SPACs are booming ‘at the expense of retail investors’, and regulators should take these 5 steps to fix the market, think tanks say

SPACs and hedge funds 4x3
  • In February, two financial reform think tanks sent a letter to Congress detailing concerns over the SPAC boom.
  • The letter said the soaring market is “fueled by conflicts of interest and compensation to corporate insiders at the expense of retail investors.”
  • It offered five recommendations for Congress and financial regulators “to better protect retail investors.”
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As SPAC mania continues in 2021, drawing big name investors and pop culture icons, there are some who believe retail investors trying to cash in on the craze are getting a raw deal.

In February, Americans for Financial Reform and the Consumer Federation of America sent a letter to the House Financial Services Committee detailing concerns over the boom among special purpose acquisition companies.

The letter, addressed to Chairwoman Maxine Waters, said that the boom in SPACs is “fueled by conflicts of interest and compensation to corporate insiders at the expense of retail investors.”

It also suggested an attempt by sponsors and their targets “to end-run longstanding rules designed to promote fair and efficient markets.” 

SPACs have been around for decades, yet they have rocketed to prominence last year and in 2021, touted as a faster and cheaper alternative for companies to go public compared to the traditional IPO. 

In the first two months of 2021 alone, 175 SPACs have gone public according to data compiled by Goldman Sachs – roughly five deals per trading day. If that pace continues, the investment bank estimates that this year’s offerings will exceed the total number of SPACS in 2020 by the end of March.

The letter, authored by Andrew Park of Americans for Financial Reform and Renee M. Jones of Boston College Law School, says SPACs should be reigned in.

The organizations offer five recommendations for Congress and financial regulators “to better protect retail investors.”

1. Modernize the definition of “blank check company”

Congress should look again at legislation that allowed the SEC to regulate blank-check firms, and the term should not be limited to companies that issue “penny stock” offerings. “Blank check companies,” using larger vehicles, can now evade the restrictions Congress adopted to protect investors from “misleading information, conflicts of interest, and fraud.” 

“Making an investment vehicle larger and attracting larger investments does not cure the problems inherent in marketing, selling, and trading in blank check stock,” the letter states. 

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2. Tamp down pre-merger hype 

SPAC sponsors, target companies, and advisors are protected from liability for overly optimistic projections. That is in contrast to traditional IPOs where unfounded financial projections are restricted. Closing this loophole will level the playing field, the letter said, especially since SPAC sponsors “often boldly claim to investors they will be able to generate billions in revenue in the near future.”

3. Ensure appropriate underwriter liability

The liability should also extend to underwriters and financial advisors during the merger phase. As SPAC underwriters receive more than half of their underwriting fees at the completion of the merger, the letter suggested that the underwriters should be the same for the entire SPAC offering.

Financial advisors should also be deemed underwriters, the letter said. These changes will level the playing field between SPACs and traditional IPOs.

4. Enhanced disclosures at SPAC offering and merger stages.

SPAC merger disclosures should explicitly include the amount of cash expected to be held by the SPAC immediately prior to the merger, the letter said. This includes side payments, agreements to pay sponsors, SPAC investors, and PIPE investors.

The letter that this information often has to be pieced together from various documents.

5. Study the risks and results of SPAC mania 

The letter recommends the Securities and Exchange Commission collect data on SPACs and to produce a report evaluating average performance. The agency should also investigate  the categories of investors that “typically bear the brunt of SPACs’ post-merger losses.”

The letter said many of these investors are retail investors who “are often drawn to SPAC investments by the publicity and hype” and “are likely unaware of the complexity of fee arrangements or the expected dilution that will eventually erode the value of their investments.” The letter suggested apps such as Robinhood played a part in all this hype.

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