Although there is indeed an increased risk of a lawsuit for companies going public via a SPAC rather than a traditional IPO, that differential in risk is not enormous.
Now let us turn from lawsuits to settlements. There have been very few publicly disclosed settlements, and some of them did not stem from an SCA, so it is very difficult to draw conclusions about trends. The ones that made the news include:
- Akazoo: A SCA settlement totaling $38.8 million in October 2021. This action involved bad diligence and fraud.
- Triterras: SCA settlement of $9 million in April 2022. The action was filed after a short seller report raised issues with disclosures about a related party.
- Multiplan: A direct-action breach of fiduciary duty claim that settled for $33.75 million in November 2022. After a short seller report raised issues with the company’s largest customer, the suit was filed in Delaware. The judge denied the motion to dismiss, and the parties settled.
- TradeZero: Private action settlement of $5 million in December 2022. A SPAC (Dune Acquisition) entered into a merger agreement with TradeZero. The merger fell apart, and Dune sued TradeZero.
It is worth remembering that outside of the actual settlement amounts, some of which were covered by a D&O insurance policy in the above cases, the defendants had to also pay substantial attorney fees. When deciding on the limit of a D&O policy, it is worth factoring in the potential costs of the attorney fees, which will be due whether or not the lawsuit ends up being frivolous or ultimately gets dismissed.
Regulatory Enforcement Actions
The other piece of the risk puzzle is, of course, the risk of regulatory enforcement actions and investigations. With the SEC taking an openly hostile stance towards SPACs in 2022, many of us expected to see a barrage of SPAC-related investigations and enforcement actions. That expectation has not yet been realized. While there have been a few investigations reported, there have been fewer than a handful of enforcements. Here are some examples that made the headlines:
- Momentus: Settlement total of $8.04 million in July 2021. The SEC alleged that Momentus and the founder misled Stable Road, the SPAC with which it planned to merge, about its technology and national security issues and that Stable Road had failed to perform its due diligence to identify those issues.
- Nikola: Settlement total of $125 million in December 2021. The enforcement was preceded by a short seller report and an SCA and centered around misleading statements about Nikola’s products, technical advancements, and commercial prospects.
- Perceptive Advisors: Settlement of $1.5 million in September 2022. This was the SEC’s first enforcement action against an investment adviser. The SEC charged the adviser with violating the Investment Advisers Act in connection with its involvement with SPACs.
- Gordon: Administrative charges settled against CEO in 2019 for $100,000. The SEC charged Benjamin Gordon, the former CEO of Cambridge Capital Acquisition Corporation, a SPAC, with failing to conduct appropriate due diligence to ensure that the SPAC’s shareholders voting on the merger were provided with accurate information concerning the target’s business prospects.
An interesting way to think about these settlements and enforcement actions is through the lens of the enterprise value of the SPAC business combinations that were completed in the last few years. The total expenditures on private settlements and government enforcement actions run in the millions of dollars and constitute a tiny fraction (likely no more than 0.05%) of the billions of dollars in enterprise value of closed de-SPACs.
Now it is true that SEC typically takes several months—if not longer—to bring and conclude an enforcement action. Considering that the SPAC market went into overdrive in late 2020 and two years have already passed since then, it is interesting that the SEC’s enforcement division has not been able to locate more examples of situations worth pursuing. Could it be that aside from the less than a handful of egregious cases that have been flagged thus far, the rest of the SPAC market teams and deals are operating within regulatorily acceptable parameters?
Update on the D&O Insurance Market
All of the above data is interesting not only in an academic sense. It has real implications for the risk and risk mitigation decisions that SPAC sponsors, their target companies, investors, and deal teams make. Those decisions inevitably involve decisions on the size and structure of each outfit and team’s directors and officers (D&O) insurance. Higher risk yields lower availability of coverage and higher premiums. But aside from the risk itself, the availability and premiums are also dictated by the state of the overall insurance market.
After many months of an almost impossibly hard SPAC D&O market, substantially diminished deal volume both in the SPAC world and the traditional IPO world has caused many carriers to reconsider their stance. In the last few months, we have witnessed a palpable easing of terms and even of pricing. Of course, carriers are keeping a close eye on each new case and enforcement action. However, if litigation and enforcement trends continue to hold at the current level or decline further, we are likely to enjoy a period of reasonable D&O insurance pricing for SPACs in 2023.
An earlier version of this article appeared in the Woodruff Sawyer SPAC Notebook.