Aug. 27, 2014
I begin my remarks by echoing others and commending the work of the team that has been working on this rule, including Rolaine Bancroft, Hughes Bates, Michelle Stasny, Kayla Florio, Heather Mackintosh, Silvia Pilkerton, Robert Errett, Max Rumyantsev, and Kathy Hsu.
Heather and Sylvia have been working on the data tagging and preparing EDGAR to accept this new data. This is no small endeavor.
I want to give a special thank you to Paula Dubberly, who retired last year from the SEC and is in the audience today. She has been a champion for investors through her leadership on asset-backed securities regulation from the development of the initial Reg AB proposal through the rules that are being considered today.
This rule is an important step forward in completing the mandated Dodd-Frank Act rulemakings.[1] The financial crisis revealed investors´ inability to actually assess pools of loans that had been sliced and diced, sometimes multiple times, by being securitized, re-securitized, or combined in a dizzying array of complex financial instruments. The securitization market was at the center of the financial crisis. While securitization structures provided liquidity to nearly every sector in the U.S. economy, they also exposed investors to significant and non-transparent risks due to poor lending practices and poor disclosure practices.
As we now know, offering documents failed to provide timely and complete information for investors to assess the underlying risks of the pool of assets.[2] Without sufficient and accurate loan level details, analysts and investors could not gauge the quality of the loans – and without an ability to distinguish the good from the bad, the secondary market collapsed.
Congress responded and required the Commission to promulgate rules to address a number of weaknesses in the securitization process.[3]
Six years after the financial crisis, the securitization markets continue to recover. While certain asset classes have rebounded, others continue to struggle.
The rule the Commission issues today partially addresses the Congressional mandate. In effect, today´s rules provide investors with better information on what is inside the securitization package. The rules today do for investors what food and drug labeling does for consumers – provide a list of ingredients.
This rule also addresses certain critical flaws that became apparent in the securitization process, including a dearth of quality information and insufficient time to make informed assessments of the underlying investments. This rule is an important step toward providing investors with tools and data to better understand the underlying risks and appropriately price the securities.
There are several important and laudable aspects of today´s rule that merit specific mentioning.
First, the rule requires the underlying loan information to be standardized and available in a tagged XML format to ensure maximum utility in analysis.[4] As noted in the Commission´s 2010 Proxy Plumbing Release: "If issuers provided reportable items in interactive data format, shareholders may be able to more easily obtain information about issuers, compare information across different issuers, and observe how issuer-specific information changes over time as the same issuer continues to file in an interactive format."[5] The same is true for underlying loan information. Investors can unlock the value and efficiency that standardized, machine readable data allows.
Today´s rule also improves disclosures regarding the initial offering of securities and significantly, for the first time, requires periodic updating regarding the loans as they perform over time. This information will provide a more nuanced and evolving picture of the underlying assets in a portfolio to investors.
The rule also requires that the principal executive officer of the ABS issuer certify that the information in the prospectus or report is accurate. These kinds of certifications provide a key control to help ensure more oversight and accountability.
As for the privacy concerns that prompted a re-proposal, the staff has worked hard to balance investor needs for loan level data with concerns that the data could lead to identification of individual borrowers. I believe the rule achieves a workable balance between these two competing needs, while still providing invaluable public disclosure.
Finally, I believe that the new disclosure rule will provide investors with the necessary tools to see what is "under the hood" on auto loan securitizations. In its latest report on consumer debt and credit, the Federal Reserve Bank of New York noted a recent spike in subprime auto lending. As the report shows, although consumer auto debt balances have risen across the board, the real growth has been in riskier loans.[6] The disclosure and reporting changes that the Commission is adopting today will help investors see the quality of the loans in a portfolio and the performance of those loans over time.
While today´s rules are an important step forward, more work needs to be done regarding conflicts of interest. We now know that many firms who were structuring securitizations before the financial crisis were also betting against those same securitizations.
In April 2010, the Commission charged the U.S broker-dealer of a large financial services firm for its role in failing to disclose that it allowed a client to select assets for an investment portfolio while betting that the portfolio would ultimately lose its value. Investors in the portfolio lost more than $1 billion.[7]
In October 2011, the Commission sued the U.S broker-dealer of a large financial services firm for among other things, selling investment products tied to the housing market and then, for their own trading, betting that those assets would lose money. In effect, the firm bet against the very investors it had solicited. An experienced collateral manager commented internally that a particular portfolio was "horrible." While investors lost virtually all of their investments in the portfolio, the firm pocketed over $160 million from bets it made against the securitization it created.[8]
The Dodd-Frank Act directed the Commission to adopt rules prohibiting placement agents, underwriters, and sponsors from engaging in a material conflict of interest for one year following the closing of a securitization transaction. Those rules were required to be issued by April 2011.[9] The Commission initially proposed these rules in September 2011, and still has not completed them.[10] We need to complete these rules as soon as possible, hopefully, by the end of this year. These rules will provide investors with additional confidence that they are not being hoodwinked by those packaging and selling those financial instruments.
Unfortunately, the Commission has put on hold its work to provide investors with a software engine to aid in the calculation of waterfall models. Although the final rule provides for a preliminary prospectus at least three business days before the first sale, this is reduced from the proposal, which provided for a five-day period. With only three days to conduct due diligence and make an investment determination, such a software engine could be an important and much needed tool for investors to use in analyzing the flow of funds. Such waterfall models can help investors assess the cash flows from the loan level data. We should return to this important initiative to provide investors with the mathematical logic that forms the basis for the narrative disclosure within the prospectus.
The rule today impacts some significant sectors of the securitization market, however, the Commission should continue to work in making improvements that will provide investors with the disclosures they need regarding other asset classes, such as student loans, equipment loans and leases, and others as appropriate.
Finally, it is vitally important that the Commission continue to work with our fellow regulators to establish important provisions for risk retention, also required by the Dodd-Frank Act.
In conclusion, I appreciate the staff´s hard work both with me and my staff over these past several months. But much work remains to be done. I am committed to working with the staff and my fellow Commissioners to continue to move forward with Dodd-Frank rulemakings and specifically rulemakings to improve the strength and resiliency of securitization markets.
A stable securitization market efficiently brings investors and issuers together. Thus far, the return of capital to securitization markets has been disappointing, and I am hopeful that this rule and others that will follow will provide incentives for both issuers and investors to return with confidence to this once vibrant marketplace.
The new tools and protections provided in today´s rule should help restore trust in a market that was at the heart of the worst financial crisis since the Great Depression. But removing this black cloud is going to require continuing focus and effort from all of us.
Thank you. I have no questions.
[1] The Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (July 21, 2010).
[2] See Sheila Bair, Bull by The Horns: Fighting to Save Main Street From Wall Street and Wall Street From Itself at 52 (2012) (investors in asset-backed securities lacked detailed loan level information and adequate time to analyze the information before making an investment decision).
[3] The Dodd-Frank Wall Street Reform and Consumer Protection Act imposed new requirements on the ABS process and required the Commission to promulgate rules in a number of areas. Section 621 prohibits an underwriter, placement agent, initial purchaser, sponsor, or any affiliate or subsidiary of any such entity, of an asset-backed security from engaging in any transaction that would involve or result in any material conflict of interest with respect to any investor in a transaction arising out of such activity for a period of one year after the date of the first closing of the sale of the asset-backed security. Section 941 requires the Commission, the Federal banking agencies, and, with respect residential mortgages, the Secretary of Housing and Urban Development and the Federal Housing Finance Agency to prescribe rules to require that a securitizer retain an economic interest in a material portion of the credit risk for any asset that it transfers, sells, or conveys to a third party. The chairperson of the Financial Stability Oversight Council is tasked with coordinating this regulatory effort. Section 942 contains disclosure and Exchange Act reporting requirements for ABS issuers. Section 943 requires the Commission to prescribe regulations on the use of representations and warranties in the ABS market. Section 945 requires the Commission to issue rules requiring an asset-backed issuer in a Securities Act registered transaction to perform a review of the assets underlying the ABS, and disclose the nature of such review. See also H.R. Rep. No. 4173 (2010) (Dodd-Frank Conference Report)
[4] See Statement of Former Federal Reserve Governor Randall S. Kroszner at the Federal Reserve System Conference on Housing and Mortgage Markets, Washington, DC, December 4, 2008, available at http://www.federalreserve.gov/newsevents/speech/kroszner20081204a.htm.
[5] See Concept Release on the U.S. Proxy System, Exchange Act Release No. 62495 (July 14, 2010), available at http://www.sec.gov/rules/concept/2010/34-62495.pdf.
[6] See Quarterly Report on Household Debt and Credit, August 14, 2014, Federal Reserve Bank of New York, available at http://www.sec.gov/servlet/Satellite?c=SECPublicStmt&cid=1370542772431&externalLink=http%3A%2F%2Fwww.newyorkfed.org%2Fmicroeconomics%2Fhhdc.html%23%2F2014%2Fq2&pagename=goodbye.
[7] See SEC v. Goldman, Sachs & Co. and Fabrice Tourre, 10 Civ. 3229 (BJ) (S.D.N.Y. filed April 16, 2010) available at http://www.sec.gov/litigation/complaints/2010/comp-pr2010-59.pdf.
[8] See SEC v. Citigroup Global Markets, 11 Civ. 7387. (Rakoff, J.) (S.D.N.Y. filed Oct. 19, 2011)., available at http://www.sec.gov/litigation/complaints/2011/comp-pr2011-214.pdf.
[9] Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, § 621, 124 Stat. 1376, 1632 (2010).
[10] See SEC Release No. 34-65355, Prohibition against Conflicts of Interest in Certain Securitizations, September 19, 2011; SEC Release No. 34-65545, October 12, 2011 (extending the comment period from December 19, 2011 to January 13, 2012); and SEC Release No. 34-66058, October 12, 2011 (extending the comment period end date from January 13, 2012 to February 13, 2012).