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Are SPACs on the Way Out? New Regulations are on the Horizon

SEC Comes Down Hard on Marcum LLP

On June 21, 2023, the PCAOB sanctioned Marcum LLP for violating PCAOB rules and quality control standards by failing to take sufficient steps to ensure that its system of quality control provided reasonable assurance that: (1) the firm would comply with the requirements regarding the acceptance of issuer clients and engagements, and (2) its personnel would comply with applicable professional standards and regulatory requirements. The firm’s failures occurred from January 2020 through December 2021. The violations are due to the way it handled special purpose acquisition transactions (SPACs).

The Scope of SPAC Activities

The explosion in SPAC mergers with private companies that formed public companies during 2020 and 2021 highlighted this new form of ownership that raises a variety of concerns, including when to reclassify equity warrants to liabilities, whether error corrections due to reclassifications should be treated as revisions or restatements of financial statements, how to comply with SEC and PCAOB regulations, and how to judge the impact on audit quality control deficiencies.

Marcum LLP is the dominant player in this market, with a fifth of its total fees of $184 million attributable to revenue from auditing SPACs. Among the 11 audit quality control deficiencies cited in the SEC’s legal settlement with Marcum include the acceptance and continuance of clients and engagement, engagement performance, and quality controls.

SPACs have changed the landscape for some audit firms that have taken on hundreds of such clients. An overriding concern is whether auditors have the requisite knowledge and experience auditing SPACs to adhere to all relevant professional standards. A variety of issues need to be addressed if auditors are to meet their professional obligations. These include accounting for SPAC acquisitions; evaluating restatements of financial statements; ensuring compliance with SEC and PCAOB regulations; adhering to PCAOB audit quality control standards; addressing audit independence issues; and considering the implications for corporate governance, including the audit committee.

SEC's Legal Action Against Marcum

According to the SEC’s legal action against Marcum in 2023, over 860 SPACs completed IPOs in the United States in 2020 and 2021. Over 400 of these SPAC IPOs were audited by Marcum. In 2019, Marcum had served as the auditor for only 185 public company issuers; by 2022, Marcum was responsible for auditing over three times that number—a total of 575 issuers, the majority of which were SPACs. This vaulted Marcum to the fifth largest public company auditing firm, as measured by number of clients. SPAC IPO

According to the SEC order, Marcum violated PCAOB Auditing Standard (AS) 1215, Audit Documentation, in a variety of ways. In most cases, the violations are attributable to a lack of audit quality controls. The violations included the following:  

  • Lacked sufficient policies, procedures, and monitoring related to work paper sign offs, including the timing and dating thereof, as well as timely assembly and retention of audit documentation.
  • Failed to comply with the requirement that the assembly and release of audit documentation be completed within 45 days after the audit report release date.
  • Lacked sufficient policies, procedures, and monitoring to provide reasonable assurance that the work performed by firm personnel with respect to the documentation of warrant accounting procedures met the requirements of AS 1215.

Eleven violations of quality control standards were cited in the SEC’s action against Marcum. Engagement quality reviews (EQR) have an important role to play as an independent voice to evaluate significant judgments and conclusions made by the audit team. A “well-performed EQR serves as an important safeguard against erroneous or insufficiently supported audit opinions and as a meaningful check on the work performed by engagement teams,” according to a PCAOB staff report

The SEC charged Marcum with failing to properly adhere to EQR standards, specifically AS 1220, Engagement Quality Review. In particular, the firm failed to adequately document EQRs. The SEC found that approximately 33% of the EQR sign offs were either signed post-issuance or were missing.

SEC Proposal to Better Regulate SPACs

Almost two years after the SEC proposed a sweeping set of reforms to rein un SPACs, the commission is set to adopt final rules during a public meeting on January 24, 2024.

The proposal in Release No. 33-11148, Special Purpose Acquisition Companies, Shell Companies, and Projections, would require additional information about business combination transactions, including disclosures related to the fairness of the transactions.

In 2020, there were 248 SPAC IPOs, followed by 613 at its peak in 2021. Then it dropped precipitously in 2022 with 86 and further decreased to 31 in 2023, according to SPAC Analytics.

Interests have waned because of different factors: the SEC's proposal itself; the failures of companies to find target companies to merge with; and unscrupulous activities that occur whenever there are any types of financial or investment fads.

Time will tell if the SEC can get a better handle on SPAC transactions or whether they will “die a natural death,”

Posted by Steven Mintz, aka Ethics Sage, on January 23, 2024. You can sign up for his newsletter and learn more about his activities at: https://www.stevenmintzethics.com/. Follow him on LinkedIn at: https://www.linkedin.com/in/steven-mintz-aka-ethics-sage-98268126/recent-activity/all/.