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Can Investors Recover After Poor SPAC Investment Performance in 2022?

Securities Lawyer Jonathan Kurta
By: Jonathan Kurta Author
February 23, 2023 at 3:13pm

2022 saw a dramatic increase in the number of Special Purpose Acquisition Companies (SPACs) on the market. Toward the end of the year, many SPACs entered liquidation out of concerns over potential tax consequences and a reduced number of suitable companies for mergers.

Over the course of the year, SPACs demonstrated their vulnerability to fraud and questionable management. The company identified for a merger may mislead the SPAC, or the SPAC CEO may fail to consider the investors’ best interests. SPACs may also choose to merge with new companies with untested business models, which always pose a significant risk for investors.

What Are SPACs?

SPACs are shell companies that form with the intention of merging with a company that has not yet debuted on a public stock exchange. They create shortcuts that allow businesses to start offering shares more quickly than they would through a traditional IPO, with the added benefit of an influx of funding from SPAC investors.

Before acquiring a company, SPACs raise money from investors by selling units, typically for $10. Investors buy shares of SPACs in hopes that the stocks will perform well following the merger.

  • SPACs must find a company to merge with by a specified deadline, usually within two years.
  • Unitholders may or may not have any input into the selection of the target company.
  • SPAC units may consist of stocks or warrants. Warrants allow investors to buy stocks at a particular price by a specific deadline.
  • Regulators must approve the merger.
  • If SPACs fail to find a suitable company to merge with by the agreed-upon deadline, they must return the money they raised to investors.

SPAC Risks for Investors

SPACs are speculative investments, and speculative investments are always vulnerable to unpredictable changes in the market. Critics of SPACs point out that they often rely heavily on celebrity sponsors, like Shaquille O’Neale or Donald Trump, to generate interest.

Securities Lawyer Jonathan Kurta
Written by: Jonathan Kurta

Jonathan Kurta is an accomplished securities attorney and a founding partner at Kurta Law.

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What Are SPACs?

SPACs are shell companies that form with the intention of merging with a company that has not yet debuted on a public stock exchange. They create shortcuts that allow businesses to start offering shares more quickly than they would through a traditional IPO, with the added benefit of an influx of funding from SPAC investors.

Before acquiring a company, SPACs raise money from investors by selling units, typically for $10. Investors buy shares of SPACs in hopes that the stocks will perform well following the merger.

  • SPACs must find a company to merge with by a specified deadline, usually within two years.
  • Unitholders may or may not have any input into the selection of the target company.
  • SPAC units may consist of stocks or warrants. Warrants allow investors to buy stocks at a particular price by a specific deadline.
  • Regulators must approve the merger.
  • If SPACs fail to find a suitable company to merge with by the agreed-upon deadline, they must return the money they raised to investors.

Why Are So Many SPACs Liquidating?

Economic factors, including rising interest rates, have made it more difficult for SPACs to find suitable companies for a merger. According to The Wall Street Journal, the absence of new public listings has made it impossible for SPACs to find a deal by the two-year deadline. Additionally, stock prices are falling across the board, and the price of a SPAC share might dip below the original $10 share price, resulting in losses for the investor before the stock even debuts.

Last year, the IRS raised the possibility that SPACs might have to pay a 1% buyback tax on funds returned to investors. Many SPACs worried they would not find a company suitable for a merger by their deadlines in 2023 and wished to avoid paying an additional tax. The IRS later clarified that SPAC liquidations would not be taxed under the buyback levy. But for many SPACs, it was too late as the decision to liquidate had already occurred.

 

SPAC Fraud Allegations

The uncertainty around SPACs makes them targets for fraud. Because SPACs bypass the disclosures associated with a traditional IPO, there is less information available about them publicly. SPACs do not always have to consult with unitholders before merging with a company, and investors are often relying on the SPAC to perform adequate due diligence.

SEC actions against allegedly fraudulent SPACs may also inspire investors to veer away from these trendy investments.

African Gold Acquisition and Allegations of Embezzling

In January 2023, the SEC charged Cooper Morgenthau, the former CFO of a SPAC called African Gold Acquisition Corp, with embezzling more than $5 million from three SPACs. He allegedly embezzled funds from African Gold and stole funds from another SPAC series called Strategic Metals Acquisition Corp I and II. Morgenthau allegedly used these funds to pay for personal expenses and to execute trades in cryptocurrency assets.

Stable Road SPAC Allegedly Misled Investors About Potential Space Travel  

Part of the growing public interest stems from SPACs’ recent tendency to merge with companies that have popular appeal. Space travel and other alluring new technologies are a popular focus in the new SPAC market.

The SEC charged Stable Road SPAC following allegations that the SPAC had misled its investors regarding the company it had identified for its merger, Momentus. According to Momentus’s website, the company “plans to offer infrastructure services to support the growing space economy. With in-space transportation as our core service, our goal is to help our customers optimize the destination of space.”

The SEC alleges that Momentus and its CEO misled Stable Road, telling them that the company had “successfully tested” propulsion technology. According to the SEC, Momentus’s only in-space test had “failed to achieve its primary mission objectives or demonstrate the technology’s commercial viability.”

Stable Road allegedly failed to perform their due diligence and simply repeated Momentus’s claims about space transportation technology to investors.

Akazoo: $38.8 Million SEC Settlement

SPACs can be duped along with ordinary investors, resulting in a merger that renders SPAC units worthless.

In October 2021, the SEC announced a $38.8 million settlement with Akazoo, a music streaming service based in Greece. Akazoo merged with a SPAC and allegedly received nearly $55 million as part of the merger. Prior to the merger, Akazoo claimed to have 38.2 million users and 4.6 million paying subscribers. The company allegedly claimed to make $120 million in annual revenue. According to the SEC, Akazoo had no subscribers and negligible revenue.

How to Recover from SPAC Losses?

Investors have a chance to redeem their units once a SPAC announces a merger. After the merger is complete, investors are subject to the same risk that investors would face buying shares of any newly publicly traded stock. Time will tell if investors’ enthusiasm for SPACs was merely a passing fad of 2022.

Brokers should only recommend SPACs to investors who have specifically stated that they are open to risk. If you told your broker or financial advisor that you wanted exclusively conservative investments, then you may have a case for a securities attorney. Call (877) 600-0078 or email info@kurtalawfirm.com.