SEC Implements Stricter Rules For SPACs, Elevating Legal Liability For Disclosures

On January 31, 2024, the U.S. Securities and Exchange Commission (SEC) adopted new regulations that amplify legal responsibilities for disclosures related to projected earnings and other material information in deals involving special-purpose acquisition companies (SPACs). The move represents a response to concerns about the risk posed to investors and follows heightened scrutiny of SPACs, which are shell companies designed to raise funds through a listing with the intention of acquiring a private company and taking it public.

The SEC's rule changes target a significant investing tool that has fallen out of favor among equity investors due to perceived regulatory loopholes. The 3-2 vote by the Commission reflects a divided opinion on the proposal, with Republican members suggesting that the rules might further inhibit the use of SPACs.

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The regulatory scrutiny on SPACs intensified after a surge of deals in 2020 and 2021, leading to worries that financial projections from target companies were frequently overly optimistic or misleading. The SEC proposed the rule changes in March 2022, aiming to bring SPACs more closely in line with initial public offering (IPO) rules.

SEC Chair Gary Gensler emphasized that the rules are intended to ensure that SPAC investors receive the same investor protections as those involved in traditional IPOs. The new rules will compel target companies to register with the SEC, holding them responsible for investor disclosures about the deal. Additionally, the regulations demand stricter disclosures regarding compensation for SPAC sponsors, conflicts of interest, and the potential dilution of share value.

The SEC's move was welcomed by Democratic Senator Elizabeth Warren, a notable advocate for financial reform. She commended the SEC's actions, stating that the rules would aid in curbing potential fraud, self-dealing, and abuse associated with SPACs.

The final rule has undergone adjustments based on public comments. Notably, the proposed 18-to-24-month window for SPACs to complete mergers or lose safe-harbor legal protections, and the automatic designation of some SPAC IPO participants as underwriters in subsequent mergers, have been dropped. Instead, the SEC will issue guidance on these matters.

The new regulations will take effect 125 days after publication in the federal register. SPACs already listed are subject to prior regulations if they conclude the acquisition during this 125-day transition period.

These rule changes come at a time when investor enthusiasm for SPAC deals has waned. As of last year, the value of SPAC IPOs had plummeted by 98% to $4 billion from its peak in 2021. Simultaneously, the performance of stocks launched by SPACs has witnessed a decline of over 90%, according to figures from SPAC Research and the financial data firm Solactive.