Blank cheque companies have been around for decades, falling in and out of fashion along with various boom-and-bust cycles. After facilitating a series of penny-stock scams in the 1980s, regulators and legislators enacted tougher rules designed to protect investors in blank cheque companies.
Recently, the blank cheque structure has experienced a resurgence in popularity. In 2020 alone, blank cheque IPOs raised more than US$80 billion – more than the previous 10 years combined, and exceeding the traditional IPO market. This trend has only accelerated, with the first three months of 2021 already eclipsing 2020’s record-setting total.
Blank cheque companies, also known as special purpose acquisition companies, or SPACs, get their name from the fact that they have no business or operations at the time of their IPO. Instead, SPAC sponsors use IPO proceeds to acquire a business, often within a specified industry. Because the target business is unknown to investors, the skill, experience and diligence of the blank cheque sponsor is of paramount importance. After a target is identified, shareholders vote on the deal.
Shareholders can also elect to redeem their shares, receiving a cash payout roughly equal to their initial investment. If the deal is approved, the target business reverse merges with the SPAC, allowing it to become publicly traded. If a SPAC sponsor fails to complete a business combination within the allotted timeframe (usually two years), proceeds from the blank cheque IPO are returned to investors.
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Proponents of the SPAC structure claim it offers a faster and cheaper route to a public listing for private companies, compared to a traditional IPO. In addition, the ability of SPAC investors to redeem their shares allow blank cheque IPOs to serve as a kind of savings account with significant potential upside if a deal is viewed favourably by the market.
But the unique structure of blank cheque companies poses heightened risks to investors, and may make them prone to fraud and abuse. Typically, SPAC sponsors receive a fee of 20% of company shares if the SPAC successfully completes a merger. This fee can be worth hundreds of millions of dollars, and is forfeit if no initial business combination is completed. This creates a strong incentive for SPAC sponsors to push for shareholders to approve any merger to ensure their fee, even if the deal is not in the best interests of shareholders.
Additional conflicts of interest, such as hefty management fees, may pervade the deal and provide added incentives for SPAC sponsors to oversell the target company to shareholders. Less stringent disclosure requirements may also apply to bringing the target company public than is the case in a traditional IPO.
Recently, several high-profile SPAC acquisitions have been followed by serious allegations of fraud, mismanagement and self-dealing. So far in 2021, more than a dozen blank cheque companies have already been accused of perpetrating frauds in connection with their initial business combinations, costing investors billions of dollars in losses.
These accusations have resulted in a wave of litigation by injured investors against blank cheque companies, SPAC sponsors, and the officers and directors implicated. This litigation trend is likely to accelerate as hundreds of SPACs are currently seeking merger targets, providing opportunities for unscrupulous actors to engage in financial misconduct.
In addition, the US Securities and Exchange Commission (SEC) recently increased regulatory focus on SPAC issuers, making two recent pronouncements that highlight the risks arising from SPAC investments. In the first, the SEC warned SPAC sponsors to ensure accuracy in representations to investors, and to ensure that the financial projections provided in proxy materials were based on true and complete information. In the second, the SEC issued accounting guidelines for SPAC warrants that caused several blank cheque companies to restate past financial results. The increased scrutiny by the SEC on SPAC activity may further heighten litigation risks for SPAC investors.
It is important that investors understand the risks and learn to identify red flags when evaluating SPAC investment opportunities. For example, investors should conduct due diligence regarding SPAC sponsors to ensure they are sufficiently experienced and qualified. In addition, investors should evaluate the sufficiency of disclosures in investment materials, especially regarding potential conflicts of interest.
Investors should also be wary of SPACs that complete their initial business combination soon after an IPO, which may indicate insufficient due diligence was conducted, or near the deadline, which may indicate a rush to complete a deal within the allotted time.
If an investor has concerns regarding a SPAC investment, the most important action to take is retaining counsel with specific expertise in SPAC litigation. It is important that the chosen counsel has experience and a track record in dealing with SPAC issues. For example, Robbins Geller Rudman & Dowd maintains a SPAC task force of experienced litigators, investigators and forensic accountants dedicated to serving injured investors in blank cheque companies.
Brian Cochran is a partner at Robbins Geller Rudman & Dowd. He can be contacted on +1 619 231 1058 or by email at bcochran@rgrdlaw.com
