CorpFin staff and Acting Chief Accountant Paul Munter covered some of the same ground in separately offering their views on financial reporting issues for SPACS, but both sets of public statements emphasized accounting and auditing topics.
The SECs’ Division of Corporation Finance (CorpFin) and the agency’s acting chief accountant issued separate but related public statements discussing accounting and financial reporting issues unique to special purpose acquisition companies (SPACs). The statements come at a time when SPACs have become extremely popular as a vehicle for taking private companies public without a traditional IPO. The statements also offer details not previously spotlighted by the SEC in a series of investor alerts or by former SEC Chair Jay Clayton in his warning about the money-back features of SPACs (See, e.g., SPACs – What You Need To Know; Celebrity Involvement with SPACs – Investor Alert; and Public statement of Jay Clayton, Confirmation of June 30 Compliance Date for Regulation Best Interest and Form CRS, June 15, 2020 (noting risks of SPACs for retail investors).
Acting chief accountant statement. SEC Acting Chief Accountant Paul Munter, in a public statement, addressed some of the same issues as the CorpFin statement, but with a more accounting-centric view. As a preliminary matter, Munter noted that SPACs are not new, although the volume of SPAC activity in terms of sheer numbers and amount of capital raised in Q1 2021 already had reached 75 percent of the same metrics for the entirety of 2020. Munter also noted that accounting risks can arise at each stage of a SPAC’s lifecycle spanning the identifications of and merger with a target private operating company, due to the "de-SPAC" process that can obviate the need for a traditional IPO, and the end-stage resulting public operating company.
Munter then emphasized five areas for SPAC participants to consider: (1) market and timing considerations; (2) financial reporting; (3) internal controls; (4) corporate governance and audit committee considerations; and (5) auditor considerations.
With respect to timing, Munter said SPACs typically have 18 to 24 months to either identify a private company target or return funds to shareholders. However, he cautioned that the identification of a target company can result in a merger within a few months and companies must be prepared for the rigors of being a public company. Munter also said that SPAC and de-SPAC filings can be the subject of SEC staff comment letters.
Financial reporting also can raise a variety of issues, according to Munter, including those regarding merger process. Key considerations include whether an entity will use GAAP or IFRS, which entity will be considered the acquirer, accounting for earn-out agreements, and the effective dates of new accounting standards (Munter suggested as examples new standards for leases and current expected credit losses).
Munter further noted that internal controls over financial reporting (ICFR) and disclosure controls and procedures (DCP) can be a challenge for newly public operating companies. Specifically, Munter said managers must know the timing of the first annual ICFR assessment and whether an auditor's report is required. The CorpFin statement discussed below elaborated on when SEC staff might not object to the exclusion of an annual ICFR assessment.
With respect to corporate governance, Munter emphasized the role of the audit committee in communicating with top managers and helping to set the tone from the top. Accordingly, a combined company must have a grasp on the concepts of auditor selection, auditor independence, and the oversight of financial reporting and related ICFR and external audit functions.
Finally, regarding auditors, Munter had two additional points. First, Munter observed that a newly public company may need to alter its existing auditor engagement to ensure the presence of adequate expertise for a public company because, as a formerly private company, the merged company may have been audited under standards issued by the American Institute of Certified Public Accountants rather than standards issued by the Public Company Accounting Oversight Board. Second, Munter provided the following cautionary words on auditor independence: "It is important to understand that the general standard of independence applies to all periods included in a registration statement. Under the general standard, an auditor is not independent if, among other things, he or she would be in a position of auditing his or her own work or if he or she acts as management" (footnotes omitted).
CorpFin statement. CorpFin staff issued a separate public statement reminding persons involved with SPACs of the many securities law obligations these entities have both before and after a merger with a target company. For example, SPACs should consider the obligations of shell companies regarding: (1) the filing of the financial statements of an acquired company; (2) the ineligibility of a combined company to incorporate Exchange Act reports for a period of time; (3) time limits on when a combined company may use Form S-8; and (4) the combined company's status as an ineligible issue under Securities Act Rule 405 for significant period of time.
The CorpFin statement also noted that books and records, ICFR, and DCP can be challenging for SPACs. The CorpFin statement reiterated that the books and records and internal control requirements apply to SPACs before the business combination and that the same requirements also apply to the combined company after the business combination.
A footnote to this section of the CorpFin statement observed that the managers of a combined company may be unable to assess ICFR in the fiscal year in which the transaction was consummated, so CorpFin staff would not object if a combined company excluded management's assessment of ICFR in the relevant Form 10-K. The statement referred readers to the additional analysis contained in Compliance and Disclosure Interpretation Question 215.02 regarding Regulation S-K.
The SEC’s concern with respect to books and records and internal control issues appears to be that a private operating company that is the subject of a business combination involving a SPAC may not have the requisite expertise and counsel to address such issues. "A private operating company may have viewed the necessity for those capacities differently prior to the business combination, and may not be able to develop those capacities without advance planning and investment in resources," said the CorpFin statement.
Lastly, CorpFin said that SPACs and combined companies must adhere to applicable exchange listing standards. For example, quantitative standards ensure that a company has sufficient public float, while qualitative standards address corporate governance issues. With respect to quantitative standards, the statement urged SPACs to focus on the loss of round lot holders. With respect to qualitative standards, the statement again expressed concern that SPACs and combined companies may lack the expertise or time to ensure the creation of key corporate governance structures such as board and audit independence and the oversight of executive compensation.
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