Under New SEC Regulations, SPACs Will Become a Relic of History

Do the new SPAC regulations mean the end of SPAC IPOs? It sure seems that way. Earlier this year, the United States Securities and Exchange Commission (“SEC”) adopted new regulations to enhance disclosures and provide additional investor protections in initial public offerings (“IPO”) by Special Purpose Acquisition Companies (“SPAC”) and in subsequent business combination transactions between SPACs and target companies (“de-SPAC transactions”). (SEC; U.S. National Archives and Records Administration: Federal Register). The new SPAC regulations, which will go into effect on July 1, 2024, are designed to close many of the loopholes that allowed companies to “go public” through SPAC and de-SPAC transactions without the time, cost, and reporting requirements of traditional IPOs. (SEC; Brian Breheny et al., Skadden, Arps, Slate, Meagher & Flom LLP). This article provides a high-level overview of what led to the SPAC craze from 2019-2022, why the SEC adopted new SPAC regulations, and a prediction on the future of SPACs.

Congress passed the Securities Act of 1933 (“Securities Act”) with the primary goals of ensuring that investors are provided with critical information about securities being offered for public sale and prohibiting “deceit, misrepresentations, and other fraud in the sale of securities.” (SEC). A company “goes public” when it sells shares of its stock to the public for the first time, and the most common way of doing this is through an IPO. (U.S. Chamber of Commerce). Companies go public for a variety of reasons, but a primary objective of public offerings is to raise significant capital for the business. (Kate Ashford & Benjamin Curry, Forbes).

Taking a company public through an IPO is a complex and expensive process that typically begins 6-12 months before the desired IPO date. (Pitchbook). An important part of the IPO process is the SEC-mandated “registration statement.” (SEC). In advance of an IPO, the registration statement provides the public with important information about the pre-IPO company, including a description of the business operations, risk factors, management, and audited financial statements. Id. The rationale behind this mandate is that investors must have access to important business information so that they can make an informed investment decision. (SEC).

The history of SPACs goes back thirty years. In 1993, investment banker David Nussbaum and lawyer David Miller invented the SPAC as a new way to give privately held companies access to everyday investors. (Amrith Ramkumar, The Wall Street Journal). In simple terms, a SPAC is a shell company that raises money from private investors, with the primary purpose of acquiring other companies, and then raises additional money through a public sale of securities. Id. Because a SPAC does not have any business operations, the pre-IPO process for a SPAC is expedited in comparison to a traditional pre-IPO company. (Julie Young, Investopedia). As a result, a SPAC may be able to complete a public offering in only a few months, as opposed to 6-12 months for a typical IPO. Id. After the SPAC goes public, it is mandated to acquire a target company within two years. (Max Bazerman & Paresh Patel, Harvard Business Review). The merger between the SPAC and the target company is known as a de-SPAC transaction, and after the de-SPAC transaction is completed, the target company becomes a publicly-listed company. (Christopher Barlow et al., Skadden, Arps, Slate, Meagher & Flom LLP). In essence, a SPAC can go public without sharing important business information and then acquire a privately-held target company with minimal public disclosures. This process, in effect, allows the target company to go public without having to meet the disclosure regime of a traditional IPO. Id.

Since inception and for nearly 25 years, taking a company public through a SPAC transaction was an obscure and uncommon method for taking a company public; until 2016, less than 12% of all IPOs were SPAC IPOs. (U.S. National Archives and Records Administration: Federal Register). Since 2016, however, the number of SPAC IPOs per year has gradually increased, representing 28% of all IPOs in 2019, and by 2020, 55% of all IPOs were SPAC IPOs. Id. In 2022, nearly three of four IPOs were SPAC IPOs. Id. Between 2019 and 2022, the peak of the SPAC IPO craze, seemingly everyone and their cousin had a SPAC – Shaquille O’Neal, Paul Ryan, and William Ackman, to name a few. (Amrith Ramkumar & Maureen Farrell, The Wall Street Journal). SPACs quickly became a cultural phenomenon that not only influenced celebrities and ordinary investors, but also notable companies such as Virgin Galactic and Draft Kings.  Id. The rapid surge in popularity of the SPAC IPO was, and is, of great concern to SEC Commissioner, Gary Gensler, who feels that the SPAC IPOs are being used to circumvent “time-tested investor protections.” (Paul Kiernan, The Wall Street Journal). Gensler’s fears are not unfounded; according to one report, companies that went public through a SPAC IPO have lost more than $100 billion in market value. (Kori Hale, Forbes).

The new SPAC regulations, which go into effect on July 1, 2024, adopt a disclosure regime for SPAC IPOs, and subsequent de-SPAC transactions, that are more closely in line with what is required for traditional IPOs. (SEC). Among the myriad of new requirements under the new SPAC regulations, perhaps most significant is that the SPAC will have to provide detailed disclosures in advance of a de-SPAC transaction, and in certain situations, a target company in a de-SPAC transaction will now be considered a “co-registrant”. Id. As a co-registrant, a target company will now have disclosure responsibilities in the SPAC’s registration statement. Id. Making a target company a co-registrant has the effect of subjecting the target company to liability under Section 11 of the Securities Act. (Ilan Katz, et al., Dentons). In essence, SPACs have been used to circumvent the spirit of the nation’s federal securities laws, which is to protect the investing public. The new regulations eliminate the regulatory loopholes that allowed companies to go public without having to tell investors how the money will be used.

2024 is shaping up to be a big year for the SEC. This year alone, the Commission has adopted, or plans to adopt, 25 new regulations aimed at increasing protections for investors and ensuring efficient capital markets. (Soyoung Ho, Thomson Reuters). Many of these new regulations have received criticism from a range of industry stakeholders, particularly on issues related to cybersecurity and climate change. (Tim Starks, The Washington Post; Richard Vanderford, The Wall Street Journal). The new SPAC regulations, however, are not one of them; this author had trouble finding any significant public opposition to the new SPAC rules since 2022. The reality is that, while the new SPAC regulations are absolutely a win for the SEC, the rate of SPAC IPOs significantly decreased before the regulations were adopted. (Paul Kiernan, The Wall Street Journal). The investing public seems to have caught on to the high-risk nature of SPACs, and in 2023, one year after the SEC first announced the proposed SPAC rules, the number of SPAC transactions decreased by 63%, and as a percentage of IPOs, SPACs went from 73% of all IPOs in 2022 to 43% in 2023. (U.S. National Archives and Records Administration: Federal Register).

The new SPAC regulations have captured the attention of securities attorneys across the country, as demonstrated by, seemingly, every major law firm writing about the legal implications of the new regulations. (see e.g. Kirkland; DLA Piper; Dentons; Holland & Knight; Skadden; Gibson Dunn; Cravath). But at the same time, the SEC has made it quite clear that it wants the number of annual SPAC transactions to eventually be zero. (Paul Kiernan, The Wall Street Journal). So, the reality is that any company thinking about going public through a SPAC IPO might want to skip the analysis of the new SPAC regulations altogether and instead come to terms with the fact that after July 1, it may just be easier to go public through the old-fashioned IPO process.