On July 13, 2021, the Securities and Exchange Commission announced partially settled charges against the Special Purpose Acquisition Company Stable Road Acquisition Co. (SRA), SRA’s sponsor and CEO, SRA’s target Momentus Inc. and Momentus’ CEO Mikhail Kokorich in connection with SRA’s proposed merger with Momentus. The SEC charged Momentus — a space infrastructure company — and Kokorich with alleged violations of the antifraud provisions of the securities laws for misrepresenting that Momentus’ technology had been successfully tested in space and making misleading claims about Kokorich. The SEC charged SRA, its CEO and its sponsor under negligence-based antifraud provisions, including those relating to proxy solicitations, stemming from their alleged failure to conduct adequate due diligence before adopting and disseminating those misrepresentations in anticipation of the merger.
Importantly, the SEC’s enforcement action highlights the extensive scrutiny it will impose on a SPAC’s diligence of its target. By taking enforcement action against the SPAC and its sponsor, arguably themselves the victims of the target’s deception, the SEC underscored that it expects SPACs to take reasonable steps to assure the truth of statements received from the target concerning the merging business before those statements are incorporated into the SPAC’s securities filings. Those diligence requirements mirror those imposed upon underwriters in traditional securities offerings, rather than those that buyers have historically undertaken in merger transactions.
What Are SPACs?
As described in prior Kramer Levin client alerts, SPACs are entities that raise a pool of cash in an initial public offering and deposit the proceeds from the IPO into a trust account. These funds are used solely to acquire an operating company, referenced as a target, in a business combination transaction. The SPAC is required to complete an initial business combination, referred to as a “de-SPAC” transaction, typically within two years of the SPAC IPO date. The sponsor of the SPAC — a sophisticated financial practitioner that forms the SPAC — will purchase warrants in an amount equal to the 2.0% upfront underwriting discount of the IPO, plus funds to cover the offering expenses and expenses to find a target. The sponsor pays a minimal amount, typically $25,000, for founder shares, which typically represent approximately 20% of the shares outstanding at the time of the SPAC’s IPO. If the SPAC fails to complete a business combination within the two-year period, the SPAC liquidates and the funds in the trust account are returned to the public shareholders.
Summary of the Action
In the second half of 2020, SRA and Momentus negotiated a transaction that would result in Momentus going public through a de-SPAC business combination with SRA. Momentus and SRA announced their merger agreement on Oct. 7, 2020. On the same day, SRA entered into subscription agreements with private investment in public equity (PIPE) investors, by which the PIPE investors agreed to inject $175 million into Momentus by purchasing 17,500,000 shares of common stock of the merged company for $10.00 per share when the de-SPAC transaction was approved.
Momentus’ business plans and revenue projections, as provided to PIPE investors and described in SRA’s Form S-4 registration statement/proxy statement filed in anticipation of the merger, were premised on Momentus’ development of viable technology that it could use to offer commercial space services on U.S.-based launches. Momentus’ ability to participate in those launches to space also required approval from various federal agencies.
The SEC charged Momentus and Kokorich with misleading SRA’s investors — including the PIPE investors — in alleged violation of the antifraud provisions of the securities laws in two ways. First, Momentus claimed that in 2019 it had successfully tested its key technology in space. However, the SEC alleged that the 2019 test actually failed to meet Momentus’ own public and internal pre-launch criteria for success, and was conducted on a prototype that was not designed to generate commercially significant thrust. Second, the SEC alleged that Kokorich and Momentus concealed and made false statements about U.S. government concerns with national security and foreign ownership risks posed by Kokorich that would affect Momentus’ ability to receive the necessary licenses to operate its business and participate in launches to space.
Of significant note, the SEC also charged SRA, its sponsor and its CEO under negligence-based antifraud provisions, including those relating to proxy solicitations, stemming from their alleged failure to perform reasonable due diligence on Momentus’ claims concerning its space technology and Kokorich’s national security issues before adopting and disseminating those claims to investors in its securities filings. Even though SRA’s disclosures were the product of misrepresentations received from Momentus and Kokorich, the SEC nevertheless alleged that SRA failed to conduct adequate due diligence into those misrepresentations and was therefore negligent and itself responsible for the misrepresentations. In its Administrative Order, the SEC stated that SRA’s due diligence of Momentus, which SRA began only “a little more than a month before the merger announcement,” was conducted “in a compressed timeframe and unreasonably failed . . . to probe the basis of Momentus’ claims.” Underscoring the point, in announcing the charges, SEC Chair Gary Gensler stated that “‘[t]his 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. . . . The fact that [the target] lied to [the SPAC] does not absolve [the SPAC] of its failure to undertake adequate due diligence to protect shareholders.’”
SRA, its sponsor and its CEO consented to violations or causing violations of negligence-based antifraud provisions (including Sections 17(a)(3) of the Securities Act and 14(a) of the Exchange Act and Rule 14a-9). SRA paid a penalty of $1 million and its CEO paid a penalty of $40,000. SRA’s sponsor also agreed to forfeit 250,000 of its founder shares if the merger receives shareholder approval. SRA and Momentus also agreed to offer PIPE investors the opportunity to terminate their subscription agreement. The SEC settled the charges against Momentus, which consented to a finding that it violated antifraud provisions of the securities laws (including Section 10(b) of the Exchange Act), for $7 million. The case against Kokorich is proceeding in the U.S. District Court for the District of Columbia (SEC v. Kokorich, 21 Civ. 1869).
Relatedly, on July 16, 2021, an SRA investor filed a proposed securities class action in federal court in Los Angeles on behalf of those who purchased SRA shares between the date of the press release announcing the merger through July 13, 2021, when the SEC filed its action. The securities complaint asserts fraud-based claims under Section 10b, Rule 10b-5, and Section 20(a) of the Exchange Act predicated on the same alleged misrepresentations, against the same parties charged in the SEC probe (Jensen v. Stable Road Acquisition Corp., et al., 21 Civ. 5744 (C.D. Cal.)).
While the SEC has previously issued warnings about SPAC transactions, this action brings to bear the following takeaways concerning the SEC’s SPAC-related enforcement objectives:
- A SPAC, even if it is the victim of misrepresentations from its target, can face SEC sanctions if it adopts and disseminates those misrepresentations before carrying out what the SEC deems to be adequate and reasonable due diligence. Accordingly, SPACs should undertake robust due diligence, and document those diligence efforts, to ensure that any disclosures about its target are accurate.
- SRA’s Form S-4 registration statement/proxy statement in this case had not yet been declared effective by the SEC, but the SEC nonetheless imposed sanctions upon the SPAC that went significantly beyond corrective disclosures. A SPAC and its sponsor should take care to vet adequately any disclosures concerning its target with respect to preliminary filings.
- In view of the heightened scrutiny to which SPAC transactions remain subject and the potential conflicts that plaintiffs in SPAC-related litigations and others have alleged, this action is a reminder that parties need to proceed with reasonable and due care, assure that they have an adequate and reasonable process for carrying out the transaction, and properly document that process as they go forward during the life of the SPAC.