Elon Musk's SEC Settlement Brings Corporate Governance Win for Investors

While hardly the worst offender in Silicon Valley, Tesla (NASDAQ: TSLA) has long had many corporate governance pitfalls that have frustrated investors. Last week, the SEC charged CEO Elon Musk with securities fraud, arguing that his tweets in early August about going private were false and misleading. The eccentric billionaire's now-infamous tweet that he had secured funding for a go-private transaction caused "significant market disruption" and harmed investors that may have purchased Tesla shares based on the misleading social media posts, the SEC alleged.

Over the weekend, Musk decided to settle with the SEC, and in doing so delivered a meaningful corporate governance win to investors.

Chairman no more

The settlement will strengthen Tesla's corporate governance practices in several meaningful ways. Most importantly, Musk will step down as Tesla's chairman and the electric-car maker will name a new independent chairman. Additionally, Musk will be ineligible to be re-elected as chairman for three years.

Generally speaking, splitting the CEO and chairman roles is better for corporate governance, as the board of directors is the entity that is tasked with overseeing a CEO and providing oversight. Those functions are fundamentally undermined when one person, often a company founder, serves as both.

Some activist investors have been calling on Tesla to split these roles to little avail. While Musk does not wield majority voting power, much of Tesla's investor base is still largely captivated by him, often supporting him unquestionably. More specifically, requiring an independent chairman was proposed at Tesla's annual meeting this year by an individual retail investor, which easily failed as investors still overwhelmingly believe in Musk. Only 16% of shareholders voted in favor of splitting the CEO and chairman roles, with 84% of shareholders voting against the proposal.

The majority of shareholders might not like it, but forcing Musk to step down as chairman is a very good thing.

The $40 million tweet

On top of Musk stepping down as chairman, Tesla will appoint two more independent directors to its board. Technically speaking, seven of Tesla's current nine directors qualify as independent directors, but that independence in practice has been questionable, as the board exerts little real oversight over Musk despite increasingly erratic behavior in recent months. Adding two more independent directors is also undeniably positive.

Tesla also agreed to establish more disclosure controls and procedures to "oversee" Musk's communications to investors. Despite telling investors in 2013 that Musk would use social media to disseminate material information, Tesla has never implemented controls to ensure he used the platform properly and in compliance with disclosure regulations. The last component of the settlement is a $40 million penalty, with Musk and Tesla each paying half. The SEC says the money will be "distributed to harmed investors under a court-approved process." At $40 million, it may go down as the most expensive tweet ever posted on the platform.

While Tesla still faces a plethora of challenges, the settlement will bring about significant improvements in the company's corporate governance practices.

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Evan Niu, CFA owns shares of Tesla. The Motley Fool owns shares of and recommends Tesla. The Motley Fool has a disclosure policy.