So far in 2021, we have seen more than 500 Special Purpose Acquisition Companies (SPACs) go public and raise more than $123 billion, and more than 160 of these “blank check firms” complete mergers with or acquisitions of private companies in “de-SPAC” transactions.[1] With the continued popularity of SPACs, however, come litigation risks and a need for market participants contemplating SPAC transactions to be aware of noteworthy private litigation trends—from assertions of breach of duty based upon conflicts of interest to securities law violations arising from alleged deficient disclosures—as well as recent Securities and Exchange Commission (SEC) guidance and the potential for increased regulatory enforcement activity around SPACs.[2]

Background on SPACs

SPACs, sometimes referred to as “blank check companies,” raise capital through traditional initial public offerings (IPOs) with the ultimate goal of funding the acquisition of private companies. SPACs are created by “sponsors”—frequently private equity or venture capital firms—that typically assemble the SPAC’s management team. Participants in a SPAC IPO generally receive “units” consisting of one common share and a fraction of a warrant to purchase an additional common share at a specified exercise price. SPACs must file registration statements in advance of their IPOs, but at the time of the offering, SPACs have not yet identified, and therefore do not disclose their acquisition targets in their registration statements. The registration statements do, however, state that the SPAC is formed to locate a private company merger or acquisition candidate in a specific industry.

After the IPO has closed and the securities are listed, SPACs begin the search for merger or acquisition candidates. Once a suitable target is identified, the SPAC negotiates the terms of a potential transaction, signs and announces a definitive agreement, and then prepares and files with the SEC a proxy statement describing the proposed de-SPAC transaction in advance of a shareholder vote. The cash portion of the merger or acquisition consideration is typically funded with the capital raised through the IPO, and sometimes with additional capital raised through private investment in public equity (PIPE) transactions. Assuming the SPAC shareholders approve the proposed transaction, the shareholders have the choice of redeeming their SPAC shares for cost plus interest.

SPACs have typically had two years to complete a de-SPAC transaction, although some recent SPAC IPOs have provided shorter time periods. If the SPAC does not complete a merger or acquisition within the prescribed period, the SPAC is liquidated and the proceeds are returned to the public shareholders.

Private Litigation

Private SPAC litigation is not new, but it is on the rise. Stakeholders have asserted various claims, including breach of duty based upon conflicts of interest, securities law violations arising from alleged deficient disclosures, violations of corporate governance documents, and breach of contract. Given the sheer number of SPAC transactions, this trend is likely to continue.

SPAC shareholders have alleged, for example, that SPAC sponsors, who typically hold “founder shares” or other equity stakes, have conflicts of interest. AP Services, LLP v. Lobell, 2015 WL 3858818 (N.Y. Sup. Ct. June 19, 2015), is an early example. There, a SPAC conducted a leveraged buyout of a target, which subsequently went bankrupt. A litigation trust brought claims against the former SPAC directors, claiming that they breached their duties, were self-interested, ignored red flags concerning the target, and saddled the company with debt it was unable to pay. The court held that the plaintiff stated a plausible claim sufficient to survive a motion to dismiss, and the parties settled a few months later.

Other cases have focused on allegations that the founder was unduly motivated to close a deal. In Amo v. Multiplan Corp., No. 2021-0258 (Del. Ch.), commenced in March 2021, a shareholder in a post-de-SPAC company charged that the sponsor received founder shares, giving it the right to obtain 20% of the SPAC’s equity for nominal consideration provided an acquisition was completed. The plaintiff alleges that this incentive and others constituted a conflict of interest that caused the sponsor to propose and complete the acquisition of an allegedly doomed target company. Indeed, the plaintiff alleges that the target company’s main customer announced its intention to create a platform that would replace the services provided by the target company, rendering the SPAC’s acquisition of the target company an alleged “disaster waiting to happen.” In April 2021, this action was consolidated with a similar action, forming In re Multiplan Corp. Stockholders Litig., No. 2021-0300. The defendants filed motions to dismiss, which have been fully briefed and argued, and are awaiting decision.

Likewise, in Laidlaw v. Ledecky, et al., No. 2021-0808 (Del. Ch.), commenced on September 20, 2021, the plaintiff shareholder in a post-de-SPAC company alleged that the directors of the SPAC pushed for a merger with an electric vehicle startup even though the directors were aware that the deal was not in the best interests of or fair to stockholders. The complaint alleges that, “[a]lthough an abysmal deal for Pivotal’s Class A stockholders, the merger provided a financial windfall for the holders of the founder shares,” the Class B shares held by Pivotal’s officers and directors. According to the complaint, “Even with XL Fleet’s loss of share value, the founder shares — which were ‘purchased’ for virtually nothing — are worth nearly $40 million.” On November 23, 2021, the parties filed a stipulation consolidating this and related actions, appointing co-lead plaintiffs, and appointing co-lead counsel.

SPAC shareholders have also asserted claims for securities law violations based upon allegedly deficient disclosures in SPAC registration and proxy statements. Such claims are often asserted after the completion of a de-SPAC transaction. According to the Stanford Law School’s Securities Class Action Clearinghouse, there are currently 38 putative securities class action complaints pending in federal courts arising from de-SPAC transactions.[3] In many of these putative class actions, the plaintiffs assert that the structure of the SPACs at issue, and the related incentives for the SPAC sponsors to complete a de-SPAC transaction within the prescribed period, establish the “scienter” (i.e., fraudulent intent) element of certain securities law violations.

Welch v. Meaux, et al., No. 19-cv-1260 (W.D. La.), which commenced on September 26, 2019, is a typical example. In this case, after the de-SPAC transaction closed, the plaintiff shareholders asserted claims against the company, certain of its officers and directors, and the underwriters of a secondary offering made in connection with the de-SPAC transaction. The shareholders allege that defendants hastily organized a flawed merger based upon inadequate diligence, and, motivated by their incentives to complete a de-SPAC transaction within the fast-approaching two-year deadline, issued materially false and misleading statements in connection with that merger. The defendants filed motions to dismiss, which have been fully briefed and argued, and are awaiting decision.

Defendants in these cases have asserted typical securities defenses in motions to dismiss based on failure to adequately plead misstatements, falsity, and scienter with particularity, and on the Private Securities Litigation Reform Act’s (PSLRA’s) safe harbor for forward-looking statements.

SPAC officers and directors have also been named as defendants in suits alleging Section 14(a) and Rule 14a-9 disclosure violations. In Nichols v. Romeo Power Inc., No. 1:21-cv-03362 (S.D.N.Y.), commenced on April 16, 2021, the plaintiff shareholders allege that, prior to a de-SPAC transaction, the defendants, including the directors and the officers of the SPAC, caused the SPAC to make various filings with the SEC that allegedly contained false and/or misleading statements regarding issues such as the target’s ability to meet customer demand. In July 2021, this action was consolidated with a similar action, forming In re Romeo Power Inc. Sec. Litig., No. 1:21-cv-03362 (S.D.N.Y.). On September 15, 2021, the plaintiffs filed a consolidated complaint and on November 5, 2021, the defendants moved to dismiss that complaint.

In certain lawsuits recently filed by SPAC shareholders alleging securities law violations, the SPAC shareholders seek to take advantage of recent guidance from the SEC—that SPACs should account for the warrants associated with SPAC “units” as liabilities rather than equity (as discussed in detail below)—by asserting securities law claims premised upon the alleged failure of SPAC disclosures to properly account for the warrants.

For example, in Lavin v. Virgin Galactic Holdings, Inc., No. 21-cv-3070 (E.D.N.Y.), commenced on May 28, 2021, after a post-de-SPAC company restated two years’ worth of financial statements—specifically to rectify its accounting treatment of warrants in light of the SEC’s guidance that warrants should be treated as liabilities rather than equity—shareholders of the company sued. The shareholders allege that the company violated securities laws by making materially false or misleading statements in SEC filings concerning its financial reporting controls, premised on the theory that, because the company improperly treated warrants as equity rather than liabilities, the company’s financial reporting controls must have been deficient, and any statements about them must have been materially false or misleading. In September 2021, the court appointed co-lead plaintiffs and co-lead counsel. The co-lead plaintiffs announced their intention to file an amended complaint, and the court directed them to do so by December 6, 2021.

SPAC shareholders have also asserted claims against SPAC sponsors for violating corporate governance documents by, for example, incurring allegedly excessive fees. In Ruffalo v. Transtech Serv. Partners Inc., 2010 WL 3307487 (Del. Ch. Aug. 23, 2010), after the subject SPAC failed to complete a merger within the prescribed period and was liquidated, SPAC shareholders alleged that the SPAC violated its corporate charter and a related trust agreement by making payments in connection with the SPAC’s liquidation in excess of an allegedly applicable cap on expenses. In that case, the court granted in part the SPAC’s motion to dismiss based upon the court’s finding that the cap on expenses did not apply in the context of a liquidation. In February 2011, the court preliminarily enjoined the defendants from transferring money out of accounts owned by the SPAC, and later in the year, the parties settled the claims.

There has also been significant attention given to litigation concerning Pershing Square Tontine Holdings, a SPAC associated with billionaire hedge-fund investor Bill Ackman. The SPAC was sued by a shareholder who alleges that, based upon an unusual structure, the SPAC is not an operating company, but actually an investment company, which must be regulated by the Investment Company Act of 1940. The case is Assad v. Pershing Square Tontine Holdings, Ltd. et al., No. 1:21-cv-06907-AT (S.D.N.Y.), commenced on August 17, 2021. The unique structure of Pershing Square Tontine Holdings may render the outcome of this lawsuit as being of limited applicability to other SPACs. An amended complaint was filed on October 15, 2021, and the case remains pending as of the date of this article.

A SPAC itself filed two lawsuits in the Southern District of New York, asserting breach of contract and tortious interference with contractual relations claims against several PIPE investors for allegedly breaching subscription agreements obligating the defendants to invest in the company in connection with its de-SPAC transaction. The parties to the de-SPAC transaction waived the minimum cash condition of the business combination agreement and closed the transaction anyway. The suits—Sustainable Opportunities Acquisition Corp. v. Ramas Capital Management LLC et al., No. 21-cv-07642 (S.D.N.Y.), and Sustainable Opportunities Acquisition Corp. v. Ethos Fund I LP et al., No. 21-cv-07640 (S.D.N.Y.), both commenced on September 13, 2021—were voluntarily dismissed one week after they were commenced. As in the transactions giving rise to these lawsuits, SPACs often need to rely on PIPE funding in order to close a contemplated de-SPAC transaction, especially when a significant number of SPAC shareholders choose to redeem their shares rather than participate in the merger. As a result, litigation may occur when PIPE investors allegedly fail to follow through on their commitment to invest, putting the merger in jeopardy because the SPAC cannot meet the minimum cash condition at closing.

In addition to litigated cases, the plaintiff’s bar regularly submits demand letters seeking books and records and demanding additional disclosures. This is consistent with activity in the M&A space more generally, and this trend is likely to continue.

SEC Guidance and Enforcement

Recent SEC guidance concerning SPACs demonstrates, at a minimum, the SEC’s increased focus on this area, and may portend increased regulatory enforcement activity.

There was a flurry of SEC guidance issued during the spring of 2021. In late March, the SEC reportedly sent requests for information to various financial institutions concerning their SPAC dealings, including related deal fees, volumes, and reporting and internal controls.[4] The SEC has since sent additional requests to various banks concerning fees earned on SPAC transactions.[5] At the end of March, the staff of the SEC Division of Corporation Finance issued a statement addressing certain accounting, financial reporting, and governance issues related to SPACs and the combined company following a de-SPAC transaction,[6] and the SEC’s chief accountant issued a statement addressing financial reporting and auditing considerations for companies merging with SPACs.[7]

In April, the acting director of the SEC’s Division of Corporate Finance, John Coates, announced that the expedited process by which SPACs bring private companies into public markets may lead to “some significant and yet undiscovered issues,” which many industry participants interpreted to mean that the SEC would scrutinize SPAC transactions more closely going forward.[8]

The SEC also issued a separate statement by Acting Director Coates in April, stating that a de-SPAC transaction likely is an IPO for purposes of the PSLRA’s exclusions from its safe harbor provisions. Thus, regardless of whether a SPAC issues new securities in connection with the de-SPAC transaction, under the SEC’s interpretation of the law, the resulting entity and controlling persons or entities could be excluded from the PSLRA’s safe harbor for forward-looking statements and potentially subject to strict liability under the Securities Act.[9]

Later that same month, the SEC released a statement that SPACs should account for certain warrants associated with SPAC “units” as liabilities rather than equity. This guidance marked a meaningful change, because treatment as liabilities would require SPACs to revalue the warrants quarterly, whereas treatment as equity requires valuation only upon the formation of the SPAC.[10]

In September, the SEC reportedly told auditors of SPACs that SPACs should account for redeemable shares issued by SPACs as temporary equity rather than permanent equity, because of the redemption feature which is central to the SPAC structure.[11] This change has caused another wave of SPAC restatements.

Industry participants are waiting to see whether the SEC’s recent guidance and requests for information will be followed by increased regulatory enforcement activity. Since the recent proliferation of SPACs beginning in 2020, the SEC, in July 2021, charged Stable Road Acquisition Corp, a newly formed SPAC that merged with Momentus, a space transportation technology company, along with the SPAC’s CEO and sponsor with various securities law violations. The SEC alleged that the SPAC failed to properly perform due diligence on its acquisition target, highlighting that the SPAC allegedly hired a space technology consulting firm to investigate Momentus only one month before the merger announcement. The SEC also alleged that the SPAC completed the merger agreement despite Momentus failing to provide responses to questions asked by Stable Road during the diligence process. More recently, in October 2021, the SEC settled charges against Akazoo S.A., a music streaming business based in Greece that went public via a SPAC merger. The SEC did not charge the SPAC or any of its executives or directors, but the facts call into question the SPAC’s diligence (as in the Stable Road matter). The press release announcing the settlement stated: “The SEC is intently focused on SPAC merger transactions, and we will continue to hold wrongdoers in this space accountable.”[12]

FINRA has also expressed interest in SPACs. The regulator recently launched an examination of member firms’ “offering of, and services provided to, [SPACs] and their affiliates (e.g., sponsors, principal stockholders, board members, and related parties).”[13] Among other things, the requests to member firms seek copies of SPAC-related policies and procedures, compliance memos and other internal guidance that were in effect or issued between July 1, 2018, and September 30, 2021. These requests are part of a previously announced sweep by FINRA of member firms’ dealings with SPACs.[14]

Congressional Interest

On September 22, 2021, US Senators Elizabeth Warren, Sherrod Brown, Tina Smith, and Chris Van Hollen sent open letters to six frequent investors in SPACs: Chamath Palihapitiya, Michael Klein, David Hamamoto, Stephen Girsky, Tilman Fertitta, and Howard Lutnick.[15] The letters state that various reports highlight “increasing concerns that the operators of [SPACs] have ‘employed a range of maneuvers — some of them downright astonishing to the uninitiated — to win even when investors lose.’” The letters continue, “If these reports are accurate, they reveal significant market dysfunction, with insiders taking advantage of legislative and regulatory gaps at the expense of ordinary investors.” The letters request information regarding each recipient’s investments in and compensation from the SPACs they have created or been affiliated with. These letters signal increased scrutiny and could trigger additional private lawsuits.

Conclusion and Takeaways

The surge in SPAC transactions has increased litigation as well as SEC and congressional scrutiny. This trend will likely continue. Market participants should learn from recent cases to limit their litigation and regulatory risk.

On the private litigation front, for example, SPAC sponsors and directors may be able to protect against allegations that they were unduly motivated to close a deal—by conflicts of interest or otherwise—by providing comprehensive disclosures about issues material to investors, including their financial incentives, any prior relationships with interested parties, and any potential conflicts generally.

Also, SPAC sponsors and directors may be able to protect against allegations that they missed or ignored red flags about targets by engaging in thorough, well-documented due diligence of potential targets, including evaluating the reasonableness of potential targets’ projections, identifying risks presented by potential targets, and, for any proposed de-SPAC transaction, explaining why the upside of the proposed de-SPAC transaction outweighs the risks (which should be clearly delineated).

On the regulatory front, SPACs’ compliance with SEC guidance—including recent guidance concerning the accounting treatment of SPAC “units”—will, of course, limit regulatory risk. Moreover, participants in SPAC transactions and entities considering participation in SPAC transactions would also be well-served to monitor reports of regulators’ and legislators’ requests for information from industry participants to anticipate possible bases for regulatory enforcement activity.