Crenshaw worries over SPAC arbitrage

Nasdaq’s and other exchanges’ decisions to scrap redemption thresholds in SPAC spin-off votes may have helped knock incentives out of whack, SEC commissioner Caroline Crenshaw says.

“The right to redeem should likely be protected,” Crenshaw told a virtual roundtable on April 28. “However, it is another question as to whether redeeming shareholders should retain the ability to vote to approve the de-SPAC after recouping their capital.”

SPACs have been the belle of Wall Street’s ball for the past two years. From 2017-2019, there were only a handful of transactions, according to new FINRA data. In 2020, there were about 400 and last year, there were more than 1,000.

The Commission is considering new rules that would clamp down on what regulators see as SPAC arbitrage. Crenshaw’s speech is peppered with “mays” and “coulds,” but it outlines the fears that she and her soon-to-be leaving fellow commissioner, Allison Herren Lee, have about shoring up public markets against private markets.

‘Poor incentives’

From 2020 until 2021, Crenshaw claims, 58 percent of SPAC shareholders cashed out just ahead of a merger, acquisition or spin-off. Early-2022 data shows even higher percentages of redemptions, she says. The problem: letting those who’re going to redeem vote on the public spin-off “insulates” them “from downsides, but retains some exposure to upside through [SPAC] warrants,” Crenshaw claims.

“This seemingly eliminates the incentive for shareholders to consider whether the proposed de-SPAC is actually worthwhile, and perhaps erodes incentives for sponsors to make a thorough, well-reasoned, well-supported case for the transaction to the shareholders,” she says. Allowing “SPACs to consummate a de-SPAC even when a substantial majority of shareholders redeems its shares creates and contributes to poor incentives, increases potential for dilution, and raises investor protection concerns.”

It wasn’t always like this, Crenshaw says. Up until recently, for instance, Nasdaq used to require a certain percentage of SPAC shareholders to commit to the other side of a transaction before a vote on that transaction could be held.

“At that time,” Crenshaw says, “this was industry practice, and it was codified as a listing standard. However, that industry practice, and the listing standard that enshrined it, has changed. While there may have been valid reasons for allowing the redemption threshold requirement to lapse, it may be appropriate to reconsider the balance of equities in light of the recent experience with SPACs, the high-rates of redemption, and a de-SPAC merger approval vote that increasingly seems pro-forma rather than an actual check that helps ensure only well-considered acquisitions proceed.”

‘Skin in the game’

The potential damage doesn’t end there, Crenshaw says.

“Further, in a scenario of high redemptions,” she says, “the SPAC affiliates may still be incentivized to consummate a merger and may rely upon new PIPE investors to offer later-stage funding, potentially at the cost to those shareholders that did not redeem.”

The commission’s investor advocate, Brian Scholl, has urged exchanges to restore redemption thresholds and set them at 50 percent or more to make sure investors “have skin in the game.”  “This would help protect against a redemption of the majority of shares depleting the SPAC trust and raising the potential for dilution for those investors that do not redeem,” Crenshaw says.

Further questions

Crenshaw has additional questions. “What impact do redeemable shares without limitations on conversion thresholds have on the different investors in the SPAC? And what impact does this have on the integrity of the public markets and investors’ confidence in those markets?” she asks.

She continues: “When PIPE investors step-in to replace the financing that exits when there are high-redemptions – how does that shape the negotiations, and to what extent are remaining investors harmed by dilution because PIPE investors demand better terms? Do these combined circumstances contribute to momentum for sub-optimal or inefficient de-SPAC transactions?”

Crenshaw is interested in understanding who the shareholders who choose not to redeem and convert their investment into the de-SPAC’d operating company are. Do those shareholders represent a minority view that the proxy disclosures represent an outlook that outweighs the risk of non-redemption? Or are those investors remaining for other reasons?

This article first appeared in affiliate publication Regulatory Compliance Watch