25 April 2019 | By Michael Thaidigsmann
Tweeting yourself into legal trouble
New York’s Southern District court is currently hearing a high-profile case pitting the US Securities and Exchange Commission against Tesla CEO Elon Musk.
Elon Musk is widely known for his erratic and unpredictable public statements, especially on Twitter. Earlier this month, the flamboyant founder and CEO of the electric car company Tesla admitted to it himself: “I was always crazy on Twitter fyi,” he tweeted.
Musk has more than 26 million followers on Twitter. Although his posts are often very short, they have repeatedly provoked the ire of the US Securities and Exchange Commission (SEC).
In September 2018, the SEC started legal action against Musk and his company. The CEO had claimed on Twitter a few weeks earlier that he could take Tesla private at $420 per share – a significant premium to the trading price. He also claimed that funding for such a transaction had been secured. The only thing still missing was shareholder approval.
The SEC alleged that Musk knew any transaction was a lot more uncertain than he had suggested. The commission also alleged that the Tesla boss had not discussed specific deal terms, including price, with any of his potential financing partners. Tesla’s stock price jumped by over six percent on the day of the Musk tweet, which according to the SEC led to “significant market disruption.” The SEC wanted to force Tesla to have a securities lawyer (either in-house or external) pre-approve all Musk tweets that “reasonably could contain” information relevant to the publicly listed car maker’s business activities.
Tesla immediately agreed to settle charges that it had failed to put adequate disclosure controls and procedures in place. While Musk, pursuant to the settlement, stepped down as Tesla Board chairman and although both he and the company agreed to pay a $20 million penalty each, Musk provoked the SEC’s ire in February 2019 when he posted a tweet claiming Tesla would build 500,000 electric cars in 2019 – significantly more than the company itself had announced previously.
The price of Tesla shares in the past six months was very volatile and oscillated between $240 and $370. Many traders were apparently following Musk’s announcements on Twitter.
Already back in 2013, Tesla announced that its CEO’s personal account would be used as a means of announcing company information. However, the SEC said the car maker had not put any “disclosure controls or procedures in place to determine whether Musk’s tweets contained information required to be disclosed.” Moreover, the company did not have sufficient processes in place to ascertain that Musk’s tweets were accurate.
Interpretation of settlement terms contested
Under US law, a consent decree is an agreement or settlement that resolves a dispute between two parties under the supervision of a court and usually without any admission of liability. Such decrees are frequently used by US courts to ensure that businesses adhere to regulations in domains such as antitrust, employment discrimination or environmental protection. In October 2018, US District Judge Alison Nathan approved the settlement between the SEC and Tesla.
Following Musk’s February 2019 tweet, the SEC seized the Southern District Court of New York again and filed a motion of contempt against Musk. The authority cited a total of 15 tweets by the Tesla CEO that had allegedly violated the terms of the settlement.
Musk was accused by the watchdog of “recklessly tweeting out material information that had no basis in fact.” The Tesla CEO hit back at the SEC and suggested that the commission’s oversight was “broken.” That tweet was deleted a little later.
In court, SEC lawyers argued that not every Musk tweet needed to be pre-approved, specifically referring to conversations with Tesla customers, but they stressed that Musk was in contempt of the settlement. Musk’s lawyers said the wording of the settlement was too vague to form the basis for any contempt finding. The Tesla CEO and his staff had a hard time interpreting those rules.
To the surprise of many observers, Nathan did not rule on the motion, but ordered the two parties to work out their differences. The judge said she had “serious concerns that no matter what I decide here, this issue won’t be resolved” and urged both sides needed to specify what the terms in their 2018 settlement agreement meant in practice, and specifically what constituted a communication that “reasonably could contain” relevant and material information about Tesla’s business.
What constitutes ‘material information’?
At the heart of the issue is a potential conflict between the First Amendment of the US Constitution, which guarantees free speech, and the provisions of the 1933 US Securities Act and subsequent laws that require publicly listed companies to disclose all material information that shareholders require with respect to potential investments.
Information is considered material if it likely affects investment decisions. This has been defined by Supreme Court case law. However, the words contained in the settlement (“reasonably could contain”) are novel and according to the SEC make the standard broader than materiality given the specific circumstances. The SEC attorney said it was probably the first time the watchdog had used such language in an enforcement order.
For Professor John Coffee, director of Columbia University Law School’s Center of Corporate Governance, the court case threatened “to undercut the SEC’s contempt power, which it rarely uses but is its ultimate sanction for noncompliance. Letting Musk decide for himself what is material is much like allowing students to grade their own calculus exams,” Coffee wrote on the CNN news website. The SEC needed “to be able to enforce the settlements it strikes with those who violate its rules.”
Other legal experts disagreed. Andrew Vollmer, a law professor at the University of Virginia and a former SEC counsel, told the ‘Wall Street Journal’: “The original settlement is a dangerous precedent – having the US government order an individual to have prospective public statements reviewed in advance and be subject to disapproval.”
Settlement at the 11th hour
On 26 April 2019, Musk and the SEC finally reached a settlement spelling out in detail in which situations the Tesla boss must secure legal approval before hitting the ‘Tweet’ button.
They concern messages touching on: information about the company’s financial condition or guidance, potential or proposed mergers, acquisitions or joint ventures; production numbers or sales or delivery numbers, including forecasts; new business lines unrelated to existing ones; the projection of figures concerning Tesla’s business that were not previously provided in official company guidance; events regarding the company’s securities; legal or regulatory findings or decisions that are not previously published; and appointments to the Board of Directors or any other senior post in the company
As of 29 April, Judge Alison Nathan still needed to approve that settlement. But in the meantime, Elon Musk already took to Twitter. Among other things he posted pictures of spaceships on Mars and on the Moon. It is unclear whether the tweets had the approval of a securities lawyer…