Acting Director Coates also suggests that the Commission could use rulemaking or guidance to provide greater clarity on whether the PSLRA safe harbor applies to de-SPAC transactions.
The scrutiny of special purpose acquisition companies (SPACs), which have put up staggering IPO numbers in recent months, continues to intensify, now rising to the Acting Director of the Division of Corporation Finance, John Coates. In a public statement, Coates reviewed the legal liability that attaches to disclosures surrounding a de-SPAC transaction, calling the claim that SPACs provide an advantage over traditional IPOs due to lesser securities law liability exposure "uncertain at best."
Coates, who asserted that he is neither pro- nor anti-SPAC, also addressed the suggestion that the Private Securities Litigation Reform Act (PSLRA) safe harbor for forward-looking statements applies to de-SPAC transactions but not to conventional IPOs. This claim raises significant investor protection questions, he said, such that it may be time for the Commission to use the rulemaking process to reconsider the applicable definitions, or to provide guidance explaining its views on how or if at all the PSLRA safe harbor should apply to de-SPACs.
If the Commission or staff pursues that route, he emphasized that they would need to keep the practicalities of SPACs in mind relative to conventional IPOs and other forms of achieving dispersed ownership, such as direct listings. He asked whether it is time for the SEC to reconsider the concept of "underwriter" in these new transactional paths, and whether guidance is needed on how projections and related valuations are presented and used in the documents for any of these public ownership paths.
SPAC numbers. The attention being paid to SPACs by Coates and others across the industry is the result of the explosion in SPAC and blank check offerings since last summer. In 2020, 248 of the year’s 464 IPOs were completed by blank check companies, including SPACs. By comparison, 59 blank check deals were completed in 2019, and 46 in 2018.
The numbers have only gotten more fantastical in 2021. In the first quarter, the blank check IPO total reached 301, already well beyond the 2020 12-month tally. In March alone, 113 blank check companies made their public market debuts.
SPAC guidance. Prior to Coates’ statement, the SPAC frenzy had driven the SEC to put out three sets of guidance and warnings. In early December, the Office of Investor Education and Advocacy issued guidance for potential investors in SPACs, and CorpFin followed later in the month with disclosure recommendations for SPACs themselves. Most recently, the agency issued a March warning to investors to not enter into a SPAC investment solely based on celebrity involvement.
With that guidance in mind, Coates said the staff is continuing to look carefully at filings and disclosures by SPACs and their private targets. In keeping with its usual approach, the staff is looking for clear disclosure and is providing feedback to filers when needed.
Coates focused his statement on the legal liability that attaches to disclosures in the de-SPAC transaction, and the suggestion that SPACs offer less liability exposure for targets and the resulting public company. Specifically, he called into question the claim that the PSLRA safe harbor for forward-looking statements is why sponsors, targets, and others involved in a de-SPAC feel comfortable presenting projections and other valuation material of a kind that is not typically found in the disclosure for a traditional IPO.
Coates asked whether current liability protections for investors voting on or buying shares at the time of a de-SPAC are sufficient if some SPAC sponsors or advisers are touting SPACs with vague assurances of lessened liability for disclosures. He also wondered whether current liability provisions give those involved, such as sponsors, private investors, and target managers, sufficient incentives to do appropriate due diligence on the target and its disclosures to public investors, especially since SPACs are designed not to include a conventional underwriter at the de-SPAC stage.
No free pass. Any claim about the reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst, Coates said. In his view, liability risks for those involved in SPACs actually may be higher than in conventional IPOs due to the potential conflicts of interest in the SPAC structure.
Specifically, he noted that any material misstatement in or omission from an effective Securities Act registration statement as part of a de-SPAC business combination is subject to Securities Act Section 11. In addition, any material misstatement or omission in connection with a proxy solicitation is subject to liability under Exchange Act Section 14(a) and Rule 14a-9, and any material misstatement or omission in connection with a tender offer is subject to liability under Exchange Act Section 14(e).
De-SPAC transactions also may give rise to liability under state law, he continued. Delaware law applies both a duty of candor and fiduciary duties more strictly in conflict of interest settings, absent special procedural steps, which themselves may be a source of liability risk, he said. Given this legal landscape, Coates stated, financial advisers should be notifying SPAC sponsors and targets that a de-SPAC transaction gives no one a free pass for material misstatements or omissions.
PSLRA. With respect to the PSLRA, Coates noted that it excludes from its safe harbor "initial public offerings," a phrase that may include de-SPAC transactions. It is commonly understood, he said, that it is the de-SPAC transaction, and not the SPAC IPO, that is the transaction in which a private operating company itself goes public. Economically, and practically, the private target of a SPAC is a different organization than the SPAC itself, so the information relevant to evaluating the investment changes dramatically in the de-SPAC because the private target has operations unlike the SPAC, he noted.
He also pointed out that the disclosure requirements surrounding the introduction of a new company to public investors are more robust. An IPO is where the protections of the federal securities laws are typically most needed to overcome the information asymmetries between a new investment opportunity and investors in the newly public company, he said.
If these facts about economic and information substance drive the understanding of what an IPO is, Coates stated, then they point toward a conclusion that the PSLRA safe harbor should not be available for any unknown private company introducing itself to the public markets. Such a conclusion should hold regardless of what structure or method it used to do so, in his opinion.
Going forward. As to the way forward for SPACs, Coates said that everyone involved in promoting, advising, processing, and investing in SPACs should understand the limits on any alleged liability difference between SPACs and conventional IPOs. Any such asserted difference is uncertain, in his view.
In addition, he believes that SPAC sponsors and targets and their advisers should already be providing the public with the information material to the investment opportunities a de-SPAC represents, regardless of how the liability analyses ultimately play out. Liability risk is an important feature of the conventional IPO process, and if it drives choices about what information to present and how, it should not be different in the de-SPAC process without clear and compelling reasons for and limits and conditions on that difference, he said.
He also suggested that it may be time to provide greater clarity on the scope of the safe harbor in the PSLRA. That could be done through rulemaking or staff guidance, in his opinion.
Finally, Coates noted that one of the more challenging aspects of recent SPAC transactions is that many investors in the SPAC IPO redeem or sell their shares around the time of the business combination, so are not the investors in the ultimate public company’s ongoing business operations. If a major shift in owners is occurring in SPACs as they progress through a de-SPAC, then it is the de-SPAC on which securities law protections should be focused, he said. If the SEC does not treat the de-SPAC transaction as the "real IPO," he concluded, then its attention may be focused in the wrong place, and potentially problematic forward-looking information may be disseminated without appropriate safeguards.
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