Securities Update

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Securities Update

Originally Published May 21, 2004

On May 3, 2004, the Securities and Exchange Commission proposed a massive set of rules for asset-backed securities ("ABS") under the Securities Act of 1933 and the Securities Exchange Act of 1934. The proposed rules aim to regulate ABS in four areas: (1) Securities Act registration, (2) disclosure under new Regulation AB, (3) communications during the offering process and (4) ongoing reporting requirements under the Exchange Act.

The SEC recognizes that asset-backed securities and issuers of asset-backed securities differ from corporate securities and operating companies. Many of the existing disclosure requirements and reporting obligations, primarily for corporate issuers, do not elicit relevant information for ABS transactions and investors in these transactions. Through no-action letters and the filing review process, the SEC staff has attempted over the past 20 years to address issues particular to asset-backed securities. The proposed rules codify and consolidate many existing staff practices relating to asset-backed securities and also add extensive additional requirements. See Release 33-8419; 34-49644.

This Securities Update highlights some of the significant changes that may result if the proposed rules are adopted and provides our initial views as to practical considerations for their application.

SECURITIES ACT REGISTRATION

Definition of Asset-Backed Security

The proposed rules will apply to any security that falls within the definition of "asset-backed security." The basic definition of an asset-backed security has been moved out of Form S-3 and is now contained in proposed Item 1101 of Regulation AB:

"a security that is primarily serviced by the cash flows of a discrete pool of receivables or other financial assets, either fixed or revolving, that by their terms convert into cash within a finite time period, plus any rights or other assets designed to assure the servicing or timely distribution of proceeds to securityholders; provided that in the case of financial assets that are leases, those assets may convert to cash partially by the cash proceeds from the disposition of the physical property underlying such leases."

The proviso relating to leases is new and favorable to issuers, but brings with it additional disclosure requirements discussed below.

In addition to the basic definition, Item 1101 codifies the following additional requirements to be considered an asset-backed security:

Neither the depositor nor the issuing entity is an investment company or will become one as a result of the ABS transaction; and

The activities of the issuing entity must be limited to passively owning or holding the pool of assets, issuing the asset-backed securities supported or serviced by those assets and other activities reasonably incidental to these activities.

The SEC states that it intends to exclude synthetic securitizations from the proposed definition because the issuing entity does not actually own the underlying asset. Payments on securities in synthetic securitizations are based on the performance of assets or indices not included in the asset pool.

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