Speech by SEC Commissioner:
The More Things Change, The More It Seems They Stay the Same: Investors Deserve Better
Commissioner Luis A. Aguilar
U.S. Securities and Exchange Commission
SEC Open Meeting
October 13, 2010
Good morning. I thank the staff for the effort that went into this recommendation but unfortunately, I cannot support this proposal.
The rule before us is designed to implement a requirement of the Dodd-Frank Act to strengthen the process by which asset-backed securities are offered.1 I fear that today’s proposal does not implement this Congressional intent. Instead, this proposal will frustrate investor protection by endorsing an “anything goes” approach for issuers reviewing assets underlying an asset-backed security because it sets no minimal standards.
Leading up to the financial crisis, underwriters and others involved in offering asset-backed securities had, and I quote Professor John Coffee’s Senate Testimony, “decreased their investment in due diligence, making only a cursory effort by 2006.”2 Because market participants approached due diligence as just a formality, there was a significant erosion in market discipline by those involved.3 As just one example, it has been reported that by 2005, outside due diligence firms hired by securitizers to conduct asset reviews were only evaluating 5 percent of the loans in the underlying mortgage pools. 4
In the Dodd-Frank Act, Congress sought to correct this by “direct[ing] the SEC to issue rules that require any issuer of an asset-backed security to perform a due diligence analysis of the assets underlying the asset-backed security; and to disclose the nature of this analysis.”5 Congress quoted Professor Coffee’s testimony and explained that the Dodd-Frank Act sought to ‘‘re-introduce due diligence into the securities offering process.’’6
Accordingly, when Congress directed the SEC to issue a rule requiring asset-backed issuers to perform a review of the assets, it is clear that Congress intended for that review to be akin to due diligence.7 Otherwise, a review without a minimum standard could be the same as the cursory review Congress was attempting to prevent. It is common sense that a “reasonable” review must be conducted to provide grounds to believe that the statements made to investors are true.
Sadly, that is not what today’s proposal does. Instead of specifying that a real due diligence review be performed, the Commission’s proposal simply says an issuer must perform a review. It sets out no standards or expectations on the nature of the review. I fought to propose a rule that would make it clear that the review must be designed and executed in a way that provides reasonable assurance that the information provided to investors is accurate. This is exactly what Congress mandated we do given the recognized egregious conduct in the industry. The Commission should be proposing rules that stay true to our mandate and actually address the conduct that has been identified as contributing to the financial crisis and harming investors.
Although proposals do change before adoption and today’s proposal does contain questions as to whether a minimum level of review should be required, I also know that the requirement to propose a minimum standard was specifically and consciously dismissed. I further recognize that the release also notes that because the federal securities laws currently prohibit material misstatements in a prospectus8, we should expect that issuers are currently performing “some level” of review in order to believe that the prospectus is accurate. However, a belief that issuers are performing “some level” of review is no substitute for requiring all issuers to meet the same basic standard.
Accordingly it appears to me that this rule is essentially an endorsement of the “anything goes” approach of the past. I hope that the public and members of Congress will send the SEC comment letters urging it to adopt a real standard of review.
The Dodd-Frank Act also requires that the issuer “disclose the nature of the review” but this additional requirement is not a substitute for the issuer to conduct a review. Disclosure is not a substitute for meaningful standards. Investors will not be in the same position as an issuer to appreciate and understand whether a particular description of the nature of the review describes a reasonable review or an ineffective review. Only the issuer is in the position to know — and because today’s proposal does not require even the most basic level of review — no one could be certain whether the issuer took this responsibility seriously. Shifting the burden from the issuer to investors cannot be what Congress had in mind. It’s certainly not what the American people and investors deserve.
This proposal reflects a failure of the SEC to learn from its own mistakes in the recent past leading up to the financial crisis. As Professor Coffee observed in his testimony, and I quote: “the SEC raced to deregulate. In 2005, it adopted Regulation AB … which simplified the registration of asset-backed securitizations without requiring significant due diligence or responsible verification of the essential facts.”9
It is astonishing to me that the Commission could propose a rule that allows the same conduct that led up to the financial crisis, in direct conflict with what Congress expects us to do.
In good conscience, I cannot support this proposal.
1 Dodd-Frank Wall Street Reform and Consumer Protection Act § 945, “Due Diligence Analysis and Disclosure In Asset-Backed Securities Issues” provides, in part, “Not later than 180 days after the date of enactment of this subsection, the Commission shall issue rules relating to the registration statement required to be filed by any issuer of an asset-backed security (as that term is defined in section 3(a)(77) of the Securities Exchange Act of 1934) that require any issuer of an asset-backed security—
“(1) to perform a review of the assets underlying the asset-backed security; and
“(2) to disclose the nature of the review under paragraph (1)”.”
2 Enhancing Investor Protection and the Regulation of Securities Markets—Part I: Testimony before the U.S. Senate Committee on Banking, Housing, and Urban Affairs, 111th Congress, 1st session, p.55 (2009) (Testimony of Professor John Coffee).
3 Id. at p.55-6.
4 See Vikas Bajaj & Jenny Anderson, “Inquiry Focuses on Withholding of Data on Loans,” New York Times, January 12, 2008 at A-1. See also E. Scott Reckard, “Subprime mortgage watchdogs kept on leash; loan checkers say their warnings of risk were met with indifference,” Los Angeles Times, March 17, 2008 at C-1 (“Early in the decade, a securities firm might have asked [an outside due diligence firm] to review 25% to 40% of the sub-prime loans in a pool, compared with typically 10% in 2006...By contrast, loan buyers who kept the mortgages as an investment instead of packaging them into securities would have 50% to 100% of the loans examined.”
5 Report of the Senate Committee on Banking, Housing, and Urban Affairs regarding The Restoring American Financial Stability Act of 2010, S. Rep. No. 111-176 at 133 (2010). “Section 945. Due diligence analysis and disclosure in asset-backed securities issues. Section 945 directs the SEC to issue rules that require any issuer of an asset-backed security to perform a due diligence analysis of the assets underlying the asset-backed security; and to disclose the nature of this analysis. Professor John Coffee, in congressional testimony, called for action to ‘reintroduce due diligence into the securities offering process.’”
7 Testimony of Professor John Coffee, supra note 2, at 57. As Professor Coffee’s testimony explains, due diligence is an affirmative defense against a material misrepresentation or omission under which any defendant (other than the issuer) will not be held liable if the person: “had, after a reasonable investigation, reasonable ground to believe and did believe … that the statements … were true and that there was [no] omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading” (emphasis in Professor Coffee’s testimony.)
8 See Securities Act Sections 11 & 12 [15 U.S.C. 77k & 77l]. See also Securities Act Section 17 [15 U.S.C. 77q], Exchange Act Section 10(b) [15 U.S.C. 78j] and Rule 10b-5 under the Exchange Act [17 CFR 240.10b-5].
9 Testimony of Professor John Coffee, supra note 2, at 3 (emphasis added).