SEC Adopts Final Rules Concerning SPAC Initial Public Offerings and de-SPAC Transactions

ENHANCED DISCLOSURE REQUIREMENTS

As part of the Final Rules, the SEC implemented additional disclosure requirements applicable to SPAC IPOs and de-SPAC transactions.

Sponsors, Conflicts of Interest and Background on the de-SPAC Transaction

The Final Rules require enhanced disclosure in the registration statement concerning the SPAC’s sponsoring entity (SPAC sponsor) and said SPAC sponsor’s affiliates and promoters. Included among the additional requirements are disclosure of:

• The SPAC sponsor’s business and the experience, material roles, and responsibilities of the SPAC sponsor and its affiliates and promoters, as well as any agreements or understandings involving (x) the SPAC sponsor and the SPAC and its officers, directors, or affiliates with respect to the de-SPAC transaction, and (y) the SPAC sponsor and unaffiliated SPAC shareholders regarding the redemption of SPAC securities
• Any persons who have material interests in the SPAC sponsor and the nature and amount of their interests
• The nature and amounts of all compensation received or to be received by the SPAC sponsor, its affiliates and any promoters
• Any circumstances or arrangements under which the SPAC sponsor and its affiliates and promoters have transferred ownership of, cancelled, or surrendered securities of the SPAC
• Any actual or potential material conflicts of interest between (x) the SPAC sponsor or its affiliates; the SPAC’s officers, directors, or promoters; or the target company’s directors and officers; and (y) the SPAC’s unaffiliated security holders.

The Final Rules also require that de-SPAC registration statements include disclosure of the background, material terms and effects of the de-SPAC transaction. This includes disclosure of:

• The reasons for engaging in the transaction
• Any material differences in the rights of the SPAC and target company security holders as compared to the combined company’s security holders
• The accounting and federal income tax consequences of the transaction
• Any material interests in the transaction held by the SPAC sponsor, target company or SPAC and their respective officers or directors
• Any redemption or appraisal rights available for security holders who object to the transaction.

Certain of these disclosures, including the disclosure with respect to conflicts of interest, must be disclosed specifically on the prospectus cover page or prospectus summary section, as more fully described in the Final Rules.

Dilution

In SPAC IPOs, registrants must disclose in both tabular and narrative form whether any compensation of the SPAC sponsor and its affiliates and promoters may materially dilute unaffiliated shareholders’ interests in the SPAC. Registrants must also disclose in both tabular and narrative form a description of material potential sources of future dilution after the offering.

With respect to de-SPAC transactions, registrants must disclose whether compensation of the SPAC sponsor and its affiliates and promoters may materially dilute the equity interests of non-redeeming shareholders who hold the securities until the consummation of the de-SPAC transaction. This includes:

• Tabular disclosure of whether compensation of the SPAC sponsor and its affiliates has resulted or may result in a material dilution of the equity interests of non-redeeming shareholders of the SPAC
• Disclosure of the dilutive impact of any financing transactions made in connection with a de-SPAC transaction
• Disclosure of redemption rights of the SPAC’s outstanding securities and the potential dilutive impact of redemptions
• Tabular disclosure of the dilutive impact of each source of dilution and a description of material potential sources of future dilution that non-redeeming shareholders may experience by electing not to tender their shares in connection with the de-SPAC transaction.

Certain of the dilution disclosures must be disclosed specifically on the prospectus cover page or prospectus summary section, as more fully described in the Final Rules.

Board Determinations Regarding de-SPAC Transactions

The Final Rules require a SPAC to provide an affirmative statement in its registration statement as to the fairness of the de-SPAC transaction to its security holders (if such a determination is required by law), and the factors it considered in making this fairness determination. Additionally, if the SPAC or SPAC sponsor received a fairness opinion from an outside party regarding the fairness of the de-SPAC transaction, the details of such opinion must be disclosed and filed as an exhibit to the applicable SEC filing. Disclosures on the fairness of a de-SPAC transaction must be included in both the cover page and prospectus summary section.

Tender Offer Filing Obligations

The Final Rules codified the SEC’s position that a tender offer document filed in connection with a de-SPAC transaction must comply with the substantive and procedural requirements of the tender offer rules when conducting such transaction (such as a redemption of the SPAC securities). However, it should be noted that the SEC’s staff has not objected if a SPAC does not comply with the tender offer rules when the SPAC files an offering document in connection with a de-SPAC transaction that complies with federal proxy rules (as these rules generally mandate substantially similar disclosures to the tender offer rules).

DISCLOSURES AND LIABILITY IN DE-SPAC TRANSACTIONS

The Final Rules also include provisions aimed at more closely aligning disclosure obligations and liability in de-SPAC transactions with traditional IPOs.

Nonfinancial Disclosures in de-SPAC Disclosure Documents

Under the Final Rules, in the event a de-SPAC transaction includes a private operating company (Private Operating Company) that was not subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (Exchange Act), prior to the transaction, a registration statement or proxy statement must include certain key information about the Private Operating Company, including (i) a description of the business and property, (ii) legal proceedings, (iii) changes in and disagreements with accountants on accounting and financial disclosures, (iv) security ownership of certain beneficial owners and management of the Private Operating Company assuming a successful de-SPAC transaction and related financial transaction, and (v) recent sales of unregistered securities.

Minimum Dissemination Period

Prospectuses and proxy and information statements filed in connection with de-SPAC transactions must be distributed to security holders at least 20 calendar days in advance of a security holder meeting or the earliest date of action by consent. In the event the registrant is incorporated in a jurisdiction where the maximum dissemination period for disclosure documents is less than 20 calendar days, registrants will be required to disseminate the materials by the maximum dissemination date in that jurisdiction.

Private Operating Company as a Co-Registrant

The Final Rules require the Private Operating Company to be a co-registrant with the SPAC on a registration statement filed in connection with a de-SPAC transaction. This results in the Private Operating Company (along with its required officers and directors) becoming subject to similar liability exposure under the Securities Act of 1933, as amended (Securities Act), as attributable to the SPAC and its board of directors and management team for content of the registration statement.

Redetermination of Smaller Reporting Company Status

The Final Rules provide that post-de-SPAC companies will be required to redetermine their smaller reporting company (SRC) status before making its first SEC filing (other than the Form 8-K filed with Form 10 information). For purposes of analyzing its SRC status, the post-de-SPAC company must measure its public float using a date within four business days after the consummation of the de-SPAC transaction and its annual revenues using the annual revenues of the Private Operating Company as of the most recently completed fiscal year reported in the Form 8-K filed with Form 10 information.

If it’s determined the post-de-SPAC company is no longer an SRC, it will still be able to take advantage of the scaled-back disclosure requirements offered to SRCs for any SEC filings within 45 days after the consummation of the de-SPAC transaction (such as a resale registration statement).

Private Securities Litigation Reform Act Safe Harbor

Under the Final Rules, for purposes of the Private Securities Litigation Reform Act of 1995 (PSLRA), the definition of “blank check company” was amended to include SPACs. As a result, any forward-looking statements made in de-SPAC registration statements will now be excluded from the PSLRA’s safe harbor liability protections and will no longer be protected from a private right of action under the Securities Act or the Exchange Act.

Underwriter Status and Liability in Securities Transactions

The SEC declined to adopt Proposed Rule 140a, which would have clarified that anyone who acts as an underwriter in a SPAC IPO and participates in the distribution associated with a de-SPAC transaction is engaged in the distribution of the surviving public entity’s securities and, therefore, is an “underwriter” within the meaning of Section 2(a)(11) of the Securities Act.

The SEC did, however, state that it will continue to follow its “longstanding practice of applying the statutory terms ‘distribution’ and ‘underwriter’ broadly and flexibly, as the facts and circumstances of any transaction may warrant.” In offering this guidance, the SEC clarified that it views a de-SPAC transaction as a distribution of securities because it results in SPAC shareholders having their interests exchanged for interests in the Private Operating Company.

In light of the above, an entity participating in the distribution of securities, such as in connection with a de-SPAC transaction, could be deemed a “statutory underwriter” even though it may not be named as an underwriter or may not otherwise be engaged in an underwriter’s typical activities.

BUSINESS COMBINATIONS INVOLVING SHELL COMPANIES

Shell Company Business Combinations and the Securities Act

The Final Rules adopt Rule 145a, which provides that a sale of securities occurs (and by virtue of this, implicates the requirements and protections of Section 5 of the Securities Act) in situations where a reporting shell company enters into a business combination involving another entity that is not a shell company. The SEC opined that a sale of securities occurs in these scenarios because the interests held by the SPAC shareholder have been exchanged for interests in a Private Operating Company that has been given access to the public markets. Rule 145a applies regardless of transaction structure or the form of business combination (statutory merger, share exchange, stock purchase, asset purchase, etc.) but does not apply to a transaction where a reporting shell company combines with another shell company.

Financial Statement Requirements in Business Combination Transactions Involving Shell Companies

The Final Rules adopt changes to Article 15 of Regulation S-X, which concerns the financial statement disclosures for Private Operating Companies engaging in a business combination with a shell company (such as SPACs). The purpose of the rule changes is to reduce any asymmetries between financial statement disclosures in business combination transactions involving shell companies and traditional IPOs. These modifications affect (i) the audit standard required for Private Operating Company financial statements, (ii) the number of years of Private Operating Company financial statements required to be disclosed, (iii) the age of Private Operating Company financial statements required to be disclosed, (iv) the inclusion of financial statements of other significant businesses acquired by the Private Operating Company, and (v) the omission of the shell company’s historical financial statements in post-business combination financial statements. However, for any registration statement filed before the first periodic report filed with the post-business combination financial statements, such as a resale registration statement to register the shares issued in connection with a private investment in public equity financing filed shortly after the de-SPAC transaction, the registration statement must include the SPAC’s financial statements.

ENHANCED PROJECTIONS DISCLOSURE

Item 10(b) of Regulation S-K

The Final Rules amend Item 10(b) of Regulation S-K, which applies to the use of projections in all SEC filings (including SPAC and de-SPAC registration statements). Under amended Item 10(b), projections not based on historical financial results or operational history must be clearly distinguished from – and must be presented in conjunction with – those that are based on historical financial results or operational history. Similarly, projections that include non-generally accepted accounting principles (GAAP) financial measures should include a description of the GAAP financial measure most directly comparable to the non-GAAP measure and an explanation as to why the non-GAAP measure was used instead of a GAAP measure.

Item 1609 of Regulation S-K

Under the Final Rules, Item 1609 of Regulation S-K provides that if projections are used in a de-SPAC transaction, disclosure is required, which includes (i) the purpose for preparing the projections and the party that prepared them, (ii) all material bases of the projections, all material assumptions underlying the projections, and any factors that may impact such assumptions, and (iii) whether the disclosed projections reflect the views of the board of directors or management team of the SPAC or the target company, as applicable, as of the most recent practicable date prior to disclosure to security holders.

If the projections do not continue to reflect the views of the board of directors or management of the SPAC or the target company as of the most recent practicable date prior to disclosure, the Final Rules require a statement that addresses the purpose of disclosing the projections and the reasons for any continued reliance by the board of directors or management team of the SPAC or the target company.

THE STATUS OF SPACS UNDER THE INVESTMENT COMPANY ACT

The SEC did not adopt the March 2022 proposed rules’ Investment Company Act of 1940 (ICA) safe harbor, which would deem a SPAC to not be an investment company if certain conditions were met. The Final Rules instead provide guidance on facts and circumstances for a SPAC that could raise concerns as to whether it is an investment company under Section 3(a)(1) of the ICA, which SPACs should evaluate both at their inception and throughout their existence. The facts and circumstances identified by the SEC are as follows:

• Nature of SPAC assets and income. A SPAC that owns or proposes to acquire 40% or more of its total assets in investment securities, including corporate bonds, or a SPAC whose income is substantially derived from such assets would likely be considered an investment company.

• Management activities. Certain activities of a SPAC and its officers and directors may be factors in an investment company determination. This includes spending a considerable amount of time in managing the SPAC’s portfolio to achieve returns as opposed to actively seeking a de-SPAC transaction. The Final Rules also state that certain management activities could cause SPAC sponsors to fall within the definition of “investment adviser” under the Investment Advisers Act of 1940.

• Duration. If a SPAC continues to operate without completing a de-SPAC transaction and its assets are substantially composed of and its income is derived from securities, its activities may be more difficult to distinguish from those of an investment company. The Final Rules discuss the 12-month safe harbor for transient investment companies under Rule 3a-2 and the 18-month limit contemplated by Rule 419 when analyzing this issue and state that the further a SPAC operates beyond these timelines, the greater the investment company concerns could be.

• Holding out. If the SPAC holds itself out as primarily engaged in investing, reinvesting or trading in securities, it will likely be considered an investment company.

• Merging with an investment company. If the operating company in a de-SPAC transaction is an investment company, the SPAC is likely to be considered an investment company.

In light of the above, SPACs should strive to complete their business combinations within the applicable 12- or 18-month time period and should avoid having its assets, income or efforts comprised of investment securities.

EFFECTIVE DATE OF THE FINAL RULES

The Final Rules will become effective 125 days after publication in the Federal Register. Registrants must comply with all Final Rules (other than Item 1610 of Regulation S-K, which concerns XBRL tagging requirements) on the effective date. For Item 1610 of Regulation S-K, registrants must comply beginning one year from the effective date.

If you have questions about the Final Rules or any other related matter, please reach out to the authors of this article or your regular McDermott lawyer.