Northern District of California Grants SEC Motion to Enforce Subpoena Compelling Testimony of Elon Musk

Northern District of California Grants SEC Motion to Enforce Subpoena Compelling Testimony of Elon Musk

On May 14, 2024, the US District Court for the Northern District of California granted the SEC’s (US Securities and Exchange Commission’s) motion to compel Elon Musk to comply with an administrative deposition subpoena in the SEC staff’s investigation related to Musk’s acquisition of X (formerly Twitter). Reviewing a report and recommendation of a magistrate judge de novo, the court adopted the recommendation to compel Musk’s testimony. 

The SEC had already taken Musk’s deposition twice in the investigation and sought to take his testimony for a third time. In challenging the SEC’s motion to compel his testimony, Musk argued that the SEC’s demand for a third round of testimony was overly burdensome and unreasonable and constituted an abuse of the SEC’s regulatory authority. Musk further argued, among other things, that the subpoena violated the Appointments Clause of Article II of the Constitution because it was issued by an “officer” of the United States who was not properly appointed in accordance with the clause. 

The court rejected Musk’s contention that the subpoena was unreasonable and overly burdensome, finding that Musk’s previous two depositions each lasted only half a day and that Musk cited no authority indicating that three rounds of testimony is unreasonable. The court noted the benefit of initial depositions, explaining that they can help agencies identify documents that are relevant and need to be requested later in the investigation. The court similarly rejected Musk’s argument that the SEC abused its authority, finding the SEC’s subpoena was pursuant to a legitimate government investigation into Musk’s alleged violations of federal securities laws and that the SEC’s request to question Musk met the “low standard of relevance” for agency subpoenas. The court also rejected Musk’s request to be deposed remotely, accepting the SEC’s argument that in-person testimony allows for easier assessment of demeanor and avoids technological delays.

The court similarly rejected Musk’s constitutional challenge to the subpoena, holding that the SEC senior counsel who issued the subpoena was not an “officer” within the meaning of Article II, but instead a nonofficer employee. Specifically, the court held that the senior counsel performed solely investigative functions as a subordinate to the SEC’s director of enforcement and lacked the authority required to be an officer under Article II. The court concluded that, because the subpoena was not issued by an officer, the appointment of the SEC senior counsel could not violate Article II. The court further rejected Musk’s argument that the for-cause removal protections for the senior counsel are unconstitutional, finding that the Constitution’s removal requirements do not apply to nonofficer employees.

This case is a reminder of the broad investigative power granted to federal agencies and the high bar subjects of investigation face in attempting to challenge an agency’s investigative authority.

Northern District of California Grants Motion to Dismiss Investor Suit Against Uber

On May 14, 2024, the US District Court for the Northern District of California granted a motion to dismiss a class action against Uber Technologies and certain of its executive officers alleging violations of Sections 10(b) and 20(a) of the Exchange Act and Rule 10b-5. 

In connection with the leak of hundreds of thousands of internal Uber records to the British press in 2022, the plaintiffs alleged that Uber and its officers made false statements by omitting certain information from Uber’s Sarbanes-Oxley Act (SOX) certifications, which were attached to Uber’s 2019 and 2020 quarterly and annual reports, and a May 2020 response to a question at an annual meeting. The court found that the plaintiffs failed to adequately allege falsity in either of the challenged statements, and it gave the plaintiffs an opportunity to amend their complaint.

First, the court rejected the plaintiffs’ assertion that failing to disclose that Uber’s former CEO ordered the use of a “kill switch” in 2015 to prevent authorities from accessing Uber’s data rendered false statements in Uber’s SOX certifications that any fraud involving management or other employees who had a significant role in financial reporting controls had been disclosed. The court found that the certifications were made in present tense and did not state or imply anything about a former CEO’s conduct from several years earlier. It further held that the plaintiffs failed to allege that the former CEO had any role in Uber’s financial controls in 2019 or 2020.

Second, the court found no falsity in CEO Dara Khosrowshahi’s response to a question posed during an annual meeting about Uber’s “plans to adapt to the new world reality subsequent to the public health crisis and the ensuing financial economic and societal crisis,” and noting that “Uber chose Amsterdam to base its international operations, in large part for a highly advantageous corporate taxation arrangement.” Khosrowshahi responded to this question by saying that the Amsterdam office was chosen because of more than taxes, which, according to the plaintiffs, was false because it failed to disclose that Uber chose Amsterdam as a European headquarters to use the Netherlands as a tax shelter. The court disagreed, holding that the question presumed that Uber was located in the Netherlands for tax advantages, and that Khosrowshahi acknowledged this in his response. The court further found no falsity in Khosrowshahi’s alleged failure to explain that Uber maintained its Amsterdam office because Dutch authorities allegedly helped Uber evade taxes in 2015, finding the omission did not make Khosrowshahi’s statement misleading, and Uber held no affirmative duty to disclose all material information on the topic.

This case confirms that statements in SOX certifications are appropriately tied to the time period covered by those certifications. In addition, the ruling serves as a reminder that federal securities laws do not require companies to disclose any and all related facts in their statements to investors as long as the omitted facts do not render statements misleading. 

Delaware Supreme Court Addresses Legal Adviser Conflict Disclosure Requirements in M&A Transactions

On March 25, 2024, the Delaware Supreme Court reversed the Delaware Court of Chancery’s ruling granting a motion to dismiss on the grounds that a proxy statement failed to adequately disclose alleged conflicts of interests between the special committee’s advisers and the counterparty to a merger.

The appeal arose from a challenge by former minority stockholders of TerraForm Power, Inc. (TerraForm) to a squeeze-out merger effected by TerraForm’s controlling stockholder, Brookfield Asset Management, Inc. (Brookfield). In their amended complaint, the minority stockholders advocated for entire fairness review of the transaction, alleging that Brookfield failed to satisfy the elements of Kahn v. M & F Worldwide Corp. (MFW), which can allow a controller to “cleanse” a conflict by establishing an independent special committee and obtaining a fully informed uncoerced vote of disinterested stockholders. The TerraForm stockholders also alleged that the special committee that recommended approving the merger selected conflicted financial and legal advisers, and that a proxy statement soliciting the stockholder vote on the merger improperly failed to disclose those conflicts rendering the minority stockholders’ vote uninformed. The defendants moved to dismiss, and the Court of Chancery granted the motion, holding in part that the plaintiffs failed to adequately plead that the proxy statement was materially deficient.

The stockholders appealed, and the Delaware Supreme Court reversed as to certain of the disclosure claims. Specifically, the court held that the proxy improperly omitted that Morgan Stanley, the special committee’s financial adviser, had a $470 million investment in Brookfield. While the Court of Chancery deemed Morgan Stanley’s conflict immaterial given that its stake in Brookfield amounted to only 0.10% of its portfolio, the Delaware Supreme Court disagreed, explaining that an investment of that size is material when viewed from the perspective of a reasonable investor, which was the proper inquiry. Moreover, the proxy disclosed that Morgan Stanley “may” invest in Brookfield, which the Delaware Supreme Court deemed misleading in light of the fact that Morgan Stanley had already invested $500 million in the company. 

The Delaware Supreme Court also held that the proxy improperly omitted potential conflicts faced by the special committee’s legal adviser, Kirkland & Ellis (Kirkland), which the court characterized as “problematic.” Kirkland represented Brookfield in a few recent matters, including a $500 million term loan and a $2 billion sale and related financing. Kirkland was also concurrently representing a Brookfield affiliate in a $260 million investment. The proxy failed to disclose both these prior and concurrent conflicts, which the court held may not be sufficient to state a claim standing alone; but taken together, and particularly given the concurrent conflict, these conflicts raised a legitimate concern that Kirkland may not want to “push Brookfield too hard given the nature of their ongoing lawyer-client relationship.” 

Ultimately, the court determined that the proxy’s failure to disclose these conflicts rendered the minority stockholders’ vote uninformed and foreclosed MFW cleansing. 

This decision shines new light on the type of disclosures necessary under the MFW framework. In particular, the court’s focus on disclosures regarding the special committee’s legal adviser could be considered an expansion of previous disclosure requirements. Companies seeking MFW cleansing should keep in mind that legal counsel’s prior representations of a buyer may require disclosure of that potential conflict to ensure that approving stockholders are fully informed. 

Delaware Superior Court Finds That Sale of Ultimate Beneficial Owner Did Not Constitute Indirect Change of Control

On March 7, 2024, the Delaware Superior Court issued an opinion concluding that the sale of the ultimate beneficial owner of a company did not trigger a change-of-control provision. 

The case involved a dispute over an October 2020 stock purchase agreement (SPA) effecting the sale of Johnson Claim Service, Inc. (JCS) by plaintiff Johnson Revocable Living Trust (the Trust) and others to defendant Davies US Inc. (Davies US). The SPA provided that the Trust would be entitled to $1.5 million in “Accelerated Deferred Compensation” from Davies US if JCS experienced a “change of control” event. The SPA defined a change of control event to include “directly or indirectly . . . the sale of 50% or more of the equity ownership or voting power of the then-outstanding capital stock of [JCS] (whether in a single transaction or a related series of transactions) to any single person or “group” (as defined in the Securities Exchange Act of 1934) of Persons . . . .”

In August 2021, private equity firm BCP acquired the “ultimate corporate parent” of JCS, Davies Topco. Following the transaction, Davies US remained the sole direct owner of JCS. Nonetheless, the Trust asserted that the transaction effected a change in control, triggering the Accelerated Deferred Compensation payment. 

On summary judgment, the Delaware Superior Court held that the sale of Davies Topco did not constitute the “indirect . . . sale of 50% or more of the equity ownership or voting power of the then-outstanding capital stock of [JCS]” under the SPA. The court honed in on the language in the change-of-control provision of the SPA requiring a sale of “equity ownership or voting power” of JCS stock. The court recognized that only Davies US held the equity ownership of and voting power over JCS, and it rejected any generalized definition of “control” that “includes a remote parent’s de facto ability to influence its subsidiaries’ subsidiaries.” Specifically, the Delaware Superior Court noted that Davies Topco could influence JCS’s operations only by directing Davies US to act and thus did not have direct control over JCS. In reaching its result, the court emphasized the foundational principle that the separate legal existence of corporations should be respected and assets are not shared across levels of corporate ownership. 

In light of this decision, practitioners should be precise when drafting change-of-control restrictions, affiliate definitions, and related provisions in contracts that are intended to cover parent entities or ultimate beneficial owners. If the term “indirect” is used, drafters should make clear that it is intended to capture equity interests of parent entities and ultimate owners (if so desired). 

 

This informational piece, which may be considered advertising under the ethical rules of certain jurisdictions, is provided on the understanding that it does not constitute the rendering of legal advice or other professional advice by Goodwin or its lawyers. Prior results do not guarantee a similar outcome.