Expansive New SEC Rule Proposals Seek to Rewrite the SPAC Playbook

On March 30, 2022, the U.S. Securities and Exchange Commission (SEC) issued proposed rules and amendments relating to special purpose acquisition companies (SPACs), shell companies and the use of projections in SEC filings that, if adopted, would significantly rewrite the playbook for SPAC initial public offerings (IPOs) and acquisitions of private operating companies by SPACs (or “de-SPAC” transactions).¹ In particular, the proposed rules (i) would require enhanced disclosures and increase potential liability under the federal securities laws for shell companies (including SPACs), target companies and investment banks participating in de-SPAC transactions, (ii) provide updated guidance regarding the use of projections in all SEC filings and (iii) propose a new safe harbor for SPACs under the Investment Company Act of 1940.

OVERVIEW OF KEY PROVISIONS OF THE PROPOSED RULES

The SEC’s stated goals for the proposed rules and amendments (the proposed rules) are “to improve the usefulness and clarity of the information provided to investors” and “to enhance investor protections” in both SPAC IPOs and de-SPAC transactions.² The proposed rules can generally be grouped into five broad topics:

1. New specialized disclosure requirements for SPACs
2. Aligning disclosures and legal obligations between de-SPAC transactions and traditional IPOs
3. Business combinations involving shell companies (including SPACs) and related financial statement requirements
4. Projections in SEC filings
5. New safe harbor for SPACs under the Investment Company Act of 1940 (Investment Company Act)

1. New Specialized Disclosure Requirements for SPACs

The proposed rules set forth specialized enhanced disclosure requirements applicable to SPAC IPOs and de-SPAC transactions in a new subpart of Regulation S-K, which would require additional disclosures in the following areas:

• additional disclosure about a SPAC sponsor³, its affiliates and any promoters, including the experience, material roles and responsibilities and compensation of these parties, the controlling persons of the SPAC sponsor and any persons who have direct and indirect material interests in the SPAC sponsor, as well as an organizational chart that shows the relationship among the SPAC, the SPAC sponsor and the SPAC sponsor’s affiliates;
• certain disclosures on the prospectus cover page, such as the SPAC’s timeframe to complete a de-SPAC transaction, redemption rights, the compensation of the SPAC sponsor, conflicts of interest, dilution (including simplified tabular disclosure incorporating a range of potential redemption levels) and, in a de-SPAC registration statement, a statement regarding the fairness of the de-SPAC transaction and related financing transactions;
• material potential sources of additional dilution that non-redeeming SPAC shareholders may experience at different phases of the SPAC lifecycle by electing not to redeem their shares in connection with de-SPAC transaction;
• a robust description of any actual or potential material conflicts of interest between the SPAC sponsor, its affiliates, or the SPAC’s directors and officers, on the one hand, and the unaffiliated security holders, on the other;
• the fiduciary duties each SPAC director and officer may owe to other companies; and
• an affirmative statement in a de-SPAC registration statement as to whether the SPAC reasonably believes that the de-SPAC transaction and any related financing transaction are fair or unfair to public investors and whether the SPAC has received any outside report, opinion, or appraisal relating to the fairness of the de-SPAC transaction.

In practice, while certain of these are standard market disclosures in SPAC registrations statements today, the proposed disclosure rules would formalize the disclosure requirements, expand the required disclosures and require prominent placement of certain disclosures. SPACs should particularly note the proposed fairness disclosure requirement and consider whether to obtain fairness opinions for pending and future de-SPAC transactions. While the proposed rules do not add a requirement that SPACs obtain a fairness opinion, the proposed rules indicate that disclosure by a SPAC regarding the fairness of a de-SPAC transaction and any related financing transaction to unaffiliated public shareholders may be material information to be included in a SPAC’s disclosure documents, and the SEC staff may issue comments inquiring as to the basis of such fairness determination where fairness opinions or other comparable third-party report are absent.

2. Aligning Disclosures and Legal Obligations Between De-SPAC Transactions and Traditional IPOs

Consistent with the SEC staff’s view that a de-SPAC transaction is the equivalent to the operating target company’s IPO, the SEC’s proposed rules would seek to align investor protections and incentives of the participants in a de-SPAC transaction more closely to those in a traditional IPO — “Treat like cases alike,” as SEC Chair Gary Gensler has repeatedly said.⁴ This includes a number of significant changes in the areas of disclosure, marketing practices and gatekeeper and issuer obligations.

Specifically, the proposed rules focus on six key changes in this area:

(a) Alignment of Nonfinancial Disclosures in De-SPAC Transaction Disclosure Documents

The proposed rules would formalize additional disclosure requirements regarding the private target company in registration statements and proxy statements in connection with de-SPAC transactions, including description of the business, property and legal proceedings of the target; changes in and disagreements with accountants; security ownership of certain beneficial owners and management; and recent sale of unregistered securities. These additional disclosures are already required to be filed in the Form 8-K announcing the consummation of the de-SPAC transaction, and this information is generally already included by SPACs and target companies in de-SPAC transaction registration statements and proxy statements.

(b) 20-Day Minimum Distribution Period

The proposed rules would require a prospectus, proxy statement, or information statement filed in connection with a de-SPAC transaction to be distributed to shareholders a minimum of 20 calendar days in advance of a shareholder meeting or earliest date of an action by written consent. Currently, depending on the transaction structure of the de-SPAC transaction, this period can be as short as 10 calendar days.

(c) Target Companies Becoming Co-Registrants on Form S-4 and Form F-4 Registration Statements

The proposed rules would deem the target company of a de-SPAC transaction to be an “issuer” for federal securities law purposes and a co-registrant with the SPAC. As a result, the target company and its principal executive officer, principal financial officer, controller/principal accounting officer and a majority of the board of directors would be required to sign the registration statement and would become subject to potential liability for material misstatements or omissions in the registration statement.

Target companies and their directors and officers should consider the proposed heightened liability exposure of becoming a co-registrant. By becoming a co-registrant on a de-SPAC transaction registration statement, the target company and its directors and certain officers would become subject to liability under Sections 11 and 12 under the Securities Act of 1933, as amended (the Securities Act). Target companies should review the scope of their existing D&O insurance coverage in light of this increased liability at an earlier stage of the de-SPAC process than is currently the case.

(d) Re-testing of a Registrant’s “Smaller Reporting Company” Status

The proposed rules would require a re-testing of the SPAC’s “smaller reporting company” status following the consummation of a de-SPAC transaction and to reflect the updated status in its next periodic report. Additionally, the public float would be determined four days after the consummation of the de-SPAC transaction, and the revenue test would look at the revenue of the target company. If adopted as proposed, this rule could significantly shorten the period of time for which certain registrants may avail themselves of the more streamlined disclosure requirements applicable to “smaller reporting companies” following a de-SPAC transaction because under the current rules the annual determination is not required until it files its Form 10-Q for the first fiscal quarter in the next fiscal year.

(e) Excluding De-SPAC Transactions From the PSLRA Safe Harbor Protections

The Private Securities Litigation Reform Act of 1995 (PSLRA) provides a safe harbor for forward-looking statements under certain conditions, but this safe harbor is unavailable to “blank check companies” or in an IPO. De-SPAC transactions have historically received the protections of the PSLRA safe harbor, as SPACs are not considered blank check companies under the current SEC definition since they do not issue “penny stock.” The proposed rules would expand the definition of “blank check company” to include SPACs.⁵ The revised definition would effectively close off the PSLRA safe harbor for forward-looking statements in all de-SPAC transactions.

SPACs and target companies should carefully consider the use of projections and other-forward looking statements in de-SPAC transactions and related SEC filings. The removal of the PSLRA safe harbor raises the potential for liability for financial projections and other forward-looking statements in de-SPAC transactions that would be made following the effective date of the proposed rules. This is a significant change given the prevalent use of projections in marketing de-SPAC transactions and especially for early-stage target companies that may have no or limited revenue and profitability history, such as many high-growth, emerging technology and early-stage life sciences companies. The ability to use projections to market de-SPAC transactions has long been considered a competitive advantage relative to going public via a traditional IPO process, and the proposed removal of the PSLRA safe harbor protection in de-SPAC transactions will likely result in a significant scaling back or curtailment of this practice.

(f) Expansion of Underwriter Status and Liability in Connection with De-SPAC Transactions

The SEC is proposing to add new Rule 140a under the Securities Act. Proposed Rule 140a would deem an underwriter of a SPAC IPO that “takes steps to facilitate the de-SPAC transaction, or any related financing transaction, or otherwise participates (directly or indirectly) in the de-SPAC transaction” to be engaged in a distribution of the securities of the combined de-SPAC company and therefore a statutory underwriter for Securities Act liability purposes. Furthermore, receipt of deferred underwriting fees or other compensation in connection with the de-SPAC transaction “could constitute direct or indirect participation.”

Importantly, the SEC staked out an expansive position regarding the definitions of a “distribution” and an “underwriter” under existing laws and rules. Pursuant to proposed Rule 145a, a de-SPAC transaction is effectively a distribution of the private target company’s securities to the public shareholders of the SPAC and would be subject to the requirements of Section 5 of the Securities Act. Additionally, the SEC noted, “financial advisors, PIPE [private investment in public equity] investors, or other advisors, depending on the circumstances, may be deemed statutory underwriters in connection with a de-SPAC transaction.”⁶

Expansion of statutory underwriter liability to de-SPAC transactions may lead to significant changes in the role and practices of investment banks advising on de-SPAC transactions. Investment banks involved with de-SPAC transactions do not typically conduct the same level of due diligence as they would for a traditional IPO. If adopted in its proposed form, Rule 140a may discourage investment banks from taking on new de-SPAC transaction engagements given the heightened risks presented. Investment banks working on de-SPAC transactions may insist on doing more thorough due diligence on the target company, including detailed legal documentary due diligence review, obtaining legal opinions (including a “10b-5 opinion” or negative assurance statement as to the target’s disclosures in the Form S-4/F-4) and a comfort letter from the target company’s auditor, consistent with a traditional IPO. SPAC IPO underwriters, placement agents, financial advisers and PIPE investors should consult with their counsel to determine whether they might be statutory “underwriters” under Section 2(a)(11) of the Securities Act and whether to conduct additional due diligence that may be appropriate to establish the “due diligence” defense to liability under Sections 11 and 12 under Securities Act. SPACs, SPAC sponsors, and shell companies should confirm whether their SPAC IPO underwriters or other financial advisers will require access to additional due diligence materials and time to complete a deeper due diligence review.

3. Business Combinations Involving Shell Companies (Including SPACs) and Related Financial Statement Requirements

The SEC proposed new Rule 145a under the Securities Act, which would apply to all “shell companies,” including SPACs, and modified the financial statement requirements applicable to business combinations involving shell companies (including SPACs). Noting that a business combination with a shell company substantively allows the business and operations of a private target company to become a public company, the SEC’s expressed intention for the proposed rules is to subject business combinations with shell companies to equivalent disclosure and liability standards that would apply if the private target company were to conduct its own IPO.

(a) Proposed Rule 145a Under the Securities Act

Proposed Rule 145a would deem any business combination of a reporting shell company and a non–shell company to involve “an offer, offer to sell, offer for sale, or sale” of securities for purposes of Section 2(a)(3) of the Securities Act to the reporting shell company’s shareholders.⁷ This proposal would subject de-SPAC transactions and business combinations with other shell companies to significant new disclosure obligations and liability, which include requiring registration of such transactions in a broader set of situations and structures, enhancing liability for signatories of a registration statement, adding potential underwriter liability, and adding expert liability, including for auditors and for anyone who prepares a fairness opinion.

(b) Proposed Modifications to Financial Statement Requirements

The proposed modifications to Regulation S-X are designed to harmonize the required financial information of private target companies involved with business combinations with shell companies (including SPACs) with traditional IPOs, including with respect to the number of years of financial statements required, audit requirements, the age of the financial statements, inclusion of financial statements of other significant businesses recently acquired or likely to be acquired, and the use of such financial statements as the sole historical financial statements of the combined company.

4. Projections in SEC Filings

The proposed rules would revise the SEC’s existing guidance regarding projections in all SEC filings and more specifically in de-SPAC transactions.

(a) Item 10(b) of Regulation S-K

The SEC proposed revisions to Item 10(b) of Regulation S-K, which currently applies to the use of projected financial information in SEC filings. The proposed rules, which apply to both SPAC and non-SPAC issuers, would retain the requirement that the projected financial information must have a reasonable basis and would add requirements that the projected financial information clearly delineate between projections that are based on historical financial results or operational history and those that are not. The proposed rules would also require projections based on historical financial results or operational history to be presented with equal or greater prominence. Additionally, any non-GAAP projected financial information should include an explanation for why the most closely related GAAP measure was not used. Finally, the proposed rules would clarify that the Item 10(b) guidance applies to all projected financial information, including that of a target company.

(b) De-SPAC Transaction Financial Projections

The proposed rules would require additional specific disclosures in a de-SPAC transaction with respect to projected financial information, including disclosure of the party that prepared the projections, the purpose for which they were prepared, all material bases and assumptions underlying the projections, any factors that may impact such assumptions and whether the target company’s management has affirmed the projections to the SPAC.

Target companies should carefully review projected financial information to be provided in connection with a potential de-SPAC transaction and supplement as needed. For projected financial information about a target company to be provided to a SPAC and ultimately included in a de-SPAC transaction registration statement, be sure to include robust disclosure of all material bases and assumptions underlying the projections, and any factors that may impact such assumptions, in order to best align disclosure duties under corporate laws and federal securities laws. Also, target companies should consider modifying the presentation of their projected financial information to align with the proposed SEC disclosure requirements.

5. New Safe Harbor for SPACs Under the Investment Company Act of 1940

The proposed rules include a new safe harbor under the Investment Company Act for SPACs that meet certain conditions. In support of the proposal, the SEC stated, “We believe that certain SPAC structures and practices may raise serious questions as to their status as investment companies. While a SPAC would not be required to rely on the safe harbor, we have designed the proposed conditions of the safe harbor to align with the structures and practices that we preliminarily believe would distinguish a SPAC that is likely to raise these questions from one that would not.”⁸

The proposed safe harbor conditions include that a SPAC would

• hold its assets only in specific securities (U.S. government securities and money market funds invested in U.S. government securities);
• pursue a single de-SPAC transaction for which the definitive business combination agreement is announced no later than 18 months after the date of the SPAC’s IPO and that is completed no later than 24 months after the date of the SPAC’s IPO;
• liquidate if it does not satisfy the above 18- or 24-month timeframes;
• pursue only a de-SPAC transaction in which “the surviving entity, directly or through a primarily controlled company, is primarily engaged in the business of the target company or companies [which may not be an investment company or investment companies]”⁹ and where the surviving company has “at least one class of securities listed for trading on a national securities exchange”;¹⁰ and
• demonstrate its intent to complete a de-SPAC transaction “by the activities of its officers, directors and employees, its public representations of policies, and its historical development …. [T]he officers, directors and employees of a SPAC wishing to rely on this safe harbor would need to be primarily focused on activities related to seeking a target company to operate and not on activities related to the management of its securities portfolio.”¹¹ Likewise, “the SPAC’s board of directors would also need to adopt an appropriate resolution evidencing that the company is primarily engaged in the business of seeking to complete a single de-SPAC transaction as described by the rule.”¹²

Existing SPACs should review whether they satisfy the proposed Investment Company Act safe harbor. In introducing the proposed new safe harbor, the SEC’s Director of the Division of Investment Management commented that for SPACs “that do not satisfy [the conditions relating to the SPAC’s activities, the holdings of its portfolio and the duration of its project], we would expect that those SPACs should be consulting closely with their advisers and considering carefully their compliance obligations…. I would expect that the staff would also be taking a look at them.”¹³

COMMENT PERIOD AND EXPECTED TIMING OF THE FINAL RULES

The proposed rules will be open for public comment until the later of May 31, 2022 or the date that is 30 days after their official publication in the Federal Register. The SEC’s proposing release seeks comment on more than 150 detailed issues. All interested parties should participate in the comment period. The SEC takes into account feedback from commentators when drafting final rules. In light of the significant new burdens the proposed rules would impose on all participants throughout the SPAC lifecycle, we encourage interested parties to reach out to counsel and other advisers as necessary to discuss giving input to the SEC on the proposed rules, either individually or through their trade associations.

Following the public comment period, the SEC staff will consider appropriate revisions to the proposed rules before proposing final rules that will be subject to a subsequent vote by the SEC Commissioners. Given the breadth of the proposed rules, a significant number of comments is anticipated as well as likely legal challenges to the final rules. As a result, it is unlikely that any final rules would be adopted prior to the fourth quarter of 2022. The proposing release does not specify whether the final rules would be effective immediately or subject to a transition period.

The Commission approved the proposed rules by a vote of 3-1, with Commissioners Gensler, Allison Herren Lee and Caroline Crenshaw voting to approve the rules. In the lone dissenting statement, Commissioner Hester Peirce argued that the rule proposal “seems designed to stop SPACs in their tracks.”¹⁴ She acknowledged that the recent SPAC boom has raised legitimate disclosure concerns and stated that she would have supported rules requiring enhanced disclosures. But the rule proposal, in her view, goes too far and would require a typical SPAC to make “significant changes to its operations, economics, and timeline” to comply with the rules as proposed. In addition, Commissioner Peirce believes the proposal to eliminate the PSLRA safe harbor protection for de-SPAC transactions exceeds the SEC’s delegated authority as it effectively rewrites the statute.¹⁵ Nor does the proposal, in her view, properly balance the SEC’s capital formation mandate in light of the significant costs and disincentives the proposal creates for private operating companies considering going public via a de-SPAC transaction.¹⁶ As a result, the proposed rules will likely be subject to challenges on a number of different fronts.

¹ SEC, Special Purpose Acquisition Companies, Shell Companies, and Projections (2022), Release Nos. 33-11048; 34-94546; IC-34549, https://www.sec.gov/rules/proposed/2022/33-11048.pdf.
² Release No. 33-11048 at 17.
³ Under the proposed rules, “SPAC sponsor” is defined to include not only the sponsor entity but also “the person(s) primarily responsible for organizing, directing or managing the business and affairs of the SPAC, other than in their capacities as directors or officers of the SPAC as applicable.”
⁴ See Chair Gary Gensler (SEC), “Statement on Proposal on Special Purpose Acquisition Companies (SPACs), Shell Companies, and Projections,” Mar. 30, 2022, https://www.sec.gov/news/statement/gensler-spac-20220330, and Chair Gary Gensler (SEC), “Remarks Before the Healthy Markets Association Conference,” Dec. 9, 2021, https://www.sec.gov/news/speech/gensler-healthy-markets-association-conference-120921.
⁵ Release No. 33-11048 at 346.
Correspondingly, the SEC’s proposed rules would add the defined term “blank check company issuing penny stock” that would be defined to mirror the scope of the current term “blank check company,” and the proposed rules would also replace the term “blank check company” with “blank check company issuing penny stock” in its rules, other than in the PSLRA.
⁶ Release No. 33-11048 at 98.
⁷ Release No. 33-11048 at 343.
⁸ Release No. 33-11048 at 136.
⁹ Release No. 33-11048 at 370.
¹⁰ Release No. 33-11048 at 371.
¹¹ Release No. 33-11048 at 148.
¹² Release No. 33-11048 at 148.
¹³ Director William Birdthistle, “Comments at the 3/30/22 SEC Open Meeting,” Mar. 30, 2022, https://www.youtube.com/watch?v=t6qX8FGiI_8.
¹⁴ Commissioner Hester M. Peirce, “Damning and Deeming: Dissenting Statement on Shell Companies, Projections, and SPACs Proposal,” Mar. 30, 2022, https://www.sec.gov/news/statement/peirce-statement-spac-proposal-033022 (“Commissioner Peirce’s Dissenting Statement”).
¹⁵ “Through a regulatory sleight of hand, the proposal would eliminate the safe harbor. Specifically, the proposal would change the existing definition of ‘blank check company’ for purposes of the PSLRA — the definition Congress looked to when it wrote the PSLRA — to include SPACs by removing the ‘penny stock’ condition. Look over there, Congress, while we rewrite the statute!” from Commissioner Peirce’s Dissenting Statement.
¹⁶ “The proposal does not adequately account for the potential cost of damming up the SPAC river. Since 2020 SPACs brought many new companies into our public markets — a welcome trend after decades of decline in the number of public companies,” from Commissioner Peirce’s Dissenting Statement.

This post is as of the posting date stated above. Sidley Austin LLP assumes no duty to update this post or post about any subsequent developments having a bearing on this post.