SPACTIVISM.

• Author: Hannes, Sharon

Table of Contents I. The Unlocked Potential of Shareholder Activism II. Scaling-Up Activism: Introducing Activist SPACs A. The Backdrop of Activist SPACs 1. Overview of SPACs 2. How does a SPAC work? 3. The Advantages of SPACs B. The Unique Structure and Features of Activist SPACs III. The Potential Impact of Activist SPACs A. The World of Activism with Activist SPACs 1. Forming a Market for Activism: Improving the Functioning of Activism 2. ESG-Oriented Activism 3. Activist SPACs ' Impact on the Scope of Activism: Widening the Scope of Activism B. Activist SPAC as the "Poor Man 's " Activist Hedge Fund IV. Potential Objections A. Why Doesn't the Market Generate Activist SPACs? B. Does the Activist SPAC Conflict with the Investors Advisors Act and the Investment Company Act? C. Is There a Real Need for Activist SPACs? Conclusion Introduction

There is much to commend about shareholder activism. (1) Supporters of shareholder activism point to its potential to enhance firm value by disciplining management and improving corporate governance. At present, however, there is an inherent limitation on the potential of shareholder activism to serve as an antidote to corporate failures: its limited scale and uniform character. The central players in shareholder activism are activist hedge funds. The resources they can deploy toward engagements are limited: in 2020, activist hedge funds initiated campaigns in only 80 (2.3%) of the 3,463 U.S. publicly traded firms with a market cap of at least $500 million. (2) Needless to say, only a fraction of the activist campaigns are successful. Evidently, in its present form, shareholder activism falls short of realizing its full potential.

The main reason for the limited reach of hedge funds is regulatory. The regulatory framework that applies to activist hedge funds practically forces them to raise money only from private sources, such as private equity firms, pension funds, and affluent individuals, thus constraining their ability to increase the funds that can be used toward engagements. (3) Investments from such private sources are dwarfed by the universe of public investments. The capital deployed by activist hedge funds in the U.S. market in 2020 amounted to $39.6 billion. (4) This sum may seem large, but it is only a tiny fraction--0.0322%--of the market cap of all U.S. public firms, which exceeded $50 trillion. (5)

Activist hedge funds are de facto precluded from raising money from the public for several reasons, especially since it would legally bar them from obtaining their traditional compensation package. (6) In addition, Securities and Exchange Commission (SEC) regulations condition raising funds from the public on extensive and comprehensive disclosure. Specifically, there are strict restrictions on public offerings that do not disclose a "specific business plan or purpose." (7) Among other things, this regulation requires the issuer to allow public investors to withdraw their funds prior to the materialization of its business endeavor.

However, the business model of activist hedge funds critically depends on secrecy until a later stage. Complying with the SEC disclosure rules would inhibit activist hedge funds from forming a position under the market's radar--an indispensable aspect of the business model shared by all activist hedge funds. Activist hedge funds search for underperforming companies, identify major deficiencies, and then devise an alternative strategic business plan in order to serve as a remedial measure and increase value. The recoupment of these costly undertakings comes, if at all, months later when the activist hedge fund sells its shares. For recoupment to occur, activist hedge funds must act covertly until the time of the engagement, buying their major stake at a low price. Otherwise, if information about the engagement reaches the market ahead of time, the target's share price will rise before the activist buys its stake, which will foil the hedge fund's plan by rendering it much less profitable. (8)

In this Essay, we introduce a modified version of the Special Purpose Acquisition Corporation (SPAC) which we dub the Activist SPAC. The Activist SPAC is a corporate form uniquely designed for the special needs of shareholders' activism, while raising capital from the public. Our proposal draws inspiration from an existing corporate form, the Special Purpose Acquisition Corporation (SPAC). The SPAC corporate form allows the public to commit funds to acquire a private company. The private target is unknown at the time of the investment, and the funds committed by individual investors are held in trust until a target is identified. Once the target is chosen, its identity is disclosed to the individual investors, who get to decide whether to withdraw their money and receive interest on their investment or go along with the acquisition plan. In 2020 alone, SPAC initial public offerings (IPOs) raised $83.4 billion, more than two times as much as all activist hedge funds. (9)

Similar to the traditional SPAC, the Activist SPAC would allow the public to commit money to a concrete purpose. Yet, there would be several critical differences between the two. As opposed to the SPAC, Activist SPACs would target a public company, selected for the purpose of an activism campaign, rather than a private company. Limiting the Activist SPAC investment to public firms would also enable it to overcome many of the existing problems with traditional SPACs. Additionally, the money invested in Activist SPACs would not be directed toward a full acquisition of (or merger with) its target, but rather toward purchasing a block of shares, normally 5%--10%,10 that would enable changing the course of the target corporation.

Another difference between Activist SPACs and traditional SPACs stems from the need of activist hedge funds to keep the identity of the target corporation under wraps prior to the engagement. Unlike the SPAC, the Activist SPAC, as we envision it, would not be required to announce its target ahead of the time of purchase. Investors in the Activist SPAC would be given an opportunity to redeem their investment following the transaction. Following the acquisition of its stake in the putative target, the Activist SPAC would have to disclose its planned strategy for activism. Such plans could have a similar form to the "white papers" that activist hedge funds send to the management of the target company and its major shareholders, in an effort to convince them why a certain change in the company is needed. (11) Such white papers would detail the strategic change the Activist SPAC would like the company to adopt, present material support for the claim that such a change is desirable and feasible, and provide an estimate of the increase in value the change may generate.

As is the case with traditional SPAC investors, Activist SPAC investors would be able to redeem their shares and receive their initial investment. (12) Moreover, the Activist SPAC would have to note in advance the rate of non-redeeming shareholders that would be required for advancing its Activist campaign, and thus also provide a market check on its strategy. A 50% threshold, representing a simple majority, seems reasonable, unless the Activist SPAC has reasons to suggest a different threshold.

Importantly, the amount received upon redemption would be capped at the amount of the initial investment, even if there is a spike in the price of the target--and as a result, in the shares of the Activist SPAC. Such cap would prevent a "stag hunt" dynamic whereby investors may prefer to redeem their shares right after the potential spike in the value of the target at the time of the announcement, rather than wait until the goal of the activist campaign materializes. (13) This dynamic, when shared by many shareholders, could prevent the actual activist campaign from being executed, as the capital the Activist SPAC will have left to deploy may be insufficient, and may not pass the threshold of supporting shareholders it has set in advance.

The redemption right in Activist SPACs would be more restricted than SPACs in two dimensions. First, as mentioned before, the Activist SPAC shareholders would have a redemption right only after the company has formed its investment position. Second, each investor would not have an absolute right to receive her initial investment plus accrued interest. Because the Activist SPAC incurs costs prior to selecting the target, and given that the target's share price may depreciate in value for various reasons, the funds available for redemption may, in some cases, be lower than the funds initially invested. We believe that this additional risk to Activist SPAC investors is warranted--as it is not considerably different than the risk pattern of investments in public companies in general. Ordinary SPAC shareholders invest in private companies that are not subject to the same stringent disclosure requirements that apply to public ones, and thus do not benefit from the price transparency of publicly traded firms. Hence, there is a serious risk that SPACs are overpaying for the target. Activist SPACs, in contrast, target public corporations that must comply with all SEC regulations. Public corporations offer much greater transparency, and therefore, pose a much smaller risk to investors. In other words, Activist SPAC shareholders are exposed to market fluctuations in the share prices of the activism target, but not to overvaluation by the Activist SPAC managerial team. After all, the activist SPAC purchases the shares of the target on the public market, which prices financial assets efficiently.

Implementation of our proposal can expand the horizons of activism. If Activist SPACs manage to raise even 10% of the amount raised by SPACs in 2020 (over $80 billion), (14) it will significantly increase the resources available for shareholder activism. Hence, the...