What are SPACs?

Special Purpose Acquisition Companies, or “SPACs”, are publicly traded companies that have no commercial operations and are formed solely to raise capital for the purpose of acquiring or merging with a private company in what is called a “business combination,” to take that company public.

Because the SPAC mechanism tends to be faster and avoids some of the regulatory hurdles of a traditional IPO, the use of SPACs to achieve public listing and raise capital has sharply increased in recent years. The Wall Street Journal called SPACs “Wall Street’s favorite pandemic bet.”

SPACs raised more than $160 billion in 2021, nearly double the $83 billion they raised in 2020 and more than 10 times the $13 billion SPACs raised in 2019

SPACs may present risks to investors.  

As SPACs have increased in popularity, so has the SEC’s scrutiny of them because of the heightened risks SPACs present to investors, particularly unsophisticated ones. Whistleblowers can play a significant role in alerting the SEC to problematic or fraudulent SPACs transactions.

There are many aspects of SPACs that make them particularly risky and vulnerable to fraud. First, the incentives of SPAC sponsors (directors, executives and other management of the SPAC) often are misaligned with the interests of shareholders. SPACs, also called “blank-check companies,” typically require that a merger with or acquisition of a private company occur within two years, or else investors’ money is redeemed to them. In their eagerness to complete a successful business combination and keep investors’ money, SPAC sponsors may overlook critical issues or fail to conduct sufficient due diligence.

In addition, financial projections about the private companies that are merging with or acquired by a SPAC may be misleading or lack a reasonable basis.

The SEC also is concerned that some SPACs are, in effect, investment companies and should be subject to the requirements of the Investment Company Act.

The SEC has warned investors about the possible risks of SPACs. “Concerns include risks from fees, conflicts, and sponsor compensation, from celebrity sponsorship and the potential for retail participation drawn by baseless hype, and the sheer amount of capital pouring into the SPACs, each of which is designed to hunt for a private target to take public,” explained Dan Coates, SEC Acting Director of the Division of Corporate Finance, in a statement.

SPACs must follow securities laws.

The SEC is holding SPACs accountable to follow the same securities rules and obligations as typical IPOs.

For example, a SPAC is required to undertake reasonable due diligence on the target company, and to disclose its findings to investors, such as through an SEC proxy merger statement. A SPAC cannot just rely on the representations made during due diligence by the target company. SPAC sponsors should look at the financial statements and other indicators of financial health of the businesses the SPAC seeks to acquire and disclose this information to investors.

The SEC has stated that a SPAC is also subject to potential liability for any material omissions or misrepresentations made in its SEC registration statement, proxy solicitation or tender offer. A SPAC is required to disclose conflicts of interest, for example.

The SEC has shown a willingness to take enforcement action against SPACs that alleged violated securities laws. Recent actions include:

  • Civil penalties of $100,000 and a cease-and-desist order against Benjamin Gordon, the CEO of SPAC Cambridge Capital Acquisition Corporation, which merged with Ability Computer & Software Industries Ltd. The SEC alleged that Gordon did not perform sufficient due diligence on the target company and failed to give accurate material information on the company to the SPAC’s investors.
  • Civil penalties of over $8 million and a cease-and-desist order against SPAC Stable Road, its target company, Momentus, and CEO Brian Kabot in July Charges were also brought against founder and former CEO Mikhail Kokorich but have yet to be resolved. The SEC’s allegations included claims that the company and CEO misrepresented to investors that the company’s space propulsion technology had worked in tests, as well as misrepresentations about difficulties obtaining necessary licenses. Furthermore, the SPAC failed to conduct sufficient due diligence before the merger. “This case illustrates risks inherent to SPAC transactions, as those who stand to earn significant profits from a SPAC merger may conduct inadequate due diligence and mislead investors,” said SEC Chair Gary Gensler in a statement.
  • Disgorgement of $38.8 million in settlement of charges against Akazoo, a music streaming business. The SEC alleged in its complaint that Akazoo had misrepresented its user base growth and revenue to investors in its business combination in 2019 and continued to misrepresent these metrics to investors after being listed. Prior to the settlement, Akazoo had stipulated to freeze its assets to preserve its remaining cash for a potential recovery and disgorgement to harmed investors. The director of the SEC’s Fort Worth Regional Office, David Peavler, stated that “The SEC is intently focused on SPAC merger transactions, and we will continue to hold wrongdoers in this space accountable.”

The SEC has proposed new rules on SPACs, signaling continued scrutiny and enforcement.

In March 2022, the SEC proposed rules that would increase disclosure requirements and investor protection in IPOs by SPACs and in business combination transactions involving shell companies, such as SPACs, and private companies.

If passed, the SEC’s rule would impose a number of new requirements for SPAC transactions. For example, the new rule would hold underwriters who participate in and assist with SPAC transactions liable for the accuracy of the SPAC’s disclosures.

SPACs also would also be required to make affirmative statements regarding the fairness of the transaction for public investors that are not affiliated with the SPAC. The SPAC would have to explain the material factors upon which its fairness statement is made. This would include any third-party opinions if the SPAC had obtained any such opinions, whether any directors voted against the transaction or abstained from the vote, the company’s financial projections, the valuation of the target company, and other possible factors.

In addition, the proposed rule would remove a safe harbor for forward-looking statements that is currently available in de-SPAC transactions. The Private Securities Litigation Reform Act of 2005 barred safe harbors for forward-looking statements made in IPOs and securities offering, but because de-SPAC transactions are technically mergers, this bar did not apply and therefore SPACs could take advantage of the safe harbor for forward looking statements in private securities litigation. The proposed rule would remove this safe harbor from the Private Securities Litigation Reform Act by including SPACs in its definition of what kinds of companies are considered “blank check companies” and cannot avail themselves of the safe harbor.

Similarly, the proposed rule would require financial projections by SPACs to have greater clarity. Financial projections made by SPACs under the proposed rule would be required to be made on a reasonable basis. Projections that are not made based on certain historical information or operational history would have to be identified as such. Other changes in how information about projections is presented, such as what information is emphasized, is also contained in the proposed rule.

The above are just several examples of the myriad of changes that would accompany the SEC’s proposed rule if it were to pass. Overall, the rule would provide investors evaluating SPACs with more information upon which to base their investment decisions.

Whistleblowers can report SPAC violations confidentially and may earn rewards.

Whistleblowers are well positioned to alert the SEC to fraudulent acts or omissions or other securities law violations made by SPACs. Whistleblowers may stand to collect rewards under the SEC’s whistleblower program.

The SEC’s whistleblower program offers whistleblowers rewards, confidentiality and employment protection for reporting violations of securities laws.

SEC whistleblower rewards range between 10% and 30% of the monetary sanctions collected by a SEC action if they total over $1 million. Whistleblowers also are eligible for rewards based on sanctions collected in related enforcement actions, if there is a successful SEC enforcement action.

Whistleblowers’ identities are kept anonymous and confidential, with certain exceptions. The Dodd-Frank Act prohibits employers from firing, harassing, demoting, suspending, threatening, or otherwise retaliating against whistleblowers who report potential commodity law violations to the SEC.

If you are aware of SEC violations involving a SPAC and would like to discuss the matter with experienced SEC whistleblower lawyers, contact Phillips & Cohen for a free, confidential review.






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