What Should SPACs Make of SEC Chairman Clayton’s Recent Remarks?
By: Carol Anne Huff, Winston & Strawn*
SEC Chairman Jay Clayton’s comments about SPACs on CNBC’s Squawk Box last week were a mixed bag for SPAC sponsors. Although Chairman Clayton expressed his views that SPACs provide “healthy” competition to traditional IPOs, he went on to stress that “for good competition and good decision making, you need good information,” and signaled that the SEC would be looking more closely at disclosure related to sponsor equity and the related incentives of SPAC sponsors.
Sponsors should rest easy that the SEC will not be passing rules setting sponsor compensation. Chairman Clayton made clear that the SEC is “not able to dictate and [the SEC] shouldn’t be able to dictate what those compensation structures are but [it] can dictate that they be disclosed fully and fairly.” Chairman Clayton did not specify where the SEC believes that current disclosure practices might be falling short, other than noting that the SEC views as material the amount of equity held by the sponsor at closing and its bearing on the sponsor’s motivation.
Chairman Clayton stated that the SEC wants to make sure that investors have the benefit of the same level of rigorous disclosure they would have in a traditional IPO, so it is worth comparing the disclosure required in the two types of transactions. In a traditional IPO, there are specific rules and safe harbors dictating how much an issuer can deviate from the size of the offering and price range set forth in the prospectus before the issuer is required to amend the registration statement or provide additional disclosure through a prospectus supplement. In short, the post-closing capital structure and public float are considered material to an IPO investor’s investment decision and the SEC rules operate to ensure that an investor has this information before purchasing shares.
A SPAC’s proxy statement clearly states how much equity is held by the sponsor pre-business combination, as well as the fact that the sponsor receives nothing if a business combination is not completed. However, at the time a SPAC stockholder makes a decision to redeem or votes on the business combination, the SPAC stockholder does not know how many shares will remain outstanding, or in some cases how many shares the sponsor will own. The amount of equity owned by each of the sponsor, the public and the target stockholders at the closing of the business combination will change based upon redemption levels, changes to the mix of stock and cash consideration paid to target stockholders, any sponsor forfeiture agreements tied to cash in trust at closing and any side agreements entered into between the sponsor and third parties with respect to transfers of founder shares or warrants.
SPACs deal with this uncertainty by disclosing in the proxy statement the pro forma capital structure and ownership under two scenarios—minimum and maximum levels of redemptions. Although neither scenario generally ends up representing the actual outcome, investors are aware that actual results could fall anywhere within the disclosed range. It was not clear from Chairman Clayton’s remarks whether it is this inherent uncertainty that concerns the SEC.
Chairman Clayton’s remarks indicate that the SEC is focused on disclosure to SPAC stockholders at the time of the business combination, but he did not draw a distinction between disclosure at the time of the redemption election and disclosure at the time of the vote. The decision whether to elect redemption is actually the more important decision for investors. Stockholder approval of business combinations has become a fait accompli because investors can vote “yes” on the transaction but still exercise redemption rights, and redeeming stockholders are incentivized to vote “yes” so that the deal closes and the warrants have value.
The level of redemptions and whether the issuer has waived any material conditions to closing, such as the minimum cash condition or the condition that the company remain listed, all impact the post-closing capital structure and are material to an investor’s decision whether to remain a stockholder. However, the amount of redemptions is not known until after the redemption deadline. Whether the disclosure in the proxy statement of the range of redemption scenarios and the risk factor discussion of the attendant risks (e.g. lack of liquidity and potential delisting) is sufficient depends on the facts and circumstances of the transaction and whether the SPAC expects that its pro forma capital structure will deviate materially from the downside scenarios disclosed in the proxy statement.
Interestingly, the SEC has always treated the redemption process as an ancillary part of the proxy voting process. Prior generations of SPACs tied the voting decision and the redemption decision together. Stockholder who voted against the business combination could elect redemption by checking a box on their proxy card. As long as SPAC stockholders are voting on the business combination and the redemption is made in connection with the distribution of a proxy statement, the SEC treats the SPAC’s purchase of its shares as a redemption in accordance with the SPAC’s charter rather than as an issuer tender offer.
Because the redemption of shares in connection with a meeting is not an issuer tender offer, the procedural protections available to stockholders in a tender offer do not apply. For example, in a tender offer, in the event of a material change to the offer terms, the offeror must provide updated disclosure and extend the offer period, the offeror cannot purchase shares or arrange for the purchase of shares outside of the tender offer and, if extending the offer period, the offeror must disclose the number of shares that have been tendered to date. Notwithstanding the fact that these procedural rules do not apply, SPACs should ensure that investors have all material information necessary to decide whether to elect redemption.
Now that SPACs have become a path of choice to the public markets and retail investors are increasingly taking an interest in SPACs, it is not surprising that the SEC is looking more closely at SPAC disclosure practices. SPAC transactions have never fit neatly into the SEC’s rules because they are a mix of business combination, initial public offering and tender offer. The SEC will undoubtedly re-examine the way in which it has applied its disclosure rules to SPACs and whether additional protections are needed to ensure stockholders have all material information at all three relevant points—in connection with the IPO, the exercise of redemption rights and voting on the business combination.
*Carol Anne Huff is a partner at Winston & Strawn and regularly advises clients on transactions involving special purpose acquisition companies.