UPDATE: The Gist of Tornetta

When the Delaware Chancery Court voided the 2018 exec comp plan that paid $56 billion in TSLA shares to CEO Elon Musk (below), everyone wondered what would happen next. Musk would no doubt appeal the order, but what else? Recut the deal? Do nothing? Something else?

Musk responded by ... posting on X his desire to move the TSLA domicile from Delaware to Texas. Presumably Texas law would let him do more than Delaware would, on exec comp, corp gov, M&A, and who knows what else. Beyond that we could only speculate, until this week. TSLA filed its proxy statement for the 2024 AGM, with two immensely significant proposals.

First, TSLA indeed asks shareholders to vote on reincorporating from Delaware to Texas. Second, TSLA asks shareholders to vote again on the 2018 exec comp plan. While the reincorporation proposal faces long odds, the comp plan has a decent chance to gain shareholder approval.

We haven't studied the reincorporation proposal, including the extensive analysis and rationale that TSLA includes in the proxy statement. Wiser observers than us can parse corporate domiciles. We activists grumble about Delaware, but end up embracing it. We also view skeptically anything TSLA claims benefits shareholders. Thus, we expect to oppose it.

We did study the compensation proposal. TSLA positioned it fairly well for another shareholder vote, and responded to some of the important challenges from Tornetta.

Recall the two central problems with the original comp plan: failure to negotiate (hard or even at all) with Musk, and deficient disclosures (of, among other things, the failure to negotiate) in the proxy statement that elicited the original shareholder approval in 2018. The proxy proposal does nothing about the negotiation, and seeks to rectify the disclosures.

For the 2024 proxy proposal, the BoD affirmatively did not renegotiate any of the 2018 plan with Musk. It "did not substantively re-evaluate the amount or terms of the 2018 CEO Performance Award and did not engage a compensation consultant. It did not negotiate with Mr. Musk.” If anything, the BoD more-or-less admits it did failed to negotiate the package in 2018, too.

Yet, the BoD improved disclosure substantially. It includes the entire Tornetta order in the proxy statement and summarizes it accurately and completely, including the bad parts. The BoD essentially asks shareholders to approve the 2018 plan again in 2024, with better disclosure than shareholders had in 2018.

TSLA speculates that shareholders won't care about the failure to negotiate. It has evidence they don't. The proxy statement goes on and on (p. E-20-22) how shareholders protested Tornetta:

Since the Tornetta Opinion ... many stockholders have strongly expressed support for Mr. Musk’s compensation. The [BoD] noted that dozens of institutional stockholders have, unprompted, told the Company’s Investor Relations team that they disagree with Tornetta’s invalidation of the 2018 CEO Performance Award. Seven institutional stockholders — including four of the top 10 — felt strongly enough to seek a meeting with the Board Chair and raise the issue. One of those top 10 investors, T. Rowe Price, sent a follow up letter to the Board Chair reiterating its support for a new stockholder vote...

The proxy statement excerpts the letter from T. Rowe Price (p. E-21), which is slightly embarrassing in its admiration.

The lack of negotiation continues to amaze us. It helps explain why the BoD wants shareholders to ratify the old plan rather than structure a new one. The BoD expects any new plan to resemble the old one:

Although the [BoD] expressly and consciously did not negotiate (or renegotiate) with Mr. Musk about his compensation, it expects ... for Mr. Musk to agree to it, any new plan would need to be of a similar magnitude to the 2018 CEO Performance Award.

This is bad! A BoD should negotiate hard on this stuff! It seems the BoD worries that it will disappoint Musk, and shareholders worry, too.

We speculate the exec comp proposal has a much better chance to gain shareholder approval than the domicile proposal. The latter requires support from a majority of outstanding shares, while the former from a majority of only the shares voting at the AGM. Both exclude shares owned by Elon and his brother Kimbal Musk.

Given the extensive retail ownership of TSLA these days, winning a majority of outstanding shares means first just locating a substantial percentage of retail shareholders. And, persuading enough institutional shareholders to relinquish the protection of Delaware law could provide daunting.

The exec comp proposal should have an easier time. The lower voting standard helps greatly. Shareholders already approved the exact same exec comp plan back in 2018, and approved every one since then. Big institutions might trade a vote for the exec comp plan and a vote against moving the domicile. TSLA understands the need to attract votes, and launched a shareholder website for that specific purpose.

Some other details in the proxy statement merit mention, mostly to illustrate the abjectly awful corp gov at TSLA. The shareholder letter from Chair Robyn Denholm crows that “[c]orporate democracy and stockholder rights are at the heart of Tesla’s values", hahaha, and “Elon has not been paid for any of his work for Tesla for the past six years…” which is just incorrect. TSLA indeed paid him under the 2018 plan, which he now needs to return, subject to an appeal in Delaware and this shareholder vote.

The proxy statement claims the BoD has talked about domicile for many years:

As part of their ongoing oversight, direction, and management of the Company’s business, certain outside directors of the Company and management have, from time to time, considered and explored the issue of the Company’s jurisdiction of incorporation without reaching a decision.

Of course, it looked seriously at the subject only after Musk lost the comp case in February. Either Musk forced the issue or it didn't really happen that way. Would be fun to look at BoD minutes, say through a DGCL Sec. 220 demand.

The BoD formed a Special Committee to study first the domicile question, and then added exec comp. It ended up having only one member, since the other one resigned the committee after it started looking at exec comp. The Special Committee sets forth its effort, meetings, documents reviewed, advisors, and much else in exhaustive detail. Other than endorsing Musk's idea to redomicile and his comp plan, what did it accomplish? It persuaded the BoD to delay the AGM one month, to give shareholders a chance to vote on both the redomicile and comp proposals. However, TSLA moves its BoD meeting all over the calendar every year. And, it insisted the proxy statement include the entire Tornetta order, which of course is a public document anyway. So, not much.

TSLA scheduled the AGM for June 13, both virtually and in-person.

The Gist of Tornetta

Sounds like a novel, right? Rather than our effort here, to distill to its essence the complicated, enormous lawsuit that TSLA shareholder Richard Tornetta won against CEO Elon Musk and eight directors to clawback $55 billion in exec comp?

To refresh memories, Tornetta sued in 2018, with a trial in Delaware Chancery Court in February 2023 before Chancellor Kathaleen McCormick. (She presided over a number of TSLA and Musk matters, including the director comp case where we intervened and the one requiring him to buy Twitter.) A few weeks ago, Chancellor McCormick issued her order, rescinding the entire $55 billion in stock options the BoD granted to Musk in 2018.

A case of this significance and magnitude merits a lengthy order, just over 200 pages with almost 1,000 footnotes. Interesting and fun nuggets include:

• embarrassing testimony about how much directors literally wept with love for Musk;
• how Musk hired his divorce attorney as TSLA General Counsel, representing the company in designing literally the largest exec comp package ever for his client;
• "Colonizing Mars is an expensive endeavor";
• citations from Shakespeare, Frankenstein, and Berle and Means; and
• staggering sums of money sprinkled throughout.

It's worth a look, not only to get up to speed about one of the most consequential shareholder lawsuits ever, but also to enjoy Chancellor McCormick's precise reasoning and direct, vitriolic prose.

Otherwise, we've read it so you don't have to. Among the numerous moving parts, we identify the two most salient:

• Directors never asked what marginal additional comp would incent Musk properly, and negotiated (or not) accordingly.
• Shareholders approved the plan pursuant to a materially misleading proxy statement.

Failure to Negotiate

Commenters on the order note how well TSLA performed since it granted Musk the plan, and how shareholders benefitted. This ignores whether TSLA and Musk needed the plan in order to do that well. The failure to negotiate meant the BoD never learned what it would take to incent Musk to deliver these results. As Chancellor McCormick asks, "Was the plan even necessary for TSLA to retain Musk?"

Abundant evidence shows that Musk proposed the overall plan structure, which the BoD basically accepted. The plan changed from draft to final to accommodate Musk's requests, suggestions, demands, and schedule. We have no evidence directors countered with their own ideas at any time.

In particular, directors did not ask themselves what additional benefit TSLA gained from awarding him addition compensation. Musk owned 21% of the company when the grant began. He already had considerable incentive to work hard.

Perhaps Musk and the BoD would have agreed to this exact same plan if the BoD negotiated aggressively. The BoD didn't give itself a chance to find out, and it had a fiduciary duty to do so.

Deficient Proxy Statement

Commenters also note independent shareholders, excluding Musk, approved the plan by a comfortable margin. They observe the plan financial structure was clearly and completely disclosed in a proxy statement. However, the proxy statement either omitted or mischaracterized other important information.

First, while the proxy asserted the directors were "independent", in fact they were anything but. The abject subservience of the directors led to "no meaningful negotiation over any of the terms", as noted above.

Second, the proxy set forth plan targets TSLA claimed were "very difficult to achieve", "ambitious", and "challenging". TSLA did not disclose at the time of the options grant it already achieved several of these goals, and it realistically expected to meet almost all of them (p. 82-86).

Perhaps shareholders would have approved the plan anyway, had they known of these two elements in sufficient detail. The BoD didn't give itself a chance to find out.

Other Moving Parts

The order explores many other important subjects. For our purpose, they represent critical details in arriving at these two main points. These include

• Musk is a "Superstar CEO" (not a compliment) who essentially controlled the BoD for purposes of determining his compensation
• the creative and subtle ways in which he exercised that control
• why that control made a shareholder vote even necessary (the "entire fairness" doctrine).

Interestingly, at least some shareholders objected to the plan, even without knowing the BoD did not negotiate and it depended on goals TSLA would easily meet. Both ISS and Glass Lewis advised clients to vote against the grant. Shareholders also protested (p. 87):

Stockholders also criticized the Grant, noting that Musk’s Tesla equity provided sufficient motivation for Musk to perform, the Grant’s size and dilutive effects were excessive, the EBITDA milestones were too low, and that linear milestones were inappropriate for an “exponential company” like Tesla.

Musk's contact with shareholders is telling and comical (p. 88):

[General Counsel] Maron informed Musk that ... two large Tesla stockholders were voting against the Grant on the grounds that its size was excessive. In response, Musk asked Maron to tell one of the large stockholders that he was “very offended by their action if they choose to vote that way, but by all means do so.” Musk also asked Maron to set up a call with one of the stockholders following the vote, during which Musk would “convince them to divest from Tesla and any of [his] companies ever. They are not welcome.”

It seems at least plausible if shareholders knew everything TSLA should or could have disclosed in the proxy statement, then they would not have approved the plan.

Larger Lessons

A few other thoughts occur to us.

The entire case brings up bad memories. It reminds us of numerous other companies where a pliant BoD in thrall to a dominant CEO barely negotiated an exec comp package. This happens mostly because the directors owe their seats to the CEO, who hires the recruiting firm for the Nominating Committee, designs director pay, and decides who stays and goes. We wrote about this awhile ago.

Delaware law calls a shareholder vote on exec comp (or a number of other decisions rife with conflicts) "cleansing", quite the metaphor. Clearly, a mere vote does not solve all the problems with conflicts. The vote needs to follow the rules, including disclosing everything shareholders might need to know about the conflict.

We smiled when we first heard about the Musk order. It represents a win for shareholders that fight conflicted directors. Yet, it also disappoints us in one way: the directors that perpetrated this poor deal for shareholders face no penalty. Only Musk pays damages. Sure, these directors may take a reputational hit. Yet, nothing prevents them from doing this on other BoDs, or trying anew to make up this loss to Musk in some other way. We don't know what, exactly, a penalty would look like. We just know we'd like to see something.

For further information, or to discuss a specific activist situation, please contact:

Michael R. Levin

m.levin@theactivistinvestor.com

847.830.1479