On June 8, 2011, the Securities and Exchange Commission (the "SEC") issued a release1 (the "Proposing Release") describing proposed rules (the "Proposed Rules") implementing the portion of Section 932 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") relating to third-party due diligence. The Proposed Rules describe i) the obligations of issuers and underwriters to disclose the findings and conclusions of third-party due diligence reports and ii) the form this disclosure should take.
The Proposed Rules:
Apply to all issuers or underwriters of all offerings, whether or not registered, of asset-backed securities ("ABS") rated by a nationally recognized statistical rating organization ("NRSRO");
The Proposed Rules are not the first SEC rules to address due diligence requirements for ABS offerings. On January 20, 2011, the SEC issued final rules (the "Section 945 Rules") implementing the provisions of Section 945 of the Dodd-Frank Act.3 These rules require issuers of registered ABS offerings to:
Under the Section 945 Rules, issuers may conduct the due diligence review through a third party. If a third party conducts due diligence to satisfy the Section 945 Rules and such diligence is provided to an NRSRO rating the transaction, the issuer would also be responsible for compliance with the third-party due diligence disclosure procedures of the Proposed Rules.
Third-Party Due Diligence Disclosure Applies to all ABS:
The Proposed Rules go beyond the Section 945 Rules in several ways. The Proposed Rules apply to all ABS4 offerings rated by NRSROs, while the Section 945 Rules were limited to registered ABS offerings. Additionally, the Proposed Rules apply to the issuer5 or the underwriter, while the Section 945 Rules apply solely to issuers.
Issuer Required to Disclose Findings and Conclusions:
2. Required information
If the issuer or underwriter is required to furnish information about the results of third-party due diligence, it must do so on Form ABS-15G, which requires the issuer or underwriter to:
What Constitutes Due Diligence?
The Proposed Rules require disclosure of any third-party due diligence report, and a third-party due diligence report is defined as "any report containing the findings and conclusions of any 'due diligence services.'" As defined in the Proposed Rules, "due diligence services" include any review of the assets underlying an ABS for the purpose of making findings with respect to:
In the comments of the Proposing Release, the SEC states that it intends the first four categories of review to describe current due diligence practices for issuances of residential mortgage-backed securities ("RMBS"), and the fifth category is designed to be a catchall for due diligence services used for pools of other asset classes, such as commercial loans, corporate loans, student loans, or credit card receivables.
In the Proposing Release, the SEC noted that, in the context of RMBS transactions, third party due diligence generally involves analyzing a sample of loans in the pool to:
We note that, based on this description, typical accountants' comfort letters would appear to be within the scope of the Proposed Rules.
The Proposed Rules were published in the Federal Register on June 8, 2011 and comments on the Proposed Rules are due on or before August 8, 2011.
1 Release No. 34-64514; File No. S7-18-11. Available for review at http://sec.gov/rules/proposed/2011/34-64514fr.pdf.
2 Note that the form is furnished rather than filed. Documents furnished are not considered to be filed for the purposes of liability under the Securities Act of 1933.
3 See our Clients & Friends Memo, SEC Issues Final Rules Regarding Diligence and Disclosure in ABS Offerings, February 1, 2011.
4 Both rules use the definition of asset-backed securities found in Section 3(a)(77) of the Exchange Act. This definition is broader than the definition in Regulation AB.
5 The Proposed Rules contain a new definition for issuer that includes the sponsor or depositor.
6 The SEC notes that the reasonable reliance standard is a facts and circumstances test intended to mirror an NRSRO's reasonable reliance on the representation made by arrangers under Rule 17g-5.
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