In a development that unquestionably raises the heat on SPACs and SPAC sponsors, a group of four Democrat senators has sent each of six serial SPAC creators a letter raising questions about the creators’ SPAC-related activities and financial rewards. The letters’ purpose ostensibly is to allow the Senators to “understand what sort of Congressional or regulatory action may be necessary to better protect investors and market integrity.” Copies of the Senators’ September 22, 2021 letters can be found here. Senator Elizabeth Warren’s September 22, 2021 press release about the letters can be found here.
The four Democratic Senators who attached their names to the letters are Senator Elizabeth Warren of Massachusetts; Senator Sherrod Brown of Ohio; Senator Tina Smith of Minnesota; and Senator Chris Van Hollen of Maryland.
The recipients of the letters are Howard Lutnick, Chairman and CEO of Cantor Fitzgerald; Michael Klein, founder of M. Klein & Associates; Tilman Fertitta, Chairman and CEO of Fertitta Entertainment Inc.; Chamath Palihapitiya, co-founder and CEO of The Social+Capital Partnership LLC; David T. Hamamoto, CEO and Chairman of DIamondHead Holdings Corp.; and Stephen Girsky, managing partner at VectoIQ LLC. A courtesy copy of each of the letters was also sent to Chair of the SEC and the President and CEO of FINRA.
Although the letters are directed to individuals, and although each of the letters are customized to a certain respect with respect to each individual recipient, all six of the letters consist of the same basic form.
The letters begin with an opening declaration about concerns that have been voiced that the SPAC process reveals “significant market dysfunction,” with “insiders taking advantage of legislative and regulatory gaps at the expense of ordinary investors” and a statement of purpose that the letters seek “information about your use of SPACs in order to better understand what sort of Congressional or regulatory action may be necessary to better protect investors and market integrity and ensure a fair, orderly, and efficient marketplace.” This opening is then followed with a made-for-the-public recitation of the extraordinary levels of SPAC-related activities in the financial marketplace in 2020 and 2021.
The letters then move on to the apparent opportunities that the SPAC creators have to profit as a result of the SPAC creation and promotion process, often at the expense of retail investors. The letters review the incentives that the typical SPAC creation process creates for its sponsors to complete a deal, any deal, quickly; to take advantage of supposed gaps in the regulatory structure to make “overly optimistic” statements about the target company and its prospects; and to try to persuade investors to approve a proposed transaction. The letter also recites that in some instances, SPAC sponsors have found additional ways to profit, such as by paying their own investment firms service fees, or even target the sponsors’ own companies as merger targets.
The letter then goes on to examine the extent to which early SPAC investors have opportunities to profit through redemptions and warrants, resulting in dilution of the cash per share value of remaining investors’ equity; the letter notes that as a result of these moves of early investors, often hedge funds, “remaining investors are left to bear the brunt of the dilution in the cash value of shares caused by the sponsor’s promote.” As a result, the “inequality of performance” between the sponsors and early investors, on the one hand, and retail investors on the other hand, is “staggering,” especially in light of the fact that many de-SPACs often perform poorly post-merger.
The senators, the letters state, are “concerned about misaligned incentives between SPACs’ creator and early investors, on the one hand, and retail investors on the other hand.” In order to “determine how Congress and regulators can best protect investors and ensure a fair and transparent marketplace,” the letters request the recipients to answer a series of questions before October 8, 2021.
The letters’ questions seek to have the recipients identify all of the SPACs in which the recipients have been involved as a “sponsor, investor, underwriter or consultant” and to identify the capacity in which the recipients were acting with respect to each SPAC. The letters also request information with respect to each SPAC for the recipients to describe their process for communicating with prospective investors, as well as about past or projected performance of an acquisition or merger target. The letters also request the recipients to identify with respect to each SPAC with which they were involved all of the compensation and financial benefits they were to receive. The questions also seek to find out with respect to each SPAC and SPAC-merger target whether the recipients had a financial arrangement, stake or interest with or in the target.
The letters themselves purportedly only seek information from the recipients. The letters do not threaten any immediate action. However, the letters’ statement of their purpose – that is, “to understand what sort of Congressional or regulatory action may be necessary to better protect investors” — sounds ominous enough. It overtly presents the possibility of Congressional action directed specifically at SPAC-related activities. It also implicitly creates Congressional pressure on regulators to consider their own separate activities to rein in the supposed excesses detailed in the letters.
The Senators’ sending of these letters to the serial SPAC creators is just the latest in a series of developments raising the temperature on SPAC creators. This Spring, SEC staff issues statements raising questions about SPAC promotional activities and SPAC accounting issues. This summer, the SEC launched two SPAC-related enforcement actions, one of which was clearly addressed to SPAC-related promotional activities, and the other of which was intended to highlight the importance of SPAC due diligence in advance of a SPAC-related merger. SPACs have also, as this blog has documented, been the focus of significant litigation activity. These letters notch the temperature on SPACs up several degrees.
It could be argued that the Senators’ efforts are coming rather late in the day. SPAC IPO activity has slowed significantly in recent weeks, with only a very small trickle of SPAC IPOs actually pricing in recent weeks. Just the same, the Senators’ letters do suggest that the scrutiny of the SPACs that have completed their IPOs may have only just begun, a consideration that will loom over the now more than 400 SPACs that are currently out in the marketplace – with the clock ticking on their search periods – looking for merger partners. The bottom line seems to be that SPACs and SPAC-related activities are and will remain the subject of a great deal of attention and scrutiny in the weeks and months ahead.
More SPAC-Related Litigation: Although there have been no SPAC-related securities class action lawsuits filed in recent days, there has been litigation activity of another sort. In the last few days, plaintiffs’ lawyers have filed two more “breach of fiduciary duty lawsuits” filed in Delaware Chancery Courts in recent days.
On September 20, 2021, a plaintiff shareholder filed an action in Delaware Chancery Court against the former board of Pivotal Investment Holdings II LLC, a SPAC, and its sponsors, in connection with the SPAC’s merger with XL Legacy to form XL Fleet, alleging breach of fiduciary duty against the defendants in connection with transaction. A copy of the complaint in this action can be found here.
Similarly, on September 23, 2021, a plaintiff shareholder filed an action in Delaware Chancery Court against the board of GigCapital 2, Inc., a SPAC, and its sponsors in connection with the SPAC’s merger with UpHealth Holdings, alleging breach of fiduciary duty against the defendants in connection with the transaction. A copy of the complaint in this action can be found here.
In each of these lawsuits, the complaints allege that the structures of the SPACs and of the transactions were such that there were conflicts of interest between the SPAC’s boards and sponsors, on the one hand, and investors in the SPACs on the other hand, resulted in a flawed process in considering the proposed mergers, such that the mergers require “judicial review for entire fairness.” The complaints allege further that because of the conflicts of interest and tainted process, the mergers “cannot meet the entire fairness test.”
Both of the complaints urge the court to “affirm that the boards and controlling shareholders of SPACs incorporated in Delaware owe the same fiduciary duties to their stockholders as do the boards and controlling shareholders of any Delaware corporation, and thus bring reasonable limits to the money-grabbing SPAC bonanza that has been burgeoning in recent years at the expense of the investing public.”
These latest lawsuits are not the first to assert SPAC-related Delaware Chancery Court claims alleging breach of fiduciary duties against SPAC boards and sponsors and urging that the SPAC transactions must be judicially reviewed under the “entire fairness standard.” For example, as discussed here, in August 2021, a plaintiff shareholder filed a SPAC-related breach of fiduciary duty action against the sponsors and directors of GigCapital3, Inc. in connection with the SPAC’s merger with Lightning eMotors. The Gig3 complaint also argued that the judicial review of the merger should employ the “entire fairness” standard.
On September 20, 2021, the parties in the Delaware Chancery Court breach of fiduciary duty action against Churchill Capital III in connection with its merger with MultiPlan had oral argument on the defendants’ motion to dismiss, as discussed here. The outcome of the dismissal motion in the MultiPlan case could have a significant impact on whether the plaintiffs’ claims in these cases are viable. The plaintiffs’ lawyers in the case are clearly testing alternative recovery theories in these cases, which could determine the amount and direction of future litigation. To the extent the plaintiff survives the dismissal motion in the MultiPlan case, we clearly could see more of these kinds of lawsuits.
The onset of this kind of litigation is one factor causing many SPAC creators to consider creating their SPACs under the laws of other jurisdictions. There has been a perceptible shift recently toward the creation of SPACs under other jurisdictions’ laws, and it could be that the possibility of these kinds of Delaware Chancery Court suits is one factor in this move.