Tomorrow, in addition to Rule 10b5-1 plan recommendations (see this PubCo post), the SEC’s Investor Advisory Committee is slated to take up draft subcommittee recommendations regarding SPACs. The new SPAC recommendations address SPAC regulatory and investor protection issues that have been under scrutiny as a result of the proliferation of SPACs in 2020 and 2021. The IAC subcommittee observes that the SEC and its staff have addressed many issues related to SPACs in staff guidance, and the topic’s appearance on the SEC’s most recent agenda signals that it may be headed for further regulatory action. With that in mind, the recommendations are focused “on the practical challenges SPAC investors face in fully assessing the risks and opportunities associated with these investment vehicles.” In light of the dynamic nature of the SPAC market in recent months, however, the subcommittee frames its recommendations as “preliminary,” and indicates an intent “to revisit the issue of SPAC governance” in the future as more data becomes available. [Update: this recommendation was approved by the Committee for submission to the SEC.]
Not according to 49 major law firms! Earlier this month, a shareholder of Pershing Square Tontine Holdings, Ltd., filed derivative litigation against the company’s board, its sponsor and other related companies, contending that the company, a SPAC organized by a billionaire hedge-fund investor, is really an investment company that should be registered under the Investment Company Act of 1940 and that its sponsor is really an investment adviser that should be registered under the Investment Advisers Act of 1940. Had they registered, so the argument goes, they would have been subject to substantial regulation regarding the rights of the SPAC’s shareholders and the form and amount of the SPAC managers’ compensation. According to the complaint, under the ICA, “an Investment Company is an entity whose primary business is investing in securities. And investing in securities is basically the only thing that PSTH has ever done.” The complaint sought “a declaratory judgment, damages, and rescission of contracts whose formation and performance violate” the ICA and IAA. What’s especially notable about the litigation—aside from its novel premise—is that the plaintiff’s lawyers include Yale law professor John Morley and Robert Jackson, an NYU law professor and former SEC Commissioner. Now, a group of 49 major law firms—including Cooley—have issued a joint statement pushing back on the plaintiff’s claims, asserting that there is no legal or factual basis for the allegation that SPACs are investment companies.
The SEC has announced charges against Stable Road Acquisition Corp. (a SPAC), SRC-NI (its sponsor), Brian Kabot (its CEO), Momentus, Inc. (the SPAC’s proposed merger target), and Mikhail Kokorich (Momentus’s founder and former CEO) for misleading claims about Momentus’s technology and about national security risks associated with Kokorich. All the parties have settled other than Kokorich, against whom the SEC has filed a separate complaint. Under the Order, the settling parties agreed to aggregate penalties of over $8 million and voluminous, specific investor protection undertakings. The SPAC sponsor also agreed to forfeit the founder’s shares that it would otherwise have received if the merger were approved. The merger vote is currently scheduled for August 2021. SEC Chair Gary Gensler weighed in—a rare comment on a litigation settlement, perhaps signaling the significance of the case: “This case illustrates risks inherent to SPAC transactions, as those who stand to earn significant profits from a SPAC merger may conduct inadequate due diligence and mislead investors….Stable Road, a SPAC, and its merger target, Momentus, both misled the investing public. The fact that Momentus lied to Stable Road does not absolve Stable Road of its failure to undertake adequate due diligence to protect shareholders. Today’s actions will prevent the wrongdoers from benefitting at the expense of investors and help to better align the incentives of parties to a SPAC transaction with those of investors relying on truthful information to make investment decisions.”
SPACs have certainly presented a well-lighted pathway for hundreds of companies to reach the public markets this past year or so. In testimony before a House subcommittee in May, SEC Chair Gary Gensler observed that we are “witnessing an unprecedented surge” in SPACs: so far in 2021, the SEC has received 700 S-1 SPAC filings, and 300 of these “blank-check IPOs” have been completed so far this year, compared to just 13 in all of 2016. Most recently, SPACs have been the target of extensive criticism, both from the SEC and outside commentators. However, in this DealBook column in the NYT, In Defense of SPACs, the Deal Professor suggests that the animus underlying much of this criticism is misguided; these “complex takeover vehicles serve an important purpose that’s worth protecting,” he contends. What is that purpose? As has long been lamented, the lane for smaller, earlier-stage companies to go public has substantially narrowed over a number of years. SPACs, he contends, have not just offered an alternative pathway to public company status—they have “single-handedly revived” the IPO market for these smaller, younger—and yes, sometimes riskier—companies to go public.
Congress now seems to be all over this SPAC phenomenon. Last week a subcommittee of the House Financial Services Committee held a hearing on “Going Public: SPACs, Direct Listings, Public Offerings, and the Need for Investor Protections.” What is the headline from the hearing? All the witnesses agreed that, to prevent regulatory arbitrage, all IPO vehicles, whether traditional IPOs or SPACs, should operate on a level playing field and be subject to the same type of regulation of disclosure and liability. Many House members also took the opportunity to promote their own proposed or pending legislation about the capital markets, and several House members offered their recommendations for a happy marriage. At a separate hearing, SEC Chair Gary Gensler gave testimony before a different subcommittee, which in part addressed SPACs. Is some kind of Congressional action in the offing?
Warrants are frequently issued in connection with the formation and initial registered offerings of SPACs, but apparently there have been some problems with accounting for some of these warrants, or at least, so it appears from this Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”) from Acting Corp Fin Director John Coates and Acting Chief Accountant Paul Munter. The Statement is intended to “highlight the potential accounting implications of certain terms that may be common in warrants included in SPAC transactions” and to discuss what needs to be done if this Statement leads a company and its auditors to determine there is an error in any previously filed financial statements. The primary issue identified in the Statement is whether these warrants should be classified as equity or liability, which depends largely on the specific terms of the warrant and the entity’s specific facts and circumstances. If warrants are classified as a liability, according to the Statement, they should be “measured at fair value, with changes in fair value reported each period in earnings.”
As has been widely reported, there has been a phenomenal increase in the volume of SPAC transactions as an alternative approach to becoming a public company. According to Bloomberg, around “300 SPACs launched on U.S. exchanges in the first quarter, raising almost $100 billion. That total was more than all of last year.” In this statement, Corp Fin Acting Director John Coates discusses liability risks potentially arising out of SPAC and de-SPAC transactions, that is, the transactions in which a private operating company undertakes a business combination with a SPAC, ultimately becoming a public operating company. The essence of his message is: why should a SPAC be treated differently from a traditional IPO?
According to the staff of the SEC’s Office of the Chief Accountant, in “just the first two months of 2021, both the number of new SPACs and amount of capital raised by those SPACs have been reported to already match approximately three-fourths of all such activity last year.” And there was quite a bit of SPAC activity last year. In light of the incredible volume of SPAC deals, on Wednesday, the staffs of Corp Fin and the OCA issued special guidance for SPACs. These statements address shell company, financial reporting, accounting, internal control, governance and auditor considerations in connection with a de-SPAC transaction, that is, a transaction in which a private operating company undertakes a business combination with a SPAC, ultimately becoming a public operating company. Both staffs seem to question whether the timing and other circumstances of de-SPAC transactions mean that the private operating company targets may not be fully equipped for what comes next and want stakeholders to carefully consider whether each of these private targets, in the words of OCA, has “a clear, comprehensive plan to be prepared to be a public company.” Corp Fin also wants all those who are clamoring for SPACs to be aware of all restrictions, impediments and other potential hiccups that come with the package. Could they possibly be trying to put the kibosh on SPAC fever? According to Reuters, analysts think the SEC is “worried about how much due diligence is performed by SPACs before acquiring assets, and about disclosures to investors.”
Happy new year! To complete the year- and term-end surge, just before Christmas, the Corp Fin staff issued CF Disclosure Guidance: Topic No. 11 regarding disclosure considerations for special purpose acquisition companies in connection with their IPOs and subsequent business combinations, often referred to as de-SPAC transactions. As usual, the staff provides some great questions to consider when crafting disclosure.