SEC CONSIDERING HEIGHTENED SCRUTINY OF PROJECTIONS IN DE-SPAC TRANSACTIONS

One of the most noteworthy developments in M&A transactions in 2020 and 2021 has been a significant increase in the number of private companies combining with special purpose acquisition companies, or “SPACs,” resulting in the formerly private company becoming a public company (such combinations are commonly referred to as “de-SPAC transactions” or “de-SPACs”). In the four-year period from 2016 to the end of 2019, a total of 104 de-SPAC transactions were announced.^[1] By comparison, in just the 15-month period from January 1, 2020 to March 31, 2021, a total of 197 de-SPAC transactions were announced.^[2]

With this increase in de-SPAC transactions, however, has come increased focus by the Securities and Exchange Commission (SEC). One particular area of SEC focus has been the liability implications for disclosures in connection with de-SPAC transactions. On April 8, 2021, the Acting Director of the Division of Corporation Finance of the SEC (the “Acting Director”) issued a statement regarding the liability risks associated with such disclosures, particularly the disclosure of financial projections of the private company target in a de-SPAC transaction, suggesting that further guidance or rules may be forthcoming. Then, on April 27, 2021, Reuters published an article stating that, according to sources with knowledge of the discussions, the SEC is considering issuing new guidance on this subject.

Background on Financial Projections

In a business combination transaction, projections of the target company’s future financial performance often are relevant in analyzing and negotiating the transaction, and these projections are often disclosed in the applicable disclosure documents provided to shareholders in connection with the transaction (e.g., the proxy statement or registration statement). The determination or obligation to disclose projections in connection with a transaction is circumstance dependent, with the requirements of state law being a key consideration. In particular, Delaware law requires the board of directors to disclose fully and fairly all material information when seeking shareholder action, and information is generally considered material if “from the perspective of a reasonable stockholder, there is a substantial likelihood that it ‘significantly alter[s] the ‘total mix’ of information made available.’”^[3] Accordingly, if the board of directors relies on projections when approving a transaction, which is often the case, then those projections are typically considered at least potentially “material” and thus disclosed to shareholders (though the decision to disclose them does not itself establish their materiality).

Similarly, in de-SPAC transactions, the projections of the private company target shared with the SPAC are often included in S-4 filings and proxy statements provided to the SPAC’s shareholders in connection with their approval of the proposed business combination transaction. These projections are usually considered by the SPAC’s board of directors in assessing the advisability of a proposed de-SPAC transaction, as the target company’s projections generally provide insight into its future financial performance, including its perceived potential for growth.

The Private Securities Litigation Reform Act of 1995 (PSLRA) created a safe harbor for forward-looking statements (which includes projections) that generally shields the parties who make forward-looking statements from liability for those statements so long as certain conditions are met (such as the identification of forward-looking statements as such, and the inclusion of cautionary statements regarding those forward-looking statements). This safe harbor, however, is not available for forward-looking statements that are “made in connection with an initial public offering,”^[4]  and projections are not typically included in initial public offering (IPO) disclosures.

Statement by Acting Director of the Division of Corporation Finance of the SEC

On April 8, 2021, the Acting Director issued a statement regarding “SPACs, IPOs, and Liability Risk under the Securities Laws.”^[5] In that statement, the Acting Director noted that practitioners “sometimes specifically point to the Private Securities Litigation Reform Act (PSLRA) safe harbor for forward-looking statements, and suggest or assert that the safe harbor applies in the context of de-SPAC transactions but not in conventional IPOs,” and that this is a reason why the parties involved in a de-SPAC transaction “feel comfortable presenting projections and other valuation material of a kind that is not commonly found in conventional IPO prospectuses.”

The Acting Director then questioned these positions, observing that “it is not clear that claims about the application of securities law liability provisions to de-SPACs provide targets or anyone else with a reason to prefer SPACs over traditional IPOs. Any simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst.” In specifically addressing claims regarding the applicability of the PSLRA safe harbor, the Acting Director expressed his view that the claim that the PSLRA offers de-SPAC transactions protections that are not available to IPOs is “uncertain at best.” The Acting Director pointed out that the PSLRA specifically excludes from the safe harbor ‘initial public offerings’, noting that there is no definition of this phrase in the PSLRA, and then suggested that this phrase “may include de-SPAC transactions” (emphasis added). Though acknowledging that a de-SPAC transaction is not an ‘initial’ offering by the SPAC, the Acting Director stated that it is “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” (emphasis original).

The Acting Director further asserted that a company’s initial public offering is a unique event, as it is “the first time that public investors see the business and financial information,” and therefore requires heightened scrutiny and a need for “the protections of the federal securities laws … to overcome the information asymmetries between a new investment opportunity and investors in the newly public company.” The Acting Director went on to remark that “[i]f these facts about economic and information substance drive our understanding of what an “IPO” is, they point toward a conclusion that the PSLRA safe harbor should not be available for any unknown private company introducing itself to the public markets. Such a conclusion should hold regardless of what structure or method it used to do so.”

Potential Implications

Though the Acting Director’s statement included a qualification that it represents only his views and not of the SEC itself, the statement suggests that the SEC may yet take an official position on the matter, and conclude, potentially through rulemaking, that the definition of “initial public offering” encompasses de-SPAC transactions for purposes of the PSLRA safe harbor, at least with respect to future transactions. If it becomes determined, through binding and jurisdictionally proper rulemaking, judicial interpretation or otherwise, that the protections of the statutory safe harbor do not apply to any projections included in the applicable disclosure documents for a de-SPAC transaction, other defenses of projections would remain available, including the “bespeaks caution” doctrine, which provides protections similar to the PSLRA safe harbor, and the limitations on claims based on opinion statements set out by the U.S. Supreme Court in its Omnicare decision.^[6]

Notably, on April 27, 2021, Reuters published an article stating that the SEC is “considering new guidance to rein in growth projections made by [SPACs], and clarify when they qualify for certain legal protections,” citing “three people with knowledge of the discussions.”^[7]   The article goes on to note that, according to these sources, this guidance would, in part, be “aimed at clarifying when a key liability protection for such forward-looking statements applies to SPACs,” which appears to be a reference to the PSLRA safe harbor. If these anonymous sources are to be believed, we may see guidance or rulemaking from the SEC on this subject soon.

Although the Reuters article suggests that the SEC is considering using guidance to effect this change, which could be at the Commission or Staff level, we believe a change of this nature to the liability framework applicable to SPACs is something that should at the very least necessitate notice and comment rulemaking.