Our First SPAC Enforcement Action

Well that’s one way to crash and burn: the SEC has charged a SPAC and the space technology company it was trying to acquire with misleading investors about the deal’s proposed risks — including national security questions raised about the space company’s founder — ahead of a proposed merger next month. 

The tale is rather nuts, and emblematic of the risks that SPAC deals pose these days. We have a SPAC firm, Stable Road Acquisition Corp., under pressure to find a private operating company it could acquire quickly. The private company in question, Momentus Inc., is a startup with an unproven technology for spaceship propulsion. The CEO of Momentus, Mikhail Kokorich, is a Russian national who couldn’t get proper security clearances from U.S. regulators to run a space technology, while lying about the technology itself, which didn’t work, the SEC says. 

Like I said, a story for our times. 

This is the first SEC enforcement action against a SPAC (special purpose acquisition company), although SEC officials have warned for some time that SPACs are a risky niche of the capital markets. So compliance officers, corporate lawyers, and entrepreneurs should take a close look at what went haywire here, to avoid a similar fate befalling your own organization.

First, a refresher. SPACs are holding companies that raise piles of cash from investors via an IPO first, and go hunting for operating companies to acquire later. The merged business is then reborn as a publicly traded operating company, leap-frogging over the tortuous steps that a private company usually takes in a traditional IPO.

If the SPAC can close a deal quickly, its sponsors get rich. On the other hand, if the SPAC can’t find an acquisition target within 18 months of its IPO, the SPAC and its sponsors must — heavens protect us! — give the money back to investors. 

Lots of money has poured into SPACs, especially since the start of this year. See Figure 1, below. 

Source: Calcbench

With so much money chasing relatively few promising private company targets, that creates the temptation to do a deal quickly, before your 18-month window closes or a competitor SPAC swoops in with a better offer. Corners get cut; red flags are ignored; needed disclosures go unspoken.

Which brings us back to the Stable Road and the spaceship company.

False Statements, Due Diligence Failures

As outlined in the SEC settlement order, Stable Road and Momentus announced a merger agreement in October 2020. As part of that deal, Stable Road also lined up $175 million in additional private investment in the venture, which is a fairly routine part of SPAC acquisitions. Those private investors would purchase 17.5 million shares of the company’s stock at $10 a share after the deal was consummated, targeted for sometime in summer 2021.

Momentus’s business plans and multi-billion dollar revenue projections, as provided to PIPE investors and described in Stable Road’s SEC filings, were premised on Momentus developing a commercially viable space propulsion technology known as a ​​microwave electro-thermal plasma thruster. 

Such technology does indeed exist in theory. According to the SEC, however, Momentus and Stable Road lied about the success of their plasma thrusters in practice: they told investors Momentus had successfully tested the technology in 2019 to move around a satellite in space, when in fact the test had failed. 

Second, the SEC said, Momentus and its CEO Kokorich made false statements about national security concerns that U.S. regulators had over Kokorich running a space technology business. Kokorich resigned from the company in January 2021 to resolve the issue (he lives in Switzerland these days), but “investors lacked material information about the extent to which Kokorich’s affiliation with Momentus jeopardized, among other things, the company’s launch schedule and the revenue projections,” as the SEC said. 

Here’s the key point in the SEC complaint:

[Stable Road]’s due diligence of Momentus was conducted in a compressed timeframe and unreasonably failed both to probe the basis of Momentus’s claims that its technology had been “successfully tested” in space, and to follow up on red flags concerning national security and foreign ownership risks. As a result, [Stable Road]’s public filings, including registration statements signed by [CEO Brian Kabot], incorporated Momentus’s and Kokorich’s false and misleading claims and caused investors to be misled about material aspects of Momentus’s business.

Ultimately, Momentus and Stable Road agreed to settle the SEC charges for $7 million and $1 million in civil penalties, respectively. Stable Road CEO Brian Kabot also agreed to pay a $40,000 penalty. (All three parties, naturally, neither confirm nor deny the accusations against them.) The SEC is pursuing its case against Kokorich in court. 

Stable Road also agreed to forfeit 250,000 in “founder’s shares” it would have received upon completion of the merger, and those private investors putting up $175 million now have rights to terminate their participation before the deal is approved. The merger itself apparently is still scheduled to proceed in August, although last month Stable Road cut the value of the deal in half

What Can a SPAC Learn Here?

If you’re a SPAC hunting for an acquisition target, slow down and do your homework. Hire the right specialists to help you perform due diligence on an acquisition target and get a true understanding of the risks involved. 

In Stable Road’s case, the SPAC originally hoped to acquire its way into the cannabis business. By June 2020 those efforts hadn’t succeeded, so Stable Road pivoted to any early-stage venture that seemed promising. The company settled on Momentus. 

Stable Road did hire a space technology consulting firm with the expertise to investigate Momentus’s technology; but didn’t hire that firm until the end of August 2020, about five weeks before announcing the proposed merger on Oct. 7, 2020. Amid that compressed time frame, Stable Road never asked the consulting firm to examine Momentus’ failed real-world test in 2019 — and ended up passing along Momentus’ false statements about the test to investors. 

As I read the SEC’s settlement order and lawsuit against Kokorich, I couldn’t help but think of the Delaware Supreme Court’s ruling about corporate governance duties in its Marchand v. Barnhill decision from 2019, more commonly known as the Blue Bell Ice Cream decision. In that case, the court reaffirmed that corporate board directors need to pay attention to the business risks that are critical to the organization.

A SPAC’s sole purpose is to acquire an operating company and take it public. In that case, therefore, performing solid and reliable due diligence and passing the results along to investors is the critical task. Providing sufficient time to do that work is part and parcel of the SPAC’s responsibility.

We should also note that the SEC warned everyone about liability risks for SPAC deals, specifically in a statement in April from John Coates, then acting director of the Division of Corporation Finance (Coates is now the SEC general counsel):

It is not clear that claims about the application of securities law liability provisions to de-SPACs provide targets or anyone else with a reason to prefer SPACs over traditional IPOs. Any simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst. Indeed, in some ways, liability risks for those involved are higher, not lower, than in conventional IPOs, due in particular to the potential conflicts of interest in the SPAC structure.

Huh. If I didn’t know any better, I’d think more enforcement actions against slipshod SPAC deals are on the way. Imagine that.

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