SPAC Losses:  Lawsuit and Arbitration Recovery Options

No one can tell you with certainty whether an investment in an innovative company or any business will be truly successful. Whether you invest in the market or want to build your retirement security from the ground up or save for a big life event, like your children’s college education, there is one guarantee. Investors are protected by the law. You have legal rights. It is possible to obtain a financial recovery from a defective security offering, such as an improperly devised SPAC. Arbitration is one means for an efficient and a speedy recovery for your investment losses. You need the right team beside you at every step along the path, to check to ensure what’s been done has been done correctly and fairly.

The investor rights services arm of the firm provides this function for everyday investors like you across the country. We understand that attention to detail can mean the difference between success and failure – we anticipate the issues and address them before they become problems. And if discover new issues affecting your rights and causing problems? We can tackle those, too.

Please review the following news articles about issues in the SPAC marketplace that may have affected you and your investments. You can contact us for a free consultation about the next steps.

Recent SPAC News Articles

The SPAC Ship Is Sinking. Investors Want Their Money Back.

One of the pandemic’s hottest trades is cooling down, as the hype surrounding ‘blank-check’ companies gives way to reality

Wall Street Journal, by Amrith Ramkumar, Jan. 21, 2022

by Matthew Frankel, CFP®, Aug 22, 2021

Attention to detail of your case

Special Purpose Acquisition Companies (SPACs): Issues for Investors

This article explains SPACs in simple terms, outlines the process as compared to a traditional IPO, provides an illustrative case study, shows growth trends, suggests a lack of viable targets, and questions whether adequate investor protection exists.

Special purpose acquisition companies (SPACs) explained

According to the accounting firm PwC, SPACs “are ‘blank check’ companies created solely to raise capital through an IPO in order to merge with private companies.” What does that mean in English?

To simplify, a group of executives, sometimes with a celebrity, get together to become the founders of a Special Purpose Acquisition Company (SPAC).

The purpose of the SPAC is to acquire something.  What will the SPAC acquire?  No one knows.  But based on the experience of the SPAC’s founders, the hope is that the SPAC will acquire something valuable.

At this point, the SPAC retains an investment bank to do an Initial Public Offering (IPO), inviting the public to buy shares of the SPAC’s stock in the form of “units”.  The founders, who contributed very little money to the SPAC, keep about 20% of the units.

If the SPAC does not acquire anything by a certain date after the IPO (generally 2 years), then the investors get their money back.  Thus, the founders are under intense pressure to make an acquisition quickly.

If all goes according to plan, the founders identify a target to acquire, usually a non-public company.  If the target agrees, then the SPAC unit holders vote on the acquisition, and if approved, the acquisition goes forward.  Thus, the previously non-public company is essentially converted into a public company.

Historically, roughly 90% of SPACs completed an acquisition generally taking almost the full 2 years to do so.  In 2020, only 50% of SPACs have so far completed an acquisition, with a much shorter acquisition time of only 7 months.

Proponents of SPACs argue that a SPAC is a much faster and less expensive method of taking a target public than doing an IPO for that target.  Notably, critics argue the same thing with the explanation that longer timelines and IPO regulatory hurdles result in more scrutiny and thus better investor knowledge respecting the target’s prospects as a public company.

Special Purpose Acquisition Company (SPAC) v. Initial Public Offering (IPO): The Process

A traditional IPO has significant protections in that the company must make detailed disclosures involving its finances and operations.  Company executives also go on “road shows” to convince institutional investors to buy during the IPO.  These institutional investors ask probing questions, seek expert opinions, and stress test management assumptions.

Theoretically, each SPAC goes through an IPO, but at the time, the SPAC has no business other than to acquire something.  No target is identified, and no track record of earnings or business methods exists.  Thus, disclosures are limited, and the approval timeline compressed.

A debate is raging over what needs to be disclosed during a SPAC acquisition.  Some argue that IPO-level disclosures are required, while others disagree and further claim any liability is eliminated by a safe harbor.  Importantly, the information that matters resides with the target, so the SPAC may lack the ability to make robust disclosures.

Furthermore, during the acquisition phase, the target’s management provides projections on the target’s future growth and earnings, usually 4-5 years down the road, which is conveniently outside the statute of limitations for a securities fraud claim, assuming one is even viable.

By contrast, in an IPO, management is prohibited from projecting future earnings.  Instead, the investment bank’s independent analysts make the projections as to future growth and earnings, providing a check on the rose-colored glasses worn by most people promoting their business.  In a SPAC, independent analysts examine the target after the acquisition takes place, and those analysts have, in many cases, disputed the rosy pre-SPAC projections.

Special Purpose Acquisition Company (SPAC) v. Initial Public Offering (IPO): A Case Study

The We Company (WeWork) was valued at $47 billion and widely lauded for its vision and potential, including being named one of three “unicorns to bet on” by Fortune magazine.  But August 2019 mandatory Pre-IPO filings detailed significant problems, including:

  • We had … net losses of $0.4 billion, $0.9 billion and $1.9 billion for the years ended December 31, 2016, 2017 and 2018, respectively, and $0.7 billion and $0.9 billion for the six months ended June 30, 2018 and 2019.
  • We have in the past experienced, and expect to continue to experience, membership agreement terminations. In many cases, our members may terminate their membership agreements with us at any time upon as little notice as one calendar month.
  • We currently lease a significant majority of our locations under long-term leases that, with very limited exceptions, do not contain early termination provisions.
  • We … have entered into several transactions with our Co-Founderand Chief Executive Officer, Adam Neumann, including leases … [that] present potential for conflicts of interest…
  • We may be unable to adequately protect or prevent unauthorized use of our trademarks and other proprietary rights and we may be prevented by third parties from using or registering our trademarks or other intellectual property.
  • Our future success depends in large part on the continued service of Adam Neumann, our Co-Founder and Chief Executive Officer, which cannot be ensured or guaranteed.
  • Adam Neumann will control a majority of our voting stock upon completion of this offering.

Thereafter, significant negative and bizarre news began to surface about Adam Neumann.  After the disclosures, failed IPO, and resulting transactions, The We Company valuation ultimately fell to under $3 billion and Neumann resigned.

Had The We Company “gone public” through a SPAC acquisition, possibly none of its disclosures would have been available to investors during the process.  If you think that investors would have discovered such information during the SPAC merger, consider that the issues subsequently revealed in the IPO filing existed when SoftBank Founder and CEO Masayoshi Son – one of the world’s most savvy tech investors – invested $18 billion in The We Company, an investment he later called “foolish”.

Special Purpose Acquisition Company (SPAC) Growth

Historically, SPACs made up a tiny share of IPOs.  By 2020, however, SPAC IPOs outnumbered all other IPOs.

As a result of this growth, many law firms and investment banks – who earn fees from the process – are touting SPACs as investment vehicles.  A recent study of SPACs that sold at $10 per share in the IPO determined that the subsequent merger reduces the cash per share by nearly 50%:

For SPACs that merged during our primary sample period of January 2019 through June 2020, mean and median net cash per share were $4.10 and $5.70, respectively. Between June 2020 and November 2021, net cash per share was somewhat higher but far below $10. We find that SPAC costs are not born by the companies they take public, but instead by the SPAC shareholders who hold shares at the time SPACs merge. These investors experience steep post-merger losses, while SPAC sponsors profit handsomely.

Michael Klausner, Michael Ohlrogge and Emily Ruan © 2022.

Renaissance Capital surveyed 93 SPACs that completed a merger since 2015 and found that only 31.1% of the SPACS posted positive returns and that overall, the common shares lost on average -9.6%, with a median return of -29.1%. This is compared to the traditional IPO average aftermarket return of 47.1%.

Another way investors have bet on SPACs involves options, a sophisticated transaction that online trading apps have simplified.  Options invite the investor to bet that the unit (or other instrument) will be trading above a certain price before a certain date.  The investor can then exercise the option and buy at that price, even if the actual market price is much higher.  If the price never exceeds the option price during the set period, then the option expires, and the investor can lose the entire investment.

Special Purpose Acquisition Companies (SPACs): Are there enough viable targets? 

Of 2020’s 248 SPAC IPOs, nearly half still need to acquire a target.  Of 2021’s 613 SPAC IPOs, 82% still need to identify a target, and only 3% have completed an acquisition.

Although over 90% of 2015-2019 SPAC IPOs acquired a target, there were only 13-59 SPAC IPOs in any of those years.  That’s 172 SPACs spread over 7 years (5 years plus the 2 years allowed for an acquisition).

Today, over 500 SPACs have less than two years to complete an acquisition, and more than 120 SPACs have less than one year.  Further, SPACs acquired over 200 targets between 2018-2020, removing those targets from the market.

Add the disruption to businesses caused by the pandemic, and wonder: Do enough viable targets exist?  Because the targets are all private companies that have not made financial disclosures, no one can accurately answer that question.

Special Purpose Acquisition Companies (SPACs): What mechanism exists to protect investors?

In most instances, an IPO has a “lockup period”, where IPO investors must hold their shares for up to six months after purchase.  By contrast, a SPAC investor may sell shares immediately after the merger.  This structural difference may eliminate a significant protection for investors.

Specifically, in theory the holders of units who bought during the SPAC IPO will scrutinize any potential purchase and vote down a bad deal.  Historical trading volumes, however, suggest that many SPAC unit holders sell right after the merger, meaning those investors are more interested in hyping the acquisition than in scrutinizing it to reveal potential flaws.

In addition, the over 620 SPACs currently seeking targets are under enormous time pressure to close an acquisition.  A compressed time schedule means less time for due diligence by the SPAC founders and investors.

The laws of supply and demand may also apply, increasing the amount the SPAC will have to pay to acquire the target and reducing the due diligence the target allows to take place.  If the market perceives the SPAC overpaid for the target, that may damage the stock price.

Finally, once the SPAC effectuates the merger, the merged target effectively becomes a public company, with all the related securities disclosure obligations.  Thus, had The We Company been acquired by a SPAC, the SPAC would have been required in post-merger filings to reveal the truth, which would have been absolutely devastating to a $47 billion acquisition.

As noted above, whether any liability at all can attach to the SPAC’s sponsors through a securities fraud lawsuit is the subject of fierce debate.  Such lawsuits typically proceed as class actions, where, in many cases, even large settlements obtained after years of litigation produce less-than-satisfactory results for individual investors.

In the alternative, an investor might seek FINRA arbitration against the broker who sold the SPAC investment.  FINRA arbitrations often turn on whether the investment was “suitable” for the individual investor.  In the face of losses, investors may well take the position that the fundamentals of the SPAC market alone made the SPAC unsuitable for investment.

Because FINRA cases do not require the same level of formality and motion practice as a court case, they proceed much faster, often resolving within a year of filing.  Although FINRA would provide the investor with a potential source of recovery, the investor would not be able to hold the SPAC sponsors or target management accountable through FINRA, unless they were also the broker.

Conclusion

The truth about the SPAC process, structure, and results is difficult for investors to obtain or understand.  The fact is that the SPAC phenomenon with limited exceptions has so far produced poor results for investors.  Whether the unprecedented mass of new SPACs seeking a shrinking number of targets will change that seems unlikely.