What are SPACs?
SPACs (special purpose acquisition companies) are formed by sponsors—usually former industry executives, institutional investors or private equity firms—for the sole purpose of acquiring one or more private companies after going public. SPACs are not operating companies; instead, they are blank-check shell companies used to identify a merger target and facilitate access to public markets. Once the SPAC’s initial public offering is completed, the SPAC begins evaluating and approaching potential merger targets. When a suitable target company is identified, and an agreement is reached and approved by the SPAC’s shareholders, the transaction closes and the target company survives as the publicly listed entity. SPACs generally have two years to find a target. If unsuccessful, SPACs return the money raised to investors.
Recent SEC Enforcement Action
The Securities and Exchange Commission (SEC) recently charged Stable Road Acquisition Corp. and its merger target, Momentus, Inc., in connection with a planned merger. As a SPAC, Stable Road has no operations of its own and exists for the purpose of merging with a privately held company with the effect of taking that company public. It completed its IPO in November 2019. Momentus is a privately held spaceflight technology company, which aspires to provide satellite-positioning services with in-space propulsion systems.
The SEC alleged that Stable Road and Momentus falsely represented to investors that Momentus successfully tested its spaceflight technology. Although Momentus was the initial source of this misrepresentation, the SEC noted that Stable Road’s due diligence failures compounded Momentus’s misrepresentations and “resulted in the dissemination of materially false and misleading information to investors.” In short, Stable Road “unreasonably failed both to probe the basis of Momentus’s claims that its technology had been ‘successfully tested’ in space.”
Further, Stable Road’s S-1 registration statement omitted concerns raised by the Committee on Foreign Investment, and Stable Road’s amended registration statement omitted that the Department of Commerce denied Momentus’s CEO’s application for an export license. As a result, the SEC charged both Stable Road and Momentus with fraud, and it charged Stable Road with reporting violations under 13(a) of the Securities Exchange Act of 1934 and soliciting a proxy containing a materially false statement under Section 14(a). The parties resolved the SEC’s misrepresentation claims, agreeing to a fine in excess of $8 million.
This enforcement action signals that increased regulatory oversight of SPAC transactions may be on the horizon, especially given the exponential increase in SPAC transactions. In 2010, only two SPACs came to market. In 2020, 115 SPACs completed or announced mergers and netted record IPO proceeds of $83.4 billion. According to data from SPAC Research, SPACs have raised more than $115 billion so far this year.
An advantage for SPAC sponsors is that the IPO process is relatively simple. Because SPACs have a straightforward business purpose, they can typically complete their paperwork within three months with little comment from the SEC. Further, target companies benefit from the SPAC transaction insofar as it offers them an expedited path to public listing and greater price and timing certainty.
But as the above SEC enforcement action demonstrates, there are also risks associated with SPAC transactions. SPAC sponsors should be aware of due diligence requirements when evaluating target companies and the evolving SEC regulation of SPAC transactions. Relatedly, potential SPAC board members should understand the D&O insurance being carried by the SPAC sponsor and assess whether they are comfortable with the level of coverage under the policy.