Is the SEC staff about to issue guidelines specifying that the safe harbor for forward looking statements does not apply to SPAC merger transactions? An April 28, 2020 exclusive report on Reuters (here) says that the SEC is considering taking the step. If the agency were to issue guidance restricting the availability of the safe harbor for SPACs, it could significantly restrict SPAC’s use of target company projections in advance of de-SPAC mergers, and even further slow the already cooling SPAC market. The SEC’s possible action is discussed further in an April 29, 2021 post on the Cooley law firms PubCo blog, here.
SEC staff has already raised warnings about SPAC’s use of merger target companies’ projections in connection with de-SPAC transactions. As discussed here, on April 8, 2021, John Coates, the acting head of the SEC’s Division of Corporate Finance, issued a public statement (here) on the legal liability exposures associated with SPACs. His particular target in his remarks are statements that have appeared in the press to the effect that disclosure responsibilities for SPACs in connection with de-SPAC transactions (and in particular with respect to the financial projections of the merger target) are different from and lower than the comparable responsibilities associated with traditional IPOs.
His comments on this point were blunt: “Any claim 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.”
Coates specifically questioned the apparent belief that the carve out of IPOs from the PSLRA’s safe harbor for forward looking statements does not apply to SPACs, a point of view that Coates said “is uncertain at best.” The safe harbor, Coates averred, was meant for companies with an established track record. The merger target in a de-SPAC transaction “have no more of a track record” than private companies involved in IPOs. Coates further comment that “the risk of misuse” of forward- looking information “should also be carefully evaluated in light of the economic realities of the capital formation process.” As the Cooley PubCo blog put it in summarizing Coates’s point of view, “Why should a SPAC be treated differently from a traditional IPO? It’s really a question of economic substance over form.”
According to the Reuters article, the SEC staff is considering issuing guidance on the question of the availability of the safe harbor protection for the use of projections in connection with SPAC merger transactions. The guidance, according to the Reuters article, would “aim to clarify the conditions upon which the safe harbor applies.” These changes, the article says, “would likely prompt more due diligence and caution on the part of SPAC dealmakers wary of incurring liability.” The article added that “the changes are being discussed by staff in the SEC’s corporate finance division” but is “unclear if the agency’s leadership would back them.” If the agency were to adopt the guidelines, it would “escalate” the agency’s “crackdown on the deal frenzy.” As the PubCo blog put it, the move “could exacerbate the slowdown that has already occurred in reaction not the SEC’s previous guidance,” particularly the slowdown that followed the SEC’s guidance on SPAC accounting for warrants (about which refer here).
In discussing the potential impact of possible SEC guidance on SPAC’s use of projections, the PubCo blog focused on SPAC IPO activity. But the issuance of guidance restricting SPAC’s use of projections could have an even more substantial impact on de-SPAC transactions. It is after all in connection with the de-SPAC transaction, not the SPAC IPO itself, that SPACs use the target companies’ projections. I emphasize this point for the simple reason that there is a huge number of SPACs out there in the search phase, seeking to identify the private company targets with which to merge. A change in the rules of the game for these searching SPACs and for their prospective mergers could have a wrenching impact.
According to SPACInsider, there are currently 421 SPACs in the search phase. All of these SPACs intend that sometime over the course of the next 24 months they will identify a target and complete the planned business combination. Up until now, there has been a consensus view that in connection with the planned merger SPACs can use the target companies’ projections to try to obtain shareholder vote in favor of the merger and also to create demand in the public securities markets for the shares of the merged company. (Indeed, the belief that SPACs can use projections this way has been an important point that SPAC advocates have used to argue that a de-SPAC merger is a better method of going public rather than a traditional IPO.)
If the SEC were to issue guidance to the effect that all of these SPACs cannot avail themselves of the safe harbor for forward looking statements, and therefore cannot use the target company’s projections in the de-SPAC deal documents, it could have a significant impact on all those projected de-SPAC transactions that are on the agenda for the coming months. At a minimum, the guidance could significantly impact the process. It could also slow things down, and perhaps tamp down some of the hoopla that has surrounded some of the proposed SPAC mergers.
To cite but one example, the proposed merger of office space company WeWork with a SPAC has been accompanied, according to the Wall Street Journal (here), by the same kind of optimistic projections that WeWork tried to rely on in connection with its ill-fated IPO. The Journal cited statements by an executive of the SPAC made in reliance on WeWork’s projected future revenues. If the agency were to issue the guidance clarifying the safe harbor rules, these kinds of statements likely would cease or at least become significantly down-played.
From my perspective, a dialing-down of SPACs’ use of target company projections would not necessarily be all bad. If you take a look at the roughly dozen or so SPAC-related lawsuits that have been filed so far in 2021, you will quickly note that many of the lawsuits related to supposed post-merger shortfall compared to pre-merger projections. Dialing down the use of projections could potential lower the securities class action risk for post-merger companies (as well as for the former directors and officers of the pre-merger SPAC).
In any event, the point that should not be lost is that while the SEC’s guidance could without a doubt have an impact on the SPAC IPO market, the impact could be even more substantial for the de-SPAC transaction marketplace.