In recent years, we have seen significant market developments and innovation in our capital markets, with a variety of structures being utilized to raise capital and facilitate taking private companies public.
The U.S. capital markets are often described as the envy of the world, and we in OCA continue to promote healthy public markets. However, our efforts to facilitate capital formation are not carried out in isolation since each tenet of the U.S. Securities and Exchange Commission’s (“SEC”) three-part mission to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation is vital to our work. Regardless of the form or structure used to access our markets, we are always keenly focused on protecting investors. High quality financial reporting—a result of stakeholders throughout the financial reporting system working together in fulfillment of their respective professional responsibilities—is a key component of investor protection. High quality financial reporting, including high quality audits of the financial statements, also directly contributes to the health of our markets, and robust public markets serve investors, issuers, and the public well.
Special Purpose Acquisition Companies (“SPACs”) have been used for decades as a vehicle for private companies to enter the public markets, but have recently become increasingly popular. In just the first two months of 2021, both the number of new SPACs and amount of capital raised by those SPACs have been reported to already match approximately three-fourths of all such activity last year. A SPAC raises capital in the public markets with the sole intention of identifying and merging with a target, a private operating company. The merger of the SPAC and target company (“de-SPAC”) and related transactions may provide the target company with capital that it might otherwise need to raise in a traditional initial public offering (“IPO”), and after the merger, SPAC shareholders and target shareholders own the now-public operating company. SPAC transactions come with their own set of risks to investors at the time of the initial SPAC offering, during the SPAC’s search for and merger with a target company, and after the merger when operating as a combined public company. A merger with a SPAC may also raise unique challenges for a private target company seeking to become a publicly-traded company. It is critical that the board of directors, audit committee (as applicable), management, and auditors of these operating companies fully understand and fulfill their respective professional responsibilities so that companies meet their obligations under the federal securities laws and investors are provided with high quality financial reporting at the time of the merger and on an ongoing basis in subsequent periods.
The merger of a SPAC and target company often raises complex financial reporting and governance issues. As we highlight below, some of the key considerations related to the unique risks and challenges of a private company entering the public markets through a merger with a SPAC include:
- Market and timing considerations;
- Financial reporting considerations;
- Internal control considerations;
- Corporate governance and audit committee considerations; and
- Auditor considerations.
Market and Timing Considerations
Some of the risks and challenges related to a private company merging with a SPAC arise due to the timeline of such transactions, since SPACs have the potential to bring private companies into the public markets more quickly than would be possible in a traditional IPO. A private company may spend years preparing to transition to a public company in a traditional IPO, focusing on significant changes to enterprise-wide functions and processes to mitigate risks related to regulatory requirements, increased attention from the press and analysts, fluctuations in market value, or potential shareholder action. Many SPAC acquisition targets may be at an earlier stage in the entity’s development compared to companies that pursue a traditional IPO. Additionally, because of the increased number of SPACs seeking to identify target companies, private companies that were not contemplating an IPO or were otherwise earlier in their preparations to become a public company may become SPAC acquisition targets in the current environment.
While a SPAC generally has 18-24 months to identify and complete a merger with a target company or liquidate and return proceeds to shareholders, once a target company is identified the merger can occur within just a few months, triggering a number of related regulatory reporting and listing requirements. It is, therefore, essential that target companies have a comprehensive plan in place to address the resulting demands of becoming a public company on an accelerated timeline. While the process of merging with a SPAC differs from a traditional IPO, the various aspects and steps of the de-SPAC process are nonetheless subject to robust financial reporting and filing requirements. SPAC initial filings and de-SPAC merger filings are potentially subject to review by the SEC staff and companies may receive comment letters in a similar fashion to a traditional IPO.
A target company should also evaluate the status of various functions, including people, processes, and technology, that will need to be in place to meet SEC filing, audit, tax, governance, and investor relations needs post-merger. It is essential for the combined public company to have a capable, experienced management team that understands what the reporting and internal control requirements and expectations are of a public company and can effectively execute the company’s comprehensive plan on an accelerated basis.
Financial Reporting Considerations
The combined public company should have personnel and processes in place to produce high quality financial reporting that is in compliance with all SEC rules and regulations. Among other considerations, the combined public company should have finance and accounting professionals with sufficient knowledge of the relevant reporting requirements, including the applicable accounting requirements, and the appropriate staffing to meet deadlines for required current and periodic reports.
While a variety of challenges may arise throughout the de-SPAC process, one example where target companies often encounter complex issues is in the accounting for and reporting of its merger with the SPAC. Some of the areas that may involve significant judgment include, but are not limited to:
- Determination of whether financial statements should be prepared in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) or alternatively may be prepared in accordance with International Financial Reporting Standards (e.g., if the combined public company will be eligible to report on forms applicable to foreign private issuers);
- Public company disclosure requirements, including issues related to the identification of the predecessor entity, the form and content of financial statements, and the preparation of pro-forma financial information;
- Identification of the entity in the merger that should be treated as the acquirer for accounting purposes, including variable interest entity considerations, and whether the transaction is a business combination or reverse recapitalization;
- Accounting for earn-out or compensation arrangements and complex financial instruments;
- Application of GAAP for public business entities (e.g., earnings per share, segment disclosures, and expanded disclosure requirements for certain topics such as fair value measurements and postretirement benefit arrangements) and the related reversal of any previously-elected Private Company Council accounting alternatives available to private companies; and
- Determination of the effective dates of recent accounting standards (e.g., leases and current expected credit losses), with certain public companies eligible to adopt those standards on a timeline that is generally more aligned with the effective dates applicable to private companies; the evaluation of, and preparation for, any potential acceleration of adoption of those standards if the company’s status changes; and the required disclosure of the impact those standards will have when adopted.
We in OCA are available for consultation on accounting and financial reporting issues involving these transactions, and we encourage stakeholders to contact our office with questions that arise in advance of or during de-SPAC merger transactions. The Division of Corporation Finance also has guidance available on a number of financial reporting and disclosure topics, including SPAC transactions.
Internal Control Considerations
Public companies are generally required to maintain internal control over financial reporting (“ICFR”) and disclosure controls and procedures (“DCP”). It is important for target companies to understand the ICFR and DCP requirements and have a plan in place for the combined public company to comply with those requirements on a timely basis.
Under section 404(a) of the Sarbanes-Oxley Act (“SOX”), management generally needs to conduct an annual evaluation of its ICFR. It is important for management to understand the timing of when the first annual ICFR assessment is required, whether an auditor’s report on ICFR is required under Section 404(b) of SOX, and situations where the staff may not object to the exclusion of a company’s annual ICFR assessment, as well as what disclosures the staff would expect to accompany such an exclusion. In addition, management is required to evaluate the effectiveness of a public company’s DCP as of the end of each fiscal quarter (or, in the case of foreign private issuers, each fiscal year).
Corporate Governance and Audit Committee Considerations
Corporate board oversight is essential prior to, during, and after the de-SPAC merger. It is important for boards to have a clear understanding of board members’ roles, responsibilities, and fiduciary duties, and for management to understand its responsibilities for communicating and interacting with the board. The composition of the board is crucial, particularly in the post-merger publicly-traded company, as generally a portion of the board members must be independent from the organization and board members should possess the right level of experience and be prepared for key committee assignments, including on the audit committee (as applicable).
The audit committee plays a vital role, including through auditor selection, a shared responsibility for compliance with auditor independence rules, and oversight of financial reporting, ICFR, and the external audit process. Strong, effective, active, knowledgeable, and independent audit committees significantly further the collective goal of providing high quality, reliable financial information to investors and our markets.
Clear and candid communications between the audit committee, auditor, and management are important for setting expectations and proactively engaging as reporting, control, or audit issues arise during and after the merger process. Effective communication will also contribute to the appropriate “tone at the top” within the combined public company and help to create and maintain an environment that supports the integrity of the financial reporting process and the independence and quality of the audit. The composition of the audit committee is critical to the effectiveness of this dialogue, since these kinds of communications can only occur when the audit committee is comprised of individuals with the appropriate skills and background to oversee these processes in accordance with public company requirements and expectations.
The target company’s annual financial statements should be audited in accordance with the Public Company Accounting Oversight Board (“PCAOB”) standards by a public accounting firm registered with the PCAOB and compliant with both PCAOB and SEC independence requirements. Given that historical audits of the target company were likely performed under American Institute of Certified Public Accountants (“AICPA”) audit and independence standards, this may add additional time and complexity to the audit process. Auditors should consider the need to change or augment the audit engagement team to include members with the appropriate experience in audits of SEC registrants under PCAOB standards.
It is also important for the auditor to consider whether the appropriate acceptance and continuance procedures have taken place when a formerly private audit client prepares to go public through a SPAC merger. While this process also occurs in a traditional IPO, the compressed timing and complexity in a de-SPAC transaction may require thoughtful consideration and analysis pertaining to the client continuance assessment and may require the audit firm to quickly make adjustments to its engagement team to ensure the team has the appropriate level of expertise and experience with SEC and PCAOB requirements. One important aspect to consider when determining acceptance or continuance of an audit relationship is the auditor’s independence under the SEC’s rules. Auditor independence is foundational to the credibility of the financial statements, and is a shared responsibility among audit committees, management, and the auditor.
OCA has received questions regarding auditor independence in de-SPAC mergers, including related to partner rotation requirements and fact patterns where the auditor had prior involvement in the preparation of the financial statements of the target company. It is important to understand that the general standard of independence applies to all periods included in a registration statement. Under the general standard, an auditor is not independent if, among other things, he or she would be in a position of auditing his or her own work or if he or she acts as management. We in OCA are available for consultation on auditor independence issues, and we encourage stakeholders to contact our office with questions that arise in these transactions.
Auditor independence, auditor registration with the PCAOB, and other audit-related requirements should be assessed early in the transaction, particularly since these considerations may result in a need to retain a new auditor or to perform additional audit procedures on prior period financial statements.
We in OCA are committed to promoting robust U.S. capital markets and facilitating capital formation to benefit investors, companies seeking to raise capital, and our economy as a whole. Whether a company enters the public markets through a merger with a SPAC, traditional IPO, or other process, the quality and reliability of financial reporting and the quality of audits on the financial statements provided to investors is vital to our efforts to protect investors and to the confidence of investors in our markets. We encourage stakeholders to consider the risks, complexities, and challenges related to SPAC mergers, including careful consideration of whether the target company has a clear, comprehensive plan to be prepared to be a public company. As more private companies enter our public markets through these structures, we remind companies, their auditors, audit committee members, and other stakeholders that the health of our public markets and the ability of companies to efficiently raise capital in these markets depends upon financial reporting participants fulfilling their respective professional responsibilities in providing high quality financial information to investors.
 This statement represents the views of the staff of the Office of the Chief Accountant (“OCA”). It is not a rule, regulation, or statement of the Securities and Exchange Commission (“SEC” or the “Commission”). The Commission has neither approved nor disapproved its content. This statement, like all staff statements, has no legal force or effect: it does not alter or amend applicable law, and it creates no new or additional obligations for any person. “Our” and “we” are used throughout this statement to refer to OCA staff.
 See Commissioner Allison Herren Lee, Investing in the Public Option: Promoting Growth in Our Public Markets; Remarks at the SEC Speaks in 2020 (October 8, 2020), available at https://www.sec.gov/news/speech/lee-investing-public-option-sec-speaks-100820.
 See Ortenca Aliaj, James Fontanella-Khan, and Aziza Kasumov, Financial Times, Spac dealmaking sets new record (March 1, 2021), available at https://www.ft.com/content/abcf1dad-833d-4620-ab57-96ea01d918ed.
 See Office of Investor Education and Advocacy, What You Need to Know About SPACs – Investor Bulletin (December 10, 2020), available at https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investor-bulletin.
 For example, refer to disclosure obligations pursuant to Regulation S-K, and the requirements of Form S-4, Form F-4, Schedule 14A, Schedule 14C, Schedule TO, and Form 8-K, as applicable.
 See Division of Corporation Finance’s “Filing Review Process” webpage, available at https://www.sec.gov/divisions/corpfin/cffilingreview.htm.
 See Accounting Standards Codification (“ASC”) Topic 842, Leases and ASC Topic 326, Financial Instruments – Credit Losses, respectively.
 See Codification of Staff Accounting Bulletins Topic 11.M, available at https://www.sec.gov/interps/account/sabcodet11.htm.
 More information about how to initiate a dialogue with OCA and what to expect from the consultation process is available on OCA’s “Communicating with OCA” webpage, available at https://www.sec.gov/page/communicating-oca.
 See, e.g., Division of Corporation Finance, CF Disclosure Guidance: Topic No. 11 (December 22, 2020), available at https://www.sec.gov/corpfin/disclosure-special-purpose-acquisition-companies.
 See Securities Exchange Act of 1934 Rules 13a-15(a) and 15d-15(a) for further information about this requirement, including certain entities who are exempt.
 See Sarbanes-Oxley Act of 2002, Title IV, Section 404(a), available at https://www.govinfo.gov/content/pkg/PLAW-107publ204/pdf/PLAW-107publ204.pdf and Securities Exchange Act of 1934, Rules 13a-15(c) and 15d-15(c).
 Accelerated filers and large accelerated filers (other than emerging growth companies) whose management is required to report on ICFR are required to provide the registered public accounting firm’s attestation report on the registrant’s ICFR. See Sarbanes-Oxley Act of 2002, Title IV, Section 404(b), available at https://www.govinfo.gov/content/pkg/PLAW-107publ204/pdf/PLAW-107publ204.pdf and 17 CFR § 229.308(b) (Item 308(b) of Regulation S-K).
 See Division of Corporation Finance, Compliance and Disclosure Interpretations: Regulation S-K, Section 215.02, for instances where the staff would not object if the issuer were to exclude management’s assessment of ICFR from the Form 10-K, and the disclosures that should be included in the report, available at https://www.sec.gov/divisions/corpfin/guidance/regs-kinterp.htm.
 See Securities Exchange Act of 1934, Rules 13a-15(b) and 15d-15(b). In the case of an investment company, management’s assessment of DCP is required within the 90-day period prior to the filing date of each report requiring certification on Form N-CSR.
 See PCAOB Quality Control Section 20 (“QC 20”), System of Quality Control for a CPA Firm’s Accounting and Auditing Practice, available at https://pcaobus.org/oversight/standards/qc-standards/details/QC20. As required by PCAOB QC 20.15, the audit firm’s policies and procedures should provide reasonable assurance that the firm undertakes only those engagements that the firm can reasonably expect to be completed with professional competence, and appropriately considers the risks associated with providing professional services in the particular circumstances.