In a blog earlier this year, we noted the increasing prevalence of special purpose acquisition companies, or SPACs, as an alternative IPO vehicle, and we shared our expectation that more regulatory scrutiny and statements on SPACs were likely to follow pronouncements already issued. The Securities and Exchange Commission (SEC) did not disappoint. On March 31, 2021, the SEC’s Division of Corporation Finance issued a Staff Statement on Select Issues Pertaining to Special Purpose Acquisition Companies. The statement addresses “certain accounting, financial reporting and governance issues that should be carefully considered before a private operating company undertakes a business combination with a special purpose acquisition company (a ‘SPAC’).”
Buried in the footnotes to this latest statement is an interesting and important observation by the SEC staff. While the statement itself serves to emphatically remind companies considering a “de-SPAC” (the term describing the SPAC acquisition/merger route of going public) of their obligation to maintain books-and-records-level internal controls and to have in place Disclosure Controls and Procedures, footnote 16 offers a balancing tone from the “no free pass” tone of the larger statement. Specifically, it states:
In some instances, management of the combined company may be unable to assess internal control over financial reporting in the fiscal year in which the transaction was consummated. In those instances, the staff would not object if the combined company were to exclude management’s assessment of internal control over financial reporting in the Form 10-K covering the fiscal year in which the transaction was consummated. For a discussion of those limited circumstances, see Compliance and Disclosure Interpretation for Regulation S-K, Question 215.02.
What Does This Footnote Mean?
The positioning in the footnote is intended to allow de-SPAC companies an internal controls reporting outcome similar to that of the companies who took the regular, non-SPAC IPO route. For such non-SPAC companies, the obligations would be triggered with their first annual report on Form 10-K covering a full year (for most, the second 10-K filed with the SEC). De-SPAC companies, on the other hand, without the footnote exception might find themselves having what amounts to an accelerated SOX Section 404 compliance timeline relative to traditional IPO companies, if the SPAC with which they transacted had already filed a first 10-K.
In late September 2020, the SEC issued guidance, specifically Section 215.02, suggesting the availability of the option described in the March footnote under the right circumstances. In the latter part of 2020, a pattern seemed to be emerging whereby many de-SPAC companies were working with counsel and other advisors to be able to avail themselves of this conditional “pass” on Sarbanes-Oxley Section 404 requirements for the year of acquisition, to be disclosed in the “controls and procedures” section of their year-end 2020 10-K reports, per Section 215.02.
The results of utilizing the relief guidance were evident in the first quarter of 2021. A large percentage of the 2020 de-SPAC companies with prior SPAC 10-Ks, whose 2020 10-K filings we examined, took advantage of the September guidance provided by section 215.02, and virtually all filers that did avail themselves of that relief specifically referred to that guidance by way of a direct or indirect citation.
In other words, de-SPAC companies seized on an opportunity carefully and conditionally offered by the SEC in September and then carefully offered again in its most recent guidance, albeit as a footnote to a much more strict and reiterative statement. Without a doubt, companies availed themselves of first-year exemption from the hefty lift that is management SOX Section 404 reporting only after thorough consultation with their legal teams and other advisors, and by observing closely the experience and public disclosures of other de-SPAC companies.
Why Does It Matter?
Pre-de-SPAC companies are without a doubt intrigued by the possibility of postponing the time- and labor-intensive SOX Section 404 work by a year, the same relief generally available to “newly public companies” as defined by the SEC staff many years ago shortly after Section 404 became effective. The relief is also analogous to the “up to one year SOX exclusion” generally afforded SEC registrants upon the consummation of a defined “business combination” transaction in regard to the acquired entity. But as companies plan for transactions with SPACs or consider alternatives such as a traditional IPO, they should consider:
- Whether the fact pattern of their transaction fits, or will fit, into the guidance/allowance of September 21, 2020, as confirmed on March 31, 2021 – and do so with the benefit of experienced attorney, accountant and/or advisor guidance, and
- Whether they would be ready to meet the rest of the required governance obligations spelled out in the staff’s latest March 31 statement.
More importantly, they should consider what to do if they do not fit the public company profile described in the September guidance and repeated in the March statement. If that’s the case, they need to accelerate the internal control reporting aspect of their public company readiness activities and make plans and budget appropriately for that extra activity.
The softer tone by the SEC staff on possible exemption from SOX Section 404 reporting in year one of going public is for the prepared, not those looking for a “free pass.”