On Friday, the SEC’s Small Business Capital Formation Advisory Committee held a virtual meeting to discuss two of the SEC’s recent rulemaking initiatives: climate disclosure and SPACs, particularly as those proposals, if adopted, would impact smaller public companies and companies about to go public. The committee heard several presentations, including summaries of the proposals from SEC staff members, and voiced concerns about a number of challenges presented by the proposals. The committee also considered potential recommendations that it expects to make to the SEC.
In his remarks to the committee, SEC Chair Gary Gensler hit on familiar themes: Gensler contended that the “proposal on climate-related disclosures builds upon this Commission’s long tradition of disclosures…. Over the decades, disclosure needs evolved to include many types of risk factors. Today, one of those risk factors is climate-related risks.” But in the absence of “clear rules of the road,” he said, “different companies are disclosing different amounts of information, in different places, and at different times. That’s why I believe this proposal, in line with our disclosure-based and not merit-based regime, would help ensure that investors receive consistent, comparable, and decision-useful information, and that issuers have clear and consistent reporting obligations.” (See this PubCo post and this PubCo post.) With regard to the SPAC proposal, SPACs, he said, “go public in two stages…. Each stage offers an alternative path from traditional IPOs for companies to raise capital from the public. Yet, currently, these paths don’t offer the same protections and obligations associated with the traditional IPO process. That’s why the SEC’s recent proposal would strengthen the disclosures, marketing practices, and gatekeeper and issuer obligations for SPACs.” Treat like cases alike, he has often said. (See this PubCo post.)
SEC Commissioner Hester Peirce also offered remarks to the committee. She noted that she had previously expressed her views about the climate proposal (see this PubCo post), but hoped to hear the unique challenges facing small companies. Do the limited exemptions for smaller companies included in the proposal suffice? Are climate-related risks even “material for all small public companies? If so, do the proposed benefits of the rule justify the costs associated with compliance?… The release was dismissive of the notion that the costs associated with the proposed rules could deter a private company from going public. Was the Commission correct, or might these new requirements be a material consideration for companies considering going public?” In addition, she highlighted a contention also addressed during the meeting: the impact of the proposal on small private companies—not directly, but indirectly—through pressure on private companies in public companies’ value chains for climate data for purposes of public companies’ own Scope 3 calculations. Private companies may also be influenced or pressured to take steps to reduce their own Scopes 1 and 2 emissions. What will the costs be, she asks, “for small private companies to reduce their emissions to improve the public image of their public company counterparties at the behest of the Commission?”
Peirce has also previously addressed the SPAC proposal, characterizing the proposal as seemingly “designed to stop SPACs in their tracks.” (See this PubCo post.) In this context, she asks whether the proposal would “diminish the desirability of SPACs as a vehicle by which small businesses can become public companies? What is attractive about SPACs to small businesses seeking to enter the public markets, and what about the traditional initial public offering process is uninviting to these companies?”
At the meeting
(Based on my notes, so standard caveats apply.)
Climate disclosure proposal. Following a summary of the proposal by an SEC staff member, there was a brief colloquy with the staff member about various aspects of the proposal. For example, with regard to Peirce’s concern that the proposal could indirectly affect private companies, the staff member pointed out that, if there are gaps in Scope 3 data, the proposal permits companies to satisfy the requirements in other ways; i.e., companies will not need to pressure private companies that do not have the data available. Nevertheless, the committee continued to express concern that there might be a disincentive to do business with or provide capital to smaller or private companies in the value chain that may not have GHG data available or have the same incentive to reduce emissions. With regard to a comment about more expansive phase-ins, although the proposal does not provide for a JOBS-Act-like phase-in for emerging growth companies, the staff member pointed out, there are a number of other carve-outs for smaller companies. As to a suggestion from a committee member that the SEC coordinate its rules with the EPA for a whole-of-government approach, the staff member responded that the SEC and EPA have different disclosure mandates—the SEC’s is investor protection and the EPA’s is environmental regulation.
Other presenters at the meeting raised a number of other comments. For example, one presenter contended that conduct of the audit could be very challenging in light of the subjective nature of many of the determinations. For example, what is a severe weather event? There were also extensive comments about the brevity of the transitional period in general, with a more specific suggestion that the SEC first evaluate performance by larger companies and, once there is a workable model for compliance, then impose requirements on smaller companies. The timing of the filing which would contain the climate disclosure could also be problematic, one presenter suggested; some data may well not be received in time for a 10-K filing. Another timing issue involved the timing constraints for nonaccelerated filers that, after redetermination of their status, may suddenly be required to report climate information with very little time to prepare.
Another challenge identified was the costs of the audit—attestation for just Scopes 1 and 2 could be very costly for small companies. Given that the disclosure would be in the 10-K, why is the attestation even necessary? More generally, the costs to implement the proposal—along with the burden imposed and distraction involved in such a significant undertaking—were a significant concern. For some companies, these costs may well increase over time. In addition, one committee member observed, many important societal issues were being “piled on” public companies, and many require enormous work to address; small companies need space for growth without spending 30% of revenue for compliance. One new committee member asked whether there was anything like Turbotax for GHG emissions disclosure? If there wasn’t, shouldn’t the SEC create a DARPA-like fund to support that development?
In the end, the committee voted on a number of general potential recommendations, to be further amplified:
- Affirm that the committee believes that climate disclosure is important, including disclosure that is consistent across companies and agencies;
- Ask the SEC to perform a more detailed cost/benefit analysis, especially with respect to smaller companies;
- Provide more scaling and phase-ins for EGCs and smaller reporting companies (such as the phase-in for EGCs in the JOBS Act);
- Expand safe harbors from liability;
- Create an incentive structure rather than a penalty structure (such as through reduced fees);
- Address considerations that could deter companies from conducting IPOs;
- Address the potential impact on very small companies;
- Consider the impact on private companies of public companies’ potential reluctance to include them in the value chain;
- Consider industry-specific requirements, similar to the SASB framework;
- Eliminate the costly and slow attestation requirement;
- Treat the disclosure as “furnished,” not “filed”;
- Delay the disclosure due date; and
- Delay the general phase-in dates to allow more time to organize and prepare.
SPAC proposal. After the release of the SEC’s proposal, are SPACs still going to be a thing? Or did the SEC’s SPACs proposal create an immediate chilling effect? That seemed to be the broader question that hung in the air during the SPAC discussion. In the current landscape for capital raising, a law firm presenter observed, where many companies continue to be reluctant to go public and institutional investors tend to focus on larger IPOs, SPACs have represented an important alternative. If the SEC wants to treat like cases alike, she continued, then it should do so completely, such as by removing all of the impediments applicable to shell companies (e.g., availability of Rule 144). The SEC staff member participating in this discussion maintained that there are differences—a SPAC involves a merger transaction and there is also a guaranteed return of capital for investors who hold redemption rights.
For the most part, there was not much criticism of the proposed disclosure requirements (e.g., conflicts of interest). A committee member appeared to favor the provisions in the proposal that levelled the disclosure playing field for investors, accelerating the timing of a number of disclosures that would have the effect of closing the disclosure gap that currently exists prior to the de-SPAC transaction. The presenter, however, identified a number of aspects of the proposal that she viewed as problematic, adding substantially to the costs and risks associated with the transaction. For example, the proposal to require a discussion of the fairness of the transaction and related fairness opinion, similar to the requirements for going-private transactions, would be costly, difficult and involve potential liability. In addition, a fairness opinion would likely rely on projections, but as proposed, there would be no safe harbor under the PSLRA for a discussion of the projections. (It was also noted that projections are commonly used in IPOs, for example, by the underwriters, but not disclosed.)
The presenter also took issue with the proposal’s treatment of the private operating target in the de-SPAC transaction as a co-registrant when the SPAC files a registration statement for a de-SPAC transaction, with the result that the private operating company and its signing persons would be subject to liability under Section 11 of the Securities Act as signatories to the registration statement. The presenter questioned that analysis, arguing that the target is not selling shares to the public; it is only providing information about itself. Nor is the target a “promoter” or a “control person.” This novel treatment, she said, was creating a slippery slope in the merger context, creating a number of issues.
Another major issue with the proposal, according to the presenter, was the proposed new rule that would treat anyone who has acted as an underwriter of the securities of a SPAC and takes steps to facilitate a de-SPAC transaction or any related financing transaction or otherwise participates in the de-SPAC transaction to be engaged in a distribution and an underwriter in the de-SPAC transaction, subject to Section 11 liability. But that treatment, the presenter urged, was inconsistent with prior treatment and conflated two processes. The SEC staff member countered that the treatment in the proposal was consistent with the statutory definition of “underwriter.” A committee member suggested that the SEC wanted to raise the bar, holding financial intermediaries responsible for conducting due diligence to verify the veracity of disclosure.
All of these aspects of the proposal have had a chilling effect, the presenter said, leading market participants to question whether the SPAC alternative still constituted a viable strategy. One committee member disfavored SPACs altogether, viewing them as an indictment of the complexities of the securities laws. That member would prefer that companies use Reg A as an IPO alternative, but acknowledged that there were not many takers for that approach.
With regard to the proposed safe harbor from application of the Investment Company Act of 1940, one committee member was critical of the safe harbor’s requirement to shorten the time frame for identifying a target and completing a de-SPAC transaction, contending that it would only incentivize companies to make bad deals.
After discussion, the committee voted on a number of general recommendations, to be further amplified:
- Encourage the SEC to keep the SPAC alternative viable;
- To protect investors, require more disclosure earlier in the process to avoid information asymmetry;
- Provide nuanced guidance to clarify who has underwriter status;
- Provide a safe harbor for the disclosure of projections; and
- Lengthen time frames in the Investment Company Act safe harbor for identifying a target and completing a de-SPAC transaction included in the safe harbor.