John Coates, Acting Director of the Division of Corporation Finance at the U.S. Securities and Exchange Commission (SEC), issued a public statement providing insight into the SEC’s views on the application of federal securities laws to transactions involving Special Purpose Acquisition Companies (SPACs). The April 8 statement, “SPACs, IPOs and Liability Risk under the Securities Law,” (Statement) takes the position that de-SPAC transactions are similar in nature to traditional initial public offerings (IPOs) and that, therefore, as a matter of policy, they may need to be treated the same as an IPO for purposes of application of the liability provisions of the federal securities laws.
As is common for this kind of statement, Acting Director Coates qualifies his guidance by indicating that it is only his view, and does not necessarily reflect the position of the SEC. Nevertheless, given his position and influence, the Statement can be viewed as reflecting the SEC’s likely position on these matters.
Implications for Private Companies, SPAC Sponsors and Financial Advisors
As a practical matter, the Statement will likely have an impact on SPAC transactions. Among other things, we expect that:
- There may be an insistence on increased due diligence of the business and financial results of private companies that are parties to SPAC transactions.
- Companies, SPAC sponsors, financial advisors and other participants in SPAC transactions may change their practices with respect to the projections that are included in SPAC disclosure. If the Statement is correct that the safe harbor does not apply to projections or other forward-looking statements, there is significant increased risk associated with forward-looking statements, including projections.
- The substantial cost of D&O insurance in connection with SPAC transactions may increase, given greater concerns regarding legal liability. This is particularly true given that concerns about Section 11 liability have long been a principal driver of increased costs for public company D&O insurance.
In addition, the SEC may take action to further clarify or codify its position regarding disclosure obligations in SPAC transactions, and the liability of participants for such disclosure, whether through rule-making or Staff guidance.
Expect Heightened Due Diligence into SPAC Targets
The safe harbor in the Private Securities Litigation Reform Act (PSLRA) for forward-looking statements is not available in a traditional IPO. Although the PSLRA does not define an IPO, Acting Director Coates offers his rationale as to why de-SPAC transactions bear similarities to
IPOs with respect to the target company. Accordingly, if de-SPAC transactions are deemed to be traditional IPOs, the common practice of including financial projections in SPAC disclosure would not have safe harbor protection. As a practical matter, the Statement is likely to lead to heightened due diligence into SPAC target companies and to changes in practices with respect to the financial projections that are now typically included in SPAC investor marketing and disclosure documents.
The Statement notes the “unprecedent surge” in the use of SPACs, that several constituencies are “sounding alarms about the surge,” and, as a result, there is a need for “unprecedented” regulatory scrutiny. The focus then turns to the legal liability that, in the SEC’s view, attaches to the disclosures in the de-SPAC transaction, and, specifically, the question of whether (as some have argued) there is lesser securities law liability exposure for participants in a SPAC transaction than in a traditional IPO.
As discussed below, the Statement answers this question in the negative. It notes that some commentators have claimed that because the PSLRA’s safe harbor for forward-looking statements “applies in the context of de-SPAC transactions but not in conventional IPOs . . . sponsors, targets, and others involved in a de-SPAC feel comfortable presenting projections and other valuation material of a kind that is not commonly found in conventional IPO prospectuses.” From Acting Director Coates’ perspective, however, “in some ways, liability risks for those involved are higher, not lower, than in conventional IPOs, due in particular to the potential conflicts of interest in the SPAC structure.”
Discussion of Legal Issues
Before addressing the safe harbor issue, the Statement outlines the various legal provisions that apply to de-SPAC transactions.
1. The Statement points out that any material misstatement in or omission from an effective Securities Act registration statement as part of a de-SPAC business combination is subject to Section 11. (Section 11 provides for strict liability for issuers, directors, officers and underwriters (i.e., bankers) for material misstatements or omissions in a registration statement for public offered securities, although individuals have a good faith defense and the underwriters have a due diligence defense.)
2. The Statement notes that any material misstatement or omission in connection with a proxy solicitation is subject to liability under Exchange Act Section 14(a) and Rule 14a-9, under which courts and the SEC have generally applied a “negligence” standard.
3. Any material misstatement or omission in connection with a tender offer is subject to liability under Exchange Act Section 14(e).
4. De-SPAC transactions also may give rise to liability under state law. The Statement points out that Delaware corporate law, in particular, applies fiduciary duties, including a duty of candor, more strictly in conflict of interest settings, absent special procedural steps, which themselves may be a source of liability risk.
Acting Director Coates follows this with an analysis of whether the PSLRA safe harbor for forward-looking statements—which does not apply to traditional IPOs—should also not apply to de-SPAC transactions. According to the Statement, the notion that “the PSLRA offers something for SPACs not available to conventional IPOs . . . is uncertain at best.” While the safe harbor does not apply to “initial public offerings,” there is no definition of IPO in the PSLRA or any SEC rule. As such, Acting Director Coates states that:
“[T]he phrase [Initial Public Offering] may include de-SPAC transactions. That possibility further calls into question any sweeping claims about liability risk being more favorable for SPACs than for conventional IPOs.”
He also notes that an “IPO is where the protections of the federal securities laws are typically most needed to overcome the information asymmetries between a new investment opportunity and investors in the newly public company.” These concerns “point toward a conclusion that the PSLRA safe harbor should not be available for any unknown private company introducing itself to the public markets.” The Statement concludes by noting that the SEC could use the rulemaking process to “reconsider and recalibrate the applicable definitions, or the [SEC] staff could provide guidance explaining its views on how or if at all the PSLRA safe harbor should apply to de-SPACs.” It also notes that the safe harbor only applies to private litigation, and thus nothing prevents the SEC itself from taking appropriate action to enforce the federal securities laws. Further:
“Even if the safe harbor clearly applies, its procedural and substantive provisions do not protect against false or misleading statements made with actual knowledge that the statement was false or misleading. A company in possession of multiple sets of projections that are based on reasonable assumptions, reflecting different scenarios of how the company’s future may unfold, would be on shaky ground if it only disclosed favorable projections and omitted disclosure of equally reliable but unfavorable projections, regardless of the liability framework later used by courts to assess the disclosures.” (Emphasis in original)
Financial Advisor Liability
The Statement also calls into question the scope of liability for financial advisors that are advising on SPAC and de-SPAC transactions. Specifically, the Statement questions whether the SEC should reconsider the concept of an “underwriter” in the context of both a SPAC and other transactions intended to achieve dispersed ownership, including direct listings. Moreover, the Statement reminds all parties involved in promoting, advising, processing and investing in SPACs that they should understand the limits on any alleged liability difference between SPACs and conventional IPOs, and stresses that SPAC sponsors and targets and their affiliates and advisors should already be providing the public with the information material to the investment opportunities a de-SPAC represents.