After a meteoric rise in the first half of 2021, the super-SPAC Pershing Square Tontine Holdings ("PSTH") has come crashing down to earth. In the wake of PSTH's failed bid to acquire a stake in Universal Music Group, disgruntled PSTH investor George Assad filed suit asserting, among other things, violations of the Investment Company Act of 1940 (the "ICA"). Litigation over SPACs that fail to live up to their hype may not be uncommon, but PSTH has an unusual ally in this case: a group of individual investors, purportedly recruited from the website Reddit, who filed an amicus brief arguing that Assad's suit is nothing more than an attempt to supplant the SEC's regulatory authority and that no reasonable investor would have viewed PSTH as an investment company. Setting aside the legal merits of the claims of Assad and the amici, the individual investor amicus brief highlights an important question relating to the regulation of SPACs: Are retail investors systematically disadvantaged in SPAC transactions, and will the SEC pursue closer regulation of SPACs as a result?
Background
PSTH was once the darling of the SPAC world. Led by Bill Ackman, the billionaire founder and CEO of hedge fund Pershing Square Capital Management, PSTH was the biggest SPAC in the world, valued at over $4 billion. PSTH pitched itself as different from other SPACs: it would collect no fees, ostensibly allowing retail investors to participate on relatively equal footing with the deep-pocketed players (such as institutional investors) that SPACS traditionally attract. But it all went south in the summer of 2021 when Ackman announced that PSTH would depart from the SPAC playbook and, rather than engage in a merger, would instead acquire a 10% stake in Universal Music Group. The SEC, however, quickly raised serious concerns about the structure of the proposed acquisition, and PSTH dropped the proposal, announcing that it would look for another target. The value of PSTH has since cratered, falling below the $20 redemption price. Retail investors were particularly hard hit by the failed bid, with a number losing hundreds of thousands or even millions of dollars on call options. Even with the security of the $20 floor, many retail investors who did not get in at the $20 IPO price realized losses that were significantly higher than those experienced by institutional investors who got into the deal at the ground floor.
The Lawsuit
PSTH now faces a legal challenge brought by investor George Assad, a Massachusetts stockbroker in an action brought in the United States District Court for the Southern District of New York before Judge Analisa Torres. Assad, a serial plaintiff in federal securities complaints, has filed similar lawsuits against two other SPACs – GO Acquisition Corp. and E.Merge Technology – and is represented in all three cases by a team that includes well-known securities law professors John Morley of Yale and former SEC Commissioner Robert Jackson, now a law professor at NYU. In the PSTH suit, Assad alleges that PSTH is an investment company and should have registered as such under the ICA and that PSTH's directors received compensation in violation of the ICA and the Investment Advisor's Act. The suit contends that PSTH's practice (widespread among SPACs) of placing proceeds reaped after going public into a trust which in turn holds government securities (and money market funds that invest in government securities) breached the ICA, as did the lucrative sponsor shares available to directors and sponsors.
While the merits of the claim are being adjudicated, some big players have come out in support of PSTH, with 49 law firms signing a memo issued by law firm White & Case entitled "SPACs are Not Investment Companies." PSTH has also garnered the support of a group of 62 individual investors, who filed an amicus brief in support of Pershing Square's motion to dismiss, characterizing Assad's suit as a misguided attempt to usurp the SEC's authority to regulate SPACs and arguing that reasonable investors (such as themselves) do not view or treat PSTH as an investment company. The amicus brief – and Assad's response to it – offers insight into a fundamental critique of SPACs that animates Assad's claims: that SPACs disadvantage retail investors while lining the pockets of sophisticated investors and directors.
The Individual Investor Amicus Brief and its Implications
The individual investor amicus brief was signed by 62 individual PSTH shareholders, purporting to offer the court the perspective of ordinary, individual PSTH shareholders, a perspective that carries some weight with the court given that, when evaluating whether a company is subject to the ICA, courts give great weight to the beliefs the company is likely to induce in its investors. Whatever the value of the amici's legal arguments, the brief sparked controversy because of its unusual origins. Specifically, Assad alleges that the signatories were recruited to the cause from the internet forum Reddit by the investor relations department of PSTH's investment advisor, and that the brief was written by an attorney handpicked by PSTH. Attaching pages of conversations from Reddit in which purported signatories say things such as "[d]on't even really understand what I'm doing here," Assad contends that the individual investor amicus (and its signatories) fundamentally misunderstand the issues in the case, reflecting the general lack of sophistication of retail investors, particularly in comparison with institutional investors.
That Reddit is taking a star turn in this complex securities case is perhaps not terribly surprising: Redditors (as users of the forum are known) dominated the financial news a year ago when the site was instrumental in the GameStop short squeeze. The connections between PSTH and the Reddit-led GameStop frenzy don't stop there: Many retail investors who profited from the GameStop affair poured their earnings into PSTH, which was being talked up by Redditors as the next big thing. The Reddit connection to both the GameStop phenomenon and the rise and fall of PSTH raises questions about an issue that has troubled SEC Chairman Gary Gensler for some time: the gamification of investing and the negative impact of the phenomenon on retail investors. For example, in a report issued on October 18, 2021, the SEC noted that the gamification of certain online trading platforms encourages retail investors to engage in more frequent trades, often to their detriment (but to the benefit of the platform), and suggests that further consideration is warranted of the gamification of such platforms. It is conceivable, therefore, that the amici's efforts to support PSTH in this case may have the (unintended) consequence of suggesting to the SEC parallels between the GameStop phenomenon and SPACs that might invite rather than discourage closer regulation. And indeed the SEC has already taken some steps toward tightening regulation on SPACs in a manner that could bear directly on the litigation under discussion. On March 30, 2022, as discussed elsewhere in this Issue, the SEC issued proposed rules for SPACs that would permit SPACs to continue to enjoy exemption from the ICA, but only under certain conditions. While the notice-and-comment period for the proposed rules is still open (and is scheduled to run until at least May 31, 2022), and while the impact, if any, of a rule change on the PSTH ligation is unclear, SEC action is coming, and soon.
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