Five Key Takeaways From The SEC’s Evolving Response To The SPAC Boom – Corporate/Commercial Law

Over the past year, the use of Special Purpose Acquisition
Companies, or SPACs, to go public has skyrocketed.¹ As
The Wall Street Journal explained, “With
interest rates on the floor and investors chasing young companies,
this is a dream scenario for SPACs.”² As the SPAC
boom continues, it is important to understand that SEC guidance on
SPACs is evolving. The SEC’s statements on SPACs have quickly
progressed from a short bulletin educating investors on using SPAC
vehicles to take companies public, to specific guidance strongly
implying that the SEC staff is carefully scrutinizing disclosures
related to SPAC transactions.³ Indeed, the SEC’s
recent guidance identifies specific disclosure areas that SEC staff
will focus on and likely provides a roadmap for both future SEC
enforcement and the plaintiffs’ bar.

The Basics: What Is a SPAC?

SPACs have exploded in popularity-and have caught the SEC’s
attention-because the SPAC lifecycle allows a private company to go
public and raise cash more quickly than a traditional IPO. A SPAC
is a shell company that is created, or sponsored, by investors to
raise money through an IPO to acquire a private company (the
so-called “target”). The SPAC offers its securities to
investors via an IPO and puts the cash raised into a trust account
to fund the purchase of a target company. SPACs typically have 24
months to complete an initial business combination with a target
company.⁴ In the event of a successful business
combination, the target merges with the SPAC in a “de-SPACing
transaction” and the target becomes a public company. After
the de-SPACing transaction, the newly created public company must
meet SEC and stock exchange public company reporting requirements,
including those that impose robust financial reporting, disclosure,
and governance requirements.

Potential SPAC Enforcement and Litigation Risks: The SEC’s
SPAC Guidance Thus Far

December 2020: A Swift Progression from Basic SPAC Information
to Specific Guidance on SPAC IPO-Related Disclosures

On December 10, 2020, the SEC issued an investor bulletin that
provided basic information on the SPAC lifecycle and urged
potential investors to carefully review the SPAC’s IPO
prospectus and SEC filings.⁵ Less than two weeks later,
however, the SEC’s Division of Corporation Finance issued
specific guidance highlighting the importance of clear disclosure
of any conflicts of interest between the SPAC sponsor and other
SPAC insiders on the one hand and public shareholders on the
other.⁶ The Division of Corporation Finance instructed
SPAC sponsors, directors and officers, and other SPAC insiders to
make clear and robust disclosures related to the IPO, including all
conflicts of interest, fiduciary and contractual obligations to
other entities, interests in potential target companies, and
financial considerations such as the price paid for the securities
and incentives to complete the business combination transaction.
The Division of Corporation Finance also urged disclosures related
to how the target company was selected and the fees that third
parties, like underwriters, would receive.

March 2021: the SEC Specifies Public Company Reporting and
Listing Requirements for SPACs and Accounting Considerations for
Targets

On March 31, 2021, the Division of Corporation Finance and the
Acting Chief Accountant Paul Munter each issued specific guidance
evidencing a continued SPAC focus.⁷ (Previously, the
SEC’s most direct SPAC-related warnings came on March 10, 2021,
when the Division of Corporation Finance staff warned investors not
to invest in SPACs based solely on a celebrity’s
endorsement.)⁸ The Division of Corporation Finance
addressed restrictions on shell companies applicable to SPACs,
identified books and records and internal controls requirements
applicable before the business combination, and initial listing
standards applicable to companies listed on national securities
exchanges, such as the New York Stock Exchange or
Nasdaq.⁹ Munter, in turn, recognized that “where
target companies often encounter complex issues is in the
accounting for and reporting of its merger with the
SPAC.”¹⁰ In addition to pointing out accounting
considerations for the de-SPAC transaction, Munter also flagged
issues to consider regarding internal controls, audits, and
corporate governance applicable to the merger between the target
and the SPAC.

April 2021: the Acting Director of the Division of Corporation
Finance Likens the De-SPAC Transaction to a “Real
IPO”

On April 8, 2021, John Coates, the Acting Director of the
Division of Corporation Finance, followed up with perhaps the most
important SEC statement to date, signaling that the SEC would apply
the same level of scrutiny to de-SPAC-related disclosures as it
would to traditional IPO disclosures.¹¹ Coates warned
that the SEC staff was “continuing to look carefully at
filings and disclosures by SPACs and their targets.”
Interestingly, Coates “focus[ed] on legal liability that
attaches to disclosures in the de-SPAC transaction.” He
challenged the view that SPACs are subject to lesser securities law
liability than traditional IPOs, warning that the Division of
Corporation Finance staff would focus on the de-SPAC transaction as
the “real IPO” and apply the “full panoply of
federal securities law protections.”

Coates’ statement could serve as a harbinger for SEC
enforcement activity and private securities litigation in the
months and years ahead. With respect to the de-SPAC transaction,
Coates stressed that (1) both Section 11 of the Securities Act of
1933 and Section 14(a) of the Securities Exchange Act of 1934, and
Rule 14a-9 thereunder, apply to material misstatements and
omissions in registration statements and proxy solicitations,
respectively; (2) the Private Securities Litigation Reform Act, or
PSLRA, safe harbor will not prevent SEC enforcement action; and (3)
state law, particularly that of Delaware, may require disclosure of
projections used in connection with the de-SPAC. Coates also
questioned whether, in private securities lawsuits, the PSLRA safe
harbor would apply to misleading disclosures made by the newly
combined company post-de-SPAC. He bluntly warned: “Any simple
claim about reduced liability exposure for SPAC participants is
overstated at best, and potentially seriously misleading at
worst.” 

Coates teamed up with Munter on April 12, 2021 to issue the
SEC’s most recent SPAC statement, this time focusing on
potential accounting implications of terms that may be common to
warrants issued as part of the units sold in SPAC
IPOs.¹² They cautioned that the accounting for warrants
requires careful consideration of the specific facts and
circumstances for each entity and each contract, and linked
specific applicable accounting standards. This statement could
indicate that, in addition to focusing on disclosures made during
the SPAC process, SEC enforcement is gearing up for investigations
focused on SPAC-related accounting.

So What Is a SPAC to Do? Five Key Takeaways

• Pay Careful Attention to Disclosures of Conflicts of
  Interest The thread that ties the SEC’s SPAC
  statements together is that the agency views disclosure of
  conflicts of interest as vital. Analyzing and disclosing the
  different economic and business interests of each SPAC
  participant-from SPAC insiders like the sponsors and management
  team, to the IPO’s public shareholders, to third parties like
  underwriters-at each stage of the SPAC lifecycle is critical to
  litigation and enforcement risk mitigation. Indeed, Coates appears
  to have signaled his view that the SPAC structure itself has
  potential conflicts of interest that, without proper mitigation
  and/or disclosure, may be a source of liability risk under the
  federal and state securities laws.




• Ensure the SPAC Meets SEC Shell Company and Stock
  Exchange Listing Requirements The March 31, 2021 Division
  of Corporation Finance guidance makes it clear that SPAC management
  teams must be aware of shell company restrictions and SEC filing
  requirements, books and records and internal controls requirements,
  and initial listing standards of the national securities exchanges,
  such as the New York Stock Exchange and Nasdaq. Given that the SPAC
  is a newly created shell with no operating history, strictly
  following these requirements can be an efficient way to mitigate
  litigation risk.




• Approach De-SPAC Disclosures Like Traditional IPO
  Disclosures Coates’ April 8, 2021 statement could not
  be clearer that, as Acting Director of the Division of Corporation
  Finance, he views the de-SPAC transaction as the “real
  IPO” and expects robust de-SPAC disclosures. In addition to
  focusing on disclosures related to conflicts of interest, it will
  be prudent to ensure that the target company’s financial
  statements and internal controls over financial reporting meet all
  SEC requirements. Working with legal, accounting, and financial
  advisors on de-SPAC disclosures will be key, as the target company
  actually has operations and an operating and financial history,
  unlike the newly created SPAC.




• Pay Attention to Accounting Munter’s
  statements stress the importance of the combined public company
  having in place both the right people and processes to produce high
  quality financial reporting that meets SEC rules and regulations.
  His April 12, 2021 joint statement with Coates provides a guide for
  how to account for warrants. As many of these accounting
  considerations involve significant judgment, engaging and working
  closely with a top notch and independent public accounting firm is
  key.




• Analyze Litigation Risk at Each Stage of the SPAC
  Lifecycle SPACs have the attention of the SEC. Coates’
  April 8, 2021 statement is best viewed as a detailed road map for
  future SEC enforcement actions and private class actions (some of
  which have already been filed). Coates has signaled that the SEC
  staff will scrutinize disclosures at every stage of the SPAC’s
  lifecycle. Analyzing litigation and regulatory enforcement risk at
  each stage of the SPAC lifecycle can help SPAC participants prepare
  for, and potentially minimize the risk and expense of, regulatory
  scrutiny and lawsuits.

Footnotes

1 The amount of money raised by U.S.-listed SPAC initial
public offerings, or IPOs, ballooned from 59 IPOs that raised $13.6
billion in 2019, to 248 IPOS that raised $83.4 billion in 2020, to
308 IPOs that raised $100 billion in just the first 3.5 months of
2021 alone. As of the writing of this article, there are around 560
active SPACs holding over $180 billion in trust. https://www.spacresearch.com/.

2 https://www.wsj.com/articles/spacs-are-the-stock-markets-hottest-trend-heres-how-they-work-11617010202.

3 While recent pronouncements reflect staff views, and
not any official rulemaking by the Commission, these statements
from senior officials offer a good window into how the staff is
analyzing and potentially investigating the SPAC space.

4 If the SPAC doesn’t complete an initial business
combination with a target by the deadline (subject to certain
extensions), the trust is liquidated and the proceeds raised via
IPO plus interest are returned to the SPAC
shareholders.

5 https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investor-bulletin.

6 https://www.sec.gov/corpfin/disclosure-special-purpose-acquisition-companies.
For example, the SPAC sponsors who create the SPAC invest on
different terms than public shareholders. The sponsors typically
own 20% of the common equity in the SPAC upon completion of the
IPO, and will have a 20% stake in the final merged
company.

7 https://www.sec.gov/news/public-statement/division-cf-spac-2021-03-31;
https://www.sec.gov/news/public-statement/munter-spac-20200331.

8 https://www.sec.gov/oiea/investor-alerts-and-bulletins/celebrity-involvement-spacs-investor-alert.

9 https://www.sec.gov/news/public-statement/division-cf-spac-2021-03-31.

10 https://www.sec.gov/news/public-statement/munter-spac-20200331.

11 https://www.sec.gov/news/public-statement/spacs-ipos-liability-risk-under-securities-laws.

12 SPAC IPO investors generally acquire units, each of
which is comprised of one share of common stock and a fraction of a
warrant. A full warrant gives the holder the right to buy one share
of additional common stock at $11.50 per share (representing a
price premium compared to the $10 per unit price at the time the
units are issued in the IPO). SPAC sponsors also purchase warrants
that generally have the same terms as the warrants included in the
units issued in the IPO.