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Why a court's punishment of Musk could backfire on shareholders

Alexis Keenan
·Reporter
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Tesla CEO Elon Musk’s power battle with Securities and Exchange Commission regulators became the interest of a New York federal court Monday, after the SEC filed a motion asking a judge to hold Musk in contempt of court.

The SEC claims Musk violated a settlement agreement by tweeting a prediction about the electric car maker’s production rate.

While the court has leeway to impose additional civil fines and strip Musk of executive authority, it must also balance the interests of shareholders in handing out penalties, if it agrees that Musk should be held in contempt.

“The court is a little bit hamstrung, because while they want a strong deterrent they're supposed to be serving shareholders,” John Coffee, Jr., professor of law at Columbia University, told Yahoo Finance. “I don't think any judge wants to eliminate him from Tesla because a lot of people believe that Tesla can't survive without him.”

Tesla and SpaceX CEO Elon Musk speaks in a "fireside chat" at the National League of Cities (NLC) 2018 City Summit in Los Angeles, California, U.S. November 8, 2018. REUTERS/Kyle Grillot
Tesla and SpaceX CEO Elon Musk speaks in a "fireside chat" at the National League of Cities (NLC) 2018 City Summit in Los Angeles, California, U.S. November 8, 2018. REUTERS/Kyle Grillot

Musk has until March 11 to respond, before the court decides whether to penalize Musk, Tesla or both.

According to the SEC, Musk’s February 19 tweet violates the terms of a settlement agreement reached between the parties last year requiring any of Musk’s written projections, forecasts, or estimates regarding Tesla’s business to be pre-approved by certain company executives before they are published. That includes statements made on social media.

Tesla made 0 cars in 2011 but will make around 500k in 2019," Musk tweeted on February 19.

Several hours later, a new tweet from Musk’s account clarified a projected annualized production rate of 500,000 vehicles, and delivery projections of 400,000.

At least 88 Tesla executives have left Tesla company since January 2018, including its former general counsel general counsel Dane Butswinkas, who left February 20 after two months in the position.

The SEC’s motion is silent on how the court should penalize Musk if he’s held in contempt.

Will Tesla face additional fines?

“The SEC has authority to ban people from serving as an officer or director of any publicly held company, but that usually requires proof of fraud,” Coffee said. “It's not impossible to put someone in jail for contempt, but this looks like it was sort of a negligent mistake, or at least it was his typical reckless mistake, not an intent to defraud investors.”

According to the SEC’s motion, Musk told the SEC he did not think his tweet concerning Tesla production levels fell under the purview of his settlement agreement.

The 2018 settlement agreement was crafted as a way to prevent Musk from making material misstatements about the company, after an August 7 tweet saying that funding had been secured to take the company private at $420 per share. According to the SEC, that statement caused Tesla stock to jump 6% and was made despite the fact that Musk knew it to be uncertain and subject to contingencies.

In addition to the agreement, the SEC imposed $40 million in fines — $20 million against Musk and $20 million against Tesla — and required Musk to give up his role as chairman of the company’s board.

“I don't think they should fine the company because the company had a protocol worked out — Musk just ignored it,” Coffee said. “I think that the judge should tell him bluntly, ‘We're going to take your iPhone away from you if you use it for social media, and if you violate this next time, possibly a third offense could be prison.’”

Like the court, Tesla’s board of directors could impose conditions on Musk, including removing him as CEO.

“They love to sit on the sideline to do nothing, but they've got to say this is a crisis for the company — we can lose our CEO,” Coffee said. “He doesn't need a salary. His wealth is tied up with the value of Tesla, but you could you could suspend his salary, you could penalize take away bonuses.”

“The problem with the board is, do you dare fire and when you have no one else?” Coffee asked.

As for the SEC, if Musk is found in contempt, it may ask the court for a broader ban on Musk’s written statements.

“I think the SEC would say we want an absolute ban on him using social media for either a period of years, or for as long as he stays as chief executive or senior officer of Tesla,” Coffee said.

Alexis Keenan is a New York-based reporter for Yahoo Finance. She previously produced live news for CNN and is a former litigation attorney. Follow her on Twitter at @alexiskweed

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