Loyola University Chicago School of Law JD 2020
On September 27, 2018, the Securities and Exchange Commission (“SEC”) filed a complaint, alleging Tesla CEO and Chairman, Elon Musk, committed stock market fraud by misleading investors. The matter was resolved through settlement and later approved by a judge. It is hoped that the settlement will prevent Tesla and Musk from causing future market disruption and harm to shareholders.
The Complaint and Settlement
The SEC complaint arose from Musk’s tweet on August 7, 2018 stating, “Am considering taking Tesla private at $420.” Musk’s tweets are subject to SEC regulation because of SEC’s 2013 report allowing companies to use social media outlets to announce key information. While the SEC continues to require companies to comply with the Regulation Fair Disclosure, which requires companies to distribute material information broadly and non-exclusively to the general public in a reasonable manner, the 2013 report allows companies to utilize social media without being penalized. Tesla quickly responded to this report by completing a Form 8-K, which announced that one of the ways Tesla will disseminate information would be through Elon Musk’s Twitter account.
Two days after the SEC complaint was submitted, the parties settled without requiring Musk or Tesla to admit or deny the allegations. The settlement requires Musk to step down as Tesla’s Chairman and to be ineligible to be re-elected for three years, Tesla to appoint two new independent directors to its board and establish a new committee of independent directors to oversee Musk’s communications, and Musk and Tesla to pay a separate $20 million penalty, which will distributed to harmed investors.
The concern now is whether the enforcement of the settlement conditions will prevent Tesla and Musk from causing future market disruption and harm to shareholders.
Enforcement by Removal as Chairman and $20 Million Penalty
Under the federal Securities Exchange Act of 1934, the SEC has the authority to prohibit a person from serving as an officer or director and enforce a monetary penalty. The removal of Musk as Chairman may have little impact on Tesla, since Musk will continue to act as the CEO. Although Tesla did not intend for Musk’s role in the company to change, it is not unexpected. Over this past summer at Tesla’s annual shareholder meeting, Musk’s dual role as Chairman and CEO was up for debate and was held to a vote. Consequently, the shareholder’s voted to maintain Musk’s dual role. Those who were suggesting the removal of Musk were hoping to reform the board. Therefore, the addition of two new independent directors to Tesla’s board and the removal of Musk, aligns with the intentions of those who sought changes in Tesla’s governing body.
Furthermore, the monetary penalty will likely have a short term impact on the multi billionaire and multi billion company. Even with the 14 percent plummet in stock once the SEC allegations were announced, Tesla believes the settlement will not have a long term impact on its operations or liquidity.
New Committee Overseeing Musk’s Communication
The SEC has authority to require a company to establish a new committee to address the issues alleged by the SEC. For Tesla, this means that it must establish a committee of independent directors to oversee Musk’s communications. Unlike the enforcement by removal and monetary penalty, this requirement may alter Tesla for an extensive amount of time and may alter how communication is disseminated to its shareholders.
To establish a new committee, Tesla will be implementing new policies and procedures and the committee with be continually monitoring Musk’s communications. The main benefit of the new committee is that Musk will likely not be able to tweet controversial statements without the board’s approval. One may think that it could be easier for Tesla to remove Musk’s Twitter account from the Form 8-K, that states Musk’s twitter account disseminates company information. However, this solution is very unlikely because Musk has about 20 million more followers than Tesla’s Twitter account. Thus, as the new committee is organized, it will be interesting to see how its oversight will impact Musk’s communication to the social media outlets.
Impact of Tesla’s Settlement At Large
While the SEC has the authority to require Tesla to establish a new committee and include new independent directs, and the judge confirmed the settlement was fair and reasonable, there is concern of how these changes will be enforced. Tesla now has 45 days to recruit independent directors, which will be a challenge. Based on previous court decisions and governance researchers, Musk’s continued dominating presence as CEO will likely reduce the new independent directors effectiveness or impact on Tesla. In addition, Musk’s ridicule of the SEC and settlement will likely make it even more difficult for the committee to control Musk’s impulses and for Musk to comply with the settlement requirements. The CEO’s dislike of the settlement and its conditions could cause friction throughout the company, making Tesla even more unstable.