SEC Addresses Five Important Considerations For SPAC Business Combination Transactions – Corporate/Commercial Law

On March 31, 2021, the Securities and Exchange Commission (SEC)
provided public statements from Acting Chief Accountant Paul Munter and from
the Division of Corporation Finance addressing
Special Purpose Acquisition Companies (SPACs). Although each of the
statements were distinct and addressed different issues, the
primary focus of both was to raise awareness of critical
accounting, financial reporting and governance considerations that
a private operating company should carefully consider and address
prior to consummating a business combination with a SPAC.

SPACs are shell companies that raise capital through an initial
public offering (IPO) for the sole purpose of acquiring a privately
held operating company. The SPAC’s business combination with
the target is commonly referred to as the “de-SPAC”
transaction. As a result of the de-SPAC and related transactions,
the target company becomes a publicly listed company with
additional capital to pursue its corporate strategy and the SPAC
shareholders, who do not choose to redeem their shares, will own
shares of a publicly traded operating company. As Mr. Munter’s
statement notes, SPACs have been used for decades as a way for
private companies to enter the public markets, but they have
increased dramatically in popularity in recent months. In fact, as
of April 8, 2021, there have already been over 300 SPAC IPOs during
2021, as compared to around 60 and 250 SPAC IPOs during all of 2019
and 2020, respectively.

Statement from Paul Munter

Given the recent explosion in SPAC IPOs and the resulting
dramatic increase in de-SPAC transactions, it is worth carefully
reviewing the risks and challenges associated with de-SPAC
transactions. Mr. Munter’s statement identifies five categories
of key considerations related to a private company entering the
public market by merging with a SPAC:

• Market and timing considerations




• Financial reporting considerations




• Internal control considerations




• Corporate governance and audit committee considerations




• Auditor considerations.

Market and Timing Considerations

SPACs can bring private companies into the public markets more
quickly than a traditional IPO, but there can be risks associated
with speeding up the process. Mr. Munter notes that many SPAC
acquisition targets may be at an earlier stage in their development
compared to companies that pursue a traditional underwritten IPO.
For that reason, these businesses may not be as prepared to handle
the scope and intensity associated with the substantial increase in
regulatory requirements, attention from the press and analysts,
fluctuations in market value and increased liability risk.

Given the speed at which a target company becomes a publicly
listed issuer, it is essential that target companies have a
detailed plan in place to address these demands that aligns with
the accelerated timeline of a de-SPAC transaction. Prior to
consummating a de-SPAC transaction, target companies should
thoroughly evaluate the functions they have in place to meet SEC
filing, audit, tax, governance and investor needs following the
de-SPAC transaction. The combined company will need a capable,
experienced management team that understands public company
reporting and internal control requirements and expectations.

Financial Reporting Considerations

Target companies often encounter complex issues when accounting
for and reporting a merger with a SPAC. Given these accounting
complexities, the combined public company will need finance and
accounting professionals with substantial public company
experience, sufficient knowledge of the relevant reporting
requirements and adequate staffing to meet deadlines to file the
current and periodic reports required of public entities.
Particular issues that may require significant experience and good
judgment include:

• Whether financial statements should be prepared in accordance
  with U.S. Generally Accepted Accounting Principles (GAAP) or in
  accordance with International Financial Reporting Standards.




• Public company disclosure requirements.




• Identifying the entity in the merger that should be treated as
  the acquirer for accounting purposes.




• Accounting for earn-out or compensation arrangements and
  complex financial instruments.




• Applying GAAP standards to accounting and reversing
  previously-elected Private Company Council accounting alternatives
  available to private companies.




• Determining effective dates to adopt recent accounting
  standards that may allow a slower adoption timeline for private
  companies.

Internal Control Considerations

Public companies are generally required to maintain internal
control over financial reporting (ICFR) and disclosure controls and
procedures (DCP). Target companies must understand the ICFR and DCP
requirements and have a plan in place to comply with those
requirements on a timely basis after becoming public companies.
Management generally needs to conduct an annual evaluation of its
ICFR and is required to evaluate the effectiveness of a public
company’s DCP at the end of each fiscal quarter (or, in the
case of foreign private issuers, each fiscal year).

Corporate Governance and Audit Committee Considerations

It is crucial that boards have a clear understanding of their
members’ roles, responsibilities and fiduciary duties, and that
management understands its responsibilities for communicating and
interacting with the board. Composition of the board is always
crucial, but particularly so in the post-merger publicly traded
company. Generally, board members should possess the right level of
experience and they should be prepared for key committee
assignments, including to the audit committee. Additionally, a
portion of the board members must be independent from the
organization.

In his public statement, Mr. Munter noted that “[s]trong,
effective, active, knowledgeable, and independent audit committees
significantly further the collective goal of providing high
quality, reliable financial information to investors and our
markets.” Clear and effective communication between the audit
committee, auditor and management is crucial to setting
expectations and proactively reacting as reporting, control or
audit issues arise during and after the de-SPAC transaction
process. An audit committee made up of members with well-rounded
and relevant skills and backgrounds can only enhance such
communication.

Auditor Considerations

While historical audits of the target company may have been
performed under another standard, the target company’s annual
financial statements should be audited by a Public Company
Accounting Oversight Board (PCAOB) registered public accounting
firm in accordance with PCAOB standards and compliant with both
PCAOB and SEC independence requirements. With respect to
independence, the general standard applies to all periods included
in the registration statement. Under the general standard, an
auditor is not independent if he or she would be in a position of
auditing his or her own work or if he or she acts as management,
among other things.

Additionally, an auditor should consider whether the appropriate
acceptance and continuance procedures have taken place when a
formerly private target company intends to go public through a
de-SPAC transaction. The compressed timing and complexity of a
de-SPAC transaction may require the audit firm to adjust its
engagement team relative to a traditional IPO in order to ensure
the team has the appropriate level of expertise and experience with
SEC and PCAOB requirements.

Statement from the Division of Corporation Finance

Addressing similar topics to those discussed by Mr. Munter and
detailed above, the statement from the Division of Corporation
Finance focused on issues that stakeholders should carefully
consider in connection with the de-SPAC transaction, including:

• Shell company restrictions




• Books and records and internal controls requirements




• Initial listing standards of national securities
  exchanges.

Shell Company Restrictions

As shell companies, SPACs are subject to certain restrictions
under securities laws. Some restrictions that the Division of
Corporation Finance highlighted included the following:

• Within four business days of the consummation of the business
  combination, financial statements for the acquired business must be
  filed pursuant to Item 9.01(c) of Form 8-K. The 71-day extension
  that is typically available under Item 9.01 is not available to
  SPACs.




• The combined company cannot use Form S-8 to register
  compensatory securities offerings until at least 60 days after
  filing current Form 10 information, usually through a so-called
  “Super 8-K.”




• Until three years after completing the business combination,
  the combined company cannot, among other things:
  
  • Incorporate reports required by the Securities Exchange Act of
    1934 (the “Exchange Act”) or proxy or information
    statements filed pursuant to Section 14 of the Exchange Act, by
    reference on Form S-1.

  
  

  • Qualify as a well-known seasoned issuer.

  
  

  • Use a free writing prospectus.

  
  

  • Use a term sheet free writing prospectus.

  
  

  • Conduct a roadshow that constitutes a free writing prospectus,
    including electronic roadshows.

  
  

  • Rely on the safe harbor of Rule 163A from Securities Act
    Section 5(c) for pre-filing communications.

Books and Records and Internal Controls Requirements

In addition to the ICFR and DCP requirements that Mr. Munter
discussed in his public statement, the combined company will also
have to comply with the “books and records” provision of
the Exchange Act, which requires issuers to maintain books, records
and accounts in reasonable detail that accurately and fairly
reflect the issuer’s transactions and dispositions of its
assets.

The internal controls and books and records provisions apply to
SPACs before the de-SPAC transaction and also generally to the
combined company after the de-SPAC transaction. When planning a
de-SPAC transaction, the SPAC and the target private company should
consider these requirements because the target private company may
not have prior experience dealing with them and may not have the
appropriate resources allocated to doing so moving forward. Once
the de-SPAC transaction is consummated, the combined company will
need the necessary expertise, books and records and internal
controls to provide reasonable assurance that it will timely and
reliably file its financial reports.

Initial Listing Standards of National Securities Exchanges

To remain listed on a national securities exchange after the
de-SPAC transaction, the combined company must satisfy quantitative
and qualitative initial listing standards upon consummation of the
de-SPAC transaction. Any material risks associated with delisting
could trigger disclosure requirements for the combined company.

Quantitative standards require that the combined company meet
minimum standards regarding the number of round lot holders, the
number of publicly held shares, market value of publicly held
shares and share price.

Qualitative standards include requirements regarding having a
board of directors made up of a majority of independent directors,
an independent audit committee consisting of directors with
specialized experience, independent director oversight of executive
compensation and the director nomination process, and a code of
conduct applicable to all directors, officers and employees. A
target private company that has not prepared for an IPO and that is
quickly acquired by a SPAC may run the risk of not meeting these
standards. Advance planning may be required to assemble all of the
necessary elements.

Conclusion

As SPACs continue to increase in popularity and billions of
dollars flow into these vehicles each month, the SEC has increased
its focus on protecting investors in connection with SPAC IPOs and
de-SPAC transactions and has continued to take action to educate
investors with respect to critical SPAC investment considerations.
The statements discussed above follow the release in December 2020
of
disclosure guidance from the Division of Corporation Finance
discussing disclosure considerations for SPACs in connection with
their IPOs and subsequent de-SPAC transactions and an
investor alert from the SEC’s Office of Investor Education
and Advocacy (OIEA) seeking to educate investors about investing in
SPACs. In March, as celebrities increasingly engaged with SPACs,
the OIEA issued an additional
investor alert cautioning investors against making investment
decisions related to SPACs based solely on celebrity involvement.
We can expect more to come from the SEC as the SPAC market
continues to evolve.

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