SEC Shelves Rules for Private Securities

New disclosure requirements for public asset-backed bonds exclude private securities; critics see it as 'a massive hole' in the rules.

The U.S. Securities and Exchange Commission (SEC), while expanding disclosure requirements for one set of asset-backed securities, has stepped back from a plan to shed more light on a major part of the market.

On Wednesday, the five SEC commissioners unanimously approved a rule to offer investors more details on bonds backed by assets such as mortgages and car financing, including specific data on individual loans, and new practices such as a cooling-off period to review documents before certain bond sales.

Dropped from the rules: a requirement that issuers of private securities be ready to furnish to buyers the same type of information that’s available for publicly registered debt. The SEC said in a Federal Register posting proposing the rule in 2010 that such a step would bring “transparency to formerly opaque” markets.

“It’s a massive hole,” said David Jacob, the former global head of structured finance at Standard & Poor’s. “Most of the asset-backed market is a private market.”

Most private securities are issued using rule 144a, which the SEC created to allow for their resale among large, sophisticated investors of securities issued without being registered under the Securities Act of 1933.

Issuers sold about $60 billion of 144a asset-backed securities in the U.S. this year through mid-August, compared with $85 billion of publicly registered notes, according to newsletter Asset-Backed Alert.

The SEC may revive the requirement for private securities, according to Keith Higgins, director of the SEC’s division of corporation finance.

“The Dodd-Frank Act mandated that the commission put in place rules for asset-level disclosure in registration statements,” Higgins said yesterday. “Consistent with that mandate, the commission determined that it was important for investors that it move forward with the rules for registered offerings as the proposal for the rule 144a market remains under consideration. While that proposal is pending, we continue to monitor the market.”

The 2010 Dodd-Frank Financial Regulatory Reform Bill, named after Senator Christopher J. Dodd and U.S. Representative Barney Frank, increased government oversight of financial transactions to try to avoid the conditions that led to the 2008 crisis.

While most mortgage bonds without U.S. government backing were publicly registered before the crisis, all 12 of the deals tied to new home loans this year have been private placements, according to data compiled by Bloomberg. The transactions packaged $3.5 billion of mortgages, down from a peak of $1.2 trillion issued in each of 2005 and 2006.

In other securitization areas that have revived more completely, lenders including Deutsche Bank AG, Citigroup Inc., and JPMorgan Chase & Co. sold commercial-mortgage bonds using the 144a safe harbor in the past month, while First Investors Financial Services Group Inc., CarFinance Capital LLC, and American Credit Acceptance LLC tapped the option for subprime-auto securities, the data show.

The 144a issuance this year accounts for 23 percent of bond sales tied to cars, including 39 percent of non-prime debt, and also generally all securities backed by speculative-grade corporate debt known as collateralized loan obligations, according to a report by JPMorgan analysts including Amy Sze.


‘Controversial Part’

In initially proposing the rule known as Reg AB II in 2010 and then re-proposing it in 2011, the SEC had said a change in the disclosure requirements for such sales was needed as it attempted to address flaws unveiled by the crisis that bonds tied to U.S. mortgages helped to create.

“The financial crisis has called into question the ability of our rules, as they relate to the private market for asset-backed securities, to ensure that investors had access to, and had sufficient time and incentives to adequately consider, appropriate information,” the agency said in its 2010 proposal.

The idea represented a “very controversial part of the proposal,” said Jason Kravitt, a partner in New York at law firm Mayer Brown LLP, who works with underwriters and issuers.

Marcus Stanley, policy director at Americans for Financial Reform, a coalition working for stronger regulations, said that he was disappointed that the private-bond market wasn’t covered.

“A lot of the biggest abuses were in precisely that area,” he said, citing mortgage-backed notes that were repackaged into other instruments. “It just leaves a huge gap in the coverage of this rule not to mandate proper disclosures for those privately issued securities.”


‘Big Reversal’

The SEC’s decision is “a pretty big reversal from what I expected,” said Ned Myers, a senior vice president at Waltham, Massachusetts-based Lewtan Technologies Inc., which runs the ABSNet information and analytics service.

While many issuers will still want the access to the broader group of potential investors offered in public sales, where the buyers don’t need to qualify as sophisticated investors, “based on my conversations, my guess is you’re probably going to see a lot of more use of the 144a structure,” he said.

Making the avenue for sales more difficult could have posed a threat to the flow of money to borrowers, said Kravitt, the lawyer. Private deals are often used by issuers “who aren’t quite ready for prime time of public offerings to introduce themselves to the markets,” being either too small or new to provide all the needed disclosures, he said.

“You’ve got to be careful before you tamper with something that’s so valuable and that’s worked so well,” he said.

Stanley of Americans for Financial Reform said the loan-level data that the SEC will be requiring for public bonds is just as needed for private securities.

“At the end of the day, this stuff is like the ingredients label on what you’re getting at the supermarket,” he said. “It’s important in making the choice whether to buy.”

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