SEC Proposes Rule Prohibiting ABS Transactions that Present Conflicts of Interest

The SEC revised and re-proposed a rulemaking to prohibit an asset-backed security ("ABS") "securitization participant" from engaging in any transaction that would involve or result in material conflicts of interest.

The new proposed rule would implement Securities Act Section 27B ("Conflicts of interest relating to certain securitizations") and would apply to any underwriter, placement agent, initial purchaser or sponsor of an ABS, as well as any affiliates or subsidiaries of these entities, with limited exceptions. Under the proposal, "conflicted transactions" would include any agreement where the securitization participant would benefit from actual, anticipated or potentially adverse credit events or other declines in value of the ABS. Such conflicted transactions could include short sales of the relevant ABS, or the purchase of a credit default swap based on a credit event pertaining to the underlying ABS.

The SEC said that the prohibition would begin on the date on which an individual "has reached, or has taken substantial steps to reach, an agreement that such person will become a securitization participant with respect to an ABS," and would end one year after the first closing date of the relevant ABS. The SEC will grant exceptions to the proposed prohibition for (i) certain risk-mitigating hedging activities, (ii) bona fide market-making activities and (iii) other commitments by securitization participants to provide liquidity for the relevant ABS.

SEC Chair Gary Gensler said that the proposal will benefit both investors and markets, as it was designed to help address conflicts of interest arising with market participants taking positions against investor interests. SEC Commissioner Jaime Lizárraga said that the proposal would provide an important safeguard against the rampant misconduct that contributed to the 2008 financial crisis, but questioned whether the scope of the proposal would adequately address the issues raised. This concern over the scope of the proposal was similarly raised in SEC Commissioner Caroline A. Crenshaw's statement.

SEC Commissioner Hester M. Peirce expressed concern that the proposed rule may be overly broad and could do more harm than good. She asked that market participants provide feedback on items including, among others, whether (i) certain disclosures can resolve certain types of material conflicts of interest, (ii) the proposal is too vague and (iii) the proposal is consistent with other market rules. SEC Commissioner Mark T. Uyeda questioned whether the proposal strikes the right balance between protecting investors from harmful conflicts and ensuring that market participants can engage in transactions that do not cause such harm.