Musk: Out of the Frying Pan, into the Fire
"Am considering taking Tesla private at $420. Funding Secured," tweeted vanguard CEO of Tesla, Elon Musk, on August 7th at 12:48PM Eastern. All hell broke loose. People bought, people sold, people shorted. The stock was halted an hour and twenty minutes later. In that time, the stock increased twenty-nine Dollars per share. It ended the day eleven percent higher, an increase of nearly six billion Dollars in shareholder value. In the subsequent two days, the stock gave back most of that. The SEC announced they had some questions on August 8th. Six of the Tesla Board members subsequently issued the following statement:
If the stock ultimately finds its way back to the price prior to Musk's tweet, $342, there was still a huge amount of potential liability created by the tweet. With ten plus billion Dollars of movement, thousands of short sellers took losses on the way up and thousands of shareholders took losses on the way back down.
Though I don't teach or practice securities law, I took a semester of securities law while a student at GWU School of Law and hold a bar license in Texas. This analysis doesn't really require a law degree, however. SEC Rule 10b-5 states in pertinent part, "It shall be unlawful for any person...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...in connection with the purchase or sale of any security." For you non-lawyers, I've made this simpler to understand by highlighting the significant parts. In essence, ANY person can be held liable for making an untrue statement or omitting a detail necessary to avoid misinterpretation of a statement about a security. Because Mr. Musk made both a finite and brief statement, he's likely in trouble regardless of the truth of the statement. The statement is finite in that it states "Funding Secured." There's not much wiggle room in this statement. In this case, it does not depend "upon what the meaning of the word is is," Mr. President.
The brevity is the real problem, however. There are some defenses available to companies when making forward-looking statements, as this is considered. However, they are defenses that are dependent upon qualifying language - the "bespeaks caution" doctrine and safe harbor provisions of the Private Securities Litigation Reform Act. Because of his brevity, Musk used no qualifying or cautionary language. This is the reason that "forward looking statements" contained in shareholder letters contain paragraphs of cautionary language. Circumstances change. Deals fail. Buyers become emotional, sellers become emotional, someone doesn't really have the money, etc. Musk provided none of this. "Funding Secured." If that's the case, a shareholder could reasonably expect to be able to sell their shares a day or two later to someone for $420. Where is that notice? Why has nothing been filed with the SEC? The vagueness should be very concerning to all shareholders.
What about the word "considering?" Musk's lawyers will likely argue that the prior sentence was conditioned via the word "considering" and, therefore, a reader should realize that anything that follows is also conditioned. That argument is likely a non-starter, however. Remember, Rule 10b-5 aims to avoid potentially misleading statements. Despite the conditioning of the prior statement, it's easy enough to foresee the many ways that the second sentence could be misleading. Indeed, a public company CEO has an obligation to foresee and avoid these situations.
Yahoo Finance has an article on application of the so called "Reed Hastings Rule." In essence, this is SEC guidance from 2013 that allows social media announcements from public companies so long as investors have been alerted about which social media forum will be used to make statements. Hastings, CEO of Netflix, had announced on Facebook that Netflix users had exceeded one billion hours of content per month. A number of analysts have used this as a basis that Musk will see no repercussions. Jim Cramer, CNBC host, stated in the days following that the SEC favors Twitter as a means of dissemination of information - that they are essentially the same as Reuters. Quoted in the Yahoo article above, and found on his blog, Gene Munster of Loup Ventures stated, "We do not see any legal risk in disseminating material information on Twitter due to the Reed Hastings Rule." Unfortunately, both Cramer and Munster fail to recognize that the Reed Hastings Rule (actually, guidance) will not be a point of contention here. It's the content of the post that will be scrutinized under Rule 10b-5, not the fact that he used Twitter. Though differentiation is likely immaterial, Mr. Hastings was not making a forward-looking statement - he made a backward-looking statement. It was easily provable as factual (could sustain itself as merely a historical fact) and careful conditioning was unnecessary. Thus, the "Reed Hastings Guidance" (I'm going to go ahead and correct this term) is easily defeated if argued as a defense.
Another distraction is the question of whether Musk will pump and dump. Cramer has focused some on this. This is really immaterial to a 10b-5 prosecution. That would be a separate offense for which Musk would very likely see prison time. However, after all the news on this, I really doubt Musk is that detached.
Unfortunately, Musk's Board threw him under the bus with their statement. No one in the media appears to be reading the Board statement this way; however, when the SEC and DOJ come knocking, Board members are going to point to their collective statement and say "We clearly stated 'Elon opened a discussion with the board....'" See it now? The Board did their job and made a carefully crafted, conditioned, and cautionary statement that leaves a lot of wiggle room. These Board members are sophisticated investors with good attorneys at their disposal. They made a statement that is very protective of their interests. They point back to Musk in this, nothing else.
If there was truth to the $420 price offer, we needed more details and the proper forum for that announcement would have been a carefully crafted SEC filing or a release on the company website. The importance and vagueness of Musk's tweet render it patently misleading. There are too many details a shareholder expects with an offer of $420 per share on the table. Musk provided nothing. The truth of the statement, if it proves truthful, will not fix the vagueness. The tweet is by its very brief nature misleading.
Cramer and many other commentators expect the SEC to let this go, to give Musk a pass. Though we are currently a country with a Tweeter-in-Chief, I sincerely doubt the SEC will allow this precedent. The Reed Hastings Guidance cannot possibly be allowed to permit two sentence violations of Rule 10b-5. Doing so would eradicate the power and importance of Rule 10b-5. This is a fundamental modern shareholder protection rule, one that provides much of security to shareholders. Thus, we should expect the SEC "examination" will expand to an "investigation" shortly.
Finally, Pomerantz and many other law firms are going to bury Tesla in shareholder lawsuits, lawsuits that will be paid for by Tesla shareholders and bondholders. Musk gave his long-hated short sellers an early Christmas gift. That will chew up millions or billions of that precious cash Tesla needs to exist. I can only predict that Tesla and Mr. Musk will have a very interesting third and fourth quarter this year.
Full disclosure, I bought a short position in TSLA on August 8, 2018. This is the only position I've ever owned in TSLA.
"Am considering taking Tesla private at $420. Funding Secured," tweeted vanguard CEO of Tesla, Elon Musk, on August 7th at 12:48PM Eastern. All hell broke loose. People bought, people sold, people shorted. The stock was halted an hour and twenty minutes later. In that time, the stock increased twenty-nine Dollars per share. It ended the day eleven percent higher, an increase of nearly six billion Dollars in shareholder value. In the subsequent two days, the stock gave back most of that. The SEC announced they had some questions on August 8th. Six of the Tesla Board members subsequently issued the following statement:
"Last week, Elon opened a discussion with the board about taking the company private. This included discussion as to how being private could better serve Tesla’s long-term interests, and also addressed the funding for this to occur. The board has met several times over the last week and is taking the appropriate next steps to evaluate this."
If the stock ultimately finds its way back to the price prior to Musk's tweet, $342, there was still a huge amount of potential liability created by the tweet. With ten plus billion Dollars of movement, thousands of short sellers took losses on the way up and thousands of shareholders took losses on the way back down.
Though I don't teach or practice securities law, I took a semester of securities law while a student at GWU School of Law and hold a bar license in Texas. This analysis doesn't really require a law degree, however. SEC Rule 10b-5 states in pertinent part, "It shall be unlawful for any person...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...in connection with the purchase or sale of any security." For you non-lawyers, I've made this simpler to understand by highlighting the significant parts. In essence, ANY person can be held liable for making an untrue statement or omitting a detail necessary to avoid misinterpretation of a statement about a security. Because Mr. Musk made both a finite and brief statement, he's likely in trouble regardless of the truth of the statement. The statement is finite in that it states "Funding Secured." There's not much wiggle room in this statement. In this case, it does not depend "upon what the meaning of the word is is," Mr. President.
The brevity is the real problem, however. There are some defenses available to companies when making forward-looking statements, as this is considered. However, they are defenses that are dependent upon qualifying language - the "bespeaks caution" doctrine and safe harbor provisions of the Private Securities Litigation Reform Act. Because of his brevity, Musk used no qualifying or cautionary language. This is the reason that "forward looking statements" contained in shareholder letters contain paragraphs of cautionary language. Circumstances change. Deals fail. Buyers become emotional, sellers become emotional, someone doesn't really have the money, etc. Musk provided none of this. "Funding Secured." If that's the case, a shareholder could reasonably expect to be able to sell their shares a day or two later to someone for $420. Where is that notice? Why has nothing been filed with the SEC? The vagueness should be very concerning to all shareholders.
What about the word "considering?" Musk's lawyers will likely argue that the prior sentence was conditioned via the word "considering" and, therefore, a reader should realize that anything that follows is also conditioned. That argument is likely a non-starter, however. Remember, Rule 10b-5 aims to avoid potentially misleading statements. Despite the conditioning of the prior statement, it's easy enough to foresee the many ways that the second sentence could be misleading. Indeed, a public company CEO has an obligation to foresee and avoid these situations.
Yahoo Finance has an article on application of the so called "Reed Hastings Rule." In essence, this is SEC guidance from 2013 that allows social media announcements from public companies so long as investors have been alerted about which social media forum will be used to make statements. Hastings, CEO of Netflix, had announced on Facebook that Netflix users had exceeded one billion hours of content per month. A number of analysts have used this as a basis that Musk will see no repercussions. Jim Cramer, CNBC host, stated in the days following that the SEC favors Twitter as a means of dissemination of information - that they are essentially the same as Reuters. Quoted in the Yahoo article above, and found on his blog, Gene Munster of Loup Ventures stated, "We do not see any legal risk in disseminating material information on Twitter due to the Reed Hastings Rule." Unfortunately, both Cramer and Munster fail to recognize that the Reed Hastings Rule (actually, guidance) will not be a point of contention here. It's the content of the post that will be scrutinized under Rule 10b-5, not the fact that he used Twitter. Though differentiation is likely immaterial, Mr. Hastings was not making a forward-looking statement - he made a backward-looking statement. It was easily provable as factual (could sustain itself as merely a historical fact) and careful conditioning was unnecessary. Thus, the "Reed Hastings Guidance" (I'm going to go ahead and correct this term) is easily defeated if argued as a defense.
Another distraction is the question of whether Musk will pump and dump. Cramer has focused some on this. This is really immaterial to a 10b-5 prosecution. That would be a separate offense for which Musk would very likely see prison time. However, after all the news on this, I really doubt Musk is that detached.
Unfortunately, Musk's Board threw him under the bus with their statement. No one in the media appears to be reading the Board statement this way; however, when the SEC and DOJ come knocking, Board members are going to point to their collective statement and say "We clearly stated 'Elon opened a discussion with the board....'" See it now? The Board did their job and made a carefully crafted, conditioned, and cautionary statement that leaves a lot of wiggle room. These Board members are sophisticated investors with good attorneys at their disposal. They made a statement that is very protective of their interests. They point back to Musk in this, nothing else.
"Elon opened a discussion with the board...included discussion as to how being private could better serve Tesla’s long-term interests...addressed the funding for this to occur."Let's examine the latter two parts further. "Included discussion as to how..." blah, blah, blah. This says nothing. It's perfectly-conditioned space filler. "Addressed the funding..." is stronger than "Discussed the funding...;" however, if funding or potential funding exists, they could have said something strong like, "We are evaluating, and do acknowledge, a potential source of financing that would potentially yield an offer price of $420 per share for those shareholders wanting to sell. We cannot at this time divulge that source of financing." So, I ask, if a source of funding exists, and a price of $420 is feasible, why was the Board so vague? A stronger statement, such as the one above, would provide cover for their CEO and give the Board members plenty of flexibility in the event of further fallout. They did not acknowledge any offers. They did not acknowledge any financing or even potential financing. They only acknowledged that Musk brought them the idea and they discussed it. If the tweet proves false, the Board has deftly left Musk out in the cold.
If there was truth to the $420 price offer, we needed more details and the proper forum for that announcement would have been a carefully crafted SEC filing or a release on the company website. The importance and vagueness of Musk's tweet render it patently misleading. There are too many details a shareholder expects with an offer of $420 per share on the table. Musk provided nothing. The truth of the statement, if it proves truthful, will not fix the vagueness. The tweet is by its very brief nature misleading.
Cramer and many other commentators expect the SEC to let this go, to give Musk a pass. Though we are currently a country with a Tweeter-in-Chief, I sincerely doubt the SEC will allow this precedent. The Reed Hastings Guidance cannot possibly be allowed to permit two sentence violations of Rule 10b-5. Doing so would eradicate the power and importance of Rule 10b-5. This is a fundamental modern shareholder protection rule, one that provides much of security to shareholders. Thus, we should expect the SEC "examination" will expand to an "investigation" shortly.
Finally, Pomerantz and many other law firms are going to bury Tesla in shareholder lawsuits, lawsuits that will be paid for by Tesla shareholders and bondholders. Musk gave his long-hated short sellers an early Christmas gift. That will chew up millions or billions of that precious cash Tesla needs to exist. I can only predict that Tesla and Mr. Musk will have a very interesting third and fourth quarter this year.
Full disclosure, I bought a short position in TSLA on August 8, 2018. This is the only position I've ever owned in TSLA.
Comments
Post a Comment