SPACs have been around for a long time, but only recently have become a darling for companies looking for public money
SPAC – Special Purposes Acquisition Company – Its More Wall Street Alchemy. Companies want investor money. They need it in fact. There are many methods by which companies obtain investor cash the most common being to sell securities like stocks or bonds. This fundraising methodology comes in many forms much of which is dependent upon whether the company is “public”. Many companies forgo “going public” and decide to raise money through “private placements”. For small companies this works fine, but the access to capital, through private placements is limited, and the market is extremely opaque leading to investor concerns and risk. If a company wants to gain access to the full market, the only way to do it is to “go public.” Traditionally, this is accomplished by filing an IPO – Initial Public Offering. The problem with a formal IPO is, it is extremely expensive and complicated, requiring legions of lawyers and high-priced Wall Street investment banks to march through the process. The IPO process is arduous for a reason – the United States puts a premium on the sanctity of the public securities markets and if a company wants to reap the benefits of being a participant, they have to play by the rules.
But there are other ways to gain access to the public securities markets without the formal IPO process. Companies can execute what is known as a “Direct Listing”. This allows a company to sell shares “OTC” or “over the counter” without any formal exchange listing. Another option is using a SPAC. A SPAC is also known as a “blank check company.” It is a publicly listed shell company that is created for the sole purposes of acquiring a private company, effectively taking that company public without going through the formal IPO process. If this sounds like a shell game, its exactly what it is, and that’s exactly what it is intended to be.
SPACs have become increasingly popular, raising a record $82 billion in 2020. Investing in SPACs can be perilous, however. According to published reports, investing in a SPAC after it lists almost guarantees investor losses. By the time a SPAC’s shares end up with a retail investor, the smart money has already bought in, and probably bailed out. In total, since 2012, buy and hold SPAC investors have lost more than 15% annually, with some years being catastrophically bad. The SPAC market tends to be driven by speculation and an outsized hunger for out-sized returns. Investors believe they are “getting in early” when the reality is, the smart money got it long before. According to CNBC, “[f]or the 114 companies that went public via SPAC mergers in the past 10 years, investors lost 15.6% on average if they bought a merged company’s common shares on the first day of trading and old it for a year.” Buying a SPAC on the market once it’s gone public is a speculative and likely, a sucker’s bet.
SPACs are regulated by the SEC and its registration is consummated through a regulatory filing called an S-1. Disclosure of the SPAC structure, target industries, management team biographies, potential conflicts of interest and risk disclosures are standard information disclosed in the registration statement. SPACs that list on the AMEX are mandated to be compliance with Sarbanes-Oxley, meaning they must have independent boards of directors and have auditing committees. SPACs sound a lot like reverse-mergers and functionally, they’re quite similar. The market, however, greatly prefers the SPAC structure, outpacing reverse-merger capital raises by about 100-1 in 2018.
Big banks and brokerage firms are piling into the SPAC craze. Cantor Fitzgerald leads the way, underwriting 14 SPAC offerings in 2019. Other banks finding their name “on the cover” for SPAC offerings including Deutsche Bank, Citigroup, Goldman Sachs, Credit Suisse, and Bank of America. The exponential growth in SPACs in 2020 where $83.6 billion was raised versus $13.6 billion in 2019, means these SPAC offerings surely find their way onto the desks of retail brokerage firms and investors need to be warry of falling for a ruse.
The brokerage firms that sell SPACs must adhere to FINRA suitability and supervision rules. Depending on what stage is being offered, the PAC may still be a “private” listing, subject to stringent due diligence requirements under FINRA Regulatory Notice 10-22. If the investment recommendation comes after the listing and involves shares or “units” of the SPAC, then the broker’s obligations change some, but at the core, must still understand the SPAC and be able to adequately explain its risks and characteristics to clients. SPACs are a complicated structure and as such, must be understood by the financial advisor prior to recommending clients invest in it. Further, SPACs by their nature are “new products” and from a market perspective, have only existed for a blip of time compared to stocks and bonds. This means brokers must adhere to regulatory guidance set forth in NASD Notice to Members 05-26 which discussed the proper vetting of new investment products. These new issues and complicated structures can carry unique risk profiles and financial advisors and their brokerage firms have obligations to understand these products before selling them. SPACs certainly fall into the category of “non-conventional investments” covered by NASD Notice to Members 03-71.
SPACs carry the same level of risk as investing in any start-up or IPO. Statistically, history tells us there is a lot more bust than boom when it comes to SPACs and the “smart” money invests long before a retail investor gets in on it. More recently, stories have surfaced suggesting professional athletes and celebrities are “sponsoring” SPACs, touting them on social media. Heed this warning – do not invest in any investment being touted on social media by anyone. Further, the SEC is re-examining some accounting rules as they apply to SPACs, which may cause a real mess in the SPAC market. These accounting restatements have to do with how the SPACs account for “warrants” which are contracts offered as part of the incentives for early-stage investors. A warrant is an option to buy a specified number of shares of stock at a later date at a pre-determined price. Traditionally, these warrants are reported as equity on the SPAC balance sheet, but the SEC is informing SPACs that they need to account for certain warrants as liabilities. Such an accounting shuffle can have massive implications for SPACs and could result in substantial upheaval in the market for SPACs.
If you invested in a SPAC and have lost money as a result, please call Stoltmann Law Offices, P.C. at 312-332-4200 for a no-obligation free consultation. We are a contingency fee firm which means we do not get paid until you do.