Recently, Tesla’s CEO, Elon Musk, asked his Twitter followers if he should sell 10% of his stock. Musk positioned the proposed sale as a way of paying his fair share in taxes and, for all I know, that truly is his motivation. But various news sources speculate that the proposed sale is actually driven by the fact that he has a massive NQSO that will expire next August (“Behind Elon Musk’s Twitter Poll Is a Tax Bill Coming Due”).
The option was granted in 2012; after Musk’s most recent exercise on November 15, over 21 million shares remain unexercised. The option is subject to performance-based vesting conditions, not all of which have been met, so Musk may end up forfeiting some of the shares. But as of the November 8 exercise, the option is vested as to over 23 million shares. The remaining vested and unexercised shares have a current gain of close to $19 billion (the option exercise price is $6.24 per share and Tesla’s stock is trading at just over $1,000 per share)—that’s a hefty tax bill.
Thus, there is speculation that Musk’s sales are in anticipation of this tax bill, not purely due to a desire to pay taxes (“Elon Musk Faces a $15 Billion Tax Bill, Which Is Likely the Real Reason He’s Selling Stock”). Since November 8, Musk has exercised over 4 million shares (in two transactions) and sold more than 7 million shares. Musk sold only about 44% of the exercised shares; the remaining sales were of previously acquired stock.
Sometimes employees wait to exercise until their options are about to expire. If Musk were to do this however, the exercise of over 20 million shares and associated sale would be so large that it would potentially have a significant impact on Tesla’s stock price. As it is, Reuters reports that Musk’s comparatively small sale last Tuesday caused Tesla’s stock to decline by 12% (although it recovered by 4.3% by the next day—"Elon Musk Sells $5 Bln in Tesla Shares After Twitter Poll”). The sales were sold in so many lots that the Forms 4 reporting them are nearly a work of art.
Given this, it makes sense for Musk to start exercising and selling now. There are about 38 weeks between now and when the options expire—if he exercises shares each week, he’d need to exercise a little under 500,000 shares per week.
Musk filed a total of 15 Forms 4 to report his exercises and sales that occurred from November 8 to November 15. Why so many? Because each Form 4 can contain a maximum of only 30 transactions in each table and the shares were sold in so many lots that, even using the SEC-sanctioned aggregate reporting method, most of the sales resulted in more than 30 reportable transactions.
When executives buy or sell large blocks of stock, it is common for the transactions to execute in multiple lots, each lot at a different price. This is because it is often hard/impossible to find a single seller or buyer for the whole block. Think about it—how many investors—even, say, institutions—are willing to transact in several million shares of stock at a time (especially a stock trading at over $1,000 per share)?
When this occurs, the SEC allows the individual lots to be reported as a single transaction, provided the following conditions are met:
Requirement #4 is the sticking point. Where the execution prices of the lots differ by more than $1, the lots must be aggregated into $1 ranges, with each range reported as a separate transaction. By my count, Musk’s sales from Nov 8 to Nov 15 were reported as 380 separate transactions. I’m guessing that someone put a lot of work into those Forms 4.
A couple of decades ago, Musk might have been able to defer the taxes due upon the exercises or Tesla might have been able to extend the expiration date of the option to allow Musk a longer period in which to exercise (although this would have had accounting ramifications even then).
Section 409A, adopted in 2005, put an end to both these alternatives. Deferring taxation of an NQSO beyond the point of exercise causes the option to become subject to Section 409A, as does extending the term of an in-the-money NQSO beyond its original contractual term. In both cases, this would result in a Section 409A violation, triggering the 20% penalty tax.
One strategy that Musk could use to avoid an open market sale is a net exercise with shares withheld to cover taxes. But this would result in no cash inflow for Tesla and would leave the company on the hook for cash necessary to deposit the tax withholding with the IRS. Given the amounts involved, Tesla and Musk may have decided that the cash can be put to better use operating the company.
* This blog was completed prior to the market opening on November 16, therefore, transactions occurring on or after November 16 are not addressed. The NY Times, CNBC, and Reuters articles cited were published between November 7 and 10 and do not reflect all of the transactions I discuss.
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