The SEC has announced charges against Stable Road Acquisition Corp. (a SPAC), SRC-NI (its sponsor), Brian Kabot (its CEO), Momentus, Inc. (the SPAC’s proposed merger target), and Mikhail Kokorich (Momentus’s founder and former CEO) for misleading claims about Momentus’s technology and about national security risks associated with Kokorich. All the parties have settled other than Kokorich, against whom the SEC has filed a separate complaint. Under the Order, the settling parties agreed to aggregate penalties of over $8 million and voluminous, specific investor protection undertakings. The SPAC sponsor also agreed to forfeit the founder’s shares that it would otherwise have received if the merger were approved. The merger vote is currently scheduled for August 2021. SEC Chair Gary Gensler weighed in—a rare comment on a litigation settlement, perhaps signaling the significance of the case: “This 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….Stable Road, a SPAC, and its merger target, Momentus, both misled the investing public. The fact that Momentus lied to Stable Road does not absolve Stable Road of its failure to undertake adequate due diligence to protect shareholders. Today’s actions will prevent the wrongdoers from benefitting at the expense of investors and help to better align the incentives of parties to a SPAC transaction with those of investors relying on truthful information to make investment decisions.”

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According to Reuters, analysts think the SEC has been “worried about how much due diligence is performed by SPACs before acquiring assets, and about disclosures to investors,” and SEC officials have previously expressed concerns about the adequacy of due diligence on proposed merger targets. For example, former Corp Fin Director John Coates (currently General Counsel) has questioned the widespread belief that SPACs retain the protection of the safe harbor for forward-looking statements in the PSLRA. In that case, he asked, “[d]o 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?” There is no “free pass” for material misstatements or omissions in de-SPAC transactions, he maintained. (See this PubCo post.)

Momentus, a private company that “aspires to provide space infrastructure services,” was seeking to go public through a SPAC transaction with Stable Road Acquisition Corp (SRAC). The transaction had the potential to generate “considerable value” for Kokorich, Momentus, Kabot, and SRC-NI (SRAC’s sponsor, of which Kabot is a managing member) as a result of the stakes they would receive in the new public company. On the date that the de-SPAC merger agreement was announced, SRAC also entered into subscription agreements with PIPE investors to invest in Momentus to the tune of $175 million through the purchase of 17,500,000 shares of common stock of the merged company after approval of the merger.

As described in the Order, Momentus provided business plans and multi-billion dollar revenue projections to the PIPE investors and to SRAC for its Form S-4 registration/proxy statement in connection with the proposed merger. The plans and projections were based on “Momentus’s development of commercially viable technology that it could employ to provide commercial space services to customers in the near-term on U.S.-based launches.” However, the SEC charged, the information provided was misleading in two key respects:

The failed test. First, Momentus and Kokorich claimed that Momentus had “successfully tested” its key technology in space—a “microwave electro-thermal (‘MET’) water plasma thruster, that Momentus claimed was designed to move a satellite into custom orbit after launch.” But, the Order alleged, Momentus had tested its MET water propulsion thruster in space only once, when it placed its 2019 version of the thruster on a third-party satellite to demonstrate the thruster’s ability to provide commercial launch services. However, the 2019 thruster was not sufficiently powerful, and the test failed to meet “Momentus’s own public and internal pre-launch criteria for success.” As described in the Order, the test mission “did not demonstrate the thruster’s ability to provide commercial launch services. The mission yielded no data to suggest that the 2019 version of the thruster would deliver an impulse of any commercial significance, failed to demonstrate the propulsion system’s reliability of longevity, and did not characterize the performance of the thrusters.” Kokorich was “informed of all relevant aspects of the test results, including the creation of a “failure review board.” But, according to the Order, in a 2019 article in Space News, Kokorich promoted the company’s success in testing water plasma propulsion, making a number of false claims.

Before the merger agreement was signed, Momentus and Kokorich told SRAC and Kabot that its test “mission was a success but did not inform them of any internal concerns or shortcomings with the in-space test.” SRAC, as a SPAC, had 18 months after its IPO to identify a target and complete an acquisition or face dissolution. SRAC originally had focused on cannabis companies, but, in June 2020, SRAC had still not identified a target, and Kabot and Kokorich began negotiations about the target space company. SRAC engaged a number of companies to assist with due diligence, including a “space technology consulting firm with the expertise to investigate the state of development of Momentus’s technology.” However, the timeframe for due diligence was compressed; that substantive due diligence began only a month or so before the merger announcement. The consulting firm was engaged to perform a rapid technical assessment, which was expected to take two weeks, but stretched into four. The Order points out that SRAC did not specifically direct the consulting firm to review the test mission, and Momentus suggested it was no longer relevant since its technology had moved past it. As a result, “the consulting firm did not evaluate the mission’s results or review any related data or other information,” and its report did not mention the failed test mission. SRAC nonetheless did not probe further and included the claims about the “successful test” in its S-4, signed by Kabot. SRAC also included Momentus’s financial projections, which were premised on commercial viability of the MET thruster. As alleged in the Order, the parties also made presentation slides for PIPE and institutional investors that included the successful test claim and filed them with the SEC.

The Order also stated that SRAC’s statements in its S-4 “gave investors the misleading impression that its due diligence extended to and independently verified the claim that Momentus’s technology had been ‘successfully tested’ in space,” but investors had “no way of knowing that the mission did not meet any of it[s] pre-launch goals.” The Order concluded that these misrepresentations and omissions were material, given that Momentus’s business plan depended on the commercial viability of its technology. Momentus knew the test was not a success and “knowingly or recklessly made the misrepresentations and omissions.”

Although Momentus did not share its internal information about the test with SRAC or Kabot, the SEC charged that “SRAC nevertheless acted unreasonably in adopting and repeating Momentus’s claim that it had successfully tested its technology in space when it had not conducted any specific due diligence to evaluate and verify the accuracy of that material assertion.” It was not until the third amendment to the S-4 filed in June 2021, that Momentus and SRAC disclosed that the test mission “did not demonstrate the MET’s ability to generate thrust in space, which is crucial to our ability to maneuver objects in space.”

SideBar

At a House subcommittee hearing in June, “Going Public: SPACs, Direct Listings, Public Offerings, and the Need for Investor Protections,” a law professor testifying on SPACs introduced the metaphor of a wedding, comparing the traditional wedding to the traditional IPO, with all the prep and long-term planning that goes into both: with an IPO, the company starts out many months ahead in selecting bankers who vet the company, preparation of a prospectus, working through the SEC comment process and going on a roadshow. A SPAC, however, was more like a Las Vegas wedding—a quick wedding that ends up in marriage, to be sure, just like the SPAC process ends up in a publicly traded company, but without the same level of preparation and vetting. As a result, she supported extending potential Section 11 liability and eliminating the safe harbor for forward-looking statements for SPACs. (See this PubCo post.)

National security concerns. Second, the Order contends, both Kokorich and Momentus knew, but did not disclose, information about U.S. government concerns with national security and foreign ownership risks posed by Kokorich. For example, Kokorich’s status as a foreign national limited his access to parts of Momentus’s technology without an export license. In March 2018, Momentus’s application for that license was denied by the Government on the basis that “Kokorich was not an ’acceptable recipient’ of U.S. origin-items controlled for national security reasons.” A second application was later also denied. Similarly, CFIUS had previously ordered Kokorich to divest his ownership interest in another space company because it “considered Kokorich to be a ‘threat’” that caused his ownership to “be a risk to national security.” While the CFIUS divestment was disclosed in the S-4, it “did not disclose CFIUS’s express concerns with Kokorich himself.”

The SEC considered these issues related to Kokorich to be material to investors because they affected Momentus’s ability to obtain licenses necessary for Momentus to participate in launches and execute its business plan. For example, Momentus was scheduled to participate in the company’s first commercial flight, a third party’s launch, in January 2021. But the FAA would not permit the launch with Momentus’s payload on board. Soon after, Momentus and SRAC learned of “correspondence from the Defense Department stating that Momentus posed a risk to national security as a result of its association with Kokorich. To address this [issue], Kokorich formally stepped down as CEO of Momentus on January 25, 2021 and on March 31, 2021, placed his shares of Momentus stock in a voting trust.” His request for political asylum was denied and he left the U.S. in January 2021. Nevertheless, the FAA continued to deny approval on national security grounds as a result of Kokorich’s continued ownership interest in the company. Although Kokorich ultimately agreed to fully divest and an agreement was signed with CFIUS for increased security measures, the resolution of these issues led to a delay of the expected launch until 2022.

While Momentus and Kokorich did not advise SRAC and Kabot of the extent of Kokorich’s national security issues, the SEC still charged that SRAC “conducted inadequate due diligence related to Kokorich’s forced divestiture in 2018 from a prior space technology company and his status as a national security risk generally.” SRAC received only a copy of CFIUS’s final order but, despite repeated requests, no other documents that would help SRAC understand the basis for the order. Momentus said that it did not possess any other correspondence or documents, although they were in the possession of Kokorich. Nevertheless, SRAC did not follow up on these red flags and instead went ahead and executed the merger agreement, filing the S-4 in November 2020.

According to the Order, the S-4 contained “false statements and misleading omissions regarding the U.S. government’s national security concerns about Kokorich.” It was not until January 2021, when Kokorich resigned, that SRAC disclosed the existence of general national security risks, and until March 2021 that SRAC “disclosed further material details about those concerns and their impact on Momentus and the merger.” For example, “Risk Factors” stated that Momentus believed “Kokorich’s asylum application would be granted, but failed to disclose the fact that Kokorich was considered a national security risk and thus less likely to obtain asylum.” “Risk Factors” also disclosed that Kokorich had not “yet” obtained an export control license, but did not explain that the first application had been denied because of national security concerns. The SEC viewed those omissions to be “materially misleading because they left investors with the impression that Momentus anticipated that Kokorich would ultimately receive an export control license, when in fact the company knew or was reckless in not knowing that it would likely not be granted.”

What’s more, the S-4 included projections that Momentus’s revenues would grow from zero revenues in 2019 to revenues of over $4 billion in 2027, but the projections did not take into account the impact of potential delays resulting from national security concerns. By the time of SRAC’s June 2021 amendment, the financial projections were cut substantially as a result of those delays, contributing to a reduction in the enterprise valuation of Momentus by almost 50%.

SEC charges and penalties. The SEC charged that Momentus violated Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, which are scienter-based prohibitions on fraudulent conduct in the offer or sale of securities and in connection with the purchase or sale of securities, and that it also caused SRAC’s violations. SRAC was charged with violating Sections 17(a)(2) and (3) of the Securities Act, which are negligence-based prohibitions, Section 14(a) of the Exchange Act and Rule 14a-9 thereunder, which are prohibitions on the solicitation of a proxy by means of a proxy statement containing a material false statement, and Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-11 thereunder, which prohibit issuers from filing reports, including Forms 8-K, that contain materially false or misleading information. SRC-NI, the SPAC sponsor, and Kabot were charged with causing SRAC’s violations of Section 17(a)(3) of the Securities Act, and Kabot was also charged with violating Section 14(a) of the Exchange Act and Rule 14a-9 thereunder.

Momentus, SRAC and Kabot agreed to pay civil penalties of $7 million, $1 million and $40,000, respectively. Momentus and SRAC have also agreed to allow the PIPE investors to terminate their subscription agreements prior to the shareholder vote on the merger. SRC-NI has agreed to forfeit the 250,000 founders’ shares it would otherwise have received upon consummation of the de-SPAC merger, and Momentus has agreed to “undertakings requiring enhancements to its disclosure controls, including the creation of an independent board committee and retention of an internal compliance consultant for a period of two years.”

As noted above, Kokorich did not agree to settle with the SEC. The SEC’s complaint against him alleges that “Kokorich violated antifraud provisions of the securities laws and aided and abetted Momentus’s violations of the same provisions. The complaint seeks permanent injunctions, penalties, disgorgement plus prejudgment interest, and an officer-and-director bar against Kokorich.”

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The SEC is not just focused on due diligence by SPACs. Reuters is reporting exclusively that the SEC has “ramped up” its SPAC inquiries, with a current focus on “potential conflicts of interest created when banks act as underwriters and advisers on the same deal.” According to the article, at issue is whether “certain fee structures may incentivize underwriters [of SPAC] listings to secure unsuitable deals when also advising on the later stage merger….” Since March, Reuters reports, the SEC has been investigating SPAC deals, “sending letters to several institutions seeking information on deal risks and internal controls,” looking in particular at potential conflicts created by fees paid when banks have participated in multiple stages of the transaction. According to the article, banks earn an underwriting fee in connection with the SPAC IPO, part of which is withheld until the completion of the de-SPAC merger, but, if they also represent the merger target or assist the SPAC sponsor in raising additional funds from private investors, such as in PIPE transactions, they obviously stand to earn more. Critics charge that a bank that acts as an underwriter and merger advisor may be incentivized “to talk up targets or play down potential problems, which could harm investors if the target company’s earnings underperform, or other regulatory or legal issues emerge following the merger.” Reuters reports that the SEC has requested information about fees, as well as due diligence the bankers performed “on SPAC mergers, including when reviewing revenue growth projections and other disclosures made by the target companies.” According to Reuters, the “increased scrutiny has prompted some banks to review their processes and increase due diligence,” as well as “more frequently separating the underwriting and advisory roles.”