Executive summary 

• SEC regulations aim to address concerns surrounding transparency and investor protection in SPAC transactions.
• These regulations encompass enhanced disclosure standards, regulatory compliance measures, and stricter guidelines for financial projections within SPAC transactions.
• Dissenting opinions from commissioners underscore the importance of a balanced approach between investor concerns and fostering market efficiency in SPAC markets. 

Introduction

In recent years, Special Purpose Acquisition Companies (SPACS) have gained immense popularity in the finance sector, offering a faster approach for companies to go public rather than your traditional IPO [Initial Public Offering]. SPACs are entities created with the sole purpose of raising capital through an IPO to merge with an existing company within a specified timeframe, typically two years. In contrast, traditional IPOs are established companies seeking to go public by offering shares to the public for the first time. This route involves less regulatory scrutiny upfront compared to the traditional IPO process. Investors in SPACs typically invest based on the reputation, track record of the SPAC’s management team, or rumors in the media, without knowing the specific target company or the SPAC’s investment strategy. This can lead to misalignments of interests and uncertainties for investors. For example, after the merger, the SPAC sponsor may negotiate preferential voting rights or board representation for themselves rather than listening to public shareholders.The SPAC sponsor could also prioritize finishing the deal even at the expense of negotiating favorable terms for SPAC investor. They can set a higher SPAC valuation to compensate the SPAC management team, leading to a dilution of the investor’s shares. 

The Securities and Exchange Commission (SEC) recently announced new regulations to enhance transparency and investor protection during SPAC transactions that align closely with traditional IPO requirements. These SEC rules mandate disclosure requirements, financial projection guidelines, and shell company merger standards during the IPO process and the de-SPAC process which is when the SPAC merges with the target company and becomes a separate entity. The final rule, however, has raised concerns among commissioners over stifling market access to private companies and the broad implications the new regulation holds over the capital markets. As SPACS could become a popular means for companies to go public, new regulations could hinder the availability of capital for businesses affecting access to job opportunities and investment opportunities.

Finalized Rules

Disclosure: New Item 1603(a) requires SPAC to be more open about the relationships and agreements between SPAC’s sponsors and the company it intends to merge with. New Items 1602 and 1604 introduce disclosure requirements regarding potential dilution in SPAC registration statements and de-SPAC transactions. SPAC sponsors must share clear details about factors that contribute to dilution, including fees, alterations in the number of shares held by shareholders, special rights associated with specific shares, and additional funds obtained through private investments.  

Financial Reporting: Furthermore, when it comes to financial reporting the SEC made changes to align reporting requirements with those of traditional IPOs that include how many years of financial history are needed, the standards for auditing the businesses involved before the merger, and how financial statements are presented after the merger.   

Financial Projections: One key requirement is for projections based on historical financial data to be distinguished from projections that are without such a basis. Now, it is seen as misleading if projections based on past data are shown without giving the same or more importance to the actual historical numbers. Furthermore, the guidelines specify that any projections utilizing non-GAAP (Generally Accepted Accounting Principles) financial measures must provide a clear definition of each metric, alongside an explanation for its usage instead of standard GAAP measures. Finally, it has to be made clear whether these projections have been endorsed by the board of the target company.  

Rationale for the Rules

Enhanced disclosure requirements in shell company mergers reveal potential conflicts of interest, sponsor compensation, and shareholder dilution which are crucial for transparency and investor protection. These measures address situations where SPAC sponsors’ interests may diverge from those of investors, while also ensuring adequate liability protections. Additionally, the SEC recognizes that there is a potential to be overly optimistic in projections because SPAC sponsors are only compensated if the transaction is completed. Therefore, these regulations seek to eliminate the possibility of misleading investors to promote confidence and fairness.  

Commissioners Dissent

Commissioner Pierce and Commissioner Uyeda have articulated their differing views regarding the regulations on SPACs. They both argue that the commission failed to identify a specific problem necessary for regulatory intervention. Commissioner Uyeda stated that the regulation was driven by a general dislike towards SPACs instead of a targeted response to the identified issues. Commissioner Pierce also reinforces the argument that the proposals are unnecessary in the absence of a demonstrated problem requiring regulatory intervention. There is no empirical evidence that suggests widespread harm in the SPAC market that is necessary for regulatory action, especially when the recent decline in SPAC activity indicates that market forces were addressing the issues without government intervention. These regulations do not allow the market to self-correct and adapt to changing circumstances, possibly stifling innovation and efficiency.  

Furthermore, both commissioners suggest that the regulations would hinder overall access to the public markets without offering significant benefits for investor protection. This would limit opportunities through capital raising, overall reducing the number of public companies. The commissioners then suggest a more measured and nuanced approach that takes into account the unique characteristics and needs of SPACs and small companies.

Conclusion

The recently approved SEC regulations targeting SPACs represent a critical effort to bolster transparency and safeguard investor interests within the dynamic landscape of SPAC transactions. By introducing enhanced disclosure standards, shell company merger standards, and stricter guidelines for financial projections, the SEC aims to address concerns surrounding potential conflicts of interest and misleading information, ultimately fostering greater investor confidence and market integrity. However, dissenting views from Commissioner Pierce and Commissioner Uyeda argue that this market regulation is unnecessary due to the market’s ability to self-correct.