Is a SPAC Investment Suitable for you?

 What is a Special Interest Acquisition Company (SPAC)? 

A SPAC (Special Interest Acquisition Company) is a unique investment vehicles that raises capital through an IPO with the sole purpose of acquiring an existing company.  

In the past few years SPACs have become popular with retail investors because they allow them to invest in private companies without meeting certain wealth or income thresholds. 

The following is a detailed look at SPACs including new rules, an explanation of the SPAC process, the risks of investing in
SPACs as well as suitability factors. We also include some recent regulatory sanctions involving SPACs. 

It’s important for investors to consider their individual circumstances before investing in SPACs or any other financial product to ensure suitability for their specific situation. 

 SEC Approves New Rules for SPAC Investor Protection 

Last week, the U.S. Securities and Exchange Commission (SEC) announced it has approved new rules aimed at enhancing investor protection in Special Purpose Acquisition Company (SPAC) initial public offerings (IPOs) and subsequent de-SPAC transactions. 

The new rules focus on increasing disclosures and imposing stricter guidelines on projected earnings advertised by SPACs. The SEC aims to protect investors from overly optimistic projections and address poor SPAC performance. 

Further, these rules include enhanced disclosures about conflicts of interest, sponsor compensation, dilution, and additional information about target companies. The changes aim to align disclosures and legal liabilities in SPAC transactions more closely with traditional IPOs. 

SEC Charges Northern Star SPAC for Material Misrepresentations  

Northern Star Investment Corp. II, a special purpose acquisition company (SPAC), has reportedly agreed to settle charges with the Securities and Exchange Commission (SEC) this week over misleading statements in its initial public offering (IPO) disclosures.
 
According to a press announcement on January 25, 2024, the SEC found that Northern Star falsely claimed in its SEC filings that it had not initiated discussions with potential target companies before the IPO. 

However, the SEC’s order revealed that the company had engaged in talks with a target company and its controlling shareholder regarding a potential business combination dating back to December 2020.  

The settlement includes a cease-and-desist order, and Northern Star agreed to pay a $1.5 million penalty if it completes a merger transaction.

FINRA Targets Broker Dealers in SPAC Examination  

In October 2021, The Financial Industry Regulatory Authority (FINRA) launched a thorough examination of the activities of brokerage firms in relation to special purpose acquisition companies (SPACs) because of the risks of the investments and the potential for financial losses for retail investors. 

FINRA indicated that while it wouldn’t disclose which brokerage firms were part of its examination sweep, that it would be looking at SPAC-related activities from July 2018 through September 2021, as well policies and procedures involving public offerings, suitability, due diligence, communications with customers, and product recommendations. 

SEC Charges Advisor with Conflicts of Interest Related to SPACs 

In September 2022, the Securities and Exchange Commission (SEC) reportedly charged Perceptive Advisors LLC, a New York-based investment adviser, for allegedly failing to disclose conflicts of interest related to its personnel’s ownership of sponsors of special purpose acquisition companies (SPACs).  

Perceptive Advisors allegedly formed multiple SPACs whose sponsors were owned by both Perceptive personnel and a private fund advised by Perceptive. The SEC claims that Perceptive personnel were entitled to a share of the compensation received by the SPAC sponsors.  

Perceptive Advisors agreed to settle the charges by consenting to a cease-and-desist order, a censure, and paying a $1.5 million penalty, without admitting or denying the findings. The SEC also found that Perceptive failed to timely file a required report concerning its beneficial ownership of stock in a public company. 

Explanation of the SPAC Process  

These shell companies are typically formed by a group of institutional investors and money is raised through an initial public offering (IPO) and moved to an interest-bearing account until the acquisition can be made. 

When the shell company goes public, it is not certain which company it is seeking to acquire. The SPAC may have up to two years to identify a target company to acquire. After a target company has been decided upon, the acquisition must be approved by the SPAC’s shareholders through a vote. 

After the acquisition, the shareholders may decide to either convert their shares of the SPAC into shares of the acquired company or redeem their shares and for the initial investment plus interest. 

If the SPAC is unable to locate a target company within the two-year time period, the SPAC is liquidated, with all shareholders receiving their original investment back along with accrued interest. 

The Risks of Investing in SPACs  

Like all investments, there are risks that come with investing in SPACs. Due diligence of the SPAC process is not as rigorous as a traditional IPO and SPAC sponsors aren’t looking out for retail investors’ best interests. 

Since the SPAC sponsors are the ones who choose what entity to acquire, this increases the possibility of self-dealing and may lead the SPAC to pay a premium price for the company at a detriment to investors. Shareholder dilution could also be a problem, due to large fees and a 20% stake by the sponsors, plus a warrant to buy more shares. 

If there are too many investors in a SPAC, then a capital short fall may occur. 

There is also the possibility that the target companies may have their acquisition rejected by SPAC shareholders. 

While there have been some successes with a few high-profile SPACs, the average returns from SPAC mergers fell short of the average post-market return for investors from an IPO, according to reports. 

Suitability Factors 

Risk Tolerance: SPACs can be speculative investments, and not all investors are comfortable with the level of risk associated with them. If an investor has a low risk tolerance, a SPAC may not align with their investment preferences. 

Investment Objectives: Investors have different goals, such as capital preservation, income generation, or capital appreciation. If a SPAC’s risk-return profile doesn’t align with an investor’s objectives, it may be considered unsuitable. 

Time Horizon: SPACs typically have a limited time frame to identify and complete an acquisition (usually two years). If an investor has a short-term investment horizon that doesn’t match the SPAC’s timeline, it could be considered unsuitable. 

Financial Situation: An investor’s financial capacity to withstand potential losses is important. If an investor cannot afford the potential risks associated with SPAC investments, it might be unsuitable. 

Understanding of SPACs: SPACs have a unique structure and involve specific risks and uncertainties. If an investor lacks a clear understanding of how SPACs work or the associated risks, it may not be a suitable investment for them. 

Filing a Complaint against your Brokerage firm      

Brokers have a fiduciary duty to perform adequate due diligence on any investment before recommending it to investors. If you think your investments were not suitable for you, and you have suffered losses, you may have a viable claim against your brokerage firm. 

If you are concerned about an investment in a special purpose acquisition company (SPAC), the securities attorneys at The White Law Group may be able to help you by filing a complaint against your brokerage firm. Please call the offices at 888-637-5510 for a free consultation with a securities attorney.  

 The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois and Seattle, Washington. Since the firm launched in 2010, it has handled over 700 FINRA arbitration cases.