Securities lawyers say the SEC’s rule proposal on special purpose acquisition companies (SPACs) is likely to put a damper on those considering SPAC deals. Some believe that even those who are in the middle of the transactions will likely feel the effect even though it is still only a proposal.
The commission’s March 2022 rulemaking comes as there has been an unprecedented surge of SPACs shortly after the COVID-19 pandemic began. But the number of new ones started to go down slightly in recent months. Regulators have been worried about risks posed to investors. Among the problems that some pointed out are relative lack of decision-useful information, potential conflicts of interest on the part of the sponsor and other insiders, and divergent financial interest of the sponsor relative to that of the retail investors in the SPAC.
“Although the SEC has expressed many of these concerns in the past year through guidance related to de-SPAC transactions, these proposed rules go even further,” said Dave Brown, a partner with Alston & Bird LLP. “Once these rules are in place, SPACs will no longer be seen as a quick or easy way to an IPO [initial public offering] or IPO-lite.”
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. It has been popular because of the speed of the deals and the certainty of price compared to a traditional IPO. 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.
Christina Thomas, a partner with Mayer Brown LLP, agreed that it would change the environment for SPACs when seen in combination with the staff’s guidance—that dealt with disclosures and accounting treatment—which arguably already chilled the market for SPACs.
“If market participants are considering entering into a SPAC transaction now, they’re probably thinking of these proposed rules because the rules could be adopted in the timeframe between the SPAC IPO and the de-SPAC transaction,” Thomas said. “So, it could have an effect on the entire transaction itself even if you did the IPO right now.”
A controversial, complex proposal could take two years for a final rule to come out.
But “two years is probably extreme,” said another securities lawyer, who asked not to be identified, because it is a priority rulemaking item for the SEC. “If I had to guess, they’re showing the body language that suggests … they are going to try and move quickly.”
The comment period for the proposal in Release No. 33-11048, Special Purpose Acquisition Companies, Shell Companies, and Projections, is end of May.
The staff will analyze the comment letters, and the source said that the rules could come out in the fourth quarter of this year, though could be in 2023.
The proposed rules indeed are sweeping. The SEC wants additional disclosures about sponsors, conflicts of interest, sources of dilution, and business combination transactions.
Gatekeepers such as auditors, lawyers, and underwriters, would be required to be responsible for basic aspects of their work because they play an essential role in ensuring the accuracy of disclosures.
It would deem any SPAC blank-check IPO underwriter that takes steps to facilitate a SPAC target IPO or any related financing transaction to be an underwriter in the SPAC target IPO.
The proposed rule would require that any business combination of a public shell company with a non-shell company be deemed a sale to the shell company’s shareholders subject to the Securities Act of 1933.
The proposal, among numerous other requirements, addresses the status of SPACs under the Investment Advisers Act of 1940. They have long been considered not to be investment companies. But the SEC proposed a safe harbor as long as certain conditions are met.
“There are a number of items that stand out, including eliminating the use of projections and the requirement for a fairness determination. The fairness determination puts the de-SPAC transaction into similar territory as a going-private transaction in Rule 13e-3” of the Securities Exchange Act of 1934, Alston’s Brown said. “This enhanced disclosure obligation will require additional work by the financial advisers and additional disclosure to shareholders relating to that work. This will result in extra costs and compliance burdens on SPACs.”
“Essentially the SEC is putting the burden of protecting investors in de-SPAC transactions on the so-called gate keepers—financial advisors and accountants,” Brown added.
Commissioner Peirce’s Criticism
The company on April 14 said that SolarMax Technology, Inc. intends to terminate its merger agreement with the SPAC. SolarMax thinks that the proposed merger would not be completed by April 26, the date by which the merger must be completed for the SPAC’s securities to remain listed on Nasdaq stock exchange. It said that as of April 13, the registration statement was not declared effective by the SEC.
“Therein lies the question that troubles me: Why exactly did the SEC not take the routine step—one typically taken on delegated authority by the staff without input from the Commission—to declare the registration statement effective?” Peirce said. “Commission inaction on a request for acceleration of the effective date of a registration statement is highly unusual.”
In her view, this is a result of the SEC’s “newfound hostility” to SPACs.
She explained that the SPAC did the IPO in October 2018. Its shareholders approved two extensions before a merger agreement in October 2020 with SolarMax, a solar energy company with operations in China. Subsequently, the shareholders approved two more extensions.
The SPAC meanwhile filed eight amendments related to the merger since October 2020.
But during that period, she noted that the SEC staff’s accounting treatment for warrants led many SPACs to restate their financial statements. In addition, she pointed to the SEC’s effort to elicit more disclosures by China-based companies.
Most significantly, she pointed to the rule proposal.
“Because of the timing—less than a month after the release of the SPAC proposal, one cannot help wondering, however, whether this SPAC might be a victim of the parameters of a non-exclusive safe harbor that have not yet been adopted,” she said.
She explained that the SPAC has been going back and forth with SEC staff for months. But the SPAC did not get the response that virtually everyone gets at this stage of the process. “That appears to be the death knell of the SPAC, which robs the investors of the opportunity to decide whether they approve the merger agreement,” she said, asking whether other SPACs will face existential questions from the SEC at the 11th hour.
“If so, why not let them know earlier in the process that there is a problem?” she said. “It is not a good look for the Commission to run a SPAC through the gauntlet of addressing disclosure comments only to say, ‘Oh, and by the way, now you are too old to be anything other than an investment company.’”
This article originally appeared in the April 19, 2022 edition of Accounting & Compliance Alert, available on Checkpoint.
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