ABS Shelf Eligibility Criteria

Transcription

1 SEC Re-proposes Shelf Eligibility Criteria for Asset-Backed Securities SUMMARY On July 26, 2011, the Securities and Exchange Commission re-proposed eligibility criteria for shelf registration of asset-backed securities (ABS) that it proposed in April 2010 as part of a comprehensive reform of its rules governing disclosure and the offering process for ABS. The new proposal reflects extensive public comments on the original proposal and the impact of a number of provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted in July 2010, including mandated rulemakings regarding risk retention and ongoing reporting requirements for ABS issuers. It significantly modifies the proposed depositor certification requirement and introduces requirements for the appointment of a credit risk manager, mandatory dispute resolution for requests to repurchase pool assets and the facilitation of investor communication. The SEC is also proposing an earlier deadline for the filing of required exhibits to shelf registration statements and is requesting additional comment of various other aspects of its April 2010 proposals, including requirements for asset-level data and the introduction of enhanced disclosure requirements for privately placed ABS to be eligible for safe harbor exemptions from registration under the Securities Act. I. BACKGROUND On April 7, 2010, as part of a comprehensive reform of its rules governing disclosure and the offering process for ABS, the SEC proposed the replacement of the existing investment grade credit ratings requirement for shelf registration with four new requirements: (i) 5% risk retention by the sponsor in a vertical slice ; (ii) third-party review of repurchase obligations; (iii) a certification by the depositor s CEO that, to the best of his or her knowledge, the assets have characteristics that provide a reasonable basis to believe that they will produce, taking into account internal credit enhancements, cash flows at times and in amounts necessary to service payments on the securities as described in the prospectus; and (iv) New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney

2 an undertaking to provide ongoing reports. 1 The April 2010 proposals also included detailed requirements for asset-level disclosure and contemplated revisions to existing private placement safe harbors that would condition their availability for structured finance products on a contractual commitment by the issuer to provide disclosures, including ongoing disclosures, that would be required for registered offerings of similar securities. By mandating risk retention and continued reporting under the Securities Exchange Act of 1934, the Dodd-Frank Act has rendered superfluous the proposed risk retention and ongoing reporting requirements for shelf eligibility. In addition, Section 939A of Dodd-Frank required the SEC, within one year of enactment, to review any regulation issued by [it] that requires the use of an assessment of the credit-worthiness of a security or money market instrument and any references to or requirements in such regulations regarding credit ratings, and upon completion of such review to remove any reference to or requirement of reliance on credit ratings and to substitute in such regulations such standards of creditworthiness as [it] determines appropriate for such regulations. In response to these developments and to comments received on the April 2010 proposals, the SEC is re-proposing shelf eligibility requirements, as well as filing deadlines for exhibits in shelf offerings of ABS, and requesting additional comment on certain other aspects of its proposed ABS reform including assetlevel data and privately offered structured finance products. II. SHELF ELIGIBILITY CRITERIA As re-proposed, the transaction requirements for shelf offerings of ABS would include: a certification, filed at the time of each offering off of a shelf registration statement, by the chief executive officer of the depositor or executive officer in charge of securitization of the depositor concerning the disclosure contained in the prospectus and the design of the securitization; provisions in the underlying transaction agreements requiring the appointment of a credit risk manager to review the underlying assets upon the occurrence of certain trigger events and provisions requiring repurchase request dispute resolution; and a provision in an underlying transaction agreement to include in ongoing distribution reports on Form 10-D a request by an investor to communicate with other investors. Certification Requirement. As originally proposed, each offering of ABS under a shelf registration statement would have required a certification by the chief executive officer of the depositor that to his or her knowledge, the securitized assets have characteristics that provide a reasonable basis to believe that they will produce, taking into account internal credit enhancements, cash flows at times and in amounts 1 Asset-Backed Securities, SEC Release Nos ; (April 7, 2010). This release is discussed in detail in our April 23, 2010 memorandum entitled SEC Asset-Backed Securities Reform. -2-

3 necessary to service any payments of the securities as described in the prospectus, and that he or she has reviewed the prospectus and the necessary documents for the certification. As re-proposed, either the chief executive officer of the depositor or the executive officer in charge of securitization of the depositor 2 must certify that he or she has reviewed the prospectus and is familiar with the structure of the securitization, including the characteristics of the securitized assets underlying the offering, the terms of any internal credit enhancements and the material terms of all contracts and other arrangements entered into to effect the securitization and that, based on his or her knowledge, the prospectus does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading; the prospectus and other information included in the registration statement of which it is a part, fairly present in all material respects the characteristics of the securitized assets underlying the offering described therein and the risks of ownership of the ABS described therein, including all credit enhancements and all risk factors relating to the securitized assets underlying the offering that would affect the cash flows sufficient to service payments on the ABS as described in the prospectus; and taking into account the characteristics of the securitized assets underlying the offering, the structure of the securitization, including internal credit enhancements, and any other material features of the transaction, in each instance, as described in the prospectus, the securitization is designed to produce, but is not guaranteed by this certification to produce, cash flows at times and in amounts sufficient to service expected payments on the ABS offered and sold pursuant to the registration statement. The SEC noted that several commentators proposed a disclosure-based certification as an alternative to an asset quality-based certification, and that several opposed certification on the grounds that the depositor s chief executive officer could not be expected to have the knowledge necessary to certify the performance of the securities. The release indicates that a certifier could rely, in part, on the review that would already be required for an issuer to comply with Rule 193, which was adopted in January 2011 and mandates the disclosure in prospectuses of the nature of the review of the securitized assets performed by the issuer, including whether the issuer engaged a third party for purposes of performing the review of the pool assets and the findings and conclusions of the review. 3 As re-proposed, the asset quality-based certification has been reworded to focus on design of the securitization and makes explicit that it is not a guarantee of the performance of the offered securities. Because the certification requirement applies only 2 3 Although several commentators suggested that, for consistency with the signature requirements for proposed Form SF-3, the senior officer in charge of securitization of the depositor be permitted to give the certification, the SEC is proposing instead to permit certification by the executive officer in charge of securitization, taking the view that more extensive oversight by an executive officer may improve the quality of the securities. For this purpose, an executive officer is defined as the president of the depositor, any vice president in charge of securitization, any other officer who performs a policy making function for the depositor or any other person who performs a similar policy making function for the depositor. SEC Release Nos ; (January 20, 2011). See our January 31, 2011 memorandum entitled Disclosure of Repurchase Requests and Issuer Review of Assets in ABS Offerings. -3-

4 to ABS offered and sold pursuant to the registration statement, the certification would not extend to lower tranches of ABS that are typically sold at a steep discount because investors do not expect the assets to generate sufficient cash flows to service their payments. These tranches are typically not investment grade and thus are not eligible for shelf registration under currently applicable criteria. The depositor certification would be an additional exhibit to the registration statement, dated as of the date of the final prospectus under Rule 424, and would have to be filed by the time the final prospectus is required to be filed under that rule. In its request for comments on the certification requirement, the SEC asks whether the certification would create new potential liability for the certifier and is soliciting feedback on allowing an opinion of an independent evaluator as an alternative to depositor certification, including what types of entities would be likely to serve as independent evaluators or should be permitted to do so, and what qualifications and independence requirements would be appropriate. Credit Risk Manager and Repurchase Request Dispute Resolution Provisions. As originally proposed, the shelf eligibility criteria would have required that the pooling and servicing agreement or other transaction agreement for each registered offering contain a provision requiring any party that has made representations and warranties relating to the pool assets and that is obligated to repurchase any noncompliant pool asset to furnish to the trustee, at least quarterly, an opinion or certificate from a nonaffiliated third party relating to any asset for which the trustee has asserted a breach of representation or warranty and which was not repurchased or replaced on the basis of an assertion that the asset did not violate the representation or warranty. In lieu of this requirement, the SEC is proposing that the underlying transaction documents (i) require that the trustee appoint a credit risk manager to review the underlying assets upon the occurrence of certain trigger events and to provide its report to the trustee of its findings and conclusions and (ii) include certain provisions to resolve repurchase request disputes. The SEC believes that the revised proposal provides a better incentive for obligated parties to consider the characteristics and quality of the underlying assets. It noted that the rules adopted under Section 943 of Dodd-Frank in January 2011 requiring disclosure relating to representations and warranties in ABS offerings do not address the enforceability of repurchase provisions, which have been the subject of investor complaint. 4 Under the revised proposal, the pooling and servicing agreement or other transaction agreement must provide for the following: 4 SEC Release Nos ; (January 20, 2011). See our January 31, 2011 memorandum entitled Disclosure of Repurchase Requests and Issuer Review of Assets in ABS Offerings. -4-

5 the selection and appointment by the trustee of a credit risk manager that is not affiliated with any sponsor, depositor or servicer of the transaction 5 ; the credit risk manager must have authority to access copies of the underlying documents related to the pool assets; the credit risk manager must be responsible for reviewing the underlying assets for compliance with the representations and warranties on the assets, at a minimum (a) when the credit enhancement requirements specified in the underlying transaction agreements are not met or (b) at the direction of investors pursuant to processes provided in the agreement and disclosed in the prospectus 6 ; the credit risk manager must provide a report to the trustee of the findings and conclusions of the review of the assets; and if an asset is subject to a repurchase request and is not repurchased within 180 days of receipt of notice, the party submitting the request shall have the right to refer the matter to mediation or third-party arbitration, and the party obligated to repurchase must agree to the selected resolution method. 7 The SEC believes that transaction parties should have the flexibility to tailor the procedures and times for investor-directed review of assets underlying each ABS transaction, and the chosen mechanism would be described in the prospectus. The SEC intends the right to refer unfulfilled requests to mediation or arbitration to address investor frustration with the current process for locating other investors to force trustees to take action with respect to perceived breaches of representations and warranties. The SEC is also proposing disclosure requirements in prospectuses and ongoing reports about credit risk managers, based in large part on the disclosure requirements for trustees under existing Item 1109 of Regulation AB. Prospectus disclosure would include the name of the credit risk manager, its form of organization, the extent of its experience serving as a credit risk manager for ABS involving similar assets and the manner and amount of its compensation. Disclosure would also be required regarding the credit risk manager s duties and responsibilities under the governing documents and applicable law, any limitations on its liability, indemnification provisions, any contractual provisions or understandings with respect to its removal, replacement or resignation and any affiliations or relationships with other The SEC is requesting comment as to whether the trustee is the appropriate party to appoint the credit risk manager, whether the trustee could itself act as the credit risk manager, what types of entities are likely to serve as, or should be excluded from acting as, credit risk manager and the scope of documentation to which the credit risk manager should have access. The SEC is also requesting comment as to whether it should specify the types of credit enhancement features that would serve as triggers, whether there are asset classes where no target credit enhancement is specified and whether additional triggers should be required, as well as to whether it would be appropriate to require the credit risk manager to conduct a review upon request of some specified percentage of investors. The SEC noted that the parties to the transaction agreements would in any event be free to specify additional trigger events. The SEC is requesting comment as to the appropriateness of the 180-day deadline, requirements as to the payment of expenses of mediation or arbitration and other aspects of the dispute resolution mechanism. The SEC noted that the transaction agreements could in any event call for a period shorter than the rule-required period. -5-

6 transaction parties. Ongoing disclosure on Form 10-D would include any events that triggered a review during the distribution period, as well as the date of and circumstances surrounding any resignation, removal or replacement of the credit risk manager during the distribution period,. The full report of any findings and conclusions provided by the credit risk manager to the trustee during the distribution period would have to be filed as an exhibit to the Form 10-D. Investor Communication. The re-proposed shelf eligibility criteria include a new condition that the pooling and servicing agreement or other transaction agreement contain a provision requiring that the party responsible for making periodic filings on Form 10-D 8 include in those filings any request received from an investor to communicate with other investors during the reporting period. The request to communicate would be required to include the name of the investor making the request, the date the request was received and a description of the method other investors may use to contact the requesting investor. A proposed instruction limits the permissible procedures for verifying that an investor is a beneficial owner to obtaining a written statement from the record holder of the securities (if other than the requesting investor) verifying that the investor beneficially holds the securities at the time the request is submitted. The release cautions that to the extent an investor wishes to communicate with other investors as to matters other than the exercise of their rights under the terms of the ABS, such as a possible tender offer, the investor must consider whether the communication is subject to other federal securities laws. General. Neither the April 2010 proposal nor the current re-proposal would change the eligibility requirements relating to delinquent assets, the residual value of securitized leases and the timely filing of Exchange Act reports by the depositor or any issuing entity previously established by the depositor or any of its affiliates with respect to a class of ABS involving the same asset class, 9 although the re-proposal includes conforming changes to the registrant requirements that would pick up the timely filing during the look-back period of any required executive officer certifications and of transaction agreements containing the required credit risk manager and investor communication provisions. A depositor or issuing entity that fails to satisfy these filing requirements during the applicable look-back period would be deemed to satisfy them 90 days after curing the deficiency. A proposed change to Rule 401(g)(4), which would require an annual evaluation, as of 90 days after the end of the depositor s fiscal year, of whether the depositor and any affiliated issuing entity have filed all reports under Section 13(a) or 15(d) of the Exchange Act on a timely basis during the previous 12 months, remains outstanding. 8 9 The SEC noted that most ABS issuers report and distribute payments to investors on a monthly basis, and that the Form 10-D must be filed within 15 days after a required distribution date, which is typically two weeks after the end of a reporting period, and is requesting comment as to whether it should require more timely reporting of requests to communicate. See General Instructions I.B.5 and I.A.4 of Form S

7 The SEC is eliminating the risk retention requirement from its shelf eligibility proposal in light of the pending risk retention requirements proposed pursuant to Section 941 of Dodd-Frank, although it may consider whether additional risk retention requirements for shelf eligibility are appropriate after the joint risk retention rules are adopted. The SEC is also eliminating the condition requiring an undertaking to provide Exchange Act reports because Section 942 of Dodd-Frank eliminated the automatic suspension of the duty to file under Section 15 of the Exchange Act for ABS issuers and granted the SEC authority to issue rules providing for the suspension or termination of such duty. Proposed Form SF-3 remains outstanding and is unchanged except to the extent necessary to reflect changes in the eligibility requirements in the general instructions to the form. Finally, the SEC is soliciting comment as to whether, in light of the new risk retention and reporting requirements mandated by Dodd-Frank, any additional conditions on shelf eligibility are necessary or appropriate, whether it should adopt an additional or alternative condition based on the depositor s history of similar prior ABS issuances, and whether shelf registration should be limited to ABS issuers relying on Rule 3a-7 under the Investment Company Act, which contains substantive conditions pertaining to conflicts of interest and other matters that are not applicable to issuers relying on the Section 3(a)(5) exemption. 10 III. DISCLOSURE REQUIREMENTS Exhibit Filings. The April 2010 proposals would have added to Regulation AB a new Item 1100(f) requiring the filing of required exhibits by the date the final prospectus is required to be filed under proposed Rule 424. In response to investor comments, the current re-proposal would require exhibits, including agreements in substantially final form, to be filed not later than the date the preliminary prospectus is required to be filed under Rule 424(h), with final agreements to be filed by the date the final prospectus is required to be filed under Rule 424. Since proposed Rule 424(h) contemplates the filing of a preliminary prospectus for each shelf takedown at least five business days prior to the first sale in the 10 Section 3(c)(5) of the Investment Company Act exempts certain issuers primarily engaged in (A) purchasing or otherwise acquiring notes, drafts, acceptances, open accounts receivable and other obligations representing part or all of the sales price of merchandise, insurance and services, (B) making loans to manufacturers, wholesalers and retailers of, and to prospective purchasers of, specified merchandise, insurance and services and (C) purchasing or otherwise acquiring mortgages and other liens and interests in real estate. Rule 3a-7 is more broadly available for ABS issuers but generally requires the issuer to appoint an unaffiliated trustee, to take reasonable steps to cause the trustee to have a valid security interest in those assets that principally generate the cash flow necessary to pay fixed-income security holders, and to take action necessary for the cash flows derived from those assets to be deposited periodically in a segregated account. -7-

8 offering, this proposal would give investors time to consider the content of exhibits prior to their investment decision. 11 Asset-Level Disclosure. The SEC is soliciting comment on whether its outstanding proposals to require disclosure of asset-level information in prospectuses and periodic reports as set out in the April 2010 release would implement the requirements of Section 7(c) of the Securities Act, which was added by Section 942(b) of Dodd-Frank. Specifically, Section 7(c) requires that in adopting regulations requiring asset-level disclosure, the SEC must: set standards for the format of the data, which shall, to the extent feasible, facilitate comparison across securities in similar types of asset classes; and require issuers at a minimum to disclose asset-level data, if necessary for investors independently to perform due diligence, including data having unique identifiers relating to loan brokers and originators, the nature and extent of the compensation of the broker or originator and the amount of risk retention by the originator and the securitizer of the assets. Although the SEC believes that its outstanding proposals would implement these requirements because they call for data sufficient to permit for investors independently to perform due diligence, it notes that, for example, these proposals do not provide for unique identifiers for originators of asset classes other than residential and commercial mortgages since the SEC believes that brokers are not typically used for those other asset classes. Accordingly, the SEC is requesting comment as to whether brokers are used for other classes and whether a system of unique identifiers exists or could reasonably be established. 12 It is also not proposing asset-level disclosure requirements for broker s compensation at this time since it believes that the currently proposed data points may provide the necessary information for investor due diligence. The release also points out the inconsistency between the risk retention requirements mandated by Section 15G of the Exchange Act (added by Section 941 of Dodd-Frank), which are not on an asset-level basis, and a requirement under Section 7(c) of the Securities Act (added by Section 942(b) of Dodd-Frank) to provide risk retention information at the asset level. In light of conflicting views expressed by commentators as to the appropriate level of asset-level disclosure requirements in light of privacy concerns, the SEC is soliciting further comment on how to reconcile these competing interests. The SEC is also requesting more information with respect to possible data points for asset-level information with respect to equipment and equipment floorplan ABS, although it did note some commentators privacy and competition concerns and proposals for grouped The SEC noted that it has not reached a conclusion with respect to the five business day filing deadline contemplated by proposed Rule 424(h). In this regard, the release notes that the recently amended FDIC safe harbor rule for securitizations by insured depository institutions requires disclosure of broker compensation for RMBS only. See Federal Deposit Insurance Corporation, Treatment by the Federal Deposit Insurance Corporation as Conservator or Receiver of Financial Assets Transferred by an Insured Depository Institution in Connection With a Securitization or Participation After September 30, 2010 (Sep. 27, 2010) [70 FR 60287]. -8-

9 account disclosure for equipment ABS, and acknowledged that equipment floorplan ABS, as revolving assets, may share some characteristics with other asset classes, such as credit card receivables, for which grouped account data may be appropriate. Noting its intention that a new Schedule L be filed under Item 6.05 of Form 8-K whenever prefunding or revolving assets increase or change the pool by 1% or more, the SEC is soliciting comment as to whether any clarification or changes to the proposed updating requirements are necessary, including as to timing and the manner of presentation of new information. Privately Placed Structured Finance Products. The April 2010 proposals included revisions to Rules 144, 144A and 506 that would condition reliance on these safe harbor exemptions from registration under the Securities Act in connection with structured finance products 13 on the issuer s granting purchasers, holders and prospective holders the right to obtain the information that would be required if the offering were registered on Form S-1 or proposed Form SF-1 and the ongoing information that would be required by Section 15(d) of the Exchange Act if the issuer were required to file reports under that section. The release notes concerns of commentators that there are no clear information requirements for certain types of ABS, such as CDOs, CLOs, ABCP and synthetic ABS, that are not typically offered under Regulation AB, and the SEC is soliciting comment on whether it should require asset-level disclosure only for structured finance products backed by collateral or assets of an asset class for which there are prescribed asset-level reporting requirements in Regulation AB. Future Re-Proposal of Waterfall Computer Program Requirement. Finally, the SEC acknowledged many helpful and detailed suggestions regarding its proposed waterfall computer program requirement and noted its plan to re-propose the requirement separately from adopting requirements for ABS shelf eligibility, offering process and disclosures. 13 In addition to asset-backed securities, the term structured finance product would cover: a synthetic asset-backed security; or a fixed-income or other security collateralized by any pool of self-liquidating financial assets, such as loans, leases, mortgages and secured or unsecured receivables, that entitles its holder to receive payments that depend on cash flows from the assets, including: o a collateralized mortgage obligation; o a collateralized debt obligation; o a collateralized bond obligation; o a collateralized debt obligation of asset-backed securities; o a collateralized debt obligation of collateralized debt obligations; or o a security that at the time of the offering is commonly known as an asset-backed security or a structured finance product. -9-

10 IV. TRANSITION PERIOD The SEC is considering the appropriate timing for implementing its April 2010 proposals and the current re-proposals, and to that end is soliciting comment as to whether any of the proposals should be phased in or whether implementation should be based on a tiered approach or based on the asset class. It has, however, reiterated its belief that compliance dates should not extend past a year after adoption of the new rules. * * * Copyright Sullivan & Cromwell LLP

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