United States: SPACs Shaken Up By SEC

IPOs and resulting business combination transactions (“de-SPAC transactions”), by special purpose acquisition companies (“SPACs”), have become a significant part of the U.S. corporate landscape over the past several years. With the growing popularity of SPACs and the increased scrutiny of these vehicles in the media and by regulators, the SEC has proposed sweeping new rules and rule amendments to add disclosure requirements and liability risks for participants in the SPAC marketplace.

The total number of SPAC IPOs reached record highs in 2021, increasing to 613 from 248 in 2020. There were 298 SPAC IPOs completed in the first quarter of 2021, declining to 60 in the second quarter, and then rebounding to 166 in the fourth quarter. As for de-SPAC transactions, approximately 220 closed during 2021, representing aggregate deal volume of approximately $400 billion.

Given this significant level of activity, and the concerns that have been expressed by some market observers about various aspects of the SPAC structure and the adequacy of the disclosures provided to investors in SPAC transactions, the Securities and Exchange Commission (the “SEC”) has taken aim at SPACs through the issuance of guidance and statements on several occasions since December 2020.¹

Through its analysis, the SEC determined that greater transparency and more robust investor protections could assist investors in evaluating and making investment, voting and redemption decisions with respect to transactions involving SPACs. Accordingly, on March 30, 2022, the SEC proposed sweeping new rules and rule amendments to enhance existing disclosure requirements and investor protections in IPOs by SPACs and in de-SPAC transactions. If adopted as proposed, these new rules and rule amendments would dramatically impact the SPAC landscape, and could make the desirability and timing of de-SPAC transactions much more uncertain. These proposals, which are set forth in a 372 page proposing release (the “Proposing Release”), include the following:

• a new Subpart 1600 of Regulation S-K that would set forth specialized disclosure requirements in connection with SPAC IPOs and de-SPAC transactions;
• amendments to provide procedural protections and to align the disclosures provided, as well as the legal obligations of companies, in de-SPAC transactions more closely with those in traditional IPOs, including the removal of the safe harbor under the Private Securities Litigation Reform Act of 1995 (the “PSLRA”) for forward looking statements made in connection with de-SPAC transactions;
• a new Rule 140a under the Securities Act of 1933, as amended (the “Securities Act”), that would deem anyone who has acted as an underwriter of the securities of a SPAC and takes steps to facilitate a de-SPAC transaction, or any related financing transaction or otherwise participates in the de-SPAC transaction, to be an underwriter in the de-SPAC transaction;
• a new Rule 145a under the Securities Act that would deem any business combination of a reporting shell company involving another entity that is not a shell company to involve a sale of securities to the shareholders of the reporting shell company;
• new Article 15 of Regulation S-X to more closely align the financial statement reporting requirements in business combinations involving a shell company and a private operating company with those in traditional IPOs;
• amendments to Regulation S-K to enhance the reliability of projection disclosures; and
• a new safe harbor under the Investment Company Act of 1940 (the “Investment Company Act”) for SPACs that satisfy certain conditions that limit their duration, asset composition, business purpose and activities.

The proposals are discussed in more detail below. The proposals are open for comment until the later of 30 days after publication in the Federal Register or May 31, 2022.

Proposed New Subpart 1600 of Regulation S-K

In the Proposing Release, the SEC proposed to add new Subpart 1600 to Regulation S-K to set forth specialized disclosure requirements applicable to SPACs regarding the sponsor, potential conflicts of interest and dilution, and to require certain disclosures on the prospectus cover page and in the prospectus summary. Proposed Subpart 1600 would also require enhanced disclosure for de-SPAC transactions, including the requirement to provide a fairness determination. The specifics of new Subpart 1600 are summarized below.

Definitions

For purposes of proposed new Subpart 1600, the SEC proposed to define certain key terms, such as “special purpose acquisition company”, “de-SPAC transaction”, “target company”, and “SPAC sponsor”.

As proposed, a “special purpose acquisition company” is broadly defined as “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 under the Securities Act; (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,” and a “de-SPAC transaction” is broadly defined as “a business combination such as a merger, consolidation, exchange of securities, acquisition of assets, or similar transaction involving a SPAC and one or more target companies (contemporaneously, in the case of more than one target company).”

Sponsors

In view of the central role of the sponsor in a SPAC's activities, the SEC proposed Item 1603(a) to require additional disclosure about the sponsor, its affiliates and any promoters of the SPAC in registration statements and schedules filed in connection with SPAC registered offerings and de-SPAC transactions. Such disclosure would include:

• 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 and 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 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 such persons upon the completion of a de-SPAC transaction.

The SEC noted in the Proposing Release that the foregoing disclosures are intended to provide prospective investors and existing shareholders with detailed information relating to the sponsor that could be important in analyzing a SPAC, including how the rights and interests of the sponsor, its affiliates and any promoters may differ from, or conflict with, those of public shareholders.

Conflicts of Interest

Wary of the many actual or potential conflicts of interest between the sponsor and public investors within a SPAC's structure that could influence the actions of the SPAC, the SEC proposed requiring disclosure of any actual or potential material conflict of interest between (1) the sponsor or its affiliates or the SPAC's officers, directors or promoters, on the one hand, and (2) unaffiliated security holders, on the other hand. This would include any conflict of interest in determining whether to proceed with a de-SPAC transaction and any 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. In addition, the SEC proposed new Item 1603(c), which would require disclosure regarding the fiduciary duties that each officer and director of a SPAC owes to other companies.

Dilution

In light of the potential for significant dilution embedded within the typical SPAC structure, and intending to help SPAC investors to better understand the potential impact upon them of the various dilutive events that may occur over the SPAC's lifespan, the SEC proposed Items 1602(a)(4), 1602(c) and 1604(c) to require additional disclosure about the potential for dilution in (1) registration statements filed by SPACs, including those for IPOs, and (2) de-SPAC transactions.

As per the proposal, dilution disclosure would be required in registration statements filed by SPACs other than for de-SPAC transactions that would require a description of material potential sources of future dilution following an IPO, as well as tabular disclosure of the amount of potential future dilution from the public offering price that will be absorbed by non-redeeming SPAC shareholders, to the extent quantifiable. The proposed disclosure would include a table reflecting a range of potential redemption levels on the prospectus cover page of registration statements on Forms S-1 and F-1 (including for an IPO) and, with respect to all SPAC registration statements, including de-SPAC transactions, (x) disclosure of each material potential source of additional dilution that non-redeeming shareholders may experience at different phases of the SPAC lifecycle by electing not to redeem their shares in connection with the de-SPAC transaction and (y) a sensitivity analysis in tabular format that shows the amount of potential dilution under a range of reasonably likely redemption levels and quantifies the increasing impact of dilution on non-redeeming shareholders as redemptions increase.

The foregoing dilution disclosure would be in addition to the dilution disclosure already required by Item 506 of Reg. S-K.

Prospectus Cover Page and Prospectus Summary Disclosure

Responding to concerns raised about the complexity of disclosures in registration statements filed by SPACs for IPOs and de-SPAC transactions, the SEC proposed that certain information be included on the prospectus cover page and in the prospectus summary. While some of this information already customarily appears in these locations, some items are new.

The information required on the inside cover page would include: (1) for registered offerings other than de-SPAC transactions, information about the time frame for the SPAC to consummate a de-SPAC transaction, redemptions, sponsor compensation, dilution and conflicts of interest; and (2) for de-SPAC transactions, information about the fairness of the de-SPAC transaction, material financing transactions, sponsor compensation and dilution, and conflicts of interest.

The information required in the prospectus summary would include, among other things: (1) for registered offerings other than de-SPAC transactions, the process by which a potential business combination candidate will be identified and evaluated, tabular disclosure of sponsor compensation and the extent to which material dilution may result from such compensation, and information about material conflicts of interest; and (2) for de-SPAC transactions, the background and material terms of the de-SPAC transaction, the fairness of the de-SPAC transaction, material conflicts of interest, and tabular disclosure on sponsor compensation and dilution.

Disclosure and Procedural Requirements in De-SPAC Transactions

To give investors an enhanced basis upon which to better understand and evaluate the merits of a prospective de-SPAC transaction, including the reasons for proposing such transaction and choosing a particular structure and financing for it, the SEC proposed a series of specialized disclosure and procedural requirements in de-SPAC transactions.

Under proposed Item 1605, new disclosure items, that are modeled, in part, on Item 1004(a)(2) and Item 1013(b) of Regulation M-A, would be required. These would include a summary of the background of the de-SPAC transaction, a brief description of any related financing transaction, and the reasons for engaging in the particular de-SPAC transaction. In addition, the SPAC would have to disclose the effects of the transaction and any related financing transaction on the SPAC, the sponsor, the target company (and the affiliates of the foregoing) and unaffiliated stockholders of the SPAC, which disclosure must include a reasonably detailed discussion of both the benefits and detriments to non-redeeming shareholders of the de-SPAC transaction and any related financing transaction, with such benefits and detriments quantified to the extent practicable. Further, disclosure of the material interest of the sponsors, directors and officers of the SPAC in the de-SPAC transaction or any related financing transaction, including any interest in or affiliation with the target company, would be required.

To address concerns regarding potential conflicts of interest and misaligned incentives in connection with the decision to proceed with a de-SPAC transaction, the SEC proposed Item 1606(a), which would require the SPAC to state whether it reasonably believes that the de-SPAC transaction and any related financing transaction are fair or unfair to the SPAC's unaffiliated shareholders, and provide a discussion of the bases for this statement. The disclosure would be required in any Forms S-4 and F-4 or Schedules 14A, 14C and TO filed for a de-SPAC transaction.

To provide additional transparency about whether a SPAC's board of directors and/or its sponsor have access to information underlying a fairness determination that shareholders could find useful in making voting, investment and redemption decisions in connection with the de-SPAC transaction, the SEC proposed Item 1607. This new item would require disclosure about whether or not the SPAC or its sponsor has received any report, opinion or appraisal from an outside party relating to the consideration or fairness of the consideration to be offered to security holders or the fairness of the de-SPAC transaction or any related financing transaction to the SPAC, the sponsor or unaffiliated shareholders (which reports, opinions or appraisals would be filed as exhibits to the applicable SEC filing).

Aligning De-SPAC Transactions with IPOs

In light of the increasingly common reliance on de-SPAC transactions as a vehicle for private operating companies to access the U.S. public markets, the SEC proposed a number of new rules and rule amendments to align more closely the treatment of private operating companies entering the public markets through de-SPAC transactions with that of companies conducting traditional IPOs. Overall, the proposed new rules and rule amendments are intended to provide investors with disclosures and liability protections comparable to those that would be present if the private operating company were to conduct a traditional firm commitment IPO. The rules and rule amendments that the SEC proposed in this area are discussed below.

Aligning Non-Financial Disclosures in De-SPAC Disclosure Documents

The SEC proposed that, if the target company in a de-SPAC transaction does not file reports under Section 13(a) or 15(d) of the Exchange Act, disclosure with respect to such company pursuant to the following items in Reg. S-K would be required in the registration statement or schedule filed in connection with the transaction: (1) Item 101 (description of business); (2) Item 102 (description of property); (3) Item 103 (legal proceedings); (4) Item 304 (changes in and disagreements with accountants on accounting and financial disclosure); (5) Item 403 (security ownership of certain beneficial owns and management, assuming the completion of the de-SPAC transaction and any related financing transaction); and (6) Item 701 (recent sales of unregistered securities).

If the target is a foreign private issuer, it could, as its option, provide the required disclosure in accordance with Items 3.C, 4, 6.E, 7.A, 8.A.7 and 9.E of Form 20-F, consistent with disclosure that could be provided by these entities in an IPO.

Minimum Dissemination Period

To better ensure that shareholders have sufficient time to consider the disclosures contained in filings made in connection with de-SPAC transactions, the SEC proposed to amend Exchange Act Rules 14a-6 and 14c-2, as well as to add instructions to Forms S-4 and F-4, to require that such prospectuses and proxy and information statements be distributed to shareholders 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 applicable laws of the SPAC's jurisdiction of incorporation or organization if such period is less than 20 days.

Private Operating Company as Co-Registrant to Form S-4 and Form F-4

In an effort to hold directors and officers of private operating companies in de-SPAC transactions accountable for the accuracy, and to improve the reliability, of the disclosures contained in de-SPAC registration statements, the SEC proposed amendments to Forms S-4 and F-4 to require that the SPAC and the target company be treated as co-registrants when these registration statements are filed in connection with de-SPAC transactions. Consequently, the additional signatories to de-SPAC registration statements would be liable for any material misstatements or omissions therein.

Re-Determination of Smaller Reporting Company Status

To address the limited scenarios whereby certain post-business combination companies can avail themselves of scaled disclosure and other accommodations of smaller reporting companies when they otherwise would not have qualified as such had they become public through a traditional IPO, the SEC proposed to require a re-determination of smaller reporting company status following a de-SPAC transaction. This re-determination would occur prior to the time the combined company makes its first SEC filing, other than the Form 8-K with Form 10 information, with the public float threshold measured as of a date within four business days after the closing of the de-SPAC transaction and the revenue threshold determined by using the annual revenues of the target as of the most recently completed fiscal year for which audited financial statements are available.

PSLRA Safe Harbor

The PSLRA provides a safe harbor for forward-looking statements – including projections – under the Securities Act and the Exchange Act, under which a company is protected from liability for forward-looking statements in any private right of action under the Securities Act or Exchange Act when, among other things, the forward-looking statement is identified as such and is accompanied by meaningful cautionary statements. While the safe harbor is currently available in connection with de-SPAC transactions, it is not available for offerings by “blank check companies” (which term, in general, does not include SPACs) or for IPOs.

To address this disparity, the SEC proposed to amend the definition of “blank check company” for purposes of the PSLRA so that it would encompass SPACs. Specifically, under the proposed definition, a “blank check company” would be defined as “a company that has no specific business plan or purpose or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies, or other entity or person.” As a result, the safe harbor would no longer be available in connection with de-SPAC transactions, thereby increasing the risks for SPACs and target companies (and their directors and officers) arising from any forward-looking disclosures or projections they may make.

Underwriter Status and Liability in Securities Transactions

The SEC noted in the Proposing Release that “underwriters” – a term that is broadly defined and interpreted under the Securities Act – form an essential link in the distribution of securities from an issuer to investors. As a result of their participation in an issuer's offering of securities, underwriters are exposed to potential liability under the Securities Act, including liability under Sections 11 and 12(a)(2) of the Securities Act. This exposure to liability, in the SEC's view, provides strong incentives for underwriters to perform robust due diligence in connection with offerings for which they serve as underwriters, and as a result, provides significant investor protections to those who acquire securities sold in such offerings.

Operating under the theory that, even though the timing of a SPAC IPO and a de-SPAC transaction is bifurcated because a private operating company is not identified at the IPO stage, the result of a de-SPAC transaction, however structured, is consistent with that of a traditional IPO, the SEC proposed new Rule 140a under the Securities Act. The proposed rule would clarify that a person who has acted as an underwriter in a SPAC IPO and participates in the distribution by taking steps to facilitate the de-SPAC transaction, or any related financing transaction, or otherwise participates (directly or indirectly) in the de-SPAC transaction, will be deemed to be engaged in the distribution of the securities of the surviving public entity in a de-SPAC transaction. In this way, according to the SEC, the proposed rule underscores and reinforces that the liability protections in de-SPAC transactions involving registered offerings have the same effect as those in underwritten IPOs.

The SEC went on to note that, although proposed Rule 140a only addresses the underwriter status of the SPAC IPO underwriter in the context of a de-SPAC transaction, federal courts and the SEC may find that other parties involved in de-SPAC transactions, including other parties that perform activities necessary to the successful completion of de-SPAC transactions (such as financial advisors, PIPE investors or other advisors), are “statutory underwriters” under the Securities Act, and thus subject to the same level of liability.

Business Combinations Involving Shell Companies

Shell Company Business Combinations and the Securities Act

The SEC noted that, depending upon the type of transaction structure deployed, in many cases the shareholders of reporting shell companies that were entering into business combination transactions with private operating companies were not receiving the same disclosure and liability protections under the Securities Act as would normally be afforded to investors in the private operating company, especially if the private company was conducting its IPO. To address this disparity, the SEC proposed new Rule 145a under the Securities Act. Under the proposed rule, any business combination of a reporting shell company involving another entity that is not a shell company would be deemed to involve a sale of securities to the reporting shell company's shareholders. As a result, appropriate disclosures and protections under the Securities Act would need to be provided to the shareholders of the reporting shell company in this context.

Financial Statement Requirements in Shell Company Business Combination Transactions

In order to reduce any asymmetries between financial statement disclosures in business combination transactions involving shell companies and traditional IPOs, the SEC proposed amendments to its forms, schedules and rules to more closely align the financial statement reporting requirements in those two scenarios.

Specifically, in proposed Rule 15-01 of Regulation S-X, the SEC proposed:

• aligning the number of fiscal years required to be included in the financial statements for a private company that will be the predecessor in a shell company combination with the financial statements required to be included in an IPO registration statement;
• aligning the level of audit assurance required for the target company in business combination transactions involving a shell company with the audit requirements for an IPO;
• basing the age of financial statements for a private operating company that would be the predecessor to a shell company in a registration or proxy statement on whether the private operating company would qualify as a smaller reporting company if filing its own initial registration statement; and
• permitting the exclusion of financial statements of a shell company, including a SPAC, for periods prior to the acquisition once (x) the financial statements of the shell company have been filed for all required periods through the acquisition date and (y) the financial statements of the registrant include the period in which the acquisition was consummated.

Enhanced Projections Disclosure

In an effort to address concerns about the use of projections in de-SPAC transactions and similar circumstances, the SEC proposed to amend Item 10(b) of Regulation S-K to expand and update the SEC's views on the use of projections, and to add new Item 1609 of Regulation S-K that would apply to financial projections used in de-SPAC transactions and would set forth additional disclosure requirements relating to financial projections.

As amended, Item 10(b) would state that:

• any projected measures that are not based on historical financial results or operational history should be clearly distinguished from projected measures that are based on historical financial results or operational history;
• it generally would be misleading to present projections that are based on historical financial results or operational history without presenting such historical measure or operational history with equal or greater prominence; and
• the presentation of projections that include a non-GAAP financial measure should include a clear definition or explanation of the measure, a description of the GAAP financial measure to which it is most closely related, and an explanation why the non-GAAP financial measure was used instead of a GAAP measure.

The guidance provided in Item 10(b) would apply to projections of future economic performance of persons other than the SPAC, such as the target company in a de-SPAC transaction, that are included in the SPAC's SEC filings.

Proposed new Item 1609, which would apply only to de-SPAC transactions, would require the following additional disclosures:

• the purpose for which any projections were prepared and the party that prepared them;
• all material bases of, and all material assumptions underlying, any disclosed projections, as well as any factors that may materially impact such assumptions; and
• a statement as to whether the disclosed projections still reflect the view of the board or management as of the filing date.

Proposed Safe Harbor Under the Investment Company Act

To assist SPACs in focusing on, and appreciating when, they may be subject to investment company regulation, the SEC proposed a new safe harbor from the definition of “investment company” under Section 3(a)(1)(A) of the Investment Company Act for SPACs that meet the conditions set forth below. The SEC designed the conditions of the safe harbor to align with the structures and practices that it believes would distinguish a SPAC that is likely to raise serious questions as to its status as an investment company from one that would not raise such questions.

To rely on the proposed safe harbor, the SPAC would have to meet the following conditions:

• the SPAC's assets must consist solely of government securities, government money market funds and cash items;
• the SPAC would be limited to seeking to complete a single de-SPAC transaction as a result of which the surviving public entity, either directly or through a primarily controlled company, will be primarily engaged in the business of the target company or companies, which is not that of an investment company. Note that although the SPAC would be able to engage in only one de-SPAC transaction while relying on the safe harbor, such transaction may involve the combination of multiple target companies, provided that the SPAC treats them for all purposes as part of a single de-SPAC transaction;
• the SPAC must seek to complete a de-SPAC transaction in which the surviving company has at least one class of securities listed for trading on a national securities exchange;
• the SPAC must be primarily engaged in the business of seeking to complete a de-SPAC transaction in the manner and within the time frame set forth in the rule (and thus not in the business of investing, reinvesting or trading in securities), and the SPAC's board of directors would need to adopt an appropriate resolution to evidence such intention; and
• the SPAC must file a Form 8-K announcing that it has entered into an agreement with a target company to engage in a de-SPAC transaction no later than 18 months after the effective date of the IPO registration statement, and then must complete the de-SPAC transaction no later than 24 months after the effective date of the IPO registration statement. The SPAC would be required to distribute its assets in cash to investors as soon as reasonably practicable if it does not meet either the 18-month or 24-month deadline.

Conclusion

As noted above, the new rules and rule amendments proposed by the SEC, if adopted as proposed, would have a dramatic impact on the SPAC marketplace. The enhanced disclosure requirements, as well as the expansion of liability regarding projections, target companies (and their directors and executive officers) and IPO underwriters, could add costs and delays throughout the SPAC lifecycle, and thus cause market participants to pursue other types of transactions. We will continue to monitor the SEC's proposal and other developments in the rapidly-evolving SPAC space, and provide updates as situations develop.

Footnote

1. These statements include: (i) CF Disclosure Guidance: Topic 11 – Special Purpose Acquisition Companies (December 2020), which provided the views of the Staff of the Division of Corporation Finance about certain disclosure considerations for SPACs in connection with their IPOs and subsequent de-SPAC transactions; (ii) Staff Statement on Select Issues Pertaining to Special Purpose Acquisition Companies (March 2021), which addressed certain accounting, financial reporting and governance issues that private operating companies should consider before merging with a SPAC; (iii) Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (April 2021), which expressed the SEC's position that many SPAC warrants should be accounted for as liabilities on the balance sheet; and (iv) Public Statement on SPACs, IPOs and Liability Risk under the Securities Laws (April 2021), in which the Acting Director of the Division of Corporation Finance questioned whether SPACs should be allowed to rely on the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995.

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