SEC Chair Gensler Issues Statement on Final Rule Prohibiting Conflicts of Interest in Securitizations

WASHINGTON, Nov. 28 -- The Securities and Exchange Commission issued the following statement on Nov. 27, 2023, by Chair Gary Gensler on final rule prohibiting conflicts of interest in securitizations:

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Today, the Commission adopted a rule to prohibit certain market participants in the asset-backed securities (ABS) market from taking positions against the products they help bring to market. I am pleased to support this rule as it fulfills Congress's mandate to address conflicts of interests in the securitization market, a market which was at the center of the 2008 financial crisis.

In the aftermath of the financial crisis, Congress addressed conflicts in the securitizations market through Section 621 in the Dodd-Frank Act, an amendment proposed by Senators Carl Levin and Jeff Merkley. An investigation led by Senator Levin found that conflict of interests arose when investment banks and other market participants sold securitized assets to investors while simultaneously taking large positions against those assets.[1]

In essence, Congress wanted to make sure that so-called securitization participants cannot bet against the ABS that they underwrite, place, or sponsor.[2]

As directed by Congress, today's rule prohibits securitization participants--including those who sell or facilitate the sale of an asset-backed security--from engaging in transactions that involve or result in any material conflict of interest with investors in that ABS.[3] The prohibition will remain in place for one year after the ABS's first sale.

Further, as required by Section 621, the final rule provides exceptions for risk-mitigating hedging activities, bona fide market making, and certain liquidity commitments. Through these congressionally mandated exceptions, the rule allows these market activities while targeting the conflicts that Congress identified.

We benefitted from public input on these matters, and today's adoption includes a number of modifications from the proposing release. I will mention three examples.

First, the final rule includes a more specific definition of a conflicted transaction than that which was proposed. Under the final rule, a conflicted transaction entails directly shorting the ABS, entering into a credit default swap that references the underlying assets, or something economically equivalent to either of those activities. These conflicted transactions represent ways of taking a position against the ABS that a securitization participant helps bring to market.

Second, the final rule makes clear that generalized hedging, such as an interest rate or currency hedge, is not a conflicted transaction.

Third, the final rule revises the proposed exception for risk-mitigating hedging to permit, subject to certain conditions, the use of risk management tools.

In addition, in response to comments from private mortgage insurers regarding whether the final rule would apply to their issuance of mortgage insurance linked notes (MILNs), the adopting release makes clear that MILNs do not meet the definition of an ABS or synthetic ABS for the purposes of the final rule.

Taken together, the final rule will help address conflicts of interest arising when securitization participants take positions against ABS investors' interests. Such a rule benefits investors and issuers alike.

I'd like to thank the members of the SEC staff who worked on this final rule, including:

* Erik Gerding, Mellissa Duru, Ted Yu, Rolaine Bancroft, Brandon Figg, Kayla Roberts, Ben Meeks, Komul Chaudhry, Deanna Virginio, Luna Bloom, Steve Hearne, Betsy Murphy, and Michael Coco in the Division of Corporation Finance;

* Jessica Wachter, Lucretia Zinnen, Juan Echeverri, Missaka Warusawitharana, Aysa Dordzhieva, Igor Kozhanov, Joe Otchin, Oliver Richard, and Charles Woodworth in the Division of Economic and Risk Analysis;

* Meredith Mitchell, Bryant Morris, Robert Teply, Dorothy McCuaig, Janice Mitnick, Joe Valerio, and Johanna Losert in the Office of the General Counsel;

* Sarah ten Siethoff, Melissa Harke, and Adele Kittredge Murray in the Division of Investment Management;

* Carol McGee, Josephine Tao, Mick (Tim) Riley, Patrice Pitts, James Curley, and Jesse Kloss in the Division of Trading and Markets;

* Jason Casey in the Division of Enforcement;

* Liz Pflaum, Ryne Duffy, and John Brodersen in the Division of Examinations; and

* Dave Sanchez, Adam Wendell, Victoria Nilsson, and Mary Simpkins in the Office of Municipal Securities.

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Footnotes:

[1] See United States Senate Permanent Subcommittee on Investigations, Committee on Homeland Security and Governmental Affairs, "Wall Street and the Financial Crisis: Anatomy of a Financial Crisis" (Dec. 9, 2011), available at https://www.hsgac.senate.gov/subcommittees/investigations/library/files/report-psi-staff-report-wall-street-and-the-financial-crisis-anatomy-of-a-financial-collapse/. This also is known as the Levin report.

[2] The rule defines securitization participants as underwriters, sponsors, initial purchasers, and placement agents of asset-backed securities (including synthetic asset-backed securities), as well as certain affiliates and subsidiaries of such entities.

[3] As further detailed in the adopting release, a "conflicted transaction" is defined in final Rule 192(a)(3) as transactions with respect to which there is a substantial likelihood that a reasonable investor would consider the transaction important to the investor's investment decision, including a decision whether to retain the ABS.

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Original text here: https://www.sec.gov/news/statement/gensler-statement-securitizations-112723