Sunday Read: SPAC Update

This overview of whistleblowers’ role in regulating Special Purpose Acquisition Companies (SPACs) was sent as part of NWC’s Sunday Read series that aims to educate supporters about specific whistleblower legislative or policy initiatives. For more information like this, please join our mailing list.

On March 30th, the Securities and Exchange Commission (SEC) proposed rule changes designed to increase investor protection concerning special purpose acquisition companies (SPACs), as hinted at late last year. These rule changes would impose new regulations on SPAC transactions, more closely aligning them with traditional initial public offerings (IPOs), and providing much needed clarity for whistleblowers.

In this week’s Sunday Read, we will reinforce the importance of whistleblowers in maintaining transparency in the investor market.

What are SPACs?

A recent popular phenomenon in the investment community, SPACs, most basically, serve to help companies transition from a private to a public company. SPACs solely exist for this purpose and do not function as traditional companies in that they have no other business goals, transactions, or relations. A SPAC raises capital from investors through an IPO without having a specific target merger company, making it very difficult for investors to understand where their money is going.

Compared to a normal IPO, SPACs can be very enticing for both the investor and the target company. With a significantly shorter timeline, this form of shell company can create a less volatile transition process, where a target company is determined sooner. As it stands, underwriters, which are investment banks that provide financial services during the transition process, have significantly less to lose than the investor. Since the target company is not announced at the beginning of the SPAC process, it can be difficult for investors to understand where their money is going and how they will profit from their contributions.

When someone invests in a SPAC at the IPO stage, there may be an “IPO prospectus”, targeted at a specific company, but there is no obligation for the SPAC to merge with that company. This means until a company outlines and identifies an “initial business combination” opportunity, investors have no guarantees as to where their contributions are going, a concept that can make it difficult for investors to trust a SPAC’s leadership.

This issue is compounded by celebrity sponsorship, a practice used to encourage investment in specific SPACs. This practice generally serves to provide a source of credibility for a SPAC’s management team, as investors are relying on leadership to choose a desirable target company. The SEC issued an investor alert in March 2021 concerning the developing trend to invest in SPACs based on celebrity opinion, noting that celebrities are just as susceptible to fraud as other investors, encouraging investors to do their research on SPACs before investing.

In 2021, 199 companies used a SPAC to go public, but only 11% of these companies are trading above their initial offering price, as of April 2022. This represents a clear issue for investors, where it can be extremely difficult to determine what is a good investment and what is not.

You can read more about SPACs in our earlier Sunday Read on SPACs.

The Rule Changes

SPACs can be very confusing, and it is not always clear how safe these “blank check companies” are as investments. With the differences in investor protections and liabilities between traditional IPOs and SPACs in mind, the SEC proposed a strict timeline for SPACs and increased underwriter liability. Since SPACs are currently avoiding becoming true ‘investment companies’ under the Investment Company Act of 1940, the SEC’s proposed changes require increased reporting to maintain this status.

Specifically, SPACs would be required to announce a business combination within 18 months of IPO and 24 months to entirely ‘de-SPAC’, completing its IPO. This would clearly define whether a SPAC falls under the jurisdiction of the Investment Company Act, something that is contested in various types of lawsuits.

Additionally, investment banks are not typically involved in the final transition and merging process but could now be financially liable for the presentation of inaccurate projection details. During the de-SPAC process, company projections are included in registration filings, something that is inherently unreliable.

To curb the publication of misleading details, the SEC is proposing disincentivizing underwriters from participating in this step of the transaction, forcing SPACs to continue without these financial advisors. Given that any projection given to the board of the SPAC must be provided in its de-SPAC registration, this would make it more difficult to mislead investors concerning the value of the SPAC.

Public Calls for Transparency:

When the SEC proposes rule changes, there is generally a period for public comment, where anyone can submit a response to the rule changes, helping the SEC determine how to best protect investors and regulate a fair market. These comments are posted on the SEC website, unedited and available for public viewing.

While there is always a mix between individual and professional comments, the SEC uses these measures to gauge public opinions on how the rules would affect both personal interest and market health.

The overwhelming trend in these comments is that greater transparency is needed to support investors and foster a fair and healthy trading environment. Many of these comments commend the SEC for trying to protect investors, but some are concerned that this is not enough. The public wants increased transparency and security in their transactions and investments, but very few solutions are proposed. This is where whistleblowers can be particularly valuable.

The Need for Whistleblowers

Whistleblowers are critical to stability and effective regulation in the securities market. The public greatly benefits from the contributions of whistleblowers and only stands to gain by ensuring that whistleblowers, and whistleblower attorneys, have clear rules and guidelines to follow. The incredible success of the SEC whistleblower program is a testament to the power whistleblowers hold and the value of effective whistleblower protections and incentives.

NWC is continuing to monitor the SEC’s action on SPACs and their efforts to protect investors. Please donate today to support NWC’s mission to champion and advocate for whistleblowers in the financial sector and subscribe to our newsletter to stay up to date on the latest whistleblower news. If you have information regarding fraud or illegal activity, please use our intake form to seek legal advice.

This story was researched and drafted by NWC Intern, Shawn Robbins, a Sophomore double major in Economics and Sociology at University of California, Irvine.