The SEC approved the issuance of a proposal that would significantly revise Regulation AB and other rules relating to the offering process and disclosure and reporting practices for asset-backed securities. SEC Chairman Mary Schapiro said the release represents a fundamental revision in the way the asset-backed securities market is regulated. Ms. Schapiro has asked the staff to continue to work with other financial regulators to ensure that their activities with respect to asset-backed securities are fully coordinated. The comment period will remain open for 90 days.

The securitization of assets played a central role in the financial crisis. The practice fostered poor lending practices by encouraging lenders to shift their risk of loss to investors, according to Ms. Schapiro. Investors suffered significant losses and have largely withdrawn from the market. After a comprehensive reevaluation of the existing rules, Ms. Schapiro said the Commission concluded that investors must have better information about the pooled assets that back these securities. The information must be current enough to enable investors to accurately assess risk and value.

The proposed rules would better inform investors about asset-backed securities by requiring the disclosure of standardized information about the loans in the pool with computer-readable data tags. The loan level information would be provided when an asset is securitized, and additional information would be provided on an ongoing basis.

Issuers of asset-backed securities would file a computer program that allows investors to analyze information about the loans within the pool of assets on the SEC’s Web site. The program would provide information about how the loan payments are distributed to investors, how losses or the lack of payment on the loans will be divided among investors and when administrative fees are paid to service providers.

Investors also would be given more time to consider the information before making an investment decision. Issuers currently may sell asset-backed securities almost immediately without providing investors with time to review the offering materials. The SEC is seeking comment on whether issuers should file a preliminary prospectus at least five business days before the first sale in the offering to give investors time to consider transaction-specific information.

The proposal would repeal the current condition that issuers must receive an investment grade rating in order to receive shelf or expedited eligibility for an asset-backed securities offering. Chief executive officers of the issuers would be required to certify that the assets have characteristics that provide a reasonable basis to believe they will produce cash flows as described in the prospectus.

The proposal would also require the sponsor to hold five percent of each class of asset-backed securities and not to hedge those holdings. The issuer would also have to agree to file Exchange Act reports with the SEC on an ongoing basis rather than just for the first year.

The proposed rules would increase the transparency in the exempt private structured finance market so that an issuer relying on a safe harbor such as Rule 144A or Regulation D for the unregistered sale of securities would have to provide investors the same information that is required for registered offerings upon request, both at the time of the offering and on an ongoing basis.

The SEC is considering whether to require issuers of asset-backed securities to file a public notice of initial placements of securities to be sold under Rule 144A. The notice would include information about the offering and would be filed on the EDGAR database. The SEC may also revise Form D to collect information on structured finance products. The proposal seeks comment on standardizing certain static pool disclosures and amending the definition of an asset-backed security to ensure that investors have sufficient information about the securities.

The proposal would require additional information about originators and sponsors. It would lower the threshold of the change in material pool characteristics that triggers the filing of Form 8-K Item 6.05 from five percent to one percent.

Chairman Schapiro said that it is important to reexamine the assumption that sophisticated investors do not need the types of protection offered by Securities Act registration. The SEC must also address whether the proposed changes may further drive asset-backed securities transactions to the private structured markets, according to the chairman.

Commissioner Kathleen Casey asked about the discovery during the financial crisis that some sophisticated investors did not fully understand the products they were buying. She asked whether they failed to conduct the necessary level of due diligence or if they sought information that was not forthcoming. Meredith Cross, the director of the Division of Corporation Finance, said the staff does not have much information about what went on in the private markets. The proposal would help with that, she said. Commissioner Casey said it is important to know the source of the failure.

Commissioner Luis Aguilar said the proposal begins the dialogue to address structural inequities in the asset-backed securities markets. He hopes that Congress will grant the Commission the authority to do more. Mr. Aguilar questioned whether the proposal goes far enough to require the key disclosures that investors need to be on equal footing with issuers.

Mr. Aguilar noted that for the first time, investors in unregistered offerings under Regulation D and Rule 144A could request the same information provided in public offerings of asset-backed securities. However, he pointed out that the rules would not apply to structured finance products offered and sold under the private placement statutory exemption of Section 4(2) or the so-called "Section 4(1-1/2)" exemption for private resales.

Commissioner Troy Paredes, who joined the other commissioners in approving the release for comment, said he has significant reservations about certain features of the proposal. He expressed concern about the proposal that the sponsor of an asset-backed securities offering retain an unhedged five percent "vertical slice" of the offering for shelf eligibility. He believes that more analysis is needed to back up a particular percentage or form of risk retention before adopting a rule. "One size may not fit all," he added, because different asset classes and deal structures may call for different degrees of risk retention.

Mr. Paredes also pointed out that many financial institutions in addition to investors suffered considerable losses when the financial crisis hit because they had “skin in the game.” He questioned how confident one could be that the five percent retention requirement would improve the quality of asset-backed securities.

Mr. Paredes said that risk retention can have an impact on accounting, regulatory capital and sales that could jeopardize the economics and the underlying rationale of asset securitization. He questioned whether it was appropriate for the SEC to adopt rules that determine the substance of securitization.

The proposal would treat private offerings of asset-backed securities substantially the same as public offerings in terms of the required disclosure, Mr. Paredes added. He said the extent to which the proposal collapses the regulatory distinction between public and private offerings of asset-backed securities is disquieting.

Commissioner Paredes also found it troubling that the proposal may provide government-sponsored enterprises with more market power at the expense of conforming loan lenders and nonconforming borrowers. He looks forward to comments on the implications for the housing market and the financial system more generally if the government-sponsored enterprises stand to benefit from the rulemaking in the way the release suggests they might.

□ Release No. 33-9117 is reported at ¶88,891.