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Checks for Conflicts of Interest are an absolutely essential part of the due diligence process in any De-SPAC transaction. While much attention has been focused on potential conflicts of interest between SPACs and their underwriters, there is more to worry about for the current vintage of open SPACs. The reasons why are not limited to:
Enforcement risks. The U.S. Securities Exchange Commission (SEC) has limited protections for directors & officers of SPACs if there is a conflict of interest, even if the conflict of interest is contained within the De-SPAC target. SEC Chair Gary Gensler has stated that lies by acquisition targets will "not absolve [the SPAC] of its failure to undertake adequate due diligence to protect shareholders". The sense that conflicts of interest are an enforcement priority was signaled in a December 2020 Disclosure Guidance by the SEC highlighting the need for disclosure of conflicts of interest, and was reinforced in a April 2021 statement by the SEC's Acting Director of the Division of Corporate Finance John Coats that the liability around SPACs may be higher "due in particular to the potential conflicts of interest in the SPAC structure". Precedents were set for SPACs more than a decade ago in re Stillwater Capital Partners Inc. Litigation, when the government alleged a violation during a de-SPAC transaction of Section 10(b) and Rule 10-b for failing to disclose related-party transactions.
Shareholder lawsuits risks. In Kwame Amo v. MultiPlan Corp the plaintiffs alleged that the SPAC failed to mitigate conflicts of interests in the de-SPAC process, which was described as "deeply flawed and unfair".
To avoid bad outcomes, SPAC executives and their advisors must demonstrate they have performed at least the same level of due diligence checks for Conflicts of Interest that a prosecutor or short seller would.
This De-SPAC Conflict of Interest Checks Guide details the tools available to enforcement officials and short sellers, and frames an approach for SPACs to demonstrate performance of conflicts of interest checks prior to completing de-SPAC transactions.
Material or significant companies in any de-SPAC acquisition may include the target company itself or any corporate shareholder who, in the words of the SEC's Gensler stands "to earn significant profits from a SPAC merger". Material or significant companies in any de-SPAC acquisition may also include third party suppliers or customers, even scientific partners.
Red flags for conflicts of interest are companies with hidden ownership, pass-throughs where a real company has one major customer, and unequal bidding processes.
Here is how a government investigator might think about the issue, when examining if a de-SPAC target had conflicts of interests:
"The conflict-of-interest entity is a legally created company and provides the services or goods as described on [an] invoice. The conflict of interest is based on an undisclosed legal or beneficial ownership of the company. The conflict-of-interest entity may operate as a shell company or as a real company with an undisclosed or legal or beneficial ownership conflict-of-interest company. In [the] first situation, the conflict of interest may have only one customer. In the second situation, the conflict-of-interest entity is in the business of providing services to the entire business community."
Leonard Vona, Fraud Data Analytics Methodology.
One way to protect against enforcement risks and shareholder lawsuit risks is to demonstrate due diligence with an independent search for conflicts of interest at the corporate level, which may require a bit of additional digging into key personal relationships.
In most major developed economies, from the United States and Canada to the United Kingdom and even China, the names of key shareholders, directors and officers of companies is publicly available information. This means enforcement officials have access to this information, and short sellers and shareholder litigants do too. So, this information needs to be pulled - ideally by an independent professional.
For which entities?
De-SPAC Target Company
Corporate Shareholders of the de-SPAC Target
Key Vendors to de-SPAC Target
Key Customers of de-SPAC Target
Other Significant Enterprises
Some follow-up research by an experienced professional will be necessary, to carefully identify key individuals associated with these entities, and some cross referencing of their own additional directorships and shareholding interests, in order to get a solid view of potential conflicts of interest.
Remember: Enforcement Officials & Short Sellers Have Access To Sophisticated Systems & Analytics Tools
Because enforcement officials and short sellers and class action / securities lawyers have access to sophisticated systems and analytics tools, it is essential for SPAC executive management and their advisors to demonstrate that all of the information collected in the de-SPAC conflicts of interest check is subjected to analysis and isn't just compiled into a 'data dump'. The results should be reviewed and discussed and followed-up on.
These are exactly the types of activities our team performs in every conflicts of interest check.
To further reduce risks of bad outcomes from undiscovered conflicts of interest, additional rounds of research focused on key individuals are essential.
Remember: Enforcement Officials & Short Sellers Know How To Search Social Media & Review People's Employment, Education & Personal Ties
Checking and cross checking for potential conflicts of interest through enhanced social media and public profile due diligence is a good thing to do. Too often there is low-hanging fruit found on-line that is overlooked. In today's enforcement and investment environment, SPAC directors and their advisors will be expected to have checked for indications of conflicts of interest online. Social media is widely used, and individuals' employment, education, and personal ties are identifiable online, so, an enhanced social media and public profile due diligence should look for this data and then perform in depth analysis to highlight commonalities. The clues might be overlapping addresses... or a shared work history... even Telegram groups. Where records research like this identifies commonalities, follow-up research should be performed - possibly through interviews.
Our team regularly performs this type of work.
Conflicts of Interest checks are available in:
Greater China (Hong Kong, Macau, Mainland, Taiwan)
Puerto Rico & Caribbean
Other areas upon request.
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I-OnAsia specializes in due diligence assignments at the instruction of corporate counsel, external legal advisors, lawyers, barristers and solicitors. I-OnAsia is recognized by Chambers.
To learn more about our SPAC and De-SPAC enhanced due diligence services, visit our website.