In January and March 2024, respectively, the Securities and Exchange Commission (SEC) issued final rules concerning special purpose acquisition companies and mandatory climate-related disclosure. Each rulemaking was the culmination of a nearly two-year review and comment process and each is widely expected to reverberate through the capital markets. In this alert, we will examine how these new rules will function once (or in one case, if) they go into effect.

Special Purpose Acquisition Companies (SPACs)

In a traditional IPO, an operating company with significant assets, a meaningful corporate history, and an established presence in its industry embarks on what is usually a major milestone, entering the public markets for additional capital, liquidity for its securities, and an elevated brand name. A SPAC, often called a “blank check company,” is not an operating company. With no or nominal assets, an IPO involving a SPAC seeks to raise capital upfront in order to finance a merger or other acquisition with a private operating company, making that company public via a process that historically has been more expedited than that of the ordinary IPO.

The SPAC was created in the early 1990s but was a relatively obscure instrument until the last 10 years. The market began to grow when more private equity firms, banks and prominent entrepreneurs began forming SPACs and taking them public, showing private companies that a negotiated SPAC combination could both lock in a control premium for their majority stake and provide liquidity for any remaining equity. By 2020-2021, SPACs were exploding in popularity, comprising more than half of all IPOs in the aggregate two-year period. Despite a steep decline since then, SPACs still represented more than 40% of the IPOs completed in 2023 and 36% of those completed through late March 2024.

The SPAC Lifecycle

Upon incorporation of a SPAC, its founders, commonly referred to as “sponsors,” usually receive an equity stake that will constitute 20% of the post-IPO public float, along with anti-dilution protection, in return for almost no capital and their efforts to complete a merger or acquisition. A SPAC IPO looks very similar to a regular one, with the sponsors filing a registration statement on Form S-1 (for U.S. domestic companies), which undergoes the normal SEC review process. Because a SPAC has almost no assets and no operating history, the SEC review is generally a shorter one, perhaps by months.

The investors in a SPAC IPO typically receive equity in the form of units, consisting of some combination of common stock and warrants. The SPAC will list its common stock and warrants with a national securities exchange, such as the NYSE or Nasdaq, upon going public. The IPO proceeds will go into trust, as the SPAC sponsors seek to identify a suitable target. If no merger or acquisition takes place within a normal SPAC lifespan of 18 to 24 months, the SPAC will liquidate and its investors will be repaid, albeit net of fees and expenses. If a combination does occur, then units will, at the option of the holder, either be redeemed for cash or convert into common stock and warrants of the new company.

Once a target company is selected, the SPAC sponsors will perform standard due diligence and they and the company’s management will negotiate an agreement to combine the entities. The total merger or acquisition price must be no less than 80% of the total amount of the IPO proceeds held in trust, though it is often more than that, and additional securities frequently must be issued by the SPAC to have sufficient capital to complete the transaction. The specific transaction documents and required SEC filings will vary depending on what form the final transaction takes. But if shareholder approval is needed, as it normally is, e.g. when the SPAC is not the surviving entity or it has to issue at least 20% of voting stock to raise more capital, then a proxy statement must be filed and sent to investors, and if additional securities are issued, a registration statement on Form S-4 will also be necessary (these two filings are routinely incorporated into a single one). After a second SEC review, once the transaction has closed, i.e. a “de-SPAC,” the now-combined company has ongoing SEC reporting requirements identical to those it would have had it gone public via the conventional IPO.

The New Rules

Observing the rapid increase in SPAC offerings in recent years, and their increasingly disproportionate presence in the capital markets, the SEC grew concerned that SPAC investors were not receiving disclosure adequate to the complex nature of these transactions, particularly in contrast to that of traditional IPOs. Among the specific issues raised were the staggered and abbreviated nature of the disclosure, the perceived and usually undisclosed conflicts of interest between sponsors and investors, the substantial dilution that SPAC investors typically experience after the business combination goes through, and whether sponsors were bringing substandard and undersized target companies into the public market to avoid liquidating their SPACs.

The SEC proposed new rules to address these and other SPAC-related issues in March 2022 and finalized them in January of this year. They will go into effect on July 1. The rules mandate the following for both SPAC IPO filings and filings relating to de-SPAC transactions, as applicable:

• Significantly more information about the sponsor, including compensation, the identities of control person(s), lock-up agreements, and actual or potential conflicts of interest.
• Additional disclosure relating to potential sources of dilution to the investors, such as sponsor compensation, shareholder dilution, underwriting fees, and outstanding warrants.
• Financial projections for the target company must be fully described, including their preparation, material assumptions and bases, and with actual historical financial results or operational history also prominently disclosed, and rules concerning GAAP vs. non-GAAP measures apply to projections, as well as to other financial information.
• SPACs will no longer be able to rely on the safe harbor available under the Private Securities Litigation Reform Act of 1995 for any forward-looking statements they make.
• The target company must be a co-registrant if the SPAC has to file an S-4 in order to raise more capital, subjecting it to potential liability under the securities laws.
• Preexisting SEC staff guidance concerning business combinations involving shell companies has now been codified, and the target company must provide financial statements comparable to that if it had engaged in a conventional IPO.
• Any determination by the SPAC board of directors as to whether the de-SPAC transaction is advisable and in the best interest of the SPAC and its shareholders must be disclosed.

Climate Disclosure

The question of whether the SEC should require public companies and companies embarking on IPOs to disclose the scope and nature of their climate-related footprints has long been hotly debated. When the proposed rules were issued in March 2022, they resulted in approximately 24,000 comment letters, a record number. And while the final rules issued last month are markedly scaled back from what was proposed, they remain highly controversial. Multiple petitions seeking judicial review of the rules were almost immediately filed in several federal courts. These petitions were consolidated in the Eighth Circuit Court of Appeals and, in response, earlier this month the SEC opted to issue a stay order pending the ruling of the court.

As a result, any examination of the climate disclosure rules at this time is largely an academic one. But given the breadth of the rules, the impact they will have on a number of major public companies if they become effective, and the broader debate over climate change and how to address it, it is still worthwhile to look at what the SEC has ruled to be in the best interest of protecting investors and facilitating capital formation.

The New Rules

In its 886-page adopting release, the SEC requires public companies and those seeking to become public to disclose the following:

• Material climate-related risks and the company’s activities to mitigate or adapt to them, including the costs involved and the use of transition plans.
• Board oversight of the material climate risks and management’s role in identifying, assessing and administering them.
• Climate-related goals and targets, to include financial estimates and assumptions, and the actions taken to achieve them.
• For companies with a public float of $75 million or greater, information about material Scope 1 greenhouse gas (GHG) emissions, i.e. direct emissions from operations owned or controlled by the company, and material Scope 2 GHG emissions, which are indirect emissions generated by purchased or acquired electricity, steam, heat or cooling that is consumed by operations owned or controlled by the company.
• With respect to financial reporting, in the notes to the audited financial statements, companies should address costs, expenses and losses related to severe weather events such as hurricanes, tornadoes, flooding, droughts, wildfires, and sea level rises, subject to a 1% disclosure threshold. Costs, expenses and losses related to carbon offsets and renewable energy credits used as material elements of achieving climate-related goals or targets should also be addressed. Qualitative disclosure relating to how estimates and assumptions used in preparing financial statements may have been materially impacted by risks and uncertainties stemming from severe weather events, targets or transition plans should also be included.

Companies Should Prepare Now

These new requirements will be onerous for public companies with carbon footprints to adapt to, and the SEC provided for lengthy phase-in periods for some of the rules, depending on filer status. It should also be noted that the safe harbor for forward-looking statements that will soon be unavailable to SPAC companies, as mentioned above, can be relied upon when discussing items like transition plans, goals and targets, internal carbon pricing and scenario analyses. The materiality threshold for disclosing GHG emissions should also not be ignored.

Despite the SEC’s stay order and the pending judicial review of these rules, companies that will need to make the disclosures discussed above should not delay in developing an effective compliance plan. In a recent panel discussion, a senior counsel of Chevron Corporation stated that despite the significant uncertainty as to how the Eighth Circuit will decide the consolidated cases before it, her company was already putting into place compliance procedures for the rules. This will be a complex process, and under the original timetable, larger reporting companies had only eight months from the date the rules were issued to begin making new disclosures.

While the actual timetable for implementation of the climate rules is now anyone’s guess, the prudent path would be to prepare now for at least some degree of enhanced disclosure. Given the fate of the share repurchase rule the SEC promulgated in May 2023, in which the rule was vacated before the year was out by the Fifth Circuit Court of Appeals for violating the Administrative Procedure Act, and was then rescinded by the SEC, it is by no means certain that the climate disclosure rules will survive in their present form. But it is worth mentioning that the SEC already had a less demanding share repurchase disclosure rule in place prior to last year, while these climate rules are entirely new, with no predecessor. Even if the Eighth Circuit rules against the agency, it seems likely that the SEC will try again to implement climate disclosure regulations, and companies would do well to pivot now to ensure they are ready when the time comes.