SPACs are great for banks, not investors

Ruth Saldanha: We’ve talked a lot about blank check companies or special purpose acquisition vehicles, also known as SPACs for short. 2021 was a record year for the formation of SPAC. They accounted for almost half of all IPOs for the year. So far, in 2022. SPACs have taken an even larger share of the IPO market at 74% of total IPO proceeds, which is approximately $10 billion. However, this money has not actually gone to retail investors. We have said in the past that many people make money on SPAC, but it is very rarely the individual investor. Now, new research from DBRS Morningstar shows that this is indeed the case, despite making money with banks, in many cases investors are somewhat left out. One of the report’s authors, Cheryl Saldanha, assistant vice president of credit ratings at DBRS Morningstar, is here today to talk about some of the report’s key findings. Cheryl, thank you so much for being here today.

Cheryl Saldanha: Thanks for having me, Ruth.

Ruth Saldanha: First of all let’s talk about these banks. How are they making so much money on SPAC?

Cheryl Saldanha: So, yeah, what we’ve seen is that with the SPAC boom the banks seem to be the big money makers. And so, it’s because there are so many different layers of fees that they can earn throughout the lifecycle of the SPAC. Therefore, usually, they can earn an initial underwriting fee for a SPAC IPO. There is usually a balance underwriting fee once SPAC has achieved its acquisition target. They may also earn advisory fees for pitching potential takeover candidates to SPAC and then later, if they need to arrange any additional financing to close the acquisition, they may not receive enough of the initial IPO proceeds. Were they can earn fee for its arrangement also. And so, the typical lifecycle of a SPAC is usually two years, and in 2021, we saw over 700 SPACs being built. So, I think what we’re going to see over the next one to two years is that banks are going to increase all these charges as these SPACs mature into their lifecycle. And so, it is also assumed that each SPAC is capable of detecting and closing its acquisitions.

Ruth Saldanha: So, where does that leave the individual investor? What has your research found in terms of how much money they are making or what happens to them?

Cheryl Saldanha: Therefore, it seems that individual investors are not always realizing the return they were looking for. And so, what we’ve seen with SPAC is that, in order to attract investors, they’re able to market their future projections or their future potential, even if they haven’t turned a profit yet. And so, what we’re seeing now is that many of these companies are missing the bullish projections they used to attract investors. And so, many of these investors are not seeing the profit or return they were expecting. And there have been cases where a company has misrepresented itself or its capabilities to investors, and this has actually resulted in fees or fines from the US Securities and Exchange Commission.

Ruth Saldanha: This brings me to my next question regarding regulations. What are regulators doing about it? Your research has found that more regulations are to come.

Cheryl Saldanha: So, it looks like more regulation is coming and in particular the SEC wants to focus on three main areas. So, the first is the difference in disclosure requirements between a traditional IPO and a SPAC. Therefore, traditional IPOs, they require far more disclosures. There are too many requirements for them. And currently, with SPAC there may actually be conflicts of interest between the SPAC sponsor and the investors, or they’re also going to be information asymmetries between different investors within the same SPAC. And hence, at present these are not required to be disclosed to the investors.

The second relates to marketing practices for SPAC. Therefore, currently, they are allowed to promote using attractive marketing materials or with investors involving celebrities. And so, this is something that is not allowed even with normal IPOs. And then, the last thing pertains to the use of financial projections. So, again, one of the main attractions of SPACs is that they are able to market their future prospects to investors, even if they haven’t made a profit. And currently, SPAC sponsors are free from civil litigation if they make misleading statements about the company’s forward-looking view, or if they perform sufficient due diligence on behalf of investors. And so, I think the SEC wants to provide more protection for the investors of SPAC.

Ruth Saldanha: So, if the SEC actually goes ahead and makes these recommendations where a lot of these benefits are taken away, does that mean that SPACs become more or less the same as traditional IPOs, and in this case , Do you think we may see lower SPAC listings ?

Cheryl Saldanha: I certainly think that regulation will have the potential to reduce the number of SPAC listings that we’re seeing. The current lack of regulation makes SPACs a more attractive option for taking a company public than traditional IPOs because you have fewer restrictions, fewer disclosure requirements. And then, on top of that, SPACs can actually be more expensive than a traditional IPO because of all these layers of fees. So, you have your initial underwriting fee, a later underwriting fee, you pay an advisory fee to the bank to pitch clients, and then on top of that, there are other fees that accrue for arranging additional financing. can go. And so, if you remove these benefits by adding more regulation, you’ve now eliminated this tempting shortcut, so to speak, of taking a company public and what you’re left with is a traditional IPO and an IPO. There is a choice between SPAC. Which is actually the more expensive option.

Ruth Saldanha: Great. Thank you so much for joining us with your perspective, Cheryl.

Cheryl Saldanha: Thanks a lot.

Ruth Saldanha: For Morningstar, I’m Ruth Saldanha.