On March 30, 2022, the SEC released highly anticipated proposed rules for transactions involving special purpose acquisition companies (SPACs). If adopted in their current form, these rules would purport to make wide-ranging changes to the disclosure and liability landscape applicable to SPACs and de-SPAC transactions. While some of these rules may be challenged in court, their impact is likely to be felt before any such challenge has been resolved. Proposed by a 3:1 vote, the SEC’s proposal once again displayed the division among Commissioners that has been evident in many of the SEC’s recent rulemaking initiatives. SEC Chair Gary Gensler characterized the proposal as simply reflecting the ancient maxim to “treat like cases alike” in seeking to afford investors the protections typically associated with traditional IPOs. In contrast, Commissioner Hester Peirce in her dissent called the proposed rules “designed to damn, diminish, and discourage SPACs,” arguing that the proposed rules go further than mandating disclosures that would enhance investor understanding.
We highlight below those elements of the proposed rules that, if adopted, would represent the most significant changes in the regulatory landscape with the greatest impact for SPAC transactions. We also briefly analyze the SEC’s rationale for those changes and offer our preliminary views on their potential implications.
Among other changes, the SEC seeks to make SPAC IPO underwriters liable for de-SPAC disclosures by deeming them “statutory underwriters” if they take steps to facilitate the de-SPAC transaction, or any related financing transaction, or otherwise participate (directly or indirectly) in the de-SPAC transaction. Rather than creating regulatory parity between de-SPACs and IPOs, this would represent a significant departure from long-established views and practices that carefully calibrate liability for investment banks based on transaction type and task performed. The proposed rules would also introduce a “merit” element into the regulation of going public transactions by requiring statements about the fairness to public investors, something not seen in IPOs.
Major Changes, Their Rationale and Their Practical Impact
Several of the proposed rules, if adopted in their current form, would make fundamental changes in the regulatory environment for SPAC deal-making. Among other things, they would purport to impose underwriter liability at the de-SPAC for investment banks that underwrote the SPAC’s IPO and are involved in various capacities in the de-SPAC transaction; require SPACs to affirmatively state their beliefs regarding the fairness of the de-SPAC transaction and any related financing to unaffiliated shareholders; remove the protection of a liability safe harbor for projections made in de-SPAC transactions; require the target and certain of its directors and officers to sign the de-SPAC registration statement and assume liability for its content; and provide an Investment Company Act safe harbor for SPACs that announce a de-SPAC within 18 months and close the business combination within 24 months of the IPO.
Underwriter Liability at De-SPAC for SPAC IPO Underwriters
The proposed rules would deem investment banks that underwrote a SPAC’s IPO to have “statutory underwriter” status in that SPAC’s de-SPAC transaction if they take “steps to facilitate the de-SPAC transaction, or any related financing transaction, or otherwise participates [sic] (directly or indirectly) in the de-SPAC transaction.” As statutory underwriters, those investment banks could be named as defendants in lawsuits alleging material misstatements or omissions in the disclosure provided to investors in connection with the de-SPAC transaction. If adopted, the proposed rules would require SPAC IPO underwriters to perform significant “gatekeeper” functions at the de-SPAC phase, thereby materially changing the liability risk profile of investment banks underwriting SPAC IPOs.
The proposing release notes that the following activities of a SPAC IPO underwriter could constitute participation in the de-SPAC transaction that triggers statutory underwriter status:
- Acting as a financial advisor to the SPAC;
- Assisting in identifying potential target companies;
- Negotiating merger terms;
- Finding investors for and negotiating private investment in public equity (PIPE) transactions; and
- Receipt of deferred SPAC IPO underwriting compensation.
Although the proposed rule would limit deemed de-SPAC underwriter status to investment banks that underwrote the SPAC’s IPO, the proposing release notes that the SEC may treat as statutory underwriters also other parties who perform activities necessary to the successful completion of de-SPAC transactions. The SEC states that the proposed rule “is not intended to provide an exhaustive assessment of underwriter status in the SPAC context.” The proposing release lists financial advisors, PIPE investors or other advisors as parties that, depending on the circumstances, may be found by the courts and the SEC to be “statutory underwriters” in connection with a de-SPAC transaction if they are purchasing from an issuer “with a view to” distribution, selling “for an issuer” and/or “participating” in a distribution.
The wide net that the SEC seeks to cast with respect to de-SPAC participants appears designed to enlist investment banks as disclosure gatekeepers in de-SPAC transactions. However, investment banks that advise on mergers or facilitate private placements have historically not been viewed as underwriters with corresponding responsibility for company disclosures. The SEC maintains that the going-public nature of de-SPAC transactions changes that, but the underlying statute does not distinguish between securities transactions based on whether they take a private company public.
The proposed rules would require a SPAC to state whether it reasonably believes that the de-SPAC transaction and any related financing transactions are fair or unfair to the SPAC’s unaffiliated investors. The SPAC would also have to state the material factors on which its belief is based. Those factors would need to include the valuation of the target, any financial projections, any third-party fairness opinion and the dilutive effects of the transaction on non-redeeming shareholders.
We believe that, if adopted, this requirement may pressure SPACs towards obtaining fairness opinions from financial advisors in order to further substantiate a SPAC’s reasonable belief as to the fairness of a de-SPAC transaction and any related financing. The proposed rules would also require public disclosure of any fairness opinions provided by an outside party. Fairness opinions are currently not typical in de-SPAC transactions except when the target is affiliated with the SPAC’s sponsor and there are therefore heightened concerns about a conflict of interest. The impact a potential need for fairness opinions would have on SPAC deal-making would depend on evolving practices regarding such opinions and on how the SEC staff will apply the corresponding disclosure requirements.
A requirement to make statements about substantive fairness, potentially backed up by third-party opinions, belies the assertion that the new rules are simply designed to ensure that de-SPAC transactions are treated “like” IPOs. No fairness statements or opinions are ever included in IPOs, although the involvement of research analysts as part of the IPO process, as well as investor views expressed during the IPO roadshow, may provide some check on valuation, as can investor feedback from a PIPE investment process. The proposed requirement thus pushes the regulatory regime away from the disclosure philosophy animating the IPO rules and towards merit review traditionally understood to be the province of corporate law and fiduciary duties. Although couched as a disclosure item, the requirement’s practical effect could be to impose a substantive fairness test as a condition for going public through the SPAC route. The SEC’s analogy to rules governing going-private transactions, which have long required fairness statements, seems strained. Even if the potential for conflicts may exist in both cases, going private transactions are not like IPOs at all. There, shareholders are being cashed out, giving up the potential upside of their equity stake, not investing in a company that is going public.
S-4/F-4 Registration for all De-SPACs, with Target as Co-registrant
In a significant departure from decades of past practice, the SEC is proposing to deem any business combination of a public shell company with an operating company to involve a sale of securities to the shell company’s shareholders, even when the shell company’s shareholders are making no voting or other investment decision with respect to the transaction. This rule would apply to de-SPAC transactions, but not be limited to them, at least on its face.
The practical effect of this rule would be to require an S-4 or F-4 registration statement in every de-SPAC transaction, even when the particular transaction structure would otherwise only trigger a proxy statement under current rules. The SEC explained that this proposal is intended to address potential disparities in the disclosure and liability protections available to reporting shell company shareholders depending on the transaction structure deployed in a reporting shell company business combination.
In a related provision, the proposed rules would treat the target as a co-registrant together with the SPAC in a de-SPAC transaction for the purposes of signing the S-4 or F-4 registration statement in a de-SPAC transaction. This would increase potential liability for the target and those of its directors and officers who would sign the registration statement.
Treatment of Projections
The proposed rules would expressly place financial projections and other forward-looking statements made in connection with de-SPAC transactions outside of the safe harbor of the Private Securities Litigation Reform Act of 1995 (PSLRA). The PSLRA safe harbor affords certain protections from liability to private plaintiffs for forward-looking statements when, among other things, those forward-looking statements are identified as such and are accompanied by meaningful cautionary statements. By its terms, the PSLRA safe harbor is not available in IPOs.
One of the distinguishing features of de-SPAC transactions compared to IPOs is that they disclose the private company’s financial projections to investors. In IPOs, those projections are only shared with the research analysts of the underwriting banks, who then use them as one of the inputs into their own financial models that they may discuss with certain potential IPO investors. Investment banks have historically and rightfully refused to take liability for projections in most cases because of their inherent uncertainty.
Disclosure documents in de-SPAC transactions typically include projections as part of the mix of information upon which the board of the SPAC relied in its decision-making process to discharge its obligations under applicable corporate law. In fact, the SEC has historically requested companies to disclose projections that were shared across the table in public company M&A transactions for this very reason to ensure parity of information between the company’s board and the shareholders voting on the transaction. Furthermore, the requirement in the proposed rules for a SPAC to state the material factors on which its belief as to fairness is based (as well as any outside party fairness opinions that might be obtained) may in practice require a discussion that includes the target’s projections. These disclosure imperatives potentially undermine the SEC’s “treat like cases alike” directive as the rationale justifying removal of the safe harbor because IPOs lack any legal or regulatory requirement to include projections.
It is also telling that the SEC justified its proposed disapplication of the safe harbor by stating that it saw “no reason to treat forward-looking statements made in connection with de-SPAC transactions differently than forward-looking statements made in traditional initial public offerings,” but then did not proceed to propose a rule that deemed a de-SPAC transaction an IPO for purposes of the safe harbor. Instead, the SEC proposes to reach that result by deeming SPACs “blank check companies,” which are also excluded from the scope of the PSLRA safe harbor, even though SPACs were not deemed blank check companies when Congress adopted the safe harbor in 1995.
An express unavailability of the safe harbor, if adopted, would add to the liability concerns that parties may have in connection with de-SPAC transactions, and could have a chilling effect on the market, including the participation of investment banks.
Investment Company Act Safe Harbor for SPACs Subject to Time Limits
The proposed rules would also address the status of SPACs as “investment companies” under the Investment Company Act. Last year, some litigants asserted the novel claim that some SPACs may in fact be investment companies required to register as such and be subject to the regulatory regime established by the Investment Company Act. Those lawsuits are currently still pending, and SPACs have generally continued to operate without registration as investment companies in reliance on the fact that they are not primarily engaged in the business of investing in securities, but are engaged primarily in identifying and consummating a business combination with one or more operating companies within a specified period of time.
To qualify for the safe harbor, a SPAC would be required to enter into an agreement to engage in a de-SPAC transaction with a target company within 18 months of its IPO and complete the de-SPAC transaction within 24 months of its IPO. This would significantly curtail structuring flexibility by preventing SPACs from extending their terms through a shareholder vote up to the maximum of 36 months prescribed by stock exchange listing rules. The investor protection benefit of limiting SPAC terms in this way is unclear. Many commentators have pointed to a SPAC’s relatively short life span as potentially creating incentives to engage in lower-quality transactions as time runs out. The time limits in the proposed safe harbor seem to exacerbate that problem. The other elements of the safe harbor seem generally unproblematic and easy to satisfy for most SPACs. While the proposed rule would technically not preclude SPACs from operating outside the safe harbor, it seems intended to put some pressure on SPACs not to do that, which could have the potential to shorten the time for a SPAC to sign and complete a de-SPAC transaction.
The proposed rules would require enhanced disclosure in registration statements filed by SPACs, including those for IPOs as well as for de-SPAC transactions. Among other changes, the proposed rules would modify the following disclosure:
- Greater detail would be mandated for projection disclosure, including who prepared the projections, greater context about the use of historical financial information in the preparation of the projections, material assumptions underlying the projections, any factors that may materially impact such assumptions and whether the SPAC board continues to rely on the projections.
- In both a SPAC IPO and in the de-SPAC transaction, prominent (including on the cover of the registration statement) and enhanced dilution disclosure.
- De-SPAC transactions would be required to provide substantially similar financial statement disclosures to investors as required by companies who become public through the traditional IPO process. The new rules generally follow current SEC guidance and positions of the Staff of the SEC in relation to de-SPAC transactions.
- In the SPAC IPO context, much of the disclosure aims to codify (with some detailed enhancements on the location and form of the disclosure) existing market practices to achieve consistency among SPAC issuers, including disclosure related to:
- Direct and indirect material interests in the sponsor (detailed ownership of the sponsor is not typically disclosed in the IPO prospectus of SPACs);
- Tabular disclosure of the material terms of any lock-up agreements with the sponsor and its affiliates;
- Compensation that the sponsor pays to officers and directors of the SPAC for services rendered to the SPAC (compensation arrangements at the sponsor level are not typically provided in IPO prospectuses of SPACs);
- The nature and amounts of any reimbursements to be paid to the sponsor, its affiliates and any promoters upon the completion of a de-SPAC transaction;
- The fiduciary duties that each officer and director of a SPAC owes to other companies; and
- Any arrangement or conflict of interest in determining whether to proceed with a de-SPAC transaction, and any conflict of interest arising from the way a SPAC compensates the sponsor or the SPAC’s executive officers and directors, or the way the sponsor compensates its own executive officers and directors.