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The Business Lawyer

Spring 2023 | Volume 78, Issue 2

SPAC Law and Myths

John Carr Coates IV

SPAC Law and Myths
Photo by K. Mitch Hodge

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Special purpose acquisition companies (SPACs) were the financial-legal hit of 2021, before they weren’t. Breaking records and displacing, to an extent, conventional initial public offerings (C-IPOs), even as C-IPOs also boomed, SPACs spiked, in part, because—in addition to myths about their financial attributes, which others have debunked—several myths about SPAC law circulated widely and persistently. SPAC promoters claimed that (1) securities regulations ban projections from being used in C-IPOs, (2) liability related to projections was lower and more certain in SPACs than it was (and is), (3) the Securities and Exchange Commission (SEC) registration process delays C-IPOs more than SPACs, (4) the SEC changed SPAC accounting rules in early 2021, (5) this “change” was the primary reason the SPAC wave slowed and peaked, and (6) the Investment Company Act clearly does not apply to SPACs. Consistent with these being myths, de-SPACs from 2021 are experiencing significant levels of litigation—even higher than in C-IPOs. These myths were aimed primarily not at unsophisticated retail investors, but business journalists, sophisticated SPAC sponsors, and owner-managers of SPAC targets. They illustrate a broader and underappreciated fact that complex financial-legal innovation permits promoters to exploit the “credence good” character of professional advice, perpetuate “deep fraud,” and distort markets and asset prices more and longer than conventional theory assumes. To moderate deep fraud’s market distortions, proposed SEC reforms should be finalized to improve SPAC disclosure, enhance investor understanding of their risks, and reduce regulatory uncertainties that contribute to legal myths about SPACs, but the inherent complexity of the product may require an ongoing role for regulators to speak clearly about SPAC law and its uncertainties.


After remaining a capital markets backwater since re-emerging in their current form in 2009, special purpose acquisition companies (SPACs) became the financial-legal hit of the first quarter of 2021, reaching a historic peak of both capital formation and acquisition activity and displacing, to a significant extent, conventional initial public offerings (C-IPOs), even as C-IPOs also reached world-historic heights. From July 2020 through March 2021, SPACs issued an ever-increasing amount of initial equity, from less than $5 billion per month in the first half of 2020 to more than $30 billion per month in the first quarter of 2021. In the first half of 2021, 62 percent of all IPOs were SPAC offerings, compared to 53 percent in 2020, and less than 25 percent in the prior four years. Once public, SPACs completed acquisitions of more than forty companies in February 2021 alone, although that turned out to be the peak for the year. Then, the SPAC boom substantially collapsed, reverting to a substantial but much more modest level of activity over the rest of the year.

As summarized below, SPAC law is complex—SPACs are governed by a mesh of contracts, listing requirements, common law, and regulation, all full of many as-yet less-than-fully specified or tested standards. The argument of this article is that SPAC law’s complexity and relative novelty—along with the more general “credence good” character of professional advice—enabled a set of myths about that law to circulate, and in so doing reinforced financial myths about SPACs. Others have debunked several financial myths—that SPACs allowed companies to go public more cheaply than C-IPOs, by reducing underwriting spreads and avoiding the phenomenon of “leaving money on the table” that characterizes C-IPOs. This article presents and debunks several legal myths, including substantially understated claims about their legal risks and substantial mischaracterizations about how SPAC law and accounting are determined.

By “legal myths,” I mean advice about law that is demonstrably incorrect at the time made, but that is plausible to even legally trained professionals and is often compelling to end-clients. As will be detailed in Part IV, the overarching point is not that, in each case, professionals asserted that simple falsehood—that a given law was “X” when it was “not X” (although for the first myth that is true). In other cases, the point is that they asserted (and continue to assert) that a given law was “clearly X,” when, in fact, that law remains highly uncertain. In the language of statistics, the myths include some misstatements about point estimates, but also misstatements about confidence intervals. In the language of lawyers, they were (erroneous) “clean opinions,” when “reasoned opinions” were the most any fair-minded lawyer should have offered.

These myths were repeated prominently by professionals and sophisticated commentators on capital markets (and continue to be repeated, as of this writing). Together with financial myths, the legal myths appear to have affected the perceived costs, benefits, and risks of SPACs. They distorted capital market activity for long enough to constitute an example of a type of meaningful informational “friction,” at odds with the presumption that publicly available information will be rapidly reflected in capital asset market prices, a common assumption in finance, law, and economic theory.

To the extent some professionals knew better but spread the legal myths anyway, the episode can also be thought of as a type of “deep fraud”: the programmatic dissemination of disinformation about the costs, benefits, and risks of a financial product outside the context of a specific transaction. Again, to be clear, many of those who repeated legal myths did not know better—they were simply passing on what they had been told by others. But at least some of the speakers did know better. Also, to be clear, “deep fraud” is not fraud in the ordinary sense: Traditional anti-fraud law does not prohibit this type of deception because the disinformation is not used directly to obtain money. Legal and financial education is a regulatory instrument often thought important solely for “retail” investors who (for example) do not know the basics of finance. Deep fraud supplies a reason that this instrument is also important for institutional investors, financial economists, and other nominally sophisticated capital market participants.

Regulators, of course, also have important roles to play in addressing legal myths, such as those spread about SPACs. Part V discusses implications of the SPAC story and reviews regulatory reforms to SPAC law proposed by the SEC. Further, Part V notes ways those reforms will help reduce legal uncertainties and improve disclosures about SPACs. The proposed reforms extend beyond the points made in this article, and the success of SPACs raises questions beyond SPACs themselves to the full range of ways companies can become listed and publicly traded. Even with those reforms, however, the SPAC product will remain sufficiently complex—legally and financially—that continued efforts to promote market understanding will be necessary. Regulators can continue to play a key role by speaking publicly and clearly about the continuing uncertainties regarding SPACs to help moderate future market and pricing distortions created by investor misunderstandings about the incentives and risks that SPACs present.

I. Summary of SPACs

The basics of a typical SPAC are complex but can be summarized as follows. A SPAC is a shell company with no operations. It proceeds in two stages. In the first stage, a SPAC is created by a “sponsor” who organizes the SPAC in compliance with stock exchange listing standards, as outlined further in Annex A. (Contrary to one myth discussed below, no SEC rule sets minimum investor protections specifically designed for SPACs.) The SPAC then registers the offer and sale of redeemable securities for cash through a conventional underwriting, sells them primarily to hedge funds and other institutions, and places the proceeds in a trust for use in a future acquisition. During this phase, a SPAC functions much like a mutual fund, has no operating business, and economically offers a fixed-income-equivalent return to its initial investors—fixed because, unlike most common shareholders of most companies, initial SPAC investors have redemption rights effectively guaranteeing them a fixed return.

Start-up expenses of the SPAC are typically paid out of funds raised by the SPAC from the sponsor, who enters into a suite of SPAC-related contracts, purchases “private warrants” and common shares from the SPAC in a private placement that precedes or sometimes accompanies the initial offering, and, through the price and terms of those purchases, obtains a “promote”—greater equity than the sponsor’s cash contribution or commitment would otherwise imply. Sponsor promotes are at risk: If a SPAC fails to find and acquire a target within a set “SPAC period”—which typically ran two years in 2021 but commonly ran twelve-to-eighteen months in 2022—the promote is forfeited and the SPAC liquidates. Initial investors buy “public warrants” to acquire additional stock at fixed prices. Because of the significant role of warrants, SPACs have a more complex capital structure—and are subject to more complex accounting standards—than most companies that engaged in C-IPOs, as discussed in Annex A.

In its second stage, a SPAC identifies and acquires an unrelated company with an actual business—or attempts to do so (and to date, most have). When a SPAC completes a business combination, known as the “de-SPAC,” the SPAC issues equity to owners of the “target” (i.e., the private company to be acquired) and sometimes to other investors. First-stage SPAC shareholders typically have a vote on the de-SPAC, and many investors who purchased securities in the first-stage SPAC either sell on the secondary market or redeem their shares before or shortly after the de-SPAC. After the de-SPAC, the target business carries on as a public company. To raise additional capital, and to fund redemptions, SPACs also often arrange for “private investments in public equity” (PIPEs) that accompany the de-SPAC.

In sum, SPACs offer private companies an alternative pathway to “go public.” To date, SPACs have provided rewards to sponsors and their affiliates and provided attractive returns for initial SPAC investors. Targets obtain stock exchange listings and liquid markets for their shares. But SPACs have also imposed significant costs (primarily in the form of dilution), which have contributed to poor returns for public investors, particularly when celebrities are involved. In so doing, targets broaden their shareholder bases and gain status as public companies with securities registered under the Securities Exchange Act of 1934 (the 1934 Act), triggering ongoing obligations regarding disclosure, audit, and internal controls. They also attract lawsuits, about which more below.

II. Overview of SPAC Law

The foregoing summary is just that—a summary. In fact, “SPAC law” is dauntingly complex in its full detail, more so than for other paths to public listings—this fact itself should be a larger “con” to SPACs than generally appreciated. As detailed more in Annex A, SPAC law starts with a suite of contracts, some simple, some standardized, some complex, some bespoke. Given that material SPAC contracts must be filed publicly, they can be copied easily. So perhaps it is not surprising that many SPAC contracts consist of significant amounts of boilerplate nearly identical to that used in other SPACs. Standard terms detail the amount of SPAC expenses sponsors are committed to pay and the nominal subscription price paid by sponsors for their initial shares.

But material terms in SPAC contracts vary, across SPACs and over time, including basic deal economics (e.g., size of the sponsor promote, duration of the SPAC period, warrant exercise prices) and more “legal” terms, such as voting rights, redemption-right triggers, limits or conditions on when warrants can be redeemed, and representations and warranties. These contracts include many as-yet untested clauses and terms, as well as the standard–ridden common law of contracts, trusts, and corporations, leaving the overall SPAC vehicle with significant legal uncertainty. As discussed in Annex A, the “contractual” elements of SPACs also include the quasi-regulatory listing standards promulgated by stock exchanges, which also contain numerous qualitative and discretionary components.

The daunting complexity and uncertainty of SPAC law is in tension with another core feature of a typical SPAC—an economic need to keep start-up costs as low as possible to keep expected returns (particularly for sponsors) as favorable as possible. Such a need is most acute for sponsors seeking smaller targets with limited resources, who face the prospect that the SPAC may liquidate without completing a de-SPAC, in which case all of those expenses will amount to a loss for the sponsor. The complexity of SPAC law no doubt contributed to some of the legal mistakes, confusions, and myth-making discussed later in this article, as did the mismatch between that complexity and efforts by SPAC sponsors to minimize costs.

SPAC law also includes background statutes—such as state corporate law and federal securities law, including the requirement of audited financial statements and the Public Securities Litigation Reform Act (PSLRA), as well as related regulations and guidance. Behind both contract and public law are several bodies of ever-evolving court-generated interpretations and glosses of key statutory terms and legal standards. SPAC law is so extensive that this article can only sketch its distinctive components with examples to illustrate its complexity. To improve readability, the article sets forth a more detailed summary of certain material aspects of SPAC law in Annex A. To ground later discussion of SPAC legal myths, the article next sets forth four sources of liability under SPAC law: (1) liability related to disclosure under federal securities law, (2) liability related to the distribution of securities under federal securities law, (3) liability related to the breach of fiduciary duties under state corporate law, and (4) liability under—including the costs of compliance with—the Investment Company Act (ICA).

A. Disclosure Liability Risk, Forward-Looking Statements, and the PSLRA

Every public company—including any SPAC—has liability risk for materially misleading statements or omissions in its communications, including its SEC filings. Depending on the nature of the communication, this liability may arise under section 11 or 12 of the Securities Act of 1933 (the 1933 Act), section 14 of the 1934 Act, and Rule 10b-5 promulgated by the SEC under the 1934 Act, among other rules and statutory sections. The precise level and nature of the risk varies, because the scope and legal requirements for plaintiffs vary by legal context. Scienter standards vary, for example. Issuers themselves have strict liability under section 11 of the 1933 Act; underwriters and directors have a “due diligence” defense under sections 11 and 12 of the 1933 Act; negligent misleading statements in proxy solicitations generally create liability under the 1934 Act; and Rule 10b-5 and other liability rules require some higher level of scienter. Because SPACs are subject to all of these liability rules at some point in the typical SPAC process, SPAC sponsors and others who determine how the SPAC “speaks” to the public must do so with care, lest they create liability exposure.

Because of perceptions that these liability provisions attracted opportunistic and meritless private litigation, Congress passed (over President Clinton’s veto) the PSLRA in 1995. That law included a “safe harbor” protecting against certain liability risks for forward-looking statements in disclosures by specified types of companies, provided specified conditions were met. Importantly, the safe harbor only applies in private litigation, and it does not prevent the SEC itself from taking appropriate action to enforce the federal securities laws, including by bringing enforcement cases against SPACs that include misleading forward-looking statements in their SEC filings.

Even in private litigation, the safe harbor is not available if the statements in question are not forward-looking. Mixed statements—which include both current and forward-looking information that were, in aggregate, misleading—have been found not to be protected by the safe harbor. Statements about current valuation or operations have been viewed as outside the safe harbor by some courts, even if they are derived from or linked to forward-looking projections or statements. For example, a CFO’s statement about the corporation’s large deferred service, healthy product backlog, and consistent quarterly linearity, made together with another statement as to expected earnings for an upcoming quarter, were non-forward-looking statements and were not protected by the safe harbor, because the statement included facts regarding the present state of the corporation, not assumptions. Nor is the full benefit of the safe harbor available unless forward-looking statements are accompanied by “meaningful cautionary statements” identifying important factors that could cause actual results to differ materially from those in the forward-looking statements. Generic statements that forward-looking statements may not be accurate predictions are not sufficient for this purpose; rather, specifics about what could cause the predictions to be wrong are required.

The safe harbor does not clearly protect against false or misleading statements made with “actual knowledge” that the statement was false or misleading. Because “actual knowledge” is a conclusion arrived at with hindsight, and because courts are aware that few will confess to “actual knowledge,” courts necessarily rely in part on inferences in assessing whether the safe harbor applies. As a result, SPAC sponsors and others who speak for SPACs bear some risk that they will be found to have had “actual knowledge” about a falsehood or misleading omission, even if they in fact did not have such knowledge. For example, a company in possession of multiple sets of projections based on reasonable assumptions, reflecting different scenarios of how the company’s future may unfold, would be taking a risk if it only disclosed favorable projections and omitted disclosure of equally reliable but unfavorable projections, even in private litigation covered by the PSLRA.

Despite all of this, it may be that the PSLRA offers something for SPACs not available to C-IPOs. That is because “initial public offerings” are explicitly excluded from the safe harbor. The phrase “initial public offering” is not defined in the statute or in any applicable SEC rule. Despite the lack of definition, it seems clear that C-IPOs are excluded from the safe harbor, as are initial SPAC offerings. (And SPACs that issue “penny stocks” are excluded both because they issue “penny stocks,” which is a separate exclusion from the safe harbor, and because they are “blank check companies” under SEC Rule 419, which is a third exclusion from the safe harbor.) It is unclear whether de-SPACs are excluded from the PSLRA safe harbor, for reasons discussed in Part IV.B below.

B. “Underwriter” Liability Risk Under Securities Law

Securities law not only creates liability risk for companies, but also for their underwriters—banks that buy shares and resell them in a C-IPO or otherwise participate in a distribution of securities. One of the possible advantages (to sponsors and target managers) of the SPAC’s two-stage structure is that by separating the initial offering—with conventional underwriters involved—from the de-SPAC—when no formal underwriters are involved, SPACs have had at least the promise of lowering the overall legal exposure of the investment banks working as underwriters on the deals. Less legal exposure possibly reduces the costs, length, intensity, and potential deal-censoring effects of due diligence and disclosure document development, which are in practice often driven by underwriters and underwriter lawyers operating in terror of their potential liability under the 1933 Act. Countervailing any benefit enjoyed by underwriters, this “advantage” exposes investors to a greater risk of fraud, leading to public concerns about SPACs prompting Chair Gensler to suggest he favors rules eliminating this “advantage,” and a proposal from the SEC in March 2022 that would “clarify that a person who has acted as an underwriter” in an initial SPAC offering and takes “steps to facilitate the de-SPAC transaction, or any related financing transaction,” would be deemed to be an underwriter of the securities issued in the de-SPAC.

But even without a change in current securities law, this advantage is far from certain. The same investment banks that would underwrite a C-IPO remain in the picture at the de-SPAC stage, albeit as “financial advisors,” mimicking (formally) the role that M&A bankers play in a true M&A deal. They provide financial advice and derive compensation from assisting the SPAC and the target (and often the PIPE investors) negotiate and complete the de-SPAC deal. Notoriously, the term “underwriter” is uncertain—by design. It includes not only conventional underwriters—who buy securities from an issuer “with a view to” a “distribution”—but also to anyone who “participates or has a direct or indirect participation” in a distribution, and only limits that general phrase by carving out those “whose interest is limited to a commission from an underwriter … not in excess of the usual and customary distributors’ or sellers’ commission.”

Financial advisors, who are paid on a contingency linked to the overall de-SPAC that (due to Rule 145) includes a public offering, arguably have a “participation”—even a “direct” one—in the offering. The sponsor itself, more straightforwardly, is purchasing from the target “with a view to” a “distribution,” and so also already bears some underwriter liability risk. PIPE investors, too, could be viewed as having a “participation” in the de-SPAC if their investments are designed to allow the de-SPAC to occur, if they receive a significant discount on their shares, and if their ability to obtain the benefits of that discount depend on the success of the de-SPAC. In each case, if financial advisors, sponsors, and PIPE investors already are at risk of being deemed “underwriters” of the offering embedded in the de-SPAC, then they have liability risk for materially misleading statements or omissions in the de-SPAC documents (typically, a Form S-4/proxy), subject to a due diligence defense.

C. Corporate Law and Fiduciary Duty Risk

In addition to securities law, SPACs raise complex corporate law questions. Beyond the basics of corporate organization and capital structure, some of which are discussed in Annex A, de-SPAC transactions may create liability for violations of the duties of candor and care, as well as the duty of loyalty, which courts scrutinize more closely in conflict-of-interest transactions, particularly if the disputed transaction involves a controlling shareholder, absent special procedural steps, which themselves may be a source of liability risk. Fiduciary duties are general in nature, and hard to predict precisely in application.

Ironically, here, one of the “features” of the SPAC process to going public—its two-stage structure—may turn out to be an Achilles heel. A SPAC, in effect, splits the overall effects of a C-IPO into two parts—an initial offering, not subject to any particularly strong corporate law fiduciary duty scrutiny (because no conflicts of interest are involved, and because, when the initial offering terms are negotiated, there are no dispersed shareholders), followed by an “M&A deal,” which does not involve formal underwriters, and therefore produces a less rigorous due diligence process in advance of the economic public offering by the “target” of that “deal.” To the extent there is truth to the notion that the SPAC is a form of regulatory arbitrage, it is due to this two-phase structure.

Yet the second step is an “M&A deal” at a point where ordinary M&A presumptions of arm’s-length bargaining do not apply to de-SPACs. Instead, SPACs build in conflicts of interest among (1) sponsors (who effectively control the SPAC in the period leading up to the deal, and who, by design, are able to benefit from doing deals that harm other pre-de-SPAC investors); (2) the target, which sits at the bargaining table and negotiates with the sponsor (and possibly with PIPE investors); (3) PIPE investors, who invest on terms that differ from terms offered to other shareholders (typically investing at a discount); and (4) the public shareholders and other shareholders. Add to this mix the significant overhang of contingent equity in the form of warrants, the terms of which differ across public warrants, private warrants, and (in some SPACs) other warrants, and the possibility—often a reality—that many voting shareholders will redeem and exit the SPAC shortly after they vote on a deal, creating a close analogue of “empty voting.”

In short, the complexity of the method by which the SPAC attempts to “arbitrage” around securities law may generate offsetting legal risks under corporate law. To be sure, this is still only a possibility—a legal uncertainty, as of this writing, because corporate law is developed on an ex-post case-by-case basis. But the questions survived one motion to dismiss in Delaware Chancery Court, which can often be a trigger for a significant settlement in lieu of trial. Whether fiduciary duties will be strictly enforced under the “entire fairness” question was and (as of this writing) remains an unanswered question, awaiting resolution of pending cases, because it turns in part on whether SPAC sponsors will be deemed to be controlling shareholders.

While sponsors usually own far less than 50 percent of the stock of a SPAC, in Delaware, as under SEC Rule 405, control can be found to exist—raising judicial scrutiny of conflict-of-interest transactions—where a shareholder owns less than 50 percent of the stock, but exercises control over the business affairs of the corporation. SPAC sponsors usually control a large block of stock, and they have other contract-, board-, and information-based methods of controlling a SPAC during the de-SPAC process, such that a court could easily conclude they are controlling shareholders, sufficient to prevent the straightforward application of the business judgment rule to a de-SPAC transaction, even if the transaction were approved by a majority of otherwise apparently independent directors and by a majority of other shareholders.

If entire fairness does apply to de-SPAC deals, as it does in other conflict-of-interest deals (such as management buyouts and parent/subsidiary freeze-outs), then a host of further legal uncertainties arise. All add untested wrinkles to how strictly courts will evaluate the fairness of de-SPAC deals. Among the SPAC-specific uncertainties are whether deals that generate investment losses may result in recoveries from sponsors or their affiliates, and whether partly or undisclosed aspects of transactions leading up to, or concurrent with, a de-SPAC (such as the identity and terms of PIPE transactions, or any side deals with first-stage investors designed to enhance the de-SPAC process) may result in state courts requiring additional disclosures, deal delays, or damage awards.

D. Investment Company Act (and Its Exemptions)

Finally, the ICA should be briefly reviewed. That law generally imposes special and quite restrictive rules on “investment companies.” As noted in Part I, SPACs function in their first stage much like mutual funds, which are classic “investment companies” governed by the ICA. If SPACs were subject to the full regulatory treatment under the ICA, they likely would not be workable. To function, SPACs and their professionals have taken the position that they are not “investment companies.”

The ICA defines an investment company to include any issuer that either (1) “is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities,” or (2) “is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40 per centum of the value of such issuer’s total assets (exclusive of Government securities and cash items) on an unconsolidated basis.” In other words, the ICA includes both a qualitative test and a quantitative test, and if a company meets either, it must comply with the ICA.

SPACs clearly appear to be investment companies under the quantitative test, because, in their initial phase, they are engaged in owning (or at least having an interest in) securities (held in the SPAC trust), and they propose to acquire investment securities of a target with most of the SPAC’s assets. The SEC adopted an exemptive rule—Rule 3a-1—that initially appears to benefit SPACs. That rule limits the reach of the ICA to companies that have more than 45 percent of their assets or that derive more than 45 percent of their income from holding securities exclusive of government securities. Because SPACs invest primarily in government securities, they can rely on this rule to exempt them from the relevant section of the ICA.

Ultimately, however, Rule 3a-1 only exempts companies from section 3(a)(1)(C) of the ICA—the quantitative test—and not from section 3(a)(1)(A)—the qualitative test. The qualitative test focuses on the activity in which a company is (or holds itself out as being) “primarily” engaged, and if the activity is primarily the “business of investing, reinvesting or trading in securities,” the company is subject to the ICA. Nothing in the SEC’s rules precisely guides courts how to identify the activity in which a company is “primarily” engaged. At best, the application of the ICA to SPACs remains uncertain—a fact discussed more below.

E. Recap on SPAC Law

The preceding sections identify some of the ways in which SPAC law is complex, confusing, varied, and uncertain, and more uncertainties and complexities are noted in Annex A. Among the uncertainties are:

  • Whether the PSLRA safe harbor applies to de-SPAC transactions,
  • Whether financial advisors, sponsors, and PIPE investors are already at risk of being found “underwriters” in connection with de-SPACs, which turns on an interpretation of the words “participation in,”
  • Whether de-SPACs are subject to “entire fairness” review, based in part on an interpretation of the word “control,” and more generally how fiduciary duties and the duty of candor will be applied on specific facts of a given de-SPAC, and
  • Whether standard (or innovative) SPACs are “investment companies” that must register under the ICA, which turns on an interpretation of the words “primarily,” “business,” and “holds … out.”

The primary take-away should be that the SPAC boom of 2021 took place with at least the possibility of significant market misunderstanding about the content and implications of SPAC law, much of which persists. Part II only sets the stage for addressing the objectively false myths about SPAC law that were circulating and that will be discussed below. Before reviewing those myths, however, it is worth reminding ourselves about more general features of the nature of law and of professional advice.

III. Law’s Complexity and Uncertainty, and Professional Advice as a Credence Good

The legal complexities and uncertainties of the SPAC product are far from unique. All law—as well as accounting standards that are required under law—generally consists of a mixture of laws-on-the-books and laws-in-action, as well as a mix of rules and standards, which are inevitably uncertain in application. The nature of the capital markets and laws that govern them take the inescapably uncertain nature of law to an even higher level. In the United States, the result is taken to a still higher level of complexity and uncertainty, due to a purposefully fragmented system of legal production—heavy reliance on private law determined by “market forces,” and public law resulting from the separation of powers, federalism, and administrative agencies, which are checked by episodic legislation and fitful and inconsistent oversight by courts.

A. Rules and Standards on the Books and in Action: A Working Example

At bottom, to restate and unpack slightly, law over any significant activity is inherently uncertain. To illustrate such uncertainty, consider laws about driving, which will also illustrate how and why laws-in-action may change without any change in laws-on-the-books. Rules—do not exceed fifty-five miles per hour—sometimes seem relatively clear and easy to understand. Standards—no “reckless” driving—are openly uncertain and their content is produced over time only through fact-specific case applications. Sometimes the standard may be reduced to a commonly understood “rule” over time, but even then, the legal enforcer often retains significant discretion, such as the police who, as a practical matter, determine the meaning of “reckless” driving.

Even rules may retain uncertainty in practice, as rules in the books may not match rules in action, at least those rules not addressed to actions otherwise understood as immoral, such as a highway speed limit. How many people drive as if fifty-five miles per hour is the true limit? Notwithstanding a clear rule, an unwritten standard, which we all know from experience, guides the police to only issue speeding tickets for driving that exceeds five, ten, or even fifteen miles per hour above the posted limit. Application of the strict rule of law, or even a tight standard (e.g., not above sixty-five-ish around Boston), would be experienced as arbitrary change by many drivers. That might be subjectively true even if driving conditions were such that the police were well motivated to slow traffic down by tightening the norm to not above sixty-ish from the usual not above sixty-five-ish. Yet drivers would not expect to win a legal challenge to a ticket on this basis—fifty-five is the rule.

Now imagine a lightly traveled but urban road, one that winds along a river but can be easily bypassed by anyone in a hurry. Police might make the reasonable determination to expend limited enforcement resources on the busier roads, and ignore driving on the remote road. As a result, driving over the posted limit would be common and unchecked, and drivers could also drive recklessly there without fear of enforcement. Effectively, drivers would face only the limits of natural law—gravity and friction and fog and the limits of their cars and reflexes. Local teenagers might even share that knowledge, and use the remote road to indulge in dangerous joy riding, and, as long as there were few enough accidents, policing might not change.

Finally, imagine a non-legal change to this scenario. A new shopping mall is built at one end of the formerly remote road. The increase in traffic also increases the danger of driving unchecked by law-in-action. Whether after accidents or plausible police foresight, enforcement policy is also likely to change, and law-in-action will change, without a change in law-on-the-books. Speeding will now be monitored, and tickets handed out to those who continue to drive five miles per hour above the posted limit, to those (teenagers) who continue to drive recklessly, and to those (teenagers) who continue to joy ride.

No doubt the teenagers will feel aggrieved. They were never stopped before. As they stand before a judge, they might even say the police had changed the law. But in fact the law-on-the-books had not changed. Even the law-in-action had not really changed: The law-in-action was always “don’t drive (much) faster than the speed limit, or recklessly, where there is enough traffic to warrant police attention.” What changed were the facts to which that law was being applied. Teenagers may not appreciate such subtleties, and may well continue to tell their parents that the police are being unfair. But none would, or should, be allowed to keep driving recklessly on the newly busy road, and would be breaking another social norm if they were to advise their peers to drive recklessly anyway, knowing that the facts on the ground had changed.

B. The Nature of Capital Markets and the Need for Specialized Capital Market Law

In the capital markets, law must respond to, and manage disputes arising out of, ongoing business arrangements that endure for years, and in the equity markets, law must address an activity—entrusting personal savings to other people in return for hoped for but necessarily speculative returns—that is highly likely to produce both fraud and regret, and with them, social risk. In such a context, law becomes complex and extensive, while retaining its uncertain character. Fraud produces a demand for both prescriptive rules and liability standards. Rules by their nature are “dumb,” producing false positives, and entice regulatory arbitrage, which generally entails greater complexity of law. Liability standards produce litigation, which leads to a mix of legislated and judicially created rules and standards to protect against some but not all fraud-risky activity. That response leads to bad facts and hard cases, and still more complexity in the resulting common law, as well as in regulatory efforts to tack back and forth between the dual goals of capital formation and investor protection.

Innovation in capital markets and capital market products only reinforces these organic legal tendencies. Even when that innovation is driven by technology or macroeconomic shocks, and not by efforts to engage in regulatory arbitrage, innovation inevitably generates new legal uncertainties. New contracts carry over boilerplate ambiguities—“material,” “control,” “primarily”—and deploy new ones. Existing legal definitions—commonly vague but then supplemented by a set of bright-line rules and safe harbors—must be applied to the new financial products. Courts splinter over difficult questions, only eventually (if ever) reconciled by appellate decisions.

C. U.S. Lawmaking as Particularly Complex and Uncertain

Capital markets law in the United States, as reflected in the sketch in Part II and Annex A, is not produced by a single coherent lawmaker. Private ordering dominates, with suites of evolving contracts responding to market outcomes, private negotiations, and hundreds or thousands of individual principals and professionals seeking marginal advantages within the scope of various relevant zones of possible agreement. That private ordering is then overlaid with public law produced in multiple ways. States—most prominently, Delaware and its courts—play an important complementary role, using standard-heavy court-made fiduciary duties shaped and constrained by many important bright-line codified rules. Congress—often uninformed and increasingly erratic in its workflow—enacts statutes that empower but constrain regulatory agencies. The primary such agency, the SEC, is limited in its ability to directly regulate the substance of capital market transactions, instead relying on a package of disclosure rules and process requirements to enhance private ordering. The SEC’s rules are themselves commonly varied over time and complex and ambiguous in their content, generating the need for guidance and interpretation by staff, courts, and private practitioners. The rules change, too, as political appointees overseeing the agencies cycle between those who favor investor protection as facilitating capital formation and those who see investor protection as an inhibitor of capital formation. Once passed, rules are routinely attacked in court, and evolving meta-doctrines of constitutional and administrative law (and legal ideology) attempt to give the political appointees even more power over career staff, generating more uncertainty over time.

D. Legal Advice as a Credence Good

Yet, despite all of these uncertainties, capital market participants must make decisions and move forward with transactions. Practitioners are forced to form views and advise about choices. Investors invest and capital flows, despite legal uncertainty. Even well-intentioned, good-faith lawyers and other professionals can, in this context, make mistakes, in the sense of predicting outcomes that diverge from what a later-in-time legal actor determines.

In such a context, it is inescapable that law governing any but the most basic and simple financial product would be complex and uncertain, and routinely generate both myths and shocks. Advice about law (and accounting standards required by law), as a result, is in its nature a form of “credence good.” Clients cannot determine in advance, or even after the fact, the quality of any given piece of legal advice. The very best lawyers in the world routinely handicap legal outcomes in ways that, after the fact, turn out to be wrong. The wide range of less-than-the-best lawyers routinely make basic legal mistakes, and their clients never realize that fact, even when the clients have been harmed. Few law or accounting firms go out of business despite generating flows of errors over time.

E. The Likelihood of Legal Shocks and Legal Myths

When transaction activity is spiking, when that activity involves a product that is relatively new (recognizing that the basic financial instruments are more than a hundred years old and still generate disputes), and when the product results from regulatory arbitrage and is inherently complex, the likelihood of legal “shocks”—shifts in relevant legal understandings due to new decisions by authorized lawmakers—are predictable. Because of the complexity of capital markets law, such shocks can take significant time to be understood, evaluated, and “priced” by capital markets—often much longer than the day or two conventionally assumed necessary for “public information” to be impounded in assets prices or reflected in capital market decisions. Slow diffusion—not instant pricing—is generally a better model of how public information about changes in capital markets law spread in financial markets.

Less obviously, however, legal myths can, in such a context, emerge, spread, and become important to capital market activity—also affecting asset prices and capital flows. By “legal myths,” I mean advice about law that is demonstrably incorrect at the time made, but that is plausible to even legally trained professionals and is often compelling to end-clients. Mistaken professional opinions—myths about law—can persist and be an important force shaping capital market activity. Given the lack of a tight (or even moderately strong) feedback loop disciplining professionals selling credence goods, such professionals can and do create and spread such myths. These myths typically serve to enhance market activity to the benefit of the professionals. They can enhance the apparent legal or regulatory appeal of a new financial product or “program” of selling a given product, by overstating their legal benefits relative to some set of alternatives, by understating their legal risks. They can also turn false claims about lawmakers and lawmaking practices and processes into political or judicially cognizable talking points, in an effort to preserve legal outcomes thought to be beneficial to their professional interests (over time, through politics, jawboning, legislation, or litigation), at the expense of accurate understandings of current law. All of these types of legal myths were at work during the SPAC bubble of 2021.

IV. Myths About SPAC Law

Let us now return to SPACs. SPACs thrived, in part, because—in addition to myths about their financial attributes, which others have debunked—several myths about SPAC law circulated widely and persistently. Professionals and investors prominent in the SPAC industry falsely claimed that (1) securities law bans projections from being used in C-IPOs, (2) liability related to projections was lower and more certain in SPACs than it was (and is), (3) the SEC registration process delays C-IPOs more than SPACs, (4) the SEC changed SPAC accounting rules in early 2021, (5) this “change” was the primary reason the SPAC wave slowed and peaked, and (6) SPACs are indisputably not “investment companies.” These misunderstandings, oversimplifications, and exaggerations of law and its effects were aimed at not only unsophisticated retail investors, but also business journalists and SPAC participants of various kinds, including sophisticated SPAC sponsors and owner-managers of SPAC targets.

Before laying out evidence that these claims were myths and that these myths were asserted and believed, let me acknowledge that the suggested causal relationship is based on general inferences from ordinary evidence of the kind routinely deployed in decision-making, not based on research claiming the mantle of science. I have no identification strategy and no data to apply thereto, and I am not trying to pin down a model of all of the reasons for SPACs’ surge and fall. These myths are not, in my view, the sole or even necessarily the most important cause of the SPAC surge—what follows is not a claim about precisely how important these myths were, only that they were not passing noise, and did have effects on the surge. These myths have persisted in the face of public refutation. They have obvious appeal to the interests of those necessary to a SPAC offering.

A. Projections Are Permitted, Unlike C-IPOs

One important myth supporting SPACs was (and is) that forecasts and projections are banned in C-IPOs. This myth is not rooted in norms or regular practice or choices by C-IPO participants but is expressed in terms that are unmistakably about what is legally permitted. For example, a published online piece about SPACs from bankers at Silicon Valley Bank includes the statement (as a leading explanation of why SPACs have been chosen over C-IPOs): “Unlike traditional IPOs, SPAC merger filings can include forecasts (usually for five years) … .” A famous billionaire and SPAC sponsor who for a while became associated with SPACs in business and popular press, Chamath Palihapitiya, commented to the same effect: “Because the SPAC is a merger of companies, you’re all of a sudden allowed to talk about the future.” In fairness to Palihapitiya, who is not a lawyer, he may have referred to projections being “allowed” by underwriters or their counsel, rather than by law. Well-known lawyers specializing in SPACs continued, as late as January 2022, to make the same claim, even while “technically” acknowledging the lack of reality to the myth.

The reason this is a myth is straightforward: There is no law or regulation barring use of projections in C-IPOs. In fact, some C-IPOs do include forecasts of cash flows. This is done routinely in offerings—including IPOs—of interests in master limited partnerships, because the tax attributes of those issuers are important to valuation, and because such forecasts are necessary to attract investors. Indeed, forward-looking information is in fact routinely presented by companies going through C-IPOs, but is typically not included in their prospectuses, not because of any law or rule barring the inclusion of such material, but because the information is developed by the banks working on the offering and presented by those banks to potential investors in the C-IPO roadshow, not as information “of ” the issuer, but as analysis by the banks.

It is a fair question as to why those kinds of forecasts are not included in a C-IPO prospectus, and whether they should be, but nothing about law forbids their inclusion. Issuers have little incentive to include such projections because, in C-IPOs, the prospectus is not a core marketing document in the same way a private placement memorandum is. The prospectus must be in a filed registration statement before the roadshow can commence, but the real sales efforts in C-IPOs occur during the roadshow meetings. As long as the forward-looking information can be conveyed in that setting, there are no strong reasons why anyone would want to include that information in the prospectus, absent a legal reason to do so. And, because the omission of positive forecasts from a prospectus is unlikely to be the basis of a future lawsuit, a defendant would be well positioned to defend even a section 11 claim by arguing that omitted positive forecasts did not cause the decline in the stock price that led to the claim. If an issuer were to propose to include positive forecasts in a C-IPO, by contrast, the prospect of downside liability borne by underwriters, coupled with transactional norms, would likely trigger a strong pushback from underwriters and their counsel.

B. de-SPAC Projections Are Clearly Exempt Under the PSLRA

A second myth—and one complementary to the first one—is that an advantage of SPACs over C-IPOs is lesser securities law liability exposure for targets and the public company itself because—goes the myth—the PSLRA safe harbor for forward-looking statements clearly applies in the context of de-SPACs but not in C-IPOs. This, such observers assert, is a reason that sponsors, targets, and others involved in a de-SPAC feel comfortable presenting projections not commonly found in C-IPO prospectuses. For example, the headline of one article about SPACs—from August 2021—read “Are SPACs Going to Lose Their Safe Harbor?” Others claimed that the PSLRA safe harbor applied to de-SPACs, even as they noted potential limits to its benefits.

From one perspective, the idea that the PSLRA safe harbor applies to de-SPACs is understandable. The safe harbor generically applies to forward-looking statements by public companies, subject only to specific exceptions. One exception is for “initial public offerings.” But, one might think, a de-SPAC is not the “initial” public offering of the SPAC vehicle—that occurs earlier, when the SPAC has no operating business and the SPAC first goes public, in phase one of a typical SPAC process.

But from another perspective, it is the de-SPAC when the target becomes a public company, so it is the de-SPAC that is, in fact, the target company’s “initial public offering,” and hence not covered by the safe harbor. Economically, and practically, the private target of a SPAC is a different organization than the SPAC itself. The information, including financial statements, relevant to evaluating the investment changes dramatically in the de-SPAC because the private target has operations, unlike the SPAC and initial SPAC investors commonly have the right to and do sell or have their shares redeemed.

The economic essence of an IPO is the introduction of a new company to the public. It is the first time that public investors see the business and financial information about a company. As a result, Congress, markets, analysts, and the SEC staff typically treat these introductions differently from other kinds of capital raising transactions. This heightened scrutiny for a company’s first introduction to the public market applies in other contexts as well—such as a company’s first registration of a class of securities under the 1934 Act or an A/B exchange offer. An IPO is where the protections of the federal securities laws are typically most needed to overcome the information asymmetries between a new investment opportunity and investors in the newly public company. To be sure, some elements of the SEC’s regulatory regime reflect a recognition that small or new public companies may not be as able to shoulder the costs of all disclosure requirements as older, larger companies. But it remains true that IPOs are understood as a distinct and challenging moment for disclosure.

If economic and information substance drive our understanding of the meaning of “initial public offering,” they point toward a conclusion that the PSLRA safe harbor should not be available for any unknown private company introducing itself to the public markets. Such a conclusion should hold regardless of what structure or method it used to do so. The reason is simple: The public knows nothing about this private company. Appropriate liability should attach to whatever claims it is making, or others are making on its behalf.

At a minimum, because the PSLRA does not clearly define “initial public offering,” and because no other relevant definition appears in the securities laws since enacted, the statute is at least ambiguous. The phrase is a classic component of a legal standard that will eventually be rendered more rule-like through interpretation (or possibly legislative reform or SEC rulemaking). What legislative history exists cuts against the idea that de-SPACs would be covered by the safe harbor. That history includes statements that the safe harbor was meant to benefit “seasoned issuers” with an “established track-record.” That history suggests that Congress was intending to limit the safe harbor to forward-looking statements made by established, publicly traded, reporting companies, to permit and even encourage them to disclose information about future plans and prospects.

Also cutting against the idea that de-SPACs should be covered by the safe harbor is the fact that the PSLRA separately excluded both “blank check companies,” referring to the SEC’s existing Rule 419, and “penny stocks,” as defined in the 1934 Act. Yet, when the PSLRA was adopted, blank check companies were limited to issuers of penny stocks. At the time, few SPAC offerings occurred other than through blank check companies covered by that rule. This suggests that, when enacting the PSLRA, Congress assumed that blank check companies—the vehicles for SPACs and de-SPACs—would be excluded from the safe harbor, even if they were separately excluded by virtue of being penny stocks, which then (and now) remains an element of the definition of “blank check company” under Rule 419. Yet, because the SEC never amended Rule 419 to pick up the ever-larger SPACs, which soon ceased to be covered by Rule 419 because of their size, the blank check company exclusion did not kick in.

Other factors possibly relevant to whether the PSLRA safe harbor covers de-SPACs include the more general policy goals served by both the PSLRA and the basic securities laws that it amended. An argument can be made that, because the reach of the PSLRA’s safe harbor does not extend to contexts where no public market for the securities exist, and because SPAC securities trade prior to the de-SPAC, the “initial public offering” exclusion from the PSLRA’s safe harbor should not apply to de-SPACs, meaning that de-SPACs benefit from the safe harbor. This argument, however, runs up against the ambiguity of which entity’s securities are the ones for which a relevant market exists prior to the offering in question. If formality is all that mattered, then de-SPACs should benefit from the PSLRA’s safe harbor. But as with the underlying economics and information points made above, a plausible understanding of the purposes of the exclusion from the PSLRA’s safe harbor counsels against the myth: The PSLRA’s safe harbor does not apply to offerings of securities of businesses that do not have markets currently pricing them based on information about those businesses. Because pre-de-SPAC, the markets in SPAC securities are not pricing the target business but are pricing only the rights of SPAC investors (including the right to redeem and not benefit or lose from the target business’s operations), the check on mispricing that might otherwise be thought to apply due to the trading market in SPAC securities does not exert anything like the same corrective pressure it exerts in the mature public company context. Whatever the merits of the “is there a secondary market” point, it is not sufficiently compelling to overcome the textual ambiguity of the PSLRA.

What is the upshot of this? In simple terms, the PSLRA excludes from its safe harbor “initial public offerings,” and that phrase may include de-SPAC transactions. It is simply a legal myth to assert that the PSLRA’s safe harbor clearly shields de-SPACs. The mythical quality of the claims about the PSLRA making SPAC liability risk lower than in C-IPOs is reinforced by the risk that de-SPAC financial advisors, sponsors, and PIPE investors may be running “underwriter” risk under current law, and the heightened corporate law liability risks of the SPAC structure, as discussed in Part II. Together, these points call into question any sweeping claims about liability risk being more favorable for SPACs than for C-IPOs. As I noted when at the SEC in spring 2021, “Any simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst.”

Consistent with this analysis is that the number of securities class actions involving de-SPACs rose along with the rise in de-SPACs, and the rate of such lawsuits is similar to or even slightly above those involving C-IPOs in recent years and roughly five times the ordinary rate of securities litigation against public companies, as illustrated in the following chart. “Rate” for this purpose is the number of lawsuits divided by the number of de-SPACs in the year. (Some SPAC promoters deflate the litigation numbers by the number of SPACs and then assert that the litigation rate is low, but that is a deceptive sleight of hand, because SPACs do not present significant liability risk equivalent to that presented by C-IPOs, until their de-SPAC phase, and of course the greater majority of SPACs taken public in 2021 are still hunting for targets.) These data do not include Delaware lawsuits attacking the corporate law aspects of de-SPACs, and, because (as noted in Part III) such lawsuits are uncommon in C-IPOs, the total litigation rate involving de-SPACs is actually higher than for C-IPOs, at least as of this writing.

Securities Class Actions Involving SPACs

Securities Class Actions Involving SPACs

While the rate of de-SPAC litigation was even higher in 2019 than 2021, the much larger number of cases made litigation risk more salient to anyone following the narrative of the SPAC “product,” and so is also likely to be at least a partial reason for the decline in SPACs during the middle two quarters of 2021, a decline discussed more below.

C. SPACs Are Faster Due to the SEC Registration Process

A third legal myth circulating in 2021 was that the SPAC path to going public was faster than C-IPOs due to the SEC’s registration process. To be fair, many claims about the speed advantages of SPACs are more general, citing overall ranges of “typical” times required by SPACs vs. C-IPOs, and these claims may well be true on average, although the ranges cited for both SPACs and C-IPOs vary widely, suggesting limited reliability of even these claims. But others are more specific in identifying a legal requirement—the SEC review process—as the reason SPACs are less time-consuming. For example, one version of this myth is that the “SEC review process can be deferred until after the closing” of a de-SPAC, while in a C-IPO, the “[f]ull SEC review process” applies.

As with the other myths, these claims are simply not true. As stated by Bill Hinman, former director of the Division of Corporation Finance:

In terms of reviewing a SPAC and the process a SPAC issuer would go through, there really is not a short cut there through the SEC process. . . . The financials would have to be the same as we see in an IPO. The review process would be very very similar… . We expect the … folks that engage in de-SPACing transactions … to be thoughtful about disclosures. We [i.e., the SEC staff] will be reviewing those disclosures.

The process of registering stock under the 1933 Act in a C-IPO is not slower than the process of registering stock under the same act on Form S-4 and clearing a related proxy statement as part of an offering in an M&A deal in a de-SPAC. While the staff does not review every Form S-4 outside the SPAC context, it does generally review de-SPACs—in part because the SEC staff understand the points made above about how de-SPACs are economically equivalent to C-IPOs, and the recognition by staff that the de-SPAC is the first time the operating company target will be making its financial statements and overall business description available to public investors.

Contrary to the legal myth in circulation, such reviews may not be “deferred” until after closing. There is nothing in the public documents about the SEC review that suggests that they can be deferred until after closing, and even a casual review of the SEC filings of a company going through a de-SPAC process shows that the staff are given an opportunity to, and they do, comment on de-SPAC registration statements before the de-SPAC closing. In fact, even after clearing a proxy statement for a de-SPAC, there is typically further delay in the de-SPAC SEC registration process (relative to the C-IPO registration process) because there is a need to solicit shareholder votes to approve the de-SPAC, before the deal can close and the target become a public company.

For example, in the de-SPAC of United Mortgage Holdings (UMH), the staff provided a letter on October 29, 2020, containing eighteen comments on a variety of topics (including the financial footnotes) in the related preliminary proxy statement filed on October 2, 2020; the company responded via counsel on November 6; on December 14, counsel responded to additional staff comments made telephonically; and the staff then cleared the proxy for use on December 15, more than sixty days after the initial filing, at which point shareholders still needed to be solicited to obtain their approval of the de-SPAC at a meeting more than thirty days later (on January 20), only after which could the de-SPAC close (on January 21), 111 days after the initial de-SPAC filing, and 121 days after the de-SPAC deal signing. For the de-SPAC of ADS-TEC Energy in 2020, the overall period from de-SPAC signing to closing was 134 days, with the SEC registration process on Form F-4 occupying only fifty of those days. Compare those periods of time to the 103 days between the filing of a draft registration statement (DRS) in a C-IPO by Ortho Clinical Diagnostics in 2020, or the seventy-six days between the DRS filing and the completion of the largest C-IPO of 2021 by Rivian Automotive.

This a simple comparison of two C-IPOs and two de-SPACs, but because SEC registration is governed by processing guidelines in place at a governmental agency, it is highly likely that a more robust statistical study would bear out this basic point: The SEC review process is not materially longer for C-IPOs than for de-SPACs. One may object to these comparisons because, in C-IPOs, there is substantial (if unobservable) delay between the date a potential public company and its underwriters begin working on the C-IPO, and the first observable filing of a DRS with the SEC, and that is true. But that delay is not fairly attributable to the SEC registration process. And in a de-SPAC, there is also commonly a significant period of time between the date the potential target and the SPAC begin negotiations and the date of the first filing for the de-SPAC with the SEC. In the UMH de-SPAC, for example, the initial non-disclosure agreement between the SPAC and UMH was signed 526 days—almost a year-and-a-half—prior to the signing of the de-SPAC deal, and the first SEC filings for that de-SPAC could only occur several weeks after that signing.

What is true is that an SEC staff review can be deferred until after “signing” of the de-SPAC deal agreements. And for some targets, that may be of some comfort, because it probably does mean that the eventual de-SPAC closing is, or is perceived by the target to be, more certain to close than may be true of a C-IPO at the outset. But the signing of a de-SPAC deal is not equivalent to closing a C-IPO, and de-SPACs are subject to contingencies, not the least of which is the level of redemptions following announcement of the deal.

During 2021, de-SPAC redemptions increased throughout the year, from an average of less than 10 percent in the first quarter to more than 50 percent in the fourth, and were even higher in a significant number of de-SPAC deals. (For more on this point, see the chart in Part IV.E below.) This surge in redemptions, in turn, produced an increasing number of failed de-SPACs, creating delay even when deals could be re-cut. Not surprisingly to anyone familiar with M&A generally, de-SPACs can and do generate disputes that can emerge between signing and closing, making closing of a de-SPAC uncertain for that reason as well.

Conversely, in a C-IPO, issuers do typically have some type of commitment from underwriters before commencing the SEC registration process, although that does not truly commit the underwriters and the issuer to completing the offering, which depends on demand for the company’s shares. Only de-SPACs coupled with relatively large PIPEs are more certain than C-IPOs, because the PIPEs commit to providing capital that can be used to offset uncertain redemptions. And some PIPEs are conditional on various uncertain contingencies that are, at best, difficult to compare to the uncertainties associated with the C-IPO process.

In truth, the “gating item” for paths to listing and public ownership is typically an audit of the company’s financial statements by an auditor registered with the Public Company Accounting Oversight Board (PCAOB). The auditing process typically requires at least three and often six months. As with companies undergoing C-IPOs, the auditing process is required for SPAC targets—along with the parallel process of preparing the target for public company status, including recruitment of an independent and qualified audit committee, along with other committees required by listing standards, the installation of a control system capable of being attested by auditors under the Sarbanes-Oxley Act, and the integration of a professional management team with the newly recruited public-company-worthy board.

D. The SEC Changed SPAC Accounting Rules in Early 2021

A fourth myth about SPAC law arose during the course of 2021, as SEC staff coped with the surge. This myth concerned both a claim about the accounting standards—imposed by law—on shareholder equity in SPACs, and about the nature of the lawmaking itself. The starkest versions baldly claimed that the SEC itself had proposed or even adopted a “rule change” not once but twice with respect to equity accounting. As one news report stated, “In April, the SEC indicated that SPACs had to account for their warrants as liabilities rather than equity. That accounting change forced many special purpose acquisition companies to restate their financials … .” And in September, Reuters reported, “Expanding its crackdown on the SPAC sector, the [SEC] has told top auditors of blank-check acquisition companies to account more strictly for public shares in these shells . . . . The development marks the second time this year that the SEC has tightened SPAC accounting guidance . . . .”

Unlike the myths sketched above, this myth was not in service of depicting SPACs as more legally advantageous than they are, but instead was in service of downplaying the lack of care apparently exhibited by professionals working on SPACs. If newfound enforcement of existing law were instead seen as a “change,” then failure to adhere to existing standards could be attributed to the failure to anticipate regulatory change, and not simply to failure to know or apply existing standards. Few worry about professionals not having political crystal balls, but most business clients do worry when their professionals make basic errors.

As sketched in Annex A, however, the temporary equity and warrant accounting standards that have been labeled as “changes” by the SEC were not new. The warrant accounting standards dated back to public accounting consultations starting more than thirty years earlier and, by 2009, were clearly set forth in the easily available Accounting Standards Code (ASC) of the Financial Accounting Standards Board (FASB), long before the SPAC surge of 2021. Nor were the standards applicable to warrants developed or created by the SEC, which rarely imposes accounting requirements on public companies. Rather, the warrant accounting standards were promulgated by the FASB, and only after the FASB’s typical, slow, highly industry-friendly deliberative process, in which bankers, issuers, lawyers, and the general public could and did participate. Similarly, the accounting standards relevant to redeemable equity dated to 1979 and were clearly applicable to common shares, such as those issued by SPACs, by 2015.

What did happen in 2021 was that the surge in SPACs brought an ever-increasing number of competent professionals into the world of SPACs, resulting in a substantially greater number of eyes being cast over standard SPAC contract terms (such as those in typical SPAC warrants and redeemable shares) and the accounting standards applicable to those terms. It was not the SEC that spoke in April 2021 or September 2021 about those topics, but the staff—a distinction that should matter to lawyers, even if perhaps understandably a nuance to others—and more importantly, the staff was not intervening on its own initiative, but was responding to requests from SPAC sponsors and their professionals for guidance—that is, the professional judgment of the staff about those topics, based on stated facts. This is a customary, and customarily non-controversial activity for staff of the SEC. More important still, each written articulation of staff guidance plainly states on its face that is not binding and can effect no legal change.

Of course, those requesting guidance may not agree with, or be happy about, the staff ’s views. But there is nothing unusual or “regulatory” about staff providing such guidance, and on occasion, companies and others subject to securities laws refuse to follow staff guidance, and when they do, it falls to the SEC’s enforcement staff to decide whether to pursue an enforcement action, and ultimately, to a court to determine who is right. On occasion, the staff is wrong, and its views on accounting are found to be in error. That is the nature of guidance in the kind of uncertain legal environment outlined in Part III of this article.

A related claim augmented the myth that the SEC had changed the rules for SPAC accounting in 2021. Per that claim, the SEC had, over the years, “approved” hundreds or even “thousands” of SPACs’ offering documents but the staff later determined, per the 2021 guidance, that the accounting included in those offering documents was in error under existing FASB standards. The implication was that the SEC had somehow, through practice, modified the FASB’s derivative and equity accounting guidance. No “repeal by implication” could have occurred because of one simple fact, known to all securities lawyers, and in fact required to be stated on the front page of every securities prospectus ever processed by the SEC: “The Securities and Exchange Commission has not approved or disapproved these securities or passed upon the adequacy of this prospectus. Any representation to the contrary is a criminal offense.”

This legal point is reinforced by practical considerations, also known to any securities professional. The SEC staff, as wonderful as they are, are limited in number, and can only do so much by way of document review during the registration and proxy clearance process. The numbers of questions that could be asked about any de-SPAC or C-IPO number in the thousands, particularly given the wide variety of businesses that go public, with all of the remarkable variety of strategies, resources, plans, assets, liabilities, business histories, managers, customer bases, supply networks, financing choices, cash management tactics, legal and compliance programs, and other elements of businesses that exist, not to mention the large number of legitimate choices for accounting practices permitted by generally accepted accounting principles (GAAP). The SEC staff has never purported to examine a filed draft registration statement or preliminary proxy statement with all of those thousands of questions in mind.

A slightly (but only slightly) more plausible version of this claim is that, if the staff adopted a new interpretation of an existing standard, then the issue should have been “material” (in some unspecified sense), and if that issue was in fact “material,” then the staff should have caught the problem earlier than it did. But that claim, too, fails in context. An issue can be “material” in the legal sense to a particular company that is offering securities without being “material” overall to the SEC and its staff. To return to the driving law example in Part III, the staff (police) allocate resources based on facts about overall market (traffic) conditions and flows, and that allocation may be altered in response to changes in those facts—such as a massive surge in a type of company (a new shopping mall). For years, SPACs were a “backwater,” according to even their biggest promoters. During that time, occasionally professionals did bring issues to the attention of the staff, even about SPAC warrants, but none asked the staff to publish formal guidance on the warrant accounting issue on which staff provided guidance in 2021. In that context, it would not have made sense for the staff to devote major resources to reviewing every possible accounting issue SPACs raised.

As SPACs surged, the SEC devoted more resources to SPACs, just as the police might devote more radar guns to a more heavily trafficked road. With more SPACs flowing through the SEC, more eyes were focused on SPACs in general, both outside and inside the SEC, despite the limits to SEC staff resources discussed in Part IV.E below. Given that additional attention, it is entirely consistent to believe that a “material” issue in earlier SPACs had not been “material” overall, but did become “material” to the markets, and material to appropriate resource allocation by the SEC.

What is, of course, interesting about the claims that “hundreds” of SPACs used this accounting is that part of this set of legal myths is true, at least for the warrant issue. Unlike the SEC staff, each audit firm is engaged on a one-off basis by a specific audit client, and it owes the same duties to each. Yet the mistaken warrant accounting was used by hundreds of SPACs prior to, and during the first part of, 2021. How could so many professionals have made such an error? Perhaps that widespread misunderstanding does suggest the SEC changed something?

Well, no, that suggestion does not follow. The reason is clear once we recall a basic fact about SPACs noted at the outset. Cost pressure exerted by SPAC sponsors is strong. If a SPAC cannot find a de-SPAC in the SPAC period, the sponsor eats all of the start-up costs of the SPAC. That includes audit costs and legal costs. As it turns out, two audit firms handled nearly all of the SPACs leading up to, and during, the SPAC surge of 2021. These two firms were paid between 0.02 percent to 0.05 percent of SPAC proceeds, compared to a C-IPO, where accountants were paid between 0.6 percent and 0.9 percent of proceeds.

Perhaps more importantly, the absolute dollars involved in these audit engagements were low—as little as $15,000 per audit. Not surprisingly, at those low rates, bigger audit firms largely eschewed SPAC audit work, at least prior to 2021, and none of the SPACs were willing to incur the additional expenses associated with asking SEC staff guidance about challenging accounting questions. It was only at the de-SPAC stage, as larger and larger targets of SPACs were acquired in 2020 and 2021, that bigger audit firms became increasingly involved in SPAC-related audit work and began to focus on issues such as accounting for warrants and redeemable equity in the SPAC context. It was only in March 2021 that the SEC staff were asked the specific questions about SPAC warrant accounting addressed in the April 2021 statement. Any such request would have been neither bold nor odd. The staff had previously been asked about accounting for SPAC warrants. The SPAC warrants prevalent in the 2021 surge, however, featured very different terms than the warrants previously addressed by the staff, and the staff had not been asked to address the appropriate accounting treatment of those newly prevalent warrants.

In such a cost-pressured environment, and particularly as the surge began to mount, with audits as a “gating item” for the going-public process, with firms pursuing SPACs and de-SPACs competing with C-IPOs (and a record-breaking amount of non-SPAC-related M&A) for attention from professional service providers (including lawyers, bankers, and auditors), professionals naturally relied on prior SPAC documentation when performing work on new SPACs. In essence, the SPAC professionals kept hitting the copy+print buttons. So what may seem like hundreds or even thousands of professional decisions to use one type of accounting may, in fact, represent really only a few occasions on which accountants reviewed relevant guidance by the FASB and SEC, read the SPAC agreements, and reached an informed judgment about the appropriate accounting. After the SPAC surge, a number of non-SPAC-specialist auditors began identifying these issues regarding warrant accounting and resolved those issues differently than the SPAC-specialist auditors.

To be clear, the “myth” circulating about warrant accounting was not the accounting treatment that was used prior to April 2021. That was, in hindsight, a mistake, but not a myth. The myth is that the staff “changed” the rules, when the truth is that the rules did not change, only the attention to the rules did.

Since the SEC staff ’s published guidance in April 2021, none of the major audit firms have disagreed with the staff about SPAC warrant accounting, and one larger audit firm has endorsed the staff ’s reported approach to mezzanine equity from September 2021. Indeed, hundreds of SPACs have chosen to restate their financial statements to come into line with the staff ’s views on the warrant issues, and many have also restated their financial statements to address the mezzanine equity issue. For the warrant issue, at least, these restatements were not required by the SEC staff—the staff did not order firms to engage in restatements, but instead, left it to the judgment of each firm as to whether its accounting was in error, and if so, whether the error was material. But neither were these restatements discretionary—it was not the case that an audit professional or audit committee could simply say, “Well, I think the SEC staff is wrong—GAAP says something different—but let’s restate anyway.” That would run afoul of professional norms and fiduciary duties, because, to repeat a point made above, the staff did not change GAAP in 2021.

In another spin on this myth, some now assert that only the SEC staff ’s views matter when it comes to accounting. That is clearly a myth, too. Audit firms are not afraid of telling the staff when they think the staff has erred. In 2001, for example, Deloitte publicly criticized the SEC staff for its interpretation of applicable accounting rules that led a Deloitte client to restate its financials; Deloitte refused to certify the restated financials and withdrew from the audit engagement. In 2016, PwC publicly disputed the SEC staff ’s application of the auditor independence requirements to fund companies that were 10 percent owned by banks from which PwC had borrowed. And as noted above, sometimes companies successfully challenge the accounting charges of the SEC’s Enforcement Division in court.

It is true that the need for restatements temporarily slowed many SPACs. In hindsight, the decision by many SPAC sponsors to rely on the cheapest possible auditors may have been “penny wise, pound foolish.” Or, to quote another adage, “you get what you pay for” in professional services, as elsewhere. In fairness, however, the general features of the markets for professional services—accounting as well as law—noted in Part III should be remembered: Professional advice is a credence good; the law and accounting for capital markets products are complex and uncertain; financial innovation naturally leads to errors and omissions; and professionals can and do routinely make mistakes without going bankrupt.

One final point should be made about these accounting mistakes. Some might claim that, because the accounting items were non-cash items, their importance was overblown, the errors were immaterial, and the SEC staff should have simply turned a blind eye to the issues. What such claims overlook is that each issuer could make its own judgment about whether the misclassifications were material, consistent with prior SEC staff guidance. Of nearly five hundred SPACs that reclassified warrants as liabilities as of October 2021, a majority corrected previously issued financial statements to reflect a restatement, but many made the judgment that they only needed to implement a revision, with the correct classification applied to current and ongoing financial statements.

Why might the accounting issues be material if they were “merely” non-cash items? The restatements reveal at least two things. First, on the substance of the restatements, the nature of the accounting classifications involved—debt vs. equity, and which type of equity—should make the conclusions of the restating companies (and their auditors, audit committees and lawyers) more understandable. What could be more fundamental to an understanding of a company’s financial position than how much equity it has? (And in most SPACs, the amounts in question were not minor in relation to the SPAC’s total capital structure.)

Second, the restatements revealed a more general feature of the professional services that SPACs have been purchasing. Less widely noted than the fact of the restatements—and less widely circulated than the myth that the SEC changed the rules—is the fact that, of those SPACs that restated their financial statements, 90 percent of them also disclosed that material weaknesses existed in their internal controls. These data are not consistent with the idea that warrant accounting is either trivial or universally material. Instead, consistent with the SEC staff ’s guidance, the basic accounting needs to be correct, but the impact of a mistake in the accounting depends on the facts and circumstances of the company and the size and significance of the mistake. While it is likely true that overall average stock price reactions to the restatements were not large, some issuers—particularly those that announced both restatements and material weaknesses in their controls—experienced significant contemporaneous stock price declines.

Part of the reason that stock market reactions to the accounting mistakes were not larger overall is that the details of the warrants themselves were available to investors in the forms of the warrant agreements. But, as noted by the FASB in 1980 and the SEC accounting staff in 1999, “[c]onsideration of potential market reaction to disclosure of a misstatement is by itself ‘too blunt an instrument to be depended on’ in considering whether a fact is material.” It is also important that accounting should be standardized and comparable, even if specific choices might not produce material new information for a given company in a given financial report. Otherwise, the minimization logic deployed by SPAC promoters would suggest that it would not matter to investors if companies could deviate from basic GAAP principles routinely, reporting wildly non-comparable numbers as equity, as long as either stock prices did not react to the choices or the companies publicly disclosed—perhaps at the end of a long contract that was attached as one of a dozen exhibits to a lengthy SEC filing—the details underlying the reporting, of when and how a set of warrants might not be exercisable for equity, or might be exercisable for some holders but not others, or when and under what conditions common shares might be redeemed and thus cease to be equity.

An approach to accounting that ignored objective errors in basic accounting classifications is contrary to the entire concept of “generally accepted accounting principles.” If all non-cash accounting errors were trivial, and if one could freely deviate from GAAP on non-cash items, then lobbyists would have wasted tens of millions of dollars battling for and against actual changes in accounting standards for pooling accounting and stock option expensing. In both cases, the transactions (all-stock mergers, stock option grants) involved non-cash events, and pro forma disclosures related to those transactions revealed much of the information that the formal accounting (before and after the changes) might not. The same logic would also suggest that managers (and investors) who attend to such things as earnings-per-share are foolhardy, because earnings is often composed of many non-cash components, and we know that companies (such as Amazon) can have no or minimal earnings for years and yet have tremendous value. Yet basic accounting is not frivolous. Accounting correlates with and predicts financial returns, and analyzing the real economics underlying the accounting is costly and for some value-relevant information impossible. As with perceptions of law, accounting can and predictably does affect capital allocation and should never be treated as optional.

E. The SEC Slowed SPACs Down in Early 2021

A fifth legal myth circulating is that the SEC slowed the SPAC market down in early 2021. Similar to the prior myth, this myth is designed to help promote the SPAC market by blaming negative feedback from poor financial returns on unpredictable regulatory forces unrelated to SPACs themselves. Prominent SPAC lawyers asserted, as late as January 2022, that the “warrant issue” was part of a “public, concerted effort to slow the SPAC market down.” This claim was repeated in many news articles, and picked up by academics with no apparent interest in the matter. Neutral staff statements about SPAC law were critiqued and mischaracterized in op eds, without explanation, as “assaults” on SPACs. In other words, efforts to combat one myth generated another. According to another version of this myth, the SEC “slowed down its response time” when reviewing SPAC filings.

In either version, this myth is simply false. As noted above, the warrant accounting issue was not one where the SEC staff (much less the SEC as a body) initiated an inquiry; rather, it was brought to the staff in a request for guidance, which the staff then gave. With respect to processing times, SPACs were filed and declared effective within the same time periods, and pursuant to the same internal guidelines throughout the spring of 2021, with no material change being shown in filing dates. I was acting director of the Division of Corporation Finance at the time, and I can personally attest that there was no concerted effort to slow SPACs down, through the disclosure review program or otherwise.

To the contrary, the staff worked well beyond expectations to maintain their dedicated and diligent reviews to the benefit of both investors and companies forming capital. Despite having had its staff reduced by more than 20 percent in the prior five years, during which the number of listed companies rose significantly, nearly doubling the number of listed companies per full-time equivalent staff from nine to fifteen, despite working under stressful COVID-19 conditions, and despite facing the largest IPO wave in U.S. history, the staff of the SEC did not slow down its work generally, nor aim at any particular kind of filing with an intent to slow down capital formation. Suggestions to the contrary are simply embarrassing for those perpetuating the myth. To the extent there were any processing delays for particular SPACs, they had to do with underinvestment by those SPACs in professional services, overworked professionals trying to cope with the surge of SPACs and IPOs that continued into April of 2021, including the use of litigators by major law firms to draft, file, and process securities filings, and specific errors and omissions in SPAC filings that required correction.

As a quick check on my beliefs about these points (and I happily acknowledge a personal interest in some of them), I reviewed SPACInsider (an online news site focused on SPACs) to find a news article for the first SPAC I could identify to file its initial filing in each of the months of February through May of 2021, and compared the related SEC processing documents and time to those of SPAC filings from January 2021, prior to the change of administrations. I found no reduction in processing times, no increase in comments, and no apparent effort to “slow down” SPACs. Specifically:

  • Nocturne Acq. Corp. filed its initial SPAC Form S-1 on February 8, 2021, received its one and only one comment from SEC staff on March 1, well within the customary thirty-day turnaround target, took eleven days to respond to the one comment (which consisted solely of asking the SPAC to update its financial statements as required by Regulation S-X), and went effective as requested on March 23.
  • Valor Latitude Acquisition Corp. filed its Form S-1 on March 11, 2021, received no comments from staff, and went effective, as requested, on May 3. Between those dates, it amended its Form S-1 twice, the last time shortly before requesting effectiveness, and in the second, filed on April 19, it added a revised form of warrant agreement. A comparison of the initially filed warrant agreement and the later one shows that the amendment reduced the size of the warrants covered by it, added a new investor, and modified the terms governing amendments to permit future amendments as needed to permit the warrants to be treated as equity, likely triggered by the SEC staff ’s statement on warrant accounting issued a week earlier, on April 12. The SPAC did not use that flexibility initially, however, and reported its warrants as liabilities rather than equity in its prospectus.
  • Ion Acquisition Corp. filed its Form S-1 on April 6, 2021, received its one and only comment letter on April 16, containing two comments, took five days to respond, and went effective, as requested, on April 29, less than a month after the initial filing—despite needing to pare down its offering due to decreased market demand.
  • OceanTech Acquisitions I Corp. filed its Form S-1 on April 9, 2021, received its one and only comment letter ten days later, and went effective, as requested, on May 27, after amending its disclosures to address the staff ’s two comments: (1) align the disclosures with the corporation’s organizational documents, and (2) revise the opinion of counsel, which initially addressed only Delaware law, to include New York law because the warrants were governed by New York law.
  • CleanTech Acquisition Corp. filed its Form S-1 on May 28, 2021, received no comment letters thereafter, and went effective, as requested, on July 14. It had previously filed a confidential draft registration statement (on March 8), about which it received one SEC staff comment letter (on April 2), which contained five comments, after which it took eight weeks to complete its complete Form S-1 in response to those five comments.

Together, these filings show that there was no general slowdown in SEC staff processing of SPACs during the spring of 2021. In fact, two filings received no SEC staff comments, and the others received minimal comments, fewer than was typical in January 2021. What these filings do show, however, is that SPACs were routinely making basic mistakes in their filings, not limited to the warrant accounting issue. While this sample is too small to make strong claims about SPAC professionals, it is striking that one in four of these initial SPAC filings contained a basic error of disclosure—a failure to correctly describe the company’s own organizational documents—and one failed to provide financial statements with an “as of ” date required by Regulation S-X. The limited evidence in this small sample is more consistent with the suggestion above that any detected slowdown in SPAC offerings was more attributable to the “infrastructure” of SPAC advisors being overloaded than to any deliberate policy change at the SEC.

It is also notable that two of the four SPACs reduced the size of their offerings, which no doubt also caused some delay, as sponsors adjusted their expectations to align with market demand. In fact, SPAC activity did slow down from March through June of 2021, as shown in the following chart (courtesy of Professor Michael Ohlrogge).

But, as this chart also clearly shows, the slowdown in SPAC activity preceded the SEC’s staff statement regarding warrant accounting in April 2021. Prices of SPACs, too, started to fall by late February. Investors’ own re-evaluation of the SPAC product, downward, in line with post-de-SPAC stock returns, is a straightforward reason for the pullback. Simply put, markets were working—albeit with a significant lag.



The slowdown no doubt is most directly related to a growing awareness by some sponsors that they might well be left with losses if they could not find targets within their SPAC periods, a prospect made more salient by the fact that redemptions rebounded from their all-time lows in the first quarter of 2021, as shown in the following chart.

Rising SPAC Redemptions

CFO Dive, data from SPACInsider

Rising SPAC Redemptions

Also, during this period, at least the more sophisticated sponsors began to realize that all of the SPACs being brought to market would be competing with each other for a limited pool of targets. While there are thousands of private companies that, in principle, might go public, many are owned by founders and families with no interest in going public. Many other private companies are more suited for a premium acquisition by a strategic buyer or for the professional management support offered by a private equity firm. Of those companies that are interested in going public, the C-IPO market was also at all-time highs, and direct listings—faster, cheaper, and easier for companies than SPACs and CIPOs alike—have begun to be used by some of the most well-known private firms.

The disruption of the SPAC boom of 2021 was most likely attributable to regression to the mean, recognition of market overreach, and market-driven deflation of a bubble. The disruption may also have been attributable, in part, to an increase in litigation over SPACs and sheer professional service market overload. As much as this former SEC staffer would like to think the public listens to the SEC staff, the slowdown had only modestly to do with SEC or SEC staff statements about the risks of SPACs. I am confident that it had nothing to do with any deliberate effort by the SEC to slow SPACs down. That is simply a myth.

F. SPACs Are Indisputably Not Investment Companies

According to a final legal myth, SPACs are indisputably not “investment companies.” As discussed in Parts I and II, SPACs, in their first phase, function economically like mutual funds—a type of investment company. As discussed in Part II.D, nothing in the ICA itself nor SEC rules promulgated thereunder clearly exempts SPACs from the ICA. And, as discussed below, it is at least plausible that SPACs are investment companies subject to the ICA. To be clear, the myth is not “SPACs should not be treated as investment companies”—a type of qualified opinion that an advocate might reasonably advance. Rather, the myth is “SPACs are indisputably not investment companies under existing law.” The myth inheres in the understatement of legal risk.

Despite the legal uncertainty of whether SPACs are subject to the ICA, a remarkable statement signed in August 2021 by more than sixty law firms opined: “[T]he assertion that SPACs are investment companies [is] without factual or legal basis and [we] believe that a SPAC is not an investment company . . . .” The statement contains no reasoning beyond the bare assertion that the “plain text” of the ICA resolves the question because SPACs are designed to attempt to acquire an operating company, so (goes the reasoning of the statement) the “primary business” of a SPAC is that acquisition. “Plain text” arguments in the face of contrary interpretations commonly fail to persuade, and in prior transient investment company disputes, the companies involved were also arguendo pursuing similar acquisitions, which did not end those disputes. Indeed, it is hard to see how such an argument could be the last word on the question, or resolve the issue as a matter of law, because such an interpretation of the ICA would invite never-ending evasions covered by the claim that the company involved would get around to buying an operating company someday, and would ignore the necessarily factual nature of the ICA’s use of contestable terms such as “primarily,” “holds … out,” and “business.” Indeed, the uncertain nature of the ICA was the reason the SEC adopted Rule 3a-2’s more bright-line exemptive safe harbor.

Despite alluding to “longstanding interpretations” of the ICA, the statement cites no authorities at all, and never attempts to engage the implications of Rule 3a-2 and prior court and SEC staff no-action positions that a one-year limit is the maximum period that a SPAC could remain outside the ICA. The statement’s only specific point is that more than one thousand SPACs have gone public without registering under the ICA. Similar reasoning has been adopted by a few readers of a draft of this article. The reasoning seems to be: If a legal issue is unclear, and the SEC does not bring an enforcement action to enforce the unclear law, the law is somehow liquidated, and no future private or SEC action can be brought based on the uncertain law. Or perhaps the argument may be: The SEC should simply resolve all legal uncertainties in favor of capital formation. Would that be a sensible approach to the legal uncertainty of SPACs under the ICA?

Not noted in the law firms’ statement is that the vast majority of those SPACs explicitly noted ICA-related risk in their offering documents, and none (to my knowledge) ever disclosed having obtained a legal opinion that the ICA does not, in fact, apply to SPACs. If the issue were as clear as the law firms’ statement makes it seem, one would think that at least one of those law firms would have been willing to risk its reputation and malpractice exposure by providing a legal opinion to one of its clients. If SPACs were arguably—but not clearly—investment companies subject to the ICA, then what would we expect the SEC staff in the Division of Corporation Finance who were reviewing filings by these SPACs to do, except include a comment in a review letter asking for a risk factor? If the SPAC included the risk factor, and made no affirmative statement about its legal status other than in the form of “we believe,” should the staff have held up the offering?

Does the claim, then, reduce to one that a regulatory agency with a limited budget should be held to have legally ceded authority by not initiating an enforcement action over an issue regarding a “backwater” corner of the market? How, indeed, is this any different from the teenager complaints of Part III? In any event, however one thinks about what the SEC staff should have done in the past, it remains unclear whether typical SPACs are covered by this part of the ICA. Any such finding would impose limits and costs beyond those anticipated by typical SPAC structures, and as a result would effectively force typical SPACs to either liquidate or find another exemption on which to rely.

Another rule—Rule 3a-2, which was adopted by the SEC in 1981—might provide a possible escape route for SPACs. But that rule is limited to companies for a one-year “transient” period. As noted in Parts I and II, most SPACs specify a SPAC period of longer than one year, and many SPACs have taken longer than one year to complete their de-SPACs. In the release adopting Rule 3a-2, the SEC suggested a company would be running a serious risk if it exceeded the one-year limit. Of course, any time limit is arbitrary, and Rule 3a-2 may not be viewed as establishing by negative implication a one-year limit on SPACs, given other aspects of the SPAC structure and their marketing. But absent a new SEC exemptive rule or a persuasive appellate court holding on point, the longer the SPAC period for a given SPAC, and the greater the flexibility the SPAC contracts and corporate documents provide for extensions beyond the initially stated period, and the longer a given SPAC continues to not achieve a de-SPAC, the greater the risk it may be found to be an inadvertent investment company.

Relevant to that risk, outside the SPAC context, courts have addressed the permissible length of the time between the sale of a non-securities business and the acquisition of another such business, without falling afoul of the ICA by being deemed to be “primarily” engaged in holding securities (despite pursuing an operating company acquisition). In the most prominent of those lawsuits, the court also used a one-year period as part of an overall fact-specific evaluation of the company’s situation. The SEC staff also has used one year as a guideline in granting no-action relief when requested by transient investment companies. Although not binding on courts, the analysis and precedents of those no-action positions may be persuasive authority on this question.

Regardless of how the pending litigation on this question is resolved, the ICA is likely to limit innovation in the SPAC space. SPAC structures that explicitly contemplate a permanent or “evergreen” company pursuing a series of acquisitions over time, such as the one proposed by Bill Ackman during 2021, would be even more likely to fall afoul of the ICA, even if SPACs are permitted to endure for more than a year. By design, any such company would continue to hold securities beyond its initial acquisition, making it much more vulnerable to being viewed as “primarily” engaged in a business other than pursuing that initial acquisition.

In sum, it is a myth that the ICA clearly or inarguably does not apply to SPACs. A plausible “as applied” reading of the ICA would sweep in SPACs that last for more than a year without engaging in a de-SPAC, and a plausible “on its face” reading of the ICA would sweep in SPACs that, by the terms of their offering documents, have SPAC periods lasting more than year. The law firms’ statement notwithstanding, the issue is legally unresolved. SPACs’ own disclosure documents clearly acknowledge this risk. As between the deal-activity-enhancing and self-serving law firms’ statement, and the under-fraud-threat disclosures of SPACs advised by those same law firms, the latter is a more reliable source of legal advice on this point—but it is rarely noticed or reported by business journalists and is likely not being made clear to either SPAC sponsors or de-SPAC targets. In the end, the main significance of the law firms’ statement is to show how broadly the SPAC product spread during the bubble of 2021, and how invested major law firms and their clients in the SPAC industry became in struggling to maintain the status quo underlying that bubble and the related fee streams it was producing.

V. Implications

The SPAC industry continued to repeat these demonstrable myths long after the SPAC bubble burst. The industry players continued to assert that only in SPACs can companies talk about the future; they continued to claim that the PSLRA safe harbor clearly applies to de-SPACs and that SPACs generally give rise to lower liability risk for participants; they continued to claim that SPACs enjoyed a faster SEC registration process than C-IPOs, even as they also claimed that the SEC has changed accounting rules and its processing program in order to slow SPACs down; and they continued to dismiss ICA concerns about SPACs as if they were trivial. In reality:

  • Companies are legally permitted to talk about the future in C-IPOs, and in fact do so through their underwriters on their roadshows.
  • The PSLRA safe harbor may—but just as likely may not—apply to de-SPACs, and, in any event, de-SPACs are subject to offsetting or even higher liability risks than C-IPOs because they include a “deal” (the de-SPAC), which under Delaware law may fairly be seen as giving rise to conflicts of interest subject to heighted judicial scrutiny because of the control exerted by sponsors over the SPAC.
  • The SEC has yet to make rule changes in response to the SPAC surge of 2021, and the staff has only done what it has always done—provide its views on accounting and legal questions when asked.
  • The SEC has not slowed down its reviews of SPAC filings, and difficulties SPACs may be finding as they work through the disclosure process are at least as often due to choices and mistakes they and their professionals continue to make.
  • The application of the ICA to SPACs remains very much a live legal issue as of this writing.

Many of these myths may have been believed by people who repeated them, which is why they were “myths” and not simply lies. In fact, they may have had greater influence if they were repeated frequently and confidently by celebrity financiers and business market commentators, who believed what they were told by lawyers.

But to the extent those repeating these myths knew what they were doing, they were engaged in a type of “deep fraud,” akin to the buying and selling of “doubt” about science. The fraud was “deep” because it did not directly elicit money from deceived strangers. Its effects were general, indirect, insidious, and downstream. It played on beliefs about over-regulation that are widespread, if unfounded, and relied on elements of classic “cons” by encouraging people to believe that they are the ones getting away with something—by evading the risk of litigation that is portrayed relentlessly by political actors as opportunistic, and by avoiding strict regulations that conflict with common sense (no talking about the future!), even when those regulations do not, in fact, exist. The “deep fraud” pointed at familiar scapegoats (overzealous civil servants) to distract from poor financial returns and professional incompetence. It conditioned market participants to believe that an overall package of contracts and structures was better than it truly was.

To be clear, the point is not that SPACs themselves are fraudulent, although some notoriously were fraudulent. Nor is the claim that anyone involved in a particular SPAC was relying specifically on this market conditioning in a way that would be actionable under conventional fraud law. Rather, the point is that, by repeating continuously these myths, the professionals repeating them made it more likely that they would generate rents in future SPAC deals.

SPAC professionals did so by creating information conditions in which it was easier to convince entrepreneurs—who of course are not typically lawyers, and who depend on lawyers to supply the credence good that is legal advice—that the SPAC product was better than it was from a legal point of view. They pulled in overoptimistic sponsors who failed to account for sponsors’ historic failure rate to find sustainable targets—greater than 90 percent, as established by market data for the second half of 2021 and the first half of 2022. They used the myths to curry favor with potential clients predisposed to believe myths with a political tint. Most of all, however, they contributed to a breathless meta-narrative for business journalists to suck up and repeat, blinding resurgent retail investors with technical complexity and tales of regulatory overreach, to fall first for an overall financial product, and only second for the specific pre-revenue version of that product, armed with hockey-stick projections that would be laughed out of a C-IPO roadshow.

SPAC professionals could only do this, to be sure, if they worked for and alongside legitimate SPACs sponsored by professional, experienced managers drawing in sophisticated private equity funding to acquire real targets and generate good, if normal, returns. Sweepingly bad products die. SPACs did appear to have genuine advantages over C-IPOs—just not the bogus ones touted in the myths reviewed above. These apparent genuine advantages primarily involve disintermediating the fairly concentrated banking industry (as well as venture capitalists) from their dominant roles as underwriters and pre-public-owners in the going public process. They thereby may enhance competitive pressure on entrenched C-IPO professionals to service companies who are looking to go public. They may also facilitate the “matching” among potential investor/managers seeking to run a public company, and private company owner/managers seeking to both list and partner with new managers without giving up a full equity stake, as they would have to do to sell to private equity. When PIPEs are involved, SPACs also give companies seeking to go public a greater degree of control over who their shareholders will be post-listing. But if they have these benefits, they are not dependent on the mythical regulatory arbitrage that many SPAC promoters continue to tout as the best reason to choose the SPAC path.

The myths about SPACs make plausible a broader claim: Financial-legal innovation can permit promoters to exploit the credence good character of professional advice, perpetuate deep fraud about complex financial products, and distort markets and asset prices longer than conventional theory assumes. Proving (as opposed to suggesting) these claims remains a task for ongoing research. In future studies, it would be worth reviewing ways in which other complex financial-legal products have been promoted with persistent myths, as well as how and when “markets” learn better, if ever, and the role that conventional forms of securities regulation (disclosure mandates, gatekeeper requirements, and liability rules) play in helping markets to function efficiently.

In the short run, however, the type of deep fraud documented here supplies a reason for two sorts of regulatory responses. First, the SEC’s pending proposals should be finalized. They will reduce legal uncertainties in several ways. They will remove any doubt that the PSLRA safe harbor does not apply to de-SPACs, even as issuers remain able to provide cautionary language that will no doubt assist in reducing liability risk under the judicially developed “bespeaks caution” doctrine. As a result, companies will have to be more careful in presenting—and before that, in developing—projections. Some claim that the removal of the PSLRA safe harbor is somehow inconsistent with the requirement that companies present projections if they are used by a target board to approve a de-SPAC merger. But the only inconsistency involved is the apparent expectation of some SPAC industry participants that multiyear projections of a kind that would never be actually relied upon by a serious and well-advised board of directors could be publicly disclosed without meaningful caveats and also without any risk of liability when they turn out rapidly to have been consistently over-optimistic—not “projections” so much as “stretch goals” used to motivate rather than inform.

The proposals will also bring certainty to the ICA issues identified in Part IV.F. SPACs could rest comfortably outside the ICA but only if the conditions to the proposed safe harbor are met. While the shortening of the SPAC period in the proposal will chill some SPAC activity, the market has already demonstrated a decreased appetite for long SPAC periods, in line with a recognition that two years is just too long a period for investors to remain in limbo while sponsors engage in speculative search. Some may think that even the extension beyond the one-year limit period in the current exemption may be too “loose” of a policy. From my perspective, the choice between one year or eighteen months falls in a range of reasonable judgment, and, as long as the SEC revisits the question periodically, the benefits of experimentation are worth some risk-taking.

Finally, the proposals will elicit more and better disclosure about SPACs—both their economics and their legal attributes. Better understanding of the true costs of SPACs, as well as whether their sponsors have engaged in a traditional process to obtain a “fair” deal for investors, and if so, on what basis they conclude that the result is likely to be fair, can only help investors and markets appropriately price specific de-SPAC deals. The opaque elements of SPAC incentives and costs—the potential for self-interested but suboptimal target selection and pricing, and the typical, but not always easy to estimate, amount of dilution—will be easier to understand if the SEC’s proposals are approved and effectively enforced.

Even after these regulatory reforms, however, SPACs will remain a highly complex product, both legally and financially. Economically, they bundle the sale of equity with a fixed income product and several different kinds of derivatives. Legally, they vary significantly in their terms (despite their reliance on boilerplate in many aspects), and the details of various kinds of contracts and ongoing uncertainties about corporate law’s application to the standard SPAC process mean that, even with clear disclosures, SPACs will remain hard to evaluate from an all-in legal perspective. Regulators must continue to speak publicly and clearly about SPACs’ ongoing uncertainties to moderate market-and-pricing distortions that tend to emerge in the presence of such complexity. Information wars are won by persistent communication of truth. Authoritative speakers matter. Regulatory voices do not always drive out myths, but they can complicate the tasks of those who speak to exploit them, and weaken or shorten the duration of their power. The need for such speech extends beyond conventional and worthwhile efforts to educate retail investors. It extends to more sophisticated participants, whose sharpened skepticism about (for example) conventional business salesmanship may lull them into not realizing how vulnerable they may be to myths about law.

Annex A
Detailed Summary of SPAC Law and Governing Contracts

1. SPAC Listing Standards

Most SPACs commit to adhere to a stock exchange’s listing standards. Before the modern SPAC was fully developed, many SPACs traded on the over-the-counter markets, but the greater liquidity of listed SPAC shares, the greater size of SPACs in 2021, and the greater attractiveness to investors of SPACs subject to listing standards, made listings an expected part of the SPAC process during the 2021 surge. Listing standards are sometimes fairly understood to be regulatory in nature, and for SPACs, they track the kinds (but not the details) of investor protections in SEC Rule 419, which was adopted in 1992 and which was initially aimed at SPAC-like companies—“blank check companies.” As one initial misunderstanding among investors, Rule 419—which would intuitively be of first-order importance for SPACs given that SPACs are “blank check companies” in the ordinary English language sense—is actually not applicable to most modern SPACs. The scope of Rule 419 is limited to “penny stocks.” Few SPACs in the 2021 boom were small enough to have issued penny stocks. Few SPACs, as a result, were required to comply with the investor protections in Rule 419. Instead, the listing standards provide key investor protections particular to SPACs.

Contrary to common understanding, listing standards are not private-law equivalents to SEC regulations. The remedy for breaching listing standards is delisting, not an SEC enforcement action. Nonetheless, once listed, companies are loath to risk delisting, so in practice many effective investor protections are contained in listing standards.

Taking the NYSE listing standards as an example, a SPAC must hold 90 percent of the proceeds of its IPO in a trust account until it has located a target for a de-SPAC that will use at least 80 percent of the amount held in trust (net of amounts provided to the target, such as for working capital). The NYSE also sets numerical minimums for non-affiliated initial SPAC investors along with other structural and qualitative requirements. Among them is a limit on the length of the SPAC period. The NYSE permits the SPAC period to run up to three years—not the two-year period typically seen in SPACs in 2021, or the fifteen-to-eighteen-month period seen in most SPACs in 2022—and provide for delisting at the end of that period. The NYSE listing standards also require independent board approval of the de-SPAC and require initial SPAC underwriters to waive the right to collect any deferred underwriter discount if the SPAC liquidates. They also importantly mandate redemption rights, which (when supplemented with other elements of the SPAC structure) give initial SPAC investors an effective fixed income security, with an option to hold onto (or through warrants, discussed below, increase) their equity stake at the de-SPAC stage. This package means that initial SPAC offerings consist of low-risk investments, at least for those sophisticated enough to exercise the rights they provide.

2. Initial SPAC Contracts

In connection with the initial SPAC offering, a SPAC enters into a suite of formal agreements with its sponsor, its initial underwriters, and sometimes other investors. A basic “SPAC agreement” among the sponsor, the SPAC, and the SPAC executives includes a commitment from the SPAC not to do a de-SPAC without consent of the sponsor, a waiver by the sponsor and the executives to their redemption rights, and their agreement that they have no claim on the trust. In the basic agreement, too, the executives commit to vote for the de-SPAC identified by the sponsor, and the sponsor agrees to liquidate (or redeem or both) if no de-SPAC is done in the SPAC period. The basic agreement also may contain “lock-up” restrictions on the sponsor and other SPAC founders, limiting when and how they can sell their equity stakes in the SPAC, the terms of which can vary across SPACs and for different participants in a given SPAC, and for different securities held by the same participant. The basic agreement also typically stipulates that neither the sponsor nor founding executives will receive any compensation from starting and running the SPAC, or from finding and completing a de-SPAC, other than that disclosed in the SPAC’s prospectus. The agreements commonly cap sponsor ownership at 20 percent of the SPAC.

Along with the basic agreement are side agreements with some or all initial investors that commit not to redeem their shares and/or to vote in favor of any or a specified de-SPAC. The material terms of these agreements, such as consideration investors receive for not redeeming, are not always disclosed, although the legality of their omission from the public record is unclear. Other initial SPAC agreements may include:

  • an initial securities purchase or subscription agreement between the SPAC and sponsor through which the sponsor obtains its basic equity ownership of the SPAC in return for a nominal investment, typically $25,000,
  • a promissory note to the sponsor to fund start-up costs, typically up to $300,000,
  • a registration rights agreement designed to secure liquidity for the SPAC securities acquired by the sponsor,
  • indemnity agreements to enable the recruitment of SPAC directors,
  • one or more forward purchase agreements between the SPAC and affiliates of the sponsor (or other third parties) committing them (or giving them an option) to help fund the de-SPAC,
  • office sharing agreements, transitional service agreements, or intellectual property licenses between the SPAC and the sponsor or an affiliate to support the operations of the SPAC in the SPAC’s initial period, and
  • financial consulting service agreements, sometimes with affiliates of the sponsor, effectively increasing the size of the sponsor’s promote.

All of these SPAC agreements are in addition to those that typically accompany any public offering, such as underwriting agreements, syndicate agreements, and agreements regarding comfort letters, legal opinions, and officers’ certificates. SPAC contracts are collectively more complex than contracts that accompany a typical C-IPO.

3. SPAC Warrants

Warrants and rights make up an unusually large and variable contingent set of equity claims in SPACs. Some SPACs have omitted warrants, but in most SPACs, they represent a significant part of the capital structure. Their terms are important to how SPACs function. Among varying terms are when warrants are exercisable and for how long, at what strike price, for how many shares, whether and on what terms the warrants are subject to redemption (commonly upon closing of a de-SPAC), when they expire (commonly thirty days after the closing of a de-SPAC, but some have longer durations), and how they may be adjusted to reflect dividends on the SPAC’s common shares. These terms are often set out in lengthy warrant agreements and certificates. Typically, the warrants sold to the public in a SPAC’s initial offering trade as a “unit” with the common shares, but not all SPACs address this issue identically.

SPAC warrants come in several varieties. SPACs commonly sell warrants to the public in the SPAC’s initial offering (“public warrants”), sell other warrants, on different terms, to the sponsor in a private placement (“private warrants”), sell still other warrants (“forward purchase warrants”) to investors affiliated with the sponsor or the SPAC in connection with forward purchase commitments to fund the de-SPAC, and commit to issue still other warrants (“working capital warrants”) in the event the sponsor or the SPAC managers loan the SPAC funds to stand up its post-de-SPAC operations and wish to convert those debt obligations in whole or in part to equity. Further complicating matters is the fact that SPACs often have side contracts with their sponsors or other subsets of shareholders regarding voting, and with warrant holders regarding their redemption and other rights, which create further variations in governance and ownership entitlements. Due to these variations, SPAC capital structures are more complex than is typical for a C-IPO.

Due to the listing standards described above, another key (but variable) set of terms specify redemption rights. These rights give initial SPAC investors the ability to redeem their shares for cash up to the closing of the de-SPAC transaction, and also commonly mandate redemption at the end of the SPAC period. Due to redemption rights, a SPAC, in its initial, pre-operating-stage, is functionally similar to a mutual fund (whose investors are able to redeem their shares at net asset value at any time). But unlike a mutual fund, SPAC redemption rights effectively die after its initial phase—so that, after the closing of the de-SPAC, a SPAC effectively converts from having the economics of a mutual fund to those of a conventional operating company.

4. GAAP Financials, PCAOB Audits, and Accounting for Warrants and Redeemable Equity

SPACs—as with all public companies—are required to include financial statements compliant with GAAP and audited by an independent audit firm subject to oversight by the PCAOB. For the most part, accounting and auditing initial SPACs is relatively simple, as they have no operating businesses, which typically generate the greatest number of choices and judgments in accounting and auditing.

A. Redeemable Shares as Mezzanine Equity

One SPAC-specific accounting question is the classification of securities as equity or debt. As noted above, SPACs issue redeemable shares to the public in their initial phase. The accounting guidance from the FASB on this classification is simple in concept: If the shares are redeemable at the option of the holder, or upon the occurrence of an event that is not “solely” within the control of the issuer, the security should be recognized “temporary” equity. Sometimes labeled “mezzanine” equity, such shares are not properly included in total (permanent) shareholder equity. This accounting treatment dates back to the 1970s when the SEC staff addressed the appropriate accounting treatment of redeemable preferred securities.

As applied to SPACs, the accounting is seemingly straightforward, and would be quite salient, given that redeemable equity is one of the core features of SPACs that distinguish them from other public companies. Standard redemption triggers—the occurrence of a de-SPAC or failure to engage in an acquisition within the SPAC period—are clearly not “solely” within the control of the SPAC, because they require negotiation with third parties and are subject to a number of customary conditions. Many SPACs, accordingly, accounted for the redeemable shares as temporary equity.

Some SPACs, however, have specified in their charters that de-SPAC-related redemptions would not occur to the extent they would bring the SPAC’s net tangible equity below $5 million. This term has reportedly been included for two reasons: The SEC’s Rule 419 may apply to SPACs if they have less than $5 million of net tangible assets, and because Nasdaq’s listing standards require listed companies to have that much net tangible equity, as “demonstrated on the … most recently filed audited financial statements filed with, and satisfying the requirements of, the [SEC].” Based on the idea that some portion of every share was subject to this $5 million limit on redeemability, many SPACs (and their auditors) took the view that $5 million of the shares could be classified as regular or “permanent” equity.

However, this condition to the redemption rights is not linked to any particular set of redeemable shares, because one cannot identify precisely which (or whether any) of the shares will not be redeemable due to the $5 million qualification. More importantly, all shares remain potentially redeemable under conditions that are not “solely” within the control of the company—in effect, the $5 million qualification simply specifies a possible reason that redemption might be deferred or delayed, but the qualification does not eliminate the possibility that the shares will be redeemed under circumstances not “solely” within the issuer’s control. And still more importantly, SPAC shares also typically include a separate right—not subject to the $5 million qualification—that they be redeemed if the SPAC has not achieved a de-SPAC prior to the end of the SPAC period. As a result, all such shares should be accounted for as “temporary equity.”

B. Warrant Contracts as Liabilities

Another prominent and material feature of SPACs—warrants—also raise accounting questions. As derivative contracts, warrants are not straightforwardly accounted for as common equity, because warrant terms vary, and some warrants produce returns that are closer to fixed income returns than to equity returns. As a result, warrants have long been treated differently under GAAP, depending on their terms. As with mezzanine equity, authoritative statements by the FASB on warrant accounting were included as part of FASB’s 2009 codification of GAAP. But the content of those statements—including the fact that warrants receive varying treatment depending on their terms—is older and was discussed repeatedly as part of Emerging Issue Task Force Issue No. 00-19 over fifteen years, from 1987 through 2002.

The content of that guidance is complex. Warrant accounting turns on the precise terms of the warrants, which vary from SPAC to SPAC. Specifically, at the risk of some simplification, ASC-815-40-15 provides that warrants should be accounted for as equity if they are “indexed” to equity. To be “indexed,” their settlement amount must equal the difference between the fair value of a fixed number of equity shares and a fixed price—a so-called “fixed for fixed” amount. If adjustments are made to such an amount, the warrants can only be accounted for as equity if the “only variables that could affect the settlement amount would be inputs to the fair value of a fixed-for-fixed forward or option on equity shares.” That general conclusion holds even if the warrants may be settled in cash, but only if all shareholders generally receive cash in the same circumstances and the event is not within the issuer’s control. The same guidance treats transactions that do not involve a change of control as being within the issuer’s control—thus, tender offers for all of a company’s shares would qualify, but tender offers for only one class of a company’s shares, not causing a change of control, would not qualify. The basic concepts under the qualifications to those two points—a limit on alternative inputs to the calculation of the shares underlying the warrant, and carefully limiting when warrants can be cashed out by the issuer—are intuitive. If the formula for what warrant exercise produces for the holder (and for what the company must issue to that holder) deviates from a standard option model, then the warrant contract economics deviate from holding (or having issued) equity itself. If the exercise of a warrant yields cash, rather than equity, then the warrant is not really an equity equivalent.

While intuitive in concept, those conditions on equity treatment are not always simple to apply. Specifying when an event falls within when an issuer’s control is not always clear, and estimating the “fair value” of an option is not a simple task. Standard option models vary. Nonetheless, with respect to the elements of fair value, the FASB’s guidance prescribes limits. It lists the fair value inputs for an equity option (share price, term, dividends, cost of borrowing stock, interest rates, share price volatility, the issuer’s credit spread, and the ability to maintain a standard hedge position). It does not list other factors. Similarly, the limit on cash payouts (even if other shareholders are to receive cash) applies only to events outside the issuer’s control, and while “control” is not always self-defining, it seems clear that a tender offer for less than a majority of all of a company’s classes of equity would not be “beyond” an issuer’s control.

More specifically, with respect to standard SPACs, warrants do not necessarily provide for cash settlement simply because the holders received cash for their equity, and they commonly settle differently depending on the identity of their holders. Specifically, a typical SPAC warrant agreement allows for forced redemption of “public warrants” for a nominal amount if certain conditions are met (commonly if the stock price reaches $18 or higher for twenty out of the previous thirty trading days). Effectively, holders are forced to exercise their public warrants upon notice of redemption. However, warrants held by the SPAC sponsor or other designated parties are not subject to the same forced redemption. As a result, the redemption price may not be the same for all outstanding warrants, even though they were initially placed at the same time and subject to the same agreements. Because the identity of the holder is not an input to a fair value model for options, this differential treatment in warrant agreements takes them out of equity treatment, and they must be accounted for as liabilities.

Likewise, in a typical SPAC public warrant agreement, a “tender offer” clause allows for a cash settlement of the warrants in the event of a tender or exchange offer made to and accepted by holders of more than 50 percent of the outstanding shares of a single class of common stock. If there are multiple classes of stock (as is typical for SPACs, because founder shares and public shares are typically different classes), such a clause would allow for a cash settlement even in cases where there has been no change in control of the company. Given such a clause and such a capital structure, the public warrants would fall outside an exception that would otherwise be available, because cash payments could be made to settle the warrants without a change in control. Such warrants must be accounted for as liabilities. Whether the FASB’s strict treatment of this issue is reasonable could be debated, but the rule can only be read reasonably in one way. SPACs with warrants having such provisions that initially accounted for them as equity have, since the SEC staff statement, typically restated their financial statements to account for them as liabilities.

5. Corporate “Contracts”

In keeping with the acronym, a SPAC typically consists of a corporation that is an empty shell company with minimal or no assets that is intended to seek out an acquisition target. The charter and bylaws (and the background corporate statute and common law) provide a set of foundational components to SPAC law, as with any other form of corporate organization. Among key corporate law attributes of a SPAC are its capital structure and the voting, liquidation, and redemption rights of its owners. Corporate law also imposes fiduciary duties on the board and officers of the SPAC—open-ended standard-like obligations that are the subject of substantial ongoing litigation in the Delaware courts, as of this writing.

For a SPAC, corporate law functions more like a contract than for a non-SPAC firm, because a SPAC is not an operating company, over which a board exercises discretionary business judgment—a fundamental feature of corporate law and critical to governance regarding non-contractible or hard-to-contract-about contingencies. Instead, SPAC corporate law largely reduces to the terms of the charters and bylaws, which vary from SPAC to SPAC. For example, about 20 percent of SPACs have dual or multi-class structures and others a more conventional one-share/one-vote structure, either in the initial SPAC stage or in the de-SPAC stage or both.

Voting rights were once important in SPACs, because they affected the process through which initial investors could and did participate in approving the de-SPAC. Prior to 2010, de-SPAC voting rights were linked to redemptions, much as corporate statutes link appraisal rights to dissenting votes regarding a merger. Only if a SPAC investor voted against a proposed de-SPAC could they redeem their shares, and if they did vote against the de-SPAC, their shares would be redeemed. This redemption right created the risk of a “hold-up,” where concentrated and sophisticated initial-stage investors could threaten to vote against a de-SPAC deal, even a good one, to extract side payments. SPACs now typically decouple the voting and redemption rights. This may create its own problems, however, as argued by Professors Rodrigues and Stegemoller.

6. SPAC Trust Agreements

To back up redemption rights, and to comply with listing standards, a SPAC settles a trust with a third-party bank, into which proceeds of the initial SPAC offering are placed and held separate from the SPAC’s assets, pending use in the de-SPAC or to pay redemptions, subject to specific exceptions, such as SPAC taxes. Redemptions leading up to the closing of the de-SPAC (or redemptions upon expiration of the de-SPAC period) are paid out of the trust. The trust agreement is designed to prevent SPAC sponsors or managers from absconding or misusing the proceeds of the initial SPAC offering while the SPAC hunts for a target.

As is typical for third-party trusts, such trust agreements are highly standardized, and create an almost-auto-pilot way for trustees to know when and how much to distribute from the trust with form instructions attached to the trust agreement to use in the event of specified payout contingencies. To keep SPAC costs low, the trustee earns a grand total of roughly $15,000 for its services if the de-SPAC is completed within one year. Nonetheless, because the trust agreements cross-reference the SPAC’s charter, its agreements with the SPAC underwriters and sponsor, and (implicitly) the terms of the SPAC securities (including variations created by agreements with sponsors), their effective terms are also variable. SPAC trusts are useful, but add to the overall complexity of the SPAC path to a listing.

7. PIPEs

Most if not all SPACs raise additional funds as they approach an identified de-SPAC acquisition. They do so to increase their acquisition capacity and amass capital to infuse into the target, but also to counteract redemptions of shares by initial investors, the precise amount of which cannot be known with certainty by the SPAC or the target in advance. These additional funds are typically raised through private placements, which, because the SPAC is already a public company, fall into the category of capital transaction traditionally called PIPEs. Unlike traditional PIPEs, however, SPAC-PIPEs are negotiated as part of the lead-up to the SPAC acquiring an actual business, which is effectively going public through the de-SPAC. As a result, typical SPAC-PIPE processes, economics, and contract terms differ from conventional PIPEs, and add still more complexity to the SPAC universe.

In terms of process, ordinary PIPEs are commonly sought from a limited number of potential investors, partly to keep the fact of a potential securities sale confidential and partly to speed up the investments, permitting them to be completed in two weeks or less from initiation. While some SPAC-PIPEs also target one or two investors, SPAC sponsors have increasingly been broadening the set of potential PIPE investors beyond a set of specialized institutions, e.g., BlackRock, Fidelity, T. Rowe, and are now reportedly conducting mini-“road shows” leading up to a PIPE, akin to what is done in a C-IPO, over many weeks or even months. SPAC sponsors now reportedly approach as many as a hundred or more potential PIPE investors to obtain the desired funding.

Complete data on the number of investors who are offered, or even those who are sold, PIPE securities are not available, because current SEC rules do not require disclosure of such details, unless a given private placement triggers specific regulations, e.g., public disclosure following the acquisition of more than 5 percent of target securities. SPACs typically have incentives to disclose the identity of prominent or well-regarded PIPE investors, because doing so “certifies” the merits of the SPAC. Many SPACs thus voluntarily disclose the identities of the investors who actually purchase PIPE securities. Others, however, do not, which may, in some cases, involve spurious or fake PIPE announcements, designed to manipulate the SPAC’s stock price or increase its bargaining power in advance of a de-SPAC negotiation.

In terms of economics, ordinary PIPEs are more commonly conducted by smaller and mid-sized companies, which often face hurdles when raising money. Professors Lim, Schwert, and Weisbach reported that 90 percent of non-SPAC-PIPEs involved issuers under $1 billion in market capitalization and the median book value of the issuers was $51 million. SPAC targets are sometimes small or mid-sized, but PIPEs are also being used in de-SPACs when the targets are large—commonly in excess of $1 billion. Non-SPAC-PIPEs routinely involved discounts, as do SPAC-PIPEs, but SPAC-PIPEs have commonly involved discounts that would be large (if not unheard of ) in non-SPAC-PIPEs.

As for legal terms, in an ordinary PIPE, the company issuing the private securities is, by definition, already a public company, so the investors conduct a due diligence investigation on that public company, subject to a confidentiality agreement. In a SPAC-PIPE, the company that enters into a securities purchase or subscription agreement with the investor is often the SPAC itself, in cooperation with the de-SPAC target, and the investors conduct a due diligence investigation on both the SPAC (including all of the financial and legal arrangements sketched above) but more importantly the target (which has an operating business). This requires a three-way negotiation and legal commitments from the to-be combined SPAC/target, including (as typical in a PIPE) registration rights. Also, unlike a typical PIPE, the SPAC-PIPE investor and the SPAC and its sponsor agree to support the de-SPAC deal.

Collectively, PIPEs are an important part of the SPAC process that nonetheless add significant complexity and variation in SPAC terms, both legal and economic.

8. The 1933 Act and Related Regulations

With so much complexity embedded in the private and quasi-private law governing SPACs, it may come as something of a relief that the primary law governing the first phase of a SPAC is comparatively simpler than in a C-IPO. Both initial SPAC offerings and C-IPOs are governed by the 1933 Act and related regulations. Both require the filing of a registration statement with the SEC and amendments thereto that respond to staff comments. (The staff traditionally reviews all IPOs. Through the initial part of 2021, that tradition of all IPO filings included SPAC offerings. Starting in the spring of 2021, staff review of initial SPAC filings was curtailed to free up resources to review de-SPACs, which were beginning to surge. Both initial SPAC filings and C-IPOs require audited financial statements.

Unlike C-IPOs, however, the initial SPAC has no business to describe, and, as a result, its financial statements are comparatively simple. The SEC’s Form S-1 requires disclosure of the SPAC agreements and underwriting contracts, as well as the corporate charter and bylaws and capital structure of the SPAC, including SPAC warrants. However, the bulk of the disclosures could be produced by borrowing boilerplate from prior SPACs. The timing of an initial SPAC offering, moreover, would not be complicated by selling an operating company’s shares through a conventional roadshow. Instead, SPAC underwriters face the comparatively simply task of assembling a potentially small group of hedge funds and SPAC enthusiasts to buy the initial SPAC shares, which have both downside protection (redemption rights), a guaranteed return (due to the trust and the contracts described above), and optionality as to a target company hoped to be acquired in a future de-SPAC (the ability to continue as investors, or even buy more shares via the public warrants).

As a result, the typical initial SPAC underwriting has taken no longer than the process for C-IPOs, and many have taken less time. All of the initial SPAC offerings on Form S-1 filed in January 2021, for example, were declared effective and the offerings completed within three to four weeks, and previously filed confidential draft registration statements were cleared for filing on Form S-1 within four to six weeks of final effectiveness. C-IPOs filed in 2020 and early 2021, by contrast, took no less time (a month) to move from Form S-1 filing to effectiveness, and the time between the DRS filings and Form S-1 filings typically taking a month more, for an effective processing period roughly double that for SPACs. This is not surprising—a review of SEC staff comments on SPAC initial offerings shows them to include relatively few, if any, comments, which typically focused on redemption rights and potential extensions of the SPAC period.

Of course, this timing advantage is not the central point for comparing SPACs to C-IPOs. From the eventual SPAC target’s perspective, the more important timing component is the length of the period from the decision to proceed with the de-SPAC to the completion of the de-SPAC deal. As discussed in Part IV, the SEC’s review process is not materially longer for C-IPOs than for de-SPACs.

For helpful comments on this topic or earlier drafts, I thank Mike Klausner, Michael Ohlrogge, Yiming Qian, Jay Ritter, Yochai Benkler, Amanda Rose, John Morley, Rob Jackson, Holger Spamann, Leo Strine, Andrew Tuch, Alex Lee Yoon-Ho, Yaron Nili, John Olson, the wonderful staff at the Securities and Exchange Commission from whom I learned a great deal while working on SPACs there in 2021, and Steven Cleveland. My thanks for research assistance to Chaim Herbstman and Clara Silva. All errors remain my responsibility.

For comments: [email protected].