Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

The SEC has proposed a rule intended to prohibit certain material conflicts of interest between those who package and sell asset-backed securities, or ABS, and those who invest in them.  According to the SEC, the proposed rule is designed to ensure that those who create and sell asset-backed securities cannot profit by betting against those same securities at the expense of those who buy them.

Proposed Rule 127B would implement the prohibition under Section 621 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, which is codified as Section 27B of the Securities Act of 1933.  The prohibition under Securities Act Section 27B applies to both registered and unregistered offerings of ABS.

The proposed rule would prohibit:

  • Securitization participants — underwriters, placement agents, initial purchasers, sponsors, or any of their affiliates or subsidiaries …
  • of an ABS — including a synthetic ABS …
  • for a designated time period — ending on the date that is one year after the date of the first closing of the sale of the ABS …
  • from engaging in certain transactions — including effecting a short sale of the securities offered in the ABS transaction or its underlying assets …
  • that would involve or result in any material conflict of interest — with respect to any investor in a transaction arising out of such activity.

A transactions involves a material conflict of interest if:

  •  a securitization participant would benefit directly or indirectly from the actual, anticipated or potential
    • adverse performance of the asset pool supporting or referenced by the relevant ABS,
    • loss of principal, monetary default or early amortization event on the ABS, or
    • decline in the market value of the relevant ABS (i.e., a “short transaction”); or 
  •      a securitization participant, who directly or indirectly controls the structure of the relevant ABS or the selection of assets underlying the ABS, would benefit directly or indirectly from fees or other forms of remuneration, or the promise of future business, fees, or other forms of remuneration, as a result of allowing a third party, directly or indirectly, to structure the relevant ABS or select assets underlying the ABS in a way that facilitates or creates an opportunity for that third party to benefit from a short transaction.

In addition to the above, there must be a “substantial likelihood” that a “reasonable” investor would consider the conflict important to his or her investment decision (including a decision to retain the security or not).

As required by the Dodd-Frank Act, the proposed rule would exempt from the conflict of interest prohibitions risk-mitigating hedging activities, liquidity commitments, and bona fide market-making.

Check frequently for updates on the Dodd-Frank Act and other important securities law matters.

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