Musk, Tesla Settle With SEC – A Creative Solution

Elon Musk famously tweeted “Am considering taking Tesla private at $420. Funding secured” on August 7, 2018. Those nine words set off a fire storm of publicity. The share price of Tesla jumped. Analysts called. The SEC investigated. The DOJ requested documents. A settlement was negotiated and rejected. The SEC filed an enforcement action on Thursday, September 27, 2018 naming Mr. Musk as a defendant but not the company, charging fraud. Elon Musk responded with a press release proclaiming the truth of his statements. More publicity.

It ended as quickly as it began. Two days later, on Saturday, September 29, 2018, the SEC filed a complaint against Tesla. Mr. Musk came to the settlement table and signed. The company came to the settlement table and signed. SEC v. Tesla, Inc., Civil Action No. 1:18-cv-8947 (S.D.N.Y. Filed Sept. 29, 2018); SEC v. Musk, Civil Action Number 1:18-cv-8865 (S.D.N.Y. Filed Sept. 27, 2018).

The complaints

The Tesla complaint charges electric car manufacturer with violations of Exchange Act rule 13a-15, alleging that the firm did not have disclosure controls or procedures regarding Mr. Musk’s use of Twitter to disseminate information about the company. The predicate for the charge is the November 5, 2013 filing of the firm stating that it intended to use Mr. Musk’s personal Twitter account as a mechanism for publically disseminating material information to the public.

Since that date Mr. Musk has repeatedly used his Twitter account to disseminate material information about the firm. That has included publishing guidance about the firm’s financial metrics and other information. Over 22 million people follow Mr. Musk’s Twitter feed.

On Tuesday, August 7, 2018, Mr. Musk published his statement revealing his thoughts on going public on Twitter just after mid-day. That statement was followed by additional tweets in which Mr. Musk noted that he did not “have a controlling vote now. . .” and that it “My hope is *all* current investors remain with Tesla even if we’re private. . .” The share price rose, trading was at one point halted and then resumed, and additional tweets were made. NASDAQ was not warned prior to Mr. Musk’s first tweet of the day as required by its rules.

Subsequently, there was speculation by investors, stock analysts and journalists. While Tesla’s IR director responded to some inquiries, it is clear that he was not prepared. Mr. Musk, according to the complaint, “did not routinely consult with anyone at Tesla before publishing Tesla related information via his Twitter account. No one at Tesla reviewed Musk’s tweets prior to publication.” In sum, since November 5, 2013 when the firm filed its Form 8-K disclosing that Mr. Musk’s Twitter account would be used, it did not have disclosure controls or procedures in place “to assess whether the information published by Musk via his Twitter account was required to be disclosed in Tesla’s Exchange Act reports within the time period specified in the Commission’s rules and forms.” The firm also did not have processes in place to ensure that the information published was accurate and complete.

The complaint against Mr. Musk also centers on the mid-day August 7, 2018 nine word tweet, amplified by those made later that day as noted above as the share price climbed and speculation swirled about its meaning. Mr. Musk had been “thinking” about taking the company private for over a year and a half, according to the chronology in the complaint. Beginning in January 2017 he had “three or four in-person meetings with representatives of a sovereign investment fund.” During those meetings the fund representative expressed a verbal desire to make a large investment in Tesla. In a late July 2018 meeting the Fund representative told Mr. Musk that 5% of Tesla’s stock had been purchased and expressed interest in taking the company private. Mr. Musk “later stated that he assumed without confirming that the lead Fund representative was proposing a ‘standard’ going-private transaction. . .” Mr. Musk continued these conversations on July 31, 2018 with the Fund representative. Despite the series of meeting, the July 31 meeting “lacked discussion of even the must fundamental terms of a proposed going-private transaction,” the complaint states.

Mr. Musk also had discussions with the Tesla board of directors. On August 2, 2018, Mr. Musk sent an email on the subject to the board of directors and the firm’s CEO and General Counsel. The next day a telephonic meeting of the board was held to discuss the idea. As those discussions took place, investors, analysts and others raised questions about the proposal as noted above. Ultimately the board decided not to move forward with the transaction.

The complaint is built on the theory that Mr. Musk knew or was reckless in not knowing that his statements regarding taking the company private on August 7 “did not have an adequate basis in fact. . . “ because he knew that: 1) he had not discussed a going private transaction at $420 per share with any potential funding source; 2) that he had “done noting” to investigate whether it would be possible for all current investors to remain” with a private company; 3) had not confirmed support with Tesla’s investors; and 4) had not “satisfied numerous additional contingencies . . .” The complaint alleges violations of Exchange Act section 10(b).

The settlements

The settlements stipulate that: 1) Mr. Musk step down as Tesla’s chairman and be replaced by an independent Chairman; 2) that Mr. Musk is not eligible to be Chairman for a period of three years; and 3) that the firm establish a new committee of independent directors and add controls and procedures to oversee Mr. Musk’s communications. The terms do not preclude Mr. Musk from serving as CEO of the firm.

Finally, the firm and Mr. Musk will each pay a penalty of $20 million.

Comment

The question here seemingly straddles the divide between the federal securities laws and corporate governance. The former are built on a disclosure model under which material facts are disclosed so that those making an investment decision have the necessary facts. The obligation to speak the truth is backed by the antifraud provisions, in this case Exchange Act section 10(b). The statutes are not a substantive guide to the operation of a company.

Corporate governance on the other hand is concerned with the structure and operations of the firm. It is largely a function of state law, typically that of Delaware as is the case with Tesla.

Mr. Musk and his twitter account agreed to speak for the corporation by making a filing with the Commission – that account was no longer his private domain. Yet the company had no control over the account or even notice of what was being published. Since that account, and the statements emanating from it, was subject to the antifraud provisions of the federal securities laws the question initially focused on whether Mr. Musk’s nine word tweet constituted a material misstatement within the meaning of section 10(b). The Commission concluded it did. Other concluded it did not.

What was lost in this debate was the broader corporate governance question about the company – it had nothing to say about the tweet and by all accounts knew nothing about it. Yet it was the company and its shareholders that was the real focus of this entire storm – a lost corporate governance question that needed to be resolved.

The Commission, however, solved this issue. By applying its rules regarding disclosure procedures the agency was able to work within the framework of the federal securities laws and resolve the key corporate governance question on which this entire matter hinged. In the future Tesla will revamp those procedures and have control of the information vital to the company and its shareholders under the terms of the settlement here and still retain the critical services of the visionary Elon Musk – a creative approach that solved the real issue here in the best traditions of SEC Enforcement.