by T. GormanPosted on Posted in SECActions

SPACs are popular investment vehicles. The number of IPOs involving these investment vehicles has increased significantly in recent years. For example, from 2019 to 2021, the number has increased by about a factor of 10. Yet not long ago these investment vehicles were called “blank check” entities because investors purchased shares not based on valuing the business the firm may be in but rather who will pick the business – the only business of the blank check company has is to invest the money entrusted to the vehicle by the public in a business selected by the insiders. That contrasts sharply with the traditional IPO.

While the number of IPO’s involving SPACs has increased, the Commission has made it more than clear that these vehicles are not favored. In recent remarks Chair Gensler discussed his views of these vehicles. Gary Gensler, Remarks Before the Healthy Markets Association Conference, Washington, D.C., December 5, 2021 (here).

Mr. Gensler began with what he called a basic public policy point: Like cases should be treated alike. Yet, the structure of SPACs, which differ from that of the traditional IPO, can create investment pitfalls for investors. For example, typically the sponsors have two years to find an investment vehicle for the merger which ultimately launches the actual business of the firm. In addition, before the ultimate merger is consummated, there is typically another round of financing, often through a PIPE offering involving institutional investors. Then, if a deal is located the initial investors have an opportunity to cash out at the IPO price. Collectively, these steps can result in misaligned interests and conflicts.

Chair Gensler highlighted concerns regarding SPACs after detailing the points above. First “there is inconsistent and differential disclosure among the various parties involved . . .” by virtue of the fact that different investor groups join the deal at different points. There are initial investors, later PIPE investors and still later the merger investors. These asymmetries can create issues.

Marketing practices used by SPACs can also create issues. The deals are often launched with “a slide deck, a press release, and even celebrity endorsements.” This is not necessarily the kind of full disclosure that investors need.

Finally, there are questions about who is performing the role of gatekeepers. In the traditional deal the issuer often works with the investment banks and underwriters. In contrasts, there may be some “who attempt to use SPCs as a way to arbitrage liability regimes.” This is not really the way to handle the obligations of a gatekeeper – Chair Gensler made it clear that nobody gets a “pass” on doing this.

Comment

Chair Gensler presented a series of serious concerns regarding SPACs. At the same time, if the disclosure is adequate so that investors can assess the issues what is the proper role for a disclosure agency like the Commission?

While a SPAC- blank check company launches with less disclosure than traditional a IPO, and perhaps more investment dangers despite adequate disclosures, this may simply be another way to say that the vehicles are very high risk and thus not for the average main street investor. That is the same problem with many very complex investment vehicles however– the disclosure is adequate but many investors still suffer large losses from the risks. This point is will illustrated by a number of recent cases bought by the Commission. In the end, there are instances when disclosure is not really enough. The question of how to solve that issue in the context of the federal securities laws presents a most difficult puzzle.

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by T. GormanPosted on Posted in SECActions

Financial fraud has long been a key focus of SEC enforcement. Traditionally, many of the cases brought followed from restatements of the financial statements. Since a restatement is predicated on an admission of an error by the issuer followed by the issuance of new, corrected financial statements, the follow-on case by the SEC was straight forward.

In recent years, however, the agency has often had difficulty developing financial fraud cases. Frequently new cases were developed from data analytics and other sources. Those cases were often more difficult to develop that those stemming from the traditional model. The most recent case of the agency in this area, however, represents a combination of approaches – the scheme was uncovered following a letter from the staff which was followed by a restatement. SEC v. American Renal Associates Holdings, Inc., Civil Action No. 21-cv-10366 (S.D.N.Y. Filed December 6, 2021).

The action names as defendants: the company, a firm whose shares are listed on the NYSE and provides dialysis services; Jonathan Wilcox, a CPA who served as the firm’s CFO for a period; Jason Boucher, a CPA who served as the VP of Finance and CFO for a period; and Karen Smith, a CPA who served as VP of Finance for a period.

Over a period of about 18 months, beginning in 2017, Defendant’s manipulated the revenue of the firm by making what they called “top side” adjustments. American Renal operated by partnering with documents who required renal services. Under the terms of the partnerships the physicians furnished the medical services. American Renal provided accounting and bookkeeping services, a business model that facilitated the scheme.

Since American Renal could not always estimate the amount various insurance carriers would pay for the services, the amounts were estimated in two steps. The initial estimate was what the firm called a “contractual allowance.” The later adjustments could be positive or negative, depending on the circumstances. It was called a “top side” adjustment.

The adjustments made at the second step were not based on patient level data. Rather, a variety of other metrics were used to adjust the revenue. In the end, however, after all the adjustments the revenue was sufficient to hit the pre-determined metrics. In addition, the increases ensured payments to the individual defendants – and were inconsistent with the firm’s internal controls which required patient level data.

The scheme to adjust revenue was discovered after the company received an inquiry from the Commission staff. At that point the company was forced to undertake a restatement of the firm’s financial statements for 2017 and the first three quarters of 2018. The restatement acknowledged a weakness in internal controls. The complaint alleges violations of Securities Act Section 17(a), Exchange Act Sections 10(b), 13(a) 13(b)(2)(A), 13(b)(2)(B), 13(b)(5) and Sox Section 304(a).

The company settled with the Commission, consenting to the entry of permanent injunctions based on the Sections cited in the Order except Exchange Act Section 13(b)(5). The case is pending as to each of the individual defendants. See Lit. Rel. No. 25282 (December 6, 2021).

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