The Absurdity of Elon Musk’s Fraud Trail

Mainstream outlets perfectly content with shallow coverage as long as they can juxtapose "Elon" and "Fraud" in the same headline.

Mr. Tweet @elonmusk

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

This tweet spawned a potential billion-dollar lawsuit.

Before looking into the trial, I did not think it would be all that interesting but was surprised at how many relevant facts surrounding the case — from the lead plaintiff’s blatant lie on the stand to the glaringly illogical basis for the suit — were being omitted by mainstream coverage. So, I decided to describe the situation in more detail. Hope you enjoy…

Background of Lead Plaintiff

In 2018, Glenn Littleton was chosen as lead plaintiff — the representative of the class-action suit — among nine candidates who initially attempted to sue Mr. Musk over the above tweet. Six of the other vying plaintiffs were investment firms. Littleton himself is a veteran derivatives and commodities trader, and while he’s now 71, he hasn’t slowed down one bit. He traded over $10 million in Tesla options in Aug ‘18 with over 470 unique trades for the month, public court filings revealed. Several individual transactions exceeded $250,000 in value. In 1984, Littleton was fined by the Commodity Futures Trading Commission (CFTC) for “wash trading” — fake transactions that inflate an asset's perceived trading activity. His license with the commission was briefly suspended as a result. In short, he’s been around the block and knew the risks he was taking on.

Taking the stand on the second day of the trial, Littleton said he viewed Musk’s “funding secured” tweet as “absolute,” then scrambled to unwind his options positions. Disclosed emails between Littleton and his stock broker at the time reveal this to be a complete lie.

“A lot of people thought it was a hoax… I saw so many red flags with Elon and Tesla,” Littleton wrote, not even four hours after the tweet was published. 

An earlier email further demonstrates Littleton’s attitude towards the tweet, calling it a “rumor” and saying, “I don’t think there is a chance in hell that the other shareholders would agree to that price.”

Littleton’s impression of the veracity of Elon Musk’s tweet could not be further from “absolute.”

Now for an analysis of the lead plaintiff’s derivatives trading and the losses he has claimed…

Littleton says the tweet has cost him $3.5 million. In a prior 2018 hearing, Calif. Judge Lucy Koh stipulated that Littleton’s “argument fails,” stating that “[Mr. Littleton] received more money from selling at fraudulently inflated prices than he spent purchasing.”

“Even if he lost money in all of his transactions, this amount was reduced by his Class Period sales when the prices were inflated,” the judge continued. Here, Class Period refers to Aug 7 - Aug 17, 2018 (which is the timeframe the plaintiffs are alleging was affected by Musk’s tweet).

We will get to whether prices were actually “inflated” shortly, but assuming they were (as the prosecution is alleging), this would be true. However, Littleton includes several trades outside the Class Period in his Profits & Losses statement to exacerbate his losses. To be fair to Littleton, there’s a case to be made that if one bought a derivative before the “funding secured” tweet and sold amid the panic, then those losses should be included too.

Let’s look at when Littleton entered into most of his contracts:

Littleton bought and sold a mixture of calls and puts but was overwhelmingly long Tesla and owned far more contracts than he had sold short. Given he exited these positions at relatively similar prices to when he entered, he lost money on nearly all of his pre-August contracts. Anyone who has traded options will tell you (and as someone who has lost a considerable amount of money trading them): IF SEVERAL MONTHS TRANSPIRE WITHOUT A SIGNIFICANT MOVE IN THE UNDERLYING STOCK PRICE, YOU ARE GOING TO LOSE MONEY OWNING OPTIONS.

There is no argument to be made that if he had held beyond the period afflicted by Elon’s tweet, that he would have been made whole. The stock price gyrated a bit thereafter, but by January of 2019 (when roughly half of his contracts expired), it's hovering around Littleton’s entry points. In fact, it’s a bit lower, so assuming he remained long, his losses would have been far greater. 

Judge Koh was absolutely correct. If anything, Musk saved Littleton from even further degradation in the price of his options.

Logical Incoherence of Lawsuit

Now to assess the inflation allegation…

The entire basis for the lawsuit is — according to the presiding Judge Edward Chen — that “Mr. Musk’s statements led to a trading frenzy that drove up the value of Tesla’s shares.” Additionally, the jury is being asked to “determine the amount of artificial inflation” on Tesla’s share price “during the Class Period” (which remember is Aug 7 - Aug 17, 2018).

However, it is objectively NOT the case that the stock inflated (even relative to other tech stocks) during that time frame.

Yes, Tesla stock did rally 11 percent on the day of the tweet but moderated two days later to just 3.1 percent above pre-tweet levels. It fell further from there, down 10.7 percent for the period in question, a span during which the tech-centric Nasdaq Composite index increased by 1.2 percent.

Either reduce the Class Period to a span of three days or change the argument to say that Elon “manipulated” as opposed to “inflated” or “drove up” the stock price. The current structure of this case is completely incoherent.

Lastly, the computational tasks being asked of the jury are truly outlandish. If determining the degree to which Musk’s tweet affected the stock price wasn’t hard enough, try retroactively calculating the changes in implied volatility for 17 different options contracts assuming that Elon Musk did not publish his tweet. This is — no joke — what the jury will have to discern on Feb 3:

Explained in a different wording in the court document, the jury will be asked to calculate “what the implied volatilities for each Tesla stock option traded during each day of the Class Period would have been but for Mr. Musk’s tweets.”

The court is essentially saying to the jury: “Imagine, if you would, a world in which Elon Musk did not publish his $420 tweet. Now, how do you think the IV component of these option contracts would have fluctuated over the course of that week in August?” By the way, here is part of the equation involved in calculating an option’s implied volatility:

On what planet could anyone — let alone a random collection of San Franciscans — possibly know the answer to this?! And their answers have bearing on whether Musk must dole out billions of dollars…

Conclusion

I could see this class-action having merit if the people affected were long-term investors, not speculating options traders. To be eligible, one should have to prove they held equity (not a derivative) in Tesla for at least one year prior to the disputed tweet. The thing is, if those were the requirements this lawsuit would never have come to pass in the first place. What equity investor would sell at ~$370 when they can wait for a rumored buyout at $420? And Tesla investors who have held until today have nothing to complain about. Keep in mind, these are pre-stock split prices. The stock is currently worth over 6x what it was then.

This trial is ridiculous and I suspect much of the media coverage is intentionally shallow. That way, it’s easier to create a fantasy in which Elon has manipulated “the little(ton) guy” with his lies and irresponsible antics.

As for Elon’s tweet and whether the funding was truly “secured,” there is an argument that this was not technically true at the time it was made. I won’t go into the weeds here as it’s not relevant to the critiques contained in this article, but a text exchange between Musk and the top Saudi investor demonstrates that the deal was VERY serious and had expected to go through. That, and just two weeks later, internal documents reveal Tesla met with Goldman Sachs and Silver Lake representatives who assured Tesla’s board that “the funding was available from a variety of sources.”

So… if we are going to start policing the fringe cases of fraud that border on harmless exaggeration, I’ve got several restaurants in my neighborhood claiming to sell the “best burger in town” whom I’d like to sue.