Editor’s Note: Charles K. Whitehead is the Myron C. Taylor Alumni Professor of Business Law at Cornell University and the founding director of the Law, Technology & Entrepreneurship program at Cornell Tech. The opinions expressed in this commentary are his own.
In the startup world, pushing regulatory limits to promote a new business is often seen as “entrepreneurial” or “disruptive.” But breaking securities laws, as Elon Musk has allegedly done, is something different.
It’s well known that Musk has a strained history with the Securities and Exchange Commission. In 2018, the SEC alleged that Musk made “false and misleading” claims about taking Tesla private. Among other things, Musk agreed in a settlement with the SEC to pay a $20 million fine and step down as Tesla’s chairman for three years. But the settlement does not seem to have deterred Musk from flouting the rules again.
Earlier this year, Musk waited 21 days to publicly disclose he had acquired 9.2% of Twitter shares when, under the SEC’s rules, investors are typically required to make such disclosures within 10 days of purchasing 5% or more of a public company’s stock. Such a disclosure would have alerted Twitter’s other shareholders that a large block of stock was being accumulated, likely sending the stock price higher. So the delay saved Musk the tens of millions of additional dollars he would have paid to buy the added shares he acquired had he made an earlier announcement.
Policing Musk places the SEC in a tough position. Any financial penalties it’s able to impose are likely to have little effect on someone as wealthy as Musk. And, in light of his importance to Tesla, other penalties could potentially harm shareholders, employees and others who have little or no say on whether or how Musk chooses to comply with the securities laws.
Indeed, Musk’s shadow extends well beyond his companies and products. It affects thousands of others whose portfolios rise and fall based on his tweets (recall the tweet about taking Tesla private that led to the 2018 SEC settlement) and who take his statements as cues on whether to buy and sell shares and other financial assets. In this case, Musk’s failure to comply with basic regulation looks less like entrepreneurism and more like simple recidivism and perhaps a lack of respect for the SEC.
One possible SEC response is to increase the size of the financial penalties it imposes. But doing so may require a change in the securities laws, and even then, in light of Musk’s net worth, no reasonable penalty based on his conduct to date is likely to be large enough to deter him.
Barring Musk from holding company office may be another response, which some refer to as the “nuclear” option. The SEC may have been reluctant so far to pursue this option due to Musk’s value to Tesla and the likelihood that doing so will hurt Tesla’s shareholders and others. Nevertheless, at some point, the SEC is likely to conclude that Musk’s importance to Tesla and its shareholders is no longer a reason not to bar him from office. Rockstar CEOs are a common feature of Silicon Valley businesses, and their tweets and public persona attract important attention, inflate stock prices and benefit shareholders. If a CEO steps over the line, and does so continually, the SEC may reason that an enforcement action should no longer be a surprise to investors and removing him from his role as CEO should be the cost shareholders bear for the stock price increases they have benefited from so far. Musk may have already crossed that line.
A third possibility is criminal prosecution. But the bar for successful prosecution is considerably higher than for civil penalties. Nevertheless, the SEC’s inquiry of Musk about his Twitter disclosures may be a first step in investigating whether those disclosures included deliberate misstatements, which could be a predicate for criminal liability. Whether or not a criminal case is brought, simply the prospect of jail time — coupled with the nuclear option — may be the only way the SEC can stop Musk from breaking the rules.
With that said, one of the most effective responses rests with Tesla itself. Musk’s breaches must be a headache for Tesla’s independent directors. His actions potentially draw into question the integrity of Tesla’s management, including its board. As fiduciaries, independent directors should insist the CEO observe all applicable laws and remove him if he is unable to do so. Failing to address that problem raises a basic concern over the board’s ability to manage Tesla, and if the board then also fails to clearly describe that risk in the company’s public disclosures, Tesla and the board should be held directly accountable.
More than financial or other penalties, the real remedy rests with Tesla’s directors, who should focus on doing what’s best for the company and its shareholders. Balanced against the value that Musk brings to Tesla, calling the CEO to task for failing to comply with the federal securities laws should be at the top of their list.