In light of the dramatic upswing in the use of special purpose acquisition companies (SPACs), the staff of the Securities and Exchange Commission (SEC) has issued several public statements highlighting concerns and issues related to SPACs and private operating companies that are going public through business combinations with SPACs. These business combinations are referred to as "de-SPAC transactions."
On April 8, 2021, John Coates, Acting Director of the SEC's Division of Corporation Finance, published a statement titled SPACs, IPOs and Liability Risk Under the Securities Laws, discussing the legal liability risks of de-SPAC transactions and traditional initial public offerings (IPOs).1 In addition, on March 31, 2021, the SEC's Division of Corporation Finance published a Statement on Select Issues Pertaining to Special Purpose Acquisition Companies,2 and Paul Munter, the SEC's Acting Chief Accountant, published a statement titled Financial Reporting and Auditing Considerations of Companies Merging with SPACs.3 Aside from these recent public statements, the SEC's Enforcement Division has also taken some preliminary action relating to these transactions. According to recent press reports, Enforcement staff has sent letters to investment banks requesting information on SPAC deals, including deal fees and volume, and the controls that these banks have implemented relating to these transactions.4
Although by their nature the foregoing statements have no legal force or effect and do not change applicable law, the statements and actions indicate a heightened focus by the SEC on SPACs and de-SPAC transactions, and signal where the SEC is headed. Given the extensive attention SPACs have received, we should expect additional SEC guidance and rulemakings relating to de-SPAC transactions, including, but not limited to, guidance and rules regarding disclosures and legal liability. Although not as likely in the near term, Congress may also take action related to SPACs and de-SPAC transactions. These SEC and legislative actions likely will result in greater convergence in liability rules and disclosure and diligence practices between traditional IPOs and de-SPAC transactions.
Division of Corporation Finance – Acting Director Statement
Acting Director Coates observed that some "practitioners and commentators have claimed that an advantage of SPACs over traditional IPOs is lesser securities law liability exposure for targets and the public company itself." In response to this claim, Acting Director Coates stated that any "claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst[,]" and that liability risks may actually be higher in de-SPAC transactions than in traditional IPOs, in part due to the potential conflicts of interest in the SPAC structure and in many de-SPAC transactions, and the speed with which companies are going public. The statement identified several liability rules relevant to de-SPAC transactions, including:
- Section 11 of the Securities Act of 1933 (1933 Act), for any material misstatements in or omissions from an effective 1933 Act registration statement. In the context of a de-SPAC transaction that is completed using a registration statement, this would give stockholders of the target operating company a claim against the SPAC and the officers and directors of the SPAC who sign the registration statement. In connection with a Section 11 claim, scienter is not an element—i.e., it is not required to show that the SPAC or its directors and officers intended to deceive the target operating company's stockholders.
- Section 14(a) and Rule 14a-9 of the Securities Exchange Act of 1934 (1934 Act), for any material misstatement or omission in connection with a proxy solicitation. This would give SPAC stockholders a claim against the SPAC, its officers and directors, and potentially others deemed proxy solicitors. In connection with a Section 14(a) claim, a plaintiff is not required to prove defendants' intent to deceive, only negligence.
- Section 14(e) of the 1934 Act, for any material misstatement or omission in connection with a tender offer. In the context of a de-SPAC transaction, whether or not it is completed using a registration statement, this would give stockholders of the target operating company that agreed to exchange their shares in the target operating company for those of the public SPAC a claim against the SPAC, its directors and officers, and potentially others deemed solicitors. In connection with a Section 14(e) claim, it is currently unsettled as to whether an intent to deceive, or merely negligence, is required.
- State law. For example, the statement notes that Delaware corporate law applies a duty of candor and fiduciary duties more strictly in conflict of interest situations, absent procedural steps.
To this list Acting Director Coates might have included a reference to SEC Rule 10b-5 for any material misstatements in or omissions from communications employed in connection with the sale of securities that, in the case of a de-SPAC transaction, could give rise to a claim from stockholders of the target operating company, SPAC stockholders (whether they acquired their shares in the SPAC IPO or in the open market), and institutional investors that purchase shares of the SPAC in connection with the announcement of the de-SPAC transaction (often referred to as a private investment in public equity, or PIPE). Claims under Rule 10b-5 are not limited to statements in a proxy statement or registration statement, but plaintiffs are required to show scienter. Acting Director Coates may also have included a reference to state law fraud claims that would allow plaintiffs to avoid some of the procedural safeguards afforded to defendants facing federal securities claims, increasing the potential cost and exposure of litigation.
These reminders regarding potential liability in the context of a de-SPAC transaction should not come as a surprise; there was not any new ground trod in that part of the statement. What may have come as a surprise to some was Acting Director Coates' observations regarding whether the safe harbor for forward-looking statements afforded by the Private Securities Litigation Reform Act (PSLRA) applies in the context of de-SPAC transactions. This garnered much attention because de-SPAC market practice has been to make public multi-year financial projections of the target operating company's performance, a practice that is not followed in the context of a traditional IPO.
In addressing whether the PSLRA safe harbor applies to de-SPAC transactions, Acting Director Coates stated that its applicability is "uncertain at best." For context, the PSLRA safe harbor does not apply to forward-looking statements made in connection with securities offerings by blank check companies and penny stock issuers, both of which are defined by statute. In addition, the PSLRA safe harbor does not apply to forward-looking statements made in connection with an initial public offering. Based on his analysis of the legislative and judicial history of the PSLRA safe harbor, and drawing on certain similarities between private companies undertaking traditional IPOs and private companies going public via a de-SPAC transaction, Acting Director Coates posits that the phrase "initial public offerings," which is not defined by statute, may and perhaps should include de-SPAC transactions. In effect, this means that in his view, the PSLRA safe harbor may not apply to forward-looking statements made in connection with de-SPAC transactions, stating explicitly that the substance of the de-SPAC transaction points "toward a conclusion that the PSLRA safe harbor should not be available for any unknown private company introducing itself to the public markets[,]" whether for a traditional IPO or a de-SPAC transaction. While we believe that a revision to the safe harbor is more properly done via SEC rulemaking rather than reinterpreting the PSLRA based on stray comments by senators at the time of its adoption, Acting Director Coates' focus on the applicability of the safe harbor may be particularly concerning in the de-SPAC transaction context, given the importance of projections in business combination transactions. Moreover, given that the PSLRA explicitly gives the SEC the ability to create exceptions to the safe harbor, we may soon see the SEC use that authority to carve out de-SPAC transactions from the protections of the safe harbor.
The statement highlights several of the limitations of the PSLRA safe harbor, including that it: 1) only applies to private litigation and not to SEC enforcement actions; 2) applies only to forward-looking statements, not to historical factual ones; 3) only applies if accompanied by meaningful cautionary statements; and 4) does not protect against false or misleading statements made with actual knowledge that the statement is false or misleading.5 Participants in de-SPAC transactions should certainly continue to keep these limitations in mind, including, for example, that Acting Director Coates opined that "[a] company in possession of multiple sets of projections that are based on reasonable assumptions, reflecting different scenarios of how the company's future may unfold, would be on shaky ground if it only disclosed favorable projections and omitted disclosure of equally reliable but unfavorable projections, regardless of the liability framework later used by courts to assess the disclosures."
Acting Director Coates' statement includes several questions relating to the current liability provisions and risks relating to de-SPAC transactions, potentially signaling areas that may be the subject of future SEC guidance or rulemaking. For example, Acting Director Coates questioned whether the current liability provisions provide transaction participants with "sufficient incentives to do appropriate due diligence on the target and its disclosures to public investors." He questioned whether the SEC should reconsider the concept of "underwriter" in de-SPAC transactions and other non-traditional paths to going public, and whether new guidance may be needed regarding the use of projections and valuations in these transactions. In addition, he questioned the appropriateness of having differing liability risks depending on the transactional path taken to go public, particularly if this is a driving force in the decision of how to go public.
Acting Director Coates asked whether "it [is] appropriate that the choice of how to go public may determine or be determined by liability rules[.]" He suggests that in his view, the de-SPAC transaction is the "real IPO" and later in the statement, he observed that "it is the de-SPAC as much as any other element of the process on which we should focus the full panoply of federal securities law protections—including those that apply to traditional IPOs." One can agree with the policy behind such a conclusion while questioning how easily the liability rules for a traditional IPO might be applied in the context of a de-SPAC transaction.
In the context of a traditional IPO, the liability rules map to clearly defined roles. For example, issuers, directors, and officers who sign an IPO registration statement and underwriters of the offering are all subject to liability under Section 11 of the 1933 Act for material misstatements in and omissions from the registration statement. Offering participants other than the issuer are entitled to a due diligence defense. Investors can bring a claim under Section 11, but must show that they purchased shares in the IPO or can trace their shares to the offending registration statement.
In the context of a de-SPAC transaction:
- Who is the issuer—the SPAC, the target operating company, or both? The statement suggests that Acting Director Coates believes it should be the target operating company, but the SPAC is the entity that executes an IPO, sells securities to PIPE investors, and exchanges its publicly traded shares for the target operating company's securities. The SPAC makes filings with the SEC in connection with the de-SPAC transaction that are signed by its officers and directors, and the SPAC stockholders stand to benefit from the business combination.
- Who are the underwriters?
The underwriters of the SPAC IPO, for whom a portion of the underwriting compensation from the SPAC IPO is deferred until the closing of the de-SPAC? What if they did not have a role in the de-SPAC transaction or if their role did not involve participation in preparation of disclosure documents? Would application of the traditional IPO liability rules mean that they would have to remain involved to collect their deferred compensation?
The financial advisors to the target operating company or the SPAC? Here, the most significant portion of their engagement is to match operating companies with SPACs and assist in the negotiation of the business terms of the business combination before any communications are made to investors (although they often provide advice about how to communicate with investors following the announcement).
The PIPE placement agents? But the PIPE involves the offer and sale of securities in a manner that is expressly not being registered with the SEC and, if anything, would seem to be more similar to concurrent private placements that are often completed in connection with a traditional IPO and that do not give investors the protection of Section 11 of the 1933 Act.
The SPAC sponsors, since the economic benefits that they hope to reap are inextricably linked to the completion of the de-SPAC transaction?
Some combination? And if so, how would liability be allocated among them?
- Who might be entitled to a due diligence defense? Officers and directors of the target operating company, the SPAC, or both? Does it depend on the answer to who is the issuer or whether the information concerns the pre-transaction SPAC or target operating company?
- Most fundamentally, who are the investors that the SEC would be trying to protect by applying the liability rules from a traditional IPO?
Should the focus be on the target operating company investors since (at least in an SEC-registered de-SPAC transaction) they are, as a practical matter, the only ones with a potential Section 11 claim in connection with a de-SPAC transaction? This result would seem odd, since they have already made the decision to invest in the target operating company, and it would be akin to a pre-IPO investor in a traditional IPO having a claim with respect to shares sold to others. In addition, on one level, the target operating company's stockholders may actually have benefitted from any misstatement or omission, which raises an interesting question of what their damages or other remedies would be.
The PIPE investors? Again, in connection with the PIPE, securities are sold to highly sophisticated investors that acknowledge the transaction is not being registered with the SEC, have the opportunity to conduct diligence directly with the management of the target operating company, and make their investment decision prior to the announcement of the de-SPAC transaction (almost always without the benefit of extensive disclosure documents, since those are usually prepared later in the transaction process).
The SPAC investors? SPAC shares are freely tradeable and holders of SPAC shares have the right to cause the SPAC to redeem their shares at the SPAC IPO price if they do not like the proposed business combination. Would a Section 11 claim for a de-SPAC transaction only be available to an investor who elected not to have his or her shares redeemed (under the theory that but for the material misstatement or omission, the investor would have submitted shares for redemption)?
Acting Director Coates concludes his statement by reminding "all involved in promoting, advising, processing, and investing in SPACs" to "understand the limits on any alleged liability difference between SPACs and conventional IPOs." We expect that in the near term, the SEC could use its rulemaking process, or the staff could issue guidance, to provide clarity as to the applicability of the PSLRA safe harbor to de-SPAC transactions. There may also be other steps to foster greater convergence in liability rules and disclosure and diligence practices between traditional IPOs and de-SPAC transactions.
Division of Corporation Finance Statement
The staff statement issued by the Division of Corporation Finance focuses on a number of issues, including management's responsibility to establish and maintain internal control over financial reporting (ICFR) and disclosure controls and procedures (DCP).6 The staff cautions SPACs and the target operating companies that the combined company will need to be prepared for public company reporting and disclosure requirements upon completion of the de-SPAC transaction, including having "the necessary expertise, books and records, and internal controls to provide reasonable assurance of its timely and reliable financial reporting."
The staff statement highlights the importance of advance planning in order to ensure that the combined company will have the necessary expertise to comply with public company reporting and disclosure requirements, as well as the listing standards of the applicable stock exchange.
Acting Chief Accountant Statement
The statement issued by the Acting Chief Accountant primarily focuses on public company readiness, noting that "SPACs have the potential to bring private companies into the public markets more quickly than would be possible in a traditional IPO," particularly in this current environment with an increased number of SPACs seeking acquisition targets. He advises target operating companies to "evaluate the status of various functions, including people, processes, and technology, that will need to be in place to meet SEC filing, audit, tax, governance, and investor relations needs post-merger."
The statement includes a discussion of various considerations for SPACs and target operating companies, including relating to financial reporting, ICFR, corporate governance (in particular, audit committee composition), and engaging independent auditors with appropriate experience to audit public companies under PCAOB standards. It also highlights some of the unique challenges for the combined company, including the accounting for and reporting of the de-SPAC transaction and auditor independence, reminding companies that the Office of the Chief Accountant is available for consultation on these issues.
Similar to the staff statement issued by the Division of Corporation Finance, this statement discusses the importance of establishing and maintaining ICFR and DCP, as well as the separate requirement under Section 404(a) of the Sarbanes-Oxley Act that management conduct an annual evaluation of its ICFR. Of note, the statement reminds companies of Compliance & Disclosure Interpretation 215.02, which describes certain limited instances where the staff will not object if the company excludes management's assessment of ICFR from the first Form 10-K after completion of the de-SPAC transaction.
What to Do Now?
Given the increased SPAC activity, it is not surprising that SEC staff have taken a keen interest in these transactions.
Although Acting Director Coates' comments about the availability of the PSLRA's safe harbor for forward-looking statements will understandably draw a lot of interest, the applicability of the safe harbor should not obscure the litigation risks that a company faces in a de-SPAC transaction, which go well beyond forward-looking statements. Accordingly, it is essential for a private company undertaking a de-SPAC transaction to ensure that the disclosures made in connection with the transaction are appropriately drafted and vetted.
Any financial projections included in investor-facing communications should be reasonable and reflect the operating company management's best view of future performance. To the extent that operating companies prepare projections under multiple scenarios, they should consider whether to include disclosure for each of them, not just the rosiest view, if disclosing only that one would be misleading. In addition, operating companies should clearly articulate the basis of their projections, the assumptions underlying them, and the risks associated with achieving such projections.
Although separate from the PSLRA safe harbor, and not addressed in Acting Director Coates' statement, companies should also consider the "bespeaks caution" defense to securities disclosure claims, which is applicable to forward-looking statements so long as such statements are accompanied by meaningful cautionary language. Companies should ensure that their risk factors and other cautionary disclosures are crafted carefully with appropriate attention and review by management and counsel.
Private companies that may be considering going public via a de-SPAC transaction should carefully consider their public company readiness, including how to ensure that they have the staffing and expertise necessary to satisfy all applicable public company reporting, disclosure, and governance requirements.
In addition, persons involved in de-SPAC transactions that may have a due diligence defense, including directors, officers, and persons that may be treated as underwriters following any change in the regulatory regime, such as investment banks, should renew their focus on their role as gatekeepers to the public markets. Given the heightened scrutiny from the SEC and attention from the plaintiffs' bar, these transaction participants should be actively engaged in the diligence process and consider adopting processes and controls similar to those employed in the context of traditional IPOs. Such an approach could lead to evolving diligence practices, such as auditor "comfort" letters, legal opinions, and negative assurance letters.
 The Acting Director’s statement can be found here: https://www.sec.gov/news/public-statement/spacs-ipos-liability-risk-under-securities-laws (last accessed on April 12, 2021).
 The staff’s statement can be found here: https://www.sec.gov/corpfin/announcement/staff-statement-spac-2021-03-31?utm_medium=email&utm_source=govdelivery (last accessed on April 12, 2021).
 The Acting Chief Accountant’s statement can be found here: https://www.sec.gov/news/public-statement/munter-spac-20200331?utm_medium=email&utm_source=govdelivery (last accessed on April 12, 2021).
 See, e.g., Jody Godoy and Chris Prentice, “Exclusive: U.S. regulator opens inquiry into Wall Street’s blank check IPO frenzy – sources,” Reuters, Mar. 24, 2021, available at https://www.reuters.com/article/us-usa-sec-spacs-exclusive/exclusive-u-s-regulator-opens-inquiry-into-wall-streets-blank-check-ipo-frenzy-sources-idUSKBN2BH09F?il=0 (last accessed on April 12, 2021).
 Although Acting Director Coates did not frame it as such, these last two provisions relate to separate, independent prongs of the safe harbor.
 Note that these requirements apply to all public companies from the time they have a class of securities registered under the 1934 Act and are separate from and in addition to the requirements of the Sarbanes-Oxley Act of 2002 for a public company to report on the effectiveness of their ICFR.