SEC Adopts Final Rules for Asset-Backed Securities - Part 1

In a release published in the Federal Register on January 7, 2005 ("Adopting Release"), the U.S. Securities and Exchange Commission ("SEC") adopted new and amended rules and forms ("Rules") to address comprehensively the registration, disclosure, and reporting requirements for publicly offered asset-backed securities ("ABS") under the U.S. Securities Act of 1933 ("Securities Act") and the U.S. Securities Exchange Act of 1934 ("Exchange Act").1 The Rules codify much of the existing SEC interpretations and staff "no action" letters applicable to securitizations and were generally adopted along the lines of the SEC's proposed rules and forms (the "Proposal"),2 although some significant modifications were made in response to the numerous comments submitted in respect of the Proposal.3

Although the Rules technically apply only to public offerings of ABS in the United States (including foreign ABS publicly offered in the United States), the market will nonetheless need to consider how the new regime may affect private ABS offerings made in reliance on Rule 144A. In particular, participants in 144A offerings of ABS will need to determine their exposure to 10b-5 liability (general antifraud) to the extent that disclosures in the offering document fall short of the Rules now applicable to public offerings of ABS.

The Rules reflect the SEC staff's recognition since the 1980s of the differences between ABS and corporate securities issued by operating companies. Accordingly, through a series of rules, staff statements, and staff "no action" letters, the SEC's registration, disclosure, and reporting requirements for securities issued by operating companies have been substantially modified for ABS offerings to focus on items such as transaction structure, quality of the asset pool, servicing, and cash flow distribution. The Rules comprise the SEC's comprehensive codification and reconciliation of these modifications.

Securities Act Registration

Current Requirements. Since 1992, registration for delayed or periodic offerings of investment-grade ABS has been permitted on Form S-3 (which, in the case of ABS, allows incorporation by reference of subsequent information contained in Exchange Act reports), so that public offerings of ABS may be effected via "takedowns off the shelf" from time to time.4 Prospectus requirements are effected by means of a base prospectus (plus a form of prospectus supplement) included as part of the registration statement, with a prospectus supplement delivered with each distribution of ABS. The Rules codify this approach, with certain modifications as described below.

Definition of Asset-Backed Security. The Rules retain the existing definition (contained in the instructions to Form S-3) of "asset-backed security," with an expansion to cover securitizations of leases (even if the residual value of the leased property must be realized to fully repay the ABS).5 The Rules also make the definition of ABS applicable irrespective of the form used for registration (i.e., applicable for both Form S-3 and Form S-1). This definition is further premised on the conditions that (i) neither the depositor nor the issuing entity is an investment company under the U.S. Investment Company Act of 1940 and (ii) the activities of the issuing entity must be restricted to passively holding the pool of assets, issuing the ABS and activities reasonably incidental thereto.

The Rules do not, however, extend the definition of ABS to cover synthetic securitizations (i.e., where exposure to an asset pool is accomplished through a credit derivative), securitizations of delinquent assets6 (although securitizations with delinquencies up to 50 percent of the asset pool would still qualify for the definition and delinquencies up to 20 percent would still qualify for shelf registration) or securitizations of nonperforming assets.7

For lease-backed securitizations, the Rules impose limits on the percentage of the securitized pool balance attributable to residual values in order to be considered an ABS: residual values may not constitute, for motor vehicle leases 65 percent or more, and for non-motor vehicle leases 50 percent or more, of the original asset pool measured by dollar volume at the time of ABS issuance. For Form S-3 eligibility, residual values may not constitute 20 percent or more of the asset pool by dollar volume at the time of ABS issuance.

The following exceptions are made under the Rules in respect of the "discrete" pool requirement: Master trusts (where multiple issuances of ABS are backed by the same pool of assets) meet the definition of ABS without any predetermined limits, but "series trusts" (where one entity issues multiple series of ABS each backed by a different pool of assets) do not qualify as ABS. Prefunding periods are permitted for up to one year from date of ABS issuance, with permitted prefunding amounts of up to 50 percent of issuance proceeds (or in the case of master trusts, up to 50 percent of the aggregate principal balance of the asset pool that supports the ABS), irrespective of the form used for registration. In respect of revolving periods, for receivables that by their nature revolve (e.g., credit cards), there would be no limits on the revolving period duration or amount of additional assets. For fixed asset receivables (e.g., residential mortgages, auto loans, leases), the revolving period may be up to three years, so long as new pool assets added are of the same general character as the original pool assets.

Securities Act Registration Statements. Under the Rules, ABS may only be registered under the Securities Act using: (i) Form S-3, for ABS that meet the S-3 eligibility criteria (i.e., ABS are investment grade, delinquent assets are less than 20 percent of pool, residual values for non-motor vehicle lease-backed transactions are less than 20 percent of pool balance), thus qualifying for shelf registration and delayed or periodic offerings; or (ii) Form S-1, for securities falling within the definition of ABS but not eligible for Form S-3. Form S-11 will no longer be used.

In the Adopting Release, the SEC adopted new instructions for both Form S-3 and Form S-1 specifically applicable to ABS offerings. Reflecting the SEC's recognition of the different nature of ABS from corporate securities issued by operating companies, and therefore the types of information that are meaningful to ABS investors, these instructions require compliance with provisions of new Regulation AB (see below), which modifies the standard disclosure requirements to dispense with certain types of corporate and operational information (notably, audited financial statements for the issuer and management's discussion and analysis of operations and financial condition) and to include information concerning the transaction structure, asset pool, servicing, and cash flow distributions.

For Form S-3, a base prospectus and form of prospectus supplement will be required. Takedowns off the shelf registration must be described within the parameters of the asset type, structural features, enhancements, and other features described in the base prospectus. A separate base prospectus and form of prospectus supplement must be prepared for each asset type or jurisdiction.8

The Rules continue existing industry practice by specifying that the depositor (often the sponsor or an affiliated intermediary that receives the pool assets and transfers them to the issuing entity) is the statutory "issuer" for purposes of signing the registration statement. As such, each of the depositor's principal executive officer, principal financial officer, controller, or principal accounting officer and a majority of its directors is required to sign the registration statement for the ABS offering. The same depositor will be considered a different statutory "issuer" in respect of each issuing entity and also in respect of its own securities.

Foreign ABS. The Rules do not establish a different registration regime for ABS issued by foreign entities that are publicly offered in the United States; such foreign ABS are required to be registered on Form S-3 or Form S-1 and are subject to the same disclosure requirements in Regulation AB. In addition, if ABS are issued by a foreign issuer, are backed by foreign assets, or are affected by credit enhancement or other support provided by a foreign entity, then additional information must be disclosed.9 Foreign ABS may also be subject to special SEC procedures, such as pre-filing conferences and full review by SEC staff on Form S-1 for first-time foreign issuers.

Exclusion from Exchange Act Rule 15c2-8(b) for Form S-3 ABS.

Recognizing the typically short time frame between finalization of the terms of an ABS transaction and closing, the Rules codify a long-standing SEC exclusion from Exchange Act Rule 15c2-8(b) for Form S-3 ABS to the effect that broker-dealers are not 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 such confirmation.

However, in the Adopting Release, the SEC indicated that this issue may be revisited depending on its evaluation of comments in respect of the SEC's proposed rules on securities offering reform published on November 17, 2004 ("Offering Process Release").10 In the Offering Process Release, the SEC raised the "unassailable proposition" that materially accurate and complete information regarding...

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