What could Aristotle possibly have to say about SPACs? In remarks on Thursday before the Healthy Markets Association, SEC Chair Gary Gensler shared his thoughts on the regulation of SPACs with a theme drawn from antiquity: Aristotle’s maxim that we must “treat like cases alike.” That concept, in Gensler’s view, should apply as finance evolves in response to new technologies and new business models. Take SPACs, for example—a type of transaction that, while not exactly new, has really “taken off in the last couple of years.” A SPAC, he said, is really an alternative method of conducting an IPO. The question addressed by Gensler in his remarks is how “this competitive market innovation [should] be treated under our public policy framework,” in effect, giving us a preview of what we may see in SPAC rulemaking, possibly next year.
According to Gensler, in 2021, there were 181 SPAC target IPOs, or de-SPAC transactions, with a total deal value of $370 billion, a substantial increase from just 26 SPAC target IPOs in 2019. Given this surge in SPAC activity, “which principles and tools do we use to ensure that like activities are treated alike?”
With regard to principles, Gensler points to three: leveling out information asymmetries; guarding against misleading information and fraud; and mitigating conflicts among parties that may have different incentives. To address these issues, Gensler highlights several policy tools for public offerings that were adopted back in the 1930s but remain central, including the need to provide full and fair disclosure on a timely basis, prohibiting the use of sales tactics to “condition the market” before the required disclosure reaches investors, imposing obligations on various gatekeepers (such as auditors, brokers and underwriters) “to stand behind and be responsible for basic aspects of their work,” and creating the SEC to serve as the “federal cop on the beat.”
In the context of SPACs, Gensler believes that a de-SPAC transaction is functionally “akin to a traditional IPO.” If we are going to treat like cases alike, then “investors deserve the protections they receive from traditional IPOs.” Yet Gensler is concerned that, whether at the time of the initial SPAC blank-check IPO or the de-SPAC merger, information asymmetries, fraud and conflicts are not being adequately mitigated and that SPAC investors are not receiving “the protections they would get in traditional IPOs, with respect to disclosure, marketing practices, and gatekeepers.”
For example, SPACs may involve even more conflicts than traditional IPOs, such as the conflict between the investors who vote and then redeem their shares to cash out and those who stay through the transaction. Do they have the same incentives in the deal? Could potentially misaligned incentives result in enrichment of some parties at the expense of others?
Gensler indicates that, “to reduce the potential for such information asymmetries, conflicts, and fraud,” he has “asked staff for proposals for the Commission’s consideration around how to better align the legal treatment of SPACs and their participants with the investor protections provided in other IPOs, with respect to disclosure, marketing practices, and gatekeeper obligations.” (The SEC’s reg-flex agenda identifies 4/22 as the target date for issuance of a proposal on SPAC regulation. (See this PubCo post.))
Disclosure. Gensler maintains that the level of disclosure can vary significantly among the different parties to the SPAC transaction. For example, Gensler contends, “PIPE investors may gain access to information the public hasn’t seen yet, at different times, and can buy discounted shares based upon that information,” while “retail investors may not be getting adequate information about how their shares can be diluted throughout the various stages of a SPAC.” Are retail investors adequately advised that the 20% of the equity that typically goes to SPAC sponsors if they complete a de-SPAC transaction “largely falls on the ‘remainers,’ not those who cash out after the vote”? Gensler has asked the staff for recommendations for better disclosure “about the fees, projections, dilution, and conflicts that may exist during all stages of SPACs, and how investors can receive those disclosures at the time they’re deciding whether to invest. [He has] also asked staff to consider clarifying disclosure obligations under existing rules.”
Marketing practices. Gensler suggests that, with slide decks and press releases available at announcement, and even celebrity endorsements, “SPAC sponsors may be priming the market without providing robust disclosures to the public to back up their claims. Investors may be making decisions based on incomplete information or just plain old hype.” Staff recommendations for rulemaking will likely include approaches to prevent improper conditioning of the de-SPAC target market, such as requiring “more complete information at the time that a SPAC target IPO is announced.”
Gatekeeper obligations. Who are the gatekeepers for the de-SPAC merger process? In traditional IPOs, investment banks are considered the “underwriters,” but, Gensler reminds us, the law “takes a broader view of who constitutes an underwriter.” Gensler expresses concern that there “may be some who attempt to use SPACs as a way to arbitrage liability regimes. Many gatekeepers carry out functionally the same role as they would in a traditional IPO but may not be performing the due diligence that we’ve come to expect. Make no mistake: When it comes to liability, SPACs do not provide a ‘free pass’ for gatekeepers.”
Citing John Coates, then-Acting Director of Corp Fin, Gensler repeats Coates’ contention that “[a]ny simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst.” Accordingly, it appears that we can expect to see rulemaking that seeks to “better align incentives between gatekeepers and investors” and to “address the status of gatekeepers’ liability obligations.”
Cop on the Beat. The Enforcement Division, according to Gensler, is the “cop on the beat.” Here he notes Enforcement’s charges brought in July against a SPAC, its sponsor, its CEO and the merger target and its CEO.
It’s worth noting that, in the end, not only does Gensler believe that SPAC investors deserve the same protections as investors in traditional IPOs, he also may be hinting at future recommendations, observing that “these innovations around SPAC target IPOs remind us that there may be room for improvements in traditional IPOs as well.”