Not Our Cup of Tea: Why the Sec Must Regulate Spacs Differently Than the United Kingdom

• Publication year: 2023

Not Our Cup of Tea: Why the SEC Must Regulate SPACs Differently Than the United Kingdom

[Page 555]

Archie L. Wilson, Jr.^*

Table of Contents

I. Introduction......................................................................................................556

II. Background......................................................................................................558

A. What is a SPAC? (U.S.).............................................................558

i. U.S. SPAC Mechanics........................................................559

B. How SPACs Developed in the U.S..........................................561

i. Rule 419.................................................................................561

C. U.S. IPO Mechanics...................................................................564

i. SPAC v. IPO.........................................................................565

D. The Fatal Flaw (Empty Voting)...............................................566

i. The Game (Empty Voting) Explained.............................567

III. Analysis............................................................................................................569

A. The SPAC Oversight Gap..........................................................569
B. Case Study: The United Kingdom...........................................570

i. The Presumption of Suspension.......................................571
ii. The Supervisory Approach and the United States........573

IV. Recommendations........................................................................................576

A. SPAC Scholar Recommendations............................................576

i. Integrated Ownership Disclosure....................................576
ii. Empty Voting Threshold....................................................577
iii. Contingent Shareholder Action........................................579

B. A New Proposal: A SPA C Two-Step.......................................580

i. Potential Critiques..............................................................584

V. Conclusion........................................................................................................585

[Page 556]

I. Introduction

Regulation is coming. U.S.-based Special Purpose Acquisition Companies have not seen significant regulatory reform since the investment structure was created in the 1990s.¹ The boom of Special Purpose Acquisition Company (SPAC) activity in the United States is influenced in part by the participation of celebrities and public figures like Shaquille O'Neal, Serena Williams, Alex Rodriguez, Colin Kaepernick, Steph Curry, Patrick Mahomes, Naomi Osaka, Peyton Manning, Andre Agassi, Steffi Graff, Ciara, Jay-Z, Sammy Hagar, Paul Ryan, and Wilbur Ross.² SPACs are now a mainstream investment option that "make up a significant and unusually high share of . . . [Initial Public Offerings]: 25% percent [sic] in 2018[,] 34.5% in 2019, 60% in 2020, and 66% in 2021."³ U.S. SPAC market growth has caught the eye of government regulators, inspiring targeted statements and events.⁴ For example, the Division of Corporation Finance within the Securities and Exchange Commission (SEC) issued a public statement specifically concerning SPACs.⁵ Additionally, the Subcommittee on Investor Protection, Entrepreneurship and Capital Markets of the U.S. House Committee on Financial Services held a hearing titled Going Public: SPACs, Direct Listings, Public Offerings, and the Need for Investor Protections⁶ Beyond speaking about the investment vehicle more pointedly, recent activity in the U.S. SPAC market has inspired action from the SEC. The SEC put SPACs on its rulemaking agenda in 2022, and has proposed new rules to govern SPACs.⁷ Additionally, the SEC has shown its interest in altering SPAC behavior by bringing charges against bad actors.⁸ In July 2021, the SEC brought charges against a SPAC named Stable Road Acquisition Company, specifically against its leadership

[Page 557]

team and CEO.⁹ The agency also brought charges against the target company, Momentus Inc., and the target company's founder and former CEO.¹⁰ These charges allege that the parties continued making misleading claims to investors after receiving numerous warnings.¹¹

Pointed changes in how U.S. SPACs operate in the future are likely. Change is probably on the horizon because SPACs historically have not been as regulated as traditional initial public offerings (IPOs),¹² leaving more questions than answers about which rules govern SPACs, and if such rules even exist.¹³ The norms of SPAC regulation in the U.S. permanently shifted in March 2022 with the proposal of new rules for U.S. based SPACs.¹⁴

Over the past few decades, the SEC has allowed "the market [to do] away with the investor protections that SPAC entrepreneurs initially used to persuade the agency into allowing the form's emergence."¹⁵ SPACs were specifically created in response to the SEC's actions against misrepresentation and fraud that would mislead investors in penny stock deals.¹⁶ The form was initially created with the promise of protecting investors and upholding market integrity. Now, SPACs mostly operate as nothing but a shell of those promises—a consequence of failing to hold key contributors in SPAC creation and operation accountable. The secrecy of empty voting in SPACs is a fatal flaw that creates a rigged game; the practice must be addressed for both moral and economic reasons. Empty voting creates a moral issue because it allows large investors to pursue beneficial merger deals to the detriment of other investor parties. Further, empty voting creates economic issues because investors—big and small—have an increased chance of being disadvantaged in the merger, thus harming their bottom lines over time. If empty voting is allowed to continue in its current state, distrust in the U.S. SPAC market will likely grow

[Page 558]

and investors will pursue other investment avenues, harming the growing sector.

This Introduction highlighted the dominant influence SPACs have gained in the United States over a short period of time. These investment vehicles affect every American because they help drive the economy, yet the form remains unknown to many. As the form has continued to gain prominence, the fatal flaw of empty voting has become more glaring. Moving forward, this Note is broken into four additional parts. Part II will include a full-bodied explanation of what SPACs are and their mechanics, the history and origins of the U.S. SPAC, the mechanics of a traditional IPO, and the differences between a SPAC and an IPO. Part II closes by discussing the SPAC's fatal flaw—empty voting—and explains how the process creates moral and economic pitfalls for the form.

Part III will discuss the oversight gap that exists in U.S. SPACs because of a lack of gatekeeping and provide a case study of steps the United Kingdom has taken to address similar issues in U.K. SPACs. Part III will argue that aggressive agency oversight like that seen in the U.K. is not the best solution for the U.S. SPAC market.

Part IV will discuss solutions to empty voting and issues of transparency in SPACs proposed by leading SPAC scholars. Part IV will then present a two-step SPAC confirmation system to address issues of empty voting and disclosure in U.S. SPACs. The recommendation is a new solution that draws upon the strengths of the previously mentioned scholars' work. Finally, Part IV anticipates and addresses potential critiques of the new recommendation. Part V will conclude the Note.

II. Background

A. What is a SPAC? (U.S.)

In the United States, a SPAC is an entity with three distinguishable attributes. First, SPACs have no commercial operations, meaning they do not actively engage in the buying or selling of goods.¹⁷ Second, SPACs are established by management or leadership teams called sponsors.¹⁸ Third, SPACs are formed for the sole purpose of raising capital from the public in the form of an "IPO."¹⁹ Before offering shares to the public, the sponsors of the newly formed SPAC own the SPAC's securities as original shareholders.²⁰ The SEC

[Page 559]

must first receive and approve a "registration statement (Form S-1)" from the SPAC before the SPAC sells shares to the public.²¹ This statement discloses key aspects of the company for review, including the SPAC's blank check status, a general description of the industry in which the SPAC plans to execute an acquisition, and key metrics that are used to analyze the longevity and success of the acquisition.²² The statement also formally announces the management team, designates the kinds of shares that will be offered to the public, and lists potential foreseeable risks for the acquisition.²³ Once approved by the SEC, the SPAC may sell its shares to the public. The SPAC vehicle is a unit offering, meaning that the company has "a combination of stock shares and warrants to purchase shares" which investors can purchase.²⁴ Purchasers of common stock buy equity in the company immediately at the time of purchase, while purchasers of warrants acquire the right to buy stock in the company "at a specific price and at a specific date" in the future.²⁵

The funds from the capital raise serve one purpose for the SPAC: to acquire an existing, almost always private, company seeking to become public without its own IPO.²⁶ Most of the public fundraising proceeds must be placed in a trust account and the funds are released only after the successful completion of an acquisition.²⁷

i. U.S. SPAC Mechanics

When the public offering concludes, the funds are placed in an escrow account, and the hunt for a target begins. The management team's primary purpose is to efficiently source an appropriate target because the search for a target is time-bound by the Code of Federal Regulations.²⁸ SPACs historically had a lifetime of two years, but recent data shows that the median lifetime is twenty-two...