A rule to implement Section 27B of the Securities Act of 1933 was proposed by the Securities and Exchange Commission today. Section 27B is a provision that was added to the Securities Act of 1933 by Section 621 of the Dodd-Frank Act.
What is the Goal of this Rule?
The goal of the rule is to eliminate the market for asset-backed securities (ABS) that have been tainted by significant conflicts of interest and make their sale impossible. To be more specific, the rule would prohibit securitization participants from engaging in certain transactions that could act as an incentive for a securitization participant to structure an ABS in a manner that would prioritize the securitization participant’s interests over those of ABS investors. In September 2011, the Commission presented an initial proposal for a rule that would implement Section 27B.
Gary Gensler, the chairman of the Securities and Exchange Commission, was quoted as saying, “I am pleased to support this re-proposed rule as it fulfills Congress’ mandate to address conflicts of interests in the securitization market, which contributed to the 2008 financial crisis.
This re-proposed rule’s goal is to help address conflicts of interest that can arise when market participants take positions that are counter to the interests of investors. In addition, in order to comply with the requirements of Section 621 of the Dodd-Frank Act, the re-proposed rule includes exemptions for risk-reducing hedging activities, genuine market making, and specific liquidity commitments. When taken together, these changes would be to the benefit of investors as well as our markets.
If it were to become law, the proposed amendment to the Securities Act’s Rule 192 would make it illegal for an underwriter, placement agent, initial purchaser, or sponsor of an ABS, as well as any affiliates or subsidiaries of those entities, to engage in any transaction that would involve or result in a material conflict of interest between the securitization participant and an investor in such an ABS.
This would apply to any transaction, whether it was conducted directly or indirectly. According to the rule that is being proposed, dealings of this kind would be considered “conflicted transactions.” A short sale of the ABS or the purchase of a credit default swap or another credit derivative that entitles the securitization participant to receive payments upon the occurrence of specified credit events in respect to the ABS are both examples of these types of transactions.
Other types of credit derivatives are also available. The prohibition on conflicted transactions would begin on the date that a person has reached, or has taken substantial steps toward reaching, an agreement that such person will become a securitization participant with respect to an ABS. The prohibition on conflicted transactions would end one year after the date of the first closing of the sale of the relevant ABS.
The rule that is being proposed would make certain exceptions for risk-reducing hedging activities, market-making activities that are conducted in good faith, and certain commitments made by a securitization participant to provide liquidity for relevant ABS.
These exemptions would be subject to certain conditions. The proposed exceptions would place an emphasis on differentiating the qualities of such activities from those of speculative trading. The currently active liquidity commitment, market-making, and balance sheet management activities would all be protected from interference if the proposed exceptions were implemented.
The public comment period will remain open for the longer of either sixty days after the proposing release was published on the SEC‘s website or thirty days after the proposing release was published in the Federal Register; whichever period is longer will apply.
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