Amidst the ongoing surge in the number of special purpose acquisition companies (“SPACs”) undertaking initial public offerings of securities and the SPACs’ related business combinations with private targets (commonly referred to as “de-SPAC transactions”), a number of challenges have recently emerged to cool down the SPAC market, most notably public statements from the staff of the Securities and Exchange Commission. SPAC market participants are working to sort through these challenges, with the SPAC market currently stalled and the longer-term effects on the market for SPACs unknown.
A SPAC is a shell company with no operations that publicly offers and sells securities, with the proceeds placed in trust for the potential future acquisition of a private operating company. The sponsors of the SPAC receive a “promote”- that is, greater equity than their cash commitment would otherwise imply. Oftentimes the consummation of the intended business combination with the target operating company is subject to the SPAC raising additional cash through a simultaneous private offering of securities to institutional investors (a “PIPE” financing). If the SPAC fails to consummate the de-SPAC transaction within a specified time (typically two years), the SPAC is liquidated and the sponsor promote is forfeited.
Commencing in December 2020, the SEC’s staff issued a series of investor alerts, disclosure guidance and public statements highlighting various potential issues particular to SPACs and related disclosure, financial reporting and auditing considerations and obligations. One of these statements focused in particular on potential conflicts of interest inherent in SPAC IPOs and de-SPAC transactions as commonly structured and the related disclosure considerations. As a general matter, these SEC staff statements were consistent with the traditional SEC practice of highlighting particular issues and guiding market participants to appropriately address those issues in order to facilitate SEC review and clearance of securities filings, improve the quality of disclosures, and ensure appropriate governance and financial controls. That pattern changed with the release of two public statements from the SEC staff in April 2021.
On April 8, the Acting Director of the SEC’s Division of Corporate Finance (the “Corp Fin Acting Director”) issued a public statement principally focused on the use of financial projections in connection with de-SPAC transactions (available here). The securities laws provide a safe harbor for certain forward-looking statements such as financial projections, but that safe harbor explicitly is not available in initial public offerings and so financial projections are not provided in an IPO prospectus. But in a de-SPAC transaction, the IPO has already occurred and so the safe harbor is available. The use of financial projections is particularly important in de-SPAC transactions because oftentimes the acquisition targets are earlier-stage companies than a typical IPO company and are valued principally on the basis of future growth, which can be displayed in the projections. Moreover, projections would have been utilized by the SPAC’s management and PIPE investors in negotiating the de-SPAC transaction, so those projections need to be provided in seeking approval of the SPAC transaction in accordance with state law and SEC practice. SPAC market participants have touted the availability of the forward-looking statement safe harbor as a defining advantage of the SPAC process as compared with a traditional IPO, and the SEC’s April 8th statement was in direct response to those sentiments, both highlighting the limitations of the protections of the safe harbor and then questioning whether the safe harbor is even available at all in de-SPAC transactions. Viewed as a matter of economic substance over form, the SEC argues that the de-SPAC transaction may be the true IPO, with the result that the forward-looking statement safe harbor is not available and that SPACs are not more favorable than conventional IPOs from a liability perspective. The SEC staff then suggests that future SEC rulemaking or guidance may be necessary to address the forward-looking statement safe harbor and related matters.
On April 12, the Corp Fin Acting Director and the Acting Chief Accountant of the SEC issued a public statement relating to the accounting of warrants issued in connection with SPAC formations and initial public offerings (available here). Historically, these warrants have been classified as equity for financial statement purposes, but the SEC’s statement says that warrants containing either of two offending features common in these warrants must now be classified as liabilities. SPACs that have not completed their IPOs will need to consider adjusting the offending warrant provisions to avoid this accounting treatment. SPACs that have already completed their IPOs will need to determine if their financial statements need to be restated to reflect material accounting errors based on this warrant treatment and if ”mark-to-market” accounting will be required for the warrants on an ongoing basis.
These recent activities of the SEC staff have had an immediate (and many would assert intended and beneficial) impact in cooling down the SPAC market. It has also been reported that the SEC’s enforcement division is seeking voluntary information from Wall Street banks regrading deal fees, volumes and compliance controls for SPAC transactions. At the same time, other challenges in the SPAC market have arisen. Given the sheer number and size of SPACs, market participants have cited the recent need for greater time and effort to line up required PIPE financing for de-SPAC transactions. The plaintiffs’ bar is increasingly challenging de-SPAC transactions in court, focusing in particular on the various structural and other conflicts of interests perceived to be present in SPAC IPOs and de-SPAC transactions, including the SPAC sponsors’ promotes. And now it appears that Congress is getting in on the act. Regardless, while slowed, it appears the SPAC train will roll on.