- The SEC has proposed new regulations on special-purpose acquisition companies.
- Hedge-fund managers say the rule changes won’t affect their outlook on the blank-check vehicles.
- The hedge funds say bored retail investors drove SPAC mania and the slowdown is a due correction.
- See more stories on Insider’s business page.
After a yearlong bout of SPAC mania, the red-hot market for blank-check companies is cooling down as regulators direct their attention to it.
March was a record-breaking month for special-purpose acquisition companies, with over 100 new deals, while April only saw 10 SPACs raised, the data provider SPAC Research found.
The Securities and Exchange Commission stoked fear in the SPAC market on April 12 when it issued new accounting guidance. The change, which would reclassify the warrants issued by SPACs as liabilities rather than equity, may force many current and future SPACs to restate their financials.
Early investors that back SPACS are given warrants, which give them the right to buy more shares of the company at a specified price in the future. The proposed rule change would increase the scrutiny and bureaucracy surrounding this key feature of SPACs, potentially making them look less attractive and more volatile to investors.
The SEC is also considering a rule to rein in the often optimistic growth projections made by listed SPACs, Reuters reported. Companies are not allowed to provide these forward-looking forecasts in typical IPOs. Conversely, the ability to lure investors with projections has been a pull for companies looking to go public through a SPAC.
Regulators, who had left SPACs largely unencumbered until recently, have been paying extra attention to the market as concerns rise that retail investors are losing out at the expense of hedge funds and other institutions that enjoy favorable terms because of the deal structure.
Celebrities such as former Speaker of the House Paul Ryan, basketball star Shaquille O’Neal, and former New York Yankees player Alex Rodriguez have put their names behind SPACs, boosting their popularity among retail investors.
Americans for Financial Reform and the Consumer Federation of America said in a February letter to the House Financial Services Committee that the SPAC boom is “fueled by conflicts of interest and compensation to corporate insiders at the expense of retail investors.”
Hedge funds, which often invest in SPACs before they go public, have won big because of the structural benefits of the vehicle. They can buy cheap shares, which come with warrants, using money borrowed from investment banks, and they often act as pre-IPO investors who can easily back out of the deal after the initial post-IPO “pop” or after a merger is announced.
A group of influential hedge funds that some industry watchers call the “SPAC Mafia” have piled into the asset class, Forbes reported. While scrutiny toward SPACs grows and the market cools, many of those funds remain bullish. Insider spoke with some of them to see how the proposed regulation and recent slowdown are informing their long-term outlook for SPACs.
‘They’re investing in SPACs, they’re investing in meme stocks, they’re doing online gambling, and they’re sitting in their houses’
While the proposed changes do not alter the deal structure for investors such as hedge funds, they do contribute to the slowdown in the SPAC market that some insiders said already began before the SEC increased its oversight in mid-April.
Hedge funds such as Westchester Capital Management, which manages $5 billion and has been investing in SPACs since 2008, are not too worried.
Roy Behren, the managing director of Westchester, said the decline could be attributed to “indigestion in the market from the massive issuance.” Many institutional players, not just retail investors, Behren said, “got caught in a downdraft” of SPACs that haven’t performed well after announcing a merger.
“I just don’t think that the SPAC mania that existed around the end of 2020 and beginning of 2021 will persist forever. But there are a number of great SPAC issuers that will continue to be successful,” Behren continued.
Behren added that SPACs were so attractive to retail investors in particular because they essentially offered them the opportunity to participate in venture capital through late-stage, pre-IPO startup investments.
He attributed the frothy 2020 SPAC market to retail investors’ boredom during lockdown.
“They’re investing in SPACs, they’re investing in meme stocks, they’re doing online gambling, and they’re sitting in their houses,” Behren said. “They have these stimulus checks, and, you know, you’ve read the same articles I have — it’s not all being spent on food, although a lot of it is.”
“Once everything opens up, they’ll be out at their jobs and not in front of their computer all day. Things might be different,” Behren said.
Mark Yusko, the founder and chief investment officer of Morgan Creek Capital, manages a SPAC exchange-traded fund and a SPAC arbitrage hedge fund. Yusko said the impending regulation has not changed his view on SPACs, and that “right now, it’s all speculation and conjecture.”
Yusko said the regulatory threats may constitute “pressure by incumbents to slow down the disruption that’s been happening with SPACs, which are taking a bigger and bigger market share of IPOs.”
He said regulators often say they will ban or impose rules around trendy asset classes such as SPACs and crypto but that “nothing actually happens.” Morgan Creek’s view, Yusko said, is that the proposed rule changes are not material to the SPAC market.
Why scrapping forward-looking projections isn’t going to save retail investors from themselves
Yusko said companies being acquired by SPACs should be allowed to provide forward-looking projections because “their best days are ahead.” He said that SPACs allow nonaccredited investors to enjoy venture-style returns in an environment in which companies are staying private for longer periods of time, and that providing projections is an integral part of informing these investors.
One “SPAC Mafia” hedge fund’s chief investment officer, who requested anonymity to discuss regulatory considerations, told Insider that in their view, banning SPACs from making projections would not change retail-investor sentiment, which is already predicated on the “vibe” of the market.
“Unfortunately, I don’t think retail investors are going through the financials of companies or understanding the warrants in the first place,” the source said.
Doug Ellenoff, the managing partner at Ellenoff Grossman & Schole, one of the most active law firms in the SPAC sector, said the SEC is trying to “protect retail investors from themselves.”
He said that while the accounting change for warrants temporarily halted SPAC IPO issuance as SPACs restated their financials, such regulation is unlikely to “considerably or meaningfully” slow down the secular trend toward companies choosing to go public via SPACs.
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