SEC Adopts Reforms to Increase Transparency of Investments

The Securities and Exchange Commission (SEC) adopted revisions to rules governing the disclosure, reporting, and offering process for asset-backed securities (ABS), as well as new requirements for credit rating agencies.

The agency said the ABS regulations are to enhance transparency, better protect investors and facilitate efficient capital formation in the securitization market. The new rules, among other things, require loan-level disclosure for certain assets, such as residential and commercial mortgages and automobile loans. The rules also provide more time for investors to review and consider a securitization offering, revise the eligibility criteria for using an expedited offering process known as “shelf offerings,” and make important revisions to reporting requirements.

The SEC also adopted requirements for issuers, underwriters, and third-party due diligence services to promote the transparency of the findings and conclusions of third-party due diligence regarding asset-backed securities.

“These are strong reforms to protect America’s investors by enhancing the disclosure requirements for asset-backed securities and by making it easier for investors to review and access the information they need to make informed investment decisions,” says SEC Chair Mary Jo White. “Unlike during the financial crisis, investors will now be able to independently conduct due diligence to better assess the credit risk of asset-backed securities.”

The new rules and amendments regarding credit rating agencies, which implement 14 rulemaking requirements under the Dodd-Frank Wall Street Reform and Consumer Protection Act, apply to credit rating agencies registered with the Commission as nationally recognized statistical rating organizations (NRSROs).

The new requirements for NRSROs address internal controls, conflicts of interest, disclosure of credit rating performance statistics, procedures to protect the integrity and transparency of rating methodologies, disclosures to promote the transparency of credit ratings, and standards for training and competence of credit analysts. The requirements provide for an annual certification by the CEO as to the effectiveness of internal controls and additional certifications to accompany credit ratings attesting that the rating was not influenced by other business activities.

“This expansive package of reforms will strengthen the overall quality of credit ratings, enhance the transparency of credit rating agencies and increase their accountability,” says White. “Today’s reforms will help protect investors and markets against a repeat of the conduct and practices that were central to the financial crisis.”

Asset-backed securities are created by buying and bundling loans, such as residential loans, commercial mortgage loans, auto loans and leases. Providers then create securities backed by those loan assets for sale to investors. A bundle of loans is often divided into separate securities with varying levels of risk and return potential. Payments made by the borrowers on the underlying loans are passed on to investors in the ABS.

ABS holders, including pension funds, suffered significant losses during the 2008 financial crisis, the SEC explained. The crisis revealed that many investors in the securitization market were not fully aware of the risks underlying the securitized assets. Investors tended to over-rely on ratings assigned by credit rating agencies, which in many cases did not appropriately evaluate the credit risk of the securities. The crisis also exposed a lack of transparency and oversight by the principal officers in the securitization transactions. The revised rules are designed to address these problems and to enhance investor protection.

In 2012, a coalition of institutional investors asked the SEC to make credit rating reform a top priority.

A fact sheet about the ABS regulations is here.  A fact sheet about the credit rating agency rules is here.