“Do Your Homework!”: SEC Order Sends Strong Message to SPAC Participants on Due Diligence
July 26, 2021
The Securities and Exchange Commission announced on July 13, 2021 that it settled fraud charges against a special purpose acquisition company, its sponsor, its sponsor’s CEO and its proposed merger target for making misleading statements about the target’s technology and national security concerns. Charges against the target’s CEO are proceeding. The settlement order imposes civil penalties on the target, the SPAC and the SPAC’s CEO of $7 million, $1 million and $40,000, respectively, and forfeiture by the sponsor of 250,000 shares it would have earned in the merger. It also gives PIPE investors the right to terminate their subscription agreements prior to the shareholder vote on the merger. The settlement order serves as a stark reminder to SPACs that they should not accept target company representations at face value and must conduct adequate due diligence on their proposed targets.
Momentus Inc. was organized in 2017 to provide “last mile” launch services that place satellites into orbit. Stable Road Acquisition Company (“SRAC”) completed its initial public offering as a SPAC (special purpose acquisition company) in November 2019 with gross proceeds of $172.5 million, and secured PIPE (private investments in public equity) investor commitments for an additional $175 million when it entered into a merger agreement with Momentus. As is typical for SPACs, it was required by the terms of its charter to complete an acquisition within two years or May 2021.
The Settlement Order
The settlement order states that Momentus and its CEO, Mikhail Kokorich, told investors on numerous occasions that Momentus had “successfully tested” its water propulsion technology in space. In fact, the testing failed to meet Momentus’ public and internal criteria for success. Momentus and Kokorich also misrepresented the extent to which national security concerns involving Kokorich as a “foreign person” jeopardized Momentus’ ability to secure governmental licenses, keep to its launch schedule and hit its revenue targets.
But the order also finds that SRAC’s due diligence of Momentus was inadequate because it was conducted in a compressed timeframe and failed to probe the basis of Momentus’ claims about its technology or follow up on red flags concerning national security and foreign ownership risks, resulting in the dissemination of false information to investors. The order further finds that SRAC’s CEO, Brian Kabot, participated in SRAC’s inadequate due diligence and inaccurate registration statements and proxy solicitations.
The order does state that SRAC engaged several firms to assist with due diligence, including a space technology consulting firm with the expertise to investigate the state of development of Momentus’ technology. However, SRAC did not retain the firm and begin its substantive due diligence on Momentus’ technology until a little more than one month before the merger announcement. SRAC did not specifically ask the consulting firm to review Momentus’ test mission results and, in response to the firm’s questions, Momentus suggested that the early-stage test launch was not relevant to their current work due to its development of the technology in the intervening sixteen months. As a result, the firm did not evaluate the test results or review any related data or other information, and the report it provided to SRAC made no mention of the test mission.
Nevertheless, SRAC included Momentus’ false claims in its S-4 registration statement, stating that Momentus had “successfully tested” its technology in space. SRAC also included Momentus’ financial projections, which were based in part on the assumption that Momentus’ technology was approaching commercial viability and buttressed by misleading claims about the success of the test mission. The Order finds that SRAC’s statements in its S-4 gave investors the misleading impression that its due diligence independently verified the claim that Momentus’ technology had been “successfully tested” in space. The order states that investors had no way to know that SRAC was merely repeating what it had been told by Kokorich and Momentus, since the due diligence concerning Momentus’ technology solutions and testing progress never examined the results of the test mission. The order states further that although Kokorich and Momentus never shared with SRAC and Kabot internal analyses about the mission’s failure, SRAC nevertheless acted unreasonably in adopting and repeating Momentus’s claim that it had successfully tested its technology in space when SRAC had not conducted any specific due diligence to evaluate and verify the accuracy of that material assertion.
Implications of the Order
The Order sends a strong message to SPACs, SPAC sponsors and SPAC management teams that they cannot take target business representations at face value, must conduct adequate due diligence to verify such representations independently and will be held accountable for a failure to do so. SPACs and their sponsors will be deemed to have acted unreasonably by repeating claims made by target companies if they fail to conduct specific due diligence to evaluate and verify the accuracy of such claims. To underscore the message, SEC Chairman Gary Gensler took the unusual step of making a statement in the order press release about the inherent conflicts in de-SPAC transactions and the due diligence obligations of SPACs. According to Chairman Gensler, “[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.” Further, “[t]he 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.”