In 2021, a Tesla employee and a tech industry researcher submitted a whistleblower complaint to the SEC, expressing worries that Elon Musk's car company may have broken securities regulations and disregarded accounting standards. The complaint contained in-depth assertions regarding Tesla's financials and business tactics, like that it improperly categorized repairs and lacked suitable control over internal systems that provided data that created financial reports. Records show that the SEC appointed one person to review one portion of the complaint, then closed the ticket a few months later. It never interacted with the whistleblowers and disregarded their willingness to review more than 18,000 files showcasing the allegations. The SEC did not confirm or deny the complaint, but shared that the agency evaluates all tips that are submitted.
In the fourth quarter of 2021, a Tesla employee and a tech industry researcher submitted a whistleblower complaint to the U.S. Securities and Exchange Commission, voicing worries that Elon Musk's car company may have violated the law on multiple occasions, impacting shareholders, employees and customers.The complaint contained numerous allegations about Tesla's financials and its practices, such as improperly tagging repairs for years and having inadequate oversight over internal systems used for capturing business data to be reported to shareholders.In January 2022, the SEC assigned someone to investigate a segment of the complaint connected to accounting firm PricewaterhouseCoopers' work for Tesla, before closing the inquiry a few months later, based on records reviewed by CNBC.The agency staff have never talked to the people who filed the complaint, according to those people, nor did they accept the offer to review about 18,000 documents - including internal Tesla emails, spreadsheets, screenshots, recordings and images, along with public records - that the whistleblowers provided in support of their claims.When contacted by CNBC, the SEC would not confirm or discount the potential of a submission, but noted that the agency assesses all tips it receives. Should any enforcement measure be brought about by the complaint, resulting in a monetary settlement or damages, the whistleblowers may be eligible for a financial reward.Since the complaint was first submitted, Musk has sold more than $39 billion of his Tesla shares, which includes approximately $23 billion in 2022, to finance a leveraged buyout of Twitter, the social network he now owns and has renamed X.CNBC has acquired a copy of the complaint - which is dubbed a TCR, a term federal agencies use for "tips, complaints and referrals" - as well as subsequent correspondence to the financial regulator, public records and some of the internal Tesla materials that the whistleblowers requested the agency to examine.The identities of the people who filed the complaint to the SEC are known to CNBC, however they requested anonymity and for their TCR to be treated as private by the agency, due to fear of vengeance by Musk against employees and critics, especially those who raise issues with government agencies or press. The whistleblower who was a Tesla employee is no longer employed by the company.
Experts in accounting, business and securities law, including Ann Lipton, a corporate and securities law trial attorney who now teaches at Tulane Law School and University of Chicago Law School, and Karen Nelson, a professor of accounting at Texas Christian University who previously served as an advisor to the Public Company Accounting Oversight Board, were asked by CNBC to read a redacted version of the whistleblower complaint protecting their privacy. Lipton found the complainants to be credible in their claims due to the number of specific examples and records they cited, which raised suspicions about whether Tesla has violated federal securities law, such as Section 13 of the Securities Exchange Act, Rule 13a-15 and Rule 15d-15, as well as the Sarbanes-Oxley Act, all of which require companies and their management to accurately and regularly report financial and business information to auditors and shareholders. Nelson was concerned with the allegations about Tesla's internal control systems regarding financial and business information and the auditor's navigation of these systems. Despite numerous inquiries from CNBC, Tesla failed to comment on any of the contentions. Financial and business experts then gave an in-depth look to some of the more severe allegations in the complaint, which, if accurate, could have implications for shareholders and regulators.
Rather than employing the usual franchised dealership system, Tesla functions with a "direct-to-consumer" model in which they market and take care of the vehicles that they produce.
Tesla employees must classify repair jobs within broad pay type categories, as flagged in internal communications, guides and policies available internally, that have been reviewed by CNBC. The tipsters included excerpts from Tesla policies, internal emails, customer service records and other documents suggesting that employees have been wrongly assigning repairs for some time, and that Tesla management was aware of it.
Generally, companies set aside a portion of each sale to cover any future repairs that will be needed under warranty, as per Nelson. However, the complaint does not allege that Tesla is not following standardindustry practice. Instead, it alleges that Tesla's employees have been incorrectly categorizing repairs and hiding warranty costs.
For "goodwill" repairs, Tesla is responsible for covering labor, parts or accessories, so that the customer will be satisfied. These costs are not counted against warranty reserves and are listed on the income statement within sales, general and administrative costs. On the other hand, "customer pay" repairs are recorded as revenue, precisely under the "services and other" category, and these are also not counted against warranty reserves.
The whistleblowers have argued that if Tesla charged customers for repair work, or labeled repairs as "goodwill" when they should have been labeled as "warranty," fundamental financial information would be misstated, and they have encouraged the SEC to launch an investigation. The tipsters stated that if repairs were accurately categorized as warranty, Tesla would need to restate earnings since at least 2017. They further mentioned that Tesla hadn't stopped from properly assigning warranty reserves, even while service employees were giving out too much "goodwill" repair coverage.
Nicholas Parks, a veteran of the automotive industry who has owned and managed car dealerships in three states, including one in California that sold battery electric vehicles, notes that Tesla was spending an extraordinary amount of money on "goodwill" in the U.S. alone in late 2021, as evidenced in the whistleblower complaint and internal Tesla dashboard reference records examined by CNBC. This figure, $17 million in a two-month period, is equivalent to about $70 of goodwill per repair order, an amount Parks believes is 10 times more than traditional auto dealers would typically spend. Accounting professor Nelson is "surprised" that the SEC didn't display more interest in the whistleblowers, since the miscategorization of repairs is something that financial regulators and investors should take very seriously. Tesla's varying instructions for addressing defective parts, seen in internal documents viewed by CNBC, may have led to the miscategorization, as employees had to navigate the company's Enterprise Resource Planning ("WARP") system, intranets and group emails to figure out the proper categories for each repair. In a bid to increase data accuracy, Tesla implemented region-specific scorecards for its service centers that assessed pay type data and warranty and goodwill costs. Parks states that traditional dealers usually aim for 99% accuracy, and employ specialists to ensure the accuracy of their claims.
The complaint in 2021 from the whistleblowers alleged that Tesla's software and systems had been frequently altering and had security flaws and could not be fully examined by external accountants and auditors. Through internal emails, policies, sales/service-related data, etc., the whistleblower, who was formerly employed at Tesla, had been allowed to access a wide range of records. Confirming this, 3 present/former Tesla staff members told CNBC that the majority of employees automatically had access to a wide variety of applications and data within the company. This inclusion of applications increased as Tesla's business expanded in its complicated sector. People speaking on Tesla's behalf asked to remain unnamed.Images of internal emails, spreadsheets, and screenshots of some of Tesla's proprietary software and back-end operations were enclosed in the complaint. The whistleblowers claimed that non-executive personnel had the capacity to read and edit data with the help of MySQL Workbench, then possibly use the information forTesla's financial statements or shareholder updates. Specifically, someone had changed the designation of materials used in manufacturing from “scrap” to “work in progress.” Additionally, other Tesla staff had allegedly switched the status of pre-owned vehicles from “used” to “new” on a program that held vehicle delivery data. The impact of this could not be known, thus the SEC was urged to investigate further.
In early 2022, the whistleblowers wrote to the SEC with added details to their initial grievance. They stated there were numerous databases and a different, manual system for audits that had been employed by Tesla for monitoring car sales and deliveries. The shifting systems caused inconsistent measurements and interpretations of “deliveries,” they declared. CNBC requested an explanation from Tesla regarding these particular allegations in the report, but received no response. Deliveries are essentially the closest incarnation of sales reported by Tesla in quarterly declarations, and one of the figures Wall Street stopwatches the most closely. If they were inaccurately listed, the firm could have met or gone beyond analysts’ anticipations for deliveries depending on unreliable or fraudulent data.In the fourth quarter of 2021, right before the whistleblowers sent their supplementary email, Tesla reported that it had reached 308,000 vehicle deliveries — a figure that matched analysts’ expectations. Issues correlated to truthful keeping track of of deliveries could possibly necessitate an inquiry into the dependability and accuracy of Tesla’s disclosures and financial reporting, and examination of whether Tesla is compliant and has safety measures in place as obligatory under the Sarbanes-Oxley Act, the whistleblower grievance stated.Under Sarbanes-Oxley, a company’s leadership is expected to reveal the effectiveness of its internal controls and point out deficiencies, such as the ability of illegitimate users to gain access to confidential information. Sarbanes-Oxley also requires auditors to inspect and report on these controls, so that financiers can trust the financial reports and so that corporations can dodge having to restate financials at a later time.Business and securities law expert Lipton told CNBC if there are weaknesses in either “disclosure controls” or the “internal controls over financial reporting” at Tesla, there could have been a “potential violation of the substantive requirement that such controls be maintained” under Section 13 of the Exchange Act, and there might have been “false statements by the company, Musk, the CFO, or PwC regarding the effectiveness of internal controls.”“If the controls turn out to be defective, but there was no mistake in the assessment — that is, top management and PwC inspected everything, but the faults were too far down the chain to detect easily — then they may not be facing penalties for incorrect declarations. Evidently, matters become more grave if they intentionally or recklessly or possibly even carelessly gave a false picture of the condition of the internal controls.”
In 2022, Tesla reported net income of $12.56 billion and cash reserves of $22.10 billion, though Musk has recalled the time when the firm nearly went bankrupt. The whistleblower complaint argued that, since Tesla was in a financial state of flux during 2018 when it increased production of the most affordable Model 3 sedan, it should have been more transparent to its stockholders. The complaint implied that Tesla should have issued a "substantial doubt" statement, otherwise known as a going concern warning, in its 2018 SEC filings, but this didn't occur. During 2019, Musk testified about Tesla's near-bankruptcy during a Delaware Court of Chancery hearing, which the whistleblowers mentioned in correspondence with the agency. The initial complaint also included information about the firm's bank account balances, but the SEC neglected to ask for the documentation.
Nelson, an accounting specialist, informed CNBC that, according to generally accepted accounting principles (GAAP) outlined by the Financial Accounting Standards Board (FASB) since mid-December 2016, organizations should issue a substantial doubt statement in their financial statements if it is likely that they will not be able to fulfil their liabilities in one year since the release of those statements. However, if they have a plan to address this doubt, they should disclose this plan, without having to make the statement.
Since 2005, Tesla's auditor PricewaterhouseCoopers has also provided tax-related consulting services to Musk enterprises SpaceX and The Boring Company. The whistleblowers produced internal Tesla materials to the SEC indicating this arrangement could compromise the firm's neutrality in assessing the company's financials. Public records from the California Alternative Energy and Advanced Transportation Financing Authority were also supplied by the whistleblowers, which is seen to confirm PwC performed non-audit work for Musk firms while acting as Tesla's auditor.Although there are only four major accounting firms, there are many respected companies Musk's privately held businesses could have applied to for tax advice. Lipton, an expert in securities legislation, suggested that usually auditors are not allowed to do certain consulting jobs for their audit customers or for affiliates of their customers if “a reasonable person would question your independence.”Records assessed by CNBC demonstrate that the SEC assigned an officer to check into probable conflicts of interest in January 2022 but closed the ticket in April without consulting the whistleblowers or assessing their files.PricewaterhouseCoopers declined to comment, while Tesla did not answer multiple requests for comment.
The people behind the whistleblower complaint contacted the SEC multiple times since late 2021, reaching out to attorneys, bureau chiefs, and other personnel. They noted the substantial records and evidence they submitted in their TCR submission. In October 2022, the Office of the Inspector General expressed concern that the SEC's senior officer turnover rate was over 20%. Professor Alex Platt's research published in the Yale Journal of Regulation showed that the SEC had received 52,400 tips and issued 216 awards from the start of the whistleblower program in 2011 to the end of 2020, with the average payout amounting to around $6.2 million. The professor believes the agency screening tips is under-resourced. Whether a tip is chosen for investigation and awards is contingent on whether it matches the SEC's current enforcement objectives. Platt also stated that former SEC officials with attorney representation have greater success in obtaining awards. However, an SEC spokesperson said in an email to CNBC that the whistleblower program's highest priority is to incentivize reporting of potential violations of the federal securities laws and that all individuals with such information can submit through the TCR portal.
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