The Anti-SPAC Attack Claque

A joint letter by 58 law firms is certainly a notable declaration, particularly when pulled together within a mere 10 days after litigation initiated by esteemed scholars. Observers might be tempted to wonder whether the motivation for such a quick and public press release is the signatories’ concern with analyzing a legal issue carefully, or with losing a large book of business and being called to account for legal advice that now stands in question.  The New York Times quotes one attorney as saying, “We really needed something powerful to take away” the “P.R. narrative.”

Upon what, precisely, have all these firms agreed? Broadly, they assert that the standard model for SPACs does not violate the Investment Company Act of 1940 by creating an unregistered investment company. That SPACs are unregistered under the ’40 Act is not in dispute. The issue turns entirely on whether they may be deemed investment companies. The ’40 Act defines investment companies in Section 3(a)(1) in two primary ways (and a third that is irrelevant to SPACs). These two definitions are, under subsection (A), any issuer which:

is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities,

and, under subsection (C), any issuer which:

is engaged or proposed to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to acquire investment securities having a value exceeding 40 per centum of the value of such issuer’s total assets (exclusive of Government securities and cash items) on a consolidated basis.

So the status of SPACs turns largely on two factors: (1) the business in which they are engaged primarily and (2) what they do with the proceeds they have raised from their IPOs. SPACs can – and, depending on the precise composition of their portfolios, might – avoid falling within the scope of subsection (C) by weighting their investments towards U.S. Treasuries and other government securities. But what about subsection (A), which makes no distinction about the kind of securities in which an issuer invests? Do not SPACs, which for up to two years or so engage in the business of investing in securities – Treasuries and money-market funds, admits the letter – trigger this definition?

The signatories contend that SPACs do not fall under the definition because the business of a SPAC today or yesterday, it would appear, turns on what its business plan says it will do someday. The mere proposal to do something else with the firm’s money in the future would thereby have the power to alter the business in which it engages currently or has engaged previously. The law firms’ letter thus appears to create a rule that grants any issuer a window during which it can act just like a mutual fund, if it someday “follows its stated business plan of seeking to identify and engage in a business combination with one or more operating companies within a specified period of time” and holds conservative investments.

But where does this grace period come from? The signatories cite no cases, SEC guidance, or other authority – just “the plain statutory text.” The statute does not say anything about future business plans – on the contrary, the “is” in the ’40 Act refers to the present tense. And how long does the window last? According to the firms, it lasts a “specified period,” which presumably could be unlimited, longer presumably than a life in being plus 21 years.

Under the signatories new rule, one could create a mutual fund that would promise to merge with the leading cold fusion enterprise 100 years hence and then enjoy a century of operating like a money market fund free from the expense of complying with the ’40 Act.

If the letter had been signed by individual attorneys, one could ask those ’40 Act counsellors what they will now tell their clients whom they have long advised to spend large amounts of time and money registering under the ’40 Act. If such an onerous regulatory burden could be sidestepped by the mere expediency of aspiring to a business plan for a future, unspecified merger, then 8,000 registered mutual funds are currently unnecessarily complying with the ’40 Act. The signatories’ language – “within a specified period of time” – is so open-ended and unmoored from any customary notions of a grace period that it would create a simple – and silly – way to evade the entire ’40 Act.

The second part of the signatories’ rule seems to suggest that safe investments – “short-term treasuries and qualifying money market funds” – are sufficiently conservative to obviate the need for registration. If true, then why do the money market funds or other mutual funds that hold Treasuries or conservative securities themselves need to register?

The argument of these law firms is missing legal authority for the proposition that businesses can escape the ’40 Act for a “specified period of time” or even the SPAC standard of 24 months (and 30 months, in the case of Pershing Square Tontine Holdings). Our legal system does not typically grant participants the ability to set their own, open-ended deadlines for compliance.

This post comes to us from Professor William A. Birdthistle at Chicago-Kent College of Law.

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