SPACs: Significant increase in US shareholder class actions causes some insurers to restrict coverageÂ
Litigation has arisen from shareholders feeling ‘misled’ when newly-listed businesses underperform
According to leading international law firm RPC, a fourfold increase in US shareholder class action lawsuits relating to special purpose acquisition companies (SPACs) has caused some insurers to restrict coverage.
The number of class actions relating to SPACs rose to 33 in 2021 – 22, up from just eight in 2020 – 21. RPC said the rise in class action lawsuits is partly due to shareholders feeling misled when companies underperform after going public. Plaintiffs have argued pressure on directors to close deals has, in some cases, resulted in projections being exaggerated, causing shares to be artificially inflated.
SPACs have gained popularity in recent years as they enable businesses to raise capital quicker than with a formal IPO. SPAC mergers typically take three to six months, compared to 12 to 18 months for an IPO.
SPACs are formed by a team of ‘sponsors’, which raises capital through an IPO. This capital is placed in an escrow account.
RPC agreed that the short timeframe in which deals must be closed can put directors and officers under considerable pressure. Typically, there is a two-year period in which a transaction opportunity must be identified and executed. Should this period elapse without a deal, funds must be returned to investors.
Shareholders who have pursued class actions have argued company directors may have made poor investment choices and not taken adequate care when carrying out due diligence.
RPC said the rise in shareholder litigation, as well as recent increased regulatory scrutiny from the Securities and Exchange Commission, has resulted in some insurers of directors and officers withdrawing coverage for SPACs in the US.
RPC partner James Wickes commented: “The boom in SPACs has given rise to a sharp increase in litigation this past year.
“Shareholders argue that SPACs are being used by companies that aren’t yet ready to go public. These cash-rich shell companies are sitting on enormous cash reserves, while the clock ticks for this capital to be put to work. Some have questioned whether these time constraints may be contributing towards sub-optimal returns for investors.
“The D&O insurance market has responded to the increased litigation risk and attention from regulators, with some carriers reducing their appetite. Directors and Officers may find it increasingly expensive to obtain coverage in the coming years, should the trend for class actions continue.”