Almost two years after the Securities and Exchange Commission (SEC) proposed a sweeping set of reforms for special purpose acquisition companies (SPACs), the commission adopted extensive rules intended to better protect investors by a vote of 3 to 2 during a public meeting on January 24, 2024.
Commissioners Hester Peirce and Mark Uyeda voted against the rulemaking because they believe it represents government overreach, and interest in SPACs—which has cooled off significantly from its peak of 2021—might even disappear because of numerous burdensome provisions in 581 pages of rule text.
A SPAC is a type of blank-check or shell company without operations that raises capital publicly for the sole purpose of identifying and merging with a target private operating company. A SPAC registers redeemable securities for cash, sells them to investors, and puts the proceeds in a trust for a future acquisition of a private operating company. Upon finding a target private company, it merges with it, completing the deal—this is called de-SPAC.
The new rules require more information about SPAC sponsor compensation, conflicts of interest, dilution, the target company, and other disclosures that are important to investors in de-SPAC transactions and SPAC initial public offerings (IPOs).
In certain cases, the SEC is requiring the target company to sign a registration statement filed by a SPAC. This makes the target company a co-registrant, and thus it will assume responsibility for the disclosures in the registration statement.
“Given the complexity of these transactions, the Commission seeks to enhance investor protection in SPAC IPOs and de-SPAC transactions with respect to the adequacy of disclosure and the responsible use of projections,” the SEC said.
Under the rules, any business combination that involves a reporting shell company is deemed to be a sale of securities. Financial statement requirements will be more aligned with those in traditional IPOs.
The regulator said that the new rules better align the regulatory treatment of projections in de-SPAC transactions with that in traditional IPOs under the Private Securities Litigation Reform Act of 1995 (PSLRA). This means that the safe harbor for forward-looking statements under the PSLRA will be unavailable for SPACs.
The new rules, among other things, require disclosures of all material bases and assumptions used to come up with projected figures. This is intended to rein in overly rosy returns promised to investors.
“Suppose a group of strangers came up to you and said: ‘I have a company. It doesn’t do much of anything, but sometime in the next two years, we’ll merge with another company. I don’t know what that company is yet,’” SEC Chair Gary Gensler said. “What if I told you that, if the strangers complete a merger, they get to pocket 20 percent of your investment? This essentially describes what SPACs do.”
Gensler said that just because a company uses a different method to go public does not mean its investors are less deserving of protections.
“Today’s adoption will help ensure that the rules for SPACs are substantially aligned with those of traditional IPOs, enhancing investor protection… by addressing information asymmetries, misleading information, and conflicts of interest in SPAC and de-SPAC transactions,” he said.
Commissioner Uyeda said that the extensive requirements—from numerous disclosure, dissemination, forward-looking statement, and liability to accounting provisions—are “purportedly designed to advance” investor protection and capital formation for SPACs.
“But there may be a far simpler explanation behind what the commission is doing for SPACs. We simply do not like them,” Uyeda criticized. To achieve this outcome, the SEC is imposing “crushingly burdensome regulations on SPACs as a form of merit regulation in disguise.”
“Nearly two years [later], the SPAC market is a shell of its former self. Today’s [rule] shows that the commission intends to never let them return,” he claimed.
Gensler disagreed, noting the importance of investor protections.
“I say this even as the volume of SPAC transactions are down from the SPAC boom of 2020 and 2021—though I would note, there still were 31 SPAC blank-check IPOs in 2023 and 86 in 2022,” Gensler said. “Markets ebb and flow, and there could be a change in the future.”
In the meantime, Daniele D’Alvia, a lecturer in banking and finance law at CCLS Queen Mary University of London, said that extending and aligning traditional finance rules designed for IPOs to SPACs “is truly remarkable.”
“SPACs that have been so far in the domain of self-regulation, market practices, and listing requirements of the NYSE and the NASDAQ can today have a formal recognition,” said D’Alvia, also an associate researcher at the European Banking Institute. “This is a total win” for SPACs.
Dave Brown, a partner with Alston & Bird LLP in Washington, said that the SEC is trying to level the playing field with the new rules for SPACs.
“In addition to the additional disclosure requirements, the technical changes regarding the target being a registration and a de-SPAC transaction to be a sale of securities to the reporting shell company’s shareholders have far reaching ramifications,” Brown said. “This essentially means that there is more risk to the gate keepers [such as] target company auditors, financial advisors, etc. This will result in more stringent processes and liability concerns among the market participants, which will result in targets being better prepared to become public companies.”
The final rules are in Release No. 33-11265, Special Purpose Acquisition Companies, Shell Companies, and Projections.
The rules become effective 125 days after publication in the Federal Register.
This article originally appeared in the January 25, 2024, edition of Accounting & Compliance Alert, available on Checkpoint.
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