By: Scarlett Keane

SPACs are the hottest IPO tool available for corporations today.[1]  SPACs, or special purpose acquisition vehicles, are shell companies designed to issue an initial public offering before acquiring a target company to bypass much of the regulation in accordance with an IPO for an existing company.[2]  Within a few months of the IPO, SPACs then enter transaction agreements—called “de-SPAC” transactions—with the existing company to establish full ownership and essentially transform into the subsidiary.[3]  The acquired company automatically goes public as a result.[4]  If the money never reaches the intended target, then the money returns to its donors.[5]  SPAC’s origins reach back decades, but its popularity skyrocketed in the last two years after markets became less stable during the COVID-19 pandemic.[6]  According to the SEC, SPACs raised $80 billion in 2020 and over $180 billion in 2021.[7]  SPACs’ appeal even reached Donald Trump, as he recently came under fire for announcing an initiative to raise $1 billion through SPAC donors for an undisclosed purpose.[8]  The SEC did not heavily regulate SPACs’ usage for much of its existence, likely because it was a relatively unpopular method of issuing an IPO.  Once SPAC transactions dominated the majority of IPOs in 2020 and 2021, the SEC took notice.[9]

On March 30, 2022, SEC Commissioner Caroline A. Crenshaw announced that the SEC intended to amend regulations for SPACs to address financial transparency concerns.[10]  The SEC determined that current regulations were insufficient because (1) investors were largely unaware of the risks associated with these shell companies, and (2) they did not require underwriters for de-SPAC transactions.[11]  The Private Securities Litigation Reform Act (PSLRA) grants a safe harbor to de-SPAC transactions, allowing them to occur with immunity when promising their shareholders success through forward-looking statements.[12]  In the traditional IPO sphere, companies may face legal action from shareholders if they do not perform as expected.[13]  The safe harbor blocks this kind of litigation, almost giving SPACs a green light to inflate their projections to potential target companies.[14]  In a dissenting statement, Commissioner Hester M. Peirce argued that the rule change was ill-timed.[15]  She contended that increasing regulation would place unjustified burdens on SPACs simply because regulators are dissatisfied that entities use them to skirt red tape.[16]  Altering the existing rules would require SPACs to hire third parties to conduct fairness assessments, require underwriters for de-SPAC transactions, and enact a safe harbor for SPACs under the Investment Company Act.[17]  Additionally, SPAC shareholders do not often bring claims against the de-SPAC process, but this will likely change with the drastic increase in the number of de-SPAC transactions in the last two years.

According to the American Bar Association, SPAC litigation is rare because plaintiffs typically allege damages for “material misrepresentations or omissions of the facts” in various documentation.[18]  SPAC transactions inherently lack transparency, as the bar to become a public SPAC is much lower than for an established corporation.[19]  SPACs are not just complex, obscure, removed areas of business, though. For example, Lordstown Motors Corporation currently faces a class action suit from stockholders after General Motors closed its Lordstown, Ohio plant in 2019.[20]  The Ohio city lost 1,500 jobs and requested the return of $28 million in state tax breaks for violating a 30-year agreement between Ohio and GM.[21]  After GM pulled its presence, Lordstown Motors sought a new deal manufacturing electric vehicles.[22]  SPAC DiamondPeak Holding Corporation agreed to enter into a deal with Lordstown to morph it into its own manufacturing corporation.[23] After the de-SPAC, DiamondPeak shareholders brought suit against Lordstown Motors for “breach[ing] their fiduciary duties by failing to disclose certain information about…purchase orders and production timeline.”[24]  They also brought claims for failing to exercise redemption rights.[25]  Plaintiffs sought to lift the automatic discovery stay under the PSLRA, but the Delaware Chancery Court denied the motion in an effort to protect the confidentiality of financial documents citing the PSLRA safe harbor provision.[26]  Under the new regulation proposed by the SEC removing the safe harbor from de-SPAC transactions, the Delaware Court would likely have to overturn its stay because the safe harbor would no longer apply.

The opacity of SPAC transactions is precisely why the SEC needs to modernize its regulation.[27]  Information exchange is the only way to protect SPAC investors and corporate boards from entering into misleading deals.[28]  As the use of SPACs drastically increases, and the number of private investors expands, the SEC should make moves toward shifting SPAC transactions toward the same model used for IPOs.

[1] Crystal Tse & Crystal Kim, SPACs were hot in 2020 and are hotter now. Here’s why, Bloomberg (April 23, 2021), https://www.bloomberg.com/professional/blog/spacs-were-hot-in-2020-and-are-hotter-now-heres-why/.

[2] SPACs, Investor.Gov, https://www.investor.gov/introduction-investing/investing-basics/glossary/spacs (last visited Sept. 7, 2022).

[3] See id.

[4] Paul Munter, Financial Reporting and Auditing Considerations of Companies Merging with SPACs, SEC (Mar. 31, 2021), https://www.sec.gov/news/public-statement/munter-spac-20200331.

[5] See id.

[6] See Brian V. Breheny et al., SEC Proposes Significant Changes to Rules Affecting SPACs, Skadden, (Mar. 31, 2022), https://www.skadden.com/insights/publications/2022/03/sec-proposes-significant-changes-to-rules-affecting-spacs; see also Caroline A. Crenshaw, Statement on the SPACs Proposal, SEC (Mar. 30, 2022), https://www.sec.gov/news/statement/crenshaw-spac-20220330; What You Need To Know About SPACs—Updated Investor Bulletin, SEC (May 25, 2021), https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investor-bulletin.

[7] Crenshaw, supra note 6.

[8] Aaron Gregg, Trump SPAC Under Investigation by Financial Regulators, Wash. Post (Dec. 6, 2021, 5:13 PM), https://www.washingtonpost.com/business/2021/12/06/trump-space-sec-investigation/.

[9] Crenshaw, supra note 6.

[10] See id.

[11] See id.

[12] See Crenshaw, supra note 6.

[13] See id.

[14] See id.

[15] Hester M. Peirce, Damning and Deeming: Dissenting Statement on Shell Companies, Projections, and SPACs Proposal, SEC (Mar. 30, 2022), https://www.sec.gov/news/statement/peirce-statement-spac-proposal-033022#_ftn12.

[16] See id.

[17] See id.

[18] Priya Cherian Huskins, Why More SPACs Could Lead to More Litigation (and How to Prepare), American Bar Association (June 25, 2020), https://www.americanbar.org/groups/business_law/publications/blt/2020/07/spacs-litigation/.

[19] See Crenshaw, supra note 6 (noting that shell companies do not have much of a history in terms of operations documents).

[20] In re Lordstown Motors Corp. Stockholders Litig., No. 2021-1066-LWW, 2022 Del. Ch. LEXIS at *46 (Del. Ch. Feb. 28, 2022).

[21] See Adam Gabbat, ‘It’s Devastating’. End of GM in Ohio Town as Trump Fails to Bring Back Midwest Jobs, THE Guardian (Aug. 23, 2029, 2:00 PM), https://www.theguardian.com/business/2019/aug/23/general-motors-factory-ohio-lordstown; see also Ben Popken, Ohio Orders GM to Pay $28 Million For Closing Lordstown Plant, NBC News (Sept. 28, 2020, 8:04 PM), https://www.nbcnews.com/business/autos/ohio-orders-gm-pay-28-million-closing-lordstown-plant-n1241292.

[22] No. 202-1066-LWW, Del. Ch. LEXIS at *3.

[23] See id.

[24] See id at *4.

[25] See id.

[26] See id.

[27] Crenshaw, supra note 6.

[28] See id.