SEC Finalizes Rules Relating to SPACs, Shell Companies, and De-SPAC Transactions
POMERANTZ MONITOR | MARCH APRIL 2024
On January 24, 2024, the U.S. Securities and Exchange Commission (“SEC”) adopted new rules and guidance that affect Special Purpose Acquisition Companies (“SPACs”) and offerings in which SPACs acquire and merge with private company targets (“de-SPACs”). The rules were initially proposed in March 2022 and were followed by a comment period. Approval was granted via a 3-2 vote, with two commissioners making statements in dissent. The rules a set to become effective July 1, 2024. The rules aim to enhance investor protection, including increasing disclosure requirements in connection with SPAC offerings, as well as to explicitly align SPAC offerings with traditional IPOs.
SPACs, also known as “shell” or “blank check” companies, are development-stage companies that have no operations of their own, apart from seeking private companies, known as “target companies,” with which to engage in a merger or acquisition to take the target public. The SPAC first has gone public via its own IPO. Once the merger between the SPAC and the target company is complete, the target, or operating company, is the sole surviving entity, and it transitions to a public company. This transaction and IPO with the target company is called a de-SPAC, since the SPAC essentially ceases to exist in the process.
SPAC IPOs have surged in popularity in recent years. In 2021, the United States saw a whopping 613 SPAC IPOs, representing 59% of all IPOs that year. SPACs have often relied on celebrity backing to boost their popularity: for example, Shaquille O’Neal advised a SPAC for Beachbody; Peyton Manning, Andre Agassi, and Steffi Graf invested in a SPAC for Evolv Technology; Jay-Z invested in The Parent Co.; Serena Williams served on the board of directors of Jaws Spitfire Acquisition Corp.; Alex Rodriguez is CEO of Slam Corp., and former Speaker of the House Paul Ryan served as Chairman of Executive Network Partnering Corp. Much like their concern with celebrity-backed crypto investments, regulators have been anxious about retail investors’ vulnerability to being misled by a famous name backing a blank check company offering. Although SPACs have subsided somewhat in popularity since their peak in 2021, SPAC IPOs remain in the news, with Trump Media Technology Group going public via de-SPAC on March 26, 2024 under the ticker “DWAC.” SPAC IPOs still accounted for 43% of IPOs in 2023.
Many have raised concerns that the SPAC structure lacks investor disclosure and transparency policies that serve as investor protections under the Investment Company Act. This means that SPAC investors lack protections that are typical in traditional IPOs, which leaves SPAC retail investors vulnerable to being misled. However, critics of the new rules, including dissenting commissioner Mark Uyeda, have pointed out that SPACs now require disclosures in excess of equivalent M&A transactions.
Given the attention and lure to retail investors, regulators will continue to focus on this means of IPO, and these new rules will shape the disclosure requirements for SPACs and de-SPACs. The SEC’s new rules set out to enhance disclosure requirements and provide guidance on the use of forward-looking statements with respect to SPACs, SPAC IPOs, blank check companies, and de-SPAC transactions. Specifically, the new rules provide that the Private Securities Litigation Reform Act (“PSLRA”) safe harbor is not applicable to de-SPAC transactions, which now explicitly aligns de-SPAC offerings with traditional IPOs. In his statement on January 24, SEC Chair Gary Gensler noted that “investors are harmed when parties engaged in a de-SPAC transaction over-promise future results regarding the target company”—something that investors regularly have suffered, as forecasted results have by and large not panned out. Although the PSLRA safe harbor is explicitly not applicable, other safe harbors, such as the “bespeaks caution” doctrine, which is judicial as opposed to statutory, may still apply. However, this new rule may tamp down on the amount and frequency of overly rosy projections in de-SPAC offerings.
The rules also address issuer obligations and liabilities for de-SPAC IPOs, including requiring that SPAC target officers sign the de-SPAC registration statements, which make them liable for misleading statements. The rules also include a new provision, Rule 145a, which makes the issuer a registrant under the Securities Act.
The final rules require disclosures from issuing companies at both the SPAC blank check stage and the de-SPAC stage regarding conflicts of interests, dilution risks, and the target company operations. Regarding dilution, the rules require detailed disclosure concerning material potential sources of additional dilution that non-redeeming SPAC shareholders may experience at different phases of the SPAC lifecycle, including the potentially dilutive impact of the securities-based compensation and securities issued to the SPAC sponsor, its affiliates, and promoters; any material financing transactions after the SPAC’s IPO, or financing that will occur in connection with the de-SPAC transaction closing; and redemptions by other SPAC shareholders.
The rules further require additional disclosure about the SPAC sponsor, its affiliates, and any promoters, including their experience, material roles and responsibilities, and the nature and amount of all compensation of these parties. SPAC sponsors will be required to disclose the circumstances or arrangements under which the SPAC sponsor, its affiliates, and promoters have or could transfer ownership of any of the SPAC’s securities. The rules also require the identification of the controlling persons of the SPAC sponsor and any persons who have direct or indirect material interests in the SPAC sponsor and the material terms of any “lock-up” arrangements for the SPAC sponsor and its affiliates. SPAC IPOs and de-SPAC IPOs will also be required to state in the prospectus cover pages the SPAC’s timeframe to complete a de-SPAC, redemption rights, and the SPAC sponsor’s compensation.
The SEC declined to adopt Rule 140a, which had been included in the proposed rules in March 2022. This would have clarified that anyone who acts as an underwriter in a SPAC IPO and participates in the distribution associated with a de-SPAC is engaged in the distribution of the surviving public entity’s securities. Such a person or entity, therefore, would be construed as an “underwriter” within the meaning of Section 2(a)(11) of the Securities Act. Under Section 11 of the Securities Act, underwriters can be liable for misstatements in registration statements, which incentivizes them to perform careful due diligence. Although this rule was not adopted, the SEC explained in the Final Release that it believes “the statutory definition of underwriter, itself, encompasses any person who sells for the issuer or participates in a distribution associated with a de-SPAC transaction,” and therefore construes anyone involved in the distribution within a de-SPAC to fall within the meaning of Section 2(a)(11) of the Securities Act.
Under these rules, SPAC target companies that are not subject to the reporting requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 will be required to make non-financial disclosures that are included in a traditional IPO, including: (i) Item 101 (description of the business); (ii) Item 102 (description of property); (iii) Item 103 (legal proceedings); (iv) Item 304 (changes in and disagreements with accountants on accounting and financial disclosure); (v) Item 403 (security ownership of certain beneficial owners and management, assuming completion of the de-SPAC transaction and any related financing transaction); and (vi) Item 701 (recent sales of unregistered securities).
Overall, these rules aim to reduce the differences between de-SPAC offerings and traditional IPOs that led to SPAC investors being less robustly protected. Companies should be mindful of these new rules, while investors can now make use of their enhanced protections when choosing to invest in a SPAC, vote on a merger, redeem or not redeem shares in a de-SPAC, or invest in a de-SPAC offering. The new regulations mean that due diligence processes in advance of de-SPAC offerings will likely take longer, and that investors will have more protections, both in terms of the robustness of disclosures and legal options should the prices decline.