Originally published January 25, 2005
On December 15, 2004, the Securities and Exchange Commission adopted a massive set of rules for asset-backed securities ("ABS") under the Securities Act of 1933 and the Securities Exchange Act of 1934 ("Regulation AB"). The final rules reflect numerous changes that have been incorporated to address issues raised in comment letters received by the SEC in response to the initial proposal released on May 3, 2004 (the "Proposal").
The newly adopted rules will regulate ABS in four areas: (1) Securities Act registration, (2) disclosure under new Regulation AB, (3) communications during the offering process and (4) ongoing reporting requirements under the Exchange Act.
The SEC recognizes that asset-backed securities and issuers of asset-backed securities differ from corporate securities and operating companies. Many of the existing disclosure requirements and reporting obligations were designed for corporate issuers and do not elicit relevant information for ABS transactions and investors in those transactions. Prior to the adoption of Regulation AB, the SEC staff had attempted over the past 20 years to address issues particular to asset-backed securities through no-action letters and the filing review process. The final rules codify and consolidate many existing staff practices relating to asset-backed securities and also add extensive additional requirements. See Release 33-8518; 34-50905.
This Securities Update highlights some of the significant changes that will result due to the SEC’s adoption of Regulation AB and provides our initial views as to practical considerations for their application.
Because significant changes in procedures and systems will be required to comply with Regulation AB, the SEC has granted a lengthy transition period. Under the transition rules, any registered offering of asset-backed securities commencing with an initial bona fide offer after December 31, 2005 must comply with the new rules and forms contained in Regulation AB. The December 31, 2005 compliance date covers all offerings, whether made on Form S-1 or Form S-3, including takedowns from a shelf registration statement on Form S-3.
For any offerings under a shelf registration statement filed:
- after August 31, 2005 , the registration statement must be amended prior to any offering occurring after December 31, 2005 to make the prospectus filed with the shelf registration statement compliant and to make the required new undertakings in Part II of the registration statement; and
- on or before August 31, 2005 , the prospectus used to make the offering must comply prior to any offering occuring after December 31, 2005, and the registration statement must be post-effectively amended prior to any offering made after December 31, 2005 to include the required new undertakings in Part II of the registration statement, if this amendment has not already been made.
After March 31, 2006, all shelf registration statements must be amended prior to any offering after that date to include a compliant prospectus and the required new undertakings, if the required new undertakings have not previously been included in the registration statement.
The transition rules make it clear that an ABS issuer cannot file a noncompliant shelf prior to August 31, 2005, offer securities under a compliant prospectus under Rule 424(b) and avoid a post-effective amendment to the shelf, which will subject the ABS issuer to a full SEC review. The SEC staff will likely be giving full reviews to most new registration statements purporting to comply with the new rules. To ease the transition, the SEC staff has recently announced a pilot program permitting ABS issuers to file their registration statement with the SEC on a confidential basis and work through SEC comments confidentially. However, ABS issuers must comply with all, and not only a portion, of the new rules.
Any issuance of asset-backed securities that subjects an issuer to Exchange Act reporting obligations on or prior to December 31, 2005 will be grandfathered and the related registrants may continue to file Exchange Act reports with respect to those securities as currently required.
Securities Act Registration
Definition of Asset-Backed Security
The final rules apply to any security that falls within the definition of "asset-backed security." The basic definition of an asset-backed security has been moved out of Form S-3 and is now contained in Item 1101 of Regulation AB, and remains unchanged from the definition included in the Proposal:
"a security that is primarily serviced by the cash flows of a discrete pool of receivables or other financial assets, either fixed or revolving, that by their terms convert into cash within a finite time period, plus any rights or other assets designed to assure the servicing or timely distribution of proceeds to security holders; provided that in the case of financial assets that are leases, those assets may convert to cash partially by the cash proceeds from the disposition of the physical property underlying such leases."
The proviso relating to leases is new and favorable to issuers, but brings with it additional disclosure requirements discussed below.
In addition to the basic definition, Item 1101 codifies the following additional requirements to be considered an assetbacked security:
- Neither the depositor nor the issuing entity is an investment company nor will become one as a result of the ABS transaction; and
- The activities of the issuing entity must be limited to passively owning or holding the pool of assets, issuing the asset-backed securities supported or serviced by those assets and other activities reasonably incidental to these activities.
The SEC has excluded synthetic securitizations from the definition because the issuing entity does not actually own the underlying assets and the payments on the securities are not based primarily on the performance of financial assets in the pool held by the issuing entity. The SEC has requested comment on whether an alternative regime would be appropriate for these kinds of securities and has indicated that it may issue additional proposals with respect to synthetic securities.
Delinquent and Non-Performing Pool Assets
Securities issued by an entity with non-performing assets in the asset pool as of the measurement date do not satisfy the definition of an "asset-backed security." Item 1101 of Regulation AB defines a non-performing asset as an asset that would be wholly or partially charged-off under any of the following: (1) the ABS transaction agreements, (2) the charge-off policies of the sponsor, an affiliate of the sponsor that originated the asset or a servicer that services the asset, or (3) the charge-off policies established by the primary safety and soundness regulator of an entity in clause (2) or the program or the regulatory entity that oversees the program under which the asset was originated. The most restrictive charge-off policy will govern. The measurement date is the designated cut-off date for the transaction as set forth in the ABS transaction documents or, in the case of master trusts, the date as of which delinquency and loss information or securitized pool balance information, as applicable, is presented in the prospectus supplement.
Under the final rules, delinquent assets may be included in the asset pool as long as they do not constitute 50% or more, as measured by dollar volume, of the asset pool as of the measurement date. In order to be eligible for Form S-3, delinquent assets must be limited to less than 20% of the asset pool as of the measurement date. A delinquent asset is defined as an asset that is more than 30 or 31 days or a single payment cycle past due from the contractual due date determined in accordance with any of the following: (1) the ABS transaction agreements, (2) the delinquency recognition policies of the sponsor, any affiliate of the sponsor that originated the asset or the servicer of the asset, or (3) the delinquency recognition policies established by the primary safety and soundness regulator of an entity in clause (2) or the program or the regulatory entity that oversees the program under which the asset was originated. Again, the most restrictive delinquency requirement will govern. The final rules, unlike the Proposal, address the fact that many financial institutions have a de minimis rule for determining delinquency, such as at least 95% or all but $25 or less of a payment has been made.
The final rules also clarify that securities issued by a structure - such as a master trust - that does not fund or purchase non-performing assets or delinquent assets from the proceeds of the issued securities, and that does not include these assets in the cash flow calculations for the securities, fall within the definition of an asset-backed security.
As noted above, the definition of asset-backed security has been expanded to include securitizations backed by leases where a portion of the securitized pool balance is attributable to the residual value of the physical property underlying the leases. However, the final rules set limits on the percentage of the securitized pool balance attributable to residual values. For motor vehicle leases (which includes automobiles, light duty trucks, SUV’s, vans, trucks, buses and motorcycles but not leisure craft), residual values must not constitute 65% or more, as measured by dollar volume, of the securitized pool balance as of the measurement date. For all other leases, residual values must not constitute 50% or more of the securitized pool balance as of the measurement date. In order to be eligible for Form S-3, residual values of lease-backed securitizations other than those backed by motor vehicle leases are further restricted to less than 20%, as measured by dollar volume, of the securitized pool balance as of the measurement date. For purposes of determining residual value thresholds, residual values need not be included to the extent that a separate party is obligated for the residuals (e.g., through a residual value guarantee or where the lessee is obligated to cover any residual loss). With respect to master trusts, calculations are measured against the total asset pool whose cash flows support the securities.
In addition to satisfying these bright line tests, ABS issuers must provide additional disclosure regarding residuals as follows:
- Statistical information on historical realization rates;
- The manner and process in which residual values will be realized; and
- The entity that will convert the residual values into cash.
The release uses a number of bright line tests for eligibility for Form S-3 as well as eligibility to use Regulation AB. In the past, the bright line tests of the SEC staff were used only in connection with S-3 eligibility. Absent other guidance from the SEC staff, under the final rules a securitization that fails the bright line tests for an asset-backed security cannot use Form S-1 without the detailed financial statement disclosures of an operating company typically found in Form S-1. If a proposed security does not meet the definition of asset-backed security, the issuer can arrange a pre-filing conference with the staff to discuss the proposed transaction and the appropriate approach.
Discrete Pool Requirement
Securities issued by master trust structures and, to the extent outlined by Item 1101, transactions with prefunding and revolving periods are permissible exceptions to the "discrete pool of assets" requirement in the definition of asset-backed security.
Master Trusts. Master trusts are discrete pools even if the offering contemplates adding additional assets to the pool in connection with future issuances of asset-backed securities or in connection with maintaining minimum pool balances in accordance with the ABS transaction documents. The definition codifies existing practice that the balance of a pool asset may revolve (as, for example, in a credit card account, home equity loan or dealer floorplan loan).
Prefunding Periods. The prefunding period may not exceed one year and the amount of proceeds that may be used for prefunding may not exceed 50% of the offering proceeds or, for master trusts, 50% of the aggregate principal balance of the total asset pool whose cash flows support the securities. In the final rules, the SEC did not carry forward the lower 25% limit on prefunding that was a condition to Forms S-3 eligibility under the Proposal. The only prefunding limit in the final rules is in the conditions to the definition of "asset-backed security." The SEC’s removal of the limit on prefunding with respect to Form S-3 eligibility in Regulation AB is also more favorable than prior staff positions, which previously only permitted use of Form S-3 for deals with up to 50% prefunding on a case-by-case basis.
Revolving Periods. Structures with revolving periods permit the use of cash flows from the asset pool to acquire new pool assets instead of being used to make payments on the asset-backed securities. With respect to transactions with revolving periods where the assets do not arise under revolving accounts (e.g., auto loans), an unlimited amount of additional assets may be acquired during the revolving period so long as the revolving period does not exceed three years and the new assets added are of the same general character as the original pool assets. The final rules do not contain the 25% and one-year limits on additions during the revolving period that were conditions to Form S-3 eligibility under the Proposal. The only limit on additions during the revolving period is now in the conditions to the definition of "asset-backed security." As discussed below, additional disclosure in both prospectuses and Exchange Act reports relating to the operation of revolving period structures and changes to the asset pool will also be required.
Securities Act Registration Statements
Forms S-1 and S-3. ABS offerings must be registered on either Form S-1 or Form S-3. ABS offerings that fall within the definition of asset-backed security and the restrictions stated above but do not meet Form S-3 eligibility requirements must be filed on Form S-1.
Disclosure requirements for both Form S-1 and Form S-3 have been modified for ABS offerings. In addition to the general information required by the forms applicable to all issuers in the past, the registrant must furnish the disclosures set forth under new Regulation AB.
"Issuer" and Required Signatures. Rule 191 under the Securities Act and Rule 3b-19 under the Exchange Act clarify that the depositor must sign registration statements for ABS offerings and may sign periodic reports for ABS offerings. Under the final rules, the issuing entity will no longer be required to sign the registration statement if formed prior to effectiveness.
Under the final rules, the depositor is the entity who "receives or purchases and transfers or sells the pool assets to the issuing entity." The depositor, acting solely in its capacity as depositor to the entity issuing asset-backed securities, is the "issuer" for these securities. A depositor acting in its capacity as depositor for an issuing entity will be a different "issuer" from the same depositor acting as a depositor in another transaction. If there is no intermediate transfer of assets between the sponsor and the issuing entity, than the sponsor will be deemed to be the depositor. As discussed under "Exchange Act Reporting" below, defining the depositor as a separate issuer for each transaction will increase the depositor’s Exchange Act filing obligations.
Foreign ABS. The new rules do not contain a separate form for ABS offerings issued by a foreign issuer or backed by foreign assets. Foreign ABS offerings must be filed on either Form S-1 or Form S-3. Foreign ABS issuers will, however, be required under Item 1100(e) of Regulation AB to provide additional disclosure relating to "any pertinent governmental, legal or regulatory or administrative matters" of their home country as well as tax matters, exchange controls, currency restrictions or other economic factors that could materially affect payments on, or performance of, the asset-backed securities. ABS transactions involving the issuance of securities backed by foreign assets or that have credit enhancement or other support (including interest rate and currency swaps) provided by a foreign entity will also have to provide these additional disclosure items. Item 1100(e) refers to the disclosures currently required by Item 202 of Regulation S-K with respect to foreign registrants, including any foreign law limits on voting or affecting dividends or interest and an outline of taxes, including withholding taxes and tax treaties, to which U.S. securityholders are subject. Item 1100(e) also requires the information required by Item 101(g) of Regulation S-K to be included in the registration statement, which will require a description of the enforceability of civil liabilities against foreign persons. The new rules specify that Exchange Act filings must describe any material impact caused by foreign legal and regulatory developments during the period covered by the report.
Since the final rules will permit some foreign ABS issuers to register on a shelf basis on Form S-3, the new rules should make it easier for foreign issuers to issue ABS securities in the United States. However, the SEC cautions that some foreign issuers may be intending to off-load poorly performing assets. The SEC historically required some foreign issuers to register first on a Form S-1 or S-11 that was fully reviewed by the staff. This condition is not included in the final rules. The final rules do, however, recommend pre-filing conferences with the staff to discuss the transaction, the applicable home jurisdiction’s legal and regulatory environment and the relevant disclosures required. In footnote 162, the SEC warns foreign issuers that registrants should expect the SEC review process to be time-consuming. Foreign issuers should also expect to provide the SEC staff with statistical disclosure as to a hypothetical pool of assets to be securitized in a takedown.
Changes to Form S-3. In addition to the current eligibility requirements, ABS offerings on Form S-3 will have to comply with the bright line tests for delinquency concentration levels discussed above. As is currently the custom, transactions with multiple asset classes must use separate base prospectuses and forms of prospectus supplements for each asset type that may be securitized in discrete pools in takedowns. The release also adds that separate base prospectuses and forms of prospectus supplements must be prepared with respect to each country in a transaction that has assets with different countries of origin or the property securing the pool assets is located in different countries and the assets with respect to a country may be securitized in discrete pools in takedowns. However, in the final release the SEC clarified that if pool assets of different asset types or different jurisdictions are pooled together in a single transaction (for example, an offering with receivables originated in several jurisdictions or with a pool consisting of 45% residential mortgages and 55% commercial mortgages), that a single base and form of prospectus supplement would be permitted so long as the appropriate disclosures for each asset type or jurisdiction are included. In addition, the final rules provide that a separate base prospectus and prospectus supplement is not required for separate asset classes and jurisdictions of origin or property if the pool consists primarily of one asset class or jurisdiction which also describes other asset classes or jurisdictions so long as the additional classes or jurisdictions in the aggregate are less than 10% of the pool, as measured by dollar volume, for any particular takedown.
To be eligible for Form S-3, the depositor and any issuing entity previously established, directly or indirectly, by the depositor or any affiliate of the depositor must have complied with Exchange Act reporting obligations with respect to all other ABS transactions involving the same asset class for which the depositor and each such issuing entity were subject to Exchange Act reporting requirements during the last 12 months and any portion of a month immediately preceding the filing of the Form S-3 registration statement. The final rules contain an exception that excludes affiliated depositors that become affiliates during the twelve months preceding the filing of the registration statement. As a result, under Regulation AB a sponsor will no longer be able to avoid Form S-3 eligibility problems arising from defects in its Exchange Act filings by filing a new Form S-3 for a new issuer. If reporting obligations are suspended under Section 15(d) of the Exchange Act, the depositor and its issuing entities must comply with all prior reporting obligations up until suspension. However, the SEC has clarified that untimely Exchange Act filings do not impact the ability of a registrant to conduct offers and sales under previously filed registration statements, because eligibility requirements for ABS issuers are determined at the time of the filing of the registration statement. In addition, depositors acquired in business combination transactions will not taint pre-existing depositors of the acquirer as long as the acquisition is not part of a scheme to avoid the reporting requirements.
48-Hour Prospectus Delivery. Asset-backed securities registered on Form S-3 will continue to be exempt from the 48-hour prospectus delivery requirement under Rule 15c2- 8(b) of the Exchange Act. The final rules do not include the condition present in no-action letters that limited the exemption to transactions in which the ABS offering did not contemplate prefunding in excess of 25% of the principal balance of the securities. The SEC stated that it is considering in connection with the Securities Offering Reform Proposal that was released on October 26, 2004 (the "Offering Process Proposal") whether additional action is necessary with respect to the availability of adequate information for investors.
Market-Making Transactions. In the past, the SEC staff required a market-making prospectus when the broker-dealer and the servicer were affiliated. Under the new rules, the SEC will no longer require registration and delivery of a prospectus for market-making transactions for asset-backed securities.
Registration of Underlying Pool Assets
If securities of another issuer are being securitized - often called resecuritization - these securities must also be registered under the Securities Act or exempt from registration, unless all of the following conditions in new Rule 190 under the Securities Act are met:
- The depositor would be free to publicly resell the underlying securities without registration (e.g., the underlying securities are not restricted securities that do not meet the conditions under Rule 144(k) under the Securities Act and are not part of the original distribution of the underlying securities);
- Neither the issuer of the underlying securities nor any of its affiliates has any direct or indirect agreements or understandings relating to the underlying securities or the ABS transaction; and
- Neither the issuer of the underlying securities nor any of its affiliates is an affiliate of the sponsor, depositor, issuing entity or underwriter of the ABS transaction.
If these conditions are not met, the underlying securities must be registered in accordance with the disclosure and delivery conditions set forth in Rule 190. However, Rule 190 also provides relief to "issuance trust" structures, which are designed to facilitate securitization transactions but would trigger registration of the underlying securities. Common examples include master owner trust structures used by credit card issuers and titling trusts used by auto lease securitizations. If the financial asset was created solely to satisfy legal requirements and not as a scheme to avoid registration or to circumvent the rules, (1) issuance trust structures would not be required to comply with the disclosure and delivery requirements that would otherwise apply under the rules and would not be subject to an additional registration fee and (2) the underlying financial asset would be eligible to register on Form S-3 if the ABS is eligible to use Form S-3.
- ABS issuers should begin addressing the additional eligibility and disclosure requirements of Regulation AB as soon as possible. It is very likely that additional systems and servicing and compliance procedures will be required, which will require long lead times.
- ABS issuers should consider as soon as possible the steps they will take to revise their offering documents. Some ABS issuers may determine it is better to amend their prospectuses and registration statements later in order to benefit from what other issuers will file. Other ABS issuers may determine that they are better served by filing early in the SEC’s pilot program and benefiting from confidential treatment of their full review. Early filers may also benefit from avoiding any possible delays due to the increased volume of filings with the SEC towards the end of the transition period. ABS issuers filing a registration statement that purports to comply with the new rules should expect a full review. In addition, the SEC staff has made it clear that ABS issuers cannot cherry pick and comply with some but not all of the new rules prior to December 31, 2005.
- Eligible auto lease issuers should begin converting their Forms S-1 to S-3 and preparing the additional disclosures required by Regulation AB on residual value realization.
- Foreign ABS issuers and issuers that issue securities backed by foreign assets or have credit enhancement or other support provided by a foreign entity should begin considering what additional information they will need to prepare in connection with the new requirements under Regulation AB, and should focus on qualifying for Form S-3.
- Failure to comply with Exchange Act reporting obligations will prevent Form S-3 shelf eligibility for other transactions of the same asset type established by a depositor or its affiliates until the depositor and its affiliated issuing entities have complied with their Exchange Act filing obligations for one year and any portion of a month preceding the filing of the registration statement. Loss of Form S-3 eligibility will also prevent the use of ABS informational and computational materials and the ability to incorporate by reference. Public issuers should confirm that their Exchange Act filings comply with SEC policy as soon as possible and set up an internal compliance infrastructure that ensures that Exchange Act requirements will be met.
Disclosure under Regulation AB
Prior to Regulation AB, none of the disclosure requirements in the Securities Act were specifically tailored to address ABS offerings. The SEC became concerned that the informal disclosure practices that had developed through the SEC comment process and industry practice were not fully transparent to issuers and investors. To address this, the SEC adopted a new disclosure regime in Regulation AB. This new regime is intended to be principles-based, rather than an exhaustive list of disclosure items required for each asset class, and to govern not only existing asset classes but also new asset classes that may develop in the future. The new rules are also intended to bring greater uniformity to the disclosure process. Regulation AB will now be a subpart of Regulation S-K and form the basis for ABS disclosure in registration statements under the Securities Act and periodic reporting under the Exchange Act. The structure of Regulation AB is as follows:
- Item 1100 sets forth items of general applicability for Regulation AB;
- Item 1101 provides definitions;
- Items 1102-1120 provide the basic disclosure package required in ABS registration statements and periodic reporting;
- Item 1121 forms the basis for disclosure for distribution reports on Form 10-D (the form on which periodic servicer’s reports will be filed);
- Item 1122 addresses assessments of compliance with servicing criteria and the filing of attestation reports by registered public accounting firms on such assessments; and
- Item 1123 specifies the form of servicer compliance report to be executed by the servicer with respect to its compliance with the particular servicing agreement.
Forepart of Registration Statement and Prospectus
Existing Items 501 to 503 of Regulation S-K will continue to provide the basic disclosure requirements for the forepart of registration statements and prospectuses. Items 1102 and 1103, however, will now amplify those requirements for ABS offerings for the cover page and summary in a manner substantially consistent with current practice. The final rules permit class-specific information that would otherwise be required to be on the cover page to be included in the summary or in a table immediately preceding the summary if there is insufficient space on the cover page.
Additional disclosures required in the summary that may go beyond current practice include:
- Diagrams of parties, flow of funds and other material features;
- Identification of 10% originators and any significant obligors; and
- A description of fees and expenses to the extent necessary to understand the payment characteristics of the offered securities.
To discourage boilerplate disclosure, Regulation AB does not specify risk factors that must be disclosed in an ABS transaction. Instead, the SEC encourages thoughtful analysis and disclosure of the most significant factors that make the transaction speculative and risky.
Sponsor. The final rules define "sponsor" as the person "who organizes and initiates an asset-backed securities transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuing entity." Item 1104 requires more detailed disclosure about the sponsor than is the current practice, including the following:
- A description of the sponsor’s securitization program, the length of time for which the sponsor has been involved in securitization and, to the extent material, the sponsor’s experience in, and overall procedures for, originating or acquiring and securitizing assets of the type included in the current transaction;
- The size, composition and growth of the sponsor’s portfolio of assets of the type to be securitized, to the extent material;
- Information related to the sponsor material to an analysis of the origination or performance of the pool assets, including whether any prior securitizations organized by the sponsor have defaulted or experienced an early amortization triggering event, to the extent material; and
- The sponsor’s material roles and responsibilities in its securitization program and its participation in structuring the transaction.
The text of the final release also requires disclosure of:
- Any action taken outside the ordinary performance of a transaction to prevent a default, early amortization or trigger event;
- Outsourcing of the origination or purchasing function; and
- Reliance on securitization as a material funding source.
Depositor. Item 1101 defines "depositor" as the entity who receives or purchases and transfers or sells the pool assets to the issuing entity. If the depositor is different from the sponsor, Item 1106 will require disclosure, to the extent material, of the same types of information about the depositor’s securitization experience and prior transactions as required for the sponsor above. In addition, Item 1106 requires the following information:
- Ownership structure of the depositor;
- Activities of the depositor and the time period during which the depositor has been so involved; and
- Continuing duties of the depositor in the current securitization.
Issuing Entities. Item 1101 defines the "issuing entity" as "the trust or other entity created at the direction of the sponsor or depositor that owns or holds the pool assets and in whose name the asset-backed securities supported or serviced by the pool assets are issued." If the issuing entity has executive officers or directors, Item 1107 expands existing practice by requiring information under Regulation S-K, Item 401 (identification of and information regarding these persons), Item 402 (compensation information), Item 403 (information about ownership of registrant’s securities) and Item 404 (information about affiliated transactions). In addition to disclosure customary in the industry, Item 1107 requires the following new disclosures about the issuing entity:
- The amount or nature of any equity contribution by the sponsor, depositor or other party;
- If the pool assets are securities as defined in the Securities Act, the market price of the securities and the basis on which the market price was determined; and
- The amount of expenses incurred in selecting and acquiring the pool assets that are payable out of offering proceeds and amounts paid to each transaction party.
Servicers. Item 1101 defines "servicer" as "any person responsible for the management or collection of the pool assets or making allocations or distributions to holders of the asset-backed securities." The definition also includes a party referred to as an "administrator," but does not include a trustee for an issuing entity that distributes funds received from a servicer and otherwise performs no servicing functions.
The SEC states that Item 1108 of Regulation AB is designed to elicit more information regarding a servicer’s function, experience and servicing practices than is currently the practice. In addition, Item 1108 requires additional disclosure regarding any servicer that services 20% or more of the pool assets or on whom the performance of the pool assets or the ABS is materially dependent. Required disclosures include:
- With respect to the servicer (1) the length of time it has been involved in securitization, (2) a general discussion of its experience servicing assets of the type to be securitized, (3) the size, composition and growth of its portfolio of serviced assets of the type to be securitized, and (4) factors material to an analysis of the servicing of the pool assets or the ABS;
- Material changes to the servicer’s servicing policies or procedures in servicing assets of the same type during the past three years;
- To the extent material, the servicer’s financial condition;
- Any special factors involved in servicing particular assets (e.g., subprime assets) and procedures to address these factors;
- If material, statistical information on advances on pool assets and on servicer’s overall portfolio for the past three years;
- If material, whether prior securitizations involving the servicer and the same asset type have defaulted or experienced an early amortization or other performance trigger because of servicing; and
- Previous material noncompliance with servicing criteria with respect to other securitizations.
Unaffiliated servicers that service at least 10%, but less than 20% of the pool assets, need only be identified.
Trustees. Item 1109 requires disclosures currently found in ABS transactions for trustees as well as some incremental requirements as follows:
- Any prior experience in similar ABS transactions; and
- Whether the trustee independently verifies distribution calculations, access to transaction accounts, compliance with covenants, use of credit enhancement, addition or removal of pool assets and underlying data.
In the final rules, the SEC clarifies that if multiple trustees are involved in the transaction, a description of the roles and responsibilities of each trustee is required.
Originators. Similar to the disclosure provisions applicable to servicers, Item 1110 requires an originator to provide additional disclosure if the originator has originated, or is expected to originate, 20% or more of the pool assets. The disclosure requires a description of the originator’s origination program, the originator’s experience in originating assets of the type being securitized, the size and composition of the originator’s portfolio and other information material to an analysis of the performance of the pool assets. Unaffiliated originators that originated or are expected to originate at least 10%, but less than 20%, of the pool assets need only be identified.
Static Pool Data
One of the biggest changes to current practice is that under Item 1105 static pool data must now be disclosed, to the extent material, in an ABS prospectus.
Amortizing Asset Pools. With respect to amortizing asset pools, Item 1105 requires disclosure of:
- Static pool data regarding delinquency, cumulative loss information and prepayment data for prior securitized pools of the sponsor for the asset type being securitized; or
- If the sponsor has less than three years of experience securitizing assets of the type included in the offered asset pool, material static pool information regarding delinquencies, cumulative losses and prepayments by vintage origination years for originations or purchases by the sponsor of that asset type.
In either case, disclosure will be required for a five-year period or for so long as the sponsor has been either securitizing assets of the type being securitized or making originations or purchases of assets of the same type if less than five years. The final rules also require, to the extent material, static pool disclosure on a pool level basis with respect to each prior securitized pool or vintage origination year involving the same asset type for this period. The most recent periodic increment for the data must be as of a date no later than 135 days of the date of the first use of the prospectus.
Item 1105 requires a summary of the material original characteristics of the prior securitized pools or vintage origination years. Examples of material characteristics identified by the SEC include the number of pool assets, weighted average initial pool balance, weighted average remaining term, weighted average and minimum and maximum credit scores, loan-to-value information and geographic distribution information.
Revolving Asset Master Trusts. For revolving asset master trusts, Item 1105 requires static pool data regarding material delinquency, cumulative loss, prepayment, payment rate, yield and standardized credit scores in separate increments (e.g., 12-month increments) based on the date of origination of the pool assets.
Alternative and Omitted Disclosure. If the static pool information required as discussed above is not material, but alternative static pool information would be, the alternative static pool information must be provided instead. If necessary in order to provide material disclosure, the statistical information described above regarding parties other than the sponsor may be included in addition to, or in lieu of, sponsor data.
Item 1105 provides that static pool information provided with respect to the sponsor’s prior securitized pools established prior to January 1, 2006, and with respect to the currently offered pool as to information about the pool for periods prior to January 1, 2006, will not be deemed to be a prospectus or part of a prospectus or registration statement for liability purposes. The information will still be subject to the general anti-fraud provisions of the Securities Act and the Exchange Act. If static pool data for periods prior to January 1, 2006 or for pools securitized prior to January 1, 2006 is unknown and not available to the registrant without unreasonable effort or expense, this information may be omitted if the registrant includes a statement disclosing that it is omitting this information in the prospectus.
The final rules did not carry forward from the Proposal the requirement to present static pool data separately based on other pool variables.
Method of Presentation. The final rules provide several methods to disclose the required static pool data. The issuer may include the information in a prospectus or, for Form S- 3 offerings, incorporate the information by reference from an Exchange Act report. Alternatively, on or prior to December 31, 2009, the issuer may post the information on a website, if specified conditions are met. This information would be deemed included in the prospectus and subject to all liability provisions applicable to prospectuses and registration statements (except as described above). The conditions to the website alternative include:
- The prospectus at effectiveness must disclose the intention to provide the information through a website and the prospectus filed in connection with the takedown must provide the internet address;
- The website providing the information must be unrestricted as to access and free of charge;
- The information must remain available on the website for not less than five years;
- The information on the website may be updated or changed so long as the date of the update or change is clearly indicated and the registrant undertakes to provide a copy of the information as of the date of the prospectus to investors free of charge, if requested;
- The registrant must retain for at least five years all versions of the information posted on the website in a form that permits easy delivery, and must agree to deliver it to the SEC upon request; and
- The registration statement must include an undertaking that information provided through the specified website is deemed part of the prospectus included in the registration statement, except for information relating to periods before the compliance date of the new disclosure requirement as previously discussed.
The five year period referred to above will commence from the earlier of the filing date of the prospectus filed pursuant to Rule 424 or the date of first use of the prospectus.
Requiring static pool data is one of the most significant incremental changes included in Regulation AB. Although some issuers may find the new disclosures burdensome, we understand that static pool data is regularly supplied to rating agencies and that investors often ask for it. The real issue may be the cost of getting an accountants’ comfort or agreed upon procedures letter with respect to the data since underwriters will continue to seek accounting comfort on all numbers in the prospectus.
The final release contains broad disclosure guidelines capable of being tailored to any particular asset type. Item 1111 requires disclosure of the following:
- The assets to be securitized;
- Material terms of the pool assets;
- Solicitation, credit-granting or underwriting criteria used to originate or purchase the pool assets;
- Selection criteria, cut-off date and material legal or regulatory provisions;
- Delinquency information in 30 or 31-day increments through the point that assets are written off or chargedoff as uncollectible;
- Loss and cumulative loss information; and
- The ways in which prefunding or a revolving period might change the composition of the asset pool, to the extent material.
Item 1111 sets forth required disclosures for amortizing loans, revolving loans and commercial mortgages. Many items contained in Regulation AB are customary but others, such as disclosing standardized credit scores of obligors, are less commonly seen. If 10% or more of the assets are in a particular state or region, factors specific to that state or region must be disclosed.
Sources of Pool Cash Flow. If the asset pool includes leases or other assets that are supported by more than one source of cash flows (such as lease payments and the residual value of an underlying physical asset), the final rules require disclosure of the sources of funds for payments on the assetbacked securities and the relative amount and percentage of funds to be derived from each source, including any assumptions or methodology used to derive these amounts. In addition, if the asset pool includes leases or other assets where a portion of the securitized balance is attributable to the residual value of the physical property underlying the leases, the following must be disclosed:
- How residual values were estimated and who selected any material discount rates, models or assumptions;
- Material procedures or requirements to preserve residual values during the term of the lease;
- Procedures by which residual values are realized and experience of the entity that is realizing on residuals and its compensation;
- Statistical information on estimated residual values, historical turn-in rates and residual value realization rates over the past three years; and
- Whether any provisions address what happens if there is not enough cash flow to cover residuals.
Existing Item 202 of Regulation S-K continues to provide the basic disclosure requirements for all offered securities, with Item 1113 requiring additional disclosure for ABS transactions as follows:
- Description of the securities and transaction structure, including a description and diagram of the flow of funds;
- Description of distribution frequency and cash maintenance;
- Description of the distribution and ownership of excess cash flows, although the final rules only require disclosure of the identity of a residual holder if they are an affiliated party or if they have rights that may alter the transaction structure beyond the receipt of the excess cash;
- To the extent material, a description of other securities issued under a master trust, including their relative priority and allocation of funds and identifying which party has the authority to determine whether additional securities will be issued;
- Optional or mandatory redemption or termination provisions and who holds such redemption or termination option or obligation; and
- Prepayment, maturity and yield considerations.
Item 1113 requires greater disclosure of fees and expenses involved in ABS transactions, including a separate table itemizing all estimated fees and expenses to be paid or payable out of the cash flows from the pool assets. The table must disclose the amount of fees, the parties receiving fees, the source of funds for fees and the distribution priority for fees.
Significant Obligors. Entities meeting one of the following requirements under Item 1101 will be "significant obligors" for which additional disclosure is required:
- An obligor or group of affiliated obligors on any pool asset or group of pool assets if the pool asset or group of pool assets represents 10% or more of the asset pool; or
- A single property or group of related properties securing a pool asset or a group of pool assets if the pool asset or group of pool assets represents 10% or more of the asset pool; or
- A lessee or group of affiliated lessees if the related lease or group of leases represents 10% or more of the asset pool.
Required additional disclosure consists of descriptive information such as the name, organization and character of the obligor’s business, the nature of the asset pool concentration and the material terms of any agreements with the obligor involving the pool assets. In addition, selected financial information meeting the requirements of Item 301 of Regulation S-K is required for obligors representing 10% or more but less than 20% of the asset pool while full financial statements meeting the requirements of Regulation S-X must be provided for obligors representing 20% or more of the asset pool. For significant obligors of a single property (representing 10% or more but less than 20% of the asset pool) as described in the second bullet above, only net operating income for the most recent fiscal year and interim period is required.
Credit Enhancement and Certain Derivative Instruments
As with significant obligors, Item 1114 requires descriptive and financial information for third party credit enhancement providers who are liable or contingently liable to provide payments representing from 10% to 20% or 20% or more of the cash flow supporting any offered class of asset-backed securities. Alternative statistical disclosure is permitted if the pool assets are specified types of student loans and the enhancement provider is a guarantee agency under the Higher Education Act.
The final rules include a new Item 1115, which treats certain derivative instruments, such as interest rate and currency swap agreements, differently than credit enhancement. These derivative instruments are used to alter the payment characteristics of the cashflows from the issuing entity and not to provide credit enhancement. Item 1115 requires descriptive and financial information (similar to the requirements regarding significant obligors) regarding the derivative counterparty, if the maximum probable exposure of the counterparty represents from 10% to 20% or 20% or more of the principal balance of the pool assets (or aggregate principal balance of the class to which the derivative relates if it does not relate to all classes). The maximum probable exposure assessment is based on a reasonable good faith estimate, made in substantially the same manner as that used in the sponsor’s internal risk management process for similar instruments.
The final rules make it less likely that a standard interest rate derivative priced at market will trigger the 10% or 20% tests than would have been the case under the Proposal.
Affiliations and Certain Relationships and Related Transactions
Item 1119 adds disclosures typically found in non-ABS offerings, but these disclosures are less common in securitizations. To the extent material to an investor’s understanding of the asset-backed securities, Item 1119 requires disclosure of any affiliations among the sponsor, depositor or issuing entity and any of the following parties, as well as among any of the following parties themselves: a servicer of at least 20% of the pool assets or other material or affiliated servicer, trustee, originator of at least 10% of the pool assets, significant obligors, significant enhancement providers (including derivative counterparties) or other material party involved in the securitization transaction.
In addition, Item 1119 requires disclosure of any business relationship, agreement, arrangement, transaction or understanding entered into outside the ordinary course of business and on a non-arm’s length basis between any of the parties mentioned above that are material to the ABS transaction. Furthermore, disclosure of any relationships between any of the parties mentioned above that involve or relate to the ABS transaction or the pool assets must be disclosed to the extent material. The final rules do not include the references to underwriters that were included in the Proposal when listing the transaction parties to which Item 1119 relates. However, the final release states that comparable disclosure to that required under Item 1119 is still required as to underwriters pursuant to Item 508 of Regulation S-K.
- The SEC staff seems particularly concerned with actions by the sponsor, depositor or servicer outside the ordinary course or not in compliance with the transaction documents. Public registrants must be prepared to dedicate the resources necessary to service their deals as required by the documents or risk embarrassing disclosures. In addition, it appears that sponsors must disclose any voluntary actions taken to "rescue" deals, such as adding new money to reserve funds, repurchasing defaulted assets or leaving money in transactions that should otherwise be paid out to the sponsor or its affiliates.
- Issuers may want to actively manage concentrations in their ABS transactions to avoid triggering increased disclosure obligations or an inability to meet S-3 eligibility tests.
- Issuers should consider whether they can obtain accounting comfort or agreed upon procedures letters on static pool data and the cost of the letters. Issuers should also consider what static pool data is most relevant to their investors within the guidelines outlined in Item 1105. Issuers may also want to ramp up their ability to post their static pool data on their own website.
- Master servicers and issuers in transactions with multiple servicers - most commonly found in mortgagebacked transactions - may need to negotiate amendments to their servicing agreements to ensure that Exchange Act reports are accurate and timely filed and to allocate responsibility for inaccuracies in the Exchange Act reports.
- Liability for misstatements of third parties such as trustees and non-affiliated servicers may also need to be negotiated between the issuer and these third parties. However, issuers should be aware that the SEC views indemnification for securities law violations as unenforceable as against public policy.
- The additional information required by single obligors and credit enhancement and derivative instrument providers may subject issuers to liability for third party information. Here again, issuers may want to negotiate for indemnification. The requirement to disclose additional information for single obligors should be carefully considered.
- Trustees will need to consider carefully how they describe their verification role in an ABS transaction.
Communications During the Offering Process
ABS Informational and Computational Material
In the time between the release of the Proposal and the adoption of Regulation AB, the SEC issued the Offering Process Proposal, which will revise the Securities Act regulatory process for all securities offerings, not just ABS. Due to its concurrent work on the interim far-reaching Offering Process Proposal, the SEC refrained from making significant changes with respect to communications during the ABS offering process in Regulation AB, and instead indicated that any reforms of this type would be made in connection with the broader Offering Process Proposal. As a result, the final rule in large part codifies pre-existing practice.
We note that many of Regulation AB’s rules regarding communications during the offering process may be amended or superceded through the Offering Process Proposal. We refer you to our Securities Update entitled "SEC Proposes Securities Act Reform," dated December 17, 2004, and available at http://www.Securitization.net , in which we provide an in-depth review and analysis of the Offering Process Proposal.
Definition. In order to streamline current practice regarding the distribution of term sheets during the period in which a registration statement has been declared effective but before a final prospectus has been delivered in connection with the offering of shelf registered asset-backed securities, the final rules combine the concepts of structural term sheets, collateral term sheets and computational materials into the single definition of "ABS informational and computational material." Under Rule 167 of the Securities Act, the distribution of ABS informational and computational materials will be permissible after the shelf registration of an offering of asset-backed securities has become effective but before the delivery of a final prospectus meeting the requirements of the Securities Act.
ABS informational and computational material is defined in Item 1101 of Regulation AB as written communications consisting of one or more of the following:
- Factual information regarding the asset-backed securities being offered and the structure and basic parameters of the securities, and descriptive information relating to each class (e.g., principal amount, yield, anticipated ratings);
- Factual information regarding the pool assets underlying the asset-backed securities (e.g., weighted average coupon, weighted average maturity and other factual information concerning the parameters of the asset pool, such as the type of assets comprising the pool), including origination, acquisition and pool selection criteria, and prefunding or revolving period information;
- Identification of key parties, including a brief description of their roles, responsibilities and experience;
- Static pool data relating to the sponsor’s and/or servicer’s portfolio, prior transactions or the asset pool;
- Statistical data for a particular class of asset-backed securities, the yield, average life, expected maturity, interest rate sensitivity, cash flow characteristics or other financial information under specified prepayment, interest rate, loss or other hypothetical scenarios;
- Anticipated schedule for the offering and a description of marketing events; or
- Description of procedures by which underwriters will conduct the offering and the procedures for transactions in connection with the offering with an underwriter or dealer, including procedures regarding account opening and submitting indications of interest and conditional offers to buy.
ABS informational and computational material may provide information at the individual pool asset level, as is often desired in commercial mortgage-backed securities transactions. Information provided by the issuer or the underwriter to investors or third party services to perform their own calculations would also fall within the scope of these materials. In addition, in the case of third party services, the resulting analysis or calculations of this information may be ABS informational and computational materials if the issuer or underwriter are affiliates of the service provider. The use of ABS informational and computational material would not be available to ABS offerings registered on Form S-1.
Filing Requirements. Rule 167 lists required information for the cover page of a term sheet. It also provides that an immaterial or unintentional failure to file or delay in filing a term sheet will not result in a Section 5(b)(1) violation, so long as a good faith and reasonable effort was made to comply and the prospectus is filed as soon as practicable after discovery of the failure to file. The final release also requires a legend that urges investors to read relevant documents filed with the SEC and clarifies that legends disclaiming liability are inappropriate.
ABS informational and computational materials delivered to (1) a prospective investor who indicated to the issuer or an underwriter that it will purchase asset-backed securities, or (2) a prospective investor after the final terms have been established for all classes of offering, must be filed with the SEC. Rule 426 under the Securities Act clarifies and unifies current filing practice by stating that term sheet materials must be filed on Form 8-K by the later of the filing deadline for the final prospectus or two business days after first use. Materials need not be filed that relate to abandoned structures or materials delivered to prospective investors (a) who have not expressed an interest in purchasing the securities and (b) prior to the time the final terms have been established for all classes of the offering. ABS informational and computational material may be aggregated and filed in consolidated form, as long as the information in that form would not make the information misleading or result in the omission of any information. All filings must be made in electronic format through EDGAR. Prior policies permitting paper filings of computational materials have been eliminated.
Under Rule 167, the failure by a particular underwriter to cause the filing of ABS informational and computational material will not affect the ability of any other underwriter who has complied with the rule to rely on its exemption.
ABS informational and computational materials filed in accordance with the final rules will be exempt from liability for use of a non-conforming prospectus under Section 5 of the Securities Act. However, materials containing untrue or misleading statements will not be exempt from liability under Sections 11 and 12 of the Securities Act because they are considered to be prospectuses and, once filed on Form 8-K, will be incorporated into the Form S-3 registration statement by reference. If the Offering Process Proposals are adopted, these liability rules will change, and ABS informational and computational materials would become free-writing prospectuses subject to Section 12(a)(2) but not Section 11 liability.
The final rules codify a 1997 no-action letter that the safe harbors provided by Rules 137, 138 and 139 under the Securities Act relating to the publication of research reports during registration by brokers or dealers apply to assetbacked securities registered on Form S-3. Rule 139a follows the current treatment of research reports with a few minor changes to accommodate asset-backed securities. The safe harbor applies only to registered offerings of investment grade asset-backed securities that meet the requirements of Form S-3. Research reports published regarding securities of this type will not violate the communication restrictions of the Securities Act if the conditions set forth in Rule 139a are met, including that the broker or dealer must have previously published with reasonable regularity information, opinions or recommendations relating to asset-backed securities with substantially similar collateral. The research report may not contain ABS informational and computational material.
Rating Agency Pre-Sale Reports. In the final release, the SEC clarifies that the extent to which information prepared and distributed by third parties is attributable to an issuer or underwriter depends upon whether the issuer or underwriter has involved itself in the preparation of the information or explicitly or implicitly endorsed or approved the information (such as by distributing a pre-sale report in connection with an offering).
Practical Considerations and Effect of Offering Process Proposal:
- For issuers and underwriters, the potential liability for incorrect ABS informational and computational materials underscores the need to establish reliable procedures to insure the correctness of this information. If the Offering Process Proposal is adopted, the importance of term sheets and their accuracy will be increased because the issuer would be liable for offering materials as of the time of sale and not when offer confirmations are mailed with the final prospectus.
- Although term sheets would not be incorporated by reference into registration statements under the Offering Process Proposal, term sheets would be subject to Section 12(a)(2) liability. In addition, under the Offering Process Proposal many of the disclaimers of liability typically found in term sheets would no longer be permitted.
- The SEC’s express consent to the use of ABS informational and computational materials provided to third party analytical service providers allows issuers and underwriters to give investors transaction information in a format that they prefer. The challenge will be figuring out what material needs to be filed.
- If the Offering Process Proposal is adopted, underwriters using materials based on but not containing issuer information would not need to file those materials (e.g., computational material prepared by the underwriter based on issuer pool data).
- Under the Offering Process Proposal, issuers on Form S-1 would no longer be prohibited from using term sheets so long as a registration statement is on file and the term sheet is preceded or accompanied by a statutory prospectus. In addition, issuers on Form S-3 could benefit from more flexible communications proposals under the Offering Process Proposal, including a safe harbor for regularly released information such as static pool data.
Exchange Act Reporting
The SEC has adopted a new scheme for Exchange Act reporting by ABS issuers. The new rules are intended primarily to codify the existing modified reporting practices established by many SEC no-action letters. The final rules also expand existing practice by adding new features to the reporting regime, including a new Form 10-D for issuers’ periodic distribution reports and establishing minimum universal servicing standards. The new rules also provide clear guidelines as to which entities must file the reports and which reports must be filed.
Determining the Issuer for Exchange Act Reports
The "issuer" for purposes of Exchange Act reporting will be the "depositor" that transfers the assets to the issuing entity. A depositor that transfers assets to multiple issuing entities in different transactions is considered to be a separate "issuer" for Exchange Act reporting purposes for each issuing entity. This definition of "issuer" will result in separate Exchange Act filing obligations for each securitization by the same depositor that utilizes a separate issuing entity. The depositor’s Exchange Act reporting obligations with respect to ABS transactions are also separate from any reporting requirements or exemptions from reporting related to any issuance of the depositor’s own securities. The SEC has noted that investors want to see periodic report information separately by the issuing entity using separate EDGAR CIK codes for each issuer, which would allow investors to search filings by the depositor for information about a particular deal.
To aid in establishing the separate issuer identity of the depositor for each set of Exchange Act reports filed, the depositor must obtain a new CIK number for each issuing entity. All Securities Act and Exchange Act filings with respect to the issuing entity would then be filed under the new CIK number, rather than under the depositor’s own CIK number. The SEC states that the EDGAR system will be reprogrammed to allow for the generation of a new CIK number for a new issuing entity before the Rule 424(b) prospectus is filed.
The final release also clarifies the rules for transactions that use an "issuance trust" structure. In this structure, if the intermediate trust is issuing a financial asset to an issuing trust, both trusts are established under the direction of the same sponsor and depositor and the transaction meets the other structural requirements set forth in the final rules, Rule 15d-23 under the Exchange Act will not require the intermediate trust to file separate Exchange Act reports.
For purposes of determining an issuer’s ability to suspend its Exchange Act reporting under Section 15(d) of the Exchange Act, the depositor is considered a separate issuer for each issuing entity. Therefore, if at the beginning of a fiscal year an issuing entity’s securities are held by fewer than 300 persons, that depositor may still suspend its Exchange Act reporting with respect to that issuing entity, even though the same depositor may continue to have Exchange Act reporting requirements resulting from its sponsorship of other issuing entities.
Form 10-D. Issuers must file their periodic distribution statements on new Form 10-D, rather than on Form 8-K as is currently the practice. Form 10-D will also require issuers to disclose certain non-financial items that might otherwise have been included in a Form 10-Q filing, including defaults of senior securities, votes of security holders, legal matters and other similar items.
Form 10-D must be filed via EDGAR no later than 15 days after each scheduled periodic distribution date for the ABS transaction. The final rules have expanded Exchange Act Rule 12b-25 to allow a five calendar day filing extension, which will allow, under the conditions in the rule, a Form 10-D to be filed up to five calendar days late, but still be deemed filed on its original due date, even for purposes of Form S-3 eligibility. Form 10-D must be signed by the depositor or the servicer and may not be signed by the trustee. The SEC has eliminated any paper filing exemptions with respect to ABS informational and computational materials that were previously available to ABS issuers.
A depositor that sponsors multiple issuing entities will be required to prepare a separate Form 10-D for each issuing entity: depositors may no longer file one report that lists the distribution statements for all of its outstanding transactions.
Distribution Statements. The new rules do not mandate any particular format for an issuer’s periodic distribution statements. The SEC acknowledges that these reports need to be tailored for each transaction based on the nature of the material characteristics of the underlying assets, the particular transaction structure and the demands of investors. However, in Item 1121 of Regulation AB, the SEC provides non-exclusive examples of material categories of information that should be included in periodic distribution statements filed under Form 10-D. Many of these items are quite common while others may appear less frequently, such as the following:
- Updated pool composition information for the period, such as weighted average coupon, weighted average life, weighted average remaining term, pool factors and prepayment amounts; for lease securitizations, this information should include turn-in rates and residual value realization rates;
- Delinquency and loss information for the period, as well as material changes in how delinquencies or charge-offs are determined or defined, as well as the effect of grace periods, re-aging or other practices relating to delinquency and loss experience;
- Amounts, terms and general purpose of any advances made or reimbursed, including the general use of funds advanced and the general source of funds for reimbursements;
- Material modifications, extensions, waivers to pool asset terms, fees, penalties or payments during the distribution period or that have cumulatively become material over time;
- Material breaches of pool asset representations or warranties or transaction covenants;
- Information regarding any new issuance of assetbacked securities backed by the same asset pool, any pool asset changes, such as additions or removals in connection with a prefunding or revolving period, and pool asset substitutions and repurchases and cash flows available for future purchases; and
- Disclosure of (1) any material changes in the solicitation, credit-granting, underwriting, origination or pool selection criteria or procedures to select new pool assets and (2) during a prefunding or revolving period, or if there has been a new issuance of asset-backed securities backed by the same pool under a master trust during the fiscal year of the issuing entity, revised pool composition information under Items 1110 (originators), 1111 (pool assets) and 1112 (significant obligors) in the Form 10-D report for the last required distribution of the fiscal year of the issuing entity, as well as in the first Form 10-D for the period in which the prefunding or revolving period ends (if applicable).
The SEC recommends that issuers include appropriate introductory and explanatory information to explain information in distribution reports and tables and graphs if helpful. The SEC acknowledges that the periodic disclosures for prefunding periods, revolving periods and master trusts are more expansive than is currently the case.
Form 10-K. The main items of Form 10-K reporting for ABS issuers will remain consistent with the system of modified reporting currently utilized. The cover page of Form 10-K will need to include the names of the issuing entity, the depositor and the sponsor, if different than the depositor. Form 10-K must be signed by the same individual who signs the Sarbanes-Oxley certification as discussed below, which may be either (1) on behalf of the depositor by the senior officer in charge of securitization of the depositor or (2) on behalf of the issuing entity by the senior officer in charge of the servicing function. If multiple servicers are servicing the pool assets, the master servicer must sign if the servicer is the signatory. The final rules add specific disclosures to Form 10-K for ABS issuers as follows:
- Financial information relating to significant obligors in the asset pool (Item 1112(b));
- Financial information relating to significant enhancement providers and certain derivative counterparties (Items 1114(b)(2) and 1115(b));
- Legal proceedings against any of the transaction parties that are material to security holders (Item 1117);
- Affiliations of transaction parties and certain related transactions (Item 1119);
- Attestation of compliance with applicable servicing criteria as described below (Item 1122); and
- A servicer compliance statement as described below (Item 1123).
Compliance with Servicing Criteria. Perhaps the most significant change from current practice contained in Regulation AB is an extensive new set of standard servicing criteria. The Proposal cited recent events as demonstrating the need for "a single set of transparent and comprehensive servicing criteria, attested to by an independent third party under recognized professional standards." The SEC has determined that the Uniform Single Attestation Program for Mortgage Bankers (USAP), developed for residential mortgage loan servicing, is not consistently applied and does not adequately establish minimum servicing levels for all ABS transactions. The final rules adopt a uniform set of criteria that will be the basis for evaluation of servicing activities.
Item 1122 provides that each party that participates in the servicing function must provide a report for filing as Exhibit 33 to the Form 10-K on that party’s compliance with these new uniform servicing standards, and each of these reports must be accompanied by an attestation by an independent accounting firm. The Sarbanes-Oxley certification discussed below will require the party signing the certificate to certify that these reports and related attestation reports have been submitted by all parties participating in the servicing function or disclosing those that have not been submitted, as well as disclosing any material instances of noncompliance. The compliance attestations of each party participating in the servicing function may be made on a platform level, rather than for each individual transaction, if the assets serviced by that party backing those transactions are all on the same servicing platform.
The statement required by Item 1122(a) must include disclosure that:
- The party is responsible for assessing compliance with servicing criteria applicable to it;
- The party used Regulation AB’s servicing criteria to assess compliance with the applicable servicing criteria;
- An assessment of compliance with the applicable servicing criteria for the fiscal year, including disclosure of any material instance of noncompliance; and
- A registered public accounting firm has issued an attestation report on the party’s assessment of compliance with the applicable servicing criteria for the fiscal year.
Reports and related accountants’ attestations will only be required under Item 1122 from each party that performs activities that address the servicing criteria if that party’s activities relate to more than 5% of the pool assets. The release clarifies that just because a party performs an aspect of servicing that requires an assessment and attestation report to be filed by that party with the Form 10-K, it does not mean that the party is included in the definition of "servicer" in Regulation AB for purposes of other requirements, such as disclosure regarding servicers and servicer compliance statements.
The new accountants’ attestation reports to be delivered with respect to each party’s report on compliance with the servicing criteria must be filed as Exhibit 34 to Form 10-K.
The servicing criteria in Item 1122(d) include:
- General servicing criteria, including use of policies and procedures to monitor performance or other triggers or events of default under the transaction agreements, monitoring of subservicers, and maintenance of backup servicers and fidelity bonds;
- Cash collection and administration criteria, including that payments on pool assets are deposited into custodial accounts no more than two business days (or such other number of days specified in the transaction agreements) after receipt, wire transfers are monitored, advances or collection guarantees are made in accordance with the transaction documents, custodial accounts are separately maintained as set forth in the transaction agreements, and reconciliations are prepared on a monthly basis for all bank accounts related to the transactions;
- Investor remittance and reporting criteria, including that (1) SEC and other investor reports are prepared in accordance with required timeframes and other terms in the transaction documents, provide information calculated in accordance with the transaction documents, are filed with the SEC as required and agree with the investors’ or trustee’s records as to unpaid principal balance of the securities and the balance and number of pool assets serviced by the servicer, (2) amounts due investors are allocated and remitted in accordance with the transaction documents, (3) distributions are posted within two business days (or such other number of days specified in the transaction agreements) to investors and (4) amounts remitted to investors agree with bank statements; and
- Pool asset administration criteria, including maintenance of collateral as required, safeguarding of pool assets and related documents, review and approval of pool asset removal, addition or substitution, payments on pool assets are posted to applicable servicer’s obligor records maintained no more than two business days (or such other number of days specified in the transaction agreements) after receipt, servicer records relating to pool assets agree with the servicer’s records with respect to an obligor’s unpaid principal balance, changes to pool asset terms are reviewed and approved by authorized personnel and loss mitigation or recovery actions are properly conducted, maintenance of collection records, interest rates adjustments are made and escrow accounts maintained in accordance with the transaction agreements and many similar provisions.
A party delivering a servicing compliance report may exclude a particular criterion if it is not applicable to the asserting party based on the activities it performs with respect to the transactions taken as a whole involving that party and that are backed by the same asset type as long as the servicer discloses the criteria being excluded in its report.
Sarbanes-Oxley Certification. The final release generally codifies the June 2003 SEC statement regarding certifications under Section 302 of the Sarbanes-Oxley Act for ABS issuers (Rule 13a-14 or Rule 15d-14 under the Exchange Act, as applicable). The senior officer of the depositor in charge of securitization or the senior officer in charge of the servicing function of the servicer must provide the Sarbanes- Oxley certification, which must be filed as Exhibit 31 to Form 10-K. The revised certificate contains certifications that reflect the new Exchange Act rules on servicer compliance:
- All distribution, servicing and other information required to be provided under Form 10-D are included;
- Based on the compliance review required by Item 1123, the servicer has fulfilled its obligations;
- That all of the reports on assessment of compliance with servicing criteria and their related attestation reports required to be included in accordance with Item 1122 and Exchange Act Rules 13a-18 and 15d-18 have been included as an exhibit to the report, except as otherwise disclosed in the report; and
- Any material instances of noncompliance described in such reports have been disclosed in the report on Form 10-K.
In addition, Item 2 of the Section 302 certification was revised to broaden the certification as to Exchange Act reports not being misleading from being determined as of the last day of the period covered by the Section 302 certification to the period covered by the report.
The same person that signs the 10-K must sign the Section 302 certification. Trustees are no longer permissible signatories. As is currently the case, signers may reasonably rely on information that unaffiliated trustees, depositors, servicers or subservicers provide.
Form 8-K. Under Regulation AB, ABS issuers must file current reports on Form 8-K, with additional events added for asset-backed securities, including:
- Bankruptcy of the sponsor, depositor, servicer, trustee, significant obligor, enhancement provider or other material party;
- Occurrence of an early amortization event, performance trigger or other event, including an event of default, that would materially alter the payment priorities or cash flows; • ABS informational and computational materials (term sheets);
- Change of servicer or trustee;
- Change in credit enhancement or other support; and
- Material failure to make required distributions.
- As a result of the creation of a written set of rules applicable to all ABS issuers, it will be easier for the SEC to bring an enforcement action against issuers, sponsors, depositors, trustees, etc. that do not comply with the new rules. ABS issuers should begin their efforts to comply with the new rules as soon as possible and be prepared to meet the increased costs of compliance and servicing.
- Issuers and servicers should undertake a complete review of their servicing and compliance procedures in order to comply with the new rules. Given the extensive new compliance burden, the new rules will make it more difficult for smaller and start-up issuers to issue public securities. The cost of complying with Regulation AB may push cost-sensitive issuers out of the public markets altogether, with presumably a higher premium paid by investors for public as opposed to private securities.
- Accountants must assess the cost and time frame for the new attestation report required by Item 1122, and what issues they see in complying with Regulation AB. The SEC staff seems particularly concerned that servicers are not complying with servicing standards in transaction documents. Failure to comply with transaction documents may now result in embarrassing disclosures.
Copyright © 2005 Mayer, Brown, Rowe & Maw LLP. This Mayer, Brown, Rowe & Maw LLP article provides information and comments on legal issues and developments of interest. The foregoing is not a comprehensive treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action with respect to the matters discussed herein.
Mayer, Brown, Rowe & Maw is a combination of two limited liability partnerships, each named Mayer, Brown, Rowe & Maw LLP, one established in Illinois, U.S.A., and one incorporated in England.