On July 13, 2021, the Securities and Exchange Commission (“SEC”) announced a major enforcement action related to a proposed merger between a special purpose acquisition company (“SPAC”) and a privately held target company (“Target”). This followed numerous warnings by the SEC staff over several months of enhanced scrutiny of such transactions under the federal securities laws. The respondents, except for the Target’s CEO, settled the action by collectively agreeing to civil penalties of approximately $8 million and to certain equitable relief described below. 
Background of the Allegations
The SPAC, Stable Road Acquisition Company, raised $172.5 million in an IPO in November 2019 and considered a number of possible merger targets before entering into a merger agreement with the Target, Momentus, in October 2020. In connection with the merger (or “de-SPAC”) transaction, the SPAC engaged in a private placement of shares (referred to as a “PIPE transaction”), securing investor commitments in an aggregate amount of $175 million.
The SPAC filed with the SEC a registration statement with respect to the merger in November 2020. In late January 2021, the SEC issued a subpoena to the SPAC, and around the same time the Target’s CEO resigned from his position. The announcement of a settlement in July 2021 represents an unusually fast resolution of the matter, presumably reflecting urgency for both the SPAC, which is still seeking to complete its de-SPAC transaction before it is required to return its capital to shareholders, and the SEC, which presumably intended to convey an important message to SPACs and their sponsors.
The SEC alleged that disclosures in the SPAC’s registration statement and other public statements were inaccurate because they misstated key testing results surrounding the Target’s technology and failed to disclose certain national security risks related to the Target’s CEO. As alleged by the SEC:
- The SPAC misrepresented in public filings that the Target’s key technology had been successfully tested, when in fact it failed to meet the Target’s own criteria for success. These statements were also contained in slide presentations given by Target and filed with the SEC by the SPAC. The SPAC additionally stated in its registration statement that it had conducted “extensive due diligence” into the Target’s technology.
- The SPAC failed to disclose that the Committee on Foreign Investment in the United States (“CFIUS”) had ordered the Target’s CEO to divest his interest in the Target approximately two years earlier, or that the Commerce Department had denied the CEO’s application for an export license—which was necessary for the CEO to access part of the Target’s technology—for reasons related to national security.
Charges Against the SPAC, Sponsor, and SPAC’s CEO
The charges against the SPAC, the Sponsor, and the SPAC’s CEO were based on allegations of negligence in the conduct of their due diligence. Specifically, the SEC alleged that these parties failed their “due diligence obligations to investors” by failing to review the key product testing results or certain documents relevant to the Target CEO’s national security risk. In this regard, the SEC alleged that the SPAC’s diligence was insufficient in that: (1) the SPAC did not ask its technology consulting firm to review the Target’s product test; and (2) the SPAC did not review documents related to the CFIUS divestiture order against the Target’s CEO (which the SPAC had requested but the Target falsely claimed it did not possess). Underscoring the SEC’s due diligence expectations, in announcing the action, SEC Chair Gary Gensler stated that “[t]he fact that [the Target] lied to [the SPAC] does not absolve [the SPAC] of its failure to undertake adequate due diligence to protect shareholders.”
The SPAC consented to an order stating violations of negligence-based anti-fraud provisions and those relating to proxy solicitations, including Sections 17(a)(2) and (3) of the Securities Act of 1933 (the “Securities Act”), Section 13(a) and 14(a) of the Securities Exchange Act of 1934 (the “Exchange Act”) and Rules 12b-20, 13a-11 and 14a-9 thereunder. The SPAC’s Sponsor and the SPAC’s CEO consented to an order stating violations as a result of their causing the SPAC’s violations of Section 17(a)(3) of the Securities Act, and the SPAC’s CEO consented to an order stating violations of Section 14(a) of the Exchange Act and Rule 14a-9 thereunder.
Charges Against the Target and Target’s CEO
The SEC also charged the Target and its CEO with scienter-based fraudulent conduct, including in violation of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and with causing the SPAC to engage in its securities law violations. The Target settled the action, while the Target’s CEO has indicated that he will contest the claims against him.
In addition to agreeing to cease and desist from future violations, the settling parties agreed to pay penalties of $1 million for the SPAC, $7 million for the Target, and $40,000 for the SPAC’s CEO. The SEC also imposed targeted equitable remedies, including (1) agreement by the Sponsor to forfeit 250,000 founder shares (approximately 6% of the total founder shares), (2) agreement by the SPAC and the Target to let PIPE investors terminate their commitments, and (3) agreement by the Target to governance-related undertakings, including the creation of an independent board committee and the retention of an internal compliance consultant for a period of two years.
- The SEC has expressed concern about the lack of gatekeepers in connection with SPACs, and questioned 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.” This action, based on the view that the sponsor had “due diligence obligations to investors,” seems to reflect an attempt by the SEC to require SPAC sponsors (and others in a position to conduct due diligence) to play a more active gatekeeping role.
- The SEC apparently used the leverage of the SPAC’s impending de-SPAC deadline to obtain a prompt settlement and consent decree establishing the due diligence obligations of sponsors. Importantly, the SEC did not prevent the de-SPAC transaction from being considered by the SPAC’s shareholders. Rather, shareholders will have the opportunity to vote and exercise redemption rights with the benefit of more robust disclosure. Of course, civil claims have already been asserted against the SPAC and will continue, including a securities fraud class action filed yesterday on behalf of SPAC shareholders citing the SEC’s allegations and enforcement action.
- The remedies have been carefully calibrated between the Target, the SPAC, the SPAC’s CEO, and the Sponsor. Notably, the Sponsor will give up part of its promote, and the PIPE investors will get a chance to withdraw before closing.
 See our prior post here on a Statement on Disclosure Risks Arising from De-SPAC Transactions issued by the Acting Director of the SEC’s Corporate Finance Division: https://www.clearygottlieb.com/news-and-insights/publication-listing/acting-director-of-secs-corp-fin-issues-statement-on-disclosure-risks.
 The defendants are: the SPAC, Stable Road Acquisition Company; the SPAC’s sponsor, SRC-NI; the SPAC’s CEO, Brian Kabot; the Target, Momentus Inc.; and the Target’s founder and former CEO, Mikhail Kokorich.
 SPACs typically are required to return to shareholders the funds raised in their IPO if they fail to engage in a de-SPAC transaction within two years following the IPO.
 John Coates, Acting Director of the SEC’s Corporate Finance Division, Statement on SPACs, IPOs and Liability Risk under the Securities Laws, https://www.sec.gov/news/public-statement/spacs-ipos-liability-risk-under-securities-laws (April 8, 2021).