Wall Street’s watchdog on Wednesday unveiled a draft new rule to enhance blank-cheque company investor disclosures and to strip them of a legal protection critics argue has allowed the shell companies to issue overly optimistic earnings projections.
The move by the United States Securities and Exchange Commission (SEC) is part of a broader crackdown on special purpose acquisition companies (SPACs) after a frenzy of deals in 2020 and early 2021 sparked concerns that some investors are getting a raw deal.
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Wall Street’s biggest gold rush of recent years, SPACs are shell companies that raise funds through a listing to acquire a private company and take it public, allowing the target to sidestep the stiffer regulatory scrutiny of a traditional initial public offering (IPO).
The SEC proposal, which is subject to consultation, broadly aims to close that loophole by offering SPAC investors protections similar to those they would receive during the IPO process, the SEC said.
“Today’s proposal, if adopted, would represent a sea change to the rules applicable to SPACs,” John Ablan, a partner at law firm Mayer Brown who advises companies on deals including IPOs, wrote in an email. “The SEC is clearly focused on creating incentives … to undertake the same amount of due diligence that would be done in a traditional IPO.”
The rule would require SPACs to disclose more details about their sponsors, their compensation, conflicts of interest and share dilution.
It would also enhance disclosures about the target takeover, known as the “de-SPAC,” more information, including the sponsor’s view on whether the deal is fair to investors and whether the proposed transaction has been vetted by third parties. Such disclosures would have to be issued at least 20 days prior to any solicited votes on the acquisition.
“Companies raising money from the public should provide full and fair disclosure at the time investors are making their crucial decisions to invest,” SEC Chair Gary Gensler said.
The rule would also strip SPACs of a liability-safe harbour for forward-looking statements, such as earnings projections.
The SEC has stepped up oversight of SPACs amid worries of inadequate disclosures and lofty revenue projections. Reuters news reported last year that the SEC was considering new guidance to rein in SPACs’ growth projections.
SPAC sponsors say the projections are important for investors, especially when targets are unprofitable startups, but investor advocates say they are frequently wildly optimistic or misleading but have been shielded by the legal safe harbour.
Improving disclosures “might not necessarily spell the death of SPACs, but I hope that better disclosures push them to evolve into less costly and more sensible forms,” said Michael Ohlrogge, a New York University law professor who has criticised SPACs for not being upfront with investors about their full costs.
If SPACs do not meet certain conditions they may have to register as investment companies, subjecting them to a slew of other rules, the SEC said.
Those conditions include: maintaining assets in certain forms, entering into a deal with a target within 18 months of the SPAC IPO, closing the transaction within 24 months and ensuring that the newly merged company engages primarily in the same business as the target.
Gatekeepers who facilitate the deals, such as auditors, lawyers and underwriters, should also be held responsible for their work before and after the SPAC listing, Gensler added.
The US SPAC market experienced a wild ride in 2021, with an explosion in deals during the first half of the year that quickly cooled off in the second half. All told, 604 SPACs raised $144bn in 2021, according to data from Renaissance Capital.