The dramatic increase in SPAC IPOs in 2020 and early 2021 and related de-SPAC merger transactions that followed are creating billions of dollars’ worth of privately-placed common stock and warrants of newly public companies. That means more demand for “no registration” and legend removal opinions from company and selling stockholders’ counsel.
SPACs are special purpose acquisition companies—shell companies, also known as blind pool or blank check companies—that are newly formed to raise equity capital in an IPO and, after they are public, to pursue an acquisition of a target company, effectively taking a private target company public. Because SPACs by their terms must offer to redeem their outstanding common stock at the time of the acquisition and the acquisition price of the target company often exceeds the SPAC’s capital, SPACs typically raise additional capital to fund their acquisitions through PIPEs offerings (Private Investment/Public Equity) at the time of the merger.
The SPAC IPO boom cooled rapidly after the first months of 2021 for a number of reasons, not least of which was renewed SEC scrutiny. The SEC staff announced changes to the accounting for SPAC warrants, and the acting head of the Division of Corporation Finance questioned the availability of the safe harbor for forward-looking statements as applied to projections used in connection with de-SPAC transactions. There have also been high profile failures and stock price volatility of some de-SPAC companies. The perceived risk of de-SPAC transactions has increased and with it the pressure to get liquidity in the shares, which could mean increased urgency for legend removal when the Rule 144 exemption permitting public resales becomes available.
“No registration” and legend removal opinions are often needed for all types of public companies, but these opinions for a former SPAC company present a specific set of problems. In particular, because every SPAC is a shell company prior to its de-SPAC transaction, Rule 144 is not available until a year after the de-SPAC transaction. Also, to maintain Rule 144 eligibility, the company must have filed all of its reports (other than Form 8-K reports) required under the Securities Exchange Act of 1934 (the “’34 Act”) with the SEC for the 12 months prior to the sale. That means a critical part of diligence for giving “no registration” and legend removal opinions is determining whether the issuer of the shares is or was a SPAC or other shell company and, if so, whether it has filed all the required periodic reports.
Policing a Private Offering Exemption
The Securities Act of 1933 (the “’33 Act”) requires all offers and sales of securities to be registered with the SEC or to fit within an exemption from registration. Private companies usually issue shares under exemptions based on Section 4(a)(2) of the ’33 Act, which exempts offers and sales of securities by issuers in transactions “not involving a public offering” (i.e., private offerings). PIPEs offerings rely on this exemption. However, subsequent resales of privately-placed securities could result in the chain of transactions being considered a public offering, thereby invalidating the private offering exemption. As a result, companies restrict resales of privately-placed securities. Typically, the stock certificates for such securities will bear a legend to the effect that:
The shares represented by this certificate have not been registered under the Securities Act of 1933 or the securities laws of any state, and have been acquired for investment and not with a view to, or in connection with, the sale or distribution thereof. No such sale or distribution may be effected without an effective registration statement related thereto or an opinion of counsel in a form satisfactory to the company that such registration is not required under the Securities Act of 1933 or the securities laws of any state. (Emphasis added)
So, to transfer shares with a legend like the foregoing on the stock certificate, the holder needs an opinion of counsel. Imposing transfer restrictions and placing legends on stock certificates are ways that companies strive to “police” their private offering exemptions. They do not permit transfers of privately-placed shares without an opinion of counsel that the transfer does not require registration under the ’33 Act, and they place a legend on the new stock certificate unless counsel advises that no legend is required. Broker-dealers and transfer agents involved in the resale of shares also enforce the transfer restrictions. Broker-dealers will conduct due diligence because of their role in buying or placing shares and potential ’33 Act liability. Transfer agents will require legal opinions to remove ’33 Act restrictive legends because of their regulation by the SEC and liability concerns.
Stock certificate legends are not the only way for issuers to police their private offering exemptions. Qualified institutional buyers (“QIBs”), as defined in Rule 144A, are often viewed as being capable of complying with the ’33 Act on their own, so a letter from the QIB to the issuer may under some circumstances substitute for legended physical certificates.
Unregistered Public Resales
While there are exemptions that permit the private resale of shares, the privately sold shares remain subject to restrictions and consequently do not trade at the same price as freely tradable shares. Often, sellers are not interested in reselling privately at the kind of discount required, so, in the absence of registration of the resale, will only be interested in an unregistered public resale under Rule 144, which allows counsel to give both a “no registration” and a legend removal opinion.
Rule 144 is a safe harbor for resales under Section 4(a)(1) of the ’33 Act, which exempts resales “by any person other than an issuer, underwriter or dealer.” If the seller holds restricted securities as defined in Rule 144(a)(3)(i), that is, securities acquired directly or indirectly from the issuer, or from an affiliate of the issuer, in a transaction or chain of transactions not involving any public offering, then by reselling through a broker (as it typically would), the broker could be viewed as an underwriter, engaged in a distribution of the securities to the public. A stockholder who resells securities in compliance with the applicable conditions of Rule 144 and its broker, however, is deemed not to be engaged in a distribution of securities and, therefore, not to be an underwriter.
Rule 144 generally permits resales of restricted securities that have been held for at least six months, in the case of an issuer that has been subject to the reporting requirements of the ’34 Act for 90 days and is current in its annual and quarterly reports, or held for at least one year in all other cases. In the case of resales by affiliates of the issuer, Rule 144 requires, in addition, that volume and manner of sale limitations be met and that the seller file a Form 144 with the SEC. However, Rule 144(i) provides that the rule is not available for a SPAC or other shell company, even after its de-SPAC transaction, until one year after it ceased to be a shell company and has filed with the SEC information that would satisfy the requirements of Form 10 or, for foreign issuers, Form 20-F (“Form 10 Information”). Although business combination related shell companies are excluded from the Rule 144(i) limitation, SPACs are not business combination related shell companies.
Another difference between Rule 144 for SPACs and Rule 144 generally is the requirement in Rule 144(i) that a former SPAC or other shell company must have filed all reports required under the ’34 Act, other than reports on Form 8-K, for the 12 months preceding the sale. Under Rule 144, for non-affiliate stockholders, once they have completed a one-year holding period, there is no current public information requirement for resales under Rule 144, so for ordinary companies there is no need in the case of non-affiliate resales to ascertain whether the company has filed its periodic reports. Even if the company has for some reason, such as accounting irregularities making it unable to finalize its financial statements, been unable to file its ’34 Act reports, non-affiliate stockholders with restricted stock and a one-year holding period can freely resell their shares under Rule 144. However, if the company was a SPAC, Rule 144 would not be available.
Affiliates are subject to the current public information requirement of Rule 144(c) even after a one-year holding period, which in the case of public companies is satisfied by the filing of reports required under the ’34 Act (other than on Form 8-K) for the 12 months prior to the sale. A note to Rule 144(c) allows a stockholder to rely on a statement in the most recent quarterly or annual report that the company has filed its ’34 Act reports, but that note does not appear in Rule 144(i) for former shell companies.
SPAC Opinion Considerations
Lawyers asked to give a “no registration” or legend removal opinion need to ascertain if the issuer is or was a SPAC or other shell company. If so, Rule 144 will not be available for resales until one year after the company ceased to be a shell company (accomplished its de-SPAC transaction) and has filed full Form 10 Information with the SEC.
Also, as described above, there is an additional requirement for all holders of securities in a former SPAC that the issuer has made periodic report filings for the preceding 12 months. Counsel will seek confirmation that those filings have been made before giving the opinion. That will likely mean, in the absence of other satisfactory policing arrangements, that legend removal will not be available for the holders of shares of issuers that were once SPACs until a sale occurs—compared to the otherwise common practice of removing legends for non-affiliate holders of restricted stock once they have a one-year holding period.
Unlike typical post-IPO companies, SPACs cannot provide the usual liquidity to their private placement investors or their directors, executive officers and other affiliates shortly after the private company “goes public.” In a traditional IPO of an operating company, non-affiliated private placement investors that have held stock for one year can sell immediately after the IPO registration statement goes effective and, 90 days after that, Rule 144 becomes available to insiders and non-affiliates with a six-month holding period, subject in each case to the underwriters’ lock-up (typically 180 days).
Former SPAC companies, following the de-SPAC transaction, often file a shelf registration statement on Form S-1 to register resales by PIPEs investors and other holders of restricted and control stock. Sometimes, counsel will be asked for a legend removal opinion for shares registered with the SEC. However, until the shares are actually sold pursuant to a registration statement, they remain restricted shares. The issuer risks allowing an indirect public offering by removing the legends before those sales take place (subject to the potential alternative for QIBs described above and imposing other policing arrangements).
Even when a resale shelf registration statement is in place for PIPEs investors and affiliates, as a practical matter, the ability to freely resell shares may be severely constrained. PIPEs investors and affiliates do not typically have the right to conduct underwritten offerings. As a result, investment banks and other broker-dealers often strictly limit the amount of resales they facilitate pursuant to resale shelfs. They are concerned about potential ’33 Act liability and the lack of due diligence procedures, negative assurance confirmations and other protections available in an underwritten offering.
SPACs are often initially capitalized with privately-placed warrants alongside shares of common stock and their PIPEs offerings may feature warrants as well. Warrants can complicate the “no registration” and legend removal analysis. The holding period for shares issued upon a cash exercise of privately-placed warrants typically begins when the warrants are exercised and the stock is issued, which means that a new Rule 144 holding period begins at that time. If, instead of paying cash to exercise the warrants, the warrants are net-share-settled (cashless exercise), then Section 3(a)(9) of the ’33 Act exempts the issuance and the holding period of the warrants may be tacked onto the holding period of the shares, potentially satisfying the Rule 144 holding period.
Lawyers who are asked to give “no registration” and legend removal opinions should exercise special care. If the issuer is or was a SPAC or other shell company, Rule 144 will not be available until one year after the de-SPAC transaction (and filing of the Form 10 Information) and then only if the issuer has filed all of its ’34 Act reports (other than on Form 8-K). As a result, lawyers should get assurance that the issuer satisfies the requirements of Rule 144(i) before issuing such an opinion, and should think twice before issuing an opinion for legend removal in the absence of a specific sale.
Lawyers should have in mind that legend removal and “no registration” opinions have been a source of liability for lawyers in the past, particularly involving penny stocks and “pump and dump” schemes. The SEC has even used its authority to deny lawyers the ability to practice before it for improper legend removal opinions. The lack of available liquidity sometimes can prompt investors and companies to find creative ways to allow resales of restricted shares, which can put added pressure on lawyers when they are asked to give these opinions. All these considerations add up to the need for lawyers to use extra caution when giving “no registration” and legend removal opinions for shares of former SPACs.
This article originally appeared in the Winter 2021–2022 issue of In Our Opinion, the newsletter of the ABA Business Law Section’s Legal Opinions Committee. Read the full issue and previous issues on the Legal Opinions Committee webpage.
See John Coates (Acting Director, Division of Corporation Finance) and Paul Munter (Acting Chief Accountant), “Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (‘SPACs’)” (April 12, 2021), available here; John Coates, “SPACs, IPOs and Liability Risk Under the Securities Laws” (April 8, 2021), available here. ↑
See Subcommittee on Securities Law Opinions, Federal Regulation of Securities Committee, ABA Business Law Section, No Registration Opinions (2015 Update), 71 Bus. Law. 129 (2015/2016), available here. ↑
See Subcommittee on Securities Law Opinions, Federal Regulation of Securities Committee, ABA Business Law Section, “Legal Opinions on Section 4(1-1/2) Resale Transactions” (to be published in a 2022 issue of The Business Lawyer). ↑
See Subcommittee on Securities Law Opinions, Committee on Federal Regulation of Securities, ABA Section of Business Law, “Negative Assurance in Securities Offerings (2008 Revision),” 65 Bus. Law 395 (2009), available here. ↑
See, e.g., the order entered by the SEC In The Matter of Virginia K. Sourlis, dated July 23, 2013, available here, suspending attorney Sourlis for five years under Rule 102(e) of the SEC’s Rules of the Practice, 17 C.F.R. § 201.102(e), for issuing a false opinion letter that facilitated the illegal public offering of securities; see also SEC v. Sourlis, 851 F.3d 139 (2d Cir. 2016) (related litigation finding Sourlis liable for securities law violations arising from the issuance of the opinion letter). ↑