Will Small Cap Investors Embrace Donald Trump’s DWAC? The latest Reddit Meme Stock

Since the fall of 2019, we’ve written a number of times about the Securities and Exchange Commission’s amendments to Rule 15c2-11, which, most importantly, require over-the-counter stocks to provide “current information” to the public. Since the end of September of this year, compliance has been required, bringing dramatic changes to the penny stock market. So where will retail players in search of potentially dramatic gains turn? Many have moved to lower-tier NASDAQ or struggling NYSE issuers, with surprising results. 

The SEC requirements forbid broker-dealers to publish quotations for any OTC issuer that fails to meet its new requirements; the regulator’s intention was that the stocks in question would be moved to the Grey Market and left there to wither away. OTC Markets had hoped to soften the blow by instead placing them on its “Expert Market,” where it further hoped public quotations could at least be offered to brokers, institutions, and accredited investors. The SEC declined to consider that proposal at this time. The “no info” stocks have indeed been moved to the Expert Market, and nearly all of them are billed as quoted on an unsolicited basis, which ought to mean quotes would be available to all comers. But U.S. broker-dealers, who are regulated by both the SEC and the Financial Industry Regulatory Authority, aren’t taking chances: those stocks cannot be purchased by their customers; only liquidating transactions are permitted. (Most Canadian brokerages do allow buys, but that is not generating much volume.)

On October 15, OTC Markets reported that “2,247 former Pink No Information securities shifted to the Expert Market tier, where securities may only be quoted on an Unsolicited (customer order) basis.” Three days later, TDAmeritrade published its own list of securities clients cannot purchase. It contains 5,870 items, though not all of them are equities. 

Despite OTC Markets’ brave words about an increase in foreign issuers making use of its services, the penny market is in the doldrums from our perspective. There’s less interest, with lower trading volumes. But retail players haven’t just given up; they’ve gone elsewhere. 

They haven’t found just one refuge. Some have migrated to the so-called “meme stocks”; others have been buying stock and warrants in special purpose acquisition companies, known as “SPACs.”

The Meme Stocks

Beginning in late 2020 and picking up speed in the first few months of 2021, a large group of retail traders gathered at a sub-reddit called WallStreetBets to discuss their plays in real-time. Many were entirely new to trading and had chosen to use online discount broker Robinhood Financial. Their picks seemed quirky, but they delivered. One of the most popular, GameStop Corporation (GME), a brick-and-mortar video game rental outfit barely getting by, zoomed from a little over $10 to a 52-week high of $483. Another favorite, AMC Entertainment Holdings (AMC), moved from the low single digits to $76.62, despite closing its theaters thanks to the COVID crisis. Both trade on the NYSE.

The only reason for the extraordinary price and volume movement was the hype generated by the (mostly) Robinhood investors. The stocks weren’t promoted in the usual way; all the heavy lifting was done, and done extravagantly, by the buyers. Many of them frequented WallStreetBets, where they contributed posts with—what else?—memes—and invented a brand new trading vocabulary. The movie Rise of Planet of the Apes inspired them to call themselves “APES”; they borrowed “HODL” — ”hold on for dear life” from cryptocurrency enthusiasts; they took pride in being unafraid to “YOLO,” or place a dangerous “you only live once” trade.

WallStreetBets wasn’t all fun and games. It had a server at Discord, another chat forum, where management banned it for “hate speech.” Its operation has also been linked to a couple of prominent penny stock promoters, one of them disciplined by the SEC in connection with other matters. Robinhood itself played a role in the rise of the meme stocks, designing graphics designed to encourage trading by, for example, showering players’ screens with confetti when they made a buy. The SEC considers that inappropriate at the very least; Chair Gary Gensler promises further consideration of what he calls the “gamification” of the markets. On October 18, the regulator released a staff report that addressed the rise of the meme stocks, with particular attention paid to GME at length. The report noted that:

Consideration should be given to whether game-like features and celebratory animations that are likely intended to create positive feedback from trading lead investors to trade more than they would otherwise. In addition, payment for order flow and the incentives it creates may cause broker-dealers to find novel ways to increase customer trading, including through the use of digital engagement practices.

It wasn’t the first time the SEC had taken on Robinhood. In December 2020, it charged the broker for neglecting to disclose its practice of accepting payment for order flow, which resulted in a failure to satisfy its duty to seek the best execution for its customers. Robinhood agreed to settle for $65 million. The content of the staff report suggests that further action, perhaps in the form of rulemaking, will be taken.

While the meme stocks were running hard, there was much talk among players about short selling, especially “naked” short selling. GME and AMC were indeed shorted heavily, and it was a succession of short squeezes that drove them to such unlikely heights. But abusive naked shorting hasn’t been a problem since Reg SHO was implemented in the middle of the first decade of the century. While selling naked to meet unexpected demand may have been painful for some market makers and their clearing firms, they all seem to have survived the experience. Naked shorting would have been accompanied by an avalanche of fails to deliver, but the staff report concluded that “GME did not experience persistent fails to deliver at the individual clearing member level. Specifically, staff observed that most clearing members were able to clear any fails relatively quickly, i.e., within a few days, and for the most part did not experience fails across multiple days.”

That is not to say GME’s stock price fell back to its 2020 levels, as most observers initially believed it would. It did drop into the $40s fairly early on, but its fans seem to have decided to YOLO and began to buy once again. It now trades around $180. 


Where can adventurous yet inexperienced investors looking for the big bucks go now? Many appear to have settled on SPACs. Of course, they aren’t the only market participants interested; serious professionals take part in these deals as well, usually as sponsors or anchor investors. SPACs aren’t new; they were first created in 1993 when blank check companies were prohibited in the United States. Until recently, they’ve been part of the investing landscape, but not a prominent part. 

But in 2020, SPAC initial offerings quadrupled to 248 and are on pace to do the same or better this year. CNBC reports that this sudden enthusiasm seems to be driven chiefly by retail investors and compares the phenomenon, as we’ve done, to the meme stock mania. And most of those investors aren’t buying at the IPO price, which is generally set at $10 a share and is redeemable if something goes wrong with the eventual merger. They’re buying on the open market. 

It may be useful to explain how a SPAC works. Like a normal reverse merger, it’s a way for a private company to go public without incurring the very high costs of a traditional IPO. It’s also faster: once the private company signs a definitive merger agreement, it may be a matter of only a few months before it begins trading. The management of the SPAC will have already done much of the work required. As with other ways of obtaining or creating public shells, there are specialists in the field, experienced people who’ve become known as successful SPAC managers.

The manager will usually serve as the CEO of the SPAC. He begins by incorporating the company and drawing up its bylaws. The bylaws will authorize the issuance of stock, rights, warrants, and options; he will later be free to issue the types of securities that will serve his purposes. 

Every SPAC needs a sponsor or sponsors. Often, though not always, the manager acts as one. The sponsor will make a nominal investment—usually $25,000—and in return will receive “founder shares” equal to a 20 percent interest in the SPAC. The sponsor(s) will then approach other industry professionals and ask them to act as “anchor investors.” The anchor investors will agree to invest in the offering planned by the company and will also receive an allotment of founder shares from the sponsor(s). Their investments in the IPO will be, like the sponsor’s investment, inexpensive. 

The SPAC then prepares a Form S-1 initial registration statement in which it describes the offering it plans. The securities to be registered (and sold in the offering) are always “units,” generally consisting of one share of common stock and a fraction of a warrant. (Fractional warrants are preferred because they’re ultimately less dilutive than would be a unit comprised of one share of stock and one warrant.) The units will be sold to the anchor investors and to retail investors. The price of each unit will be about $10. Subsequently, the common stock and the warrants will trade separately on the open market.

In the registration statement, the SPAC will state that it seeks to find a company to merge with. It may note a broad field of interests but cannot have already selected a target company. The SPAC has a predetermined amount of time to execute a merger, usually around two years, at most three. Once the target company is identified, a merger agreement will be drawn up, and within a few months, the once-private entity will begin a new life as a publicly-traded company.

Thanks to their founder shares and considerable quantities of units, the sponsor and the anchor investors will do very well if the deal goes as planned. 

Should the SPAC not find a suitable target company, or should the merger fall through for some reason, investors in the offering will be able to get their money back through a redemption process. For this reason, some advisers recommend SPAC offerings as a safe, almost risk-free, investment. But in this moment of new enthusiasm for SPACs, that isn’t when most retail investors are buying. They’re waiting till the SPAC shares begin trading, and a target company is announced, and then they buy on the open market. That evidently makes sense. According to a report from Kiplinger, SPAC investments do best after the definitive merger agreement is announced but before the merger actually takes place.

Digital World Acquisition Corp

Digital World Acquisition Corp (DWAC) is a SPAC that has, to use a hackneyed, but in this case, accurate, phrase, taken the investing world by storm since it announced its initial business combination on October 20. 

DWAC’s chairman and CEO is Patrick Orlando. He’s managed a number of SPACs, not all of which consummated eventual mergers. Its CFO is Luis Orleans-Braganza, who, oddly, is a current member of Brazil’s National Congress. The SPAC’s sponsor is ARC Global Investments II, LLC. In a footnote to the S-1 filed in the spring of 2021, we learn that:

ARC Global Investments II LLC, our sponsor, is the record holder of the securities reported herein. Patrick Orlando, our chairman and chief executive officer, is the managing member of our sponsor. By virtue of this relationship, Mr. Orlando may be deemed to share beneficial ownership of the securities held of record by our sponsor. Mr. Orlando disclaims any such beneficial ownership except to the extent of his pecuniary interest.

In January 2021, ARC purchased 2,875,000 founder shares, comprised of Class B common stock, in a private placement, for a price of $25,000. (He didn’t get off that lightly; he also agreed to buy 306,275 units, which at $10 a pop set him back $3,062,750.) The Class B commons are convertible into Class A commons on a 1:1 basis. ARC sold 1,650,000 founder shares to each anchor investor in the offering. The price was about $0.0029 per share. The anchor investors also agreed to purchase significant quantities of the units sold in the offering, but the company did not report how many they actually purchased. Each unit consisted of one share of commons and half a warrant. The underwriter was none other than EF Hutton, described as a division of Benchmark Investments, LLC. Benchmark bought the rights to the name in May 2021, just as DWAC was beginning to prepare its offering. Plans are underway to use it as the underwriter for a series of SPACs.

If the entire offering had been sold, the company would have raised $346,725,000. It appears, however, that it did not; according to the October 20 press release, the proceeds, which were and still are held in trust, were $293 million.

The Form S-1 was filed on May 26, 2021, and went through six amendments before it was deemed effective on September 2. The following day, DWAC was listed on the NASDAQ. It also listed its warrants (DWACW) and units (DWACU) separately. 

The registration statement noted that it had, as was required of it, not engaged, directly or indirectly, in discussions with potential target companies. It added that:

While we may pursue an initial business combination target in any business or industry, we intend to focus our search on middle-market emerging growth technology-focused companies in the Americas, in the SaaS and Technology or Fintech and Financial Services sector.

When the announcement came, it was a bombshell.

Trump Media & Technology Group

Late in the day on October 20, DWAC and Trump Media & Technology Group (TMTG) issued a joint press release announcing their entry into a definitive merger agreement. Subject to regulatory and stockholder approval, TMTG will soon be a public company listed on the NASDAQ. At least according to the two entities’ calculations, it’ll be worth a pretty penny:

The transaction values Trump Media & Technology Group at an initial enterprise value of $875 Million, with a potential additional earnout of $825 Million in additional shares (at the valuation they are granted) for a cumulative valuation of up to $1.7 Billion depending on the performance of the stock price post-business combination. Trump Media & Technology Group’s growth plans initially will be funded by DWAC’s cash in trust of $293 Million (assuming no redemptions).

Needless to say, the chairman of TMTG is Donald J. Trump, who vowed to create a rival to the “liberal media consortium,” remarking:

I created TRUTH Social and TMTG to stand up to the tyranny of Big Tech. We live in a world where the Taliban has a huge presence on Twitter, yet your favorite American President has been silenced. This is unacceptable. I am excited to send out my first TRUTH on TRUTH Social very soon. TMTG was founded with a mission to give a voice to all. I’m excited to soon begin sharing my thoughts on TRUTH Social and to fight back against Big Tech. Everyone asks me why doesn’t someone stand up to Big Tech? Well, we will be soon!

The new company also plans to launch a subscription video-on-demand service featuring entertainment programming, news, podcasts, and more. 

TMTG will soon be filing a registration statement and a proxy statement with the SEC. No doubt there’ll be a name and ticker change as well. DWAC has already filed an 8-K to fulfill its Regulation FD disclosure requirements.

Trump has spoken in the past about starting his own media company. On the homepage of the TMTG website, readers are promised it’ll be “a uniting force for freedom of expression” and a shot in the chops to Big Tech and “cancel culture.” There’s no reason this idea can’t sell. He does, after all, have lots of fans; it seems likely many of them would be interested in frequenting Truth Social and subscribing to its video service. Some may even buy stock in the company. 

But there are a few clouds on the horizon. Rolling Stone and The Verge reported that whoever created the “test site” for Truth Social so that interested parties could take it for a spin in advance of its official opening used an open-source software program called Mastodon. It’s free to anyone who wants to use it. Still, according to the licensing agreement, those who use it—in this case, the users of Truth Social—must be given “an opportunity to receive the entire Corresponding Source for the website based on that code.” Bradley Kuhn, a policy fellow for the Software Freedom Conservancy, says he feels strongly about the violation and has given Trump Media 30 days to comply with the terms of the agreement or lose all rights to the software. That may be a small point; it seems possible the TMTG people only intended to use Mastodon temporarily. But it isn’t an auspicious start. The test site has been taken down.

It goes without saying that by Friday, word of DWAC’s initial business combination had spread far and wide. The SPAC, with shares outstanding of only 39 million, traded as high as $179.99, on volume of 133,311,715 shares. More stunning still was the dollar volume of $16.3 billion.

Two professionals with substantial positions sold their unrestricted shares. One was hedge fund manager Boaz Weinstein, whose Saba Capital Management was an anchor investor. He said after he sold on Thursday, “I knew that for Saba, the right thing was to sell our entire stake of unrestricted shares, which we have now done.” Lighthouse Investment Partners reported on Friday that they’d done the same.

While they probably didn’t sell at a loss, they did, in all likelihood, sacrifice greater potential gains. The immediate future looks bright for DWAC. The future of TMTG is less clear, but it’s bound to be interesting and, in Trumpian fashion, full of twists and turns.

For further information about this securities law blog post, please contact Brenda Hamilton, Securities Attorney at 200 E. Palmetto Park Rd, Suite 103, Boca Raton, Florida, (561) 416-8956, by email [email protected] or visit www.securitieslawyer101.com.  This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as and does not constitute legal advice on any specific matter, nor does this message create an attorney-client relationship.  Please note that the prior results discussed herein do not guarantee similar outcomes.

Hamilton & Associates | Securities Lawyers
Brenda Hamilton, Securities Attorney
200 E. Palmetto Park, Suite 103
Boca Raton, Florida 33432
Telephone 561-416-8956