SEC Proposes Rules to Enhance Disclosure and Investor Protection Relating to Special Purpose Acquisition Companies, Shell Companies, and Projections
By Prashanta Panta, Senior Manager, Assurance Services
Over the past two years, the U.S. public securities markets have experienced an exponential surge in the number of initial public offerings by special purpose acquisition companies (“SPACs”). The rise in activity has generated a large amount of market attention and scrutiny, as well as litigation involving post-SPAC merger companies. There are increased concerns over investors’ access to information about various aspects of the SPAC structure, and over the increasing use of shell companies as mechanisms for private operating companies to become public companies. In response to these concerns, on March 30, 2022, the SEC proposed new rules (the “proposed rules;” see below for links to the SEC web pages containing the proposed rules, a press release, and a fact sheet) and amendments to enhance disclosure and provide investor protection in SPAC IPOs and in business combination transactions involving shell companies (such as SPACs) and private operating companies. The proposed rules are also meant to narrow the differences between the information required for, and the liability assumed under, a SPAC merger and a conventional IPO.
Below are four key components of the proposed rules.
Enhancing Disclosure and Investor Protection
This component proposes disclosure requirements to provide investors with more complete and detailed understanding of the role of SPAC sponsors. It would require SPACs to disclose sponsors’ experience, roles and responsibilities, agreements, and compensation, as well as to sponsors’ affiliates and any promoters for all services rendered to the SPAC. The proposed rules would also require SPACs to provide investors with a complete understanding of potential conflicts between sponsors, directors, and unaffiliated security holders. At the IPO stage of a SPAC’s lifecycle, the proposed rules would require additional granularity on the prospectus cover page: SPACs would have to present redemption scenarios in quartiles up to the maximum redemption scenario. The proposed rules would also require SPACs to disclose the cash dilution impact of public shareholder redemptions at the time of the merger and material potential sources of dilution that could result from the de-SPAC transaction. They would also require the SPAC to make additional disclosures about the fairness of the transactions (such as the business combination) to the SPAC investors, for both the SPAC IPOs and de-SPAC transactions.
Business Combinations Involving Shell Companies
The Commission’s concern over private companies becoming U.S. public companies via de-SPAC transactions is mainly related to the possibility that private companies will view this as an easier alternative to a traditional IPO because it avoids the disclosure, liability, and other provisions involved in traditional registered offerings. This component of the proposed rules deems a business combination transaction involving a reporting shell company and a private operating company a “sale” of securities under the Securities Act of 1933. The proposed rule helps to better align the financial statement requirements applicable to transactions involving shell companies with those required in registration statements for initial public offerings and amends the current “blank check company” definition to make clear that SPACs cannot rely on the safe harbor provision under the Private Securities Litigation Reform Act of 1995.
This component of the proposed rules requires enhancing the disclosures on the presentation of projections to address the reliability of such projections. To do so, SPACs must add supplemental information such as historical results, the use of non-GAAP measures, and the bases, assumptions, and views management and the board used to create the financial projections. These enhanced disclosures are expected to give investors a better understanding of the basis of the projections used in business combination.
New Safe Harbor Under the Investment Company Act of 1940
Because SPACs are generally formed to identify, acquire, and operate a target company through a business combination (and not to operate as an investment company), the proposed rules seek to clarify SPAC status by limiting their asset composition, activities, business purpose, and duration. This component would require SPACs to hold only assets comprising of cash, government securities, or certain money market funds. It would also require the surviving entity after the de-SPAC transaction to be engaged primarily in the business of the target company, and it would impose a time limit, from the date of the SPAC IPO, of 18 months for the announcement (and 24 months for the completion) of the de-SPAC transaction.
Due to the surge in the SPAC market, these proposed rules intend to impose traditional IPO regulations and disclosures on the SPAC IPO to provide investors with more complete and detailed information. The proposed rules state that if adopted, they “could help the SPAC market function more efficiently by improving the relevance, completeness, clarity, and comparability of the disclosures provided by SPACs at the initial public offering and de-SPAC transaction stages, and by providing important investor protections to strengthen investor confidence in this market.” On the other hand, this may have consequences for the future of SPACs as an alternative vehicle to traditional IPOs as these supplemental disclosures could significantly increase costs and complexity. Also, because a SPAC merger would be deemed a distribution of securities similar to a conventional IPO, some additional responsibilities may be imposed upon gatekeepers and regulators to potentially expand the guidelines around who might be deemed an underwriter.