Examining Audit Complexity in the Evolving SPAC Merger Process

Through the traditional mechanism, a private company conducting an initial public offering (IPO) must file a detailed registration statement with regulators and conduct a roadshow to market shares to investors. This process typically takes 1–2 years. Instead, a company can also become public more quickly by using the Special Purpose Acquisition Company (SPAC) mechanism.

By design, a SPAC operates as a ‘blank check’ company that is already listed on an exchange. It is called a blank check because investors provide cash to a sponsor without knowing exactly how those funds will be used. The sponsor, acting as the SPAC’s manager, will then search for a target company to acquire. This merger and acquisition process allows the target company to become a public entity, effectively replacing the SPAC on the stock exchange. This mechanism, known as a de-SPAC, is favoured because it offers private companies a faster, cheaper, and more predictable path to going public than a traditional IPO. This model provides a strong incentive for sponsors to secure and finalize profitable deals. Investors are also protected as they have “Redemption Rights,” allowing them to receive back cash equivalent to their initial IPO share price.

However, the rapid expansion of SPACs has led to an alarming decline in audit quality. Two key US regulatory bodies have become involved: the SEC (Securities and Exchange Commission), which concentrates on safeguarding investors by enforcing disclosure regulations, and the PCAOB (Public Company Accounting Oversight Board), which supervises and establishes standards for public company auditing firms. The SEC found violations in 25%–50% of the audits they reviewed. Similarly, the PCAOB found high rates of deficiencies, indicating auditor failures to apply professional scepticism in high-risk areas. As a result, a large number of SPACs were required to issue financial statement corrections. The total number of corrections in 2021 surged by 289% to 1,470, with 77% attributable to SPACs. Furthermore, 497 of these corrections were restatements, with over 90% identifying material weaknesses in the company’s internal controls.

The decline in audit quality for SPACs is attributed to their unconventional structure, which significantly differs from that of traditional public companies. Unfortunately, many auditors are inexperienced in SPAC transactions, particularly in relation to testing the target company’s internal controls, classifying warrants, evaluating the merger structure, and considering the need for restatement. This lack of competence increases the risk of material misstatement (RMM). Extremely tight completion deadlines further magnify this risk. The main audit work for an SPAC occurs during the de-SPAC phase, which must be completed within 3–6 months. Conducting a thorough independent review is difficult for auditors in this short period, forcing them to rely heavily on documents prepared by management. Even when audit procedures are performed, management’s assertions are difficult to substantiate, which impacts the audit opinion on the financial statements. Overall, the failure of SPAC audits to meet quality control standards is a combination of extreme time pressure and inadequate auditor preparedness.

The case of Marcum LLP demonstrates how market euphoria and commercial pressures can undermine the ethical foundations of the audit profession. As SPACs surged in 2021, Marcum became the most dominant auditor in that market, auditing over 400 SPACs. However, adequate quality control procedures and systems did not meet this growth requirement. The SEC determined that Marcum experienced a systemic failure in maintaining audit quality.

In its investigation, the SEC found that Marcum committed serious violations of various Auditing Standards (AS) set by the PCAOB. Regarding its quality control system, Marcum failed to have an adequate system as required by QC Section 20, resulting in insufficient oversight for its SPAC clients. When auditing SPACs, Marcum also violated AS 1215 in its documentation, as the evidence and procedures used were insufficient to support its opinions. Marcum failed to identify high-risk areas, such as excessive valuations and overly speculative financial projections, by disregarding AS 2110’s requirements for assessing misstatement risks. Marcum also committed violations of AS 1220, AS 1015, and AS 1301. The accumulation of these violations suggests that audits were carried out primarily to meet requirements and commercial pressures, rather than to guarantee the fairness of the financial statements. This resulted in a decline in audit quality and an increased risk of material misstatement, especially in the valuation and assurance of SPAC’s financial statements.

SPAC audit oversight is expected to be tightened. The PCAOB is developing Audit Quality Indicators (AQIs) to measurably assess auditor quality, while the SEC is proposing new rules to strengthen disclosures in the IPO and de-SPAC processes. These measures are being implemented alongside regulations that address potential conflicts of interest and overly optimistic financial projections. These steps are intended to enhance transparency and accountability, ensuring that SPAC audits will no longer be exploited as a loophole for manipulating financial statements, but rather serve as a mechanism to safeguard capital market integrity and protect investors through more robust audit standards.