The SEC Moves to Close the (IPO) Back Door

April 22, 2022

On March 30, 2022, the Securities and Exchange Commission issued proposed rules focused on special purpose acquisition companies (SPACs) and subsequent business combination transactions between SPACs and private operating companies (known as de-SPAC transactions). SPACs aren’t a new development, but their use grew exponentially over the last two years, with SPACs raising more than $83 billion in 2020 and more than $160 billion in 2021. In fact, in 2020 and 2021, more than half of all initial public offerings were conducted by SPACs. In the wake of that overheated market, we are finding that many SPACs haven’t performed well. Although the SPAC high water mark has likely already passed, the SEC is seeking to stem, or at least regulate, the tide.

SEC Aims to Conform Alternate Avenues of Going Public

Fundamentally a de-SPAC transaction is a way for a private company to go public without going through the traditional IPO process – referred to as a “back door” IPO. The SEC’s proposal is extensive, introducing new rules and amending numerous existing rules and forms, but the overarching principal is to conform alternate avenues of going public through the back door, such as the de-SPAC, with the requirements of a traditional IPO. As a result, the proposal is primarily disclosure oriented and would:

  • For the SPAC IPO, require additional disclosures about the sponsor of the SPAC, potential conflicts of interest, and dilution; and
  • For the de-SPAC transaction, require additional disclosures concerning the fairness of the de-SPAC and the private operating company going public, including enhanced financial and projection requirements, aligning de-SPAC disclosures with those of an S-1 registration statement.

As extensive as the disclosure requirements are, the more far-reaching elements of the proposal are focused on imposing liability on parties who wouldn’t otherwise be at risk under the current SPAC and de-SPAC regimen.

The SEC Argues that the Imposition of Potential Liability Will Ensure Due Diligence

In connection with a de-SPAC transaction, the SPAC will often conduct a registered offering to raise additional capital to fund the acquisition and operations of the private company acquired by the SPAC. Because the SPAC is conducting the offering and issuing securities, the board and officers of the SPAC may be held responsible for false or misleading statements contained in the offering materials. The private company acquired in the de-SPAC transaction is not an issuer and as a result the officers and directors of the private company are not responsible for any misstatements contained in the offering documents. The SEC argues that because the private target company is going public in connection with the de-SPAC offering, the target company is actually the issuer, or at least a co-issuer with the SPAC. The proposed rules and form revisions would make the private company a co-issuer required to sign the de-SPAC registration statement. If the private company is considered a co-issuer, then the officers and directors of the private company are liable for misstatements in the offering documents. The SEC concludes that the threat of liability will incent management of the target company to make certain that the offering documents are complete and accurate, tying this proposal to improved disclosure.

When a SPAC conducts an initial public offering and raises capital to locate an acquisition candidate, the underwriters of the IPO may be held responsible for false or misleading statements contained in the offering materials. As a result, the underwriters perform due diligence and take steps to ensure that the IPO prospectus is complete and accurate. However, the IPO underwriters would not be held responsible for the accuracy of disclosures made in connection with the de-SPAC transaction. But, the SEC points out, the sole purpose of the SPAC IPO is to raise capital to acquire an operating company in a de-SPAC transaction, and then argues that in effect the de-SPAC is a continuation of the IPO (despite the fact that the de-SPAC may be years later). Under a new proposed rule, if the IPO underwriter “takes steps to facilitate” the de-SPAC (a less than crystal clear standard), then it is considered to be an underwriter of the target company’s securities in the registered de-SPAC transaction, even if they are not in fact serving as an underwriter of the offering. Once again, the SEC argues that the imposition of potential liability will motivate the underwriter to make certain that the disclosures in the de-SPAC offering are complete and accurate.

The SEC goes through significant legal gymnastics to justify imposing liability on the SPAC IPO underwriters and management of the de-SPAC target company, and these will likely be the most controversial provisions of the proposed rules; there isn’t agreement within the SEC on the scope of the proposal. In her dissent, SEC Commissioner Hester M. Peirce stated:

“Today’s proposal does more than mandate disclosures that would enhance investor understanding. It imposes a set of substantive burdens that seems designed to damn, diminish, and discourage SPACs because we do not like them, rather than elucidate them so that investors can decide whether they like them.”

Pushback on the SEC’s Proposed Rules is Expected

At nearly 400 pages, the SEC’s proposal addresses various elements that were not highlighted in this analysis. Additional aspects of the proposal would eliminate the Private Securities Litigation Reform Act safe harbor for forward-looking statements in de-SPAC transactions, and require a reassessment of smaller reporting company status in connection with the de-SPAC, for example. Although the SPAC boom may already be past, we can expect significant pushback to many aspects of the SEC’s proposed SPAC rules, and it is unclear how much of the proposal will make it into the final regulations. Comments to the Proposed Rules must be submitted to the SEC by the later of May 31, 2022 or 30 days following the publication of the Proposed Rules in the Federal Register

KJK will continue to monitor the developments related to these Proposed Rules. If you have any questions, please contact KJK Corporate and Securities attorney Christopher Hubbert (CJH@kjk.com; 216.736.7215).