FAIRNESS OPINIONS AND SPAC REFORM.

• Author: Tuch, Andrew F.

ABSTRACT

This paper assesses the emerging regulatory framework for special purpose acquisition companies (SPACs). According to this framework, mergers of SPACs, known as de-SPACs, must be "fair" to public (or unaffiliated) SPAC shareholders, and transaction participants face heightened liability risk for disclosure errors. In this environment, third-party fairness opinions have been regarded as a de facto requirement for de-SPACs.

A study of all fairness opinions used in de-SPACs from 2019 to 2023 shows that these opinions suffer profound methodological problems and fail in their intended purpose. To be fair to public shareholders, a de-SPAC should represent value to these shareholders of at least $10 per share, the amount they would receive if they chose to redeem. This requires a pro forma assessment of the post-merger entity's value, accounting for the effects of dilution, an assessment that will be highly contingent. Nevertheless, most opinions borrowed from the public mergers & acquisitions (M&A) play book by addressing fairness to the SPAC, rather than to public shareholders, adopting assumptions that often produced implausible valuations while also being unresponsive to fiduciary concerns. Other opinions reflected poor practices, drawing either mistaken or ambiguous conclusions. Another set of opinions expressly purported to address the position of public shareholders. On their face, therefore, they were responsive. But, with one exception, these opinions failed to perform analyses to address the position of public shareholders. While the challenges of assessing fairness to public shareholders can be overcome, fairness opinions should be greeted with skepticism.

The article argues in favor of other features of the emerging regulatory framework that would heighten incentives for complete and accurate disclosures of deal value to investors. With stronger incentives to assure complete and accurate disclosures, investment banks, SPAC sponsors, and target companies would be less likely to stand behind de-SPACs in their current form. Incentivizing complete and accurate disclosures, then, should lead to changes in transaction terms and structures that will result in greater fairness to public shareholders.

TABLE OF CONTENTS I. THREATS TO PUBLIC SHAREHOLDERS II. FAIRNESS TO PUBLIC SHAREHOLDERS A. The Relevance of Fairness B. The Appeal of Fairness Opinions C. The Meaning of Fairness D. Practical and Conceptual Challenges 1. Existing Practices 2. Value of SPAC Shares as Transaction Consideration 3. Dilution Inherent in SPAC Structure 4. Post-Merger Value 5. Reliance on Management-Provided Projections 6. Identifying Comparable Transactions III. EMPIRICAL RESULTS A. Basic Data B. Assessment C. What Analyses Would Be Responsive? D. Summary IV. ENHANCED DISCLOSURE A. Section 11 and Incentives for Due Diligence 1. Deeming SPAC IPO Underwriters de-SPAC Underwriters 2. Private Operating Company as Co-Registrant to Form S-4 and Form F-4 3. Deeming Business Combination of a Shell Company to Involve a "Sale" 4. Shortfalls B. PSLRA Safe Harbor V. POLICY IMPLICATIONS A. The Value of Fairness Opinions B. Redemption-Relevant Information for Public Shareholders C. The Future of SPACs D. Fairness Opinions CONCLUSION INTRODUCTION

Briefly, mergers of SPACs, or special purpose acquisition companies, constituted a mainstream technique for taking companies public. (1) SPACs initially raise cash in their initial public offerings (IPOs), and then through a merger, known as a de-SPAC, confer public status on a target company and fulfil traditional IPO functions. To protect investors, SPACs integrate certain safeguards, such as the right of public shareholders to redeem their shares, effectively providing them a money-back guarantee if they believe a de-SPAC to be ill-conceived. (2) In situations where no de-SPAC occurs, the SPAC will liquidate, giving public shareholders their money back. DeSPACs have enabled record numbers of companies to enter public markets without a traditional IPO, reversing a decades-long decline in U.S. companies going public. (3)

Yet, the conventional SPAC structure compromises the incentives of SPAC sponsors and directors, who are fiduciaries, and can leave public shareholders--those unaffiliated with these fiduciaries--poorly informed about transaction risks. (4) SPAC sponsors and directors face conflicting interests, as their remuneration can give them powerful incentives to consummate a de-SPAC, even if it will be value-decreasing for other shareholders. (5) They also have incentives to discourage public shareholders from exercising their redemption rights, as high redemption rates may jeopardize a de-SPAC's viability. (6) Moreover, the SPAC structure dilutes public shareholders' interests, as SPAC sponsors and other investors receive shares at significant discounts, thereby reducing the net cash backing each share. (7) This dilution, or value transfer to SPAC fiduciaries, not only compounds SPAC fiduciaries' conflicts but also makes it less likely that the de-SPAC will be value-increasing for public shareholders, thereby diminishing the prospect that public shareholders will be better off investing in the post-merger entity than redeeming their shares. Outcomes for public shareholders of de-SPACs have been dismal, prompting the Securities and Exchange Commission (SEC) and Delaware courts to propose or impose heightened investor safeguards. (8)

The emerging regulatory framework focuses on protecting public shareholders through two measures. First, de-SPACs must be "fair" to these shareholders, whose interests are distinct from those of other SPAC shareholders and the SPAC itself as an entity. To this end, recent Delaware Court of Chancery rulings hold that corporate fiduciaries should face entire fairness review, an exacting standard of judicial scrutiny that in its application seeks to protect public SPAC shareholders. (9) Expressing a similar concern, the SEC's recent reform proposal ("SPAC Reform Proposal") models rules on those for Rule 13e-3 going-private transactions, among other things, requiring SPACs to disclose whether they consider the de-SPAC to be fair or unfair to their public shareholders. (10)

The second protective measure aims to incentivize transaction participants to provide public shareholders accurate and complete information--in particular, information material to their decisions whether to exercise redemption rights. The SEC proposes increasing the prospect of underwriter liability for investment banks that participate in de-SPACs, thereby strengthening the deterrent effect of Section 11 of the Securities Act of 1933, the most potent liability provision in federal securities law. (11) Additionally, the SEC would abolish preferential treatment that de-SPACs are believed to receive under the Public Securities Litigation Reform Act (PSLRA) when communicating financial forecasts and other forward-looking statements to investors. (12) Meanwhile, the Delaware Court of Chancery considers disclosure deficiencies in de-SPACs "inextricably intertwined" with loyalty issues, allowing it to rigorously scrutinize the accuracy and completeness of disclosures made in de-SPACs when assessing fairness. (13)

This article examines the emerging regulatory landscape by analyzing the significance of third-party fairness opinions and the proposed disclosure-oriented reforms. These opinions--which, in the wake of the SEC's announcement of proposed reforms, have been regarded as a de facto requirement for de-SPACs (14)--typically assess whether the consideration paid in a transaction is fair, from a financial point of view, to a party or group. The assessment of fairness opinions sheds light on the difficulties associated with evaluating and demonstrating a de-SPAC's value for public shareholders. The heightened risk of disclosure liability adds to the stakes, given the transaction value's materiality to public shareholders and the potential ramifications of any misstatement or omission for those involved.

According to the analysis, a low quality market emerged for SPAC fairness opinions. To address fairness to public shareholders, financial advisors must estimate the value of the post-merger entity, adjusting for dilution. However, SPAC boards obtained fairness opinions, generally from less reputationally sensitive financial advisors, which failed to address the position of public shareholders. These opinions were unresponsive to fiduciary concerns and relied on assumptions that often yielded implausible valuations. Nevertheless, SPACs disclosed these opinions and their underlying analyses to public investors as these investors decided whether to exercise their redemption rights.

In Part I, I provide background on de-SPACs and their primary threats to investor protection. Part II examines the significant challenges involved in assessing fairness to public shareholders. To be fair from a financial perspective to public shareholders, a de-SPAC should represent value to these shareholders of at least $10 per share, the amount they would receive if they chose to redeem. For fairness opinions, this requires financial advisors to estimate the value of the post-merger entity, taking into account the position of public shareholders. This analysis would require a comparison of public shareholders' $10 redemption option with the per share value in the post-merger company, adjusting for dilution. Since the business combination and related transactions has yet to occur, the latter calculation must be performed on a pro forma basis considering various possible scenarios and generating a range of possible outcomes.

However, financial advisors face significant difficulties in applying this criterion for fairness. The required analysis deviates from the standard fairness opinion template for public M&A where buy-side opinions assess whether the transaction consideration paid by the buyer (here, the SPAC) is...