The Special Purpose Acquisition Company (“SPAC”) market is facing both a new set of rules and amendments to rules already in place under the Securities Act of 1933 and Securities Exchange Act of 1934. Last month, the U.S. Securities and Exchange Commission (“SEC”) proposed rules in response to what it called an “unprecedented” surge in non-traditional IPOs by SPACs. Though the use of SPACs first became common in the 1990s, they have become far more popular in the last few years. The increased use of SPACs has largely been due to extreme market volatility caused, in part, by the pandemic. The substantial uptick in the use of SPACs has spurred growing concerns. The SEC, in announcing its proposals, cited to a number of concerns and criticisms about various aspects of the SPAC market, such as conflicts of interest, questionable sponsor compensation, inadequate and often incomplete and unreliable disclosures, poor investor returns, and lack of robust due diligence. Through the proposed rules, the SEC seeks “greater transparency and more robust investor protections [that] could assist investors in evaluating and making investment, voting, and redemption decisions with respect to these transactions.”
SPACs are typically shell companies with nominal or no assets, organized for the purpose of merging with or acquiring one or more unidentified private operating companies (a “de-SPAC transaction”) within a certain time frame, which is often two years. Typically, SPACs’ only assets are the money raised in the SPAC’s initial public offering. Investors who participate in the IPO do not know the identity of the target company to be acquired. Once the SPAC raises capital, the money goes into an interest-bearing trust account until the SPAC finds a private company looking to go public through an acquisition. When the acquisition occurs, the investors have the option of either swapping their SPAC shares for shares of the merged company or redeeming their SPAC shares, in which case they would receive back their original investment, plus accrued interest.
The most significant rules from the SEC’s proposal are as follows:
- Disclosure Requirements. The rules would require additional disclosures to investors, within a certain time period, about the SPAC’s sponsor, potential conflicts of interest, and dilution, and additional disclosures on de-SPAC transactions. Notably, each SPAC will be required to state “(1) whether it reasonably believes that the de-SPAC transaction and any related financing transaction are fair or unfair to investors, and (2) whether it has received any outside report, opinion, or appraisal relating to the fairness of the transaction.” The SEC would also require certain disclosures on the prospectus cover page and in the prospectus summary of registration statements filed in connection with SPAC initial public offerings and de-SPAC transactions.
- Underwriter Liability. The rules would impose greater liability on underwriters, and would expand the pool of underwriters subject to liability by deeming anyone who has (1) acted as an underwriter of the securities of a SPAC, (2) taken steps to facilitate a de-SPAC transaction or any related financing transaction, or (3) otherwise participated (directly or indirectly) in the de-SPAC transaction, to be an underwriter within the meaning of Section 2(a)(11) of the Securities Act. The SEC’s goal is to “better motivate SPAC underwriters to exercise the care necessary to ensure the accuracy of the disclosure in these transactions by affirming that they are subject to Section 11 liability for that information.”
- More Securities Act Protections Concerning Business Combinations Involving SPACs. The rules also would deem any business combination transaction involving a reporting shell company, including a SPAC, that involve a sale of securities to the reporting shell company’s shareholders. Moreover, the SEC proposes to amend a number of financial statement requirements applicable to transactions involving shell companies. These rules would, among other things, require financial statement reporting requirements in business combinations that are more in line with requirements for traditional IPOs.
- Projections. One of the proposed rules would update the SEC’s guidance regarding the use of projections in Commission filings, as well as to require additional disclosure regarding projections when used in connection with business combination transactions involving SPACs.
- Target Acquisition as Co-Registrant. The rules would require that the target acquisition be a co-registrant when a SPAC files a registration statement on Form S-4 or Form F-4 for a de-SPAC transaction. These measures are intended to improve reliability of the disclosures provided to investors in the de-SPAC transaction by ensuring the target acquisition’s directors and officers are held accountable to investors thereby making them liable for disclosures in the registration statement.
- Safe Harbor under the Investment Company Act of 1940. The SEC is proposing a new safe harbor under this Act which would provide that a SPAC that satisfies the conditions of the proposed rule would not be an investment company and therefore would not be subject to regulation under that Act. These conditions include: (1) the SPAC must announce a business combination within 18 months and complete the transaction within 24 months of its IPO; (2) the SPAC’s assets must only consist of government securities or funds; (3) the SPAC’s activities must be limited to one de-SPAC transaction in which the surviving entity will be primarily engaged in the business of the target company and have a class of securities registered; and (4) the SPAC’s employees, officers and directors must be engaged in the business of the target company.
One commissioner, Hester M. Peirce, dissented to the proposal, arguing that these rules seem designed to stop SPACs in their tracks. The dissent reflects concern among many market participants that these rules, if adopted, would chill SPAC activity. However the contemplated rules, and the other commissioners who support them, manifests a substantial countervailing concern that SPACs have proliferated because of the absence of meaningful oversight, and that their more widespread use has too often led to significant losses for investors.
The SEC is currently receiving and reviewing comments on the proposed new rules.