The SEC has cracked down on one of retail investors’ new favorite buys on Wall Street — SPACs — and the impact has been quick.
New data from SPACInsider shows there have been just 10 SPAC IPOs in the month of April, down sharply from the breakneck pace seen at the beginning of 2021.
SPACs set a new record in the first three months of the year, raising nearly $88 billion dollars with 109 IPOs in March, 97 in February, and 89 in January. That beat out all of 2020, when SPACs raised a total of $83.4 billion for the year.
The SEC seemed to take note of that increase at the end of March, launching an investigation into the frenzy of SPACs and how banks were managing the risks. Later in March the Commission also issued a reminder on the restrictions which apply to those companies.
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What Is a SPAC?
In case you haven’t dipped your toes into these types of trades just yet, an explainer on SPACs might be necessary…
SPAC stands for special-purpose acquisition companies. The SEC defines SPACs as “blank check” companies.
The purpose of those shell companies is to raise capital through their own IPO and then later merge with or acquire another company to take them public without having to do their own IPO.
Investors buy into the SPAC — which has no way of making any money on its own — on a promise it will merge with a private company that does make money.
Some of the biggest SPAC deals of 2020 included DraftKings (DKNG), Virgin Galactic (SPCE) and Nikola Motors (NKLA). All of those companies went public by merging with an already public shell company and avoided the volatility of holding their own IPO.
Why Have SPACs Become So Popular?
SPACs became the target of retail traders in 2020 and early 2021 as the listings saw a boom amid increased market volatility during the pandemic.
Many companies faced the choice of canceling their IPOs last year in fear that extreme volatility might ruin their debut on Wall Street. While some chose to still go ahead with the traditional listing strategy, others turned to SPAC mergers.
Going the SPAC route gives a company a much faster influx of cash than the months-long capital-raising process of an IPO. Going public through a traditional IPO takes about six to nine months on average, while a SPAC merger can take a company public in just about three months.
Retail traders ramped up their interest in SPACs early this year, seeing an opportunity to make some quick money.
As shell companies prepare to merge with or acquire another company, rumors swirl about what the deal will be. If it’s a company with lots of hype, the SPAC stock usually soars. The old “buy the rumor, sell the news” rule seems to apply often to these deals.
Reuters reported in March on data from Dealogic that found 25 SPACs saw shares rise more than 10% in their trading debut — even with no merger deal in sight — compared to just seven SPACs which saw the same surge in 2020.
SEC Destroys the Boom
On April 12, the SEC issued new accounting guidance for SPACs which suggests warrants should be listed as liabilities not equity investments.
SPAC warrants are issued through the IPO alongside shares as a way to entice investors to buy more shares in the future following a merger with or acquisition of a private company.
It’s unclear if that guidance will become law but SEC staff have put new SPAC approvals on hold until they know. If it does become law, companies would have to value warrants every quarter versus just at the start of a SPAC. And it wouldn’t just impact upcoming listings, existing SPACs would have to go back and restate their financials as well.
SPACs have relied on the safe-harbor provision in the Private Securities Litigation Reform Act to protect them from liability for statements they make about a future merger deal while raising capital. But the SEC has said that protection might not apply.
In a statement on April 8, John Coates, the SEC’s acting director of corporate finance, said, “Any simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst… The safe harbor only applies in private litigation, and does not prevent the Commission from taking appropriate action to enforce the federal securities laws”.
What Does This Mean for Traders?
The big question here: How does this regulatory crackdown impact your trades?
Most simply, there will be fewer SPACs to buy in the near term. It’s unclear at this point when new SPAC approvals might resume or when the SEC might make a decision on new laws regarding the liability of warrants.
The latest data shows retail investors might be rethinking the promise of SPACs. Bank of America said its client flows showed a sharp slowdown in retail SPAC buys in April. “Early data from April suggest that retail may be returning back to their ‘traditional’ roots, favoring more established companies over low-priced, speculative securities.”
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