SEC relies on PSPCs for detailed risk and control disclosures

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Wall Street’s main regulator promises to release new, stricter rules for SPACs, but the agency has already stepped up its review of blank check companies that have become market hot spots in 2020.

Securities and Exchange Commission Challenging Growth Projections, Calls For Details On Risks, Seeks More Information On Internal Controls Of Special Purpose Acquisition Firms, Says Comment Letters It Sent To Firms .

The queries, which the agency makes public after completing its reviews, are part of the SEC’s normal process of combing through company registration statements to ensure critical disclosures don’t mislead investors. . Although the mailing process is routine, the agency’s questions to SPACs are revealing, identifying the main concerns about businesses and the risks their transactions could pose to investors.

“What you see with the comments is another avenue where the SEC is raising concerns or reflecting its scrutiny on this particular area,” said Luke Cadigan, partner at Cooley LLP and former lawyer in the Enforcement Division. of the SEC.

The underlying theme in letters from agency staff to SPACs: Tell us, and potential investors, find out more.

Letters

SPACs are shell companies – without employees or operations – that raise funds, go public and find a promising private company to acquire. The process gives target companies a shortcut to public listings.

Electric car maker Nikola Corp., sports betting company DraftKings Inc. and baker HoHos and Ding Dong Hostess Brands Inc. all went public through the SPAC merger.

Companies submit registration statements to the SEC before certain transactions, such as PSPC mergers. Commission staff selectively review these statements and send letters asking questions before allowing a transaction to proceed.

In commentary letters, SEC staff has peppered PSPC executives with questions about conflicts of interest, how they valued target companies, and how they reduced promising targets from private companies. gain. In some cases, the agency told them to recall pink projections or at least manage expectations, the letters show.

  • At a PSPC that then went public with a seabed mining start-up, the SEC asked for more disclosure on how the plan presented “substantial scientific and logistical challenges” and whether the process of d ‘mining the ocean floor for minerals to make electric car batteries’ will likely take some time. long time.”
  • In another exchange with the company, the SEC asked it to clarify that it had not obtained final regulatory approval or licenses for the collection and processing of underwater polymetallic nodules. In September, this PSPC merged with DeepGreen Metals Inc. and renamed it The Metals Company (TMC) Inc.
  • In July, the SEC asked a PSPC considering going public with a gene therapy company to disclose the company’s history of net losses, its lack of commercial revenue, and the expectation “that it will take several years, if not. never ”, before it markets a product and its expenses will increase substantially if and as it develops products. In September, SPAC, Chardan Healthcare Acquisition 2 Corp., finalized a merger with Connecticut-based Renovacor Inc.

In other cases, the regulator has delved into one of the biggest criticisms of SPACs, which is that the pressure to find a target company to go public on a short notice can mean that a target is not ready for it. prime time.

The SEC has asked many companies to make general disclosures that the sponsor, certain board members and officers would benefit from the completion of a merger and “may be pressured into completing the acquisition of a company.” less favorable target or under conditions less favorable to shareholders than liquidation. The SEC requested such disclosures in July from CM Life Sciences II Inc., New Beginnings Acquisition Corp. and Amplitude Healthcare Acquisition Corp., among others.

The pressure to close on a target is a key risk that investors and academics have highlighted about PSPCs.

“Sponsors are encouraged to make a deal – any deal – because they lose all of their money unless there is an acquisition,” said Usha Rodrigues, president of corporate finance and law. of Securities at the University of Georgia Law School.

Warnings

As the SPAC market was booming in 2020 and early 2021, the SEC began raising red flags. In the spring of 2021, the regulator warned investors not to invest money in PSPCs solely because of celebrity approval, and in a separate alert, it signaled that the rush to go public could lead to accounting and auditing pitfalls for young private companies.

In April, agency accountants intervened. An announcement from SEC staff said PSPCs should account for warrants – important fundraising tools ubiquitous in PSPC transactions – as liabilities, not equity. The announcement interrupted the initial public offerings and led hundreds of SPACs and the companies they had made public to remake or restate their past financial results.

When Gary Gensler took over as head of the agency in April of this year, he promised a more in-depth review of SPAC.

“There are a lot of fees and potential conflicts inherent in PSPC structures, and investors should be given clear information so that they can better understand the costs and risks,” Gensler said in prepared remarks to the Financial Services Committee. of the House on October 5.

In July, the SEC’s Enforcement division sued Stable Road Acquisition Corp. and space transportation company Momentus Inc. for allegations that they lied about the space company’s technology, including a false claim that its propulsion system had been “successfully tested” in space. The SEC fined the companies and its executives more than $ 8 million, less than a month before PSPC went public with the space travel company.

“It was an indication that they were going to be aggressive in this space,” Cooley’s Cadigan said of the law enforcement announcement.

The SEC investor advisory committee also recommended that the SEC strengthen information on the main risks associated with investing in SPACs.

Some of the questions posed by the SEC in the most recent series of publicly available letters reflect concerns raised by groups like the Advisory Group. In some cases, the SEC has asked companies to highlight the lucrative structure of a SPAC to make it clear that early investors can make money as soon as the SPAC has completed a merger, the operating company is successful. or not. The agency has asked several companies to clarify whether sponsors and affiliates can achieve positive returns “even if other PSPC shareholders experience a negative rate of return” after the merger.

PSPCs monitor the agency’s movements. Some are considering including additional details in their files, as the advisory committee recommended, even if they are not obligated to, said Mark Wood, co-head of national capital markets practice at Katten Muchin Rosenman LLP.

“We’re always thinking about ways to improve our disclosure to make sure we’re providing the best information, and also to avoid SEC commentary,” he said.

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