SPAC rule changes add complexity and delays for companies eying public markets
- Haim Ratzabi
- Oct 16, 2022
- 4 min read
SEC markedly increases its focus on SPACs. Surprise pronouncements call into question use of the Private Securities Litigation Reform Act (PSLRA) safe harbor for projections and accounting treatment for warrants.
1. PSLRA safe harbor for projection
On April 8, 2021 John Coates, the Acting Director of the Division of Corporation Finance, issued a statement entitled “SPACs, IPOs, and Liability Risk under the Securities Laws.” Coates called into question whether the PSLRA safe harbor provision for forward-looking statements applies to de-SPAC mergers. Coates suggested that the economic substance of a de-SPAC merger, which according to Coates is more like a traditional IPO than a traditional corporate merger, points “towards a conclusion that the PSLRA should not be available for any unknown private company introducing itself to the public markets.”
Financial projections in a SPAC-related proxy statement or registration statement distinguish SPACs, and their attendant litigation risks, from traditional IPOs. Such projections are generally protected by the safe harbor for forward-looking statements afforded by the PSLRA, whereas projections made in connection with traditional IPOs are not. Compared to a traditional IPO, a SPAC acquisition presents the opportunity for an operating company to speak more directly to the market about its financial prospects.
A de-SPAC transaction is structured as a merger and virtually all merger transactions include extensive disclosure of projections, underlying the fairness analysis that is expected by and generally mandated by state law. In contrast, the PSLR’s safe harbor rules, dating from 1995, specifically exclude IPOs from the safe harbor, and state law does not mandate the same fairness analysis required for mergers. Hence, projections are almost never included in IPO prospectuses.
What is Safe-harbor-statement?
The SEC’s rules require companies to say that their projections are forward-looking and to include cautionary statements advising investors about key risk factors that might affect the statements’ accuracy.
The safe harbor statement received a large push from the Private Securities Litigation Reform Act of 1995. That law protects issuers of publicly-traded securities from liability for certain financial projections and related facts and figures.
Implications for Private Companies, SPAC Sponsors and Financial Advisors
As a practical matter, the Statement will likely have an impact on SPAC transactions. Among other things, we expect that:
There may be an insistence on increased due diligence of the business and financial results of private companies that are parties to SPAC transactions.
Companies, SPAC sponsors, financial advisors and other participants in SPAC transactions may change their practices with respect to the projections that are included in SPAC disclosure. If the Statement is correct that the safe harbor does not apply to projections or other forward-looking statements, there is significant increased risk associated with forward-looking statements, including projections.
The substantial cost of D&O insurance in connection with SPAC transactions may increase, given greater concerns regarding legal liability. This is particularly true given that concerns about Section 11 liability have long been a principal driver of increased costs for public company D&O insurance.
In addition, the SEC may take action to further clarify or codify its position regarding disclosure obligations in SPAC transactions, and the liability of participants for such disclosure, whether through rule-making or Staff guidance.
2. Accounting for Warrants: Equity or Liabilities?
On April 12, 2021 the Division of Corporation Finance and the Office of the Chief Accountant issued a statement regarding accounting for warrants issued by SPACs. In that statement—which almost immediately created controversy, if not consternation—Acting Director Coates and Acting Chief Accountant Paul Munter asserted that some warrants should be classified as liabilities—rather than equity or an asset—because the warrants were not indexed to the issuer’s stock. They also opined that a tender offer provision, included as a term of a warrant issued by many SPACs, required those warrants to be treated as liabilities. Although the statement was issued in the context of the staff’s review of the accounting treatment for warrants by two specific SPACs, it included a general caution that “warrants issued by a SPAC … require careful consideration of the specific facts and circumstances for each entity.” The statement also cautioned that registrants and their auditors must review any potential errors in accounting for warrants to determine whether the issuer must take any corrective measures—e.g., a restatement.
The staff’s statement surprised most observers and inevitably will cause SPACs to revisit their accounting policies and assess the adequacy of internal accounting controls regarding classification and valuation of warrants. These assessments may also lead to some SPACs filing restated or revised financial statements with the Commission. This statement also may cause a decrease (perhaps only temporary) in the volume of SPAC-related transactions as the market assesses the impact of the new guidance. In the longer term, the staff’s statement—in conjunction with other recent guidance and actions from the Commission—may suggest increasing skepticism about the SPAC market and foreshadow that SPACs will enter the Commission’s crosshairs as targets for rulemaking and for enforcement actions.
Sources:
SEC Takes Aim at SPACs - https://bit.ly/338tEdm
SEC’s New Guidance on Liability Risks Likens SPACs to IPOs - https://bit.ly/3aW4K54
SPACs, IPOs and Liability Risk under the Securities Laws - https://bit.ly/3xFOSxn
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