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SEC Proposes Rule to Prohibit Conflicts of Interest in Certain Asset-Backed Securities Transactions


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Chairman Schapiro discusses the proposed rule:
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Washington, D.C., Sept. 19, 2011 — The Securities and Exchange Commission today voted unanimously to propose a rule intended to prohibit certain material conflicts of interest between those who package and sell asset-backed securities (ABS) and those who invest in them.

The proposal, which is not intended to prohibit traditional securitization practices, implements Section 621 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

The proposed rule would prohibit securitization participants of an ABS for a designated time period from engaging in certain transactions that would involve or result in any material conflict of interest. Two criteria to determine whether the transaction involves a material conflict of interest are set out in the rule proposal.

“This 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,” said SEC Chairman Mary L. Schapiro. “At the same time, the proposed rule is not intended to interfere with traditional securitization practices in which loans are originated, packaged into asset-backed securities, and offered to investors in different structures.”

The SEC has made significant progress in writing rules required by the Dodd-Frank Act. Of the nearly 100 mandatory rulemaking provisions, the SEC has now proposed or adopted rules for about three-quarters of them. Today’s proposal is just one of several rulemaking efforts aimed at addressing issues associated with asset-backed securities.

The public comment period on the proposal will last 90 days.

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Conflicts of Interest Relating to Certain Securitizations

SEC Open Meeting
Sept. 19, 2011


Asset-backed securities (ABS) are created by buying and bundling assets — such as residential mortgage loans, credit card receivables, commercial loans or student loans — and creating securities backed by those assets that are then sold to investors.

Typically, the process of creating and selling the ABS includes several persons performing different roles, including sponsoring or underwriting the offering of the ABS to investors.

As the securitization market has grown, the existence and potential effects of conflicts of interest in that process have received increased attention. The Dodd-Frank Act prohibits certain conflicts of interest related to securitizations.

EXAMPLE 1: Among other things, the proposed rule could — if certain conditions are otherwise met — prohibit a firm from packaging an ABS, selling the ABS to an investor, and subsequently shorting the ABS to potentially profit at the same time as the investor would incur losses.

EXAMPLE 2: The proposed rules also could — if certain conditions are otherwise met — prohibit a firm from allowing a third party to help assemble an ABS in a way that creates an opportunity for the third party to profit from the failure of the ABS.

The Proposed Rule

The proposed rule would prohibit:

  • Securitization participantsunderwriters, placement agents, initial purchasers, sponsors, or any of their affiliates or subsidiaries
  • of an ABSincluding a synthetic ABS ...
  • for a designated time periodending on the date that is one year after the date of the first closing of the sale of the ABS
  • from engaging in certain transactionsincluding 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.

Material Conflict of Interest:

Under the proposed rule, a transaction involves a “material conflict of interest” if it meets two criteria …

First Criteria:

As in Example 1 above, a securitization participant would benefit directly or indirectly from the actual, anticipated or potential:

  • Adverse performance of the underlying pool of assets.
  • Loss of principal, monetary default or early amortization event on the ABS.
  • Decline in the market value of the relevant ABS.


As in Example 2 above, a securitization participant, who directly or indirectly controls the structure of the ABS or the selection of assets underlying the ABS, would benefit directly or indirectly from such things as fees or the promise of future business as a result of allowing a third party, directly or indirectly, to structure the ABS or select assets underlying the ABS in a way that facilitates or creates an opportunity for that third party to benefit from a decline in the ABS or the assets underlying the ABS as described above.

Second Criteria:

There is a substantial likelihood that a reasonable investor would consider the conflict important to his or her investment decision.


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.

What’s Next

The proposed rules will be published in the Federal Register with a 90-day public comment period. The Commission will then review the comments it receives and consider those comments in determining whether to adopt the proposed rules.



Modified: 09/19/2011