The following article was published by Law360 on May 7, 2021. It was written by Benjamin Horney. Click here to view.

The pace of special purpose acquisition company initial public offerings and subsequent mergers has slowed since it became clear the U.S. Securities and Exchange Commission is heavily examining SPAC disclosure documents, but that doesn't mean the trend has run its course.

SPACs, also known as blank-check companies, are corporate entities that raise money through IPOs in order to take a private company public, usually within 18 to 24 months after the offering. The rate of SPAC IPOs and subsequent de-SPAC mergers — which is the term used when a SPAC that has gone public merges with a target — skyrocketed in the wake of the coronavirus outbreak last year, in part because a volatile stock market meant the deals offered more price certainty than traditional IPOs.

Through the end of March, the markets for both de-SPAC mergers and SPAC IPOs remained strong, with that month seeing 30 de-SPAC mergers worth a combined $73.64 billion and 109 SPAC IPOs totaling $35.38 billion, according to data provided by Dealogic. In April, mergers took a dip, while IPOs fell off a cliff.

Experts maintain that the numbers do not necessarily mean there's a diminished appetite for SPAC deals. Instead, the figures may reflect the market's reaction to the reality that the SEC has taken an increased interest in SPACs.

Freshfields Bruckhaus & Deringer LLP is among the law firms that has capitalized on the surging SPAC market, including its recent work helping U.K. online car retailer Cazoo list on the New York Stock Exchange through a $7 billion SPAC merger and its role advising an investor in an $8 billion SPAC merger for Indian clean energy giant Renew Power.

Law360 recently spoke with three Freshfields attorneys who work on SPAC deals: Andrea Basham, Kimberly Zelnick, and Michael Levitt. Basham is a corporate and mergers and acquisitions partner; Zelnick is a partner and global head of the firm's financial institutions disputes group; and Levitt is a partner in the firm's financing and capital markets group.

This interview has been edited for length and clarity.

First and foremost, in your view, is the SPAC trend still on the rise? Or are there any reasons to think we might hit a tipping point anytime soon?

Basham: Generally, until a few weeks ago, the SPAC trend was still on the rise. Beginning in March, we started seeing some softness in the PIPE [private investment in public equity] market, and activity has now slowed down a bit as the market addresses changes that need to be made in response to the SEC's recent announcement regarding SPAC warrant accounting. Nonetheless, the number of SPACs and amount of SPAC dry powder in the market has not changed — and all those SPACs will be looking for targets before their lifeline ends.

Last month, John Coates, acting director for the SEC's division of corporate finance, made significant comments about the "unprecedented surge" in SPAC activity. He touched on a number of issues, including whether SPACs have the protection of the Private Securities Litigation Reform Act, or PSLRA, safe harbor. What were your general takeaways from his comments?

Basham: First, I think it's important to note that nothing he said changes the law. However, it certainly raises questions that many market participants have been asking for the last many months. We all know that one advantage to going public via a SPAC transaction is presumed to be the ability to avail oneself of the safe harbor for use of projections in de-SPAC registration statements.

What Coates questioned was whether, when the safe harbor was enacted, it was in fact intended to cover de-SPAC transactions, and not exclude them in the way IPOs are excluded. But he didn't go as far as to say that the safe harbor doesn't apply to de-SPAC deals.

We saw it as a cautionary speech to remind participants that projections are not a free pass to say whatever one desires to say about the future. Projections still require due diligence and accountability. Companies should ensure they have a reasonable basis for the projections they make. It's a reminder that, in the context of de-SPAC transactions, diligence is still necessary, and vetting the projections is still necessary.

Zelnick: The message was very much a reminder that you're not operating in a liability-free zone where anything goes. People need to be careful, diligent and truthful, because the SEC is watching. There's a sheriff in town, so to speak. There are rules, there are laws and there are regulations. A de-SPAC transaction is not a free-for-all.

Prior to Coates' comments, was there a perception in the market that SPACs were beholden to less rules than other transaction types, such as traditional IPOs?

Basham: I don't think the perception was that there were no rules or liability. I just think the proliferation of de-SPAC deals has led the SEC to really pay attention. If you look at the market, there are a lot of pre-revenue, and even pre-commercialized product, companies that have taken advantage of the de-SPAC route. They can tell their story, take advantage of the safe harbor, and explain to investors what they might look like in the future. In a regular IPO, you typically focus on the history of the company.

Pre-revenue companies that haven't done a de-SPAC deal are now sitting in a market where, even if they aren't quite ready to enter the public market, or didn't think they were going to, they're now looking down the street and seeing that competitor one went public and competitor two is going public via a de-SPAC and adding cash to the balance sheet in the process. They're thinking, "If I don't do this also, I may miss the boat."

Meanwhile, people forget that projections are not the only reason the SPAC route is preferable to a traditional IPO, in some cases, for these private companies. It also offers stability in that the valuation is set at the time you sign the business combination agreement with a SPAC. That's very different from a traditional IPO, where you have underwriters doing price discovery until, basically, the very moment that you list, and you just hope for the best.

Are you anticipating any new guidance or rules from the SEC in the near future?

Basham: I don't think we're necessarily anticipating a change in law. The comments certainly raised questions, though. We advise our clients to be very careful with projections. Notwithstanding there is no underwriter taking liability, clients nevertheless need to have standards for backing up all the statements they make. To the extent that anyone was not operating under that type of cautionary approach, these comments are a reminder that they should.

Zelnick: Coates does raise questions about whether de-SPAC deals should be considered IPOs and excluded from the safe harbor. He doesn't say what the answer is. He raises the question: Should de-SPACs qualify for the safe harbor? Was that the intention of the safe harbor? I view that as a subject for rulemaking; it may be a candidate for change, but it's probably not a tomorrow thing. It could also be the subject of litigation down the road.

Speaking of litigation, do you expect there to be a spike in SPAC-related lawsuits?

Zelnick: There's been a tremendous volume of SPAC activity. One would expect over time that some SPACs will be successful and some will not. For those SPACs that are not successful, some people will be unhappy and they'll file lawsuits. I think that's something many people are anticipating given the state of the market for SPACs. There are many topics that could be the subject of litigation, including those that Coates raised regarding conflicts of interest or whether de-SPACs should get the protection of the safe harbor.

Basham: There are different types of cases that could come about. A lot of these de-SPACs are facing what we consider to be regular M&A lawsuits. There's a business combination, a proxy statement goes out, and the plaintiffs' bar sues asking for more disclosure. Sometimes they even ask for more projections. Those are not stock-drop suits, which are a very different animal. It may be hard for an investor to win a case on projections having not panned out to be true. You'd have to prove that any cautionary language was inadequate as well as bad faith and that there was no reasonable basis to have made those projections. But putting liability risk aside for a minute, projections have also created a new landscape that is ripe for activist investors.

In two or four years, or in some cases the projections go out to five or eight years, if those projections don't come true, it's easy for a hedge fund, or whomever, to move in and say, "Hey, management promised $1 billion of revenue, and you haven't met that expectation." There will be real opportunity for activist investors to run competing slates, or to try and force directors out. This is a space in which we might see that activism is quicker and more effective than a lawsuit.

The de-SPAC process is a very rapid one, especially compared to a regular IPO, where companies are thinking for years about what the post-IPO governance structure will look like, what defenses against activism will look like. In these de-SPAC deals, companies are making those decisions in a matter of months, if not weeks. Governance should not be left to the wayside due to the rapidity of these transactions getting signed up.

How can you, as attorneys, help clients ensure they will be protected from future litigation or activism?

Levitt: In almost every single de-SPAC deal, shareholders are asked to approve a series of changes to the company's charter and organizational documents, and that's where you can give the company some of the most important kinds of protection, such as creating dual-class stock or a classified board structure. There are others, including ways of making sure shareholders can't call a special meeting, or not letting them act by written consent.

Building provisions like that into the charter is one way to protect companies from activists. Most of these are also in normal IPOs as well.

The classified board is pretty standard, but the dual-class stock isn't as much. Many shareholders don't like it, because it might mean one person gets 20 votes while another gets one or five votes. It's usually done when there's a founder, or someone whose vision permeates the company.