In November 2020, we published a client alert entitled “SPACs to the Future: What Types of Litigation May Arise for SPACs and SPAC Targets?”
At the time, few cases had been filed in connection with the recent surge in activity by Special Purpose Acquisition Companies (“SPACs”).
Five months later, while the SPAC surge has continued, the Securities and Exchange Commission (“SEC”) has made multiple public statements highlighting SPAC-related regulatory issues, public reports indicate that the SEC’s Enforcement Division is examining some aspects of certain SPAC transactions, and private litigants have begun to bring numerous SPAC-related claims in both federal and state courts.
None of these developments—of course—suggest anything untoward about SPAC transactions generally. They do, however, highlight areas where SPACs, sponsors, targets, and their respective officers and directors should exercise particular prudence and diligence.
A SPAC raises capital in its initial public offering (“IPO”) for the purpose of acquiring an existing (but yet to be identified) private company that would become publicly traded. Investors in the SPAC IPO typically receive both equity shares in the SPAC and warrants to purchase additional stock.
Following its IPO, a SPAC typically has up to 24 months from the IPO closing to enter into a business combination with a target, commonly called a “de-SPAC” transaction. SPAC stockholder approval may be required for the de-SPAC transaction, which would ordinarily require the filing and delivery of proxy statements to the SPAC stockholders.
If an acquisition does not take place during that time, the SPAC liquidates and returns its funds to investors.
The SEC Speaks, Repeatedly
Over the last several months, the SEC Staff has made numerous SPAC-related statements, focusing in particular on disclosure and accounting considerations.1 Because these statements highlight areas that the SEC Staff believes are significant, they may be a harbinger of issues the SEC’s Enforcement Division will focus on in future investigations, and these statements can also be used by the private plaintiffs’ bar as a roadmap of sorts in drafting complaints.
Indeed, in late March 2021, it was publicly reported that the Enforcement Division had begun seeking information from SPAC underwriters regarding (i) SPAC deal fees, (ii) internal controls at banks involved in SPAC underwriting, and (iii) potential insider trading between the IPO and the SPAC’s announcement of its target.2 Further, many of the private SPAC-related lawsuits filed to date have focused on inadequate disclosures regarding conflicts of interest, areas then-SEC Chairman Clayton highlighted in September 20203 and which, as discussed below, the SEC has continued to publicly emphasize.
Below we note a number of areas where the SEC has been particularly vocal regarding SPACs.
Conflicts of interest. The SEC Staff has continued to emphasize the importance of disclosures to investors regarding, for example,
- potential conflicts of interest between the investors and the sponsors,
- any relationships between the officers and directors of the SPAC (or the sponsor) and those of the target,
- any continued relationship that the SPACs officer and directors will have with the combined company
- any conflict of interest a SPAC underwriter may have in providing services for the SPAC IPO in light of any deferred IPO underwriting compensation.4
Accounting and internal controls. Other SEC statements have focused on the importance of accounting and internal controls issues.
As to SPAC targets: In a March 31 statement, the SEC’s Acting Chief Accountant, Paul Munter, focused on the complex financial reporting and governance issues posed by a SPAC target’s relatively quick (as compared to a traditional IPO) transition from a private entity to a publicly traded company. Mr. Munter emphasized, among other things, that SPAC targets must be prepared to meet the audit, tax, governance, and investor relations standards expected of a public company, including having the people, processes, and technology to satisfy those expectations.5
Classification of SPAC-Issued Warrants: On April 12, the SEC’s Acting Director of the Division of Corporate Finance and the SEC’s Acting Chief Accountant issued a statement concerning accounting and reporting considerations for SPAC-issued warrants.6 The statement suggested that some SPACs had mis-classified these warrants as equity instruments, rather than as a liability. More specifically, citing general accepted accounting principles (GAAP), the April 12 statement noted that (i) the pricing of at least some SPAC warrants was not necessarily indexed to the issuer’s own stock but depended, for example, on the identity of the holder of the warrant, which would preclude classifying the warrant as an equity instrument, and, separately, (ii) the facts and circumstances of tender offer provisions, including circumstances where warrants could be redeemed for cash rather than equity shares, could also preclude classification as an equity instrument. While the statement emphasized that the accounting treatment for SPAC warrants depended heavily on the terms and conditions of the particular warrant at issue, it also noted the SEC Staff’s “understand[ing] that certain features of warrants issued in SPAC transactions may be common across many entities” and thus raised the potential that numerous SPACs and other companies with SPAC warrants may have to re-visit their accounting for the warrants and issue a recharacterization or restatement. The statement also addressed potential materiality of the accounting error, and guidance on how that may be determined and reported. While an accounting error arising from the described warrant classification is unlikely to be material standing alone, the statement emphasizes the SEC’s focus on accounting and controls at SPACs and their targets.
Projections/PSLRA Safe Harbor. On April 8, the Acting Director of the SEC’s Division of Corporate Finance, John Coates, issued a public statement concerning the “safe harbor” in the Private Securities Litigation Reform Act,7 that, subject to a number of exceptions, bars private actions based on a false statement or material omission with respect to “forward-looking statements,” e.g., statements containing certain financial projections, describing the issuer’s future plans and objectives, or predicting the issuer’s future economic performance.8
One of the exceptions to the safe harbor is for statements made in connection with an IPO. Some commentators have suggested that an advantage of SPACs is that, unlike a company going public through a traditional IPO, SPACs and their targets can take advantage of the PSLRA safe harbor in connection with the de-SPAC transaction. However, in the April 8 statement, Acting Director Coates suggested otherwise, asserting that it was “uncertain at best” whether the safe harbor applied in a de-SPAC transaction. Acting Director Coates reasoned that, in its economic substance, a de-SPAC “may” be a type of “initial public offering” for purposes of the PSLRA safe harbor, because “it is also commonly understood that it is the de-SPAC—and not the initial offering by the SPAC—that is the transaction in which a private operating company itself ‘goes public,’ i.e., engages in its initial public offering.”9
In assessing the impact on SPAC transactions if such a view were adopted by the courts, it bears noting that the PSLRA safe harbor is not a “get out of jail free card.” It does not apply where a plaintiff can show a forward-looking statement was made with actual knowledge that it was false or misleading. Nor does it apply if the forward-looking statement is not accompanied by appropriate cautionary language identifying factors that could cause actual results to differ from those projected or predicted in the statement. Nor does the safe harbor apply in enforcement actions brought by the SEC.
Moreover, the applicability of the PSLRA safe harbor has never been a prerequisite to include forward-looking projections in registration statements for IPOs or otherwise. Many traditional IPOs, such as those for master limited partnerships and Yieldcos, have historically included projections in their registration statements (though commonly only one year’s projections). Additionally, distinct from the PSLRA safe harbor, the common law “bespeaks caution doctrine” remains a potential shield against disclosure liability for forward-looking statements that are later found to be incorrect if they were sufficiently tempered with meaningful cautionary language.10
But, stepping back and looking more broadly, Acting Director Coates’ statement highlights that securities liability is a real threat in de-SPAC transactions, that the SEC is closely watching, and that disclosures must be carefully drafted, vetted, and, if necessary, updated.
In sum, the frequency of recent statements by the SEC Staff suggest the agency has, over the last several months, dramatically increased the focus on regulatory and enforcement issues related to SPACs. The statements also indicate what theories and factors the plaintiffs’ bar may try to seize on in bringing SPAC-related private actions. It remains to be seen whether the SEC will use its rule-making authority to enact additional formal rules, regulations or interpretations addressing the concerns raised in these informal public statements.
Filed Claims in Federal and State Court
In addition to the various statements from the SEC, numerous SPAC-related lawsuits have been filed in federal and state court (in particular in New York and Delaware) in the last five months, both pre- and post-business combination. We still, however, have not seen a significant body of case law develop, given the relatively young age of these cases and because (as discussed below) a significant number of cases were voluntarily discontinued or mooted by amended disclosures.
Breach of Fiduciary Duty Litigation: In addition to the federal-securities based claims referenced in our previous client alert, private plaintiffs have brought a significant number of SPAC-related claims under state-law breach of fiduciary duty theories, focusing on undisclosed conflicts of interest, no doubt taking a page from the SEC guidance discussed above.
Some of these claims have been brought after the announcement of the business combination but before the deal closes, and sought to enjoin the proposed business combination. In a number of cases, the SPAC ended up filing supplemental disclosures, thereby mooting the case.11
In addition, shareholders have filed breach of fiduciary duty-based claims after the business combination, particularly, again, when the combined company did not perform as expected. For example, on March 25, 2021, in Amo v. Multiplan Corp. et al., a SPAC shareholder filed a class-action complaint in the Delaware Court of Chancery against the combined company and its directors, alleging that the SPAC’s directors and officers had breached their duties of care and loyalty to the SPAC shareholders and that the SPAC’s sponsor had aided and abetted those breaches.12 More specifically, the Complaint alleged that the defendants structured the SPAC to give its directors “strong (indeed, overriding) incentives to get a deal done . . . without regard to whether” any deal was truly in the shareholders’ best interests and that disclosures around the deal “were not done with the rigor of the usual IPO process.”13 To support their claim that the sponsor and directors were incentivized to complete a deal, the Complaint alleged that both the sponsor and the directors were given “founder” shares, which gave them the right to obtain 20% of the equity of the SPAC if an acquisition was completed. The complaint further claimed that that the business combination “ha[d] been a financial catastrophe,” causing the loss of hundreds of millions of dollars of shareholder value.”14
Significantly, while, under Delaware law, directors are generally protected by the deferential business-judgment rule, plaintiffs can rebut that presumption by showing the directors had a conflict of interest, in which case the directors must show the decision in question meets the much less-deferential “entire fairness” standard. The plaintiffs in the Amo case assert that the “entire fairness” standard should be applied to assessing the de-SPAC transaction in light of alleged conflicts,15 and we expect future plaintiffs will attempt to do the same, by citing purported financial incentives for a board to close a de-SPAC transaction and relationships between board members and the SPAC sponsor.
Securities Law Disclosure Litigation: As we predicted in our previous update, SPAC investors have filed post-business combination complaints alleging violations of the federal securities laws, focusing on the accuracy of disclosures made in connection with the business combination, particular in connection with the proxy solicitation.16 Many of these claims arise in the context of de-SPAC transactions completed near the SPAC’s liquidation deadline, which plaintiffs have asserted is indicative of the scienter required to support a claim under Section 10(b) of the Exchange Act and SEC Rule 10b-5.17 SPACs, sponsors and targets should ensure that proper diligence supports statements in any registration statement or prospectus, including a reasonable basis for forward-looking statements or financial projections, and meaningful cautionary language, as discussed above.
The SEC guidance and the litigation to date reinforces a number of key takeaways:
- SEC guidance and SPAC litigation continues to rapidly evolve. SPACs, sponsors, targets, and their directors and officers should carefully review these ongoing developments.
- Charters and bylaws of SPACs and post-transaction companies should contain appropriate exculpatory provisions for liability and business opportunity waivers to shield directors from fiduciary duty claims to the extent permitted by law. Additionally, appropriate forum selection provisions (both for federal claims and fiduciary duty claims) should be included in these organizational documents.
- SPAC disclosures, whether forward-looking statements, financial projections or otherwise, should be accompanied by meaningful cautionary language. Beyond potentially qualifying for the PSLRA, the “bespeaks caution doctrine” is an additional defense to protect SPACs, sponsors, targets and their directors and officers from potential liability.
- Between the time of the SPAC IPO and the business combination, the SPAC is a public company, despite its limited operations. SPAC officers and directors should maintain corporate formalities and good corporate governance practices, which, among other things, will help prevent allegations that the officers and directors breached their fiduciary duties of care and loyalty.
- Diligence of the SPAC target obviously remains critical. Appropriate diligence and analysis not only may also uncover latent liabilities to inform pricing and process, but can protect against future securities law claims and fiduciary duty claims. To mitigate later claims about inadequate diligence, the SPAC should maintain a proper record of the diligence investigation, documents reviewed and related efforts, including reports from outside professionals.
- At all stages of the transaction, careful attention must be paid to related party transactions as well as potential conflicts of interest, including but not limited to those which may give actors—including but not limited to the SPAC’s directors and officers—an incentive to “get a deal done.” This includes, for example, paying attention to potential conflicts resulting from fee arrangements with underwriters, increasing pressure as the SPAC liquidation deadline approaches, and any SPAC arrangements with sponsor such as forward-purchase commitments.
- Both the target company and the SPAC should be careful to ensure that the newly combined company will be prepared to meet the audit, tax, governance, legal and investor relations standards expected of a public company on an ongoing basis after the de-SPAC transaction, including maintaining required internal controls and disclosure expectations.
1 See, e.g.,
- John Coates and Paul Munter, Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”), Apr. 12, 2021, available at https://www.sec.gov/news/public-statement/accounting-reporting-warrants-issued-spacs?utm_medium=email&utm_source=govdelivery;
- John Coates,; SPACs, IPOs and Liability Risk under the Securities Laws, Apr. 8, 2021, available at https://www.sec.gov/news/public-statement/spacs-ipos-liability-risk-under-securities-laws (“4/8/21 Coates Statement”).
- Paul Munter, Financial Reporting and Auditing Considerations of Companies Merging with SPACs, Mar. 31, 2021, available at https://www.sec.gov/news/public-statement/munter-spac-20200331 (“3/31/21 Munter Statement”).
- Division of Corporate Finance, taff Statement on Select Issues Pertaining to Special Purpose Acquisition Companies, Mar. 31, 2021, available at https://www.sec.gov/corpfin/announcement/staff-statement-spac-2021-03-31.
- Division of Corporate Finance, Special Purpose Acquisition Companies, CF Disclosure Guidance: Topic No. 11, Dec. 22, 2020, available at https://www.sec.gov/corpfin/disclosure-special-purpose-acquisition-companies. (“12/20/20 Corp. Fin. Statement”)
- SPACs – What You Need To Know, Dec. 10, 2020, available at https://www.investor.gov/introduction-investing/general-resources/news-alerts/alerts-bulletins/investor-bulletins/what-you;,
2 Jody Godoy, Chris Prentice, Exclusive: U.S. regulator opens inquiry into Wall Street's blank check IPO frenzy – sources, Reuters.com, 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
3 Dave Michaels and Alexander Osipovich, Blank-Check Firms Offering IPO Alternative Are Under Regulatory Scrutiny, The Wall St. Journal, Sept. 24, 2020 (noting Clayton’s statements that the SEC was “’particularly focused on . . . the incentives and compensation to the SPAC sponsors,’” including “‘How much of the equity do they have now? How much of the equity do they have at the time of the IPO-like transaction? What are their incentives?‘”
4 See 12/22/20 Corp. Fin. Statement (providing a meaningful list of potential disclosures for SPACs to consider when preparing disclosure).
5 See 3/31/21 Munter Statement (noting “[s]ome of the risks and challenges related to a private company merging with a SPAC arise due to the timeline of such transactions, since SPACs have the potential to bring private companies into the public markets more quickly than would be possible in a traditional IPO,” and laying out six areas of accounting that “may involve significant judgment”).
6 See Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”), Apr. 12, 2021, available at https://www.sec.gov/news/public-statement/accounting-reporting-warrants-issued-spacs?utm_medium=email&utm_source=govdelivery
7 See 15 U.S.C. § 77z-2.
8 See 15 U.S.C. § 77z-2(i)(1).
9 4/8/21 Coates Statement.
10 See, e.g., SEC v. Merchant Capital, 483 F.3d 747, 767 (11th Cir. 2007) (holding that “cautionary language, specifically tailored to several of the risks faced by the debt purchasing business, rendered the projections immaterial as a matter of law, even if they were misrepresentations”).
11 See, e.g., Form 8K, Hennessy Capital Acquisition Corp. IV (Dec. 16, 2020) (describing breach of fiduciary duty claims filed by plaintiffs in New York State court and SPAC’s filing of supplemental disclosures to moot those claims).
12 See Complaint, Amo v. Multiplan Corp. et al., No 2021-0258 (Del Ch. Mar. 25 2021) (“Amo Compl.”)
13 Amo Compl. ¶ 6.
14 Amo Compl. ¶ 16.
15 Amo Compl. ¶ 17 (“the entire fairness standard applies to this deeply conflicted Merger. In light of the conflict-laden structure of this SPAC and the manner in which M. Klein and the Board acted with respect to those conflicts and the deal process in general, the Merger cannot meet the test of entire fairness”).
16 See, e.g., Complaint, Jensen v. GigCapital3, et al., 21 Civ. 649 (S.D.N.Y. Jan. 25, 2021); Complaint, Pitman v. Immunovant, Inc., et al., No. 21 Civ. 918 (E.D.N.Y. Feb. 19, 2021). Complaint, Paradis v. Multiplan Corp., 21 Civ. 1853 (E.D.N.Y. Apr. 6, 2021).
17 See, e.g., Complaint, Welch v. Meaux, et al., 19 Civ. 1260 (W.D. La. Sept. 26, 2019) ¶¶ 3-4 (“For [certain SPAC directors] the failure to find an acquisition target within the two years since they raised money using their blank-check company was especially problematic. . . . It was with 2 weeks left before [the SPAC’s] deadline that it announced the last-minute agreement to enter a combination with [the target].”).
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