A Primer on the (Not So) Special Purpose Acquisition Company Boom

Posted on by Kevin Maedomari

Despite the unprecedented nature of 2020 and the challenges brought by the COVID-19 pandemic, Special Purpose Acquisition Companies (“SPACs”) cemented their place in, and return to, the world of finance. SPAC initial public offerings (“IPOs”) erupted in 2020, with greater average size and overall frequency. In 2020, SPAC IPOs raised over US$89 billion in gross proceeds,1 and increased in number from 59 SPAC IPOs in 2019 to 248 SPAC IPOs in 2020.2 This spectacular pace has continued and accelerated into 2021, with SPAC IPOs already raising US$97 billion in gross proceeds across 297 IPOs in just the first three months of the calendar year.3

The SPAC Briefly Explained

A SPAC is a “type of blank check company . . .  created specifically to pool funds in order to finance a merger or acquisition within a set timeframe,” though the particular M&A opportunity or target usually has not been identified at the SPAC’s inception.4 Effectively, SPACs have no commercial operations and are sponsored by institutional investors (the “Sponsors”) who, through an IPO, raise and store capital from outside investors in an interest-bearing trust account for the sole purpose of acquiring an existing, private company.5

SPACs generally have 18-24 months to find a suitable target company and complete the merger or acquisition of the company (the “de-SPAC transaction”).6 When the Sponsors find a potential target company to merge with or acquire during the stipulated timeframe delineated in the SPAC’s governing documents, the Sponsors must get the SPAC’s shareholder approval. Assuming there is SPAC shareholder approval, the de-SPAC transaction closes, resulting in a public entity.7

If the SPAC fails to find an appropriate target company and subsequently fails to execute a de-SPAC transaction within the stipulated timeframe, the SPAC is liquidated.8 The public shareholders then get their pro-rata share of invested capital from the SPAC’s interest-bearing trust account returned.9 

Why are de-SPAC transactions so popular?

One major reason why the number of SPAC transactions exploded in 2020 was the “economic dislocations caused by” COVID-19.10 But the overarching reason for the growing popularity of SPACs is that a company going public through a de-SPAC transaction saves time relative to following the traditional IPO path.11 The target company of a SPAC can directly negotiate with the Sponsors with respect to its valuation, rather than roll the dice on the volatile IPO market, where pricing remains uncertain until the night before the company goes public.12

SEC Scrutiny and Predictive Increase in SPAC-Related Litigation

The SEC has unsurprisingly taken notice of the exponential growth in SPAC activity. On December 10, 2020, the SEC’s Office of Investor Education and Advocacy issued an investor alert, providing the SEC’s guidance on investing in SPACs.13 On December 22, 2020, the SEC’s Division of Corporate Finance issued guidance regarding the disclosure obligations for SPAC IPOs and de-SPAC transactions, as well as the process and disclosure-related issues involved in recent SPAC-related litigation.14 Though SPAC-related litigation has been relatively scarce to date, one can expect a commensurate boom in SPAC-related shareholder litigation given the current SPAC IPO climate. SPAC-related litigation primarily involves claims of two broad categories: disclosure-based and conflict-of-interest-based.

Disclosure-Based Claims

Disclosure-based claims can come at two distinct periods with respect to a de-SPAC transaction – pre-closing and post-closing. I address claims during these periods in turn.

Pre-closing claims

With respect to the pre-closing period of a de-SPAC transaction, shareholder suits may be brought under Section 14(a) and Rule 14a-9 of the Securities Exchange Act of 1934 for deficient proxy statements issued in connection with a SPAC’s acquisition or merger of its target operating company.15 Illustrative of these types of suits is Wheby v. Greenland Acquisition Corp., which involves an investor’s allegation that the SPAC’s proxy statement was materially false or misleading in that it failed to make disclosures related to line items and reconciliations underlying financial statements, among a myriad of other claims.16

However, within a week of the Wheby complaint, the SPAC at issue amended its preliminary proxy statement – making the plaintiff’s claims moot – and subsequently resulted in the investor voluntarily dismissing the complaint.17 One should not be surprised to see a commensurate rise in pre-closing claims regarding deficient proxy statement disclosures along with the sharp increase in de-SPAC transactions that are occurring. Furthermore, SPACs can expect Wheby­-like actions to be brought by disgruntled shareholders should they fail to sufficiently produce materially complete and accurate proxy statements to its investors during the pre-closing stages of a de-SPAC transaction. It is important to note however, that Wheby-like claims will likely either be dismissed for mootness or probably settle before going to trial, like most suits. 

Post-closing claims

It is not surprising that the recent eruption in SPAC popularity has attracted the attention of short sellers.18 The underlying premise of short selling traditional investment vehicles (e.g., stocks) applies equally in the context of de-SPAC transactions. SPACs are shell companies however and are therefore subject to minimal disclosure requirements relative to companies that pursues the traditional IPO route. As such, public investors of SPACs do not have the relative luxury of information. Therefore, when short-seller, investigative investment firms bring to light new, undisclosed information in the post-closing period of a de-SPAC transaction, the negative effect on the newly public company’s market valuation is significant relative to the effect that such newly disclosed information would have with respect to a company offering a traditional IPO. Consequently, an increasing number of post-closing claims by disgruntled shareholders have been brought before the courts due to sub-par performances of newly public companies relative to the optimistic projections made in SEC filings with respect to the de-SPAC transaction.19

One of the most notable cases to date involving post-closing disclosure-based claims is Nikola Corporation. Nikola Corporation is a zero-emissions vehicle company that went public in June 2020 after it merged through a de-SPAC transaction with VectoIQ Acquisition Corp.20 VectoIQ Acquisition Corp. is a SPAC formed by former General Motors executives looking to break into the smart transportation sector. Nikola’s market capitalization “doubled on itself and continued to climb” to $34 billion during the week after the de-SPAC transaction closing.21

Just two days after Nikola entered into a strategic partnership with General Motors, Hindenburg Research (a short-seller, investigative investment firm) released an extensive report declaring the firm “believe[d] Nikola [was] an intricate fraud built on dozens of lies over the course of its Founder and Executive Chairman Trevor Milton’s career.”22

Soon after the detailed Hindenburg Research report was published, a litany of lawsuits ensued against VectoIQ for materially false and misleading statements under Section 10(b) and Rule 10b-5 of the Exchange Act.23 The allegations stem from the assertion that Nikola overstated its capabilities, and that VectoIQ had falsely stated that it performed significant, wide-spread due diligence when choosing Nikola as its target company.24

Today, Nikola’s stock continues to plummet, and the public company has “incurred significant expenses as a result of regulatory and legal matters,” amounting to over $27.5 million last year, all relating to the Hindenburg Research report.25

The Nikola case is ongoing, but the case highlights the significance of performing vigorous due diligence with respect to any de-SPAC transaction that SPACs may pursue. Further, detailed disclosures, as discussed with respect to pre-closing claims above, are highly recommended to mitigate Nikola-like litigation risks. SPACs are now on notice and better take care to ensure accurate and detailed disclosures are made and proper due diligence is carried out going forward.26  

Conflict of Interest-Based Claims

The second broad class of claims that arise in SPAC litigation are conflict of interest-based claims. When a company pursues a traditional IPO, the required registration statements and prospectus for the IPO almost never include financial projections with respect to the company’s performance once the company goes public.27 The primary rationale for this is that the safe harbor provision for forward-looking statements in the Private Securities Litigation Reform Act of 1995 (the “PSLRA”) does “not apply to a forward-looking statement made in connection with an [IPO].”28 Yet, financial projections made in connection with de-SPAC transactions are “generally protected by the safe harbor for forward-looking statements afforded by the [PSLRA].”29 From a policy perspective, one can see how this makes sense. Given the limited disclosure requirements imposed on SPACs with respect to de-SPAC transactions, one could argue that it reasonably follows that outside investors rely on the forward-looking financial projections made by SPACs and their Sponsors to determine whether an investment is worthwhile. But the issue comes when these statements are not accompanied by meaningful cautionary information. What follows is misleading information disseminated to public investors – the exact opposite intent of generally all SEC regulations.

The conflict of interest in such a scenario is self-evident. As aforementioned, when a SPAC fails to find an appropriate target company within the stipulated timeframe (e.g., 24-months), the SPAC’s interest-bearing trust account is liquidated. Therefore, as the deadline approaches, it follows that the SPAC Sponsors are more motivated to find targets that are, by plaintiffs’ contentions, not suitable to not lose the invested capital. This exacerbates the misaligned incentives between the Sponsors and public shareholders.

The case Welch v. Meaux et al. highlights a scenario in which shareholders may bring a conflict of interest-based claim.30 The SPAC and Sponsors in Welch had raised about $250 million from its SPAC IPO and, with only two weeks before the de-SPAC transaction deadline, the complaint alleges that the SPAC “raced to enter a merger” with the financially unfavorable target company “to protect their reputations as high-power deal-makers.”31 Post-closing, the public company’s stock price plummeted over 50%. Effectively, the conflict-of-interest claim centers around the assertion that the Sponsors were not acting in accordance with their fiduciary duty of loyalty to act in furtherance of the best interests of the shareholders, but rather operated with the sole purpose of closing the de-SPAC transaction at all costs to prevent the loss of their own investment.

The shareholders’ suit makes two primary allegations with respect to the inapplicability of the PSLRA’s safe harbor provision for forward-looking statements. First, the shareholders argue that “there were no meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the purportedly forward-looking statements.”32 Second, the shareholders argue (2) that “at the time each . . . forward-looking statement was made . . . the [defendants] knew that the particular forward-looking statement was false.”33

Welch is also ongoing, but it may provide further guidance on how the safe harbor provision of the PSLRA may be applied by courts going forward. SPACs and Sponsors have now been put on notice by Welch – shareholder suits can be expected if investors are not sufficiently informed of the risks of the financial projections made in connection with de-SPAC transactions, particularly when such transactions are made near the stipulated deadline to liquidate.

Concluding Thoughts

With the SPAC flood spilling over into 2021, SPACs, Sponsors, and companies looking to go public through de-SPAC transactions should reasonably expect a commensurate increase in civil litigation and SEC oversight. While SPAC-related litigation is still relatively sparse, SPACs and Sponsors should pay attention to the available guidance provided by the SEC, particularly with respect to disclosure and conflicts of interest issues. 

  1. SPACInsider, https://spacinsider.com/stats/ (last visited Mar. 10, 2020). ↩

  2. Id.; Christopher M. Barlow et al., The Year of the SPAC, Skadden (Jan. 26, 2021), https://www.skadden.com/insights/publications/2021/01/2021-insights/corporate/the-year-of-the-spac. ↩

  3. SPACInsider, supra; see also Amrith Ramkumar & Maureen Farrell, When SPACs Attack! A New Force is Invading Wall Street, Wall St. J. (Jan. 23, 2021, 12:00 AM), https://www.wsj.com/articles/when-spacs-attack-a-new-force-is-invading-wall-street-11611378007?st=rdhzg5v32j87idr&reflink=article_email_share. ↩

  4. SEC, Blank Check Company, Investor.gov, https://www.investor.gov/introduction-investing/investing-basics/glossary/blank-check-company. ↩

  5. SEC, What You Need to Know About SPACs – Investor Bulletin (Dec. 10, 2020), https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investor-bulletin. ↩

  6. Id. ↩

  7. Bruce A. Ericson et al., The SPAC Explosion: Beware the Litigation and Enforcement Risk, Pillsbury Insights (Dec. 15, 2020), https://www.pillsburylaw.com/en/news-and-insights/spac-litigation-enforcement-risk.html. ↩

  8. SEC, What You Need to Know About SPACs, supra. ↩

  9. Id. ↩

  10. Tom Zanki, How the SPAC Boom Could Trigger More Lawsuits, Law360 (Jan. 27, 2021, 6:57 PM), https://www.law360.com/articles/1348858/how-the-spac-boom-could-trigger-more-lawsuits. ↩

  11. Id. ↩

  12. Ramkumar, supra; see generally, IPO Process, Corp. Fin., https://corporatefinanceinstitute.com/resources/knowledge/ finance/ipo-process/ (last visited Mar. 10, 2021) (highlighting the mechanics of IPO pricing). ↩

  13. SEC, What You Need to Know About SPACs, supra. ↩

  14. Id. ↩

  15. Securities Exchange Act of 1934, 15 U.S.C. §§ 78a–78qq (2010). ↩

  16. Complaint at 4-7, Wheby v. Greenland Acquisition Corp., No. 1:19-CV-01758 (D. Del. Sept. 19, 2019). ↩

  17. Id.; Greenland Acquisition Corp., Current Report (Form 8-K) (Oct. 18, 2019). ↩

  18. Ilya Banares, Blank-Check Company Deals Driven by Speculation, Chanos Says, Bloomberg (Oct. 20, 2020, 4:01 PM), https://www.bloomberg.com/news/articles/2020-10-20/blank-check-company-deals-driven-by-speculation-chanos-says. ↩

  19. See, e.g., Complaint, Srock v. MultiPlan Corp. f/k/a Churchill Capital Corp. III et al., No. 1:21-CV-01640 (S.D.N.Y. Feb. 24, 2021); Complaint, Borteanu, et al. v. Nikola Corp., et al., No. 2:20-CV-01797-JZB (D. Ariz. Sept. 15, 2020); Complaint, In re Akazoo S.A. Sec. Litig., 1:20-CV-01900 (E.D.N.Y. June 19, 2020). ↩

  20. Nikola and VectoIQ Acquisition Corp. Announce Closing of Business Combination, Nikola Motor (June 3, 2020), https://nikolamotor.com/press_releases/nikola-and-vectoiq-acquisition-corp-announce-closing-of-business-combination-77. ↩

  21. Matt Prosky, Nikola’s Valuation Seems Crazy, The Truth About Cars (June 9, 2020), https://www.thetruthaboutcars.com/2020/06/nikolas-valuation-seems-crazy/. ↩

  22. Nikola and General Motors Form Strategic Partnership; Nikola Badger to be Engineered and Manufactured by General Motors, Gen. Motors Corp. Newsroom (Sept. 8, 2020), https://media.gm.com/media/us/en/gm/home.detail.html/content/Pages/news/us/en/2020/sep/0908-gen2fcs.html; Nikola: How to Parlay an Ocean of Lies into a Partnership with the Largest Auto OEM in America, Hindenburg Rsch. (Sept. 10, 2020), https://hindenburgresearch.com/nikola/. ↩

  23. See Borteanu et al., supra; Complaint, Salem v. Nikola Corp. et al., No. 2:20-CV-02374-SPL (D. Ariz. Sept. 16, 2020); Complaint, Wojichowski et al. v. Nikola Corp. et al., No. 2:20-CV-01819-DLR (D. Ariz. Sept. 17, 2020); Complaint, Malo et al. v. Nikola Corp. et al., No. 2:20-CV-02237-SPL (D. Ariz. Oct. 16, 2020); Complaint, Holzmacher et al. v. Nikola Corp. et al., No. 2:20-CV-02123-JJT (D. Ariz. Nov. 3, 2020); Complaint, Eves et al. v. Nikola Corp. et al., No. 2:20-CV-02168-SPL (D. Ariz. Nov. 10, 2020). ↩

  24. Borteanu et al., supra at 7. ↩

  25. Michael Wayland, Nikola Admits Ousted Chairman Misled Investors as Legal Costs Mount, CNBC (Feb. 25, 2021, 6:12 PM), https://www.cnbc.com/2021/02/25/nikola-is-paying-8point1-million-in-legal-fees-for-ousted-chairman-milton.html. ↩

  26. See Rachel O’Brien, SPAC Investors Sue to Block $3.7B Medicare Co.’s Formation, Law360 (Oct. 29, 2020 8:59 PM), https://libproxy.law.umich.edu:2067/articles/1324212/spac-investors-sue-to-block-3-7b-medicare-co-s-formation. ↩

  27. See Richard A. Rosen & Jessica S. Carey, The Safe Harbor for Forward-Looking Statements after Twenty Years, Paul Weiss Insights (May 2016), https://www.paulweiss.com/media/3592238/insights_0516_rosen.pdf. ↩

  28. Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737, 753 (1995). ↩

  29. Ericson et al., supra. ↩

  30. Complaint, Welch v. Meaux et al., No. 2:19-CV-01260-TAD-KK (W.D. La. Sept. 26, 2019) https://www.docketbird.com/court-documents/Welch-v-Meaux-et-al/COMPLAINT-against-Tilman-J-Fertitta-Richard-Handler-Jefferies-Financial-Group-Inc-Jefferies-L-L-C-Christopher-Meaux-David-Pringle-Waitr-Holdings-Inc-Jeff-Yurecko-with-Jury-Demand-Filing-fee-400-receipt-number-0536-4060085-filed-by-Walter-Welch/lawd-2:2019-cv-01260-00001. ↩

  31. Id. at 24. ↩

  32. Id. at 102. ↩

  33. Id. ↩

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