by T. GormanPosted on Posted in SECActions

Elon Musk, founder of Tesla, and the Securities and Exchange Commission are again at loggerheads, back in court on a motion by the agency for an order to show cause why Mr. Musk should not be held in contempt of court. SEC v. Musk, Civil Action No. 1:18-cv-8865 (S.D.N.Y. Motion Filed Feb. 25, 2019). No response has been filed by Mr. Musk.

Background

The SEC’s Motion presents the issue for decision as simple: Mr. Musk violated the agreed to court order entered to resolve the claims by the Commission that he made false statements about Tesla going private. Specifically, in August 2018 Mr. Musk published a series of brief statements on Twitter regarding the prospect of taking the company private. The SEC claimed the statements were false, focusing on the undefined phrase “funding assured.”

The Commission’s claims were resolved the next month in a settlement which imposed certain restrictions on material communications by Mr. Musk about Tesla. Those procedures require the “pre-approval of any such written communications that could contain, or could reasonably contain information material to the Company or its shareholders,” according to the Final Judgment entered by the Court.

On February 19, 2019 Mr. Musk tweeted “Tesla made 0 cars in 2011, but will make around 500k in 2019.” The statement was disseminated to Mr. Musk’s 24 million Twitter followers.

A few hours later Mr. Musk published a second tweet stating “Meant to say annualized production rate at end of 2019 probably around 500K, ie 10k cars/week. Deliveries for year still estimated to be around 400k.”

Letters from counsel for the company and Mr. Musk to the Commission staff in response to inquires about the communications, admit that the first tweet on February 19th was not pre-approved. Mr. Musk believed that the first tweet was simply a reiteration of publications made earlier by the firm. The second statement made on February 19th was pre-approved. Counsel assisted in preparing the clarification, citing facts from earlier Tesla public statements.

The Commission’s motion asserts four key points: 1) The Final Judgment is clear – it requires pre-approval; 2) Mr. Musk admits that he did not secure pre-approval for the first February 19th tweet; 3) this is not a technical violation – the point of the settlement was to prevent the dissemination of inaccurate information as was done here; and 4) Mr. Musk’s post settlement, pre-February 19th statements confirm that he has not diligently attempted to comply with the Final Judgment. Accordingly, the requested order should be entered.

Discussion

The dispute in round one between the Commission and Mr. Musk hinged in large part on the meaning of the phrase “funding secured.” While volumes were written about the surrounding circumstances, those two words remained at the center of all the arguments.

Round two is similar but different. The dispute is similar since it keys to the words tweeted by Mr. Musk. It is different because the critical point is the text of the Final Judgment. The text of that court order requires pre-approval for the publication of any material information about the automaker by Mr. Musk. Since it is undisputed that there was no pre-approval and that the information was material and about Tesla the case is over – at least according to the SEC.

Perhaps. If the point of the Final Judgment was to ensure proper and accurate communications of information about Tesla as the SEC argues, then the ultimate resolution of this case may turn on whether the phrase “pre-approval” in the Final Judgment includes a reiteration of previously published information. Stated differently, if the publication of the information has been approved, must it be approved a second time?

It seems unlikely that the SEC and the Court intended to create and impose needless disclosure procedures requiring unnecessary duplication. Yet in this case the factual record presented by the SEC to the court specifically states that Mr. Musk reasonably believed he was reiterating information that previously had been published. Arguably the pre-publication review requirement of the Final Judgment has not been violated under such circumstances. Alternatively, any violation is substantially mitigated in view of these facts, counseling minimal, if any, sanction. This is particularly true in this case since the Commission has the burden of establishing a violation of the Final Judgement by clear and convincing evidence.

In the end, the real point of these proceedings is not so much the words or the court orders. It is about good corporate governance – reflected here in the disclosure policies incorporated in the Final Judgment – and a visionary company founder who does not fit into the typical public company senior executive mold. No doubt all companies – including Tesla – benefit from good corporate governance. No doubt companies such as Tesla greatly benefit from visionaries like Mr. Musk. Round two needs to resolve with an accommodation that draws the best from each side.

Tagged with: , ,

by T. GormanPosted on Posted in SECActions

Financial fraud actions frequently involve the improper use of accounting principles such as the premature recognition of revenue or the incorrect capitalization of expenses, each of which will improperly boost revenue and ultimately profit. The Commission’s most recent case in this area differs from the more traditional cases. It centers on what amounts to a series of sham transactions used to boost long term debt. The scheme, which continued even after the executives executing it were forced to reveal the conduct in part, was designed to secure certain government funds for the company. SEC v. Massimino, Civil Action No. 2:19-cv-01374 (C.D. Cal. Filed Feb. 25, 2019).

Defendants Jack Massimino and Robert Owen were, respectively the CEO and CFO of Corinthian Colleges, Inc., a publicly traded operator of 125 for profit colleges. About 80% of the firm’s revenue came from the federal government through student loans and grants under Title IV of the Higher Education Act of 1968.

Receipt of revenue under Title IV depended on the company achieving a certain composite score calculated by the U.S. Department of Education from certain financial metrics. Long term debt increased the institution’s composite score. If the score equaled or exceeded 1.5 the institution received unqualified access to Title IV Funds. If the composite score was below that point, the institution faced heightened scrutiny and possible delay in receiving the funds.

To ensure that Corinthian achieved a score that assured Title IV Funds would flow, at year-end the company boosted its long-term debt through borrowings on its line of credit. A short while later the borrowings would be repaid. Thus, for example, at FY year-end 2011 Corinthian borrowed $43 million which was initially added to its long term debt but was repaid within a few days. At FY 2012 the firm borrowed $52 million for the same reason which was also repaid a short time later. And, at FY 2013 year-end Corinthian borrowed $25 million, repaid within a few days.

The Department of Education sent Corinthian a letter in mid-August 2013 stating in part that the year-end borrowings were incorrectly included in long term debt for FY 2011, dubbing them “questionable accounting treatment.” Corinthian excluded the borrowings and filed a Form 8-K later the same month. The filing stated that the Department of Education required the elimination of the long term debt for 2011, that the company disagreed and that there could be no assurance there would not be “additional disagreements” with the government.

The disclosures were false and misleading, according to the complaint. Material facts were omitted because the filing did not disclose the 2012 and 2013 borrowings which were identical to those in 2011 and which were under review. The firm also failed to disclose the risk that the Department of Education would require the elimination of the claimed long-term borrowings in those two years and the impact of such a determination. The suggestion that there might be additional disagreements was not sufficient to alert investors the complaint asserted. The complaint alleges violations of Securities Act Section 17(a)(3) and Exchange Act Section 13(a).

To resolve the case each Defendant consented to the entry of a permanent injunction as to Mr. Massimino based on the sections cited in the complaint and as to Mr. Owen on Section 13(a). Mr. Massimino will also pay a penalty of $80,000 while Mr. Owen will pay $20,000. See Lit. Rel. No. 24410 (February 25, 2019).

Tagged with: ,