SEC Charges Parties to SPAC Combination for Misleading Disclosures and Due Diligence Failures
On July 13, 2021, the SEC filed (i) a settled action against multiple parties involved in a proposed acquisition of Momentus, Inc. (“Momentus”)—a privately held space technology company—by Stable Road Acquisition Corp. (“SRAC”), a special purpose acquisition company and (ii) an enforcement action in federal district court against Momentus’s founder and former CEO, Mikhail Kokorich.
In these cases, the SEC alleged that Momentus and Kokorich (i) falsely told investors that Momentus had “successfully tested” propulsion technology in outer space when, in fact, that test had failed to achieve its primary objectives and (ii) misrepresented the extent to which national security concerns undermined Momentus’s ability to secure required government licenses. Further, in the settled action, the SEC also alleged that SRAC failed to conduct adequate due diligence into Momentus’s claims and repeated these claims to investors.
The cases are notable for several reasons. First, they are one of the first SEC enforcement actions focused on SPACs since the uptick in SPAC activity began several years ago. Second, the SEC brought claims against the SPAC itself, even though the SEC acknowledged the SPAC had been lied to by the target. Third, and relatedly, the actions further highlight the importance that SPACs must place on performing sufficient diligence of the target.
SRAC went public November 2019 and had an 18-month window, i.e., until July 2021, to close an acquisition, or it would be dissolved with funds returned to investors. Initially, SRAC tried to find an acquisition target in the cannabis industry, but this failed. By late June 2020, one third of the way through its liquidation window, SRAC had still not identified a target. Around this time, SRAC’s CEO met Kokorich, Momentus’s CEO. Momentus and SRAC announced their merger on October 7, 2020, approximately three months later.
Far removed from the cannabis industry, Momentus was developing technology, including “MET thrusters,” to lift satellites into higher, custom orbits around the Earth. During negotiations with SRAC, Kokorich touted the MET thrusters as a “proven” and “successfully tested” technology fit for commercial use. Similar claims appeared on Momentus’s public website. SRAC then repeated these and similar claims regarding Momentus’s technology in an S-4 registration/proxy statement in November 2020, in later amendments to that statement and in presentations to PIPE investors.
According to the SEC, these statements were, in fact, lies. In particular, the only test flight Momentus conducted of the MET thrusters—which had taken place in 2019—showed the MET thrusters were not powerful enough to provide commercial satellite-placement services, or even produce detectable changes in a satellite’s orbital velocity.
In addition to the statements regarding the thrusters, Momentus and Kokorich also concealed and made false statements about the U.S. government’s national security and foreign ownership concerns with Kokorich, a Russian national. In particular, in April 2018, the U.S. Committee on Foreign Investment in the United States ("CFIUS") informed Kokorich that it considered him to be a “threat” (as defined by CFIUS) and therefore ordered him to divest his interest in another space technology company. SRAC’s S-4 registration/proxy statement disclosed that Kokorich had been ordered to divest ownership in the other space technology company but failed to disclose that CFIUS considered Kokorich himself a “threat.” Further, U.S. Customs and Immigration raised concerns about “inconsistences” in an asylum application Kokorich had made, and in late 2020, after the filing of the initial registration statement but before filing of the amendment, the Commerce Department denied Kokorich an export license for reasons related to national security.
Although SRAC asked Momentus for correspondence with CFIUS relating to Kokorich, Momentus responded that it did not possess these documents, even though Kokorich, its founder and then-CEO, had possession, custody, and control of them.
According to the SEC, SRAC’s registration statement failed to disclose that CFIUS considered Kokorich a national security risk, which rendered false statements suggesting that Kokorich would likely be granted asylum and that Kokorich would receive an export license.
The SEC’s Claims
Based on these false statements and omissions concerning both Momentus’s technology and national security concerns surrounding Kokorich, the SEC brought claims against Momentus and Kokorich under its go-to scienter-based, anti-fraud provisions: Section 10(b) of the Exchange Act and Section 17(a) of the Securities Act.
Further, despite Momentus’s and Kokorich’s alleged deceit regarding these issues during negotiations, the SEC charged SRAC and certain executives under Sections 17(a)(2) and (a)(3) of the Securities Act and Section 14(a) of the Exchange Act, based on SRAC’s failure to conduct a thorough due diligence investigation.
Notably, unlike the charges against Momentus and Kokorich, none of the provisions used to charge SRAC required the SEC to prove scienter. Still the SEC emphasized in its order that “SRAC’s due diligence failures compounded Momentus’s and Kokorich’s misrepresentations and omissions…” and that SRAC’s due diligence process was “conducted in a compressed timeframe and unreasonably failed to … probe the basis of Momentus’s claims…” For example, the SEC noted that SRAC retained a space technology firm to help it evaluate the state of Momentus’s technology, but the firm did not begin its substantive diligence work until a little more than a month before the merger announcement.
The SEC’s actions reinforce several points we have made in previous client alerts regarding SPAC litigation and enforcement issues:
- The SPAC’s diligence of the target is critical. These charges reinforce that, fairly or not, the SEC is looking to SPACs to fill a gatekeeper role of sorts in bringing private companies to the public markets.
- Due in part to the enhanced financial pressures to consummate a deal prior to liquidation, there continues to be a separation among the parties to a de-SPAC transaction when balancing efficient deal execution with proper due diligence. Parties to a de-SPAC transaction should therefore allot sufficient time to conduct thorough diligence and ensure all disclosures relevant to the business combination are sufficiently vetted, which can help mitigate the regulatory enforcement and litigation risks highlighted in these latest SEC charges.
- To mitigate against the risk of future litigation, the SPAC management team should document its diligence process.
- Further, if the SPAC retains outside diligence experts, the SPAC should ensure those experts are given a reasonable timeline to complete diligence before a merger is announced.
- Diligence should extend not only to the target itself but also to any “key personnel” of the target where appropriate.
- Because de-SPAC transactions involve the solicitation of proxies, the filing of a registration statement and the use of a prospectus, the SEC may have additional causes of action that do not require it to show the knowing or intentional dissemination of false statements. Instead, both Section 14(a) of the Exchange Act and Rule 14a-9 promulgated thereunder (applicable to proxy statements) and Sections 17(a)(2) and 17(a)(3) of the Securities Act (applicable to registration statements) allow the SEC to prove its claims under a negligence, or “should have known,” standard.
- The SEC continues to closely scrutinize the SPAC market. Notably, these claims were brought after the business combination was announced but before the de-SPAC transaction closed. It appears the SEC moved fairly quickly – and much faster relative to the pace of other SEC investigations – to bring these charges, and we should expect them do to the same in the future.
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