The Securities and Exchange Commission announced on March 30 that it is proposing disclosure rules for special purpose acquisition companies, also known as SPACs.
A SPAC is a publicly traded company with no commercial operations. It is created for the sole purpose of acquiring or merging with an existing company to raise capital.
Examples of SPAC include Soaring Eagle Acquisition Corp., which is valued at $1.7 billion, and Altimar Acquisition Corp., which is valued at $275 million.
They are often referred to as “blank check” companies. They have become increasingly famous on Wall Street in 2020 and 2021, and account for many public offerings.
Their rise to fame aligning with COVID-19 is no coincidence. With interest rates low, borrowing money was cheap and encouraged many people to invest in SPACs.
They have become as popular as they are today because it is a cheap way to raise funds and allows their sponsors to earn financially.
Additionally, many prefer SPACs to initial public offerings, or IPOs, because they require a much simpler and less time-consuming process.
Last year, SPACs raised more than $160 billion, more than the previous pandemic year, which raised $83 billion.
With such astronomical growth, SPACs continue to push the envelope at the expense of the investor, especially after seeing the tremendous appeal of IPOs.
Something to note when comparing the two, IPO pricing is based on historical financial records, while SPACs provide forward-looking financials to support their assessment. This is the crux of all issues surrounding SPACs and SEC involvement.
The current SPAC rules are not heavily regulated and allow a private company access to everyday investors without providing the timely information that an IPO would require. Moreover, a company can make upward forecasts on its business prospects, which is prohibited by an IPO.
The current rules also allow people who run SPACs to multiply their initial investment, even if their businesses are struggling and shareholders lose money.
Investors in distressed companies inflate their business prospects for other companies they seek to acquire.
Another issue that annoyed investors and was behind the SEC’s push for stricter regulation was sponsors taking promotions and a 20% founder’s share.
In one of the biggest attempts to take control of SPACs, SEC Chairman Gary Gensler has said no more about this leniency and wants to force more disclosures and give those who have suffered from SPACs a sense of protection.
Implementing SEC rules would make it harder for SPACs to raise funds from investors and execute mergers. The SEC aims to craft these rules to reduce the disclosure advantages of SPAC insiders over investors, to require more disclosure to avoid conflicts of interest, and to tighten the rules.
Under the new rules, SPACs will be required to disclose information about their sponsors’ compensation and the dilution shareholders may suffer if an acquisition is completed. There will be limited types of financial statements that shell companies may constitute potential business combinations and their merger targets.
Critics did not take this decision lightly and see it as a threat to their existence. SEC Commissioner Hester Peirce voted against it, saying it hindered the growth of SPACs instead of asking for proper disclosures.
This was done to create a fairer system and resolve issues with SPACs, particularly regarding the Private Securities Litigation Reform Act. Adopting such rules enables SPACs to follow IPO-like regulations and perform due diligence for IPOs.
The problem with these SPACs is that investors bet on unrealistic growth forecasts and future promises to entice more investors into deals, but investors brag that these projections are often misleading. These extravagant projections and growing startups are things that attract investors to a lot of capital.
Public comments will be open for 60 days after the proposal is posted on the SEC’s website or 30 days after the Federal Register, whichever is longer.
More regulation is bound to bring fairer outcomes for everyone, but in this case, care must be taken about future loopholes that will be created to attract unfair gains.