SEC Sets its Sights on SPACs With Newly Proposed Disclosure Rules

On Wednesday, March 30^th, the Securities and Exchange Commission (SEC) announced newly proposed rules and rule amendments governing Special Purpose Acquisition Companies (SPACs), shell companies, and the projections that these companies make. The aggregate proposed rule is aimed at heightening investor protections for those who choose to invest in SPACs and shell companies, where such investor protections are currently quite slim.

Understanding the new rules necessitates a working understanding of SPACs themselves. SPACs are a form of “blank-check” company, in which capital is raised by investors through an Initial Public Offering (IPO). [2] SPAC IPOs differ greatly from traditional IPOs, however, in that at the time of a SPAC IPO, the SPAC has no physical operations of its own. [2] Instead, post-IPO, a SPAC is granted a two year term during which it must acquire or merge with an existing company, thereby taking that company public without ever going through the traditional, and often costly, IPO process. [2]

New SPAC IPOs have been on a meteoric rise since 2020. In 2019, just 59 SPAC IPOs occurred, while 2020 saw 247 and 2021 saw a record 613 SPAC IPOs. [2] These 613 SPAC IPOs in 2021 represented over $160 billion of capital raised. [2]

Yet even with the number of SPAC IPOs growing rapidly, the actual financial of SPACs is currently lagging behind index funds, which track to the S&P 500. [3] In fact, the ETF which tracks the prices of companies which stem from SPAC IPOs is down 33% year over year, while the S&P 500 is up 17% over the same time period. [3]

This performance disparity perfectly highlights the SEC’s core rationale for introducing SPAC disclosure rules. At present, SPACs raise money through IPOs with minimal disclosure requirements. More striking, the companies they eventually acquire or merge with are not subject to typical disclosure requirements either – leaving investors uniquely vulnerable to fraudulent misrepresentations.

The SEC’s newly proposed rules present an opportunity to clarify some aspects of the SPAC IPO process for prospective investors.

First, the rules, if enacted, would require new disclosures from and about SPAC sponsors, conflicts of interest, and dilution sources. [4] First, the rule proposes the adoption of a broad definition of SPAC sponsors as “the entity and/or person(s) primarily responsible for organizing, directing, or managing the business and affairs of a SPAC. . .” [4]

The rule further requires disclosures regarding conflicts of interest between SPAC sponsors and their public investors. [4] Such a conflict of interest could potentially arise if one SPAC sponsor is in the process of sponsoring multiple SPACs, or if a SPAC acquires a private company in which the SPAC’s sponsor already holds some financial interest. [4]

Additionally, the new rules look to better tackle issues relating to forward-looking projections made both by SPACs and by their potential target companies, further demystifying SPAC processes for their investors. [1]

In announcing the proposed rule, SEC Chair Gary Gensler harkened back to Congress’s initial attempt at addressing information asymmetries, misleading information, and conflicts of interest over 90 years ago when it first created the SEC in the wake of the 1929 market crash. [1] Gensler then noted that because, functionally, SPAC IPOs present firms with an alternative to traditional IPOs, investors “deserve the protections they receive from traditional IPOs, with respect to information asymmetries, fraud, and conflicts, and when it comes to disclosure, marketing practices, gatekeepers, and issuers.” [1]

The SEC’s proposed rule will be subject to a 60-day public comment period before ultimately being adopted by the regulator. If enacted in much the same format as the rules currently stand, investors stand to gain critical information about the true viability of SPACs in which they choose to invest.

As news around this proposed rule develops, Savage Villoch attorneys are ready to handle your questions or concerns. Reach out for consult today!

Sources:

[1] https://www.sec.gov/news/press-release/2022-56

[2] https://www.investopedia.com/terms/s/spac.asp

[3] https://www.forbes.com/sites/jonathanponciano/2022/03/30/sec-unveils-new-spac-rules-targeting-unreasonable-financial-projections-and-requiring-more-disclosures/?sh=6395435c74dd

[4] https://www.sec.gov/rules/proposed/2022/33-11048.pdf