The Ongoing Battle Between Musk and the SEC Heats Up Again

March 30, 2022

Elon Musk’s Tumultuous History With the SEC

Tesla’s colorful CEO, Elon Musk, has a history of feuding with the Securities and Exchange Commission (SEC), and it looks like the fight isn’t over. In 2018, the SEC investigated Musk for securities fraud after he tweeted that he could take Tesla private for $420 a share, a significant premium over the trading price at the time. When Musk was unable to provide any support for the $420 price (likely a cannabis reference), he stepped down as Tesla’s chairman (but remained CEO) and Musk and Tesla each paid a $20 million fine and submitted to ongoing SEC monitoring. Musk has remained vociferously unrepentant and seems unwilling to give up his habit of tweaking the SEC with his tweets.

On Nov. 6, 2021, Musk, referring to a proposed tax on unrealized capital gains that ultimately stalled, tweeted:

“Much is made lately of unrealized gains being a means of tax avoidance, so I propose selling 10% of my Tesla stock. Do you support this? Yes / No.”

With more than 3.5 million votes, almost 58% were in favor of selling. The market didn’t react well to the poll, and the price of Tesla’s stock dropped 5% the day following the tweet and eventually more than 30% from pre-tweet levels. On Nov. 8, 2021, Musk began selling billions of dollars of Tesla stock (a total of $16 billion by the time he stopped selling at year-end).

On Nov. 5, 2021, the day before Musk’s tweet, his brother Kimbal Musk, who is also a Tesla director, sold 88,500 shares of Tesla stock on the open market for $108 million, avoiding millions of dollars of losses had he sold after the tweet and the subsequent stock price slide. Was the timing purely coincidental, or did Musk tip his brother off about his tweet in advance so that Kimbal could avoid the foreseeable drop in the stock price if Musk threatened to dump 10% of his stock into the market? According to the Wall Street Journal, the SEC wants to know as well.

In an email to the Financial Times, Musk said that Tesla’s lawyers were “aware” of his plans, but that “Kimbal had no idea I was going to do a Twitter poll.” Musk went on to say, “The idea that I would care about whether my brother might sell shares for a few million dollars less when my Twitter poll caused my own share sale to be over a billion dollars less is utterly absurd.” Apparently, Musk also couldn’t refrain from taking a swipe at SEC enforcement director Steven Buchholz, adding that the investigation was “simply more evidence of Stevie grinding his very tiny axe yet again.”

If the SEC concludes that Kimbal Musk was unaware of the planned poll, the commission will likely drop the investigation without bringing any charges. But, if the SEC believes that Musk did tip his brother off in advance of the tweet, the SEC may charge Kimbal with violating Section 10 of the Securities Exchange Act and Rule 10b5-1 under the act. In essence, Rule 10b5-1 states that it is a crime to buy or sell a stock while aware of “material nonpublic information about that security or issuer.” The SEC charged lifestyle maven Martha Stewart with insider trading and violating Section 10 (among other violations) when she sold thousands of shares of ImClone Systems after being tipped off that the company’s experimental drug Erbitux had not received FDA approval. The company’s stock price plummeted the next day when the news was made public. Stewart ultimately served jail time, paid fines and was barred from serving as a director of a public company for five years. Thus, the stakes for the Musk brothers are high.

What Would the SEC Have to Prove to Pursue a 10b5-1 Claim Against Kimbal Musk?

First and foremost, the SEC would need to prove that Kimbal Musk was aware of the planned tweet. Assuming Musk had the hubris to put something like that in writing, a text or email would be a smoking gun, but other circumstantial evidence such as suspiciously timed phone calls could suffice. Next, the SEC would have to show that the information was material and nonpublic. Allegedly no one knew about the poll other than Tesla’s attorneys, so the information was not available to the public before Musk tweeted the poll. The SEC generally defines information as material if there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision. The SEC would certainly argue that the market’s reaction to the poll and subsequent drop in the Tesla stock price is strong evidence that the investing public considered the Twitter poll material. But it might not be that simple. The rule refers to material information about the security or issuer. The poll wasn’t about Tesla and it was only indirectly about Tesla’s stock. Instead, the information was about Musk in that he would consider selling 10% of his stock to cover taxes (which ultimately were never imposed). Even if the SEC finds that smoking gun text, the fight won’t be over.

In addition, 10b5-1(c) contains an affirmative defense if “Before becoming aware of the information, the person had … adopted a written plan for trading securities…” So called 10b5-1 trading plans allow officers and directors of public companies to adopt a plan to buy or sell stock while they are not in possession of material nonpublic information. The plan then remains in effect and shares can be sold or purchased pursuant to the pre-set plan parameters without violating the law even if the insider subsequently becomes aware of material nonpublic information. Kimbal Musk has used these plans in the past, and if his Nov. 5, 2021 sales were pursuant to a pre-existing plan, then he would be able to sell Tesla stock even if Musk did tell him about the poll. Of course, in that case, Musk would likely still face charges for lying about not telling his brother about the tweet.

The SEC and Musk Aren’t Done Yet

Regardless of the outcome of the investigation, we can be confident that the SEC and Musk aren’t done yet. In February, Tesla and Musk’s attorneys filed a letter with US District Judge Alison Nathan who is overseeing the 2018 settlement concerning the $420 tweet requesting that the judge curtail the SEC’s ongoing oversight of Tesla and Musk. Among other criticisms of the SEC, the letter states that the SEC “has been weaponizing the [2018 settlement] by using it to try to muzzle and harass Mr. Musk and Tesla” and,

“The SEC seems to be targeting Mr. Musk and Tesla for unrelenting investigation, largely because Mr. Musk remains an outspoken critic of the government; the SEC’s outsized efforts seem calculated to chill his exercise of First Amendment rights rather than to enforce generally applicable laws in evenhanded fashion.”

SEC enforcement director Steven Buchholz responded with his own letter to the court, and Judge Nathan denied the requests made by Tesla and Musk. Tesla and Musk haven’t given up and have filed a memorandum of law in support of a motion to terminate the 2018 settlement. In the memorandum, Musk claims he was “forced” into the settlement and that the SEC is using it to “micro-manage” his Twitter activity. It appears we will be able to refer to the ongoing battle for some time to come as an example of how not to interact with your regulator.

KJK’s Corporate & Securities practice group is well-equipped to assist you and your company with navigating insider trading policies and 10b5-1 plans designed in order to avoid insider trading accusations and clashes with the SEC. For further information, please contact Christopher Hubbert (CJH@kjk.com; 216.736. 7215).