Ex-Twitter security chief’s whistleblower complaint is a ‘godsend’ for Elon Musk

Twitter’s (TWTR) ex-security chief has filed a whistleblower complaint with claims that, if proven true, could make it easier for Elon Musk to walk away from his $44 billion deal to buy the social media company.

Peiter “Mudge” Zatko, a widely respected hacker who was fired in January, sent a 200-page complaint to federal officials accusing Twitter’s top executives of violating laws and regulations by covering up lax security, and eschewing resources to fully understand its prevalence of fake accounts. The issue of fake accounts plays a central role in the legal battle between Musk and Twitter, which is suing him in an attempt to force him to go through with the deal.

The whistleblower claims regarding fake accounts present a considerable tide change in the lawsuit, set for trial in Delaware Chancery Court beginning Oct. 17. Prior to the claims, some legal experts had predicted that the seller-friendly merger agreement would tip the case in Twitter’s favor, with Delaware’s Chancellor ordering Musk to go through with the deal.

“This changes everything,” University of Iowa law professor Robert Miller said about the claims. “This is like a godsend for Musk. The whistleblower’s complaints, if true…are exactly what Musk needs to get out of the deal. I mean, tailor made.”

‘The timing is amazing’

Weeks after agreeing on April 25 to acquire Twitter’s outstanding stock at $54.20 per share, Musk posted on Twitter hinting of cold feet. A termination letter from his lawyers followed, accusing Twitter of breaching the deal by withholding the methods it used in its public filings to estimate that less than 5% of its 238 million monetizable daily active users or “mDAUs” are fake or spam accounts. Musk and his lawyers say they suspect the number is higher.

If Zatko’s complaint is accurate, Miller and two other legal experts tell Yahoo Finance that it would make it easier for Musk to accuse Twitter of fraud, and in turn, use the fraud claim as a basis for exiting the deal. Musk’s has previously faced an uphill argument in the claim that Twitter breached a contractual information-sharing duty to turn over data backing up its estimate because Musk waived his right to further due diligence. And without access to Twitter’s data, Musk would have a tough time proving that Twitter’s regulatory filings misrepresented its mDAUs.

Elon Musk photo, Twitter logos and US dollar banknotes are seen in this illustration, August 10, 2022. REUTERS/Dado Ruvic/Illustration

Musk’s lawyers also allege that Twitter overstated its number of users, causing the company to experience a “material adverse effect” — another difficult-to-prove legal standard that in rare instances allows a buyer to terminate a merger if a target’s business operations change significantly .

Now Musk is armed with a witness who can strengthen his case, according to Case Western Reserve University law school professor Anat Beck.

“Musk’s lawyers will try to use [Zatko] to show fraud or a misstatement and try to get around the material adverse effect issue,” Beck said. “The timing is amazing for Musk’s case.”

In an email to Yahoo Finance, a spokesperson for Twitter raised skepticism about that timing, calling it “opportunistic” and noting that Zatko had been fired in January based on “ineffective leadership and poor performance.”

“What we’ve seen so far is a false narrative about Twitter and our privacy and data security practices that is riddled with inconsistencies and inaccuracies and lacks important context,” Twitter’s spokesperson said.

Widener University Delaware Law professor Lawrence Hamermesh says now that Zatko’s claims are in play, Musk’s case no longer rests on guesses about Twitter’s fake account figures, which Musk himself admitted lacking enough data to prove.

Instead he’ll have the opportunity to elicit testimony from Zatko, who has alleged that Twitter’s executives knowingly lacked tools to know how many fake accounts ran on its network, a claim that conflicts with Twitter’s regulatory filings that say the company stands behind its spam and bot counting methods.

“If it pans out, Musk’s case looks a lot better,” Hamermesh told Yahoo Finance. “I didn’t think he really had much of a case without this.”

Aside from any viable evidence from Zatko, Musk would still need more to prevail on a fraud claim, the lawyers say. The Tesla chief must prove that Twitter knowingly made a material false or misleading statement about the fake account estimates, and also show that he relied upon the inaccurate information. Material statements are those that significantly impact Musk’s expectations under the contract.

It’s a little harder for Musk to show that he relied on bot or spam representations, Miller said, because he claims he always knew that Twitter had more than the estimated percentage of bots. However, if Musk can persuade the judge that the problem was worse than he expected, or that he relied on Twitter operating in accordance with the law when it did not, Musk may be able to rescind the contract.

Chester Spatt, former chief economist and director of the SEC’s Office of Economic Analysis, said he could see Zatko’s complaint as posing a real problem for Twitter if it shows Twitter’s leadership knew that the company made misrepresentations to regulators.

“The Twitter leadership is basically being accused of lying, and in particular that those lies, indirectly, would have permeated regulatory filings on which investors must reasonably rely,” Spatt said. “It’s a statement that the executives knew and that they systematically lied. This is what this is what I think could quickly create the problem.”

In an email to Yahoo Finance, John Tye, chief disclosure officer for Whistleblower Aid, an organization providing legal representation to Zatko said, “Mudge stands by everything in his disclosure, and his career of ethical and effective leadership speaks for itself. The focus should be on the facts laid out in the disclosure, not ad hominem attacks against the whistleblower.”

Shares of Twitter closed at $39.86 on Tuesday, down 7.3% from the previous day’s close.

Alexis Keenan is a legal reporter for Yahoo Finance. Follow Alexis on Twitter @alexiskweed.

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