October 4, 2018
Beating a Hasty Retweet
I had hoped to be done with Elon Musk's tweets, but then the SEC sued him. https://www.sec.gov/litigation/complaints/2018/comp-pr2018-219.pdf. It hastily filed its complaint last Thursday, after Musk walked away from a settlement struck the night before. Then Musk changed his mind. And so, on Saturday (Saturday?), the SEC announced a settlement. The settlement included a second suit, also filed on Saturday (Saturday???), against Tesla itself.
Omnicare filed a registration statement to sell stock to the public. In that registration statement, Omnicare's management gave its "opinion" that its major contracts didn't violate any laws. It turned out they did. Management's reaction to that was, basically, "so sue us, it was just our opinion." So, of course, they were sued, under § 11 of the Securities Act of 1933, which lets buyers of stock rescind if the registration statement contains false or misleading statements.
The problem with management's "opinion" was it had no basis in fact. Not merely a weak basis, but no basis at all! Management had not even asked its lawyers if its contracts were legal, which one would think they would have to form an opinion about, say, the legality of their contracts. That, said a unanimous Supreme Court, made management's opinion misleading:
In the context of the securities market, an investor . . . likely expects [management's opinion of legality] to rest on some meaningful legal inquiry-rather than, say, on mere intuition, however sincere. . . . . [The investor] expects not just that the issuer believes the opinion (however irrationally), but that it fairly aligns with the information in the issuer's possession at the time. * * * Investors do not, and are right not to, expect opinions contained in [registration] statements to reflect baseless, off-the-cuff judgments, of the kind that an individual might communicate in daily life.
To begin with, Musk's four bad tweets were not, as the SEC complaint alleges, "assertions." Assertions imply statements of facts. Musk tweeted plans, thoughts, hopes, and dreams. Musk was "considering" taking Tesla private; he "hoped" all investors would stay in the private company, but shareholders "could" sell if they wanted; the whole transaction was "not certain" and "contingent" on shareholder approval of terms still being worked out. Those were all airy-fairy statements. So were the supposedly affirmative statements "Funding secured" and "Investor support is confirmed." How much funding; under what terms; from whom; when; which investors; what exactly did they support? Without details, all these were too vague to pass muster as factual "assertions."
The SEC knows this. The SEC channeled Omnicare's language to suggest we treat these tweets like Omnicare's "opinions without bases in fact." It's a nice bit of legal legerdemain, but it can't work.
First, Omnicare's management violated of § 11 of the Securities Act, while the SEC charged Musk with fraud under § 10(b) of the Securities Exchange Act of 1934. Section 11 lets buyers rescind on account of any misleading statement in a registration statement -- no excuses. But § 10(b) requires an intent to defraud, and federal rules require fraud to be pled in detail. The SEC complaint doesn't detail any fraudulent intent. Sure, Musk didn't like short sellers and Tesla's price rose 11% after his tweets. Well, no management likes shorts, and Tesla's price dropped 13% after the SEC complaint. None of that proves anything without a particularly-stated fraudulent intent.
Second, unlike Omnicare's management, Musk did have factual bases for his vague musings. The complaint details Musk's communications with prospective Saudi financiers, with Tesla's major investors, with the board. He was "considering" it. Musk thought he had a handshake deal to take Tesla private on any "reasonable" terms, and a take-out premium of 20% over the current market price, to derive the $420 price Musk quoted, is reasonable (including that buck to humor his girlfriend).
Most importantly, Omnicare's management put its spurious opinion in a registration statement. As the Court said, "Investors do not, and are right not to, expect opinions contained in [registration] statements to reflect baseless, off-the-cuff judgments, of the kind that an individual might communicate in daily life." You know, the kind that one will generally find in a tweet!
The settled Saturday complaint against Tesla built on Musk's tweets and fares no better. The actual charge is that Tesla violated SEC Rule 13a-15 because it had no process to police Musk's tweeting. But that Rule only applies to SEC filings. The contents of Musk's tweets could not properly have gone into an SEC filing, because, again, they didn't contain material facts required to be reported. So, Tesla supposedly violated a rule about accurate SEC reports because it didn't prevent Musk from tweeting stuff that neither was nor should have been in an SEC report. Put that in your bong and smoke it!
I sound harsh, but I don't mean to be. In their Thursday press release, the Heads of the Enforcement Division said that, "Taking care to provide truthful and accurate information is among a CEO's most critical obligations. That standard applies with equal force when the communications are made via social media or another non-traditional form." https://www.sec.gov/news/press-release/2018-219. I totally get that. I'm not unsympathetic to the SEC's desire to tame executives gone tweeting wild. The SEC could not politically avoid suing an executive as notoriously wild as Elon Musk. It did what it had to do. Likewise, Musk and Tesla had to settle. The risks were too great, no matter how solid their defenses. They reached a good practical deal for all concerned. Tesla's shareholders agree -- its stock was up 17% on the news. All ends well. But maybe not so well. The SEC is already touting a new standard for corporate tweets, visible in Chairman Clayton's statement that "when companies and corporate insiders make statements, they must act responsibly." https://www.sec.gov/news/public-statement/clayton-settlements-elon-musk-and-tesla. Who can argue with it? But such an ethereal standard, not anchored in the federal securities laws we actually have, will likely cause more problems than it solves where tweeting is concerned. If tweets contain material facts, those must be disclosed in an SEC filing. If tweets are used to defraud, they are illegal. But Musk's tweets were neither. They were just stupid. And yet utterly typical as well, because tweets invite "baseless, off-the-cuff judgments" by very their very nature. The federal securities laws are not designed to handle them. Without a change in those laws, the SEC's visions of "truthful and accurate" tweets are just nice dreams.
ABOUT THE AUTHOR
Aegis J. Frumento
Stern Tannenbaum & Bell
Co-Head, Financial Markets Practice
380 Lexington Avenue
New York, NY 10168
Aegis Frumento is a partner of Stern Tannenbaum & Bell, and co-heads the firm's Financial Markets Practice. Mr. Frumento represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations); SEC and FINRA regulated firms and persons on regulatory compliance issues and in SEC and FINRA enforcement investigations and proceedings; and senior executives of public corporations personal securities law and corporate governance matters. Mr. Frumento has also represented clients in forming and registering broker-dealers and registered investment advisers, in developing compliance policies, procedures and controls, and in adopting proper disclosure documents.
Prior to joining the firm, Mr. Frumento was a managing director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP.
He graduated from Harvard College in 1976 and New York University School of Law in 1979. Mr. Frumento is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments.
NOTE: The views expressed in this Guest Blog are those of the author and do not necessarily reflect those of BrokeAndBroker.com Blog.