Pershing Square Capital CEO Bill Ackman has long been critical of some of the flaws of the special purpose acquisition company structure, and now he has honed in on another one — its protection from investor litigation over financial projections.
“This is a loophole in the regulations that should be closed,” Ackman wrote in a Sept. 27 comment letter to the Securities and Exchange Commission regarding a New York Stock Exchange rule change. The NYSE proposal would enable him to offer warrants on a new-fangled SPAC, called a SPARC, or special purpose acquisition rights company. He says a SPARC would not benefit from what has become a controversial loophole — and one the SEC is concerned about.
The loophole is what is known as the “safe harbor” protection that arguably gives certain companies liability protection for financial projections via the Private Securities Litigation Reform Act of 1995. The safe harbor protection doesn’t apply to companies engaged in an initial public offering, so those companies don’t make forward projections.
Due to its structure, a SPARC would not get this liability protection either, Ackman explained. He said that would “discourage aggressive and/or fraudulent projections from SPACs that adopt the subscription warrant structure.”
Earlier this year, SPAC sponsors like Chamath Palihapitiya cited the safe harbor protection as a key advantage of SPACs over IPOs. Since then the topic has become controversial as many of today’s SPAC deals are with venture capital-backed companies whose future revenues and profits are hazy, at best. Many have not met their lofty projections, and the stocks have tanked post-merger.
The SEC has expressed its concerns as well. In May, John Coates, who is now the agency’s general counsel, made a lengthy public statement about the safe harbor issue, saying the claim about reduced liability exposure for SPACs is “overstated at best and potentially seriously misleading at worst.” He said the SEC might just consider the SPAC merger an IPO, which would negate such advantages during any litigation.
Ackman has had his own issues with the SEC, whose disapproval of his Pershing Square Tontine Holdings SPAC’s plans to invest in Universal Music Group ahead of its spinoff from French conglomerate Vivendi led him to cancel the effort. That has sent him scrambling to find another deal and led him to push for the issuance of the SPARC, whose structure he says is far superior to a traditional SPAC.
In his letter, he argued that a SPARC would not have the incentives that have led sponsors to make unrealistic forward projections.
The main advantage of the SPARC, as Ackman outlined in the letter, is that unlike a SPAC, it doesn’t require investors to hand over money, which is then invested in Treasury and other low-risk securities, while waiting for a deal to materialize.
Because SPACs are holding investors’ cash, they typically have a two-year time limit to find a deal — which he called a “fast ticking ‘shot clock.’” And since sponsors (though not Pershing Square) typically get 20 percent of the SPAC proceeds for finalizing a transaction, there is an “incentive for the sponsor to complete any deal regardless of its terms or quality by the typical two-year expiration of the SPAC’s term,” Ackman argued in his letter.
“The incentives for sponsors of conventional SPACs have led to a large number of SPAC mergers of early-stage, highly speculative and even pre-revenue companies that are difficult to value,” he wrote. That leads sponsors to be “highly promotional about the target, its prospects, and its potential revenues and cash flows many years in the future.”
But sponsors haven’t had to worry about being wrong. “The sponsor takes the position that their projections and forward guidance are protected from liability,” wrote Ackman.
“As SPACs are simply cash shells, particularly when 100 percent of shareholder capital can be redeemed when a transaction is announced it doesn’t seem right or proper that SPACs get liability protection and companies that do conventional IPOs do not,” he noted.
If the SPARC warrant rule change is approved, Ackman plans to give warrants on the SPARC to investors in his Tontine SPAC, which tumbled below its net asset value of $20 per share when its plans to invest in Universal Music were nixed by the SEC.
Ackman said he may liquidate Tontine, return money to investors, and give them long-dated SPARC warrants while he looks for a new merger partner. If the warrant holders like the deal, they will have the right to pay $20 per share to invest in the new company.
The deadline for comments on the SPARC warrants rule change is Friday. So far, the SEC has received more than 100 comments, and less than a handful have been in opposition. Many investors have said they believe the SPARC may help them recoup their losses in Ackman’s SPAC.