Over the last twelve months, the U.S. Securities and Exchange Commission (SEC) has bolstered oversight of special purpose acquisition companies (SPACs) in response to shareholder allegations of fraud, conflicts of interest, and inadequate disclosures relating to de-SPAC M & A transactions.
For example, in an aggressive and ground-breaking decision, the SEC somewhat recently announced enforcement actions against a SPAC, its sponsor and CEO, and the target company and its former CEO before a shareholder vote on the merger. The enforcement action arose from allegations that the proposed target company misrepresented material facts and omitted or made misstatements in its public disclosures to the SEC and proxy materials intended for investors, in violation of the Securities Act and the Exchange Act.
Securities class action lawsuits targeting SPACs have also increased. This year, 25 lawsuits have been filed, a substantial increase compared to the 10 suits that were filed in 2019 and 2020 combined.
Yet, despite the SEC’s heightened scrutiny and the unprecedented uptick in securities class action lawsuits, SPACs remain an attractive option for investors and those hoping to take their companies public.
Indeed, even former President Donald Trump has joined the SPAC craze. The former president recently completed a de-SPAC transaction with Digital World Acquisition Corp., a SPAC, to bring his social platform Trump Media & Technology Group public. Former President Trump’s announcement came just days after the SEC urged SPACs to disclose conflicts of interest, again signalling the Commission’s intent to regulate the SPAC world.
Clearly, the heightened risk of SEC scrutiny and securities lawsuits have not deterred market participants from engaging in SPAC transactions. Just recently, NBA star Kevin Durant announced his intent to launch a $200 million blank-check company, making him the latest celebrity to get in on the SPAC craze. Given the SEC’s continued scrutiny, it is imperative that SPACs, their sponsors, and target companies implement measures to reduce the risk of litigation and avoid SEC scrutiny. Market participants should consider the following preventive measures:
Conflicts. SPACs must consider all potential conflicts of interests and whether their public disclosures adequately disclose them. SPACs must be particularly cognizant of conflicts with the ultimate de-SPAC M&A targets and misaligned incentives with sponsors that are more keen on completing the merger (especially if they are bumping up against the two-year statutory time frame) than conducting adequate due diligence. SPACs should also always maintain adequate directors and officers insurance to protect high-level sponsors should any issues arise.
Due Diligence. SPAC sponsors should hire reputable third-party investigators and top notch audit firms and use extreme caution when relying on unverified statements from proposed merger targets. They should document all diligence efforts undertaken in connection with mergers and err on the side of more comprehensive disclosures.
Accounting. SPACs must prepare their internal accounting controls, so that the post-merger publicly-traded company will meet the SEC’s reporting demands. Sponsors should engage in a documented, critical review and ensure that financial projections are based on reasonable grounds and not unsupported opinions. Sponsors should also consider hiring outside financial advisors to determine whether such projections are sound. A reputable accounting firm may also provide value by addressing concerns from both the market and regulators on target companies’ accounting integrity and governance weaknesses.
Fairness Opinions. SPACs should hire reputable third-parties to prepare fairness opinions to mitigate litigation risk and evidence proper due diligence. Fairness opinions also provide value to shareholders as an indication of the quality of the proposed transaction. A diligently prepared fairness opinion may offer value to a SPAC’s board, which may then rely on it to demonstrate that the board complied with its duty of care.
Litigation Preparation. To limit litigation risks, market participants should ask experienced litigation counsel, rather than relying solely on their usual corporate counsel, for input on the documents being prepared, relied upon, and disseminated. Litigation counsel should also weigh in on the recommended strategic approach in managing litigation risk, and can also provide input on insider trading risks that the post-merger company may face.
By following these measures, market participants can avoid or, at the very least, minimize the chances of facing an adverse outcome of SEC investigations and/or enforcement actions and related follow on or concurrent securities class actions and/or shareholder derivative actions.
Perrie M. Weiner is a partner and Desirée Hunter-Reay is an associate with Baker & McKenzie LLP. Learn more at bakermckenzie.com.
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