Elon Musk’s Ultimatum to Tesla: Fight the S.E.C., or I Quit

Securities and Exchange Commission officials were understandably taken aback on Thursday morning when Tesla’s board — and its chairman, Elon Musk — abruptly pulled out of a carefully crafted settlement.

After the S.E.C. responded by accusing Mr. Musk, but not the company that he had co-founded, of securities fraud, the board further defied regulators, issuing a provocative statement saying that the directors were “fully confident in Elon, his integrity, and his leadership of the company.”

It was a stunning reversal: The board had rejected a settlement that was extraordinarily generous — it would have allowed Mr. Musk to remain as chief executive, and required him to step down as chairman for only two years. Now, the company was at risk of losing Mr. Musk as chairman and chief executive if regulators prevailed in court.

“What it tells us is this board, as a strategic plan, must be using the Jim Jones-Jonestown suicide pact,” Jeffrey Sonnenfeld, a professor at the Yale School of Management, said Friday on CNBC. “They are drinking the Kool-Aid of the founder. It is completely as self-destructive as Musk is.”

But Mr. Musk had given the board little choice: In a phone call with directors before their lawyers went back to federal regulators with a final decision, Mr. Musk threatened to resign on the spot if the board insisted that he and the company enter into the settlement. Not only that, he demanded the board publicly extol his integrity.

Threatened with the abrupt departure of the man who is arguably Tesla’s single most important asset, the board caved to his demands, according to three people familiar with the board’s decision.

The next day, Tesla’s lawyers were back at the S.E.C., all but groveling for a second chance — this time with Mr. Musk’s grudging approval.

One factor in Mr. Musk’s change of heart: Tesla’s stock plunged Friday morning as investors absorbed news of the rejected settlement and the possibility that the S.E.C. would force Mr. Musk to step down. It would finish down almost 14 percent on Friday.

On Saturday, the company and Mr. Musk finally agreed to settle the matter, ending a crisis that began with Mr. Musk’s now-infamous Twitter post saying that he had “funding secured” for a buyout at $420 a share.

Mr. Musk’s 48 hours of obstinance came at a significant price to him and the company. They had passed on Thursday’s generous offer, and the S.E.C. felt compelled to extract greater concessions. The ban on Mr. Musk’s serving as chairman went from two years to three, and his fine doubled to $20 million. Tesla will also pay a $20 million fine, and Mr. Musk agreed to personally buy the same amount in Tesla stock.

The S.E.C. is also requiring the company to add two independent directors and to elect an independent director as chairman.

“Rejecting such a favorable settlement is proof that he needs monitoring,” said John C. Coffee Jr., a professor at Columbia Law School. “He didn’t have a legal leg to stand on, and I’m sure his lawyer told him that. But he got very touchy about not being able to proclaim his innocence.”

From Mr. Musk’s view, that had been a crucial problem with a settlement from the beginning. Mr. Musk neither admitted nor denied guilt as part of the agreement, and he cannot publicly contest the S.E.C.’s allegations. He cannot say, as he did on Thursday, that “I have always taken action in the best interests of truth, transparency and investors” and “the facts will show I never compromised this in any way.”

Tesla’s stock has rebounded this week, reflecting investors’ relief that Mr. Musk will remain as chief executive while the company puts mechanisms in place to curb his increasingly impulsive behavior. The board will closely watch Mr. Musk’s communications with investors, and establish a permanent committee responsible for, among other things, monitoring disclosures.

But it remains to be seen how effective the board can be, given Mr. Musk’s erratic temperament and his dominant role in the company.

People involved in the board’s deliberations this week told me that some directors have proposed their fellow director, James Murdoch — the chief executive of 21st Century Fox, most of which is being sold to the Walt Disney Company — as chairman. But Mr. Murdoch hasn’t volunteered for the post nor has he discussed it with any other director. And another person close to the selection process said the board hadn’t yet engaged in any “serious” discussions of who should be chairman. The people spoke on the condition of anonymity because the board discussions were private.

Under terms of the settlement, the board has 45 days before Mr. Musk must resign. Whether it is Mr. Murdoch or another similarly qualified candidate who takes over as chairman, managing Mr. Musk will be no easy challenge.

Independent directors frequently face difficulty asserting themselves in any company with an outsize figure like Mr. Musk, whether it be a founder, controlling shareholder or powerful chief executive, said Lucian Bebchuk, a professor at Harvard Law School and an expert in corporate governance. Such people can often replace any director who crosses them, he said.

“Adding two independent directors can be expected to help, but its impact is likely to be limited,” Professor Bebchuk said. “As courts and governance researchers have long recognized, the presence of a dominant shareholder is likely to reduce the effectiveness of independent directors as overseers of the C.E.O.’s decisions and behavior.”

In the end, it took legal action by the S.E.C. to accomplish what had been increasingly obvious to most Tesla observers, including many of Tesla’s own directors: For all his brilliance, Mr. Musk’s reckless impulses must be kept in check.

Foremost among those should be threats to quit if he doesn’t get his way.

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