Almost two years after the publication of proposed rules (the Proposed Rules) on March 30, 2022, the SEC has adopted final rules (the Final Rules) to enhance disclosure and expand liability in initial public offerings by special purpose acquisition companies and in business combination transactions (de-SPAC transactions) involving SPACs and private operating companies (targets).
The Final Rules, published on January 24, 2024, and set forth in Release No. 33-11265, were adopted largely as proposed, and require additional, detailed disclosures in connection with de-SPAC transactions, including disclosures related to SPAC Sponsor compensation, dilution and conflicts of interest, and, accordingly, expand the scope of the disclosures for which the parties involved in a de-SPAC transaction could have liability. Further, the Final Rules require that, in most cases, the target be a co-registrant with the SPAC in a registered de-SPAC transaction–subjecting the target, its directors, principal executive officer, principal financial officer, and controller or principal accounting officer (collectively, principal officers) to liability under the Securities Act of 1933 (the Securities Act) for material misstatements or omissions in the de-SPAC transaction offering documents.
However, the Final Rules differ from the Proposed Rules in that they do not require that underwriters in the SPAC IPO be deemed an underwriter in connection with the de-SPAC transaction when certain conditions are met nor do the Final Rules add a safe harbor for SPACs under the Investment Company Act of 1940 (the Investment Company Act).
In a statement accompanying the adopting release, SEC Chair Gary Gensler said the that the SEC seeks to harmonize investor protection standards that apply to traditional IPOs and de-SPAC transactions, with a specific focus on applying similar standards for disclosure, use of projections, and issuer obligations. SEC Commissioner Mark Uyeda dissented, stating that the Final Rules “impose crushingly burdensome regulations on SPACs [and targets] as a form of merit regulation in disguise”—seemingly in a bid to eliminate SPACs as a form of going public.
We summarize below key elements of the Final Rules applicable to targets and remind target companies considering listing on an exchange through a de-SPAC transaction to consult with counsel regarding the impact of the Final Rules.
Enhanced Disclosure and Projections
The Private Securities Litigation Reform Act of 1995 is a safe harbor for public companies’ forward-looking statements, such as projections. Targets and their SPAC merger partners have relied on the safe harbor to shield them from liability in litigation over the target’s future performance projections that are typically provided in de-SPAC transaction offering documents. The Final Rules make the applicable safe harbor unavailable to SPACs and targets in public filings in connection with a de-SPAC transaction. This will make it more difficult, time-consuming, and costly for SPACs, targets, 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 potential liability.
Notwithstanding the increased risks associated with including projections in de-SPAC transaction offering documents, it may still be difficult for SPACs and targets to avoid disclosing projections in de-SPAC transactions. Reasons include:
- Existing SEC disclosure guidance requiring the disclosure of projections when considered by a board in approving an M&A transaction
- The need to “cleanse” Private Investment in Public Equity investors (who do not want material non-public information that would preclude them from trading) of any projections provided in de-SPAC-related financings
- The long-settled practice of disclosing projections in M&A transactions (including de-SPAC transactions) because of Delaware jurisprudence
The Final Rules also require additional disclosures regarding financial projections when they are included in de-SPAC transaction offering documents. Such disclosures include:
- The purpose for which the projections were prepared and the party that prepared the projections
- All material bases of the projections, all material assumptions underlying the projections, and any factors that may materially impact such assumptions
- An affirmation from the target as to whether the projections still reflect the view of the target’s board or management regarding future performance of the target as of the most recent practicable date prior to the date of the de-SPAC transaction offering documents
These requirements expand the disclosure from what is currently included in M&A transactions. In addition, the Final Rules create new requirements for financial projections included in any SEC filings, including:
- When presenting projections based on historical financial results or operational history, such historical results or operational history be presented with equal or greater prominence
- Any projected measures not based on historical financial results or operational history be clearly distinguished from those projected measures that are based on historical financial results or operational history
Additional Target Company Disclosures
The Final Rules specifically amend the registration statement forms and schedules filed on Form S-4 in connection with de-SPAC transactions to align with the requirements applicable to an IPO registration statement on Form S-1. This effectively subjects registrants (including the target) to the same potential liability under Sections 11 and 12 of the Securities Act as in an IPO. Newly required target disclosures 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 Final Rules require further disclosures throughout the de-SPAC transaction offering documents, including:
- A discussion of material financing transactions, conflicts of interest, and SPAC sponsor compensation and dilution on the cover page of the registration statement as well as in the prospectus summary
- Enhanced dilution disclosure in a tabular format that includes intervals representing selected potential redemption levels that may occur across a reasonably likely range of outcomes
- Disclosure about the background, material terms, and effects of a proposed de-SPAC transaction, including any material interests that the SPAC sponsor as well as the target’s and SPAC’s respective 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
Persons Subject to Liability
The Final Rules expand liability by requiring the target in the de-SPAC transaction to co-register when a SPAC files a registration statement on Form S-4 or Form F-4. This imposes liability on the target and its principal officers under Sections 11 and 12 of the Securities Act for misstatements or omissions of material facts in the registration statement—subject, in the case of directors and other principal officers, to the so-called “due diligence” defense.
However, the Final Rules did not adopt the proposal that, in most circumstances, would have deemed underwriters in a SPAC IPO to be de facto statutory underwriters in a subsequent de-SPAC transaction (and therefore subject them to potential underwriter liability in respect of the de-SPAC transaction offering documents). The SEC instead provided guidance intended to assist parties in applying the statutory definition of “underwriter” in the context of de-SPAC transactions. This guidance states that, depending on facts and circumstances, an entity can be deemed a “statutory underwriter” (without being named as an underwriter in the de-SPAC transaction offering documents or engaging in activities generally performed by underwriters in IPOs) if the entity is selling for the issuer or is otherwise participating in the distribution of securities in connection with the de-SPAC transaction. Unfortunately, the guidance does not clarify the meaning of “participating” in the de-SPAC transaction distribution, so financial institutions and other parties may continue to distance themselves from SPAC IPOs and de-SPAC transactions to avoid underwriter liability.
Liability Owed to Additional Parties
The Final Rules deem any de-SPAC transaction to involve a sale of the combined company’s securities to the SPAC’s shareholders, regardless of transaction structure. This expands the universe of parties with standing to bring Section 11 claims.
We expect that most de-SPAC transactions will still need to be registered pursuant to a registration statement (consistent with current practice) because, given the publicly traded nature of a SPAC’s shareholder base, we believe it would 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 disclosure defects in the de-SPAC transaction offering documents. It would also enhance potential liabilities for people with Section 11 liability for the content of the registration statement.
Investment Company Act Status
The SEC did not adopt a proposed safe harbor that would have allowed SPACs not to be deemed investment companies under the Investment Company Act provided certain conditions were met. Instead, the SEC provided guidance (akin to the approach utilized by the SEC for underwriter liability) regarding its views of the facts and circumstances relevant to making such determination. While this guidance may make it easier for the SEC, and perhaps others, to claim that a SPAC is an investment company, Fenwick stands behind a joint statement issued alongside more than 60 law firms in September 2021 that states there is no factual or legal basis for the SEC’s assertion that traditional SPACs are unregistered investment companies.
Smaller Reporting Company Implications
The Final Rules amend the definition of smaller reporting company (SRC) to require an issuer to redetermine its SRC status within four days following the consummation of a de-SPAC transaction—and to reflect this redetermination of SRC status in its first SEC filing (excluding the so-called “Super 8-K”) following a de-SPAC transaction. As a result, an issuer that ceases to qualify as an SRC will no longer be able to avail itself of scaled disclosure and other accommodations as of the first periodic report’s filing.
Timing for Shareholder Meeting
In most circumstances, the Final Rules require that a de-SPAC transaction’s disclosure documents be disseminated to investors at least 20 calendar days before a shareholder meeting to approve the de-SPAC transaction, or the earliest date of action by written consent.
Updates to Financial Statements
The Final Rules are intended to align de-SPAC financial statement reporting requirements more closely with those in traditional IPOs. One advantageous change for many targets expands the circumstances in which target companies may report two years of financial statements as an emerging growth company (EGC) by no longer factoring in whether the SPAC has filed its first annual report when determining the number of years required. Among several amendments to Regulation S-X, the rules covering de-SPAC-related financial statements now require that:
- The target calculates the significance of an acquired business prior to the de-SPAC transaction using its own financial information as the denominator instead of the SPAC’s
- Item 2.01(f) of the Super 8-K includes any target-acquired businesses’ financial statements that were omitted from the previously filed registration statement or proxy statement because the acquisition’s significance was greater than 20% but less than 50%
Effective Date and Compliance
The Final Rules take effect 125 days after publication in the Federal Register. Compliance with the structured data requirements mandating inline XBRL tagging of information disclosed pursuant to new subpart 1600 of Regulation S-K will be required 490 days after publication.