Attack On The SPAC: Biglaw Fights Back
Professor William Birdthistle analyzes the new SPAC litigation—and the letter from almost 60 Biglaw firms coming to the defense of the controversial companies.
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Last month, in a remarkable show of Biglaw solidarity, some 58 law firms signed a letter criticizing new litigation. What precipitated this banding together of Biglaw? A trio of lawsuits filed against blank-check or special-purpose acquisition companies (“SPACs”), the hottest thing in the world of M&A right now.
As readers of this newsletter know, the SPAC—an investment vehicle in which the SPAC sponsor raises money by taking a blank-check company public, then merges that company with a private operating company—has transformed the world of dealmaking in the past two years. Since the start of 2020, almost 700 SPACs have raised more than $200 billion in funds, with celebrities and professional athletes like Shaquille O’Neal and Serena Williams getting into the game of sponsoring SPACs.
The lawsuits filed last month allege that the three defendant SPACs, which park their money in short-term investments like Treasury bills while they look for merger targets, are investment funds—and should be regulated as such. This theory, if accepted, would completely upend the world of SPACs in its current form—and jeopardize the nine to ten figures in legal fees associated with SPAC work.1 So it’s not surprising to see how dozens of law firms came together in just a few days to take a stand against this litigation.
And one can see why the firms might be worried. The anti-SPAC litigation is the brainchild of two prominent professors in corporate and securities law: Robert J. Jackson Jr. of NYU, a former Commissioner of the SEC, and John D. Morley of Yale, an expert in the law of investment funds. The high-powered firms filing the suits include Susman Godfrey, one of the nation’s most fearsome litigation shops, and Bernstein Litowitz, a leading plaintiff-side securities firm.
The first of the three lawsuits, Assad v. Pershing Square Tontine Holdings, Ltd., has already borne fruit—less than 72 hours after it was filed.2 Hedge-fund billionaire William Ackman, who launched Pershing Square Tontine Holdings—at $4 billion, the largest SPAC ever—announced that he will not move forward with his SPAC in its current form. He cited the uncertainty generated by the litigation and explained that “the nature of the suit and our legal system make it unlikely that it can be resolved in the short term.”
Bill Ackman referred to the lawsuit against his SPAC as “meritless,” and the letter from the law firms similarly declared that “the assertion that SPACs are investment companies [is] without factual or legal basis.” But can the theory behind this litigation be dismissed so easily? Might the days of SPACs—and all the legal fees that they generate—be numbered?
I reached out to an expert in corporate and securities law—Professor William A. Birdthistle of Chicago-Kent College of Law, author of Empire of the Fund: The Way We Save Now—to get his thoughts. Here’s a (lightly edited and condensed) write-up of our conversation.
DL: What is this lawsuit about, in a nutshell?
WAB: The lawsuit alleges that Pershing Square Tontine Holdings (“PSTH”), the SPAC of billionaire Bill Ackman, is operating in violation of the Investment Company Act of 1940 (“ICA,” “’40 Act,” or “Act”). The professors behind the lawsuit are basically saying that PSTH is a fund under the ICA and failed to register as required by the Act.
DL: So why can’t PSTH just register?
WAB: There are two possible constraints. First, imagine if someone accused you of the unauthorized practice of medicine. You can’t just say, “Well, I’ll become a licensed doctor!” It’s not that easy.
If a fund falls under the ’40 Act, it has to order its business in a ton of other ways to comply besides just registering. For example, the Act regulates the process by which a fund compensates its advisers. It has rules restricting transactions between the fund and affiliated advisers. It has requirements about board composition and a fund’s portfolio.
The existing business model of SPACs is incompatible with the Act. There’s no way the SPAC industry, at least as it currently operates, can comply.
Second, even if a SPAC were to change its operations to comply with the ’40 Act going forward, it might still be liable for the period during which it operated problematically.
DL: If the theory of this lawsuit might apply to the entire industry, why did the professors target Ackman’s SPAC?
Besides being the largest SPAC ever created, Ackman’s SPAC had some vulnerabilities that not all SPACs have. First, Ackman wanted 30 months to enter into a transaction, which is longer than the typical 24 months. Second, one proposed investment for his SPAC was buying a minority interest in Universal Music Group. The primary argument that SPACs use to defend against claims that they fall under the ’40 Act is that investing isn’t their business; instead, their business is to find an operating company to buy, and then that will be their business. But buying a minority position in a public company that you don’t propose to take over looks a lot like … investing.
DL: What do you think of this lawsuit on the merits? Should SPACs be regulated under the ’40 Act?
WAB: As I recently explained in a piece for the Columbia Law School Blue Sky Blog, my personal view is that the plaintiffs’ argument is quite persuasive. Let’s look at the letter from the law firms defending SPACs (emphasis added):
The undersigned law firms view the assertion that SPACs are investment companies as without factual or legal basis and believe that a SPAC is not an investment company under the 1940 Act if it (i) follows its stated business plan of seeking to identify and engage in a business combination with one or more operating companies within a specified period of time and (ii) holds short-term treasuries and qualifying money market funds in its trust account pending completion of its initial business combination.
First, how long is “a specified period of time”? The language is so open-ended that it would create a simple—and silly—way to evade the entire ’40 Act.
They’re basically arguing that SPACs have a “grace period” for complying with the Act—say, the 24 months that many SPACs give themselves to close a deal. But where does this grace period come from? The signatories cite no cases, SEC guidance, or other authority, just “the plain statutory text.” But the statute does not say anything about future business plans; on the contrary, the “is” in the ‘40 Act refers to the present tense.3 And the only regulatory guidance says that “transient” investment companies cannot exceed 12 months.
Second, the letter seems to suggest that safe investments—“short-term treasuries and qualifying money market funds”—are sufficiently conservative to obviate the need for registration. If that’s true, then why do money-market funds and other mutual funds that hold treasuries or other conservative securities need to register?
DL: Speaking of the letter, what do you make of it—and the fact that it was signed by so many top law firms?
This kind of unity from the law firms may have much to do with the huge amount of money at stake. The firms would like to suggest they’re taking a principled stand—but these fifty-something firms aren’t standing up for the Republic or for civil rights. This isn’t a unified stand for George Floyd or against the attack on the Capitol. The letter is hardly a statement of what’s in the national interest. It’s within bounds to wonder how much these firms collectively billed on SPAC transactions in the last 18 months.
One thing worth noting: with a handful of exceptions, the signatories are mainly M&A firms, as opposed to firms that focus more on ’40 Act work, or firms where ’40 Act work is just as important or more important than M&A work. If you’re a firm that does a lot of ’40 Act work, you have mutual-fund clients that have been paying you millions of dollars a year to help them comply with the ’40 Act. That work exists in good times and in bad; it’s less cyclical than M&A work. Would you sign a letter suggesting that the requirements of the ’40 Act could be avoided so easily? Then why should mutual funds continue to pay you to help with expensive compliance?
DL: Is there anything SPACs can do to avoid falling under the ’40 Act?
WAB: If you’re a SPAC, one simple change would be to hold all your money in cash. You don’t trigger the ’40 Act if you hold nothing but cash. If you park your money in treasuries and money-market mutual funds, as most SPACs do, then you’re investing in securities. (Of course, holding everything in cash means losing out on some upside, which could hurt your return on investment or ROI, though not much in our environment of low interest rates.)
After this lawsuit was filed, Ackman came back with an interesting idea: something he called a special-purpose acquisition rights company, or “SPARC.” Instead of taking people’s money upfront, he proposes to give investors the ability to buy into the deal the SPARC proposed. But this seems very hard to administer. First, the novel idea would require SEC approval, which is far from certain. Second, the mechanics of assembling funds in this way have never been done before, so nobody—including the SEC—can be quite certain how it will unfold.
Those disenchanted with the litigation cloud over SPACs might be better off sticking to the traditional model of hedge funds and private-equity funds, which avoid the ’40 Act by having only investors who are few in number or all sufficiently sophisticated. They get commitments from investors like sovereign wealth funds and major universities, and when they need to tap into that money, the investors send the money immediately.
DL: Has the SEC itself said anything about whether SPACs are governed by the ’40 Act?
WAB: No, not yet. So this is why the law firms, in their letter, claim that “more than 1,000 SPAC IPOs have been reviewed by the staff of the SEC over two decades and have not been deemed to be subject to the 1940 Act.”
But this isn’t quite right. The SEC hasn’t said anything, either way, on the question whether the ’40 Act applies to SPACs. When the SEC accepts your registration statement for an IPO, it’s simply acknowledging that you filled out the required forms, that you complied with the IPO process; it’s not an endorsement of the business model or the accuracy of the information in those forms.
SPACs have been around for almost two decades, but they’ve only really mattered in the past 18 months. So it’s understandable that the SEC hasn’t yet focused serious resources on them. And it’s not unprecedented for the SEC to take its time investigating something before taking action.
For example, take initial coin offerings (ICOs). They were booming off the charts for a while. But after the SEC suggested some ICOs might involve securities—and thus require registration—the appeal of ICOs really waned.
Or consider spin-offs. About fifty years ago, spin-off transactions were very popular, and companies were doing them without registering them under the securities laws. For a while the SEC didn’t do anything, but eventually it took action and brought a case, SEC v. Datronics Engineers, which it won.
That really killed the cottage industry of these backdoor-IPO spinoffs. You could imagine something similar happening with SPACs.
DL: Whether it’s by claiming they fall under the ’40 Act or taking some other action, do you expect the SEC to regulate SPACs more heavily, given how popular they’ve become?
WAB: It’s hard to know from reading the tea leaves. But there are two things that make me think the SEC could take some action.
First, we have a new administration, a Democratic administration. In general, Republican administrations like to lower barriers to investment, while Democratic administrations tend to be more concerned about investor protection. I could see the Biden Administration contemplating action here.
Second, John Coates, the Harvard law professor now serving as general counsel to the SEC and a leading ’40 Act expert, issued a statement back in April in which he raised concerns about investor protection in the SPAC context. And then in May, SEC chair Gary Gensler gave testimony to Congress in which he also identified issues relating to SPACs and said he has asked the SEC staff to look into them more closely. Two top SEC officials expressing some skepticism or concern about SPACs suggests that the Commission might do something, in addition to the enforcement action it brought in July against one SPAC.
DL: That sounds to me like… more work for lawyers, which means that SPACs really are the gift that keeps on giving to Biglaw. And I feel I understand them so much better after this conversation. Thanks for taking the time to share your insights, William!
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A SPAC IPO can cost $200,000 to $400,000 in legal fees, and the so-called “de-SPAC” transaction, in which the publicly traded SPAC merges with the privately held operating company, can cost three to five times as much, as reported by Jack Newsham of Business Insider. According to SPACInsider, in 2020 and 2021 to date there have been 669 SPAC IPOs, which have collectively generated more than $206 billion in proceeds. Assuming an average of $1 million in legal fees per SPAC—from the IPO, the de-SPAC deal, and other events in the SPAC life cycle—that’s almost $700 million in legal fees.