Markets

SPAC Lawsuits Jump in Another Sign of Suspect Deal-Making for the Once Red-Hot Space

Dustin Franz | Bloomberg | Getty Images

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SPACs are getting hit by a rising number of class-action lawsuits as more hyped-up deals turn out to be flops.

Shareholder lawsuits against post-merger special purpose acquisition companies rose to 15 through the first half of 2021, tripling from just five in all of 2020, according to data from Woodruff Sawyer. The jump came even as overall securities cases fell 13% this year, according to the data.

"That's a lot of litigations for one section of the capital markets in a short period of time," said Priya Huskins, partner at Woodruff Sawyer. "SPACs have been marketed as a way to go public faster and easier compared to a traditional IPO, but that might tend to attract companies that are perhaps not ready for public company scrutiny. It is certainly the case the plaintiffs are trying to prove."

These cases are so-called stock-drop litigations when negative announcements lead to a significant decline in share prices. Plaintiffs would argue that the stock price was inflated as the company had made material misstatements or omissions in their earlier public statements.

The SPACs that found themselves in legal battles this year include electric vehicle start-ups Lordstown Motors and Canoo as well as Chamath Palihapitiya-backed Clover Health, all of which are undergoing inquiries by the Securities and Exchange Commission. Churchill Capital Corp IV, Purecycle Technologies, XL Fleet and Quantumscape also got hit by class-action suits.

While many of these suits could be dismissed in court, some have resulted in punishing settlements. In April, music streaming company Akazoo S.A. settled two security lawsuits for an aggregate amount of $35 million and the stock was delisted from the Nasdaq.

Investors are trying to hold SPAC leaders accountable at a time when regulators are stepping up their oversight. The SEC has repeatedly warned investors of underlying risks in investing in corporate shells, while demanding better disclosures and tighter accounting rules from blank-check deals.

"The day of being cavalier is over," Huskins said. "One of the things we may see as a result of this pressure on diligence and disclosure is a cooling off of valuation. In a world where diligence is increasingly precise, it's harder to tolerate puffiness in the numbers."

Following a record first quarter, the SPAC market came to a screeching halt with issuance dropping nearly 90% in the second quarter as regulatory pressure mounted. SPACs raise capital in an initial public offering and use the cash to merge with a private company and take it public, usually within two years.

Share prices have come back down to earth as more signs of a bubble emerged. The proprietary CNBC SPAC Post Deal Index, which is comprised of the largest SPACs that have come to market and announced a target, wiped out its 2021 rally and tumbled nearly 25% on the year.

Last month, the SEC charged Stable Road Acquisition, space company Momentus and two executives for alleged misleading claims over their planned merger.

"I think people are going to wait to see how many more SPACs that they go after," said Kennedy Chinyamutangira, financial services senior analyst at RSM US LLP. "The market will likely to continue to be depressed through the rest of the year."

The SEC recently filed civil securities fraud charges against Nikola founder Trevor Milton, while a federal grand jury charged him with three counts of criminal fraud for allegedly lying about "nearly all aspects of the business." Nikola's shares have come all the way back to just $10.28 apiece, a few cents above its IPO price.

"Sometimes a target is trying to drive up the price to an unsustainable level, somehow not realizing that the market will correct and you don't want that correction to happen shortly after you went public," Huskins said.

— With assistance from Nate Rattner.

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