Growth of SPACs Prompts Concerns Over Audit Quality

Special purpose acquisition companies – more commonly known as SPACs – have seemingly disappeared from the investing scene in recent years. And when they do make the news, it’s usually news of the wrong kind.

After a tidal wave of SPACs washed over the public markets in 2020 and 2021, they quickly fell out of favor with investors. Sponsors use SPACs to bypass the usual steps required to hold an initial public offering. The SPACs are listed on exchanges as shell companies to amass capital for acquisitions of private companies. Once these acquisitions go final, the acquired companies have effectively gone public without engaging in the costly and time-consuming requirements of an IPO.

Regulators’ skepticism about SPACs probably contributed to their downturn, and now enforcement actions by the Securities and Exchange Commission and Public Company Accounting Oversight Board have again put the companies back in the spotlight. Importantly, it’s not just SPACs garnering attention, but also their auditors.

Lordstown Motors Corp.

You’ve heard of electric vehicle manufacturers Tesla and Rivian. On the other hand, Lordstown Motors is probably more of a mystery.

After merging with a SPAC in 2020, Lordstown declared bankruptcy last year. According to an SEC statement, the EV maker inflated the number of orders it received for its Endurance, Lordstown’s flagship model truck. The agency also cited Lordstown for allegedly misrepresenting its schedule for delivering vehicles to the public after encountering difficulties in obtaining vital parts for the cars. Lordstown’s settlement with the SEC included a disgorgement of $25.5 million.

Lordstown’s former auditor also found itself caught up in the company’s troubles. The SEC and PCAOB charged Clark Schaefer Hackett and Co. with violating independence standards as a result of its work with the EV manufacturer. Apparently, CSH audited financial statements linked to Lordstown’s de-SPAC transaction that the firm had prepared while Lordstown was a private company.

Marcum LLP

Here’s an odd case: In January, the SEC sued an accountant at Marcum LLP for “repeatedly violating” audit standards over the course of a decade. According to the SEC Division of Enforcement, Marcum partner Edward F. Hackert oversaw 240 audits of public companies, nearly two-thirds of which were SPACs, between 2012 and 2022. He allegedly “failed to supervise the work of the engagement team as shown by, among other things, his failure to review the work of the engagement team and to document his review by the report release date” in 85% of those reviews, per the SEC.

SEC Chair Gary Gensler has taken Marcum to task previously for doing audits of hundreds of new SPAC clients, which he says eroded the quality of the firm’s work.

WithumSmith+Brown, PC

In February, the PCAOB announced it had tagged WithumSmith+Brown, PC with a $2 million fine for violating rules and quality control standards. Much like the Marcum case, the board attributed shoddy work at WithumSmith to overextending its audit practice with new SPAC clients. The firm saw its audit workload grow nearly fivefold between the start of 2020 and the end of 2021, according to the PCAOB.

At the same time, WithumSmith boosted its allotment of partners assigned to audits from 15 to 23. With so few partners working on audits relative to the rise in the number of clients, the firm couldn’t offer assurances about the quality of its audit work, the PCAOB said.

Amid the concern for the impact of SPACs on audit quality, the SEC’s chief accountant called on firms to tighten their standards. Paul Munter noted in comments made last month that the PCAOB is identifying deficiencies in a growing percentage of the audits it inspects overall. Auditors should act “with a mindset that the investors, rather than management, are the audit client,” according to Munter.

“Auditors and audit committees serve as gatekeepers for investor protection and the financial reporting process and have an important role in facilitating the high-quality audits that are critical to the proper functioning of our capital markets,” he said.

If the SEC’s crackdown wasn’t enough to drive SPACs away, its focus on auditors’ involvement in supporting the controversial shell companies might just be the “straw that breaks the camel’s back.”