Once upon a time, a Special Purpose Acquisition Company (SPAC) carried a great deal of stigma. Most organizations didn’t consider it the ideal way to go public. However, attitudes have shifted, and SPACs are bringing many young companies public.
The rise in SPACs has garnered a great deal of attention from prospective investors. SPACs have also attracted the attention of the U.S. Securities and Exchange Commission (SEC). The SEC issued guidance and warnings over the past several months. Along with SEC interest, there’s been an increase in SPAC-related lawsuits.
Understanding SPACs
A SPAC, also called a blank check company, starts as a traditional public company through an Initial Public Offering (IPO). However, a Special Purpose Acquisition Company has little-to-no operations. Instead, its purpose is to gather investments, which are in trust, and identify a private company to invest in.
The SPAC usually has up to 24 months to identify and complete a merger with a target company. Once it identifies a target company, the two entities merge in a de-SPAC transaction. As a result, the SPAC and target entity’s shareholders now own a public company.
If the SPAC fails to find a target company, it must liquidate and return funds to the shareholders. This entity loses the capital it put into formation, target hunting, and deal-making, which can be millions. The potential loss pushes SPACs to find a target company, make a deal, and merge quickly.
SPACs Are Becoming More Common
Special Purpose Acquisition Company has been around for decades. However, they’ve become much more common in recent years. As of June 2021, 330 SPACs raised nearly $105 billion. The previous year, SPACs raised over $83 million, and in 2019, more than $13 million. As of March 1, the largest SPAC merger occurred when Lucid, an electric vehicle startup, agreed to merge. In the $24 billion deal, Lucid merged with Churchill Capital Corp IV, a SPAC formed by ex-Citigroup banker Michael Klein.
By June 2021, concern grew over the SPAC’s poor market performance. The number of deals at the beginning of the year left many calling it a “frenzy.” The recent slump has individuals and the SEC concerned that riskier deals could hurt investors.
SEC Issues Guidance and Warnings
The SEC has taken a close interest in the rise in SPACs and is monitoring potential risks and enforcement issues.
The SEC has issued several statements in 2021 regarding SPACs, including:
- Disclosing conflicts of interest to investors
- Considering accounting and internal controls
- Meeting public companies’ audit, tax, governance, and investor relations standards
- Misclassifying SPAC-issued warrants as an equity instrument
- Applying the “safe harbor” provision in the Private Securities Litigation Reform Act
The SEC is heavily concerned with target companies understanding their reporting and disclosure requirements. Many target companies aren’t as prepared for an IPO-like transaction, whereas companies that seek traditional IPOs spend years preparing. Lack of preparation and expertise and immature systems and processes could lead to regulatory violations if target companies aren’t careful.
The SEC Division of Enforcement has started an inquiry. The Division of Enforcement asked Wall Street banks to provide information on Special Purpose Acquisition Company deals voluntarily. The division may be looking at SPACs’ level of due diligence and disclosures. Some speculate the division may be ramping up to a formal investigation.
Increase in SPAC Lawsuits to Continue
There’s been an influx of SPAC-related lawsuits in New York, Delaware, California, and other jurisdictions. Between September 2020 and April 2021, plaintiffs filed 38 cases in New York state court alone.
Plaintiffs have brought claims under state-based breach of fiduciary duty laws. They alleged the Special Purpose Acquisition Company directors are responsible for undisclosed conflicts of interest and other inadequate disclosures. The SEC has warned SPACs about conflicts of interest between parties associated with the SPAC and the target company’s shareholder. Many lawsuits appear to rely on this guidance.
In other cases, shareholders filed breach of fiduciary duty claims when the new company failed to perform as expected after the merger. Shareholders alleged the transaction wasn’t in the shareholder’s best interests. Some argue the SPAC didn’t perform appropriate due diligence concerning the target company’s operations and prospects.
Plaintiffs have based some lawsuits on federal securities laws violations. This included whether disclosures and proxy materials made related to the de-SPAC transaction were accurate and adequate.
Future of SPAC Litigation
Despite the rise in litigation, courts have not had the chance to influence the law surrounding these companies and transactions. Most of the lawsuits are either in the early stages or don’t proceed to trial. For example, many SPACs resolve conflicts by providing additional disclosures pre-merger.
However, in time, some of these conflicts are bound to make it before a state or federal judge. During these suits, parties will require the assistance of IPO, SEC, fiduciary duty, mergers and acquisitions, valuation, finance, and accounting experts.
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