Sunday Read: Understanding SPACs

Wall Street has been abuzz in recent months over the soaring popularity of SPACs — and the Securities and Exchange Commission is paying attention.

While this new investment trend has generated significant media and regulatory scrutiny, especially in light of recent high profile SPAC acquisitions, less attention has been given to how the rise in SPACs might affect potential whistleblowers, which will be the focus of this week’s Sunday Reading.

SPACs, or Special Purpose Acquisition Companies, are essentially shell companies that exist for the sole purpose of finding a private company to merge with. SPACs do not have any commercial operations but are instead used to raise capital through an initial public offering (IPO) that will then be used to acquire a target company. The newly merged company will then be listed on a public stock exchange thereby allowing the target company to become publicly traded through a much quicker and less cumbersome process.

This is because, traditionally, a company seeking to go public must first announce an IPO and then initiate a lengthy process in which it must disclose detailed information about its commercial operations to both regulators and potential investors. This process can take a year or longer. In contrast, by using a SPAC, a company does not need to go through the IPO process. Instead, the SPAC itself conducts the IPO, which is much quicker because, again, it does not have any business operations to disclose and merely consists of a pool of capital. Once the SPAC merges with the private company, the SPAC’s investors will then own stock in the newly formed company rather than simply a shell company.

Once viewed as shady tactic to evade the regulatory requirements of conventional IPOs, SPACs have become extraordinarily popular: in 2010, only two SPACs came to market, whereas, in the first quarter of 2021 alone, a record $96 billion was raised from 295 SPACs. Recent high profile SPAC acquisitions include gaming company DraftKings, space travel company Virgin Galactic, and the shared workspace real estate company WeWork.

So, what does this mean for whistleblowers? Under the Dodd-Frank Act SEC whistleblower program, individuals can receive financial awards for reporting violations of federal securities law to the SEC. Whistleblowers with inside knowledge of wrongdoing can play an especially important role in protecting investors and the public given the ability of SPACs to flout certain regulatory disclosure rules.

SPAC investors can often be lured into investing in SPACs without fully understanding the risks. Indeed, when SPACs are formed, investors typically have no idea what the target company will be, and they often make the decision to invest based on the celebrity of the SPAC sponsor — Shaquille O’Neal, former House Speaker Paul Ryan, and the prominent investor Bill Ackman, for example, have all launched their own SPACs. The SEC even had to issue an “Investor Alert” in response to the rise in celebrity-sponsored SPACs. This creates the potential for fraud and other deceptive tactics that can have serious consequences for investors who are often not given full and accurate disclosures of the terms of SPAC transactions.

A notable example is a SPAC called Digital World Acquisition Corp. (DWAC), which recently announced plans to merge with former President Trump’s social media venture. Trump, who has a history of bankruptcies and loan defaults, likely would have been unable to attract enough investors on his own. Merging with a SPAC therefore provided him a convenient means of raising capital. Yet, DWAC failed to disclose in its filings certain conversations it had with Mr. Trump and, as a result, is now under investigation by the SEC.

The SEC has recently taken a more aggressive stance in regulating SPACs thereby providing an opportunity for whistleblowers to come forward. Over the summer, the SEC brought an enforcement action against a SPAC called Stable Road Acquisition Corp., as well as its sponsor, CEO, and target company. The SEC also initiated an action against automobile company Nikola Corp. in connection with a SPAC transaction in which the former CEO has since been indicted for fraud.

SPAC investors, target company insiders, banks, and market observers can all possess critical inside information of misconduct that could qualify them as whistleblowers. Moreover, SEC Chair Gary Gensler recently announced that the SEC will be adopting new regulations for SPACs early next year. These regulations could provide additional opportunities for whistleblowers to come forward.

NWC will be closely monitoring any further action by the SEC to ensure that whistleblower protections and incentives are fully incorporated. Those with knowledge of securities violations related to SPACs should consult an experienced whistleblower attorney.