Monday, May 02, 2022

SEC’s Investor Advocate pushes NYSE, Nasdaq for tougher SPAC listing standards

By John Filar Atwood

SEC Investor Advocate Rick Fleming has asked the NYSE and Nasdaq to join the Commission in enhancing protections surrounding special purpose acquisition companies (SPACs) by putting in place tougher listing standards for SPACs. Fleming expressed “significant reservations” about the current listing regime, and asked the exchanges to prohibit the consummation of a SPAC business combination when SPAC shareholders exercise their conversion rights for more than 50 percent of the shares.

In separate letters to the NYSE and Nasdaq, he indicated that the SEC’s Office of the Investor Advocate has been monitoring the experience of investors in exchange-listed SPACs in recent years, and is concerned about substantial rise in the occurrence of “empty voting.” This is a practice by which companies go public through a SPAC business combination even though the majority of the SPAC’s shareholders have, by redeeming their shares for cash, expressed a lack of faith in the future of the company.

Recent problem. Fleming noted that this did not used to be a problem because of the existence of listing standards specifically tailored to SPACs. These included the right to vote for the proposed business combination, the right of dissenters to convert their shares back to cash, and on the NYSE the requirement that the business combination could not go forward if more than 40 percent of shareholders converted their shares to cash. If enough shareholders voted against the deal, he noted, there was no way for SPAC sponsors to finalize a poorly-received business combination.

That all changed with allegations of abusive hedge fund practices in the shareholder voting process, he said. In looking for ways to remove the ability of hedge funds to take advantage of SPACs and their investors, exchanges decided to enhance investor conversion rights at the expense of voting rights, according to Fleming. They removed the 40-percent restriction in favor of registration statement risk disclosures, and made it possible for all SPAC shareholders to receive their money back.

High redemption rates. The result of those changes, Fleming said, was to open the floodgates for companies to go public even though the majority of SPAC IPO investors redeem their shares. He cited recent market reports that found that SPAC redemption rates have jumped to over 80 percent in recent months.

The percentage has risen so high, Fleming suggested, in part because investors in a SPAC IPO are usually given warrants in addition to common shares, and the warrants retain value only if the business combination is completed. As a result, investors have an incentive to vote in favor of a merger, because they retain their warrants, even if they believe it is a bad deal. Fleming added that some commenters believe this SPAC structure amounts to a “fatal flaw” because shareholders that vote for a proposed deal but still redeem their shares for cash have separated their vote from their economic interest.

50 percent threshold. Fleming asked the exchanges to change their listing standards to reinstate a conversion right threshold, although he would like to see it set at 50 percent rather than the previous 40 percent level. It would be better for all parties, including SPAC sponsors, investors, and the listing exchanges, if the SPAC business model were sustainable, he argued, and the exchanges are in a unique position to move the industry back to this more sustainable path quickly.

Fleming acknowledged the financial innovation behind exchange-listed SPACs and their potential to bring more private issuers into the public market, especially those that might not have been well served by a traditional IPO. However, he recommended listing standard changes due to his doubts about the current system that allows for empty voting and otherwise permits significant conflicts of interest.

Fleming expressed his view that the recommended action needs to be implemented by all exchanges that list SPACs. Otherwise, it would incentivize a “race to the bottom” among the exchanges, which was part of the NYSE’s justification for eliminating the conversion threshold in the first place, he concluded.