The SEC’s recent enforcement against Perceptive Advisors for allegedly failing to tell its clients and investors about conflicted SPAC investments is likely the first of many to come as the SEC scrutinizes SPACs and de-SPACs.
According to the Commission, Perceptive failed to disclose conflicts of interest, made material misstatements and omissions and failed to adopt written P&Ps regarding its personnel’s ownership interest in SPAC sponsors and the firm’s practice of investing client assets in affiliated SPACs.
Under the settlement agreement, Perceptive was censured and fined $1.5 million. The firm did not admit to any wrongdoing.
The enforcement action is in line with the Commission’s proposed SPACs rules and its ongoing focus on conflicts of interest and disclosures of private fund managers.
“This is something the Commission has long been focused on, and SPACs have really been in their crosshairs,” one private fund lawyer said. “I think this is just the first of many of these types of enforcements against SPAC managers that we’ll see. And as de-SPAC activity picks up you can be sure that the SEC will be looking closely at those too.”
Betsy Cottam, a director at ACA Group, agreed that the Perceptive enforcement – and the SEC’s approach to SPACs in general – has been consistent in focusing on investor protection, conflicts of interest and making sure those conflicts are properly mitigated, part of which includes making adequate disclosures.
Impact on SPACs
The increased regulatory scrutiny has slowed down the number of new SPACs being launched, noted Ken Joseph, a managing director and head of the Financial Services Compliance and Regulation practice for the Americas at Kroll.
Howard Fischer, a partner at Moses & Singer, agreed that the SEC’s scrutiny and its proposed SPAC rules have made it difficult for the industry to operate.
“When the SEC is inherently skeptical of a product, process or a vehicle there is a tendency for them to be very careful in reviewing those transactions,” Fischer said. “I think we’ll see more enforcement actions, particularly in the next few months.”
However, while new SPACs appears to have lost favor, there are numerous de-SPAC transactions that are expected to come to market during the next few months – all of which are likely to face intense regulatory scrutiny, Joseph predicted.
In March, the SEC proposed new rules that would enhance disclosure requirements and investor protections in SPAC IPOs and de-SPACs.
Among other things, the rules would require many SPACs to register under the Investment Company Act.
The private funds lawyer said the proposed SPAC rules are supposed to better align the regulatory treatment of SPAC transactions with traditional IPOs. The result from this regulatory scrutiny is that some entities involved in a SPAC deal would be exposed to increased liability from the greater disclosure requirements around sponsors, conflicts of interest, dilution and the fairness of de-SPACs.
The importance of disclosure
The underlying themes of the proposed rules are disclosure and investor protection.
Fischer said the best way for SPAC managers to protect themselves is to be “very robust on the disclosure front.”
The first step in robust disclosure practices for SPAC sponsors is to understand their conflicts of interest, Cottam stated.
“The sponsor, management team, officers and any affiliates are going to have a different economic interest than the public shareholders, and this is one area where there are a lot of potential conflicts of interest. As the sponsor works towards a business combination, legal counsel should be consulted as they work through the life cycle to understand potential conflicts and how to mitigate them,” Cottam advised.
So, what should SPAC managers disclose to investors, and when should it be disclosed? Kroll’s Joseph noted that disclosure is a facts-and-circumstances analysis based on the total mix of information available to a reasonable investor. There is an obligation to disclose promptly, fully and fairly all material information.
Cottam said there are various times at which different things need to be disclosed. For example, at the IPO stage sponsors must disclose any securities that are owned by the sponsor, the directors and officers, and include the price that they are paying for those securities.
“You want to make sure to clearly disclose conflicts of interest that result from the sponsors’, directors’ or officers’ ownership, and whether it can create any financial incentive for them to complete a business combination that may not be in the best interest of the other shareholders. An example of that could be that the SPAC is nearing the period where they would need to make a business combination so they may make a lesser deal,” Cottam explained.
SPAC sponsors should also disclose whether the target company has a tie or affiliation with any of the sponsors, directors or officers.
At the business combination stage, disclosures need to be made about how the SPAC sponsor evaluated and decided on a particular target over others, and include an explanation of the material terms of the transaction.
Joseph warned SPAC sponsors that they cannot disclose away every conflict, but full and fair disclosure goes a long way to showing that the sponsor intended to act in an appropriate way.
“My advice to SPAC managers would be to tread very carefully because there is regulatory scrutiny on these types of transactions,” Joseph said.