There is a rule, called Regulation FD, that says that U.S. public companies cannot selectively disclose material nonpublic information to some analysts or investors without disclosing it publicly. So a chief executive officer can’t meet with a big mutual fund, or a Wall Street analyst, and say “our earnings will be $1.75 per share this quarter,” unless her company has disclosed those earnings publicly.1 It is a weird set of stylized facts that:
1. Public-company executives meet constantly with their big shareholders;
2. The shareholders value these meetings, as you can tell because (a) they go to them and (b) they reward Wall Street banks for setting them up;
3. There is some evidence that shareholders who go to these meetings ask useful questions and outperform shareholders who don’t; and
4. Cases of Regulation FD enforcement are quite rare.
What do they talk about in these meetings, which investors find so valuable, if not material nonpublic information? The weather? Information that is immaterial, but that can be combined with other immaterial information to become material? In insider-trading lore this is called the “mosaic theory”; in philosophy I believe it is called the “sorites paradox.”
Anyway Reg FD was adopted in 2000 not so much to stop companies from telling their favored shareholders stuff that they didn’t tell everyone (though that too), but to stop them from telling Wall Street analysts stuff that they didn’t tell everyone. Before Reg FD it was sort of an accepted casual theory that the main channel for public companies to communicate with investors was through analysts. The analysts were in charge of explaining the company to the investing public, and it was important for the company to talk to the analysts so that they got the explanation right. If, for instance, the analysts all wrote reports saying “Amalgamated Widgets will make $2.15 per share this quarter on 20% gross margins,” and Amalgamated Widgets knew it was actually going to make $1.75 on 17% gross margins, Amalgamated Widgets would call up the analysts saying “you’ve got too high a gross margin in your model,” and the analysts would fix their models, and the quality of public information about Amalgamated Widgets would be better.
This was always a weird theory: Analyst reports are not exactly public (each analyst’s reports are generally provided only to clients of that analyst’s bank), and if a company wanted the public information about it to be better, it could always just release it publicly. In practice though it is awkward for a company to put out a press release saying, like, “we’re going to release earnings in two weeks but FYI gross margins will be a little lower than you think”; it is easy—or it was—for the company to call up a dozen sell-side analysts and say that. So companies made occasional formal public announcements to communicate big definite things, and they made more frequent informal private calls to analysts to communicate smaller less certain things.
You can’t do that anymore, and that’s probably an improvement, but something was lost.
AT&T Inc. allegedly keeps it old-school though. Here’s a U.S. Securities and Exchange Commission enforcement action from Friday:
According to the SEC's complaint, AT&T learned in March 2016 that a steeper-than-expected decline in its first quarter smartphone sales would cause AT&T's revenue to fall short of analysts' estimates for the quarter. The complaint alleges that to avoid falling short of the consensus revenue estimate for the third consecutive quarter, AT&T Investor Relations executives Christopher Womack, Michael Black, and Kent Evans made private, one-on-one phone calls to analysts at approximately 20 separate firms. On these calls, the AT&T executives allegedly disclosed AT&T's internal smartphone sales data and the impact of that data on internal revenue metrics, despite the fact that internal documents specifically informed Investor Relations personnel that AT&T's revenue and sales of smartphones were types of information generally considered “material” to AT&T investors, and therefore prohibited from selective disclosure under Regulation FD. The complaint further alleges that as a result of what they were told on these calls, the analysts substantially reduced their revenue forecasts, leading to the overall consensus revenue estimate falling to just below the level that AT&T ultimately reported to the public on April 26, 2016.
The complaint is worth reading to understand how public companies’ investor relations (IR) departments work. In the world of financial journalism, you will occasionally meet reporters and editors who argue that it is wrong to say “AT&T missed earnings estimates,” because—they argue—companies can’t miss estimates; if a company’s actual earnings differ from estimates, that means that the estimates missed, that the analysts got it wrong. AT&T does not experience life that way! AT&T’s goal in life, alleges the SEC, was to make sure it didn’t miss estimates:
Negative headlines generated by AT&T’s 4Q15 revenue miss in January 2016 caused consternation within AT&T’s IR department.