A special purpose acquisition company (SPAC) can be thought of as an investment vehicle that allows companies to bypass the traditional initial public offering (IPO) process in order to raise capital. While this may seem like an attractive option, recent trends are showing that SPACs come with challenges. For example, there has been an uptick in SPAC litigation. Plaintiffs are alleging misleading statements during the fundraising period and loss of value immediately after the stock’s initial sale on the secondary market.
The Evolving Landscape
Increasing litigation, enhanced regulation, and changing market dynamics have challenged the purpose of SPACs. Critics have been suggesting that SPACs are rife with conflicts of interest, make investors more vulnerable, and are excessively liquid.
Supporters argue that SPACs benefit market efficiency. Additionally, they argue SPACs can reverse the trend of technology companies remaining private. As well as, letting ordinary investors get in on the potential of early-stage high-growth companies. They argue SPACs can be rewarding to financial investors and bear less liability exposure than conventional IPOs. Consequently, most shrewd participants in the market will acquire a competitive advantage.
The Ongoing Litigations
Increasingly, plaintiffs have brought private litigation against SPACs. Much of the litigation centers on the process that starts at the time of the IPO and continues through the solicitation of proxy votes. They can also occur post-deal divestitures.
The SEC has been very interested in the SPACs surge. On December 22, 2020, the SEC issued guidance for SPACs. The SEC staff made it clear that SPACs preparing to conduct an IPO or presenting de-SPAC transactions to shareholders the company should consider carefully their disclosure obligations under the federal securities laws regarding conflicts of interest.
Regulations Set to Hit SPACs
SPACs have emerged as a new and effective way for companies to go public. However, the evolving legal landscape around SPACs has put them under tighter regulations. As a result, it’s becoming more difficult for SPACs to run the way they have in the past.
How the Securities and Exchange Commission Is Cracking Down On SPACs
The SEC is trying to push a law that would regulate SPACs the same way financial watchdogs regulate IPOs. Sponsors and underwriters of the SPACs would be held liable for false information. This is similar to if they were to go the formal IPO route.
If these regulations are passed, the compensation and any vested interests of the sponsors will be made public.
Proposed Rule Changes
SPACs are different from IPOs that involves only one step: when the SPAC sponsor acquires an operating business. However, there is a two-step process. This involves both gathering funds and the first fundraising event called a de-SPAC. Typically, the companies announce which company they’re looking to acquire or merge with. Consequently, they are given the opportunity to sell their stock if they are not interested in the merged business.
SPAC filings related to de-SPAC deals have often included financial projections for the target business. This isn’t allowed in an IPO. The deals also reduce the holdings of public investors.
The proposed rules would clarify that blank-check SPACs don’t get a free pass to issue projections that are devoid of fact. All deal-caused dilution would be shown clearly on the cover of the post-SPAC filing. A fair opinion would need to come from an unbiased company.
Under the new rules, all participants involved in the SPAC would be legally liable for false statements or omissions. This would hold them accountable, just like the promoters and underwriters of an IPO. Executives of the acquired company would be required to sign the de-SPAC registration statement. The underwriter of the initial SPAC would stay involved until the end, which carried the responsibility for any repayment.
The Breakdown of the SEC’s Proposed Rules and Amendments
The SEC wants to modify the definition of a blank check company. Consequently, this would eliminate the liability shield for forward-looking statements in SPAC filings. This will leave SPACs open to litigation if investors feel like the company’s estimates were outrageously overinflated.
Require SPACs to partner with a blank-check company when the company files a take-public Form S-4 or F-4.
Creating policies to limit potential conflicts of interest and damage to investor holdings.
The Securities Act of 1933 should be updated to limit the types of financial statements that shell companies can produce to include potential business combinations and merger targets.
Legal lawsuits, as outlined in the Commission’s release, are largely driven by commentators who want more transparency and protection for shareholders of SPACs concerning conflicts of interest and financial projections concerning target companies. Lack of comprehensive guidance on what they are required to disclose and conflicts in their dealings creates fertile ground for shareholder lawsuits involving de-SPACs and SPACs. Approval of the proposed rules by the Commission will undermine some of the potential suits by taking away shareholders’ claims that vital information about the deals was hidden. While such lawsuits have not stopped in other realms like the traditional IPO environment that the Commission’s proposed SPAC rules seem to mimic, it will not necessarily happen here either.
That being said, with new potential rules, there may be an uptick in class-action lawsuits.