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Musk’s Tesla Fun Does Not Amuse SEC

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Tesla Securities Fraud Lawsuit Watch 2018.

Look, I don’t know what to tell you. Elon Musk publicly announced, on Aug. 7, on Twitter, that he was considering taking Tesla Inc. private at $420 per share, that he had “funding secured,” that “investor support is confirmed,” and that he had a structure that would allow all of Tesla’s public shareholders to keep their shares in a private Tesla if they wanted to. All of those statements seemed very implausible at the time, and as days went by with no confirmation or clarification, it became pretty evident that they were false. Eventually Musk admitted that he had not actually secured any financing, that investors did not support the idea, and that there was no way for retail shareholders to roll over into a private company, so he abandoned the going-private plan three weeks after announcing it. You can’t do that. You can’t announce your plans to buy a public company unless the announcement is more or less true. Even if you’re just floating the idea, and don’t mean it to be taken too seriously, investors will take it seriously. The stock went up on Musk’s announcement, and then went down when it became clear he was kidding. The people who believed Musk, and bought stock thinking it would go to $420, were deceived, and lost money. That is what we in the business tend to call “securities fraud.” When dealing with any sort of business deals with regards to finance, you will need to do some research, communicate with others, networking, and reading reviews, you can find a CFD Broker and find a trustworthy one to get information from and decide which financial route you would like to take. You do not want to get into any fraudulent difficulties.

Yesterday the Securities and Exchange Commission filed a securities fraud lawsuit against Musk, and, duh. Two days after Musk’s original tweet, I wrote:

Of course the SEC is looking into this. I can’t think of a thing that the SEC would look into more. If Warren Buffett was giving insider tips about accounting fraud at the Fed to Lloyd Blankfein so that he could help Donald Trump and the pope insider trade against the Illuminati, the SEC team investigating that would be scheming to get transferred to the Elon Musk team.

It only got more obvious after that. Here is the SEC’s complaint, which is about as open-and-shut an SEC complaint as you’ll see. You could write a pretty compelling securities fraud complaint based solely on Tesla’s and Musk’s public statements—and lawyers have!—but the SEC also interviewed Musk and Tesla about what happened, and the results of its investigation inform its complaint, and they’re even worse.

For instance, the basis for Musk’s claim that funding was secured was a single meeting with the Saudi sovereign wealth fund that lasted “approximately 30 to 45 minutes” and “lacked discussion of even the most fundamental terms of a proposed going-private transaction,” including things like how much capital the fund was able or willing to invest and at what price. And:

According to Musk, at the close of the July 31 meeting, the lead representative of the Fund asked Musk to tell the Fund how he wanted to do a going-private transaction and represented that so long as the terms were “reasonable,” the Fund would be fine with them. Musk acknowledged that no specific deal terms had been established at the meeting and that there was no discussion of what would or would not be considered reasonable. Nothing was exchanged in writing, and there was no discussion of confidentiality. Musk did not communicate with representatives of the Fund again about a going-private transaction until August 10, three days after his August 7 statements.

Based on those conversations, Musk emailed Tesla’s board with the subject line “Offer to Take Tesla Private at $420.” The board told him that it would be “really difficult for small investors” to keep their shares in a private Tesla, but gave him permission to contact some shareholders about the idea “and asked him to report back to the board on those conversations.”

He did not do that, or much of anything else really:

Between the July 31 meeting with representatives of the Fund and the morning of August 7, Musk (1) did not have any further substantive communications with representatives of the Fund; (2) did not discuss a going-private transaction at a share price of $420 with any potential funding source; (3) had a conversation with a private equity fund representative about the process, but did not actually contact any additional potential strategic investors to assess their interest in participating in a going-private transaction; (4) did not provide Tesla’s Board of Directors with a more specific proposal to take Tesla private; (5) did not contact existing Tesla shareholders to assess their interest in remaining invested in Tesla as a private company; (6) did not formally retain any advisors to assist with a going-private transaction; (7) did not determine whether retail investors could remain invested in Tesla as a private company; (8) did not determine whether there were restrictions on illiquid holdings by Tesla’s institutional investors; and (9) did not determine what regulatory approvals would be required for such a transaction or whether they could be satisfied.

So, no funding, no deal structure, no investor support, no advisors. Instead he just tweeted about it. Tesla was … surprised.

At 1:00 PM EDT, approximately 12 minutes after Musk published his tweet stating, “Am considering taking Tesla private at $420. Funding secured,” Tesla’s own head of Investor Relations sent a text to Musk’s chief of staff asking, “Was this text legit?”

That head of IR is a heartbreaking character. It’s not clear what if any response he got to his text, but in any case he decided that the offer was legit, and bravely went ahead trying to convince investors that everything was good and normal. He told three different investment bank research analysts “yes, there is a firm offer,” “Elon’s first tweet, which mentioned ‘financing secured’ is correct,” and:

“The very first tweet simply mentioned ‘Funding secured’ which means there is a firm offer. Elon did not disclose details of who the buyer is.” The analyst then asked, “Firm offer means there is a commitment letter or is this a verbal agreement?” The head of Investor Relations responded, “I actually don’t know, but I would assume that given we went full-on public with this, the offer is as firm as it gets.”

It was not as firm as it gets. But what could he do? His job was to relate to investors, and his chief executive officer had made a highly material announcement about the future of his company, and investors had questions for him, and the questions all boiled down to “is this announcement true or is your CEO nuts,” and he just chose to assume that the announcement was true, because the alternative was unthinkable. That was a damaging decision: By translating Musk’s random Twitter nonsense into normal corporate language, he probably made investors take it more seriously. But it’s hard to blame him for that. The problem is that Musk is the head of a big normal-ish public-company, but is not himself a normal-ish public-company CEO. He is not domesticated enough to communicate normally and accurately, but there is a public-company apparatus around him that relies on him to do that, and that gets all jammed up when he doesn’t.

Oh also yes fine the weed thing:

According to Musk, he calculated the $420 price per share based on a 20% premium over that day’s closing share price because he thought 20% was a “standard premium” in going-private transactions. This calculation resulted in a price of $419, and Musk stated that he rounded the price up to $420 because he had recently learned about the number’s significance in marijuana culture and thought his girlfriend “would find it funny, which admittedly is not a great reason to pick a price.”

I am going to defend Musk on that one a little. Everything else here is insane and terrible, but “take the trading price and add 20 percent” seems to me to be a perfectly normal and reasonable way to calculate a preliminary price to start buyout negotiations. People who expected Musk to do a thorough discounted cash-flow analysis have an overly rosy view of how merger negotiations normally work, and of how Tesla is valued for that matter. “Take the trading price, add 20 percent, and round to a number that’s a weed joke because your girlfriend will find it funny” is … less standard, sure, but you gotta keep yourself entertained. I have no real problem with this.

I will make one more point in Musk’s defense, which is: This is very obvious securities fraud, but it is not especially bad securities fraud. To prove a civil securities fraud case the SEC needs to show that “Musk knew or was reckless in not knowing that his August 7 statements were false and misleading,” and the evidence mostly points to recklessness. Musk’s statements were false, but there is no real reason to think that he was intentionally lying. He was just, like, being Elon Musk: a character, a dreamer, an unfiltered Twitter addict, and a guy with a long history of promising a lot of wildly ambitious nonsense and then delivering like half of it. There is no evidence of any malicious intent or knowing deception here; the SEC points (as I have) to Musk’s public statements about the “short burn of the century” to suggest that blowing up short sellers might have motivated him, but it doesn’t lean particularly hard on that idea. Nor of course does it argue that Musk made any money on this nonsense; there is boilerplate in the complaint about ordering Musk to disgorge “any ill-gotten gains,” but no suggestion that there actually were any.

It seems pretty clear that Musk announced that he wanted to take Tesla private, not because he had a secret plan to burn the short sellers or enrich himself by deceiving shareholders, but because he wanted to take Tesla private, and because he was hazy and over-optimistic and, yes, reckless about what that would involve.

And while investors were deceived and lost money, they weren’t that deceived, or for that long. “At the end of August 7, after Musk’s tweets and the post on Tesla’s blog, the stock closed at $379.57, up 6.42% from just prior to the first tweet,” says the SEC, a big absolute gain—I once estimatedthe damages to shareholders from Musk’s tweets at between $600 million and $1.4 billion—but also nowhere close to Musk’s supposed deal price, suggesting that investors were skeptical from the beginning. They got more skeptical within days, and the whole stupid drama was over in three weeks. This was not a long-running fraud about the basic facts of a large public company. It was just a dumb lark that provided some entertainment for a few weeks.

You can tell that the SEC also thinks the fraud wasn’t that bad, because it offered Musk a pretty generous settlement. CNBC reports:

Tesla and the Securities and Exchange Commission were very close to a no-guilt settlement Thursday, reported CNBC’s Andrew Ross Sorkin on Friday, citing sources. But, these people say Musk pulled out of the agreement at the last minute.

Under the terms of the deal, Musk and Tesla would have had to pay a nominal fine, and he would not have had to step down as an officer. Musk reportedly refused to sign the deal because he felt that by settling he would not be truthful to himself, and he wouldn’t have been able to live with the idea that he agreed to accept a settlement and any blemish associated with that, the sources said.

If I ran the SEC I would have done the same, except instead of a “nominal fine” I’d have demanded a “whopping great fine.” Musk is rich, and this is all idiotic, and you have to make it clear that you take it seriously. But barring him from running a public company seems counterproductive for a regulator whose mission is to protect shareholders, because Musk’s presence, annoying as it is, really does seem to be essential for Tesla shareholders. After the SEC sued (and sought a director-and-officer ban), the stock opened down 12.1 percent this morning, giving shareholders losses of about $6.4 billion, which is way more than anyone lost due to Musk’s tweets.

But Musk walked away from the settlement and decided to fight:

“I have always taken action in the best interests of truth, transparency and investors,” he said in a statement. “Integrity is the most important value in my life and the facts will show I never compromised this in any way.”

And so the SEC sued and is seeking a director-and-officer ban. I doubt that the SEC exactly wants that—it has already made clear its willingness to settle without it, and putting the demand in the complaint gives it leverage to extract a settlement—but it has to ask.

What will happen now? Well, the rational thing is that everyone will realize that they don’t want to fight over this, they’ll sign a settlement much like the earlier one, except with a bigger fine, and Musk will agree to lay off Twitter for a bit. And then he can get back to running the company and building cars. But surely the last few months at Tesla have taught us that the rational outcome is never the most likely outcome, that Musk has an unquenchable craving for drama and distraction, and that just running a car company (and a rocket company) (and a Boring Company) and executing on his vision(s) is not enough to keep him occupied and engaged. Musk, remember, baselessly called a stranger a “pedo guy” on Twitter, apologized for it, and then un-apologized when he decided that he’d rather be sued. Why would he treat the SEC any differently? Why settle, pay a small fine, and move on with your life, when you can have a distracting and high-risk fraud lawsuit to occupy your time and attention? Surely Musk owes it to himself, and his shareholders, to make this as difficult and complicated and contentious and risky as possible? What else did the shareholders think they were signing up for?

By the way.

Yesterday was a busy and emotionally draining day for a lot of us for reasons that have nothing to do with Tesla. Anticipating that, I wrote on Wednesday:

If you have some sort of terrible fraud or huge operational error to announce, consider doing it tomorrow, because no one will care. Like if Tesla Inc. announced tomorrow that Elon Musk stole all its money and fled on a rocket to Mars, it probably wouldn’t even be front-page news.

I … was … pretty close? I mean, it’s weird, you can see why Tesla would want to bury the SEC news, but I am not sure why the SEC would, and they were the ones who announced it. In any case, a reader emailed me last night:

I sent your piece about TSLA potentially announcing something today around to some friends yesterday (cuz I thought it was funny) and one guy took it seriously and spent $150 on $295 puts expiring this Fri. According to him they’re now worth $35K.

I don’t know if this is true, but Sept. 28 $295-strike Tesla puts closed at 29 cents yesterday, and opened at $24.91 today, so it’s in the ballpark of possibility. I want to emphasize that nothing in this newsletter is ever investing advice, but if a joke of mine caused someone to make a windfall by buying short-dated out-of-the-money options that correctly anticipated an SEC enforcement action, then honestly that is a pretty good encapsulation of what this newsletter is about, and I am glad that the SEC and this anonymous friend-of-a-reader cooperated to make this happen for me.

Penny stocks.

Let’s assume that it is dumb and reckless and unnecessarily risky to own penny stocks. (Is that true? Maybe, but let’s just assume it for now.) If you go to your broker and say “what should I buy” and she says “buy this penny stock, it is great,” then she is, on our assumptions, doing a bad job. She is neither recommending a suitable investment nor acting in your best interests. Bad job!

But what if you go to your broker and say “hey here’s a penny stock I really like, please buy 1,000 shares of it for me”? Should she buy it for you? There’s a pretty good argument that she should: You’re the customer, she’s the stockbroker, it’s perfectly legal to buy penny stocks, you’re all adults. Maybe she should try to talk you out of it, but if you’re adamant, it’s really your decision. The argument that she shouldn’t is more complicated. Part of it is, if things go wrong, there will be some factual debate over whether you were really an adult making your own decisions: Did you know the risks? Did she warn you? Was she actually the one who suggested the stock to you? But part of it is also a realization that full-service retail stockbrokers are rarely pure execution brokers; they normally have some advisory relationship with their customers even if they are not technically advisers, and it just looks like bad advice if you keep helping your customer buy bad stocks. If you want to know more about stocks with detailed stock reports, check out Stocktrades.ca. They can provide some useful insight.

One basic theme of modern retail stockbroking is that it is evolving from a caveat-emptor, “we just put the products on the shelves and you can buy whatever you want” set of expectations to more of a fiduciary/advisory set of expectations. Finance is complicated, and there are so many products, and there are so many ways for brokerages to make money selling them to you, and there is just a lot of suspicion of the idea that retail customers know what they want and that brokers can just neutrally give it to them. There is a growing expectation that brokers will be, if not fiduciaries, at least a little paternalistic. Anyway:

Penny stocks are no longer welcome at Bank of America’s Merrill Lynch brokerage. … The bank’s Merrill Lynch division banned purchases of the risky securities in late July, according to the people, who declined to be identified speaking about the move. About six weeks later, the bank abruptly said that it was restricting clients’ sales of penny stocks, then amended that policy to give financial advisers more time to exit positions, the people said. ….

“We were told to get rid of them by a certain date,” said one Merrill Lynch broker. “I called compliance today to say my client doesn’t want to do that. Now they’re telling me he doesn’t have to sell, but it could be hard to get rid of it down the road.”

Yeah look, get it in writing from that guy that he understands the risks and doesn’t want to sell.

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