As has been extensively noted on this site and elsewhere, the sheer level of SPAC-related action has been the one of the top business stories of the last few months. However, as I noted earlier this week, there have already been some distant early warning signs of possible problems on the SPAC horizon. Further developments this week suggest there could be growing trouble in SPAC-land. As discussed below, a newly released statement by the SEC about SPAC accounting potentially could cool off the hot market for SPACs, and a statement of intent by a leading plaintiffs’ firm raises the possibility of further SPAC-related litigation.
SEC Statement on Accounting for SPAC Warrants: An April 12, 2021 statement by John Coates, Acting SEC Director of the Division of Corporation Finance, and Paul Munter, the Acting SEC Chief Accountant, addressed accounting and reporting considerations regarding warrants issued by Special Purpose Acquisition Companies (SPACs).
This statement is important because many SPAC vehicles sell units in the financial markets at the time of their IPO; the units consist of equity shares and of warrants to purchase additional shares. The availability of the units, inclusive of the warrants, is an attractive part of the SPAC proposition for prospective SPAC IPO investors and in fact has been an important part of what has driven investor interest in SPAC IPOs.
In their April 12 statement, the SEC officials in effect said that some SPACs may not have properly accounted for warrants sold to investors. In the past, many SPACs have classified warrants as equity on their balance sheets. However, in the statement, the SEC officials said that in certain circumstances the units would have to be classified as liabilities, rather than as equity, depending on their payout structure, settlement in cash or stock, or whether their value is indexed solely to the performance of the underlying stock. The classification of the warrants as liabilities would require companies to periodically account for changes in the warrants’ value.
As the Wall Street Journal noted in its April 13, 2021 article about the SEC statement, “one impact of the SEC’s announcement: SPACS that are affected would have to restate their financial results if the fluctuations are deemed to be material, the SEC said.”
In an April 12, 2021 Forbes article “Hot SPAC Market Could Freeze After Potential SEC Rule Change” (here), the article’s authors said that “the new guidance will likely cause most issuers to revisit their accounting.” The change could also affect the current financial market for SPAC IPOs as “the potential accounting change for SPAC warrants could create further slowdowns and new costs as the new treatment will likely require the upcoming SPACs to rewrite financial statements and reporting documents.” The Forbes article cites unnamed sources as saying that the SEC may have “intentionally created confusion in the industry to temporarily slow the soaring SPAC market so the agency can catch up on regulatory audits and governance.”
The Forbes article says that the proposed changes could also have “ramifications well beyond the current SPAC IPO pipeline.” The article cites unnamed sources as having told the authors that “the SEC’s switch could further send the entire SPAC world scrambling by forcing the hundreds of currently active SPACs to restate and refile their full slate of financial statements.” The accounting change could also “cause market swings to have a greater effect on earnings reports, impact profits, and make the already roller-coaster world of SPACs more turbulent.”
The one thing that has become clear in the last few days is that the SEC is clearly focused on SPACs. The statement late last week warning about SPAC IPOs use of projection (discussed in my post earlier this week, here) and the new SEC statement about accounting for SPAC warrants are, as the Forbes article put it, “just the tip of the iceberg,” suggesting further that we should not be surprised if SEC comes forward with further initiatives and actions addressed to SPAC activity.
Plaintiffs’ Firm Forms SPAC Task Force: As if the SEC’s recent SPAC-related pronouncements were not trouble enough, an unrelated development suggests further trouble ahead for SPACs. In an April 12, 2021 press release (here), the Robbins Geller law firm has announced the formation of a “SPAC Task Force.” The Task Force is to be “comprised of experienced securities and M&A lawyers” and also includes “in-house investigators, forensic accountants, and economists dedicated to rooting out and prosecuting fraud on behalf of injured blank check investors.”
The press release notes that supposed SPAC features, such as, according to the press release, “significant conflicts of interest” and “less stringent disclosure requirements,” have caused several high-profile SPAC offerings to result in “serous allegations of fraud and misconduct, collectively costing investors billions of dollars investment losses.”
The press release notes that the Robbins Geller firm already serves as lead counsel in an existing SPAC-related securities class action lawsuit, and includes a statement from one of the firm’s partners saying that “Robbins Geller is committed to assisting those victimized by fraud and corporate malfeasance in connection with SPAC investments.”
As I have documented on this blog (most recently here), there has already been a certain amount of SPAC-related securities class action litigation activity this year. The Robbins Geller law firm’s initiative can only be interpreted to mean that we should expect to see further litigation ahead.
For those who wonder why the law firm is forming a task force, well, obviously it formed the task force so the firm could issue a press release. And why is the firm issuing a press release? Because they anticipate three things: (1) a lot of SPAC-related securities litigation coming down the pike; (2) that the SPAC-related litigation will be good business, and therefore there will be competition among plaintiffs’ firms for the best cases; (3) in order to be positioned to attract the best cases, the law firm wants to try to position itself advantageously in order to best compete for the business.
None of this is good news for SPACs and SPAC directors and officers; SPAC sponsors; post de-SPAC transaction operating companies; or for D&O Insurers.
New York State Court SPAC-Related Litigation: In my post earlier this week about SPACs, I noted the growth of SPAC-related state court litigation in Delaware. According to a recent law firm memo, there apparently has also been a recent rise of SPAC-related state court litigation in New York, as well.
In an April 8, 2021 memo entitled “Recent SPAC Shareholder Suits in New York State Courts: The Beginning Wave of SPAC Litigation” (here), the Akin Gump law firm reports that “between September 2020 and March 2021, at least 35 SPACs have been hit with one or more shareholder lawsuits filed in New York state court.”
Most of these lawsuits have been filed against SPAC directors and allege that the directors breached their fiduciary duties by providing allegedly inadequate disclosures concerning proposed de-SPAC mergers. The report notes that some of these lawsuits have been filed against the SPAC itself, as well as the target company and its board of directors, for allegedly aiding and abetting the SPAC directors’ breach. The state court complaints so far have been limited to state law tort claims, and do not typically include any federal or even state securities law claims.
Most of the complaints were filed after the proposed merger was announced but before the shareholder vote on the proposed merger. The suits typically seek preliminary injunctive relief to enjoin the shareholder vote and/or the merger. Many of the cases filed have been voluntarily dismissed (as is often the case for merger objection suits). The memo speculates that the plaintiffs may have chosen to file the complaints in New York courts rather than in Delaware to avoid unfavorable Delaware precedent on disclosure-only settlements.
The memo concludes by suggesting that the recent flurry of New York state court lawsuit filings is only “the beginning wave of SPAC-related litigation,” noting further that “the plaintiffs’ bar appears focused in SPAC.” SPAC shareholder lawsuits “are likely to multiply, potentially subjecting SPACs, their boards and sponsors to more significant civil risk and exposure.” The likely future litigation activity could include, the memo suggests, not only litigation in New York’s courts, but also in Delaware courts and in federal courts as well.