144A Transactions: Impact of Dodd-Frank and Proposed SEC Reg AB II

August.05.2010

Issuers and financial intermediaries in securitization offerings made pursuant to Rule 144A of the U.S. Securities Act of 1933 should be aware of the implications of the Dodd-Frank Wall Street Reform and Consumer Protection Act, signed into law in the United States on July 21, 2010, as well as the proposed changes to U.S. SEC Regulation AB on their future issuances.

Historically, Rule 144A transactions have not been subject to the disclosure and reporting requirements applicable to public registered deals or to the provisions of Reg AB, which was introduced to address registration, disclosure and reporting requirements for publicly issued asset-backed securities ("ABS").

However, as a result of changing sentiment toward the risks of securitization transactions, the Dodd-Frank Act and the SEC's proposed amendments to Reg AB may increase the disclosure and reporting burden of 144A issuers and other deal participants and are likely to impose new substantive requirements on these transactions.  A summary of the relevant provisions is set out below.

Securitization Provisions in the Dodd-Frank Act

The Dodd-Frank Act imposes a variety of new requirements for securitization transactions, some of which will be applicable to Rule 144A transactions.

  • Risk Retention: The Federal banking agencies (defined as the OCC, the Fed and the FDIC) and the SEC are required to jointly propose regulations by April 17, 2011 to require "securitizers" to retain an economic interest in a portion of the credit risk of any securitized asset.  A "securitizer" is defined as (A) an issuer of an asset-backed security or (B) 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.  No distinction is made between public deals and Rule 144A offerings in the legislation related to risk retention, and it is not clear whether the Federal banking agencies will make any such distinction.
  • Representations and Warranties; Enforcement Mechanisms: The SEC has been called upon to pass regulations by January 17, 2011 relating to securitization disclosure and representations and warranties.  These regulations would likely affect Rule 144A offerings in the following ways:
    • In any report accompanying a rating on a securitization, rating agencies will be required to include a description of the representations and warranties and enforcement mechanisms available to investors as well as how those provisions differ from such provisions in similar types of securitizations.
    • A securitizer (as defined above) will be required to disclose any fulfilled and unfulfilled repurchase requests across all of its transactions in order to allow investors to "identify asset originators with clear underwriting deficiencies".

Additional detail regarding matters discussed in this section and a summary of the provisions in the Dodd-Frank Act affecting securitizations can be found here.

Credit Rating Agency Provisions in the Dodd-Frank Act

The new requirements imposed by the Dodd-Frank Act to improve the regulation of credit rating agencies will also have implications for 144A issuers.

  • Due Diligence Reports:  The issuer or underwriter of any asset-backed security will be required to make publicly available the findings and conclusions of any third party due diligence report it obtains.  While there had been some concern that this provision would be immediately applicable, the SEC has stated that it believes it has until July 21, 2011 to adopt regulations to implement these provisions.  No distinction is made between public deals and Rule 144A offerings in the legislation requiring this disclosure.  There is no indication whether the SEC will make any such distinction. 
    • Although it is not clear what sort of information is encompassed by "third party due diligence report", a review of the legislative history of the Dodd-Frank Act suggests that it is meant to refer to the type of loan-level diligence done by third party diligence contractors. 
  • Information Provided to Rating Agencies: To the extent that an issuer is a reporting company under the Securities Exchange Act of 1934, the elimination of the exemption under Regulation FD for information provided to credit rating agencies may be applicable.  Under Regulation FD, if an issuer discloses material nonpublic information about the issuer or its securities to certain enumerated entities, then the issuer must make that disclosure public.  The current rule exempts disclosures made to credit rating agencies.  The SEC has until October 19, 2010 to adopt regulations to remove that exemption.
  • Information Relating to Credit Rating: The SEC must issue regulations by July 21, 2011 to require credit rating agencies to publicly disclose information on the initial credit rating given to each obligor, security, and money market instrument, and on any subsequent rating change.  Each credit rating agency will be required to provide, among other things, the assumptions used in making the rating determination, an assessment of the quality of information available to make the rating determination, and details of any third party due diligence services used by the credit rating agency.

Additional detail regarding the matters discussed in this section and a summary of the provisions in the Dodd-Frank Act affecting credit rating agencies can be found here.

SEC Proposals for Public and Private Offerings of ABS

On April 7, 2010, the SEC unanimously approved for public comment proposed rules that, if adopted, would substantially revise Reg AB and other rules regarding the offering process, disclosure and reporting for ABS, including rules relating to enhanced disclosure standards for privately-placed ABS.  The comment period for these proposals, which the industry has been referring to collectively as "Reg AB II," ended on August 2, 2010.

  • Disclosure and Public Notice: In connection with the unregistered sale of "structured finance products" to a "qualified institutional buyer" in reliance on the safe harbor from registration under Rule 144A (or to an "accredited investor" under Regulation D), the proposed rules would require the issuer to:
    • provide to prospective investors, upon request, substantially the same information that the issuer would be required to provide in the public markets, both upon issuance and on an ongoing basis;
    • file a public notice of the initial placement of the ABS to be sold under Rule 144A; and
    • undertake to provide offering materials to the SEC upon request.
  • Scope: The SEC has defined the term "structured finance product" more broadly than the definition of "asset-backed security" under Reg AB in an effort to make the proposed rules applicable to the wide range of private securitization products previously seen in the market, such as CDOs and synthetic securities.
  • Private Placement and Resales: The proposed rules would apply to ABS offerings undertaken in reliance on the safe harbors afforded by Rule 144A and Regulation D, but would not apply to structured finance products offered and sold exclusively in reliance upon the private placement statutory exemption of Section 4(2) of the Securities Act of 1933 and the Section 4(1-1/2) exemption for private resales (in other words, without invoking the protections of the safe harbors).