United States: SEC Adopts New Rules On SPACs—just Investor Protection Or Will It Spell The Demise Of SPACs?

Recently, SPACs seem to have lost much of their allure, but why? Certainly there are multiple reasons related to the capital markets, but one reason may have been the anxiety of many SPAC proponents precipitated by the proposal that the SEC advanced in 2022 to regulate SPAC and de-SPAC disclosure and liability. Commissioner Hester Peirce, who had dissented on even issuing the proposal, remarked at the time that the proposal "seem[ed] designed to stop SPACs in their tracks." Yesterday, the SEC voted, three to two, to adopt those rules, with some changes. The new rules and amendments will affect SPACs, shell companies and the use of projections in SEC filings. The SEC is also issuing new guidance addressing potential underwriters in de-SPAC transactions, as well as the status of SPACs under the Investment Company Act of 1940 (in lieu of adopting a proposed rule). According to Gensler, "Today's adoption will help ensure that the rules for SPACs are substantially aligned with those of traditional IPOs, enhancing investor protection through three areas: disclosure, use of projections, and issuer obligations. Taken together, these steps will help protect investors by addressing information asymmetries, misleading information, and conflicts of interest in SPAC and de-SPAC transactions." Peirce and Commissioner Mark Uyeda dissented, in essence, viewing the new rules as "merit regulation" and overkill, with the emphasis on "kill"—that is, as Peirce commented, the "regulatory reaper came for SPACs and seems to have won." Similarly, Uyeda remarked that, with the current SPAC market just "a shell of its former self," the new rules show that the SEC "intends to never let them return." The final rules will become effective 125 days after publication in the Federal Register, except that compliance with the requirement to use inline XBRL will not be mandatory until 490 days after publication in Federal Register.

Here are the 581-page final rule, the fact sheet and the press release.

The new rulemaking reflects a call by SEC Chair Gary Gensler and others to treat SPACs as an alternative method of conducting an IPO under the SEC's policy framework. (See this PubCo post, this PubCo post and this PubCo post.) Not to mention the extensive recommendations from the SEC's Investor Advisory Committee addressing SPAC regulatory and investor protection issues. (See this PubCo post.) These investor protection concerns were exacerbated as a result of the proliferation of SPACs in 2020 and 2021—raising $83 billion in 2020 and $160 billion in 2021 and, in those same two years, constituting more than half of all IPOs. Those original concerns made SPACs an appealing target for SEC rulemaking, and, in 2022, the SEC approached the challenge by crafting a detailed proposal. But it's been almost two years since the rules were proposed and, during that time, the volume of SPACs has declined significantly. According to the WSJ, in 2023, there were only 31 SPAC IPOs raising $3.8 billion. (That said, the release indicates that SPAC IPOs still "constituted 43% of all U.S. IPOs in 2023.") As Gensler noted, "markets ebb and flow," and the SEC apparently concluded that the new rulemaking remained imperative.

What is a SPAC? Very loosely, SPACs are companies with no real operations formed for the purpose of raising capital in an IPO to be used to acquire an operating company. In the interim, the offering proceeds are placed into a trust or escrow account. Essentially, SPACs act as vehicles for the acquired operating companies to go public through the de-SPAC acquisition transactions.

As summarized in the fact sheet, the final rules will, among other things:

In addition, the fact sheet indicated, the release offers guidance from the SEC "to assist SPACs in assessing when they may meet the definition of an investment company under the Investment Company Act of 1940 and regarding statutory underwriter status under the Securities Act of 1933 in connection with de-SPAC transactions."

Final Rules

New disclosures. In the final rules, the SEC adopted new Subpart 1600 of Reg S-K, which "sets forth specialized disclosure requirements for SPAC IPOs and de-SPAC transactions," including, among other thing, requirements for:

• "additional disclosures about the SPAC sponsor, potential conflicts of interest, and dilution," including SPAC sponsor compensation and disclosures about the target;
• "certain disclosures on the prospectus outside front cover page and in the prospectus summary of registration statements filed in connection with SPAC IPOs and de-SPAC transactions"; and
• "additional disclosures regarding de-SPAC transactions, including (1) if the law of the jurisdiction in which the SPAC is organized requires its board of directors (or similar governing body) to determine whether the de-SPAC transaction is advisable and in the best interests of the SPAC and its shareholders, or otherwise make any comparable determination, disclosure of that determination, and (2) if the SPAC or SPAC sponsor has received any outside report, opinion, or appraisal materially relating to the de-SPAC transaction, certain disclosures concerning the report, opinion, or appraisal."

Also, where consistent with local law, there will be a 20-calendar-day minimum dissemination period for prospectuses and proxy and information statements filed for de-SPAC transactions.

Investor protections. The final rules are also designed to "provide procedural protections and to align the disclosures provided to investors, as well as the legal obligations of companies, in de-SPAC transactions more closely with those in traditional IPOs." More specifically, the final rules will:

That re-determination will need to be reflected in filings beginning 45 days after consummation of the de-SPAC transaction.

The SEC is also "providing guidance regarding potential underwriter status under Section 2(a)(11) of the Securities Act in de-SPAC transactions." In addition, to "provide reporting shell company shareholders, including SPAC shareholders, with more consistent Securities Act liability protections regardless of transaction structure," the SEC has adopted new Rule 145a, which provides that any business combination of a reporting shell company, (excluding a business-combination-related shell company), involving another entity that is not a shell company is deemed to involve a sale of securities to the reporting shell company's shareholders within the meaning of Section 2(a)(3) of the Securities Act. The final rules also include new Article 15 of Reg S-X (and related amendments) designed to "more closely align the financial statement reporting requirements in business combinations involving a shell company and a target company with those in traditional IPOs."

Projections. As noted above, the new rules also address the use of projections in business combinations involving blank check companies, aligning them with the rules for traditional IPOs. The new rules makes the safe harbor for forward-looking statements under the PSLRA unavailable for blank check companies, including SPACs, by adopting a new definition of "blank check company" under the PSLRA. In addition, an amendment to Item 10(b), which provides SEC guidance on factors to be considered in "formulating and disclosing management's projections of future economic performance," clarifies that the rule will apply to a target company's projections when they are presented to investors through the registrant's SEC filings. The final rules also mandate new disclosures regarding projections, including distinguishing "projected measures that are not based on historical financial results or operational history...from projected measures that are based on historical financial results or operational history," and disclosure of the material bases of the projections and the material assumptions underlying the projections.

Investment Company Act. In the final rules, the SEC elected not to adopt proposed Rule 3a-10 under the Investment Company Act of 1940, which would have provided SPACs with a safe harbor from the definition of investment company under Section 3(a)(1)(A), provided that they complied with the rule's conditions—which was viewed by some as perhaps a bit challenging. (One of the conditions was that the SPAC needed to enter into an agreement with a target company to engage in a de-SPAC transaction within 18 months after its IPO and complete its de-SPAC transaction within 24 months of that offering.) Because, whether a SPAC is an investment company under the Act "is a question of facts and circumstances" requiring individualized analysis, and "because, depending on the facts and circumstances, a SPAC could be an investment company at any stage of its operations such that a specific duration limitation may not be appropriate," the SEC decided against adoption of the proposed rule. Instead, the SEC is issuing guidance regarding the status of SPACs under the Investment Company Act. The guidance identifies the "type of activities that would likely raise serious questions about a SPAC's status as an investment company under the Investment Company Act."

At the open meeting:

In his statement, Gensler focused again on the need to give investors in SPACs the same protections as investors in IPOs. "The federal securities laws," he observed, "provide a range of protections for investors in traditional IPOs—through disclosure, marketing standards, as well as gatekeeper and issuer obligations. This adoption will ensure that similar protections apply to investors in these non-traditional IPOs as much as they do for investors in traditional IPOs. Just because a company uses an alternative method to go public does not mean that its investors are any less deserving of time-tested investor protections. IPOs are IPOs, and as Aristotle once said, 'treat like cases alike.' Whether you are doing a traditional IPO or a SPAC target IPO, SPAC investors are no less deserving of our time-tested investor protections." The new rules will offer these protections, Gensler indicated, through new disclosures at both the SPAC blank-check IPO stage as well as the SPAC target IPO stage, and make SPACs accountable for their forward-looking statements and projections. The new rules, he said, will also "address issuer obligations and liability with regard to SPAC target IPOs. In particular, the final rules require SPAC targets to sign the de-SPAC registration statements, thus making them liable for false or misleading disclosure. In addition, under new Rule 145a, a de-SPAC is deemed to involve a sale, thus subjecting the transaction to registration under the Securities Act."

In her statement, Peirce, perhaps alluding to the problem identified by the Fifth Circuit in overturning the SEC's stock repurchase disclosure rules (see this PubCo post), contended that, in crafting these rules, the SEC had "failed to identify a problem in need of a regulatory solution." Rather, she argued, the final rules will just exacerbate the existing problem of the "shrinking pool of public companies." Although there may have been some problems with SPACs, the market was already addressing those problems. A narrower rule that did not venture into "merit-based regulatory territory" would have been preferable, in her view.

The substantial decline in the number of SPACs occurred under the "shadow" of the rule proposal, she maintained, and the final rule will "render SPACs a much less useful pathway for companies to enter the public markets." In particular, she noted, the increased costs that may arise as a result of required co-registration, unprotected projections and the investment company guidance, which has the potential of "rushing the completion of de-SPAC transactions." She also pointed to dilution disclosure requirements that may be very speculative and problematic requirements to disclose third-party assessments and board votes.

The SEC, she said, has failed to "grapple with[] real issues around the public markets' accessibility for small companies." There may be "[m]yriad factors ...at work, but the regulatory costs facing public companies are one factor." Instead, she contended, the SEC "compounds the underlying problem by further impeding these companies' preferred pathway to the public markets." De-SPACs may be well-suited for some types of companies, but, by "layering obligations on the SPAC process, we are effectively taking this option off the table for companies, some of which are likely not to go public at all."

She also accused the SEC of "fancy legal footwork" in changing the definition of "blank check company," the "underwriting guidance's attempt to deem de-SPAC transactions as distributions, and the guidance on investment-company status, which will "function like a backdoor rule," causing cautious sponsors to turn "the references in the guidance to 12- and 18 month-time periods into ironclad deadlines."

At the end of her statement, Peirce asked a number of questions, including whether SPACs offered any benefits (to which Corp Fin Director Erik Gerding responded that they did not conduct a merit evaluation); would they view it as good or bad if, in five years there were no de-SPACs (Corp Fin was interested in investor protection, not in ending a practice); whether there were any accommodations for small companies (the final rules provide a 45-day period for redetermination of SRC status); whether the elimination of the PSLRA safe harbor would lead to overly pessimistic projections (the elimination was just intended to require that companies take the same care as in an IPO); whether an unintended consequence might be fewer projections (rule change was intended to make projections more accurate, not to reduce the level of projections, but that might be a consequence); and finally, she asked, referring to the newly revised definition of "blank-check" companies, whether the SEC had authority to revise definitions of terms used in the statute (to which Gerding replied that Congress had delegated that authority in the PSLRA and that the change in definition created equivalence with IPOs).

Commissioner Caroline Crenshaw argued that the SEC "is not seeking to regulate a bubble or opine on the merits of a rise in SPACs. Rather, the Commission and its staff have worked to put forth a rule that reduces incentives for financial engineering and arbitrage." In addition, the rule is designed to reduce "asymmetries in terms of investor protections between a traditional IPO and a SPAC transaction." Her remarks then focused on the SEC's analysis of investment companies under the 1940 Act and statutory underwriters. While the SEC did not ultimately address these issues with specific rules, she cautions that care should be taken in applying the analyses provided in the SEC guidance on these topics. With regard to the investment company analysis, she pointed out that the SEC is essentially "reiterat[ing] the existing test for determining whether an entity meets the definition of investment company." It does not set a prescribed timeframe, but relies instead on a "more principles-based facts and circumstances analysis." Some SPACs may not satisfy this test, but some will satisfy that definition. She urged "all participants in a SPAC transaction to carefully consider whether the particular features of the SPAC—whether considered alone or in aggregate—cause the SPAC to meet the definition of investment company. As the release reiterates, each day a SPAC exists increases the likelihood that the SPAC is, in fact, an investment company, particularly once the SPAC exceeds the existing twelve-month grace period already afforded to 'transient investment companies.' SPAC sponsors who have proven unable to complete a de-SPAC transaction expeditiously should either register as an investment company, as required by the 1940 Act, or return investors' money."

Under Section 11 of the Securities Act, underwriters have potential liability for the contents of registration statements, which provides an incentive for them to conduct "thorough due diligence." Although the final rule did not adopt the specific language that would have automatically made underwriters of SPAC IPOs also underwriters in the de-SPAC transaction if they participated in it, she warns that "participants in SPAC transactions should be aware that the analysis under the existing Securities Act provisions is dependent upon the facts and circumstances. They should consult existing statutory provisions and case law to conduct an analysis of whether they may be an underwriter given the activities they are conducting. And those participants conducting such analysis should be aware that, as the adopting release states, a de-SPAC is a distribution of securities and, under the statute and existing law, parties who are involved in the distribution of securities may become statutory underwriters and assume all attendant liabilities and responsibilities."

In conclusion, she noted that some would prefer to make the rules related to public offerings easier, with fewer requirements, less liability and less due diligence, but the "thoroughness and reliability of the processes" in place contribute to the "reliability of public financial reporting," which "informs the fairness and efficiency of the U.S. capital markets."

In his dissenting statement, Uyeda contended that the final rules were "purportedly designed to advance investor protection and facilitate capital formation for [SPACs]. But there may be a far simpler explanation behind what the Commission is doing for SPACs: we simply do not like them. In order to achieve this desired outcome, the Commission seeks to impose crushingly burdensome regulations on SPACs as a form of merit regulation in disguise."

The SEC could have developed a balanced regulatory framework for SPACs containing elements of its rules for IPOs and M&A transactions. But, unfortunately, the final rules "stray[] from that mission by imposing rigorous and expansive requirements from nearly every corner of the federal securities laws on SPACs, its IPOs, and any related de-SPAC transaction." The result may be to discourage SPAC and de-SPAC transactions. Given that the SEC lacks authority to ban SPACs altogether, he said, it has instead "resorted to promulgating rules aimed at significantly increasing the costs and decreasing the attractiveness of being associated with SPACs, to the extent that few rational actors would even attempt such an offering. Today's recommendation effectively constitutes a form of de facto merit regulation." To illustrate, he provides several examples where the new disclosure required for de-SPAC transactions is broader than that required for equivalent M&A transactions, such as the requirement to disclose whether "projections reflect the views of the applicable board or management team," or the requirement to identify the SPAC board members who vote against, or abstained from voting on, approval of the de-SPAC transaction, giving the reasons for the vote or abstention must also be disclosed. These disclosures are not required by the SEC in any other M&A transaction, he contended. As another example, he said that, while normally, disclosure rules for related-party transactions, compensation, and governance apply to "executive officers," for SPACs, disclosure regarding conflicts of interest and fiduciary duties apply to all officers.

Another illustration of de facto merit regulation Uyeda identified relates to the Investment Company Act guidance. While the final rules "abandon[] a problematic safe harbor from the definition of investment company under section 3(a)(1)(A) of the Investment Company Act," he cautions us not to "be fooled. What the Commission does instead is arguably worse. Over the course of ten pages of 'guidance,' the Commission misapplies existing rules to raise concerns about SPACs that operate beyond arbitrary 12 or 18 month timeframes prior to completing a business combination. Under the guidance, any SPAC that allocates any portion of its assets to investment securities—such as money market funds—triggers investment company status concerns, even if it complied with the timeframe for completing a business combination set forth in the relevant exchange listing rule." "Thus," he concludes, "it appears that SPACs—as they typically operate today—are investment companies that must register with the Commission or rely on an exemption." He goes on to argue that the SEC has no legal basis for its guidance and cautions all issuers—not just SPACs—to "pay heed to this guidance because the framework for investment company status determinations could have implications for an operating company that temporarily derives income from investment securities." Uyeda's addendum delves at some length into, in his view, the misapplication of existing rules in the SEC's guidance regarding the investment company status of SPACs "to raise concerns about SPACs that operate beyond arbitrary 12 or 18 month timeframes prior to completing a business combination." Although the "guidance is full of generic references to a need to consider 'all relevant facts and circumstances' when evaluating investment company status..., as a practical matter, when faced with such strong language, issuers and their legal counsels will need to weigh the risk that the bright line duration limits set forth in the guidance will be used as a basis to bring enforcement actions."

In his statement, Commissioner Jaime Lizárraga said that, relative to traditional IPOs, investors currently "face informational disadvantages when evaluating whether to invest in companies that raise capital through a [SPAC]." That's particularly true given "SPACs' structural complexity, along with their sponsors' financial incentives." Nor do investors have the same legal protections in a de-SPAC. Regular retail investors "are more adversely affected by the dilution effects of SPAC structures" and suffer from informational asymmetry that prevents them "from understanding how diluted their shares may be." That "results in inefficient market prices. This is not, by any reasonable standard, a good thing for our capital markets." The final rules address this issue.

The final rules, he said, also align "SPACs' treatment of financial projections with traditional IPOs. Financial projections for target companies are very common in de-SPAC transactions. However, academic studies and comments from investor advocates find that such projections can be overly optimistic, with retail investors experiencing substantial losses following a de-SPAC transaction." The final rules make the PSLRA safe harbor for forward-looking statements unavailable for both IPOs and de-SPACs. Finally, "by requiring that a target company sign the registration statement filed in connection with a de-SPAC transaction, the final rule ensures that investors more consistently receive the full liability protections of the Securities Act."

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