As we have previously shared, market interest in special-purpose acquisition companies (SPACs) has been soaring this past year, with more than 240 SPAC initial public offerings (IPOs) in 2020 and another 296 SPAC IPOs so far in 2021. Now, the US Securities and Exchange Commission (SEC) has reportedly launched an inquiry into what has been described as a “blank check” acquisition frenzy and has sent letters to Wall Street banks seeking information on their dealings with SPACs.
SPACs are, in simple terms, shell companies with no actual operations that are set up for the sole purpose of raising funds via an IPO to acquire another company. SPACs are sponsored by private equity firms, business executives, hedge funds, investment firms and other institutions. Critically, when a SPAC raises money, investors do not know what the eventual acquisition target will be. At the time that an acquisition is to be consummated, post-IPO, SPAC investors can choose either to retain their investment and continue to own shares in the acquired company, or otherwise redeem their shares to get back their original investment.
The SEC’s reported informal investigation follows a statement earlier in March by Acting Commission Chair Allison Herren Lee expressing concern over the recent SPAC wave. During an Investor Advisory Committee Meeting on March 11, 2021, Lee stated, “Lately, we have seen more and more evidence on the risk side of the equation for SPACs as we see studies showing that their performance for most investors doesn’t match the hype.” Just a day prior, on March 10, the SEC issued an investor alert that warned investors about the rise of celebrity sponsors for SPACs and emphasized, “It is never a good idea to invest in a SPAC just because someone famous sponsors or invests in it or says it is a good investment.” And in December 2020, the SEC issued disclosure guidance laying out disclosure obligations for a SPAC IPO, including whether the SPAC had clearly described the potential conflicts of interests and financial incentives of sponsors, directors, officers and investment banks.
It remains to be seen whether the SEC will escalate its inquiry into a formal investigation, but there are steps which financial institutions can take now to protect themselves. First, companies should be encouraged to comply with the SEC’s SPAC disclosure guidelines in connection with SEC filings related to the SPAC’s business combination. Second, these SEC filings should be sure to disclose all applicable conflicts of interest, including any conflicts of the banks themselves. Third, in actual conflict situations, companies should adhere to tried and true procedures for handling related party transactions. And fourth, nothing beats robust due diligence, including diligence with respect to the company’s forecasts. The SEC has fired a warning shot – the time for protective action is now.