SEC Adopts New Rules Regarding SPAC Transactions

On January 24, 2024, the Securities and Exchange Commission (“SEC”) adopted final rules (the “Rules”) and issued guidance regarding special purpose acquisition companies (“SPACs”).

The Rules address a number of topics, including enhanced disclosure requirements in SPAC initial public offerings (“SPAC IPOs”) and business combinations between SPACs and target companies (“de-SPACs”); use of projections in de-SPAC and other registration statements; and business combinations involving shell companies, including SPACs. In an important departure from its March 2022 rule proposal regarding SPACs (the “Proposed Rules”), the SEC did not adopt specific rules regarding underwriter liability in de-SPAC transactions or create a safe harbor under the Investment Company Act of 1940 (the “Investment Company Act”) with respect to SPACs but did provide some general guidance to market participants on these topics.

SPAC IPOs. For SPAC IPOs, the Rules are substantively similar to the Proposed Rules and broadly consistent with recent market practice. The Rules require additional disclosure in the SPAC IPO registration statements, including:

• information regarding the SPAC sponsor, including the experience of the SPAC sponsor, its affiliates and promoters, and their involvement with other SPACs;
• the identity of the controlling person of the SPAC sponsor and the identities of persons who have a direct or indirect material interest in the SPAC sponsor;
• tabular disclosure of the material terms regarding any lock-up agreement entered into by the SPAC sponsor; and
• disclosures regarding actual or potential conflicts of interests between SPAC sponsors and SPAC public investors along with increased disclosure regarding potential sources of dilution to SPAC public investors.

De-SPAC transactions. For de-SPAC transactions, the Rules are also substantively similar to the Proposed Rules, although there are some notable departures from the proposal. The Rules will require additional disclosure in the de-SPAC registration statement consisting of:

• any agreements between the SPAC sponsor and the SPAC regarding whether to proceed with a de-SPAC;
• the nature of all compensation that has been or will be paid to the SPAC sponsor, its affiliates and any promoters;
• any agreements between the SPAC sponsor and unaffiliated security holders of the SPAC regarding the redemption of SPAC shares;
• a reasonably detailed discussion of the reasons of the SPAC and target company for engaging in the de-SPAC as well as the reasons of the SPAC for the proposed structure and timing of the de-SPAC;
• any determination made by the SPAC board as to whether the proposed de-SPAC is advisable and in the best interests of the SPAC and its security holders; and
  • This disclosure requirement shifted from the Proposed Rules which would have required disclosure regarding whether the SPAC reasonably believes that the de-SPAC transaction, and any related financing, are fair or unfair to the SPAC’s unaffiliated security holders.
  • In a further departure from the Proposed Rules, the Rules now only require this disclosure if such determination is required under the law of the jurisdiction of the SPAC’s organization or if the SPAC’s board otherwise makes any such determination.
  • In response to numerous comments, the SEC also made clear that these changes “should avoid any misimpression that [the Rules] creates a requirement, implicit or explicit, or expectation that a fairness opinion must be obtained.”
• the material factors considered by the SPAC board in making such determination, including the valuation of the target company, any financial projections relied upon by the SPAC board and any third-party reports or opinions received by the SPAC board.

Projections. The Rules also change the requirements with respect to projections. Certain of those changes apply to registration statements for both SPACs and issuers other than SPACs. Those changes:

• provide that projections that are not based on historical financials and operational history should be clearly distinguished from projections that are based on historical financial results or operational history;
• provide that it would be considered misleading to present projections based on historical financial results and operational history without providing the historical financial results or operational history with equal or greater prominence; and
• provide that projections that provide non-GAAP financial measures should clearly define each such measure as well as the GAAP financial measure to which it is most directly comparable and an explanation of why the non-GAAP measure was used instead of a GAAP measure.

With respect to projections in de-SPAC transactions specifically, the Rules:

• provide that with respect to target projections made as of a certain date included in the de-SPAC registration statement, the registration statement must state whether or not the target company has affirmed to the SPAC that its projections reflect the view of the target company’s management or board about the target company’s future performance as of the most recent practicable date prior to the date the disclosure document is required to be disseminated to security holders; and
• modify the definition of “blank check company” to include SPACs so that the safe harbor provision for forward-looking statements under the Private Securities Litigation Reform Act is not available in respect of projections included in de-SPAC registration statements.

Other changes to de-SPAC transactions. The Rules also mandate certain changes to the timing of the dissemination of disclosure documents in connection with shareholder votes for certain de-SPAC transactions, impose additional liability on target company officers and directors and require an earlier redetermination of Smaller Reporting Company status. In particular, the Rules:

• require de-SPAC prospectuses and proxy and information statements be disseminated to stockholders at least 20 calendar days in advance of the stockholder meeting;
• require the de-SPAC registration statement be signed by the target company, its principal executive officer(s), its principal financial officer, its principal accounting officer and a majority of its board of directors, subjecting such signatories to potential liability under Section 11 of the Securities Act; and
• require post-de-SPAC companies to make a redetermination regarding Smaller Reporting Company status in its first SEC filing made more than 45 days after the de-SPAC closing, rather than waiting until the next annual date to make such redeterminations.

Changes to all reverse mergers with SEC reporting shell companies, including SPAC transactions. As part of the Rules, the SEC adopted new Rule 145a under the Securities Act which provides that business combination transactions between a reporting shell company that is not a business combination-related shell company and an entity that is not a shell company, which transactions include de-SPACs and certain other reverse mergers with public shell companies (including, potentially, mergers with so-called “fallen angel” companies), are deemed to involve an offer, offer to sell, offer for sale, or sale to the reporting shell company’s stockholders. As a result of Rule 145a, de-SPAC and other reverse merger transactions will now (except in limited cases, where an exemption from registration may be available) be required to utilize a registration statement as public shell companies (including SPACs) and target companies will no longer be permitted to accomplish the merger transaction solely with a proxy statement.

Guidance on underwriter liability and Investment Company Act status. In the adopting release, the SEC abandoned two of its proposed rules—one concerning potential underwriter liability in de-SPAC transactions and another creating a safe harbor under which SPACs would not be considered investment companies under the Investment Company Act — following significant objections and concerns expressed in comment letters submitted by SIFMA, a number of law firms (including Ropes & Gray) and other SPAC market participants. Instead, the SEC provided “guidance” on these topics.

Guidance Regarding Statutory Underwriters

The Proposed Rules included a proposal to adopt new Rule 140a which would have “clarified” that anyone who acts as an underwriter in a SPAC IPO and participates in the distribution associated with a de-SPAC by taking steps to facilitate such transaction, or otherwise participates (directly or indirectly) in the de-SPAC is engaged in a “distribution” of securities and is therefore an “underwriter” under Section 11 of the Securities Act. Instead of adopting this rule, the Commission provided guidance regarding when a person may be an underwriter on a de-SPAC transaction.

In its guidance, the SEC explained that a de-SPAC involves a process by which there is a distribution to the SPAC’s investors, and therefor the public, who receive interests in the post-de-SPAC company. The SEC stated that while it “acknowledge[s] that in a [de-SPAC], there is generally no single party accepting securities from the issuer with a view to resell such securities,” it suggested that an underwriter would be present in a de-SPAC “where someone is selling for the issuer or participating in the distributions of securities in the combined company to the SPAC’s investors and the broader public” and that such entity may be a “statutory underwriter” depending on the facts and circumstances. The SEC noted that the guidance is “not intended to signal that [it] believe[s] that every [de-SPAC] or offering of securities generally involves or needs the involvement of an underwriter” but explained that when both a distribution and underwriter are present, such underwriter would be subject to liability under Section 11 of the Securities Act and “will need to perform the necessary due diligence of the disclosures made in connection with the registered offering of securities or face full exposure to liability without the benefit of the due diligence defense under the Securities Act.”

While we view the SEC’s move away from adopting proposed Rule 140a as a positive development, the SEC’s general guidance and commentary on the topic of potential underwriter liability in de-SPAC transactions does little to resolve the uncertainty the SEC created as a result of proposed Rule 140a. Ultimately, the issue will only be resolved through litigation and a federal court’s view of whether the SEC’s guidance can expand the scope of Section 11 liability.

Finally, the SEC clarified, in response to numerous comments that it had received on the Proposed Rules, that the proposed “Rule 140a was not intended to address any business combination transaction not involving a de-SPAC” and that its guidance “is not intended to influence current practice in traditional M&A.”

Guidance Regarding the Investment Company Act

In the Proposed Rules, the SEC included a proposed safe harbor under which SPACs would not be considered an investment company under the Investment Company Act. The Rules did not adopt this proposed safe harbor but instead provided guidance regarding how a SPAC could be deemed an investment company under the traditional Tonopah factors analysis.¹ In evaluating a particular SPAC under this analysis, the SEC flagged certain activities “that would raise concerns about [a SPAC’s] status as an investment company under the Investment Company Act”: (1) the nature of SPAC assets/income; (2) the actions of its directors, officers and employees, including the amount of time spent by such individuals seeking a de-SPAC transaction; (3) the duration of time before a SPAC announces and completes the de-SPAC; (4) whether the SPAC holds itself out in a manner that suggests investors should invest primarily to gain exposure to its portfolio; and (5) whether the SPAC ultimately merges with an investment company. Regarding the duration factor, the SEC identified the 12-month time period set forth in Rule 3a-2 of the Investment Company Act and the 18-month time period provided for in Rule 419 under the Securities Act as potentially relevant periods by analogy that could factor into whether a SPAC is deemed an investment company.

We expect that this general guidance will result in SPACs and their advisors needing to consider permissible application of trust proceeds, particularly in situations in which SPACs take longer to consummate transactions, and that the lack of specific guideposts may lead to SPACs taking different approaches based on facts and circumstances and risk tolerance. We continue to believe the focus on the potential application of the Investment Company Act to SPACs is misplaced as it is clearly disclosed that the SPAC will be engaged primarily in identifying and consummating a de-SPAC transaction and that if a de-SPAC transaction is not completed within the set time frame, the public SPAC investors will be entitled to their pro rata share of the cash in the trust account. These disclosures make clear that the purpose of the SPAC is the de-SPAC transaction—not providing investors with an interim investment program akin to an investment in a fund.

The Rules will become effective 125 days after their publication in the Federal Register.