that the information was material or nonpublic at the time it was
Certain actions continue to be most risky. Calls to
analysts in advance of the reporting of quarterly earnings remains risky,
especially if the purpose of the calls is to adjust analysts’ expectations.
Calls immediately following an earnings call that points to those public results
should remain relatively low risk. But the risk increases as the quarter
progresses and is especially heightened when company personnel making the calls,
or instructing personnel to make the calls, have nonpublic information about the
quarter’s results. Risk may also be heightened if quarterly earnings have not
yet been announced but company personnel convey to analysts how the quarter is
trending compared to expectations.
Materiality will be viewed in hindsight. Companies
must make difficult materiality judgments all the time, but the SEC, courts and
juries will judge those decisions in hindsight. Here, AT&T claimed the three
metrics disclosed to the analysts in private conversations were not material
because they did not materially impact the company’s financial performance. But
the court was not convinced as it viewed the information, such as total revenue,
to constitute key financial metrics, especially as the metrics determined
whether the company would meet or miss consensus expectations.
It is difficult to prove that information is already public when
company personnel use nonpublic results in their conversations. AT&T
argued that the information already was public because it was consistent with
known industry trends, and consistent with statements previously made publicly
by the executives at conferences. The decision though relied in part on the fact
that the personnel who called analysts had access to, and conveyed, nonpublic
information to make their point.
Public statements should be specific and clear. SEC
filings and Regulation FD-compliant forums offer opportunities for companies to
update and clarify potential confusion in the market, but only if the
information conveyed is sufficiently specific. The statements made by AT&T’s CFO
at a conference were public, but the court determined that he did not convey any
new information with enough specificity that the analysts would have understood
the impact to revenues.
Senior leadership at companies is often implicated. Past
SEC enforcement cases usually charged senior leadership at companies, including
CEOs, CFOs and heads of investor relations. The only individual defendants in
this case were three employees working in investor relations, though the court
pointed out that the adopting release for Regulation FD stated that senior
management would be responsible if they “directed” employees to make selective
Harvard Law School Forum
on Corporate Governance
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