Managing Directors’ and Officers’ Personal Liability as SPAC Fever Pitch Continues
In 2018, 46 IPOs by special purpose acquisition companies (SPACs) were listed on US exchanges, raising a total of $10.8 billion, according to databases at SPACInsider.com. The SPAC frenzy has continued this year, with 27 SPACs listed through June, putting 2019 on pace to at least match — and most likely exceed — last year. But with this increase in offerings comes greater scrutiny from investors — and, ultimately, the plaintiffs’ bar — that could put directors’ and officers’ personal assets at risk.
Limited Indemnification as Class Action Numbers Grow
Often described as “blank check” companies, SPACs raise capital from the public via initial public offerings (IPOs), which is then held in trusts used to complete the acquisition of existing privately held entities. Over the last decade, corporate sponsors have increasingly used SPACs to enable mergers and acquisitions.
Unlike traditional businesses, SPACs generally do not have robust balance sheets that can indemnify directors and officers in the event they are named in litigation. The 27 SPACs that have completed IPOs so far this year had an average of just over $1 million in cash on hand, according to a Marsh analysis of public S-1 filings. That’s well below the average settlement and defense costs for a traditional securities class action.
SPAC trusts also cannot be used to indemnify directors and officers, meaning that directors and officers could be forced to dip into their own pockets to cover such costs at a time when the threat of litigation is growing. 441 federal securities class actions were filed against public companies in 2018, according to NERA Economic Consulting. That’s the highest number since 2001, and it comes on the heels of 434 class actions filed in 2017 — a significant jump from the annual average of 228 for the prior 10 years. These lawsuits highlight the liabilities that SPACs and their directors and officers could face, arising from:
- Representations made within IPO road shows, S-1s, and quarterly and annual filings.
- Due diligence and business combination proxy filings.
- Ongoing operations of post-combination entities.
Crafting Your D&O Program
A well-designed insurance program can protect the personal assets of directors and officers when a SPAC is unable to indemnify them. In building a directors and officers (D&O) liability policy specifically for a SPAC, directors and officers should seek to obtain:
- Broad personal assets protection coverage.
- Coverage for alleged violations of the Securities Act of 1933, Securities Exchange Act of1934, Dodd-Frank, and Sarbanes-Oxley.
- Coverage for regulatory investigations.
- Policy terms that line up with a SPAC’s due diligence period.
- Pre-negotiated tail coverage for claims brought after completion of a business combination.
- Coverage for indemnity owed to sponsor entities and underwriters named in suits.
- Coverage for claims brought by prospective targets and PIPE investors.
As organizations continue to use SPACs to deploy capital, directors and officers must consider the implications for them personally. An effective D&O policy can address potential liabilities and exposures, allowing organizations to use SPACs with confidence and continue to take advantage of the bull market.