The Securities and Exchange Commission (the “SEC” or “the Commission”) has adopted final rules to implement Sections 932, 943 and 945 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”). These rules impose new disclosure requirements in connection with requests to repurchase securitized assets and a mandatory issuer due diligence review of securitized assets, each in connection with offerings of asset-backed securities (“ABS”). The Dodd-Frank Act, which was signed into law on July 21, 2010,1 required the SEC to adopt final rules no later than 180 days after enactment. The new rules were first proposed in October 20102 and were adopted on January 20, 2011.3
The new rules on repurchase requests require securitizers of “asset-backed securities,” as newly and broadly defined by the Dodd-Frank Act (“Exchange Act ABS”), for which the underlying transaction agreements contain a covenant to repurchase underlying assets for breach of a representation or warranty to make quarterly disclosures of all fulfilled and unfulfilled asset repurchase requests for all of the securitizer’s Exchange Act ABS trusts. These rules apply to all issuances of Exchange Act ABS, both public and private, with the initial disclosure for all securitizers that issued and sold such ABS during the three-year period ended December 31, 2011, to cover that three-year period and with quarterly reports thereafter. In addition, in registered offerings of ABS, prospectus disclosure regarding repurchase requests for all of a securitizer’s Exchange Act ABS trusts of the same asset class will be required for the most recent three-year period, and periodic distribution reports on Form 10-D must disclose the repurchase request activity for the asset pool underlying those ABS.
As adopted, new Rule 15-Ga-1 is somewhat narrower in scope than it was when originally proposed. In particular, the look-back periods for the initial disclosure of the securitizer’s Exchange Act ABS repurchase activity, and for prospectus disclosure in registered ABS offerings regarding repurchase activity in assets of the same class, have been reduced to three years from five. Also, the periodic reports required to be filed with the SEC to report activity for all of the securitizer’s Exchange Act ABS are required to be filed quarterly, rather than monthly, and will cover only activity during the applicable reporting period.
In addition, the SEC has adopted rules requiring nationally recognized statistical rating organizations (“NRSROs”) to include in any rating report a description of the representations, warranties and enforcement mechanisms available to investors, and how they differ from representations, warranties and enforcement mechanisms in issuances of similar securities.
The new rules on due diligence reviews require each issuer of registered ABS to perform a review of the underlying pool assets, either directly or through a third-party diligence provider. The new rules also amend Item 1111 of Regulation AB under the Securities Act of 1933, as amended (the “Securities Act”), to require each issuer of publicly registered ABS to disclose the nature of its review and its findings and conclusions. If the issuer engages a third-party diligence provider to undertake any of this review and attributes any of the review’s conclusions to the third-party reviewer, the diligence provider would be required to consent to “expert” status under the Securities Act.
The Commission adopted an ambiguous minimum standard for issuers’ diligence reviews that prompted two of the five Commissioners to vote against approval of new Rule 193. Each issuer’s review of the pool assets for purposes of this rule must, at a minimum, “be designed and effected to provide reasonable assurance that the disclosure regarding the pool assets” in the prospectus “is accurate in all material respects.”4
The Commission also adopted amendments to Regulation AB requiring disclosure regarding pool assets that deviate from the disclosed underwriting or other criteria, including which entity or entities made the decision to include the nonconforming assets in the pool, as well as the factors used to make that decision.
Disclosure of Repurchase Requests
The rules requiring disclosure by securitizers include a new Rule 15Ga-1 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which requires the filing of a new Form ABS-15G. Each filed Form ABS-15G will include a tabular summary of all rejected, disputed, withdrawn, fulfilled and pending repurchase requests made during the applicable reporting period. The required disclosure will not be limited to repurchase requests made by the securitization trustee or another party having a contractual right to request repurchase; repurchase requests made by investors will also be required to be disclosed. Securitizers will be permitted to indicate by footnote, if applicable, that the securitizer had been unable to obtain from the trustee information regarding investor repurchase requests made prior to the effective date of the new rules. In addition, securitizers will be permitted to omit information that is unknown or not reasonably available to the securitizer without unreasonable effort or expense, if they include a statement describing why unreasonable effort or expense would be required.
The new rules apply not only to publicly registered ABS as defined in Regulation AB, but also will require disclosures for all issuances of Exchange Act ABS.5 This new definition of ABS encompasses a much broader range of instruments than “asset-backed securities” under Regulation AB, including all securities, whether offered publicly or privately, that are collateralized by self-liquidating financial assets that allow the holders to receive payments based primarily on the cash flows from those assets.6 Among other things, Exchange Act ABS include collateralized debt obligations and, according to the SEC’s statements in the adopting release, securities issued or guaranteed by a government-sponsored entity such as Fannie Mae or Freddie Mac, and municipal ABS.7 The new rules require disclosures with respect to all Exchange Act ABS for which the transaction documents provide a covenant to repurchase or replace underlying assets for breach of a representation or warranty (“Reportable ABS”).
Rule 15Ga-1 applies to all “securitizers,” a definition also added to the Exchange Act by the Dodd-Frank Act, which generally includes ABS sponsors and depositors.8 However, for transactions where the sponsor and depositor are affiliated, only the sponsor or the depositor, but not both, will be required to make the required disclosures.9
New Rule 15Ga-1 will require reporting with respect to all ABS transactions by securitizers in the United States, including Reportable ABS sold outside the United States. Rule 15Ga-1 also will cover offerings of Reportable ABS in the United States by foreign securitizers.
Form ABS-15G. Under Rule 15Ga-1(c)(1), an initial Form ABS-15G will be required to be filed via EDGAR by every securitizer that issued Reportable ABS, or organized a relevant Reportable ABS transaction by securitizing assets, during the three-year period ending December 31, 2011, by filing the Form no later than February 14, 2012. This report must reflect repurchase request activity for all of the securitizer’s Reportable ABS, no matter when issued, during the three-year reporting period. Securitizers that issued Reportable ABS during this three-year period but no longer have any Reportable ABS held by non-affiliates as of December 31, 2011 will still be required to file an initial Form ABS-15G, but will need only to check a box indicating that no non-affiliates hold any of the related ABS.
Rule 15Ga-1(c)(2) requires that for each subsequent calendar quarter, each securitizer that issued Reportable ABS, or organized a relevant Reportable ABS transaction by securitizing assets, during the three-month period, will be required to file an updated Form ABS-15G covering the applicable three-month period no later than 45 days after the end of the quarter. A literal interpretation of this rule also would require filing by each securitizer that had any outstanding Reportable ABS held by nonaffiliates during the period, no matter when those ABS were issued.10 It is not clear whether the Commission intended the rule to sweep so broadly, or whether the Commission intended that the quarterly filings be required only of securitizers that issued Exchange Act ABS during or after the initial three-year look-back period contemplated by Rule 15Ga-1(c)(1). In any event, this report must reflect repurchase request activity for all of the securitizer’s Reportable ABS, no matter when issued, during the three-month reporting period. The securitizer may prospectively suspend its duty to file quarterly updates if no repurchase request activity occurred during the reporting period, by checking a box on the Form. Unless and until the quarterly reporting obligation is reinstated by the receipt of a repurchase demand during a reporting period, the securitizer will only be required to file the Form on an annual basis, no later than 45 days after the end of each calendar year.11
As required by the Dodd-Frank Act, the requirements of Form ABS-15G are not limited to successful demands for repurchase, but also include disclosure of both pending and unfulfilled repurchase requests by the trustee, as well as repurchase requests made by a securityholder even if the trustee did not make a demand for repurchase. Form ABS-15G will require disclosure in a tabular format by asset class, listing the names of all of the relevant issuing entities of Reportable ABS by date of formation of the issuing entity. The table will include an indication as to whether any Reportable ABS of the relevant issuing entity were registered under the Securities Act, and requires the securitizer to detail the repurchase statistics for each originator of underlying assets, without regard to concentration. For each originator and for each issuing entity, Form ABS-15G will require disclosure of the number, outstanding principal balance and percentage by principal balance, for the applicable period, of: assets originated by each originator in the pool at the time of securitization for each issuing entity; assets that were the subject of a repurchase demand for breach of representations and warranties; assets that were actually repurchased or replaced; assets that are pending repurchase or replacement due to the expiration of a cure period; assets that are pending repurchase or replacement where the demand currently is in dispute; assets that were not repurchased or replaced because the demand was withdrawn; and assets that were not repurchased or replaced because the demand was rejected. Each of these number and principal amount disclosures will be required to be totaled by asset class. Outstanding principal balance means, for this purpose, the principal balance as of the reporting end date, and the percentage by principal balance means the outstanding principal balance of the assets subject to the repurchase request divided by the outstanding principal balance of the asset pool as of the reporting period end date.
Registered Offerings of ABS. The SEC proposed significant changes to Regulation AB in April 2010 (the “2010 ABS Proposing Release”),12 and has modified some of those proposed changes to be consistent with new Rule 15Ga-1 in amendments to Regulation AB adopted last week. An amendment to Item 1104 of Regulation AB will now require the prospectus for any registered Reportable ABS transaction that is subject to the requirements of Regulation AB to include the same information required by Rule 15Ga-1 for the securitizer’s last three years. The information in the prospectus may be no more than 135 days old. Because of concerns regarding whether information before the compliance date for the new rules was collected at all, or even if collected, whether it was subject to the controls required for disclosure in a prospectus, the SEC has phased in this requirement. A prospectus filed in the first year after the compliance date may include only a one-year look-back period, and a prospectus filed in the second year after the compliance date may include only a two-year look-back period.13
An amendment to Item 1121 of Regulation AB will require that distribution reports on Form 10-D for any registered Reportable ABS transaction that is subject to the requirements of Regulation AB include the same information required by Rule 15GA-1, but only as to repurchase requests with respect to the related asset pool.
The foregoing disclosures will be required to be made in each prospectus for a new public offering of Reportable ABS commencing with an initial bona fide offer on or after February 14, 2012, and in Forms 10-D required to be filed after December 31, 2011.
Disclosures by NRSROs. The SEC also has adopted new Exchange Act Rule 17g-7, which implements the requirement of Section 943 of the Dodd-Frank Act that NRSROs make certain disclosures in any report accompanying a credit rating relating to Exchange Act ABS. Under this new rule, which was adopted in the form proposed, an NRSRO will be required to include a description of the representations and warranties (including corporate representations and warranties) and enforcement mechanisms and how they differ from those applicable to issuances of similar securities.14 This disclosure would be required for all Exchange Act ABS, whether sold in a registered offering or exempt from registration. For purposes of Rule 17g-7, a “credit rating” will include any expected or preliminary credit rating issued by an NRSRO, including those disclosed in pre-sale reports. NRSROs will be required to comply with Rule 17g-7 six months after its effective date, which will be 60 days after publication in the Federal Register.
Mandatory Asset Due Diligence Review and Related Disclosures
Section 945 of the Dodd-Frank Act added new Section 7(d) to the Securities Act, under which the SEC must issue rules requiring an issuer of ABS to perform a review of the assets underlying the ABS and disclose the nature of that review. The SEC has adopted new Securities Act Rule 193 to implement Section 945 of the Dodd-Frank Act.15
New Rule 193 requires ABS issuers to perform a review of the pool assets underlying the ABS. While Section 7(d) refers explicitly to Exchange Act ABS, because it only requires the SEC to issue rules “relating to the registration statement,” new Rule 193 applies only to issuers of Exchange Act ABS that are offered in registered offerings.
As adopted, Rule 193 requires that the review must, at a minimum, be designed and effected to provide “reasonable assurance” that the disclosure in the prospectus regarding the assets is “accurate in all material respects.”16 Commissioners Kathleen Casey and Troy Paredes voted against adoption of Rule 193 because of the addition of the “reasonable assurance” standard, which they characterized as unclear.17 The meaning and significance of this standard of review will likely be a subject of debate and analysis by securities lawyers for some time.
Rule 193 does not mandate any particular type of review; according to the SEC, the scope of the review may vary depending on the circumstances, such as the nature of the securitized assets, and there is a range of judgments that an issuer might make as to what constitutes “reasonable assurance.” Sampling may be appropriate depending on the circumstances, such as the type of ABS being offered, the number of pool assets, the size of the sample and whether further review was conducted if the initial review indicated that it was warranted. If sampling is used, the sample size and the criteria used to select the sampled assets should be disclosed.
Under new Rule 193, the pool asset review is required to be performed by the “issuer” of the registered Exchange Act ABS. The review required under Rule 193 may be performed by either the depositor or the sponsor, and Rule 193 permits an issuer to engage another third party to perform any part of the required review. However, a review of the assets by an unaffiliated originator would not suffice for purposes of Rule 193. In the view of the SEC, an unaffiliated originator may have different interests in the securitization and different review standards than the issuer or sponsor, particularly where it has contributed only a small portion of the pool assets.
New Section 7(d)(2) of the Securities Act requires each issuer to disclose in the prospectus the nature of the review it conducts. In implementing Section 7(d)(2), Rule 193 requires the issuer to disclose not only the nature of the review, but also the findings and conclusions of the review. While Section 7(d)(2) does not by its terms require disclosure of the findings and conclusions of the issuer’s investigations, as adopted the SEC required disclosure of that information on the ground that it will provide investors with a better picture of the assets and a better ability to evaluate the review.
Rule 193 also requires the issuer to disclose in the prospectus whether it hired a third party to undertake any of the required review. As adopted, Rule 193 permits the issuer to choose whether to attribute the findings and conclusions of a third-party diligence provider to that third party or to itself. If the issuer attributes the findings and conclusions to the third party, then the diligence provider must be specifically named, and it must consent to being named as an “expert” pursuant to Section 7 of the Securities Act and Rule 436 thereunder, and therefore be subject to liability under Section 11 of the Securities Act. If the issuer attributes the findings and conclusions of the third party to itself, then the diligence provider need not be specifically named, and need not consent to expert status.18
In the 2010 ABS Proposing Release, the SEC had proposed to require that Regulation AB disclosure regarding pool assets that deviate from the disclosed underwriting criteria be accompanied by data about the amount and characteristics of those assets that did not meet the disclosed standards, as well as what compensating or other factors were used to determine that the asset should be in the pool. The new rules finalize these requirements, adding a requirement to disclose which entity or entities (e.g., the depositor, the sponsor or the underwriter) made the decision to include the nonconforming assets in the pool, as well as the factors used to make that decision.
As originally proposed, the required disclosure would have been triggered only when an asset that did not meet specified underwriting criteria was included in the pool. Some industry participants believed that if the disclosed underwriting criteria themselves allowed for the inclusion of loans that did not meet a list of specified first-level criteria, the decision to include such loans in the pool would not constitute a deviation from disclosed underwriting criteria triggering the required disclosures. However, as adopted, the rules will require disclosure when an asset included in the pool does not meet specified underwriting criteria, or any other criteria or benchmark used to evaluate the assets. Therefore, where underwriting criteria provide that originators may approve loans at multiple levels, and the loans that fail to meet the first level of underwriting criteria nevertheless are included in the pool, the determination to include these loans in the pool will trigger the required disclosures.
Issuers will be required to comply with all of these new requirements for offerings commencing with an initial bona fide offer after December 31, 2011.
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1 The Dodd-Frank Act is available at http://banking.senate.gov/public/_files/Rept111517DoddFrankWallStreetReformandConsumerProtectionAct.pdf. Our summary of the Dodd-Frank Act is available at /Media.aspx?MediaID=10963.
2 Disclosure for Asset-Backed Securities Required by Section 943 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Rel. Nos. 33-0148 and 34-63029, available at http://www.sec.gov/rules/proposed/2010/33-9148.pdf; Issuer Review of Assets in Offerings of Asset-Backed Securities, SEC Release Nos. 33-9150, 34-63091, available at http://www.sec.gov/rules/proposed/2010/33-9150.pdf. Our summaries of the proposing releases are available at /Media.aspx?MediaID=11332 and /Media.aspx?MediaID=11379, respectively.
3 Disclosure for Asset-Backed Securities Required by Section 943 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Rel. Nos. 33-9175 and 34-63741, available at http://www.sec.gov/rules/final/2011/33-9175.pdf (“Release No. 33-9175”); Issuer Review of Assets in Offerings of Asset-Backed Securities, SEC Release Nos. 33-9176, 34-63742, available at http://www.sec.gov/rules/final/2011/33-9176.pdf (“Release No. 33-9176”).
4 Release No. 33-9176, p.12.
5 In the adopting release, the Commission states its view that filing Form ABS-15G will not “foreclose the reliance of an issuer on the private offering exemption in the Securities Act of 1933 and the safe harbor for offshore transactions from the registration provisions in Section 5.” Release No. 33-9175, p.34.
6 Exchange Act § 3(a)(77).
7 However, the new rules delay the compliance date for municipal securitizers for three years after the date that other securitizers are required to comply.
8 A “securitizer” is “(A) an issuer of an asset-backed security; or (B) a person who organizes and initiates an asset-backed securities transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuer.” Securities Act § 15G(a)(3).
9 The Commission notes in the adopting release that some securitizers may choose to have the depositor file Form ABS-15G in order to differentiate these reports on the basis of asset class. Some commenters on the proposed rules had requested that securitizers be required to report repurchase demand activity for different asset classes in separate reports rather than in a single report as is required under Rule 15Ga-1. Because sponsors typically securitize different asset classes through separate affiliated depositors, reporting with respect to each such asset class could be segregated through separate Forms ABS-15G filed by each depositor rather than a single filing by the sponsor. Release No. 33-9175, fn. 82.
10 Rule 15Ga-1(c)(2) provides that “[f]or each calendar quarter, by any securitizer that issued an asset-backed security during the period, or organized and initiated an asset-backed securities transaction by securitizing an asset, either directly or indirectly, including through an affiliate, or had outstanding asset-backed securities held by non-affiliates during the period, in each case, if the underlying transaction agreements provide a covenant to repurchase or replace an underlying asset for breach of a representation or warranty.” (emphasis added)
11 When a securitizer’s outstanding ABS are no longer held by any third parties, the securitizer may terminate its duty to report by filing a notice on Form ABS-15G.
12 The proposing release is available at http://www.sec.gov/rules/proposed/2010/33-9117.pdf. Our client alert on these proposals is available at /Media.aspx?MediaID=10665.
13 Therefore, prospectuses filed between February 14, 2012 and February 13, 2013 may include only one year of repurchase activity, and prospectuses filed between February 14, 2013 and February 13, 2014 may include only two years of repurchase activity, while prospectuses filed on or after February 14, 2014 must include a full three years of repurchase activity.
14 According to the adopting release, one way that an NRSRO could fulfill this requirement would be to review previous issuances on an initial and ongoing basis and establish benchmarks for various types of securities.
15 The SEC also had originally proposed to adopt rules implementing Section 15E(s)(4)(A) of the Exchange Act, as added by Section 932 of the Dodd-Frank Act, which requires certain disclosures as to third-party due diligence reports obtained by an issuer or underwriter of ABS. However, the SEC postponed consideration of those rules until it adopts rules implementing the remainder of Section 15E(s)(4), relating to use of diligence providers by NRSROs, which it expects to propose later this year.
16 The SEC states in the adopting release that this standard is similar to the standard required for reporting companies in designing and maintaining disclosure controls and procedures in accordance with Rule 13a-15 under the Exchange Act. That rule refers to a “process” that is “effected” to “provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.”
The Commission also states in the adopting release that the “reasonable assurance” standard in Rule 193 is similar to language in the Foreign Corrupt Practices Act of 1977. Section 13(b)(2)(B) of the Exchange Act requires that issuers devise and maintain a system of internal accounting controls sufficient to provide “reasonable assurances" that transactions are authorized and appropriately recorded. Section 13(b)(7) of the Exchange Act defines “reasonable assurances” for this purpose as such degree of assurance “as would satisfy prudent officials in the conduct of their own affairs.”
17 Commissioner Casey said the new minimum standard “appears to convert a process and disclosure obligation into a substantive, performance-based rule that stands in contrast to the clear reading” of Section 945 of the Dodd-Frank Act. Commissioner Paredes noted that “longstanding provisions of the federal securities laws already hold issuers accountable” for disclosure that is materially misleading, and asked, “What, if anything, does Rule 193 demand of issuers of asset-backed securities that these existing provisions do not?”
18 However, the Commission states that if a third-party diligence provider is engaged but the findings and conclusions of the review are attributed to the issuer, use of that diligence review by the issuer to market its securities would be inconsistent with disclosure attributing the review to the issuer.
This article was originally published by Bingham McCutchen LLP.