Recent Motion-to-Dismiss Decisions Underscore Uncertain Litigation Prospects for SPAC Participants
The Situation: Following the poor performance of many companies that recently combined with special purpose acquisition companies ("SPACs"), investors filed dozens of securities class-action lawsuits alleging that the companies and their officers and directors made misrepresentations, typically both before and after the de-SPAC transaction.
The Result: Over the last year, federal district courts have begun to evaluate motions to dismiss SPAC-related securities claims. In the first three decisions, the courts declined to dismiss most of the claims against SPAC participants, but the most recent decision granted the defendants' motion (without prejudice).
Looking Ahead: The fact that the first three decisions allowed securities claims to proceed to discovery was an unwelcome development for SPAC participants. The most recent decision shows, however, that SPAC participants can prevail on a motion to dismiss, particularly on falsity and scienter-based arguments. Those arguments are likely to play a key role in other securities cases that were filed in the wake of the SPAC surge.
The use of SPACs to take companies public increased dramatically in recent years, but many of these new companies performed poorly after entering the public capital markets. This poor performance, often accompanied by negative reports from short sellers, led to the filing of numerous securities class actions. These lawsuits typically name a number of participants in the de-SPAC transaction as defendants, including the companies and their officers and directors. The lawsuits allege misstatements—typically both before and after the de-SPAC transaction—about the business prospects of the target companies.
In the first three motion-to-dismiss decisions in this line of cases, courts allowed most claims to proceed to burdensome discovery. However, in the fourth and most recent decision, the court dismissed the Exchange Act claims on falsity and scienter grounds. This decision demonstrates that the pleading standards imposed by Rule 9(b) of the Federal Rules of Civil Procedure and the Private Securities Litigation Reform Act of 1995 ("PSLRA") still have teeth, even in the SPAC context.
Alta Mesa Resources, Inc.
In Camelot Event Driven Fund v. Alta Mesa Res., Inc., No. 4:19-cv-00957 (S.D. Tex. Apr. 14, 2021), shareholders of a SPAC that entered into a business combination with two oil-and-gas companies sued individuals and entities involved in the de-SPAC transaction for alleged misstatements about the target companies' growth potential and production capabilities. In declining to dismiss the plaintiffs' claims under Sections 10(b) and 14(a) of the Securities Exchange Act of 1934, the court relied heavily on the fact that the company was forced to take a $3.1 billion write-down (allegedly "equivalent to more than 80% of the company's value"), announced that it discovered material weaknesses in its internal controls, and disclosed that it was unable to file its annual report on time, all within approximately one year of when the de-SPAC transaction closed and many of the alleged misrepresentations were made. The court also declined to dismiss the Section 20(a) control person liability claims against certain individuals and entities involved in the de-SPAC transaction (including two individuals affiliated with the SPAC's sponsor), concluding that the allegations of a "complex web of securities ownership, contracts, business relationships, [and] interlocking directors" among the defendants were sufficient to state a claim.
In In re QuantumScape Securities Class Action Litigation, No. 3:21-cv-00058 (N.D. Cal. Jan. 14, 2022), shareholders of a company formed through the combination of a SPAC and a target involved in the production of solid-state batteries for electric vehicles sued the company and three officers (who were also officers of the target company before the merger) for alleged misrepresentations issued shortly after the de-SPAC transaction closed about the effectiveness of the company's batteries. In declining to dismiss most of the claims under Section 10(b) of the Exchange Act, the court relied—at least in part—on a short-seller report and an article authored by a competitor's CEO to establish the falsity of the alleged misstatements (for pleading purposes). The court also rejected the defendants' argument that the company's testing methodologies and data were accurately disclosed, concluding that it could not "definitively say that [the defendants'] more categorical statements would be rendered entirely non-misleading by the far more technical and narrow disclosures that QuantumScape relies on."
Romeo Power, Inc.
In In re Romeo Power Inc. Securities Litigation, 21-cv-03362 (S.D.N.Y. June 2, 2022), shareholders in a company focused on developing battery modules and packs for use in electric vehicles filed a securities class action against the company and certain individuals affiliated with the SPAC and the target that combined to form the surviving entity. The plaintiffs alleged that the defendants made misstatements about the target company's committed contract revenue and supply chain in public filings both before and after the de-SPAC transaction closed. The court concluded that at least one of the defendants' alleged misstatements about the company's battery cell suppliers was not protected by the PSLRA safe harbor for forward-looking statements, and allowed that part of the plaintiffs' Section 10(b) claim to proceed. The court also determined that the plaintiffs adequately alleged that two officers of the target company (who continued as officers in the post-merger entity) acted with the requisite scienter "[b]ased on the importance of battery cells" to the company (which were a "daily focus") and the officers' repeated statements about the company's supply agreements. The court, however, concluded that the plaintiffs' claims under Section 14(a) of the Exchange Act for alleged misstatements in the proxy statement for the de-SPAC transaction were derivative in nature rather than direct, and dismissed those claims due to the plaintiffs' failure to adequately plead demand futility.
Most recently, in Jedrzejczyk v. Skillz, Inc., 21-cv-03450 (N.D. Cal. July 5, 2022), shareholders in a mobile gaming technology company that went public via a SPAC brought securities claims against the company and certain of its current and former officers and directors (among others) for alleged misstatements about the company's existing business and future prospects. The court dismissed all of the Exchange Act claims without prejudice, finding that some of the alleged misstatements were protected by the PSLRA's safe harbor for forward-looking statements, others were non-actionable puffery, and that the plaintiffs had failed to adequately plead that other alleged misstatements were actually false. The court also concluded that the plaintiffs had failed to adequately plead scienter, finding that the inference of fraudulent intent was not as compelling as opposing inferences.
Two Key Takeaways
- While the motion-to-dismiss decisions in Alta Mesa, QuantumScape and Romeo Power could be viewed as an unfavorable trend for participants in de-SPAC transactions, the Skillz decision shows that investors still have a significant pleading burden for federal securities claims related to such transactions.
- There are dozens of SPAC-related securities cases in which motions to dismiss have not yet been decided. Market participants should continue to monitor those cases for additional developments, including the success of the types of falsity and scienter-based arguments that prevailed in the Skillz decision.
Jones Day publications should not be construed as legal advice on any specific facts or circumstances. The contents are intended for general information purposes only and may not be quoted or referred to in any other publication or proceeding without the prior written consent of the Firm, to be given or withheld at our discretion. To request reprint permission for any of our publications, please use our “Contact Us” form, which can be found on our website at www.jonesday.com. The mailing of this publication is not intended to create, and receipt of it does not constitute, an attorney-client relationship. The views set forth herein are the personal views of the authors and do not necessarily reflect those of the Firm.