A new analysis by Watchdog Research shows a spike in 2021 of SPACs breaking bad news in amended 10-K filings, rather than using 8-Ks and other traditional methods. According to the analysis, there is an unusual new trend of 10-K/As being used to disclose negative information for the first time, including going concern opinions, ineffective internal control disclosures, and financial restatements.
John Cheffers, the financial research company’s Director of Research, said in a blog post that this new and growing use of the 10-K/A is driven mainly by SPACs and may be a sign of incompetence, or may be a way of burying bad news to soften the impact on share price.
10-K/As not traditionally used to break bad news. First, as context, Cheffers notes that 10-K/As themselves are not rare. 10K/As are filed by about 10 percent of companies per year, so the mere filing of a 10-K/A is not in itself unusual.
But 10-K/As historically have not been used to make initial disclosures. Over the last 10 years, Watchdog’s analysis shows that 10-K/As account for less than 1 percent of initial disclosures overall. Most initial disclosures by far are made in 8-K filings, at a rate of 70 percent.
Regarding initial disclosure of negative information, in the nearly 6,000 10-K/As filed from 2011-2020:
- 3.6% of 10-K/As were used to reveal ineffective internal controls;
- 0.06% of 10-K/As were used to reveal a going concern opinion;
- Just 3 K/As were used to initially disclose a non-reliance restatement.
The biggest jump was in disclosure of ineffective internal controls. From 2011-2020, an average of 18.7 disclosures were made in 10-K/As on this topic. In 2021 to date, there have already been 80 initial disclosures in 10-K/As of internal control issues, of which 70 were SPACs.
The incidence of going concern opinions and financial statements being initially disclosed in 10-K/As also increased, though at a smaller rate.
Lordstown Motors. For example, Lordstown Motors, an electric car company that went public via SPAC, filed a 10-K/A on June 8, more than two months after it released its annual report on March 25th. The 10-K/A disclosed a going concern opinion, an ineffective internal control assessment by management, and two subpoenas from the SEC, which indicated that the SEC was conducting a formal investigation, not an informal inquiry.
Lordstown further disclosed that their restatement announced in May would include an additional charge of $23.5 million—which is perhaps what tipped it into the "going concern" warning range, said Cheffers.
Incompetence or burying bad news? Cheffers concluded that this disparity is another example of difference in companies that go public via SPAC rather than IPO, and may raise questions about the competence of the accounting, finance, and legal advisors to these companies and their auditors, who are also supposed to be act as a control on bad financial information.
As to the exact motivation for initially disclosing bad news in a 10-K/A rather than 8-K or other traditional method, Cheffers speculated it may be down to either incompetence or a sneaky attempt to soften the impact on share price. Cheffers noted that what the market does not see, the market does not react to.
Either way, whether the trend is due to incompetence or sneakiness, Cheffers said that "SPACs are in a hurry to make deals and are incentivized to overpay for acquisitions."
"The penchant for hiding bad news in a 10-K/A is a sign that many SPACs are not prepared to become a successful public company, and that their sponsors may have pushed them through a SPAC merger because the payout was too good to turn down," Cheffers wrote.