5/26/21 - Insights
SPACs Stand or Fall on Their Disclosures
The special purpose acquisition company (SPAC) boom has hit a major roadblock in the form of faulty disclosures. The recent deluge of SPAC litigation has mainly focused on these disclosures—specifically, disclosures made during the SPAC’s initial public offering as well as the de-SPAC transaction (wherein a SPAC purchases a private company, making it public). One recent lawsuit naming the so-called “King of SPACs,” Chamath Palihapitya, focused on a number of allegedly misleading and fraudulent statements made in the SPAC’s Form S-4 Registration Statement. Another, a class involving LiDAR technology intended for use in autonomous vehicles, targeted statements made in the SPAC’s 10-Q concerning various aspects of the company’s performance.
In both of these, as well as numerous other SPAC lawsuits, plaintiffs allege that the SPAC made representations through its disclosures that its performance, financial position, and/or future outlook were far rosier than was actually the case. When the truth came out, stock prices dropped precipitously, leading to major losses.
Given the centrality of the SPAC’s disclosures to a plaintiff’s claims, SPACs need to take special care in crafting their disclosures going forward. This article will examine how SPACs can use guidance issued by the SEC to craft robust disclosures that will weaken a plaintiff’s claims.
Arguably the single most important subject of SPAC disclosure—whether in the SPAC’s IPO or in the de-SPAC business combination—concerns the duties owed by SPAC sponsors (typically investment firms, wealthy individuals, etc.), directors, and officers. Often, a SPAC’s directors and officers may hold positions with the SPAC sponsor or an entity controlled by the SPAC sponsor. The directors’ and officers’ dual roles may therefore create conflicts of interest.
This conflict often arises from the way in which SPAC sponsors are compensated for successfully completing a de-SPAC transaction, typically a 25 percent share, free of charge. As a result of this “promote,” SPAC sponsors have a vested interest in consummating de-SPAC transactions. Because these transactions are subject to shareholder approval, a SPAC may lean towards crafting its disclosures concerning the target corporation in a way that makes the acquisition more likely.
Seen in this light, the potential conflicts between the duties owed to SPAC shareholders and the potentially lucrative incentives in completing the de-SPAC transaction provide fertile ground for plaintiff’s claims. To minimize litigation risk, SPACs should strongly consider making disclosures regarding the following topics:
- Disclosure of the relationship between the SPAC sponsor and the SPAC’s officers and directors, including any employment relationship between the SPAC sponsor and the officers and directors.
- Disclosure of any compensation that may be paid to the SPAC’s officers and directors upon consummation of the de-SPAC transaction.
- Disclosure of the financial benefits that may be realized (e.g., the promote) by a SPAC sponsor, or its directors and officers, in the event that a de-SPAC transaction is successfully consummated.
- Disclosure of any interest in the target company held by the SPAC sponsor or any SPAC officer or director.
- Disclosure of the potential losses that SPAC sponsors, officers, and directors may suffer if the de-SPAC transaction is not consummated.
- Disclosure of the diligence that was conducted in identifying a target for the de-SPAC transaction as well as the diligence done in developing deal terms.
- Disclosure of the amount of control, or lack thereof, exercised by the SPAC sponsor, directors, and officers. A SPAC could also consider the use of an independent committee to identify an acquisition target as well as vet deal terms. If a SPAC uses a committee as a part of this process, disclosure of such use is also to be considered.
II. Litigation Impact
The Securities Exchange Act of 1934 contains one of the most relevant provisions for SPAC-related litigation. Section 14(a), along with so-called Rule 14a-9, regulates the type of statements that can be made to solicit investment in a SPAC. That rule prohibits the making of statements which, at the time of their making, are “false or misleading with respect to any material fact, or which omit material facts necessary” to make the statements “not false or misleading.”
The SEC itself has highlighted the applicability of Section 14(a) and Rule 14a9 to a SPAC’s disclosures, noting:
De-SPAC transactions also may give rise to liability under state law. Delaware corporate law, in particular, conventionally applies both a duty of candor and fiduciary duties more strictly in conflict of interest settings, absent special procedural steps, which themselves may be a source of liability risk. Given this legal landscape, SPAC sponsors and targets should already be hearing from their legal, accounting, and financial advisors that a de-SPAC transaction gives no one a free pass for material misstatements or omissions.
Because Rule 14a9 focuses on statements that are either directly “false and misleading” or that otherwise omit essential information, disclosures of the items noted above may go a long way towards gutting a plaintiff’s ability to bring claims premised on a SPAC’s disclosures. As the adage goes, sunshine is the best disinfectant: plaintiffs may face difficulties alleging that a SPAC misled them if the SPAC’s disclosures follow SEC guidelines.