House Democrats displayed an eagerness to impose stricter regulation on Special Purpose Acquisition Companies during a financial services subcommittee hearing Monday, arguing that their explosion in popularity in recent years is due to the perception that going public via SPAC is less burdensome.
SPACs raise cash through an initial public offering that typically prices shares at $10, after which the shell company has two years to use the raised funds to purchase a private company, thereby making that company public. Though the process has surged in popularity over the past three years, SPAC companies
since late March have returned negative 8.4%, versus a 6.3% rise for the S&P 500 index
Rep. Maxine Waters, the California Democrat who heads the House Financial Services Committee, pointed to studies that show that sponsors of SPACs and valued investment partners like hedge funds often earn risk-free returns through discounted shares and warrants. These investors often sell shares in the runup to the “de-SPAC” event, when the private company is officially acquired by the SPAC and taken public, earning the difference between the price of discounted shares and their market value, while maintaining warrants that could earn further profits.
Retail investors, meanwhile, suffer as the median price of a company that has gone public via spac typically falls 6% after the target company is announced, according to a Reuters analysis.
“Why is it that once again, it appears that Wall Street and hedge funds are profiting, while retail investors are left bearing the costs?” Waters asked during a hearing of her panel’s subcommittee on investor protection, entrepreneurship and capital markets. The California lawmaker’s characterization of SPACS has been vindicated since the asset class began to seriously underperform the S&P 500
since March, according to a Bloomberg analysis.
Rep. Brad Sherman, a California Democrat, expressed concern that the popularity of SPACS could be related to pricing practices of investment banks that typically market IPOs to institutional investors and manage the allocation of shares to those investors.
“Do we have in effect a system of bribery, where an underwriter can go to someone with fiduciary duty — the CFO of a large corporation, the trustee of a large charitable foundation — and give them for their own account a chance to buy a $30 stock for $20 and then go back a month later and go back and do business not with the individual whom they enriched, but with the business they control?” he said.
Many of the expert witnesses on the panel at Monday’s hearing called attention to the perceived regulatory benefits of going public via SPAC rather than through a traditional IPO. Andrew Park, senior policy analyst at Americans for Financial Reform, noted that SPACs have raised more than $100 billion so far in 2021, nearly 10 times the total seen in 2018.
“This fast growth appears to be driven in part by private companies to exploit the perceived speed, streamlined liaility, reduced liability and reduced shareholder rights that are offered by the SPAC process,” Park said.
Last month, the Securities and Exchange Commission poured cold water on the idea that SPACs provide liability protection for providing misleading claims about a company’s future performance. John Coates, acting director of the SEC’s corporate-finance division, questioned whether federal security laws actually offer this protection.
Coates said in an April public statement that the law does not define what an initial public offering means and that courts may very well interpret it such that a company that goes through a SPAC transaction is resposible to follow all the rules related to a traditional IPO.
“All involved in promoting, advising, processing and investing in SPACs should understand the limits on any alleged liability difference between SPACs and conventional IPOs,” Coates warned. “Simply put, any such asserted difference seems uncertain at best.”
Scott Kupor, managing partner at the venture capital firm Andreessen Horowitz, and the sole Republican-invited member of the panel, even agreed that Congress or the SEC should seek to harmonize rules for different methods of going public.
“The most important thing is that we should have a level playing field, whatever this body determines, it should not be the case that there are diffrent regulatory regimes for traditional IPOs relative to SPACS.”
Republican lawmakers were determined to portray the SPAC boom as a reaction to the overly burdensome regulations related to the traditional IPO. Rep. Tom Emmer, Republican of Minnesota, said that it costs a company on average “$2.5 million for a company to achieve initial regulatory compliance for going public and an additional $1.5 million annually thereafter,” he said. “These business are turning to more streamlined approaches to access to capital, like SPACs, direct listing or even staying private.”
Indeed, there are only about 4,700 public U.S. companies extant today, down from roughly 8,500 in 1997, though its not clear that growing regulatory burdens, rather than the growing buying power of private investors or the declining need for expensive physical capital in a tech-dominated company, is the primary driver of this trend.