[Edit. Note: Significant updates to the below guidance are available in a Fenwick alert published 4/9/2021: “SEC’s New Guidance on Liability Risks Likens SPACs to IPOs.”]
Special purpose acquisition companies (SPACs) are increasingly being used as an alternate vehicle to traditional initial public offerings. Companies that go public through a traditional IPO process are often subject to shareholder securities class actions. Inevitably, securities class actions will be filed against companies that become publicly traded and file public reports with the U.S. Securities and Exchange Commission as a result of a merger with a SPAC.
One often-referenced advantage of the SPAC process as compared to a traditional IPO is the ability to directly communicate financial projections to the market. Such projections may become a greater area of focus for shareholder-driven SPAC securities litigation. With increasing numbers of companies going public through the SPAC process, companies should be mindful of the litigation risks attendant with such projections and take proactive measures to mitigate that risk.
What is a SPAC?
A SPAC is a shell company with no commercial operations that is formed to raise capital in an IPO solely in anticipation of identifying and acquiring an existing private company. The acquisition of the private company by the SPAC (often referred to as the “de-SPAC transaction”), results in the target merging into the SPAC and thereby becoming a public reporting company with publicly traded shares.
Financial Projections – Traditional IPO vs. SPAC
Companies typically do not include financial projections in a registration statement and related prospectus for an IPO because of the liability risks associated with such disclosures. In particular, the safe harbor for forward-looking statements under the Private Securities Litigation Reform Act (PSLRA) that generally applies to statements made by SEC registrants expressly does not apply to statements “made in connection with initial public offering[s].” The same constraints do not apply to de-SPAC transactions. In a de-SPAC transaction, the target becomes a publicly traded company by virtue of its merger into the SPAC, and the target company can include financial projections in the proxy statement and S-4 registration statement filed with the SEC in connection with the de-SPAC transaction.
The ability to provide projections directly to the investors is a key feature of de-SPAC transactions. Because projections provide investors visibility into the target’s future financial growth, they may be especially attractive to companies that will not be profitable for a few years. Moreover, assuming projections provided in connection with de-SPAC transactions are identified as forward-looking and are accompanied by meaningful cautionary language, the projections will be protected under the PSLRA’s safe harbor for forward-looking statements.
The Litigation Risk
With the increasing popularity of de-SPAC transactions as an alternative to the traditional IPO, we expect to see a rise in the number of shareholder securities class actions challenging statements made in connection with de-SPAC transactions. While projections and other forward-looking statements have been challenged in recent SPAC litigation, they have not been the primary focus of the lawsuits, and have simply been included among a litany of other challenged statements. With an uptick in SPAC litigation, projections will likely receive increased scrutiny from the plaintiffs’ bar.
The recently filed securities class action related to the Waitr de-SPAC transaction is illustrative. The Waitr complaint (Welch v. Meaux (W.D. La.)) asserts claims under Sections 11, 12(a)(2) and 15 of the Securities Act of 1933 and Sections 14(a), 10(b) and 20(a) of the Exchange Act of 1934, alleging that various statements (including 2018-2020 financial projections) included in the proxy and registration statement filed in connection with the Waitr de-SPAC transaction, along with other statements made after the de-SPAC transaction, were false and misleading. The plaintiffs allege that the Waitr de-SPAC transaction was completed in haste—just two weeks before the expiration of the SPAC’s deadline to complete a business combination—and that the proxy and registration statement deceived investors as to Waitr’s true prospects for profitability. After the de-SPAC transaction, Waitr performed poorly. When it announced disappointing financial and operational results several quarters after the de-SPAC transaction, Waitr’s stock dropped over 50%. In challenging the projections and other forward-looking statements, the complaint alleges that the PSLRA safe harbor does not apply to those statements because they were either (1) not accompanied by meaningful cautionary statements; or (2) the defendants knew the forward-looking statements were false when made. Although the Waitr case is still in its early stages, it may serve as a blueprint for how plaintiffs and their counsel frame these cases going forward.
Steps Companies Can Take to Mitigate the Litigation Risk Related to Projections Provided in Connection with a De-SPAC Transaction
- Projections should have a reasonable basis. If a company chooses to provide financial projections, it needs to ensure that they are based on assumptions that have a reasonable basis and represent the company’s balanced view. To achieve those objectives, the company should ensure that it has followed an appropriate process for vetting the assumptions underlying the projections, which typically includes critical review of these assumptions by the board of directors, with input from financial advisors.
- Document the process used to generate projections in real-time. Securities class actions are often filed long after the challenged events or statements occurred. If a lawsuit is filed long after the events in question, it can be difficult to gather all of the facts necessary to defend against the suit. Accordingly, a company disclosing projections should ensure that it adequately documents the process used to generate and vet these projections at the same time they are created. By documenting the process in real-time, the company will ensure that it has a clear, well-documented and contemporaneous record in the event a suit challenging the projections is subsequently filed.
- Projections should be identified as forward-looking and accompanied by meaningful cautionary statements. Under the PSLRA’s safe harbor provision, forward-looking statements—such as projections—are generally not actionable so long as they are: (1) identified as forward-looking; and (2) accompanied by “meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement.” In order to ensure safe harbor coverage for projections, companies should ensure that they not only identify that forward-looking statements are being made, but also provide meaningful cautionary language. Although the safe harbor provides broad protection, boilerplate risk disclosures may not be sufficient. Courts may decline safe harbor protection to forward-looking statements where the cautionary language does not identify the risks that ultimately caused the prediction not to come to pass. Cautionary statements should be tailored to fit the guidance and should disclose the risks that may cause the anticipated results not to be realized. Cautionary language should also clearly attribute the source of the projections, and describe the process through which they were generated.