PCAOB Inspection of SPAC Audits Finds Flaws

The U.S. audit watchdog found at least one deficiency in 46% of about 115 SPAC-related audits it inspected.
PCAOB Inspection of SPAC Audits Finds Flaws
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Inspections of more than 100 SPAC-related U.S. public company audits performed in 2021 and 2022 found significant deficiencies, according to the Public Company Accounting Oversight Board (PCAOB).

The deficiencies included weaknesses in internal controls, incomplete audit sampling techniques, insufficient communications between auditors and audit committees, and failures in identifying material misstatements due to errors in accounting for derivatives.

The PCAOB’s report on the inspections said that 61% of the 44 special purpose acquisition company (SPAC)-related audits from 2021 had at least one deficiency, and of 71 SPAC-related audits in 2022 that it examined, 37% had at least one deficiency.

In comparison, about 55% of the total 690 audit engagements the PCAOB reviewed in 2021 had one or more deficiencies.

The board inspected year-end audit reports of SPAC entities — “blank check” companies formed solely to raise capital — and companies formed from the subsequent reverse merger (de-SPAC transaction) of a public SPAC and a private operating company.

The PCAOB’s staff inspection priorities report released on April 17 also said the board is interested in ‘the trend of deal cancellations and redemptions related to SPACs.’

The PCAOB inspections of SPACs found audits where “weaknesses in internal controls over financial reporting (ICFR) were pervasive due to company management’s lack of experience,” said the PCAOB. For example, PCAOB staff found auditors failed to evaluate control procedures related to assumptions in the valuation of contingent consideration paid to the seller and the valuation of acquired intangible assets.

Among other errors, the PCAOB said, it found instances in which audit engagement teams did not communicate material weaknesses in writing to the auditor committee nor communicate their assessment of critical accounting policies and practices; did not correctly determine the number of items needed in a sample for testing; failed to complete audit documentation on time; or had financial interests in the audit client.

The PCAOB performed the SPAC audit reviews because “companies going public via SPACs are not subject to many of the conventions and requirements of a traditional IPO — including reporting requirements — and because of their structure, SPACs pose risks to investors not present in traditional IPOs.”

For this year’s inspections, PCAOB staff plan to pay particular attention to de-SPAC transactions, which are technically reverse mergers. In addition, the PCAOB’s staff inspection priorities report released on April 17 said the board is interested in “the trend of deal cancellations and redemptions related to SPACs.”

According to Reuters, the average SPAC saw 60% of its investors redeeming their shares in the second half of 2022. Investors can opt out of a de-SPAC transaction and receive a pro-rata share of the IPO proceeds. 

Potential Lawsuits

A deficiency in a PCAOB inspection report does not necessarily mean an issuer’s financial statements are materially misstated or that undisclosed weaknesses in ICFR exist. Still, the inspection team can refer matters to the PCAOB’s division of enforcement or the Securities and Exchange Commission (SEC).

To date, the SEC has only brought a handful of cases against SPACs, including fraud charges against the former CFO of African Gold Acquisition for allegedly stealing more than $5 million from the company and investors in two other SPACs. 

“We haven’t yet experienced a fully blossomed SEC enforcement program in relation to the SPAC boom,” said Scott Mascianica, a litigation partner at Holland & Knight, quoted on JD Supra. He noted that, among other factors, the average length of an SEC division of enforcement investigation is 24 to 30 months.

Of about 351 U.S. companies that completed a merger with a SPAC since 2020, 161 were trading below $2 per share as of the April 20 close.

As of January 2023, more than 60 shareholder lawsuits have been filed against SPACs or the resulting merged operating company, according to Woodruff Sawyer.

SPAC Tailspin

After 613 IPOs from SPACs in 2021 that raised gross proceeds of $144.5 billion, activity in 2022 dropped to 84 IPOs that raised $11.3 billion, according to PCAOB data.

The market’s appetite for SPAC offerings slowed substantially in the first quarter of 2023. Just eight SPAC IPOs raised $709 million, according to S&P Global Market Intelligence.

Operating companies that have completed a merger with a SPAC are performing particularly poorly in the aftermarket. Of about 351 U.S. companies that completed their transaction with a blank-check company since 2020, 161 were trading below $2 per share as of the April 20 close, according to a CFO analysis of S&P Global Market Intelligence data. (SPACs have a nominal IPO price of $10 per share.)

Symbotic had the highest stock price of the group, closing at $30.26 per share on Thursday. The developer of A.I.-enabled robotics technology for the supply chain completed its de-SPAC transaction in June 2022.