Regulation is the most important topic of the SPAC conference

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Gary Gensler, Chairman of the Securities and Exchange Commission

Bill Clark-Pool/Getty Images

The proposed regulations are the biggest threat to the market for special purpose acquisition companies, several SPAC experts said Wednesday.

SPAC market struggles and regulatory proposals – from the Securities and Exchange Commission and Democratic Senator Elizabeth Warren of Massachusetts— were the hottest topics of the PSPC Conference 2022 in the New York suburb of Rye.

Since last year’s conference, the SPAC market has cooled. The number of SPAC IPOs and mergers is down, and several deals have been canceled.

A brief recap of the process: A so-called blank check company raises funds from investors. Then its management team, called sponsors, researches and negotiates a merger with a private company, usually within two years. Once the companies are merged, the private company assumes the stock market listing of SPAC and becomes a public company.

The drop in volume has been dramatic, given the explosive growth of SPAC IPOs over the past few years. The totals: 59 in 2019, 248 in 2020 and 613 in 2021. So far this year, the count stands at 68 SPAC IPOs, according to SPAC Research, and 44 closed mergers.

SPAC shareholders can vote on the deal; they have the option of either receiving shares of the combined company or redeeming their SPAC shares for a proportionate share of its cash in trust. Redemptions have tended to be 85% or higher this year, leaving SPAC targets with significantly less cash collected from their trades. Many post-SPAC merger stocks have underperformed the broader market, much like recent IPOs, while pre-trade SPACs traded on average for discounts to their confidence values.

“We could be in the same beautiful place as last year, with beautiful weather too,” said Mitch Nussbaum, co-chairman of capital markets and corporate practice at Loeb & Loeb and vice president of the firm. “But, folks, the SPAC market is in a very different place than last year.”

The significant downturn is a function of three forces: a market-wide abandonment of risky investments, the glut of SPACs already traded and looking for deals, and proposed changes to SPAC rules by the SEC.

Companies that go public through a SPAC take a different legal route than those that go public through a traditional IPO. The IPO of a SPAC is an IPO like any other, but the subsequent merger that takes the company public is treated as an M&A transaction and is regulated as such.

“Functionally, the SPAC Target IPO is used as an alternative way to conduct an IPO,” SEC Chairman Gary Gensler said in a statement in March. “Thus, investors deserve the protections they receive from traditional IPOs, with respect to information asymmetries, fraud and conflict, and with respect to disclosure, marketing practices, gatekeepers and transmitters.”

In an IPO, underwriters have legal responsibility for facts and statements made in a company’s related documents. This requires considerable due diligence and typically leads companies to avoid making “forward-looking statements” about their finances when made public through an IPO.

There is no such requirement for a merger, including the business combination of a SPAC, and these companies tend to offer detailed forecasts of their sales, earnings and operating results, sometimes years in advance. These projections have been criticized for being far from the truth in several instances.

The SEC rules proposed in late March would extend underwriters’ legal liability to the SPAC merger, treating it much more like an IPO. This regulatory uncertainty has prompted some major underwriters to suspend the issuance of new SPACs or suspend their involvement in SPACs they have already made public, including Goldman Sachs (ticker: GS),

Citigroup

(VS),

German Bank

(DB), and

Swiss credit

(CS).

“The proposed rules are intended to impose custodian and underwriter liability on companies and advisors going forward and retroactively,” said Douglas Ellenoff, partner at SPAC law firm Ellenoff Grossman & Schole. “That’s at the heart of the SEC’s goal. If custodians are exposed to the projections, there will be further scrutiny and review of the reasonableness of the numbers provided and disclosed.

Other potential regulations proposed by the SEC were also causing angst at the conference. One would require the board of a SPAC to certify that transactions in the filings are “fair,” which is not required for IPOs or direct listings. This step would increase costs, as it would require hiring an appraisal firm to establish a fairness opinion. Others would require additional transparency regarding SPAC sponsors and their potential conflicts of interest and make other changes to disclosure requirements.

Write to Nicholas Jasinski at nicholas.jasinski@barrons.com

Jessica C. Bell