In what is the latest step in what the Wall Street Journal has called “SEC Chairman Gensler’s wider push to rein in Wall Street through tougher regulation,” the SEC has approved, by a 3-1 vote, new proposed disclosure requirements and investor protections in connection with SPAC IPOs and de-SPAC transactions. The overall effect of the proposed new regulations, if implemented in a form similar to the proposal, would be to make the SPAC-related disclosure requirements more like those applicable to traditional IPOs. The proposed rules could have a sweeping impact not just on the SPAC IPO marketplace, but also on the marketplace for de-SPAC transactions, at a time when over 600 SPACs are currently searching for merger targets.
The SEC’s March 20, 2022 press release about the proposed new rules can be found here. The Commission’s 372-page proposal can be found here. The Commission’s short fact sheet about the proposed new rules can be found here. Cydney Posner’s detailed analysis of the proposal on the Cooley law firm’s PubCo blog can be found here.
SPACs of course were one of the big stories in the financial markets in 2020 and 2022. According to SPACInsider, there were a total of 248 SPAC IPOs in 2020, raising a total of $83.3 billion, followed in 2021 with a total of 613 SPAC IPOs raising $162.4 billion. All of this activity generated a lot of attention, scrutiny, and a fair amount of criticism. In addition, and as has been documented in detail on this site (refer for example, here) , there has been a fair amount of litigation involving post-SPAC-merger companies that stumbled early in their lives as public companies. Concerns have arisen about, among other things, possible conflicts of interest between the SPAC sponsors and directors; the adequacy of SPAC’s pre-merger due diligence; the SPAC’s use of pre-merger projections for the proposed post-merger companies; the cash dilution impact of public shareholder redemptions at the time of the merger; and even whether SPACs are Investment Companies with the meaning of the Investment Company Act of 1940.
The Commission’s Proposal
As the Commission’s lengthy proposal release documents details, the proposed release represents the Commission’s efforts to try to address a number of these concerns. The fact sheet the Commission issued in connection with the proposal release summarizes the proposed new rules and amendments as intended to:
- Enhance disclosures and provide additional investor protections in SPAC initial public offerings and in business combination transactions between SPACs and private operating companies (de-SPAC transactions);
- Address the treatment under the Securities Act of 1933 of business combination transactions involving a reporting shell company and amend the financial statement requirements applicable to transactions involving shell companies;
- Provide additional guidance on the use of projections in SEC filings to address concerns about their reliability; and
- Assist SPACs in assessing when they may be subject to regulation under the Investment Company Act of 1940.
With respect to the proposed enhanced disclosures in connection with SPAC IPOs and de-SPAC transactions, the proposal document says that the proposed rules, if adopted, “could help the SPAC market function more efficiently by improving the relevance, completeness, clarity, and comparability of the disclosures provided by SPACs at the initial public offering and de-SPAC transaction stages, and by providing important investor protections to strengthen investor confidence in this market.”
As described in the proposal document, the new specialized disclosure requirements would:
- Require additional disclosures about the sponsor of the SPAC, potential conflicts of interest, and dilution;
- Require additional disclosures on de-SPAC transactions, including a requirement that the SPAC state (1) whether it reasonably believes that the de-SPAC transaction and any related financing transaction are fair or unfair to investors, and (2) whether it has received any outside report, opinion, or appraisal relating to the fairness of the transaction; and
- Require certain disclosures on the prospectus cover page and in the prospectus summary of registration statements filed in connection with SPAC initial public offerings and de-SPAC transactions.
The proposed rules also include a number of requirements designed to “align the disclosures provided, as well as the legal obligations of companies, in de-SPAC transactions more closely with those in traditional initial public offerings.” Specifically, the Commission proposes to:
- Amend the registration statement forms and schedules filed in connection with deSPAC transactions to require additional disclosures about the private operating company;
- Require that disclosure documents in de-SPAC transactions be disseminated to investors at least 20 calendar days in advance of a shareholder meeting or the earliest date of action by consent, or the maximum period for disseminating such disclosure documents permitted under the laws of the jurisdiction of incorporation or organization if such period is less than 20 calendar days;
- Deem a private operating company in a de-SPAC transaction to be a co-registrant of a registration statement on Form S-4 or Form F-4 when a SPAC files such a registration statement for a de-SPAC transaction, such that the private operating company and its signing persons would be subject to liability under Section 11 of the Securities Act as signatories to the registration statement;
- Amend the definition of smaller reporting company to require a re-determination of smaller reporting company status following the consummation of a de-SPAC transaction; and
- Propose a definition for “blank check company” that would encompass SPACs and certain other blank check companies for purposes of the Private Securities Litigation Reform Act of 1995 (PSLRA) such that 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 deSPAC transaction.
The proposed rules and amendments would also address the question of whether and under what circumstances a SPAC could be an Investment Company under the Investment Company Act of 1940 (an issue that has come up in connection with some recent SPAC-related litigation, as discussed here). To assist SPACs in “focusing on and appreciating when they may be subject to investment company regulation, we are proposing a new safe harbor under the Investment Company Act,” which would be available for SPACs that “satisfy certain conditions that limit a SPACs duration, asset composition, business purpose and activities.”
The Republican SEC Commissioner Hester Pierce voted against the proposal and entered a separate dissenting statement, saying that the proposal “seems designed to stop SPACs in their tracks,” rather than imposing sensible disclosures that she would have supported. She said that the rules would impose a “set of substantive burdens that seem designed to damn, diminish, and discourage SPACs because we do not like them, rather than elucidate them so that investors can decide whether they like them.”
The proposed rules are now subject to a public comment period. (Indeed, the proposal document is replete with a litany of specific topics on which the Commission has solicited public comment.) The public comment period will remain open for 60 days following publication of the proposing release on the SEC’s website or 30 days following publication of the proposing release in the Federal Register, whichever period is longer.
The proposed new SPAC and de-SPAC disclosure rules may draw objections from certain quarters, but there is also a sense, as the Wall Street Journal noted in its article about the proposed new rules, that the proposals “may be coming too late to help the investors who already suffered losses after the peak of the SPAC frenzy.” The fact is that, as the Journal also observed, the SPAC “enthusiasm” has diminished and the market for SPAC IPOs has “cooled” as of late.
However, whatever the impact of the new rules could be in connection with the now-diminishing number of SPAC IPOs, the new rules, if implemented, undoubtedly could have a significant impact on future de-SPAC transactions. In that regard, as detailed on SPACInsider, there are currently over 600 SPACs seeking merger targets. The Journal article notes that if the proposed rules are completed in their current form, “the proposed disclosure requirements would extend to existing SPACs that have yet to complete a merger.”
With those putative future de-SPAC transactions in mind, it is important to note what John Jenkins on The CorporateCounsel.net blog called “the biggest news in the proposal” – that is, the loss of the PSLRA safe harbor for projections in connection with de-SPAC transactions. The belief that participants in the de-SPAC transactions could rely on the safe harbor in ways that are not available to participants in a traditional IPO transaction was one of the important supposed advantages for a private company of a SPAC merger over a traditional IPO. Frankly, the over-eager use of projections in connection with at least some SPAC merger transactions has been the source of a lot of the post-merger problems de-SPAC companies have faced.
While I agree that the loss of the safe harbor is big news, what may be even bigger news is, as Jenkins also notes, the extension of Section 11 liability to the de-SPAC target and the potential that the SPAC IPO underwriters might also face Section 11 liability for the de-SPAC. These details will even further diminish for a prospective merger target the attractiveness of a SPAC merger as opposed to a traditional IPO. The prospective liability of SPAC IPO offering underwriters for the de-SPAC merger will further diminish the attractiveness of SPAC IPO activity for the investment bank underwriters.
There is also a lot of very important disclosure detail to be required in connection with the SPAC sponsor and conflicts of interest, particularly as pertains to the compensation and fees to be earned by the sponsor and the SPAC’s directors. These requirements, calculated to try to disclose where the SPAC insiders’ interests could diverge from those of the SPAC’s public shareholders, are likelier to eliminate practices that create the possibilities for possible divergences of interest. These disclosures could have the effect of making SPAC vehicles less remunerative and therefore less appealing to prospective SPAC organizers. By the same token, full disclosure about the dilutive impact on the cash value of transactions could make SPAC mergers even less appealing to public shareholders, further motivating them to exercise their redemption rights, which in turn could make SPAC mergers even less appealing to prospective SPAC merger targets.
As always when the SEC proposes new disclosure requirements, there is the imbedded prospect for possible future enforcement activity, as the SEC seeks to motivate behavior by utilizing a few public examples. And any time there are new disclosure requirements, there are possibilities for the plaintiffs’ bar to try to rely on the requirements as a basis on which to assert that public shareholders have been misled. To cite but one example, I could easily foresee plaintiffs’ lawyers trying to make something out of the new requirement, directing SPACs to state, in connection with a proposed de-SPAC transaction, whether it reasonably believes that the de-SPAC transaction and any related financing transactions are fair or unfair to investors. (Call it a hunch, but I don’t think there will be too many de-SPAC merger documents that will say that the SPAC believes the proposed transaction is “unfair” to investors.)
Of course, it does remain to be seen what form the final rules will take, and how many of the proposed rules will in the end go into effect. In the meantime, I wonder whether there is an incentive for prospective de-SPAC transactions that are in the pipeline to try to accelerate their merger timeline? Or whether the marketplace will expect more disclosures along the lines the SEC has proposed even in advance of the new rules’ effective date?