Merging company

Recent SEC Enforcement Measures Significant Greater Oversight of SPACs | Bradley Arant Boult Cummings LLP

In one of the most high-profile actions recently taken by the Fort Worth office of the Securities and Exchange Commission, the SEC settled nearly $ 40 million in securities fraud charges against Akazoo, SA, in late October. Special Purpose Acquisition Company (SPAC) which had merged into a private music streaming company. The action is notable because it emphasizes SAVS, an increasingly popular alternative for raising capital to the traditional IPO process, and because it highlights the increased risk for investors in after-sales service.

PSPC transactions are increasingly in the sights of SEC enforcement and regulation. In public statements and testimony, SEC Chairman Gary Gensler has repeatedly emphasized the need for strict regulation of PSPCs, citing the risks inherent in PSPC transactions in which sponsors with the potential to achieve large profits can exercise inadequate due diligence and mislead investors. And just a few weeks ago, Senator Elizabeth Warren sent a letter to the SEC asking the agency to investigate a proposed PSPC deal involving former President Donald Trump’s Trump Media and Technology Group for no -disclosure of key facts in PSPC offering documents.

In the Fort Worth stock, the fraud spread to several groups of investors – the early PSPC investors, later the private investors who invested in the merger, and the investing public, once the The combined company’s shares have been publicly traded on the NASDAQ. The SEC Division of Enforcement’s focus on PSPCs is likely to intensify as transactions become more popular among companies looking for a quick and less expensive way to go public and among private investors looking for an affordable way to invest in a company that is ready to go public. Public.

A brief introduction to PSPCs

A SAVS is a company without commercial operations formed solely to raise capital for the purpose of acquiring or merging with an existing company. PSPCs are formed by sponsors who receive what is known as a “promotion” of 20% of the company’s equity in exchange for a “nominal investment”. Just about anyone can sponsor a PSPC – and recently celebrities such as Colin Kaepernick, Shaquille O’Neal, Larry Kudlow, and pop star Ciara have been promoting their own PSPCs. A SAVS is often formed with a focus on a particular industry or line of business, but usually does not know which business it is going to acquire in advance. For this reason, SPACs are often referred to as “blank check companies”.

Funds raised by a PSPC, usually through an IPO, are placed in a trust account and can only be dispersed to complete a merger or acquisition – this is called a trading transaction. de-SPAC – or to return the money to investors if the SPAC is liquidated. A SPAC generally has two years to complete a business acquisition transaction, obtain shareholder consent for an extension of the two-year period or it must proceed with its liquidation. This last point is critical, as sponsors only get their 20% promotion if they strike a deal in this two-year-old widow.

PSPCs have become extremely popular in recent years, with nearly 250 PSPC IPOs raising around $ 83 billion in 2020 and more than 300 PSPC IPOs raising more than $ 95 billion over the years. first three months of 2021. PSPCs are popular in part because they allow target companies to go public faster and more cheaply than through traditional IPOs. Among other benefits, the target company negotiates directly with PSPC regarding the valuation. A common, though not always present, characteristic of a PSPC transaction is the need for PSPC to raise additional capital for the acquisition of the target company. This is usually done through a so-called private investment in public capital (PIPE) transaction, in which the PSPC issues shares under a private agreement with a selected group of investors in conjunction with the combination. of PSPC / target companies. PIPEs are often required because many initial PSPC investors cash in prior to the de-PSPC transaction.

As emerges from this model, there is a strong incentive for PSPC sponsors to close a deal with a target quickly – and potentially reduce the costs of due diligence and disclosure – because the sponsor has a huge stand to gain if a deal is struck within the window. two years. while earning nothing if a deal fails to close within two years.

SEC c. Akazoo, SA

In Akazoo, a SPAC named Modern Media Acquisition Corp., which was formed in 2017 and publicly traded on NASDAQ, was formed for the purpose of affecting a merger or acquisition of a company in the “media industry, entertainment and marketing services ”. Modern Media had a deadline to enter into such an agreement by February 2019 or to dissolve, liquidate or request an extension from its shareholders. The SAVS did not meet the deadline and requested and obtained extensions from its shareholders. Modern Media eventually identified a private company operating as Akazoo Ltd., which claimed to have a free, ad-supported streaming radio service and a portfolio of patented artificial intelligence-based technologies. Modern Media’s failure to complete a merger before the original February 2019 deadline prompted many of its shareholders to divest themselves before the merger (the de-SPAC transaction), leaving PSPC with insufficient funds to complete the transaction, forcing it to raise capital through a PIPE.

It turns out that Akazoo’s CEO and CFO allegedly gave false information to Modern Media to trick SPAC into closing the merger / de-SPAC transaction – false statements, including misrepresentation about the number of registered users that Akazoo had, as well as on Akazoo’s revenue, profitability and business relationships. Modern Media incorporated these false statements into its proxy statement regarding the merger, encouraging Modern Media shareholders to support the transaction on the basis of grossly false information. On top of that, the management of SPAC and Akazoo made the same misrepresentations to investors in the PIPE offering – an increase in funds needed by the many investors who had already cashed in when Modern Media missed its deadline. initial de-SPAC. The inaccuracies continued after the de-SPAC, as Akazoo’s shares were publicly traded on NASDAQ, with the company continuing to make the same misrepresentations it started with.

Less than a year later, a short-selling hedge fund released a detailed report concluding that Akazoo was essentially a scam, with few followers and little income. Soon after, Akazoo’s share price dropped significantly and an internal investigation quickly revealed that indeed Akazoo had only negligible revenue and subscribers for years and that the fraud had been perpetrated. by former members of the Akazoo management team. Akazoo settled the case late last month, agreeing to pay nearly $ 40 million in disgorgement to return to investors, including those in a securities class action lawsuit in the Eastern District of New York.

In Momentus, Inc., et al.

Akazoo’s enforcement action follows another high-profile enforcement action by PSPC, this one in July 2021 against a PSPC named Stable Road Acquisition Corp., which was formed with the aim of amalgamating with a private company (no sector specified) and make it public. Stable Road entered into negotiations with Momentus, a company that presented itself as a space infrastructure company providing, among other things, satellite positioning services. The Momentus fraud follows the Akazoo facts closely. As alleged in a lawsuit filed against the CEO of Momentus, the CEO first made multiple misrepresentations to Stable Road – regarding the effectiveness and business value of Momentus’ technology and government concerns about the CEO’s track record likely. prevent the business from obtaining the necessary government authorizations to operate. then repeated the false statements to investors in PIPE and in the registration statements. The SEC has indicted PSPC, Momentus and their respective CEOs. All settled with the SEC (for about $ 8 million) except for the CEO of Momentus whose case is pending in the District of Columbia.

In announcing the Momentus fraud, President Gensler noted that the case “illustrates the risks inherent in PSPC transactions, as those who could derive significant benefits from a PSPC merger may exercise inadequate due diligence and induce claims. investors in error “. Critically, Gensler pointed to PSPC’s failure to conduct adequate due diligence even though Momentus CEO lied to it: “The fact that Momentus lied to Stable Road does not absolve Stable Road of its inability to undertake. adequate due diligence to protect shareholders. Today’s actions will prevent wrongdoers from profiting at the expense of investors and help better align the incentives of parties to a PSPC transaction with those of investors who rely on truthful information to make investment decisions.

Takeaway meals

Senator Warren’s recent letter to the SEC asking it to investigate the former president’s PSPC transaction is only the SEC’s latest public call for review. In August 2021, the SEC Advisory Board released recommendations for SEC SPAC regulation, including that the agency “more intensely regulate SPACs by exercising increased attention and stricter enforcement of existing disclosure rules under the Securities Exchange Act of 1934 “. And as the Akazoo and Momentum actions demonstrate, the agency has also stepped up regulatory actions, warning sponsors and investors in SAVS that the agency will use all the tools at its disposal to deal with risks for investors and the SAVS markets.

Republished with permission. This article, “Recent SEC Enforcement Steps Sign of Heightened SPAC Oversight, was published by The Texas Law Book December 6, 2021.