Derivatives and
Structured Products Alert
November 2, 2010
Authors:
Philip M. Cedar
phil.cedar@klgates.com
+1.212.536.4820
Anthony R. G. Nolan
anthony.nolan@klgates.com
+1.212.536.4843
SEC Proposes Diligence and Disclosure
Rules for Asset-Backed Securities under
the Dodd-Frank Act
On October 19, 2010, the Securities and Exchange Commission (the “SEC”)
published for comment several new rules intended to implement the disclosure
requirements contained in Section 945 and a portion of Section 932 of the DoddFrank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).1
Drew A. Malakoff
drew.malakoff@klgates.com
+1.212.536.4034
K&L Gates includes lawyers practicing out
of 36 offices located in North America,
Europe, Asia and the Middle East, and
represents numerous GLOBAL 500,
FORTUNE 100, and FTSE 100
corporations, in addition to growth and
middle market companies, entrepreneurs,
capital market participants and public
sector entities. For more information,
visit www.klgates.com.
The centerpiece of these initiatives is proposed new Rule 193 (“Rule 193”) under the
Securities Act of 1933 (the “Securities Act”), which would require that an issuer of
an “asset-backed security” (“ABS”), as that term is defined in Section 3(a)(77) of the
Securities Exchange Act of 1934 (the “Exchange Act”), that is being publicly
offered, to “perform a review of the pool assets underlying the asset-backed
security.” In order to conform Regulation AB to the requirements of the proposed
rule, the SEC also is proposing an amendment to Item 1111 of Regulation AB that
would require, among other items, disclosure of the “nature” of the review of the
assets performed by an issuer or sponsor pursuant to Rule 193 and the findings and
conclusions of the issuer’s review. Lastly, the SEC is proposing that an issuer or
underwriter of an ABS offering (regardless of whether it is public or private) file a
new Form ABS-15G that sets forth the findings and conclusions of any report of a
third party engaged for purposes of performing a review of the pool assets five days
prior to the first sale in the offering.
These proposed rules give further insight into the morass of issues facing the
industry under the new order of securitization. While much still remains unclear
given the preliminary stage of the process, what is clear is that with every solution
proposed by regulators, new questions arise. Most pertinent of these new questions
facing the industry are: who will be performing these diligence reviews, particularly
in light of the potential need for any “experts” conducting the reviews to be willing
to accept added securities law liability in order to do so; what will be the required
scope of the pool asset review; where will the securitization industry settle in
delineating between public and private deals and, perhaps most importantly, when
will we start to have some answers instead of just new questions.
Comments on the proposed rules must be submitted by November 15, 2010.
1
Issuer Review of Assets in Offerings of Asset-Backed Securities, 75 Fed. Reg. 64182
(October 19, 2010) (Securities Act Release No. 33-9150 and Exchange Act Release No.
34-63091).
Derivatives and Structured Products Alert
Required Review of Securitized Assets
by or on Behalf of Issuer or Sponsor
unclear whether currently existing diligence firms
would be willing to do so.
Proposed Rule 193 would require an issuer of an
ABS to “perform a review of the pool assets
underlying the asset-backed security.” The proposed
rule does not specify the level or type of review, as
the SEC stated in the proposing release that the level
of required review may vary depending on
circumstances, such as the nature of the securitized
assets and the degree of continuing involvement of
the sponsor. For example, the SEC states that it may
be appropriate in offerings of residential mortgagebacked securities, where the asset pool is comprised
of a large group of loans, to review a sample of
loans, while in other transactions, where the pool is
comprised of a small number of loans, such as a
commercial mortgage-backed security transaction,
for the review to include every asset in the pool.
Instead, the disclosure (to the extent required, as
discussed below) of the level and type of review
conducted would put potential investors in a position
to take the level and quality of the asset review into
account in assessing their confidence in the
description of the pool assets. This raises the
question of whether a generic disclosure-based
solution driven by issuers would be sufficient or
whether it would be preferable for the rule to
prescribe a minimum standard of diligence review.
Proposed Rule 193 would apply solely to publicly
registered offerings because it is proposed under the
authority of Section 7(d) of the Securities Act,
which authorizes the SEC to issue rules relating to
registration statements filed thereunder. However,
the proposing release raises the question of whether
the SEC will condition the safe harbors for
exemptions from registration of ABS under the
Securities Act under Regulation D and Rule 144A
upon a requirement that the issuer of the nonregistered ABS perform a diligence review that
complies with Rule 193. This is the approach that
the SEC took in its recently proposed revisions to
Regulation AB. If the SEC takes a similar approach
to the diligence under proposed Rule 193, it would
represent a further erosion of the line between
unregistered and registered ABS offerings.
The proposing release states that the required
diligence review may be performed by either the
issuer or the sponsor of the ABS offering, but not by
originators that are unaffiliated with the issuer or the
sponsor. While an issuer or sponsor could engage a
third party to perform the required review, the
proposing release provides that any third party
diligence provider must be named in the registration
statement and consent to being named as an “expert”
pursuant to Section 7 of the Securities Act. Experts
named as such, with their consent, are strictly liable
under Section 11 of the Securities Act for material
misstatements and omissions in the disclosure
prepared or comforted by them. The proposing
release identifies accountants and lawyers as parties
that might provide the required level of diligence
and consent to being named as experts. This is
problematic on several levels, one of which is
finding third parties who are willing to take on this
added securities law liability, particularly since it is
Proposed Disclosure Requirements
for Review of Securitized Assets
Regulation AB
The SEC proposes to amend Regulation AB by
including a new Item 1111(a)(7), which would
require disclosure regarding the “nature of a review
of the assets performed by an issuer or sponsor (in
accordance with [Rule 193]), including whether the
issuer of any asset-backed security engaged a third
party for purposes of performing a review of the
pool assets underlying an asset-backed security; and
. . . the findings and conclusions of the review . . . .”
By requiring disclosure of the conclusions of the
review regardless of the identity of the person
performing the review, proposed Item 1111(a)(7)
may be intended to discourage issuers of publicly
offered ABS from conducting these diligence
reviews in-house (as well as removing the potential
for different disclosure regimes for publicly offered
ABS based solely on who conducts the review).
Although Regulation AB currently applies solely to
publicly registered transactions, the proposed
revisions to Regulation AB would require the
underlying transaction agreement for an ABS to
obligate the issuer on request to provide to an
investor that has purchased ABS in reliance on Rule
144A the same “information as would be required if
November 2, 2010
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Derivatives and Structured Products Alert
the offering were registered.” Therefore, proposed
Item 1111(a)(7) could be read so as to condition an
ABS issuer’s access to the Rule 144A market on the
provision of any due diligence review of securitized
assets, even if that review was not required by Rule
193.
Form ABS-15G
Section 932 of the Dodd-Frank Act amends the
Exchange Act by adding Section 15E(s)(4)(A)
thereto. This section obligates “the issuer or
underwriter of any asset-backed security [to] make
publicly available the findings and conclusions of
any third-party due diligence report obtained by the
issuer or underwriter.” The SEC has taken the
position that this section applies to issuers and
underwriters of both registered and unregistered
offerings of ABS. In order to implement the
disclosure requirement for unregistered offerings,
the SEC has proposed new Rule 15Ga-2 under the
Exchange Act, which would require an issuer or
underwriter to file Form ABS-15G in either
registered or unregistered transactions to disclose the
findings and conclusions of any third party engaged
for purposes of performing a review obtained by an
issuer with respect to unregistered transactions, and
which would also require an underwriter to file
Form ABS-15G to disclose the information
contained in such reports obtained by the
underwriter. Proposed Form ABS-15G would have
to be filed with the SEC on EDGAR five business
days before the first sale of ABS in the offering,
potentially resulting in the need for issuers and
underwriters to change their current pre-sale
marketing practices to allow for the diligence report
to be prepared, reviewed and Form ABS-15G to be
filed.
The SEC has stated in the proposing release that it
“is of the view that issuers and underwriters can
disclose information required by Rule 15Ga-2
without jeopardizing reliance on those exemptions
and safe harbors, provided that the only information
made publicly available is that which is required by
the proposed rule, and the issuer does not otherwise
use Form ABS-15G to offer or sell securities or in a
manner that conditions the market for offers or sales
of its securities.” The SEC seems to be preserving
here the possibility that ABS may continue to be
issued in transactions that are exempt from
registration notwithstanding this required public
filing. However, when coupled with the proposed
changes in Regulation AB requiring the provision of
public style disclosures to requesting 144A
investors, this portion of proposed Rule 15Ga-2
further suggests that, for ABS, the practical
distinction between registered and private offerings
continues to erode. This conflict between private
offerings requirements and required new public
disclosure is likely to be a continued issue requiring
careful monitoring by the transaction parties.
Conclusion
As a part of the mandated rulemaking under DoddFrank, these proposed rules regarding pool asset
review and disclosure provide additional pieces of
the post-Dodd-Frank ABS regulatory mosaic. While
the required scope of the pool asset review remains
unclear, it is clear that the disclosure obligations of
issuers and underwriters will notably increase and
that third party review providers who consent to
being named as “experts” will become subject to
significant potential liability under the Securities
Act.
November 2, 2010
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Derivatives and Structured Products Alert
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November 2, 2010
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