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 first blog in this series, I provided background on and a summary of the proposed new rules (see HERE). The second blog began a granular discussion of the 372-page rule release drilling down on new disclosure requirements associated with SPAC IPOs (see HERE). The third week continued summarizing new disclosure requirements focusing on de-SPAC transaction (see HERE). This week’s blog will dissect several rule changes intended to align a de-SPAC transaction with an old-fashioned IPO.
The SEC has been vocal about its views that a de-SPAC transaction is just another form of an IPO – a private company accessing public securities markets and becoming public reporting company. In April, 2021, John Coates, then Acting Director of the Division of Corporation Finance, issued a statement detailing areas of concern between a de-SPAC transaction and an IPO. A few of the topics he touched upon included the perceived protections of the Private Securities Litigation Reform Act (PSLRA) safe harbor for forward-looking statements, including projections, that many SPACs rely upon and which protection is not available in an IPO transaction; and a target companies lack of liability for the SPACs registration statements or proxy statements utilized in a de-SPAC transaction (see HERE).
The new proposed rules address both of these issues and more with the intent to provide investors with disclosures and liability protections comparable to those that would be present if the private operating company were to conduct a traditional firm commitment initial public offering. In particular, the proposed new rules would: (i) require non-financial disclosure about the private target company that would normally be included in an S-1 or F-1 for an IPO, in pre-closing de-SPAC transaction documents such as proxy or registration statements; (ii) require a minimum dissemination period for disclosure documents in de-SPAC transactions; (iii) treat the private operating company as a co-registrant of the Form S-4 or Form F-4 for a de-SPAC transaction when a SPAC is filing the registration statement; (iv) require a re-determination of smaller reporting company status following the consummation of a de-SPAC transaction; (v) amend the definition of a “blank check company” in the PSLRA such that the forward-looking statement safe-harbor will not apply to projections in filings by SPACs and other blank check companies that are not penny stock issuers; and (vi) provide that underwriters in a SPAC initial public offering are deemed to be underwriters in a subsequent de-SPAC transaction under certain circumstances.
New Non-Financial Disclosure Requirements in De-SPAC Disclosure Documents
The proposed rules would require that the following Regulation S-K disclosures be made, regarding the private target company, in registration statements (S-4 or F-4) or schedules (14A; 14C and TO) filed in connection with a de-SPAC transaction: (i) Item 101 – description of business; (ii) Item 102 – description of property; (iii) Item 103 – legal proceedings; (iv) Item 304 – changes in and disagreements with accountants on accounting and financial disclosure; (v) Item 403 – security ownership of certain beneficial owners and management, assuming the completion of the de-SPAC transaction and any related financing transaction; and (vi) Item 701 – recent sales of unregistered securities. See HERE for a discussion of recent amendments to Items 101 and 103.
Each of these disclosures is currently required to be filed in a Super 8-K post-closing but would be required pre-closing if the rule amendments come to fruition. Moreover, if this disclosure is included in a Form S-4 or Form F-4, any material misstatements or omissions contained therein would subject the issuers and other parties to liability under Sections 11 and 12 of the Securities Act.
Minimum Dissemination Period
There is currently no federally mandated period in business combination transactions to provide security holders with a minimum amount of time to consider proxy statements or other disclosures. The proposed rules would amend proxy Rules 14a-6 and 14c-2 and the instructions to Forms S-4 and F-4 to require that prospectuses and proxy and information statements filed in connection with de-SPAC transactions be distributed to shareholders at least 20 calendar days in advance of a shareholder meeting or the earliest date of action by consent, or the maximum period under the applicable law of the SPACs jurisdiction of organization if less than the 20 calendar days.
Private Operating Company as Co-Registrant to Form S-4 and Form F-4
Currently, when a SPAC offers and sells its securities in a registered de-SPAC transaction, only the SPAC, its principal executive officer or officers, its principal financial officer, its controller or principal accounting officer, and at least a majority of its board of directors (or persons performing similar functions) are required to sign the registration statement for the transaction. The proposed rules would amend Form S-4 and F-4 to require that the SPAC and the target company be treated as co-registrants when these registration statements are filed by the SPAC in connection with a de-SPAC transaction.
This requirement would make the additional signatories to the form, including the principal executive officer, principal financial officer, controller/principal accounting officer, and a majority of the board of directors or persons performing similar functions of the target company, liable for any material misstatements or omissions in the Form S-4 or F-4.
Re-Determination of Smaller Reporting Company Status
A smaller reporting company is a company that is not an investment company, an asset-backed issuer or a majority-owned subsidiary of a parent that is not a smaller reporting company, and had (i) a public float of less than $250 million, or (ii) had annual revenues of less than $100 million during the most recently completed fiscal year for which audited financial statements are available and either had no public float or a public float of less than $700 million. Smaller reporting companies are a category of registrants that are eligible for scaled disclosure requirements in Regulation S-K and Regulation S-X and in various forms under the Securities Act and the Exchange Act. For a detailed discussion of smaller reporting companies, see HERE and HERE.
Smaller reporting company status is determined at the time of filing an initial registration statement under the Securities Act or Exchange Act for shares of common equity and is re-determined on an annual basis. Currently, most SPACs qualify as smaller reporting companies, and, when a SPAC is the legal acquirer of the private operating company in a de-SPAC transaction, a post-business combination company is permitted to retain this status until the next annual determination date.
The SEC is concerned that these companies will be able to avail themselves of scaled disclosures that they would not qualify for in an IPO. The proposed rules would require a re-determination of smaller reporting company status following the consummation of a de-SPAC transaction and prior to such companies next Exchange Act periodic report, other than the closing 8-K. As proposed, the public float threshold would be measured as of a date within four business days after the consummation of the de-SPAC transaction and the revenue threshold determined by using the annual revenues of the private operating company as of the most recently completed fiscal year for which audited financial statements are available.
The four-business day measurement period would allow the post business combination company to know whether it has retained smaller reporting company status when it files its Super 8-K, but disclosure of same would not be required until its next period report (10-Q or 10-K).
Interestingly, the SEC rule release does not even mention emerging growth company (EGC) status. An EGC is defined as a company with total annual gross revenues of less than $1,070,000,000 during its most recently completed fiscal year that first sells equity in a registered offering after December 8, 2011. An EGC loses its EGC status on the earlier of (i) the last day of the fiscal year in which it exceeds $1,070,000,000 in revenues; (ii) the last day of the fiscal year following the fifth year after its IPO (for example, if the issuer has a December 31 fiscal year-end and sells equity securities pursuant to an effective registration statement on November 2, 2022, it will cease to be an EGC on December 31, 2027); (iii) the date on which it has issued more than $1,070,000,000 in non-convertible debt during the prior three-year period; or (iv) the date it becomes a large accelerated filer (i.e., its non-affiliated public float is valued at $700 million or more).
EGC status and smaller reporting company status are separate determinations. Although the scaled disclosure requirements for an EGC are not exactly the same as a smaller reporting company, they are similar. For a chart on the differences, see here – however, note this blog was written before a June, 2018 amendment to the definition of a smaller reporting company – HERE..
Note the EGC definition depends on large-accelerated filer status (among other factors). There is a category of company in between smaller reporting company and large accelerated filer – i.e., an accelerated filer. An accelerated filer is one that (i) has a non-affiliate float of $75 million or more but less than $700 million and (ii) is not eligible for smaller reporting company status. Smaller reporting company, accelerated and large accelerated filer status are determined annually with the public float determined as of the last business day of its most recently completed second fiscal quarter and revenues determined as of fiscal year end based on audited financial statements.
Importantly, a company that is classified as an accelerated or large accelerated filer is subject to, among other things, the requirement that its outside auditor attest to, and report on, management’s assessment of the effectiveness of the issuer’s internal control over financial reporting (ICFR) as required by Section 404(b) of the Sarbanes-Oxley Act (SOX). The JOBS Act exempted emerging growth companies (EGCs) from this requirement.
As written, a company could lose smaller reporting company status but retain EGC status if it is an accelerated filer, but not a large-accelerated filer (i.e., if it has a non-affiliated public float of $250 million but less than $700 million and $100 million or more of revenue) and thereby retain most scaled disclosure benefits including the exemption from compliance with SOX 404(b). Such a company could retain such status until its next annual determination (float as of last day of second fiscal quarter and revenue as of last day of fiscal year end based on audited financial statements).
PSLRA Safe Harbor
Section 27A of the Securities Act and 21E of the Exchange Act, both created by the Private Securities Litigation Reform Act of 1995 (PSLRA), provide certain statutory protections for qualifying companies in qualifying materials, for forward-looking statements. The protections afforded by the PSLRA are not available to a company that: (i) has been convicted of a felony or misdemeanor related to securities fraud within the last three years; (ii) has been, within the past three years, subject to a judicial or administrative decree or order prohibiting future violations of the antifraud provisions of the securities laws; (iii) has been, within the past three years, subject to a judicial or administrative decree or order requiring the company to cease and desist from violating the antifraud provisions of the securities laws; (iv) has been, within the past three years, subject to a judicial or administrative decree or order determining the company has violated the antifraud provisions of the securities laws; (v) makes the forward-looking statement in connection with an offering of securities of a blank check company; (vi) is a penny stock company; or (vii) is an investment company.
In addition, the forward-looking statements protections of the PSLRA are not available for forward-looking statements that are: (i) included in financial statements that are prepared in accordance with GAAP; (ii) made in connection with a roll-up transaction; (iii) made in connection with a going private transaction; (iv) made in connection with a tender offer; (v) made in connection with an IPO; (vi) made in connection with an offering by, or relating to the operations of a partnership, limited liability company, or a direct participation program; or (vii) made in a disclosure of beneficial ownership under Section 13 of the Exchange Act (Schedule 13D and 13G).
For purposes of the PSLRA, the SEC defined a “blank check company” as a development stage company that is issuing “penny stock,” as defined in Exchange Act Rule 3a51-1, and that has no specific business plan or purpose, or has indicated that its business plan is to merge with or acquire an unidentified company or companies, or other entity or person and accordingly SPACs are excluded from the definition. Projections of the private operating company’s performance are typically prepared and disclosed in connection with a de-SPAC transaction with the belief that the disclosures are protected from liability under the PSLRA.
The SEC is now proposing to amend the definition of “blank check company” for purposes of the PSLRA to remove the “penny stock” condition and to define the term as “a company that has no specific business plan or purpose or has indicated that its business plan is to engage in a merger or acquisition with an unidentified company or companies, or other entity or person.” As such, the PSLRA would not be available for forward-looking statements, such as projections, made in connection with de-SPAC transactions involving an offering of securities by a SPAC.
The SEC is also proposing conforming amendments to Rule 419 and various Securities Act rules.
Underwriter Status and Liability in Securities Transactions
The term “underwriter” is broadly defined in Section 2(a)(11) of the Securities Act to mean “any person who has purchased from an issuer with a view to, or offers or sells for an issuer in connection with, the distribution of any security, or participates or has a direct or indirect participation in any such undertaking, or participates or has a participation in the direct or indirect underwriting of any such undertaking.” The determination of whether a particular person is an “underwriter” does not depend on the person’s business but rather on that person’s relationship to a particular securities offering. Any person whose activities with respect to any given offering fall within one of the prongs of the Section 2(a)(11) definition is deemed to meet the statutory definition of underwriter—commonly known as a “statutory underwriter.” The definition of an underwriter is meant to be, and has been, interpreted very broadly.
An underwriter’s participation in a company’s offering also exposes the underwriter to potential liability under Sections 11 and 12 of the Securities Act. Section 11 of the Securities Act imposes civil liability for any part of the registration statement, at effectiveness, which contained an untrue statement of a material fact or omitted to state a material fact required to be stated therein or necessary to make the statements therein not misleading, to any person acquiring such security. Similarly, Section 12 imposes liability upon anyone, including underwriters, who offers or sells a security, by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in the light of the circumstances under which they were made, not misleading. Both Sections 11 and 12 have due diligence defenses available to an underwriter.
The SEC rule release views the entirety of a SPAC lifecycle as a public offering. That is, the purpose of a SPAC initial public offering is to raise a pool of cash in order to subsequently merge with a private operating company in a de-SPAC transaction that will convert the private operating company into a public company. Although the timing of a SPAC initial public offering and a de-SPAC transaction is bifurcated because a private operating company is not identified at the SPAC initial public offering stage, the result of a de-SPAC transaction, however structured, is consistent with that of a traditional initial public offering.
Proposed new Rule 140a would clarify that a person who has acted as an underwriter in a SPAC initial public offering (“SPAC IPO underwriter”) and participates in the distribution by taking steps to facilitate the de-SPAC transaction, or any related financing transaction, or otherwise participates (directly or indirectly) in the de-SPAC transaction will be deemed to be engaged in the distribution of the securities of the surviving public entity and come within the definition of underwriter in Section 2(a)(11) of the Securities Act.
Rule 140a would clarify that the SPAC IPO underwriter is an underwriter with respect to the distribution that occurs in the de-SPAC transaction, when it takes steps to facilitate the de-SPAC transaction, or any related financing transaction, or otherwise participates (directly or indirectly) in the de-SPAC transaction. The SEC is clear that the receipt of deferred underwriter compensation in a de-SPAC transaction, as is typically the case, would constitute direct or indirect participation in the de-SPAC transaction.
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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