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From Securities Regulation Daily, October 5, 2018

Court orders letter justifying approval of SEC/Musk consent judgment

By Rodney F. Tonkovic, J.D.

The district court sitting in Manhattan has ordered that the SEC and Elon Musk file a joint letter explaining why the court should approve a proposed consent judgment. In the brief order, the court noted that requesting such letters is a regular practice and part of its duty to ensure the proposed consent judgment is fair and reasonable. The parties have until October 11, 2018, to file a joint letter of less than ten double-spaced pages explaining why the court should give its approval (SEC v. Musk, October 4, 2018, Nathan, A.).

Charges. On September 27, 2018, the Commission charged Tesla chair Elon Musk with securities fraud based on a series of tweets about potentially taking Tesla private. The Commission alleged that Musk knew the potential transaction was uncertain, and that he had not discussed specific deal terms with any potential financing partners. A complaint against Tesla charging the company with failing to have required disclosure controls and procedures relating to Musk's tweets followed soon after.

Proposed settlement. Musk (and Tesla) quickly agreed to settle, without admitting or denying the allegations. Among other actions, the proposed consent judgment requires that Musk be replaced by an independent chairman; he is, however, eligible to be elected chairman again after three years. Musk also agreed to appoint two independent directors to Tesla's board and to pay $20 million in penalties.

Since 2014, the standard for evaluating consent decrees in the Second Circuit has been whether the proposed consent decree is fair and reasonable. There is an additional requirement that the public interest would not be disserved in the event that the consent decree includes injunctive relief. The primary focus of the court's inquiry should be on ensuring the consent decree is procedurally proper, using objective measures, taking care not to infringe on the SEC’s discretionary authority to settle on a particular set of terms. The district court is required to enter the order unless there is a "substantial basis" to conclude that the proposed decree does not meet these requirements.

In that case, SEC v. Citigroup Global Markets, Inc., the SEC filed a proposed settlement with Citigroup, which Judge Rakoff of the District Court for the Southern District of New York rejected for not being fair, reasonable, adequate, or in the public interest; here, the public interest was defined as an overriding interest in knowing the truth. Judge Rakoff also took issue with the SEC deciding to settle without requiring an admission of liability. The Second Circuit ruled that it was an abuse of discretion for the district court to require that the SEC establish the "truth" of the allegations against a settling party as a condition for approving a consent decree, stating that it is not within the district court's purview to demand "cold, hard, solid facts." The panel also omitted adequacy from the clarified standard.

The case is No. 18-cv-8865.

Attorneys: Cheryl L. Crumpton for the SEC.

Companies: Tesla Inc.

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