On Thursday January 20, 2011, the Securities and Exchange Commission (SEC) approved a set of final rules required by the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) for asset-backed securities (ABS). In a unanimous vote, the SEC approved rules required by Section 943 of Dodd-Frank adopting rule 15G-1 under the Exchange Act of 1934 (the Exchange Act) and amending Items 1104 and 1121 of Regulation AB requiring securitizers1 to file reports, and requiring issuers to include disclosure in their Forms 10-D and to disclose in prospectuses fulfilled and unfulfilled requests from lenders to repurchase loans. In a 3-2 vote split on party lines, the SEC approved Rule 193 under the Securities Act of 1933 (the Securities Act) and amended Item 1111 of Regulation AB to comply with Section 945 of Dodd-Frank. Rule 193 will require issuers to review, or have a third party review, the assets underlying each security and to make that review public. In addition, the SEC also approved rules requiring a nationally recognized statistical rating organization (NRSRO) to provide information about the representations issuers make about a security. The SEC postponed consideration of rules to implement Section 15E(s)(4)(A) of the Exchange Act, which requires issuers or underwriters of any ABS to make publicly available the findings and conclusions of any third-party due diligence report the issuer or underwriter obtains, until a later date when they adopt rules to implement the rest of Section 15(E)(s)(4), which they intend to propose later this year. The rules have not yet been published in the Federal Register, but the SEC has posted them on their website at http://www.sec.gov/rules/final/2011/33-9175.pdf and http://www.sec.gov/rules/final/2011/33-9176.pdf
Representations, Warranties and Repurchase History
Do the rules apply to publicly and privately offered ABS?
Dodd-Frank adds a definition of ABS to the Exchange Act2 that is broader than what is included in Regulation AB. It is important, therefore, when considering the rules that the SEC adopts regarding ABS to understand whether or not a particular rule applies to ABS as used in Regulation AB or to the broader Exchange Act ABS. Thursday’s rules impact both publicly offered and reporting ABS and privately offered ABS. This advisory follows the rules and uses the term “Exchange Act ABS” to refer to the broader definition.
What are the new requirements?
The first set of rules that the SEC adopted on Thursday require new disclosures relating to representations and warranties by three parties: Exchange Act ABS securitizers, ABS issuers and NRSROs. Importantly, the new disclosure is only triggered if the underlying transaction agreements contain a covenant to repurchase or replace an asset.
Exchange Act Rule 15G-1 requires securitizers of Exchange Act ABS (whether registered or privately placed) to disclose, on new Form ABS-15G, demand, repurchase and replacement history in a tabular format for an initial three-year look-back period ending December 31, 2011, and to disclose, subsequent to that date, demand, repurchase and replacement activity in a tabular format on a quarterly basis.
For the tabular disclosure required by Rule 15G-1, seehttp://www.alston.com/files/docs/33-9175 27.pdf.
As amended, Item 1104 of Regulation AB requires ABS issuers to disclose demand, repurchase and replacement history for the same asset class for a three-year look-back period, in the same tabular format as new Rule 15Ga-1, in the body of a prospectus and, as amended Item 1121 requires ABS issuers to disclose demand, repurchase and replacement activity for a specific ABS, in the same tabular format, in periodic reports filed on Form 10-D for all Forms 10-D required to be filed after December 31, 2011.
In addition, under amended Exchange Act Rule 17g-7, NRSROs will be required to disclose, in any report accompanying a credit rating for an Exchange Act ABS transaction, the representations, warranties and enforcement mechanisms available to investors and how they differ from the representations, warranties and enforcement mechanisms in issuances of similar securities. NRSROs will be required to provide the information to be included in a report accompanying a credit rating for an offering of Exchange Act ABS for any such report issued on or after six months after the effective date of the rule (60 days from publication in the Federal Register).
Did the SEC provide any relief for circumstances when information is not available?
The SEC noted that it may not be possible to obtain information that predates Dodd-Frank from trustees, given that such requests were not contemplated in pre Dodd-Frank transaction agreements. The SEC adopted a provision in Rule 15Ga-1 to permit a securitizer to omit information that is unknown or not reasonably available to the securitizer without unreasonable effort or expense similar to Exchange Act Rule 12b-21. The securitizer will be required to include a statement describing why unreasonable effort or expense would be involved in obtaining the omitted information. Further, if a securitizer requested and was unable to obtain all information with respect to investor demands upon a trustee that occurred prior to July 22, 2010, the securitizer should include a statement to that effect and include a statement that the disclosures do not contain investor demands upon a trustee made prior to July 22, 2010.
What is the effective date of the new requirements?
Recognizing that implementation will require issuers and securitizers to gather data they have not tracked previously, Rule 15G-1 does not begin to require disclosure until February 14, 2012. Of course, the information that will be required on February 14 is for a three-year look-back ending on December 31, 2011. In addition, after the initial filing, the securitzer must file updated information on a quarterly basis. New Item 1121 requires the information for all Forms 10-D is required for all Form 10-Ds required to be filed after December 31, 2011. In addition the requirements for prospectus disclosure are phased in over several years. Any registered offering of ABS commencing with an initial bona fide offer on or after February 14, 2012, must comply with the information requirements of new Item 1104(e) of Regulation AB relating to sponsors. Item 1104 disclosures would be required with the first bona fide offering of registered ABS on or after February, 14, 2012. The information in prospectuses should be as of that date no older than 135 days. However, the SEC phased in the look-back in the first two years of compliance. For prospectus supplements filed prior to February 14, 2013, information may be limited to the prior year and for supplements filed on or after February 14, 2013, but prior to February 14, 2014, information may be limited to the prior two years. For shelf offerings, any registration statement filed after December 31, 2011, relating to a shelf offering must be pre-effectively or post-effectively amended to make the prospectus included in the registration statement compliant.
The disclosure requirements apply to issuers of registered and unregistered Exchange Act ABS, including municipal Exchange Act ABS. However, municipal Exchange Act ABS disclosure will not be required for an additional three-year phase-in period. Further, municipal ABS may provide their information on the MSRB’s EMMA database, rather than on EDGAR.
Issuer Review of Assets
The SEC also adopted new Rule 193 under the Securities Act requiring any issuer registering the offer and sale of an asset-backed security as that term is defined in Dodd-Frank to perform a review of the assets underlying the ABS. In addition, the SEC adopted amendments to Item 1111 of Regulation AB that will require an ABS issuer to disclose the nature of its review of the assets, and the findings and conclusions of the issuer’s review of the assets. Consistent with the rules as proposed, Rule 193 requires the issuer of the ABS to conduct the review of the assets. For the purposes of this rule, the term “issuer” refers to the depositor or the sponsor of the securitization. In cases where the originator and sponsor may be different, including transactions involving a so-called “aggregator,” the review may be performed by the sponsor, but not by an unaffiliated originator.
What is the standard of review?
Rule 193 includes a “minimum standard of review,” although the SEC stated that the standard is a “flexible, principles-based standard that is workable across a wide variety of asst classes and issuers.” Under Rule 193, the review must be designed and effected to provide reasonable assurance that the disclosure in the prospectus regarding the assets is accurate in all material respects. The SEC noted that this standard is similar to the standards under Exchange Act Rule 13a-15 relating to disclosure controls and procedures. A minimum standard of review was not included in the proposed rules, although the SEC did request comment on whether or not a minimum standard of review should be included. At the proposal stage, Commissioner Aguilar, in particular, was very much opposed to the lack of a minimum standard of review. The final rule does include a minimum standard, and this aspect was the primary reason stated by Commissioners Casey and Paredes for their inability to vote in favor of the new rule.
Rule 193 does not, however, specify the type of review and the SEC expects that the type of review could vary, depending on circumstances such as the nature of the assets being securitized and the degree of continuing involvement by the sponsor. The SEC noted that whether or not “sampling” will be sufficient to satisfy the “reasonable assurance” standard in Rule 193 will depend on a variety of factors, such as the type of ABS being offered, number of obligors and assets in size of the pool. The SEC specifically noted that in some cases, such as pools with few individual assets, it may be appropriate for the review to include every pool asset. In others, such as credit card pools, sampling might be appropriate. Although Rule 193 does not specify the type of review, it does require disclosure about the type of review. Under Item 1111 issuers of ABS will disclose:
- information about how the loans in the pool differ from the disclosure in the prospectus about the underwriting criteria;
- information about loans that did not meet the disclosed underwriting criteria; and
- information about the entity that made the determination that such loans should be included in the pool, despite not having met the disclosed underwriting standards.
Is a third-party review allowed?
An issuer may engage a third party (or multiple third parties) to perform the Rule 193 review. The issuer may rely on the third party’s review only if the third party agrees to be named in the registration statement and provides a consent to be named as an “expert” under Securities Section 7 and Rule 436. In the alternative, the issuer may attribute to itself the third party’s findings and conclusions of the review in the prospectus, while making clear whether the findings are those of the issuer or of the third party. The SEC noted that this alternative is similar to the way that issuers who engage valuation consultants deal with the problem of expert liability for third parties.
What is the effective date of the new rules?
The rules will be effective 60 days after publication in the Federal Register. Any registered offering of ABS commencing with an initial bona fide offer after December 31, 2011, must comply with the new rules and forms.