By Ben Woessner 

The last few decades have seen significant debate surrounding the generous compensation of the top executives of publicly-held corporations.  While some view the current system of pay as functional and driven by market forces like scarce executive talent,[1] many watch the upward trajectory of an increasingly disproportionate gap between executive pay and the average American’s salary with equally growing dismay.[2]

Some commentators point to the fact that executive compensation packages have increasingly utilized stock-based compensation to account for the trending upward spiral of executive pay, which may pose a threat to a company by potentially misaligning the interests of its directors with those of its shareholders.[3]  For example, while stock-based compensation attempts to award executives based on stock performance, thereby motivating higher returns to shareholders, it can also incentivize hedging transactions that permit directors to shield themselves from stock declines while still benefiting from compensation.[4]

In response to concerns regarding corporate transparency in the wake of the Financial Crisis of 2008, Congress instituted disclosure reforms through the Dodd-Frank Act of 2010, which, among other measures, included provisions for “clawback” recovery of incentive-based pay awarded on the basis of erroneous accounting reports.[5]  The implementation of a provision of the Act requiring a clawback of executive pay based on inaccurate reports regardless of whether the errors are “due to fraud, error, or any other factor” was delayed until recently.[6]

On Wednesday, October 26, the Securities and Exchange Commission (“SEC”) voted 3-2 in favor of a provision of the Dodd-Frank Act requiring publicly held companies to implement clawback policies to recover erroneously awarded incentive-based compensation paid to directors, even where the director had no responsibility over the inaccurate accounting statement.[7]  The new rule will require exchanges to “prohibit the listing of issuers that do not develop and implement policies to recover erroneously awarded incentive-based compensation.”[8]  These policies will be triggered whenever companies are forced to issue financial restatements for later-discovered accounting errors and will apply to compensation awarded up to three years from the policy’s implementation.[9]

The SEC intends the rule to “return erroneously awarded compensation to the issuer and its shareholders.”[10]  In so doing, the Commission hopes to realign the interests of executives and shareholders by increasing corporate accountability regarding the distorted incentives potentially created by stock-related forms of incentive-based compensation.[11]

However, the clawback rule may suffer from overbroad definitions that potentially undercut its goals to align executive and shareholder interest.  The first of these definitions concerns what qualifies as an accounting restatement that would trigger a recovery of incentive-based compensation.  Under the original proposal of the rule, only “Big R” restatements, or those that are “material to previously issued financial statements,” would trigger a clawback.[12]  However, the newly adopted rule also requires recovery of pay after so-called “little r” restatements—those that correct nonmaterial errors that could constitute material errors if left unreported.[13]

While the SEC hopes that including both material and immaterial restatements will incentivize executives to assert more control over accounting, thereby reducing instances of accounting error and allowing shareholders to put greater trust in the financial reporting of a company,[14] the rule contains another expansive definition that potentially undermines this goal.  The rule’s definition of “executive officer” not only includes the President, CFO, and principal accounting officer, but also “any other officer who performs a policymaking function.”[15]  As a result, even individuals who may have no actual control over the company’s compliance with accounting rules, and therefore no practical way to ensure greater accountability, are at risk of a compensation clawback.[16]

Furthermore, the clawback rule includes an expansive definition of what qualifies as incentive-based compensation that is subject to recovery if a company issues a financial restatement, including “any compensation that is granted, earned, or vested based wholly or in part upon the attainment of any financial reporting measure.”[17]  Therefore, at-risk compensation could include not only bonuses and equity-based compensation, but also nonqualified deferred compensation and long-term incentive compensation, so long as it is granted at least in part on the attainment of a financial reporting measure.[18]

Accordingly, critics of the rule argue that companies are likely to significantly decrease the amount of at-risk incentive compensation offered to executives, who will instead elect for a compensation restructuring to retain executive talent with higher salaries or increased discretionary bonuses unrelated to performance goals.[19]  Such restructuring would tend to go against the very heart of the clawback rule’s purpose—while clawbacks hope to align executive and shareholder interests through increased accountability, a shift away from performance-based compensation altogether may untie executive incentives from stock performance to the shareholder’s detriment.

When the rule goes into effect in about one year, the increasing trend toward shareholder activism may serve to keep potentially detrimental compensation restructuring in check.[20]  In fact, at least one study has shown that clawback policies required by the new rule are popular with shareholders as demonstrated by positive stock returns for companies following the initial 2015 announcement of the newly adopted clawback rule.[21] Nevertheless, in addition to being “burdensome to administer,” the rule may increase the divide between executive and shareholder interests as a result of its sweeping definitions, raising doubts as to whether its proposed benefit will outweigh its costs.[22]


[1] See generally Randall S. Thomas, Explaining the International CEO Pay Gap: Board Capture or Market Driven?, 57 Vand. L. Rev. 1171 (2004).

[2] Josh Bivens & Jori Kandra, Economic Policy Institute, CEO Pay Has Skyrocketed 1,460% Since 1978 (2022), https://www.epi.org/publication/ceo-pay-in-2021/.

[3] Luis A. Aguilar, Aligning the Interests of Company Executives and Directors with Shareholders, Harv. L. Sch. F. on Corp. Governance (Feb. 16, 2015), https://corpgov.law.harvard.edu/2015/02/16/aligning-the-interests-of-company-executives-and-directors-with-shareholders/.

[4] Id.

[5] Gary Gensler, Statement by Chair Gensler on Final Rules Regarding Clawbacks of Erroneously Awarded Compensation, Harv. L. Sch. F. on Corp. Governance (Oct. 30, 2022), https://corpgov.law.harvard.edu/2022/10/30/statement-by-chair-gensler-on-final-rules-regarding-clawbacks-of-erroneously-awarded-compensation/.

[6] Id.

[7] Paul Kiernan, Accounting Errors to Cost Executives Their Bonuses Under SEC Rule, Wall St. J. (Oct. 26, 2022), https://www.wsj.com/articles/sec-to-vote-on-rule-to-claw-back-executive-pay-11666792822.

[8] Sec. & Exch. Comm’n, Listing Standards for Recovery of Erroneously Awarded Compensation 125 (2022), https://www.sec.gov/rules/final/2022/33-11126.pdf.

[9] Id. at 86.

[10] Id. at 80.

[11] Id.

[12] Id. at 28.

[13] Meredith O’Leary et al., What SEC Bonus Clawback Rule Means For Public Cos., Law360 (Nov. 1, 2022, 4:52 PM), https://plus.lexis.com/newsstand#/law360/article/1545558?crid=719884c7-8ae5-4c53-95a7-cbe621d17e6d.

[14] Id.

[15] Id.

[16] O’Leary et al., supra note 13.

[17] Sec. & Exch. Comm’n, supra note 8, at 57.

[18] O’Leary et al., supra note 13.

[19] Kiernan, supra note 7.

[20] Id.

[21] Id.

[22] O’Leary et al., supra note 13.

By Michael J. Riedl

 

Shaquille O’Neal.  Patrick Mahomes.  Serena Williams.  Alex Rodriguez.  No, this is not a reading of the guest list at the 2021 ESPY Awards,[1] but rather a list of athletes on the management or advisory boards of various Special Purpose Acquisition Companies (“SPACs”).[2]  SPACs, far from a novel financial vehicle,[3] grew to prominence over the past few years as record numbers of SPACs listed on exchanges across the globe.[4]  The capital flooding into SPACs reached a high watermark when investor William Ackman raised $4 billion for his fund, Pershing Square Tontine Holdings (“PSTH”), in July 2020.[5]  However, issuance[6] dramatically slowed towards the end of 2020,[7] and the valuation of SPACs both pre- and post-business combination fell precipitously.[8]

In a nutshell, SPACs are capital vehicles for purchasing equity ownership in a private company and then bringing that company public through a business combination.[9]  SPACs raise money through a fairly traditional Initial Public Offering (“IPO”), with a few key differences.[10]  Unlike a traditional IPO, in which the company uses the proceeds from the issuance for further growth or expansion, SPAC IPO proceeds are held in a trust account until a merger with a private company occurs.[11]  Additionally, most SPACs issue warrants (the right to purchase shares of the SPAC at a certain price)[12] at the time of the IPO to investors and SPAC sponsors.[13]  Lastly, because SPAC IPOs are not taking an existing company public at the time of IPO, reporting and regulatory requirements are significantly lessened.[14]

In the early stages of the SPAC resurgence, both issuance and post-business combination valuation remained healthy.[15]  For example, after combining with VectoIQ Acquisition Corp.,[16] the hydrogen vehicle start-up Nikola soared to a market capitalization of $34 billion—on almost no revenue.[17]  However, investors soon learned that Nikola’s groundbreaking hydrogen truck was rolling downhill in a demonstration and not moving on its own power.[18]  Nikola’s CEO at the time, Trevor Milton, was subsequently indicted for securities and wire fraud.[19]  In addition, the “SPAC King,” Chamath Palihapitiya, who has led ten SPAC IPOs,[20] ran into significant investor pushback after the Securities and Exchange Commission (“SEC”) launched an investigation into one of his SPAC combinations.[21]

Outside of the concern about the quality of the companies that SPACs are bringing public,[22] the decline in SPAC activity may result from a change in guidance from the SEC,[23] recent investor behavior,[24] and an uptick in shareholder litigation.[25] On April 12, 2021, the SEC issued guidance that the warrants issued by a vast majority of SPACs should be classified as liabilities on financial statements, not as equity instruments.[26]  This guidance was based on the consideration that, when sponsor warrants are transferred by sponsors to non-sponsors, their settlement price changes in ways not indexed to the SPAC’s underlying price.[27]  This change in guidance led to a rush of SPACs to file Form 8-Ks to update their previous filings.[28]

More recently, SPACs have been hit by a wave of redemptions prior to business combination.[29]  SPACs are required to offer shareholders the ability to redeem their shares before the official merger between the entities for a pro-rata share of the money in the trust account.[30]  This requirement has been said to make SPACs a relatively low-risk investment, at least before business combination.[31]  For example, a shareholder who purchased ten shares of a SPAC IPO priced at ten dollars per share can redeem their shares for one hundred dollars pre-combination.  However, in recent months, redemption rates have skyrocketed, with some SPACs seeing redemption rates over 50 percent, and Sandbridge Acquisition Corp. (“SBG”) having a redemption rate of 86 percent.[32]  Curiously, these redemptions are happening after shareholders—many of whom will later redeem—approve the business combination.[33]  One can only assume that investors want to get their money out of the SPAC as quickly, and at as high of a price, as possible.

Besides the apparent effects on investor sentiment, one consequence of the high redemption rate is that the amount of money held in trust by some SPACs have fallen below the minimum capital requirement set by the SPAC.[34]  Because investors can redeem their shares for the cash held in trust prior to business combination, a minimum capital requirement is typically structured into SPAC mergers to allow the target company an “out” when the capital they were expecting to get no longer exists.[35] For example, SBG, with its 86 percent redemption rate,[36] was $125 million short of its minimum capital requirement.[37]  However, the company they merged with, Owlet Baby Care, Inc., waived the capital requirement  in order to consummate the deal.[38]  For investors that did not redeem, this meant they were left owning equity in a company with significantly less capital to grow their business.[39]  Should the high redemption trend continue, it might further be a headwind on new SPAC issuance, since investors may lack confidence in SPACs and private companies may see SPAC mergers as increasingly risky.

Lastly, and perhaps most importantly, shareholders are beginning to bring derivative suits against SPACs.[40]  Most actions have been brought regarding falling share prices, where investors allege that the company mislead investors.[41]  However, after Mr. Ackman’s fund, PSTH, failed to acquire an equity stake in Universal Music Group due to the likelihood of violating SEC regulations,[42] an investor brought suit alleging the fund was an “Investment Company.”[43]  Such a lawsuit, according to Mr. Ackman, will “have a chilling effect on the ability of other SPACs to consummate merger transactions or to engage in IPOs until the litigation is resolved.”[44]

At the heart of the suit is whether Mr. Ackman’s fund, and SPACs writ large, is an Investment Company as classified by the Investment Company Act of 1940, 15 U.S.C. §§ 80a-1 to 64.[45]  The plaintiff’s lawyers allege that PSTH invested in short-term U.S. Treasuries which qualifies them as an Investment Company.[46]  If so, the sponsor warrants and other compensation structures that are ubiquitous in the SPAC industry could be found to violate the Investment Company Act.[47]  In a rebuke to this assertion, fifty-eight of the largest law firms in the world signed a joint statement stating that they “view the assertion that SPACs are investment companies as without factual or legal basis.”[48]  It is the view of the collective firms that SPACs are “engaged primarily in identifying and consummating a business transaction,” not a company that is “primarily, in the business of investing, reinvesting or trading in securities.”[49]

Regardless of how the merits of the lawsuit turn out, it has already affected Mr. Ackman’s SPAC, as he plans to return the $4 billion that he raised.[50]  However, Mr. Ackman is already looking to create another capital vehicle called a Special Purpose Acquisition Rights Company (“SPARC”).[51]  Unlike a SPAC, which requires investors to purchase shares at an IPO, a SPARC does not require such an investment.[52]  A SPARC issues warrants which grant rights, but not obligations, for warrant holders to purchase shares in a proposed future business combination.[53]  This has the benefit of allowing investors to put their capital to work in other investments while the SPARC seeks a merger target.[54]  Whether or not this new capital vehicle gets approved is ultimately up to the SEC and the New York Stock Exchange.[55]  However, one thing is clear, even if the SPAC boom has officially faded, sophisticated investors will continue to financially engineer capital vehicles to pursue business combinations.


[1]See Press Release, Isabelle Lopez, ESPN, Nominees Announced for The 2021 ESPYS Presented by Capital One as Fan Voting Begins, (June 16, 2021) https://espnpressroom.com/us/press-releases/2021/06/nominees-announced-for-the-2021-espys-presented-by-capital-one-as-fan-voting-begins/.

[2] Amrith Ramkumar, The Celebrities From Serena Williams to A-Rod Fueling the SPAC Boom, Wall St. J. (Mar. 17, 2021, 5:32 AM), https://www.wsj.com/articles/the-celebrities-from-serena-williams-to-a-rod-fueling-the-spac-boom-11615973578.

[3] See Devin Sullivan, A Look at SPACs: From the 90s to Covid-19, IR Magazine (Aug. 11, 2020), https://www.irmagazine.com/small-cap/look-spacs-90s-covid-19.

[4] Id.

[5] Tomi Kilgore, Billionaire Bill Ackman Has a $4 Billion ‘Blank Check’ to Buy a Company, but He Hasn’t Said Which One, MarketWatch (July 23, 2020, 7:40 AM), https://www.marketwatch.com/story/billionaire-bill-ackman-has-a-4-billion-blank-check-to-buy-a-company-but-he-hasnt-said-which-one-2020-07-22.

[6] Adam Hayes, Issue, Investopedia, https://www.investopedia.com/terms/i/issue.asp (Aug. 30, 2021).

[7] See Ben Scent, Wall Street’s $100 Billion SPAC Boom Upends the League Tables, Bloomberg, https://www.bloomberg.com/news/articles/2021-04-01/wall-street-s-100-billion-spac-boom-is-resetting-the-rankings (Apr. 1, 2021, 4:10 PM).

[8] Yun Li, SPACs are becoming less of a sure thing as the deals get stranger, shares roll over, CNBC, https://www.cnbc.com/2021/03/04/spacs-are-becoming-less-of-a-sure-thing-as-the-deals-get-stranger-shares-roll-over.html (Mar. 4, 2021).

[9] Ramey Layne & Brenda Lenahan, Special Purpose Acquisition Companies: An Introduction, Harv. L. Sch. Forum on Corp. Governance (July 6, 2018), https://corpgov.law.harvard.edu/2018/07/06/special-purpose-acquisition-companies-an-introduction/.

[10] Id.

[11] Id.

[12] James Chen, Warrant, Investopedia, https://www.investopedia.com/terms/w/warrant.asp (Aug. 8, 2021).

[13] Joel L. Rubenstein et al., Clarity Emerges in the Aftermath of the SEC Statement on SPAC Warrant Accounting: A Roadmap for the Changes to Permit Equity Classification, White & Case LLP (June 1, 2021), https://www.whitecase.com/publications/alert/clarity-emerges-aftermath-sec-statement-spac-warrant-accounting-roadmap-changes.

[14] Layne & Lenahan, supra note 9.

[15] See Nicholas Jasinski, Why Nikola Decided to Merge With a SPAC. And Why More Such Deals Are Coming., Barron’s (Aug. 2, 2020, 8:00 AM), https://www.barrons.com/articles/after-the-sept-11-attacks-how-barrons-helped-investors-navigate-a-changed-world-51630604795.

[16] Press Release, Nikola Corporation, Nikola and VectoIQ Acquisition Corp. Announce Closing of Business Combination (June 2, 2020), https://nikolamotor.com/press_releases/nikola-and-vectoiq-acquisition-corp-announce-closing-of-business-combination-77.

[17] Edward Ludlow & Craig Trudell, Nikola May Not Be Next Tesla, But Its Valuation Is More Extreme, Bloomberg, https://www.bloomberg.com/news/articles/2020-06-09/meet-nikola-a-26-billion-electric-truck-maker-with-no-revenue (June 10, 2020, 11:15 PM).

[18] Timothy B. Lee, Nikola Admits Prototype Was Rolling Downhill in Promotional Video, Ars Technica (Sept. 14, 2020, 1:58 PM), https://arstechnica.com/cars/2020/09/nikola-admits-prototype-was-rolling-downhill-in-promotional-video/; see also Nikola: How to Parlay An Ocean of Lies Into a Partnership with the Largest Auto OEM in America, Hindenburg Rsch. (Sep. 10, 2020), https://hindenburgresearch.com/nikola/.

[19] Michael Wayland, Grand Jury Indicts Trevor Milton, Founder of Electric Carmaker Nikola, on Three Counts of Fraud, CNBC, https://www.cnbc.com/2021/07/29/us-prosecutors-charge-trevor-milton-founder-of-electric-carmaker-nikola-with-three-counts-of-fraud.html (July 29, 2021, 4:16 PM).

[20] David Pogemiller, Chamath and Social Capital’s 4 New SPACs IPO Today, TheStreet, https://www.thestreet.com/boardroomalpha/spac/chamath-spac-king-dnaa-dnab-dnac-dnad-ipo (June 30, 2021) (NASDAQ: DNAA, DNAB, DNAC, DNAD; NYSE: IPOA, IPOB, IPOC, IPOE, IPOD, IPOF).

[21] See Zeke Faux, The SPAC King Is Doing Just Fine Even as the Bubble Starts to Burst, Bloomberg Businessweek (Mar. 13, 2021, 5:00AM), https://www.bloomberg.com/news/features/2021-05-13/spac-king-chamath-palihapitiya-hopes-his-hype-will-keep-mesmerizing-you.

[22] Li, supra note 8.

[23] Yun Li, SPAC Transactions Come to a Halt Amid SEC Crackdown, Cooling Retail Investor Interest, CNBC, https://www.cnbc.com/2021/04/21/spac-transactions-come-to-a-halt-amid-sec-crackdown-cooling-retail-investor-interest.html (Apr. 22, 2021, 9:35 AM).

[24] See infra note 29 and accompanying text.

[25] See infra note 40 and accompanying text.

[26] John Coates & Paul Munter, Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”), SEC (Apr. 12, 2021), https://www.sec.gov/news/public-statement/accounting-reporting-warrants-issued-spacs.

[27] Rubenstein et al., supra note 13.

[28] See Coates & Munter, supra note 26.

[29] David Pogemiller, A SPAC Risk Exposed?, TheStreet (July 16, 2021), https://www.thestreet.com/boardroomalpha/spac/spac-risk-exposed-redemptions-sponsor-promote.

[30] Layne & Lenahan, supra note 9.

[31] See Pogemiller, supra note 29.

[32] Id.

[33] David Drapkin, Spring Valley / AeroFarms Need More Capital, TheStreet (Aug. 30, 2021), https://www.thestreet.com/boardroomalpha/spac/spacs-sv-snooze-september.

[34] Pogemiller, supra note 29.

[35] See Pamela Marcogliese et al., 20 Key Considerations for Private Companies Evaluating Whether to Be Acquired by a SPAC, Freshfields Bruckhaus Deringer LLP (July 27, 2020), https://blog.freshfields.us/post/102gcbg/20-key-considerations-for-private-companies-evaluating-whether-to-be-acquired-by.

[36] See Pogemiller, supra note 29.

[37] See Sandbridge Acquisition Corp., Current Report (Form 10-K, Item 8.01) (July 14, 2021) (At a special meeting of stockholders, 19,758,773 shares of common stock were presented for redemption, which left $15 million of “Available Sandbridge Cash.” The agreement with Owlet Baby Care, Inc., provided Owlet the option to leave the deal if, after redemption, Sandbridge did not have $140 million in cash.).

[38] See Sandbridge Acquisition Corp., Current Report (Form 10-K, Exhibit 99.1) (July 14, 2021), https://sec.report/Document/0001140361-21-024354/brhc10026886_ex99-1.htm.

[39] See Pogemiller, supra note 29.

[40] Jean Eaglesham, SPACs Are Having Their Day—in Court, Wall St. J. (Aug. 25, 2021, 7:00 AM), https://www.wsj.com/articles/spacs-are-having-their-dayin-court-11629889200.

[41] Id.

[42] Thomas Seal & Nishant Kumar, Ackman Abandons Universal Music SPAC Deal After SEC Backlash, Bloomberg, https://www.bloomberg.com/news/articles/2021-07-19/pershing-square-decides-not-to-proceed-with-universal-music-deal (July 19, 2021, 8:49 AM).

[43] Complaint at 6, Assad v. Pershing Square Tontine Holdings, Ltd., No. 1:21-cv-06907 (S.D.N.Y.  Aug. 17, 2019), ECF No. 1.

[44] Press Release, William A. Ackman, CEO, Pershing Square Tontine Holdings, Ltd., Pershing Square Tontine Holdings, Ltd. Releases Letter to Shareholders (Aug. 19, 2021), https://pstontine.com/wp-content/uploads/2021/08/8.19.2021-Press-Release-PSTH-Letter-to-Shareholders.pdf.

[45] Assad, supra note 31, at 6.

[46] Id. at 10–11.

[47] Id. at 43, 47.

[48] Press Release, Sidley Austin LLP, Over 55 of the Nation’s Leading Law Firms Respond to Investment Company Act Lawsuits Targeting the SPAC Industry (Aug. 30, 2021), https://www.sidley.com/-/media/update-pdfs/2021/08/joint-statement.pdf?la=en.

[49] Id.

[50]Ackman, supra note 44, at 2.

[51] Andrew Ross Sorkin et al., Bill Ackman’s SPAC Deal Gets Messier, N.Y. Times, https://www.nytimes.com/2021/08/20/business/dealbook/bill-ackman-spac-sparc.html (Aug. 20, 2021).

[52] Id.

[53] See, e.g., Press Release, Pershing Square Tontine Holdings, Ltd., Pershing Square Tontine Holdings, Ltd. (“PSTH”) to Acquire 10% of the Ordinary Shares of Universal Music Group (“UMG”) from Vivendi S.E. for Approximately $4 Billion, Representing an Enterprise Value of €35 Billion (June 20, 2021), https://pstontine.com/wp-content/uploads/2021/06/Final-Announcement-Press-Release-6.20.2021.pdf.

[54] Id. at 5.

[55] Sorkin et al., supra note 51.


Post image by Ken Teegardin on Flickr