Final SEC Rules on SPACs, Shell Companies and Projections

On January 24, 2024, the SEC adopted its long-awaited final rules relating to special purpose acquisition companies (SPACs), shell companies and projections. The adopting release can be found here, and the proposing release, dated March 30, 2022, may be found here.

The final rules as expected reflect the SEC's central premise that a de SPAC transaction—the mergers and acquisitions (M&A) transaction that follows a SPAC initial public offering—is the functional equivalent of, and should be regulated as, the private target company's IPO.  In the SEC's view, this is because a de SPAC transaction results in the target company becoming part of a combined company that is a US reporting company and provides the target company with access to cash proceeds that the SPAC had previously raised from the public.  The final rules have largely been enacted as proposed. However, there have been important modifications, particularly for investment banks, which are often justified with reference to the premise that a de SPAC transaction, while analogous to a traditional IPO, is a hybrid transaction that contains elements of both an IPO and an M&A transaction.

We have set forth below short summaries of some of the more important points in the final rules, with a focus on those that implicate liability issues.  We do not expect that the adoption of the final rules will result in wholesale changes to the execution practices that banks have adopted globally in the wake of the proposed rules, but practices will no doubt evolve over time.  The final rules will become effective 125 days from the date of publication in the Federal Register, which should occur promptly.

Any of the Herbert Smith Freehills capital markets lawyers listed below would be very pleased to discuss disclosure and liability concerns stemming from, or any other aspects of, the final rules, at your convenience.

Our key takeaways include:

• Underwriter liability: Of greatest significance for investment banks, the SEC has declined to adopt its proposed Rule 140a.  This proposed rule would have provided that a person who has acted as an underwriter of the securities offered in a SPAC IPO and had taken steps to facilitate the de SPAC transaction, or any related financing transaction, or otherwise participated directly or indirectly in the de SPAC transaction, would be deemed to be engaged in the distribution of the securities of the surviving public entity in the de SPAC transaction, and thus be subject to underwriter liability under the Securities Act.  The SEC has instead provided general guidance regarding statutory underwriter status in a de SPAC transaction.  Rather than promulgating a rule clarifying underwriter status, the SEC intends to follow its longstanding practice of applying the terms "distribution" and "underwriter" broadly and flexibly, as the facts and circumstances of a transaction may warrant.  An underwriter would be present where an entity is selling for the issuer or participating in a distribution of securities in the combined company to the SPAC's investors and the broader public, even though that entity is not named as an underwriter in a given offer.  The SEC also helpfully clarified that nothing in proposed Rule 140a was intended to address any M&A transaction other than a de SPAC transaction, distinguishing traditional M&A from the "unique circumstances" of conducing a public offering through a de SPAC transaction.

In adopting the final rules, the SEC was also clearly mindful that courts have taken a narrower view of who, other than named underwriters, has acted as a distribution participant and is thus subject to underwriter liability.  The SEC referred in particular to the In re Lehman Bros. Mortgage-Backed Sec. Litig. Case from the Second Circuit and attempted to distinguish that ruling since it was in the context of a more conventional capital raising.  However, particularly since the SEC has itself left the determination as to who constitutes an underwriter to a facts and circumstances determination, we believe this issue will continue to be tested in the courts, including in the ongoing In re Arrival SA Securities Litigation in New York federal court.

• Distribution of securities/Rule 145a: Consistent with the above guidance on statutory underwriter liability (or to facilitate the analysis of whether a statutory underwriter is present), the SEC clarified that a de SPAC transaction is considered a "distribution of securities" by adopting Rule 145a. Under Rule 145a, there is a "sale" from the combined company to the SPAC's existing shareholders, even in de SPAC transaction structures where the SPAC shareholders are not actually receiving new shares from the combined company.  Here, the SEC also distinguished between de SPAC transactions and traditional M&A transactions, noting that in de SPAC transactions there is a change in the nature of the investment from an entity that has no or nominal operations to a combined operating company which does not occur in traditional M&A.  This conclusion reflects the SEC's central position that a de SPAC transaction is, and in its view should be, more analogous to a traditional IPO.
• Target becomes co-registrant: Under the final rules, as was the case in the proposed rules, the target company in a de SPAC transaction is considered an "issuer" of securities.  As a result, the target and its principal executive officer(s), principal financial officer, principal accounting officer and at least a majority of its board of directors will be required to sign the registration statement as a co-registrant with the SPAC and assume Section 11 liability for any material misstatements or omissions in the registration statement.  In the case of a de SPAC transaction involving the purchase of assets or a business, the signatories of the asset purchase agreement (or similar agreement) would be required to sign the registration statement.  The SEC further clarified that as a co-registrant, the target would become an Exchange Act reporting company subject to the ongoing reporting requirements of US Exchange Act from the time at which the registration statement becomes effective.  Accordingly, the target would be required to file Exchange Act reports during the interim period between effectiveness and closing.  To reinforce the appropriateness of co-registrant status, the SEC noted that the majority of disclosure in a de SPAC registration statement is about the target, and that the target is the principal beneficiary of the capital that the SPAC previously raised in its IPO.
• Financial projections/forward-looking statements: In response to concerns that "SPACs are rife with disclosures that border on or cross into outright fraud", the SEC amended the definition of "blank check company" to include SPACs. This amendment followed a lengthy discussion of a long list of objections from commentators based on diverse observations and alternative proposals. Several commentators argued that disclosure of projections is a practice that goes beyond traditional IPOs (and that the traditional IPO practice of refraining from publishing projections would not work in a de SPAC transaction) and could alter the issuer's determination as to whether projections must be disclosed under State corporate law.  The SEC also rejected a proposal to permit underwriters to benefit from the Private Securities Litigation Reform Act (PSLRA) safe harbour so long as the underwriter was not the "maker" of the forward-looking statement.  In doing so, the SEC clarified that the PSLRA safe harbour for forward-looking statements is not available for financial projections in a de SPAC transaction.  In the SEC's view, to permit PSLRA safe harbour protections for de SPAC transactions would be inconsistent with the goal of incentivising blank check companies (including SPACs) to take more care in avoiding the use of unreasonable forward-looking statements.  Several commentators complained that the SEC does not have authority to amend the legislative definition of blank check company, indicating that this aspect of the new rules could be subject to legal challenge in the future.  The final rules also contain enhanced disclosure requirements concerning the basis of the projections.
• Fairness determination: In order to address "potential conflicts of interest" and "misaligned incentives" in connection with a SPAC's decision to proceed with a de SPAC transaction, in the 2022 proposing release the SEC proposed Item 1606(a) to require a statement from a SPAC as to whether it reasonably believes that the de SPAC transaction and any related financing are fair or unfair to the SPAC's unaffiliated shareholders.  In response to significant concerns from commentators, including that proposed Item 1606(a) would create a new substantive corporate law requirement and result in increased liability and litigation risk, the SEC modified its approach.  Under the final rules, Item 1606(a) does not require the de SPAC transaction to be substantively fair or the SPAC to make a fairness determination (or to obtain a fairness opinion) when it is not otherwise required to do so under applicable state or foreign corporate law (and the reference to related financing has been moved to Item 1606(b)).  Instead, if the SPAC's governing law requires its board of directors to determine whether the de SPAC transaction is advisable and in the best interests of shareholders, the SPAC must disclose that determination.  This new disclosure requirement does not impose procedural obligations on how such a decision is made.  In addition, to the extent that a fairness determination is disclosed, final Item 1606(b) will now require the factors considered by the SPAC's board of directors to be disclosed with reference to a non-exclusive list of factors, including financial projections relied upon and the terms of any related financing.
• Investment Company Act: The SEC decided not to provide SPACs with a safe harbour from the definition of "investment company" under the Investment Company Act as had been proposed for comment.  Instead, the question of whether a SPAC is an investment company will require a facts and circumstances analysis to be made on a case by case basis.  The SEC noted that certain activities by the SPAC could tip in favour of investment company act status, such as if the SPAC invested in corporate bonds or acquired a minority interest in a target with the intention of being a passive investor.  In addition, the SEC indicated that if a SPAC takes a long time to achieve its stated business purpose, questions will arise as to whether its officers, directors and employees are more engaged in achieving investment returns than achieving a business combination with a target.
• Other matters: Other significant matters include a wide variety of disclosure matters (which largely track the proposals), including conflicts of interest and dilution disclosure, expanded target disclosure, expanded financial statement disclosure intended to align de SPAC disclosure with IPO disclosure and a minimum dissemination period for shareholder communications (20 calendar days or any shorter period under the applicable laws of the SPAC's jurisdiction of organisation).