SEC Releases Proposed Rules for Special Purpose Acquisition Companies (“SPACs”)
On March 30, 2022, the commissioners of the Securities and Exchange Commission (“SEC”), in a 3-to-1 decision approved the much anticipated proposed rules relating to special purpose acquisition companies (“SPACs”). An SEC “Fact Sheet” on the proposed rules is available here, and the proposed rules are available here. The proposed rules cover the following topics:
- Enhancing Disclosure and Investor Protection
- Revising the Registration Requirements for De-SPAC Transactions
- Projections Disclosure
- Status of SPACs under the Investment Company Act of 1940
Below are our preliminary thoughts on the proposed rules. We intend to follow with a more complete analysis after we have an opportunity to review the proposed rules.
Companies that want to raise concerns or provide information to support or flag issues with the proposed rules have until May 31, 2022 to provide written comments to the SEC.
Enhancing Disclosure and Investor Protection
The enhanced disclosure topics covered in the proposed rules include the following items:
- “Enhanced disclosures regarding, among other things, SPAC sponsors, conflicts of interest, and dilution.” In our view, this will likely simply codify existing disclosure practices of the last several years, including disclosure added in response to recent SEC comments. Any new disclosure would likely be basic mathematic additions and tables.
- “Additional disclosures on de-SPAC transactions, including with respect to the fairness of the transactions to the SPAC investors.” Disclosure with respect to fairness (of the De-SPAC and any related financing) would be new, and potentially similar to the requirement of fairness disclosure in connection with tender offers. However, in light of the fiduciary duties applicable to SPACs and their directors, we believe this change will not be a substantive change to disclosure or liability existing before the rules.
- “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.” This will expand Exchange Act liability for material misstatements and omissions in the S-4 or F-4 to the target and its directors who sign the registration statement, in addition to exposure under the Exchange Act. In our view, this may not be a substantive expansion. Post De-SPAC, the target company will have merged with or been acquired by the SPAC, and have effectively assumed any securities law liability the SPAC incurred. Moreover, in many De-SPAC transactions, the target company or its affiliate already serves as the registrant, with tax consequences driving the structure more than liability concerns. Finally, the target company and its directors and officers already have practically the same exposure, as they are participating in the proxy solicitation by the SPAC, as seen in recent SEC settlements involving material misstatements or omissions by target companies that are repeated by SPACs.
- “A re-determination of smaller reporting company status within four days following the consummation of a de-SPAC transaction.” Substantively, smaller reporting company (“SRC”) status allows target companies to avail themselves of reduced disclosure obligations, notably with respect to financial statements. This is important, as target companies in De-SPAC transactions do not qualify as emerging growth companies (“EGC”) like they would in an initial public offering (“IPO”). In our view, the proposed change could be potentially problematic for companies that may be above or below the smaller reporting company thresholds depending on stock price post closing, as it could provide uncertainty about disclosure that may be required promptly after the De-SPAC transaction and not provide sufficient time to plan for and prepare that disclosure.
- “An amended definition of “blank check company” to make the liability safe harbor in the Private Securities Litigation Reform Act of 1995 for forward-looking statements, such as projections, unavailable in filings by SPACs and certain other blank check companies.” We view this as unlikely to alone impact the decision of whether or not to disclose projections in De-SPAC transactions. However, when combined with the proposed expansion of underwriter liability described below, this may have a chilling effect on the use of projections in connection with De-SPAC transactions.
- “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.” This would be a major substantive change, and may have a chilling effect on the willingness of underwriters to participate in SPAC IPOs and De-SPAC transactions, or, as noted by one of the SEC commissioners, may prompt them to reconfigure their role and compensation in De-SPAC transactions in an attempt to avoid this designation.
Revising the Registration Requirements for De-SPAC Transactions
With respect to the De-SPAC transaction, the proposed rule 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.” This will likely require a Form S-4 or Form F-4 for any De-SPAC transaction, rather than merely a proxy statement, where the SPAC survives as the public company and the issuance of securities to the target stockholders can be accomplished in a private placement. In our view, this will not be a substantive change. Structuring considerations other than securities laws often require that the target company or one of its newly formed subsidiaries serve as the resulting company, which requires a registration statement for the offering of securities to the public stockholders. Moreover, the SPAC has substantively identical obligations for misstatements or omissions in a proxy statement as in a registration statement.
- “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.” The target company financials are already required to be audited by the Public Company Accounting Oversight Board per SEC policy (but not rule). To the extent the proposed rules reduce the number of years of audited financials from three to two for target companies that would constitute EGCs, this would be a welcome change.
The SEC is proposing to “expand and update the Commission’s guidance on the presentation of projections of future economic performance in Commission filings to allow investors to better assess the reliability of the projections and whether they have a reasonable basis.”
Status of SPACs under the Investment Company Act of 1940
The SEC is proposing a new Rule 3a-10 under the Investment Company Act of 1940 that would establish a safe harbor from investment company act status for SPACs so long as certain conditions are met. Those conditions include:
- “Maintain assets comprising only cash items, government securities, and certain money market funds.” SPACs already operate in this manner.
- “Seek to complete a de-SPAC transaction after which the surviving entity will be primarily engaged in the business of the target company.” This is effectively what almost every SPAC already does.
- “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.” This would shorten the investment horizon of certain SPACs with 24 month signing targets, and limit the ability of SPACs to seek extensions of their outside dates. In our view this should be eliminated, or lengthened to the 36 month time horizon specified in national securities exchange rules.
What Happens Next?
The SEC will accept written comments from members of the public through May 31, 2022. These comments will form part of the “administrative record” that serves as the basis for the SEC’s decision to issue any final rule. Filing comments is an important way to raise specific concerns with the proposal or to provide support for aspects of the proposal. The SEC is required to review and consider these comments before finalizing a rule, and comments can result in changes to a proposal. Even when the comments don’t result in changes to a rule, they are important because of the role they play in the almost-inevitable legal challenges to any final rule. Comment letters are part of the body of evidence (i.e., the “administrative record”) that the court considers when evaluating the SEC’s decision, and courts generally won’t allow an argument to be raised in court unless it was already raised in a public comment. Providing information that supports or critiques the SEC’s proposal can therefore play an important role in whether a court ultimately upholds the SEC’s rule.
We expect to see a final rule by the end of the year. Any final rule will include an “effective date” that will trigger the rule’s requirements. Court challenges will likely be filed as soon as the SEC issues any final rule, and may impact the effective date of the rule because courts have the power to “stay” or pause a rule’s effective date during the case, or once the case is completed.
We welcome the SEC’s attempt to improve its rules and to rationalize them for SPACs and De-SPAC transactions and look forward to commenting on the proposed rules themselves.
This information is provided by Vinson & Elkins LLP for educational and informational purposes only and is not intended, nor should it be construed, as legal advice.