Securities Enforcement and Regulatory Update

FINRA Announces Impending Special Purpose Acquisition Company Sweep

July 26, 2021

On July 22, Financial Industry Regulatory Authority (FINRA) CEO Robert Cook announced the self-regulatory organization’s plan to conduct a series of targeted reviews into special purpose acquisition companies or SPACs. Speaking at the Securities Industry and Financial Markets Association’s virtual summit, Cook said FINRA is in the “early stages of preparing some targeted sweeps” to address the latest trends affecting financial markets, such as SPACs, “finfluencers” (social media influencers giving financial advice), and options account openings by unsophisticated investors. Cook noted that FINRA continues to be “interested in the SPAC space and the conflicts of interest that might be there.”

Member firms that have participated in SPAC transactions as underwriters or advisers should expect to receive requests from FINRA’s Examinations and Enforcement departments regarding, among other things, potential conflicts of interest presented by their roles in SPAC transactions. FINRA’s Corporate Financing Department may also use this period as an opportunity to more closely scrutinize disclosures in SPAC initial public offerings.

Member firms would be well advised to proactively review their SPAC-related policies and procedures as well as the specific transactions presenting high-profile characteristics in order to identify and, where appropriate, proactively remediate any deficiencies. More specifically, member firms should consider performing targeted reviews of select deal files and relevant electronic communications before those materials are called for in forthcoming inquiries from FINRA, the U.S. Securities and Exchange Commission (SEC), and private litigants. Timely identification and remediation of any highlighted weaknesses can greatly enhance member firms’ ability to defend and respond to the impending scrutiny.

The combined scrutiny of the SEC and FINRA, as well as the ever-present threat of private litigation, will continue to put pressure on SPAC market participants in the coming months. The expectation should be that enforcement activity and litigation will only increase as regulators and plaintiffs obtain more information about industry practice and identify which transactions underperformed their financial projections or involved potential conflicts of interest.

SEC Scrutiny Already Underway

The FINRA announcement follows similar statements by the SEC, which has already begun scrutinizing SPAC transactions, the resulting public companies, and the intermediaries involved in those transactions. For example:

On March 31, the Division of Corporation Finance issued a statement emphasizing the limitations associated with SPAC transactions and noting the extensive compliance and disclosure requirements of being a public company (e.g., filing requirements, books and records, strong accounting and disclosure controls).

Also on March 31, Acting Chief Accountant Paul Munter issued a statement focusing on the complex financial reporting and governance issues posed by a target company’s expedited rise to public status. Munter encouraged market participants “to consider the risks, complexities, and challenges related to SPAC mergers, including careful consideration of whether the target company has a clear, comprehensive plan to be prepared to be a public company.”

On April 8, Acting Director John Coates of the Division of Corporation Finance issued a statement stressing that contrary to claims by some commentators, SPAC transactions are not subject to “lesser securities law liability exposure.” Specifically, Coates warned that misleading statements about a target’s expected performance were prohibited by the securities laws and that the Private Securities Litigation Reform Act safe harbor did not prevent the SEC from taking action.

And, on April 12, Coates and Munter issued a joint statement discussing certain accounting and reporting considerations related to warrants issued by SPACs. The statement called for warrants to be reclassified as liabilities (depending on their terms) and urged registrants to evaluate whether there is an error in previously filed financial statements. This statement disrupted the market for SPACs seeking to go public and caused SPACs that had previously issued warrants to consider the need to amend the financial statements in their public reports.

The SEC has been backing up these public statements with corresponding enforcement activity. The Division of Enforcement has requested information from various financial institutions and audit firms about their SPAC-related activities and has reportedly sought information about all SPAC transactions in which those institutions and firms participated as far back as 2017. Enforcement has also reportedly been seeking information about troubled deals and interviewing the parties involved. Most recently, on July 13, the SEC announced an $8 million enforcement action against a SPAC and a target company for, among other things, misrepresentations, omissions, and inadequate due diligence.

Plaintiffs Already Filing State and Federal Claims

In addition to the above scrutiny from regulators, there have been numerous SPAC-related lawsuits filed in federal and state courts over the past five months. Private plaintiffs have brought a significant number of claims under state law breach of fiduciary duty theories focusing on undisclosed conflicts of interest and underwhelming performance. Others have filed claims alleging violations of the federal securities laws and focusing on the accuracy of disclosures made in connection with proxy solicitations.

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