For the most part the CSA’s proposed prospectus disclosure rules escaped substantive comment although we and a few others did provide some technical comments. This is not surprising in as much as they by and large are a copy of the existing rules under Reg AB Among the few items which did attract attention were those requiring the disclosure of financial information in respect of significant obligors, credit enhancers and counterparties and that requiring disclosure of any material conflict of interest between participants in a transaction and investors.
In respect of the first item, several commentators pointed out that, where the obligor or credit enhancer is a private company, imposing an obligation on an issuer to obtain the financial information and to disclose it would be unfair and may preclude a seller from accessing the market due to a refusal of the obligor, etc. to provide such information. Most of these commentators recommended that it should be sufficient to direct the reader to publicly available information, if any, and not require disclosure of private and/or confidential information.
The conflict of interest disclosure is a more benign version of the Dodd-Frank prohibition on transactions where a material conflict of interest exists. Several commentators (including the author) pointed out that a broad interpretation of the proposed rule relating to conflicts of interest could also catch many activities essential to securitizations such as hedging, servicing and market-making and recommended that the proposal be tailored to specifically target the types of transactions in connection with which the abuse arose. These of course are the well-publicized occasions where financial firms that had designed certain highly complex synthetic CDOs and sold them to their customers then entered into transactions whereby they would profit from the failure of the original transaction.
Later developments on this front are illustrative of the danger in following along in the slip-stream of the U.S. proposals, at least until the final rules are published. On September 19, 2011, the SEC released for comment a proposed rule under the Dodd-Frank prohibition against conflicts of interest wherein they essentially adopted precisely the approach described above.
In so doing the SEC indicated that they were “not aware of any basis in the legislative history … to conclude that [the Dodd-Frank provision]was expected to alter or curtail the legitimate functioning of securitization markets, as opposed to targeting and eliminating specific types of improper conflict. Moreover, as a preliminary matter, we believe that certain conflicts of interest are inherent in the securitization process and accordingly [the Dodd-Frank Act]and our proposed rule should be construed in a manner that does not unnecessarily prohibit or restrict the structuring and offering of an ABS.”
Therefore, the SEC has proposed for comment a rule that specifically targets “short transactions” or transactions in which the securitization participant (or third party enabled by it) would benefit directly or indirectly from the actual, anticipated or potential adverse performance of the asset pool or the loss, default, early amortization or decline in market value of the ABS. In order to ensure that even this rule not limit certain bona fide activities, the SEC also provided specific exemptions relating to risk-mitigating hedging activities, liquidity commitment’s and bona fide market making.