The SPAC Market Changes due to the SEC’s Rule Proposal

The SEC is willing to put what it perceives to be a needed damper on the recent explosion of SPAC offerings that reversed what had been a long-term trend away from IPO’s and new company listings on the American exchanges...

The SEC is willing to put what it perceives to be a needed damper on the recent explosion of SPAC offerings that reversed what had been a long-term trend away from IPO’s and new company listings on the American exchanges. The newly proposed rules for SPAC IPO’s, de-SPAC disclosure practices and broadened liabilities, if enacted as proposed, will likely lead to meaningful changes in how these offerings and transactions are structured, disclosed and, when a failure occurs, in who gets sued.  Investment bankers see this as an effort to increase their duties and potential liabilities. The success in capital raising through SPAC offerings creating a ready pool of cash for worthy companies that might otherwise have sought an IPO is now the focus for greater regulation, given the examples of excess and the perceived need to protect retail investors.     

On March 30, 2022, the Securities and Exchange Commission (SEC) proposed new rules for initial public offerings by special purpose acquisition companies (SPACs), as well as business combinations involving SPACs and private operating companies. The new rules, which are intended to enhance investor protection, establish new disclosure requirements for SPACs; align the legal requirements for business combination transactions involving shell companies with those of traditional IPOs; amend the SEC’s guidance regarding the use of projections in SEC filings; and create a new safe harbor for SPACs under the Investment Company Act.

The SEC rule proposal reflects the rapid growth of the SPAC market, as well as the SEC’s concerns that investor protection is lacking. “Ultimately, I think it’s important to consider the economic drivers of SPACs. Functionally, the SPAC target IPO is being used as an alternative means to conduct an IPO,” SEC Chair Gary Gensler said in a press statement. “Thus, investors 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.”

Key Provisions of the SEC’s SPAC Rule Proposal

The changes that the SEC is proposing are significant and would greatly increase the compliance burdens associated with SPAC IPOs, as well as mergers between publicly-traded SPACs and private operating companies (known as “de-SPAC transactions”). Below are some of the most notable proposed changes:

New Disclosure Requirements for SPAC IPOs and De-SPAC Transactions

The SEC is proposing to add new Subpart 1600 to Regulation S-K to set forth specialized disclosure requirements applicable to SPACs regarding the sponsor, potential conflicts of interest, and dilution, and to require certain disclosures on the prospectus cover page and in the prospectus summary. Proposed Subpart 1600 would also require enhanced disclosure for de-SPAC transactions, including a fairness determination requirement.

The SEC is also proposing:

• A requirement that the private operating company would be a co-registrant when a SPAC files a registration statement on Form S-4 or Form F-4 for a de-SPAC transaction;
• A re-determination of smaller reporting company status within four days following the consummation of a de-SPAC transaction;
• An amended definition of “blank check company” to make the liability safe harbor in the Private Securities Litigation Reform Act of 1995 (PLSRA) for forward-looking statements, such as projections, unavailable in filings by SPACs and certain other blank check companies; and
• A rule that deems underwriters in a SPAC initial public offering to be underwriters in a subsequent de-SPAC transaction when certain conditions are met.

Alignment of De-SPAC Transactions With IPOs

Citing that it is likely that a significant proportion of companies in the coming years that enter the U.S. public securities markets will do so through de-SPAC transactions, the SEC is looking to align de-SPAC transactions with IPOs. The proposed rules applicable to business combination transactions involving shell companies, including SPACs, would:

• Deem by rule that a business combination transaction involving a reporting shell company and another entity that is not a shell company constitutes a sale of securities to the reporting shell company’s shareholders for purposes of the Securities Act; and
• Better align the required financial statements of private operating companies in transactions involving shell companies with those required in registration statements for initial public offerings.

Use of Projections in SEC Filings

According to the SEC, the surge in SPAC IPOs has renewed concerns about the use of projections, particularly with respect to business combination transactions in which projections about private operating companies may lack a reasonable basis. The proposed amendments to Item 10(b) of Regulation S-K would expand and update the SEC’s guidance on the presentation of projections of future economic performance in SEC filings to allow investors to better assess the reliability of the projections and whether they have a reasonable basis. The SEC is proposing additional disclosure requirements to allow investors to better assess the basis of projections when they are used in SPAC business combination transactions.

New Safe Harbor for SPACs Under the Investment Company Act of 1940

The SEC is proposing a new safe harbor under the Investment Company Act of 1940 that 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 the Act. The proposed conditions include, among other things, that a SPAC must:

• Maintain assets comprising only cash items, government securities, and certain money market funds;
• Seek to complete a de-SPAC transaction after which the surviving entity will be primarily engaged in the business of the target company; and
• Enter into an agreement with a target company to engage in a de-SPAC transaction within 18 months after its initial public offering and complete its de-SPAC transaction within 24 months of such offering.

While a SPAC would not be required to rely on the proposed rule, the proposed conditions are intended to align with the structures and practices that the SEC preliminarily believes would distinguish a SPAC that is likely to raise serious questions as to its status as an investment company from one that does not.

What’s Next?

The public comment period will remain open for 60 days following publication of the proposing release on the SEC’s website (May 31, 2022) or 30 days following publication of the proposing release in the Federal Register, whichever period is longer. Given the extent of the changes proposed by the SEC, as well as its impact on the SPAC market, the agency is likely to be flooded with comments. The SEC will take the comments it receives into account when drafting its final rules, which may take time. We encourage impacted entities to check back for updates. It is hoped that, as a result of input received during the public comment period, the resultant rule changes will allow for a continued increase in this bedrock of the capitalist economy: investment in new and growing businesses. 

If you have questions, please contact us

If you have questions or if you would like to discuss the matter further, please contact me, Dan Brecher, or the Scarinci Hollenbeck attorney with whom you work, at 201-896-4100.