Lawyers, accountants, and sponsors for special-purpose acquisition companies are bracing for impact.
The potential effects of new SPAC guidance issued earlier this week by U.S. regulators are becoming clearer, and they could be sweeping. Lawyers who advice SPAC deals told Institutional Investor that the new accounting guidance has already had an immediate impact, slowing deals as compliance teams meet to determine a path forward.
Top officials at the Securities and Exchange Commission on Monday issued a statement warning that some 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 instead be classified as liabilities in certain situations, making the company account for adjustments in the warrants’ value over time.
It may seem an obscure issue, but the SEC officials warned that SPACs will have to re-state their financials, throwing a temporary wrench in one of the hottest investment markets of the past year. It’s still unclear exactly how many companies will have to do so, but lawyers who advice on SPAC mergers are already sounding the alarm that the new guidance is slowing down the SPAC market.
Davis Polk & Wardwell, named by Refinitiv as the top law firm advising SPAC deals in 2020 based on combined deal value, said Wednesday in a note to clients that the SEC guidance “has already caused a pause in offerings by SPACs.” The firm also said the change has delayed the completion of some SPAC mergers, but added that guidance likely won’t have a material impact on investors.
“We are not aware of other situations in the recent past where the SEC staff, with no notice or comment, simply issued a proclamation that had such a significant chilling effect on capital markets activities,” Davis Polk wrote in the note.
Ripple effects of the guidance have already been seen. BurgerFi, which went public through a SPAC in December, delayed its earnings on Tuesday, telling investors that it needed time to determine the impact of the SEC guidance on its current and previous financial statements.
However, the SEC statement doesn’t appear to have erased investor appetite for SPACs. The day after the new SEC guidance was published, Southeast Asia’s largest ride-hailing and food delivery company, Grab, announced plans to go public in the biggest-ever SPAC merger.
The Grab deal aside, the SEC guidance is “unquestionably going to slow the market down,” Doug Ellenoff, partner at law firm Ellenoff Grossman & Schole, said in a phone interview with Institutional Investor. “If deals don’t get processed effectively and efficiently, deals that are in process could not get done, which hurts public investors. There will be no quick fixes in my estimation.”
Ellenoff said law firms, accountants, and valuation firms are all meeting to determine precisely what the impact of the warrants guidance is and what needs to be done in response. He described the process as a “non-cash charge” and a “paperwork exercise.” Ellenoff said “the added pressure” from the SEC on the SPAC market is unnecessary and that the advisory firms and companies doing the deals are behaving responsibly.
“This is not a retail playground,” he said. “This is institutional investors, and they’re looking for return and now the SPAC market enables Fidelity and Wellington and T. Rowe, to invest in more interesting, pre-revenue, venture-like deals in the public market, so that they can compete with venture and private equity firms for return.”
Warrants are not the only issue the SEC has expressed concern about. The regulatory agency last week published 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 initial public offerings. One advantage of SPAC deals is that it allows companies to make lofty projections about future earnings and revenue. In contrast, companies that go public via IPO don’t typically make projections about the future in their main filings because it opens them up to legal liabilities.
But Coates, the SEC official, 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.”
Travis Wofford, a partner at Houston-based law firm Baker Botts, said the projections issue is likely more important, but the warrants issue is having a more immediate impact. He added that the upcoming May deadline for companies to file their quarterly reports is adding pressure for companies to resolve the warrants issue before then.