How Elon Musk scored a $55bn pay package that’s now under fire

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The largest executive-pay package in US corporate history was born in a text message from Elon Musk.

On April 8, 2017, the entrepreneur was asked by his friend Ira Ehrenpreis, a Tesla board member, about how to structure his future compensation as the electric-vehicle maker’s CEO.

Musk replied that he should end up “owning 10 percent of the company” in a performance plan built around a progression of targets that would each grant him 1% of Tesla’s outstanding shares, according to a court filing. As Musk later mused to one of his co-founders in an email, he was “planning on something really crazy, but also high risk.”

Less than a year later, Tesla’s directors awarded Musk a trove of stock options that could potentially pay out $55 billion based on the company’s share price at the time — about $3 billion more than the company was then worth. The package had the same core features that Musk suggested in his initial messages with Ehrenpreis.

Had Musk just given himself $55 billion?

That’s a key question at the center of a lawsuit headed to trial on Monday. The trial caps a drama-filled month for the mercurial Musk, who completed his controversial $44 billion acquisition of Twitter, only to plunge the social-media platform into chaos and a threat of bankruptcy with a series of policy, product and personnel upheavals and an exodus of advertisers.

Little to fear

At issue in Delaware Chancery Court is whether Tesla’s board, which is responsible for setting its CEO’s compensation, failed to exercise independence from Musk as it drew up a new pay package for its charismatic chief executive.

Musk, who will testify at the trial, has acknowledged he had little to fear from the board’s review of his pay proposal, according to court filings. “Me negotiating against myself” is how he described the process of tweaking the pay package’s details in a pretrial deposition.

If Judge Kathaleen St. J. McCormick sides with a shareholder who accused the board of acting improperly — a long shot — she could order Musk to pay back some or all of the stock awards to Tesla.

McCormick is the same judge who presided over a showdown between Musk and Twitter in recent months when he was trying to back out of the buyout — before he capitulated and agreed to honor his original offer.

In defense of Musk’s lucrative pay package, board members have cited the need to keep the CEO, who doesn’t take a salary from Tesla, focused on the EV company’s growth.

Time spent elsewhere 

The peripatetic billionaire spends considerable time on his other startups, including aeronautics firm Space Exploration Technologies Corp, Boring Co. and Neuralink, and now, Twitter.

Lawsuits targeting executive compensation traditionally face a high bar, partly because the packages are contingent on ambitious share-price targets. Under Delaware law, directors generally get leeway to use their “business judgment” to set pay.

“It’s true the executive compensation package approved for Elon Musk is remarkably large, but Delaware courts are usually rather deferential” to directors’ decisions on pay when a majority of shareholders vote to back the plan, said Paul Regan, a Widener University law professor who specialises in Delaware corporate law.

Still, the failure of the Tesla directors to disclose to investors some of the pay package’s “challenging” milestones were likely to be achieved within a little over a year could be problematic, said Joel Fleming, a partner at law firm Block & Leviton, who isn’t involved in the case.

“This is a strong case,” Fleming said. “Tesla’s board appears to have misled Tesla’s stockholders” who voted to back the package, he said.

In addition, “the fact that Musk has spent all this time on the Twitter takeover” strengthens the argument that he’s spread too thin to focus enough on Tesla.

The case is playing out in Delaware because Tesla is incorporated in the state, the home to 1.8 million US companies and more than 60% of Fortune 500 firms. Judges in its chancery court are business-law experts who hear cases without a jury.

Heavy-metal drummer

The suit was filed by Richard Tornetta, who has owned nine Tesla shares since February 2018, according to court filings. Tornetta, whose business sells car parts for stereo systems and radar detectors, has been threatened online for bringing the case against Musk, his lawyers said.

Besides once playing drums for a now-defunct heavy-metal band, Tornetta is the lead plaintiff in another securities case in Delaware over Sirius XM’s 2018 buyout of Internet radio service Pandora. Tornetta didn’t respond to a request for comment.

Musk’s Tesla equity awards helped him become the world’s richest person last year. At his peak, Musk was worth $340 billion last November, according to the Bloomberg Billionaires Index. His net worth dropped below $200 billion this month as Tesla shares hit a 52-week low.

Tesla directors justify Musk’s compensation in court filings by pointing to the company’s 12-fold increase in value over four years to $690 billion as of last month — including a brief period starting in October 2021 when it exceeded more than $1 trillion.

Most US companies have adopted a similar pay-for-performance model, they say.

Tornetta also contends Tesla’s board is loaded with Musk’s friends and confidantes, making it so rife with conflicts of interest that it was incapable of making an independent decision on the billionaire’s pay.

He points to Musk’s long ties to Ehrenpreis, who headed up the board committee responsible for reviewing the CEO’s pay, as an example of the conflicts. Ehrenpreis, a Silicon Valley venture capitalist, was one of Tesla’s early investors and served as one of Musk’s advisers on the Twitter buyout. He is set to be the first witness in the case.

Musk also had the help of Todd Maron — Tesla’s general counsel at the time, who had previously served as Musk’s divorce attorney — in finalizing the compensation plan, Tornetta said. Maron, who left Tesla in 2018, also will testify in the case.

Tesla directors denied in court filings that they were beholden to Musk or that their judgment about his pay was tainted by conflicting interests.

Tornetta wants McCormick to tag Musk as Tesla’s controlling shareholder even though he owned only about 22% of the car company’s shares as of early 2018.

If Musk is deemed Tesla’s effective controller, the company must prove his pay package was “entirely fair,” a higher legal standard to meet rather than just relying on directors’ business judgment.

Tornetta filed his so-called derivative suit against Musk and other Tesla directors on behalf of the company. That means any money recovered will go back to the electric-car maker and not to Tornetta.

The case is Tornetta v. Musk, 2018-0408, Delaware Chancery Court (Wilmington).

© 2022 Bloomberg

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