A Bridge Over Troubled Waters: The Role of Due Diligence in Mitigating SPAC Litigation Risks

INTRODUCTION

Through the first half of 2021, special purpose acquisition companies (SPACs) raised approximately $113 billion across 366 initial public offerings (IPOs).[1] That level far exceeded the previous records, which were set in 2020 ($83.4 billion raised in 248 IPOs) and 2019 ($13.6 billion in 59 IPOs).[2] Given their unique structure and rapid growth, it is not surprising that SPACs have attracted growing regulatory attention and are increasingly the subject of litigation and enforcement actions.

This article explores the role of due diligence in mitigating litigation and enforcement action risks associated with both the SPAC IPO and subsequent business combination (de-SPAC). Because SPACs involve a number of complexities and novel attributes, this article is sequentially structured with each section building on the foundational information conveyed in the sections that precede it. First, we explain SPACs and how they work, highlighting some of the structural features that have garnered the most controversy. We then summarize the relevant regulatory regime within which SPAC litigation typically arises and explain the role of due diligence (including explicit and implicit due diligence defenses) within that regime. Building on these foundational elements, we then examine recent regulatory developments and survey a sample of informative pending SPAC lawsuits. Finally, we offer insights regarding how many of the risks associated with SPACs may be mitigated through effective due diligence and related disclosure practices.

I. THE SPAC PROCESS

A. Overview

SPAC is an acronym for special purpose acquisition company. Initially, a SPAC is a shell company with no operations or assets. It is formed to raise capital through an underwritten initial public offering (IPO), the proceeds of which are intended to be used within a defined period of time to identify and acquire an existing operating company through a de-SPAC transaction.[3] Thus, at inception, a SPAC has only the cash proceeds derived from the IPO and investments associated with those cash proceeds.

SPACs are sponsored by entities (sponsors) that typically have expertise and experience in a given industry. While the sponsors may intend to acquire an operating company in a particular sector,[4] they typically have not identified a specific target at the time of the IPO. As a result, the offering documents contain more limited disclosures than are commonly associated with a traditional IPO. Given the relative simplicity of the process, including the limited disclosures and lower upfront costs, merging into a SPAC through a de-SPAC transaction has become a popular vehicle for achieving public company status.

Over its life cycle, a typical SPAC engages in a number of due diligence and related disclosure processes. These processes involve potential litigation risks for participants, including the sponsor, directors, and officers. In addition, the SPAC IPO involves risks for the underwriter(s), and the de-SPAC transaction involves risks for the advisory firm (which is sometimes affiliated with the original underwriter[5]).

B. SPAC IPO

Like a traditional IPO, a SPAC IPO involves the filing of a Form S-1 registration statement and prospectus with the Securities and Exchange Commission (SEC or Commission). However, given the absence of operations and assets, SPAC IPOs have a number of attributes that distinguish them from traditional IPOs.

For example, whereas a traditional IPO involves the issuance of shares of common stock, a SPAC IPO involves the issuance of a bundled unit of securities (a SPAC unit) consisting of one share of common stock and one warrant typically priced at $10 per unit. The warrant entitles the holder to purchase an additional share (or fraction thereof) of common stock from the company, typically at a price of $11.50 per whole share (i.e., higher than the initial SPAC unit offer price).[6] After the IPO, the SPAC unit initially trades on an exchange as a single combined security. Thereafter, the common stock and warrants may trade separately under independent trading symbols.[7]

In a traditional IPO, underwriters typically receive an underwriting discount at closing (a discount of the purchase price paid by the underwriters for the shares) approximating 5%–7% of the gross IPO proceeds.[8] In contrast, the typical discount at closing in a SPAC IPO is in the range of 2%, with an additional amount (often in the range of 3%–5%) deposited into the trust account and payable only upon consummation of the de-SPAC transaction.[9] Therefore, if the SPAC is unable to complete a subsequent de-SPAC business combination within the specified time period, the deferred portion of the underwriter’s compensation is never paid.

Sponsors of a SPAC also implicitly receive compensation. In exchange for a nominal initial investment and the work they will perform in identifying a potential business combination, sponsors typically receive fully diluted post-IPO shares in the range of 20%–25% (sponsor shares).[10] Sponsors also often make additional cash investments through the purchase of warrants. The proceeds of the latter are intended to cover the SPAC’s out-of-pocket IPO and initial operating costs.[11] Sponsor shares and warrants only have potential value if a business combination is consummated; they do not represent an interest in the trust funds and have no value if the trust dissolves.[12]

As explained later in this article, recent SPAC litigation has alleged that sponsors, directors, officers, and underwriters have an economic interest that favors consummation of a de-SPAC business combination whether or not it is in the best interests of the shareholders.[13]

C. De-SPAC

At closing, the net proceeds of the SPAC IPO are placed in trust. The trust invests those funds in U.S. treasury securities pending a subsequent business combination (typically a merger) between the SPAC and a target company. This transaction is commonly referred to as a “de-SPAC” or an “initial business combination.”[14] A de-SPAC transaction involves the merger of a private operating company (target) and a publicly traded SPAC (or a subsidiary of the SPAC). In the merger, target shareholders receive consideration consisting of either shares of the SPAC, cash, or a combination of both. If the merger consideration involves the issuance of shares of common stock, the SPAC must file a registration statement on Form S-4 with the SEC to register those shares. The S-4 is subject to review and comment by the SEC, and the SEC may request modified or additional disclosures.

The de-SPAC merger involves a number of activities and associated litigation risks. These include the solicitation of shareholder consent, the preparation and dissemination of an Information Statement, the registration and issuance of SPAC securities constituting part of the merger consideration, and the private offering and issuance of securities immediately prior to the merger to provide additional required capital.[15]

Upon consummation of the de-SPAC transaction, the target becomes a public company whose shareholders typically include non-redeeming SPAC IPO investors (i.e., those who did not exercise the redemption right discussed below), SPAC sponsors, and any entities that acquired shares as part of a pre-merger financing round (also discussed below). If the merger consideration includes shares of the SPAC, the shareholder base also includes former target company shareholders.

A SPAC must consummate a de-SPAC transaction within a disclosed time period, typically 24 months after the IPO (although some SPACs have elected shorter periods).[16] If it does not do so, then the funds held in trust (including interest earned on those funds) must be returned to the shareholders entitled to receive them.[17]

If the SPAC identifies a suitable business combination opportunity within the permitted window, SPAC shareholders will have the opportunity to redeem their shares (and receive their pro rata amount of the funds held in the trust account) and, in most cases, vote on the initial business combination transaction.[18] If a shareholder elects to exercise this redemption right, it no longer is a shareholder but retains the warrants (if the warrants were not sold) that were part of the bundled SPAC unit acquired in the IPO.[19] If the de-SPAC merger involves shareholder approval, the SPAC must file a proxy statement[20] pursuant to Section 14 of the Securities Exchange Act of 1934 (Exchange Act).[21] Where public shareholder approval is not required (for example, where the sponsors hold enough votes to approve the transaction independently), the SPAC will provide shareholders with an Information Statement on Schedule 14C. If the merger consideration includes SPAC shares, the Form S-4 and proxy are typically combined in a joint registration/proxy statement.

Depending upon the number of redeeming shareholders and the amount of cash required to satisfy the redemptions, a SPAC may require additional capital at the time of the de-SPAC transaction to fund the redemption obligations, finance operations, and meet the liquidity needs of the combined entity. This additional funding has typically been raised through a private placement of SPAC securities structured as a private investment in public equity (PIPE) transaction.[22] Thus, the sources of cash to fund a de-SPAC merger typically involve the initial capital raised in the IPO (net of redemptions), sponsor-purchased shares, and proceeds of the PIPE transaction.

While the PIPE offering is a private placement and therefore not subject to Section 11 of the Securities Act of 1933 (Securities Act),[23] claims for intentional misconduct or negligent misrepresentation may be based on the anti-fraud provisions of the Exchange Act,[24] common law, or state securities laws.[25]

Finally, within four business days after consummation of the initial business combination, the company must file with the SEC a Form 8-K (sometimes referred to as a “Super 8-K”) containing information substantially equivalent to that required in a traditional registration statement and similar to the information contained in the Form S-4.

II. DUE DILIGENCE: FUNDAMENTAL CONCEPTS

Given the number of disclosure events associated with a typical SPAC life cycle, it is not surprising that due diligence is often a central theme in SPAC litigation and enforcement actions. Our survey of pending cases shows that plaintiffs often allege due diligence failures that either led to material misstatements or omissions in the at-issue disclosure documents or that were elemental components of a breach of a defendant’s fiduciary duties (typically, the duty of care). Therefore, before addressing how effective due diligence and related disclosure practices can mitigate these risks, it is important to understand the concept of due diligence.

A. Due Diligence

The term “due diligence” is not defined in statutes or regulations. Instead, it is a term of art that is part of the regulatory, judicial, scholarly, and practical lexicon. In its simplest formulation, due diligence is the investigation conducted by and/or the reliance placed on others in a business transaction. At a more granular level, it is the process and practice of using reasonable efforts, appropriate in the context, to investigate (or reasonably rely on others regarding) the material aspects of a proposed transaction so that a reasonable person (such as a potential investor in a securities offering) can make an informed decision.

While due diligence is an affirmative obligation of underwriters,[26] all parties to a securities offering or other business transaction, including those involving SPACs, have an interest in conducting reasonable due diligence because, among other things, it:

• Enhances investment and other business decisions
• Minimizes the risk of post-closing disputes and litigation
• Supports the material accuracy and completeness of disclosures in securities offering documents
• Protects reputations and business franchises
• Facilitates compliance with applicable laws and regulations, and
• Establishes a basis for one or more affirmative due diligence defenses.

B. Reasonableness

The standard by which due diligence is measured is “reasonableness,” not “perfection.”[27] In the context of a lawsuit, reasonableness is a legal conclusion made by a court or trier of fact,[28] though the term also has a common understanding in the industry that mirrors the legislative, regulatory, and judicial understandings.^[29] Under both, reasonableness is based on what a prudent person in a similar context would have done in the management of their own property.[30] Reasonableness is measured by a negligence standard^[31] involving the use of “ordinary care.”^[32] 

Reasonableness is assessed in “a specific factual context.”^[33] The Due Diligence Task Force of the American Bar Association (ABA) expressed this concept as follows: “as a standard of conduct, ‘reasonableness’ is meaningless except in a specific factual context.”[34] Similarly, the National Association of Securities Dealers (NASD), the predecessor of the Financial Industry Regulatory Authority (FINRA), the self-regulatory organization for broker-dealers (including those acting as underwriters), has stated that the “type of due diligence investigation that is appropriate will vary….”[35] And the formal report of the SEC’s Advisory Committee on Corporate Disclosure[36] stressed that “the important point is that each subject person should evaluate the surrounding facts, including the extent of his prior relationship with the registrant, and utilize techniques of investigation appropriate to the circumstances of the offering….”[37]

As explained below, SPAC sponsors, officers, directors, underwriters, and financial advisors, among others, conduct due diligence at both the SPAC IPO and de-SPAC stages. This due diligence involves, for example, assessing the material accuracy and completeness of disclosures in public and private placement offering documents and the operational, financial, and other attributes of target companies. Given some of the novel attributes of SPACs, the scope and character of due diligence can differ from that associated with more traditional securities offerings and business combination transactions.

For example, traditional IPO offering documents contain a range of disclosures such as historical information about the issuer, its business, operations, management, and past financial performance. Because a SPAC is a shell company, these are not relevant (or even possible) disclosures in SPAC IPO offering documents.[38] As a result, FINRA has stated that the unique nature of SPACs leads to relatively less due diligence and disclosure at the SPAC IPO stage compared to a traditional IPO.[39]

Nonetheless, for the reasons explained above, sponsors, directors, officers, and underwriters conduct due diligence into the material accuracy and completeness of SPAC IPO disclosures.[40] However, given the narrower scope and more limited character of SPAC IPO disclosures, the risk of material misstatements or omissions in SPAC IPO offering documents clearly is more limited than in a traditional IPO (and correspondingly the prophylactic effects of due diligence, while still present, are less pronounced).

Moreover, investor redemption rights (whereby investors redeem their shares at a slight premium to their original IPO purchase price) substantially reduces the likelihood of a SPAC IPO investor incurring a loss (damages) on the investment. Indeed, based on our research, to date there have been no suits brought forth under Section 11 of the Securities Act related to SPAC IPOs, and, absent regulatory changes, it seems unlikely that SPAC IPO offering document disclosures will be a primary focus in future litigation and enforcement actions. At the de-SPAC stage, however, the topics addressed in disclosure documents expand significantly and litigation exposure is correspondingly increased.

Thus, both SPAC IPOs and de-SPAC transactions involve due diligence, and that due diligence, as explained below, can mitigate risk in litigation and enforcement actions.

III. DUE DILIGENCE IN THE SPAC LIFE CYCLE: REGULATORY REGIME AND DEFENSES

Based on our survey of recent cases, SPAC litigation often involves allegations of material misstatements and omissions in disclosure documents and unreasonable due diligence into those disclosures. These allegations have arisen in the context of claims asserted under the Securities Act, the Exchange Act, state securities laws, and various fiduciary duty laws. This section offers a brief overview of these laws and explains their relevance in the context of SPAC litigation.

A. Securities Act and Exchange Act

The Securities Act imposes civil liability for material misstatements and omissions in registered securities offering documents including those related to the SPAC IPO and the de-SPAC transaction.[41] In addition, the anti-fraud provisions of the Exchange Act prohibit fraudulent conduct in connection with securities transactions (both public offerings and private placements) and establish disclosure standards that are particularly relevant at the de-SPAC stage. While the two Acts employ different standards for determining liability (the Exchange Act, for example, requiring proof of scienter), taken together they are the bedrock of the regulatory regime governing modern securities issuances and trading in the United States.

Parties to SPAC transactions, including issuers, sponsors, directors, officers, underwriters, and advisory firms (such as an advisory firm in a de-SPAC transaction), are potential defendants under both Acts. However, a number of these potential defendants[42] can avoid liability by proving that they acted reasonably in conducting due diligence. For example, the Securities Act contains three affirmative “due diligence” defenses that are available to enumerated defendants including directors and underwriters. The first two are set forth in Section 11—reasonable investigation[43] and reasonable reliance.[44] The third—reasonable care—is set forth in Section 12(a)(2).[45] Each requires a “reasonableness” determination by the court.[46]

Parties to SPAC transactions also have potential fraud-based liability under the Exchange Act, including Section 10(b) and Rule 10b-5.[47] Unlike the Securities Act, the Exchange Act contains no express due diligence defenses. However, a number of courts have held that establishing a reasonable due diligence defense under the Securities Act negates the existence of scienter (a mandatory element of an Exchange Act fraud-based claim).[48]

As is clear from the formulation of each of the three express Securities Act due diligence defenses, and the implicit due diligence defense that arises from judicial interpretations of the implications of reasonable due diligence for the Exchange Act’s scienter requirement, reasonableness of due diligence is often a central issue in litigation arising under both Acts.

As explained earlier, each transaction is unique, and what is reasonable due diligence in one context may or may not be reasonable in another. Therefore, there is no one-size-fits-all checklist of mandatory or appropriate due diligence processes or practices to be followed in every context.

However, over the course of more than 60 years, a number of authoritative and informative sources have offered constructive guidance regarding what may constitute reasonable investigation and reliance (the two primary components of due diligence) in various contexts. These include the SEC;[49] special committees and task forces, such as the SEC Advisory Committee on Broker-Dealer Compliance,[50] the SEC Advisory Committee on Corporate Disclosure,[51] and the ABA Due Diligence Task Force;[52] self-regulatory organizations such as FINRA and its predecessor the NASD;[53] and judicial rulings.[54] While the pronouncements regarding reasonableness are not extensive in number and some are of early vintage, they involve a variety of transactional, situational, positional, and temporal contexts, and explore the issue of reasonableness in due diligence from a diverse range of perspectives. Taken together, they provide essential insight into reasonableness in securities offering due diligence, including for SPACs.

B. State “Blue Sky” Laws

In addition to the federal laws and regulations summarized above, each state has its own securities laws and regulations governing the offer and sale of securities within the state’s boundaries or to citizens of the state. These are commonly referred to as “Blue Sky” laws.[55] While such laws tend to mirror many core concepts of the federal regulatory regime, they can differ in some important ways. For example, Blue Sky laws typically require registration (or in the case of private placements, exemptions from registration) for securities offerings and establish a legislatively empowered state body (often a “state securities commission”) to regulate securities issuances and to deal with other matters such as the registration of broker-dealers and investment advisors. They may also contain different due diligence defenses and may potentially offer a wider range of protections than are available under federal law.[56]

C. Fiduciary Duty Laws

Finally, in addition to bringing claims under federal and/or state securities laws, shareholders may sue for breaches of fiduciary duties.[57] The majority of such SPAC-related lawsuits we have identified to date allege breaches of fiduciary duties by directors and/or officers regarding a de-SPAC business combination. However, some also include claims against the SPAC, the target company (and its board or officers), and/or others for allegedly aiding and abetting fiduciary duty breaches by the SPAC board.

A fiduciary is defined as “someone who is required to act for the benefit of another person on all matters within the scope of their relationship.”[58] Directors and officers[59] have a fiduciary relationship with the company and its shareholders. Directors are responsible for oversight and compliance.[60] Officers, as delegates of the board, are responsible for day-to-day operations. Both directors and officers must act in the best interest of the corporation when exercising their responsibilities[61] and must exercise reasonable care and diligence in performing their functions. Their conduct in these regards is assessed with reference to the conduct of a similarly situated prudent person.[62]

Director and officer fiduciary duties are addressed in, among others, state corporation laws (and such suits often are brought in state court). While fiduciary duty laws vary somewhat from state to state, most are based on the ABA’s Model Business Corporation Act (MBCA). The MBCA identifies two primary fiduciary duties of directors—the duty of care (sometimes called the “duty of care and diligence,” which incorporates a duty of good faith) and the duty of loyalty:

(a) Each member of the board of directors, when discharging the duties of a director, shall act:

(i) in good faith, and

(ii) in a manner the director reasonably believes to be in the best interests of the corporation.

(b) The members of the board of directors or a board committee, when becoming informed in connection with their decision-making function or devoting attention to their oversight function, shall discharge their duties with the care that a person in a like position would reasonably believe appropriate under similar circumstances.[63]

The duty of care requires that directors make informed decisions based on a reasonable process, including a reasonable due diligence process. The duty of loyalty requires directors to place the interests of the corporation above their personal interests and those of their affiliates.

If these duties are deemed to have been satisfied, the defendant’s conduct typically is measured according to the “business judgment rule,” which provides that the court will defer to the defendant’s judgment provided the decision was made in good faith and the defendant reasonably believed that he or she was acting in the best interests of the company.[64] Conducting reasonable due diligence is one of the ways defendants seek to establish that the duty of care was met.

When a defendant invokes the business judgment rule and the court finds that the presumption applies, then the burden of proof is on the plaintiff to prove that the business judgment rule does not apply. Plaintiffs typically endeavor to do so on the basis of bad faith, conflicts of interest, or gross negligence, including in connection with the defendant’s due diligence. If the court concludes that the plaintiff has met this burden of proof, then the court will judge the matter according to the “entire fairness standard” pursuant to which the defendant must prove that the process was fair and the decisions were informed.[65]

As explained below, our review of recent and pending SPAC litigation involving fiduciary duty breach allegations reveals a focus on allegations that the defendants conducted inadequate due diligence into the proposed target company merger, failed to conduct proper due diligence into statements made (or omitted) in de-SPAC stage disclosure documents, and/or had undisclosed or inherent conflicts of interest.

While the pending litigation is still at an early stage, given the potential for conflicts of interest inherent in SPAC business combinations, recent SEC and staff pronouncements, the large number of SPAC s formed to date, and the more than 400 de-SPAC transactions yet to be completed,[66] we anticipate an increase in fiduciary duty breach allegations. As explained above, that litigation is likely to present questions about the application of state-law rules, and in particular the application of the “business judgment rule” and the “entire fairness” standard with a focus on the defendant’s due diligence.

IV. RECENT SEC COMMENTARY, GUIDANCE, AND PRONOUNCEMENTS

A. Overview

In recent months, the SEC has issued guidance regarding SPAC due diligence and related disclosure and accounting practices. In addition, SEC staff members, including Chairman Gary Gensler and Acting Director of the SEC’s Division of Corporation Finance John Coates, have addressed SPACs in personal commentary.

For example, on April 8, 2021, Acting Director Coates issued a public statement (which was not officially endorsed by the SEC) confirming the Commission’s increased interest in and focus on SPACs and the disclosures made at both the IPO and de-SPAC stages (Coates Commentary). Among other things, Acting Director Coates stated: “The staff at the Securities and Exchange Commission are continuing to look carefully at filings and disclosures by SPACs and their private targets. As customary, and in keeping with the Division of Corporation Finance’s ordinary practices, staff are reviewing these filings, seeking clearer disclosure, and providing guidance to registrants and the public. 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.”[67]

Subsequently, on May 26, 2021, Chairman Gensler summarized his concerns regarding SPACs as follows:

First and foremost, are SPAC investors being appropriately protected? Are retail investors getting the appropriate and accurate information they need at each stage—the first blank-check IPO stage and the second target IPO stage? Second, how do SPACs fit in to our mission to maintain fair, orderly, and efficient markets? It could be the case that SPACs are less efficient than traditional IPOs. One recent study shows that SPAC sponsors generate significant dilution and costs. SPAC sponsors generally receive 20 percent of shares as a “promote.” The first-stage investors can redeem when they find the target, leaving the non-redeeming and later investors to bear the brunt of that dilution. In addition, financial advisors are paid fees for the first-stage blank-check IPO, for the PIPEs, and for the merger with the target. Further, it’s often the case that the investors in these PIPEs are buying at a discount to a post-target IPO price. It may be that the retail public is bearing much of these costs. I’ve asked staff to consider what recommendations they would make to the Commission for possible rules or guidance in this area. Our Corporation Finance, Examinations, and Enforcement Division staffs will also be closely looking at each stage to ensure that investors are being protected. Each new issuer that enters the public markets presents a potential risk for fraud or other violations.[68]

According to a March 25, 2021 Reuters article, the SEC’s enforcement division recently sent voluntary cooperation letters of inquiry to at least four major investment banks seeking information about their fees, volumes, compliance, reporting, internal controls, and other matters associated with their involvement in SPAC IPOs and subsequent de-SPAC transactions.[69] The Commission’s decision to contact the investment banks reflects the fact that the original underwriter or an affiliate entity may “provide additional services such as identifying potential targets, providing financial advisory services, acting as a placement agent in a private offering or underwriting or arranging debt financing….”[70] Consistent with this, a July 13, 2021 article stated that the SEC was focused on better understanding potential conflicts when a bank is serving as both the underwriter and a financial advisor in the de-SPAC transaction.[71]

On June 11, 2021, the Commission announced a target date of April 2022 for proposed amendments to rules governing SPACs.[72] While it did not specify the precise nature of the forthcoming amendments, our analysis of the SEC’s recent guidance and commentary suggests that the amendments are likely to focus on several areas. The first is disclosures, especially those related to sponsor compensation and potential conflicts of interest that may incentivize SPAC participants to consummate a de-SPAC transaction not deemed to be in the best interests of SPAC shareholders. The second is due diligence processes and practices related to assessing the appropriateness of the potential de-SPAC target company and the statements made in the contemporaneous disclosure documents. Third is accounting treatment and related practices.

B. SPAC Due Diligence and Disclosure: IPO Stage

Despite the existence of a shareholder redemption right and the corresponding difficulty of proving damages, the SEC has shown an interest in heightened disclosure at the SPAC IPO stage, especially with respect to the relationship between the SPAC and its sponsor(s) and underwriters. For example, in a September 2020 interview, then-SEC Chairman Jay Clayton stated: “One of the areas in the SPAC space I’m particularly focused on, and my colleagues are particularly focused on, is the incentives and compensation to the SPAC sponsors… What are their incentives?”[73] Also, on December 22, 2020, the SEC issued CF Disclosure Guidance: Topic No. 11[74] (CF Disclosure Guidance) encouraging SPACs to include certain disclosures in the IPO offering documents regarding, among others:

• The sponsors’, directors’, and officers’ potential conflicts of interest;
• Whether and how sponsors, directors, and officers may be compensated for services to the SPAC, including whether any payments will be contingent on the completion of a business combination transaction and the amount of any such contingent payments;
• The financial incentives of SPAC sponsors, directors, and officers to complete a business combination transaction, including how they differ from the interests of the public shareholders, and information about the losses the sponsors, directors and officers could incur if the SPAC does not complete a business combination transaction;
• Whether the underwriter of the IPO may provide additional services such as identifying potential targets, providing financial advisory services, acting as a placement agent in a private offering or underwriting, or arranging debt financing, and what fees the SPAC may pay for such services;
• Whether payment for any such additional services will be conditioned on the completion of a business combination transaction; and
• Any conflict of interest the underwriter may have in providing such services if IPO underwriting compensation is to be deferred until the completion of a business combination transaction.[75]

C. SPAC Due Diligence and Disclosure: De-SPAC Stage

The Commission also has made recent statements regarding the de-SPAC business combination, and in particular the due diligence conducted in connection therewith.

For example, in an October 29, 2020 comment letter associated with Legacy’s de-SPAC merger with Onyx Enterprises Int’l Corp, the SEC specifically inquired about and sought revisions to the disclosure documents to include additional disclosures pertaining to the due diligence that was conducted as part of the de-SPAC merger, including, among others:

• Comment 1: “Please tell us how you arrived at the Business Combination Consideration amount. Please include sufficient details and assumptions that went into determining the Business Combination Consideration, including any relevant industry and business stage information as well as any financial projections you may have relied upon. Revise to disclose the Aggregate Purchase Price, as of a current date, in order to give context to how this amount will be determined.”
• Comment 3: “Please revise your disclosure to include the details surrounding your search [for possible target businesses], the basis on which you evaluated each potential target business, including why certain of the other potential target businesses were not pursued and what parties or advisors were involved in the process.”
• Comment 4: “We note that the terms of the Business Combination were the result of ‘extensive arms’ length negotiations.’ Please revise your disclosure in this section to include a description of the negotiations relating to material terms of the transaction.”
• Comment 6: “Please provide a summary of the financial, business, and legal due diligence questions that arose during your diligence meetings.”
• Comment 9: “To the extent applicable, please include how valuations, comparable companies, and advisors played a role in approving and signing the Business Combination Agreement.”
• Comment 11: “Explain how you determined the transaction to be fair to shareholders when it does not appear that the Board took into account the consideration to be received in exchange for Legacy shares.”[76]

In addition, the SEC’s CF Disclosure Guidance[77] also addressed de-SPAC stage disclosure. This component of the guidance was directed particularly to “SPAC sponsors, directors and officers” and to “the underwriter of the SPAC’s IPO [that] may have provided services in addition to those associated with the underwriting of the IPO….” [78] According to this guidance, de-SPAC-related disclosure documents should contain, among other things:

• Detailed information about how the SPAC and its sponsors, directors, officers, and advisors evaluated and decided to propose the identified transaction, including why the target company was selected as opposed to alternative candidates and who initiated contact, including what material factors the board of directors considered in its determination to approve the transaction;
• A clear description of any conflicts of interest of the sponsors, directors, and officers in presenting this opportunity to the SPAC, how the SPAC addressed these conflicts of interest, and how the board of directors evaluated the interests of sponsors, directors, and officers;
• Detailed information regarding how the sponsors, directors, and officers will benefit from the transaction, including by quantifying any material payments they will receive as compensation, the return they will receive on their initial investment, and any continuing relationship they will have with the combined company;
• Information on fees that the underwriter of the IPO will receive upon completion of the business combination transaction, including the amount of fees that is contingent upon completion of a business combination transaction; and
• Information on services the underwriter provided, the cost of those services, and how the underwriter and/or its affiliates were compensated for those services, including disclosure of whether those services were conditioned on the completion of the business combination transaction and whether the underwriter may have a conflict of interest, given any deferred IPO underwriting compensation.[79]

Similarly, the Coates Commentary also addressed de-SPAC stage due diligence and related disclosure practices. Among other things, it queried whether “current liability provisions give those involved—such as sponsors, private investors, and target managers—sufficient incentives to do appropriate due diligence on the target and its disclosures to public investors.”[80] In addition, it challenged the notion that the Private Securities Litigation Reform Act (PSLRA) safe harbor for forward-looking statements (such as those related to projections and other valuation metrics)[81] applied to de-SPAC disclosures.[82] It further noted that, even assuming the PSLRA safe harbor provision applied to de-SPAC transactions, the safe harbor only applies to private litigation, and not to SEC enforcement actions.[83]

The Coates Commentary also expressed the view that the de-SPAC transaction is akin to a traditional IPO in that “it is the first time that public investors see the business and financial information about a company.”[84] It further indicated that the SEC could use rulemaking or guidance to explain its views regarding how, or if at all, the PSLRA safe harbor should apply to de-SPACs, and cautioned that any claim about reduced liability exposure for SPAC participants relative to a traditional IPO is “overstated at best, and potentially seriously misleading at worst.”[85]

Finally, Acting Director Coates questioned whether the SEC should reconsider the concept of an “underwriter” in de-SPAC transactions, and whether additional guidance is needed about how projections and related valuations are presented and used in de-SPAC transactions.[86] He concluded by stating that “we should focus the full panoply of federal securities law protections” on de-SPAC transactions, adding that “[i]f we do not treat the de-SPAC transaction as the ‘real IPO,’ our attention may be focused on the wrong place, and potentially problematic forward-looking information may be disseminated without appropriate safeguard.”[87]

D. Accounting and Reporting Considerations

In addition to commentary regarding due diligence and related disclosure practices, the SEC also has issued guidance related to SPAC accounting practices.[88] For example, on April 12, 2021, Acting Director Coates and Acting Chief Accountant Paul Munter issued a statement discussing “the potential accounting implications of certain terms that may be common in warrants included in SPAC transactions.”[89] The statement expressed the authors’ views that certain contractual provisions that are common in warrants issued in connection with a SPAC transaction (such as provisions related to settlement amounts and tender offers) should be analyzed to determine if the warrants should be accounted for as liabilities rather than equity, and if so, whether the impact of the change in accounting treatment is material, requiring a restatement of previously issued financial statements.[90] Warrants issued in connection with SPAC transactions have historically been classified as equity;[91] classifying warrants as liabilities would require a measurement of fair value, with changes in fair value reported in earnings for each period.[92]

Commentators have noted that the change in accounting treatment, if it were to become law, would require SPACs to perform quarterly valuations of warrants as debt (versus a one-time equity valuation), a process that would potentially make SPACs less attractive to targets and other investors.[93] In certain cases, the change in accounting treatment could also lead to restatement of prior financial statements.[94]

E. Summary

SPACs are an increasing area of focus for the SEC and its senior staff. Primary areas of interest include due diligence and disclosure practices involving potential conflicts of interest, investment banking involvement (including compensation) in the various phases of the SPAC process, and, at the de-SPAC stage, inadequate due diligence of the target catalyzed by potential conflicts of interest related to economic incentives to the sponsors and other parties.

This increased level of scrutiny and attention is not remarkable given the dramatic and rapid increase in SPAC activity (as noted above, through the first half of 2021, SPACs raised approximately $113 billion across 366 IPOs[95]). While recent developments suggest that this increased regulatory focus may be contributing to a decline in SPAC IPO activity (approximately 300 SPAC IPOs occurred during the first quarter of 2021 versus approximately 60 during the second quarter of 2021[96]), as of July 2021, more than 400 SPACs were seeking acquisition targets.[97]

Given the SEC’s recent guidance and commentary regarding SPACs, as well as the statements of senior SEC staff, we anticipate more developments, including in response to the new regulations that the SEC has stated are forthcoming. In the meantime, the pronouncements and statements made to date are clear indications of the Commission’s primary areas of concern, and they offer constructive insight regarding how effective due diligence can minimize risk to SPAC participants.

V. RECENT LITIGATION DEVELOPMENTS

A. Overview

According to the Stanford Law School Securities Class Action Clearinghouse, shareholders filed 30 federal class action lawsuits involving SPACs between January 2019 and July 2021, more than half of which were filed in 2021.[98] In addition, between October 2020 and April 2021, more than 60 shareholder lawsuits involving SPACs were filed in state courts (including in New York[99] and Delaware[100]). In many respects, the allegations made in these cases mirror the areas of concern addressed in the regulatory developments and commentary discussed above. These include allegedly inadequate due diligence and disclosures regarding sponsor compensation and potential conflicts of interest, and the extent and character of due diligence and disclosure related to the de-SPAC business combination. Following is a brief survey of some of these cases.

B. Securities Law Claims

On July 13, 2021, the SEC announced charges against SPAC Stable Road Acquisition Company (Stable Road), its sponsor, and its CEO, as well as against Momentus Inc. (Momentus)—the SPAC’s proposed merger target, an early-stage space transportation company—and Momentus’s founder and former CEO Mikhail Kokorich for misleading claims regarding Momentus’s technology and national security risks purportedly associated with Kokorich.[101] According to the SEC’s press release, it has filed a complaint against Kokorich in the U.S. District Court for the District of Columbia (all other parties have agreed to a settlement that includes total penalties of more than $8 million, certain investor protection undertakings, and, if the merger currently scheduled for August 2021 is approved, forfeiture by the SPAC sponsor of founder’s shares it stands to receive).[102] 

The SEC claims include that:

• Kokorich and Momentus repeatedly told investors that Momentus had “successfully tested” its propulsion technology in space whereas, according to the SEC, the company’s only in-space test “had failed to achieve its primary mission objectives or demonstrate the technology’s commercial viability.”
• Momentus and Kokorich misrepresented the extent to which national security concerns associated with Kokorich “undermined Momentus’s ability to secure required governmental licenses essential to its operations.”
• Stable Road repeated Momentus’s misleading statements in public filings related to the proposed merger and failed to satisfy its due diligence obligations to investors. According to the SEC, despite Stable Road’s claim that it conducted extensive due diligence of Momentus, it never received sufficient documents to assess the national security risks posed by Kokorich or reviewed the results of Momentus’s in-space test. Specifically, with respect to due diligence, Chairman Gensler stated:

This case illustrates risks inherent to SPAC transactions, as those who stand to earn significant profits from a SPAC merger may conduct inadequate due diligence and mislead investors. Stable Road, a SPAC, and its merger target, Momentus, both misled the investing public. The fact that Momentus lied to Stable Road does not absolve Stable Road of its failure to undertake adequate due diligence to protect shareholders. Today’s actions will prevent the wrongdoers from benefitting at the expense of investors and help to better align the incentives of parties to a SPAC transaction with those of investors relying on truthful information to make investment decisions.[103]

• As a result of the alleged inadequate due diligence, Stable Road’s registration statements and proxy solicitations were inaccurate.[104]

According to the SEC, the SEC’s complaint against Kokorich includes factual allegations that are consistent with these claims.[105] Following the SEC’s announcement of these charges and partial settlement, a federal class action lawsuit was filed on July 15, 2021 by investors of Stable Road containing similar allegations.[106]

In re Akazoo S.A. Securities Litigation includes several consolidated federal and state securities class actions regarding Akazoo S.A., a global music streaming platform that was formed through a 2019 merger of Modern Media Acquisition Corp. (MMAC), a SPAC, and Akazoo Limited. Plaintiffs allege violations of Sections 10(b) and 14(a) of the Exchange Act, as well as Section 11 of the Securities Act (regarding statements made in the Form S-4 filed in connection with the de-SPAC merger). These alleged violations arise from purportedly false and misleading statements regarding the target company, including:

• the number and growth of registered users and subscribers;
• the company’s revenue and profit;
• the size of the company and its services;
• the areas in which the company operated; and
• its relationships with mobile operators in various markets.

Sections 10b and 14(a) defendants include Akazoo, officers and directors of MMAC, and Akazoo Limited. Section 11 defendants include the same parties as well as Akazoo Limited’s independent auditor.[107] On April 23, 2021, the parties reached a $35 million partial settlement.[108] In addition, the SEC filed an enforcement action against Akazoo on September 30, 2020 seeking permanent injunction against Akazoo and disgorgement of allegedly ill-gotten gains,[109] which resulted in an agreed order of judgment on April 2, 2021 that permanently enjoins and restrains Akazoo under Section 17(a) of the Securities Act, and Sections 10(b), 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Exchange Act.[110]

Pitman et al. v. Immunovant, Inc. et al, filed in the Eastern District of New York on February 19, 2021, involves the pharmaceuticals industry de-SPAC business combination of SPAC Health Sciences Acquisition Corp. (HSAC) and Immunovant Sciences, Ltd. (Immunovant). Plaintiffs allege violations of Section 10(b) and Rule 10b-5 of the Exchange Act resulting from allegedly inadequate pre-merger due diligence that plaintiffs assert would have revealed safety and efficacy problems with the target company’s clinical trials of a monoclonal antibody drug (the application was withdrawn after consummation of the business combination). Among other things, plaintiffs allege that:

• HSAC performed inadequate due diligence into Immunovant prior to the merger;
• defendants ignored or failed to disclose safety issues associated with Immunovant’s monoclonal antibody drug; and
• the at-issue drug was less safe than the company had led investors to believe, which foreseeably diminished the drug’s prospects for regulatory approval, commercial viability, and profitability.[111]

Borteanu et al. v. Nikola Corporation et al. is a class action filed in the District of Arizona on September 15, 2020. Plaintiffs allege violations of Section 10(b) and Rule 10b-5 of the Exchange Act in connection with the de-SPAC acquisition of Nikola Corporation in June 2020 by VectoIQ Acquisition Corp. Among other things, the complaint asserts that the SPAC failed to “engage in proper due diligence,” which plaintiffs allege would have revealed misrepresentations by the target regarding its technology and business model. More specifically, the complaint alleges that:

• VectoIQ did not engage in proper due diligence regarding its merger with Nikola;
• Nikola overstated its in-house design, manufacturing, and testing capabilities; and
• Nikola overstated its ability to lower the cost of hydrogen fuel and the work experience and background of key Nikola employees.[112]

Welch et al. v. Meaux et al., filed in the Western District of Louisiana on September 26, 2019 (amended October 16, 2020), involves a de-SPAC combination between SPAC Landcadia Holdings and Waitr, an online food ordering and delivery service. Plaintiffs allege violations of Section 10(b), Rule 10b-5, and Section 14(a) of the Exchange Act. The complaint alleges material misstatements in the de-SPAC Information Statement and other documents regarding:

• the market opportunity for Waitr’s services;
• Waitr’s business model and growth strategy; and
• Waitr’s accounting practices and internal controls.

Section 14(a) defendants include Waitr, its directors and officers, and the investment bank involved in the de-SPAC transaction. Section 10(b) and Rule 10b-5 defendants include Waitr and its directors and officers; the complaint alleges, among other things, material misstatements after completion of the de-SPAC transaction in a scheme to artificially inflate and maintain the price of Waitr following the de-SPAC combination.[113]

C. Fiduciary Duty Claims

Delman v. Croskey is a shareholder derivative action filed in the Delaware Court of Chancery on May 24, 2021, arising from the combination of SPAC Live Oak Acquisition Corp. and Danimer Scientific (Danimer), which produces bioplastic replacements for traditional petrochemical-based plastics such as water bottles, food containers, and drinking straws. The plaintiff, a shareholder of Danimer, claims that Danimer’s board members breached their fiduciary duties by:

• disseminating misleading statements about the biodegradability and future prospects of Danimer’s Nodax product in order to keep Danimer’s stock price above $18, the threshold at which Danimer’s board members and affiliated entities would be entitled to exercise stock warrants to buy shares at a discount;
• misrepresenting the company’s capacity to manufacture Nodax products at a scale sufficient to meet revenue estimates; and
• failing to maintain adequate internal controls in the company’s hiring practices.[114]

In Amo v. Multiplan Corp., filed in the Delaware Court of Chancery on March 25, 2021, a shareholder of Multiplan asserts breach of fiduciary duty claims under Delaware state law in connection with the merger of SPAC Churchill Capital Corp III and Multiplan, a provider of data analytics and technology management solutions to the U.S. healthcare industry. The complaint alleges that the sponsor of the SPAC and its board members breached their fiduciary duties by prioritizing their personal and financial interests in going forward with the de-SPAC merger to the detriment of shareholders. Specifically, the complaint alleges that the sponsor of the SPAC and its board members had conflicts of interest stemming from:

• the need to complete a deal within the SPAC’s two-year expiry period to preclude the value of the “sponsor” or “founder” shares, which had been granted to both the sponsor and the outside directors, becoming worthless;
• the board members’ alleged personal and financial ties to the sponsor; and
• the SPAC’s retention of an entity affiliated with the sponsor to serve as its financial advisor, rather than an independent third party.

The complaint also asserts that the defendants breached their fiduciary duties because the disclosures surrounding the merger were allegedly false and misleading in that they highlighted the “extensive due diligence” performed and projected Multiplan’s financial success, while failing to disclose that one of Multiplan’s main customers, UnitedHealth Group Inc., was in the process of “abandoning MultiPlan in favor of its own competing data analytics platform.”[115] Notably, the Amo v. Multiplan Corp. complaint asserts that the defendants’ conduct should be judged under the “entire fairness standard” rather than the “business judgment rule,” which as discussed above is a level of heightened scrutiny that, if applicable, would require the defendants to demonstrate that the transaction was both procedurally and substantively fair.

VI. CONCLUSIONS AND INSIGHTS

Reasonable due diligence, both with respect to disclosures and target companies, can mitigate many of the litigation and regulatory enforcement action risks described in this article. Accordingly, we conclude with a few general recommendations. In considering these recommendations, it is important to understand that there is no one-size-fits-all approach to SPAC IPO, de-SPAC, or any other kind of due diligence. Each transaction is contextually unique; therefore, our recommendations should be considered a point of departure to be supplemented and tailored to the context as appropriate.

A. Monitor the Evolving Risk Landscape

The SPAC landscape is rapidly evolving, regulatory interest is mounting, and lawsuits alleging SPAC-related misconduct are proliferating. Accordingly, SPAC participants should monitor and consider developments, especially as they relate to sponsor compensation, potential conflicts of interest, and the extent and character of due diligence and disclosure related to the de-SPAC business combination. We anticipate more regulatory guidance and rulemaking (indeed, the SEC has announced as much), as well as new and novel allegations in litigation. Both should be monitored closely, and due diligence and disclosure practices adjusted in light of them.

B. Be Mindful of Fiduciary Duties and “Gatekeeping” Roles

Directors, officers, underwriters, and others involved in securities offerings sometimes are referred to as “gatekeepers.” Gatekeepers are persons or entities who have “the background and knowledge to conduct a sufficient investigation to protect the investor.”^[116] In general terms, gatekeepers are deemed to “bear a duty to investors to monitor the quality of … disclosures.”^[117] Or stated differently, they “are ‘reputational intermediaries’ in the securities markets.”^[118] We anticipate future authoritative and informative guidance regarding the relevance and significance of the gatekeeper role in SPAC transactions. Until then, directors, investment banks, and other potential gatekeepers should be conscious of the commentary to date regarding gatekeeping and fiduciary roles, and should act accordingly.

C. Establish a Diligence Process and Conduct Guidance-Based Due Diligence

Authoritative and informative guidance over many decades makes clear that process matters in securities offering and business combination due diligence. Therefore, prior to a SPAC IPO and subsequent de-SPAC business combination, sponsors, boards, underwriters, advisors, and others should establish a due diligence process tailored to the context and consistent with historical guidance regarding what the SEC, courts, and other sources have considered reasonable. In tailoring that process, attention may be given to a range of factors, including, for example, staffing and leadership, scope and character of investigation and reliance, third-party support (such as legal opinions, negative assurance letters, and fairness opinions), and due diligence documentation.

As explained in this article, SPAC litigation and regulatory enforcement actions often involve allegations of inadequate due diligence and disclosures regarding sponsor compensation, potential conflicts of interest, the extent and character of due diligence and disclosure related to the de-SPAC business combination, and other matters. Thus, due diligence and related disclosures should be a focus at each stage of the SPAC process. Disclosure due diligence is guided by more than six decades of authoritative and informative publications and pronouncements, including from the SEC[119] and its Advisory Committee on Corporate Disclosure,[120] FINRA,[121] the ABA Task Force on Due Diligence Defenses,[122] SIFMA,[123] and an abundance of practitioner and scholarly literature.[124] While not a guarantee against litigation, following this guidance in conducting due diligence is likely to result in better due diligence and investment decisions and a corresponding level of mitigation of litigation exposure.

In summary, SPACs involve a range of legal risks, such as potential violations of the Securities Act, the Exchange Act, and state laws, including those addressing fiduciary duties. Many of these risks can be mitigated with securities offering and business combination due diligence that is consistent with longstanding, well-established authoritative and informative guidance.

[1] SPACInsider (https://spacinsider.com/stats/).

[2] “SPAC Hot Streak Put on Ice by Regulatory Warnings,” The Wall Street Journal, April 16, 2021; https://spacinsider.com/stats/. Recent and ongoing developments regarding SPAC accounting treatment and other matters may slow the proliferation of SPACs in the future, but the trend to date has been one of strong and expanding growth.

[3] https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investor-bulletin.

[4] https://www.finra.org/investors/insights/spacs.

[5] https://www.sec.gov/corpfin/disclosure-special-purpose-acquisition-companies.

[6] https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investor-bulletin.

[7] Id.

[8] See generally, William K. Sjostrom, Jr., The Untold Story of Underwriter Compensation Regulation, 44 UC Davis L. Rev. 625 (Dec. 2010) at https://ssrn.com/abstract=1582498.

[9] https://corpgov.law.harvard.edu/2018/07/06/special-purpose-acquisition-companies-an-introduction/.

[10] Id.

[11] Id.

[12] Id.

[13] https://www.sec.gov/corpfin/disclosure-special-purpose-acquisition-companies.

[14] Id.

[15] These attributes may vary depending on the specific situation.

[16] https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investor-bulletin. 

[17] Id.

[18] In some cases, the sponsor and its affiliates may hold enough votes to approve the transaction. In that case, the SPAC does not solicit the approval of public shareholders, but rather provides shareholders with an Information Statement. In either case, typical disclosures include a description of the proposed merger, governance mechanisms, and extensive information about the target company including historical financial statements, management’s discussion and analysis (MD&A), and pro forma financial statements.

[19] https://corpgov.law.harvard.edu/2018/07/06/special-purpose-acquisition-companies-an-introduction/.

[20] Sometimes, though it is less common, a SPAC will opt to conduct a tender offer (giving the SPAC’s shareholders the option of tendering their shares), in lieu of seeking shareholder approval. “A New SPAC Structure May Lead to Renewed Interest in SPAC Offerings,” Bloomberg Law Reports, 2011.

[21] 15 U.S.C. § 78a et seq.

[22] PIPEs are a type of secondary offering in which a publicly traded issuer sells equity at a discounted rate relative to the market price to an accredited investor. The PIPE funding ensures that the SPAC has sufficient capital commitments prior to entering into the definitive de-SPAC business combination agreement. These funds typically ensure that the SPAC has sufficient funds to consummate the de-SPAC transaction by, among other things, replenishing capital expended to redeeming shareholders (see, e.g., https://corpgov.law.harvard.edu/2018/07/06/special-purpose-acquisition-companies-an-introduction/#8b).

[23] 15 U.S.C. § 77a et seq.

[24] 15 U.S.C. § 78j. While the anti-fraud provisions of the Exchange Act do not expressly provide for a private right of action (as does Section 11, for example), for many decades federal courts have recognized an implied right. See, e.g., Kardon v. National Gypsum Co., 69 F. Supp. 512, 514 (E.D. Pa. 1946). Moreover, the U.S. Supreme Court has confirmed the right. See Herman & MacLean v. Huddleston, 459 U.S. 375, 378 (1983).

[25] See, e.g., Robert B. Robbins, Due Diligence in Private Placement Offerings (American Law Institute, March 2015) at 7-9, available at https://www.pillsburylaw.com/images/content/1/0/v2/1059/DueDiligenceinPrivatePlacementOfferings1.pdf.

[26] Although the SEC has observed that “there is no express provision in the [Securities] Act requiring an underwriter to conduct a due diligence investigation….” (“New High Risk Ventures,” Securities Act Release No. 33-5275, 1972 WL 125474 at *4 (July 27, 1972)), it has repeatedly expressed the view that underwriters have a non-statutory affirmative obligation to conduct reasonable due diligence (beyond having an affirmative defense). For example, as early as 1953, the SEC held that an underwriter “owe[s] a duty to the investing public to exercise a degree of care reasonable under the circumstances of the offering to assure the substantial accuracy of representations made in the prospectus….” (In re Charles E. Bailey & Co., 35 S.E.C. 33, 41, [1952–1956 Transfer Binder] Fed. Sec. L. Rep. [CCH] 76,218 (Mar. 25, 1953)). And, in a 1963 administrative proceeding, the SEC found a registration statement false and misleading and criticized the underwriter for failing to perform a reasonable investigation. In re Richmond, 41 S.E.C. 398, (1961–1964 Transfer Binder) Fed. Sec. L. Rep. (CCH) 76,904 (Feb. 27, 1963) at *7 (an underwriter: “[b]y associating himself with a proposed offering … impliedly represents that he has made such an investigation in accordance with professional standards. Investors properly rely on this added protection which has a direct bearing on their appraisal of the reliability of the representations in the prospectus. The underwriter who does not make a reasonable investigation is derelict in his responsibilities to deal fairly with the investing public.”). In another proceeding, the SEC emphasized the responsibilities of underwriters and selling agents. In re Hamilton Grant & Co., Securities Act Release No. 6724, 38 S.E.C. Docket 1030, 1987 WL 755965 (July 7, 1987) at *5. FINRA and its predecessor the NASD have expressed similar views regarding an underwriter’s affirmative duty to conduct reasonable due diligence despite the absence of an express statutory mandate.

[27] In re Int’l Rectifier Corp. Sec. Litig., No. CV91-3357-RMT (BQRX), 1997 WL 529600 (C.D. Cal. 1997) at *11.

[28] “Circumstances Affecting the Determination of What Constitutes Reasonable Investigation and Reasonable Grounds for Belief Under Section 11 of the Securities Act,” Securities Act Release No. 33-6335, 1981 WL 31062 (Aug. 6, 1981) (“SEC Release 33-6335”) at *13–14. See also, In re WorldCom Sec. Litig., 346 F. Supp. 2d 628, 670 (S.D.N.Y. 2004) (“the SEC cautioned that ‘only a court can make the determination of whether a defendant’s conduct was reasonable under all the circumstances of a particular offering’.”).

[29] See, e.g., National Association of Securities Dealers, “Special Report Due Diligence Seminars” (July 1981) (“NASD Special Report”) at 5; NASD Notice to Members 73-17, Proposed New Article III, Section 35 of the Rules of Fair Practice Concerning Underwriter Inquiry Standards Respecting Distributions of Issues of Securities to the Public, National Association of Securities Dealers, March 14, 1973 (“NASD Notice 73-17”); FINRA Regulatory Notice: Obligation of Broker-Dealers to Conduct Reasonable Investigations in Regulation D Offerings, Notice 10-22 (Apr. 2010) (“FINRA Notice 10-22).

[30] 15 U.S.C. § 77k (Section 11(c) of the Securities Act). While this definition is contained in the Securities Act and applies to public offerings of securities, the concept has been universally embraced as the appropriate standard of transactional due diligence in any context. The standard for reasonableness in due diligence is commonly described as one of negligence. See, e.g., Ernst & Ernst v. Hochfelder, 425 U.S. 185, 208 (1976) (“the standard for determining ‘reasonableness’ in a ‘reasonable investigation’ and ‘reasonable ground for belief’ in the two affirmative [due diligence] defenses is a negligence standard, i.e., ‘that required of a prudent man in the management of his own property.’”).

[31] See, e.g., Joseph K. Leahy, The Irrepressible Myths of BarChris, 37 Del. J. Corp. L. 411, 455 (2012) (“The ‘prudent person’ standard, located in Section 11(c), was originally borrowed from the law of trusts. It is the standard to which a trustee is held [but that] standard…has evolved in ways that are not relevant to due diligence….”). See also, House Committee on Interstate and Foreign Commerce, “Report of the Advisory Committee on Corporate Disclosure to the Securities and Exchange Commission,” November 3, 1977 (SEC Advisory Committee Report), at 669 (“Negligence is the standard of liability….”).

[32] See, e.g., Joseph K. Leahy, The Irrepressible Myths of BarChris, 37 Del. J. Corp. L. 456 (2012) (“[the standard requires] ‘the exercise of reasonable care, skill, and caution.’ [citing Restatement Third of Trusts]. To this extent, the prudent [man] standard is simply a negligence standard-the duty to exercise ordinary care.”). See also, Memorandum of Law of Amicus Curiae the Securities Industry and Financial Markets Association in Opposition to Lead Plaintiffs’ Motion for Partial Summary Judgment,” In re Refco Inc. Securities Litigation, No. 05 Civ. 8626 (GEL) (S.D.N.Y May 6, 2009) at 14, available at https://www.sifma.org/wp-content/uploads/2017/05/refco-inc-securities-litigation.pdf (“Discussing the 1934 revision of the definition of reasonable inquiry, Professor Folk observed that the common law is ‘indispensable’ in interpreting a ‘prudent man’ standard, as it ‘resembles one of the classic common law tests of a director’s duty of care’ which requires ‘the same degree of care which a business man of ordinary prudence generally exercises in the management of his own affairs.’ [citing Folk, 55 Va. L. Rev. at 42-43]”.); Robert J. Haft, Arthur F. Haft, and Michelle Haft Hudson, Due Diligence—Periodic Reports and Securities Offerings, § 7:3, (West, 2015-2016 Ed.) (“Due diligence may be construed as a standard that depends to some extent on what constitutes commonly accepted corporate or commercial practice. If it can be established that the steps taken meet the standard of the trade as it presently exists, a court should not, in applying the Section 11(c) standard, hold one liable for not being duly diligent….”).

[33] Committee on Federal Regulation of Securities, “Report of Task Force on Sellers’ Due Diligence and Similar Defenses Under the Federal Securities Laws,” The Business Lawyer, Vol. 48, May 1993, 1185 (ABA Due Diligence Task Force Report) at 1232.

[34] Id.

[35] National Association of Securities Dealers Notice to Members: 03-71, Non-Conventional Investments: NASD Reminds Members of Obligations When Selling Non-Conventional Investments (Nov. 2003), http://www.complinet.com/file_store/pdf/rulebooks/nasd_0371.pdf (NASD Release 03-71).

[36] SEC Advisory Committee Report.

[37] “Adoption of Integrated Disclosure System,” Securities Act Release No. 33-6383, 1982 WL 90370 (March 3, 1982) (SEC Release 33-6383) at *35. [internal citations omitted]

[38] https://www.finra.org/rules-guidance/notices/08-54. If a SPAC had identified potential acquisition targets prior the IPO, it would need to disclose information including the target’s financials in its registration statement which would lead to additional required due diligence. Also, as discussed more fully later in this article, some commentators and participants in SPACs have asserted that financial projections made in connection with a de-SPAC transaction fall within Private Securities Litigation Reform Act’s (PSLRA) safe harbor for forward-looking statements. Commentary from the SEC suggests that the Commission may disagree.

[39] https://www.finra.org/investors/insights/spacs (“One key difference between a traditional IPO and SPAC IPO process is that the SPAC IPO is much faster. From the decision to proceed with a SPAC IPO, the entire IPO process can be completed in as little as eight weeks and without much of the financial reporting, due diligence and disclosure involved in a traditional IPO. However, the later SPAC step of merging with the target company involves many (but not all) of the same requirements that would apply to an IPO of the target business, including audited financial statements and other disclosure items. In other words, the SPAC process back-loads the documentation requirements to the latter stages of the process, sometimes referred to as ‘De-SPACing.’”)

[40] For example, John Coates, the Acting Director of the SEC’s Division of Corporation Finance, stated on April 8, 2021: “To be clear, in the initial offering by a SPAC, when the shell company is first raising funds to finance all (or more commonly a portion) of its hoped-for acquisition of the yet-to-be-named target, disclosures clearly have a role to play under the federal securities laws. Investors need to know about sponsors and their financial arrangements, the procedural protections of the SPAC structure, and what kinds of returns the SPAC is likely to generate for investors absent a de-SPAC transaction or for those who choose to exit before the de-SPAC is completed. But it also is clear that investors at the time of the initial SPAC filing cannot understand all aspects of the long-term value proposition of the offering, precisely because a SPAC does not have operations or a business plan beyond a search for a target.” (https://www.sec.gov/news/public-statement/spacs-ipos-liability-risk-under-securities-laws)

[41] Section 11 of the Securities Act provides a cause of action for material misstatements or omissions in offering documents. Section 12 of the Securities Act prohibits the selling of securities through distribution of a prospectus or oral communication that omits or falsifies material facts (15 U.S.C. § 77k(a), § 77e, § 77I(a)(2)).

[42] An issuer does not have a due diligence defense under Section 11 of the Securities Act. The situation under Section 12(a)(2) is more nuanced, but the result appears to be effectively the same. See SEC Advisory Committee Report at 451 (“The company [issuer] itself has no defenses under the 1933 Act.”); Jack C. Auspitz and Susan E. Quinn, Litigator’s View of Due Diligence, Conducting Due Diligence 2003 (2003) at 146 (citing Robert Alan Spanner, A Litigation Perspective on Prospectus Preparation Process for an IPO, 116 Sec. Reg. L.J. 115, 127 (1988)) (“There is no statutory due diligence defense for issuers under Section 11 or Section 12(a)(2). Issuers are held to the highest standards of liability, because for them ‘omniscience is virtually presumed and omnicompetence is required.’”). See also Herman & MacLean v. Huddleston, 459 U.S. 375, 382 (1983) (“[l]iability against the issuer of a security is virtually absolute, even for innocent misstatements.”).

[43] 15 U.S.C. § 77k(b)(3)(A).

[44] 15 U.S.C. § 77k(b)(3)(C).

[45] 15 U.S.C. § 77I(a)(2).

[46] SEC Release No. 33-6335 at *13 (“The Commission also believes that only a court can make the determination of whether a defendant’s conduct was reasonable under all the circumstances of a particular offering.”).

[47] 15 U.S.C. § 78j.

[48] In re Int’l Rectifier, No. CV91-3357-RMT (BQRX), 1997 WL 529600 at *12 (“by virtue of the extensive due diligence they conducted, they cannot be said to have acted “recklessly…the Underwriters’ establishment of a due diligence defense under Sections 11 and 12(2) of the 1933 Act negates the existence of scienter under Section 10(b) of the 1934 Act.”). See also, In re Software Toolworks Sec. Litig., 789 F. Supp. 1489 (N.D. Cal. 1992), aff’d in part and rev’d in part, 38 F.3d 1078 (9th Cir. 1994), opinion amended and sup’d, 50 F.3d 615, 626 (9th Cir. 1994) (“[b]ecause we conclude that the Underwriters acted with due diligence in investigating Toolworks’ Nintendo business and OEM revenues, we also hold that the Underwriters did not act with scienter regarding those claims.”).

[49] See e.g., 17 C.F.R. § 230.176 (2008) (Rule 176); The Regulation of Securities Offerings, Sec. Act. Release No. 33-7606A, 63 Fed. Reg. 67,174, 67,231 (Dec. 4, 1998) (proposing unadopted changes to Rule 176 that would have added six due diligence practices to be considered by a court when assessing the reasonableness of due diligence for certain offerings) [hereinafter Aircraft Carrier Release].

[50] See Report of the Broker-Dealer Model Compliance Program Advisory Committee to the Securities and Exchange Commission (Nov. 13, 1974).

[51] See SEC Advisory Committee Report.

[52] See ABA Due Diligence Task Force Report.

[53] See, e.g., NASD Notice 73-17 and NASD Notice 75-33. Under the Securities Act, the SEC has authority to regulate broker-dealers, and Section 15(a) of the Exchange Act requires all broker-dealers who are engaged in interstate commerce involving securities transactions to register with the Commission. See 15 U.S.C. § 78o(b)(8). This regulatory oversight function is largely accomplished through FINRA. As the primary self-regulatory organization for broker-dealers in the United States, FINRA oversees the conduct of thousands of brokerage firms, including licensed investment banks and broker-dealers, all of which are legally required to be members of FINRA. FINRA was created in 2007 through the merger of the NASD’s and the New York Stock Exchange’s member regulation arms. https://www.finra.org/media-center/news-releases/2007/nasd-and-nyse-member-regulation-combine-form-financial-industry.

[54] See, e.g., Weinberger v. Jackson, 1990 WL 260676 at *2 (N.D. Cal. Oct. 12, 1990); Endo v. Albertine, 863 F. Supp. 708, 727-33 (N.D. Ill. 1994)

[55] The term is of unclear origin, but appears to derive from an early Supreme Court ruling in which Justice Joseph McKenna noted: “[t]he name that is given to the [state securities] law indicates the evil at which it is aimed, that is, to use the language of a cited case, ‘speculative schemes which have no more basis than so many feet of ‘blue sky.’” Hall v. Geiger-Jones Co., 242 U.S. 539 (1917).

[56] See, e.g., Ohio Rev. Code § 1707.043 (2014) available at https://codes.ohio.gov/ohio-revised-code/section-1707.043.

[57] A significant percentage of all SPACs formed to date have been organized under the laws of the Cayman Islands or British Virgin Islands. Where the offshore SPAC has acquired a U.S. target company, a number have effected a domestication to a U.S. jurisdiction (such as Delaware) as part of the business combination transaction, with a domestic U.S. entity as the resulting public company (https://www.americanbar.org/groups/business_law/publications/blt/2021/06/de-spac-transactions/; https://corpgov.law.harvard.edu/2020/08/17/update-on-special-purpose-acquisition-companies/).

[58] Black’s Law Dictionary, Ed. Bryan A. Garner (10th ed., Thomson Reuters, 2014) at 1257.

[59] See, e.g., Gantler v. Stephens, 965 A.2d 695, 709 (Del. 2009) (“…fiduciary duties of officers are the same as those of directors.”); Hampshire Grp., Ltd. v. Kuttner, 2010 WL 2739995, at *11 (Del. Ch. July 12, 2010) (“… duties of corporate officers are similar to those of corporate directors. Generally, like directors, [they are] expected to pursue the best interests of the company in good faith (i.e., to fulfill their duty of loyalty) and to use the amount of care that a reasonably prudent person would use in similar circumstances (i.e., to fulfill their duty of care).”).

[60] See generally National Association of Corporate Directors Center for Board Leadership, Report of the NACD Blue Ribbon Commission on Director Professionalism (National Association of Corporate Directors 2011).

[61] Id.

[62] See generally, Ernest Folk, State Statutes: Their Role in Prescribing Norms of Responsible Management Conduct, 31 Bus. Law. 1031 (1976).

[63] American Bar Association, Model Business Corporation Act (2016 Revision), § 8.30 Standards of Conduct for Directors available at https://www.americanbar.org/content/dam/aba/administrative/business_law/corplaws/2016_mbca.authcheckdam.pdf.

[64] See, e.g., Aronson v. Lewis, 473 A.2d 805, 812 (1984); Kaplan v. Centex Corp., Del. Ch., 284 A.2d 119, 124 (1971); Robinson v. Pittsburgh Oil Refinery Corp., Del. Ch., 14 Del. Ch. 193, 126 A. 46, 49 (1926).

[65] See, e.g., Stephen B. Brauerman, Delaware Insider: When Business Judgment Isn’t Enough: The Impact of the Standard of Review on Deal Litigation, Business Law Today (2014).

[66] https://www.spacanalytics.com/.

[67] Id.

[68] https://www.sec.gov/news/testimony/gensler-2021-05-26#_ftnref9

[69] https://www.businessinsurance.com/article/2021032 5/NEWS06/912340688/SEC-opens-SPAC-IPO-inquiry .

[70] https://www.sec.gov/corpfin/disclosure-special-purpose-acquisition-companies.

[71] https://www.reuters.com/business/exclusive-us-sec-focuses-bank-fee-conflicts-it-steps-up-spac-inquiry-sources-2021-07-13/.

[72] https://www.sec.gov/news/press-release/2021-99; https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=202104&RIN=3235-AM90

[73] The interview may be viewed at: https://www.cnbc.com/video/2020/09/24/sec-chairman-jay-clayton-on-disclosure-concerns-surround-going-public-through-a-spac.html.

[74] https://www.sec.gov/corpfin/disclosure-special-purpose-acquisition-companies.

[75] Id.

[76] https://www.sec.gov/Archives/edgar/data/1698113/000121390020034413/filename1.htm

[77] https://www.sec.gov/corpfin/disclosure-special-purpose-acquisition-companies. 

[78] https://www.sec.gov/corpfin/disclosure-special-purpose-acquisition-companies.

[79] Id.

[80] https://www.sec.gov/news/public-statement/spacs-ipos-liability-risk-under-securities-laws.

[81] The safe harbor referred to bars private actions based on material misstatements or omissions regarding statements containing certain kinds of financial projections and future economic performance or describing targeted objectives or future plans. 15 U.S. Code § 78u–5 – Application of safe harbor for forward-looking statements.

[82] https://www.sec.gov/news/public-statement/spacs-ipos-liability-risk-under-securities-laws.

[83] Id.

[84] Id.

[85] Id.

[86] “[F]orward-looking information can of course be valuable. Modern finance and valuation techniques focus on risk and expected future cash flows. Investors and owners commonly view forward-looking information as decision-useful and relevant. That is true for companies being acquired, as well as for companies going public. But forward-looking information can also be untested, speculative, misleading or even fraudulent, as reflected in the limitations on the PSLRA’s liability protections, even when the safe harbor applies. Reflected in the PSLRA’s clear exclusion of ‘initial public offerings’ from its safe harbor is a sensible difference in how liability rules created by Congress differentiate between offering contexts. Private companies that combine with SPACs to enter the public markets have no more of a track record of publicly-disclosed historical information than private companies that are going through a conventional IPO. If there are risks to the use of cost-effective, complete, and reliable forward-looking information in any setting, those risks should be carefully evaluated in light of the goals of the federal securities laws. At the same time, the risk of misuse of such information should also be carefully evaluated in light of the economic realities of the capital formation process.” Id.

[87] Id.

[88] https://www.sec.gov/news/public-statement/munter-spac-20200331; https://www.sec.gov/news/public-statement/division-cf-spac-2021-03-31; https://www.sec.gov/news/public-statement/accounting-reporting-warrants-issued-spacs; https://www.sec.gov/news/public-statement/accounting-reporting-warrants-issued-spacs.

[89] https://www.sec.gov/news/public-statement/accounting-reporting-warrants-issued-spacs.

[90] Id.

[91] “Regulators Step Up Scrutiny of SPACs With New View on Warrants,” Wall Street Journal, April 12, 2021.

[92] https://www.sec.gov/news/public-statement/accounting-reporting-warrants-issued-spacs.

[93] See, e.g., “SPAC Transactions Come to a Halt Amid SEC Crackdown, Cooling Retail Investor Interest,” CNBC, April 22, 2021 (https://www.cnbc.com/2021/04/21/spac-transactions-come-to-a-halt-amid-sec-crackdown-cooling-retail-investor-interest.html); “Wall Street Grapples With New SPAC Equity Contracts After Regulator Crackdown,” Reuters, June 8, 2021 (https://www.reuters.com/business/wall-street-grapples-with-new-spac-equity-contracts-after-regulator-crackdown-2021-06-08/).

[94] https://www.sec.gov/news/public-statement/accounting-reporting-warrants-issued-spacs.

[95] https://spacinsider.com/stats/.

[96] Id.

[97] https://www.spacanalytics.com/.

[98] https://securities.stanford.edu/current-topics.html.

[99] https://www.reuters.com/business/legal/new-deal-tax-spac-defendants-are-paying-plaintiffs-lawyers-drop-ny-state-suits-2021-05-05/.

[100] See, e.g., Laidlaw v. Acamar Partners Acquisition Corp., filed on January 7, 2021; Pels v. Fintech Acquisition Corp. IV, filed on March 2, 2021; Amo v. Multiplan Corp., filed on March 25, 2021; and Delman v. Croskrey et al., filed on May 25, 2021.

[101] https://www.sec.gov/news/press-release/2021-124. Specifically, the SEC claims violations of, among others, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder and Section 14(a) of the Exchange Act and Rule 14a-9 thereunder. See https://www.sec.gov/litigation/admin/2021/33-10955.pdf.

[102] Id.

[103] Id.

[104] Id.

[105] Id.

[106] https://securities.stanford.edu/filings-documents/1077/SRAC00107765/2021715_f01c_21CV05744.pdf.

[107] In re Akazoo S.A. Securities Litigation, Case 1:20-cv-01900-BMC, September 8, 2020 (https://securities.stanford.edu/filings-documents/1074/AS2400_20/202098_r01c_20CV01900.pdf).

[108] https://www.dandodiary.com/wp-content/uploads/sites/893/2021/04/Akazoo-settlement-stipulation.pdf. The settling defendants include Akazoo; certain former directors and officers of Akazoo Limited; certain other directors and officers of Akazoo; certain former directors and officers of MMAC; as well as certain financial entities that were involved in the SPAC and PIPE transactions. The non-settling defendants include several accounting firms that acted as auditors for Akazoo Limited, Akazoo, or MMAC; the founder of Akazoo Limited and the CEO of Akazoo; and certain other financial entities and other Akazoo service providers (https://www.dandodiary.com/2021/04/articles/securities-litigation/akazoo-spac-related-litigation-partially-settled-for-35-million/).

[109] Securities Exchange Commission v. Akazoo, Case 1:20-cv-08101-AKH, September 30, 2020 (available at https://www.dandodiary.com/wp-content/uploads/sites/893/2021/04/Akazoo-SEC-complaint.pdf).

[110] Securities Exchange Commission v. Akazoo, Case 1:20-cv-08101-AKH, Agreed Judgment, April 2, 2021 (available at https://www.dandodiary.com/wp-content/uploads/sites/893/2021/04/Akazoo-agreed-SEC-order.pdf).

[111] Pitman et al. v. Immunovant, Inc. et al., Case 1:21-cv-00918, February 29, 2021 (https://securities.stanford.edu/filings-case.html?id=107642).

[112] Borteanu et al., v. Nikola Corporation et al., Case 2:20-cv-01797-JZB, September 15, 2020 (https://securities.stanford.edu/filings-documents/1075/NC1500_15/2020915_f01c_20CV01797.pdf; https://securities.stanford.edu/filings-case.html?id=107530)..

[113] Welch et al. v. Meaux et al., Case 2:19-cv-01260-TAD-KK, October 16, 2020 (https://securities.stanford.edu/filings-documents/1071/WHI0700_07/20201016_r01c_19CV01260.pdf).

[114] Delman v. Croskrey et al., Case No. 2021-0451-, May 24, 2021. On June 24, 2021, Delman v. Croskrey was stayed pending the resolution of motions to dismiss filed in several concurrent federal securities class actions filed in the Eastern District of New York and Middle District of Georgia involving similar alleged misstatements and claims brought forth under the Exchange Act (Rosencrants v. Danimer Scientific, Inc., Case No. 1:21-cv-02708-MKB-RLM (E.D.N.Y.) and Skistimis v. Danimer Scientific, Inc., Case No. 1:21-cv-02824-MKB-RLM (E.D.N.Y.); Caballero v. Danimer Scientific, Inc., et al., Case No. 1:21-cv-00095-LAG (M.D. Ga.) and Wilkins v. Danimer Scientific, Inc., Case No. 21-cv-00096-LAG (M.D. Ga.)).

[115] Kwame Amo v. Multiplan et al., Case No. 2021-0258-, March 25, 2021 (https://www.dandodiary.com/wp-content/uploads/sites/893/2021/03/Multiplan-delaware-complaint.pdf).

[116] Arthur B. Laby, Differentiating Gatekeepers, 1 Brook. J. Corp. Fin. & Com. L. 119, 132 (2006).

[117] Peter Oh, Gatekeeping, 29 J. Corp. L. 735, 741 (Summer 2004).

[118] Reinier H. Kraakman, Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy, 2 J.L. Econ. & Org. 53, 61 (note 20). As applied to underwriters, the term refers to the fact that underwriters perform due diligence on behalf of investors given that investors typically do not have the opportunity to conduct some kinds of due diligence activities independently.

[119] See, e.g., 17 C.F.R. § 230.176; see also, Securities Act Release No. 7606A at *92-99.

[120] See SEC Advisory Committee Report. While the Committee rejected the notion of rigid definitions and checklists, it did conclude that it would be advisable for the SEC to adopt a rule setting out several non-exclusive, contextually oriented factors courts might consider in assessing the issue of reasonableness as it relates to the due diligence defenses. Rule 176 was part of the response to this recommendation.

[121] FINRA (and its predecessor the NASD) have consistently stated that there is no one-size-fits-all approach to due diligence, and that what is appropriate can only be determined considering the context presented.

[122] See generally ABA Due Diligence Task Force Report at 1232-33; 1204 (quoting a November 6, 1981 letter from the Securities Industry Association Corporate Finance and Federal Regulation Committees to the SEC Committee: “We believe that what constitutes a reasonable investigation depends on all the surrounding circumstances, including, but not limited to, those described in proposed Rule 176. We believe these include the quality of the issuer (its size, the type and stability of business or businesses in which it is engaged, whether it is regulated, its financial condition, its earnings history and its prospects); the type of the security (including the terms of the security, the size of the issue and, if debt, its maturity and credit rating, if any); the quality of its management, auditors and outside counsel, if any, involved; the time available for an investigation and the degree of cooperation extended by management…”); 1232 (“As a standard of conduct, ‘reasonableness’ is meaningless except in a specific factual context.”).

[123] SIFMA Refco Brief (“Like any flexible standard of prudent conduct, the Section 11 due diligence defense has no content in the abstract. It only has meaning in a specific factual context, i.e., the conduct of underwriters of a particular registered public offering of securities. Congress did not enact a detailed code of specific obligations for underwriters, as it did with the extensive disclosure requirements imposed on issuers by a web of SEC rules and forms. Instead, it commanded judges and juries to determine what was ‘reasonable’ or ‘prudent,’ using those commonly-accepted common law terms as their only guide.”)

[124] See, e.g., Due Diligence in Business Transactions; Due Diligence: Investigation, Reliance & Verification; Robert J. Haft, Arthur F. Haft, and Michelle Haft Hudson, Due Diligence—Periodic Reports and Securities Offerings, § 7:3, (West, 2015-2016 Ed.