SPACs originally appeared in the 1990s as an alternative to blank check businesses governed by Securities Act Rule 419. On March 30, 2022 – Noting that the number of SPAC initial public offerings has increased at an unprecedented rate in the last two years, the Securities and Exchange Commission (SEC) enforced new regulations, with additional amendments to further improve the disclosure as well as the protection of investors in IPO regarding special purpose acquisition companies (SPACs).
The proposed new rules are expected to increase the costs and complexity of complying with the additional disclosure requirements for SPAC sponsors and management teams, as well as target companies, and rise litigation and implementation among SPACs, de-SPAC firms, and their directors and officials Simultaneously, the guidelines would improve the information available to investors and provide them with specific procedural safeguards in SPAC IPOs and de-SPAC transactions.
The amendments appear so onerous that Hester Peirce, the lone commissioner who contradicts them, stated that they "seem tailored to stop SPACs in their tracks." Meanwhile, investors would also be able to sue SPACs under the new laws if they made deceptive estimates.
Aligning de-SPAC Transactions with Traditional IPOs
The severe responsibility would apply not only to the sponsors, but also to their underwriters, accountants, and whoever engaged in the merging of a SPAC, identified as a deSPAC. In addition, these amendments tackle the criticism against SPACs, being able to make exceedingly optimistic forward-looking statements in a deSPAC since they are eligible for the Private Securities Litigation Act's safe harbor provisions, which IPOs do not have.
The SEC along with commentators have criticized de-SPAC transactions on the grounds, as the liability regime for companies turning public through a de-SPAC transaction, differs from that of a typical IPO. Furthermore, the proposed regulations would require de-SPAC transactions to be registered on Form S-4 or Form F-4 regardless of transaction structure, and the target business would be presumed to be a co-registrant on that registration statement even if it is not supplying securities as part of the transaction.
Not surprisingly, companies that turned public through SPACs have underperformed. The De-SPAC Index, which measures them, was down 52% year on year as of March 31, compared to a 14% rise.
Proposed Disclosure Rules
The SEC established specialized disclosure rules for SPACs, including the sponsor, possible conflicts of interest, and dilution, in a new subpart 1600 to Regulation S-K are given as follows:
Disclosure of the Transaction Background and the Determination of the Transaction's Fairness
In registration and proxy statements filed in connection with a de-SPAC transaction, the SPAC would be required to include a statement as to whether it practically considers that the de-SPAC transaction and any related financing transaction are fair to the SPAC's unaffiliated security holders, as well as a discussion of the bases for this statement.
In addition, disclosure would include whether the transaction required the approval of disinterested stockholders or most of the on-employee directors and whether non-employee directors retained an unaffiliated representative to negotiate the terms of the de-SPAC transaction or prepare a report concerning the fairness of the de-SPAC transaction.
Enhanced Sponsorship Disclosure
Regarding SPAC IPOs and de-SPAC transactions, the proposed regulations would require specific disclosure regarding the sponsor, its affiliates, and any promoters of the SPAC, as well as associated conflicts of interest, much of which is now standard practice.
An organizational plan indicating the association between the SPAC, the sponsor, and the sponsor's affiliates, as well as information about the sponsor's controlling individuals and any persons with direct and indirect material interests in the sponsor, would be included in these disclosures. The Securities and Exchange Commission has not developed a quantitative criterion for what constitutes a "material" interest in the sponsor.
A new directory setting forth dilution to public stockholders, assuming 25%, 50%, 75%, and maximum redemptions, would be required on the cover page of a SPAC's IPO registration statement, and the prospectus would be obliged to give a discussion of major potential causes of future dilution.
A simplified tabular disclosure of dilution would also be required in registration statements in aggregation with a de-SPAC transaction. Non-redeeming shareholders would be required to disclose every significant source of additional dilution in the prospectus, including dilution from sponsor pay, underwriting expenses, existing warrants and convertible instruments, and financing transactions such as PIPE transactions.
Given the extensive and critical nature of the proposed regulations, it is expected that industry participants will note extensively on the SEC’s proposal. The proposed rules will likely be viewed by many industry participants as tipping the scales in approval of traditional IPOs and against de-SPAC transactions.
Ideally, this regulatory process should imply a re-examination by all means of going public, involving direct listings, IPOs, and de-SPAC transactions, with the goal of supporting capital formation in all forms.