On March 30, 2022, the SEC proposed rules related to SPAC and de-SPAC transactions including significantly enhanced disclosure obligations including related to financial projections, making a target company a co-registrant when a SPAC files an S-4 or F-4 registration statement associated with a business combination, and aligning de-SPAC transactions with initial public offering rules. In addition, the SEC has also proposed rules that would deem any business combination transaction involving a reporting shell company, including but not limited to a SPAC, to involve a sale of securities to the reporting shell company’s shareholders. The new rules would amend a number of financial statement requirements applicable to transactions involving shell companies.
In addition, the SEC has 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 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). The fourth blog in the series dissected several rule changes intended to align a de-SPAC transaction with an old-fashioned IPO (see HERE). The fifth blog covered new proposed Rule 145a and Article 15 for business combinations with any shell company, not just SPACs (see HERE). This week’s blog is the sixth and final in the series and delves into the enhanced disclosure requirements related to financial projections and the proposed ’40 Act safe harbor.
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. The PSLRA safe harbor is specifically not available in an IPO transaction (see HERE).
The fourth blog in this series covered the SEC proposed amendment to the PSLRA to make it clear that the safe harbor is not available in a de-SPAC transaction. To accomplish this, the SEC proposed to amend the definition of “blank check company” for purposes of the PSLRA 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 separately also added provisions to enhance the disclosure obligations associated with the use of projections.
Another issue that has plagued SPACs are allegations that a SPAC is a veiled unregistered Investment Company in contravention of the Investment Company Act of 1940 (’40 Act) and that its sponsors are acting in violation of the Investment Advisors Act of 1940. The allegations stem from a practice of investing the funds held in escrow in short-term government securities and money market funds. These investments can stem over a year, beginning at the close of the IPO and ending at the close of the de-SPAC transaction. A slew of lawsuits have been filed alleging investment company violations, including one against Bill Ackman’s $4 billion Pershing Square Tontine Holdings, Ltd., the largest SPAC in history to date.
To address these concerns, the SEC has proposed a limited safe harbor from the ’40 Act for SPACs that satisfy certain conditions, including the nature and management of SPAC assets; SPAC activities, including related to the de-SPAC transaction; and duration limitations.
Enhanced Projections Disclosure
Disclosure of financial projections is not expressly required by the federal securities laws; however, there are various reasons why companies produce and disclose such information, including to justify a board’s decision to approve a business combination transaction or to form the basis for an underlying fairness opinion. Companies engaged in business combination transactions may use projections to negotiate the offered consideration, terms, and conditions and to allocate risks in those transactions.
Current Item 10(b) of Regulation S-K addresses the use of projections and requires that a Company have a reasonable basis for any future performance assessment. Item 10(b) also sets for the SEC’s views on the need for disclosure of the assumptions underlying the projections, the limitations of such projections, and the format of the projections.
The SEC is proposing to amend Item 10(b) to: (i) modify the presentation of projections by companies with no history of operations; and (ii) expand the scope of the guidance in the Item to include projections of future economic performance of entities other than the registrant such as the target in a business combination. The SEC is also proposing new Item 1609 of Regulation S-K that would be particularly applicable to the use of projections in de-SPAC transactions including expanding the disclosure requirements.
The SEC is proposing to amend Item 10(b) to state that:
- Any projected measures that are not based on historical financial results or operational history should be clearly distinguished from projected measures that are based on historical financial results or operational history;
- It generally would be misleading to present projections that are based on historical financial results or operational history without presenting such historical measure or operational history with equal or greater prominence;
- The presentation of projections that include a non-GAAP financial measure should include a clear definition or explanation of the measure, a description of the GAAP financial measure to which it is most closely related, and an explanation why the non-GAAP financial measure was used instead of a GAAP measure (for more on disclosures required when using non-GAAP financial measures, see HERE, and the links therein); and
- The guidance in Item 10(b) applies to any projections of future economic performance of persons other than the registrant, such as the target company in a business combination transaction, that are included in the registrant’s SEC filings.
Proposed new Item 1609 would apply only to de-SPAC transaction. Proposed Item 1609 would require a registrant to provide the following disclosures:
- As to any projections disclosed by the registrant a disclosure of the purpose for which the projections were prepared and the party that prepared the projections;
- As to any projections disclosed by the registrant, including a disclosure of all material bases and assumptions underlying the projections, and any factors that may materially impact such assumptions (including a discussion of any factors that may cause the assumptions to be no longer reasonable, material growth rates or discount multiples used in preparing the projections, and the reasons for selecting such growth rates or discount multiples); and
- Whether the disclosed projections still reflect the view of the board or management of the SPAC or target company, as applicable, as of the date of the filing; if not, then discussion of the purpose of disclosing the projections and the reasons for any continued reliance by the management or board on the projections.
Safe Harbor Under the Investment Company Act
As discussed above, there have been allegations that a SPAC is a veiled unregistered Investment Company in contravention of the Investment Company Act of 1940 (’40 Act) and that its sponsors are acting in violation of the Investment Advisors Act of 1940. The allegations stem from a practice of investing the funds held in escrow in short-term government securities and money market funds. To address these concerns, and offer guardrails as to SPAC investment activity, the SEC is proposing new Rule 3a-10 to provide a safe harbor from the definition of “investment company” in the ’40 Act.
Section 3(a)(1)(A) of the ’40 Act defines an “investment company” as any issuer that is or holds itself out as being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting, or trading in securities. Depending on the facts and circumstances, SPACs could meet the definition of “investment company.” To assess a SPAC’s status as an investment company, the SEC generally looks to the SPAC’s assets, the sources of its income, its historical development, its public representations of policy, and the activities of its officers and directors (known as the “Tonopah factors”).
The proposed safe harbor focuses on conditions that limit a SPAC’s duration, asset composition, nature and management of SPAC assets and business purpose and activities.
As with any safe harbor, compliance with the terms is not required, but provides a level of certainty to the company management and its shareholders. The SEC also points out activities that could cause ’40 Act compliance concerns for a SPAC such as actively managing its portfolio, or hold itself out in a manner that suggests investors should invest to gain exposure to the portfolio it holds prior to the de-SPAC transaction. Holding securities beyond the time allotted in the safe harbor is also problematic as is purchasing a non-controlling interest in a target company.
The safe harbor is specifically focused on the definition in Section 3(a)(1)(A) of the ’40 Act, which is a subjective test. Separately, Section 3(a)(1)(C) provides an objective test whereby an investment company is “any issuer that is engaged or proposes to engage in the business of investing, reinvesting, owning, holding, or trading in securities, and that owns or proposes to acquire investment securities, having a value exceeding 40% of the value of the company’s total assets (exclusive of Government securities and cash items) on an unconsolidated basis.” The SEC is clear that if a SPAC fits within this objective test it would need to register and be regulated as an investment company.
Nature and Management of SPAC Assets
In order to rely on the proposed safe harbor, a SPAC’s assets must consist solely of Government securities, Government money market funds, and cash items prior to the completion of the de-SPAC transaction. The SPAC’s assets refer to both the assets held in the trust or escrow account and any assets held by the SPAC directly. Under the proposed rule, the assets would not be able to be acquired or disposed of for the primary purpose of recognizing gains or decreasing losses resulting from market value changes, which would be seen as actively managing the portfolio and thus analogous to investment management.
Under the proposed rule, a SPAC seeking to rely on the safe harbor may not acquire any other type of asset, including interests in an operating company, prior to the completion of a de-SPAC transaction. I note that during the recent SPAC boom, many SPACs would acquire a non-controlling interest in an operating business prior to the bigger de-SPAC transaction. The SPAC would then spin-off that company to the SPAC shareholders (resulting in the SPAC bringing more than one company public) or sell it to a third party. The SEC would no longer allow this practice under the new rules.
The proposed rule would provide a safe harbor only to those SPACs that seek to complete a single de-SPAC transaction as a result of which the surviving public entity, either directly or through a primary controlled company (such as a holding company), will be primarily engaged in the business of the target company or companies, which is not the business of an investment company. The term “primary controlled company” requires that the holding company own at least a majority of the operating business.
In other words, the SPAC business purpose must be to provide shareholders with an interest in an operating business. Although the rule only allows for a single de-SPAC transaction, that single transaction could involve multiple targets as long as the roll-up is part of a single transaction. In addition, the SPAC would need to seek to complete a de-SPAC transaction which results in at least one class of the post business combination stock trading on a national exchange.
As noted, the SPAC must be “seeking to complete a de-SPAC transaction.” The SEC will consider various evidence to support this intention, including activities of its officers, directors and employees, its public representations of policies, and its historical development. As noted above, management cannot actively manage the company’s securities portfolio. A SPAC relying on the proposed rule also may not hold itself out as being primarily engaged in the business of investing, reinvesting or trading in securities.
To rely on the safe harbor, the SPAC’s board of directors would also need to adopt an appropriate resolution evidencing that the company is primarily engaged in the business of seeking to complete a single de-SPAC transaction as described by the rule, and which is recorded contemporaneously in its minute books or comparable documents.
To rely on the safe harbor, a SPAC would have a limited time period to announce and complete a de-SPAC transaction. Specifically, the SPAC would have to file a Form 8-K announcing that it has entered into an agreement with the target company to complete a de-SPAC transaction no later than 18 months after the effective date of the SPAC’s registration statement for its initial public offering. The SPAC must then complete the de-SPAC transaction no later than 24 months after the effective date of its registration statement for its initial public offering.
Likewise, if a de-SPAC transaction is not completed within the time limitation, it would need to distribute its assets in cash to investors as soon as reasonably practicable if it does not meet either the 18-month deadline or the 24-month deadline. “Reasonably practicable” is not defined but would generally depend on, among other things, any logistical or legal limitations on an orderly, immediate return of funds to investors.
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