Yesterday, the SEC announced rule proposals intended to enhance disclosure and investor protection in SPAC initial public offerings and in de-SPAC transactions. Here’s the 372-page proposing release & here’s the 3-page fact sheet. The SEC is pitching the proposal as a way to level the playing field between SPACs & traditional IPOs, which SEC Chair Gary Gensler emphasized in his statement on the proposal. This excerpt from the fact sheet summarizes the additional disclosure & investor protections for SPAC IPOs & de-SPACs that would be put in place under the proposed rules:
– Enhanced disclosures regarding, among other things, SPAC sponsors, conflicts of interest, and dilution;
– Additional disclosures on de-SPAC transactions, including with respect to the fairness of the transactions to the SPAC investors;
– A requirement that the private operating company would be a co-registrant when a SPAC files a registration statement on Form S-4 or Form F-4 for a de-SPAC transaction;
– A re-determination of smaller reporting company status within four days following the consummation of a de-SPAC transaction;
– An amended definition of “blank check company” to make the liability safe harbor in the Private Securities Litigation Reform Act of 1995 for forward-looking statements, such as projections, unavailable in filings by SPACs and certain other blank check companies; and
– A rule that deems underwriters in a SPAC initial public offering to be underwriters in a subsequent de-SPAC transaction when certain conditions are met.
The proposal would also add a new Rule 145a, which provides that a business combination involving a reporting shell company and another entity that is not a shell company constitutes a “sale” of securities to the reporting shell company’s shareholders. The proposal also addresses the status of SPACs under the Investment Company Act and would establish a non-exclusive “safe harbor” for SPACs that, among other things, enter into a de-SPAC agreement within 18 months of their IPO & complete the deal within 24 months following the IPO.
The proposed rules about the fairness of the transaction would require disclosure similar to that required in going private deals and, like the going private rules, are intended to incentivize sponsors to shape the transaction process in a more investor-favorable way. The biggest news in the rule proposal is probably the loss of the PSLRA safe harbor for projections in de-SPAC transactions, which is something that the Staff has telegraphed was coming for a long time. However, the extension of Section 11 liability to the de-SPAC target & the potential that the IPO underwriters might also face Section 11 liability for the de-SPAC are also significant. As usual, Tulane’s Ann Lipton has a Twitter thread that’s full of insights on some of the issues raised by the proposal
SPACs’ status under the Investment Company Act has been another hot topic in recent months, and the safe harbor approach came as a bit of a surprise to me in light of the publicly expressed views of the current head of the SEC’s Division of Investment Management. Frankly, if the SEC wanted to drive a stake through the heart of SPACs, this could have been the place to do it.
Commissioner Peirce once again dissented from the SEC’s decision, essentially arguing that the SEC came to bury SPACs, not to regulate them. She states that the rules would impose “a set of substantive burdens that seems designed to damn, diminish, and discourage SPACs because we do not like them, rather than elucidate them so that investors can decide whether they like them.”
As per the new normal for comment periods, this one expires 30 days after publication in the Federal Register or May 31, 2022, whichever is later.
While the SEC’s latest rule proposal has the greatest relevance to SPACs & shell companies, there’s one aspect of it that applies to all public companies – proposed tweaks to the agency’s guidance on the inclusion of projections in SEC filings (see p. 130 of the release). That guidance is laid out in Item 10(b) of Reg S-K and the proposal would inject some familiar concepts from Reg G into that guidance. Specifically, the SEC proposes to amend Item 10(b) to state that:
– Any projected measures that are not based on historical financial results or operational history should be clearly distinguished from projected measures that are based on historical financial results or operational history;
– It generally would be misleading to present projections that are based on historical financial results or operational history without presenting such historical measure or operational history with equal or greater prominence; and
– The presentation of projections that include a non-GAAP financial measure should include a clear definition or explanation of the measure, a description of the GAAP financial measure to which it is most closely related, and an explanation why the non-GAAP financial measure was used instead of a GAAP measure.
The SEC would also amend the guidance to clarify that it applies to the projections of any entity included in the filing, such as the target in a business combination transaction.
If a 506-page proposing release on climate disclosure rules wasn’t enough to convince you that climate change was top of mind at the SEC, this CompanyIQ report says that 1/3rd of S&P 500 comment letters released during the 90 days ended March 4, 2022 asked companies to provide additional information on climate disclosure.
If you’re thinking about initiating a stock repurchase during the current period of global turmoil and market volatility, be sure to check out this Skadden memo. It provides a comprehensive overview of the strategic & legal considerations, alternative transaction structures, and the pros and cons of repurchasing stock. This excerpt addresses the implications of a decision to engage in a buyback on earnings guidance:
How should a company consider earnings guidance preceding the company’s implementation of a share repurchase program?
As in the ordinary course of business, a company contemplating a share repurchase should examine its past earnings guidance to ensure that subsequent developments have not rendered such guidance materially misleading. Companies should pay close attention to earnings guidance given in the midst of a turbulent market and uncertain economic conditions because such guidance is more likely to be revealed, in hindsight, to have been based on faulty assumptions. Overly pessimistic guidance runs the risk of inducing investors to participate in a share repurchase where they otherwise would have abstained, particularly where more accurate projections would have pointed to stronger future earnings.
To minimize the risk of potential liability under Rule 10b-5 in the current market environment, a company contemplating a share repurchase should be wary of allowing too much time to elapse between releasing its earnings guidance and implementing a share repurchase program. Initiating a contemplated share repurchase close to the time earnings guidance is released reduces the likelihood of subsequent developments retroactively rendering such guidance materially misleading. If developments arise that cause a company’s prior earnings guidance to be misleading, the company should consult counsel and update such guidance before proceeding with its share repurchase.
The SEC has issued proposed rules intended to promote increased transparency when it comes to stock buybacks, but according to this NY Times DealBook report, the Biden Administration intends to go much further, and will propose legislation to discourage buybacks by hitting public company executives right in their wallets:
The White House plans to propose new restrictions on buybacks, DealBook has learned. This could have further-reaching implications than its plan for a minimum tax for billionaires that’s also expected to be announced today. The buyback proposal goes beyond the 1 percent tax on share repurchases that was part of the administration’s ill-fated $2.2 trillion climate and social spending bill last year, which was meant to raise around $124 billion in tax revenue.
The proposal will call for a three-year freeze on corporate executives selling their shares after a buyback. To support this move, the administration is likely to cite academic research that found company executives tend to sell far more stock in days following a buyback announcement than at any other time. Other research shows that buybacks have accounted for an increasingly large share of corporate profits (often more than 50 percent of net income) over the years. Apple has spent more than $420 billion buying back its shares over the past decade.
Call me a cynic, but if the objective is to reduce the level of buybacks, I think this approach is likely to be very effective. But people are already raising objections about the potential unintended consequences, including a jump in executive comp. Here’s an excerpt from this Forbes article, which says the proposed legislation is a bad idea:
Third, if the targeting of stock buybacks leaves top executives worse off financially, then you can expect CEOs to demand a hike in their cash pay to make up the difference. That may happen because some business leaders will feel (rightly) unfairly targeted by the government. Or it may be that job offers arrive from other countries with more liberal regulations. Either way, the war for top talent will result in fatter executive paychecks.
Like I said, you can call me a cynic, but I think this is also very likely to happen if the proposal becomes law. Of course, I also think that the sun rising tomorrow will very likely result in increased CEO pay.
When the SEC issued its cybersecurity disclosure rule proposals earlier this month, it said that the comment period would expire 60 days following publication of the proposing release on the SEC’s website or 30 days following publication of the proposing release in the Federal Register, whichever period is longer. I guess I’m not surprised that an MIT professor turned SEC Chair would make us do math – but seriously, why did it have to be word problems?
Anyway, the proposal was published in the Federal Register on March 23rd, which means by my calculations – and the statement in the online version of the Federal Register – that the comment period will end on May 9th.
If your company or clients are among the ever-growing group of businesses that are looking to exit Russia following that nation’s invasion of Ukraine, you may want to take a look at this two-part guide to the decision-making process from The Conference Board. The first part reviews the actions that companies have taken to sever ties with Russia, provides advice on developing a clear and consistent decision-making framework, and offers guidance on how companies can prepare for situations involving violations of international law and human rights.
The second part focuses on disclosure & communications and discusses compliance with SEC disclosure requirements and corporate communications policies to describe the actions they have taken. Here’s an excerpt about some of the things to consider when corporate disclosures that go beyond regulatory requirements:
Many companies that have or had operations in Russia have engaged in communications other than those required by the SEC, such as statements by management and social media postings designed to communicate the companies’ commitment to corporate purpose, corporate citizenship, and other values underpinning their decision to suspend or continue operations in Russia. These statements can also serve other purposes, such as demonstrating that the decision to leave or not leave Russia is consistent with short- or long-term strategy.
However, these communications do not stand alone; they need to be considered in the context of SEC requirements and prohibitions and must also be consistent with the company’s communications policy. Among other things, companies should align their informal communications with the information in their SEC filings, as inconsistencies may raise comments from the SEC or subject the company to liability.
The content of informal communications, as well as their preparation, review, and dissemination, needs to be handled in accordance with the company’s communications policy. These internal policies, many of which reflect the requirements of SEC Regulation FD, often require reviews by specified individuals or groups, indicate who is authorized to speak for the company, and direct members of management and the board—and in some cases all employees—that any questions from the media or otherwise must be referred to a designated spokesperson.
Adhering to these policies will help make these communications “consistent, appropriate in tone, and reasonable in terms of time horizon and other factors.” He also points out that companies need to monitor developments so that their communications remain relevant and reflect reality. Above all, he says that companies must keep their boards informed so that they can provide appropriate oversight to the communications process & suggests that boards review these communications before they are issued.
Be sure to check out our “Ukraine Crisis” Practice Area for resources dealing with disclosure, sanctions compliance and other issues associated with the crisis.
Russia’s invasion of Ukraine has presented companies with an unprecedented decision – should they cut all ties with the world’s 11th largest economy? Companies pondering next steps when it comes to their Russian business operations should keep in mind that the eyes of the media – and their investors – are on them. In that regard, Yale School of Management Prof. Jeffery Sonnenfeld is maintaining a list of over 400 companies with Russian operations and their current status.
The list is graded – in order to earn an “A”, companies must have made a “clean break” with Russia. Companies temporarily curtailing their Russian operations while keeping return options open earn a “B” grade, while those scaling back some business operations while continuing others rate a “C”. Companies that are buying time by postponing new investments but maintaining current operations get a “D”, while those are digging in & defying calls for severing ties rate an “F”.
What’s the impact of this list? Well, it’s been credited in the media with helping accelerate the exodus of U.S. businesses from Russia, but it also looks like it’s having a bottom-line impact on those that have decided to stay. According to a recent Fortune article by Prof. Sonnenfeld, those companies identified as “digging in” have taken a sizeable hit to their stock prices:
Finally, our list provided a much cited “hall of shame” that guided the voices of employees, customers, and investors seeking to show their disapproval. In fact, the first day our list appeared on CNBC, many of the companies we identified as remaining in Russia saw their stocks drop 15% to 30%, on a day where the key market indexes fell only two to three percent.
This WSJ article discusses another issue that companies that continue operations in Russia, especially those that do so for “humanitarian” reasons, have to address – what do you do with the profits you’ve earned there?
Cutting business ties with Russia will cause financial losses – and in some cases, the amount involved can be staggering. Companies will likely look for ways to recoup some of these losses, and this Reuters article notes that one source may be political risk insurance. While standard insurance policies don’t cover extraordinary events like the fallout from Russia’s invasion of Ukraine, the article notes that $1 billion of political risk insurance was issued in 2020 alone for companies with Russian operations.
Unfortunately, having a political risk policy doesn’t mean that companies withdrawing from Russia will necessarily have a claim under it. This excerpt explains:
Companies that leave and abandon their business without any action taken by the Russia government to seize control of their assets will have a tough time collecting insurance, according to legal experts. “You see companies saying ‘we’re leaving because we support Ukraine.’ The question is then whether the policy covers a voluntary departure,” said Micah Skidmore of the law firm Haynes and Boone. Insurers are most likely to pay claims for revenues earned in Russian roubles that are no longer convertible to foreign currency, said legal experts.
The article says that additional actions by Russia that could support claims under political risk policies include asset seizures and nationalization of industries – all of which appear to be on the table.
One thing about the SEC’s climate change rule proposal seems pretty certain – if the rules are adopted in their current form, they are going to face legal challenges. On what grounds might the validity of the SEC’s climate change rules be subject to attack? This excerpt from Davis Polk’s recent blog on the rule proposal provides some insights:
Challenges to the SEC’s statutory authority. Nothing in the federal securities laws expressly authorizes the SEC to require the disclosures contemplated by the proposal. Instead, these laws generally permit the SEC to require disclosure that is “necessary or appropriate in the public interest or for the protection of investors.”
One of the SEC’s central arguments in support of its authority is that many investors—including certain large institutional investors—have expressed a desire to receive climate-related disclosure. However, public interest alone may not be enough to meet the statutory threshold, if a hypothetical “reasonable investor” would not find the required disclosure necessary for investment or voting purposes. This may also make it more difficult for the SEC to demonstrate that it has met its obligation to show that the benefits of the new requirements outweigh their costs.
This challenge is likely to be bolstered by the “major questions” doctrine, which provides that agency rules of major significance be the subject of a clear delegation of Congressional authority (and was relied on by the Supreme Court to nix the Biden Administration’s COVID-19 vaccine and eviction moratorium policies).
First Amendment challenges. The proposal is also likely to be challenged as violating the First Amendment, by compelling speech. This topic has received close scrutiny by the Supreme Court in recent years in other cases involving corporate speech.
If you’re looking for more information on the “major questions” doctrine, check out this Arent Fox Schiff memo. As to the First Amendment issues, Liz blogged last year about a letter from West Virginia’s AG threatening to bring an action on that basis against any ESG-related rulemaking by the SEC and you can check that out for more details on the First Amendment argument. Meanwhile, this post on the Business Law Prof Blog lays out an argument supporting the validity of the proposed rules.