The U.S. Securities and Exchange Commission (the “SEC”) recently released proposed rules that would significantly change the offering process, disclosure requirements, and reporting requirements related to mortgage-backed and asset-backed securities (collectively, “ABS”). If adopted, the rules would significantly affect all parties involved in ABS transactions, including corporate trustees. Of particular significance to corporate trustees, the rules could be interpreted to expand both the monitoring and record-keeping duties of trustees and weaken trustees’ ability to rely on rating agency confirmations when taking certain actions. The proposed rules have been published in the Federal Register, and are open to comment until August 2, 2010.
Currently, Regulation AB requires that issuers provide disclosure on a pool level basis. Under the new rules, issuers would be required to provide detailed disclosure at the asset level. These rules would also change existing shelf registration requirements by replacing credit rating requirements with new eligibility requirements. Additionally, privately placed ABS transactions would now be subject to increased disclosure requirements that could prove to be every bit as onerous as public offering disclosure requirements.
To the extent that trustees receive SEC filings, the new rules may require them to be even more vigilant in monitoring the issuer’s and other parties’ compliance with filing obligations, including expanded disclosure requirements under Regulation AB related to the assets underlying the ABS. A significant departure from the current regulations, the proposed Item 512(a)(7)(ii) of Regulation S-K would do away with the ability to suspend reporting requirements after a year, if certain conditions are met, on shelf registrations. In the new framework, such reporting requirements would continue indefinitely as long as non-affiliates of the depositor hold any of the issuer’s securities that were sold in registered transactions. Concomitantly, the trustee’s role with respect to such requirements would also continue for the life of the security, instead of only during the first year of the securitization. As trustees often must receive copies of reports the issuer files with the SEC, increased ongoing reporting requirements in ABS offerings may necessitate an increased obligation to receive and monitor SEC filings.
In the realm of shelf offerings, the proposed rules could increase the nature and frequency of trustees’ obligations to monitor issuers. One such proposed rule would put in place a third-party opinion requirement, meant to ensure compliance with repurchase provisions in transaction documents and allow trustees to better monitor and enforce repurchase obligations. Because the trustee would be required to receive the third-party opinion on a quarterly basis, their monitoring efforts would increase in frequency. To the extent that trustees are often obligated to make such demands on behalf of investors, the proposed shelf-eligibility requirement of a third-party opinion regarding breaches to the representations and warranties may result in greater monitoring and obligations to take action. Although the proposals are unclear on whether the attestation should be based on a random cross-section of the assets or whether there must be a review of all assets underlying the security, the requirement could increase costs to the trustee, as well as to the issuer and originator. Additionally, future shelf offerings may require the trustee to monitor or otherwise ensure compliance with the eligibility criteria through receipt of additional certificates and opinions.
Additionally, proposed amendments to Items 1104 and 1110 of Regulation AB would require disclosure under the Exchange Act of the amount of repurchase demands made and repurchases made pursuant to those demands. As a result of the trustee’s potentially greater responsibility to monitor repurchase requirements, public disclosure of repurchase demands may put greater pressure on trustees to ensure that the issuer is in compliance with its obligations under repurchase provisions in an ABS offering. The greater public disclosure requirement would give the trustee a way to monitor repurchase obligations and thereafter make demands pursuant to their increased obligations under the above-referenced sections.
Of significant note with regards to the new shelf eligibility requirements is the replacement of credit rating requirements. The SEC has explicitly expressed the desire to phase out credit rating requirements under certain circumstances. As a result, investors and future ABS offerings may rely less on credit rating agencies as indicators of the efficacy of the issuer’s actions under the transaction documents. Corporate trustees have often relied upon rating agency confirmations regarding credit ratings to gain comfort that an action, such as an amendment to the transaction documents or the replacement of a servicer, would protect investor interests. The reduced reliance on credit ratings may require the trustee, as well as other transaction parties, to develop alternative systems for monitoring and approving transactions and other actions taken by the issuer and other parties in an ABS. Trustees may choose to rely on compliance with shelf eligibility requirements as a substitute for the comfort they received from credit rating agencies, but these requirements may not adequately address the protection of the interests of investors that a trustee is obligated to uphold. In particular, although most of the shelf eligibility requirements would give investors more information about ABS transactions, these requirements may not adequately reflect the effect of common events throughout the life of the ABS issue. For example, whereas in the past trustees could rely on a rating agency to confirm that a proposed amendment to a particular agreement would not affect the rating of an issuance, the proposed shelf eligibility requirements do not include a metric that would provide such comfort. As a result, alternative mechanisms to provide trustee’s comfort for actions throughout the life of the transaction would be necessary in ABS to understand and act in the face of various common events in the life of the ABS offering.
The trustee’s duties in private placements may also increase because of the proposed disclosure requirements under proposed revisions to Rule 144A and to Rule 506 of Regulation D and under a newly proposed Rule 192. Although disclosure need not be provided to the SEC or investors unless requested, it is anticipated that, as a matter of contract, trustees in future privately placed transactions may be obligated to demand periodic disclosure statements for investors for the life of the transaction. Additionally, trustees may be responsible for monitoring the issuers’ compliance with investor demands for ongoing disclosure or may be the intermediary through which investors demand disclosure documentation from issuers. As a result, the proposed rules may increase the demands placed upon a trustee in private ABS offerings.
The U.S. Senate recently passed S. 3217, the Restoring American Financial Stability Act, which contains some provisions aimed at improving the asset-backed securitization process. The bill must now be reconciled with a similar bill passed by the House of Representatives earlier this year. It is unclear at this time what bearing this legislation would have on the proposed SEC rules changes.
Conclusion
The proposed rules released by the SEC could significantly affect the duties and obligations of the corporate trustee in ABS transactions. The rules, if adopted, would increase the extent and length of corporate trustees’ monitoring of SEC filings and would increase trustees’ obligations with regards to enforcement of contractual provisions, such as repurchase obligations. Additionally, the ability of the trustee to rely upon rating agency confirmations, prior to the taking of certain actions, may be minimized. Therefore, the proposed rules may result in corporate trustees fashioning new methods with which to both gain the assurance and comfort necessary to fulfill their obligations and to meet additional operational challenges. As a result, the proposed rules may necessitate changes in the administrative approaches of corporate trustees and corporate trustees should begin developing processes with which to approach these potentially greater obligations.
