The cost of directors and officers insurance (D&O) for special purpose acquisition companies has spiked in 2021, meaning executives and board members may end up exposed to personal liability if companies don’t hold an adequate amount of insurance in the face of rising costs.
“Premiums are abnormally high, retentions/deductibles are significantly—and abnormally—high and limit capacity is very low,” Gray Holden, the management liability practice leader at Higginbotham, one of the largest insurance brokers in the U.S., said in an email.
The issue isn’t specific to sports-related SPACs, but there are plenty of sports business figures involved. More than 113 sports-related SPACs seeking targets are in the IPO process, accounting for one in five SPACs in the market today, according to the Sportico Sports SPAC Tracker. The wave of new SPACs make it seem easy to join the Wall Street fun, but it comes with the distinct downside: Legally, board members are fiduciaries, which means they are considered stewards of public trust and must act in the best interest of the organization and shareholders, even if it opposes their own benefit.
“While it seems that every major corporate executive, athlete, entertainer and deep-pocketed investor is taking advantage of this scorching hot marketplace on a daily basis, one of the last items mentioned within the exciting and emerging SPAC market is the need for D&O insurance,” said Joshua Peikon, a partner at insurance firm Paradigm Gilbert and a former sales executive for Anschutz Entertainment, the New York Jets and Brooklyn Nets.
Directors and officers insurance is a policy taken by publicly traded companies to protect the personal assets of executives and board members in the event they are sued for actions managing the company. Typically, a policy will cover the legal fees of defending against shareholder lawsuits and cover some or all of judgments that may be leveled against management. In the first quarter of this year, D&O policy premiums have jumped 30% compared to the end of 2020, according to research by Holden. That means the average-sized SPAC now has to commit to a million dollars or more in premiums, money that may not have been budgeted for in the business prospectus pitched to investors. According to Holden and others, it isn’t unusual for premiums to cost 10% to 20% of the total coverage a SPAC buys.
“D&O insurance is a critical component of any SPAC launch, particularly in view of some of the recent litigation that has arisen in the SPAC space,” said John J. Mahon, a partner at Schulte Roth & Zabel, a law firm specializing in financial services and mergers and acquisitions.
In particular, one recent lawsuit seeks to pin blame for a flop of a deal on independent board members. Shareholders of MultiPlan, a health care tech company that went public by merger with Churchill Capital Corp. III, have seen shares fall more than 50% to about $6. They filed suit last month contending that independent board members were incentivized to make any deal they could get, regardless of what was in the best interests of SPAC shareholders. That case has specifics that don’t necessarily apply to other businesses, Mahon cautioned. “But nonetheless, it is a shot across the bow for a lot of the SPACs that are out there,” he explained. “Each director of the SPAC has fiduciary obligations to the SPAC itself and to SPAC shareholders—that’s the critical point.”
Part of the problem is that D&O insurance is a significant cost, especially for SPACs. Typically blank checks want to keep costs low for the sponsor who puts up the money to launch the SPAC—as well as ensure they don’t veer from the budget presented to IPO investors, since a SPAC is more restricted than a typical publicly traded business in how it can use its money.
Higginbotham’s Holden examined 15 SPAC deals between September and March, with an average IPO size of $219 million. The SPACs purchased $10.3 million of D&O insurance coverage, paying premiums of about $1 million over two years. That’s a lot of money—and well more than non-SPAC businesses pay—but it gets worse: Insurance firms demanded an average $5 million “retention” on those deals. Retention in this case means the SPAC pays the first $5 million of costs and judgments resulting from lawsuits before the insurance company steps in.
“Considering overall market factors that we are currently experiencing, we don’t see that softening any time soon,” Holden added. “I see a lot of the entities exploring this not getting decent advice. They wind up significantly exceeding budget for insurance costs, and then not really securing enough insurance to protect their board members.”
To date there haven’t been a lot of SPAC lawsuits, because SPACs are essentially a new vehicle—in 2021 SPACs have filed to raise more money ($161 billion) than they have cumulatively every year before now ($139 billion), according to historical data compiled by Jay Ritter at the University of Florida and current market data from SPACalpha. The likelihood of lawsuits will only increase as SPACs announce mergers that don’t replicate the success of DraftKings.
“You’re going to announce publicly at some point,” said one chief executive of a sports SPAC, who asked not to be named because of regulatory considerations. “You’ll get a merger agreement, and the press release will go out. On the second day, you’re going to get a lawsuit. It’s part of the process.”
Mahon, the attorney, added: “You need to have someone who’s writing the checks to be able to pay the attorneys that are working on the case and defending you. Otherwise, it’s coming out of your pocket.”