If the Securities and Exchange Commission wants to crack down on what critics view as rampant abuses in the booming SPAC market, it is going to need help from Congress, according to a financial reform group.
“Congress is going to have to do the initial heavy lifting on this,” Andrew Park, senior policy analyst at Americans for Financial Reform, told Institutional Investor, adding that “the best thing the SEC can do is make a lot of noise.”
Americans for Financial Reform, allied with the Consumer Federation of America, are pushing Congress to “close the legal loopholes” that they say have ended up enriching sponsors of SPACs, or special purpose acquisition companies, and their initial investors — primarily hedge funds — at the expense of retail investors. Over time, as many studies and analyses have shown, investors in SPACs lose money.
The SEC has been increasingly signaling concern about the SPAC market, with the latest announcement coming on Wednesday. “The rapid increase in the volume of SPACs represents a significant change and we are taking a hard look at the disclosures and other structural issues surrounding SPACs,” tweeted John Coates, acting director of the SEC’s Division of Corporation Finance.
He posted a March 10 investor alert that warned, “SPAC sponsors generally acquire equity in the SPAC at more favorable terms than investors in the IPO or subsequent investors on the open market. As a result, the sponsors will benefit more than investors from the SPAC’s completion of a business combination and may have an incentive to complete a transaction on terms that may be less favorable to you.”
The SEC’s investor advisory committee is holding a panel discussion on the topic Thursday afternoon. At the meeting, criticisms of SPACs are expected to get their first public hearing with the SEC, according to an individual familiar with the plans.
But members of Americans for Financial Reform — an umbrella policy group that was formed during the 2008 financial crisis and that was instrumental in the creation of the Consumer Financial Protection Bureau — won’t be on the panel. Instead, it will be filled largely with SPAC practitioners.
Nor is the need for legislative reform expected to get much, if any, attention.
The reformers think Congress should rewrite the 1990 legislation that allowed the SEC to regulate penny-stock blank check companies, which in the 1980s were rife with fraud. SPACs, while often referred to as “blank check companies,” were created precisely to avoid being subject to that designation — and the rules surrounding it — which was possible as long as the SPAC had at least $5 million in assets.
“Now that promoters and sponsors are using significantly larger vehicles to finance blank check companies, they can evade the restrictions Congress adopted to protect investors from the misleading information, conflicts of interest, and fraud so often associated with blank check offerings,” wrote Park and co-author Renee M. Jones, associate professor at Boston College Law School, in recent letters to the chairs of both the House Financial Services Committee and the Senate Banking Committee.
“Making an investment vehicle larger and attracting larger investments does not cure the problems inherent in marketing, selling, and trading in blank check stock,” they wrote.
While making all SPACs subject to this law is their first priority, the policy wonks also believe there must be legislative reform to “tamp down pre-merger hype” — a problem critics have said is leading today’s SPAC sponsors to make outlandish projections about their merger targets.
“SPAC sponsors, target companies, and their advisors are currently protected from liability for overly optimistic projections included in merger related disclosure due to the safe harbor for ‘forward looking statements’ provided under Private Securities Litigation Reform of 1995,” the letter explained.
Traditional IPOs are excluded from this safe harbor, and so they don’t make such projections. The consumer groups want Congress to amend the sections of securities laws so that SPACs are treated the same as IPOs; they also want to make sure that underwriters are also liable for their roles.
“Closing this loophole and requiring SPAC sponsors and their financial advisors to assume liability for misleading projections will help to ensure that blank check company sponsors and advisors will not inject overly optimistic or unrealistic projections in SPAC-related documents,” the letter explained. “Tamping down on hype is especially important because many SPAC merger targets have no revenues at all, but often boldly claim to investors they will be able to generate billions in revenue in the near future.”
The reformers also want enhanced disclosure on the payments made to sponsors, other SPAC investors, and PIPE investors, including the “potential dilutive impact” of warrants issued in conjunction with both the IPO and the merger.
Finally, they are asking Congress to direct the SEC to “study the risks and results of SPAC mania.”
They suggest the SEC collect data on SPAC shareholders and warrant holders, and produce a report evaluating average performance across investor types — which it says can only occur “if the definition of a blank check company is updated to include SPACs as our prior recommendation suggests.”
“This key information should enable the Commission to accurately assess the categories of investors that typically bear the brunt of SPACs’ post-merger losses,” they added.
The answers might be needed soon. After soaring earlier this year, one market indicator — the IPOX SPAC index — last week briefly entered a bear market, down 20 percent from its peak. It is still down more than 15 percent from that level.