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SEC Puts SPACs on Notice for More Regulations to Protect Investors

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The financial world was aflutter in early April when the Securities and Exchange Commission took aim at special purpose acquisition companies (SPACs), saying additional regulations are necessary to protect less sophisticated individual investors.

Proposed regulatory changes that would tighten reporting and disclosure requirements to bring them into alignment with initial public offering (IPO) standards were well-received by investors. Since their introduction into the business world, SPACs have earned a dodgy reputation with moves like stingy disclosures and overhyped potential.

When a SPAC is created, retail investors provide cash to a shell company without knowing precisely what they are investing in. The administrators establish basic parameters, such as a sector of interest or a $50-million valuation for the acquisition target, but usually do not reveal specific targets of interest or acquisition dates up front. Investors may choose to withdraw from the fund when the details are announced or stay in with implied benefits of early equity. When the targeted privately owned company merges with the publicly traded shell company, the deal bypasses established IPO reporting requirements, effectively allowing shareholders to get in on the ground floor of a company that may not be viable.

Detractors call SPACs blank-check companies, because that’s how investors’ contributions are treated under existing regulations. SPAC investments are extremely risky, because while returns may be impressive with an undervalued acquisition, investors stand to lose part or all of their contribution if the target does not live up to projections or shares are diluted in subsequent capital raises. Another issue, according to Viridian Capital Advisors: There are more cannabis SPACs than there are potential targets that meet their criteria; consequently, five of eighteen SPACs within the past year merged into other industries. To overcome that speed bump, SPAC administrators sometimes cobble together a deal consisting of several smaller businesses. The resulting conglomeration might be more powerful than an existing entity, or it might combine operations in a way that doesn’t make a lot of sense.

The proposed new rules would require SPACs to disclose conflicts of interest, potential dilution of early shareholders’ equity, and many other aspects involved in the routine scrutiny of initial public offerings but currently not applied to SPAC transactions.

But the reverse mergers have a special place in the cannasphere, which is filled with capable entrepreneurs and promising small companies that cannot access capital through traditional means. Fifty years of prohibition means publicly traded companies and federally chartered banks will not or cannot do business with plant-touching entities. Blue-chip hedge funds, which would rather make money than case law, also are sitting out these early days.

Although the first proto-SPACs began trading in the late 1990s, the instrument hit its heyday between 2019 and 2020 as more states began to legalize medical and adult-use cannabis. That enthusiasm is softening.

It’s not just scrappy small businesses hoping to gain cash and secure their reputations by trading on an American stock exchange. Weedmaps, the Los Angeles-based company that began as an online directory of marijuana deliveries and dispensaries, merged with publicly traded Silver Spike Acquisition Corp. in June 2021 with a NASDAQ valuation of $1.5 billion. The listing — oversubscribed by 300 percent — brought Weedmaps $580 million and was one of the rare SPACs that immediately made money for investors. Shares in April were trading well below the fifty-two-week high of $22.24, but analysts consider the stock among the industry’s sturdiest. Moving forward, Weedmaps plans to continue its expansion into international markets.

One factor likely to blunt the SEC’s proposed regulations: The U.S. agency does not have jurisdiction over Canadian companies, and a large percentage of the industry’s reverse mergers trade on Canada’s exchanges.

By Betsy Pisik

Originally published at https://mgretailer.com/business/finance-acquisitions/the-sec-puts-spacs-on-notice-for-more-regulations-to-protect-investors/ on May 9th, 2022.

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