“What’s driving this is, of course, the new capacity that has come in the past few years,” said Choo. “But what is also contributing is the slowdown in companies going public and the new business premiums those risks generate. That has created more competition for renewals, particularly for those public companies with good fundamentals. All but the most difficult risks should face a much friendlier D&O market this year.”
One group that will continue to experience challenging conditions, according to RPS, are special purpose acquisition companies (SPACs). SPACS are a popular alternative to an initial public offering (IPO). They have two years to acquire a private company and then take them public via the acquisition, in what is referred to as a de-SPAC. If it fails to complete the transaction in the required time period, the SPAC must dissolve and return the money raised by the IPO back to shareholders.
This creates risk because SPACs are incentivized to complete deals within 18-24 months, even if the target company isn’t quite ready to go public. That risk has started to play out in the courts, with plaintiff attorneys targeting SPAC-related litigation.
“De-SPACs are an interesting animal,” said Choo. “We’ve had blank check companies around for many years, and they have a bit of a bad history back from the 1980s, but SPACs are nothing new. What is new about SPACs is the sheer volume of them.”
According to SPAC Analytics, there were 613 SPAC IPOs in the US in 2021, up from 248 in 2020 and just 59 in 2019. That is significant growth in just three years, and is catching up with regular IPOs, at 968 in 2021, 450 in 2020, and 213 in 2019.
Another new element to this SPAC activity is the use of private financing to complete larger and more complex transactions. More SPACs are using PIPE deals to access alternative funding to finance their business combination, rather than raising additional finance from traditional sources.
PIPE stands for private investment in public equity, and it refers to the private placement of public company shares at a price below the current market value (CMV) to a select group of accredited investors (typically hedge funds, mutual funds, and other large institutional investors). PIPEs can help SPACs raise funds more quickly.
“SPACs were partnering with other investors to put together these very large PIPEs [and] we saw these much larger deals being done on a de-SPAC basis, which increases the exposure from a securities litigation perspective because you have to file an S-1 [with the SEC] in connection with that PIPE,” Choo explained. “That’s the trigger to bring de-SPACs under a traditional liability, like an IPO.”
Choo saw a “large uptick in SPAC-related litigation” in 2021, as well as a shift in the nature of the allegations to more classic fraud actions and “a sharp drop in the lag between close of the de-SPAC and time the cases are brought”.
The challenge for D&O insurers is that the litigation risk can implicate three policies: the SPAC runoff, the private company runoff, and the go-forward public company program.
“I think everyone’s figured out that SPACs are generally riskier than IPOs,” he added. “The biggest challenge now, candidly, is there’s just not enough companies that are properly ready to go public […] through a de-SPAC. They’re good companies but they’re just not ready – and SPACs need to get these deals done.”