On January 24, 2024, the U.S. Securities and Exchange Commission (SEC) adopted new rules intended to enhance disclosures and provide additional investor protection in initial public offerings (IPOs) by special purpose acquisition companies (SPACs) and in subsequent business combination transactions between SPACs and target companies, known as de-SPAC transactions.

SPAC IPOs and de-SPAC transactions can be used as a means for private companies to get access to the public market. By adopting the new rules, the SEC seeks to enhance investor protection in SPAC IPOs and de-SPAC transactions by aligning the protections investors receive when investing in SPACs with those provided to them when investing in traditional IPOs.

In adopting the new rules, SEC Chair Gary Gensler commented:

Just because a company uses an alternative method to go public does not mean that its investors are any less deserving of time-tested investor protections... Today's adoption will help ensure that the rules for SPACs are substantially aligned with those of traditional IPOs, enhancing investor protection through three areas: disclosure, use of projections, and issuer obligations. Taken together, these steps will help protect investors by addressing information asymmetries, misleading information, and conflicts of interest in SPAC and de-SPAC transactions.

The new rules were adopted on a 3-2 vote by the SEC. Commissioner Hester M. Peirce noted in her dissenting statement, "The Commission has failed to identify a problem in need of a regulatory solution. To the contrary, the rule will exacerbate a problem—the shrinking pool of public companies—by closing down one road into the public markets." In his dissenting statement, Commissioner Mark T. Uyeda noted, "there may be a far simpler explanation behind what the Commission is doing for SPACs: we simply do not like them. In order to achieve this desired outcome, the Commission seeks to impose crushingly burdensome regulations on SPACs as a form of merit regulation in disguise."

A brief summary of the new requirements set forth in the new rules is as follows.

Disclosure Requirements

Sponsors

The new rules impose additional disclosure requirements regarding the SPAC sponsor, its affiliates and promoters, including, among other things:

  • Their respective experience with organizing SPACs and the extent of their involvement with other SPACs, their business and their material roles and responsibilities in directing and managing the SPAC;
  • Any arrangements between the SPAC sponsor and the SPAC or its directors, officers and affiliates related to determinations of whether to enter into a de-SPAC transaction;
  • Details regarding the nature and amount of their compensation for any and all services provided to the SPAC and any reimbursements paid to them upon consummation of the de-SPAC transaction;
  • The price and number of securities issued or to be issued to them and details regarding when their ownership in SPAC securities were or could be directly or indirectly transferred, surrendered or cancelled;
  • The identity of the controlling persons of the SPAC sponsor and details regarding the persons who have direct or indirect material interests in the SPAC sponsor;
  • Arrangements between the SPAC sponsor and unaffiliated SPAC shareholders related to the redemption of SPAC securities; and
  • Detailed tabular disclosure of material arrangements regarding restrictions on the sale of SPAC securities by the sponsor and its affiliates.

Conflicts of Interest

The new rules require additional disclosure relating to conflicts of interest between the SPAC sponsor or its affiliates or the SPAC's officers, directors or promoters, on the one hand, and unaffiliated security holders of the SPAC, on the other hand. These include any conflict of interest with respect to determining whether to proceed with a de-SPAC transaction and any conflict of interest arising from the SPAC's compensation structure. The new rules also require disclosure regarding the fiduciary duties each officer and director of a SPAC owes to other companies.

Dilution

The new rules require disclosures related to circumstances that may cause dilution to an investor, including, for example, dilution caused by compensation paid to the SPAC sponsor or its affiliates, incurred as a result of financing transactions occurring alongside a de-SPAC transaction or suffered due to redemptions.

Board Determination

The new rules require additional disclosures in de-SPAC transactions regarding any determination by a board of directors or similar body as to whether the de-SPAC transaction is advisable and in the best interests of the SPAC and its shareholders, if required by law, and any outside report, opinion or appraisal received that materially relates to the de-SPAC transaction.

Target Company

The new rules will require significantly expanded disclosure related to the target company in a de-SPAC transaction, including, among other things:

  • Item 101 of Regulation S-K (Description of business);
  • Item 102 of Regulation S-K (Description of property);
  • Item 103 of Regulation S-K (Legal proceedings);
  • Item 304 of Regulation S-K (Changes in and disagreements with accountants on accounting and financial disclosure);
  • Item 403 of Regulation S-K (Security ownership of certain beneficial owners and management); and
  • Item 701 of Regulation S-K (Recent sales of unregistered securities).

De-SPAC Background

The new rules include detailed disclosure requirements related to the background, reasons, terms and effects of a contemplated de-SPAC transaction and any related financing arrangements.

Projections

The new rules include enhanced disclosure requirements related to projections in de-SPAC transactions, including disclosure of all material bases of the projections and all material assumptions underlying the projections.

Liability Provisions

Target Company as Co-Registrant

The new rules consider the target company in a de-SPAC transaction as an issuer and require its principal financial officer, controller or principal accounting officer and a majority of its board of directors to sign any Securities Act registration statement filed in connection with a de-SPAC transaction, thereby subjecting such individuals to Section 11 liability for material misstatements or omissions under the Securities Act.

No Safe Harbor for Forward-Looking Statements

The new rules make the Private Securities Litigation Reform Act of 1995 safe harbor from liability for forward-looking statements unavailable to certain blank check companies, including SPACs. This is intended to align the regulatory treatment of projections in business combinations involving certain blank check companies with that in traditional IPOs.

Other Changes

In addition, the new rules also seek to protect investors' interest in SPAC IPOs and de-SPAC transactions by:

  • Requiring a 20-calendar-day minimum dissemination period for prospectuses and proxy and information statements filed for de-SPAC transactions where consistent with local law;
  • Requiring a redetermination of smaller reporting company status following the consummation of a de-SPAC transaction and requiring such redetermination to be reflected in filings beginning 45 days after the de-SPAC transaction's consummation;
  • Adopting Rule 145a, which provides that any direct or indirect business combination of a reporting shell company (that is not a business combination related shell company) involving another entity that is not a shell company is deemed to be a sale of securities to the reporting shell company's shareholders; and
  • Expanding financial statement requirements applicable to de-SPAC transactions to be better aligned with those in traditional IPOs.

Potential Effects

According to the SEC, the new rules are intended to improve investor protection at both the SPAC IPO and the de-SPAC stages by increasing the availability of information for investors, thereby incentivizing more investors to invest in reporting shell companies, including SPACs, thus enhancing capital formation. However, the new rules may create significant costs for shell companies, including SPACs, and reduce the number of private companies that go public through shell company mergers, including de-SPAC transactions. Given the potential increase in the cost of going public through a shell company merger, some private companies may consider using the traditional IPO channel or a merger with a nonshell company as a more cost-effective alternative.

What's Next?

The new rules will become effective 125 days after publication in the Federal Register. Compliance with the structured data requirements, which require tagging of information disclosed pursuant to new subpart 1600 of Regulation S-K in Inline XBRL, will be required 490 days after publication of the rules in the Federal Register.

For More Information

If you have any question about this Alert, please contact Darrick M. Mix, Phuong (Michelle) Ngo, any of the  attorneys in our Capital Markets Group or the attorney in the firm with whom you are regularly in contact.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.