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SEC Poised to Adopt Tougher Rules for SPACs

January 19, 2024 

Almost two years after the Securities and Exchange Commission (SEC) proposed a sweeping set of reforms to rein in what some believe was the SPAC world running amok during the COVID-19 pandemic, the commission is set to adopt final rules during a public meeting on January 24, 2024.

A SPAC—special purpose acquisition company—is a type of blank-check or shell company without operations that raises capital publicly for the sole purpose of identifying and merging with a target private operating company. A SPAC registers redeemable securities for cash, sells them to investors, and puts the proceeds in a trust for a future acquisition of a private operating company. Upon finding a target private company, it merges with it, completing the deal—this is called de-SPAC.

It had been popular because of the speed of the deals and the certainty of price compared to a traditional initial public offering (IPO).

With an unprecedented surge in the number of SPACs from 2020 to 2021, the SEC, worried about risks posed to investors, proposed in March 2022 to require additional disclosures about sponsors, conflicts of interest, and sources of dilution.

Investor protection advocates said that there are many problems with SPACs. Among other problems, they pointed out the dearth of information about the role of the SPAC sponsor and any potential conflicts of interest on the part of the sponsor and other insiders as well as any divergent financial interest of the sponsor relative to that of the retail investors in the SPAC.

The proposal in Release No. 33-11048, Special Purpose Acquisition Companies, Shell Companies, and Projections, also would require additional information about business combination transactions, including disclosures related to the fairness of the transactions.

In addition, the proposed rule would address projections made by SPACs and their target companies, including the Private Securities Litigation Reform Act (PSLRA) safe harbor for forward-looking statements.

The SPAC market has cooled off significantly since the commission’s proposal.

In 2020, there were 248 SPAC IPOs, followed by 613 at its peak in 2021. Then it dropped precipitously in 2022 with 86 and further decreased to 31 in 2023, according to SPAC Analytics.

Interests have waned because of different factors: the SEC’s proposal itself; the failures of companies to find target companies to merge with; and unscrupulous activities that occur whenever there are any types of financial or investment fads.

Ro Sokhi, a partner with CPA firm UHY LLP, however said that there “are still a number of SPACs that are alive and still looking for targets.” About 250 and about 150 of them are “supposedly actively looking for targets,” he recalled.

“That’s a potential for a hundred or so private companies going public if deals are able to be made, and thus the need to protect investors,” Sokhi said.

In his view, “many of the provisions are likely needed to protect investors as there are differences between using a SPAC to go public versus a traditional IPO that probably shouldn’t exist.”

However, some of the proposed changes are “somewhat tangential to protecting investors that are going to be interesting to watch,” Sokhi said.

For example, he cited the SEC’s proposal in relation to the Form AP requirements for CPA firms. The Public Company Accounting Oversight Board (PCAOB) requires accounting firms that audit public companies to submit the form to disclose the names of lead partners and other accounting firms that participated in the audit. The SEC oversees the audit regulatory board.

“The proposal may align Form AP filing requirements for SPACs and IPOs that could significantly impact accounting firms, including how they are regulated by the PCAOB,” Sokhi said. There was “some ambiguity as to whether a private company would be considered an issuer under the new rules, that hopefully will be resolved.”

He said this has implications for all audit firms, especially those serving the middle markets that are doing much of the SPAC target audits and are at or close to having 100 public company clients.

“Once an accounting firm exceeds 100 registrants, they are required to be reviewed by the PCAOB every year instead of every three years,” he explained.

Moreover, the PCAOB’s audit inspections under Chair Erica Williams has been quite rigorous.

In the meantime, some accounting firms, including the Big Four, wrote comment letters to the SEC, largely asking for clarity on financial reporting matters.

KPMG LLP, for example, noted that the proposal does not touch upon internal control over financial reporting (ICFR).

Section 404(a) of the Sarbanes-Oxley Act of 2002 requires management to implement ICFR and assess its effectiveness. Section 404(b)requires auditors of larger companies to evaluate their ICFR. And KPMG asked the SEC to clarify when an ICFR is required after de-SPAC.

“In practice, we have observed confusion in determining when ICFR assessments are required,” the firm wrote.

BDO USA, LLP asked the SEC to conform the due date of the first Form 10-Q.

In a traditional IPO, the first quarterly report is due later of “45 days after the effective date of the registration statement or the date on which such report would have been required to be filed if the issuer has been required to file reports on Form 10-Q as of its last fiscal quarter.”

By contrast, following de-SPAC, the due date of the private operating company’s most recently completed interim period financial statements before the merger is based on the SPAC’s filing status.

For example, if the registration statement for a de-SPAC transaction was declared effective on October 14, 2022, and the transaction was executed on November 7, a calendar year-end private operating company’s interim financial statements for the period ended September 30, 2022, would be due on November 14, 2022. But for a traditional IPO, it would be due November 28, 2022.

“We believe the Commission should consider whether an exception to the age requirements for de-SPAC transactions in the Form 8-K with Form 10-equivalent information should be provided to further align the financial reporting requirements following the ‘go public’ transaction,” BDO wrote.

[Thomson Reuters]

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