PCAOB inspectors find plenty of problems with SPACs

The Public Company Accounting Oversight Board issued a staff report Wednesday warning of the high rates of audit deficiencies they're uncovering in special purpose acquisition companies.

SPACs, also known as blank-check companies, were a popular way until last year for companies to go public while skirting some of the regulatory hurdles involved with traditional initial public offerings. The process involves merging a private company with what's effectively a shell company that goes public. But SPACs typically have no commercial operations of their own and are formed just to raise capital so they can merge with or acquire a private company to take it public.

The PCAOB noted that from 2020 to 2021, U.S. markets experienced an unprecedented surge in the number of IPOs by SPACs. 

However, the Securities and Exchange Commission began cracking down on SPACs in 2021 with new guidance on how they should account for warrants, which had helped fuel the market. That, combined with the failures of a number of high-profile SPACs, led to a dramatic downturn in the market last year. For the six months leading up to Dec. 1, there were only 16 new SPAC IPOs, according to the Yale Journal on Regulation, a 93% plunge from the same period in 2021. 

In recent years, the PCAOB said it has considered SPAC-related risks to investors while planning its inspections. Earlier this week, PCAOB inspectors once again included SPACs among their list of priorities for 2023 inspections (see story).

From 2021 to 2022, PCAOB inspectors reviewed over 100 audits of companies that were either considered SPACs or that were formed through a de-SPAC transaction. At many of them, there were audit deficiencies. The board reviewed 44 SPAC-related audits performed in 2021. Of those, 61% had at least one deficiency. It also reviewed 71 SPAC-related audits performed in 2022. Of those, 37% had at least one deficiency.

Based on the inspections, the report offers a number of cautions for auditors. The takeaways include the need to:

• Exercise due professional care and professional skepticism;
• Consider whether the presentation and disclosures in the financial statements conform with GAAP;
• Understand the public company's processes to develop its accounting estimates; and
• Be alert to changes in the public company's or the auditor's circumstances that may lead to situations that could impair an auditor's independence.

The PCAOB said its reviews of audits of SPACs and de-SPAC transactions most frequently focused on the following audit areas:

• Assessing the valuation of financial instruments using complex valuation models;
• Evaluating quarterly mark-to-market valuation adjustments;
• Determining which entity in a business combination is the accounting acquirer;
• Internal control over financial reporting, if applicable;
• Evaluation of financial presentation and disclosures; and,
• Restatements, if they occurred.

The PCAOB chose those areas of focus because they were generally significant to the public company's financial statements, may have included complex issues for auditors, and/or involved complex judgments.