Saturday, September 29, 2018
By now, I’m sure everyone’s seen the eyebrow-raising SEC complaint filed against Elon Musk for his fateful tweet announcing “funding secured” for his plan to take Tesla private at $420/share – while keeping all the old shareholders. There are a lot of juicy details here, including an allegation that the $420 price was – as many suspected – a reference to marijuana; he ballparked a 20% premium, which would bring the price to $419, and then rounded up to impress his girlfriend.
Well, as we all know by now, funding was not secure, there was no plan, and – as I previously posted – there was no way the plan was ever going to work in the first place, because you can’t go private while keeping a massive retail shareholder base.
That said, the thing I keep wondering is, if anyone but the SEC had brought this case, would there be a serious question of materiality?
For starters, there has been a private complaint. A short-seller, apparently injured when Tesla’s price shot up in the wake of Musk’s initial tweet, filed a class action complaint alleging securities fraud. Now, this case is in the early stages so there’s no way to tell exactly where it will go, but I first note that even though a short-seller filed the complaint, the class appears to consist of people who went long – who bought in on the tweet, and lost money when it became clear that no take-private deal would be forthcoming.
Well, short-sellers occupy a kind of weird position in Section 10(b) cases, especially for a scenario like this. They borrow shares, sell them, and lose money if they have to return the borrowed shares by repurchasing at a higher price. If the allegation is that the company’s lies forced them to cover at a higher price than they otherwise would have – i.e., if the lies happened after the initial sale – there may not be any reliance in the traditional sense. That is, the seller may not have necessarily believed the lie, but might have been forced to cover anyway. Courts have been a bit inconsistent in how these claims are treated, see Rocker Management, LLC v. Lernout & Hauspie Speech Products N.V., 2007 WL 2814653 (D.N.J. 2007) (discussing cases), and Basic v. Levinson, 485 U.S. 224 (1988) suggests that forced transactions made while knowing the truth are not in reliance on the fraud – so it is not clear that under existing doctrine, a short-seller who saw through the lie almost immediately, but was injured because other people didn’t, has a Section 10(b) claim. (It’s not impossible that Halliburton Co. v. Erica P. John Fund, Inc., 134 S.Ct. 2398 (2014) will change how courts think about these things; in that case, the Supreme Court was explicit that reliance exists for traders who disbelieve the market price but expect it to eventually correct; the Court was not talking about short-sellers, but the logic might extend that far).
But anyway! Leaving aside the short-seller bit for a moment, the problem from a materiality standpoint is that the market saw through the lie almost immediately.
We start with the definition of materiality: a fact is material if there is a “substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available” Basic, 485 U.S. at 231-32. Well, would a reasonable shareholder have taken Musk’s statement seriously? Musk has a history of bizarre tweets, so on the day the fatal tweet issued, people were speculating it was a joke. For example:
FUNDING SECURED pic.twitter.com/svlPG4ifNa— The_Real_Fly (@The_Real_Fly) August 7, 2018
From now on signing off every tweet “funding secured.”— Downtown Josh Brown (@ReformedBroker) August 7, 2018
Am considering taking a sandwich private at 12:15. Funding secured.— Jim Prosser 🖖 (@jimprosser) August 7, 2018
Am considering taking the wife to dinner tonight. Funding secured.— Matthew Argersinger (@MArgersinger) August 7, 2018
I think “funding secured” may become this generations “mission accomplished “ #tsla— Guy Adami (@GuyAdami) August 7, 2018
To be sure, with respect to this argument, one of the best points in the class’s favor is a nugget in the SEC complaint that market analysts - sophisticated people - privately contacted Tesla’s head of investor relations for more information and were assured that the tweet was legit. So that’s evidence the market took it seriously.
That said, as I explained in my prior post, the structure Musk proposed was legally impossible – indeed, his failure even to investigate the legality is a central factor in the SEC’s complaint. But those legal standards are publicly known, and thus are part of the “total mix of information made available.” See, e.g., Wielgos v. Commonwealth Edison Co., 892 F.2d 509 (7th Cir. 1989) (“Issuers needn’t print the Code of Federal Regulations…”). So, one might argue – especially in the fraud-on-the-market context, where truths might have an offsetting impact on market price – that the truth about the impossibility of Musk’s plan was necessarily known to investors and could not have impacted the stock’s price.
Aha, you might say – but the tweet did impact the stock’s price – it closed up nearly 11%! Market reaction was so volatile that the NASDAQ had to temporarily suspend trading! Isn’t that proof of materiality?
Well, you would think, but it turns out courts aren’t really eager to relinquish their authority over materiality determinations to market evidence, and frequently reject stock price reaction as proof of materiality. See, e.g, Police Ret. Sys. v. Intuitive Surgical, Inc., 759 F.3d 1051, 1060 (9th Cir. 2014); Greenhouse v. MCG Capital Corp., 392 F.3d 650 (4th Cir. 2004).
That said, whatever challenges these issues might pose for private plaintiffs, it’s not clear they’ll get much traction in the context of a governmental action, where, rightly or wrongly, courts often treat materiality differently than they do in the private-litigation context. Cf. Margaret V. Sachs, Materiality and Social Change: The Case for Replacing “the Reasonable Investor” with “the Least Sophisticated Investor” in Inefficient Markets, 81 Tul. L. Rev. 473 (2006) (describing some cases). However, Musk reportedly already rejected an SEC settlement and – Musk being Musk – might be determined to fight this thing all through trial, so I’m curious to see how it plays out.
Edit: Well, doesn’t look like we'll get a chance to find out, because Musk backed down and agreed to settle with the SEC after all. We might see these arguments play out in the private action, though - and while I don’t actually expect a court to dismiss on materiality grounds (the market furor was just too great to ignore), the fact that these arguments are even available in the doctrine highlights, to me, a point I’ve emphasized in this space before: concepts of materiality, loss causation, market efficiency and so forth have become stylized to the point of fiction.