If you need proof that no good deed goes unpunished, look at Luminar Technologies. Like so many other companies in recent years, it went public through a SPAC merger. But when it did the right thing and posed an accounting question to the Securities and Exchange Commission, according to the Wall Street Journal, its query led to a regulatory response that has put the entire SPAC craze on pause.
Craze is not overstating it. SPACs have already raised $100 billion this year, and 550 of them have filed to go public. It’s only April, and both of those numbers surpass annual records that were set just last year. Alas, the SPAC fever may have been broken, at least in part, by an April 12 statement from the SEC that slaps a cold washcloth onto the financial statements of SPACs.
The issue deals with the accounting treatment of warrants. Before they identify and merge with a target company, SPACs are little more than empty shells – great on the seashore, no doubt, but not terribly attractive investments. To entice investors in their IPOs, SPACs typically bundle their stock with “warrants,” which function much like stock options and allow early investors to cash in big if the SPAC proves successful. SPACs have always accounted for those warrants as equity, but no longer.
As the SEC’s acting chief accountant Paul Munter and acting director of the division of corporation finance John Coates declared in their April statement, under certain conditions warrants should be treated instead as liabilities. The obvious questions, of course, are what exactly those certain conditions are and how common are they. With regard to the former, we’ll let the legal types at Cooley explain them in detail, but they have to do with the indexing of warrants to the stock (a prerequisite for classifying the warrants as equity) and tender offers. Regarding the latter, apparently pretty common. The SEC delicately noted that certain terms are “common across many entities.”
The implications feel serious. For one thing, existing SPACs might have to restate their financials, at least if any necessary correction of their accounting treatment of warrants is material. For SPACs waiting to go public, the party is at least temporarily over. The SEC has paused approvals, with some 260 would-be SPACs already backed up in line to go public.
And that’s not even the only sobering news SPACs have received. There’s a separate issue with forward-looking statements made by SPACs, which, like warrants, can drum up investor interest. Conventional wisdom has held that SPACs can make forward-looking statements about their mergers under the protection of a statutory safe harbor (from the Private Securities Litigation Reform Act of 1995), which shields companies that discuss performance expectations in connection with mergers. But in a separate April 8 statement, Coates questioned that wisdom, noting that the PSLRA safe harbor only protects companies from private litigation, not SEC action.
That development, at least, can’t be attributed to Luminar Technologies. In fact, while it has been hard to notice, the entire SPAC momentum may have been cooling off since February. That’s when one SPAC ETF hit an all-time high. It’s down 25% since.