[Federal Register Volume 76, Number 16 (Tuesday, January 25, 2011)]
[Rules and Regulations]
[Pages 4231-4244]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-1503]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 229 and 230
[Release Nos. 33-9176, 34-63742; File No. S7-26-10]
RIN 3235-AK76
Issuer Review of Assets in Offerings of Asset-Backed Securities
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: We are adopting new requirements in order to implement Section
945 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of
2010 (the ``Act''). We are adopting a new rule under the Securities Act
of 1933 to require any issuer registering the offer and sale of an
asset-backed security (``ABS'') to perform a review of the assets
underlying the ABS. We also are adopting amendments to Item 1111 of
Regulation AB that would 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.
DATES: Effective Date: March 28, 2011.
Compliance Date: Any registered offering of asset-backed securities
[[Page 4232]]
commencing with an initial bona fide offer after December 31, 2011,
must comply with the new rules and forms.
FOR FURTHER INFORMATION CONTACT: Eduardo Aleman, Special Counsel,
Division of Corporation Finance, at (202) 551-3430, U.S. Securities and
Exchange Commission, 100 F Street, NE., Washington, DC 20549.
SUPPLEMENTARY INFORMATION: We are adopting amendments to Item 1111 \1\
of Regulation AB \2\ (a subpart of Regulation S-K). We also are
adopting Rule 193 \3\ under the Securities Act of 1933 \4\ (the
``Securities Act'').
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\1\ 17 CFR 229.1111.
\2\ 17 CFR 229.1100 through 17 CFR 229.1123.
\3\ 17 CFR 230.193.
\4\ 15 U.S.C. 77a et seq.
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I. Background and Overview
On October 13, 2010, we proposed new requirements in order to
implement Section 945 and a portion of Section 932 of the Dodd-Frank
Act.\5\ As discussed in the Proposing Release, Section 945 of the Act
amends Section 7 of the Securities Act to require the Commission to
issue rules relating to the registration statement required to be filed
by an issuer of ABS. Pursuant to new Section 7(d), the Commission must
issue rules to require that an issuer of an ABS perform a review of the
assets underlying the ABS, and disclose the nature of such review.
Section 945 of the Act reflects the testimony provided to Congress that
due diligence practices in ABS offerings had eroded significantly.\6\
We also proposed new requirements relating to the disclosure of third-
party findings and conclusions in ABS transactions in order to
implement Section 15E(s)(4)(A) of the Exchange Act, as added by Section
932 of the Act. We received over 50 comment letters on the Proposing
Release.\7\
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\5\ Issuer Review of Assets in Offerings of Asset-Backed
Securities, Release No. 33-9150 (Oct. 13, 2010) [75 FR 64182]
(``Proposing Release'').
\6\ See S. Rep. No. 111-176, at 133 (2010) (``Senate Report'').
\7\ The comments on the Proposing Release are available at
http://www.sec.gov/comments/s7-26-10/s72610.shtml.
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As discussed below, after consideration of the comments received on
the proposed amendments, we are adopting the proposed amendments to
implement Section 7(d) of the Securities Act. We have revised the final
rules from the proposal to establish a new minimum standard for the
required review. We are postponing consideration of rules to implement
Section 15E(s)(4)(A) of the Exchange Act, which requires issuers or
underwriters of any asset-backed security 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 we adopt
rules to implement the rest of Section 15(E)(s)(4), which we anticipate
proposing this year. We are persuaded by the suggestion by several
commentators that new Exchange Act Section 15E(s)(4) should be read as
a whole, and that we should postpone implementation of 15E(s)(4)(A)
until the Commission implements the rest of Section 15E.\8\
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\8\ See comment letters from American Bar Association (``ABA'');
National Association of Bond Lawyers (``NABL'').
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II. Final Rules
A. Scope of Rule 193
1. Proposed Amendments
We proposed new Rule 193 under the Securities Act to require
issuers of ABS to perform a review of the assets underlying registered
ABS offerings.\9\ This rule would implement Securities Act Section
7(d)(1),\10\ as added by Section 945 of the Act. As proposed, Rule 193
would require an issuer to perform a review of the assets underlying an
ABS in a transaction that the issuer registers under the Securities
Act.
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\9\ The requirement to perform a review should not be confused
with, and is not intended to change, the due diligence defense
against liability under Securities Act Section 11 [15 U.S.C. 77k] or
the reasonable care defense against liability under Securities Act
Section 12(a)(2) [15 U.S.C. 77l(a)(2)]. Our rule is designed to
require a review of the underlying assets by the issuer and to
provide disclosure of the nature, findings and conclusions of such
review.
\10\ 15 U.S.C. 77g(d)(1).
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2. Comments on the Proposed Amendments--Scope of Rule 193
With respect to the applicability of the proposed rule, some
commentators agreed that the rule should apply only to registered
offerings of ABS.\11\ Some commentators recommended the review
requirement be extended to also apply to unregistered offerings and
predicted that unless the rule applies to unregistered offerings,
abusive practices are likely to migrate into the market for
unregistered offerings.\12\ One such commentator supported the approach
in the Proposing Release's request for comment conditioning the
Commission's safe harbors from registration on a requirement that the
underlying transaction agreements include a representation that the
issuer performed an asset review that complies with Rule 193.\13\ Three
commentators expressed concern with such a requirement.\14\ One
commentator sought clarification that the issuer may rely on a review
performed by an affiliated originator.\15\
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\11\ See comment letters from ABA; Securities Industry and
Financial Markets Association (``SIFMA'').
\12\ See comment letters from Center for Responsible Lending
(``CRL''); Senator Levin, Permanent Subcommittee on Investigations,
United States Senate Committee on Homeland Security and Governmental
Affairs (``Levin''); Consumer Federation of America (``Consumer
Federation''); Christopher Chuff.
\13\ See comment letter from Consumer Federation.
\14\ See comment letters from ABA; American Financial Services
Association (``AFSA''); SIFMA.
\15\ See comment letter from SIFMA. Another commentator noted
that the relationship between the issuer and originator is an
important consideration in determining the appropriateness of a
review, and suggested that in so-called ``aggregator'' transactions,
where the issuer is unaffiliated with the originator of the assets,
the review should be more fulsome. See comment letter from ABA.
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3. Final Rule--Scope of Rule 193
Consistent with the proposal, final Rule 193 requires that the
asset review be conducted by the issuer of the ABS.\16\ The issuer, for
purposes of this rule, is the depositor or sponsor of the
securitization. A sponsor typically initiates a securitization
transaction by selling or pledging to a specially created issuing
entity a group of financial assets that the sponsor either has
originated itself or has purchased in the secondary market. In some
instances, the transfer of assets is a two-step process: The financial
assets are transferred by the sponsor first to an intermediate entity,
the depositor or the issuer, and then the depositor transfers the
assets to the issuing entity for the particular asset-backed
transaction. The issuing entity is typically a statutory trust.\17\ In
cases
[[Page 4233]]
where the originator and sponsor may be different, including in
transactions involving a so-called ``aggregator,'' our final rule,
consistent with the proposal, provides that the review may be performed
by the sponsor, but a review performed by an unaffiliated originator
will not satisfy Rule 193. An unaffiliated originator may have
different interests in the securitization, especially if the
securitization involves many originators where each originator may have
contributed a very small part of the assets in the entire pool, and may
have differing approaches to the review.\18\
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\16\ Under Securities Act Rule 191 (17 CFR 230.191), the
depositor for the asset-backed securities acting solely in its
capacity as depositor to the issuing entity is the ``issuer'' for
purposes of the asset-backed securities of that issuing entity.
``Depositor'' means the depositor who receives or purchases and
transfers or sells the pool assets to the issuing entity. See Item
1101 of Regulation AB (17 CFR 229.1101). For asset-backed securities
transactions where there is not an intermediate transfer of the
assets from the sponsor to the issuing entity, the term depositor
refers to the sponsor. For asset-backed securities transactions
where the person transferring or selling the pool assets is itself a
trust, the depositor of the issuing entity is the depositor of that
trust. See id. As defined in Item 1101 of Regulation AB, the
``sponsor'' means the person who organizes and initiates an ABS
transaction by selling or transferring assets, either directly or
indirectly, including through an affiliate, to the issuing entity.
See id.
\17\ See Asset-Backed Securities, Release No. 33-8518 (Dec. 22,
2004) [70 FR 1506] (``2004 Regulation AB Adopting Release'') at
Section III.B.3. The issuing entity is designed to be a passive
entity, and in order to meet the definition of ABS issuer in
Regulation AB its activities must be limited to passively owning or
holding the pool of assets, issuing the ABS supported or serviced by
those assets, and other activities reasonably incidental thereto.
\18\ In the case of so-called aggregators, the sponsor acquires
loans from many other unaffiliated sellers before securitization.
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As discussed in the Proposing Release, Section 7(d)(1) relates to
an asset-backed security, as defined in new Section 3(a)(77) of the
Exchange Act.\19\ This new statutory definition (``Exchange Act-ABS'')
is broader than the definition of ``asset-backed security'' in
Regulation AB \20\ and includes securities typically offered and sold
in private transactions. Although the Exchange Act-ABS term is used in
Section 7(d)(1), we have concluded that the review requirements
mandated by Section 7(d)(1) are limited to registered offerings of ABS
because Section 7(d)(1) requires the Commission to issue rules
``relating to the registration statement.'' Therefore, the rule we
adopt today that requires an ABS issuer to perform a review of the
assets applies to issuers of ABS in registered offerings and not
issuers of ABS in unregistered offerings.
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\19\ 15 U.S.C. 78c(a)(77). This definition was added by Section
941(a) of the Act.
\20\ See Item 1101(c)(1) of Regulation AB [17 CFR
229.1101(c)(1)].
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As noted above, in the Proposing Release we asked whether, even
though Section 7(d)(1) does not extend to unregistered offerings, we
should condition reliance on the Securities Act safe harbors from
registration on a requirement that the underlying transaction agreement
for the ABS contain a representation that the issuer performed a review
that complies with Rule 193, or, alternatively, that the issuer perform
a Rule 193 review. Given the mixed comments on this question and our
outstanding proposals from April 2010 related to offerings under the
safe harbors from registration,\21\ we are not adopting at this time a
separate requirement to condition the Commission's safe harbors for an
exemption from registration on a requirement that the issuer conduct a
review of the assets. As we noted in the 2010 ABS Proposing Release, we
have concerns about investor protection in the exempt ABS markets.\22\
While we continue to have these concerns, at this point we believe a
comprehensive approach to the Commission's safe harbors for an
exemption from registration would better serve investors and provide
more certainty to issuers than an incremental approach. In the future,
we may determine that discrete amendments to the safe harbors
addressing ABS matters are appropriate.
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\21\ See Asset-Backed Securities, Release No. 33-9117 (April 7,
2010) [75 FR 23328] (the ``2010 ABS Proposing Release''). In the
2010 ABS Proposing Release we proposed requiring that the underlying
transaction agreement in a transaction relying on certain Commission
safe harbors for an exemption from registration under the Securities
Act contain a provision requiring the issuer to provide to any
initial purchaser, security holder, and designated prospective
purchaser the same information as would be required in a registered
transaction. In addition, the Commission solicited comment
concerning whether safe harbors from registration should not be
available for offerings of structured finance products and whether
any restrictions should be imposed on private offerings of asset-
backed securities.
\22\ See id. at 23394.
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B. Standard of Review of Assets by Issuers of ABS
1. Proposed Amendments
Proposed Rule 193 provided that an issuer would be required to
conduct a review of the assets and disclose the findings and
conclusions of the review. Proposed Rule 193 did not specify the level
or type of review an issuer would be required to perform, or require
that a review be designed in any particular manner. However, the
Proposing Release included detailed requests for comment on whether we
should set a minimum review standard, including possible standards that
could be included in a final rule. In particular, the Proposing Release
sought comment on a possible review standard that would require issuers
to perform a review that, at a minimum, must be designed to provide
reasonable assurance that the disclosure in the prospectus regarding
the pool assets is accurate in all material respects. We also sought
comment on whether the rule should mandate that the review should not
only be designed, but also effected, to provide reasonable assurance
that the prospectus disclosure was accurate in all material respects.
2. Comments on the Proposed Amendments--Standard of Review
Comments on the proposed review requirement, including the absence
of a minimum review standard, were varied. Some commentators responded
that the review requirement, as proposed, did not address the problems
that Section 945 of the Act sought to address and suggested that the
Commission set a minimum level of review.\23\ One commentator
recommended that ABS issuers be required to conduct reviews that are
both ``designed and effected'' with sufficient scale and scope to
discover assets that violate applicable law or standards as set forth
in the prospectus.\24\ This commentator explained that this would go
beyond providing ``reasonable assurance that the disclosure in the
prospectus is accurate in all material respects.'' One commentator
cautioned that the rule, as proposed, would create a perverse incentive
to decrease due diligence reviews even further in order to decrease the
likelihood that they reveal problems that would have to be disclosed to
investors.\25\
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\23\ See comment letters from Chris Barnard (``Barnard'');
Consumer Federation (supporting a principles-based review standard
such as the ``reasonable assurance'' standard discussed in the
Proposing Release's request for comment, and suggesting that where
initial reviews uncover discrepancies, further reviews sufficient to
uncover the extent of the problem should be conducted); CRL; Levin;
American Society of Appraisers, American Society of Farm Managers
and Rural Appraisals, National Association of Independent Fee
Appraisers (collectively, ``Appraisers''); Clayton Holdings, LLC
(``Clayton''); Americans for Financial Reform (``AFR''); Fitch, Inc.
(``Fitch''). See also comment letter from ABA (supporting Rule 193
as proposed, but agreeing that the ``reasonable assurance'' approach
discussed in the Proposing Release's request for comment is workable
if the Commission were to adopt a minimum level of review).
\24\ See comment letter from CRL.
\25\ See comment letter from Consumer Federation.
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Some commentators suggested possible alternative review standards
that encompass other aspects of the assets, instead of disclosure. Some
commentators urged the Commission to require a review that assesses the
actual quality of the underwriting of the assets \26\ and exclude the
type of review of assets that amounts to a mere comparison or
``comforting'' of data that relates to the prospectus disclosure. These
commentators stated that in light of the existing liability framework
under the federal securities laws, it is not necessary for the
Commission to require that issuers conduct or disclose any particular
review that merely verifies the accuracy of the disclosure in the
prospectus.\27\ Some commentators believed that the type of review that
should be disclosed under Rule 193 is a review that relates to the
underwriting of the assets \28\ or quality of the underlying assets
(e.g., credit quality).\29\
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\26\ See comment letters from ASF; SIFMA.
\27\ See comment letters from ASF; SIFMA.
\28\ See comment letters from ASF; SIFMA.
\29\ See comment letter from BDO USA, LLP.
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Other commentators suggested that at a minimum, the review should
include, for example, verifying the accuracy of the loan data and
related information, determining whether the assets complied with the
underwriting guidelines, determining compliance with the originator's
property valuation guidelines, and determining whether the loans were
originated in compliance with applicable laws.\30\
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\30\ See comment letters from Clayton; CRL.
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Other commentators, in support of a minimum review standard,
suggested that the issuer's review should include disclosure of key
indicators of loan quality (e.g., weighted average FICO scores, loan-
to-value ratios, borrower debt-to-income ratios, and the absence of
data suggesting loan fraud) \31\ and a minimum sample size
requirement.\32\ Some commentators suggested that this should include a
statistically valid sample of assets whose analysis could be
extrapolated to the entire asset pool.\33\ Two of these commentators
argued that such a requirement would ensure a level playing field and
that no issuer gains a competitive cost advantage by using smaller
sample sizes.\34\ One commentator suggested that the Commission
consider the minimum sample sizes set forth by the various rating
agencies,\35\ while another noted that sampling should be conducted in
a manner appropriate to provide confidence that a representative
portion of the pool has been examined (e.g., a sample size could be
computed using a 95% confidence level and a 5% confidence
interval).\36\
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\31\ See comment letter from Levin.
\32\ See comment letters from ABA; Clayton; Fitch; Levin; SIFMA.
\33\ See comment letters from Clayton; Fitch; Levin; SIFMA.
\34\ See comment letters from Clayton; Levin.
\35\ See comment letter from Clayton.
\36\ See comment letter from Fitch.
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On the other hand, some commentators supported the Commission's
proposal, which did not prescribe a minimum level of review.\37\ One
commentator opposed the ``reasonable assurance'' standard in the
Proposing Release's request for comment and argued that the standard is
inappropriate and unnecessary to address the intent of the Act or to
improve disclosure because the new requirements mandated by the Act
should address a review of the assets, as opposed to a review of the
disclosure about the assets.\38\ This commentator cautioned that a
``reasonable assurance'' standard would require issuers to describe
what they did to get comfortable that they met their disclosure
obligations, and expose them to liability for failing to have used
procedures that provided such ``reasonable assurance'' or for not
having accurately described the nature of the procedures and their
findings and conclusions, even if there was no material error or
omission in the prospectus about the pool assets.\39\
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\37\ See, e.g., comment letters from ABA; American Bankers
Association Securities Association (``ABASA''); Association for
Financial Markets in Europe (``AFME''); Commercial Real Estate
Finance Council (``CRE Finance Council''); and Mortgage Bankers
Association (``MBA'').
\38\ See comment letter from ASF.
\39\ See comment letter from ASF (noting that the scope of a
``reasonable assurance'' standard is overly broad considering the
substantial amount of disclosure regarding the pool assets that is
contained in the prospectus including, in addition to numerical
information about the assets, narrative disclosure about such
matters as the pool assets generally, risk factors relevant to the
pool assets, servicing of the pool assets, and legal aspects of the
pool assets).
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One commentator requested confirmation that Rule 193 addresses a
review of assets in connection with the preparation of the
securitization, rather than a review performed in connection with
origination of a securitized asset.\40\ This commentator explained that
in the context of CMBS transactions, the sponsor of the securitization
is often also the originator (or an affiliate of the originator) of the
assets being transferred into a securitization, and that it would be
unusual for any extra level of diligence to be performed on the assets
themselves in connection with the securitization since the sponsor
previously underwrote the assets and is familiar with the assets.
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\40\ See comment letter from CRE Finance Council.
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3. Final Rule--Issuer Review Requirement
After considering the comments, we are adopting Rule 193 with a
minimum review standard. We agree with commentators who suggested that
Rule 193 should require a minimum level of review to implement the
directive in Section 7(d), as added by Section 945 of the Act. Absent a
minimum standard of review, we are concerned that issuers could satisfy
new Rule 193 with a review that was not designed or carried out in a
way that would address the concerns that led to the enactment of
section 7(d)(1)--that due diligence be ``re-introduced'' into the
offering process.\41\ We also believe a minimum standard of review is
appropriate in light of Congress's direction that issuers ``of an
asset-backed security * * * perform a due diligence analysis of the
assets.'' \42\ Indeed, permitting issuers to satisfy the statutory
requirement with such a review potentially could undercut the statutory
purpose by erroneously suggesting that due diligence was conducted.
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\41\ See Senate Report, at 133 (quoting Senate committee
testimony by Professor John Coffee). We note that some commentators
supported the standard described in the Proposing Release's request
for comment. See comment letters from Consumer Federation; ABA
(suggesting that this approach is workable if the Commission were to
adopt a minimum level of review, though supporting Rule 193 as
proposed).
\42\ Id.
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While we have concluded that a minimum review standard is
appropriate for our final rule, we believe a flexible, principles-based
standard that would be workable across a wide variety of asset classes
and issuers would best accomplish our objectives. Consequently, we are
adopting Rule 193 modified from the proposal to require an issuer to
perform a review of the assets underlying an ABS in a transaction that
will be registered under the Securities Act that, at a minimum, must be
designed and effected to provide reasonable assurance that the
disclosure in the prospectus regarding the assets is accurate in all
material respects.\43\
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\43\ Thus, for example, if the prospectus disclosed that the
loans are limited to borrowers with a specified minimum credit
score, or certain income level, the review, as designed and
effected, would be required to provide reasonable assurance that the
loans in the pool met this criterion.
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We note that the minimum standard that we are adopting is similar
to the standard many companies use in designing and maintaining
disclosure controls and procedures required under Exchange Act Rule
13a-15.\44\ Our rules, which have applied to reporting companies for
many years, generally ``require an issuer to maintain disclosure
controls and procedures to provide reasonable assurance that the issuer
is able to record, process, summarize and report the information
required in the issuer's Exchange Act reports'' within appropriate time
frames.\45\ We believe that many issuers and their advisers are
familiar with this type of standard.\46\
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\44\ 17 CFR 240.13a-15.
\45\ See Management's Report on Internal Control over Financial
Reporting and Certification of Disclosure in Exchange Act Periodic
Reports, Release No. 33-8238 (June 5, 2003). See also Certification
of Disclosure in Companies' Quarterly and Annual Reports, Release
No. 34-8124 (June 14, 2002) (``Certification in Periodic Reports
Release''). ABS issuers must provide in Form 10-K an assessment by
each party participating in the servicing function regarding its
compliance with specified servicing criteria set forth in Item 1122
of Regulation AB. See 17 CFR 229.1122. A registered public
accounting firm must issue an attestation report on such party's
assessment of compliance. See id.
\46\ Although ABS issuers are not subject to Rule 13a-15, ABS
issuers that also issue corporate securities are familiar with it.
We previously have recognized that, because the information ABS
issuers are required to provide differs significantly from that
provided by other issuers, and because of the structure of ABS
issuers as typically passive pools of assets, the certification
requirements should be tailored specifically for ABS issuers. See
Certification in Periodic Reports Release.
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Rule 193 does not specify the particular type of review an issuer
is required to perform.\47\ We expect that the type of review of the
assets an issuer performs may vary depending on the circumstances. For
example, the nature of review may vary among different asset classes.
While Rule 193 does not require a particular type of review, as
described below, disclosure describing the type of review is required.
The ``reasonable assurance'' standard is similar to language in the
Foreign Corrupt Practices Act of 1977.\48\ We recognize that while
``reasonableness'' is an objective standard, there is a range of
judgments that an issuer might make as to what will provide
``reasonable assurance.'' \49\ Thus, the term ``reasonable assurance''
in Rule 193 does not imply a single methodology, but encompasses the
full range of reviews an issuer may perform to ensure that its review
is designed and effected to provide reasonable assurance that the
prospectus disclosure regarding the pool assets is accurate in all
material respects.
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\47\ We understand that various levels and types of review may
be performed in a securitization. For example, commentators on the
2010 ABS Proposing Release have identified that the type of review
conducted by a sponsor of a securitization of sub-prime mortgage
loans typically falls into three general categories. First, a credit
review examines the sample loans to ascertain whether they have been
originated in accordance with the originator's underwriting
guidelines. This would include a review of whether the loan
characteristics reported by the originator are accurate and whether
the credit profile of the loans is acceptable to the sponsor. A
second type of review could be a compliance review which examines
whether the loans have been originated in compliance with applicable
laws, including predatory lending and Truth in Lending statutes.
Third, a valuation review entails a review of the accuracy of the
property values reported by the originators for the underlying
collateral. This could include a review of each original appraisal
to assess whether it appeared to comply with the originator's
appraisal guidelines, and the appropriateness of the comparables
used in the original appraisal process. See comment letter from The
Commonwealth of Massachusetts Office of the Attorney General
(``Massachusetts AG comment letter'') on the 2010 ABS Proposing
Release. The comment letters are available at http://www.sec.gov/comments/s7-08-10/s70810.shtml.
\48\ Title 1 of Pub. L. 95-213 (1977). Exchange Act Section
13(b)(7) defines ``reasonable assurance'' as ``such level of detail
and degree of assurance as would satisfy prudent officials in the
conduct of their own affairs.'' 15 U.S.C. 78m(b)(7). We have long
been of the view that ``reasonableness'' is not an ``absolute
standard of exactitude for corporate records.'' Release No. 34-17500
(Jan. 29, 1981) [46 FR 11544].
\49\ See Commission Guidance Regarding Management's Report on
Internal Control Over Financial Reporting Under Section 13(a) or
15(d) of the Securities Exchange Act of 1934, Release No. 34-55929
(June 20, 2007).
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We continue to believe that the nature of review may vary depending
on numerous circumstances and factors which could include, for example,
the nature of the assets being securitized and the degree of continuing
involvement by the sponsor.\50\ We note the suggestion by several
commentators that sampling should be permitted.\51\ While we agree that
sampling may be appropriate depending on the facts and circumstances,
we believe that whether sampling is 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. For example, in
offerings of residential mortgage-backed securities (``RMBS''), where
the asset pool consists of a large group of loans, it may be
appropriate, depending on all the facts, to review a sample of loans
large enough to be representative of the pool, and then conduct further
review if the initial review indicates that further review is warranted
in order to provide reasonable assurance that disclosure is accurate in
all material respects. By contrast, for ABS where a significant portion
of the cash flow will be derived from a single obligor or a small group
of obligors, such as ABS backed by a small number of commercial loans
(``CMBS''), it may be appropriate for the review to include every pool
asset. Moreover, in ABS transactions where the asset pool composition
turns over rapidly because it contains revolving assets, such as credit
card receivables or dealer floorplan receivables, a different type of
review may be warranted than in ABS transactions involving term
receivables, such as mortgage or auto loans. We are not adopting a
minimum sample size for offerings where sampling may be appropriate for
the review as we believe any appropriate sample size must be based on
the facts and circumstances. While reviewing a sample of assets may or
may not be appropriate under the particular facts, we agree with
commentators who suggested that, where a sample of the assets is
reviewed, the size of the sample and the criteria used to select the
assets sampled should be disclosed. Accordingly, we are adding an
instruction noting that this disclosure should be provided as part of
the description of the nature of the review, as discussed further
below.
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\50\ We agree with one commentator's view that the review that
is required is a review of the assets for purposes of the
securitization and not the review conducted to originate the assets.
\51\ See, e.g., comment letters from ABA; Fitch; Levin; SIFMA.
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We have considered comment letters stating that the required review
should relate to the credit quality, or underwriting, of the assets
rather than the accuracy of the disclosure in the prospectus. We
believe that accuracy of disclosure in the prospectus is an appropriate
objective for the required review. The minimum review standard we are
adopting will necessarily include credit quality and underwriting of
the assets since disclosure about these factors is required in the
prospectus, but also will be broader than just a review of the
underwriting of the assets. Because an issuer is required under
Regulation AB to provide disclosure about material characteristics of
the asset pool indicating the quality of the asset pool, under the
review requirement we are adopting today, the issuer will be required
to review whether the disclosure regarding the asset pool is accurate
in all material respects.\52\ In addition to credit quality, this will
include the disclosure currently required by Item 1111 of Regulation
AB. Further, under Item 1111 of Regulation AB, as revised today,
prospectus disclosure of the nature of the review is required.
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\52\ We note that the federal securities laws currently require
that disclosure in the prospectus not contain an untrue statement of
a material fact or omit to state a material fact required to be
stated therein or necessary to make the statements not misleading.
See Securities Act Section 11 [15 U.S.C. 77k] and Securities Act
Section 12 [12 U.S.C. 77l]. See also Securities Act Section 17 [15
U.S.C. 77q], Exchange Act Section 10(b) [15 U.S.C. 78j] and Rule
10b-5 under the Exchange Act [17 CFR 240.10b-5].
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C. Third Party Reviews
1. Proposed Amendments
Proposed Rule 193 would have permitted an issuer to rely on third
parties to satisfy its obligations under Rule 193 provided the third
party is named in the registration statement and consents to being
named as an ``expert'' in accordance with Section 7 of the Securities
Act and Rule 436 under the Securities Act.\53\
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\53\ Section 7 of the Securities Act requires the consent of any
person whose profession gives authority to a statement made by him,
is named as having prepared or certified any part of the
registration statement, or is named as having prepared or certified
a report or valuation for use in connection with the registration
statement.
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2. Comments on the Proposed Amendments
Some commentators supported the proposal to permit issuers to rely
on third-party firms to conduct the
[[Page 4236]]
required review.\54\ One commentator noted that issuers should be
responsible for the sufficiency and accuracy of the reviews without
regard to whether the review is conducted by a third party.\55\ Another
commentator recommended that any third-party review be at arm's
length.\56\ In contrast, another commentator did not believe that an
independence requirement was needed because an issuer may perform the
review itself and cannot be independent or conflict-free with respect
to itself.\57\ This commentator reasoned that since an issuer is not
required to rely on a third party and could conduct the review itself,
there is no greater likelihood that the independence would be
impaired.\58\
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\54\ See comment letters from ABA; Consumer Federation.
\55\ See comment letter from CRL.
\56\ See comment letter from Barnard.
\57\ See comment letter from CAQ.
\58\ See comment letter from CAQ.
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Some commentators expressed concern that third-party due diligence
providers would be considered experts under the Securities Act and
asserted that this treatment would be inconsistent with the principles
guiding Section 11(a)(4) of the Securities Act.\59\ Some commentators
predicted that this requirement is likely to result in these providers
withdrawing from providing services to transactions where expert
liability would attach.\60\ One commentator noted that if these third-
party due diligence providers are subject to expert liability and they
refuse to consent to being named as experts, registered RMBS
transactions will become impossible because many NRSROs require that a
non-affiliated third party perform a due diligence review in order to
rate RMBS.\61\ This commentator explained that if issuers are unable to
obtain a third-party review because of expert liability they would be
unable to obtain a credit rating because of the lack of a third-party
review.\62\
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\59\ See comment letters from ABASA; Clayton; SIFMA.
\60\ See comment letters from Clayton; SIFMA.
\61\ See comment letter from SIFMA.
\62\ See comment letter from SIFMA.
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Several commentators who expressed concern that third-party due
diligence providers would be considered experts under the Securities
Act reasoned that due diligence providers are not licensed
professionals and are not part of a regulated industry that is governed
by a formal professional association.\63\ One commentator argued that
in light of an issuer's continuing liability under Section 11 for its
disclosure related to due diligence, the additional comfort to the
Commission and investors as to the accuracy of the diligence results
gained by requiring expert liability is outweighed by the loss of
diligence firms that will not consent to becoming experts.\64\
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\63\ See comment letters from ABASA; Clayton; SIFMA.
\64\ See comment letter from SIFMA. See also comment letter from
Clayton (noting there is a significant risk it will refrain from
accepting engagements to perform the asset review mandated by Rule
193 leading issuers to more in-house reviews, which could give rise
to potential conflicts of interest).
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3. Final Rule--Third-Party Review
We are adopting, as proposed, a requirement that if an issuer
engages a third party for purposes of performing its Rule 193 review,
then an issuer may rely on the third-party's review to satisfy its
obligations under Rule 193 provided the third party is named in the
registration statement and consents to being named as an ``expert'' in
accordance with Section 7 of the Securities Act and Rule 436 under the
Securities Act. We believe that allowing issuers to contract with a
third-party due diligence provider \65\ is consistent with Section
15E(s)(4) of the Exchange Act.\66\
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\65\ In this release, we refer to third parties engaged for
purposes of reviewing the assets also as third-party due diligence
providers.
\66\ As noted above, Section 15E(s)(4) of the Exchange Act
requires the issuer or underwriter of an ABS to make publicly
available the findings and conclusions of a third-party due
diligence report obtained by the issuer or the underwriter and
requires a third-party due diligence provider that is employed by a
nationally recognized statistical rating organization (``NRSRO''),
an issuer or an underwriter to provide a written certification to
the NRSRO that produces a credit rating. Under Section 15E(s)(4) of
the Exchange Act, the Commission is required to establish the
appropriate format and content for the certifications ``to ensure
that providers of due diligence services have conducted a thorough
review of data, documentation, and other relevant information
necessary for a nationally recognized statistical rating
organization to provide an accurate rating.'' As noted above, we
will address these requirements in a subsequent rulemaking.
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We recognize that issuers may routinely hire third parties to
conduct various types of reviews, and not all persons assisting an
issuer in these reviews would be subject to the new requirements. Under
our new rule, any third party hired by the issuer to perform the review
required under Rule 193, and to whom the issuer attributes findings and
conclusions of the review in the prospectus will be required to be
named in the registration statement and consent to being named as an
``expert'' as described above. On the other hand, if an issuer obtains
assistance from a third party but attributes to itself the findings and
conclusions of the review required by Rule 193, the third party would
not be required to consent to being named as an expert.\67\ In either
case, the prospectus disclosure should make clear whether the disclosed
finding and conclusions are those of the issuer or of a third
party.\68\ We believe that the hiring by an issuer of a third party to
perform the review and using that review to market its securities would
be inconsistent with disclosure that the issuer attributes to itself
the findings and conclusions of the review.\69\ We also note that an
issuer may rely on multiple third parties to fulfill its Rule 193
review obligation, provided the issuer complies with the above
requirements for each third party.
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\67\ If the findings and conclusions are attributed to a third
party, that portion of the disclosure would be expertised. If the
findings and conclusions are instead attributed to the issuer, that
portion of disclosure would not be expertised. See Securities Act
Section 11 [15 U.S.C. 77k].
\68\ We note that this approach is comparable to the staff's
position in the context of a registrant that has engaged a third-
party expert to assist in determining the fair values of certain
assets or liabilities disclosed in a Securities Act registration
statement. See Compliance and Disclosure Interpretations, Division
of Corporation Finance, at Section 233, available at http://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm (whether a registrant that has engaged a third-party
expert to assist in determining fair value must disclose the name of
the third-party expert in its registration statement and obtain the
third-party's consent under Securities Act Section 7(a) depends on
whether the disclosure attributes the statement to the third-party
expert).
\69\ If an issuer obtains the assistance of a third party to
perform the review, and discloses this fact pursuant to Item 1111 of
Regulation AB, as discussed below, this would not be using the
information to market the securities provided the only information
disclosed is that which is required by the rule, and the issuer does
not otherwise use this fact to market the securities. Similarly, we
are of the view that consent to being named as an expert would not
be required of a third party hired by the issuer to assist in
performing the review solely based on the fact that the issuer
provides disclosure pursuant to Item 1111 of Regulation AB that the
issuer hired a third party for the purpose of assisting it to
perform the Rule 193 review.
---------------------------------------------------------------------------
We note commentators' concern that some third parties might not
consent to being named as experts. We are not requiring a third-party
review and, if the issuer obtains the assistance of a third party, the
issuer can attribute the findings and conclusions of the review to
itself and avoid the need to obtain consent. If, however, the issuer
attributes the findings and conclusions to a third party, we believe
that the third party should be named in the registration statement and
be treated in the same manner as other experts, such as investment
banks that provide fairness opinions. We believe, based on discussions
with industry participants, that at least some third-party reviewers
will continue to perform reviews for ABS issuers and will revise their
review procedures as needed to be comfortable
[[Page 4237]]
being named as experts in registered ABS transactions. We also note
that third parties would not be required to provide consent in all
instances, but only where the issuer attributes the findings and
conclusions of the review to the third party.
D. Disclosure Requirements
1. Proposed Rules
Item 1111 of Regulation AB \70\ outlines several aspects of the
pool that the prospectus disclosure for ABS should cover. We proposed
amendments to Item 1111 to require disclosure regarding the nature of
the issuer's review of the assets under Rule 193 and the findings and
conclusions of the review. In addition, we re-proposed amendments from
our 2010 ABS Proposing Release to require disclosure regarding the
composition of the pool as it relates to assets that do not meet
disclosed underwriting standards, as we believe this information would
promote a better understanding of the impact of the review and the
composition of the pool assets.
---------------------------------------------------------------------------
\70\ 17 CFR 229.1111.
---------------------------------------------------------------------------
We proposed new Item 1111(a)(7) of Regulation AB to require that an
issuer of ABS disclose the nature of the review it conducts to satisfy
proposed Rule 193. This proposed requirement would implement Securities
Act Section 7(d)(2),\71\ as added by the Act. As discussed in the
Proposing Release, this disclosure would include whether the issuer has
hired a third-party firm for the purpose of reviewing the assets. We
also proposed to amend Item 1111(a)(7) to require an ABS issuer to
disclose the findings and conclusions of any review performed by the
issuer or by a third party engaged for purposes of reviewing the
assets.\72\ We also proposed Item 1111(a)(8) which re-proposed
additional requirements substantially similar to those we had
previously proposed in the 2010 ABS Proposing Release. This item would
have required disclosure of whether, and if so, how, any assets in the
pool deviate from the disclosed underwriting criteria and data on the
amount and characteristics of those assets that did not meet the
disclosed standards. In addition to what we proposed in the 2010 ABS
Proposing Release, we proposed a requirement that the issuer disclose
the entity (e.g., sponsor, originator or underwriter) who determined
that such assets would be included in the pool, despite not having met
the disclosed underwriting standards.
---------------------------------------------------------------------------
\71\ 15 U.S.C. 77g(d)(2).
\72\ This language is intended to be consistent with the
language used in Exchange Act Section 15E(s)(4)(A).
---------------------------------------------------------------------------
2. Comments on the Proposed Amendments
Comments on the proposal were mixed. Some commentators supported
the proposal in Item 1111(a)(7) \73\ and another commentator expressed
support for the proposal in Item 1111(a)(8).\74\ Another commentator
requested that the Commission modify the proposal in Item 1111(a)(8)
such that the disclosure would be required only to the extent it is
material to investors.\75\ This commentator also suggested that the
Commission clarify that subparagraph (8) not be read to require 100%
diligence of the pool such that, to the extent that an issuer does a
sampling of the pool, only the deviations that are discovered in that
sampling would need to be reported.\76\ This commentator also objected
to the proposal to disclose the entity who made the decision to include
the deviating assets as part of the pool, because multiple transaction
parties could collectively agree on what assets are to be included in
the pool.\77\ To the extent that in a particular transaction a single
party makes the decision, this commentator argued that the disclosure
is not material and should not be required to be reported.\78\ Another
commentator suggested that such disclosure not be required for
offerings of CMBS because decisions about CMBS pool assets are not
susceptible to being attributed to a particular party due to the
fungible nature of CMBS assets and the fact that the decisions are an
iterative process involving the sponsor, issuer, and at times
investors, to largely the same degree.\79\
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\73\ See comment letters from Chuff; SIFMA.
\74\ See comment letter from Fitch.
\75\ See comment letter from SIFMA.
\76\ See comment letter from SIFMA.
\77\ See comment letter from SIFMA.
\78\ See comment letter from SIFMA.
\79\ See comment letter from CRE Finance Council.
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Some commentators recommended that the rule provide further
guidance on the findings and conclusions that must be disclosed.\80\
One commentator highlighted that third-party due diligence reviews
typically evaluate a sample of assets according to underwriting
guidelines provided by the asset seller and other criteria specified by
the asset purchaser.\81\ This commentator noted that the typical end
product of a third-party due diligence review in RMBS offerings is the
grading of specific loans in a sample provided by the asset purchaser,
according to whether the loans meet the seller guidelines and buyer
criteria or whether they comply with applicable laws.\82\ In order for
investors to be able to understand the loan ``grades'' and evaluate the
quality of the reviewed assets, however, this commentator suggested
that the rule require disclosure of the controlling guidelines and
criteria used to produce the loan grades or designations.\83\
---------------------------------------------------------------------------
\80\ See comment letters from CRE Finance Council; Levin.
\81\ See comment letter from Levin.
\82\ See comment letter from Levin.
\83\ See comment letter from Levin.
---------------------------------------------------------------------------
One commentator argued that Item 1111(a)(8) seems to assume that
all originators have uniform underwriting criteria that permit the
evaluation of most loans on a mechanical basis.\84\ In particular, this
commentator explained that auto loan originators do not have hard and
fast guidelines by which most loan applications can be evaluated.
Instead, explained this commentator, such originators use electronic
decision-making systems as a first filter for applications. Most
decisions, however, are made by credit analysts at a variety of levels
and the fact that a given loan required a higher level of approval does
not mean that the loan should be considered an exception to the
underwriting guidelines because there may be many reasons why a loan
might require a higher level of approval and still fit within the
``standard process'' of the originator. While this commentator did not
object to the Commission's formulation of Item 1111(a)(8), it believed
that many sponsors of auto loan ABS would not provide any incremental
disclosure in response to new Item 1111(a)(8) because the underwriting
guidelines in their prospectuses indicate that they make judgmental
underwriting decisions, and there are not disclosed standards by which
loans are evaluated, so there will not be a need to describe loans that
fail to meet those standards.
---------------------------------------------------------------------------
\84\ See comment letter from AFSA.
---------------------------------------------------------------------------
3. Final Rules
After considering the comments, we are adopting the amendments to
Item 1111 of Regulation AB substantially as proposed. We agree with
commentators that the disclosure should provide a clear picture of the
review undertaken and the results and have thus revised the item to
make that clearer.
a. Nature of Review
New Item 1111(a)(7) of Regulation AB requires that an issuer of ABS
disclose the nature of the review it conducts to satisfy proposed Rule
193. This would include whether the issuer has hired a third-party firm
for the purpose of
[[Page 4238]]
reviewing the assets, or to assist it in reviewing the assets. This
would include a description of the scope of the review, such as whether
the issuer or a third party conducted a review of a sample of the
assets and what kind of sampling technique was employed (i.e., random
or adverse).
b. Findings and Conclusions
Under new Item 1111(a)(7), the issuer will be required to disclose
the findings and conclusions of the review performed by the issuer or
by a third party engaged for purposes of reviewing the assets. Although
Section 7(d) of the Securities Act does not require our rules to
mandate that the issuer disclose the findings and conclusions of a
review in its registration statement, we continue to believe this
information is important for investors to consider along with the
information in the registration statement relating to the nature of the
issuer's review as required to be publicly disclosed by Securities Act
Section 7(d). We continue to believe that disclosure of the findings
and conclusions of the review will provide investors with a better
picture of the assets than would be provided by disclosure only of the
nature of the review and would provide a better ability to evaluate the
review. We have revised the item to make clear that disclosure of the
findings and conclusions necessarily requires disclosure of the
criteria against which the loans were evaluated, and how the evaluated
loans compared to those criteria along with the basis for including any
loans not meeting those criteria.\85\ In order to ensure that this
requirement is clear, we have included an instruction to the rule.
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\85\ Such disclosure would be required in order to provide
meaningful context to disclosure of the findings and conclusions of
the issuer or their-party due diligence providers. See comment
letter from Levin (stating that disclosure of loan grades, as used
by third-party due diligence providers, in isolation, without
disclosure of controlling guidelines used to produce those grades,
is not useful to investors).
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c. Disclosure Regarding Exception Loans
We are adopting, as proposed, Item 1111(a)(8) of Regulation AB.
Item 1111(a)(8) of Regulation AB requires issuers to disclose how the
assets in the pool deviate from the disclosed underwriting criteria and
include data on the amount and characteristics of those assets that did
not meet the disclosed standards. Issuers are required to disclose the
entity (e.g., sponsor, originator, or underwriter) who determined that
such assets should be included in the pool, despite not having met the
disclosed underwriting standards, and what factors were used to make
the determination. For example, this could include compensating
factors, such as those included in an issuer's waiver policies for
including in the pool loans that fail to meet the disclosed
underwriting criteria, or a determination that the exception was not
material. If compensating or other factors were used, issuers will be
required to provide data on the amount of assets in the pool, or in the
sample or otherwise known to the issuer if only a sample was reviewed,
that are represented as meeting each factor and the amount of assets
that do not meet those factors. We also believe that this information
will help provide investors with a more complete understanding of the
quality and extent of the issuer's review of the assets (through hiring
a third-party or otherwise) and how that relates to a determination to
either include a loan in the pool or exclude it from the pool.
To the extent the underwriting criteria outlined in the prospectus
are broad or describe underwriting decisions involving the use of
discretion, the prospectus would need to provide disclosure of how the
broad subjective underwriting decisions were applied. We note that Item
1111 of Regulation AB requires a description of the underwriting
criteria used to originate or purchase the pool assets. Thus, where
originators may approve loans at a variety of levels, and the loans
underwritten at an incrementally higher level of approval are evaluated
based on judgmental underwriting decisions, the criteria for the first
level of underwriting should be disclosed, and loans that are included
in the pool despite not meeting the criteria for this first level of
underwriting criteria should be disclosed under Item 1111(a)(8).
We also are adopting, with some clarification, the requirement that
the issuer disclose the entity (e.g., sponsor, originator or
underwriter) who determined that such assets would be included in the
pool, despite not having met the disclosed underwriting standards.
While we are aware of some commentators' objection to reporting this
information because of the possibility that multiple transaction
parties could collectively agree on what assets are to be included in
the pool, we continue to believe that this additional requirement will
assist investors in understanding the entities along the securitization
chain that may be directing decisions to include exception loans in the
pool, even where more than one entity may be involved.\86\ We believe
this information will be useful to investors because it will provide
investors with information to gauge whether the decision to accept such
loans may be subject to a potential conflict of interest. We have
revised the rule to clarify that if multiple parties are involved in
this decision, they should all be named.
---------------------------------------------------------------------------
\86\ See, e.g., Massachusetts AG comment letter.
---------------------------------------------------------------------------
E. Transition Period
Consistent with one commentator's suggestion, we have set a
compliance date for the rule we adopt today that will allow market
participants and industry groups sufficient time to develop procedures
and systems required to comply with rule's requirements.\87\ As this
commentator noted, and as we recognize, other initiatives and changes
to the markets are simultaneously affecting participants in the
securitization industry.\88\ Accordingly, any registered offering of
ABS commencing with an initial bona fide offer after December 31, 2011,
must comply with the new rules. We believe, consistent with one
commentator's suggestion, a transition period will allow issuers time
to design a review to meet the rule's minimum standard.\89\ We also
believe a transition period will benefit third parties who, under the
rule, potentially may be subject to expert liability in certain
circumstances and may require a transitional period to implement
procedures, or revise current ones, in light of the potential expert
liability.
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\87\ See comment letter from SIFMA.
\88\ See, e.g., Improvements to the Asset-Backed Securitization
Process, Title IX, Subtitle D of the Act; Treatment by the Federal
Deposit Insurance Corporation as Conservator or Receiver of
Financial Assets Transferred by an Insured Depository Institution in
Connection with a Securitization or Participation After September
30, 2010, Final Rule, Federal Deposit Insurance Corporation (Sept.
27, 2010).
\89\ See comment letter from SIFMA.
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III. Paperwork Reduction Act
Certain provisions of the final rules contain ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act of 1995 (PRA).\90\ We published a notice requesting
comment on the collection of information requirements in the Proposing
Release for the rule amendments, and we submitted these requirements to
the Office of Management and Budget (``OMB'') for review in accordance
with the PRA.\91\ An agency may not conduct or sponsor, and a person is
not required to comply with, a collection of information unless it
displays a currently valid control
[[Page 4239]]
number. The titles for the collections of information are: \92\
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\90\ 44 U.S.C. 3501 et seq.
\91\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
\92\ The paperwork burden from Regulation S-K is imposed through
the forms that are subject to the requirements in those regulations
and is reflected in the analysis of those forms. To avoid a
Paperwork Reduction Act inventory reflecting duplicative burdens and
for administrative convenience, we assign a one-hour burden to
Regulation S-K.
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(1) ``Form S-1'' (OMB Control No. 3235-0065);
(2) ``Form S-3'' (OMB Control No. 3235-0073); and
(3) ``Regulation S-K'' (OMB Control No. 3235-0071).
Compliance with the proposed amendments is mandatory. Responses to the
information collections will not be kept confidential and there is no
mandatory retention period for the information disclosed.
Our PRA burden estimates for the final amendments are based on
information that we receive on entities assigned to Standard Industrial
Classification Code 6189, the code used with respect to ABS, as well as
information from outside sources.\93\ When possible, we base our
estimates on an average of the data that we have available for the
years 2004 through 2009.
---------------------------------------------------------------------------
\93\ We rely on two outside sources of ABS issuance data. We use
the ABS issuance data from Asset-Backed Alert on the initial terms
of offerings, and we supplement that data with information from
Securities Data Corporation (SDC).
---------------------------------------------------------------------------
In the Proposing Release, we requested comment on the PRA analysis.
No commentators responded to our request for comment on the PRA
analysis.
Forms S-1 and S-3
The amendments to Item 1111 of Regulation AB will increase the
disclosure required in offerings of ABS registered on either Forms S-1
or S-3. The amendment to Item 1111 requires issuers to disclose how the
assets in the pool deviate from the disclosed underwriting criteria,
and include data on the amount and characteristics of those assets that
did not meet the disclosed standards. Issuers will be required to
disclose the entity who determined that such assets should be included
in the pool and what factors were used to make the determination. Under
new Rule 193, if an issuer employs a third party to perform the review
and attributes the findings and conclusions of the review to the third
party, the third party must be named in the registration statement and
consent to being named as an expert in accordance with Securities Act
Rule 436. Thus, we anticipate that issuers will incur a burden in
obtaining a consent from the third party.
We believe that the requirements will increase the annual
incremental burden to issuers by 30 hours per form.\94\ For
registration statements, we estimate that 25% of the burden of
preparation is carried by the company internally and that 75% of the
burden is carried by outside professionals retained by the registrant
at an average cost of $400 per hour. From 2004 through 2009, an
estimated average of four offerings was registered annually on Form S-1
by ABS issuers. We believe that the requirements will result in an
increase to the internal burden to prepare Form S-1 of 30 burden hours
(0.25 x 30 x 4) and an increase in outside costs of $36,000 ($400 x
0.75 x 30 x 4). During 2004 through 2009, we estimate an annual average
of 929 offerings of ABS registered on Form S-3. Therefore, we believe
that the requirements we are adopting will result in an increase to the
internal burden to prepare Form S-3 filings of 6,968 burden hours (0.25
x 30 x 929) and a total cost of $8,361,000 (400 x 0.75 x 30 x 929).
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\94\ This does not reflect burdens associated with the review
that would be required as a result of Rule 193, which we believe
does not impose a collection of information requirement for purposes
of our PRA analysis.
---------------------------------------------------------------------------
Regulation S-K
Regulation S-K includes the item requirements in Regulation AB and
contains the disclosure requirements for filings under both the
Securities Act and the Exchange Act. In 2004, we noted that the
collection of information requirements associated with Regulation S-K
as it applies to ABS issuers are included in Form S-1 and Form S-3.\95\
The amendments that we are adopting revise Regulation S-K. The
collection of information requirements, however, are reflected in the
burden hours estimated for the various Securities Act and Exchange Act
forms related to ABS issuers. The rules in Regulation S-K do not impose
any separate burden. Consistent with historical practice, we have
retained an estimate of one burden hour for Regulation S-K for
administrative convenience.
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\95\ See 2004 Regulation AB Adopting Release.
[[Page 4240]]
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
Proposed Current Increase in Proposed
Form Current annual annual Current burden Increase in Proposed professional professional professional
responses responses hours burden hours burden hours costs costs costs
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
S-1....................................................... 1,168 1,168 247,982 30 248,012 $297,578,400 $36,000 $297,614,400
S-3....................................................... 2,065 2,065 236,959 6,968 243,927 284,350,500 8,361,000 292,711,500
-------------------------------------------------------------------------------------------------------------------------------------
Total................................................. .............. .............. .............. 6,998 .............. ................ 8,397,000 ................
------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
[[Page 4241]]
IV. Benefit-Cost Analysis
The amendments to our regulations for ABS relate to requiring an
issuer of an ABS to perform a review of the assets underlying the
security. The rules we are adopting are intended to implement the
requirements under new Section 7(d) of the Securities Act. First, we
are adopting a new Securities Act rule to require issuers of registered
offerings of asset-backed securities to perform a review of the assets
underlying the asset-backed securities that, at a minimum, must be
designed and effected to provide reasonable assurance that the
disclosure regarding the pool assets in the prospectus is accurate in
all material respects. Second, we also are adopting new requirements in
Regulation AB to require disclosure regarding:
The nature of the review of assets conducted by an ABS
issuer;
The findings and conclusions of a review of assets
conducted by an ABS issuer or third party;
Disclosure regarding assets in the pool that do not meet
the underwriting standards; and
Disclosure regarding which entity determined that the
assets should be included in the pool, despite not having met the
underwriting standards and what factors were considered in making this
determination.
The Commission is sensitive to the costs and benefits imposed by
the rules it is adopting. The discussion below focuses on the costs and
benefits of the amendments made by the Commission to implement the Act
within the Commission's permitted discretion and related amendments not
required by the Act, rather than the costs and benefits of the Act
itself. Except as discussed below, no commentators responded to our
request for comment on the costs and benefits of the proposed rule
identified in the Proposing Release.
A. Benefits
The amendments we are adopting are designed to increase investor
protection by implementing the requirement in Section 7(d) of the
Securities Act, which was added by Section 945 of the Act, for issuers
to perform a review of the underlying assets and disclose the nature of
the review. We expect that requiring a minimum level of review of the
assets will result in loan pools that have fewer loans that do not
conform to the disclosures in the prospectus regarding the pool assets.
We also expect that establishing a minimum level of review will prevent
some potential reviews that are not sufficiently thorough, and
disclosures about the pool assets that are not sufficiently accurate.
Finally, we also expect that a minimum standard of review will benefit
investors by facilitating comparability among reviews performed by
different issuers.
On the other hand, we believe that a principles-based approach is
appropriate to allow for review procedures to be based upon the
economic characteristics of the asset pool that is being examined.
Accordingly, our rules do not prescribe specific guidelines to employ
in reviews. This flexibility should help increase the usefulness of
reviews for investors and limit their costs.
Further, the detailed description of the nature of the review and
disclosure of findings and conclusions should encourage more rigorous
asset reviews, whether by issuers or third parties engaged to perform
the asset reviews. These disclosures would complement the requirement
to perform a review by improving the quality, and investor
understanding, of the review.
Although issuers in registered offerings are not required to use a
third party to satisfy the review requirement, as a condition to such
use, if the findings and conclusions of the review will be attributed
to a third party, a third party would be required to consent to being
named in the registration statement and thereby accept potential expert
liability, which should increase the quality of that review. In
registered offerings, where the third party consents to being named in
the prospectus, the potential expert liability for the findings and
conclusions of third-party reviews should provide accountability and
creates stronger incentives to perform high-quality reviews that
protect investors. The resulting disclosures should reduce the
information risk of investing in these securities. Our amendments to
require detailed disclosure by the issuer of the nature, findings and
conclusions of its review could result in improved asset review
practices. Moreover, this could be useful to investors if they prefer
investing in securities about which there is disclosure indicating a
more robust review over investing in securities about which the
disclosure indicates a less robust review.
The requirement to disclose exception loans may provide important
information to investors regarding the characteristics of the pool that
may otherwise not be publicly known. For those issuers that currently
provide asset-level information about the pool, an investor might be
able, without this new requirement, to determine some information about
the number of exception loans; however, even where this could be
determined under current rules, the amendments would reduce investors'
cost of information production by reducing duplicative efforts to
gather such data on their own or purchase it through data
intermediaries. We also are adopting amendments to require disclosure
of the entities that have determined that an asset that deviates from
underwriting standards should, nonetheless, be included in the pool.
Because third-party asset review providers typically work for sponsors,
there is potentially a conflict of interest when a sponsor can waive or
overrule the third-party's conclusions that insufficient compensating
factors exist to allow inclusion of an asset that does not meet the
underwriting standards governing the pool.\96\ We expect that
information about which entity made the determination to include an
asset in the pool despite not having met the underwriting standards
will provide investors with information to gauge whether the decision
to accept such loans otherwise may be subject to a conflict of
interest. We also expect this will reduce the cost of information
asymmetry and could be useful information to investors because
investors may be able to price a securitization of a pool of assets
more accurately. It also may assist credit rating agencies in assigning
more informed credit ratings, and investors may be able to price ABS
offerings more accurately.
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\96\ See, e.g., comment letter from Massachusetts AG.
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Our amendments requiring detailed disclosure of the nature of the
review, as well as the findings and conclusions of any such review, may
increase investor confidence in the market for ABS. These disclosures
could allow investors to better understand the information about the
asset pool and credit risk of the asset pool.
B. Costs
The final rule would implement the requirement in Section 7(d) of
the Securities Act, added by Section 945 of the Act, that all issuers
of registered ABS offerings perform a review of the underlying assets
and that those issuers disclose the nature of their review. Although
issuers of ABS likely already perform some level of review of the
underlying assets and many originators review the assets at
origination, ABS issuers in registered offerings may incur additional
costs to perform more extensive reviews that are sufficient to comply
with the minimum level of
[[Page 4242]]
review required by the rule, whether the issuer performs the review
itself, or hires a third-party to perform the review. Moreover, this
could be costly to issuers, if investors do not seek to invest in
securities about which there is disclosure indicating a more robust
review over investing in securities about which the disclosure
indicates a less robust review.
It is possible that by establishing a minimum standard for the
review, some issuers who otherwise may have performed a more thorough
review may design their reviews to accomplish no more than the minimum
required by the rule.\97\ We note, however, that under Rule 193 issuers
may obtain a third party to perform the required review and attribute
the review to the third party provided the third party is named in the
registration statement and consents to being named as an expert in the
registration statement. This flexibility in the rule allows for those
third-party reviewers that consent to being named as an expert in the
registration statement to conduct more thorough reviews and separate
themselves from other third-party reviewers that would not provide
those higher levels of assurance. At the same time, commentators
observed that there are incentives not to conduct adequate due
diligence, which supports the need for a minimum standard required by
law.\98\
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\97\ See, e.g., comment letter from Consumer Federation
(observing that all members of the securitization supply change have
``strong incentives * * * to skimp on due diligence'').
\98\ Id.
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Rule 193 permits an issuer to rely on a third party to perform the
required review, provided the review satisfies the standard in Rule
193. If the issuer will attribute the findings and conclusions of the
review to the third party, the third party will be required to be named
in the registration statement and consent to be named as an expert in
the registration statement. One commentator predicted that requiring
third parties to be named in the registration statement as experts will
materially impact the cost of due diligence services which will likely
render securitizations non-economic for issuers.\99\ Some asset classes
may not have third-party due diligence providers available to be
engaged to conduct a review. In instances where an issuer must conduct
the review and attributes to itself the findings and conclusions of the
review, we believe that the costs of conducting these reviews will not
exceed the costs of engaging third parties to conduct the reviews.
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\99\ See comment letter from SIFMA.
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Further, it is possible that third-party providers may lack
sufficient capabilities to provide the review for which they are
retained. Additionally, third-party review firms are not registered
with the Commission and some may not be subject to professional
standards. However, our rules subject third-party review firms in
registered transactions to potential expert liability for the
disclosure regarding the findings and conclusions of their review of
the assets. For certain firms, however, in particular smaller review
firms that may lack the financial resources to cover their potential
liabilities, expert liability may not be a significant deterrent
because these firms have less financial resources exposed to potential
liability and may not be as concerned about losing potential claims
compared to firms that have more financial resources exposed to
liability. This may create a burden on both qualified providers of due
diligence and the securitizers that hire them.
We acknowledge that the potential for expert liability could impose
costs on issuers and third-party due diligence providers, and they may
be required to adjust their practices (and prices in the case of third
parties) to account for this new requirement. Some commentators noted
that it is possible that third parties engaged by issuers to perform
the review required by Rule 193 may be unwilling to consent to being
named in the registration statement as experts.\100\ In the context of
RMBS, some credit rating agencies require third-party reviews on all
residential mortgage pools as a condition to rating the
transaction.\101\ If all third-party providers are unwilling to consent
to being named in the registration statement as experts, issuers that
are unwilling to attribute to themselves alone the findings and
conclusions of the review may be unable to obtain a third party review
and, consequently, be unable to obtain a credit rating. We note,
however, that a third party would not be required to consent to being
named as an expert if an issuer does not attribute the findings and
conclusions of the review to the third party. We also believe, based on
discussions with industry participants, including third-party review
firms, that at least some third parties hired to perform the review
will make any necessary adjustments to their review procedures and
prices in order to be willing to be named in the registration statement
as experts.
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\100\ See, e.g., comment letters from ASF; Clayton; SIFMA.
\101\ See comment letter from Fitch.
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As adopted, the amendments requiring issuers to provide detailed
disclosure relating to the nature of the review, the findings and
conclusions of such review, and disclosure about loans that deviate
from the disclosed underwriting criteria will impose a disclosure
burden.
V. Consideration of Burden on Competition and Promotion of Efficiency,
Competition and Capital Formation
Section 23(a) of the Exchange Act \102\ requires the Commission,
when making rules and regulations under the Exchange Act, to consider
the impact a new rule would have on competition. Section 23(a)(2)
prohibits the Commission from adopting any rule that would impose a
burden on competition not necessary or appropriate in furtherance of
the purposes of the Exchange Act. Section 2(b) of the Securities Act
\103\ and Section 3(f) of the Exchange Act \104\ require the
Commission, when engaging in rulemaking that requires it to consider
whether an action is necessary or appropriate in the public interest,
to consider, in addition to the protection of investors, whether the
action would promote efficiency, competition, and capital formation.
Below, we address these issues for each of the substantive changes we
are adopting regarding offerings of ABS.
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\102\ 15 U.S.C. 78w(a).
\103\ 15 U.S.C. 77b(b).
\104\ 15 U.S.C. 78c(f).
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As a result of the financial crisis and subsequent events, the
market for securitization has declined due, in part, to perceived
uncertainty about the accuracy of information about the pools backing
the ABS and perceived problems in the securitization process that
affected investors' willingness to participate in these offerings.\105\
Greater transparency of the review performed on the underlying assets
would decrease the uncertainty about pool information and, thus, should
help investors price these products more accurately. The requirements
we are adopting are likely to positively affect pricing, efficiency,
and capital allocation in ABS capital markets. The minimum review
standard that we are adopting helps to strengthen these effects by
decreasing the possibility of low quality review providers entering the
market and possibly precipitating a decrease in the quality of due
diligence.
---------------------------------------------------------------------------
\105\ See, e.g., David Adler, A Flat Dow for 10 Years? Why It
Could Happen, Barrons (Dec. 28, 2009).
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Finally, the introduction of expert liability on the third-party
review
[[Page 4243]]
providers may have consequences for the competition in this market. The
possibility of expert liability may provide an incentive for due
diligence providers to improve the quality of their reviews. Thus, one
possible market outcome is for reviewers to compete on the quality of
their services, because high quality providers may credibly separate
themselves from lower quality providers by consenting to be named as
experts, with potential liability resulting from that designation.
On the other hand, the possibility of expert liability may not be a
significant deterrent for smaller due diligence providers that do not
have the financial resources to cover their potential liabilities. This
may adversely affect competition in both the market for the provision
of due diligence and the market for ABS. Diligent providers of asset
reviews may be pressured to decrease their standards, their prices or
both. In addition, ABS with reviews obtained from such parties may
affect the pricing of competing securities.
One commentator predicted that imposing expert liability on third-
party reviewers could result in new and less-qualified firms entering
the market, particularly since the third-party diligence business does
not have any barriers to entry like those that apply to other
professions which have potential expert liability.\106\ Alternatively,
the possibility of expert liability could be an incentive for due
diligence providers to compete on quality and improve their
capabilities.
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\106\ See comment letter from Clayton.
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In summary, taken together the amendments and regulations we are
adopting implement Congress' mandate under the Act and are designed to
improve investor protection, improve the quality of the assets
underlying an ABS, and increase transparency to market participants. We
believe that the amendments also would improve investors' confidence in
asset-backed securities and help recovery in the asset-backed
securities market with attendant positive effects on efficiency,
competition and capital formation.
VI. Regulatory Flexibility Act Certification
Under Section 605(b) of the Regulatory Flexibility Act,\107\ we
certified that, when adopted, the proposals would not have a
significant economic impact on a substantial number of small entities.
We included the certification in Part VIII of the Proposing Release.
While we encouraged written comment regarding this certification, none
of the commentators responded to this request.
---------------------------------------------------------------------------
\107\ 5 U.S.C. 605(b).
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VII. Statutory Authority and Text of Rule and Form Amendments
We are adopting the new rules and amendments contained in this
document under the authority set forth in Sections 6, 7, 10, 19(a), and
28 of the Securities Act, and Sections 3(b), 23(a), and 36 of the
Exchange Act.
List of Subjects in 17 CFR Parts 229 and 230
Advertising, Reporting and recordkeeping requirements, Securities.
For the reasons set out above, Title 17, Chapter II of the Code of
Federal Regulations is amended as follows:
PART 229--STANDARD INSTRUCTIONS FOR FILING FORMS UNDER SECURITIES
ACT OF 1933, SECURITIES EXCHANGE ACT OF 1934 AND ENERGY POLICY AND
CONSERVATION ACT OF 1975 -- REGULATION S-K
0
1. The authority citation for part 229 continues to read in part as
follows:
Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z-2,
77z-3, 77aa(25), 77aa(26), 77ddd, 77eee, 77ggg, 77hhh, 777iii,
77jjj, 77nnn, 77sss, 78c, 78i, 78j, 78l, 78m, 78n, 78o, 78u-5, 78w,
78ll, 78mm, 80a-8, 80a-9, 80a-20, 80a-29, 80a-30, 80a-31(c), 80a-37,
80a-38(a), 80a-39, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350,
unless otherwise noted.
* * * * *
0
2. Amend Sec. 229.1111 by:
0
a. Revising the introductory text to paragraph (a):
0
b. Adding paragraphs (a)(7) and (a)(8).
The revision and additions read as follows:
Sec. 229.1111 (Item 1111) Pool assets.
* * * * *
(a) Information regarding pool asset types and selection criteria.
Provide the following information:
* * * * *
(7)(i) The nature of a review of the assets performed by an issuer
or sponsor (required by Sec. 230.193), including whether the issuer of
any asset-backed security engaged a third party for purposes of
performing the review of the pool assets underlying an asset-backed
security; and
(ii) The findings and conclusions of the review of the assets by
the issuer, sponsor, or third party described in paragraph (a)(7)(i) of
this section.
Instruction to Item 1111(a)(7): The disclosure required under this
item shall provide an understanding of how the review related to the
disclosure regarding the assets. For example, if benchmarks or criteria
different from that specified in the prospectus were used to evaluate
the assets, these should be described, as well as the findings and
conclusions. If the review is of a sample of assets in the pool,
disclose the size of the sample and the criteria used to select the
assets sampled. If the issuer has engaged a third party for purposes of
performing the review of assets, and attributes the findings and
conclusions of the review to the third party in the disclosure required
by this item, the issuer must provide the name of the third-party
reviewer and comply with the requirements of Sec. 230.436 of this
chapter.
(8) If any assets in the pool deviate from the disclosed
underwriting criteria or other criteria or benchmark used to evaluate
the assets, or any assets in the sample or assets otherwise known to
deviate if only a sample was reviewed, disclose how those assets
deviate from the disclosed underwriting criteria or other criteria or
benchmark used to evaluate the assets and include data on the amount
and characteristics of those assets that did not meet the disclosed
standards. Disclose which entity (e.g., sponsor, originator, or
underwriter) or entities determined that those assets should be
included in the pool, despite not having met the disclosed underwriting
standards or other criteria or benchmark used to evaluate the assets,
and what factors were used to make the determination, such as
compensating factors or a determination that the exception was not
material. If compensating or other factors were used, provide data on
the amount of assets in the pool or in the sample that are represented
as meeting each such factor and the amount of assets that do not meet
those factors. If multiple entities are involved in the decision to
include assets despite not having met the disclosed underwriting
standards, this should be described and each participating entity
should be disclosed.
* * * * *
PART 230--GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933
0
3. The authority citation for part 230 is amended by adding the
following citation in numerical order to read as follows:
Authority: 15 U.S.C. 77b, 77c, 77d, 77f, 77g, 77h, 77j, 77r,
77s, 77z-3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78t, 78w,
78ll(d), 78mm, 80a-8, 80a- 24, 80a-28, 80a-29, 80a-30, and 80a-37,
unless otherwise noted.
* * * * *
[[Page 4244]]
Section 230.193 is also issued under sec. 943, Pub. L. 111-203,
124 Stat. 1376.
* * * * *
4. Add Sec. 230.193 to read as follows:
Sec. 230.193 Review of underlying assets in asset-backed securities
transactions.
An issuer of an ``asset-backed security,'' as that term is defined
in Section 3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(77)), offering and selling such a security pursuant to a
registration statement shall perform a review of the pool assets
underlying the asset-backed security. At a minimum, such review must be
designed and effected to provide reasonable assurance that the
disclosure regarding the pool assets in the form of prospectus filed
pursuant to Sec. 230.424 of this chapter is accurate in all material
respects. The issuer may conduct the review or an issuer may employ a
third party engaged for purposes of performing the review. If the
findings and conclusions of the review are attributed to the third
party, the third party must be named in the registration statement and
consent to being named as an expert in accordance with Sec. 230.436 of
this chapter.
Instruction to Sec. 230.193: An issuer of an ``asset-backed
security'' may rely on one or more third parties to fulfill its
obligation to perform a review under this section, provided that the
reviews performed by the third parties and the issuer, in the
aggregate, comply with the minimum standard in this section. The issuer
must comply with the requirements of this section for each third party
engaged by the issuer to perform the review for purposes of this
section. An issuer may not rely on a review performed by an
unaffiliated originator for purposes of performing the review required
under this section.
Dated: January 20, 2011.
By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2011-1503 Filed 1-24-11; 8:45 am]
BILLING CODE 8011-01-P