on July 30, 2016
On July 11, 2016, the Wall
Street Journal reported that the Securities and Exchange
Commission is investigating whether Tesla Motors Inc. violated the securities
laws, apparently by not disclosing timely a fatal crash involving a Tesla
Model S. Tesla’s handling of the incident from a disclosure standpoint raises
interesting issues involving materiality and risk factors.
It seems the SEC is examining
whether Tesla should have disclosed information regarding the fatal crash in
offering documents relating to the sale of approximately $2.8 billion of Tesla
common stock, nearly $600 million of which were sold by Tesla CEO, Elon Musk.
Here are the facts. On May 7,
2016, a Model S Tesla featuring Tesla’s autonomous driving technology
“Autopilot” collided with a tractor trailer that had turned in front of it,
killing the driver of the Model S. Ironically, the driver, Joshua Brown,
regularly posted videos of his rides in the car, and he was clearly a big fan
of Autopilot. On May 10, Tesla filed its first quarter 10-Q without any reference to
the crash. Eight days later, Tesla filed a preliminary prospectus with the SEC to sell up
to 10,697,674 shares of common stock without mentioning the crash. Two
days after that, Tesla filed a prospectus supplement disclosing the pricing
of the offering (up to $2 billion of stock, approximately $1.4 billion by Tesla
and nearly $600 million by Musk), and again with no disclosure regarding the
crash. On June 29, Tesla learned the National Highway Traffic Safety
Administration would conduct a preliminary evaluation of the crash, which Tesla
addressed in a blog post after the markets closed the following day.
As to Tesla’s blog post, one
thing that caught my attention was the part that states that Tesla informed the
NHTSA about the accident “immediately after it occurred”. Yet the accident took
place on May 7 and Tesla didn’t notify the NHTSA until May 16, a full nine days
later. In Tesla’s defense, it claimed that the extent of the wreckage
made remote data analysis impossible, and it had to dispatch its internal
investigators to the scene of the accident which slowed down the process.
As a general rule, SEC reporting
companies must disclose categories of information specifically mandated by
regulation as well as any information that’s material to investors. But there
is no clearly defined standard for whether the May 7 accident was “material”
enough to require disclosure. Instead, general standards regarding materiality
have been established in SEC rules, judicial decisions and administrative
guidance. As a general proposition, information is deemed material if
“there is a substantial likelihood that a reasonable shareholder would consider
it important in making an investment decision”. For a fact to be
material, there must be a substantial likelihood that the fact would have been
viewed by the reasonable investor as having significantly altered the “total
mix” of information made available.
So is the crash material to
Tesla investors? If so, the failure to disclose it would be deemed to be a
material omission. One place to look for evidence of materiality is the stock
market. In this case, the reaction of the stock market seems to indicate
that the crash is not material. The day the news broke about the NHTSA
investigation (June 29), the stock closed at $210.19, up from 201.79 the day
before. It rose to $212.29 on the first day after Tesla blogged about the
crash (July 1), and it closed at $234.79 on July 29, the last trading day
before this blog post. In fact, the only noticeable drop in price after
the crash date of May 7 occurred on June 22, when Tesla shares cratered (down
$22.95 from the previous close of $219.61) in reaction to Tesla’s bid for Solar
City.
The history of auto fatalities
may be another reason the crash itself should not be deemed to be
material. In 2015, there were an estimated 38,000 auto fatalities in the United
States. Nearly 1.3 million people die in road
crashes each year worldwide, an average of 3,287 deaths per day. In
its June 30 blog post, Tesla asserted that the May 7 crash was the first
fatality in the 130 million miles driven with Autopilot. By comparison,
Tesla asserted that there is a fatality every 94 million miles for all American
vehicles and one every 60 million miles worldwide, which Tesla asserts proves
it has a “better-than-human” driving capability. Companies do disclose
safety recalls and product liability suits when they trigger significant
financial charges, but not fatal crashes. Perhaps the reason may be that
fatal car crashes in and of themselves are not perceived to have a material
adverse effect on a company.
But perhaps an
argument in favor of materiality here is that Tesla had been
aggressively promoting its Autopilot technology, which it bills as the mostadvanced
self-driving system on the road. Investors have been drawn to Tesla shares in
large part on the conviction that the company is on the cutting edge of
technology, particularly with Autopilot, and may be poised to leap ahead of
more traditional car manufacturers. A fatal crash, however, could lead to a
change in perception of autonomous vehicles in general, and Autopilot in
particular, on the part of both the public and the insurance industry. But even
assuming as much, it appears that Tesla did not determine that the car was
actually on Autopilot at the time of the crash until after it filed its 10-Q
and offering prospectus.
One of the stranger aspects of
this story is the email and tweet battle that broke out between Musk and
Fortune Magazine. Fortune editor Alan Murray tweeted “[s]eems pretty material
to me,” with a link to the magazine’s online article in which Musk is quoted
saying in an email that the matter was “not material” to Tesla shareholders.
Musk then retorted to Murray on Twitter: “Yes, it was material to you — BS
article increased your advertising revenue. Just wasn’t material to [Tesla], as
shown by market.” Murray then predicted that the materiality issue would
be resolved in a lawsuit, implicitly inviting shareholders to sue (sort of like
Trump inviting the Russians to find Hillary Clinton’s deleted emails).
Another interesting aspect to
all this is Tesla’s risk factor disclosure. Tesla’s 10-Q filed on May 10 for the
quarter ended March 31 contained a risk factor entitled “We may become
subject to product liability claims, which could harm our financial condition
and liquidity if we are not able to successfully defend or insure against such
claims”, in which it stated that a successful liability claim associated
with its technology, including the Autopilot feature, could harm the company’s
financial condition, “could generate substantial negative publicity about [its]
products and business and would have material adverse effect on
[its] brand, business, prospects and operating results” (emphasis added).
Seems like Tesla is careful to draw a distinction between an isolated crash and
a products liability claim. Also, in its June 30 blog post, Tesla
referred to the foregoing risk factor as “boilerplate”, something Tesla may
regret saying as the SEC has a long history of discouraging intensely
boilerplate disclosures. And finally, the part of that risk factor that
really jumped off the page at me was that “We self-insure against the risk of
product liability claims, meaning that any product liability claims will have
to be paid from company funds, not by insurance.” My hunch is that
self-insurance is not very common in the industry, and it will be interesting
to see whether Tesla revisits its insurance approach in the aftermath of all of
the post-crash scrutiny.
No comments:
Post a Comment