Editor’s Note: John C. Coffee Jr. is the Adolf A. Berle Professor of Law at Columbia University Law School and director of its Center on Corporate Governance. The opinions expressed in this commentary are his own.
The SEC and Elon Musk need to reach a settlement fast. Although Musk continues to trip over his oversized ego and sense of his own infallibility, the SEC is facing its own serious problem: Can it still enforce the consent decrees that it relies upon to make companies and executives comply with its settlements? To keep Musk from making any further major blunders on social media, the SEC must not back down in its efforts to keep him on a tight leash.
United States District Judge Alison Nathan has given Musk and the SEC until Thursday to reach an agreement after they failed to do so by the first deadline, which expired last week. In the time leading up to the original April 18th deadline, the two sides apparently managed only one hour-long phone conversation. If they were seriously pursuing settlement, there would have been face-to-face meetings and a flurry of emails, exchanging drafts. But this does not seem to have happened. Why?
Musk is, of course, scornful of the SEC, but this is a battle he can no longer afford to fight. Tesla increasingly appears to be near the brink of disaster: Its first quarter deliveries were markedly down; it will lose money for the first quarter; it is constantly changing its business model (both products and pricing); multiple class actions are pending against it; and the short sellers are chasing it with renewed enthusiasm. Also, Tesla may need to raise capital quickly, and making an enemy of the SEC does not facilitate that process.
The SEC similarly has a problem. Although it probably thought it had a slam dunk of a case, Judge Nathan has not supported its position in the manner that most Southern District judges normally do. In August 2018, Musk posted on Twitter that he had “funding secured” for his plan to take Tesla private at $420 per share, when in fact he was not close to achieving that funding. When the SEC sued him for securities fraud, Musk settled and agreed to have a securities lawyer (either inside or outside Tesla) review any written communication or tweets to his shareholders or the market that “reasonably could contain” material information about Tesla.
That phrasing is unusual and was deemed difficult to interpret by the Court, which is why the judge ordered Musk and the SEC to draft a more specific standard.
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The SEC would be both embarrassed and injured if the Court found that Musk’s post on Twitter in February — in which he asserted that Tesla would produce about 500,000 cars this year — did not violate that standard. Musk’s estimate was in fact well wide of the mark, as a month earlier Tesla had predicted that it would produce only 400,000 cars this year. Musk had simply confused the total annual production number with the annualized rate he hoped to hit by the end of 2019. This error, while only negligent, seems the direct product of Musk’s failing to consult a lawyer (as his settlement with the SEC required).
Given that Musk has been wrong twice and didn’t consult counsel despite the settlement, the SEC must have thought it was an easy case when it sought to hold Musk in contempt of court for the February tweet. But instead, Judge Nathan told the parties to reach a settlement and clarify when Musk must consult counsel. More than simply disappointing the SEC, this threatens to undercut the SEC’s contempt power, which it rarely uses but is its ultimate sanction for noncompliance.
What should the new settlement say? For the SEC, it is critical that the standard for when Musk needs to consult a lawyer be set much lower than simply that the information was “material.” Letting Musk decide for himself what is material is much like allowing students to grade their own calculus exams.
The settlement could state that Musk must consult a Tesla attorney about any written communication (including tweets) that he makes about Tesla unless it would be obvious to any reasonable person that the statement could not possibly be deemed material at the time it was made. Or, it could go further and broadly require that any statement made by Musk about Tesla to the public be pre-cleared by counsel.
What is critical, however, is that the standard not require the SEC to prove that a statement was material in order to show a violation of the settlement. That would render the settlement meaningless. Musk is a demonstrated delinquent who has repeatedly blundered when he tweets his own unreviewed disclosures. The Court appears to be overly concerned about Musk’s constitutional rights, but his tweets fall clearly within the zone of commercial speech, where reasonable restraints are upheld. The Court is not protecting The Pentagon Papers, but a “shoot from the hip” entrepreneur who regularly seems to shoot himself in the foot.
Bottom line: Musk cannot decide for himself what is material, and the SEC needs to be able to enforce the settlements it strikes with those who violate its rules.