Blank-Check Bankers Have a Spotty Past

EarlyBirdCapital has a hand in about half of these shells.
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A Long Island investment firm has carved out a niche finding money for dreams before they are dreamt.

EarlyBirdCapital is leading a revival in so-called blank-check IPOs, stock offerings filed by fledgling start-ups whose sole reason for existence is to buy a business they have yet to identify.

This year alone, the Melville, N.Y., firm has been the lead underwriter or co-manager on half of the two dozen blank-check initial public offerings that are awaiting approval from the

Securities and Exchange Commission

. Of the eight blank-check stock deals that have priced and begun trading this year, EarlyBirdCapital has been the investment banker behind four of them, raising $160 million in the process.

Other little-known investment banks such as Broadband Capital Management, Maxim Group and Morgan Joseph also are getting into the game of underwriting these business strategies-in-waiting.

But none has come to dominate the market like EarlyBirdCapital, a securities firm that's led by executives with a long history of fashioning blank-check deals.

David Nussbaum, EarlyBirdCapital's chairman, and Steven Levine, the firm's chief executive, both hail from GKN Securities, a defunct brokerage that tried to make a name for itself by underwriting blank-check IPOs. The firm ran into problems with securities regulators in the 1990s.

In the mid-1990s, GKN managed about a dozen blank-check IPOs, which the firm calls "specified purpose acquisition companies," or SPAC. GKN even applied in 1992 to trademark the name. In all, the deals raised about $140 million and a good number of the GKN blank checks found merger partners with small companies.

But GKN's monopoly in blank checks came to a crashing halt when in 1997 the

NASD

ordered the firm and 29 brokers and supervisors to pay more than $2 million in fines and restitution to settle allegations it had overcharged investors buying shares in eight newly minted stocks. The regulators alleged that GKN had excessive markups on the shares because it essentially controlled their post-IPO trading.

Some of the stocks GKN allegedly gouged investors on were the same blank-check companies it had taken public.

In conjunction with the NASD regulatory action, Nussbaum, who was GKN's chairman and CEO, was fined $50,000 and suspended from the brokerage business for 30 days. Roger Gladstone, GKN's president, also was fined $50,000 and suspended for 30 days. Gladstone also now works at EarlyBird.

In the wake of GKN's troubles, the bursting of the bubble in tech stocks and the three-year bear market, blank-check IPOs all but disappeared. Now they're back, in large part due to the efforts of EarlyBirdCapital. The investment firm, which employs other GKN alums, even has gone back to calling its blank-check deals SPACs.

Nussbaum dismisses the regulatory problems at GKN as ancient history and says it should have no bearing on EarlyBirdCapital and its attempt to revive blank checks as an investment vehicle. He says the regulatory violations at GKN involved post-IPO trading, and EarlyBirdCapital doesn't make a market in the stocks of companies it takes public.

Clearly, a lot of investors agree with Nussbaum. Investors, mostly cash-rich hedge funds, have sunk more than $650 million into eight completed blank-check offerings over the past two years, even though only one of those companies has found an actual merger partner.

Some of the hedge funds that have made multiple investments in blank check offerings, according to regulatory filings, are

Fir Tree Partners

,

Hummingbird Management

,

Polar Securities

and

Woodland Partners

. Woodland is led by Barry Rubenstein, the co-founder of

Wheatley Partners

, a New York private equity firm that has provided financial backing to EarlyBird.

But those hedge funds and other blank check investors haven't gotten much bang for their buck. To date, only one of the newest crop of blank check deals has found an actual merger partner.

Last August,

Millstream Acquisition

, which raised $21 million in a deal led by EarlyBirdCapital, acquired

NationsHealth

(NHRX)

, a small, profitless medical supply company. Shares of NationsHealth most recently traded at $5.87, a bit below the $6 offering price, which also included two warrants to buy future shares.

Given that sorry track record, it's mystifying to some why blank checks have become hot again. Indeed, some investors in blank checks say they are beginning to sour on them because they feel like they are tying up cash in a dead-money investment.

"I'm completely SPAC'd out," says Paul Sonkin, a hedge fund manager with Hummingbird Management and an adjunct professor at Columbia Business School, who has invested in blank-check IPOs for

Ardent Acquisition

(AACQ)

and

Rand Acquisition

(RAQC)

.

Sonkin says the allure of blank checks is the ability to get into a potential corporate buyout situation on the cheap. But he says it takes too long for deals to be consummated. Right now, he says, the only ones making money off blank checks are the investment firms that are collecting fees for underwriting the IPOs.

Investment banking fees and expenses in a blank-check deal, on average, total about 10% of the gross proceeds raised in the IPO.

"I've told

the bankers not to call me anymore," says Sonkin.

The insiders who put these deals together also stand to make a bundle if a merger gets done. Because the company has no operations, the founders don't have to invest a lot of their money as seed capital. And the sliver of money they do pony up often buys a bushel of stock at a deeply discounted price.

While the founders wait for a merger to come their way, they typically collect rent money for providing office space to the fledgling start-up.

Of course, blank checks do have plenty of supporters. Blank-check boosters say the deals are relatively low-risk propositions because investors can get most of their money back if the company doesn't find a merger partner within 18 months. An IPO investor also can get back most of his money back if he doesn't like the company chosen as a merger partner.

The SEC requires blank-check companies that raise cash in an IPO to put the proceeds, minus expenses, into a bank account. Most blank-check companies are putting money into interest-bearing accounts.

"To me, it provides an almost no-lose situation," says Gary Stein, a private investor who says he has invested in several blank checks. "You're getting 80% to 90% of your money back if you want it."