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SEC Grants Relief in Connection With Term Asset-Backed Securities Loans

The SEC's Division of Trading and Markets has granted relief to primary dealers in connection with a term asset-backed securities loan facility ("TALF") authorized by the Federal Reserve Board and created by the Federal Reserve Bank of New York. The Federal Reserve Bank explained that the TALF program is intended to unblock the flow of funds into certain asset classes, such as student loans, auto loans and credit card loans, which have dried up. The increased credit availability is a critical objective of the government in its efforts to stabilize and revitalize the nation’s economy.

Under the TALF program the Federal Reserve Bank will offer up to $200 billion of nonrecourse loans to borrowers to facilitate their purchases of asset-backed securities. The loans will be secured by the acquired securities but without recourse to the borrower. By providing nonrecourse financing at an attractive price, TALF may increase the demand for asset-backed securities which in turn would restore liquidity to the market and encourage new lending to consumers and small businesses.

The Federal Reserve Bank lacks the administrative and operational resources to administer the program which is why it is relying on the primary dealers. The program would be undermined if the primary dealers are not permitted to perform under TALF while also acting as underwriters or selling group members with respect to a particular issue of asset-backed securities that is serving as eligible collateral for a TALF loan.

Without the relief requested by the Federal Reserve Bank, a primary dealer would be precluded by 1934 Act Section 11(d)(1) from directly or indirectly arranging for the extension or the maintenance of credit to or for a customer on any security, other than an exempted security, that was part of a new issue in the distribution of which the dealer participated as a member of a selling syndicate or group within 30 days prior to the transaction unless another exemption was available.

The TALF program contemplates that the primary dealers will act as agents of borrowers in making applications for TALF loans. The dealers will assess the eligibility of the prospective borrowers and the collateral. They will receive the portion of the interest and principal distributions on the collateral that is for the borrower’s account and disburse it to the borrower.

The nonrecourse loans will each be in a minimum principal amount of $10 million for eligible borrowers that pledge eligible collateral as security. An eligible borrower is a business entity or institution that is organized under the laws of the U.S. and conducts significant operations or activities within the U.S., including a U.S. subsidiary of such an entity. Eligible borrowers also include a U.S. branch or agency of a foreign bank, other than a foreign central bank, that maintains reserve with a federal reserve bank and a U.S. organized and managed investment fund that maintains an account relationship with one of the primary dealers.

Eligible collateral includes U.S. dollar denominated asset-backed securities in an eligible category that is rated at least AAA from two or more rating agencies that were issued after January 1, 2009 and to which substantially all of the underlying credit exposures are to U.S. domiciled obligors. The sponsors must agree to comply with the executive compensation requirements in the Economic Stabilization Act of 2008.

The primary dealers will perform the necessary "know your customer" processes with respect to their borrowers and determine whether each prospective borrower is eligible. The dealers will perform certain screening procedures to establish the eligibility of the collateral proposed to be pledged by the borrowers. They will keep records of the loans and receive and deliver TALF-related notices on behalf of the borrowers.

The loans will have a maturity of three years, will bear interest at either a fixed or a floating rate that is payable monthly and will be secured by eligible collateral with a value of no less than the amount of the loan.

The Division, by delegated authority, found that it is in the public interest and consistent with the protection of investors to grant a limited exemption under 1934 Act Section 36 to any broker-dealer that acts as a primary dealer in government securities from the prohibitions on arranging for the extension or maintenance of credit contained in Section 11(d)(1). The exemption is strictly limited to the application of the prohibitions on arranging for the extension or maintenance of credit under Section 11(d)(1) to activities involving primary dealers as described in the letter by the Federal Reserve Bank.