Based on select SPAC contract reviews, this month the SEC issued a statement that has brought attention to a common accounting practice related to SPACs, or special purchase acquisition companies. The statement raises the question of whether classifying warrants as equity within financial statements is appropriate and whether the classification truly represents the provisions and characteristics of the warrant in accordance with the entity’s contract.
The SEC’s interest in how warrants are recorded may have an impact on accounting and financial reporting for SPACs, but it is does not change the market value or economics of a deal.
This is the latest in a series of recent SEC statements that reflect the SEC’s continued focus and increased scrutiny of filings by SPACs and their targets. This statement follows last month’s SEC investor alert regarding celebrity endorsement of SPACs and the caution to investors to consider all the distinct risks before deciding on their investment of choice.
These may be early signs of further tightening of regulations and an effort to control the SPAC craze, support shareholder advocates, increase transparency and reduce market risk. The 400+ active SPACs now have one more important aspect to consider. With Chair Gensler taking the reins of the SEC it will be interesting to see what changes the next few months may bring.
In the staff statement, the SEC pointed to two SPAC filings the staff had examined that raised this question and in both cases, the statement suggested that the instrument may have been misclassified as equity and should have been recognized as a liability measured at fair value, with changes in fair value reported through earnings in each period.
The staff statement is likely to prompt a more in-depth review of SPAC filings and disclosures, since warrants are common in a SPAC structure and the commonly used accounting practice has been to classify them as equity within the financial statements. A careful reading of each SPAC’s contractual warrant provisions will be required to determine whether asset\liability treatment is applicable rather than equity treatment.
The SEC statement also discussed the financial reporting considerations that apply if a registrant and its auditors determine there is an error in any previously-filed financial statements, reminding filers that if the impact of such change in accounting treatment is material it could require a restatement of previously issued financial statements.
Regardless of the stage they are in, this statement is likely to cause a widespread review of SPAC filings to determine appropriate classification. Companies should also closely review Financial Accounting Standards Board Accounting Standards Codification 815-40 - Contracts in Entity’s Own Equity, to fully understand the accounting implications when assessing their contracts.
In the short term, this may slow down the current frenzied pace of SPAC deals, but it is unclear what impact it will have on the investment climate or viability of SPAC investments in the long term.
For more information about the SEC statement and the impact on SPAC contracts, contact us. We are here to help.