Article

The Further Erosion of Investor Protection: Expanded Exemptions, SPAC Mergers, and Direct Listings

Introduction

Since at least the 1930s, when the federal securities framework was adopted, most companies undertaking initial public offerings (“IPOs”) have relied on firm-commitment underwriters to act as intermediaries between themselves and investors. Underwriters buy issuers’ securities and resell them to public investors at an agreed markup representing the underwriting fee.1 The close relationship between IPOs and underwriting, governed in part by Section 11 of the Securities Act of 1933, is implicit in a regime that has proven enormously successful over the years.2 Section 11 imposes near-strict liability on corporate insiders and certain secondary actors, primarily underwriters, incentivizing careful due diligence. Among other provisions of the Securities Act, Section 11 was instrumental in restoring confidence in U.S. capital markets in the wake of the Great Depression and has helped them become the world’s deepest and most liquid. It is no surprise that investors, their interests guarded by underwriters acting in the role of gatekeepers, made the IPO the pinnacle event for emerging companies seeking capital for growth.3

Today, traditional IPOs may be on the wane as firms increasingly turn to mergers with special purpose acquisition companies (“SPACs”) and direct listings, novel alternatives that provide routes to public markets entirely or partially without an underwriter or due diligence. SPAC mergers and direct listings dispense with nearly century-old techniques for capital raising, weakening investor protection. As a result, these IPO alternatives introduce new risks into financial markets. The shift in corporate activities has been permitted, indeed encouraged, by Congress and the Securities and Exchange Commission (“SEC”).4

SPAC mergers and direct listings comprise a significant proportion of IPO activity. In 2020 and 2021, SPACs accounted for over half of all U.S. IPOs.5 The value and volume of SPAC mergers also soared to record levels. In 2020, SPACs undertook ninety-two mergers valued at $139 billion, more than doubling 2019 activity levels.6 Activity levels in 2021 doubled again, with SPACs merging with, and taking public, 221 companies in transactions valued at $404 billion.7 Dealmaking has since slowed considerably but with over 500 SPACs still seeking merger targets,8 robust SPAC merger activity is likely for some time to come. For their part, direct listings do not occur at the same rate as SPAC mergers, but companies intending to “go public” today routinely consider direct listings as alternatives to traditional IPOs, and their popularity may well increase.

The idea of the SPAC merger originates with reverse mergers, transactions long regarded with suspicion.9 SPACs are shell companies formed for the purpose of raising capital to merge with an as-yet-unidentified private company.10 In merging with private companies, SPACs confer on them public status. In this way, a SPAC merger fulfills the primary functions of a traditional IPO: the target company’s newly dispersed owners provide cash for growth, and the formerly private company can issue registered shares that are freely tradeable. But the decision to merge rather than undertake a traditional IPO obviates the need for conventional underwriters, largely removing the threat of Section 11 liability for investment banks. Mergers also benefit from certain regulatory accommodations under federal securities law.

Direct listings also exclude the conventional underwriting role but are otherwise much like a traditional IPO. This is possible due to rule changes enacted in 2018 by the New York Stock Exchange (“NYSE”), which now allow private companies to become publicly traded by listing their shares on the exchange without undertaking an underwritten offering.11 Spotify quickly took advantage of this regulatory accommodation in an offering for selling shareholders and was soon followed by Slack, Palantir, and Coinbase. In December 2020, the SEC approved NYSE rule changes permitting direct listings that include a primary offering.12 In 2019 and 2021, the Nasdaq was granted authority for selling shareholder- and primary-offering direct listings, respectively.13

Both SPAC mergers and direct listings are in the crosshairs of regulators. In testifying before Congress in 2021, SEC Chair Gary Gensler cited IPOs and SPACs first among “trends that will affect [the SEC’s] resource needs going forward,” asking whether “SPAC investors [are] being appropriately protected.”14 Congress proposed legislation to strip SPAC mergers of protections for the use of forward-looking information—protections that allow SPAC sponsors unusual leeway in communicating financial forecasts to potential investors.15 More recently, the Commission proposed far-reaching changes intended to enhance investor protections and align disclosure and liability rules for SPAC mergers more closely with those for traditional IPOs.16 Reform may occur for direct listings as well. Two SEC Commissioners opposed 2020 SEC rules expanding the use of direct listings.17 In July 2022, the Commission issued an order instituting a proceeding to determine whether to approve or disapprove a New York Stock Exchange proposed rule change that includes questions that suggest a broad Commission review of direct listings.18

SPAC mergers in particular have courted controversy, with SPAC participants facing allegations of securities fraud. The SEC recently charged participants in the SPAC merger of Momentus, Inc. with securities fraud for having “repeatedly told investors that [Momentus] had ‘successfully tested’ its propulsion technology in space when, in fact, the company’s only in-space test had failed.”19 To the SEC, “[t]h[e] 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.”20 SPAC mergers have also generated numerous private lawsuits.21

This article critically examines SPAC mergers and direct listings, assessing their perceived benefits alongside the threats they pose to investor protection, and proposes strategies for reform. The article situates these IPO alternatives in the context of the decades-long decline of investor protections in federal securities law. The purported benefits of these developments are overstated and, in any case, fail to justify the erosion of investor protection implicit in these transactions—a further degradation of critical safeguards. These transactions reduce the effectiveness of Section 11 in the heartland of its operation: registered transactions to which the provision has, until now, applied with full force.

In Part I we trace the decline of Section 11, observing that decisions by the SEC and Congress have permitted the decline by substantially increasing the number and scope of exemptions from Securities Act registration. A result is that a significant majority of the capital raised in securities offerings today lie beyond the Section’s reach. As an illustration, consider that in 1970, roughly seventeen percent of funds raised in new corporate offerings relied on an exemption22; by 2019, the corresponding figure was around seventy percent.23 We also take stock of other forces that have made experimentation with SPAC mergers and direct listings more appealing to those looking to take companies public.

Part II addresses SPAC mergers specifically, focusing on the regulatory leniency they enjoy, the troubling incentives they create for certain transaction participants, and the high costs they impose. We are not the first to note problems with SPAC mergers, but our emphasis on their deal structures and arguments justifying underwriter liability are novel. Focusing on structure provides a more nuanced understanding of the regulatory accommodations SPAC mergers enjoy, showing, for instance, that because structure drives the availability of safe harbors for forward-looking statements, some SPAC mergers fall outside safe harbor protections.

Because transaction structure shapes the extent of Section 11 liability, generally little risk of underwriter liability exists in SPAC mergers, significantly limiting the force of Section 11. This produces weaker incentives for all gatekeepers—not only investment banks but also auditors and legal counsel—to assure the accuracy of corporate disclosures, relative to the incentives in traditional IPOs. Meanwhile, other factors give transaction participants incentives to act contrary to investor interests.

We assess the merits of underwriter liability in SPAC mergers by using traditional IPOs as a benchmark. This comparison shows that underwriter liability would generate benefits in SPAC mergers at least as great as those accrued to traditional IPOs, without imposing additional costs. Accordingly, the case for underwriter liability is at least as strong for SPAC mergers as it is for traditional IPOs. If underwriter liability is cost-justified for traditional IPOs, as we contend, the same is true for SPAC mergers.

We also assess the empirical evidence regarding SPAC mergers, highlighting salient areas of dispute among scholars. The evidence is mixed on where the high costs of SPAC mergers fall at the time of a SPAC merger, how the costs of SPAC mergers and traditional IPOs compare from the perspective of target companies, and the extent of any unique benefits SPAC mergers provide. An appreciation of this uncertainty should limit any regulatory impulse to steer private companies toward traditional IPOs and away from SPAC mergers (or vice versa), since neither transaction necessarily provides greater welfare, although it does not alter our conclusions as to Section 11. Regarding other potential reforms, we liken the position of SPAC mergers to going-private transactions, transactions in which participants often have misaligned incentives and are denied safe harbors protection for financial projections.

In Part III, we assess direct listings, questioning the purported advantages of these transactions, which are said to provide significant cost savings over traditional IPOs. Even if the purported advantages do materialize, they fail to justify the omission of underwriter liability, the merits of which turn on a comparison of the benefits and accompanying costs of Section 11 liability. Although the costs and benefits of underwriter liability are an empirical matter, good reason suggests they are also justified in this setting.

We conclude in Part IV by urging the Commission to undertake a comprehensive review of the Securities Act. The regulation of SPAC mergers and direct listings must be assessed alongside issues including the rise of private markets, the growth of exemptions, technological advances, and the mechanics of complying with provisions of the Securities Act.

Regulatory and Historical Backdrop

Key provisions of federal securities law create powerful incentives for due diligence by underwriters in traditional IPOs. In this Part, we explain why the protections afforded by these incentives are justified. We then detail factors that have put the vast majority of capital raised in recent transactions beyond the reach of these provisions, diminishing their capacity to deter wrongdoing The Part concludes by considering critiques of IPOs and underwriters, arguing that, whatever the merits of these criticisms, they fail to defeat the case for underwriter liability in traditional IPOs.

The Securities Act of 1933

The Securities Act of 1933 was the initial response to the 1929–1933 Stock Market Crash, the greatest financial debacle of the twentieth and twenty-first centuries.24 The statute relies on three primary techniques to protect investors in public securities offerings.

First, Section 5 requires registration with the SEC of securities offered to the public through “any means or instruments of transportation or communication in interstate commerce” unless the security or transaction is exempted by Section 3 or Section 4.25 In those instances in which the full registration process is applicable, the Act creates a statutory waiting period of twenty days before the security registered with the SEC can be sold,26 requires underwriters and securities dealers to furnish prospective investors with a prospectus based on the information in the registration statement,27 and empowers the Commission to issue stop orders to prevent the sale of a security that “includes any untrue statement of a material fact or omits to state any material fact required to be stated . . . or necessary to make the statements therein not misleading.”28

Second, the Securities Act requires full disclosure of material information to be provided to the SEC in the registration statement and to investors in a prospectus derived from the registration statement.29 This disclosure framework superseded the inadequate, often minimal disclosure paradigms of earlier state law, the NYSE, and the applicable accounting standards.30

Third, Section 11 transformed the process of selling securities to the public. The SEC, the Department of Justice, and any private person may bring a lawsuit whenever any part of a registration statement contains a material misrepresentation or omission. Section 11 creates virtually strict liability for a long list of corporate insiders, including every person who signed the registration statement, the firm’s principal executive and financial officers, and every person who was or agreed in the registration statement to become a member of the corporate board.31 The provision popularized the concept of outside gatekeepers.32 Critically, Section 11(a) includes as potential defendants every underwriter and every expert, including accountants who certify “any part of the registration statement.”33 Section 11 also requires joint and several liability for the persons specified in Section 11(a)34 as well as any person who controls any person liable under Section 11.35

In sharp contrast to earlier state law, the plaintiff in a Section 11 claim does not have to prove reliance unless he or she bought after the issuer had made generally available to its security holders an earnings statement covering a period of at least twelve months beginning after the effective date. But even then “reliance may be established without proof of the reading of the registration statement by such person.”36 The plaintiff is not required in a prima facie case to prove scienter, that is intentional or reckless conduct by the defendants, only a material representation or omission. Nor need the plaintiff prove causation, although damages are reduced to the extent that the defendant proves that they did not result from her or his misconduct.37

The most transformative element of Section 11 for registered securities sales to the public involves the due diligence defenses of Section 11(b)(3). This provision creates exemptions from Section 11 liability for defendants—including underwriters—when they can establish that they used due diligence to affirmatively conduct a reasonable investigation and had grounds for belief equal to that of a prudent person when the registration statement became effective.38 Because of the threat of liability and underwriters’ interest in protecting their reputations, Section 11 made underwriters virtually full partners with the issuer in corroborating the truthfulness of the registration statement. Underwriters became prominent, if not dominant, participants in due diligence meetings for registered offerings.

Lead underwriters in registered offerings perform other functions, including marketing securities through their contact with other underwriters, with dealers who help sell the security without assuming an underwriter’s risk, and with institutional investors, including at road show presentations. Underwriters distribute securities for the issuer, typically on a “firm commitment” basis, under which they agree to buy the offered securities at a fixed price. In return, underwriters receive a fee from the public sale price known as the gross spread, calculated as the difference between the price at which they purchase securities from the issuer and resell them to public investors.39 Underwriters often also help stabilize the price of a security during the offering period to the extent permitted by the SEC’s stabilization rules.40

The Unique Position of Underwriters

In imposing liability on underwriters for material misstatements or omissions in registration statements, Section 11 conceives of underwriters as gatekeepers—as parties capable of deterring wrongdoing by issuers.41 The provision recognizes underwriters’ “unique position” among offering participants in assuring the accuracy and completeness of the issuer’s disclosures.42 Putting their reputations at stake in an offering,43 underwriters certify to investors the accuracy of corporate disclosures and reduce the extent to which investors, fearing they will be sold “lemons,” discount the value of newly issued securities.44

The structure and interpretation of Section 11 assure that multiple gatekeepers will exercise diligence in order to ensure the completeness and accuracy of issuer disclosures.45 Section 11 makes “[u]nderwriters . . . ‘the first line of defense’” against disclosure errors.46 That is, among secondary actors, underwriters primarily face liability under Section 11, subject to a due diligence defense. Specifically, underwriters may be liable for defects in a registration statement’s non-expertised portions, which comprise the bulk of the statement and include both textual discussion and some financial and graphical data.47 By contrast, auditors’ Section 11 liability is largely limited to the financial statements they certify, and lawyers rarely face liability under Section 11.48

However, the risk of underwriter liability affects other secondary participants, further ensuring investor protection. Courts allow due diligence performed by auditors and lawyers to help satisfy underwriters’ diligence defense,49 so underwriters in registered offerings secure assurances from the issuer’s legal counsel and auditors as to the accuracy of non-expertised portions of registration statements. Underwriters require these assurances, known as 10b-5 letters and comfort letters, as conditions precedent to underwriting the proposed securities offering.50 A law firm’s 10b-5 letter attests that the firm, or individual lawyers, is unaware of any material misstatements or omissions in the registration statement. The auditor’s comfort letter gives assurance as to a wide array of financial information in the registration statement, including information appearing in the text, charts, and graphs—information that is separate from the audited financial statements, which are expertised portions of a registration statement. Though the terms of these letters are highly tailored,51 they expose their authors to liability for negligent or fraudulent preparation, creating incentives for their authors to perform robust due diligence.52 Thus, while the liability regime places greater reliance on underwriters than on any other offering participant,53 Section 11 nonetheless assures that the expertise of multiple gatekeepers is brought to bear in the cause of deterring corporate misconduct.

In addition to shifting risks to other gatekeepers, underwriters routinely seek indemnification from issuers for liability under Section 11.54 Because these indemnification arrangements may be unenforceable, underwriters also obtain contractual rights of contribution, as permitted by Section 11(f) of the Securities Act, allowing underwriters to recover from other parties that share fault.55 This regime has garnered support in part by not threatening underwriters with financial ruin.

The initial case for the Securities Act of 1933 was historical and based on both the greater than eighty percent investor losses in the 1929–1932 stock market crash56 and subsequent hearings documenting the failure of corporate selling materials, typically written by underwriters, to fully disclose material information to investors.57 The historical case for the Securities Act has been made in the period after the Act was adopted.58 We have seen on several occasions that market incentives alone fail to elicit desirable conduct by investment banks.59 And more direct forms of liability, including enterprise and individual managerial liability, do not sufficiently deter corporate misconduct at an acceptable cost.60 The costs of underwriter liability, by contrast, have often proved warranted, measured against the harm it averts.61

Though underwriters initially resisted the imposition of liability under Section 11,62 this form of liability has become broadly accepted, including by underwriters—and for sound reason. Because issuers in IPOs are untested, information asymmetries are high, making verification costs for investors high and suggesting a role for third-party assurance mechanisms if they are cost-effective.63 In this setting, issuers and managers have limited resources, raising the prospect that enterprise liability and individual managerial liability will be met with asset insufficiency, a condition justifying gatekeeper liability.64 Issuers and founders may have much to gain by overstating the merits of their product in an IPO,65 again suggesting the need for a third-party certifier that, as a repeat player, benefits less from misconduct in a given transaction. During boom times, it is not unreasonable to think that founders or corporate managers will underestimate the risk of sanction, diminishing the deterrent effect of monetary sanctions and leaving misconduct under-deterred.66 Underwriters are well suited for service as third-party certifiers because they are uniquely positioned among offering participants to detect disclosure errors, having had decades to hone their diligence practices and procedures. Underwriters are also cost-effective certifiers since issuers already engage them to act in transactions.67

It is unlikely to be enough to rely on market incentives to ensure that underwriters take adequate precautions to deter client wrongs.68 Though underwriters’ reputations restrict their incentives to facilitate issuer wrongdoing, their reputations are crudely calibrated to gatekeeper performance and convey limited informational content, suggesting the need for liability.69 For their part, investors face formidable coordination problems that limit the prospect that they will privately contract for underwriter gatekeeping in the absence of liability, again suggesting the need for underwriter liability.70

If anything, recent developments seem to have strengthened the justification for underwriter liability in traditional IPOs and the enhanced due diligence that results. Reputational constraints for investment banks have arguably weakened, diminishing the market discipline on underwriters.71 The threat posed by alternative or supplementary legal controls on underwriters (and other secondary actors), most notably Rule 10b-5, seems to have weakened.72 And, although companies have been delaying their IPOs, when they do “go public” they are less likely to be profitable than in past decades, increasing the prospect of asset insufficiency in the case of enterprise liability, which buttresses the case for gatekeeper liability.73 The case for underwriter liability in IPOs is stronger still where secondary actors or other transaction participants have incentives misaligned with those of investors or have little reputational capital at stake.

Expansion of Exemptions

Section 11 had been the bȇte noire of the 1933 Securities Act, which opponents had urged would stifle finance.74 New public issues of registered corporate securities—which had limped along and reached as low as $11 million in January 193575—have skyrocketed in recent years to annual totals over $1 trillion.76

For decades, the due diligence procedures particularly of underwriters and their counsel and auditors, virtually eliminated private securities fraud in IPOs.77 The very term due diligence entered the popular vocabulary as a byword for careful investigation of facts whether required by legal process or otherwise.

Nevertheless, the deterrent force of Section 11 has markedly diminished in an important respect. A significant majority of the capital raised in securities offerings today lies beyond the Section’s reach. The most important reason is that the SEC and Congress have substantially expanded the exemptions from Securities Act registration.

By 2019, exempt offerings, valued at approximately $2.7 trillion, accounted for 69.2 percent of all new corporate offerings; registered offerings of $1.2 trillion accounted for a mere 30.8 percent.78 This marks a remarkable reversal. In 1970, exempt offerings comprised just seventeen percent of funds raised in new corporate offerings.79 Indeed, by December 2021, there were 473 “unicorns” or private firms with at least $1 billion in valuation. The aggregate number has skyrocketed from forty-three in 2013 to 251 in December 2020. The aggregate implied valuation of unicorns was $1.58 trillion in December 2021, an eleven-fold increase since 2013.80

One of the major sources of this shift is Rule 144A, which the Commission adopted in 1990.81 This rule formally permits Qualified Institutional Buyers (“QIBs”) to sell exempt securities to other QIBs without registration or required disclosures. This created a parallel exempt securities market.

The SEC in a strikingly partisan 3-2 vote six days before the November 2020 elections further expanded several Securities Act exemptions.82

Regulation D’s Rule 504, previously limited to offers and sales of up to $5 million, was increased to $10 million. Rule 504 is a de minimis Securities Act exception.83 Meanwhile, Tier 2 of Regulation A grew from maximum offerings of $50 million in a twelve-month period to $75 million.84

Regulation Crowdfunding, which Section 4(a)(6) of the Securities Act authorized up to $1 million in any twelve-month period, and after a specified five-year cost of living increase was $1.07 million, was increased to $5 million, employing the Commission’s authority under Section 28 of the Securities Act. Under the initial limits, Regulation Crowdfunding had been a success. Approximately two thousand crowdfunding offerings were made in the three and a half years after the exemption first became available through December 31, 2019.85

Another 2020 expansion of exemptions lies in the Commission’s adoption of a new definition of accredited investor in Regulation D’s Rule 501(a), broadly increasing the number of individuals who could buy Rule 506 exempt offerings without fulfilling otherwise-mandatory disclosure requirements. The new definition adds 691,041 registered broker dealers, 13,400 registered and 4,244 exempt investment advisers, 17,500 state-registered investment advisers, and between 2,500 and 10,489 family offices exempt under the Investment Advisers Act.86 Rule 506 is the dominant Regulation D exemption. Between 2009 and 2017, 99.9 percent of all funds raised under Regulation D were raised under Rule 506.87

The November 2020 expansion of Securities Act exemptions occurred with little or no serious consideration of fraud risk.88

Critiques of Section 11

Underwriting practices have faced a series of critiques in recent years. Critics assert, for example, that underwriters “underprice” IPOs at the expense of issuers,89 generate excessive fees,90 engage in collusive practices,91 and otherwise exploit issuers.92 While much disagreement exists on the reasons for and effects of these alleged practices, critics point to them as evidence that the IPO-underwriting process is deeply flawed.93

It is true that IPOs between 2001 and 2019 were underpriced, with an average “pop,” or price increase, of 13.7 percent between the IPO and first-day close.94 However, no consensus exists as to why this is happening.95 Indeed, for many issuers, a pop is desirable because it speaks to the attractiveness of the new issue.96 Few events would be more disheartening than an instantaneous price decline in the aftermath of an IPO, which would make the listing appear to be a failure. Moreover, it is open to dispute whether the first day’s closing price is a price at which issuers could have initially sold their shares, as critics assume in regarding a lower IPO price as “underpricing.”97

Even assuming they have merit, these criticisms of traditional IPOs—concerning underpricing, high fees, collusion, and exploitation—do not undermine the case for underwriter liability under Section 11. No one suggests that underwriting is costless; the question in seeking to protect investors is whether the benefits of underwriter liability, measured primarily by the harm it averts, exceed the accompanying costs. The available evidence suggests it does.98

These criticisms of the IPO process may nonetheless have had some bite. After the dot-com bust, when many of these alleged shortcomings were expressed with particular force,99 IPOs declined markedly, with annual averages falling from 310 between 1980 and 2000 to just 108 between 2001 to 2016.100 Commentators suggested other explanations as well, including a less attractive “IPO ecosystem” for smaller firms, increased compliance costs occasioned by the Sarbanes-Oxley Act of 2002, and the increased relative attractiveness of trade sales for small firms.101 Meanwhile, many market participants explored new methods of taking companies public. IPO activity rebounded, reaching unprecedented levels in 2021,102 with two transaction structures emerging as mainstream alternatives for traditional IPOs—the SPAC merger and direct listing. As discussed next, however, these transactions may further the decline of Section 11 in the heartland of its operation—registered transactions.103

SPAC Mergers

Once regarded with disdain for the poor quality of the firms they brought public,104 “SPAC [mergers] ha[ve] become [a] viable substitute for a traditional IPO.”105 They developed as a market response to sidestep stringent rules adopted in 1990 to govern penny stock offerings by blank check companies.106 As such, their primary terms are largely the product of private ordering,107 according to which a SPAC merger is the second stage of a two-stage transactional process. In the first stage, a SPAC undertakes an IPO, raising funds for use in the second stage, in which it merges or otherwise combines with a private operating company, bringing the once-private company public. From the perspective of the private company that merges with the SPAC, a SPAC merger serves the functions of a traditional IPO—providing cash for growth, Exchange Act–registered securities, opportunities for exit by investors in the private company, and significant publicity. The formerly private company adopts the merger process to achieve these objectives even as it sidesteps the traditional IPO process.

In this Part, we critically examine the SPAC merger, assessing its purported benefits alongside its threats to investor protection, giving particular attention to the extent to which transaction structure shapes liability risk.

General Terms and Primary Functions

In the first stage of the SPAC life-cycle, a shell company—the SPAC—is formed to merge or otherwise combine with a yet-to-be-identified private operating company.108 The SPAC raises cash by undertaking an underwritten IPO. It does so in much the same way that an operating company would undertake a traditional IPO: by registering securities using a registration statement on Form S-1, or Form F-1 for foreign issuers. However, having no commercial operations or financial history, a SPAC has relatively little to disclose.109 The SPAC holds the IPO proceeds in an interest-bearing escrow account. It then has a designated acquisition window, usually eighteen to twenty-four months from the IPO (or longer, with shareholder approval),110 to undertake the second stage of the process—a SPAC merger—for which it may use the IPO proceeds.111 In the usual case,112 a SPAC merger occurs, with the SPAC and target continuing life in combined form. If no SPAC merger occurs within the acquisition window, the SPAC dissolves, returning the IPO proceeds with accrued interest to investors.113

SPACs are formed and operated by sponsors. These generally are private equity firms or other asset managers acting through small groups of individuals, who often include former public company executives, former investment bankers, or other financial professionals.114 These individuals will raise funds in a SPAC IPO, identify potential targets, and seek to execute a merger. As compensation for its work, a sponsor receives “founder” shares, typically a twenty-percent stake in the SPAC after its IPO, for a nominal consideration.115 Sponsors may also profit by investing in warrants and other securities issued by the SPAC in private placements at the time of the IPO.116 Founder shares and these other securities are worthless if no SPAC merger occurs.

In its IPO, a SPAC issues “units” typically priced at $10 and consisting of a share and a warrant (or a fraction of a warrant) to purchase additional equity.117 Importantly, the shares are redeemable when the SPAC proposes a merger, meaning that shareholders can, at that time, elect to have their initial investment (of $10 per share) returned, plus interest, rather than remain as shareholders and participate in the merger.118 Since SPAC IPO shares are tradeable, shareholders may sell their positions at any time. For example, a shareholder might sell at a profit before a merger occurs if the share price is trading above its redemption value of $10. SPACs also issue warrants—call options giving holders the option to buy a share in the SPAC at a fixed price, the strike price, within five years of any merger. Most SPACs select a strike price of $11.50.119 Like a SPAC’s shares, its warrants are also tradeable.120

The terms of these securities give SPAC shareholders key decisions to make at the time of a proposed merger. Once a SPAC has negotiated and announced a proposed merger, its shareholders must typically decide whether to approve the merger and whether to have their shares redeemed.121 Shareholders routinely approve mergers,122 even bad mergers, since a failed merger vote prevents shareholders from redeeming their shares and keeps their cash tied up as the SPAC seeks a better target under greater time pressure.123 Even shareholders that have voted in favor of a merger can—and do—demand redemption.124 Shareholders who are to vote receive materials soliciting their proxies in the form of a merger proxy statement under Section 14(a) of the Securities Exchange Act.125 If securities are to be registered in the transaction, a registration statement on Form S-4 (or Form F-4 for foreign issuers) is permitted to serve as a proxy statement.126 These materials provide the basis for shareholders’ decisions, making informational accuracy and completeness a vital policy objective.

In a conventionally structured SPAC merger, the SPAC survives the merger, keeping its status as a public company. It absorbs the target, usually in a reverse triangular merger, takes the target’s name, and appoints target managers to run the business.127 The SPAC issues shares to target shareholders, making them shareholders of the SPAC, a company that now combines the target’s business with the SPAC’s cash.

SPACs have generally experienced high redemptions, with mean and median rates above fifty percent, except during periods of inflated stock prices.128 Redemptions diminish the IPO proceeds available for a merger, making it practically a necessity for SPACs to raise further funds for their proposed mergers.129 To do so, SPACs may make private placements to selected institutional investors—often on favorable terms—in “PIPE” transactions, or private investments in public equity. PIPEs qualify for an exemption from registration,130 but shortly after the merger, SPACs register the resale of the PIPE shares on a shelf registration statement, which allows investors to freely sell their shares over an extended period of time.131

Conceptual differences exist between SPAC mergers and traditional IPOs. Structured as mergers, de-SPACs avoid the need for conventional underwriters. They invert the traditional IPO process by raising funds from investors before any IPO candidate has been identified. Initial investors do not bet on a particular company, as they do in the case of a traditional IPO. Rather, they bet on a sponsor’s skill in identifying a merger candidate by providing cash to get the sponsor’s acquisition vehicle up and running.132 And a SPAC is a safe bet for initial investors, because if they still hold shares when the merger occurs, they can decide to have their initial investment returned. Non-redeeming investors then bear the risk of the merger. These investors include those in the SPAC IPO, typically institutions, and those to whom these initial investors sold their shares—often retail investors hoping that the SPAC merger would create value.133

From private companies’ perspective, SPAC mergers can be viewed as alternatives to traditional IPOs.134 Both transactional structures provide permanent capital for growth; give companies Exchange Act–registered securities—publicly traded currency they can use to make acquisitions and remunerate their employees; provide companies’ existing shareholders the opportunity to sell shares; and enhance corporate brands. Moreover, like many traditional IPOs, SPAC mergers leave the target’s business intact, its management in place, and its existing shareholders largely in control, with new shareholders effectively contributing cash for a minority position in the company. Still, SPAC mergers are structured as business combinations, typically mergers, raising threats to investor protection.135 Gaps in Section 11 liability arise. Transaction participants benefit from more liberal rules on deal publicity and on the use of forward-looking statements. Typical compensation structures further weaken participants’ incentives to deter misconduct. We consider these threats, focusing on the merits of underwriter liability in this setting.

The Deterrent Force of Underwriter Liability

Generally, no underwriter liability arises in SPAC mergers, limiting the force of Section 11. This produces weaker incentives for all gatekeepers to assure the accuracy of corporate disclosures, relative to the incentives in traditional IPOs.

Liability Exposure

Commentators have argued that SPAC mergers benefit from more lenient liability exposure for disclosure errors than do traditional IPOs. This is a matter of controversy.136 In assessing liability exposure of SPACs, we first consider the conditions under which SPAC mergers will be subject to Section 11. That question turns first on the use of registration statements in SPAC mergers, an issue on which the scholarly literature diverges.137

A SPAC may file three kinds of registration statements; only one of these is of special interest here, but we will briefly lay out the others as well. The first of these statements comes during the IPO, when a SPAC files a registration statement much as an operating company would in a traditional IPO. But, with no operating or financial history, a SPAC has little to disclose other than the obvious risks in such an offering.138 Moreover, this registration statement predates the crucial investor decisions taken when a SPAC merger occurs. The last of the three statements may come after consummating a merger, at which point a SPAC will likely file a shelf registration statement to register the resale of securities for the benefit of PIPE investors and warrant holders.139 But such statements come too late to influence investors’ decisions concerning whether to approve the merger and whether to demand redemption. We are focused on the second registration statement—made using Form S-4 or F-4—which may come at the time of the SPAC merger. Disclosures on this statement will inform basic investor decisions as to merger approval and redemption.

The contents of this merger registration statement are vital, and in most cases registration will probably occur. The need to register securities depends on the merger structure adopted and the particular demands of target shareholders. At least three structures are common: a conventional or SPAC-on-top structure, a target-on-top structure, and a double-dummy structure.

Under the conventional structure, the SPAC sets up a subsidiary, which merges with the target, with the target surviving as a wholly owned SPAC subsidiary.140 In consideration for the merger, the SPAC issues securities to target shareholders. Whether the issued securities need registration depends on whether they qualify for an exemption from registration under the Securities Act of 1933.141 The most common exemption is Rule 506 under Regulation D, for private placements to accredited investors and up to thirty-five non-accredited investors.142 When the proposed offering fails to satisfy the exemption requirements—say, because the target has a large number of non-accredited investors under an employee incentive plan—the SPAC will register the securities using a Form S-4 (or F-4).143 Not all qualified SPACs will choose to take their exemption. Even if the proposed offering would qualify for an exemption from registration, a SPAC may nevertheless register the securities it issues to provide target shareholders the flexibility to freely trade their shares.

The target-on-top structure reverses the conventional SPAC merger structure. In this case, it is the target or a subsidiary that survives the business combination and issues securities to SPAC shareholders in consideration of a merger.144 Under this structure, the target will be required to register the securities issued because the offering will fall beyond the usual exemptions available for private offerings, given the number and character of SPAC shareholders.

In a third transactional form, the double-dummy structure, either the SPAC or target forms a holding company that acquires both the SPAC and target by exchanging newly issued shares for those of the SPAC and target.145 The new holding company must therefore make a public offer of securities falling outside exemptions from registration.

In sum, liability under Section 11 cannot arise for conventionally structured SPAC mergers that rely on an exemption from registration. But conventionally structured SPAC mergers may be required to use registration statements, and some that are not required to do so nevertheless will. For any of these companies, Section 11 liability will arise, as it will for SPAC mergers structured using the target-on-top and double-dummy models. Casual empiricism suggests that many if not most SPAC mergers will involve registration of securities, bringing them within the scope of Section 11, although the exact proportion is an issue requiring empirical investigation.146

Variations among transaction structures may nevertheless limit the force of Section 11 even when it applies. Under the various structures for SPAC mergers, the registrant of securities may be the SPAC or the target, or a related company, with the result that Section 11 directly exposes this entity (and its required signatories under Section 11), rather than the other entities (and their respective signatories), to the threat of liability. Moreover, the shareholders to whom securities are issued—those having rights of action under Section 11 as acquirers of securities—may not include non-redeeming SPAC shareholders under certain structures. In consequence, these investors, the most vulnerable among those participating in SPAC mergers, may lack recourse under Section 11 even when the provision otherwise applies, a result driven by the peculiarities of transaction planning rather than economic substance.

According to some commentators, even if a SPAC files a registration statement that becomes effective, the potential for Section 11 liability may be limited for secondary market purchasers by the concept of “tracing”—the requirement that purchasers be able to trace each security for which they claim damages to an actionable registration statement. Section 11(a) limits recovery to “any person acquiring such security,” a phrase Judge Friendly in Barnes v. Osofsky147 interpreted narrowly to mean “acquiring a security pursuant to the registration statement,” rather than “acquiring a security of the same nature as that issued pursuant to the registration statement.”148 However, this is less of an impediment than it sounds. Indeed, tracing raises no impediment to those shareholders issued shares pursuant to a registration in a corporate merger.149 Specifically, when an entity other than the SPAC issues securities to SPAC and target shareholders in a corporate merger, as it often will,150 SPAC shareholders may trace their shares to the issuer’s registration statement.151 These shares will be distinguishable from those shares issued in the SPAC IPO because they will have been exchanged for those IPO shares.152 Target shareholders may themselves have claims under Section 11, although when claims regarding the accuracy of registration statements or other corporate disclosures made in connection with SPAC mergers arise, major target shareholders are likely to find themselves defendants.153

As for purchasers in secondary markets of the surviving company’s shares, tracing difficulties may arise under Section 11 but need not. Every court of appeals to consider the issue has adopted Judge Friendly’s “narrow” version, requiring claimants to trace each individual security for which they claim damages to the particular registration statement at issue.154 However, if the market contains only shares issued under the allegedly actionable registration statement, traceability would be possible. Consider a SPAC merger in which the SPAC forms a subsidiary (“Hold Co.”). The SPAC and Hold Co. merge, with Hold Co. surviving and taking the SPAC’s status as a public company. In a closely related transaction, Hold Co. merges with the target company, surviving and absorbing the target’s business, taking the target’s name, and appointing the target’s managers to run the business.155 Hold Co. will file a single registration statement on Form S-4 or F-4, registering securities to be issued to SPAC shareholders (in exchange for SPAC IPO shares) and target shareholders (in exchange for target shares). If Hold Co.’s “stock has only entered the market via a single offering,” then “traceability . . . is satisfied, as a matter of logic.”156 Because Hold Co. has only issued stock once, secondary-market purchasers may not have difficulty tracing their shares to the allegedly flawed registration statement.157 Similar analysis would pertain to the target-on-top and double-dummy structure because shares will have been sold to SPAC investors via a single offering.

Investment Banks’ Diligence: Incentives and Market Practices

For some transactions, the requirement for “tracing” does not give SPACs substantial protection against Section 11 suits. The more pressing concern—applicable to all SPAC mergers, and in fact to mergers generally—is the likely absence of underwriter liability under Section 11. As defined in the Securities Act, the term underwriter applies not to investment banks in particular but to any actor—whether a professional investment bank or amateur—that performs a specified function,158 such as “purchas[ing] from an issuer with a view to, or offer[ing] or sell[ing] for an issuer in connection with, the distribution of any security.”159 In SPAC mergers, investment banks routinely act as M&A advisors to SPACs or target companies and as placement agents in PIPE transactions.160 In acting as M&A advisors or placement agents, investment banks will rarely perform any of the specified functions for underwriter status161; in fact, they may deliberately avoid performing any of those functions, wary of the potential for Section 11 liability if they do.162

The absence of underwriter liability in SPAC mergers can be expected to significantly weaken incentives for investment banks to perform due diligence to assure the accuracy of corporate disclosures. Professor Joseph Leahy observes that, in traditional IPOs, Section 11 liability gives issuers and underwriters “maximum incentive to test the accuracy of the assertions in [disclosure] document[s]. This same incentive is not present, for example, when the investment banker advises a client concerning a potential merger.”163 More than this, investment banks have little incentive to require comfort letters and negative-assurance letters from auditors and lawyers, respectively, of the type they require as underwriters in traditional IPOs. If freed from responsibility for providing these letters, on which liability can arise, auditors and lawyers would not face potential liability to underwriters for material misstatements in or omissions from non-expertised portions of registration statements, as they do in traditional IPOs.164

Investment banks and other transaction participants in SPAC mergers can be held liable under other federal securities law than Section 11, but these provisions are inadequate substitutes for Section 11. The most relevant such provisions are the omnibus fraud provision Section 10(b) and Rule 10b-5 and the proxy fraud provision Section 14(a) and Rule 14a-9 under the Exchange Act. In the SPAC context, the force of private suits under Section 10(b) and Rule 10b-5 is limited. Specifically, the Supreme Court’s decision in Central Bank of Denver v. First Interstate Bank of Denver165 shields investment banks and other secondary actors from liability for aiding and abetting wrongdoing by issuers. More recent decisions have further reduced the threat of liability for secondary actors under Rule 10b-5.166 Accordingly, for placement agents the prospect of primary liability under 10b-5 is remote.167 The same is true for M&A advisors unless they engage in misconduct such as “purposefully and intentionally caus[ing] a false statement to be issued” in a fairness opinion.168 Similarly, investment banks have rarely faced liability under Section 14(a) of the Securities Exchange Act and only then for fairness opinions shown to be objectively and subjectively false.169 And corporate fiduciary litigation and enforcement by the industry regulators similarly pose little risk to investment banks acting on SPAC mergers.170

If securities-law provisions are unable to offset the deterioration of Section 11 underwriter liability, nor can non-legal forces be expected to do so. Among the non-legal forces that have robust influence in traditional settings is reputational capital. In traditional IPOs, investment banks acting as underwriters put their reputations at stake, giving the banks incentives to perform due diligence and ensure the accuracy and completeness of corporate disclosures, even apart from the incentives produced by the threat of liability for disclosure errors. There is no reason to think that investment banks acting as M&A advisors or placement agents for SPACs have more reputational capital at stake than do underwriters in traditional IPOs—certainly not enough to make up for the absence of Section 11 liability. Indeed, traditional IPO underwriters may face greater reputational discipline. Significantly, firm commitment underwriters act as principals, buying the securities at issue. Doing so more closely associates them with the transaction than are M&A advisors and placement agents involved in SPACs, which have more distant roles.

Beyond the lack of incentives created by liability and other forces, we can look to market practices for evidence that investment banks involved in SPAC mergers lack incentives to undertake robust due diligence. In mergers, neither an investment bank nor any other transaction participant requires comfort letters or negative-assurance letters attesting to the accuracy of corporate disclosures—a basic difference from the verification process in traditional IPOs. Indeed, in mergers generally, investment banks’ due diligence role is often limited. Guides on market practices concerning M&A due diligence tend to assign banks a secondary role, focusing instead on the diligence roles of lawyers and auditors. One guide, indicating a narrow diligence role for bankers, suggests they merely provide feedback on the due diligence checklist prepared by lawyers, “perhaps” assist the buyer in reviewing operational information about the target, and give “input” to the buyers and public accountants whose job it is to “carefully analyze” the target’s financial statements and other financial data.171 Reinforcing this picture of bankers’ limited diligence role in mergers, bankers themselves routinely disclaim responsibility for verifying the information on which they have relied in preparing fairness opinions. Their opinions are heavily qualified, for example cautioning that they have, “with the[ir] [client’s] consent[,] . . . relied on the information supplied to [them] . . . [and] have not assumed any responsibility for independent verification of, and have not independently verified, any of such information.”172 In an interview with one of the authors, one SPAC advisor explained that investment banks in particular tend to confine their diligence review of registration statements in SPAC mergers to any references made to their own institutions, which typically arise in the Section outlining the background of the business combination.173

Diligence by Other Transaction Participants

It seems straightforward that investment banks in particular perform weaker diligence in SPAC mergers than they do in traditional IPOs, stemming from the absence of underwriter liability. But what of other participants? It is not self-evident that due diligence in mergers is necessarily weaker than that in IPOs; respected commentators resist this assertion, suggesting that the opposite may be true—that merger diligence may be more “extensive” or “go further” than that of traditional IPOs.174 Nor can we dismiss the possibility that due diligence will be performed by cast members in SPAC mergers that have no role in IPOs, including sponsors and PIPE investors.

However, we are skeptical that due diligence in SPAC mergers is generally as extensive as it is in traditional IPOs. The structure of SPACs’ and sponsors’ remuneration gives them incentives to support a deal if the alternative is no deal, especially as the acquisition window closes, diluting their incentives to perform robust diligence. Moreover, when mergers occur in the context of a competitive auction—as is often the case with SPAC mergers, and which may be expected given the large numbers of SPACs seeking targets—the incentives for due diligence may weaken since diligence may not be possible until after the price has been largely settled.175 IPOs look different. Although conducting due diligence for an IPO is also an adversarial process, issuers need not fear disclosure to potential competitors. Rather, the disclosure is to gatekeepers selected by the issuers themselves. In addition, these gatekeepers take a less oppositional posture than a prospective buyer.

What about due diligence performed by PIPE investors in SPAC mergers? That may inure to the benefit of public SPAC investors. Investors in PIPEs are accredited institutions and have access to non-public information about a SPAC and its target. These sophisticated investors are capable of verifying the information they obtain. However, we doubt that these investors generally undertake due diligence that substitutes for the due diligence underwriters perform in an IPO. We cannot speak conclusively to the point for lack of relevant data; the question is, after all, an empirical one. But we note that PIPE investors may invest on more favorable terms than public investors, potentially undermining claims their due diligence protects those investors.176 Moreover, PIPE investors seek to be “cleansed” of material nonpublic information for insider trading purposes, generally will want any such information they receive to be publicly disclosed by the time of either the announcement or consummation of the SPAC merger.177 That imperative necessarily limits the scope of PIPE investors’ due diligence on a SPAC and its target. We also note that these investors have weaker incentives to perform due diligence than underwriters: PIPE investors avoid Section 11 liability investing in PIPEs and are likely to face less reputational harm for failing to deter disclosure errors.178 Reputational incentives surely exist for some investors, but “the portfolio approach” many sophisticated investors adopt—making multiple investments with the hope that outsized gains in some will more than compensate for losses in others179—diminishes the reputational harm they suffer from making a poor investment that results from inadequate diligence, assuming their shortcomings come to light.180 To be sure, PIPE investors’ due diligence is likely to vary according to the type of investor and the intended holding period. But not all investors are in for the long haul, and commentators express doubts about the rigor of PIPE investors’ due diligence in some settings, observing that “[p]ublic investors lose a significant component of certified due diligence in PIPE deals, even under circumstances where it could be helpful.”181 According to experienced practitioners, data rooms for PIPEs often contain little more than slide presentations known as “investor decks” that SPACs publicly disclose soon after the merger announcement,182 making IPO underwriter-style due diligence impossible for PIPE investors.

Finally, the involvement of PIPE investors may create particular pressures that compromise the integrity of due diligence efforts. Certainly, SPAC participants “often face pressure to expedite the [due diligence] process.”183 Before any merger proxy or registration statement on Form S-4 is prepared and filed, SPACs and targets provide investor decks to PIPE investors and, once the merger is announced, to analysts and other investors. These presentations soon become publicly available, being filed with the SEC in order to cleanse PIPE investors from insider trading restrictions.184 Transaction participants preparing proxy statements may feel pressure not to later disclose information inconsistent with that already publicly released.185 These pressures rarely arise in traditional IPOs, because the issuer’s first public disclosure in connection with its IPO will typically be a heavily vetted draft registration statement.

In sum, the analysis suggests that, while SPAC participants, including a SPAC and its directors and officers, are vulnerable to Section 11 liability, investment banks will escape liability for the roles they perform, resulting in weaker incentives for due diligence by gatekeepers in SPACs than in traditional IPOs. Structural differences between mergers and traditional IPOs are also likely to weaken the diligence role of transaction participants in SPACs, exacerbating concerns created by the absence of underwriter liability. We are skeptical that due diligence by sponsors or PIPE investors can substitute for the absence of gatekeeper liability required for traditional IPOs. Weaker incentives for due diligence threaten investor protection since they can be expected to result in less accurate and complete disclosures.

Other Threats to Investor Protection

Other factors contribute to the weakened deterrent force of underwriter liability under Section 11. First, SPACs’ structure distorts the incentives of sponsors and IPO underwriters, creating pressure for SPACs to act contrary to the best interest of their outside investors, including by overpaying for targets. Second, SPAC mergers do not face the same restrictions on publicity as traditional IPOs, with the result that SPAC investors may make investment decisions on information that is more weakly vetted than information available to their counterparts in traditional IPOs. Finally, federal securities law provides a safe harbor from liability for estimates, projections, and other forward-looking statements—a safe harbor widely interpreted as applying to SPAC mergers but not to traditional IPOs. Although we suggest there are many de-SPACs to which this safe harbor does not apply, its potential availability may encourage greater use of forward-looking information in SPAC mergers, meaning that investors may rely on relatively weakly tested projections of target companies, predictions that are inevitably uncertain and often not borne out.

Misaligned Incentives

The terms of SPACs typically distort the incentives of sponsors and underwriters, potentially harming outside SPAC investors, many of them retail investors.186 Sponsors are largely compensated via founder shares, which gives them a substantial stake in the SPAC for a nominal consideration.187 Their incentives diverge from those of outside SPAC investors both because they receive their securities on more favorable terms than do investors and because these shares provide no return unless the SPAC consummates a merger within the defined time frame.188 Sponsors therefore will often have incentives to undertake a merger, even at a lofty price, because the remuneration structure allows them to profit even if shareholders lose. Otherwise put, a sponsor may choose to merge with a “lemon” rather than have to liquidate the SPAC and lose the benefit of its founder shares and other securities.189

Sponsors may choose to transfer a portion of their founder shares or warrants to the target company or other parties in order to facilitate a SPAC merger.190 Studying the twenty most recently completed business combinations as of October 2020, Minmo Gahng and coauthors show that, on average, sponsors gave up thirty-four percent of their founder shares and forty-two percent of their warrants, transferring most of these securities to other participants—primarily PIPE investors—to induce them to invest new capital or at least not to demand redemption.191 Consistent with an interpretation of these transfers as inducements, Gahng et al. find greater transfers for deals that were poorly received by investors, as evidenced by high redemption rates.192

Give-ups confirm sponsors’ powerful incentives to pursue even loss-producing deals. The need for give-ups suggests both that the terms otherwise may be inadequate from the perspective of those investors receiving the give-ups and that investors who do not receive these inducements experience harm. Underscoring the perversity of sponsors’ incentives, in recent years they earned outsized positive returns even when SPAC mergers performed poorly.193

Investment banks have similarly compromised incentives. In SPAC mergers, investment banks routinely act as M&A advisors to SPACs or target companies and as placement agents in PIPE transactions. SPACs tend to select their M&A advisors and placement agents from among the underwriters to their earlier IPO,194 allowing investment banks to have designated roles in both SPAC stages by underwriting the IPO and then advising on the SPAC merger and/or facilitating the related PIPE offering. Some evidence suggests that underwriters in the SPAC IPO that are not formally engaged as M&A advisors will nevertheless “typically assist [the] SPAC in finding targets and assisting with capital structure matters for SPAC mergers”195 and therefore perform an informal advisory role.

Consider that the majority of underwriting fees for SPAC IPOs are deferred until, and conditional upon, the closing of the SPAC merger.196 These arrangements create incentives for investment banks to recommend or support mergers even if they do not serve SPAC interests, because the banks lose their deferred compensation if no merger occurs within the acquisition window.197 This situation holds whether a bank is operating as M&A advisor or in an informal capacity on the deal. Both roles are common.198 The same goes for placement agents because they may simultaneously be serving as M&A advisors to the SPAC or target,199 roles that award “outsized benefits from completing acquisitions,”200 giving them added incentives to solicit PIPE investors. Illustrating the strength of these incentives, SPAC IPO underwriters often forego fees to facilitate SPAC mergers, and are more likely to do so when investor redemptions are high.201

Traditional IPOs do not seem to create such strongly misaligned incentives between transaction participants on the one hand and outside investors on the other. Sponsors perform no role in traditional IPOs. For their part, underwriters receive contingent compensation in IPOs, receiving a fee only if an IPO occurs, but they have powerful incentives to protect the interests of outside investors, and are alleged to underprice securities, in part, with the intention of doing so.202

Sales Promotion

SPAC mergers also face fewer barriers to the use of weakly vetted sales promotional materials. Traditional IPOs face firm limits on offers and sales of securities prior to the filing of a registration statement and require written offers to be made in connection with a statutory prospectus. Although these so-called gun-jumping rules are not as strict as they once were,203 in practice they continue to discourage investment activity before a well-vetted registration statement has been filed with the SEC.204 “[T]h[is] generally prevents executives from providing information not previously disclosed in the registration statement and prospectus until forty days after the new stock begins trading.”205 In marked contrast, mergers, including SPAC mergers, benefit from more lenient rules intended to allow companies and other participants to announce a proposed transaction long before a registration statement has been filed.206 SPACs typically announce their mergers many weeks before the filing of a registration statement. They may also make other communications before a registration statement has been filed, so long as that communication is filed with the SEC.207 The SPAC merger announcement is often quickly followed by the disclosure of the investor deck used to solicit PIPE investors. These materials are typically lengthy slide presentations promoting the SPAC, the target, and the proposed merger; they include earnings and other projections for the target. These materials—which would not be permitted in a traditional IPO—“condition the market” for the SPAC before any well-vetted registration statement has been filed. After the announcement of the SPAC and the filing of these materials, SPACs and targets then undertake “roadshows” with potential investors, give presentations at industry conferences, have conference calls with research analysts, issue press releases, and update previously disclosed information—filing with the SEC promotional materials at a steady pace that would not be permitted in a traditional IPO. In industry parlance, the purpose of these materials is to “cycle out” the yield-oriented investors, the “SPAC mafia,” and “cycle in” long-only fundamental investors.

Regulatory leniency exposes SPAC investors to arguably less reliable disclosures. SPACs and their merger targets get to arouse investor interest much earlier in the deal process than issuers in traditional IPOs, before a registration statement has been prepared, with the result that SPAC investors may make investment decisions on information that is more weakly vetted than information available to investors in traditional IPOs. Although investors may yet redeem their shares, this decision too depends on the accuracy and completeness of information available.208 Transaction participants report feeling pressure not to later disclose information in proxy statements inconsistent with that already publicly released,209 and in any case, these later disclosures may be compromised by diminished incentives for due diligence.

Forward-Looking Statements

Relatedly, the forward-looking or prospective statements disclosed in SPAC mergers probably enjoy greater protection from liability than such statements would in a traditional IPO. Under provisions of the Securities Act and Securities Exchange Act enacted by the Private Securities Litigation Reform Act (PSLRA),210 issuers benefit from safe harbors from liability for certain forward-looking statements in private suits provided that the statements are accompanied by meaningful cautionary language.211 The safe harbors are subject to exclusions, including for forward-looking statements “made in connection with an initial public offering.”212 Yet legal practitioners generally regard SPAC mergers as benefiting from the safe harbors—that is, they do not regard a SPAC merger as “an initial public offering” within the terms of the exclusion.213

The perceived availability of these liability safe harbors for SPAC-merger participants, not participants in traditional IPOs, has been thought to explain differences in deal practices.214 Issuers in traditional IPOs do not publicly disclose forward-looking statements, including in their registration statements “other than vague narrative disclosure in response to the SEC’s management discussion and analysis [MD&A] rules,” while issuers and targets in SPAC mergers “routinely provid[e]” forward-looking information in their proxy and registration statements and in other materials.215 In traditional IPOs, it is not that projections of revenue or earnings and other forward-looking information are unavailable but that such information is not publicly disclosed in the offering process. Issuers in traditional IPOs generate forward-looking information, which their underwriters scrutinize as part of their due diligence in order to “avoid surprises and investor disappointment.”216 By contrast, public investors in SPAC mergers have ready access to such information, including in the proxy or S-4 disclosures, giving them information that may mitigate information asymmetry but is likely the product of a weaker diligence process than that applied in traditional IPOs. The irony is that IPO issuers refuse to release earnings projections, even though they have benefited from third-party review, while SPACs routinely disclose the relatively weakly tested projections of target companies, exposing investors to risk. Whether that risk results in investor harm awaits further evidence.217

Whether the safe harbors apply or should be applied to SPACs is a matter of debate. John Coates recently cast doubt on the prevailing practitioner interpretation, suggesting that “initial public offerings” as used in the exemptions “may include de-SPAC transactions.”218 Pointing to similarities in the “economic and information substance” of SPAC mergers and IPOs, the statement opines that whether the PSLRA safe harbors apply differently to traditional IPOs and SPAC mergers is “uncertain at best.”219 The statement goes further, arguing “that the PSLRA safe harbor[s] should not be available for any unknown private company introducing itself to the public markets. . . . regardless of what structure or method it used to do so.”220

Although we defer our discussion of whether the PSLRA safe harbors ought to apply to SPAC mergers until Part D, we contend that some SPAC structures are more plausibly regarded as “initial public offerings” than others and may therefore not benefit from the safe harbor. Recall the three main transactional forms for SPAC mergers.221 In the target-on-top and double-dummy structures, a private target and newly formed holding company, respectively, make initial offerings of securities to the public during a SPAC merger. These structures contrast with the conventional structure—which commentators seem to have in mind—whereby an issuer of securities in the SPAC merger (the SPAC) has often already undertaken an initial offering of securities. The argument that SPAC mergers are not “initial public offerings” within the PSLRA exclusions is more plausible for transactions not adopting the conventional structure.222 Nevertheless, SPACs routinely make use of forward-looking statements in SPAC mergers, without apparent regard for how they are structured.223

Assessment and Proposals

Outcomes

Empirical evidence suggests that the misaligned incentives common in SPAC mergers shape deal outcomes. SPAC mergers have often performed poorly for public investors, harming those SPAC shareholders who elected to hold their shares through the merger rather than selling or demanding redemption.224

Sponsors have nevertheless tended to earn outsized returns even when SPAC mergers performed poorly.225 This comes as no surprise considering sponsors’ receipt of founder shares amounting to twenty percent of the post-IPO company for nominal consideration, conditional on a merger occurring. In Michael Klausner, Michael Ohlrogge, and Emily Ruan’s 2019–2020 merger cohort, sponsor returns, on average, were around five hundred percent, measured twelve months post-merger on a market-adjusted basis.226 The authors find that “while sponsors are not absolutely guaranteed to profit, they have a very good chance of doing so, even when investors do quite poorly.”227 These results suggest that sponsors prefer to enter into deals that harm outside investors’ interests when the only alternative is to undertake no deal at all.

Justification for Regulation

In assessing the merits of underwriter liability under Section 11 in SPAC mergers, we use traditional IPOs as a benchmark for analysis, arguing that the case for underwriter liability is as strong in the setting of SPAC mergers as it is in that of traditional IPOs.

First, we contend that the benefits of underwriter liability are at least as great for SPAC mergers as they are for traditional IPOs. Both SPAC mergers and traditional IPOs introduce largely unknown and untested companies to public markets, and in such settings, information asymmetries between investors and companies seeking capital are likely to be substantial. In both transactions, information comes from the companies themselves, parties with “incentive[s] to act opportunistically by misrepresenting the accuracy . . . of the information.”228 After all, traditional IPOs and SPACs represent companies’ best shot at capitalizing on their innovations, so firms face pressure to attract funds on the most favorable terms.229 These environments of high information asymmetries are precisely the ones in which the investor “protections of . . . federal securities law[] are typically most needed.”230 If anything, the benefits of underwriter liability may be greater in the SPAC setting because SPAC sponsors and SPAC IPO underwriters have incentives misaligned with those of SPAC investors, which magnifies the risk of disclosure error.

Second, the costs of underwriter liability are no greater for SPAC mergers than they are for traditional IPOs. In both settings, investment banks have roles that allow them to perform due diligence. These firms have developed time-tested methods for assuring the accuracy of registration statements and other disclosures, methods that would seem equally applicable in both settings. Indeed, some legal advisors have advised participants to consider performing IPO-style due diligence in SPAC mergers without regarding cost as a barrier to banks.231

Assuming the accuracy of this assessment of costs and benefits, the case for underwriter liability is as strong for SPAC mergers as it is for traditional IPOs. On this reasoning, underwriter liability would generate benefits for SPAC mergers at least as great as those accrued to traditional IPOs, without imposing additional costs. If Section 11 underwriter liability is justified for traditional IPOs, the same is true for SPAC mergers.

The available empirical evidence does not justify extensive reforms designed to steer private companies toward traditional IPOs away from SPAC mergers. The empirical evidence is mixed on where the high costs of SPAC mergers fall at the time of the merger, how the costs of SPAC mergers and traditional IPOs compare from the perspective of target companies, and the extent of any unique benefits SPAC mergers provide. Accordingly, scholars studying these questions cannot conclude that traditional IPOs are necessarily superior to, or strictly dominate, SPAC mergers by providing greater welfare. Studies assessing SPAC mergers provide consistent results in some respects but diverging results in important other respects.

Scholars agree that SPAC mergers are, in aggregate, significantly more costly than traditional IPOs, contrary to the oft-repeated claims that SPAC mergers offer cost savings.232 IPOs and SPAC mergers impose somewhat different categories of costs. In traditional IPOs, costs primarily take the form of fees paid to underwriters and the potential losses resulting from “underpricing” of shares, whereby shares sold in an IPO tend to be priced below investors’ apparent willingness to pay for them. Although SPAC mergers do not suffer from such underpricing and face slightly lower underwriting fees (around 5.5 percent in total), other elements of their structure—founder shares and rights and warrants that SPACs issue—dilute the cash backing each SPAC share,233 which is amplified when SPAC shareholders have their shares redeemed and depletes the cash available for a proposed merger.234 These dilution costs must be borne by the post-merger company. In a seminal study of a cohort of SPAC mergers in 2019 and 2020, Klausner et al. estimate the median cost of SPAC mergers at sixty-two percent of the cash delivered, roughly double the corresponding figure for traditional IPOs.235 Measuring costs as a percentage of target or issuer market values using a similar analytical framework, Gahng and coauthors find SPAC mergers to be almost three times as costly as traditional IPOs.236

On which of the primary transaction participants—SPAC shareholders, target shareholders, or sponsors—do these costs largely fall? Scholars tend to agree that initial investors in SPAC IPOs earn attractive returns. The option to have their shares redeemed allows investors to recoup their investment, giving them “a money-back guarantee” plus interest.237 Their warrants, which they can sell or exercise, also have value.238 Investors that redeemed their shares earned mean annualized returns of 11.6 percent from their shares and warrants, despite facing no downside risk on their investment.239

As a class, initial SPAC investors—those investing in the SPAC IPO—are largely distinct from those SPAC shareholders holding at the time of merger and beyond. Initial SPAC investors generally have their shares redeemed or sell their shares before a SPAC merger, with the result, according to Klausner et al., “that very few pre-merger shareholders hold their shares until after the merger’s completion.”240 The primary role these SPAC investors perform “is to create a public vehicle that will be used later to bring a private company public through a merger in which new shareholders will invest.”241

Importantly, however, empirical evidence diverges on which of the remaining transaction participants bear the high costs of raising funds via a SPAC merger at the time of the merger: target shareholders or non-redeeming SPAC shareholders, a group that typically includes retail investors. The answer will depend on the terms of the agreement the merger parties strike and, in particular, whether targets negotiating mergers account for the heavily dilutive effect of founder shares, warrants, and rights, a consequence of which is that SPACs hold less cash per share than their $10 nominal share value suggests.242 Klausner et al. suggest that, in negotiating with SPACs, targets protect their interest by accounting for SPACs’ dilutive structure.243 Pointing to the substantial price declines SPACs experience after a merger and to their finding of a strong correlation between those declines and the extent of dilution, Klausner et al. infer that “SPAC shareholders bear the costs . . . embedded in the SPAC structure,” although “they extract some [modest] surplus from the deal, so their net losses are partially mitigated.”244 Non-redeeming SPAC shareholders “unwittingly subsidize” target companies, with the result that, from a target’s perspective, going public via a “SPAC has been cheap—cheaper than an IPO.”245

The inference made by Klausner et al. that non-redeeming SPAC shareholders—rather than target companies—bear the brunt of the expense is equivocal. Considering immediate post-merger prices, rather than the longer-term post-merger prices on which Klausner et al. base their inferences, and taking an alternative perspective to valuing IPO costs, Klausner et al. report the opposite result, that “SPACs would seem to be very expensive for target companies.”246 But Klausner et al. are skeptical of this alternative approach, suggesting instead that SPAC post-merger prices may be slow to adjust.247 Rather than rely on a SPAC’s immediate post-merger price, Klausner et al. point to evidence that SPAC prices decline in the weeks and months post-merger, which they interpret as consistent with the view that SPAC investors are bearing the cost of SPAC mergers.248 Again, however, this interpretation or inference—that target companies do not generally bear the brunt of the dilutive impact of SPACs—hinges on the view that SPAC prices are not highly informationally efficient but rather adjust slowly, a plausible but contestable claim.249

Gahng and coauthors prefer the alternative methodological approach, finding that the costs at the time of merger fall heavily on target shareholders. Gahng and coauthors therefore pose the difficult question of why target companies would engage in SPAC mergers rather than less costly conventional IPOs.250 Klausner et al. need not answer that question, as they suggest that, from a target’s perspective, SPAC mergers are cheaper than traditional IPOs,251 making the appeal of SPACs more obvious, especially considering the higher regulatory burdens traditional IPOs carry. But Klausner et al. must explain why SPAC shareholders would have agreed to bear these costs, a question they cannot answer definitively.252 Under both interpretations, however, the bottom line is that SPAC mergers have been, in aggregate, significantly more costly than traditional IPOs, largely due to their highly dilutive structure. Non-redeeming SPAC shareholders have also fared poorly post-merger, with SPAC shares generally declining in value after the merger.

In addition to disputing which participants bear the dilutive effect of SPAC mergers and how the costs of SPAC mergers and traditional IPOs compare from the perspective of target companies, scholars contest the extent to which SPAC mergers provide unique benefits. Scholars speculate that SPAC mergers offer advantages “for firms with information that is difficult to convey to investors or firms that investors have difficulty valuing.”253 SPAC deals are thought to be speedier to execute,254 have more certain deal terms,255 and benefit from sponsors giving advice and certification to private companies.256 If these benefits exist, they might well explain why so many companies have preferred SPAC mergers when, on Gahng et al.’s view, SPAC mergers are more expensive than traditional IPOs for target companies. However, Klausner et al. doubt whether SPAC mergers are executed more quickly or result in more certain deal terms. They accept that sponsors may provide value in selecting and advising targets and that PIPE investors may certify the transaction and thus aid in price discovery. But Klausner et al. suggest that these benefits are available at less cost by integrating certain features of SPACs into traditional IPOs.257

The point, however, is that dispute exists as to the relative costs of SPAC mergers and traditional IPOs and to the existence and size of any benefits SPAC mergers provide. Moreover, even critics of de-SPACs find that during their study period de-SPACs created social value, meaning that these transactions provided, on average, a net collective gain among all parties involved.258 This suggests that with changed terms, de-SPACs might also be value-increasing for non-redeeming SPAC shareholders, although that would mean lower returns for SPAC sponsors, IPO investors, and underwriters.259 The evidence therefore fails to establish that traditional IPOs strictly dominate SPAC mergers by providing greater welfare, or vice versa, or that reforms should avoid seeking to channel private companies away from either type of transaction to the other. However, the evidence does justify imposing Section 11 liability in SPAC mergers. The case for underwriter liability in SPAC mergers is as strong as it is in traditional IPOs: comparing the former setting to the latter, underwriter liability provides as significant benefits without imposing greater costs. If, as we contend in Part I, underwriter liability is justified for traditional IPOs, the same holds true for SPAC mergers.

Reform Proposals

We recommend that a SPAC’s IPO underwriters bear liability under Section 11 for any misstatements or omissions in registration statements used in connection with a SPAC merger. This could be achieved by viewing a SPAC IPO and its associated SPAC merger as one integrated transaction. The purpose would be to treat underwriters of the SPAC IPO as underwriters of the SPAC merger under Section 11. These investment banks may be formally retained by the SPAC as M&A advisors and in any event often advise on or otherwise facilitate the SPAC merger260—having incentives to do so because of their deferred compensation. If these investment banks were to face suit, they would benefit from the due diligence defense under Section 11. In practice, such liability would likely result in an underwriter undertaking due diligence to avoid liability, including seeking negative assurance and comfort letters from the SPAC’s counsel and auditors, respectively, attesting to the accuracy of the relevant registration statement. These heightened standards would apply to SPAC mergers only, a distinguishable class of merger in which special investor risks arise, rather than to mergers generally. These proposed standards would also align due diligence standards with those of traditional IPOs, buttressing investor protections.261

One factor potentially complicating the reform of underwriter liability under Section 11 concerns the routine inclusion of projected financial results in registration statements for SPAC mergers. This practice differs sharply from that for traditional IPOs, a setting in which projections are rarely disclosed in registration statements, perhaps because underwriters are unwilling to bear Section 11 liability for financial projections. On the one hand, if underwriters were to face Section 11 liability for projections in SPAC mergers, they might undertake greater due diligence than they do in traditional IPOs, making the costs of underwriter liability greater in the SPAC merger setting and weakening the case for Section 11 underwriter liability in that setting. On the other hand, underwriters necessarily perform some level of due diligence on projections in traditional IPOs, since these statements do become known to potential IPO investors, even though they rarely appear in registration statements.

We can also analogize the regulation of SPAC mergers with that of going-private transactions under federal securities law. The quintessential going-private transaction is the management buyout (“MBO”), a transaction that, like SPAC mergers, creates conflicts of interest for transaction participants, including corporate fiduciaries. In MBOs, managers of a firm participate in buying the firm, a position that pits managers’ self-interest against their fiduciary duties of loyalty.262 Federal securities law responds to these transactions by requiring enhanced disclosure.263 Rule 13e-3 compels an issuer and affiliates engaged in a going-private transaction to file with the SEC and to publicly disseminate a Schedule 13E-3, which requires disclosure of the transaction’s purposes and a written justification of its structure. The target company and its affiliates must attest that they reasonably believe the transaction is fair to shareholders and must explain why this is so.264

Some SPAC sponsors could be required to attest that they reasonably believe a SPAC merger is fair to SPAC shareholders and explain why. They could also discuss factors bearing on their incentives—and those of their advisors—to act contrary to or in congruence with the interests of outside SPAC shareholders. This discussion could include information about remuneration for sponsors, underwriters, and advisors as well as details of arrangements with third parties, such as PIPE investors and SPAC shareholders, as sponsors seek these third parties’ support for a proposed merger to proceed.265

We also recommend harmonizing safe harbors for forward-looking statements used in SPAC mergers and traditional IPOs. The case for reform of safe harbors is more contested than that for Section 11 liability because the existing regime for traditional IPOs (denying PSLRA safe harbor protections) is contested. We take no firm position on what those rules ought to be, recognizing that forward-looking information may be particularly important for a range of small companies that investors find difficult to value in the absence of good-faith estimates and projections.266 We recognize also that if SPACs base their decisions to merge on such information, “fairness” might require the disclosure of this information to outside SPAC investors as well.267 But it is difficult to see why any allowances in SPAC mergers ought not also apply in traditional IPOs, given the evidence at hand. We see no barrier to denying safe harbor protection on the basis that state law requires the disclosure of projections. Forward-looking information is already required and disclosed in SPAC mergers that now probably fall beyond the protection of PSLRA safe harbors (because of the particular transaction structure adopted).268 The same is true of going-private transactions, which the PSLRA deprives of safe harbor protections. If SPAC mergers were exempted from the PSLRA safe harbor, we would see this exemption as falling into line with the exclusion of going-private transactions, transactions that also suffer from misaligned incentives where transaction participants have stronger-than-usual incentives to over- or under-state figures for personal benefit.269

In suggesting reforms, we do not seek to channel private companies toward traditional IPOs or vice versa since neither transaction strictly dominates the other. Nevertheless, the case for Section 11 underwriter liability finds as strong justification for SPAC mergers. If, as we argue, underwriter liability is warranted for traditional IPOs, the same is true for SPAC mergers. We also suggest that doctrinal coherence favors aligning PSLRA safe harbors for SPAC merges with those for traditional IPOs and going-private transactions.

On March 30, 2022, the Commission proposed far-reaching reforms to SPACs broadly intended to align the regulatory treatment of SPAC mergers with that of traditional IPOs.270 Since final rules have yet to be adopted and one of us has commented on the proposal in detail elsewhere,271 we comment on relevant proposals briefly.

First, proposed reforms would significantly enhance the prospect of Section 11 liability in SPAC mergers, especially for investment banks that acted as underwriters for related SPAC IPOs. An underwriter of a SPAC IPO would be deemed to be a statutory underwriter for the associated SPAC merger if it took steps to facilitate the de-SPAC transaction, or any related financing transaction, or otherwise participated in that de-SPAC.272 The SEC describes the proposed provision as a “clarification” of existing law, an interpretation at odds with our analysis. The reforms cast the underwriter liability net wide, observing that financial advisors, PIPE investors, or other advisors may also be statutory underwriters of a SPAC merger.273 Reforms would also make target companies co-registrants with SPACs on registration statements, ensuring that targets and their directors have strong incentives under Section 11 to assure the accuracy and completeness of registration statements.274 Another proposed rule would deem the business combination of a shell company to be a “sale” of securities to the reporting shell company’s shareholders, a reform intended to assure that unaffiliated security holders enjoy the protections of registration under the Securities Act.275

These proposed reforms to enhance the Section 11 liability go somewhat beyond those we proposed but are sensibly crafted, reflecting an appreciation for a point we have emphasized, that regulatory treatment varies according to the particular structure a SPAC merger employs. The Commission’s broad interpretation of “underwriter” under Section 2(a)(11) of the Securities Act also shows a heavy regulatory hand. The Commission has not suggested exempting underwriters from Section 11 liability for financial projections in registration statements, an accommodation that may better align the treatment of SPAC mergers with those of traditional IPOs.

Sensibly, the Commission has proposed eliminating the PSLRA safe harbor for forward-looking statements.276 This accords with our proposals as well. In commenting on this reform, prominent advisors to SPACs have not offered strong resistance, noting—as we have—that the safe harbor is not regarded as essential protection for SPACs undertaking SPAC mergers.277

Finally, the SEC has styled a range of reforms on Rule 13e-3 of the Exchange Act applicable to going-private transactions.278 We proposed reforms based on Rule 13e-3 and agree that a clear analogy exists between SPAC mergers and going-private transactions subject to Rule 13e-3 in the conflicts they create between the interests of corporate fiduciaries and those of unaffiliated security holders.279

Direct Listings

Direct listings have been much less frequently employed than SPAC mergers or traditional IPOs. Beginning with Spotify in 2018, there have been a total of thirteen direct listings in the United States through June 2022.280

As with traditional IPOs, direct listings require the filing of a Securities Act registration statement. However, in contrast to traditional IPOs, direct listings do not rely on investment banks as conventional underwriters. Nor do direct listings generally use lock-up agreements, a fixture of most IPOs whereby underwriters require existing shareholders to agree not to sell their shares on the public market for a specified period, usually 180 days after the date of the final prospectus. The practical consequence of these differences is to render the application of Section 11 of the Securities Act uncertain and to weaken investor protection.

Regulatory Backdrop

While there are several means to distribute securities to the public,281 historically the most prevalent type of underwriting has been the firm commitment. In a firm commitment IPO, underwriters buy issuers’ securities and resell them to public investors at an agreed markup representing the underwriting fee.282 The issuer accepts the possibility that underwriters will underprice (or overprice) the securities offered to the public because the underwriters provide the issuer a contractually guaranteed sum of money, engage in sales activities to market the securities and may stabilize the public offering price by buying back securities during the public offering period. The underwriters’ reputations, due diligence, and willingness to assume losses are the key to the success of many IPOs.283

A direct listing is different. A direct listing does not require an investment bank to serve as a conventional underwriter. Nor does it generally require corporate managers, sponsors, affiliates, and other existing shareholders to enter lock-up arrangements. The offering price in a direct listing is not determined by agreement between the underwriter and the issuer; rather, it is determined by the law of supply and demand when public trading begins.

There are two types of direct listing on the NYSE and Nasdaq stock exchanges: the Selling Shareholder Direct Floor Listing and the Primary Direct Floor Listing. We focus on the more widely used NYSE rules.284

Under Section 102.01B, Footnote (E) of the NYSE Listing Manual, for several years it was possible for common stock not previously registered under Section 12(b) of the Securities Exchange Act as shares on a National Securities Exchange to be sold through a private placement such as Regulation D and then listed on the NYSE simultaneously with the filing of a Securities Act registration statement. This type of sale often is made by board members, executives, and other existing shareholders, such as sponsors or founders, when a firm goes public.

In 2020, the full Commission approved the two variants of direct listings. (Earlier, in 2018, the SEC Staff had approved the Selling Shareholder form.) When the Commission approved the NYSE Selling Shareholder Direct Floor Listings in 2020, it did so subject to the issuer demonstrating that it has $100 million aggregate market value of publicly held shares based on (1) an independent third-party valuation of the company and (2) the most recent trading history for the company’s common stock in a trading system for unregistered common stock operated by a National Securities Exchange or a registered broker-dealer under Rule 144A (Private Placement Market). Selling Shareholder Direct Floor Listings involve only sales by existing shareholders to the public and do not raise new money for the firm. When a Private Placement Market for unregistered shares is not available, the selling shareholder alternatively can provide a valuation evidencing a market value of publicly held shares of at least $250 million. To date, all direct listings have been for selling shareholders.

In December 2020, the SEC approved the Primary Direct Floor Listing, although, to date, this transaction has never been used. In this variant of direct listings, an issuer registers its shares with the SEC and the Exchange and then directly sells those shares to the public in the opening auction on the Exchange. To satisfy the market value requirement, the company has to either sell $100 million or more in the opening auction or, if the company anticipates selling a lesser amount, to provide a determination that the company has an aggregate market value of at least $250 million. Unlike a Selling Shareholder Direct Floor Listing, a Primary Direct Floor Listing can occur without any prior trading in a Private Placement Market.

Proponents of direct listings explain that Primary Direct Floor Listings will not be possible unless the SEC Division of Trading and Markets provides relief from Regulation M, the Commission’s anti-manipulation rules under which in a public offering underwriters can buy back shares to stabilize the offering price.285 On March 23, 2018, the Commission did provide a no-action letter to permit Regulation M relief to Spotify, limited to a Selling Shareholder Direct Floor Listing.286

The NYSE urged approval of both types of direct listing on the basis that a traditional IPO has a minimum $40 million market value287 “and, ‘in the Exchange’s experience in listing IPOs, a liquid trading market develops after listing for issuers with a much smaller value of publicly-held shares that the Exchange anticipates would exist after the opening auction in a Primary Direct Floor Listing’” and in a Selling Shareholder Direct Floor Listing.288

A Selling Shareholder Direct Floor Listing without a recent sustained history of trading in a Private Placement Market is required to cause the NYSE Designated Market Maker to consult with the issuer’s financial advisor in order to effect a fair and orderly opening of the security. This requirement does not apply to a Primary Direct Floor Listing which includes a price range within which the issuer anticipates selling its shares in the offering.289

In December 2020, when the Commission approved the NYSE rule changes to permit both types of direct listings, the Commission found that the NYSE rule changes were consistent with the protection of investors, the maintenance of fair and orderly markets, and the facilitation of capital markets.290 Specifically the SEC found that the NYSE Direct Floor Listing requirements set the opening price at the lowest price in the range established by the issuer after discussion with the financial advisors and market makers. The SEC emphasized that the NYSE proposal had been modified to highlight the requirements for direct listings to be conducted consistent with Regulation M stabilization rules and other anti-manipulation provisions and for the NYSE to retain FINRA to monitor compliance with Regulation M.291

The SEC, in effect, trusted the market because of benefits to existing and potential investors:

First, because the securities to be issued by the company in connection with a Primary Direct Floor Listing would be allocated based on matching buy and sell orders, in accordance with the proposed rules, some investors may be able to purchase securities in a Primary Direct Floor Listing who might not otherwise receive an initial allocation in a firm commitment underwritten offering. The proposed rule change therefore has the potential to broaden the scope of investors that are able to purchase securities in an initial public offering, at the initial public offering price, rather than in aftermarket trading. Second, because the price of securities issued by the company in a Primary Direct Floor Listing will be determined based on market interest and the matching of buy and sell orders, some believe that Primary Direct Floor Listings may be a more accurate way to price securities offerings.292

 The Commission emphasized,

The opening auction in a Primary Direct Floor Listing provides for a different price discovery method for IPOs which may reduce the spread between the IPO price and subsequent market trades, a potential benefit to existing and potential investors. In this way, the proposed rule change may result in additional investment opportunities while providing companies more options for becoming publicly traded.293

The 3-2 Commission majority was unpersuaded that direct listings would increase risks for investors by circumventing traditional due diligence and traditional underwriter liability. One commentator had vociferously complained that allowing companies to raise primary capital through a direct listing “would be a complete end run around the traditional underwriting process and . . . create a massive loophole in the regulatory regime that governs the offerings of securities to the public.”294

But the Commission rejected this type of concern, stating:

[T]he Securities Act does not require the involvement of an underwriter in registered offerings. Moreover, given the broad definition of underwriter in the Securities Act, a financial advisor to an issuer engaged in a Primary Direct Floor Listing may, depending on the facts and circumstances including the nature and extent of the financial advisor’s activities, be deemed a statutory underwriter with respect to the securities offering, with attendant underwriter liabilities. Thus, the financial advisors to issuers in Primary Direct Floor Listings have incentives to engage in robust due diligence, given their reputational interests and potential liability, including as statutory underwriters under the broad definition of that term.295

Two SEC Commissioners, Allison Herren Lee and Caroline A. Crenshaw, dissented from the direct floor listing approval, lamenting, “Had [the Commission] acted with greater deliberation, we could have considered or debated possible approaches to mitigating these increased risks to investors.”296 They continued:

In particular, we should have provided guidance addressing what might trigger status as a statutory underwriter for other market participants involved in a primary direct listing. This guidance could have been targeted to the anticipated roles of financial advisors involved in a primary direct listing offering, given their potential role as one of the main market participants to guide companies through the listing process. We support considering what guidance is needed in the future as primary direct listing market practices evolve.297

Transactional Practice

In practice, the firms choosing direct listings are little different from many high-tech companies that have recently pursued traditional IPOs. Backed by leading investment banks and law firms, sales on the opening day typically were substantial.298

The companies that were directly listed posed considerable risk for investors. Most had a recent record of net income losses or a negative stockholder equity.299 Most did not intend to pay dividends for the foreseeable future.300 Many were emerging growth companies with less than $1.07 billion in revenue during the fiscal year preceding their listing and faced reduced mandatory disclosure requirements.301 Most disclosed, “Our management team have limited experience managing a public company.”302 In each direct listing, existing shareholders sold shares, reaping a payoff from the going-public event while adding no resources to the issuing company.303

Each direct listing was conducted without investment banks acting as conventional underwriters and reaching out to potential investors such as institutional investors to gauge their interest in a potential purchase or book building. Spotify, in its 2018 direct listing, provided a template for the subsequent direct listings when it wrote:

There are no underwriters. Consequently, prior to the opening of trading on the NYSE, there will be no book building process and no price at which underwriters initially sold shares to the public to help inform efficient price discovery with respect to the opening trades on the NYSE. Therefore, buy and sell orders submitted prior to and at the opening of trading of our ordinary shares on the NYSE will not have the benefit of being informed by a published price range or a price at which the underwriters initially sold shares to the public. Moreover, there will be no underwriters assuming risk in connection with the initial resale of our ordinary shares. . . . Given that there will be no underwriters’ option to purchase additional shares or otherwise underwriters in engaging in stabilizing transactions, there could be greater volatility in the public price of our ordinary shares during the period immediately following the listing. . . . The public price of our ordinary shares may be volatile, and could, upon listing on the NYSE, decline significantly and rapidly.304

Although none of the direct listings had an investment bank serving as a conventional underwriter, all of the companies engaged investment banks to act as financial advisors. Based on the Commission’s no-action letter guidance, financial advisors in a direct listing may be engaged to provide advice and assistance to the company in filing its registration statement and listing its shares, including to help value the company’s securities and advise the designated market maker in setting an opening price or price range. However, financial advisors may not further assist the company by planning or actively participating in investor meetings. Nor may financial advisors engage in stabilizing transactions or special selling efforts, as do underwriters in a traditional IPO.305 While financial advisors may not permissibly market securities in a direct listing, as do underwriters in traditional IPOs, they often serve as market makers in the security and provide analyst coverage.

It is difficult to understand the use of multiple high profile investment banks as financial advisors, with financial advisor groups as numerous as thirteen in direct listings.306 In off-the-record interviews we conducted, proponents of direct listings were adamant that financial advisors in direct listings do not engage in sales activity either by reaching out to institutional investors or attending meetings with investors. They argued that multiple financial advisors ensure there will be continued analyst coverage of an issuer after a direct listing, a means to protect against abrupt stock price declines. Analyst coverage only can occur if a financial advisor also serves as a market maker.

Spotify set the pace for investment banker participation in direct listings by hiring Goldman Sachs, Morgan Stanley, and Allen & Co. as financial advisors.307 Subsequent direct listings usually involved leading investment banks as financial advisors.308

To compensate for the lack of a roadshow combining executive and underwriter presentations, each of the direct listings held an investor day and other investor education meetings for prospective investors,309 conducted by senior management.

With one limited exception, none of the direct listings had lock-up arrangements.310 These arrangements prevent existing shareholders selling their unregistered securities, even though these securities may be exempt from registration, and in consequence only registered shares trade immediately after a traditional IPO. In a direct listing, however, the general absence of lock-up arrangements means that registered as well as unregistered shares exempt from registration trade once trading begins, a feature that complicates the application of Section 11.

Purported Advantages

Proponents and others identify several advantages of direct listings.

First, the SEC characterized direct listings as democratizing the market, explaining that “some investors may be able to purchase securities in a Primary Direct Floor Listing who might not otherwise receive an initial allocation in a firm commitment underwritten offering.”311 The equalizing of opportunity for retail investors with major institutions in public offerings is a long-sought goal of the federal securities laws. But, in fact, it is at most a momentary advantage. Democratization only occurs with respect to the initial sale. Once trading of a traditional IPO begins, anyone can buy shares.

Second, the Commission urged that “because the price of securities issued by the company in a Primary Direct Floor Listing will be determined based on market interest and the matching of buy and sell orders,” some believe that Primary Direct Floor Listings may be a more accurate way to price securities offerings.312 For proponents of direct listings, this is a key advantage. Selling shareholders receive the benefits of the market-determined price, which may be higher than the amount underwriters would have agreed to had the offering been a traditional IPO.

It is true that traditional IPOs are sometimes underpriced, giving rise to share pops. But, as previously noted, it is not self-evident that issuers are harmed in these cases.313 It is notable that so few selling shareholder groups have employed a direct listing if market discovery is a large advantage. Again, trading in traditional IPOs and direct listings once a stock is listed and traded on the Exchange is identical. In both cases, the matching of buy and sell orders determines prices.

Third, commentators point to the elimination of underwriting fees as a key advantage of the direct listing. These commentators observe that financial advisors are paid a fixed advisory fee, while underwriters in traditional IPOs receive a “spread” between their purchase price from the issuer and sale of the securities in the market, so it is conceivable that costs of financial advising would be lower than those of underwriting. Indeed, some proponents of direct listings urge that financial advisory fees are as low as fifty percent of underwriting spreads in traditional IPOs.314 It is uncertain whether this claim can be corroborated; it may be greatly exaggerated.

In fact, given the reported cost of financial advisors in direct listings, there does not appear to be as much of an advantage. In a much cited 2015 PricewaterhouseCoopers estimate of the costs of IPOs raising more than $300 million, total expenses would be $44.35 million, with the underwriting fees equal to $37 million or eighty-four percent of total expenses.315 Financial advisor expenses in direct listings are a comparable percentage of registration expenses. Spotify paid $35 million of the $45.7 million it incurred in registration statement expenses, or seventy-seven percent, to financial advisors.316 Slack Technologies paid its financial advisors $22 million of $26.7 million in registration expenses, or eighty-two percent.317 Asana paid $19.9 million to register and list its Class A common stock; $14.5 million, or seventy-three percent, went to financial advisors.318

Proponents of direct listings counter that underwriting fees are often about seven percent of gross proceeds.319 In contrast Spotify’s $35 million in financial advisory fees amounted to just 0.42 percent of the $8.3 billion of shares registered, based on the first day’s closing price.320 But this apparent reduction in fees when foregoing traditional underwriting can be explained in part by the size of the offering, not its method. Large offerings typically involve lower underwriting fees and discounts. When, for example, Facebook registered $16 billion in its 2012 public offering, it negotiated a 1.1 percent fee.321

These lower negotiated rates are hardly surprising. The nonmarketing costs of a registered offering essentially are fixed. There will be SEC registration fees, listing fees, printing costs, auditor fees, legal fees and expenses, transfer agent and registrar fees, and other miscellaneous fees in any event. The corporate board and specified officers and experts who certify parts of the registration statement must conduct due diligence whether the offering is a traditional IPO or direct listing.322 One major law firm characterized the absence of underwriters’ fees as a savings “[t]h[at] may marginally decrease a company’s cost of capital, although the company will still incur significant fees to market makers or specialists, independent valuation agents, auditors and legal counsel.”323

Another cost advantage of direct listings comes from dispensing with roadshows. Instead, direct listings use streamlined investor days and investor education, which do cost less than a traditional roadshow. But, compared to the overall magnitude of the direct listings, this cost savings is small.

A fourth and final purported advantage is greater flexibility in the issuing corporation’s ability to provide guidance to investors in Selling Shareholder Direct Listings. The registration statement in such transactions is effective one or two weeks before trading begins. By the time trading occurs, corporations are eligible to make forecasts under Section 27A(b) of the Securities Act, which does not provide a safe harbor for a traditional IPO. When trading begins, the issuer will have an earnings call which can include forecasts for the next quarter or year. Underwriters in a traditional IPO almost invariably prevent forecasts in a registration statement as one means to reduce their Section 11 liability risk.

Threats to Investor Protection

Whatever their purported advantages, direct listings render the application of Section 11 of the Securities Act uncertain and thereby weaken investor protection. Investment banks have diminished incentives for due diligence because they may not be underwriters under Section 11. Other transaction participants share in these diminished incentives, because plaintiffs may lack standing under Section 11. This is a risk in direct listings because, once trading begins, existing shareholders may sell either registered shares or unregistered shares exempt from registration.

We assess underwriter liability in more detail in Part E. For now, we note that to date, direct listings have been subject to limited judicial review. In Pirani v. Slack, the first case to address Section 11 in a direct listing, plaintiffs were held to have standing to sue to establish Section 11 liability.324 There has been no judgment on the merits.

In the Ninth Circuit decision in Pirani325 the panel majority addressed a plaintiff who appeared incapable of tracing his unregistered shares in a direct listing. The Ninth Circuit nonetheless held that the unregistered shares were characterized as “‘such securities’ [under] Section 11[(a)] because their public sale cannot occur without the only operative registration in existence.”326 Judge Miller dissented,327 writing that the majority decision contradicted Judge Friendly’s decision in Barnes v. Osofsky,328 which had limited tracing under Section 11 to a “narrow” reading, interpreting “acquiring such security” to mean “acquiring a security pursuant to the registration statement.”329 Liability in Friendly’s construct in Barnes was limited to purchasers of a registered offering or “purchasers who can trace the lineage of their shares to the new offering.”330 The burden of demonstrating tracing is on the plaintiffs.331 Miller emphasized, “Until today, every court of appeals to consider the issue, including ours, has done the same.”332

Pirani in any event does not effectively address investment banks serving as underwriters or providing gatekeeping and due diligence. Pirani does not require that there be an underwriter. A basic purpose of the Securities Act of 1933 was to create a gatekeeping system to provide an outside check on insiders.333 Holding that insiders can be held liable does not ensure the robust due diligence envisioned under the Securities Act.

Assessment and Proposals

For the foreseeable future, use of direct listings will be limited to selling shareholders in a small number of companies able to overcome the relative weakness of a direct listing in marketing the company’s securities. With a few exceptions, only companies with a well-known sponsor such as Peter Thiel of Palantir and Facebook fame334 have undertaken direct listings, advised by top tier investment banks and top tier legal counsel.

Nevertheless, direct listings, like SPAC mergers, promise to weaken Section 11 liability for IPO-equivalent transactions, where the justification for underwriter liability has had its strongest force. Whether the courts will consider a financial advisor in a direct listing to be a statutory underwriter under Section 2(a)(11) of the Securities Act is uncertain. This provision reaches an investment bank in a traditional IPO “who has purchased from an issuer with a view to, or offers or sells for an issuer in connection with, the distribution of any security” as well as any person who “participates or has a participation in the direct or indirect underwriting of any such undertaking.”335 This means that, “[n]o distinction is made between professional investment bankers and amateurs. Any person who performs one of the specified functions in relation to the offering is a statutory underwriter even though he or she is not a broker or dealer.” 336 As such, it is possible that a financial advisor in a direct listing would be characterized as an underwriter. Indeed, in the much-cited case SEC v. Chinese Consol. Benevolent Ass’n, Inc.,337 the court took an expansive view of the underwriter’s role, holding that a benevolent association whose motive was purely patriotic could be held to be a statutory underwriter when it received $600,000 from members of various Chinese communities during World War II for the purpose of acquiring Chinese “Liberty Bonds.” The court did not require the Chinese Consolidated Benevolent Association to operate under a contract or to have received any compensation from China.

Commentators have argued on the basis of Chinese Consolidated and subsequent cases, most notably Harden v. Raffensperger, Hughes & Co.,338 that financial advisors should or could be considered statutory underwriters.339 Nonetheless, no court has directly addressed whether financial advisors are liable as underwriters under Section 11.

Aware of this concern, the SEC’s December 2020 3-2 majority took the position that a “financial advisor to an issuer engaged in a Primary Direct . . . Listing may, depending on the facts and circumstances including the nature and extent of the financial advisor’s activities, be deemed a statutory ‘underwriter’ with respect to the securities offering, with attendant underwriter liabilities.”340 We agree, although we note that financial advisors carefully structure their activities in direct listings to minimize the risk that they may be deemed statutory underwriters. We also agree with the dissenting Commissioners that “it is currently unclear what types of involvement would result in meeting the statutory definition” of an underwriter.341

This uncertainty makes investment banks potentially big beneficiaries of reforms allowing direct listings. Banks attempt to secure gains by participating in a direct listing as financial advisors and avoiding Section 11 liability. They take heart from the registration statement, according to which, “There are no underwriters.”342

Proponents of direct listings nevertheless assert that selling shareholders and investment banks acting as financial advisors undertake “the exact same due diligence process” they do in a traditional IPO, given the risk of Section 11 liability.343 In off-the-record interviews, many advisors repeated this view, insisting that financial advisors have an incentive to perform equivalent due diligence in case they are sued and found to be statutory underwriters.

These claims frame an unanswered empirical question: Are financial advisors in direct listings conducting due diligence equivalent to underwriter due diligence in a traditional IPO? We are skeptical. First, investment banks do face a reduced risk of Section 11 liability in direct listings, diminishing their incentives to perform due diligence to assure the accuracy of corporate disclosures. Second, we doubt that financial advisors face reputational incentives equivalent to those faced by underwriters in traditional IPOs, even taking into account the apparent decline in investment banks’ sensitivity to reputational damage.344 Finally, the diligence taken in direct listings may well vary across transactions and not conform with IPO standards. Indeed, one prominent law firm advises its corporate clients that financial advisors “may want customary diligence” in a direct listing, suggesting that diligence practices vary.345

Other empirical questions about investment banks in direct listings also deserve further analysis. As noted, one company undertaking a direct listing engaged thirteen financial advisors. Why do so if these advisors were not engaged in sales activities or equivalent activities? Many of the functions of a financial advisor, such as an independent valuation or consulting with the Designated Market Maker about the initial price or price range, could be performed by a single financial advisor. Proponents of direct listings argue that investment banks acting as financial advisors may not engage in any sales activity. But they also acknowledge that an advantage of multiple advisors is to help secure greater analyst coverage, which can only occur if the financial advisor becomes a market maker. How much compensation do financial advisors in the initial direct listings receive as market makers? Is this the equivalent of an underwriting spread? Do financial advisors receive compensation other than financial advisory fees?

The SEC, in its approval of the NYSE direct listing rules, made an important policy decision when it rejected the initial NYSE proposal to permit direct listings simply on the basis of a Securities Exchange Act registration under Section 12(b) and the Stock Exchange’s listing requirements. By requiring a Securities Act registration as well, the Commission ensured that at least board members, senior executives, and the outside accountant who expertized parts of the registration statement would be subject to near strict liability under Section 11, provided that tracing can be established. The Commission urged that the higher $100 million market value or $250 million valuation requirements buttressed the greater investor protection extended by Section 11. The Commission could increase the number of new issues eligible to use direct listing by reducing market value and valuation requirements to, or nearer to, the current NYSE $40 million level. At this time, no persuasive justification exists for doing so.

While investment banks may benefit from direct listings, the major winners in the NYSE direct listing rules are selling shareholders, usually corporate insiders and sponsors, who have generally been able to sell their shares without limits from lock-ups. Instant sales could drive prices down by dint of the law of supply and demand, but this does not appear to have been an issue in direct listings thus far.346

The biggest loser in a direct listing is investor protection. Without near-strict Section 11 liability on an underwriter, and without underwriter due diligence, the preparation of the Securities Act registration statement may be conducted by corporate insiders who include existing selling shareholders with an interest in securities sales at the highest price. Financial advisors, meanwhile, have diminished incentives for due diligence.

In determining whether underwriter liability is justified in this setting, it appears that the benefits of Section 11 liability for direct listings are at least as great as those for traditional IPOs. Although direct-listed companies tend to have strong name recognition, experience with direct listings is too brief to clarify whether these firms expose investors to lower risk; our initial assessment is that listed companies are little different from many high-tech companies that have recently pursued traditional IPOs.347 Moreover, the benefits of underwriter liability may be even greater than for traditional IPOs because the absence of lock-ups magnifies insider incentives to overstate the corporation’s prospects and thereby instantly capitalize on overpricing. Furthermore, investment banks may face weaker reputational incentives to verify corporate disclosures as financial advisors than as underwriters, a role in which they are closely associated with transactions. If the costs of underwriter liability are no greater in direct listings than in traditional IPOs, as we have little reason to doubt, the case for underwriter liability in direct listings is as strong as it is for traditional IPOs.

How to address this arguably problematic state of affairs? Professor Horton concluded his article on direct listings with the observation, “Perhaps the most obvious solution is to deem a financial advisor to be an underwriter for purposes of the Securities Act of 1933.”348

There are other ways for the SEC to secure investor protection. Each direct listing could be required to have an underwriter, which could be achieved by statutory amendment or SEC rule. Another, potentially simpler, way to secure investor protection would be for the SEC to secure a stock exchange rule change requiring an underwriter in a direct listing. After all, a direct listing is only possible if the SEC approves an exchange rule, and the SEC can “abrogate, add to, and delete from . . . the rules of a[n]” exchange.349 The Commission’s notice of a proposed rulemaking would also provide the Commission the opportunity to amplify its understanding of direct listings.

Such an exchange rule for direct listings would require a statutory underwriter to perform due diligence and provide an independent review of the material facts. The underwriter would be subject to the same near strict Section 11 liability to which an underwriter in a traditional IPO is subjected. However, unlike a traditional IPO underwriter, the direct listing underwriter would not be required to buy shares in the direct listing or be expected to engage in stabilizing transactions. We anticipate that the underwriter in such a case would be an investment bank similar or identical to the investment banks serving as financial advisors in direct listings. The essence of this proposal would be to require traditional due diligence by imposing potential Section 11 liability.

If the SEC reopens the direct listing NYSE and Nasdaq rules, it could engage in rulemaking on a more fully informed basis, addressing the basic concerns expressed by the two SEC Commissioners who dissented from the 3-2 rule approval vote.350

In July 2022, the Commission instead issued an order to the New York Stock Exchange instituting proceedings to determine whether to approve or disapprove a proposed rule change to modify certain pricing limitations for securities listed on the Exchange in a Primary Direct Floor Listing.351 The Commission’s order explained that the Exchange

has not addressed certain differences between listings that would occur under this proposed rule change and firm commitment underwritten initial public offerings . . . that may affect investor protection, including the lack of a named underwriter [and] challenges to bringing claims under Section 11 of the Securities Act due to the potential assertion of tracing defenses.352

The Commission raised several other points. If the opening price in a direct listing is executed outside of the disclosed price range (a practice the proposed rules would permit), in the absence of a named underwriter “there may not be an adequate assurance that a party who may meet the definition of underwriter will review the information disclosed in the registration statement and take the steps necessary to claim a ‘due diligence’ defense.”353 The Commission noted the absence of greater clarity as to a financial advisor’s status as a statutory underwriter that will occur under the proposed rule, resulting in investors having “no way to know whether financial advisors named as assisting with the direct listing would face Section 11 liability . . . . Less robust due diligence could result in reduced disclosure quality and lead investors to improperly value the securities offered under the proposed rules.”354

The Commission may choose to decline the proposed rule change to the Issuer Price Range as it had in February 2022 to a similar Nasdaq proposal.355

We urge the Commission to go further if it disapproves the New York Stock Exchange proposal on the basis of the concerns it articulated in instituting proceedings to review the Exchange’s proposal. Mere disapproval of this proposed modification of rules concerning Primary Direct Floor Listings does not effectively address the serious questions that the Commission has posed with respect to the lack of a required statutory underwriter, due diligence, and tracing in all direct listings.

Conclusion

In a 2019 Concept Release, the SEC sought “to simplify, harmonize, and improve the exempt offering framework to promote capital formation and expand investment opportunities while maintaining appropriate investor protections.”356 The Commission’s focus, “in light of the increased activity in the exempt markets” was on whether the “offering framework is working effectively to provide access to capital for a variety of issuers, particularly smaller issuers, and access to investment opportunities for a variety of investors while maintaining investor protections.”357 The most important outcome of this review was the dramatic November 2020 expansion of several Securities Act exemptions described above.358

In our view the piecemeal nature of this review, emphasizing only exemptions, and the partisan outcome is exactly the wrong way to address the Securities Act in the twenty-first century. We urge the Commission to make a comprehensive review of the Act, systematically focusing on several core issues. Comprehensive reviews of the operation of the Securities Act have been conducted often in the past.359 These studies cast a wide net in an effort to understand the contemporary dynamics of securities offerings as they evolved at the time.

Several issues call out for systematic review.

First is the number of public companies. Several SEC leaders, including SEC Chair Jay Clayton in 2017360 and Commissioner Hester Peirce in November 2021,361 have expressed concern that the number of public companies has declined from more than 7,000 in the 1990s to fewer than 4,000 in 2010. In our view a primary cause of this decline has been the substantial expansion of exemptions for securities trading and the growth of institutional investor trading in the parallel Rule 144A marketplace.362 While the size of the decline alone may seem concerning, a new study should examine additional questions. Importantly, has there been harm to investor protection or capital formation? We have evolved in several steps toward a bifurcated securities market, dividing securities offerings into a registered category and an exempt category largely for the benefit of institutional investors. Is this as it should be, given the ability of institutions “to fend for themselves”?363 Or do the less detailed disclosures in private securities markets and lesser liability exposure of issuers unduly cause investor protection risks? Answering this type of question requires an assessment of the greater speed of some exempt processes and the risk of fraud in these processes.364

A second issue is the effects of technology. The mechanics of complying with the Securities Act were last systematically reviewed in the 2005 Securities Offering Reform initiative. Much has changed since, such as the increased role of social media and computer technology in securities trading. Do concepts such as waiting periods or gun-jumping—that is, prohibition of premature disclosures—continue to make sense? We appear to have reached a time when a thorough revision of the public and private securities offering processes is in order. This would involve ending or modifying protections adopted at a time of more primitive communications and would entail a review of whether disclosure requirements should be based on real time disclosure and mark-to-market valuation concepts that are now feasible.365

Third, as we have stressed in this Article, we believe the dramatic expansion of exemptions from the Securities Act and development of alternative means of complying with the Act deserve serious review.366 Why do we have so many exemptions? Can the November 2020 expansion of exemptions be justified? In particular, the ability to comply with the private placement Regulation D was dramatically increased by expansion of Rule 501(a) and by raising dollar magnitudes of several exemptions.367 Are the criteria for compliance with exemptions appropriately drawn given fraud risk?

Fourth, new registered securities offering techniques, most notably SPAC mergers and direct listings, should be reviewed against the backdrop of the comprehensive review we propose. Is underwriter liability justified in these settings, based on a comparison of its benefits and accompanying costs? Before the Commission permits new techniques for public offerings that weaken longstanding safeguards, it must do more than assert the adequacy of existing protections.368

The most difficult question if a systematic review is undertaken and the need for different standards is found will involve how to implement desired change. The Commission may seek legislative amendments, but this may prove politically infeasible at least in the short-to-medium term. Another option would be to proceed through rulemaking or modification of securities exchange rules or listing requirements, but in that case the Commission may well find itself tied up in litigation before the new standards can be implemented. These are the standard political considerations for the SEC.369 They should not dissuade the Commission from proceeding if new standards are justified.

  1. [1]. As to firm commitment underwriting, the most prevalent underwriting technique, see 1 Louis Loss, Joel Seligman & Troy Paredes, Securities Regulation 654–90 (6th ed., 2019) [hereinafter 1 Securities Regulation 6th Ed.].

  2. [2]. Reflecting the close relationship between securities offerings and underwriting, “[t]he registration and prospectus provisions of the Securities Act of 1933 can be understood—and their effectiveness evaluated—only on the background of the [underwriting] techniques by which securities are distributed in the United States.” Id. at 647. Federal securities law has contributed to the position of U.S. capital markets internationally as the world’s deepest, most liquid, and arguably most efficient capital markets. See SIFMA, 2022 Capital Markets Factbook, 7–14 (2022) (providing data on the relative position of U.S. capital markets internationally). Securities underwriters nevertheless faces criticism, as to which see Section I.D.

  3. [3]. See Darian M. Ibrahim, The New Exit in Venture Capital, 65 Vand. L. Rev. 1, 1 (2012) (“Initial public offerings ... [are] the gold standard in venture capital success . . . .”); Robert B. Thompson & Donald C. Langevoort, Redrawing the Public-Private Boundaries in Entrepreneurial Capital Raising, 98 Cornell L. Rev. 1573, 1573 (2013) (referring to IPOs as “long the gold standard for capital raising by successful emerging companies” (footnote omitted)).

  4. [4]. See Part I.

  5. [5]. See SPAC Analytics, https://www.spacanalytics.com [https://perma.cc/6BTV-J4JY] (SPAC IPOs accounted for fifty-five percent and sixty-three percent of U.S. IPOs in 2020 and 2021, respectively). The trend has continued in 2022, with SPACs comprising seventy-eight percent of the ninety U.S. IPOs to date. Id.

  6. [6]. White & Case, US De-SPAC & SPAC Data & Stats. Roundup 4 (2021), https://www
    .whitecase.com/sites/default/files/2022-01/us-spac-de-spac-data-statistics-round-up.pdf [https://
    perma.cc/65YP-YJMW]. 2019 saw thirty-nine SPAC mergers valued at $24.4 billion. David A. Curtiss, Market Trends 2020/21: Special Purpose Acquisition Companies (SPACs), Paul | Weiss (Apr. 16, 2021), https://www.paulweiss.com/media/3981062/market-trends-spacs.pdf [https://perma
    .cc/ZKX4-WS5X].

  7. [7]. White & Case, supra note 6.

  8. [8]. See SPAC Analytics, supra note 5 (530 SPACs seeking acquisition targets, as of October 7, 2022).

  9. [9]. See infra notes 102–03.

  10. [10]. See Section II.B.

  11. [11]. Self-Regulatory Organizations, Exchange Act Release No. 34-82627, 118 SEC Docket 3499 (Feb. 2, 2018).

  12. [12]. See Self-Regulatory Organizations, Exchange Act Release No. 34-90768 (Dec. 22, 2020); File No. SR-NYSE-2019-67, https://www.sec.gov/rules/other/2020/34-90768.pdf [https://perma
    .cc/7U3D-MGQ4].

  13. [13]. Exchange Act Release No. 34-87648, File No. SR-NASDAQ-2019-059 (Dec. 3, 2019), https://www.sec.gov/rules/sro/nasdaq/2019/34-87648.pdf [https://perma.cc/23PU-KMUF] (selling shareholder direct listings); Exchange Act Release No. 34-91947, File No. SR-NASDAQ-2020-057 (May 19, 2021), https://www.sec.gov/rules/sro/nasdaq/2021/34-91947.pdf [https://
    perma.cc/QUH2-EPX4] (primary offerings).

  14. [14]. Testimony, Gary Gensler, Chair, Securities and Exchange Commission, Testimony Before the Subcommittee on Financial Services and General Government, U.S. House Appropriations Committee (May 26, 2021), https://www.sec.gov/news/testimony/gensler-2021-05-26 [https://
    perma.cc/5FP5-NWM4].

  15. [15]. The Investor Protection, Entrepreneurship, and Capital Markets Subcommittee of the U.S. House Committee on Financial Services held hearings on “Going Public: SPACs, Direct Listings, Public Offerings, and the Need for Investor Protections,” on May 24, 2021. Proposed legislation would amend the Securities Act of 1933 and Securities Exchange Act of 1934. See Discussion Draft, 117th Cong. 1 (2021), https://financialservices.house.gov/uploadedfiles/
    5.24_bills-117pih-hr____.pdf [https://perma.cc/GX4U-65GZ].

  16. [16]. On March 29, 2022, the SEC proposed rules intended to enhance investor protections in SPAC IPOs and mergers. Special Purpose Acquisition Companies, Shell Companies, and Projections, Exchange Act Release No. 33-11048, File No. S7-13-22 (Mar. 30, 2022), https://www
    .sec.gov/rules/proposed/2022/33-11048.pdf [https://perma.cc/KUS7-E6ND]; Exchange Act Release No. 34-94546, File No. S7-13-22 (Mar. 30, 2022), https://www.sec.gov/rules/proposed
    /2022/33-11048.pdf [https://perma.cc/KUS7-E6ND] [hereinafter, SEC SPAC Release]. Commissioners split 3-1 on the proposal, with Commissioner Hester M. Peirce observing that the proposal “seems designed to stop SPACs in their tracks” and “makes a lot of sweeping interpretations of the law.” Statement, Hester M. Peirce, Comm’r, SEC, Damning and Deeming: Dissenting Statement on Shell Companies, Projections, and SPACs Proposal (Mar. 30, 2022), https://www.sec.gov/news/statement/peirce-statement-spac-proposal-033022 [https://perma.cc
    /EF7U-9VTG].

  17. [17]. See Statement, Allison Herren Lee & Caroline A. Crenshaw, Comm’rs, SEC, Statement on Primary Direct Listings (Dec. 23, 2020), https://www.sec.gov/news/public-statement/lee-crenshaw-listings-2020-12-23 [https://perma.cc/5FN4-ASZ8].

  18. [18]. Self-Regulatory Organizations, Exchange Act Release No. 34-95312, File No. SR-NYSE-2022-14 (July 18, 2022), https://www.sec.gov/rules/sro/nyse/2022/34-95312.pdf [https://
    perma.cc/X6XX-CCFK]; see also infra notes 346–48 and accompanying text.

  19. [19]. Press Release, SEC, SEC Charges SPAC, Sponsor, Merger Target, and CEOs for Misleading Disclosures Ahead of Proposed Business Combination (July 13, 2021), https://www
    .sec.gov/news/press-release/2021-124 [https://perma.cc/NS7E-NBTA].

  20. [20]. Id. (internal citation marks omitted). For another example, see Press Release, SEC, Post-SPAC Music Streaming Company Reaches $38.8 Million Settlement in Ongoing Fraud Action (Oct. 27, 2021), https://www.sec.gov/news/press-release/2021-216 [https://perma.cc/QQF9-9UQ7] (SEC “settle[s] of charges against .. . a purported music-streaming business . . . for allegedly defrauding investors out of tens of millions of dollars in connection with a 2019 [SPAC merger]”).

  21. [21]. Roger E. Barton, Caution Ahead: SPAC Litigation Trends Provide a Road Map for Directors and Officers, Reuters (Sept. 2, 2021, 11:38 AM), https://www.reuters.com/legal/legalindustry
    /caution-ahead-spac-litigation-trends-provide-road-map-directors-officers-2021-09-02 [https://
    perma.cc/manage/create?folder=34910] (reporting an increase in lawsuits concerning SPACs). For aggregate data on private lawsuits against SPACs and related parties, see Emily Strauss, Suing SPACs, S. Cal. L. Rev. (forthcoming), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=40
    30815# [https://perma.cc/YE2A-5FBD].

  22. [22]. See infra notes 76–77 and accompanying text.

  23. [23]. Id.

  24. [24]. See 15 U.S.C. §§ 77a–77aa (2018). From 1920 to 1933, some $50 billion of securities were sold in the United States. By 1933, half were worthless. In 1934, the American public also held over $8 billion of foreign securities, of which $6 billion had been sold in the years 1923 to 1930. By March 1934, $3 billion were in default. The aggregate value of all stocks listed on the New York Stock Exchange on September 1, 1929, was $89 billion. In 1932, the aggregate figure was $15 billion—a loss of eighty-three percent in two and one-half years. Securities Exchange Act Amendments, Hearings on S. 2408 Before a Subcomm. of the Senate Comm. on Banking & Currency, 81st Cong. 10 (1950); see also Joel Seligman, The Transformation of Wall Street: A History of the Securities and Exchange Commission and Modern Corporate Finance 1–38 (3d ed. 2003); Ralph F. De Bedts, The New Deal’s SEC: The Formative Years 1–29 (1964); Michael E. Parrish, Securities Regulation and the New Deal 42–72 (1970).

  25. [25]. § 77e.

  26. [26]. § 77h(a); see also 1 Securities Regulation 6th Ed., supra note 1, at 753.

  27. [27]. §§ 77e(c), 77f, 77g.

  28. [28]. § 77h(d).

  29. [29]. § 77j. As to the content of the registration statement and prospectus, see 2 Louis Loss, Joel Seligman & Troy Paredes, Securities Regulation Chapter 2.D. (6th ed., 2019) [hereinafter 2 Securities Regulation 6th Ed.]. For historical context, see Joel Seligman, Misalignment: The New Financial Order and the Failure of Financial Regulation 328–44 (2020).

  30. [30]. See, e.g., Seligman, The Transformation of Wall Street, supra note 24, at 42–49; John C. Coffee, Jr., Market Failure and the Economic Case for a Mandatory Disclosure System, 70 Va. L. Rev. 717, 722, 739–43 (1984) (“A particular flaw in th[e] theory [of voluntary disclosure] is that it overlooks the significance of corporate control transactions and assumes much too facilely that manager and shareholder interests can be perfectly aligned.”). See generally Joel Seligman, The Historical Need for a Mandatory Corporate Disclosure System, 9 J. Corp. L. 1, 9 (1983).

  31. [31]. §§ 77k(a), 77f(a). Section 11 has been strictly enforced. See, e.g., Escott v. BarChris Const. Corp., 283 F. Supp. 643, 696–97 (S.D.N.Y. 1968); In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d 628, 677–96 (S.D.N.Y. 2004), and reaches both direct purchasers of a registered offering and those who repurchase shares and can “trace” their shares back to a misrepresentation or omission in a registered offering. Barnes v. Osofsky, 373 F.2d 269, 271 (2d Cir. 1967); Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1080 n.4 (9th Cir. 1999).

  32. [32]. See, e.g., John C. Coffee, Jr., Gatekeepers: The Role of the Professions and Corporate Governance 353 (“The underwriter’s obligation to ensure full disclosure in this context is enforced by Section 11 of the Securities Act of 1933 ... .”).

  33. [33]. § 77k(a)(4).

  34. [34]. § 77k(f).

  35. [35]. § 77o(a).

  36. [36]. § 77k(a).

  37. [37]. § 11(e), § 77k(e). The issuer’s liability is absolute with one exception: The issuer has the improbable defense available to all defendants of showing that the plaintiff knew of the untruth or omission at the time of her or his acquisition of the security. § 77k(a).

  38. [38]. 9 Louis Loss, Joel Seligman & Troy Paredes, Securities Regulation 322–73 (5th ed. 2018) [hereinafter 9 Securities Regulation 5th ed.]. Regarding § 11, see generally id. at Ch. 11.C.d; John C. Coffee, Jr., Hillary A. Sale & Charles K. Whitehead, Securities Regulation: Cases and Materials 919–22, 962–76, 980–82, 992–95 (14th ed. 2021).

  39. [39]. 1 Securities Regulation 6th Ed., supra note 1, at 674–76 (discussing the gross spread and its allocation among members of the underwriting syndicate and selling group).

  40. [40]. Id. at 654–90; 9 Securities Regulation 5th ed., supra note 38, at 2–88 (describing price stabilization rules in Regulation M); id. at 322–73 (liability under § 11); Coffee, Sale & Whitehead, supra note 38, at 67–92.

  41. [41]. Reinier H. Kraakman, Corporate Liability Strategies and the Costs of Legal Controls, 93 Yale L.J. 857, 890 (1984) [hereinafter Kraakman, Corporate Liability] (“The first requisite for gatekeeper liability is, of course, an outsider who can influence controlling managers to forgo offenses.”). As to the monitoring function of gatekeepers, see id. at 891; Reinier H. Kraakman, Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy, 2 J.L. Econ. & Org. 53, 62–66 (1986) [hereinafter Kraakman, Gatekeepers].

  42. [42]. See Ernest L. Folk, III, Civil Liabilities Under the Federal Securities Acts: The BarChris Case, 55 Va. L. Rev. 1, 56 (1969) (“[U]nderwriter[s] [are] uniquely able to adopt an objective or even adverse posture towards the issuer regarding the accuracy of the registration statement.” (footnote omitted)); In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d. 628, 662 (S.D.N.Y. 2004) (“[U]nderwriters[’] ... unique position ... enabled them to discover and compel disclosure of essential facts about the offering.” (quoting The Regulation of Securities Offerings, Securities Act Release No. 7606A, 63 Fed. Reg. 67174, 67230 (Dec. 4, 1998)).

  43. [43]. Ronald J. Gilson & Reinier H. Kraakman, The Mechanisms of Market Efficiency, 70 Va. L. Rev. 549, 620 (1984) (“The investment banker represents to the market (to whom it, and not the issuer, sells the security) that it has evaluated the issuer’s product and good faith and that it is prepared to stake its reputation on the value of the innovation.”) [hereinafter Gilson & Kraakman, Market Efficiency].

  44. [44]. As to the “lemons problem,” see George A. Akerlof, The Market for “Lemons”: Quality Uncertainty and the Market Mechanism, 84 Q.J. Econ. 488, 489–90 (1970).

  45. [45]. See Andrew F. Tuch, Multiple Gatekeepers, 96 Va. L. Rev. 1583, 1636–41, 1645–48 (2010) [hereinafter Tuch, Multiple Gatekeepers].

  46. [46]. In re WorldCom, Inc. Sec. Litig., 346 F. Supp. 2d at 662.

  47. [47]. Underwriters also face potential liability for expertised portions of registration statements, subject to a more generous defense that omits a requirement for a “reasonable investigation.” 15 U.S.C. §77k(b)(3)(C).

  48. [48]. Lawyers are not an enumerated category of defendant in Section 11. With limited exceptions, nor do they typically consent to being named as having prepared or certified any part of the registration statement. See §77k(a).

  49. [49]. For example, in determining whether the due diligence defense is established, underwriters’ “receipt of [a] comfort letter[] will be important evidence,” although by itself it is insufficient to establish the defense. See In re Worldcom, Inc. Sec. Litig., 346 F. Supp. 2d at 683–84.

  50. [50]. See James D. Cox, Robert W. Hillman & Donald C. Langevoort, Securities Regulation: Cases and Materials 121–22 (9th ed. 2020).

  51. [51]. See Tuch, Multiple Gatekeepers, supra note 45, at 1640.

  52. [52]. See Cox et al., supra note 50, at 122.

  53. [53]. Chris-Craft Indus., Inc. v. Piper Aircraft Corp., 480 F.2d 341, 370 (2d Cir.1973) (“No greater reliance in our self-regulatory system is placed on any single participant in the issuance of securities than upon the underwriter.”).

  54. [54]. See 2 Louis Loss, Joel Seligman & Troy Paredes, Fundamentals of Securities Regulation 1837 (6th ed., 2011) (referring to the “common practice” of issuers generally indemnifying underwriters other than “with respect to any information furnished by the underwriters expressly for the registration statement”).

  55. [55]. 1 Edward F. Greene et al., U.S. Regulation of the International Securities and Derivatives Markets § 11.03(1)(e)(i) (11th & 12th eds. 2014–17), https://www.clearygottlieb
    .com/-/media/files/isdm-12th-edition/15-chapter-11-pdf.pdf [https://perma.cc/S759-6XD7].

  56. [56]. See discussion supra note 24.

  57. [57]. Most significantly the Stock Exchange Practices Hearings of 1932–1934 described in Seligman, supra note 24, at 1–38, made key findings.

  58. [58]. See, e.g., Seligman, supra note 24, at 42–49 (examining justifications in the 1930s). See also generally Seligman, supra note 30 (documenting before the 1964 Securities Act amendments the extent to which over-the-counter securities not subject to the full disclosure requirements of those registered on the stock exchanges had greater levels of fraud and the extent to which through that date when SEC enforcement had waned, as it had notably in the late 1950s, fraud returned).

  59. [59]. Market incentives include reputational constraints and the ability of investors—the direct victims of misconduct—to contract to guard their interests. See Kraakman, Gatekeepers, supra note 41, at 93–100.

  60. [60]. See Kraakman, Corporate Liability, supra note 41, at 868 (“[Gatekeeper liability] serves to remedy enforcement insufficiencies ... .”); id. at 888 (“Enforcement insufficiency occurs when both enterprise and individual penalties fail to elicit sufficient compliance at an acceptable cost.”).

  61. [61]. See Merritt B. Fox, Shelf Registration, Integrated Disclosure and Underwriter Due Diligence: An Economic Analysis, 70 Va. L. Rev. 1005, 1032–33 (1984) (assessing the desirability of gatekeeper liability based on its costs and benefits). As to limits of gatekeeper liability, see Stavros Gadinis & Colby Mangels, Collaborative Gatekeepers, 73 Wash. & Lee L. Rev. 797, 812–23 (2016); Andrew F. Tuch, The Limits of Gatekeeper Liability, 73 Wash. & Lee L. Rev. Online 619, 627–38 (2017).

  62. [62]. See Seligman, supra note 24, at 71–78 (Wall Street, including investment banks, opposed civil liability provisions of the Securities Act); Kraakman, Gatekeepers, supra note 41, at 99–100.

  63. [63]. Gilson & Kraakman, Market Efficiency, supra note 43, at 618–21.

  64. [64]. See Howell E. Jackson, Reflections on Kaye, Scholer: Enlisting Lawyers to Improve the Regulation of Financial Institutions, 66 S. Cal. L. Rev. 1019, 1047–48 (1993) (explaining that gatekeeper liability “makes sense when” a corporation “becomes insolvent or otherwise judgment-proof before [its] wrongdoing comes to light”).

  65. [65]. Gilson & Kraakman, Market Efficiency, supra note 43, at 595 (“[O]riginator[s] [of information] will have an incentive to act opportunistically by misrepresenting the accuracy, and therefore the value, of the information.”).

  66. [66]. Indeed, under-deterrence is a concern for all market actors during boom times when the deterrent effect of liability can deteriorate. As Erik Gerding explains, “booms provide immediate benefits yet delay legal liability and other costs for breaking the law”; may lead transaction participants to “systematically underestimate the legal and other consequences to violating the law”; and “often coincide with broader social shifts in which norms of legal compliance and the perceived legitimacy of law erodes.” Erik F. Gerding, Law, Bubbles, and Financial Regulation 10 (2014); see also id. at 196–222.

  67. [67]. See Kraakman, Gatekeepers, supra note 41, at 93–99.

  68. [68]. As this analysis suggests, the case for “gatekeeper liability, by its nature, hinges on the satisfaction of numerous complex conditions that cannot be established—easily, or at all—at least to the satisfaction of those inclined to oppose new liability regimes.” Tuch, supra note 61, at 622. Although we regard underwriter liability as justified in the traditional IPO setting, our primary claim concerns the relative strength of the justifications for Section 11 underwriter liability in the traditional IPO and SPAC merger settings, that is, that the case for underwriter liability is stronger in the latter setting than it is in the former. See Section II.D.2.

  69. [69]. See Tuch, Multiple Gatekeepers, supra note 45, at 1613–14.

  70. [70]. For a more detailed analysis, see Kraakman, Gatekeepers, supra note 41, at 95–96.

  71. [71]. See Alan D. Morrison, Aaron Thegeya, Carola Schenone & William J. Wilhelm, Jr., Investment-Banking Relationships: 1933–2007, at 30–36 (Saïd Bus. Sch., Working Paper No. 2014-1, 2017), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2376481 [https://perma.cc/UP
    P6-5TKV] (presenting evidence on the weakening role of investment banking reputations in constraining conflicts of interest and other misconduct); Jonathan R. Macey, The Death of Corporate Reputation: How Integrity Has Been Destroyed on Wall Street 49 (2013) (“[T]he traditional model of reputation, that predicts that investment banks ... will put their customers’ interest ahead of their own and avoid conflicts of interest, no longer has much, if any, explanatory force.”).

  72. [72]. See infra notes 165–70 and accompanying text.

  73. [73]. See Aswath Damodaran, Disrupting the Disruptors? The “Going Public Process” in Transition 7 (2021), https://ssrn.com/abstract=3892419 [https://perma.cc/QHA4-NSPB] (between 1980 and 1990, eighty percent of firms undertaking IPOs were profitable; the corresponding figure was twenty percent between 2016 and 2020). As to the rising appetite of investors for companies subject to uncertainty in IPOs, see James J. Park, Investor Protection in an Age of Entrepreneurship, Harv. Bus. L. Rev. (forthcoming), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3911
    454 [https://perma.cc/E5FA-2X22].

  74. [74]. See Seligman, supra note 24, at 77 (quoting Arthur Dean, The Federal Securities Act: I, Fortune, Aug. 1933 at 104, 106 (criticizing the liability provisions of the 1933 Act as being so severe that they “would render financing exceedingly difficult”)).

  75. [75]. Seligman, supra note 24, at 114.

  76. [76]. Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, Exchange Act Release No. 33-10763, File No. S7-05-20 8 nn.12–14 (Mar. 4, 2020), https://www.sec.gov/rules/proposed/2020/33-10763.pdf [https://
    perma.cc/VKU9-RXZ9].

  77. [77]. 9 Securities Regulation 5th ed., supra note 38, at 322 n.135 (“The 30,000 registration statements filed during the first 35 years of the SEC’s history resulted in two adjudicated recoveries and six reported decisions approving settlements of class actions.”).

  78. [78]. Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, Exchange Act Release No. 33-10763, File No. S7-05-20 nn.12–14. (Mar. 4, 2020), https://www.sec.gov/rules/proposed/2020/33-10763.pdf [https://perma.cc/VKU9-RXZ9] (proposal); Exchange Act Release No. 33-10884, File No. S7-05-20 (Nov. 2, 2020), https://www.sec.gov/rules/final/2020/33-10884.pdf [https://perma.cc/QH5W-73PW] (adopted):

    Since the mid 2000s, so-called unicorns, private companies with $1 billion or more in value, have dramatically increased. Professor de Fontenay reported that by 2015, 103 private companies had valuations exceeding $1 billion. Elisabeth de Fontenay, The Deregulation of Private Capital and the Decline of the Public Company, 68 Hastings L.J. 445, 495 (2017).

  79. [79]. See data in 3 Louis Loss, Joel Seligman & Troy Paredes, Securities Regulation 359 (6th ed., 2020) [hereinafter 3 Securities Regulation 6th Ed.] (quoting 1988 Rule 144A Proposal Release, Sec. Act Rel. 6806, 42 SEC Dock. 76, 77 (1988)).

  80. [80]. See generally George S. Georgiev, The Breakdown of the Public-Private Divide in Securities Law: Causes, Consequences, and Reforms, 18 N.Y.U. J.L. & Bus. 221 (2021) (characterizing the rapid growth of unicorns as one reason for the breakdown of the public-private divide in Federal securities laws).

  81. [81]. See, e.g., 1 Securities Regulation 6th Ed., supra note 1, at 682–703.

  82. [82]. Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, 86 Fed. Reg. 3496, 3602 (Jan. 14, 2021) (to be codified at 17 C.F.R. pts. 227, 229, 230, 239, 240, 249, 270, 274).

  83. [83]. 1 Securities Regulation 6th Ed., supra note 1, at 390–93.

  84. [84]. Id. at 274–315.

  85. [85]. See 1 Securities Regulation 6th Ed., supra note 1, at 457–516.

  86. [86]. Accredited Investor Definition, Exchange Act Release No. 33-10824, File No. S7-25-19 (Aug. 26, 2020), https://www.sec.gov/rules/final/2020/33-10824.pdf [https://perma.cc/LD5
    3-CHEN] (adoption).

  87. [87]. Coffee, Sale & Whitehead, supra note 38, at 415.

  88. [88]. Statement, Allison Herren Lee, Comm’r, SEC, Statement on Amendments to the Exempt Offering Framework (Nov. 2, 2020), https://www.sec.gov/news/public-statement/lee-harmonization-2020-11-02 [https://perma.cc/5BKL-FP2Y].

  89. [89]. See e.g., Alexander P. Ljungqvist & William J. Wilhelm Jr., IPO Allocations: Discriminatory or Discretionary, 65 J. Fin. Econ. 167, 169 (2002); Patrick M. Corrigan, The Seller’s Curse and the Underwriter’s Pricing Pivot: A Behavioral Theory of IPO Pricing, 13 Va. L. & Bus. Rev. 335, 363–71 (2019) (reviewing literature on IPO underpricing).

  90. [90]. See, e.g., A.C. Pritchard, Revisiting “Truth in Securities” Revisited: Abolishing IPOs and Harnessing Private Markets in the Public Good, 36 Seattle U. L. Rev. 999, 1013 (2013) (“Underwriters ... reap a substantial gain from IPOs. In economic jargon, these professionals are termed ‘transactions costs.’ Although not intended as a compliment, the term is undoubtedly less tendentious than ‘blood-sucking parasite,’ which is the term that more than one entrepreneur might use, pained by giving away such a substantial slice of their growing business to a mere salesman.” (footnotes omitted)).

  91. [91]. See, e.g., Hsuan-Chi Chen & Jay R. Ritter,The Seven Percent Solution, 55J. Fin. 1105, 1108
    –12, 1130 (2000) (finding that IPO underwriting commissions being clustered at seven percent of deal value may be explained by implicit collusion). See generally John William Hatfield, Scott Duke Kominers, Richard Lowery & Jordan M. Barry, Collusion in Markets with Syndication, 128 J. Pol. Econ. 3779 (2020) (explaining how underwriters of IPOs might sustain collusive pricing in the absence of high market concentration).

  92. [92]. See, e.g., Corrigan, supra note 89, at 396 (contending that banks pursue a two-pronged strategy in underwriting IPOs, profiting when stock is either underpriced or over-priced). See generally Patrick M. Corrigan, Footloose with Green Shoes: Can Underwriters Profit From IPO Underpricing?, 38 Yale J. on Regul. 908 (2021) (theorizing that underwriters may have incentives to use their over-allotment options to profit from IPO mis-pricing).

  93. [93]. See, e.g, Christine Hurt, Moral Hazard and the Initial Public Offering, 26 Cardozo L. Rev. 711, 790 (2005) (concluding, after having examined spinning, flipping, laddering, and price stabilization practices, that “the IPO process is broken ...”); John C. Coffee, Jr., The IPO Investigations: Who’s the Victim? What’s the Harm?, PBS, https://www.pbs.org/wgbh/pages/frontline/shows/dot
    con/crying/coffeeipos.html [https://perma.cc/ZY2X-JJL4] (certain underwriting practices “indicate that something is seriously wrong, or at least dysfunctional, within the IPO market”); Pritchard, supra note 90, at 1013 (“IPOs are bad for companies, bad for insiders, and bad for retail investors. The few parties that do clearly benefit from these deals are the individuals who service them: accountants, lawyers, and underwriters.”).

  94. [94]. Testimony, Scott Kupor, Managing Partner, Andreessen Horowitz, Testimony to Financial Services Committee, U.S. House of Representatives 5 (May 24, 2021), https://financial
    services.house.gov/uploadedfiles/hhrg-117-ba16-wstate-kupors-20210524.pdf [https://perma.cc
    /LU46-LKFW].

  95. [95]. See, e.g., Tim Loughran & Jay R. Ritter, Why Don’t Issuers Get Upset About Leaving Money on the Table in IPOs?, 15 Rev. Fin. Stud. 413, 416 (2015) (underwriters underprice IPOs in expectation of reward from benefited investors); Janet Cooper Alexander, The Lawsuit Avoidance Theory of Why Initial Public Offerings Are Underpriced, 41 UCLA L. Rev. 17, 19 (1993) (explaining the “theory
    ... that IPOs are underpriced as a form of insurance against legal liability”); Ann E. Sherman & Sheridan Titman, Building the IPO Order Book: Underpricing and Participation Limits with Costly Information, 65 J. Fin. Econ. 3, 4–5 (2002) (describing underpricing IPOs as a mechanism for underwriters to recoup the costs of “extract[ing] information from their investors”).

  96. [96]. See, e.g., Connie Loizos, An IPO Expert Bats Back at the Narrative that Traditional IPOs Are for ‘Morons, TechCrunch (Sep. 3, 2020, 1:02 AM), https://techcrunch.com/2020/09/02/its-not-just-airbnb-an-ipo-expert-pushes-back-against-the-spac-frenzy-and-other-new-ways-to-going-p
    ublic [https://perma.cc/XHU8-5JPS] (asserting that issuers often instruct underwriters to underprice their IPOs as a long-term business strategy).

  97. [97]. For example, if a class of investors are uninformed, issuers may need to underprice shares in the initial offering to get those investors to participate in the issue. See generally Kevin Rock, Why New Issues Are Underpriced, 15 J. Fin. Econ. 187 (1986) (discussing the underpricing of initial public offerings). Under another theory, issuers may underprice issues to compensate institutional investors for revealing “indication[] of interest” for use in determining the IPO price. See Lawrence M. Benveniste & Paul A. Spindt, How Investment Bankers Determine the Offer Price and Allocation of New Issues, 24 J. Fin. Econ. 343, 344 (1989).

  98. [98]. See supra notes 56–73 and accompanying text

  99. [99]. See supra note 93 and accompanying text.

  100. [100]. See John C. Coffee, Jr., The Irrepressible Myth That SEC Overregulation Has Chilled IPOs, The CLS Blue Sky Blog (May, 29, 2018), https://clsbluesky.law.columbia.edu/2018/05/29/the-irrepressible-myth-that-sec-overregulation-has-chilled-ipos [https://perma.cc/P7TP-V33D]. As IPOs dwindled, so did the number of publicly listed firms, which reduced by almost half in the past two decades. 1 Securities Regulation 6th Ed., supra note 1, at 741 (“Beginning in about 2000, ... [d]omestic listings have declined by about 50 percent from over 7000 to under 4000.”).

  101. [101]. See Xiaohui Gao, Jay R. Ritter & Zhongyan Zhu, Where Have All the IPOs Gone?, 48 J. Fin. & Quantitative Analysis 1663, 1679–81 (2013); de Fontenay, supra note 78, at 463–65; Paul Rose & Steven Davidoff Solomon, Where Have All the IPOs Gone? The Hard Life of the Small IPO, 6 Harv. Bus. L. Rev. 83, 90–93 (2016).

  102. [102]. Joel Rubinstein, Michael Immordino & John Guzman, Backed by SPACs, IPOs Hit New Heights in 2021, Harv. Law Sch. F. Corp. Governance (March 24, 2022), https://corpgov.law
    .harvard.edu/2022/03/24/backed-by-spacs-ipos-hit-new-heights-in-2021 [https://perma.cc/WK5L
    -RNUW].

  103. [103]. For detailed discussions of other IPO alternatives, see Thompson & Langevoort, supra note 3, at 1588–98; Jeff Schwartz, The Twilight of Equity Liquidity, 34 Cardozo L. Rev. 531, 564
    –69 (2012).

  104. [104]. Paul R. La Monica, Why 2020 Is the Year of the SPACs (And What the Heck Is a SPAC?), WRAL.com (Aug. 6, 2020), https://www.wral.com/why-2020-is-the-year-of-the-spacs-and-what-the-heck-is-a-spac/19222838/?version=amp [https://perma.cc/5BAP-78C9].

  105. [105]. 2020 The Year of the SPAC, Chambers and Partners (2022), https://chambers
    .com/guides/usa/2020-the-year-of-the-spac [https://perma.cc/KGZ3-YVX3]; see also Christopher M. Barlow, C. Michael Chitwood, Howard L. Ellin, P. Michelle Gasaway & Gregg A. Noel, Skadden Discusses “The Year of the SPAC, CLS Blue Sky Blog (Feb. 18, 2021), https://www.skadden.com/-/media/files/publications/2021/02/skadden_discusses_the_year_of_the_spac.pdf [https://perma
    .cc/3FDR-WG2M] (“SPACs have clearly established themselves as legitimate and, in many cases, preferred alternatives to a traditional IPO or M&A transaction for target companies seeking liquidity.”).

  106. [106]. SPACs avoid treatment as blank check companies under Securities Act Rule 419, adopted in response to the Securities Enforcement Remedies and Penny Stock Reform Act of 1990, because they do not issue “penny stock,” as defined in SEC Rule 3a51-1. Rule 419 imposes restrictions on certain offerings by blank check companies, including their use of proceeds. SPACs nevertheless voluntarily tend to comply with many of Rule 419’s restrictions. See William K. Sjostrom, Jr., The Truth About Reverse Mergers, 2 Entrepreneurial Bus. L.J. 743, 757–58 (2008); SEC SPAC Release, supra note 16, at 8–10.

  107. [107]. Listing standards of national securities exchanges also govern as do generally applicable provisions of federal securities law and doctrines under corporate law. See SEC SPAC Release, supra note 16, at 9–10.

  108. [108]. For a detailed study of SPACs’ development and evolution, see Usha Rodrigues & Mike Stegemoller, Exit, Voice, and Reputation: The Evolution of SPACs, 37 Del. J. Corp. L. 849, 871–90 (2013).

  109. [109]. For more detailed descriptions, see Michael Klausner, Michael Ohlrogge & Emily Ruan, A Sober Look at SPACs, 39 Yale J. on Regul. 228, 236­–38 (2022); Minmo Gahng, Jay R. Ritter & Donghang Zhang, SPACs 25, 43 (2022), https://papers.ssrn.com/sol3/papers.cfm?abstract
    _id=3775847 [https://perma.cc/3B9W-DCMF].

  110. [110]. Shareholders may agree to extend the deadline. See Ropes & Gray, Special Purpose Acquisition Companies (SPACs): An Introduction 3, 21, https://www.ropesgray.com/-/med
    ia/Files/Brochures/SPACs-Overview-August-2020.pdf?la=en&hash=FC656560FD9F790B342EB
    8D2FE48A438D7DECAAA [https://perma.cc/XKT4-WV3F]. Extensions have been common. Professors Fagan and Levmore construct a sample of 87 SPACs that undertook IPOs between June 2015 and December 2018 and thereafter merged, finding that thirty-nine (or forty-five percent) of these SPACs obtained extensions, merging more than two years after their IPOs. Frank Fagan & Saul Levmore, SPACs, PIPEs, and Common Investors 19 (Univ. Chi. Coase-Sandor Inst. For L. & Econ. Rsch. Paper No. 954, 2022), https://ssrn.com/abstract=4036767 [https://
    perma.cc/V8HX-SSBM].

  111. [111]. The relevant transaction may be a merger, share exchange, or other similar business combination.

  112. [112]. See Jessica Bai, Angela Ma & Miles Zheng, Segmented Going-Public Markets and the Demand for SPACs 8 (2021), https://ssrn.com/abstract=3746490 [https://perma.cc/YD48-UJYP] (noting that of the 500 SPAC IPOs between 2003 and the third quarter of 2020, ninety had liquidated, 276 had announced or completed an acquisition, and the remainder were still seeking a target).

  113. [113]. Statement, Paul Munter, Acting Chief Accountant, SEC, Financial Reporting and Auditing Considerations of Companies Merging with SPACs (Mar. 31, 2021), https://www.sec.
    gov/news/public-statement/munter-spac-20200331 [https://perma.cc/LV7A-BVGV].

  114. [114]. See Ropes & Gray, supra note 110, at 3.

  115. [115]. See, e.g., Second Corrected Consolidated Amended Complaint for Violations of the Federal Securities Laws at 19–20, In re Alta Mesa Res., Inc., Sec. Litig., No. 19-cv-00957 (S.D. Tex. Apr. 6, 2020) (describing general terms of SPAC transactions).

  116. [116]. These offerings tend to cover SPAC IPO costs, including underwriting fees, giving sponsors more “skin in the game” and reassuring public IPO investors that their funds will not be depleted by IPO expenses. For further discussion, see Ropes & Gray, supra note 110, at 17.

  117. [117]. For a discussion of the terms of SPACs, see id. at 16–17, Klausner et al., supra note 109, at 234–41.

  118. [118]. Shareholders are entitled to their pro rata share of IPO proceeds held in trust, although because limited withdrawals from trust funds are permitted, the redemption amount typically equals the IPO price of $10 per share. See Ramey Layne & Brenda Lenahan, Special Purpose Acquisition Companies: An Introduction, Harv. L. Sch. F. Corp. Governance (July 6, 2018), https://corpgov.law.harvard.edu/2018/07/06/special-purpose-acquisition-companies-an-intr
    oduction [https://perma.cc/8XUR-N4MD].

  119. [119]. See id.

  120. [120]. Although shares and warrants are initially bundled as units, they soon trade separately.

  121. [121]. See What You Need to Know About SPACs – Updated Investor Bulletin, SEC (May 25, 2021), https://www.sec.gov/oiea/investor-alerts-and-bulletins/what-you-need-know-about-spacs-investo
    r-bulletin [https://perma.cc/4KAF-2B2J] (“Once the SPAC has identified an initial business combination opportunity, the shareholders of the SPAC will have the opportunity to redeem their shares and, in many cases, vote on the initial business combination transaction.”).

  122. [122]. See Usha Rodrigues & Michael A. Stegemoller, Redeeming SPACS 34–43 (Univ. of Ga. Sch. of L. Legal Rsch. Paper, Paper No. 2021-09, 2021), https://ssrn.com/abstract=3906196 [https:
    //perma.cc/5RU6-MAVF].

  123. [123]. Moreover, warrants are worthless unless a SPAC merger occurs, giving shareholders incentives to approve. Id. at 30–39.

  124. [124]. See Gahng et al., supra note 109, at 34. For detailed explanations of such apparently contradictory voting behavior, see Mira Ganor, The Case for Non-Binary, Contingent, Shareholder Action, 23 U. Pa. J. Bus. L. 390, 411–14 (2021); Rodrigues & Stegemoller, supra note 122, at 30
    –39.

  125. [125]. If shareholders’ proxies are not solicited, the SPAC will seek shareholder approval via an information statement on Schedule 14C.

  126. [126]. 3 Securities Regulation 6th Ed., supra note 79, at 190–91.

  127. [127]. See What You Need to Know About SPACs – Updated Investor Bulletin, supra note 121. As to the structure, see Pamela Marcogliese, Michael Levitt & Sebastian Fain, 20 Key Considerations for Private Companies Evaluating Whether to Be Acquired by a SPAC, Freshfields (July 27, 2020), https://blog.freshfields.us/post/102gcbg/20-key-considerations-for-private-companies-evaluati
    ng-whether-to-be-acquired-by [https://perma.cc/9UE9-KXDC] (“The most typical structure for domestic SPAC acquisitions involves the SPAC setting up a merger subsidiary which merges with and into the target company so that the target company becomes a wholly-owned subsidiary of the SPAC.”).

  128. [128]. Mean and median redemption rates reported by Klausner et al., are, respectively, fifty-eight percent and seventy-three percent during 2019–2020, twenty-two percent and zero percent during late 2020 and early 2021 when prices were inflated, and fifty-seven percent and sixty-eight percent in late 2021. See Klausner, et al., supra note 109, at 293; Michael Klausner, Michael Ohlrogge & Emily Ruan, A Second Look at SPACs: Is This Time Different?, Harv. L. Sch. F. Corp. Governance (Jan. 24, 2022), https://corpgov.law.harvard.edu/2022/01/24/a-second-look-at-spacs-is-this-time-different/#more-142879 [https://perma.cc/VC62-W4EP].

  129. [129]. See Klausner, et al., supra note 109, at 245 (explaining that seventy percent of SPACs raised additional funds; of these SPACs, eighty-three percent raised funds from investors other than sponsors).

  130. [130]. See William K. Sjostrom, Jr., PIPEs, 2 Entrepreneurial Bus. L. J. 381, 391 (2007).

  131. [131]. Id. at 393–95. In the absence of registration, the PIPE shares would remain “restricted” securities and in practice would be subject to holding periods specified in Rule 144.

  132. [132]. Klausner et al., supra note 109, at 241 (“The SPAC’s IPO simply gets the SPAC established as a public company.”).

  133. [133]. It is the participation of retail investors in SPAC mergers that prompts intense regulatory concern. Other jurisdictions have attempted to limit these investors’ involvement in SPACs, conscious of their vulnerability. For example, Hong Kong bans retail investors from participating in SPAC IPOs and mergers. For a detailed analysis, see generally Umakanth Varottil, Special Purpose Acquisition Companies (SPACs): A Discordant Tale of Two Asian Financial Centres (ECGI Working Paper Series in Law, Working Paper No. 648/2022, 2022), https://papers.ssrn.com
    /sol3/papers.cfm?abstract_id=4119063 [https://perma.cc/UU4H-ELL6] (comparatively evaluating SPAC regulations in Hong Kong and Singapore).

  134. [134]. See Statement, John Coates, Acting Dir.: Div. of Corp. Fin., SEC, IPOs and Liability Risk Under the Securities Laws (Apr. 8, 2021) [hereinafter Coates Public Statement], https://www.sec
    .gov/news/public-statement/spacs-ipos-liability-risk-under-securities-laws [https://perma.cc/P6
    K7-UKWP].

  135. [135]. SPAC mergers may therefore be seen as an example of regulatory arbitrage by “investment switching,” since they are designed “to provide the same economics as heavily regulated or prohibited investment but subject to a much lower regulatory tax.” See Gerding, supra note 66, at 11; see also id. at 235–38. We do not argue for reform based on the existence of regulatory arbitrage, aware that arbitrage may be net positive or negative, depending on the merits of the underlying rules avoided. See Victor Fleischer, Regulatory Arbitrage, 89 Tex. L. Rev. 227, 234–35 (2010).

  136. [136]. John Coates, former acting director of the SEC Division of Corporation Finance, disagrees, contending that “[a]ny simple claim about reduced liability exposure for SPAC participants is overstated at best, and potentially seriously misleading at worst.” Coates, supra note 134 (footnote omitted). Nevertheless, Coates appears to acknowledge the differences in the application of Section 11 by asking whether “current liability provisions give those involved
    ... sufficient incentives to do appropriate due diligence on the target and its disclosures to public investors, especially since SPACs are designed not to include a conventional underwriter at the de-SPAC stage?” Id. He also questions 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.” Id.

  137. [137]. Compare Thompson & Langevoort, supra note 3, at 1590 n.80 (2013) (“In the SPAC transaction, ... The result is less intense ’34 Act disclosure, due diligence, and liability for the deal.”) and James D. Cox, Robert D. Hillman & Donald C. Langevoort, Securities Regulation: Cases and Materials 421 (8th ed. 2017) (“[A] company that goes public through a reverse merger [defined to include SPAC mergers] thereby avoids the lengthy review process of Securities Act registration as well as the threat of Section 11 liability . . . .”), with Quinn Emanuel Urquhart & Sullivan, LLP, Quinn Emanuel Private Equity Litigation Practice Alert: Litigation Risk in the SPAC World 5 (2020), https://www.quinnemanuel.com/the-firm/pub
    lications/litigation-risk-in-the-spac-world [https://perma.cc/UC2K-MJST] (“[I]n some circumstances the SPAC merger requires issuance of shares by the merged company, and thus necessitates a registration statement.”). Though apparently inconsistent, these descriptions may reflect practices existing at the times they were written.

  138. [138]. See Quinn Emanuel Urquhart & Sullivan, LLP, supra note 137, at 5.

  139. [139]. See supra notes 130–31 and accompanying text.

  140. [140]. See supra note 127 and accompanying text. For an example, consider the merger involving Soaring Eagle Acquisition Corp and Ginkgo, on which see Soaring Eagle Acquisition Corp., Registration Statement (Form S-4) (May 14, 2021).

  141. [141]. The exchange of acquirer securities for target securities is considered a sale under Securities Act, § 2(a)(3) and within the scope of the prohibition on offers and sales of securities under Securities Act, § 5.

  142. [142]. Under Rule 506, non-accredited investors must meet certain financial and business sophistication requirements. 17 C.F.R. § 230.506 (2022). For further discussion of privately placed securities as acquisition currency, see also Claire Hill, Brian JM Quinn & Steven Davidoff Solomon, Mergers and Acquisitions: Law, Theory, and Practice 155–61 (2016).

  143. [143]. See, e.g., Silver Run Acquisition Corp. II, Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 (Schedule 14A) (Jan. 19, 2018), https://www.sec.gov/Arch
    ives/edgar/data/0001690769/000119312518014904/d510702ddefm14a.htm [https://perma
    .cc/6YHJ-CVPM] (outlining a business combination—without the use of a registration statement—among SPAC Silver Run Acquisition Corporation II and Alta Mesa Holdings, LP and Kingfisher Midstream, LLC).

  144. [144]. See, e.g., SPAC merger of The Lion Electric Company with Northern Genesis Acquisition Corp., on which see The Lion Electric Co., Registration Statement (Form F-4) (Dec. 31, 2020); SPAC merger of Foley Trasimene Acquisition Corp. II and Paysafe Limited, on which see Paysafe Ltd., Registration Statement (Form F-4) (Feb. 24, 2021); the merger of Taboola and Ion Acquisition Corp., on which see Taboola.com Ltd., Registration Statement (Form F-4) (May 20, 2021).

  145. [145]. The new holding company in fact forms two new subsidiary corporations and merges the SPAC and target into each subsidiary, respectively, with the SPAC and target surviving. SPAC and target shareholders exchange their respective shares for those of the holding company. As an example, consider the merger involving Genius Sports and SPAC dMY Technology Group. See Galileo NewCo Ltd., Registration Statement (Form F-4)(Jan. 15, 2021). For further discussion, see Bruce A. Ericson, Ari M. Berman & Stephen B. Amdur, The SPAC Explosion: Beware the Litigation and Enforcement Risk, Harv. L. Sch. F. Corp. Governance (Jan. 14, 2021), https://corpgov.law
    .harvard.edu/2021/01/14/the-spac-explosion-beware-the-litigation-and-enforcement-risk [https:
    //perma.cc/LF5E-855B].

  146. [146]. In its recently proposed reforms, the Commission observes that in 2020 and 2021, fifty-seven percent (twenty-one out of thirty-seven) and eighty-two percent (212 out of 260) SPAC mergers were registered, respectively. See SEC SPAC Release, supra note 16, at 102 n.212.

  147. [147]. Barnes v. Osofsky, 373 F.2d 269, 271 (2d Cir. 1967).

  148. [148]. Id. at 271–73.

  149. [149]. These individuals would be “acquiring” a registered security under Section 11 as in, for example, Hildes v. Arthur Andersen LLP,734 F.3d 854, 862 (9th Cir. 2013).

  150. [150]. This is true of double dummy and other structures such as those in In re Akazoo S.A. Sec. Litig., No. 20-cv-01900, 2021 WL 4318070, at *2 (E.D.N.Y. Sept. 10, 2021); In re Ability Inc. Sec. Litig., No. 16-cv-03893, 2018 WL 11300488, at *1 (S.D.N.Y. Sept. 17, 2018).

  151. [151]. Matters get more complicated if shareholders have irrevocably agreed to vote their shares in favor of the merger before the registration statement is declared effective, as in APA Excelsior III L.P. v. Premiere Techs., Inc., 476 F.3d 1261, 1264–65 (11th Cir. 2007). In the Eleventh Circuit under these circumstances, the Section 11 presumption of reliance to which the plaintiff is generally entitled may be rebutted. Id. at 1277 (“[T]he Section 11 presumption of reliance does not apply in the limited and narrow situation where sophisticated investors participating in an arms-length corporate merger make a legally binding investment commitment months before the filing of a defective registration statement.”). In contrast, the Ninth Circuit allows a plaintiff to recover under Section 11 “without regard to” whether the plaintiff actually relied on the tainted registration statement. Hildes, 734 F.3d at 856.

  152. [152]. It should be clear that such newly issued stock would not be “mixed in” with any other issuances.

  153. [153]. Major shareholders of a target routinely have management positions in the target and responsibility for providing information disclosed in registration statements, proxy statements, and other materials provided to investors. See, e.g., SEC v. Hurgin, 484 F. Supp. 3d 98, 104–05 (S.D.N.Y. 2020); Akazoo, 2021 WL 4318070, at *1; Momentus, Inc., Exchange Act Release No. 92391, (July 13, 2021), https://www.sec.gov/litigation/admin/2021/33-10955.pdf [https://
    perma.cc/2TGR-2B23].

  154. [154]. Pirani v. Slack Techs., Inc., 13 F.4th 940, 951–52 (9th Cir. 2021) (Miller, J., dissenting).

  155. [155]. For examples of this transactional structure, see Akazoo, 2021 WL 4318070; Ability Inc., 2018 WL 11300488.

  156. [156]. Krim v. PcOrder.com, Inc., 402 F.3d 489, 496 (5th Cir. 2005) (citing Rosenzweig v. Azurix Corp., 332 F.3d 854, 873 (5th Cir. 2003)); see also DeMaria v. Andersen, 318 F.3d 170, 176 (2d Cir. 2003) (“[W]here there has been only one stock offering, any person who acquires the security may sue under § 11, ‘regardless of whether he bought in the initial offering, a week later, or a month after that.’”) (quoting Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1080 (9th Cir. 1999)).

  157. [157]. Scattered cases nevertheless indicate that a plaintiff must be able to trace the ownership history of their shares, even if the company at issue has only ever made one issuance. See Hillary A. Sale, Disappearing Without a Trace: Sections 11 and 12(a)(2) of the 1933 Securities Act, 75 Wash. L. Rev 429, 465–66 (2000).

  158. [158]. See 2 Securities Regulation 6th Ed., supra note 29, at 1469 (interpreting the term underwriter).

  159. [159]. See Securities Act of 1933, 15 U.S.C. § 77(b)(11).

  160. [160]. See infra notes 192–202 and accompanying text.

  161. [161]. M&A advisors advise on the merits of a proposed transaction and alternatives to it; on a transaction’s “timing, structuring, and pricing”; “on the structuring of a sales process”; and on financing issues. See Andrew F. Tuch, Banker Loyalty in Mergers and Acquisitions, 94 Tex. L. Rev. 1079, 1093–94 (2016) (footnotes omitted); Andrew Tuch, Investment Banks as Fiduciaries: Implications for Conflicts of Interest, 29 Melb. U. L. Rev. 478, 489 (2005). When investment banks “arrang[e] a private placement on behalf of the issuer or a person in a control relationship with the issuer,” they are not typically regarded as statutory underwriters either. See 2 Securities Regulation 6th Ed., supra note 29, at 1469–70 (“[E]ven a professional investment banker is not a statutory underwriter ... in arranging a private placement on behalf of the issuer or a person in a control relationship with the issuer.” (footnote omitted)).

  162. [162]. A similar argument has been made in the direct-listings setting, on which see Lee & Crenshaw, supra note 17 (“Sophisticated institutions that advise on primary direct listings may be incented to structure their participation to avoid such [underwriter] status.”).

  163. [163]. Joseph K. Leahy, What Due Diligence Dilemma? Re-Envisioning Underwriters’ Continuous Due Diligence After Worldcom, 30 Cardozo L. Rev. 2001, 2062 n.330 (2009).

  164. [164]. As to these assurances and the potential liability they create for law firms and auditors, see supra notes 50–51.

  165. [165]. Cent. Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164, 185 (1994). Investment banks continue to face such aiding-and-abetting liability in SEC actions, under Section 20(e) of the Securities Exchange Act.

  166. [166]. See, e.g., Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148, 165–66 (2008) (narrowing circumstances in which secondary actors may be liable under Rule 10b-5 for participating in a “scheme” to defraud); Janus Cap. Grp., Inc. v. First Derivative Traders, 564 U.S. 135, 142–44 (2011) (narrowly interpreting the requirement to “make” a statement under Rule 10b-5(b)).

  167. [167]. Accordingly, treatises considering liability arising from defective disclosures in private placements identify corporate insiders, controlling shareholders, and selling shareholders as targets for liability but not placement agents. See, e.g., 1 Greene et al., supra note 55, § 6.05.

  168. [168]. Helfant v. La. & S. Life Ins. Co., 459 F. Supp. 720, 725 (E.D.N.Y. 1978) (dismissing claim that a bank’s fairness opinion was a misrepresentation under Section 10(b) because it did not “alleg[e] that the firm purposefully and intentionally caused a false statement to be issued or that the financial data upon which the firm based its opinion was false or omitted from the proxy statement” (citing Santa Fe Indus., Inc. v. Green, 430 U.S. 462 (1977))); see also Robert J. Giuffra, Jr., Note, Investment Bankers’ Fairness Opinions in Corporate Control Transactions, 96 Yale L.J. 119, 129 (1986) (“Plaintiff shareholders rarely, if ever, can prove that ... investment bankers acted with scienter.” (footnote omitted)); Charles M. Elson, Fairness Opinions: Are They Fair or Should We Care?, 53 Ohio State L.J. 951, 974–75 (1992) (“Given ... the firmly rooted scienter requirement ... it does not appear likely that shareholders angered by a misformed fairness opinion will find any solace through an action under the federal securities laws.”).

  169. [169]. See In re McKesson HBOC, Inc. Sec. Litig., 126 F. Supp. 2d 1248, 1265–66 (N.D. Cal. 2000) (dismissing a plaintiff’s Section 14(a) claim against an investment bank for failure to “plead[] with particularity why the fairness opinion was knowingly false” (footnote omitted)); In re Reliance Secs. Litig., 135 F. Supp. 2d 480, 515–16 (D. Del. 2001) (granting summary judgment for defendant investment banks on Section 14(a) claims because “no reasonable juror could find that [their] statements were subjectively false”); In re AOL Time Warner, Inc. Sec. & “ERISA” Litig., 381 F. Supp. 2d 192, 243–44 (S.D.N.Y. 2004) (finding an investment bank’s fairness opinion objectively false, but dismissing the plaintiff’s Section 14(a) claim because the investment bank did not subjectively believe the fairness opinion was false); Washtenaw Cnty. Emps. Ret. Sys. v. Wells Real Est. Inv. Tr., Inc., No. 07-cv-862, 2008 WL 2302679, at *8 (N.D. Ga. Mar. 31, 2008) (dismissing a plaintiff’s Section14(a) claim against an investment bank for failure to allege subjective falsity). As a practical matter, establishing investment bank liability for false opinions is difficult. Steven M. Davidoff, Fairness Opinions, 55 Am. U. L. Rev. 1557, 1567 n.36 (2006).

  170. [170]. Liability may be assessed when an actor is found to have aided and abetted a fiduciary breach by directors, but that actor must “knowing[ly] participat[e] in th[e] breach.” See Andrew F. Tuch, M&A Advisor Misconduct: A Wrong Without a Remedy?, 45 Del. J. Corp. L. 177, 199 (2021) (footnote omitted). Egregious facts tend to be required. Id. Investment banks acting as financial advisors face greater risk if they do not serve as independent third party advisors. See In re Multiplan Corp. S’holders Litig., 268 A.3d 784, 813–15 (Del. Ch. 2022). Placement agents, as broker-dealers, must conduct a suitability analysis for PIPE offerings, an obligation falling short of requiring a sustained investigation that would satisfy the Section 11 due diligence defense. See Rule 2310. Direct Participation Programs, Fin. Indus. Reg. Auth. (Sept. 16, 2020), https://www.finra.org/rules-guidance/rulebooks/finra-rules/2310 [https://perma.cc/UA5S-RH3T]. FINRA has rarely enforced rules against investment banks when those harmed are large, sophisticated investors (as they tend to be in PIPE offerings). See Andrew F. Tuch, The Self-Regulation of Investment Bankers, 83 Geo. Wash. L. Rev. 101, 108–10, 159–61 (2014).

    Recent litigation involving SPAC mergers raises doubts about the deterrent effect of merger litigation. Although SPAC mergers with low redemption rates would seem to be qualitatively stronger deals, they have been more likely to attract lawsuits, a puzzling result since low redemptions signal investor confidence in a deal. Strauss, supra note 21 (examining competing explanations for this puzzling evidence and concluding that pre-closing SPAC merger cases appear unmeritorious).

  171. [171]. Lou R. Kling, Eileen T. Nugent & Brandon A. Van Dyke, Negotiated Acquisitions of Companies, Subsidiaries and Divisions § 8.02 (1992) (“The Buyer’s public accountants together with the Buyer’s management (again with input from its investment bankers) should carefully analyze the Company’s financial statements and other financial data.”). See also generally Jeffrey M. Weiner, Due Diligence in M&A Transactions: A Conceptual Framework (2010) (identifying key players in due diligence teams in M&A without mentioning investment banks).

  172. [172]. Gores Holding IV, Inc., Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 (Schedule 14A), at 151–56 (Sept. 22, 2022), https://www.sec.gov/Arch
    ives/edgar/data/1783398/000119312520262465/d36177dprem14a.htm#rom36177_47 [https://
    perma.cc/FK29-FFAP]. See the fairness opinion provided by Moelis & Company LLC in the merger of SPAC Gore Holdings IV, Inc. with United Shore Financial Services, LLC for more. Id. at Annex H.

  173. [173]. Interview with Legal Advisor (June 22, 2021) (notes on file with authors). We interviewed law firm partners with experience advising on SPAC mergers and/or direct listings. We undertook not to attribute comments to interview participants by name. Some participants expressed no views on certain questions. Some chose not to be identified. Some of the individuals identified in this article did not participate in interviews but instead provided background information.

  174. [174]. Stephen M. Bainbridge & Iman Anabtawi, Mergers and Acquisitions: A Transactional Perspective 256 (2017) (“M&A due diligence may be either more or less extensive than the due diligence conducted by potential § 11 defendants, depending on the particular goals of the parties to the transaction.”); Kling et al., supra note 171, at § 8.02 (“[I]n many circumstances a [due diligence] review in the context of an acquisition must go further [than a review in the public offering area] if the Buyer is to be placed in a position to make a reasonable judgment about the achievability of its plans for, and prospects of, the Company.”).

  175. [175]. As to mergers generally, see Sean J. Griffith, Deal Insurance: Representation and Warranty Insurance in Mergers and Acquisitions, 104 Minn. L. Rev. 1839, 1915 (2020); Weiner, supra note 171, at 18 (explaining that in auctions, “adequate time [for due diligence] may simply be unavailable”).

  176. [176]. See Klausner et al., supra note 109, at 240 (PIPE investors enjoyed discounts of ten percent or more in one-third of all forty-seven SPACs that merged between January 2019 and June 2020 in the study).

  177. [177]. See Anna T. Pinedo, Brian D. Hirshberg & Ryan Castillo, Top 10 Practice Tips: PIPE Transactions by SPACs 3 (2020), https://www.mayerbrown.com/-/media/files/perspectives-events/publications/2020/10/top-10-practice-tips-pipe-transactions-by-spacs.pdf [https://perma
    .cc/22RQ-CVGP]; Baker McKenzie, Global PIPE Guide: Your Questions Answered 2 (2020), https://www.bakermckenzie.com/-/media/files/insight/publications/2020/06/global-private-investment-in-public-equity-guide-050620.pdf [https://perma.cc/DG5J-C2KQ].

  178. [178]. Sjostrom, supra note 130, at 409–10 (“[A] hedge fund generally does not face potential liability under Section 11 when investing in a PIPE deal nor is its investment in a deal viewed as an implicit certification of the issuer. Hence, it can get away with performing minimal due diligence.”).

  179. [179]. Bob Zider, How Venture Capital Works, Harv. Bus. Rev. (1998), https://hbr.org/1998
    /11/how-venture-capital-works [https://perma.cc/TDU9-TNUA] (explaining that under this approach used by VC firms “more than half the companies will at best return only the original investment and at worst be total losses” while “only 10% to 20% of the companies funded need to be real winners to achieve the targeted return rate”).

  180. [180]. Sophisticated investors, keen to avoid embarrassment, are reluctant to reveal when they are victims of securities fraud. Matt Levine, You Never Want to Be Suckered This Badly, Bloomberg (May 17, 2018, 5:00 PM), https://www.bloomberg.com/opinion/articles/2018-05-17/securities
    -fraud-can-happen-with-private-transactions [https://perma.cc/6JF2-NQZ3].

  181. [181]. See Thompson & Langevoort, supra note 3, at 1603; see also Sjostrom, supra note 130.

  182. [182]. Interview with Legal Advisor (Sept. 21, 2021) (notes on file with authors); Interview with Legal Advisor (Oct. 1, 2021) (notes on file with authors). As to as to our interviews, see supra note 173.

  183. [183]. See Robert Malionek & Ryan Maierson, SPAC-Related Litigation Risks and Mitigation Strategies, Harv. L. Sch. F. on Corp. Governance (Aug. 9, 2021), https://corpgov.law.harvard
    .edu/2021/08/09/spac-related-litigation-risks-and-mitigation-strategies [https://perma.cc/X45L-CKK4].

  184. [184]. For an example of the timing of these events in a SPAC merger, see Momentus, Inc., Exchange Act Release No. 92391, at 7 (July 13, 2021), https://www.sec.gov/litigation/admin
    /2021/33-10955.pdf [https://perma.cc/2TGR-2B23].

  185. [185]. Interview with Legal Advisor (June 22, 2021) (notes on file with authors). As to our interviews, see supra note 173.

  186. [186]. These incentives may be constrained by fiduciary duties, which are owed by SPAC directors and often also by sponsors. See In re MultiPlan Corp. S’holders Litig., 268 A.3d 784, 815 (Del. Ch. 2022) (assessing alleged self-dealing by SPAC fiduciaries under the entire fairness standard); Minor Myers, The Corporate Law Reckoning for SPACs 34–41 (Aug. 2, 2022) (unpublished manuscript), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4095220 [https://perma.cc/FJQ7-RR27] (arguing that the conduct of fiduciaries of Delaware-incorporated SPACs should be reviewed under the entire fairness standard). However, a significant proportion of SPACs are formed in the Cayman Islands, which provides for the waiver of conflict-of-interest rules. As to the regulation of conflicts for Cayman SPACs and for Cayman-incorporated companies more generally, see William Magnuson, The Failure of Market Efficiency, BYU L. Rev. (forthcoming), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4096270 [https://perma.cc/J6NM-5762], and William J. Moon, Delaware’s Global Competitiveness, 106 Iowa L. Rev. 1683, 1726–27 (2021), respectively.

  187. [187]. See supra note 115 and accompanying text.

  188. [188]. See Kirkland & Ellis, Family Offices and SPACs Part I: SPAC Overview and the Current Market 1, https://www.kirkland.com/-/media/publications/pifo/pifo_family-offices-and-spacs-part-i.pdf [https://perma.cc/K946-LWAR] (“Sponsor [founder] shares and warrants will have no value unless a business combination is consummated.”).

  189. [189]. See Bai et al., supra note 112, at 5 (“SPAC sponsors may prefer to bring a ‘lemon’ firm public rather than liquidate the SPAC.”).

  190. [190]. Gerry Spedale & Eric Pacifici, 9 Factors to Evaluate When Considering A SPAC 2 (2019), https://www.gibsondunn.com/wp-content/uploads/2019/03/Spedale-Pacifici-9-Factors
    -To-Evaluate-When-Considering-A-SPAC-Law360-03-11-2019.pdf [https://perma.cc/G22D-JHZG] (“While the SPAC sponsor would rather not give up any of these securities, some or all of them can be offered to the target company (or an additional financing source needed to fund the deal) as an incentive to enter into the business combination.”).

  191. [191]. Gahng et al., supra note 109, at 6, 33; see also Klausner et al., supra note 109, at 289 (“[I]t is common for PIPEs either to be priced at a discount, for PIPE investors to be issued warrants or other sweeteners, or for sponsors to transfer shares or warrants ... to PIPE investors to subsidize their investment.” (footnote omitted)).

  192. [192]. Gahng et al., supra note 109, at 6.

  193. [193]. Klausner et al., supra note 109, at 264 (finding “that sponsors tend to do very well [from SPAC mergers] even where SPAC investors do quite poorly”).

  194. [194]. For instance, Goldman Sachs underwrote the IPO of SPAC Diamond Eagle Acquisition Corp. and also acted as exclusive financial advisor to Diamond Eagle on its merger with DraftKings. See Diamond Eagle Acquisition Corp., Registration Statement 136 (Form S-1) (May 9, 2019); DEAC NV Merger Corp., Registration Statement 95 (Form S-4) (Jan. 6, 2020).

  195. [195]. Ropes & Gray, supra note 110, at 26; see also id. (“Underwriters for the IPO often continue to assist SPAC through back-end mergers.”).

  196. [196]. See id. at 26 (underwriters typically earn fees of 5.5 to 6.0 percent, with 2.0 percent paid at the IPO’s closing and the balance deferred until closing of any SPAC merger).

  197. [197]. See Testimony, Usha R. Rodrigues, Professor, Univ. of Ga. Sch. of L., Testimony Before the Investor Protection, Entrepreneurship, and Capital Markets Subcommittee of the U.S. House Committee on Financial Services: Going Public: SPACs, Direct Listings, and Public Offerings, and the Need for Investor Protections 5 (May 24, 2021), https://www.congress.gov/11
    7/meeting/house/112698/witnesses/HHRG-117-BA16-Wstate-RodriguesU-20210524.pdf [https://perma.cc/SW6N-E573] (“[T]he underwriter is incentivized [by the structure of its compensation] to make sure that an acquisition—any acquisition—closes and that the target goes public.”).

  198. [198]. Ropes & Gray, supra note 110, at 27.

  199. [199]. See Pinedo et al., supra note 177, at 1 (placement agents may be selected from target or SPAC M&A advisors).

  200. [200]. Afra Afsharipour & J. Travis Laster, Enhanced Scrutiny on the Buy-side, 53 Ga. L. Rev. 443, 456 (2019) (referring to M&A advisor compensation in mergers generally).

  201. [201]. Gahng et al., supra note 109, at 6, 52.

  202. [202]. See supra Section I.C.

  203. [203]. As to which, see 1 Securities Regulation 6th Ed., supra note 1, at 788–926. The traditional prohibitions have been relaxed most for Well-Known Seasoned Issuers, or WKSIs, which benefit from an “automatic” shelf-registration process. See id. at 716–33.

  204. [204]. See Harald Halbhuber, Economic Substance in SPAC Regulation, Yale J. on Regul. (June 3, 2022), https://www.yalejreg.com/bulletin/economic-substance-in-spac-regulation [https://perma
    .cc/2T92-Y5Q4] (“[S]oft restraints still enforce a ‘quiet period.’” (footnote omitted)).

  205. [205]. Jonathan Kolodner, Rahul Mukhi & Jared Gerber, DOJ Indicts Founder of Nikola for Allegedly Defrauding Retail SPAC Investors, Harv. L. Sch. F. Corp. Governance (Aug. 15, 2021), https://corpgov.law.harvard.edu/2021/08/15/doj-indicts-founder-of-nikola-for-allegedly-defr
    auding-retail-spac-investors [https://perma.cc/F3AT-2BZZ].

  206. [206]. See Kling & Nugent, supra note 171, § 23.04. Specifically, see 17 C.F.R. § 230.145; 17 C.F.R. § 230.165; 17 C.F.R. § 230.166; and Regulation of Takeovers and Security Holder Communications, Exchange Act Release No. 33-7760, File No. S7-28-98 (Oct. 22, 1999), https://www.sec.gov/rules/final/33-7760.htm [https://perma.cc/KJ5T-2T35].

  207. [207]. See 17 C.F.R. § 230.165(a).

  208. [208]. Indirect means of investor protection, including competition among sophisticated investors to assure that market prices reflect fundamental values, are weakened by the availability of redemption. The redemption right assures that a SPAC’s market price is at least equal to the redemption value, effectively preventing that price reflecting any anticipated loss resulting from a SPAC merger. See generally Holger Spamann & Hao Guo, The SPAC Trap: How SPACs Disable Indirect Investor Protection, 40 Yale J. on Regul. (forthcoming). As to indirect investor mechanisms, see Holger Spamann, Indirect Investor Protection: The Investment Ecosystem and Its Legal Underpinnings, 14 J. Leg. Analysis (forthcoming 2022).

  209. [209]. See supra note 185 and accompanying text.

  210. [210]. See Securities Act of 1933 § 27A, 15 U.S.C. § 77z-1; 15 U.S.C. § 77u.

  211. [211]. For a detailed discussion of these safe harbors, see 2 Securities Regulation 6th Ed., supra note 29, at 127–61; Joel Seligman, The SEC’s Unfinished Soft Information Revolution, 63 Fordham L. Rev. 1953 (1995).

  212. [212]. Securities Act, Section 27A(b)(2)(D). Also excluded are forward-looking statements made in connection with an offering of securities by a blank check company. Securities Act, Section 27A(b)(1)(B).

  213. [213]. See, e.g., Eddie Best & Anna Pinedo, De-SPACing: Overview, Securities Law & Financial Statement Considerations; Derisking with a PIPE Transaction 34, 38 (2021), https://www.mayerbrown.com/-/media/files/perspectives-events/events/2021/01/despacing-mbpli-webinar-materials-jan2021.pdf [https://perma.cc/36VW-G2Q5] (“[F]orward-looking statements will benefit from the safe harbor.”); Josh DuClos & Martin Wellington, Two Paths, One Destination? How De-SPACs and IPOs Can Both Be Fruitful 3 (2021), https://www.sidley.com/-/media/publications/two-paths-one-destination-how-despacs-and-ipos-can-both-be-fruitful.pdf?la=en [https://perma.cc/226R-DR9E] (“[I]n the de-SPAC context, the securities laws provide companies the benefit of a safe harbor for forward looking statements.”); Malionek & Maierson, supra note 183 (referring to “[t]he general view that de-SPAC transactions would be shielded by the protections of safe harbor”).

  214. [214]. However, as Amanda Rose observes, “state fiduciary obligations [are considered to] compel [the] disclosure[] of projections” in SPACs. See Amanda M. Rose, SPAC Mergers, IPOs, and the PSLRA’s Safe Harbor: Unpacking Claims of Regulatory Arbitrage 8 (Vanderbilt Univ. L. Sch. Working Paper, 2022), https://ssrn.com/abstract=3945975[https://perma.cc/EP5T-Q9GS].

  215. [215]. See Spencer Feldman,Growth Cos. Should Disclose Projections in IPO Prospectuses, LAW360 (Apr. 9, 2021, 6:02 PM), https://www.law360.com/articles/1372725/growth-cos-should-discl
    ose-projections-in-ipo-prospectuses [https://perma.cc/7CRF-HPLF] (noting differences in disclosure practices in traditional IPOs and SPAC mergers).

  216. [216]. Charles J. Johnson, Jr. & Joseph McLaughlin, Corporate Finance and the Securities Law 166–67 (3d ed. 2004). Underwriters may in turn disclose an issuer’s forward-looking information to sophisticated institutional investors. See Donald C. Langevoort & Robert B. Thompson, IPOs and the Slow Death of Section 5, 102 Ky. L. J. 891, 921 (2014).

  217. [217]. The available evidence is mixed. Compare Kimball Chapman, Richard Frankel & Xiumin Martin, SPACs and Forward-Looking Disclosure: Hype or Information? 29–30 (Oct. 20, 2021) (unpublished manuscript), https://ssrn.com/abstract=3920714[https://perma.cc/4D
    EZ-JW7Z] (finding evidence that “is consistent with the argument that forward-looking information mitigates information asymmetry, aiding price discovery” and “inconsistent with the supposition that disclosing such information enables SPACs to hype and mislead investors”), with generally Elizabeth Blankespoor, Bradley E. Hendricks, Gregory S. Miller & Douglas R. Stockbridge, Jr., A Hard Look at SPAC Projections, 68 Mgmt. Sci. 3975 (2022) (SPAC targets make more optimistic projections than comparable firms in other settings).

  218. [218]. Coates, supra note 134; see also John C. Coates, SPAC Law and Myths, Harv. L. Sch. F. Corp. Governance (Feb. 28, 2022), https://corpgov.law.harvard.edu/2022/02/28/spac-law-and-myths [https://perma.cc/8795-LTB4].

  219. [219]. Coates, supra note 134.

  220. [220]. Id.

  221. [221]. See supra notes 143–44 and accompanying text.

  222. [222]. SPAC mergers are occasionally also structured as tender offers. Forward-looking statements made in connection with a tender offer are outside the protection of the PSLRA safe harbors. See Securities Act of 1933, 15 U.S.C. § 77z-2(b)(2)(C).

  223. [223]. See, e.g., Kupor, supra note 94 (“[M]any SPACs provide 5-year forward forecasts that are used in connection with the marketing process for the pending acquisition.”).

  224. [224]. See, e.g., Lora Dimitrova, Perverse Incentives of Special Purpose Acquisition Companies, the “Poor Man’s Private Equity Funds,” 63 J. Acct. & Econ. 99, 99 (2017) (reporting “extremely poor[]” average post-merger performance by a sample of 73 SPACs conducting de-SPACs between 2004 and 2010); Klausner et al., supra note 109, at 259–64 (reporting steep post-merger losses for non-redeeming investors in forty-seven SPACs that merged between January 2019 and June 2020); Johannes Kolb & Tereza Tykvová, Going Public via Special Purpose Acquisition Companies: Frogs Do Not Turn into Princes, 40 J. Corp. Fin. 80, 88–93 (2016) (finding that a sample of 127 SPACs that undertook IPOs and mergers between 2003 and 2015 severely underperform comparable IPOs). For a general overview of empirical results, see Yochanan Shachmurove & Milos Vulanovic, SPAC IPOs, in The Oxford Handbook of IPOs 301 (Douglas Cumming & Sofia Johan eds., 2019).

  225. [225]. See supra note 193 and accompanying text.

  226. [226]. Klausner et al., supra note 109, at 264. Returns measured twelve months post-merger were somewhat lower but still suggest “that sponsors tend to do very well even where SPAC investors [that hold post-merger] do quite poorly.” Id.

  227. [227]. Id.

  228. [228]. Gilson & Kraakman, Market Efficiency, supra note 43, at 595 (1984) (footnote omitted).

  229. [229]. In traditional IPOs, the use of underwriters is a market technique adopted by issuers and investors to address the problem of verification. Id. at 619–28.

  230. [230]. See Coates, supra note 134.

  231. [231]. Adam Brenneman, Nicolas Grabar & Jared Gerber, Rising Threat of Securities Liability for SPAC Sponsors, Harv. L. Sch. F. Corp. Governance (Nov. 9, 2020), https://corpgov.law.harvard
    .edu/2020/11/09/rising-threat-of-securities-liability-for-spac-sponsors [https://perma.cc/P4LY-MNR6] (“SPAC sponsors may consider performing the type of diligence associated with a traditional IPO, in addition to the valuation-focused due diligence typical of the merger context.”).

  232. [232]. See, e.g., Ortenca Aliaj, Sujeet Indap & Miles Kruppa, Can SPACs Shake Off Their Bad Reputation?, Fin. Times (Aug. 12, 2020), https://www.ft.com/content/6eb655a2-21f5-4313-b287-964a63dd88b3 [https://perma.cc/W7GQ-9858] (“By using S[PAC]s, [sponsors] can skip over the expensive and time-consuming IPO process.”).

  233. [233]. See Klausner et al., supra note 109, at 246–54.

  234. [234]. Id. at 246.

  235. [235]. Id. at 269. The figure for traditional IPOs accounts for the potential cost to issuers of IPO underpricing.

  236. [236]. Gahng et al. report figures of 14.1 percent and 4.8 percent for SPAC mergers and IPOs, respectively. See Gahng et al., supra note 109, at 35, 45.

  237. [237]. See id. at 2.

  238. [238]. Id. at 3, 28.

  239. [239]. Klausner et al., supra note 109, at 128 (basing the study on a cohort of SPACs in 2019 and 2020). Gahng and coauthors provide a “back of the envelope” calculation showing why initial SPAC investors would enjoy abnormal positive returns on their shares and warrants. See Gahng et al., supra note 109, at 28–29.

  240. [240]. Klausner et al., supra note 109, at 245.

  241. [241]. Id. at 246.

  242. [242]. Id. at 254 (“The terms of a merger agreement determine which party bears a SPAC’s costs.”).

  243. [243]. Id. at 255 (finding evidence consistent with the implication “that targets tend to negotiate deals that protect themselves from SPACs’ costs”).

  244. [244]. Id. at 262 (footnote omitted).

  245. [245]. Id. at 233–34.

  246. [246]. Id. at 302.

  247. [247]. Id. In an earlier version, the authors explain: “Especially for companies that are difficult to value—the type of target for which SPACs are supposedly best suited—the market may need time and additional quarters of financial results to arrive at accurate valuations.” Michael Klausner, Michael Ohlrogge & Emily Ruan, A Sober Look at SPACs 34 n.62 (ECGI Working Paper Series in Finance, Working Paper No. 746/2021, 2021), https://ecgi.global/sites/default/files
    /working_papers/documents/klausnerohlroggeruanfinal.pdf [https://perma.cc/N4JJ-S6SA].

  248. [248]. The implication is that a SPAC’s price weeks or months after a SPAC merger more accurately reflects its true value at the date of the merger. On this view, a SPAC price of less than $10 weeks or months after the merger, when markets have had enough time to arrive at accurate valuations, suggests that SPAC shareholders—rather than target shareholders—carry the dilution costs, even if the price one day post-merger may suggest the opposite. Klausner et al., supra note 109, at 301–03.

  249. [249]. See Fagan & Levmore, supra note 110, at 9, 21 n.53 (questioning causal claims in existing empirical research on SPACs).

  250. [250]. Gahng et al., supra note 109, at 6–15.

  251. [251]. See Klausner et al., supra note 247, at 1 (“SPAC investors are ... in effect subsidizing the companies they bring public”); id. at 4 (“From the perspective of companies going public, therefore, SPACs have indeed been cheap.”).

  252. [252]. Klausner et al., supra note 109, at 263 (“We cannot answer that question definitively, but ... at least a partial answer may lie in poor disclosure practices and sponsor incentives that are misaligned with shareholder interests.”).

  253. [253]. Klausner et al., supra note 247, at 5. These companies might also “expect difficulty communicating their story to the market.” Id. at 45. Bai et al. suggest systematic differences exist between firms preferring SPAC mergers and firms preferring traditional IPOs, see Bai et al., supra note 112, at 1–8, but the Gahng study casts doubt on the possibility that SPAC mergers benefit a distinct set of firms, see Gahng et al., supra note 109, at 6–15.

  254. [254]. Gahng et al., supra note 109, at 11 (“[I]t is frequently stated that the time it takes for an operating company to negotiate a merger with a SPAC and win shareholder approval is less than that of a traditional bookbuilt IPO.”).

  255. [255]. Id. at 12 (“[M]erging with a SPAC may provide relative certainty compared to a traditional IPO.”).

  256. [256]. Id. at 10.

  257. [257]. Klausner et al., supra note 109, at 278–82.

  258. [258]. Id. at 266–67 (“[T]he entire SPAC process results, on average, in a net collective gain among all parties involved in SPACs, and that the costs that we have analyzed constitute a distribution of the surplus value created by having a company go public.” (footnote omitted)).

  259. [259]. Id.

  260. [260]. See supra note 195 and accompanying text.

  261. [261]. SPAC sponsors would not be exempt from liability. They might face Section liability as control persons or under Section 12 of the Securities Act for soliciting sales.

  262. [262]. See Andrew F. Tuch, Managing Management Buyouts: A US-UK Comparative Analysis, in Research Handbook on Comparative Corporate Governance 477, 478 (Afra Afsharipour & Martin Gelter eds., 2021) [hereinafter Tuch, Management Buyouts].

  263. [263]. See 17 C.F.R. § 240.13e-3(d) (2019). This schedule requires disclosure of the purposes of the transaction and the reasons for its structure. The target company and its affiliates must attest that they reasonably believe the transaction is fair to shareholders and must explain why this is so. For a more detailed discussion of MBOs and required disclosures, see Tuch, Management Buyouts, supra note 262, at 494–95.

  264. [264]. 17 C.F.R. § 240.13e-100.

  265. [265]. See Klausner et al., supra note 109, at 289 (“All PIPE transactions and associated side payments are material to a public shareholder’s decision to redeem or remain invested in a merger.”).

  266. [266]. See Coates, supra note 134 (“[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.”).

  267. [267]. See Robert Charles Clark, Corporate Law 754 (1986) (referring to the argument, made by proponents of allowing predictive information in SEC filings, “that fairness required disclosure of management’s projections to the ordinary investor, because the projections were already being given to professional securities analysts”).

  268. [268]. See supra notes 221–22 and accompanying text.

  269. [269]. Securities Act of 1933 § 27A(b)(1)(B), 15 U.S.C. § 77z-2.

  270. [270]. See SEC SPAC Release, supra note 16; see id. at 66 (proposal intended to “align more closely the treatment of private operating companies entering the public markets through de-SPAC transactions with that of companies conducting traditional [IPOs]”).

  271. [271]. See Andrew F. Tuch, SEC Proposed Reforms of SPACs: A Comment from Andrew Tuch, Harv. L. Sch. F. Corp. Governance (July 21, 2022) [hereinafter Tuch, SEC Proposed Reforms of SPACs], https://corpgov.law.harvard.edu/2022/07/21/sec-proposed-reforms-of-spacs-a-comm
    ent-from-andrew-tuch [https://perma.cc/H4A7-66VB]. See generally Andrew F. Tuch, Comment Letter on SEC Proposed Reforms of SPACs, Shell Companies, and Projections (Wash. Univ. in St. Louis Legal Stud. Rsrch. Paper Series, No. 22-07-01, 2022), https://papers.ssrn.com/sol3/papers.c
    fm?abstract_id=4160185 [https://perma.cc/48TN-XBHC] (writing to the SEC on the SEC SPAC Release and proposed rules).

  272. [272]. SEC SPAC Release, supra note 16, at 86–97 (Proposed Rule 140a).

  273. [273]. Id. at 98.

  274. [274]. Id. at 74–78.

  275. [275]. SEC SPAC Release, supra note 16, at 101 (Proposed Item 145a).

  276. [276]. Id. at 82–86.

  277. [277]. See, e.g., Letter from Davis Polk to the SEC 7 (June 13, 2022), https://www.davispolk
    .com/sites/default/files/2022-06/davis-polk-comment-letter-sec-spac-rule-proposals.pdf [https:
    //perma.cc/6D5Y-9H7G] (“While the potential benefits of the safe harbor for projections disclosure in the context of de-SPAC transactions has provided some comfort to parties to such transactions in the abstract, the safe harbor has never provided a meaningful shield from liability. Best practice for participants in de-SPAC transactions has always been to ensure that any prospective financial information is based on the best then available information and that the key assumptions are reasonable and appropriately disclosed. Therefore, we do not expect that the absence of the safe harbor will have a substantial impact on current market disclosure practices and we do not object to the disapplication of the safe harbor to de-SPAC transactions.”).

  278. [278]. See, e.g., SEC SPAC Release, supra note 16 (proposed item 1606 and 1607).

  279. [279]. In comments on the proposed reforms, one of us questions whether the Commission has achieved the right calibration, considering the cumulative effect of these reforms, including the enhanced threat of Section 11 liability, and the Commission’s desire to align the treatment of de-SPACs with that of traditional IPOs. More detailed comments are provided elsewhere. See supra note 271.

  280. [280]. Spotify Tech. S.A., Registration Statement (Form S-1) (Feb. 28, 2018); Watford Holdings Ltd., Registration Statement (Form S-1) (Mar. 6, 2019); Slack Techs., Inc., Registration Statement (Form S-1) (Apr. 26, 2019); Asana, Inc., Registration Statement (Form S-1) (Aug. 24, 2020); Palantir Techs., Inc., Registration Statement (Form S-1) (Aug. 25, 2020); Thryv Holdings, Inc., Registration Statement (Form S-1) (Sept. 1, 2020); Roblox Corp., Registration Statement (Form S-1) (Nov. 19, 2020); Coinbase Glob., Inc., Registration Statement (Form S-1) (Feb. 25, 2021); ZipRecruiter, Inc., Registration Statement (Form S-1) (Apr. 23, 2021); Squarespace, Inc., Registration Statement (Form S-1) (Apr. 16, 2021); Amplitude, Inc, Registration Statement (Form S-1) (Aug. 30, 2021); Warby Parker Inc., Registration Statement (Form S-1) (Aug. 24, 2021); Bright Green Corp, Registration Statement (Form S-1) (Aug. 1, 2022); see also Jay R. Ritter, Initial Public Offerings: Direct Listings Through May 19, 2022, at 2 (2022), https://site.warrington.ufl.edu/ritter/files/Direct-Listings.pdf [https://perma.cc/2L79-G32V]. This list is current at September 1, 2022.

    There has been a limited literature to date with respect to Direct Listings. See, e.g., Coffee, Sale & Whitehead, supra note 38, at 147–50; Brent J. Horton, Spotify’s Direct Listing: Is It a Recipe for Gatekeeper Failure?, 72 SMU L. Rev. 177, 187–89 (2019); Anat Alon-Beck, Robert Rapp & John Livingstone, Investment Bankers as Underwriters–Barbarians or Gatekeepers? A Response to Brent Horton on Direct Listings, 73 SMU L. Rev. F. 251, 251–55 (2020); Ran Ben-Tzur & James D. Evans, The Rise of Direct Listings: Understanding the Trend, Separating Fact from Fiction, Fenwick (Dec. 5, 2019), https://www.fenwick.com/insights/publications/the-rise-of-direct-listings-understanding-the-trend-separating-fact-from-fiction [https://perma.cc/2VKD-XSH9].

  281. [281]. See, e.g., 1 Securities Regulation 6th Ed., supra note 1, at 647–748.

  282. [282]. See 1 Securities Regulation 6th Ed., supra note 1, at 654–90; see also supra notes 39–40 and accompanying text.

  283. [283]. See 1 Securities Regulation 6th Ed., supra note 1, at 654–95; Self-Regulatory Organizations, Exchange Act Release No. 34-90768, File No. SR-NYSE-2019-67, at 5 (Dec. 22, 2020), https://www.sec.gov/rules/other/2020/34-90768.pdf [https://perma.cc/7U3D-MGQ4].

  284. [284]. See Self-Regulatory Organizations, Exchange Act Release No. 34-90768, File No. SR-NYSE-2019-67 (Dec. 22, 2020), https://www.sec.gov/rules/other/2020/34-90768.pdf [https://perma.cc/7U3D-MGQ4] (full SEC approval of NYSE selling shareholder and primary direct listings); Self-Regulatory Organizations, Exchange Act Release No. 34-87648, File No. SR-NASDAQ-2019-059 (Dec. 3, 2019), https://www.sec.gov/rules/sro/nasdaq/2019/34-87648.pdf [https://perma.cc/23PU-KMUF] (Nasdaq Selling shareholders approval); Self-Regulatory Organizations, Exchange Act Release No. 34-91947, File No. SR-NASDAQ-2020-057 (May 19, 2021), https://www.sec.gov/rules/sro/nasdaq/2021/34-91947.pdf [https://perma.cc/QUH2-EPX4] (primary offerings).

    To date, there have been three direct listings on the Nasdaq, Amplitude, Thryv, and Watford Holdings. Nine have been on the NYSE.

    See also Self-Regulatory Organizations, Exchange Act Release No. 34-82627, File No. SR-NYSE-2017-30 (Feb. 2, 2018), https://www.sec.gov/rules/sro/nyse/2018/34-82627.pdf [https://
    perma.cc/QSZ2-YGZD], in which the SEC approved amendments to NYSE Listing Manual § 101.03 Footnote (E) to allow companies without a prior Exchange Act registration to simultaneously sell securities for the Selling Shareholders under a Securities Act registration statement and register their shares under the Securities Exchange Act to enable listing on the NYSE. See Self-Regulatory Organizations, Exchange Act Release No. 34-90768, File No. SR-NYSE-2019-67, at 6–7, nn.15–17 (Dec. 22, 2020), https://www.sec.gov/rules/other/2020/34-9076
    8.pdf [https://perma.cc/7U3D-MGQ4].

  285. [285]. The concern is that the SEC might view a direct listing as a distribution in violation of Regulation M. See David Lopez, Jeff Karpf & Helena Grannis, Direct Listings 2.0–Primary Direct Listings, Harv. L. Sch. F. Corp. Governance, (Sept. 20, 2020), https://corpgov.law.harvard
    .edu/2020/09/20/direct-listings-2-0-primary-direct-listings [https://perma.cc/XWT3-FPED] (suggesting direct listings, especially Primary Direct Floor Listings, pose difficulties under Regulation M without SEC no-action relief).

  286. [286]. Spotify Tech. S.A., SEC Staff No-Action Letter (Mar. 23, 2018), https://www.sec.gov/div
    isions/marketreg/mr-noaction/2018/spotify-technology-032318-regm.pdf [https://perma.cc/32L7-MG53].

  287. [287]. With the exception of Primary Direct Floor Listings, shares held by officers, directors, or owners of more than ten percent of the common stock are not included in calculations of publicly held shares under the NYSE listing rules.

    With either a Primary Direct Floor Listing or a Selling Shareholder Direct Floor Listing, a company would be subject to all other applicable initial listing requirements. These include having 400 round lot shareholders (shareholders owning 100 shares or more) and 1.1 million publicly held shares outstanding at the time of the initial listing with a minimum price of $4.00. Self-Regulatory Organizations, Exchange Act Release No. 34-90768, File No. SR-NYSE-2019-67, at 10 n.29 (Dec. 22, 2020), https://www.sec.gov/rules/other/2020/34-90768.pdf [https://perma.cc/7U3D-MGQ4].

  288. [288]. Id. at 20 (quoting Self-Regulatory Organizations, 85 Fed. Reg. 39246, 39250 (June 30, 2020)).

  289. [289]. Rule 7.35A. DMM-Facilitated Core Open and Trading Halt Auctions, NYSE (2022), https:
    //nyseguide.srorules.com/rules/document?treeNodeId=csh-da-filter!WKUS-TAL-DOCS-PHC-%7B4A07B716-0F73-46CC-BAC2-43EB20902159%7D—WKUS_TAL_19401%23teid-46 [https://
    perma.cc/NK99-28V4] (referring to rule 7.35A(d)(2)(A)(iv)).

  290. [290]. Self-Regulatory Organizations, Exchange Act Release No. 34-90768, File No. SR-NYSE-2019-67, at 16 n.54 (Dec. 22, 2020), https://www.sec.gov/rules/other/2020/34-90768.pdf [https://perma.cc/7U3D-MGQ4]. The Commission also found that both types of direct listings were consistent with Section 6(b)(5) of the Securities Exchange Act.

  291. [291]. Id. at 31–32. Regarding Regulation M, see 9 Securities Regulation 5th ed., supra note 38, at 2–88.

  292. [292]. See Self-Regulatory Organizations, Exchange Act Release No. 34-90768, File No. SR-NYSE-2019-67, at 37–38. (Dec. 22, 2020), https://www.sec.gov/rules/other/2020/34-90768.pdf [https://perma.cc/7U3D-MGQ4].

  293. [293]. Id. at 38 (footnote omitted).

  294. [294]. Id. at 26 n.78 (alterations in original) (citation omitted). See generally id. at 26–30. It acknowledged that other participants, including issuers, officers, and accountants also “play important roles in assuring” accurate and complete disclosures. Id. at 33.

  295. [295]. Id. at 33 (emphasis added).

  296. [296]. Lee & Crenshaw, supra note 17.

  297. [297]. Id. (footnotes omitted).

  298. [298]. Spotify’s principal legal advisor in the United States was Latham & Watkins. Spotify Tech. S.A., Registration Statement 185 (Form F-1) (Feb. 28, 2018). Davis Polk & Wardwell served as legal advisor to the financial advisors. Tom Zanki, Spotify Opens Door to Direct Listings Among Tech Unicorns, LAW360 (Apr. 3, 2018, 10:20 PM), https://www.law360.com/articles/1029200/spotify-opens-door-to-direct-listings-among-tech-unicorns [https://perma.cc/2US8-Y5VX].

    In addition to Latham & Watkins and Davis Polk & Wardwell, leading law firms including Clifford Chance; Goodwin Proctor; Wilson Sonsini; Weil, Gotshal & Manges; Cooley; Schiff Hardin; Orrick Herrington & Sutcliff; Skadden Arps; and Fenwick & West were involved in each other direct listing as counsel to the company or financial advisors.

  299. [299]. Slack Techs. Inc., Registration Statement 5, 53 (Form S-1) (Apr. 26, 2019); Squarespace, Inc., Registration Statement 50 (Form S-1) (Apr. 16, 2021).

  300. [300]. See, e.g., Spotify Tech. S.A., Registration Statement 59 (Form F-1) (Feb. 28, 2018); ZipRecruiter Inc., Registration Statement 52 (Form S-1) (Apr. 23, 2021); Slack Techs. Inc., Registration Statement 59 (Form S-1) (Apr. 26, 2019); Asana, Registration Statement 47 (Form S-1) (Aug. 24, 2020); Squarespace Inc., Registration Statement 47 (Form S-1) (Apr. 16, 2021).

  301. [301]. Slack Techs. Inc., Registration Statement 8–9, 43 (Form S-1) (Apr. 26, 2019); Asana Inc., Registration Statement 11, 39 (Form S-1) (Aug. 24, 2020); Roblox Corp., Registration Statement 10, 64–65 (Form S-1) (Nov. 19, 2020); ZipRecruiter Inc., Registration Statement 1, 17, 52 (Form S-1) (Apr. 23, 2021); Squarespace, Inc., Registration Statement 6, 84–85 (Form S-1) (Apr. 16, 2021).

  302. [302]. See, e.g., Slack Techs. Inc., Registration Statement 41 (Form S-1) (Apr. 26, 2019); ZipRecruiter, Inc., Registration Statement 45 (Form S-1) (Apr. 23, 2021).

  303. [303]. Spotify Tech. S.A., Registration Statement 180 (Form F-1) (Feb. 28, 2018) (“We will not receive any proceeds from the sale of ordinary shares by the Registered Shareholders.”). Virtually identical language appears in each other direct listing. See, e.g., Slack Techs. Inc., Registration Statement 58 (Form S-1) (Apr. 26, 2019); Palantir Techs. Inc., Registration Statement 242 (Form S-1) (Aug. 25, 2020); Roblox Corp., Registration Statement 71 (Form S-1) (Nov. 19, 2020); Coinbase Global Inc., Registration Statement 78 (Form S-1) (Feb. 25, 2021); ZipRecruiter, Inc., Registration Statement 58 (Form S-1) (Apr. 23, 2021); Squarespace, Inc., Registration Statement 46, 142 (Form S-1) (Apr. 16, 2021).

  304. [304]. Spotify Tech. S.A., Registration Statement 43–44 (Form F-1) (Feb. 28, 2018). See similar statements in Slack Techs., Inc., Registration Statement 46 (Form S-1) (Apr. 26, 2019); Asana, Inc., Registration Statement 39–40 (Form S-1) (Aug. 24, 2020); Palantir Techs. Inc., Registration Statement 66 (Form S-1) (Aug. 25, 2020); Roblox Corp., Registration Statement 57, 191–92 (Form S-1) (Nov. 19, 2020); Coinbase Glob. Inc., Registration Statement 65 (Form S-1) (Feb. 25, 2021); ZipRecruiter, Inc., Registration Statement 46 (Form S-1) (Apr. 23, 2021); Squarespace, Inc., Registration Statement 34 (Form S-1) (Apr. 26, 2021).

  305. [305]. Id.

  306. [306]. Horton, supra note 280, at 195–96 (doubting that financial advisors perform marketing and selling).

  307. [307]. Spotify Tech S.A., Registration Statement 186–87 (Form F-1) (Feb. 28, 2018).

  308. [308]. Slack Techs., Inc., Registration Statement 47, 171–72 (Form S-1) (Apr. 26, 2019), engaged Goldman Sachs, Morgan Stanley, and Allen & Co. as financial advisors and Credit Suisse, Barclays, Citigroup, RBC Capital Markets, KeyBanc Capital Markets, Canaccord Genuity, and William Blair as associate financial advisors.

    The firms involved in the Spotify direct listing were involved in many of the other direct listings as were other leading investment banks including JP Morgan, Bank of America, Jefferies, and HSBC.

  309. [309]. Spotify Tech. S.A., Registration Statement 4–5 (Form F-1) (Feb. 28, 2018); Slack Techs., Inc., Registration Statement 47 (Form S-1) (Apr. 26, 2019); Asana, Inc., Registration Statement 40 (Form S-1) (Aug. 24, 2020); Palantir Techs. Inc., Registration Statement 67 (Form S-1) (Aug. 25, 2020); Roblox Corp., Registration Statement 58 (Form S-1) (Nov. 19, 2020); Coinbase Glob. Inc., Registration Statement 66, 210 (Form S-1) (Feb. 25, 2021); ZipRecruiter, Inc., Registration Statement 47 (Form S-1) (Apr. 23, 2021); Squarespace, Inc., Registration Statement 35 (Form S-1) (Apr. 16, 2021).

  310. [310]. Spotify Tech. S.A., Registration Statement 45–49 (Form F-1) (Feb. 28, 2018); Slack Techs., Inc., Registration Statement 46, 51-52 (Form S-1) (Apr. 26, 2019); Asana, Inc., Registration Statement 40 (Form S-1) (Aug. 24, 2020); Roblox Corp., Registration Statement 58, 62 (Form S-1) (Nov. 19, 2020); Coinbase Glob., Inc., Registration Statement 65–66, 70–71 (Form S-1) (Feb. 25, 2021); ZipRecruiter, Inc., Registration Statement 46, 48–49 (Form S-1) (Apr. 23, 2021); Squarespace, Registration Statement 35, 38 (Form S-1) (Apr. 16, 2021).

    Spotify Tech. S.A., Registration Statement 45–49 (Form F-1) (Feb. 28, 2018) did have lock-ups with two investors, TME and Tencent, owners of 9.1 and 7.2 percent of Spotify respectively. Spotify Tech. S.A., Registration Statement 150 (Form F-1) (Feb. 28, 2018).

  311. [311]. Self-Regulatory Organizations, Exchange Act Release No. 34-90768, File No. SR-NYSE-2019-67, at 37 (Dec. 22, 2020), https://www.sec.gov/rules/other/2020/34-90768.pdf [https://
    perma.cc/7U3D-MGQ4].

  312. [312]. Id. at 37–38.

  313. [313]. See supra notes 94–97 and accompanying text.

  314. [314]. Interview with Legal Advisor (Sept. 29, 2021) (notes on file with authors); Interview with Legal Advisor (Oct. 1, 2021) (notes on file with authors). As to our interviews, see supra note 173.

  315. [315]. PWC Deals, Considering an IPO? An Insight Into the Costs Post-JOBS Act (2015), quoted in Coffee, Sale & Whitehead, supra note 38, at 149.

  316. [316]. Spotify Tech S.A., Registration Statement 186–87 (Form F-1) (Feb. 28, 2018).

  317. [317]. Slack Techs., Inc., Registration Statement II-1 (Form S-1) (Apr. 26, 2019). Other direct listings did not publish registration expenses in their last Amended Form S-1 or in accompanying Exhibits.

  318. [318]. Asana, Inc., Registration Statement F-42 (Form S-1) (Aug. 24, 2020).

  319. [319]. See Chen & Ritter, supra note 91, at 1108–12.

  320. [320]. As depicted in the table above, Spotify registered 55,731,480 and had a closing price of $149 on its first day of trading. Multiplying the total number of registered shares by the first day closing price equals approximately $8.3 billion.

    In the PricewaterhouseCoopers illustration for IPOs, the costs were denominated as follows:

    See supra note 315.

  321. [321]. Alistair Barr, Facebook Underwriters to Get 1.1 Percent Fee: Source, Reuters (Mar. 19, 2012, 5:57 PM), https://www.reuters.com/article/us-facebook-ipo/facebook-underwriters-to-get-1-1-p
    ct-fee-source-idUKBRE82I15N20120319 [https://perma.cc/576F-65G5].

  322. [322]. See supra Part I for description of due diligence process.

  323. [323]. Gibson Dunn, A Current Guide to Direct Listings 3 (2021), https://www.gibson
    dunn.com/wp-content/uploads/2021/01/a-current-guide-to-direct-listings-january-2021.pdf [https://perma.cc/J8UD-DWFM].

  324. [324]. Pirani v. Slack Techs., Inc., 13 F.4th 940, 943 (9th Cir. 2021).

  325. [325]. Id. at 946.

  326. [326]. Id. at 947.

  327. [327]. Id. at 951–52 (Miller, J., dissenting).

  328. [328]. Barnes v. Osofsky, 373 F.2d 269, 271 (2d Cir. 1967).

  329. [329]. Id. at 271–73; see also supra notes 147–48.

  330. [330]. Barnes, 373 F.2d at 271 (footnote omitted).

  331. [331]. Id. at 273 n.2.

  332. [332]. Pirani v. Slack Techs., Inc., 13 F.4th 940, 952 (9th Cir. 2021). Judge Miller cited the following cases: Plumbers’ Union Local No. 12 Pension Fund v. Nomura Asset Acceptance Corp., 632 F.3d 762, 768, 768 n.5 (1st Cir. 2011); Rosenzweig v. Azurix Corp., 332 F.3d 854, 873 (5th Cir. 2003); Lee v. Ernst & Young, LLP, 294 F.3d 969, 975–78 (8th Cir. 2002); Hertzberg v. Dignity Partners, Inc., 191 F.3d 1076, 1080 (9th Cir. 1999); Joseph v. Wiles, 223 F.3d 1155, 1159–60 (10th Cir. 2000), abrogated on other grounds by California Pub. Emps.’ Ret. Sys. v. ANZ Sec., Inc., 137 S. Ct. 2042 (2017); APA Excelsior III L.P. v. Premiere Techs., Inc., 476 F.3d 1261, 1271 (11th Cir. 2007). Id. Judge Miller stated “[i]n Hertzberg, we held that ‘such security’ requires the plaintiff to ‘have purchased a security issued under that, rather than some other, registration statement.’ 191 F.3d at 1080. And in In re Century Aluminum Co. Securities Litigation, 729 F.3d 1104, 1106 (9th Cir. 2013), we reiterated that ‘such security’ means that the shares were ‘issued under the allegedly false or misleading registration statement.’” Id.

  333. [333]. See supra notes 32–68.

  334. [334]. See generally, e.g., Max Chafkin, The Contrarian: Peter Thiel and Silicon Valley’s Pursuit of Power (2021) (describing Peter Thiel’s life and career).

  335. [335]. 17 C.F.R. § 230.144, preliminary note.

  336. [336]. 2 Securities Regulation 6th Ed., supra note 29, at 1469 (footnote omitted).

  337. [337]. See generally SEC v. Chinese Consol. Benevolant Ass’n, 120 F.2d 738 (2d Cir. 1941), cert. denied, 314 U.S. 618 (discussing who may be deemed an underwriter); see 1 Securities Regulation 6th Ed., supra note 1, at 1481–82; id. at 1445–98.

  338. [338]. See generally Harden v. Raffensperger, Hughes & Co., 65 F.3d 1392 (7th Cir. 1995) (discussing who may be deemed an underwriter). In Harden, FirstMark under then applicable National Association of Securities Dealers rules was required to hire a qualified independent underwriter to perform due diligence in a registration statement. Id. at 1395. Raffensperger did not agree to buy, sell, distribute, or solicit orders for the covered FirstMark notes. Id. Because the court viewed Raffensperger’s role as “necessary to the distribution of [the FirstMark] securities,” the Seventh Circuit ruled that Raffensperger was an underwriter by participating in the securities issuance. Id. at 1401 (alterations in original) (quotation omitted); see also SEC v. Platforms Wireless Int’l Corp., 617 F.3d 1072, 1086 (9th Cir. 2010) (“Any intermediary between the issuer and the investor that is an essential cog in the distribution process may be a statutory underwriter.”).

  339. [339]. See, e.g., John C. Coffee, Jr., The Spotify Listing: Can an “Underwriter-less” IPO Attract Other Unicorns?, CLS: Blue Sky Blog (Jan. 16, 2018), https://clsbluesky.law.columbia.edu/2018/01
    /16/the-spotify-listing-can-an-underwriter-less-ipo-attract-other-unicorns [https://perma.cc/244W-RFZE]; Benjamin J. Nickerson, Note, The Underlying Underwriter: An Analysis of the Spotify Direct Listing, 86 U. Chi. L. Rev. 985, 1014–24 (2019).

  340. [340]. See supra note 12, at 33.

  341. [341]. Lee & Crenshaw, supra note 17.

  342. [342]. See supra note 304 and accompanying text.

  343. [343]. Ben-Tzur & Evans, supra note 280 (“[I]nvestment banks [acting as financial advisors] and their legal counsel “put companies through the exact same due diligence process as in a traditional IPO.”).

  344. [344]. As to which, see supra note 71 and accompanying text.

  345. [345]. Interview with Legal Advisor (Oct. 7, 2021) (notes on file with authors). As to our interviews, see supra note 173.

  346. [346]. If there had been an earlier private placement of securities, existing shareholders would be limited by Rule 144(e) in terms of the value of securities they could sell in any three months. In contrast, if there was no private placement, Rule 144(e) with its volume limits would not apply. See 3 Securities Regulation 6th Ed., supra note 79, at 648–61.

  347. [347]. See supra note 298–03 and accompanying text.

  348. [348]. Horton, supra note 280, at 212.

  349. [349]. Securities Exchange Act of 1993, 15 U.S.C. § 78s(c); see also 6 Louis Loss, Joel Seligman & Troy Paredes, Securities Regulation 86–96 (6th ed., 2021).

  350. [350]. As to this vote, see supra notes 17–18.

  351. [351]. Self-Regulatory Organizations, 87 Fed. Reg. 43914 (July 22, 2022) (citing a draft of this article in n.82).

  352. [352]. Id. at 43919 (footnotes omitted).

  353. [353]. Id.

  354. [354]. Id. at 43919–20 (footnote omitted).

  355. [355]. Self-Regulatory Organizations, Exchange Act Release No. 34-94311, File No. SR-NASDAQ-2021-045 (Feb. 24, 2022), https://www.sec.gov/rules/sro/nasdaq/2022/34-94311.pdf [https://perma.cc/39UN-445X].

  356. [356]. Concept Release on Harmonization of Securities Offering, Exchange Act Release No. 33-10649, File No. S7-08-19, at 1 (June 18, 2019), https://www.sec.gov/rules/concept/2019/33
    -10649.pdf [https://perma.cc/3T6G-RRAC].

  357. [357]. Id. at 21.

  358. [358]. See supra notes 78–84 and accompanying text.

  359. [359]. See, e.g., Disclosure to Investors: A Reappraisal of Federal Administrative Policies Under the ’33 and ’34 Acts (1969) (examining the disclosure provisions under the securities Acts) (popularly known as the “Wheat Report” after its Chair, SEC Commissioner Francis Wheat); see 2 Securities Regulation 6th Ed., supra note 29, at 22–23; H.R. Rep No. 95-29, 92–95 (1977) (popularly known as the “Sommer Report” after its Chair, Commissioner A.A. Sommer). The 2005 Securities Offering Reform proposed a comprehensive revamping of the public offering process, see 1 Securities Regulation 6th Ed., supra note 1, at 765–79.

  360. [360]. Hearing Before the Senate Comm. on Banking, Hous., & Urb. Affs., 115th Cong. (2017) (statement of Jay Clayton, Nominee for Chairman, SEC) (expressing concern that U.S.-listed public companies had decreased over thirty-five percent since 1997); Statement, Jay Clayton, Chairman, SEC, Remarks at Meeting of the Investor Advisory Committee (June 22, 2017), https://www.sec.gov/news/public-statement/clayton-6-22-17 [https://perma.cc/TP77-4NEA] (“The substantial decline in the number of U.S. IPOs and publicly listed companies in recent years is of great concern to me.”).

  361. [361]. Hester M. Peirce, Speech by Commissioner Peirce on the Future of the SPAC Market, Harv. L. Sch. F. Corp. Governance (Nov. 1, 2021), https://corpgov.law.harvard.edu/2021/11/01/spe
    ech-by-commissioner-peirce-on-the-future-of-the-spac-market [https://perma.cc/QNQ6-H8L7].

  362. [362]. As to these developments, see supra notes 81–86 and accompanying text.

  363. [363]. See generally SEC v. W.J. Howey Co., 328 U.S. 293 (1946) (distinguishing which investors did not need the protection of a registered offering from those who do).

  364. [364]. As to the potential for elevated risk of fraud in private securities markets, especially among the largest private companies, see Renee M. Jones, The Unicorn Governance Trap, 166 U. Pa. L. Rev. Online 165, 179–82 (2017); Donald C. Langevoort & Hillary A. Sale, Corporate Adolescence: Why Did “We” Not Work?, 99 Texas L. Rev. 1347, 1357–67 (2021); Ann M. Lipton, Not Everything Is About Investors: The Case for Mandatory Stakeholder Disclosure, 37 Yale J. on Regul. 499 (2020); Elizabeth Pollman, Private Company Lies, 109 Geo. L.J. 353, 368–86 (2020); Matthew Wansley, Taming Unicorns, 97 Ind. L.J. 1203, 1236–50 (2022); Verity Winship, Private Company Fraud, 54 U.C. Davis L. Rev. 663, 685–702 (2020). For evidence that sophisticated actors undertake suboptimal bargaining in private markets, evidence consistent with a potentially elevated fraud risk in private securities markets, see William W. Clayton, High-End Bargaining Problems, 75 Vand. L. Rev. 703 (2022). For an account skeptical that the largest companies in private markets pose enhanced fraud risk relative to those in public markets, see Alexander I. Platt, Unicorniphobia, Harv. Bus. L. Rev. (forthcoming 2022), https://papers.ssrn.com/sol3/papers.cfm?abstract
    _id=3915793 [https://perma.cc/GGK6-TCR2]. Cf. 3 Securities Regulation 6th Ed., supra note 79, at 250–56 (historically, small securities offerings were regarded as carrying a high incidence of fraud).

  365. [365]. See generally 1 Securities Regulation 6th Ed., supra note 1, at 748–1138 regarding the mechanics of compliance with the Securities Act.

  366. [366]. See Section I.C.

  367. [367]. See supra notes 83–84 and accompanying text.

  368. [368]. As an example of this approach, see supra note 295.

  369. [369]. See generally Seligman, supra note 24 (describing history of SEC decision-making).

*

Andrew Tuch is Professor of Law, Washington University in St Louis.


**

Joel Seligman is President Emeritus and University Professor at the University of Rochester and Dean Emeritus and Professor of Law at Washington University in St. Louis.


For helpful comments and discussions, we thank Ken Ayotte, Scott Baker, Bobby Bartlett, Patrick Corrigan, Jens Frankenreiter, Stavros Gadinis, Harald Halbhuber, Michael Klausner, Michael Ohlrogge, Frank Partnoy, Robert Pollack, Jay Ritter, Adam Rosenzweig, Kyle Rozema, Jonathan Smith, Holger Spamann, Emily Strauss, Robert Thompson, and audiences at the University of California, Berkeley, University of Chicago, University of Oklahoma, University of Sydney, and Washington University in St. Louis. For help in understanding market practices, we thank numerous market participants including Jon Avina, Ran Ben-Tzur, Calise Cheng, Douglas Ellenoff, Jared Gerber, Matthew Gray, Michael Kliegman, Ramey Layne, Greg Rodgers, David Segre, and Richard Truesdell. For excellent research assistance we thank Andrew Stubbs, Jim Yan, and Ryan Ellingson.