The US Securities and Exchange Commission is said to be preparing to adopt rules that would make those overseeing special purpose acquisition companies (SPACs) liable for financial exaggerations to investors.
According to Bloomberg, the Wall Street watchdog is expected to release expanded rules for SPACs on Wednesday. The rule change “would clarify that investors can sue over inaccurate special purpose acquisition company forecasts.” Specifically, forecasts about the company a SPAC and its sponsors are trying to take public.
Asked to confirm the report, an SEC spokesperson pointed to SEC Chair Gary Gensler’s comment on Twitter that the agency will be having a meeting on Wednesday to discuss SPACs.
If the agency does decide to treat overly bullish financial claims from SPACs in the same way it treats unsupported hype from regular public companies, it wouldn’t be a surprise. Gensler has signaled his unease with SPACs – which have become exceedingly popular – because they provide the public with less protection than a traditional initial public offering (IPO).
SPACs begin with a sponsor who raises cash through what’s known as a blank-check IPO, so named because investing in a firm with no actual business operations or assets amounts to writing a blank check. The sponsor – a group of investors, a hedge fund, or the like – then has two years to identify a company to merge with, in order to subsequently take it public.
When a merger target is identified, the investors who bought into the SPAC IPO have the option to redeem their shares rather than participating in the merger and public debut of the combined firm. That’s an appealing scenario to some investors because it shields them from downside risk. But the results tend to be worse for those who don’t immediately redeem their shares.
A 2020 research paper on SPACs found that given a $10 SPAC IPO share price, “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.”
That is to say, SPACs tend to enrich original investors who exit early at the expense of those who retain their shares through the merger or buy-in later. We’ve seen a few tech-related SPAC IPOs lately.
As Gensler has stated in recent speeches, there’s a need to apply long standing financial policy principles to SPACs, like leveling information asymmetries, guarding against misinformation and fraud, and mitigating conflicts of interest.
“There may be some who attempt to use SPACs as a way to arbitrage liability regimes,” said Gensler in December. “Many gatekeepers carry out functionally the same role as they would in a traditional IPO but may not be performing the due diligence that we’ve come to expect.”
“Make no mistake: When it comes to liability, SPACs do not provide a ‘free pass’ for gatekeepers,” he said, adding that he had asked SEC staff to formulate recommendations to better align incentives between gatekeepers, like SPAC sponsors, and investors.
Look for those recommendations to be embraced by the SEC on Wednesday. ®