SEC Publishes Final Rule for SPAC Transactions, Bringing Much-Needed Clarity and Certainty to Rules for Capital Raising
On January 24, the SEC adopted its final rule (the Final Rule) with respect to special-purpose acquisition companies (SPACs) and mergers of SPACs with private businesses that result in the private businesses becoming public companies (De-SPAC transactions). The Final Rule primarily seeks to improve the standard of disclosures for SPAC and De-SPAC transactions, as well as to enhance investor protections and realign disclosure requirements for De-SPAC transactions comparable to traditional initial public offerings (IPOs). In a statement made by SEC Chair Gary Gensler concurrently with the release of the Final Rule, Chair Gensler reaffirmed, “The federal securities laws provide a range of protections for investors in traditional IPOs — through disclosure, marketing standards, as well as gatekeeper and issuer obligations. This adoption will ensure that similar protections apply to investors in these non-traditional IPOs as much as they do for investors in traditional IPOs.” The Final Rule comes in the wake of a surge of entities becoming public companies via SPAC and De-SPAC transactions from 2020-2022. During this time, SPAC IPOs constituted over half of all IPOs (as well as 43% in 2023), with corresponding De-SPAC transactions likewise increasing during this period.
The Final Rule provides a new, comprehensive disclosure regime for SPAC and De-SPAC transactions, as well as clarity for legal liability questions and governance matters. Ultimately, the Final Rule removes legal uncertainty from capital raising in many respects and addresses some of the critiques this type of transaction has received from market participants. Accordingly, entities considering raising capital through the SPAC door should consider the following:
- The overall outcome of the Final Rule is that traditional IPOs and De-SPAC transactions should now require levels of disclosure that are more similar to each other.
- There are still valid reasons to become a public company through a De-SPAC transaction as opposed to a traditional IPO, most notably having more control over the valuation of shares and avoiding the market risk in terms of the timing of a De-SPAC transaction.
- The Final Rule requires disclosure — both on the outside cover page of the prospectus and within the prospectus summary — of any actual or potential conflict of interest between unaffiliated security holders of a SPAC and (1) the SPAC sponsor or its affiliates; (2) the officers, directors, or promoters of the SPAC; or (3) the officers and directors of the target company (in the context of a De-SPAC transaction, the Target). These conflicts of interest should include any that may arise in determining whether to proceed with a De-SPAC transaction or from how the SPAC compensates its officers and directors and the SPAC sponsor (and its officers and directors).
- In many instances, the Final Rule attempted to codify disclosures that the SEC believed were already market practice for the purpose of creating more consistent and comparable disclosures amongst different issuers. As such, for these disclosures, there may not be a large gap to address to comply with the requirements of the Final Rule.
- The Final Rule readjusts the potential legal liability for misstatements in De-SPAC transactions to the same level as traditional IPOs — i.e., strict liability, now applicable to the Target as a co-registrant as well.
- The increased legal liability standards for all issuers under the Final Rule may also affect the level of directors and officers insurance required to become a public company under a De-SPAC transaction.
- The Final Rule also realigns the requirements for financial reporting and audits meeting the standards of the Public Company Accounting Oversight Board (PCAOB) to match that of traditional IPOs. Planning ahead to comply with this updated requirement, particularly in light of the new requirement to re-determine smaller reporting company (SRC) status within 45 days, is crucial to making sure a new public company does not inadvertently fall short in its financial reporting obligations shortly upon becoming a public company.
- With increased disclosure requirements and increased legal liability under the Final Rule, becoming a public company via a De-SPAC transaction may no longer appeal to those interested in short paths to becoming a public company.
- All in all, the Final Rule makes some key changes in the landscape of SPAC and De-SPAC transactions, and gives companies and investors evaluating a potential SPAC/De-SPAC transaction plenty to discuss with their legal and financial advisors.
Overview of the Final Rule
Below, we summarize highlights of the Final Rule with respect to (1) disclosure requirements for SPACs and De-SPAC transactions under a new Subpart 1600 to Regulation S-K (Reg. S-K 1600); (2) required disclosures and enhanced investor liability protection in De-SPAC transactions; (3) updated disclosures for business combinations involving shell companies; and (4) enhanced projections disclosures. The Final Rule becomes effective 125 days after publication in the Federal Register, and entities must comply with the Final Rule within 490 days after publication in the Federal Register.1
New Disclosure Requirements in New Reg. S-K 1600
The Final Rule adds a new Subpart 1600 to Regulation S-K that sets forth disclosure requirements applicable to SPACs regarding, among other things, the SPAC sponsor, potential conflicts of interest, dilution, and diligence by the board of directors.
In connection with SPAC offerings and De-SPAC transactions, Reg. S-K 1603 requires disclosure of the experience, material roles, and responsibilities of the SPAC sponsor, its affiliates and any promoters. Reg. S-K 1603 also requires disclosure of any agreement, arrangement, or understanding (1) between the SPAC sponsor and the SPAC, its executive officers, directors, or affiliates, with respect to determining whether to proceed with a De-SPAC transaction and (2) between the SPAC sponsor and unaffiliated security holders of the SPAC regarding the redemption of outstanding securities. SPACs will now have to disclose the controlling persons of the SPAC sponsor and any persons who have direct and indirect material interests in the SPAC sponsor and the nature and amount of their interests; provide tabular disclosure of the material terms of any lock-up agreements with the SPAC sponsor and its affiliates; and disclose nature and amounts of all compensation that has or will be awarded to, earned by, or paid to the SPAC sponsor, its affiliates, and any promoters for all services rendered in all capacities to the SPAC and its affiliates, as well as the nature and amounts of any reimbursements to be paid to the SPAC sponsor, its affiliates, and any promoters upon the completion of a De-SPAC transaction.
Conflicts of Interest
The Final Rule requires disclosure of certain conflicts of interest on both the prospectus front cover page and in the prospectus summary for both registered offerings and De-SPAC transactions. Reg. S-K 1603 requires disclosure of any actual or potential material conflict of interest between (1) any SPAC sponsor or its affiliates or the SPAC’s officers, directors, or promoters and (2) unaffiliated security holders of the SPAC. This includes any conflict of interest with respect to determining whether to proceed with a De-SPAC transaction and any conflict of interest arising from the manner in which a SPAC compensates any SPAC sponsor or the SPAC’s officers and directors or the manner in which any SPAC sponsor compensates its own officers and directors. Reg. S-K 1603 also requires disclosure regarding the fiduciary duties each officer and director of a SPAC may owe to other companies.
For De-SPAC transactions, the Reg. S-K 1605 requires disclosure of any material interests in the De-SPAC transaction or any related financing transaction held by the SPAC sponsor or the SPAC’s officers and directors, including fiduciary or contractual obligations to other entities, as well as any interest in, or affiliation with, the Target.
The Final Rule requires additional information about SPAC dilution in connection with registered offerings by SPACs, including IPOs, and in connection with De-SPAC transactions. Reg. S-K 1602 requires disclosure on the prospectus outside cover page of whether compensation of the SPAC sponsor, its affiliates, and promoters may materially dilute purchasers’ equity interests, as well as tabular disclosure of the net tangible book value per share, as adjusted, at quartile intervals based on percentages of the maximum redemption threshold. In addition, Reg. S-K 1602 requires tabular disclosure in the summary prospectus of the extent to which compensation of the SPAC sponsor, its affiliates, and promotors may materially dilute purchasers’ equity interests. Further, Reg. S-K 1602 requires a description of material potential sources of future dilution after the registered offering by the SPAC, including tabular disclosure of future dilution (in the same quartile intervals) from the public offering price that will be absorbed by purchasers of the securities being offered, to the extent known and quantifiable.
For De-SPAC transactions, Reg. S-K 1604 requires disclosure on the prospectus outside front cover page of whether compensation of the SPAC sponsor, its affiliates, and promoters may materially dilute the equity interests of non-redeeming shareholders who hold the securities until the consummation of the De-SPAC transaction, including cross-references (highlighted by prominent type or in another manner) to related disclosures in the prospectus. Within the prospectus summary, Reg. S-K 1604 requires (1) tabular disclosure of whether compensation of the SPAC sponsor and its affiliates has resulted or may result in a material dilution of the equity interests of non-redeeming shareholders of the SPAC; (2) disclosure of the dilutive impact of any financing transactions that have occurred or will occur in connection with the consummation of the De-SPAC transaction on non-redeeming shareholders; (3) disclosure of the rights of security holders to redeem the outstanding securities of the SPAC and the potential dilutive impact of redemptions on non-redeeming shareholders; and (4) tabular disclosure at each redemption level in the sensitivity analysis of the dilutive impact on non-redeeming shareholders of each source of dilution and a description of material potential sources of future dilution that non-redeeming shareholders may experience by electing not to tender their shares in connection with the De-SPAC transaction.
Prospectus Cover Page
For registered offerings (including IPOs) by SPACs other than De-SPAC transactions, Reg. S-K 1602 requires disclosure on the prospectus outside front cover page about, among other things (1) the time frame for the SPAC to consummate a De-SPAC transaction; (2) redemptions; (3) SPAC sponsor compensation and dilution, including simplified tabular disclosure (as discussed in further detail above); and (4) conflicts of interest.
For De-SPAC transactions, Reg. S-K 1604 requires that SPACs include information on the prospectus outside front cover page about, among other things (1) the SPAC board of directors’ determination of whether it reasonably believes that a De-SPAC transaction is advisable and in the best interest of the SPAC and its security holders, if required under the law of the jurisdiction of the SPAC’s organization, and whether it received a report, opinion, or appraisal as to the fairness of the De-SPAC transaction; (2) material financing transactions; (3) SPAC sponsor compensation and dilution, as discussed in further detail above; and (4) conflicts of interest.
Background and Reasons for De-SPAC Transactions
Reg. S-K 1605 requires disclosure of the background, material terms, and effects of a De-SPAC transaction, including (1) a summary of the background of the De-SPAC transaction, including, but not limited to, a description of any contacts, negotiations, or transactions that have occurred concerning the De-SPAC transaction; (2) a brief description of any related financing transaction, including any payments from the SPAC sponsor to investors in connection with the financing transaction; (3) the reasons of the SPAC and the Target for engaging in the particular De-SPAC transaction and for the structure and timing of the De-SPAC transaction and any related financing transaction; (4) an explanation of any material differences in the rights of the SPAC and the Target security holders of the post-business combination company as a result of the De-SPAC transaction; (5) the accounting treatment and the Federal income tax consequences of the De-SPAC transaction to the SPAC, the Target, and their respective security holders; (6) any material interests in the De-SPAC transaction or any related financing transaction held by the SPAC sponsor and the special purpose acquisition company’s officers and directors, including fiduciary or contractual obligations to other entities as well as any interest in, or affiliation with, the Target; or held by the Target’s officers or directors that consist of any interest in, or affiliation with, the SPAC sponsor or the SPAC; and (7) a statement as to whether or not security holders are entitled to any redemption or appraisal rights, a summary of such redemption or appraisal rights, and, if there are no redemption or appraisal rights available for security holders who object to the De-SPAC transaction, a brief outline of any other rights that may be available to security holders.
Board Determination of De-SPAC Transactions
Reg. S-K 1606 requires a statement from a SPAC as to, if the law of the jurisdiction of the SPAC’s organization requires, whether the SPAC’s board of directors reasonably believes that a De-SPAC transaction is advisable and in the best interest of the SPAC and its security holders, as well as whether any director voted against or abstained from voting on the approval of the De-SPAC transaction. The Final Rule does not require a SPAC to obtain a fairness opinion in connection with a De-SPAC transaction. Reg. S-K 1606 adds a discussion of a non-exclusive list of factors the board of directors (or similar governing body) considered in making such determination disclosed to the extent such factors were considered. These factors include, but are not limited to, the valuation of the Target; financial projections relied upon by the board of directors (or similar governing body); the terms of financing materially related to the De-SPAC transaction; dilution; and any report, opinion, or appraisal referred to in Reg. S-K 1607. Reg. S-K 1607 requires the disclosure and filing of any report, opinion (other than an opinion of counsel), or appraisal from an outside party or unaffiliated representative materially relating to the board of directors’ (or similar governing body) determination, if any was received by the SPAC or SPAC sponsor.
Disclosure Re Tender Offer Filings
Reg. S-K 1608 codifies an SEC Staff position that a Schedule TO filed in connection with a De-SPAC transaction should contain substantially the same information about a target private operating company that is required under the proxy rules and that a SPAC must comply with the procedural requirements of the tender offer rules when conducting the transaction for which the Schedule TO is filed, such as a redemption of the SPAC securities. Reg. S-K does not affect the SEC Staff’s position for those SPACs that file a Schedule 14A or 14C for their De-SPAC transactions or extensions.
Disclosures and Liability in De-SPAC Transactions
The Final Rule also modifies existing rules to more closely align the treatment of De-SPAC transactions with traditional IPOs. In doing so, the SEC expressed the view that a private operating company’s method of becoming a public company should not negatively impact investor protection.
Non-Financial Disclosures in De-SPAC Disclosure Documents
The Final Rule states that if the Target is not subject to the reporting requirements of Section 13(a) or 15(d) of the Exchange Act, disclosure with respect to the Target would be required in the registration statement or schedule filed in connection with the De-SPAC transaction, each pursuant to Reg. S-K. These disclosures include (1) description of the business; (2) description of property; (3) legal proceedings; (4) changes in and disagreements with accountants on accounting and financial disclosure; (5) security ownership of certain beneficial owners and management, assuming the completion of the De-SPAC transaction and any related financing transaction; and (6) recent sales of unregistered securities. The Final Rule also amends Forms S-1 and F-1 to provide that, where they are used to register securities in connection with a De-SPAC transaction, they must include the information required in Forms S-4 and F-4, respectively. Further, the Final Rule amends Schedule TO and Schedule 14A to incorporate the disclosure provisions of Reg. S-K 1600 if such filing relates to a De-SPAC transaction.
Minimum Dissemination Period
The Final Rule requires that prospectuses and proxy and information statements filed in connection with De-SPAC transactions be distributed to security holders at least 20 calendar days in advance of a security holder meeting or the earliest date of action by consent, or the maximum period for disseminating such disclosure documents permitted under the applicable laws of the SPAC’s jurisdiction of incorporation or organization if such period is less than 20 calendar days. Historically, there has been no requirement under SEC rules to provide security holders with a minimum amount of time to consider a proxy statement or other disclosure in connection with business combination transactions.
Private Operating Company as Co-Registrant
The Final Rule amends Forms S-4 and F-4 to require that both the SPAC and the Target are “registrants” for the purpose of the De-SPAC transaction and that both entities’ officers and directors sign the registration statement, taking the position that the “issuer” of securities in a De-SPAC transaction is the Target, in substance. As a result, the Target, and its officers and directors, will from now on be subject to liability under Section 11 of the Securities Act (i.e., strict liability), just as if the Target had undergone a traditional IPO on Form S-1 or F-1. As “registrants” and “issuers,” Targets must file periodic reports after the effectiveness of the De-SPAC registration statement and until the Target terminates and/or suspends its Exchange Act reporting obligations.
Re-Determination of SRC Status
If applicable, the Final Rule requires a re-determination of SRC status following the consummation of a De-SPAC transaction and prior to the time it makes its first SEC filing (other than a Form 8-K filed with Form 10 information). However, the Final Rule provides that the registrant does not need to reflect non-SRC status in any filing that is due in the 45-day period following the consummation of the De-SPAC transaction. The SEC notes in the Final Rule that it believes this provision will “help level the playing field” for when a company undergoes a De-SPAC transaction rather than a traditional IPO.
PSLRA Safe Harbor
The Final Rule makes the Private Securities Litigation Reform Act (PSLRA) safe harbor unavailable for SPACs and De-SPAC transactions, further aligning the liability exposure of De-SPAC transactions with traditional IPOs. The PSLRA provides a safe harbor for forward-looking statements, under which a company is protected from liability for forward-looking statements in any private right of action when, among other conditions, the forward-looking statement is identified and accompanied by meaningful cautionary language. However, the PSLRA safe harbor is not available for forward-looking statements made in connection with, among other things, an offering by a blank check company, an offering by an issuer of penny stock, or an IPO. Accordingly, the Final Rule accomplishes the foregoing by adopting a new definition of “blank check company” intended to make the PSLRA safe harbor unavailable for blank check companies, like SPACs.
Business Combinations Involving Shell Companies
In response to concerns regarding the use of shell companies as a means of accessing the U.S. capital markets, the SEC proposed new rules that would apply to business combination transactions involving shell companies, which include De-SPAC transactions. To that end, the Final Rule includes new Rule 145a under the Securities Act that would deem such business combination transactions to involve a sale of securities to a reporting shell company’s shareholders and new Article 15 of Reg. S-X and related amendments to more closely align the required financial statements for De-SPAC transactions with those of a traditional IPO.
Rule 145a — Shell Company Business Combinations and the Securities Act
Rule 145a addresses the use of reporting shell companies (such as SPACs) as a means to enter the U.S. capital markets without Securities Act registration and the related disclosures. Accordingly, Rule 145a deems any direct or indirect business combination of a reporting shell company (that is not a business combination-related shell company) involving another entity that is not a shell company to involve a sale of securities to the reporting shell company’s shareholders. That is, in the context of a De-SPAC transaction, Rule 145a would find that the Target sold its securities to the security holders of the SPAC entity. Accordingly, the exemption from registration under Section 3(a)(9) — for securities exchanged by an issuer with existing security holders exclusively where no commission or other remuneration is paid or given directly or indirectly for soliciting such exchange — would not be available for De-SPAC transactions. However, Rule 145a does not otherwise prevent or prohibit the use of another valid exemption, if available, for the deemed sale of securities to a reporting shell company’s shareholders.
Reg. S-X Art. 15 — Financial Statement Requirements in Business Combination Transactions Involving Shell Companies
Consistent with the SEC’s position that the method of becoming a public company should not affect the standard of disclosures, the Final Rule also amends Reg. S-X so as to not result in substantially different financial statement disclosures to investors. Such amendments to Reg. S-X include:
- Audit Requirements. The Final Rule adds Reg. S-X 15-01, which requires, for a business that is or will be a predecessor to a shell company, an examination of the financial statements by an independent accountant in accordance with the standards of the PCAOB for the purpose of expressing an opinion thereon. Accordingly, a predecessor to a shell company, such as the Target, is subject to the same financial statement audit requirements as if it were filing for a traditional IPO.
- Number of Years of Financial Statements. Reg. S-X 15-01 aligns the number of fiscal years required to be included in the financial statements for a business that will be the predecessor in a shell company business combination with that required in a traditional IPO. That is, in a De-SPAC transaction, the Target (often the predecessor entity for accounting purposes) must determine its filer status and provide the same number of years of financial statements for the SPAC registrant to file in its Form S-4 or F-4, as applicable, as if the Target were filing its own registration statement in a traditional IPO. This change permits the SPAC registrant to file only two years of financial statements if the Target qualifies as a smaller reporting company or an emerging growth company.
- Staleness of Financial Statements. Reg. S-X 15-01 provides that the financial statements of a business that will be the predecessor to the shell company must comply with Reg. S-X 3-12 and 8-08 in determining the staleness of the financial statements of the predecessor business in the registration statement or proxy statement of the registrant, consistent with the requirements in a traditional IPO.
- Financial Statements of a Shell Company Registrant After Combination With the Predecessor. Reg. S-X 15-01 permits a shell company, including a SPAC, to exclude the financial statements of the shell company for periods prior to the business combination that resulted in the combined entity no longer being a shell company once the following conditions have been met (1) the financial statements of the predecessor, as that term is used in financial reporting, have been filed for all required periods through the acquisition date and (2) the financial statements of the combined entity registrant include the period in which the acquisition was consummated, which would also include the accounting for the business combination. The Final Rule adds that if a registrant is to acquire or has acquired a shell company, the financial statements of the shell company must be included in any filing requiring the registrant’s financial statements as if the shell company were the registrant, unless the registrant’s financial statements include the period in which the acquisition was consummated. The historical financial statements of the shell company must be included in all filings that require financial statements (including registration statements and the Form 8-K with Form 10 information filed following the De-SPAC transaction) filed prior to the first periodic report.
- Balance Sheets of Predecessors. The Final Rule amends Reg. S-X 3-01, 8-02, and 10-01 to refer specifically to financial statements of predecessors, not only registrants.
Enhanced Projections Disclosures
Finally, the Final Rule amends Reg. S-K 10(b) and adds Reg. S-K 1609 to enhance the disclosures related to financial projections in SEC filings.
Reg. S-K 10(b)
Reg. S-K 10(b) provides guidance for the factors to be considered in formulating and disclosing management’s projections of future economic performance in SEC filings. The Final Rule expands and updates this guidance and reiterates that projected financial information must have a reasonable basis. The Final Rule provides (1) any projected measures not based on historical financial results or operational history should be clearly distinguished from those that are; (2) it generally would be misleading to present projections that are based on historical financial results or operational history without presenting such historical measure or operational history with equal or greater prominence; and (3) the presentation of projections that include a non-GAAP financial measure should include a clear definition or explanation of the measure, a description of the GAAP financial measure to which it is most directly comparable, and an explanation of why the non-GAAP financial measure was used instead of a GAAP measure. The Final Rule further clarifies that this guidance also applies to the Target’s projections when they are presented to investors through the registrant’s SEC filings.
Reg. S-K 1609
For De-SPAC transactions, Reg. S-K 1609 requires registrants to disclose (1) the purpose for which any projections disclosed in an SEC filing were prepared and the party that prepared the projections; (2) all material bases of the disclosed projections, all material assumptions underlying the projections, and any material factors that may impact such assumptions (including a discussion of any material growth or reduction rates or discount rates used in preparing the projections, and the reasons for selecting them); and (3)(A) whether the disclosed projections reflect the view of the board or management of the SPAC or the Target, as applicable, as of the most recent practicable date prior to the date of the disclosure document required to be disseminated to security holders and (B) if the disclosed projections no longer reflect the view of the board or management of the SPAC or the Target, a statement regarding the purpose of disclosing the projections and the reasons for any continued reliance by management or the board on the projections.
The Final Rule likewise amends the General Instructions to Form 8-K to require the information in clauses (1) and (2) above and include the projections relating to the performance of the SPAC or the Target.
Underwriter Status and Liability and Investment Company Issues – Not in Final Rule
While the SEC initially proposed to provide further guidance with respect to underwriter status and liability and the treatment of SPACs as investment companies, the Final Rule ultimately did not prescribe further guidance on these topics. The SEC stated that such determinations should continue to be analyzed based on individual facts and circumstances under current law, which the Final Rule said are customarily interpreted broadly.
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© Arnold & Porter Kaye Scholer LLP 2024 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.