The proposed exempt distribution rules published for comment by the CSA on April 1, 2011, if enacted as proposed, will have a very significant impact on the exempt market for securitization transactions and would effectively transform the exempt market for securitized products into a quasi-public market. In addition to narrowing the scope of eligible exempt investors (creating a special category of “eligible securitized product investors”, which has been discussed in a previous post), the proposed amendments to NI 45-106 would also impose significant disclosure obligations at the time of issuance and on a continuous basis and create certification requirements as part of a broader statutory civil liability regime. The proposed changes to the exempt market are a significant departure from traditional securities regulatory policy and its emphasis on the protection of unsophisticated investors.
Information Memorandum Requirements
In order to qualify for the securitized product exemption, the issuer will be required to deliver an information memorandum (IM) to the purchaser, which must (i) disclose sufficient information about the securitized product and securitized product transaction to enable a prospective purchaser to make an informed investment decision; (ii) describe the rights of action that the issuer will have against, among others, the issuer, the sponsor and the underwriter for any misrepresentations in the IM; (iii) describe the relevant resale restrictions; and (iv) not contain a misrepresentation. For a short term securitized product, the IM also has to be in the prescribed form.
In its request for comments, the CSA indicated that it developed the prescribed form of IM by reviewing, among other things, existing ABCP information memoranda, the information that the Bank of Canada expects when reviewing to accept ABCP as eligible collateral for its standing liquidity facility and comment letters on the October 2008 ABCP Concept Proposal. A typical IM in the market today is basically a very broad overview of the types of assets that will be acquired by the ABCP issuer and a description of the main parties involved in administering and/or providing support to the ABCP issuer and the expected rating of the ABCP to be issued.
While all of this information is required by the prescribed form, it also requires more extensive detail, in particular with respect to specific transactions. For example, the prescribed form requires disclosure of the investment guidelines applied to the pool assets that limit the types and credit quality of assets and asset originators – while a general set of eligibility criteria can be constructed, these will vary somewhat across asset classes and will also vary somewhat from originator to originator. In addition, if the issuer has acquired pool assets, it is required to provide certain disclosure prescribed by Form 45-106F8 (the prescribed form of periodic disclosure for short-term exempt securitized products). This would include disclosure of each asset type acquired by the issuer (expressed as a dollar amount and as a percent of the issuer’s aggregate assets), the industry of the seller (expressed as a dollar amount and as a percent of the aggregate assets) and the percent of assets in the series acquired by each seller. It would also require disclosure describing the assets, including the average remaining term, number of obligors and weighted average life of the assets and detailed performance data, including default and delinquency data. These information requirements would seem to require that an IM be continually updated to reflect the acquisition of new assets, the amortization of existing assets, and to provide an updated performance report. As ABCP issuers are continuously distributing their securities, compliance with these requirements may pose a very significant challenge. Given the periodic disclosure obligations that are proposed to be imposed on ABCP issuers by way of monthly reports (among other things), it isn’t clear why this information would be required to be contained in the IM.
For securitized products that are not short-term, there are no prescribed requirements but, as noted, the IM will need to disclose sufficient information about the securitized product and securitized product transaction to enable a prospective purchaser to make an informed investment decision. This obligation sounds an awful lot like “full, true and plain disclosure” and is clearly a higher standard than applies generally to offering memoranda under existing securities laws (which require that offering memoranda not contain a misrepresentation). Existing disclosure in the exempt term market for securitized products has often been described as “prospectus-like”; and given this heightened standard, coupled with the increased certification requirements discussed below, this is certain not to change.
One of the CSA’s guiding principles in establishing the securitized product rules was that the rules should take into account the particular features of the Canadian securitization market and be proportionate to the risks associated with particular types of securitized products available in Canada and should not unduly restrict investor access to securitized products. Some may question whether the proposed IM rules, which apply irrespective of the type of asset class or issuer involved, are consistent with this guiding principle.
Certification Requirements/Expanded Statutory Civil Liability
One of the more significant aspects to the IM requirements is the requirement that a certificate be signed by the issuer’s CEO and CFO (or individuals acting in a similar capacity), each promoter and each sponsor, stating that the IM does not contain a misrepresentation. In addition, each underwriter will be required to sign a certificate stating that, to the best of its knowledge, information and belief, there is no misrepresentation in the IM. The certifications are required to be true at both the date the certificate is signed and the date the IM is delivered to the purchaser (the latter requirement being further indication that the IM needs to be continually updated). These certification requirements are part of the intended extension of statutory liability for disclosure in information or offering memoranda for securitized products to include third parties such as sponsors and underwriters. The CSA has noted that the statutory civil liability can be achieved in most jurisdictions by prescribing the IM as an offering document to which statutory civil liability rights apply which would then permit a right of action for damages against anyone signing the IM. In Ontario, legislative amendments would be required for statutory rights of action to be available against sponsors and underwriters. Although the standard of disclosure in a private securitized products transaction will not on its face be the same as in a public transaction (which requires full, true and plain disclosure of all material facts), one would expect that underwriters will cease to draw much of a distinction between public and private offerings of securitized products going forward.
A copy of any IM delivered to a prospective purchaser will need to be delivered to the securities regulatory authority and posted on a website within 10 days after a distribution under the IM. A report for the distribution of a short-term securitized product is not required to be delivered if the report is filed not later than 30 days after the calendar year in which the distribution occurs.
Periodic Disclosure Requirements for Exempt Securitized Products
The proposed rules also impose periodic disclosure obligations on issuers of securitized products. These rules would appear to apply not only to new securitized product issuances but also to existing securitized products. As with the IM rules, a distinction is drawn between short-term securitized products and other securitized products. Issuers that distribute securitized products under the securitized product exemption, other than short-term securitized products, will be required to prepare a prescribed form of payment and performance report similar to what is required to be prepared by a reporting issuer and post it on a website within 15 days of each payment date (and deliver a copy to the securities regulatory authority). The issuer is also required to prepare a timely disclosure report upon the occurrence of certain stated events (which are the same events that a reporting issuer is required to disclose). In essence, the continuous disclosure obligations for reporting issuers and non-reporting issuers who issue securitized products maturing more than one year from the date of issuance have effectively been conformed.
Continuous disclosure obligations will be discussed in a future post but would include payment defaults, rating changes, changes in trustees or servicers, certain triggering events such as early amortization events that would materially alter the payment priority or distribution of cash flows and a “difference of 5% or more occurring in a material pool characteristic of an asset pool for outstanding securitized products from the time of issuance of the securitized products, other than as a result of the pool assets converting into cash in accordance with their terms” (one can only imagine the number of ways that this could be interpreted). This report would need to be posted on a website no later than two business days after the occurrence of the event and investors must be provided with a copy or otherwise advised of the report. Query whether all reportable events will be known to the issuer within two business days of the occurrence of the event, in particular asset performance-related events where reporting to the issuer may lag the occurrence of the event.
Issuers of short-term securitized products are required to prepare a periodic disclosure report in the prescribed form dated as of the end of the last business day of each month and within 15 days of the end of each month it is required to delivery a copy to the securities regulatory authority and post a copy to a website. This disclosure report requires a significant amount of information, including very detailed transaction-specific disclosure in regards to asset composition and performance.
If an investor would reasonably require the information to make an informed investment decision, an issuer is also required to provide disclosure of any change to the information disclosed in the most recently delivered report or to the disclosure in the IM as well as disclosure of an event that affects payments or pool performance. This report is required to be delivered to the securities regulatory authority and posted to a website no later than two business days after the date on which the relevant event or change occurred. As noted, for some events there may be a delay between the time when the event occurs and the reporting of that event to the issuer, which would preclude reporting within this timeframe. Also, the requirement to provide timely disclosure of any change to the disclosure in the IM would seem to be a further indication that the IM is intended to be a document that requires continuous monitoring and updating.
The proposed rules would make the first trade of a securitized product that was distributed under the securitized product exemption a distribution, with the effect that the only prospectus exemption that would be available for a resale of a securitized product would be the same securitized product exemption, resulting in a “closed-system” for securitized products.