On March 30, 2022, the Securities and Exchange Commission (SEC) published a proposal for new rules and amendments under the Securities Act of 1933 and the Securities Exchange Act of 1934 governing initial public offerings (IPOs) of special purpose acquisition companies (SPACs) and subsequent business combination transactions between SPACs and nonpublic operating companies (known as "de-SPAC transactions").
While the SPAC structure has existed as an alternative to the more traditional IPO route for several decades, the proposed rules aim to address a number of concerns that have arisen over the past two years with the surge in SPAC activity. This is not the first time the SEC has raised concerns. Since December 2020, the SEC staff has provided guidance concerning SPACs on five occasions. The staff has also asked for enhanced disclosure in comment letters in connection with a number of recent SPAC IPOs and de-SPAC transactions.
The proposed SEC rules are summarized in the SEC's Fact Sheet, and are discussed briefly below.
Enhanced Disclosure Requirements
- Sponsor Disclosure. Recognizing the central role of a SPAC sponsor in formation of the SPAC, in the SPAC IPO and in the de-SPAC transaction, the proposed rules would require additional disclosure concerning the sponsor and its affiliates, including their relevant experience, roles and responsibilities, compensation arrangements, agreements about determining whether to move forward with a de-SPAC transaction, agreements with respect to redemptions, the material terms of any lockup agreements, and an organizational chart showing the relationships among the SPAC, its sponsor and the sponsor's affiliates.
- Conflicts of Interest. A concern that is sometimes raised concerning SPACs is the sponsor may be incentivized to pursue and close a business combination within the required time frame even when the transaction would not be in the best interests of public shareholders. To address this, and any other potential conflicts of interest, the proposed rules require disclosure of any actual or potential material conflicts of interest between the sponsor or its affiliates and unaffiliated SPAC securityholders, and a discussion of the fiduciary duties of each SPAC officer and director to other companies.
- Fairness. The proposed rules also require an affirmative statement from the SPAC as to whether it reasonably believes the de-SPAC transaction and related financing transactions are fair or unfair to unaffiliated securityholders, and the basis for that belief.
- Dilution and Redemptions. SPAC shareholders, and particularly those who elect not to redeem their shares in connection with a de-SPAC transaction, may be subject to several sources of dilution, including from redemptions, sponsor compensation, underwriting fees and concurrent financings. The proposed rules mandate disclosure concerning potential sources of dilution for public shareholders following a SPAC IPO and a table presenting potential redemption levels that would be included on the cover page of the prospectus for SPAC registrations on Forms S-1 and F-1.
- Additional Disclosures Concerning SPAC IPOs and De-SPAC Transactions. To provide investors with information concerning the SPAC structure and the nature of the SPAC life cycle in an easily digestible form, the proposed rules require additional disclosures (i) on the cover page of the prospectus, including plain English disclosure of the required time frame for a de-SPAC transaction, dilution, sponsor compensation, effects of redemptions, conflicts of interest and the fairness of the de-SPAC transaction; and (ii) in the prospectus summary, including the process by which targets will be identified and evaluated; the extent to which shareholder approval is required for a de-SPAC transaction; the material terms of the securities that are being offered, including redemption rights; any plans to seek additional financing; any material conflicts of interest; the background and terms of the particular de-SPAC transaction; and the fairness of the de-SPAC transaction to unaffiliated securityholders.
Alignment of De-SPAC Transactions With IPOs
- Target Company as Co-Registrant. Currently, in connection with a de-SPAC transaction, only a SPAC, its executive officers and at least a majority of its directors are required to sign the registration statement, which contains disclosures about the business of the private operating company that is acquired in the de-SPAC transaction. The officers and directors of the operating company do not sign the registration statement, and may therefore avoid liability under Sections 11 and 12 of the Securities Act for any material misstatements or omissions in its disclosures. To address this, and to create a strong incentive for officers and directors of the target to review the disclosures more closely and conduct more meaningful due diligence in connection with a de-SPAC transaction, the proposed rules provide that a target company in a de-SPAC transaction will be treated as a co-registrant with the SPAC. This would require executive officers and a majority of the board of directors of the target to sign the registration statement and thereby subject them to Securities Act liability for misstatements or omissions in the registration statement.
- Disclosure With Respect to Target. Currently, information required by Regulation S-K Items 101 (description of business), 102 (description of property), 103 (legal proceedings), 304 (changes in and disagreements with accountants on accounting and financial disclosure), 403 (security ownership of certain beneficial owners and management, assuming the completion of the de-SPAC transaction and any related financing transaction) and 701 (recent sales of unregistered securities) must be included in a Form 8-K in connection with a de-SPAC transaction (known as the "Super 8-K"). The Super 8-K must be filed with the SEC within four business days after the closing. The staff now proposes that if a target is not a reporting company, this information would need to be included in the registration statement on Form S-4 or F-4 that is filed in connection with the de-SPAC transaction. The information would then be available to shareholders before they make investment or redemption decisions in connection with the proposed de-SPAC transaction. Including such information in the relevant S-4 or F-4 filing would also subject the issuers and other parties to liability under Sections 11 and 12 of the Securities Act for misstatements or omissions, as in the traditional IPO context.
- Minimum Dissemination Period. To ensure that investors have adequate time to evaluate the information disclosed in prospectuses and proxy and information statements filed in connection with de-SPAC transactions, the SEC will require that this information be distributed to shareholders at least 20 calendar days before a shareholder meeting to approve the transaction (or, if earlier, the maximum period for disseminating the disclosure documents under the laws of the state in which the SPAC is organized).
- Smaller Reporting Company Status. Most SPACs qualify under current rules as "smaller reporting companies", which gives them the benefit of scaled disclosures under Regulation S-K and Regulation S-X. Because smaller reporting company status is determined annually, a company that goes public in a de-SPAC transaction may retain the benefits of scaled disclosure until the next annual determination date, even when the company would not otherwise be eligible for smaller reporting company status (for example, if it had become public through a traditional IPO process). The proposed rules will require a redetermination of smaller reporting company status before the first SEC filing by the company after its Super 8-K filing, with the public float measured for purposes of the redetermination as of a date within four business days after the consummation of the de-SPAC transaction. This change will require SPACs that might otherwise retain smaller reporting company status until the next determination date to lose that status and provide more robust disclosure earlier.
- PSLRA Safe Harbor. Under the Private Securities Litigation Reform Act (PSLRA), registrants are protected from liability for forward-looking statements if they identify the forward-looking statements and accompany them with certain cautionary language, except when the forward-looking statements are made by a "blank check company" or in an IPO. SPACs are typically structured to avoid falling into the definition of a blank check company. They are therefore able to avail themselves of the PSLRA protections in their filings in connection with de-SPAC transactions. In contrast, no such protections exist for a typical IPO. To address this disparity, the proposed rules amend the definition of a "blank check company" to remove the PSLRA protection for forward-looking statements in connection with de-SPAC transactions.
- SPAC IPO Underwriters Are Underwriters in Registered De-SPAC Transactions. In the traditional IPO context, underwriters serve as "gatekeepers" to the public markets by, among other things, verifying the accuracy of information presented in registration statements. This "due diligence" function both insulates underwriters from Securities Act liability for material misstatements and omissions in the disclosure and provides a level of comfort to the investing public that disclosures in publicly filed documents are free from such misstatements or omissions. However, in registered de-SPAC transactions, there is typically no clear underwriter that performs this function. None are named as underwriters in the registration statement associated with the de-SPAC transaction. To address this, the proposed rules provide that any person who acted as an underwriter in a SPAC IPO and who later takes certain steps in connection with a de-SPAC transaction - such as acting as a financial advisor, negotiating merger terms, or finding investors for related financing, including associated PIPE transactions - would be deemed to be engaged in the distribution of securities of the surviving public company in connection with the de-SPAC transaction.
Business Combinations Involving Shell Companies
- Deemed Sales of Securities. Newly proposed Rule 145a would deem any business combination of a reporting shell company (such as a SPAC) and another entity that is not a shell company to involve a sale of securities to the reporting shell company's shareholders. As a result, de-SPAC transactions would need to be registered under the Securities Act (or otherwise be exempt from registration) and such "sales" of securities would be subject to disclosure obligations and potential liabilities under the Securities Act similar to other sales of securities.
- Financial Statements Requirements. The SEC has explained that a company's choice of the manner in which it goes public should not, generally speaking, impact the substantive financial statements disclosures that are provided to investors. The proposed rules seek to align de-SPAC transactions with IPOs by harmonizing the requirements for the financial statements, the age of the financial statements and certain audit requirements.
Recent de-SPAC transactions have drawn increased scrutiny for their use of financial projections in disclosure documents. While projections can be useful to investors, there is also a risk that the projections may be misleading. The proposed rules expand the disclosure requirements concerning projections and management's basis for the projections. Among the changes are requirements that projections that are not based on historical results or operational history be clearly distinguished from those that are based on historical information, projections that are based on historical measures or operational history be presented with equal or greater prominence, and projections that involve non-GAAP financial information include a description of the most closely related GAAP measure. In addition, the proposed rules would require disclosure of the purpose for which projections used in connection with de-SPAC transactions were prepared, the party that prepared the disclosures, and the material bases of, and assumptions underlying, the projections.
Investment Company Act Safe Harbor
The proposed rules include a safe harbor under the Investment Company Act for SPACs that may otherwise have been deemed to fall under the definition of an "investment company." The safe harbor would be available to a SPAC that, among other things, (i) has assets consisting solely of government securities, government money market funds and cash items; (ii) seeks to complete a single de-SPAC transaction in which the surviving public entity will be primarily engaged in an operating business; and (iii) announces an agreement with a target to enter into a de-SPAC transaction no later than 18 months after its IPO and completes the de-SPAC transaction no later than 24 months after its IPO.
The comment period for the proposed rules will be open until the later of May 31, 2022, or 30 days after the publication of the proposed rules in the Federal Register.
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