SEC Announces Enforcement Action Relating to Proposed De-SPAC Transaction

Wilson Sonsini Goodrich & Rosati

On July 13, 2021, the U.S. Securities and Exchange Commission (SEC) announced a settlement with special purpose acquisition company (SPAC) Stable Road Acquisition Corp. (SRAC), its CEO, its sponsor, SRC-NI, and SRAC's proposed merger target, Momentus Inc. (Momentus). This announcement marks the SEC's first SPAC-related enforcement action and settlement since its April 2021 statements indicating a heightened focus on SPACs and de-SPAC transactions.

The cease-and-desist order (Order) related to the settlement asserts violations of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 against Momentus, violations of Sections 17(a)(2) and (3) of the Securities Act and Sections 13(a) and 14(a) of the Exchange Act, and various rules promulgated thereunder, against SRAC, and violations of Section 14(a) and Rule 14a-9 against SRAC's CEO and SRC-NI, based on allegedly false and misleading statements concerning Momentus's business and its former CEO that were made in connection with the parties' planned de-SPAC transaction. The SEC also separately instituted proceedings against the former CEO of Momentus asserting violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act.

The Order stated that SRAC engaged in negligent misconduct as a result of "due diligence failures." Specifically, the SEC alleged that SRAC's due diligence i) was conducted in a compressed timeframe, ii) failed to probe claims regarding the merger target's technology, and iii) failed to follow up on national security and foreign ownership risks relating to Momentus's former CEO. The SEC alleged that by failing to engage in comprehensive due diligence, SRAC adopted and disseminated materially false and misleading information regarding the merger target. These allegedly false and misleading statements were included in SRAC's SEC filings, as well as presentation materials given to potential private investment in public entity (PIPE) investors, institutional investors, and analysts. In the SEC's press release, SEC Chairman Gary Gensler said "this case illustrates risks inherent to SPAC transactions, as those who stand to earn significant profits from a SPAC merger may conduct inadequate due diligence and mislead investors[.]"

The settlement includes civil monetary penalties in excess of $8 million—$7 million to Momentum, $1 million to SRAC, and $40,000 to SRAC's CEO—and it requires that Momentus create a permanent independent committee of its board of directors to oversee compliance with disclosure controls and retain an independent compliance consultant for a period of two years. This undertaking imposes a significant burden moving forward. In addition, the settlement includes remedies specifically tailored to the mechanics of de-SPAC transactions. First, the settlement requires the SPAC's sponsor to forfeit 250,000 in founder's shares should the merger be approved.

Second, the Order contains an additional, even more significant remedy: the requirement that the SPAC and de-SPAC target notify and offer each PIPE investor who entered into a subscription agreement the right to terminate such subscription agreement. According to the Order, PIPE investors agreed to purchase 17,500,000 shares of the common stock of the merged company at $10/share, or $175 million, if and after the business combination was approved. That was an amount just slightly higher than the gross proceeds obtained in SRAC's initial public offering ($172.5 million). PIPE investors typically do not have the right to terminate their subscription agreements. While it is impossible to predict whether PIPE investors will terminate their subscription agreements if given the opportunity, the mere possibility presents significant risks to de-SPAC transactions. Most notably, the target company risks the loss of significant amounts of expected capital, which could result in undercapitalization.

While it is too early to tell if these remedial measures will become commonplace, the Order, and the novel remedies it imposes, may impact other similar transactions. 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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