The Bitcoin resurgence that began in 2020 has received a boost from a new mini-trend: publicly held companies accumulating large reserves of the cyptocurrency.
Tesla Inc., leading maker of electric cars, and MicroStrategy Inc. a business intelligence software and services company, have each acquired billions of dollars worth of Bitcoin. Moreover, each company’s founder/CEO has become a headline-generating spokesman for Bitcoin.
An important question hangs over this entertaining business news, however: Do Tesla’s and MicroStrategy’s purchases of large blocks of Bitcoin, and their CEOs’ accompanying crypto-boosting comments, expose them to SEC enforcement or private litigation risks?
At first glance, the risk of SEC enforcement activity does not appear to be significant—but the risk is also not nonexistent. The SEC has previously stated in informal advice that Bitcoin is not a security under the Howey test due to the decentralized nature of the currency. Although the essence of securities law compliance is disclosure and both companies havepublicly disclosed and described their digital currency purchases in SEC filings, the question whether an issuer fully and fairly disclosed the nature of the transactions and the attendant risks to the company arises for all filings. Another risk involves communications outside the filings, which is of particular concern to Tesla given the fondness of Elon Musk for the Twitter spotlight.
MicroStrategy, Tesla, and the SEC
Both MicroStrategy and Tesla — and their CEOs — have been involved in significant SEC enforcement actions. The previous cases remain important, because the CEOs of both companies remain subject to sanctions imposed as a condition of their settlements.
MicroStrategy became a reporting company in June 1998 after an initial public offering and listed its securities on the Nasdaq Stock Exchange. Less than two years later, the SEC brought an administrative action against the company and sued its senior management in federal court, claiming that MicroStrategy materially overstated its revenues and earnings in violation of generally accepted accounting principles. According to the SEC, the company reported positive net income during this two-year period when it should have reported net losses from the time of the IPO forward.
Without admitting or denying the charges, three senior MicroStrategy officers agreed to disgorge a total of approximately $10 million, including a disgorgement order of $8.28 million entered against the company’s CEO and co-founder, Michael Saylor. The officers also consented to the entry of antifraud injunctions, and each agreed to pay $350,000 in civil penalties. The company agreed to abide by a cease-and-desist order and be subjected to significant corporate governance undertakings designed to prevent future reporting violations.
More recently, Elon Musk’s Twitter feed has generated headlines and regulatory interest. In 2018, Musk famously tweeted, “Am considering taking Tesla private at $420. Funding secured.” That tweet cost Musk and Tesla $40 million in SEC-imposed penalties, as well as his role as Tesla board chairman. The settlement agreement with the SEC — modified in response to another round of tweeting about Tesla production numbers — also requires Musk to seek approval by “securities counsel” before making public statements on social media on various aspects of Tesla’s operations. Musk has shown little regard for the tweet pre-approval mandate; last spring, he again took to Twitter and stated that in his opinion, Tesla’s stock price was “too high.” The SEC did not act to enforce the terms of the settlement agreement.
The Bitcoin Buys: MicroStrategy
On March 1, MicroStrategy announced that it had purchased approximately 328 bitcoins, raising the company’s holdings to 90,859 bitcoins. The value of the holdings as of March 22 was $5.02 billion, acquired at an aggregate purchase price of $2.186 billion. The company described its Bitcoin purchases as a key part of its business strategy, and has disclosed its purchases in its Form 10-K and Form 8-K SEC filings.
MicroStrategy disclosed that it may convert cash, cash equivalents, and short-term investments into the digital currency when those funds are not needed for working capital. MicroStrategy also stated that it may purchase more Bitcoin in the future from proceeds from the issuance of debt or equity securities. The company views its digital currency interests as long-term holdings, and does not plan to engage in regular Bitcoin trading or hedging.
In its most recent Form 10-K filing, MicroStrategy disclosed several risks associated with its Bitcoin investments. According to the company, it faces risks because:
—fluctuations in Bitcoin price may adversely impact the company;
—the company’s Bitcoin holdings could subject it to regulatory scrutiny;
—the concentration of Bitcoin holdings enhances the risks inherent in the acquisition strategy;
—Bitcoin holdings are less liquid than cash reserves and cash equivalents, and might not be able to serve as a source of liquidity when needed; and
—Bitcoin value might be lost in the event of a security breach or cyberattack, or if the company’s private key was lost or destroyed.
The Bitcoin Buys: Tesla
In its current Form 10-K, Tesla announced that it had updated its investment policy to diversify and maximize returns on cash reserves that were not needed to maintain adequate operating liquidity, and invested $1.5 billion in Bitcoin. The company disclosed several risk factors associated with the investment. According to Tesla:
—digital asset prices are volatile;
—the prevalence of digital assets is a relatively recent trend, and their long-term adoption by investors, consumers and businesses is unpredictable;
—these assets may be subject to the threat of malicious attacks and technological obsolescence;
—the application of securities laws or other regulations to such assets is unclear and may change in the future, and any changes may impact the value of the assets; and
—digital assets may be subject to security breaches, cyberattacks or other malicious activities, or human error or computer malfunctions that may result in the loss or destruction of private keys needed to access these assets.
Limited Potential for Securities Law Exposure
While the SEC has made it clear that tokens and digital currencies may be securities subject to federal regulation, the agency staff’s informal advice excluded Bitcoin under the Howey definition of a security because “we do not believe that current purchasers of bitcoin are relying on the essential managerial and entrepreneurial efforts of others to produce a profit.”
This treatment of Bitcoin is significant because it means that neither company risks being characterized as an investment company under the Investment Company Act. Under that statute, an investment company is an issuer that “holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities.” Because Bitcoin is not a security, neither MicroStrategy nor Tesla isrequired to comply with the provisions of the Investment Company Act.
As MicroStrategy CEO Saylor tweeted in December 2020, “MicroStrategy is not an ETF/ETP, ETFs & ETPs exist to invest in stocks, bonds or commodities—they’re investment companies per ’40 [Investment Company] Act. Like Apple & Microsoft, MicroStrategy is an operating company traded on a stock exchange. We just happen to hold [Bitcoin] in our treasury reserves.”
Both companies also appear to have adequately disclosed their Bitcoin purchases in their SEC filings, along with the risks associated with those investments. Liability is unlikely, barring any material misstatements or omissions in these filings.
One wild card in this deck appears to be Elon Musk’s penchant for tweeting.
I spoke with J. Ashley Ebersole, a former SEC staff attorney and partner in the Washington, D.C. office of Bryan Cave Leighton Paisner. Ebersole suggested that Musk could expose Tesla and himself to the risk of enforcement actions if he “speaks before he thinks” in his Twitter account.
Musk has already tweeted several times concerning digital currencies. On March 12, he tweeted that “BTC (Bitcoin) is an anagram of TBC ([Musk’s] The Boring Company).” He has also mentioned another digital currency, Dogecoin, in several tweets.
According to Ebersole, Musk’s theatrics concerning digital currencies will likely not be enough to trigger SEC enforcement interest as long as he tinkers around the edges of Tesla business and is not making specific factual representations, as in his infamous “taking private” tweet. Even if Musk flouts the SEC’s tweet pre-approval order, Ebersole doubts that a resource-strapped enforcement division will “look behind the curtains” absent a clear factual misrepresentation.
Only the at-times-mercurial Musk can ensure that his tweeting will not create risks for Tesla and himself, however.
As Ebersole cautioned, however, the limited securities law exposure characterization for both companies comes in part because we are in “the good times” of a bull market for Bitcoin. A sudden market downturn would likely find both companies facing both a more interested SEC Enforcement Division and securities class action plaintiffs based on insufficient disclosures of volatility risks.
A further wild card is the potential for private litigation under state corporate laws. This issue will be the subject of the next part of this series.
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