On September 19, 2011, the SEC voted unanimously to propose rules intended to prohibit material conflicts of interest between those who package and sell asset-backed securities (ABS), and those who invest in them. The new rules would implement the prohibition under Section 621 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Dodd-Frank Act") on material conflicts of interest in connection with certain securitizations. The proposed rules would prohibit persons who create and distribute an ABS, including a synthetic ABS, from engaging in transactions, within one year after the date of the first closing of the sale of the ABS, that would involve or result in a material conflict of interest with respect to any investor in the ABS.

For the purposes of the proposed rules, a "material conflict of interest" exists between a securitization participant and investors in the ABS if either:  

  • a securitization participant would benefit directly or indirectly from the actual, anticipated or potential:
    • adverse performance of the asset pool supporting or referenced by the relevant ABS
    • loss of principal, monetary default or early amortization event on the ABS, or
    • decline in the market value of the relevant ABS (i.e., a "short transaction"); or
  • a securitization participant, who directly or indirectly controls the structure of the relevant ABS or the selection of assets underlying the ABS, would benefit directly or indirectly from fees or other forms of remuneration, or the promise of future business, fees, or other forms of remuneration, as a result of allowing a third party, directly or indirectly, to structure the relevant ABS or select assets underlying the ABS in a way that facilitates or creates an opportunity for that third party to benefit from a short transaction as described above  

In addition, there must be a a "substantial likelihood" that a " reasonable" investor would consider the conflict important to his or her investment decision (including a decision to retain the security or not).

Under the Dodd-Frank Act, the proposed rules would exempt from the conflict of interest prohibitions certain risk-mitigating hedging activities, liquidity commitments and bona fide market-making.  

Commission Chairman Mary L. Schapiro stated "th[e] proposed rule is designed to ensure that those who create and sell asset-backed securities cannot profit by betting against those same securities at the expense of those who buy them. At the same time, the proposed rule is not intended to interfere with traditional securitization practices in which loans are originated, packaged into asset-backed securities, and offered to investors in different structures.”