The SEC proposes new rules related to representations and warranties in asset-backed securities (ABS's) offerings.  Comments should be submitted by 11/15.  As proposed:

• ABS securitizers would be required to disclose fulfilled and unfulfilled repurchase requests across all trusts aggregated by securitizer, so that investors may identify asset originators with clear underwriting deficiencies; and
• Nationally recognized statistical rating organizations - i.e., rating agencies - would be required to include, in any report accompanying an credit rating for an ABS offering, a description of: (A) the representations, warranties and enforcement mechanisms available to investors; and (B) how they differ from the representations, warranties and enforcement mechanisms in issuances of similar securities.

    What the Rule Seeks to Target.   The proposed rule addresses an obligation of the SEC under Section 943 of the Dodd-Frank Wall Street Reform and Consumer Protection Act related to asset-backed securities (“ABS”) - which requires the SEC to prescribe regulations on the use of representations and warranties in the market for asset-backed securities.  The Act requires the SEC to adopt these rules within 180 days of enactment of the Act.

Since the financial crisis, many investors and other transaction parties have questioned whether the loans in the bundle meet the characteristics specified by the representations and warranties in transaction agreements, and have been seeking to enforce repurchase provisions.  The Dodd-Frank Act imposes new disclosure obligations so that investors receive information about the representations and warranties and repurchase history so they may identify originators with clear underwriting deficiencies.

    SEC's Earlier Proposals.   In April 2010, the SEC proposed rules that would revise the disclosure, reporting and offering process for ABS's.  Among other things, it was proposed that issuers disclose in prospectuses the repurchase demand and repurchase and replacement activity for the last 3 years of sponsors of asset-backed transactions or originators of underlying pool assets if they are obligated to repurchase assets pursuant to the transaction agreements.  These disclosure requirements would apply to offerings of ABS's registered under the Securities Act or ABS's offered and sold without registration in reliance upon Securities Act rules, which includes both offerings eligible for Rule 144A resales and other offerings conducted in reliance on exemptions from registration.  The SEC also proposed that issuers disclose the repurchase demand and repurchase and replacement activity concerning the asset pool on an ongoing basis in periodic reports.  As described in this rule proposal, they are re-proposing the disclosure requirements with respect to repurchase requests in Regulation AB in order to conform the disclosures to those required by Section 943 of the Act.

In the underlying transaction agreements for an ABS, sponsors or originators typically make representations and warranties relating to the pool assets and their origination, including about the quality of the pool assets - e.g., for residential MBS's, a typical representation and warranty is that each of the loans has complied with applicable federal, state and local laws, including truth-in-lending, consumer credit protection, predatory and abusive laws and disclosure laws.  Another representation would be that no fraud has taken place in connection with the origination of the assets on the part of the originator or any party involved in the origination of the assets. 

Upon discovery that a pool asset does not comply with the representation or warranty, under transaction covenants, an obligated party, typically the sponsor, must repurchase the asset or substitute a different asset that complies with the representations and warranties for the non-compliant asset. The effectiveness of the contractual provisions related to representations and warranties has been questioned and lack of responsiveness by sponsors to potential breaches of the representations and warranties
relating to the pool assets has been the subject of investor complaint.

For further details, click onto:   [ SEC PR 10-182, 10/6 ] and/or [ Proposed Rule Release 33-9148, 10/5 ]