Remarks at Virtual Roundtable on the Future of Going Public and Expanding Investor Opportunities: A Comparative Discussion on IPOs and the Rise of SPACs
April 28, 2022
Thank you Hal [Scott] for that kind introduction and for inviting me to speak today. I am honored to precede such an esteemed panel of practitioners and academics. As always, I must give my standard disclaimer that my remarks are my own and do not necessarily represent the views of the Commission or its staff.
I cannot emphasize enough how important discussions such as today’s are – thinking through some of the most pressing questions in our markets. And, one of those areas is Special Purpose Acquisition Companies, or SPACs. Now, of course, this was an issue that we were paying attention to well before the notice and comment period for the SPAC rulemaking proposal. But nothing takes place in a vacuum, and the meteoric rise in SPACs and the Commission’s proposed rulemaking must be considered in the context of changes in both the public and private markets. So today’s topic is particularly apt. I hope the roundtable will be one of many, and that such discussions will lead to academic work, public input, and engagement from all stakeholders and interested parties.
As you are all aware, the U.S. public markets provide many benefits, including disclosures and safeguards at the offering stage followed by periodic reporting, public trading venues that offer high degrees of liquidity, and an ecosystem of laws and regulations that provide investors with protections and remedies when needed. In 2020, 165 operating companies went public via a traditional initial public offering (IPO). There were a total of 248 SPAC IPOs that same year, meaning roughly 60% of all IPOs were conducted through SPACs. While that level of SPAC activity may not be sustained over the long-term, it is clear SPACs provide an alternative to the traditional IPO model, and may offer some competitive challenges. That’s a good thing. But, perhaps, we need to be careful not to facilitate a race to the bottom in terms of public market protections. And since the boom, the Commission and its staff identified several areas of concern with SPACs. Such concerns include misaligned incentives, several points of dilution that may disproportionately impact retail investors, and a lack of liability that may be creating an unjustified advantage in this path to the public markets over the traditional IPO. The questions and challenges of how to adequately address these concerns in a balanced way remain. And I, of course, look forward to your thoughts and engagement on the SPACs proposed rulemaking.
I noted this a couple of weeks ago during prior remarks, but I think it is a point that bears repeating: there is an ongoing debate about what the right balance is between the public and private markets, and what that means for retail investors. For today’s symposium, we are focused on the balance within the public markets, between the two primary paths to becoming a publicly traded company – SPACs and traditional IPOs. However, these questions of balance within the public markets are really a part of a broader debate about the balance between public and private markets. The private markets are growing, with more companies remaining private for longer, while enjoying more access to private capital than at any time in recent memory. I look forward to the panel, and to the future discussions and research that the panel may generate. But I would encourage the panel to contextualize their discussion about SPACs in light of the growing divide between public and private markets. I will try to do the same, as I highlight some additional observations about SPACs.
In elections for political office, the ideal has been “one person, one vote.” In corporate governance, the ideal that some cite is “one share, one vote.” The shareholder vote is meant to be a key check on management, on whom investors rely to generate returns and manage risks. Shareholders exchange their capital for ownership shares, and depend on a board of directors and management to represent their interests in the operation and decision-making of a corporation. Shareholders generally only vote on a few fundamental events in a corporation’s life, including certain proposed mergers and acquisitions. However, shareholder ownership is often dispersed, which may diffuse the incentives for individual investors to meaningfully participate in corporate governance, and diligence proposed mergers and acquisitions. In SPACs, that lack of incentive to meaningfully participate in governance of the shell company and the selection of a target for de-SPAC may be especially acute.
As you know, early investors in a SPAC IPO are issued “units,” which typically include redeemable shares and a fraction of a warrant. Such units are nominally priced at $10, and a full warrant entitles the shareholder to buy a share at an exercise price at a future date. The shares and warrants usually begin trading separately after a certain period and, typically, investors may only exercise whole warrants, not fractions of warrants. Once the SPAC sponsors identify a target for de-SPAC, there is a shareholder vote. If a de-SPAC is approved by the requisite majority vote, shareholders have the option to hold onto their shares and become shareholders of the de-SPAC’d entity – or, they can redeem their shares. Interestingly, the choice to redeem one’s shares does not impact the ability to vote in favor of completing the de-SPAC. So a shareholder can vote to approve the de-SPAC transaction and redeem their shares to recoup their initial investment plus any interest earned while funds were in the SPAC’s trust, and retain their warrant. In effect, a redemption but vote to approve insulates from downsides, but retains some exposure to upsides through warrants. 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. Data collected indicates that an average of 58% of SPAC IPO shareholders redeemed in 2020-2021, and reporting indicates that redemptions from the first quarter of 2022 are higher.
So what is the problem here? SPACs involve sophisticated sponsors, underwriters, shareholders, PIPE investors, and private operating companies. Some may argue that, even if the voting mechanism is a rubber stamp, diligence of the proposed transaction still occurs at a couple of levels. First by the sponsors and other SPAC related advisors, and then by the PIPE investors who come in at a later-stage. And the SEC has a proposal out that seeks to address these concerns. So why am I talking about SPAC voting today? One reason is that SPACs were not always structured to allow for unlimited redemptions, and observers have noted that 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.
Stock exchanges are self-regulatory organizations and gatekeepers that provide investor and corporate governance protections. As part of that gatekeeping function, the exchanges establish listing standards designed to protect financial markets and the investing public. With regard to SPACs, one exchange formerly had listing standards that required certain redemption thresholds, or really non-redemption thresholds, to be met in order for a de-SPAC’d company to be publicly listed. In other words, a certain amount of shareholders had to stay in order for the de-SPAC’d company to be listed as a public company. At that time, 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. To be clear, the option to redeem is an important investor safeguard, it is one safety valve against potential misaligned incentives between sponsors and shareholders; and illiquidity in shell company shares. The right to redeem should likely be protected. 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. As the Commission’s proposal notes, “cases where…the shareholders are able to vote in favor of a merger but also redeem their shares…could present a moral hazard problem, in economic terms, because these redeeming shareholders would not bear the full cost of a less than optimal choice of target.”
Further, in a scenario of high redemptions, 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. As the SEC’s Office of the Investor Advocate recently noted in public recommendations, current listing standards contribute to “an inherent conflict of interest in the consummation of the SPAC’s proposed business combination…permit[ing] these [de-SPACs] to occur even when assets are depleted by significant exercise of conversion rights, and early investors have economic incentives to allow deals of questionable quality to occur.” Importantly, the Investor Advocate has urged all exchanges that list SPACs to implement a conversion threshold of at least 50 percent, similar to a previous listing standard, to “ensure at least half of the outstanding shares of the SPAC” keep 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.
So as you discuss these issues today, I am curious about your thoughts. 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? 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? Further, I’m 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?
SPACs – The Equity “Complex Product”
Investing in a SPAC IPO share is fundamentally different from investing in equity shares of publicly listed operating companies. The optionality of the redemption, second layer of diligence about the private company that the shell company targets, and potential for dilution, among other factors, add complexities. Calculating the potential for dilution is not straightforward and may be impacted by multiple considerations, including the amount of redemptions, the sponsor’s promote, the equity overhang from warrants, and the negotiating dynamics of the PIPE investors. As one of today’s panelists recently stated, it initially took his colleagues and him eight hours to calculate dilution, which indicates the opaqueness of the dilutive effect and how difficult it may be for investors who choose not to redeem their shares to understand the extent of dilution. A SPAC shareholder must decide whether or not to redeem, in part, given the potential for dilution and the prospects of the future de-SPAC’d company. The Commission’s proposal seeks to address concerns around dilution through enhanced disclosures, including a table showing the potential for dilution based upon percent of redemption, a requirement to disclose each material potential source of additional dilution that non-redeeming shareholders may experience, and greater information about financing arrangements.
Simply stated, SPACs are complex, and some of the purported benefits, such as a cheaper and more efficient path to the public markets for private companies, have been questioned. Studies have found that the cost of going public via SPAC costs may actually be higher than a traditional IPO, indicating that a detailed understanding of the costs and benefits of this avenue to the public markets is not widely agreed upon. Hopefully, the SEC’s proposal, if approved, will provide certainty and disclosure where it is needed most, but I’d be interested to hear further input on how the SEC could ameliorate these concerns. And I will continue to follow the work being done on all these questions.
SPACs & Other Paths
Practitioners, academics, and policy-makers should continue to think holistically about the public markets. As many have pointed-out, an increasing trend is that fewer companies are going public, small- and mid-sized IPOs are less frequent, and companies are staying private for longer. Ensuring that companies, particularly small- and medium-sized companies, have adequate access to the public markets is an important policy objective. It provides investors more opportunities to diversify, more entrepreneurs access to the capital they need, and promotes market integrity and investor protections. The recent SPAC boom raised concerns about the rigor of forward-looking statement disclosures, potential conflicts of interests, and whether adequate liability attached to the key second-phase of a SPAC, the de-SPAC. In some cases, SPACs may have elevated companies to the public markets sub-optimally. One question I will be thinking through is whether this alternative path to the public markets provides unjustified opportunities for legal or regulatory arbitrage when compared to the traditional IPO. In other words, whether the form, an IPO through merger rather than offering, has been elevated over substance.
All of this being said, the traditional IPO process is not free from critique. While there are certain safeguards built into that process, it is well-documented that there are areas of friction and inefficiency with a traditional IPO, including high fees imposed on issuers. As counsel to former Commissioner Robert Jackson, I worked with him on a speech about the middle-market IPO “tax,” describing fees for middle-market companies to go public, which have remained stagnant at 7% for decades. We worked with one of the panelists today to revisit whether the middle-market IPO 7% fee was still observable, and found that from 2001-2016, over 96% of mid-sized IPOs had a spread of 7%. Another area of friction in the traditional IPO is the pricing of the stock. Recent academic work has noted that “IPOs tend to be underpriced, relative to aftermarket prices, and that the underpricing phenomenon is persistent over time and across countries.”
So I am also interested in understanding how we can provide competitive pressure to reduce such frictions. Whether that is through improvements to the traditional IPO or ensuring well-calibrated disclosures and investor protection safeguards are incorporated into alternative avenues such as SPACs and primary direct listings.
Finally, I encourage everyone at this symposium to think about the ever-growing divide between the public and private markets and how the paths to public markets can be improved and made more efficient while preserving key investor and market integrity protections. Part of the underlying problem in many, if not all, discussions about public market paths such as SPACs, is that the public securities markets are declining in terms of overall market share. Increased exemptions to public offering registration requirements have put into place strong incentives to remain private for longer than ever before, and more capital is raised in the private markets than in the public markets. But at what cost? As I noted a couple of weeks ago, the unicorn is no longer a unique or novel creature found in the woods of the private market. Rather, they have become larger and more common, with the largest unicorn valuation exceeding $400 billion. I think we cannot have a conversation about integrity of the public markets, without acknowledging that more capital is raised in the private markets every day, and there are fewer public companies than in recent memory.
I know all of these are difficult, big, questions with no easy answers. But I also know that today’s panelists, and the symposium attendees, are among the individuals that can help us answer these questions.
 See, e.g., Special Purpose Acquisition Companies, Shell Companies, and Projections, Release Nos. 33-11048; 34-94546; IC-34549 at 13-22 (proposed Mar. 30, 2022) [hereinafterthe Release]; Recommendations of the Investor Advisory Committee Regarding Special Purpose Acquisition Companies at 4-5 (Sept. 9, 2021).
 Of course, another path to going public is through primary direct listings.
 See, e.g., McKinsey & Company Global Private Markets Review 2022,Private Markets Rally to New Heights, at 2 & 6, Exh. 1.
 See, e.g., Council of Institutional Investors, Dual-Class Stock (“’One share, one vote is a bedrock principle of good corporate governance.”).
 See Cox, Mondino & Thomas, Understanding the (Ir)relevance of Shareholder Votes on M&A Deals, at 511 (in a sample of 1,620 proposed M&A transactions at US public companies from 1996-2017 only 0.3% of mergers failed a shareholder vote).
 See id; John Coates, The Problem of 12 at 14 (Sept. 20, 2018) (noting that the rise of indexation has led to an indirect concentration of control, and index provides are relatively hands-off in terms of monitoring the governance of the public companies in their portfolios).
 See, e.g., Ghang, Ritter & Zhang at 1.
 See, e.g., id.
 See, e.g., Rodigues & Stegemoller, Redeeming SPACs at 28-32 (U. of Georgia Sch. L. Research Paper No. 2021-09); Eric Ver Ploeg, Tech SPAC Redemption Rates (Jan. 11, 2022) (concluding that an attractively priced transaction, followed up with a well-managed analyst and investor outreach program, has a high probability of achieving a low redemption rate).
 See Klausner, Ohlrogge & Ruan, A Sober Look at SPACs at 19 (ECGI Fin. Working Paper No. 746/2021).
 See Joanna Makris, SPAC Market Review, March 2022, Boardroom Alpha (April 1, 2022) (“Redemptions were 82% in [March 2022], down from 89% in February.”).
 See, e.g., Office of the Investor Advocate, Letter to NASDAQ on listing standards for Special Purpose Acquisition Companies (Apr. 21, 2022) [hereinafter OIAD Letters]; Office of the Investor Advocate, Letter to NYSE and NYSE American on listing standards for Special Purpose Acquisition Companies (Apr. 21, 2022) [hereinafter OIAD Letters]; Rodriguez & Stegemoller at 28-32; Ghang, Ritter & Zhang at 12 (noting that the unbundling of the redemption and voting rights of shareholders contributes to an “incentive to approve a bad merger and redeem their shares, whereas previously, [public shareholders] had an incentive to vote down a bad merger so that they could redeem their shares”)
 See OIAD Letters.
 See id.
 See id.
 See id.
 For a well-articulated analysis and historical background, please refer to the OIAD Letters.
 See the Release at 172 (proposed Mar. 30, 2022).
 Here, SPAC affiliates is a reference to SPAC sponsors and their advisors.
 See Klausner, at 21 (finding that “where redemption rates are high, public equity is often replaced by PIPE investment. In our 2019-20 Merger Cohort, 77% of SPACs had PIPE investments. Of those that did, 83% included third-party investors, 61% raised equity from their sponsor, and 44% raised equity from both sources. Across all SPACs, the mean equity infusion from the total of sponsor and third-party investments at the time of the merger was 40% of the cash a SPAC delivered in its merger. In over a third of SPACs, the majority of cash delivered to targets came from such equity infusions.”).
 OIAD Letters at 11.
 See Rodriguez & Segemoller at 45.
 Professors Rodriguez & Stegemoller notes that SPACs are not equivalent to public companies, “not with respect to liquidity, not with respect to alignment of incentives between large and small shareholders, not with respect to the vetting and disclosure practices the next Section will discuss. Current SPACs claim all the benefits of public markets without providing the liquidity and disclosure we expect from them.” See id. at 45.
 See, e.g., the Release at 36; Ghang, Ritter & Zhang at 2.
 See Klausner, Ohlrogge & Ruan at 22.
 See John Coates, SPAC Law & Myths at 9 (Feb 11, 2022).
 See e.g., Banerjee & Syzdlowski, Harnessing the Overconfidence of the Crowd: A Theory of SPACs, at 32 (Dec. 8, 2021).
 See James Thorn, This Skeptic Exposed Flaws in SPACS. The SEC Listened, PitchBook (Apr. 1, 2022). And now, after writing and publishing a paper detailing the dilutive effects associated with a full life-cycle SPAC, they are able to complete such calculations in two to three hours. See id.
 See the Release at 18, 36-38, 39,
 I certainly have not captured every complexity here. Others include managing warrants. The terms of a given warrant vary across SPACs, but typically warrants have their own redemption date – or date after which the warrants are no longer exercisable and are of no value. Not all brokerage firms notify investors that the deadline to exercise a warrant is on the horizon. The laws governing SPACs are a mix of private contracts, common law, listing standards, regulation, statutory law, and standards with pockets of ambiguity and questions on application. The capital structures can also be complicated, with public warrants, private warrants, forward purchase warrants, and working capital warrants.
 See, e.g., Coates, SPAC’s Law & Myths.
 See Klausner, Ohlrogge & Ruan at 29-31; Ghang, Ritter & Zhang at 5 (“from a private operating company’s point of view, we find that merging with a SPAC is a much more expensive way of going public than a traditional IPO”).
 See, e.g., George Georgiev, The Breakdown of the Public-Private Divide in Securities Law: Causes, Consequences, and Reforms, 18 NYU L. Bus. J. 221, 262, 269-277.
 See, e.g., Rodriguez & Segemoller at 45.
 See Robert J. Jackson, Jr., The Middle-Market IPO Tax, (April 25, 2018) (“[M]y Staff and I asked Professor Ritter to help us take a closer look with more recent data. He kindly worked with us to examine more than 700 middle-market IPOs over a fifteen-year period starting in 2001. We found that the problem he documented years ago has, if anything, gotten worse.As the figure below shows, from 2001 through 2016, we found that over 96% of midsized IPOs featured a spread of exactly 7%.”)
 See Chang, Chiang, Qian & Ritter, Pre-market Trading and IPO Pricing, 30 Rev. Fin. Studies 835 (Mar. 2017).
 To discuss primary direct listings briefly, we only have a small sample size of those direct listings since the Commission approved NYSE’s rule change in late 2020, with an analogue from NASDAQ that followed shortly thereafter. And, while primary direct listings remain another potential avenue for accessing the public markets, it is an avenue that may need further scrutiny. As of today, there have only been a dozen or so primary direct listings, and many of them have been high-profile private companies. This may indicate that the direct-listing option is available or desirable mainly to those companies that can proceed without a robust marketing process, and may not be accessible for a wider range of companies seeking to go public. Further, I remain concerned about the sufficiency of the due diligence on the company in the absence of a firm-commitment underwriter. While there may be benefits to not utilizing an underwriter in the listing process—potentially relating to costs and flexibility, among other benefits—underwriters can also provide an important backstop to ensure a robust diligence process and a thorough registration statement. And, because they bear Section 11 and Section 12(a)(2) liability, they are incentivized to perform their task fully and accurately. Finally, direct listings also raise questions around traceability. Courts have traditionally held that shareholders seeking to recover damages for false or misleading statements in a registration statement must show that the shares they purchased were sold pursuant to the misleading registration statement. But, in direct listings, shares issued pursuant to exemptions (such as Rule 144) and not subject to the registration statement of the newly public company, may be sold immediately following the direct listing. This makes it nearly impossible to determine whether any given shareholder purchased shares pursuant to a registration statement. The question therefore becomes whether these shareholders have standing to sue for misleading registration statements. Last year, in Pirani v. Slack Technologies, 13 F.4th 940 (9th Cir. 2021) the Ninth Circuit held that the plaintiff did in fact have standing to bring Sections 11 and 12 claims even though he did not know if he had purchased registered or unregistered shares in a direct listing. Nonetheless, this was a case of first impression and other courts could weigh in differently on this subject, potentially eroding an important means of holding companies to account for misstatements in direct listings. But, these are just a few of the issues surrounding direct listings, andI would encourage the panel, and all observers, to write, discuss, and engage on these three paths to the public market.
 See, e.g., Office of the Advocate for Small Business Capital Formation 2021 Annual Report at 11; Kat Tretina and Benjamin Curry,The Wilshire 5000: Invest in the Entire U.S. Stock Market,Forbes Advisor (Sept. 9, 2021).