Forty-nine US law firms on Friday issued a joint response in support of special purpose acquisition companies and regulatory exemptions that allow them to avoid being treated as investment advisers.
The move follows a wave of recent lawsuits brought against SPACs, including Bill Ackman’s US$4bn Pershing Square Tontine, that seeks to regulate them as investment advisers under the Investment Company Act of 1940, a post-Depression law designed to cap fees charged by mutual funds, hedge funds, ETFs and other investment advisers.
“Consistent with longstanding interpretations of the 1940 Act, and its plain statutory text, any company that temporarily holds short-term treasuries and qualifying money-market funds while engaging in its primary business of seeking a business combination with one or more operating companies is not an investment company under the 1940 Act,” the law firms said in the joint statement.
A lawsuit against PST, filed in the Southern District of New York on August 17, seeks to rescind a portion of future compensation to Ackman’s Pershing Square Capital Management as well as similar compensation schemes to PST directors, some of which have already paid out.
When the suit was filed, many thought litigation would be isolated to PST because of peculiarities associated with that particular SPAC, most notably attempts to purchase a 10% stake in Vivendi’s Universal Music Group.
“To us, Pershing Square seemed unique, both in terms of its structure and the nature of the investment it had proposed to undertake,” said Jeffrey Steinfeld, a securities litigator at Winston & Strawn, one of the 49 signatories to the joint response.
But now two additional SPACs – GO Acquisition and E.Merge Technology – have also been sued. All three cases are being brought by George Assad, an individual who purchased shares in the SPACs, via law firms including Susman Godfrey and Bernstein Litowitz Berger & Grossmann.
Robert Jackson, a former SEC commissioner, and John Morley, a law professor at Yale University, are arguing the case brought against PST.
Reuters reported on Thursday that as many as 50 similar suits could be filed against SPACs, citing two sources, though a third source the news agency spoke to said that estimate was incorrect and that no new legal action was imminent.
“[Go and E.Merge] are both fairly standard in how they are structured,” Steinfeld told IFR. “The claims against them could seemingly be brought against every SPAC currently looking for acquisitions. We certainly believe there is a possibility for other copycat lawsuits.”
The joint legal response pointed to “more than 1,000 SPAC IPOs” that have been reviewed by the SEC staff “over two decades” that have not been subject to the 1940 Act.
There are 439 US SPACs currently searching for acquisitions. Some 416 SPACs have gone public in 2021 and another 309 have filed to go public, according to SPACInsider.
As blank-cheque companies, SPACs were thought to be exempt from being regulated as investment advisers under the Investment Company Act of 1940 because proceeds raised from IPOs are placed in a trust, invested in government securities and returned to investors if a business combination is not consummated within a defined period of time, typically 18 to 24 months.
One key question of the litigation is whether the SPACs’ primary business was investing in securities. And importantly, according to Steinfeld, whether the SPACs led investors to believe their principal activity was trading and investing in securities, through regulatory disclosure and other communications to stockholders.
“Under the prevailing case law standards and the regulatory history of blank-cheque companies, we do not believe the plaintiffs’ lawsuits should succeed against standard SPACs,” he said.
Fiery response
Ackman told PST shareholders that the lawsuit impairs the ability of his SPAC to negotiate a merger by its January 2023 deadline and that he was seeking to revive plans for an alternative SPAC structure, known as a SPARC.
“While we have been working diligently to identify and close a transaction, and we have begun discussions with potential merger candidates, our ability to complete a transaction in the required timeframe has been impaired by the lawsuit,” Ackman said in the letter to shareholders dated August 19. “We are working to accelerate the launch of [SPARC], and expect that we will shortly be making a public filing.”
PST shares are now trading at US$19.75, below their US$20-par redemption value. They had fetched US$20.13 before the lawsuit was filed.
The SPARC was hatched from plans for PST, the SPAC, to acquire a 10% stake in Vivendi’s Universal Music. PST shareholders would have received UMG shares and the ability to participate in future deals by exercising rights to invest US$20 after reviewing the merger – a SPAC with an opt-in provision rather than opt-out.
That right is the SPARC.
Initially, Ackman rejected SPARCs as overly complex and instead assigned the right to purchase the 10% of UMG to Pershing Square Capital, PST’s sponsor. Regulators, including the NYSE, also rejected the new structure.
One problem with a SPARC, lawyers say, is how to create one if there is no SPAC. In other words, the SPARC IPO would entail purchasing a right (no money) to participate in future deal flow with no upfront capital commitment.