On January 24, 2024, the Securities and Exchange Commission (“SEC”) adopted final rules (the “Final Rules”) to enhance disclosure and investor protection in initial public offerings (“IPOs”) by special purpose acquisition companies (“SPACs”) and in business combination transactions involving shell companies, such as SPACs, and private operating companies (so-called “de-SPAC transactions”).  The Final Rules come almost two years after the SEC proposed the amendments on March 30, 2022 (the “Proposed Rules”). The full text of the 581 page adopting release, including the Final Rules can be viewed here.

Background

Since the early 1990s, SPACs have been used as an alternative to blank check companies. During the SPAC surge of 2020 and 2021, public securities markets in the United States saw an unprecedented increase in the number of IPOs by SPACs, due to certain perceived advantages over a traditional IPO, such as streamlined disclosure requirements and pricing certainty. SPAC’s rapid popularity heightened investor protection concerns about certain elements of the SPAC structure and the increased use of de-SPAC transactions as mechanisms for private operating companies to become public companies while avoiding certain safeguards built into the IPO process. The boom in SPAC IPOs also renewed concerns about the use of projections, particularly with respect to business combination transactions in which projections about private operating companies may lack a reasonable basis, and the potential classification of some SPACS as “investment companies” subject to the Investment Company Act of 1940 (the “Investment Company Act”). In the last year, SPAC IPOs and de-SPAC transactions have slowed down considerably, and market practices have generally evolved in response to the SEC’s Proposed Rules. However, even with these recent developments, in adopting the Final Rules, the SEC observed that SPAC activity has become a much larger part of the securities market framework and may increase in the future.

Enhanced Disclosures and Investor Protections

The Final Rules adopt a new Subpart 1600 of Regulation S-K, which requires enhanced disclosures and provides additional investor protections in SPAC IPOs and de-SPAC transactions, including:

• additional detailed disclosures about the SPAC sponsors, potential conflicts of interest, and dilution of shareholder interests;
• additional disclosures on de-SPAC transactions, including the requirement that the SPAC state:
  • whether the law of the jurisdiction in which the SPAC is organized requires its board of directors (or a similar governing body) to determine whether the de-SPAC transaction is advisable and in the best interests of the SPAC and its shareholders, or any such comparable determination, and disclosure of such determination  supplemented by a discussion of the material factors considered by the board of directors in making its determination, and
  • whether the SPAC has received any outside report, opinion, or appraisal materially relating to the fairness of the transaction; and
• certain disclosures on the prospectus front cover page and in the prospectus summary of registration statements filed in connection with SPAC IPOs and de-SPAC transactions.

Notably, the Final Rules do not include the requirement in the Proposed Rules that the SPAC disclose whether it thinks its de-SPAC transaction and any related financing is “fair” to its unaffiliated security holders, and the adopting release expressly states that SPACs are not required to obtain a fairness opinion. This is consistent with the SEC’s rules on IPOs and traditional M&A transactions.

In order to facilitate investors’ ability to analyze and differentiate between SPAC features, the Final Rules require SPACs to tag all information disclosed pursuant to new Subpart 1600 of Regulation S-K in Inline XBRL.

Furthermore, in an effort to align disclosures and legal liabilities in de-SPAC transactions more closely with those in traditional IPOs, the Final Rules also:

• amend the registration statement forms and schedules filed in connection with de-SPAC transactions to require additional disclosures about the target company and sponsor compensation;
• require the target company in a registered de-SPAC transaction to be a co-registrant on the registration statement used for the de-SPAC transaction, such that the target company and its directors and officers will be subject to liability under Section 11 of the Securities Act of 1933 (the “Securities Act”);
• require a minimum dissemination period of 20 calendar days (or the maximum period allowable by the SPAC’s jurisdiction, if the period is less than 20 days) for prospectuses and proxy or information statements filed in connection with a de-SPAC transaction;
• amend the definition of “blank check company” to include SPACs and certain other blank check companies for purposes of the Private Securities Litigation Reform Act of 1995 (“PSLRA”), with the result that the safe harbor for forward-looking statements under the PSLRA would not be available to SPACs, including with respect to projections of target companies seeking to access the public markets through a de-SPAC transaction; and
• require the re-determination of smaller reporting company (“SRC”) status within four business days following consummation of the de-SPAC transaction. The post-de-SPAC company must reflect the re-determined status in its SEC filings beginning 45 days after consummation of the de-SPAC transaction.

Business Combinations Involving Shell Companies

In an effort to provide the investors of a reporting shell company with more consistent Securities Act disclosure and liability protections regardless of transaction structure, the SEC adopted Rule 145a which provides that any business combination transaction involving a reporting shell company (that is not a business-combination related shell company) and an entity that is not a shell company is deemed to involve an offer, offer to sell, offer for sale, or a sale of securities to the reporting shell company’s shareholders for purposes of the Securities Act. Rule 145a also applies when a shell company business combination is used to convert a private operating company into a public company. As a result of Rule 145a, a registration statement will be required for most de-SPAC transactions and other reverse mergers since, absent an exemption from registration, shell companies and target companies will no longer be able to effect such transactions solely through a proxy statement. The Final Rules note that Rule 145a will not have an impact on conventional business combination transactions between operating businesses, including transactions structured as traditional reverse mergers and traditional business combination transactions that only use business combination related shells.

The SEC also adopted updates to Regulation S-X, which amends forms, schedules, and rules to better align the financial statement reporting requirements in business combinations involving a shell company and a private operating company with those found in traditional IPOs.

Enhanced Projections Disclosures

The Final Rules amend Item 10(b) of Regulation S-K to expand guidance on the use of projections in all SEC filings (not just a de-SPAC transaction) as follows:

• Any projected measures that are not based on historical financial results or operational history should be clearly distinguished from projected measures that are based on historical financial results or operational history.
• It generally would be misleading to present projections that are based on historical financial results or operational history without presenting such historical measure or operational history with equal or greater prominence.
• The presentation of projections that include a non-GAAP financial measure should include a clear definition or explanation of the measure, a description of the GAAP financial measure to which it is most directly comparable, and an explanation why the non-GAAP financial measure was used instead of a GAAP measure.
• The guidance applies to any projections of future economic performance of persons other than the registrant, such as the target company in a business combination transaction, that are included in the registrant’s SEC filings.

Additionally, in order to allow investors to better assess the basis of projections when they are used in SPAC business combination transactions and to address the concern of increased risks due to the SPAC structure, new Item 1609 of Regulation S-K imposes the following additional disclosure requirements for financial projections used in a de-SPAC transaction:

• the purpose for which the projections were prepared and the party that prepared them;
• all material bases of the disclosed projections and all material assumptions underlying the projections, and any material factors that may impact such assumptions;
• any material growth or reduction rates or discount rates used in preparing the projections and the reasons for selecting such growth or reduction rates or discount rates; and
• whether the disclosed projections still reflect the view of the board or management of the SPAC or target company, as applicable, as of the most recent practicable date of the disclosure document required to be disseminated to security holders, and if not, then the purpose of disclosing such projections and the reasons for any continued reliance by the management or board on the projections.

Status of SPACs under the Investment Company Act

The SEC declined to adopt Proposed Rule 3a-10 under the Investment Company Act, which would have provided a safe harbor to certain SPACs from the definition of “investment company.” Instead, the SEC provided guidance regarding the types of activities that would “likely raise serious questions about a SPAC’s status as an investment company under the Investment Company Act,” including activities that would affect a SPAC’s analysis under a multi-factor test (commonly known to as the Tonopah Factors). Some factors that would raise concern about a SPAC’s status as an investment company under the Investment Company Act include:

• the nature of a SPAC assets and income (e.g., not engaging in a de-SPAC transaction but owns or proposes to acquire 40% or more of its total assets in investment securities);
• the activities of directors, officers and employees (e.g., not actively seeking a de-SPAC transaction or management spending significant time actively managing the SPAC’s portfolio for the primary purpose of achieving investment returns);
• whether the SPAC holds itself out in a manner that suggests that investors should invest in its securities primarily to gain exposure prior to a de-SPAC transaction (referred to as “holding out”);
• the duration between a SPAC’s inception and entering into an agreement to purchase an operating business and completing a de-SPAC transaction (e.g., duration exceeds 12-18 months); and
• whether a SPAC merges with an investment company (e.g., a SPAC engages or proposes to engage in a de-SPAC transaction with a target company that meets the definition of investment company).

Underwriter Status and Liability

The SEC declined to adopt controversial Proposed Rule 140a, which sought to clarify whether person who acted as an underwriter in an SPAC IPO and participated in facilitating the de-SPAC transaction (or any related financing transaction, directly or indirectly) would be deemed engaged in the distribution of securities of the surviving public entity and thus considered an “underwriter” under Section 2(a)(11) of the Securities Act.  However, the SEC stated that a de-SPAC transaction is considered a “distribution” of securities, since the purpose of a de-SPAC transaction, similar to an IPO is to provide the target company with capital and access to the public markets.  While acknowledging that the determination of whether a party is a statutory underwriter in a particular transaction is a facts and circumstances test, the SEC stated that it intends to “follow the Commission’s longstanding practice of applying the statutory terms “distribution” and “underwriter” broadly and flexibly.”

The Final Rules will become effective 125 days after publication in the Federal Register. Compliance with the structured data requirements (i.e., tagging of information disclosed pursuant to new subpart 1600 of Regulation S-K) will be required 490 days after publication of the Final Rules in the Federal Register.

For additional information related to the Final Rules, please contact one of the authors, or any member of our Securities Law Practice Group.