The SPAC market has exploded, growing from 59 IPOs in 2019 to 248 in 2020. There have been more SPAC IPOs in 2021 than in all of last year. In response to this rapid explosion, the Securities and Exchange Commission released three public statements that, taken together, demonstrate that SPACs are under increasing regulatory scrutiny. The implications of this for the market are still being worked out, but SPAC sponsors and target companies should proceed with added caution.
One advantage of a de-SPACing transaction over a traditional IPO is faster access to the public markets. The first SEC public statement, issued by the Division of Corporation Finance, seems designed to remind target companies of the speed bumps to a de-SPACing transaction. Over time, the securities laws have evolved to permit easier access to the public markets for companies of sufficient size and trading volume that make them well-known to the market. Public companies that began life as a SPAC often have to wait for a period of time after the de-SPACing transaction before they can take advantage of those rules, if at all. The public statement highlights those restrictions, as well as other technical securities law restrictions that are applicable only to de-SPACed companies, pointing out that even if initial access to the public markets is quicker, that subsequent offerings will be more difficult.
The first public statement also contains two warnings to target companies that are considering going public through a de-SPACing transaction. The first warning relates to the extensive books and records requirements that are applicable to public companies. Even a private company that has its books audited annually by a leading accounting firm will likely not have the internal controls in place required of a public company, and a target company that rapidly “goes public” through a de-SPACing transaction may not have the time to implement those procedures. This public statement effectively warns target companies that they “may not be able to develop those capacities without advance planning and investment in resources.”
The second warning relates to the ability of the de-SPACed company to meet the continued listing requirement of the securities exchanges. One of the hallmarks of a de-SPACing transaction is the ability of the SPAC investors to have their common stock redeemed. Depending on the number of shares redeemed and the profile of the target company, it may be difficult for the de-SPACed company to meet continued listing requirements relating to items such as the number of round lot holders, publicly held shares, and market value of publicly held shares. The SEC warns that “non-compliance with a listing standard may also present a material risk requiring disclosure under Item 105 of Regulation S-K.”
Another perceived advantage of a de-SPACing transaction over a traditional IPO is the availability of a safe harbor from securities law liability for forward-looking statements that meet certain criteria. This safe harbor, however, is not available in an IPO. Part of the allure of a de-SPACing transaction is the ability of the target company to put projections in the de-SPACing prospectus sent out to the SPAC shareholders (and viewed by the market) to support a higher valuation, and that those projections will be subject to the forward-looking statement safe harbor. If those projections were in an IPO prospectus, they would not have the same protection.
The second SEC public statement dramatically reduces this advantage. The statement notes that there is no statutory definition of “initial public offering” and strongly suggests that in the context of the forward-looking statement safe harbor, a de-SPACing proxy statement should be considered an “initial public offering.” Securities law plaintiffs can now cite the public statement for that proposition, and thus the public statement has effectively largely nullified the safe harbor advantage of a de-SPACing transaction over an IPO. Additional SEC rulemaking defining “initial public offering” for purposes of the forward-looking statement safe harbor to include a de-SPACing proxy may follow.
In my opinion, while the safe harbor has always been a nice side-benefit of a de-SPACing transaction, in most cases it has likely not been a deciding factor in whether to go public through an IPO or a SPAC. While the public statement disclaims being “anti-SPAC,” it does raise the specter of treating the de-SPACing transaction like an IPO and increased regulatory scrutiny.
The third SEC public statement is a technical interpretation of the accounting for SPAC warrants. Although SPAC warrants are typically treated as equity for accounting purposes, the public statement notes that for certain “fact patterns,” they should be treated as a liability measured at fair value. Given the common features of many SPAC warrants, it is likely that that fact pattern will be repeated for many existing SPACs and de-SPACed companies. If there is a determination that the prior equity accounting for SPAC warrants was in error, that could implicate the effectiveness of a company’s internal controls over financial reporting and may require a SPAC or de-SPACed company to restate previously-issued financial statements. The restated balance sheet will be less attractive going forward and may have secondary effects, such as the calculation of commonly-used financial ratios in credit agreements and equity market analysis. This public statement makes a de-SPACing transaction with an existing SPAC with the offending SPAC warrant features much less attractive. Future SPACs should be able to structure their SPAC warrants to avoid this adverse accounting result.
These SEC statements have demonstrated increased scrutiny of — and some might say hostility toward — SPACs. It is hard to predict how the dance between securities regulators and SPAC sponsors, investors, and advisors will play out.
Maurice M. Lefkort W86 is a partner in the Corporate & Financial Services Department of Willkie Farr & Gallagher LLP and the former Chairman of the Corporation Law Committee of the Association of the Bar of the City of New York.
Editor’s note: This blog post is intended as general information on the law and legal developments, and is not legal advice as to any particular situation. Under New York ethical rules, please note that this post may constitute attorney advertising.