On July 26, 2011, the US Securities and Exchange Commission (the “SEC”) issued a re-proposal (the “Revised Proposal”)1 of the Form SF-3 shelf registration statement eligibility rules originally contained in the SEC’s massive Asset-Backed Securities rule proposed in April 2010 (the “Original Reg AB II Proposal”).2 The Revised Proposal is designed, in part, to align the Original Reg AB II Proposal with the various subsequent rulemaking initiatives under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Revised Proposal also reflects comments on the Original Reg AB II Proposal received by the SEC3 and seeks additional comments on numerous aspects of the asset-level data disclosure rules and other provisions in the Original Reg AB II Proposal.
Deadline for Comments
Comments on the Revised Proposal are due 60 days following publication of the Revised Proposal in the Federal Register.
The Revised Proposal does not specify a compliance date. Rather, the SEC states that it is considering the appropriate compliance date for the Original Reg AB II Proposal and the Revised Proposal, if adopted. The SEC has stated its belief that the compliance date should occur within a year after the adoption of final rules.4
Revision of Eligibility Conditions for Shelf Registration Statements on Form SF-3
The Original Reg AB II Proposal requires that issuers of asset-backed securities (“ABS”) use new Form SF-3 shelf registration statements for shelf offerings of ABS.5 In lieu of the current investment-grade rating requirement for ABS offered under Form S-3 shelf registration statements, the Original Reg AB II Proposal imposes the following eligibility requirements for the use of Form SF-3:
- A certification by the chief executive officer of the depositor as to the adequacy of the cash flows generated by the securitized pool assets;
- A covenant to periodically furnish an opinion of an independent third party regarding instances in which securitized assets were not repurchased following a demand for repurchase based on an alleged breach of representations or warranty;
- A specified minimum amount of risk retention; and
- An undertaking by the issuer to file reports under the Securities Exchange Act of 1934 (the “Exchange Act”) for so long as ABS held by non-affiliates remain outstanding.
The Revised Proposal reformulates these shelf eligibility requirements to reflect intervening developments under the Dodd-Frank Act and to address certain comments on the Original Reg AB II Proposal received by the SEC. As described in further detail below, the Revised Proposal replaces the first two Form SF-3 shelf eligibility requirements listed above with the following set of transaction-based eligibility requirements:
- A substantially revised certification by the chief executive officer of the depositor, or executive officer in charge of securitization of the depositor, regarding the securitized assets and the disclosure contained in the prospectus;
- A credit risk manager and dispute resolution requirement relating to demands to repurchase securitized assets following the breach of a representation or warranty; and
- A requirement that the securitization transaction documents contain provisions designed to facilitate communication among investors.
The Revised Proposal also contains a revised set of eligibility conditions based on past compliance with SEC filing requirements. Those revisions reflect comments received by the SEC on the version of the filing-based eligibility conditions contained in the Original Reg AB II Proposal.6
SHELF ELIGIBILITY REQUIREMENT #1: REVISED DEPOSITOR CERTIFICATION
The Revised Proposal contains substantial revisions to the certification required to be made by a senior officer of the depositor.7 Those revisions are set forth in the chart which can be seen here.
Note that the officers permitted to sign the depositor certification are also required to sign the Form SF-3 registration statement. Any person who signs a registration statement has liability under Section 11(a)(1) of the Securities Act for any untrue statement of a material fact in the registration statement or the omission to state a material fact in the registration statement necessary to make the statements therein not misleading. The required depositor certification extends to matters for which an officer who signs a registration statement would ordinarily not have liability under Section 11 of the Securities Act. As a result, many issuers are likely to have serious concerns about the incremental securities law liability that may be incurred by an officer who signs the depositor certification.
SHELF ELIGIBILITY REQUIREMENT #2: CREDIT RISK MANAGER AND DISPUTE RESOLUTION MECHANISM
As noted above, the Original Reg AB II Proposal contains a shelf eligibility requirement that the issuer periodically furnish an opinion of an independent third party regarding instances in which securitized assets were not repurchased following a demand for repurchase. In response to comments that the SEC received on the Original Reg AB II Proposal,11 the Revised Proposal eliminates this independent third-party opinion requirement and replaces it with a credit risk manager requirement and a repurchase request dispute resolution mechanism.12
Credit Risk Manager. The Revised Proposal requires that the transaction documents include a provision directing the trustee of the issuing entity to appoint a “credit risk manager” upon the occurrence of certain trigger events.13 The Revised Proposal defines credit risk manager as a person appointed by the trustee to review the underlying assets for compliance with the representations and warranties on the underlying assets.14 A credit risk manager may not be affiliated with any sponsor, depositor or servicer.15
Review of Securitized Assets by the Credit Risk Manager. Under the Revised Proposal, the credit risk manager must review the securitized assets for compliance with the representations and warranties on the securitized assets upon the occurrence of trigger events specified in the transaction agreements. The Revised Proposal requires that, at a minimum, the transaction agreements must specify a triggering event:
- When the credit enhancement requirements, such as required reserve account amounts or overcollateralization percentages, as specified in the underlying transaction agreements, are not met;16 and
- At the direction of investors pursuant to the processes provided in the transaction agreement and disclosed in the prospectus.17
The Revised Proposal requires that the credit risk manager have authority to access copies of the underlying documents relating to the securitized assets. However, the Revised Proposal does not mandate that the credit risk manager follow specific procedures in its review of the securitized assets. Rather, the SEC believes that transaction parties should have the flexibility to tailor the review procedures to each ABS transaction, taking into account the specific features of the transaction and the underlying asset class. Similarly, under the Revised Proposal, transaction parties would have the flexibility to determine the appropriate processes for investordirected review of the securitized assets.
Delivery of the Report of the Credit Risk Manager to the Trustee. Under the Revised Proposal, the credit risk manager must provide a report of its findings to the trustee.18 The SEC states that the trustee could use the credit risk manager’s report to determine whether a repurchase request would be appropriate under the terms of the transaction agreements. However, the Revised Proposal does not require the trustee to use the credit risk manager’s report for that, or any other, purpose.
Prospectus Disclosure about the Credit Risk Manager. The Revised Proposal requires disclosure about the credit risk manager in the prospectus and in ongoing reports. The Revised Proposal requires disclosure of the following information about the credit risk manager in the prospectus:
- Form of organization;
- Extent of its experience serving as a credit risk manager for ABS transactions involving similar pool assets;
- Duties and responsibilities regarding the ABS under the transaction documents and applicable law;
- Manner and amount of compensation for its services;
- Any limitations on the credit risk manager’s liability under the transaction documents;
- Any contractual provisions or understandings regarding the credit risk manager’s removal, replacement or resignation; and
- Any affiliations and relationships, to the extent material, between the credit risk manager and other transaction parties.19
Form 10-D Disclosure about the Credit Risk Manager. The Revised Proposal provides that if, during a distribution period, the credit risk manager has resigned, or has been removed, replaced or substituted, or if a new credit risk manager has been appointed, the related Form 10-D must disclose the date the event occurred, and the circumstances surrounding the change. That Form 10-D would also need to provide the disclosures concerning the new credit risk manager as listed above under “Prospectus Disclosure about the Credit Risk Manager.”20
Form 10-D Disclosure about the Reports of the Credit Risk Manager. If the credit risk manager is required to review the assets during a distribution period, the Revised Proposal requires disclosure on the related Form 10-D of the event(s) that triggered the review by the credit risk manager during that distribution period. The Revised Proposal also requires that any report delivered by the credit risk manager to the trustee during a distribution period be filed as an exhibit to the related Form 10-D.21
Dispute Resolution Mechanism. Under the Revised Proposal, the transaction agreements must provide that if a repurchase request pursuant to the terms of the transaction agreements has been made with respect to a securitized asset, and that securitized asset is not repurchased by the end of the 180-day period beginning when notice is received, then the party that submitted such repurchase request shall have the right to refer the matter, at its discretion, to either mediation or third-party arbitration.22 The Revised Proposal provides that the party obligated to repurchase must agree to the selected resolution method.23
SHELF ELIGIBILITY REQUIREMENT #3: INVESTOR COMMUNICATION PROVISION
Most ABS are issued as book-entry global securities and are registered in the name of The Depository Trust Company or similar securities depositories. The identity of the underlying beneficial owners of the ABS may not always be readily obtained from the trustee or note registrar in an ABS transaction.
In the Revised Proposal, the SEC noted that some investors have expressed concerns about their inability to identify other investors for the purpose of enforcing rights contained in transactions agreements. Of particular concern to the SEC has been the difficulty that some investors have had in communicating and coordinating with each other for the purpose of exercising their right to demand a repurchase of underlying assets for breach of representations and warranties.
In order the address those concerns, the Revised Proposal contains a new shelf eligibility requirement that the transaction agreements must require the party responsible for making periodic filings on Form 10-D to disclose on the Form 10-D any request from an investor to communicate with other investors received during that reporting period by the party responsible for making the Form 10-D filings.24 The disclosure on Form 10-D must include the name of the investor making the request, the date the request was received and a description of the method by which other investors may contact the requesting investor.
The Revised Proposal contains two safeguards to prevent the use of this investor communication facilitation requirement in unintended ways. Under the Revised Proposal:
- Investors may not request to communicate with other investors for purposes other than exercising their rights under the terms of the ABS; and
- The transaction parties may specify procedures for verifying the identity of a beneficial owner in a particular ABS prior to including the proposed notice in a Form 10-D.25
SHELF ELIGIBILITY REQUIREMENT #4: REVISED ELIGIBILITY CONDITIONS BASED ON HISTORY OF SEC FILING COMPLIANCE
The Revised Proposal contains a modified set of eligibility conditions that require a history of SEC filing compliance in order to use Form SF-3 for shelf offerings of ABS.26 Those eligibility conditions are summarized in the chart which can be seen here.
These revised eligibility conditions based on past SEC filing compliance are complex and will require careful analysis and due diligence by transaction parties when determining whether the conditions have been met under particular circumstances. An illustration of the application of these revised conditions is presented in Appendix 1.
The Revised Proposal retains the requirement in the Original Reg AB II Proposal that the registration statement state that the registrant has complied with the conditions described above. The SEC believes that this disclosure will better enable investors and the SEC to assess compliance with the Form SF-3 shelf eligibility conditions.
ELIMINATION OF SHELF ELIGIBILITY REQUIREMENTS MADE REDUNDANT BY THE DODD-FRANK ACT
The Revised Proposal eliminates the risk retention requirement for Form SF-3 eligibility because risk retention is separately addressed with respect to all ABS in the proposed credit risk retention rules.35 Similarly, the Revised Proposal eliminates the eligibility requirement that the issuer undertake to file Exchange Act reports for the life of the ABS transaction because Section 942(a) of the Dodd-Frank Act eliminated the automatic suspension of the duty to file Exchange Act reports and granted the SEC the authority to issue rules providing for the suspension or termination of the duty to file Exchange Act reports.36
Re-Proposal of Revised Filing Deadlines for Transaction Documents
The Revised Proposal requires that the transaction documents, in “substantially final form,” be filed and made part of the registration statement by the date the preliminary prospectus is required to be filed under Rule 424(h).37 As proposed, Rule 424(h) requires the preliminary prospectus to be filed with the SEC at least five business days before the date of the first sale in the offering or, if used earlier, the second business day after first use.38
According to the SEC, this requirement, if adopted, would allow investors additional time to analyze the actual underlying transaction documents containing the specific structure, assets and contractual rights regarding each transaction. If the exhibits filed with the preliminary prospectus remain unchanged at the time final prospectus is required to be filed under Rule 424(b), then an issuer would not be required to re-file the same exhibits.39
Request for Additional Comment on Asset-Level Data Disclosure
The Original Reg AB II Proposal requires assetlevel disclosures for ABS backed by residential mortgages, commercial mortgages, automobile loans or leases, equipment loans or leases, student loans, floorplan financings, corporate debt and resecuritizations. For ABS backed by credit card receivables, the Original Reg AB II Proposal requires disclosure of grouped account data in lieu of asset-level data.
The Revised Proposal does not contain any changes to the asset-level data disclosure contemplated by the Original Reg AB II Proposal. However, with respect to equipment ABS and equipment floorplan ABS, the SEC is requesting additional comments as to how to modify the proposed rule to address concerns that asset-level data disclosure could create privacy issues and risk dissemination of competitively sensitive information. The SEC is also requesting comment as to whether grouped account or pool-level data, rather than asset-level data, is sufficient for equipment ABS.
UPDATED SCHEDULE L
The Original Reg AB II Proposal requires that issuers provide the asset-level data described in proposed Schedule L. This data must be presented as of a recent practicable date (the “measurement date”) and filed at the time the preliminary prospectus is filed. The Original Reg AB II Proposal requires that an updated Schedule L, containing data as of the cut-off date for the securitization, be filed with the final prospectus.
The Original Reg AB II Proposal requires issuers to update Schedule L to report changes to the pool under Item 6.05 of Form 8-K. According to the SEC, some comment letters expressed confusion as to the circumstances under which an updated Schedule L is required on Form 8-K. In the Revised Proposal, the SEC is requesting additional comment to determine whether it should make clear that the filing of a Schedule L under Item 6.05 of Form 8-K is required when assets are added to the pool after the issuance of the ABS, either through prefunding periods, revolving periods or substitution.
ASSET-LEVEL DISCLOSURE IN PRIVATE OFFERINGS OF STRUCTURED FINANCE PRODUCTS
The Original Reg AB II Proposal contains amendments to the SEC’s safe harbors for exempt offerings and resales and new related rules regarding the information that must be made available to investors in private offerings of “structured finance products.” In general, those amendments require that, in order for a seller of a structured finance product to sell a security in reliance on Securities Act Rule 144A, or in order for an issuer of a structured finance product to sell a security in reliance on Rule 506 of Regulation D:
- The underlying transaction documents must grant any purchaser, any security holder and any prospective purchaser of the securities designated by the holder the right to obtain, upon request of the purchaser or security holder, information that would be required if the offering were registered on Form S-1 or proposed Form SF-1; and
- The issuer would have to represent that it would provide such information to the purchaser, security holder, or prospective purchaser upon request of the purchaser or security holder.
The Revised Proposal does not alter the proposal described above as set forth in the Original Reg AB II Proposal. However, in response to comments received by the SEC on the Original Reg AB II Proposal, the SEC is requesting comments on whether it should require asset-level disclosures only where the structured finance product being sold in reliance on Rule 144A, or Rule 506 of Regulation D, is backed by assets of an asset class for which there are specific asset-level reporting requirements set forth in the Original Reg AB II Proposal.40
In addition, the SEC acknowledged the concerns of commentators about the hybrid of the corporate disclosure requirements under Form S-1 and the Regulation AB disclosure requirements under Form SF-1 that would apply for offerings of structured finance products that are not asset backed securities as defined in Regulation AB.41 The SEC is seeking comments as to how it can address those concerns. If the SEC does not require asset-level disclosure for structured finance products or novel asset types or structures that fall outside of the Regulation AB definition of asset backed security, the SEC is also seeking comments as to what alternative disclosure should be provided to investors.
Future Re-Proposal of Cash Flow Waterfall Program Requirement
The Original Reg AB II Proposal contains a requirement that ABS issuers file a computer program that gives effect to the flow-of-funds, or “waterfall,” provisions of the transaction documents. According to the SEC, this proposal was designed to make it easier for an investor to analyze the ABS offering at the time of its initial investment decision and to monitor ongoing performance of the ABS.
The SEC has received many comments on its cash flow waterfall program proposal. The SEC has indicated that it plans to re-propose the cash flow waterfall program requirement separately from its project to enact final rules relating to ABS shelf eligibility, the offering process and asset-level data disclosure.
Click here to view Appendix 1.