"SPACS the way to do it"- the impact on the D&O landscape and possible future exposure to the UK
Special Purpose Acquisition Companies (SPACs) are publicly traded “shell companies” that raise capital in an IPO process which is then used to merge with a privately held business (known as a reverse merger or De-SPAC). There is usually a two-year period within which SPACs need to find a suitable target company before the funds are liquidated and returned to the investors.
Historically, companies have taken the view that if you couldn’t go public in a traditional IPO and you couldn’t find a traditional M&A buyer, then the next viable option would be to consider a SPAC.
This perspective has now shifted with SPACs being the preferred method of choice as opposed to the traditional IPO, which consists of a lengthy process that can be particularly consuming, both in time and resources.
The attractiveness of SPACs, especially to tech start-up companies, also includes a greatly reduced amount of disclosure responsibilities needed in the process, particularly in respect of the financial projections, when compared to the traditional IPO.
Indeed, in 2020 alone, there were a total of approximately 246 SPAC IPOs completed in the US (raising USD $79.6bn in capital) and even more than that in the first quarter of 2021, indicating the ever-increasing rise in popularity for this type of capital raising in the corporate business world.
As a result of this stratospheric rise in SPAC activity, there has been an increase in litigation too with various US Class Actions being filed.
The Securities and Exchange Commission have announced that they are actively continuing to look carefully at filings and disclosures and will continue to be vigilant about SPAC and private target disclosures so that the public can make informed investment and voting decisions about these transactions.
This announcement from the SEC indicates to prospective SPAC participants that any perception of lesser securities law liability exposures in the process is far from the reality and they should therefore tread carefully to avoid any serious liability issues arising in the future.
So, how does this affect policyholders and insurers?
Whilst the allure of SPACs as a quick-fire way to obtain capital for companies by means of what seems to be less intrusive disclosure requirements can be appealing, it can also lead to pitfalls. For example, the limited amount of time given to SPACs to obtain a suitable target company (two years) before liquidation of the funds, means that if the right company isn’t found as the deadline approaches, individuals may be tempted to opt for a less suitable option with often inflated projections, resulting in what can be controversial investments which in time invite claims from investors.
The swift increase in the number of SPACs in the US is leading to concerns in the D&O market that insurers might as a result be over exposed, leading to an increase in premiums for D&O policies.
Looking closer to home and across the pond in the UK, the new changes made by the FCA to the Listing Rules came into effect on the 10th August 2021 to drive further investment and in doing so, potentially making SPACs a more enviable option in the UK.
The key changes are:
- A minimum of £100m needs to be collated in the initial capital raising (lowered from £200m)
- Shareholder approval for the proposed acquisition
- Redemption options available
- Ring Fencing of investment, preventing it from being used for anything other than to fund the SPAC transaction (accept specifically agreed costs)
- Introduction of a time limit of two years for the acquisition to be completed (with an option to extend to three years with shareholder approval)
- Adequate and sufficient disclosures on the key terms and risks throughout the lifecycle of the SPAC process
There are various coverage considerations that need to be had when dealing with SPACs, namely:
Who would need cover?
There could be up to three different entities/individuals that would require cover during the lifecycle of the SPAC process:
- The SPAC and its D&O’s
- The target and its D&O’s
- The combined company and its D&O’s (to cover wrongful acts of the new entity going forwards)
Individuals could serve as D&O’s in two capacities (such as in the SPAC and then the newly combined entity), raising questions as to which policy would respond and the issue of double insurance and proportionality.
Which policy should respond?
A D&O policy would in the normal sense of things be in the frame for certain losses arising out of a SPAC, however, it might not be enough. SPACs will likely require cover for a policy period of two years (instead of the traditional one) in order to link in with the acquisition timeframe, therefore consideration of run off extensions will be needed. In addition, a POSI policy or extension would also have to be considered to provide some form of risk protection for the public offering element of the process.
Warranty &Indemnity insurance is also another factor to consider given the inherent nature of mergers within the SPAC world and the indemnities provided under the acquisition agreement.
Continuity of cover will be an extremely important consideration for both policyholder and broker to prevent any gaps in cover occurring.
Historical Data
This in turn leads into the next challenge, historical data. This won’t be readily available to underwriters for them to analyse, therefore making the underwriting process and risk analysis that more difficult, especially in the current hard market, even resulting in SPACs not being able to secure the requisite cover they require.
Fraud risk
The vetting stage is a vital component of the process and as such, fraud might be more prevalent than in an ordinary run of the mill merger. Target companies tend to be smaller with ambitious future projections and, when coupled with the time pressures of completing a transaction within a two-year period, this could lead to misinformation being communicated and ultimately relied upon.
Of course, these are just a few examples of areas in which insureds and insurers shall need to be alert should the SPAC trend continue.
In conclusion, SPACs continue to be very much on the rise in the US and could before long find their way into the UK, creating some interesting and challenging situations for the Insurance industry, especially in the ever changing regulatory and economic environment.
Credit to references from the D&O Diary and Clyde & Co LLP.
