The U.S. Securities and Exchange Commission has proposed new rules and amendments (the Proposed Rules) to enhance disclosure and expand liability in initial public offerings by special purpose acquisition companies (SPACs) and in business combination transactions (de-SPAC transactions) involving SPACs and private operating companies (target companies).
The Proposed Rules, published on March 30, 2022, and set forth in Release No. 33-11048, would expand the liability associated with de-SPAC transactions in several notable ways, including by: requiring additional and detailed disclosures in connection with de-SPAC transactions and, accordingly, expanding the scope of the disclosures for which the parties involved in a de-SPAC transaction could have liability; increasing the number of parties who have could have liability for material misstatements or omissions in the de-SPAC transaction documents; and increasing the universe of potential plaintiffs. Target companies considering listing on an exchange through a de-SPAC transaction should consult with their counsel regarding the impact of the Proposed Rules. The sections below summarize key elements of the Proposed Rules applicable to target companies.
Background: SEC Concerns to Be Addressed
With the Proposed Rules, the SEC is seeking to harmonize investor protection standards that apply to traditional IPOs and de-SPAC transactions, with a specific focus on applying similar standards for disclosure, marketing practices and gatekeeper and issuer obligations. The SEC’s proposal cited several concerns underlying the Proposed Rules, including:
- Inadequate disclosures about the target company that may be less complete and less reliable than disclosures provided by an issuer in a traditional IPO
- The use of projections that, in some instances, may have been unreasonable, unfounded or potentially misleading, particularly where the target company is an early-stage company with no or limited sales, products or operations
- The absence of a named underwriter that would typically perform traditional gatekeeping functions, such as due diligence, and would be subject to liability under Sections 11 and 12 of the Securities Act of 1933, as amended (the Securities Act)
However, this desire to align legal standards between IPOs and de-SPAC transactions is at odds with the differing practices related to the two types of transactions. For example, SEC filings for public mergers and acquisitions transactions frequently include financial projections, and we believe there will be increased legal pressure to continue to include projections in connection with de-SPAC transaction documents as a result of the Proposed Rules. In contrast, while company projections are disclosed to the investment banks’ research analysts in connection with the IPO diligence process and underly the model developed by the analysts as part of their research process, company projections are traditionally not included in the IPO registration statement due to the increased liability associated with projections.
Enhanced Disclosure and Projections
The Private Securities Litigation Reform Act of 1995 (PSLRA) is a safe harbor for forward-looking statements, such as projections, made by existing public companies. The PSLRA does not, however, apply to forward-looking statements made in connection with IPOs. The Proposed Rules would amend certain definitions so that the safe harbor will also be unavailable to SPACs and target companies in public filings. This would make it more difficult, time-consuming and costly for SPACs, target companies and other involved parties to dismiss claims related to forward-looking statements made in connection with de-SPAC transactions and thus subject them to increased liability risk.
Notwithstanding this enhanced liability for projections and the fact that projections are rarely—if ever—used in traditional IPOs of operating companies, it will be difficult for SPACs and target companies to avoid disclosing projections in de-SPAC transactions as a result of the combination of (1) the Proposed Rules, including the proposed requirement that the SPAC discuss the fairness of a de-SPAC transaction (which is described in more detail below), and (2) existing pressures to include projections in de-SPAC transaction filings. These include existing SEC disclosure requirements, the need to “cleanse” disclosure of projections to PIPE investors in related financing transactions who do not want to be precluded from trading due to possession of material non-public information, and the long-settled practice of disclosure of projections in M&A transactions (including de-SPAC mergers) as a result of Delaware jurisprudence and litigation pressure. It may be that the Proposed Rules result in more conservative projections or the use of projections based on multiple scenarios, including downside scenarios.
In addition to the loss of the PSLRA safe harbor, the Proposed Rules would require additional disclosures regarding financial projections in a de-SPAC transaction. Such disclosures would include (1) the purpose for which the projections were prepared and the party that prepared the projections; (2) all material bases of the disclosed projections, all material assumptions underlying the projections and any factors that may materially impact such assumptions; and (3) whether the disclosed projections still reflect the view of the board or management of the SPAC or target company, as applicable, as of the date of the filing.
The Proposed Rules also include amendments to Item 10(b) of Regulation S-K that are intended to address broader concerns regarding the use of projections generally and to enhance the reliability of projections disclosure, not specifically within the context of SPACs or de-SPAC transactions. These amendments include requiring that, when projections are presented that are based on historical financial results or operational history, such historical results or operational history is presented with equal or greater prominence, and that any projected measures that are not based on historical financial results or operational history be clearly distinguished from projected measures that are based on historical financial results or operational history.
The Proposed Rules would require disclosure in a de-SPAC registration statement as to whether the SPAC reasonably believes that the de-SPAC transaction and any related financing transactions are fair or unfair to unaffiliated SPAC investors. While not required by the Proposed Rules to obtain fairness opinions, this may result in a greater number of SPACs seeking to obtain fairness opinions from financial advisors in connection with the de-SPAC transaction to support such fairness beliefs (although the imposition of additional liability on such advisors, discussed below, will likely make such opinions more difficult and/or expensive to obtain). Furthermore, where a SPAC’s fairness belief or a third party’s fairness conclusion or opinions are based in part on a review of projections, we expect the associated disclosure will need to include these projections, implicating the increased liability that the Proposed Rules would impose.
Additional Target Company Disclosures
The Proposed Rules specifically amend the registration statement forms and schedules filed in connection with de-SPAC transactions to require additional disclosures about the target company that would otherwise have been required in the “Super 8-K” following the closing of the de-SPAC transaction, which has the effect of subjecting the issuers and other parties (including underwriters in the SPAC IPO that participate in the de-SPAC transaction) to liability under Sections 11 and 12 of the Securities Act for such statements. Such disclosures of the target company, which are consistent with the disclosures included in traditional IPOs, include: description of business; description of property; legal proceedings; changes in and disagreements with accountants on accounting and financial disclosure; security ownership of certain beneficial owners and management, assuming the completion of the de-SPAC transaction and any related financing transaction; and recent sales of unregistered securities.
Additional De-SPAC Transaction Disclosures
The Proposed Rules include further required disclosures throughout the de-SPAC registration statement. Such disclosures include:
- A discussion of material financing transactions, SPAC sponsor compensation and dilution, conflicts of interest and the fairness of the de-SPAC transaction on the cover page of the registration statement
- Background and material terms of the de-SPAC transaction, fairness of the de-SPAC transaction, material conflicts of interest, tabular disclosure on SPAC sponsor compensation and dilution, financing transactions in connection with de-SPAC transactions and redemption rights in the prospectus summary
- Enhanced dilution disclosure of each material potential source of additional dilution that non-redeeming SPAC shareholders may experience at different phases of the SPAC lifecycle by electing not to redeem their shares
- A sensitivity analysis in a 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 SPAC shareholders as redemptions increase, which requires disclosure of a description of the model, methods, assumptions, estimates and parameters necessary to understand the sensitivity analysis disclosure
- Disclosure about the background, material terms and effects of a proposed de-SPAC transaction, including any material interests that the SPAC sponsor and the SPAC’s officers and directors have in a de-SPAC transaction or any related financing transaction, including fiduciary or contractual obligations to other entities as well as any interest in, or affiliation with, the target company
- Additional disclosure about the SPAC sponsor, its affiliates and any promoters of the SPAC, including regarding:
- The redemption of outstanding securities
- The nature and amounts of all compensation that has or will be awarded to, earned by, or paid to the SPAC 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 same upon the completion of a de-SPAC transaction
- Any actual or potential material conflict of interest between (a) the SPAC sponsor or its affiliates or the SPAC’s officers, directors or promoters, and (b) unaffiliated security holders, including any conflict of interest in determining whether to proceed with a de-SPAC transaction
Persons Subject to Liability
The Proposed Rules would expand the categories of persons bearing liability by requiring the target company in the de-SPAC transaction to be a co-registrant when a SPAC files a registration statement on Form S-4 or Form F-4 for a de-SPAC transaction. This will have the effect of imposing liability on the target company and its directors and principal executive officer, principal financial officer and controller or principal accounting officer (collectively, principal officers) under Sections 11 and 12 of the Securities Act, for disclosures in the registration statement, subject to the so-called “due diligence” defense, in addition to the liability already imposed upon the SPAC, its board and its principal officers.
In addition, the Proposed Rules would deem underwriters in a SPAC IPO to be statutory underwriters in a subsequent de-SPAC transaction (and therefore subject them to potential underwriter liability in respect of the de-SPAC SEC filings) when certain conditions are met, including when such underwriter has taken steps to facilitate a de-SPAC transaction or any related financing transaction (such as a PIPE transaction) or otherwise participates (directly or indirectly) in the de-SPAC transaction. This may include any underwriter that receives a typical deferred underwriting commission that is paid on completion of the de-SPAC transaction or any financial advisor providing a fairness opinion. This would have the effect of affirming that such underwriters are subject to Section 11 liability in connection with the registration statement filed in connection with the de-SPAC transaction. The expansive view of statutory underwriters in a de-SPAC transaction in the Proposed Rules could even be deemed to include other financial advisors participating in the transaction, PIPE investors or other advisors, depending on the circumstances.
While the desired outcome is for underwriters to conduct more robust due diligence akin to what would be conducted in a traditional IPO, a potential result is that SPAC IPO underwriters will seek to avoid being captured by the applicable Proposed Rules, such as by demanding all underwriting compensation up front at the time of the SPAC IPO rather than being paid on a deferred basis in connection with the de-SPAC transaction or by not participating in de-SPAC transactions for issuers where such underwriter participated in the SPAC IPO. Some investment banks that have been active in underwriting SPAC IPOs have already announced that they intend to pause this activity pending clarity regarding the Proposed Rules. In any event, SPAC IPO underwriters, placement agents, financial advisors, PIPE investors and other advisors directly or indirectly participating in a de-SPAC transaction should consult with their counsel to determine whether they might be underwriters and whether they should therefore conduct additional due diligence that may be appropriate to establish a “due diligence” defense to liability under Sections 11 and 12 of the Securities Act.
Experts, including auditors who opine on the financial statements associated with de-SPAC transactions and any person who has prepared or certified any report or valuation that is used in connection with the registration statement, would similarly be subject to liability under Section 11 to the shareholders of the SPAC pursuant to the Proposed Rules.
Liability Owed to Additional Parties
The Proposed Rules would deem any de-SPAC transaction to involve a sale of securities to the SPAC’s shareholders, regardless of transaction structure. This would have the impact of expanding the universe of parties entitled to the benefit of bringing Section 11 claims and to be potential plaintiffs as well as ensuring that SPAC shareholders more consistently receive the full protections of the Securities Act disclosure and liability provisions in de-SPAC transactions.
We expect that most de-SPAC transactions will continue to need to be registered under a registration statement (consistent with current practice) as, given the publicly traded nature of a SPAC’s shareholder base, we believe it will be challenging to structure de-SPAC transactions as exempt from registration. Registration in this context would provide a right of action for SPAC shareholders for defects in the de-SPAC transaction documents and result in enhanced liabilities for signatories to any registration statement and potential underwriter liability as described above.
Smaller Reporting Company Implications
The Proposed Rules would amend the definition of smaller reporting company (SRC) to require an issuer to re-determine its SRC status within four days following the consummation of a de-SPAC transaction and to reflect this re-determination of SRC status in its first periodic report (Form 10-K or Form 10-Q) following a de-SPAC transaction. As a result, an issuer who ceases to qualify as an SRC as of such re-determination would no longer be able to avail itself of scaled disclosure and other accommodations as of the filing of such first periodic report.
Timing for Shareholder Meeting
The Proposed Rules would require that disclosure documents in de-SPAC transactions be disseminated to investors 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 the laws of the jurisdiction of incorporation or organization if such period is less than 20 calendar days). While currently this period can be as short as 10 calendar days, depending on the structure of the de-SPAC transaction, this change is unlikely to materially affect most de-SPAC transactions. That said, it may have the effect of adding time pressure with a SPAC that is fast approaching the end of the time frame (typically 12 – 24 months) within which the SPAC must complete its de-SPAC transaction.
Updates to Financial Statements
The Proposed Rules are also intended to align the financial statement reporting requirements more closely in de-SPAC transactions with those in traditional IPOs. One change that would be advantageous to many target companies is the proposed expansion of the circumstances in which target companies may report two years of financial statements as an emerging growth company (EGC) by removing the question of whether the SPAC has filed its first annual report as a factor in determining the number of years required. Additional changes in the financial statements in connection with a de-SPAC transaction would include requiring that:
- The significance of an acquired business by the target company prior to the de-SPAC transaction be calculated using the target company’s financial information as the denominator instead of that of the SPAC
- Any financial statements of an acquired business of the target company omitted from the previously filed registration statement or proxy because the significance of the acquisition was greater than 20% but less than 50% would be required in Item 2.01(f) of the Super 8-K
The SEC has set the later of 30 days after publication in the Federal Register or May 31, 2022, as the deadline for the public to submit comments regarding the Proposed Rules. These rules would not take effect until after that comment period and subsequent reconsideration by the SEC.