There has been a lot of turmoil in the SPAC market lately, especially since the SEC announced its proposed rule changes. Everyone is trying to figure out what steps to take next. I recently sat down with three SPAC experts to get their take on the current situation and what’s ahead.
Here are highlights of my conversation with Sarah Mitchell, a partner in the Dallas office of Vinson & Elkins in the mergers and acquisitions and capital markets group; Rebecca Fike, a partner in the Dallas office of Vinson & Elkins, who rejoined the firm earlier this year after spending 10 years at the SEC in the enforcement division; and Kristi Marvin, a founder of SPAC Insider, a data and analysis firm.
Liquidations in the SPAC Market
Yelena Dunaevsky: Kristi, can you please take us through the liquidation numbers you’re seeing out there?
Kristi Marvin: In any given year—other than this one—typically, there are between three to five liquidations. On average looking back at 2019 and before, about 5% of whatever was issued each year was liquidated. If we apply that to the current year, where we have 587 SPACs out searching for targets, even if you double the numbers because everyone is expecting a lot more liquidations, we should be seeing something close to about 60 liquidations.
We have seen 10 so far this year. We’ll most likely see many additional liquidations come in the first quarter of 2023. Most SPACs are probably just going to have to let the clock run out instead of liquidating early and that clock is going to run out for most of them in the first quarter of 2023. We have 313 SPACs with expiration dates in the first quarter of 2023, so it could be a very, very big number of liquidations.
SEC has been also getting rid of abandoned registration statements that were filed but had not been touched or updated in more than nine months. And some SPACs have chosen to withdraw their registration statements instead of keeping them on file.
Right now, we still have 140 SPACs still on file to IPO. Many of those will never IPO, but that number has been greatly reduced from the beginning of the year, when it was closer to 300. Since then, we’ve had 93 registration withdrawals and 40 abandonments. That is a significant amount.
Yelena Dunaevsky: What are you seeing teams do to prepare to get ahead of this looming liquidation wall?
Kristi Marvin: It is beneficial to shareholders to liquidate early because having their money tied up in a trust account for another 12 months will only earn another five to 10 cents of interest.
Many teams are out there still grinding away, trying to find a deal. It’s just really challenging right now, and that’s obviously not just the stock market. It’s the larger capital markets.
Yelena Dunaevsky: What kind of risks could we be seeing after liquidation?
Sarah Mitchell: From my perspective, a SPAC has been a public company for the time period from that IPO until it liquidates.
Directors and officers are going to remain liable for anything that happened in that period under the SEC rules and as targets of any plaintiff’s action brought by the shareholder. I think the chances of that kind of lawsuit or SEC enforcement action are much lower than they are if a de-SPAC transaction closes and there’s a go-forward company that suffers a stock drop in the future.
That said, you can never say never, and I think it’s a scary thing for an individual to choose to not pay this premium for the D&O tail and know that they will not be protected should the SEC come knocking in the next six years.
Some will choose to take the risk with their personal assets and know that they might get sued. SPAC teams are sometimes a little surprised by the amount of money they may need to spend in a liquidation scenario.
It depends partly on how much you raised at your SPAC IPO, how expensive your policy is, and just how much you’re willing to spend.
What About SEC Enforcement?
Yelena Dunaevsky: Litigation is not the only risk. What enforcement actions do you foresee from the SEC?
Rebecca Fike: We should expect more to come; it takes one to two-plus years to run a full enforcement action before anything becomes public. When the SEC started bringing some SPAC actions, everyone expected there to be an avalanche of them. There could still be plenty to come.
At the end of the day, the cases will come down to traditional misrepresentation or omission fraud cases.
Yelena Dunaevsky: Do you think the SEC could start bringing enforcement actions based on what people are not doing to comply with the non-final rules?
Rebecca Fike: It will be challenging until the rules pass anyway. That said, people should get used to disclosing things in the way that is proposed.
Yelena Dunaevsky: Many bankers are worried about Section 11 liability in the SEC proposal. What are you hearing on the banking side?
Kristi Marvin: If I call five different bankers on the same day, I’ll probably get five different answers. And if I call them the following week, they may have changed their minds. No one can seem to come to a conclusion yet.
Everybody is putting their heads together to think of a better SPAC without knowing what the framework is going to look like.
Getting Ahead of Potential Litigation
Yelena Dunaevsky: Many people are trying to come up with ways of getting ahead of potential claims. What advice are you providing to your clients in terms of litigation?
Sarah Mitchell: One new trend we’re starting to see is litigation between SPACs and their targets even after the signing of the business combination agreement. Suddenly markets are not looking as good as they did, and somebody wants to get out of the deal.
Another problem I’m seeing is private targets entering into de-SPAC conversations without D&O insurance already in place. When you have litigation by the SPAC involving alleged misconduct by the directors and officers of the private target, and there’s no D&O insurance, the only protection is the indemnity from the private company. That protection will be only as good as the balance sheet of that private company.
One thing in terms of insurance planning that’s become a sticking point in business combination agreements is an identification for the SPAC sponsor. This is because the D&O insurance policy will cover the de-SPAC go forward public company itself, subject to the terms and conditions of the policy.
But the SPAC sponsor is not an insured under that policy, and if the SPAC sponsor is a private equity company, it might have its own form of insurance. If it’s not, it might have some kind of insurance that covers SEC enforcement actions. Or it might not.
One of the issues in negotiating these agreements is: Who will provide the insurance and what does the coverage look like?
How Does the SEC View Short Seller Reports in This Market?
Rebecca Fike: Short seller reports—depending on the short seller—can be like a whistleblower report. They can give you information that a regulator might not otherwise have had.
You need to keep kicking the tires to see if any of that might be true and see if it would be worth reaching out to the company. And maybe even call the person who wrote the report with questions about where the information came from.
Yelena Dunaevsky: In terms of short seller reports in numbers, we looked at how many of the securities class actions came after a short seller report.
In 2021, there were 13 out of 33, which was about 40%. And by mid-May 2022 year, there were five out of 16, which is about 30%. So, it’s a fairly significant number.
The Importance of Due Diligence
Sarah Mitchell: Performing due diligence is the number one thing you can do to de-risk your transaction. And that includes going out and getting third-party advisors to do the due diligence.
The other thing is to document your diligence with written reports from your advisors and your board minutes that show you have discussed the scope of the diligence and the findings.
Rebecca Fike: Many people will be looking at that diligence and asking questions, whether because of a short seller report, a whistleblower, or for some other reason.
So, they’re now looking at the diligence. They will want to know whether the SPAC asked questions about this issue. What did the target say? What did they have to support this? And that’s where documentation is so important.
I cannot stress the importance of diligence and documentation enough. From my former SEC perspective, most investigations are a year-plus to two years later. When you’re being asked very detailed questions by the SEC two years later, it’s nice if you can point to a spreadsheet, a chart, and an email chain.
I think you should assume someone is going to look at this at some point. And this is a case where not remembering is not helpful. Not remembering is not a good answer.
Yelena Dunaevsky: One of the solutions we’ve come up with is to have the team going ahead with a merger with a target undergo the process of obtaining Reps and Warranties insurance. That process bolsters the diligence process and the defense, should one be needed, against claims of insufficient diligence.
It’s all on record and very clear who reviewed what, what was known, and what was unknown.
How Can SPAC Participants Do More to Protect Themselves?
Sarah Mitchell: One of the trickiest pieces is that the private company D&O policy looks very different from the public company D&O insurance policy. It’s intended to cover private company risks and not public company risks, such as filing documents with the SEC.
That’s why I want to talk to clients as soon as possible—before they engage in the SPAC conversations. Talk to your broker. Talk to your lawyer. Get the policy in place to have the best protection you can. It can be very tricky to structure, and it needs to be done correctly.
Look at your risk management program top to bottom. Think about claims that could be brought against directors and officers of the target, of the SPAC, of the SPAC sponsor. And think about what is in place to protect them if the claim was brought prior to closing or after.
And I’d also say, don’t just think about de-risking D&O insurance-type claims. Think about de-risking the rest of the program.
If it’s a pre-revenue company, what other kinds of insurance does it need to have in place if it’s going to be an operating company? Do you need to disclose that it doesn’t have insurance as you go forward under the SEC rules as a public company? There are a lot of risk management pieces that need to be in place as you as you go through this process.
Yelena Dunaevsky: I think we are all in agreement here that you need to talk to your advisors.
What Does the SPAC Market Have in Store for Us?
Kristi Marvin: In my recent newsletter, I went back through the past four years and found that every summer, there was some SPAC news that was completely out of left field. We don’t know what’s coming next, but something weird probably will. We’ll have to wait to see.
But I think it’s going to be more of a waiting game until we get the final SEC proposal. Once we get that final paperwork in the fall, we will start to see some additional IPOs.
Markets like these never stay this way forever. At some point, they will moderate.
Yelena Dunaevsky: Yes. Everyone’s going through similar painful uncertainty right now. It is good to speak with as many of your SPAC friends as you can find.
Contact your lawyers and your brokers. We are all working on solutions for these problems, and there are new solutions in place that might not have existed just a few weeks ago.
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