This newsletter discusses noteworthy updates, key regulatory decisions and upcoming compliance reminders. You can view previous versions at this link.

Elon Musk Contempt Settlement Further Highlights Importance of Disclosure Controls, Presumptively Material Information and the Dangers of Social Media

By William Cole

In late April, the SEC agreed to settle contempt allegations with Elon Musk, the CEO and former Chairman of Tesla. The SEC claimed that Musk should be held in contempt for allegedly violating a 2018 court approved settlement with the SEC stemming from his use of Twitter.

The SEC alleged that a February 2019 Musk tweet about company production figures was made without pre-approval by securities counsel, which was required by the earlier court order. As part of the contempt settlement, the prior settlement agreement was amended to expand and clarify the list of topics requiring pre-approval. The contempt settlement highlights the dangers of social media, the importance of controls around such disclosures and may be instructive as to what may be considered presumptively material information.

2018 Settlement

As we have discussed previously, in late 2018, the SEC charged Musk with fraud in connection with a series of allegedly false and misleading tweets about his plan to take Tesla private. The SEC also charged Tesla with failing to have sufficient disclosure controls and procedures to assess whether information should be disclosed in SEC reports or to ensure that it was accurate or complete. As part of the 2018 settlement, Musk and Tesla agreed to financial penalties of $20 million each, that Musk would step down as Chairman, that his tweets would have to be pre-approved by securities counsel and to other undertakings.

Contempt Allegations

Musk certainly gave the impression to some that he did not fully respect the original settlement or the SEC. On October 4, 2018, Musk tweeted congratulating the “Shortseller Enrichment Commission” for their “incredible work.” In December, the CBS program 60 Minutes aired an interview with Musk which included statements that suggested that he was not having his tweets pre-approved and that he “might make some mistakes” in following the policy. He also stated that: “I want to be clear, I do not respect the SEC. I do not respect them.”

Then, in February 2019, Musk made the offending tweet about production statistics. On February 19, 2019, at approximately 7:15 pm, Musk tweeted that “Tesla made 0 cars in 2011, but will make around 500k in 2019.” A few hours later at 11:41 pm, Musk published another tweet correcting the prior one: “Meant to say annualized production rate at end of 2019 probably around 500k, ie 10k cars/week. Deliveries for year still estimated to be about 400k”. The earlier tweet had not in fact been reviewed by securities counsel and the SEC sought to hold Musk in contempt for not complying with the court approved settlement.

Among other things, the SEC argued that the original settlement required pre-approval of any Musk communications “that contain, or reasonably could contain, information material to the Company or its shareholders.” Moreover, a Tesla policy adopted pursuant to the settlement required pre-approval for topics including “projections, forecasts or estimates regarding Tesla’s business”. Musk argued that the projection had been previously disclosed and thus did not need to go through the typical vetting process and that he had otherwise reduced his volume of tweets and had in fact been diligent in attempting to comply with the earlier settlement.

Amended Settlement and Presumptively Material Information

In what was viewed as a win for Musk, U.S. District Judge Alison Nathan indicated that she wanted the SEC to work “it out” with Musk and that the earlier language in the settlement may have been too vague. In late April, the SEC and Musk amended the settlement agreement.

To enhance clarity and reduce potential future disputes, the revised agreement specifies certain topics in communications by Musk that are subject to pre-approval by an experienced securities lawyer, including:

  • the Company’s financial condition, statements, or results, including earnings or guidance;
  • potential or proposed mergers, acquisitions, dispositions, tender offers, or joint ventures;
  • production numbers or sales or delivery numbers (whether actual, forecasted, or projected) that have not been previously published via pre-approved written communications issued by the Company (“Official Company Guidance”) or deviate from previously published Official Company Guidance;
  • new or proposed business lines that are unrelated to then-existing business lines (presently includes vehicles, transportation, and sustainable energy products);
  • projection, forecast, or estimate numbers regarding the Company’s business that have not been previously published in Official Company Guidance or deviate from previously published Official Company Guidance;
  • events regarding the Company’s securities (including Musk’s acquisition or disposition of the Company’s securities), credit facilities, or financing or lending arrangements;
  • nonpublic legal or regulatory findings or decisions;
  • any event requiring the filing of a Form 8-K by the Company with the Securities and Exchange Commission, including:
    • a change in control; or
    • a change in the Company’s directors; any principal executive officer, president, principal financial officer, principal accounting officer, principal operating officer, or any person performing similar functions, or any named executive officer; or
  • such other topics as the Company or the majority of the independent members of its Board of Directors may request, if it or they believe pre-approval of communications regarding such additional topics would protect the interests of the Company’s shareholders

See Consent to Motion to Amend Final Judgement, SEC v. Musk, No. 18-cv-08865 (Apr. 26, 2019).


The amended language looks very similar to the materiality examples used in insider trading or disclosure policies. Companies should consider cross-checking the cited language against their own policies. Moreover, the case illustrates the difficult factual arguments that arise in determining whether a particular disclosure is materially consistent with prior disclosure, especially as the context changes. This difficulty is only enhanced by the inherent brevity, and ease of use, of social media.

As we have previously noted, we would continue to advise our public company clients to:

  • Review the composition of your company’s disclosure committee to make sure it has adequate independence from those making disclosures, as well as adequate federal securities law expertise.
  • Consider the implications of distributing material non-public information via social media. These disclosures present tricky issues around disclosure controls and procedures. They run the risk of being less rigorously vetted and may not include cautionary or other protective language.
    • Disclosure should be compliant with Reg FD.
    • Statements should be properly vetted for, among other things, accuracy, completeness and consistency with prior public statements.
    • Inaccurate statements can, in turn, lead to issues such as whether a “duty to update” has been created, and in any event may lead to liability through shareholder lawsuits.
  • If you decide to make statements via social media, consider reviewing your disclosure controls and procedures and/or disclosure policies to ensure that your company has adequate procedures to both fully vet statements and determine whether such statements need to be included in (or supplemented by) your company’s SEC filings.

SEC Proposes Amendments to Financial Information Reporting Requirements for Acquired and Disposed Businesses

By Paul William and Diana Rosia

In May 2019, the Securities and Exchange Commission (“SEC”) issued proposed amendments to financial disclosure requirements relating to the financial statements of acquired businesses (or business that will be acquired) and business dispositions. Through proposed amendments to Rules 3-05, 3-14 and Article 11 of Regulation S-X, the SEC intends to (i) improve the financial information provided to investors relating to acquired and disposed businesses, (ii) facilitate more timely access to capital and (iii) reduce the complexity and costs of preparing the disclosures. The proposed amendments are subject to a 60-day public comment period, with all comments due to the SEC on or before July 29, 2019.

The proposed amendments are complex and contain numerous specific features that merit careful study if relevant to your situation. We have narrowed the scope of this article to a review of changes relevant to determining if pro forma financial statements are required in connection with a potential transaction.

Current Financial Information Reporting

When a registrant is acquiring a business, both (i) historical financial information about the target and (ii) pro forma financial information about the combined business, may be relevant to the public. Likewise, when a registrant is selling a business, pro forma financial information showing the effects of the sale may be relevant to the public. Regulation S-X sets forth the rules relevant to the disclosure of historical financial information of a target company and the pro forma financial information of the combined business for all registered security offerings. Regulation S-X is also commonly used for an issuer’s financial presentation when selling privately-placed securities, including in Rule 144A offerings.

Significance Tests

In order to determine the financial information that must be disclosed under Regulation S-X, a registrant must initially determine if the potential transaction involves the acquisition of a “significant” business. To determine if the acquired business (the “Target Business”) is significant, Regulation S-X Rule 1-02(w) provides three tests: the Asset Test, the Investment Test and the Income Test (the “Significance Tests”).

Generally, the Asset Test is calculated by dividing the issuer’s proportionate interest in the total assets of the Target Business by the issuer’s total assets as of the end of the most recent fiscal year. The Investment Test generally measures the issuer’s investments in, and advances to, the Target Business (e.g. the purchase price) divided by the sum of the issuer’s total assets as of the end of the most recent completed fiscal year. The Income Test generally measures the issuer’s proportionate interest in the total income from continuing operations of the Target Business divided by the issuer’s total income from continuing operations as of the end of its most recent fiscal year.

Historical Financial Statements

Under Rule 3-05 of Regulation S-X, the historical financial statements of the Target Business that must be presented will vary depending of the level significance resulting from the Significance Tests. At best, no historical financial statements of the Target Business may be required. At worst, three years of audited income and cash flow statements and two years of audited balance sheets, together with unaudited interim financial statements may be required.

Pro-forma Financial Statements

Under Article 11 of Regulation S-X, a reporting company must also file unaudited pro forma financial statements for business acquisitions and dispositions based on historical financial statements of the registrant and the acquired or disposed business, which is intended to show how the acquisition or disposition will affect the registrant. The pro forma financial statements generally include a pro forma balance sheet as of the most recent balance sheet date and a pro forma income statement as of the most recent fiscal year and any subsequent interim period.

Proposed Amendments to Financial Information Reporting

The proposed amendments would:

  • Revise the Investment Test to compare the issuer’s investments in, and advances to, the acquired business to the aggregate worldwide market value of the issuer’s voting and non-voting common equity, instead of its total assets;
  • Revise the Income Test by adding a new revenue component to the income component, and the calculation of income would be simplified by using income or loss from continuing operations after income taxes;
  • Expand the use of pro forma financial information to determine significance to allow issuers to measure significance using filed pro forma financial information that depicts significant business acquisitions consummated after the prior fiscal year end;
  • Increase the significance threshold for dispositions from 10% to 20%;
  • Shorten the period of financial statements presentation of a Target Business to a maximum of two years; and
  • Eliminate any requirement for financial statements of a Target Business after the acquisition has been reflected for a complete fiscal year regardless of significance.

For a side-by-side chart comparing some of the key differences between the current reporting obligations and the SEC’s proposed amendments, please see the version of this article available at this link.

Proposal to Amend Accelerated Filer Definitions in 404(b) of SoX

On May 9, 2019, the Securities and Exchange Commission (the “Commission”) voted to propose amendments to the accelerated filer and large accelerated filer definitions. Under the proposal, issuers that are eligible to be a smaller reporting company (an “SRC”) and that had no revenues or annual revenues of less than $100 million in the most recent fiscal year for which audited financial statements are available would be excluded from the definitions of accelerated and large accelerated filer. The proposed amendments would also increase the transition thresholds for accelerated and large accelerated filers becoming a non-accelerated filer from $50 million to $60 million and for exiting large accelerated filer status from $500 million to $560 million. In addition, the proposed rules would add a revenue test to the transition thresholds for exiting both accelerated and large accelerated filer status.

The main policy rationale for the proposal is that SRCs with less than $100 million in revenues would no longer be required to obtain an attestation of their internal control over financial reporting (“ICFR”) from an independent outside auditor.

According to the Commission’s press release announcing the proposal, the proposed amendments would purportedly reduce costs for certain lower-revenue companies by “more appropriately tailoring” the types of companies that are categorized as accelerated and large accelerated filers “while maintaining effective investor protections.” In his remarks at the Commission meeting approving the proposed rules Commission Jay Clayton stated:

“In particular, our proposed rules are aimed at that subset of issuers where the added step of an ICFR auditor attestation is likely to add significant costs and is unlikely to enhance financial reporting or investor protection. The proposed amendments are intended to reduce costs without harming investors for certain smaller public companies and, importantly, encourage more companies to enter our public markets.”

The Commission in its press release noted that the proposed amendments would not change key protections from the Sarbanes-Oxley Act of 2002, such as independent audit committee requirements, CEO and CFO certifications of financial reports, or the requirement that companies continue to establish, maintain, and assess the effectiveness of their ICFR.

The Commission approved the proposal 3-1, with Commissioner Jackson dissenting. In his dissent, Commissioner Jackson noted that “[t]he proposal rolls back 404(b) only for smaller companies on the theory that these are the firms for which the costs of attestation are most burdensome. But it’s equally possible that these are the firms—high-growth companies where the risk, and consequences, of fraud are greatest—where the benefits of the auditor’s presence are highest.” He suggested that any cost savings achieved by the rule changes might outweighed by the costs of potential fraud, arguing that “when we roll back protections like these, we can expect the cost of capital to rise; investors will either diligence the risk of fraud themselves or require higher returns to protect against that risk.” He noted he did not believe any serious attempt had been made to quantify the benefits of attestation. Commissioner Jackson also argued that the data relied on in the proposal was more than 10-years old, and that potential evidence that companies “bunched” around the current $75 million public float is not borne out by more recent data.

The public comment period will remain open for 60 days following publication of the proposing release in the Federal Register.

Delaware Courts Allow Challenge to Constitutionality of State’s Unclaimed Property Audit Practices to Continue in Court

The words “unclaimed property” can be a source of headache for many companies, especially those incorporated in Delaware. Onerous reporting requirements across states often require that companies dedicate significant personnel time to the task. Penalties for noncompliance can also be steep, and states can audit companies and find noncompliance. Recent procedural developments in an ongoing lawsuit challenging the constitutionality of Delaware’s unclaimed property auditing practices are worth noting, as the case may have legal implications for the many companies with ties to Delaware. They also underscore that companies should ensure that they are compliant with state unclaimed property laws.

Insider Trading Enforcement Remains a Priority

By R. Randall Wang

Several recent enforcement actions demonstrate that insider trading remains a focus of the Justice Department and SEC – with heightened focus on lawyers.

One case involved Paul B. Powers, a former in-house lawyer with SeaWorld who had access to key revenue information as the associate general counsel and assistant secretary. Beginning in June 2018, he participated in several Revenue Committee meetings discussing positive trends, and took notes in his capacity as assistant secretary. He purchased $385,000 of shares the day after receiving an early draft of the Q2 2018 earnings release and Form 10-Q as part of the package for an upcoming Audit Committee meeting. The materials showed strong financial performance after a lengthy period of decline, as well as the settlement of an SEC enforcement investigation. After the earnings release was issued and the stock price increased 17%, he immediately sold his shares for $65,000 in profits. Mr. Powers consented to a permanent injunction with the amounts of disgorgement and penalties to be decided by the court and pleaded guilty in a parallel Justice Department action.

Another case shows that lawyers can never be too careful in safeguarding confidential information. In May, the SEC announced the settlement of insider trading charges against Brian Fettner, who discovered a pending corporate merger from a lifelong friend, who was the general counsel of the acquirer -- Cintas. Mr. Fettner was staying with his friend, as he always did when in town. While changing into golf shoes in the study before a charity golf tournament, he flipped through papers on his friend’s desk and found out about the merger. Saying nothing to his friend, he then purchased shares of the target in the brokerage accounts of his ex-wife and a former girlfriend, and persuaded his father and another girlfriend to purchase shares. The SEC alleged that his friendship with the general counsel was sufficient to create a duty of trust and confidence. Without admitting or denying the allegations, Mr. Fettner consented to a permanent injunction from violating Rule 10b-5 and a penalty of $253,000 – even though he did not personally profit. His ex-wife and former girlfriend also agreed to disgorge their profits with interest.

Earlier cases have focused on internal computer networks. For example, in one case from 2014, the SEC charged a managing clerk at a law firm and a stockbroker with insider trading around more than a dozen mergers or other corporate transactions for illicit profits of $5.6 million during a four-year period. The clerk accessed the information using the law firm’s computer system. The clerk was ultimately sentenced to 37 months in prison. In another case from 2010, the SEC charged a former IT manager at a prominent Delaware law firm with accessing confidential information about pending M&A and trading in advance of at least 22 deals that involved the firm’s clients. He also tipped his brother-in-law. The Justice Department announced parallel indictments. And in 2011, the SEC charged a corporate attorney with accessing information on 11 M&A deals involving law firm clients and tipping a middleman, resulting in $32 million in illicit profits. The Justice Department announced a parallel criminal action.

Insiders, attorneys and their organizations should review their insider trading policies, as well as their document management procedures and the use of security in computer systems and documents, using code names and restricting access to those on a need-to-know basis.

SEC Adopts Simplified Disclosure Requirements, Including Streamlined Procedures for Confidential Treatment of Agreements Filed as Exhibits

By R. Randall Wang

As reported in our April 2nd client alert, the SEC amended a wide variety of disclosure rules, primarily under Regulation S-K, to modernize and simplify disclosure requirements for public companies, investment advisers and investment companies. The most notable changes included significantly streamlined procedures for confidential treatment of commercially sensitive provisions in agreements filed as exhibits with the SEC.

Under the new rules, companies can omit confidential information from exhibits pursuant to either Item 601(b)(2)(M&A contracts) or Item 601(b)(10)(material contracts) and file redacted versions without the need to submit a confidential treatment request, provided that the omitted information is both immaterial and “would likely cause competitive harm” if publicly disclosed.

Companies must continue to:

  • clearly mark the exhibit index to indicate that portions of the exhibit or exhibits have been omitted
  • include a prominent statement on the first page of the redacted exhibit that certain identified information has been excluded from the exhibit because it is both (i) not material and (ii) would likely cause competitive harm to the company if publicly disclosed
  • indicate by brackets where the information is omitted from the filed version of the exhibit.

SEC staff will continue to review filings selectively, and assess whether redactions appear to be limited as required by the rules. Upon request, a company must provide supplemental materials to the staff similar to that currently required in a confidential treatment request. On April 1, the SEC published additional guidance on redactions and confidential treatment procedures.

The new rules do not substantively change SEC requirements – consistent with prior guidance, the redaction “should include no more text than necessary to prevent competitive harm,” typically only limited words or phrases.

Companies may also request an extension of a previously granted confidential treatment order by following the streamlined procedures announced by the SEC on April 16.