SEC Deals a Big Blow to SPACs
The commission’s proposed changes include heightened disclosure, no safe harbor for misleading projections — and less time to find a deal.
The hype around special purpose acquisition companies — and the investor losses that have resulted since the SPAC boom began to fizzle a year ago — has led the Securities and Exchange Commission to issue harsh new SPAC rules and amendments that go beyond what many originally envisioned.
The changes are so onerous that Hester Peirce, the lone commissioner who opposed them, said in a hearing Wednesday that they “seem designed to stop SPACs in their tracks.” (Peirce is the only Republican commissioner at the SEC.)
But according to SEC Chairman Gary Gensler, the commission is simply trying to protect investors and erase the arbitrage that exists between initial public offerings and SPACs, which is often to the detriment of investors.
Unlike hedge funds and institutional investors, who can benefit from a SPAC’s lucrative warrants by getting in on the IPO or PIPE deal, retail investors typically lose money investing in SPACs. Critics have argued this is due to a SPAC’s complex and opaque structure, which rewards insiders, as well as the often poor quality of companies that choose to go public via a SPAC rather than a traditional IPO, which has tougher requirements.
“Functionally, the SPAC target IPO is being used as an alternative means to conduct an IPO,” Gensler said in a statement. “Thus, investors deserve the protections they receive from traditional IPOs, with respect to information asymmetries, fraud, and conflicts, and when it comes to disclosure, marketing practices, gatekeepers, and issuers.”
The proposed changes include “specialized disclosure requirements with respect to, among other things, compensation paid to sponsors, conflicts of interest, dilution, and the fairness of these business combination transactions,” the SEC said.
The new rules would also allow investors to sue SPACs over misleading projections. The strict liability would not only affect the sponsors, but also their underwriters, accountants, and others involved in a SPAC’s merger deal, known as a deSPAC.
This change addresses the criticism of SPACs being able to make overly optimistic forward-looking statements in a deSPAC because they are entitled to the safe harbor provisions of the Private Securities Litigation Act — something IPOs do not have. Last year, the SEC’s acting director of the division of corporation finance, John Coates, indicated that the SEC was prepared to challenge those protections.
The issue became more serious during the recent SPAC boom, with many more speculative companies — those with no revenues — choosing to go public via a SPAC. Many of those stocks crashed after the companies did not meet their lofty projections.
Now the SEC is proposing to change the definition of “blank-check company” for the purposes of the PSLRA safe harbor for forward-looking statements to exclude SPACs and target companies in de-SPAC transactions.
“Many commentators have raised concerns about the use of forward-looking statements that they believe to be unreasonable in de-SPAC transactions,” the SEC’s proposal states. “By providing greater clarity regarding the availability of the PSLRA safe harbor, the proposed amendment should strengthen the incentives for a blank-check company, including a SPAC, to avoid potentially unreasonable and potentially misleading forward-looking statements.”
Strict liability means that no intent to defraud is required to prove damages. SPAC participants have pushed back against this proposed change, in particular the provision that puts underwriters on the hook along with the SPAC’s sponsors, according to people familiar with their lobbying efforts.
The SEC acknowledged that the change is going to add costs to SPACs, limiting their appeal.
“This increase in potential liability from the current baseline for targets and their signing officers and directors could impact the decision of a private company to go public via a de-SPAC transaction,” the SEC said in its proposal, acknowledging “the increased litigation risk and the potential need for new insurance coverage or higher premiums for existing coverage.”
Finally, SPAC sponsors will have less time to find a deal in order to keep their IPO proceeds invested in cash-like securities without coming under the 1940 Investment Company Act rules. Three SPACs, including Bill Ackman’s Pershing Square Tontine Holdings, have been sued by law professors claiming that they should fall under that act’s provisions because the SPACs are holding government securities in trust (like all SPACs do).
The proposed rule would allow SPACs to avoid the risk of such litigation if they meet certain conditions. Currently SPACs give sponsors 24 months to find a merger target — and additional time to complete the deal — before they must liquidate and return cash to investors.The proposed rule would shorten that time period to 18 months to announce a deal, and 24 months to complete it, in order to be avoid being considered an investment company.
That provision could have unintended consequences. One of the biggest criticisms of SPACs is that sponsors who get a 20 percent stake in a SPAC virtually for free have an incentive to complete any deal within the time frame, and many poor deals have been struck right before the 24-month deadline. If that deadline is pushed up, even more bad deals could be struck.
More than 500 SPACs that went public in 2020 and 2021 are still searching for deals.