SPACs under the microscope as lawsuits mount

REUTERS/Dado Ruvic/Illustration
  • Dealmakers double down on disclosure, due diligence to prevent suits
  • Change comes as SPACs face wave of litigation, ramped up SEC scrutiny
  • 420% jump in securities class actions against SPAC-related companes since 2020

(Reuters) - As litigation over special acquisition vehicles heats up, deal lawyers are taking steps to help avoid such challenges.

Investors in recent months have accused companies, such as electric truck maker Nikola Corp, of making misleading or false statements about their businesses through mergers with SPACs.

Now, attorneys are advising clients to more thoroughly vet a potential target's business and to increase transparency around conflicts of interest and other issues that could spark lawsuits.

“Both parties have to take their time to do more diligence, do more vetting and create disclosure that's more narrowly tailored to the facts and the situation,” said Joshua DuClos, a mergers and acquisition partner at Sidley Austin.

SPACs, also known as blank check companies, raise funds through initial public offerings to merge with privately held companies and take them public.

Securities class actions against SPAC-related companies have been on the rise since 2019, when there were just two such lawsuits, according to a report from insurance brokerage Woodruff Sawyer.

From January 2021 through October 29, 26 securities class actions were filed against SPAC-related companies, a 420% jump from 2020 when only five suits were brought, according to the data.

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The increase comes as the U.S. Securities and Exchange Commission is ramping up enforcement actions and scrutiny of the SPAC deals market, a booming business for Wall Street over the past 19 months.

Jim Ducayet, the co-head of Sidley Austin’s Securities and Shareholder Litigation practice, said that shareholder complaints and demand letters challenging SPAC mergers pre-closing are often quickly settled out of court because they’re only asking the companies to disclose more information.

But “the stakes are much higher" when it comes to lawsuits brought after the merger is completed, Ducayet said.

Paul, Weiss, Rifkind, Wharton & Garrison litigation partner Gregory Laufer said one of the ways to avoid SPAC-related lawsuits is to ensure that disclosures "robustly and comprehensively" lay out the risks of the deal.

Disclosing potential conflicts of interest is an area lawyers are increasingly focused on.

If there's a potential conflict, such as when the SPAC sponsor is invested in the target company, there’s an emphasis on guaranteeing the fairness of the deals early on, DuClos said.

That’s meant creating independent board committees to review and negotiate the transaction, obtaining fairness opinions from financial advisers, and securing approval from minority disinterested shareholders before problems arise.

Making more modest projections about a SPAC target's business is another way to fend off lawsuits, deal lawyers said.

Allegedly false projections are at the heart of shareholder lawsuits Nikola is facing following its $3.3 billion merger with blank check firm VectoIQ Acquisition Corp.

Citing a report by short-seller Hindenburg Research, the lawsuits claim that some of the company’s executives and directors made false and misleading statements about Nikola's technology and products in regulatory filings about the merger.

Nikola has denied the allegations.

Sidley partner Ducayet said that modest projections are important because a target company's projections "are going to be under a microscope and scrutinized with the luxury of hindsight."

"They should be pressure-tested and based on realistic, not aspirational, assumptions," Ducayet said.

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Sierra Jackson reports on legal matters in major mergers and acquisitions, including deal work, litigation and regulatory changes.