SEC Releases Proposal to Enhance Disclosures for SPACs and De-SPAC Transactions
In this post, Holland & Knight's Corporate, M&A and Securities Team unpacks the U.S. Securities and Exchange Commission's (SEC) recent rule proposal covering enhanced disclosures for SPACs and de-SPAC transactions. Next week, the firm's Securities Enforcement Defense Team will offer some key takeaways on the proposal from an SEC enforcement and litigation risk perspective.
The U.S. Securities and Exchange Commission (SEC) proposed new rules on March 30, 2022, that would require enhanced disclosures in initial public offerings (IPOs) by special purpose acquisition companies (SPACs) and in business combination transactions involving SPACs (de-SPAC transactions). The proposed new rules are anticipated to increase the costs and complexity for SPAC sponsors and management teams as well as target companies in complying with the additional disclosure requirements and increase litigation and enforcement activity against SPACs, de-SPAC companies and their directors and officers. At the same time, the rules would enhance the information that is available to investors and provide them with certain procedural protections in SPAC IPOs and de-SPAC transactions.
The proposed rules regarding SPAC disclosures would affect SPACs and de-SPAC transactions in several major respects. The rules would include, but are not limited to, the following noteworthy proposals, which are examined more closely on the following pages:
- enhanced disclosures regarding SPAC sponsors, conflicts of interests and dilution of shareholder interests
- additional disclosures on de-SPAC transactions, including with respect to the fairness of the transactions to the SPAC investors
- a requirement that the private target company in a de-SPAC transaction would be a co-registrant when a SPAC files a registration statement on Form S-4 or Form F-4, subjecting the signatories to potential liability under Section 11 of the Securities Act of 1933, as amended (Securities Act)
- a re-determination of smaller reporting company (SRC) status within four business days following the consummation of a de-SPAC transaction
- an amended definition of "blank check company" to make the liability safe harbor in the Private Securities Litigation Reform Act of 1995 (PSLRA) for forward-looking statements such as projections, unavailable in filings by SPACs and certain other blank check companies
- a rule that deems underwriters in a SPAC IPO to be underwriters in a subsequent de-SPAC transaction when certain conditions are met, subjecting underwriters to potential Section 11 liability
- a rule that a business combination transaction involving a reporting shell company and another entity that is not a shell company constitutes a sale of securities to the reporting shell company's shareholders for purposes of the Securities Act
- a new rule and amendments better aligning the required financial statements of private companies in transactions involving shell companies with those required in registration statements for traditional IPOs
- a proposal that a SPAC would not need to register as an investment company under the Investment Company Act of 1940 (1940 Act) if it meets certain conditions
Background on SPACs
SPACs first emerged in the 1990s as an alternative to blank check companies that were regulated under Rule 419 of the Securities Act. SPACs gained immense popularity over the last two years as an alternative to a traditional IPO. SPACs raised more than $83 billion in 2020 and more than $160 billion in 2021 through IPOs. During those two years, more than half of all IPOs were conducted by SPACs.1
A SPAC is typically a shell company created for the purpose of acquiring a private company (the de-SPAC transaction) within a certain timeframe (typically 18-24 months). A SPAC is organized and managed by a sponsor investor and typically conducts a firm commitment underwritten IPO of redeemable shares and warrants. Following the IPO, the SPAC usually places most or all of the proceeds in a trust or escrow account to fund the de-SPAC transaction, and the SPAC's shares and warrants are registered and begin trading on a national securities exchange.
If a SPAC does not consummate a de-SPAC transaction within its listed timeframe, the sponsor may seek an extension or the SPAC may dissolve and liquidate proceeds from the trust or escrow account on a pro rata basis to the SPAC's public shareholders. If a SPAC proposes a de-SPAC transaction, SPAC shareholders may either 1) redeem their shares and receive a pro rata amount of the IPO proceeds or 2) remain a shareholder of the post-combination company. To offset redemptions, SPACs often conduct private investment in public equity (PIPE) transactions.
The SPAC has become a popular vehicle for issuers to access the capital markets because it allows a private company to become a publicly listed company while avoiding the enhanced disclosure requirements and potential liability in a typical IPO process. Additionally, a SPAC may offer greater pricing certainty in merger negotiations, a faster route to going public and more freedom in using projections.
In its proposal, the SEC mentioned several concerns about SPACs and de-SPAC transactions from commentators regarding transparency around conflicts of interests, compensation, dilution, shareholder rights and financial projections. The SEC said it believes "greater transparency and more robust investor protections could assist investors in evaluating and making investment, voting, and redemption decisions with respect to these transactions."
Proposed New Subpart 1600 of Regulation S-K
The proposal would create a new Subpart 1600 of Regulation S-K, which sets forth special disclosure requirements for SPAC IPOs and de-SPAC transactions. The new subpart would require:
- enhanced disclosures for SPAC IPOs and de-SPAC transactions about the SPAC sponsor and its affiliates. Among other things, the proposal would require disclosure around the SPAC sponsor's experience and involvement in the SPAC's activities and its compensation; interests in the SPAC of controlling persons; agreements among the SPAC, sponsor and unaffiliated holders regarding the redemption of outstanding securities; agreements among the SPAC sponsor or its affiliates and the SPAC's directors or officers regarding determining whether to proceed with a de-SPAC transaction; and tabular disclosure of material lock-up agreements.
- additional disclosures for a de-SPAC transaction, including 1) whether the SPAC reasonably believes the de-SPAC transaction and any related financing transaction are fair or unfair to investors and 2) whether the SPAC has received any outside report, opinion or appraisal relating to the fairness of the transaction
- certain disclosures on the prospectus cover page for 1) SPAC IPOs regarding the timing of the SPAC transaction, redemptions, sponsor compensation, dilution (including tabular dilution disclosure) and material conflicts of interest and 2) de-SPAC transactions regarding material financing transactions, sponsor compensation, dilution and material conflicts of interest
- further disclosure in the prospectus summary for 1) SPAC IPOs regarding how a target company will be identified, any shareholder approval requirements, material financing transactions, and material conflicts of interest and material terms of the securities offered and 2) de-SPAC transactions regarding background and material terms of the transactions, redemption rights, material conflicts of interest, financing transactions and tabular disclosure of sponsor compensation and dilution
Aligning de-SPAC Transactions with Traditional IPOs
The proposal would seek to align de-SPAC transactions with typical IPOs by providing procedural protections for investors and aligning disclosures and the legal obligations of issuers to those typically found in an IPO. More specifically, the proposal would:
- amend the registration statement forms and schedules filed in de-SPAC transactions to require additional disclosures about the private target company
- require that disclosure documents in de-SPAC transactions be disseminated to investors 1) at least 20 days before a shareholder meeting or the earliest date of action by consent or 2) if the jurisdiction of incorporation or organization limits the period to less than 20 days, the maximum period for disseminating such disclosure documents permitted under the law
- deem a private target company in a de-SPAC transaction to be a co-registrant when a SPAC files a Form S-4 or Form F-4 for a de-SPAC transaction, causing the target company and its signing persons – including the principal executive officer, principal financial officer, controller/principal accounting officer and a majority of the board of directors or persons performing similar functions of the target company – to be subject to potential liability under Section 11 of the Securities Act
- amend the definition of SRC to require a re-determination of SRC status within four business days of the consummation of a de-SPAC transaction. This would generally require SPACs that initially qualified as SRCs to provide more comprehensive disclosures – such as three years of financial statements and quantitative and qualitative information about market risk – earlier following a de-SPAC transaction than under existing rules.
- propose a definition for "blank check company" that would encompass SPACs and certain other blank check companies for purposes of the PSLRA. The safe harbor for forward-looking statements under the PSLRA would not be available to SPACs, including with respect to projections of target companies seeking to access the public markets through a de-SPAC transaction.
Business Combinations Involving Shell Companies
To further emulate the typical IPO process, the SEC is proposing to add a new Rule 145a and new Article 15 of Regulation S-X and related amendments. Under Rule 145a, any business combination between a reporting shell company and another entity that is not a shell company will be deemed to involve a sale of securities to the reporting shell company's shareholders, which could give rise to greater liability under the federal securities laws for parties involved in the de-SPAC transaction. Under Article 15 and related amendments, financial statement reporting requirements in a business combination would more closely align with traditional IPOs.
The proposal would seek to amend relevant forms, schedules and rules to closely align the financial statement reporting requirements in de-SPAC transactions to those in traditional IPOs. One primary change broadens the circumstances in which the private target company may only report two years of financial statements relating to the SPAC's status as an emerging growth company (EGC) and the target company's qualification as an EGC and SRC.
Enhanced Projections Disclosure
The SEC also seeks to enhance the reliability of projections disclosures in SEC filings and require additional disclosures when projections are disclosed in connection with de-SPAC transactions. The proposal would seek to amend Item 10(b) of Regulation S-K to address the broad concerns of projections generally.
- Any projected measures that are not based on historical financial results or operational history should be clearly distinguished from projected measures that are based on historical financial results or operational history.
- It generally would be misleading to present projections that are based on historical financial results or operational history without presenting such historical measure or operational history with equal or greater prominence.
- The presentation of projections that include a non-Generally Accepted Accounting Principles (GAAP) financial measure should include a clear definition or explanation of the measure, a description of the GAAP financial measure to which it is most closely related and an explanation why the non-GAAP financial measure was used instead of a GAAP measure.
Proposed Item 1609 of Regulation-S-K would address de-SPAC transaction concerns specifically. Item 1609 would require a registrant to provide the following disclosures in a de-SPAC transaction:
- with respect to any projections disclosed by the registrant, the purpose for which the projections were prepared and the party that prepared the projections
- all material bases of the disclosed projections, all material assumptions underlying the projections and any factors that may materially impact such assumptions, including a discussion of any factors that may cause the assumptions to be no longer reasonable, the material growth rates or discount multiples used in preparing the projections and the reasons for selecting such growth rates or discount multiples
- whether the disclosed projections still reflect the views of the board or management of the SPAC or target company, as applicable, as of the date of the filing; if not, then discuss the purpose of disclosing the projections and the reasons for any continued reliance by the management or board on the projections
Proposed Safe Harbor Under the 1940 Act
The SEC stated in its proposed rules that it is concerned that SPACs may fail to recognize when their activities trigger the 1940 Act and the investor protections provided under the 1940 Act. To address this issue, the SEC proposed a new safe harbor under the 1940 Act that would change the definition of "investment company" for SPACs that satisfy certain conditions. To meet the conditions, a SPAC must, among other things:
- maintain assets comprising only cash items, government securities and certain money market funds
- seek to complete a de-SPAC transaction after which the surviving entity will be primarily engaged in the business of the target company
- enter into an agreement with a target company to complete a de-SPAC transaction within 18 months of its IPO and complete the de-SPAC transaction within 24 months of the IPO; any assets not used in the de-SPAC transaction must be distributed in cash to investors as soon as reasonably practicable
Underwriters' Section 11 Liability
In recognizing underwriters' role as gatekeepers to the public markets, the SEC is proposing Securities Act Rule 140a, which would subject underwriters to potential Section 11 liability for certain activities related to a SPAC. Underwriters may be liable under Section 11 if they 1) act as an underwriter of a SPAC's securities and 2) take steps to facilitate a de-SPAC transaction or any related financing transaction or otherwise participate (directly or indirectly) in the de-SPAC transaction. As indicated in the proposed rules, acting as a financial advisor to the SPAC, assisting in identifying potential target companies, negotiating merger terms, finding and negotiating PIPE or other financing or receiving compensation in connection with a de-SPAC transaction, among other activities, could all constitute underwriter participation in the de-SPAC transaction and expose the underwriter to potential liability.
The SEC believes these rules will better motivate SPAC underwriters to exercise the proper care in ensuring the accuracy of these transactions' disclosures.
Although these proposed rules and amendments may change before being finalized, the proposed rules have put participants in SPAC transactions on notice that the SEC intends to aggressively regulate SPAC IPOs and de-SPAC transactions. In the short term, the market is expected to see increased de-SPAC activity to get ahead of the SEC's implementation of the final rules regulating SPACs. Some commentators to the proposed rules will likely urge the SEC to consider a transition period for the new rules, but what such a transition would look like, or whether one will be adopted, is unclear.
SPAC sponsors and the management teams of SPACs and companies considering merging with a SPAC should anticipate providing enhanced disclosures in their public filings, a longer timeline from start to finish for SPAC-related transactions (including greater reliance on legal and accounting advisors for planning, structuring and drafting the necessary documentation and preparing for a more complex comment and response process with the SEC), and potential increased risk of liability from private litigation and SEC enforcement. At the same time, the rules would enhance the information that is available to investors and better align the interests of SPAC sponsors, operators and investors.
The public comment period will remain open for the longer of: 1) 30 days following publication of the proposal in the Federal Register or 2) May 31, 2022, which is 60 days following the proposal's publication date on the SEC's website.
1 Proposed Rules, at page 8.
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