Musk Shareholder Lawsuit Shows Disregard for Acquirers’ Interests

Despite its seemingly open-and-shut nature, a lawsuit involving the Securities and Exchange Commission and Elon Musk raises an important policy issue: whether an outsider’s effort to take over a company via the purchase of its shares should be subject to certain regulatory scrutiny, or whether such scrutiny overly favors a company’s current shareholders over potential acquirers.

The SEC last month sued the Tesla Inc. and Space Exploration Technologies Corp. CEO for alleged violations of federal securities laws in his acquisition of X Corp., then known as Twitter Inc.

The agency claimed Musk misled Twitter shareholders when he failed to timely disclose that he had amassed a large stake in the company prior to acquiring it in 2022. Under SEC rules governing such transactions at the time, anyone acquiring 5% of the common stock of a public company was required to publicly disclose that fact within 10 calendar days—shortened to five days since then.

Musk waited 11 more days before notifying the SEC, while purchasing more shares at bargain prices. This allowed him to save more than $150 million at the expense of Twitter shareholders, according to the SEC.

To regulators, such activity obviously warrants enforcement. As the SEC noted in its complaint, Congress enacted the reporting requirement to help investors make informed investment decisions by giving them information about the potential to change or influence control of that company.

The SEC said Musk’s delay in reporting allowed him “to make these purchases from the unsuspecting public at artificially low prices,” that “did not yet reflect the undisclosed material information of [his] beneficial ownership of” a large stake in the company. In the SEC’s view, the $150 million that Musk saved in not complying with this requirement constituted an ill-gotten gain that belonged to the shareholders.

But arrayed against this view, as SEC Commissioner Hester Peirce argued, is the need to “preserv[e] an incentive structure for investors to seek change of control at under-performing companies.” That structure allows those who identify firms that are mismanaged, are operating poorly, or simply are undervalued to benefit from their efforts.

Permitting buyers to profit from such activity “is often needed to induce them to invest the effort to discover firms that are mismanaged,” as one commenter said. Peirce noted that requiring purchasers to disclose too early enables uninformed traders to share in profits created by more informed investors’ diligent efforts.

While the disclosure requirement here may strike many as worthwhile—and not all that burdensome—it can make completing a takeover more difficult. As soon as a buyer reveals their position to the market, the price of the target gets bid up, making the proposition more expensive and hence more difficult to achieve.

But that’s exactly the point and the problem with this form of regulation—it requires those who gather information about undervalued firms to share that information with others who have made no such effort. Peirce explained that people who lawfully possess information shouldn’t have to hand that information over to their uninformed counterparties, absent a “compelling reason.”

The SEC’s concern appears to be ensuring that shareholders receive timely access to such information and to the benefits that can be derived from it. Others’ concerns—especially those of economists—center on ensuring that the agency’s rules don’t deter market participants from seeking to identify and improve the performance of mismanaged or undervalued companies because they can’t be adequately compensated for their efforts and the risk they undertake.

Ultimately, the public policy choice here is whether the gains generated from takeover activity belong primarily to potential acquirers or current shareholders. Although mandating early disclosure may benefit certain shareholders, it may do so at the cost of discouraging would-be acquirers from engaging in such efforts in the first place.

What may appear to be a routine regulatory infraction at first glance raises an important policy question on who is entitled to the gains emanating from discovering suitable takeover targets. If we leave this question solely to regulators, we may regret the outcome, as incentives for such activities erode over time.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Robert Zwirb is an attorney who has advised market participants on financial regulatory issues. He served as counsel to a Wall Street law firm and two former chairmen of the Commodity Futures Trading Commission.

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