SPAC Law and Myths

John C. Coates is the John F. Cogan, Jr. Professor of Law and Economics at Harvard Law School. This post is based on his recent paper.

Special purpose acquisition companies (SPACs) were the financial-legal hit of 2021, before they weren’t. SPACs broke records and displaced to an extent conventional initial public offerings (C-IPOs), even as C-IPOs also boomed.

SPACs spiked, in part, because of myths about their financial attributes, which others have debunked.

(See Michael Klausner, Michael Ohlrogge and Emily Ruan, A Sober Look at SPACs, Yale J. on Reg (forthcoming 2022, discussed on the Forum here); Minmo Gahng, Jay R. Ritter, Donghang Zhang, SPACs (January 29, 2021))

But SPACs also benefited from widespread and persistent circulation of several myths about SPAC law and its uncertainties. SPAC promoters falsely claimed—and continue to claim—that:

  1. securities regulations ban projections from being used in conventional IPOs,
  2. liability related to projections was lower and more certain in SPACs than it was (and is),
  3. the Securities and Exchange Commission (SEC) registration process makes C-IPOs slower than SPACs,
  4. the SEC changed SPAC accounting rules in early 2021,
  5. this “change” was the sole or primary reason the SPAC wave slowed, and
  6. the Investment Company Act clearly does not apply to SPACs.

In a paper available here, each of these myths is shown to be false.

Internally inconsistent sub-myths also continue to circulate: for example, some continue to assert, on the one hand, the SEC accounting “change” (which in fact was not a change) slowed SPACs down, yet, on the other hand, no one in the market thought it was important, even as most companies restated their financials, which is only required for material misstatements. And on the third hand, the same promoters are forced by reality to admit that SPAC activity did not resume at anything like the early 2021 levels after the calculations and reporting for what SPAC promoters claim were immaterial restatements took place—a process that at most took a few weeks for most SPACs.

Consistent with these claims being myths, de-SPACs from 2021 are experiencing significant levels of litigation—even higher than in conventional IPOs, which experience more litigation than normal for mature public companies. SPAC litigation includes pending lawsuits in Delaware and many federal courts, challenging the fairness of de-SPACs under corporate law, the completeness and accuracy of SPAC disclosure under securities law, and their status under the Investment Company Act. Numerous important legal issues about SPACs remain uncertain in the U.S., even as poor average de-SPAC performance has led to increased redemptions, broken and repriced de-SPACs, and a much lower level of overall SPAC activity from April 2021 through today.

These legal myths were aimed primarily not at unsophisticated retail investors, but business journalists, sophisticated SPAC sponsors and owner-managers of SPAC targets. They illustrate a broader and underappreciated fact that complex financial-legal innovation permits promoters to exploit the “credence good” character of professional advice, perpetuate a type of deep or indirect deception not addressed by fraud law, and distort markets and asset prices more and longer than conventional theory assumes. To moderate these market distortions, regulators have a role in speaking frequently and clearly about law and its uncertainties, at least when a product achieves the market importance achieved by SPACs in late 2020 and early 2021. Speaking clearly about their legal uncertainties is a role for regulators that is separate from addressing concerns about celebrity sponsors, and from considering potential rule changes for disclosures about conflicts and divergences of interest, about their costs and risks, about the massive turnover of investors around the de-SPAC, and about their expected financial performance, as well as who should count as an underwriter of a de-SPAC.

SPACs—along with direct listings and auction-based IPOs—might play a potentially useful role in providing private companies with an alternative path to going public. C-IPOs continue to function in practice with underwriters playing a strong and potentially conflicted gate-keeping role. By linking entrepreneurial financial service providers with the dedicated capital assembled or available to sponsors, SPACs disintermediate the issuer-underwriter-investor relationship, possibly enhancing competition for the primary capital formation and listing process for the subset of private businesses that are both ready and interested in a listing. SPACs may allow for better matching and sorting among potential managers, board members, anchor investors (who commonly enter via private investments in public equity or PIPEs), and private businesses. If these potential virtues make SPACs worth considering, however, they should be separated from mythical claims that they allow for regulatory arbitrage or which attribute their success or failure to over- or under-regulation. Ultimately SPAC market participants themselves would be better off dropping the legal nonsense and emphasizing the economic reality of what might make the product a good one.

The complete paper is available for download here.

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