The Securities Exchange Commission (SEC) filed court documents this afternoon bringing fraud charges against Elon Musk, the CEO of Tesla (NASDAQ: TSLA). TSLA shares plunged more than 10% in after-hours trading to $276.20. The charges stem from the notorious August 7 “funding secured” tweet in which Musk said that he was considering taking Tesla private at a roughly 20% premium.
“Musk’s statements, disseminated via Twitter, falsely indicated that, should he so choose, it was virtually certain that he could take Tesla private at a purchase price that reflected a substantial premium over Tesla stock’s then-current share price, that funding for this multi-billion dollar transaction had been secured, and that the only contingency was a shareholder vote. In truth and in fact, Musk had not even discussed, much less confirmed, key deal terms, including price, with any potential funding source,” the SEC alleged in its filing.
The SEC pointed out that from the time of Musk’s tweets to the end of trading on August 7, Tesla stock was up by more than 6%, and closed up 10.98% from the previous day.
There are several reasons that Musk would have issued materially false and misleading statements to pump Tesla’s stock price. The first is that he has just a matter of months before Tesla’s convertible bonds mature, and if Tesla stock is below $359.86 on February 27, 2019, Tesla will have to pay bondholders $920M.
The second reason is that most of Musk’s personal wealth is in the form of Tesla stock, and he’s leveraged his assets. Forbes reported that by the end of 2017, Musk was using 40% of his shares as collateral for cash loans. Based on Tesla’s closing price on December 29, 2017, Musk had pledged $4.29B worth of Tesla stock as collateral for his loans. Here’s the thing about collateral: if the value of the collateral goes down, the lender wants more protection—either in the form of more collateral or cash to maintain the proper margin. On Dec. 29, TSLA stock closed at $311.35; over the course of 2018 so far, it’s been as low as $252.48 (April 2). The downward volatility in Tesla’s stock price probably caused Musk real problems when it came to his personal cash flow as banks became nervous about the risk they had assumed.
Not only are Musk’s personal assets heavily leveraged, but Tesla’s debt ratio had climbed to 1.97 by the end of Q1 2018. So Musk has heavily leveraged equity in a company that is already deeply indebted.
Musk has tied his personal fate to Tesla’s stock price, and with the convertible bond maturation date approaching inexorably, the risk to the company itself is not insignificant. Bloomberg said on September 3 that Tesla had about $2.2B cash on hand, so the convertible bond, if Tesla’s stock price doesn’t exceed $359.86, will cost them about half of their cash.
Our theories about Elon Musk’s potential motivation to commit securities fraud are just that: speculative theories. But they do show what Musk and his company stand to gain from a pump in stock price. Beyond that, there are other reasons making investors nervous, like Musk’s increasingly erratic behavior and penchant for recreational drug use. Apparently the $420 price Musk set for the private sale of Tesla was a pot joke, for instance, and he recently smoked a combination of marijuana and tobacco on Joe Rogan’s podcast.
With a securities fraud trial now on the horizon, Tesla’s stock is facing more headwinds than ever at a critical time in the company’s history, when it is struggling mightily to achieve profitability.