SEC’s Proposed New Rules for SPACs: A Lot of Change Coming

Introduction and Summary Observations

On March 30, 2022, the Securities and Exchange Commission (SEC) proposed new rules affecting Special Purpose Acquisition Companies (SPACs). If adopted, the proposed rules would represent a comprehensive overhaul of the current securities regulatory regime governing SPACs.

The most important of the proposed changes would do the following:

• make the protections of the Private Securities Litigation Reform Act of 1995 (PSLRA) unavailable for projections used in the de-SPAC transaction and enhance disclosure regarding those projections;
• add new third-party gatekeeping functions to these transactions by (1) making an underwriter of the SPAC’s IPO that facilitated, or directly or indirectly participated in, the de-SPAC transaction or any related financing, a so-called “statutory underwriter” regarding the de-SPAC transaction, and (2) adding additional disclosure requirements about fairness opinions regarding the transaction; and
• make the private company target be a co-registrant with the SPAC in the registration statement for the de-SPAC and, therefore, require its directors to sign that registration statement.

The SEC’s goal regarding the new proposed rules is to address what it describes as “information asymmetries, misleading information and conflicts of interest” in SPAC and de-SPAC transactions. What is behind these rules is the SEC’s belief that the typical SPAC/de-SPAC transaction structure is the functional equivalent of a conventional IPO but, because of the structure of the current rules, does not afford investors the same protections as the rules governing IPOs. The purpose of these proposed rules would be to more closely align the rules governing the combined effect of a SPAC IPO and a de-SPAC with those governing a conventional IPO.

There are also several aspects of the proposed new rules, such as those requiring enhanced disclosure, that reflect an effective codification of the SEC staff’s existing positions.

To anticipate the practical and market effect of the proposed rules, we spoke with market participants, from which there were a wide variety of reactions. While it is difficult to make predictions, and market practice will likely take a while to settle after the SEC publishes its final, adopting release, we believe that the following will be key issues to watch for:

Will Projections Continue To Be Used? Removing the safe harbor protections of the PSLRA and therefore subjecting many parties to enhanced liability—notably, the SPAC and its board, the target company and its board (if they are required to become co-registrants for the de-SPAC filing as proposed) and the underwriters (to the extent they are deemed so-called “statutory underwriters” as proposed if they are involved in both the SPAC offering and the de-SPAC transaction)—could lead to reduced use of projections in the proxy statement/prospectus for the de-SPAC transaction. While final market practices are uncertain, it would seem unlikely likely that projections will stop being used and disclosed for the following reasons:

• The combination of state corporate law (such as the Delaware General Corporation Law) and existing SEC rules require the disclosure of the material information that the SPAC board of directors considered in making its determination to acquire the target company, which often includes the target’s projections. From the standpoint of the fiduciary duty of directors when evaluating a target business combination, it seems unlikely, as a general matter, that directors will stop reviewing projections as part of their overall package of information. It is possible that five-year projections will be reduced to three years due to the incremental unreliability, in some cases, of the latter years.
• Many market participants believe that the use of projections in the de-SPAC transaction is, as a general matter, critical to the marketing of the deal and will need to continue for business reasons.
• Private Investment in Public Equity (PIPE) investors will demand, in many cases, to see projections as part of their due diligence about the target company. As redemption rates have remained high, the availability of PIPE financing and the need to satisfy these investors have increased in importance. One should expect that PIPE investors will also demand to be cleansed of the material non-public information (including projections) they received so they can trade freely.
• Projections, as forward-looking information, still carry, in principle, the protections of the SEC’s “bespeaks caution” doctrine and, as a result, market participants may feel that they still have some protections, notwithstanding the removal of the PSLRA protections. The bespeaks caution doctrine provides protection regarding the use of forward-looking information if accompanied by meaningful cautionary or risk disclosure regarding the information. Whether the bespeaks caution doctrine will be available to defendants in defective disclosure cases regarding projections may well be tested in future lawsuits, and the outcome is uncertain. In addition, the degree of protection that the PSLRA has, in fact, provided in this context may be overrated, based on what protections the statute actually affords and case law in this area.
• The impact on, and the increased risk posed to, underwriters by the combination of the elimination of the PSLRA safe harbor and the risk of SPAC underwriters being deemed so-called “statutory underwriters” for the de-SPAC remains unclear. We summarize some practical considerations about this below.

Target Co-Registration Requirement Would Increase Standards and Costs. We believe that there are two likely impacts of the proposed rule to have the target company be a co-registrant, along with the SPAC, on the registration statement and merger statement/proxy that is filed with the SEC as part of the de-SPAC and, therefore, have the target company’s board of directors sign the registration statement:

• By exposing these directors to liability under US federal securities laws, we would expect that the standards applied to disclosure, diligence and the degree to which the target is ready for prime-time as a public company would increase.
• The costs of effecting these transactions would inevitably rise as companies, their counsel, financial advisers and underwriters on all sides would need to engage in more extensive due diligence, among other things.

Impact on Underwriters Is Unclear. By making a SPAC IPO underwriter a so-called “statutory underwriter” if it participates in the de-SPAC transaction, the proposed rules would expand the potential liability of these banks, particularly in combination with the elimination of the PSLRA safe harbor. Most underwriters have historically taken a conservative approach regarding the use of projections in conventional IPOs as a risk matter. We aware of announcements by two bulge bracket firms regarding their re-assessment of the risk of these transactions as a result of the proposed rules. It remains to be seen how underwriters will respond if the proposed rule changes are adopted. Some practical observations:

• Some underwriters may decide to participate only at the SPAC IPO phase to avoid the risk of being deemed a statutory underwriter regarding the de-SPAC, particularly if projections are disclosed and the PSLRA safe harbor is eliminated. This would presumably require them to be paid their underwriting fee at the closing of the IPO, as opposed to the current practice of splitting such fee between the IPO closing and the closing of the de-SPAC transaction. Whether SPAC sponsors will agree to pay the full fee up front for just the IPO remains to be seen.
• Banks that participate in these transactions may also seek higher fees to compensate them for the increased risk they face. Whether SPAC sponsors will accept that increase in fees is unclear.
• Other banks may decide that they will stay involved in the de-SPAC phase and simply put additional guardrails in place, such as enhanced disclosure, due diligence and legal opinions. Whether or not these banks seek increased fees, their expenses will rise due to the enhanced diligence, internal guidelines regarding these guardrails and the changed nature of the process.

What Will Be the Overall Market Impact of the Proposed Rules? If adopted, the combined effect that the proposed rules would have on the market is unclear, particularly in three respects:

• The effect of the proposed rules on the current large pipeline of SPACs is unclear. As of today, there are about 600 SPACs looking for targets, and many market participants believe that a large portion of those SPACs will fail to merge with a target by their deadlines, which would result in the liquidation of the IPO proceeds contained in the trust and of the SPAC. We understand that, in this regard, many large banks have found it challenging to service all of their SPAC clients to find them targets. SPACs, their financial advisors (including their IPO underwriters, in particular), potential targets and their respective advisors may take some time to digest the effect of the proposed rules, which could cause more SPACs to fail to achieve a merger by their deadlines. We wonder whether, in the interest of orderly financial markets, the SEC should consider a phase-in period for the new rules that are adopted.
• The alignment of the regulatory regime between the SPAC/de-SPAC structure and conventional IPOs as a result of the proposed rules could cause a comparable equilibration in the relative economics between the two ways a private company can go public. We expect that, if the proposed rules are adopted, the fees and expenses incurred during a SPAC/de-SPAC process will likely increase, including from the underwriters, accountants, lawyers and fairness opinion providers. As a result, the perceived advantages of the SPAC/de-SPAC structure may lessen in the eyes of market participants. Market participants’ views on this question will likely be affected by the degree to which worthy companies are brought to market using one or the other structure and their post-closing trading patterns.
• If an economic equilibration and lessening of the perceived advantages of the SPAC/de-SPAC structure occur, we would attribute a part of that to the increased standards that would apply to these transactions, as noted above—and many market participants think these changes would be a good thing for the SPAC market and its investors. One consequence that remains to be seen and is more difficult to track is whether the combined effect of the increased muscularity of the regulatory regime, the increased costs, the lessening of the perceived advantages of the SPAC/de-SPAC structure and what some believe to be the institutional, large cap company orientation of investment banks will also result in hindering worthy private companies from accessing the public markets. If true, it also remains to be seen whether the private capital market, including venture capital firms, private equity firms and institutional investors, will fill that capital access gap and, whether there would be any change in the relative advantages of the public markets compared to the private ones as a result.

More Detailed Summary of the Proposed Rules

New Subpart 1600 of Regulation S-K

A new proposed subpart 1600 of Regulation S-K sets forth the new disclosure requirement with regards to the sponsors, conflicts of interest, dilution, the cover page and summary to prospectuses and de-SPAC transactions. Additionally, there are procedural requirements in connection with de-SPAC transactions.

Disclosures relating to sponsors, conflicts of interest, dilution and transaction background have been receiving additional scrutiny of SEC examiners during the review process of the de-SPAC registration statements for some time, and these proposed rules seem in many instances to standardize and codify comments that the SEC has been making. However, the statements regarding the fairness of the transaction and the disclosures regarding reports and opinions is a new focus, as is the form and placement of some of these disclosures.

Sponsors           

Proposed Item 1603(a) of Regulation S-K would require additional disclosures in registration statements or disclosure documents filed in connection with SPAC IPOs and de-SPAC transactions, including:

• the experience, material roles and responsibilities of the sponsor as well any arrangement or understanding between (i) the sponsor and the SPAC, its executive officers, directors or affiliates in determining whether to proceed with a de-SPAC transaction and (ii) with respect to the redemption of outstanding securities;
• information as to the controlling person of the sponsor or any person with a direct or indirect interest in the sponsor, including an organizational chart of such relationships;
• tabular information with regard to lock-up agreements with the sponsor or affiliates; and
• the nature and amount of all compensation that has or will be earned by the sponsor, its affiliates and any promoters, including with respect to de-SPAC transactions.

Conflicts of Interest

Proposed Item 1603 of Regulation S-K would require disclosure of actual or potential material conflicts of interest, including:

• conflicts of interests between the sponsor or its affiliates or the SPAC’s officers, directors or promoters and unaffiliated security holders, including conflicts regarding a future de-SPAC transaction or how the sponsor compensates its executive officers and directors; and
• conflicts of interest due to fiduciary duties that each officer and director of a SPAC may owe to other companies.

Practical Observation: Market participants would need to pay close attention to and disclose typical conflicts such as: the limited time in which to make a de-SPAC transaction before the funds in the trust or escrow account need to be distributed back to the IPO investors; that the compensation that the sponsor and its executive officers and directors receive depends on the de-SPAC transaction occurring and as such may induce them to enter into a de-SPAC transaction that may not benefit the shareholders of the SPAC; and that the sponsor and its affiliates may have financial interests in and contractual obligations with other entities.

Dilution

With respect to registration statements filed by SPACs, other than for de-SPAC transactions, the proposed Item 1602 of Regulation S-K would require disclosure of material potential sources of future dilution following the SPAC’s IPO and a tabular disclosure of the amount of potential future dilution from the public offering price, to the extent quantifiable. A simplified tabular dilution disclosure incorporating potential redemption levels would also be included in the prospectus cover page, with dilution ranging from 25% of maximum redemption to maximum redemption.

For de-SPAC transactions, proposed Item 1604 of Regulation S-K would require a sensitivity analysis in tabular form disclosing dilution under a range of likely redemption levels demonstrating how dilution affects non-redeeming holders.

Practical Observation: To comply with the proposed dilution disclosure requirements, market participants would need to consider all possible sources for dilution, including PIPE financings, warrants (including private warrants given to the sponsor and its affiliates and to the public in the IPO); underwriting fees (including fees given for completion of a successful de-SPAC); combined company stock plans; convertible securities (of the SPAC or of the target company) and existing shareholders of target company.

Cover Page and Prospectus Summary Disclosure

Proposed Items 1602 and 1604 of Regulation S-K would require that certain items, including items elsewhere discussed here, be included on the cover page of a prospectus: (i) the time frame for the SPAC to consummate the de-SPAC transaction; (ii) information about redemptions; (iii) sponsor compensation; (iv) dilution (including tabular disclosure); (v) conflicts of interest; (vi) a statement as to fairness of the de-SPAC transaction; and (vii) any material financing transaction contemplated, such as any concurrent PIPE transaction.

For a transaction other than a de-SPAC, proposed Item 1602(b) of Regulation S-K would require the following information in the summary: (i) the process by which the business combination candidate is to be selected; (ii) whether shareholder approval is required; (iii) the material terms of the trust/escrow account; (iv) the material terms of the securities being offered; (v) whether securities being offered are of the same class as those held by the sponsor and its affiliates; (vi) disclosure about the time period during which the SPAC may consummate a business combination; (vii) additional financing plans and how they might impact shareholders; and (viii) tabular disclosure on sponsor compensation.

For a de-SPAC transaction, proposed Item 1604(b) of Regulation S-K would require: (i) the background and material terms of de-SPAC transaction; (ii) a statement as to the fairness of the transaction; (iii) tabular disclosure on sponsor compensation and dilution; and (iv) redemption rights.

Background of and Reasons for the Terms and Effects

Proposed Item 1605 of Regulation S-K would require disclosure with regards to the de-SPAC transaction, including: (i) a summary of the transaction with discussion of the contacts, negotiations and transactions that occurred concerning the de-SPAC transaction; (ii) a description of any financing transaction and any payments from the sponsor to investors in connection with the de-SPAC transaction; (iii) reasons for engaging in the de-SPAC transaction, as well as to the structure, timing and related financing; (iv) a description of any material rights of security holders post-business combination; and (v) disclosure regarding accounting treatment and federal income tax consideration, if material.

Fairness of the de-SPAC transaction

Proposed Item 1606(a)-(b) of Regulation S-K would require a statement from a SPAC as to whether it is reasonably believes the de-SPAC transaction is fair or unfair to the SPAC’s unaffiliated security holders, including any material factors upon which such reasonable belief is founded, and to the extent practicable, the weight assigned to each factor.

Additionally, proposed Items 1606(c), (d) and (e) of Regulation S-K would require disclosure on whether: (i) the de-SPAC transaction is structured so that approval of at least a majority of unaffiliated security holders is required; (ii) a majority of directors who are not employees of the SPAC have retained separate representatives for negotiating on behalf of unaffiliated holders the terms of the de-SPAC transaction and/or for preparing a report concerning the fairness of the de-SPAC transaction; and (iii) the de-SPAC transaction was approved by a majority of directors of the SPAC who are not employees.

Practical Observation: This requirement is likely to increase the use of fairness opinions in de-SPAC transactions because disclosure stating that the board of directors of the SPAC did not receive such an opinion may well have a negative impact on marketing and legal protections. Fairness opinions would, like other actions taken in response to the proposed rules, increase the costs of the transaction, but may provide comfort to transaction participants.

Reports, Opinions and Appraisals

Under proposed Item 1607, disclosure would be required as to whether or not the SPAC or its sponsor has received any report, opinion or appraisal by an outside party relating to the fairness of the consideration to be received in the de-SPAC transaction by non-affiliated holders, and if so, would require all such reports, opinions or appraisals to be filed as exhibits to a Form S-4, Form F-4, Schedule TO or included in Schedule 14A or 14C, as applicable.

In particular, under proposed Item 1607, disclosure would be required concerning:

• the identity, qualifications and method of selection of the outside party;
• any material relationship between the outside party or representative and the SPAC or its affiliates (including the sponsor);
• whether the SPAC or the sponsor determined either the amount of consideration to be paid to the private operating company or its security holders, or the valuation of the private operating company, or whether those amounts were recommended by an outside party; and
• a summary concerning the negotiation, report, opinion or appraisal regarding the consideration paid, which would be required to include a description of the procedures followed; the findings and recommendations; the bases for and methods of arriving at such findings and recommendations; instructions received from the SPAC or its sponsor; and any limitation imposed by the SPAC or its sponsor on the scope of the investigation.

Practical Observation: While proposed Item 1607 falls short of requiring a fairness opinion, as discussed above, proposed Item 1606 already increases the likelihood that fairness opinions will be obtained as part of every de-SPAC transaction. Furthermore, the new disclosure requirement in proposed Item 1607 with respect to fairness opinions may raise the costs associated with obtaining a fairness opinion.

Structured Data Requirement

The proposed rules require that all information required under the proposed Subpart 1600 of Regulation S-K be tagged in inline XBRL.

Aligning de-SPAC Transactions with IPOs

Aligning Non-financial Disclosures in de-SPAC Disclosure Documents

In connection with a disclosure document for a de-SPAC transaction, the proposed rules would require that the business combination candidate disclose much of the same information as a company in an IPO would have to disclose, including information about its business, properties, legal proceedings, changes in and disagreements with accountants, security ownership of certain beneficial owners and management assuming completion of the de-SPAC transaction and recent sales of unregistered securities.

Practical Observation: Much of this information is already required in the Super 8-K, and in the past, many business combination candidates would have disclosed it as part of market practice. As a result, we do not believe that this part of the proposed rules would have an impact on market behavior.

Minimum Dissemination Period

There is currently no federally mandated minimum period which business combination parties must provide security holders to consider a proxy statement, and such a period can be as short as 10 calendar days under applicable state law. Under the proposed rules, amendments would be made to Rules 14a-6 and 14c-2, and instructions would be added to form S-4 and F-4, to require that prospectuses and proxy and information statements filed in connection with a de-SPAC transaction 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 for disseminating such documents in the SPAC’s jurisdiction of incorporation or formation, if such period is less than 20 days.

Practical Observation: While it may have little effect on most, it is possible that SPACs approaching the expiration of their period in which to complete a business combination (particularly in conjunction with the strict duration requirements of the Investment Company Act safe harbor being proposed) may be negatively affected by this proposed rule.

Business Combination Candidate as Co-Registrant to Registration Statement

Under the proposed rules, the business combination candidate would be treated as co-registrant of the securities under a registration statement and as such, its principal executive officer, principal financial officer, controller/principal accounting officer and a majority of its directors would be required to sign the registration statement and would be subject to securities law liability for any material misstatements or omissions in the disclosure included in the registration statement. Parties other than the SPAC and the business combination candidate would still be eligible for a due diligence defense.

Practical Observation: We believe that this change would have a significant impact on market practices, by increasing standards of review, diligence and related costs of the target and its directors and officers. This would be the case especially when considered in combination with the proposed rules regarding projections and the increased liability those changes may bring to the target company, board members and executive officers. We recognize that under some de-SPAC structures, the private company is already a signatory to registration statements, but this tends to occur when the private company is a foreign entity and the structure’s tax considerations drive the necessity to have them undertake the additional potential liability.

Re-Determination of Smaller Reporting Company Status

Currently, the surviving entity of the business combination would not typically have to re-determine its smaller reporting company status after a de-SPAC transaction until the next annual determination date. The proposed rules would require a re-determination of the smaller reporting company status of the surviving entity before its first SEC filing that occurs after the filing of its Super 8-K, with the public float information determined as of a date within four business days following the consummation of the de-SPAC transaction. The Super 8-K, being the report on Form 8-K which includes Form 10 information for the private target company that is issued within four days of the consummation of the de-SPAC transaction. If the surviving company is no longer a smaller reporting company, it would have to provide additional disclosures, including three years of financial statements and quantitative and qualitative information about market risk in its first quarterly or annual report. The surviving company may however rely on emerging growth company status, if it so qualifies.

Underwriter Status and Liability in Securities Transactions

Proposed Rule 140a would define any underwriter of the SPAC IPO who participates in the distribution of securities or facilitates the de-SPAC transaction, including by participating in related financing transactions, or otherwise participating directly or indirectly in the de-SPAC transaction, as a statutory underwriter under Section 2(a)(11) of the Securities Act of 1933 for purposes of the securities issued in the de-SPAC transaction. The proposed rule provides a non-exhaustive list of activities to serve as guide as to qualifying activities for a SPAC underwriter to be a statutory underwriter in the de-SPAC, including acting as a financial advisor to the SPAC, identifying potential business combination candidates, negotiating merger terms, acting as a placement agent for a PIPE or arranging other debt financing and otherwise receiving compensation in connection with a de-SPAC. We believe that the underwriter getting paid a portion of its fee for the IPO at the closing of the de-SPAC would constitute the kind of participation and facilitation the SEC had in mind.

Practical Observations: In addition to our observations under Introduction & Summary Observations above, we note the following:

• This rule change would, in effect, require the de-SPAC participants who were SPAC IPO underwriters to conduct the typical “gate keeper” functions that they do in IPO transactions, which would drive costs higher and timelines longer for the entire process in order to be able to rely on a due diligence defense.
• The full meaning and contours of what the SEC determines to be a “statutory underwriter” in this context remain to be clarified.
• The proposed rule is not a limitation of Section 2(a)(11), which contains the definition of an “underwriter.” As such, it leaves open the possibility that others may still be considered statutory underwriters even if they are not SPAC IPO participants. In addition, this means that SPAC IPO underwriters for closed IPOs may still be considered de-SPAC underwriters if they facilitated or participated in the de-SPAC in the ways noted above.
• Enhanced due diligence and controls that underwriters may undertake due to the proposed rule may include hiring of separate counsel for the de-SPAC transaction, receiving 10b-5 letters from counsel in connection with a registration statement in the de-SPAC transaction, requiring payment of their fees upfront for the SPAC IPO, receiving any documentary due diligence memorandum that the board of the SPAC receives (which may cause issues with regard to attorney-client privilege), having its own counsel conduct documentary review, receiving comfort letters from auditors and negotiating indemnities for the de-SPAC transaction with respect to disclosures in the registration statement or disclosure document.

PSLRA Safe Harbor

The PSLRA provides a safe harbor protecting a company from US federal securities law liability in a private action for forward-looking statements made in a disclosure document, so long as the safe harbor conditions are satisfied. The safe harbor is not available in connection with an IPO or an offering by a blank check company. The proposed rules would amend the definition of “blank check company” to effectively include SPACs, causing the statutory safe harbor not to be available for forward-looking statements in de-SPAC transactions. In particular, the SEC is using this modification to target projections, a type of forward-looking statement, made in connection with a de-SPAC transactions, which may discourage their use given the increase potential liability. The proposed change would also extend to projections made by the target company.

Practical Observations: In addition to our observations under Introduction & Summary Observations above, we note the following:

• The PSLRA safe harbor does not currently apply to knowingly false or misleading projections and also does not preempt the SEC from bringing securities law actions; however if the safe harbor were to be removed, some underwriters may increase the amount of due diligence they perform, while others may decide not to use projections in de-SPAC transactions, opting instead to rely on peer company analyses and historical financials.
• The bespeaks caution doctrine is still a possible fallback given the proposed unavailability of the PSLRA safe harbor. In order to be used by an issuer, such issuer would need to provide cautionary language with regard to the projections in order for them not to be misleading to a reasonable person. De-SPAC participants would want to carefully consider such disclosure throughout the process. It remains to be seen whether the SEC or the courts would allow the bespeaks caution doctrine to be applied to de-SPAC transactions when the PSLRA, which reflects a codification of that doctrine, eliminated it.
• It is unclear whether a court would allow the doctrine to be used at a motion to dismiss stage or a summary judgment stage. The former would allow a suit to be dismissed prior to costly discovery having been commenced, while the latter would occur after. In any event, it is likely the shareholder plaintiffs’ bar will look closely at the proposed enhanced projections disclosure rules and may attempt to use them as a roadmap in future legal challenges to de-SPAC transactions.

Business Combinations Involving Shell Companies

Shell Company Business Combinations as Sales to Shell Company Investors

Proposed Rule 145a would deem any business combination of a reporting shell company (such as a SPAC) involving another entity that is not a shell company (such as operating target company) to involve a “sale” of securities to the reporting shell company holders. In doing so, such sale would be subject to the disclosure requirements and liability provisions of the Securities Act of 1933. The justification provided in the release for this proposed rule is that when a reporting shell company combines with a non-shell company, what effectively happens is an exchange of the securities of the reporting shell company for a new securities in the combined company.

De-SPAC Financial Statement Requirements

Under the new proposed Article 15 to Regulation S-X, financial reporting requirements of a business combination between a shell company and an entity that is not a shell company would more closely resemble the reporting requirements of a company in an IPO. In particular, these requirements include: disclosure of up to three years of financial statements (subject to other considerations, such as emerging growth company status), that the predecessor to a shell company be audited under PCAOB standards, that the predecessor to a shell company follow relevant rules for the age of the financial statements and provisions for when financial statements of the predecessor shell company must be provided after a business combination is effective.

Enhanced Projection Disclosure

The proposed rules would amend Item 10(b) of Regulation S-K, continuing to require that any projections in a disclosure document have a reasonable basis, but also further providing 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 would be generally considered 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;
• presentation of projections that include a non-GAAP financial measure should also clearly define or explain the measure, including a description of the GAAP financial measure to which it is most closely related, and explanation as to why the non-GAAP financial measure was used instead of a GAAP measure; and
• the guidance also applies to projections of future economic performance of persons other than the registrant, such as the business combination candidate, which are included in the registrant’s filings with the SEC.

In connection with de-SPAC transactions, and due to the heightened concern that the SEC has in connection with the use of projections such transactions, proposed Item 1609 of Regulation S-K would require that the following be additionally disclosed:

• with respect to projections disclosed by a registrant, the purpose for which the projections were prepared and the party that prepared them;
• all material bases of the disclosed projections and all material assumptions underlying such projections, and any material factors that may impact such assumptions; and
• whether the disclosed projections still reflect the view of the board or management of the SPAC or the business combination candidate, as applicable, as of the date of the filing, and if not, then a discussion must be provided as to the purpose of the projections and the reasons for any continued reliance by management or the board on the projections.

Proposed Safe Harbor Under the Investment Company Act

The proposed rules would amend Rule 3a-10 under the Investment Company Act of 1940 (the “40 Act”) to provide a non-exclusive safe harbor for SPACs from the definition of “investment company” under the 40 Act. In particular, if the proposed rules were adopted, a SPAC would not be deemed to be an investment company for purposes of the 40 Act if it satisfied the following conditions:

• Duration Limitations. The SPAC must file a report on Form 8-K announcing the entering into an agreement with a target company no later than 18 months after the effective date of the SPAC’s IPO registration statement and complete the de-SPAC transaction no later than 24 months after the effective date of its IPO registration statement. Following completion of the de-SPAC transaction, cash in the trust or escrow account and any other assets not used in connection with the de-SPAC would need to be distributed as soon as reasonably practicable after the consummation of the de-SPAC.
• Nature and management of SPAC Assets. The SPAC’s assets consist solely of government securities, government money funds and cash items prior to the completion of the de-SPAC transaction. These assets may not at any time be acquired or disposed of for the primary purpose of recognizing gains or decreasing losses resulting from market value changes.
• De-SPAC Transactions. The safe harbor only applies to SPACs that seek to complete a single de-SPAC transaction as result of which the surviving public entity will be primarily engaged in the business of target company, which such business is not that of an investment company. The SPAC would also need to seek to complete a de-SPAC transaction were the surviving company has at least one class of securities trading on a national securities exchange.
• Evidence of Primary Engagement. The SPAC must be primarily engaged in the business of seeking to complete a de-SPAC transaction in the manner and within the duration as set forth in the proposed rule. As evidence of such engagement, the rule requires that the board of directors approve a resolution as to this business purpose. The SPAC’s management, directors and employees should also be primarily involved in seeking a business combination candidate and not in activities related to its securities portfolio.

Practical Observations:

• While the proposed rules describe the safe harbor as non-exclusive, it is unclear whether SPACs that fall outside the conditions above would nevertheless be found by the SEC to be, or pursued by private litigants as, unregistered investment companies.
• Stock exchanges have allowed extensions to SPACs beyond their disclosed intent to complete a de-SPAC transaction in a 24-month period. The stock exchanges currently allow up to a maximum of 36 months for the completion of a de-SPAC transaction. Therefore, the duration limitation in the proposed 40 Act safe harbor is of particular concern for some SPACs, as it could have an adverse effect on structuring flexibility by preventing SPACs from extending their terms through a shareholder vote.

Timing of Comments

The deadline for comments on the proposed rules is the latter of May 31, 2022, or 30 days from the publication of the proposed rules in the Federal Register.

The proposed rules are controversial and are likely to draw extensive comment, some of which may be inspired by Commissioner Peirce’s dissenting view that the proposal “seems designed to stop SPACs in their tracks” and “does more than mandate disclosures that would enhance investor understanding.”

© Arnold & Porter Kaye Scholer LLP 2022 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.