The Securities and Exchange Commission (“SEC”) has issued proposed rules (the “Proposing Release”)1 that would require an issuer of registered asset-backed securities (“ABS”) to perform a review of the underlying pool assets, either directly or through a third-party diligence provider. The proposed rules also would amend Item 1111 of Regulation AB to require any issuer of publicly registered ABS to disclose the nature of its review and its findings and conclusions.2 Finally, the proposed rules would require that any issuer of unregistered ABS or any underwriter of registered or unregistered ABS3 file a new form with the SEC, Form ABS-15G, to make certain disclosures relating to third-party due diligence reviews.
Under the proposed rules, a third-party diligence provider whose findings and conclusions are included in a registration statement may be required to consent to being named in the registration statement as an expert and thus be subject to liability under Section 11 of the Securities Act of 1933, as amended (the “Securities Act”). The proposed rules do not clearly delineate what sort of third-party report would be subject to these requirements or would be required to be filed on Form ABS-15G, leaving unanswered questions as to whether accountants’ agreed-upon procedures letters or law firms’ opinion letters would be required to be filed with the SEC or could subject the accountant or law firm to expert liability.
The proposed rules would implement Sections 932 and 945 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was signed into law on July 21, 2010.4 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. These rules must be adopted no later than 180 days after enactment of the Dodd-Frank Act. Section 932 of the Dodd-Frank Act added new Section 15E(s)(4)(A) to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which requires an 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. The SEC proposed both sets of rules together because, the SEC said, the substance of new Section 7(d) of the Securities Act is related to new Section 15E(s)(4)(A) of the Exchange Act.
Required Diligence Review of Pool Assets
The SEC has proposed new Rule 193 to implement Section 7(d) of the Securities Act. Proposed Rule 193 would require ABS issuers to perform a review of the pool assets underlying the ABS. Section 7(d) uses the term “asset backed security” as defined by the Dodd-Frank Act (“Exchange Act ABS”), which encompasses a much broader range of instruments than ABS as defined in Regulation AB, including all securities, that are collateralized by self-liquidating financial assets that allow the holders to receive payments based primarily on the cash flows from those assets, whether offered publicly or privately. Among other things, Exchange Act ABS include collateralized debt obligations, securities issued or guaranteed by a government sponsored entity such as Fannie Mae or Freddie Mac, and municipal ABS. However, because Section 7(d) only requires the SEC to issue rules “relating to the registration statement,” proposed Rule 193 would apply only to issuers of Exchange Act ABS that are issued in registered offerings.
Proposed Rule 193 does not specify the level or type of review an issuer must perform. Instead, the related disclosure requirements would “give investors an ability to evaluate the level and adequacy of the issuer’s review of the assets.” The SEC states in the Proposing Release that the review may vary depending on the circumstances, such as the nature of the securitized assets and the degree of continuing involvement of the sponsor.5 However, the SEC does request comment on whether the SEC should specify the nature of the review,6 and the Proposing Release notes that the delineation of various levels of required review by asset class would require more work than can be accomplished in the time available before the SEC must adopt the rules. Based upon comments made by Commissioners at the SEC’s open meeting on October 13, it appears likely that the SEC ultimately will prescribe specific standards for the level or type of review that will be required. Commissioner Luis Aguilar voted against the proposal because Proposed Rule 193 does not include a minimum standard for the pool asset review. Chairman Mary Schapiro said that she has “a preliminary view that we should likely mandate a minimum level of review,” and further stated that “I expect we likely will end up, although I don’t want to prejudge the comments, with a mandated level of review.”
Under proposed Rule 193, the pool asset review would be required to be performed by the issuer of the registered Exchange Act ABS. According to the Proposing Release, the review required under proposed Rule 193 may be performed by either the issuer or the sponsor. A review of the assets by an unaffiliated originator would not suffice for purposes of proposed 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.
Proposed Rule 193 would permit an issuer to engage a third party to perform the required review, as long as the third party is named in the registration statement and consents to being named as an “expert” pursuant to Section 7 of the Securities Act and Rule 436 thereunder. This would subject such a third-party diligence provider to liability under Section 11 of the Securities Act.7
In its request for comment, the SEC asks what types of entities might be considered to be a “third party engaged for purposes of performing a review of the pool assets” under Proposed Rule 193 and thus, if relied upon by the issuer, be required to be named in the registration statement and consent to being named as “experts.” Among other things, the SEC identifies as possible third-party diligence providers both accountants who perform agreed-upon procedure reviews and lawyers who provide perfection opinions regarding the security interest in the collateral.
Issuer Disclosure of Diligence Reviews in Registered Public Transactions
To implement new Section 7(d)(2) of the Securities Act with respect to registered offerings of ABS, proposed Item 1111a(7) of Regulation AB would require each issuer to disclose in the prospectus the nature of the review it conducts to satisfy proposed Rule 193, including whether the issuer has hired a third-party review firm for this purpose. According to the Proposing Release, the SEC expects that “this would include a description of the scope of the review, such as whether the issuer or a third party conducted a review of a sample of the assets or what kind of sampling technique was employed (i.e., random or adverse).” As discussed further below, new Section 15E(s)(4)(A) of the Exchange Act would require an issuer or underwriter of ABS in any offering, public or private, to make publicly available the findings and conclusions of any third-party due diligence report obtained by the issuer or underwriter. While Section 7(d)(2) does not by its terms require disclosure of the findings and conclusions of investigations made by the issuer (such as those that would be required by proposed Rule 193), proposed Item 1111(a)(7) would require this disclosure to be included in the prospectus for registered ABS offerings with regard to both issuer reviews and third-party reviews in an effort to avoid creating incentives for regulatory arbitrage.
In its proposed comprehensive revisions to Regulation AB (the “2010 ABS Proposing Release”),8 the SEC 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. In the Proposing Release, the SEC re-proposes these requirements, adding a requirement to disclose which entity (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 it used to make that decision.
The wording used in proposed Item 1111(a)(7) for third parties (“third party engaged for purposes of performing a review of the pool assets”) is the same as that used in proposed Rule 193, as described above. The SEC notes its view that “the third party engaged by the issuer to perform a review of the assets for purposes of complying with [proposed] Rule 193 likely would be the same third-party due diligence providers whose reports must be made publicly available by an issuer or underwriter for purposes of Section 15E(s)(4)(A),” as implemented by proposed Item 1111(a)(7) for issuers in registered public offerings (and proposed Rule 15Ga-2 for underwriters, and for issuers in unregistered offerings, as described below). While the Proposing Release is not entirely clear, this may mean that, for example, any agreed-upon procedures report provided by an accountant, or any perfection opinion provided by a lawyer, would be required to be disclosed under proposed Item 1111(a)(7) (or, pursuant to proposed Rule 15Ga-2, on Form ABS-15G, as discussed below). Because the SEC uses the same language in proposed Item 1111(a)(7) and proposed Rule 193, it is also possible that the accountant or lawyer would be required to be named in the registration statement and its consent provided under proposed Rule 193 — even if the issuer did not specifically intend for the report of the accountant or lawyer to be the source of its required review.Disclosure by Issuers in Unregistered Transactions and by Underwriters in All Transactions
New Section 15E(s)(4)(A) of the Exchange Act would require an issuer or underwriter of ABS to make publicly available the findings and conclusions of any third-party due diligence report obtained by the issuer or underwriter. Section 15E(s)(4)(A) would apply to all Exchange Act ABS whether offered publicly or privately, not just the more limited group of ABS subject to Regulation AB. Unlike Section 945 of the Dodd-Frank Act, Section 932 does not refer to registration statements under the Securities Act. Proposed Rule 15Ga-2 under the Exchange Act would require the filing of a Form ABS-15G to disclose the findings and conclusions of any third party engaged to perform a review obtained by an issuer in an unregistered offering of Exchange Act ABS, as well as for reports obtained by an “underwriter” in any offering of Exchange Act ABS, whether registered or not.
Form ABS-15G would be required to be filed with the SEC via EDGAR five business days before the first sale in the offering.9 The Form would be signed by the senior officer in charge of securitization of the depositor or by a duly authorized officer of the underwriter, as applicable.
In the Proposing Release, the SEC acknowledges that “public disclosure of information relating to an unregistered offering could raise concerns regarding an issuer’s or underwriter’s reliance on the private offering exemptions and safe harbors under the Securities Act,” but goes on to state that, in the SEC’s view, the required information can be disclosed “without jeopardizing reliance on those exemptions and safe harbors, provided that the only information made publicly available is that which would be 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 recently took a similar position with respect to its proposal to require public disclosure of fulfilled and unfulfilled asset repurchase requests for all of a securitizer’s ABS trusts over a five-year period.10
The SEC notes in the Proposing Release that Section 15E(s)(4)(A) of the Exchange Act does not specify how it is to apply to offshore transactions, but proposed Rule 15Ga-2 would require issuers and underwriters to disclose information about Exchange Act ABS sold in unregistered transactions outside the United States. Proposed Rule 15Ga-2 apparently also would cover private offerings of Exchange Act ABS in the United States by foreign issuers, as the SEC acknowledges that the proposed rule “may result in foreign issuers seeking to avoid the filing requirement by excluding U.S. investors from purchasing portions of ABS primarily offered outside the United States. . . .”
Comments on the proposed rules are due to the SEC by November 15, 2010.
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