What’s in an Acronym? (Or, Can Bill Ackman “SPARC” a Fix to SPACs?)
POMERANTZ MONITOR | NOVEMBER DECEMBER 2023
A recent innovation in the realm of investment vehicles, SPACs, or Special Purpose Acquisition Companies, have experienced a dramatic rise and fall in the past few years. Unlike traditional IPOs, SPACs go public without a business model, later acquiring or merging with an existing company with a defined business. In so doing, SPACs circumvent many of the disclosures required of a traditional IPO. This provides a quicker path to going public, however avoiding the safeguards that the disclosures impose has led to a disturbing string of frauds and scandals. This, in turn, has resulted in SPACs trading for under $10 per share, as well as some companies withdrawing from previously announced SPAC deals, even if they have to pay millions of dollars to the SPAC for backing out. The sense that SPACs are endangered may be what prompted billionaire investor (and former SPAC aficionado) Bill Ackman to step into the arena of SPAC reform. Ackman’s innovation comes in the form of the suspiciously-similar-sounding “SPARC,” or Special Purpose Acquisition Rights Company. However, the question remains: is this enough to save the SPAC from extinction? The answer: quite possibly.
SPACs are sometimes referred to as “blank check companies” because they are created for the sole purpose of acquiring another company and taking it public. They recall the 1980s penny stock market where highly speculative stocks sold for less than $5 per share. Most penny stock offerings were similarly made by blank check companies whose stated purposes were to merge with a to-be-identified target. While penny stocks were cheaper than shares sold on reputable exchanges such as the NYSE, the unregulated market on which they were traded was rife with manipulation and outright fraud, subsequently dramatized in classic films like Boiler Room and The Wolf of Wall Street. By 1990, annual investor losses of $2 billion prompted Congress and the SEC to finally regulate the penny stock market through the Securities Enforcement Remedies and Penny Stock Reform Act of 1990 (PSRA) and Rule 419, respectively.
Fortunately for fans of Wild West-style investing, two bankers developed the concept of a SPAC in the 1990s as an end-run around the PSRA and Rule 419. Like the penny stocks of yore, SPACs lack their own business model; initial investors simply have no idea what type of company they will ultimately be investing in. When formed, SPACs usually have an industry in mind, such as mining or software, but no specific acquisition target. The gap between the empty holding company and the entity that ultimately emerges through the SPAC process has led some observers to note that a more accurate term is “SCAMs.”
The typical SPAC timeline is as follows: first, the SPAC’s sponsors, who often possess significant financial and reputational clout, e.g., Martha Stewart and Shaquille O’Neal, provide the starting funds for the SPAC; second, the sponsors, assisted by underwriters, take the SPAC public through a standard IPO, which allows the SPAC to raise funds that are held in a trust, pending identification of an acquisition target; and third, assuming the sponsors identify a target company within 18 to 24 months and obtain shareholder approval, the SPAC merges with the target company in a process known as “De-SPAC-ing.” Once the de-SPAC is complete, the resultant company retains the name and operations of the target company, which then trades publicly on a stock exchange. Shareholders can typically redeem their investment if the 18 to 24-month window lapses and shareholders vote to extend the period for the SPAC to find an acquisition target, or if an acquisition target is found but the shareholders don’t like it.
As the number of SPACs skyrocketed from 2019 into 2021, the informational disadvantage to investors inherent in the penny stock market began to reproduce in the SPAC space. SPACs have raised vast sums selling warrants as part of their IPOs, which can be used to buy shares in the de-SPAC-ed company. In the de-SPAC process, sponsors receive compensation in the form of a large ownership stake for a nominal cost, setting up a textbook conflict of interest. As The D&O Diary’s Kevin LaCroix aptly put it, “[t]he conflict arises from the SPAC sponsor’s financial interest in completing a merger even if the merger is not value-creating, which may conflict with the shareholders’ interest in redeeming their shares if they believe that the proposed merger is disadvantageous.” What’s more, these lucrative sponsor compensation arrangements create dilutive effects affecting investors in the SPAC.
Even where they can show they’ve been wronged, SPAC investors are likely to have the courthouse doors slammed in their faces. Freed from the constraints of a traditional IPO, SPAC operators are permitted to speak directly to the market about the SPAC’s financial prospects. SPAC projections are generally protected by the safe harbor for forward-looking statements afforded by the Private Securities Litigation Reform Act (PSLRA), whereas projections made in connection with traditional IPOs are beyond the PSLRA’s safe harbor.
Almost as soon as SPACs became popular, scandals began to erupt. Nikola and Clover Health Investments, two of the biggest SPACs to go public in 2020, found themselves embroiled in fraud investigations conducted by the SEC and DOJ. In July 2021, Ackman’s own SPAC, Pershing Square Tontine Holdings, abandoned a deal to buy 10% of Vivendi’s flagship Universal Music Group after the SEC flagged several elements of the deal. According to Ackman, a colorful figure best known for his crusades against Herbalife and Harvard President Claudine Gay, the SEC “said that, in their view, the transaction did not meet the New York Stock Exchange SPAC rules and what that meant was what I would call a dagger in the heart of the transaction.” Ackman was forced to return $4 billion to investors.
In response, the price of Directors and Officers insurance for SPACs was reported to have almost doubled by the end of 2020. Democratic legislators in the U.S. House of Representatives introduced the “Holding SPACs Accountable Act of 2021,” which would have excluded all SPACs from the safe harbor, and the “Protecting Investors from Excessive SPACs Fees Act of 2021,” which would have compelled the SEC to adopt a rule requiring SPACs to disclose compensation arrangements in the interest of transparency. While both pieces of legislation passed the Committee on Financial Services, neither became law. For its part, the SEC has increased its scrutiny of SPACs, tightened disclosure regulations, and clarified that the safe harbor applies only to private litigation action and not SEC enforcement.
After the SEC spiked his SPAC’s Universal deal in mid-2021, Ackman debuted a new take on the faltering investment vehicle, the SPARC. SPARCs do not require up-front money from investors like SPACs do. Instead of shares, SPARCs issue rights. Because the SPARC gives rights away, no money is held in trust. Once the acquisition target is identified, SPARC investors are given the chance to either walk away or opt in. Only if these investors approve the acquisition target and the amount that the SPARC is asking them to fork over (which will vary based on the size of the deal), can the deal close. At this point, the acquisition target gets the money and becomes public, and the SPARC rights transform into shares of the new public company. Importantly, SPARCs do not offer IPO warrants, which are used by SPACs as a way to enhance the capital raised in an IPO. This means that SPARC investors will not be diluted by such warrants and will therefore retain more of the company. Finally, SPARCs will have 10 years to complete an acquisition, in contrast to the 18 to 24-month period typically allocated to SPACs.
Though the future of the SPARC remains uncertain, it appears to address several of the concerns that have imperiled SPACs. Most prominently, SPARC investors, unlike their SPAC counterparts, have the ability to hold back their investment while they evaluate the target. The increased control granted to SPARC investors also avoids the elimination of the safe harbor, and investors will have a greater chance to probe the specifics of the proposed acquisition. Lastly, SPARCs sidestep the share dilution endemic to SPAC compensation agreements, the precise concern underlying the “Protecting Investors from Excessive SPACs Fees Act of 2021.” The SPARC is accurately characterized as shifting risk from the investor to the sponsor, who must corral investors without the leverage that comes from holding a pool of money in trust. In early October 2023, Ackman announced that he had received SEC approval to use a SPARC to raise a minimum of $1.5 billion from investors for the acquisition of a private company. Ackman seems to have bet that regulators will be more receptive to a model that simultaneously levels the informational playing field and endows investors with more discretion. Given his early victory in bringing the SPARC to fruition, it’s a wager that may have already begun to pay dividends.