Published on March 4th, 2019 | by Jennifer Sensiba0
Tesla & The SEC: It’s Complicated, And Awful
March 4th, 2019 by Jennifer Sensiba
The story of Tesla and the SEC isn’t as simple as many think.
We all probably know the story. An entrepreneur sees serious problems with the automobile industry. He decides to start his own company to make safer, more reliable vehicles with new propulsion technology and fewer maintenance headaches. Sleek lines and better aerodynamics, combined with the better propulsion technology, could help the car be more efficient than others on the road.
Then, along comes the SEC with allegations that the entrepreneur ripped off investors, and this has a negative impact on the company.
You may be surprised that I’m not talking about Elon Musk or Tesla in the last couple of paragraphs. The above story is that of Preston Tucker just after World War II. His plan was to release a new and innovative car in the postwar years: the Tucker ‘48. While he did have some funding problems before the SEC trial in 1949–1950, he struggled on. The lengthy trial ended in a full acquittal for Tucker and his company, but despite winning, his good name had been tarnished, and previously patient investors and suppliers closed their doors to him.
There’s debate to this day over whether the company failed because of Tucker’s mistakes or whether the company was brought down by sneaky or even conspiratorial moves from the bigger auto companies. Looking at Facebook groups, Twitter, and Tesla enthusiast websites, there’s plenty of similar sentiment today with Tesla. Some feel that Tesla’s financial struggles and clashes with regulators are Elon Musk’s fault, while others insist that Big Oil, Big Auto, narrow-minded short sellers, and others are in a conspiracy to bring Tesla down.
I decided to take a hard look at the issue. Not only did I try to do my own best research, but I gathered up a small army of helpers from social media (if you’re one of them, thank you!) to help me find more information and data. I looked at a variety of sources, including things shared by Tesla shorts (some of whom were rather rude and sexist).
I did find some good things and some disturbing things about the SEC. What follows is a summary of what I found. In the interest of being fair, and as part of my commitment to journalistic ethics, I’m going to start with the good things.
The Good at The SEC
If you haven’t already done so, check out the SEC website’s “about” section. According to that page, “The mission of the SEC is to protect investors; maintain fair, orderly, and efficient markets; and facilitate capital formation. The SEC strives to promote a market environment that is worthy of the public’s trust.” The SEC’s “What We Do” page also has a lot of helpful information.
While I’d love the fun and excitement of telling readers about the dastardly scheme we uncovered with the help of those kids and their dog Scooby Doo, real life isn’t like that. There’s no boogeyman behind the scenes pulling the strings, no robber baron from Big Oil Evil Inc twisting his moustache while ordering the SEC to kill Tesla, and nobody saying, “It’s curtains for you! Mwuhahahaha!” I didn’t even get to hear the “I’m about to kill you, so here’s my entire plot for world domination!” talk from any Bond villains.
If there is anything like that going on, it’s extremely well hidden, but Occam’s Razor probably applies here. Such a complex conspiracy would only take a few honest people to expose, or perhaps just one disgruntled executive who gets turned on or who didn’t get his cut of the loot.
The vast majority of the SEC’s staff are good people like the rest of us, and they really do catch con artists, matchstick men, and others who would plunder your retirement or your kids’ college money. They probably wouldn’t be willing to follow a direct order to take an innocent entrepreneur down. If nothing else, being caught doing that would be a career ender or even a ticket to prison. They have their own families to take care of.
Regulatory Capture and the “Revolving Door”
The more informed critics of the SEC think the problem is more down to earth, and doesn’t require the use of aluminum foil for protection. Good people, individually, trying to do good things, can do harmful things as a group when operating in an environment of perverse incentives.
In 2014, long-time SEC lawyer James Kidney made some very interesting remarks at his retirement party. “There are three major reasons for my misanthropy at the SEC. They are the bureaucracy, the incredible over pleading of minutiae and picking on the little guys,” he said. After describing some of his odd experiences during his career, and talking about good and talented people he worked with, he started describing some of the serious problems he dealt with. “The revolving door is a very serious problem. I have had bosses, and bosses of my bosses, whose names we all know, who made little secret that they were here to punch their ticket. They mouthed serious regard for the mission of the Commission, but their actions were tentative and fearful in many instances.”
When he said “revolving door,” he was talking about the agency’s relatively rapid churn of employees coming and going, with many coming from the ranks of the very entities the SEC is supposed to police, and then later leaving the SEC to go back to work for the same companies. Kidney said the “best and the brightest” tended to leave, saying that, “They see an agency that polices the broken windows on the street level and rarely goes to the penthouse floors. On the rare occasions when Enforcement does go to the penthouse, good manners are paramount. Tough enforcement – risky enforcement – is subject to extensive negotiation and weakening.”
The full remarks of his retirement speech were later removed from the SEC Union’s website, but they are still available on the Wayback Machine.
According to the Project on Government Oversight (aka POGO), the SEC tends to take it easy on the big players in the economy because future career prospects are at risk. Again, people take a job at the SEC sometimes just to “punch their ticket” as Kidney said, or put more plainly, they’re just there to get the SEC on their resume so they can get a better paying job later defending companies from the SEC.
“You can get back to Wall Street by acting tough, by using the SEC publicity apparatus to promote yourself as tough, and maybe even on a few occasions being tough, if you pick your targets carefully,” Kidney said. “But don’t appear to fail. Don’t take risks where risk would count.”
In other words, the goal is often not to enforce the law or protect investors, because individual lawyers are trying to “look tough” in their enforcement actions while not upsetting the best places that they may eventually want to work for. This could lead to an agency that, on the whole, goes hard after the smaller and/or less well connected businesses, while ignoring or softly enforcing the law against big companies. About this, Kidney said, “For the powerful, we are at most a tollbooth on the bankster turnpike. We are a cost, not a serious expense.”
In the SEC’s defense, academics have studied this issue to see whether this was actually reflected in the agency’s records. They divided the agency lawyers’ motivations into two broad hypotheses: “rent seeking” and “human capital.” “Rent seeking” lawyers are looking to use the agency to further their future career prospects as alleged by POGO and Kidney. “Human capital” lawyers are trying to make a name for themselves fighting hard doing good to impress future employers. The researchers found a mix of the two, depending on what types of businesses were being investigated and what part of the country they were in.
POGO does question the methodology of these studies, and the researchers themselves indicate that there are limitations in their data. The biggest limitation may be that they are only able to obtain data about the cases that the SEC’s lawyers chose to pursue, and Kidney’s remarks indicate that the choice to pursue or not pursue is a big part of the revolving door’s impact on cases.
Allegations of Misconduct Due to the Revolving Door
Researchers at the Brookings Institution covered this issue in depth in 2011. Not only has a federal judge alleged regulatory capture when rejecting a settlement, but there have been many cases that throw suspicion on the agency’s ability to go after the big players when they’re doing wrong by their investors.
At least one SEC lawyer has been caught protecting a company from investigation for years, and then later getting paid to do work for the company they protected. Bernie Madoff, the well known perpetrator of a massive Ponzi scheme, operated just below the agency’s radar, possibly because he once served on an advisory board inside. There was even a ten-year period where contempt allegations like those recently filed against Elon Musk were not filed against a single repeat offender.
There are many other examples of alleged misconduct around the internet, but The Intercept makes it clear that the problem may go right to the top of the agency, and may have for years. Our own Zachary Shahan told the tale of the SEC dragging their feet when tasked to implement the Foreign Corrupt Practices Act, which would have put oil companies in a bad position. He also points out that the SEC rarely goes after executives demanding they lose their position at the company, as they did with Elon Musk.
Current Actions against Elon Musk
Before I move on to discussing the current case against Elon Musk, I want to share something from the Kidney retirement speech that many media outlets don’t, probably because it’s not juicy enough. However, it would be unfair to omit this. He said, “Despite these program and policy failures, on a personal level I could not have asked for a better employer than the Division or for kinder colleagues. Don’t mistake my criticisms of the institution for a personal criticism of its staff. Working with the staff on litigated cases has been fun. There is great talent and even better people on the staff. It is tragic to waste them, as we sometimes do. And to my colleagues in the trial unit – have a little understanding. The system is broken. The staff has to work with it.”
I want to discuss the possible conflicts of interest the individuals involved may have, but I don’t want this sharing of information to be taken the wrong way. Nothing in this section of the article can tell us what goes on in their heads, or what kind of a person they are. They may be among Kidney’s “best and brightest”– the people who are trying to do the right thing in a system with problems. They may also be “punching their ticket,” hoping to use this high-profile case against a smaller player to land a lucrative job elsewhere later, perhaps at one of the institutions shorting TSLA. The truth is, we don’t know. We can’t know, at least not yet.
Possible Conflicts of Interest
According to The Nation, the chairman of the SEC (nominated by Donald Trump) “has a major conflict of interest problem.” As a former partner in a high-powered law firm, he represented numerous big businesses and banks, to the point where he wouldn’t be able to vote in many important cases for two years. When looking at the automotive industry in particular, he represented Volkswagen, known for the “Dieselgate” scandal.
Looking further down in the organization, Twitter user EVfreshAir pointed me to The Legal 500’s page on Steven Peikin, the Co-Director of the SEC’s Division of Enforcement. Before working for the SEC, he was Managing Partner of Sullivan & Cromwell LLP’s Criminal Defense and Investigations Group. His firm “successfully defended BP against two putative class actions concerning an alleged conspiracy to fix the price of North Sea Brent Crude. The firm also acts for Volkswagen and Audi in Re German Automotive Manufacturers Antitrust Litigation.”
To find out who is working directly on the Elon Musk/Tesla case, we had to look at the records of the New York Southern District Court, available here.
SEC lawyers who filed the case against Musk in September are:
- Jina L. Choi, Regional Director of Enforcement, and head of the SEC’s San Francisco Office
- Cheryl Crumpton, Supervisory Assistant Chief
- E. Barrett Atwood, Trial Counsel
According to Choi’s LinkedIn page, she previously worked at Davis, Polk, and Wardell, a firm recognized by POGO for participating heavily in the revolving door. TechCrunch reports that Choi retired from the SEC in late November 2018. It is unclear whether she would work in the private sector after retirement, but TechCrunch says, “it’s worth noting that many federal employees are eventually lured into higher-paying jobs in the private sector.” Either way, she is unlikely to continue working on this case, but was a part of starting it.
According to the LinkedIn accounts of Cheryl Crumpton and Barrett Atwood, both previously worked for Baker Botts, a firm that represents 52 of the largest 100 companies in the US. The Legal 500 notes that oil and energy companies are important clients in Baker Botts’ environmental and SEC-related work.
Do these connections mean these SEC lawyers, or their supervisors, had nefarious motives? Of course not We simply don’t know their motives. However, accumulating information and looking at it in context may eventually help us to understand what is going on here.
A Few Closing Things to Consider
Right after the current case started, a retired senior SEC lawyer told Business Insider that it wasn’t right for them to sue Musk over his tweets. He said that his contact with interested investors looking to help take Tesla private was probably enough to support his statement, and that it was a questionable case, judgment wise, for the SEC to be using resources on.
Finally, some of those helping me gather information pointed me to some potentially suspicious trading activity on the day the case for holding Elon Musk in contempt was filed. According to NASDAQ, there was “exceptionally high volume” for the $100 strike put option expiring March 15, 2019. The existence of the new legal activity against Musk wasn’t reported in the press until the next day, and, depending on the time of day the papers were filed and when they were publicly accessible, it might not have been public knowledge at all on that day, or at the very least after the increased options trading started.
The proof is still thin at this point, but there could be an illegal leak of information from the SEC that is being used to educate bets against Tesla. Thus, Musk’s accusation that the SEC is the “Shortseller Enrichment Commission” may be far truer than we thought.
On Friday, Elon Musk switched lawyers representing him in the SEC’s case against him. He replaced outgoing Tesla general counsel Dane Butswinkas with a team lead by John Hueston, who led the prosecution against Enron in 2006. With this experienced counsel, Musk may be able to defend himself from the revolving door system by having an experienced player on his side.
Some of the things I dug up and shared here look downright awful, but do keep in mind that the SEC is a complex organization and there is surely other information that I didn’t find. I’d highly recommend that the readers continue looking for more information, especially as the current battle between the SEC and Elon Musk unfolds.
My personal opinion is that there are some serious problems with the SEC that Congress needs to substantively address. The revolving door needs to be closed and locked. Large players shouldn’t see the law as a “tollbooth” they pay their way through while smaller players are put through the wringer so that some faceless bureaucrat can make a career. Even if nobody at the SEC wants to target Musk specifically, the perverse incentives that may lead them to stifle innovation, deny freedom of speech, and strengthen Wall Street’s “good ol’ boys’ club” are problems that could be costing our whole society in incalculable ways.
No matter the outcome of this case, we should push hard for serious reform at the SEC and ensure that the “best and brightest” Kidney mentions can lead the agency to truly protect investors from the real con artists in the market.