I. Introduction
In August 2021, Mr. George Assad – an alleged stockholder in each defendant SPAC – filed novel claims against three separate Special Purpose Acquisition Companies (SPACs), including Mr. Bill Ackman’s Pershing Square Tontine Holdings, Ltd. (“PSTH”).[1] The complaint alleges that the defendant SPACs are “investment companies” under the Investment Company Act of 1940 (ICA) and, consequently, because the SPACs did not register with the Securities and Exchange Commission (SEC), therefore the Initial Public Offerings (IPOs) for each were illegal and should be voided.[2] These ICA lawsuits have received a large amount of media attention, in part because of their potential to disrupt the SPAC industry, but also because Mr. Robert Jackson Jr., an NYU Law Professor and former SEC commissioner, and Mr. John Morley, a Yale Law Professor, are representing Mr. Assad.
In what has already been a roller-coaster year for SPACs, this series of newly filed ICA lawsuits have the potential to upend the SPAC industry. The increase in SPAC litigation has already had a “very chilling effect on all responsible capital markets, participants who are trying their best to do things in compliance with the securities laws,” said Doug Ellenoff, a corporate and securities partner at Ellenoff Grossman & Schole LLP.[3] The legal uncertainties stemming from these lawsuits have left some investors and target companies hesitant to proceed with SPAC acquisitions. For example, we have seen a sharp decline in SPAC issuances in the second quarter of 2021.[4] “If there is now a compelling new theory for why SPACS are violating federal law, that could be their death knell,” said William A. Birdthistle, a Chicago-Kent College of Law professor.[5] Consequently, this decline has raised important questions about investor trust in the SPAC framework and the longevity of the SPAC market.
In a series of lawsuits that will likely determine the future of SPACs, one thing we can be certain about is that the defendant SPACs won’t go down without a fight. In a letter to the court, defendant PSTH asserted that the “claims are without merit and contradict decades of SEC-approved practices, and we intend to defend against them vigorously.”[6] Additionally, Mr. Ackman himself stated that the lawsuits are “meritless.”[7] Harmonious with this view, and an encouraging sign for the SPAC market, over 60 of the nation’s leading law firms have issued a Joint Statement in defense of SPACs.[8] The statement concludes that the claims are “without factual or legal basis.”[9] Ultimately, I believe in the longevity of the SPAC framework. I believe that once the legal uncertainties surrounding these ICA lawsuits are resolved, and confidence in SPACs is restored, SPAC issuances will undergo a substantial revival.
II. SPACs and the Investment Company Act of 1940
A SPAC is a publicly listed blank check company that – after raising funds from investors – seeks to acquire privately-held target companies for an IPO.[10] The process of merging with the target company and taking the company public is referred to within the SPAC industry as a “de-SPAC transaction.”[11] After fundraising has commenced, typically the SPAC has two years to identify a target company and begin the acquisition process.[12] If the SPAC completes the acquisition, its investors will be offered the opportunity to either redeem their investment or own stock in the merged company.[13] However, if the SPAC fails to complete the acquisition within two years, the de-SPAC will be undone, and the shareholders’ initial investments will be returned.[14] Importantly, while the SPAC attempts to locate a target company, the IPO proceeds are held in a trust account, which is typically either held as cash or invested in short-term U.S. government securities.[15] Holding the proceeds in cash or invested in short-term U.S. government securities allows SPACs to fall within well-established exceptions to the ICA.
The ICA defines “investment company” as any issuer which “is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities.”[16] However, to “make investments and sell stock without restrictions before merging with a company,” SPACs rely on exceptions from registering as investment companies provided in the ICA.[17] Specifically, SPACs have frequently relied upon 15 U.S.C. §§ 80a-3(a)(1)(C) and 3(b)(2).[18] Section 3(a)(1)(C) defines an investment company to include any issuer which is “engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40 per centum of the value of such issuer’s total assets (exclusive of Government securities and cash items).”[19] This provides an alternative definition of an investment company that explicitly excludes government securities and cash items.[20] SPACs have also relied on 3(b)(2), which provides that if the SEC finds that an applicant (here, a SPAC) is “primarily engaged in a business or businesses other than investing, reinvesting, owning, holding, or trading in securities,” the applicant may obtain an order declaring it not to be an investment company.[21] Here, if the defendant SPACs can establish that their business models are not predicated on investing in securities, but rather on identifying target companies and completing business mergers, then they have a strong argument that they fall within the 3(b)(2) exception.[22]
III. Analysis
In each of the three ICA lawsuits, the complaints allege that the SPAC had invested only in short-term U.S. government securities or money market funds securities for over a year and therefore had been operating illegally by not registering as an investment company. Specifically, the PSTH complaint asserts:
PSTH is an investment company under the ICA because its primary business is to invest in securities. Since the Company’s initial public offering more than a year ago, investing in securities is all the Company has ever done. From the moment of its IPO, PSTH has invested all of its assets in securities of the United States government and shares of money market mutual funds. PSTH and its advisers have spent most of their time working for PSTH negotiating a purchase of still more securities in a recently-abandoned agreement [referencing PSTH’s attempted investment in Universal Media Group].[23]
Consequently, these allegations have upended investor confidence in the longevity of SPACs and have led to a massive decline in SPAC issuances since the first quarter of 2021.
The longevity of the SPAC market – as it currently exists[24] – depends on whether confidence in the SPAC framework can be restored; confidence lost in large part due to the increase in SPAC litigation. Mr. Ackman said the ICA lawsuits have amplified legal uncertainty in the SPAC market, could deter potential merger partners from entering deals with PSTH, and may weigh on other SPACs.[25] Adding to the uncertainty, CNBC, citing two unnamed sources, reported that the plaintiff’s lawyers “may file as many as 50 lawsuits against SPACs in the coming months.”[26] In 2021 alone, the increase in SPAC lawsuits has had a significant impact on the SPAC market. In the first quarter, we saw a record number of SPAC issuances, with more than 100 new issuances in March 2021.[27] Since March, SPAC issuances have come to a near standstill – dropping nearly 90% in the second quarter.[28] There is hope, however, for a resurgence in SPAC issuances as many law firms agree that there are strong defenses available to the defendant SPACs.
On August 30, 2021, over 60 of the nation’s leading law firms signed a joint statement arguing that SPACs do not constitute investment companies under the ICA. The statement provides that:
[C]onsistent with longstanding interpretations of the 1940 Act, and its plain statutory text, any company that temporarily holds short-term treasuries and qualifying money market funds while engaging in its primary business of seeking a business combination with one or more operating companies is not an investment company under the 1940 Act.[29]
The joint statement goes on to argue that, in the firms’ view:
[T]he 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.[30]
Given the convincing defenses available to the defendants, and the overwhelming backing of many law firms, I believe that a decision in favor of the defendant SPACs is the likely outcome of these ICA cases. Furthermore, I believe that a holding in favor in the SPAC defendants will reignite confidence in the SPAC framework and, contingent upon possible further SEC regulations,[31] and we should see a significant revival of SPAC issuances.
[1] See generally Assad v. Pershing Square Tontine Holdings, No. 21-cv-06907 (S.D.N.Y. Aug. 17, 2021); Assad v. E.Merge Tech. Acquisition Corp., No. 21-cv-07072 (S.D.N.Y. Aug. 20, 2021; Assad v. GO Acquisition Corp., No. 21-cv-7076 (S.D.N.Y. Aug. 20, 2021).
[2] Complaint at 4, Assad v. Pershing Square Tontine Holdings, No. 21-cv-06907 (S.D.N.Y. Aug. 17, 2021), ECF No. 1.
[3] Svea Herbst-Bayliss et al., EXCLUSIVE Lawyers behind Ackman’s retreat may target more SPACs, Reuters (Aug. 26, 2021, 4:40 PM), https://www.reuters.com/business/finance/exclusive-lawyers-behind-ackmans-retreat-target-dozens-more-spacs-2021-08-26/.
[4] See discussion infra Part III.
[5] New SPACs Lawsuit Could be “Death Knell” for the Industry and Chill New Activity, Investment Funds Legal Expert Says, Chicago-Kent Coll. of Law (Aug. 17, 2021), https://www.kentlaw.iit.edu/news/2021/new-spacs-lawsuit-could-be-death-knell-for-the-industry-birdthistle-says.
[6] Letter to Court for Pershing Square Tontine Holdings, as Defendant at 2, Assad v. Pershing Square Tontine Holdings, No. 21-cv-06907 (S.D.N.Y. Aug. 17, 2021), ECF No. 29.
[7] Svea Herbst-Bayliss, Ackman seeks SPAC relaunch to fix lawsuit’s ‘harm’, Reuters (Aug. 19, 2021, 11:08 PM), https://www.reuters.com/business/ackman-seeks-spac-relaunch-fix-lawsuits-harm-2021-08-20/.
[8] Over 60 of the Nation’s Leading Law Firms Respond to Investment Company Act Lawsuits Targeting the SPAC Industry, Skadden, Arps, Slate, Meagher, & Flom LLP and Affiliates (Sept. 3, 2021), https://www.skadden.com/en/insights/publications/2021/08/the-nations-leading-law-firms-respond.
[9] Id.
[10] What is a SPAC?, CB Insights (July 14, 2021), https://www.cbinsights.com/research/report/what-is-a-spac/.
[11] Id.
[12] Id.
[13] Id.
[14] Id.
[15] Ramey Layne and Brenda Lenahan, Special Purpose Acquisition Companies: An Introduction, Harv. Law Sch. F. on Corp. Governance, https://corpgov.law.harvard.edu/2018/07/06/special-purpose-acquisition-companies-an-introduction/#2b.
[16] 15 U.S.C. § 80a-3(a)(1) (emphasis added).
[17] See Herbst-Bayliss, supra note 3.
[18] New lawsuits alleging that SPACs are unregistered investment companies face significant hurdles, Paul, Weiss, Rifkind, Wharton & Garrison LLP (Aug. 30, 2021), https://www.paulweiss.com/practices/litigation/securities-litigation/publications/new-lawsuits-alleging-that-spacs-are-unregistered-investment-companies-face-significant-hurdles?id=40857.
[19] 15 U.S.C. § 80a-3(a)(1)(C) (emphasis added).
[20] See id.
[21] 15 U.S.C. § 80a-3(b)(2) (emphasis added).
[22] See id.
[23] See Complaint, supra note 2.
[24] Mr. Ackman announced that he was working to create an updated SPAC structure – called a Special Purpose Acquisition Rights Company (“SPARC”) – which, unlike a SPAC, would give shareholders the right to invest in a merger once the target had been announced. However, this new framework would need to be approved by the SEC.
[25] See Herbst-Bayliss, supra note 7.
[26] Lawyers suing Bill Ackman’s SPAC plan up to 50 more lawsuits against blank-check firms, sources say, CNBC (Aug. 26, 2021, 1:49 PM), https://www.cnbc.com/2021/08/26/lawyers-suing-bill-ackmans-spac-plan-up-to-50-more-lawsuits-against-blank-check-firms-sources-say.html.
[27] Yun Li, SPAC transactions come to a halt amid SEC crackdown, cooling retail investor interest, CNBC (April 21, 2021, 6:27 AM), https://www.cnbc.com/2021/04/21/spac-transactions-come-to-a-halt-amid-sec-crackdown-cooling-retail-investor-interest.html.
[28] Yun Li, SPEC lawsuits jump in another sign of suspect deal-making for the once red-hot space, CNBC (Aug. 9, 2021, 6:11 AM), https://www.cnbc.com/2021/08/09/spac-lawsuits-jump-in-another-sign-of-suspect-dealmaking-for-the-once-red-hot-space.html.
[29] Over 60 of the Nation’s Leading Law Firms Respond to Investment Company Act Lawsuits Targeting the SPAC Industry, supra note 8 (emphasis added).
[30] Id.
[31] Nicola M. White, SEC leans on SPACs for detailed disclosures of risk, controls, Bloomberg (Oct. 13, 2021, 4:45 AM), https://www.bloomberglaw.com/bloomberglawnews/.
