De-SPAC and SOX 404: what the transition period leaves open

Closing a de-SPAC raises a question that tends to get the optimistic answer: does the newly public transition period apply, so that management's first report on internal control over financial reporting can wait a year? The transition period is real. The harder problem is that the SEC staff's own manual says the rules do not directly address a registrant's reporting obligations after this kind of transaction. In our view that is a reason to plan for the earlier date rather than the later one.

The test is prior-year reporting history, not the closing date

Instruction 1 to Item 308 of Regulation S-K sets the condition: "A registrant need not comply with paragraphs (a) and (b) of this Item until it either had been required to file an annual report pursuant to section 13(a) or 15(d) of the Exchange Act (15 U.S.C. 78m or 78o(d)) for the prior fiscal year or had filed an annual report with the Commission for the prior fiscal year." The Financial Reporting Manual restates the test at Section 4310.6, keyed to whether the company "had been required to file or had filed a Form 10-K with the Commission for the prior fiscal year."

Rule 13a-15 carries the condition in three paragraphs — (a), (c) and (d). Paragraph (a) requires every issuer with a class of securities registered under section 12 of the Act, "other than an Asset-Backed Issuer ..., a small business investment company registered on Form N–5 ..., or a unit investment trust as defined in section 4(2) of the Investment Company Act of 1940," to maintain disclosure controls and procedures and, "if the issuer either had been required to file an annual report pursuant to section 13(a) or 15(d) of the Act" for the prior fiscal year, internal control over financial reporting. Paragraph (c) attaches the same prior-year condition to the annual evaluation, and paragraph (d) to the evaluation of changes. Notice what the switch is not keyed to: not a merger, not a change of control, not the arrival of an operating business.

What the manual says about reverse acquisitions

A de-SPAC leaves a registrant and an accounting acquirer that are not the same company. Section 12100 of the manual describes the structure: "The acquisition of a private operating company by a non-operating public shell corporation typically results in the owners and management of the private company having actual or effective voting and operating control of the combined company."

Section 12210.1 then says the rules run out: "SEC rules do not directly address a registrant's financial reporting obligations in the event that it acquires another entity in a transaction accounted for as either a reverse acquisition or reverse recapitalization." What the manual offers instead is an accounting-led convention: "For accounting purposes, the legal acquiree is treated as the continuing reporting entity that acquired the registrant (the legal acquirer)," and reports filed by the registrant afterwards "should parallel the financial reporting required under GAAP—as if the accounting acquirer were the legal successor to the registrant's reporting obligation as of the date of the acquisition."

In our view, settle the first assessment year with counsel against the actual filing records on both sides, then plan for the earlier answer. The gap is not a filing you can make late — it is a period of control operation nobody can recreate.

The exception that exists is not the transition period

The manual lists the staff position that gets mistaken for the transition period among the limited exceptions at Section 4310.11, the fourth of which is "A reverse acquisition between an issuer and a private operating company when it is not possible to conduct an assessment of the private operating company or accounting acquirer's ICFR in the period between the consummation date of a reverse acquisition and the date of management's assessment of ICFR." It points to Question 215.02 of the Division's Regulation S-K interpretations.

The Division's Staff Statement on Select Issues Pertaining to Special Purpose Acquisition Companies puts the same position in a footnote: "in some instances, management of the combined company may be unable to assess internal control over financial reporting in the fiscal year in which the transaction was consummated. In those instances, the staff would not object if the combined company were to exclude management's assessment of internal control over financial reporting in the Form 10-K covering the fiscal year in which the transaction was consummated."

Three features follow, and each shortens the runway people assume.

• It reaches the fiscal year in which the transaction was consummated — one annual report, not a rolling allowance.
• It is a staff non-objection, not an exemption written into the rule, and it is conditioned on it not being possible to conduct the assessment. Infeasibility, not inconvenience.
• It covers management's assessment, not the control environment. Nothing in it suspends the obligation to have internal control over financial reporting.

What is due anyway in the closing year

Books and records and internal accounting controls. The Corporation Finance statement describes the duty to maintain books, records and accounts in reasonable detail that accurately and fairly reflect the issuer's transactions, and to maintain a system of internal accounting controls. Its wording on who owes them is careful: these requirements "apply to SPACs before the business combination," and they "generally also apply to the combined company after the business combination."

The quarterly disclosure controls conclusion. Rule 13a-15(b) requires management to evaluate the effectiveness of disclosure controls and procedures "as of the end of each fiscal quarter," and unlike paragraphs (c) and (d) it is not conditioned on any prior-year reporting history. The Office of the Chief Accountant reads the rule the same way: "Management is required to evaluate the effectiveness of a public company's DCP as of the end of each fiscal quarter." What else starts early is set out in the newly public SOX timeline.

Evidence, and the exit that is not there. Instruction 2 to Item 308 requires that "The registrant must maintain evidential matter, including documentation, to provide reasonable support for management's assessment of the effectiveness of the registrant's internal control over financial reporting." Instruction 1's deferral is written to paragraphs (a) and (b) of the Item. And in whatever year paragraph (a) does bite, Item 308(a)(3) leaves no soft landing: "Management is not permitted to conclude that the registrant's internal control over financial reporting is effective if there are one or more material weaknesses in the registrant's internal control over financial reporting."

Filer status is arithmetic, so do the arithmetic

Rule 12b-2 makes an issuer an accelerated filer only "after it first meets" four conditions as of the end of its fiscal year: non-affiliate common equity market value of "$75 million or more, but less than $700 million, as of the last business day of the issuer's most recently completed second fiscal quarter"; at least "twelve calendar months" subject to section 13(a) or 15(d); "at least one annual report" filed under those sections; and not being "eligible to use the requirements for smaller reporting companies under the revenue test." The large accelerated filer definition uses "$700 million or more" with the same remaining three.

Only one of the four carries its own earlier measurement date: the market value figure, read at the last business day of the most recently completed second fiscal quarter, which may fall before the merger closed.

Whether the auditor has to attest is a further gate. Section 4310.6 again: "Only 'accelerated filers' that are not EGCs and 'large accelerated filers' are required to provide an auditor's attestation report on ICFR under Item 308(b) of Regulation S-K." Emerging growth company status therefore matters, and Topic 12 answers it by referral: Section 12220.2 carries a note, "See Section 10120.2 to determine whether the registrant qualifies as an EGC for purposes of filing its Form 8-K subsequent to the merger transaction." One of the four end points in section 2(a)(19) of the Securities Act is "the last day of the fiscal year of the issuer following the fifth anniversary of the date of the first sale of common equity securities of the issuer pursuant to an effective registration statement." Ask counsel which sale started that clock. The difference between the two regimes is laid out in 404(a) versus 404(b).

What to do next

1. Get the first assessment year in writing, from counsel, reasoning from Instruction 1 and the filing records on both sides rather than from the closing date — and ask whether the scope-limitation exception is available at all.
2. Treat that exception, if available, as one annual report of runway rather than a holiday. Scoping, documentation and IT general controls all have to exist before the next year-end.
3. Start evidence retention now for access reviews, change management and the financial close. What an ITGC is covers the categories auditors reach for first.

The SOX 404 deadline calculator lays the milestones back from your year-end, and a fuller calendar is in the SOX 404 first-year timeline. This is general information rather than audit or legal advice; confirm your filer status and your first assessment year with your auditor or counsel.

Common questions

Does the newly public transition period apply after a de-SPAC?

The rules do not answer that directly. Instruction 1 to Item 308 and Rule 13a-15 condition the first management report on whether the registrant had been required to file, or had filed, an annual report for the prior fiscal year, and Financial Reporting Manual Section 12210.1 says SEC rules 'do not directly address a registrant's financial reporting obligations' in a reverse acquisition or reverse recapitalization. Settle it with counsel against the actual filing records on both sides. In our view, plan for the earlier answer.

What is the staff exception for the year the merger closes?

The Division of Corporation Finance has said that where management of the combined company may be unable to assess internal control over financial reporting in the fiscal year in which the transaction was consummated, the staff would not object if the combined company excluded management's assessment from the Form 10-K covering that fiscal year. Financial Reporting Manual Section 4310.11 frames it as a scope limitation available where it is not possible to conduct the assessment. It is premised on infeasibility, not on preference.

Do disclosure controls get the same break?

No. Rule 13a-15(b) requires management to evaluate the effectiveness of disclosure controls and procedures 'as of the end of each fiscal quarter,' and unlike paragraphs (c) and (d) of the same rule it is not conditioned on prior-fiscal-year reporting history. Foreign private issuers evaluate as of the end of each fiscal year instead.

Are we still an emerging growth company after the merger?

Possibly, and it is one of the gates that decide whether the auditor has to attest at all. One of the statutory end points in section 2(a)(19) of the Securities Act is 'the last day of the fiscal year of the issuer following the fifth anniversary of the date of the first sale of common equity securities of the issuer pursuant to an effective registration statement,' so ask counsel which sale started that clock in your structure.

What should we start first while the first assessment year is unsettled?

Evidence retention for IT general controls and the financial close, because those controls have to operate across a period and no later effort creates a history that was not kept. Scoping and documentation can be caught up afterwards; operation cannot.

Sources

1. Financial Reporting Manual, Topic 4 — Independent Accountants' Involvement, including Section 4310, Management's Annual Report on Internal Control Over Financial Reporting [S-K 308] · U.S. Securities and Exchange Commission, Division of Corporation Finance
2. Financial Reporting Manual, Topic 12 — Reverse Acquisitions and Reverse Recapitalizations · U.S. Securities and Exchange Commission, Division of Corporation Finance
3. Staff Statement on Select Issues Pertaining to Special Purpose Acquisition Companies · U.S. Securities and Exchange Commission, Division of Corporation Finance
4. Financial Reporting and Auditing Considerations of Companies Merging with SPACs · U.S. Securities and Exchange Commission, Office of the Chief Accountant
5. 17 CFR 229.308 (Item 308 of Regulation S-K) — Internal control over financial reporting, with Instructions · U.S. Government Publishing Office (Code of Federal Regulations)
6. 17 CFR 240.13a-15 — Controls and procedures · U.S. Government Publishing Office (Code of Federal Regulations)
7. 17 CFR 240.12b-2 — Definitions (accelerated filer, large accelerated filer, smaller reporting company) · U.S. Government Publishing Office (Code of Federal Regulations)
8. 15 U.S.C. 77b — Definitions, including the definition of emerging growth company in section 2(a)(19) · U.S. Government Publishing Office (United States Code)
9. Special Purpose Acquisition Companies, Shell Companies, and Projections — small business compliance guide · U.S. Securities and Exchange Commission