SEC Enforcement Action Against SPAC, Sponsor, Merger Target, and CEOs for Misleading Statements
On July 13, 2021, the U.S. Securities and Exchange Commission (the “SEC”) filed an administrative enforcement action and announced a settlement with Stable Road Acquisition Corp. (“Stable Road”), a special purpose acquisition company (“SPAC”); SRC-NI Holdings, LLC, Stable Road’s sponsor (the “Sponsor”); Brian Kabot, Stable Road’s Chief Executive Officer and the Sponsor’s managing member (“Kabot”); and Momentus, Inc. (“Momentus”), the target of the proposed merger with Stable Road. On the same date, the SEC filed a civil lawsuit against Mikhail Kokorich, Momentus’ former Chief Executive Officer (“Kokorich”), in the U.S. District Court for the District of Columbia. The claims in both proceedings concern misleading statements by Momentus and Stable Road and, more notably, negligence in the conduct of due diligence by Stable Road. All parties other than Kokorich have settled with the SEC.
Momentus is a privately held space transportation company that offers space infrastructure and satellite positioning services. Stable Road is a Delaware SPAC that closed its initial public offering in November 2019, and in October 2020, entered into a merger agreement with Momentus valued at $1.1 billion on the announcement of the deal. In connection with the proposed merger, Stable Road also received investment commitments through private investment in public equity (“PIPE”) totaling $175 million. The enterprise valuation was reported by Stable Road to be $566.6 million in June 2021.
The SEC’s cease-and-desist order (the “Order”), incorporated in the settlement,1 finds that Stable Road violated negligence-based antifraud provisions and reporting and proxy solicitation rules, and that Kabot participated in Stable Road’s insufficient due diligence and in filing its misleading and incorrect registration statements and proxy solicitations. Further the Order found that Kabot and SRC-NI caused Stable Road’s violations of the “scheme” liability provisions contained in 17(a)(3) of the Securities Act of 1933, as amended.
More specifically, the Order states that Momentus misrepresented and made materially false statements with respect to (1) the success of a test conducted in space involving its key technology, and (2) the extent to which national security concerns surrounding Kokorich, a foreign national, impacted Momentus’ business and ability to meet revenue projections. Both Momentus and Stable Road claimed in 2019 that Momentus had “successfully tested” a technology that was designed to move a satellite into custom orbit after launch, when in fact, the test failed to meet Momentus’ public and internal criteria for success. And while Momentus and Stable Road had disclosed potential CFIUS restrictions due to Kokorich’s status as a foreign national, the SEC found that investors lacked material information about the extent to which his status could jeopardize Momentus’ launch schedule and revenue projections.
The Order also states that Stable Road was negligent in its conduct of due diligence, which compounded Momentus’ and Kokorich’s misrepresentations, resulting in materially false and misleading information being included in public filings and distributed to investors. In particular, the SEC highlighted the compressed timeline of the due diligence process, the fact that Stable Road did not engage its own technology consulting firm to review Momentus’ product test, and Stable Road’s failure to review the documents pertaining to a CFIUS divestiture order against Kokorich, even though Stable Road had requested such documents and was falsely informed by Momentus that they were not in Momentus’ possession.
The parties, with the exception of Kokorich, agreed to a settlement pursuant to which (1) Momentus, Stable Road and Kabot will pay civil penalties of $7 million, $1 million and $40,000, respectively; (2) all investors in the PIPE may terminate their subscription agreements; (3) the Sponsor will forfeit 250,000 founder shares that it owns in Stable Road; and (4) Momentus will substantially enhance its disclosure controls, including the creation of an independent committee and retention of an independent consultant.
The SEC’s lawsuit against Kokorich in the District of Columbia is still pending, and alleges violation of antifraud provisions and aiding and abetting Momentus’ violations. The SEC is seeking injunctive relief, civil penalties, disgorgement plus prejudgment interest, and an officer-director bar against Kokorich.
This action comes at the heels of other warnings and statements issued by the SEC over the previous months reflecting enhanced scrutiny of SPACs and SPAC-related transactions, and has important implications for companies contemplating a future acquisition through a SPAC. The Order, in combination with various commentary by SEC officials, highlights the SEC’s concern that conflicts of interest and misalignments in incentives may lead to superficial and insufficient diligence and false and misleading disclosures. For instance, since the sponsor stands to gain significant profits if a business combination is consummated (even if the combined business is not successful post-closing), and may lose substantial invested capital if no business combination occurs, the SEC is concerned that a sponsor may not be incentivized to undertake the careful and methodical approach to due diligence that is typical of a traditional M&A deal. The SEC is therefore requiring SPACs to conduct appropriate and adequate diligence, and not merely rely without investigation on target company statements. The fact that a target withholds truthful information from, or makes false claims to, a SPAC does not absolve the SPAC from being charged with failure to conduct adequate due diligence. The onus is on the SPAC and its sponsor to perform a thorough due diligence review on a timeline sufficient for such review. All potential issues that are flagged during the diligence process should be identified and properly investigated, and statements by the target should be evaluated for accuracy. Additionally, all filings made by a SPAC should be prepared with the same level of care as those in connection with traditional IPOs.
Further, the SEC, through its litigation against Kokorich, is signaling its commitment to hold individuals accountable for statements to investors in connection with SPACs.
It is important to note that failure to adhere to the standards set forth by the SEC poses significant risks to SPACs and de-SPAC transactions. The sponsor’s obligation to forfeit founder shares in the settlement further reflects the SEC’s focus on holding founders accountable for actions undertaken by a SPAC, and coupled with the ability of PIPE investors to terminate their subscription agreements, can result in substantial loss of previously committed capital of the SPAC.