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Regulators Ramp Up Scrutiny of SPACs

Top SEC officials have issued another warning on blank-check companies.

SPACs have gotten a lot of attention from investors. Now, regulators are watching, too.

The Securities and Exchange Commission is stepping up scrutiny of special-purpose acquisition companies, which exploded in popularity during the pandemic as a way for early-stage companies to go public without the regulatory scrutiny of a traditional IPO. But increased attention from the SEC may throw a wrench in the market. 

In the latest of a string of warnings issued by the SEC in recent weeks, the regulator said late Monday that some of the blank-check firms, called SPACs, may have failed to properly account for warrants sold or given to investors.

Warrants, which give some investors the right to buy more shares of the company at a preset price in the future, are a common instrument through which SPACs raise money, including from hedge funds and other early investors. SPACs are shell companies that trade on a stock exchange before merging with a private company to take it public. 

SPACs have historically listed warrants as equity on their balance sheets. But the SEC’s acting chief accountant, Paul Munter, and the SEC’s top official for corporate filings, John Coates, said Monday that warrants should rather be classified as liabilities in certain situations, making the company account for adjustments in the warrants’ value over time. 

That’s important because SPACs that are materially affected by the SEC’s new warrants guidance will need to revise previous financial filings, the two SEC officials said. It’s not clear how many firms will be affected by the change. 

Coates and the SEC have been ramping up pressure on SPACs with a string of official statements and warnings in recent weeks. The statements have largely targeted the common assertion that going public through a SPAC deal allows companies to bypass the safeguards and avoid the regulatory scrutiny of a traditional initial public offering.

[II Deep Dive: Free of IPO Constraints, SPACs Can Make ‘Absurd’ Financial Projections — And This Hedge Fund Manager Says The Fallout Is Coming]

Stanford business and corporate law professor Michael Klausner said in an interview with Institutional Investor that professional staff at the SEC have likely been concerned about some aspects of SPACs for a while but are just now acting on it.

“There was a complete lack of information, of deep analysis about SPACs even just a few months ago,” Klausner said by phone, adding that regulators are now sorting it out. 

Klausner in recent months has published research on SPACs showing, for example, that blank-check companies that completed deals between January 2019 and January 2020 fell an average of 34.9 percent in the 12 months after their mergers. He said it’s not clear how much of an impact the SEC’s warrants guidance will have, but he added that the agency’s statement last week is among the more notable developments.

Coates on Thursday issued a statement about potentially misleading earnings projections made by SPAC sponsors, suggesting that the SEC will give the same scrutiny to SPAC deals as it does IPOs.  

One advantage of SPAC deals is that it allows companies to make lofty projections about future earnings and revenue. In contrast, companies that IPO don’t typically make projections about the future in their main filings because it opens them up to legal liabilities.

But Coates put SPACs on notice, saying that the SEC will scrutinize future earnings projections made as a result of the deals. 

“With the unprecedented surge has come unprecedented scrutiny, and new issues with both standard and innovative SPAC structures keep surfacing,” Coates said. “Any simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst.”

Earlier last week, Coates, speaking at a legal conference, had warned of “some significant and yet undiscovered issues” with SPACs, according to the Wall Street Journal.

Klausner said he could see harsher regulation from the SEC coming in the next few months. Targets of scrutiny could include the “dilutive impact of the SPAC structure,” which involve the ways SPACs award shares, warrants and rights to parties that do not contribute cash to the eventual merger, Klausner said. He added that the SEC might also come out and require more transparent and fuller disclosures at the time of the merger between a blank-check firm and private company. 

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