The SEC Proposes New Rules for Special Purpose Acquisition Companies

On March 30, 2022, the U.S. Securities and Alternate Fee (SEC) authorized, by a 3-to-1 vote, a 372-page proposal of quite a few guidelines concerning disclosures and procedural necessities for particular function acquisition firms (SPACs). SEC Chair Gary Gensler said that their function was to impose lots of the laws relevant to conventional preliminary public choices (IPOs) on SPACs, stating that SPAC traders “deserve the protections they receive from traditional IPOs, with respect to information asymmetries, fraud, and conflicts, and when it comes to disclosure, marketing practices, gatekeepers, and issuers.”1

If these sweeping laws are applied as proposed, they might considerably have an effect on capital markets practices for each issuers and underwriters, and open up new avenues for regulatory enforcement and extra personal securities litigation. Even earlier than these proposed laws, SPACs had been already being sued nearly twice as a lot as conventional IPOs, with 32 SPAC securities class actions filed in 2021, a greater than sixfold improve in comparison with 2020.2 As well as, the SEC had beforehand introduced varied enforcement actions towards contributors in SPAC transactions. The proposed guidelines are open for public remark via a minimum of Could 31, 2022, and entities and underwriters working within the SPAC house might want to think about whether or not and the way to answer the SEC’s proposal.

Background

SPACs are shell firms that elevate funds via an underwritten IPO with the purpose of buying a yet-to-be-identified working firm. As soon as the SPAC identifies the goal firm, it completes a enterprise mixture (the “de-SPAC” transaction) leading to a mixed public firm.

Though SPACs have existed for a long time, they solely turned more and more common over the past a number of years, as evidenced by the quantity of capital raised by SPACs doubling from $80 billion in 2020 to greater than $160 billion in 2021. Proponents of SPACs have cited their capital formation flexibility and nimbleness in bringing new firms to market, as referenced in SEC Commissioner Hester M. Peirce’s assertion opposing the proposed guidelines: “SPACs brought many new companies into our public markets—a welcome trend after decades of decline in the number of public companies.”3 Alternatively, critics of SPACs have argued they disproportionately profit insiders and lack enough disclosures,4 and the SEC has been signaling some sort of new forthcoming guidelines. Roughly a 12 months in the past, the appearing director of the Division of Company Finance issued an announcement saying SEC workers was “continuing to look carefully” at filings by SPACs and their targets, and that “[a]ny simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst.”5 The proposed guidelines are the fruits of that effort.

Whereas a number of the proposed guidelines mirror present greatest practices, others might current a “square peg/round hole” facet, as they seem to combine and match totally different ideas of potential legal responsibility below the 1933 Securities Act (‘33 Act) and the 1934 Securities Exchange Act (‘34 Act). This asymmetry arises most clearly in connection with projections of future performance. Whereas in a traditional IPO governed by the ’33 Act, firms sometimes don’t supply projections of future efficiency, within the merger context ruled by the ’34 Act, a SPAC board’s evaluation of projections of the mixed firm is important each to satisfying the board’s fiduciary duties and to making sure an knowledgeable shareholder vote.

The Proposed Rules

The SEC’s proposed guidelines would have an effect on SPAC IPOs and de-SPAC transactions within the following methods:

  • No PSLRA (Non-public Securities Litigation Reform Act) Protected Harbor for Ahead-Wanting Statements: As acknowledged within the SEC’s launch, practitioners on this discipline sometimes deal with monetary projections, that are an inherent a part of the de-SPAC transaction, as protected by the PSLRA’s statutory protected harbor for forward-looking statements. The proposed guidelines would change that by defining a SPAC as a “blank check company,” which might not entitle SPACs to the advantages of the statutory protected harbor. The guidelines would lengthen legal responsibility for forward-looking statements to different merger contributors, together with underwriters.

    The proposed guidelines would impose extra rigorous standards on monetary projections supplied to traders in reference to de-SPAC transactions. For instance, projected measures not primarily based on historic monetary outcomes or operational historical past would have to be clearly distinguished from these which might be. Registrants can be required to reveal the aim of the projections, who ready them, the fabric bases and assumptions beneath the projections, whether or not the projections replicate the view of the SPAC’s board of administrators or administration as of the date of submitting, and whether or not projections concerning the goal firm replicate the view of that firm’s board of administrators or administration.

    In some methods, together with in the case of underwriters, this standards might not considerably deviate from present practices, as SPACs sometimes assessment monetary projections the goal firm ready as a part of their due diligence and valuation of the goal firm, and disclose these projections to public shareholders in de-SPAC transaction supplies. Underwriters assessment these supplies as a part of their due diligence. It’s unlikely that SPACs will exclude monetary projections from de-SPAC supplies altogether due to their significance in understanding the goal firm’s perceived worth, and the choice by the SPAC’s board of administrators to do the merger. SPACs might want to scrutinize assumptions underlying monetary projections and specific them in a way that may be understood by traders in de-SPAC supplies.

  • De-SPAC Equity Willpower: For de-SPAC transactions, the principles would require the SPAC to conduct a equity dedication, which might be much like the equity determinations required in going-private transactions topic to Rule 13e-3. The equity dedication would state, amongst different objects, whether or not the SPAC moderately believes the de-SPAC transaction is truthful to unaffiliated shareholders and determine the idea for this discovering with cheap element, together with the consideration of any goal projections and the valuation of the goal firm. The guidelines would require disclosures concerning all outdoors studies, opinions, or value determinations acquired by both the SPAC or its sponsors regarding: (i) the consideration or the equity of the consideration to be supplied to shareholders; or (ii) the equity of the de-SPAC transaction or any associated financing transaction to the SPAC, its sponsors, or unaffiliated shareholders. Required disclosures would come with a background abstract of the de-SPAC transaction, any underlying contracts and negotiations, the explanations for the de-SPAC transaction, investor redemption rights, materials financing transactions, sponsor compensation, shareholder dilution, and potential and precise conflicts of curiosity.

    Whereas these disclosures are sometimes made by SPACs, the proposed rule would seemingly have the impact of inflicting SPACs to acquire a equity opinion from an impartial funding agency, and thus require further charges regarding the transaction.

  • Underwriter Legal responsibility: The guidelines would set up that underwriter legal responsibility below Part 11 of the ’33 Act applies to de-SPAC transactions if the underwriter takes steps to facilitate the de-SPAC transaction, or any associated financing transaction, or if the underwriter in any other case participates instantly or not directly within the de-SPAC transaction. The SEC recognized a number of examples of conduct that might represent underwriter participation in a de-SPAC transaction, together with offering monetary recommendation to the SPAC, figuring out potential merger targets, negotiating merger phrases, and negotiating or soliciting PIPE (personal funding in public fairness) financing. As SEC Commissioner Peirce said in her dissent, this growth of underwriter legal responsibility could also be designed to advertise due diligence through the de-SPAC transaction, however it could as an alternative lead to SPAC underwriters “do[ing] everything possible to avoid being captured by the rule[.]” Accordingly, underwriters taking part in a de-SPAC transaction might want to conduct themselves in the identical method as they do in a conventional IPO.

    It’s common for the underwriters of SPAC IPOs to obtain a portion of their underwriting payment upon the closing of the IPO, and defer the rest to completion of the de-SPAC transaction (which ends up in forfeiture of the rest if a de-SPAC shouldn’t be accomplished). This makes the SPAC IPO enticing for sponsors bearing the preliminary prices of launching the SPAC, however the brand new proposed guidelines theoretically might topic underwriters to further legal responsibility for de-SPAC transactions with which they had been comparatively uninvolved. Consequently, underwriters might search to restructure these charges to guarantee they aren’t topic to further legal responsibility within the de-SPAC.

    The proposed elimination of the PSLRA’s protected harbor for monetary projections utilized in de-SPAC transactions would have an effect on underwriter legal responsibility, though a lot much less so for underwriters which have already adopted greatest practices. The SEC’s proposal confirmed that due diligence defenses would proceed to be obtainable to underwriters and defined that the principles had been designed to impose new prices on underwriters solely “to the extent to which [underwriters] do not already perform due diligence that would be sufficient to perfect such a defense in connection with a de-SPAC transaction or a related financing transaction.”6 The Supreme Court docket’s choice in Omnicare, Inc. v. Laborers District Council Building Business Pension Fund, 575 U.S. 175, 186 -87 (2015), which held that no Part 11 legal responsibility attaches to “a sincere statement of pure opinion” so long as no omission of reality renders the assertion “misleading to an ordinary investor,” will even circumscribe underwriter legal responsibility for monetary projections utilized in de-SPAC transactions.

  • SPAC Goal Co-Registration and Goal Legal responsibility: The proposed guidelines would deem the de-SPAC an providing of shares to the SPAC’s present shareholders whatever the transaction construction, successfully requiring that any de-SPAC transaction embrace the submitting of a registration assertion on Type S-4 or Type F-4 below the ’33 Act. As well as, the principles would require that, in de-SPAC transactions, the goal personal firm should be recognized and handled as a co-registrant. The proposal acknowledges that this new co-registration requirement would trigger an “increase in potential liability from the current baseline for targets and their signing officers and directors” and would pose an “increased litigation risk and the potential need for new insurance coverage or higher premiums for existing coverage.” Alternatively, the impact of this requirement could also be minimal as a result of the mixed firm already takes on the SPAC’s liabilities after the closing of the de-SPAC enterprise mixture.

  • Protected Harbor From 1940 Act: The proposed guidelines present a protected harbor for SPACs from the definition of an “investment company” below the Funding Firm Act of 1940 (1940 Act). This seems to be the SEC’s response to comparatively latest 1940 Act challenges raised by sure third events towards varied SPACs. During the last 12 months, three SPACs have been sued by legislation professors contending that the 1940 Act ought to apply to those entities as a result of they maintain authorities securities in belief, corresponding to short-term treasuries and qualifying market cash funds. In August 2021, quite a lot of main legislation companies (together with Greenberg Traurig, LLP) authored a letter explaining that SPACs shouldn’t be thought of funding firms below the 1940 Act as a result of they’re engaged primarily in figuring out and consummating enterprise combos inside a specified time interval and solely briefly maintain authorities securities. Thus, by proposing new guidelines establishing a protected harbor to the 1940 Act, the SEC’s proposal confirms that a minimum of some SPACs don’t resemble funding firms topic to legal responsibility below the 1940 Act. SPACs which might be already concerned in pending litigation might cite this proposal as assist for the proposition that they shouldn’t be seen as an funding firm topic to the 1940 Act.

    To fall inside the protected harbor, SPACs should discover a merger goal and provoke the de-SPAC transaction inside 18 months of the SPAC’s IPO, and should full the de-SPAC transaction inside 24 months of the IPO. If a SPAC fails to fulfill both deadline, it might then have to distribute its property in money as quickly as moderately practicable, or not be capable to depend on the protected harbor.

  • Different Proposed Disclosures: SPACs can be required to determine their sponsors, associates, and promoters, in addition to the particular expertise, materials roles, and obligations of those contributors. SPAC IPO disclosures would additionally have to determine all compensation to be awarded or paid to underwriters in reference to companies rendered to the SPAC or after completion of the de-SPAC transaction, in addition to any dilutive impact of that compensation. The disclosures would additional embrace the phrases of any lock-up agreements with sponsors, associates, and promoters. The guidelines would require a SPAC to reveal any precise or potential materials battle of curiosity. The new guidelines would require addressing potential shareholder dilution arising from quite a few sources throughout SPAC formation, together with excellent warrants, convertible securities, and PIPE financing, in addition to the impression that varied ranges of redemptions in reference to a de-SPAC transaction could have on non-redeeming shareholders.

The proposed guidelines would revise the necessities for goal firm monetary statements in de-SPAC transactions to place them in the identical place as a conventional IPO. Normally, this may profit goal firms that qualify as smaller reporting firms or rising development firms.

The SEC’s proposal, open for public remark via a minimum of Could 31, 2022, represents a considerable effort by the company to impose important controls on the SPAC market.

Jason T. Simon and Alex Linhardt additionally contributed to this text.

FOOTNOTES

1 “Statement on Proposal on Special Purpose Acquisition Companies (SPACs), Shell Companies, and Projections” (Mar. 30, 2022).

2 “Securities Class Action Filings: 2021 Year in Review,” Cornerstone Analysis (Feb. 2, 2022).

3 “Damning and Deeming: Dissenting Statement on Shell Companies, Projections, and SPACs Proposal” (March 30, 2022).

4 See, e.g., “A Sober Look at SPACs,” Harvard Regulation Faculty Discussion board on Company Governance (Nov. 19, 2020).

5 “SPACs, IPOs, and Liability Risk Under the Securities Laws” (April 8, 2021).

6 Securities and Exchange Commission’s Proposed Rules for Special Purpose Acquisition Companies, Shell Companies, and Projections (Mar. 30, 2022), p. 250.

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