Thank you, Chairman Schapiro.
In accordance with Section 621 of Dodd-Frank, which adds new Section 27B to the Securities Act, the Commission is advancing the proposal before us to prohibit certain material conflicts of interest relating to certain securitizations. Even though the Commission is acting pursuant to Section 621 of Dodd-Frank, it is important to recognize that room still exists for the SEC to exercise discretion in fashioning the rules implementing the statute.
I am willing to support the recommendation before us, although I do so with hesitation. The risk that the proposed prohibition of certain securitization transactions and structures could unduly stifle the free flow of capital, constrain market participants in managing their risks, frustrate capital formation, and cut investors off from investment opportunities troubles me. I am concerned that proposed Rule 127B’s prohibition will prove to be overinclusive, banning more than is called for — that the proposal may characterize a “material conflict of interest” too expansively and that the proposal may implement the statutory exceptions for hedging activities, liquidity commitments, and market making too narrowly.
The proposing release solicits comment on a range of topics and asks a number of thoughtful questions. As always, I look forward to considering the comments we will receive. I am particularly interested in comments that address the following:
(1) If the proposal were adopted, what would the likely impacts be on the securitization market, including investor protection, capital formation, and liquidity? On risk management? Concerning risk management, the release, for example, recognizes that a “type of synthetic collateralized debt obligations (CDOs) — balance sheet CDOs — would generally be prohibited under the proposed rule.”
(2) I am concerned that, as proposed, Rule 127B does not incorporate a role for disclosure. When a transaction or structure is banned, investors may find themselves forced to forego investment opportunities that they might welcome if given the opportunity to make an informed choice. One way to keep from sacrificing investor choice in the context of this rulemaking could be to allow for proper disclosure to redress what might otherwise be treated as a prohibited material conflict of interest. Indeed, the tradition of the federal securities laws is one of disclosure whereby investors are allowed to make investment decisions as they see fit with the benefit of the information provided to them.
If, when given the choice, an investor were to decide to transact in the face of an identified and disclosed conflict of interest — because, say, the investor determines that the next best investment alternative is inferior — should Rule 127B nonetheless block the investor from the investor’s preferred investment? Should government decision making, as effectuated through a ban on certain transactions and structures, displace informed investor decision making? In short, what role should disclosure play in the context of the Commission’s proposed Rule 127B?
(3) New Section 27B of the Securities Act only prohibits material conflicts of interest that arise during a specified covered timeframe. Namely, a prohibited transaction cannot occur “at any time for a period ending on the date that is one year after the date of the first closing of the sale of the asset-backed security.” Notwithstanding this statutory language, the release explains that the proposed rule would prohibit transactions occurring before the “date of the first closing of the sale of the asset-backed security.” Does the proposed Rule 127B prohibition, therefore, reach too far, extending the covered timeframe to include a period that is earlier than what the statute calls for?
Let me conclude by joining my colleagues in thanking the staff — particularly those from the Division of Trading and Markets and the Division of Risk, Strategy, and Financial Innovation — for your hard work on this rulemaking.