On December 9th, the Chair of the U.S. Securities and Exchange Commission (“SEC”), Gary Gensler (“Chair Gensler”), announced in a speech to the Healthy Markets Association that he has asked the SEC Staff for proposals around how the SEC can better protect public SPAC investors. In a year fraught with warning signs, Chair Gensler’s latest statements indicate that heightened enforcement with respect to SPACs may be forthcoming.
In his remarks, Chair Gensler explained that SPACs present an alternative from traditional IPOs for private companies to go public, in which there are more players competing for profits and more moving parts. In Chair Gensler’s view, unlike traditional IPOs, SPAC transactions have a two-part IPO. In the first step, a SPAC raises cash through initial public offerings, which Chair Gensler refers to as the “SPAC blank-check IPO.” In the second step, the SPAC merges with the target in a transaction commonly called a “de-SPAC,” but which Chair Gensler calls the “SPAC target IPO.”
Chair Gensler’s speech echoed a theme voiced by members of the SEC Staff earlier this year: that public investors in SPACs are not receiving the same level of protections enjoyed by those who invest in companies undergoing the traditional IPO process. Chair Gensler highlighted concerns with “information asymmetries, fraud, and conflicts, and when it comes to disclosure, marketing practices, and gatekeepers.” With respect to information asymmetries, Chair Gensler noted that SPAC targets and principals have access to information not necessarily available to the public shareholders. Also, PIPE investors in the de-SPAC may gain access to information that has not been disclosed to the public, which provides them with the opportunity to acquire shares based on that information at discounted prices.
With respect to conflicts, Chair Gensler pointed to an inherent conflict between public shareholders who may opt to vote for the merger but redeem their shares and those shareholders who decide to remain in the investment. This dilution will burden those remaining in the deal but not those redeeming. Moreover, SPAC sponsors typically retain two percent of the equity, but only if the sponsor can consummate a deal. To address these issues, Chair Gensler suggested changes to marketing practices, stricter disclosure requirements, and expanded liability for SPAC “gatekeepers,” which may include directors, officers, SPAC sponsors, financial advisors and accountants.
The SEC’s focus on SPACs this year has been apparent. In April, the then-Acting Director of the SEC’s Division of Corporation Finance, John Coates, issued a public statement calling into question whether the safe harbor in the Private Securities Litigation Reform Act applied in a de-SPAC transaction. At that time, we published a client alert noting that the SEC’s 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. As we later noted in another client alert in June, proposed (and still-pending) legislation sought to expressly prohibit SPACs from using this safe harbor. Then in July, we reviewed the SEC’s attention to proper SPAC diligence procedures in light of an enforcement action involving Stable Road Acquisition Corp.
Chair Gensler’s recent speech has highlighted concerns with the level of diligence that “gatekeepers” to a SPAC transaction are conducting, stating that “many gatekeepers carry out functionally the same role as they would in a traditional IPO but may not be performing the due diligence that we’ve come to expect.”
Below, in light of Chair Gensler’s latest remarks, we anticipate certain ways the SEC may sharpen its focus on certain SPAC disclosure, marketing and gatekeeping issues.
Chair Gensler noted his concerns about SPAC sponsors announcing their de-SPAC with inordinate fanfare, often touting celebrity endorsements of the transaction. These marketing practices may dramatically impact the value of the SPAC’s shares, which Chair Gensler noted is based on incomplete information and happens long before a full disclosure statement is filed. Moreover, PIPE investors in the de-SPAC are able to invest with information not yet disclosed to the public, as well as at a cheaper price than the public. The SEC’s attention to these issues can already be seen with its recent investigation into possible pre-announcement stock trades and communications between former President Trump’s social media company and its SPAC.
Chair Gensler also said he has asked SEC staff to make recommendations around how to guard against what could be improper conditioning of the de-SPAC market. Such regulation may include a demand for more complete information about the target at the time the de-SPAC is announced—similar to “gun-jumping” laws governing the dissemination of public information in traditional IPOs.
Cooling Off Periods:
In a traditional IPO, the company and its underwriters must wait a period of time after filing before they can meet with investors, known as a “cooling off period.” During this time, the SEC reviews the company’s filings and registration form to ensure that the investing public has access to all of the issuer’s required disclosures before any sales activity can occur.
In light of Chair Gensler’s concerns about ensuring public investors access to complete information, we may see the SEC require a similar cooling-off period around the time of the de-SPAC . This cooling-off period would allow the SEC and other regulators more time to thoroughly review the SPAC’s filings before members of the public can invest.
Statutory Underwriter Liability:
Finally, Chair Gensler emphasized the role that parties to a de-SPAC play as “gatekeepers.” Notably, while the SEC and DOJ have repeatedly emphasized the role that lawyers and accountants play as “gatekeepers” in a variety of different contexts, Chair Gensler explicitly included “brokers . . . and underwriters” as “gatekeepers” in the SPAC context and stated that they “should have to stand behind and be responsible for basic aspects of their work.” Moreover, Chair Gensler disagreed with the notion that the term “‘underwriters’ solely refers to investment banks” and instead asserted that “the law . . . takes a broader view of who constitutes an underwriter.” Chair Gensler’s broad view of who is an underwriter and his view that the de-SPAC transaction is essentially an IPO are notable, because Section 11 of the Securities Act imposes liability on (among others) “underwriters” for misstatements in a registration statement, without any requirement for the plaintiff to show scienter or bad intent, while providing underwriters with an explicit “due diligence” defense.
Consequently, we may see broadened liability for the parties to a de-SPAC, including the SPAC’s directors and officers, sponsor and financial advisors. From the SEC’s perspective, taking a broad view of which parties are liable for material misstatements or omissions may help align the interests of gatekeepers and the investing public, while encouraging these parties to conduct proper due diligence and provide comprehensive disclosure.
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