Let’s recap on why the SEC filed yesterday (Thursday) to sue Elon Musk for fraud, misrepresentation and are pushing for him to be banned from being an officer or director of a public company.
Back on August 7th, 2018, Musk became vocal on Twitter about re-privatising Tesla with an investment from the Saudi Arabian Sovereign Wealth Fund. He used the words “Am considering taking Tesla private at $420. Funding secured.”
About 12 minutes after Musk published this tweet, Tesla's own head of Investor Relations sent a text to Musk's chief of staff asking, “Was this text legit?” One thing is for sure, this text is now a legit part of the SEC’s claim that Musk is guilty of fraud and misrepresenting shareholders by sharing false information.
What happened to Tesla shares post Musk’s Tweet:
Musk’stweet saw Tesla’s share price increase as privatising the company would mean investors would be able to sell their shares back to the company for a higher price, or they may be able to keep their shares when the company delists from the stock exchange and becomes a private company.
Musk claims to have released the information to ensure all investors were aware of the potential to privatise the company. However, as this is known to inflate the share price and as Tesla was struggling with cashflow (so much so that he was asking suppliers for refunds just to make his Q3 earnings report look better to investors so the share price wouldn’t drop), this could be seen as securities fraud, meaning Musk attempted to manipulate the stock market for the benefit of increasing the share price without the intention of taking the company private.
And, what do you know, Musk decided not to take Tesla private.
The SEC’s argument for fraud:
Musk knew that he had not agreed upon any terms for taking Tesla private with the Saudi Arabian sovereign wealth fund or any other funding sources (like other investors).
Musk had no further substantial communications with representatives of the sovereign wealth fund beyond their 30–45 minute meeting back on July 31st2018.
Musk had never discussed taking the company private at a share price of $420 with any potential funding source.
Musk had not contacted any potential strategic investors to assess their interest in participating in taking the Tesla private.
Musk had not even contacted Tesla shareholders to assess their interest in remaining invested in Tesla if it were to become a private company again.
Musk had not formally engaged any legal or financial advisors to assist with taking the company private.
Musk had not investigated whether or not retail investors could even remain invested in Tesla as a private company (due to regulatory restrictions on retail investors investing in private companies).
Musk has not investigated whether or not there are restrictions on illiquid holdings by Tesla’s institutional investors, meaning some current investors in Tesla may not be able to retain their shares if the company goes private.
Musk has not investigated what regulatory approvals would be required or whether Tesla would be able to meet any obligations required by regulators in taking the company private.
Additional concerns to be aware of:
Although Musk states that “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."
There are a few concerns around Musk’s integrity and ability to act in the best interests of his shareholders.
John Gavin, CEO of Probes Reporter, a business intelligence firm that focuses on undisclosed SEC probes and enforcement actions against public companies pointed out to CNBC today that SolarCity (now owned by Tesla) has been investigated by the SEC multiple times but Tesla never disclosed those investigations to shareholders — not even ahead of Tesla’s acquisition of SolarCity in 2016 for $2.6 billion.
What’s more, Musk shared in an interview with The New York Times on how he calculated a take-private price for Tesla of $420.
"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 transaction. 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.'"
Despite not being a great reason to pick a price, it’s also not a great reason to post an inaccurate price to the public and of course shareholders when you know that releasing this information will affect the current share price.
Musk has also been threatening to “burn” short-sellers who targeted Tesla stock, meaning he was aiming to drive the share price up just so traders that were betting Tesla stock would drop would lose money.
Note:Going short or short selling is where you borrow and or sell a stock with the view that the price will go down in the short term. This gives you the ability to sell at a high and buy back the share after it drops for a lessor price. Going short is typically a day trading strategy, that enables you to collect short term profits. When the market goes back up in value, so do the value of your shares. An example of going short are inverse ETFs.
I guess it’s the ‘short’ traders that are laughing now!
How this lawsuit affects Tesla & Space X:
Tesla shares dropped more than 13 percent in extended trading Thursday.
Note:Extended-hours trading is stock trading that happens either before or after the regular trading hours of a stock exchange, i.e., pre-market trading or after-hours trading. After-hours trading is the name for buying and selling stocks when the major markets are closed (this happens because of the difference in time zones).
Tesla stock is roughly 30 percent below its 52-week high (the highest point the share has traded at over the past 52 weeks) of $387.46.
Despite the drop in shares of Tesla, if Musk is banned as an officer or director of a public company this will mean that Tesla shares could drive themselves right of a cliff and Space X may not be able to take the company public through an IPO if Musk is an officer, director or CEO.
The majority of investors are highly influenced by the leadership of the company and would be concerned if Tesla would be as successful without Musk driving the company. However, one could argue that there have been several questionable choices Musk has made as leader of Tesla.
Likewise, current investors in Space X will be highly concerned if Space X cannot be taken public with Musk as CEO. Investors in private companies largely use IPO’s as a means of gaining their return on investment by selling their shares to the public post IPO.
It’s no wonder Tesla’s board of directors issued the following statement on Thursday evening.
"Tesla and the board of directors are fully confident in Elon, his integrity, and his leadership of the company, which has resulted in the most successful U.S. auto company in over a century. Our focus remains on the continued ramp of Model 3 production and delivering for our customers, shareholders and employees,".
If you thought self-driving Tesla’s were risky, I’d hate to be an investor in their stock.
Please know, the value of investments can go up as well as down and you may receive back less than your original investment, meaning, when investing your capital is at risk.
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