Maya Pillai

Trust, but verify. This is a common methodology in the audit world and was even mentioned by the SEC Acting Chief Accountant Paul Munter in his statement on “The Auditor’s Responsibility for Fraud Detection.” [1]  He commented, “[T]he mindset of ‘trust but verify’ may represent potential bias if it is anchored in the belief that management is honest and has integrity.” Well, that is bold. We all want to believe that management has nothing but the purest intentions. But, what happens when this spotlight turns on the investor? Does the same principle exist?

Section 3(a)(11) of the Securities Act, known as the “intrastate offerings exemption,” provides small businesses with options to procure financing. [2]  Rule 147, the “safe harbor” rule under § 3(a)(11), lists objective criteria with which companies must comply. [3]  The newly loosened exemption, Rule 147A, permits issuers to make offers to out-of-state residents, as long as sales are only made to in-state residents and allows for a company to be incorporated out-of-state when its principal place of business remains in-state. [4]  (The limited framework of the SEC’s interpretation of § 3(a)(11) precludes issuers under Rule 147A from offering securities to out-of-state residents.) [5]  Deregulation is good, right? Well, it depends. Based on my study of these changes—and the caution given by Munter— the provision permitting issuers to rely on representations by investors to display their in-state status should be reconsidered.

This criterion removes a key due diligence requirement for issuers. That isn’t really that important, right? Let’s look at current events. One of the many reasons for the downfall of Silicon Valley Bank (“SVB”) was the loosening of regulatory requirements. Had SVB still been subject to regular stress tests, portfolio misrepresentation would likely have been noted much earlier. Relying only on an investor’s representation to satisfy the in-state requirement shows the issuer conducts no additional “test” to verify residency. As such, the issuer is more likely to fail. Therefore, additional measures should be put in place under Rule 147A for issuers to confirm the veracity of a purchaser’s residency. Once again, trust, but verify.

Why is due diligence necessary? Especially in the financial sector, institutions can “uncover any potential risk … of doing business with a specific organization or individual by analyzing information from a variety of sources.” [6]  Due diligence takes on many forms and consists of a wide range of processes. Knowing the individual or organization from whom you receive money helps ensure every party complies with the applicable rules and regulations to avoid exposure to liability, such as imprisonment and fines. There is also a non-tangible consequence: reputational risk. Financial institutions, like law firms, rely heavily on their name and reputation. Public perception holds a significant amount of weight (notice who the sponsors are at the next golf tournament or non-profit fundraiser you attend). If a financial institution receives a fine or shuts down for non-compliance, that makes headlines around the world. (And, of course, reactions are evident in the stock markets.) Nonetheless, the big institutions (e.g., Wells Fargo, Bank of America, Charles Schwab, etc.) manage to stay afloat, despite bad press. Maybe the banks took a page from Kanye West when he said, “Bad publicity is still publicity.”

There should be preventative measures from the issuer to prevent investors from making false representations about their in-state status.

Rule 147A’s language currently reads,

Sales of securities pursuant to this section shall be made only to residents of the state or territory in which the issuer is resident, as determined pursuant to paragraph (c) of this section, or who the issuer reasonably believes, at the time of sale, are residents of the state or territory in which the issuer is resident. [7]

There is the word, “reasonably.” Does the SEC provide further guidance on the rule? Yes, at the end of paragraph (d), a note states, “Obtaining a written representation from purchasers of in-state residency status will not, without more, be sufficient to establish a reasonable belief that such purchasers are in-state residents.” [8] 

Once again, with the term “reasonable,” but now we gain a clearer picture. While the investor’s written representation is expected to be truthful, this is not always guaranteed. Perhaps the SEC should revise the guidance note for paragraph (d) to read, “Obtaining a written and truthful representation from purchasers of in-state residency status will not, without more, be sufficient to establish a reasonable belief that such purchasers are in-state residents.”

This feels a little better. However, these changes introduce a new uncertainty when evaluating a generally recognized valid measure to confirm a truthful representation from an investor. Remember, “trust, but verify!” A residency affidavit (which must be notarized) would certainly suffice,

“It has been verified that on the ___ day of _____, 202_, John Smith’s principal residence is at 123 Main St, Charlotte, NC 28204. The following documents have been presented to corroborate John Smith’s residency: [.]”

In addition to one’s driver’s license containing an investor’s current address, the following documents should also be considered in verifying an investor’s principal residence: (1) most recent mortgage statement or lease agreement; (2) most recent utility statement; (3) vehicle insurance card from your most current policy; and (4) most recent property tax receipt. An investor’s most recent credit card statement may not be the best because the statement could be addressed to your billing address, which may differ from your principal residence address. Even a W2 or 1099 from the most recent tax year could list a different address if you moved after those tax documents were created and provided to you.

Although partial to the suggestions above, I would be remiss if I did not also question whether the reasonable belief standard is best suited for the securities industry. [9]  From tort law, a reasonable belief is the belief that an ordinary person would hold under like circumstances as those faced by the person in question. It is worth noting that the SEC does not explicitly define “reasonable belief.” (For this essay, I assume the SEC adopted the tort law definition of this term.) In Rule 147A, reasonable belief is merely supported by obtaining a written representation from the investor regarding their residency. [10]  The individuals at these financial institutions tasked with reviewing the representations from purchasers are not your average teller or loan officer at Chase or Wells Fargo. These due diligence/compliance employees are held to a higher standard by their employers because of their expected understanding of the applicable rules and regulations for intrastate offerings. The fate of an entire company rests in the hands of those tasked with reviewing the necessary documents. If a single investor is not an in-state resident, then the entire offering is no longer in compliance with the exemption under Rule 147A.  [11]

In his concluding remarks, Munter reiterated, “[T]he value of the audit and the related benefits to investors, including investor protections, are diminished if the audit is conducted without the appropriate levels of due professional care and professional skepticism.” [12]  It is clear that the entire offering depends upon the accuracy of the audit. With such high stakes, this should be a more defined process. Trust, but verify.


[1] Paul Munter, The Auditor’s Responsibility for Fraud Detection, SEC (Oct. 11, 2022),

[2] Intrastate offerings, SEC (Apr. 6, 2023),

[3] Id.

[4] Id.

[5] Joe Green, SEC Adopts New Rules to Facilitate Intrastate Crowdfunding, LinkedIn (Oct. 28, 2016),

[6] What is Customer Due Diligence (CDD)?, SWIFT, (last visited Aug. 7, 2023).

[7] Intrastate sales exemption, 17 C.F.R. § 230.147(A) (2021).

[8] Id.

[9] Amanda M. Rose, The “Reasonable Investor” of Federal Securities Law: Insights from Tort Law’s “Reasonable Person” & Suggested Reforms, 43 Iowa 77, 79 (2017) .

[10] Covington & Burling LLP, SEC Enhances Exemptions for Local Offerings, Covington (Dec. 1, 2016),

[11] Alan Palmiter, Securities Regulation, (8th ed. 2021).

[12] Munter, supra note 1.


Securities and Exchange Logo

Securities and Exchange Commission Logo

13 Wake Forest L. Rev. Online 1

Mark T. Wilhelm[*] & Michael T. Byrne[**]

Publicly traded companies in the United States are required to disclose a significant amount of information to the public in order to comply with applicable securities laws.[1] While at times those disclosure requirements are rather rigid, there are many circumstances in which these companies retain latitude to keep secrets out of the public eye—and notably, out of the reach of their competitors.

Public companies are required to file disclosure documents with the U.S. Securities and Exchange Commission (“SEC”), which are made available to the public pursuant to the Freedom of Information Act (“FOIA”).[2] In particular, Item 601(b)(10) of Regulation S-K requires public companies to file as an exhibit to their disclosure documents copies of certain material contracts into which the company has entered.[3] These exhibits often include sensitive information that companies prefer to keep confidential for competitive or other reasons.

Accordingly, under Rule 406 of the Securities Act of 1933[4] and Rule 24b-2 of the Securities Exchange Act of 1934,[5] the SEC permits public companies to request confidential treatment of certain information contained in these exhibits—meaning a company may redact the sensitive information and shield it from public view. FOIA permits the SEC to grant such requests if the redacted information falls into one of FOIA’s specified exemptions. The most commonly cited FOIA exemption in this context is found in Section 552(b)(4), which protects “trade secrets and commercial or financial information obtained from a person and privileged or confidential.”[6]

Historically, at the time that public companies redacted information from these exhibits, they were required to submit along with the exhibit a formal, hard copy confidential treatment request (“CTR”) with the SEC.[7] Submitting a CTR was a relatively arduous process that involved preparing and mailing a particularly formatted application to the SEC that specified (i) the justifications for redacting each piece of information, (ii) which FOIA exemption applied to each piece of information, and (iii) other pertinent details. The CTR also needed to include an unredacted copy of the exhibit that was the subject of the request. Upon receipt of a CTR, the SEC issued a confidential treatment order (“CT Order”) either granting or denying the CTR.[8] If denied, the company had to publicly refile the exhibit without the proposed redactions.

On March 20, 2019, the SEC announced it had modernized and simplified its rules related to, among other things, confidential treatment of information in filed exhibits.[9] The changes, which went into effect in May 2019, were aimed at bringing the SEC’s disclosure requirements into compliance with the Fixing America’s Surface Transportation Act (“FAST Act”).[10] Initially, following the rule changes, a public company could forgo submitting a formal CTR application if the redacted information was not material and would be competitively harmful if publicly disclosed.[11] However, on November 2, 2020, the SEC adopted amendments to eliminate the competitive harm requirement of CTRs in response to the Supreme Court’s clarification of the definition of “confidential” in Food Marketing Institute v. Argus Leader Media,[12] which stated: “[a]t least where commercial or financial information is both customarily and actually treated as private by its owner and provided to the government under an assurance of privacy, the information is ‘confidential’ within the meaning of [FOIA Section 552(b)(4)].”[13]

Thus, currently, if a public company redacts portions of a filed exhibit without submitting a formal CTR, the company must:

(i) mark the exhibit index to indicate that portions of the exhibit or exhibits have been redacted;

(ii) include a prominent statement on the first page of the redacted exhibit that certain information has been excluded from the exhibit because it is both (1) not material and (2) the type that the company treats as private or confidential; and

(iii) include brackets indicating where the information has been redacted from the filed version of the exhibit.[14]

Notably, public companies retain the option to submit formal CTRs to the SEC, and even after the rule changes, a very limited number of public companies have continued to do so.[15] This continued practice is likely a result of such companies (i) simply being unaware of the rule changes, (ii) failing to adjust their practices to conform with the new, relaxed rules, or (iii) taking what could be aggressive positions on what information is confidential, and proactively seeking SEC guidance on whether such confidential treatment would be granted.

As part of the same rule changes, the SEC also reduced the quantity of materials that public companies must file as exhibits.[16] Previously, and among other things, public companies were required to file as exhibits each material contract (i) entered within the preceding two years, or (ii) which was to be performed in whole or in part at or after the filing of the disclosure document.[17] Following the rule changes, the two-year lookback applies only to newly reporting companies—this means that most public companies must file material contracts meeting only the second requirement above.[18]

And finally, the rule changes also made clear that certain types of personally identifiable information (“PII”) such as social security numbers, home addresses, etc., could be redacted outside of the CTR process.[19] Anecdotally, prior to this rule change, certain practitioners would file CTRs to redact these types of personally identifiable information, while other practitioners would redact the information outside of the CTR process on the basis that it was obviously confidential and that the likelihood of the SEC objecting would be very small.[20]

A. SEC’s Standard of Review of Redacted Information

The SEC has stated it “intend[s] to review registrant filings for compliance with the new rules” as part of its regular filing review process.[21] However, the SEC only selectively reviews filings,[22] which means that some (if not many) redacted exhibits will not undergo a formal review. During the rulemaking process related to the applicable Regulation S-K changes, the SEC admitted that “[o]ne potential cost of the amendments is that information may be redacted that would not otherwise be afforded confidential treatment by the [SEC] staff.”[23] However, the SEC felt that the impact of this potential shortcoming was mitigated by the fact that the SEC very rarely denies CTRs. In fact, from 2014 to 2018, the SEC formally denied only one CTR, and an additional 1% of CTRs were withdrawn by filers after the SEC determined the information in the exhibits was too material to redact.[24] But the SEC also noted that 11% of CTRs from those years were granted only after the SEC required the filer to reduce or modify the requested redactions.[25] Thus, while an overwhelming majority of CTRs were granted as-is, the rule changes will likely result in at least some redacted information that would have been revealed in a traditional CTR review remaining hidden from the public.

Nevertheless, it is important to emphasize that while the SEC’s review process has changed, the standard for what information actually qualifies for confidential treatment remains largely the same (aside from some changes in what verbiage should appear in the filings to mark the redactions and the clarification of the treatment of personally identifiable information).[26] Public companies therefore must still ensure they disclose all material information and redact no more information than necessary. If a public company does redact questionably protectable information and the SEC identifies it, the SEC may require that the company provide additional explanation or documentation regarding why the redacted information should qualify for confidential treatment, as well as unredacted copies of the relevant exhibits—essentially replicating the effort and cost of a traditional CTR.[27] If the explanation and documentation do not sufficiently justify the redactions, the SEC will require the company to publicly file an unredacted copy of the exhibit, which could result in negative publicity for the company.

B. Major Increase in Filing of Redacted Exhibits

This Study utilized the Intelligize® database to search SEC filings and estimate the number of exhibits for which confidential treatment was sought from January 1 to December 31 of each year from 2012 through 2022. Searches were intended to uncover the total number of exhibits seeking confidential treatment during each calendar year, rather than the total number of CT Orders issued by the SEC each year, because the SEC often issues a single CT Order to grant confidential treatment of multiple exhibits for the same public company. Search terms reflected common verbiage used by public companies seeking confidential treatment in each respective year analyzed.[28] For example, since the 2019 rule changes, almost all redacted exhibits use the phrase “not material” in their prominent statements marking the redactions; this phrase was not commonly used prior to the rule changes. Search terms additionally accounted for some companies using outdated verbiage in their prominent statements marking the redactions, likely as a result of failing to recognize or comply with the rule changes.

As shown below in Figure 1, an estimated 4,247 redacted exhibits were filed with the SEC in 2022. This represents an increase of approximately 61% above the estimated average number of redacted exhibits filed in the years analyzed prior to the 2019 changes (an average of 2,635 redacted exhibits per year from 2012-2018). Note that while a vast majority of redacted exhibits are filed as an “Exhibit 10” pursuant to Item 601(b)(10) of Regulation S-K (including over 91% of redacted exhibits filed in 2018),[29] the results of this search include other types of redacted exhibits as well.

Figure 1

When considering these results in light of the SEC’s (i) removal of the two-year lookback period for filing material contracts—which presumably reduced the total number of material contracts required to be filed as exhibits following the rule change, and (ii) clarification of the treatment of personally identifiable information, the increase in redacted exhibits is even more significant than it first appears. In fact, as shown below in Figure 2, the estimated number of aggregate annual Exhibit 10 and Exhibit 2 filings—which constitute the overwhelming majority of redacted exhibits—shows a downward trajectory from 2012 to 2022, despite a temporary spike in Exhibit 10 and Exhibit 2 filings in 2021 and early 2022 that was likely the result of increased merger and acquisition activity in the midst of the COVID-19 pandemic, including a short boom in the use of Special Purpose Acquisition Company (“SPAC”) vehicles.[30]

Figure 2

Despite the unique market factors present in 2021, the rate at which the number of redacted exhibits filed per year has increased following the 2019 rule changes has consistently—and significantly—outpaced the growth in the number of Exhibit 10 and Exhibit 2 filings. This suggests that in addition to filing more total redacted exhibits per year since the rule changes, public companies are also redacting information from a larger percentage of the material contract exhibits they file. The estimates below in Figure 3, which were calculated by dividing the total number of redacted exhibits by the total number of combined Exhibit 10 and Exhibit 2 filings per year, support this conclusion.

Figure 3

Moreover, the increase in redacted exhibits takes on added magnitude when considering the reduction of the number of public companies over the analyzed time period. To estimate the number of public companies per year, this Study again utilized the Intelligize® database to find the total number of required annual reports filed with the SEC—specifically forms 10-K, 10-KT, 1-K, and 20-F—in each year.[31]

As shown below in Figure 4, the total number of public companies gradually decreased from 2012 to 2020, but then jumped back up in 2021 and 2022. The recent rise is (at least in part) a likely result of the aforementioned SPAC boom. Because SPACs are public companies with no business operations, until they go through a de-SPAC process their filings do not typically contain the type of sensitive information that would warrant redactions in their SEC filings. Thus, to allow a clearer picture of how often public companies with actual business operations are redacting portions of their exhibits, Figure 4 also includes the estimated total number of public companies per year when SPACs are removed from the presentation. After removing SPACs, there is a much more consistent downward trend in the number of public companies over the studied period, from an estimated 8,361 in 2012 to an estimated 7,671 in 2022—a decrease of approximately 8%.[32]

Figure 4

The intersection of the generally declining number of public companies and the increase in redacted exhibits following the 2019 rule changes suggests that public companies are now submitting a higher number of redacted exhibits per year. The estimates below in Figure 5A—calculated by dividing the total number of redacted exhibits by the total number of public companies in each respective year—support this inference, as the number of redacted exhibits filed per company has soared since the rule changes. As shown in Figure 5B, the growth in the number of redacted exhibits filed per company becomes slightly more pronounced when excluding SPACs from both data points.

Figure 5A

Figure 5B

Notably, the SPAC expansion also presumably played a major role in the influx of Exhibit 10 (and to a lesser extent, Exhibit 2) filings in 2021 and 2022. Again, when considering that SPAC exhibits are less likely to contain materially sensitive information because SPACs have no business operations prior to undergoing the de-SPACing process, the dramatic increase in the number of redacted exhibits filed per public company following the rule changes becomes all the more noteworthy.

An additional partial explanation of this phenomena may be the corresponding increase in the average size of public companies in recent years.[33] As public companies grow in size, it stands to reason that they may be party to more material contracts that warrant requesting confidential treatment.

More obviously, a significant portion of the increase in redacted exhibits may be attributable to companies seeking cost savings.[34] Public companies (especially smaller companies) that could not afford to or did not feel strongly about redacting certain immaterial information may have previously forgone the CTR process to avoid the expense of doing so.

But in addition to cost savings, it is no secret that public companies generally want to keep as much information private as they are legally allowed, and it appears that many are now testing the limits. In light of what appears to be a de-emphasis from the SEC on the administrative checks surrounding CTR redactions, public companies may be taking more aggressive stances on what information they redact in publicly filed exhibits.

C. Implications

The SEC’s modernization and simplification of its confidential treatment rules in 2019 made it drastically easier for public companies to redact information from their material contract exhibits. The results shown in this report reveal that public companies have already begun redacting information more often—and are thus keeping more sensitive (or purportedly sensitive) information away from their competitors—than before the rule changes. Overall, the rule changes appear to be a positive development for most public companies, as well as the SEC, primarily due to the associated cost savings and relieving administrative burden.

When looking at the impact of these changes on the market as a whole, the analysis of the increase in confidential treatment redactions is more mixed. The SEC’s loosened CTR application standards will undoubtedly increase the amount of redacted information that is actually material—and thus should have been disclosed to the public. The question is, to what degree? Measuring just how much material information is improperly redacted will be all but impossible to quantify, especially in light of the redactions obviously not being made public for study. But if the redactions are more extensive than expected, this could negatively impact competitive activity in a way the rule changes could not have intended. Conceivably, the SEC could further deter public companies from over-redacting by imposing serious penalties for clear violations of the new rules, but this has not yet occurred and does not seem likely.

In the end, assuming the SEC maintains a strong level of oversight, it seems unlikely that the increased volume of redacted exhibits will dramatically affect the investing public or the market in general. Public companies should remain diligent about disclosing all material information and complying with the updated rules to avoid unnecessary costs and compliance and enforcement risks.


* Associate, Corporate & Securities, Troutman Pepper Hamilton Sanders LLP, Philadelphia, Pennsylvania; J.D., Villanova University Charles Widger School of Law; B.A., University of Michigan. The views expressed in this Study are only those of the Authors and do not reflect the views of Troutman Pepper Hamilton Sanders LLP or its clients.

** Associate, Corporate & Securities, Troutman Pepper Hamilton Sanders LLP, Berwyn, Pennsylvania; J.D., Villanova University Charles Widger School of Law; B.A., Villanova University. The views expressed in this Study are only those of the Authors and do not reflect the views of Troutman Pepper Hamilton Sanders LLP or its clients.

  1. See Rules and Regulations for the Securities and Exchange Commission and Major Securities Law, U.S. Sec. & Exch. Comm’n, (last visited Apr. 3, 2023).

  2.  5 U.S.C. § 552 (2018).

  3.  17 C.F.R. § 229.601(b)(10) (2022).

  4.  17 C.F.R. § 230.406 (2022).

  5.  17 C.F.R. § 240.24b-2 (2022).

  6.  5 U.S.C. § 552(b)(4) (2018). See FAST Act Modernization and Simplification of Regulation S-K, 84 Fed. Reg. 12,674, 12,680 n.45 (Apr. 2, 2019).

  7. See generally, Securities and Exchange Commission Confidential Treatment Procedure Under Rule 83, U.S. Sec. & Exch. Comm’n, (last visited Apr. 3, 2023).

  8. For an example of an order denying confidential treatment, see Order Denying Applications by New York Stock Exchange, LLC, Release No. 34-83760 (Aug 1, 2008), available at

  9.  Press Release, SEC Adopts Rules to Implement FAST Act Mandate to Modernize and Simplify Disclosure, U.S. Sec. & Exch. Comm’n (Mar. 20, 2019),

  10.  Fixing America’s Surface Transportation Act, Pub. L. No. 114-94, § 72002–72003, 129 Stat. 1312 (2015).

  11.  FAST Act Modernization and Simplification of Regulation S-K, 84 Fed. Reg. at 12,680.

  12.  139 S. Ct. 2356 (2019).

  13.  Id. at 2366; Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, 86 Fed. Reg. 3496, 3530 (Jan. 14, 2021).

  14. Facilitating Capital Formation and Expanding Investment Opportunities by Improving Access to Capital in Private Markets, 86 Fed. Reg. at 3530. In addition, confidential treatment secured under the new rules is indefinite rather than having a fixed lifespan as it did in the past. See Div. Corp. Fin, U.S. Sec. & Exch. Comm’n, CF Disclosure Guidance: Topic No. 7, Confidential Treatment Applications Submitted Pursuant to Rules 406 and 24b-2 (Dec. 19, 2019, as amended March 9, 2021), This means that under the new rules, public companies no longer need to file requests to extend confidential treatment. However, public companies that secured confidential treatment of exhibits prior to the rule changes should confirm the SEC’s instructions for how to handle extensions going forward. Id.

  15. Search for Confidential Treatment Orders, U.S. Sec. & Exch. Comm’n, (last visited December 31, 2022).

  16. FAST Act Modernization and Simplification of Regulation S-K, 84 Fed. Reg. at 12,692.

  17. Id.

  18. Id.

  19. Id. at 12,719.

  20. Id. at 12,691 (“As a matter of practice, the staff generally does not object where a registrant omits PII from exhibits without also submitting a confidential treatment request under Rule 406 or Rule 24b-2. To codify this current staff practice, the Commission proposed new Item 601(a)(6) to allow registrants to omit PII from their required Item 601 exhibits without submitting a confidential treatment request for the information.”).

  21. New Rules and Procedures for Exhibits Containing Immaterial, Competitively Harmful Information, U.S. Sec. & Exch. Comm’n (Apr. 1, 2019),

  22. See Filing Review Process, U.S. Sec. & Exch. Comm’n, (last visited December 31, 2022).

  23. FAST Act Modernization and Simplification of Regulation S–K, 84 Fed. Reg. at 12,705–06.

  24. Id.

  25. Id.

  26. See 17 C.F.R. § 229.601(b)(10)(iv) (2022).

  27. See New Rules and Procedures for Exhibits Containing Immaterial, Competitively Harmful Information, supra note 23.

  28. For exhibits filed from 2012-2018 (prior to 2019 rule changes), the following search terms were used: ((omit* OR redact* OR omission*) w/40 (“filed separately” OR “separately filed”)) OR “confidential treatment has been requested”.

    For exhibits filed from 2019-2022 (to account for the 2019 rule changes), the following search terms were used: (((omitted OR omits OR omission* OR redacted OR redacts OR redaction*) w/40 “not material”) OR (“has been excluded” w/20 “not material”)) OR (((omit* OR redact* OR omission*) w/40 (“filed separately” OR “separately filed”)) OR “confidential treatment has been requested”).

  29. FAST Act Modernization and Simplification of Regulation S-K, 84 Fed. Reg. at 12,682 n.69.

  30. See Christine Dobridge, Rebecca John & Berardino Palazzo, The Post-COVID Stock Listing Boom, Bd. Governors Fed. Rsrv. Sys.: FED Notes (June 17, 2022),,increase%20of%20about%2028%20percent; Kristin Broughton, M&A Likely to Remain Strong in 2022 as Covid-19 Looms Over Business Plans, Wall St. J. (Dec. 23, 2021 5:30 AM), A SPAC is a type of blank check company “with no operations that offers securities for cash and places substantially all the offering proceeds into a trust or escrow account for future use in the acquisition of one or more private operating companies. Following its initial public offering . . . the SPAC will identify acquisition candidates and attempt to complete one or more business combination transactions after which the company will continue the operations of the acquired company or companies . . . as a public company.” Div. Corp. Fin, U.S. Sec. & Exch. Comm’n, CF Disclosure Guidance: Topic No. 11, Special Purpose Acquisition Companies (Dec. 22, 2020),

  31. The search excluded amended filings, such as 10-K/A, 10-KT/A, 1-K/A, and 20-F/A forms, to avoid duplication.

  32. The decline in the number of public companies extends all the way back to the 1990s. Heightened regulation of public companies, especially via the Sarbanes-Oxley Act of 2002, has incentivized companies to stay private or go private. See Jason M. Thomas, Where Have All the Public Companies Gone?, Wall St. J. (Nov. 16, 2017, 7:10 PM), The expansion of private equity and venture capital are other driving forces in this movement. See Spencer Israel, The Number Of Companies Publicly Traded In The US Is Shrinking—Or Is It?, MarketWatch (Oct. 30, 2020, 8:53 AM),

  33. Where Have All the Public Companies Gone?, Bloomberg (Apr. 9, 2018, 7:00 AM),

  34. FAST Act Modernization and Simplification of Regulation S-K, 84 Fed. Reg. at 12,705.

By Ben Woessner 

The last few decades have seen significant debate surrounding the generous compensation of the top executives of publicly-held corporations.  While some view the current system of pay as functional and driven by market forces like scarce executive talent,[1] many watch the upward trajectory of an increasingly disproportionate gap between executive pay and the average American’s salary with equally growing dismay.[2]

Some commentators point to the fact that executive compensation packages have increasingly utilized stock-based compensation to account for the trending upward spiral of executive pay, which may pose a threat to a company by potentially misaligning the interests of its directors with those of its shareholders.[3]  For example, while stock-based compensation attempts to award executives based on stock performance, thereby motivating higher returns to shareholders, it can also incentivize hedging transactions that permit directors to shield themselves from stock declines while still benefiting from compensation.[4]

In response to concerns regarding corporate transparency in the wake of the Financial Crisis of 2008, Congress instituted disclosure reforms through the Dodd-Frank Act of 2010, which, among other measures, included provisions for “clawback” recovery of incentive-based pay awarded on the basis of erroneous accounting reports.[5]  The implementation of a provision of the Act requiring a clawback of executive pay based on inaccurate reports regardless of whether the errors are “due to fraud, error, or any other factor” was delayed until recently.[6]

On Wednesday, October 26, the Securities and Exchange Commission (“SEC”) voted 3-2 in favor of a provision of the Dodd-Frank Act requiring publicly held companies to implement clawback policies to recover erroneously awarded incentive-based compensation paid to directors, even where the director had no responsibility over the inaccurate accounting statement.[7]  The new rule will require exchanges to “prohibit the listing of issuers that do not develop and implement policies to recover erroneously awarded incentive-based compensation.”[8]  These policies will be triggered whenever companies are forced to issue financial restatements for later-discovered accounting errors and will apply to compensation awarded up to three years from the policy’s implementation.[9]

The SEC intends the rule to “return erroneously awarded compensation to the issuer and its shareholders.”[10]  In so doing, the Commission hopes to realign the interests of executives and shareholders by increasing corporate accountability regarding the distorted incentives potentially created by stock-related forms of incentive-based compensation.[11]

However, the clawback rule may suffer from overbroad definitions that potentially undercut its goals to align executive and shareholder interest.  The first of these definitions concerns what qualifies as an accounting restatement that would trigger a recovery of incentive-based compensation.  Under the original proposal of the rule, only “Big R” restatements, or those that are “material to previously issued financial statements,” would trigger a clawback.[12]  However, the newly adopted rule also requires recovery of pay after so-called “little r” restatements—those that correct nonmaterial errors that could constitute material errors if left unreported.[13]

While the SEC hopes that including both material and immaterial restatements will incentivize executives to assert more control over accounting, thereby reducing instances of accounting error and allowing shareholders to put greater trust in the financial reporting of a company,[14] the rule contains another expansive definition that potentially undermines this goal.  The rule’s definition of “executive officer” not only includes the President, CFO, and principal accounting officer, but also “any other officer who performs a policymaking function.”[15]  As a result, even individuals who may have no actual control over the company’s compliance with accounting rules, and therefore no practical way to ensure greater accountability, are at risk of a compensation clawback.[16]

Furthermore, the clawback rule includes an expansive definition of what qualifies as incentive-based compensation that is subject to recovery if a company issues a financial restatement, including “any compensation that is granted, earned, or vested based wholly or in part upon the attainment of any financial reporting measure.”[17]  Therefore, at-risk compensation could include not only bonuses and equity-based compensation, but also nonqualified deferred compensation and long-term incentive compensation, so long as it is granted at least in part on the attainment of a financial reporting measure.[18]

Accordingly, critics of the rule argue that companies are likely to significantly decrease the amount of at-risk incentive compensation offered to executives, who will instead elect for a compensation restructuring to retain executive talent with higher salaries or increased discretionary bonuses unrelated to performance goals.[19]  Such restructuring would tend to go against the very heart of the clawback rule’s purpose—while clawbacks hope to align executive and shareholder interests through increased accountability, a shift away from performance-based compensation altogether may untie executive incentives from stock performance to the shareholder’s detriment.

When the rule goes into effect in about one year, the increasing trend toward shareholder activism may serve to keep potentially detrimental compensation restructuring in check.[20]  In fact, at least one study has shown that clawback policies required by the new rule are popular with shareholders as demonstrated by positive stock returns for companies following the initial 2015 announcement of the newly adopted clawback rule.[21] Nevertheless, in addition to being “burdensome to administer,” the rule may increase the divide between executive and shareholder interests as a result of its sweeping definitions, raising doubts as to whether its proposed benefit will outweigh its costs.[22]

[1] See generally Randall S. Thomas, Explaining the International CEO Pay Gap: Board Capture or Market Driven?, 57 Vand. L. Rev. 1171 (2004).

[2] Josh Bivens & Jori Kandra, Economic Policy Institute, CEO Pay Has Skyrocketed 1,460% Since 1978 (2022),

[3] Luis A. Aguilar, Aligning the Interests of Company Executives and Directors with Shareholders, Harv. L. Sch. F. on Corp. Governance (Feb. 16, 2015),

[4] Id.

[5] Gary Gensler, Statement by Chair Gensler on Final Rules Regarding Clawbacks of Erroneously Awarded Compensation, Harv. L. Sch. F. on Corp. Governance (Oct. 30, 2022),

[6] Id.

[7] Paul Kiernan, Accounting Errors to Cost Executives Their Bonuses Under SEC Rule, Wall St. J. (Oct. 26, 2022),

[8] Sec. & Exch. Comm’n, Listing Standards for Recovery of Erroneously Awarded Compensation 125 (2022),

[9] Id. at 86.

[10] Id. at 80.

[11] Id.

[12] Id. at 28.

[13] Meredith O’Leary et al., What SEC Bonus Clawback Rule Means For Public Cos., Law360 (Nov. 1, 2022, 4:52 PM),

[14] Id.

[15] Id.

[16] O’Leary et al., supra note 13.

[17] Sec. & Exch. Comm’n, supra note 8, at 57.

[18] O’Leary et al., supra note 13.

[19] Kiernan, supra note 7.

[20] Id.

[21] Id.

[22] O’Leary et al., supra note 13.

By Michael J. Riedl


Shaquille O’Neal.  Patrick Mahomes.  Serena Williams.  Alex Rodriguez.  No, this is not a reading of the guest list at the 2021 ESPY Awards,[1] but rather a list of athletes on the management or advisory boards of various Special Purpose Acquisition Companies (“SPACs”).[2]  SPACs, far from a novel financial vehicle,[3] grew to prominence over the past few years as record numbers of SPACs listed on exchanges across the globe.[4]  The capital flooding into SPACs reached a high watermark when investor William Ackman raised $4 billion for his fund, Pershing Square Tontine Holdings (“PSTH”), in July 2020.[5]  However, issuance[6] dramatically slowed towards the end of 2020,[7] and the valuation of SPACs both pre- and post-business combination fell precipitously.[8]

In a nutshell, SPACs are capital vehicles for purchasing equity ownership in a private company and then bringing that company public through a business combination.[9]  SPACs raise money through a fairly traditional Initial Public Offering (“IPO”), with a few key differences.[10]  Unlike a traditional IPO, in which the company uses the proceeds from the issuance for further growth or expansion, SPAC IPO proceeds are held in a trust account until a merger with a private company occurs.[11]  Additionally, most SPACs issue warrants (the right to purchase shares of the SPAC at a certain price)[12] at the time of the IPO to investors and SPAC sponsors.[13]  Lastly, because SPAC IPOs are not taking an existing company public at the time of IPO, reporting and regulatory requirements are significantly lessened.[14]

In the early stages of the SPAC resurgence, both issuance and post-business combination valuation remained healthy.[15]  For example, after combining with VectoIQ Acquisition Corp.,[16] the hydrogen vehicle start-up Nikola soared to a market capitalization of $34 billion—on almost no revenue.[17]  However, investors soon learned that Nikola’s groundbreaking hydrogen truck was rolling downhill in a demonstration and not moving on its own power.[18]  Nikola’s CEO at the time, Trevor Milton, was subsequently indicted for securities and wire fraud.[19]  In addition, the “SPAC King,” Chamath Palihapitiya, who has led ten SPAC IPOs,[20] ran into significant investor pushback after the Securities and Exchange Commission (“SEC”) launched an investigation into one of his SPAC combinations.[21]

Outside of the concern about the quality of the companies that SPACs are bringing public,[22] the decline in SPAC activity may result from a change in guidance from the SEC,[23] recent investor behavior,[24] and an uptick in shareholder litigation.[25] On April 12, 2021, the SEC issued guidance that the warrants issued by a vast majority of SPACs should be classified as liabilities on financial statements, not as equity instruments.[26]  This guidance was based on the consideration that, when sponsor warrants are transferred by sponsors to non-sponsors, their settlement price changes in ways not indexed to the SPAC’s underlying price.[27]  This change in guidance led to a rush of SPACs to file Form 8-Ks to update their previous filings.[28]

More recently, SPACs have been hit by a wave of redemptions prior to business combination.[29]  SPACs are required to offer shareholders the ability to redeem their shares before the official merger between the entities for a pro-rata share of the money in the trust account.[30]  This requirement has been said to make SPACs a relatively low-risk investment, at least before business combination.[31]  For example, a shareholder who purchased ten shares of a SPAC IPO priced at ten dollars per share can redeem their shares for one hundred dollars pre-combination.  However, in recent months, redemption rates have skyrocketed, with some SPACs seeing redemption rates over 50 percent, and Sandbridge Acquisition Corp. (“SBG”) having a redemption rate of 86 percent.[32]  Curiously, these redemptions are happening after shareholders—many of whom will later redeem—approve the business combination.[33]  One can only assume that investors want to get their money out of the SPAC as quickly, and at as high of a price, as possible.

Besides the apparent effects on investor sentiment, one consequence of the high redemption rate is that the amount of money held in trust by some SPACs have fallen below the minimum capital requirement set by the SPAC.[34]  Because investors can redeem their shares for the cash held in trust prior to business combination, a minimum capital requirement is typically structured into SPAC mergers to allow the target company an “out” when the capital they were expecting to get no longer exists.[35] For example, SBG, with its 86 percent redemption rate,[36] was $125 million short of its minimum capital requirement.[37]  However, the company they merged with, Owlet Baby Care, Inc., waived the capital requirement  in order to consummate the deal.[38]  For investors that did not redeem, this meant they were left owning equity in a company with significantly less capital to grow their business.[39]  Should the high redemption trend continue, it might further be a headwind on new SPAC issuance, since investors may lack confidence in SPACs and private companies may see SPAC mergers as increasingly risky.

Lastly, and perhaps most importantly, shareholders are beginning to bring derivative suits against SPACs.[40]  Most actions have been brought regarding falling share prices, where investors allege that the company mislead investors.[41]  However, after Mr. Ackman’s fund, PSTH, failed to acquire an equity stake in Universal Music Group due to the likelihood of violating SEC regulations,[42] an investor brought suit alleging the fund was an “Investment Company.”[43]  Such a lawsuit, according to Mr. Ackman, will “have a chilling effect on the ability of other SPACs to consummate merger transactions or to engage in IPOs until the litigation is resolved.”[44]

At the heart of the suit is whether Mr. Ackman’s fund, and SPACs writ large, is an Investment Company as classified by the Investment Company Act of 1940, 15 U.S.C. §§ 80a-1 to 64.[45]  The plaintiff’s lawyers allege that PSTH invested in short-term U.S. Treasuries which qualifies them as an Investment Company.[46]  If so, the sponsor warrants and other compensation structures that are ubiquitous in the SPAC industry could be found to violate the Investment Company Act.[47]  In a rebuke to this assertion, fifty-eight of the largest law firms in the world signed a joint statement stating that they “view the assertion that SPACs are investment companies as without factual or legal basis.”[48]  It is the view of the collective firms that SPACs are “engaged primarily in identifying and consummating a business transaction,” not a company that is “primarily, in the business of investing, reinvesting or trading in securities.”[49]

Regardless of how the merits of the lawsuit turn out, it has already affected Mr. Ackman’s SPAC, as he plans to return the $4 billion that he raised.[50]  However, Mr. Ackman is already looking to create another capital vehicle called a Special Purpose Acquisition Rights Company (“SPARC”).[51]  Unlike a SPAC, which requires investors to purchase shares at an IPO, a SPARC does not require such an investment.[52]  A SPARC issues warrants which grant rights, but not obligations, for warrant holders to purchase shares in a proposed future business combination.[53]  This has the benefit of allowing investors to put their capital to work in other investments while the SPARC seeks a merger target.[54]  Whether or not this new capital vehicle gets approved is ultimately up to the SEC and the New York Stock Exchange.[55]  However, one thing is clear, even if the SPAC boom has officially faded, sophisticated investors will continue to financially engineer capital vehicles to pursue business combinations.

[1]See Press Release, Isabelle Lopez, ESPN, Nominees Announced for The 2021 ESPYS Presented by Capital One as Fan Voting Begins, (June 16, 2021)

[2] Amrith Ramkumar, The Celebrities From Serena Williams to A-Rod Fueling the SPAC Boom, Wall St. J. (Mar. 17, 2021, 5:32 AM),

[3] See Devin Sullivan, A Look at SPACs: From the 90s to Covid-19, IR Magazine (Aug. 11, 2020),

[4] Id.

[5] Tomi Kilgore, Billionaire Bill Ackman Has a $4 Billion ‘Blank Check’ to Buy a Company, but He Hasn’t Said Which One, MarketWatch (July 23, 2020, 7:40 AM),

[6] Adam Hayes, Issue, Investopedia, (Aug. 30, 2021).

[7] See Ben Scent, Wall Street’s $100 Billion SPAC Boom Upends the League Tables, Bloomberg, (Apr. 1, 2021, 4:10 PM).

[8] Yun Li, SPACs are becoming less of a sure thing as the deals get stranger, shares roll over, CNBC, (Mar. 4, 2021).

[9] Ramey Layne & Brenda Lenahan, Special Purpose Acquisition Companies: An Introduction, Harv. L. Sch. Forum on Corp. Governance (July 6, 2018),

[10] Id.

[11] Id.

[12] James Chen, Warrant, Investopedia, (Aug. 8, 2021).

[13] Joel L. Rubenstein et al., Clarity Emerges in the Aftermath of the SEC Statement on SPAC Warrant Accounting: A Roadmap for the Changes to Permit Equity Classification, White & Case LLP (June 1, 2021),

[14] Layne & Lenahan, supra note 9.

[15] See Nicholas Jasinski, Why Nikola Decided to Merge With a SPAC. And Why More Such Deals Are Coming., Barron’s (Aug. 2, 2020, 8:00 AM),

[16] Press Release, Nikola Corporation, Nikola and VectoIQ Acquisition Corp. Announce Closing of Business Combination (June 2, 2020),

[17] Edward Ludlow & Craig Trudell, Nikola May Not Be Next Tesla, But Its Valuation Is More Extreme, Bloomberg, (June 10, 2020, 11:15 PM).

[18] Timothy B. Lee, Nikola Admits Prototype Was Rolling Downhill in Promotional Video, Ars Technica (Sept. 14, 2020, 1:58 PM),; see also Nikola: How to Parlay An Ocean of Lies Into a Partnership with the Largest Auto OEM in America, Hindenburg Rsch. (Sep. 10, 2020),

[19] Michael Wayland, Grand Jury Indicts Trevor Milton, Founder of Electric Carmaker Nikola, on Three Counts of Fraud, CNBC, (July 29, 2021, 4:16 PM).

[20] David Pogemiller, Chamath and Social Capital’s 4 New SPACs IPO Today, TheStreet, (June 30, 2021) (NASDAQ: DNAA, DNAB, DNAC, DNAD; NYSE: IPOA, IPOB, IPOC, IPOE, IPOD, IPOF).

[21] See Zeke Faux, The SPAC King Is Doing Just Fine Even as the Bubble Starts to Burst, Bloomberg Businessweek (Mar. 13, 2021, 5:00AM),

[22] Li, supra note 8.

[23] Yun Li, SPAC Transactions Come to a Halt Amid SEC Crackdown, Cooling Retail Investor Interest, CNBC, (Apr. 22, 2021, 9:35 AM).

[24] See infra note 29 and accompanying text.

[25] See infra note 40 and accompanying text.

[26] John Coates & Paul Munter, Staff Statement on Accounting and Reporting Considerations for Warrants Issued by Special Purpose Acquisition Companies (“SPACs”), SEC (Apr. 12, 2021),

[27] Rubenstein et al., supra note 13.

[28] See Coates & Munter, supra note 26.

[29] David Pogemiller, A SPAC Risk Exposed?, TheStreet (July 16, 2021),

[30] Layne & Lenahan, supra note 9.

[31] See Pogemiller, supra note 29.

[32] Id.

[33] David Drapkin, Spring Valley / AeroFarms Need More Capital, TheStreet (Aug. 30, 2021),

[34] Pogemiller, supra note 29.

[35] See Pamela Marcogliese et al., 20 Key Considerations for Private Companies Evaluating Whether to Be Acquired by a SPAC, Freshfields Bruckhaus Deringer LLP (July 27, 2020),

[36] See Pogemiller, supra note 29.

[37] See Sandbridge Acquisition Corp., Current Report (Form 10-K, Item 8.01) (July 14, 2021) (At a special meeting of stockholders, 19,758,773 shares of common stock were presented for redemption, which left $15 million of “Available Sandbridge Cash.” The agreement with Owlet Baby Care, Inc., provided Owlet the option to leave the deal if, after redemption, Sandbridge did not have $140 million in cash.).

[38] See Sandbridge Acquisition Corp., Current Report (Form 10-K, Exhibit 99.1) (July 14, 2021),

[39] See Pogemiller, supra note 29.

[40] Jean Eaglesham, SPACs Are Having Their Day—in Court, Wall St. J. (Aug. 25, 2021, 7:00 AM),

[41] Id.

[42] Thomas Seal & Nishant Kumar, Ackman Abandons Universal Music SPAC Deal After SEC Backlash, Bloomberg, (July 19, 2021, 8:49 AM).

[43] Complaint at 6, Assad v. Pershing Square Tontine Holdings, Ltd., No. 1:21-cv-06907 (S.D.N.Y.  Aug. 17, 2019), ECF No. 1.

[44] Press Release, William A. Ackman, CEO, Pershing Square Tontine Holdings, Ltd., Pershing Square Tontine Holdings, Ltd. Releases Letter to Shareholders (Aug. 19, 2021),

[45] Assad, supra note 31, at 6.

[46] Id. at 10–11.

[47] Id. at 43, 47.

[48] Press Release, Sidley Austin LLP, Over 55 of the Nation’s Leading Law Firms Respond to Investment Company Act Lawsuits Targeting the SPAC Industry (Aug. 30, 2021),

[49] Id.

[50]Ackman, supra note 44, at 2.

[51] Andrew Ross Sorkin et al., Bill Ackman’s SPAC Deal Gets Messier, N.Y. Times, (Aug. 20, 2021).

[52] Id.

[53] See, e.g., Press Release, Pershing Square Tontine Holdings, Ltd., Pershing Square Tontine Holdings, Ltd. (“PSTH”) to Acquire 10% of the Ordinary Shares of Universal Music Group (“UMG”) from Vivendi S.E. for Approximately $4 Billion, Representing an Enterprise Value of €35 Billion (June 20, 2021),

[54] Id. at 5.

[55] Sorkin et al., supra note 51.

Post image by Ken Teegardin on Flickr