As the wave of SPAC IPOs and de-SPAC transactions continues to build, so too has the scrutiny of these transactions from the SEC and the shareholder plaintiff’s bar. On April 8, 2021, the SEC gave its clearest warning yet among a series of recent signals that it plans to intensify its review of de-SPAC transactions. Most recently, the SEC raised the possibility that statements in a de-SPAC transaction proxy statement fall within the IPO exclusion to the Private Securities Litigation Reform Act (“PSLRA”) safe harbor for forward-looking statements. Meanwhile, a SPAC shareholder recently filed suit in the Delaware Court of Chancery alleging that the SPAC’s board and sponsors breached their fiduciary duties in approving a de-SPAC transaction, and argued that the claims should be reviewed under Delaware’s demanding entire-fairness standard due to conflicts posed by the board’s and sponsors’ receipt of founder shares. Together, these developments highlight the litigation uncertainties for SPACs and reinforce the importance of adequate disclosures, a robust diligence process, and the careful consideration of any material conflicts.
The SEC’s April 8 Statement
On April 8, 2021, SEC Division of Corporation Finance Acting Director John Coates issued a statement in light of the “unprecedented surge” in SPAC activity, a surge Coates described as raising “new issues” and causing commentators from many quarters to “sound alarms.”1 The focus of the remarks was whether “current liability protections for investors” give those running SPACs “sufficient incentives to do appropriate due diligence on the target and its disclosures to public investors.”2 Specifically, Coates noted that one perceived benefit of going public through a de-SPAC transaction, rather than an IPO, is the availability of the PSLRA safe harbor for forward-looking statements — such as projections and other valuation materials — issued in a de-SPAC proxy statement, which would not apply to IPO registration statements.3 Injecting a new uncertainty, Coates then posed that the PSLRA’s exclusion of IPOs from the safe harbor “may include de-SPAC transactions.” Coates acknowledged an IPO is “generally understood to be the initial offering of a company’s securities to the public,” which for a SPAC occurs before any de-SPAC transaction. But he argued that applying the safe-harbor IPO exclusion to the de-SPAC transaction would elevate “economic substance over form,” because the de-SPAC transaction is like an IPO in that it is the first time the public sees financial information about a company. Coates indicated that the SEC could use rulemaking or guidance to address this issue. He went on to question the degree to which the PSLRA safe harbor provides additional protection — even assuming it applied to de-SPAC transactions — and emphasized that the safe harbor only applies to private litigation, and not to SEC enforcement actions.
The remarks serve as practically an invitation to the shareholder plaintiff’s bar to advance in de-SPAC proxy litigation the argument that the PSLRA safe harbor does not apply. We expect such uses of the IPO exclusion argument to proliferate as a result (at least until a critical mass of courts have squarely addressed the issue). Under the current securities provisions, the argument strikes us as strained. As Coates acknowledges, a SPAC completes its IPO before even identifying a target for a de-SPAC transaction — apparently requiring a proponent of this argument to contend that the SPAC has two separate initial public offerings. It would also upset the established understanding that the PSLRA safe harbor generally applies to merger proxy statements issued pursuant to Section 14(a) of the Exchange Act. But whether or not this argument ultimately succeeds, it portends increased litigation exposure for upcoming de-SPAC transactions. To address this risk, SPACs should continue to diligently investigate the prospects and projections of the target business and carefully craft their public disclosures, particularly as they relate to disclosing material assumptions and risks related to the projections.
In addition to his exposition on the applicability of the PSLRA to de-SPAC transactions, Coates hinted at the possibility of the SEC reconsidering the concept of an “underwriter” in de-SPAC transactions and direct listings and posited the possible need for additional guidance on projections and valuations in documents used for such transactions. Coates concluded with a suggestion that the SEC “should focus the full panoply of federal securities law protections” on de-SPAC transactions.
While it remains to be seen whether and how these remarks will be followed up by rulemaking and/or enforcement actions, when combined with prior SEC statements regarding SPACs, the SEC has unmistakably fired a shot across the bow regarding SPAC disclosures.
The MultiPlan Fiduciary Duty Litigation
On March 25, 2021, a shareholder of MultiPlan Corp. — the entity resulting from a de-SPAC transaction that closed in October 2020 — filed a class-action lawsuit in the Delaware Court of Chancery against the SPAC’s directors and sponsors for breach of fiduciary duty.4 The crux of the allegations is that the defendants approved the de-SPAC transaction in order to enrich themselves through the receipt of founder shares and deal-related fees, despite knowing that the target was at imminent risk of losing a contract that accounted for roughly one-third of its revenues, which was not disclosed in the proxy. According to the complaint, when the loss of the contract came to light, MultiPlan fell nearly 40% below its $10/share IPO price. Echoing Coates’ April 8, 2021 statement, the complaint also alleges that “disclosures around the deal . . . were not done with the rigor of the usual IPO process.”5
As explained in our article from December 2020 predating the MultiPlan lawsuit, it is a somewhat undeveloped question what standard of review Delaware courts will apply to breach of fiduciary duty claims arising from a typical de-SPAC transaction. But a SPAC shareholder could argue (as the MultiPlan plaintiff has now done) that the receipt of founder shares which convert into publicly traded securities only if a de-SPAC transaction is completed uniquely incentivizes the recipient to close any transaction possible, even if it means overpaying or pursuing a transaction that is not in the SPAC shareholders’ best interests. Thus, goes the argument, the directors and sponsors faced a material conflict in approving the de-SPAC transaction which triggers entire fairness — Delaware’s highest standard of review, which places the burden on the defendants to prove that both the price and the process of the challenged transaction were entirely fair to the company’s shareholders.
Notably, the MultiPlan complaint all but expressly frames itself as a test case for this question. The complaint argues that the typical SPAC structure of awarding founder shares — which it calls “SPAC 1.0” — “is conflict-laden and practically invites fiduciary – misconduct.”6 The complaint asks the court to apply entire fairness review, and thereby incentivize future SPAC sponsors “to mitigate avoidable conflicts by structuring entities that better protect public stockholders” — which is calls “SPAC 2.0.”7 While the MultiPlan complaint contains some allegations that could distinguish the case from the typical de-SPAC, a decision in that lawsuit could certainly affect the standard of review applied by other courts in future challenges. The lawsuit may also be the first of many such SPAC fiduciary duty claims in the coming months. Such lawsuits dovetail with SEC guidance from December 2020, indicating that the SEC will be particularly focused on the disclosure of potential director and founder conflicts — including conflicts posed by founder shares — in SPAC public filings.
For the reasons given in our prior article, we believe there are several strong arguments against applying entire fairness review of a typical de-SPAC transaction. And, as always, fulsome disclosure and informed approval by a majority of disinterested shareholders is the best way to insulate SPACs and their directors from the anticipated increase in fiduciary duty lawsuits challenging de-SPAC transactions. Still, the heightened risk of these lawsuits and the somewhat unsettled standard of review may lead SPACs increasingly to consider structural changes to mitigate litigation risk — including potentially delegating aspects of the de-SPAC transaction to a committee of independent directors who are not compensated in founder shares.
We will continue to be closely watching for any developments. In the meantime, these developments place greater pressure on SPAC participants to (i) have a robust diligence process with respect to de-SPAC M&A, particularly as it relates to developing the target’s forecast, and, (ii) similar to a traditional IPO process, diligence and carefully consider all disclosures, particularly as they relate to any conflicts and relationships between the parties and materials risks with respect to the forecast.
1 Public Statement, John Coates, Acting Dir., Div. of Corp. Fin., U.S. Sec. & Exchange Comm’n, SPACs, IPOs and Liability Risk under the Securities Laws (Apr. 8, 2021), https://www.sec.gov/news/public-statement/spacs-ipos-liability-risk-under-securities-laws.
2 These remarks followed on the heels of, among others: (i) December 22, 2020 guidance from the SEC Division of Corporate Finance emphasizing the importance of disclosing potential conflicts of a SPAC’s directors, officers, and sponsors in the SPAC’s IPO and de-SPAC filings; and (ii) March 31, 2021 statements from the SEC’s Division of Corporation Finance and the Office of the Chief Accountant regarding accounting, financial reporting and governance issues arising following a de-SPAC transaction. CF Disclosure Guidance: Topic No. 11: Special Purpose Acquisition Companies, U.S. Sec. & Exchange Comm’n (Dec. 22, 2020), https://www.sec.gov/corpfin/disclosure-special-purpose-acquisition-companies; Public Statement, Div. of Corp. Fin., U.S. Sec. & Exchange Comm’n, Staff Statement on Select Issues Pertaining to Special Purpose Acquisition Companies (Mar. 31, 2021), https://www.sec.gov/news/public-statement/division-cf-spac-2021-03-31; Public Statement, Paul Munter, Acting Chief Acct. U.S. Sec. & Exchange Comm’n, Financial Reporting and Auditing Considerations of Companies Merging with SPACs (Mar. 31, 2021), https://www.sec.gov/news/public-statement/munter-spac-20200331.
3 While this perceived benefit was the focus of Coates’ remarks, in our experience it is not a significant driver in parties’ decisions to pursue a de-SPAC transaction over alternative structures.
4 Complaint, Kwame Amo v. MultiPlan Corp., C.A. No. 2021-0258 (Del. Ch. filed Mar. 25, 2021).
5 Id. ¶ 6.
6 Id. ¶ 2.
7 Id. ¶ 4.
