United States: Proposed Amendment To ERISA Underwriter Exemptions For Mortgage-Backed And Asset-Backed Securitizations (The “Underwriter Exemptions”)

On August 23, 2000, the U.S. Department of Labor ("DOL") published a proposed amendment to the ERISA Underwriter Exemptions in the Federal Register (65 Fed. Reg. 51454). These proposed changes come as a result of efforts by The Bond Market Association ("TBMA"), similar to the TBMA effort that resulted in Prohibited Transaction Exemption ("PTE") 97-34.¹ With the few exceptions described below, the effective date for the amendment generally will be August 23, 2000. Note, however, that any effective date is contingent on the publication of a final notice in the Federal Register. The proposal provides for a comment period until October 10, 2000; however, it is not possible to predict with certainty how soon after the close of the comment period the DOL will publish the final notice, or whether comments received by the DOL will result in any changes to the amendment as proposed.

The amendment provides two kinds of relief. In the case of "designated transactions" in which certain specified types of assets underlie the securities, subordinated securities rated investment-grade (at least as high as the "BBB" category) will be permitted to be sold under the Underwriter Exemptions (provided that all the other requirements for application of the exemptions are met).² The designated transactions are those involving (i) commercial mortgage-backed securities, (ii) residential mortgages and various types of home equity loans, (iii) manufactured housing contracts, and (iv) motor vehicle sales contracts.

With respect to residential and home equity loans, the proposed amendment will permit inclusion of assets with LTVs in excess of 100%. However, securities backed by such collateral (a) must be senior (i.e., non-subordinated) securities and (b) must be rated in the two highest ratings categories by a rating agency.

In addition to the relief described above for designated transactions, the DOL has proposed additional relief applicable to all covered transactions:

1. Debt securities which otherwise meet the requirements of the Underwriter Exemptions will be eligible for coverage. This will allow plans to purchase covered debt securities without reliance on the five Investor-Based Exemptions.³ Further, in the case of debt (but not equity) securities, the issuer may be a partnership, owner trust, SPC or LLC, not just the REMICs, FASITs and grantor trusts currently permitted under the Underwriter Exemptions.
2. The same relief with respect to interest rate swaps recently granted by the DOL in individual exemptions for credit card-backed securitizations⁴ (at our request, in part) will be extended to fixed-pool transactions which otherwise meet the requirements of the Underwriter Exemptions. If the transaction contains a swap contract, and if the swap counterparty defaults and the trustee cannot obtain an appropriate replacement counterparty, the Underwriter Exemptions will cease to apply. However, the proposal provides for a six-month period after notification of the default for holders to dispose of the securities.
3. In keeping with paragraph (b), the inclusion under the current Underwriter Exemptions of yield supplement agreements as permitted assets will be expanded to cover yield supplement agreements that feature notional principal contracts and clarify that such agreements may use the ISDA contract form. Relief under this provision (under the provision referred to in paragraph (b) above) is proposed to be retroactive to April 7, 1998.
4. A six-month grace period is provided for correction of a situation (i.e., resolution by replacement of the trustee or the no-longer-independent member of the restricted group) where a corporate acquisition causes the trustee of a transaction closing on or after January 1, 1998 to no longer be independent of the "restricted group"⁵ under the Underwriter Exemptions. In the case of mergers creating this problem which occurred after January 1, 1998 but before the effective date, the proposed amendment provides for a six-month period in which to correct the problem; i.e., February 23, 2001.
5. Reflecting DOL Advisory Opinion 99-05A, the Underwriter Exemptions will be amended to reflect that Farmer Mac bonds will be considered government guaranteed mortgage certificates and therefore permitted assets.

Finally, the proposed amendment discusses defeasance of a commercial mortgage loan by substitution of government securities for existing collateral. The amendment describes two forms a defeasance transaction may take. In the first, a new borrower (an SPE) assumes the original note, which remains outstanding (albeit with the underlying collateral changing from real estate to government securities). The second form of defeasance is used to defease commercial mortgage loans while preserving the benefit of a mortgage tax paid in respect of the existing debt. In this structure, a new note collateralized by government securities is created and assigned to the securitization vehicle in exchange for the original note backed by the real property. The proposed amendment provides that this second type of defeasance will be covered by the Underwriter Exemptions retroactive to January 1, 1999. While the proposed amendment does not specifically discuss the application of the Underwriter Exemptions to the first type of defeasance, the understanding is that the continuing existence of the original note means that the fundamental "fixed pool" requirement of the current Underwriter Exemptions is not violated. Consequently, no additional relief is necessary to cover the first type of defeasance.

1PTE 97-34, 62 Fed. Reg. 39021 (July 21, 1997), expanded the Underwriter Exemptions by, inter alia, providing for prefunding accounts that meet specified criteria and extending the Underwriter Exemptions to cover senior interests in static FASITs (i.e., FASITs that do not permit substitution of collateral).

2The Underwriter Exemptions currently provide that the following six conditions must be satisfied: (1) the acquisition of certificates by a plan must be on terms that are at least as favorable to the plan as they would be in an arm’s-length transaction with an unrelated party; (2) the rights and interests evidenced by the certificates must not be subordinated to the rights and interests evidenced by other certificates of the same trust; (3) the certificates at the time of acquisition by the plan must be rated in one of the three highest generic rating categories by Standard & Poor’s, Moody’s or Fitch; (4) the trustee cannot be an affiliate of any member of the "restricted group" (i.e., each underwriter, each insurer, the sponsor, the trustee, each servicer, on obligor with respect to obligations or receivables in the trust constituting more than 5% of the initial principal balance of the trust, or any affiliate of any of these); (5) the sum of all payments made to and retained by the underwriter must represent not more than reasonable compensation for underwriting the certificates; the sum of all payments made to and retained by the pool sponsor pursuant to the assignment of the obligations or receivables to the trust must represent not more than the fair market value of such obligations or receivables; and the sum of all payments made to and retained by the servicer must represent not more than reasonable compensation for such person’s services under the pooling and servicing agreement and reimbursement of such person’s reasonable expenses in connection therewith; and (6) the investing plan either must represent (in the context of a private placement) that it is, or must be put on notice (in the prospectus in the context of a public offering) that it must be, an "accredited investor" as defined in Rule 501(a)(1) of Regulation D of the Securities and Exchange Commission under the Securities Act.

3The Investor-Based Exemptions include PTE 84-14 (the QPAM exemption), PTE 96-23 (the INHAM exemption), PTE 91-38 (the bank collective fund exemption), PTE 90-1 (the insurance company separate account exemption) and PTE 95-60 (the insurance company general account exemption).

4 Under the terms of the credit card-backed securitization exemptions, classes of certificates to which a swap agreement applies can only be acquired and held by "qualified plan investors," i.e., plan investors on whose behalf the purchase decision is made by an independent fiduciary that is (a) a QPAM, (b) an INHAM or (c) a plan fiduciary with total assets under management of at least $100 million at the time such certificates are acquired.

5The "restricted group" is defined in note 2.