Key Points

• Between September 2020 and March 2021, at least 35 SPACs have been hit with one or more shareholder lawsuits filed in New York state court.
• These lawsuits generally allege that SPAC directors breached their fiduciary duties to shareholders by providing allegedly inadequate disclosures regarding proposed de-SPAC mergers. Some of these lawsuits also assert claims against the SPAC itself, as well as the target company and its board of directors, for allegedly aiding and abetting the SPAC directors’ breaches.
• Although these cases are in their early stages and assert claims that are limited in scope, they signify that the plaintiffs’ bar is actively monitoring and pursuing SPACs. As additional de-SPAC transactions are announced and close, SPAC shareholder lawsuits are likely to multiply, potentially subjecting SPACs, their boards and sponsors to more significant civil risk and exposure.

For months, lawyers and industry experts have been expecting a surge of litigation and regulatory proceedings related to publicly traded special purpose acquisition companies (SPACs). Thus far, litigation and regulatory enforcement activity in the SPAC space has been relatively infrequent. However, recent activity in New York state court evidences that the wave is beginning.

(more…)

Last week, John Coates, the Acting Director of the SEC’s Division of Corporation Finance (“Corp Fin”), released a statement discussing liability risks in de-SPAC transactions.

The statement focused in particular on the concern that companies may be providing overly optimistic projections in their de-SPAC disclosures, in part based on the assumption that such disclosures are protected by a statutory safe harbor for forward-looking statements (which is not available for traditional IPOs). Director Coates’s statement questions whether that assumption is correct, arguing that de-SPAC transactions may be considered IPOs for the purposes of the statute (and thus fall outside the protection offered by the statutory safe harbor). He therefore encourages SPACs to exercise caution in disclosing projections, including by not withholding unfavorable projections while disclosing more favorable projections.

The statement has received considerable media attention and is plainly part of a broader effort by the Commission staff to identify potential securities law and policy concerns with the growing SPAC market. In addition to statements by staff in the Division of Corporation Finance, the effort includes:

(more…)

Introduction

Not far behind the dramatic increase in the use of special purpose acquisition companies (SPACs) is a corresponding increase in the number of shareholder lawsuits and increased activity at the US Securities and Exchange Commission (SEC). In recent days, Reuters reported that the SEC opened an inquiry seeking information on how underwriters are managing the risks involved in SPACs, [1] and the SEC’s Division of Corporation Finance (Corp Fin) and acting chief accountant have issued two separate public statements on certain accounting, financial reporting and governance issues that should be considered in connection with SPAC-related mergers. [2] This increase in activity by SEC staff comes on the heels of nearly two dozen federal securities class action filings, several SEC investor alerts and earlier guidance from Corp Fin. [3] The surge in litigation and regulatory interest is likely to continue and expand throughout 2021 and beyond.

In Depth

A SPAC is a company with no operations that raises funds from public investors through an initial public offering (IPO). The proceeds from the IPO are placed in a trust or escrow account for future use in the acquisition of one or more companies. A SPAC will typically have a two-year period to identify and complete a business transaction. If the SPAC fails to do so during the specified period, then it must return the funds in the account to its public shareholders on a pro rata basis and then dissolve.

(more…)

Over the past six months, the U.S. securities markets have seen an unprecedented surge in the use and popularity of Special Purpose Acquisition Companies (or SPACs). [1] [2] Shareholder advocates—as well as business journalists and legal and banking practitioners, and even SPAC enthusiasts themselves [3]—are sounding alarms about the surge. Concerns include risks from fees, conflicts, and sponsor compensation, from celebrity sponsorship and the potential for retail participation drawn by baseless hype, and the sheer amount of capital pouring into the SPACs, each of which is designed to hunt for a private target to take public. [4] With the unprecedented surge has come unprecedented scrutiny, and new issues with both standard and innovative SPAC structures keep surfacing.

The staff at the Securities and Exchange Commission are continuing to look carefully at filings and disclosures by SPACs and their private targets. As customary, and in keeping with the Division of Corporation Finance’s ordinary practices, staff are reviewing these filings, seeking clearer disclosure, and providing guidance to registrants and the public. They will continue to be vigilant about SPAC and private target disclosure so that the public can make informed investment and voting decisions about these transactions.

(more…)

I am very grateful to Mr. Evans for his thoughtful reply to my prior post on the Forum. His reply raises important interpretive issues that I hope that the SEC and FINRA will directly address.

In connection with U.S. initial public offerings (IPOs), underwriters usually trade in the issuer’s stock for their own principal accounts, including by short selling the issuer’s stock and by exercising a green shoe option. I have argued that applicable U.S. law permits underwriters, subject to certain compliance measures, to monetize the value of their principal trading positions.

Mr. Evans’s reply post makes the empirical claim that underwriters do not use the green shoe option to profit from IPO stock pops. Mr. Evans asserts this empirical claim on the basis of deductive logic. According to Mr. Evans, Regulation M permits underwriters to pick one and only one of the following two activities: (1) making a market in an issuer’s stock as soon as exchange trading begins, and (2) profiting from IPO stock pops. Since we observe underwriters making markets once exchange trading begins, Mr. Evans concludes, underwriters do not use green shoe options to profit from IPO stock pops.

(more…)

The combination of record-level SPAC issuance and a flood of non-SPAC M&A has created a supply-demand imbalance in the event-driven asset class. With SPACs garnering most of the limelight, we believe investors are missing an excellent opportunity to deploy capital into “other” event-driven investments, most prominently merger arbitrage.

A Wild Year

It’s certainly been an interesting 12 months in the event-driven asset class. From soft catalyst event situations upended by the onset of COVID in Q1 2020, to the March 2020 “Arbageddon” widening in merger arbitrage spreads, to countless instances of hedge fund repositioning causing atypical volatility in typically boring share class arbitrage. It’s been a truly wild ride.
The combination of Q1 2020 performance challenges for the asset class and slow-to-recover new merger volume last spring and summer led to the perception that there was “nothing to do” in event-driven. The record issuance of SPACs in 2020 and early 2021, accompanied by some high-profile bouts of outperformance in former SPACs like Nikola, amended that narrative slightly. Recent commentary has been willing to stipulate that there was nothing to do in event-driven, apart from SPACs.

The Current Opportunity

As experienced event-driven investors, we’ve often chafed at the notion that event-driven’s attractiveness waxes and wanes as much as commentators would suggest. Indeed, our team mantra is “there’s almost always something to do,” and our historical results have supported this claim’s veracity.

(more…)

Over the past two decades, academic research has found little evidence that gender diversity on the boards of directors has a positive impact on firm value. In recent years, however, practitioners have increasingly argued that diversity among the board of directors has a positive economic impact on firms. In January 2020, the Nasdaq Stock Market filed a proposal with the Securities and Exchange Commission to adopt Rule 5605(f) (Diverse Board Representation) which argued for mandatory diversity on boards of firms listed on NASDAQ, based on economic arguments that diverse boards were positively associated with improved corporate governance and financial performance. In the same month, Goldman Sachs announced it would stop financing the Initial Public Offerings (IPOs) of companies in the U.S. and Europe with only white male board members again on the basis of superior performance by firms with gender-diverse boards.

In our paper Are Women Underpriced? Board Diversity and IPO Performance, we examine the economic impact of gender diversity on the performance of IPOs from 2000–2018. IPOs are an appropriate venue to study the effect of shareholder preferences on gender diversity because it is the only type of corporate transaction where investors can express their opinions about company valuation. Specifically, the book-building process provides a unique opportunity for investors to give feedback on the valuation range proposed by the investment bank. Investors can show that they value stocks differently from traditional valuation methods, such as discounted cash flows and earnings multiples, by incorporating a premium for diversity, for example. Because the underpricing of IPO shares reflects the difference between market valuations and the valuations by the investment bank, such a premium can be measured directly. There is no other event where this is empirically feasible. In addition, investment banks have an outsized impact on the terms of the offering and the structure of the firm. For example, the insistence by Goldman Sachs that it would not consider taking public a firm that did not have a gender-diverse board is unique. Investors can invest in any type of publicly listed firm, such as “sin stock” firms, depending on their preferences. However, if a non-gender-diverse firm is unable to go public, investors are necessarily constrained in expressing their preferences. Finally, IPO underpricing is likely to be less subject to the endogeneity problems that plague many studies that find a positive relation between gender diversity and stock market or operating performance. Indeed, it is not obvious whether diversity causes performance or vice versa. On the other hand, it is implausible that underpricing encourages firms to put women on the board.

(more…)

Introduction

2020 marked an incredible surge in the prevalence of Special Purpose Acquisition Company (“SPAC”) initial public offerings and business combinations (“deSPAC transactions”). In 2020, there were 248 SPAC IPOs (raising total gross proceeds of over $83 billion) and 66 deSPAC transactions, as compared with 2019’s 59 SPAC IPOs (raising approximately $13.6 billion in gross proceeds) and 28 deSPAC transactions. [1] And the pace continues to skyrocket in 2021 with 160 SPAC IPOs in the first two months of the year and 13 completed deSPAC transactions. [2] This spectacular rise, and the related profits, has unsurprisingly garnered attention from both the United States Securities and Exchange Commission (“SEC”) and plaintiffs’ law firms. Most recently, the SEC’s Division of Corporation Finance released guidance [3] (the “SEC’s SPAC Guidance”) concerning disclosure obligations for SPAC IPOs and deSPAC transactions, highlighting many process and disclosure-related issues that plaintiffs’ lawyers typically raise and have focused on in recent SPAC lawsuits. As we anticipate that plaintiffs’ firms will continue to hone in on SPAC-related litigation in 2021 (likely using the SEC’s SPAC Guidance as its new and more tailored playbook), SPAC sponsors, their boards of directors, and the directors and officers of acquisition targets should all be focused on key steps to limit litigation risks and minimize costs associated with these risks.

Disclosure-Based Claims and the SEC’s SPAC Guidance

Given that SPAC transactions have not historically been the subject of significant litigation, particularly as compared to traditional IPOs and public-to-public M&A transactions, plaintiffs’ firms played catch-up in this area during 2020, largely recycling their traditional M&A playbook. Accordingly, following the filing of the initial Form S-4 in connection with the deSPAC transaction, plaintiffs’ firms have alleged disclosure-based claims under Section 14(a) of the Exchange Act, claiming that the proxy statements issued are deficient due to the failure to disclose financial projections for the SPAC entity, immaterial details relating to negotiations or pursuit of other potential acquisition targets, reasoning for not hiring a financial advisor, or financial analyses that the SPAC board considered. See Wheby v. Greenland Acquisition Corp., C.A. No. 1:19-cv-01758 (D. Del. Sept. 19, 2019) (basing Section 14(a) action on alleged failure to make disclosures related to line items and reconciliations underlying financial statements, the target’s financial projections, terms of a non-disclosure agreements and letters of intent with potential targets, the basis for not hiring a financial advisor, and communications regarding future employment of the SPAC sponsors). More recently, however, plaintiffs’ firms are couching such pre-closing disclosure-based claims as breach of fiduciary duty claims, often filing in New York state courts, and are honing in on the unique aspects of SPACs and deSPAC transactions.

(more…)

Professor Corrigan offers a new theory about why some IPO stocks pop and others suffer steep drops—underwriters are to blame. His “principal trading theory” maintains that, contrary to accepted wisdom, overallotments and green shoe options in IPOs are used to maximize trading payoffs for underwriters. His theory is wrong. Matt Levine, in his Bloomberg column, Money Stuff, agrees.

As a matter of market practices and because of the SEC’s Regulation M, underwriters must complete their sales, including overallotments, before the IPO stock starts trading in the market. They cannot, for these reasons, hold back and sell more shares at higher prices in the aftermarket.

Establishing a new and vibrant trading market where one never existed is a challenging task. The investors that a company doing an IPO and its underwriters seek as shareholders have lots of competing ways to invest their money. Even in the same industry as the IPO company, there are competitors with established trading markets a track record of being a public reporting company.

Transforming a privately-held venture into a NYSE- or Nasdaq-traded company involves considerable art as well as science. Underwriters are asking the investors to take on some of the risk of that launch into the unknown of public trading. The dynamics of supply and demand for the shares can influence the success or failure of the company’s entering into the public markets.

(more…)

In academic and public commentary, entrepreneurial finance is usually portrayed as a quintessential American success story, an institutional structure whereby expert venture capitalists with strong reputational incentives channel much-needed equity to deserving entrepreneurs, then subject them to intense monitoring to assure they stay on the path to hoped-for success in the form of an initial public offering or public company acquisition. Yet, in recent years there have been gross embarrassments and allegations of outright criminality, at companies like Uber, Theranos, and the subject of our paper, WeWork. In short, we argue, fiduciary deficits and rent-seeking behaviors abound and the costs are borne not just by the venture capitalists or other investors.

Although we do not quarrel with the historical record of success, we are focused on the changes in the market for start-up capital that may well have contributed to the recent bouts of rent-seeking and extreme. Indeed, our title’s reference to corporate adolescence underscores the ever-lengthening period of time that high-tech start-up companies have before undergoing the so-called rites of passage to public adulthood. We argue that the private privileges allow for a build-up of bad choices and testy behaviors commonly observed in human adolescents, e.g., risk-taking and rule-breaking, thereby embedding in the firm’s habits and culture problems that may later be hard to fix.

(more…)

Last year, in particular the second half of the year, saw a vibrant market for initial public offerings (“IPOs”) of special purpose acquisition companies (“SPACs”). Coming out of this surge in SPAC offerings, the Division of Corporation Finance of the Securities and Exchange Commission (the “Staff”) published new disclosure guidance on December 22, 2020. [1] With the publication of this guidance, the Staff sought to remind SPAC sponsors, underwriters and other market participants of key concerns they have noted in their comment letters for SPAC filings in connection with IPOs and business combination transactions.

This guidance is particularly focused on the potential conflict of interest between a SPAC’s public shareholders, on the one hand, and a SPAC’s sponsor, directors, officers and their affiliates (the “insiders”), on the other hand. The insiders’ economic interests in the SPAC often differ from the economic interests of public shareholders in a number of important ways. As the Staff notes, this difference may lead to conflicts of interest, in particular as the insiders evaluate potential targets for the SPAC’s initial business combination.

The Staff notes that, unlike in the traditional IPO process where a private operating company’s securities are valued through market-based price discovery, the SPAC insiders are solely responsible for deciding how to value potential targets. While this is often cited as a reason why SPACs provide greater certainty for private companies considering a traditional IPO, the Staff points out that this can lead to potential conflicts of interest and risks for the public shareholders of the SPAC. Therefore, the Staff repeatedly emphasizes the importance of clear disclosure regarding these potential conflicts of interest and the nature of the insiders’ economic interests in the SPAC.

(more…)

In April 2020, the NYSE initially adopted, and the SEC approved, a temporary waiver (“NYSE Waiver”) of certain NYSE stockholder approval rules set forth in Section 312.03 of the NYSE Listed Company Manual (“NYSE Manual”) in order to lessen the hurdles companies face when seeking to raise capital, as many needed to do during the COVID-19 pandemic. [1]

After a series of extensions of the NYSE Waiver (the latest through March 31, 2021), the NYSE is proposing to officially amend Section 312.03 of the NYSE Manual. The proposed rule change will now go through a notice and comment period, but, if adopted, will make permanent the following.

Rule 312.03(b) — The Related Party Stockholder Approval Rule, as amended, would:

(more…)

Shortly before the end of his tenure as Chair of the Securities and Exchange Commission (SEC), Chair Jay Clayton presided over the SEC as it considered and approved the New York Stock Exchange’s (NYSE) proposed rule change modifying the NYSE’s rules in order to permit, as described below, primary issuances in connection with a direct listing of a class of the issuer’s equity securities on the exchange. As summarized in the timeline, the SEC’s consideration of the NYSE’s proposed rule change and the proposed rule change includes a number of twists and turns.

NYSE Proposal Approval Timeline

(more…)

Initial public offerings (IPOs) are set to rocket out of the gates again in 2021. Recently, we have witnessed some big pops (for example, Airbnb, 113 percent first-day return) and some steep drops (Wish, negative 16 percent).

With all this pricing variability following IPOs, what role is underwriter price stabilization playing? Relatedly, what role do overallotments and green shoe options play?

Overallotments are sales by the underwriting syndicate in excess of the number of shares the syndicate is obligated to purchase to underwrite the offering. A green shoe option is the right of the underwriters to purchase an amount of shares in addition to and at the same price as the base shares in the IPO.

Leading academic theories claim that underwriters use overallotments and green shoe options to help stabilize an issuer’s stock price following an IPO.

(more…)

Emerging companies have historically been backed by venture capital funds, but as Europe’s startup scene matures, involvement by more traditional private equity investors is growing, particularly in the tech, consumer, and digital health sectors. The number of PE investments in emerging companies has increased year on year, with investments in companies such as Wolt, Moonbug Entertainment, Zwift, Klarna, Epic Games, and Oatly demonstrating the range of opportunities available to PE sponsors in this space. While PE investors are increasingly familiar with VC deal dynamics, they are also pushing to align growth-deal terms more closely with traditional buyout concepts.

Relinquishing Control

Investors typically invest in a growth company as a minority investor at the top of a stack of existing institutional investors, meaning they are unable to exert the level of control usually seen in buyout deals. One board seat and a limited set of reserved matters are likely to be the limits of their influence. Alignment with fellow investors is therefore an important dynamic, and something that we are seeing deal teams consider at the outset of the transaction.

(more…)

Special Purpose Acquisition Companies (SPACs) have exploded in popularity. These so-called “blank check” companies are used as vehicles to take companies public without going through a traditional IPO process. In the life cycle of a SPAC, a management team forms a new public company (the SPAC) for the express purpose of identifying and acquiring an existing (but unspecified) private operating company and the SPAC sells shares of stock in the SPAC to the public (the SPAC IPO). Later, the SPAC’s management team identifies a private operating company for acquisition and then merges the target and the SPAC to create a continuing public entity that is the successor to the target’s business (the de-SPAC transaction). The year 2019 saw a record $13.6 billion raised across 59 SPAC IPOs. In 2020 through December 14, the value of SPAC investments has more than quintupled with $77.5 billion raised across 230 IPOs.

Although SPAC-related litigation has been relatively infrequent to date, that is likely to change given 2020’s explosion in SPAC IPOs. Tellingly, the price of D&O insurance for SPACs has reportedly nearly doubled in recent months, with insurers reducing their maximum exposure limits from $10 million to $5 million but continuing to charge similar premiums. In this climate, SPAC sponsors, investors and targets should be mindful of litigation risks presented by the SPAC process. In particular, any litigation filed after the de-SPAC transaction is complete will almost inevitably embroil all three of these constituencies and could prove a significant distraction to the continuing public entity that is the successor to the target’s business. Risks include litigation based on: (1) SPAC IPO registration statements; (2) de-SPAC proxy statements; (3) potential de-SPAC registration statements; (4) financial projections—which significantly distinguish SPAC disclosures from those made in traditional IPOS; (5) redemption of SPAC shares; (6) de-SPAC deadlines; and (7) post-SPAC public status.

(more…)

Today [Dec. 23, 2020], the Commission approved a new listing rule from the New York Stock Exchange (“NYSE”) which fundamentally shifts how companies can access the public markets. [1] The new listing standard will allow primary direct listings of companies seeking to go public and, importantly, raise capital outside of the traditional initial public offering (“IPO”) process. [2] NYSE’s proposal represents what could have been a promising and innovative experiment. Unfortunately, the rule fails to address very real concerns regarding protections for investors. As a result, we are unable to support this specific approach. [3]

Before delving into the specifics, we believe it is important to acknowledge that the current IPO process is far from perfect. Among other things, the structure often imposes relatively high fees on issuers. Market participants and the Commission should continue to explore ways to innovate and modernize the IPO process, but it need not be at the expense of fundamental investor protections.

(more…)

Alibaba Group Holding Limited (Alibaba), which in 2014 conducted a record-breaking initial public offering (IPO) on the New York Stock Exchange and in mid-2020 was valued at over $500 billion, is based in China but is subject to U.S. securities law and to Cayman Islands corporate law. It is one of hundreds of U.S.-listed firms that are based in China but subject only to the securities and corporate laws of other jurisdictions. In a paper recently posted on SSRN, China and the Rise of Law-Proof Insiders, we show that this arrangement renders the insiders of these firms law-proof. As a result, the law cannot prevent or deter them from expropriating substantial value from U.S. investors.

The main problem, we show, is that almost every person or thing required to enforce the law—the insiders, the insiders’ assets, the firms’ records, and the firms’ assets—is behind China’s “Great Legal Wall” and out of reach both for private plaintiffs and for public prosecutors in the United States. China cannot be expected to extradite defendants, enforce foreign judgments, allow foreigners to file claims in its courts, or even permit litigation-critical information to be shared with foreign authorities or plaintiffs’ lawyers. Enforcement is even harder when, as is typically the case for large Chinese technology companies like Alibaba, the firm domiciles in the Cayman Islands rather than in the United States. And the problem is not merely hypothetical. China-based insiders of China-based firms have expropriated billions of dollars from U.S. investors, making clear both the imperviousness of China’s Great Legal Wall and insiders’ willingness to exploit it.

(more…)

Special purpose acquisition companies (“SPACs”) grabbed the investment spotlight this year and remain among the most active investment classes in the market. While the SPAC model has evolved over the better part of the past two decades, SPACs have recently enjoyed an unprecedented surge in popularity as a result of a number of high-profile SPAC launches and subsequent business combinations. In this year alone, as of Oct. 9, 2020, there have been 138 SPAC initial public offerings (“IPOs”) yielding $53.6 billion in gross proceeds—a record haul for new SPAC launches. [1] To put these numbers in proper perspective, from 2004 to 2018, approximately $49.1 billion was raised across 332 SPAC IPOs in the United States. [2]

Overview

Both the aggregate IPO proceeds raised, as well as the average SPAC IPO size, have jumped considerably in 2020. Not surprisingly, that type of success breeds imitation, and interest in prospective new SPAC IPOs remains relatively high. However, based on feedback we have received, demand for new SPAC IPOs appears to have tightened in recent weeks, potentially as a result of the large amount of IPO proceeds already raised in 2020. Accordingly, prospective sponsors may face increasing pressure to differentiate their proposed SPACs from other recent or proposed offerings. In contrast, we expect that potential SPAC investors may see increasingly attractive investment opportunities as the SPAC IPO market further tightens and sponsors become more flexible on terms. To that end, we have already seen movement towards incentivizing larger IPO investors through various economic incentives, including through access to sponsor-level economics.

(more…)

Special purpose acquisition companies (SPACs) have seen a surge in 2020. There have been several high-profile private companies, such as DraftKings and Nikola, going public by completing business combinations with SPACs and high-profile investment firms, such as Bill Ackman’s Pershing Square (for the second time) and Jeff Smith’s Starboard Value, sponsoring SPACs of their own.

A SPAC is a public shell company formed for the purpose of completing a business combination within a specified period of time with a private operating company. Combining with an already public shell allows the private company to essentially complete an IPO with an intact public shareholder base at a lower cost than a traditional IPO. It can also provide greater deal certainty in uncertain times.

(more…)