SEC Proposes A

On March 30, 2022, the Securities and Exchange Commission (the "SEC") proposed new rules and amendments to existing rules and forms (the "Proposed Rules") addressing the treatment of special purpose acquisition companies ("SPACs") in connection with their initial public offerings ("IPOs") and subsequent de-SPAC transactions. Comments on the Proposed Rules are due 30 days after publication in the Federal Register or May 31, 2022 (60 days after issuance), whichever is later.¹

The Proposed Rules, if adopted, would represent a sea change in the treatment of SPACs by the SEC. A wide variety of market participants would do well to take heed of the Proposed Rules and to consider commenting on the Proposed Rules. If the Proposed Rules were to be adopted as written, they reflect a number of fundamental changes to basic principles of securities law liability that extend in their application beyond SPACs and de-SPAC transactions.

This Legal Update (i) provides background on SPACs generally; (ii) summarizes the Proposed Rules; and (iii) provides key takeaways and practical considerations.

Background on SPACs

A SPAC is a shell company that completes an IPO with no business operations of its own. Instead, a SPAC's sole purpose is to identify, and consummate a business combination (also commonly referred to as a "de-SPAC transaction") with, a target operating company; a process that the SPAC has a limited time to complete. Upon completion of the business combination, the target effectively becomes a publicly traded company. Because a SPAC has no operations, the disclosure in a SPAC IPO typically focuses on the prior experience of the SPAC's organizers/founders (referred to as "sponsors"), who are expected to successfully find a target company and complete the de-SPAC transaction.

Although terms vary from offering to offering, a SPAC's IPO typically consists of the sale of units, typically priced at $10.00 per unit, comprised of one share of Class A common stock and a fraction of a redeemable warrant to purchase one share of Class A common stock with a strike price of $11.50. The gross proceeds from a SPAC's IPO are placed in a trust account and are generally unavailable to the SPAC prior to consummation of the business combination. Funds in the trust account may be removed only in limited circumstances, primarily if either: (i) the SPAC completes a business combination; or (ii) the SPAC fails to complete a business combination in the allotted time and dissolves, in which case the funds in the trust account are returned to Class A stockholders.

Investment banks that underwrite a SPAC's IPO typically receive one-third of their underwriting compensation upon the closing of the SPAC IPO, with the remaining portion payable when, and only if, the SPAC completes the business combination.

The terms of a SPAC's charter typically include a requirement that the SPAC must offer to redeem its Class A shares (though not its warrants) in connection with the consummation of the business combination. The redemption price equals the investor's original $10.00 investment plus the investor's pro rata share of any interest earned on the funds while held in the trust account.

A SPAC's sponsors typically receive a "sponsor promote" consisting of shares of Class B common stock (sometimes referred to as "founder shares") issued prior to the IPO for a nominal amount (typically $25,000) and warrants purchased in a private placement consummated simultaneously with the IPO (typically for a purchase price of $1.00 to $1.50 per warrant). These "private placement" warrants typically allow their holders to purchase one share of Class A common stock for a strike price of $11.50. The founder shares typically represent 20% of the SPAC's total outstanding common stock after closing of the IPO. The number of private placement warrants varies based on the size of the IPO and the price per warrant paid. The proceeds from the sale of the private placement warrants fund the SPAC's IPO expenses and working capital while the SPAC searches for a target company.

Once a SPAC identifies a target company with which to combine, the SPAC will often raise additional capital through a private investment in public equity ("PIPE") transaction in order to provide additional cash for the post-business combination company and to mitigate the risk that a significant number of SPAC stockholders will tender their Class A shares for redemption. Typically, a SPAC will market the PIPE to institutional investors as it nears execution of a business combination agreement with the target company. The marketing materials provided to potential PIPE investors typically include projected financial information for the target company. The terms of a SPAC's PIPE transaction vary more widely than the terms of a SPAC's IPO. A typical PIPE transaction will include one share of Class A common stock for a price of $10.00. However, as investor interest in PIPE transactions has waned over the past year, some SPACs have had to modify the terms of these transactions to include warrant coverage, rights or even a share of the sponsor promote all for the same $10.00 price. Typically, a SPAC will simultaneously sign the business combination agreement with the target company and subscription agreements for a PIPE transaction with investors, and then announce all transactions to the market in a press release filed with the SEC on a Current Report on Form 8-K. The SPAC will usually also publicly release the projected financial information for the target company, which was shared with PIPE investors.

Prior to consummating a de-SPAC transaction, a SPAC will typically seek approval for the transaction from its stockholders using a proxy statement to solicit proxies to be voted at a special stockholder meeting. The proxy statement will describe, among other things, the terms of the business combination as well as the target company, including the target company's business, results of operations, financial condition, prospects and risks. In many cases, SPACs combine the proxy statement with a prospectus registering securities to be in issued to the target company sellers in the business combination on a Form S-4 or Form F-4 registration statement.

If the business combination is approved by the stockholders and the other conditions precedent to the business combination agreement have been satisfied, the SPAC will consummate its de-SPAC transaction shortly after the stockholder meeting. The funds from the trust account are released to the target company (net of any amounts returned to investors who tender their Class A shares for redemption and payment of the deferred IPO underwriting fee to the underwriters of the SPAC's IPO) and any financing transactions are simultaneously consummated.

The Proposed Rules

As mentioned, the Proposed Rules would represent a significant change in the treatment of SPACs under the U.S. securities laws and would impact (i) the disclosure required in SPAC IPOs and de-SPAC transactions; (ii) the potential liability of various transaction participants in a de-SPAC transaction; (iii) the use and content of forward-looking statements, including projections, in de-SPAC transactions; and (iv) a SPAC's status under the Investment Company Act of 1940 (the "Investment Company Act").

SPECIALIZED DISCLOSURE REQUIREMENTS FOR SPAC TRANSACTIONS

The Proposed Rules would introduce a new Subpart 1600 to Regulation S-K that would set forth specialized disclosure requirements in connection with SPAC IPOs and de-SPAC transactions.²

Information on SPAC Sponsors

New Item 1603(a) would require additional disclosure about a SPAC's sponsor,³ its affiliates and any promoters in registration statements or schedules used in either a SPAC IPO or de-SPAC transaction, including:

the experience, material roles, and responsibilities of these parties, as well as any agreement, arrangement or understanding (1) between the sponsor and the SPAC, its executive officers, directors or affiliates, in determining whether to proceed with a de-SPAC transaction; and (2) regarding the redemption of outstanding securities;
the controlling persons of the sponsor and any persons who have direct or indirect material interests in the sponsor, as well as an organizational chart that shows the relationship between the SPAC, the sponsor, and the sponsor's affiliates;
tabular disclosure of the material terms of any lock-up agreements with the sponsor and its affiliates; and
the nature and amounts of all compensation that has been or will be awarded to, earned by, or paid to the sponsor, its affiliates and any promoters for all services rendered in all capacities to the SPAC and its affiliates, as well as 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.

As noted by the SEC, some of this information is already provided by SPACs in their SEC filings and the proposed rules would codify and amplify these existing disclosure practices to ensure that SPACs provide consistent information.

Conflicts of Interest

In both SPAC IPOs and de-SPAC transaction filings, new Item 1603(b) would require disclosure of any actual or potential material conflicts of interest between (a) the sponsor or its affiliates or the SPAC's officers, directors, or promoters; and (b) unaffiliated security holders. The release states that Item 1603(b) would require a description of any material conflict of interest in determining whether to proceed with a de-SPAC transaction and any material conflict of interest arising from the manner in which a SPAC compensates the sponsor or the SPAC's executive officers and directors, or the manner in which the sponsor compensates its own executive officers and directors. The proposing release includes several examples of potential conflicts of interest, including the following:

conflicts stemming from the contingent nature of the sponsor's compensation that result in the sponsor having an incentive to complete a de-SPAC transaction even when doing so results in lower returns to Class A stockholders when compared to a liquidation of the SPAC or an alternative transaction;⁴
conflicts arising when a sponsor is the sponsor of multiple SPACs simultaneously and manages several different SPACs at once;
conflicts arising when a sponsor and/or its affiliate holds financial interests in, or have contractual obligations to, other entities;
conflicts arising when a SPAC's target is affiliated with the sponsor, the SPAC or its founders, officers or directors; and
conflicts arising from the fact that a SPAC's officers may not work full time for the SPAC and thus have limited ability to devote the time necessary to find and execute a de-SPAC transaction.

Footnotes

1 While the release says that "[w]e welcome feedback and encourage interested parties to submit comments on any or all aspects of the proposed new rules and amendments," the imposition of a very short comment period, which overlaps with the comment periods of other significant SEC rulemakings, leaves the impression that the SEC is not, in fact, really interested in feedback or comments. Recent use by the SEC of "short" comment periods in rulemakings has drawn Congressional attention. See the Jan. 10, 2022 letter to Chair Gensler from Representative McHenry and Senator Toomey at https://republicans-financialservices.house.gov/uploadedfiles/2022-01- 10_pmc_toomey_letter-gensler_sec_comment_period.pdf.

2 In proposed Item 1601(a) of Regulation S-K, the SEC proposes to define "de-SPAC transaction" as a business combination such as a merger, consolidation, exchange of securities, acquisition of assets, or similar transaction involving a special purpose acquisition company and one or more target companies (contemporaneously, in the case of more than one target company). Proposed Item 1601(b) would define "special purpose acquisition company" to mean a company that has indicated that its business plan is to (1) register a primary offering of securities that is not subject to the requirements of Rule 419; (2) complete a de-SPAC transaction within a specified time frame; and (3) return all remaining proceeds from the registered offering and any concurrent offerings to its shareholders if the company does not complete a de-SPAC transaction within the specified time frame.

3 In proposed Item 1601(c) of Regulation S-K, the SEC proposes to define "SPAC sponsor" as the entity and/or person(s) primarily responsible for organizing, directing or managing the business and affairs of a SPAC, other than in their capacities as directors or officers of the SPAC as applicable. The SEC proposes to exclude from the scope of the definition of "SPAC sponsor" the activities performed by natural persons in their capacities as directors and/or officers of the SPAC to avoid overlap with existing disclosure requirements relating to directors and officers.

4 It is unclear how far "alternative transactions" would go in this context and whether and to what extent disclosure on any such alternative transactions would be required.

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