The dot.com bubble did not end well for stock markets or investors. Further, it precipitated a range of unethical and manipulative practices that stained Wall Street and financial analysts for years.
Fast forward to the fall of 2021, and the long-dormant SPAC structure (Special Purpose Acquisition Company) for taking companies public appears to be provoking a similar dynamic in terms of unethical and manipulative practices and/or unwarranted speculation detached from any fundamental data or analysis.
As most of the money being raised via initial public offerings is now dominated by this SPAC structure, it can’t be ignored. We at CFA Institute, a global professional group that promotes ethics, education, and professional excellence in the global investment industry, are particularly worried about the damage that SPACs could do to investor confidence in the stock market over the long run. Rather than encouraging Americans to invest for building longterm wealth, some SPACs promote a get-rich-quick mentality and could expose individual investors to unreasonable risks.
The SPAC Working Group at CFA Institute is examining a range of market integrity issues as they relate to the SPAC structure for IPOs. Generally, IPOs are highly speculative for any investor, tend to proliferate at market highs and have a spotty record of performance short and long term, regardless of structure.
Even still, the SPAC version of an IPO has introduced several twists into the analysis of market fairness and investor protection. Never has the structure been so dominant, nor have IPOs been as extensively hyped via celebrity sponsorship and unregulated social media chatter. These highly complex structures are being touted as a private-equity opportunity with private-equity returns for the individual investor with very little evidence to support those declarations.
While it may be true and investors of all sorts should be able to take advantage of free-market opportunities, the industry would be well advised to protect against the misinformation and manipulation that plagued the dot.com era.
The CFA Institute SPAC Working Group has empaneled a broad-based group including industry practitioners, stock exchanges, SPAC sponsors, academic experts and investor protection advocates. The group is focused on:
Various SPAC processes and structural issues including the issuance and trading of initial SPAC units.
Trading around the announcement of the merger (known as the d-SPAC transactions) and the economics of what a public SPAC investor ends up with compared to other investors in the d-SPAC merger.
The clarity and prominence of disclosures on structural issues as well as the risk factors and realistic prospect for investment returns of these highly speculative investments.
The balance among conflicts of interest and investor protections that do not exist in traditional IPOs. Of immediate concern for investor protection is the dynamic posed by sponsors more focused on finding a merger candidate to avoid significant deal costs than the merits of the target company.
Free-market capitalism is on full display in the brave new SPAC world. The excitement of finding the next tech giant or biopharma game-changer can be intoxicating for individual investors normally foreclosed from private-equity-type opportunities.
What worries us is whether this new structure is that it will lead to lack of investor confidence of the IPO market at large and among emerging-growth companies in particular. This could happen in one of two ways. The SPAC IPO structure may allow Wall Street to extract much more of the upside potential due to the complexity of deal structures and the fees inherent in, and unique to, the SPAC process. Alternatively, the way in which the SPAC structure mitigates “deal risk” would potentially result in mergers for companies completely unfit for public markets.
If this new IPO juggernaut is honest and transparent about the risks, the likelihood of returns and can modulate the coming rush of mergers, this may well be a concrete step toward the democratization of private-equity opportunities. We have the opportunity to make sure the SPAC structure is not a dot.com encore. Let’s use it.
Kurt N. Schacht is the head of advocacy for the CFA Institute and the former chair of the SEC’s Investor Advisory Committee.