On September 27, 2018, the Securities and Exchange Commission (SEC) filed charges against Tesla Chairman and CEO Elon Musk for violating federal securities laws. See Complaint, SEC v. Musk, No. 1:18-cv-8865 (S.D.N.Y. Sept. 27, 2018). Two days later, after filing charges against Tesla itself, the SEC announced it had reached a settlement with both Musk and Tesla. Press Release, U.S. Sec. & Exch. Comm’n, Elon Musk Settles SEC Fraud Charges; Tesla Charged With and Resolves Securities Law Charge (Sept. 29, 2018). Pending judicial approval, the settlement will remove Musk as chairman for three years, force Tesla to appoint two new independent directors to Tesla’s board and cost both Musk, and Tesla $20 million in penalties. Id.

Charges Against Musk

Musk was charged with violating Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and Rule 10b-5. Complaint, Musk, No. 1:18-cv-8865. This section of the Exchange Act and Rule 10b-5 is meant to protect investors from fraud in relation to the sale and purchase of securities. See 15 U.S.C. § 78j(b), 17 C.F.R. § 240.10b-5. Rule 10b-5 prohibits 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.” 17 C.F.R. § 240.10b-5. These charges arise from Musk’s tweets during August of 2018 stating that he was considering taking Tesla private for $420 a share, and that funding was secured. Complaint at 10, Musk, No. 1:18-cv-8865. The SEC alleges that funding was never secured, no formal proposal from the funding source ever existed and the $420 share price was an arbitrary amount Musk came up with. Id. at 16–17. By making these public statements that were not necessarily true and by omitting some information through his tweets, Musk misled Tesla investors.

Charges Against Tesla

The complaint against Tesla alleges that Tesla failed to have sufficient procedures and controls in place to monitor Musk’s disclosure of information through his tweets. Complaint at 2, SEC v. Tesla, No. 1:18-cv-8947 (S.D.N.Y. filed Sept. 29, 2018). Under the Exchange Act, management must have controls and procedures in place to ensure that disclosed information conforms to federal securities laws and SEC rules and regulations. 17 C.F.R. § 240.13a-15(a), (e). The SEC alleges that by failing to review Musk’s tweets prior to publication and failing to have processes to ensure that Musk’s tweets included accurate information, Tesla violated the Exchange Act. Complaint at 7–8, Tesla, No. 1:18-cv-8947.

Proposed Settlement

While in its complaint against Musk the SEC sought to remove Musk as both an officer and a director, the proposed settlement only removes Musk as chairman. Press Release, U.S. Sec. & Exch. Comm’n, Elon Musk Settles SEC Fraud Charges; Tesla Charged With and Resolves Securities Law Charge (Sept. 29, 2018). The settlement also requires the appointment of an independent chairman, two new independent directors to Tesla’s board, a new committee of independent directors, additional controls and procedures to monitor Musk’s communications, and $20 million in penalties against both Musk and Tesla which will be distributed to harmed investors. Id.

Had there been no settlement, the SEC would have to prove that Musk:

  1. Directly or indirectly made untrue statements of material fact, or
  2. 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
  3. In connection with the purchase or sale of securities,
  4. With scienter. See Complaint at 21, SEC v. Musk, No. 1:18-cv-8865 (S.D.N.Y. filed Sept. 27, 2018).

Material facts are facts in which there is a substantial likelihood that a reasonable investor would find the information significant given the total mix of information. See TSC Indus. v. Northway, 426 U.S. 438, 449 (1976). Arguably, the SEC has a strong case that reasonable Tesla investors would want to know whether funding to take the company private actually exists and is secured, and whether a $420 share price is based on Tesla’s financial position or is arbitrarily created.

Chairman of the SEC Jay Clayton released a statement supporting the settlement and stated that “when companies and corporate insiders make statements, they must act responsibly, including endeavoring to ensure the statements are not false or misleading and do not omit information a reasonable investor would consider important in making an investment decision.” See Press Release, Jay Clayton, Chairman, U.S. Sec. & Exch. Comm’n, Statement Regarding Agreed Settlements with Elon Musk and Tesla (Sept. 29, 2018).  Chairman Clayton’s statement is in line with the disclosure-based regime the SEC has created through its federal securities laws. Federal securities laws, such as Rule 10b-5, are not concerned with whether investors are getting a good deal, but rather that investors are able to make informed decisions through disclosures by companies, even if such disclosure comes in the form of 280-characters.