The Securities and Exchange Commission (SEC) recently reinforced its focus on the importance of corporate governance and financial reporting by special purpose acquisition companies (SPACs).
Acting Chief Accountant Paul Munter issued a statement last week highlighting key financial reporting and auditing considerations for private companies entering public markets through a merger with a SPAC. On the same day, the staff of the Division of Corporation Finance issued a statement on issues to be considered before a private company undertakes a business combination with a SPAC.
“SPACs have been used for decades as a vehicle for private companies to enter public markets but have recently become increasingly popular,” Munter said. As the use of SPACs continues to appeal to companies looking to go public, SEC scrutiny will likely increase. “Regardless of the form or structure used to access our markets, we are always keenly focused on protecting investors,” Munter advised.
Key considerations for private companies entering public markets include the following:
Market and timing. Because private companies can be brought into public markets more quickly through a SPAC than the traditional initial public offering (IPO) process, and because many private companies are in earlier stages of development compared to IPO companies, the target company might not be prepared for certain demands and new risks of being a public company. These include new financial reporting processes and SEC filing requirements under accelerated timelines and deadlines that cannot be missed; new regulatory and listing requirements; and additional communications with shareholders, analysts, and the media. To support these new demands, there might be a need for changes to people, processes, and technology.
Financial reporting. Private company targets may not have the appropriate level of staff with knowledge of accounting and financial reporting requirements of a public company. Accounting for and reporting of the merger itself are complex, including the presentation of financial statements and pro forma information. Public company GAAP is different in certain areas, like reporting segments, earnings per share, and incremental disclosure requirements. Effective dates for new standards, like leases and credit losses (CECL), can be different and are likely accelerated, and they might require new processes and systems.
Internal controls. Public companies are required to maintain internal controls over financial reporting (ICFR) and disclosure controls and procedures (DCP). There are unique Sarbanes-Oxley requirements for management evaluations of ICFR and DCP, along with potential auditor reporting requirements on ICFR.
Corporate governance and audit committees. Oversight responsibilities for public company boards of directors and management’s communication with the board are different. There are requirements for the composition, experience, and independence of public company boards of directors. The audit committee has responsibility for oversight of ICFR; auditor selection; and the quality of the audit process, so audit committee members must have the appropriate skills. For boards to be effective, there should be clear and candid communication with management and appropriate tone at the top about integrity and openness.
Auditors. As a private company, financial statement audits require compliance with American Institute of Certified Public Accountants (AICPA) standards for audits and independence. As a public company, the audit of the target’s financial statements must be compliant with Public Company Accounting Oversight Board standards, and the audit firm must be registered with the PCAOB and be knowledgeable and professionally competent. The audit team’s experience in these matters must be evaluated by the audit firm, along with client acceptance, continuance, and the firm’s independence.
Additional issues for a private operating company to consider before it undertakes a business combination with a SPAC include:
Books and records must be maintained in reasonable detail. The system of internal accounting controls must be devised and maintained sufficient to provide reasonable assurances about management’s control, authority, and responsibility over the issuer’s assets. Transactions must be authorized and recorded so GAAP financial statements can be presented, and management is responsible for the related ICFR and DCP.
National securities exchange initial listing requirements must be satisfied at the consummation of the SPAC transaction in order for SPAC shares listed on the exchanges to remain listed. These include both quantitative (number of shares and share price, investor base) and qualitative (audit committee experience and independence, independent director oversight) requirements.
There are shell company restrictions SPACs are subject to. These include the requirement to file the financial statements of the acquired business within four business days of completing the acquisition (not subject to the 71-day extension) and restrictions on SEC rules relating to incorporation by reference into Form S-1 and use of Form S-8 for registering securities. There are also restrictions relating to roadshows and prospectus requirements for issuing securities.
In addition to presenting these issues and considerations, the SEC statements offered resources and assistance to companies involved in SPAC transactions. Both the Office of the Chief Accountant and Division of Corporation Finance are available for consultation with companies during the process. The Division of Corporation Finance previously issued disclosure guidance for SPACs under federal securities laws.
The SPAC process and completing the acquisition transaction are not the end of the road. Companies have a lot to think about as they become public companies, and the SEC is likely going to be keeping an eye on their progress.
“The staff at the Securities and Exchange Commission are continuing to look carefully at filings and disclosures by SPACs and their private targets,” John Coates, acting director of the Division of Corporation Finance, said in a statement Thursday. “They will continue to be vigilant about SPAC and private target disclosure so that the public can make informed investment and voting decisions about these transactions.”