- An advisory panel to the Securities and Exchange Commission (SEC) released a draft recommendation that the agency step up regulation of special purpose acquisition companies (SPACs) by mandating tougher standards for disclosure.
- The SEC’s Investor Advisory Committee, created under the Dodd-Frank Act, released an eight-page document urging the agency to “regulate SPACs more intensively by exercising enhanced focus and stricter enforcement of existing disclosure rules.”
- “SPACs by their very nature are rife with conflicts of interest which must be disclosed to potential investors,” according to the panel’s draft recommendation. “Even when those conflicts are disclosed, their import may not be clear to an unsophisticated investor.” The committee plans to consider the non-binding recommendation on Sept. 9.
SEC chair Gary Gensler in May flagged risks to investors posed by SPACs and said the agency will investigate how the shell companies raise cash from the public and merge with target companies.
The SEC’s corporate finance, examinations and enforcement divisions will “be closely looking at each stage to ensure that investors are being protected,” Gensler said in testimony to the House subcommittee on financial services and general government. “Each new issuer that enters the public markets presents a potential risk for fraud or other violations.”
A SPAC — or what Gensler called a “blank-check” initial public offering (IPO) — offers private companies a quicker, cheaper alternative to traditional IPOs. A SPAC raises money by selling shares, which it lists on a stock exchange. It then merges with a private company.
SPAC IPOs accounted for more than half of $67 billion in IPO capital raised in the U.S. last year, the advisory committee said, citing Goldman Sachs data. During the first quarter of 2021, SPACs raised $87 billion of $125 billion in total IPO financing.
The SEC slowed the SPAC market in April when staff accountants released a memo saying that warrants attached to SPAC shares should be treated as liabilities rather than as equity.
In order to comply with the new guidance, sponsors need to hire accountants and auditors to value the warrants each quarter using a complex calculation. When treating warrants as equity, sponsors make a simpler, up-front calculation.
Based on the draft document, the advisory committee would recommend SPACs be required to:
- describe the role of its sponsor (including “insiders or affiliates such as celebrity sponsors/advisors”), their “expertise and capital contributions,” and any potential conflicts of interest, according to the advisory committee’s draft document;
- enable investors to gauge risks by providing “plain English” disclosure about stages in the SPAC process, including the “promote” to be paid to sponsors and the impact on dilution of shares and;
- detail “the mechanics and timeline of the SPAC process,” including a description of the asset to be purchased, events required during the next two years for the asset to appreciate and the shareholder approval process at the time of de-SPAC.
The committee is also weighing whether the SEC should require disclosure by SPACs on the terms for raising any additional funding, the “competitive pressures and risks” in finding and pricing appropriate targets, and “the minimum pre-de-SPAC diligence the sponsor will commit” in reviewing a target company’s accounting practices.
The SPAC structure poses hazards to investors while benefiting sponsors and target companies, according to the advisory committee.
Sponsors “can raise money rapidly without having to deal with company preparation or company specific disclosure at the time of the IPO,” while target companies enjoy “a fast, certain route to liquidity without the delay, pricing risk, and market-condition risk associated with the typical IPO process,” the committee said.
“The separation in time between the IPO disclosure and the company specific disclosure means that investors do not learn what they are investing in until after the fact,” the panel said. “Their invested funds are tied up for a period of time while the investors rely on the sponsors to find an appropriate target.
“Furthermore, the transactions by their very nature are complex and have some misalignments between the initial investors, sponsors, investors in the target and any intermediate financiers joining the de-SPAC transaction,” according to the panel.
While detailing eight ways to strengthen disclosure requirements, the draft also calls on the SEC to advance the public interest and “promote investor protection” by providing “an analysis of the players in the various SPAC stages, their compensation and their incentives.”
The advisory committee includes representatives from retail and institutional investors, including those who reflect the interests of mutual funds, pension funds and investment companies. It also includes an advocate for senior citizens and a representative from state securities commissions.