Dissenting Statement on Final Rule on Special Purpose Acquisition Companies, Shell Companies, and Projections: The Commission Embraces Merit Regulation

Thank you, Chair Gensler, and thank you to the staff for your presentations.

Today, the Commission considers a lengthy adopting release of nearly 600 pages that extensively describes numerous disclosure, dissemination, forward looking statement, liability, and accounting provisions purportedly designed to advance investor protection and facilitate capital formation for special purpose acquisition companies (SPACs). But there may be a far simpler explanation behind what the Commission is doing for SPACs: we simply do not like them. In order to achieve this desired outcome, the Commission seeks to impose crushingly burdensome regulations on SPACs as a form of merit regulation in disguise.

Following the dramatic rise in SPAC IPOs and associated de-SPAC transactions in 2020 and 2021,[1] the Commission had an opportunity to propose a harsh regulatory framework for this investment vehicle and method of accessing the capital markets. Nearly two years after the Commission proposed this rulemaking,[2] the SPAC market is a shell of its former self.[3] Today’s recommendation shows that the Commission intends to never let them return.

According to the Adopting Release, a fundamental premise that underlies this rulemaking is that “[t]he de-SPAC transaction­­ is a hybrid transaction that contains elements of both an [IPO] and [an M&A] transaction…[and] [w]hile structured as an M&A transaction, the de-SPAC transaction also is the functional equivalent of the private target company’s IPO.”[4]

Following that premise, the Commission could have developed a regulatory framework for SPACs that contained elements of its rules for IPOs and M&A transactions. In this framework, the Commission could have balanced the application of the two sets of rules to ensure that SPAC investors receive material information and have adequate recourse for fraudulent behavior and material misstatements or omissions, while at the same time ensuring that SPACs remain a viable method for private companies to become reporting companies and access our capital markets. Market participants would expect such a balanced approach given the Commission’s mission.[5]

Unfortunately, the Adopting Release strays from that mission by imposing rigorous and expansive requirements from nearly every corner of the federal securities laws on SPACs, its IPOs, and any related de-SPAC transaction. This approach may have the effect of discouraging people from forming SPACs or private companies from engaging in a de-SPAC transaction as a way of becoming a reporting company. Over the long term, this may result in fewer opportunities for companies to access our public markets and fewer opportunities for people to make investments.

The Commission lacks statutory authority to outright ban making investments in SPACs or becoming a reporting company via a de-SPAC transaction. Instead, it has resorted to promulgating rules aimed at significantly increasing the costs and decreasing the attractiveness of being associated with SPACs, to the extent that few rational actors would even attempt such an offering. Today’s recommendation effectively constitutes a form of de facto merit regulation.

I will share some examples of this de facto merit regulation.

There are several areas where the Adopting Release will impose more stringent disclosure requirements on SPAC filings than comparable filings not involving SPACs. Left unanswered is why more stringent requirements are necessary if SPACs are to be treated like any other investment vehicle and de-SPAC transactions are to be regulated like traditional IPOs.

• Disclosure Regarding de-SPAC Transactions. Disclosure for the de-SPAC transactions will be broader than the equivalent disclosure for other M&A transactions, including going private transactions involving affiliates, in at least three ways:
  • If the SPAC or the target company makes projections, including those contained in a third-party fairness opinion, disclosure will be required on whether the projections reflect the views of the applicable board or management team as of the most recent practicable date before the filing is disseminated.[6] There is no similar requirement for filings with respect to any other M&A transaction where projections are included.
  • Board members of a SPAC who vote against, or abstained from voting on, approval of the de-SPAC transaction must be identified and, if known, the reasons for the vote or abstention must also be disclosed.[7] Again, this disclosure is not required in any other M&A transaction subject to the Commission’s rules.[8]
  • The SPAC must disclose all “contacts,” which means discussions, that it had with the target company concerning the de-SPAC transaction.[9] In contrast, the buyer in a typical M&A transaction needs to disclose only “material contacts” between it and the target company.[10]
• Disclosure Applicable to “Officers.” The Commission’s general disclosure rules for related-party transactions, compensation, and governance apply to a narrow group of persons defined as “executive officers,” meaning persons who are in charge of a principal business unit, division, or function or perform policy making functions.[11] In the case of SPACs, disclosure regarding conflicts of interest and fiduciary duties in SPAC IPOs and de-SPAC transactions will apply to a much broader group of “officers” of the SPAC or target company, which essentially means anyone holding a title.[12]
• XBRL Tagging in IPO Registration Statement. Registration statements for traditional IPOs do not require any XBRL tagging.[13] However, for SPAC IPOs, the Commission is mandating that certain disclosure included in registration statement must be tagged in XBRL – without any evidence that such tagging would be even used by investors.[14]

Beyond more stringent disclosure requirements, the Adopting Release further engages in de facto merit regulation with respect to treatment of SPACs under the Investment Company Act of 1940 (the “Investment Company Act”). The Adopting Release abandons a problematic safe harbor from the definition of investment company under section 3(a)(1)(A) of the Investment Company Act.[15] But don’t be fooled. What the Commission does instead is arguably worse. Over the course of ten pages of “guidance,” the Commission misapplies existing rules to raise concerns about SPACs that operate beyond arbitrary 12 or 18 month timeframes prior to completing a business combination.[16]

Under the guidance, any SPAC that allocates any portion of its assets to investment securities – such as money market funds – triggers investment company status concerns, even if it complied with the timeframe for completing a business combination set forth in the relevant exchange listing rule. The one-year timeframe emphasized in the guidance is based on a rule granting a temporary exemption from registration as an investment company.[17] Thus, it appears that SPACs – as they typically operate today – are investment companies that must register with the Commission or rely on an exemption.

To be clear, no provision of the Investment Company Act or any rule adopted by the Commission establishes a bright line duration beyond which an entity triggers investment company status concerns under section 3(a)(1)(A). Lacking a legal basis for its guidance, the Commission engages in inappropriate tactics to make irrelevant rules appear relevant. For instance, the Commission dismisses the only timelines that are relevant to SPACs: the duration limits imposed by exchange listing rules. According to the Commission, “those rules were adopted for a different regulatory purpose and do not address investment company status concerns.”[18] Yet, without a hint of irony, the Commission introduces its bright-line duration test by invoking two rules that also were developed for a different regulatory purpose and do not provide a framework for evaluating investment company status.

All types of issuers – not just SPACs – should pay heed to this guidance because the framework for investment company status determinations could have implications for an operating company that temporarily derives income from investment securities. Would a pharmaceutical company that takes more than 12 or 18 months to bring a drug to market suddenly find itself primarily engaged in the business of investing in securities? While targeted at SPACs, the knock-on effects of this guidance could raise serious legal and compliance issues across a wide array of issuers. Part of the Commission’s obligation under the Administrative Procedure Act requires that an administrative agency provide due notice of what is being proposed. With respect to this guidance, that did not occur.

I have more to say regarding the Investment Company Act analysis included in the Adopting Release. However, to respect everyone’s time, I will not raise further issues and will include my additional thoughts when this statement is published on the Commission’s website.

Because of these and other concerns that I have with the Adopting Release, I am unable to support it. However, I thank the staff of the Division of Corporation Finance, the Division of Investment Management, the Division of Economic and Risk Analysis, and the Office of the General Counsel for their work on this rulemaking.

Questions Asked to the Commission Staff at the Open Meeting

1. If there are no SPAC IPOs after this rulemaking, would this be a successful outcome?
2. What should a SPAC at the IPO stage disclose about potential private target companies that it may combine with?
3. The guidance regarding the investment company status of SPACs introduces two relevant timeframes beyond which a SPACs failure to effect a business combination would raise “concerns” that the SPAC is an investment company: 12 months and 18 months. Will the Division of Enforcement refer to these timeframes when evaluating whether the particular facts and circumstances regarding a SPAC cause it to fall within the definition of “investment company?”

Addendum

The Commission’s guidance regarding the investment company status of SPACs has misapplied existing rules to raise concerns about SPACs that operate beyond arbitrary 12 or 18 month timeframes prior to completing a business combination.[19]

The Commission’s guidance states that “a SPAC should consider how its duration falls within the framework of the Investment Company Act…including Rule 3a-2 [thereunder] and the Commission’s position regarding Rule 419 under the Securities Act.”[20] As applied to investment company status determinations, these timeframes are legally irrelevant.

Rule 3a-2 provides a one-year safe harbor during which certain “transient investment companies” need not register as an investment company even though they otherwise would satisfy the statutory definitions set forth in Sections 3(a)(1)(A) or 3(a)(1)(C).[21] The Commission asserts that this one-year timeframe is relevant to the threshold question of whether a particular entity falls within the statutory definition of “investment company.” But that is an improper reading of the exemption since – by its terms – the exemption applies only after an issuer has determined that it falls within the statutory definition. For example, an issuer that determines that it does not satisfy the definition of an investment company never needs to rely on Rule 3a-2. The one-year timeframe is not a test for determining investment company status. Yet the Commission misapplies the rule by incorporating the timeframe into investment company status determinations.

The Commission’s invocation of Rule 419 is equally inapt. Rule 419 requires funds received and securities issued in an offering of penny stock by a blank check company to be placed in an escrow or trust account.[22] The rule provides that the funds held in the escrow or trust account must be returned if the blank check company has not made an acquisition within 18 months of the effective date of its initial registration statement.[23] In adopting the rule, the Commission stated that “although a [trust or escrow account of a blank check company] may be an investment company under the [Investment Company Act], in light of the purposes served by the regulatory requirement to establish such an account, the limited nature of the investments, and the limited duration of the account, such an account will neither be required to register as an investment company nor regulated as an investment company as long as it meets the requirements of Rule 419.”[24] As with Rule 3a-2, the Commission was explaining why an entity that otherwise would satisfy the definition of an investment company need not register as such within the framework of a particular rule. The 18-month duration set forth in Rule 419 is not – and was not considered by the Commission to be – a factor to be considered when evaluating the threshold question of investment company status.

In order to be an investment company under Section 3(a)(1)(A), an issuer must be primarily engaged in the business of investing, reinvesting, or trading in securities.[25] The Commission provides no explanation as to why a SPAC that works toward a business combination in exactly the manner disclosed to investors is suddenly more likely to be “primarily engaged in the business” of investing in securities once it crosses a specified duration threshold.

The Commission could have simply stated that the activities of a SPAC – depending on the facts and circumstances – could trigger investment company status issues. I would have agreed with this statement. However, the Commission went much further by invoking specified duration limits – the shortest of which is pulled from an exemptive rule applicable to entities that are deemed to be investment companies. One might reasonably conclude that the Commission is expressing its view that all SPACs that hold any percentage of their assets in investment securities are investment companies that must either register under the Investment Company Act or qualify for an exemption.

The Commission guidance is full of generic references to a need to consider “all relevant facts and circumstances” when evaluating investment company status.[26] However, as a practical matter, when faced with such strong language, issuers and their legal counsels will need to weigh the risk that the bright line duration limits set forth in the guidance will be used as a basis to bring enforcement actions. This guidance was not subject to notice and comment and it should have no legal force or effect. But if the Commission is bothering to express this view, industry participants are left to wonder whether the Commission means what it says and, more importantly, how staff in the Division of Enforcement may apply such guidance in the years to come.

It is unclear what the Commission sought to achieve by issuing its guidance in this form, but its misapplication of existing rules and general failure to appreciate the impact of its words will impose harmful costs on issuers and their shareholders without any corresponding benefits.