Keywords: SEC, Regulation AB, asset-backed security, structured finance, financial services,
After more than three years from the original proposal and several additional requests for comment,1 on August 27, 2014, the US Securities and Exchange Commission (the "SEC") adopted final rules that amend Regulation AB ("Final Reg AB II").2 Final Reg AB II adopts new rules, forms and disclosures for registered asset-backed security transactions effective as of the compliance dates discussed below. The five most significant requirements relate to the following: (1) changes to the definition of an "asset-backed security"; (2) new eligibility conditions for shelf registration; (3) changes to the shelf offering process, including changes related to the timing of required filings; (4) asset-level data disclosure for selected asset classes and related privacy issues; and (5) other new prospectus disclosure requirements. Final Reg AB II includes many changes that will affect the marketing process, deal terms, disclosure requirements, registration process and periodic reporting requirements for registered transactions, but it does not govern asset-backed securities offered for sale pursuant to an exemption from registration (i.e., Rule 144A or Regulation S offerings).
Final Reg AB II becomes effective 60 days after publication in the Federal Register. We expect this publication to occur in September 2014. The compliance dates are bifurcated between (i) changes to the rules, forms and disclosures and (ii) implementation of asset-level disclosures. Registrants must comply with the new rules, forms and disclosures (except for asset-level disclosures) one year after effectiveness. Asset-backed securities offerings backed by residential mortgages, commercial mortgages, automotive loans, automotive leases, debt securities and resecuritizations must comply with the new asset-level disclosure requirements no later than two years after effectiveness.3
DEFINITION OF AN "ASSET-BACKED SECURITY"
Final Reg AB II sets forth amendments to the definition of an "asset-backed security" (as defined by Final Reg AB II, "ABS"). The SEC amended the definition to address its concern that pools of assets are not sufficiently developed at the time of an offering but may still qualify for ABS treatment, and as a result investors do not receive appropriate information about the asset pool. The SEC was particularly concerned with whether the asset pool was truly a discrete pool of assets that by their terms convert to cash. To address these concerns, the SEC decreased the pre-funding limit to qualify as an ABS from 50% to 25% of the offering proceeds (or in the case of master trusts, the principal balance of the total asset pool). The SEC, however, did not adopt proposals described in the Reg AB II Proposal (i) to exclude ABS backed by assets in non-revolving accounts from the master trust exception or (ii) to reduce the permissible duration of the permitted revolving period for ABS backed by non-revolving assets.
ELIGIBILITY CONDITIONS FOR SHELF REGISTRATION STATEMENTS ON FORM SF-3
The SEC recognized that ABS issuers need the timing and flexibility afforded by shelf registration in order to access the capital markets quickly. However, the SEC treated the shelf registration process as an opportunity to further its mandate under the Dodd-Frank Act to add protections for investors and reduce the industry's reliance on credit ratings. Final Reg AB II institutes a number of new registrant and transaction eligibility requirements for using Form SF-3, including:
- a certification by the chief executive officer of the depositor as to, among other things, the disclosure in the prospectus and the structure of the securitization at the time of the filing of a final prospectus for each takedown off the shelf (see Exhibit A for the full text of the certification);
- inclusion in the transaction documents of provisions with respect to (1) requiring an asset representations reviewer to review delinquent assets for compliance with representations and warranties if a delinquency test has been triggered and investors vote to direct a review, (2) establishing dispute resolution procedures for repurchase requests unresolved after 180 days and (3) facilitating communication among investors; and
- a registrant requirement regarding the timely filing of Exchange Act reports and required Form SF-3 transaction documents, including annual compliance checks.
Shelf Eligibility Requirement #1: Depositor CEO Certification.
In an attempt to ensure that executives are actively involved in the oversight of each shelf-registered securitization transaction, Final Reg AB II requires that the depositor's chief executive officer sign an officer's certification at the time of the final prospectus for each takedown from a shelf (the "certification").4 The SEC noted that each of the depositor's executive officers incurs liability under Section 11 of the Securities Act by his or her execution of the registration statement and are expecting that by requiring the certification for each takedown, the depositor's executives would conduct the same level of diligence and scrutiny on the prospectus as they do for the initial registration statement filing. However, the certification extends to matters, and creates additional liability, beyond those created under Section 11 of the Securities Act when an officer signs a registration statement.5 In response to issuers' concerns about the certification as proposed in the Reg AB II Re- Proposal, the SEC made some concessions on the certification, including adding language to reflect that (i) the certification is a statement of what is known by the certifier at the time and (ii) the securitization is structured to produce, but is not a guarantee that it will produce, expected cash flows to pay interest and principal in accordance with the transaction's terms. In addition, the SEC added a final paragraph to the certification clarifying that the certifer has rights to "any and all defenses" available under the federal securities laws, including defenses available to an executive officer who signed the registration statement. As a result, executives will likely only become comfortable signing the required certification by establishing and implementing an extensive internal review process, which may include obtaining sub-certifications from other officers and employees, holding disclosure review meetings with key members of the securitization team and analyzing cash-flow models prepared by investment banks or other third parties.6 We believe an extensive internal review process will reduce the risk of potential securities liability with respect to the certification. However, since Final Reg AB II does not govern securities issued pursuant to an exemption from registration, some issuers may opt to issue securities in the private market (under Rule 144A or Regulation S) to avoid making the certification.
Shelf Eligibility Requirement #2: Asset- Level Review Provision.
Asset Representations Reviewer.
Final Reg AB II requires that the transaction documents governing a takedown appoint an asset representations reviewer. Instead of the trustee appointing the asset representations reviewer, as was proposed in the Reg AB II Re-Proposal, Final Reg AB II allows the sponsor to select the asset representations reviewer. The asset representations reviewer must not be:
- the sponsor, depositor, servicer, trustee or any of their respective affiliates;
- the party that determines whether noncompliance constitutes a breach; or
- the party(s) hired by the sponsor or underwriter to perform pre-closing due diligence on the pool assets or its affiliates.
Triggers for Review.
The transaction documents must provide that, at a minimum, the asset representations reviewer conduct a review of the delinquent assets in the pool for compliance with representations and warranties if both: (1) delinquencies7 exceed a certain threshold and (2) the requisite number of investors vote to conduct the review. While Final Reg AB II allows the transaction parties to designate a delinquency threshold,8 the prospectus must disclose how the delinquency threshold was determined to be appropriate and provide a comparison of the delinquency threshold against the delinquencies disclosed for prior securitized pools of the sponsor for the applicable asset class. Once this delinquency threshold is met, the transaction documents will need to provide investors with a right to vote as to whether the review should occur.9 To prevent the transaction parties from nullifying investor control by agreeing to onerously high voting thresholds, Final Reg AB II requires that (i) if the documents provide for a minimum investor demand percentage in order to trigger a vote, this minimum must be no more than 5% of the total investor interests outstanding and (ii) no more than a simple majority of those voting investors will be required to start the review. The SEC felt that such investor control was important because investors will ultimately bear the financial costs related to this asset-level review.
Scope of Review.
Once both triggers have been satisfied, the asset representations reviewer must conduct a review of all assets that are 60 or more days delinquent as reported in the most recent periodic report. Final Reg AB II does not mandate the specific procedures that the asset representations reviewer must use to conduct its review. However, the asset representations reviewer must be provided with access to copies of the underlying loan-level documents to determine whether the assets complied with the representations and warranties in the transaction documents.
Disclosure of Results.
The asset representations reviewer's full report must be delivered to the trustee, but, citing privacy concerns over the disclosure of the underlying data, Final Reg AB II only requires a summary of the results to be filed with the SEC on Form 10-D.
Shelf Eligibility Requirement #3: Dispute Resolution Provision.
The Reg AB II Re- Proposal incorporated dispute resolution procedures into the asset-level review requirement described above. In order to clarify that these dispute resolution procedures apply to all requests for the repurchase of assets (not just those that arise as a result of the asset-level review and regardless of whether the investors directed the review), in Final Reg AB II the requirement that the transaction documents contain dispute resolution procedures is a separate and distinct requirement for shelf eligibility. The dispute resolution procedures must state that if a repurchase request with respect to a securitized asset has not been resolved within 180 days from when the repurchase request was received, the party submitting the repurchase request has the right to refer the matter to mediation or third-party arbitration. The party with the potential obligation to repurchase the securitized assets must agree to the selected resolution method and the arbitrator or mediator will determine which party is obligated to pay for its services.
We believe that these dispute resolution procedures will facilitate enforcement of the repurchase provisions but may also lead investors to claim that breaches of representations and warranties have occurred more frequently than in the past, and in certain cases, without cause, in order to force a repurchase by the ABS sponsor to cover credit losses on the securitized assets.
Shelf Eligibility Requirement #4: Investor Communication Provision.
Final Reg AB II adopts the requirement proposed in the Reg AB II Re-Proposal that the transaction documents require the party that is obligated to make the Form 10-D filings to include in its periodic filing any request received from an investor to communicate with other investors. The SEC stated that this disclosure will facilitate investor communications in offerings where most securities are held through The Depository Trust Company (or another clearing agency), which does not provide the name of the underlying beneficial owner. Form 10-D disclosure will be required to include:
- the name of the investor making the request;
- the date the request was received;
- a statement to the effect that the party responsible for filing received a request from such investors to communicate with other investors about the exercise of rights under the transaction documents;10 and
- a description of the method by which other investors may contact the requesting investor.
Shelf Eligibility Requirement #5: Satisfaction of Shelf Filing and Exchange Act Filing Requirements.
As detailed in the chart attached as Exhibit B, Final Reg AB II contains eligibility requirements for filing a new shelf registration statement related to (i) the timely filing of Exchange Act reports and (ii) compliance with the transaction requirements of shelf registration.11 Additionally, Final Reg AB II requires an annual evaluation with respect to the same Exchange Act filing requirements and transaction requirements for shelf registration in order to complete takedowns from an existing shelf registration. These requirements are detailed in Exhibit C. We anticipate that these timely filing requirements will be strictly enforced by the SEC staff and therefore will require issuers to be vigilant that all filings have been timely made.
TIMING AND OTHER CHANGES RELATED TO FILING REQUIREMENTS
Final Reg AB II significantly changes the timeline for filing and delivery of the preliminary prospectus in connection with shelf registered offerings by imposing the following requirements:
|At least three business days prior to first sale12||File preliminary prospectus with SEC|
|At least 48 hours prior to first sale13||File any material changes to preliminary prospectus with SEC|
|At least 48 hours prior to investor receiving confirmation of sale14||Broker or dealer must deliver preliminary prospectus to the investor (note that access does not equal delivery for a preliminary prospectus)|
|By the time that the final prospectus is required to be filed15||File transaction documents with SEC|
As noted above, for shelf-registered offerings, Final Reg AB II requires the filing of a preliminary prospectus at least three business days in advance of the first sale of the ABS.16 The current market practice for many registered securitization issuers is to issue a preliminary prospectus and price the securities on a much more compressed timeline, sometimes on the same business day. Often the sale of ABS occurs before the preliminary prospectus is filed with the SEC. Because this new requirement is intended to give investors additional time to analyze the specific structure, assets and contractual rights regarding each transaction and to encourage investors not to rely on the credit ratings of the ABS, issuers and underwriters will have to build the three additional business days into their issuance timeline.
Further, prior to enactment of Final Reg AB II, Exchange Act Rule 15c2-8(b) contained an exemption for shelf-registered ABS transactions from the general rule that a broker or dealer is required to deliver a copy of the preliminary prospectus to any person who is expected to receive a confirmation of sale at least 48 hours prior to the sending of the confirmation. Final Reg AB II removes this exemption. The SEC noted that delivery of the preliminary prospectus to an investor 48 hours prior to sale should be a relatively simple task since that same prospectus needs to be filed with the SEC three business days prior to sale as described above. So as a practical matter, the removal of this exemption will not impact deal execution. Any material change in a preliminary prospectus needs to be filed (and delivered pursuant to the above Rule 15c2-8(b)) at least 48 hours prior to the first sale.
In an effort to provide investors with even more information about the transaction, the Reg AB II Re-Proposal included a provision that would require the underlying transaction documents to be filed in substantially final form by the date the preliminary prospectus is required to be filed. Persuaded by issuers' reactions to this proposal,17 the SEC declined to adopt such a provision in the Final Reg AB II Rules. Instead, the SEC stated that its adoption of a general requirement that exhibits filed with respect to an offering registered on Form SF-3 must be on file and made part of the registration statement by the date the final prospectus is required to be filed, coupled with the other protections implemented in Final Reg AB II (i.e., advance filing of preliminary prospectus and the certification), provides investors with adequate information about the transaction.
Other Changes to ABS shelf registration.
The SEC has adopted the following additional changes to the shelf registration process:
- requiring the combination of the base prospectus and the prospectus supplement into a single unified prospectus for each takedown;18
- limiting each registration statement to a single asset class, which would eliminate so called "rent-a-shelf" filings by investment banks to be offered to clients to securitize almost any asset;19
- establishing a "pay as you go" system for filing fees for ABS shelf registrations, meaning that registration fees may be paid at the time of the filing of the preliminary prospectus for each takedown from the shelf at the rate then in effect rather than before the shelf is declared effective;20
- clarifying that no separate filing fee for collateral certificates or SUBI certificates is necessary;21 and
- providing ABS specific shelf registration forms (new Forms SF-1 and SF-3).
As a result of the implementation of the new Form SF-3 and the requirement for a unified prospectus rather than a separate base and supplement, takedowns from existing shelf registration statements on Form S-3 will not be permitted after the initial one-year compliance date.
Originally published September 9, 2014
1. The SEC originally proposed amendments to Regulation
AB in April 2010 (the "Original Reg AB II Proposal").
See SEC Release No. 33-9117, available at: http://sec.gov/rules/proposed/2010/33-9117.pdf.
Key proposed changes in the Original Reg AB II Proposal included:
(i) requiring risk retention for shelf offerings; (ii) requiring
disclosure of asset-level data, both in offering disclosure and
ongoing reports; (iii) changing the prospectus format for
asset-backed securities shelf takedowns; (iv) requiring
public-style disclosure and ongoing reporting for private offerings
of "structured finance products"; and (v) eliminating the
"de-listing" option for asset-backed securities offered
under shelf registrations. For a summary of the Original Reg AB II
Proposal, see "Summary of the US SEC's ABS Rule Change
Proposal," Mayer Brown Securitization Update, April 21, 2010,
On July 26, 2011, the SEC issued a re-proposal of the Original Reg AB II Proposal (the "Reg AB II Re- Proposal," and together with the Original Reg AB II Proposal, the "Reg AB II Proposal"). See SEC Release No. 33-9244, available at: http://www.sec.gov/rules/proposed/2011/33-9244.pdf. The Reg AB II Re-Proposal was issued to align the Original Reg AB II Proposal with the various subsequent rulemaking initiatives under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), address certain comments on the Original Reg AB II Proposal received by the SEC and seek additional comments on numerous aspects of the shelf registration rules and various other provisions. For a summary of the Reg AB II Re-Proposal, see "SEC Re-Proposes Shelf Eligibility Conditions for Asset-Backed Securities," Mayer Brown Legal Update, August 4, 2011, available at: http://www.mayerbrown.com/publications/SEC-Re-Proposes-Shelf-Eligibility-Conditions-for-Asset-Backed-Securities-08-04-2011/.
The SEC then re-opened the comment period on February 25, 2014 for certain proposed amendments to Regulation AB related to disclosure of asset-level information to investors and potential investors in ABS. See SEC Release No. 33-9552, available at: https://www.sec.gov/rules/proposed/2014/33-9552.pdf. The SEC stated that it re-opened the comment period to "permit interested persons to comment on an approach for the dissemination of potentially sensitive asset-level data."
2. See SEC Release No. 33-9638, available at: http://www.sec.gov/rules/final/2014/33-9638.pdf
3. Any offering commenced after these dates must comply with the applicable provisions of Final Reg AB II.
4. The full text of the certification is set forth in Exhibit A.
5. Section 11 imposes liability on the executives who sign the registration statement for any untrue statement of a material fact in the registration statement or the omission to state a material fact in the registration statement necessary to make the statements therein not misleading. In addition to certifying as to the facts and omissions in the prospectus, the certification must include a statement as to the characteristics of the securitized assets, the structure of the securitization and the risks of ownership of the securities as well as the expected cash flows of the transaction. The certification uses language that has been specifically tailored to asset-backed transactions and, therefore, has not yet been interpreted by courts or the SEC staff in prior decisions.
6. We note that many ABS issuers already conduct an internal review process for ABS offerings, including in connection with Rule 193 requirements. Existing procedures may need to be formalized or further documented to support the certification.
7. Final Reg AB II did not define "delinquencies" in this context. Issuers may have differing determinations of what constitutes a delinquency based on the number of days payment is past due or the percentage of payment received.
8. Final Reg AB II requires that the delinquency threshold be calculated as a percentage of the aggregate dollar amount of delinquent assets in a pool of assets compared to the aggregate dollar amount of all the assets in that pool.
9. The transaction documents must clearly define mechanics for the investor vote in the second prong of the test.
10. Disclosure is not required for any investor request to communicate for potential marketing or resale purposes.
11. These requirements are contained in General Instruction I.A. of the new Form SF-3.
12. See Securities Act Rule 424(h)(1). Pursuant to new Rule 430D, the preliminary prospectus must include all information previously omitted from the prospectus filed with the registration statement except for information with respect to the offering price, underwriting syndicate, underwriting discounts or commissions, discounts or commissions to dealers, amount of proceeds or other matters depended upon the opening price to the extent such information is unknown or not reasonably available to the issuer.
13. See Securities Act Rule 424(h)(2).
14. See Securities Act Rule 15c2-8(b).
15. See Item 1100(f) of Regulation AB.
16. The Reg AB II Re-Proposal suggested a five-day waiting period. Citing issuer's concerns that the waiting period would result in losses due to the exposure in the volatility of the market and the results of an examination of the time series changes in the price of the Bank of America Merrill Lynch U.S. Fixed Rate Asset Backed Security Index (R0A0) over the period from 2004 to 2013, the SEC concluded that a reduced period, three business days, was appropriate.
17. Issuers expressed concern that the earlier filing of transaction documents would be costly and difficult and would delay their access to markets.
18. See General Instruction IV of Form SF-3.
19. See General Instruction IV of Form SF-3. Final Reg AB II clarifies that master trusts with multiple affiliated depositors would be reviewed as a single transaction with multiple registrants.
20. See Securities Act Rule 456(c). The cover of the prospectus must state that the filing fee will be paid on a "pay-as-you-go" basis. Unused fees can be applied to future takedowns from the same registration statement or to another registration statement of the same depositor or affiliates of the depositor pursuant to Securities Act Rule 457(p).
21. See Securities Act Rule 190(d) and Rule 457(t).
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