The Securities and Exchange Commission has approved the proposal of a new rule designed “to prohibit certain material conflicts of interest between those who package and sell asset-backed securities (ABS) and those who invest in them.”
The measure would, if approved after a 90-day comment period, impose a one-year ban on those conflicts of interest.
The proposed rule, which would implement Section 621 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, was approved by a 4-0 vote and is a response to concerns that some banks have been issuing structured products for sale to investors without telling those investors that the bank was simultaneously also helping other investors to bet against those products -- or even were betting against the issued securities themselves.
In the most notable example of this practice, the SEC sued Goldman Sachs accusing the company of issuing and selling a Collateral Debt Obligation (CDO) called ABACUS 2007-ACI, without informing investors that Paulson & Co., a hedge fund, had helped Goldman to select the underlying securities in the CDO, and that Paulson & Co. was then betting against those very securities it had selected.
Goldman Sachs settled that case for $550 million.
SEC Chair Mary L. Schapiro said, “This proposed rule is designed to ensure that those who create and sell asset-backed securities cannot profit by betting against those same securities at the expense of those who buy them.”
But she added, “At the same time, the proposed rule is not intended to interfere with traditional securitization practices in which loans are originated, packaged into asset-backed securities, and offered to investors in different structures.”
In a fact sheet accompanying the SEC announcement of the proposed rule, which will now have a 90-day comment period, the commission gives two examples of how it would work.
One case, the SEC said, would be to prohibit a firm from packaging an asset-backed security (ABS), selling it to investors, and then shorting that ABS to profit even as the investor incurred losses. The other would, under “certain conditions,” prohibit a firm from allowing a third party to help assemble an ABS so as to the profit from the failure of that ABS.
As written, the proposed rule would prohibit underwriters, placement agents, initial sponsors, sponsors or any affiliates or subsidiaries of an ABS or synthetic ABS for a year after the date of the sale closing from engaging in transactions that would involve or result in any material conflict of interest with respect to investors in the transaction.
The rule exempts from those restrictions risk-mitigating hedging activities or market-making but limits those activities to the value of the issued securities. That is, no hedging can exceed the value of the position.
Tom Deutsch, executive director of the American Securitization Forum, has expressed support for the proposed rule, but expressed “concerns about its execution.”
The Forum’s view is that while the commission’s comments on the rule sound good, the rule itself may have been written over broadly.
It is likely that the Forum, a trade organization for the securitization industry, will in the comment period call for a narrowing of the wording of the rule, or as one member of the forum put it, “clearer wording.”