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Tesla Investors Closely Following Discrimination Suit

Shares are down nearly double the market's decline so far this year.

Long-term shareholders of Tesla TSLA are preparing to push the company on race issues after California sued the electric car maker for alleged racial discrimination and harassment.

The complaint filed by the California Department of Fair Employment and Housing earlier this month followed claims from hundreds of workers that they were the targets of discrimination, including the use of racial slurs by co-workers.

Since news of the lawsuit broke on Feb. 9, 2022, Tesla shares are up 0.05%, reversing a slide triggered in part by investors focusing on growing competition and the impact of supply-chain disruptions. By contrast, the Morningstar US Large-Mid Index is down 0.84% in that time. After closing at $923.39 per share on Feb. 16, it still trades above Morningstar's fair value estimate of $700. Since the start of the year, Tesla is down 12.7%, about double the 6.4% decline for the U.S. large-mid index.

That may not sound like the lawsuit and related issues are affecting the company, but that may change soon as the so-called proxy season unwinds. Shareholders often voice their concerns at corporate annual meetings by voting on management, key business issues, who sits on the board of directors, and proposals by other investors.

To be sure, such resolutions are nonbinding, but boards normally pay close attention because shareholders also vote on directors. If the issues described in the lawsuit "become much more rampant and you see lots of employees speaking up and leaving the company, if Tesla is unable to retain its superstar employees, that could be a problem," says Morningstar senior analyst Seth Goldstein, who covers Tesla.

The New York State Common Retirement Fund is proposing a resolution that Tesla publish what it spends on settling discrimination complaints, along with its progress on addressing diversity and inclusion. The company published its first diversity report in 2020.

Tesla has been the target of numerous complaints about having a work environment hostile to Blacks and women, particularly at its location in Fremont, California, one of its four large global facilities.

A former employee at the site was awarded $137 million in damages last year after a federal jury found that Tesla had subjected the worker to a racially hostile work environment. Tesla asked for a new trial or a lower award. Another former employee won $1 million after an arbitrator found his supervisors at Fremont called him a racial slur and gave him undesirable hours after he complained. The company faces a proposed class-action lawsuit about racism in the workplace as well as several lawsuits by female employees regarding sexual harassment.

Tesla, in turn, has called the California suit "misguided" and noted that investigations by the agency over the past five years "did not find misconduct against" the company. Tesla didn't respond to request for comment.

“The California lawsuit is another proof point that the issue is a very serious one and we’ll continue to engage," says John Streur, chief executive officer of Calvert Research and Management, a sustainable investment firm owned by Morgan Stanley. Last year, a resolution proposed by Calvert won a majority of votes at Tesla's annual meeting. The resolution asked Tesla to provide more data about its diversity, equity, and inclusion efforts, arguing that increased diversity at the company will help ensure it remains competitive and innovative.

In a Feb. 15 interview, Streur wouldn't specify the results of Calvert's conversations with Tesla. He did say his objective is "to strengthen their capacity to create a safe and inclusive work environment for all people and improve the company’s ability to drive value for all stakeholders."

The issues in the California lawsuit are "a financially material risk factor," Streur says. He describes Calvert as a long-term owner, "almost a permanent investor in some of these companies, so we take a long horizon." Employees "innovate and drive the technology of the products going forward and to really be able to staff and scale globally is critical to the success and for the long-term value of Tesla."

It's a difficult needle to thread because many investors regard Tesla as a solution to the climate crisis, leading the way to net-zero emissions. Tesla Energy is also one of the largest solar panel players in the U.S. Recently, Tesla placed among the top 10 companies in the Clean200 list of publicly traded companies that are leading the way to a clean energy future.

Other long-term investors may also act. Garvin Jabusch, portfolio manager of Green Alpha Advisors, which runs Shelton Green Alpha NEXTX, says he read the complaint at length. "There's an awful lot of smoke there. I find it hard to believe there wouldn't be some fire." Green Alpha has owned Tesla for clients since 2010.

In the past, Tesla has pushed back with a narrative that punitive regulators, prodded by incumbent automakers, are overreacting to allegations. But this is not what is happening now.

"This should never have involved regulators, because Tesla shouldn't have allowed this behavior to exist," Jabusch says. The portfolio manager doesn't regard himself as an activist shareholder, but he has asked Tesla for a meeting to discuss the California lawsuit and says that depending on the outcome of the litigation, he may consider divesting or selling his entire position in the shares.

NIA Impact Capital CEO Kristin Hull says she is planning to move Tesla out of client portfolios into a new "activist" portfolio. "It's too embarrassing" to hold it in client portfolios after the California lawsuit, Hull says. She made a shareholder proposal last year asking Tesla to report on its use of mandatory arbitration, in which employees must submit to arbitration rather than bring their claims to court. Tesla has been criticized for requiring mandatory arbitration for employee claims of sexual harassment and racial discrimination. The proposal garnered 46.4% of the vote.

With President Joe Biden to sign into law a bill ending mandatory arbitration for claims of sexual harassment or assault, Hull plans to submit a rewritten proposal that focuses on racial discrimination.

"When it comes to ownership on a company that's doing egregious things, we need people who are able to see the long term," Hull says. "When people don't feel comfortable bringing their full selves, Tesla won’t have the innovation that's required."

Morningstar's Goldstein notes that any settlement "is really not going to have a huge impact," given Tesla's market value of nearly $1 trillion. Still, Goldstein expects "management and policy changes to ensure these discrimination types of lawsuits don't have to happen again. This could be the likely change for internal policies that hopefully would prevent this from happening to other employees."

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