There’s nothing like a little regulatory spat to kick off a new year. And for 2021 the target is, not for the first time, special purpose acquisition companies (Spacs), the blank cheque vehicles that soared in popularity last year with record IPO fundraisings as well as a host of de-Spac merger deals.
That Spac volumes should have surged in the pandemic year of 2020 was little surprise. Volatile market conditions meant that companies looking to go public were increasingly receptive to alternatives to the traditional initial public offering (IPO). And an assumption that this appetite would continue through the next 18 months or so helped to drive record volumes of new Spac formations.
This combined with another big driver – the ever-increasing number of firms with highly speculative but very ‘of-the-moment’ business models. The electric vehicle sector, for instance, has attracted much interest from Spacs.
Volatile market conditions meant that companies looking to go public were increasingly receptive to alternatives to the traditional initial public offering
But they are not to everyone’s taste. For all the talk that traditional equity investors are increasingly getting involved at the IPO stage of a Spac, the bulk are not. An official at one of the very biggest equity investors tells me that his firm is looking at every de-Spac merger, but barely giving a moment’s thought to the IPOs that preceded them.
“That’s just investing in the people running the Spac,” he says. “That’s really not what we do.” Well, quite.
But while having an identified target means firms like his can consider buying in at the merger stage, there are other hurdles. It comes down to disclosure.
Unlike how the debate is sometimes framed, it’s not the absolute amount of disclosure that’s the issue here. It’s more what’s being disclosed. In a traditional IPO, financial forecasts are fairly near-term and assessed by research analysts who then publish their thoughts. The listing company and its advisers are reputationally on the hook for the projections that they offer.
Things are rather different when a Spac proposes a merger with a target company. Its filing documents are not a marketing effort for the stock in as formal a way as they are in an IPO. They certainly tout the story of the company, but with much more flexibility – and the kind of long-term horizon that IPOs can’t.
No revenues? That’s fine. Spac targets can tell you what they reckon they might look like in five years’ time instead.
Arcane, but it matters
And so, to the latest debate. On the surface, it looks arcane. Back in September, Nasdaq proposed a rule change that would allow Spac mergers an extra 15 days after the closing of the deal to demonstrate that the new listed entity complied with all listing requirements.
Specifically, the extension applies only to the exchange’s round lot shareholding requirement – which determines the minimum number of shareholders a listed company must have, depending on which of Nasdaq’s markets the stock is listed on. Spacs will still be expected to be able to show compliance with all other requirements upon closing.
Why grant this extra minimum-shareholder leniency for Spac mergers? Usually, Nasdaq relies on public filings to figure out whether a company will have the required minimum number of shareholders. If it can’t get the information it needs, it asks the company to provide it.
But Spacs pose a particular problem because of how the Spac merger process works. Pre-merger shareholders of the Spac vehicle can choose not to participate in the merger, instead tendering their shares for cash before the merger closes.
That means it can be difficult for the company to know with any degree of certainty exactly how many shareholders it might have. (That uncertainty is one of the inherent risks facing Spac shareholders, since it is hard to know precisely what your interest in the business will be – but that’s another story.)
This is why Nasdaq has proposed the change – which it stresses is not intended to give the de-Spacced company any additional time to comply, just more time to provide the evidence that it had complied upon closing of the merger.
[Nasdaq] has provided no data or other evidence
Securities and Exchange Commission
All sounds reasonable, right? No, not according to the Securities and Exchange Commission (SEC).
On December 16, the regulator issued “notice of the grounds for disapproval” of the change. The SEC holds minimum shareholder requirements in high regard and doesn’t like the idea of tampering with them in even the apparently small degree proposed by Nasdaq.
It certainly had little time for the exchange’s arguments for doing so, saying that Nasdaq “has provided no data or other evidence” to support its position that Spacs have particular difficulty in complying with the minimum shareholder requirements, and had also not shown how this had impacted previous mergers.
Most critically of all, the SEC was at a loss to understand how the extra 15 days would tackle the substantive point of what would happen in the case of companies that were at serious risk of not complying. A merger and listing would go ahead, the SEC noted, and the stock trade for up to 15 days despite being non-compliant.
As a result, the SEC opened up the process to a new round of comments. And sure enough, one vocal party that welcomed the opportunity to pitch in was the Council of Institutional Investors (CII), which speaks for entities managing some $4 trillion of assets in the US.
Good work!
I haven’t checked, but I assume it’s fairly rare for the sentence “The purpose of this letter is to commend the staff of the Securities and Exchange Commission” to feature in letters to the SEC. But the CII couldn’t speak highly enough of the regulator’s work.
When it comes to Nasdaq’s proposal, however, the CII is rather less complimentary. It sees such moves in the context of a long-running race to the bottom between the New York Stock Exchange and Nasdaq when it comes to listing standards – a view that echoes its previous worries about such abominations as direct listings that contain an element of primary capital raising.
Citing the findings of an October 2020 study led by Michael Klausner at Stanford Law School, the CII noted that Spacs tend to be insulated from liability to investors for material misstatements and that they generally create losses for long-term investors.
The comment period closed on January 11, but rebuttals can be filed until January 25. It isn’t over quite yet, but Nasdaq might need to rethink this one.
