the money game

Why Smart-Money Investors Are Shorting Trump’s SPAC

Buyer beware. Photo-Illustration: Intelligencer; Photo: Mandel Ngan/AFP via Getty Images

Over the past month, the stock price of the company that hopes to merge with Donald Trump’s new media outfit has surged by almost 25 percent, a move that seems counterintuitive given that the proposed deal is under investigation by both the Department of Justice and the Securities and Exchange Commission. By comparison, the S&P 500 rose only 9 percent in its July rally.

Could the Trump true believers who are still buying and holding the stock — 94 percent of its investors are individuals, not institutions — be falling for another Trump grift?

Some of their optimism may lie in the perception that all of Trump’s legal woes are illusory and that he will shake them off as easily as he did his unprecedented two impeachments and, to date, the various threats of prosecution that have hung over him and his real-estate company. (For what it’s worth, that doesn’t seem like a good bet — the DOJ and SEC investigations of a SPAC are entirely different sorts of legal processes.) Another reason for retail investors’ continued irrational exuberance about the Trump SPAC is that it could benefit if Elon Musk is successful in his effort to get out of purchasing Twitter — leaving Trump’s Truth Social as the likely social-media hub of his 2024 campaign. (Musk has said he plans to let Trump return to Twitter if he takes ownership, which could make Truth Social all but irrelevant.)

But these are slim reeds on which to build a case for the success of Trump’s latest business venture, Trump Media & Technology Group. While retail investors are still buying, smart-money institutional investors are betting the shares will go down, as the company’s prospects seem to worsen by the week under a steady stream of negative news.

Trump Media has been beset by controversy, executive departures, and technical difficulties ever since its existence was unveiled last October, when it sought to cash in on a financial craze with a plan to raise something like $1 billion by merging with a publicly traded blank-check company known as a SPAC, or a special-purpose acquisition company. The merger of the two (the private company seeking to go public and the already-public shell company promising investors an auspicious marriage) amounts to a sort of legal backdoor route to an IPO. The appeal for the private company is that the regulatory hurdles and the financial scrutiny tend to be lower than going public in the traditional way.

But it is looking less likely that Trump’s company will get the deal done. That could mean the end of Truth Social, a segment of Trump Media that would be financed by the SPAC’s proceeds.

Like meme stocks and crypto, SPACs were a phenomenon of the bull market that has largely fizzled, leaving many aggrieved investors deep in the red. But Trump’s SPAC effort has an even bigger problem: In June, Digital World Acquisition Corp., the publicly traded shell company that agreed to buy Trump Media, disclosed that both companies and their executives had received subpoenas from a federal grand jury in the Southern District of New York.

This DOJ investigation comes on the heels of a similar one by the SEC, which is looking to see if the SPAC broke securities laws by agreeing to the deal with Trump’s company ahead of its IPO without telling prospective investors. And there’s even a third investigation — by the Financial Industry Regulatory Authority — that is related to trading activity ahead of the merger announcement.

The combined weight of these probes makes it unlikely that Trump Media will ever get its public listing — and the cash that would go along with it. “The fact that the DOJ is looking at it is going to give the SEC more pause about allowing this deal to go forward,” says Robert Jackson, a former SEC commissioner who is now a professor at New York University School of Law.

Even before the latest news, there was skepticism about the fate of the Trump SPAC. “With each passing day, the truth becomes harder to deny; a merger between two sketchy companies that is already taking too long is likely headed for collapse,” wrote short seller Sahm Adrangi, founder of hedge fund Kerrisdale Capital, in a prescient research report in April after Musk’s announced takeover of Twitter.

When the deal was made public, there was no shortage of optimistic buyers. The stock went on a tear as enthusiastic Trump supporters piled in, making it the Reddit meme stock play du jour. But after an initial surge that took the stock from $10 to as high as $175 per share, Digital World has been under pressure all year. Even with the gain in July, the stock is now down about 40 percent in 2022, including a near 10 percent drop when the DOJ probe was announced in June. It recently traded around $30 per share.

While retail investors had piled in, smart-money players were immediately skeptical of the Trump SPAC merger — in no small part because it appeared to be just another Trump grift. In reality, Trump Media was as much of a shell company as the blank-check company with which it planned to merge. Although Trump’s firm has since hired some staff, including former California representative Devin Nunez as CEO, and gotten Truth Social off the ground after a bungled launch, the company’s initial website featured a 22-page deck filled with graphics about Trump’s Twitter following and the platform’s plans to disrupt everything from Facebook to Disney — but no financial information.

The merger between Trump Media and Digital World was announced only six weeks after the SPAC’s IPO, and the hedge-fund investors that had bought into Digital Global when it went public (like Boaz Weinstein’s Saba Capital and D.E. Shaw) quickly sold out in the trading frenzy that followed.

That left retail investors owning something like 94 percent of the shares, according to Nasdaq. Among the few institutional owners left, according to the most recent disclosures, is Susquehanna International Group, whose founder, Jeff Yass, is a top GOP donor this cycle.

If the deal is nixed, SPAC rules require that the company return to investors the IPO net asset value of $10 per share. But most of the investors who own the stock — including Susquehanna — bought in after the IPO, meaning they are likely to lose money if the deal flops.

Yet institutional investors have not only been selling shares; they’ve been shorting them. This year, Digital World became the biggest SPAC short in the market, according to S3 Research Partners’ managing director of predictive analytics Ihor Dusaniwsky. He says about 15 percent of its shares that trade freely and aren’t bound by lockup arrangements have been shorted.

“Digital World isn’t just another dubious 2021 SPAC — it is a poster child for some of the worst abuses the investment vehicle has spawned,” short seller Adrangi wrote in his report, detailing numerous red flags with the company and predicting the deal will never get the regulatory approval necessary for the merger to go through.

Among those red flags: Digital World and its CEO, Patrick Orlando, are associated with ARC Capital, a Shanghai-based investment bank that has run afoul of the SEC in the past. ARC also allegedly has ties to Digital Global’s underwriter, which renamed itself E.F. Hutton in 2021. Digital World’s ties to ARC, its sponsor, and E.F. Hutton are currently under investigation by the SEC. Another danger signal is what Adrangi calls the “blistering speed” with which the deal was struck. Under SEC rules, SPACs cannot identify the company they plan to buy ahead of time, nor can they, “directly or indirectly, have participated in any substantive discussions with any merger target.” Finding the right partner often takes a year or more. Yet within days of the deal’s announcement, the New York Times reported that Digital World’s Orlando had been in talks with representatives from Trump Media months earlier. This matter is being investigated by the SEC and the DOJ. Trump Media issued a statement proclaiming, “We encourage — and will cooperate with — oversight that supports the SEC’s important mission of protecting retail investors.”

A SPAC’s failure to disclose such prior arrangements is a violation of anti-fraud rules. It is not a new issue for the SEC, nor a minor one.  A 2005 case involving  a SPAC sponsored by International Shipping Enterprises that struck its deal within two months of going public was such a big problem that it “shut down the SPAC market for a year” while the investigation was ongoing, says former SEC commissioner Jackson.

Another area of regulators’ concern appears to involve the trading in warrants — which give the owner the right to buy stock in the future at a preset price — ahead of the announcement. While the disclosure about the FINRA investigation into trading isn’t specific, a week before the merger of Digital World and Trump Media was disclosed, more than 2.5 million warrants exchanged hands, according to another report in the New York Times. The newspaper also recently reported that employees at a Miami investment firm, Rocket One Capital, had learned of the impending deal months ahead of time. The grand jury has sought information about that firm, and one of its top executives, a former director of Digital World, has resigned from the board.

If any insiders were trading those warrants, “that’s as bad as it gets,” says Joel Rubinstein, a partner at White & Case whose practice includes SPACs. Such insider trading, he says, “goes right to the integrity of the markets.”

The SEC has been cracking down on SPACs for almost a year now, both with enforcement actions and new proposed rules designed to stem the abuses that have caused so many investors — particularly individual investors — to lose so much money.

Adds Jackson, the former SEC commissioner, “For better or worse, all eyes are on the SEC on what they’ll do about SPACs — particularly ones that have issues with compliance with the law.”

Adrangi, the short seller, says the government’s new rules are designed to weed out companies “that seem to make a mockery of the process through a SPAC merger. “A SPAC,” he says, “is not supposed to allow any wisp of a company to gain public market access by gaming regulatory regimes.”

“A SPAC,” he says, “is not supposed to allow any wisp of a company to gain public market access by gaming regulatory regimes.”

Why Smart-Money Investors Are Shorting Trump’s SPAC