SPACs and the End of Technological Mystification
Posted on Oct 26, 2021Vinay Sridharan
Special-purpose acquisition companies, or SPACs, may go out on a high. Even in the wake of Grab Holdings’ record $40 billion SPAC merger, fears abound that the SPAC bubble is bursting.[1] Such concerns are driven primarily by increased regulatory scrutiny from the Securities and Exchange Commission (“SEC”), which worries that investors do not fully recognize the risks inherent in SPACs.[2]
SPACs are “blank check” companies that are used to take companies public without the usual IPO process.[3] The SPAC’s management team forms the SPAC as a new public company with the explicit intention to find and merge with a yet to be identified private company.[4] The mechanism has proved highly popular; 59 SPAC IPOs in 2019 were proceeded by 230 IPOs in 2020.[5] IPO activity exceeded this benchmark in the first quarter of 2021 alone, with 298 SPACs raising nearly $88 billion dollars and 430 SPACs actively seeking a merger target.[6] A third of SPACs are targeting the technology sector, giving the industry an outsized share of in SPAC activity.[7] Such a pairing is natural as technology companies are by their nature speculative and perceive SPACs as a means to propel their speculative growth.[8] Technology companies (often nowhere near profitability) may perceive SPACs as a means to grow based on forward-looking projections without the strict scrutiny applied to such forecasts in a traditional IPO process.[9]
The SEC casts strong doubt on that rationale in a recent statement.[10] In the statement, the Acting Director of Corporate Finance, John Coates, questions whether the safe harbor provision of the Private Securities Litigation Reform Act (“PSLRA”) offers SPACs providing forward-looking projections any additional legal protection over an ordinary IPO process.[11] Under certain conditions (e.g. when accompanied by meaningful cautionary statements), the PSLRA provides companies protection from private litigation under the Securities Act of 1933 and the Securities Exchange Act of 1934 when forward-looking statements omit, or untruthfully state, a material fact.[12] Perception that SPACs enjoy this safe harbor protection and can therefore make more aggressive forecasts when merging with a private company (the “de-SPAC”) may even be driving the current SPAC boom.[13]
Coates begins by indicating that SPACs are subject to other disclosure laws which may effectively obviate any legal benefits from the safe harbor provision.[14] He then goes on to question whether the PSLRA even provides protections to de-SPAC transactions.[15] Initial public offerings are excluded from the safe harbor provision of the PSLRA but the term “initial public offering” is never defined.[16] Coates implies that de-SPACs should be interpreted as an IPO because de-SPACs and traditional IPOs are essentially economically equivalent in that both introduce a new company to the public.[17] Given the current SPAC frenzy—at least five electric-vehicle companies project that they’ll beat Google’s record and make $10 billion of revenue within seven years after earning their first dollar[18]—such a statement could be chilling indeed.
But for technology investors, this may transform SPACs into a unique vehicle to better understand the true prospects of technology companies. SPACs cater to the numerous private technology companies in a variety of different growth stages which seek further capital.[19] In this way, SPACs may effectively play the role traditionally occupied by venture capital or private equity.[20] But this has replicated in public markets the problems of technology financing in private markets. In private markets, overly-enthusiastic projections of the future are sold to venture capitalists who understand that this is a part of the financing culture while companies traditionally go public only when they have something viable.[21] SPACs have eliminated the distinction; startup founders can now pitch wild visions of the future without much in the way of historical financials to a retail trader investing their retirement account just as they would to a venture capital firm.[22]
However with mounting startup scandals, Silicon Valley’s culture of “fake it ‘till you make it” is looking increasingly problematic.[23] Venture capitalists often allow a certain degree of truth-stretching that in public markets might be seen as legally ambiguous at best. This is chalked up to a culture where startup exaggeration is practically expected as products and technologies are so preliminary that they are little more than a vision.[24] With a spate of new technology ventures in areas like artificial intelligence, even employees question the capabilities their companies claim.[25] Private technology companies can selectively choose and release metrics (often inflated or exaggerated) to create the impression of success.[26] And this culture appears to have already spilled over to the SPAC market—two electric-car SPACs have already been the subject of federal inquiries after short sellers accused them of providing fake order numbers or false claims.[27]
While private companies are also subject to broad anti-fraud prohibitions, the apparatus of securities law is primarily designed to investigate disclosures related to public securities. Private companies do not currently release the amount of information necessary for effective anti-fraud regulation.[28] The lack of information, transparent pricing, and the differing economics between bringing suit against a private versus a public company make pursuing securities fraud litigation against private companies extraordinarily difficult.[29] This creates problems of accountability in an economy where private markets dominate public markets in many respects, including aggregate size.[30]
If SPACs do not go out on a high, the vigorous SPAC disclosure regime presaged by John Coates’s recent statement and increasing SEC scrutiny could create an unexpected social benefit from SPACs; namely, increasing accountability and policing fraud in the otherwise opaque and suspiciously-optimistic private technology sector. SPACs may act as a key source of financing only to the most “honest” technology companies who can confidently substantiate their projections. For companies whose purported technological innovations exist mostly on their slide decks, this might make capital harder to come by even in a favorable economic climate. SPACs could turn out to be a feat of financial engineering that, almost despite itself, sheds some disinfecting sunlight on the actual prospects of the technology sector.
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[1] Joshua Franklin & Katanga Johnson, Analysis: As U.S. watchdog steps up scrutiny, Grab deal signals blank-check party peak, Reuters (Apr. 15, 2021), https://www.reuters.com/article/usa-sec-spacs/analysis-as-u-s-watchdog-steps-up-scrutiny-grab-deal-signals-blank-check-party-peak-idUSL4N2M63W7.
[2] Id.
[3] Bruce E. Ericson, Ari M. Berman, & Stephen B. Amdur, The SPAC Explosion: Beware the Litigation and Enforcement Risk, Harv. L. Sch. F. on Corp. Governance (Jan. 14, 2021), https://corpgov.law.harvard.edu/2021/01/14/the-spac-explosion-beware-the-litigation-and-enforcement-risk/.
[4] Id.
[5] Id.
[6] ICR, ICR, the Leading SPAC Advisor, Publishes Q1 2021 SPAC Market Update, Business Wire (Apr. 7, 2021), https://www.businesswire.com/news/home/20210407005635/en/ICR-the-Leading-SPAC-Advisor-Publishes-Q1-2021-SPAC-Market-Update
[7] Tech and SPACs: A dance of Wall Street darlings, S&P Global (Mar. 16, 2021), https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/tech-and-spacs-a-dance-of-wall-street-darlings-63155224
[8] Id.
[9] Id.
[10] John Coates, SPACs, IPOs and Liability Risk under the Securities Laws, SEC (Apr. 8, 2021), https://www.sec.gov/news/public-statement/spacs-ipos-liability-risk-under-securities-laws#_ftn7
[11] Id.
[12] Richard A. Rosen and Jessica S. Carey, The Safe Harbor for Forward-Looking Statements after Twenty Years, Paul Weiss (May 2016), https://www.paulweiss.com/media/3592238/insights_0516_rosen.pdf.
[13] John Jenkins, SPACs: Is the PSLRA Safe Harbor Driving the Boom?, Deal Lawyers.com (Feb. 3, 2021), https://www.deallawyers.com/blog/2021/02/spacs-is-the-pslra-safe-harbor-driving-the-boom.html.
[14] Coates, supra note 10. See also Bruce A. Ericson et al., The SPAC Explosion: Beware the Litigation and Enforcement Risk, Pillsbury (Dec. 15, 2020), https://www.pillsburylaw.com/en/news-and-insights/spac-litigation-enforcement-risk.html (describing legal liabilities SPACs may be subject to when providing financial projections in a de-SPAC proxy statement or a de-SPAC registration statement).
[15] Id.
[16] Id.
[17] Id.
[18] Eliot Brown, Electric-Vehicle Startups Promise Record-Setting Revenue Growth, Wall Street Journal (Mar. 15, 2021), https://www.wsj.com/articles/electric-vehicle-startups-promise-record-setting-revenue-growth-11615800602?mod=pls_whats_news_us_business_f.
[19] Tech and SPACs: Too much of two good things, S&P Global (Mar. 16, 2021), https://www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/tech-and-spacs-too-much-of-two-good-things-63177042.
[20] S&P Global, supra note 7.
[21] Matt Levine, Money Stuff: Startups Sometimes Stretch the Truth, Bloomberg (Feb. 26, 2021), https://www.bloomberg.com/news/newsletters/2021-02-26/money-stuff-startups-sometimes-stretch-the-truth.
[22] Id.
[23] Erin Griffith, The Ugly Unethical Underside of Silicon Valley, Fortune (Dec. 28, 2016), https://fortune.com/longform/silicon-valley-startups-fraud-venture-capital/.
[24] Id.
[25] Newley Purnell and Parmy Olson, AI Startup Boom Raises Questions of Exaggerated Tech Savvy, Wall Street Journal (Aug. 14, 2019), https://www.wsj.com/articles/ai-startup-boom-raises-questions-of-exaggerated-tech-savvy-11565775004.
[26] Kerry Flynn, The big con: How tech companies made a killing by fudging their numbers, Mashable (Jan. 18, 2018), https://mashable.com/2018/01/18/silicon-valley-companies-misleading-metrics/.
[27] Michael Wayland, Lordstown Motors shares close down 13.8% after confirming SEC inquiry, CNBC (Mar. 18, 2021), https://www.cnbc.com/2021/03/18/lordstown-motors-shares-fall-as-much-as-12percent-after-confirming-sec-inquiry.html.
[28] Verity Winship, Private Company Fraud, 54 UC Davis L. REV. 663, 723 (2020). See also Securities Exchange Act of 1934 § 10(b), 15 U.S.C. § 78j(b) (2018) (in which manipulation or deception "in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered" is made illegal); U.S. Sec. and Exch. Comm'n Rule lOb-5, 17 C.F.R. § 240.10b-5(c) (2020) (where deception "in connection with the purchase or sale of any security" is rendered illegal).
[29] Elizabeth Pollman, Private Company Lies, 109 Geo. L.J. 353, 403 (2020).
[30] Id. at 370.