Did Elon Musk breach Regulation FD or Rule 10b-5 by tweeting that he was “considering” taking Tesla private during market hours?
Mr. Musk stunned the markets and caused a 10% surge in Tesla’s stock price (and a trading halt) when he announced that he was considering taking Tesla private, meaning delisting Tesla from the Nasdaq and running it as a private company. Is the transaction genuine or is Mr. Musk just giving a bad time to the shorts?
There are two interesting pieces of securities laws at play here: Regulation Fair Disclosure (Regulation FD) and Rule 10b-5. It only makes sense to look at this from a US law perspective because Tesla is incorporated and listed in the United States. Regulation FD regulates how listed companies disclose important information while Rule 10b-5 is an anti-fraud provision for the purchase and sale of securities.
Quick disclaimer: this is post is not meant to be legal advice to you. If you are Tesla stockholder and you want to inquire about the legality of the announcement, please consult your own lawyer.
On Regulation FD
Scope
Regulation FD applies to all companies that have a class of securities registered under Section 12 of the Exchange Act or that are required to file reports under Section 15(d) of the Exchange Act (excluding certain investment companies, any foreign government or foreign private issuer).
Tesla is listed on the Nasdaq, which is a national securities exchange. Tesla’s shares are registered (the original registration statement S-1 can be found here).
Rule 100
Rule 100 of Regulation FD sets forth the basic rule regarding selective disclosure. Under this rule, whenever:
(1) an issuer, or person acting on its behalf (i.e. Mr. Musk, as CEO, is acting on behalf of Tesla, the issuer);
(2) discloses material nonpublic information (i.e. Mr. Musk’s tweet, stating that he is considering taking Tesla private at $420 a share, with funding secured, was non-public material information);
(3) to certain enumerated persons (in general, securities market professionals or holders of the issuer’s securities who may well trade on the basis of the information) (i.e. based on his twitter account, it seems that he has already locked the support of one or more investors. Those are probably sophisticated investors who could trade the stock. There may be brokers or advisors involved in this process who may have the ability to trade).
(4) the issuer must make public disclosure of that same information:
(a) simultaneously (for intentional disclosures), or
(b) promptly (for non-intentional disclosures). (i.e. Timing is a bit unclear here but it is likely that the disclosure was intentional as this was a private discussion with investors. For how long Musk has secured the backing of those investors is unclear, but presumably, it would have been a short amount of time. Alternatively, it is possible that his plans to take Tesla private leaked and he made the announcement as soon as possible).
The timing of the disclosure
The timing of the required public disclosure depends on whether the selective disclosure was intentional or unintentional. The company must make the public disclosure (i) simultaneously, in the case of intentional disclosures, or (ii) promptly afterward, in the case of unintentional disclosures. As previously stated, nothing indicates that the announcement was not made either simultaneously or at least promptly after the disclosure to certain enumerated persons such as securities market professionals or holders of the issuer’s securities.
What constitutes “material non-public information”?
Regulation FD applies to disclosures of “material non-public” information about the issuer or its securities. While the regulation does not define materiality but relies on existing case law, information is deemed material if there is a “substantial likelihood that a reasonable shareholder would consider it important” in making an investment decision. There must be a substantial likelihood that a fact “would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” Information is nonpublic if it has not been disseminated in a manner making it available to investors generally. Here, there is no doubt that taking Tesla private would constitute material information.
Means of disclosure
The public disclosure may be made through an Exchange Act filing such as a Current Report on Form 8-K or through any method reasonably designed to effect broad, non-exclusionary distribution of the information. Here, there was no Form 8-k filing. Instead, Mr. Musk first tweeted at 9:48 am on 7 August 2018 and the link to a blog post “Taking Tesla Private” was tweeted on the Tesla twitter feed at 12:28 pm on 7 August 2018.
Are Twitter and/or Tesla’s website an appropriate alternative method of public disclosure?
Things get trickier here. The SEC recognizes alternative methods of public disclosure to give issuers the flexibility to choose another method or a combination of methods of disclosure that will achieve the goal of effecting broad, non-exclusionary distribution of information to the public (Rule 101(e)(2)). Therefore, failure to file a Form 8-k is not in itself a break of Regulation FD.
In the SEC release, acceptable methods of public disclosure include press releases distributed through a widely circulated news or wire service, announcements made through press conferences or conference calls that interested members of the public may attend or listen to, or by other electronic transmission. The public must be given adequate notice of the conference or call and the means for accessing it. The regulation does not prescribe a particular means and leaves the decision to the issuer to choose methods that are reasonably calculated to make effective, broad, and non-exclusionary public disclosure, given the particular circumstances of that issuer.
Interestingly, in the Proposing Release, the SEC stated that an issuer’s posting of new information on its own website would not by itself be considered a sufficient method of public disclosure. However, as technology evolves and more investors have Internet access, some issuers, whose websites are widely followed by the investment community, could use such a method. The SEC also states that “while the posting of information on an issuer’s website may not now, by itself, be a sufficient means of public disclosure”, the regulator agrees that the issuer’s website can be one important component of an effective disclosure method.
Announcing such non-public material information on social media is unusual but there is a precedent. In April 2013, the SEC agreed with Netflix CEO Hastings that disclosure over major open social media sites could constitute public disclosure – as long as investors have been altered to what social media will be used to disseminate the information. “One set of shareholders should not be able to get a jump on other shareholders just because the company is selectively disclosing important information,” George Canellos, then acting director of the SEC’s enforcement division said in a statement at the time. “Most social media are perfectly suitable methods for communicating with investors, but not if the access is restricted or if investors don’t know that’s where they need to turn to get the latest news.”
Furthermore, Mr. Musk’s tweet was well documented and distributed in multiple news outlets such as CNBC or Bloomberg. In conjunction with Tesla’s blog post, it seems likely that the information was properly disseminated.
One note of caution: the SEC cautioned “issuers that a deviation from their usual practices for making public disclosure may affect [the SEC’s] judgment as to whether the method they have chosen in a particular case was reasonable.” In short, an issuer’s methods of making disclosure in a particular case should be judged with respect to what is “reasonably designed” to effect broad, non-exclusionary distribution in light of all relevant facts and circumstances. There could be some doubts here as no such announcement has ever been made on Twitter. But then, such announcement – being unique in its nature, i.e. the delisting of a company – has never been made in the history of the company either.
On Rule 10b-5 of the Securities Exchange Act of 1934
Rule 10b-5 is meant to prevent acts of fraud or deceit in relation to the purchase or sale of securities. This rule is frequently used in insider trading cases.
Rule 10b-5: definition
“Rule 10b-5: Employment of Manipulative and Deceptive Practices”:
It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.”
For a claim to be successful, a plaintiff will have to show (i) deception or manipulation (through false or misleading statements for instance), (ii) materiality (of the misleading statement, meaning this would have impacted the decision to buy or sell the security), (iii) causality (the deception must be the reason you decided to buy or sell the security) and (iv) scienter (there must have been an intent by the other party to deceive you).
If any portion of Elon Musk’s tweet is untrue or even misleading, then Mr. Musk would be in violation of Rule 10b-5. From his tweet, it is unclear what “funding secured” means. And this is by far the biggest point. What does it mean? Is this a handshake agreement or is there a signed commitment letter? There are already reports that the SEC requested further information from Tesla. If this proved to be untrue or misleading, Tesla would soon be dogged with lawsuits.
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