SEC Proposes Asset-Backed Securities Reform

On April 7, 2010, the Securities and Exchange Commission proposed significant revisions to Regulation AB and other rules relating to the disclosure, reporting and offering process for asset-backed securities. The proposed rules are intended to provide investors with more information, additional useful tools and more time to consider their investment in the asset-backed securities, and to align the interests of sponsors with those of investors. The proposals would also revise the conditions to use of shelf registration in the context of asset-backed securities, replacing the investment grade rating requirement with a new set of requirements, including a condition that the ABS sponsor hold five percent of each class of ABS, net of any hedging arrangements. Significantly, in an apparent effort to encourage continued use of shelf registration and to provide more information to investors in the private markets, the proposals would condition availability of the Rule 144A and Regulation D safe harbors, for a private offering of asset-backed securities and other “structured finance products”, on investors’ being given, upon request, the same information that would be required if the offering were registered.

We plan to issue a memorandum analyzing these proposals in more detail and to submit a comment letter to the SEC on the proposals. Comments will be due 90 days after publication of the proposing release in the Federal Register.

Proposals

Key elements of the proposals are as follows:

Provide Investors with More Time to Consider Transaction-Specific Information

Most ABS offerings are effected pursuant to shelf registration, which permits issuers to sell ABS almost immediately off the shelf. The proposed rules would impose a waiting period before a sponsor of the ABS could conduct the first sale in a shelf offering for each shelf takedown. The issuer would be required to file a preliminary prospectus at least five business days before the first sale in the offering.

Require the Filing of Tagged Computer-Readable, Standardized Loan-Level Information

Under the current ABS rules, information about the loans in an ABS pool is required only at the pool level. The SEC proposes new disclosure rules that would require ABS issuers to provide specific data for each loan in the asset pool, both at the time of securitization and on an ongoing basis.

The loan-level data would cover items such as the terms and underwriting of the loan, credit information about the borrower and/or characteristics of the property securing the loan. To make the required information comparable among issuers of the same asset class and more useful to investors, the proposed rules would require that the data be provided in accordance with proposed standards and in a format tagged in eXtensible Markup Language (XML) so that it may be processed by computer.

The proposal requiring loan-level information would apply to ABS issuers that offer securities backed by residential mortgages, commercial mortgages, automobile loans and leases, equipment loans and leases, student loans, floorplan financings, corporate debt and ABS backed by other ABS. ABS that are backed by credit card receivables would be exempt from loan-level information requirements, due to the large number of underlying accounts, but the proposed rules would require issuers to disclose more granular information regarding the underlying credit card accounts in tagged, computer-readable and standardized groupings.

Require the Filing of a Computer Program That Gives Effect to the Waterfall

The proposed rules would require, along with the filing of a prospectus for an ABS transaction, the filing of a computer program that demonstrates the effect of the “waterfall” that dictates how borrowers’ loan payments are distributed to investors in the ABS and to other parties, how losses or lack of payment on those loans is divided among the investors, and when administrative expenses such as those incurred in servicing those loans are paid to service providers. The SEC intends that investors would be able to use this program, along with loan-level data, to do their own analysis of the underlying assets. The requirement for a preliminary prospectus to be filed at least five business days before the first sale would give investors time to conduct this analysis.

Impose Additional Requirements in the Private Structured Finance Market

Under the proposals, reliance on the Rule 144A and Regulation D safe harbors for private offerings of ABS would be conditioned on the issuer’s providing investors, upon request, at the time of the offering and on an ongoing basis, with the same information that would be required if the offering were registered with the SEC. This requirement would also apply to offerings of structured finance products, such as CDOs and synthetic ABS, that do not qualify as “asset-backed securities” within the meaning of Regulation AB.

The proposed rules would also require that an issuer of structured finance products file a public notice of the initial placement of securities to be sold under Securities Act Rule 144A. This notice would require information about that offering of structured finance products and would be publicly filed with the SEC in its EDGAR database. Form D, the notice of an offering made in reliance on Regulation D, also would be revised to collect information on structured finance products.

Repeal the Investment Grade Ratings Criterion for ABS Shelf-Eligibility

Under existing rules, an ABS offering is not eligible for shelf registration unless the securities are rated investment-grade by a credit rating agency registered with the SEC. The SEC proposes the following new ABS shelf-eligibility criteria to replace the rating requirement:

• The chief executive officer of the ABS issuer must certify that the assets have characteristics that provide a reasonable basis to believe that they will produce cash flows as described in the prospectus.
• The ABS sponsor must hold five percent of each class of asset-backed securities or, in the case of revolving asset master trusts, must retain at least five percent of the nominal amount of the securitized exposures, in each case net of any hedging arrangements.
• The ABS issuer must provide a mechanism whereby the investors will be able to confirm that the assets comply with the issuer’s representations and warranties, such as representations and warranties that the loans in the ABS pool were underwritten in a manner consistent with the lenders’ underwriting standards.
• The ABS issuer must agree to file Exchange Act reports with the SEC on an ongoing basis (rather than stop reporting with the SEC in the first year, which the Exchange Act currently permits many ABS issuers to do).

Make Other Revisions to the Regulation of ABS

In addition to the changes described above, the SEC also proposes to:

• Standardize certain static pool disclosure.
• Tighten up in various respects the Regulation AB definition of an “asset-backed security.”
• Require additional information regarding originators and sponsors, such as information for certain identified originators and the sponsor relating to the amount of the originator’s or sponsor’s publicly securitized assets that, in the last three years, has been the subject of a demand to repurchase or replace.
• Lower the threshold change in the material pool characteristics that triggers the filing of a Form 8-K (pursuant to Item 6.05) from five percent to one percent.
• Specify, in addition to the loan-level proposed requirements, the disclosure that must be provided on an aggregate basis relating to the type and amount of assets that do not meet the underwriting criteria that are described in the prospectus.