I’m looking forward to Battery Day. But not for the same reasons most people are.
I am, at best, only mildly interested in what Tesla (TSLA) will claim as advancements on the battery front. The questions will be:
- When will these breakthroughs be commercially available?
- What will they cost?
- Will they be available only to Tesla, or shared by other OEMs?
(One of the scores of articles and videos from around the world anticipating, breathlessly, the wonders of Tesla’s Sept. 22 battery day. You can read this one here.)
Of far greater interest to me is what Tesla will produce as a Directors & Officers insurance policy. Let’s back up and review the history:
Musk Writes Tesla’s D&O Coverage
On April 28, Tesla made the following disclosure:
Tesla determined not to renew its directors and officers liability insurance policy for the 2019-2020 year due to disproportionately high premiums quoted by insurance companies. Instead, Elon Musk agreed with Tesla to personally provide coverage substantially equivalent to such a policy for a one-year period, and the other members of the Board are third-party beneficiaries thereof.
This was stunning. Except for Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B), which is managed in an entirely different fashion from Tesla and which obviously has ample funds on hand to satisfy its indemnity obligations to its directors and officers, I know of no other company traded on U.S. stock exchanges that does not purchase third-party directors and officers (D&O) coverage. With very, very few exceptions, no publicly-traded company could attract either competent officers or capable directors if it failed to provide such insurance.
As I wrote several months back, having the CEO provide D&O coverage is extraordinarily risky for the enterprise, for its directors, and for its stakeholders. This is especially the case where, as for Tesla, the “disproportionately high premiums quoted by insurance companies” was surely the consequence of the CEO’s recklessness.
Two obvious examples are the “funding secured” episode (whose danger continues in private lawsuits) and the pending challenge to Tesla’s acquisition of SolarCity (where the directors have settled for $60 million, and the case against Elon Musk is set for trial next March).
Having the CEO provide D&O coverage for the directors creates some obviously unhealthy incentives. Consider the position of a director who learns of some fraudulent financial practice or other illegality in Tesla’s operations.
If the director directs disclosure of the wrongdoing, then the immediate result would likely be downward share price pressure. Musk, who has hundreds of millions in margin debt, might be faced with margin calls, leading to forced selling of his stock, creating yet more downward price pressure, and ultimately imperiling Musk’s ability to perform his defense and indemnity obligations.
Under those circumstances, what’s the director’s incentive: To insist on disclosure of the wrongdoing, or rather to advocate concealment?
Revealed: Musk’s Indemnification Agreement
When I wrote about Tesla’s D&O coverage in late May, Tesla had not yet disclosed the terms its Indemnification Agreement with Musk. Tesla finally made such disclosure in an exhibit to its most recent 10-Q. Here’s an abbreviated summary:
- The Indemnification Agreement was effective June 23 and expires on Sept. 22;
- The parties covered are all directors and officers who are contractually indemnified by Tesla;
- Tesla paid Musk a one-time fee of $972,361 for assuming the defense and indemnity obligations;
- Musk is obligated to make payments only if and to the extent that Tesla fails to do so under its applicable contractual indemnity obligation;
- Musk’s obligations are limited to claims made during the three-month term, or claims later made that arise out of events that occurred during the term;
- Musk’s aggregate maximum liability under the Indemnification Agreement is $100 million;
- Tesla must use its reasonable efforts to obtain, by Sept. 22, “a binding quote proposal” for D&O policy “with an aggregate ‘Side A’ coverage limit of $100,000,000 from a reputable insurance broker with nationwide standing, for a term commencing [on Sept. 22].”
- If the premium in the binding quote proposal, multiplied by one-eighth, is greater than the one-time fee paid by Tesla to Musk, then Tesla shall pay the difference to Musk.
Musk Is “Uninsurable”
We recently had this news:
Sources told (insurance insider) that the Marsh JLT Specialty-brokered Tesla policy is currently circulating in the London market, with an exclusion in place for the CEO and co-founder of the Silicon Valley firm.
Sources said the flamboyant CEO was effectively uninsurable, pointing to his habit of sharing Twitter indiscretions with his 38 million followers. These have included a boast about a potential take-private offer for the electric car maker, which provoked a Securities and Exchange Commission (SEC) suit…
Excluding certain people from D&O policies is a tactic occasionally used by policyholders, but sources said it was unusual to exclude the CEO.
Conditions are currently very challenging in the D&O market, with many clients forced to accept lower limits and higher deductibles as rates surge after years of heavy losses and carrier fears of future claims brought on by recessions.
Let us recall that in its entire history as a public company, Tesla’s Board of Directors has adopted a posture of supine indifference to Musk’s actions. Very rarely it has perked up, such as after the SEC sued Musk during the “funding secured” fiasco. Musk demanded that the Board to stand behind him, threatening to quit immediately if the Board failed to do so, and the Board quickly fell into line with a supportive statement.
Given that, when it comes to Tesla’s Board, whatever Elon wants, Elon gets, the insurance insider story presents an obvious question: How can a D&O carrier possibly exclude the CEO from the policy when the liability of the directors derives from failing to fulfill their responsibilities to oversee his activities and statements?
In other words, if Musk is uninsurable, then how can the Tesla board possibly be insurable? How can those risks be separated?
Indeed, as MaxedOutMama reminded me after she saw the Insurance Insider story, Tesla is currently operating under a settlement agreement with the SEC that stems from precisely the problem of director apathy in its oversight duties toward the CEO.
All by way of saying, that for me, the most interesting aspect of Battery Day will not be the hype about battery developments. After all, we’ve had lots of hype about solar-powered Superchargers, battery swapping, solar roof tiles, one-hour body shops, and the Gigafactory fully powered by renewables, all of which (and so much more) has come to naught. Indeed, we still await the one million robotaxis (this year!), the Tesla semi, the Roadster 2.
The most interesting part of battery day will be any revelations about Tesla’s post-Sept. 22 D&O coverage.
What happens if Tesla cannot procure third-party D&O insurance? It will be fascinating to see.
Are MOM and I Allowed to Say, “We Told You So?”
Oh, the pushback MaxedOutMama and I received when we expressed the view that Tesla’s Shanghai factory would be making many more cars than could be absorbed by the domestic Chinese market, and that in order to meet its annual revenue requirement (RMB 75 billion by the end of 2023), it would need to export to Australia, to New Zealand, to other Asian countries, and even to Europe.
And, lo and behold.
Yeah. Don’t do it. It’s too soon. I’ll be sure to let you know when I think it’s safe.
Well, not completely safe, but more safe than now.
OK, not exactly more safe, but less perilous.
Because Tesla’s share price continues to be a complete and utter stranger to its business and financial fundamentals.
Correction: Sept. 16 at 11:11 pm Mountain Time
The original version of this article stated that Side A D&O coverage was first dollars out, and thus not comparable to the coverage provided by Musk under his Indemnification Agreement.
In fact, as @OldMillennial (who is a D&O underwriter) advises in his comment, Side A D&O insurance covers the board members only if the insured (here, Tesla) is unable to do so. In other words, as @OldMillennial writes, “Side A would respond very similarly to how Musk’s policy would respond.”
I have deleted the paragraphs in the article the contain this error. My apologies for the mistake, and my thanks to @OldMillennial for the correction.
@OldMillennial writes further:
Main difference is that Musk has a massive conflict of interest.
I think the main take away from this arrangement is that the massive D&O insurance market with hundreds of different carriers and players all collectively said “Elon Musk is uninsurable”. This should be the biggest take away. There are tons of carriers out there that don’t have a clue what they are doing with D&O insurance. they see the large premiums and hope to make money. But even the worst carriers with no understanding still were not willing to insure Musk. This is crazy. almost unheard of.
How can anyone risk their own money when people who are paid to intelligently risk money are unwilling to? I for one, am unwilling to and thus sit on the sidelines for this one.
Again, I regret the error, appreciate the correction, and feel fortunate to have a commenter with @OldMillennial’s qualifications.
Disclosure: I am/we are short TSLA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I have a very small, long-dated TSLA bearish call spread, which in terms of my overall portfolio is inconsequential. I strongly discourage the shorting of this stock.
Originally published on Seeking Alpha