New rules being proposed by the Securities and Exchange Commission to regulate offerings of asset-backed and mortgage-backed securities (collectively, “ABS”) would substantially expand the disclosure requirements for ABS offerings and could virtually eliminate any distinction between disclosure required in the SEC-registered and Rule 144A ABS markets.
In a historic shift away from the decades-old doctrine that large, sophisticated institutional investors are able to fend for themselves, the SEC voted to propose new rules that would require that in any private offering made in reliance on Rule 144A or Rule 506 of Regulation D, an ABS issuer provide to any investor that so requests, at the time of the initial offering and on an ongoing basis, all information that would be required in an SEC-registered offering. In addition, the proposed rules would:
- Eliminate the investment-grade rating requirement for shelf eligibility and impose new disclosure, risk retention, certification and reporting requirements;
- Require five percent unhedged risk retention by securitization sponsors as a condition to shelf eligibility, but not for individually registered or private offerings;
- Require detailed asset-level disclosure regarding the pool assets at the time of the offering and on an ongoing basis;
- Require that ABS issuers file with the SEC a computer program that investors can use to model the cash flow waterfall; and
- For private offerings, apply (upon investor request) broadly to offerings of “structured finance products,” including synthetic transactions and collateralized debt obligations.
The proposed changes are summarized below.
The proposed rules would include the following new Regulation AB disclosure requirements and modifications of existing requirements, among others:
- In a shelf offering of ABS, issuers would no longer be permitted to utilize a base prospectus that describes the general terms of ABS offerings under the registration statement and a prospectus supplement that describes the specific terms of the particular offering. Instead, a new, complete prospectus would be required for each transaction that includes all of the required disclosure in a single document.
- In each offering of ABS, detailed disclosure in a standardized, computer-readable format regarding each pool asset would be filed with the SEC at the time of the offering, when assets are added to the asset pool and on an ongoing basis. Specific disclosure requirements would apply to offerings of residential mortgage-backed securities; it appears that these requirements would be similar to the proposals made by the American Securitization Forum in its Project RESTART. Asset-level disclosure would not be required in offerings of ABS backed by credit card or charge card receivables or utility “stranded costs.” Issuers of credit or charge card ABS would be required to provide “grouped account data.”
- In each offering of ABS, the issuer would be required to file with the SEC a computer program for the cash flow waterfall that would permit prospective investors to input data regarding the pool assets and model projected cash flows and allocation of losses.
- Disclosure requirements for pool asset information and static pool information would be “refined.” In addition, issuers would no longer be permitted to satisfy SEC filing requirements by posting static pool information on Internet web sites, but would instead need to file such data with the SEC.
- The Regulation AB definition of “asset-backed security” would be modified to reduce the maximum amount of permitted pre-funding from 50 percent to 10 percent, and to restrict offerings of ABS issued by revolving trusts that hold non-revolving assets.
- Additional information would be required regarding originators and sponsors, including the amount of an originator’s or sponsor’s securitized assets that have been subject to demands for repurchase or substitution.
The proposed rules would eliminate the current requirement that ABS be rated investment grade and instead require, as a condition to eligibility for use of a shelf registration statement, that:
- The securitization sponsor retain a five percent “vertical slice” of the issued ABS, in a term securitization, or retain a five percent originator’s interest, in a revolving trust securitization, which could not be hedged;
- A preliminary prospectus that includes all information required to be included in the final prospectus other than pricing-related information be filed with the SEC at least five business days before the first sale of securities in the offering;
- The securitization documents provide that if a demand for repurchase of a pool asset was made on the basis of a claim of a breach of representations and warranties and the asset was not repurchased, the trustee would be entitled to receive an opinion of an independent party to the effect that the representations and warranties were not breached;
- The chief executive officer of the issuer certify that there is a reasonable basis to believe that the pool assets will provide sufficient cash flow to make payments on the offered securities; and
- The issuer agree to file periodic reports with respect to the ABS for as long as the securities are held by third parties.
Compliance with the shelf eligibility criteria would be tested periodically, and compliance failures could result in the issuer's inability to conduct shelf offerings.
The SEC would create two new registration forms, Form SF-1 for individual registrations and Form SF-3 for shelf registrations, specifically tailored for offerings of ABS. Risk retention by the securitization sponsor would not be required by the SEC in offerings on Form SF-1.
In any offering of ABS made in reliance on an SEC safe harbor exemption from registration, including offerings to “qualified institutional buyers” under Rule 144A or to “accredited investors” under Rule 506 of Regulation D, each investor would be entitled to receive, upon request, the same information to which the investor would be entitled if the offering were registered with the SEC. This requirement would apply at the time of the offering and on an ongoing basis. Further, the proposed rules would reach even more broadly, requiring Regulation AB disclosure for offerings of “structured finance products” that do not qualify as “asset-backed securities” under Regulation AB. The definition of structured finance products would include synthetic transactions, collateralized debt obligations, and any instrument commonly known as an asset-backed security or structured finance product.
In the view of the SEC, investors that did not receive the requested information would be entitled to sue for breach of contract. The SEC will propose a new rule that would give the Commission the authority to take enforcement action against any issuer that did not provide the required information.
In addition, in any Rule 144A offering of structured finance products, the issuer would be required to file a notice of the offering with the SEC.
The new rules would not require risk retention by the securitization sponsor in private offerings.
The Proposing Release
The complete text of the proposed new rules, together with SEC commentary, is available at http://www.sec.gov/rules/proposed/2010/33-9117.pdf.
For assistance, please contact any of the following lawyers:
Edward E. Gainor, Partner, Structured Transactions
Reed D. Auerbach, Practice Group Leader, Structured Transactions
Roger P. Joseph, Practice Group Leader, Investment Management; Co-chair, Financial Services Area
Edwin E. Smith, Partner, Financial Restructuring, Co-chair, Financial Services Area