Thursday, August 19, 2021

Professors Jackson & Morley on SPACs

A few days ago, NYU’s Robert Jackson and Yale’s John Morley filed a lawsuit contending that the world’s largest SPAC was actually an investment company and thus subject to the Investment Company Act of 1940.  A copy of the complaint is available here.  The case has also been covered by the D&O Diary and the N.Y. Times.

A few days after the suit was filed, Bill Ackman, the SPAC’s sponsor, announced an intention to return investor funds.  He also took the opportunity to take a swipe at Jackson and Morley:

Why you might ask, would a PSTH shareholder bring such a meritless lawsuit when any shareholder would understand that the mere filing of the lawsuit, and the delays inherent in its resolution, would impair PSTH’s ability to create shareholder and warrant holder value within its remaining term, by interfering with the process of consummating a merger transaction?

While the lawsuit is brought on behalf of a purported shareholder of PSTH, this individual is simply an unwitting prop to enable the academics, and the plaintiff law firms with whom they have partnered, to bring the lawsuit. The two law professors who concocted the legal theory behind the complaint conceded to the press that their motivation in bringing the lawsuit was “to reform” the entire SPAC industry.

As the largest SPAC ever, PSTH is an attractive target in that its scale and visibility maximize media attention for the lawsuit’s claims and the professors’ proposed efforts at reform. . . .

Notably, one of the professors who is leading the suit, Robert Jackson, served as an SEC Commissioner between January 2018 and February 2020. During his more than two-year term as Commissioner, the SEC reviewed and declared effective more than 100 SPAC IPO registration statements, and oversaw dozens of de-SPAC merger transactions. If Mr. Jackson is so sure that SPACs are in fact illegal investment companies, why didn’t he take steps to shut them down while he was an SEC Commissioner

Still, as William Birdthistle has pointed out, the SPAC had largely just held securities for a year after its IPO, making it seem like it operated as . . . an investment company.  Jackson and Morley make this point on the first page of the Complaint:

Under the ICA, an Investment Company is an entity whose primary business is investing in securities. And investing in securities is basically the only thing that PSTH has ever done. From the time of its formation, PSTH has invested all of its assets in securities. And it has spent nearly all of its time negotiating a transaction that would have invested those assets in still more securities.

The Complaint explains that the SPAC compensated its investment manager in a way that would have been impermissible under the Investment Company Act and Investment Advisers Act:

Defendants’ decision to avoid registering the Company as an investment company has allowed them to use their positions of control to extract compensation from PSTH in forms and amounts that violate federal law. Rather than pay reasonable fees and structure them in the standardized and transparent ways required by the ICA and IAA, the Company has paid its investment advisers indirectly, in the form of complex securities of the Company that were never offered for purchase by the Company’s public investors.

It will be interesting to continue to watch the SPAC space to see how things continue to develop.  For now, I’d call this a $4 billion win for Jackson and Morley.

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The Investment Company Act of 1940 and the SEC's rules under it are exceedingly complex. While I am many years away from spending time on investment companies, exemptive and interpretive rules have safe harbors for up to 45% of assets in investment securities as well as definitional exclusions for both government securities and money market funds. We need a '40 Act practitioner to weigh in on this.

Posted by: Craig Sparks | Aug 20, 2021 9:26:14 AM

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