The SEC has issued its long-awaited rule proposals regarding SPACs and de-SPACs. The proposals, if adopted, will significantly alter the de-SPAC route to the public markets for private companies and could make de-SPAC transactions less attractive as a means of going public as compared to a traditional IPO or direct listing.
The main proposals include the following:
- Underwriter Liability. Any person who was an underwriter of the SPAC’s IPO and either (1) takes steps to facilitate a de-SPAC transaction, or (2) takes steps to facilitate any related financing transaction, or (3) otherwise participates (directly or indirectly) in the de-SPAC transaction, would be deemed an underwriter of the de-SPAC transaction. An “underwriter” of the de-SPAC transaction would have Section 11 and Section 12(a)(2) liability for the contents of the registration statement used in the de-SPAC transaction, subject to a due diligence defense, increasing the time and expense of de-SPAC transactions for companies and the risk of liability for SPAC IPO underwriters.
- Liability for Projections. The safe harbor for forward looking statements contained in the Private Securities Litigation Reform Act of 1995 would no longer be available to SPACs and projections of target companies in a de-SPAC transaction – potentially increasing the liability of SPACs, target companies and IPO underwriters in de-SPAC transactions where the safe harbor previously would have applied.
- Fairness of De-SPAC Transactions. Prospectuses and proxy statements for de-SPAC transactions would need to disclose if the SPAC reasonably believes that the transaction is fair or unfair to unaffiliated shareholders, the basis for this conclusion, and whether the SPAC or SPAC sponsor received a fairness opinion – potentially increasing the pressure on SPACs to obtain fairness opinions (although a fairness opinion would not be required).
- Registration of De-SPAC Transactions. Any business combination involving a reporting shell company (such as a SPAC) and another entity that is not a shell company (such as a target company in a de-SPAC transaction) would need to be registered with the SEC unless an exemption was available – thus requiring most de-SPAC transactions to be registered with the SEC, increasing the potential liability of SPACs, target companies and the SPAC’s IPO underwriters.
- Target Company Liability. A private operating company in a de-SPAC transaction would be deemed to be a co-registrant of a registration statement filed by a SPAC in a de-SPAC transaction so that the target company, its directors and its principal executive, financial and accounting officers would have liability for the disclosure.
- Minimum Dissemination Period. The proxy statement and prospectus in a de-SPAC transaction would need to be disseminated to investors at least 20 calendar days in advance of a shareholder meeting.
- SPAC IPO Disclosures. Prospectuses for SPAC IPOs would need to include certain specified disclosures on the cover page, in the summary, and in the body of the prospectus, including disclosure about the SPAC sponsor, SPAC sponsor compensation, conflicts of interest and dilution. Much, though not all, of this new disclosure is already included in many deals in the market.
- De-SPAC Disclosures. Prospectuses and proxy statements for de-SPAC transactions would need to include certain specified disclosures on the cover page, in the summary and in the body of the document, including disclosure about the SPAC sponsor, SPAC sponsor compensation, conflicts of interest, dilution and a sensitivity analysis showing potential dilution under a range of reasonably likely redemption levels. Much, though not all, of this new disclosure is already included in many deals in the market.
- Disclosure Regarding the Target Company. The prospectus or proxy statement in a de-SPAC transaction would be required to include specified minimum information about the target company, including its business, property, legal proceedings, shareholders, disagreements with accountants, and recent sales of unregistered securities. Most of this disclosure is already included in most deals in the market.
- Approval of De-SPAC Transactions. The disclosure in de-SPAC disclosure documents would also include whether any director voted against or abstained from approving the transaction, whether a majority of non-employee directors approved the transaction, whether approval of unaffiliated shareholders is necessary to approve the transaction, and whether a majority of non-employee directors retained an unaffiliated representative to negotiate the de-SPAC transaction.
- Financial Statement Disclosures. A number of financial statement practices would be codified related to the PCAOB audit requirement, the number of years of financial statements required, the age of financial statements, the significance of target company acquired entities, the use of pro forma financial statements to determine significance, and exclusion of SPAC financial statements after the de-SPAC transaction closes. In particular, target companies which are emerging growth companies would only need to provide two years of audited financial statements, whether or not the SPAC has filed its annual report.
- Disclosure Regarding Projections. If projections are included in the prospectus or proxy statement for a de-SPAC transaction, the disclosure would need to include the purpose of the projections, who prepared them, all material bases and assumptions underlying the projections, any material growth rates or discount multiples used, and whether the target company has affirmed that they reflect the view of the target company’s management or board. Much of this new disclosure has been included in recent deals in response to SEC comments. The SEC also proposes to update certain of its disclosure requirements for projections utilized by all companies (not just SPACs).
- Smaller Reporting Company Status. Following the closing of a de-SPAC transaction, the post-business combination company would be required to redetermine whether it qualifies as a smaller reporting company prior to the time the company makes its first SEC filing after filing its super 8-K. This will result in the inability to utilize the scaled disclosure requirements available to smaller reporting companies potentially much sooner than currently permitted.
- Investment Company Act Exemption. A SPAC would not be deemed to be an investment company under Section 3(a)(1)(A) of the Investment Company Act if it meets specified criteria, including in particular that it must enter into an agreement for its de-SPAC transaction within 18 months, and must consummate its de-SPAC transaction within 24 months, of the effective date of its IPO registration statement. A significant minority of SPACs do not satisfy these criteria and would not be able to use the safe harbor.
The totality of these new liabilities and disclosure requirements, if they are all adopted, will likely further slow down the SPAC and de-SPAC surge of 2020 and 2021. SEC Commissioner Hester M. Peirce concluded in her dissent that the proposal “seems designed to stop SPACs in their tracks” and “imposes a set of substantive burdens that seems designed to damn, diminish, and discourage SPACs because we do not like them.” At the same time, de-SPAC transactions will still retain other advantages notwithstanding the incremental liabilities which may be potentially imposed, including certainty of price at signing, the support and relationships of the SPAC sponsor, validation by PIPE investors, and an existing trading market.
The deadline for comments on the SEC proposals is May 31, 2022, or 30 days after publication in the Federal Register, whichever is later. We expect interested parties will submit substantial comments objecting to many aspects of the SEC’s proposals. In particular, the application of the proposals to currently pending transactions is not made clear in the proposal and we expect commenters will ask for additional clarity on the timing of application of the proposals.
This memo includes two parts. The first part is a summary of the most significant proposals – and how they might affect current practice. The second part is a discussion of what we believe various participants in the SPAC market – SPACs, target companies, and investment banks - should consider doing now in light of these proposals.
Summary of the Most Significant Proposals
1. Underwriter Liability
Potentially the most significant proposal would provide that any person who has acted as an underwriter of the securities of a SPAC and either (1) takes steps to facilitate a de-SPAC transaction, (2) takes steps to facilitate any related financing transaction or (3) otherwise participates in the de-SPAC transaction would be engaged in a distribution and therefore would be an “underwriter” of the de-SPAC transaction and subject to liability under Section 11 and 12(a)(2) of the Securities Act for the disclosures made in such transaction.
This means that any SPAC IPO underwriter would be viewed as an underwriter of the de-SPAC transaction – even a de-SPAC transaction that occurs more than a year after the completion of the SPAC IPO -- if it (1) acts as a financial advisor or capital markets advisor to the SPAC in the de-SPAC transaction, (2) acts as a PIPE placement agent for the de-SPAC transaction or (3) assists in identifying potential target companies, helps to negotiate merger terms or assists in finding investors for and negotiating PIPE investments.
Investment banks who were underwriters of the SPAC’s IPO currently are not liable for the disclosure in the de-SPAC transaction. If this proposal is adopted, SPAC IPO underwriters who play a role in the de-SPAC transaction would need to adopt procedures necessary to establish a due diligence defense with respect to the de-SPAC disclosure document similar to what they would do in a typical IPO – such as, among other things, conducting management due diligence sessions, reviewing documents in a data room, and obtaining 10b5 letters from law firms and comfort letters from auditors. This could increase the time and cost of a de-SPAC transaction because the due diligence exercise would take time and the investment banks may increase their fees to compensate for their additional potential liability and work.
A due diligence defense shields an underwriter from liability if it can establish that, after reasonable investigation, the underwriter had reasonable grounds to believe and did believe at the time the registration statement became effective that the statements in the registration statement and related prospectus were true in all material respects and there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading.
In addition, if SPAC IPO underwriters can be liable for the disclosure in the de-SPAC transaction, the underwriting agreements in SPAC IPOs may also be amended to include an indemnification by the SPAC (and its successors) for losses suffered by the underwriter in any related de-SPAC transaction.
The incremental liability in de-SPAC transactions could lead one or more investment banks to elect to no longer serve as an underwriter of SPAC IPOs. Alternatively, SPAC IPO underwriters could choose to not participate in any way in the de-SPAC transaction. In addition, underwriting terms in connection with SPAC IPOs could change to require 100% of the underwriting fee to be paid at the time of the SPAC IPO.
We believe there are significant questions about whether the SEC has the authority to expand the concept of underwriter to include parties who participate in a de-SPAC transaction. The term “underwriter” is defined in Section 2(a)(11) of the Securities Act of 1933 as “any person who has purchased from an issuer with a view to, or offers or sells for an issuer in connection with, the distribution of any security, or participates or has a direct or indirect participation in any such undertaking, or participates or has a participation in the direct or indirect underwriting of any such underwriting.” This definition on its face does not necessarily encompass a SPAC’s financial advisor in a de-SPAC transaction, or a SPAC’s placement agent in a de-SPAC transaction, merely because a bank served as a SPAC IPO underwriter.
Language in the SEC’s proposing release suggests that the imposition of potential liability for de-SPAC transactions could extend beyond SPAC IPO underwriters. The SEC’s proposing release also stated, without incremental gloss, that, in addition to SPAC IPO underwriters, “financial advisors, PIPE investors, or other advisors, depending on the circumstances, may be deemed statutory underwriters in connection with a de-SPAC transaction.” Commenters will likely request that the SEC clarify these open-ended statements in its adopting release.
2. Liability for Projections
The SEC proposes to codify its position that projections used in connection with de-SPAC transactions are not protected by the Private Securities Litigation Reform Act safe harbor for forward looking information. The safe harbor generally provides that a company is protected from liability for forward looking statements in any private right of action under the federal securities laws when, among other things, the forward looking statement is identified as such and is accompanied by meaningful cautionary language.
The ability to use projections publicly has been a significant competitive advantage for de-SPAC transactions as compared to a traditional IPO (where projections have not typically been disclosed publicly). Projections are shared by the target company with the SPAC sponsor and PIPE investors in the context of the de-SPAC transaction and related financing. The projections have been included in an investor presentation filed with the SEC upon announcement of the de-SPAC transaction in order to cleanse the PIPE investors and in the registration statements and proxy statements for the de-SPAC transactions. Most practitioners believe that the projections are currently protected by the PSLRA safe harbor in de-SPAC transactions which do not constitute an IPO by the SEC registrant. Imposing liability for projections could potentially lead some companies to choose a traditional IPO, or direct listing, rather than a de-SPAC.
Notwithstanding the possible loss of the PSLRA safe harbor, projections utilized in de-SPAC transactions may still benefit from the protection of the bespeaks caution doctrine. When the PSLRA safe harbor was adopted in 1995, Congress intended to codify, but not replace, the bespeaks caution doctrine that already existed at common law. In broad terms (which vary sometimes among federal circuits), the doctrine holds that forward-looking statements may be protected from liability when they are accompanied by sufficient cautionary language or risk disclosure such that reasonable minds could not disagree that the challenged statements were not misleading. The doctrine is available as a legal argument on a motion to dismiss before any discovery takes place. In some instances, however, courts have elected to address the doctrine at the summary judgment stage, and only after discovery. Of course, the doctrine does not protect statements that fail to disclose risks that have already occurred, not does it apply to false statements if the defendants knew the statements were false when made.
In addition to eliminating the forward-looking statement safe harbor, the SEC also proposed new disclosure requirements with respect to target company projections included in the disclosure documents related to de-SPAC transactions. These include disclosure of (1) the purpose of the projections, (2) the party that prepared them, (3) material bases and assumptions underlying the projections, (4) factors that may materially impact such assumptions, (5) material growth rates or discount multiples used in preparing the projections, and the reasons for selecting them, and (6) for projections about the target company, whether the target company has affirmed that its projections reflect the view of its management or board as of the date of the filing, and if not, the purpose of disclosing the projections and the reasons for the continued reliance on the projections by the SPAC’s management or board. Much of this new disclosure has been included in recent deals in response to SEC comments.
3. Fairness Disclosure
The disclosure documents in a de-SPAC transaction would need to disclose whether the SPAC reasonably believes that the de-SPAC transaction and any related financing are fair or unfair to unaffiliated security holders of the SPAC. The SPAC would need to discuss in reasonable detail the material factors upon which its belief regarding the fairness is based, and whether or not the SPAC or SPAC sponsor received any report, opinion or appraisal from an outside party relating to the consideration or the fairness of the consideration.
SPACs currently do not generally obtain fairness opinions in connection with de-SPAC transactions. Of the 199 closed de-SPAC business combinations in 2022, in only approximately 15% were fairness opinions delivered, and almost all of these were transactions with specific conflicts. The new SEC requirements could lead SPACs and SPAC sponsors to seek fairness opinions more frequently in de-SPAC transactions, even in non-conflict situations.
The SEC proposals would also require additional disclosures about the process of approving the de-SPAC transaction. If any director voted against, or abstained from voting on, approval, the director must be identified and the reasons for the vote or abstention provided. The disclosure would include whether the de-SPAC transaction or any related financing requires the approval of a majority of unaffiliated shareholders and whether it was approved by a majority of the directors of the SPAC who are not employees of the SPAC. In addition, the disclosure would need to indicate whether a majority of non-employee directors of the SPAC retained an unaffiliated representative to act solely on behalf of unaffiliated shareholders for purposes of negotiating the de-SPAC transaction or any related financing or preparing a report on the fairness of the transaction.
4. Target Company Liability
As proposed, a private operating company in a de-SPAC transaction will be deemed to be a co-registrant of a registration statement on Form S-4 or Form F-4 when a SPAC files such a registration statement for the de-SPAC transaction. Currently, where a SPAC files a Form S-4 or Form F-4 for the de-SPAC transaction, the target company in the de-SPAC transaction typically is not a registrant and is not directly liable under Section 11 for the disclosure contained in the disclosure documents for the de-SPAC (although they do currently have potential 10b-5 liability for this disclosure).
This change would mean that in de-SPAC transactions where the SPAC files a Form S-4 or Form F-4, the target company and its principal executive, accounting and financial officers and its directors will have Section 11 liability for the contents of the registration statement. The target company would be strictly liable, and the officers and directors would have a due diligence defense. Although in many cases the target company will already assume the liability of the SPAC post-closing, this liability provision would be particularly relevant for directors of the target company who do not continue as directors of the post-closing company. If this proposal is adopted, target company directors in particular would likely want to adopt incremental review procedures to establish a due diligence defense.
Target companies will also need to ensure that their D&O insurance policy covers the potential securities law liability they and their directors and senior officers would assume as a result of this provision. This could cause the costs for D&O insurance – already high – to increase even more.
5. Registration Requirement
The SEC proposals provide that any business combination of a reporting shell company (such as a SPAC), involving another entity that is not a shell company (such as a target company in the de-SPAC transaction), would be deemed to involve an offer or sale of securities to the reporting shell company’s shareholders.
In most cases, this would require the de-SPAC business combination to be effected on a Form S-4 or Form F-4 and not just on a proxy statement. This is a significant change from current practice because it would require virtually any de-SPAC transaction to be registered on a Form S-4 or Form F-4 (absent an exemption from registration). Registration would then trigger potential Section 11 and 12(a)(2) liability for applicable parties, including the target company, its directors and senior officers, and the SPAC’s IPO underwriters. The auditors of the financial statements included in the registration statement, and any other experts (e.g., authors of any fairness opinions), could also be liable under Section 11 for the portions of the registration statement which they expertized.
Of 199 closed de-SPAC transactions in 2021, 14% were not registered. Of 64 closed de-SPAC transactions in 2020, 31% were not registered. If the SEC proposal had been in effect during 2020 and 2021, all of these transactions would have required registration.
6. Dilution Disclosure
The proposed rules would enhance the disclosure of dilution to non-redeeming shareholders in the de-SPAC transaction disclosure documentation. Companies would be required to describe each material potential source of future dilution, including among others the SPAC sponsor compensation, the terms of outstanding warrants and convertible securities, the terms of PIPE investments and underwriting and other fees.
The disclosure would include a sensitivity analysis in tabular format that expresses the amount of potential dilution under a range of reasonably likely redemption levels. At each redemption level, the disclosure would need to quantify the dilutive impact for non-redeeming shareholders for each individual source of dilution. In addition, the disclosure would include at each redemption level the company valuation at or above which the potential dilution results in the amount of the non-redeeming shareholders’ interest per share being at least the IPO price per share.
The disclosure of dilution would also be enhanced in SPAC IPOs. The SPAC IPO registration statement would disclose the material potential sources of future dilution following the registered offering, and disclose in tabular format the amount of future dilution to the extent known and quantifiable. The cover of the SPAC IPO prospectus would also include a new table showing the estimated remaining pro forma net tangible book value per share at 25%, 50%, 75% and 100% of the maximum amount of redemptions.
7. Investment Company Act Exemption
The SEC proposes to add a new exemption from status as an “investment company” under the Investment Company Act of 1940 for SPACs and other companies who meet specified criteria.
Most of the criteria are consistent with current SPAC practice: (1) the company’s assets must consist solely of government securities, securities issued by government money market funds and cash items, (2) the assets are not acquired or disposed of for the primary purpose of recognizing gains or decreasing losses resulting from market value changes, (3) the company seeks to complete a single de-SPAC business combination in which the surviving company will be listed on a national securities exchange (a business combination with multiple targets would still constitute a single business combination), (4) the SPAC is primarily engaged in the business of seeking to complete a business combination and (5) the SPAC does not hold itself out as being primarily engaged in the business of investing or trading in securities.
However, not all SPACs currently comply with certain of the other criteria: (1) the SPAC must enter into an agreement within 18 months after the effective date of its IPO registration statement, (2) the SPAC must consummate the business combination within 24 months after the effective date of its IPO registration statement and (3) any assets of the SPAC that are not used in connection with the de-SPAC transaction, or in the event the SPAC does not meet the 18 month or 24 month standards, must be distributed in cash to investors.
Not all SPACs necessarily enter into an agreement for their de-SPAC transaction within 18 months, and not all SPACs close their business combination within 24 months. The stock exchanges allow SPACs 36 months to consummate their business combination, and SPACs with 24 month periods to complete an initial business combination generally can obtain extensions from shareholders beyond this 24 month period. If the SEC proposal is adopted as proposed, future SPACs may need to include the new deadlines, and some existing SPACs may need to amend their charters to include the new deadlines, if there is a concern that they would otherwise not fit within the safe harbor and therefore increase the risk of being an investment company.
What Should Clients Do Now if Engaged in or Contemplating a Future SPAC or De-SPAC Transaction?
Investment banks and financial advisors to SPACs or target companies, SPACs contemplating a SPAC IPO, SPACs and target companies evaluating a potential de-SPAC transaction, and SPACs and target companies currently in SEC registration for a pending business combination, will all need to evaluate their next steps in light of these proposed rules. We consider each of their positions in turn:
1. Investment Banks / Financial Advisors
The SEC is proposing to make Section 11 and Section 12(a)(2) liability applicable to SPAC IPO underwriters in connection with de-SPAC transactions where the SPAC IPO underwriter serves as financial advisor, placement agent or capital markets advisor in connection with the de-SPAC transaction. The effects of this liability provision could be significant and raise various questions which will need to be worked out over time among market participants.
Adoption of the proposals could result in investment banks performing the same or a similar degree of due diligence in de-SPAC transactions that they perform in traditional initial public offerings. This could include, among other things, management meetings, 10b5 opinions from law firms, and comfort letters from auditors. Banks may charge higher fees as compensation for the incremental liability and incremental work that would be involved in de-SPAC transactions. Banks may also include indemnification provisions in SPAC IPO underwriting agreements which cover the potential liability they could incur in future de-SPAC transactions.
It remains to be seen whether some investment banks will stop underwriting SPAC IPOs, or no longer serve as financial advisor, capital markets advisor or placement agent for SPACs in which they served as an underwriter in the SPAC IPO. Similarly, another open question is whether the compensation structure in a SPAC IPO will change to eliminate the deferred compensation portion, particularly if banks intend to play no role at the time of the de-SPAC transaction. Finally, it remains to be seen whether the issuance of fairness opinions in connection with de-SPAC transactions will become more prevalent, opening up a new workstream for some investment banks.
2. SPACs Contemplating a SPAC IPO
For SPAC sponsors contemplating a SPAC IPO or in the midst of SEC registration, deal teams should consider whether or not to preemptively comply with the proposed disclosure requirements applicable to the cover page, summary and body of Form S-1 and Form F-1.
Many of the newly proposed disclosure requirements are not onerous and, for the most part, are already market standard and are easy to comply with. For example, most SPAC IPO prospectuses already contain significant disclosures regarding conflicts, SPAC sponsor compensation, rights to redeem, material terms of the trust account, material terms of the securities offered, and the period of time in which the SPAC intends to consummate a de-SPAC transaction. The proposed rules would require the SPAC sponsor compensation to be disclosed in tabular format, which differs from current practice. In addition, the SEC proposals would require a dilution table on the cover of the prospectus.
SPACs should also consider shortening the term of the SPAC to match the 18 month / 24 month time periods contained in the proposed Investment Company Act safe harbor in order to avoid issues under the Investment Company Act. Many recent SPACs already have terms that are 18 months or less.
3. SPACs Looking for a Target
For SPACs that have completed their IPO and are now looking for a target company, it is possible that the new rules will become effective before they sign a business combination agreement with a target or before the closing of their business combination. Unfortunately, the proposal does not contain any indication of when the rules will become effective, whether there will be a transition period or whether existing SPACs might be grandfathered; we expect such questions will be the subject of comments and fleshed out in the final adopting release.
SPACs actively pursuing a target will need to consider the proposed requirements regarding fairness of the merger as they evaluate potential target companies. As proposed, the Form S-4, Form F-4 or proxy statement for the de-SPAC transaction would need to disclose whether the SPAC reasonably believes that the de-SPAC transaction and any related financing is fair or unfair to unaffiliated security holders of the SPAC. While the SEC is not requiring a fairness opinion in every de-SPAC transaction, a SPAC sponsor may conclude that the SPAC needs to obtain a fairness opinion in order to make this disclosure.
Another key consideration is the potential liability that may be imposed on forward-looking information when the SEC proposals are implemented. In many cases the projections may be necessary for purposes of marketing the company to investors. In addition, if the SPAC sponsor is required to indicate in the disclosure document whether the transaction is fair, and is therefore required to obtain a fairness opinion, the projections shared with the bank providing the fairness opinion may need to be included in the disclosure document in any event. At the same time, the loss of the safe harbor, combined with the new proposal creating potential “underwriter” liability for SPAC IPO underwriters in connection with de-SPAC transaction, could result in using projections less frequently, showing fewer years of projections, showing fewer line items, or showing multiple sets of projections (such as a base case, a best case and a downside case). In addition, the liability for projections could influence the target companies SPACs pursue – a SPAC may conclude it is too risky to pursue smaller, pre-revenue, early stage or more speculative companies where more aggressive projections for a greater number of years are needed for the sales process.
If the SPAC expects that it will continue to utilize projections in marketing to PIPE investors and will need to include them in the de-SPAC disclosure documents, then the SPAC will need to make sure that the projections are prepared in a manner that will be able to comply with the new disclosure requirements applicable to projections. These include disclosure of (1) the purpose of the projections, (2) the party that prepared them, (3) material bases and assumptions underlying the projections, (4) factors that may materially impact such assumptions, (5) material growth rates or discount multiples used in preparing the projections, and the reasons for selecting them, and (6) for projections about the target company, whether the target company has affirmed that its projections reflect the view of its management or board as of the date of the filing, and if not, the purpose of disclosing the projections and the reasons for the continued reliance on the projections by the SPAC’s management or board.
4. SPACs with a Pending Business Combination
For SPACs party to a pending de-SPAC transaction, it is possible but less likely that the new rules would become effective before the closing of their de-SPAC transaction.
SPACs with a pending registration statement on Form S-4 or F-4 or a pending proxy statement will need to evaluate whether or not to make changes to their disclosure to conform with some or all of the proposed disclosure requirements applicable to de-SPAC transactions. A large portion of the proposed disclosures are already market standard, such as disclosure regarding background of the merger, material terms of the transaction, reasons for the transaction, structure and timing of the transaction, material differences in the rights of security holders, accounting treatment and tax consequences.
But other proposed disclosures are not universally market standard and will need to be evaluated for inclusion in the disclosure document – including certain disclosures about conflicts of interest, fiduciary duties, SPAC sponsor compensation, transaction fairness, approval by a majority of disinterested shareholders, approval by a majority of non-employee directors, and dilution, including sensitivity analysis disclosure in tabular format that expresses the amount of potential dilution under a range of reasonably likely redemption levels. SPACs will also need to consider updating the disclosure about projections to be consistent with the proposed SEC guidance regarding projections.
One other consideration relates to deal timing. The SEC has proposed to require 20 calendar days between the proxy mailing date and the date of the SPAC’s shareholder meeting. SPACs may consider including this in their transaction timetable. We expect that during the comment process the SEC will be asked to clarify that the 20 calendar day period applies to the initial proxy statement and prospectus but not necessarily to dissemination of supplemental material.
5. Target Companies Evaluating a Potential De-SPAC Transaction
Target companies evaluating whether to pursue a de-SPAC transaction, a traditional IPO or a direct listing may conclude that some of the advantages of a de-SPAC transaction will no longer be available in the future. For example, there may be greater risk in using projections in the PIPE marketing process – this would have the greatest effect on smaller, pre-revenue, early stage or more speculative companies. Financial advisors may need to start performing full due diligence in the de-SPAC transaction – similar to what they would need to do in a traditional IPO – which will require more time from senior management than is currently the case. In addition, the target company and its directors and senior officers may have the same liability in a de-SPAC transaction which they have in a traditional IPO. In any event, directors of a private operating company will need to take into consideration their own potential personal liability when evaluating whether to pursue a de-SPAC transaction.
At the same time, de-SPAC transactions will still retain other advantages notwithstanding the incremental liabilities which may be potentially imposed, including certainty of price at signing, the support and relationships of the SPAC sponsor, validation by PIPE investors, an existing trading market, and greater corporate governance flexibility. From the target’s point of view, the disclosure requirements will not change substantially as a result of the new rules, which focus more on the SPAC sponsor, conflicts, sponsor compensation and dilution and less on the target company. Further, certain of the proposed changes to Regulation S-X could be helpful to target companies, such as the proposal to allow targets which are emerging growth companies to provide only 2 years of audited financial statements even if the SPAC has already filed its annual report. And the loss of the safe harbor for forward-looking information must be balanced against (1) the fact that in many historic de-SPAC transactions the safe harbor did not historically apply in any event and (2) the ability of companies to utilize the bespeaks caution doctrine to defend their projections when necessary.
6. Target Companies Party to a Pending de-SPAC Transaction
For target companies party to a pending de-SPAC transaction, it is possible, although less likely, that the new rules would become effective before the closing of their de-SPAC transaction.
Target companies should consider whether the proposed disclosures about target companies have been included in the registration statement or proxy statement for the de-SPAC transaction. This includes a description of the business, a description of property, a description of legal proceedings, changes in and disagreements with accountants, beneficial ownership of management and 5% holders, and recent sales of unregistered securities. Target companies that are foreign private issuers will be subject to similar, but slightly different, requirements. Most of these disclosures are already market standard in de-SPAC disclosure documents.
Target companies may also evaluate whether the disclosure regarding projections in the de-SPAC documents need to be updated to reflect the new proposed disclosure rules regarding projections. These include disclosure of (1) the purpose of the projections, (2) the party that prepared them, (3) material bases and assumptions underlying the projections, (4) factors that may materially impact such assumptions, (5) material growth rates or discount multiples used in preparing the projections, and the reasons for selecting them, and (6) for projections about the target company, whether the target company has affirmed that its projections reflect the view of its management or board as of the date of the filing, and if not, the purpose of disclosing the projections and the reasons for the continued reliance on the projections by the SPAC’s management or board.
If the proposals become effective prior to the closing of a de-SPAC transaction, without any grandfathering of existing transactions, then the target company and its directors and senior officers could have liability for the disclosure in the Form S-4 or Form F-4 for the de-SPAC transaction. In this event, the directors and senior officers would want to perform some amount of due diligence in order to protect themselves with a due diligence defense. Target companies and their officers and directors should also investigate whether or not their D&O insurance policy will cover this potential increased liability.