In the first two Parts of this series we introduced the SPAC, explored some examples and highlighted some concerns. The very nature of the SPAC attracts private companies that either do not have the money or the time to access the public markets through the ordinary IPO process. But are such companies suitable for the public markets? Being a public company comes with its own sets of challenges and costs. To exacerbate the problem – in the U.S. at least – there certainly seems to be too many SPACs and too few desirable targets. Add celebrity names to the mix, including Jay-Z or Bill Ackman, and we’re looking at an easy way to attract inexperienced retail investors to potentially unattractive investment opportunities.
It is true that there are many other investment opportunities where investors are likely to be investing solely on the faith of the management team, including an investment fund where the manager has discretion to build a portfolio, or a young pharmaceutical company where management is attempting to bring an uncertain drug through the clinical trial stage. In the first example however, the investor is likely to be owed a fiduciary duty or at the very least contractual rights and remedies against the investment fund. In the case of a pharmaceutical start-up, the investors targeted are not likely to be retail investors but instead sophisticated investors who understand the risk and possibly even specialize in risky pharmaceutical investments.
While all this may feel problematic, our securities regime is not one based on merit, but instead one based on disclosure – so long as investors have the information they need to make a decision, the law has done its job. A merit-based test would arguably be too prohibitive, reducing opportunities for investors with a risk appetite. But concerns remain as to whether sufficient disclosure is achieved when SPACs are in play. On September 21st, 2020 then CEO of Nikola, an electric trucking company often dubbed “the Tesla of trucking”, announced his resignation. Milton was a founder of Nikola and came under fire after Hindenburg Research released a report claiming that a promotional video released by Nikola of a truck in motion was actually moving not because of Nikola’s batteries but because of the force of gravity. This sent Nikola’s share price tumbling. The SEC and the Department of Justice have since begun an investigation. If the allegations of short sellers are correct, it begs the question as to whether such a misrepresentation would have been discovered through the traditional IPO process where Nikola’s own underwriters and lawyers would need to investigate the representations being made to investors. Because Nikola went public through a SPAC known as VectoIQ (NASDAQ: VTIQ), it was the management team of VectoIQ looking to evaluate Nikola’s potential. In this case Hindenburg Research – the short sellers – played an invaluable role in helping to disclose information that, if true, would certainly be material to investors of Nikola.
One of the claimed saving graces of the SPAC from an investor protection standpoint is the ability for shareholders of the SPAC to vote on the transaction. Even if the transaction is approved, disapproving shareholders can be bought out and recover their investment. If the SPAC’s share price is trading at a value higher than what the investor paid for it then the shareholder can sell into the market for a premium. In any case a SPAC investor backing out at this stage is likely to make a return in addition to retrieving all of their investment, especially in considering that investors are able to continue holding the warrants granted to them after the SPAC buys them out. Investors at this stage are effectively making a second investment decision – one that differs from their original decision to invest in the SPAC to begin with.
But what about the shareholders who vote in favour of the transaction only to discover a potential fraud that the SPAC management team did not catch, as in the case of Nikola and Milton’s sudden departure? Such shareholders will be out of luck. Because the SPAC management team is on a timer to find a qualifying target company to take public, such issues as Nikola’s alleged false video are likely to be swept under the rug. This may be too cynical a view especially given how much variation in experience there is across different SPAC management teams, but the problem is still very real. With Garry Gensler set to take the helm of the SEC in the near future, these problems and others are sure to be on his mind given the speed with which SPACs have come to market in the United States. Gensler may also focus on conflicts within the SPAC management team that may sway potential acquisition decisions. SPAC investors should be aware if any of the management team have obligations to other businesses. Whereas in an IPO the underwriter is responsible for valuing the securities to be sold, in the case of a SPAC merger the management team is solely responsible, providing opportunities for self-dealing. In any case it will be interesting to follow the SPAC trend into the next few years with a new seasoned leader at the SEC.