Proposed Rule: Asset-Backed Securities; Release Nos. 33-8419; 34-49644; File No. S7-21-04

Summary: We are proposing new and amended rules and forms to address comprehensively the registration, disclosure and reporting requirements for asset-backed securities under the Securities Act of 1933 and the Securities Exchange Act of 1934. Principally, we are proposing to: update and clarify the Securities Act registration requirements for asset-backed securities offerings, including expanding the types of asset-backed securities that may conduct delayed primary offerings on Form S-3; consolidate and codify existing interpretive positions that allow modified Exchange Act reporting that is more tailored and relevant to asset-backed securities; provide tailored disclosure guidance and requirements for Securities Act and Exchange Act filings involving asset-backed securities; and streamline and codify existing interpretive positions that permit the use of written communications in a registered offering of asset-backed securities in addition to the statutory registration statement prospectus.

For Further Information Contact: Jeffrey J. Minton, Special Counsel, or Jennifer G. Williams, Attorney-Advisor, Office of Rulemaking, Division of Corporation Finance, at (202) 942-2910, or Eric J. Schuppenhauer, Professional Accounting Fellow, Office of Chief Accountant, at (202) 942-4400, U.S. Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549.

Supplementary Information: We are proposing to amend Rules 1-02, 2-01, 2-02 and 2-07¹ of Regulation S-X² under the Securities Act of 1933 (the “Securities Act”)³; to amend Items 10, 308, 401 and 406⁴ of Regulation S-B⁵ under the Securities Act; to amend Items 10, 202, 308, 401, 406, 501, 503, 512 and 601⁶ of Regulation S-K⁷ under the Securities Act, to add a new subpart of Regulation S-K, the 1100 series (“Regulation AB”);⁸ to amend Rules 411, 424 and 434⁹ under the Securities Act; to add Rules 139a, 167, 190, 191 and 426¹⁰ under the Securities Act; to amend Rule 311¹¹ of Regulation S-T;¹² to amend Forms S-1, S-2, S-3, S-11, F-1, F-2 and F-3¹³ under the Securities Act; to amend Rules 10A-3, 12b-2, 12b-15, 13a-10, 13a-11, 13a-13, 13a-14, 13a-15, 13a-16, 15c2-8, 15d-10, 15d-11, 15d-13, 15d-14, 15d-15 and 15d-16¹⁴ under the Securities Exchange Act of 1934 (the “Exchange Act”);¹⁵ to add Rules 3a12-12, 3b-19, 13a-17, 13a-18, 15d-17, 15d-18, 15d-22 and 15d-23¹⁶ under the Exchange Act; to amend Rule 100¹⁷ of Regulation M¹⁸ under the Exchange Act; to amend Rule 101¹⁹ of Regulation BTR²⁰ under the Sarbanes-Oxley Act of 2002 (the “Sarbanes-Oxley Act”);²¹ to amend Forms 20-F, 40-F, 8-K and 10-K²² under the Exchange Act; and to add Form 10-D²³ under the Exchange Act.

A. What are Asset-Backed Securities?

B. Securities Act Registration

C. Disclosure

D. Communications During the Offering Process

E. Ongoing Reporting under the Exchange Act

F. Other Miscellaneous Proposals

2. Determining the "Issuer" and Operation of the Section 15(d) Reporting Obligation

I. Overview

Asset-backed securities, or ABS, are securities that are backed by a discrete pool of self-liquidating financial assets. Asset-backed securitization is a financing technique in which financial assets, in many cases themselves less liquid, are pooled and converted into instruments that may be offered and sold more freely in the capital markets.²⁴ In a basic securitization structure, an entity, often a financial institution and commonly known as a “sponsor,” originates or otherwise acquires a pool of financial assets, such as mortgage loans, directly or through an affiliate. It then sells the financial assets to a specially created investment vehicle that issues securities backed by those financial assets, which are “asset-backed securities.” Payment on the asset-backed securities depends primarily on the cash flows generated by the assets in the underlying pool and other rights designed to assure timely payment, such as guarantees or other features generally known as credit enhancements. The structure of asset-backed securities is intended, among other things, to insulate ABS investors from the corporate credit risk of the sponsor that originated or acquired the financial assets.

The ABS market is fairly young and has rapidly become an important part of the U.S. capital markets. One source estimates that U.S. public ABS issuance grew from $46.8 billion in 1990 to $416 billion in 2003.²⁵ Another source estimates 2003 new issuance closer to $800 billion.²⁶ While residential mortgages were the first financial assets to be securitized, non-mortgage related securitizations have grown to include many other types of financial assets, such as credit card receivables, auto loans and student loans. The Commission has not previously addressed on a comprehensive basis the regulatory treatment of asset-backed securities under the Securities Act or the Exchange Act.

Asset-backed securities and ABS issuers differ from corporate securities and operating companies. In offering these securities, there is generally no business or management to describe. Instead, information about the transaction structure and the quality of the asset pool and servicing is often what is most important to investors. Many of the Commission’s existing disclosure and reporting requirements, which are designed primarily for corporate issuers, do not elicit the information that is relevant for most asset-backed securities transactions. Over time, Commission staff, through no-action letters and the filing review process, has developed a framework to address the different nature of asset-backed securities while being cognizant of developments in market practice.

We now propose to address comprehensively the treatment of asset-backed securities under the Securities Act and the Exchange Act. With a few exceptions, our proposals consolidate and codify current staff positions and industry practice. Our proposals relate to four primary regulatory areas: Securities Act registration; disclosure; communications during the offering process; and ongoing reporting under the Exchange Act.

We propose a definition of asset-backed security that would demarcate the securities and offerings to which the new proposed rules would apply. The proposed definition would consolidate several staff positions regarding the definition of asset-backed security, including those regarding delinquent and non-performing pool assets. The proposed definition also would allow more lease-backed transactions to be included in the definition of asset-backed security and permit the use of master trusts and revolving periods by more asset classes. These changes are designed to remove regulatory uncertainty and reduce regulatory obstacles and costs of securitization.

In 1992, the Commission amended Form S-3 to allow registration of offerings of investment grade asset-backed securities on a delayed, or “shelf,” basis.²⁷ We propose that all registered offerings of asset-backed securities be registered either on Form S-1 or Form S-3, and we propose to specify in those forms which disclosure items would be required. We propose to expand the types of investment grade asset-backed securities that qualify for shelf registration. Consistent with existing staff positions, we do not propose to add a reporting history requirement for Form S-3 eligibility. However, we do propose to codify that previously established reporting obligations regarding other asset-backed securities transactions by the sponsor or the depositor must have been satisfied to maintain Form S-3 eligibility for new transactions. Consistent with a staff no-action letter, we also propose to exclude offerings of asset-backed securities eligible for Form S-3 registration from the requirements of Exchange Act Rule 15c2-8(b) to deliver a preliminary prospectus prior to delivery of a confirmation of sale.

We propose to clarify that the depositor—often the sponsor or an affiliated intermediary that receives the pool assets and transfers them to the issuing entity—would be the statutory “issuer” for purposes of signing the registration statement for the asset-backed securities transaction. We also propose to alleviate impediments to the shelf registration of offerings of asset-backed securities by foreign issuers or backed by foreign financial assets. Finally, we propose to codify, consolidate and streamline staff positions regarding when and how the offering of underlying debt securities must be concurrently registered with an offering of the asset-backed securities backed by those underlying securities.

Currently, there are no disclosure items specifically tailored to asset-backed securities. We propose a new principles-based set of disclosure items, “Regulation AB,” that would form the basis for disclosure in both Securities Act registration statements and Exchange Act reports. While we request comment on this point, we do not believe it would be practical or effective to draft detailed disclosure guides for each asset type that may be securitized. Instead, we have attempted to identify the disclosure concept required and provide several illustrative examples, while understanding that the application of the particular concept must be tailored to the information material to the particular transaction and asset type involved.

For the most part, our proposed disclosure items are based on the market-driven disclosures that appear today. With a proposed codification of a universal set of disclosure items, however, we do seek a reevaluation by transaction participants of the manner and content of presented disclosure, including the elimination of unnecessary boilerplate and a de-emphasis on unnecessary legal recitations of terms. We also understand that existing disclosure standards may not adequately capture certain categories of information that may be material to an asset-backed securities transaction, such as the background, experience, performance and roles of various transaction parties, including the sponsor, the servicing entity that administers or services the financial assets and the trustee. Our proposed disclosure items relating to these entities are designed to elicit more useful information in these areas. We also propose to require, for the first time, that certain statistical information on a “static pool” basis be provided if material to the transaction to aid in an investor’s analysis of current and prior pool performance. Consistent with current practice, we do not propose to require audited financial statements regarding the issuing entity for the asset-backed securities in Securities Act or Exchange Act filings, although we do request comment on this point.

Finally, we propose to consolidate and codify current staff positions on when financial or other descriptive information would be required regarding certain third parties, such as obligors of financial assets that reach pool concentration levels or significant providers of credit enhancement or other support for the asset-backed securities. We also propose to streamline and codify current staff positions on when financial information regarding such third parties may be incorporated by reference or referred to in an asset-backed securities filing in lieu of actually including the information in the filing.

In the mid 1990’s, Commission staff issued a series of no-action letters permitting the use of various written materials in addition to the statutory registration statement prospectus in an offering of asset-backed securities.²⁸ These materials provide data about the potential payouts of the financial assets and the asset-backed securities using various prepayment and other assumptions as well as disclose information about the structure of the offering or about the underlying asset pool. We propose to codify and simplify current staff positions on when these materials can be used and when they must be publicly filed with the Commission. We also propose to clarify several interpretive issues regarding the use of these materials given market developments over the decade since the letters were issued. In this regard and given advances made to EDGAR (our electronic data gathering, analysis and retrieval system), we also propose to eliminate the current exemption from electronic filing for these materials.

Shortly after the no-action letters referred to above were issued, Commission staff also issued a no-action letter regarding the publication of research reports by brokers or dealers proximate to an offering of asset-backed securities registered or to be registered on Form S-3.²⁹ The Commission had previously adopted several rules that provided safe harbors under which the publication of research reports would not be deemed a violation of the communications restrictions of Section 5 of the Securities Act.³⁰ However, several of the conditions in those rules were not relevant or practical for asset-backed securities. We propose to codify the modified conditions in the staff no-action letter to provide a similar safe harbor for research reports as they relate to registered offerings of asset-backed securities on Form S-3.

As with registration, the ongoing periodic and current reporting requirements applicable to operating companies do not elicit information that would be the most relevant for asset-backed securities. First through a series of exemptive orders, and then primarily through the issuance of no-action letters and other interpretations, Commission staff has allowed modified Exchange Act reporting by ABS issuers. In lieu of quarterly reports on Form 10-Q,³¹ ABS issuers generally file under cover of Form 8-K the distribution reports required to be prepared under the transaction agreements that detail the payments and performance of the financial assets in the asset pool and payments on the securities backed by that pool. Current reporting on Form 8-K for certain extraordinary events also is required regarding asset-backed securities, but historically only for a narrow subset of events. A modified annual report on Form 10-K is required with two items being most important: a servicer’s statement of compliance with its servicing obligations; and a report by an independent public accountant regarding compliance with particular servicing criteria. Financial statements of the issuing entity are not required. An asset-backed issuer is required to include a certification under Section 302 of the Sarbanes-Oxley Act³² with its Form 10-K, and, as provided by the Commission’s rules governing certification, the staff has previously provided a special form of certification for ABS issuers to use.³³ ABS issuers are exempt from the rules implementing Section 404 of the Sarbanes-Oxley Act³⁴ regarding reporting on internal control over financial reporting.³⁵

We propose to codify the basic modified reporting system for asset-backed securities. To distinguish periodic reporting regarding distributions from disclosure of important events that appropriately call for current reporting, we propose one new form type, Form 10-D, to act as the report for the periodic distribution information currently provided under cover of Form 8-K. We also propose to specify which of the Commission’s recently adopted Form 8-K events would be applicable to asset-backed securities, and we propose a few additional events specific to asset-backed securities. Consistent with the modified reporting no-action letters, we propose to exclude ABS from quarterly reporting on Form 10-Q and exempt ABS from reporting under Section 16 of the Exchange Act.³⁶ We also propose to clarify how transition reports are to be filed regarding a change in fiscal year.

We propose to specify the disclosure requirements applicable for annual reports on Form 10-K regarding asset-backed securities, which also will be drawn from Regulation AB, and to codify the form of certification to be used under Section 302 of the Sarbanes-Oxley Act. We propose to retain the long-standing requirements for a servicer compliance statement and a report by an independent public accountant as to compliance with particular servicing criteria. Regarding servicing criteria, there are very few existing criteria for evaluating compliance, the most widely used of which currently is the Uniform Single Attestation Program, or USAP, promulgated by the Mortgage Bankers Association of America. However, the USAP’s “minimum servicing standards” are designed to be applicable only to servicing of mortgages and do not necessarily represent the full spectrum of servicing activities that may be material to an asset-backed securities transaction. We propose disclosure-based servicing criteria that would form the basis for an assessment and assertion as to material compliance with such criteria (or disclosure as to non-compliance). We also continue the practice of accountant involvement in assessing compliance with servicing criteria by proposing a requirement that a registered public accounting firm attest to the assertion of compliance. Both the report containing the assertion of compliance and the accountant’s attestation report would be required to be filed with the report on Form 10-K.

As with the Securities Act, we propose to codify that the depositor is the “issuer” for purposes of Exchange Act reporting regarding asset-backed securities. We also propose to specify who may sign the various Exchange Act reports. Under the proposals, either the depositor or the servicer may sign the reports on Form 10-K, Form 10-D and Form 8-K, and the same party that signs the annual report on Form 10-K also would be the party that would be required to sign the Sarbanes-Oxley Act Section 302 certification and make the proposed assertion of compliance with servicing criteria. We also propose to clarify how filings regarding asset-backed securities are to be filed on EDGAR and the operation of the reporting obligation for asset-backed securities under Section 15(d) of the Exchange Act,³⁷ including proposals to codify several interpretive positions as to when the obligation starts and when it may be suspended.

Finally, our proposals include several miscellaneous and technical amendments to our rules and forms to accommodate the new proposals and update references regarding asset-backed securities. We also request comment on any additional areas that should be addressed regarding the registration, reporting and disclosure requirements for asset-backed securities under the Securities Act or the Exchange Act.

II. Background and Development of ABS and Regulatory Treatment

The ABS market rapidly has developed into an important part of the U.S. capital markets.³⁸ The modern securitization market originated in the 1970’s with the securitization of residential mortgages.³⁹ Since the mid-1980’s, the techniques pioneered in the mortgage-backed securities, or MBS, market have been used to securitize other asset types. Most asset types that have been securitized have homogenous characteristics, including similar terms, structures and credit characteristics, with proven histories of performance, which in turn facilitate modeling of future payments and thus analysis of yield and credit risks.

While the ABS market is still fairly young, it has rapidly become very large. By way of example, one source estimates that annual issuance of U.S. public non-GSE ABS grew from $46.8 billion in 1990 to $416 billion in 2003.⁴⁰ Another source estimates 2003 new issuance at $800 billion.⁴¹ The four primary asset classes currently securitized are residential mortgages, automobile receivables, credit card receivables and student loans, which represented approximately 52%, 19%, 16% and 9% of 2003 new issuance, respectively.⁴²

There are several distinguishing features between asset-backed securities and other fixed-income securities. For example, ABS investors are generally interested in the characteristics and quality of the underlying assets, the standards for their servicing, the timing and receipt of cash flows from those assets and the structure for distribution of those cash flows. As a general matter, there is essentially no business or management (and therefore no management’s discussion and analysis of financial performance and condition) of the issuing entity, which is designed to be a solely passive entity. GAAP financial information about the issuing entity generally does not provide useful information to investors. Information regarding characteristics and quality of the assets is important for investors in assessing how a pool will perform. Information relating to the quality of servicing of the underlying assets also is relevant to assessing how the asset pool is expected to perform and the reliability of the allocation and distribution functions. Another focus is the legal and structural nature of the issuing entity and the transfer of the assets to the issuing entity to assess legal and credit separation from third parties. ABS investors also analyze the impact and quality of any credit enhancements and other support designed to provide additional protection against losses and ensure timely payments.

A sponsor typically initiates a securitization transaction by selling or pledging to a specially created issuing entity a group of financial assets that the sponsor either has originated itself or has purchased in the secondary market.⁴³ Sponsors of asset-backed securities often include banks, mortgage companies, finance companies, investment banks and other entities that originate or acquire and package financial assets for resale as ABS. In some instances, the transfer of assets is a two-step process: the financial assets are transferred by the sponsor first to an intermediate entity, often a limited purpose entity created by the sponsor for a securitization program and commonly called a depositor, and then the depositor will transfer the assets to the issuing entity for the particular asset-backed transaction.⁴⁴

The issuing entity, most often a trust with an independent trustee, then issues asset-backed securities to investors that are either backed by or represent interests in the assets transferred to it. The proceeds of the sale of the asset-backed securities are used to pay for the assets that were transferred to the trust. Because the issuing entity is designed to be a passive entity, a “servicer,” which may often be an affiliate of the sponsor, is often necessary to collect payments from obligors of the pool assets, carry out the other important functions involved in administering the assets and to calculate and pay the amounts net of fees due to the investors that hold the asset-backed securities to the trustee, which actually makes the payments to investors.

The predominant purchasers of asset-backed securities today are institutional investors, including financial institutions, pension funds, insurance companies and money managers.⁴⁵ Generally, ABS are not marketed to retail investors. However, securitizations of one fairly unique asset type—transactions that pool and securitize outstanding debt securities of other issuers—often are marketed to retail investors and are listed on a national securities exchange.⁴⁶

While some ABS transactions consist of simple pass-through certificates representing a pro rata share of the cash flows from the underlying asset pool, ABS transactions often involve multiple classes of securities, or tranches, with complex formulas for the calculation and distribution of the cash flows. In addition to creating internal credit enhancement or support for more senior classes, these structures allow the cash flows from the asset pool, and hence varying degrees of risk from pool performance, to be packaged into securities designed to address a given risk and return profile.

Transaction agreements specify the structure of an ABS transaction. A common form for these agreements is a “pooling and servicing agreement,” or PSA, often among the sponsor, the trustee and the servicer. A pooling and servicing agreement often governs the transfer of the assets from the sponsor to the issuing entity and sets forth the rights and responsibilities of participants. Typically the agreement also will detail how cash flows generated by the asset pool will be divided, typically referred to as the “flow of funds” or “waterfall.” The flow of funds specifies the allocation and order of cash flows, including interest, principal and other payments on the various classes of securities, as well as any fees and expenses, such as servicing fees, trustee fees or amounts to maintain credit enhancement or other support. Cash flows also may be directed into various accounts, such as reserve accounts to provide support against potential future shortfalls. The agreement also specifies the type and content of reports that will be provided to investors regarding ongoing performance of the transaction.

In addition to any internally provided credit enhancement or support, the sponsor or other third parties may provide external credit enhancements or other support for the asset-backed securities.⁴⁷ For example, third party insurance may be obtained to reimburse losses on the pool assets or the asset-backed securities themselves. In addition, the issuing parties may arrange with a counterparty for an interest rate swap or similar swap transaction to avoid a cash-flow mismatch, such as where a floating-rate interest is to be paid on ABS backed by financial assets that pay a fixed rate of interest.

Credit rating agencies play a large role in most ABS transactions. As with a traditional corporate debt security, a rating on an asset-backed security is designed only to reflect credit risk. The rating generally does not address other market risks that may result from changes in interest rates or from prepayments on the underlying asset pool.

To date, there have been few Commission initiatives directly related to ABS. In connection with the passage of the Secondary Mortgage Market Enhancement Act of 1984 (SMMEA),⁴⁸ the Commission permitted shelf registration to SMMEA eligible securities.⁴⁹ In 1992, the Commission extended shelf registration to non-mortgage investment grade ABS.⁵⁰ That same year, the Commission also adopted a rule under the Investment Company Act of 1940⁵¹ to exclude ABS transactions under specific conditions from the definition of an investment company.⁵² More recently, the Commission tailored rules for asset-backed securities in its implementing rulemakings under the Sarbanes-Oxley Act, including exempting asset-backed securities from the reporting and attestation requirements relating to internal control over financial reporting established by Section 404 of the Sarbanes-Oxley Act.⁵³ The Commission followed this approach in contemplation of current staff practice and this rulemaking initiative where applicable objectives underlying the Sarbanes-Oxley Act, including requirements suitable to ABS transactions, could be evaluated.

The staff has to date addressed the lack of a defined set of regulatory requirements for asset-backed securities through the filing review process and, where necessary, through staff no-action letters or interpretive statements. For example, through the filing review process, an informal disclosure scheme for ABS registration statements has developed taking into account evolving industry practices. The 2003 MBS Disclosure Report also provided valuable insight on the type of information investors find useful in ABS transactions. A system of modified reporting under the Exchange Act has developed, first through exemptive orders under Exchange Act Section 12(h),⁵⁴ and then subsequently through staff no-action letters and interpretative positions.

The Commission recognizes that securitization is playing an increasingly important role in the evolution of the fixed income financial markets. Our staff has attempted to accommodate the different nature of ABS and evolving business practices, while reducing unnecessary or impractical compliance burdens, through its numerous no-action and interpretive positions. However, the accumulated informal guidance, while helpful to some ABS transactions, has diminished the transparency of applicable requirements because an ABS registrant or investor seeking to understand the applicable requirements must review and assimilate a large body of no-action letters and other staff positions. This time-consuming practice decreases efficiency and transparency and leads to uncertainty and common problems. Many issuers, investors and other market participants have requested a defined set of regulatory requirements for guidance.⁵⁵ Staff reviews of filings provide further evidence that many compliance issues may be mitigated and potential issues avoided through clearer and more transparent regulatory requirements. Recent market events involving distressed transactions also have highlighted the need for improved disclosures as well as a renewed attention on servicing practices.⁵⁶ The Commission believes it is thus appropriate to clarify the regulatory requirements for asset-backed securities in order to increase market efficiency and transparency and provide more certainty for the overall ABS market and its investors and other participants.

III. Discussion of the Proposals

The 1992 Release, as part of a broad effort to expand access to shelf registration, allowed shelf registration for offerings of investment grade⁵⁷ asset-backed securities without requiring a reporting history requirement for the issuing entity.⁵⁸ As a result, a sponsor or depositor may register asset-backed securities to be offered on a delayed basis in the future through one or more offerings, or “takedowns,” of securities off of the shelf registration statement. Since the 1992 Release, shelf registration on Form S-3 has become the predominant method of registration for public offerings of asset-backed securities. Offerings generally are only registered on another form, most likely Form S-1 and less frequently Form S-11, if for some reason the securities technically do not meet the definition of “asset-backed security” in General Instruction I.B.5 of Form S-3 or an interpretation of that definition.

For offerings registered on a shelf basis on Form S-3, the prospectus disclosure in the registration statement is often presented through the use of two primary documents: the “base” or “core” prospectus and the prospectus supplement. The base prospectus outlines the parameters of the various types of ABS offerings that may be conducted in the future, including asset types that may be securitized, the types of security structures that may be used and possible credit enhancements. The registration statement at the time of effectiveness also contains a form of prospectus supplement, which outlines the format of deal-specific information that will be disclosed at the time of each takedown. At the time of a takedown, a final prospectus supplement is prepared which describes the specific terms of the takedown, and the base prospectus and the final prospectus supplement together form the final prospectus which is filed with the Commission pursuant to Securities Act Rule 424(b).⁵⁹

Currently, the term “asset-backed security” is defined only for purposes of Form S-3. As many of our proposals relate to the treatment of asset-backed securities regardless of the form on which their offering is initially registered, we are proposing to move the definition of “asset-backed security” to the definition section of proposed Regulation AB, our proposed sub-part in Regulation S-K for asset-backed securities (discussed more fully in Section III.B). We propose to retain any additional conditions appropriate for Form S-3 eligibility, such as an investment grade requirement, in General Instruction I.B.5 of Form S-3. Under our proposed format, however, a security that met the general definition of “asset-backed security” would be subject to the disclosure and other requirements we propose regardless of how registered.

After more than ten years of experience with the definition of “asset-backed security,” we believe that the core definition is still sound. The definition allows broad flexibility as to asset types and structures that we believe should be subject to the alternative disclosure and regulatory regime that exists for asset-backed securities. As the Commission stated in the 1992 Release, the definition does not distinguish between pass-through (i.e., equity) and pay-through (i.e., debt) asset-backed securities nor does it limit application to a list of “eligible” assets that can be securitized, so long as such assets meet the general principle that they are financial assets that by their terms convert into cash within a finite time period.⁶⁰ We believe, conversely, that the alternative regime for asset-backed securities would not be appropriate for securities that fall outside the definition.

Experience with the definition has resulted in several interpretations since its adoption. These interpretations have developed primarily through staff processing of ABS registration statements and in a few instances through staff no-action letters. As such, these interpretations may not always have been transparent.

Accordingly, we propose to retain the same basic definition of asset-backed security, with one modification discussed below with respect to leases. We also propose to codify several clarifying interpretations of the definition that recognize and build upon the operational and structural distinctions between ABS and non-ABS transactions. In many cases, through the process of codifying these interpretations, we also are proposing to expand many of the existing interpretations to allow additional asset types and transaction features to be considered an “asset-backed security,” including for purposes of shelf registration if the asset-backed securities meet the additional criteria for registration on Form S-3, such as the investment grade requirement.

Our proposed definition and interpretations are intended to establish parameters for the types of securities that are appropriate for our proposed alternative regulatory regime for asset-backed securities, including, for securities that meet the additional criteria for Form S-3 registration, delayed shelf registration and the use of certain written communications. The proposals would not mean or imply that public offerings of securities outside of these parameters may not be registered with the Commission, but only that the disclosure and other requirements in the regime for asset-backed securities are not designed for those securities. The proposals would mean that such securities would need to rely on non-ABS form eligibility for registration, including shelf registration. Additional disclosures are currently required for such securities under our existing disclosure regime.

Under our proposal, the basic definition of “asset-backed security” would be “a security that is primarily serviced by the cash flows of a discrete pool of receivables or other financial assets, either fixed or revolving, that by their terms convert into cash within a finite time period, plus any rights or other assets designed to assure the servicing or timely distributions of proceeds to the securityholders; provided that in the case of financial assets that are leases, those assets may convert to cash partially by the cash proceeds from the disposition of the physical property underlying such leases.”⁶¹ The only change we propose from the current definition is the addition of the proviso with respect to leases, discussed below.

The proposed definition of “asset-backed security” includes the same basic concept of a discrete pool of financial assets that by their terms convert into cash within a finite time period. We believe this does not include so-called “synthetic” securitizations.⁶² Synthetic securitizations are a relatively recent development in structured finance designed to create exposure to an asset that is not transferred to or otherwise part of the asset pool. These synthetic transactions are often effectuated through the use of credit derivatives such as a credit default swap or total return swap. Synthetic securitizations do not actually own the underlying assets; instead, the assets that are to constitute the actual “asset pool” under which the return on the ABS is primarily based are only referenced through the credit derivative.

The first set of interpretations we propose to codify relates to the nature of the issuing entity in whose name the asset-backed securities are issued. In this regard, we believe that two interpretations always have been implied. We propose to codify both as additional conditions to the definition of “asset-backed security.”

The first condition is that neither the depositor nor the issuing entity is an investment company under the Investment Company Act, nor will either become one as a result of the asset-backed securities transaction. If either was the case, we believe the separate regulatory regime for investment companies should be followed in lieu of our proposals for asset-backed securities. The second condition is that the issuing entity must be passive and its activities restricted to the asset-backed securities transaction. In particular, the activities of the issuing entity must be limited to passively owning or holding the pool of assets, issuing the asset-backed securities supported or serviced by those assets, and other activities reasonably incidental thereto.⁶³ As we stated in the proposing release for the 1992 amendments, the legal nature of the issuing entity—whether a trust, limited purpose subsidiary or other legal person—is not necessarily relevant.⁶⁴ However, we believe the limited function and permissible activities of the issuing entity are fundamental to the notion of a security that is to be backed solely by a pool of assets.

In 1997, Commission staff issued a no-action letter clarifying that an asset pool having total delinquencies of up to 20% at the time of the proposed offering may still be considered an “asset-backed security.”⁶⁵ In addition, there also exists a longstanding staff interpretive position that no non-performing assets may be included as part of the asset pool at the time of the proposed offering. The issue in either case is that such assets may no longer be (or in the case of non-performing assets, are not) converting into cash within a finite time period, as required by the definition of asset-backed security, given that such assets are not performing in accordance with their terms and management or other action may be needed to convert them to cash.

We propose to codify these interpretations. First, we propose that no non-performing assets may be part of the original asset pool at the time of issuance of the asset-backed securities.⁶⁶ Part of the difficulty for issuers in complying with the existing interpretive position is that there is no uniform definition of what is a “non-performing asset.” We understand that the point at which a financial asset is considered “non-performing” is often dependent upon asset type, with some financial assets being considered non-performing before other types of financial assets would. However, we believe the point at which the financial asset should be charged-off appears to be a consistent reference point, even if the point at which that event would occur may vary. Accordingly, we propose to define “non-performing” to be a pool asset if any of the following was true:

We believe this definition provides flexibility for different asset classes while still ensuring that no assets are included in the pool that would otherwise be considered to be non-performing and thus charged-off under an objective standard. We propose to require disclosure of these charge-off policies in Regulation AB, discussed more fully in Section III.B.

We also propose to codify a delinquency concentration limit in a manner consistent with the staff no-action letter. However, as we are proposing a general definition of “asset-backed security” regardless of eligibility for shelf registration, we propose two separate delinquency concentration limits. For the general definition (e.g., for offerings that could be registered on a non-shelf basis on Form S-1), we propose that delinquent assets may not constitute 50% or more, as measured by dollar volume, of the original asset pool at the time of issuance of the asset-backed securities. We believe concentrations above that threshold begin to raise serious doubt that the transaction should be characterized as an “asset-backed security” as the payments on the securities in such transactions would appear to depend more on the ability of the entity or entities that provide collection services for the delinquent assets than on the self-liquidating nature of the underlying assets. For shelf registration eligibility, we propose to retain the existing 20% delinquency concentration level. For purposes of determining whether a pool asset is delinquent under either threshold, we propose to define a pool asset as “delinquent” if any portion of a contractually required payment on the asset is 30 days or more past due. This is the existing standard in the staff no-action letter.⁶⁸

With regard to determining delinquency, one potential area of concern is improper re-aging or restructuring of delinquent accounts, such as declaring an asset with multiple past-due payments as current even if only the last payment was made. Improper re-aging or recharacterization of delinquent accounts cannot be employed for purposes of satisfying delinquency concentration limits. We propose to clarify in the definition of “delinquent” that a pool asset that was more than one payment past due could not be characterized as not delinquent if only partial payment on the total past due amount had been made, unless the obligor had contractually agreed to restructure the obligation, such as part of a workout plan.⁶⁹ In proposing our delinquency limits, we also are proposing to require disclosure, discussed more fully in Section III.B., of policies regarding grace periods, re-aging, restructures or other such practices on delinquencies. We also propose disclosure on an on-going basis, discussed more fully in Section III.D., regarding material modifications, extensions or waivers to pool asset terms, fees, penalties or payments.

The one change we propose to the basic definition of “asset-backed security” is to expand the definition to include securitizations backed by leases where part of the cash flows backing the securities is to come from the disposal of the residual asset underlying the lease (e.g., selling an automobile at the end of an automobile lease).⁷⁰ In that instance, the asset-backed securities are not backed solely by financial assets that “by their terms convert into cash,” because the transaction also involves a physical asset that must be sold in order to obtain cash. As a result, securitizations where a portion of the cash flow to repay the securities is anticipated to come from the residual value of the physical property do not fall within the current definition of “asset-backed security” in Form S-3 and thus are often registered on a non-shelf basis on Form S-1.

Lease-backed ABS have grown into a common and recognized segment of the overall ABS market.⁷¹ However, even though we are recognizing the growth in lease-backed ABS that include securitizations of residual value, such securitizations are subject to additional factors that are not present in securitizations backed solely by financial assets that convert into cash. Residual value is often determined at the inception of a lease contract and represents an estimate of the leased property’s resale value at the end of the lease. Assumptions and modeling are necessary to determine the amount of the residual value. In addition, the transaction is not simply dependent on the servicing and amortization of the pool assets, but also on the capability and performance of the party that will be used to convert the physical property into cash and thus realize the residual values.

The higher the percentage of cash flows that are to come from residual values, the more important these other factors become and the less the transaction resembles a traditional securitization of financial assets for which our regime for asset-backed securities is designed. We propose to address this concern in two ways. First, we propose additional disclosures, discussed more fully in Section III.B., on how residual values were estimated and derived, statistical information on historical realization rates and disclosure of the manner and process in which residual values will be realized, including disclosure about the entity that will convert the residual values into cash. Second, similar to existing practice regarding delinquencies, we propose limits on the percentage of the cash flow anticipated to come from residual values in order to be considered an “asset-backed security.”

In proposing residual value limits, we recognize that market practice regarding lease-backed securitizations vary on the typical percentage of cash flows that are expected to come from residual values. For example, auto lease securitizations often have higher residual value percentages than equipment-backed securitizations due to the higher resale values that often exist between automobiles and other equipment. Accordingly, after reviewing residual value percentages for typical lease-backed securitizations, we propose that for the general definition of “asset-backed security,” the portion of the cash flow to repay the securities anticipated to come from the residual value of the physical property underlying the leases may not constitute:

In addition, we propose a more stringent limitation for cash flow from residual values for offerings of securities backed by leases other than automobile leases that may be registered on Form S-3 and thus eligible for shelf registration. For Form S-3 eligibility, we propose that for leases other than automobile leases, the portion of the cash flow anticipated to come from residual values may not constitute 20% or more, as measured by dollar volume, of the original asset pool at the time of issuance of the asset-backed securities, which we believe is consistent with market practice and the types of offerings that would be appropriate for shelf eligibility. We believe these proposals will expand eligibility of lease-backed transactions for shelf registration and appropriately permit lease-backed transactions under our proposed rules while continuing to apply the basic principles underlying the definition of “asset-backed security.”

The last set of interpretations we propose to codify relates to exceptions to the requirement in the definition of “asset-backed security” that the asset pool be “discrete.” The existence of the “discrete” requirement is to prevent a level of portfolio management that is not contemplated by the definition of “asset-backed security” or consistent with this registration and reporting regime. In addition, the lack of a “discrete” requirement would make it difficult for an investor to make an informed investment decision when the composition of the pool is unknown or could change over time.

However, ever since the original definition of “asset-backed security” was adopted, there has been some confusion over the meaning of the term “discrete” in the definition, particularly with respect to language in the definition that specifies the asset pool must be a “discrete pool of receivables or other financial assets, either fixed or revolving.” The 1992 Release specified that the phrase “fixed or revolving” was added “in order to make clear that the definition covers ‘revolving’ credit arrangements, such as credit card and short-term trade receivables, home equity loans and automotive dealer floorplan financings, where account or loan balances revolve due to periodic payments, charge-offs and closings of the receivables.”⁷³ Thus, the basic principle is that the balance of a pool asset may revolve, but not the asset pool itself.⁷⁴

Nevertheless, in response to market developments, the staff has allowed certain exceptions, with limits, to the discrete pool requirement. These exceptions relate to master trusts, prefunding periods and revolving periods. In a master trust, the ABS transaction contemplates adding additional pool assets in connection with future issuances of asset-backed securities backed by the same, but expanded, asset pool. Pre-existing securities also would therefore be backed by the same expanded asset pool. In a prefunding period, a limited portion of the proceeds of the offering is set aside for the future acquisition of additional pool assets within a specified period of time after the issuance of the asset-backed securities. In a revolving period, a limited amount of cash flows from the asset pool may be recycled for a specified period to acquire new pool assets instead of being applied to payments on the asset-backed securities.⁷⁵

The staff’s interpretive history in this area has resulted in limits on which asset classes may use these structures and still be considered an “asset-backed security.”⁷⁶ We now propose to codify these three exceptions and also expand them so that they are applicable to all asset types.⁷⁷ A transaction could employ one or more of these features and still qualify as an “asset-backed security.” These expansions should result in increased flexibility in structuring transactions that meet market demands without regard to regulatory restrictions.

As in the case of our proposals for lease-backed ABS that involve residual values, we believe the concern relating to these structures can be appropriately addressed through disclosure, both at the time of issuance of the asset-backed securities as well as on an ongoing basis through disclosure of how the asset pool is materially changing.⁷⁸ As such, we are proposing more detailed disclosures in Regulation AB, discussed more fully in Section III.B., regarding the operation of such structures and changes to the asset pool over time.

Consistent with current staff practice, we also are proposing limits on the amount and duration of prefunding and certain revolving periods to limit the amount of changes to the asset pool, while still allowing flexibility to accommodate market demands. These limits are designed to establish parameters for the types of securities that should be subject to the ABS regulatory regime. As with lease-backed ABS, we believe these proposals will expand eligibility of these structures while continuing to apply the basic principles underlying the definition of “asset-backed security.”

Our proposal would allow master trust structures to meet the definition of “asset-backed security” without any pre-determined limits.⁷⁹ For prefunding periods, we propose separate limits for shelf and non-shelf offerings similar to our proposals for lease-backed ABS. For the general definition of “asset-backed security,” the amount of proceeds that may be used for a prefunding period may be up to 50% of offering proceeds and the length of the prefunding account may last up to one year from the date of issuance of the asset-backed securities. As with our other proposed thresholds, we believe prefunding periods above these thresholds begin to raise serious doubt that the transaction should be characterized as an “asset-backed security.” For Form S-3 eligibility, we propose that the amount of proceeds that may be used for a prefunding period may be up to 25% of offering proceeds over a similar one-year period. With larger prefunding periods, as with larger revolving periods discussed below, we believe investors should be entitled to the additional time and information they would receive that is typical for transactions conducted on a non-shelf basis.

For revolving periods, our proposals would recognize the nature of the asset being securitized (i.e., whether it itself is fixed or revolving). For receivables or other financial assets that by their nature revolve (e.g., credit cards, dealer floorplan financings or home equity lines of credit), there would as today be no limit on the number of assets that may revolve nor a limit on the duration of the revolving period. For fixed receivables or other financial assets (e.g., standard residential mortgages, auto loans and leases), we propose limits similar to prefunding periods; that is, the general definition of “asset-backed security” would specify that the additional assets that may be acquired in the revolving period may constitute up to 50% of the proceeds of the offering and the duration of the revolving period may last for up to one year from the date of issuance of the asset-backed securities. For Form S-3 eligibility, the revolving period would be limited to 25% of proceeds over a one-year period.

Questions regarding proposed exceptions to the “discrete pool” requirement:

We do not propose a new registration statement form for offerings of asset-backed securities. We preliminarily believe that the existing form structure is sufficient, provided there are appropriate instructions in the applicable forms as to their use for ABS offerings. We do propose to limit the registration of asset-backed securities offerings to two forms: Form S-1 or Form S-3.⁸⁰ As is currently the case, Form S-3 would retain the requirements that would qualify an offering for delayed shelf registration on that form. Form S-1 would thus become the form for all offerings that meet the basic definition of an “asset-backed security” but do not meet the additional eligibility requirements for Form S-3 (e.g., investment grade and proposed additional limits on lease-backed ABS, delinquent pool assets and prefunding and revolving periods). We propose to amend our other Securities Act registration statement forms for primary offerings to exclude explicitly their use for ABS offerings.⁸¹ Since as discussed below we do not intend to have a separate disclosure regime or requirements for foreign ABS, there is no need to provide separate form types for foreign ABS offerings. These offerings also would be registered on Forms S-1 or S-3, as applicable.

While Form S-3 currently specifies eligibility for ABS offerings, neither it nor any other form clarifies how the form is to be prepared for such an offering. Therefore, we propose separate general instructions for both Form S-1 and Form S-3 to specify use for ABS offerings. Proposed General Instruction VI. to Form S-1 would clarify how that form is to be prepared for an ABS offering. In particular, the proposed instruction would clarify who is to sign the registration statement (discussed more fully in Section III.A.3.d.) as well as the menu of required disclosure items. As to the latter, the proposed instruction would identify the existing items in the form that may be omitted as well as substitute core disclosure items from proposed Regulation AB that would be required. As discussed in Section III.B., proposed Items 1102-1118 of Regulation AB would represent the basic disclosure package for registered ABS offerings. Any other applicable items specified in Form S-1, such as the description of the securities and the offering, would continue to be required.⁸² The proposed application of the disclosure items for Form S-1 is presented in the following table:

¹ Descriptions regarding pool assets and relevant property underlying the pool assets would be covered under new Items in proposed Regulation AB.

³ Except for Item 403(a) of Regulation S-K and if the issuing entity does not have any executive officers or directors.

⁴ If the issuing entity does not have any executive officers or directors. We propose a separate item in Regulation AB regarding affiliations and related transactions among transaction participants.

Proposed General Instruction V. to Form S-3 would perform a similar function for that form. Unlike current practice on Form S-1, non-ABS offerings on Form S-3 rely predominately on incorporation by reference of Exchange Act reports for disclosure unrelated to the offering. As a result, existing Form S-3 does not set forth a detailed menu of disclosure items apart from disclosure about the offering. However, because a reporting history is not required for ABS for Form S-3 eligibility, investment grade ABS offerings registered on that form often must present all of their disclosure in the base prospectus and prospectus supplement in lieu of incorporating information by reference. Accordingly, the proposed Form S-3 instruction for ABS does not specify any existing items that may be omitted, but rather simply specifies the addition of the same basic disclosure package from Regulation AB. The other disclosure items required by Form S-3, such as the description of the securities and the offering, would continue to be required as applicable. Therefore, as shown in the following table, the effect of the proposed general instruction is to add the basic disclosure package of proposed Items 1102-1118 of Regulation AB:

b. Presentation of Disclosure in Base Prospectuses and Prospectus Supplements

In proposing to specify the menu of disclosure items applicable for ABS offerings eligible for Form S-3, and thus shelf registration, we do not intend to change the current practice or ability to present such disclosure in a separate base prospectus and prospectus supplement, a practice also available for non-ABS offerings.⁸³ Items in the basic disclosure package that are known or reasonably available should continue to be described in the base prospectus, while disclosure dependent on the final terms of the particular takedown could still be provided in the prospectus supplement.⁸⁴ A form of prospectus supplement would still be required to accompany the base prospectus in the registration statement at the time of effectiveness that outlines the format of deal-specific information that will be disclosed at the time of each takedown.⁸⁵

As referenced in the 1992 Release, the type or category of asset to be securitized must be fully described in the registration statement at the time of effectiveness. The structural features contemplated also should be disclosed. In addition, risks associated with changes in interest rates or prepayment levels should be fully disclosed. The various scenarios under which payments on the asset-backed securities could be impaired also should be discussed, as well as identification of the types or categories of securities that may be offered, such as interest-weighted or principal-weighted classes (including IO or PO securities), planned amortization or companion classes or residual or subordinated interests.

In presenting disclosure in base prospectuses and prospectus supplements, registrants are reminded that, as is the case today for all shelf offerings, the base prospectus must fully describe the types of offerings contemplated by the registration statement. A takedown off of a shelf that involves assets, structural features, credit enhancement or other features that were not described as contemplated in the base prospectus will usually require either a new registration statement (e.g., to include additional assets) or a post-effective amendment (e.g., to include new structural features or credit enhancement) rather than simply describing them in the final prospectus filed with the Commission pursuant to Securities Act Rule 424.⁸⁶ Registrants should exercise discretion, however, in describing only the material asset types or features reasonably contemplated to be included in an actual takedown in lieu of attempting to identify every conceivable permutation, no matter how remote. Such a practice only exacerbates unnecessarily the length of the base prospectus and limits the usefulness of this method of disclosure by including unnecessary and uninformative disclosure that obscures material information.

We do propose to specify in the proposed general instruction to Form S-3 the existing requirement to prepare separate base prospectuses and forms of prospectus supplements when multiple asset types may be securitized. As stated in the 1992 Release, a registration statement may not merely identify several alternative types of assets that may be securitized. A separate base prospectus and form of prospectus supplement must be presented for each asset class that may be securitized in a discrete pool in a takedown under that registration statement. Any difference in country of origin or country of property securing the pool assets also would require a separate base prospectus and form of prospectus supplement for each country.

An additional issue that often results in staff comment is the inclusion of language in registration statements that investors should rely on the information in the prospectus supplement if the terms of a particular series of securities conflict or vary between the base prospectus and the accompanying prospectus supplement. Disclosure in prospectus supplements regarding the transaction may enhance disclosure in the base prospectus regarding contemplated transactions, but should not contradict it. Similarly, including language to the effect of “Except as otherwise provided in the prospectus supplement” will permit some supplemental or modified terms of transactions, but should not be construed as creating the ability to add asset types or structural features in a takedown that were not otherwise contemplated by and described in the base prospectus.

Questions regarding presentation of disclosure in base prospectuses and prospectus supplements:

We propose to maintain the existing requirement for ABS Form S-3 eligibility that the asset-backed securities must be rated “investment grade” by a nationally recognized statistical rating organization, or NRSRO, at the time of offer and sale to the public.⁸⁷ The definition of “investment grade” would remain the same as for other investment grade securities that may be registered on Form S-3.⁸⁸ The “investment grade” requirement has existed for over ten years with respect to asset-backed securities and for over twenty years with respect to other non-convertible securities. The Commission is engaged in a review of the role of credit rating agencies in the operation of the securities markets, including whether credit ratings should continue to be used for regulatory purposes under the federal securities laws.⁸⁹ However, pending outcome of that review, we propose to maintain the same rules and standards currently used for purposes of Form S-3 eligibility.

As discussed previously, we propose four additional conditions regarding the types of asset-backed securities that would qualify for Form S-3 eligibility. First, we propose to codify the current position that delinquent assets may not constitute 20% or more, as measured by dollar volume, of the original asset pool. Second, for securities backed by leases other than automobile leases, the portion of the cash flow to repay the securities anticipated to come from the residual value of the physical property underlying the leases may not constitute 20% or more, as measured by dollar volume, of the original asset pool. Third, the offering may not contemplate a prefunding account in excess of 25% of the proceeds of the offering or that lasts for more than one year. Finally, with respect to fixed financial assets that do not by their nature revolve, the amount of additional assets to be acquired in a revolving period may not exceed 25% of the proceeds of the offering or last for more than one year.

Consistent with existing requirements, we do not propose to add a reporting history requirement for ABS Form S-3 eligibility. However, we do propose codifying that reporting obligations regarding other asset-backed securities transactions established by the sponsor and the depositor have been complied with for the prior 12 months for continued Form S-3 eligibility for new transactions.⁹⁰ This proposal would not require that there be a reporting history with respect to any prior transactions, only that any existing or prior requirements during the past year have been met. This would include all prior reporting obligations during the preceding year, even if and only up until those obligations were suspended at some point during the year pursuant to Section 15(d) of the Exchange Act. While we believe the instances when this requirement would not be met should be rare, we do not believe it would be appropriate to continue to allow the benefits of shelf registration to new transactions established by sponsors or depositors that have not complied with ongoing reporting obligations involving previous asset-backed securities transactions.

We propose to clarify which entity is considered the “issuer” under the Securities Act with respect to an offering of asset-backed securities. The Securities Act defines the term “issuer” in part to include every person who issues or proposes to issue any security, except that with respect to certificates of deposit, voting-trust certificates, or collateral trust certificates, or with respect to certificates of interest or shares in an unincorporated investment trust not having a board of directors (or persons performing similar functions), the term issuer means the person or persons performing the acts and assuming the duties of depositor or manager pursuant to the provision of the trust or other agreement or instrument under which the securities are issued.⁹² Under current staff positions, the depositor must sign the Securities Act registration statement for an ABS offering. In addition, the issuing entity also must sign in the rare situation where it is formed prior to effectiveness.

We propose to clarify that the depositor for the asset-backed securities, acting solely in its capacity as depositor to the issuing entity, is the “issuer” for purposes of the asset-backed

securities of that issuing entity.⁹³ Further, our proposed rule would specify that the person acting in its capacity as the depositor for the issuing entity of an asset-backed security is a different “issuer” from that same person acting as a depositor for any other issuing entity or for purposes of that person’s own securities. As the proposed definition of asset-backed security would clarify that the issuing entity would need to be a passive special purpose investment vehicle, the proposed rule would apply regardless of the issuing entity’s form of organization.

By clarifying that the person acting as the depositor in its capacity as depositor to the issuing entity is a different “issuer” from that person in respect of its own securities, any applicable exemptions from registration that person may have with respect to its own securities would not be applicable to the asset-backed securities.⁹⁴ Similarly, the reporting history with respect to a particular class of asset-backed securities would not affect Form S-3 eligibility with respect to the depositor’s or sponsor’s own securities, although as discussed above we do propose that the reporting history with respect to prior asset-backed securities transactions established by the sponsor or the depositor could affect continued Form S-3 eligibility for future ABS transactions.

Consistent with this proposal, we propose to codify in the general instructions for Forms S-1 and S-3 that the registration statement would need to be signed, as is currently the case, by the depositor, the depositor’s principal executive officer or officers, principal financial officer and controller or principal accounting officer, and by at least a majority of the depositor’s board of directors or persons performing similar functions. We would no longer require the issuing entity to sign if formed prior to effectiveness as such a requirement would be superfluous.

Questions regarding proposed definition of “issuer” and signatures required:

While not as prevalent as in the U.S., securitization by foreign issuers has been developing rapidly.⁹⁵ However, asset-backed securities issued by a foreign issuer⁹⁶ or that are backed by foreign assets raise special issues due to potential differences in the legal and regulatory regime of the relevant home country. Differing laws and practices regarding banking regulation, accounting, bankruptcy, property rights, secured transactions, “true sale,” tax, asset servicing, consumer protection and other matters may alter fundamentally the basic principles underlying an “asset-backed security.” Also, given the early stage of securitization in some foreign markets, ABS may be used not just as an alternative funding source, but more for capital management, including efforts to “prune” a lender’s portfolio by off-loading poorly performing assets.⁹⁷

As a result of these concerns, the staff currently requires additional conditions for the processing of Form S-3 registration statements involving foreign ABS offerings. These conditions may include first requiring one or more registered offerings on a non-shelf basis on Form S-1 or S-11 that is fully reviewed by the staff, as well as other steps or conditions to help assure that novel or unique questions can be addressed by the staff. As experience with a particular issuer, asset type and laws related to asset-backed issues in the home country increases, the requirements decrease. Nevertheless, while designed to address the concerns noted above, these additional steps and conditions can result in delays and possible impediments to access to the U.S. public capital markets through shelf registration for foreign ABS, even if the other requirements for shelf registration, such as an investment grade rating, can be met.

To address the foreign and legal and regulatory issues while appropriately treating foreign ABS transactions, we are not proposing a different disclosure or regulatory regime for foreign ABS, with the one exception discussed below. Foreign ABS would be registered on the same Securities Act registration forms as domestic ABS, and with the exception of the disclosure discussed below, foreign ABS would be subject to the same disclosure requirements in proposed Regulation AB. Foreign ABS offerings registered on Form S-3 also would be eligible for our proposals regarding the use of ABS informational and computational material and ABS research reports discussed in Section III.C.

Like several of our other proposals, we believe that many of the concerns relating to foreign ABS can be appropriately addressed through adequate disclosure. As such, we are proposing an additional general instruction in Regulation AB focused on foreign ABS that if asset-backed securities are issued by a foreign issuer, are backed by foreign assets, or are affected by credit enhancement or other support provided by a foreign entity, then in providing the disclosures required, the filing also must describe any pertinent governmental legal or regulatory or administrative matters and any pertinent tax matters, exchange controls, currency restrictions or other economic, fiscal, monetary or potential factors that could materially affect payments on the performance of, or other matters relating to, the assets contained in the pool or the asset-backed securities.⁹⁸ This disclosure should particularly address the material items and legal and regulatory or administrative factors discussed above. Similar to the proposed requirement that registrants have separate base prospectuses for different asset classes, as discussed in Section III.A.3.c., is a proposed requirement that a registrant would need to prepare separate base prospectuses for each country of origin or country of property securing the pool assets.

We would expect that at the time of filing, the registration statement would include fully developed disclosure clearly articulating the material differences and effects of the home country legal and regulatory regime. In this regard, we also encourage pre-filing conferences with the staff where appropriate to discuss the home country legal and regulatory environment, the proposed transaction and the relevant disclosures that would be required.⁹⁹

We also do not propose a different Exchange Act reporting structure for foreign ABS. We believe periodic disclosure of distribution and pool performance information, reports regarding servicing compliance (including an attestation report on an assessment of compliance with servicing criteria) and current disclosure of significant events would be equally relevant and applicable for foreign ABS as they are for domestic ABS. Thus, like domestic ABS, foreign ABS would be required to report on Forms 10-D, 10-K and 8-K. In addition, ongoing disclosures would be required in Forms 10-D and 10-K regarding any material impact caused by foreign legal and regulatory developments during the period covered by the report which had not been previously described.

Through a series of staff no-action letters, in connection with offerings of asset-backed securities eligible for registration on Form S-3, broker-dealers are not required under Exchange Act Rule 15c2-8(b) to deliver a copy of a preliminary prospectus to any person who is expected to receive a confirmation of sale at least 48 hours prior to the sending of such confirmation.¹⁰⁰ Without these no-action letters, most broker-dealers would be required to deliver a preliminary prospectus in ABS offerings because Rule 15c2-8(b) requires such delivery if the issuer has not previously been required to file reports with the Commission pursuant to Section 13(a)¹⁰¹ or 15(d) of the Exchange Act, which most ABS issuers at the time of the ABS offering are not. In arguing for the no-action relief, the incoming requests to the staff cited the ability to use term sheets and computational material as substitutes,¹⁰² the expense of preparing a preliminary prospectus and practical difficulties in preparing a preliminary prospectus given that the structure of an ABS transaction often evolves during the offering process.

Given our more than eight years of experience with the staff no-action letters, we are proposing to codify the position as a formal exclusion from Exchange Act Rule 15c2-8(b).¹⁰³ Although we propose to codify the staff position regarding Rule 15c2-8(b), the proposal does not affect any other obligation in that rule nor any other prospectus delivery obligation that may be applicable. The proposed exclusion only would be available with respect to registered offerings of investment grade asset-backed securities that meet the requirements of General Instruction I.B.5 of Form S-3. With respect to asset-backed securities that do not meet Form S-3 requirements (i.e., those that would be registered on Form S-1), we believe investors should be entitled to the additional time and information they would receive as a result of Rule 15c2-8(b). We also believe that because of a separate registration statement for each Form S-1 offering, the impact of complying with the rule is less significant in that context.

Although we do propose to codify the exclusion from Rule 15c2-8(b) for Form S-3 ABS, we are concerned with statements from investors in previous communications to the staff that a combination of factors, including the introduction of shelf registration for ABS, relief from Rule 15c2-8(b) and the ability to use term sheets and computational material, has reduced the amount of time and information investors have to make informed investment decisions.¹⁰⁴ In this regard, we note that investors should have adequate information at the time of an investment decision in an ABS offering, as in the case of all offerings. We request comment regarding these concerns.

The 1992 Release included a statement that the definition of “asset-backed security” does not encompass securities issued in structured financings for one obligor or group of related obligors. It also stated that asset-backed offerings with a significant asset concentration—that is, a significant concentration of obligations of one obligor or related obligors—may involve one or more co-issuers under Securities Act Rule 140.¹⁰⁵ In interpreting these provisions, the staff has focused on ensuring that an ABS offering does not constitute an unregistered distribution of underlying securities and that non-S-3 eligible registrants do not circumvent Form S-3 eligibility requirements by attempting to structure their offering as an asset-backed offering. One of the basic premises underlying ABS offerings is that an investor is buying participation in the assets. Therefore, if the assets being securitized are themselves securities under the Securities Act, the offering of those securities also must be registered or exempt from registration from the Securities Act.¹⁰⁶

In considering whether the distribution of the underlying assets must be registered in addition to the distribution of the ABS, the basic proposition is that where the underlying securities themselves are not exempt from registration, the depositor must be free to publicly resell the underlying securities without registration. Otherwise, their distribution must be registered. If registration of the underlying securities distribution is required, certain conditions and disclosures have developed through the staff comment process and industry practice regarding the method and manner of such registration. These conditions are designed to provide clear disclosure to investors of the different distributions involved, the relationships between the distributions and investor rights with respect to each distribution.

The nature of the distribution of the underlying securities is the important factor in determining whether concurrent registration is required, not necessarily their concentration in the pool. For example, if a $100 million asset pool included $5 million of securities that were not freely resalable by the depositor without registration, then the distribution of those $5 million of securities through the ABS distribution also would need to be registered, even though such securities only constituted 5% of the asset pool. Similarly, if a depositor obtained $100 million of freely resalable securities of one obligor from the secondary market, the offering of ABS backed by those securities would not require concurrent registration of the distribution of the underlying securities, even though one obligor represented 100% of the pool, because the securities were not purchased from the issuer or underwriter but rather were purchased in the secondary market. In that case, additional disclosure would be required regarding the concentrated obligor, including financial information about the obligor, but the concentration itself would not trigger a separate registration requirement.¹⁰⁷ As a result, the definition of “asset-backed security” may encompass securities issued in structured financings for one obligor or group of related obligors, so long as any required disclosure about the underlying obligor is provided and any distribution of the underlying securities is registered, if required.

To provide further clarification and regulatory certainty regarding this topic, we propose to codify in substantial part existing staff positions, as well as to streamline the conditions that would be required if the distribution of the underlying securities also must be registered.¹⁰⁸ First, we propose to delineate the conditions when registration of the distribution of the underlying security would not be required. Most asset types that are securitized today, including residential mortgages, student loans, auto loans and credit card receivables, would meet these conditions and thus would not be affected.

Under our proposal, in an ABS offering where the asset pool includes securities of another issuer, unless the underlying securities are exempt from registration under the Securities Act, the offering of the underlying securities itself must be registered as a primary offering of such securities, unless all of the following are true:

The first condition states the basic proposition that the securities of the underlying issuer must be freely resalable without registration. Consistent with existing staff practice, we propose to include two examples to clarify this condition. First, the underlying securities may not include restricted securities (e.g., privately placed securities) that do not meet the conditions for resale in Securities Act Rule 144(k) (e.g., a two-year holding period by non-affiliates).¹⁰⁹ Second, the offering of the asset-backed security could not constitute part of a distribution of the underlying securities. Underlying securities which at the time of their purchase for the asset pool are part of a subscription or unsold allotment would be considered a distribution of the underlying securities.

We also propose to codify a staff interpretive position where the ABS offering involves a sponsor, depositor or underwriter that was an underwriter or an affiliate of an underwriter in a registered offering of the underlying securities.¹¹⁰ Under the proposal, the distribution of the asset-backed securities would not constitute part of a distribution of the underlying securities if the underlying securities were purchased at arm’s length in the secondary market at least three months after the last sale of any unsold allotment or subscription by the affiliated underwriter that participated in the registered offering of the underlying securities. In this instance, we believe three months provides sufficient certainty that the purchase was not part of the original distribution.

The second and third conditions clarify that if the issuer of the underlying securities is engaged in the distribution of its securities through the asset-backed securities or is affiliated with the sponsor, depositor, issuing entity or any underwriter for the ABS offering, then registration of the underlying distribution would be required along with registration of the ABS offering.

If any of the three conditions was not met, the offering of the relevant underlying securities itself would be required to be separately registered as a primary offering of such securities. Such registration would need to be conducted in accordance with the following proposed conditions:¹¹¹

Some ABS transactions are structured such that the asset pool consists of one or more financial assets that represent an interest in or the right to the payments or cash flows of another asset pool solely in order to facilitate the asset-backed issuance and not in order to re-securitize other securities. For example, some older credit card master trust structures have added an “issuance trust” structure to provide additional flexibility in the types of ABS that may be offered. An issuance trust generally receives a collateral certificate from the master trust representing an interest in the master trust asset pool. The master trust often may have issued its own ABS backed by the same pool. The issuance trust then issues its own ABS backed by the collateral certificate, and hence indirectly by the whole master trust pool.

Similarly, in some auto lease transactions, the auto leases and car titles often are originated in the name of a separate trust, sometimes called an “origination” or “titling” trust, to avoid administrative expenses in retitling the physical property underlying the leases. The origination trust will issue to the issuing entity for the ABS a certificate, often called a “special unit of beneficial interest” or SUBI, representing a beneficial interest in a pool of leases and automobiles in the origination trust which is to constitute the asset pool. The ABS issuing entity will issue ABS backed by the SUBI certificate, and hence indirectly by the assets underlying the SUBI.

In each instance, these structures are solely designed to facilitate the ABS transaction. The ABS will be primarily serviced by cash flows from the underlying pool assets.

Securities and Exchange Commission

17 CFR PARTS 210, 228, 229, 230, 232, 239, 240, 242, 245 and 249

[RELEASE NOS. 33-8419; 34-49644; File No. S7-21-04]

RIN 3235-AF74

Asset-Backed Securities

TABLE OF CONTENTS

I. Overview

II. Background and Development of ABS and Regulatory Treatment

III. Discussion of the Proposals