AT&T And SEC Settle Regulation FD Enforcement Action After SDNY Denies Summary Judgment To Either Side - Securities

On Dec. 5, the Securities and Exchange Commission (SEC) announced that AT&T has agreed to a $6.25 million penalty, resolving charges brought against it under the securities rule known as Regulation Fair Disclosure (Regulation FD), the largest Regulation FD penalty exacted to date.¹ Three midlevel executives from the company's Investor Relations department will also each pay $25,000 to settle charges that they "aided and abetted" AT&T's violations. As part of the settlement, the company and the executives neither admit nor deny the allegations. The case is also notable for producing one of the only judicial decisions to apply Regulation FD in adversarial litigation since its publication over 20 years ago. Judge Paul Engelmayer's September opinion denying cross-motions for summary judgment is likely to become the "textbook case" on this scarcely litigated regulation.²

Background

Codified at 17 C.F.R. § 243.100(a), Regulation FD prohibits public companies from intentionally or recklessly disclosing "material nonpublic information" to select audiences without simultaneously making that information available to the rest of the market. The SEC has enforced the rule sparingly since promulgating Regulation FD in 2000, taking legal action only when the violations involve disclosures that are unquestionably material or deliberate attempts to game the system. These cut-and-dried enforcement actions almost invariably result in quick settlements. Judge Engelmayer's summary judgment evaluation of the parties' claims and defenses, therefore, provided rare insight for public companies in their efforts to comply with Regulation FD.

As we have previously reported here, the SEC sued AT&T and the Investor Relations executives (together, AT&T) in March 2021 in the United States District Court for the Southern District of New York. The complaint charged AT&T with violating Regulation FD in early 2016 when its executives disclosed internal financial metrics on the company's smartphone sales to approximately 20 investment firms without also disclosing that information publicly. The selective disclosures were allegedly part of a campaign to reduce the average forecast of AT&T's revenue to a level just below what the company expected to report for the first quarter of 2016. AT&T had failed to meet Wall Street's consensus estimates for two of three preceding quarters and wanted to avoid a third. AT&T responded that it had, in fact, publicly disclosed the information and that the metrics had "no material impacts on its earnings" because "investors understood that AT&T's core business was selling connectivity (i.e., wireless service plans), not devices."³

Denial of Summary Judgment

In his lengthy opinion denying both parties' summary judgment motions, Judge Engelmayer first rejected AT&T's threshold arguments that Regulation FD is unconstitutional, outside the SEC's regulatory authority and logically inoperable given an exception AT&T argued swallowed the rule. The opinion considered the defendants' First Amendment challenge as a matter of first impression, but ultimately rebuffed these threshold challenges as "perfunctory." The meat of the Regulation FD analysis asks whether the information disclosed to the selected analysts was (a) material, (b) nonpublic and (c) shared with a culpable mental state, also known as "scienter." The court ultimately determined that, although the SEC presented considerable evidence that AT&T selectively disclosed information that was material and nonpublic, a material dispute of fact remained — whether the executives had the culpable mental state necessary to be liable for violating Regulation FD. A reasonable jury could conclude either way: that the executives knew or didn't know that the information they shared with the analysts was material and nonpublic.

Purpose matters. The court took seriously the SEC's claims that the executives' private calls to the analysts were part of an organized scheme to lower the consensus estimates, essentially deciding that the metrics would be significant to the public if AT&T thought the metrics would be significant to analysts. Among the facts identified by the court as evidence of scienter were the number of disclosures, the variety of internal financial information disclosed and the executives' persistence until the analyst consensus came into line with AT&T's estimates.
Materiality is contextual. Judge Engelmayer used four intersecting categories to evaluate the SEC's argument that the disclosed metrics were material: (1) quantitative significance, (2) significance within AT&T, (3) significance to the market and (4) impact on earnings. The court rejected AT&T's argument that the metrics did not materially impact the company's financial performance as too narrow, particularly given the importance of the financial data to AT&T's ability to meet analysts' expectations.
Publicness is evaluated in hindsight. The court found formidable evidence that the financial data were not public when disclosed to the select analysts. Although AT&T's CFO had spoken about declining equipment revenue and update rates at a public conference before the analyst calls, the court found the remarks to be at "a high level of generality." Also, the analysts' behavior following the CFO's remarks was muted compared to the analysts' behavior directly after the executives' calls, at which point they adjusted their estimates to align with AT&T's internal reports.
Private conversations are risky when you have nonpublic information. Defendants argued that the information they disclosed was consistent with publicly known industry trends and AT&T's previous public statements. Yet the executives' access to relevant, nonpublic information undercut the argument. Private discussions are riskier for individuals with insider knowledge just before quarterly reports and other significant announcements.
Individual state of mind is murky. When it came to evaluating scienter and the defendants' understanding of prohibited disclosures, Judge Engelmayer found the evidence less clear. The court found no evidence that showed, in real time, that any person within AT&T or the analysts' firms expressed alarm or reservation about the legality of the disclosure campaign. On the other hand, the opinion credits the SEC's evidence that AT&T's training and internal policies instructed employees not to discuss any nonpublic metrics with analysts, regardless of whether the data were material.

It is worth noting that Regulation FD does not define "material nonpublic information," instead incorporating existing definitions established in securities regulation case law. This lawsuit and Judge Engelmayer's summary judgment decision provide public companies valuable context for these terms and guidance for complying with their mandate.

Footnotes

1. Press Release, SEC, AT&T Settles SEC Charge of Selectively Disclosing Material Information to Wall St. Analysts (Dec. 5, 2022), https://www.sec.gov/news/press-release/2022-215.

2. Securities and Exchange Commission v. AT&T, Inc., 21 Civ. 1951 (PAE), 2022 WL 4110466 (S.D.N.Y. Sept. 8, 2022).

3. 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.

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