The SEC's New Proposed SPAC Rules: Death Knell or Much-Needed Guidance?
In Short
The Situation: In response to the unprecedented surge in SPAC activity in 2020 and the first quarter of 2021, the SEC made a number of public statements expressing concern about various aspects of SPACs and suggesting that increased regulatory oversight might be appropriate. The SEC then included SPACs on its list of areas for proposed rulemaking in June 2021, and also announced enforcement actions against individuals involved in two relatively high-profile de-SPAC transactions.
The Result: On March 30, 2022, the SEC proposed new rules to "enhance disclosure and investor protection" in SPAC IPOs and de-SPAC transactions The proposed rules, if adopted, would, among other things: (i) require SPAC participants to make additional public disclosures, including regarding potential conflicts of interest, dilution, and the fairness of any proposed business combination; (ii) potentially expose certain SPAC participants to an increased risk of liability under the federal securities laws; (iii) remove the safe harbor for forward-looking statements that many SPACs have relied upon to include financial projections in their de-SPAC disclosures; and (iv) create a safe harbor that would exempt SPACs from registering as investment companies if certain criteria are satisfied.
Looking Ahead: The SEC's proposed rules are designed to treat de-SPAC transactions more like traditional IPOs from a regulatory perspective, and to provide investors in SPACs with many of the same protections available to investors in companies that go public through more traditional means. By increasing the risk of liability for SPAC participants, the new rules could chill SPAC activity, and in that way reduce the ability (or willingness) of some private companies to access the public capital markets in this way.
In 2020 and the first quarter of 2021, the use of special purpose acquisition companies ("SPACs") as a means of taking companies public grew exponentially. SPAC IPOs raised a total of more than $160 billion in that five quarter period, compared to less than $25 billion in 2018 and 2019 combined. This surge, together with the sub-par performance of many of the companies that went public in recent years through business combinations with SPACs, increasingly drew the interest of the U.S. Securities and Exchange Commission ("SEC"), and resulted in the SEC making numerous public statements in 2021 about the need for increased regulation in the space. The SEC also brought high-profile enforcement actions against participants in two de-SPAC transactions. This increased level of SEC scrutiny likely contributed to the decline in SPAC activity in the second half of 2021, as market participants waited for the regulatory landscape to become more clear.
On March 30, 2022, the SEC released its highly anticipated proposed rules for SPAC IPOs and de-SPAC transactions. The proposed rules address a variety of issues related to SPACs' disclosure obligations and the potential liability of SPAC participants, including:
- Enhanced Disclosures Regarding Conflicts of Interest, Dilution, and Fairness to Unaffiliated Shareholders: The SEC's proposal would impose new disclosure requirements on SPACs related to, among other things: (i) the SPAC's sponsor (including regarding its experience, roles, any lock-up agreements, and the nature of all compensation that it, or its affiliates or promoters, have received (or will receive) in connection with any de-SPAC transaction); (ii) potential conflicts of interest (including related to the contingent nature of the sponsor's compensation, the sponsor's involvement with other SPACs, and the fact that the SPAC's officers/directors may have competing responsibilities with the sponsor or other companies); (iii) the potential for dilution (including resulting from shareholder redemptions, sponsor compensation, underwriting fees, warrants and convertible securities, and PIPE offerings); and (iv) the reasons for the specific de-SPAC transaction, the fairness to investors of that transaction and any related financing transactions, and any reports/appraisals from outside parties related to the fairness of the transaction (i.e., fairness opinions). While the SEC acknowledged that many SPACs already provide some of this information in their disclosures, it stated that codifying and amplifying existing disclosure practices would help ensure that investors are able to make informed investment decisions.
- Target Companies as Co-Registrants: The proposed rules would amend the registration statement forms used for de-SPAC transactions to treat the SPAC's private company target as a co-registrant for purposes of the de-SPAC transaction, such that the target company and its signing persons (e.g., the target's principal executive officer, principal financial officer, principal accounting officer, and board members), would be subject to liability for material misstatements and omissions in the registration statement under Section 11 of the Securities Act of 1933.
- Underwriter/Gatekeeper Liability: The SEC's proposal would add a new rule (Rule 140a) that would deem anyone who has acted as an underwriter of securities in a SPAC IPO and who takes steps to facilitate the subsequent de-SPAC transaction (or any related financing) to be an underwriter of the de-SPAC transaction. According to the SEC, this rule would incentivize underwriters to help ensure the accuracy of disclosures related to de-SPAC transactions, and thereby protect the investing public.
- PSLRA Safe Harbor for Forward-Looking Statements: The SEC's proposal would revise the definition of "blank check company" in Rule 419 under the Securities Act to include SPACs, and thereby make clear that SPACs cannot rely on the safe harbor for forward-looking statements created by the Private Securities Litigation Reform Act of 1995 ("PSLRA") in their de-SPAC disclosures. The SEC stated that it sees "no reason to treat forward-looking statements made in connection with de-SPAC transactions differently than forward-looking statements made in traditional initial public offerings," and emphasized that SPACs should not get a free pass to make overly optimistic projections in their de-SPAC-related disclosures.
- Investment Company Act Safe Harbor: The SEC's proposal would add new Rule 3a-10 (the "SPAC ICA Safe Harbor") that would exclude SPACs from the definition of an "investment company" in Section 3(a)(1)(A) of the Investment Company Act of 1940 ("ICA") if they satisfy certain requirements, including: (i) the SPAC's assets must consist solely of Government securities, Government money market funds and cash items prior to completing its de-SPAC transaction (and those assets may not be acquired or disposed of for the primary purpose of recognizing gains or decreasing losses); (ii) the SPAC must only seek to complete a single de-SPAC transaction in which the surviving entity would be engaged in the business of the target(s); (iii) the SPAC must be primarily engaged in the business of seeking to complete a de-SPAC transaction; and (iv) the SPAC would have to announce an agreement to enter into a de-SPAC transaction within 18 months of the effective date of its IPO registration statement, and complete the de-SPAC transaction with 24 months of that effective date. Notably, the SPAC ICA Safe Harbor would not provide relief from the definition of "investment company" in Section 3(a)(1)(C) of the ICA. Thus, SPACs would still need to be careful to avoid qualifying as an "investment company" under Section 3(a)(1)(C).
Four Key Takeaways
- If adopted, the SEC's proposed rules would require SPAC participants to include a substantial amount of additional information in their IPO and de-SPAC-related disclosures. While the new required disclosures would be voluminous, the proposed rules would nonetheless provide SPAC participants with clarity on the types of information that should be disclosed.
- The SEC's proposals to treat SPAC targets as a co-registrants of de-SPAC registration statements, to deem underwriters of SPAC IPOs as underwriters of de-SPAC transactions, and to remove the protection provided by the PSLRA safe harbor for forward looking statements, would all increase the liability risk for participants in de-SPAC transactions. These changes —which are designed to place de-SPAC transactions and traditional IPOs on a level playing field —seem likely to reduce overall SPAC activity and to increase the costs associated with de-SPAC transactions.
- The SEC's proposed rules would provide useful guidance to SPAC sponsors on how they can structure their SPACs to avoid having to register as investment companies, and thereby avoid liability for the types of Investment Company Act "status" claims that were first asserted against a few SPACs in 2021.
- Market participants have until 30 days after publication in the Federal Register or May 31 (whichever is later) to comment on the SEC's new proposed rules, and provide the SEC with feedback on whether the new rules are a necessary or appropriate way to address concerns generated by the SPAC surge.
