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SPACS: Due Diligence Forensic Approach to Minimize Litigation Risk

March 29, 2021

What are SPACs and why have they increased in popularity?

SPACs are becoming a storm like no other; and this storm has no end in sight. They have increased in popularity with private and public traders, and new SPACs appear overnight. This deluge has seen a corresponding increase in securities litigation cases against SPACs.


Since 2019, 15 securities litigation cases were filed against SPACs, including five new cases in 2021 alone. SPAC litigation has centered on allegations of material misstatements or the wrongful omission of information from proxy statements and prospectus filings during the acquisition process. SPACs can seek to mitigate litigation risk by engaging accounting experts to perform a forensic review as part of the legal due diligence process.

What are SPACs?

More than 800 SPACS have been established raising more than $189 billion during their initial public offerings, or "IPO". In the past three years alone, the number of SPACs has increased almost fourfold, raising more than $155 billion. SPACs, often referred to as "blank check companies," provide an alternative to the traditional IPO process for private companies to become publicly traded. SPACs are formed solely to raise capital through an IPO in order to acquire one or more businesses or assets (together referred to as "business").

Once a SPAC has identified the business it wishes to acquire, it files a proxy statement, in addition to the prospectus for the completion of an acquisition, as part of the "de-SPAC" process. This process occurs after the execution of an agreement to acquire, but before the actual merger of the SPAC and targeted business. The filings include details about the business, relevant financial statements, and outlooks for future market growth.

Typically, SPACs have a defined life span of no more than two years that can be extended up to a maximum of 36 months with shareholder approval. If the SPAC is unsuccessful in acquiring a new business, it is liquidated and the net proceeds are returned to shareholders. Due to these time constraints, it is important that the SPAC team perform adequate due diligence processes while actively pursuing acquisition candidates. This will reduce the likelihood of any material misstatements or omission of relevant information that may arise from a rushed process.

SPAC Due Diligence and Short Sellers

The main arguments in recent securities litigation cases against SPACs concern the due diligence process and its sufficiency in providing an accurate understanding of the risks of the acquired business. SPAC due diligence has been actively challenged by short seller reports alleging misinformation and overstated financials, which has led to decreases in share price and further litigation. The potential for DOJ or SEC enforcement also exists.

A lawsuit involving Akazoo Limited ("Akazoo") and its reverse merger with a SPAC, Modern Media Acquisition Corp. ("MMAC"), alleged that Akazoo, "overstated its revenue, profits, and cash holdings and, Akazoo overstated the size of the Company and its services." This size overstatement was in relation to the number of music distribution rights Akazoo held and the number of countries in which it operated. These allegations followed the April 2020 short seller report from Quintessential Capital Management ("QCM") that discussed these overstatements and other issues related to misstatements on the level of detailed due diligence supposedly performed by MMAC prior to the merger.

Another case was filed in February 2021 against the SPAC, Churchill Capital Corp. III ("Churchill") and its merger with MultiPlan Corp. ("Multiplan"), alleging that Multiplan was, "losing tens of millions of dollars in sales and revenues "to a competitor created by Multiplan's largest customer, in addition to declines due to, "fundamental deterioration in demand for MultiPlan's services and increased competition. "These allegations followed a short seller report from Muddy Waters Research claiming, "MultiPlan had obscured its deteriorating financial position by manipulating cash reserves to show inflated earnings."

Risks associated with the due diligence of companies that may have ongoing government investigations based on accounting related or valuation issues should be assessed prior to the acquisition as to their nature and significance, and be disclosed accordingly. An ongoing case filed in February 2021 against Clover Health Investments Corp. ("Clover") and Social Capital Hedosophia Holdings Corp. III ("SCH"), alleges that Clover and SCH did not disclose details of an ongoing investigation by the U.S. DOJ prior to approving the merger. The short seller Hindenburg Research published a report discussing this missing information, stating that Clover was, "under active investigation by the Department of Justice (DOJ), which is investigating at least 12 issues ranging from kickbacks to marketing practices to undisclosed third-party deals." In response to this report, Clover confirmed that there were inquiries received from the DOJ that they believed were not, "material to investors", and were therefore not disclosed prior to finalizing the merger.

In all three cases, SPACs have allegedly omitted material facts from information released to the public in the proxy statements prior to the merger. These proxy statements are subject to similar review to those in traditional IPOs and therefore should appropriately disclose any risks identified to mitigate the risk of litigation or securities disputes.

Reducing Risk and Identifying Accounting Red Flags Prior to SPAC Acquisition

In order to reduce risk, the legal due diligence process should include forensic review to detect signs of accounting red flags. This would include a risk-based review of the business' books and. records, accounting systems and internal controls. Independent accounting experts and experienced forensic accountants are an essential component in the identification of red flags, such as inadequate controls, questionable accounting judgments and unusual financial reporting items.

For example, forensic accounting experts' detailed analysis can include identification and review of:

  • unexplained increases in sales or revenue close to acquisition date,
  • potentially inflated inventory or other asset valuations,
  • undisclosed related party transactions,
  • reliance on a small number of customers or vendors,
  • management interaction with State Owned Entities ("SOEs"),
  • evaluation of going concern,
  • review of auditors' work in high risk areas,
  • evaluation of red flag prevention and monitoring internal controls, and
  • identification of outliers or red flags through use of data analytics.


We expect the proliferation of SPACs to continue in 2021 and beyond. In order to reduce the potential for litigation or DOJ and SEC enforcement, those involved in SPACs should perform adequate due diligence to ensure the risks involved in these transactions are addressed. Specifically, the books and records, accounting systems and internal controls of the acquired business should be scrutinized, particularly in areas of heightened risk, and a forensic review should be performed by accounting experts before any acquisition is finalized.

Nathan Gibson, an Associate on FRA's Forensic Accounting team, is also a contributing author to this article.

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