On March 30, 2022, the SEC proposed rules enhancing disclosure requirements associated with SPAC initial public offerings (IPOs) and de-SPAC merger transactions; requiring that a private operating company be a co-registrant when a SPAC files an S-4 or F-4 registration statement associated with a business combination; requiring a re-determination of smaller reporting company status within four days following the consummation of a de-SPAC transaction; amending the definition of a “blank check company” to make the liability safe harbor in the Private Securities Litigation Reform Act of 1995 for forward-looking statement such as projections, unavailable in filings by SPACs and other blank check companies; and deeming underwriters in a SPAC IPO to be underwriters in a de-SPAC transaction when certain conditions are met.
The proposed rules would require specialized disclosure with respect to compensation paid to sponsors, conflicts of interest, dilution and the fairness of business combination transactions. Further disclosures will also be required in connection with the use of projections. The SEC is also proposing a rule that would deem any business combination transaction involving a reporting shell company, including a SPAC, to involve a sale of securities to the reporting shell company’s shareholders and is proposing to amend a number of financial statement requirements applicable to transactions involving shell companies. In the wake of the chilled market and proposed rule changes, dozens of SPACs have pulled their offerings since January of this year.
On the positive side, the SEC is proposed a new safe harbor under the Investment Company Act of 1940 (‘40 Act’) that would provide that a SPAC that satisfies the conditions of the proposed rule would not be an investment company and therefore would not be subject to regulation under the ’40 Act.
In last week’s blog, I provided background on and a summary of the proposed new rules (see HERE). This week’s blog begins a granular discussion of the 372-page rule release and its vast implications to not only the SPAC market, but shell company reverse mergers in general.
New Subpart 1600 to Regulation S-K
The proposed new rules would add a new Subpart 1600 to Regulation S-K delineating specialized disclosure requirements in connection with SPAC IPOs and de-SPAC transaction. New Subpart 1600 would: (i) require additional disclosures about the sponsor of the SPAC, potential conflicts of interest, and dilution; (ii) require additional disclosures on de-SPAC transactions, including that the SPAC disclose (a) whether it reasonably believes that the de-SPAC transaction and any related financing transaction are fair or unfair to investors (indirectly requiring a fairness opinion), and (b) whether it has received any outside report, opinion, or appraisal relating to the fairness of the transaction; and (c) require certain disclosures on the prospectus cover page and in the prospectus summary of registration statements filed in connection with SPAC initial public offerings and de-SPAC transactions.
Subpart 1600 would also require changes to several forms including S-1, F-1, S-4, F-4, and Schedules 14A, 14C and TO. To the extent that the disclosure requirements in proposed Subpart 1600 address the same subject matter as the existing disclosure requirements of the forms or schedules, the requirements of proposed Subpart 1600 would be controlling.
In my experience, SPACs already disclose whether it has received a fairness or third-party opinion relating to a de-SPAC transaction. In many cases, the SPAC has not received such a fairness opinion. However, with a requirement to make a reasonable determination that a transaction is fair, a third-party fairness opinion will be the only safe option.
New Item 1601 will add definitions of “special purpose acquisition company,” “de-SPAC transaction,” (which currently is just a term of art), “target company,” and “SPAC sponsor.” A “special purpose acquisition company” or “SPAC” would be defined to mean a company that has indicated that is business plan is to (i) register a primary offering of securities that is not subject to the requirements of Rule 419; (ii) complete a de-SPAC transaction within a specified time frame; and (iii) return all remaining proceeds from the registered offering and any concurrent offerings to its shareholders if the company does not complete a de-SPAC transaction within the specified time frame. The proposed definition is intended to be broad to account for potential variations in and the evolution of SPAC structures.
As a reminder, the requirements of Rule 419 apply to every registration statement filed by a blank check company that is issuing a penny stock as defined in Exchange Act Rule 3a51-1. For more on Rule 419, how SPACs avoid the Rule and the definition of a “penny stock,” see HERE.
The term “de-SPAC transaction” would be defined as a business combination such as a merger, consolidation, exchange of securities, acquisition of assets, or similar transaction involving a SPAC and one or more target companies. The term “target company” would be defined as an operating company, business, or assets. The term “SPAC sponsor” would be defined as the entity and/or person(s) primarily responsible for organizing, directing or managing the business and affairs of a SPAC, other than in their capacities as directors or officers of the SPAC as applicable. Again, the terms are designed to be very broad, to the point of encompassing transactions that may not be permitted under today’s exchange listing rules to allow for continued growth and evolution in SPAC market designs.
Registered Offerings by SPACs
New Item 1602 would require certain information on the prospectus cover page and in the prospectus summary of Form S-1 and F-1 registration statements for offerings by SPACs other than de-SPAC transactions. The new Item will also require enhanced dilution disclosure in SPAC IPOs and de-SPAC transactions.
Item 1602 will require information on the prospectus cover page in plain English about, among other things, the time frame for the SPAC to consummate a de-SPAC transaction, redemptions, sponsor compensation, dilution (including simplified tabular disclosure), and conflicts of interest. In a de-SPAC transaction, Item 1604 would require that SPACs include information on the prospectus cover page in plain English about, among other things, the fairness of the de-SPAC transaction, material financing transactions, sponsor compensation and dilution, and conflicts of interest.
Item 1602 would also add information that would need to be included in the prospectus summary, including:
- The process by which a potential business combination candidate will be identified and evaluated;
- Whether shareholder approval is required for the de-SPAC transaction;
- The material terms of the trust or escrow account, including the amount of gross offering proceeds that will be placed in the trust;
- The material terms of the securities being offered, including redemption rights;
- Whether the securities being offered are the same class as those held by the sponsor and its affiliates;
- The length of the time period during which the SPAC intends to consummate a de-SPAC transaction, and its plans if it does not do so, including, whether and how the time period may be extended, the consequences to the sponsor of not completing an extension of this time period, and whether shareholders will have voting or redemption rights with respect to an extension of time to consummate a de-SPAC transaction;
- Any plans to seek additional financing and how such additional financing might impact shareholders;
- Tabular disclosure of sponsor compensation and the extent to which material dilution may result from such compensation; and
- Material conflicts of interest.
In regard to registered de-SPAC transactions, Item 1604 would require that SPACs include the following information in the prospectus summary in plain English:
- The background and material terms of the de-SPAC transaction;
- The fairness of the de-SPAC transaction;
- Material conflicts of interest;
- Tabular disclosure on sponsor compensation and dilution;
- Financing transactions in connection with de-SPAC transactions; and
- Redemption rights.
Several parts of the new proposed rules require additional disclosures on dilution. Item 1602 requires additional dilution disclosures in all registered offerings by a SPAC other than a de-SPAC transaction, and Item 1604 requires dilution disclosures in a de-SPAC transaction. Item 1602 requires a tabular dilution disclosure on the prospectus cover page in registered offerings by a SPAC on Forms S-1 or F-1. The table would disclose the dilutive impact (remaining pro forma net tangible book value per share) of the IPO assuming 25%, 50%, 75% and 100% redemptions both with and without the exercise of any overallotment option.
Item 1604 would require disclosure of each material potential source of additional dilution that non-redeeming shareholders may experience at different phases of the SPAC lifecycle by electing not to redeem their shares in connection with the de-SPAC transaction. Such sources of dilution may include sponsor compensation, underwriting fees, outstanding warrants and convertible securities, and financing transactions (including PIPE transactions). Like Item 1602, Item 1604 would require a tabular disclosure quantifying the increasing impact of dilution on non-redeeming shareholders as the amount of redemptions increase.
There are a number of potential sources of dilution in a SPAC’s structure, including dilution resulting from shareholder redemptions, sponsor compensation, underwriting fees, outstanding warrants and convertible securities, and PIPE financings. This dilution may be particularly pronounced for the shareholders of a SPAC who do not redeem their shares prior to the consummation of the de-SPAC transaction and who may not realize or appreciate that these costs are disproportionately borne by the non-redeeming shareholder. The SEC rule release cites a study which suggests that the dilutive impact in a SPAC transaction is as high as 50.4% of the cash raised in the SPAC IPO.
Item 506 of Regulation S-K already requires disclosure of the net tangible book value per share before and after the distribution; the amount of the increase in such net tangible book value per share attributable to the cash payments made by purchasers of the shares being offered; and the amount of the immediate dilution from the public offering price which will be absorbed by such purchasers. The new Items 1602 and 1604 disclosures would be in addition to and not replace the Item 506 disclosure.
SPAC Sponsor; Conflicts of Interest
New Item 1603 would require certain disclosure regarding the sponsor and its affiliates and any promoters of SPACs and disclosures regarding conflicts of interest between the sponsor or its affiliates or promoters and unaffiliated security holders. In particular, the following information would be required regarding the sponsor, its affiliates and any promoters in any registration statement or schedules filed in connection with a SPAC registered offering or de-SPAC transaction:
- The experience, material roles, and responsibilities of these parties, as well as any agreement, arrangement or understanding (i) between the sponsor and the SPAC, its executive officers, directors or affiliates, in determining whether to proceed with a de-SPAC transaction and (ii) regarding the redemption of outstanding securities;
- The controlling persons of the sponsor and any persons who have direct and indirect material interests in the sponsor, as well as an organizational chart that shows the relationship between the SPAC, the sponsor, and the sponsor’s affiliates;
- Tabular disclosure of the material terms of any lock-up agreements with the sponsor and its affiliates; and
- The nature and amounts of all compensation that has or will be awarded to, earned by, or paid to the sponsor, its affiliates and any promoters for all services rendered in all capacities to the SPAC and its affiliates, as well as the nature and amounts of any reimbursements to be paid to the sponsor, its affiliates, and any promoters upon the completion of a de-SPAC transaction.
The nature of a SPAC structure creates an inherent potential conflict of interest between the sponsor and public investors. A notable example is the potential conflict of interest stemming from the contingent nature of the sponsor’s compensation, whereby the sponsor and its affiliates have significant financial incentives to pursue a business combination transaction even though the transaction could result in lower returns for public shareholders than liquidation of the SPAC. Other conflicts of interest may arise when a sponsor is a sponsor of multiple SPACs and manages several different SPACs at the same time; when a sponsor and/or its affiliates hold financial interests in, or have contractual obligations to, other entities; or when a SPAC enters into a business combination with a private operating company affiliated with the sponsor, the SPAC, or the SPAC’s founders, officers, or directors, all of which are just a few examples and common occurrences.
Accordingly, Item 1603 would require disclosure of any actual or potential material conflict of interest between (i) the sponsor or its affiliates or the SPAC’s officers, directors, or promoters, and (ii) unaffiliated security holders. This would include any conflict of interest in determining whether to proceed with a de-SPAC transaction and any conflict of interest arising from the manner in which a SPAC compensates the sponsor or the SPAC’s executive officers and directors, or the way the sponsor compensates its own executive officers and directors. Furthermore, Item 1603 would require disclosure regarding the fiduciary duties each officer and director of a SPAC owes to other companies.
In the next blog in this series, I will delve into the new proposed de-SPAC transaction disclosures.
Securities attorney Laura Anthony and her experienced legal team provide ongoing corporate counsel to small and mid-size private companies, OTC and exchange traded public companies as well as private companies going public on the Nasdaq, NYSE American or over-the-counter market, such as the OTCQB and OTCQX. For more than two decades Anthony L.G., PLLC has served clients providing fast, personalized, cutting-edge legal service. The firm’s reputation and relationships provide invaluable resources to clients including introductions to investment bankers, broker-dealers, institutional investors and other strategic alliances. The firm’s focus includes, but is not limited to, compliance with the Securities Act of 1933 offer sale and registration requirements, including private placement transactions under Regulation D and Regulation S and PIPE Transactions, securities token offerings and initial coin offerings, Regulation A/A+ offerings, as well as registration statements on Forms S-1, S-3, S-8 and merger registrations on Form S-4; compliance with the Securities Exchange Act of 1934, including registration on Form 10, reporting on Forms 10-Q, 10-K and 8-K, and 14C Information and 14A Proxy Statements; all forms of going public transactions; mergers and acquisitions including both reverse mergers and forward mergers; applications to and compliance with the corporate governance requirements of securities exchanges including Nasdaq and NYSE American; general corporate; and general contract and business transactions. Ms. Anthony and her firm represent both target and acquiring companies in merger and acquisition transactions, including the preparation of transaction documents such as merger agreements, share exchange agreements, stock purchase agreements, asset purchase agreements and reorganization agreements. The ALG legal team assists Pubcos in complying with the requirements of federal and state securities laws and SROs such as FINRA for 15c2-11 applications, corporate name changes, reverse and forward splits and changes of domicile. Ms. Anthony is also the author of SecuritiesLawBlog.com, the small-cap and middle market’s top source for industry news, and the producer and host of LawCast.com, Corporate Finance in Focus. In addition to many other major metropolitan areas, the firm currently represents clients in New York, Los Angeles, Miami, Boca Raton, West Palm Beach, Atlanta, Phoenix, Scottsdale, Charlotte, Cincinnati, Cleveland, Washington, D.C., Denver, Tampa, Detroit and Dallas.
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