Everyone’s talking about the possibility SpaceX will acquire Tesla, presumably in a stock merger, likely using the nonvoting shares SpaceX has authorized but unissued in its charter.

If that happens, the question is – who wins, SpaceX shareholders, or Tesla shareholders, or will the price be perfection itself?

If you assume that Elon Musk’s personal interests will play a role here, then part of the pricing will have something to do with his relative financial stake in each company, which I am in no way going to try to calculate (also, I suppose he might have tax considerations, again, not going to calculate). But legally, there are very good reasons why the price would favor Tesla shareholders.

First, Elon Musk’s pay package at Tesla awards him around 35 million shares when he hits certain market cap milestones, coupled with operational milestones. But if Tesla is acquired, the operational milestones disappear, and the merger price becomes the market cap. Which means, if Tesla is acquired for a nominal price of $2 trillion, he gets an additional 35 million Tesla shares (which, in a stock for stock merger with SpaceX, convert to SpaceX shares). If Tesla is acquired for 2.5…

Somehow, this keeps happening.

A company goes public with a dual class share structure – 10 votes per share for insiders, 1 vote per share for the public, something like that. 

But the company pays its employees in stock, so it issues more 1-vote shares.  Then maybe the company wants to make stock acquisitions – and it issues still more 1-vote shares.  The insiders want to monetize some of their stock, so they convert their 10-vote shares to 1-vote shares and sell them.

Eventually, there is a risk that the insiders’ 10-vote shares will no longer represent a majority.

The board could, I suppose, issue more 10-vote shares to the founders, but even if the charter permits that, it creates difficult questions.  How much should the founders pay for that extra control?  What’s a good price for it? 

When this first happened, the company was Google, and their solution was to amend the charter to create a new class of no-vote shares that could be issued for acquisitions and so forth without diluting the founders’ control.  (It was also an interesting end-run around the exchange listing rules that prohibit disparately reducing or restricting the voting power of traded shares, because…

So as long as we’re talking about semi-annual vs quarterly reporting – It has long been observed that the disclosure obligations of the federal securities laws function as sub rosa substantive governance regulation. The obligation to report necessarily carries with it an obligation of oversight; you can’t report what you don’t know.

Thus, a switch to semi-annual reporting may not simply mean less information to investors; it loosens the obligations of boards, and managers, to oversee the company. 

A new paper by Anne Tucker and Timothy Lytton demonstrates this point in the context of mutual fund disclosures.  After interviewing a variety of market players, including investment advisers, fund managers, compliance officers, and fund counsel, they conclude that it’s less important whether anyone reads the disclosures than the fact that the process of drafting them triggers legal and professional norms which end up substantively shaping mutual fund products.

We can extend the reasoning to the SEC’s announcement that it would pull back on enforcement over things like “retention of books and records, that consumed excessive Commission resources not commensurate with any measure of investor harm.”

Sure, maybe each individual violation doesn’t result in investor harm, but when companies know…

No not that one.

I speak of the proposed redomestication of Natural Gas Corporation from Colorado to Texas. As Bloomberg reported, ISS recommended in favor of the move, even though it had recommended against Exxon’s move, which prompted accusations of opacity.

(Exxon, ludicrously, argued that Glass Lewis and ISS objected to its move because of their litigation over Texas’s proxy advisor law, conveniently ignoring that well before Texas moved to insulate corporate managers and instigated its war on proxy advisors, Glass Lewis objected to Tesla’s move, and ISS only tentatively recommended in favor, specifically on the understanding that Texas’s legal protections for shareholders were, at that time, comparable to Delaware’s. Also, I note, under Texas law – currently on hold on First Amendment grounds – merely for recommending a vote against management based on governance considerations, Glass Lewis and ISS would have had to announce publicly that they do not provide advice solely in the financial interests of shareholders and notify Ken Paxton of their recommendation.)

Anyhoo, ISS’s change of heart for Natural Gas is interesting and worth unpacking. Natural Gas Corporation currently has a staggered board, which can only be destaggered by an overwhelming vote…

Well, it’s here, the SpaceX S-1.

I still haven’t gone through the whole thing, so I’m jumping specifically to the provisions limiting shareholder litigation rights. 

As we all know, Texas does plenty of that all on its own, by immunizing officers and directors against any liability absent a showing of “fraud, intentional misconduct, an ultra vires act, or a knowing violation of law,” and by allowing (as SpaceX will opt into) its corporations to bar derivative claims unless the plaintiff holds at least 3% of the outstanding stock.

Naturally, SpaceX proposes to go further, with various forum selection and arbitration clauses.

First, interestingly, SpaceX has chosen to put these in the bylaws, and not in the charter.  Why is this interesting?  As we all know, bylaws can be amended unilaterally by directors; charter amendments require a shareholder vote.  Back when the Delaware Supreme Court first authorized forum selection clauses governing federal securities claims in Salzberg v. Sciabacucchi, it did a very curious thing: first, it held these clauses would be treated as contractually binding in part because charters require a shareholder vote, and second, it held – with no further explanation – that bylaws are contractually binding as well.

I, of course, have long argued charters aren’t contracts, bylaws certainly aren’t contracts, and none of this can cover federal securities claims, etc etc, but after Salzberg, courts in other jurisdictions began to enforce forum selection provisions for federal securities claims, both in bylaws and charters, as contractually binding without much further thought (which I have angsted over repeatedly both in this blog, and in a paper).  My sense was always, courts – especially generalist courts with no corporate expertise – really didn’t want to be bothered with the issue, especially when forum selection, directing federal securities cases to federal court, didn’t seem particularly unreasonable.  Except that precedent exists now, that bylaws are contracts, as are charters, and that’s the precedent SpaceX will rest upon when it argues its arbitration bylaws are contracts.  We’ll see if courts apply any more scrutiny to the issue now, if they distinguish between bylaws and charters, or if perhaps they figure that so long as the company went public with the bylaws in place, there’s no need to draw a distinction and they can worry about that onion slicing when an arbitration bylaw is unilaterally adopted by a corporate board midstream.

Moving on, and here’s where it gets long because I need to block quote a buncha stuff, so under the cut it goes.

The traditional line is that shareholders have three powers with respect to the corporations in which they invest: to vote, to sell, and to sue, and through these mechanisms, they can protect their investment and discipline management. 

Voting can oust unfaithful or incompetent managers; the prospect of a lawsuit can deter misconduct and compensate shareholders for losses; sales both allow investors to exit if they view an investment unfavorably, and can drive down stock prices, which will then pummel the stock options of recalcitrant managers and encourage activist interventions.

So what happens when shareholders have none of these?

I speak, of course, of the upcoming SpaceX IPO (I was going to wait to talk about it until the S-1 was public, but at this point so much has leaked – here’s me and Mike Levin talking about the implications of those leaks on our podcast – that waiting seemed unnecessarily coy).  So with the caveat that maybe the S-1 will have information contrary to what’s been publicly reported, what we know is:

(1)  SpaceX will have dual or multiple classes of stock that will give Elon Musk voting control and require his votes to remove him from…

So, the SEC is out with its proposal to allow companies to choose whether to provide interim reports quarterly or semi-annually.  The Commission currently consists of three Republican members, two of whom seem pretty committed to the idea, so I suspect the “request for comments” is pro forma and the rule will be finalized soon.  

Previously, I posted about how this new rule might affect securities fraud litigation; now that the rule is out, I’ll point out it allows registrants to shift to between quarterly reporting and semi-annual reporting – back and forth – every year, by checking a box on the 10K.  Since the 10K is usually filed around 3 months into the following fiscal year, registrants will already know what the first quarter of the new fiscal year looks like when they make the election to report semi-annually or quarterly.  Which … I mean, Rule 10b5-1 was just changed to add a cooling-off period after amending the plan, you’d think reporting frequency could be at least as rigorous.  I’m sure market norms will develop around sudden changes, but, well, it seems to me to be a recipe for abuse.

Meanwhile, there are already a bunch of…