SPAC BOARDS and the FRANCHI COMPLAINT: an SPAC directors avoid a 'conflict-laden' invitation to fiduciary misconduct?

• Author: Placenti, Frank M.
• Position: SPACS

Without a doubt, the trendiest transactions on Wall Street from 2020 into 2021 have been the formation of special-purpose acquisition corporations (SPACs) and the follow-on mergers (known as "de-SPAC" transactions) that enable private companies to achieve public company status without the rigors, risks and expenses associated with traditional IPOs.

Standard & Poor's Capital IQ database reports that 294 SPACs formed in 2020, up from 51 in the prior year and more than double the number of SPACs formed in the prior three years. Equally impressive is the long list of prominent individuals associated with SPACs. Their credentials (or at least notoriety) conferred an aura of respectability upon this asset class that it had not previously enjoyed.

The sheer volume of recent SPAC transactions, coupled with the impressive pedigrees of some SPAC sponsors, suggest that they have made real progress toward overcoming the taint associated with their ancestors. The much-maligned reverse shell mergers of the early 2000s and discredited "blank check" public companies of the 1980s have moved more into the mainstream of the U.S. capital markets.

Even so, a recently filed Delaware class action complaint contends that the typical SPAC governance structure is so "conflict-laden" that it "practically invites fiduciary misconduct."

Filed in April 2021, Franchi v. Multiplan Corp., et al. challenges the way most SPAC boards are structured and compensated, as well as the less than rigorous manner in which some de-SPAC transactions have been executed.

Do SPAC directors have a structural conflict?

As the Franchi complaint portrays it, the heart of the problem is that most SPAC directors are compensated with heaping portions of founders' shares either as an outright grant or purchased for a nominal amount, sometimes as low as $25,000. These founders' shares are potentially worth millions of dollars to individual directors if a de-SPAC transaction is completed and the market assigns even a lackluster valuation to the post-merger public company.

However, under SEC rules and market practice, if no suitable merger candidate is found within two years, the SPAC's initial public investors receive their money back with interest, the SPAC folds and the directors' shares become essentially worthless. Given this financial version of "Sophie's choice," Franchi sees SPAC directors as hopelessly conflicted when deciding whether to support a de-SPAC transaction.

It is, of course, quite common for public company directors to hold shares when acting on...