Risks from SPAC Mania Demand Policy Response
SPACs, or Special Purpose Acquisition Companies, have boomed in recent years, with offerings reaching an all-time high of $83 billion in 2020 and with even more in the pipeline for 2021. According to investor advocates, however, this growing way for companies to go public “represents attempts by sponsors and their targets to end-run longstanding rules designed to promote fair and efficient markets, and exposes investors and our markets to significant risks.”
“In a matter of just a few years, SPACs have come to dominate the way companies enter our public markets,” said CFA Director of Investor Protection Barbara Roper. “We are concerned, however, that investors who are attracted by the celebrity hype and the chance to be in on the ground floor may not fully understand the risks and conflicts of interested associated with these investments, or the extent to which they are able to rely on loopholes in our current regulations.”
As a result, CFA and Americans for Financial Reform (AFR) sent a letter to members of the House Financial Services Committee last month outlining their concerns with SPACs and their recommendations for steps Congress and financial regulators should take to better protect retail investors.
The letter identifies the following as key risks SPACs pose to investors:
- Initial SPAC disclosures may not provide investors with an appropriate understanding of the ultimate target company’s risks, operations, or other factors;
- The SPAC sponsor typically has insufficient incentive to “drive a hard bargain,” when negotiating with a merger target, because the sponsor’s primary objective is simply a completed transaction, along with the compensation it will earn upon the merger’s consummation;
- The SPAC sponsor and other financial advisors typically have insufficient incentives to perform robust due diligence that might turn up information that jeopardizes the deal;
- Target company disclosures may be less reliable, as a result of significantly lighter scrutiny in the SPAC process and the fact that SPAC sponsors and underwriters do not face the same legal liability risks as underwriters in an IPO, thereby increasing the risk of fraud;
- SPAC sponsors and other late-stage investors (in PIPE transactions) often receive incentives and significant compensation that materially dilute investors’ interests;
- SPAC investors have little ability to address perceived problems with corporate governance of the target company, executive compensation, or other terms because they are typically not party to the merger negotiations (often leading to more favorable terms for the target company executives and venture capital investors);
- Investors and the public have insufficient time to review detailed disclosures of the target, which reduces their ability to conduct thorough due diligence before deciding whether to stay invested through the merger;
- Due to certain loopholes in the federal securities laws, investors have fewer legal protections against misstatements by the target company and underwriter than they would have in a traditional IPO; and
- Investors have already committed to parting ways with the capital prior to receiving detailed disclosures, which creates significant “inertia” to remain invested.
To address the conflicts of interest inherent in SPAC structures and protect retail investors from misleading and incomplete disclosure regarding SPACs, CFA and AFR offered the following policy recommendations:
Modernize the Definition “Blank Check Company”
SPACs are a form of “blank check company,” in that investor money is committed before the target company is identified. But they are structured in ways that enable them to evade the requirements Congress adopted several decades ago when it was seeking to reform abuses in the penny stock market. CFA and AFR called on Congress to “revisit the legislation that authorized the SEC to regulate blank check companies. Specifically the definition of ‘blank check company’ should be amended so that it is not limited to blank check companies that issue ‘penny stock’… [With] promoters and sponsors using significantly larger vehicles to finance blank check companies, they can evade the restrictions Congress adopted to protect investors from the misleading information, conflicts of interest, and fraud so often associated with blank check offerings.”
Tamp Down Pre-Merger Hype
Because the SPACs are not subject to the standards regarding “forward-looking statements” that apply to traditional IPOs, SPAC sponsors, target companies, and their advisors are currently protected from liability when they make overly optimistic projections about their future prospects. “Closing this loophole and requiring SPAC sponsors and their financial advisors to assume liability for misleading projections will help to ensure that blank check company sponsors and advisors will not inject overly optimistic or unrealistic projections in SPAC related documents,” CFA and AFR wrote.
Ensure Appropriate Underwriter Liability
Similarly, underwriters involved in SPAC transactions can avoid liability for misstatements. CFA and AFR called on Congress to ensure that “Section 11 liability extends not only to SPAC sponsors, but also to their underwriters and financial advisors in connection with disclosures made during the merger phase… Ensuring underwriter liability for the merger transaction will help to ensure that SPAC merger disclosures are prepared with the same level of care as a typical IPO S-1.”
Enhance Disclosures at SPAC Offering and Merger Stages
Current disclosures fail to alert investors to costs and conflicts associated with the transaction, CFA and AFR argued. To correct that problem, “SPACs must on their offering documents clearly disclose fees and other payments to the sponsor, underwriter, and other parties. The average sponsor takes 20% of the final SPAC while the underwriting investment bank charges around 5.5%… Although this information can often be pieced together from various parts of the public offering documents, the dilutive impact of warrants, redemptions, and pre-merger PIPEs should be made more explicit to investors, especially retail investors who often purchase SPAC shares in the secondary market.”
Study the Risks and Results of SPAC Mania
Given the rising dominance of SPACs as the primary way companies enter the public markets, more study is needed, CFA and AFR argued. They called on Congress to, “Direct the SEC to collect data on SPAC shareholders and warrant holders, and produce a report evaluating average performance across investor types. In particular, the SEC should study SPAC investors and the performance of SPAC shares, including by collecting the firms, addresses, and other information for each investor in the shares and warrants of SPACs… This key information should enable the Commission to accurately assess the categories of investors that typically bear the brunt of SPACs’ post-merger losses.”
Secretary Yellen Elevates Climate Issues at Treasury
Fulfilling a commitment made during her confirmation hearing to “create a hub” at the Treasury Department focused on climate issues with a “very senior-level” role to lead it, Treasury Secretary Janet Yellen announced earlier this month that she had named Catherine Wolfram as the Deputy Assistant Secretary For Climate and Energy Economics within the Office of Economic Policy.
This announcement comes following a letter sent by more than 145 groups, including CFA, urging her to follow through on this commitment to climate. The action is needed, according to the letter, because “[the US] currently [lags behind] many other countries in terms of incorporating climate into our financial regulatory frameworks or exploring the needed changes to our monetary policy to account for climate risk.”
“We cannot rely exclusively on market actors to solve the climate crisis, nor on financial engineering or voluntary corporate commitments,” the groups stated. “Assuring U.S. climate-finance leadership will require a very senior Treasury hire devoted full-time to integrating climate thoroughly and effectively into financial regulatory missions. This official will drive strategy and coordination, regularly gathering the financial regulators, ensuring the U.S has a coordinated climate finance plan, working with Congress to rationalize current and proposed tax credits and subsidies, and engaging with our central bank and financial regulatory counterparts throughout the world,” the groups continued.
Injuries Rose during Pandemic Even as ER Visits Dropped
A new report released earlier this year by the Consumer Product Safety Commission (CPSC) shows an increase in emergency room (ER) treatment for certain product-related injuries such as batteries, fireworks, all-terrain vehicles (ATVs), and skateboards during the pandemic, documenting that “stay-at-home orders have fundamentally impacted product safety injuries in the United States,” stated Rachel Weintraub, CFA Legislative Director and General Counsel.
Specifically, compared with the same time frame prior to the pandemic, injuries related to button batteries rose significantly (93%) among young children ages 5-9, as did injuries related to cleaning agents (84%) and soaps and detergents (60%). The largest increases in ER-treated injuries across all age ranges occurred with fireworks and flares (56%), skateboards, scooters, and hover-boards (39%), and ATVs, mopeds, and minibikes (39%).
The CPSC’s important new report on consumer product injuries during the COVID-19 pandemic demonstrates that “CPSC needs significantly more resources to address these hazards,” Weintraub stated.
CPSC’s report offers four safety tips for consumers:
- Keep cleaning products in their original bottles. Lock them up and away from younger children;
- Wear a helmet before riding a scooter, skateboard, hover board, or bicycle. When buying a helmet look for the label that reads “Complies with U.S. CPSC Safety Standards for Bicycle Helmets;
- Don’t allow young children to play with or ignite fireworks, including sparklers; and
- Keep products with small batteries, including TV remotes, away from kids, and make sure that the battery compartments on children’s toys are secured properly.
In addition, Weintraub cautioned consumers not to operate OHVs on roads and only to operate OHVs that are approved for their age.
CFA, U.S. PIRG, and Kids-In-Danger have produced a consumer guide detailing common hazards at home that have been exacerbated during the pandemic while sheltering in place.
FDA Urged to Act on Cell-Cultured Seafood Products
The U.S. Food and Drug Administration (FDA) should conduct a pre-market safety review and ensure accurate product labeling of cell-cultured food products derived from seafood, CFA argued in a comment letter to the agency earlier this month. If made affordable and shown to be safe, these products could help to address important challenges in the food system, CFA said. However, the group warned that consumer trust is essential.
The letter was sent in response to a request for information from the agency. In it, CFA noted that, “conventional seafood products pose significant safety risks from microbiological and chemical contamination. Overfishing and overharvesting present an increasing strain on wild seafood stocks, including on species used as inputs in aquaculture, and aquaculture implicates its own set of safety and environmental risks, such as those associated with the overuse of antibiotics.”
The letter goes on to state that, “Cell cultured seafood products could help to alleviate some of the pressure in meeting rising global demand for seafood, as well as help the U.S. to become less dependent on foreign suppliers, which currently import 94% of the seafood consumed domestically.”
In order to foster consumer trust in cell-cultured seafood—assuming such products become affordable and are shown to be safe—CFA urged FDA to accurately label these products with “pertinent information about the production process, including the source of the animal cells, and the use of genetic engineering.” Furthermore, CFA urged FDA not to consider cell-cultured meat to be “generally recognized as safe,” or GRAS, but rather to conduct its own pre-market safety review. According to the letter, “relying on the GRAS process virtually guarantees uncertainty because it leaves open the possibility that some cell-cultured seafood product manufacturers will proceed under secret GRAS determinations, made by company hired researchers with an inherent conflict of interest.”
“Cell-cultured seafood has the potential to help address many problems in the food system, but consumers should be able to understand that these products are grown in a laboratory,” stated Thomas Gremillion, CFA Director of Food Policy. “Consumers should also have information about the species whose cells were used to grow the tissue, in part to avoid allergic reactions.” But labeling alone is not enough, Gremillion added, noting that “an effective and efficient pre-market approval process is critical to protect consumers, and also to set the foundation for a risk-based inspection system.”