U.S. SEC Adopts New Regulations for SPAC and De-SPAC Transactions

On January 24, 2024, the U.S. Securities and Exchange Commission (SEC) adopted new and amended rules and issued guidance (the “Final Rules”) relating to special purpose acquisition companies (SPACs) and business combination transactions between SPACs and private operating companies (“de-SPAC transactions”).[1] With limited exceptions, the Final Rules follow the proposed rules (the “Proposed Rules”) issued by the SEC on March 30, 2022,[2] previously discussed in our April 11, 2022 alert, which had chilling effects on the SPAC industry and garnered substantial public commentary for nearly two years. In many ways, the requirements of the Final Rules are already reflected in current market practice, as many market participants—in the face of regulatory uncertainty—have operated as if the Proposed Rules were already in effect.

Notwithstanding the market reaction to the proposed rules and the resulting changes in the SPAC market, SPAC IPOs and de-SPAC transactions continue to represent an attractive way for certain private companies to enter the public markets. Despite SEC Chair Gary Gensler’s comments noted below, the market slowdown in SPAC IPOs and de-SPAC transactions likely has more to do with the post de-SPAC transaction performance of many de-SPAC companies rather than the Proposed Rules or Final Rules. Furthermore, market practice had largely evolved to preemptively address many of the changes that ultimately were adopted in the Final Rules, and the release of the Final Rules should provide SPAC sponsors, target companies, investors and investment banks greater certainty to pursue SPAC transactions.

The SEC indicated the Final Rules are meant to enhance investor protections for initial public offerings (IPOs) by SPACs and de-SPAC transactions.[3] SEC Chair Gary Gensler stated the Final Rules “will help ensure that the rules for SPACs are substantially aligned with those of traditional IPOs, enhancing investor protection through . . . disclosure, use of projections, as well as issuer obligations.”[4] Commissioners Peirce and Uyeda dissented, with Peirce noting the “regulatory reaper came for SPACs and seems to have won”[5] and Uyeda commenting “there may be a far simpler explanation behind what the Commission is doing for SPACs: we simply do not like them . . . . [T]he SPAC market is a shell of its former self. Today’s recommendation shows that the Commission intends to never let them return.”[6]

The Final Rules, among other things:

• Align de-SPAC transactions with traditional IPOs by (i) creating potential disclosure liability for additional parties, (ii) making the Private Securities Litigation Reform Act of 1995 (PSLRA) safe harbor for forward-looking statements unavailable to SPACs, and (iii) requiring a redetermination of smaller reporting company status after a de-SPAC transaction;
• Require additional disclosures for SPACs regarding, among other things, the role of the SPAC sponsor, conflicts of interest, dilution, financial projections, and whether the SPAC’s board determined that a de-SPAC transaction is advisable and in the best interests of the SPAC and its shareholders;
• Enhance disclosure requirements regarding the use of projections in all SEC filings, for both SPAC and non-SPAC issuers; and
• Amend rules applicable to all reporting shell companies (including SPACs) regarding what qualifies as a “sale” of securities under the Securities Act of 1933 (“Securities Act”) and financial statement requirements applicable to transactions involving reporting shell companies.

The SEC did not adopt two noteworthy elements of the Proposed Rules:

• First, the SEC declined to adopt proposed Securities Act Rule 140a (the “Statutory Underwriter Proposal”) that would have deemed anyone who acted as an underwriter of SPAC securities and later takes steps to facilitate a de-SPAC transaction, or any related financing transaction, or who otherwise participates (directly or indirectly) in the de-SPAC transaction to be considered an “underwriter” within the meaning of Section 2(a)(11) under the Securities Act in connection with de-SPAC transactions.

• Second, the SEC declined to adopt a safe harbor from the “investment company” definition under the Investment Company Act of 1940 (“Investment Company Act”) for SPACs that meet certain requirements regarding asset classes, activities, primary engagement, and duration (including that a SPAC must announce a business combination within 18 months of its IPO and complete a business combination within 24 months of its IPO).

Instead of adopting these proposed rules, the SEC offered guidance that seeks to “assist SPACs in assessing when they may meet the definition of an investment company under the Investment Company Act of 1940 and regarding statutory underwriter status under the Securities Act of 1933 in connection with de-SPAC transactions.”[7]

Background

SPACs are a type of blank check company, the purpose of which is to raise money in a public offering, identify a suitable target for a business combination, and then consummate that business combination. SPACs generally target private companies and, accordingly, de-SPAC transactions represent an alternative to the traditional IPO for private companies seeking to go public. In 2020 and 2021, SPAC IPOs surged in popularity in part due to certain benefits (or perceived benefits) of de-SPAC transactions relative to traditional IPOs, including greater certainty in execution and valuation, the relatively faster path to go public, and, importantly, the belief that SPACs, unlike traditional IPOs, could more easily present financial projections. SPACs conducted more than half of all IPOs completed in the years 2020 and 2021.[8] This spike raised some concerns with the SEC, which publicly questioned the premise that de-SPAC transactions were not subject to the same securities law disclosure obligations and statutory liability scheme applicable to traditional IPOs.

After numerous pronouncements during 2021—most of which were akin to purposeful reminders to the market that SPACs are subject to robust disclosure and other obligations required for the protection of investors—the SEC issued the Proposed Rules on March 30, 2022. After nearly two years of substantial public commentary from the SPAC, general business, academic, and legal communities, the SEC adopted the Final Rules substantially as proposed.

The Final Rules Provide Guidance on Statutory Underwriter and Investment Company Status

Underwriter Status and Liability in Securities Transactions

As discussed above, the SEC declined to adopt the Statutory Underwriter Proposal that would have deemed anyone who has acted as an underwriter of SPAC securities and takes steps to facilitate a de-SPAC transaction, or any related financing transaction, or who otherwise participates (directly or indirectly) in the de-SPAC transaction to be considered an “underwriter” within the meaning of Section 2(a)(11) under the Securities Act in connection with de-SPAC transactions. The Statutory Underwriter Proposal sent particularly significant shockwaves through the market in 2022, with many investment banks preemptively suspending their participation as SPAC IPO underwriters and/or placement agents, terminating existing engagements to act as PIPE placement agents, and/or waiving their entitlement to deferred IPO compensation relating to SPAC IPOs for which they served as an underwriter.

In lieu of adopting the Statutory Underwriter Proposal, the SEC provided guidance regarding statutory underwriter status in connection with de-SPAC transactions, indicating that it would continue applying the statutory terms “distribution” and “underwriter” through broad, flexible, and fact-specific analysis. The SEC (i) reiterated that a de-SPAC transaction is a distribution of securities for the purposes of Section 2(a)(11) of the Securities Act, (ii) referenced new Rule 145a (which deems there to be a sale from the combined company to the SPAC’s existing shareholders regardless of the de-SPAC transaction’s structure), and (iii) noted that an underwriter would be present in a de-SPAC transaction “where someone is selling for the issuer or participating in the distribution of securities in the combined company to the SPAC’s investors and the broader public” even if the entity is not named as an underwriter or engaged in activities typical of a named underwriter in traditional capital raising transactions.[9] The Adopting Release does not offer meaningful guidance on the definition of “participating” in a distribution of securities in connection with a de-SPAC transaction.

Key Takeaways: Given the lack of clarity in the SEC’s statutory underwriter guidance (in particular, regarding the meaning of an entity’s “participation” in a de-SPAC transaction and the untested facts and circumstances approach in the context of de-SPAC transactions), we expect that the dialogue around the SEC’s positions with respect to statutory underwriter status will continue. In the meantime, we expect that many market participants will continue refraining from involvement with de-SPAC transactions altogether or, alternatively, requiring enhanced procedures undertaken in a traditional IPO, including significant due diligence and the delivery of legal opinions, negative assurance letters, and auditor comfort letters. The use of projections in connection with de-SPAC transactions has likewise been chilled, as potential underwriters and issuers remain reticent to take on liability associated with such projections in light of the Proposed Rule and Final Rule changes to the liability regime discussed below, as well as the failure of many companies post de-SPAC transaction to meet disclosed projections, leading, in part, to the poor trading performance of many companies.

Investment Company Status

As discussed above, the SEC declined to adopt the proposed non-exclusive safe harbor for SPACs from the “investment company” definition under the Investment Company Act. Instead, the SEC provided guidance on which actions might push a SPAC towards investment company status, while emphasizing that it ultimately remains a question of facts and circumstances. The SEC also emphasized that a SPAC should evaluate its Investment Company Act status “at its inception and throughout its existence.”[10]

Factors identified by the SEC in the determination of investment company status include:

• The Nature of the SPAC’s Assets and Income. On the one hand, a SPAC owning or proposing to acquire 40% or more of its total assets in investment securities would weigh in favor of investment company status. On the other hand, a SPAC holding its assets in U.S. government securities, money market funds, and cash items prior to a de-SPAC transaction would weigh against investment company status. Additionally, a SPAC should not seek to achieve returns on these assets instead of its de-SPAC transaction as its primary business activity.
• Management Activities. A SPAC’s officers, directors, and employees spending a considerable amount of their time actively managing the SPAC’s portfolio for the primary purpose of achieving investment returns or failing to actively seek a de-SPAC transaction would weigh in favor of investment company status.
• Duration. A SPAC should reference the 12-month safe harbor for transient investment companies under Rule 3a-2 of the Investment Company Act and the 18-month limit contemplated by Rule 419 of the Securities Act. A SPAC operating beyond these timelines would weigh (increasingly as the departure from these timelines lengthens) in favor of investment company status.
• Public Statements. A SPAC holding itself out as primarily engaged in investing, reinvesting, or trading in securities would weigh in favor of investment company status.
• Merger with an Investment Company. A SPAC engaging in a de-SPAC transaction with an investment company would weigh in favor of investment company status.

Key Takeaways: In our view, this guidance will not have a significant effect on the market because it is consistent with current market practices and generally follows well-established guidelines for investment company status under the Investment Company Act (known as the Tonopah factors). However, the guidance on a SPAC’s duration may concern some market participants. While many commenters suggested that the SEC follow standard listing requirements (which provide a 36-month timeline to complete a de-SPAC transaction) and recent market practice has commonly recognized at least a 24-month period to complete a de-SPAC transaction, the SEC imposed new timelines that could be considered in making the determination. SPACs who have extended their lifecycle beyond the typical 24-month period have increasingly been exiting their investments in U.S. government securities, money market funds in favor of cash.

The Final Rules Align De-Spac Transactions with Traditional Initial Public Offerings

Private Operating Company as Co-registrant in de-SPAC Registration Statement

The Final Rules amend Forms S-1, S-4, F-1, and F-4 to reflect that a private operating company (i.e., the target company) will be deemed a co-registrant when a SPAC or another shell company files a registration statement for a de-SPAC transaction. As signatories to the registration statement, the private company and its signing persons (e.g., principal executive, financial and accounting officers, and board members) are subject to strict liability under Section 11 of the Securities Act for material misstatements or omissions in the disclosure included or incorporated into the registration statement, in addition to the SPAC or holding company and its officers and directors.[11]

The Final Rules seek to strengthen the target company’s accountability in a de-SPAC transaction and thereby “improve the reliability of the disclosure provided to investors in connection with de-SPAC transactions by creating strong incentives for such additional signing persons (among others who would have liability under Section 11 as a result of these requirements, such as non-signing directors) to conduct thorough diligence in connection with the de-SPAC transaction and review more closely the disclosure about the target company.”[12]

Although target companies already expect to assume any federal securities law liability of the SPAC arising out of materially false or misleading statements in its public disclosures in a registration statement used in connection with a de-SPAC transaction, target companies are now deemed to be “registrants” under the federal securities laws and, as a result, have direct liability exposure for such disclosures.

PSLRA Safe Harbor

The PSLRA provides a safe harbor for forward-looking statements under the Securities Act and the Securities Exchange Act of 1934 (“Exchange Act”). The Final Rules amend the definition of “blank check company” to include SPACs, thereby making the PSLRA safe harbor unavailable for forward-looking disclosures—including projections—in de-SPAC registration statements.

A significant perceived advantage of de-SPAC transactions relative to traditional IPOs was the ability to present projections with the benefit of the safe harbor. Although members of the SEC staff and Chairman Gensler attempted in prior public remarks to disabuse market participants of the belief that this perceived benefit was supported by the law, and the use of projections in de-SPAC transactions decreased following the release of the Proposed Rules, the Final Rules put to rest any question about the applicability of the safe harbor by amending the SEC’s definition of “blank check company” to include SPACs.

In light of this rule change, SPACs, target companies, and, depending on the facts and circumstances, SPAC IPO underwriters (and potentially others, including placement agents and financial advisors) must now confront the choice of either disclosing projections and other forward-looking information—which historically have been critical to the marketing of PIPE transactions and necessary to present a compelling investment thesis to SPAC shareholders in the hopes that they will not elect to redeem their shares—thereby taking on additional exposure to securities law liability, or omitting such projections and certain other forward-looking information in an effort to limit such exposure. If market participants choose the latter, the Final Rules may have the presumably unintended consequence of reducing information that might otherwise be provided to investors. Additionally, many target companies—particularly high-growth companies with historical losses, but significant projected growth—may find it more challenging to consummate de-SPAC transactions.

Non-financial Disclosures of the Private Operating Company

The Final Rules provide that, if the target company is not subject to the reporting requirements of Section 13(a) or 15(d) of the Exchange Act, the SPAC must provide non-financial statement disclosures similar to those in a traditional IPO, including a description of the target company’s business, property, and legal proceedings, changes in and disagreements with accountants, security ownership of certain beneficial owners and management, and recent unregistered sales of securities. While this information is already required to be included in a Current Report on Form 8-K filed within four days of the completion of the de-SPAC transaction, this rule seeks to provide this information to shareholders prior to voting, investing, or redeeming their shares and establish a “uniform, transparent, minimum floor standard of disclosure across transactions.”[13]

Re-test a Registrant’s Status as a “Smaller Reporting Company”

A “smaller reporting company” is currently defined as a company that is not an investment company, an asset-backed issuer, or a majority-owned subsidiary of a parent that is not a smaller reporting company, and has (1) public float of less than $250 million or (2) annual revenues of less than $100 million during the most recently completed fiscal year for which audited financial statements are available and either had no public float or a public float of less than $700 million. The status of a smaller reporting company is determined at the time of filing an initial registration statement. Most SPACs qualify as smaller reporting companies, and, prior to the adoption of the Final Rules, a post-business combination company could retain that status until the next annual determination.

The Final Rules require companies to re-determine smaller reporting company status prior to the time it makes its first SEC filing (other than the Form 8-K filed with Form 10 information) with (i) public float measured as of a date within four business days after the closing of the de-SPAC transaction and (ii) annual revenues measured using the annual revenues of the target company as of the most recently completed fiscal year. Companies are now required to reflect any re-determination in filings made 45 or more days following the closing of the de-SPAC transaction and the thresholds for such determinations remain unchanged.

The Final Rules Amend Disclosure Requirements Regarding the Use of Projections in All Sec Filings (by Both Spac and Non-Spac Issuers)

Item 10(b) of Regulation S-K currently applies to the use of projected financial information in SEC filings. Prior to the adoption of the Final Rules, an issuer could provide projections of future performance if there was a reasonable and good-faith basis for those projections and they included disclosure of the underlying assumptions and limitations of the projections.

The Final Rules, which apply generally to all issuers, amend Item 10(b) of Regulation S-K to require that projected financial information be clearly distinguished between projections based on historical financial results or operational history and those that are not. Further, when projections include a non-GAAP financial measure, an issuer now must include an explanation for why the most closely related GAAP measure was not used, in addition to a clear description of the non-GAAP measure and the directly comparable GAAP measure.

The Final Rules also clarify that the guidance in Item 10(b) would apply to projections relating to the registrant and to persons other than the registrant, including a target company in a business combination transaction.

Key Takeaways: Both the SPAC and target company should be mindful that any projections used may be cause for liability in light of the unavailability of the PSLRA safe harbor, as described above. To prevent any risks of liability, SPACs and target companies should include in-depth disclosure covering as much material information and assumptions used as possible to best align with the obligations under these proposals as well as corporate laws and federal securities laws.

The Final Rules Enhance Disclosure Requirements

The Final Rules add to Regulation S-K new Subpart 1600, which provides new disclosure requirements applicable to SPACs regarding certain areas such as the sponsor, potential conflicts of interest, dilution, and the use of fairness opinions in analyzing both de-SPAC transactions and related financial transactions. Many of these disclosure requirements are consistent with current market practice for SPAC IPOs and de-SPAC transactions and, as a result, are not expected to significantly disrupt the market.

• Sponsors:[14] The Final Rules require disclosure regarding the SPAC sponsor, its affiliates, and any promoters, including, among other things:
• the experience, material roles, and responsibilities of these parties;
• the circumstances or arrangements under which these parties have transferred or could transfer ownership of any of the SPAC’s securities;
• the material terms for any lock-up agreements for the sponsor and its affiliates;
• the controlling persons of the sponsor and any persons who have direct or indirect material interests in the sponsor; and
• the nature and amount of all compensation paid to these parties.
• Conflicts of Interest: The Final Rules require disclosure related to any actual or potential material conflicts of interests between the SPAC sponsor, its affiliates, the SPAC’s officers and directors, or the target company’s officers and directors, on the one hand, and the SPAC’s unaffiliated shareholders on the other hand.
• Dilution: The Final Rules require additional disclosure on material potential sources of additional dilution that non-redeeming SPAC shareholders may experience, including shareholder redemptions, sponsor compensation, underwriting fees, and PIPE transactions.
• Prospectus Cover Page and Summary: The Final Rules require standardized disclosure on the prospectus cover page and prospectus summary regarding the timeframe for a de-SPAC transaction, redemption rights, sponsor compensation, conflicts of interest, and dilution.
• SPAC Board Fairness Determinations and Fairness Opinions: Unlike the Proposed Rules, which would have required all SPACs to provide disclosure regarding the fairness of a de-SPAC transaction, the Final Rules instead only require the SPAC to provide such disclosure to the extent such a determination is required by the law of the jurisdiction where the SPAC is organized. Additionally, if the SPAC board of directors received any outside report, opinion, or appraisal that materially relates to the fairness of the de-SPAC transaction, the SPAC will be required to disclose certain information about the report, opinion, or appraisal consistent with existing rules under SEC Regulation MA.
• Projections: In addition to the generally applicable amendments to Item 10(b) of Regulation S-K discussed above, the Final Rules require additional disclosure regarding projections in the specific context of a de-SPAC transaction, including who prepared the projections, the purpose for which the projections were prepared, material assumptions used in preparing the projections, and whether or not the projections still reflect the view of the board or management of either the SPAC or target company regarding the financial outlook on the filing date.

Key Takeaways: Many of these disclosure requirements were consistent with current market practice when the Proposed Rules were released. The SEC received strong pushback on the proposed requirement for all SPACs to provide fairness determination disclosure, with many commenters expressing concern that the SEC was making an implied suggestion for SPACs to obtain a fairness opinion. The SEC was receptive to these comments and, as adopted, the disclosure requirements in the Final Rules continue to be consistent with existing market practice. Notwithstanding the SEC backing off its initial proposal, more SPACs are seeking fairness opinions as a result of litigation activity after a de-SPAC transaction, aligning de-SPAC transactions more with traditional M&A transactions.

The Final Rules Establish Requirements for Business Combinations Involving Shell Companies

Shell Company Business Combinations as Sales to Shell Company Investors

The Final Rules created Rule 145a, which deems a business combination of a reporting shell company (including, but not limited to, a SPAC) with a non-reporting entity that is not a shell company to involve the “sale” of securities to the shareholders of the reporting shell company for purposes of Section 2(a)(3) of the Securities Act.

As a result, the disclosure requirements and liability provisions of the Securities Act will now apply to such a transaction regardless of its structure and the transaction will require Securities Act registration unless an exemption from registration is available.

The SEC clarified that Rule 145a will not have any impact on conventional business combination transactions between operating businesses, including transactions structured as traditional reverse mergers and traditional business combination transactions that make use of only business combination-related shell companies.

Financial Statement Requirements

The Final Rules more closely align financial statement reporting requirements in transactions between a shell company and a private operating company (including de-SPAC transactions) with financial statement reporting requirements in connection with a traditional IPO.

The Final Rules require that:

• the financial statements for a de-SPAC transaction where the target business will be a predecessor to the SPAC registrant include the same financial statements for that business as would be required in a registration statement for a traditional IPO of that business;
• the audit of financial statements be conducted by an independent accountant in accordance with the standards of the Public Company Accounting Oversight Board; and
• the age of financial statements for a private operating company that would be the predecessor to a shell company in a registration statement be based on whether the private operating company would qualify as a smaller reporting company if filing its own initial registration statement.

In addition, the Final Rules allow a registrant to exclude the financial statements of a SPAC for the period prior to the de-SPAC transaction if all financial statements of the SPAC have been filed for all required periods through the de-SPAC transaction and the financial statements of the registrant include the period on which the de-SPAC transaction was completed.

The SEC emphasized that these rules simply codify current staff guidance related to shell company transactions.

Compliance Dates

The Final Rules will become effective 125 days after publication in the Federal Register. It is possible, however, that the Final Rules may be subject to legal challenges that could delay the effective date. Registrants will be required to tag information disclosed pursuant to new subpart 1600 of Regulation S-K in Inline XBRL beginning 490 days after publication of the final rules in the Federal Register.

Conclusion

The SPAC market may be down, but it’s certainly not out. While the volume and aggregate value of SPAC transactions had declined precipitously since the boom in 2021 and early 2022, many sponsors and targets remain committed to SPACs as an alternative to traditional IPOs. Furthermore, a shift in the market from targets with unproven business models, historical losses and “moonshot” projections to established, profitable businesses with realistic expectations of future growth has attracted investors with longer-term investment horizons than historical players in the SPAC space (such as hedge funds, for example), which should result in less volatility in post de-SPAC stock prices and greater prioritization on establishing reasonable, supportable valuations. The result is likely to be fewer deals led by an increasingly consolidated group of sponsors who can creatively structure transactions, including PIPEs and other fundraising transactions, in connection with business combinations with public-ready targets who can operate effectively with sustainable performance.

[1] Special Purpose Acquisition Companies, Shell Companies, and Projections, Release No. 33-11265 (Jan. 24, 2024) (“Adopting Release”).

[2] Special Purpose Acquisition Companies, Shell Companies, and Projections, Release No. 33-11048 (March 30, 2022) [87 FR 29458 (May 13, 2022)] (“Proposing Release”).

[3] Adopting Release at 1.

[4] Chair Gary Gensler, “Statement on Final Rules Regarding Special Purpose Acquisition Companies (SPACs), Shell Companies, and Projections,” Jan. 24, 2024.

[5] Commissioner Hester M. Peirce, “For the Birds: Statement on Adoption of Rule Regarding Special Purpose Acquisition Companies, Shell Companies, and Projections,” Jan. 24, 2024.

[6] Commissioner Mark T. Uyeda, “Dissenting Statement on Final Rule on Special Purpose Acquisition Companies, Shell Companies, and Projections: The Commission Embraces Merit Regulation,” Jan. 24, 2024.

[7] SEC Fact Sheet, “SPACs, Shell Companies, and Projections: Final Rules,” Jan. 24, 2024.

[8] Proposing Release at 8.

[9] Adopting Release at 287–288.

[10] Adopting Release at 364.

[11] Adopting Release at 21.

[12] Adopting Release at 193.

[13] Adopting Release at 171.

[14] Under the Final Rules, the definition of “SPAC sponsor” extends beyond the traditional SPAC sponsor entity because it also includes “any entity and/or person primarily responsible for organizing, directing, or managing the business and affairs of a special purpose acquisition company, excluding, if an entity is a SPAC sponsor, officers and directors of the SPAC who are not affiliates of any such entity that is a SPAC sponsor.”