The US securities regulator has proposed sweeping reforms of special purpose acquisition companies, including stripping them of legal safeguards that have allowed sponsors to present rosy forecasts to potential investors.
On Wednesday the Securities and Exchange Commission voted in favor of proposals that would heighten disclosures on Spac sponsors, in particular their potential conflicts of interest and performance projections. The rules would be more in line with those governing traditional initial public offerings. The steps would hamper executives’ ability to embellish expected revenues and put them at greater risk of lawsuits.
“Investors deserve the protections they receive from traditional IPOs, with respect to information asymmetries, fraud and conflicts,” Gary Gensler, SEC chair, said in a statement. SEC commissioners must take a second vote after receiving public comments in order to enact the proposed rules.
Spacs are shell companies which raise capital by listing on the stock market before seeking a merger with a target company. A deal spree involving Spacs engulfed Wall Street in 2020, but investor interest has since cooled.
Many deals have failed to reach the optimistic forecasts presented to investors.
Virgin Galactic, Richard Branson’s space tourism company, went public in 2019 via a merger with a Spac vehicle backed by the serial promoter Chamath Palihapitiya. While it had projected 2021 revenues of $ 210mn in its investor presentation, the company took in only $ 3.3mn in revenue in that year, missing the forecast by 98 per cent.
AppHarvest, an agritech company which counts Martha Stewart among its board members, projected 2021 revenues of $ 25mn but achieved just $ 9mn.
Spac forecasts, including revenue projections, would lose legal protection under the SEC’s new rules, opening the companies to potential lawsuits.
“The idea is that parties to the transaction should not use overly optimistic language or overpromise future results in an effort to sell investors on the deal,” Gensler said.
Hester Peirce, the SEC’s lone Republican commissioner, dissented in Wednesday’s 3-1 vote. She said the proposals imposed “a set of substantive burdens that seems designed to damn, diminish and discourage Spacs because we do not like them”.
The guidance would also require additional disclosures on Spac mergers’ fairness to investors. Banks that work on the IPOs of Spacs would be required to underwrite the subsequent merger. Underwriters would also be potentially liable for misstatements in connection with the Spac merger.
The SEC is seeking to fix a timeframe in which a deal must be completed under the US’s Investment Company Act, proposing that Spacs must enter into a deal with a target company 18 months after listing, and complete the merger within two years.
As the timeframe to complete a merger stretches out, a risk arises that investors may view Spacs as funds – offering protections typically found in investment vehicles – rather than businesses focused on operating a company, the SEC said.
The SEC’s proposal follows a rush of investigations last year into companies that chose to list on stock markets via Spacs. In December, Digital World Acquisition Corp – a Spac that is merging with Donald Trump’s entertainment start-up, Trump Media and Technology Group – said the SEC was seeking information on dealings between the entities before they revealed their plans in October.
Lucid Motors, an electric car group that listed in a blockbuster Spac deal, said last year that the regulator had requested information on its projections.
Additional reporting by Nicholas Megaw