SEC Targets Conflicts of Interest in Asset-Backed Securities in New Proposal

If adopted, the proposal would prohibit transactions that allow asset-backed issuers to benefit from an adverse event affecting the security.
Reported by Paul Mulholland



At an open hearing on Wednesday, the Securities and Exchange Commission proposed a new rule that would prohibit securitization participants, largely the investment banks that bring such deals to market, from shorting or otherwise betting against asset-backed securities in which they are a participant. The proposal received unanimous support from SEC commissioners.

According to the SEC, “Securities Act Rule 192 would prohibit an underwriter, placement agent, initial purchaser, or sponsor of an ABS, including affiliates or subsidiaries of those entities, from engaging, directly or indirectly, in any transaction that would involve or result in any material conflict of interest between the securitization participant and an investor in such ABS.”

Common examples of conflicted transactions include a short sale of the ABS; purchase of a credit default swap that would pay the participant if an adverse credit event affected the ABS; or the purchase or sale of any other financial instrument that would result in the issuer benefitting from an adverse event affecting the ABS, such as a decline in market value.

The proposal provides for some exceptions, which include risk hedging, “bona fide market-making activities” and liquidity commitments. The prohibition also only lasts for one year after the initial sale of the ABS.

A statement from one SEC commissioner, Jaime Lizárraga, noted that the SEC proposed a similar rule in 2011, but it was never finalized.

The latest proposed rule would implement Section 27B of the Securities Act of 1933, a provision which was added by Section 621 of the Dodd-Frank Act. The proposal was informed by the experience of the 2008 financial crash in which market actors shorted their own assets, a practice that in one instance contributed to a $550 million settlement between Goldman Sachs and the SEC.

The comment period for this rule will stay open for 60 days from its proposal yesterday or 30 days after its entry in the Federal Register, whichever is longer.

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