Securities and Exchange Commission concerns over forward-looking disclosures in special purpose acquisition company (SPAC) deals make it important for CFOs keep a tight rein on their financial forecasts, a securities law specialist says.
The SEC wasn’t calling for a halt to forward-looking disclosures in SPAC deals in its early-April statement on the issue, Withers partner M. Ridgway Barker told CFO Dive. Rather, it was signaling it’s going to look hard at what sponsors and target companies say about their merger for the same reason such statements are banned in traditional IPOs.
“They see these shell companies talking freely about what the future brings and they’re saying, ‘Hey, wait a minute; you wouldn’t do that in an IPO; why are you doing it now?” said Barker.
In its statement, the SEC said the safe harbor SPACs have been partly relying on in the Private Securities Litigation Reform Act (PSLRA) for legal protection doesn’t preclude it from taking action if the forward-looking guidance appears to be misleading or otherwise based on questionable data.
“A [SPAC] transaction gives no one a free pass for material misstatements or omissions,” John Coates, the SEC’s acting director of corporate finance, said in the agency’s April 8 statement.
The PSLRA was passed in 1995 to help curb frivolous M&A lawsuits.
Given the heightened scrutiny the SEC has promised, it falls to the CFO to tightly manage the forecasting process and ensure the target company and sponsor are singing from the same song sheet when they talk about performance, Barker said.
“You want to have one forecast for all purposes,” he said. “Use the same forecast for your bank credit facility, for example, that you use for the public markets, or for every other purpose.”
CFOs appropriately and commonly prepare multiple forecasts to ensure their company has an action plan for whatever kind of market they face. But only the actual forecast should get disclosed as part of the merger narrative.
“Define which is your definitive case, and make clear all those other forecasts are sensitivities for purposes of analysis, but they’re not your forecast,” he said. “You don’t want to get into a situation where, for example, somebody confuses your upside case as your final forecast or the third sensitivity that you ran through and somehow somebody concluded that was your final forecast.”
The risk of that happening isn’t remote in a SPAC deal because of the often-accelerated timeframe in which these mergers get executed.
“Things are happening pretty fast,” he said. “There are a lot of numbers moving and you just want to be thoughtful when you get to the final one, that it’s clear that’s the final one and anything else is not.”
Time pressure can be especially heavy if the sponsor is coming up against the SEC’s regulatory deadline with the deal still not closed.
Under SPAC rules, sponsors have between 18 and 24 months after they go public to find and merge with a target company. Sponsors put the money they invest, called the promote, at risk if they miss the deadline.
“Let’s assume you’re the sponsor and you’ve invested $9 million or $12 million in this $300 million SPAC deal,” he said. “Now you’re coming up to months 16, 17, 18, and all of a sudden the potential to lose that $9 million or $12 million puts a lot of pressure on you.”
It’s natural for the sponsor and target company to put the most positive spin on the numbers, but the move has to be justified.
“You’re saying, ‘I think my revenue or EBITDA over the next three years is going to be a,b,c,’” he said. “And then you get a call from the SEC saying, ‘Hey, we see that; provide us the supplemental support for that statement,’ and the SEC isn’t satisfied with the support you provide.”
The problem is compounded if the SEC makes you restate your projections.
“If you have to go out and rescind that statement, modify it, the impact on your investors from having to modify forward-looking guidance is significant,” he said. “So, that’s the kind of pressure they're bringing to bear on the SPAC market as opposed to saying it’s a rule.”