Special Purpose Acquisition Companies (SPACs): A Summary

The SEC Division of Corporate Finance (“DCF”) defines a SPAC as “a company with no operations, that offers securities for cash, and places substantially all the offering proceeds into a trust or escrow account for future use in the acquisition of one or more private operating companies.” The purpose for the creation of the shell company, often referred to as a “blank check company” and funded through an initial public offering (“IPO”), is to find private companies to acquire and then, after acquisition or merger, operate the combination as a public company.

Guidance and Disclosure

Regulatory issues arise for potential investors at two key stages: at the early IPO stage of the SPAC and at the business combination stage.

Regulatory agencies are most focused on proper disclosure so that investors can better understand conflicts inherent in the SPAC structure and to make clear to public investors that the interests of sponsors “often differ” from those of public shareholders, (particularly as the management team “recommend[s] business combination transactions to shareholders”). 

At the early stage of a SPAC (pre-business combination), the DCF emphasizes that, unlike in “the traditional IPO process where a private operating company sells its securities in a manner in which the company and its offered securities are valued through market-based price discovery, these individuals [sponsors] are solely responsible for deciding how to value the private operating company and how much the SPAC will pay for it.” As a result, the SEC advises SPAC sponsors, directors and officers to disclose any potentially differing economic interests, particularly regarding to compensation. 

The SEC also recommends that public investors assess the SPAC investment opportunity by reviewing the SPAC’s IPO prospectus and any periodic and currently filed reports to help them understand the business background of the sponsors. For example, most SPACs have a set period to consummate a business combination. These can be of various lengths (often between 18 months and two years) and might include extension provisions. According to the SEC’s Office of Investor Education and Advocacy ("OIEA"), if the SPAC is listed on an exchange, it must complete the combination within three years. If it fails to do so, shareholders are entitled to a pro rata share of the amount in the trust instrument.

The SEC suggests that investors fully understand (i) the terms of the trust account in which the escrow funds are held; (ii) the implications of their pro-rata share of the trust account (not the price at which the SPAC share was purchased); (iii) redemption rights; (iv) risks associated with the trading price of shares that are not based on a business valuation, (v) the time period for the completion of any business combination; (vi) the terms and risks of warrants to purchase additional shares at a set price; and (vii) competition for startup targets in increasingly crowded SPAC market sectors. 

At the business combination stage, the SEC urges investors to fully understand their redemption rights and, if provided for, a public investor’s right to vote on the acquisition. Specifically, the SEC alerts retail investors to the fact that upon acquisition, the nature of the investment changes from a trust account into an operating company, and, therefore, represents a pivotal time for an investor to reassess the value of the investment and whether to redeem or to remain an investor in the combined company. The SEC wants retail investors to review disclosures contained in a proxy or information statement (or a tender offer statement) which will contain information about the “to-be acquired” business, including the financial statements, interests of the parties, and the terms of the acquisition and the capital structure of the combined entity. 

Additional FINRA Concerns

FINRA maintains longstanding guidance on SPACs (since 2008). The obligations for firms under FINRA rules center on whether the SPAC is suitable for certain investors and that marketing materials “provide an accurate and balanced description of SPACs” including risks associated with the investments. In its 2021 Exam Report, FINRA reaffirmed much of the SEC’s (and its own) prior guidance, and warned about (i) “misrepresentations and omissions in offering documents;” (ii) shareholder communications on SPAC acquisition targets; (iii) transaction fees; (iv) affiliate compensation; (v) control of funds; and (vi) the potential for insider trading. FINRA urged firms who are involved at the early stages of a SPAC to ensure that any written supervisory procedures require “due diligence of SPACs’ sponsors, and procedures that address other potential fraud risks.” Effective January 1, 2020, FINRA amended certain rules related to equity IPOs, adding rule restrictions on the purchase and sale of initial equity public offerings and new issue allocations and distributions to exclude foreign offerings.