Lost in Spacs

Here is how special purpose acquisition companies (Spacs) are generally expected to work. An executive team, hopefully with good reputations for identifying investment opportunities, says to investors: “If you give us hundreds of millions of dollars, we will float our company on the stock exchange and find another company to merge with and then you will own shares in that company instead, and because we are so good at identifying investment opportunities those shares will go up in value. But if you don’t like the merger, you can have your money back instead. And if we don’t find a company to buy before a certain date, you can also have your money back.”

In return, the investors usually have to agree to various complicated shareholder structures that end up paying the executives fat fees as a reward for finding a company to merge with and letting the investors tag along for the ride. But, hopefully, those investors get to share in a wonderful journey as the newly listed company spreads its wings and flies, so everyone is very happy.

As we have discussed here, here, here and here, that doesn’t necessarily happen. The executives often can’t find a good company to merge with, so they end up giving the money back or they merge with a bad company instead. Or the investors don’t like the merger so they redeem their shares.

Or the institutions that Spacs rely on to stump up the private investment in public equity (Pipe) funding that often forms the bulk of the acquisition proceeds decide to stop helping Spacs buy other companies. Or regulators tell Spacs that their accounting is all wrong. Or any combination of all those.

But sometimes other things happen. Here is a complaint from the Securities and Exchange Commission (SEC), published on January 3: “The Securities and Exchange Commission today announced fraud charges against Cooper J Morgenthau, the former CFO of African Gold Acquisition Corp, a Spac or special purpose acquisition company, for orchestrating a scheme in which he stole more than $5 million from the company and from investors in two other Spacs that he incorporated.

“The SEC’s complaint alleges that, from June 2021 through July 2022, Morgenthau embezzled money from African Gold and stole funds from another Spac series called Strategic Metals Acquisition Corp. I and II to pay for his personal expenses and to trade in crypto assets and other securities.”

This sounds a lot worse than some of the other things that can go wrong with Spacs, although regular readers of Euromoney will know that it is not a million miles away from telling someone that you are spending $244 million of their money feeding 265,000 cows for them but then actually using it to cover trading losses and to buy a plane.

Anyway, African Gold floated in February 2021 and raised $414 million to look for a target in the gold mining sector within two years. The SEC says that Morgenthau, who is now aged 35, transferred more than $1.2 million of African Gold’s money to his personal accounts, which he then used for things like trading options on meme stocks.

Any withdrawal of more than $50,000 would have had to be reviewed by a board member, so Morgenthau ended up making no fewer than 34 withdrawals by July 2021.

Fortunately, he didn’t have the entire IPO proceeds to play with. The bulk of a Spac’s IPO cash is placed in escrow, ready for an eventual acquisition. All he had access to was the money that the company was using for its own day-to-day operations. Meanwhile, he was hiding what he was doing by changing the company’s bank statements, which he then passed to its accountants and auditor.

The SEC says that Morgenthau spent or lost all the money he stole, and by July 29, 2021, African Gold had only $100 in its operating account. So Morgenthau decided to launch two new Cayman Island-incorporated Spacs, Strategic Metals Acquisition Corps I and II, to cover his losses. Between July 2021 and July 2022, he managed to raise about $4.7 million from about 50 pre-IPO investors, but neither entity ever actually floated.

He popped some of what he had raised back into African Gold’s bank account just in time for a year-end audit at the end of 2021, but then took it out again to trade crypto. At the end of January 2022, African Gold had just $13. Over the following months, to avoid detection, Morgenthau would periodically deposit enough to cover essential legal and accounting costs. Eventually, though, even that would end.

Here’s the SEC again: “But by August 2022, Morgenthau had run out of money. The bank accounts for African Gold and Strategic Metals were empty. African Gold vendors refused to perform work for the company, and Morgenthau’s scheme was exposed. African Gold fired Morgenthau on August 26, 2022.”

This is dramatic stuff, but elsewhere the SEC’s literary style is a little more robotic. In the part of its complaint that deals with Morgenthau’s filings to the SEC in relation to African Gold, it is obsessed with detailing the precise size of his misstatements. The result is somewhat… dry.

“African Gold reported in its Form 10-Q for the second quarter of 2021 (the quarter ended June 30, 2021) that it held $1.3 million in cash that it could use to search for a company to acquire. Because of Morgenthau’s theft, however, African Gold held only $101,303, and thus overstated its cash holdings in its Form 10-Q by more than 1,100 percent.”

And so on.

Alongside the SEC’s complaint, the US Attorney’s Office for the Southern District of New York also announced criminal charges against Morgenthau, who has pleaded guilty to wire fraud and will be sentenced on April 25. He has also agreed to be barred by the SEC from being an officer or director of a public company.

John Dugan, associate director for enforcement in the SEC’s Boston office, said that the action “demonstrates our commitment to holding individuals accountable, particularly when they seek to take advantage of public interest in investment vehicles such as Spacs.”

US attorney Damian Williams said that his office was committed to “rooting out fraud in the Spac market and to protecting Main Street investors from abuses on Wall Street”.

Thank goodness for that.