I have long thought that it was only a matter of time before somebody filed a securities class action lawsuit based on disclosures made through social media. I knew we were going to see that lawsuit someday or other. Well, the day has arrived. On Friday, August 10, 2018, two Tesla investors each filed separate securities class action lawsuits against Tesla, Inc. and its Chairman, CEO, and largest shareholder, Elon Musk, based on Musk’s tweets last Tuesday that he was considering a take-private deal for which he had “secured” funding and that only shareholder approval was required for completion of the deal. As discussed below, there are a host of interesting things about the lawsuit and about the surrounding circumstances.
Readers are undoubtedly aware that on Tuesday August 7, Musk set the securities markets and the business pages alight with an extraordinary series of Tweets on his Twitter feed, in which Musk stated, among other things, that he is “considering taking Tesla private at $420” (the company’s share price had closed the previous trading day at $X); that “funding secured”; “shareholders could either sell to [SIC] sell at 420 or hold shares & go private”; and “Investor support confirmed.” Musk’s Twitter account has over 22 million followers.
There is some important context for this series of tweets. For months, Musk has been engaged in a war on Twitter and elsewhere with short sellers whom he believes are trying to drive down Tesla’s share price in order to profit from their short positions. He has very publicly battled with commentators who have questioned his statements that Tesla’s capital position is sufficient and will not need to raise money this year, and about Musk’s statements pertaining to its production schedule and targets. For example, on August 2 2018, just days before Musk’s take-private Twitter storm, the Wall Street Journal ran an article entitled For Tesla’s Elon Musk, Twitter is a Sword Against Short Sellers (here).
As a result of Musk’s August 7 twitter storm, the company’s share price leapt upwards, to an inter-day high of $387.46, $45.47 (13%)above the prior day’s closing price of $341.99. The trading volume in Telsa’s share rose to 30 million shares (compared to an average daily trading volume of 8 million), representing over $11 billion of purchases in the open market.
However, news has begun emerging that Musk had indeed initiated discussions with the company’s board the prior week about taking the company private. There has as yet been no public statement from the company or otherwise confirming that funding for the take private transaction has been “secured” or indeed that the only thing needed to complete the transaction was a shareholder vote. If Musk were to take the company private at his designated share price, the implied $70 billion transaction amount would represent the largest take-private deal ever. This from a company that is cash-flow negative and whose debt currently carries a junk rating.
Almost immediately after Musk’s tweets, commentators began asking whether Musk’s tweets could have violated the securities laws. News reports emerged that the SEC has initiated a probe into Musk’s statements. The Wall Street Journal reported that the SEC had asked Tesla about whether Musk was “truthful when he tweeted that he had secured funding” for the proposed take-private deal. The SEC, the Journal said, wants “to know whether Mr. Musk had a factual basis for tweeting Tuesday that the going-private transaction was all-but certain, with only a shareholder vote needed to pull it off.”
As questions began to circulate about Musk’s statements and as news of the regulatory inquiries began to circulate, the share price lift that had followed immediately after the statements began to drop. By Friday evening, the company’s share price had settled back down to $355.54.
The Securities Lawsuits
With this sequence of events as background, it was perhaps inevitable that a securities class action lawsuit would follow. And so, on Friday, two Tesla shareholders filed separate securities class action lawsuits in the Northern District of California against Tesla and Musk.
The first of the lawsuits, filed by Tesla shareholder William Chamberlain, purports to be filed on behalf of a class of shareholders who purchased or sold Tesla shares between August 7, 2018 and August 10, 2018, inclusive. A copy of Chamberlain’s complaint can be found here.
The second of the two lawsuits, filed by Tesla investor Kalman Isaacs, purports to be filed on behalf of a class of shareholders who purchased Tesla securities after 12:48 pm EST on August 7, 2018 (the time of Musk’s first take-private tweets) and including August 8, 2018. According to news reports, Issacs is a short seller who sustained significant losses purchasing shares at the inflated price to cover his short position. A copy of Isaacs’ complaint can be found here.
Both complaints allege that Musk’s tweets contained material misrepresentations in violation of the federal securities laws and seek to recover damages on behalf of the plaintiff class.
The possibility of a securities class action lawsuit based on alleged misrepresentations made on social media has been there as long as there have been social media. The potential relation between statements made on social media and the requirements of the federal securities laws was highlighted in 2013 when Netflix CEO Reed Hastings used his Facebook account to announce that Netflix subscribers had surpassed 1 billion users. That sparked an SEC investigation looking into whether, among other things, Hastings’ Facebook post violated Reg. FD. The SEC ultimately concluded that companies can use social media to announce key information in compliance with Reg. FD as long as investors have been told to look there. In fact, in Tesla’s case, the company had previously announced that Musk’s Twitter feed would be used for these purposes.
The recognition that companies could use social media for company announcements raised the possibility that investor would later claim that a company statement on Twitter or Facebook would be the basis of a securities class action. I have in fact been watching for this possibility to become reality for some time now. With Musk’s Twitter storm and the ensuing lawsuits, this possibility has now come about.
Just because a company can use social for key announcements doesn’t necessarily mean it is a good idea, just as the possibility of using social media to discuss important government matters doesn’t necessarily mean it is a good idea to for, say, a national leader to use Twitter to conduct diplomacy, engage in foreign relations, discuss military affairs, or comment on the economy. Think of this as Musk’s “covfefe” moment.
The complaints have only just been filed so it of course too early to tell whether or not they will be meritorious. For me, it feels like the complaints were filed a bit early, as more information likely will emerge in the next few days about the state of Musk’s take private discussion with the company’s Board and the extent to which he actually has secured funding.
Setting aside for now the possibility that all of Musk’s statements were truthful and, for purposes of discussion, considering the possibility that one or more of his statements about the possibility of a take private deal were untruthful, the question arises about his motivations. Why would he make all of these statements if they were untrue? One obvious possibility is that he wanted to spite the short sellers with whom he had been battling. The sharp rise in the company’s share price undoubtedly caused some short seller pain, but the effect was very short-lived. The longer term effects likely are to undermine his fights with the short sellers.
In its article about the SEC’s investigation of Musk’s statements, the Wall Street Journal suggested another reason why Musk may have been motivated to try to boost the company’s share price – as a way to “preserve the company’s much-needed cash.” Tesla apparently has $920 million in convertible bonds coming due in March 2019. If the company’s share price is below the bonds’ conversion price of $359.87, Tesla will have to spend cash to redeem the bonds. If it is above that price, “convertible holders will convert them into Tesla shares, relieving the company of the need to lay out cash.” As of June 30 , 2018, the company’s balance sheet showed cash of $2.2 billion and free cash flow of negative $1.8 billion in the first half of 2018.
Those interested in thinking about what the SEC investigation, as well as the new lawsuits (and the others that undoubtedly will follow) may mean for Tesla and for Musk will want to consider this statement from the company’s Risk Factors in its most recent filing on Form 10-K (here, see page 28):
Our insurance strategy may not be adequate to protect us from all business risks.
We may be subject, in the ordinary course of business, to losses resulting from products liability, accidents, acts of God and other claims against us, for which we may have no insurance coverage. As a general matter, we do not maintain as much insurance coverage as many other companies do, and in some cases, we do not maintain any at all. Additionally, the policies that we do have may include significant deductibles or self-insured retentions, and we cannot be certain that our insurance coverage will be sufficient to cover all future losses or claims against us. A loss that is uninsured or which exceeds policy limits may require us to pay substantial amounts, which could adversely affect our financial condition and operating results.
This Risk Factor discussion of the company’s insurance arrangements does not specifically refer to the company’s D&O insurance. The discussion at least raises the possibility that the company does not carry D&O insurance, or that the D&O insurance has a very high deductible or that the company does not carry the amount of insurance that other companies of Tesla’s size might carry. The company’s approach to insurance obviously is calculated as a way to try to save money. If the company applied this approach to its purchase of D&O insurance, the savings the company earned by this approach are about to be complexly subsumed by litigation costs.
It will in any event be interesting to see how event unfold. There is still a lot of this story to be told. In the days ahead, look for further news coverage about the supposed financing that Musk said was in place, as well as further details about Musk’s take private discussions with Tesla’s Board. In the weeks or months ahead, there undoubtedly will be news about the SEC’s inquiries.
Beyond that, look for more lawsuits in the future involving alleged misrepresentations made using social media. The Tesla lawsuit may be the first, but it surely will not be the last.