Regular readers know that I have been tracking SPAC-related securities class action lawsuits and other SPAC-related litigation. As I discuss in the second item below, the SPAC-related class actions have continued to be filed as the year has progressed. There have also been SPAC-related shareholder derivative lawsuits filed as well, but none quite like the derivative lawsuit filed this week on behalf of Wall Street investor William Ackerman’s SPAC vehicle, Pershing Square Tontine Holdings Ltd. against the SPAC’s directors and other defendants. The suit claims that the defendants structured massive compensation arrangements for the SPAC sponsor and the SPAC directors in violation of the Investment Company Act of 1940 and the Investment Advisers Act of 1940. A copy of the complaint can be found here.

 

Background

Pershing Square Tontine Holdings, Ltd. (PSTH) is a special purpose acquisition company (SPAC). PSTH completed an initial public offering on July 22, 2020. The company’s IPO raised approximately $4 billion, making PSTH the largest SPAC in history. William Ackman is PSTH’s CEO and Chairman of the Board of Directors. Pershing Square TH Sponsor LLC is the SPAC’s sponsor. The sponsor is owned by three funds affiliated with Pershing Square Capital Management, L.P, Ackman’s investment company. PSTH invested the IPO proceeds in U.S. government securities and money market funds while the company searched for an acquisition target.

 

In June 2021, PSTH announced that it had entered an agreement with Vivendi S.E. to purchase 10% of the outstanding shares of Universal Music Group in a complex, multi-step transaction. On July 19, 2021, PSTH announced that it had decided not to proceed with the proposed UMG transaction. In its announcement of the decision not to complete the deal, PSTH said that it did not believe it could complete the deal owing to issues that the SEC had raised with the transaction. According to news reports, among the SEC’s concerns is that the UMG deal would have left PSTH with more than $1 billion; the plan was to set up yet another acquisition vehicle, which would then search for another target.

 

The Lawsuit

On August 17, 2021, a PSTH investor filed a shareholder derivative lawsuit in the Southern District of New York against four PSTH directors; the sponsor; the Pershing funds that own the sponsor; and PSTH itself as nominal defendant. The lawsuit relates to warrants that the company allowed the director defendants and the sponsor to purchase. The lawsuit alleges that PSTH later repurchased the warrants from the director defendants. The gist of the complaint is that PSTH is an “investment company” as that term is defined in the Investment Company Act and that the warrant deal with the sponsor and the directors was illegal in both form and amount under the ICA and the Investment Advisers Act.

 

In support of its argument that PSTH is an investment company, the complaint alleges that “the only thing PSTH has ever done” is invest in securities, and that it has “spent nearly all of its time negotiating a transaction that would have invested [its] assets in still more securities,” a reference to the abandoned deal to purchase UMG securities.

 

The complaint alleges that the defendants’ “decision to avoid registering the Company as an investment company” allowed them “to use their positions of control to extract compensation from PSTH in forms and amounts that violate federal law.” The amount of compensation was, the complaint alleges, “astronomical.” When PSTH repurchased the warrants, the valuation implied that the warrants were in the aggregate worth “more than $880 million – thirteen times what the Sponsor and Director defendants originally paid for them.” This “staggering compensation” was “promised at a time when the returns to the Company’s investors have starkly underperformed the rest of the stock market.”

 

The complaint seeks to have the Court enter a declaratory judgment stating that PSTH is an investment company and that Ackman’s investment bank Pershing Square Capital Management is the company’s investment advisor; enter an order rescinding the warrant compensation arrangements; and award damages “reflecting Defendants’ breach of fiduciary obligations” under the ICA.

 

In a statement, Ackman said that PSTH is not an investment firm, adding that “PSTH has never held investment securities that would require it to be registered under the [ICA], and does not intend to do so in the future.”

 

Discussion

There are several interesting things about this new lawsuit. The first is the list of firms and individuals named as defendants. For starters, though the complaint names four individual directors as defendants, Ackman himself is not named as a defendant (presumably because he did not participate in the warrant transaction that is at the center of this lawsuit). However, the complaint does name as a defendant the SPAC sponsor and also names as defendants the Pershing Square funds that own the sponsor. The list of defendants raises very interesting issues about where liability exposures surrounding SPACs may flow.

 

The second interesting thing to me is that this lawsuit is focused on the basic question of how insiders are able to profit from arrangements relating to the SPAC. Questions have been swirling around SPACs about how the sponsors and other insiders are able to obtain outsized benefits. This lawsuit suggests that these kinds of questions could be the target of litigation. In that respect, it is interesting to note that the legal team that filed this suit includes former SEC commissioner Robert Jackson and Yale law professor John Morley, which suggests something of a policy-oriented approach toward targeting SPAC insider compensation.

 

The lawsuit is also something of an inquisition into PSTH’s novel proposal to use SPAC proceeds to purchase securities representing only partial ownership of the target company. Somewhere in the midst of the fight in this lawsuit is going to be a dispute about whether this type of transaction is an appropriate objective for a SPAC, since the plaintiff’s allegations that PSTH is an investment company turn in part of on PSTH’s proposed use of its IPO proceeds.

 

This new lawsuit is complex and relates to transactions that are complex, and involves legal theories that are unfamiliar (at least to me). It is hard for me to form any kind of opinion about the merits of the plaintiff’s allegations. However, the one thing that this lawsuit does tell me is that SPACs and SPAC-related transactions, including compensation arrangements, are going to be subject to scrutiny from investors and from the plaintiffs’ bar. In some instances, the scrutiny may include litigation, particularly with respect to SPAC transactions that are creative or that push the envelope.

 

For those involved in thinking about SPAC-related insurance issues, there is much to contemplate here as well. The lawsuit arose during the pre-merger search period (albeit after a proposed merger transaction was abandoned), and accordingly triggers the SPACs pre-merger insurance policy. In some D&O insurance arrangements for SPACs, the sponsor is added to the policy as a named insured on a co-defendant basis, which would appear to address this situation, but the sponsor’s owners are not named, meaning that the funds that own the sponsor here would have to look to Pershing Square’s own insurance tower.

 

One final thought on the insurance issue has to do with the improper compensation exclusion found in most D&O insurance policies. The gist of this lawsuit is that the directors received compensation to which they were not legally entitled, which might otherwise implicate the exclusion. However, these days, many policies’ improper compensation exclusions are written on an “after adjudication” basis, meaning that the preclusive effect is not triggered unless there is a final adjudication that the precluded conduct actually took place.

 

Physical Therapy Company Hit with SPAC-Related Securities Suit: On August 16, 2021, a plaintiff shareholder filed a SPAC-related securities class action lawsuit against ATI Physical Therapy, a company that merged in June 2021 with Fortress Value Acquisition Corp. II, a SPAC that completed its IPO in August 2020. A copy of the complaint can be found here. The individuals named as defendants include not only two officers of ATI, but also eight former directors of the SPAC. The lawsuit follows the company’s July 26, 2021 announcement of disappointing financial results, among other reasons because of “attrition” of therapists due to increased competition in the labor market.

 

The ATI complaint is by my count the 19^th SPAC-related securities suit to be filed this year. Interestingly the SPACs involved in the ATI lawsuit and the PSTH lawsuit described above both completed their IPOs in August, which is right about when the SPAC IPO market really started to take off last year. In other words, we could be starting to see the litigation effects of the SPAC IPO frenzy that kicked in at the end of last year and the beginning of this year. I suspect there is going to be a lot more litigation to come.