In a series of statements, comments, and staff actions, the SEC has in recent months evinced a growing concern with SPAC-related activities in the financial marketplace. The agency has now brought its first SPAC-related enforcement action (at least during the current era) against Momentus, Inc., a SPAC-merger target; Stable Road Acquisition Corp., the SPAC itself; and several other participants involved in the SPAC transaction, including the SPAC sponsor. This proceeding may be the first of many. The SEC’s July 13, 2021 press release about the proceedings can be found here. The SEC’s administrative order instituting cease-and-desist proceedings can be found here. The SEC’s separate civil action complaint against the CEO of the merger target can be found here.
Stable Road Acquisition Corp. (SRAC) is a special purpose acquisition company (SPAC) that completed an IPO on November 13, 2019. SRC-NI Holdings LLC is the SRAC’s sponsor, having provided the SPAC’s initial capital. Brian Kabot is SRAC’s Chairman and CEO. Momentus, Inc. is a Delaware corporation based in California seeking to develop commercially viable technology it could deploy to provide commercial space services. Mikhail Kokorich, a Russian citizen residing in Switzerland, served as the CEO and Chairman of Momentus until his January 25, 2021 resignation.
On October 7, 2020, Momentus and SRAC announed their agreement to merge, with Momentus to be the surviving entity, as a publicly traded company. In connection with the merger agreement, SRAC entered into a subscription agreement for a private investment in public equity (PIPE) offering. The proposed merger between Momentus and SRAC has not yet been completed.
The SEC Proceeding
In a July 13, 2021 administrative cease-and-desist proceeding filed against Momentus; SRAC; SRC-NI, and Brian Kabot, the SEC charged that the defendants violated the U.S. securities laws in connection with a series of misrepresentations about Momentus’s technology and about national security risks associated with Kokorich. The SEC also filed a related but separate complaint in the United States Disrict Court for the District of Columbia against Kokorich. The civil action against Kokorich charges him with violating anti-fraud provisions of the federal securities laws. The administrative proceeding against Momentus and the others has been resolved though an agreed cease-and-desist order. The proceedings against Kokorich remain pending.
According to the settled order in the administrative proceeding, Kokorich and Momentus misled investors in two ways. First, by making a series of statements that the company had “successfully tested” its key space technology, when in fact the company’s 2019 test failed to meet the company’s own pre-launch criteria for success and was conducted on a prototype that was not designed to meet commercially viable launch characteristics.
Second, the administrative order alleges that Kokorich and Momentus “concealed and made false statements about U.S. government concerns with national security and foreign ownership risks posed by Kokorich.” Investors, the SEC alleged, “lacked material information about the extent to which Kokorich’s affiliation with Momentus jeopardized, among other things, the company’s launch schedule and the revenue projections” that were based on assumptions about the timetable for commercialization.
With respect to SRAC, the administrative order alleges that the SPAC repeated Momentus’s misleading statements in public filings associated with the proposed merger. The administrative order alleges that “SRAC’s due diligence failures compounded Momentus’s and Kokorich’s misrepresentations and omissions and resulted in the dissemination of materially false and misleading information to investors.” The order specifically alleges that SRAC never reviewed the results of Momentus’s in space test or reviewed sufficient documents relevant to assessing the national security risks associated with Kokrich’s involvement. The administrative order alleges that Kabot participated in SRAC’s inadequate due diligence and that Kabot, SRAC’s CEO, signed registration statements containing Momentus’s “false and misleading claims.”
The order finds that Momentus violated scienter-based antifraud provisions of the U.S. securities laws and caused certain of SRAC’s violations. It also finds that SRAC violated negligence-based antifraud provisions and well as certain reporting and proxy solicitation provisions. The order also finds that Kabot violated provisions of the securities laws relating proxy solicitations and that Kabot and SRC-NI caused SRAC to violate Section 17 of the Securities Act of 1933. Without admitting or denying the SEC’s findings, Momentus, SRAC, and Kabot agreed to desist from future violations.
In addition, Momentus agreed to pay a civil penalty of $7 million. SRAC agreed to a civil penalty of $1 million. Kabot agreed to a civil penalty of $40,000. Momentus and SRAC have agreed to provide PIPE investors with the right to terminate their subscription agreements prior to the shareholder vote on the merger. SRC-NI has agreed to forfeit 250,000 founders’ shares it would otherwise have received at the time of the merger. Finally, Momentus has agreed to a series of undertakings requiring enhancements to its disclosure controls and internal compliance.
Based on the number and variety of concerned statements and staff actions concerning SPAC activity in the financial markets, it seemed as if it would only be a matter of time before the SEC targeted a specific SPAC transaction in an enforcement action. In that sense at least, the SEC’s administrative proceeding against Momentus and SRAC arguably was not unexpected. But while the possibility of a proceeding like this might have been anticipated, the specifics involved are still interesting and have important implications.
First and foremost, the breadth of the SEC’s enforcement action is interesting and impressive. As John Jenkins noted in a July 14, 2021 post on TheCorporateCounsel.net blog about the SEC’s enforcement action (here), the SEC cast a “wide net.” The defendants in the administrative proceeding include not only Momentus, which made the misrepresentations, but also included SRAC, which allegedly repeated the misrepresentations and allegedly failed to conduct sufficient due diligence. The defendants also included SRAC’s CEO and even SRAC’s sponsor. The breadth of the SEC’s reach underscores the extent and scope of the potential securities liability exposures and the potential reach of the SEC’s enforcement authority under the U.S. securities laws.
The timing of the SEC’s proceeding with respect to the planned merger transaction is also interesting and important. The SEC filed its action after the merger was announced but before the business combination was completed. The timing of the SEC’s action has important implications about when potential liabilities arise in connection with SPAC-related transactions.
The specifics of the allegations against SRAC and Kabot are also interesting. The SPAC and its CEO are charged with repeating the prospective merger target’s misrepresentations and of conducting insufficient due diligence. The nature of these allegations has important implications with respect to the type of securities law exposures that SPACs and their executives face. The enforcement action emphasized the critical importance of the SPAC’s due diligence in connection with its identified target, identifying due diligence both as an important SPAC responsibility and as a potential source of liability if inadequate.
In a statement in the agency’s press release, SEC Chair Gary Gensler emphasized that certain aspects of the SPAC transaction structure create risks and impose obligations on the SPAC and its executives, particularly with respect to due diligence. Gensler said “This case illustrates risks inherent to SPAC transaction, as those who stand to earn significant profits from a SPAC merger may conduct inadequate due diligence and mislead investors.” Gensler emphasized that both Momentus and SRAC “both misled the investing public,” adding that “the fact that Momentus lied to Stable Road does not absolve Stable Road of its failure to undertake adequate due diligence to protect shareholders.” Gensler said that the enforcement action “will help to better align the incentives of parties to a SPAC transaction with those of investors relying on truthful information to make investment decisions.
These various key aspects of this proceeding – the timing, the scope of the defendants involved, and the nature of the allegations—have important D&O insurance implications. The possibility of these types of claims involving these types of allegations at this point in the SPAC transaction process clearly has significant implications for the SPAC’s D&O insurer. Indeed, the filing of this SEC enforcement action and the nature of the allegations against the SPAC involved are unlikely to simplify the current disrupted D&O insurance for SPACs. At a minimum, the enforcement action highlights the critical importance of the SPAC’s due diligence responsibilities, and the potential for due diligence responsibilities to give rise to liabilities.
The same factors also have important implications for the D&O insurance of SPAC merger target companies. In that regard, it is important to consider that Momentus remains a private company, so the D&O insurance policy involved likely is written on a private company form. The private company form may have a securities law liability exclusion that, depending on how it is written, might preclude or complicate coverage for this type of claim.
One final note about this action is that it involves a 2019 SPAC IPO company. That is, it doesn’t involve a company that was part of the SPAC IPO frenzy that erupted in the second half of 2020 and the first four months of 2021. The sheer volume of SPAC transaction activity in late 2020 and early 2021 – and the likelihood for continuing SPAC merger activity in the months ahead – would seem to suggest that this proceeding will not be the only SPAC transaction-related enforcement activity the SEC will file. To the contrary, it seems likely that we will be seeing further SPAC-focused SEC enforcement activity in the months ahead.