What the Shell? Understanding the SEC’s Latest Rule for SPACs

By: Liam Sullivan

Last month, SEC Commissioners adopted new rules regarding special purpose acquisition companies (SPACs), concluding a years-long effort to increase transparency and protections around investments in SPACs and the acquisition (de-SPAC) and initial public offering (IPO) of existing companies using this investment vehicle. The SEC turned a critical eye towards SPACs during a surge in SPAC funding and IPOs in 2020 and 2021, first proposing a rule in March 2022.[1] SEC Chair Gary Gensler reiterated the SEC’s focus on investor protections and bringing rules regarding SPAC funding and IPOs in-line with the traditional IPO process, succinctly summarizing his position, “Functionally, the SPAC target IPO is being used as an alternative means to conduct an IPO.”[2]

Preceding the SEC’s rule proposal, the SEC’s Investor Advisory Committee (IAC) recommended action, with one member explaining that the Committee “recommended that the commission staff dig in a little harder and push as hard as they can on the disclosure to try to help retail investors.”[3] The proposed rule and its now-finalized version retains this emphasis on investor protection and responds to an unprecedented increase in SPAC funding in recent years.[4] In 2020 and 2021, there were over 850 SPAC IPOs, raising more money in each year than all prior years combined.[5] While SPAC proponents point to broader market trends and caution against cherry-picking anecdotal failures, the many companies that merged with SPACs lost or never realized that initial investor value.[6] In 2023 alone, twenty one firms that utilized SPACs filed for Chapter 11 bankruptcy, including WeWork.[7] In adopting the rule, Gensler emphasized the need to protect investors from this uncertainty, explaining, “Whether you are doing a traditional IPO or a SPAC target IPO, SPAC investors are no less deserving of our time-tested investor protections.”[8]

The SEC’s rule targets two phases of the SPAC process, the fundraising venture for the shell company and the “de-SPAC” merger process.[9] SPACs have been described as exploiting a loophole in securities laws that skirt traditional disclosure requirements and review by the SEC to expedite capital collection.^[10] This latest SEC action effectively closes that loophole, creating reporting requirements for de-SPAC transactions similar to IPOs and labeling business combination transactions conducted by SPACs as a sale of securities.^[11] These actions effectively stop the convenience of SPAC IPOs, requiring the SPAC managers or holders to disclose details such as the target company or other revenue projections that they previously either held close or could share confidentially and informally with would-be investors.[12] This new rule changes the convenience of SPACs (and the de-SPAC process) as a method to sidestep traditional IPO requirements, but in no way abolishes it.[13] Notably, the rule requires the target companies to sign their registration statements, subjecting them to new disclosure requirements and standards that they previously avoided.[14] While the various levels of fiduciary duty remained subject to debate amongst regulators, Wall Street, and academics, the new rule alters the SEC’s definition of “blank check company” to foreclose safe harbor for forward looking statements under the Private Securities Litigation Reform Act (PSLRA), bringing these regulations in line with those applied to traditional IPOs.[15] While investors and regulators may not agree on all facets of the new regulation, this rule will provide clarity for all parties moving forward, permitting future de-SPAC transactions to operate with new consumer protections and clearer guardrails.

[1] Gary Gensler, Statement on Proposal on Special Purpose Acquisition Companies (SPACs), Shell Companies, and Projections, Sec. and Exch. Comm’n (Mar. 30, 2022) https://www.sec.gov/news/statement/gensler-spac-20220330.

[2] Bob Pisani, SEC to Vote Today on Tough New Rules for Blank-Check ‘SPAC’ Companies, CNBC (Jan. 24, 2024) https://www.cnbc.com/2024/01/24/sec-to-vote-today-on-tough-new-rules-for-blank-check-spac-companies.html

[3] Soyoung Ho, Investor Advisory Committee Recommends Stronger SEC Regulation of SPACs, Reuters (Sept. 15, 2021) https://tax.thomsonreuters.com/news/investor-advisory-committee-recommends-stronger-sec-regulation-of-spacs/.

[4] Sec. and Exch. Comm’n, Special Purpose Acquisition Companies, Shell Companies, and Projections, Release Nos. 33-11265; 34-99418, p. 19, to be published at 17 CFR Parts 210, 229, 230, 232, 239, 240, and 249 (published Jan. 24, 2024) https://www.sec.gov/files/rules/final/2024/33-11265.pdf (“While we recognize that the number of SPAC IPOs has declined since 2021, the investor protection concerns regarding SPACs and the hybrid nature of the de-SPAC transaction identified in the Proposing Release do not depend on market fluctuations.”)

[5] Soyoung Ho, SEC Poised to Adopt Tougher Rules for SPACs, Reuters (Jan. 19, 2024) https://tax.thomsonreuters.com/news/sec-poised-to-adopt-tougher-rules-for-spacs/ (“In 2020, there were 248 SPAC IPOs, followed by 613 at its peak in 2021.”); Amrith Ramkumar, The SPAC Ship is Sinking. Investors Want Their Money Back, Wall Street Journal (Jan. 21, 2022) https://www.wsj.com/articles/the-spac-ship-is-sinking-investors-want-their-money-back-11642761012 (“SPACs have been around for decades…but raised more than $80 billion in 2020, topping the amount raised in all other years combined. Last year, they raised over $160 billion, accomplishing that feat again.”).

[6] William Cohan, The Spac Bubble and Bust is one for the History Books, Financial Times (Nov. 24, 2023), https://www.ft.com/content/83f0feba-5168-44da-90d7-b0aa11030cf0 (“The Spac’s stock soared about 500 per cent. The value of Klein’s, and his fellow sponsors’, $43mn investment in the Spac was suddenly worth some $3.3bn on paper, according to Reuters. The implied value of Lucid was $56bn. The closing of the deal was still five months away. These days Lucid is valued at $10bn and the stock is down 92 per cent from its peak.”).

[7] Bob Pisani, SEC to Vote Today on Tough New Rules for Blank-Check ‘SPAC’ Companies, CNBC (Jan. 24, 2024) https://www.cnbc.com/2024/01/24/sec-to-vote-today-on-tough-new-rules-for-blank-check-spac-companies.html; (“In 2023, the SPAC craze collapsed. Bloomberg data cited by Forbes indicated that 21 firms that had gone public via SPACs went bankrupt in 2023, the largest of which was flexible workplace provider WeWork.”).

[8] Gary Gensler, Statement on Final Rules Regarding Special Purpose Acquisition Companies (SPACs), Shell Companies, and Projections, Sec. and Exch. Comm’n (Jan. 24, 2024) https://www.sec.gov/news/statement/gensler-statement-final-rule-012424.

[9] Id. (“There are two stages embedded in the SPAC process. First is when a blank-check company raises money from the public through an IPO, what I call the SPAC blank-check IPO. Second involves the merger or de-SPAC, what I call the SPAC target IPO.”).

[10] Daniel Morrissey, Special Purpose Acquisition Companies: Wall Street’s Latest Shell Game, 75 Ark. L. Rev. 465, 466 (2022).

[11] Sec. and Exch. Comm’n, Special Purpose Acquisition Companies, Shell Companies, and Projections, Release Nos. 33-11265; 34-99418, p. 1-2, to be published at 17 CFR Parts 210, 229, 230, 232, 239, 240, and 249 (published Jan. 24, 2024) https://www.sec.gov/files/rules/final/2024/33-11265.pdf.

[12] Gary Gensler, Statement on Final Rules Regarding Special Purpose Acquisition Companies (SPACs), Shell Companies, and Projections, Sec. and Exch. Comm’n (Jan. 24, 2024) https://www.sec.gov/news/statement/gensler-statement-final-rule-012424 (“First, the final rules will require additional disclosures from issuing companies at both the SPAC blank-check IPO stage as well as the SPAC target IPO… Second, the final rules make SPACs accountable for their forward-looking statements.”).

[13] Sec. and Exch. Comm’n, Special Purpose Acquisition Companies, Shell Companies, and Projections, Release Nos. 33-11265; 34-99418, p. 19, to be published at 17 CFR Parts 210, 229, 230, 232, 239, 240, and 249 (published Jan. 24, 2024) https://www.sec.gov/files/rules/final/2024/33-11265.pdf (“we are adopting final rules that will provide for greater transparency and more robust investor protections in SPAC IPOs and de-SPAC transactions. The final rules will enhance the completeness, usefulness, and comparability of the disclosures provided by SPACs and target companies at the SPAC IPO and de-SPAC transaction stages and will provide other important protections for investors in this market, all of which may promote market efficiency.”)

[14] Gary Gensler, Statement on Final Rules Regarding Special Purpose Acquisition Companies (SPACs), Shell Companies, and Projections, Sec. and Exch. Comm’n (Jan. 24, 2024) https://www.sec.gov/news/statement/gensler-statement-final-rule-012424. (“the final rules address issuer obligations and liability with regard to SPAC target IPOs. In particular, the final rules require SPAC targets to sign the de-SPAC registration statements, thus making them liable for false or misleading disclosure.”); see also Sec. and Exch. Comm’n, Special Purpose Acquisition Companies, Shell Companies, and Projections, Release Nos. 33-11265; 34-99418, p. 170, to be published at 17 CFR Parts 210, 229, 230, 232, 239, 240, and 249 (published Jan. 24, 2024) https://www.sec.gov/files/rules/final/2024/33-11265.pdf (“we are adopting as proposed…(b) General Instruction I.2 to Form F-4”).

[15] See generally Amanda M. Rose, SPAC Mergers, IPOS, and PSLRA’s Safe Harbor: Unpacking Claims of Regulatory Arbitrage, 64 Wm. & Mary L. Rev. 1757 (2023); see Sec. and Exch. Comm’n, Special Purpose Acquisition Companies, Shell Companies, and Projections, Release Nos. 33-11265; 34-99418, p. 256, to be published at 17 CFR Parts 210, 229, 230, 232, 239, 240, and 249 (published Jan. 24, 2024) https://www.sec.gov/files/rules/final/2024/33-11265.pdf (“we are adopting a definition of “blank check company” under the PSLRA in Securities Act Rule 405 and Exchange Act Rule 12b-2 to clarify that such definitions are solely for purposes of the PSLRA and not for purposes of any other rules.”).