Law profs defend theory that SPAC is illegal under Investment Company Act

People are seen on Wall Street outside the New York Stock Exchange in New York City. REUTERS/Brendan McDermid
  • GO - Memorandum in opposition to defendants' motion to dismiss
  • EMERGE - Memorandum in support of defendants' motion to dismiss

(Reuters) - There should be quite a wide audience for a brief filed last week by law professors John Morley of Yale University and Robert Jackson of New York University, opposing the dismissal of an investor's lawsuit against the blank-check company GO Acquisition Corp.

After all, when Morley, Jackson and their co-counsel from Susman Godfrey, Bernstein Litowitz Berger & Grossmann and RM Law first sued GO and two other special purpose acquisition companies in Manhattan federal court in August, more than 60 law firms united in an extremely unusual joint statement decrying the law professors’ theory that SPACs are subject to regulation under the Investment Company Act of 1940 when they fail to acquire an operating company within a year of offering shares to the public.

The new brief is the profs’ first public rejoinder to the firms, which insisted that SPACs are not investment companies because their primary business is searching for a target business to acquire. Jackson and Morley aren’t backing down an inch: Their brief argues that the Securities and Exchange Commission’s 1947 test for an “inadvertent investment company” leaves no doubt that GO falls under Investment Company Act regulation. More than a year after going public, their brief argued, the SPAC has no operations, income or assets aside from investors’ capital – and that capital is invested in government securities.

It simply doesn’t matter, according to the law professors’ brief, that GO represented itself to investors as a blank check company that planned to acquire an operating business or that the SPAC sponsors say they are continuing to shop for a target.

There are plenty of examples, the brief said, of the SEC and the courts imposing Investment Company Act strictures on companies that claimed their investments were merely a stopgap as they searched for an operating company to acquire. In fact, the brief said, that was the situation in the leading case, In the Matter of the Tonopah Mining Co, which involved a onetime mine operator that pivoted to investing in securities of other mining businesses. Tonopah executives told the SEC that the company hoped to take over a mining enterprise, but the SEC said it was interested only in the business’ present income and assets.

The same can be said of GO, the law professors said. The SPAC’s "aspirations to a future business do not help it here, because the test expressly focuses only on assets and income in the ‘present,’" the brief said. Like every other company, SPACs are entitled to a one-year grace period before Investment Company Act regulation kicks in, the brief said. But once that grace period has expired, they said, SPACs are not entitled to an extra, regulation-free year simply because they specified a two-year time frame in offering documents.

The professors' opposition brief is a weird mirror image of the SPAC’s dismissal motion. Both sides agree that no court has considered whether the Investment Company Act applies to the vehicles. Both agree that the Tonopah case governs the analysis. And both agree on the basic facts of GO’s $575 million offering: The SEC allowed the SPAC to go public with a promise that investors could redeem their shares for cash if they didn’t like GO’s proposed acquisition or if GO’s sponsors failed to find an operating business to acquire within a two-year time frame. GO is holding investors’ money investors in a trust account that owns only government securities to assure that it can meet redemption requests.

But the SPAC dismissal brief – in contrast to the opposition brief – emphasized the company’s representations to investors. Defense lawyers from Simpson Thacher & Bartlett, Dontzin Nagy & Fleissig and Wollmuth Maher & Deutsch argued that the key question, under the Tonopah test, is what investors believed they were buying. And no reasonable purchaser of GO shares, the brief said, could have construed the offering as an opportunity to invest in government securities paying a paltry interest rate.

The SPAC brief quoted from the 7th U.S. Circuit Court of Appeals’ 2007 ruling in SEC v. National Presto Industries Inc, which applied the Tonopah test to a onetime manufacturing company that sank about 60% of its assets into securities after divestitures left it sitting on a pile of cash. The 7th Circuit concluded that Presto was not subject to the Investment Company Act because reasonable investors would still regard it as an operating company, not a mutual fund.

So too with GO investors, according to the SPAC’s brief, which argued that investors were buying the expertise of its founders and officers, not the opportunity to park their money in government securities for two years. So even if GO’s capital is invested in these securities, the brief said, the SPAC’s most important “asset” – its founders’ purported ability to source a deal – is not those holdings.

The law professors’ opposition brief countered that the Tonopah test is comparative, not absolute. So the question, the brief said, isn’t simply whether investors perceive GO to be an investment company but whether it seems more like an investment company than an operating company. Given that GO has no operations or income – and that many investors will choose to redeem their shares if and when it finds an acquisition – the law professors argued that the SPAC is more akin to an investment company.

In essence, GO is arguing that the SEC and investors recognize SPACs as their own distinct category whose “operating business” is finding a company to acquire, while the law professors contend that SPACs should be forced to adhere to the same standards as every other company.

NYU professor Jackson declined to comment in response to my query to him and Morley. GO’s lawyers didn’t respond to my email.

The GO case, which is before U.S. District Judge John Cronan, is the farthest along of the three SPAC lawsuits Jackson and Morley filed in August. Their brief opposing a dismissal motion by E.Merge Technology Acquisition Corp is due later this week. The Pershing Square Tontine Holdings SPAC faces a Nov. 4 deadline for its dismissal brief.

Read more:

49 firms in 72 hours: How the SPAC bar united against law profs’ splashy lawsuits

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Alison Frankel has covered high-stakes commercial litigation as a columnist for Reuters since 2011. A Dartmouth college graduate, she has worked as a journalist in New York covering the legal industry and the law for more than three decades. Before joining Reuters, she was a writer and editor at The American Lawyer. Frankel is the author of Double Eagle: The Epic Story of the World’s Most Valuable Coin.