The Facts on SPACs: Why Wall Street Darlings Fell Back to Earth
By: Michael Dark and Nathaniel Orenstein, Berman Tabacco
After an eye-popping surge in the number of special purpose acquisition companies—SPACs—in the first two years of this decade, these merger vehicles have lost their bloom for many institutional investors.
This is an excerpt from NCPERS Fall 2023 issue of PERSist, originally published October 24, 2023.
After an eye-popping surge in the number of special purpose acquisition companies—SPACs—in the first two years of this decade, these merger vehicles have lost their bloom for many institutional investors. Skepticism has grown among both regulators and the investment community about not only the lack of information these entities provide for investors, but their vulnerability to abuse.
A SPAC is, in simplest terms, a vehicle for companies to go public without the need to follow some of the strict regulatory requirements governing traditional initial public offerings, or “IPOs”. A SPAC begins life as a shell company listed on a stock exchange—typically NASDAQ—for the purpose of acquiring a private company and then taking it public. The SPAC pools funds to finance mergers or acquisitions even before a specific target company has been identified. By avoiding the intensive compliance requirements of the normal IPO process, SPACs can avoid certain regulatory burdens and save time in bringing a company to the public market.
While SPACS have been used since the 1990s, their combination of reduced regulatory burden and speed to market proved irresistible to financial firms and venture capitalists over the last few years.
But this cost- and time-saving device is a double-edged sword—one that can be problematic for defrauded investors because the regulatory scheme that these vehicles avoid is one aimed at ensuring that investors have access to adequate information for making investment decisions. When the Securities Act of 1933 was passed ninety years ago, the lessons of the stock market crash and the great depression were fresh in the minds of legislators. One of the primary objectives of the statute was to ensure that investors receive financial and other significant information concerning securities being offered for public sale through the registration process, which requires that companies seeking access to the public market provide essential facts to investors.
Not surprisingly, the looser regulatory regime to which SPACs are subject can foster abuse. A congressional investigation into SPACs resulted in a 2022 report that detailed several significant concerns, including hidden fees levied by financial institutions in the transactions and disclosures that sometimes are alleged to cross the line into outright fraud. In conjunction with the issuance of the report, the U.S. Securities and Exchange Commission introduced a package of regulations that seek to address many of the problems identified in the report, including inadequate disclosures, the misuse of forward-looking statements, and conflicts of interest or breach of fiduciary duties owed to investors by SPAC officers, directors, and sponsors.
Institutional investors will be key partners to government regulators in reforming SPACs to better protect the markets, and the last two years have seen a significant uptick in the number of shareholder derivative and federal securities law cases being brought by pension funds and other investors to rein in some of the opaqueness from SPAC practices and misinformation contained within SPAC disclosures. Until new regulations are adopted, private civil litigation may still represent the best recourse for many funds to help beneficiaries recover losses resulting from SPAC abuses.
About the Authors:
Michael Dark is Of Counsel to Berman Tabacco, where his practice focuses on securities litigation on behalf of institutional investors.
Nathaniel Orenstein is a Partner at the Firm, and his practice focuses on both securities and shareholder derivative actions on behalf of institutional investors.