The rise of special purpose acquisition companies (SPACs) as a popular alternative structure for taking a company public in the past year has caused increased regulatory scrutiny surrounding the SPAC structure. On May 24, 2021, the U.S. House Committee on Financial Services will hold a hearing regarding SPACs, direct listings, public offerings and investor protections associated with these offerings. In advance of the hearing, the committee released draft legislation amending the Securities Act of 1933 and the Securities Exchange Act of 1934 to specifically exclude all SPACs from the safe harbor for forward-looking statements. If passed, this amendment would create increased potential liability for inaccuracies in forward-looking statements for companies looking to go public through a SPAC.
Previous SEC Statement
In April 2021, by John Coates, Acting Director of the Division of Corporation Finance of the U.S. Securities and Exchange Commission (SEC), issued a public statement questioning whether projections, a key component of the disclosures made in connection with taking a company public through the SPAC structure, are covered by the safe harbor under the federal securities laws for forward-looking statements. For more information on the Coates statement, including its implications for companies looking to go public through a SPAC, please see our previous alert, SEC’s New Guidance on Liability Risks Likens SPACs to IPOs.
Safe Harbor for Forward-Looking Statements
As noted in the Coates statement, the safe harbor for forward-looking statements currently excludes statements in an offering by a “blank check company.” The federal securities law defines a “blank check company” as a development stage company that (1) 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, and (2) is issuing penny stock. Because most SPACs do not issue penny stock, the safe harbor for forward-looking statements applies to projections and other forward-looking statements used in connection with going public through a SPAC. The draft House legislation clarifies that all SPACs, not just SPACs that are issuing penny stock, are not entitled to rely on the safe harbor.
Implications for Private Companies, SPAC Sponsors and Financial Advisors
To the extent that this legislation is adopted, and as noted in our previous alert, companies going public through a SPAC will be subject to increased potential liability for inaccuracies in forward-looking statements, including projections. The increased risk of liability associated with forward-looking statements will likely result in companies and other market participants, including SPAC sponsors and financial advisors, applying additional rigor to projections. These increased risks may even cause companies to reconsider the use of projections in their SPAC transaction and/or result in an increase to the already significant costs associated with directors and officers (D&O) liability insurance for a SPAC transaction.
In order to establish a due diligence defense in connection with any securities litigation associated with missed projections, the board of directors of companies contemplating a SPAC transaction should consider meeting with management to discuss and review any projections to be used in the transaction and documenting those meetings with management.