SPACs have helped many fledgling firms go public at warp speed. But the money-raising vehicles have just as quickly left a trail of burned investors and accusations of fraud and malfeasance.
There were only two investor class actions against SPAC sponsors filed in U.S. federal courts in 2019, and just five in 2020. But last year the number surged to 30. Attorneys expect even more to be filed this year. After record levels of activity in SPACs, hundreds remain out looking for deals. The vehicles typically have 12-to-24-months after raising money through an IPO to select a target for acquisition. Now many of those deadlines are coming and the market is slowing — creating an environment ripe for more investor complaints.
“You can expect there’s going to be an even bigger surge in litigation coming,” said John Vukelj, a partner at Day Pitney LLP.
For the uninitiated, a Special Purpose Acquisition Company is a public company whose purpose is to acquire and therefore make public a private company. In most cases this is a faster, less expensive, “back door” method of accessing the public markets for startups and small, growing companies. But SPACs can be a gamble for investors: because the SPAC itself has no financial history, early investors must put their trust in the people who created the SPAC and their ability to acquire a successful company. These SPAC sponsors are often veteran executives with some knowledge of a specific industry, but not always.
"You can expect there’s going to be an even bigger surge in litigation coming,” said John Vukelj, a partner at Day Pitney LLP.
Undoubtedly, some of the lawsuits stem from investor sour grapes as many of the companies that merged with SPACs have not ultimately fared well in the market. Others, however, are rife with serious accusations of insider dealing, failures to disclose pertinent information and over-hyping performance expectations.
The lawsuits that have sprung from the deals fall into one of several categories, according to Yelena Dunaevsky, vice president for transactions insurance at Woodruff-Sawyer & Co.
First off, there are suits filed before the deal goes through attempting to block the proposed merger, usually by claiming the deal isn’t good enough and inadequate disclosures were made to shareholders. Then there are the suits filed after the deal closes, which are usually brought on behalf of large groups of shareholders and which frequently claim that the deals weren’t vetted properly. These suits tend to be where sponsors get accused of more serious wrongdoing.
“I would characterize the pre-close merger and acquisition opposition litigation as mostly nuisance stuff,” said Shannon Eagan, a partner at international law firm Cooley LLP. But she said suits that come up post-close are “much more troubling.”
"I would characterize the pre-close merger and acquisition opposition litigation as mostly nuisance stuff,” said Shannan Eagan, a partner at international law firm Cooley LLP. But she said suits that come up post-close are “much more troubling.”
One major case to keep an eye on to see where this is all headed is currently making its way through the court in Delaware. It involves Multiplan Corp., a maker of healthcare data analytics and cost management software. Multiplan merged in 2020 with a SPAC created by former Citicorp executive Michael Klein, who controlled 80% of the SPAC. The ultimate $11 billion transaction, known as a de-SPAC, closed in October 2020 with the total value of the shares redeemed by Klein and the other sponsors roughly coming to $305 million, for which they paid about $20,000. Klein’s share alone came to $230 million. The other class of shareholders didn’t fare as well, as Multiplan stock immediately fell to below its $10 per share original offering price (the shares currently trade around $4.00 per share).
Shortly after it went public, it was revealed that Multiplan’s biggest customer, accounting for 35 percent of its revenues, was planning to build a technology platform of its own that would directly compete with Multiplan’s. The lawsuit alleges that the SPAC’s board was made aware of the customer’s intentions during due diligence but failed to pass that information along to the SPAC’s shareholders properly.
Last month, the Delaware Court of Chancery (a highly respected court that often hears major business cases) refused to toss most of the lawsuit, issuing a hotly-anticipated decision allowing claims to proceed against the SPAC’s sponsor and directors, as well as aiding and abetting claim against its financial advisor.
“It's an important decision,” said Vukelj. “Basically, [the sponsors] were motivated to just do a deal because they knew if it didn't work out, they'd be fine. And it really didn't matter that there's other investors who would be harmed. That's the allegation, anyway.”
The ruling marked the first time the court applied traditional fiduciary principles to a SPAC merger. The decision was also noteworthy in being the first to determine what standard of review the court would use to evaluate SPAC deals, and it opted for one known as the entire fairness standard, which subjects the deal to closer scrutiny. In doing so, the court noted that Klein, who had the power to appoint the entire SPAC board, had financial or familial ties to all the board members, so it could not really be considered independent. Because most SPACs are incorporated in Delaware, the case is likely to impact what future disclosures from SPAC sponsors look like.
"The enforcement actions and investigations are not surprising in the least,” said Woodruff Sawyer’s Dunaevsky.
Another group of cases to watch assert that SPACs are essentially illegally operating investment firms. Three lawsuits filed late last year against billionaire Bill Ackman’s SPAC Pershing Square Tontine Holdings, E. Merge Technology Acquisition Corp., and GO Acquisition Corp., contend these SPACs are really investment companies, meaning they should register as such (which SPACs don’t).
The high-profile attorneys leading the charge against the SPACs in these cases are former SEC Commissioner Robert Jackson, now at NYU, and Yale law professor John Morley – and the cases go to the very heart of what SPACs do. While they search for a target, SPACs usually put investors’ money into trust accounts that hold short-term Treasury and money-market securities. Those trusts are supposed to protect against losses if it doesn’t find a target. The suits argue that when SPACs fail to find an investment target and hold investors’ money for a year or more, they essentially become investment companies subject to regulation.
The cases have met stiff pushback from more than 60 law firms – most of which earn significant fees from working with SPACs – that banded together to say that the primary purpose of SPACs is to make a merger happen within a set period of time.
A different line of attack against SPACs that comes up in several suits is that the shareholder vote wasn’t conducted properly (once again in violation of Delaware rules). Suits against dMY Technology Group IV, and Mudrick Capital Acquisition Corp. II allege the SPACs’ boards attempted to improperly force Class A shareholders to vote together with Class B shareholders in violation of Delaware incorporation laws.
Beyond plaintiffs’ lawyers, SPACs have also started to draw attention from the U.S. Securities and Exchange Commission, the Justice Department and Congress, which could yield other kinds of future lawsuits or increased regulation. Most notable is the investigation into Digital World Acquisition Corp. and its proposed SPAC merger with Trump Media & Technology Group Corp.
“The enforcement actions and investigations are not surprising in the least,” said Woodruff Sawyer’s Dunaevsky. “They mostly center around misrepresentations, disclosure failures, and inadequate diligence. They are, however, growing in inventiveness and variety.”
