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A Surge in Trading Preceded Trump’s SPAC Deal
Trading in the merger partner’s warrants, which allow holders to buy shares later, spiked several times before the Trump Media agreement was made public.

https://www.nytimes.com/2021/12/09/business/trump-spac-stock.html


Dec. 9, 2021
A few weeks before Digital World Acquisition announced a deal to merge with a fledgling social media company backed by former President Donald J. Trump, it was at the center of a sudden trading frenzy.

Digital World, a special purpose acquisition company, began allowing the trading of warrants — potentially lucrative contracts that give the holder the right to buy shares of a stock at a predetermined price at a future date. Such securities are typically offered to investors or executives as sweeteners, allowing them to buy additional shares of a company cheaply if the stock rises.

About 350,000 warrants of Digital World traded in the first two days. But on the third day — Oct. 4, a week after Digital World and Trump Media & Technology Group entered into formal talks that were not disclosed at the time — trading in the warrants exploded. More than 2.5 million changed hands that day.

The surge was unusual, especially for a little-known SPAC that hadn’t publicly identified a merger target, experts said. And with the Financial Industry Regulatory Authority now scrutinizing the merger deal — particularly trading activity that took place before the companies announced their agreement on Oct. 20 — warrants could be under a microscope.

“FINRA may see something in the high volume of warrant trading that makes it wonder whether something improper drove the volume burst,” said Erik Gordon, a law and business professor at the University of Michigan.

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Digital World disclosed the investigation by regulators in a corporate filing this week, but it did not specify what kind of trading was being examined. The filing said the “inquiry should not be construed as an indication that FINRA has determined that any violations of Nasdaq rules or federal securities laws have occurred.”

The company also disclosed that the Securities and Exchange Commission has requested information about some of Digital World’s investors and communications it has had with Trump Media. The investigation comes after The New York Times reported that the chief executive of Digital World, Patrick Orlando, had talks with representatives of Trump Media as far back as March.

Digital World declined to comment.

Warrants are one of Wall Street’s more esoteric securities, and have become a staple feature of special purpose acquisition companies like Digital World, which go public first and raise money with the intention of finding a merger target. Since the beginning of 2020, about 820 SPACs have gone public, according to Dealogic, and almost all have issued warrants along with shares.

Warrants cost only a fraction of what a share does because they can’t be exercised right away, but are a valuable commodity if share prices rise sharply. In the case of Digital World, a warrant is redeemable 30 days after the merger closes and can be used to buy a share at $11.50. Warrants were trading at roughly 50 cents each before the merger was announced, and closed at $21.50 on Wednesday. The price of a single share of Digital World was $65.42.

When a SPAC goes public, its shares and warrants initially trade as a single security, unless a company decides to trade them separately. Digital World announced its plan to separate them on Sept. 27, the same day it signed a letter of intent formalizing the merger talks, a person who was briefed on the matter said. The announcement did not mention the talks.

Few analysts closely track trading in warrants, so analyzing trading patterns can be difficult. Data compiled by FactSet shows that, on average, about 200,000 warrants in Digital World were traded daily during the three weeks before the merger was announced. That’s in line with how warrants in other SPACs traded after decoupling from their shares.

But there were unusual spikes in the trading of Digital World’s warrants: 2.5 million on Oct. 4, 900,000 on Oct. 7 and one million on Oct. 20, the day of the merger announcement, which happened after the market closed for the day.

Trading in actual shares of Digital World was far more tepid over that same period: Daily volume exceeded 600,000 shares just twice, and fewer than 50,000 traded hands on some days. Digital World’s highest volume in stock trading before the announcement was 1.3 million shares on Sept. 16, before the warrants could be traded on their own.

Mike Stegemoller, a finance professor at Baylor University who studies SPACs, said the trading volume in warrants on Oct. 4 was “particularly abnormal.” That may not indicate any wrongdoing, he said, but the handful of high-volume days coupled with the early deal discussions “are reason enough for FINRA to take a look.”

Mr. Gordon agreed that there might be nothing amiss in the trading. “These inquiries often fizzle out because nobody did anything wrong,” he said.

The flood of SPACs into the market has caught the attention of regulators.

In a speech on Thursday, the S.E.C. chair, Gary Gensler, said he had asked his staff to look into ways of making sure SPAC investors are adequately protected. Speaking before the Healthy Markets Association Conference, Mr. Gensler said investor protections with SPACs should be on par with traditional I.P.O.s “with respect to disclosure, marketing practices, and gatekeeper obligations” in order to reduce the potential for “information asymmetries, conflicts, and fraud.”

FINRA has already been looking closely at warrants because of the way SPACs have exposed more average investors to the once-obscure securities. The regulator issued an advisory in August cautioning investors to be mindful that warrants can become worthless if an investor misses a company’s deadline for redeeming them. FINRA said retail investors should be aware of “the risks associated with these speculative securities.”

The trading in warrants of Digital World has often been even more frenzied than the company’s stock.

On Oct. 21, the day after Digital World announced its merger deal, the stock rose more than 350 percent. But its warrants went from about 50 cents to $7 — a nearly 1,300 increase.

David Enrich contributed reporting.

Matthew Goldstein covers Wall Street and white collar crime and housing issues. @mattgoldstein26

A version of this article appears in print on Dec. 10, 2021, Section B, Page 8 of the New York edition with the headline: Trading Surge, Now Scrutinized, Preceded Trump’s SPAC Deal. Order Reprints | Today’s Paper | Subscribe