Introduction and Background

On November 27, 2023, the SEC adopted Final Rule 192 prohibiting certain conflicts of interest in securitization transactions.

1 Final Rule 192 is intended to implement the prohibition against such conflicts as set forth under Section 27B ("Section 27B") of the Securities Act of 1933 ("Securities Act").2

Final Rule 192 was adopted ten months after the SEC issued proposed Rule 192 ("Proposed Rule 192").3 The SEC received over 900 comment letters on Proposed Rule 192,4 and indicated that it considered all of the comments it received, including those submitted after the March 27, 2023, comment deadline.5

The text of Final Rule 192, marked against Proposed Rule 192, is set forth in Appendix A.

Commenters had urged the SEC to issue a re-proposal rather than a final rule.6 The Adopting Release briefly acknowledges those comments, but states that the SEC does not believe that a re-proposal of the rule is necessary.7 Notably, SEC Commissioner Hester M. Peirce disagreed, stating in her dissent that "[a]s burdensome as it would have been for the [SEC] and commenters to formally re-engage, the consequences of getting this rule wrong loom large enough to warrant one more round of comments."8

Below, we answer some of the key questions that securitization participants are likely to have about Final Rule 192:

  • When does Final Rule 192 become effective and when is compliance required?
  • What is the prohibition period?
  • What transactions are prohibited?
  • What types of asset-backed securities are covered?
  • Who is covered?
  • What are the exceptions?
  • Are bank CRT deals permitted? What about other types of synthetic securitizations?
  • Does Final Rule 192 apply to foreign transactions?
  • What can securitization participants do to prepare for Final Rule 192?

When does Final Rule 192 become effective and when is compliance required?

Final Rule 192 becomes effective on the date that is 60 days after the date of publication in the Federal Register. However, compliance with Final Rule 192 will be required with respect to any ABS the first closing of the sale of which occurs 18 months after the date of publication in the Federal Register. 9

WHAT IS THE PROHIBITION PERIOD?

Under Final Rule 192, the period of time securitization participants will be prohibited from entering into a conflicted transaction:

  • begins "on the date on which such person has reached an agreement that such person will become a securitization participant with respect to an asset-backed security;" and
  • ends on the "date that is one year after the date of the first closing of the sale of such asset-backed security."

The end date for the prohibition period comes directly from Section 27B and is reasonably clear on its face. The beginning date for prohibition period, on the other hand, is not directly specified by Section 27B.

Proposed Rule 192 specified the beginning date of the prohibition period as the date on which a person "has taken substantial steps" to reach an agreement to become a securitization participant. Proposed Rule 192 did not, however, define "substantial steps" and instead indicated that the determination as to whether substantial steps were taken will be a "facts and circumstances" analysis of the securitization participant's actions.10

At the request of market participants, the SEC removed the substantial steps trigger. Thus, an agreement to become a securitization participant is required. Final Rule 192 does not define "agreement," but the Adopting Release contains guidance that diminishes to some extent the certainty that marked participants were hoping for:

For purposes of Rule 192, "agreement" refers to an agreement in principle (including oral agreements and facts and circumstances constituting an agreement) as to the material terms of the arrangement by which such person will become a securitization participant. An executed written agreement, such as an engagement letter, is not required; whether there has been an agreement to become a securitization participant will depend on the facts and circumstances of the securitization transaction and the parties involved.11

WHAT TRANSACTIONS ARE PROHIBITED?

Final Rule 192 provides that a securitization participant shall not, during the prohibition period, directly or indirectly engage in any transaction that would involve or result in a "material conflict of interest" between the securitization participant and an investor in an ABS. Under Final Rule 192, a transaction would result in a material conflict of interest between a securitization participant and an investor in an ABS if that transaction is a "conflicted transaction."

The "prohibition period" referred to above is the period commencing on the date on which a person has reached an agreement that such person will become a securitization participant with respect to an ABS and ending on the date that is one year after the date of the first closing of the sale of such ABS.12

Definition of "Conflicted Transaction"

Final Rule 192 defines "conflicted transaction" as:

[A]ny of the following transactions with respect to which there is a substantial likelihood that a reasonable investor would consider the transaction important to the investor's investment decision, including a decision whether to retain the asset-backed security:

i . A short sale of the relevant asset-backed security;

ii. The purchase of a credit default swap or other credit derivative pursuant to which the securitization participant would be entitled to receive payments upon the occurrence of specified credit events in respect of the relevant asset-backed security; or

iii. The purchase or sale of any financial instrument (other than the relevant asset-backed security) or entry into a transaction that is substantially the economic equivalent of a transaction described in paragraph (a)(3)(i) or (a)(3)(ii) of this section, other than, for the avoidance of doubt, any transaction that only hedges general interest rate or currency exchange risk.

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Footnotes

1. See SEC Release No. 33-11254 ("Prohibition Against Conflicts of Interest in Certain Securitizations") ("Adopting Release"), available at: https://www.sec.gov/files/rules/final/2023/33-11254.pdf.

2. Section 27B, which was added to the Securities Act by Section 621 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ("Dodd-Frank Act"), reads as follows:

  1. IN GENERAL.—An underwriter, placement agent, initial purchaser, or sponsor, or any affiliate or subsidiary of any such entity, of an asset-backed security (as such term is defined in section 3 of the Securities Exchange Act of 1934 (15 U.S.C. 78c), which for the purposes of this section shall include a synthetic asset-backed security), shall not, at any time for a period ending on the date that is one year after the date of the first closing of the sale of the asset-backed security, engage in any transaction that would involve or result in any material conflict of interest with respect to any investor in a transaction arising out of such activity.
  2. RULEMAKING.—Not later than 270 days after the date of enactment of this section, the Commission shall issue rules for the purpose of implementing subsection (a).
  3. EXCEPTION.—The prohibitions of subsection (a) shall not apply to—
    1. risk-mitigating hedging activities in connection with positions or holdings arising out of the underwriting, placement, initial purchase, or sponsorship of an asset-backed security, provided that such activities are designed to reduce the specific risks to the underwriter, placement agent, initial purchaser, or sponsor associated with positions or holdings arising out of such underwriting, placement, initial purchase, or sponsorship; or
    2. purchases or sales of asset-backed securities made pursuant to and consistent with—
      1. commitments of the underwriter, placement agent, initial purchaser, or sponsor, or any affiliate or subsidiary of any such entity, to provide liquidity for the asset-backed security, or
      2. bona fide market-making in the asset backed security.
  4. RULE OF CONSTRUCTION.—This subsection shall not otherwise limit the application of section 15G of the Securities Exchange Act of 1934.
  5. EFFECTIVE DATE.—Section 27B of the Securities Act of 1933, as added by this section, shall take effect on the effective date of final rules issued by the Commission under subsection (b) of such section 27B, except that subsections (b) and (d) of such section 27B shall take effect on the date of enactment of this Act.

3. Proposed Rule 192 was released by the SEC on January 25, 2023. See SEC Release No. 33-11151, available at: https://www.sec.gov/rules/proposed/2023/33-11151.pdf. Proposed Rule 192 was subsequently published in the Federal Register on February 14, 2023. See 88 Fed. Reg. 9678 ("Proposing Release"). Section 27B directed the SEC to adopt implementing rules "not later than 270 days after July 21, 2010." On September 19, 2011, the SEC proposed Securities Act Rule 127B. See SEC Release No. 34-65355, available at: https://www.sec.gov/rules/proposed/2011/34-65355.pdf. Proposed Rule 127B drew many comments from market participants. After several months of deliberation, and several extensions of the comment period, the SEC took no further action on proposed Rule 127B, effectively withdrawing it from consideration.

4. See Adopting Release, at p. 6. For an overview of Proposed Rule 192 and the comments thereon, see Christopher B. Horn and Jon A. Schlotterback, Conflicts of Interest in Asset-Backed Securitization: An Analysis of Proposed Rule 192, The Review of Securities & Commodities Regulation (Oct. 25, 2023), available at: https://www.retainedinterest.com/wp-content/uploads/sites/31/2023/11/Conflicts-of-Interest-in-Asset-Backed-Securitization.pdf.

5. See Adopting Release, at p. 6 (fn. 9).

6. See, e.g., Sec. Indus. and Fin. Mkts. Ass'n, Comment Letter on Proposed Rule on Prohibition Against Conflicts of Interest in Certain Securitizations, 7 (Mar. 27, 2023) ("First SIFMA Letter"), at p. 2, available at: https://www.sec.gov/comments/s7-01- 23/s70123-20161806-330705.pdf.

7. See Adopting Release, at p. 6 (fn. 9).

See Unsettling End of an Era: Statement on Adoption of Rule Prohibiting Conflicts of Interest in Certain Securitizations, Commissioner Hester M. Peirce (Nov. 27, 2023), available at: https://www.sec.gov/news/statement/peirce-statement-securitizations-112723.

9. See Adopting Release, at p. 170.

10. See Proposing Release, at 9692.

11. See Adopting Release, at 83 (emphasis added).

12. See "What Is the Prohibition Period?" above for a discussion of the prohibition period.

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