SEC adopts final rules relating to special purpose acquisition companies, shell companies, and projections
On January 24, 2024, following a 3-to-2 vote, the US Securities and Exchange Commission (SEC) adopted new rules and amendments (collectively, the Final Rules) designed to enhance disclosure and investor protection in initial public offerings (IPOs) by special purpose acquisition companies (SPACs) and in subsequent business combination transactions between SPACs and target companies (de-SPAC transactions).
The SEC’s stated objective in this rulemaking process was to align rules governing SPACs and de-SPAC transactions with those governing traditional IPOs, thereby reducing the potential for regulatory arbitrage by private companies that go public through a business combination with a SPAC rather than a traditional IPO – or, in Chair Gary Gensler’s words, “treating like cases alike.”
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Final rules at a glance The Final Rules’ most significant provisions relate to the following:
The press release[1] and fact sheet[2] for the Final Rules are available on the SEC’s website. The Final Rules reflect the considerations raised in the comment process for the SEC’s proposed rules and amendments issued on March 30, 2022 (collectively, the Proposed Rules). |
Effective dates
The Final Rules will become effective 125 days after publication in the Federal Register. In the adopting release, the SEC noted that the “extended period before the Final Rules are effective will provide sufficient time for an IPO to be made under the existing rules for any transactions that are currently pending or planned. Any filings made on or after the effective date must comply with the Final Rules.” Inline XBRL tagging of information disclosed pursuant to new subpart Item 1600 of Regulation S-K will be required 490 days after publication of the Final Rules in the Federal Register. There are no exemptions or phase-in periods for SRCs, emerging growth companies (EGCs), or foreign private issuers.
An in-depth look at the Final Rules
- Enhanced disclosure: Under the new Subpart 1600 of Regulation S-K, the Final Rules require additional disclosures of the following matters (the list below is not exhaustive, nor intended to capture all aspects of the Final Rules):
- SPAC sponsor disclosure: The Final Rules require in-depth disclosure in SPAC IPOs and de-SPAC transactions regarding SPAC sponsors, their affiliates, and any promotors, including, as of the most recent practicable date, the persons who have direct and indirect material interests in the SPAC sponsor, as well as the nature and amount of their interests. Transfers of ownership interests in SPAC sponsors and holding companies that own interests in SPAC sponsors will now be required to be disclosed.
- SPAC sponsor compensation: The Final Rules require additional disclosure in SPAC IPOs and de-SPAC transactions regarding the nature (eg, cash, shares, warrants, and rights) and amounts of all compensation that has been or will be awarded or paid to the SPAC sponsor, its affiliates, and any promoters, including (i) the amount of securities issued and price paid for such securities; (ii) any arrangements under which the SPAC sponsor, its affiliates, or any promoters could transfer ownership of the securities of the SPAC or result in the surrender or cancellation of such securities; and (iii) any reimbursements to be paid to the SPAC sponsor upon completion of a de-SPAC transaction.
- IPO conflicts: The Final Rules require disclosure of potential conflicts of interest in SPAC IPOs between the SPAC sponsor (including its affiliates or promotors) and the purchasers in the SPAC IPO.
- Dilution: The Final Rules require tabular disclosure in SPAC IPOs and de-SPAC transactions regarding dilution with intervals showing (i) the nature and amounts of each source of dilution used to determine net tangible book value per share, as adjusted; (ii) the number of shares used to determine net tangible book value per share, as adjusted; and (iii) any adjustments to the number of shares used to determine the per share component of net tangible book value per share, as adjusted.
- Board determination: The Final Rules require disclosure in de-SPAC transactions regarding the determination of the board of directors, if required under applicable law, regarding whether a de-SPAC transaction is advisable and in the best interests of the SPAC and its security holders, including material factors considered in such determination such as the valuation of the target company, financial projections relied upon by the board, and terms of financing materially related to the de-SPAC transaction. The Final Rules also require disclosure regarding whether any director voted against, or abstained from voting on, approval of the de-SPAC transaction or any related financing transaction.
- Target company and de-SPAC transaction: The Final Rules require disclosure in de-SPAC transactions regarding the target company and the de-SPAC transaction, including (i) any contacts, negotiations, or transactions that have occurred concerning the de-SPAC transaction; (ii) material terms of the de-SPAC transaction; (iii) any related financing transaction, including any payments from the SPAC sponsor to investors; and (iv) a reasonably detailed discussion of the reasons, structure, and timing of the de-SPAC transaction and its effect on the rights of the SPAC and target company security holders.
- Projections: The SEC provided guidance on disclosure considerations related to financial projections in de-SPAC transactions, including the purpose for which the projections were prepared; all material bases, assumptions, and factors affecting the projections; whether the projections reflect the view of the SPAC or target company’s management or board of directors as of the most recent practicable date prior to dissemination of disclosure documents; and whether an outside review of such projections was conducted, including the qualifications of the reviewer, extent of review, and certain material relationships.
- Target company as co-registrant: The Final Rules require the target company in a registered de-SPAC transaction to be a co-registrant with the SPAC (or other shell company, such as a new holding company issuer, in connection with a de-SPAC transaction), resulting in the target company, its principal executive officer or officers, its principal financial officer, its comptroller or principal accounting officer, and a majority of its board of directors or persons performing similar functions signing the registration statement filed in connection with the de-SPAC transaction and assuming liability under Section 11 of the Securities Act for the disclosures contained therein.
- Minimum dissemination period: The Final Rules impose a minimum dissemination period for prospectuses and proxy/information statements of 20 calendar days prior to the date on which the meeting of SPAC security holders is to be held or action is to be taken in connection with the de-SPAC transaction.
- Removal of safe harbor for forward-looking statements under the PSLRA: The Final Rules now align regulatory treatment of forward-looking statements in de-SPAC transactions with that in traditional IPOs such that the safe harbor for forward-looking statements provided by the PSLRA will no longer be available for disclosures in de-SPAC registration statements, including projections. The removal of the PSLRA safe harbor for SPACs and de-SPAC transactions reflects the SEC’s concern that, similar to IPOs, market participants may not exercise the same level of care in preparing forward-looking statements and projections.
- Re-determination of SRC status: Following a de-SPAC transaction, the Final Rules require the combined company to re-determine its eligibility as a SRC, to the extent applicable, within four business days after consummation of the de-SPAC transaction, or when the Form 8-K with Form 10 information, the “Super 8-K,” is required to be filed with the SEC. A change in status is effective for SEC filings made 45 days after consummation of the de-SPAC transaction.
- Shell company business combinations involve a “sale of securities”: The new Rule 145a under the Securities Act deems any business combination transaction involving a SPAC or reporting shell company to be a sale of securities to such SPAC’s or other reporting shell company’s security holders. Therefore, regardless of the transaction structure, a registration statement on Form S-4 or Form F-4, rather than a proxy statement on Schedule 14A, will be required unless an exemption from registration is available.
- Amendments to financial statement requirements: The Final Rules adopt new Article 15 of Regulation S-X, which aims to more closely align the financial statement reporting requirements in de-SPAC transactions involving a private target company with those in traditional IPOs. New Article 15:
- Requires the financial statements of a business that is or will be a predecessor to a shell company to be audited in accordance with the standards of the Public Company Accounting Oversight Board
- Permits a SPAC to include in its Form S-4/F-4/proxy or information statement balance sheets as of the end of the two most recent fiscal years and two years of statements of comprehensive income, changes in stockholders’ equity, and cash flows for the target company where both the SPAC and the target company would qualify as an EGC, regardless of whether or not the shell company has filed or was already required to file its annual report
- Codifies existing market practice providing that the age of financial statements for a target company that will be acquired by a SPAC will be based on the age requirements in Rule 3-12 or Rule 8-08 of Regulation S-X, rather than the target company provisions in Item 17 of Form S-4
- Codifies existing market practice that requires application of Rule 3-05 or Rule 8-04 of Regulation S-X related to financial statements of an acquired business or real estate operation, to an acquisition by the business that will be the predecessor of the SPAC, with the related significance tests of the acquired business calculated using the predecessor’s financial information as the denominator instead of that of the SPAC, and
- Permits a registrant after a de-SPAC transaction to exclude the pre-acquisition financial statements of the SPAC for periods prior to the business combination that results in the combined entity no longer being a shell company once certain conditions are met.
Deciding not to address statutory underwriter and investment company status through rulemaking, the SEC provided the following guidance:
- Status as an investment company: Depending on the facts and circumstances, a SPAC may be an investment company under Section 3(a)(1)(A) or Section 3(a)(1)(C) (or both) of the Investment Company Act. By way of illustration, the SEC described certain activities that would raise concerns about a SPAC’s status as an investment company based on (i) the nature of the SPAC’s assets and income; (ii) the actions of the SPAC’s officers, directors, and employees; (iii) the length of time that the SPAC has been operating prior to entering into an agreement with a target company and then completing the de-SPAC transaction with that target company; (iv) how the SPAC holds itself out; and (v) if the SPAC engages or proposes to engage in a de-SPAC transaction with a target company that is an investment company.
- Status as statutory underwriters: The SEC intends to follow its longstanding practice of applying the statutory terms “distribution” and “underwriter” broadly and flexibly. According to the SEC, a de-SPAC transaction involves a “distribution” of securities under Section 2(a)(11) of the Securities Act based on the process by which the SPAC’s investors, and therefore the public, receive interests in the combined operating company. The SEC reiterated that it would be insufficient to conclude that a person is not an underwriter, as such term is defined in Section 2(a)(11) of the Securities Act, solely because such person did not purchase securities from an issuer with a view to distribution – it must also be established that the person is not offering or selling for an issuer in connection with the distribution of the securities, does not participate or have a direct or indirect participation in any such undertaking, and does not participate or have a participation in the direct or indirect underwriting of such an undertaking. Notably, the SEC declined to adopt a narrower view of the concept of “participation” than what was discussed in the Proposed Rules[3]. As a result, Section 11 of the Securities Act would apply to anyone acting as a statutory underwriter with respect to a registered de-SPAC transaction, and such person will have liability for any material misstatement or omission in the registration statement. Similarly, any such persons would have any defenses available to the parties (other than the issuer) upon whom Section 11 of the Securities Act imposes liability.
Chair and Commissioner statements
The Final Rules seek to “ensure that the rules for SPACs are substantially aligned with those of traditional IPOs, enhancing investor protection through three areas: disclosure, use of projections, and issuer obligations,” according to Chair Gensler. Citing the declining trajectory of SPAC transactions since 2021, Commissioner Hester M. Peirce expressed concerns that by imposing additional regulatory obstacles on SPACs, the Final Rules compounded the underlying problem by “removing a potential avenue for bringing small companies into the public market,” and Commissioner Mark T. Uyeda described the Final Rules as constituting a form of de facto merit regulation in which several areas impose more stringent disclosure requirements on SPACs as compared to filings not involving SPACs.
Key takeaways
The Final Rules did not depart significantly from the Proposed Rules and, for the most part, codified current market practices developed in response to the Proposed Rules. While the Final Rules will create some additional burdens on SPACs, the incremental chilling effect on the SPAC market should not be at the magnitude already experienced due to the Proposed Rules and should generally benefit investors.
In light of the SEC’s guidance on statutory underwriter status, we expect financial institutions to continue to approach de-SPAC transactions with caution and, depending on their roles, seek to establish a due diligence defense, with negative assurance and comfort letters continuing to remain the market standard.
In regard to the Investment Company Act, SPACs will put significant emphasis on ensuring that they structure the SPAC offering, the de-SPAC activities, and trust investments to avoid what the SEC perceives to be negative factors and indicators that a SPAC is an investment company. While historically SPAC investors did not view investment in a SPAC akin to investing in an investment company, they will be keenly interested in understanding how the SPACs in which they invest will react to the SEC’s guidance, given the adverse impact on yields of holding trust funds in cash, particularly if interest rates for demand deposits decline.
The inner workings of a SPAC sponsor vehicle were previously opaque in many respects. In light of the increasing prevalence of syndicated sponsor vehicles, investors should be aware that their investments in SPAC sponsors, if material, will be made public.
The current rules limiting certain actions involving shell company transactions continue to remain in place, such as the restriction on former shell companies from using Form S-8 for compensatory securities offerings until at least 60 calendar days after the combined company has filed current Form 10 information and the requirement for former shell companies to satisfy the requirements of Rule 144(i)(2) under the Securities Act for a person to resell securities initially issued by a shell company in reliance on Rule 144.
For many years, market participants in SPAC and de-SPAC transactions have repeatedly demonstrated their ability to adapt to regulatory and market headwinds. During the first half of 2024, we expect a measured pace of new SPAC issuances and a flight to quality sponsors and target companies in de-SPAC transactions. By November 2024, we may see a shift in a number of market dynamics which could impact the capital markets overall, including SPACs and de-SPACs.
For more information, please contact the authors.
[1] See, “SEC Adopts Rules to Enhance Investor Protections Relating to SPACs, Shell Companies, and Projections,” published on January 24, 2024 (available at: https://www.sec.gov/news/press-release/2024-8).
[2] See, “SPACs, Shell Companies, and Projections: Final Rules,” (available at: https://www.sec.gov/files/33-11265-fact-sheet.pdf).
[3] The Proposed Rules included the following statement: “For example, financial advisors, PIPE investors, or other
advisors, depending on the circumstances, may be deemed statutory underwriters in connection with a de-SPAC transaction if they are purchasing from an issuer ‘with a view to’ distribution, are selling ‘for an issuer,’ and/or are ‘participating’ in a distribution.”
