Issuer Review of Assets in Offerings of Asset-Backed Securities, 4231-4244 [2011-1503]

Download as PDF Federal Register / Vol. 76, No. 16 / Tuesday, January 25, 2011 / Rules and Regulations proposed rulemaking and an opportunity for public comment be given for this rule. Because a notice of proposed rulemaking and an opportunity for public comment are not required to be given for this rule by 5 U.S.C. 553, or by any other law, the analytical requirements of the Regulatory Flexibility Act, 5 U.S.C. 601 et seq., are not applicable. Accordingly, no Regulatory Flexibility analysis is required and none has been prepared. Notwithstanding these considerations, BIS welcomes public comments and will review them on a continuing basis. Supplement No. 1 To Part 740— [Amended] Supplement No. 4 To Part 744— [Amended] 4. Supplement No. 1 to part 740 is amended: ■ a. By adding ‘‘India’’ to the Country Group A table in alphabetical order and adding and ‘‘X’’ for ‘‘India’’ in Country Group A:2; and ■ b. By removing the entry ‘‘India’’ from the Country Group D table. ■ List of Subjects Authority: 50 U.S.C. app. 2401 et seq.; 50 U.S.C. 1701 et seq.; 22 U.S.C. 3201 et seq.; 42 U.S.C. 2139a; 22 U.S.C. 7201 et seq.; 22 U.S.C. 7210; Sec 1503, Pub. L. 108–11, 117 Stat. 559; E.O. 12058, 43 FR 20947, 3 CFR, 1978 Comp., p. 179; E.O. 12851, 58 FR 33181, 3 CFR, 1993 Comp., p. 608; E.O. 12938, 59 FR 59099, 3 CFR, 1994 Comp., p. 950; E.O. 13026, 61 FR 58767, 3 CFR, 1996 Comp., p. 228; E.O. 13222, 66 FR 44025, 3 CFR, 2001 Comp., p. 783; Presidential Determination 2003–23 of May 7, 2003, 68 FR 26459, May 16, 2003; Notice of August 12, 2010, 75 FR 50681 (August 16, 2010); Notice of November 4, 2010, 75 FR 68673 (November 8, 2010). 15 CFR Part 738 Exports. 15 CFR Part 740 Administrative practice and procedure, Exports, Reporting and recordkeeping requirements. 15 CFR Part 742 Exports and Terrorism. 15 CFR Part 744 ■ PART 742—[AMENDED] 5. The authority citation for part 742 continues to read as follows: ■ 9. The entry for ‘‘India’’ in Supplement No. 4 to part 744 is amended by removing the following entities: ‘‘Bharat Dynamics Limited’’; ‘‘The following subordinates of Defense Research and Development Organization (DRDO): Armament Research and Development Establishment (ARDE); Defense Research and Development Lab (DRDL), Hyderabad; Missile Research and Development Complex; Solid State Physics Laboratory’’; and ‘‘The following Indian Space Research Organization (ISRO) subordinate entities: Liquid Propulsion Systems Center; Solid Propellant Space Booster Plant (SPROB); Sriharikota Space Center (SHAR); and Vikram Sarabhai Space Center (VSSC), Thiruvananthapuram.’’. Dated: January 20, 2011. Eric L. Hirschhorn, Under Secretary for Industry and Security. [FR Doc. 2011–1471 Filed 1–24–11; 8:45 am] § 742.3—[Amended] BILLING CODE 3510–33–P Accordingly, parts 738, 740, 742 and 744 of the EAR (15 CFR parts 730–774) are amended as follows: 6. Paragraph (a)(2) of § 742.3 is amended by removing the phrase ‘‘except India’’. ■ 7. Paragraph (d) of § 742.5 is revised to read as follows: SECURITIES AND EXCHANGE COMMISSION PART 738 [AMENDED] § 742.5 1. The authority citation for part 738 continues to read as follows: * Exports, Reporting and recordkeeping requirements, Terrorism. ■ Authority: 50 U.S.C. app. 2401 et seq.; 50 U.S.C. 1701 et seq.; 10 U.S.C. 7420; 10 U.S.C. 7430(e); 22 U.S.C. 287c; 22 U.S.C. 3201 et seq.; 22 U.S.C. 6004; 30 U.S.C. 185(s), 185(u); 42 U.S.C. 2139a; 42 U.S.C. 6212; 43 U.S.C. 1354; 15 U.S.C. 1824a; 50 U.S.C. app. 5; 22 U.S.C. 7201 et seq.; 22 U.S.C. 7210; E.O. 13026, 61 FR 58767, 3 CFR, 1996 Comp., p. 228; E.O. 13222, 66 FR 44025, 3 CFR, 2001 Comp., p. 783; Notice of August 12, 2010, 75 FR 50681 (August 16, 2010). 2. Supplement No. 1 to Part 738 is amended by removing the ‘‘X’’ in ‘‘CB Column 3’’ for ‘‘India’’. PART 740—[AMENDED] 3. The authority citation for part 740 continues to read as follows: ■ Authority: 50 U.S.C. app. 2401 et seq.; 50 U.S.C. 1701 et seq.; 22 U.S.C. 7201 et seq.; E.O. 13026, 61 FR 58767, 3 CFR, 1996 Comp., p. 228; E.O. 13222, 66 FR 44025, 3 CFR, 2001 Comp., p. 783; Notice of August 12, 2010, 75 FR 50681 (August 16, 2010). 16:23 Jan 24, 2011 Jkt 223001 Missile technology. * * * * (d) Missile Technology Control Regime. Missile Technology Control Regime (MTCR) members, and India as an MTCR adherent, are listed in Country Group A:2 (see Supplement No. 1 to part 740 of the EAR). Controls on items identified in paragraph (a) of this section are consistent with the list agreed to in the MTCR and included in the MTCR Annex. PART 744—[AMENDED] 8. The authority citation for part 744 continues to read as follows: ■ VerDate Mar<15>2010 ■ ■ Supplement No. 1 To Part 738— [Amended] srobinson on DSKHWCL6B1PROD with RULES 4231 Authority: 50 U.S.C. app. 2401 et seq.; 50 U.S.C. 1701 et seq.; 22 U.S.C. 3201 et seq.; 42 U.S.C. 2139a; 22 U.S.C. 7201 et seq.; 22 U.S.C. 7210; E.O. 12058, 43 FR 20947, 3 CFR, 1978 Comp., p. 179; E.O. 12851, 58 FR 33181, 3 CFR, 1993 Comp., p. 608; E.O. 12938, 59 FR 59099, 3 CFR, 1994 Comp., p. 950; E.O. 12947, 60 FR 5079, 3 CFR, 1995 Comp., p. 356; E.O. 13026, 61 FR 58767, 3 CFR, 1996 Comp., p. 228; E.O. 13099, 63 FR 45167, 3 CFR, 1998 Comp., p. 208; E.O. 13222, 66 FR 44025, 3 CFR, 2001 Comp., p. 783; E.O. 13224, 66 FR 49079, 3 CFR, 2001 Comp., p. 786; Notice of August 12, 2010, 75 FR 50681 (August 16, 2010); Notice of November 4, 2010, 75 FR 68673 (November 8, 2010). PO 00000 Frm 00031 Fmt 4700 Sfmt 4700 17 CFR Parts 229 and 230 [Release Nos. 33–9176, 34–63742; File No. S7–26–10] RIN 3235–AK76 Issuer Review of Assets in Offerings of Asset-Backed Securities Securities and Exchange Commission. ACTION: Final rule. AGENCY: We are adopting new requirements in order to implement Section 945 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the ‘‘Act’’). We are adopting a new rule under the Securities Act of 1933 to require any issuer registering the offer and sale of an asset-backed security (‘‘ABS’’) to perform a review of the assets underlying the ABS. We also are adopting amendments to Item 1111 of Regulation AB that would require an ABS issuer to disclose the nature of its review of the assets and the findings and conclusions of the issuer’s review of the assets. DATES: Effective Date: March 28, 2011. Compliance Date: Any registered offering of asset-backed securities SUMMARY: E:\FR\FM\25JAR1.SGM 25JAR1 4232 Federal Register / Vol. 76, No. 16 / Tuesday, January 25, 2011 / Rules and Regulations commencing with an initial bona fide offer after December 31, 2011, must comply with the new rules and forms. FOR FURTHER INFORMATION CONTACT: Eduardo Aleman, Special Counsel, Division of Corporation Finance, at (202) 551–3430, U.S. Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549. SUPPLEMENTARY INFORMATION: We are adopting amendments to Item 1111 1 of Regulation AB 2 (a subpart of Regulation S–K). We also are adopting Rule 193 3 under the Securities Act of 1933 4 (the ‘‘Securities Act’’). I. Background and Overview On October 13, 2010, we proposed new requirements in order to implement Section 945 and a portion of Section 932 of the Dodd-Frank Act.5 As discussed in the Proposing Release, Section 945 of the Act amends Section 7 of the Securities Act to require the Commission to issue rules relating to the registration statement required to be filed by an issuer of ABS. Pursuant to new Section 7(d), the Commission must issue rules to require that an issuer of an ABS perform a review of the assets underlying the ABS, and disclose the nature of such review. Section 945 of the Act reflects the testimony provided to Congress that due diligence practices in ABS offerings had eroded significantly.6 We also proposed new requirements relating to the disclosure of third-party findings and conclusions in ABS transactions in order to implement Section 15E(s)(4)(A) of the Exchange Act, as added by Section 932 of the Act. We received over 50 comment letters on the Proposing Release.7 As discussed below, after consideration of the comments received on the proposed amendments, we are adopting the proposed amendments to implement Section 7(d) of the Securities Act. We have revised the final rules from the proposal to establish a new minimum standard for the required review. We are postponing consideration of rules to implement Section 15E(s)(4)(A) of the Exchange Act, which requires issuers or underwriters of any asset-backed 1 17 CFR 229.1111. CFR 229.1100 through 17 CFR 229.1123. 3 17 CFR 230.193. 4 15 U.S.C. 77a et seq. 5 Issuer Review of Assets in Offerings of AssetBacked Securities, Release No. 33–9150 (Oct. 13, 2010) [75 FR 64182] (‘‘Proposing Release’’). 6 See S. Rep. No. 111–176, at 133 (2010) (‘‘Senate Report’’). 7 The comments on the Proposing Release are available at https://www.sec.gov/comments/s7-2610/s72610.shtml. srobinson on DSKHWCL6B1PROD with RULES 2 17 VerDate Mar<15>2010 16:23 Jan 24, 2011 Jkt 223001 security to make publicly available the findings and conclusions of any thirdparty due diligence report the issuer or underwriter obtains, until a later date when we adopt rules to implement the rest of Section 15(E)(s)(4), which we anticipate proposing this year. We are persuaded by the suggestion by several commentators that new Exchange Act Section 15E(s)(4) should be read as a whole, and that we should postpone implementation of 15E(s)(4)(A) until the Commission implements the rest of Section 15E.8 II. Final Rules A. Scope of Rule 193 1. Proposed Amendments We proposed new Rule 193 under the Securities Act to require issuers of ABS to perform a review of the assets underlying registered ABS offerings.9 This rule would implement Securities Act Section 7(d)(1),10 as added by Section 945 of the Act. As proposed, Rule 193 would require an issuer to perform a review of the assets underlying an ABS in a transaction that the issuer registers under the Securities Act. 2. Comments on the Proposed Amendments—Scope of Rule 193 With respect to the applicability of the proposed rule, some commentators agreed that the rule should apply only to registered offerings of ABS.11 Some commentators recommended the review requirement be extended to also apply to unregistered offerings and predicted that unless the rule applies to unregistered offerings, abusive practices are likely to migrate into the market for unregistered offerings.12 One such commentator supported the approach in the Proposing Release’s request for comment conditioning the 8 See comment letters from American Bar Association (‘‘ABA’’); National Association of Bond Lawyers (‘‘NABL’’). 9 The requirement to perform a review should not be confused with, and is not intended to change, the due diligence defense against liability under Securities Act Section 11 [15 U.S.C. 77k] or the reasonable care defense against liability under Securities Act Section 12(a)(2) [15 U.S.C. 77l(a)(2)]. Our rule is designed to require a review of the underlying assets by the issuer and to provide disclosure of the nature, findings and conclusions of such review. 10 15 U.S.C. 77g(d)(1). 11 See comment letters from ABA; Securities Industry and Financial Markets Association (‘‘SIFMA’’). 12 See comment letters from Center for Responsible Lending (‘‘CRL’’); Senator Levin, Permanent Subcommittee on Investigations, United States Senate Committee on Homeland Security and Governmental Affairs (‘‘Levin’’); Consumer Federation of America (‘‘Consumer Federation’’); Christopher Chuff. PO 00000 Frm 00032 Fmt 4700 Sfmt 4700 Commission’s safe harbors from registration on a requirement that the underlying transaction agreements include a representation that the issuer performed an asset review that complies with Rule 193.13 Three commentators expressed concern with such a requirement.14 One commentator sought clarification that the issuer may rely on a review performed by an affiliated originator.15 3. Final Rule—Scope of Rule 193 Consistent with the proposal, final Rule 193 requires that the asset review be conducted by the issuer of the ABS.16 The issuer, for purposes of this rule, is the depositor or sponsor of the securitization. A sponsor typically initiates a securitization transaction by selling or pledging to a specially created issuing entity a group of financial assets that the sponsor either has originated itself or has purchased in the secondary market. In some instances, the transfer of assets is a two-step process: The financial assets are transferred by the sponsor first to an intermediate entity, the depositor or the issuer, and then the depositor transfers the assets to the issuing entity for the particular assetbacked transaction. The issuing entity is typically a statutory trust.17 In cases 13 See comment letter from Consumer Federation. comment letters from ABA; American Financial Services Association (‘‘AFSA’’); SIFMA. 15 See comment letter from SIFMA. Another commentator noted that the relationship between the issuer and originator is an important consideration in determining the appropriateness of a review, and suggested that in so-called ‘‘aggregator’’ transactions, where the issuer is unaffiliated with the originator of the assets, the review should be more fulsome. See comment letter from ABA. 16 Under Securities Act Rule 191 (17 CFR 230.191), the depositor for the asset-backed securities acting solely in its capacity as depositor to the issuing entity is the ‘‘issuer’’ for purposes of the asset-backed securities of that issuing entity. ‘‘Depositor’’ means the depositor who receives or purchases and transfers or sells the pool assets to the issuing entity. See Item 1101 of Regulation AB (17 CFR 229.1101). For asset-backed securities transactions where there is not an intermediate transfer of the assets from the sponsor to the issuing entity, the term depositor refers to the sponsor. For asset-backed securities transactions where the person transferring or selling the pool assets is itself a trust, the depositor of the issuing entity is the depositor of that trust. See id. As defined in Item 1101 of Regulation AB, the ‘‘sponsor’’ means the person who organizes and initiates an ABS transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuing entity. See id. 17 See Asset-Backed Securities, Release No. 33– 8518 (Dec. 22, 2004) [70 FR 1506] (‘‘2004 Regulation AB Adopting Release’’) at Section III.B.3. The issuing entity is designed to be a passive entity, and in order to meet the definition of ABS issuer in Regulation AB its activities must be limited to passively owning or holding the pool of assets, issuing the ABS supported or serviced by those assets, and other activities reasonably incidental thereto. 14 See E:\FR\FM\25JAR1.SGM 25JAR1 Federal Register / Vol. 76, No. 16 / Tuesday, January 25, 2011 / Rules and Regulations srobinson on DSKHWCL6B1PROD with RULES where the originator and sponsor may be different, including in transactions involving a so-called ‘‘aggregator,’’ our final rule, consistent with the proposal, provides that the review may be performed by the sponsor, but a review performed by an unaffiliated originator will not satisfy Rule 193. An unaffiliated originator may have different interests in the securitization, especially if the securitization involves many originators where each originator may have contributed a very small part of the assets in the entire pool, and may have differing approaches to the review.18 As discussed in the Proposing Release, Section 7(d)(1) relates to an asset-backed security, as defined in new Section 3(a)(77) of the Exchange Act.19 This new statutory definition (‘‘Exchange Act-ABS’’) is broader than the definition of ‘‘asset-backed security’’ in Regulation AB 20 and includes securities typically offered and sold in private transactions. Although the Exchange Act-ABS term is used in Section 7(d)(1), we have concluded that the review requirements mandated by Section 7(d)(1) are limited to registered offerings of ABS because Section 7(d)(1) requires the Commission to issue rules ‘‘relating to the registration statement.’’ Therefore, the rule we adopt today that requires an ABS issuer to perform a review of the assets applies to issuers of ABS in registered offerings and not issuers of ABS in unregistered offerings. As noted above, in the Proposing Release we asked whether, even though Section 7(d)(1) does not extend to unregistered offerings, we should condition reliance on the Securities Act safe harbors from registration on a requirement that the underlying transaction agreement for the ABS contain a representation that the issuer performed a review that complies with Rule 193, or, alternatively, that the issuer perform a Rule 193 review. Given the mixed comments on this question and our outstanding proposals from April 2010 related to offerings under the safe harbors from registration,21 we are 18 In the case of so-called aggregators, the sponsor acquires loans from many other unaffiliated sellers before securitization. 19 15 U.S.C. 78c(a)(77). This definition was added by Section 941(a) of the Act. 20 See Item 1101(c)(1) of Regulation AB [17 CFR 229.1101(c)(1)]. 21 See Asset-Backed Securities, Release No. 33– 9117 (April 7, 2010) [75 FR 23328] (the ‘‘2010 ABS Proposing Release’’). In the 2010 ABS Proposing Release we proposed requiring that the underlying transaction agreement in a transaction relying on certain Commission safe harbors for an exemption from registration under the Securities Act contain a provision requiring the issuer to provide to any initial purchaser, security holder, and designated VerDate Mar<15>2010 16:23 Jan 24, 2011 Jkt 223001 not adopting at this time a separate requirement to condition the Commission’s safe harbors for an exemption from registration on a requirement that the issuer conduct a review of the assets. As we noted in the 2010 ABS Proposing Release, we have concerns about investor protection in the exempt ABS markets.22 While we continue to have these concerns, at this point we believe a comprehensive approach to the Commission’s safe harbors for an exemption from registration would better serve investors and provide more certainty to issuers than an incremental approach. In the future, we may determine that discrete amendments to the safe harbors addressing ABS matters are appropriate. B. Standard of Review of Assets by Issuers of ABS 1. Proposed Amendments Proposed Rule 193 provided that an issuer would be required to conduct a review of the assets and disclose the findings and conclusions of the review. Proposed Rule 193 did not specify the level or type of review an issuer would be required to perform, or require that a review be designed in any particular manner. However, the Proposing Release included detailed requests for comment on whether we should set a minimum review standard, including possible standards that could be included in a final rule. In particular, the Proposing Release sought comment on a possible review standard that would require issuers to perform a review that, at a minimum, must be designed to provide reasonable assurance that the disclosure in the prospectus regarding the pool assets is accurate in all material respects. We also sought comment on whether the rule should mandate that the review should not only be designed, but also effected, to provide reasonable assurance that the prospectus disclosure was accurate in all material respects. 2. Comments on the Proposed Amendments—Standard of Review Comments on the proposed review requirement, including the absence of a minimum review standard, were varied. Some commentators responded that the review requirement, as proposed, did not address the problems that Section prospective purchaser the same information as would be required in a registered transaction. In addition, the Commission solicited comment concerning whether safe harbors from registration should not be available for offerings of structured finance products and whether any restrictions should be imposed on private offerings of assetbacked securities. 22 See id. at 23394. PO 00000 Frm 00033 Fmt 4700 Sfmt 4700 4233 945 of the Act sought to address and suggested that the Commission set a minimum level of review.23 One commentator recommended that ABS issuers be required to conduct reviews that are both ‘‘designed and effected’’ with sufficient scale and scope to discover assets that violate applicable law or standards as set forth in the prospectus.24 This commentator explained that this would go beyond providing ‘‘reasonable assurance that the disclosure in the prospectus is accurate in all material respects.’’ One commentator cautioned that the rule, as proposed, would create a perverse incentive to decrease due diligence reviews even further in order to decrease the likelihood that they reveal problems that would have to be disclosed to investors.25 Some commentators suggested possible alternative review standards that encompass other aspects of the assets, instead of disclosure. Some commentators urged the Commission to require a review that assesses the actual quality of the underwriting of the assets 26 and exclude the type of review of assets that amounts to a mere comparison or ‘‘comforting’’ of data that relates to the prospectus disclosure. These commentators stated that in light of the existing liability framework under the federal securities laws, it is not necessary for the Commission to require that issuers conduct or disclose any particular review that merely verifies the accuracy of the disclosure in the prospectus.27 Some commentators believed that the type of review that should be disclosed under Rule 193 is a review that relates to the underwriting of the assets 28 or quality of the underlying assets (e.g., credit quality).29 23 See comment letters from Chris Barnard (‘‘Barnard’’); Consumer Federation (supporting a principles-based review standard such as the ‘‘reasonable assurance’’ standard discussed in the Proposing Release’s request for comment, and suggesting that where initial reviews uncover discrepancies, further reviews sufficient to uncover the extent of the problem should be conducted); CRL; Levin; American Society of Appraisers, American Society of Farm Managers and Rural Appraisals, National Association of Independent Fee Appraisers (collectively, ‘‘Appraisers’’); Clayton Holdings, LLC (‘‘Clayton’’); Americans for Financial Reform (‘‘AFR’’); Fitch, Inc. (‘‘Fitch’’). See also comment letter from ABA (supporting Rule 193 as proposed, but agreeing that the ‘‘reasonable assurance’’ approach discussed in the Proposing Release’s request for comment is workable if the Commission were to adopt a minimum level of review). 24 See comment letter from CRL. 25 See comment letter from Consumer Federation. 26 See comment letters from ASF; SIFMA. 27 See comment letters from ASF; SIFMA. 28 See comment letters from ASF; SIFMA. 29 See comment letter from BDO USA, LLP. E:\FR\FM\25JAR1.SGM 25JAR1 4234 Federal Register / Vol. 76, No. 16 / Tuesday, January 25, 2011 / Rules and Regulations Other commentators suggested that at a minimum, the review should include, for example, verifying the accuracy of the loan data and related information, determining whether the assets complied with the underwriting guidelines, determining compliance with the originator’s property valuation guidelines, and determining whether the loans were originated in compliance with applicable laws.30 Other commentators, in support of a minimum review standard, suggested that the issuer’s review should include disclosure of key indicators of loan quality (e.g., weighted average FICO scores, loan-to-value ratios, borrower debt-to-income ratios, and the absence of data suggesting loan fraud) 31 and a minimum sample size requirement.32 Some commentators suggested that this should include a statistically valid sample of assets whose analysis could be extrapolated to the entire asset pool.33 Two of these commentators argued that such a requirement would ensure a level playing field and that no issuer gains a competitive cost advantage by using smaller sample sizes.34 One commentator suggested that the Commission consider the minimum sample sizes set forth by the various rating agencies,35 while another noted that sampling should be conducted in a manner appropriate to provide confidence that a representative portion of the pool has been examined (e.g., a sample size could be computed using a 95% confidence level and a 5% confidence interval).36 On the other hand, some commentators supported the Commission’s proposal, which did not prescribe a minimum level of review.37 One commentator opposed the ‘‘reasonable assurance’’ standard in the Proposing Release’s request for comment and argued that the standard is inappropriate and unnecessary to address the intent of the Act or to improve disclosure because the new requirements mandated by the Act should address a review of the assets, as opposed to a review of the disclosure 30 See comment letters from Clayton; CRL. comment letter from Levin. 32 See comment letters from ABA; Clayton; Fitch; Levin; SIFMA. 33 See comment letters from Clayton; Fitch; Levin; SIFMA. 34 See comment letters from Clayton; Levin. 35 See comment letter from Clayton. 36 See comment letter from Fitch. 37 See, e.g., comment letters from ABA; American Bankers Association Securities Association (‘‘ABASA’’); Association for Financial Markets in Europe (‘‘AFME’’); Commercial Real Estate Finance Council (‘‘CRE Finance Council’’); and Mortgage Bankers Association (‘‘MBA’’). srobinson on DSKHWCL6B1PROD with RULES 31 See VerDate Mar<15>2010 16:23 Jan 24, 2011 Jkt 223001 about the assets.38 This commentator cautioned that a ‘‘reasonable assurance’’ standard would require issuers to describe what they did to get comfortable that they met their disclosure obligations, and expose them to liability for failing to have used procedures that provided such ‘‘reasonable assurance’’ or for not having accurately described the nature of the procedures and their findings and conclusions, even if there was no material error or omission in the prospectus about the pool assets.39 One commentator requested confirmation that Rule 193 addresses a review of assets in connection with the preparation of the securitization, rather than a review performed in connection with origination of a securitized asset.40 This commentator explained that in the context of CMBS transactions, the sponsor of the securitization is often also the originator (or an affiliate of the originator) of the assets being transferred into a securitization, and that it would be unusual for any extra level of diligence to be performed on the assets themselves in connection with the securitization since the sponsor previously underwrote the assets and is familiar with the assets. 3. Final Rule—Issuer Review Requirement After considering the comments, we are adopting Rule 193 with a minimum review standard. We agree with commentators who suggested that Rule 193 should require a minimum level of review to implement the directive in Section 7(d), as added by Section 945 of the Act. Absent a minimum standard of review, we are concerned that issuers could satisfy new Rule 193 with a review that was not designed or carried out in a way that would address the concerns that led to the enactment of section 7(d)(1)—that due diligence be ‘‘re-introduced’’ into the offering process.41 We also believe a minimum 38 See comment letter from ASF. comment letter from ASF (noting that the scope of a ‘‘reasonable assurance’’ standard is overly broad considering the substantial amount of disclosure regarding the pool assets that is contained in the prospectus including, in addition to numerical information about the assets, narrative disclosure about such matters as the pool assets generally, risk factors relevant to the pool assets, servicing of the pool assets, and legal aspects of the pool assets). 40 See comment letter from CRE Finance Council. 41 See Senate Report, at 133 (quoting Senate committee testimony by Professor John Coffee). We note that some commentators supported the standard described in the Proposing Release’s request for comment. See comment letters from Consumer Federation; ABA (suggesting that this approach is workable if the Commission were to adopt a minimum level of review, though supporting Rule 193 as proposed). 39 See PO 00000 Frm 00034 Fmt 4700 Sfmt 4700 standard of review is appropriate in light of Congress’s direction that issuers ‘‘of an asset-backed security * * * perform a due diligence analysis of the assets.’’ 42 Indeed, permitting issuers to satisfy the statutory requirement with such a review potentially could undercut the statutory purpose by erroneously suggesting that due diligence was conducted. While we have concluded that a minimum review standard is appropriate for our final rule, we believe a flexible, principles-based standard that would be workable across a wide variety of asset classes and issuers would best accomplish our objectives. Consequently, we are adopting Rule 193 modified from the proposal to require an issuer to perform a review of the assets underlying an ABS in a transaction that will be registered under the Securities Act that, at a minimum, must be designed and effected to provide reasonable assurance that the disclosure in the prospectus regarding the assets is accurate in all material respects.43 We note that the minimum standard that we are adopting is similar to the standard many companies use in designing and maintaining disclosure controls and procedures required under Exchange Act Rule 13a–15.44 Our rules, which have applied to reporting companies for many years, generally ‘‘require an issuer to maintain disclosure controls and procedures to provide reasonable assurance that the issuer is able to record, process, summarize and report the information required in the issuer’s Exchange Act reports’’ within appropriate time frames.45 We believe that many issuers and their advisers are familiar with this type of standard.46 42 Id. 43 Thus, for example, if the prospectus disclosed that the loans are limited to borrowers with a specified minimum credit score, or certain income level, the review, as designed and effected, would be required to provide reasonable assurance that the loans in the pool met this criterion. 44 17 CFR 240.13a–15. 45 See Management’s Report on Internal Control over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, Release No. 33–8238 (June 5, 2003). See also Certification of Disclosure in Companies’ Quarterly and Annual Reports, Release No. 34–8124 (June 14, 2002) (‘‘Certification in Periodic Reports Release’’). ABS issuers must provide in Form 10–K an assessment by each party participating in the servicing function regarding its compliance with specified servicing criteria set forth in Item 1122 of Regulation AB. See 17 CFR 229.1122. A registered public accounting firm must issue an attestation report on such party’s assessment of compliance. See id. 46 Although ABS issuers are not subject to Rule 13a–15, ABS issuers that also issue corporate securities are familiar with it. We previously have E:\FR\FM\25JAR1.SGM 25JAR1 Federal Register / Vol. 76, No. 16 / Tuesday, January 25, 2011 / Rules and Regulations srobinson on DSKHWCL6B1PROD with RULES Rule 193 does not specify the particular type of review an issuer is required to perform.47 We expect that the type of review of the assets an issuer performs may vary depending on the circumstances. For example, the nature of review may vary among different asset classes. While Rule 193 does not require a particular type of review, as described below, disclosure describing the type of review is required. The ‘‘reasonable assurance’’ standard is similar to language in the Foreign Corrupt Practices Act of 1977.48 We recognize that while ‘‘reasonableness’’ is an objective standard, there is a range of judgments that an issuer might make as to what will provide ‘‘reasonable assurance.’’ 49 Thus, the term ‘‘reasonable assurance’’ in Rule 193 does not imply a single methodology, but encompasses the full range of reviews an issuer may perform to ensure that its review is designed and effected to provide reasonable assurance that the prospectus disclosure regarding the pool recognized that, because the information ABS issuers are required to provide differs significantly from that provided by other issuers, and because of the structure of ABS issuers as typically passive pools of assets, the certification requirements should be tailored specifically for ABS issuers. See Certification in Periodic Reports Release. 47 We understand that various levels and types of review may be performed in a securitization. For example, commentators on the 2010 ABS Proposing Release have identified that the type of review conducted by a sponsor of a securitization of subprime mortgage loans typically falls into three general categories. First, a credit review examines the sample loans to ascertain whether they have been originated in accordance with the originator’s underwriting guidelines. This would include a review of whether the loan characteristics reported by the originator are accurate and whether the credit profile of the loans is acceptable to the sponsor. A second type of review could be a compliance review which examines whether the loans have been originated in compliance with applicable laws, including predatory lending and Truth in Lending statutes. Third, a valuation review entails a review of the accuracy of the property values reported by the originators for the underlying collateral. This could include a review of each original appraisal to assess whether it appeared to comply with the originator’s appraisal guidelines, and the appropriateness of the comparables used in the original appraisal process. See comment letter from The Commonwealth of Massachusetts Office of the Attorney General (‘‘Massachusetts AG comment letter’’) on the 2010 ABS Proposing Release. The comment letters are available at https://www.sec.gov/comments/s7-0810/s70810.shtml. 48 Title 1 of Pub. L. 95–213 (1977). Exchange Act Section 13(b)(7) defines ‘‘reasonable assurance’’ as ‘‘such level of detail and degree of assurance as would satisfy prudent officials in the conduct of their own affairs.’’ 15 U.S.C. 78m(b)(7). We have long been of the view that ‘‘reasonableness’’ is not an ‘‘absolute standard of exactitude for corporate records.’’ Release No. 34–17500 (Jan. 29, 1981) [46 FR 11544]. 49 See Commission Guidance Regarding Management’s Report on Internal Control Over Financial Reporting Under Section 13(a) or 15(d) of the Securities Exchange Act of 1934, Release No. 34–55929 (June 20, 2007). VerDate Mar<15>2010 16:23 Jan 24, 2011 Jkt 223001 assets is accurate in all material respects. We continue to believe that the nature of review may vary depending on numerous circumstances and factors which could include, for example, the nature of the assets being securitized and the degree of continuing involvement by the sponsor.50 We note the suggestion by several commentators that sampling should be permitted.51 While we agree that sampling may be appropriate depending on the facts and circumstances, we believe that whether sampling is sufficient to satisfy the ‘‘reasonable assurance’’ standard in Rule 193 will depend on a variety of factors, such as the type of ABS being offered. For example, in offerings of residential mortgage-backed securities (‘‘RMBS’’), where the asset pool consists of a large group of loans, it may be appropriate, depending on all the facts, to review a sample of loans large enough to be representative of the pool, and then conduct further review if the initial review indicates that further review is warranted in order to provide reasonable assurance that disclosure is accurate in all material respects. By contrast, for ABS where a significant portion of the cash flow will be derived from a single obligor or a small group of obligors, such as ABS backed by a small number of commercial loans (‘‘CMBS’’), it may be appropriate for the review to include every pool asset. Moreover, in ABS transactions where the asset pool composition turns over rapidly because it contains revolving assets, such as credit card receivables or dealer floorplan receivables, a different type of review may be warranted than in ABS transactions involving term receivables, such as mortgage or auto loans. We are not adopting a minimum sample size for offerings where sampling may be appropriate for the review as we believe any appropriate sample size must be based on the facts and circumstances. While reviewing a sample of assets may or may not be appropriate under the particular facts, we agree with commentators who suggested that, where a sample of the assets is reviewed, the size of the sample and the criteria used to select the assets sampled should be disclosed. Accordingly, we are adding an instruction noting that this disclosure should be provided as part of the 50 We agree with one commentator’s view that the review that is required is a review of the assets for purposes of the securitization and not the review conducted to originate the assets. 51 See, e.g., comment letters from ABA; Fitch; Levin; SIFMA. PO 00000 Frm 00035 Fmt 4700 Sfmt 4700 4235 description of the nature of the review, as discussed further below. We have considered comment letters stating that the required review should relate to the credit quality, or underwriting, of the assets rather than the accuracy of the disclosure in the prospectus. We believe that accuracy of disclosure in the prospectus is an appropriate objective for the required review. The minimum review standard we are adopting will necessarily include credit quality and underwriting of the assets since disclosure about these factors is required in the prospectus, but also will be broader than just a review of the underwriting of the assets. Because an issuer is required under Regulation AB to provide disclosure about material characteristics of the asset pool indicating the quality of the asset pool, under the review requirement we are adopting today, the issuer will be required to review whether the disclosure regarding the asset pool is accurate in all material respects.52 In addition to credit quality, this will include the disclosure currently required by Item 1111 of Regulation AB. Further, under Item 1111 of Regulation AB, as revised today, prospectus disclosure of the nature of the review is required. C. Third Party Reviews 1. Proposed Amendments Proposed Rule 193 would have permitted an issuer to rely on third parties to satisfy its obligations under Rule 193 provided the third party is named in the registration statement and consents to being named as an ‘‘expert’’ in accordance with Section 7 of the Securities Act and Rule 436 under the Securities Act.53 2. Comments on the Proposed Amendments Some commentators supported the proposal to permit issuers to rely on third-party firms to conduct the 52 We note that the federal securities laws currently require that disclosure in the prospectus not contain an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements not misleading. See Securities Act Section 11 [15 U.S.C. 77k] and Securities Act Section 12 [12 U.S.C. 77l]. See also Securities Act Section 17 [15 U.S.C. 77q], Exchange Act Section 10(b) [15 U.S.C. 78j] and Rule 10b–5 under the Exchange Act [17 CFR 240.10b–5]. 53 Section 7 of the Securities Act requires the consent of any person whose profession gives authority to a statement made by him, is named as having prepared or certified any part of the registration statement, or is named as having prepared or certified a report or valuation for use in connection with the registration statement. E:\FR\FM\25JAR1.SGM 25JAR1 4236 Federal Register / Vol. 76, No. 16 / Tuesday, January 25, 2011 / Rules and Regulations srobinson on DSKHWCL6B1PROD with RULES required review.54 One commentator noted that issuers should be responsible for the sufficiency and accuracy of the reviews without regard to whether the review is conducted by a third party.55 Another commentator recommended that any third-party review be at arm’s length.56 In contrast, another commentator did not believe that an independence requirement was needed because an issuer may perform the review itself and cannot be independent or conflict-free with respect to itself.57 This commentator reasoned that since an issuer is not required to rely on a third party and could conduct the review itself, there is no greater likelihood that the independence would be impaired.58 Some commentators expressed concern that third-party due diligence providers would be considered experts under the Securities Act and asserted that this treatment would be inconsistent with the principles guiding Section 11(a)(4) of the Securities Act.59 Some commentators predicted that this requirement is likely to result in these providers withdrawing from providing services to transactions where expert liability would attach.60 One commentator noted that if these thirdparty due diligence providers are subject to expert liability and they refuse to consent to being named as experts, registered RMBS transactions will become impossible because many NRSROs require that a non-affiliated third party perform a due diligence review in order to rate RMBS.61 This commentator explained that if issuers are unable to obtain a third-party review because of expert liability they would be unable to obtain a credit rating because of the lack of a third-party review.62 Several commentators who expressed concern that third-party due diligence providers would be considered experts under the Securities Act reasoned that due diligence providers are not licensed professionals and are not part of a regulated industry that is governed by a formal professional association.63 One commentator argued that in light of an issuer’s continuing liability under Section 11 for its disclosure related to 54 See comment letters from ABA; Consumer Federation. 55 See comment letter from CRL. 56 See comment letter from Barnard. 57 See comment letter from CAQ. 58 See comment letter from CAQ. 59 See comment letters from ABASA; Clayton; SIFMA. 60 See comment letters from Clayton; SIFMA. 61 See comment letter from SIFMA. 62 See comment letter from SIFMA. 63 See comment letters from ABASA; Clayton; SIFMA. VerDate Mar<15>2010 16:23 Jan 24, 2011 Jkt 223001 due diligence, the additional comfort to the Commission and investors as to the accuracy of the diligence results gained by requiring expert liability is outweighed by the loss of diligence firms that will not consent to becoming experts.64 3. Final Rule—Third-Party Review We are adopting, as proposed, a requirement that if an issuer engages a third party for purposes of performing its Rule 193 review, then an issuer may rely on the third-party’s review to satisfy its obligations under Rule 193 provided the third party is named in the registration statement and consents to being named as an ‘‘expert’’ in accordance with Section 7 of the Securities Act and Rule 436 under the Securities Act. We believe that allowing issuers to contract with a third-party due diligence provider 65 is consistent with Section 15E(s)(4) of the Exchange Act.66 We recognize that issuers may routinely hire third parties to conduct various types of reviews, and not all persons assisting an issuer in these reviews would be subject to the new requirements. Under our new rule, any third party hired by the issuer to perform the review required under Rule 193, and to whom the issuer attributes findings and conclusions of the review in the prospectus will be required to be named in the registration statement and consent to being named as an ‘‘expert’’ as described above. On the other hand, if an issuer obtains assistance from a third party but attributes to itself the findings and conclusions of the review required by Rule 193, the third party 64 See comment letter from SIFMA. See also comment letter from Clayton (noting there is a significant risk it will refrain from accepting engagements to perform the asset review mandated by Rule 193 leading issuers to more in-house reviews, which could give rise to potential conflicts of interest). 65 In this release, we refer to third parties engaged for purposes of reviewing the assets also as thirdparty due diligence providers. 66 As noted above, Section 15E(s)(4) of the Exchange Act requires the issuer or underwriter of an ABS to make publicly available the findings and conclusions of a third-party due diligence report obtained by the issuer or the underwriter and requires a third-party due diligence provider that is employed by a nationally recognized statistical rating organization (‘‘NRSRO’’), an issuer or an underwriter to provide a written certification to the NRSRO that produces a credit rating. Under Section 15E(s)(4) of the Exchange Act, the Commission is required to establish the appropriate format and content for the certifications ‘‘to ensure that providers of due diligence services have conducted a thorough review of data, documentation, and other relevant information necessary for a nationally recognized statistical rating organization to provide an accurate rating.’’ As noted above, we will address these requirements in a subsequent rulemaking. PO 00000 Frm 00036 Fmt 4700 Sfmt 4700 would not be required to consent to being named as an expert.67 In either case, the prospectus disclosure should make clear whether the disclosed finding and conclusions are those of the issuer or of a third party.68 We believe that the hiring by an issuer of a third party to perform the review and using that review to market its securities would be inconsistent with disclosure that the issuer attributes to itself the findings and conclusions of the review.69 We also note that an issuer may rely on multiple third parties to fulfill its Rule 193 review obligation, provided the issuer complies with the above requirements for each third party. We note commentators’ concern that some third parties might not consent to being named as experts. We are not requiring a third-party review and, if the issuer obtains the assistance of a third party, the issuer can attribute the findings and conclusions of the review to itself and avoid the need to obtain consent. If, however, the issuer attributes the findings and conclusions to a third party, we believe that the third party should be named in the registration statement and be treated in the same manner as other experts, such as investment banks that provide fairness opinions. We believe, based on discussions with industry participants, that at least some third-party reviewers will continue to perform reviews for ABS issuers and will revise their review procedures as needed to be comfortable 67 If the findings and conclusions are attributed to a third party, that portion of the disclosure would be expertised. If the findings and conclusions are instead attributed to the issuer, that portion of disclosure would not be expertised. See Securities Act Section 11 [15 U.S.C. 77k]. 68 We note that this approach is comparable to the staff’s position in the context of a registrant that has engaged a third-party expert to assist in determining the fair values of certain assets or liabilities disclosed in a Securities Act registration statement. See Compliance and Disclosure Interpretations, Division of Corporation Finance, at Section 233, available at https://www.sec.gov/divisions/corpfin/ guidance/securitiesactrules-interps.htm (whether a registrant that has engaged a third-party expert to assist in determining fair value must disclose the name of the third-party expert in its registration statement and obtain the third-party’s consent under Securities Act Section 7(a) depends on whether the disclosure attributes the statement to the third-party expert). 69 If an issuer obtains the assistance of a third party to perform the review, and discloses this fact pursuant to Item 1111 of Regulation AB, as discussed below, this would not be using the information to market the securities provided the only information disclosed is that which is required by the rule, and the issuer does not otherwise use this fact to market the securities. Similarly, we are of the view that consent to being named as an expert would not be required of a third party hired by the issuer to assist in performing the review solely based on the fact that the issuer provides disclosure pursuant to Item 1111 of Regulation AB that the issuer hired a third party for the purpose of assisting it to perform the Rule 193 review. E:\FR\FM\25JAR1.SGM 25JAR1 Federal Register / Vol. 76, No. 16 / Tuesday, January 25, 2011 / Rules and Regulations being named as experts in registered ABS transactions. We also note that third parties would not be required to provide consent in all instances, but only where the issuer attributes the findings and conclusions of the review to the third party. D. Disclosure Requirements srobinson on DSKHWCL6B1PROD with RULES 1. Proposed Rules Item 1111 of Regulation AB 70 outlines several aspects of the pool that the prospectus disclosure for ABS should cover. We proposed amendments to Item 1111 to require disclosure regarding the nature of the issuer’s review of the assets under Rule 193 and the findings and conclusions of the review. In addition, we re-proposed amendments from our 2010 ABS Proposing Release to require disclosure regarding the composition of the pool as it relates to assets that do not meet disclosed underwriting standards, as we believe this information would promote a better understanding of the impact of the review and the composition of the pool assets. We proposed new Item 1111(a)(7) of Regulation AB to require that an issuer of ABS disclose the nature of the review it conducts to satisfy proposed Rule 193. This proposed requirement would implement Securities Act Section 7(d)(2),71 as added by the Act. As discussed in the Proposing Release, this disclosure would include whether the issuer has hired a third-party firm for the purpose of reviewing the assets. We also proposed to amend Item 1111(a)(7) to require an ABS issuer to disclose the findings and conclusions of any review performed by the issuer or by a third party engaged for purposes of reviewing the assets.72 We also proposed Item 1111(a)(8) which re-proposed additional requirements substantially similar to those we had previously proposed in the 2010 ABS Proposing Release. This item would have required disclosure of whether, and if so, how, any assets in the pool deviate from the disclosed underwriting criteria and data on the amount and characteristics of those assets that did not meet the disclosed standards. In addition to what we proposed in the 2010 ABS Proposing Release, we proposed a requirement that the issuer disclose the entity (e.g., sponsor, originator or underwriter) who determined that such assets would be included in the pool, despite not having 70 17 CFR 229.1111. U.S.C. 77g(d)(2). 72 This language is intended to be consistent with the language used in Exchange Act Section 15E(s)(4)(A). 71 15 VerDate Mar<15>2010 16:23 Jan 24, 2011 Jkt 223001 met the disclosed underwriting standards. 2. Comments on the Proposed Amendments Comments on the proposal were mixed. Some commentators supported the proposal in Item 1111(a)(7) 73 and another commentator expressed support for the proposal in Item 1111(a)(8).74 Another commentator requested that the Commission modify the proposal in Item 1111(a)(8) such that the disclosure would be required only to the extent it is material to investors.75 This commentator also suggested that the Commission clarify that subparagraph (8) not be read to require 100% diligence of the pool such that, to the extent that an issuer does a sampling of the pool, only the deviations that are discovered in that sampling would need to be reported.76 This commentator also objected to the proposal to disclose the entity who made the decision to include the deviating assets as part of the pool, because multiple transaction parties could collectively agree on what assets are to be included in the pool.77 To the extent that in a particular transaction a single party makes the decision, this commentator argued that the disclosure is not material and should not be required to be reported.78 Another commentator suggested that such disclosure not be required for offerings of CMBS because decisions about CMBS pool assets are not susceptible to being attributed to a particular party due to the fungible nature of CMBS assets and the fact that the decisions are an iterative process involving the sponsor, issuer, and at times investors, to largely the same degree.79 Some commentators recommended that the rule provide further guidance on the findings and conclusions that must be disclosed.80 One commentator highlighted that third-party due diligence reviews typically evaluate a sample of assets according to underwriting guidelines provided by the asset seller and other criteria specified by the asset purchaser.81 This commentator noted that the typical end product of a third-party due diligence review in RMBS offerings is the grading of specific loans in a sample provided by the asset purchaser, according to 73 See comment letters from Chuff; SIFMA. comment letter from Fitch. 75 See comment letter from SIFMA. 76 See comment letter from SIFMA. 77 See comment letter from SIFMA. 78 See comment letter from SIFMA. 79 See comment letter from CRE Finance Council. 80 See comment letters from CRE Finance Council; Levin. 81 See comment letter from Levin. 74 See PO 00000 Frm 00037 Fmt 4700 Sfmt 4700 4237 whether the loans meet the seller guidelines and buyer criteria or whether they comply with applicable laws.82 In order for investors to be able to understand the loan ‘‘grades’’ and evaluate the quality of the reviewed assets, however, this commentator suggested that the rule require disclosure of the controlling guidelines and criteria used to produce the loan grades or designations.83 One commentator argued that Item 1111(a)(8) seems to assume that all originators have uniform underwriting criteria that permit the evaluation of most loans on a mechanical basis.84 In particular, this commentator explained that auto loan originators do not have hard and fast guidelines by which most loan applications can be evaluated. Instead, explained this commentator, such originators use electronic decisionmaking systems as a first filter for applications. Most decisions, however, are made by credit analysts at a variety of levels and the fact that a given loan required a higher level of approval does not mean that the loan should be considered an exception to the underwriting guidelines because there may be many reasons why a loan might require a higher level of approval and still fit within the ‘‘standard process’’ of the originator. While this commentator did not object to the Commission’s formulation of Item 1111(a)(8), it believed that many sponsors of auto loan ABS would not provide any incremental disclosure in response to new Item 1111(a)(8) because the underwriting guidelines in their prospectuses indicate that they make judgmental underwriting decisions, and there are not disclosed standards by which loans are evaluated, so there will not be a need to describe loans that fail to meet those standards. 3. Final Rules After considering the comments, we are adopting the amendments to Item 1111 of Regulation AB substantially as proposed. We agree with commentators that the disclosure should provide a clear picture of the review undertaken and the results and have thus revised the item to make that clearer. a. Nature of Review New Item 1111(a)(7) of Regulation AB requires that an issuer of ABS disclose the nature of the review it conducts to satisfy proposed Rule 193. This would include whether the issuer has hired a third-party firm for the purpose of 82 See comment letter from Levin. comment letter from Levin. 84 See comment letter from AFSA. 83 See E:\FR\FM\25JAR1.SGM 25JAR1 4238 Federal Register / Vol. 76, No. 16 / Tuesday, January 25, 2011 / Rules and Regulations reviewing the assets, or to assist it in reviewing the assets. This would include a description of the scope of the review, such as whether the issuer or a third party conducted a review of a sample of the assets and what kind of sampling technique was employed (i.e., random or adverse). b. Findings and Conclusions Under new Item 1111(a)(7), the issuer will be required to disclose the findings and conclusions of the review performed by the issuer or by a third party engaged for purposes of reviewing the assets. Although Section 7(d) of the Securities Act does not require our rules to mandate that the issuer disclose the findings and conclusions of a review in its registration statement, we continue to believe this information is important for investors to consider along with the information in the registration statement relating to the nature of the issuer’s review as required to be publicly disclosed by Securities Act Section 7(d). We continue to believe that disclosure of the findings and conclusions of the review will provide investors with a better picture of the assets than would be provided by disclosure only of the nature of the review and would provide a better ability to evaluate the review. We have revised the item to make clear that disclosure of the findings and conclusions necessarily requires disclosure of the criteria against which the loans were evaluated, and how the evaluated loans compared to those criteria along with the basis for including any loans not meeting those criteria.85 In order to ensure that this requirement is clear, we have included an instruction to the rule. srobinson on DSKHWCL6B1PROD with RULES c. Disclosure Regarding Exception Loans We are adopting, as proposed, Item 1111(a)(8) of Regulation AB. Item 1111(a)(8) of Regulation AB requires issuers to disclose how the assets in the pool deviate from the disclosed underwriting criteria and include data on the amount and characteristics of those assets that did not meet the disclosed standards. Issuers are required to disclose the entity (e.g., sponsor, originator, or underwriter) who determined that such assets should be included in the pool, despite not having met the disclosed underwriting standards, and what factors were used 85 Such disclosure would be required in order to provide meaningful context to disclosure of the findings and conclusions of the issuer or their-party due diligence providers. See comment letter from Levin (stating that disclosure of loan grades, as used by third-party due diligence providers, in isolation, without disclosure of controlling guidelines used to produce those grades, is not useful to investors). VerDate Mar<15>2010 16:23 Jan 24, 2011 Jkt 223001 to make the determination. For example, this could include compensating factors, such as those included in an issuer’s waiver policies for including in the pool loans that fail to meet the disclosed underwriting criteria, or a determination that the exception was not material. If compensating or other factors were used, issuers will be required to provide data on the amount of assets in the pool, or in the sample or otherwise known to the issuer if only a sample was reviewed, that are represented as meeting each factor and the amount of assets that do not meet those factors. We also believe that this information will help provide investors with a more complete understanding of the quality and extent of the issuer’s review of the assets (through hiring a third-party or otherwise) and how that relates to a determination to either include a loan in the pool or exclude it from the pool. To the extent the underwriting criteria outlined in the prospectus are broad or describe underwriting decisions involving the use of discretion, the prospectus would need to provide disclosure of how the broad subjective underwriting decisions were applied. We note that Item 1111 of Regulation AB requires a description of the underwriting criteria used to originate or purchase the pool assets. Thus, where originators may approve loans at a variety of levels, and the loans underwritten at an incrementally higher level of approval are evaluated based on judgmental underwriting decisions, the criteria for the first level of underwriting should be disclosed, and loans that are included in the pool despite not meeting the criteria for this first level of underwriting criteria should be disclosed under Item 1111(a)(8). We also are adopting, with some clarification, the requirement that the issuer disclose the entity (e.g., sponsor, originator or underwriter) who determined that such assets would be included in the pool, despite not having met the disclosed underwriting standards. While we are aware of some commentators’ objection to reporting this information because of the possibility that multiple transaction parties could collectively agree on what assets are to be included in the pool, we continue to believe that this additional requirement will assist investors in understanding the entities along the securitization chain that may be directing decisions to include exception loans in the pool, even where more than one entity may be involved.86 We believe this information will be useful to investors because it will provide 86 See, PO 00000 e.g., Massachusetts AG comment letter. Frm 00038 Fmt 4700 Sfmt 4700 investors with information to gauge whether the decision to accept such loans may be subject to a potential conflict of interest. We have revised the rule to clarify that if multiple parties are involved in this decision, they should all be named. E. Transition Period Consistent with one commentator’s suggestion, we have set a compliance date for the rule we adopt today that will allow market participants and industry groups sufficient time to develop procedures and systems required to comply with rule’s requirements.87 As this commentator noted, and as we recognize, other initiatives and changes to the markets are simultaneously affecting participants in the securitization industry.88 Accordingly, any registered offering of ABS commencing with an initial bona fide offer after December 31, 2011, must comply with the new rules. We believe, consistent with one commentator’s suggestion, a transition period will allow issuers time to design a review to meet the rule’s minimum standard.89 We also believe a transition period will benefit third parties who, under the rule, potentially may be subject to expert liability in certain circumstances and may require a transitional period to implement procedures, or revise current ones, in light of the potential expert liability. III. Paperwork Reduction Act Certain provisions of the final rules contain ‘‘collection of information’’ requirements within the meaning of the Paperwork Reduction Act of 1995 (PRA).90 We published a notice requesting comment on the collection of information requirements in the Proposing Release for the rule amendments, and we submitted these requirements to the Office of Management and Budget (‘‘OMB’’) for review in accordance with the PRA.91 An agency may not conduct or sponsor, and a person is not required to comply with, a collection of information unless it displays a currently valid control 87 See comment letter from SIFMA. e.g., Improvements to the Asset-Backed Securitization Process, Title IX, Subtitle D of the Act; Treatment by the Federal Deposit Insurance Corporation as Conservator or Receiver of Financial Assets Transferred by an Insured Depository Institution in Connection with a Securitization or Participation After September 30, 2010, Final Rule, Federal Deposit Insurance Corporation (Sept. 27, 2010). 89 See comment letter from SIFMA. 90 44 U.S.C. 3501 et seq. 91 44 U.S.C. 3507(d) and 5 CFR 1320.11. 88 See, E:\FR\FM\25JAR1.SGM 25JAR1 Federal Register / Vol. 76, No. 16 / Tuesday, January 25, 2011 / Rules and Regulations number. The titles for the collections of information are: 92 (1) ‘‘Form S–1’’ (OMB Control No. 3235–0065); (2) ‘‘Form S–3’’ (OMB Control No. 3235–0073); and (3) ‘‘Regulation S–K’’ (OMB Control No. 3235–0071). Compliance with the proposed amendments is mandatory. Responses to the information collections will not be kept confidential and there is no mandatory retention period for the information disclosed. Our PRA burden estimates for the final amendments are based on information that we receive on entities assigned to Standard Industrial Classification Code 6189, the code used with respect to ABS, as well as information from outside sources.93 When possible, we base our estimates on an average of the data that we have available for the years 2004 through 2009. In the Proposing Release, we requested comment on the PRA analysis. No commentators responded to our request for comment on the PRA analysis. srobinson on DSKHWCL6B1PROD with RULES 92 The paperwork burden from Regulation S–K is imposed through the forms that are subject to the requirements in those regulations and is reflected in the analysis of those forms. To avoid a Paperwork Reduction Act inventory reflecting duplicative burdens and for administrative convenience, we assign a one-hour burden to Regulation S–K. 93 We rely on two outside sources of ABS issuance data. We use the ABS issuance data from Asset-Backed Alert on the initial terms of offerings, and we supplement that data with information from Securities Data Corporation (SDC). VerDate Mar<15>2010 16:23 Jan 24, 2011 Jkt 223001 Forms S–1 and S–3 The amendments to Item 1111 of Regulation AB will increase the disclosure required in offerings of ABS registered on either Forms S–1 or S–3. The amendment to Item 1111 requires issuers to disclose how the assets in the pool deviate from the disclosed underwriting criteria, and include data on the amount and characteristics of those assets that did not meet the disclosed standards. Issuers will be required to disclose the entity who determined that such assets should be included in the pool and what factors were used to make the determination. Under new Rule 193, if an issuer employs a third party to perform the review and attributes the findings and conclusions of the review to the third party, the third party must be named in the registration statement and consent to being named as an expert in accordance with Securities Act Rule 436. Thus, we anticipate that issuers will incur a burden in obtaining a consent from the third party. We believe that the requirements will increase the annual incremental burden to issuers by 30 hours per form.94 For registration statements, we estimate that 25% of the burden of preparation is carried by the company internally and that 75% of the burden is carried by outside professionals retained by the registrant at an average cost of $400 per hour. From 2004 through 2009, an 94 This does not reflect burdens associated with the review that would be required as a result of Rule 193, which we believe does not impose a collection of information requirement for purposes of our PRA analysis. PO 00000 Frm 00039 Fmt 4700 Sfmt 4700 4239 estimated average of four offerings was registered annually on Form S–1 by ABS issuers. We believe that the requirements will result in an increase to the internal burden to prepare Form S–1 of 30 burden hours (0.25 × 30 × 4) and an increase in outside costs of $36,000 ($400 × 0.75 × 30 × 4). During 2004 through 2009, we estimate an annual average of 929 offerings of ABS registered on Form S–3. Therefore, we believe that the requirements we are adopting will result in an increase to the internal burden to prepare Form S–3 filings of 6,968 burden hours (0.25 × 30 × 929) and a total cost of $8,361,000 (400 × 0.75 × 30 × 929). Regulation S–K Regulation S–K includes the item requirements in Regulation AB and contains the disclosure requirements for filings under both the Securities Act and the Exchange Act. In 2004, we noted that the collection of information requirements associated with Regulation S–K as it applies to ABS issuers are included in Form S–1 and Form S–3.95 The amendments that we are adopting revise Regulation S–K. The collection of information requirements, however, are reflected in the burden hours estimated for the various Securities Act and Exchange Act forms related to ABS issuers. The rules in Regulation S–K do not impose any separate burden. Consistent with historical practice, we have retained an estimate of one burden hour for Regulation S–K for administrative convenience. 95 See E:\FR\FM\25JAR1.SGM 2004 Regulation AB Adopting Release. 25JAR1 1,168 2,065 ........................ Total ...................................................... Current annual responses S–1 .............................................................. S–3 .............................................................. Form srobinson on DSKHWCL6B1PROD with RULES VerDate Mar<15>2010 ........................ 1,168 2,065 Proposed annual responses ........................ 247,982 236,959 Current burden hours 6,998 30 6,968 Increase in burden hours ........................ 248,012 243,927 Proposed burden hours ............................ $297,578,400 284,350,500 Current professional costs 8,397,000 $36,000 8,361,000 Increase in professional costs ............................ $297,614,400 292,711,500 Proposed professional costs 4240 Federal Register / Vol. 76, No. 16 / Tuesday, January 25, 2011 / Rules and Regulations 16:23 Jan 24, 2011 Jkt 223001 PO 00000 Frm 00040 Fmt 4700 Sfmt 4700 E:\FR\FM\25JAR1.SGM 25JAR1 Federal Register / Vol. 76, No. 16 / Tuesday, January 25, 2011 / Rules and Regulations IV. Benefit-Cost Analysis The amendments to our regulations for ABS relate to requiring an issuer of an ABS to perform a review of the assets underlying the security. The rules we are adopting are intended to implement the requirements under new Section 7(d) of the Securities Act. First, we are adopting a new Securities Act rule to require issuers of registered offerings of asset-backed securities to perform a review of the assets underlying the asset-backed securities that, at a minimum, must be designed and effected to provide reasonable assurance that the disclosure regarding the pool assets in the prospectus is accurate in all material respects. Second, we also are adopting new requirements in Regulation AB to require disclosure regarding: • The nature of the review of assets conducted by an ABS issuer; • The findings and conclusions of a review of assets conducted by an ABS issuer or third party; • Disclosure regarding assets in the pool that do not meet the underwriting standards; and • Disclosure regarding which entity determined that the assets should be included in the pool, despite not having met the underwriting standards and what factors were considered in making this determination. The Commission is sensitive to the costs and benefits imposed by the rules it is adopting. The discussion below focuses on the costs and benefits of the amendments made by the Commission to implement the Act within the Commission’s permitted discretion and related amendments not required by the Act, rather than the costs and benefits of the Act itself. Except as discussed below, no commentators responded to our request for comment on the costs and benefits of the proposed rule identified in the Proposing Release. srobinson on DSKHWCL6B1PROD with RULES A. Benefits The amendments we are adopting are designed to increase investor protection by implementing the requirement in Section 7(d) of the Securities Act, which was added by Section 945 of the Act, for issuers to perform a review of the underlying assets and disclose the nature of the review. We expect that requiring a minimum level of review of the assets will result in loan pools that have fewer loans that do not conform to the disclosures in the prospectus regarding the pool assets. We also expect that establishing a minimum level of review will prevent some potential reviews that are not sufficiently thorough, and disclosures VerDate Mar<15>2010 16:23 Jan 24, 2011 Jkt 223001 about the pool assets that are not sufficiently accurate. Finally, we also expect that a minimum standard of review will benefit investors by facilitating comparability among reviews performed by different issuers. On the other hand, we believe that a principles-based approach is appropriate to allow for review procedures to be based upon the economic characteristics of the asset pool that is being examined. Accordingly, our rules do not prescribe specific guidelines to employ in reviews. This flexibility should help increase the usefulness of reviews for investors and limit their costs. Further, the detailed description of the nature of the review and disclosure of findings and conclusions should encourage more rigorous asset reviews, whether by issuers or third parties engaged to perform the asset reviews. These disclosures would complement the requirement to perform a review by improving the quality, and investor understanding, of the review. Although issuers in registered offerings are not required to use a third party to satisfy the review requirement, as a condition to such use, if the findings and conclusions of the review will be attributed to a third party, a third party would be required to consent to being named in the registration statement and thereby accept potential expert liability, which should increase the quality of that review. In registered offerings, where the third party consents to being named in the prospectus, the potential expert liability for the findings and conclusions of third-party reviews should provide accountability and creates stronger incentives to perform high-quality reviews that protect investors. The resulting disclosures should reduce the information risk of investing in these securities. Our amendments to require detailed disclosure by the issuer of the nature, findings and conclusions of its review could result in improved asset review practices. Moreover, this could be useful to investors if they prefer investing in securities about which there is disclosure indicating a more robust review over investing in securities about which the disclosure indicates a less robust review. The requirement to disclose exception loans may provide important information to investors regarding the characteristics of the pool that may otherwise not be publicly known. For those issuers that currently provide asset-level information about the pool, an investor might be able, without this new requirement, to determine some information about the number of PO 00000 Frm 00041 Fmt 4700 Sfmt 4700 4241 exception loans; however, even where this could be determined under current rules, the amendments would reduce investors’ cost of information production by reducing duplicative efforts to gather such data on their own or purchase it through data intermediaries. We also are adopting amendments to require disclosure of the entities that have determined that an asset that deviates from underwriting standards should, nonetheless, be included in the pool. Because thirdparty asset review providers typically work for sponsors, there is potentially a conflict of interest when a sponsor can waive or overrule the third-party’s conclusions that insufficient compensating factors exist to allow inclusion of an asset that does not meet the underwriting standards governing the pool.96 We expect that information about which entity made the determination to include an asset in the pool despite not having met the underwriting standards will provide investors with information to gauge whether the decision to accept such loans otherwise may be subject to a conflict of interest. We also expect this will reduce the cost of information asymmetry and could be useful information to investors because investors may be able to price a securitization of a pool of assets more accurately. It also may assist credit rating agencies in assigning more informed credit ratings, and investors may be able to price ABS offerings more accurately. Our amendments requiring detailed disclosure of the nature of the review, as well as the findings and conclusions of any such review, may increase investor confidence in the market for ABS. These disclosures could allow investors to better understand the information about the asset pool and credit risk of the asset pool. B. Costs The final rule would implement the requirement in Section 7(d) of the Securities Act, added by Section 945 of the Act, that all issuers of registered ABS offerings perform a review of the underlying assets and that those issuers disclose the nature of their review. Although issuers of ABS likely already perform some level of review of the underlying assets and many originators review the assets at origination, ABS issuers in registered offerings may incur additional costs to perform more extensive reviews that are sufficient to comply with the minimum level of 96 See, e.g., comment letter from Massachusetts AG. E:\FR\FM\25JAR1.SGM 25JAR1 srobinson on DSKHWCL6B1PROD with RULES 4242 Federal Register / Vol. 76, No. 16 / Tuesday, January 25, 2011 / Rules and Regulations review required by the rule, whether the issuer performs the review itself, or hires a third-party to perform the review. Moreover, this could be costly to issuers, if investors do not seek to invest in securities about which there is disclosure indicating a more robust review over investing in securities about which the disclosure indicates a less robust review. It is possible that by establishing a minimum standard for the review, some issuers who otherwise may have performed a more thorough review may design their reviews to accomplish no more than the minimum required by the rule.97 We note, however, that under Rule 193 issuers may obtain a third party to perform the required review and attribute the review to the third party provided the third party is named in the registration statement and consents to being named as an expert in the registration statement. This flexibility in the rule allows for those third-party reviewers that consent to being named as an expert in the registration statement to conduct more thorough reviews and separate themselves from other third-party reviewers that would not provide those higher levels of assurance. At the same time, commentators observed that there are incentives not to conduct adequate due diligence, which supports the need for a minimum standard required by law.98 Rule 193 permits an issuer to rely on a third party to perform the required review, provided the review satisfies the standard in Rule 193. If the issuer will attribute the findings and conclusions of the review to the third party, the third party will be required to be named in the registration statement and consent to be named as an expert in the registration statement. One commentator predicted that requiring third parties to be named in the registration statement as experts will materially impact the cost of due diligence services which will likely render securitizations non-economic for issuers.99 Some asset classes may not have third-party due diligence providers available to be engaged to conduct a review. In instances where an issuer must conduct the review and attributes to itself the findings and conclusions of the review, we believe that the costs of conducting these reviews will not exceed the costs of engaging third parties to conduct the reviews. 97 See, e.g., comment letter from Consumer Federation (observing that all members of the securitization supply change have ‘‘strong incentives * * * to skimp on due diligence’’). 98 Id. 99 See comment letter from SIFMA. VerDate Mar<15>2010 16:23 Jan 24, 2011 Jkt 223001 Further, it is possible that third-party providers may lack sufficient capabilities to provide the review for which they are retained. Additionally, third-party review firms are not registered with the Commission and some may not be subject to professional standards. However, our rules subject third-party review firms in registered transactions to potential expert liability for the disclosure regarding the findings and conclusions of their review of the assets. For certain firms, however, in particular smaller review firms that may lack the financial resources to cover their potential liabilities, expert liability may not be a significant deterrent because these firms have less financial resources exposed to potential liability and may not be as concerned about losing potential claims compared to firms that have more financial resources exposed to liability. This may create a burden on both qualified providers of due diligence and the securitizers that hire them. We acknowledge that the potential for expert liability could impose costs on issuers and third-party due diligence providers, and they may be required to adjust their practices (and prices in the case of third parties) to account for this new requirement. Some commentators noted that it is possible that third parties engaged by issuers to perform the review required by Rule 193 may be unwilling to consent to being named in the registration statement as experts.100 In the context of RMBS, some credit rating agencies require third-party reviews on all residential mortgage pools as a condition to rating the transaction.101 If all third-party providers are unwilling to consent to being named in the registration statement as experts, issuers that are unwilling to attribute to themselves alone the findings and conclusions of the review may be unable to obtain a third party review and, consequently, be unable to obtain a credit rating. We note, however, that a third party would not be required to consent to being named as an expert if an issuer does not attribute the findings and conclusions of the review to the third party. We also believe, based on discussions with industry participants, including thirdparty review firms, that at least some third parties hired to perform the review will make any necessary adjustments to their review procedures and prices in order to be willing to be named in the registration statement as experts. 100 See, e.g., comment letters from ASF; Clayton; SIFMA. 101 See comment letter from Fitch. PO 00000 Frm 00042 Fmt 4700 Sfmt 4700 As adopted, the amendments requiring issuers to provide detailed disclosure relating to the nature of the review, the findings and conclusions of such review, and disclosure about loans that deviate from the disclosed underwriting criteria will impose a disclosure burden. V. Consideration of Burden on Competition and Promotion of Efficiency, Competition and Capital Formation Section 23(a) of the Exchange Act 102 requires the Commission, when making rules and regulations under the Exchange Act, to consider the impact a new rule would have on competition. Section 23(a)(2) prohibits the Commission from adopting any rule that would impose a burden on competition not necessary or appropriate in furtherance of the purposes of the Exchange Act. Section 2(b) of the Securities Act 103 and Section 3(f) of the Exchange Act 104 require the Commission, when engaging in rulemaking that requires it to consider whether an action is necessary or appropriate in the public interest, to consider, in addition to the protection of investors, whether the action would promote efficiency, competition, and capital formation. Below, we address these issues for each of the substantive changes we are adopting regarding offerings of ABS. As a result of the financial crisis and subsequent events, the market for securitization has declined due, in part, to perceived uncertainty about the accuracy of information about the pools backing the ABS and perceived problems in the securitization process that affected investors’ willingness to participate in these offerings.105 Greater transparency of the review performed on the underlying assets would decrease the uncertainty about pool information and, thus, should help investors price these products more accurately. The requirements we are adopting are likely to positively affect pricing, efficiency, and capital allocation in ABS capital markets. The minimum review standard that we are adopting helps to strengthen these effects by decreasing the possibility of low quality review providers entering the market and possibly precipitating a decrease in the quality of due diligence. Finally, the introduction of expert liability on the third-party review 102 15 U.S.C. 78w(a). U.S.C. 77b(b). 104 15 U.S.C. 78c(f). 105 See, e.g., David Adler, A Flat Dow for 10 Years? Why It Could Happen, Barrons (Dec. 28, 2009). 103 15 E:\FR\FM\25JAR1.SGM 25JAR1 Federal Register / Vol. 76, No. 16 / Tuesday, January 25, 2011 / Rules and Regulations srobinson on DSKHWCL6B1PROD with RULES providers may have consequences for the competition in this market. The possibility of expert liability may provide an incentive for due diligence providers to improve the quality of their reviews. Thus, one possible market outcome is for reviewers to compete on the quality of their services, because high quality providers may credibly separate themselves from lower quality providers by consenting to be named as experts, with potential liability resulting from that designation. On the other hand, the possibility of expert liability may not be a significant deterrent for smaller due diligence providers that do not have the financial resources to cover their potential liabilities. This may adversely affect competition in both the market for the provision of due diligence and the market for ABS. Diligent providers of asset reviews may be pressured to decrease their standards, their prices or both. In addition, ABS with reviews obtained from such parties may affect the pricing of competing securities. One commentator predicted that imposing expert liability on third-party reviewers could result in new and lessqualified firms entering the market, particularly since the third-party diligence business does not have any barriers to entry like those that apply to other professions which have potential expert liability.106 Alternatively, the possibility of expert liability could be an incentive for due diligence providers to compete on quality and improve their capabilities. In summary, taken together the amendments and regulations we are adopting implement Congress’ mandate under the Act and are designed to improve investor protection, improve the quality of the assets underlying an ABS, and increase transparency to market participants. We believe that the amendments also would improve investors’ confidence in asset-backed securities and help recovery in the asset-backed securities market with attendant positive effects on efficiency, competition and capital formation. VI. Regulatory Flexibility Act Certification Under Section 605(b) of the Regulatory Flexibility Act,107 we certified that, when adopted, the proposals would not have a significant economic impact on a substantial number of small entities. We included the certification in Part VIII of the Proposing Release. While we encouraged written comment regarding 106 See 107 5 comment letter from Clayton. U.S.C. 605(b). VerDate Mar<15>2010 16:23 Jan 24, 2011 Jkt 223001 this certification, none of the commentators responded to this request. VII. Statutory Authority and Text of Rule and Form Amendments We are adopting the new rules and amendments contained in this document under the authority set forth in Sections 6, 7, 10, 19(a), and 28 of the Securities Act, and Sections 3(b), 23(a), and 36 of the Exchange Act. List of Subjects in 17 CFR Parts 229 and 230 Advertising, Reporting and recordkeeping requirements, Securities. For the reasons set out above, Title 17, Chapter II of the Code of Federal Regulations is amended as follows: PART 229—STANDARD INSTRUCTIONS FOR FILING FORMS UNDER SECURITIES ACT OF 1933, SECURITIES EXCHANGE ACT OF 1934 AND ENERGY POLICY AND CONSERVATION ACT OF 1975 — REGULATION S–K 1. The authority citation for part 229 continues to read in part as follows: ■ Authority: 15 U.S.C. 77e, 77f, 77g, 77h, 77j, 77k, 77s, 77z–2, 77z–3, 77aa(25), 77aa(26), 77ddd, 77eee, 77ggg, 77hhh, 777iii, 77jjj, 77nnn, 77sss, 78c, 78i, 78j, 78l, 78m, 78n, 78o, 78u–5, 78w, 78ll, 78mm, 80a–8, 80a–9, 80a–20, 80a–29, 80a–30, 80a–31(c), 80a–37, 80a–38(a), 80a–39, 80b–11, and 7201 et seq.; and 18 U.S.C. 1350, unless otherwise noted. * * * * * 2. Amend § 229.1111 by: a. Revising the introductory text to paragraph (a): ■ b. Adding paragraphs (a)(7) and (a)(8). The revision and additions read as follows: ■ ■ § 229.1111 (Item 1111) Pool assets. * * * * * (a) Information regarding pool asset types and selection criteria. Provide the following information: * * * * * (7)(i) The nature of a review of the assets performed by an issuer or sponsor (required by § 230.193), including whether the issuer of any asset-backed security engaged a third party for purposes of performing the review of the pool assets underlying an assetbacked security; and (ii) The findings and conclusions of the review of the assets by the issuer, sponsor, or third party described in paragraph (a)(7)(i) of this section. Instruction to Item 1111(a)(7): The disclosure required under this item shall provide an understanding of how the review related to the disclosure regarding the assets. For example, if PO 00000 Frm 00043 Fmt 4700 Sfmt 4700 4243 benchmarks or criteria different from that specified in the prospectus were used to evaluate the assets, these should be described, as well as the findings and conclusions. If the review is of a sample of assets in the pool, disclose the size of the sample and the criteria used to select the assets sampled. If the issuer has engaged a third party for purposes of performing the review of assets, and attributes the findings and conclusions of the review to the third party in the disclosure required by this item, the issuer must provide the name of the third-party reviewer and comply with the requirements of § 230.436 of this chapter. (8) If any assets in the pool deviate from the disclosed underwriting criteria or other criteria or benchmark used to evaluate the assets, or any assets in the sample or assets otherwise known to deviate if only a sample was reviewed, disclose how those assets deviate from the disclosed underwriting criteria or other criteria or benchmark used to evaluate the assets and include data on the amount and characteristics of those assets that did not meet the disclosed standards. Disclose which entity (e.g., sponsor, originator, or underwriter) or entities determined that those assets should be included in the pool, despite not having met the disclosed underwriting standards or other criteria or benchmark used to evaluate the assets, and what factors were used to make the determination, such as compensating factors or a determination that the exception was not material. If compensating or other factors were used, provide data on the amount of assets in the pool or in the sample that are represented as meeting each such factor and the amount of assets that do not meet those factors. If multiple entities are involved in the decision to include assets despite not having met the disclosed underwriting standards, this should be described and each participating entity should be disclosed. * * * * * PART 230—GENERAL RULES AND REGULATIONS, SECURITIES ACT OF 1933 3. The authority citation for part 230 is amended by adding the following citation in numerical order to read as follows: ■ Authority: 15 U.S.C. 77b, 77c, 77d, 77f, 77g, 77h, 77j, 77r, 77s, 77z–3, 77sss, 78c, 78d, 78j, 78l, 78m, 78n, 78o, 78t, 78w, 78ll(d), 78mm, 80a–8, 80a– 24, 80a–28, 80a–29, 80a– 30, and 80a–37, unless otherwise noted. * E:\FR\FM\25JAR1.SGM * * 25JAR1 * * 4244 Federal Register / Vol. 76, No. 16 / Tuesday, January 25, 2011 / Rules and Regulations Section 230.193 is also issued under sec. 943, Pub. L. 111–203, 124 Stat. 1376. * * * * * 4. Add § 230.193 to read as follows: Tuesday, October 19, 2010, make the following correction: § 1.411(a)(13)–1 § 230.193 Review of underlying assets in asset-backed securities transactions. An issuer of an ‘‘asset-backed security,’’ as that term is defined in Section 3(a)(77) of the Securities Exchange Act of 1934 (15 U.S.C. 78c(a)(77)), offering and selling such a security pursuant to a registration statement shall perform a review of the pool assets underlying the asset-backed security. At a minimum, such review must be designed and effected to provide reasonable assurance that the disclosure regarding the pool assets in the form of prospectus filed pursuant to § 230.424 of this chapter is accurate in all material respects. The issuer may conduct the review or an issuer may employ a third party engaged for purposes of performing the review. If the findings and conclusions of the review are attributed to the third party, the third party must be named in the registration statement and consent to being named as an expert in accordance with § 230.436 of this chapter. Instruction to § 230.193: An issuer of an ‘‘asset-backed security’’ may rely on one or more third parties to fulfill its obligation to perform a review under this section, provided that the reviews performed by the third parties and the issuer, in the aggregate, comply with the minimum standard in this section. The issuer must comply with the requirements of this section for each third party engaged by the issuer to perform the review for purposes of this section. An issuer may not rely on a review performed by an unaffiliated originator for purposes of performing the review required under this section. Dated: January 20, 2011. By the Commission. Elizabeth M. Murphy, Secretary. [FR Doc. 2011–1503 Filed 1–24–11; 8:45 am] BILLING CODE 8011–01–P [Corrected] On page 64137, in § 1.411(a)(13)–1,in the first column, in paragraph (e)(1)(iii)(E), in the fourth and fifth lines, ‘‘section 411(a)(13)(B) but would otherwise apply’’ should read ‘‘section 411(a)(13)(B) would otherwise apply’’. [FR Doc. C1–2010–25941 Filed 1–24–11; 8:45 am] BILLING CODE 1505–01–D 26 CFR Part 1 [TD 9391] RIN 1545–BF85 Internal Revenue Service (IRS), Treasury. ACTION: Correcting amendment. AGENCY: This document contains a correction to final regulations (TD 9391) that were published in the Federal Register on Wednesday, April 9, 2008 (73 FR 19350) providing rules under section 937(b) of the Internal Revenue Code for determining whether income is derived from sources within a U.S. possession or territory specified in section 937(a)(1) (generally referred to in this preamble as a ‘‘territory’’) and whether income is effectively connected with the conduct of a trade or business within a territory as well as providing guidance under section 932 and other provisions related to the territories. DATES: This correction is effective on January 25, 2011, and is applicable on April 9, 2008. FOR FURTHER INFORMATION CONTACT: J. David Varley, (202) 435–5262 (not a tollfree number). SUPPLEMENTARY INFORMATION: SUMMARY: As published, final regulations (TD 9391) contain an error that may prove to be misleading and is in need of clarification. srobinson on DSKHWCL6B1PROD with RULES Jkt 223001 PO 00000 Frm 00044 Authority: 26 U.S.C. 7805 * * * * * * * (e) * * * (1) U.S. returns. Except as otherwise provided for returns filed under paragraph (c)(2)(ii) of this section, a return required under the rules of paragraphs (b) and (c) of this section to be filed with the United States must be filed as directed in the applicable forms and instructions. * * * * * LaNita Van Dyke, Chief, Publications and Regulations Branch, Legal Processing Division, Associate Chief Counsel, Procedure and Administration. [FR Doc. 2011–1408 Filed 1–24–11; 8:45 am] BILLING CODE 4830–01–P DEPARTMENT OF THE INTERIOR Bureau of Ocean Energy Management 30 CFR Part 285 [Docket ID: BOEM–2010–0045] RIN 1010–AD71 Regulation and Enforcement; Renewable Energy Alternate Uses of Existing Facilities on the Outer Continental Shelf—Acquire a Lease Noncompetitively Bureau of Ocean Energy Management, Regulation and Enforcement (BOEMRE), Interior. ACTION: Withdrawal of direct final rule. AGENCY: Correction In rule document 2010–25941 beginning on page 64123 in the issue of 16:23 Jan 24, 2011 Paragraph 1. The authority citation for part 1 continues to read in part as follows: ■ * Source Rules Involving U.S. Possessions and Other Conforming Changes; Correction Need for Correction VerDate Mar<15>2010 PART 1—INCOME TAXES § 1.932–1 Coordination of United States and Virgin Islands income taxes. Hybrid Retirement Plans [TD 9505] Accordingly, 26 CFR part 1 is corrected by making the following correcting amendment: Par. 2. Section 1.932–1 is amended by revising paragraph (e)(1) to read as follows: Internal Revenue Service RIN 1545–BG36 26 CFR Part 1 Correction of Publication ■ The final regulations and removal of temporary regulations that are the subjects of this document are under sections 1, 170A, 861, 871, 876, 881, 884, 901, 931, 932, 933, 934, 935, 937, 957, 1402, 6012, 6038, and 6046 of the Internal Revenue Code. Internal Revenue Service Income taxes, Reporting and recordkeeping requirements. DEPARTMENT OF THE TREASURY Background DEPARTMENT OF THE TREASURY List of Subjects in 26 CFR Part 1 Fmt 4700 Sfmt 4700 BOEMRE is withdrawing the direct final rule to amend BOEMRE’s renewable energy regulatory provisions that pertain to noncompetitive acquisition of leases, published on November 26, 2010 (75 FR 72679), under Docket ID: BOEM–2010–0045. In the direct final rule, BOEMRE stated that if it received significant adverse SUMMARY: E:\FR\FM\25JAR1.SGM 25JAR1

Agencies

SECURITIES AND EXCHANGE COMMISSION

[Federal Register Volume 76, Number 16 (Tuesday, January 25, 2011)]
[Rules and Regulations]
[Pages 4231-4244]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-1503]


=======================================================================
-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 229 and 230

[Release Nos. 33-9176, 34-63742; File No. S7-26-10]
RIN 3235-AK76


Issuer Review of Assets in Offerings of Asset-Backed Securities

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

-----------------------------------------------------------------------

SUMMARY: We are adopting new requirements in order to implement Section 
945 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 
2010 (the ``Act''). We are adopting a new rule under the Securities Act 
of 1933 to require any issuer registering the offer and sale of an 
asset-backed security (``ABS'') to perform a review of the assets 
underlying the ABS. We also are adopting amendments to Item 1111 of 
Regulation AB that would require an ABS issuer to disclose the nature 
of its review of the assets and the findings and conclusions of the 
issuer's review of the assets.

DATES: Effective Date: March 28, 2011.
    Compliance Date: Any registered offering of asset-backed securities

[[Page 4232]]

commencing with an initial bona fide offer after December 31, 2011, 
must comply with the new rules and forms.

FOR FURTHER INFORMATION CONTACT: Eduardo Aleman, Special Counsel, 
Division of Corporation Finance, at (202) 551-3430, U.S. Securities and 
Exchange Commission, 100 F Street, NE., Washington, DC 20549.

SUPPLEMENTARY INFORMATION: We are adopting amendments to Item 1111 \1\ 
of Regulation AB \2\ (a subpart of Regulation S-K). We also are 
adopting Rule 193 \3\ under the Securities Act of 1933 \4\ (the 
``Securities Act'').
---------------------------------------------------------------------------

    \1\ 17 CFR 229.1111.
    \2\ 17 CFR 229.1100 through 17 CFR 229.1123.
    \3\ 17 CFR 230.193.
    \4\ 15 U.S.C. 77a et seq.
---------------------------------------------------------------------------

I. Background and Overview

    On October 13, 2010, we proposed new requirements in order to 
implement Section 945 and a portion of Section 932 of the Dodd-Frank 
Act.\5\ As discussed in the Proposing Release, Section 945 of the Act 
amends Section 7 of the Securities Act to require the Commission to 
issue rules relating to the registration statement required to be filed 
by an issuer of ABS. Pursuant to new Section 7(d), the Commission must 
issue rules to require that an issuer of an ABS perform a review of the 
assets underlying the ABS, and disclose the nature of such review. 
Section 945 of the Act reflects the testimony provided to Congress that 
due diligence practices in ABS offerings had eroded significantly.\6\ 
We also proposed new requirements relating to the disclosure of third-
party findings and conclusions in ABS transactions in order to 
implement Section 15E(s)(4)(A) of the Exchange Act, as added by Section 
932 of the Act. We received over 50 comment letters on the Proposing 
Release.\7\
---------------------------------------------------------------------------

    \5\ Issuer Review of Assets in Offerings of Asset-Backed 
Securities, Release No. 33-9150 (Oct. 13, 2010) [75 FR 64182] 
(``Proposing Release'').
    \6\ See S. Rep. No. 111-176, at 133 (2010) (``Senate Report'').
    \7\ The comments on the Proposing Release are available at 
https://www.sec.gov/comments/s7-26-10/s72610.shtml.
---------------------------------------------------------------------------

    As discussed below, after consideration of the comments received on 
the proposed amendments, we are adopting the proposed amendments to 
implement Section 7(d) of the Securities Act. We have revised the final 
rules from the proposal to establish a new minimum standard for the 
required review. We are postponing consideration of rules to implement 
Section 15E(s)(4)(A) of the Exchange Act, which requires issuers or 
underwriters of any asset-backed security to make publicly available 
the findings and conclusions of any third-party due diligence report 
the issuer or underwriter obtains, until a later date when we adopt 
rules to implement the rest of Section 15(E)(s)(4), which we anticipate 
proposing this year. We are persuaded by the suggestion by several 
commentators that new Exchange Act Section 15E(s)(4) should be read as 
a whole, and that we should postpone implementation of 15E(s)(4)(A) 
until the Commission implements the rest of Section 15E.\8\
---------------------------------------------------------------------------

    \8\ See comment letters from American Bar Association (``ABA''); 
National Association of Bond Lawyers (``NABL'').
---------------------------------------------------------------------------

II. Final Rules

A. Scope of Rule 193

1. Proposed Amendments
    We proposed new Rule 193 under the Securities Act to require 
issuers of ABS to perform a review of the assets underlying registered 
ABS offerings.\9\ This rule would implement Securities Act Section 
7(d)(1),\10\ as added by Section 945 of the Act. As proposed, Rule 193 
would require an issuer to perform a review of the assets underlying an 
ABS in a transaction that the issuer registers under the Securities 
Act.
---------------------------------------------------------------------------

    \9\ The requirement to perform a review should not be confused 
with, and is not intended to change, the due diligence defense 
against liability under Securities Act Section 11 [15 U.S.C. 77k] or 
the reasonable care defense against liability under Securities Act 
Section 12(a)(2) [15 U.S.C. 77l(a)(2)]. Our rule is designed to 
require a review of the underlying assets by the issuer and to 
provide disclosure of the nature, findings and conclusions of such 
review.
    \10\ 15 U.S.C. 77g(d)(1).
---------------------------------------------------------------------------

2. Comments on the Proposed Amendments--Scope of Rule 193
    With respect to the applicability of the proposed rule, some 
commentators agreed that the rule should apply only to registered 
offerings of ABS.\11\ Some commentators recommended the review 
requirement be extended to also apply to unregistered offerings and 
predicted that unless the rule applies to unregistered offerings, 
abusive practices are likely to migrate into the market for 
unregistered offerings.\12\ One such commentator supported the approach 
in the Proposing Release's request for comment conditioning the 
Commission's safe harbors from registration on a requirement that the 
underlying transaction agreements include a representation that the 
issuer performed an asset review that complies with Rule 193.\13\ Three 
commentators expressed concern with such a requirement.\14\ One 
commentator sought clarification that the issuer may rely on a review 
performed by an affiliated originator.\15\
---------------------------------------------------------------------------

    \11\ See comment letters from ABA; Securities Industry and 
Financial Markets Association (``SIFMA'').
    \12\ See comment letters from Center for Responsible Lending 
(``CRL''); Senator Levin, Permanent Subcommittee on Investigations, 
United States Senate Committee on Homeland Security and Governmental 
Affairs (``Levin''); Consumer Federation of America (``Consumer 
Federation''); Christopher Chuff.
    \13\ See comment letter from Consumer Federation.
    \14\ See comment letters from ABA; American Financial Services 
Association (``AFSA''); SIFMA.
    \15\ See comment letter from SIFMA. Another commentator noted 
that the relationship between the issuer and originator is an 
important consideration in determining the appropriateness of a 
review, and suggested that in so-called ``aggregator'' transactions, 
where the issuer is unaffiliated with the originator of the assets, 
the review should be more fulsome. See comment letter from ABA.
---------------------------------------------------------------------------

3. Final Rule--Scope of Rule 193
    Consistent with the proposal, final Rule 193 requires that the 
asset review be conducted by the issuer of the ABS.\16\ The issuer, for 
purposes of this rule, is the depositor or sponsor of the 
securitization. A sponsor typically initiates a securitization 
transaction by selling or pledging to a specially created issuing 
entity a group of financial assets that the sponsor either has 
originated itself or has purchased in the secondary market. In some 
instances, the transfer of assets is a two-step process: The financial 
assets are transferred by the sponsor first to an intermediate entity, 
the depositor or the issuer, and then the depositor transfers the 
assets to the issuing entity for the particular asset-backed 
transaction. The issuing entity is typically a statutory trust.\17\ In 
cases

[[Page 4233]]

where the originator and sponsor may be different, including in 
transactions involving a so-called ``aggregator,'' our final rule, 
consistent with the proposal, provides that the review may be performed 
by the sponsor, but a review performed by an unaffiliated originator 
will not satisfy Rule 193. An unaffiliated originator may have 
different interests in the securitization, especially if the 
securitization involves many originators where each originator may have 
contributed a very small part of the assets in the entire pool, and may 
have differing approaches to the review.\18\
---------------------------------------------------------------------------

    \16\ Under Securities Act Rule 191 (17 CFR 230.191), the 
depositor for the asset-backed securities acting solely in its 
capacity as depositor to the issuing entity is the ``issuer'' for 
purposes of the asset-backed securities of that issuing entity. 
``Depositor'' means the depositor who receives or purchases and 
transfers or sells the pool assets to the issuing entity. See Item 
1101 of Regulation AB (17 CFR 229.1101). For asset-backed securities 
transactions where there is not an intermediate transfer of the 
assets from the sponsor to the issuing entity, the term depositor 
refers to the sponsor. For asset-backed securities transactions 
where the person transferring or selling the pool assets is itself a 
trust, the depositor of the issuing entity is the depositor of that 
trust. See id. As defined in Item 1101 of Regulation AB, the 
``sponsor'' means the person who organizes and initiates an ABS 
transaction by selling or transferring assets, either directly or 
indirectly, including through an affiliate, to the issuing entity. 
See id.
    \17\ See Asset-Backed Securities, Release No. 33-8518 (Dec. 22, 
2004) [70 FR 1506] (``2004 Regulation AB Adopting Release'') at 
Section III.B.3. The issuing entity is designed to be a passive 
entity, and in order to meet the definition of ABS issuer in 
Regulation AB its activities must be limited to passively owning or 
holding the pool of assets, issuing the ABS supported or serviced by 
those assets, and other activities reasonably incidental thereto.
    \18\ In the case of so-called aggregators, the sponsor acquires 
loans from many other unaffiliated sellers before securitization.
---------------------------------------------------------------------------

    As discussed in the Proposing Release, Section 7(d)(1) relates to 
an asset-backed security, as defined in new Section 3(a)(77) of the 
Exchange Act.\19\ This new statutory definition (``Exchange Act-ABS'') 
is broader than the definition of ``asset-backed security'' in 
Regulation AB \20\ and includes securities typically offered and sold 
in private transactions. Although the Exchange Act-ABS term is used in 
Section 7(d)(1), we have concluded that the review requirements 
mandated by Section 7(d)(1) are limited to registered offerings of ABS 
because Section 7(d)(1) requires the Commission to issue rules 
``relating to the registration statement.'' Therefore, the rule we 
adopt today that requires an ABS issuer to perform a review of the 
assets applies to issuers of ABS in registered offerings and not 
issuers of ABS in unregistered offerings.
---------------------------------------------------------------------------

    \19\ 15 U.S.C. 78c(a)(77). This definition was added by Section 
941(a) of the Act.
    \20\ See Item 1101(c)(1) of Regulation AB [17 CFR 
229.1101(c)(1)].
---------------------------------------------------------------------------

    As noted above, in the Proposing Release we asked whether, even 
though Section 7(d)(1) does not extend to unregistered offerings, we 
should condition reliance on the Securities Act safe harbors from 
registration on a requirement that the underlying transaction agreement 
for the ABS contain a representation that the issuer performed a review 
that complies with Rule 193, or, alternatively, that the issuer perform 
a Rule 193 review. Given the mixed comments on this question and our 
outstanding proposals from April 2010 related to offerings under the 
safe harbors from registration,\21\ we are not adopting at this time a 
separate requirement to condition the Commission's safe harbors for an 
exemption from registration on a requirement that the issuer conduct a 
review of the assets. As we noted in the 2010 ABS Proposing Release, we 
have concerns about investor protection in the exempt ABS markets.\22\ 
While we continue to have these concerns, at this point we believe a 
comprehensive approach to the Commission's safe harbors for an 
exemption from registration would better serve investors and provide 
more certainty to issuers than an incremental approach. In the future, 
we may determine that discrete amendments to the safe harbors 
addressing ABS matters are appropriate.
---------------------------------------------------------------------------

    \21\ See Asset-Backed Securities, Release No. 33-9117 (April 7, 
2010) [75 FR 23328] (the ``2010 ABS Proposing Release''). In the 
2010 ABS Proposing Release we proposed requiring that the underlying 
transaction agreement in a transaction relying on certain Commission 
safe harbors for an exemption from registration under the Securities 
Act contain a provision requiring the issuer to provide to any 
initial purchaser, security holder, and designated prospective 
purchaser the same information as would be required in a registered 
transaction. In addition, the Commission solicited comment 
concerning whether safe harbors from registration should not be 
available for offerings of structured finance products and whether 
any restrictions should be imposed on private offerings of asset-
backed securities.
    \22\ See id. at 23394.
---------------------------------------------------------------------------

B. Standard of Review of Assets by Issuers of ABS

1. Proposed Amendments
    Proposed Rule 193 provided that an issuer would be required to 
conduct a review of the assets and disclose the findings and 
conclusions of the review. Proposed Rule 193 did not specify the level 
or type of review an issuer would be required to perform, or require 
that a review be designed in any particular manner. However, the 
Proposing Release included detailed requests for comment on whether we 
should set a minimum review standard, including possible standards that 
could be included in a final rule. In particular, the Proposing Release 
sought comment on a possible review standard that would require issuers 
to perform a review that, at a minimum, must be designed to provide 
reasonable assurance that the disclosure in the prospectus regarding 
the pool assets is accurate in all material respects. We also sought 
comment on whether the rule should mandate that the review should not 
only be designed, but also effected, to provide reasonable assurance 
that the prospectus disclosure was accurate in all material respects.
2. Comments on the Proposed Amendments--Standard of Review
    Comments on the proposed review requirement, including the absence 
of a minimum review standard, were varied. Some commentators responded 
that the review requirement, as proposed, did not address the problems 
that Section 945 of the Act sought to address and suggested that the 
Commission set a minimum level of review.\23\ One commentator 
recommended that ABS issuers be required to conduct reviews that are 
both ``designed and effected'' with sufficient scale and scope to 
discover assets that violate applicable law or standards as set forth 
in the prospectus.\24\ This commentator explained that this would go 
beyond providing ``reasonable assurance that the disclosure in the 
prospectus is accurate in all material respects.'' One commentator 
cautioned that the rule, as proposed, would create a perverse incentive 
to decrease due diligence reviews even further in order to decrease the 
likelihood that they reveal problems that would have to be disclosed to 
investors.\25\
---------------------------------------------------------------------------

    \23\ See comment letters from Chris Barnard (``Barnard''); 
Consumer Federation (supporting a principles-based review standard 
such as the ``reasonable assurance'' standard discussed in the 
Proposing Release's request for comment, and suggesting that where 
initial reviews uncover discrepancies, further reviews sufficient to 
uncover the extent of the problem should be conducted); CRL; Levin; 
American Society of Appraisers, American Society of Farm Managers 
and Rural Appraisals, National Association of Independent Fee 
Appraisers (collectively, ``Appraisers''); Clayton Holdings, LLC 
(``Clayton''); Americans for Financial Reform (``AFR''); Fitch, Inc. 
(``Fitch''). See also comment letter from ABA (supporting Rule 193 
as proposed, but agreeing that the ``reasonable assurance'' approach 
discussed in the Proposing Release's request for comment is workable 
if the Commission were to adopt a minimum level of review).
    \24\ See comment letter from CRL.
    \25\ See comment letter from Consumer Federation.
---------------------------------------------------------------------------

    Some commentators suggested possible alternative review standards 
that encompass other aspects of the assets, instead of disclosure. Some 
commentators urged the Commission to require a review that assesses the 
actual quality of the underwriting of the assets \26\ and exclude the 
type of review of assets that amounts to a mere comparison or 
``comforting'' of data that relates to the prospectus disclosure. These 
commentators stated that in light of the existing liability framework 
under the federal securities laws, it is not necessary for the 
Commission to require that issuers conduct or disclose any particular 
review that merely verifies the accuracy of the disclosure in the 
prospectus.\27\ Some commentators believed that the type of review that 
should be disclosed under Rule 193 is a review that relates to the 
underwriting of the assets \28\ or quality of the underlying assets 
(e.g., credit quality).\29\
---------------------------------------------------------------------------

    \26\ See comment letters from ASF; SIFMA.
    \27\ See comment letters from ASF; SIFMA.
    \28\ See comment letters from ASF; SIFMA.
    \29\ See comment letter from BDO USA, LLP.

---------------------------------------------------------------------------

[[Page 4234]]

    Other commentators suggested that at a minimum, the review should 
include, for example, verifying the accuracy of the loan data and 
related information, determining whether the assets complied with the 
underwriting guidelines, determining compliance with the originator's 
property valuation guidelines, and determining whether the loans were 
originated in compliance with applicable laws.\30\
---------------------------------------------------------------------------

    \30\ See comment letters from Clayton; CRL.
---------------------------------------------------------------------------

    Other commentators, in support of a minimum review standard, 
suggested that the issuer's review should include disclosure of key 
indicators of loan quality (e.g., weighted average FICO scores, loan-
to-value ratios, borrower debt-to-income ratios, and the absence of 
data suggesting loan fraud) \31\ and a minimum sample size 
requirement.\32\ Some commentators suggested that this should include a 
statistically valid sample of assets whose analysis could be 
extrapolated to the entire asset pool.\33\ Two of these commentators 
argued that such a requirement would ensure a level playing field and 
that no issuer gains a competitive cost advantage by using smaller 
sample sizes.\34\ One commentator suggested that the Commission 
consider the minimum sample sizes set forth by the various rating 
agencies,\35\ while another noted that sampling should be conducted in 
a manner appropriate to provide confidence that a representative 
portion of the pool has been examined (e.g., a sample size could be 
computed using a 95% confidence level and a 5% confidence 
interval).\36\
---------------------------------------------------------------------------

    \31\ See comment letter from Levin.
    \32\ See comment letters from ABA; Clayton; Fitch; Levin; SIFMA.
    \33\ See comment letters from Clayton; Fitch; Levin; SIFMA.
    \34\ See comment letters from Clayton; Levin.
    \35\ See comment letter from Clayton.
    \36\ See comment letter from Fitch.
---------------------------------------------------------------------------

    On the other hand, some commentators supported the Commission's 
proposal, which did not prescribe a minimum level of review.\37\ One 
commentator opposed the ``reasonable assurance'' standard in the 
Proposing Release's request for comment and argued that the standard is 
inappropriate and unnecessary to address the intent of the Act or to 
improve disclosure because the new requirements mandated by the Act 
should address a review of the assets, as opposed to a review of the 
disclosure about the assets.\38\ This commentator cautioned that a 
``reasonable assurance'' standard would require issuers to describe 
what they did to get comfortable that they met their disclosure 
obligations, and expose them to liability for failing to have used 
procedures that provided such ``reasonable assurance'' or for not 
having accurately described the nature of the procedures and their 
findings and conclusions, even if there was no material error or 
omission in the prospectus about the pool assets.\39\
---------------------------------------------------------------------------

    \37\ See, e.g., comment letters from ABA; American Bankers 
Association Securities Association (``ABASA''); Association for 
Financial Markets in Europe (``AFME''); Commercial Real Estate 
Finance Council (``CRE Finance Council''); and Mortgage Bankers 
Association (``MBA'').
    \38\ See comment letter from ASF.
    \39\ See comment letter from ASF (noting that the scope of a 
``reasonable assurance'' standard is overly broad considering the 
substantial amount of disclosure regarding the pool assets that is 
contained in the prospectus including, in addition to numerical 
information about the assets, narrative disclosure about such 
matters as the pool assets generally, risk factors relevant to the 
pool assets, servicing of the pool assets, and legal aspects of the 
pool assets).
---------------------------------------------------------------------------

    One commentator requested confirmation that Rule 193 addresses a 
review of assets in connection with the preparation of the 
securitization, rather than a review performed in connection with 
origination of a securitized asset.\40\ This commentator explained that 
in the context of CMBS transactions, the sponsor of the securitization 
is often also the originator (or an affiliate of the originator) of the 
assets being transferred into a securitization, and that it would be 
unusual for any extra level of diligence to be performed on the assets 
themselves in connection with the securitization since the sponsor 
previously underwrote the assets and is familiar with the assets.
---------------------------------------------------------------------------

    \40\ See comment letter from CRE Finance Council.
---------------------------------------------------------------------------

3. Final Rule--Issuer Review Requirement
    After considering the comments, we are adopting Rule 193 with a 
minimum review standard. We agree with commentators who suggested that 
Rule 193 should require a minimum level of review to implement the 
directive in Section 7(d), as added by Section 945 of the Act. Absent a 
minimum standard of review, we are concerned that issuers could satisfy 
new Rule 193 with a review that was not designed or carried out in a 
way that would address the concerns that led to the enactment of 
section 7(d)(1)--that due diligence be ``re-introduced'' into the 
offering process.\41\ We also believe a minimum standard of review is 
appropriate in light of Congress's direction that issuers ``of an 
asset-backed security * * * perform a due diligence analysis of the 
assets.'' \42\ Indeed, permitting issuers to satisfy the statutory 
requirement with such a review potentially could undercut the statutory 
purpose by erroneously suggesting that due diligence was conducted.
---------------------------------------------------------------------------

    \41\ See Senate Report, at 133 (quoting Senate committee 
testimony by Professor John Coffee). We note that some commentators 
supported the standard described in the Proposing Release's request 
for comment. See comment letters from Consumer Federation; ABA 
(suggesting that this approach is workable if the Commission were to 
adopt a minimum level of review, though supporting Rule 193 as 
proposed).
    \42\ Id.
---------------------------------------------------------------------------

    While we have concluded that a minimum review standard is 
appropriate for our final rule, we believe a flexible, principles-based 
standard that would be workable across a wide variety of asset classes 
and issuers would best accomplish our objectives. Consequently, we are 
adopting Rule 193 modified from the proposal to require an issuer to 
perform a review of the assets underlying an ABS in a transaction that 
will be registered under the Securities Act that, at a minimum, must be 
designed and effected to provide reasonable assurance that the 
disclosure in the prospectus regarding the assets is accurate in all 
material respects.\43\
---------------------------------------------------------------------------

    \43\ Thus, for example, if the prospectus disclosed that the 
loans are limited to borrowers with a specified minimum credit 
score, or certain income level, the review, as designed and 
effected, would be required to provide reasonable assurance that the 
loans in the pool met this criterion.
---------------------------------------------------------------------------

    We note that the minimum standard that we are adopting is similar 
to the standard many companies use in designing and maintaining 
disclosure controls and procedures required under Exchange Act Rule 
13a-15.\44\ Our rules, which have applied to reporting companies for 
many years, generally ``require an issuer to maintain disclosure 
controls and procedures to provide reasonable assurance that the issuer 
is able to record, process, summarize and report the information 
required in the issuer's Exchange Act reports'' within appropriate time 
frames.\45\ We believe that many issuers and their advisers are 
familiar with this type of standard.\46\
---------------------------------------------------------------------------

    \44\ 17 CFR 240.13a-15.
    \45\ See Management's Report on Internal Control over Financial 
Reporting and Certification of Disclosure in Exchange Act Periodic 
Reports, Release No. 33-8238 (June 5, 2003). See also Certification 
of Disclosure in Companies' Quarterly and Annual Reports, Release 
No. 34-8124 (June 14, 2002) (``Certification in Periodic Reports 
Release''). ABS issuers must provide in Form 10-K an assessment by 
each party participating in the servicing function regarding its 
compliance with specified servicing criteria set forth in Item 1122 
of Regulation AB. See 17 CFR 229.1122. A registered public 
accounting firm must issue an attestation report on such party's 
assessment of compliance. See id.
    \46\ Although ABS issuers are not subject to Rule 13a-15, ABS 
issuers that also issue corporate securities are familiar with it. 
We previously have recognized that, because the information ABS 
issuers are required to provide differs significantly from that 
provided by other issuers, and because of the structure of ABS 
issuers as typically passive pools of assets, the certification 
requirements should be tailored specifically for ABS issuers. See 
Certification in Periodic Reports Release.

---------------------------------------------------------------------------

[[Page 4235]]

    Rule 193 does not specify the particular type of review an issuer 
is required to perform.\47\ We expect that the type of review of the 
assets an issuer performs may vary depending on the circumstances. For 
example, the nature of review may vary among different asset classes. 
While Rule 193 does not require a particular type of review, as 
described below, disclosure describing the type of review is required. 
The ``reasonable assurance'' standard is similar to language in the 
Foreign Corrupt Practices Act of 1977.\48\ We recognize that while 
``reasonableness'' is an objective standard, there is a range of 
judgments that an issuer might make as to what will provide 
``reasonable assurance.'' \49\ Thus, the term ``reasonable assurance'' 
in Rule 193 does not imply a single methodology, but encompasses the 
full range of reviews an issuer may perform to ensure that its review 
is designed and effected to provide reasonable assurance that the 
prospectus disclosure regarding the pool assets is accurate in all 
material respects.
---------------------------------------------------------------------------

    \47\ We understand that various levels and types of review may 
be performed in a securitization. For example, commentators on the 
2010 ABS Proposing Release have identified that the type of review 
conducted by a sponsor of a securitization of sub-prime mortgage 
loans typically falls into three general categories. First, a credit 
review examines the sample loans to ascertain whether they have been 
originated in accordance with the originator's underwriting 
guidelines. This would include a review of whether the loan 
characteristics reported by the originator are accurate and whether 
the credit profile of the loans is acceptable to the sponsor. A 
second type of review could be a compliance review which examines 
whether the loans have been originated in compliance with applicable 
laws, including predatory lending and Truth in Lending statutes. 
Third, a valuation review entails a review of the accuracy of the 
property values reported by the originators for the underlying 
collateral. This could include a review of each original appraisal 
to assess whether it appeared to comply with the originator's 
appraisal guidelines, and the appropriateness of the comparables 
used in the original appraisal process. See comment letter from The 
Commonwealth of Massachusetts Office of the Attorney General 
(``Massachusetts AG comment letter'') on the 2010 ABS Proposing 
Release. The comment letters are available at https://www.sec.gov/comments/s7-08-10/s70810.shtml.
    \48\ Title 1 of Pub. L. 95-213 (1977). Exchange Act Section 
13(b)(7) defines ``reasonable assurance'' as ``such level of detail 
and degree of assurance as would satisfy prudent officials in the 
conduct of their own affairs.'' 15 U.S.C. 78m(b)(7). We have long 
been of the view that ``reasonableness'' is not an ``absolute 
standard of exactitude for corporate records.'' Release No. 34-17500 
(Jan. 29, 1981) [46 FR 11544].
    \49\ See Commission Guidance Regarding Management's Report on 
Internal Control Over Financial Reporting Under Section 13(a) or 
15(d) of the Securities Exchange Act of 1934, Release No. 34-55929 
(June 20, 2007).
---------------------------------------------------------------------------

    We continue to believe that the nature of review may vary depending 
on numerous circumstances and factors which could include, for example, 
the nature of the assets being securitized and the degree of continuing 
involvement by the sponsor.\50\ We note the suggestion by several 
commentators that sampling should be permitted.\51\ While we agree that 
sampling may be appropriate depending on the facts and circumstances, 
we believe that whether sampling is sufficient to satisfy the 
``reasonable assurance'' standard in Rule 193 will depend on a variety 
of factors, such as the type of ABS being offered. For example, in 
offerings of residential mortgage-backed securities (``RMBS''), where 
the asset pool consists of a large group of loans, it may be 
appropriate, depending on all the facts, to review a sample of loans 
large enough to be representative of the pool, and then conduct further 
review if the initial review indicates that further review is warranted 
in order to provide reasonable assurance that disclosure is accurate in 
all material respects. By contrast, for ABS where a significant portion 
of the cash flow will be derived from a single obligor or a small group 
of obligors, such as ABS backed by a small number of commercial loans 
(``CMBS''), it may be appropriate for the review to include every pool 
asset. Moreover, in ABS transactions where the asset pool composition 
turns over rapidly because it contains revolving assets, such as credit 
card receivables or dealer floorplan receivables, a different type of 
review may be warranted than in ABS transactions involving term 
receivables, such as mortgage or auto loans. We are not adopting a 
minimum sample size for offerings where sampling may be appropriate for 
the review as we believe any appropriate sample size must be based on 
the facts and circumstances. While reviewing a sample of assets may or 
may not be appropriate under the particular facts, we agree with 
commentators who suggested that, where a sample of the assets is 
reviewed, the size of the sample and the criteria used to select the 
assets sampled should be disclosed. Accordingly, we are adding an 
instruction noting that this disclosure should be provided as part of 
the description of the nature of the review, as discussed further 
below.
---------------------------------------------------------------------------

    \50\ We agree with one commentator's view that the review that 
is required is a review of the assets for purposes of the 
securitization and not the review conducted to originate the assets.
    \51\ See, e.g., comment letters from ABA; Fitch; Levin; SIFMA.
---------------------------------------------------------------------------

    We have considered comment letters stating that the required review 
should relate to the credit quality, or underwriting, of the assets 
rather than the accuracy of the disclosure in the prospectus. We 
believe that accuracy of disclosure in the prospectus is an appropriate 
objective for the required review. The minimum review standard we are 
adopting will necessarily include credit quality and underwriting of 
the assets since disclosure about these factors is required in the 
prospectus, but also will be broader than just a review of the 
underwriting of the assets. Because an issuer is required under 
Regulation AB to provide disclosure about material characteristics of 
the asset pool indicating the quality of the asset pool, under the 
review requirement we are adopting today, the issuer will be required 
to review whether the disclosure regarding the asset pool is accurate 
in all material respects.\52\ In addition to credit quality, this will 
include the disclosure currently required by Item 1111 of Regulation 
AB. Further, under Item 1111 of Regulation AB, as revised today, 
prospectus disclosure of the nature of the review is required.
---------------------------------------------------------------------------

    \52\ We note that the federal securities laws currently require 
that disclosure in the prospectus not contain an untrue statement of 
a material fact or omit to state a material fact required to be 
stated therein or necessary to make the statements not misleading. 
See Securities Act Section 11 [15 U.S.C. 77k] and Securities Act 
Section 12 [12 U.S.C. 77l]. See also Securities Act Section 17 [15 
U.S.C. 77q], Exchange Act Section 10(b) [15 U.S.C. 78j] and Rule 
10b-5 under the Exchange Act [17 CFR 240.10b-5].
---------------------------------------------------------------------------

C. Third Party Reviews

1. Proposed Amendments
    Proposed Rule 193 would have permitted an issuer to rely on third 
parties to satisfy its obligations under Rule 193 provided the third 
party is named in the registration statement and consents to being 
named as an ``expert'' in accordance with Section 7 of the Securities 
Act and Rule 436 under the Securities Act.\53\
---------------------------------------------------------------------------

    \53\ Section 7 of the Securities Act requires the consent of any 
person whose profession gives authority to a statement made by him, 
is named as having prepared or certified any part of the 
registration statement, or is named as having prepared or certified 
a report or valuation for use in connection with the registration 
statement.
---------------------------------------------------------------------------

2. Comments on the Proposed Amendments
    Some commentators supported the proposal to permit issuers to rely 
on third-party firms to conduct the

[[Page 4236]]

required review.\54\ One commentator noted that issuers should be 
responsible for the sufficiency and accuracy of the reviews without 
regard to whether the review is conducted by a third party.\55\ Another 
commentator recommended that any third-party review be at arm's 
length.\56\ In contrast, another commentator did not believe that an 
independence requirement was needed because an issuer may perform the 
review itself and cannot be independent or conflict-free with respect 
to itself.\57\ This commentator reasoned that since an issuer is not 
required to rely on a third party and could conduct the review itself, 
there is no greater likelihood that the independence would be 
impaired.\58\
---------------------------------------------------------------------------

    \54\ See comment letters from ABA; Consumer Federation.
    \55\ See comment letter from CRL.
    \56\ See comment letter from Barnard.
    \57\ See comment letter from CAQ.
    \58\ See comment letter from CAQ.
---------------------------------------------------------------------------

    Some commentators expressed concern that third-party due diligence 
providers would be considered experts under the Securities Act and 
asserted that this treatment would be inconsistent with the principles 
guiding Section 11(a)(4) of the Securities Act.\59\ Some commentators 
predicted that this requirement is likely to result in these providers 
withdrawing from providing services to transactions where expert 
liability would attach.\60\ One commentator noted that if these third-
party due diligence providers are subject to expert liability and they 
refuse to consent to being named as experts, registered RMBS 
transactions will become impossible because many NRSROs require that a 
non-affiliated third party perform a due diligence review in order to 
rate RMBS.\61\ This commentator explained that if issuers are unable to 
obtain a third-party review because of expert liability they would be 
unable to obtain a credit rating because of the lack of a third-party 
review.\62\
---------------------------------------------------------------------------

    \59\ See comment letters from ABASA; Clayton; SIFMA.
    \60\ See comment letters from Clayton; SIFMA.
    \61\ See comment letter from SIFMA.
    \62\ See comment letter from SIFMA.
---------------------------------------------------------------------------

    Several commentators who expressed concern that third-party due 
diligence providers would be considered experts under the Securities 
Act reasoned that due diligence providers are not licensed 
professionals and are not part of a regulated industry that is governed 
by a formal professional association.\63\ One commentator argued that 
in light of an issuer's continuing liability under Section 11 for its 
disclosure related to due diligence, the additional comfort to the 
Commission and investors as to the accuracy of the diligence results 
gained by requiring expert liability is outweighed by the loss of 
diligence firms that will not consent to becoming experts.\64\
---------------------------------------------------------------------------

    \63\ See comment letters from ABASA; Clayton; SIFMA.
    \64\ See comment letter from SIFMA. See also comment letter from 
Clayton (noting there is a significant risk it will refrain from 
accepting engagements to perform the asset review mandated by Rule 
193 leading issuers to more in-house reviews, which could give rise 
to potential conflicts of interest).
---------------------------------------------------------------------------

3. Final Rule--Third-Party Review
    We are adopting, as proposed, a requirement that if an issuer 
engages a third party for purposes of performing its Rule 193 review, 
then an issuer may rely on the third-party's review to satisfy its 
obligations under Rule 193 provided the third party is named in the 
registration statement and consents to being named as an ``expert'' in 
accordance with Section 7 of the Securities Act and Rule 436 under the 
Securities Act. We believe that allowing issuers to contract with a 
third-party due diligence provider \65\ is consistent with Section 
15E(s)(4) of the Exchange Act.\66\
---------------------------------------------------------------------------

    \65\ In this release, we refer to third parties engaged for 
purposes of reviewing the assets also as third-party due diligence 
providers.
    \66\ As noted above, Section 15E(s)(4) of the Exchange Act 
requires the issuer or underwriter of an ABS to make publicly 
available the findings and conclusions of a third-party due 
diligence report obtained by the issuer or the underwriter and 
requires a third-party due diligence provider that is employed by a 
nationally recognized statistical rating organization (``NRSRO''), 
an issuer or an underwriter to provide a written certification to 
the NRSRO that produces a credit rating. Under Section 15E(s)(4) of 
the Exchange Act, the Commission is required to establish the 
appropriate format and content for the certifications ``to ensure 
that providers of due diligence services have conducted a thorough 
review of data, documentation, and other relevant information 
necessary for a nationally recognized statistical rating 
organization to provide an accurate rating.'' As noted above, we 
will address these requirements in a subsequent rulemaking.
---------------------------------------------------------------------------

    We recognize that issuers may routinely hire third parties to 
conduct various types of reviews, and not all persons assisting an 
issuer in these reviews would be subject to the new requirements. Under 
our new rule, any third party hired by the issuer to perform the review 
required under Rule 193, and to whom the issuer attributes findings and 
conclusions of the review in the prospectus will be required to be 
named in the registration statement and consent to being named as an 
``expert'' as described above. On the other hand, if an issuer obtains 
assistance from a third party but attributes to itself the findings and 
conclusions of the review required by Rule 193, the third party would 
not be required to consent to being named as an expert.\67\ In either 
case, the prospectus disclosure should make clear whether the disclosed 
finding and conclusions are those of the issuer or of a third 
party.\68\ We believe that the hiring by an issuer of a third party to 
perform the review and using that review to market its securities would 
be inconsistent with disclosure that the issuer attributes to itself 
the findings and conclusions of the review.\69\ We also note that an 
issuer may rely on multiple third parties to fulfill its Rule 193 
review obligation, provided the issuer complies with the above 
requirements for each third party.
---------------------------------------------------------------------------

    \67\ If the findings and conclusions are attributed to a third 
party, that portion of the disclosure would be expertised. If the 
findings and conclusions are instead attributed to the issuer, that 
portion of disclosure would not be expertised. See Securities Act 
Section 11 [15 U.S.C. 77k].
    \68\ We note that this approach is comparable to the staff's 
position in the context of a registrant that has engaged a third-
party expert to assist in determining the fair values of certain 
assets or liabilities disclosed in a Securities Act registration 
statement. See Compliance and Disclosure Interpretations, Division 
of Corporation Finance, at Section 233, available at https://www.sec.gov/divisions/corpfin/guidance/securitiesactrules-interps.htm (whether a registrant that has engaged a third-party 
expert to assist in determining fair value must disclose the name of 
the third-party expert in its registration statement and obtain the 
third-party's consent under Securities Act Section 7(a) depends on 
whether the disclosure attributes the statement to the third-party 
expert).
    \69\ If an issuer obtains the assistance of a third party to 
perform the review, and discloses this fact pursuant to Item 1111 of 
Regulation AB, as discussed below, this would not be using the 
information to market the securities provided the only information 
disclosed is that which is required by the rule, and the issuer does 
not otherwise use this fact to market the securities. Similarly, we 
are of the view that consent to being named as an expert would not 
be required of a third party hired by the issuer to assist in 
performing the review solely based on the fact that the issuer 
provides disclosure pursuant to Item 1111 of Regulation AB that the 
issuer hired a third party for the purpose of assisting it to 
perform the Rule 193 review.
---------------------------------------------------------------------------

    We note commentators' concern that some third parties might not 
consent to being named as experts. We are not requiring a third-party 
review and, if the issuer obtains the assistance of a third party, the 
issuer can attribute the findings and conclusions of the review to 
itself and avoid the need to obtain consent. If, however, the issuer 
attributes the findings and conclusions to a third party, we believe 
that the third party should be named in the registration statement and 
be treated in the same manner as other experts, such as investment 
banks that provide fairness opinions. We believe, based on discussions 
with industry participants, that at least some third-party reviewers 
will continue to perform reviews for ABS issuers and will revise their 
review procedures as needed to be comfortable

[[Page 4237]]

being named as experts in registered ABS transactions. We also note 
that third parties would not be required to provide consent in all 
instances, but only where the issuer attributes the findings and 
conclusions of the review to the third party.

D. Disclosure Requirements

1. Proposed Rules
    Item 1111 of Regulation AB \70\ outlines several aspects of the 
pool that the prospectus disclosure for ABS should cover. We proposed 
amendments to Item 1111 to require disclosure regarding the nature of 
the issuer's review of the assets under Rule 193 and the findings and 
conclusions of the review. In addition, we re-proposed amendments from 
our 2010 ABS Proposing Release to require disclosure regarding the 
composition of the pool as it relates to assets that do not meet 
disclosed underwriting standards, as we believe this information would 
promote a better understanding of the impact of the review and the 
composition of the pool assets.
---------------------------------------------------------------------------

    \70\ 17 CFR 229.1111.
---------------------------------------------------------------------------

    We proposed new Item 1111(a)(7) of Regulation AB to require that an 
issuer of ABS disclose the nature of the review it conducts to satisfy 
proposed Rule 193. This proposed requirement would implement Securities 
Act Section 7(d)(2),\71\ as added by the Act. As discussed in the 
Proposing Release, this disclosure would include whether the issuer has 
hired a third-party firm for the purpose of reviewing the assets. We 
also proposed to amend Item 1111(a)(7) to require an ABS issuer to 
disclose the findings and conclusions of any review performed by the 
issuer or by a third party engaged for purposes of reviewing the 
assets.\72\ We also proposed Item 1111(a)(8) which re-proposed 
additional requirements substantially similar to those we had 
previously proposed in the 2010 ABS Proposing Release. This item would 
have required disclosure of whether, and if so, how, any assets in the 
pool deviate from the disclosed underwriting criteria and data on the 
amount and characteristics of those assets that did not meet the 
disclosed standards. In addition to what we proposed in the 2010 ABS 
Proposing Release, we proposed a requirement that the issuer disclose 
the entity (e.g., sponsor, originator or underwriter) who determined 
that such assets would be included in the pool, despite not having met 
the disclosed underwriting standards.
---------------------------------------------------------------------------

    \71\ 15 U.S.C. 77g(d)(2).
    \72\ This language is intended to be consistent with the 
language used in Exchange Act Section 15E(s)(4)(A).
---------------------------------------------------------------------------

2. Comments on the Proposed Amendments
    Comments on the proposal were mixed. Some commentators supported 
the proposal in Item 1111(a)(7) \73\ and another commentator expressed 
support for the proposal in Item 1111(a)(8).\74\ Another commentator 
requested that the Commission modify the proposal in Item 1111(a)(8) 
such that the disclosure would be required only to the extent it is 
material to investors.\75\ This commentator also suggested that the 
Commission clarify that subparagraph (8) not be read to require 100% 
diligence of the pool such that, to the extent that an issuer does a 
sampling of the pool, only the deviations that are discovered in that 
sampling would need to be reported.\76\ This commentator also objected 
to the proposal to disclose the entity who made the decision to include 
the deviating assets as part of the pool, because multiple transaction 
parties could collectively agree on what assets are to be included in 
the pool.\77\ To the extent that in a particular transaction a single 
party makes the decision, this commentator argued that the disclosure 
is not material and should not be required to be reported.\78\ Another 
commentator suggested that such disclosure not be required for 
offerings of CMBS because decisions about CMBS pool assets are not 
susceptible to being attributed to a particular party due to the 
fungible nature of CMBS assets and the fact that the decisions are an 
iterative process involving the sponsor, issuer, and at times 
investors, to largely the same degree.\79\
---------------------------------------------------------------------------

    \73\ See comment letters from Chuff; SIFMA.
    \74\ See comment letter from Fitch.
    \75\ See comment letter from SIFMA.
    \76\ See comment letter from SIFMA.
    \77\ See comment letter from SIFMA.
    \78\ See comment letter from SIFMA.
    \79\ See comment letter from CRE Finance Council.
---------------------------------------------------------------------------

    Some commentators recommended that the rule provide further 
guidance on the findings and conclusions that must be disclosed.\80\ 
One commentator highlighted that third-party due diligence reviews 
typically evaluate a sample of assets according to underwriting 
guidelines provided by the asset seller and other criteria specified by 
the asset purchaser.\81\ This commentator noted that the typical end 
product of a third-party due diligence review in RMBS offerings is the 
grading of specific loans in a sample provided by the asset purchaser, 
according to whether the loans meet the seller guidelines and buyer 
criteria or whether they comply with applicable laws.\82\ In order for 
investors to be able to understand the loan ``grades'' and evaluate the 
quality of the reviewed assets, however, this commentator suggested 
that the rule require disclosure of the controlling guidelines and 
criteria used to produce the loan grades or designations.\83\
---------------------------------------------------------------------------

    \80\ See comment letters from CRE Finance Council; Levin.
    \81\ See comment letter from Levin.
    \82\ See comment letter from Levin.
    \83\ See comment letter from Levin.
---------------------------------------------------------------------------

    One commentator argued that Item 1111(a)(8) seems to assume that 
all originators have uniform underwriting criteria that permit the 
evaluation of most loans on a mechanical basis.\84\ In particular, this 
commentator explained that auto loan originators do not have hard and 
fast guidelines by which most loan applications can be evaluated. 
Instead, explained this commentator, such originators use electronic 
decision-making systems as a first filter for applications. Most 
decisions, however, are made by credit analysts at a variety of levels 
and the fact that a given loan required a higher level of approval does 
not mean that the loan should be considered an exception to the 
underwriting guidelines because there may be many reasons why a loan 
might require a higher level of approval and still fit within the 
``standard process'' of the originator. While this commentator did not 
object to the Commission's formulation of Item 1111(a)(8), it believed 
that many sponsors of auto loan ABS would not provide any incremental 
disclosure in response to new Item 1111(a)(8) because the underwriting 
guidelines in their prospectuses indicate that they make judgmental 
underwriting decisions, and there are not disclosed standards by which 
loans are evaluated, so there will not be a need to describe loans that 
fail to meet those standards.
---------------------------------------------------------------------------

    \84\ See comment letter from AFSA.
---------------------------------------------------------------------------

3. Final Rules
    After considering the comments, we are adopting the amendments to 
Item 1111 of Regulation AB substantially as proposed. We agree with 
commentators that the disclosure should provide a clear picture of the 
review undertaken and the results and have thus revised the item to 
make that clearer.
a. Nature of Review
    New Item 1111(a)(7) of Regulation AB requires that an issuer of ABS 
disclose the nature of the review it conducts to satisfy proposed Rule 
193. This would include whether the issuer has hired a third-party firm 
for the purpose of

[[Page 4238]]

reviewing the assets, or to assist it in reviewing the assets. This 
would include a description of the scope of the review, such as whether 
the issuer or a third party conducted a review of a sample of the 
assets and what kind of sampling technique was employed (i.e., random 
or adverse).
b. Findings and Conclusions
    Under new Item 1111(a)(7), the issuer will be required to disclose 
the findings and conclusions of the review performed by the issuer or 
by a third party engaged for purposes of reviewing the assets. Although 
Section 7(d) of the Securities Act does not require our rules to 
mandate that the issuer disclose the findings and conclusions of a 
review in its registration statement, we continue to believe this 
information is important for investors to consider along with the 
information in the registration statement relating to the nature of the 
issuer's review as required to be publicly disclosed by Securities Act 
Section 7(d). We continue to believe that disclosure of the findings 
and conclusions of the review will provide investors with a better 
picture of the assets than would be provided by disclosure only of the 
nature of the review and would provide a better ability to evaluate the 
review. We have revised the item to make clear that disclosure of the 
findings and conclusions necessarily requires disclosure of the 
criteria against which the loans were evaluated, and how the evaluated 
loans compared to those criteria along with the basis for including any 
loans not meeting those criteria.\85\ In order to ensure that this 
requirement is clear, we have included an instruction to the rule.
---------------------------------------------------------------------------

    \85\ Such disclosure would be required in order to provide 
meaningful context to disclosure of the findings and conclusions of 
the issuer or their-party due diligence providers. See comment 
letter from Levin (stating that disclosure of loan grades, as used 
by third-party due diligence providers, in isolation, without 
disclosure of controlling guidelines used to produce those grades, 
is not useful to investors).
---------------------------------------------------------------------------

c. Disclosure Regarding Exception Loans
    We are adopting, as proposed, Item 1111(a)(8) of Regulation AB. 
Item 1111(a)(8) of Regulation AB requires issuers to disclose how the 
assets in the pool deviate from the disclosed underwriting criteria and 
include data on the amount and characteristics of those assets that did 
not meet the disclosed standards. Issuers are required to disclose the 
entity (e.g., sponsor, originator, or underwriter) who determined that 
such assets should be included in the pool, despite not having met the 
disclosed underwriting standards, and what factors were used to make 
the determination. For example, this could include compensating 
factors, such as those included in an issuer's waiver policies for 
including in the pool loans that fail to meet the disclosed 
underwriting criteria, or a determination that the exception was not 
material. If compensating or other factors were used, issuers will be 
required to provide data on the amount of assets in the pool, or in the 
sample or otherwise known to the issuer if only a sample was reviewed, 
that are represented as meeting each factor and the amount of assets 
that do not meet those factors. We also believe that this information 
will help provide investors with a more complete understanding of the 
quality and extent of the issuer's review of the assets (through hiring 
a third-party or otherwise) and how that relates to a determination to 
either include a loan in the pool or exclude it from the pool.
    To the extent the underwriting criteria outlined in the prospectus 
are broad or describe underwriting decisions involving the use of 
discretion, the prospectus would need to provide disclosure of how the 
broad subjective underwriting decisions were applied. We note that Item 
1111 of Regulation AB requires a description of the underwriting 
criteria used to originate or purchase the pool assets. Thus, where 
originators may approve loans at a variety of levels, and the loans 
underwritten at an incrementally higher level of approval are evaluated 
based on judgmental underwriting decisions, the criteria for the first 
level of underwriting should be disclosed, and loans that are included 
in the pool despite not meeting the criteria for this first level of 
underwriting criteria should be disclosed under Item 1111(a)(8).
    We also are adopting, with some clarification, the requirement that 
the issuer disclose the entity (e.g., sponsor, originator or 
underwriter) who determined that such assets would be included in the 
pool, despite not having met the disclosed underwriting standards. 
While we are aware of some commentators' objection to reporting this 
information because of the possibility that multiple transaction 
parties could collectively agree on what assets are to be included in 
the pool, we continue to believe that this additional requirement will 
assist investors in understanding the entities along the securitization 
chain that may be directing decisions to include exception loans in the 
pool, even where more than one entity may be involved.\86\ We believe 
this information will be useful to investors because it will provide 
investors with information to gauge whether the decision to accept such 
loans may be subject to a potential conflict of interest. We have 
revised the rule to clarify that if multiple parties are involved in 
this decision, they should all be named.
---------------------------------------------------------------------------

    \86\ See, e.g., Massachusetts AG comment letter.
---------------------------------------------------------------------------

E. Transition Period

    Consistent with one commentator's suggestion, we have set a 
compliance date for the rule we adopt today that will allow market 
participants and industry groups sufficient time to develop procedures 
and systems required to comply with rule's requirements.\87\ As this 
commentator noted, and as we recognize, other initiatives and changes 
to the markets are simultaneously affecting participants in the 
securitization industry.\88\ Accordingly, any registered offering of 
ABS commencing with an initial bona fide offer after December 31, 2011, 
must comply with the new rules. We believe, consistent with one 
commentator's suggestion, a transition period will allow issuers time 
to design a review to meet the rule's minimum standard.\89\ We also 
believe a transition period will benefit third parties who, under the 
rule, potentially may be subject to expert liability in certain 
circumstances and may require a transitional period to implement 
procedures, or revise current ones, in light of the potential expert 
liability.
---------------------------------------------------------------------------

    \87\ See comment letter from SIFMA.
    \88\ See, e.g., Improvements to the Asset-Backed Securitization 
Process, Title IX, Subtitle D of the Act; Treatment by the Federal 
Deposit Insurance Corporation as Conservator or Receiver of 
Financial Assets Transferred by an Insured Depository Institution in 
Connection with a Securitization or Participation After September 
30, 2010, Final Rule, Federal Deposit Insurance Corporation (Sept. 
27, 2010).
    \89\ See comment letter from SIFMA.
---------------------------------------------------------------------------

III. Paperwork Reduction Act

    Certain provisions of the final rules contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995 (PRA).\90\ We published a notice requesting 
comment on the collection of information requirements in the Proposing 
Release for the rule amendments, and we submitted these requirements to 
the Office of Management and Budget (``OMB'') for review in accordance 
with the PRA.\91\ An agency may not conduct or sponsor, and a person is 
not required to comply with, a collection of information unless it 
displays a currently valid control

[[Page 4239]]

number. The titles for the collections of information are: \92\
---------------------------------------------------------------------------

    \90\ 44 U.S.C. 3501 et seq.
    \91\ 44 U.S.C. 3507(d) and 5 CFR 1320.11.
    \92\ The paperwork burden from Regulation S-K is imposed through 
the forms that are subject to the requirements in those regulations 
and is reflected in the analysis of those forms. To avoid a 
Paperwork Reduction Act inventory reflecting duplicative burdens and 
for administrative convenience, we assign a one-hour burden to 
Regulation S-K.

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.