Rule2023-26430
Prohibition Against Conflicts of Interest in Certain Securitizations
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
December 7, 2023
Effective
February 5, 2024
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("SEC" or "Commission") is adopting a rule to implement Section 621 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 ("Dodd-Frank Act") prohibiting an underwriter, placement agent, initial purchaser, or sponsor of an asset-backed security (including a synthetic asset-backed security), or certain affiliates or subsidiaries of any such entity, from engaging in any transaction that would involve or result in certain material conflicts of interest.
Full Text
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<title>Federal Register, Volume 88 Issue 234 (Thursday, December 7, 2023)</title>
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[Federal Register Volume 88, Number 234 (Thursday, December 7, 2023)]
[Rules and Regulations]
[Pages 85396-85466]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-26430]
[[Page 85395]]
Vol. 88
Thursday,
No. 234
December 7, 2023
Part III
Securities and Exchange Commission
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17 CFR Part 230
Prohibition Against Conflicts of Interest in Certain Securitizations;
Final Rule
Federal Register / Vol. 88 , No. 234 / Thursday, December 7, 2023 /
Rules and Regulations
[[Page 85396]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 230
[Release No. 33-11254; File No. S7-01-23]
RIN 3235-AL04
Prohibition Against Conflicts of Interest in Certain
Securitizations
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission (``SEC'' or
``Commission'') is adopting a rule to implement Section 621 of the
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
(``Dodd-Frank Act'') prohibiting an underwriter, placement agent,
initial purchaser, or sponsor of an asset-backed security (including a
synthetic asset-backed security), or certain affiliates or subsidiaries
of any such entity, from engaging in any transaction that would involve
or result in certain material conflicts of interest.
DATES: Effective date: This final rule is effective on February 5,
2024.
Compliance date: See Section II.I.
FOR FURTHER INFORMATION CONTACT: Brandon Figg, Special Counsel, or
Kayla Roberts, Special Counsel in the Office of Structured Finance,
Division of Corporation Finance at (202) 551-3850, Securities and
Exchange Commission, 100 F Street NE, Washington, DC 20549.
SUPPLEMENTARY INFORMATION: We are adopting the following rule under 15
U.S.C. 77a et seq. (``Securities Act''):
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Commission reference CFR citation (17 CFR)
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General Rules and Regulations,
Securities Act of 1933:
Rule 192............................ Sec. 230.192.
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Table of Contents
I. Introduction
A. Background
B. Summary of the Proposed Rule
C. Summary of the Final Rule
II. Discussion of Rule 192
A. Scope: Asset-Backed Securities
1. Proposed Definition of Asset-Backed Security
2. Comments Received
3. Final Rule
B. Scope: Securitization Participants
1. Proposed Scope of Securitization Participants
2. Comments Received
3. Final Rule
C. Prohibition Timeframe
1. Proposed Prohibition Timeframe
2. Comments Received
3. Final Rule
D. Prohibition
1. Proposed Prohibition
2. Comments Received
3. Final Rule
E. Exception for Risk-Mitigating Hedging Activities
1. Proposed Exception
2. Comments Received
3. Final Rule
F. Exception for Liquidity Commitments
1. Proposed Approach
2. Comments Received
3. Final Rule
G. Exception for Bona Fide Market-Making Activities
1. Proposed Approach
2. Comments Received
3. Final Rule
H. Anti-Evasion
1. Proposed Rule
2. Comments Received
3. Final Rule
I. Compliance Date
III. Other Matters
IV. Economic Analysis
A. Introduction
B. Economic Baseline
1. Overview of the Securitization Markets
2. Affected Parties
3. Current Relevant Statutory Provisions, Regulations, and
Practices
C. Broad Economic Considerations
D. Costs and Benefits
1. Benefits
2. Costs
E. Anticipated Effects on Efficiency, Competition, and Capital
Formation
1. Competition
2. Efficiency
3. Capital Formation
F. Reasonable Alternatives
1. Changes to Scope of Definitions
2. Information Barriers
3. Changes to Exclusions
4. Conditions of the Exceptions
V. Paperwork Reduction Act
A. Summary of the Collections of Information
B. Summary of Comment Letters
C. Effects of the Final Rule on the Collections of Information
D. Aggregate Burden and Cost Estimates for the Final Rule
VI. Final Regulatory Flexibility Analysis
A. Need for, and Objectives of, the Final Rule
B. Significant Issues Raised by Public Comments
C. Small Entities Subject to the Rule
D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
E. Agency Action To Minimize Effect on Small Entities
Statutory Authority
I. Introduction
A. Background
On January, 25, 2023, the Commission proposed new Rule 192 to
implement the prohibition in Securities Act Section 27B \1\ (``Section
27B''),\2\ which was added by Section 621 of the Dodd-Frank Act.\3\
Section 27B(a) provides that an underwriter, placement agent, initial
purchaser, or sponsor, or affiliates or subsidiaries of any such
entity, of an asset-backed security (``ABS''), including a synthetic
asset-backed security, shall not, at any time for a period ending on
the date that is one year after the date of the first closing of the
sale of the asset-backed security, engage in any transaction that would
involve or result in any material conflict of interest with respect to
any investor in a transaction arising out of such activity.\4\ Section
27B(b) further requires that the Commission issue rules for the purpose
of implementing the prohibition in Section 27B(a).\5\ Section 27B(c)
provides exceptions from the prohibition in Section 27B(a) for certain
risk-mitigating hedging activities, liquidity commitments, and bona
fide market-making activities.\6\
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\1\ 15 U.S.C. 77z-2a.
\2\ Prohibition Against Conflicts of Interest in Certain
Securitizations, Release No. 33-11151 (Jan. 25, 2023) [88 FR 9678
(Feb. 14, 2023)] (``Proposing Release'' or ``proposed rule''). In
Sept. 2011, the Commission proposed a rule designed to implement
Section 27B, but no further action was taken on that proposal. See
Prohibition against Conflicts of Interest in Certain
Securitizations, Release No. 34-65355 (Sept. 19, 2011) [76 FR 60320
(Sept. 28, 2011)].
\3\ Sec. 621, Public Law 111-203, 124 Stat. 1376, 1632.
\4\ 15 U.S.C. 77z-2a(a).
\5\ 15 U.S.C. 77z-2a(b).
\6\ 15 U.S.C. 77z-2a(c).
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B. Summary of the Proposed Rule
Proposed Rule 192 would implement the prohibition in Securities Act
Section 27B(a) and, consistent with Section 27B(c), provide exceptions
from the prohibition for certain risk-mitigating hedging activities,
liquidity commitments, and bona fide market-making activities.\7\ The
proposal was intended to target transactions that effectively represent
a bet against a securitization and focus on the types of transactions
that were the subject of regulatory and Congressional investigations
following the financial crisis of 2007-2009.\8\
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\7\ See Proposing Release Section II.
\8\ See Proposing Release Section I.
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[[Page 85397]]
In response to the Proposing Release, the Commission received over
900 comment letters from a variety of commenters, including
institutional investors, issuers, and various other market
participants, professional, policy, and trade associations, Members of
Congress, former Federal Government officials, academics, and
unaffiliated individuals.\9\ Commenters generally supported the
Commission's statutorily-mandated goal of protecting investors by
preventing the sale of ABS tainted by material conflicts of
interest,\10\ but many commenters expressed concern that the scope of
the proposed rule was overly broad and could have unintended
consequences on securitization markets as a whole.\11\ While
acknowledging that adopting a rule to address conflicts of interest in
securitizations is still appropriate, some commenters also stated that
the rule as proposed was not appropriately balanced to the current
state of securitization markets in light of the evolution of those
markets since the enactment of the Dodd-Frank Act.\12\ Section 27B
mandates that the Commission issue rules with regard to conflicts of
interest in securitizations. While we recognize that securitization
markets have evolved in the years since the financial crisis of 2007-
2009, we continue to believe that the adopted rule is necessary to
prevent the resurgence of the types of transactions that were prevalent
leading up to that time.\13\ Additionally, we believe that the changes
we have made in response to comments regarding the breadth of the
proposed rule, which are discussed in detail below, take into account
the current state of securitization markets, while still providing
strong investor protection against material conflicts of interest in
securitization transactions. As discussed in greater detail below, many
commenters sought clarification or limitations with respect to the
types of transactions and financial products that would be subject to
the rule,\14\ as well as the activities of various market participants
that would or would not result in such entities being securitization
participants subject to the final rule.\15\ Many commenters also
expressed concerns that the proposed commencement point of the
prohibition timeframe was insufficiently clear to allow market
participants to conform their activities for compliance with the
rule.\16\ Most significantly, commenters expressed general opposition
to the proposed definition of ``conflicted transaction'' as overly
broad and stated that it would unnecessarily capture a wide range of
activities that are essential to the functioning and issuance of ABS
and the routine risk management of securitization participants.\17\
Commenters also requested that the final rule include an alternative
materiality standard \18\ and an ``anti-evasion'' provision rather than
the ``anti-circumvention'' provision that was proposed.\19\ Some
commenters also requested that the final rule include a foreign
transaction safe harbor to provide clarity with respect to the rule's
cross-border application.\20\ Finally, the Commission received comments
suggesting certain revisions to the proposed exceptions for risk-
mitigating hedging activities, liquidity commitments, and bona fide
market-making activities.\21\ As we discuss in greater detail below, we
have made certain revisions in response to the comments received.
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\9\ Comment letters received by the Commission are available on
our website at <a href="https://www.sec.gov/comments/s7-01-23/s70123.htm">https://www.sec.gov/comments/s7-01-23/s70123.htm</a>. The
comment period for the Proposing Release was open for 60 days from
issuance and publication on <a href="http://SEC.gov">SEC.gov</a> and ended on Mar. 27, 2023.
Several commenters said that the comment period was insufficient.
See, e.g., letters from American Investment Council dated Mar. 27,
2023 (``AIC''); Investment Company Institute dated Mar. 27, 2023
(``ICI''); National Association of Bond Lawyers et al. dated Mar.
27, 2023 (``NABL et al.''); U.S. Representatives Ann Wagner and Bill
Huizenga dated Mar. 24, 2023 (``Representatives Wagner and
Huizenga''); U.S. Senator John Kennedy dated Mar. 30, 2023
(``Senator Kennedy''). In stating that the comment period was
insufficient, some commenters requested an extension (see, e.g.,
letters from Alternative Investment Management Association and
Alternative Credit Council dated Mar. 27, 2023 (``AIMA/ACC'');
Association for Financial Markets in Europe dated Mar. 27, 2023
(``AFME''); American Property Casualty Insurance Association et al.
dated Feb. 16, 2023 (``APCIA et al.''); Loan Syndications and
Trading Association dated Mar. 1, 2023 (``LSTA I'')) and others
indicated that they would submit multiple comment letters, some of
which were received after the close of the comment period (see
letters from Loan Syndications and Trading Association dated Mar.
27, 2023 (``LSTA II''); Loan Syndications and Trading Association
dated May 2, 2023 (``LSTA III''); Loan Syndications and Trading
Association dated Oct. 30, 2023 (``LSTA IV''); Managed Funds
Association dated May 16, 2023 (``MFA II''); Structured Finance
Association dated July 13, 2023 (``SFA II''); Securities Industry
and Financial Markets Association, the Asset Management Group of
SIFMA, and the Bank Policy Institute dated June 27, 2023 (``SIFMA
II''). Some commenters requested that the Commission re-propose the
rule after reviewing the comment letters. See letters from American
Bar Association dated Apr. 5, 2023 (``ABA''); Andrew Davidson Co.
dated Mar. 27, 2023 (``Andrew Davidson''); LSTA III; Securities
Industry and Financial Markets Association, the Asset Management
Group of SIFMA, and the Bank Policy Institute dated Mar. 27, 2023
(``SIFMA I''). Also, after the close of the comment period, one
commenter submitted a letter referencing several of the Commission's
proposals and stating that the number of outstanding proposals,
together with insufficient time to respond, operated to deprive the
public of the ability to meaningfully comment on all of the
proposals. See letter from Managed Funds Association dated July 24,
2023 (``MFA III''). We have considered comments received since the
issuance of the proposed rule, including those received after Mar.
27, 2023, and do not believe an extension of the comment period or a
re-proposal of the rule is necessary.
\10\ See, e.g., letters from ABA; Americans for Financial Reform
Education Fund dated June 7, 2023 (``AFR''); Better Markets dated
Mar. 27, 2023 (``Better Markets''); Structured Finance Association
dated Mar. 27, 2023 (``SFA I'').
\11\ See, e.g., letters from ABA, CRE Finance Council dated Mar.
27, 2023 (``CREFC I''); ICI; Arch Capital Group Ltd., Enact Holdings
Inc., Essent Group Ltd., MGIC Investment Corporation, NMI Holdings,
Inc., and Radian Group Inc. dated Mar. 27, 2023 (``PMI Industry
I''); SFA I; SIFMA I.
\12\ See, e.g., letters from ABA; SIFMA I. These commenters
cited the following as examples of the changes in securitization
markets in that time period: the adoption and implementation of 17
CFR 246 (``Regulation RR''), 17 CFR 255 (``the Volcker Rule''),
rules regulating swaps and security-based swaps, and changes in the
regulation of nationally recognized statistical rating organizations
(``NRSROs'') to enhance transparency and address conflicts of
interest in connection with the issuance of ABS.
\13\ See, e.g., Wall Street and The Financial Crisis: Anatomy of
a Financial Collapse, Majority and Minority Staff Report, Permanent
Subcommittee on Investigations, United States Senate (Apr. 13, 2011)
(``Senate Financial Crisis Report'').
\14\ See Section II.A.
\15\ See Section II.B.
\16\ See Section II.C.
\17\ See Section II.D.
\18\ See Section II.D.3.d.
\19\ See Section II.H.
\20\ See Section II.A.3.c.
\21\ See Sections II.E. through II.G.
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C. Summary of the Final Rule
New Rule 192 implements Section 27B to the Securities Act.
Fundamentally, the rule is intended to prevent the sale of ABS that are
tainted by material conflicts of interest by prohibiting securitization
participants \22\ from engaging in certain transactions that could
incentivize a securitization participant to structure an ABS in a way
that would put the securitization participant's interests ahead of
those of ABS investors. By focusing on transactions that effectively
represent a ``bet'' against the performance of an ABS, Rule 192 will
provide strong investor protection against material conflicts of
interest in securitization transactions while not unduly hindering
routine securitization activities that do not give rise to the risks
that Section 27B is intended to address.
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\22\ The definition of ``securitization participant'' for
purposes of new Rule 192 includes a sponsor, underwriter, placement
agent, initial purchaser, and certain affiliates and subsidiaries of
such entities, as discussed in detail in Section II.B.
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To achieve these objectives, Rule 192:
<bullet> Prohibits, for a specified period, a securitization
participant from engaging in any transaction that would result in a
material conflict of interest between the securitization participant
and an investor in the relevant ABS. A securitization participant may
not, for a period beginning on the date on which
[[Page 85398]]
such person has reached an agreement to become a securitization
participant with respect to an ABS and ending on the date that is one
year after the date of the first closing of the sale of such ABS,\23\
directly or indirectly engage in any transaction that would involve or
result in a material conflict of interest between the securitization
participant and an investor in such ABS. Under the final rule, such
transactions are ``conflicted transactions'' and include (i) engaging
in a short sale of the relevant ABS, (ii) purchasing a credit default
swap or other credit derivative that entitles the securitization
participant to receive payments upon the occurrence of specified credit
events in respect of the ABS, or (iii) purchasing or selling any
financial instrument (other than the relevant ABS) or entering into a
transaction that is substantially the economic equivalent of the
aforementioned transactions, other than, for the avoidance of doubt,
any transaction that only hedges general interest rate or currency
exchange risk.\24\ Transactions unrelated to the idiosyncratic credit
performance of the ABS, such as reinsurance agreements, hedging of
general market risk (such as interest rate and foreign exchange risks),
or routine securitization activities (such as the provision of
warehouse financing or the transfer of assets into a securitization
vehicle) are not ``conflicted transactions'' as defined by the rule,
and thus are not subject to the prohibition in 17 CFR 230.192(a)(1)
(``Rule 192(a)(1)''); \25\
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\23\ See Section II.C.
\24\ See Section II.D.
\25\ Id.
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<bullet> Defines the persons that are subject to the rule. A
securitization participant includes any underwriter, placement agent,
initial purchaser, or sponsor of an ABS (each as defined by 17 CFR
230.192(c) (``Rule 192(c)'') and also includes any affiliate or
subsidiary that acts in coordination with an underwriter, placement
agent, initial purchaser, or sponsor or that has access to, or receives
information about, the relevant ABS or the asset pool underlying or
referenced by the relevant ABS prior to the first closing of the sale
of the relevant ABS. The final rule includes functional definitions for
the terms ``underwriter,'' ``placement agent,'' ``initial purchaser,''
and ``sponsor,'' which are based on the person's activities in
connection with a securitization and are generally based on existing
definitions of such terms under the Federal securities laws and the
rules thereunder.\26\ The definition of ``sponsor'' in the final rule
excludes: (i) a person that acts solely pursuant to such person's
contractual rights as a holder of a long position in the ABS; (ii) any
person that performs only administrative, legal, due diligence,
custodial, or ministerial acts related to the structure, design,
assembly, or ongoing administration of an ABS or the composition of the
underlying pool of assets; \27\ and (iii) the United States or an
agency of the United States with respect to any ABS that is fully
insured or fully guaranteed as to the timely payment of principal and
interest by the United States; \28\
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\26\ Rule 192(c) also defines ``distribution'' as used in the
definition for ``underwriter'' and ``placement agent.'' See Section
II.B.
\27\ As discussed in greater detail below, this exclusion
includes accountants, attorneys, and credit rating agencies with
respect to the creation and sale of an ABS and the activities
customarily performed by trustees, custodians, paying agents,
calculation agents, and other contractual service providers,
including servicers. See Section II.B.3.b.iii.
\28\ As discussed in greater detail below, we are not adopting
proposed paragraph (ii)(B) of the ``sponsor'' definition, which
would have captured any person that directs or causes the direction
of the structure, design, or assembly of an asset-backed security or
the composition of the pool of assets underlying the asset-backed
security. See Section II.B.3.b.ii. We are also not adopting the
proposed exclusion from the definition of ``sponsor'' for the
Federal National Mortgage Association (``Fannie Mae'') or the
Federal Home Loan Mortgage Corporation (``Freddie Mac'' and,
together with Fannie Mae, the ``Enterprises'') while operating under
the conservatorship or receivership of the Federal Housing Finance
Agency (``FHFA'') with capital support from the United States with
respect to any ABS that is fully insured or fully guaranteed as to
the timely payment of principal and interest by such entity. See
Section II.B.3.b.iv.
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<bullet> Defines asset-backed securities that are subject to the
prohibition. Under the final rule, an ``asset-backed security'' subject
to the prohibition is defined, consistent with Section 27B, to include
asset-backed securities as defined in Section 3 of the Exchange Act of
1934 (``Exchange Act'') \29\ and also includes synthetic ABS and hybrid
cash and synthetic ABS; \30\
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\29\ 15 U.S.C. 78a et seq.
\30\ For purposes of this rule, we use the term ``cash ABS'' to
refer to ABS where the underlying pool consists of one or more
financial assets. We use the term ``hybrid cash and synthetic ABS''
to refer to ABS where the underlying pool consists of one or more
financial assets as well as synthetic exposure to other assets. See
Section II.A.
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<bullet> Provides exceptions to the prohibition for risk-mitigating
hedging activities, liquidity commitments, and bona fide market-making
activities. These exceptions, which are specified in Section 27B,
permit certain market activities, subject to satisfaction of the
specified conditions, that would otherwise be prohibited by the rule;
\31\
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\31\ See Sections II.E. through II.G.
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<bullet> Addresses evasion of the exceptions. Under 17 CFR
230.192(d) (``Rule 192(d)''), if a securitization participant engages
in a transaction or series of related transactions that, although in
technical compliance with the exception for risk-mitigating hedging
activities, liquidity commitments, or bona fide market-making
activities, is part of a plan or scheme to evade the prohibition in
Rule 192(a)(1), that transaction or series of related transactions will
be deemed to violate the prohibition; \32\ and
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\32\ See Section II.H.
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<bullet> Provides a safe harbor for certain foreign transactions.
Pursuant to 17 CFR 192(e) (``Rule 192(e)''), the prohibition will not
apply to an asset-backed security if it is not issued by a U.S. person
(as defined in 17 CFR 902(k) (``Rule 902(k) of Regulation S'') and the
offer and sale of the asset-backed security is in compliance with 17
CFR 203.901 through 905 (``Regulation S'').\33\
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\33\ See Section II.A.3.c.
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We discuss in greater detail below the securitization transactions
and participants subject to Rule 192's prohibition, the timeframe
during which the prohibition applies, the types of transactions that
are prohibited by Rule 192 and the related exceptions, and the
compliance date by which securitization participants must conform their
activities with the requirements of the final rule. As adopted, Rule
192 will complement the existing federal securities laws that
specifically apply to securitization, as well as the general anti-fraud
and anti-manipulation provisions of the Federal securities laws,\34\ by
explicitly protecting ABS investors against material conflicts of
interest.
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\34\ See, e.g., Section 17(a) of the Securities Act of 1933 (15
U.S.C. 77q), Section 10(b) of the Securities Exchange Act of 1934
(15 U.S.C. 78j) and 17 CFR 240.10b-5.
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II. Discussion of Rule 192
A. Scope: Asset-Backed Securities
1. Proposed Definition of Asset-Backed Security
The Commission proposed to prohibit a securitization participant,
for a specified period of time with respect to an asset-backed
security, from engaging in any transaction that would involve or result
in a material conflict of interest between such securitization
participant and an investor in such asset-backed security. Consistent
with Section 27B, the Commission proposed that the term ``asset-backed
security'' would include ABS as defined in Section 3 of the
[[Page 85399]]
Exchange Act \35\ (``Exchange Act ABS'') (which encompasses both
registered and unregistered offerings), as well as synthetic ABS and
hybrid cash and synthetic ABS.\36\ The Commission did not propose a
definition of ``synthetic ABS'' due to concerns that any such
definition could be potentially overinclusive or underinclusive, and
that a securitization participant might attempt to evade the
prohibition by structuring transactions around a particular definition,
despite creating a product that is substantively a synthetic ABS, as
that term is commonly understood in the market.\37\
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\35\ 17 U.S.C. 78c(a)(79). An Exchange Act ABS is defined as ``a
fixed-income or other security collateralized by any type of self-
liquidating financing asset (including a loan, a lease, a mortgage,
or a secured or unsecured receivable) that allows the holder of the
security to receive payments that depend primarily on cash flow from
the asset . . .''
\36\ See Proposing Release Section II.A.
\37\ See Proposing Release Section II.A.
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2. Comments Received
Commenters generally supported the proposal to define ``asset-
backed security'' for purposes of Rule 192 to include Exchange Act ABS,
synthetic ABS, and hybrid cash and synthetic ABS,\38\ though several
commenters requested additional clarification regarding certain types
of financial products and securities,\39\ or that certain securities be
excluded from the definition,\40\ which we discuss in greater detail
below. With respect to the proposed rule's inclusion of Exchange Act
ABS in the definition of ABS, commenters generally supported the
decision to incorporate the Exchange Act definition,\41\ with some
agreeing that market participants are familiar with analyzing whether a
given security meets the definition and that there is common market
understanding of whether Commission rules that use the Exchange Act ABS
definition apply to them.\42\ Other commenters disagreed, however,
stating that it remains unclear to them whether certain securities
would be captured by the definition as proposed.\43\ Additionally,
several commenters requested that the final rule include definitions
for ``synthetic ABS'' \44\ and ``hybrid cash and synthetic ABS'' \45\
to provide clarity regarding the scope of transactions that are subject
to the prohibition in Rule 192. The Commission also received comments
suggesting that we adopt a safe harbor for ABS transactions offered and
sold outside of the United States.\46\ Finally, while some commenters
agreed that Rule 192's prohibition should not be limited to ABS
transactions that are intentionally ``designed to fail,'' \47\ others
expressed the view that Section 27B targets only ABS that are
intentionally ``designed to fail.'' \48\
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\38\ See, e.g., letters from ABA; AFR; Better Markets; ICI.
\39\ See, e.g., letters from ABA (seeking, e.g., clarification
with respect to reliance on existing guidance regarding a
transaction's status as an asset-backed security); NABL et al.
(indicating confusion regarding whether certain municipal securities
are Exchange Act ABS); PMI Industry I (seeking clarification that
mortgage insurance-linked notes are not synthetic ABS).
\40\ See, e.g., letters from AFME (urging that the final rule
include a safe harbor for ABS transactions that are not offered or
sold to U.S. investors as part of the primary issuance); National
Association of Health and Educational Facilities Finance Authorities
dated Mar. 27, 2023 (``NAHEFFA'') (requesting that single-asset
conduit bonds be excluded from the definition of asset-backed
security); NABL et al. (requesting that municipal securities be
excluded from the definition of asset-backed security); SIFMA I
(requesting that the Commission exclude corporate debt, insurance
products, and Section 4(a)(2) private placement transactions from
the definition of asset-backed security).
\41\ See, e.g., letters from ABA; ICI; SIFMA I.
\42\ See, e.g., letters from ABA; ICI. For example, one
commenter expressed the view that common market understanding is
that investment funds registered under the Investment Company Act of
1940 do not issue ABS and that their securities are not considered
Exchange Act ABS. See letter from ICI. Whether such securities are
Exchange Act ABS will depend on the characteristics and structure of
the security.
\43\ See, e.g., letters from NAHEFFA; NABL et al.
\44\ See letters from ABA; AFME; AIMA/ACC; ICI; SFA I; SFA II;
SIFMA I; SIFMA II.
\45\ See letter from AIMA/ACC.
\46\ See, e.g., letters from ABA; AFME; AIC; SFA I; SFA II;
SIFMA I; SFA II.
\47\ See letters from AFR; Better Markets.
\48\ See, e.g., letters from AIC; American Securities
Association dated Mar. 23, 2023 (``ASA'').
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3. Final Rule
We are adopting, as proposed, a definition of ``asset-backed
security'' for purposes of the prohibition in Rule 192(a)(1). As
discussed below, under the final rule, ``asset-backed security'' will
be defined to mean an Exchange Act ABS, a synthetic ABS, and a hybrid
cash and synthetic ABS.\49\ Rule 192, therefore, will apply to
offerings of asset-backed securities as defined in Rule 192(c),
regardless of whether the offerings are registered or unregistered.
Consistent with the proposal, we are not adopting a definition for
``synthetic ABS'' or ``hybrid cash and synthetic ABS.'' In response to
comments received, final Rule 192 includes a safe harbor for certain
foreign securitizations, which is discussed in greater detail in
Section II.A.3.c. Finally, Rule 192 does not require that an ABS was
intentionally ``designed to fail'' for the ABS to be subject to the
prohibition against engaging in conflicted transactions. Section 27B
does not contain language referencing an intent element and provides,
in relevant part, that securitization participants ``of an asset-backed
security . . . shall not . . . engage in any transaction that would
involve or result in any material conflict of interest.'' \50\ The
statutory text refers plainly to asset-backed securities (as defined in
Section 3 of the Exchange Act and including synthetic ABS); it does not
indicate that the ABS must have been intentionally designed to fail to
be subject to the prohibition. As discussed below, further narrowing
the scope in this way could reduce the effectiveness of the rule to
prophylactically prevent these types of material conflicts of interest
with investors.\51\ This, in turn, would frustrate the statutory
mandate of Section 27B.
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\49\ 17 CFR 230.192(c).
\50\ 15 U.S.C. 77z-2a(a).
\51\ See also Sections II.B.3. and II.D. for additional
discussions about why the final rule does not include a knowledge-
or intent-based standard for securitization participants or
conflicted transactions.
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a. Exchange Act ABS
Section 27B imposes a prohibition on transactions that would
involve or result in a material conflict of interest, i.e., a
conflicted transaction under 17 CFR 230.192(a)(3) (``Rule 192(a)(3)''),
and specifies that the prohibition applies to Exchange Act ABS. As a
general matter, asset-backed securities differ from other types of
securities because the securities are issued by a special purpose
entity that has no business activities other than holding or owning the
assets supporting the ABS and other activities reasonably incidental
thereto.\52\ As specified in the Exchange Act ABS definition, an asset-
backed security is a security collateralized by any ``self-liquidating
financial asset.'' \53\
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\52\ See Section III.A.2. of Asset-Backed Securities, Release
No. 33-8518 (Dec. 22, 2004) [70 FR 1506 (Jan. 7, 2005)] (``2004
Regulation AB Adopting Release'').
\53\ 17 U.S.C. 78c(a)(79).
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The Commission received various comments requesting clarification
about whether certain products and securities would be captured by the
Rule 192 ABS definition and further requesting that, for the avoidance
of doubt, certain products and securities be exempt from the
definition.\54\ For example, several
[[Page 85400]]
commenters requested that the rule exempt certain municipal securities
from being ABS subject to the prohibition in 17 CFR 230.192(a) (``Rule
192(a)'').\55\ These commenters generally stated that certain municipal
securities, including single-asset conduit bonds,\56\ are structured
and sold to achieve certain policy goals for the benefit of the
government entity's citizens and that municipal issuers of such
securities are subject to strict investment policies and federal and
state statutes that limit their ability to engage in speculative
investments, making it unlikely that relevant securitization
participants could engage in conflicted transactions, therefore
rendering the application of Rule 192 to municipal transactions
unnecessarily burdensome.\57\ Municipal securitizations that are
collateralized by any type of self-liquidating financial asset and that
allow the holder of the security to receive payments that depend
primarily on the cash flow from such self-liquidating financial asset
fall within the Exchange Act ABS definition. While it may be the case,
as discussed above, that a municipal issuer is subject to restrictions
that may limit their ability to engage in conflicted transactions,
other parties to the securitization may not be subject to such
restrictions and would therefore have the opportunity to engage in
transactions that bet against the municipal ABS. For example, as one
commenter stated, persons involved in municipal securitizations, such
as the underwriter, may enter into swaps to mitigate risk associated
with the security.\58\ Such swaps or other transactions could be
conflicted transactions if they meet the definition in Rule
192(a)(3).\59\ We see no reason, therefore, why municipal securities
that meet the definition of Exchange Act ABS (and are consequently
subject to other federal securities laws), and which, like other
Exchange Act ABS, involve securitization participants, such as an
underwriter, that would have an opportunity to engage in conflicted
transactions, should be exempted from the definition of ABS--and, thus,
the prohibition against conflicts of interest--for purposes of this
rule.\60\
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\54\ As discussed in greater detail below, one commenter stated
that it was unclear whether certain municipal securities meet the
definition of Exchange Act ABS. We also note that municipal market
participants are already required to analyze whether such a security
meets the Exchange Act ABS definition and whether other Commission
rules implementing various provisions of the Dodd-Frank Act that use
the Exchange Act ABS definition, such as Regulation RR, 17 CFR
240.15Ga-1(a) (``Exchange Act Rule 15Ga-1''), and 17 CFR 240.17g-
7(a)(1)(ii)(N) (``Exchange Act Rule 17g-7'') are applicable. See
Proposing Release Section II.A. See also Section IV.A.D.6 of Credit
Risk Retention, Release No. 34-70277 (Aug. 28, 2013) [78 FR 57928
(Sept. 20, 2013)] (``RR Proposing Release'') (explaining why an
exemption from risk retention for securitizations of tax lien-backed
securities sponsored by municipal entities was not proposed) and
Credit Risk Retention, Release No. 34-73407 (Oct. 22, 2014) [79 FR
77602 (Dec. 24, 2014)] (``RR Adopting Release'') at 77661 (adopting
certain provisions that apply to municipal tender option bonds) and
77680 (explaining why separate loan underwriting criteria for single
borrower or single credit commercial mortgage transactions were not
adopted). Because participants in this market are already required
to consider whether a municipal security meets the definition of
Exchange Act ABS to determine whether such offering must comply with
other rules and regulations adopted under the Securities Act and
Exchange Act, we believe that concerns relating to burdens
associated with determining whether or not a municipal security is
an Exchange Act ABS for purposes of compliance with Rule 192 will be
mitigated.
\55\ See, e.g., letters from ASA; NABL et al.; NAHEFFA; SIFMA I;
Wulff, Hansen & Co. dated Apr. 14, 2023 (``Wulff Hansen''). See also
Section II.B. for a discussion of comments received related to
municipal issuers and the definition of ``sponsor'' in the final
rule.
\56\ As described by one commenter, a single-asset conduit bond
is a tax-exempt bond issued by state and local governments for the
benefit of tax-exempt organizations (as defined under Section
501(c)(3) of the Internal Revenue Code). The proceeds of the bond
issuance are used to make a single loan to a single 501(c)(3)
borrower, such as a hospital, higher education institution, provider
of housing for elderly or low-income populations, museum, or other
non-profit entity. The government issuer assigns the loan agreement
to the bond trustee, which receives the borrower's loan payments
(which mirror the government issuer's payment obligations on the
bond) and makes those payments to the bondholders. See letter from
NAHEFFA.
\57\ See, e.g., letters from ASA; NABL et al.; NAHEFFA; letter
from National Association of Municipal Advisors dated Mar. 31, 2023
(``NAMA''); SIFMA I.
\58\ See letter from ASA.
\59\ See Section II.D.
\60\ See Section II.B.3.b. for a discussion of the definition of
a ``securitization participant'' with respect to municipal
securitizations.
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With respect to single-asset conduit bonds, one commenter stated
that the market (both municipal and non-municipal) does not consider a
conduit bond backed by a single loan to be an asset-backed
security.\61\ This commenter further stated that, by referencing
Exchange Act ABS instead of the definition of ABS included in
Regulation AB, the Commission was using a broader definition and
``eliminating'' the requirement that an asset-backed security include a
``pool'' \62\ of financial assets.\63\ The commenter described this as
a ``novel application'' of the Exchange Act ABS definition.\64\ We
disagree with the commenter's characterization of the proposed
definition. Section 27B, which was added by Section 621 of the Dodd-
Frank Act, specifically states that the prohibition shall apply to ABS
as defined in Section 3 of the Exchange Act, and the definition in
Section 3 was added by Section 941 of the Dodd-Frank Act. Defining
``asset-backed security'' for purposes of Rule 192 by referencing
Exchange Act ABS, therefore, is consistent with Section 27B. As the
Commission has previously stated, an ABS that is backed by a single
obligation would meet the definition of Exchange Act ABS.\65\
Therefore, referring to Exchange Act ABS in identifying the types of
ABS subject to the final rule is consistent with Section 27B and the
inclusion of single-asset conduit bonds that meet the definition of
Exchange Act ABS is consistent with our prior interpretation of both
definitions.\66\ Moreover, if we were to adopt an exemption for
transactions collateralized by a single, self-liquidating asset, it
would provide the opportunity for securitization participants to
structure offerings as a series of transactions that would serve to
evade the rule. For these reasons, we decline to include such an
exemption from the definition of ``asset-backed security.''
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\61\ See letter from NAHEFFA.
\62\ The definition of ``asset-backed security'' in Regulation
AB Item 1101(c) (``Regulation AB ABS''), which was adopted for the
limited purpose of identifying an ABS that is eligible for the
specialized registration and reporting regime under Regulation AB,
defines an ``asset-backed security,'' in relevant part, as a
security that is primarily serviced by the cash flows of a
``discrete pool of receivables or other financial assets. . .'' See
17 CFR 229.1101(c). Additionally, the word ``pool'' in the
Regulation AB ABS definition does not require that the ABS be
collateralized by more than one asset. Instead, it is part of the
phrase ``discrete pool'' in the definition, which indicates the
general absence of active pool management, and emphasizes the self-
liquidating nature of pool assets. See, e.g., Section III.A.2. of
2004 Regulation AB Adopting Release.
\63\ See letter from NAHEFFA.
\64\ Id.
\65\ See, e.g., Section V.B.2. of the RR Adopting Release
(explaining why separate loan underwriting criteria for single
borrower or single credit commercial mortgage transactions were not
adopted) and Section IV.D.6. of RR Proposing Release (explaining why
an exemption from risk retention for securitizations of tax lien-
backed securities sponsored by municipal entities was not proposed).
See also Proposing Release Section II.A., n. 31 (stating that an ABS
that is backed by a single asset or one or more obligations of a
single borrower (often referred to as ``single asset, single
borrower'' or ``SASB'' transactions) meets the definition of an
Exchange Act ABS).
\66\ Analyzing whether a municipal single-asset conduit bond is
an ABS entails a consideration of the nature of the activities of
the issuing entity. For example, if the issuing entity is authorized
to extend credit or make loans and it engages in activities in
addition to holding or owning the underlying single obligation
supporting the bonds, or in addition to other activities reasonably
incidental to holding or owning the underlying obligation, the
securities it issued will not be an ABS.
---------------------------------------------------------------------------
One commenter suggested that we exclude direct private placement
transactions exempt from registration under Section 4(a)(2) of the
Securities Act,\67\ stating that the ABS purchasers in such
transactions are highly sophisticated investors that participate
directly in nearly all phases of the
[[Page 85401]]
structuring and creation of the ABS.\68\ The commenter stated that such
investor involvement renders the risk of a securitization participant
entering into a separate transaction that gives rise to a material
conflict of interest very low.\69\ As discussed in the Proposing
Release, and as we continue to believe, even if an investor is involved
in asset selection or has access to information about those assets,
such investor may not be aware of the involvement of other parties, nor
does the participation of one investor in asset selection necessarily
protect any other investors in the ABS.\70\ We see no reason why
investors in ABS sold in a Section 4(a)(2) private offering should not
receive the protections provided by Section 27B that are available to
all investors. Rather, excluding these transactions would place the
burden on investors to confirm or otherwise negotiate for transaction
terms to require that securitization participants not engage in bets
against the ABS. Furthermore, excluding transactions that rely on
Section 4(a)(2) would also result in excluding from the rule ABS sold
to an initial purchaser in furtherance of resales in compliance with
Securities Act Rule 144A.\71\ As a result, purchasers of that ABS in
the immediately subsequent Rule 144A transaction would not benefit from
the protections afforded by the rule. Consequently, we believe that
such an exclusion to the ABS definition would not be appropriate.
Therefore, any securities that meet the definition of ``asset-backed
security,'' as adopted for purposes of Rule 192, will be subject to the
prohibition in Rule 192(a), whether registered or unregistered.
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\67\ 15 U.S.C. 77d. Section 4(a)(2) permits, without
registration, the offer and sale of securities that do not involve a
public offering.
\68\ See letter from SIFMA I.
\69\ Id.
\70\ See Proposing Release Section II.A. Moreover, even if an
investor were aware of a potential conflict of interest, Rule 192
does not include an exception based on disclosure of material
conflicts of interest because such an exception would be
inconsistent with the prohibition in Section 27B. See Section II.D.
for a discussion of comments received related to the use of
disclosure to mitigate conflicts of interest.
\71\ 17 CFR 230.144A. For example, collateralized loan
obligations (``CLOs'') are typically sold in a private placement to
one or more initial purchasers in reliance on Section 4(a)(2) (which
is only available to the issuer), followed by resales of the
securities to ``qualified institutional buyers'' in compliance with
Rule 144A.
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The Commission also received comments requesting exclusions or
clarifications regarding certain financial products and securities that
the Commission has not historically viewed as asset-backed
securities.\72\ Some commenters sought clarification that insurance
policies or contracts (and securities related to those insurance
products, such as mortgage insurance linked-notes (``MILNs'') \73\) and
corporate debt securities are not Exchange Act ABS.\74\ Insurance
policies and contracts, such as private mortgage insurance contracts,
are not securities,\75\ and therefore are not Exchange Act ABS subject
to Rule 192. MILNs are reinsurance products used by insurance companies
to obtain reinsurance coverage for a portion of their risk related to
private mortgage insurance policies, which assist homebuyers in
obtaining low-down payment mortgages.\76\ The collateral for the MILN
are the private mortgage insurance contracts, which are not self-
liquidating financial assets.\77\ Corporate debt securities are issued
by a corporate issuer and represent direct payment obligations of the
corporate issuer.\78\ The corporate issuer is ultimately responsible
for payment on the debt, compared to asset-backed securities that are
issued by a special purpose issuing entity where payment depends
primarily on the cash flow from an underlying self-liquidating
financial asset. In each of these cases, the securities do not meet the
definition of Exchange Act ABS and, therefore, are not asset-backed
securities as defined in Rule 192(c).\79\
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\72\ See, e.g., letters from ABA; Representative Nickel et al.;
SFA I; SIFMA I.
\73\ See also note 80, and the accompanying text for a
discussion regarding funding agreement-backed notes.
\74\ See letters from AFME; ABA; SIFMA I.
\75\ 15 U.S.C. 77c.
\76\ See, e.g., letter from ABA.
\77\ For additional discussion regarding mortgage insurance-
linked notes, and why the existing structures do not satisfy the
criteria to be synthetic ABS or ``conflicted transactions,'' see
Sections II.A.3.b. and II.D.
\78\ See, e.g., letter from SIFMA I.
\79\ See 17 CFR 230.192(c).
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One commenter also requested clarification that, where the
Commission or its staff has already provided guidance stating that a
financial product or security would not be an asset-backed security,
such products or securities would not be asset-backed securities under
Rule 192(c) and thus would not be subject to the prohibition.\80\ The
definition of asset-backed security we are adopting in Rule 192(c) does
not change the Exchange Act ABS definition, nor does it impact existing
Commission guidance or staff positions regarding that definition.
Market participants may, therefore, continue to look to such guidance
or staff positions unless and until they are changed, withdrawn, or
otherwise superseded, as applicable.
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\80\ See letter from ABA. This commenter provided the example of
an existing staff position indicating that funding agreements
between an insurance company and a special purpose entity, where the
insurance company is directly liable for the funding agreement that
backs the notes, is not an Exchange Act ABS. See Regulation AB
Compliance & Disclosure Interpretation 301.03 (updated Sept. 6,
2016), available at <a href="https://www.sec.gov/corpfin/divisionscorpfinguidanceregulation-ab-interpshtm">https://www.sec.gov/corpfin/divisionscorpfinguidanceregulation-ab-interpshtm</a>. These
interpretations, and any other staff statements referenced in this
release, represent the views of SEC staff. They are not rules,
regulations, or statements of the Commission. The Commission has
neither approved nor disapproved their content. Staff statements
have no legal force or effect: they do not alter or amend applicable
law, and they create no new or additional obligations for any
person.
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b. Synthetic ABS and Hybrid Cash and Synthetic ABS
As discussed in the Proposing Release, we have previously described
synthetic securitizations as transactions that are designed to create
exposure to an asset that is not transferred to or otherwise part of
the asset pool, generally effectuated through the use of derivatives
such as a credit default swap (``CDS'') or a total return swap (or an
ABS structure that replicates the terms of such a swap).\81\ The
Commission received several comment letters requesting that we adopt a
definition of ``synthetic asset-backed security'' \82\ and ``hybrid
cash and synthetic asset-backed security'' \83\ to address what the
commenters said was a lack of certainty with respect to the scope of
Rule 192. Some of these commenters offered suggestions for a definition
of synthetic ABS that they believe represent market understanding of
the term and that would appropriately capture the types of transactions
that Section 27B and Rule 192 are intended to cover.\84\ While the text
of the suggested definitions vary, including with respect to the level
of specificity, they include a number of common elements, generally
identifying synthetic ABS as a security issued by a special-purpose
entity, secured by one or more credit derivatives or similar financial
instrument that references a self-liquidating financial asset or pool
of assets, and for which payment to the investor is dependent primarily
on the performance of such reference asset or reference pool.\85\
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\81\ See Proposing Release Section II.A. and Section III.A.2. of
the 2004 Regulation AB Adopting Release.
\82\ See, e.g., letters from ABA; AIMA/ACC; AFME; SFA I; SFA II;
SIFMA I; SIFMA II.
\83\ See letter from AIMA/ACC.
\84\ See letters from ABA; AFME; SFA II; SIFMA I; SIFMA II.
\85\ See, e.g., letters from ABA; SFA II; SIFMA II.
---------------------------------------------------------------------------
Given the variation of suggested definitions provided by
commenters, we do not believe that adopting any one of these
definitions, or a combination thereof, would appropriately capture the
scope of the various features of existing
[[Page 85402]]
synthetic ABS and possible future structures or designs of synthetic
ABS; however, commenters' suggestions are consistent with the
characteristics that we have previously identified as features of
synthetic ABS.\86\ Because of the complexity of these transactions,
however, we agree with commenters that guidance regarding synthetic ABS
is beneficial. Accordingly, while a synthetic ABS may be structured or
designed in a variety of ways, we generally view a synthetic asset-
backed security as a fixed income or other security issued by a special
purpose entity that allows the holder of the security to receive
payments that depend primarily on the performance of a reference self-
liquidating financial asset or a reference pool of self-liquidating
financial assets.\87\
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\86\ See Proposing Release Section II.A. and Section III.A.2. of
the 2004 Regulation AB Adopting Release.
\87\ Id.
---------------------------------------------------------------------------
The Commission also received comments requesting clarification
about whether the rule applies to synthetic transactions that have not
traditionally been considered synthetic securitizations. Some
commenters asked that we clarify that mortgage insurance-linked notes
are not synthetic asset-backed securities under Rule 192(c) and that
the reinsurance agreements embedded in the MILN transactions are not
``conflicted transactions'' under Rule 192(a)(3).\88\ As discussed in
Section II.A.3.a., above, while MILNs create synthetic exposure to
insurance contracts, they are not covered by this rule because the
underlying private mortgage insurance contracts are not self-
liquidating.\89\ Accordingly, MILNs are not synthetic ABS subject to
the prohibition in Rule 192(a)(1), and consequently, neither would the
reinsurance agreements executed between the mortgage insurer and the
special purpose insurer be conflicted transactions under Rule
192(a)(3).\90\
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\88\ See, e.g., letters from ABA; letter from Housing Policy
Council dated Mar. 27, 2023 (``HPC''); Mortgage Bankers Association
dated Mar. 27, 2023 (``MBA''); PMI Industry I; Arch Capital Group
Ltd., Enact Holdings Inc., Essent Group Ltd., MGIC Investment
Corporation, NMI Holdings, Inc., and Radian Group Inc. dated Oct.
20, 2023 (``PMI Industry II'') (suggesting rule text to include an
exclusion in the final rule for activities related to the purchase
or sale of MILNs); U.S. Representatives Blaine Luetkemeyer and
Emmanuel Cleaver dated May 23, 2023 (``Representatives Luetkemeyer
and Cleaver''); SFA I; SIFMA I. See also Section II.D. for a
discussion of the types of transactions that would be ``conflicted
transactions'' under the final rule.
\89\ In a typical MILN structure, the mortgage insurer enters
into a reinsurance agreement with a special purpose insurer, which
issues the MILNs to investors and places the proceeds from the sale
of those securities in a reinsurance trust to make any required
payments to the mortgage insurer under the reinsurance agreement,
which requires payments based on certain losses incurred on a
specified pool of mortgage insurance policies that are obligations
of the mortgage insurer. The premiums paid by the mortgage insurer
to the special purpose insurer are used to make interest payments to
the holders of the MILNs. Because the reinsurance agreement
functions similarly to a swap and the reference mortgage insurance
policies are not transferred to the reinsurance trust, commenters
requested confirmation that MILNs are not synthetic ABS that would
be asset-backed securities as defined for purposes of Rule 192. See,
e.g., letters from ABA; HPC; MBA; PMI Industry I; Representatives
Luetkemeyer and Cleaver; SFA I; SIFMA I.
\90\ See Section II.D. for a discussion of ``conflicted
transactions'' under the final rule.
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Some commenters also requested confirmation that synthetic ABS for
purposes of Rule 192 does not include equity-linked or commodity-linked
products.\91\ Because such products do not involve self-liquidating
financial assets, they are not synthetic ABS subject to Rule 192's
prohibition. Similarly, some commenters requested confirmation that
corporate debt obligations and security-based swaps are not synthetic
ABS.\92\ As described above, we generally view a synthetic asset-backed
security as a fixed income or other security issued by a special
purpose entity that allows the holder of the security to receive
payments that depend primarily on the performance of a reference self-
liquidating financial asset or a reference pool of self-liquidating
financial assets. In contrast, as discussed above, a corporate debt
obligation is issued by, and offers investors recourse to, an operating
entity that is not a special purpose entity. Therefore, a corporate
debt obligation is not a synthetic ABS for purposes of Rule 192.
Similarly, a security-based swap is also not a synthetic ABS for
purposes of Rule 192 because it is a financial contract between two
counterparties without issuance of a security from a special purpose
entity.\93\ A security-based swap can represent a component of a
synthetic ABS transaction where, for example, the relevant special
purpose entity that issues the synthetic ABS enters into a security-
based swap that collateralizes the synthetic ABS that it is issuing.
However, the standalone security-based swap in such example is not a
synthetic ABS; it is only one component of the broader synthetic ABS
transaction. Under the final rule, whether a transaction is a
``synthetic ABS'' subject to Rule 192 will depend on the nature of the
transaction's structure and characteristics of the underlying or
referenced assets.\94\ A similar analysis will be necessary to
determine whether a transaction constitutes a hybrid cash and synthetic
ABS, which would have characteristics of both cash ABS and synthetic
ABS.
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\91\ See, e.g., letters from SFA II; SIFMA I; SIFMA II.
\92\ See, e.g., letters from ABA; SFA II; SIFMA I; SIFMA II.
\93\ See also Further Definition of ``Swap,'' ``Security-Based
Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps;
Security-Based Swap Agreement Recordkeeping, Release No. 33-9338
(July 18, 2012) [77 FR 48208 (Aug. 13, 2012)] (establishing that a
credit default swap or total-return swap on a single loan or narrow-
based index is a security-based swap).
\94\ For example, such transactions generally should be analyzed
to determine whether the assets that are transferred to or otherwise
part of the asset pool are self-liquidating. Additionally, we note
that a synthetic transaction could be effectuated through the use of
derivates or swaps but could also use some other feature or
structure that replicates the terms of a derivate or swap.
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c. Cross-Border Application of Rule 192
The Commission received several comments relating to the potential
cross-border application of Rule 192.\95\ Before addressing those
comments, we are providing the following guidance as to Rule 192's
cross-border scope. As a threshold matter, Rule 192's cross-border
scope is co-extensive with the cross-border scope of Securities Act
Section 27B(a), which this rule implements pursuant to the mandate in
Section 27B(b). It is therefore appropriate to consider Section
27B(a)'s cross-border scope when determining whether Rule 192 applies
in a cross-border context.
---------------------------------------------------------------------------
\95\ See, e.g., letters from ABA; AFME; AIC; SFA I; SFA II;
SIFMA I; SIFMA II.
---------------------------------------------------------------------------
Our understanding of Section 27B(a)'s cross-border scope is based
on the territorial approach that the Commission has applied when
adopting rules to implement other provisions of the securities
laws.\96\ Consistent with that territorial approach, which is based on
U.S. Supreme Court precedent, including Morrison v. National Australia
Bank, Ltd,\97\ the Commission understands the relevant domestic conduct
that triggers the application of Section 27(B)(a)'s prohibition to be
the sale in the United States of the ABS.\98\ If there are ABS sales in
the United
[[Page 85403]]
States to investors, the prohibition of Section 27B(a)--as implemented
through the provisions of Rule 192--applies. Put simply, the existence
of domestic ABS sales to investors means that securitization
participants are prohibited pursuant to the terms of Rule 192 from
engaging in their own separate transactions that would cause a material
conflict with the ABS investors.\99\ And when domestic ABS sales exist,
the prohibition on securitization participants engaging in separate
transactions that would cause the material conflicts of interest
applies even if the securitization participants seek to engage in those
prohibited transactions exclusively overseas or if the securitization
participant is itself a non-U.S. entity.\100\ In this way, Section
27B(a) and Rule 192 further the statutory objective of prophylactically
protecting ABS investors in the U.S. securities markets from ABS
transactions that would involve material conflicts of interest.\101\
---------------------------------------------------------------------------
\96\ See, e.g., Regulation SBSR--Reporting and Dissemination of
Security-Based Swap Information, Release No. 34-74244 (Feb. 11,
2015), [80 FR 14563, 14649 (Mar. 19, 2015)] (``2015 Regulation SBSR
Adopting Release'') (discussing the territorial approach to the
cross-border application of Title VII requirements for regulatory
reporting and public dissemination of security-based swap
transactions).
\97\ Morrison v. National Australia Bank, Ltd. et al., 561 U.S.
247 (2010).
\98\ See generally 561 U.S. 247. See, e.g., Abitron Austria GmbH
v. Hetronix Int'l, Inc, No. 21-1043, 2023 WL 4239255, at *4 (U.S.
June 29, 2023) (stating that ``[the Supreme Court has] repeatedly
and explicitly held that courts must ``identif[y] `the statute's
``focus''' and as[k] whether the conduct relevant to that focus
occurred in United States territory'').
\99\ Securitization participants are advised that even if there
is no domestic sale to an investor that would trigger Rule 192's
regulatory prohibition, the Commission still retains broad cross-
border antifraud authority that will apply when securities
participants engage in fraudulent or manipulative conduct that has a
sufficient nexus to the United States. Specifically, the
Commission's antifraud authorities will apply if a securities
participant engages in securities fraud that involves: (1) conduct
within the United States that constitutes significant steps in
furtherance of the fraud, even if the securities transaction occurs
outside the United States and involves only foreign investors; or
(2) conduct occurring entirely outside the United States that has a
foreseeable substantial effect within the United States. See Section
27(b) of the Exchange Act (15 U.S.C. 78aa). See also SEC v.
Scoville, 913 F.3d 1204, 1215-1219 (10th Cir. 2019) (holding ``that
Congress has `affirmatively and unmistakably' indicated that the
antifraud provisions of the federal securities acts apply
extraterritorially when the statutory conduct-and-effects test is
met'').
\100\ See Abitron Austria GmbH, 2023 WL 4239255, at *2529
(explaining that ``[i]f the conduct relevant to the statute's focus
occurred in the United States, then the case involves a permissible
domestic application of the statute, even if other conduct occurred
abroad'' (citations and internal quotation marks omitted)).
\101\ See, e.g., Section I.C.
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Having provided the foregoing general guidance regarding Rule 192's
cross-border scope, we turn to address those comments that raised
cross-border considerations. Some commenters expressed concerns that
the Commission did not address cross-border application of the proposed
rule in the Proposing Release,\102\ with some stating that, without
guidance regarding cross-border applicability, together with the
proposed definition of affiliates and subsidiaries, the proposed rule
could potentially apply to all affiliates and subsidiaries of the named
securitization participants anywhere in the world, regardless of their
knowledge of, or participation in, the transaction.\103\ One commenter
further stated that such application could have a significant adverse
effect on the ability of market participants in non-U.S. jurisdictions
to satisfy the prudential and capital requirements regulations related
to permissible securitization transactions used for capital
optimization and balance sheet management in those jurisdictions.\104\
For example, this commenter stated that certain synthetic
securitizations are permitted in the European Union and the United
Kingdom under the European Banking Authority's Simple, Transparent and
Standardized (``STS'') framework.\105\ The commenter further stated
that, to the extent that such framework could be inconsistent with
final Rule 192, cross-border applicability of Rule 192 could result in
those transactions being impermissible, which could have undesirable
consequences for European markets.\106\
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\102\ See, e.g., letters from AFME, AIC; SFA I.
\103\ See, e.g., letter from AFME. One commenter also stated
that it is unclear whether the Commission has authority over foreign
entities apart from legal and practical issues regarding supervision
and enforcement and that Rule 192 could put U.S. entities at a
competitive disadvantage in relation to their international peers.
See letter from AIMA/ACC. In addition to the changes discussed in
this section, we believe that the revisions to the rule's coverage
of affiliates and subsidiaries, as discussed in Section II.B.3.c.
below, will mitigate such concerns.
\104\ See letter from AFME.
\105\ Id.
\106\ Id.
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The Commission also received comments requesting that the final
rule include a safe harbor for foreign transactions and securitization
participants to provide clarity to the market.\107\ These commenters
stated that such an approach would be consistent with other Commission
rules applicable to securitizations that were promulgated under the
Securities Act and Exchange Act, such as Regulation RR \108\ and
Exchange Act Rule 15Ga-2.\109\ Some of these commenters further
suggested that the final rule include a foreign transaction safe harbor
that states specifically that the prohibition in Rule 192 does not
apply to an asset-backed security if the offer and sale of the ABS was
or is not required to be registered (and is/was not registered) under
the Securities Act of 1933, the offer and sale of all of the ABS is or
was made outside the United States, and the issuing entity of the ABS
is a foreign issuer,\110\ which is similar to the safe harbor included
in Rule 15Ga-2 and incorporates principles contained in Regulation
S.\111\
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\107\ See, e.g., letters from ABA; AFME; AIC (requesting that
the Commission adopt a safe harbor for foreign entities and
transactions and suggesting that it could do so by exempting foreign
entities from the definition of ``securitization participant'' and
excluding securities issued pursuant to Regulation S from the
definition of ``asset-backed security''); SFA I; SFA II; SIFMA I
(citing Morrison v. Nat'l Austl. Bank Ltd., 561 U.S. 247 (2010) as
the existing law on the extent of the rule's extraterritorial reach
and seeking a safe harbor to provide clarity in order to facilitate
compliance); SIFMA II.
\108\ See 12 CFR 246.20.
\109\ 17 CFR 240.15Ga-2. See, e.g., letters from ABA; AIC; AFME;
SFA I; SFA II; SIFMA I; SIFMA II.
\110\ See, e.g., letters from SFA II; SIFMA II.
\111\ See 17 CFR 240.15Ga-2(e) (``Rule 15Ga-2(e)'') and 17 CFR
230.901 and 902(e).
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After considering these suggestions, we are including a foreign
transaction safe harbor in final Rule 192 to provide additional
certainty with regard to the territorial approach discussed above.
Moreover, we agree with commenters that including a foreign transaction
safe harbor is consistent with other securitization rules promulgated
by the Commission, such as Regulation RR and Exchange Act Rule 15Ga-2,
and that commenters' suggestions to rely on the principles contained in
Regulation S in adopting such a safe harbor are consistent the
Commission's cross-border authority.\112\ We also agree with commenters
that it is appropriate to model the safe harbor provision in Rule 192
on existing Rule 15Ga-2(e).\113\ Therefore, the prohibition in final
Rule 192(a)(1) will not apply to an asset-backed security (as defined
by this rule) if it is not issued by a U.S. person (as that term is
defined in Rule 902 of Regulation S) \114\ and the offer and sale of
such asset-backed security is in compliance with Regulation S.\115\ The
inclusion of this safe harbor for certain foreign securitizations will
help address commenters' concerns with respect to application of the
rule to extraterritorial transactions and securitization participants.
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\112\ See Morrison v. Nat'l Austl. Bank Ltd., 561 U.S. 247
(2010).
\113\ Rule 15Ga-2(e) generally states that the requirements of
Rule 15Ga-2 would not apply to an offering of an asset-backed
security if certain conditions are met, including (1) the offering
is not required to be, and is not, registered under the Securities
Act, (2) the issuer of the rated security is not a U.S. person (as
defined in Rule 902 of Regulation S), and (3) all offers and sales
of the ABS is in compliance with Regulation S.
\114\ 17 CFR 230.902(k).
\115\ 17 CFR 230.901 through 905. See Rule 192(e).
Securitization participants are advised that even if the safe harbor
conditions are met, the Commission still retains broad cross-border
antifraud authority that will apply when securities participants
engage in fraudulent or manipulative conduct that has a sufficient
nexus to the United States. See supra note 99.
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[[Page 85404]]
B. Scope: Securitization Participants
1. Proposed Scope of Securitization Participants
Consistent with Section 27B(a), the Commission proposed that the
prohibition in Rule 192 would apply to transactions entered into by an
underwriter, placement agent, initial purchaser, or sponsor of a
covered ABS, as well as any of their affiliates or subsidiaries, each
of which would be a ``securitization participant'' as defined in Rule
192(c).\116\ The Commission proposed definitions for the terms
``underwriter,'' ``placement agent,'' ``initial purchaser,'' and
``sponsor'' that are generally based on existing definitions and
reflect the functions of these market participants in ABS transactions
and not merely their formal labels.\117\ In addition, the proposed
definition of ``sponsor'' was based on the definition of sponsor in
Regulation AB as well as, subject to certain exceptions, any person
that directs or causes the direction of the structure, design, or
assembly of the ABS or the composition of the pool of assets underlying
the ABS or that has the contractual right to do so.\118\ As explained
in the Proposing Release, such a person is in a unique position to
structure the ABS and/or construct the underlying asset pool or
reference pool in a way that would position the person to benefit from
the actual, anticipated, or potential adverse performance of the of the
relevant ABS or its underlying asset pool if such person were to enter
in a conflicted transaction.\119\ The Commission also proposed certain
limited exclusions from the definition of ``sponsor'' for persons that
perform only administrative, legal, due diligence, custodial, or
ministerial acts related to the structure, design, or assembly of an
asset-backed security or the composition of the pool of assets
underlying the ABS,\120\ as well as for certain U.S. Federal Government
entities and the Enterprises, subject to certain conditions.\121\
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\116\ See Proposing Release Section II.B.
\117\ Id. The Commission also proposed that ``affiliate'' and
``subsidiary'' would have the same meaning as set forth in
Securities Act Rule 405 (17 CFR 230.405).
\118\ See Proposing Release Section II.B.
\119\ See Proposing Release Section II.B.
\120\ See Proposing Release Section II.B.2.b.
\121\ See Proposing Release Section II.B.2.c.
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2. Comments Received
Commenters generally supported the proposal to define the
securitization participants subject to the prohibition in the final
rule.\122\ While some commenters agreed with the proposed approach of
defining the covered persons with respect to their functions in
securitization markets,\123\ several commenters expressed significant
concerns regarding the scope of the proposed definition of ``sponsor,''
stating that it could potentially capture market participants that
Section 27B did not intend to include.\124\ For example, several
commenters stated that the proposed definition of ``sponsor'' was
overly broad and exceeded the intent of Section 27B.\125\ As discussed
below, some of these commenters stated that including any person that
directs or has the contractual right to direct the structure, design,
or assembly of an ABS could result in nearly every participant in a
securitization transaction being a sponsor, including, for example,
investors in the relevant ABS.\126\ Many commenters acknowledged that
Section 27B specifically identifies affiliates and subsidiaries of
other named securitization participants as being subject to the rule's
prohibition, but also expressed concern that the inclusion of certain
affiliates and subsidiaries would make the rule unworkable.\127\
Accordingly, several commenters requested that the rule permit the use
of information barriers to address these challenges.\128\ The
Commission also received comments requesting revisions to the proposed
exclusion for persons that perform only administrative, legal, due
diligence, custodial, or ministerial acts related to the ABS or its
underlying or referenced asset pool \129\ and the proposed exclusion
for certain U.S. Federal Government entities and the Enterprises, which
we discuss in greater detail below.\130\ Finally, one commenter stated
that a securitization participant should only come within the scope of
the prohibition in Rule 192 if such participant intended to profit from
the securitization transaction to the detriment of investors or
otherwise designed an ABS to fail.\131\
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\122\ See, e.g., letters from AFR; ICI. The Commission also
proposed a definition of ``distribution'' as used in the underwriter
and placement agent definition but did not receive comment
addressing the proposed definition of ``distribution.''
\123\ See, e.g., letters from AFR; Better Markets (expressing
support for the definition of ``sponsor'' as proposed).
\124\ See, e.g., letters from ABA; AIMA/ACC; CREFC I, MBA; MFA
II; NAMA; U.S. Representatives Wiley Nickel, Bryan Steil, Josh
Gottheimer, Blaine Luetkemeyer, Jim Himes, Michael V. Lawler, Juan
Vargas, Scott Fitzgerald, Vicente Gonzalez, Young Kim, Ritchie
Torres, Zach Nunn, Gregory W. Meeks, Andy Barr, Steven Horsford,
Andrew R. Garbarino, Brittany Pettersen, Ann Wagner, David Scott,
Bill Huizenga, Brad Sherman (Ranking Member, Subcommittee on Capital
Markets), Byron Donalds, Bill Foster, Emanuel Cleaver, II, and Sean
Casten dated Oct. 31, 2023 (``Representative Nickel et al.'')
(referring generally to the definition of ``securitization
participant''); SFA I; SIFMA I. Some commenters also stated that
certain underwriters, placement agents, and initial purchasers that
were not part of the design of the ABS could be scoped in as well.
See Sections II.B.2. and II.B.3.a.
\125\ See, e.g., letters from ABA; AIC; AIMA/ACC; AFME; Loan
Syndications & Trading Association dated May 2, 2023 (``LSTA III'');
MBA; MFA II; NAMA; Representatives Wagner and Huizenga; Senator
Kennedy; SFA I; SIFMA I; Wulff Hansen.
\126\ See, e.g., letters from ABA; AFME; CREFC I; International
Association of Credit Portfolio Managers dated Mar. 27, 2023
(``IACPM''); MBA; SFA I.
\127\ See, e.g., letters from ABA; AIC; AFME; ICI; LSTA III;
Loan Syndications & Trading Association dated Oct. 30, 2023 (``LSTA
IV''); MFA II; SFA I; SIFMA I.
\128\ See, e.g., letters from ABA; AIMA/ACC; AFME; AIC; ICI;
LSTA II; LSTA III; MFA II; Pentalpha Surveillance LLC dated Mar. 27,
2023 (``Pentalpha''); SFA I; SIFMA I.
\129\ See, e.g., letters from CREFC I; LSTA III; SFA I; SIFMA I.
\130\ See, e.g., letters from Fannie Mae and Freddie Mac dated
Mar. 27, 2023 (``Fannie and Freddie''); Housing Policy Council dated
Mar. 27, 2023 (``HPC''); Mark Calabria, Former FHFA Director, dated
Mar. 25, 2023 (``M. Calabria'').
\131\ See letter from HPC.
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3. Final Rule
As discussed below, we are adopting the definitions of
``underwriter,'' ``placement agent,'' ``initial purchaser,'' and
``distribution'' as proposed. We are modifying the proposed definition
of ``sponsor'' to address commenter concerns regarding the scope of the
definition with respect to a person who acts solely pursuant to such
person's contractual rights as a holder of a long position in an asset-
backed security and a person's administrative and ministerial
activities related to the ongoing administration of an ABS.\132\ Also,
as discussed in greater detail in Section II.B.3.b.ii. below, we are
not adopting proposed paragraph (ii)(B) of the ``sponsor'' definition,
which would have captured any person that directs or causes the
direction of the structure, design, or assembly of an asset-backed
security or the composition of the pool of assets underlying the asset-
backed security. In response to comments received relating to confusion
with respect to the proposed rule's treatment of credit risk transfer
transactions, we are removing the specific exclusion for the
Enterprises in favor of addressing those comments through the risk-
mitigating hedging exception, which we discuss in more detail in
Sections II.B.3.b.iv. and II.E., below. To address concerns about the
rule's applicability to affiliates and subsidiaries, we are
[[Page 85405]]
adopting revisions to the definition of ``securitization participant''
regarding when an affiliate or subsidiary of an underwriter, placement
agent, initial purchaser, or sponsor is subject to the prohibition
against engaging in conflicted transactions.\133\ Final Rule 192 does
not include a requirement that the securitization participant intended
to profit from a transaction to the detriment of investors or otherwise
designed the ABS to fail. As discussed in greater detail in Sections
II.A.3. and II.D., we believe that narrowing the scope of the final
rule to add an element of intent is inappropriate and it is not
relevant for purposes of the final rule whether the securitization
participant makes (or intended to make) a profit. Narrowing the scope
of the rule to require knowledge or intent would frustrate the
statutory mandate of Section 27B.
---------------------------------------------------------------------------
\132\ See Section II.B.3.b. for a detailed discussion of the
comments received and the revised definition.
\133\ See Section II.B.3.c.
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a. Placement Agent, Underwriter, and Initial Purchaser
Consistent with the proposal, final Rule 192(c) defines ``placement
agent'' and ``underwriter'' as a person who has agreed with an issuer
or selling security holder to:
<bullet> Purchase securities from the issuer or selling security
holder for distribution;
<bullet> Engage in a distribution for or on behalf of such issuer
or selling security holder; or
<bullet> Manage or supervise a distribution for or on behalf of
such issuer or selling security holder.\134\
---------------------------------------------------------------------------
\134\ 17 CFR 230.192(c).
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These definitions are focused on the functional role that a person
would assume in connection with a distribution of securities.\135\ Also
consistent with the proposal,\136\ final Rule 192(c) defines
``distribution'' as used in the definitions for ``underwriter'' and
``placement agent'' to mean:
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\135\ The definition of underwriter for purposes of Rule 192 has
no impact on the definition, responsibility, or liability of an
underwriter under Securities Act Section 2(a)(11). Additionally,
while these definitional prongs are also used for the definition of
``underwriter'' in the Volcker Rule (17 CFR 255.4(a)(4)) and
Regulation M (17 CFR 242.100(b)), the definition we are adopting in
Rule 192(c) has no impact on the definition of ``underwriter'' in
either of those rules. See also Proposing Release Section II.B.1.
\136\ The Commission did not receive any comments addressing the
proposed definition of ``distribution.''
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<bullet> An offering of securities, whether or not subject to
registration under the Securities Act, that is distinguished from
ordinary course trading transactions by the presence of special selling
efforts and selling methods; or
<bullet> An offering of securities made pursuant to an effective
registration statement under the Securities Act.\137\
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\137\ 17 CFR 230.192(c). As the Commission noted in the
Proposing Release, activities generally indicative of special
selling efforts and methods include, but are not limited to, greater
than normal sales compensation arrangements, delivering a sales
document (e.g., a prospectus or offering memorandum), and conducting
road shows. A primary offering of ABS pursuant to an effective
Securities Act registration statement would also be captured because
such an offering is a primary issuance by an issuer immediately
following the creation of the ABS, which is clearly distinguishable
from an ordinary secondary trading transaction. See Proposing
Release at 9683.
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The definition of ``initial purchaser'' is similarly focused on a
person's function in a securities offering and includes, as proposed,
``a person who has agreed with an issuer to purchase a security from
the issuer for resale to other purchasers in transactions that are not
required to be registered under the Securities Act in reliance upon
Rule 144A or that are otherwise not required to be registered because
they do not involve any public offering.'' \138\
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\138\ The definition of ``initial purchaser'' in Rule 192(c) has
no impact on the application of Rule 144A (17 CFR 230.144A).
---------------------------------------------------------------------------
Some commenters requested that we limit the definition of
``underwriter,'' ``placement agent,'' and ``initial purchaser'' to
capture only those persons who are directly involved in structuring the
relevant ABS or selecting the assets underlying the ABS, stating as an
example that underwriting syndicate co-managers generally rely on lead
managers and have little direct involvement with the aforementioned
securitization activities.\139\ While it may be the case that
underwriters, placement agents, or initial purchasers are involved in
the issuance of an ABS in varying degrees, the prohibition in Rule
192(a)(1) only applies to such persons if they have entered into an
agreement \140\ with an issuer (or, with respect to underwriters and
placement agents, a selling security holder) because those persons
would likely be privy to certain information about the ABS or
underlying assets. Conversely, underwriters, placement agents, and
initial purchasers with no such agreement with the issuer or selling
security holder (``selling group members''), as applicable, may help
facilitate a successful distribution of securities to a wider variety
of purchasers, but these selling group members do not have a direct
relationship with the issuer or selling security holder and, thus, are
unlikely to have the same ability to influence the design of the
relevant ABS. Therefore, selling group members who do not have such an
agreement are not underwriters, placement agents, or initial purchasers
as defined in Rule 192(c).\141\ Moreover, such a limitation could have
the unintended consequence of creating uncertainty about whether an
underwriter, placement agent, or initial purchaser is subject to the
rule's prohibition because it would require a determination of whether
such person is ``directly involved'' in structuring an ABS or selecting
the underlying assets. For purposes of Rule 192, therefore, it is
sufficient that a person who otherwise meets the definitions of
``underwriter,'' ``placement agent,'' or ``initial purchaser'' in Rule
192(c) has an agreement with the issuer or selling security holder, as
applicable, to perform the enumerated functions because, as stated
above, such persons would likely be privy to information about the ABS
or underlying assets, giving them the opportunity to influence the
structure of the relevant ABS and engage in a bet against it. No
factual determination of whether such person actually had ``direct
involvement'' in the structure or design of the ABS is required.
---------------------------------------------------------------------------
\139\ See letters from SFA I; SIFMA I. Another commenter stated
that underwriters and other participants should be defined to
include persons who make a ``material contribution'' to the economic
structure, composition, management, or sale of an ABS. See letter
from AFR.
\140\ See Section II.C.3. for a discussion of what constitutes
an ``agreement'' for purposes of Rule 192(a)(1).
\141\ See also Proposing Release Section II.B.1.
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b. Sponsor
We are adopting the definition of ``sponsor'' with certain
modifications from the proposal in response to comments received. The
definition of ``sponsor'' will differ in four ways from the proposal.
First, we are not adopting proposed paragraph (ii)(B) of the
``sponsor'' definition, which would have captured any person that
directs or causes the direction of the structure, design, or assembly
of an asset-backed security or the composition of the pool of assets
underlying the asset-backed security. Second, we are revising the text
of the final rule to state that persons who act solely pursuant to
their contractual rights as holders of a long position in the relevant
ABS are excluded from paragraph (ii) of the definition of sponsor, as
discussed below. Third, we are revising the text to specifically
exclude persons who perform only administrative, legal, due diligence,
custodial, or ministerial activities related to the ongoing
administration of the ABS or the composition of the pool of assets
[[Page 85406]]
underlying or referenced by the ABS.\142\ Fourth, we are deleting the
proposed exclusion from the ``sponsor'' definition for the Enterprises
while they are operating under the conservatorship or receivership of
FHFA with capital support from the United States, which we discuss in
Section II.B.3.b.iv., below.\143\ Accordingly, for purposes of Rule
192, ``sponsor'' means:
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\142\ The inclusion of the language ``or referenced by the
asset-backed security'' in the definition of sponsor and other
aspects of final Rule 192 is designed to address activities related
to the reference pool for a synthetic ABS.
\143\ As discussed below, final Rule 192 includes the proposed
exclusion from definition of ``sponsor'' for the United States or
any agency of the United States with respect to its fully insured or
fully guaranteed ABS.
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<bullet> Any person who organizes and initiates an asset-backed
securities transaction by selling or transferring assets, either
directly or indirectly, including through an affiliate, to the entity
that issues the asset-backed security (a ``Regulation AB-based
Sponsor''); or
<bullet> Any person with a contractual right to direct or cause the
direction of the structure, design, or assembly of an asset-backed
security or the composition of the pool of assets underlying or
referenced by the asset-backed security (a ``Contractual Rights
Sponsor''), other than a person who acts solely pursuant to such
person's contractual rights as a holder of a long position in the ABS
(a ``Long-only Investor'')
<bullet> But not including:
[cir] A person who performs only administrative, legal, due
diligence, custodial, or ministerial acts related to the structure,
design, assembly, or ongoing administration of an asset-backed security
or the composition of the pool of assets underlying or referenced by
the asset-backed security (the ``Service Provider Exclusion''); or
[cir] The United States or an agency of the United States with
respect to an asset-backed security that is fully insured or fully
guaranteed as to the timely payment of principal and interest by the
United States (``U.S. Government Exclusion'').\144\
---------------------------------------------------------------------------
\144\ See Sections II.B.2. and II.B.3.b.iv. for a discussion of
comments received and the final U.S. Government Exclusion.
---------------------------------------------------------------------------
As with the definitions discussed above, we are adopting a
functional definition of ``sponsor'' that will apply regardless of the
person's title and that instead focuses on the person's activities with
respect to the ABS transaction. Accordingly, a person who organizes and
initiates an ABS transaction, or who has a contractual right to direct
or cause the direction of the structure, design, or assembly of an ABS
or the composition of the pool of assets underlying or referenced by
the ABS whether before or after the initial issuance of the relevant
ABS, is a sponsor under Rule 192 (unless one of the exceptions
described below applies). For example, an ``issuer'' of a municipal
securitization will be a ``sponsor'' if its activities meet the
definition. This definition also includes, for example, a portfolio
selection agent for a collateralized debt obligation (``CDO'')
transaction with a contractual right to direct or cause the direction
of the composition of the pool of assets on behalf of the CDO or a
collateral manager for a collateralized loan obligation (``CLO'')
transaction with the contractual right to direct or cause the direction
of asset purchases or sales on behalf of the CLO.\145\
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\145\ See also Sections II.A.2. and II.A.3. for a discussion of
the comments received and the final definition of ``asset-backed
security'' as it applies to municipal securitizations.
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i. Regulation AB-Based Sponsor
We are adopting paragraph (i) of the definition of ``sponsor'' as
proposed. For purposes of Rule 192, therefore, a sponsor includes, but
is not limited to, any person who organizes and initiates an asset-
backed securities transaction by selling or transferring assets, either
directly or indirectly, including through an affiliate, to the entity
that issues the asset-backed security.\146\ This portion of the
definition is derived from the definition of the term ``sponsor'' in
Regulation AB and was generally supported by commenters, who stated
that it is consistent with the use of the term in both Regulation AB
\147\ and Regulation RR,\148\ as well as market understanding of what a
securitization sponsor is.\149\
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\146\ 17 CFR 230.192(c).
\147\ 17 CFR 229.1101(l).
\148\ 17 CFR 246.
\149\ See, e.g., letters from AIC; SFA I; SIFMA I.
---------------------------------------------------------------------------
Some commenters requested that we exclude states and their
political subdivisions from the definition of ``sponsor'' under the
final rule.\150\ These commenters generally stated that application of
Rule 192's prohibition to municipal issuers is unnecessary because
these issuers engage in transactions pursuant to enabling legislation
that is designed specifically to aid in the furtherance of important
government functions and other public purposes, are restricted from
engaging in speculative investments, and are not driven by a profit
motive that would lead to the type of behavior that Section 27B is
intended to address.\151\ While municipal issuers may be subject to
other provisions that regulate their conduct, we are not persuaded that
issuers of municipal ABS are uniquely different from other
securitization participants such that they should be excluded from the
final rule. Similarly, the fact that municipal entities are subject to
investment policies that limit the ability of such entities as
investors to engage in speculative investments is not a reason to
exempt these entities from the definition of ``sponsor.'' While the
outcome of such policies may be that the entities may not, for example,
take a short position against their municipal ABS, the objectives of
those policies are typically focused on protection of the entity's
investment portfolio.\152\ Being subject to various laws and
regulations that may intersect is not a position that is unique to
issuers of municipal ABS. Additionally, the prohibition in Rule 192 is
designed to prophylactically protect investors in U.S. securities
markets from ABS transactions tainted by material conflicts of
interest, regardless of whether a securitization participant has a
profit motive or actually does profit from such transactions.\153\ As
such, while it may be unlikely, as some commenters stated, that issuers
of municipal ABS would engage in the type of conduct that Section 27B
prohibits for the reasons discussed above,\154\ we do not believe that
an exclusion from the definition of ``securitization participant'' or
``sponsor'' would be appropriate because investors are entitled to the
[[Page 85407]]
protections afforded by the statute regardless of how likely the
securitization participant is to engage in a conflicted transaction.
---------------------------------------------------------------------------
\150\ See, e.g., letters from NABL et al.; NAHEFFA (also
requesting that 501(c)(3) organizations and the issuers of qualified
501(c)(3) conduit bonds to such organizations be excluded from the
definition); NAMA; SIFMA I; Wulff Hansen (expressing support for the
comments submitted by NAMA).
\151\ Id. One of these commenters also stated that application
of the prohibition in Rule 192 to State and local governmental
issuers would be a breach of the principles of federalism and
intergovernmental comity. See SIFMA I. The U.S. Supreme Court has
held that State and local governments ``must find their protection
from congressional regulation through the national political
process, not through judicially defined spheres of unregulable state
activity.'' See Garcia v. San Antonio Metropolitan Transit
Authority, 469 U.S. 528 (1985); South Carolina v. Baker, 485 U.S.
505 (1988). Congress enacted Section 621 of the Dodd-Frank Act,
adding Section 27B of the Securities Act. Rule 192 implements
Section 27B of the Securities Act with respect to certain activities
undertaken by State and local governmental issuers that fall within
its proscriptions. It follows, therefore, as provided in Garcia and
Baker, that the application of Rule 192 to State and local
governmental issuers is not inconsistent with principles of
federalism and intergovernmental comity.
\152\ See letter from NABL et al. (stating that municipal
investment policies are ``centered on preservation of principal or
moderate growth.'')
\153\ See Section II.D.3
\154\ See, e.g., letters from NABL et al.; NAHEFFA; NAMA; SIFMA
I.
---------------------------------------------------------------------------
Some commenters went on to state that, because municipal ABS
issuers are unlikely to engage in conflicted transactions for the
reasons discussed above, these entities would need to expend
administrative and financial resources to ``prove a negative'' (i.e.,
that they do not engage in conflicted transactions), especially if
securitization participants were to be required to have documented
policies and procedures in place to prevent violation of the
prohibition, adding compliance costs without a clear regulatory
benefit.\155\ Although the Commission requested comment in the
Proposing Release about whether the final rule should include a
requirement that a securitization participant have documented policies
and procedures reasonably designed to prevent a violation of the rule's
prohibition on conflicted transactions,\156\ the Commission did not
receive any comments in support of such a requirement. Commenters,
however, expressed concerns about the potential costs associated with
such a provision,\157\ and therefore, final Rule 192 does not include a
requirement that securitization participants have documented policies
and procedures reasonably designed to prevent a violation of the rule's
prohibition. As such, while we recognize that compliance with the
prohibition against engaging in conflicted transactions may result in
increased compliance costs to municipal issuers subject to Rule 192, we
expect that such costs will be modest because the final rule does not
include a general requirement for policies and procedures.\158\
---------------------------------------------------------------------------
\155\ See, e.g., letters from NAHEFFA; NAMA.
\156\ See Proposing Release Request for Comment 59.
\157\ See, e.g., letters from NAHEFFA, NAMA.
\158\ See Section IV for a discussion of the Commission's
economic analysis of the impacts of Rule 192 and a discussion of
alternatives considered.
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For these reasons, we continue to believe that any such costs will
be justified because investors in municipal securitizations should be
entitled to the same legal protections as investors in other types of
ABS that meet the definition of ``asset-backed security'' in Rule
192(c). Accordingly, if a municipal security meets the definition of
Exchange Act ABS,\159\ then the municipal issuer that organizes and
initiates such an offering \160\ is a sponsor for purposes of Rule
192.\161\
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\159\ See Section II.A.3.a.
\160\ Or, in the case of a municipal advisor, if the advisor has
a contractual right to direct or cause the direction of the
structure, design, or assembly of a municipal ABS, such person is a
sponsor under paragraph (ii) of the ``sponsor'' definition in final
Rule 192(c). See Section II.B.3.b.ii.
\161\ The same analysis will apply for issuers of single-asset
conduit bonds that meet the definition of Exchange Act ABS or
otherwise meet the definition of ``asset-backed security'' in Rule
192(c). See Section II.A.3.a.
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ii. Contractual Rights Sponsor
We are adopting the definition of ``Contractual Rights Sponsor''
that was proposed in paragraph (ii)(A) of the proposed definition of
``sponsor'' with certain modifications in response to comments
received. Also, in response to comments received, we are not adopting
the definition of ``Directing Sponsor'' that was proposed in paragraph
(ii)(B) of the proposed definition of ``sponsor.'' Accordingly,
paragraph (ii) of the definition of ``sponsor'' for purposes of Rule
192 captures, subject to certain exceptions discussed below, any person
with a contractual right to direct or cause the direction of the
structure, design, or assembly of an asset-backed security or the
composition of the pool of assets underlying or referenced by the
asset-backed security (a Contractual Rights Sponsor), other than a
person who acts solely pursuant to such person's contractual rights as
a holder of a long position in the asset-backed security (a Long-only
Investor).\162\ The revision to explicitly exclude Long-only Investors
from the definition of sponsor by deleting the proposed ``Directing
Sponsor'' definition is consistent with the Commission's stated intent
in the Proposing Release that an ABS investor (that does not otherwise
meet any of the other definitions of parties covered by the rule) would
not be a sponsor under the rule merely because such investor expresses
its preferences regarding the assets that would collateralize its ABS
investment.\163\ Also, Rule 192 is not designed to discourage ABS
investors from exercising contractual rights as a holder of a long
position in an ABS. As discussed below, the final rule excludes any
person who acts solely pursuant to such person's contractual rights as
a holder of a long position in the ABS.
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\162\ As discussed in more detail below, we are also adopting an
exclusion from the ``sponsor'' definition for any person who
performs only administrative, legal, due diligence, custodial, or
ministerial acts related to the ABS and for the United States or an
agency of the United States with respect to ABS that is fully
insured or fully guaranteed as to the timely payment of principal
and interest by the United States. See Sections II.B.3.b.iii. and
II.B.3.b.iv.
\163\ See Proposing Release Section II.B.2.b.
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The Commission proposed a comprehensive definition of ``sponsor''
that would include a person that is in a unique position to structure
the ABS and/or construct the underlying asset pool or reference pool in
a way that would position the person to benefit from the actual,
anticipated, or potential adverse performance of the relevant ABS or
its underlying asset pool if such person were to enter in a conflicted
transaction.\164\ Some commenters supported this approach, citing the
significant role that such parties play in securitization
transactions.\165\ As discussed in greater detail below, a number of
commenters, however, opposed the proposed inclusion of Contractual
Rights Sponsors and Directing Sponsors as too broad.\166\ Some of these
commenters requested that the ``sponsor'' definition be limited to
paragraph (i) (i.e., a Regulation AB-based sponsor),\167\ while others
stated that such a definition would not be sufficient to capture the
key transaction parties that have a significant role in asset selection
for ABS transactions.\168\ Some commenters also stated that defining
``sponsor'' to include functions beyond the scope of the Regulation AB-
based Sponsor definition extends beyond the ``ordinary and natural
meaning'' of the term, which they state is understood by market
participants to be the definition that was codified in Regulation
AB.\169\ These commenters stated that the Commission codified the
``ordinary and natural meaning'' of the term ``sponsor'' when it
adopted the definition in Regulation AB in 2004 and that, because
Section 27B uses the term ``sponsor'' without separately defining it,
any other definition for purposes of Rule 192 would be inconsistent
with Congressional intent.\170\
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\164\ See Proposing Release Section II.B.
\165\ See letters from AFR; Better Markets.
\166\ See, e.g., letters from ABA; AIMA/ACC; AFME; CREFC I, CRE
Finance Council dated July 5, 2023 (``CREFC II''); NAMA;
Representatives Wagner and Huizenga; Senator Kennedy; SFA I; SFA II;
SIFMA I.
\167\ See, e.g., letters from ABA; AIC; SIFMA I. letters from
ABA; AIC; SIFMA I. See Section II.B.3.b.i. above for a discussion of
paragraph (i) of the ``sponsor'' definition in Rule 192(c).
\168\ See, e.g., letters from Better Markets (expressing support
for the scope of the definition and stating that collateral managers
should be subject to the rule because they play a significant role
in selecting and managing the assets underlying an ABS); SFA II
(acknowledging the Commission's desire to scope in CLO managers that
are not sponsors for purposes of Regulation RR).
\169\ See, e.g., letters from ABA; AIC; SIFMA I.
\170\ See, e.g., letters from ABA; AIC; SIFMA I.
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Regulation AB is a set of disclosure items that form the basis for
disclosure in Securities Act registration statements and Exchange Act
reports for asset-
[[Page 85408]]
backed securities and identify the transaction parties responsible for
making that disclosure.\171\ When the Commission adopted these
specialized registration, disclosure, and reporting requirements in
Regulation AB for certain types of asset-backed securities, it
explained that those requirements were specifically designed for asset-
backed securities that have certain characteristics (i.e., ABS as
defined in Regulation AB).\172\ At that time, the Commission
acknowledged that the types of ABS that would meet the definition in
Regulation AB were a subset of the full spectrum of ABS in the
market.\173\ For example, synthetic securitizations are not eligible
for registration and reporting under Regulation AB because such
securitizations are primarily based on the performance of assets or
indices not included in the ABS.\174\ As such, the concept of a sponsor
``selling or transferring assets . . . to the entity that issues the
[ABS]'' in the ``sponsor'' definition under Regulation AB would not be
applicable in a synthetic ABS because, as described in Section
II.A.3.b. above, a synthetic ABS is designed to create exposure to an
asset that is not sold, transferred to, or otherwise part of the asset
pool. Rule 192, consistent with the express language of Section 27B,
applies to a wider spectrum of ABS (i.e., Exchange Act ABS, synthetic
ABS, and hybrid cash and synthetic ABS) \175\ than Regulation AB and--
as discussed throughout this section--the characteristics of the
structure, assets, and the role of transaction parties involved in
those types of ABS may differ significantly from those in Regulation AB
ABS. We do not believe the concept of ``sponsor'' in Section 27B is
limited to the Regulation AB definition of that term, as that would
mean that there is no ``sponsor'' for synthetic asset-backed
securities, even though Congress explicitly referenced those
participants in the statute. It is therefore appropriate for Rule 192
to define the securitization participants subject to the rule's
prohibition to align with the characteristics of that wider spectrum of
ABS. Accordingly, we continue to believe that, while it is appropriate
for the final rule to incorporate a definition based on the Regulation
AB definition of sponsor, defining ``sponsor'' for purposes of Rule 192
as a Regulation AB-based sponsor alone would not be sufficient to
address the full range of securitization activities involved in asset-
backed securities transactions that Section 27B addresses.
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\171\ See Sections III.A.2. and III.B.3. of the 2004 Regulation
AB Adopting Release.
\172\ See Section III.A.2. of the 2004 Regulation AB Adopting
Release.
\173\ Id. (stating, for example, that a default application of
the traditional disclosure regime might not be appropriate for some
structured securities, but that treating them the same as ABS as
defined in Regulation AB may not be appropriate either and that,
depending on the structure of the transaction and the terms of the
securities, it might be most appropriate to apply some aspects of
both regimes in combination). The Commission also acknowledged in
that release that there may be securities developed in the future
that are not contemplated in Regulation AB, which would similarly
require consideration of which regulatory regime would be most
appropriate.
\174\ See also Section III.A.2. of the 2004 Regulation AB
Adopting Release.
\175\ See Section II.A.3.
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One commenter also cited to the holding of the U.S. Court of
Appeals for the District of Columbia Circuit that the application of
the term ``securitizer'' \176\ to CLO collateral managers in Regulation
RR was an overreach of its authority.\177\ The Court's analysis was
centered around the statutory text that directed the Commission,
together with several other Federal agencies, to issue regulations to
require any securitizer to ``retain'' an economic interest in a portion
of the credit risk for any asset that the securitizer, through the
issuance of an asset-backed security, ``transfers, sells, or conveys''
to a third party.\178\ The Court held that, because open-market CLO
managers do not ``hold'' the securitized loans in a CLO transaction at
any point, they can neither ``transfer'' those loans, nor ``retain''
credit risk in the loans because such terms require that the
``securitizer'' has control over the assets via possession or
ownership.\179\ We believe a different analysis is applicable to
Section 27B, which directs the Commission to prohibit securitization
participants of Exchange Act ABS and synthetic ABS from engaging in
transactions that would involve or result in a material conflict of
interest. Section 941 of the Dodd-Frank Act added Section 15G of the
Exchange Act,\180\ in which Congress provided a statutory definition
for the term ``securitizer'' that incorporated from the Regulation AB
definition of sponsor the general concept of transferring or selling
assets into a special purpose entity. In the case of Section 15G,
therefore, the statutory text specified the functions that Congress
intended to be captured by the term ``securitizer.'' In Section 27B,
however, Congress did not define ``sponsor,'' but it did specify the
types of ABS (i.e., Exchange Act ABS and synthetic ABS) that are
subject to the prohibition. Moreover, as evidenced by statutory text in
other laws, where Congress intended to refer to a portion of Regulation
AB, it did so explicitly.\181\
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\176\ The statutory term at issue in the case was
``securitizer,'' which was defined by Congress as an issuer of an
ABS or a person who organizes and initiates an ABS transaction by
selling or transferring assets, either directly or indirectly,
including through an affiliate, to the issuer. See Section 15G(a)(3)
of the Securities Exchange Act of 1934 (15 U.S.C. 78o-11(a)(3)),
which was added by Section 941 of the Dodd-Frank Act (Pub. L. 111-
203).
\177\ See letter from AIC (citing The Loan Syndications and
Trading Association v. Securities and Exchange Commission et al.,
882 F.3d 220 (D.C. Cir. 2018) (the ``LSTA Decision'') and stating
that, by proposing to define ``sponsor'' in Rule 192 to refer to
functions beyond the scope of the Regulation AB-based Sponsor
definition, the Commission failed to heed the D.C. Circuit's
guidance and exceeded the scope of its authority).
\178\ See LSTA Decision. See also 15 U.S.C. 78o-11(b)(1).
\179\ See LSTA Decision, 882 F.3d at 223.
\180\ 15 U.S.C. 78o-11(a)(3).
\181\ See, e.g., Credit Rating Agency Reform Act of 2006 (Pub.
L. 109-291) (referring specifically to ``issuers of asset-backed
securities (as that term is defined in section 1101(c) of part 229
of title 17, Code of Federal Regulations, as in effect on the date
of enactment of this paragraph)''). We also note that the term
``sponsor'' appears in several other places throughout the
securities laws with varying meanings. For example, in Item 901 of
Regulation S-K, a sponsor is defined in the context of roll-up
transactions as ``the person proposing the roll-up transaction.''
See 17 CFR 901(d).
---------------------------------------------------------------------------
As we discussed above, the characteristics of the structure,
assets, and the role of transaction parties involved in the wider
spectrum of ABS covered by Section 27B (including synthetic asset-
backed securities) differ significantly from those ABS subject to
Regulation AB, and therefore the definitions adopted by the Commission
in Regulation AB do not capture the types of ABS that Congress
determined should be subject to Rule 192's prohibition. Accordingly, we
believe that the statutory inclusion of these types of ABS requires
that Rule 192 define the market participants and their roles in such
ABS in congruence with the structures and characteristics specific to
the relevant ABS.
A number of commenters also expressed concern that paragraph (ii)
of the ``sponsor'' definition includes activities that could be
attributed to a wide variety of transaction parties and could therefore
be understood to scope in, as a Contractual Rights Sponsor or Directing
Sponsor, almost any party with any role in the structuring of the
transaction.\182\ Commenters stated that the definition could include
entities such as investors,\183\ asset managers \184\
[[Page 85409]]
and other investment advisers,\185\ servicers,\186\ and warehouse
lenders,\187\ each of which we discuss below.
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\182\ See, e.g., letters from ABA; AIMA/ACC; AFME, CREFC I;
CREFC II; NAMA; Representatives Wagner and Huizenga; Senator
Kennedy; SFA I; SFA II; SIFMA I.
\183\ See, e.g., letters from ABA; CREFC I; CREFC II; SFA I; SFA
II; SIFMA I.
\184\ See, e.g., letter from ABA; LSTA IV.
\185\ See, e.g., letter from ICI.
\186\ See, e.g., letters from MBA; SFA I; CREFC I. We discuss
the final rule's applicability to servicers in Section
II.B.3.b.iii., below.
\187\ See, e.g., letter from ABA.
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Many commenters expressed concern that ABS investors could be
captured by the definition of sponsor by virtue of the iterative
negotiation process between deal participants and investors.\188\ These
commenters recognized the stated intent in the Proposing Release \189\
that investors acquiring a long position in an ABS would not be
Directing Sponsors merely because they express their preferences
regarding the structure of the ABS or the underlying assets, but
requested that this be codified in rule text to avoid the unintended
consequence of discouraging investors from actively participating in
discussions about deal structures and underlying asset pools in their
ABS investments and to help ensure that they are not unnecessarily
subject to additional costs associated with developing compliance
programs under Rule 192.\190\ In current market practice, investors in
ABS transactions may receive information about collateral (including,
for example, specific loan data and due diligence results) and may
specify preferences or requirements for a given deal structure or terms
of the security.\191\ Commenters stated, and we agree, that these
negotiations are important and beneficial market functions.\192\
Consequently, as requested by commenters and to help ensure that Rule
192 is not an impediment to an investor's negotiating power, we are not
adopting paragraph (ii)(B) (Directing Sponsor) of the proposed
definition of ``sponsor.''
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\188\ See, e.g., letters from ABA; AFME; CREFC I; CREFC II;
IACPM; ICI; MBA; MFA II; LSTA III; LSTA IV; Representatives Wagner
and Huizenga; Senator Kennedy; SFA I; SFA II; SIFMA I; SIFMA II.
\189\ See Proposing Release Section II.B.2.
\190\ See, e.g., letters from ABA; AFME; CREFC I; CREFC II;
IACPM; ICI; MBA; MFA II; LSTA III; Representatives Wagner and
Huizenga; Senator Kennedy; SFA I; SFA II; SIFMA I; SIFMA II.
\191\ For example, investors may specify a certain rating,
yield, or maturity on the bonds, require particular levels of
subordination or credit enhancement, or may request that assets be
added or removed to satisfy preferences with respect to asset
quality, concentration levels, etc.
\192\ See, e.g., letters from CREFC I; ICI; SFA II.
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Some commenters suggested that the regulatory text should specify
that long investors are also excluded from proposed paragraph (ii)(A)
(Contractual Rights Sponsor).\193\ Relatedly, some commenters stated
that the exercise of contractual rights inherent to the purchase of the
ABS should not be conflicted transactions under Rule 192(a)(3).\194\ In
securitizations, it is often the case that long investors purchasing
the most senior or the most subordinated tranche of the relevant ABS
negotiate for certain rights that are exercisable over the life of the
securitization. A person's contractual rights as a holder of a long
position in the ABS could include, for example, consent rights over
major decisions such as initiating foreclosure proceedings with respect
to assets underlying the ABS, the right to replace the special servicer
of the ABS, or the right to direct or cause the direction of an
optional redemption of outstanding interests in the ABS. Rule 192 is
not designed to impair an ABS investor's ability to negotiate for such
contractual rights as a holder of a long position in the ABS. Nor is it
designed to discourage investors from exercising such rights as a
holder of a long position in the ABS. Therefore, we are adopting
paragraph (ii) of the definition of ``sponsor'' to exclude from the
definition of Contractual Rights Sponsor any person who acts solely
pursuant to such person's contractual rights as a holder of a long
position in the ABS.
---------------------------------------------------------------------------
\193\ See, e.g., letters from CREFC I; SFA II; SIFMA II.
\194\ See, e.g., letter from CREFC I; SFA I.
---------------------------------------------------------------------------
Whether a long investor is acting ``solely'' pursuant to its
contractual rights as a holder of a long position in the relevant ABS
will depend on the relevant facts and circumstances, including what
other roles the long investor may have in the transaction. For example,
some commenters requested that the rule specify that the holders of
``B-piece'' bonds (the ``B-piece buyer'') in commercial mortgage backed
securities (``CMBS'') transactions \195\ are not ''sponsors'' as
defined by the final rule or, alternatively, that the B-piece buyers be
otherwise excluded because they should be considered long
investors.\196\ Whether a B-piece buyer in a CMBS transaction is a
``sponsor'' for purposes of Rule 192 or satisfies the condition of the
exclusion for Long-only Investors will depend on the facts and
circumstances of a given transaction and B-piece buyer.\197\ Generally,
the B-piece buyer purchases the most subordinate tranches of the ABS
and, in connection with this investment, performs extensive due
diligence on the underlying loans and negotiates with the deal sponsor
for changes to pool composition and to increase credit quality of the
pool. As a holder of a long position in the relevant ABS, a B-piece
buyer will generally have additional ongoing rights in an ABS
transaction. For example, transaction agreements may dictate that
certain actions with respect to the asset pool underlying the ABS (such
as releasing a property from a lien) are subject to the approval of the
B-piece buyer,\198\ giving the B-piece buyer a contractual right to
direct or cause the direction of the composition of the pool. As such,
absent the exclusion we are adopting for Long-only Investors, a B-piece
buyer could be subject to the prohibition of Rule 192(a)(1) as a
Contractual Rights Sponsor. Under the final rule, if the B-piece buyer
exercises such rights solely pursuant to its contractual rights as a
holder of a long position in the ABS, then the B-piece buyer will
satisfy the conditions for the Long-only Investor carve-out from the
definition of Contractual Rights Sponsor as adopted and, therefore,
will not be subject to the prohibition in Rule 192(a)(1).
---------------------------------------------------------------------------
\195\ As is the case with most ABS, CMBS securities are offered
in tranches, with each tranche representing a different risk
profile. The top tranche (referred to as ``AAA'') represents the
lowest risk investment while the lower tranches (typically non-
investment grade) represent the highest risk profile because they
are the first to incur losses in the event that there are shortfalls
in collections on the underlying assets. In CMBS, the ``B-piece''
bonds are the lowest tranche(s) of the CMBS (i.e., the most
subordinate tranche(s), meaning that holders are purchasing the
first-loss position) and the holders of those bonds are typically
third-party purchasers, commonly referred to as the ``B-piece
buyer.'' See, e.g., Section III.B.5. of the RR Adopting Release.
\196\ See, e.g., letters from ABA; CREFC I; Fannie and Freddie;
MBA.
\197\ The same analysis applies for the directing noteholder in
a commercial real estate collateralized loan obligation (``CRE
CLO''), which functions similarly to the B-piece buyer in CMBS
transactions.
\198\ See, e.g., letter from CREFC I.
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In some circumstances, however, the B-piece buyer can also act as a
special servicer for the securitization (i.e., a contractual party to
the transaction) or may be an affiliate or subsidiary of the special
servicer. Whether a special servicer's activities satisfy the
conditions of the exclusion for persons that perform only
administrative, legal, due diligence, custodial, or ministerial acts
with respect to the relevant ABS will depend on the nature of the
special servicer's activities.\199\ Accordingly, if a B-piece buyer is
also a special servicer for an ABS transaction, the B-piece buyer will
not be acting ``solely'' pursuant to its rights as a holder of a long
position in the relevant ABS and will need to then consider whether the
performance of its contractual obligations as special servicer will be
sufficiently administrative or custodial in nature to be excluded from
the
[[Page 85410]]
definition.\200\ Similarly, if the B-piece buyer is an affiliate or
subsidiary, as defined by this rule, of another securitization
participant in the relevant ABS, then it will also be a securitization
participant subject to the prohibition in Rule 192(a)(1).\201\ For the
foregoing reasons, whether a B-piece buyer is a ``sponsor'' for
purposes of Rule 192, or is eligible for the Long-only Investor
exclusion, will depend on the facts and circumstances of the particular
ABS and the roles of the B-piece buyer and its affiliates and
subsidiaries in the ABS transaction.
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\199\ See Section II.B.3.b.iii. for a discussion of the final
rule's application to special servicers.
\200\ Id. As discussed in Section II.D.3.c., however, the
exercise of such contractual rights and obligations will not
themselves be conflicted transactions under the final rule. Also, if
the performance of the B-piece buyer's contractual obligations as
special servicer is sufficiently administrative or custodial in
nature to rely on the Service Provider Exclusion and the B-piece
buyer's only other role in the transaction is as a Long-only
Investor, then the B-piece buyer will not be a sponsor under the
final rule.
\201\ See Section II.B.3.c.
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Some commenters requested that market participants acting subject
to a fiduciary duty to a client or customer, such as open-market CLO
collateral managers, municipal advisors,\202\ or other investment
advisers be excluded from the definition of ``sponsor'' because such
participants are already subject to various laws and regulations that
regulate their conduct and address conflict management.\203\ Rule 192
will complement the existing federal securities laws, including those
that govern a market participant's Federal fiduciary duties. As
discussed earlier, the fact that an entity is subject to other rules,
laws, or regulatory policies pertaining to its conduct, including the
existence and management of conflicts of interest, does not preclude
such entity from satisfying the conditions of other regulatory
requirements. Additionally, we recognize, as one commenter stated, that
securitization participants in an ABS subject to Rule 192 do not owe a
fiduciary duty to the investors in an ABS because the securitization
participants' advisory clients are the deal sponsors rather than the
ABS investors.\204\ In cases where a sale of an ABS does not involve
the sale of an interest in a private fund \205\ or other vehicle
advised by an investment adviser, there is no advisory relationship
creating a Federal fiduciary duty owed between a purchaser and seller.
In cases where the private fund issues ABS (such as tranches of a CLO),
the private fund's adviser owes a Federal fiduciary duty to the fund
and the antifraud provisions of the Advisers Act and the rules
thereunder (the ``Antifraud Provisions'') apply.\206\ Such advisers
include CLO collateral managers who will also be subject to Rule 192.
Although the application of an adviser's Federal fiduciary duty, which
requires the adviser to serve the best interests of its clients,\207\
and the Antifraud Provisions provide protections relating to conflicts
of interest that act in harmony with Rule 192, these duties and
provisions do not necessarily require elimination of conflicted
transactions. Accordingly, a fiduciary duty-based exclusion from Rule
192 would frustrate Section 27B's prophylactic investor protection
objectives to eliminate certain conflicted transactions.
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\202\ See Section II.B.3.b.i. for additional discussion about
Rule 192's application to municipal advisors.
\203\ See, e.g., letters from ABA; ICI; LSTA IV; NAMA; Wulff
Hansen.
\204\ See letter from SIFMA I.
\205\ Section 202(a)(29) of the Investment Advisers Act of 1940
(the ``Advisers Act'') defines the term ``private fund'' as an
issuer that would be an investment company, as defined in section 3
of the Investment Company Act of 1940 (15 U.S.C. 80a-3), but for
section 3(c)(1) or 3(c)(7) of that Act.
\206\ See 17 CFR 275.206(4)-8 (``Advisers Act Rule 206(4)-8''),
which prohibits investment advisers to a pooled investment vehicle
from (1) making untrue statements of a material fact or omitting to
state a material fact necessary to make the statements made, in the
light of the circumstances under which they were made, not
misleading, to any investor or prospective investor in the pooled
investment vehicle; or (2) otherwise engaging in any act, practice,
or course of business that is fraudulent, deceptive, or manipulative
with respect to any investor or prospective investor in the pooled
investment vehicle). See also Prohibition of Fraud by Advisers to
Certain Pooled Investment Vehicles, Release No. IA-2628 (Aug. 3,
2007) [72 FR 153 (Aug. 9, 2007)]).
\207\ See Commission Interpretation Regarding Standard of
Conduct for Investment Advisers, Release No. IA-5248 (June 5, 2019)
[84 FR 33669 (July 12, 2019)] (``IA Interpretation'').
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Some commenters also stated that an adviser's Federal fiduciary
duty may address conflicts of interest, including through appropriate
disclosure and informed client consent.\208\ As the Commission has
stated, while full and fair disclosure of all material facts relating
to the advisory relationship or of conflicts of interest and a client's
informed consent prevent the presence of those material facts or
conflicts themselves from violating the adviser's fiduciary duty, such
disclosure and consent do not satisfy the adviser's duty to act in the
client's best interest.\209\ By contrast, Rule 192 sets forth an
express prohibition against certain conflicted transactions. The final
rule will therefore provide additional prophylactic protections for ABS
investors by requiring the elimination of those conflicted
transactions. For these reasons, we do not believe it would be
necessary, appropriate, or consistent with the investor protection
objectives of Section 27B to provide a fiduciary duty-based exclusion
from the definition of ``sponsor.''
---------------------------------------------------------------------------
\208\ See, e.g., letters from AIMA/ACC; ICI; SIFMA I. See also
IA Interpretation at 33676 (noting that an adviser must eliminate or
at least expose through full and fair disclosure the conflicts
associated with its allocation policies, including how the adviser
will allocate investment opportunities between clients, such that a
client can provide informed consent.).
\209\ See IA Interpretation at 33676.
---------------------------------------------------------------------------
Some commenters also expressed concern that investment advisers who
do not participate in the structuring or distribution of ABS would be
captured by the proposed definition of ``securitization participant''
only as a result of being an affiliate or subsidiary of another named
securitization participant.\210\ One of these commenters stated,
however, that permitting the use of information barriers in the final
rule would ``solve this problem.'' \211\ Our changes to the scope of
the affiliates and subsidiaries covered by the rule, including
permitting securitization participants and their affiliates and
subsidiaries to employ various mechanisms (such as information
barriers) to prevent coordination or sharing of information tailored to
their organization,\212\ will help address commenters' concerns about
the rule's applicability to affiliates and subsidiaries. Therefore, a
fiduciary duty-based exclusion to address these concerns is
unnecessary.\213\
---------------------------------------------------------------------------
\210\ See, e.g., letters from AIC; ICI; LSTA IV. For example,
these commenters stated that investment advisers may engage in
separate businesses that are unrelated to their securitization
activities, and thus those entities and their employees would have
no knowledge of, or involvement in, the securitization activity. See
also letter from SFA II (stating that advisers typically have
fiduciary duties to multiple clients and that such advisers must act
in the best interest of each client separately).
\211\ See letter from LSTA IV.
\212\ See Section II.B.3.c.
\213\ See also Section II.D. for a discussion of the revised
definition of ``conflicted transaction'' and the rule's
applicability to transactions undertaken pursuant to a fiduciary
duty.
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Some of these commenters also requested that municipal advisors be
excluded from the definition of ``sponsor.'' \214\ These commenters
stated that, in addition to the reasons already stated that make it
unlikely that a municipal issuer would engage in conflicted
transactions, municipal advisors also have a fiduciary duty to their
clients, various existing rules and regulations governing their
conduct, and that any proprietary bet by a municipal advisor against
its client's ABS would already be a violation of the federal securities
laws.\215\ Municipal advisors
[[Page 85411]]
participate in structuring the securities, and although municipal
advisors may be subject to other provisions that regulate their
conduct, we are not persuaded that advisors to municipal ABS are
uniquely different from other securitization participants such that
they should be excluded from the final rule. The fact that such
entities are subject to potential liability for violations of other
laws and regulations does not preclude the Commission from subjecting
them to other rules with different objectives. In particular, we note
that a municipal advisor's fiduciary duty is to its municipal entity
clients, not to investors, and therefore would not necessarily require
elimination of conflicted transactions.\216\ As discussed earlier, Rule
192 will complement the existing federal securities laws, including
general anti-fraud and anti-manipulation provisions, as well as those
that apply specifically to securitization, by prophylactically
protecting against the sale of ABS tainted by material conflicts of
interest.\217\
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\214\ See letters from NAMA; Wulff Hansen.
\215\ Id. See also Sections II.B.3.c. and II.D.3. for additional
discussions with respect to fiduciary duties in relation to Rule
192.
\216\ 15 U.S.C. 78o-4(c)(1).
\217\ See Section I.C.
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The Commission also received comment requesting that providers of
warehouse financing be excluded from the definition of ``sponsor.''
\218\ A warehouse financing facility is a secured loan from a warehouse
lender to provide capital to sponsors to acquire and aggregate assets
for securitization.\219\ One commenter stated that, because a warehouse
lender bears the risk with respect to any assets that cannot be
securitized, it acts pursuant to strict underwriting standards
reflective of the lender's risk tolerance.\220\ If a lender determines
that it is unwilling to lend against certain assets, this commenter
stated that such influence over the exclusion of those assets could be
construed as directing or causing the direction of the structure,
design, or assembly of an ABS or the composition of the asset
pool.\221\ As stated in the Proposing Release, the rule is not designed
to hinder routine securitization activities that do not give rise to
the risks that Section 27B was intended to address.\222\ Warehouse
financing is a routine activity to finance the purchase of assets by a
securitization participant in furtherance of the issuance of an ABS. A
warehouse lender whose role is to engage in such routine lending
activity with respect to the ABS, including the lender's right to
determine which assets it is or is not willing to finance pursuant to
its underwriting standards, does not meet the definition of ``sponsor''
under the final rule.\223\ However, if a securitization participant has
an affiliate or subsidiary that is a warehouse lender, and such
affiliate or subsidiary meets the definition of securitization
participant in Rule 192(c), such person will be subject to the
prohibition in Rule 192(a).\224\
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\218\ See letter from ABA.
\219\ See also Section II.D.
\220\ Id.
\221\ Id.
\222\ See Proposing Release Section II.D.1.
\223\ See also Section II.D. below for a discussion of why
warehouse financing is not a ``conflicted transaction'' under the
final rule.
\224\ See Section II.B.3.c.
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In the Proposing Release, the Commission explained that the
definition of Contractual Rights Sponsor in paragraph (ii)(A) would not
require an actual exercise of contractual rights. Two commenters
opposed this approach, stating that such person should only be a
sponsor if it actually exercised its contractual rights to direct or
cause the direction of the structure, design, or assembly of an ABS or
the underlying or referenced assets.\225\ One of these commenters
requested that, if the definition of ``sponsor'' is not limited to
paragraph (i), the final rule should define ``sponsor'' to include a
Regulation AB-based Sponsor or both a Contractual Rights Sponsor and
Directing Sponsor (i.e., a person who both has a contractual right to,
and actually does, direct or cause the direction of the structure,
design, or assembly of an ABS or the underlying or referenced
assets).\226\ This commenter stated that any person who does not have
the contractual right, but that is actually involved in the structuring
of an ABS or the composition of the underlying or referenced asset
pool, would have no practical ability to structure the ABS to fail
because the Regulation AB-based Sponsor in the deal (who has exposure
to the credit risk of the ABS by operation of the risk retention
requirement in Regulation RR) would have no reason to take direction
from such person, and that any person who has the contractual right but
does not exercise it has no real culpability.\227\ While the risk
retention requirement in Regulation RR does contribute to the alignment
of interests between ABS sponsors and investors, not all types of ABS
that are subject to the prohibition in Rule 192 are subject to
Regulation RR. A sponsor of an ABS that is not subject to Regulation RR
would not be required to retain exposure to the credit risk of the ABS,
meaning that there may not be an alignment of interests between the
sponsor and investors, which could create an opportunity for the
sponsor to be influenced by a third party's requests. Moreover, any
person with a contractual right to structure, design, or assemble an
ABS or the underlying or referenced pool of assets--whether those
rights are exercised or not--would have access to information about the
ABS or its underlying or referenced assets prior to the sale of the ABS
and would therefore have the opportunity to use that information to
engage in a conflicted transaction with respect to such ABS or
underlying or referenced assets. As discussed above, final Rule 192 is
designed to eliminate such opportunity and incentive. As such, a person
may be a ``sponsor'' subject to the prohibition in final Rule 192 if it
is either a Regulation AB-based Sponsor or a Contractual Rights
Sponsor, and the final rule does not require that an actual exercise of
contractual rights is necessary to meet the definition of ``sponsor.''
Consequently, a person who meets the definitional criteria in Rule
192(c) can be a ``sponsor'' regardless of whether it is referred to as
the sponsor or some other title (e.g., issuer, depositor, originator,
collateral manager).
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\225\ See letters from AIC; SIFMA I (stating that such a
position would be inconsistent with the ordinary and natural meaning
of the term). We discuss the comments related to the ``ordinary and
natural meaning'' of sponsor earlier in this section.
\226\ See letter from AIC.
\227\ Id.
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While we understand commenter concerns about the number and types
of entities that may be sponsors under the rule, we continue to
believe, for the reasons discussed above, that the scope of the
definition is necessary to capture the relevant securitization
participants that would have the incentive and ability to engage in
conflicted transactions as a result of their ability to structure,
design, or assemble an ABS or its underlying or referenced asset pool.
Moreover, we believe that commenters' concerns will be mitigated by the
revisions made to the definition of ``sponsor'' to exclude Long-only
Investors and to not adopt the proposed definition of Directing
Sponsor, as discussed above, and to the scope of affiliates and
subsidiaries captured by the definition of ``securitization
participant'' discussed in Section II.B.3.c. below, as well as the
guidance that we have provided with respect to certain market
participants discussed in this section and in the discussion about the
Service Provider Exclusion in Section II.B.3.b.iii. below.
iii. Service Provider Exclusion
Commenters generally supported an exclusion from the definition of
[[Page 85412]]
``sponsor'' for transaction parties performing the enumerated types of
activities, but requested certain modifications to clarify the scope of
the exclusion.\228\ Several commenters stated that the activities
performed over the life of the securitization by servicers, special
servicers, and other contractual providers are consistent with the
activities enumerated in the Service Provider Exclusion in proposed
paragraph (ii)(C) and requested that servicers be specifically listed
in the exclusion.\229\ Some commenters further requested that the rule
include an explicit exclusion for credit rating agencies in the final
rule text.\230\
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\228\ See, e.g., letters from AIC; CREFC I; LSTA III; LSTA IV;
MBA; SFA II; SIFMA I; SIFMA II.
\229\ See, e.g., letters from AIC; CREFC I; CREFC II; MBA; SFA
II; SIFMA I. One of these commenters noted that its membership was
not in agreement with respect to whether a special servicer in CMBS
transactions should be included in the Service Provider Exclusion.
See letter from SFA II.
\230\ See letters from LSTA III; SFA I; SFA II; SIFMA I.
---------------------------------------------------------------------------
Consistent with the view expressed by the Commission in the
Proposing Release,\231\ we agree with commenters that the activities
customarily performed by accountants, attorneys, and credit rating
agencies with respect to the creation and sale of an ABS, as well as
the activities customarily performed by trustees, custodians, paying
agents, calculation agents, and servicers,\232\ relating to the ongoing
management and administration of the entity that issues the ABS and its
related assets, are the types of activities described in the Servicer
Provider Exclusion. We understand, however, commenters' concern that,
because the proposed text of the exclusion did not refer specifically
to activities that constitute ``ongoing administration'' of the ABS or
the underlying or referenced asset pool, the scope of the exclusion as
proposed could be read to refer only to activities performed in
connection with the initial creation of the securitization and
therefore was not sufficiently clear.\233\
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\231\ See Proposing Release at 9686.
\232\ See Section II.D. below for a discussion of servicing
activity as it relates to the definition of ``conflicted
transaction'' under the rule.
\233\ See, e.g., letters from AIC; CREFC I; CREFC II; MBA; SFA
I; SFA II.
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We are revising the definition of ``sponsor'' to align with the
Commission's intent as stated in the Proposing Release and in response
to commenter requests to specify in the rule text that the activities
performed over the life of the securitization by third-party servicers
and other contractual providers \234\ are consistent with the
activities enumerated in the rule.\235\ As adopted, therefore, the
definition of ``sponsor''--notwithstanding paragraph (ii)--excludes any
person that performs only administrative, legal, due diligence,
custodial, or ministerial acts related to the structure, design,
assembly, or ongoing administration of the ABS or the composition of
the pool of assets underlying or referenced by the ABS (the Service
Provider Exclusion).\236\ For purposes of the Service Provider
Exclusion, ``ongoing administration'' refers to the types of activities
typically performed by servicers, trustees, custodians, paying agents,
calculation agents, and other contractual service providers pursuant to
their contractual obligations in a securitization transaction over the
life of the ABS; it does not refer to active portfolio management or
other such activity that would be subject to the ``sponsor''
definition.\237\
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\234\ Servicers and other contractual service providers whose
activities meet the criteria specified in the Service Provider
Exclusion may nonetheless be securitization participants subject to
the prohibition in Rule 192(a)(1) with respect to the relevant ABS
if, for example, such person is an affiliate or subsidiary of a
named securitization participant. See Section II.B.3.c.
\235\ See, e.g., letters from AIC; CREFC I; CREFC II; MBA; SFA
II; SIFMA I.
\236\ Because the types of activities listed in the Service
Provider Exclusion rule text already cover the activities of credit
rating agencies, no additional revision to the rule text is
unnecessary.
\237\ See, e.g., the discussion in Section II.D. below related
to normal-course servicing activity in a covered transaction not
constituting a ``conflicted transaction'' under the final rule.
---------------------------------------------------------------------------
Some commenters also requested that we replace the qualifier
``only'' in the Service Provider Exclusion with ``primarily,'' \238\
stating that the use of ``only'' erodes the exclusion because the
administrative, legal, due diligence, custodial, or ministerial acts
performed by the service providers discussed above could also be viewed
as activities causing the direction of the structure, design, or
assembly of an ABS or the composition of the pool assets.\239\ As one
of these commenters pointed out, such activities could include the
drafting and negotiation of the operating and disclosure documents with
respect to an ABS, setting fees to be paid to certain transaction
parties, reviewing the asset pool, negotiating the priority of payments
within an ABS transaction, potentially advising on how to structure an
ABS to meet the objectives of the deal parties, collecting payments on
underlying assets, and making distributions to bondholders.\240\ While
we agree that such activities could be understood to be consistent with
the activities described in the Contractual Rights Sponsor definition,
we also agree that they are consistent with the administrative, legal,
due diligence, custodial, and ministerial activities covered by the
Service Provider Exclusion. As the Commission stated in the Proposing
Release, the Service Provider Exclusion is intended to avoid
inadvertently including certain parties to securitization transactions
whose contractual rights could be interpreted as consistent with the
activities described in paragraph (ii) of the definition of ``sponsor''
but who are otherwise not the parties that Section 27B was intended to
cover. For this reason, so long as a person's activities with respect
to the relevant ABS are only administrative, legal, due diligence,
custodial, or ministerial in nature, the Service Provider Exclusion is
available ``notwithstanding'' the fact that such a person's contractual
rights could also be understood to be captured by paragraph (ii) of the
definition of sponsor. Accordingly, we do not believe that changing
``only'' to ``primarily'' is necessary.
---------------------------------------------------------------------------
\238\ See, e.g., letters from SFA I; SFA II; SIFMA II.
\239\ See, e.g., letters from SFA I; SFA II.
\240\ See letter from SFA II.
---------------------------------------------------------------------------
Moreover, we continue to believe that limiting the exclusion in
this way is necessary to ensure that it does not inadvertently extend
to deal participants with more active participation in the creation and
administration of asset-backed securities. For example, a special
servicer can potentially have a significant role in the servicing and
disposition of troubled assets in an asset pool, such as the ability to
determine whether (and when) to negotiate a workout of a loan, take
possession of the property collateralizing a loan, and purchase the
loan out of the securitization at a discount and, therefore, the
special servicer's activities may not be limited to the types of
administrative or ministerial functions eligible for the
exclusion.\241\ As such, whether a special servicer qualifies for the
exclusion will depend on the facts and circumstances of the ABS and the
activities performed by the special servicer.\242\ Similarly, as
support for its request that the Service Provider Exclusion include
activities relating to ongoing administration of the ABS, one commenter
gave the example of a
[[Page 85413]]
situation in which a placement agent for a CLO may also be an
administrative agent under a loan that underlies a CLO and therefore
has various duties that it must perform.\243\ This commenter requested,
therefore, that the final rule include an exception for actions taken
by securitization participants pursuant to their duties under the CLO
or underlying loan documents and stated that including ongoing
administration activities in the Service Provider Exclusion would
achieve that.\244\ In the example provided by this commenter, such
administrative agent is also the placement agent for the relevant ABS,
and therefore will be ineligible to rely on the Service Provider
Exclusion because its activities are not ``only'' administrative in
nature and because, as placement agent, such person is a securitization
participant pursuant to the definition of ``placement agent'' in Rule
192(c).\245\ For these reasons we do not believe that it would be
appropriate to revise the exclusion as requested.
---------------------------------------------------------------------------
\241\ See Section II.B.3.b.ii. and Section II.D.1.c.iii.
\242\ For example, if the special servicer for a CMBS
transaction is also the B-piece buyer (or an affiliate or subsidiary
of the B-piece buyer) and can exercise such contractual rights with
respect to the asset pool without needing to obtain the consent of
any unaffiliated investor or transaction party in the CMBS
transaction, then the special servicer's activities are not only
administrative, legal, due diligence, custodial, or ministerial in
nature with respect to such CMBS transaction.
\243\ See letter from LSTA IV.
\244\ Id.
\245\ See Section II.B.3.a.
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The Commission also received comment requesting that third-party
asset sellers be included in the Servicer Provider Exclusion.\246\ A
third-party asset seller is a third-party originator who sells loans or
other assets to the ultimate ABS sponsor before those assets are
transferred into the securitization structure. The purchase of assets
from unaffiliated originators to be later transferred into a
securitization is a routine capital market function through which the
seller would not have the contractual right to direct or cause the
direction of the structure, design, or assembly of an ABS or the
composition of the underlying or referenced pool of assets. Such
persons' activities are limited to merely originating assets that are
then transferred to the ABS sponsor in a true sale; they do not have
ongoing roles or contractual rights or duties with respect to the
assets or the ultimate ABS. Therefore, while we do not believe that the
function performed by these third-party asset sellers is consistent
with the types of activities enumerated in the Service Provider
Exclusion, we do agree that such persons are not ``sponsors'' under the
rule.\247\
---------------------------------------------------------------------------
\246\ See letter from SFA II.
\247\ An originator that is affiliated with an underwriter,
placement agent, initial purchaser, or sponsor of a covered
transaction, however, may be a securitization participant subject to
the rule's prohibition against engaging in conflicted transactions.
See Section II.B.3.c. below.
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iv. U.S. Government Exclusion
Consistent with the proposal, the United States or an agency of the
United States is not a ``sponsor'' for purposes of the final rule with
respect to its ABS that are fully insured or fully guaranteed as to the
timely payment of principal and interest.\248\ However, in a change
from the proposal, we are not adopting the proposed exclusion from the
``sponsor'' definition for the Enterprises, which we discuss in greater
detail below.
---------------------------------------------------------------------------
\248\ 17 CFR 192(c).
---------------------------------------------------------------------------
With respect to an ABS that is fully insured or fully guaranteed as
to the timely payment of principal and interest by the United States,
it is the United States as guarantor that is exposed to the full credit
risk related to the underlying assets, rather than the investors in the
ABS.\249\ This is because investors in such ABS rely on the support
provided by the full faith and credit of the United States and not on
the creditworthiness of the obligors on the underlying assets, meaning
they are not exposed to the credit risk of the underlying assets.\250\
Consequently, investors in such ABS are not exposed to the risk that
was present in certain ABS transactions at the time of the financial
crisis of 2007-2009 where investors suffered credit-based losses due to
the poor performance of the relevant asset pool while key
securitization parties entered into transactions to profit from such
poor performance.
---------------------------------------------------------------------------
\249\ See Proposing Release Section II.B.2.c.
\250\ Id.
---------------------------------------------------------------------------
Commenters supported the proposal to exclude the United States
Government and its agencies from the definition of ``sponsor,'' \251\
with one of these commenters specifically agreeing that mortgage-backed
securities (``MBS'') guaranteed by the Government National Mortgage
Association (``Ginnie Mae'') are fully guaranteed by the United States
Government \252\ and thus should be excluded from the ``sponsor''
definition.\253\ This commenter also stated that, because issuers of
Ginnie Mae MBS have ``considerable discretion'' over which loans to
include in the MBS, those issuers should be sponsors under the
rule.\254\ For purposes of the final rule, and as noted in the
Proposing Release, the exclusion in paragraph (iv) of the definition of
``sponsor'' applies only to the specified entities (i.e., the United
States or an agency of the United States).\255\ Any other
securitization participant involved with an ABS issued or guaranteed by
a specified entity (e.g., an underwriter or a non-governmental sponsor)
is subject to the prohibition in Rule 192 against engaging in
transactions that effectively represent a bet against the relevant
ABS.\256\ If, therefore, the issuer of a fully-guaranteed Ginnie Mae
ABS meets the definition of ``sponsor'' as adopted,\257\ such issuer is
prohibited from engaging in conflicted transactions.\258\
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\251\ See, e.g., letters from M. Calabria; SIFMA I.
\252\ See Title III of National Housing Act, 12 U.S.C. 1716-1723
(2019) (stating that ``[t]he full faith and credit of the United
States is pledged to the payment of all amounts which may be
required to be paid under any guaranty under this subsection.'')
available at <a href="https://www.ginniemae.gov/about_us/what_we_do/Documents/statutes.pdf">https://www.ginniemae.gov/about_us/what_we_do/Documents/statutes.pdf</a>.
\253\ See letter from M. Calabria.
\254\ Id.
\255\ See Rule 192(c) and Proposing Release Section II.B.2.c.
\256\ Id.
\257\ See Sections II.B.3.b.i. and II.B.3.b.ii.
\258\ See Section II.D. for a discussion of what constitutes a
``conflicted transaction'' under the final rule.
---------------------------------------------------------------------------
Comments related to the proposed exclusion from the definition of
``sponsor'' for the Enterprises were mixed. Some commenters supported
the exclusion of Fannie Mae and Freddie Mac from the ``sponsor''
definition with some modifications to extend the exclusion beyond
conservatorship,\259\ with one suggesting that the exclusion be
conditioned on the Enterprises retaining their current status as
government sponsored entities because the Federal Housing Finance
Agency's (``FHFA'') oversight sufficiently guards against the types of
behavior that Section 27B is intended to prevent.\260\ Another
commenter suggested that, in addition to the exclusion from the
``sponsor'' definition, the rule should exclude from the definition of
``asset-backed security'' any ABS that is fully insured or fully
guaranteed as to the timely payment of principal and interest by the
Enterprises while operating under the conservatorship or receivership
of the FHFA.\261\
---------------------------------------------------------------------------
\259\ See, e.g., letters from Fannie and Freddie; SFA II.
\260\ See letter from Fannie and Freddie.
\261\ See letter from ABA. As discussed below, the final rule
does not include an exclusion from the definition of ``sponsor'' for
the Enterprises while in conservatorship in light of concerns that
the proposed exclusion was unclear and concerns regarding the impact
of an automatic change to the Enterprises' status immediately upon
existing conservatorship. For the same reasons, the final rule does
not contain an exclusion for an ABS that is fully insured or fully
guaranteed as to the timely payment of principal and interest by the
Enterprises while in conservatorship. See Section II.A. for more
information about the types of ABS that are subject to the final
rule.
---------------------------------------------------------------------------
Some commenters, however, opposed including the Enterprises in the
exclusion from the ``sponsor''
[[Page 85414]]
definition.\262\ One commenter stated that the capital support from the
United States while in conservatorship or receivership is not an
explicit government guarantee of the Enterprises' ABS or MBS.\263\
Another commenter suggested that the Enterprises should be sponsors for
purposes of Rule 192, but that the final rule should permit credit risk
transfer (``CRT'') transactions regardless of sponsor,\264\ which would
treat the Enterprises and other market participants alike.
---------------------------------------------------------------------------
\262\ See, e.g., letters from HPC; M. Calabria.
\263\ See letter from M. Calabria. This commenter also stated
that an exclusion from the prohibition in Rule 192 would
disincentivize or prevent the Enterprises from leaving
conservatorship.
\264\ See letter from HPC.
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Because, as proposed, the Enterprise exclusion from the ``sponsor''
definition would only apply with respect to ABS fully guaranteed by the
Enterprises and not with respect to the CRT securities they issue,\265\
some commenters expressed concerns that, together with the proposed
restriction that the initial distribution of an asset-based security
would not be risk-mitigating hedging,\266\ the proposed rule would have
the effect of prohibiting all Enterprise CRTs as per se conflicted
transactions.\267\ Some commenters stated that, for this reason, the
cumulative effect of the proposed approach (i.e., to exclude the
Enterprises as sponsors with respect to fully-guaranteed ABS, but not
with respect to CRTs, and to exclude CRT transactions from the risk-
mitigation hedging exception) was unclear.\268\ To address this
concern, one commenter requested that either the Enterprises be
excluded from the ``sponsor'' definition in perpetuity (or until the
Commission revisited the exclusion), or that the Enterprises' synthetic
ABS issuances (i.e., CRT transactions) be permitted to qualify under
the risk-mitigating hedging exception so long as they continue to be
government-sponsored enterprises.\269\ Alternatively, this commenter
requested that the sponsor exclusion remain in place for at least 24
months following the Enterprises' exit from conservatorship to permit
the Commission to make a determination after the nature of the post-
conservatorship landscape becomes clear.\270\ Relatedly, one commenter
stated that permitting the Enterprises to continue their credit risk
transfer securitization program under the risk-mitigating hedging
exception would provide more clarity and certainty for all participants
involved than excluding the Enterprises from the ``sponsor''
definition.\271\
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\265\ The Enterprises engage in security-based credit risk
transfer transactions to allow for efficient mitigation of the
Enterprises' retained credit risk associated with their holdings of
residential and commercial mortgages and MBS. A security-based CRT
transaction typically involves the issuance of unguaranteed ABS by a
special purpose trust where the performance of such ABS is linked to
the performance of a reference pool of mortgage loans that
collateralize Enterprise guaranteed-MBS. As part of a security-based
CRT transaction structure, the relevant Enterprise enters into an
agreement with the special purpose trust pursuant to which the trust
has a contractual obligation to pay the Enterprise upon the
occurrence of certain adverse events with respect to the referenced
mortgage loans. See letter from Fannie and Freddie; see also, e.g.,
the relevant legal documentation and other related information about
Freddie Mac's single-family transaction, available at <a href="https://capitalmarkets.freddiemac.com/crt/securities/deal-documents">https://capitalmarkets.freddiemac.com/crt/securities/deal-documents</a>.
\266\ See Section II.E.
\267\ See, e.g., letters from ABA; Fannie and Freddie; SFA I.
Some of these commenters stated that they did not believe that this
was the intent in light of the Commission's statement in the
Proposing Release that the exclusion from the ``sponsor'' definition
should address concerns that, absent such an exception, an
Enterprise might be prohibited from engaging in a security-based CRT
transaction. See letters from ABA; SIFMA II.
\268\ See, e.g., letters from ABA; Fannie and Freddie; SIFMA II.
\269\ See letter from Fannie and Freddie. See also Section II.E.
for a discussion of the risk-mitigation hedging exception under the
final rule.
\270\ See letter from Fannie and Freddie.
\271\ See letter from SIFMA II.
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After considering the comments received, we are not adopting the
proposed Enterprise exclusion from the ``sponsor'' definition and,
therefore, the Enterprises are sponsors under the final rule with
respect to any ABS they issue, whether or not it is fully guaranteed.
Although we still believe that, while the Enterprises are in
conservatorship, investors in their guaranteed ABS are not exposed to
the same types of risk that existed in certain ABS transactions leading
up the financial crisis of 2007-2009,\272\ that would not be the case
once the Enterprises exit conservatorship. In light of the concerns
that the cumulative effect of the proposed exclusion from the
``sponsor'' definition and the proposed exception for risk-mitigating
hedging activities was unclear, we have concluded that including the
Enterprises as sponsors and permitting Enterprise CRT transactions so
long as they meet the conditions enumerated in the risk-mitigating
hedging exception,\273\ would provide more certainty for the
Enterprises and the market. Further, we believe that the revisions to
the definition of ``conflicted transactions,'' together with the
revised exception for risk-mitigating hedging activities discussed
below, sufficiently address commenter concerns with respect to the
ability of the Enterprises to continue to engage in CRT transactions
for purposes of managing their credit risk.\274\ As sponsors--and,
thus, securitization participants--subject to the prohibition in Rule
192(a) against engaging in conflicted transactions, the Enterprises are
subject to the same limitations on such behavior as private market
participants.
---------------------------------------------------------------------------
\272\ See Proposing Release Section II.B.2.c.
\273\ See Section II.E.
\274\ As discussed in detail below, the definition of
``conflicted transaction'' in final Rule 192(a)(3) captures the
relevant conflict of interest in the context of the issuance of a
new synthetic ABS (e.g., the issuance of a CRT transaction), but
such synthetic ABS will be permissible if it meets the conditions
for the exception for risk-mitigating hedging activities.
Furthermore, the synthetic ABS will be subject to the rule and the
related securitization participants will be subject to the
prohibition. See Sections II.D. and II.E. below.
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c. Affiliates and Subsidiaries
After consideration of commenters' concerns and recommendations,
discussed in detail below, we are revising paragraph (ii) of the
definition of ``securitization participant'' to limit which affiliates
or subsidiaries \275\ are securitization participants. An affiliate or
subsidiary is a securitization participant for purposes of the final
rule only if it acts in coordination with \276\ an underwriter,
placement agent, initial purchaser, or sponsor or if it has access to
or receives information about the relevant ABS or the asset pool
underlying or referenced by the relevant ABS prior to the date of the
first closing of the sale of the relevant ABS.\277\
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\275\ For purposes of the final rule, the terms ``affiliate''
and ``subsidiary'' will have the same meaning as in Securities Act
Rule 405 (17 CFR 230.405). Under Securities Act Rule 405, an
``affiliate'' of a specified person is a person that directly, or
indirectly through one or more intermediaries, controls or is
controlled by, or is under common control with, the person
specified, and a ``subsidiary'' of a specified person means an
affiliate controlled by such person directly, or indirectly through
one or more intermediaries. Securities Act Rule 405 also defines the
term ``control'' to mean the possession, direct or indirect, of the
power to direct or cause the direction of the management and
policies of a person, whether through the ownership of voting
securities, by contract, or otherwise. 17 CFR 230.405.
\276\ As suggested by one commenter, an affiliate or subsidiary
would be acting in coordination with a named securitization
participant if it (i) directly engages in the structuring of or
asset selection for the securitization, (ii) directly engages in
other activities in support of the issuance and distribution of the
ABS, or (iii) otherwise acts in concert with its affiliated
securitization participant through, e.g., coordination of trading
activities. See letter from ABA.
\277\ 17 CFR 230.190(c).
---------------------------------------------------------------------------
While some commenters supported the proposal to include affiliates
and subsidiaries of underwriters, placement agents, initial purchasers,
and sponsors as securitizations participants,\278\ many commenters
expressed concerns that the
[[Page 85415]]
proposed approach would hinder market participants' ability to
effectively comply with the rule's prohibition.\279\ Commenters stated
that compliance with Rule 192 as proposed could interfere with
securitization participants' ability to comply with existing
information barriers, including those that may be required by other
applicable Federal- and State-level laws, in order to effectively
implement a compliance program designed to monitor for, and prevent the
occurrence of, potentially conflicted transactions.\280\ Some of these
commenters acknowledged that Section 27B specifies that the prohibition
applies to affiliates and subsidiaries of other named securitization
participants \281\ and many supported such application in circumstances
in which affiliates or subsidiaries have direct involvement in, or
knowledge of, the covered ABS or are otherwise acting in coordination
with the named securitization participant.\282\ Commenters recommended
various approaches to address their stated concerns, which can
generally be grouped into three categories, which we discuss below.
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\278\ See, e.g., letters from AARP dated Mar. 23, 2023
(``AARP''); Better Markets.
\279\ See, e.g., letters from ABA; AIC; AFME; AIMA/ACC; ICI;
LSTA III; LSTA IV; MFA II; SFA I; SIFMA I.
\280\ See, e.g., letters from ABA; AIC; AFME; ICI; MFA II. Some
commenters also expressed concern that, without recognizing
information barriers or including other limitations on the rule's
applicability to affiliates and subsidiaries, the prohibition could
apply to foreign affiliates and subsidiaries of U.S.-based
securitization participants regardless of their participation in the
transaction. See, e.g., letters from AFME; AIC. We believe that,
together with the discussion in Section II.A.3.c. above about the
cross-border application of Rule 192, the definition of
``securitization participant'' with respect to affiliates and
subsidiaries, as discussed in greater detail below, will
appropriately limit such application only to those affiliates and
subsidiaries who have direct involvement in, or access to
information about, a covered ABS, which should mitigate these
concerns.
\281\ See, e.g., letters from ABA; SFA I; SFA II.
\282\ See, e.g., letters from ABA; AFME; ICI; LSTA III; SFA II;
SIFMA I; SIFMA II.
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First, several commenters requested that the rule exclude
affiliates and subsidiaries from the definition of ``securitization
participant'' and instead treat a securitization participant's use of
an affiliate or subsidiary to indirectly engage in a conflicted
transaction as an evasion of the prohibition in Rule 192(a).\283\ To
implement this recommendation, commenters suggested that the proposed
anti-circumvention provision could be revised to make clear that a
securitization participant could not engage in a transaction as part of
a plan or scheme to evade the prohibition of the rule, whether directly
or indirectly, including through the use of affiliates and
subsidiaries.\284\ Section 27B, however, states that affiliates and
subsidiaries of an underwriter, placement agent, initial purchaser, or
sponsor of a relevant ABS are subject to the prohibition in their own
right, not merely that the other parties to the transaction are
prohibited from engaging in conflicted transactions directly or
indirectly through an affiliate or subsidiary. Accordingly, we believe
that the suggested revision to treat a securitization participant's use
of an affiliate or subsidiary to engage in a conflicted transaction as
an evasion of the prohibition would not be appropriate or consistent
with Section 27B.
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\283\ See, e.g., letters from ABA; AIC; ICI; SFA I.
\284\ See, e.g., letter from AIC.
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Second, some commenters requested that the rule exclude affiliates
and subsidiaries bound by, and operating consistent with, fiduciary
duties from the definition of securitization participant.\285\ These
commenters stated that funds advised by the same asset manager should
not be considered affiliates to the extent that the manager is bound by
fiduciary duties to the issuing entity for the securitization and/or
its investors and that the term ``securitization participant'' should
exclude any entity acting in its capacity as an investment adviser, as
well as that entity's advisory clients.\286\ For the reasons stated in
Section II.B.3.b.ii. above, we believe that permitting a fiduciary
duty-based exclusion from the rule is inconsistent with the rule's
objective.\287\
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\285\ See, e.g., letters from ABA; AIC; ICI; LSTA IV; SIFMA I.
See also Section II.B.3.b.ii., above, for a discussion of comments
requesting an exclusion from the definition of ``sponsor'' for any
person operating pursuant to a fiduciary duty.
\286\ See, e.g., letters from ABA; SIFMA I.
\287\ See Section II.D. for a discussion of why the rule does
not include a similar exclusion from the definition of ``conflicted
transactions'' for transactions that such securitization
participants may enter into pursuant to a fiduciary duty.
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Finally, while some commenters agreed that the rule should not
include an exemption for affiliates and subsidiaries dependent on the
use of information barriers,\288\ other commenters requested that the
final rule permit the use of information barriers or other indicia of
separateness to mitigate potential conflicts of interest.\289\ In
support of this request, these commenters referenced the Proposing
Release statements \290\ acknowledging that the Commission has
recognized information barriers in other Federal securities laws and
the rules thereunder.\291\ Some of these commenters requested that we
adopt a specific information barrier exception in the final rule and
offered suggestions for modifications to the conditions for such an
exception as discussed in the Proposing Release,\292\ but several
others articulated concerns that the conditions would be too burdensome
or expensive.\293\ Instead, many commenters suggested that the final
rule should consider the presence or absence of information barriers
(and the robustness and effectiveness thereof) as part of a multi-
factor analysis as a preferred alternative to affirmatively requiring
the use of prescriptive information barriers.\294\ To highlight the
challenges that would be presented by a prescriptive information
barrier exception, some commenters stated that
[[Page 85416]]
several securitization participants already use information barriers
and similar mechanisms to ensure compliance with various laws and that
requiring these entities to establish new information barriers tailored
to Rule 192 could lead to inconsistent, intersecting, and/or
conflicting information barriers that compromise rather than facilitate
compliance.\295\ Other commenters stated that, while some
securitization participants may have existing information barriers for
compliance with other securities laws, such as the Volcker Rule,\296\
not all securitization participants subject to the prohibition in Rule
192 are necessarily subject to such laws, and therefore a prescriptive
information barrier exception (including one modeled on such an
exception to another securities law) would disproportionately increase
costs of compliance for those entities.\297\
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\288\ See, e.g., letters from AARP; Better Markets.
\289\ See, e.g., letters from ABA; AIMA/ACC; AFME; AIC; ICI;
LSTA II; LSTA III; LSTA IV; MFA II; Pentalpha; SFA I; SIFMA I; SFA
II; SIFMA II. Some of these commenters also recommended that, in the
alternative, the final rule could specify that any transaction
described in paragraph (a)(3) of the final rule, entered into at the
direction of a related person, would be presumed to be a conflicted
transaction unless that person demonstrates that it had no
substantive role in structuring, marketing, or selling the ABS or in
the selection of the asset pool underlying or referenced by the
relevant ABS. See letters from SFA II; SIFMA II.
\290\ See Proposing Release Section II.B.c.3. The Proposing
Release noted as an example that brokers and dealers have used
information barriers to manage the potential misuse of material non-
public information to comply with Exchange Act 15(g) (17 U.S.C.
78o(g)) and that Regulation M contains an exception for affiliated
purchasers if, among other requirements, the affiliate maintains and
enforces written policies and procedures reasonably designed to
prevent the flow of information to or from the affiliate that might
result in a violation of Regulation M (17 CFR 242.100-105; 17 CFR
242.100(b)). Id.
\291\ See, e.g., letters from ABA; AIMA/ACC; AFME; AIC; ICI;
LSTA II; LSTA III; MFA II; Pentalpha; SFA I; SIFMA I.
\292\ See, e.g., letters from ICI; Institute of Internal
Auditors dated Mar. 27, 2023 (``IIA''); Pentalpha. See Proposing
Release Section II.B.3. and Requests for Comment 29-38 for a
discussion of potential conditions for an information barrier
exception. The modifications suggested by these commenters include:
to specify that policies and procedures must be ``reasonably
designed,'' that an internal audit group be allowed to conduct the
required independent assessment, and that the independent assessment
should be conducted with respect to individual securitizations
rather than on a corporate platform basis. While one of these
commenters supported the inclusion of an information barrier
exception subject to certain conditions in the final rule, the
commenter also requested that investment funds and advisers be
exempt from the conditions to qualify for such exception. See letter
from ICI.
\293\ See, e.g., letters from ABA; AFME; AIC; LSTA III; MFA II;
SIFMA I.
\294\ See, e.g., letters from LSTA III; LSTA IV; SFA II; SIFMA
I. Other commenters similarly indicated that a final rule that
merely permits the use of existing information barriers would be
sufficient to address their concerns. See, e.g., letters from ABA
(stating that it is critical for the final rule to acknowledge
information barriers); MFA II (noting that any information barriers
permitted must be workable).
\295\ See, e.g., letters from AFME; SIFMA I.
\296\ 17 CFR 255.
\297\ See, e.g., letter from AIC (noting as an example that
investment funds and portfolio companies are not subject to the
Volcker Rule).
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While it is true that the Federal securities laws recognize the use
of information barriers in certain situations, we do not believe that
an information barrier exception would be appropriate in the context of
Rule 192 for several reasons. First, we are concerned that an
information barrier exception has the potential to become a ``check-
the-box'' exercise that could result in an emphasis on form over
function or effectiveness of such information barriers. Due to the wide
range of securitization participants subject to the prohibition in Rule
192, any prescriptive information barrier exception would have to be
drafted in such a way as to be generally applicable to the various
types of securitization participants, which could result in standards
that are either too permissive for one type of securitization
participant (resulting in weakened protections for ABS investors) or
too difficult for another to satisfy due to limitations such as numbers
of employees, regulatory regimes applicable to certain types of
securitization participants, etc.\298\ Additionally, as demonstrated by
the commenter concerns discussed above, an information barrier
exception could have the unintended consequence of potentially
compromising various existing compliance programs or disadvantaging
certain securitization participants.\299\ For these reasons, Rule 192
does not include an information barrier exception. However, we
acknowledge commenters' concerns about their ability to concurrently
comply with the prohibition in Rule 192 with respect to various
affiliates and subsidiaries, as well as other applicable Federal- and
State-level laws that may permit or require information barriers or
other similar firewalls. The revisions we are adopting to the
definition of ``securitization participant,'' as discussed in greater
detail below, are aimed at alleviating commenters' concerns with
respect to the scope of the rule's prohibition, while also obviating
the need for a prescriptive information barrier exception, avoiding
potential additional costs associated with establishing policies and
procedures to satisfy conditions imposed by such an exception.
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\298\ For example, while it may be relatively easy for large
multi-service firms to implement information barriers by
establishing completely separate teams of employees to prevent the
flow of information where necessary, smaller securitization
participants may not have a sufficient number of employees to do so,
and therefore such persons may need to employ different mechanisms
to prevent such flow of information.
\299\ For example, larger multi-service entities may have many
different business units already subject to various regulatory
provisions related to the unit's particular business and that may
require compliance programs involving information barriers. A
prescriptive information barrier exception in Rule 192, therefore,
has the potential to overlap and/or interfere with those existing
compliance programs, which could potentially increase compliance
burdens.
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As adopted, an affiliate or subsidiary of an underwriter, placement
agent, initial purchaser, or sponsor will only be a securitization
participant if the affiliate or subsidiary acts in coordination with a
securitization participant or has access to, or receives, information
about a covered ABS or the asset pool underlying or referenced by the
relevant ABS prior to the date of first closing of the sale of the
covered ABS.\300\ This approach is consistent with the commenter
suggestions, as noted above, that affiliates or subsidiaries should
only be subject to the prohibition if they have direct involvement in,
or access to information about, the relevant ABS or are otherwise
acting in coordination with the named securitization participant.\301\
This approach is also consistent with commenter recommendations that
the final rule permit securitization participants to demonstrate lack
of involvement or control through the presence and effectiveness of
information barriers or other indicia of separateness.\302\
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\300\ 17 CFR 230.192(c).
\301\ See, e.g., letters from ABA; AFME; ICI; LSTA III; LSTA IV;
SFA II; SIFMA I; SIFMA II.
\302\ See, e.g., letters from AIC; LSTA III; SFA II; SIFMA I;
SIFMA II.
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Whether an affiliate or subsidiary acts in coordination with a
securitization participant or had access to, or received, information
about an ABS or its underlying asset pool or referenced asset pool
prior to the closing date will depend on the facts and circumstances of
a particular transaction.\303\ Therefore, an affiliate or subsidiary
may not be a ``securitization participant'' if the named securitization
participant, for example:
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\303\ If an affiliate or subsidiary receives information--or has
access to information--after the closing of the first sale of the
ABS, then--absent coordination with the securitization participant--
the affiliate or subsidiary will not be a securitization participant
as defined by the final rule.
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<bullet> Has effective information barriers between it and the
relevant affiliate or subsidiary (including written policies and
procedures designed to prevent the flow of information between relevant
entities, internal controls, physical separation of personnel,
etc.),\304\
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\304\ It will not be inconsistent with this example if the
relevant entity has a shared research desk that provides research to
the named securitization participant and an affiliated fund but the
named securitization participant and the affiliated fund themselves
do not share information with each other.
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<bullet> Maintains separate trading accounts for the named
securitization participant and the relevant affiliate or subsidiary,
<bullet> Does not have common officers (or persons performing
similar functions) or employees (other than clerical, ministerial, or
support personnel) between the named securitization participant and the
relevant affiliate or subsidiary,
<bullet> Is engaged in an unrelated business from the relevant
affiliated entity and does not, in fact, communicate with such relevant
affiliated entity,\305\ or
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\305\ As an example, one commenter stated that, if affiliated
entities operate as independent businesses, notwithstanding their
common control by a shared manager, such entities may have no
relationship or communication with one another. See letter from AIC.
As stated above, whether the operation as independent businesses,
despite common control, is sufficient to effectively prevent the
flow of information between the named securitization participant and
the affiliate or subsidiary will depend on the facts and
circumstances of the particular transaction.
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<bullet> Has personnel with oversight or managerial responsibility
over accounts of both the named securitization participant and the
affiliate or subsidiary, but such persons do not have authority to (and
do not) execute trading in individual securities in the accounts or
authority to (and do not) pre-approve trading decisions for the
accounts.\306\
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\306\ This list is not exhaustive and simply includes examples
of the types of barriers that could be used by securitization
participants and their affiliates and subsidiaries. We are not
endorsing any one of these methods over another mechanism that may
be used to prevent the flow of information between the relevant
entities. While it is possible that one of these methods (or another
method not listed here) may be sufficient for compliance with the
final rule, securitization participants may find that they need to
utilize a combination of methods to establish an effective
compliance program.
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[[Page 85417]]
Any such mechanisms must effectively prevent the affiliate or
subsidiary from acting in coordination with the named securitization
participant or from accessing or receiving information about the
relevant ABS or the asset pool underlying or referenced by the relevant
ABS.\307\
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\307\ A securitization participant generally should consider the
structure of its organization and the ways in which information is
shared to assess what mechanisms should be employed to comply with
Rule 192. If, for example, a securitization participant employs an
information barrier, and the barrier fails, whether the affiliate or
subsidiary is a securitization participant under Rule 192 will
depend on the facts and circumstances. On one hand, if the failure
was accidental, was quickly remedied upon discovery, and the
affiliate did not use the information to influence the assets
included in the ABS, then the affiliate would likely not be a
securitization participant under Rule 192. On the other hand, even
if the failure was accidental, but the access to information led to
the affiliate using the information to influence the assets included
in the ABS, then that affiliate would likely be a securitization
participant for purposes of Rule 192. Additionally, if the
affiliated entity did not meet the terms of the definition of
affiliate and subsidiary, as adopted, at the time that it enters
into the conflicted transaction (i.e., it did not act in
coordination with the named securitization participant and did not
have information (or access to information) about the ABS or the
asset pool prior to closing), such affiliated entity would not then
retroactively become a securitization participant upon the
subsequent receipt of such information. For example, if an affiliate
or subsidiary receives information--or has access to information--
after having previously engaged in a conflicted transaction, whether
the affiliate or subsidiary would then be a securitization
participant under the final definition depends on the facts and
circumstances as they existed leading up to and at the time of the
entry into the conflicted transaction.
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By revising the definition of ``securitization participant'' in
this way, the final rule aims to capture the range of affiliates and
subsidiaries with the opportunity and incentive to engage in conflicted
transactions without frustrating market participants' ability to meet
their obligations under other Federal- and State-level laws that
require the use of information barriers or other such firewalls. Rather
than an information barrier exception potentially becoming a ``check-
the-box'' exercise, securitization participants will be incentivized to
regularly assess their compliance programs to confirm the presence and
effectiveness of their information barriers or other firewalls to
prevent a potential violation of Rule 192. Moreover, this approach
addresses commenters' concerns with respect to additional compliance
burdens for securitization participants by not requiring that they
either create new or recalibrate existing information barriers to
satisfy a prescriptive set of conditions for Rule 192 compliance. The
final rule is designed to provide securitization participants with the
flexibility to use information barriers or other mechanisms to prevent
coordination or sharing of information with an affiliate or subsidiary,
while still achieving the objective of prohibiting securitization
participants from engaging in conflicted transactions.
If, however, an information barrier or other tool used to maintain
the separation of an affiliate or subsidiary from another named
securitization participant failed or was otherwise breached, it would
call into question whether the affiliate or subsidiary had access to,
or received, information or otherwise acted in coordination with such
named securitization participant and such affiliate or subsidiary could
therefore be a securitization participant.\308\ This approach is
consistent with Section 27B and appropriately balances market
participants' need for sufficiently clear boundaries to establish
effective compliance programs. Further, the final rule acknowledges the
role that information barriers play in the financial markets, without
the need for a prescriptive exception, which, as noted above, has the
potential to prioritize form over function in light of the wide range
of securitization participants subject to Rule 192.\309\
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\308\ See id.
\309\ This approach also significantly mitigates concerns
expressed with respect to both the scope of the rule's applicability
to affiliates and subsidiaries and compliance burdens that would be
associated with a new prescriptive information barrier requirement.
See Section IV.
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C. Prohibition Timeframe
1. Proposed Prohibition Timeframe
Section 27B specifies that securitization participants be
prohibited from entering into a conflicted transaction at ``any time
for a period ending on the date that is one year after the date of the
first closing of the sale of the asset-backed security,'' but does not
specify the commencement point of that prohibition. The Commission
proposed that the prohibition in Rule 192(a)(1) would commence on the
date on which a person has reached, or has taken substantial steps to
reach, an agreement that such person will become a securitization
participant (``proposed commencement point'') and would end one year
after the date of the first closing of the sale of the relevant
ABS.\310\ The Commission did not propose definitions of ``agreement''
\311\ or ``substantial steps,'' stating that whether a person has taken
``substantial steps to reach an agreement to become a securitization
participant'' would be a facts and circumstances determination based on
the actions of such person in furtherance of becoming a securitization
participant.\312\ The proposed approach to the c
[…truncated; see source link]Indexed from Federal Register on December 7, 2023.
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