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 and would establish a non-exclusive Investment Company Act 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.
– John Jenkins
The most recent issue of Evan Epstein’s Board Governance Newsletter discusses the decision of some VCs to eschew seeking board seats in connection with their investments. Here’s an excerpt:
One of the distinctive features of Tiger Global’s startup investment strategy is to be an unobtrusive capital partner. This laissez-faire attitude includes not taking board seats and rarely getting involved in a company’s operations. This has also allowed them to speed up their investment process, striking deals in a matter of days rather than weeks or months. In 2021, Tiger Global invested in 335 companies, almost a deal per day, an unprecedented number for a venture investor. But the NY-based firm did not invent this hands-off or “passive investment” approach. In 2009, Yuri Milner from DST invested $200 million in Facebook at a $10 billion valuation (plus an option to purchase extra common stock from employees at a $6.5 billion valuation) without taking a board seat, somewhat unprecedented at the time.
“You do not need to have a board seat to be influential” Yuri Milner told Jason Calcanis, as recounted in the All-In Podcast.
See below another take from Ron Conway, the founder and co-managing partner of SV Angels, telling Mark Suster from Upfront Ventures why he doesn’t take board seats:
“Board meetings take a ton of time and it’s the duty of the board to manage the CEO. SV Angels also said early-on that our mantra was to be advocates for founders, so if we were sitting on a board that was making a decision to fire the CEO or get into a big argument, we didn’t want to be part of the conversation. That conversation is necessary, boards are necessary, but that’s not SV Angels role. Our role is just to be advocates for founders, help them at inflection points, and build a great company.”
The newsletter goes on to discuss FT.com’s recent article noting that “VCs said it had become normal to pass on board seats in companies focusing on digital assets. Many founders want to limit the involvement of outside backers. A wide swath of largely unregulated projects such as DAOs do not even have formal boards.”
– John Jenkins
How does having women in leadership positions affect M&A strategies and outcomes? Those are the topics considered in this recent Intralinks report, which looked at over 11,000 transactions completed from January 1, 2010 to October 31, 2021. Only about 3% of those deals involved acquirers led by female CEOs, and 11% involved acquirers with at least 30% female representation on their boards, but as these highlights from the report demonstrate, these deals outperformed other transactions – even though the market initially didn’t think they would:
– Initial market reactions to women-led deals are more unfavorable than those for deals led by men. Shares of acquirers with female CEOs tended to underperform those of acquirers led by male CEOs by an average of 1.5 percentage points when looking at a 40-day window pre- and post-announcement. The onset of Covid-19 appears to have enhanced that disparity, as acquirers led by female CEOs saw their share prices underperform those led by male CEOs by an average of 9.6 percentage points for deals during the pandemic.
– Contrary to market reaction, deals completed by acquirers with female CEOs performed better than deals completed by acquirers with male CEOs in terms of share price performance, in the first, second- and third- year following deal completion. Companies with at least 30% female boards outperformed by 7.1 percentage points relative to all-male boards or those with less than 30% female representation.
– Deals led by women didn’t just outperform when it came to share price appreciation. Over a three-year period, these deals produced better ROE, EBITDA/sales and EBIT/adjusted sales than deals completed by acquirers with male CEOs. The most significant difference was post-closing ROE. When looking at this metric three years post-acquisition, companies led by female CEOs outperformed those led by male CEOs by 7.9 percentage points.
– Deals announced by female CEOs also have a slightly better chance of closing – 97% of the deals led by female CEOs closed, while 95% of those led by male CEOs closed. All of the female-led deals announced during the pandemic closed, while the male-led deals continued to close at a 95% rate.
There are all sorts of other interesting nuggets in the report, including the fact that companies involved in female-led deals were more likely to retain a financial advisor, that the targets in female-led deals involved less risk than those in male-led deals, and that female-led deals were more likely to include a reverse termination fee.
– John Jenkins
It has been a little surprising that nearly three years into the SPAC boom, Delaware has only weighed-in on the corporate law issues surrounding SPACs on one occasion. However, this memo (p. 3) by Hunton Andrews Kurth’s Steve Haas says that a recent decision by the Delaware Chancery Court not to stay an action in the face of parallel federal securities litigation suggests that it is looking for an opportunity to say more about SPACs. Here’s an excerpt:
The Delaware Court of Chancery recently denied a motion to stay a lawsuit challenging a de-SPAC transaction wherethe defendants asked the court to wait for the outcome in a related federal securities action. Although the decision to allow state law claims to proceed alongside a related federal action is not itself extraordinary, the court’s commentary signals the Delaware judiciary’s desire to weigh in on SPACs. Among the factors negating a stay, according to the court, were the “emerging” and “novel issues of Delaware law” implicated by SPAC transactions.
In In re Lordstown Motors Corp. S’holders Litig., C.A. No. 2021-1066-LWW (Del. Ch. Mar. 7, 2022), the state law plaintiffs purportedly represent the SPAC stockholders who did not exercise their redemption rights in the de-SPAC transaction. They alleged injury from inadequate disclosures and conflicts of interest driving the transaction. In contrast, the federal securities action involves a broader class of securities holders spanning before and after the de-SPAC transaction and alleging that the company artificially inflated its stock price through misleading disclosures about the acquired company’s electric vehicle business.
While acknowledging some overlap, the court held that the actions involved different plaintiffs, defendants, and remedies. But more importantly, the court focused on Delaware’s need to address SPACs, stating that “[t]his court’s essential role of providing guidance in developing areas of our law would be impaired if the court were to denude its jurisdiction because a federal securities action resting on similar facts was filed first.”
– John Jenkins
I’ve previously blogged about In re Multiplan Stockholders Litigation, (Del. Ch.; 1/22), the Chancery Court’s first decision addressing fiduciary duties in the SPAC context. That decision covered a fair amount of ground, and we’ve posted a bunch of memos on the case in our SPACs Practice Area. However, this recent Woodruff Sawyer blog addresses an aspect of the decision that I haven’t seen covered elsewhere – its potential implications for D&O insurance. This excerpt addresses the importance of the Court’s conclusion that the claims in Multiplan were direct, not derivative:
From a D&O insurance perspective, there is a real consequence to the direct versus derivative distinction because of the way the insurance agreements work. The “Side A” part of the ABC D&O insurance program responds on a first-dollar basis, but only to non-indemnifiable claims. Settlements of derivative suits are usually not indemnifiable under Delaware corporate law, while direct suits are indemnifiable. While many SPAC D&O insurance programs are structured as traditional “ABC” programs, some SPAC teams, as a cost-saving alternative, are choosing to structure their programs as “Side A” only.
To the extent that a SPAC purchased a Side A-only policy, and the lawsuit is determined, like in MultiPlan, to be a direct one, there may be no D&O insurance response for a settlement (outside of a corporate bankruptcy).
The blog covers several other topics, including issues concerning which D&O policy would apply to claims associated with a de-SPAC transaction, the problems with acquiring tail coverage from a different carrier than the one that provided coverage for the SPAC IPO, and the potential effects of the decision on the D&O market.
Speaking of SPACs, as Liz blogged yesterday on TheCorporateCounsel.net, the SEC has scheduled a meeting next week to propose some pretty dramatic changes to the regulatory landscape.
– John Jenkins
The regulatory environment for vertical mergers has changed pretty significantly in recent months – and with the antitrust agencies promising a rewrite of the Merger Guidelines, it looks like more changes may be on the way. This Gibson Dunn memo addresses some of the trends in vertical merger review and enforcement that have emerged from regulators’ recent actions. This excerpt makes it clear that the enhanced scrutiny of vertical deals isn’t just a U.S. phenomenon:
Vertical transactions are receiving heightened scrutiny from regulatory agencies around the world, including, most notably, the U.S. antitrust agencies, EC and European Union member states, and SAMR. Further, antitrust agencies across the globe are increasing cooperation. For example, in the NVIDIA-Arm transaction, the EC indicated it is “cooperating with competition authorities around the world.”
It appears that this increased cooperation may lengthen the merger review period. Coordination among agencies was the suspected reason behind the unprecedented eight-month SAMR pre-filing investigation. And in the Illumina-Grail transaction, the EC has exercised the ability to take referrals from member states without those member states independently having jurisdiction to review the transaction under their own merger control regimes.
The memo also points out that in the U.S. and other countries, intragovernmental cooperation is an important part of antitrust review and enforcement. One example cited by the memo is the Defense Department’s role in reviewing Lockheed’s proposed vertical acquisition of Aerojet.
– John Jenkins
Yesterday, the SEC’s Division of Corporation Finance issued a handful of new CDIs relating to M&A topics. Here are links to the individual CDIs & a brief summary of the issues they address:
Exchange Act Form 8-K
– CDI #102.04 – The material terms and conditions of an acquisition agreement that should be disclosed in an Item 1.01 Form 8-K.
– CDI #102.05 – Whether the acquisition agreement should be filed as an exhibit to the Item 1.01 Form 8-K.
Proxy Rules & Schedules 14A/14C
– CDI #101.02 – When a private target that isn’t soliciting its own shareholders may be viewed as engaged in a “solicitation” of the acquirer’s shareholders.
– CDI #132.01 – The availability of Rule 14a-12 for communications by a private target under the circumstances described in CDI #101.02.
– CDI #132.01 – The availability of Rule 14a-12 for communications by an acquirer relating to a transaction for which the target is soliciting proxies but the acquirer is not.
Tender Offers & Schedules
– CDI #166.01 – Guidance on the circumstances under which the Staff will not object to will not object to purchases by the SPAC sponsor or its affiliates outside of the redemption offer.
– John Jenkins
Earlier this month, the Delaware Supreme Court once again weighed in on the subject of the obligations created by “preliminary agreements” relating to potential business transactions – and in the Court’s words, provided a reminder that the good faith obligations imposed under the terms of these agreements are “not worthless.”
In Cox Communications v. T-Mobile US, (Del.; 3/22), the Court was called upon to interpret a contractual provision contained in a settlement agreement that obligated Cox to enter into a definitive exclusive provider agreement with Sprint “on terms to be mutually agreed upon between the parties for an initial period of 36 months” before offering mobile wireless services to its customers. After T-Mobile bought Sprint in April 2020, Cox opted to partner with Verizon and T-Mobile promptly accused Cox of breaching its contractual obligations. Cox responded by seeking a declaratory judgment concerning the extent of its contractual obligations.
Cox argued that those obligations were limited to, at most, a requirement to negotiate in good faith a definitive agreement with Sprint, while T-Mobile contended that the contract obligated Cox to refrain from partnering with another carrier for a 36-month period. The operative language was contained in Section 9(e) of the settlement agreement, and provided as follows:
Before Cox or one of its Affiliates (the “Cox Wireless Affiliate”), begins providing Wireless Mobile Service (as defined below), the Cox Wireless Affiliate will enter into a definitive MVNO agreement with a Sprint Affiliate (the “Sprint MVNO Affiliate”) identifying the Sprint MVNO Affiliate as a “Preferred Provider” of the Wireless Mobile Service for the Cox Wireless Affiliate, on terms to be mutually agreed upon between the parties for an initial period of 36 months (the “Initial Term”).
The Chancery Court held that this provision obligated Cox to negotiate in good faith and prohibited it from entering into a deal with another carrier during the 36-month period. The Supreme Court disagreed:
We cannot reconcile the Court of Chancery’s reading with the plain contractual text. In particular, we do not see two promises in the first sentence of Section 9(e). Instead, we read the provision as a single promise that unambiguously contemplates a future “definitive” agreement but leaves many terms open, “to be mutually agreed upon between the parties[.]” Because it leaves material terms open to future negotiations, Section 9(e) is a paradigmatic Type II agreement of the kind we recognized in SIGA v. PharmAthene. Parties to such agreements must negotiate the open terms in good faith, but they are not required to make a deal.
In PharmAthene, the Court said that “Type II” preliminary agreements were those in which the parties “‘agree on certain major terms, but leave other terms open for future negotiation.” Agreements of this type “do not commit the parties to their ultimate contractual objective but rather to the obligation to negotiate the open issues in good faith.” As a result of this conclusion, the Court remanded the case back to the Court of Chancery in order to determine whether Cox had satisfied its obligation to negotiate in good faith. Justices Valihura and Montgomery-Reeves dissented in part from the Court’s decision, noting that although they agreed that Section 9(e) reasonably could be read as a Type II agreement, the provision was sufficiently ambiguous that it could be read as the Chancery Court read it as well.
Weil’s Glenn West recently blogged about this case, and commented on the perils associated with the “hazy lines” dividing unenforceable agreements to agree, actual agreements that are “preliminary,” and otherwise non-binding preliminary agreements that may impose an obligation to negotiate in good faith:
Many times parties use non-binding term sheets and letters of intent as a means of providing a road map for the deal that the parties then contemplate, but with the understanding that the chosen route described in the term sheet or letter of intent could well change and that the parties are not binding themselves to the stated route or destination.
If the outlined terms are to be converted into a fully-baked deal by the court and then damages assessed based on breach of that deal to the extent there is a finding that one of the parties failed to negotiate in good faith, the risk is that those damages could far exceed the actual damages that may have been available to the non-breaching party pursuant to a fully-negotiate definitive agreement that, for example, contained a damages limitation provision.
So, what’s the best way for parties to protect themselves in these situations? Glenn says it’s to provide disclaimers of any intent to enter into a binding agreement or to negotiate in good faith. You can also take a look at some practice points for letters of intent that I posted over on the John Tales blog.
Also, be sure to check out Francis Pileggi’s blog on the Court’s decision, which focuses on the nuances of Delaware contract law involved in the case.
– John Jenkins
This Proskauer blog discusses how the EU’s robust enforcement of cybersecurity and privacy regulations are increasing the risk of liability to PE fund sponsors & corporate parents for activities of their portfolio companies and subsidiaries. The blog highlights the $255 million fine recently imposed on What’s App Ireland, which was calculated by reference to its parent Facebook’s overall global revenue. It goes on to point out that parent companies and PE sponsors may now face direct enforcement action with respect to GDPR issues involving their affiliates – including those in which the sponsor or parent holds a minority stake.
As this excerpt indicates, the key to parental liability is whether the parent or sponsor is deemed to be engaged in an “undertaking” with its affiliate:
The GDPR refers to EU competition law jurisprudence to understand the concept of an “undertaking”. EU case law establishes that where a parent company (or potentially a PE sponsor) holds all, or nearly all, the shares in a subsidiary, a rebuttable presumption arises that both companies are part of an “undertaking”. With respect to lower levels of investment, the key is whether the shareholder is in a position to exercise “decisive influence” over the subsidiary entity’s commercial policy. While the existence of “decisive influence” is fact-specific, relevant factors include (for example) the parent company or PE sponsor’s:
– Veto rights: Veto rights relative to the affiliate or portfolio company’s budget, business plan, operational investments or the appointment of senior management are relevant factors. The crucial element is whether the right is sufficient to enable the parent company or PE sponsor to influence the strategic business behavior of a venture. Importantly, the mere existence of a veto right, even where not exercised, can be sufficient to establish “decisive influence”;
– Right to appoint board members: The right to appoint independent non-executive directors with observer roles (rather than executives with management power) is less indicative of “decisive influence”; and
– Power to have personal data protection rules implemented within a company.
To illustrate, “decisive influence” has been held to exist (under EU competition law) with a minority shareholding as low as 30% (for example, in the Fuji case, where there were common directors). Similarly, in the Prysmian case (under EU competition law), the investor was fined EUR37.3 million for the power cable cartel in which the company in which it had invested had engaged due to the “decisive influence” that was held to exist. The investor’s interest in the company through a fund vehicle was only approximately 33%, but its voting rights were far higher (at one point 100%) and it controlled the composition of the board of directors.
The blog recommends that fund sponsors and parent companies consider implementing risk mitigation measures, including identifying GDPR compliance issues during due diligence and remediating them pre- or post-closing, structuring investor rights to reduce the risk that they will cause the investor to be viewed as having “decisive influence,” and obtaining appropriate GDPR-related reps & indemnities, as well as post-closing covenants.
– John Jenkins
This recent Forbes article by Okapi Partners’ Bruce Goldfarb says that recently deSPAC-ed companies may face a wave of activism this year. This excerpt says that Third Point’s recent initiative at Cano Health may be a preview of things to come:
Third Point’s push may be one of the first instances of a prominent activist investor targeting a SPAC – but it won’t be the last. In addition to depressed share prices, SPACs have other features that may draw the attention of activists. It’s important to remember: companies that went public through a SPAC merger are very new to the public markets and didn’t go through the typical underwriting process that comes with an IPO. That difference alone could leave both their managements and boards unprepared for an activist approach, although the problems may be greater than just a lack of underwriter diligence.
Specifically, the corporate governance of a typical SPAC is especially vulnerable to criticism. A recent study notes that since SPAC sponsors usually hold significant stakes in the company, as well as seats on the board, there can be an inherent conflict between their interests and those of public shareholders. Activists could also seek to challenge typical aspects of SPAC governance structure, including dual classes of shares and staggered boards. Further, many SPAC boards still include members held over from pre-merger days, who may be criticized for not having the relevant experience needed to oversee the acquired business in its current form.
Bruce adds a word of caution to activists targeting SPACs – their campaigns aren’t likely to be easy. That’s because the governance features that make them attractive targets, as well as sponsors’ large continuing ownership stakes in them, make SPACs tough targets.
– John Jenkins