The Dodd-Frank Wall Street Reform and Consumer Protection Act: Asset-Backed Securities and Rating Agency Reforms

July 01, 2010

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Bill”) was approved by the House on Wednesday, June 30.1 The Senate vote is not expected until mid-July, and the outcome there is uncertain.

The Bill covers almost every aspect of financial regulation, and analysis of its practical implications is in the relatively early stages. Implementation of the Bill will require an extraordinary amount of rulemaking and regulators are given significant discretion. If the Bill passes, amendments will likely follow. Consequently, even if enacted, the final shape and practical impact of the Bill are in many respects still to be determined. Bingham attorneys will continue to monitor developments on behalf of our clients as the process unfolds.

Comprising over 2,300 pages of text, the Bill would, among other things, create a new systemic risk regulator, establish the authority for the orderly resolution of non-bank financial institutions, consolidate the Office of Thrift Supervision into the Office of the Comptroller of the Currency, regulate hedge funds and derivatives, and create the Bureau of Consumer Financial Protection to regulate the offering of financial products to consumers.2

Among the Bill’s many provisions are several that would directly and indirectly affect offerings of asset-backed securities (“ABS”), including a risk retention (or “skin in the game”) requirement, various new grants of authority to the Securities and Exchange Commission (“SEC”), provisions regarding due diligence, and several new disclosure requirements for ABS offerings. Provisions of the Bill that affect offerings of ABS, the majority of which are contained within Subtitle D (“Improvements to the Asset-Backed Securitization Process”) to Title IX (“Investor Protections and Improvements to the Regulation of Securities”), include the following:


Credit Risk Retention (Section 941)

  • Within 270 days after enactment of the Bill, the Federal banking agencies (OCC, FDIC and Federal Reserve), the SEC and, for residential mortgage securitizations only, the Department of Housing and Urban Development and the Federal Housing Finance Agency, will issue regulations to require securitizers or originators to retain an economic interest in a portion of the credit risk of any securitized asset. These regulations will:
    • Take effect in one year, for securitizations of residential mortgages, or two years, for securitizations of other assets, after publication in the Federal Register,
    • Be enforced by the appropriate Federal banking agency, for insured depository institutions, or by the SEC, for all other securitizers,
    • Prohibit direct or indirect hedging or transfer of the credit risk that is required to be retained,
    • Require securitizers or originators to retain at least five percent of the credit risk for any securitized assets (with the allocation determined by considering the credit risk of the assets, the form or volume of transactions in securitization markets, and the potential impact of risk retention obligations on the availability of credit),
    • Establish appropriate standards for retention of economic interests with respect to collateralized debt obligations (“CDOs”), securities collateralized by CDOs, and similar instruments collateralized by other ABS, and
    • Specify forms and duration of risk retention that will comply with the requirement.
      • For commercial mortgages, specify the permissible types, forms and amounts of risk retention, which may include:
        • Retention of a specified amount or percentage of the total credit risk of the asset,
        • Retention of the first-loss position by a third-party purchaser that negotiates for such purchase and provides due diligence on pool assets before issuance,
        • A determination by a Federal banking agency or the SEC that the underwriting standards and controls for the asset are adequate, or
        • The provision of adequate representations and warranties and related enforcement mechanisms.
  • The rules will provide several exemptions to the risk retention requirement, including exemptions for:
    • “Qualified residential mortgages,” which will be jointly defined by the Federal banking agencies, the SEC, the Secretary of Housing and Urban Development and the Director of the Federal Housing Finance Agency as those containing underwriting and product features that indicate a lower risk of default (such as verification of assets and income, maximum debt-to-income ratios, required mortgage insurance and others), although the definition of “qualified residential mortgages” may not be broader than the definition of “qualified mortgages” under the Truth in Lending Act,
    • Securitizations of assets originated under specified underwriting standards that the Federal banking agencies will issue for each asset class, which may be subject to a requirement to retain less than five percent of the credit risk of such assets,
    • Any securitization of an asset guaranteed by the United States or any agency of the United States (excluding Fannie Mae and Freddie Mac) or by any state, or any institution supervised by the Farm Credit Administration, including the Federal Agricultural Mortgage Corporation, and
    • Other securitizations where such exemption may be appropriate in the public interest and for the protection of investors.
  • All joint rulemaking under this section will be coordinated by the Chairperson of the Financial Stability Oversight Council.

Study on Risk Retention Requirements (Section 946)

  • The Chairman of the Financial Services Oversight Council will conduct a study, with a report due to Congress within 180 days of enactment of the Bill, on the macroeconomic effects of risk retention requirements with emphasis on potential benefits in stabilizing the real estate market. The study will include:
    • An analysis of the effects of risk retention on real estate bubbles, including an estimate of the fraction of real estate losses that may have been averted in recent years,
    • An analysis of the feasibility of preventing real estate bubbles by proactively adjusting risk retention levels based on market conditions,
    • A comparable analysis for proactively adjusting mortgage origination requirements,
    • An assessment of whether such proactive adjustments should be made by an independent regulator or by formula, either independently or in concert with monetary policy, and
    • Recommendations for implementation and enabling legislation.

Elimination of Automatic Periodic Reporting Suspension (Section 942)

  • The duty to file periodic reports for any class of ABS under Section 15(d) of the Securities Exchange Act of 1934 will no longer be automatically suspended after the year of issuance when the ABS are held by fewer than 300 persons.
  • Instead, the SEC will be authorized to suspend these reporting obligations by rule.

Asset-Level Data Disclosure for ABS Offerings (Section 942)

  • The SEC will issue rules requiring ABS issuers to disclose information regarding the assets backing that ABS, including asset-level or loan-level data necessary for investors to perform due diligence, including:
    • Data having unique identifiers relating to loan brokers or originators,
    • The nature and extent of compensation of loan brokers or originators, and
    • The amount of risk retention by the originator or securitizer.

Due Diligence Analysis of ABS Issues (Section 945)

  • The SEC will, no later than 180 days after enactment of the Bill, issue rules requiring issuers of registered ABS to perform a due diligence review of the assets underlying the ABS and disclose the nature of the review.

Disclosure of Third-Party Due Diligence Reports for ABS (Section 932)

  • ABS issuers or underwriters will be required to publicly disclose the findings and conclusions of any third-party due diligence reports.
  • In cases where a nationally recognized statistical rating organization (“NRSRO”) hires a third party to perform due diligence services, the SEC will require the NRSRO to publicly disclose a certification by the third party that it has conducted a thorough review of information necessary for an NRSRO to provide an accurate rating.

Representations and Warranties in ABS Offerings (Section 943)

  • The SEC will, no later than 180 days after enactment of the Bill, issue rules requiring NRSROs to include in any rating report a description of representations, warranties and enforcement mechanisms available to investors, and how they differ from representations, warranties and enforcement mechanisms in issuances of similar securities.
  • The SEC will, no later than 180 days after enactment of the Bill, issue rules requiring securitizers to disclose fulfilled and unfulfilled repurchase requests across all trusts aggregated by that securitizer.

Conflicts of Interest in Offerings of ABS (Section 621)

  • Within 270 days of the enactment of the Bill, the SEC will issue rules prohibiting underwriters or sponsors of ABS (or their affiliates) from engaging in any transaction within one year of the first sale of a class of ABS that would constitute a material conflict of interest with respect to any investor in a transaction relating to that ABS.
  • This general prohibition will not apply to:
    • Risk-mitigation activities, provided that such activities are designed to reduce the specific risks to the underwriter or sponsor arising out of the ABS transaction,
    • Purchases or sales of ABS made pursuant to liquidity commitments of the underwriter or sponsor, or
    • Purchases or sales of ABS made pursuant to bona fide market-making in the ABS.

Removal of Statutory References to Credit Ratings (Section 939)

The Securities Exchange Act of 1934 is amended, effective two years after enactment, by removing the ratings requirement from the definitions of “mortgage related security” and “small business related security” and instead requiring that securities meet “standards of credit-worthiness” as established by the SEC.

In addition to the sections of the Bill that directly affect ABS transactions, the Bill contains a comprehensive overhaul of the regulation of credit rating agencies in Subtitle C (“Improvements to the Regulation of Credit Rating Agencies”) of Title IX. While the SEC already had authority to regulate NRSROs, the provisions of Subtitle C greatly enhance the SEC’s ability to monitor rating agency activities and prevent conflicts of interest from harming investors. As outlined below, Subtitle C empowers the SEC to examine the rating activities of NRSROs, to require reports and public disclosures, to enforce various corporate governance requirements, and generally to supervise NRSROs on a more comprehensive basis. Sections relating to the regulation of credit rating agencies include, among others:


Enhanced Regulation of Credit Rating Agencies (Section 932)

  • Applications for NRSRO status will be required to be filed with the SEC, rather than merely furnished.
  • Each NRSRO will be required to establish effective internal controls over the credit ratings process.
  • The SEC will issue rules requiring each NRSRO to submit an annual internal controls report, detailing:
    • A description of the responsibility of the management of the NRSRO in maintaining an effective internal control structure,
    • An assessment of the effectiveness of such internal control structure, and
    • An attestation of the CEO, or equivalent, of the NRSRO.
  • The SEC is authorized to fine NRSROs under certain circumstances where, previously, it was only authorized to censure them.
  • The SEC is authorized to censure, limit the activities of, suspend or bar persons from association with an NRSRO under certain circumstances.
  • The SEC is authorized to temporarily suspend or permanently revoke the registration of an NRSRO with respect to a particular class of securities if it does not have adequate financial and managerial resources to produce credit ratings with integrity.
  • The SEC will issue rules to separate the ratings functions of NRSROs from sales and marketing activities, and compliance officers of NRSROs will be prohibited from participating in the ratings function, performing marketing or sales activities, or establishing compensation levels.
  • Compensation of compliance officers will not be linked to the financial performance of the NRSRO.
  • Compliance officers will submit an annual report on the compliance of the NRSRO with the securities laws and its own policies and procedures, which will be filed with the SEC.

Look-Back Requirement for Former NRSRO Employees (Section 932)

  • Each NRSRO will be required to establish, maintain and enforce policies and procedures designed to review whether any employees of issuers, underwriters or sponsors of rated securities that were previously employed by the NRSRO during the one year period preceding the initial rating or rating action influenced the credit rating, and to take appropriate action in accordance with SEC rules.
  • The SEC will review these policies of NRSROs at least annually and whenever they are materially modified or amended.
  • Each NRSRO will be required to report to the SEC, which will publicly disclose the report, any case where the NRSRO knows or can be reasonably expected to know that a person who had been associated with the NRSRO during the previous five years obtains employment with any obligor, issuer or underwriter of securities rated by the NRSRO, if the person:
    • Was a senior officer of the NRSRO,
    • Was involved in determining credit ratings for the obligor, issuer or underwriter, or
    • Supervised an employee who participated in determining credit ratings for the obligor, issuer or underwriter.

Office of Credit Ratings (Section 932)

  • The SEC will establish the Office of Credit Ratings (the “Office”) to enforce rules relating to NRSROs.
  • The Office will examine each NRSRO annually and review the NRSRO’s compliance with internal controls, policies, procedures, methodologies, and statutory requirements, with an annual report detailing its essential findings available to the public.

Public Disclosure of Ratings and Methodologies (Section 932)

  • The SEC will issue rules requiring each NRSRO to publicly disclose information about its credit ratings (and subsequent changes thereto) so that the performance of its ratings over time may be compared to that of other NRSROs.
  • Each NRSRO will be required to include an attestation with every credit rating it issues affirming that the rating was not influenced by any other business activities, that the rating was based solely on the merits of the securities being rated, and that the rating was an independent evaluation of the instrument’s risks and merits.
  • The SEC will require each NRSRO to ensure that all methodologies used to produce credit ratings are approved by its board, that material changes are applied consistently, and that those methodologies are disclosed to users of credit ratings, including:
    • The version of such methodology,
    • Material changes to any methodology used to produce the credit rating,
    • Any significant errors identified in a methodology that may result in credit rating actions, and
    • The likelihood of a material change to any methodology resulting in a change to current ratings.
  • The SEC will require NRSROs to prescribe a form to accompany the publication of credit ratings which includes, among other things:
    • Assumptions used to produce the rating and in constructing the applicable ratings methodologies,
    • Potential limitations of the rating and the types of risks excluded from the rating,
    • Information on the uncertainty of the rating, including the reliability and limitations of the data relied on to produce the rating,
    • Any use of servicer or remittance reports used to conduct surveillance of the rating, and
    • Historical performance information, including volatility, expected probability of default, and sensitivity of the rating to assumptions made by the NRSRO.

Penalties for Statements Made by Credit Rating Agencies (Section 933)

  • Enforcement and penalty provisions of the securities laws will apply to statements made by credit rating agencies in the same way as they apply to statements made by public accounting firms and securities analysts, and those statements will not be deemed forward-looking statements for purposes of the forward-looking statement safe harbor from liability.

State of Mind in Private Actions (Section 933)

  • In an action for money damages brought against a credit rating agency or a controlling person, to plead state of mind, the complaint will need only to state facts giving rise to a strong inference that the credit rating agency knowingly or recklessly failed to:
    • Conduct a reasonable investigation of the rated security with respect to facts relied upon to make the rating, or
    • Obtain reasonable verification of such facts from other sources that it deems to be competent that were independent of the issuer or underwriter.

Duty to Report Tips to Law Enforcement (Section 934)

  • Each NRSRO will be required to refer to law enforcement authorities any credible tips alleging that an issuer of rated securities has committed a material violation of law that has not been adjudicated in court.

Consideration of Other Information About an Issuer (Section 935)

  • An NRSRO will be required to consider any information about an issuer of rated securities that it obtains from a source other than the issuer or underwriter if it finds the information credible and potentially significant to a rating decision.

Universal Ratings Symbols (Section 938)

  • The SEC will issue rules requiring NRSROs to establish, maintain and enforce policies and procedures that assess the probability of default by assigning clearly defined ratings symbols in a consistent manner for all types of securities and money market instruments. However, different sets of symbols may be used for different types of securities and money market instruments.

Review of Reliance on Ratings (Section 939A)

  • Within one year of enactment of the Bill, each Federal agency will review any regulations issued by that agency that require an assessment of the credit-worthiness of a security or money market instrument, and any references to credit ratings in those regulations.
  • Each Federal agency will be required to remove any such reference to or requirement for credit ratings and to substitute a standard of credit-worthiness that the agency determines to be appropriate.
  • Each Federal agency will submit a report to Congress detailing a description of any changes made to regulations pursuant to this section.

Assigned Credit Ratings (Section 939F)

  • The SEC will conduct a study, with a report due within 24 months of enactment of the Bill, regarding the credit rating process for structured finance products and the conflicts of interest associated with compensation of rating agencies for producing ratings, including:
    • The feasibility of establishing a system where an independent utility would assign NRSROs to rate structured finance products,
    • The range of metrics that could be used to judge the accuracy of credit ratings, and
    • Any alternative means for compensating NRSROs that would incentivize more accurate ratings.
  • After submitting this report to Congress, the SEC will be authorized to establish a system for assigning NRSROs to rate structured finance products in a manner that prevents the issuer, sponsor or underwriter of the product from selecting the NRSRO to provide the rating.

Effect of Rule 436(g) (Section 939G)

  • Securities Act Rule 436(g), which provides that ratings made by NRSROs are not part of the registration statement for liability purposes, is repealed.

For assistance, please contact:

John Arnholz, Partner, Structured Transactions, 202.373.6538

Reed D. Auerbach, Practice Group Leader, Structured Transactions, 212.705.7400

Michael P. Braun, Partner, Structured Transactions, 212.705.7540

Jeffrey R. Johnson, Partner, Structured Transactions, 212.373.6626

Matthew P. Joseph, Partner, Structured Transactions, 212.705.7333

Steve Levitan, Partner, Structured Transactions, 212.705.7325

Edmond Seferi, Partner, Structured Transactions, 212.705.7329

Charles A. Sweet, Partner, Corporate, M&A and Securities, 202.373.6777

Roger P. Joseph, Practice Group Leader, Investment Management; Co-chair, Financial Services Area, 617.951.8247

Edwin E. Smith, Partner, Financial Restructuring; Co-chair, Financial Services Area, 617.951.8615

Timothy P. Burke, Practice Group Leader, Broker-Dealer Group; Co-chair, Financial Services Area, 617.951.8620

1 The conference report is available at:

2 For information regarding other provisions of the Bill, see Bingham McCutchen’s comprehensive summary, available at: /Media.aspx?MediaID=10963.

This article was originally published by Bingham McCutchen LLP.