- In the past two years, IPOs involving SPACs have raised an unprecedented $240 billion, partially due to a streamlined IPO and de-SPAC process.
- The new rules would make the SPAC IPO and de-SPAC process more closely aligned with the traditional IPO rules.
- The proposed enhanced regulation of SPAC IPOs and the de-SPAC process may have an adverse effect on the SPAC IPO market, potentially resulting in a reduction in the number of SPAC IPOs.
The Bottom Line
SPACs are a rapidly growing financial product, after raising $240 billion in two years and accounting for half the IPOs in 2020 and 2021. This rapid growth has led to concern among regulators that the public is investing in entities without the same safeguards and oversight as traditional companies.
A SPAC is a company without any operations that is formed for the sole purpose of merging with a yet-to-be-identified private company. As a result of the merger, the private company becomes publicly listed without executing the traditional IPO process. Because the operative transaction is a merger instead of a public offering, the transaction, disclosed in a proxy statement on Schedule 14A, would have different regulatory requirements than the traditional IPO.
In the proposed rules and amendments, released on March 30, 2022, the SEC plans to protect consumers by (1) enhancing disclosure by SPACs and their target companies and (2) increasing the likelihood of Securities Act of 1933 (Securities Act) liability for the entities involved in affecting the de-SPAC transaction.
The proposed rules would classify the target company as an “issuer” and a co-registrant of the SPAC on the registration statement on Form S-4 or F-4. As an issuer, the CEO, the CFO, and the board of directors of the target company would be required to sign the registration statement, putting them at risk for liability under Section 11 of the Securities Act.
Also affected is a safe harbor in the Private Securities Litigation Reform Act of 1995 (PSLRA), which allows the target company of a SPAC to publish projections about its future growth with moderate protection if they are not fulfilled. It is not clearly established that the safe harbor is applicable to SPACs making forward-looking statements in their disclosure documents.
The proposed rules would amend the definition of “blank check company” to make the safe harbor in the PSLRA definitively unavailable to SPACs, potentially giving rise to liability for incorrect projections. Removing the safe harbor protection would likely discourage SPACs from making forward projections, which is in line with the current practice of traditional IPO companies.
The SEC also is proposing a new Rule 140a under the Securities Act that affects classification of underwriters, expanding the scope of liability and potentially increasing the burden of diligence. This new rule would classify any underwriter for the SPAC IPO that facilitates, or takes part in the transaction, either directly or indirectly, as being “engaged in the distribution of securities and therefore a statutory underwriter for Securities Act liability purposes.”
Underwriters are not the only advisors who would have the new classification. Rather, this classification would also apply to “financial advisors, PIPE [private investment in public equity] investors, or other advisors, depending on the circumstances.” Having the statutory underwriter classification would expand these financial entities’ potential liability in connection with the SPAC, possibly resulting in these entities performing significantly more due diligence in order to protect themselves. Two traditional benefits of consummating a de-SPAC transaction versus a traditional IPO are a more certain timeline and lower fees. The need for greater due diligence potentially would slow the de-SPAC process and make it more expensive.
Compared with the new rules, companies currently going through the de-SPAC process can more easily qualify as a “smaller reporting company” for up to a year without testing to ensure the classification still applies. The new rules would retest a company immediately after completing a de-SPAC transaction to see if the company still meets the “smaller reporting company” requirements. If it does not, the company would have to meet the more arduous requirements in its next quarterly report.
A new proposed subpart to Regulation S-K would increase the disclosures that SPAC sponsors, affiliates, and promoters provide to potential investors. Among other things, the new rules would require additional disclosures on the background of, and reasons for, the transaction; a statement from the SPAC as to whether it reasonably believes that the de-SPAC transaction and any related financing transaction are fair or unfair to unaffiliated security holders; disclosure on any outside report, opinion, or appraisal relating to the fairness of the transaction; information regarding SPAC sponsors; potential conflicts of interest; and detailed disclosure regarding the impact of dilution on shareholders. In order to comply with the new subpart, companies will have to disclose how the rights of the stockholders will change as a result of the de-SPAC and give a description of related financing agreements connected with the larger transaction.
A new Regulation S-X article and related amendments are being proposed to align the financial statement reporting requirements of a de-SPAC target with a traditional IPO. The rule would standardize reporting financial statement disclosures for companies going public through an IPO or a de-SPAC and would put further limits on the use of projections in financial statements.
Not all of the proposed rules were designed to increase disclosure and accountability of SPACs. The SEC also included a rule to give SPACs a safe harbor from plaintiffs seeking compensation under the Investment Company Act of 1940 as amended (1940 Act). With the popularity of SPACs, some plaintiffs have filed lawsuits alleging that SPACs were unregistered investment companies under the 1940 Act. While it was unlikely, but unsettled, whether SPACs could face liability under this theory, the SEC used the new proposed rules to offer a safe harbor to SPACs to avoid liability under the Investment Company Act. Under the proposed rule, a SPAC would not be considered an investment company (and would not be required to register as an investment company) if it operates like a traditional SPAC.
Based on the initial statements from the SEC’s Commissioners, we anticipate the SEC will receive extensive and contrasting feedback on the proposed rules during the 60-day comment period, after which final rules likely will be adopted. The final rules could have a meaningful impact on this important source of financing, the broader capital markets, and the environment for mergers and acquisitions. SPAC and de-SPAC participants are encouraged to consult with counsel on how any new rules could affect their proposed transactions.
From startup financing to public offerings, the Securities and Capital Markets Group at Ballard Spahr advises private and public companies through all stages of development and capital-raising activities. We also help clients comply with public reporting, proxy, and disclosure obligations. Please contact us for more information.
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