Elon Musk’s August 7, 2018 Tweets, in which he had “secured” funding to take Tesla private at a substantial premium over the then-current share price, have already produced a storm of controversy and a series of securities class action lawsuits against him and the company. The Tesla CEO’s now-infamous Tweets have now also led to a SEC enforcement action against him, in which the agency alleges that Musk’s statements in the Tweets were “false and/or misleading” because “he did not have an adequate basis in fact for making these assertions.” The agency seeks injunctive relief, disgorgement, civil penalties, and a bar prohibiting Musk from serving as an officer or director of any public company. The SEC’s complaint against Musk can be found here. The SEC’s September 27, 2018 press release about the enforcement action can be found here.
Background
As I detailed in a prior post concerning the securities class action lawsuits that have been filed against Musk and Tesla, during the trading day on August 7, 2018, Musk issued a series of tweets in which he not only said that funding for the take private transaction was secured and that the only thing remaining in order for the transaction to be completed was a shareholder vote (implying that it had already been approved by the company’s board of directors).
The SEC’s complaint alleges that Musk did meet on July 31, 2018 with representatives of a sovereign wealth fund, in which, among other things, a possibility of take private transaction was raised. However, the SEC alleges that the July 31 meeting lacked discussion of even the most fundamental terms of a proposed going-private transaction. The discussion did not include any dollar amount or specific ownership percentage for the transaction; the fund’s available liquid capital; any regulatory hurdles; or the process for securing board approval. Musk later acknowledged that no specific term deals were discussed at the meeting, and that nothing was exchanged in writing. Musk did not meet with the fund representatives again until August 10, three days after his August 7 Twitter storm
The complaint also alleges that on August 2, 2018, Musk send the board an email entitled “Offer to Take Tesla Private at $420.” Musk did not discuss the $420 price with any funding source prior to sending the email. Musk later said there was “a lot of uncertainty” regarding the possible transaction. In an August 3, 2018 phone call with the board Musk expressed his hope that many shareholders would stay with the company even if the company went private. He asked for the board’s authorization to contact shareholders to sound out their interest in the proposed deal.
The complaint alleges that between July 31, 2018 and August 7, 2018, Musk did not discuss a take-private transaction at $420/share with any other funding source, did not provide Tesla’s board with a more specific proposal to take Tesla private, did not retain any advisors, did not contact any retail investors or determine whether institutional investors had restrictions on holding what would be illiquid shares if Tesla were to go private, and did not determine what regulatory approvals would be required for a take private transaction.
Notwithstanding all of these limitations, Musk nevertheless launched his tweets during the day on August 7. The SEC’s complaint alleges that following the first of Musk’s tweets, Tesla’s share price rose over 6% and it closed the day up over 10%. The complaint shows that Musk’s tweets clearly caught not only investors and analysts by surprise, but caught company officials by surprise as well. The SEC’s complaint quotes a number of both internal and external messages where it is clear that the uniform initial reaction to Musk’s tweets were confusion and uncertainty.
In a series of subsequent communications Musk further tried to explain his earlier statements and validate the proposed transaction. However, even in these further statements over the following trading days, he did not clarify that the $420/share price had never been agreed to by any funding source. On August 24, 2018, after the close of trading, Tesla published a blog post stating that Musk had abandoned the process of trying to take Tesla private.
In alleging that Musk’s Twitter statements on August 7 had been false and misleading, the SEC alleged that “Musk’s statements that funding was ‘secured’ and investor support was ‘confirmed’ were false and misleading because, in reality, Musk had no ‘secured’ or ‘confirmed’ commitment from any source to provide any amount of funding.” In addition, he had never even discussed taking Tesla private at a price of $420 per share with the Fund or any other potential investor. The SEC alleged that Musk’s statement that the only remaining contingency was a shareholder vote was also false and misleading because no formal proposal had ever been presented to the board. The SEC also alleges that there were numerous omissions from his disclosures of facts that were known to him, including the relative limitation of his discussions with the sovereign wealth fund and with the board.
The complaint alleges that by engaging in this conduct, “Musk violated, and unless restrained and enjoined will violate again” Section 10(b) of the Securities and Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint seeks injunctive relief, disgorgement, civil penalties, and a bar prohibiting Musk from serving as an officer or director of any public company.
Discussion
As far as I know, this is the first enforcement action that the SEC has filed alleging securities fraud based alleged misrepresentations or omissions on social media. In any event, is is at least as far as I am aware the first SEC enforcement action based on alleged misrepresentations or omission in statements on Twitter.
The rest of us can only speculate what in the world Musk thought he was doing by making the statements on Twitter. The SEC’s complaint, citing statements in subsequent statements and internal emails from Musk and Tesla, suggests that Musk was motivated to try to get back at short interest investors who had been criticizing the company, questioning its finances, and challenging the company’s ability to meet its production goals. Whatever his motivation, there is no doubt that Musk went off the reservation more than just a little bit.
One element that has hung over this story from its inception, and for that matter has hung over Musk as part of his public life as a technology entrepreneur, is that as a serial founder of several successful tech companies, Musk feels mightily entitled and he bridles seriously when challenged or questioned. I have no business trying to analyze Musk’s psychology, but one thing that certainly seems like a pretty big factor in all of this is Musk’s apparent belief that, because of his entrepreneurial success, rules that might apply others don’t apply to him. After all, he’s changing the world, right?
In its press release, the SEC addresses this last point. The press release quotes Steven Peikin, Co-Director of the SEC’s Enforcement Division, as saying that “An officer’s celebrity status or reputation as a technological innovator does not give license to take [his] responsibilities lightly.”
The SEC also make a point in its press release that the securities laws apply even to statements made within the relatively informal and less structured world of social media. The press release quotes Stephanie Avakian, Co-Director of the SEC’s Enforcement Division, as saying that the obligation to provide investors with truthful information “applies with equal force when the communications are made via social media or another non-traditional form.”
The circumstances of this case underscore the dangers to public companies when company executives use social media for communicating with investors. The media’s informality and unstructured environment create their own perils, but those dangers are magnified if an executive uses the media impulsively and without the kind of oversight, review, and scrutiny that would be employed in communications about corporate transactions using more traditional means. The SEC’s complaint highlights the dangers involved under these kinds of circumstances: “Musk made his false and misleading public statements about taking Tesla private using his mobile phone in the middle of the active trading day. He did not discuss the content of the statements with anyone else prior to publishing them to his over 22 million Twitter followers and anyone else with access to the Internet. He also did not inform Nasdaq that he intended to make this public announcement, as Nasdaq rules required.”
The SEC’s complaint makes it clear that corporate executives who allegedly mislead investors as Musk is alleged to have done are not going to be let off the hook or given any leeway merely because the medium used to communicate is one of relative informality, like Twitter. Nor, for that matter, should there be any leeway; Musk’s statements clearly had a significant market impact, without respect to the fact that the statements appeared only on social media.
The dangers involved with corporate executives’ use of social media presents something of an underwriting challenge for D&O insurance underwriters. I suppose it is enough to determine with an applicant company allows its executives to use social media for means of communicating with investors, and if so what guidelines and controls exist. I suspect that many underwriters will now want to go ahead and review the actual communications, in order to understand how the media are being used and to try to determine if there are sufficient controls around the process.
Of all the many interesting things about the SEC’s complaint, perhaps the most interesting is the SEC’s request for an officer and director bar against Musk. Were a bar to be put in place prohibiting Musk from serve as a director or officer of a public company, that would not only preclude him from serving in those positions at Tesla, but it would also prohibit him from serving as an officer or director of SpaceX if that company were to go public, as well as any future companies that Musk might seek to launch and take public. In any event, investors apparently attach a lot of value to having Musk at Tesla; the value of its shares sank 11% after news of the SEC action against him became public.
It of course remains to be seen how the SEC action will unfold; it will be interesting to watch. UPDATE: As detailed in a September 29, 2018 press release from the SEC (here), the SEC, Musk, and Tesla have reached a settlement of the enforcement action the agency filed against Musk. According to the press release, Musk has agreed to pay the agency $20 million and step down as the company’s Chairman. At the same time, the agency filed an action against Tesla that was also resolved as part of the SEC’s settlement with Musk. In its complaint against Tesla, a copy of which can be found here, the agency alleged that Tesla failed to have required disclosure controls and procedures relating to Musk’s tweets, a charge that Tesla has agreed to settle. As part of the settlement, the company also agreed to pay a $20 million penalty, adopt certain governance reforms, appoint an independent Chairman, and appoint two independent directors. The $40 million in penalties is to be distributed to harmed investors as part of a court-supervised process. The settlement is subject to court approval.