POMERANTZ MONITOR | MAY JUNE 2022
By James M. LoPiano
By now, many investors are aware of that recently trending phenomenon, the Special Purpose Acquisition Company, or “SPAC” for short. However, investors may confuse going public via “de-SPAC” transactions, whereby a SPAC takes a private company public, as equivalent to traditional initial public offerings, or “IPOs.” Others may be unaware that SPACs first conduct their own IPO before taking other companies public.
IPOs and de-SPAC transactions are subject to very different rules, and holding SPACs, and companies formed by de-SPAC transactions (“de-SPAC companies”), accountable in connection with IPOs and de-SPAC transactions may prove more complicated than holding other companies accountable in connection with IPOs. Recognizing this, both Pomerantz and the SEC have been formulating their own ways to harmonize SPAC-related liabilities with traditional IPO liabilities.
Most investors are familiar with the idea of a “traditional” IPO, whereby a private company, supported by underwriters, satisfies certain conditions to begin publicly trading on a national securities exchange at a pre-determined initial offering price. For example, take a hypothetical private company called “XYZ Corp.” that conducts an IPO and thereby first begins publicly offering its shares to the public under the ticker symbol “XYZ” at an IPO price of $10 per share.
Recently, however, private companies have increasingly gone public through business combinations with SPACs, also called “blank-check companies,” which are development stage companies that have no operations of their own, apart from looking for private entities with which to engage in a merger or acquisition (called “target” companies) to take the target public. The SPAC has already gone public via its own IPO in this scenario and, indeed, a SPAC usually touts its management’s ability to identify and merge with potentially lucrative targets in the registration statement for its IPO.
So, what does a de-SPAC transaction look like? Let’s assume a hypothetical SPAC called “ABC Company” recently went public via an IPO. Individuals invested in ABC Company’s IPO on the understanding that its management have expertise in identifying targets and conducting due diligence in selecting and closing mergers with those targets. ABC Company then identifies several targets looking to go public, including our hypothetical XYZ Corp., and agrees to take XYZ Corp. public. ABC Company then merges with XYZ Corp. and, in the process of doing so, changes its name and business operations to XYZ Corp.’s name and business operations (or something similar), issues new shares under a new ticker symbol reflecting its new identity (for example, converts “ABC” shares to “XYZ” shares), and some or all of XYZ Corp.’s management starts running the newly combined company. In our hypothetical, XYZ Corp. has essentially “gone public” through the already-public ABC Company’s transformation into, essentially, what was XYZ Corp.
In this way, SPACs are like shapeshifters or doppelgangers; they are publicly listed blank slates waiting to take on the persona, business operations, and executive teams of private companies. However, these de-SPAC transactions present their own issues that individuals may be unaware of when investing in the post-merger de-SPAC company or pre-merger SPAC.
When individuals lose money on their investments in IPOs, they may seek relief under the federal securities laws through a strict liability claim under Section 11 of the Securities Act of 1933. Under Section 11, public companies can be held strictly liable in connection with material misstatements or omissions made in the IPO’s registration statement—which is required to register new shares and conduct the IPO—so long as the Section 11 claim is brought within a time limit set by the law. When investors purchase shares pursuant or traceable to an IPO’s registration statement, they typically show a loss on their investment for Section 11 purposes by comparing the share’s IPO price to its current trading price.
In the context of a SPAC IPO or de-SPAC transaction, however, it can be difficult to identify whether the original security is trading below its initially offered price. Why? The answer depends on whether you are bringing a Section 11 claim based on the SPAC’s IPO, or the de-SPAC transaction.
Shares offered in a SPAC’s IPO, usually called units, typically become stock and warrants that eventually list under different ticker symbols at different prices. Additionally, the SPAC’s securities (unit, stock, warrant, or otherwise) will typically convert into shares of the de-SPAC company following the de-SPAC transaction. Under both scenarios, shares purchased pursuant or traceable to the SPAC’s IPO may not be listed anymore, so it becomes difficult to know what their current market value is and to compare that value to the IPO price for purposes of Section 11.
De-SPAC transactions present their own issues simply because, unlike IPOs, they often do not have an IPO price or other formally, predetermined, easy to identify initial trading value to compare to current market values.
In bringing SPAC cases to the courthouse, Pomerantz has formulated several potential solutions to these problems. For example, if an investor wants to bring a Section 11 lawsuit in connection with shares purchased in a SPAC’s IPO (let us say they are units), and the units no longer trade, so there is no current unit price to compare to the IPO price, you might allege liability by seeing whether whatever the units transformed into—stock, warrants, or otherwise—are trading so far below the unit’s IPO as to be reasonably certain that you lost money on your investment.
On the other hand, if an investor wants to bring a Section 11 lawsuit in connection with shares purchased in a de-SPAC transaction, and they see that the shares purchased in the de-SPAC transaction are trading low, but there is no IPO price, per se, to compare it to, the investor might allege liability by substituting a formal IPO price for the de-SPAC company’s first publicly listed closing price.
Moving beyond strict liability claims under Section 11 of the Securities Act, an investor may opt to allege securities fraud claims under Section 10(b) of the Securities Exchange Act of 1934. Although more difficult to allege, in this scenario an investor might argue that the SPAC and its management knowingly overstated their expertise and due diligence efforts in identifying and acquiring a target company. Alternatively, investors might argue that the target company and its management knowingly hid issues from the SPAC or the public when announcing it would go public via a de-SPAC transaction.
Additionally, somewhat like a Section 11 claim under the Securities Act, there is a Section 14(a) claim under the Exchange Act, which investors can bring in connection with material misstatements or omissions made in a merger’s registration statement. Here, too, there may not be a formal IPO or other predetermined listing price for new shares created in a merger for a de-SPAC transaction, so one might compare the de-SPAC company’s current trading price to its first publicly listed closing price to allege liability.
The SEC, on the other hand, has proposed sweeping rule changes for SPACs that, if adopted, could better align de-SPAC transaction liability with traditional IPO liability. As noted by The National Law Review, these proposed rule changes cover six broad areas: (1) specialized SPAC disclosure requirements; (2) aligning de-SPAC transactions with traditional IPOs; (3) business combinations involving shell companies; (4) increased projections disclosures; (5) Investment Company Act safe harbor for SPACs; and (6) fairness of the de-SPAC transaction.
One such rule could effectively end protections afforded to companies under the Private Securities Litigation Reform Act of 1995 (“PSLRA”) when making forward-looking statements accompanied by meaningful cautionary language in connection with de-SPAC transactions. These safe harbor protections essentially boil down to companies and management disclaiming liability for positive statements made about potential future projections, earnings, results, plans, etc. (hence, “forward-looking” statements) when paired with adequate warnings about the certainty of these events occurring. Companies provide safe harbor warnings in many contexts, including earnings releases, quarterly reports, and even investor calls. The SEC’s proposed rule changes would modify the definition of a “blank check company” for the purposes of the PSLRA to include SPACs, and the PSLRA bars such safe harbor from applying to forward-looking statements made in connection with traditional IPOs or securities offerings by blank check companies.
Another example of rules aimed at harmonizing de-SPAC transaction liability with IPO liability includes a proposal that would amend registration statements issued in connection with de-SPAC transactions. Under this rule change, the target company would have to sign as a co-registrant on the registration form filed by the SPAC for the de-SPAC transaction. Additional signatories could include the target company’s principal executive officer, principal financial officer, controller/principal accounting officer, and board members, who could then be held strictly liable under Section 11 of the Securities Act for any material misstatements or omissions in the registration statement.
As stated by SEC Chair Gary Gensler, “Functionally, the SPAC target IPO is being used as an alternative means to conduct an IPO. 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.”
Although Pomerantz and the SEC are using different government branches to tackle these issues—for Pomerantz, the courthouses of the judicial branch, and for the SEC, the rule-making process of the executive branch—both are working to harmonize SPAC-related liabilities with traditional IPO liabilities. All the same, investors should avoid confusing IPOs with de-SPAC transactions and remain aware of the foregoing issues when deciding to invest in either SPAC IPOs or de-SPAC transactions.
