Author: Syedur Rahman
27 October 2021
3 min read
Syed Rahman of financial crime specialists Rahman Ravelli outlines the reasons for the rise of special purpose acquisition companies (SPACs) and the obligations imposed on those who run them.
Special purpose acquisition companies (SPACs) have become an increasingly popular option for those looking for a quick way into the financial markets.
They are proving popular with investors, as they can be used to facilitate a merger with a private company in a way that does not depend on the normal procedure of filing for an initial public offering (IPO) – and they can provide quicker returns.
With a traditional IPO, a company is audited, files a registration statement with the appropriate exchange commission and work then begins on listing its shares on a stock exchange. But a SPAC is created by a team of investors specifically to acquire another company. Once incorporated, the SPAC undertakes an IPO, its shares are listed on a public stock exchange, but it has no commercial operations and no assets other than the money it raises through the IPO. That money is placed in an account until those running the SPAC identify a private company that is seeking to go public via an acquisition.
In most cases, founders will be on the SPAC’s board of directors. When a SPAC’s founders establish the company, they invest in it in exchange for preferred shares or “founder shares”. This investment may fund some or all of the IPO. It often leads to the founders both keeping a 10-20% stake of the company when the IPO is completed and being entitled to a percentage of the rise in value of the company after the acquisition.
With the rise in the popularity of SPACs, it was inevitable that the regulators would start to take a close look. In July this year, the UK’s Financial Conduct Authority (FCA) published its rules for SPACS. The rules, which came into effect on 10 August 2021, have a strong emphasis on protecting SPAC investors. Yet those who take responsibility for the formation and / or running of the SPAC need to be aware of their need to comply with the FCA rules – and the possible consequences if they fail to do so.
A SPAC’s directors will be faced with the need to devise and oversee the implementation of its operating strategy. Their early tasks will include evaluating companies that might be suitable for acquisition and identifying the most effective investment plan of action for the money that the SPAC has at its disposal. In such situations, there is a risk of conflict of interest. Directors have to act in the best interests of the board and disclose any possible conflict of interest. SPAC directors will need to assess whether their ownership of “founder shares” in it constitutes a conflict or whether any links to venture capitalist firms of hedge funds – who may invest in the potential SPAC targets – create a similar risk.
In drafting its rules for SPACs, the FCA stated that if any of the SPAC’s directors have a conflict of interest regarding the acquisition target, a statement would have to be published by the board (reflecting advice from an appropriately qualified and independent adviser) that the proposed transaction is fair and reasonable as far as the SPAC’s public shareholders are concerned. The FCA has also made it a condition of any SPAC that the money it raises is ring-fenced, so it can only be used to finance the acquisition of another company. The FCA has also introduced time limits for an acquisition, the requirement of a majority vote of public shareholders for an acquisition to go ahead and the opportunity for investors to leave the SPAC before any acquisition is completed if they are unhappy with any part of it.
The regulator wants to see information disclosed at all appropriate stages in the SPAC’s development, from listing through to either an acquisition or its dissolution. It has made it clear that private companies listing in the UK via a SPAC will still be subject to the full rigour of the FCA’s listing rules and transparency and disclosure obligations.
Any shortcomings when it comes to meeting the FCA’s conditions could see a SPAC subject to enforcement action. But directors who are thought to have failed to meet their obligations could also find themselves the subject of commercial litigation brought by either the SPAC’s shareholders or those involved with the company that is the acquisition target.
Such action could be brought on the grounds that the directors have breached their fiduciary duty: the duty that is owed when one person has undertaken to act for another in circumstances which leads to a relationship of trust and confidence. There is also the possibility of legal action if there were omissions or inaccuracies in company registration documents.
For those running SPACs, awareness of their obligations and complying with them are of paramount importance. Compliance and a successful acquisition can bring swift and sizeable financial gains. But failure to meet those obligations and / or an acquisition that does not meet expectations can produce major legal difficulties, which is why informed advice should be sought at all stages of a SPAC’s development.
Syedur Rahman is known for his in-depth experience of serious fraud, white-collar crime and serious crime cases, as well as his expertise in worldwide asset tracing and recovery, civil recovery, cryptocurrency and high-stakes commercial disputes.