Welcome back to the Big Law Business column on the changing legal marketplace written by me, Roy Strom. Today, we look at the potential for a flood of lawsuits against blank-check companies. Sign up to receive this column in your Inbox on Thursday mornings.
Stanford Law Professor Michael Klausner’s legal push aimed at showing SPACs are a rip-off for everyday investors is going as well as he could have hoped. And some fear it’s going too well.
Klausner and Grant & Eisenhofer lawyers won a ruling last week allowing their case against a SPAC, GigCapital3 Inc., to move toward trial.
The Delaware Chancery Court ruling essentially rubber-stamped Klausner’s conclusions about the murky economics of special purpose acquisition companies. I profiled his research into the vehicles in September.
Klausner’s victory is important because his criticisms are applicable, in varying degrees, to every SPAC merger—and there were lots of them.
There were 301 completed SPAC mergers in 2021 and 2022, valued at more than $650 billion, according to SPAC Research. Virtually all those companies’ shares have performed poorly post-merger, a factor that would help lawyers calculate potential damages.
Among nearly 250 completed SPAC deals as of mid-2022, only four were trading above their initial offering price, according to Valuation Research Corp.
But it’s an open question if plaintiff’s firms will bring a wave of similar cases based on Klausner’s research.
Delaware Vice Chancellor Lori Will asked the law professor if the upshot of his claim was that there had been “a massive, industrywide breach of fiduciary duty.”
Klausner told the judge that three lawsuits he’s involved in are the only similar cases he’s aware of, and he doesn’t expect the courtroom will be “flooded” with lawsuits.
But others are sounding the alarm. The lawyers defending “Gig3” argued in court that a win for Klausner will lead to a deluge of lawsuits.
Perrie Weiner, chair of Baker McKenzie’s North America securities litigation practice, put it this way: “This decision will be the full employment act for lawyers and judges in Delaware.”
Nowhere Near $10
Klausner argues that Gig3’s deal to merge with an electric car manufacturer denied shareholders crucial information to help them make arguably the most important decision SPAC investors face: whether to cash out their investment or roll it into a business acquisition.
The information they lacked stems from the way SPACs compensate “sponsors” who set up the deals. The insiders receive “warrants”—essentially free shares in the new company.
Klausner’s research systematically calculates the cost of those warrants across dozens of SPACs. He says the free shares dilute the value of the shares sold to other investors—which in the SPAC world, crucially, are almost always $10 apiece.
What he found was that while SPACs sell shares for $10, only about $5 or $6 goes toward purchasing a target company—and that is rarely clearly disclosed. Klausner calls this the SPAC’s true “cash per share.”
He is talking about the basic structure of SPACs. It is not unique to GigAcquisitions3 or the other two SPACs Klausner has targeted—GigCapital2 and Pivotal Investment Corp. II. (Rulings in both those cases have not been issued.)
But his research was persuasive.
“If Gig3 had less than $6 per share to contribute to the merger, the proxy’s statement that Gig3 shares were worth $10 each was false—or at least materially misleading,” Vice Chancellor Will wrote in her ruling.
Defense counsel argues Gig3 had disclosed the amount of cash it held and the number of shares that would be issued. But it had not disclosed Klausner’s cash-per-share figure.
“If that’s a viable disclosure claim, every SPAC has a viable disclosure claim against it,” DLA Piper partner Ronald Brown III said, according to a transcript.
In the second oral argument, for the Gig2 case, Brown joked that his appearance was like the movie Groundhog Day, noting Bill Murray’s character relived the same day for seven years.
“I think that’s about as many cases as you will have if plaintiff is successful here,” Brown said, according to the transcript.
Klausner acknowledged it’s true that no SPAC would spend 100% of the money it raised buying a private company—it must pay banking and lawyer fees, for instance.
But he pushed back on the idea that there would be seven years’ worth of SPAC lawsuits.
He argued there is some threshold where dilution becomes a “material” disclosure, and that the SPACs he targeted had crossed that line more clearly than almost any other. Investors might not be concerned about small amounts of dilution, he said.
For instance, he said Gig2’s net cash per share was below $5 when shareholders were asked to redeem their shares or roll their investment into a business acquisition.
“With respect to Gig2 and Gig3, the multiple sources of dilution and dissipated cash were either poorly disclosed or undisclosed entirely, all the time while stating that the shares are worth $10,” Klausner argued in court. “So Gig2 is an extreme. That’s why we’re here.”
Plaintiff’s Bar Challenges
Of course, Klausner won’t decide if other lawyers show up at the Delaware courthouse. That will be decided in part by the economics of the plaintiff’s bar.
Plaintiff’s lawyers face two challenges in bringing these claims, Stanford Law Professor Joe Grundfest said in an interview. (He is admittedly partial to his colleague Klausner’s work—calling him the “Ace of SPACs.” But he is also an expert in securities litigation and its plaintiff’s bar.)
One challenge is finding lead plaintiffs, which may prove difficult considering the large investment houses or pension plans that typically play that role did not invest in SPACs.
The other is finding SPACs that were big enough to support big damages claims.
“If the plaintiff’s bar can find the sweet spot—a cohort of plaintiffs who have standing combined with SPACs that will generate sufficient damages—then there is more business here,” Grundfest said, adding that a settlement was likely in the Gig3 case.
“The larger the settlement,” he said, “the more litigation we can expect.”
Baker McKenzie’s Weiner urged the Gig3 defendants to appeal the ruling. Otherwise, he said, the “exacting standard” it applied sets forth a rubric that will “suffocate this whole opportunity for the capital markets and M&A markets.”
“Every plaintiff lawyer is going to stare at SPACs, and when they’re trading at less than $10 a share, you can bet they’re going to bring copycat lawsuits,” Weiner said.
Worth Your Time
On Cozen O’Connor: The law firm’s CEO said in a Bloomberg Law interview that he’s ready to make big investments if there’s a recession. That got jump-started this week when the firm inked sponsorship deals with the PGA Tour’s Brendon Todd and LPGA Tour player Ally Ewing.
On FTX: Sullivan & Cromwell is the wrong firm to lead FTX’s bankruptcy case because the firm’s prior work for the crypto exchange raises impartiality concerns, four US senators said. Justin Wise has the story.
On Layoffs: Stroock & Stroock & Lavan became the latest firm to announce layoffs, separating with nine lawyers and 18 staff.
On Latham: Not everybody’s tightening the belt. Latham & Watkins has been on a hiring spree early in the year, bringing on two corporate partners from Cahill, a former federal judge in Chicago, and the former adviser to the chair at DLA Piper, Joseph Alexander.
The firm is looking to add “opportunistic” hires, said Marc Jaffe, head of its New York office. “Are there other people we’re pursuing? Absolutely,” Jaffe said. “We are bullish from a long-term perspective.”
That’s it for this week! Thanks for reading and please send me your thoughts, critiques, and tips.
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