SPACs Have Been Hot and Regulators Have Been Watching

Broker-dealers dealing in SPACs should be mindful of compliance considerations

It’s been difficult over the last six months to get through an entire day without seeing or hearing a news story about “SPACs.”

Special purpose acquisition companies (SPACs) are shell companies that raise capital in initial public offerings (IPOs) for the purpose of merging with or acquiring an operating company following the IPO. SPAC growth this year has already surpassed all of 2020 and is already seven times over that of 2019. In addition, we are seeing more and more highly anticipated companies from WeWork to Vice Media electing to go public via SPAC and many with celebrity endorsements, which is certainly adding to the buzz.

For those focused on compliance and building out the frameworks to mitigate the regulatory scrutiny that usually follows, this may feel all too familiar. Business development companies (BDCs), unit investment trusts (UITs), collateralized mortgage obligations (CMOs), leveraged ETFs, penny-stocks, variable annuities, cryptocurrencies, private placements, and plenty of other types of investment options often go through a roller coaster of popularity, usually followed by intense regulatory scrutiny with some broker-dealers left wishing they would have never entered that market while others appear to pass with flying colors.

So, if you’re a broker-dealer in today’s market and want to get in on the action or perhaps you are already participating, how can you prepare to succeed in this space?

Compliance Areas to Consider Now

First, understand your broker-dealer’s role and the capacity you are (or are looking to) act in. Broker-dealers can underwrite SPAC IPOs or perform other management and investment banking functions on behalf of the SPAC’s sponsor or even the acquisition company. Broker-dealers may also be looking to simply provide their retail and institutional customers with access to the SPAC’s IPO or access to a SPAC’s units, common stock, or warrants that are currently trading on the market post-IPO.

A broker-dealer’s role will largely define its compliance and regulatory obligations, but here are a few considerations to keep in mind:

• Conflicts of Interest: A consistent theme in recent regulatory releases related to SPACs is the unique conflicts of interest that can arise. Broker-dealers need to carefully consider and confirm they have met their regulatory obligations under Regulation Best Interest (Reg BI) and other rules that require mitigation and/or disclosures of certain conflicts of interest.
• Disclosure: Similarly, Reg BI will require disclosures around the unique compensation structure of SPACs and mitigation of the conflicts of interest that can arise as a result. In addition, there are risks unique to SPACs that are explicitly identified by regulators. Failing to confirm a customer receives adequate disclosures in connection with a SPAC recommendation can lead to regulatory issues down the road, especially when a SPAC fails.
• Suitability and Reg BI Considerations: One of these will apply depending on the type of customer. The unique risks and benefits associated with these investments means financial professionals need to understand the securities product they are recommending and feel confident they can meet their care or suitability obligation when making that recommendation.
• Written Supervisory Procedures (WSP): Perhaps the most obvious, given the expected regulatory scrutiny to come, confirming a broker-dealer’s procedures adequately cover all of the obligations above is a must.

In a recent investor insight release from FINRA, the agency mentions conflicts of interest, the speculative nature of the investment, disclosures, and the unique compensation and incentives associated with SPACs. Broker-dealers should feel confident they understand and have addressed these areas before moving forward.

Kaufman Rossin’s Risk Advisory Services team can help broker-dealers establish a sound framework to comply with these obligations. This includes helping to confirm the broker-dealer has identified and mitigated associated conflicts of interest, is providing adequate disclosures, has a framework for meeting Reg BI and suitability obligations, and confirming the firm’s WSP are sufficient to address these obligations. Contact me or another member of our Risk Advisory Services practice for assistance with these and other regulatory compliance matters.