Welcome to our blog’s new SPAC Corner, as we kick-off an ongoing series of posts dedicated to this bourgeoning field of investor litigation.
A natural starting point for our focus on SPACs is to highlight the upcoming September 9 meeting of the SEC’s Investor Advisory Committee (IAC), at which the IAC will be discussing two recommendations to the SEC intended to increase SPAC disclosure and accountability. As laid out here, in the IAC’s August 26, 2021 draft agenda, the IAC is proposing that the SEC (i) regulate SPACs more intensively with enhanced focus and stricter enforcement of existing disclosure rules under the Securities Exchange Act of 1934, (ii) provide an analysis of the players in the various SPAC stages, along with their compensation and incentives.
In laying out its case for greater transparency, the IAC provided the following background statement on SPACs, which provides a concise and neutral enough description of SPAC formation and mechanics that we thought it useful to reproduce a summary statement here:
In simple terms, a SPAC is a type of “blank-check” company that raises capital through an initial public offerings (“IPO”) with the intention to use the proceeds to acquire other companies at a later time.5 Unlike traditional IPOs, SPACs do not have commercial operations at the time of the IPO, which explains why they are referred to as “blankcheck” or “shell” companies. SPACs first appeared in the 1980s but have gained accelerating popularity in recent years, especially since 2020.
SPAC sponsors generally raise money in IPOs for future acquisitions of other private companies. Because finding acquisition targets can take time (typically two years), the cash raised (typically $10 per share) is held in a trust while the sponsors search for a target. After the SPAC completes a merger with the target company, the previously privately held target company becomes a publicly listed operating company. This last step of creating the listed successor company is referred to as a “de-SPAC” transaction. A SPAC is required to keep 90% of its IPO gross proceeds in an escrow account through the date of acquisition. The SPAC should complete acquisitions reaching an aggregate fair market value of at least 80% of the value of the escrow account within 36 months. If the acquisitions cannot be completed within that time, the SPAC must file for an extension or return funds to investors. At the time of de-SPAC transaction, the combined company also must meet stock exchange listing requirements for an operating company.
SPACs can be an attractive option for sponsors because they can raise money rapidly without having to deal with company preparation or company specific disclosure at the time of the IPO. Moreover, SPACs are attractive to targets because they represent a fast, certain route to liquidity without the delay, pricing risk, and market condition risk associated with the typical IPO process. However, the separation in time between the IPO disclosure and the company specific disclosure means that investors do not learn what they are investing in until after the fact and therefore, their invested funds are tied up for a period of time while the investors rely on the sponsors to find an appropriate target. Furthermore, the transactions by their very nature are complex and have some misalignments between the initial investors, sponsors, investors in the target and any intermediate financiers joining the de-SPAC transaction. At the time of the merger, often over two thirds of the SPAC’s shares are tendered for redemption and the sponsor or third parties purchase shares in a private investment in public equity (“PIPE”) transaction to replenish cash the SPAC paid to redeem its shares, diluting the original investors’ slice of the new company’s equity. These complexities and misalignments are why researchers (such as NYU Professor Michael Ohlrogge and others) assert that SPACs can be frustrating and will likely continue to frustrate the shareholder value performance expectations of many of their retail investors.
The IAC went on to discuss the more recent slow-down and evolution in the SPAC market, which has experienced a reduction in the average volume of SPAC IPOs, increased participation of retail investors prior to the de-SPAC transaction, as well as increased pricing for D&O insurance, among other phenomena. With this evolution has come a decreasing number of sufficient SPAC targets, which the IAC fears may spur sponsors to pursue substandard targets.
In addition, the IAC articulated a concern that many in the market have observed about the nature of shareholder votes, noting that a number of stockholders tend to vote to approve the de-SPAC transaction while redeeming their shares, suggesting that such shareholders do not believe in the underlying rationale behind the merger but vote to approve anyway. Such votes have also raised concerns about the adequacy of the disclosures that SPACs have provided in advance of the shareholder vote.
We will continue to monitor the IAC meeting later this week and report on any resultant actions that the SEC may take in response to the IAC’s recommendations.