Statement on the Proposal to Enhance Investor Protections in SPACs
Washington D.C.
March 30, 2022
The last two years have seen an unprecedented surge in the use of special purpose acquisition vehicles (SPACs) as an alternative means of going public. Indeed the amount of capital raised by SPAC initial public offerings (IPOs) in 2021 was more than $160 billion, a fifteen fold increase over 2018.[1] The rise of SPACs, and the corresponding innovation around their use, raises specific investor protection concerns, especially for retail investors. Today the Commission responds to those concerns by proposing a package of amendments designed to promote transparency and accountability in the SPAC market.
In its simplest formulation, a SPAC is a shell company that raises capital in the public markets with the intention of identifying and merging with a target private operating company.[2] In practice, SPAC transactions are often exceedingly complex and governed by regulations designed for more traditional IPO structures. The complexity and the novelty of the SPAC structure have yielded a host of questions, including whether shareholders have adequate insight into the compensation, incentives, and potential conflicts related to the SPAC sponsors, whether the absence of traditional investor protections and liability, or at least uncertainty about their application at the de-SPAC stage, leaves shareholders vulnerable, and generally whether retail shareholders may be left holding the bag on an ill-advised or underperforming business after sponsors have collected their compensation and insiders have cashed out their shares.[3]
Today’s proposal addresses these concerns through, among other things, new disclosure requirements to enhance transparency and clarified liability provisions to enhance accountability.
Enhanced transparency. The proposal would require additional disclosures regarding the de-SPAC transaction, including whether the SPAC sponsors believe the de-SPAC transaction is fair to unaffiliated shareholders. It further would require additional disclosure on sponsor compensation, conflicts of interest, and the potential for dilution of share value. With respect to dilution, the nature of SPACS, offering as they do compensation and various rights to third parties along the path to the de-SPAC, presents heightened risks, especially for shareholders who do not redeem their shares before the completion of the business combination.[4] I hope commenters will weigh in on whether the proposed content and presentation of these disclosures will meet investor needs.
Enhanced accountability. The proposal would deem the target private operating company in a de-SPAC transaction to be a co-registrant thereby subjecting it to traditional signing liability. It would further propose a definition of “blank check company” that would encompass SPACs so that the safe harbor for forward-looking statements under the Private Securities Litigation Reform Act of 1995 (PSLRA) would not be available to SPACs or to target private operating companies. It also proposes a new rule to clarify that SPAC IPO underwriters are underwriters in the de-SPAC and therefore subject to underwriter liability. On this last point, I note that, in addition to the SPAC IPO underwriter, there are a number of participants in the de-SPAC transaction that may also be subject to statutory underwriter liability if they participate in the distribution. Because underwriter liability is a key mechanism to help ensure adequate due diligence and materially complete and accurate disclosures for investors, I hope to hear from commenters on whether there is adequate certainty as to which de-SPAC participants are statutory underwriters, and whether and how to mitigate the risk that participants will structure their participation to avoid such liability.
Lastly I’ll note that the amendments also include a proposed safe harbor under the Investment Company Act. I have some concerns regarding whether we’ve taken the right approach here. It’s not clear to me whether SPACs that meet the conditions of the proposed safe harbor should nevertheless be exempted from the investor protections of the Investment Company Act. I think we would especially benefit from robust comments on this important issue.
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Today’s proposed amendments are tailored to address investor protection gaps in the existing regime, which should increase investor confidence in SPACs and help ensure their continuing viability as a pathway to the public market.
I want to thank the staff for their careful and thoughtful work in crafting today’s proposal. I’m pleased to support it, and I look forward to public comment. Thank you.
[1] Special Purpose Acquisition Companies, Shell Companies, and Projections, Release No. 33-11048 (March 30, 2022) (providing that, in IPOs, SPACs raised “more than $83 billion in such offerings in 2020 and more than $160 billion in such offerings in 2021” compared to “$13.6 billion in initial public offerings in 2019 and a total of $10.8 billion in initial public offerings in 2018.”) [Proposing Release]; see also John C. Coates, SPAC Law and Myths (last rev. Feb. 14, 2022) (“In the first half of 2021, 62% of all initial public offerings were SPAC offerings, compared to 53% in 2020, and less than 25% in the prior four years.”).
[2] A SPAC is designed to take a private company public through its acquisition by a registered shell company. It proceeds in two basic stages. First, a registered public offering that raises funds to be put in trust for the acquisition of a private company. Second, the acquisition itself, or business combination, sometimes called the de-SPAC, where shareholders in the first stage IPO vote on the acquisition of the target private company. If the SPAC fails to complete the business combination within two years, it liquidates, and the sponsors forfeit their potentially lucrative “promotes.” See Proposing Release at 9-10.
[3] See Proposing Release at 13-14 (identifying concerns raised by commentators, including “sponsor compensation and other costs and their dilutive effects on a SPAC’s shareholders,” potential conflicts of interest inherent in conditioning sponsor compensation on completing the de-SPAC that “could lead sponsors to enter into de-SPAC transactions that are unfavorable to unaffiliated shareholders,” listing rules under which SPAC shareholders can “vote[] in favor of proposed de-SPAC transactions while still redeeming their shares prior to the closing of the transactions,” and studies showing that “returns are relatively poor for investors in companies following a de-SPAC transaction.”); see also Michael Klausner, Michael Ohlrogge & Emily Ruan, A Sober Look at SPACs, 39 Yale J. on Reg. 1 (2022) (“We find that the SPAC structure—designed to support a circuitous two-year process from IPO to merger—entails costs that are subtle, opaque, and far higher than have been previously recognized. We further find that nearly all investors in SPAC IPOs redeem or sell their shares by the time of a SPAC’s merger, leaving a new group of shareholders to bear the costs embedded in SPACs as they merge. Furthermore, the SPAC structure results in misaligned interests between its sponsor and the holders of SPAC shares at the time of a merger.”).
[4] See Proposing Release at 36 (“There are a number of potential sources of dilution in a SPAC’s structure, including dilution resulting from shareholder redemptions, sponsor compensation, underwriting fees, outstanding warrants and convertible securities, and PIPE financings. This dilution may be particularly pronounced for the shareholders of a SPAC who do not redeem their shares prior to the consummation of the de-SPAC transaction and who may not realize or appreciate that these costs are disproportionately borne by the non-redeeming shareholders.”); see also Klausner, et al., supra note 3 (“We find that the median SPAC delivers only $5.70 per share in net cash in its merger, which means a total of $4.30 per share has been extracted by the sponsor, the IPO investors, the underwriter, and various advisors. In order for both holders of SPAC shares at the time of the merger and target shareholders to come out ahead on the deal, a merger must produce a surplus in value that fills the hole created by these costs. We find that, in most SPACs, this does not happen.”).