SEC vs. SPACs – The SEC is Keeping Up
The name “Special Purpose Acquisition Company” or “SPAC” has been around since the 1990s but only recently have these blank-check companies become popular enough to draw significant attention from investors and the Securities and Exchange Commission (“SEC”). (Holmes, Forbes). According to the SEC, a SPAC is a company with no operations that goes public for the sole purpose of acquiring a private company—effectively bringing the private company public. (Division of Corporate Finance Staff, SEC). SPACs offer an alternative to the traditional Initial Public Offering (“IPO”) route for taking a company public. (Frank Holmes, Forbes). While this alternative has its advantages, the SEC has begun taking action as it relates to SPACs and applicable disclosures.
The Nikola Saga
One of the most recent examples of the SEC’s regulatory crusade is a $125 million settlement with Nikola Corp., an electric truck maker. (Franck & Wayland, CNBC). Nikola went public in June of 2020 by merging with a SPAC company backed by former General Motors (“GM”) Vice Chairman, Steve Girsky. Id. By November of 2020, Nikola disclosed the company was under investigation. (Heller, CFO). The SEC investigated Nikola and its founder and former Chief Executive Officer (“CEO”), Trevor Milton, for alleged misrepresentations to investors regarding “products, technical capacity and business prospects.” (Franck & Wayland, CNBC). During the investigation, the SEC found evidence of severe misrepresentations, which confirmed reports that Milton had fraudulently falsified Nikola’s technological capabilities—namely, “the refueling capabilities of its hydrogen fuel cell trucks.” (Heller, CFO).
The SEC also found that Milton had inflated and maintained Nikola’s stock price through a public relations campaign before the company had made a single commercial product. (Franck & Wayland, CNBC). SEC Division of Enforcement Director, Gurbir Grewal, stated that Milton’s claims “falsely portrayed the true state of the company’s business and technology.” Id. As a result, investors based their investment decisions on representations of company milestones that had in fact not been reached. Id. The SEC is now holding Nikola responsible for the misleading claims made by Milton, who left the company in September of 2020 and later pleaded not guilty to separate Justice Department charges brought in July of 2021. (Franck & Wayland, CNBC).
While analysts see the settlement as a good thing for Nikola, allowing the company to move on from the investigation and from Milton, the investigation and resulting multi-million dollar penalty is just one hammer brought down by the SEC on SPACs. Id.
SPAC Accounting Methods and Risk Disclaimers
The Nikola settlement follows two enforcement actions still resonating with SPACs and their investors, including a July 2021 action against Stable Road Acquisition Corp. and an October 2021 action against Akazoo—or Modern Media Acquisition Corp. (Kobre, Bradley). In August of 2021, the SEC’s Investor Advisory Committee recommended that the agency “regulate SPACs more intensively by exercising enhanced focus and stricter enforcement of existing disclosure rules under the Securities Exchange Act of 1934.” (SEC Investor Advisory Committee, SEC). The SEC is also investigating a SPAC merger involving former President Donald Trump following pressure from Senator Elizabeth Warren. (Kobre, Bradley). The number of investigations and enforcement actions at the end of 2021 and the beginning of 2022 evidences the SEC’s dedication to protect investors and the market from misrepresentations by SPACs and those involved.
Beyond investigations and enforcement actions, the SEC has sent letters to SPACs warning against “broad disclaimers that long-standing SPAC accounting practice could change and lead to future errors.” (White, Bloomberg Law). While traditional SPAC accounting practices have been longstanding and (for the most part) unquestioned, such practices do not follow U.S. Generally Accepted Accounting Principles (“GAAP”). Id. Risk factors disclaimers regarding accounting method changes and their effects on reported revenues and valuations are often acceptable; however, disclaimers regarding potential mistakes are likely considered to “limit liability or pawn off some of the responsibility.” Id. These warnings against broad disclaimers have been coupled with SEC requirements for hundreds of SPACs to restate past financial statements due to errors regarding “key money-raising tools” and classification of “shares they offer to investors.” Id.
Accounting Risk Disclaimers, Nikola, and the Future of SPAC Regulation
The SEC’s warning letters against blanket accounting risk disclaimers raises serious concerns for SPAC financial reporting that is not in compliance with GAAP, and the Nikola settlement alerts SPACs to the consequences of misrepresentations and faulty public relations campaigns. SPACs are being flanked from every side, and SEC forces are closing in on any and all abuse they can find.
Though SPACs once offered a streamlined path to public company status, enhanced scrutiny from the SEC will likely cause them to become more laborious, more risky, and more expensive than a traditional IPO should penalties be levied. Closer monitoring of blanket disclosures will cause investors to become more skeptical of young SPAC companies without any track record, and SEC disclosure requirements will help bring to light how risky a SPAC investment can prove to be. One thing is certain: the SEC is keeping up with the speed of SPAC acquisitions, so SPACs and their targets will need to make sure i’s are dotted and t’s are crossed for any acquisition to pass muster.