On July 26, 2011, the Securities and Exchange Commission (the "SEC") re-proposed rules (the "Re-Proposal")1 regarding new shelf eligibility requirements for asset-backed securities ("ABS"). In April 2010, the SEC had proposed rules that would revise the disclosure, reporting and offering process for ABS (the "2010 Proposal")2, and the Re-Proposal is being made in light of changes mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act3 (the "Dodd-Frank Act") as well as to address certain comments that the SEC received on the 2010 Proposal.
Specifically, the Re-Proposal for ABS shelf eligibility would require:
- a certification filed at the time of each shelf offering of the chief executive officer of the depositor or the executive officer in charge of securitization of the depositor concerning the disclosure contained in the prospectus and the design of the securitization;
- provisions in the underlying transaction agreements regarding the appointment of a credit risk manager to review the securitized assets upon the occurrence of certain trigger events and provisions requiring repurchase request dispute resolution;
- a provision in the underlying transaction agreements that would enable an investor to communicate with other investors by means of a request made in Form 10-D; and
- an annual evaluation of compliance with the registrant requirements for shelf eligibility.
The Re-Proposal also:
- re-proposes revised filing deadlines for exhibits in ABS shelf offerings to require that the underlying transaction agreements, in substantially final form, be filed by the time the preliminary prospectus is required to be filed under the 2010 Proposal,
- requests additional comment on the 2010 Proposal relating to asset-level data in light of Section 942(b) of the Dodd-Frank Act relating to the disclosure of asset-level information, and
- severs from the implementation of the rest of the 2010 Proposal, the portion of it that would require ABS issuers to file a "waterfall" computer program allowing investors to analyze the ABS using loan-level collateral information also required to be filed by issuers at the inception of the securitization and then periodically throughout the life of the transaction. The SEC indicated its intention to re-propose the waterfall program filing requirement separately.
This memorandum focuses primarily on the re-proposed shelf eligibility requirements.
SHELF ELIGIBILITY PROPOSALS
In the 2010 Proposal, the SEC proposed to add a new shelf registration Form SF-3 for ABS, which would require disclosure in accordance with the items applicable to ABS offerings currently required in Form S-3 as modified by the 2010 Proposal. The Re-Proposal re-proposes certain registrant and transaction requirements contained in the instructions to Form SF-3. The other proposals in the 2010 Proposal relating to Form SF-3 remain unchanged and outstanding, including, among other things, enhanced disclosure requirements.4
The Re-Proposal revises and re-proposes certain transaction requirements for shelf eligibility to replace the current requirement that the offered securities be rated investment grade by at least one nationally recognized statistical rating organization. In light of the Dodd-Frank Act requirements for rules with respect to credit risk retention and for continued periodic reporting by ABS issuers under the Securities Exchange Act of 1934, as amended (the "Exchange Act")5, the Re-Proposal does not include the risk retention or continued Exchange Act reporting requirements that were proposed in the 2010 Proposal. As further described below, the Re-Proposal proposes to modify the certification and representations and warranties enforcement shelf eligibility transaction requirements in the 2010 Proposal, as well to add an investor communication shelf eligibility transaction requirement.
The SEC does not propose to change the other current ABS shelf offering transaction requirements related to the amount of delinquent assets in the asset pool and residual values of leases.6
The revised proposed certification would be required to be provided by the chief executive officer or the executive officer in charge of securitization for the depositor, and would state that:
- the executive officer has reviewed the prospectus and is familiar with the structure of the securitization, including without limitation the characteristics of the securitized assets underlying the offering, the terms of any internal credit enhancements, and the material terms of all contracts and other arrangements entered into to effect the securitization;
- based on the executive officer's knowledge, the prospectus does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading;
- based on the executive officer's knowledge, the prospectus and other information included in the registration statement of which it is a part, fairly present in all material respects the characteristics of the securitized assets underlying the offering described therein and the risks of ownership of the asset-backed securities described therein, including all credit enhancements and all risk factors relating to the securitized assets underlying the offering that would affect the cash flows sufficient to service payments on the asset-backed securities as described in the prospectus; and
- based on the executive officer's knowledge, taking into account the characteristics of the securitized assets underlying the offering, the structure of the securitization, including internal credit enhancements, and any other material features of the transaction, in each instance, as described in the prospectus, the securitization is designed to produce, but is not guaranteed by the certification to produce, cash flows at times and in amounts sufficient to service expected payments on the asset-backed securities offered and sold pursuant to the registration statement.7
As was proposed in the 2010 Proposal, the certification would have to be furnished exactly as required under the Re-Proposal.8 In making this certification, the executive officer is precluded from taking into account external credit enhancements such as third party insurance.9
Note: This re-proposed certification significantly expands the certification to be provided from the certification proposed in the 2010 Proposal. In addition to certifying as to the cash flows supporting the ABS, the executive officer must certify that the prospectus fairly presents the characteristics of the securitized assets, and the risks of ownership of the ABS, and that the prospectus does not contain any material misstatements or omissions that would cause the disclosure to be misleading.10
Note: In the 2010 Proposal, the SEC stated that although the proposed certification could not be altered, prospectus disclosure addressing risk of non-payment or other risk that cash flows may not be produced could be taken into consideration in signing the certification.11 The Re-Proposal, on the other hand, omits this consideration and instead offers comfort to issuers by stating that that the classes most likely to incur losses are typically not sold in registered transactions and therefore would not be the subject of the certification.12 The irony is that the reason the more subordinate classes are typically not sold in registered transactions is because of the current shelf eligibility investment grade rating requirement, which is proposed to be removed.
In making the certification, the executive officer may rely, in part, on the review required by Rule 193 under the Securities Act of 1933, as amended (the "Securities Act"), and on the work of others in structuring the ABS transaction, but is expected to provide appropriate oversight so that he or she will be able make the certification.13
Note: In discussing the proposed requirement that the certification be "based on the executive officer's knowledge," the SEC expresses the view that the executive officer would be expected to have reviewed the necessary documents regarding the assets, transactions and disclosures.14
The certification would be required to be dated as of the date of the prospectus, and filed as an exhibit to the registration statement by no later than the time the final prospectus is required to be filed under Rule 424 under the Securities Act.15
Note: The Re-Proposal would allow the certification to be signed by either an executive officer in charge of securitization or the chief executive officer of the depositor, whereas the 2010 Proposal would have required the chief executive officer to certify.16
2. Credit Risk Manager and Repurchase Request Dispute Resolution Provisions
The Re-Proposal proposes a revised method for dealing with breaches of representations and warranties. The 2010 Proposal would have required a provision in the transaction agreements that would require the party obligated to repurchase the assets for breach of representations and warranties to periodically furnish an opinion of an independent third party regarding whether the obligated party acted consistently with the terms of the transaction agreement with respect to any loans that the trustee put back to the obligated party for violation of representations and warranties and that were not repurchased. The Re-Proposal takes a different approach, and would require the appointment by the trustee of a credit risk manager to address breaches of representations and warranties in certain circumstances as well as mandate certain dispute resolution provisions in transaction documents for buy-back claims. The Re-Proposal would require the inclusion of provisions in the underlying transaction agreements mandating the appointment by the trustee of a credit risk manager not affiliated with any sponsor, depositor, or servicer in the transaction. The credit risk manager would be required to review the underlying assets for compliance with the representations and warranties upon the occurrence of trigger events specified in the transaction agreements. The credit risk manager would be authorized to access the underlying loan documents in conducting its review. At a minimum, trigger events would include:
- when credit enhancement requirements specified in the underlying transaction agreements are not met, and
- the direction of investors pursuant to procedures provided in the transaction agreements and disclosed in the prospectus.
The credit risk manager would be required to provide a report of the findings and conclusions of its review to the trustee.17
Note: For those transactions that would not normally have specific credit enhancement requirements, it appears that this credit risk manager proposal would require them, although the SEC does not mandate what they should be. In addition, the SEC leaves it to the transaction parties to determine the appropriate procedures and times for an investor-directed review.18
In the prospectus, the following information relating to the credit risk manager would be required to be disclosed: its name, its form of organization, its experience serving as credit risk manager in similar transactions, and the manner and amount of its compensation. In addition, disclosure would be required concerning its duties, responsibilities, and limitations on its liability. Furthermore, disclosure would be required for contractual provisions dealing with its replacement or resignation, and material affiliations and relationships between it and other transaction parties.19
Full reports by the credit risk manager, as well as the occurrence of any specified event triggering a credit risk manager review or the removal, replacement or substitution of the credit risk manager would be required to be disclosed on Form 10-D.20
The Re-Proposal would also require the inclusion of a provision in the underlying transaction agreements providing for repurchase dispute resolution. The provision would require that if a party submits a repurchase request pursuant to transaction agreement and assets are not repurchased 180 days after notice is given, the party submitting the repurchase request will have the right to refer the matter, at its discretion, to either mediation or third-party arbitration. The party obligated to repurchase must agree to the selected resolution method.21
3. Investor Communications
The Re-Proposal calls for the inclusion of a provision in the underlying transaction agreements requiring the party responsible for making 10-D filings to include in a Form 10-D any request by an investor to communicate with other investors if the nature of the request is related to an investor's exercise of rights under the terms of the ABS. The disclosure of such requests would be required to include the name of the investor making the request, the date the request was received and a description of the method by which other investors may contact the requesting investor.22
If the transaction agreement contains a procedure to verify whether an investor is a beneficial owner, the verification procedures may only require that:
- if the investor is a record holder of the securities at the time of the request to communicate, then the investor would not have to provide verification of ownership (because the person obligated to make the disclosure will have access to a list of record holders), and
- if the investor is not the record holder of the securities at the time of the request to communicate, the person obligated to make the disclosure must receive a written statement from the record holder verifying that, at the time the request is submitted, the investor beneficially held the securities.23
Registrant Requirements for Shelf Eligibility
The proposed registrant requirements for Form SF-3 build on the existing shelf requirements relating to delinquent filings of a depositor or an affiliate as well as on the 2010 Proposal. Similar to existing requirements, the 2010 Proposal proposed that prior to filing a registration statement on proposed Form SF-3, to the extent the depositor or any issuing entity previously established by the depositor or an affiliate of the depositor are or were, at any time during the twelve months prior to filing the registration statement, required to file Exchange Act reports with respect to a class of ABS involving the same asset class, the depositor and each such issuing entity must have filed all material required to be filed during the twelve months (or shorter period that the entity was required to have filed such materials), and, with the exception of certain information required to be filed on Form 8-K, such material would be required to have been timely filed. These proposals remain unchanged and outstanding.24
In addition, to the extent the depositor, or any issuing entity previously established by the depositor or an affiliate of the depositor, is or was at any time during the twelve month look-back period required to comply with the proposed transaction requirements of Form SF-3 (described above), with respect to a previous offering of ABS involving the same asset class, the depositor and each such issuing entity would be required to have timely filed:
- all required certifications of the depositor's chief executive officer or executive officer in charge of securitization,
- all transaction agreements containing the required provisions relating to the credit risk manager and repurchase request disputes, and
- all transaction agreements containing the required provision relating to investor communication.25
Additionally, the Re-Proposal requires the registrant to disclose in the registration statement that it has complied with all of the registrant requirements.26
Annual Evaluation of Shelf Eligibility
Similar to what the SEC proposed in the 2010 Proposal, under the Re-Proposal, in order to conduct a takedown from an effective shelf registration statement, and notwithstanding that the registration statement may have been previously declared effective, an ABS issuer would be required to conduct an annual evaluation as to whether it continues to meet the Form SF-3 registrant requirements for shelf eligibility. More specifically, proposed Rule 401(g)(4) under the Securities Act would require an evaluation in connection with an ABS offering as to whether the Form SF-3 shelf eligibility requirements were met as of 90 days after the end of the depositor's fiscal year end prior to the offering.27
Under the Re-Proposal, to the extent the depositor or any issuing entity previously established, directly or indirectly, by the depositor or any affiliate of the depositor, is or was at any time during the previous twelve months, required to comply with the proposed new transaction requirements related to the executive officer certification and the credit risk manager, repurchase dispute resolution and investor communication provisions, with respect to a previous offering of ABS involving the same asset class, the depositor and each issuing entity would be required to have filed on a timely basis, at the required time for each takedown, all transaction agreements containing the provisions that are required by the proposed shelf eligibility transaction requirements as well as all certifications as of 90 days after the end of the depositor's fiscal year end prior to the proposed ABS offering.28
In addition, as was proposed in the 2010 Proposal, to the extent the depositor or any issuing entity previously established, directly or indirectly, by the depositor or any affiliate of the depositor, is or was at any time during the previous twelve months required to file Exchange Act reports with respect to a class of asset-backed securities involving the same asset class, the depositor and each such issuing entity would be required to have filed all material required to be filed during the twelve months (or shorter period that the entity was required to have filed such materials), and, with the exception of certain information required to be filed on Form 8-K, such material would be required to have been timely filed as of 90 days after the end of the depositor's fiscal year end prior to the proposed ABS offering.29
With respect to the proposed new transaction requirements, a depositor or an issuing entity may cure a filing deficiency if it subsequently files the information required by the transaction requirements; then after a 90 day waiting period, the depositor and the issuing entity would be deemed to have met the shelf eligibility registrant requirements and ABS offerings would be permitted to continue using the shelf registration statement.30
FILING OF TRANSACTION AGREEMENTS
Under the Re-Proposal, ABS issuers would be required to file copies of the underlying transaction agreements in substantially final form at the same time the preliminary prospectus would be required to be filed under proposed Rule 424(h).31 Rule 424(h), which was proposed by the SEC in its 2010 Proposal, would require an ABS issuer to file a preliminary prospectus with the SEC for each offering at least 5 business days prior to the first sale in the offering.32
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The SEC has requested comments on the Re-Proposal as well as on its request for additional comments relating to the disclosure of asset-level information. Comments should be provided to the SEC by October 4, 2011, 60 days after publication of the Re-Proposal in the Federal Register. The SEC is also requesting comment on the appropriate timing for implementation of the 2010 Proposal and the Re-Proposal, if adopted. The SEC states in the Re-Proposal that it does not believe the compliance date should extend more than a year after the rules are adopted.33
1 See Re-Proposal of Shelf Eligibility Conditions for Asset-Backed Securities, SEC Release Nos. 33-9244; 34-64968; File No. S7-08-10; Re-proposed Rule (July 26, 2011), 76 Fed. Reg. 47948 (August 5, 2011), available at http://sec.gov/rules/proposed/2011/33-9244fr.pdf.
2 See Asset-Backed Securities. SEC Release No. 33-9117; 34-61858; File No. S7-08-10; Proposed Rule (April 7, 2010), 75 Fed. Reg. 23328 (May 3, 2010), available at http://sec.gov/rules/proposed/2010/33-9117fr.pdf.
3 Public Law 111-203, 124 Stat.1376 (July 21, 2010).
5 See our memoranda Reforms to the Asset-Backed Securitization Process and the Regulation of Credit Rating Agencies under Dodd-Frank Wall Street Reform and Consumer Protection Act (July 20, 2010) and Proposed Credit Risk Retention Requirements for Asset-Backed Securities Transactions (April 6, 2011).
6 76 Fed. Reg. at 46951.
7 See proposed Form SF-3, General Instruction I.B.1(a), id at 47981, and proposed Item 601(b)(36) of Regulation S-K, id. at 47977-47978.
8 See proposed Item 601(b)(36) of Regulation S-K, id. at 47977.
9 Id. at 47953, fn 55.
10 The 2010 Proposal would have required the chief executive officer of the depositor to certify that, to the officer's knowledge, the securitized assets have characteristics that provide a reasonable basis to believe that they will produce, taking into account internal credit enhancements, cash flows at times and in amounts necessary to service any payments of the securities as described in the prospectus; and that the officer has reviewed the prospectus and the necessary documents for the certification. 75 Fed. Reg. 23420.
11 Id. at 23346.
12 76 Fed. Reg. 47953.
13 Id. at 47952. Rule 193 requires that an issuer of a registered ABS perform a review of the underlying assets designed to ensure that the disclosure in the prospectus concerning the pool assets is materially accurate.
14 Id. at 47953.
15 See proposed Item 601(b)(36) of Regulation S-K, id. at 47977.
16 Rule 405 under the Securities Act defines "executive officer" to mean the president of the registrant, any vice president of the registrant in charge of a principal business unit, division or function (such as sales, administration or finance), any other officer who performs a policy making function or any other person who performs similar policy making functions for the registrant. Executive officers of subsidiaries may be deemed executive officers of the registrant if they perform such policy making functions for the registrant.
17 See proposed Form SF-3, General Instruction I.B.1(b), id. at 47981-47982.
18 Id. at 47956-47957.
19 See proposed Items 1109(b) and 1119(a)(7) of Regulation AB, id. at 47978. Note that the proposed disclosure Item 1109(b) does not appear to require disclosure of indemnification arrangements, whereas the proposing release does. See id. at 47957.
20 See proposed Item 1121(f) of Regulation AB, id. at 47978, and proposed Item 1B of Form 10-D, id. at 47984.
21 See proposed Form SF-3, General Instruction I.B.1(b)(E), id. at 47982.
22 See proposed Form SF-3 General Instruction I.B.1(c), id. at 97982, and proposed Item 1121(g) of Regulation AB, id. at 47978.
23 See proposed Form SF-3, Instruction to General Instruction I.B.1(c), id. at 47982.
24 Id. at 47961.
25 See proposed Form SF-3, General Instruction I.A.1, id. at 47981.
31 See proposed revised Item 1100(f) of Regulation AB, id. at 47978. See also the 2010 Proposal, 75 Fed. Reg. 23335.
32 Rule 430D, proposed by the SEC in its 2010 Proposal, would require the Rule 424(h) preliminary prospectus to contain substantially all the information for the specific ABS takedown previously omitted from the prospectus filed as part of an effective registration statement, except for pricing information. See the 2010 Proposal, 75 Fed. Reg. 23336.
33 Id. at 47971.
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