Suit against William Ackman's SPAC raises questions for all SPACs

New York

PERSHING Square Tontine Holdings, the special purpose acquisition company run by the billionaire hedge fund investor William A Ackman, was sued on Tuesday in federal court. The novel case could have far-reaching implications for the SPAC industry.

The suit was filed in US District Court for the Southern District of New York on behalf of a SPAC shareholder by Robert Jackson, a former commissioner of the Securities and Exchange Commission, and John Morley, a law professor at Yale. It contends that Mr Ackman's SPAC isn't an operating company, but is actually an investment company like Mr Ackman's funds, which should be regulated by the Investment Company Act of 1940. If certain SPACs were regulated as investment companies, much of the industry could be affected because it would make it harder for anyone in the investment business to participate in a SPAC.

A SPAC is a public shell company formed to acquire and operate a private company. This lets a private company go public with less scrutiny than a traditional initial public offering. Many SPACs are started by professional investors with investment businesses that contribute services to the SPAC, like Mr Ackman and his hedge fund, Pershing Square Capital Management.

SPACs are already under fire from regulators who have pledged to tighten protections for investors, and they face a rising number of class-action lawsuits by aggrieved shareholders. Around 600 SPACs have gone public over the past year, and SPAC-linked merger deals worth more than US$700 billion have been announced over that time.

Securities law experts have raised questions about whether SPACs are used as a means to avoid the more onerous rules that apply to investment funds. The lawsuit highlights this increasingly common complaint.

"Investing in securities is all the company has ever done since its IPO," the complaint says of Pershing Square's SPAC. Simply buying some stock is not what a SPAC is meant to do, the lawsuit argues. Yet Mr Ackman negotiated a stock deal between his SPAC and Universal Music Group. (He originally pursued a merger.) The arrangement was complicated, with the Pershing Square SPAC spending US$4 billion to buy a 10 per cent stake in the company, which was already being taken public by its parent, Vivendi. The SEC questioned the terms, which raised concerns that Mr Ackman's SPAC was not a SPAC at all.

Mr Ackman abandoned the Universal Music deal last month, admitting in a letter to investors that he had underestimated regulatory and shareholder resistance to the complex transaction. But the new lawsuit asks the court to declare that Pershing Square's SPAC is an investment company, and to find that it was deliberately mischaracterised to avoid legal requirements to the detriment of investors. The suit is also seeking to rescind contracts worth hundreds of millions of dollars to members of the company's board.

If successful, the lawsuit could make professional investors who have found SPACs attractive wary of potential legal challenges, chilling the market. Proving damages will be difficult because the Universal Music deal was scrapped. But more importantly, perhaps, the case tries to address underlying issues about the motivations of some SPAC sponsors. And its analysis of the meaning of investing in securities - part of any merger or acquisition - raises existential questions about the purpose and treatment of SPACs in general.

The irony is that Pershing Square's SPAC was more investor-friendly than most. The SPAC was structured so that its sponsors would be paid only if its deal proved successful over time. Most other SPACs give sponsors shares and warrants that pay out regardless of the performance of the company after a merger.

A spokesman for Pershing Square's SPAC said in a statement that the "litigation is totally without merit" and that the SPAC had never held securities that would require it to register as an investment company, nor did it have any plans to do so in the future. NYTIMES