Speech by SEC Chairman:
Opening Statement at the SEC Open Meeting
Chairman Mary L. Schapiro
U.S. Securities and Exchange Commission
April 7, 2010
Good Morning. This is an open meeting of the U.S. Securities and Exchange Commission.
Today, we are considering a recommendation that the Commission approve for public comment proposed rules that would fundamentally revise the regulatory regime for asset-backed securities.
The proposed rules are intended to better protect investors in the securitization market by giving them more detailed information about pooled assets, more time to make their investment decisions, and the benefits of better alignment of the interests of issuers and investors through a retention or "skin in the game" requirement. Finally, the rules would bring greater transparency to the private market as well.
As we know all too well, securitization — that is, the buying and bundling of assets such as housing, student or commercial loans into securities that are then sold to investors — played a central role in the financial crisis. Like most investment products, securitization has both its positive and negative attributes.
At one time, the securitization market provided trillions of dollars of liquidity to virtually every sector of the economy. This enabled lenders to make loans and credit available to a wide range of borrowers and companies seeking financing.
But, securitization has also fostered poor lending practices by encouraging lenders to shift their risk of loss to investors. In the area of mortgage-backed securities, sound underwriting practices sometimes took a back seat to immediate profits. When poorly underwritten mortgages began to default, the securities backed by the mortgages lost their value. Investors suffered significant losses, and have consequently largely withdrawn from the market.
During the past year, we have worked hard to better understand the practices that contributed to the financial crisis, and to identify ways to prevent reoccurrence in the future. We — along with other financial regulators — have looked closely at ABS oversight both in the public and private markets for these instruments, and have concluded that we can and must do a better job of protecting investors.
The release that the Commission is considering today is the result of our comprehensive reevaluation of existing rules, and our conclusion that three fundamental things need to change in order to better protect investors and promote more efficient asset-backed securities markets.
First, investors must have better information about the pooled assets that "back" these securities. This information must be both granular and current enough to provide investors the data they need to accurately assess risk and value. It also must be provided in a manner, and within a timeframe, so that investors can access and use the information effectively.
Second, the interests of organizations that issue and sponsor these securities must be better aligned with the interests of investors.
And third, we must consider the impact that more rigorous rules for the public ABS market will have on the private ABS market, and make sure that we are not simply moving tomorrow's problems into a less regulated area.
There are likely many avenues to address these macro objectives. As staff will explain in more detail in a moment, the release proposes to address these issues in a number of specific ways.
First, to provide investors with better, more timely and usable information, the proposal would require ABS issuers to file with the Commission standardized information about the specific loans in the pool, allowing investors to better understand their investment. This "loan level information" would be required at the time that the asset is securitized and on an ongoing basis.
Additionally, these issuers would be required to file on the SEC Web site a computer program of the contractual cash flow provisions, or "waterfall." The waterfall is essentially the rules that dictate how the borrowers' loan payments are distributed to investors in the ABS, how losses or lack of payment on those loans is divided among the investors, and when administrative expenses (such as servicing fees), are paid to service providers.
This computer program could be used to analyze the loan level information and would give investors and the markets better tools to analyze asset-backed securities.
And lastly in this area, the proposal would for the first time give investors a minimum period of time — specifically five business days — to consider transaction-specific information, including the loan level data, before an ABS investment decision needs to be made.
Second, to better align interests — as well as improve the quality of securities that are offered through the shelf registration process — the proposal would remove references to the ABS' credit rating as an eligibility requirement for shelf registration, replacing this instead with four new eligibility criteria:
The chief executive officer of the ABS depositor would need to certify that the assets have characteristics that provide a reasonable basis to believe that they will produce cash flows as described in the prospectus.
The ABS sponsor would be required to retain five percent of the securitization, net of the sponsor's hedging, to ensure that the sponsor — like investors — has "skin in the game."
The ABS issuer also would be required to provide a mechanism whereby the investors could confirm that the assets comply with the issuer's representations and warranties, such as representations and warranties that the loans in the ABS pool were underwritten in a manner consistent with the lenders' underwriting standards.
The ABS issuer would have to agree to file Exchange Act reports with the Commission on an ongoing basis (rather than discontinuing reporting with the Commission in the first year, which the Exchange Act currently permits many ABS issuers to do).
And lastly, we need to re-examine the assumption, in light of the financial crisis, that sophisticated investors do not need the types of protections that come with registration under the Securities Act.
Further, as we make improvements to the disclosure provisions which apply in the public markets, we also must address the potential that these changes will further drive ABS transactions to the private structured products markets where some types of asset-backed securities (such as collateralized debt obligations) are sold.
As a result, we are proposing that when an SEC safe harbor is relied upon for the unregistered sale of securities (for example, under Rule 144A or Regulation D), the issuers would have to provide investors, upon request, the same information that would be required if the offering were in the public markets. This information would need to be provided at the time of the offering and on an ongoing basis.
The proposal also would require that an ABS issuer file a public notice of the initial placement of securities to be sold under Securities Act Rule 144A. This notice would require information tailored to ABS offerings and be publicly filed with the SEC in its EDGAR database. Form D, the notice of an offering made in reliance on Regulation D, also would be revised to collect information on structured finance products.
This release represents a fundamental revision to the way in which the ABS market would be regulated. I think changes are both necessary and critical components of restoring investor confidence. The 90-day comment period will provide an important opportunity for market participants to weigh in on the judgment calls that we have preliminarily made.
During this time, I have also asked our staff to continue to work with other financial regulators — the FDIC, the Fed, Treasury and the President's Working Group — to ensure that our work in this area is fully informed by the activities of our regulatory colleagues.
Before I ask Meredith Cross to provide us with more details on the proposal, I would like to thank our staff for their yeoman's effort on this very weighty project. From the Division of Corporation Finance, thank you to Meredith Cross, Paula Dubberly, Kathy Hsu, Rolaine Bancroft, Cecile Peters, Amy Starr, Jennifer Zepralka, Max Webb, Julie Rizzo, Lauren Nguyen, Shu Liu, Christina Padden, John Harrington, Paula Lee, Paul Dudek, and Gerry Laporte.
From our Office of General Counsel, thanks go to David Becker, David Fredrickson, Bryant Morris and Bill Barton. And thank you also to our colleagues in the Division of Risk, Strategy and Financial Innovation, specifically Henry Hu, Adam Glass, Gregg Bermann, Rick Bookstaber, Josh White, Stas Nikolova, Kathleen Hanley and Don Monk.
Now I'll turn the meeting over to Meredith Cross, Director of the Division of Corporation Finance.