The world of special-purpose acquisition companies, or SPACs, the shell corporations that have flooded onto markets in recent years to raise money from investors and then hunt for companies to buy. The instrument is a stock warrant, which gives holders the right to buy shares at a specified price in the future.
The curious trading pattern starts when someone buys piles of a SPAC’s warrants, sending the daily volume of trading 10, 20, or even 60 times above normal levels. Within a few weeks, word emerges that the SPAC has found a business to buy, often sending the warrant prices soaring.
A review of almost 300 mergers announced since late 2018 shows that such spikes in warrant trading appear before about one out of every four SPAC deals.
In more than a dozen cases, warrant buyers would have at least doubled their money if they held onto the instruments for mere days or a few weeks. In one case, the warrants soared 888%.
The U.S. Securities and Exchange Commission is now examining warrant trades that took place before deals to discern whether they were illegally based on inside information, according to people with knowledge of the matter.
The SEC may open more inquiries as it sifts through additional reports of well-timed bets flagged by market surveillance systems, such as one run by the Financial Industry Regulatory Authority.
The potential for making big money in warrants burst into public consciousness last year, when a surge in warrant trades preceded the October announcement that former President Donald Trump would merge his media platform with a SPAC called Digital World Acquisition Corp.
In December, Digital World disclosed that Finra sought information on trades that occurred before the deal was announced. The SPAC also said the SEC requested descriptions of the company’s trading policies and procedures. Authorities haven’t accused anyone of wrongdoing.
There have been even larger spikes in warrant trading before numerous other SPAC deals. Warrant trades before SPAC merger announcements can be benign.
Investors may act in response to a SPAC issuing an update on the prospects of finding a target company, a press report that talks have opened, or market moves affecting the price of underlying shares.
Yet, there is no public information that would explain about two thirds of the bursts of warrant trading, including several of the most profitable. The increase in volume before an announcement is a telltale sign of someone with information.
It isn’t clear which warrants they are examining. The opening of an inquiry doesn’t necessarily mean authorities will bring an enforcement case. SEC and Finra declined to comment.