Should SPACs Be Considered Investment Companies?

The rising popularity of special-purpose acquisition companies (SPACs) garnered the attention of both investors and regulators last year...

The rising popularity of special-purpose acquisition companies (SPACs) garnered the attention of both investors and regulators last year. As we begin the New Year, an emerging question is how SPACs should be regulated, with some making the argument that they should be treated akin to investment companies. Such a designation would be significant given that investment companies require heightened disclosures, and they are subject to greater regulation. 

Federal Suit Argues SPACs Akin to Investment Companies

A close-watched federal lawsuit against billionaire Bill Ackman’s SPAC alleges that it should be deemed an investment company under the Investment Company Act of 1940. Pershing Square Tontine Holdings, Ltd. (Pershing Square or PSTH) went public in July 2020 after selling 200 million units at $20 each. The SPAC raised a record $4 billion, the most ever for a SPAC, but has yet to complete an acquisition.

According to the investors’ lawsuit, SPACs that haven’t identified acquisition targets within one year of going public should be regulated under the Investment Company Act because their only real activity is holding investors’ money in Treasury or money-market accounts. “Under the ICA, an Investment Company is an entity whose primary business is investing in securities. And investing in securities is basically the only thing that PSTH has ever done. From the time of its formation, PSTH has invested all of its assets in securities,” the complaint states. “And it has spent nearly all of its time negotiating a transaction that would have invested those assets in still more securities.”

The plaintiffs’ attorneys include New York University law professor (and former Securities and Exchange Commissioner) Robert Jackson and Yale University law professor John Morley. “The Investment Company Act is really concerned about the transparency of an investment company’s compensation arrangements, the governance of the investment company, and the fairness and reasonability of compensation,” Morley stated to Law360. “For all those reasons, we think [this case] is a good fit.”

Not all of the Pershing Square investors agree. Another group of investors filed an amicus brief arguing that the Investment Company Act does not apply to SPACs. In support, they cite their own expectations, which courts must take into account when determining whether a company should be registered under the Investment Company Act. The shareholders note that their expectation when investing in the SPAC was not to earn profits from government securities while the SPAC looked for a target, but rather to capitalize on the gains realized from the ultimate acquisition.

SPACs Likely Not Investment Companies

While the court will have the final say, the investors raise a compelling argument that SPACs should not be treated like investment companies as they maintain in their brief, SPAC investors are certainly not looking at the investment that way – the funds raised by a SPAC in its IPO are usually invested in treasury bills (T-bills) or the like, to ensure the funds are there to make a contemplated — indeed promised — acquisition of some sort; not to buy interest or dividend-bearing securities, or to hold minority investments in public companies’ traded equities, which is what investment companies do.

An investment company typically invests in securities of other companies for the purpose of profiting by a rise in the value of the holdings. A SPAC puts the raised funds aside in non-risk securities that are held not for the purpose of investing for a rise in the value of other companies.  The SPAC, to fulfill its purpose and promise, and to ensure that all the funds raised will remain safely there, should not invest in minority positions in other companies.  This is because the raised funds are promised to be used to purchase another company that is an operating company with sufficient upside and market value on conclusion of the de-SPAC merger to provide increased value to SPAC investors by marrying the idle funds to the vibrant growth opportunity presented by the merged entity.  The idea is to quickly create a substantial increase over the SPAC’s IPO price by virtue of the synergy found in the de-SPAC process: simply put, 1+1= 3, or in some cases, = 5 or 10. That is one reason that SPACs have become hot commodities and, for a while, completely replaced IPOs.    

Key Takeaway

The legal landscape surrounding SPACs will continue to evolve in 2022. Given that the market will likely be shaped by both SPAC litigation and further regulation, we encourage businesses to closely monitor legal developments and work closely with experienced counsel to determine how you may be impacted.

If you have questions, please contact us

If you have questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.