PCAOB flags widespread weaknesses in audits of SPACs

Dive Brief:

The Public Company Accounting Oversight Board flagged widespread weaknesses in audits of special purpose acquisition companies, including flaws in estimating the fair value of warrants and failures in evaluating departures from generally accepted accounting principles.
“We observed instances where the public company’s auditors failed to identify material misstatements in issued financial statements due to errors in the accounting for warrants,” the PCAOB said in a report.
The PCAOB found at least one deficiency in 61% of the 44 audits related to SPACs that it reviewed from 2021, and at least one error in 37% of the 71 SPAC-related audits that it studied from last year.

Dive Insight:

A two-year surge in the number of SPACs reversed in 2022 amid financial market volatility, tougher scrutiny of SPACs by the Securities and Exchange Commission and a rise in interest rates during the most aggressive monetary tightening in four decades.

The number of SPAC initial public offerings plummeted to 84 last year, an 86% decline compared with the 613 completed in 2021, according to the PCAOB, which oversees the accounting firms that audit public companies.

A SPAC has been widely perceived to be a faster, cheaper way to raise money than through a conventional IPO. It sells shares listed on a stock exchange and then merges with a private company, usually within two years, in a so-called de-SPAC transaction.

The SEC in March 2022 proposed tougher disclosure rules for SPACs aimed at ensuring the same protections offered to investors in traditional IPOs.

The new rules would require deeper disclosure about tie-ups between SPACs and private operating companies, and tighten requirements on performance projections by SPACs and the companies that they target for purchase.

“The SEC staff have noted that the market interest ebbs and flows, with certain market participants having a view that a SPAC transaction is a way to take a private company public with more certainty as to pricing and control over deal terms” compared with a traditional IPO, the PCAOB said.

SPACs in 2021 pushed up the total number of financial restatements by all categories of firms to a 15-year high, underscoring the impact from sharper SEC scrutiny of the so-called blank-check companies.

Restatements surged to 1,470 in 2021 — a 289% increase over the prior year — with 77% filed by SPACs, according to Audit Analytics. Excluding SPACs, the number of restatements in 2021 fell 10% compared with 2020.

The PCAOB in its review of audits in 2021 and 2022 found that many auditors failed to identify a conflict with GAAP related to valuation of warrants prior to a restatement of a company’s financial statements, stock compensation or classification of redeemable shares, the PCAOB said.

Auditors in some cases also failed to assemble a final set of audit documentation within 45 days after releasing the audit report, and to test the accuracy of data provided by the company, or ensure adequate controls over the data, the PCAOB said.

The board this year plans to evaluate the work of auditors in valuation and accounting of financial instruments using complex models and in the assessment of business combinations, including reverse mergers, and internal control over financial reporting, the PCAOB said.

The board will also focus on auditors’ work related to financial statement presentation and disclosure, significant equity and debt restructuring and a company’s ability to continue as a going concern.