Within the last decade, tech companies have risen from obscurity to multibillion dollar enterprises. Names like Microsoft, Apple, and Facebook are more prevalent than ever. Along with these companies are their larger than life CEOs: Bill Gates, Mark Zuckerberg, and the late Steve Jobs.
Once tech companies have reached a certain echelon, their CEOs and directors continuously look for ways to expand into new and emerging fields with the hope of finding the next “big thing.” Among the superstar personalities in the tech world is Elon Musk. In 1999, Musk co-founded an online financial service company who was later acquired and became a part of Paypal. In 2002, Musk founded SpaceX with the goal of enabling commercial space travel. In 2003, Musk invested in Tesla Motors. In 2006, Musk began investing in SolarCity, an alternative energy company.
In August, 2016, Musk confirmed the merger between Tesla and SolarCity. The proposed bid in June was priced at approximately $2.5 billion—a price point that overshadowed SolarCity’s appraised fair market value by more than 30 percent. Musk serves as the CEO of Tesla and is the chairman of SolarCity. At the time of the announcement, Musk owned an approximately 21 percent stake in Tesla and 22.5 percent stake in SolarCity. In addition to his numerous personal connections to this merger, such as the CEO of SolarCity being Musk’s cousin, there is a potential for a conflict of interest. Stephen Diamond, a law professor at Santa Clara University who is a leading expert in corporate governance, explains that while the Tesla-SolarCity merger “is a conflict of interest,” it is not “the same as ‘self-dealing,’ which is where you get into trouble.”
The difference between the two terms is a critical one. On the one hand, a conflict of interest is worth noting because it should serve as a red-flag to transaction monitors that very close attention should be paid to a transaction as to not run afoul of the law. A conflict of interest in a transaction arises when one or more of a merging party’s directors or officers (otherwise known as “fiduciaries”) has economic interests or operational control on both sides of the transaction. Unless a transaction in which a conflict of interest arises has been authorized by a majority of disinterested directors or approved in good faith by the shareholders, the transaction will be voided.
The reason self-dealing is prohibited is that it prevents directors with a potential conflict of interest from conducting a transaction the transaction is undertaken for personal gain rather than for the good of the shareholders. Officers of corporations owe a duty of loyalty to act in the best interests of the principal—which are shareholders in public companies. When fiduciaries, who are agents on the principals, engage in self-dealing, they are no longer acting in the best interest of the principals and are therefore breaching their duty of loyalty.
The problem with self-dealing can be clearly seen in the case where Musk is able to play an active role directing the acquisition of SolarCity. Tesla is offering to acquire SolarCity in exchange for Tesla stock at a price per share that is nearly 30 percent above SolarCity’s market price. In his affiliation with SolarCity, Musk is serving the shareholders’ best interests by soliciting the best value possible and therefore making them the most money possible on the deal. However, at the same time, as CEO of Tesla, Musk would be harming his principal shareholders by overpaying for SolarCity. Additionally, taking into account of the fact that Musk owns 22.5 percent of SolarCity, he is in essence taking money from one of his pockets and putting it in his other pocket at the cost of shareholders. By using his assets from Tesla, he is increasing the value of his SolarCity stock.
This is why Musk has recused himself from the transaction process. By removing himself from the transaction, Musk is attempting to put away accusations of self-dealing and personal motivations. The transaction is still subject to shareholder votes from both SolarCity and Tesla. There will will likely still be shareholder actions against both Tesla and SolarCity in an effort to stop this transaction from happening—this is America after all. However, the chance that a shareholder suit alleging self-dealing and a violation of duty of loyalty succeeding is very unlikely because Musk does not have an active role directing the transaction.