SPAC WARS: Revenge of the SEC
January 31, 2024 — In the Star Wars universe, the conflict between the Rebel Alliance and the Galactic Empire represents an age-old dramatic struggle between the forces of freedom and those of tyranny.
The Galactic Empire, led by the Emperor and imposed by his formidable enforcer, Darth Vader, ruled the galaxy with an iron fist, employing overwhelming military might and oppressive tactics to maintain control.
Opposing this authoritarian regime was the Rebel Alliance, a scrappy coalition of freedom fighters and defectors from across the galaxy. They were driven by the hope of restoring the Old Republic’s values of democracy and justice.
Despite being outmatched in resources and power, the Rebels engaged in guerrilla tactics and strategic strikes, such as the iconic destruction of the Death Star, in their quest to topple the Empire and bring freedom to the galaxy.
The historic conflict between the Rebel Alliance and the Galactic Empire is analogous to the modern-day battle between entrepreneurs and investors on one side and regulators such as the Securities and Exchange Commission (the “SEC”) on the other.
Investors and entrepreneurs are akin to the Rebel Alliance. They are the innovators, the risk-takers, and the disruptors of the status quo. They work to create value and bring new ideas to the market. However, they often face challenges including limited resources and opposition from established incumbents. They must be agile and creative, taking risks as they seek to change the market landscape, often pushing back against the boundaries of existing regulations.
Regulators resemble the Galactic Empire in that they establish rules and guidelines intended to maintain order and prevent chaos in the capital markets. Their role is to protect the public interest, ensure fair play, and prevent fraud. However, much like the Empire, their actions can be seen as restrictive and stifling innovation by those pushing for change.
In this analogy, just as the Rebel Alliance doesn’t seek to create anarchy but rather to bring balance and fairness to the governance of the galaxy, investors and entrepreneurs don’t inherently oppose regulation; they seek a business environment where innovation can thrive while maintaining the integrity of the market.
Conversely, just as the Galactic Empire believes in the necessity of its rule for the greater stability of the galaxy, regulators believe in the importance of rules and regulations to prevent fraud, protect consumers, and maintain the overall health of the economy.
Three years ago, the market’s Rebel Alliance was flourishing. The first quarter of 2021 represented one of the most heated and speculative stages of the post-Covid bull market, with a myriad of asset classes surging in both price and popularity. One of the most favoured asset classes by investors and entrepreneurs at the time was Special Purpose Acquisition Companies.
In Q1 of 2021, the SPAC market was on fire, with a frenzy of new issuance coming to market, as the Rebel Alliance was spreading its influence throughout the NSYE and NASDAQ galaxies. During this quarter, SPAC IPOs reached a frenzied pace, with 300 blank check initial public offerings hitting the market, raising nearly $100 billion in just three months. At the time, this aggressive pace of new issuance represented nearly 5 SPAC IPOs per day.
The Rebel Alliance was battling a wretched two-decade trend of declining U.S. listed securities, in which the number of publicly traded stocks fell from approximately 7,500 to merely 3,500. This dramatic decrease in the number of listed securities put the livelihoods of all investors at risk, reducing opportunities for diversification and alpha generation (both long and short). Moreover, the decline of public market capital formation threw sand into the gears of innovation and entrepreneurship, as access to risk capital represents the lifeblood of new ventures.
Due to the actions and efforts of the Rebels, the decline in U.S. listed securities had briefly reversed its decades-long decline, rising by nearly 1,000 new issuers starting in 2021.
Source: Center for Research in Security Prices (CRSP), Accelerate
However, this frenetic level of growth and capital formation caught the scornful eye of the SEC, and the Galactic Empire was keen to slow the stunning progress of the Rebel Alliance with their ballooning dealmaking and SPAC issuance.
The Empire Strikes SPACs
Shortly after the SPAC market’s record first quarter, the SEC launched its first strike against the Rebels on April 12, 2021. The Empire homed in on SPAC warrant accounting, ultimately forcing most blank check companies to restate their financial statements, a devastating blow to the rapid growth of the asset class.
Coincidentally with the SEC’s first retaliation against the SPAC market, macro tailwinds reversed into headwinds for the Rebels. The market for speculative issues, such as SPACs and deSPACs, had turned, with early-stage and innovation-related securities beginning to plunge in value.
The SEC’s preliminary regulatory pushback, combined with a fresh bear market in speculative securities, put the Rebels on their heels throughout 2021.
However, the SEC did not stop its hostility toward the asset class. In December 2021, the SEC published a video on its website in which the Chair of the SEC was openly disdainful of SPACs:
“Suppose a group of strangers came up to you and said, ‘I have a company that doesn’t do much of anything, but sometime in the next two years will merge with another company. I don’t know what that company is yet.’ Would you invest in the stranger’s company? That’s essentially what a special purpose acquisition company, a SPAC, does.”
In early 2022, the SEC sought to crack down further on SPACs, although the blank check market had stopped growing by that point. In proposed draft regulations, the SEC sought to grant market participants the power to sue if they were presented with too rosy a picture regarding future financial gains of SPAC mergers. In addition, the proposed regulations sought increased disclosure regarding sponsor compensation in SPAC mergers. This threat of legal action chilled SPAC sponsors’ willingness to take the risk and launch a new blank check company.
Last week, the proposed rule changes restricting the disclosure of forecasts and increasing sponsor compensation information to the market were approved. Unfortunately, the combination of negative market forces and increasing regulatory pressure had already defeated much of the Rebel Alliance, leaving the now $15-billion SPAC market a fraction of its $210 billion peak, when the SEC first cracked down.
Source: Accelerate
The American Securities Association, an organization representing small and midsized financial firms, criticized the SEC rules, stating, “They will chill participation in the SPAC market and reduce the ability of private companies to access public capital markets.”
A New Hope?
But all is not lost. There remains hope for capital formation, innovation, and entrepreneurship in the capital markets. While the Rebel Alliance has been decimated, a cabal of dedicated entrepreneurs, sponsors, investors, and hedge funds, continue to allocate, build, and innovate within the SPAC universe. In addition, with the blank check asset class whittled down significantly in size, the SEC has presumably achieved its goals and has set its sights on new perceived threats, including cryptocurrency, greenwashing, and climate change disclosures.
While one lone SPAC IPO launched thus far in 2024 when JVSPAC Acquisition raised $57.5 million (Disclosure: Long JVCAU in the Accelerate Arbitrage Fund (TSX: ARB)), the prospects for a bit of a resurgence in the blank check market is not out of the question. The reasonable quantity of recent SPAC S-1 filings, or paperwork indicating plans for an upcoming IPO, tells us that the Rebel Alliance is not dead yet.
The Accelerate AlphaRank SPAC Monitor details various metrics on the current opportunity set while offering details on every individual SPAC currently outstanding. The Accelerate AlphaRank SPAC Effective Yield tracks the average arbitrage yield offered. The Accelerate AlphaRank SPAC Index tracks the price return of the SPAC universe.
* AlphaRank is exclusively produced by Accelerate Financial Technologies Inc. (“Accelerate”). The Accelerate Arbitrage Fund may hold some securities discussed in this research. Visit AccelerateShares.com for more information.
Disclaimer: This research does not constitute investment, legal or tax advice. Data provided in this research should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information in this research is based on current market conditions and may fluctuate and change in the future. No representation or warranty, expressed or implied, is made on behalf of Accelerate as to the accuracy or completeness of the information contained herein. Accelerate does not accept any liability for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on all or any part of this research and any liability is expressly disclaimed. Accelerate may have positions in securities mentioned. Past performance is not indicative of future results.
