As has been widely reported, there has been a phenomenal increase in the volume of SPAC transactions as an alternative approach to becoming a public company. According to Bloomberg, around "300 SPACs launched on U.S. exchanges in the first quarter, raising almost $100 billion. That total was more than all of last year." In this statement, Corp Fin Acting Director John Coates discusses liability risks potentially arising out of SPAC and de-SPAC transactions, that is, the transactions in which a private operating company undertakes a business combination with a SPAC, ultimately becoming a public operating company. The essence of his message is: why should a SPAC be treated differently from a traditional IPO?
After describing how SPACs work as an alternative path to "go public," Coates moves on to address the liability issues arising out of disclosures in the de-SPAC transaction. He observes that some practitioners and commentators have argued that SPACs involve lower securities laws liability risk because, in contrast to traditional IPOs, SPACs are entitled to rely on the safe harbor for forward-looking statements in the PSLRA, allowing SPAC sponsors, targets, and others involved in the SPAC (SPAC participants) to disclose projections and other valuation material that would normally not be disclosed in conventional IPO prospectuses. In that case, he queries, are protections for investors voting on or buying shares in the de-SPAC transaction adequate? Do the current protections fail to adequately incentivize SPAC participants and private investors to perform appropriate due diligence on the target and its disclosures to public investors, especially given that the de-SPAC transaction may not involve a traditional underwriter? Importantly, should the level of liability be determined by the form of the IPO pathway?
But, in reality, how much lower is the liability risk in SPAC transactions? According to Coates, the claim among some practitioners and commentators "about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst. Indeed, in some ways, liability risks for those involved are higher, not lower, than in conventional IPOs, due in particular to the potential conflicts of interest in the SPAC structure." There is no "free pass" for material misstatements or omissions in de-SPAC transactions. Material misstatements in or omissions from the de-SPAC registration statement are still subject to liability under Section 11 and the related proxy statement is subject to liability under Section 14(a) and Rule 14a-9, which has typically been assessed under a "negligence" standard. In addition, tender offers are subject to liability under Section 14(e). There is also potential liability under state law. Notably, he argues, Delaware applies "both a duty of candor and fiduciary duties more strictly in conflict of interest settings, absent special procedural steps, which themselves may be a source of liability risk."
And about that thorny question of PSLRA protection? Don't be so sure, Coates contends. First, he argues, the PSLRA does not provide any protection against SEC enforcement, nor does it "protect against false or misleading statements made with actual knowledge that the statement was false or misleading." According to Coates, a
"company in possession of multiple sets of projections that are based on reasonable assumptions, reflecting different scenarios of how the company's future may unfold, would be on shaky ground if it only disclosed favorable projections and omitted disclosure of equally reliable but unfavorable projections, regardless of the liability framework later used by courts to assess the disclosures. The safe harbor is also not available if the statements in question are not forward-looking. Statements about current valuation or operations have been viewed as outside the safe harbor by some courts, even if they are derived from or linked to forward-looking projections or statements. Nor is the safe harbor available unless forward-looking statements are accompanied by 'meaningful cautionary statements' identifying important factors that could cause actual results to differ materially from those in the forward-looking statements."
But just putting all that aside, is it even true that the PSLRA safe harbor provides protection for SPACs? That, Coates argues, "is uncertain at best." Specifically excluded from the safe harbor are statements made in connection with an offering of securities by a blank check company, those made by a penny stock issuer and those made in connection with an initial public offering. But there is no definition provided for "initial public offering" and, in Coates's view,
"that phrase may include de-SPAC transactions....To be sure, an 'IPO' is generally understood to be the initial offering of a company's securities to the public, and the SPAC shell company initially offers redeemable equity securities to the public when it first registers to raise funds in order to look for and later acquire a target. However, it is also commonly understood that it is the de-SPAC—and not the initial offering by the SPAC—that is the transaction in which a private operating company itself 'goes public,' i.e., engages in its initial public offering. Economically, and practically, the private target of a SPAC is a different organization than the SPAC itself. The information, including financial statements, relevant to evaluating the investment changes dramatically in the de-SPAC because the private target has operations unlike the SPAC; and initial SPAC investors commonly have the right to and do sell or have their shares redeemed."
Isn't it really a question of economic substance over form? According to Coates, the
"economic essence of an initial public offering is the introduction of a new company to the public. It is the first time that public investors see the business and financial information about a company. As a result, Congress, markets, analysts, and the SEC staff typically treat these introductions differently from other kinds of capital raising transactions....An IPO is where the protections of the federal securities laws are typically most needed to overcome the information asymmetries between a new investment opportunity and investors in the newly public company. To be sure, some elements of the SEC's regulatory regime reflect a recognition that small or new public companies may not be as able to shoulder the costs of all disclosure requirements as older, larger companies. But it remains true that IPOs are understood as a distinct and challenging moment for disclosure. If these facts about economic and information substance drive our understanding of what an 'IPO' is, they point toward a conclusion that the PSLRA safe harbor should not be available for any unknown private company introducing itself to the public markets. Such a conclusion should hold regardless of what structure or method it used to do so. The reason is simple: the public knows nothing about this private company. Appropriate liability should attach to whatever claims it is making, or others are making on its behalf."
In addition, he said, disclosures are also important in the initial SPAC offering by the shell company first raising funds, particularly, the disclosure "about sponsors and their financial arrangements, the procedural protections of the SPAC structure, and what kinds of returns the SPAC is likely to generate for investors absent a de-SPAC transaction or for those who choose to exit before the de-SPAC is completed." However, at the time of the initial SPAC filing, the "long-term value proposition of the offering" cannot be clearly understood because the SPAC does not yet have any operations.
What does Coates propose? First, all SPAC participants and investors need to understand that the supposed limits on any alleged liability difference between SPACs and conventional IPOs seem "uncertain at best. SPAC participants should provide the public with the information material to the de-SPAC investment, "regardless of how the liability analyses ultimately play out. Liability risk is an important feature of the conventional IPO process. If that risk drives choices about what information to present and how, it should not in my view be different in the de-SPAC process without clear and compelling reasons for and limits and conditions on any such difference."
Second, the scope of the safe harbor in the PSLRA should be revisited, either through new SEC rulemaking to revise the applicable definitions or through staff guidance regarding the application, or not, of the PSLRA safe harbor to de-SPAC transactions, keeping in mind the "practicalities" of SPACs and SPAC structures relative to conventional IPOs and direct listings. He also raises the issue of whether the concept of "underwriter" should be reconsidered in these new approaches and whether new guidance is necessary to address the use of projections and related valuations in these contexts? Forward-looking information, such as projections, can be valuable and decision-useful, but it can
"also be untested, speculative, misleading or even fraudulent....Reflected in the PSLRA's clear exclusion of 'initial public offerings' from its safe harbor is a sensible difference in how liability rules created by Congress differentiate between offering contexts. Private companies that combine with SPACs to enter the public markets have no more of a track record of publicly-disclosed historical information than private companies that are going through a conventional IPO. If there are risks to the use of cost-effective, complete, and reliable forward-looking information in any setting, those risks should be carefully evaluated in light of the goals of the federal securities laws."
Finally, he observes that, in light of the tendency of investors in the SPAC's first public capital raise to redeem their shares before the de-SPAC, they are often not investors in the ultimate public company. Accordingly, it is the de-SPAC transaction, where new investors invest in the combined operating company, that should be the focus of the "full panoply of federal securities law protections—including those that apply to traditional IPOs. If we do not treat the de-SPAC transaction as the 'real IPO,' our attention may be focused on the wrong place, and potentially problematic forward-looking information may be disseminated without appropriate safeguards."
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