Further Thoughts on Tornetta (and a bit about Veracini)

Attorneys' fees, earnings implications, shareholder windfalls, policy questions... And a dip into some seldom heard Baroque music

My most recent post examined the Tornetta decision and detailed why I believe Tesla’s Board of Directors is unlikely to try to replace the stock options grant that Delaware’s Court of Chancery voided in late January. And why, if any such attempt were made, litigation would ensue with high potential peril to Musk and Tesla’s board.

Today, we look at some intriguing related issues. And we’ll conclude with a word about this guy:

Attorneys’ Fees - A World Record, But How Big?

Any week now, we will have a decision from Chancellor Kathaleen St. Jude McCormick about the attorneys’ fees to be awarded the plaintiff’s counsel. The plaintiff’s lawyers have requested 29 million Tesla shares, which is about 11% of the 266 million shares that Tesla will recover.

How does that translate into a dollar value? Using the April 11 closing price of $174.60, that works out to $5.06 billion. With each change in the stock price, of course, the dollar value of the fee also changes.

Now, $5 billion is a staggering legal fee, working out to $233,000 per hour billed. (By contrast, the billing rate of Elon Musk’s favorite “hard-core litigator,” Alex Spiro, is probably about $2,000 per hour, and most trial lawyers charge a fraction of that.) The previous record legal fee is $688 million, in the Enron litigation. So, $5 billion would be more than seven times higher. Truly, a world record.

I just wrote that the requested fee is staggering. And, in absolute terms, it is. However, viewed in another light, 11% of the recovery amount is well within the range of what courts have awarded in similar cases. This article from Reuters does a fine job of describing some of the Delaware attorneys’ fee awards, and the circumstances giving rise to them. It’s also worth noting, as the Reuters article does, that the requested award would cost Tesla nothing. Its balance sheet would look the same both before and after such an award. And, as the plaintiff’s attorneys have themselves pointed out in their brief in support of the award (an impressively-argued effort, well worth a read), the award would be tax deductible to Tesla.

It’s impossible to guess how the Chancellor will rule. But I think it’s safe to say that, regardless of the size of the award, it will set a new record.

What Happens Next?

Let’s assume the Court of Chancery awards Tesla shares, as requested, rather than cash. I think that’s a safe assumption; a cash award would place Tesla in a terrible position. What will happen to those shares?

I would guess that the attorneys will wish to sell those shares, as soon as reasonably possible, in a manner calculated to maximize the cash recovery. What effect will such a sale have on Tesla’s stock price? As I write this, the average daily volume of Tesla shares is more than 100 million shares. And 29 million shares is only about one percent of Tesla’s diluted share count, after deducting the 266 million shares represented by the voided options. Still, I’m imagining the overhang of those 29 million shares will tend to create some downward price pressure until they are fully unloaded.

Can Musk post some sort of bond to prevent the sale of the shares pending an appeal? I would suppose any such bond would have to guarantee the plaintiff’s counsel the dollar value of the shares as of the date on which the sale of the shares is stayed pending the appeal. That would be interesting.

Regardless of how it finally ends, it will be fascinating to watch the attorneys’ fee drama play out.

Tornetta Creates a Huge Earnings Windfall

I receive an intriguing comment to my first Tornetta post from jaberwock, who is a truly brilliant fellow (I highly recommend his substack, which dissects the continuing insanity of European energy policies, with obvious implications for equally misguided U.S. energy policies):

I wish I had thought about jaberwock’s second point. The share price of Tesla has rocketed so enormously since the 2018 grant was approved that granting Musk similar options today would result in a huge hit to the income statement. It underlines my thesis that the Tesla board is highly unlikely to grant Musk the further options award he desires. The destruction to Tesla’s income statement would be a sight to behold.

Jaberwock’s first point is also intriguing. Assuming Tornetta is upheld, Tesla will book a $2 billion credit to earnings. When can Tesla take that credit under GAAP accounting? I am by no means an accounting expert, so, take with a grain of salt my assumption that the Tornetta ruling is a “gain contingency” for purposes of Accounting Standards Codification (ASC) 450. But if I’m right about that, then at what point can Tesla deem the gain “realizable” and reflect it on its income statement? Assuming Musk appeals, then is the credit not realizable for so long as the appeal is pending, even if (as I believe) the Delaware Supreme Court is highly likely to affirm the Chancellor’s ruling? If the appeal does freeze any effort to book the credit, then Musk’s decisions regarding whether to appeal put him and Tesla at odds with one another.

In all events, Tesla shareholders should be thrilled about the prospect of a $2 billion credit to earnings, right? Yet, many are not (more about that later in this post).

Keeping Musk at Tesla

I also received this interesting question from jefke:

Tesla board members urged at trial that they voted for the 2018 compensation plan because they wanted to assure the continued services of Musk as CEO. The Chancellor noted, however, that Musk already had ample incentive to stay by reason of his 21% ownership share (he already would enjoy at $10 billion increase in wealth for every $50 billion increase in market cap), and that the 2018 plan did not commit Musk to spending any minimum amount of time at Tesla, as opposed to SpaceX, Neuralink, or the Boring Company, to which can now be added X (formerly Twitter) and xAI (Musk’s artificial intelligence company).

(I also outlined in my earlier post Matt Levine’s litany of reasons why Musk badly needs Tesla for liquidity, borrowing, and reputational purposes.)

Still, jefke’s question raises an interesting point: how does one measure shareholder value? Professor Ann M. Lipton, a law professor at Tulane University’s Law School, who writes intelligent and provocative pieces about Delaware corporate law, wrote a terrific blog post immediately after Tornetta was handed down. Near the end, she posed this question:

Leaving aside the legal formalities, the obvious question is – was McCormick right?  Whether or not Tesla formally complies with Delaware corporate governance standards, Musk has unquestionably delivered extraordinary value to its shareholders.  The “Technoking” title may very well highlight the casualness with which Tesla directors approach their responsibilities, but also that’s the kind of thing Tesla shareholders value.  It may not improve cash flows, but, at least historically, it improves stock prices by pleasing Musk fans.  Which raises a very interesting doctrinal question – one I think posed in a more academic way in this paper by Charles Korsmo and Minor Myers – is it the duty of a Delaware board to raise stock prices – even by, say, taking Zoom calls with no pants on or buying a gold mine – or is it the duty to improve fundamental value?  

Societally we may prefer the latter but Tesla shareholders individually presumably prefer the former.  On the other hand, even the share-price approach is a bit like catching the tiger by the tail; it only lasts as long as Musk’s star power lasts, and that may not be forever.

I don’t fully agree with the good Professor. Is inflating the share price (and hence, the market cap) by means of empty promises and endless stock pumping the same thing as “deliver[ing] extraordinary value” to shareholders? I submit that, no, it is not. Professor Lipton halfway acknowledges this with her comment that the “extraordinary value” may be only as durable as Musk’s “star power.” What she calls “star power,” I call shameless lying.

Regardless, the issue she poses is worth considering. For my part, I am pleased that the corporate law in general, and Delaware courts in particular, view improving fundamental value as the proper duty of a board of directors. Daniel Peris has just published a book (The Ownership Dividend: The Coming Paradigm Shift in the U.S. Stock Market) that illuminates this issue with a fascinating examination of the intellectual foundations of dividend investing. I highly recommend it to anyone attracted to the idea that when one is buying a stock, one is investing in a business.

Hey, Tesla Shareholders, What’s Not to Like about Tornetta?

If the Tornetta decision stands, Tesla will benefit to the tune of some $2 billion on its income statement. Tesla shareholders will awaken one day to discover their percentage ownership in the company has increased.

Will Elon Musk, for all his complaining and nasty attacks on the Delaware court system, still be at the company’s helm? I think the answer is, yes, he will. For a host of reasons, he simply cannot afford to leave.

Despite all this, the Musk superfans are heartbroken about Tornetta. I suppose one must admire their loyalty to their religious leader.

Veracini (and Locatelli, and Tartini, and Vivaldi)

Francesco Maria Veracini (1690-1768), whose image appears at the top of this post, is probably not a name known to most of you. It was unknown to me, too, until I almost by accident came across his music in an album called Duello D’Archi a Venezia (Duel of Strings in Venice).

Veracini’s Concerto a otto stromenti (concerto for eight instruments) in D major for violin and orchestra, from 1711, is revelatory. It is played with great panache by violinist Chouchane Siranossian and the Venice Baroque Orchestra under the baton of Andrea Marcon. (It’s curious, no, that the hair styles of Veracini and Siranossian are so similar?)

The three other highly engaging pieces — by Locatelli, Tartini, and Vivaldi — are likewise brilliantly performed. So, if you want to dip into some baroque offerings a bit off the beaten path, this album (available for streaming on Apple Classical and, no doubt, other streaming services as well) would be a wonderful place to start.