It's been weeks since the SEC last took SPACs to task! According to Bloomberg, the SEC is now requiring many SPACs to "Big R" restate their financial statements because they tripped over the classification of certain shares they offered to investors. Auditors with whom Bloomberg spoke said that the latest SPAC accounting snafu relates to incorrect categorization of Class A shares-which are typically redeemable-as "permanent equity instead of temporary equity." One auditor described the issue as "pervasive[:] everyone's dealing with it because everyone did it wrong."
SPACs typically issue non-redeemable founders' shares and redeemable Class A shares as part of their capital structures. The redemption feature in the Class A shares provides part of the appeal of SPACs for many investors: if they aren't satisfied with the de-SPAC merger transaction, they can simply redeem their shares for cash. However, under ASC 480, "if an equity instrument is redeemable and this redemption feature is outside the control of the company, that instrument can't be considered permanent," advised another auditor, whose firm, he insisted, consistently applied the proper accounting treatment.
Apparently, "most audit firms considered the errors small enough to be fixable with a revision, a minor correction that gets disclosed in the next period's financial statement," the article reports. However, according to one auditor cited in the article, "the SEC came back and made it clear that they believe it's a big R." That means that, instead of a simple "little r" revision, companies will need to file a "Big R" restatement, requiring them to file an 8-K reporting that the financial statements may no longer be relied on and to complete a more time-consuming and complicated restatement of their financial statements. However, that chore may be a bit lighter than normal. One audit firm reported being advised by the SEC that it "won't require SPACs to amend their old 10-Qs, as is the case with typical 'Big R' restatements. Instead, SPACs can offer details about the corrections in their next filing." Nevertheless, it was "unclear" how the SEC would approach corrections for past annual financial statements.
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This isn't the first classification glitch that SPACs have encountered. In April 2021, then-Acting Corp Fin Director John Coates and Acting Chief Accountant Paul Munter issued this Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies ("SPACs"). The primary issue identified in the Statement was whether the warrants issued in connection with de-SPAC transactions should be classified as equity or liability, which depends largely on the specific terms of the warrant and the entity's specific facts and circumstances. If warrants are classified as a liability, according to the Statement, they should be "measured at fair value, with changes in fair value reported each period in earnings." If the company and its auditors determined that, in light of this Statement, there was an error regarding the classification of warrants in previously filed financials, the company had to consider the materiality of the error in assessing whether it needed to restate its financials-which could involve amending one or more periodic reports-and file an 8-K. In addition, the Statement observed, the company needed to consider whether it had to upgrade its ICFR and disclosure controls and procedures and amend its prior disclosures on the evaluation of ICFR and disclosure controls. That analysis required consideration of the severity of the control deficiency, if any, individually or in the aggregate. The Statement cautioned that the "evaluation of the severity of any control deficiency should not be limited to the actual misstatement that occurred or whether that misstatement was material, but instead should consider the magnitude of the potential misstatement resulting from the deficiency or deficiencies, amongst other considerations. Where applicable, the auditor also will have to evaluate management's assessment." (See this PubCo post.)
Bloomberg reports that over 170 of the 200-plus companies that had announced restatements as of May 15 were SPACs, citing data from Audit Analytics. Moreover, the "number of accounting mistake admissions in the [preceding] month alone is almost double all of 2020's restatements combined." What's more, the SPAC-related errors were largely attributable to warrant misclassifications. In addition, according to a study by Audit Analytics, the increase in SPAC transactions and the SEC's April statement on SPAC warrants led to a number of adverse internal control assessments related to debt and/or equity classification. Audit Analytics reported a significant increase in accounting issues "related to the recording of debt and warrants and debt/equity classification," with the recording of debt and warrants becoming the sixth most common issue in adverse attestations. By comparison, these issues did not even figure in the top ten in the previous five years. (See this PubCo post.)
The auditors cited in the article believe that this equity classification snag "isn't likely to cause as much of a disruption" as the stumble over warrant classification because the equity classification errors "do not affect the cash or the economics of a SPAC." Still, the burden of implementing the restatement remains, and the issue could certainly interfere with SPAC timetables: "That's because most SPACs need to maintain tangible assets of a certain amount to consummate a business combination. If their permanent equity dips, it can tie up a deal."
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