Saving Spacs from the Sec's Potentially Ruinous Overreach

• Jurisdiction: United States,Federal
• Publication year: 2023
• Citation: Vol. 72 No. 4

Saving SPACs from the SEC's Potentially Ruinous Overreach

Carson S. Clear

SAVING SPACS FROM THE SEC'S POTENTIALLY RUINOUS OVERREACH

ABSTRACT

The resurgence of Special Purpose Acquisition Companies ("SPACs") in the U.S. securities market has demonstrated potential as an alternative to the traditional initial public offering ("IPO"). However, the evolution of SPACs from their fraudulent "blank check" ancestors has left the Securities and Exchange Commission ("SEC") weary of SPACs' continued presence in the market. Currently, SPACs exist as an exception to Rule 419 and the Penny Stock Reform Act of 1990, thereby allowing them to escape the rigorous disclosure requirements that not only eradicated their ancestors, but also significantly burdened the timeline of the traditional IPO process. While many consider SPACs a unique opportunity for non-institutional investors to reap benefits similar to those seen in private equity, a closer look into their evolution in the market suggests an entirely different conclusion.

This Comment offers a critical assessment of the SPAC structure and advances unique regulatory solutions. It begins with a focus on the landscape surrounding the SPAC structure, looking to the evolution of securities market regulations and the rise and evolution of the SPAC as an alternative to the traditional IPO. Following discussions on the various tensions present in the current form, this Comment sheds light on persistent issues lingering within the current form, illustrating the necessity for SPAC reform. Finally, this Comment proposes four solutions—bringing back investor voice, mitigating dilution to the investors, tidying disclosure requirements, and revisiting due diligence—and argues the need for SPAC creators to accept guidance from the SEC and look inward to SPAC performance to undergo self-reform in order to avoid the possibility of SPACs being regulated out of existence.

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TABLE OF CONTENTS

INTRODUCTION........................................................................................ 1019

I. SETTING THE STAGE: UNDERSTANDING THE MARKET REGULATORY FRAMEWORK................................................................................ 1022

A. Brief History of Market Regulation ....................................... 1022
B. The Rise of Early Blank Check Companies—Fraud Continues in the Market.................................................................................. 1026
C. The SEC's Response—Diminishing Early Blank Check Companies............................................................................ 1028

II. THE RISE OF THE SPAC STRUCTURE............................................. 1029

A. The Creation of SPACs ......................................................... 1030

1. Introducing the Basic Form and Function ....................... 1031
2. Development of the SPAC Structure ................................ 1032
3. The SPAC Life Cycle—Form, Acquire, Merge, and Dissolve.......................................................................... 1035

B. SPACs as an Alternative to the Traditional LPO .................... 1038

III. ANALYZING SPACS: TENSIONS TO REVEAL KEY ISSUES IN THE CURRENT STRUCTURE.................................................................................. 1040

A. Tensions Between the Investor, Sponsor, and Target Company .............................................................................. 1040
B. Key Issues Within the Current SPAC Structure...................... 1044

1. Harm to the Investor—Removal of Voice and Dilution of Ownership ...................................................................... 1044
2. Harm to the Public Market—Deficient Disclosure and Lack of Due Diligence................................................................. 1049

IV. REFORM WITHOUT REGULATION: PROPOSED REFORM FOR SPACS TO PERSIST AS ASSETS....................................................................... 1051

A. Reforms to Advance SPACs as a Legitimate Vehicle.............. 1052

1. Bringing Back Investor Voice.......................................... 1052
2. Dispersing Dilution......................................................... 1053
3. Enhancing Precision in Disclosure ................................. 1054
4. Revisiting Due Diligence................................................. 1055

B. Reform, Not Regulation—Why SPACs Must Self-Regulate..... 1055

CONCLUSION............................................................................................ 1057

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INTRODUCTION

The United States securities market has articulated one thing with utter clarity: investing in private companies—venture capital, leveraged buyout, and hedge funds—is reserved for the wealthy.¹ The average American's participation in the market used to be limited to buying and selling shares after a company made an initial public offering ("IPO"), a process managed by investment banks.² The emergence of "blank check companies"³ in the 1980s demonstrated the first attempt at providing the average American with a newfound opportunity to invest in a private company; however, due to the loose regulatory structure, early blank check offerings frequently took advantage of these non-institutional investors.⁴ Following an alarming presence of fraudulent investment schemes, the Securities and Exchange Commission ("SEC") promulgated Rule 419⁵ in efforts to enforce the Penny Stock Reform Act of 1990 ("PSRA")⁶ and halt the prominent defrauding of inexperienced investors.⁷

In their wake, innovative lawyers developed a new vehicle, Special Purpose Acquisition Companies ("SPACs"),⁸ to reinvent the concept of the blank check company—one that was uniquely situated outside the purview of the newly formed SEC regulations.⁹ To highlight their legitimate purpose, SPAC creators voluntarily implemented various investor protection mechanisms outlined by Rule 419 into the SPAC's structure.¹⁰

As the burdensome disclosure requirements from the SEC's enhanced regulations drove the costs for IPOs out of reach for many smaller companies, SPACs have exploded in popularity as a means to democratize capitalism by

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dethroning the investment banks' executive hold on the traditional IPO.¹¹ To effectuate this purpose, a SPAC will undergo a SPAC IPO, raising the capital necessary to embark on a two-year hunt for the ideal target company to bring to the public market.¹² Once a target company is identified, the SPAC will utilize a form of reverse merger to provide these small companies with a cash infusion and introduce them into the securities market.¹³

Since SPACs are still a relatively new vehicle in the market, legal scholarship surrounding SPACs has only recently begun to analyze their form.¹⁴ Nevertheless, the SEC has been paying particularly close attention to the new structure's activity with the purpose of determining what regulations—if any—are necessary to ensure SPACs do not abuse their position as an exclusion to the current rules.¹⁵ The recent surge in SPAC activity since 2020 raised concern for upcoming litigation arising from alleged deficiencies in disclosure, issues surrounding various financial statements, redemption rights, the exercise of warrants, and poor returns to investors.¹⁶ Accordingly, the SEC and its staff have

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provided numerous statements cautioning SPACs further away from actions that could mimic their fraudulent past.¹⁷ With these new statements clearly affecting the market presence of SPACs in the latter half of 2021,¹⁸ speculation has arisen as to whether additional regulation is needed to ensure SPACs do not echo the failed patterns of their ancestors.¹⁹

Looking to the evolution of the regulatory structure in the securities market and the uprising and evolution of the SPAC structure as an alternative offering to the traditional IPO, this Comment identifies weaknesses in the current SPAC form and sheds light on the falsity of the commonly echoed notion that SPACs are a more efficient, functional equivalent to the traditional IPO.²⁰ This Comment reveals, instead, that the current SPAC structure shortchanges its investors in a desperate attempt to persist as a legitimate vehicle to bring a private company into the public market.²¹ This Comment advocates for self-reform as the means to address the current SPAC structure's key weaknesses without compromising SPACs' unique positioning as modern blank check offerings.

An understanding of the history surrounding SPAC mechanics is crucial to grasp the issues embedded deep within its current form. Accordingly, Part I explores the history of the market regulatory framework, walks through the rise and subsequent fall of SPAC's early fraudulent ancestors—blank check

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companies—and describes the SEC's attempt at mitigating fraud in the market. Part II pivots toward the SPAC structure, discussing its general form, key features distinguishing it from its fraudulent counterparts, and its life cycle, and illuminates its development as an alternative to the traditional IPO. Part III assesses existing tensions between the sponsor, investor, and target company IPO and provides empirical data to illuminate the ongoing issues within the SPAC structure: disappearance of investor voice,²² poor investor returns as a result of dilution, deficiencies in disclosure, and issues surrounding due diligence. Finally, Part IV proposes potential solutions for each of the above issues and argues these issues should be addressed by SPAC creators rather than by additional regulation from the SEC in efforts to prevent potential overregulation from driving the SPAC structure to extinction.

I. SETTING THE STAGE: UNDERSTANDING THE MARKET REGULATORY FRAMEWORK

Part I explores the development of the securities market regulations most relevant to the unique positioning of the SPAC structure to shed light on how the SPAC structure plays upon the gaps in the existing regulations. Section A outlines...