First SPAC-Related SEC Enforcement Action Targets SPAC's Alleged Due Diligence Failures

Yesterday, the SEC brought its first enforcement action against participants in a deSPAC transaction, in which a private company attempts to go public through a merger with a special purpose acquisition company (SPAC).[1] The action demonstrates that a SPAC can be exposed to punitive SEC sanctions even as a “victim” of alleged misrepresentations by a merger target, if the SPAC’s due diligence is found to have been inadequate. SEC Chair Gary Gensler emphasized this point in the SEC’s press release announcing the action: “The fact that [the private company] lied to [the SPAC] does not absolve [the SPAC] of its failure to undertake adequate due diligence to protect shareholders.”[2] Notably, the SEC brought the action before the closing of the deSPAC transaction.

The deSPAC, which was announced in October 2020 along with a PIPE (private investment in public equity) financing, involved the acquisition of Momentus, Inc., a “space infrastructure” company, by a SPAC called Stable Road Acquisition Corp. (SRAC). The SEC found that Momentus and SRAC inaccurately told investors that Momentus had successfully tested its key technology and materially understated the risks arising from national security concerns identified by the Committee on Foreign Investment in the United States (CFIUS).[3]

The SEC pointed to two alleged due diligence failures by SRAC. First, according to the SEC, SRAC did not begin substantive due diligence on Momentus’s technology until little more than a month before the merger announcement, and did not evaluate the results of the company’s sole in-space test of the technology, which failed to meet any of the company’s success criteria.[4] Second, the SEC found that SRAC had failed to conduct adequate due diligence regarding a CFIUS order against the company’s then-CEO, a Russian citizen, which would have revealed that national security concerns posed a significant threat to Momentus’s business prospects.[5]

The SEC brought enforcement actions against Momentus, SRAC, their respective CEOs, and a SPAC funding vehicle in which the SPAC’s CEO was a minority shareholder. The severest sanctions were assessed against Momentus, which was charged with scienter-based securities fraud and agreed to a settlement including a $7 million penalty and the retention of an independent consultant to review its disclosure practices.[6] By contrast, SRAC settled to non-scienter-based charges and agreed to pay a $1 million penalty. Significantly, both Momentus and SRAC were required to notify the PIPE investors of their right to terminate their subscription agreements.[7] SRAC’s CEO agreed to pay a $40,000 penalty, and the SPAC funding vehicle in which he is a minority shareholder agreed to forgo founders shares it was otherwise due to receive upon shareholder approval of the deSPAC.[8] All of the settling parties neither admitted nor denied the SEC’s allegations, and were subject to cease-and-desist orders. Momentus’s former CEO is litigating the SEC’s charges.[9]

It is no secret that the SEC has taken a skeptical view of the proliferation of SPACs and deSPAC transactions in lieu of traditional initial public offerings. Since late last year, the staff of the agency’s Division of Corporation Finance has issued multiple warnings regarding potential liability arising from deSPACs, including with regard to financial projections by target companies.[10] Consistent with the agency’s stated concerns, we expect that the Momentus case is just the beginning of a wave of SEC enforcement activity against participants in deSPAC transactions.

If you have any questions concerning the material discussed in this client alert, please contact the following members of our Securities Litigation and Enforcement practice.