Anyone reading the business pages know that SPAC IPO activity continues to surge; indeed, we have not yet even officially completed 2021’s first quarter, yet the number of SPAC IPOs completed and the amount of funding raised have both already exceeded the totals for the full year 2020. As I have already noted in prior posts on this site, all of this SPAC activity has already attracted some legal action. At the end of the last week, there were further signs that the legal activity could be about to pick up. As discussed below, news reports circulated late last week that the SEC has sent informal inquiries to Wall Street banks concerning SPACs, and, as also discussed below, a plaintiff shareholder has initiated a class action lawsuit against the directors and officers of a SPAC, among others, in Delaware Chancery Court presenting some alternative liability theories.
The SEC’s Informal Inquiry into SPACs
A March 25, 2021 Reuters article (here) reported that the SEC has “opened an inquiry into Wall Street’s blank check acquisition frenzy” and has sent letters to Wall Street banks “seeking information” about their SPAC dealings. The letters, according to the article, were sent by the agency’s Enforcement Division, and seek information on SPAC deal fees, volumes, and what controls banks have in place to police the deals internally. The letters also apparently asked questions “relating to compliance, reporting and internal controls.”
The Reuters article comments that the SEC’s letters are “the strongest sign yet that it is stepping up scrutiny of such deals and the Wall Street banks that underwrite them.”
A March 25, 2021 Law360 article entitled “SEC Inquiry Into Blank-Check Boom Could Be Just The Start” (here) sounds the same theme. The Law360 article quotes one source as saying about the SEC letters that “this is the first step in making sure that folks know the SEC is watching.”
The Law360 article also other sources commenting on possible areas of interest for the SEC. One commentator is quoted as saying that “one of the major issues is that the incentives of the SPAC sponsors are not aligned with investors.”
Another commentator noted that it will be interesting to watch how shares of companies taken public by SPACs fare in the coming months, as “lockup periods that so far have constrained insiders from selling shares could begin to expire.” An increase in share sales “could place further downward pressure on the stocks of such companies.”
Delaware Chancery Court Lawsuit Involving SPAC Transaction
In another development last week that suggests that legal action relating to SPACs may be about to pick up, on March 25, 2021, a plaintiff shareholder filed a class action lawsuit in Delaware Chancery Court relating to the facts and circumstances surrounding the October 8, 2020 merger of Churchill Capital Corp III, a SPAC, and MultiPlan Corporation.
As I noted in a February post (here), there previously had been securities class action lawsuits filed in connection with this same merger transaction and relating to a short seller report criticizing the transaction. Interestingly, the two federal court securities class action lawsuits previously filed and relating to the transaction were in recent days voluntarily dismissed (see the voluntary dismissal motions here and here.) [Note: On April 6, 2021, yet another plaintiffs’ law firm filed a third securities class action lawsuit against MultiPlan and others, containing allegations related to the SPAC. A copy of this third complaint can be found here.] Nevertheless, and notwithstanding the separate voluntary dismissals of the prior securities class action lawsuits, last Thursday, a separate plaintiff shareholder, acting through a different plaintiffs’ law firm, filed the Delaware Chancery Court complaint seeking damages based on alleged breaches of fiduciary duty and other legal theories. A copy of the Delaware complaint can be found here.
By way of background, Churchill Capital Corp. III (“Churchill III”) is a Special Purpose Acquisition Corporation (SPAC) that completed an IPO on February 14, 2020. The IPO was sponsored by M. Klein and Company, a financial services firm headed by Michael Klein, who has been, according to the Delaware complaint, a “serial sponsor of SPACs.”
On July 13, 2020, Churchill III announced that it had entered into an agreement, subject to shareholder approval, to merge with MultiPlan Corp. MultiPlan is a data analytics firm that provides cost management solutions to the U.S. healthcare industry. Its customers include, among others, large national insurance companies. The merger was to be funded with the proceeds of the IPO as well as new debt and equity issuances. At the completion of the transaction, the merged company was to be known as MultiPlan. In an October 7, 2020 vote, Churchill III shareholders approved the merger and related financing.
On November 11, 2020, short seller Muddy Waters Research published a report entitled “MultiPlan: Private Equity Necrophilia Meets The Great 2020 Money Grab” (here). Among other things, the Muddy Waters report claimed that at the time of the merger, MultiPlan was in the process of losing its largest client, UnitedHealthcare, which, the report claimed, could cost the company about 35% of the company’s revenues and 80% of its levered free cash flow in the next two years. The report further claimed that United Healthcare had launched a competitor, Naviguard, to reduce its business with MultiPlan. The report further claimed that MultiPlan had obscured its deteriorating financial position by manipulating cash reserves to show inflated earnings. MultiPlan’s share price declined on this report.
The Delaware complaint purports to be filed on behalf of a class of stockholders who held Churchill stock between the “Record Date” (September 14, 2020) and the merger “Closing Date” (October 8, 2020). The complaint asserts claims against the former directors and officers of Churchill (including Michael Klein); Klein and his financial vehicles, as well as the related entity that sponsored the SPAC, as the SPAC sponsors; and a related Klein Group, an entity affiliated with Michael Klein, and which performed advisory services in connection with Churchill’s merger with MultiPlan.
The complaint alleges that Klein and the Churchill directors and officers had founder shares and ownership interests that provided massive financial incentives for them to seek and to approve a deal – any deal – and alleges further that even a bad deal for the SPAC’s public investors “would yield massive windfalls to holders of their shares.” However, disclosures surrounding the deal were “not done with the rigor of the usual IPO process,” and indeed, the board “did not bother retaining their own independent third-party financial advisor, but instead the board “retained Michael Klein’s own vehicle, Klein Group, thus transferring a $30.5 million ‘advisory fee’ to M. Klein on top of his founder shares windfall.” (The complaint estimates that Michael Klein’s founde’rs shares, for which he paid $25,000, were worth over $300 million up on the Merger’s closing, representing a personal return over 1.2 million percent.)
The complaint alleges further that while the board had a duty of diligence, it “failed in that duty or ignored and concealed the basic facts making clear that the acquisition was a disaster waiting to happen.” The complaint alleges that well before the merger deal was even announced, MulitPlan’s largest customer has disclosed its intentions to create an internal operation to provide the services it previously acquired from MultiPlan. The complaint alleges that the disclosures in advance of the merger were deficient as well, among other things owing to its failure to disclose that the customer was setting up a competing operation. The complaint alleges that these alleged due diligence and disclosure deficiencies came to light in the November short seller’s report, the result of which was a “financial catastrophe” causing MultiPlan’s share price to plummet.
The complaint alleges that the “entire fairness standard applies to this deeply conflicted Merger.” And that in light of the “conflict-laden structure” of the SPAC and the “manner in which Michael Klein and the Board acted with respect to those conflicts and the deal process in general, the Merger cannot meet the test of entire fairness.”
The complaint asserts claims for breach of fiduciary duty against the director defendants and against the officer defendants; a claim for breach of fiduciary duty against Michael Klein and his related entities (the “controller defendants”) for breach of fiduciary duty; and a claim for aiding and abetting breach of fiduciary duty against the Klein Group, the Klein affiliated entity that received the advisory fee in connection with the transaction.
The complaint seeks the award of monetary damages arising from “the unfair acquisition of MultiPlan and in the alternative for public shareholders who purchased Churchill stock prior to the Record Date and continue to hold such stock, for the Court to “equitably reopen the redemption window to allow them to put back their … shares for $10 per share, plus interest.”
The extent of SPAC activity has been well documented on this site and elsewhere. There is a temptation to use colorful terms to describe the level of activity, such as, for example, calling it a “frenzy.” In whatever way anyone might want to try to characterize it, there can be no doubt that the amount of SPAC activity is reaching extraordinary levels. For anyone looking for a sign of this phenomenon may be nearing its crescendo, they need look no further than Friday’s news that SPAC BowX Acquisition plans to merge with the failed IPO company, WeWork, in a deal that values WeWork at $9 billion including debt.
Up until this point, the activity that has drawn all of the attention has been the financial and transaction activity. I have tried on this blog to try to document the accompanying, related legal activity, but so far at least the financial news has greatly predominated. The legal developments I described above may represent distant early warning signs that the legal side of things may be about to heat up.
The news described above suggests that the SEC may be gearing up to take some further action. It is no mistake that the Reuters and Law360 article I cited above both interpreted the news about the SEC’s recent informal actions as merely the start of the SEC’s efforts. Although there is no way to know what specifically the SEC may do, the likelihood is that the agency investigation will expand.
The new Delaware complaint described above also represents a significant development, in several ways. For starters, it represents a different legal approach to seeking damages in connection with the SPAC transaction; rather than asserting claims under the federal securities laws, it seeks damages under the common law for breach of fiduciary duty claims. For another thing, the emotional center of the lawsuit is the alleged conflict of interest between the SPAC sponsor and directors, on the one hand, and the public investors, on the other; the complaint essentially alleges that the defendants were motivated to act, and did act, in their own financial interests, to the detriment of investors.
Indeed, the complaint goes further than just complaining about the Churchill merger with MultiPlan; it actively alleges that the conflicts of interest between the sponsors and investors and in the very nature of the ways SPACs generally are structured. Thus, the complaint alleges that the basic SPAC structure in general is “conflict-laden” and “practically invites fiduciary misconduct.” The complaint expressly invites the court to make clear that SPACs are “subject to the same level of fiduciary duty review applicable to any other Delaware corporation,” so that “future SPACs will … adapt” as a result of which future SPAC sponsors “can easily choose to mitigate avoidable conflicts by structuring entities that better protect public stockholders.”
In other words, the plaintiffs’ lawyers apparently intend to position themselves as providing the Delaware courts as a chance to remedy excesses that are imbedded in the way SPACs are structured.
It should not be overlooked that – even though the Delaware complaint was filed months after the merger transaction was completed – the ONLY defendants in the lawsuit are the SPAC directors and officers, SPAC sponsors, and affiliated entities. The successor company executives are not named. In addition, the claimants on whose behalf this lawsuit is filed are those who held Churchill stock at the time the deal was announced – that is, SPAC investors. This is a lawsuit about the SPAC, the way the SPAC conducted the deal, and the extent to which the SPAC directors, officers, and sponsors, financially benefited from the transaction. This point bears emphasis because there is often confusion on the part of SPAC founders and officials about where liability and litigation risk potential may reside.
I want to underscore the fact that this is a lawsuit against the SPAC organizers and officials, and it is a lawsuit about the SPAC itself. I have received message from readers in recent days suggesting that the SPAC-related lawsuits I have documented on this site are really not about SPACs at all but are really about the activities and actions of the merger targets. To those who have tried to make this argument to me, I say, take a look at the complaint in this lawsuit.
Of course, the Delaware complaint has only just been filed and it remains to be seen how it will fare. In that regard, it is worth emphasizing that for all of the arm-waving in the complaint, the complaint depends to a large extent on the veracity of the assertions in the short seller’s report on which the complaint relies.
In thinking about the merits of this new lawsuit, there is also the anomaly noted above of the voluntary dismissal of the securities class action lawsuits to contemplate. There is really no way to know from the outside what is going on or why the securities suits were voluntarily dismissed. The dismissals may be significant, or they may signify nothing, it is hard to tell. It is odd that both sets of plaintiffs’ lawyers that filed securities lawsuits chose to dismiss their actions. The dismissals may or may not be relevant in thinking about the likelihood of success of the Delaware action. But whatever they may mean, the dismissals are kind of interesting, even if inexplicable, and do provide interesting context within which to consider the new Delaware action.
One final note. I know that some might question why I am assuming that there must be legal activity ahead, as if it were the result of some kind of physical law or something like that. I am by no means claiming that anything is preordained. However, I just think that there is no way you can get as much financial activity on the scale that has been involved in the SPAC wave and not get a fair amount of litigation as a result. I could be proven wrong – but I don’t expect that.
More About WeWork: According to a March 27, 2021 article in the New York Times (here), BowX, the SPAC that is set to merge with WeWork, is backed by Bow Capital, “an investment firm that counts Shaquille O’Neal, the former basketball player, as an adviser.” I guess that would make BowX a Shaq SPAC. And in my scale of values, that is not necessarily a recommendation for the deal.