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SPACs and Personal Liability for Teams. What’s the Risk?
by Kristi Marvin on 2019-06-21 at 1:47pm

Given just how many SPACs we have in the market right now (and with a few trading pretty strangely), we spoke with Andrew Pendergast, at Marsh, a provider of D&O insurance, to help get a better sense of the risks associated with being part of a SPAC team.  Read on for his take on the personal liability landscape.


As SPAC Activity Heats Up, Directors and Officers Must Consider Their Personal Liability

By Andrew Pendergast, SPAC Practice Leader, Marsh

Special Purpose Acquisition Companies (SPACs) have enjoyed a resurgence in the past few years and now account for approximately 20% of all IPO issuance.  In fact, there were 46 SPACs listed on US exchanges in 2018, raising a total of $10.8 billion. With 27 SPACs listed so far through June, 2019 is on pace to at least match 2018, and most likely exceed it. With this increase in offerings comes greater scrutiny from investors, the SEC — and, ultimately, law firms trolling for plaintiffs.

While the number of suits brought against SPACs and their directors is still low in comparison to traditional public companies it appears we are hitting an inflection point. This year, we have seen SPAC directors and officers face suits alleging wrongdoings brought by shareholders, potential targets during the due diligence process and even minority shareholders of those targets. SPAC Directors and Officers need to consider the potential risks they face and how to appropriately protect their personal assets in the event of a claim.

Risks for Directors and Officers

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, and are still searching for a target, have an average of just over $1 million in cash on hand, according to a Marsh analysis of public S-1 filings. That’s below the median settlement and defense costs for a traditional securities class action; see the chart from NERA, a Marsh & McLennan company, below. Additionally, the funds raised via the IPO held in SPAC trusts cannot be used to indemnify directors and officers.

 

MEDIAN SECURITIES CLASS ACTION SETTLEMENT VALUES FOR ALL PUBLICLY TRADED COMPANIES

Marsh graph 1

Source: NERA Economic Consulting, Recent Trends in Securities Class Action Litigation: 2018 Full-Year Review

More than 430 federal securities class actions were filed in 2017 and 2018 against public companies, more than double the number of filings in 2014, according to NERA Economic Consulting. 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.

To give you an example, let’s say you are the CEO of a SPAC that files its proxy informing shareholders about a proposed transaction and the shareholders subsequently file a securities class action naming you and the SPAC itself alleging misrepresentations made within the 8-k. Regardless of whether or not the allegations have any merit you will need to defend yourself.  Your first line of defense against your personal assets being tapped to pay for defense counsel is the indemnity owed to you by the SPAC. Given today’s rates for defense counsel, the $1M in cash on hand at most SPACs may not last long. This is where a D&O Insurance policy comes in to bridge the gap. If indemnity is available from the SPAC, the policy will protect the balance sheet by stepping in and paying defense and settlement owed to the D&Os on the SPACs behalf. More importantly, if indemnity is not available from the SPAC, the policy will pay defense and settlement on behalf of the directors and officers from dollar one.

While we haven’t seen a claim against a SPAC result in a significant settlement recently it will be interesting to keep an eye on the claims filed against SPACs this year given the increased focus by the SEC and law firms.

Building an Effective D&O Program

A directors and officers (D&O) liability policy, manuscript to cover the unique exposures of a SPAC, is intended to  protect the personal assets of directors and officers and the balance sheet of the SPAC. In building a D&O program specifically for a SPAC, directors and officers should seek to obtain:

  • Broad personal assets protection coverage with no deductible.
  • Coverage for claims brought by prospective targets, shareholders of those targets and PIPE investors.
  • 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 against the SPAC brought after completion of a business combination.
  • Coverage for indemnity owed to sponsor entities and underwriters named in suits.

More often than not the cost of insurance stated within the S-1 is simply a placeholder copied from previous SPAC S-1 filings with no due diligence done on the actual state of the marketplace. You’ll note that SPAC S-1’s from 2019 are using the same cost noted in SPAC filings from 2005 while the cost and scope of coverage has changed dramatically. Additionally, SPACs generally buy lower limits than their public company peers while facing many of the same exposures and the potential for investor losses. SPACs raising $250M-$350M buy on average $10M of total limits while public companies with similar market caps buy anywhere from $30M to in excess of $50M according to Marsh’s proprietary peer benchmarking.  SPACs and their bankers should be consulting with insurance experts prior to releasing their filings to ensure they are not caught off guard by what a policy actually costs.

As the use of SPACs as a means to deploy capital continues to grow, it’s important for directors and officers to consider the implications for them personally. Your liability as a director and officer doesn’t end when you resign from the board as suits can still name you for actions taken while you were a member. A well-crafted D&O policy can address the liabilities and exposures discussed in this article, allowing organizations and individuals to deploy SPACs with confidence.

 

Additional Securities Class Action Statistics:

 

FEDERAL SECURITIES CLASS ACTION FILINGS FOR ALL PUBLICLY TRADED COMPANIES

Marsh graph 2

 

Marsh graph 3

Source: NERA Economic Consulting, Recent Trends in Securities Class Action Litigation: 2018 Full-Year Review

For more on SPAC risk and Marsh’s SPAC risk specialists, visit Marsh’s SPAC specialist page or contact Andrew Pendergast.

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