Special Purpose Acquisition Companies (SPACs) are a hot topic in the news right now—and an issue that’s been on the mind of SEC Chair Gary Gensler as well. In remarks at several events over the past few months he’s voiced concerns that SPACs can leave investors vulnerable and at risk.
The SPAC process leaves individuals and firms open to conduct risk and conflicts of interest along the way. And even as SPACs are in the limelight these days, it’s important to remember that there’s ample room for conduct risk in a traditional Initial Public Offering (IPO) as well.
A SPAC is a publicly listed company created to acquire one or more privately held companies. A SPAC is a shell company when it goes public, raising funds to acquire the target companies after the fact. Also known as blank check companies, SPACS bypass the traditional IPO process.
According to RBC Capital Markets, SPACs represent $700 billion to $1 trillion of buying power. In the first four months of 2021, SPACs accounted for roughly a little over 20% of all M&A transaction volume in the United States. To put that in perspective, prior to 2020, SPAC transactions represented roughly 1%. But SPAC activity has been waning in the later part of this year. A recent PitchBook report notes that SPAC IPOs declined 66% by number and 81.3% by capital raised relative to the record shattering first quarter. Lackluster aftermarket performance could lead to “a related decline of investor sentiment around SPACs, if returning capital due to failure to find a target becomes a regular occurrence.”
Even with the recent slowdown, SPACs still remain an area of regulatory concern. SPACs are part of the SEC’s 2021 regulatory agenda. On Tuesday, September 14 Gary Gensler testified in front of the Senate Committee on Banking, Housing and Urban Affairs. Gensler said that he has asked SEC staff for recommendations on enhancing SPAC disclosures, noting that “There are a lot of fees and potential conflicts inherent within SPAC structures, and investors should be given clear information so that they can better understand the costs and risks.”
SPACs bring the potential for conflicts of interest where SPAC directors, officers and affiliates could make decisions based on their own best interests at the expense of the investor. Disclosure guidance from the SEC Division of Corporation Finance notes that the economic interests of a SPAC’s sponsors, directors, officers and affiliates can often differ from the economic interests of public shareholders which may lead to conflicts of interests as they evaluate target companies. Clear disclosure regarding these potential conflicts of interest is particularly important because these parties are generally responsible for negotiating the SPAC’s business combination transaction. Unlike the traditional IPO process where a private operating company sells its securities in a manner in which the company and its offered securities are valued through market-based price discovery, these individuals are solely responsible for deciding how to value the private operating company and how much the SPAC will pay for it.
FINRA’s Guidance on Special Purpose Acquisition Companies reminds firms of their disclosure obligations when participating in this market. The guidance also outlines some of the differences between SPAC’s and traditional IPOs. “There are significant differences in the liability and disclosure obligations regarding a company that becomes public by acquisition by a SPAC and one that becomes public through a traditional IPO. In a traditional IPO, underwriters conduct significant and thorough due diligence on a company and assume liability for the information disclosed in the registration statement. There may be no similar "gatekeeper" function by underwriters in connection with the acquisition target of a SPAC.”
An IPO board has a wider focus – and with that a wider range of places for risk. IPOs require disclosures around pricing, fees, allocation basis and conflicts of interest. The Board of the International Organization of Securities Commissions (IOSCO) Consultation Report Conflicts of interest and associated conduct risks during the equity capital raising process provides guidance on the potential risks and harms that can compromise the integrity and efficiency of the IPO process. These areas include conflicts of interest and pressure on analysts who provide opinions during the pre-offering stage to have a favorable view, timing, sequencing and level of information provided in the offering phase, conflicts of interest during the allocation of securities that could favor specific investors or employees, and personal transactions by staff employed within firms managing securities offerings.
Manage conflicts of interest throughout the SPAC and IPO lifecycle
Whether through traditional IPO or SPAC, there are inherent conflicts of interest on both the employee and organizational level as companies make the transition from private to public. MCO provides firms with a solution suite to identify conflicts across employee, firm and third party transactions.
MyComplianceOffice enables comprehensive monitoring, workflow-directed task management, real-time alerts to exceptions and sophisticated hierarchy management. Integrated data sets including global company and security master of public and private companies provide information on firms both pre and post-IPO. Business entity lookup capabilities provide cross employee surveillance and a connection between the individual and the organization.
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