Syedur Rahman, partner at financial crime specialists Rahman Ravelli, assesses the legal issues relevant to the rise of special purpose acquisition companies (SPACs).
The rise of the special purpose acquisition company (SPAC) as an alternative means for a private company to go public has attracted large amounts of attention and investment.
An estimated $64 billion was raised in the US by 200 SPACS going public in 2020. It is a figure almost equal to the amounts involved in companies going public via the traditional initial public offering (IPO) route the same year. At the time of writing, the UK government is to assess a Treasury-backed review of the City that wants the rules regarding company listing to be redrafted to enable London to catch some of the work being generated by the rapid increase in popularity being enjoyed by SPACs in the US.
What is a SPAC?
Under a traditional IPO, a company is audited, it files a registration statement with the appropriate exchange commission – such as the US Securities and Exchange Commission (SEC) or the UK’s Financial Conduct Authority (FCA) – and arrangements are made to list shares on a stock exchange.
A SPAC, however, is created by a team of investors (sponsors) to acquire another company. It is essentially a shell company which is listed on a stock exchange. Its sole purpose is to acquire private companies, thereby making it public without it going through the traditional IPO process. A SPAC will raise money through its own IPO. But it has no commercial operations and no assets whatsoever, other than the money it raises through its IPO.
When this money has been raised, it is placed in an account until those running the SPAC identify a private company that is seeking to go public via an acquisition. When the acquisition is complete, investors in the SPAC can either swap their shares for shares in the acquired company or cash in their shares for what they paid for them plus any interest accrued.
SPACs must be completed within a set period of time. If a company is not acquired within a set deadline – usually two years after the SPAC’s IPO – it is liquidated and investors have their money returned.
The rise to popularity of SPACs
SPACs have always been around but have recently become increasingly popular, due in some part to the uncertainty that has been created by Covid-19.
Many companies have delayed taking their companies public, due to the current volatility in the markets and how this may affect their stock. Other companies, however, have taken a different approach by merging with a SPAC. Doing this allows companies to go public and be able to raise capital much quicker than would be possible using the conventional IPO process.
The SPAC process usually takes a few months whereas the traditional IPO registration can take significantly longer, due to its regulation and compliance procedure. For some, this is seen as a factor that can lead them to favour the SPAC process.
While the SPAC process has many enthusiastic supporters and has been behind many recent major, high-profile mergers, their use touches on a number of areas of law.
Misleading statements and misleading impressions
One of the most immediately obvious legal areas relevant to SPACs is that regarding misleading statements and misleading impressions.
Misleading statements is covered by s89 of the Financial Services Act 2012. This applies where someone:
- makes a statement which a person knows to be false or misleading in a material respect
- makes a statement which is false or misleading in a material respect, being reckless as to whether it is, or
- dishonestly conceals any material facts whether in connection with a statement made by a person or otherwise
Misleading impressions comes under s90 of the Financial Services Act 2012. This contains an additional offence of knowingly or recklessly creating a false impression for the purpose of (or with the knowledge that it is likely to lead to) personal gain, or the purpose of causing (or with the knowledge that it is likely to lead to) a loss to another person (or exposing that person to risk of loss).
The Market Abuse Regulation
Any conduct in relation to SPAC creation, promotion and subsequent activities will have to comply with the FCA’s Market Abuse Regulation. The Market Abuse Regulation (MAR), introduced in 2016, aims to protect investors by ensuring there is transparency in the financial markets.
MAR outlines three main forms of market abuse:
- Insider Dealing: Using inside information to make, change or cancel deals to obtain an advantage or to encourage a third-party to do so using this knowledge.
- Unlawful disclosure of inside information: Releasing inside information to another person without having permission to do so.
- Market manipulation: Actions that distort the performance of the market by misleading the market through a particular activity that manipulates the price. It is detailed in Article 12 of MAR, while Annexe l of MAR lists all activities that could indicate market manipulation.
MAR also regulates (via its Article 11) the practice of market sounding; where information is communicated before the announcement of a transaction in order to gauge the scale of possible interest from investors.
While MAR relates to the UK, SPACS based in the United States face similar responsibilities. Section 204A of the Investment Advisers Act of 1940 imposes obligations regarding the use of insider information and the prevention of insider trading, while SEC Rule 10b5 makes it an offence to use any measure to defraud, mislead the market or conduct business operations that would deceive another person regarding transactions involving stock and other securities.
Any SPAC, therefore, has to ensure it discloses and records all inside information in a compliant way while also having in place procedures to make sure that market abuse can be identified and reported.
Provisions relating to fraud exist in the US’s Securities Exchange Act 1934, the Securities Act 1933 and the Sarbanes-Oxley Act 2002. In the UK, investment fraud is an offence under the Fraud Act 2006. Activities relating to SPACs could possibly fall under fraud by false representation (Section 2), fraud by failure to disclose information when there is a legal duty to do so (Section 3) or fraud by abuse of position (Section 4). In each case, the conduct must be dishonest and the intention must be to make a gain or cause loss or risk of loss to another.
The Section 2 offence requires a defendant to have made a false representation, knowing that it was or might be untrue or misleading. Fraud by failing to disclose information (Section 3), involves a defendant failing to disclose information to another person when he was under a legal duty to disclose that information. The Section 4 offence of fraud by abuse of position relates to a defendant occupying a position in which they were expected to safeguard - or not to act against - the financial interests of another person but abused that position.
All three offences could be relevant to SPACs if they become a reality in the UK. One other area of concern could be accounting fraud, if the capital raised in the SPAC is distorted.
With the popularity of SPACs in the US having been a factor in the UK Treasury-backed review that has called for Britain to change its listing rules, the ultimate aim would appear to be attracting tech companies into the UK markets as opposed to the US markets.
While this should, arguably, be encouraged, there will need to be a high standard of governance in order to manage risk and ensure there is adequate investor protection if and when SPACs become a feature of the UK markets.