Tuesday, June 14, 2022

CII supports SEC’s call for enhanced disclosure by SPACs

By John Filar Atwood

The Council of Institutional Investors (CII) has thrown its support behind the SEC’s proposed rule addressing special purpose acquisition companies (SPACs), calling it “meaningful reform” that addresses gaps in transparency between the SPAC route to the public markets and other routes. CII said that there is an urgent need to adopt a final rule in this area given that nearly 600 SPACs are now actively searching for private company merger partners.

The SEC’s proposal includes measures to strengthen investor protections in initial public offerings by SPACs and in business combinations between SPACs and private operating companies (de-SPACs). In a comment letter on the proposal, CII agreed with the Commission’s proposals to:
  • clarify the obligation of SPAC sponsors and their affiliates to disclose all material conflicts of interest;
  • bring greater clarity to dilution under various SPAC share redemption scenarios;
  • ensure that underwriter status and liability under 1933 Act Section 11 apply to SPAC underwriters who participated in the distribution of shares by taking steps to facilitate the de-SPAC (but not to private investment in public equity (PIPE) investors in SPACs);
  • establish private operating companies merging with SPACs as co-registrants; and
  • clarify that the Private Securities Litigation Reform Act (PSLRA) safe harbor with respect to forward-looking statements does not apply to the de-SPAC merger proxy.
CII has no objection to there being more than one avenue for private companies to go public since more paths to the public markets promotes capital formation. However, it is critical that those paths—traditional IPO, de-SPAC merger, or direct listing—offer consistently robust investor protections, the group stated.

Misalignment of interests. In addressing some of the proposing release’s specific questions, CII said that it supports improving and codifying disclosure to clarify the misalignment of interests between the sponsor or its affiliates or the SPAC’s officers, directors or promoters, and unaffiliated security holders, as proposed. The group believes that there should be mandatory disclosures of conflicts of interest among SPAC directors, SPAC officers, target company directors, and target company officers.

CII also supports disclosure that would shed light on how compensation arrangements and other financial incentives create fundamental differences in outcome priorities among participants. In CII’s opinion, the de-SPAC proxy should describe the differences in priorities and how they may impact voting decisions on the business combination.

Dilution. CII also said that it favors including disclosure of net cash per share after taking into account all sources of dilution and dissipation of cash, under various redemption scenarios. The group feels that given the complexity and contingencies involved in the de-SPAC process, investors—particularly SPAC investors who are considering declining the redemption opportunity—need clear information about potential consequences to inform their understanding of the true cost of the business combination.

CII supports requiring tabular disclosure in the de-SPAC proxy that illustrates net cash per share after taking into account all sources of dilution and dissipated cash under 25 percent, 50 percent, 75 percent, 90 percent, and 100 percent redemption scenarios. Citing a recent study by three securities experts that recommended using a 90 percent redemption scenario, the group said that it would not object if the SEC’s proposal were modified to adopt the methodology outlined in that study.

Accountability. CII would like to see the SEC require that the SPAC and the target company act as co-registrants upon filing of the registration statement in connection with the de-SPAC. In CII’s view, treating both the SPAC and the target as an issuer under 1933 Act Section 6(a) would help to align investor protections with those of a traditional IPO.

The group advised the SEC that a narrow interpretation exempting the target company as a registrant is inappropriate given that the de-SPAC serves the same practical purpose as a private company entering the public markets through a traditional IPO, and the extent to which private companies have embraced the de-SPAC option.

CII also favors the proposed amendments to the signature instructions of Form S-4 to require that officers and a majority of the board of the target company are liable for any material misstatements or omissions in the S-4. This would ensure that they are accountable for the accuracy of the registration statement under 1933 Act Section 11, the group said.

Safe harbor. On the question of whether clarifying that the safe harbor under the PSLRA is unavailable would improve the quality of projections in connection with de-SPAC transactions, CII offered its view that uncertainty surrounding the availability of the safe harbor may have contributed to the proliferation of unreasonably optimistic forward projections that would not have been made if liability had more clearly paralleled the traditional IPO regime. Accordingly, CII supports the proposal’s revision to the definition of “blank check company” to ensure that the safe harbor against a private right of action for forward-looking statements under the PSLRA is not available.

CII also stated that it favors the enhanced investor protection that would result from assigning underwriter status for the de-SPAC transaction to a person who has acted as an underwriter in a SPAC IPO and participates in the distribution by taking steps to facilitate the de-SPAC transaction. The group supports limiting the application of proposed Rule 140a so that PIPE investors in the SPAC are excluded. CII believes that PIPE investors do not fit the traditional function of an underwriter, and that including PIPE investors in Rule 140a could significantly reduce investor appetite to backstop this route to entering the public markets.