Speech by SEC Staff:
Remarks at the Annual Meeting of the American Securitization Forum
Alan L. Beller
Director, Division of Corporation Finance
U.S. Securities and Exchange Commission
New York, New York
June 8, 2004
Thank you, Vernon, for that kind introduction. I am very pleased to have been invited to the American Securitization Forum's annual meeting and to be able to speak with you this morning.
I note that Vernon in his introduction did not refer to any particular expertise in the area of asset-backed securities on my part. Indeed, I am sure that many who have addressed this group in the past, and indeed most who will be speaking to you today, have more technical or in-depth knowledge in the area. However, the involvement that my Division and others at the Commission now have in the asset-backed market has required that we both develop expertise and reach out to market participants, including many in this room, to augment what we know with real market familiarity and experience. And it is very much in that spirit that I am before you today, to share with you some thoughts about the direction and development of securitization and where I see the Commission's role in that process.
This would be a good time for me to insert the standard Commission disclaimer as a matter of policy the Commission disclaims responsibility for the remarks of Commissioners and staff, and therefore my remarks today represent my own views and not necessarily those of the Commission or any other member of its staff.
The first thing I know about the asset-backed securities market is its importance to the nation's, and indeed the world's, capital markets and economy. I also understand the importance of securitization to the efficient operation of the processes of risk management and transference.
Not only is the asset-backed securities market large, but also it has grown extraordinarily rapidly in a relatively short time. In January 2003 the joint staff study of the mortgage-backed securities market by the Department of the Treasury, the Office of Federal Housing Enterprise Oversight, and the Commission stated that the mortgage-backed market, including Government-Sponsored Enterprises, grew nearly tenfold from 1981 to 2001, from $367 billion outstanding to more than $3.3 trillion. In 2003 the total amount of all private label (that is, non-GSE) registered securities issued was estimated at $800 billion and at the end of 2003 the total of those securities outstanding was estimated as approaching two trillion dollars. These are enormous numbers and dwarf other segments of the capital markets that have received much more attention over the years.
In the face of the importance of this market and its size, the Commission has the task of applying the federal securities laws and its regulations to securitization transactions and the ABS markets in ways that fulfill its primary responsibility of investor protection and that promote honest and efficient markets. In my view securitization and issues raised by securitization will be with us, and increasingly so, in the future. The Commission and the staff have developed a recognition of this fact that I hope will allow us to anticipate, or at least react to, continuing developments. We can all be nearly certain that those developments will include continued broadening of asset classes, increased sophistication of structures and continuing pressure on the applicability of the regulatory framework that we are trying to codify. There will also be continuing examination and change in the regulatory and accounting environment applicable to originators and sponsors. And certainly evolution (or, if the recent past is a guide, even revolution) of information technology and communications will continue, will drive changes in offering processes and structures, will increase the amount and sophistication of information that is available to the markets and will increase pressures to change the permitted manner of delivery of that information.
I thought it would be worthwhile for me to address briefly my view of what the Commission's general thinking might be at the moment on some of these issues.
The Proposed Rules Regarding Asset-Backed Securities
Our highest profile current project in the area is of course the Commission's rules proposal relating to registration, disclosure and periodic reporting for asset-backed securities. Paula Dubberly, Associate Director (Legal) of the Division of Corporation Finance, will be spending the next hour discussing the proposal. I just want to make a couple of general points.
My key point to you is that we are looking for the most thoughtful and detailed comment that we can get from people in this room and other market participants like you. Together, you know all aspects of this market better than anyone. We have now all seen the initial reports of the Commission's proposal, and we have also seen what I would call the "instant analysis." It's been very much like the pundits and others instantly reacting to a speech or press conference. And those instant analyses are helpful in spreading the word rapidly and in focusing interested parties, including us, on at least some of the most important matters at hand.
What I want to try to ensure is that the instant analyses do not become the accepted wisdom and do not limit either the breadth or depth of the matters that you and other market participants address in the comment process. As I said before, we are looking for detailed comments that delve into the proposal and its consequences. Comment that focuses on conclusions "It's too expensive," or "Delivery of this information is impracticable," may tell us where the commenter stands, but comment that explains why a requirement is expensive or how it could be made less expensive or how information could practicably be delivered is more helpful to us in crafting the best rule. At its most basic, rule-making is not a negotiation process. The Commission is responsible for making rules based on its best judgments and on the input it receives through the comment process. So keep those cards and letters coming, but in doing so think about how they could be most helpful to the rule-making process and to us.
I have a couple of other observations on what we've heard so far on the ABS proposal. First, I cannot help but observe one irony of this project that is already apparent. When we first began indicating that we were looking to suggest rule-making to the Commission in this area, about a year ago now, the reaction from all types of market participants was positive, evincing a strong desire for the consistency, transparency and certainty that rules would bring to the ABS area. Now that the release is out and people have read it, some thoroughly and some quickly, the enthusiasm may have waned in some quarters, among issuers, underwriters and especially the lawyers. "Good grief," they say. "These are rules. They're regulatory."
I would submit that at least part of the reaction is to the mere fact that, yes, what the Commission has proposed are rules. Rules have content, more content than the informal guidance that has existed heretofore. What we want from the industry and market participants is for you to get past that first reaction. We would like to receive detailed comment about where you believe the Commission has gone beyond what it set out to do, as indicated in the proposing release, which was in significant part to codify current practice and to enhance disclosure and reporting in some identified areas. And in considering your comments please remember that the proposed rules are intended to operate in a principles-based way across all asset classes and structures, present and future, and are therefore intended to call for information, to the extent material, for a particular asset class or transaction. We thought that was a better approach than a detailed disclosure template for each current asset class and transaction structure, and we hope you agree.
Second, in crafting the ABS proposal we have really tried to consider what information is important to investors and to consult with investors and other groups about that issue. We at the Commission, and especially in the Division of Corporation Finance and the Office of the Chief Accountant, the two groups most responsible for the ABS proposal, are constantly bombarded with commentary and criticism that the disclosure under our rules for corporate issuers requires too much unnecessary information and omits some of the most relevant information for investors.
Over the years we have tried to be responsive in at least some contexts. As an historical example, for decades the Commission prohibited forward-looking information; since the 1970s we have permitted and indeed encouraged it, tried to give it some safe harbor protection as part of our encouragement and in some circumstances in Management's Discussion and Analysis, or MD&A, required it. More recently, there has been a fair amount of commentary to the effect that the GAAP financial disclosure relied on by the Commission omits some of the key financial and other performance indicators that members of management rely on to run their businesses and that investors would find material. We are not about to back away from the central importance of GAAP financial statements for corporate issuers. However, in its December 2003 interpretive release regarding MD&A, the Commission explicitly called for better disclosure and analysis in MD&A of key performance indicators, both financial and non-financial.
In crafting the approach to disclosure in the ABS area I think we have actually been bolder in focusing on what information is most important to investors. For example, the ABS rules proposal is consistent with the current staff guidance in that it does not require financial statements for ABS issuers. The proposing release does ask a lot of questions about this subject and whether the Commission should change the current practice, but for now there is no financial statement requirement. In the same spirit of seeking to call for information in our disclosure documents that is most important, we have focused on an issue static pool information that many investors have identified, and the proposal includes a requirement for that information to the extent material for a given transaction.
The Commission will be very interested in seeing the comments on this aspect of the proposal. And as I note above, depth of analysis and detail in the comments will be much more helpful than mere conclusions, such as "Unavailable, too hard to deliver, too much liability, too expensive." We all know it is in many if not most cases available, because it often appears on websites or is provided to rating agencies. The release makes clear it can be delivered electronically and incorporated by reference in prospectuses and registration statements. There seems to be enough comfort from a liability perspective to provide it on a limited basis why not as part of the offering process? (And yes I do understand the particular concerns regarding underwriters' liability under Section 11.) Expense is also a concern I understand, and one that has to be weighed against the benefits to investors and markets. That is one of the essential aspects of the rule-making process and one where the comment process can be very helpful
What I am really hoping is that the comments from all market participants, be they negative or positive, will address the details of static pool information, the materiality of given categories of that information for given transactions and the concerns that may exist. Again, it is important to understand the principles-based nature of the proposal. We started from the premise that static pool information can be useful. What the proposal would seek is static pool information classified in the ways that would be material in the context of a particular transaction, and not large amounts of information or large numbers of tables that would not be material for that transaction. How within a principles-based approach can we best call for material information and appropriately balance costs and benefits?
Information Delivery and Securities Act Reform
One of the features of the ABS market is the detailed amount of information regarding transaction structure and scenario analyses that investors seek and issuers and underwriters and dealers provide. That information has taxed the regulatory framework requiring that written information be included as part of the registration statement and prospectus. The current ABS rules proposal seeks to codify and simplify earlier no-action positions regarding delivery of that information and subsequent filing of some of that information that thereby becomes part of the registration statement and prospectus. I believe that the ABS project will continue on the course of working with the existing framework, which already facilitates written communications in ways not available outside the ABS area.
There is, however, thought of revisiting broader issues of reform under the Securities Act of 1933. To the extent such an effort proceeds, one of the subjects that is likely to be addressed is liberalization of the restrictions on written communications during marketing periods. In particular, any such effort should seek to address the question of whether there should be "free-writing" outside of the framework of the prospectus. Corollary questions would include whether and to what extent free-writing materials should be filed with the Commission and what liability framework should apply to free-writing materials. It is far too early to give anything like definitive answers to these questions, and they will ultimately of course be decided by the Commission. But any developments in this area could have a significant impact on offerings and communications in the ABS area.
The GSEs and the Securities Laws
The issue of registration under the federal securities laws for the housing related GSEs Fannie Mae, Freddie Mac and the Federal Home Loan Banks continues to be of interest.
These GSEs issue marketable debt to the public. In addition Fannie Mae and Freddie Mac have publicly held common stock and also issue guaranteed mortgage-backed securities to the public. All of these entities and their securities are exempt from the registration and disclosure provisions of the federal securities laws. None of the debt securities issued by any of these GSEs is backed by the full faith and credit of the United States.
Since at least 1992, in a Joint Report with the Department of the Treasury and the Board of Governors of the Federal Reserve System, the Commission has expressed the view that, because the GSEs, most prominently Fannie Mae and Freddie Mac, but also including the Federal Home Loan Banks, sell securities to the public and have public investors, and do not have the "full faith and credit" government backing of government securities, their corporate disclosures should comply with the requirements of the federal securities laws. Importantly, because of the guarantees provided by Fannie Mae and Freddie Mac on their mortgage-backed securities, this corporate disclosure is extremely material even in the context of these mortgaged-backed securities.
This objective can be achieved in a number of ways, including through legislation requiring registration under the Securities Exchange Act of 1934 or through voluntary registration with the Commission under the Exchange Act. What is important is mandatory compliance with our Exchange Act disclosure requirements.
On July 12, 2002, Fannie Mae and Freddie Mac announced that each would voluntarily register its common stock under the Exchange Act and thus become subject to Commission reporting requirements. Fannie Mae's registration statement under the Exchange Act was declared effective on March 31, 2003. Freddie Mac has stated it intends to complete the Exchange Act registration process when it completes its restatement and audit.
For well over a year the Division of Corporation Finance, with the participation of the Commission's Office of the Chief Accountant, has been in discussions initiated by the Federal Home Finance Board and many of the Federal Home Loan Banks regarding registration by the Banks under the Exchange Act. We have not initiated any process to seek voluntary registration by the Federal Home Loan Banks of their securities, but we do believe that registration under the Commission's rules will provide the desired result. If registration by the Banks is pursued, we are committed to achieving that result with maximum protection for investors and maximum efficiency for all registrants consistent with our mission to protect investors.
For companies registered under the Exchange Act and under the Commission's rules, required disclosure includes financial statements, management's discussion and analysis, description of business, information regarding directors and management and compensation and information regarding related party transactions. Exchange Act registration and resulting required disclosure of this corporate information are the matters on which the Commission and staff have focused in urging disclosure by GSEs. Registration under the Exchange Act also subjects reporting companies to the provisions of the Sarbanes-Oxley Act applicable to issuers. These provisions include CEO and CFO certification requirements, internal control requirements, prohibition on loans to insiders, restrictions on the use of non-GAAP financial measures and enhanced disclosure requirements, for example regarding off-balance sheet transactions.
Sponsors and Originators of Securitization Transactions
While most of the headline attention has been devoted to our ABS proposal, there are a number of very important continuing issues regarding securitization under our disclosure rules and GAAP accounting for corporate issuers that are sponsors or originators.
For many financial institutions and for many other companies that use securitization transactions to impact their balance sheets or capital requirements, and/or use these transactions to manage or transfer risk, securitization both can have an important effect on their financial condition and results of operations and can be a critical part of their business plans and their calculus of opportunity and risk.
It is important that these aspects of securitization be transparent to investors in these companies. The place to start is of course the financial statements, including the notes. Sound robust financial statements are the starting point. FASB Interpretation 46, and where applicable Interpretation 45, are important recent enhancements to this reporting.
However, because of the very nature of securitization transactions and their consequences, disclosure outside the financial statements is critical to an understanding of the full picture of securitization. To the extent material, business descriptions should include a description of how securitization fits into a company's business and business plans. And accurate and complete disclosure of material matters regarding securitization is crucial to good MD&A for these companies.
Regarding MD&A, I would direct companies and their advisers to the Commission's December 2003 interpretive release on the subject. That release outlines the general purposes of MD&A, as follows:
The purpose of MD&A is not complicated. It is to provide readers information "necessary to an understanding of [a company's] financial condition, changes in financial condition and results of operations."
The release goes on to give some helpful specific guidance in what I think are pretty simple terms. First, make sure that MD&A conveys management's clear view of the business and its risks and opportunities. For these purposes companies should be considering how management sees securitization as affecting financial performance and condition. For example, how important is a continuing securitization program to revenues, profits, cash flows or liquidity?
Does management see the securitization program expanding or shrinking? Otherwise changing in material ways? Are there material impediments to what management wants to do or must do as a result of market developments, credit issues or other considerations?
Second, make sure that MD&A through both presentation and content emphasizes the material, and within the universe of the material, what is most important to investors. Correspondingly de-emphasize the immaterial and unimportant. What are the most crucial aspects of securitization for the particular company? Don't just blindly use the list of considerations from a competitor your business is different. And how do these critical aspects change over time? Don't just mark up last year's document and change the numbers. How have things changed in the last year? Further, the Commission release devotes special attention to requirements regarding cash flows and liquidity, which have too often been under-emphasized in MD&A. I would also refer you to a speech I made a little more than a year ago, in April 2003, about disclosures in MD&A regarding cash flow and liquidity, to The Bond Market Association, of which I believe a number of you are also members.
I have one final point on MD&A related to securitization. We will be taking a close look at the new MD&A disclosure regarding off-balance sheet transactions mandated by Sarbanes-Oxley. We are expecting disclosure in this section, taken together with the new reporting and disclosure requirements of FIN 45 and FIN 46, will provide investors with important additional information regarding how securitizations and other off-balance sheet transactions impact financial condition and performance. The Commission will also be delivering a report to Congress later this year regarding disclosure of off-balance transactions; this is the last report required of us under Sarbanes-Oxley.
To return to accounting for a moment, I know that later today you have a program that will consider current accounting issues and developments in detail. I only want to point out that the Commission, particularly through its Office of the Chief Accountant, is involved and engaged in these matters, both with registrants and with the FASB. Issues include continued attention to FIN 46, treatment of commercial paper conduits, QSPEs and the consideration of loan participations and FAS 140. As Commission Chairman William Donaldson recently pointed out in a letter to a member of Congress in the context of the expensing of stock options, we support the work of the FASB in the various important areas related to securitization and believe that its open processes will produce the best results and accounting standards. I would point out particularly the roundtables that the FASB has been holding and has scheduled regarding the treatment of loan participations and FAS 140 as the kind of process that we support.
My final thought for companies engaged in securitization and securitization transactions is that we, and I speak particularly for the Division of Corporation Finance and the Office of the Chief Accountant, would encourage you to come in and explain situations to us where you believe you have questions about accounting and disclosure of accounting and financial matters. We are not always sure that message has been clear, and we are not sure the interaction has been as robust as it might be on the level of both individual companies and the industry. When you seek our views, we expect you to follow the protocol of the Office of the Chief Accountant posted on the Commission website where it applies, and we also expect you and where applicable your auditors to have a position and to express that position to us. But the Commission's Chief Accountant Don Nicolaisen, my Division's Chief Accountant Carol Stacey and I (and our respective staffs) all share a willingness to engage in that process to help ensure proper reporting and disclosure.
With that I will close. Thank you again for giving me the opportunity to be here with you this morning. I believe we have time for a few questions.