Investors around the globe look to the SEC to properly supervise public companies and take enforcement action when necessary. The SEC is supposed to instill confidence in American markets. The problem is: the SEC’s enforcement is so inconsistent it is confusing. Take for example, the erratic nature of its fines and its complete lack of patience with Elon Musk compared to its apparent unending patience with Mark Zuckerberg.
Just consider what we know about Facebook. A consolidated class action suit filed on October 15, 2018, against Facebook and CEO Mark Zuckerberg, COO Sheryl Sandberg, and CFO David Wehner alleges the defendants made “materially false and misleading statements and omissions concerning Facebook’s privacy and data protection practices,” “employed devices, schemes and artifices to defraud…and engaged in acts, practices, and a course of business that operated as a fraud or deceit,” impacting the company’s stock price and impacting its investors. Far from puffery, in July 2018, Facebook lost $119 billion in market value in one day — the single largest drop in the U.S. stock market history, following an earnings call which revealed a decline in Facebook users and a lack of readiness to comply with the EU’s General Data Protection Regulation.
The class action complaint also alleges the three executives violated insider trading laws, detailing Zuckerberg’s sale of more than 29.4 million Facebook shares for nearly $5.3 billion, Sandberg’s sale of over 2.5 million shares worth $389 million, and Wehner’s trades totaling $21 million. The 164-page complaint is eye-opening and worth a read.
Following Mark Zuckerberg’s testimony to Congress in April 2018, numerous media reports speculated whether he had possibly lied to Congress; the Washington Post ran a story detailing 14 years of Zuckerberg repeatedly apologizing for privacy lapses and then promising to do better. Following the Cambridge Analytica scandal and Zuckerberg’s testimony, we learned that the SEC, FTC, Department of Justice, and FBI were investigating Facebook over its sharing of personal user data and other actions and statements by officers. Since then, there has been no further news about the SEC’s investigation. It is apparently progressing, but certainly not swiftly. (In contrast, The Washington Post reported recently that the FTC was negotiating a “multi-billion” dollar fine with Facebook for violating its 2011 Consent Order about protecting personal data.)
There is another very important point to make here: the SEC is the only entity that can rein in Mark Zuckerberg. He owns 60% of the stock and 70% of the voting rights. Neither the board nor the shareholders can curb his greed or errors in management. The only entity who can be the parent to Zuckerberg and protect shareholders is the SEC, and they have failed to take action.
Let’s look at a couple of other SEC enforcement actions to get a clearer picture of the uneven nature of its enforcement actions. In April 2018, the SEC took action against Yahoo for failing to notify investors of a 2014 breach that involved personal data on 500 million users. (It is unclear why the SEC took no action regarding a 2013 breach that also was not reported, but which involved 3 times the number of users…1.5 billion Yahoo account holders.) In addition to the 2014 breach that was undisclosed to Yahoo users, the SEC found that Yahoo misled Verizon in its due diligence. The SEC Order states:
Although Yahoo was aware of additional evidence in the first half of 2016 indicating that its user database had been stolen, Yahoo made affirmative representations denying the existence of any significant data breaches in a July 23, 2016 stock purchase agreement with Verizon, by which Verizon was to acquire Yahoo’s operating business for $4.825 billion.
Yeow! That is a serious misrepresentation. The SEC ultimately fined Altaba (the name of the company holding the remaining Yahoo shares that Verizon did not purchase) a paltry $35 million. One may ask why the SEC did not go after Marissa Mayer, CEO of Yahoo who managed these incidents. “We do not second-guess good faith exercises of judgment about cyber-incident disclosure,” Steven Peikin, a codirector of the SEC’s Enforcement Division, said in a statement.
Also consider the action that the SEC took against Theranos founder and CEO Elizabeth Holmes and the company’s president “Sunny” Balwani, charging that they raised “more than $700 million from investors through an elaborate, years-long fraud in which they exaggerated or made false statements about the company’s technology, business, and financial performance.” Holmes’s settlement with the SEC amounted to a $500,000 penalty and disbarment from serving as an officer or director of a public company for 10 years. She also had to return shares she obtained during the fraud and voting control of the company.
Now, contrast all of this with the SEC’s swift action against Elon Musk for tweeting on August 7 that he was taking his company, Tesla, private. The very next day, on August 8, the Wall Street Journal reported that the SEC was making inquiries into the truthfulness of Mr. Musk’s statements. On September 27, 2018, the SEC filed suit against Elon Musk that sought civil penalties and asked the court to bar Mr. Musk from serving as an officer or director in a public company, noting the stock price fell 16% after he pulled back from his statement that he was taking the company private.
Mr. Musk caved to the pressure and within two days reached a settlement with the SEC that required him to step down as chairman for 3 years, add two new independent directors to the board, put new controls in place, and he and Tesla would each pay a $20 million fine. That is a $40 million penalty contrasted with a $500,000 penalty against Holmes for massive fraud and a $35 million penalty against Altaba for the worst data breach in history and an attempt to defraud a $5 billion purchaser.
Plus, as John Reed Stark, who has 20 years of experience in the SEC’s Enforcement Division, noted so well in one of his own posts:
The SEC does not typically file SEC enforcement actions like the one against Musk. Indeed, a close reading of the SEC’s complaint against the celebrated billionaire finds a litany of glaring absences within the SEC’s allegations, including:
- No alleged profits or other ill-gotten gain earned by Musk;
- No alleged scheme conducted by Musk;
- No alleged market manipulation orchestrated by Musk;
- No alleged pump and dump ploy executed by Musk;
- No alleged conspiracy between Musk and anyone else;
- No alleged evidence of scienter or intent by Musk;
- No alleged false filing or other false or inaccurate Tesla report to the SEC by Musk;
- No alleged violation of any sort of required SEC “quiet period” by Musk; and
- No concrete evidence of an alleged motive attested to Musk (though not required in SEC enforcement actions, motive is typically pled or implied in some way, shape or form).
This week, we were greeted with the news that the SEC filed another court action against Musk, claiming that he had violated the terms of his settlement because he tweeted on February 19, 2019 (after the market closed), about planned production without getting the tweets approved by the SEC. Let this soak in…within one week the SEC rushed to court to hold Elon Musk in contempt, yet it has failed to take any action against Facebook, Zuckerberg, or Sandberg for 164 pages of alleged shenanigans, public statements, and $119 billion drop in market value. The agency is letting the shareholders do all of the heavy lifting, with a heavy burden of proof in pleading securities fraud.
It is also important to note that the impact of Elon Musk’s tweets on Tesla’s stock was not long term or significant. In fact, the SEC’s action may have harmed investors more than it helped them. A historical review of Tesla’s stock price indicates the stock closed on August 6 at $341.99; on August 7 it (day of the tweet) it closed at $379.57 and on August 8 at $370.34. So, it spiked a little after the tweet-to-go-private, but then it dropped and on September 7 it closed at $263.24. On September 27 (the day SEC filed) it closed at $307.52, and the SEC and Musk settled on Saturday, September 29. On Monday, October 1, the stock closed at $264.77 and slid further to close on October 8 at $250.56.
Prior to the SEC’s second filing on February 25, 2019, Tesla’s shares had been on a steady rise since February 21, but The Wall Street Journal reported that the shares “were off 4% after hours following the SEC filing.” Nevertheless, the stock closed at $297.86, just slightly down from the prior day.
I wonder…did the SEC think about how much Tesla investors would be harmed if Mr. Musk was actually removed from the company? He is the brain trust, force of innovation, and driver of that company. (Don’t fool yourself…we don’t have three clones waiting in the wings.) If, by SEC orders, he is forced to keep his companies private, we all lose because he will not have investor money to grow them and America — including our economy — won’t get maximum benefit from his genius. He is a cowboy, but he is much less of a cowboy than Zuckerberg and much less of a fraudster than Holmes. The SEC is handling this all wrong.
Either Elon Musk made some bureaucrat terribly mad at the SEC or their enforcement division is mismanaged and seemingly oblivious to its own erratic behavior and the message that it sends to the market. It can’t justify these discrepancies as Celebrity Fines that set a precedent and send a message because that is laughable in the face of the Theranos fraud and Yahoo’s attempt to hide the worst breach in history during a $4.8 billion bid for the company, which it later acknowledged was a breach of personal data on 3 billion accounts.
We can’t look to administrative solutions here. Congress needs to investigate what is going on at the SEC Enforcement Division and introduce legislation that reins in this erratic enforcement bureaucratic behavior.