On September 27, 2018, the SEC filed a lawsuit against Elon Musk for committing securities fraud because of some tweets he published on August 7, 2018. A mere two days later, September 29, 2018, Musk settled with the SEC.
As part of their settlement agreement, Musk agreed to step down as Tesla’s chairman. An independent chairman will replace him and he will be ineligible to be re-elected as chairman for three years. Musk will also pay a $20 million penalty.
On the same day as Musk’s settlement, the SEC also charged Tesla (NASDAQ:TSLA) for failing to have “required disclosure controls and procedures relating to Musk’s tweets.” Tesla settled such charges by agreeing to pay a separate $20 million dollar penalty. A court will oversee the distribution of the $40 million in penalties to harmed investors. The funds from Tesla and Musk will be distributed to investors harmed “will be distributed to harmed investors under a court-approved process.”
Although $40 million for a few tweets may seem like a harsh penalty, Musk could have faced a far worse fate if the case had gone to trial. The SEC’s charges against Musk illustrates how easy it is to violate federal securities laws and the severe penalties that can result from such violations.
The Tweets that Lead to the SEC’s Complaints
On August 7, 2018, Musk tweeted the following: “Am considering taking Tesla private at $420. Funding secured.”
As a follow-up to his initial tweet, Musk also tweeted:
- “Shareholders could [sic] either to sell at 420 or hold shares & go private.”
- “My hope is *all* current investors remain with Tesla even if we’re private. Would create special purpose fund enabling anyone to stay with Tesla. Already do this with Fidelity’s SpaceX investment.”
- “Investor support is confirmed. Only reason why this is not certain is that it’s contingent on a shareholder vote.”
The Aftermath of the Tweets
Following the tweets, Tesla stock jumped 7%. The SEC alleged that the tweets caused market chaos and harmed investors, that “Musk knew or was reckless in not knowing that each of these statements was false and/or misleading because he did not have an adequate basis in fact for his assertions,” and that he “directly or indirectly made untrue statements of material fact and omitted to state material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.”
The Allegations of the SEC Against Musk
As support for the SEC’s case, it alleged the following:
- Musk never discussed a going-private transaction with any potential funding source for $420/share
- He had not “investigated whether it was possible for all current investors to remain with Tesla as a private company via a “special purpose fund,” and had not confirmed support of
- Tesla’s investors for a potential going- private transaction.
- He also knew that he had not satisfied numerous additional contingencies, the resolution of which was highly uncertain, when he unequivocally declared, “Only reason why this is not certain is that it’s contingent on a shareholder vote.”
- Musk’s public statements and omissions created the misleading impression that taking Tesla private was subject only to Musk choosing to do so and a shareholder vote.”
The Timeline of Events that Lead Up to Elon Musk’s August 7 Tweets
On the days leading up to Musk’s tweets, he had in fact talked to potential investors about going private.
On July 31, 2018, he spoke to a lead representative of a fund (the “Fund”) that recently acquired five percent of Tesla’s common stock. The representative was an authorized decision-maker for the Fund and represented that the Fund was interested in taking Tesla private.
On August 2, 2018, he wrote to his board, CFO and general counsel, “Offer to go private at $420.” The $420 price was based on a 20% premium over the price which Tesla was trading on August 1. On July 31, the stock had closed at $298, but spiked 17% following Tesla’s August 1 earnings report.
According to the SEC, “Musk realized that a spike in Tesla’s share price might make a going-private transaction not feasible because it would require an investor in the transaction to pay a “premium on a spike.””
On August 3, 2018, as a follow-up to Musk’s email, he and Tesla’s board had a conference call. Musk informed the board that the Fund was interested in taking Tesla private and that he wished for Tesla’s current shareholders to remain investors.
At least one board member informed him that it would be very difficult for small shareholders to remain invested if Tesla goes private.
Musk told the board that he wanted to contact shareholders about their interest in Tesla going private. The board approved and asked Musk to report back his findings.
On August 6, 2018, Musk talked to a private equity fund partner about going private. He was informed that to go private, Tesla could have no more than 300 shareholders. Currently, Tesla has over 800 institutional shareholders and many more individual shareholders. Given this, the fund partner informed Musk that his proposed transaction was “unprecedented.”
The August 7, 2018 Tweets and the Aftermath
Despite the uncertainty about whether going private was a possibility, he tweeted to his followers that Tesla was going private at $420 per share and it was only contingent on a shareholder vote. In addition, public companies are required to notify NASDAQ at least 10 minutes before announcing certain corporate events, such as going private, but Musk made no announcement before tweeting to his followers.
On August 13, 2018, possibly after realizing the egregious mistake he had made, Musk posted a blog on Tesla’s website explaining why he published the offending tweets.
The SEC Seeks the Ultimate Punishment for Musk
Given the August 7 Tweets, the SEC sought to stop Musk from further violating certain anti-fraud provisions of the Exchange Act and asked for a court order to disgorge Musk of profits plus interest, penalties, and to bar Musk from ever serving as an officer or director of any public company again.
The potential penalties were so severe that Musk settled with the SEC a mere two days after the SEC filed its complaint.
Key Takeaways in the SEC Lawsuit Against Elon Musk
For some corporate executives, monetary penalties may be par for the course of doing business, but a bar from serving as an officer or director of a public company is devastating to blow to any corporate executive’s career.
The SEC’s complaint against Elon Musk is a good case study in how easy it is to violate securities laws and how severe the consequences can be.
1- Anti-Fraud Provisions Are Easy to Trigger
The SEC charged Elon Musk under Section 10(b) of the Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5 thereunder (the “Anti-Fraud Rules”).
What the Anti-Fraud Rules Say
The Anti-Fraud Rules prohibit any direct or indirect “use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,”
- “To employ any device, scheme, or artifice to defraud,
- To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
- To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.”
What the Anti-Fraud Rules Mean
You Can Violate the Anti-Fraud Rules with Indirect Statements of Fact or Even Omissions of Fact
The Anti-Fraud Rules do not prohibit only direct statements of untrue facts. You can violate the anti-fraud rules even if you make indirect statements of material facts that are untrue or omit material facts that would make a statement not misleading.
For example, if Elon Musk linked to someone else’s tweet about Tesla going private at $420 per share, that would be an “indirect statement of fact.” If he did not correct this statement with clarifying information such as the share price hasn’t been discussed and whether going private is even a possibility, it would be an omission of material facts, and thus, a violation of the anti-fraud rules.
Under Section 10(b) and Rule 10b-5 of the Exchange Act, you can violate the anti-fraud rules even if you make indirect statements of material facts that are untrue or omit material facts that would make a statement not misleading.
For example, if Elon Musk linked to someone else’s twitter post about Tesla going private at $420 per share, that would be an indirect statement of fact.” If he did not correct this statement with clarifying information such as the share price hasn’t been discussed and whether going private is even a possibility, it would be an omission of material of material facts, and thus, a violation of the anti-fraud rules.
You Don’t Have to Know That You Are Making a False or Misleading Statement
You don’t even have to know that you are making a false or misleading statement as long as you are reckless in not knowing.
Musk was in fact contemplating going private at $420/share and had been discussing this with potential investors and even his board. However, he didn’t do any additional investigation to determine whether this was in fact possible, which suggests that at best, he was reckless in not knowing, which violates the Anti-Fraud Rules.
2- Consequences for Securities Violations Are Severe
Possible Consequences for Securities Law Violations
The SEC can seek various penalties against those who violate the federal securities laws, such as disgorgement, civil penalties, and jail.
The SEC Seeks the Ultimate Civil Sanction Against Musk
In the case against Elon Musk, the SEC sought the ultimate sanction: an order ousting him from his current company and from ever serving in another on the board or as an executive of any public company.
If the SEC had prevailed in its lawsuit against Musk, it would not have only affected his role at Tesla, it would have prevented him from taking an executive or board position in any company and even owning over a certain percentage of voting stock in any company, public or private.
Under the Bad Actor Disqualification Rules, Companies That Are “Bad Actors” or Have Certain Affiliations with “Bad Actors” Will Face Bleak Obstacles Raising Money
The federal securities laws have “bad actor rules” that prevent companies that are lead by bad actors or where bad actors own 20% or more of a company’s voting shares from relying on certain securities exemptions from raising money, including Rule 506 of Regulation D (Reg D), one of the most relied-upon exemptions for private companies to raise substantial—and unlimited—amounts of capital.
The bad actor disqualification provisions also apply to Regulation A and Regulation Crowdfunding (Reg CF), which takes another two exemptions off the table for raising money, forcing an issuer that is a bad actor or has certain affiliations with one to rely on a different exemption for raising money.
In Musk’s case, if the SEC had prevailed in its lawsuit against him, Musk’s career at Space X could have been jeopardized. For example, if Space X ever had to raise funding, Musk’s role as CEO would have prevented Space X from raising funding under many exemptions unless SpaceX successfully applied for a waiver. Similarly, if Musk owns more than 20% of SpaceX’s voting shares, SpaceX will face similar obstacles raising money. In addition, if it decided to raise money by going public, Musk would have had to resign as CEO.
Given the severe consequences that Musk could have faced if the SEC had prevailed in the lawsuit against him, it is unsurprising that he decided to settle.
3 – You Must Be Careful About How You Communicate With the Public, Especially if the Subject of Your Communication Involves Your Securities
Finally, the SEC’s lawsuit against Elon Musk reminds us that it is important to be careful about how you communicate with the public, especially if you are raising money or or discussing your securities in any way.
Before making such communications, especially in a public forum, you should run your communications by a qualified securities lawyer to ensure that the communications are permissible.
In the SEC’s complaint against Musk, it alleged that he did not run his tweets by Tesla’s General Counsel before tweeting them. If he did, the GC very likely would have advised Musk against tweeting.
The time to review a communication is before it is made, not after.
Once a communication is made, it is too late. When Musk attempted to take back his August 7 tweets in a blog post on August 13, it was already too late. Similarly, when Tesla’s Chief Financial Officer asked Musk if he would like the assistance of the head of Tesla’s communications and General Counsel to draft a follow-up communication for him, Tesla’s fate had also befallen it as well.
Musk and Tesla were fined $20 million each, for a total of $40 million, a few tweets that Musk distributed on a single day, a steep price to pay for the party making the tweet as well as the one responsible for overseeing such communications.
Onki Kwan is a partner at Vanguardium Legal LLP, a San Francisco-based law firm that advises blockchain and technology startups. Her expertise includes entity formation, capital-raising, blockchain-related securities and regulation issues, commercial transactions, and employment, technology, product, marketing, consumer protection and privacy related matters. In her previous role as a senior attorney and director at a public interest law firm, she launched and managed a SEC and FINRA compliant JOBS Act funding portal.
Disclaimer: The author’s views may not reflect the views of Vanguardium Legal LLP or any other person. This article is intended to provide general information only and should not be construed as legal advice or a legal opinion. If you have a legal problem, you should contact a lawyer for advice on your particular set of facts and circumstances. The information provided herein may not reflect the most current legal developments and is subject to change without notice. You should not take any action or refrain from taking any action in reliance on the information contained within this article. The author and Vanguardium Legal LLP disclaim all liability with respect to such actions to the fullest extent permitted by law.