Statement on the Proposed Rule: Prohibition against Conflicts of Interest in Certain Securitizations

Thank you, Chair Gensler. Before I discuss today’s proposal, I want to recognize Renee Jones for her leadership of the Division of Corporation Finance since June 2021 and wish her the best in her return to academia. Congratulations to Erik Gerding as he prepares to step into his new role as Renee’s successor. I also want to recognize Dan Berkovitz for serving as general counsel to the Commission, as well as a lifetime of public service, including as a Congressional staffer and at the Commodity Futures Trading Commission, both as general counsel and a commissioner.

When it comes to protecting investors from conflicts of interest, the federal securities laws and the Commission’s rules have often used disclosure as an appropriate response, requiring market participants to disclose transactions involving a related party or creating conflicts of interest.[1] But in the case of securitizations and in the aftermath of the financial crisis, Congress instructed the Commission, in Section 621 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, to do more than require disclosure about conflicts of interest. The statute directs the Commission to implement a rule that prohibits certain transactions of asset-backed securities if they involve or result in a material conflict of interest. Because of the stark nature of an outright prohibition – in contrast to a disclosure rule where the underlying transaction can still occur – a rule prohibiting transactions must especially balance protecting investors from harmful conflicts, with ensuring that market participants can engage in transactions that do not cause such harm.

I have concerns whether today’s rule proposal[2] correctly strikes this balance. Thus, comments from market participants will be especially important in consideration of any final rule. I am pleased that the staff’s recommendation acknowledges and attempts to address some of the concerns raised with the 2011 proposed rule that commenters had identified.[3] Among the proposal’s requests for comment, I particularly look forward to feedback on the following issues:

1. Should a person that has taken “substantial steps” to become a securitization participant be subject to the rule? If yes, do market participants understand the specific activities that constitute “substantial steps?”[4] For example, does an organization’s receipt of a preliminary term sheet to join the underwriting syndicate fall within or outside of “substantial steps?”
2. Should the rule exempt an entity from being an “affiliate” or “subsidiary” of a securitization participant if the securitization participant uses information barriers to manage conflicts of interest? If yes, what should be the conditions to the information barriers?[5]
3. Will securitization participants practically be able to satisfy the proposed conditions to relying on the rule’s exceptions for risk-mitigating hedging activities, liquidity commitments, and bona fide market-making activities?[6]

The answers to these and other requests for comment can have a profound impact on the effects of a final rule. If done correctly, the rule could “lower adverse selection costs . . . and expected volatility” in securitization markets, which may ultimately “lower credit costs in loan markets for households,” as noted in the proposing release.[7] However, if the rule is overly broad and strays beyond Section 621’s mandate, the opposite can also become true: adverse selection costs and expected volatility could increase and result in higher credit costs for those families and individuals trying to obtain a mortgage for a home or finance an electric vehicle purchase.

Because the proposing release sets forth a number of requests for comments on key aspects of the rule, I intend to support today’s recommendation to obtain public comment on it. I thank the staff of the Division of Corporation Finance, the Division of Economic and Risk Analysis, and the Office of the General Counsel for their work. I would like to specifically recognize the Division of Corporation Finance’s Office of Structured Finance, which led this rulemaking. Rolaine Bancroft and her team, as well as her predecessor Katherine Hsu, have done an incredible amount of work since the financial crisis. That works does not often come before the full Commission, but the office’s expertise in structured finance helps lower the cost of credit and enhance economic activity in our country.