SEC Rules Would Make SPAC Process More Burdensome than Traditional IPOs

On March 30, 2022, the Securities and Exchange Commission proposed new rules that would eliminate many of the current benefits for a private company in going public through a merger with a SPAC (in a so-called “de-SPAC” transaction) rather than through a traditional initial public offering (IPO) process. The proposed rules are more far-reaching than was expected and would transform the SPAC process, making it lengthier, more costly, and more complex, and imposing a greater risk of liability for the entities involved. Even before issuance of the proposal, the SPAC market has been receding due to increased regulatory, judicial and investor scrutiny and skepticism. Market changes underway over the past year or so have made SPACs less attractive as compared to traditional IPOs than they had been (as discussed below)—and the proposed rules, if adopted, would accelerate this trend.

According to the SEC, the proposed changes are motivated by the SEC’s view that “a private operating company’s method of becoming a public company should not negatively impact investor protection.” The proposed rules “are intended to provide investors with disclosures and liability protections comparable to those that would be present if a private operating company were to conduct a traditional firm commitment initial public offering,” the SEC stated. We would observe that, arguably, the proposed rules are in fact more burdensome than those applicable to a traditional IPO—in light of the requirements relating to the SPAC making a fairness determination with respect to the de-SPAC and the significantly expanded potential liability for financial advisors and others with respect to de-SPACs (as discussed below).

In this post, we note the key proposed changes and their likely impact; explain the SPAC structure; provide a brief background; summarize the proposed new rules; and reach conclusions, noting open issues arising from the proposal.

Key Proposed Changes

Most notably, the proposed new rules, if adopted, would:

• Require a determination and disclosure by the SPAC relating to the fairness to the SPAC investors of a proposed de-SPAC;
• Deem a de-SPAC to be a “sale of securities” to the SPAC investors and deem the de-SPAC target company to be a co-registrant of the SPAC’s registration statement filed for the de-SPAC;
• Deem the underwriters of a SPAC IPO also to be underwriters of the de-SPAC transaction in most circumstances (and, in some circumstances, potentially deem as a statutory underwriter even a financial advisor, PIPE investor, or other advisors who directly or indirectly facilitate the de-SPAC);
• Render inapplicable the protection of safe harbor rules for the use of projections in connection with de-SPACs;
• Provide safe harbor protection against a SPAC constituting an “investment company” only if it satisfies certain conditions relating to its duration, asset composition, business purpose, and activities;
• Require additional disclosure by SPACs, relating to the sponsor, conflicts of interest, and sources of dilution; and require financial statements of SPACs to be more closely aligned with those required in registration statements for traditional IPOs; and
• Require SPACs that initially qualified as “smaller reporting companies” to provide more comprehensive disclosures at an earlier point following a de-SPAC than under existing rules.

Key Effects of the Proposed Rules

The proposed rules, if adopted, would eliminate many of the distinctions between SPACs and traditional IPOs and make SPACs less attractive as an alternative than they have been.

One benefit of the SPAC structure that would not change based on the proposed new rules is the greater pricing certainty afforded to the company going public than in a traditional IPO. In a de-SPAC, the valuation and pricing is determined through negotiation directly with the SPAC, while in a traditional IPO, the valuation and pricing is set by the market (in real time during a road show by underwriters to institutional investors). This benefit would not be directly affected by the new proposed rules—and, if the rules are adopted, would continue to be a differentiator of the de-SPAC route as compared to the traditional IPO.

The key effects of the rules, if adopted, would be:

• Increased timing and cost. The SPAC structure initially offered a quicker timeframe for going public than a traditional IPO process. Due to recent increased scrutiny of SPACs by regulators and investors, decreased interest in de-SPACs by PIPE investors, and frenzied competition among SPACs for de-SPAC targets, going public through a de-SPAC already has become a lengthier and more costly process than it was previously—now approaching, or in some cases even exceeding, the timing and expense involved in a traditional IPO. The extensive new disclosure requirements in the proposed new rules would make SPAC-related disclosure potentially an even more lengthy and costly process than in a traditional IPO given the inherent greater complexity of the SPAC structure.
• Expanded potential liability for financial advisors and others. The proposed rules require that the SPAC make a determination as to whether the de-SPAC is fair or unfair to the SPAC shareholders and, in that connection, require disclosure of the basis on which the fairness determination was made, including a summary of any outside report or opinion received. It is unclear to what extent projections would have to be disclosed although the safe harbor for projections would not be available (as discussed below). The broad expansion of the parties potentially subject to underwriters’ liability in a de-SPAC would result in those parties being responsible for, among other things, the fairness determination and disclosure.

Although the SEC’s stated intention with these changes is “to provide investors with disclosures and liability protections comparable to those that would be present if a private operating company were to conduct a traditional firm commitment initial public offering,” the changes, in fact, would expand the scope of potential liability far beyond that present in a traditional IPO. First, in a traditional IPO, there is no affirmative requirement that the issuer or its sponsor make disclosure regarding its belief as to the fairness of the transaction and any related financing transaction (nor regarding the material factors upon which any such belief is based, including factors such as the valuation of the target and the consideration of financial projections). Second, in an IPO there is no requirement to disclose whether or not a report, opinion or appraisal was obtained from an outside party nor to provide a summary of any such report, opinion or appraisal received. Third, these disclosure requirements regarding fairness would make it more likely that parties will need to include projections in the de-SPAC disclosure documents, which also are not typically disclosed in an IPO prospectus (as discussed below). By broadening the scope of the parties subject to underwriter liability in a de-SPAC, the SEC would be subjecting those parties to underwriter liabilities for these required disclosures (including projections), which are not typically disclosed in an IPO prospectus.

• Reduced use, or no use, of projections. As noted, generally, issuers do not include projections in registration statements for traditional IPOs—in part due to the lack of a safe harbor for issuers, together with the fact that underwriters involved in a traditional IPO face potential liability for forward-looking statements. De-SPACs have not involved underwriters in the traditional sense; and the general view has been that the safe harbor provisions of the Private Securities Litigation Reform Act (“PSLRA”) protect issuers against liability for forward-looking statements in the context of merger proxies and registration statements in the context of deSPAC transactions. The proposed new rules deem the PSLRA’s safe harbor provisions to be inapplicable in the context of de-SPACs, and thus would strongly discourage the use of projections in de-SPAC merger proxies. We note that the “bespeaks caution” doctrine may alone (without reliance on the safe harbors) provide protection from liability for the use of projections in de-SPACs. However, as the proposed new rules would deem a de-SPAC to be a “sale of securities,” and generally would deem the underwriters of a SPAC IPO to be underwriters also of the ensuing de-SPAC (with potential liability for misstatements in the merger proxy), underwriters will now have concerns about potential liability for the use of projections in connection with a de-SPAC. It remains to be seen whether, in response, less comprehensive projections, or no projections, would be disclosed in connection with de-SPACs, and/or whether underwriters would insist on different economic terms or additional rights and protections in light of the additional liability risks. It is also unclear to what extent projections would have to be disclosed (notwithstanding the lack of a safe harbor) as a basis on which the SPAC determined whether the de-SPAC was fair.
• More extensive due diligence and less opportunity for very early-stage companies to go public. The more extensive disclosure requirements, as well as the potential increased liability for sponsors, underwriters, and de-SPAC target company directors and officers, that are embodied in the proposed new rules, particularly in combination with the trend of increasing private litigation targeted at de-SPACs, should lead to more extensive due diligence of de-SPAC targets and even more intense competition among SPACs to identify and complete deals with high-quality targets. In addition, as the proposed changes would require substantially the same level of detail and accuracy with respect to disclosure and financial statements under the SPAC route as apply in a traditional IPO, the opportunity to go public that SPACs have provided to early-stage companies “not ready” for a traditional IPO generally would no longer be available.

The SPAC Framework

A SPAC (special purpose acquisition company) is a shell company that is formed to raise capital in an IPO, with the offering proceeds serving as a blind pool of funds held in trust to finance a merger with an as-yet-undetermined private target operating company (such merger being the “de-SPAC” transaction). The target company becomes public through the merger with the SPAC that is already public.

In the IPO in which the SPAC goes public, the SPAC offers units consisting of common stock and out-of-the-money warrants to acquire common stock. The SPAC then identifies a de-SPAC target. The de-SPAC usually is subject to approval by the SPAC shareholders. Once the de-SPAC target is identified (and before the closing), each SPAC shareholder (whether it votes for the merger or not) can elect to have its common shares redeemed by the SPAC. If a shareholder elects redemption, it still retains its warrants, which trade separately from the common stock.

At the time of formation of the SPAC, the SPAC’s sponsor makes a nominal initial investment in the SPAC in exchange for equity that will represent (usually) about 20% of the SPAC’s equity after the IPO (the “promote”). At the time of the IPO, the Sponsor makes an at-risk investment in warrants, which provides capital to the SPAC to pay IPO expenses and fund the SPAC until the de-SPAC occurs. When the de-SPAC target is identified, PIPE investors often are brought in to provide necessary additional funding for the acquisition price and to backstop any SPAC shareholder redemptions (and also to lend credibility to the valuation of the target in the de-SPAC). If the de-SPAC does not occur within a specified period after the IPO (usually either 18 or 24 months), then, unless the SPAC investors agree to extend the deadline, the SPAC is liquidated, with a return to the public investors of their full investment plus interest, while the sponsor’s promote becomes worthless and its at-risk capital is lost.

Background

The SEC approved issuance of the proposed rules by a 3 to 1 vote (with Commissioner Peirce dissenting). The rules are subject to a comment period, which will end on the later of May 31, 2020 or 30 days after the publication of the proposing release in the Federal Register.

While SPACs were utilized with modest frequency over recent decades, there was a phenomenal surge in their use in 2020 and 2021. There were fewer than 60 IPOs by SPACs in every year prior to 2020, but in 2020, there were 248 (raising more than $83 billion, up from $13.6 billion in 2019), and, in 2021, there were 613 (raising more than $160 billion). In both 2020 and 2021, more than half of all IPOs were conducted by SPACs rather than being traditional IPOs. There has been a decline in the usage of SPACs since the second quarter of 2021, due to a variety of market factors (including increased regulatory and judicial scrutiny, as well as competition among the many new SPACs for de-SPAC targets). The number of SPAC IPOs in the second quarter of 2021 was only 64 (down from 298 in the first quarter); their use only slightly rebounded in the third and fourth quarters (88 and 163, respectively); and their use declined further in the first quarter of 2022 (only 54). While the decline from the 2020 and early-2021 rate has been dramatic, the use of SPACs is still at a high level compared to the years prior to 2020.

Associated with the decline in the use of SPACs, we have seen over the last year or so: less favorable terms for sponsors in some transactions; resistance to SPACs sponsored by less experienced operators; fewer de-SPACs completed and more forced liquidations of SPACs; a lowering of initial valuations of de-SPAC targets in some cases; a decline in PIPE investors’ participation in de-SPACs (from 94% of deals in 4Q 2020 to 75% in 4Q 2021); more favorable terms for PIPE investors in some de-SPACs; a longer time period from the initial SPAC IPO filing to the offer date of the IPO (an average of 55 days for SPAC IPOs priced in 3Q 2020, increasing to 156 days in 4Q 2021); a longer time period from the IPO offer date to the de-SPAC announcement (an average of 148 days for de-SPACs announced in 4Q 2020, increasing to 286 days for those announced in 4Q 2021); and a decrease in the use of cash in de-SPAC transactions (from 71% of transactions in 2016 having a cash component, declining to just 18% in 2021).

Highlights of the Proposed Rules

The proposed new rules, and the proposed amendments to existing rules and forms, would add specialized disclosure requirements in connection with both SPAC IPOs and de-SPACs—in many cases relating to matters that already are commonly disclosed, but the proposed rules would provide a codified baseline for consistent disclosures across transactions. More significantly, the proposed rules would make the disclosures and the procedural protections provided, and the legal obligations of the entities involved in de-SPACs, more closely aligned with those in traditional IPOs and would increase the risk of liability for sponsors, de-SPAC targets, underwriters, and others. With respect to the requirements for determining fairness of the de-SPAC and the expanded potential liability for financial advisors and others, the proposed rules would be more burdensome than in a traditional IPO. The proposed changes include the following:

With respect to SPACs:

• Additional disclosure about the SPAC sponsor. The rules propose adoption of a new Subpart 1600 to Regulation S-X. Additional disclosure would be required about the SPAC sponsor—including the sponsor’s experience, material roles, and responsibilities, as well as any agreement or understanding between the sponsor and the SPAC (or its executive officers, directors or affiliates), in determining whether to proceed with a de-SPAC and regarding the redemption of outstanding securities; the controlling persons of the sponsor and any persons who have direct or indirect material interests in the sponsor; the material terms of any lock-up agreements with the sponsor and its affiliates; and the nature and amounts of compensation that has or will be paid to the sponsor, its affiliates and any promoters for all services rendered to the SPAC, as well as amounts of reimbursements to be paid to the sponsor, its affiliates and any promoters upon the completion of a de-SPAC.
• Additional disclosure about SPAC-related conflicts of interest. The new subpart also would require disclosure of actual or potential material conflicts of interest between the sponsor (or its affiliates or the SPAC’s officers, directors, or promoters) and public investors—such as the potential conflicts arising from (i) the contingent nature of the sponsor’s compensation (“whereby the sponsor and its affiliates have significant financial incentives to pursue a [de-SPAC] even though the transaction could result in lower returns for public shareholders than liquidation of the SPAC or an alternative transaction”); (ii) the sponsor being a sponsor of multiple SPACs at the same time, having interests in or obligations to other entities, or entering into a business combination with a target affiliated with the sponsor, the SPAC or the SPAC’s founders, officers or directors; or (iii) the SPAC’s officers working for both the sponsor and the SPAC and/or having responsibilities at other companies that take their time and attention and may influence their decision-making with respect to a particular de-SPAC.
• Additional disclosure about fiduciary duties of SPAC officers and directors to other companies. The new subpart also would require disclosure of the fiduciary duties each officer and director of a SPAC owes to other companies—so that investors can assess to what extent the officers or directors may have to navigate conflicts of interest, act in the interest of another company that competes with the SPAC for business opportunities, or may have their attention divided or their decision-making affected.
• Additional disclosure about potential dilution. The new subpart would require disclosure, in a registration statement filed by a SPAC (including for an IPO) and in connection with de-SPACs, about material potential sources of dilution following the SPAC’s IPO—including tabular disclosure (on the prospectus cover page) of the amount of potential future dilution from the public offering price that will be absorbed by non-redeeming SPAC shareholders, and simplified tabular disclosure of various potential levels of redemption, and, in connection with the de-SPAC, each material potential source of additional dilution that non-redeeming shareholders may experience at different phases of the SPAC lifecycle by electing not to redeem their SPAC shares in connection with the de-SPAC (such as when other SPAC shareholders retain their warrants after redeeming their shares prior to the de-SPAC).

With respect to de-SPACs:

• Disclosure about the fairness of the transaction to the SPAC shareholders. The proposed new rules would require disclosure as to whether the SPAC “reasonably believes” that the proposed de-SPAC and any related financing are fair or unfair to the SPAC investors. Also required would be disclosure as to the material factors upon which such belief is based, including factors such as the valuation of the target and the consideration of financial projections. The proposed rules also require disclosure as to whether the SPAC or the sponsor has received any outside report, opinion or appraisal relating to the fairness of the de-SPAC or any related financing, and a summary of any such report, opinion or appraisal received. Notably, this requirement, which generally tracks the disclosure requirement in Item 1015 of Regulation MA, does not include the exclusion contained in Item 1015 for legal opinions.
• Deeming the de-SPAC target to be a co-registrant with the SPAC and as an issuer of securities. Under the proposed new rules, the de-SPAC target company would be deemed to be a co-registrant with the SPAC of a registration statement on Form S-4 or F-4 when the SPAC files such a registration statement for a de-SPAC, and as an “issuer” under Section 6(a) of the Securities Act of 1933—with the executive officers and directors signing the registration statement generally being subject to liability under Section 11 of the Securities Act as signatories to the registration statement. The proposed rules also call for deeming a business combination of a reporting shell company with an entity that is not a shell company (such as a de-SPAC) to involve a “sale” of securities to the shareholders of the reporting shell company; and, therefore, the disclosure requirements and liability provisions of the Securities Act would apply to the transaction. A consequence of the adoption of the rule would be that all de-SPAC transactions—including those in which SPAC investors are not receiving new shares and which, under current rules, would not require the filing of a registration statement—would have to be registered under the Securities Act and, as noted above, would subject the underwriter of the SPAC’s IPO (and possibly other advisors) to potential underwriter liability in connection with the de-SPAC.
• Making the projections safe harbors unavailable. The proposed new rules would amend the definition of “blank check company” for purposes of the PSLRA to encompass SPACs (and certain other blank check companies)—with the result that the safe harbor under PSLRA for forward-looking statements (including with respect to the use of projections) would not be available to SPACs or to target companies engaging in a de-SPAC.
• Enhancing the reliability of disclosures relating to projections. A proposed amendment to Item 10(b) of Regulation S-K is intended to allow investors to understand the basis for (and so to better assess the reliability of) projections disclosed in SEC filings; and an amendment to Item. 1609 of Regulation S-K would add certain requirements when projections are disclosed in connection with de-SPACs.
• Deeming the underwriter of a SPAC’s IPO (and possibly other advisors) to be an underwriter of the de-SPAC as well. A proposed new rule (Securities Act Rule 140a) would deem anyone who has acted as an underwriter of the securities of a SPAC IPO, and who takes steps to facilitate a de-SPAC (or any related financing, or who otherwise participates, directly or indirectly, in the de-SPAC), to be engaged in a distribution and to be an underwriter of the securities in the de-SPAC.

As a large portion of SPAC IPO underwriting fees typically is deferred until, and conditioned on, the completion of the de-SPAC, a SPAC IPO underwriter usually has a strong financial interest in taking steps to ensure the consummation of the de-SPAC. Thus, although SPAC IPO underwriters typically are not retained to act as firm commitment underwriters in the de-SPAC, they nevertheless “typically participate in activities that are necessary to that distribution” (such as acting as a financial advisor to the SPAC, assisting in identifying targets, negotiating merger terms, or finding and negotiating PIPE investments). Receipt of compensation in connection with the de-SPAC “could constitute” direct or indirect participation in the de-SPAC, the SEC wrote. The SEC’s commentary makes clear that that the underwriter of the SPAC IPO would be deemed to be the underwriter of the de-SPAC as well under most circumstances. The SEC emphasized the critical “gatekeeping” role played by underwriters, and wrote: “By affirming the underwriter status of SPAC IPO underwriters in connection with de-SPAC transactions, the proposed rule should better motivate SPAC underwriters to exercise the care necessary to ensure the accuracy of the disclosure…by affirming that they are subject to Section 11 liability for that information.”

Broadening these concepts even further, the SEC noted that Rule 140a would address the underwriter status only of the SPAC IPO underwriter in the context of a de-SPAC. The SEC wrote that, in addition, some of the activities by SPAC IPO underwriters also may establish that the SPAC IPO underwriter is participating in the distribution of target company securities. The SEC stated that the new proposed rules are not intended to be “exhaustive” with respect to potential underwriter liability and noted that the SEC or courts “may find that other parties involved in securities distributions, including other parties that perform activities necessary to the successful completion of de-SPAC transactions, are ‘statutory underwriters’ within the definition of underwriter in Section 2(a)(11).” It continued: “For example, financial advisors, PIPE investors, or other advisors, depending on the circumstances, may be deemed statutory underwriters in connection with a de-SPAC transaction if they are purchasing from an issuer ‘with a view to’ distribution, are selling ‘for an issuer,’ and/or are ‘participating’ in a distribution.”

• Imposing conditions on a safe harbor for not being an investment company. A proposed new rule to the Investment Company Act (Rule 3a-10) would provide a safe harbor such that a SPAC would not be an “investment company” if (i) the SPAC’s only assets are cash items, government securities, and certain money market funds; (ii) the SPAC seeks to complete a de-SPAC, after which the surviving entity will be primarily engaged in the business of the target company; and (iii) the SPAC enters into an agreement with the target company to engage in a de-SPAC within 18 months after its IPO, and completes the de-SPAC within 24 months of the offering. SPACs are currently typically structured to satisfy these conditions, although the proposed Rule would limit the flexibility SPACs currently have to seek investor approval to extend the deadline for completing a de-SPAC. The proposed Rule would limit more unusual structures that have occasionally been introduced—such as a SPAC engaging in more than one de-SPAC transaction (although a “combination of multiple target companies,” treated as a single transaction, would be permissible); or a SPAC seeking “to acquire a minority interest in a target company with the intention of being a passive investor.” If a SPAC relies on the new safe harbor but fails to comply with the 18-month or 24-month timeframes, it would not be able to rely on the 12-month safe harbor afforded to “transient investment companies” under Rule 3a-2 under the Investment Company Act. (In other words, it would not be possible to tack together the safe harbor periods provided under the existing and the proposed rules.) While a SPAC would not be required to rely on the safe harbor, the conditions specified reflect the factors that the SEC believes would distinguish a SPAC as to which “serious questions” as to whether it is an investment company arise from those as to which they would not.
• Additional disclosure about the de-SPAC target. The proposed amendments to the registration statement forms and schedules filed in connection with de-SPACs would require additional disclosures about the target operating company, consistent with the type of disclosures an operating company would include in a traditional IPO.
• Timing requirement for disclosure to SPAC investors. Disclosure documents in connection with de-SPACs would have to be disseminated to investors 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 disclosure documents permitted under the laws of the jurisdiction of incorporation or organization if such period is less than 20 calendar days.
• Re-determining “smaller reporting company” status post-de-SPAC. The proposed new rules would amend the definition of “smaller reporting company” (SRC) to require a re-determination of such status at an earlier stage following the consummation of a de-SPAC. The company would have to predetermine its SRC status before its first SEC filing after the filing of a “Super Form 8-K,” with the company’s public float measured as of a date within four business days following the consummation of the de-SPAC.
• Aligning financial statements reporting. A proposed new article (Article 15) of Regulation S-X would more closely align the financial statement reporting requirements in business combinations involving a shell company and a private operating company with those in traditional IPOs—including requiring disclosure of three years of statements of comprehensive income, changes in stockholder’s equity, and cash flows (subject to accommodations for SRCs and emerging growth companies).

Conclusions and Open Questions

• Considerations for a private company in choosing whether to go public through a de-SPAC or a traditional IPO. As discussed, the proposed rule changes would accelerate market changes already underway that have reduced the advantages of going public through a de-SPAC rather than a traditional IPO. The proposed changes would further reduce or eliminate the timing and cost advantages that the de-SPAC structure initially offered but that have significantly diminished over time as regulatory and investor scrutiny have increased. Also, the proposed changes likely would significantly reduce or eliminate the market practice of using projections to market a de-SPAC transaction. Thus, the key remaining advantage of the SPAC route would be the ability the private operating company has to negotiate its valuation face-to-face with a single counterparty (albeit tested in the PIPE process in some cases)—versus the traditional IPO process in which a valuation range is set with underwriters and there is a book-building process with institutional investors through a roadshow, with changing investor sentiments and market conditions often influencing pricing. It remains to be seen how the SPAC route’s advantage of greater pricing certainty will be valued by a private company when deciding which route to take to go public—and whether this advantage would be sufficient to sustain SPACs as an ongoing significant feature of the capital markets and M&A landscapes.
• It is uncertain to what extent the SEC’s proposing the new rules may affect existing SPACs now seeking de-SPAC targets. It is generally expected that the SEC Staff will proceed toward prompt adoption of the final rules soon after the comment period ends. It is not clear what transition period may be provided for in the final rules, nor how SPAC IPOs or de-SPACs that are pending at that time will be impacted by the new rules. Currently, there are over 300 SPACs currently seeking de-SPAC targets and about 300 SPACs publicly in the registration process. It is uncertain whether the SEC’s approach toward SPACs as reflected in the proposed new rules, which is more rigorous than was generally expected (and, arguably, more burdensome than would be applicable in a traditional IPO), may cause some of these SPACs to abandon their process. To be sure, in most cases sponsors are highly incentivized to complete a de-SPAC rather than liquidate the SPAC. Indeed, we note that there could well be a rush to complete de-SPACs before the new rules are adopted—which would further intensify the existing pressures SPACs have been facing in finding de-SPAC targets, conducting an appropriate level of due diligence, and agreeing on deal terms. In addition, targets may consider conducting parallel de-SPAC and traditional IPO processes pending further finalization and adoption of the proposed rules.
• It remains to be seen whether, if the proposed rules are adopted, market practice changes would develop with respect to the economic terms of SPAC transactions that would restore the SPAC route to being economically equivalent or preferable to the traditional IPO route in many cases. Assuming the SEC rules have the desired impact of equalizing the disclosure, timing, and potential liability features of SPACs as compared to traditional IPOs, the decision as to which to use in a particular case would depend on the all-in cost of one route versus the other. The SPAC route would appear to be more costly in most cases, as it would involve, effectively, both an IPO of the SPAC and the equivalent of an IPO of the de-SPAC target, as well as the costs associated with the sponsor’s promote and dilution from warrants. Changes in market practice with respect to the economic terms relating to SPACs conceivably could develop in response to make SPACs a more attractive alternative. In all cases, however, the SPAC route would involve the cost and complexity of an initial SPAC IPO and then a de-SPAC merger proxy process that is the equivalent of a traditional operating company IPO (albeit without the cost and complexity of a roadshow). Moreover, and most importantly, market practice likely would change to take into account the expanded potential liability for financial advisors and others.
• It remains to be seen to what extent market practice changes could develop in response to the new rules and SEC commentary expanding the parties potentially subject to liability as underwriters in connection with a de-SPAC. The proposed new rules with respect to potential underwriter liability are very broad in their scope and to some extent still to be defined. The proposed rules and accompanying SEC commentary would subject SPAC underwriters and possibly other advisors, including financial advisors, who may be deemed to be “participating” in the distribution associated with a de-SPAC, to potential underwriter liability in connection with the de-SPAC. As discussed, the proposed changes would expand the scope of potential liability far beyond that present in a traditional IPO. An open question is to what extent market practice changes might develop that could mitigate the liability issues. For example, would a market practice possibly develop such that the underwriter for the SPAC IPO would not “participate” at all in the de-SPAC? This could involve, among other things, the underwriter receiving all or most of its fees upfront rather than deferring a substantial portion until the de-SPAC. Pending further development, it is also uncertain even whether this (or other changes) would be sufficient to insulate underwriters from liability in connection with the de-SPAC. Moreover, such changes could substantially increase the upfront costs payable by SPAC sponsors, increase at-risk capital for sponsors, and reduce overall returns on invested capital for sponsors; and, if underwriters will face potential liability in connection with a de-SPAC, there likely would be different economic terms and additional rights and protections that they will insist upon in connection with their expanded role and risk profile, which may impact the de-SPAC process (in particular with respect to due diligence of the target company) and the relationship between the SPAC sponsor and the target.
• It remains to be seen what process would develop to support the fairness of a de-SPAC to the SPAC investors. It is uncertain what process sponsors would use to form and support a “reasonable belief” in the fairness of the de-SPAC transaction to the SPAC investors (and, whether they would seek any external advice in that process). We note that the Delaware Court of Chancery, in Amo v. MultiPlan, recently suggested that, generally, it will review a challenged de-SPAC under the heightened scrutiny of the “entire fairness” standard due to the inherent conflicts in the SPAC structure. It is uncertain to what extent the Delaware ruling may impact the process sponsors would use in connection with the requirement to express a “reasonable belief” as to fairness. It is also uncertain what the result will be of the interaction of, on the one hand, the requirement under the proposed new rules for disclosure of the basis for the fairness determination and, on the other hand, the increased potential liability for disclosure of projections.
• It remains to be seen under what circumstances a SPAC not meeting the safe harbor conditions under the proposed Investment Company Act rule would be deemed not to be an “investment company.” The SEC stated in the proposing release that SPACs’ traditional asset composition and sources of incomes raise questions about their status under the Investment Company Act, which would have to be weighed with other relevant factors in determining whether a SPAC is an investment company.
• The proposed rules may be challenged or revised. It remains to be seen whether the rules will be challenged and whether any challenge would be successful; what changes (if any) the SEC may make in response to comments it receives; what clarifications may be provided in connection with adoption of final rules; and what changes in market practices may occur.