Saturday, March 13, 2021
By now, you’ve probably seen that the SEC filed a lawsuit against AT&T for, allegedly, violating Regulation FD by selectively leaking information about an upcoming earnings announcement in 2016. According to the complaint, in previous quarters, AT&T had disappointed the market by announcing earnings below analysts’ consensus expectations; when it realized it was going to do so again, its Investor Relations department began contacting the analysts with high expectations in order to dampen their optimism. The result was a lowered consensus estimate, and when AT&T did announce its 1Q2016 results, they actually came in slightly above expectations.
AT&T disputed the charges with a curious statement:
The evidence could not be clearer – and the lack of any market reaction to AT&T's first quarter 2016 results confirms – there was no disclosure of material nonpublic information and no violation of Regulation FD.
Well, yeah, genius, because the point of the scheme was to prevent a market reaction to AT&T’s first quarter 2016 results.
But what really strikes me about the whole situation is that it’s as clear an example as you can imagine of a company apparently violating the securities laws for the explicit purpose of trying to avoid a negative market reaction rather than to induce a positive one.
That’s important because in recent years, defendants in Section 10(b) actions have tried to cast doubt on the viability of the “price maintenance” theory of fraud, i.e., the theory that some fraudulent actions are designed not to push prices upward, but to withhold negative information so that prices can be maintained at existing levels. Defendants have argued that statements that merely maintain prices are not material to investors and/or have no impact on prices, and therefore cannot form the basis of a fraud claim. Happily, most courts have rejected that argument, but it’s getting a new workout now before the Supreme Court in Goldman Sachs v. Arkansas Teachers’ Retirement System (my most recent blog post on that case is here; it links to earlier ones). There, the defendants are not explicitly arguing that price maintenance theory is illegitimate, but they are suggesting there is something suspicious about it that warrants extra scrutiny:
Critically, respondents conceded that the challenged statements did not increase Goldman Sachs’ stock price when made. Instead, respondents relied on the increasingly popular “inflation-maintenance” theory—a theory this Court has never endorsed—to assert that the statements maintained the stock price at a previously inflated level….
The inflation-maintenance theory already seriously impedes a defendant’s ability to rebut the Basic presumption. The theory allows plaintiffs to rely on the presumption even if there is no evidence that a misstatement increased the stock price when it was made. Nor do plaintiffs need to identify what statement (if any) inflated the price in the first place.
Some of Goldman’s amici are attacking the theory more directly. To wit.
Happily, a group of former SEC officials have filed a brief in support of the plaintiffs that is almost entirely devoted to defending the inflation-maintenance theory, and highlighting how important it’s been to SEC enforcement actions.
(In case anyone cares, I also signed on to a law professors’ brief in support of the plaintiffs, here).
To bring this back to AT&T, obviously, AT&T is not accused of fraud, or doing anything to mislead the market, but its alleged conduct demonstrates the lengths to which companies will go in order to avoid negative market shocks; it should be utterly unsurprising that many frauds are designed precisely to minimize market reaction, and defendants in those cases shouldn’t be rewarded for success.
That said, as Matt Levine points out, in AT&T’s case specifically, the whole kerfuffle raises interesting questions about what kinds of information move the market or are material to it. If AT&T’s stock price stayed flat after its earnings announcement because the company had already lowered analysts’ expectations, you would expect to see a downward drift in the stock price before the announcement, when AT&T was quietly walking it down. I eyeballed its stock prices during that period and - without running a statistical analysis or comparing it to peer companies or anything - it doesn’t seem like the revisions to analyst estimates was having much of an effect. That could be for any number of reasons - my eyeballs may not be sensitive enough to the detect the pattern, or maybe these analysts were already known to get things wrong and their estimates weren’t baked into the stock price - but it’s amusing that (AT&T thought, at least) the difference between a negative market reaction and no reaction was not the earnings themselves, but what analysts had said about them the day before. In fact, the market appears to have been a lot more sanguine about analyst commentary than AT&T was.
Which, ahem, doesn’t mean that nonpublic information AT&T’s upcoming earnings was not material; just that it confirmed market expectations, no matter what analysts said. If anything wasn’t material here, it was the analysts.
The Goldman case is set for oral argument on March 29.