On January 20, 2011, the Securities and Exchange Commission (SEC) adopted several final rules applicable to asset backed securities (ABS), which were mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Wall Street Reform Act) as codified in revisions to the Securities Act of 1933, as amended (the Securities Act) and the Securities Exchange of 1934, as amended (the Exchange Act). The final rules will have a significant impact on both public and private securitizations and it is hoped that they will help revitalize securitization markets by requiring more and more timely disclosure.
Rule 193 and Items 1111 (a) (7) and (8) of Regulation AB require issuers (sponsors or depositors) of registered ABS to conduct a review of the assets underlying the ABS offering and disclose the nature, findings and conclusions of the review in the prospectus relating to the offering, including matters relating to assets that deviate from the underwriting criteria for the asset pool. Under Rule 193, the review may be conducted in whole or in part by the ABS issuer or one or more third parties engaged for this purpose. If the review is conducted by third parties and the findings and conclusions of the review described in the prospectus are attributed to such third parties, then those third parties must be named in the prospectus along with other experts (typically legal counsel and accountants) and consent to being treated as experts in accordance with Rule 436 of the Securities Act.
Because the types of assets in ABS offerings vary widely (e.g., residential mortgages, commercial mortgages, student loans, auto loans, credit card receivables, trade receivables and life insurance policies, etc.), the SEC did not enumerate specific measures that issuers must undertake or specify methodologies that must be used in connection with the mandated issuer review of the asset pool. However, new Rule 193 does include a minimum, albeit general, review standard. Specifically, the review must be "designed and effected to provide reasonable assurance" that the disclosure in the prospectus regarding the pool assets is accurate in all material respects.
Amendments to Item 1111(a) of Regulation AB require issuers to disclose in the prospectus "how the review related" to the disclosure regarding the assets in the prospectus. This requirement appears to require disclosure of the methodology employed in the review. Thus, the instructions to Item 1111(a) provide that if a review is based upon a sampling of assets underlying the ABS, the appropriate prospectus disclosure would include the size of the sample and the criteria used to select the sample.
In addition, amendments to Item 1111(a) of Regulation AB require disclosures relating to assets that deviate from the disclosed underwriting criteria. Specifically, Regulation AB now requires prospectus disclosure of (i) how assets in the pool deviate from the underwriting criteria disclosed in the prospectus, (ii) the amount and characteristics of deviant assets and (iii) the identity of the entity (e.g., sponsor, originator, underwriter) which determined that deviant assets should be included in the asset pool and the factors used to make the determination to include deviant assets in the pool.
On January 21, 2011, the SEC adopted new Rules 15Ga-1 and 17g-7 under the Exchange Act and new Form ABS- 15G and amendments to Regulation AB implementing Section 943 of the Wall Street Reform Act. Section 943 of the Wall Street Reform Act required the SEC to prescribe regulations on the use and effectiveness of representations and warranties in the market for ABS. Section 943 provides that such regulations must require "securitizers" to disclose fulfilled and unfulfilled repurchase requests across all trusts aggregated by the securitizer. The regulations also must require each nationally recognized statistical rating organization (NRSROs) to include in any report accompanying a credit rating a description of the representations, warranties and enforcement mechanisms available to investors in the rated securities and how these differ from the representations, warranties and enforcement mechanisms for similar securities. Section 943 of the Wall Street Reform Act reflected Congress' belief that the ABS issuer's right, in a typical ABS asset purchase agreement, to require the originator or sponsor of assets underlying ABS to repurchase assets if they do not conform to the originator's or sponsor's representations and warranties, was largely illusory, and that periodic disclosure of the fulfilled and unfulfilled repurchase requests across all trusts aggregated by securitizers would enable ABS purchasers to identify asset originators or sponsors with clear underwriting deficiencies.
Rule 15Ga-1 requires securitizers (issuers, sponsors and depositors) of registered and unregistered ABS to disclose on new Form ABS-15G, to be filed with the SEC on EDGAR, all fulfilled and unfulfilled requests for asset repurchases or replacements based on breach of representations and warranties concerning the asset pool for all assets securitized by such securitizer during the three-year period ending December 31, 2011 and quarterly thereafter. The required disclosure must be made in tabular form (supplemented by footnotes and a narrative, as necessary), grouped by asset class, issuer and originator, and must include: (i) disclosure by originator of the total assets securitized, (ii) the principal amount of assets subject to requests for repurchase or replacement for breach of representations and warranties, (iii) the principal amount of assets that were repurchased or replaced, (iv) the principal amount of assets pending repurchase or replacement and (v) the principal amount of assets subject to repurchase or replacement requests that are in dispute, have been withdrawn and have been rejected. All requests for asset repurchase or replacement must be disclosed on Form ABS 15G, regardless of the merit of the request and regardless of whether the request was made by the ABS's trustee on its own initiative or at the request of investors. Recognizing that securitizers may not be able to provide complete historical information concerning investor prompted requests, Rule 15Ga-1 permits a securitizer to omit information that is unknown or not reasonably available to the securitizer without unreasonable effort or expense, provided that the they include a statement describing why unreasonable effort or expense would be involved in obtaining the omitted information. In addition, in order to give securitizers sufficient time to set up systems to track the required data, any securitizer that issued ABS during the three-year period ending December 31, 2011 that includes a covenant to repurchase or replace an underlying asset for a breach of a representation or warrant will have until February 14, 2012 to file its initial Form ABS-15G. Thereafter, quarterly filings on Form ABS-15G must be made by securitizers that issue ABS during the applicable quarter or had outstanding ABS held by non-affiliates during the applicable quarter.
As indicated above, disclosure on Form ABS-15G is required of securitizers of privately placed, as well as registered, ABS. However, as one would expect, the SEC adopted comparable requirements for prospectus disclosure in registered ABS transactions. Thus, the SEC adopted new Item 1104(e) of Regulation AB requiring issuers of registered ABS, which include the right to require the repurchase or replacement of underlying assets for breach of a representation or warranty, to include in the ABS prospectus the repurchase and replacement data specified in Rule 15G-1 for the prior three-year period for all assets securitized by the sponsor of the same asset class as the registered securities that are the subject of the offering. Any registered offering of ABS commencing with an initial bona fide offer on or after February 14, 2012 must comply with the information requirements of new Item 1104(e) of Regulation AB. However, recognizing that securitizers may not have been collecting and tracking the required replacement/ repurchase data, the prospectus look back period is being phased in. So a prospectus filed after February 14, 2012 but before February 14, 2013 need only include one year of such data, and a prospectus filed on or after February 14, 2013 and before February 14, 2014 must include two prior years of such data.
In addition, the SEC adopted new Item 1121(c) requiring the replacement and repurchase information required by Rule 15Ga-1(a) to be included in all reports on Form 10-Ds filed after December 31, 2011.
Implementing Section 943(1) of the Wall Street Reform Act, the SEC adopted Rule 17g-7 under the Exchange Act. Rule 17g-7 requires all NRSROs to include in any report accompanying an ABS credit rating a description of the representations, warranties and enforcement mechanisms available to investors and how they differ from the representations, warranties and enforcement mechanisms in issuances of "similar securities." The new rule applies to both registered and unregistered ABS transactions, whether or not they are offered in the U.S. The required disclosure must be included in both final ratings and preliminary or expected ratings, including sales reports. One of the more obvious challenges to compliance with Rule 17g-7 is determining which issuances are "similar" to the one being rated: the new rule does not include definitions or interpretive rules. The SEC expects an NRSRO to draw upon its knowledge of industry standards as well as its expertise with previously rated deals and knowledge of the market generally.
More to Come
The securitization market still awaits final SEC rules in several other key areas. For example, the market awaits adoption of final rules relating to the "skin in the game" requirement of Section 941(b) of the Wall Street Reform Act that requires the SEC, and, in the case of the securitization of residential mortgage assets, the Housing and Urban Development and Federal Housing Finance Agency, to prescribe regulations that (i) require securitizers of both registered and privately placed ABS to retain not less than 5 percent of the credit risk of any asset that the securitizer through the issuance of ABS transfers, sells or conveys to a third party and (ii) prohibit such securitizers from directly or indirectly hedging the retained credit risk. On March 30, 2011, the SEC issued proposed "skin in the game" rules and is currently considering comments on the proposed rules.
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