Tesla: Musk Fought the Law, the Law Won, So What?
CEO Elon Musk forced to step down, but refuses to back down.
CEO Elon Musk is stepping down as Chairman of Tesla (TSLA) for three years as part of a settlement just reached with the SEC related to his aborted scheme in August to take the company private.
Musk and Tesla each will pay $20 million in fines; Tesla is compelled to appoint two new independent directors and create a new committee of independent directors responsible for Musk-oversight.
Few expected Musk and Tesla not to settle with the SEC, but it is surprising that it happened so fast. Of course, given the extreme pressure Musk and the company face with executing ambitious results in the vital third quarter which closes tomorrow, the fewer dark overhangs the better.
Signs are the company is scrambling with delivery and production problems right up to the wire—a bad sign of potentially weaker than expected revenue and profits as I have projected. But we'll see.
The SEC's latest deal is tougher versus the one Musk impetuously walked away from Thursday morning, which prompted the SEC to file a lawsuit Thursday night accusing Musk of fraud and seeking to bar him from serving as an officer or director of any public company.
The SEC settlement is a good start to addressing Tesla’s serious management deficiencies, but there's much more to do—as I most recently discussed again in What Tesla Can Learn From Navistar About Arrogant Management, Serious Mistakes, and Survival.”
No Joke
Tesla stock and bonds were in free fall Friday after news broke late Thursday that the SEC had filed a lawsuit against CEO Elon Musk suing him for fraud related to his aborted scheme in August to take the company private, for which the SEC also seeks to bar him from serving as an officer or director of a public company.
It's hardly unexpected that Musk could face serious consequences following his buyout debacle—the Department of Justice has also started a criminal investigation which coincided with the SEC’s probe.
It was surprising that the typically lumbering SEC had taken such serious action so quickly, and even more disturbing when we learned why.
The Wall Street Journal reported the SEC actually had “rushed to pull together the complaint it filed” after Musk suddenly abandoned a settlement finalized Thursday morning. Musk decided to fight the SEC’s accusations instead because, as it turned out, his ego couldn't take it.
Super good. Musk refused to accept blame for his self-made calamity no matter what, even after he already admitted he actually had no deal, no buyers, no funding, not even a supportable price worked out, even when his destructive management destroyed value, and even when exacerbating his mounting legal troubles could take the company and all its stakeholders down with him.
As expected, the SEC found that Musk made “false and misleading public statements and omissions” that generated “significant confusion and disruption in the market for Tesla’s stock and resulting harm to investors,” saying Musk:
“falsely indicated that, should he so choose, it was virtually certain that he could take Tesla private at a purchase price that reflected a substantial premium over Tesla stock’s then-current share price, that funding for this multi-billion dollar transaction had been secured, and that the only contingency was a shareholder vote.”
The SEC cited Musk’s often expressed hatred and frequent taunting of short-sellers as a potential motive for juicing the stock price, and that his proposed $420 buyout price actually was decided as an inside joke about marijuana culture to amuse his girlfriend.
No one was laughing.
And as I observed when he abandoned the whole stunt three weeks later, Musk’s escapade “triggered a tsunami in volatility for investors in Tesla, resulting in a swing and then evaporation of some $13 billion in market cap for the company as the stock plunged to as low as $300 per share before recovering somewhat to $323 as of Friday's close.
That's down 6%—$3.3 billion lost in market cap versus where the stock closed the day before Musk's shocking announcement via tweet that he wanted to take Tesla private with "funding secured” (see Tesla’s Take-Private Plan: Never Mind) on 8/26/18).
The fallout continues. The stock now is down 23% since the day before the buyout tweet to $265 per share.
Yet, in light of Musk’s obviously “reckless” behavior, as the SEC characterized it, and the substantial harm to shareholders he caused, the SEC offered a remarkably benign settlement.
The final terms SEC offered Thursday morning called for Musk to step down as Chairman for two years and for Musk and Tesla to pay a nominal fine of “tens of millions.”
Tesla also would be compelled to name two new independentdirectors—which is a really good idea. Finally, Musk must agree to neither “admit nor deny” any guilt.
Screeetch! What was that last part?
Yup. Musk walked away from the deal because he couldn’t tell the world he did nothing wrong, which actually is yet another arrogantly false statement.
Musk explained:
“This unjustified action by the SEC leaves me deeply saddened and disappointed. I have always taken action in the best interests of truth, transparency and investors. Integrity is the most important value in my life and the facts will show I never compromised this in any way.”
Yeah, that doesn’t ring true either.
Incensed, the SEC filed its lawsuit against Musk by the end of the day Thursday with a trial date set for February 1st, setting the stage for potentially months of additional melodrama and screaming headlines (and snarky Elon tweets) Tesla certainly doesn't need.
Then Saturday the showdown was surprisingly over when Musk accepted a much less favorable deal which allows him to keep his job as CEO—subject to important new conditions.
Restrictions Apply
Terms of the SEC settlement, which are subject to court approval, clearly are aimed at addressing serious management failures I also have long attributed to Musk and Tesla's closely tied and deeply entrenched board which has rubber-stamped his every decision and remained “fully confident in Elon, his integrity, and his leadership of the company"—no matter what he did.
The SEC explained:
“The total package of remedies and relief announced today are specifically designed to address the misconduct at issue by strengthening Tesla’s corporate governance and oversight in order to protect investors,” said Stephanie Avakian, Co-Director of the SEC’s Enforcement Division.
“As a result of the settlement, Elon Musk will no longer be Chairman of Tesla, Tesla’s board will adopt important reforms —including an obligation to oversee Musk’s communications with investors—and both will pay financial penalties,” added Steven Peikin, Co-Director of the SEC’s Enforcement Division. “
The resolution is intended to prevent further market disruption and harm to Tesla’s shareholders.”
Musk and Tesla have agreed to settle the charges against them without admitting or denying the SEC’s allegations. Among other relief, the settlements require that:
Musk will step down as Tesla’s Chairman and be replaced by an independent Chairman. Musk will be ineligible to be re-elected Chairman for three years;
Tesla will appoint a total of two new independent directors to its board;
Tesla will establish a new committee of independent directors and put in place additional controls and procedures to oversee Musk’s communications;
Musk and Tesla will each pay a separate $20 million penalty. The $40 million in penalties will be distributed to harmed investors under a court-approved process.
It's a Good Start, but...
It's critical that Musk and Tesla realize the SEC actually let them off lightly.
Criminal investigations continue and those investigators will be paying close attention to how Musk and Tesla proceed. So will shareholders who have filed numerous lawsuits alleging securities fraud.
Tesla's new chairman must be a truly independent, seasoned auto industry veteran who can demonstrate management strength, operating prowess, and help begin to restore the company's shredded credibility.
New directors Tesla is compelled to add must be truly independent, and the company should increase its board to at least 12 directors to ensure demonstrable management oversight.
Tesla's board should create and publish new standards for management oversight, accountability, and public communication.
Tesla must install and retain a broad-based bench of seasoned auto industry veterans who can help Musk lead and help Tesla execute its critical transition into a sustainable carmaker. Better-healed rivals are bringing strong competition for 2019.
Tesla needs to replace and retain top-flight accounting and finance execs to ensure there are no worrisome financial irregularities. If there are problems, get them fixed and install appropriate compliance and controls before the year closes for audited financial statements. Too many high-level finance folks leaving too frequently have raised serious concerns. Getting seasoned, credible management in place early can head off problems and damaging fallout later.
Bolstering its finance team also can help ease growing concerns from Tesla's wary suppliers, creditors, bondholders, and investors that the company can appropriately manage its troubling liquidity pressure and the potential need for additional funding while it navigates at least three more difficult quarters before the company becomes convincingly self-sustaining.
Musk must tow the line—his vision and passion are needed and desired, not his frat boy antics which have severely damaged Tesla and its prospects.
Musk may not believe it, but the SEC's quick and decisive action may have forced him and the board to grow up a little—truly a gift considering how challenging the next 6-9 months could prove to be as the company becomes viable, or not.
Whether he has learned anything that sticks remains to be seen.
I remain wary for the foreseeable future, however, given my expectation that Tesla will fall short of management's guidance and market estimates for third-quarter results.
Maintain “Underperform” on TSLA 5.3% Senior Notes due 2025, last seen at 84.4 (8.3% ytw; 530 bps)—down nearly 6 points since 8/15/18 when I initiated coverage. Given Tesla's persistently volatile situation we still could see 3-5 points additional downside from here.
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