New Rules Aim to Keep SPACs in Line with Traditional IPOs

Source: WSJ | Published on January 24, 2024

New SEC rules for SPACs

The speculative bonanza in special-purpose acquisition companies, better known as SPACs, appears to be dead. Gary Gensler wants to make sure it doesn’t come back to life.

The Securities and Exchange Commission, which Gensler chairs, voted 3-2 Wednesday to adopt rules that seek to make it clearer to SPAC investors if they are getting a raw bargain. Once the rules take effect in about five months, according to lawyers familiar with the deals, they will likely drive another nail into the coffin of a recent Wall Street fad fueled by market froth and regulatory arbitrage.

Also called a blank-check company, a SPAC is a shell firm that lists publicly with the sole intent of merging with a private company to take it public. After regulators approve the deal, the company going public replaces the SPAC in the stock market.

“Just because a company uses an alternative method to go public does not mean its investors are any less deserving of time-tested investor protections,” Gensler said Wednesday.

Voting against the SEC rule were Republican SEC commissioners Hester Peirce and Mark Uyeda, who accused their colleagues of seeking to regulate away a fundraising model that some companies find useful.

More than 860 SPACs raised $246 billion in 2020 and 2021, according to the data service SPACInsider, a period that also saw the rise of meme stocks and a cryptocurrency bubble. The blank-check entities bought companies with ideas ranging from flying taxis to small space rockets, essentially allowing them to sell stock to individual investors with few of the disclosures that accompany a traditional initial public offering.

Since 2022, SPAC fundraising has slowed to a trickle as regulators and courts questioned the model and financial markets sobered up amid higher interest rates. Last year saw just 31 SPAC IPOs raise $3.8 billion, SPACInsider data show.

“Things have changed forever,” said John Ablan, a partner at Mayer Brown who has advised clients on SPAC transactions.

One reason for the cool-down, he said, was the looming regulatory push by the SEC. The agency proposed Wednesday’s rule change in early 2022. Its goal is to give SPAC investors the same protections that investors in traditional IPOs receive, mainly by requiring more disclosures from companies and making executives liable for them.

Investors can also pull their money out before the transactions close—and often do if share prices are low. That can leave the newly public company with even less cash to grow. It also means there are very few shares available for trading after a deal is completed, a force that often drives the stocks haywire.

This recently occurred with Vietnamese electric-car startup VinFast, which was briefly valued at $190 billion shortly after closing its SPAC deal. That is twice the combined value of Ford and General Motors, despite the company just starting to increase production. Its shares then tumbled.

Ahead of a normal IPO, companies have to be careful about any projections they make regarding their future performance. But SPAC targets—some of which had yet to begin operations—often made wildly optimistic forecasts about their revenue or market share. Regulators worry this encouraged SPAC shareholders to go along with acquisitions without understanding them.

SPAC deals typically include favorable terms for their creators, known as sponsors. They initially put up a small amount to cover expenses before the SPAC goes public and then get a 20% stake at a deep discount if the SPAC combines with another company. This makes it possible to earn returns several times the original investment—even if the acquisition is a bad deal for other investors.

During the boom, a group of hedge funds known on Wall Street as the SPAC Mafia cashed in by negotiating unique rights given to early investors.

For smaller investors, who were sometimes drawn in by participation from celebrities including Shaquille O’Neal, Jay-Z and Peyton Manning, the returns have been dour. Of 401 SPACs that have closed acquisitions since the beginning of 2021, only 27 have seen their share prices rise, according to SPACInsider.

“These vehicles were a road to nowhere for investors,” said Michael Klausner, a law professor at Stanford University who has sued several SPAC sponsors on behalf of investors. “They’re not going to come back—at least in their current structure.”

One reason most SPAC shares have performed so poorly is that their cash is heavily diluted by the time a merger takes place. After the sponsor’s cut, bankers’ and lawyers’ fees, and warrants held by early investors, a SPAC might only have 50 cents to invest in the target company for every dollar that its shareholders contributed, Klausner said.

Information about dilution in existing securities filings can be confusing and often scattered in different places. That makes it hard for SPAC investors to determine whether they should go through with a merger or redeem their shares beforehand, according to SEC staff.

The rules adopted Wednesday require additional disclosure about the potential for dilution in SPACs. The information will have to appear in standardized tables on the cover page of key filings.

In addition, SPAC acquisition targets that make forward-looking statements will generally have to show the basis for those projections and will be legally liable for their disclosures. SPACs will also have to disclose any conflicts of interest between a sponsor or its affiliates and ordinary shareholders.

Lawyers say warning statements from the SEC and uncertainty about the timing of Wednesday’s rules contributed to the die-down in SPACs because few sponsors wanted to raise money from investors and then face restrictions on how they could use it. Investment banks, which rode the SPAC wave as underwriters, also pulled back starting in 2022.

“Nearly two years after the commission proposed this rulemaking, the SPAC market is a shell of its former self,” said Uyeda, one of the SEC’s GOP commissioners. “The commission intends to never let them return.”