SEC Proposes Requirements Regarding Review of Assets Underlying Asset-Backed Securities Offerings and Disclosure of Findings and Conclusions SUMMARY On October 13, 2010, the Securities and Exchange Commission proposed rules pursuant to Section 945 and a portion of Section 942 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Proposed Rule 193 under the Securities Act of 1933 would require any issuer registering the offer and sale of an asset-backed security to perform a review of the assets underlying the ABS. The SEC is also proposing amendments to Item 1111 of Regulation AB that would require an ABS issuer to disclose the nature of its review of the assets and the findings and conclusions of its review. If the issuer has engaged a third party to review the assets, the issuer would be required to disclose the third party s findings and conclusions. The SEC is also proposing a new Rule 15Ga-2 under the Securities Exchange Act of 1934 to require that an issuer or underwriter of an ABS offering file a form to include certain disclosures relating to third-party due diligence providers. THE PROPOSALS Section 945 of the Dodd-Frank Act added a new Section 7(d) to the Securities Act of 1933 (Securities Act) requiring the Securities and Exchange Commission (SEC) to issue, within 180 days of enactment, rules requiring the issuer of an asset-backed security, as that term is defined in the Dodd-Frank Act (ABS), 1 registered under the Securities Act 2 to perform a review of the assets underlying the ABS and to disclose the nature of that review. 3 Section 932 of the Dodd-Frank Act added a new Section 15E(s)(4) to the Securities Exchange Act of 1934 (Exchange Act) requiring the issuer or underwriter of any ABS to make publicly available the findings and conclusions of any third-party due diligence report obtained by the issuer or underwriter. 4 Proposed Rule 193 would implement Section 7(d)(1) of the Securities Act, as added by Section 945 of the Dodd-Frank Act; the proposed amendments to Item 1111 of Regulation AB New York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney www.sullcrom.com
would require disclosure regarding the nature of the issuer s review of the assets under proposed Rule 193 and the findings and conclusions of the review; and proposed Rule 15Ga-2 and Form 15G-ABS 5 would implement the above described provisions of Section 15E(s)(4) of the Exchange Act, as added by Section 932 of the Dodd-Frank Act. Proposed Rule 193 does not specify the level or type of review an issuer is required to perform, which the SEC expects may vary depending on the circumstances, including the nature of the assets being securitized and the degree of continuing involvement by the sponsor, 6 but the proposed rule would require a description of the level and type of review. 7 The issuer, for purposes of this rule, would be the depositor or the sponsor of the securitization. The SEC noted that a review performed by an unaffiliated originator would not satisfy the rule. The proposed rule would permit an issuer to rely on a third-party review if the third party is named in the registration statement and consents to being named as an expert in accordance with Section 7 of the Securities Act and Rule 436 under the Securities Act. The SEC is requesting comment as to whether it should mandate a minimum level of review, and in particular whether it should require that the review provide reasonable assurance that the disclosure in the prospectus is accurate in all material respects or that it meet some other standard, as well as whether the safe harbor exemptions from registration provided by Regulation D and Rule 144A under the Securities Act should be conditioned on the issuer performing a review that complies with proposed Rule 193. The SEC is also soliciting comment on what entities should be considered third-party reviewers engaged for purposes of performing a review of the pool assets and in particular whether these entities should include accountants and attorneys, or perhaps appraisers and engineers for certain types of ABS offerings, as well as on whether there are potential conflicts of interest similar to those for NRSROs operating under the issuer pays model and whether there should be an independence requirement for third-party reviewers. The proposed amendments to Item 1111 of Regulation AB would both (i) address the disclosure of the nature of the review conducted to satisfy proposed Rule 193 to implement the requirements of Section 7(d)(2) of the Securities Act, as added by Section 945 of the Dodd-Frank Act, and (ii) expand the disclosures required with respect to assets that deviate from disclosed underwriting standards. To harmonize the requirements of Section 7(d)(2), which does not require the disclosure of the findings and conclusions of the review, and Section 15E(s)(4) of the Exchange Act, which does require the disclosure of the findings and conclusions of the review but does not apply to reviews conducted by the issuer, the SEC is proposing a new Item 1111(a)(7) of Regulation AB that would require the disclosure of the findings and conclusions of the review conducted by the issuer, sponsor or third party. Proposed Item 1111(a)(8) 8 of Regulation AB would expand the disclosures proposed to be required for pool assets that deviate from the disclosed underwriting criteria to include information on which entity determined that such assets should be included in the pool and what factors were used to make such determination. The SEC believes that this information would help provide investors with a fuller understanding of the quality -2-
and extent of the issuer s review of the assets and how that relates to a determination to either include a loan in the pool or exclude it from the pool. Proposed Rule 15Ga-2 and the revisions to proposed Form ABS-15G address the requirement that the issuer or underwriter of any ABS make publicly available the findings and conclusions of any third-party due diligence report obtained by the issuer or underwriter. The SEC views Section 15E(s)(4)(A) of the Exchange Act as not being limited to registered offerings of ABS, in light of the scope of the definition of ABS, as added to the Exchange Act by Section 941 of the Dodd-Frank Act. Proposed Rule 15Ga-2 and Form ABS-15G would apply to issuers of unregistered ABS, as well as to underwriters of registered and unregistered ABS. 9 The deadline for filing Form ABS-15G would be five business days prior to the first sale of the offering, to give investors and NRSROs time to consider the required disclosures. 10 The form would have to be signed by the senior officer in charge of securitization of the depositor, if the third party is hired by the issuer, and by a duly authorized officer of the underwriter, if the third party is engaged by an underwriter. The SEC noted that Section 15E(s)(4)(A) does not specify how its requirements apply to offshore transactions and that, consistent with Section 15E(s)(4)(A), proposed Rule 15Ga-2 would require issuers and underwriters to disclose information about ABS sold in unregistered offerings outside the United States and private placements of ABS by foreign issuers in the Unites States, and in particular that the imposition of this filing requirement may result in foreign issuers seeking to avoid the filing requirement by excluding U.S. investors, depriving them of diversification and related investment opportunities. 11 * * * ENDNOTES 1 2 3 This definition is broader than the definition in Regulation AB, and encompasses any fixedincome or other security collateralized by any type of self-liquidating financial assets that allow the holder to receive payments that depend primarily on cash flow from the asset, including CMOs, CDOs, collateralized bond obligations and CDOs of ABSs and CDOs. Exchange Act Section 3(a)(77). Although the term ABS includes securities typically offered in private transactions, the SEC has concluded that the review requirements mandated by Section 7(d)(1) of the Securities Act apply only to registered offerings because it specifically requires the SEC to issue rules relating to the registration statement. The recently adopted amendments by the Federal Deposit Insurance Corporation to its Rule 360.6, which provides safe harbor protection in a receivership or conservatorship of an insured depository institution in connection with certain securitizations and participations, require the disclosure of a third-party due diligence report in connection with securitizations of residential mortgage loans. See our May 21, 2010 memorandum entitled FDIC Proposes Revised Securitization Rule Including Safe Harbors for Securitization Transactions Not Entitled to Off Copyright Sullivan & Cromwell LLP 2010-3-
4 5 6 7 8 9 10 11 Balance Sheet Treatment under New Accounting Standards, discussing the FDIC s Notice of Proposed Rulemaking with respect to these amendments. Section 15E(s)(4) includes a new requirement for third-party providers of due diligence services employed by a nationally recognized statistical rating organization (NRSRO), issuer or underwriter in connection with ABS to provide a certification to any NRSRO that produces a rating to which such services relate and requires further SEC rulemaking that is not addressed by the current SEC release to establish the appropriate form and content of this certification and require the disclosure of this certification to the public by the NRSRO at the time it produces a rating. Final regulations under this section must be adopted within one year of the enactment of the Dodd-Frank Act. Form 15G-ABS as initially proposed on October 4, 2010 in Release Nos. 33-9148; 34-63029 (75 Fed. Reg. 62718 (October 13, 2010)) applied to periodic filings by securitizers regarding fulfilled and unfulfilled demands to repurchase or replace assets for breaches of representations and warranties, as discussed in our October 13, 2010 memorandum entitled SEC Proposes Disclosure Requirements Regarding Representations and Warranties in Asset-Backed Securities Offerings. The current release expands proposed Form 15G-ABS so that it will also cover the disclosure of third-party due diligence reviews. For example, the SEC indicated that in offerings of residential-mortgage backed securities it may be appropriate to review a sample of loans large enough to be representative of the pool and conduct further review if the initial review indicates that further review is warranted, whereas for commercial mortgage-backed securities it might be appropriate to review every pool asset where a significant portion of the cash flow will be derived from a single obligor or a small group of obligors. The SEC noted that in light of the deadline for the adoption of the proposed rules, it believes that devising various levels of review applicable to each different asset class is not feasible in the time provided, but nonetheless it is soliciting comments on whether it should consider proposing more detailed standards at a later date. Proposed Item 1111(a)(8) appears to supersede the amendments to Item 1111(a)(3) proposed in SEC Release Nos. 33-9117; 34-61858 (75 Fed. Reg. 23328, 23421 (May 3, 2010)) and described in our April 23, 2010 memorandum entitled SEC Proposes Significant Revisions to Rules on the Offering Process, Disclosure and Reporting for Asset-Backed Securities. The SEC notes that filing proposed Form ABS-15G would not foreclose reliance on the private offering exemption in the Securities Act and the safe harbor for offshore transactions so long as no information is included beyond what is required in proposed Rule 15Ga-2. This timing is intended to be consistent with proposed Rule 424(h), which would require the filing of a preliminary prospectus containing transaction-specific information at least five business days in advance of the first sale of securities in the offering. The SEC also noted in its request for comments on proposed Rule 15Ga-2 that the rule would also apply to securities that are exempted by Section 3(a)(12) of the Exchange Act, including government and municipal securities. -4-
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