SPACs - and the risks that remain

It was perhaps inevitable that the Financial Conduct Authority (FCA) would look to reassess and reform its regime in an attempt to help the UK catch some of the millions being generated by the burgeoning special purpose acquisition company (SPACs) market.

The FCA has now set out proposals for a more flexible regime that will bring the UK closer to the approach being taken by its major financial rivals. The ultimate aim is to lure SPACs to the City, as opposed to going to places – such as New York – where the rules are viewed as being more SPAC-friendly.

It is an approach that makes sense. SPACs involve money being raised from investors who are told that the purpose is to merge with a private company, albeit one that has yet to be identified. At present, almost half of the money raised around the world for new listings is being shovelled into SPACs. London, however, has been far from the centre of such activity. Which is why the FCA is rethinking its rulebook. It has recognised both the opportunity and the current obstacles to taking advantage of it.

While SPACs have been around for years (although they have been referred to by different names in the past) they are currently the in-demand investment vehicle. As public companies that have no detailed business plan and no sellable commodity, product or service, they exist simply to raise money from investors to facilitate a merger with a private company. The appeal of such a ‘backdoor’’ initial public offering (IPO) is that the private company goes public without the need to go through the normal process of filing for an IPO – a process that requires far greater transparency and takes far more time than the SPAC way of doing things. For the investor looking for a swift return on their investment, the SPAC route has great appeal. And that appeal is clear from the scale of interest currently being shown in SPACs – and the amounts being put into them.

As investors do not know what private company the SPAC intends to merge with, they have to place their trust in the investment without knowing the full picture. But the trust issue does not seem to have hampered SPACs in recent years. Figures as diverse as former politicians and sports stars have launched SPACs – giving them instant publicity and appeal – and a number of the major investment banks have backed them, providing that all-important credibility.

In the face of such developments, the rethink that the FCA has undertaken is an understandable response. As the UK is currently a far from attractive option for SPACs and their investors, it was clear some changes needed to be made. At present, the presumption here is that trading in a SPAC’s shares should be suspended when there is an announcement of a potential acquisition or merger target.

But doing this removes the main appeal of a SPAC – that it is a less onerous listing process. The consequence of the current situation is that investors have no freedom to pull out – irrespective of whether they approve or disapprove of the deal that is proposed – and companies seeking a SPAC acquisition or merger still have to go through the process of producing a full prospectus and meeting free-float requirements.

For these reasons, it came as no surprise that the FCA, at the end of March, made it clear that its consultation exercise was being carried out with the intention of determining exactly what structural features and enhanced disclosure were necessary in order to provide investors in SPACs with the protection they required. The FCA recognised changes needed to be made to the UK Listing Rules if there was to be any chance of creating a market environment here that was conducive to SPACs.

The FCA has made it clear it wanted to devise proposals that would help make sure SPACs could operate here in a framework of high regulatory standards and oversight. This, the FCA stated, would take away the need for suspension of the listing for a company when the announcement of an acquisition target is made. If the UK were ever to become a ‘SPAC magnet’ the FCA was always going to have to remove this particular obstacle – a change that the FCA referred to as “aligning this element of our rules more closely with other major jurisdictions”.

Proposals

Under the new FCA proposals, SPACs would need to raise a minimum of $200m, which would be ringfenced so that it could only be used to fund an acquisition or – if that does not happen, be returned to shareholders within two years. The FCA believes its approach will give investors protection, while aligning London more closely to the rules of its financial rivals.

Perhaps most significantly, the FCA wants to abolish the requirement for the SPAC to be suspended when it makes an acquisition, providing it can satisfy other higher requirements. As the existing FCA rules class such a deal as a reverse takeover, trading on shares can face a long delay – a delay that is not required in other countries currently doing very well out of attracting SPACs, while London watches on.

The FCA proposals, therefore, can be viewed as an encouraging move, as they are a major step towards making the UK Europe’s main SPAC destination of choice. But – and I don’t want to appear the grumpy killjoy here – it should never be forgotten that there are risks associated with SPACs. SPACs do seem to have created a financial whirlwind and have prompted the FCA to do what it can to welcome them to these shores. But nevertheless, those risks remain, and they need to be addressed.

Litigation

The introduction of SPACs in the UK is certain to lead to significant amounts of litigation in the financial services sector. The very nature of SPACs, their promotion, and the expectations surrounding them, will, at least in some cases, result in parties feeling let down, misled or even duped by those who went to great lengths to attract investment. The precise circumstances will vary from SPAC to SPAC, but there will be scope for litigation. Without wanting to condemn SPACs or cast doubt on their value before they even become a feature in the UK, there are plenty of aspects of them that could prompt legal action.

Anyone looking to be involved in one can, and should, do all the research that is possible beforehand. But even if that has been done, if the outcome is not as financially rewarding as investors were led to believe, litigation may be the next logical step as parties either look to recoup their investment or hold to account those they blame for what has happened.

More specifically, there is the potential for legal action regarding the activities of those who devised and ran the SPAC. The issue of whether everyone involved has been provided with the true financial position of the company is one that, potentially at least, could spark litigation from any number of investors.

There could be grounds for litigation based on filings and disclosures by SPACs and acquisition targets. Material misstatements in company registration statements, or omissions from them, can be the basis of legal action brought by shareholders. It is also possible that a SPAC’s shareholders could sue its officers and directors for breach of fiduciary duty – and this is a course of action that could also be taken by the shareholders in the company that is the acquisition target.

A SPAC’s shareholders could sue for shares sale and investment fraud. Even the subsequent poor performance of a SPAC could prompt litigation. If a company that has been created as a result of a SPAC acquisition goes bankrupt, there is always the possibility that its creditors – which could include its shareholders – may sue. Unsuccessful acquisition negotiations could even end with the SPAC and the acquisition target suing each other for breach of contract or breach of the duty to negotiate in good faith.      

Criminal Law Issues 

It should be emphasised that regardless of the potential for litigation, there are also serious legal issues surrounding the operation of SPACs.

From a criminal law standpoint, misleading statements is covered by Section 89 of the Financial Services Act 2012. It 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 come under Section 90 of the Financial Services Act 2012. It contains an 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).

Those who are involved in the creation of a SPAC, its promotion, and any other related activities will also have to ensure compliance with the FCA’s Market Abuse Regulation. This covers insider dealing, unlawful disclosure of inside information and market manipulation

Investment fraud in the UK is covered by the Fraud Act 2006. Activities relating to SPACs could possibly fall under the Fraud Act’s 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.

Conclusion

If this reads like a catalogue of doom, it isn’t intended to. The FCA, like many others, has realised that the SPAC route may well be a cheaper route to market, and there are benefits to using that route. Its current actions are its recognition of the need to change to ensure the UK can provide that route. The argument for attempting to do is compelling – or at least the statistics are. Last year saw records broken for SPACs, with a total of $73bn raised through them. And this was topped in the first three months of this year, which 298 SPACs raising almost $88bn. Yet, while the other side of the Atlantic has seen such a phenomenal increase in SPAC activity, the fact that the grand European total for SPACs in 2020 was just three illustrates why the FCA is looking to act.

But whenever anyone sets out on a new route, it always pays to know what risks may lie ahead. As I mentioned earlier, SPACs have been around for many years, albeit in a number of guises. There will be plenty of people who have benefited from them. No doubt there are currently many more who are looking to make such gains – including many who will be attracted to them in the wake of the FCA’s proposals for bringing them to these shores.

At present, SPACs are viewed as being the hot investment favourite in the race to wealth. The FCA wants to see the UK involved in that race and, if possible, at the forefront of it.  As with any race, however, there are winners and losers. The FCA is happy to rewrite its rule book for SPACs to ensure that SPACs come here. That does not necessarily mean that SPACs should be viewed as a failsafe bet.

Syed Rahman is a Partner with financial crime specialists Rahman Ravelli: rahmanravelli.co.uk