[Anushri Uttarwar is a 4th year law student at O.P. Jindal Global University]
On March 11, 2021, the Securities and Exchange Board of India (“SEBI”) formed a group of experts to study the viability of introducing structures like special purpose acquisition companies (“SPACs”) in India. Contrary to SEBI’s guarded position, the International Financial Services Centre Authority (“IFSCA”) has already released draft regulations (“Draft Regulations”) for SPAC listings in India’s maiden International Financial Services Centre, Gujarat International Financial and Tec-City, and seems determined to participate in the SPAC phenomenon that has captured the global financial markets.
These Draft Regulations constitute the first attempt of a domestic authority to regulate SPAC listings since SPACs came into existence around 20 years ago in the United States (“US”). This post attempts to highlight and comparatively analyze themes within the Draft Regulations pertaining to the sponsors, i.e., the management team that forms the SPAC. It does so in light of international standards, practices and regulatory attempts on the SPAC front.
IFSCA’s Draft Regulations
A SPAC is a blank-cheque company, being a company with no assets and no operational business. It is one that seeks listing on the very few stock markets in the world that has thus far permitted such listings to raise capital and then to effect a business combination or a de-SPAC transaction (a merger, or an amalgamation, and the like, with a target company). The SPAC sponsors can only begin the search for a target following its initial public offering (“IPO”) and within a limited time frame (usually 36 months). If the sponsors fail to find a suitable investment, the SPAC would have to be liquidated, whereby the investors would receive their investments back with a minimal loss. Clauses 66 and 83 of the Draft Regulations too, reflect these features.
The most vulnerable parties within a SPAC structure are the retail investors. Since the due diligence carried out in a de-SPAC transaction is not as rigorous and stringent as in an IPO, greater caution is required on their part before they choose to invest in them. They have limited information to work with and to assess the suitability of their investment in these skeleton companies. Hence, the details about and the trustworthiness of the sponsors becomes all the more crucial, and regulatory attempts must focus on investor-protection safeguards, especially on the provisions related to the sponsors.
Management’s post-IPO equity interest
Equity stake threshold: Clause 72(2) of the Draft Regulations states that the sponsors or the management team of the SPAC must hold a minimum of 20 percent equity stake of the post-IPO paid up capital.
The New York Stock Exchange (“NYSE”) and the National Association of Securities Dealers Automated Quotations (“NASDAQ”) listing rules do not mandate any threshold for the management’s post-IPO equity interest. However, the usual practice while floating SPACs in the US is that the management reserves a 20 percent equity stake within the post-IPO paid up capital. The Draft Regulations seek to codify this widespread US practice.
In July 2020, Perishing Square Tontine Holdings (“Tontine Holdings”) became the largest SPAC to ever be floated. It is said to be the most investor-aligned SPAC that sought to eliminate all the distorted incentives within the SPAC structure. Its management compensation structure surprisingly included zero percent shares in the SPAC post-IPO. The sponsors received zero percent direct equity stake in the post-IPO paid up capital of the company. Instead, the sponsors received warrants, i.e., securities that allow the beneficiaries to purchase the company’s shares at a later date at a fixed price. These were purchased at a fairly high price (when compared to average warrant prices among other SPACs), and are only exercisable three years after finalizing the business combination and after there is a 20 percent increase in the share price of the merged entity. The level of commitment shown towards its potential investors by the sponsors of Tontine Holdings is empowering.
Considering the fact that there are very few successes in SPACs and that most of them end up underperforming, more focus on the part of SPAC sponsors is needed. Since mandating that sponsors should have zero direct equity interest in the post-IPO SPAC seems unreasonable, we may consider the alternative of at least not specifying a rather high 20 percent threshold.
Price of sponsors’ shares: In relation to the price at which the sponsors would purchase these shares, clause 73 of the Draft Regulations leaves it open and allows for determining the issue price (for the sponsors, and the public investors, among others) following consultation with the lead manager or through a book-building process.
It is also usual practice in the US that the SPAC sponsors purchase the 20 percent stake at a very nominal price. As the Securities Exchange Commission warned, they are able to obtain the said share of their compensation structure at terms that are more favourable than those offered to the investors in the IPO or other subsequent investors in the open market. Consequently, their interests are misaligned with those of the other SPAC investors. They would derive profits from the business combination regardless of the transaction’s quality. This creates scope for abuse, as the sponsors may be inclined to finalize a transaction with a sub-optimal target company or on terms that are less favourable for the public and subsequent investors.
By excluding crucial limits on the price of the post-IPO equity interest of the sponsors, the Draft Regulations fail to protect the IPO investors and to prevent potential abuse on the part of the sponsors. Bursa Malaysia places a minimum limit on the effective price of securities offered to the management at 10 percent of the IPO issue price. This limit being rather menial, the Malaysian stock exchange also creates an obligation on the SPAC applicant to demonstrate that the discount level offered to the management team is in proportion to its business strategy and the SPAC’s expected returns. It additionally requires the SPAC applicant to include sufficient disclosures regarding the management team’s interests and rewards in the prospectus so that the investors can take an informed decision.
Interestingly, when the Singapore Exchange (“SGX”) sought to bring about some regulations in relation to SPACs in 2010 (and subsequently failed to do so), its consultation paper mentioned that the management team cannot subscribe for shares at a price less than the IPO issue price, thereby seeking to introduce a very stringent limit. However, in the 2021 consultation paper, the SGX makes no mention of any limit on the price of the sponsors’ shares.
The Draft Regulations would benefit from revisiting this issue and from considering some price limitations for the sponsors’ post-IPO equity interest as was done by Malaysia and intended to be done by Singapore in 2010.
Post-acquisition moratorium on the management’s shares
Clauses 85 and 89(3) of the Draft Regulations require the sponsors’ shareholding to not just be locked up until the consummation of the business acquisition but also for another 180 days post such acquisition. A moratorium on the management’s shares post-acquisition would prevent them from actions such as transfer or disposal of such shares, which is a rather commendable move as it helps in keeping the sponsors’ opportunistic behaviors in check.
Bursa Malaysia also mandates for such post-acquisition moratorium, but only in cases where the acquisition in question involves ‘other assets which are not yet income generating’. The period of this moratorium is from the date of listing till the assets generate operating profits for one full financial year and positive cash flow from their operating activities. A re-look at the Tontine Holdings case study reveals that the management self-imposed a post-acquisition moratorium upon themselves until certain favourable conditions arise for the SPAC investors.
However, one cannot guarantee that a blanket 180 days of post-acquisition moratorium of management’s shares would be useful in alleviating investor concerns regarding the SPAC-quality in all cases. Hence, a more open-ended provision is necessary here. Perhaps clause 89 may be amended to say that the IFSCA can decide to extend this period if it deems necessary, considering that some cases would require a longer commitment from the sponsor team. Such an approach was also recommended by the SGX, where a minimum of 6-month moratorium period following the business combination is imposed on the sponsors’ shares. They have made it flexible and may increase that limit depending on its appropriateness.
Like every other jurisdiction’s regulations on SPACs currently, clause 68 of the Draft Regulations states that the IFSCA would determine on a ‘case-by-case basis’ whether or not a SPAC would be listed. It is important to note that the factors for such determination are missing within these regulations. Listing rules of exchanges such as Bursa Malaysia and the NYSE have mentioned such factors, and one of them is the ‘experience and track record’ of the management. In fact, Bursa Malaysia has gone further to include within its rules a dedicated clause mandating competence, skill and trustworthiness of the management team.
Apart from clause 71, where it is stated that the SPAC’s offer document must disclose requisite information about the management’s experience and qualifications, the Draft Regulations do not explicitly discuss sponsors’ experience. To ensure legal certainty and investor-protection, the Draft Regulations may include further mandates on this front.
As has been established throughout this post, the management team of a SPAC is the only asset (of the otherwise cashless and business-less company) that is capable of being valued and closely assessed by both the authorities in question as well as the subsequent investors of the SPAC. Hence, provisions focusing on the same simply cannot be titled towards sponsor interests and must ensure maximum alignment of interests between the sponsors and the investors. This post seeks to draw attention to such relevant clauses within the Draft Regulations and urges all Indian regulatory authorities to take cognizance of this issue if and when they enact laws on listing SPACs in India.
– Anushri Uttarwar