SEC Investigation of Elon Musk
On August 7, Elon Musk made an abrupt announcement regarding his plan to take Tesla private. Mr. Musk claimed that this Twitter announcement came after he had “secured” funding from the Saudi Arabian sovereign wealth fund. (Ben Bain and Matt Robinson, Bloomberg). After the announcement, Tesla’s shares rose in value to over $381 per share, from $342 (the closing price on August 6). (Mark Matousek, Business Insider). Nevertheless, the share price dropped dramatically over the next few weeks to as low as $263 on September 7.
On August 8, the day after the Tweet, the Securities and Exchange Commission (SEC) began investigating whether Mr. Musk’s statements were truthful or misleading in order to determine if he had violated SEC Rule 10b-5, a securities law violation. (Mark Matousek, Business Insider). After the investigation commenced, Mr. Musk blogged about his actions; specifically, his personal beliefs on why he considered taking the company private and his reasoning for making the initial announcement on Twitter. The blog post could be construed as Mr. Musk’s attempt to dissuade the SEC from believing that he had engaged in deceptive practices. Nevertheless, the SEC began a formal investigation. Subsequently, on August 24th, Mr. Musk addressed shareholder concerns and announced that Tesla would be “staying public” in another blog post.
Under SEC Rule 10b-5, it is “unlawful for any person … by the use of any means or instrumentality of interstate commerce … [t]o 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.”
To prove a fraud under Rule 10b–5, six elements must be established: (1) a material misrepresentation or omission; (2) scienter; (3) a connection between the misrepresentation and the purchase or sale of a security; (4) reliance upon the misrepresentation; (5) economic loss; and (6) loss causation.
The SEC could establish that Mr. Musk made a material misrepresentation that caused an economic loss due to the rapid spike and later decline in Tesla’s stock from the day of his initial Tweet. (Peter J. Henning, The New York Times). The high stock price could mean that he misled investors who either bought in because they thought Tesla would go private or those that sold their shares because they did not want to own shares of Tesla stock if it went private. Scienter could be established by either showing that Mr. Musk had both motive and opportunity to commit fraud or by establishing facts that constitute circumstantial evidence of recklessness or conscious behavior. Connection and reliance could be shown by a potential buyer who was dissuaded from purchasing as a result of the fraudulent statement, or by an investor who held a security and, in reliance on the alleged misstatement, sold the security. (See Merrill Lynch, Pierce, Fenner & Smith Inc. v. Dabit, 547 U.S. 71, 79–80 (2006). Loss causation could be shown when the misrepresented or concealed information negatively affected the stock price. (See Dura Pharmaceuticals, Inc. v. Broudo, 544 U.S. 336 (2005). According to Bloomberg, some investors have already filed suit against Mr. Musk and Tesla for manipulating Tesla’s stock prices.
Scienter (or an intent to defraud) may be more difficult to prove, as Tesla’s Board of Directors acknowledged the talks of “going private” had been previously discussed with Saudi Arabia's sovereign wealth fund, which could show that Mr. Musk did not act with the required knowledge to defraud investors but was being truthful about his negotiations; however, his conduct could also be considered reckless since he failed to consider the consequences of his Tweet and how it could affect Tesla and its shareholders. (Aisha Al-Muslim, The Wall Street Journal). His state of mind at the time of making the Tweet would be crucial in the SEC’s determination of whether he acted with scienter and thus whether he violated Rule 10b5. (Ben Bain and Matt Robinson, Bloomberg).
The implications of the investigation could result in a formal charge from the SEC, which could result in millions of dollars in fines for Tesla. Certain professionals believe that the SEC has moved away from enforcing huge monetary penalties against corporations for these types of violations, which could result in Tesla playing a significantly lower fine than those imposed by the SEC in the past.” These professionals believe that this trend is due in part to the SEC wanting to punish individual wrongdoers as opposed to holding companies liable for their employees’ wrongdoings. “Even if the commission ultimately concludes Musk’s tweet was unfounded, the Tesla CEO’s potential penalty would probably be less than $200,000, according to two securities law professors and a defense lawyer who tracks SEC enforcement”. (Alison Frankel, Reuters)
At this time, the SEC has declined to comment over the extent of the investigation or whether it will decide to formally charge Elon Musk with violating securities laws.