It’s been a shocking couple of months for Elon Musk, his publicly traded company Tesla, its shareholders and the market at large.
It started with Musk calling a British cave rescuer a “pedo,” before doubling down and inviting the rescuer to sue him, which the rescuer recently did. Musk then smoked marijuana during a videotaped recording of Joe Rogan's podcast, an act that may now jeopardize his eligibility for the security clearances he might require for SpaceX’s military contracts.
Tesla later suffered a power drain, with the same-day departures of its chief audit executive and its head of human resources. The chief auditor, notably, resigned after just one month on the job.
But perhaps the most striking event was Musk’s Aug. 7 tweet, which came shortly after noon, during trading hours: “Am considering taking Tesla private at $420. Funding secured.” The tweet violated exchange rules, which prohibit market-moving information to be announced without exchange preclearance.
What’s worse, we now know that funding was not secured, and that Tesla's board of directors was not even consulted before the tweet. Not surprisingly, the tweet caused substantial market disruption. There was even a trading outage, perhaps the first tweet-related outage ever in the U.S. securities markets.
I saw the tweet in real time, and as the former chief investigator for the U.S. Securities and Exchange Commission, I understood that it was the beginning of the end to this hot, crazy summer.
Since then, the tweet has been the subject of numerous discussions in undergraduate- and graduate-level ethics and fraud courses at the University of Maryland’s Robert H. Smith School of Business.
To my students and me, the real question the Musk tweet raises is: Where was the board? Why did the board not ground him and take away his smartphone? Were the board members not, indeed, in charge? A little background is needed.
In the days before the Enron and WorldCom scandals, boards of directors of publicly traded companies were not required to have a majority of independent directors. The degree of board independence was up to each company.
That changed in 2002, as part of the Sarbanes-Oxley Act (SOX), which, along with exchange requirements, mandated that at least a simple majority of each board of directors be independent. It also called for the creation of independent audit committees, consisting only of independent directors.
In theory, the independence requirements should have allowed the board of directors of Tesla to control the conduct of its CEO. However, the directors repeatedly failed to do so, and Musk repeatedly shocked the markets with his polarizing public comments and behavior.
In addition to the independence requirements, SOX also required all publicly traded companies to have a code of conduct. Tesla’s is painful to read in light of what we know today.
Some examples from Tesla’s Code of Conduct and Business Ethics:
- "Tesla aspires to be a 'do the right thing' company — in other words, engaging in conduct that your family would be proud of. That higher principle, if followed correctly, pretty much takes care of this whole topic. That said, this Code of Business Conduct and Ethics sets out basic principles that should help anyone working at or for Tesla avoid even the appearance of improper behavior."
- "Obeying the law, both in letter and in spirit, is the foundation on which this Company's ethical standards are built. You must respect and obey the laws of the places where we operate."
- "Anyone who violates this Code or any other applicable standards of his or her position will be subject to disciplinary action, potentially including termination."
So with what we now know, why did Tesla’s supposedly independent board fail to act against what were obvious acts of unwise and plainly unlawful conduct by Musk? Unfortunately, it appears it was because the board is not truly independent.
The audit committee chair used to work at Arthur Andersen, which was convicted of obstruction of justice in 2002 relating to its shredding of documents from its audit of Enron, though that conviction was later overturned by the Supreme Court.
Another supposedly independent director was the CFO of Solar City, a firm Musk owned before Tesla’s $2.6 billion acquisition, a blatant self-dealing transaction that enriched Musk and some board members. Another board member is Elon’s brother, Kimbal Musk.
It is important to note that part of the reason the board appears to lack independence is the way the company is structured. Musk owns roughly 22 percent of Tesla’s shares.
As we discuss in class, based on Tesla’s supermajority voting rules (which many corporations enact), Musk maintains control over Tesla, including the election of its directors. Tesla’s bylaws require that a supermajority of shareholders approve certain changes, including changes to its board structure.
Last Thursday, the SEC finally struck, seeking to permanently bar Musk from serving as a public company director. In my view, this was the only appropriate remedy for his August “funding secured” tweet.
Just two days after the SEC move, Musk settled the case, agreeing to a three-year ban from serving as chairman of the board of directors. It wasn’t a shocking outcome, although the case resolution was lightning quick.
As part of the settlement, Musk was permitted by the board and the SEC to remain as CEO.
Shareholders deserve better and deterrence must be demonstrated to the market, which this SEC settlement did not fully accomplish. Unfortunately, we must now await the Department of Justice’s pending criminal investigation.
Because the board has consistently failed to oversee Musk, the limits of the SOX independence requirements have now been revealed in the glare of bright light.
Congress should act to amend SOX to prevent situations in which sole stakeholders of public companies can control the boards of directors or audit committees.
A simple remedy could allow all shareholders to have an equal vote in selection of audit committee members or, alternatively, to prevent a controlling shareholder from voting in elections intended to oversee that particular shareholder because voting in such an election would conflict the purpose of electing independent directors.
David P. Weber is the former assistant inspector general for investigations at the SEC. He is the academic director of Fraud Management Programs at the University of Maryland’s Robert H. Smith School of Business and a full-time lecturer in Maryland Smith’s Accounting and Information Assurance Department. He owns a Tesla Model 3.