United States: SEC Adopts Final Rules for Asset-Backed Securities - Part 2

Research Reports. In the Adopting Release, the SEC notes that the current SEC rules creating safe harbors for distribution of broker or dealer research reports in the context of a public offering²⁸ do not correspond well to ABS offerings. The Rules as adopted provide a safe harbor to the effect that the publication or distribution by a broker or dealer of a research report with respect to investment-grade ABS meeting the other criteria of Form S-3 will not be deemed to constitute an offer for sale or offer to sell such ABS registered or proposed to be registered, even if the broker or dealer is a participant in the registered offering, if the following conditions are met:

• the broker or dealer has previously published or distributed with reasonable regularity information, opinions, or recommendations of Form S-3 ABS backed by substantially similar collateral as that backing the Form S-3 in the research report;

• if the ABS are part of an unsold allotment, the research report must not identify those ABS or give those ABS greater prominence than other ABS mentioned in the research report or contain any ABS informational and computational material with respect to those ABS;

• if the research report identifies specific ABS of a specific issuer and specifically recommends that such ABS be purchased, sold, or held, then the last publication of such broker or dealer prior to its participation in the distribution of the current ABS offering must have contained a recommendation of such ABS as favorable or more favorable than that contained in the research report;

• sufficient information is available from one or more public sources to provide a reasonable basis for the views expressed by the broker or dealer in the research report;

• if the research report identifies other ABS backed by collateral that is substantially similar to collateral backing the ABS being registered and specifically recommends that such ABS be preferred over ABS backed by different types of collateral, then the research report must explain in reasonable detail the reasons for such preference.

Other Communications During the Offering Process. In the Adopting Release, the SEC reiterated its "adoption" and "entanglement" theories with respect to pre-sale reports by rating agencies as being equally applicable to ABS offerings. In short, information (such as a pre-sale report) prepared and distributed by third parties that are not offering participants (such as a rating agency) may be attributed to an issuer or an underwriter (who would therefore be liable for its contents) if the issuer or underwriter had "adopted" such information (e.g., by distributing the information in connection with an offering) or had become "entangled" with such information (e.g., by being heavily engaged in its preparation).

Current Requirements. As with the current Securities Act registration requirements, the current Exchange Act reporting requirements were designed for disclosures by operating companies. Nonetheless, post-issuance reporting in respect of ABS is critically important to ABS investors in their monitoring of asset pool performance and the performance of the transaction parties, thereby contributing to the liquidity of ABS. The transaction documents for ABS offerings generally require (as a matter of private contract) that periodic servicing and cash flow distribution reports be sent to ABS investors and/or made available on web sites. As a result, the SEC staff has issued "no action" letters permitting a modified Exchange Act reporting system for ABS, whereby reports on Form 8-K are filed based on the frequency of distribution reports (generally monthly) in lieu of quarterly reports on Form 10-Q, and whereby a modified annual report on Form 10-K must be filed (e.g., audited financial statements are generally not required for the issuing entity, but the accountant’s report on compliance with servicing criteria and the servicer compliance statement on compliance with its obligations under the servicing agreement are both required to be filed as exhibits). In addition, to comply with the certification requirement under Section 302 of the U.S. Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act"), the SEC has prepared a tailored form of certification for use with ABS annual reports on Form 10-K.

The following Exchange Act reporting requirements, to the extent they are applicable to any particular ABS, would apply alike to both U.S. domestic- and foreign-issued ABS (including the Exchange Act forms to be used as described below). In other words, the Rules do not contemplate a separate Exchange Act reporting system for foreign ABS.

Determining the "Issuer" and Operation of the Section 15(d) Reporting Obligation. The Exchange Act rule as adopted clarifies that the depositor for ABS, acting solely in its capacity as depositor to the issuing entity, is the "issuer" under the Exchange Act for purposes of ABS of that issuing entity. As with the SEC’s similar definition for the Securities Act, the Exchange Act definition specifies that the person acting in its capacity as depositor for the issuing entity of an ABS is a different "issuer" from that same person acting as a depositor for any other issuing entity or for purposes of that person’s own securities.

As such, each takedown of ABS by a new issuing entity triggers a new reporting obligation under Section 15(d) of the Exchange Act, and the starting and suspension dates for any reporting obligation with respect to a takedown of ABS is determined separately for each takedown.

The SEC in the Adopting Release identifies who must sign Exchange Act reports: The depositor is to sign Exchange Act reports, although an authorized representative of the servicer will be permitted to sign on behalf of the issuing entity as an alternative.

Reporting on EDGAR. Registration statements and annual and other periodic and current reports are required to be filed in electronic format on EDGAR. The Rules provide guidance on how to submit documents on EDGAR that will enable investors and others to locate material information about particular ABS more efficiently.

Under the EDGAR system, each entity that makes an EDGAR submission is assigned a Central Index Key code, or "CIK" code. For submissions to appear under the correct entity, the correct CIK code must be included in the EDGAR submission header. With each takedown of ABS by a new entity off the registration statement, a new reporting obligation under Section 15(d) of the Exchange Act is created. The EDGAR system will automatically generate a new CIK code and an Exchange Act reporting file number for the new entity. The issuer in its capacity as depositor for newly created entities should then prepare separate annual, periodic, and current reports for each issuing entity and file such reports under the separate CIK code for each issuing entity.

Distribution Reports on Form 10-D. Since Form 8-K was not designed to be a report filed on a periodic basis, the SEC has now adopted a new Form 10-D to be used in lieu of Form 8-K to report periodic distributions and pool performance information for ABS, to be filed within 15 days²⁹ after each required distribution date.

Form 10-D requires a description of the distribution and pool performance information for the related distribution period, with statistical information presented in tabular or graphical format (if the same will aid understanding). While the material information will vary depending on the nature of the transaction, such information may include, inter alia: record, accrual, determination, and distribution dates; cash flows received; distribution of the flow of funds (fees and expenses, payments with respect to enhancement or other support, principal and interest distributions, excess cash flow); beginning and ending principal balances on ABS; interest rates on the pool assets and ABS; beginning and ending balances on transaction accounts; any amounts drawn on credit enhancement or other support; beginning and ending amounts of pool assets; delinquency and loss information; advances made or reimbursed; material modifications, extensions or waivers; material breaches; information on ratio, coverage, or other tests; and any new issuance of ABS. The distribution report delivered to the trustee or security holders pursuant to the transaction agreements must be filed as an exhibit to Form 10-D.

Form 10-D also requires disclosure of other information for the relevant period, such as legal proceedings, sales of securities and use of proceeds, defaults upon senior securities, submission of matters to a vote of security holders, significant obligors of pool assets, and significant enhancement provider information. Updated financial information in respect of significant obligors and significant enhancement providers must be provided on Form 10-D in accordance with the percentage breakpoints described above.

The Form 10-D report is required regardless of whether the required distribution is actually made or whether a distribution report is in fact delivered pursuant to the transaction documents.

Annual Reports on Form 10-K. In the Adopting Release, the SEC is adding a new general instruction for Form 10-K to specify how that form is to be used for an annual report with respect to ABS. The general instruction identifies the existing items on the form that may be omitted as well as substitute items from Regulation AB that are required. Any other applicable items specified in Form 10-K will continue to be required.

The additional items from Regulation AB include: significant obligor financial information and significant enhancement provider financial information in accordance with the percentage breakpoints described above; legal proceedings (same information as required for Form 10-D); and affiliations and certain relationships and related transactions.

The separate instructions to Form 10-K make clear that audited financial statements for the issuing entity are not required. Instead, the Adopting Release will require: (i) a servicer compliance statement; (ii) an assessment of and attestation regarding compliance with servicing criteria (see below); and (iii) a Section 302 certification (see below).

The servicer compliance statement must be signed by an authorized officer of the servicer and must state that a review of the activities of the servicer and its performance under the servicing agreement has been made under the officer’s supervision, and that to the best of the officer’s knowledge and except as otherwise disclosed, the servicer has fulfilled its obligations under the agreement in all material respects throughout the reporting period, or specifying each material failure to fulfill any such obligation.

Certifications under Section 302 of the Sarbanes-Oxley Act. The Adopting Release amends Item 601 of Regulation S-K to add the specific form and content of the certification required under Section 302 of the Sarbanes-Oxley Act as applied to ABS.

In the new form of certification, the signatory thereto (who must be the same person that signs the Form 10-K) must certify that: (i) he or she has reviewed the Form 10-K report and all Form 10-D reports in respect of the period covered by the Form 10-K report; (ii) the Exchange Act reports taken as a whole do not contain any untrue statement of material fact or any material omissions;³⁰ (iii) all of the distribution, servicing, and other information required under Form 10-D for the period covered in the Form 10-K report is included in the Exchange Act periodic reports; (iv) each servicer has fulfilled its obligations under the servicing agreement(s);³¹ and (v) all of the reports on assessment of compliance with servicing criteria for ABS and their related attestation reports have been included as an exhibit to the Form 10-K report.³²

Report on Assessment of Compliance with Servicing Criteria and Accountant’s Attestation. In the Adopting Release, the SEC states that it seeks a single uniform set of servicing criteria that covers all aspects of the servicing function and that could be used in the context of multiple asset classes. The SEC states that the only generally used criteria for assessing and reporting on servicing compliance is the Uniform Single Attestation Program for Mortgage Bankers ("USAP"), which was created early in the development of securitization to provide uniform minimum criteria for mortgage-backed securities, and as such the USAP’s utility for ABS reporting has significant limitations. Nevertheless, in view of the absence of any other generally used criteria at this time, the SEC in the Adopting Release is adopting servicing criteria designed to be incremental to the current criteria in the USAP. These criteria consist of four broad categories: (i) general servicing considerations; (ii) cash collection and administration; (iii) investor remittances and reporting; and (iv) pool asset administration.

The annual report on Form 10-K must include as exhibits reports from each party participating in the servicing function that assess compliance with the servicing criteria adopted by the SEC.³³ Each assessment report must include: (i) a statement of the party’s responsibility for assessing compliance with the servicing criteria applicable to it; (ii) a statement that the party used the servicing criteria to assess compliance with the applicable servicing criteria; (iii) the party’s assessment of compliance with the applicable servicing criteria for the period covered by the Form 10-K report, including any material instance of noncompliance; and (iv) a statement that a registered public accounting firm has issued an attestation report on the party’s assessment of compliance in respect of the relevant period.

To ensure independence and objectivity for the attestation function, the Adopting Release requires, for each attestation, that a registered public accounting firm will perform an attestation examination in accordance with the standards for attestation engagements issued or adopted by the Public Company Accounting Oversight Board and issue an attestation report to be filed as an exhibit to the Form 10-K report.

In assessing compliance, the Adopting Release permits a "platform" level of compliance. This means an assessment of compliance with respect to all ABS transactions involving the asserting party that are backed by assets of the type backing the ABS covered by the Form 10-K report. This permits a single assessment and assertion regarding compliance for entities involved in multiple ABS transactions.

Current Reporting on Form 8-K. Similar to Form 10-K, the SEC is adding a new general instruction to Form 8-K to specify how the form is to be used with respect to ABS. The general instruction identifies the existing items on the form that may be omitted as well as substitute items from Regulation AB that are required. Any other applicable items specified in Form 8-K will continue to be required. Form 8-K must be filed within four business days after the occurrence of the relevant reportable event (being responsive to the "real time disclosure" mandate under the Sarbanes-Oxley Act).

Items on current Form 8-K that remain applicable to ABS include: entry into a material definitive agreement; termination of a material definitive agreement; bankruptcy or receivership of the sponsor, depositor, servicer, trustee, significant obligor, significant enhancement provider, or other material party to the ABS transaction; triggering events that accelerate or increase a direct financial obligation under an off-balance sheet arrangement (including an occurrence of early amortization, performance trigger, event of default, or other event that would materially alter the payment priority or distribution of cash flows or amortization schedule); material modifications to rights of security holders; amendments to articles of incorporation or bylaws and change of fiscal year; and Regulation FD disclosure.³⁴

New items added to Form 8-K for ABS include: ABS informational and computational material; change of servicer or trustee; change in credit enhancement or other external support; failure to make a required distribution (that is material); and securities act updating disclosure (i.e., where the composition of the actual asset pool at the time of issuance of the ABS differs from the composition of the pool described in the final prospectus for the offering by 5 percent or more, other than as a result of conversion into cash).

Other Exchange Act Amendments. The Rules codify the requirement to file reports tied to distributions on ABS in lieu of quarterly reporting on Form 10-Q. The Rules exempt ABS from Section 16 of the Exchange Act (regarding transactions by corporate insiders) in view of the fact that issuing entities often do not have directors or officers. The Rules adopt special rules for transition reports applicable to ABS when an issuing entity changes its fiscal year.

The effective date of the Rules is March 8, 2005. However, the Rules include transition provisions to enable market participants time to prepare and satisfy the new requirements. Registered offerings of ABS commencing after December 31, 2005 ("Post-2005 Offerings") will be required to comply with the new rules and forms, with offerings commencing prior to that date grandfathered under the current regime. Shelf registration statements filed prior to September 1, 2005 and relied upon for Post-2005 Offerings on or prior to March 31, 2006, need not be amended to conform the base prospectus to the requirements of the Rules, but the Rule 424(b) prospectus and supplement must, taken together, comply with the Rules, and Part II of the registration statement must comply with the undertakings required by the Rules (including by way of post-effective amendment, if necessary). For shelf takedowns after March 31, 2006, Part I of such registration statement must comply with the Rules, and Part II must contain the undertakings required by the Rules (in each case by way of post-effective amendment, if necessary). Shelf registration statements relied upon for Post-2005 Offerings, if filed after August 31, 2005, must be pre- or post-effectively amended to make the prospectus included in Part I thereof compliant and to make any required undertakings in Part II thereof (and for Post-2005 Offerings commencing after March 31, 2006, to make all changes required in Part II thereof).

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