Public Companies’ Uneasy Relationship With Social Media

Am considering taking Tesla private at $420. Funding secured.

— Elon Musk (@elonmusk) August 7, 2018

This simple tweet on August 7 by Tesla CEO Elon Musk sent social media—and indeed the business world—into a frenzy. The tweet caused Tesla’s stock price to rise for a short time, before it fell after Musk announced on August 24 the company would not be going private.

Musk’s tweet caused more damage than just sending the media into a spin. Some Tesla shareholders are now suing, the Department of Justice commenced an investigation and the SEC charged Musk with securities fraud on the basis that his first tweet was false and misleading. On September 29, the SEC charges were settled, subject to court approval, on the following terms:

• Musk agreed to pay a US$20 million penalty, to be distributed to harmed investors, and agreed to step down as Chair of Tesla’s board of directors for at least three years;
• Tesla also agreed to pay a US$20 million penalty, to be distributed to harmed investors, for failing to have the required disclosure controls and procedures in place relating to Musk’s use of Twitter; and
• Tesla agreed to add two independent directors to its board and to form an independent committee of directors to establish controls and procedures to oversee Musk’s communications.

Cross-Border Differences

Although an extreme example, Musk’s tweets provide a cautionary tale for public companies in the United States and Canada about the risks of using social media to disseminate information to investors.

The controversy also highlights differences between U.S. and Canadian securities laws in terms of permissible social media communications. In Canada, companies are permitted to share material information on their websites or via Facebook and other social media channels, only after broadly disseminating the information to the marketplace by issuing a news release. In the publication Review of Social Media Used by Reporting Issuers (2017),¹ Canada’s securities regulators gave clear direction that disclosure through social media channels is not a substitute for disclosure by news release.

In contrast, companies in the United States are generally permitted to publicly announce material information on their websites or via social media channels instead of issuing a news release, so long as investors have been forewarned of a company’s planned channels of communication and access to them is unrestricted. This is known as the Reed Hastings rule, articulated by the SEC in April 2013 when it decided not to penalize Netflix’s CEO for announcing on his personal Facebook page that monthly customer viewing hours had exceeded one billion. In November 2013, Tesla filed a Form 8-K with the SEC informing the market that Musk’s personal Twitter account would be used as a means of announcing material company information.

While the Reed Hastings rule expands the ways in which U.S. public companies may disseminate information to the marketplace, it does not exempt social media disclosures from securities laws. Rule 10b-5 under the U.S. Securities Exchange Act of 1934 prohibits companies and their representatives from making material false statements or omissions, regardless of the medium. Because of the Reed Hastings rule, the crux of the Tesla matter is not Musk’s use of Twitter per se, but rather the substance and veracity of its content. In 280 characters, Musk could not provide details or nuances, such as the factors that could affect the definitiveness of the funding for a potential going private transaction or the potential regulatory or other impediments to the transaction.

Social media communications are short and casual, but are no less significant under securities laws than formal disclosures in a company’s filings.

The negative publicity associated with the shareholder lawsuits against Telsa, the SEC settlement and the potential criminal proceedings by the Department of Justice should motivate public companies to take a fresh look at their internal practices and controls governing disclosures via channels such as Facebook, Twitter, YouTube, LinkedIn, Instagram and GooglePlus.

Cross-Border Companies Must Follow the Conservative Canadian Approach

Canadian companies dual-listed on a Canadian and U.S. stock exchange must comply with the more conservative Canadian requirement to first disseminate material information via news release. Social media should be treated not as a primary means of communication with investors but as a complementary tool that is subordinate to news releases and formal regulatory filings.

Although U.S. companies have more flexibility under the federal securities laws, they should still consider the guidance of the New York Stock Exchange in this area—companies are permitted to disseminate material news using any method permitted under securities laws, including social media, but “while not requiring them to do so, the Exchange encourages listed companies to comply with the immediate release policy by issuing press releases.”

The Medium Should Suit the Message

Social media communications tend to be short and casual, but they are no less significant under securities laws than formal disclosures in a company’s filings with the OSC, SEC or other securities regulator. In presenting information like quarterly results, potential transactions or other key information or projections, companies should ensure that the medium suits the message. If a social media platform is not conducive to a balanced presentation of complex information, a company risks being accused of misrepresenting or omitting material information. The companion policy to Canada’s proposed new rules on non-GAAP financial measures cautions companies against using social media channels like Twitter if the character limits preclude disclosing all required information. Similarly, the regulators stated in the above-noted 2017 report that forward-looking information disclosures tend to be deficient when presented via social media and that linking to third party materials via social media is problematic if such material is limited to favorable information, such as positive news articles or analyst reports.

Disclosure Policies Should Cover Social Media Activity

Most public companies have disclosure policies that address the confidentiality of company information; prohibitions on insider trading and tipping; trading black-out periods; the appointment of authorized company spokespersons; dealing with rumors in the marketplace; the company’s relationship with analysts; and various other matters to help ensure that the company protects and disseminates material information in compliance with securities laws. Disclosure policies should also explicitly address a company’s approach to social media disclosures, including:

• identifying permissible social media channels;
• limiting the personnel who are authorized to communicate on behalf of the company via social media;
• establishing a chain of command for approving social media communications to ensure that they are not misleading and are in keeping with the company’s formal disclosure record; and
• monitoring responses by third parties to the company’s social media posts in case it appears that the company’s disclosure needs to be updated, clarified or corrected.

Crucially, employees, officers and the board of directors should read the company’s policy and understand their obligations under it, and companies should monitor compliance with the policy so that there can be prompt remedial action in the case of a breach.

Use Company Accounts, Not Executives’ Personal Accounts

Using executives’ personal social media accounts for company communications is not prohibited, but it is better practice to use only the company’s social media accounts. Otherwise, there is a heightened risk for communications bypassing the company’s formal procedures for review and approval, and selective disclosure of material information (e.g., if an officer’s personal account blocks certain users or groups or is otherwise not accessible to the entire marketplace).

Using executives’ personal social media accounts will also create marketplace confusion in situations where the interests of the company and the executive are not aligned. When Musk tweeted about taking Tesla private, he was not speaking on behalf of the company, rather, he was speaking in his capacity as a shareholder considering a transaction with the company as a counter-party. In order to protect their legal and reputational interests, public companies should avoid scenarios like this by setting clear boundaries in their social media policies for acceptable uses of company versus personal social media accounts.

The Uneasy Relationship Between Social Media and Securities Laws

Musk’s going-private tweet has been described in the news media as “unconventional,” “crazy,” “errant,” “infamous,” “unorthodox” and “audacious.” Such characterizations may be understandable if one is comparing a tweet to a prospectus or a proxy circular, which typically consists of hundreds of pages of detailed disclosure. Unfortunately, traditional disclosure documents under securities laws can be overly dense and too voluminous to realistically expect the average investor to read and understand. Securities regulators have acknowledged this problem, which is driven partly by disclosure rules that over time have become unwieldy and that need to be scaled back and modernized. Both the SEC and Canadian securities regulators are actively engaged in broad reviews of existing securities laws to find ways of reducing the regulatory burdens of disclosure while still protecting investors.

While Musk’s tweet may have been the briefest going-private announcement in history, traditional securities regulations are at the other extreme and need some revamping to align with modern communication methods. In 2013, the SEC’s Director of Enforcement stated that “most social media are perfectly suitable methods for communicating with investors.” That simple statement holds true in both the United States and Canada, but to avoid liability and protect their reputations, public companies must be alert to the significant qualifications imposed by securities regulations regarding the method, content and timing of social media communications.

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¹ See http://www.osc.gov.on.ca/en/SecuritiesLaw_csa_20170309_51-348_staffs-review-of-social-media.htm.