Five Key Takeaways From The SEC’s Evolving Response To The SPAC Boom | Morrison & Foerster LLP
9 min readOver the past year, the use of Special Purpose Acquisition Companies, or SPACs, to go public has skyrocketed.[1] As The Wall Street Journal explained, “With interest rates on the floor and investors chasing young companies, this is a dream scenario for SPACs.”[2] As the SPAC boom continues, it is important to understand that SEC guidance on SPACs is evolving. The SEC’s statements on SPACs have quickly progressed from a short bulletin educating investors on using SPAC vehicles to take companies public, to specific guidance strongly implying that the SEC staff is carefully scrutinizing disclosures related to SPAC transactions.[3] Indeed, the SEC’s recent guidance identifies specific disclosure areas that SEC staff will focus on and likely provides a roadmap for both future SEC enforcement and the plaintiffs’ bar.
The Basics: What Is a SPAC?
SPACs have exploded in popularity—and have caught the SEC’s attention—because the SPAC lifecycle allows a private company to go public and raise cash more quickly than a traditional IPO. A SPAC is a shell company that is created, or sponsored, by investors to raise money through an IPO to acquire a private company (the so-called “target”). The SPAC offers its securities to investors via an IPO and puts the cash raised into a trust account to fund the purchase of a target company. SPACs typically have 24 months to complete an initial business combination with a target company.[4] In the event of a successful business combination, the target merges with the SPAC in a “de-SPACing transaction” and the target becomes a public company. After the de-SPACing transaction, the newly created public company must meet SEC and stock exchange public company reporting requirements, including those that impose robust financial reporting, disclosure, and governance requirements.
Potential SPAC Enforcement and Litigation Risks: The SEC’s SPAC Guidance Thus Far
December 2020: A Swift Progression from Basic SPAC Information to Specific Guidance on SPAC IPO-Related Disclosures
On December 10, 2020, the SEC issued an investor bulletin that provided basic information on the SPAC lifecycle and urged potential investors to carefully review the SPAC’s IPO prospectus and SEC filings.[5] Less than two weeks later, however, the SEC’s Division of Corporation Finance issued specific guidance highlighting the importance of clear disclosure of any conflicts of interest between the SPAC sponsor and other SPAC insiders on the one hand and public shareholders on the other.[6] The Division of Corporation Finance instructed SPAC sponsors, directors and officers, and other SPAC insiders to make clear and robust disclosures related to the IPO, including all conflicts of interest, fiduciary and contractual obligations to other entities, interests in potential target companies, and financial considerations such as the price paid for the securities and incentives to complete the business combination transaction. The Division of Corporation Finance also urged disclosures related to how the target company was selected and the fees that third parties, like underwriters, would receive.
March 2021: the SEC Specifies Public Company Reporting and Listing Requirements for SPACs and Accounting Considerations for Targets
On March 31, 2021, the Division of Corporation Finance and the Acting Chief Accountant Paul Munter each issued specific guidance evidencing a continued SPAC focus.[7] (Previously, the SEC’s most direct SPAC-related warnings came on March 10, 2021, when the Division of Corporation Finance staff warned investors not to invest in SPACs based solely on a celebrity’s endorsement.)[8] The Division of Corporation Finance addressed restrictions on shell companies applicable to SPACs, identified books and records and internal controls requirements applicable before the business combination, and initial listing standards applicable to companies listed on national securities exchanges, such as the New York Stock Exchange or Nasdaq.[9] Munter, in turn, recognized that “where target companies often encounter complex issues is in the accounting for and reporting of its merger with the SPAC.”[10] In addition to pointing out accounting considerations for the de-SPAC transaction, Munter also flagged issues to consider regarding internal controls, audits, and corporate governance applicable to the merger between the target and the SPAC.
April 2021: the Acting Director of the Division of Corporation Finance Likens the De-SPAC Transaction to a “Real IPO”
On April 8, 2021, John Coates, the Acting Director of the Division of Corporation Finance, followed up with perhaps the most important SEC statement to date, signaling that the SEC would apply the same level of scrutiny to de-SPAC-related disclosures as it would to traditional IPO disclosures.[11] Coates warned that the SEC staff was “continuing to look carefully at filings and disclosures by SPACs and their targets.” Interestingly, Coates “focus[ed] on legal liability that attaches to disclosures in the de-SPAC transaction.” He challenged the view that SPACs are subject to lesser securities law liability than traditional IPOs, warning that the Division of Corporation Finance staff would focus on the de-SPAC transaction as the “real IPO” and apply the “full panoply of federal securities law protections.”
Coates’ statement could serve as a harbinger for SEC enforcement activity and private securities litigation in the months and years ahead. With respect to the de-SPAC transaction, Coates stressed that (1) both Section 11 of the Securities Act of 1933 and Section 14(a) of the Securities Exchange Act of 1934, and Rule 14a-9 thereunder, apply to material misstatements and omissions in registration statements and proxy solicitations, respectively; (2) the Private Securities Litigation Reform Act, or PSLRA, safe harbor will not prevent SEC enforcement action; and (3) state law, particularly that of Delaware, may require disclosure of projections used in connection with the de-SPAC. Coates also questioned whether, in private securities lawsuits, the PSLRA safe harbor would apply to misleading disclosures made by the newly combined company post-de-SPAC. He bluntly warned: “Any simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst.”
Coates teamed up with Munter on April 12, 2021 to issue the SEC’s most recent SPAC statement, this time focusing on potential accounting implications of terms that may be common to warrants issued as part of the units sold in SPAC IPOs.[12] They cautioned that the accounting for warrants requires careful consideration of the specific facts and circumstances for each entity and each contract, and linked specific applicable accounting standards. This statement could indicate that, in addition to focusing on disclosures made during the SPAC process, SEC enforcement is gearing up for investigations focused on SPAC-related accounting.
So What Is a SPAC to Do? Five Key Takeaways
- Pay Careful Attention to Disclosures of Conflicts of Interest
The thread that ties the SEC’s SPAC statements together is that the agency views disclosure of conflicts of interest as vital. Analyzing and disclosing the different economic and business interests of each SPAC participant—from SPAC insiders like the sponsors and management team, to the IPO’s public shareholders, to third parties like underwriters—at each stage of the SPAC lifecycle is critical to litigation and enforcement risk mitigation. Indeed, Coates appears to have signaled his view that the SPAC structure itself has potential conflicts of interest that, without proper mitigation and/or disclosure, may be a source of liability risk under the federal and state securities laws.
- Ensure the SPAC Meets SEC Shell Company and Stock Exchange Listing Requirements
The March 31, 2021 Division of Corporation Finance guidance makes it clear that SPAC management teams must be aware of shell company restrictions and SEC filing requirements, books and records and internal controls requirements, and initial listing standards of the national securities exchanges, such as the New York Stock Exchange and Nasdaq. Given that the SPAC is a newly created shell with no operating history, strictly following these requirements can be an efficient way to mitigate litigation risk.
- Approach De-SPAC Disclosures Like Traditional IPO Disclosures
Coates’ April 8, 2021 statement could not be clearer that, as Acting Director of the Division of Corporation Finance, he views the de-SPAC transaction as the “real IPO” and expects robust de-SPAC disclosures. In addition to focusing on disclosures related to conflicts of interest, it will be prudent to ensure that the target company’s financial statements and internal controls over financial reporting meet all SEC requirements. Working with legal, accounting, and financial advisors on de-SPAC disclosures will be key, as the target company actually has operations and an operating and financial history, unlike the newly created SPAC.
- Pay Attention to Accounting
Munter’s statements stress the importance of the combined public company having in place both the right people and processes to produce high quality financial reporting that meets SEC rules and regulations. His April 12, 2021 joint statement with Coates provides a guide for how to account for warrants. As many of these accounting considerations involve significant judgment, engaging and working closely with a top notch and independent public accounting firm is key.
- Analyze Litigation Risk at Each Stage of the SPAC Lifecycle
SPACs have the attention of the SEC. Coates’ April 8, 2021 statement is best viewed as a detailed road map for future SEC enforcement actions and private class actions (some of which have already been filed). Coates has signaled that the SEC staff will scrutinize disclosures at every stage of the SPAC’s lifecycle. Analyzing litigation and regulatory enforcement risk at each stage of the SPAC lifecycle can help SPAC participants prepare for, and potentially minimize the risk and expense of, regulatory scrutiny and lawsuits.
Mr. Martin is the firmwide Managing Partner at Morrison & Foerster LLP and is a former enforcement attorney at the SEC’s San Francisco Regional Office. Ms. Marlier and Mr. Birnbaum are partners at Morrison & Foerster LLP and are former Senior Trial Counsels at the SEC’s New York Regional Office.
[1] The amount of money raised by U.S.-listed SPAC initial public offerings, or IPOs, ballooned from 59 IPOs that raised $13.6 billion in 2019, to 248 IPOS that raised $83.4 billion in 2020, to 308 IPOs that raised $100 billion in just the first 3.5 months of 2021 alone. As of the writing of this article, there are around 560 active SPACs holding over $180 billion in trust. https://www.spacresearch.com/.
[3] While recent pronouncements reflect staff views, and not any official rulemaking by the Commission, these statements from senior officials offer a good window into how the staff is analyzing and potentially investigating the SPAC space.
[4] If the SPAC doesn’t complete an initial business combination with a target by the deadline (subject to certain extensions), the trust is liquidated and the proceeds raised via IPO plus interest are returned to the SPAC shareholders.
[6] https://www.sec.gov/corpfin/disclosure-special-purpose-acquisition-companies. For example, the SPAC sponsors who create the SPAC invest on different terms than public shareholders. The sponsors typically own 20{14cc2b5881a050199a960a1a3483042b446231310e72f0dc471a7a1eddd6b0c3} of the common equity in the SPAC upon completion of the IPO, and will have a 20{14cc2b5881a050199a960a1a3483042b446231310e72f0dc471a7a1eddd6b0c3} stake in the final merged company.
[7] https://www.sec.gov/news/public-statement/division-cf-spac-2021-03-31; https://www.sec.gov/news/public-statement/munter-spac-20200331.
[8] https://www.sec.gov/oiea/investor-alerts-and-bulletins/celebrity-involvement-spacs-investor-alert.
[9] https://www.sec.gov/news/public-statement/division-cf-spac-2021-03-31.
[10] https://www.sec.gov/news/public-statement/munter-spac-20200331.
[11] https://www.sec.gov/news/public-statement/spacs-ipos-liability-risk-under-securities-laws.
[12] SPAC IPO investors generally acquire units, each of which is comprised of one share of common stock and a fraction of a warrant. A full warrant gives the holder the right to buy one share of additional common stock at $11.50 per share (representing a price premium compared to the $10 per unit price at the time the units are issued in the IPO). SPAC sponsors also purchase warrants that generally have the same terms as the warrants included in the units issued in the IPO.
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