On March 5, 2021, the U.S. Securities and Exchange Commission filed a civil enforcement action in the United States District Court for the Southern District of New York against AT&T, Inc. and three executives alleging a series of Regulation FD violations dating back to 2016. We previously wrote about Regulation FD in connection with an SEC investigation of Eastman Kodak, Co.’s announcement that it would receive a $765 million loan from the U.S. International Development Finance Corp. to develop and manufacture generic drug ingredients. AT&T now faces allegations that it intentionally shared material non-public information with analysts in order to alter their earnings’ estimates.
Regulation FD is now a seldom-used enforcement tool but was once an SEC favorite in enforcement actions through the early 2000s. The rule prohibits issuers, or persons acting on their behalf, from disclosing material non-public information to certain third parties without disclosing that same information to the general public. The rule was adopted in response to SEC findings that issuers used selective disclosure of material non-public information to reveal earnings and other financial data that would hopefully impact analysts’ and other sell-side firms’ expectations, resulting in those recipients profiting by front-running corporate earnings announcements. The rule was designed to prevent this kind of selective disclosure, which the SEC found was often provided to larger institutional shareholders, and level the playing field between individual and institutional investors.[1]
According to the SEC’s complaint, AT&T suffered an unanticipated decline in its first quarter 2016 smartphone sales. In an effort to avoid missing analysts’ consensus revenue estimate, the SEC alleged that AT&T investor relations executives had a series of one-on-one phone calls with equity analysts from at least 20 different sell-side firms during which they disclosed the lackluster sales figures. According to the SEC, these calls were designed to alter analysts’ expectations such that AT&T would avoid missing the consensus estimate for a third consecutive quarter. The SEC alleges that the disclosures were material and not shared with the general public.
The filing of a civil enforcement action against a blue-chip issuer like AT&T is striking. Since 2010, the SEC has brought very few enforcement actions against issuers for Regulation FD violations and even fewer have been pursued in federal court. The most recent enforcement action before AT&T was a 2019 administrative proceeding against TherapeuticsMD, Inc. There, TherapeuticsMD agreed to pay a modest fine without admitting or denying the SEC’s findings.
Whether the enforcement action against AT&T, or the investigation of Kodak, is a signal that the SEC will be dusting off Regulation FD and taking a more active approach in the future remains to be seen. It was absent from the Division of Examinations’ 2021 Examination Priorities report,[2] but one can assume that Regulation FD compliance remains an important consideration for the SEC.
Issuers and investment professionals alike should take heed and re-visit their compliance programs and ensure they address Regulation FD. For issuers, this means implementing internal information controls to ensure that material non-public information is identified and appropriately disclosed to the general public consistent with the timing requirements of Regulation FD – either simultaneously for intentional selective disclosures or “promptly” if the selective disclosure was unintentional. The SEC’s complaint against AT&T alleges an intentional selective disclosure without any simultaneous public disclosure.
Issuers should also maintain external information controls. This is generally achieved by marking draft press releases or earnings announcements with “embargo” language that indicates it must not be shared or disseminated and anyone possessing it must not trade in the issuer’s securities. Issuers may also enter into non-disclosure agreements or agreements not to trade with investment professionals that generally preclude the investment professional from disclosing information or trading based on information it receives prior to the issuer’s public announcement. These types of agreements are vital to avoiding a Regulation FD violation, as the rule includes a safe harbor for issuers that obtain express agreements that selectively disclosed information will not be further disclosed or used to trade.
Investment professionals, including analysts, broker-dealers, and investment advisors, should be mindful of the information they receive from issuers, how they receive it, and what they do with it. If material non-public information is conveyed, it may expose the recipient to insider trading liability if they buy or sell securities or disclose the information to another party that buys or sells securities. Therefore, investment professionals should be trained to identify whether any information received is material non-public information and should take steps to independently assess any information received from issuers. Investment firm compliance officers should also maintain records of any restrictions on the disclosure or use of non-public information provided by issuers.
[1] Final Rule: Selective Disclosure and Insider Trading, Exchange Act Rel. No. 43154, 65 Fed. Reg. 51, 721 (Aug. 15, 2000) (https://www.sec.gov/rules/final/33-7881.htm).
[2] Securities and Exchange Commission – Division of Examinations, “2021 Examination Priorities” (Mar. 3, 2021) (https://www.sec.gov/files/2021-exam-priorities.pdf).