When senior SEC staff issued a statement in April saying that most warrants issued by SPACs should be treated as liabilities rather than as equity, it triggered a huge slowdown in the previously hot SPAC IPO market. It also forced many existing SPACs to review the way they had previously accounted for warrants; in some instances, individual SPAC companies concluded that they needed to restate their prior financial statements. Now, in a development that highlights the risks that these seemingly obscure accounting issues present, a plaintiff shareholder has filed a securities class action lawsuit against  Virgin Galactic Holdings, a post-SPAC-merger company that restated its financials based on the warrant accounting issue. The May 28, 2021 complaint, a copy of which can be found here, alleges that the company had previously improperly accounted for its warrants, and that the prior accounting treatment violated the securities laws.



Social Capital Hedosophia Holdings Corp. (SCH), a special purpose acquisition company (SPAC), completed its IPO on September 14, 2017. On October 25, 2019, SCH completed a merger with a then-private company referred to in the subsequent securities suit as Legacy Virgin Galactic. Virgin Galactic is an aerospace company seeking to develop private commercial space travel. Following the merger, SCH changed its name to Virgin Galactic Holdings.


On April 12, 2021, John Coates, Acting SEC Director of the Division of Corporation Finance, and Paul Munter, the Acting SEC Chief Accountant, issued a  statement addressing accounting and reporting considerations regarding warrants issued by SPACs. The SEC officials in effect said that some SPACs may not have properly accounted for warrants sold to investors. In the past, many SPACs classified warrants as equity on their balance sheets. However, in the statement, the SEC officials said that in certain circumstances the units would have to be classified as liabilities, rather than as equity.


The classification of the warrants as liabilities would require companies to periodically account for changes in the warrants’ value. As the Wall Street Journal noted in its April 13, 2021 article about the SEC statement, “one impact of the SEC’s announcement: SPACS that are affected would have to restate their financial results if the fluctuations are deemed to be material.”


On April 30, 2021, Virgin Galactic announced that it was postponing the release of its first quarter 2021 financial results until May 10, 2021. The company said that it was rescheduling its reporting due to the SEC’s April 12 statement on the accounting treatment of warrants. The company said further that it would be restating its financial statements for fiscal years 2019 and 2020; the restatement, the company said, was “due solely to the accounting treatment for the warrants of Social Capital Hedosophia Holdings Corp. that were outstanding at the time of the Company’s busines combination on October 25, 2019.”


According to the subsequent securities lawsuit complaint, Virgin Galactic’s stock price fell over nine percent on the news of the reporting delay and restatement.


The Lawsuit

On May 28, 2021, a plaintiff shareholder filed a securities class action lawsuit in the Eastern District of New York against Virgin Galactic Holdings and certain of its officers. The individual defendants named in the complaint include Michael Colglazier, who has acted as Virgin Galactic’s CEO and President since July 20, 2020; George Whitesides, who was Virgin Galactic’s CEO and President from the start of the class period until July 20, 2020;  Doug Ahrens, who has served as Virgin Galactic’s CFO since March 1, 2021; and Jon Campanga, who served as the company’s CFO from the start of the class period until March 1, 2021.


The complaint purports to be filed on behalf of a class of investors who purchased Virgin Galactic securities between October 26, 2019 (the day the merged company’s securities began trading on the public markets) and April 30, 2021 (the day Virgin Galactic announced its reporting delay and restatement).


The complaint quotes extensively from the company’s SEC filings during the class period, focusing in particularly on the company’s statements about its internal controls over financial reporting. The complaint asserts that during the class period, the defendants made false or misleading statements or failed to disclose that: “(i) for accounting purposes, SCH’s warrants were required to be treated as liabilities rather than equities; (ii) Virgin Galactic had deficient disclosure controls and procedures and internal control over financial reporting; (iii) as a result, the Company improperly accounting for SCH warrants that were outstanding at the time of the Business Combination; and (iv) as a result, the Company’s public statements were materially false and misleading at all relevant times.”


The complaint alleges that the defendants’ statements or omissions violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder. The complaint seeks to recover damages on behalf of the plaintiff class.



The new complaint against Virgin Galactic has only just been filed and it remains to be seen how it will fare. But while the lawsuit has far to go before it is tested on the merits, it does seem fair to point out now that when the time comes the Court is going to have to look very hard to find anything in this complaint that would support the plaintiff’s obligation to allege that the defendants acted with scienter. In addition, the defendants undoubtedly will argue that a mere regulatory pronouncement affecting the accounting treatment of a balance sheet item does not transform prior reporting about the item into securities fraud.


However, regardless of the merits of the plaintiff’s complaint in this lawsuit – or lack thereof – the filing of this lawsuit is likely to send a serious chill throughout the SPAC world and the world of SPACs’ D&O insurers.


The fact is that, based on the SEC statement on accounting for warrants, many SPACs and post-SPAC-merger companies have had to reexamine their accounting treatment of warrants the SPACs issued at the time of their IPOs. A significant number of these companies, like Virgin Galactic, concluded that, due to the changed accounting treatment of their warrants, they needed to restate their previously issued financial statements.


If, as this lawsuit seems to suggest, the mere restatement of the financials due to the changed accounting treatment is sufficient to trigger a lawsuit, a significant number of companies (both SPACs and post-SPAC-merger companies) could potentially also get hit with securities suits.


It is interesting to review the list of individuals named as defendants in this lawsuit. The fact is that Virgin Galactic’s accounting treatment of the warrants pre-dated the merger transaction; the accounting for the warrants was established at the time SCH completed its IPO and carried forward to the merged company at the time of the merger transaction. Even though the warrant accounting issue is a vestige of the pre-merger SPAC’s accounting, none of the former directors or officers of the SPAC were named as defendants in this lawsuit (undoubtedly due to the fact that the plaintiffs’ lawyers chose to start the class period on the date of the merger, rather than some date prior). But while this complaint did not name as defendants any of the former SPAC directors and officers, there is a possibility that another complaint involving these SPAC warrant accounting issues could include officers and directors of the SPAC as named defendants.


The insurance implications of the various SPAC-related lawsuits is always interesting to me. In this case, because the named defendants are limited to the post-merger company and its post-merger directors and officers, and because the wrongful acts alleged are limited to post-merger events, the only insurance program that is triggered is the go-forward coverage that was put in place at the time the merger was completed; the runoff insurance programs of the pre-merger SPAC and the pre-merger private company apparently have not been triggered, and so in this instance the insurance implications are relatively uncomplicated.


It is also worth noting that this is the second SPAC-related lawsuit to be filed involving one of the Social Capital Hedosophia SPACs. Social Capital Hedosphia is the private equity vehicle of Chamath Palihapitiya, the so-called King of SPACs. Through Social Capital Hedosophia, Palihapitiya has formed a series of SPACs. In addition to the SPAC involved in these circumstances, Palihapitiya also formed Social Capital Hedosphia III, which in January 2021 merged with Clover Health Investments. As discussed here, in February 2021, Clover Health Investments was hit with a securities class action lawsuit over the company’s alleged failure to disclose the existence of a U.S. Department of Justice investigation prior to the merger.


This new lawsuit against Virgin Galactic is merely the latest of the SPAC-related lawsuits to be filed. By my count, there have now been a total of 14 SPAC-related securities class action lawsuits filed in 2021. While I have long thought that there would be a significant additional number of SPAC-related securities suits filed this year, if the warrant accounting treatment issue is going to be the subject of further securities litigation, there could be even more SPAC-related litigation than I was assuming previously.


In addition to all of the above comments, one other interesting thing about this SPAC-related lawsuit is that it relates to SPAC transactions from an earlier time. SCH completed its IPO waaay back in 2017, which is to say it is from a different time and place. The merger transaction took place in October 2019, which, by the standards of the current market for SPAC transactions, is also getting to be a while ago. If nothing else, this lawsuit shows the potential for seemingly long-settled deals to be subject to renewed scrutiny. Which in turn further underscores the possibilities for further SPAC-related litigation.