Federal Regulation of Securities Committee of the Business Law Section of the American Bar Association Takes Aim at SEC Proposed SPAC Rules

The proposed rules, which include new rules and amendments to existing rules, are available here.

These proposals follow in the wake of increasing attention by the SEC on SPACs, which in 2021 completed more than 600 initial public offerings (“IPOs”) and facilitated the public market debut of more than 200 companies through de-SPAC transactions.  The Commission stated that it issued the Proposed Rules to enhance investor protections in initial public offerings (“IPOs”) by SPACs and in subsequent business combination transactions (“De-SPAC Transactions”) between SPACs and operating companies (“Targets”).  SEC Chairman Gary Gensler has stated that the proposal “would strengthen disclosure, marketing standards and gatekeeper and issuer obligations by market participants in SPACs, helping ensure that investors in these vehicles get protections similar to those when investing in traditional IPOs.” The “overarching principle,” Mr. Gensler said, is Aristotle’s maxim: “Treat like cases alike.”[1]

The Proposed Rules include wide-ranging changes to the disclosure requirements that attach in connection with De-SPAC Transactions.  In addition, the Proposed Rules seek to impose; (i) a mandatory requirement that a fairness opinion be obtained in connection with a De-SPAC Transaction, as well as a mandatory requirement that any such fairness opinion solely address the fairness from a financial point of view solely for the SPAC’s unaffiliated security holders, (ii) requiring the De-SPAC Target to be a co-registrant to the Merger Registration Statement, (iii) underwriter liability in De-SPAC Transactions, and (iv) elimination of the PSLRA safe harbor for forward-looking statements disseminated by the SPAC in connection with a De-SPAC Transaction inapplicable.

On June 17, 2022, the Federal Regulation of Securities Committee of the Business Law Section of the American Bar Association (the “Committee”) submitted comments with respect to the Proposed Rules (the “ABA Letter”). The ABA Letter was drafted by over fifty experienced securities law practitioners, including Ralph V. De Martino, a partner at ArentFox Schiff[2] (the “Authors”), who characterized themselves as being dedicated to preserving the integrity and consistent application of the federal securities law and to avoiding disruption of longstanding and accepted practices in the securities industry without clear justification.  Generally the ABA Letter supports the enhanced disclosure requirements contained in the Proposed Rules but strongly opposes the Commission proposals to require a fairness opinion in connection with a De-SPAC Transaction, to require that any such fairness opinion solely address the fairness from a financial point of view solely for the SPAC’s unaffiliated security holders, to require that the De-SPAC Target be a co-registrant to the Merger Registration Statement, to impose underwriter liability in De-SPAC Transactions, and to eliminate the PSLRA safe harbor for forward-looking statements disseminated by the SPAC in connection with a De-SPAC Transaction inapplicable.

The ABA Letter supports the Commission’s investor protection mission in relation to SPAC IPOs and De-SPAC Transactions and agrees that investors are entitled to robust disclosures by issuers in connection with the investors’ investment decisions, but also admonishes that the goal of furthering investor protections should be accompanied by advancing another of the Commission’s equally important missions, which is to facilitate capital formation, so that investors may benefit from having a range of available investment opportunities.  The Committee observes that having a range of investment opportunities, public investors can compare the risks and benefits available to them from each investment, have the option to choose or not to choose certain investments and ultimately identify a financial product that meets their risk appetites and investment goals.

While the ABA Letter generally supports the enhanced disclosure initiatives included in the Proposed Rules, it opposes (i) the proposed requirement that fairness opinions be obtained in connection with De-SPAC transactions as well as the proposed requirement that any such fairness opinion solely address the fairness from a financial point of view solely for the SPAC’s unaffiliated security holders (proposed Items 1606 and 1607 of Regulation S-K), (ii) the proposed requirement that the De-SPAC Target be a co-registrant to the Merger Registration Statement, (iii) the imposition of underwriter liability in De-SPAC Transactions (proposed Rule 140a), and (iv) the elimination of the PSLRA safe harbor for forward-looking statements disseminated by the SPAC in connection with a De-SPAC Transaction inapplicable.  Finally, the ABA Letter recommends that the Commission delay the effectiveness of any final rules or amendments (“Final Rules”) for three months after approval of the Final Rules, and adopt a transition period (i) for SPAC IPOs, of six months from filing of the IPO registration statement following the effective date of the Final Rules and (ii) for De-SPAC Transactions, only as to business combination agreements that were signed and announced following the effective date, at which point the underwriters’ liability commences to the extent applicable assuming proposed Rule 140a were to be adopted in a form that provides the market with some certainty regarding the scope of activity that triggers liability.

Committee Comments and Recommendations

The need to preserve the availability of distinct capital-raising alternatives for issuers and investors

The Committee asserts that the Commission’s efforts to regulate SPAC IPOs and De-SPAC Transactions through the Proposed Rules in order to enhance investor protections should be balanced with the Commission’s mission to promote capital formation and access to the capital markets for issuers and investors, and that the Proposed Rules fail to strike the right balance.

The ABA Letter asserts that Targets should continue to have at least four distinct alternatives in order to reach the public markets:  a traditional IPO, a De-SPAC Transaction, a direct listing and an outright sale to, or merger with, a public company.  The merits of each alternative depend on market cycles and the particular characteristics of the Target, including, but not limited to, the Target’s size, industry sector, stockholder base, development stage and objectives.  The Commission has recognized the significant decline in the number of U.S. public companies in recent years, the increased reliance by both private companies and public companies on exempt offerings to raise capital and the popularity of business combinations with private equity firms rather than through transactions with public companies (which deprived public stockholders of opportunities to invest in many earlier-stage companies).  It is not consistent with the public interest, through regulation, to foreclose a financing alternative that would facilitate a path to the public markets by private companies.  Inasmuch as investors will be best served by keeping all of these options available, the Committee asserts that the Proposed Rules take the decision out of the hands of investors, and that the mere release of the Proposed Rules has had a chilling effect on the SPAC IPO and De-SPAC Transaction market because the Proposing Release continues to propagate a number of misconceptions related to SPACs, SPAC IPOs and De-SPAC Transactions, which have featured prominently in statements made by Commissioners and other public figures.  The ABA Letter highlights for example that the Proposed Rules  gloss over the fact that De-SPAC Transactions are fundamentally merger and acquisition (“M&A”) transactions that often require the use of, and disclosure of, projections.  The Proposing Release suggests that the parties involved in the SPAC IPO and De-SPAC Transaction process are not already encouraged to undertake rigorous diligence and are not subject to securities liability for the statements made in connection with the materials prepared to seek stockholder approval for the business combination, simply because of the absence of a traditional underwriter in the process. The absence of a traditional underwriter does not mean that there are no gatekeepers or that there are no investor protections. The ABA Letter submits that conflating the SPAC IPO and the De-SPAC Transaction into one continuing distribution of some issuer’s securities and seeking to identify one or more statutory underwriters and associating them with this process is inconsistent with basic securities law principles regarding underwriter status and creates a level of uncertainty regarding potential and actual liability that adversely affects these transactions as viable capital-raising and capital markets alternatives. The ABA Letter asserts that if the Proposed Rules are adopted in substantially the form in which these have been currently proposed, SPACs and Targets would need to undertake additional measures, which would entail significant, new and additional costs, in order for market participants to be prepared to move forward. 

Items in the Proposed Rules that would enhance investor protection and that the Committee supports, subject to our suggested modifications

The Committee generally supports the additional disclosures included in Proposed Rules, as these largely codify current market practice.  The disclosure requirements should, in its view, be adapted to account for the status of the issuer and provide appropriate accommodations, for example, for smaller reporting companies, emerging growth companies (“EGCs”) and foreign private issuers (“FPIs”).

Proposed Rules relating to De-SPAC Transactions that require additional clarification in order to treat like case alike

The Committee supports the Commission’s efforts to improve the quality of disclosure in connection with M&A transactions involving shell companies, which include De-SPAC Transactions.  However, the Committee believes the description of “sale” in the context of proposed Rule 145a is unclear and that the imposition of liability under the Securities Act of 1933, as amended (the “Securities Act”)[3] by requiring the filing of a registration statement on Form S-4 or F-4 (each, “Merger Registration Statement”) in all transactions is conceptually flawed.

Proposed Rules that the Committee opposes

The Committee takes exception to, and does not support the following proposed amendments in the Proposed Rules and Proposing Release:

• Determining fairness of the De-SPAC Transaction (proposed Items 1606 and 1607 of Regulation S-K).  The Committee asserts that proposed Items 1606 and 1607 are outside the scope of the Commission’s rulemaking authority.  However, the Committee also observes that even assuming that the Commission has such authority, it believes that the scope of the fairness determination in proposed Item 1606 should cover the De-SPAC Transaction and any related financing transaction as a whole, and security holders as a whole, rather than solely the SPAC’s unaffiliated security holders.  In addition, the factors enumerated in proposed Item 1606(b) in determining fairness should be discussed to the extent they were actually used by the SPAC in making its fairness determination; and registrants should not be required to assign a weight to each material factor underlying the fairness determination.  Fairness determinations are not made in the context of traditional IPOs.  Similarly, with respect to proposed Item 1607, the Committee believes that  it is unnecessary and unrealistic to require the filing of board books and other written materials presented to the board in connection with the reports, opinions or appraisals, as in the case with going-private transactions. The Committee noted that these requirements are inconsistent with what would be required in a traditional IPO.
• Making Target a co-registrant to Merger Registration Statement.  The Committee stated that requiring the Target in a De-SPAC Transaction to be a co-registrant (together with the SPAC) on Merger Registration Statement  in connection with a De-SPAC Transaction (the “Co-Registrant Amendment”) is inappropriate.  Simply stated, the Target is not necessarily issuing any securities in a De-SPAC Transaction and there is, therefore, no basis for requiring the Target to be a co-registrant.  Existing rules governing business combinations address when a party to the transaction is an issuer of securities and required to be a registrant.  In addition, there are already strong incentives under the existing framework to ensure the Merger Registration Statement disclosures are accurate and complete, as well as liabilities available should the Merger Registration Statement contain material misstatements or omissions.  The Committee further noted that Co-Registrant Amendment is inconsistent with existing Securities Act rules and interpretations regarding co-registrant status, as well as market practice, and also raises significant questions and practical challenges. 
• Imposing underwriting liability in De-SPAC Transactions.  The Committee opposes proposed Rule 140a and requests that the Commission clarify its overly broad and unsupported interpretation in the Proposing Release relating to the entities that may be considered to be statutory underwriters.  The Committee notes that the Commission’s desire to identify additional “gatekeepers” in connection with a De-SPAC Transaction is not supported by the definition of “underwriter” in Section 2(a)(11) of the Securities Act.  In its effort to justify its proposed amendments, the Commission advances an overly expansive view of the activities and connections that give rise to statutory underwriting liability.  The Commission does this in order to identify a traditional underwriter in a De-SPAC Transaction where, in fact, there is none.  The Committee asserts that the Proposing Release’s concept of statutory underwriters in the context of a De-SPAC Transaction is flawed, is at odds with interpretations of existing law and disregards longstanding and accepted market practice.  The interpretive position and proposed Rule 140a inappropriately stretch the concept of “distribution” in the definition of “underwriter.”  The SPAC IPO and De-SPAC Transaction are two completely separate transactions and should not be conflated.  Not every De-SPAC Transaction involves a “distribution” of securities.  Proposed Rule 140a would impose underwriting liability on a number of De-SPAC Transaction financial intermediaries without sufficient participation in the “distribution” of securities.  It mischaracterizes basic securities law principles to find a gatekeeper, when there already are numerous parties with rigorous responsibilities in connection with the SPAC IPO and the De-SPAC Transaction.  It fails to consider that the required level of “participation” to be a statutory underwriter in a De-SPAC Transaction should only be the activities that are “related to the actual distribution of securities” and not those that merely facilitate the participation of others in a securities offering.

Proposed Rule 140a purports to be retroactive, creating uncertainty as to what level of participation that has already occurred or that can be undertaken in transactions underway results in underwriter status.  Because the Commission’s statements in the Proposing Release are characterized as an interpretation of its current views, even though the language of proposed Rule 140a is more narrowly written, the mere issuance of the Proposing Release has resulted in such uncertainty and market concern that there has been a chilling effect on legitimate capital formation transactions.  If the Commission nevertheless decides to identify an “underwriter” in a De-SPAC Transaction, the Committee admonishes that the Commission should do so only on the following basis:  (i) any rule should be prospective only, with a suitable transition period, (ii) the rule should clearly define the nature and level of participation that is necessary for a SPAC IPO underwriter to be considered an “underwriter” in the De-SPAC Transaction, (iii) that participation should be limited to parties who, in fact, are in a position to perform the necessary diligence, (iv) the rule should define the scope of the “distribution” to which underwriter status relates, and (v) the disclosures to which underwriter responsibility relates should align with those in a traditional IPO, such as by excluding from the Merger Registration Statement merger-related disclosures like Background of the Merger and projections.

• Enhancing projection disclosures.  The Committee generally supports the proposed amendments to Item 10(b) and 1609 of Regulation S-K to enhance projections disclosure but believes that these amendments should apply to all filings in order to level the playing field as to disclosures related to projections.
• Rendering the PSLRA safe harbor inapplicable.  The Committee opposes the proposed amendment to remove the current safe harbor under the Private Securities Litigation Reform Act of 1995 (“PSLRA”).  The Committee believes that there are important distinctions between a De-SPAC Transaction and a traditional IPO that justify maintaining the PSLRA safe harbor in the form enacted by Congress.  There is no evidence of any legislative intent on the part of Congress that it intended to limit the scope of the safe harbor in the form in which the Commission proposes to amend it.  Unlike companies undertaking a traditional IPO, SPACs are compelled by a combination of federal securities regulation and state corporate law to share Target projections with stockholders.  Excluding De-SPAC Transactions from the safe harbor would not operate to silence projections the way the traditional IPO exclusion does, although it might operate to discourage De-SPAC Transactions.  To truly place De-SPAC Transactions on a “level playing field” with traditional IPOs in connection with forward-looking statements, the Committee asserts that the Commission would have to change its disclosure requirements in connection with De-SPAC Transactions and somehow override the state fiduciary obligations that compel disclosure of projections.  When coupled with other proposed amendments that would require disclosure of a fairness determination (effectively mandating the provision of projections) as well as impose underwriter liability in a De-SPAC Transaction, the Committee believes that  removal of the PSLRA safe harbor protections would have a chilling effect on De-SPAC Transactions.
• Proposing a safe harbor under the Investment Company Act.  The Committee asserts that SPACs are not investment companies under Section 3(a)(1)(A) because they are not, and do not hold themselves out as being, engaged primarily or propose to engage primarily, in the business of investing, reinvesting or trading in securities.  Assuming, but without admitting, otherwise, the Committee avers that there is no need or basis for the proposed “safe harbor.” 

Transition period to comply with Proposed Rules.  Finally, the Committee recommends that the Commission delay the effectiveness of any final rules or amendments (“Final Rules”) for three months after approval of the Final Rules, and adopt a transition period (i) for SPAC IPOs, of six months from filing of the IPO registration statement following the effective date of the Final Rules and (ii) for De-SPAC Transactions, only as to business combination agreements that were signed and announced following the effective date, at which point the underwriters’ liability commences to the extent applicable assuming proposed Rule 140a were to be adopted in a form that provides the market with some certainty regarding the scope of activity that triggers liability.

[1] Statement on Proposal on Special Purpose Acquisition Companies (SPACs), Shell Companies and Projections by Chair Gary Gensler (the “Gensler Statement”), available here.

[2] The positions advanced in the ABA Letter represent the views of the Committee and the Authors and do not represent the views of the ABA’s House of Delegates or Board of Governors or the law firms and other organizations with which the Authors are associated.

[3] 15 U.S.C. §77a.