# Prohibition Against Conflicts of Interest in Certain Securitizations > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/fr%3A2023-26430 ## Record - **Collection:** Federal Register - **Document type:** Rule - **Published:** December 7, 2023 - **Citation:** 88 FR 85396 ## Text SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 230 [Release No. 33-11254; File No. S7-01-23] RIN 3235-AL04 Prohibition Against Conflicts of Interest in Certain Securitizations AGENCY: Securities and Exchange Commission. ACTION: Final rule. SUMMARY: The Securities and Exchange Commission (“SEC” or “Commission”) is adopting a rule to implement Section 621 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) prohibiting an underwriter, placement agent, initial purchaser, or sponsor of an asset-backed security (including a synthetic asset-backed security), or certain affiliates or subsidiaries of any such entity, from engaging in any transaction that would involve or result in certain material conflicts of interest. DATES: Effective date: This final rule is effective on February 5, 2024. Compliance date: See Section II.I. FOR FURTHER INFORMATION CONTACT: Brandon Figg, Special Counsel, or Kayla Roberts, Special Counsel in the Office of Structured Finance, Division of Corporation Finance at (202) 551-3850, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549. SUPPLEMENTARY INFORMATION: We are adopting the following rule under 15 U.S.C. 77a et seq. (“Securities Act”): Commission reference CFR citation (17 CFR) General Rules and Regulations, Securities Act of 1933: Rule 192 § 230.192. Table of Contents I. Introduction A. Background B. Summary of the Proposed Rule C. Summary of the Final Rule II. Discussion of Rule 192 A. Scope: Asset-Backed Securities 1. Proposed Definition of Asset-Backed Security 2. Comments Received 3. Final Rule B. Scope: Securitization Participants 1. Proposed Scope of Securitization Participants 2. Comments Received 3. Final Rule C. Prohibition Timeframe 1. Proposed Prohibition Timeframe 2. Comments Received 3. Final Rule D. Prohibition 1. Proposed Prohibition 2. Comments Received 3. Final Rule E. Exception for Risk-Mitigating Hedging Activities 1. Proposed Exception 2. Comments Received 3. Final Rule F. Exception for Liquidity Commitments 1. Proposed Approach 2. Comments Received 3. Final Rule G. Exception for Bona Fide Market-Making Activities 1. Proposed Approach 2. Comments Received 3. Final Rule H. Anti-Evasion 1. Proposed Rule 2. Comments Received 3. Final Rule I. Compliance Date III. Other Matters IV. Economic Analysis A. Introduction B. Economic Baseline 1. Overview of the Securitization Markets 2. Affected Parties 3. Current Relevant Statutory Provisions, Regulations, and Practices C. Broad Economic Considerations D. Costs and Benefits 1. Benefits 2. Costs E. Anticipated Effects on Efficiency, Competition, and Capital Formation 1. Competition 2. Efficiency 3. Capital Formation F. Reasonable Alternatives 1. Changes to Scope of Definitions 2. Information Barriers 3. Changes to Exclusions 4. Conditions of the Exceptions V. Paperwork Reduction Act A. Summary of the Collections of Information B. Summary of Comment Letters C. Effects of the Final Rule on the Collections of Information D. Aggregate Burden and Cost Estimates for the Final Rule VI. Final Regulatory Flexibility Analysis A. Need for, and Objectives of, the Final Rule B. Significant Issues Raised by Public Comments C. Small Entities Subject to the Rule D. Projected Reporting, Recordkeeping, and Other Compliance Requirements E. Agency Action To Minimize Effect on Small Entities Statutory Authority I. Introduction A. Background On January, 25, 2023, the Commission proposed new Rule 192 to implement the prohibition in Securities Act Section 27B 1 (“Section 27B”), 2 which was added by Section 621 of the Dodd-Frank Act. 3 Section 27B(a) provides that an underwriter, placement agent, initial purchaser, or sponsor, or affiliates or subsidiaries of any such entity, of an asset-backed security (“ABS”), including a synthetic asset-backed security, shall not, at any time for a period ending on the date that is one year after the date of the first closing of the sale of the asset-backed security, engage in any transaction that would involve or result in any material conflict of interest with respect to any investor in a transaction arising out of such activity. 4 Section 27B(b) further requires that the Commission issue rules for the purpose of implementing the prohibition in Section 27B(a). 5 Section 27B(c) provides exceptions from the prohibition in Section 27B(a) for certain risk-mitigating hedging activities, liquidity commitments, and bona fide market-making activities. 6 1 15 U.S.C. 77z-2a. 2 Prohibition Against Conflicts of Interest in Certain Securitizations, Release No. 33-11151 (Jan. 25, 2023) [88 FR 9678 (Feb. 14, 2023)] (“Proposing Release” or “proposed rule”). In Sept. 2011, the Commission proposed a rule designed to implement Section 27B, but no further action was taken on that proposal. See Prohibition against Conflicts of Interest in Certain Securitizations, Release No. 34-65355 (Sept. 19, 2011) [76 FR 60320 (Sept. 28, 2011)]. 3 Sec. 621, Public Law 111-203, 124 Stat. 1376, 1632. 4 15 U.S.C. 77z-2a(a). 5 15 U.S.C. 77z-2a(b). 6 15 U.S.C. 77z-2a(c). B. Summary of the Proposed Rule Proposed Rule 192 would implement the prohibition in Securities Act Section 27B(a) and, consistent with Section 27B(c), provide exceptions from the prohibition for certain risk-mitigating hedging activities, liquidity commitments, and bona fide market-making activities. 7 The proposal was intended to target transactions that effectively represent a bet against a securitization and focus on the types of transactions that were the subject of regulatory and Congressional investigations following the financial crisis of 2007-2009. 8 7 See Proposing Release Section II. 8 See Proposing Release Section I. In response to the Proposing Release, the Commission received over 900 comment letters from a variety of commenters, including institutional investors, issuers, and various other market participants, professional, policy, and trade associations, Members of Congress, former Federal Government officials, academics, and unaffiliated individuals. 9 Commenters generally supported the Commission's statutorily-mandated goal of protecting investors by preventing the sale of ABS tainted by material conflicts of interest, 10 but many commenters expressed concern that the scope of the proposed rule was overly broad and could have unintended consequences on securitization markets as a whole. 11 While acknowledging that adopting a rule to address conflicts of interest in securitizations is still appropriate, some commenters also stated that the rule as proposed was not appropriately balanced to the current state of securitization markets in light of the evolution of those markets since the enactment of the Dodd-Frank Act. 12 Section 27B mandates that the Commission issue rules with regard to conflicts of interest in securitizations. While we recognize that securitization markets have evolved in the years since the financial crisis of 2007-2009, we continue to believe that the adopted rule is necessary to prevent the resurgence of the types of transactions that were prevalent leading up to that time. 13 Additionally, we believe that the changes we have made in response to comments regarding the breadth of the proposed rule, which are discussed in detail below, take into account the current state of securitization markets, while still providing strong investor protection against material conflicts of interest in securitization transactions. As discussed in greater detail below, many commenters sought clarification or limitations with respect to the types of transactions and financial products that would be subject to the rule, 14 as well as the activities of various market participants that would or would not result in such entities being securitization participants subject to the final rule. 15 Many commenters also expressed concerns that the proposed commencement point of the prohibition timeframe was insufficiently clear to allow market participants to conform their activities for compliance with the rule. 16 Most significantly, commenters expressed general opposition to the proposed definition of “conflicted transaction” as overly broad and stated that it would unnecessarily capture a wide range of activities that are essential to the functioning and issuance of ABS and the routine risk management of securitization participants. 17 Commenters also requested that the final rule include an alternative materiality standard 18 and an “anti-evasion” provision rather than the “anti-circumvention” provision that was proposed. 19 Some commenters also requested that the final rule include a foreign transaction safe harbor to provide clarity with respect to the rule's cross-border application. 20 Finally, the Commission received comments suggesting certain revisions to the proposed exceptions for risk-mitigating hedging activities, liquidity commitments, and bona fide market-making activities. 21 As we discuss in greater detail below, we have made certain revisions in response to the comments received. 9 Comment letters received by the Commission are available on our website at https://www.sec.gov/comments/s7-01-23/s70123.htm. The comment period for the Proposing Release was open for 60 days from issuance and publication on SEC.gov and ended on Mar. 27, 2023. Several commenters said that the comment period was insufficient. See, e.g., letters from American Investment Council dated Mar. 27, 2023 (“AIC”); Investment Company Institute dated Mar. 27, 2023 (“ICI”); National Association of Bond Lawyers et al. dated Mar. 27, 2023 (“NABL et al.”); U.S. Representatives Ann Wagner and Bill Huizenga dated Mar. 24, 2023 (“Representatives Wagner and Huizenga”); U.S. Senator John Kennedy dated Mar. 30, 2023 (“Senator Kennedy”). In stating that the comment period was insufficient, some commenters requested an extension ( see, e.g., letters from Alternative Investment Management Association and Alternative Credit Council dated Mar. 27, 2023 (“AIMA/ACC”); Association for Financial Markets in Europe dated Mar. 27, 2023 (“AFME”); American Property Casualty Insurance Association et al. dated Feb. 16, 2023 (“APCIA et al.”); Loan Syndications and Trading Association dated Mar. 1, 2023 (“LSTA I”)) and others indicated that they would submit multiple comment letters, some of which were received after the close of the comment period ( see letters from Loan Syndications and Trading Association dated Mar. 27, 2023 (“LSTA II”); Loan Syndications and Trading Association dated May 2, 2023 (“LSTA III”); Loan Syndications and Trading Association dated Oct. 30, 2023 (“LSTA IV”); Managed Funds Association dated May 16, 2023 (“MFA II”); Structured Finance Association dated July 13, 2023 (“SFA II”); Securities Industry and Financial Markets Association, the Asset Management Group of SIFMA, and the Bank Policy Institute dated June 27, 2023 (“SIFMA II”). Some commenters requested that the Commission re-propose the rule after reviewing the comment letters. See letters from American Bar Association dated Apr. 5, 2023 (“ABA”); Andrew Davidson Co. dated Mar. 27, 2023 (“Andrew Davidson”); LSTA III; Securities Industry and Financial Markets Association, the Asset Management Group of SIFMA, and the Bank Policy Institute dated Mar. 27, 2023 (“SIFMA I”). Also, after the close of the comment period, one commenter submitted a letter referencing several of the Commission's proposals and stating that the number of outstanding proposals, together with insufficient time to respond, operated to deprive the public of the ability to meaningfully comment on all of the proposals. See letter from Managed Funds Association dated July 24, 2023 (“MFA III”). We have considered comments received since the issuance of the proposed rule, including those received after Mar. 27, 2023, and do not believe an extension of the comment period or a re-proposal of the rule is necessary. 10 See, e.g., letters from ABA; Americans for Financial Reform Education Fund dated June 7, 2023 (“AFR”); Better Markets dated Mar. 27, 2023 (“Better Markets”); Structured Finance Association dated Mar. 27, 2023 (“SFA I”). 11 See, e.g., letters from ABA, CRE Finance Council dated Mar. 27, 2023 (“CREFC I”); ICI; Arch Capital Group Ltd., Enact Holdings Inc., Essent Group Ltd., MGIC Investment Corporation, NMI Holdings, Inc., and Radian Group Inc. dated Mar. 27, 2023 (“PMI Industry I”); SFA I; SIFMA I. 12 See, e.g., letters from ABA; SIFMA I. These commenters cited the following as examples of the changes in securitization markets in that time period: the adoption and implementation of 17 CFR 246 (“Regulation RR”), 17 CFR 255 (“the Volcker Rule”), rules regulating swaps and security-based swaps, and changes in the regulation of nationally recognized statistical rating organizations (“NRSROs”) to enhance transparency and address conflicts of interest in connection with the issuance of ABS. 13 See, e.g., Wall Street and The Financial Crisis: Anatomy of a Financial Collapse, Majority and Minority Staff Report, Permanent Subcommittee on Investigations, United States Senate (Apr. 13, 2011) (“Senate Financial Crisis Report”). 14 See Section II.A. 15 See Section II.B. 16 See Section II.C. 17 See Section II.D. 18 See Section II.D.3.d. 19 See Section II.H. 20 See Section II.A.3.c. 21 See Sections II.E. through II.G. C. Summary of the Final Rule New Rule 192 implements Section 27B to the Securities Act. Fundamentally, the rule is intended to prevent the sale of ABS that are tainted by material conflicts of interest by prohibiting securitization participants 22 from engaging in certain transactions that could incentivize a securitization participant to structure an ABS in a way that would put the securitization participant's interests ahead of those of ABS investors. By focusing on transactions that effectively represent a “bet” against the performance of an ABS, Rule 192 will provide strong investor protection against material conflicts of interest in securitization transactions while not unduly hindering routine securitization activities that do not give rise to the risks that Section 27B is intended to address. 22 The definition of “securitization participant” for purposes of new Rule 192 includes a sponsor, underwriter, placement agent, initial purchaser, and certain affiliates and subsidiaries of such entities, as discussed in detail in Section II.B. To achieve these objectives, Rule 192: • Prohibits, for a specified period, a securitization participant from engaging in any transaction that would result in a material conflict of interest between the securitization participant and an investor in the relevant ABS. A securitization participant may not, for a period beginning on the date on which such person has reached an agreement to become a securitization participant with respect to an ABS and ending on the date that is one year after the date of the first closing of the sale of such ABS, 23 directly or indirectly engage in any transaction that would involve or result in a material conflict of interest between the securitization participant and an investor in such ABS. Under the final rule, such transactions are “conflicted transactions” and include (i) engaging in a short sale of the relevant ABS, (ii) purchasing a credit default swap or other credit derivative that entitles the securitization participant to receive payments upon the occurrence of specified credit events in respect of the ABS, or (iii) purchasing or selling any financial instrument (other than the relevant ABS) or entering into a transaction that is substantially the economic equivalent of the aforementioned transactions, other than, for the avoidance of doubt, any transaction that only hedges general interest rate or currency exchange risk. 24 Transactions unrelated to the idiosyncratic credit performance of the ABS, such as reinsurance agreements, hedging of general market risk (such as interest rate and foreign exchange risks), or routine securitization activities (such as the provision of warehouse financing or the transfer of assets into a securitization vehicle) are not “conflicted transactions” as defined by the rule, and thus are not subject to the prohibition in 17 CFR 230.192(a)(1) (“Rule 192(a)(1)”); 25 23 See Section II.C. 24 See Section II.D. 25 Id. • Defines the persons that are subject to the rule. A securitization participant includes any underwriter, placement agent, initial purchaser, or sponsor of an ABS (each as defined by 17 CFR 230.192(c) (“Rule 192(c)”) and also includes any affiliate or subsidiary that acts in coordination with an underwriter, placement agent, initial purchaser, or sponsor or that has access to, or receives information about, the relevant ABS or the asset pool underlying or referenced by the relevant ABS prior to the first closing of the sale of the relevant ABS. The final rule includes functional definitions for the terms “underwriter,” “placement agent,” “initial purchaser,” and “sponsor,” which are based on the person's activities in connection with a securitization and are generally based on existing definitions of such terms under the Federal securities laws and the rules thereunder. 26 The definition of “sponsor” in the final rule excludes: (i) a person that acts solely pursuant to such person's contractual rights as a holder of a long position in the ABS; (ii) any person that performs only administrative, legal, due diligence, custodial, or ministerial acts related to the structure, design, assembly, or ongoing administration of an ABS or the composition of the underlying pool of assets; 27 and (iii) the United States or an agency of the United States with respect to any ABS that is fully insured or fully guaranteed as to the timely payment of principal and interest by the United States; 28 26 Rule 192(c) also defines “distribution” as used in the definition for “underwriter” and “placement agent.” See Section II.B. 27 As discussed in greater detail below, this exclusion includes accountants, attorneys, and credit rating agencies with respect to the creation and sale of an ABS and the activities customarily performed by trustees, custodians, paying agents, calculation agents, and other contractual service providers, including servicers. See Section II.B.3.b.iii. 28 As discussed in greater detail below, we are not adopting proposed paragraph (ii)(B) of the “sponsor” definition, which would have captured any person that directs or causes the direction of the structure, design, or assembly of an asset-backed security or the composition of the pool of assets underlying the asset-backed security. See Section II.B.3.b.ii. We are also not adopting the proposed exclusion from the definition of “sponsor” for the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac” and, together with Fannie Mae, the “Enterprises”) while operating under the conservatorship or receivership of the Federal Housing Finance Agency (“FHFA”) with capital support from the United States with respect to any ABS that is fully insured or fully guaranteed as to the timely payment of principal and interest by such entity. See Section II.B.3.b.iv. • Defines asset-backed securities that are subject to the prohibition. Under the final rule, an “asset-backed security” subject to the prohibition is defined, consistent with Section 27B, to include asset-backed securities as defined in Section 3 of the Exchange Act of 1934 (“Exchange Act”) 29 and also includes synthetic ABS and hybrid cash and synthetic ABS; 30 29 15 U.S.C. 78a et seq. 30 For purposes of this rule, we use the term “cash ABS” to refer to ABS where the underlying pool consists of one or more financial assets. We use the term “hybrid cash and synthetic ABS” to refer to ABS where the underlying pool consists of one or more financial assets as well as synthetic exposure to other assets. See Section II.A. • Provides exceptions to the prohibition for risk-mitigating hedging activities, liquidity commitments, and bona fide market-making activities. These exceptions, which are specified in Section 27B, permit certain market activities, subject to satisfaction of the specified conditions, that would otherwise be prohibited by the rule; 31 31 See Sections II.E. through II.G. • Addresses evasion of the exceptions. Under 17 CFR 230.192(d) (“Rule 192(d)”), if a securitization participant engages in a transaction or series of related transactions that, although in technical compliance with the exception for risk-mitigating hedging activities, liquidity commitments, or bona fide market-making activities, is part of a plan or scheme to evade the prohibition in Rule 192(a)(1), that transaction or series of related transactions will be deemed to violate the prohibition; 32 and 32 See Section II.H. • Provides a safe harbor for certain foreign transactions. Pursuant to 17 CFR 192(e) (“Rule 192(e)”), the prohibition will not apply to an asset-backed security if it is not issued by a U.S. person (as defined in 17 CFR 902(k) (“Rule 902(k) of Regulation S”) and the offer and sale of the asset-backed security is in compliance with 17 CFR 203.901 through 905 (“Regulation S”). 33 33 See Section II.A.3.c. We discuss in greater detail below the securitization transactions and participants subject to Rule 192's prohibition, the timeframe during which the prohibition applies, the types of transactions that are prohibited by Rule 192 and the related exceptions, and the compliance date by which securitization participants must conform their activities with the requirements of the final rule. As adopted, Rule 192 will complement the existing federal securities laws that specifically apply to securitization, as well as the general anti-fraud and anti-manipulation provisions of the Federal securities laws, 34 by explicitly protecting ABS investors against material conflicts of interest. 34 See, e.g., Section 17(a) of the Securities Act of 1933 (15 U.S.C. 77q), Section 10(b) of the Securities Exchange Act of 1934 (15 U.S.C. 78j) and 17 CFR 240.10b-5. II. Discussion of Rule 192 A. Scope: Asset-Backed Securities 1. Proposed Definition of Asset-Backed Security The Commission proposed to prohibit a securitization participant, for a specified period of time with respect to an asset-backed security, from engaging in any transaction that would involve or result in a material conflict of interest between such securitization participant and an investor in such asset-backed security. Consistent with Section 27B, the Commission proposed that the term “asset-backed security” would include ABS as defined in Section 3 of the Exchange Act 35 (“Exchange Act ABS”) (which encompasses both registered and unregistered offerings), as well as synthetic ABS and hybrid cash and synthetic ABS. 36 The Commission did not propose a definition of “synthetic ABS” due to concerns that any such definition could be potentially overinclusive or underinclusive, and that a securitization participant might attempt to evade the prohibition by structuring transactions around a particular definition, despite creating a product that is substantively a synthetic ABS, as that term is commonly understood in the market. 37 35 17 U.S.C. 78c(a)(79). An Exchange Act ABS is defined as “a fixed-income or other security collateralized by any type of self-liquidating financing asset (including a loan, a lease, a mortgage, or a secured or unsecured receivable) that allows the holder of the security to receive payments that depend primarily on cash flow from the asset . . .” 36 See Proposing Release Section II.A. 37 See Proposing Release Section II.A. 2. Comments Received Commenters generally supported the proposal to define “asset-backed security” for purposes of Rule 192 to include Exchange Act ABS, synthetic ABS, and hybrid cash and synthetic ABS, 38 though several commenters requested additional clarification regarding certain types of financial products and securities, 39 or that certain securities be excluded from the definition, 40 which we discuss in greater detail below. With respect to the proposed rule's inclusion of Exchange Act ABS in the definition of ABS, commenters generally supported the decision to incorporate the Exchange Act definition, 41 with some agreeing that market participants are familiar with analyzing whether a given security meets the definition and that there is common market understanding of whether Commission rules that use the Exchange Act ABS definition apply to them. 42 Other commenters disagreed, however, stating that it remains unclear to them whether certain securities would be captured by the definition as proposed. 43 Additionally, several commenters requested that the final rule include definitions for “synthetic ABS” 44 and “hybrid cash and synthetic ABS” 45 to provide clarity regarding the scope of transactions that are subject to the prohibition in Rule 192. The Commission also received comments suggesting that we adopt a safe harbor for ABS transactions offered and sold outside of the United States. 46 Finally, while some commenters agreed that Rule 192's prohibition should not be limited to ABS transactions that are intentionally “designed to fail,” 47 others expressed the view that Section 27B targets only ABS that are intentionally “designed to fail.” 48 38 See, e.g., letters from ABA; AFR; Better Markets; ICI. 39 See, e.g., letters from ABA (seeking, e.g., clarification with respect to reliance on existing guidance regarding a transaction's status as an asset-backed security); NABL et al. (indicating confusion regarding whether certain municipal securities are Exchange Act ABS); PMI Industry I (seeking clarification that mortgage insurance-linked notes are not synthetic ABS). 40 See, e.g., letters from AFME (urging that the final rule include a safe harbor for ABS transactions that are not offered or sold to U.S. investors as part of the primary issuance); National Association of Health and Educational Facilities Finance Authorities dated Mar. 27, 2023 (“NAHEFFA”) (requesting that single-asset conduit bonds be excluded from the definition of asset-backed security); NABL et al. (requesting that municipal securities be excluded from the definition of asset-backed security); SIFMA I (requesting that the Commission exclude corporate debt, insurance products, and Section 4(a)(2) private placement transactions from the definition of asset-backed security). 41 See, e.g., letters from ABA; ICI; SIFMA I. 42 See, e.g., letters from ABA; ICI. For example, one commenter expressed the view that common market understanding is that investment funds registered under the Investment Company Act of 1940 do not issue ABS and that their securities are not considered Exchange Act ABS. See letter from ICI. Whether such securities are Exchange Act ABS will depend on the characteristics and structure of the security. 43 See, e.g., letters from NAHEFFA; NABL et al. 44 See letters from ABA; AFME; AIMA/ACC; ICI; SFA I; SFA II; SIFMA I; SIFMA II. 45 See letter from AIMA/ACC. 46 See, e.g., letters from ABA; AFME; AIC; SFA I; SFA II; SIFMA I; SFA II. 47 See letters from AFR; Better Markets. 48 See, e.g., letters from AIC; American Securities Association dated Mar. 23, 2023 (“ASA”). 3. Final Rule We are adopting, as proposed, a definition of “asset-backed security” for purposes of the prohibition in Rule 192(a)(1). As discussed below, under the final rule, “asset-backed security” will be defined to mean an Exchange Act ABS, a synthetic ABS, and a hybrid cash and synthetic ABS. 49 Rule 192, therefore, will apply to offerings of asset-backed securities as defined in Rule 192(c), regardless of whether the offerings are registered or unregistered. Consistent with the proposal, we are not adopting a definition for “synthetic ABS” or “hybrid cash and synthetic ABS.” In response to comments received, final Rule 192 includes a safe harbor for certain foreign securitizations, which is discussed in greater detail in Section II.A.3.c. Finally, Rule 192 does not require that an ABS was intentionally “designed to fail” for the ABS to be subject to the prohibition against engaging in conflicted transactions. Section 27B does not contain language referencing an intent element and provides, in relevant part, that securitization participants “of an asset-backed security . . . shall not . . . engage in any transaction that would involve or result in any material conflict of interest.” 50 The statutory text refers plainly to asset-backed securities (as defined in Section 3 of the Exchange Act and including synthetic ABS); it does not indicate that the ABS must have been intentionally designed to fail to be subject to the prohibition. As discussed below, further narrowing the scope in this way could reduce the effectiveness of the rule to prophylactically prevent these types of material conflicts of interest with investors. 51 This, in turn, would frustrate the statutory mandate of Section 27B. 49 17 CFR 230.192(c). 50 15 U.S.C. 77z-2a(a). 51 See also Sections II.B.3. and II.D. for additional discussions about why the final rule does not include a knowledge- or intent-based standard for securitization participants or conflicted transactions. a. Exchange Act ABS Section 27B imposes a prohibition on transactions that would involve or result in a material conflict of interest, i.e., a conflicted transaction under 17 CFR 230.192(a)(3) (“Rule 192(a)(3)”), and specifies that the prohibition applies to Exchange Act ABS. As a general matter, asset-backed securities differ from other types of securities because the securities are issued by a special purpose entity that has no business activities other than holding or owning the assets supporting the ABS and other activities reasonably incidental thereto. 52 As specified in the Exchange Act ABS definition, an asset-backed security is a security collateralized by any “self-liquidating financial asset.” 53 52 See Section III.A.2. of Asset-Backed Securities, Release No. 33-8518 (Dec. 22, 2004) [70 FR 1506 (Jan. 7, 2005)] (“2004 Regulation AB Adopting Release”). 53 17 U.S.C. 78c(a)(79). The Commission received various comments requesting clarification about whether certain products and securities would be captured by the Rule 192 ABS definition and further requesting that, for the avoidance of doubt, certain products and securities be exempt from the definition. 54 For example, several commenters requested that the rule exempt certain municipal securities from being ABS subject to the prohibition in 17 CFR 230.192(a) (“Rule 192(a)”). 55 These commenters generally stated that certain municipal securities, including single-asset conduit bonds, 56 are structured and sold to achieve certain policy goals for the benefit of the government entity's citizens and that municipal issuers of such securities are subject to strict investment policies and federal and state statutes that limit their ability to engage in speculative investments, making it unlikely that relevant securitization participants could engage in conflicted transactions, therefore rendering the application of Rule 192 to municipal transactions unnecessarily burdensome. 57 Municipal securitizations that are collateralized by any type of self-liquidating financial asset and that allow the holder of the security to receive payments that depend primarily on the cash flow from such self-liquidating financial asset fall within the Exchange Act ABS definition. While it may be the case, as discussed above, that a municipal issuer is subject to restrictions that may limit their ability to engage in conflicted transactions, other parties to the securitization may not be subject to such restrictions and would therefore have the opportunity to engage in transactions that bet against the municipal ABS. For example, as one commenter stated, persons involved in municipal securitizations, such as the underwriter, may enter into swaps to mitigate risk associated with the security. 58 Such swaps or other transactions could be conflicted transactions if they meet the definition in Rule 192(a)(3). 59 We see no reason, therefore, why municipal securities that meet the definition of Exchange Act ABS (and are consequently subject to other federal securities laws), and which, like other Exchange Act ABS, involve securitization participants, such as an underwriter, that would have an opportunity to engage in conflicted transactions, should be exempted from the definition of ABS—and, thus, the prohibition against conflicts of interest—for purposes of this rule. 60 54 As discussed in greater detail below, one commenter stated that it was unclear whether certain municipal securities meet the definition of Exchange Act ABS. We also note that municipal market participants are already required to analyze whether such a security meets the Exchange Act ABS definition and whether other Commission rules implementing various provisions of the Dodd-Frank Act that use the Exchange Act ABS definition, such as Regulation RR, 17 CFR 240.15Ga-1(a) (“Exchange Act Rule 15Ga-1”), and 17 CFR 240.17g-7(a)(1)(ii)(N) (“Exchange Act Rule 17g-7”) are applicable. See Proposing Release Section II.A. See also Section IV.A.D.6 of Credit Risk Retention, Release No. 34-70277 (Aug. 28, 2013) [78 FR 57928 (Sept. 20, 2013)] (“RR Proposing Release”) (explaining why an exemption from risk retention for securitizations of tax lien-backed securities sponsored by municipal entities was not proposed) and Credit Risk Retention, Release No. 34-73407 (Oct. 22, 2014) [79 FR 77602 (Dec. 24, 2014)] (“RR Adopting Release”) at 77661 (adopting certain provisions that apply to municipal tender option bonds) and 77680 (explaining why separate loan underwriting criteria for single borrower or single credit commercial mortgage transactions were not adopted). Because participants in this market are already required to consider whether a municipal security meets the definition of Exchange Act ABS to determine whether such offering must comply with other rules and regulations adopted under the Securities Act and Exchange Act, we believe that concerns relating to burdens associated with determining whether or not a municipal security is an Exchange Act ABS for purposes of compliance with Rule 192 will be mitigated. 55 See, e.g., letters from ASA; NABL et al.; NAHEFFA; SIFMA I; Wulff, Hansen & Co. dated Apr. 14, 2023 (“Wulff Hansen”). See also Section II.B. for a discussion of comments received related to municipal issuers and the definition of “sponsor” in the final rule. 56 As described by one commenter, a single-asset conduit bond is a tax-exempt bond issued by state and local governments for the benefit of tax-exempt organizations (as defined under Section 501(c)(3) of the Internal Revenue Code). The proceeds of the bond issuance are used to make a single loan to a single 501(c)(3) borrower, such as a hospital, higher education institution, provider of housing for elderly or low-income populations, museum, or other non-profit entity. The government issuer assigns the loan agreement to the bond trustee, which receives the borrower's loan payments (which mirror the government issuer's payment obligations on the bond) and makes those payments to the bondholders. See letter from NAHEFFA. 57 See, e.g., letters from ASA; NABL et al.; NAHEFFA; letter from National Association of Municipal Advisors dated Mar. 31, 2023 (“NAMA”); SIFMA I. 58 See letter from ASA. 59 See Section II.D. 60 See Section II.B.3.b. for a discussion of the definition of a “securitization participant” with respect to municipal securitizations. With respect to single-asset conduit bonds, one commenter stated that the market (both municipal and non-municipal) does not consider a conduit bond backed by a single loan to be an asset-backed security. 61 This commenter further stated that, by referencing Exchange Act ABS instead of the definition of ABS included in Regulation AB, the Commission was using a broader definition and “eliminating” the requirement that an asset-backed security include a “pool” 62 of financial assets. 63 The commenter described this as a “novel application” of the Exchange Act ABS definition. 64 We disagree with the commenter's characterization of the proposed definition. Section 27B, which was added by Section 621 of the Dodd-Frank Act, specifically states that the prohibition shall apply to ABS as defined in Section 3 of the Exchange Act, and the definition in Section 3 was added by Section 941 of the Dodd-Frank Act. Defining “asset-backed security” for purposes of Rule 192 by referencing Exchange Act ABS, therefore, is consistent with Section 27B. As the Commission has previously stated, an ABS that is backed by a single obligation would meet the definition of Exchange Act ABS. 65 Therefore, referring to Exchange Act ABS in identifying the types of ABS subject to the final rule is consistent with Section 27B and the inclusion of single-asset conduit bonds that meet the definition of Exchange Act ABS is consistent with our prior interpretation of both definitions. 66 Moreover, if we were to adopt an exemption for transactions collateralized by a single, self-liquidating asset, it would provide the opportunity for securitization participants to structure offerings as a series of transactions that would serve to evade the rule. For these reasons, we decline to include such an exemption from the definition of “asset-backed security.” 61 See letter from NAHEFFA. 62 The definition of “asset-backed security” in Regulation AB Item 1101(c) (“Regulation AB ABS”), which was adopted for the limited purpose of identifying an ABS that is eligible for the specialized registration and reporting regime under Regulation AB, defines an “asset-backed security,” in relevant part, as a security that is primarily serviced by the cash flows of a “discrete pool of receivables or other financial assets. . .” See 17 CFR 229.1101(c). Additionally, the word “pool” in the Regulation AB ABS definition does not require that the ABS be collateralized by more than one asset. Instead, it is part of the phrase “discrete pool” in the definition, which indicates the general absence of active pool management, and emphasizes the self-liquidating nature of pool assets. See, e.g., Section III.A.2. of 2004 Regulation AB Adopting Release. 63 See letter from NAHEFFA. 64 Id. 65 See, e.g., Section V.B.2. of the RR Adopting Release (explaining why separate loan underwriting criteria for single borrower or single credit commercial mortgage transactions were not adopted) and Section IV.D.6. of RR Proposing Release (explaining why an exemption from risk retention for securitizations of tax lien-backed securities sponsored by municipal entities was not proposed). See also Proposing Release Section II.A., n. 31 (stating that an ABS that is backed by a single asset or one or more obligations of a single borrower (often referred to as “single asset, single borrower” or “SASB” transactions) meets the definition of an Exchange Act ABS). 66 Analyzing whether a municipal single-asset conduit bond is an ABS entails a consideration of the nature of the activities of the issuing entity. For example, if the issuing entity is authorized to extend credit or make loans and it engages in activities in addition to holding or owning the underlying single obligation supporting the bonds, or in addition to other activities reasonably incidental to holding or owning the underlying obligation, the securities it issued will not be an ABS. One commenter suggested that we exclude direct private placement transactions exempt from registration under Section 4(a)(2) of the Securities Act, 67 stating that the ABS purchasers in such transactions are highly sophisticated investors that participate directly in nearly all phases of the structuring and creation of the ABS. 68 The commenter stated that such investor involvement renders the risk of a securitization participant entering into a separate transaction that gives rise to a material conflict of interest very low. 69 As discussed in the Proposing Release, and as we continue to believe, even if an investor is involved in asset selection or has access to information about those assets, such investor may not be aware of the involvement of other parties, nor does the participation of one investor in asset selection necessarily protect any other investors in the ABS. 70 We see no reason why investors in ABS sold in a Section 4(a)(2) private offering should not receive the protections provided by Section 27B that are available to all investors. Rather, excluding these transactions would place the burden on investors to confirm or otherwise negotiate for transaction terms to require that securitization participants not engage in bets against the ABS. Furthermore, excluding transactions that rely on Section 4(a)(2) would also result in excluding from the rule ABS sold to an initial purchaser in furtherance of resales in compliance with Securities Act Rule 144A. 71 As a result, purchasers of that ABS in the immediately subsequent Rule 144A transaction would not benefit from the protections afforded by the rule. Consequently, we believe that such an exclusion to the ABS definition would not be appropriate. Therefore, any securities that meet the definition of “asset-backed security,” as adopted for purposes of Rule 192, will be subject to the prohibition in Rule 192(a), whether registered or unregistered. 67 15 U.S.C. 77d. Section 4(a)(2) permits, without registration, the offer and sale of securities that do not involve a public offering. 68 See letter from SIFMA I. 69 Id. 70 See Proposing Release Section II.A. Moreover, even if an investor were aware of a potential conflict of interest, Rule 192 does not include an exception based on disclosure of material conflicts of interest because such an exception would be inconsistent with the prohibition in Section 27B. See Section II.D. for a discussion of comments received related to the use of disclosure to mitigate conflicts of interest. 71 17 CFR 230.144A. For example, collateralized loan obligations (“CLOs”) are typically sold in a private placement to one or more initial purchasers in reliance on Section 4(a)(2) (which is only available to the issuer), followed by resales of the securities to “qualified institutional buyers” in compliance with Rule 144A. The Commission also received comments requesting exclusions or clarifications regarding certain financial products and securities that the Commission has not historically viewed as asset-backed securities. 72 Some commenters sought clarification that insurance policies or contracts (and securities related to those insurance products, such as mortgage insurance linked-notes (“MILNs”) 73 ) and corporate debt securities are not Exchange Act ABS. 74 Insurance policies and contracts, such as private mortgage insurance contracts, are not securities, 75 and therefore are not Exchange Act ABS subject to Rule 192. MILNs are reinsurance products used by insurance companies to obtain reinsurance coverage for a portion of their risk related to private mortgage insurance policies, which assist homebuyers in obtaining low-down payment mortgages. 76 The collateral for the MILN are the private mortgage insurance contracts, which are not self-liquidating financial assets. 77 Corporate debt securities are issued by a corporate issuer and represent direct payment obligations of the corporate issuer. 78 The corporate issuer is ultimately responsible for payment on the debt, compared to asset-backed securities that are issued by a special purpose issuing entity where payment depends primarily on the cash flow from an underlying self-liquidating financial asset. In each of these cases, the securities do not meet the definition of Exchange Act ABS and, therefore, are not asset-backed securities as defined in Rule 192(c). 79 72 See, e.g., letters from ABA; Representative Nickel et al.; SFA I; SIFMA I. 73 See also note 80, and the accompanying text for a discussion regarding funding agreement-backed notes. 74 See letters from AFME; ABA; SIFMA I. 75 15 U.S.C. 77c. 76 See, e.g., letter from ABA. 77 For additional discussion regarding mortgage insurance-linked notes, and why the existing structures do not satisfy the criteria to be synthetic ABS or “conflicted transactions,” see Sections II.A.3.b. and II.D. 78 See, e.g., letter from SIFMA I. 79 See 17 CFR 230.192(c). One commenter also requested clarification that, where the Commission or its staff has already provided guidance stating that a financial product or security would not be an asset-backed security, such products or securities would not be asset-backed securities under Rule 192(c) and thus would not be subject to the prohibition. 80 The definition of asset-backed security we are adopting in Rule 192(c) does not change the Exchange Act ABS definition, nor does it impact existing Commission guidance or staff positions regarding that definition. Market participants may, therefore, continue to look to such guidance or staff positions unless and until they are changed, withdrawn, or otherwise superseded, as applicable. 80 See letter from ABA. This commenter provided the example of an existing staff position indicating that funding agreements between an insurance company and a special purpose entity, where the insurance company is directly liable for the funding agreement that backs the notes, is not an Exchange Act ABS. See Regulation AB Compliance & Disclosure Interpretation 301.03 (updated Sept. 6, 2016), available at https://www.sec.gov/corpfin/divisionscorpfinguidanceregulation-ab-interpshtm. These interpretations, and any other staff statements referenced in this release, represent the views of SEC staff. They are not rules, regulations, or statements of the Commission. The Commission has neither approved nor disapproved their content. Staff statements have no legal force or effect: they do not alter or amend applicable law, and they create no new or additional obligations for any person. b. Synthetic ABS and Hybrid Cash and Synthetic ABS As discussed in the Proposing Release, we have previously described synthetic securitizations as transactions that are designed to create exposure to an asset that is not transferred to or otherwise part of the asset pool, generally effectuated through the use of derivatives such as a credit default swap (“CDS”) or a total return swap (or an ABS structure that replicates the terms of such a swap). 81 The Commission received several comment letters requesting that we adopt a definition of “synthetic asset-backed security” 82 and “hybrid cash and synthetic asset-backed security” 83 to address what the commenters said was a lack of certainty with respect to the scope of Rule 192. Some of these commenters offered suggestions for a definition of synthetic ABS that they believe represent market understanding of the term and that would appropriately capture the types of transactions that Section 27B and Rule 192 are intended to cover. 84 While the text of the suggested definitions vary, including with respect to the level of specificity, they include a number of common elements, generally identifying synthetic ABS as a security issued by a special-purpose entity, secured by one or more credit derivatives or similar financial instrument that references a self-liquidating financial asset or pool of assets, and for which payment to the investor is dependent primarily on the performance of such reference asset or reference pool. 85 81 See Proposing Release Section II.A. and Section III.A.2. of the 2004 Regulation AB Adopting Release. 82 See, e.g., letters from ABA; AIMA/ACC; AFME; SFA I; SFA II; SIFMA I; SIFMA II. 83 See letter from AIMA/ACC. 84 See letters from ABA; AFME; SFA II; SIFMA I; SIFMA II. 85 See, e.g., letters from ABA; SFA II; SIFMA II. Given the variation of suggested definitions provided by commenters, we do not believe that adopting any one of these definitions, or a combination thereof, would appropriately capture the scope of the various features of existing synthetic ABS and possible future structures or designs of synthetic ABS; however, commenters' suggestions are consistent with the characteristics that we have previously identified as features of synthetic ABS. 86 Because of the complexity of these transactions, however, we agree with commenters that guidance regarding synthetic ABS is beneficial. Accordingly, while a synthetic ABS may be structured or designed in a variety of ways, we generally view a synthetic asset-backed security as a fixed income or other security issued by a special purpose entity that allows the holder of the security to receive payments that depend primarily on the performance of a reference self-liquidating financial asset or a reference pool of self-liquidating financial assets. 87 86 See Proposing Release Section II.A. and Section III.A.2. of the 2004 Regulation AB Adopting Release. 87 Id. The Commission also received comments requesting clarification about whether the rule applies to synthetic transactions that have not traditionally been considered synthetic securitizations. Some commenters asked that we clarify that mortgage insurance-linked notes are not synthetic asset-backed securities under Rule 192(c) and that the reinsurance agreements embedded in the MILN transactions are not “conflicted transactions” under Rule 192(a)(3). 88 As discussed in Section II.A.3.a., above, while MILNs create synthetic exposure to insurance contracts, they are not covered by this rule because the underlying private mortgage insurance contracts are not self-liquidating. 89 Accordingly, MILNs are not synthetic ABS subject to the prohibition in Rule 192(a)(1), and consequently, neither would the reinsurance agreements executed between the mortgage insurer and the special purpose insurer be conflicted transactions under Rule 192(a)(3). 90 88 See, e.g., letters from ABA; letter from Housing Policy Council dated Mar. 27, 2023 (“HPC”); Mortgage Bankers Association dated Mar. 27, 2023 (“MBA”); PMI Industry I; Arch Capital Group Ltd., Enact Holdings Inc., Essent Group Ltd., MGIC Investment Corporation, NMI Holdings, Inc., and Radian Group Inc. dated Oct. 20, 2023 (“PMI Industry II”) (suggesting rule text to include an exclusion in the final rule for activities related to the purchase or sale of MILNs); U.S. Representatives Blaine Luetkemeyer and Emmanuel Cleaver dated May 23, 2023 (“Representatives Luetkemeyer and Cleaver”); SFA I; SIFMA I. See also Section II.D. for a discussion of the types of transactions that would be “conflicted transactions” under the final rule. 89 In a typical MILN structure, the mortgage insurer enters into a reinsurance agreement with a special purpose insurer, which issues the MILNs to investors and places the proceeds from the sale of those securities in a reinsurance trust to make any required payments to the mortgage insurer under the reinsurance agreement, which requires payments based on certain losses incurred on a specified pool of mortgage insurance policies that are obligations of the mortgage insurer. The premiums paid by the mortgage insurer to the special purpose insurer are used to make interest payments to the holders of the MILNs. Because the reinsurance agreement functions similarly to a swap and the reference mortgage insurance policies are not transferred to the reinsurance trust, commenters requested confirmation that MILNs are not synthetic ABS that would be asset-backed securities as defined for purposes of Rule 192. See, e.g., letters from ABA; HPC; MBA; PMI Industry I; Representatives Luetkemeyer and Cleaver; SFA I; SIFMA I. 90 See Section II.D. for a discussion of “conflicted transactions” under the final rule. Some commenters also requested confirmation that synthetic ABS for purposes of Rule 192 does not include equity-linked or commodity-linked products. 91 Because such products do not involve self-liquidating financial assets, they are not synthetic ABS subject to Rule 192's prohibition. Similarly, some commenters requested confirmation that corporate debt obligations and security-based swaps are not synthetic ABS. 92 As described above, we generally view a synthetic asset-backed security as a fixed income or other security issued by a special purpose entity that allows the holder of the security to receive payments that depend primarily on the performance of a reference self-liquidating financial asset or a reference pool of self-liquidating financial assets. In contrast, as discussed above, a corporate debt obligation is issued by, and offers investors recourse to, an operating entity that is not a special purpose entity. Therefore, a corporate debt obligation is not a synthetic ABS for purposes of Rule 192. Similarly, a security-based swap is also not a synthetic ABS for purposes of Rule 192 because it is a financial contract between two counterparties without issuance of a security from a special purpose entity. 93 A security-based swap can represent a component of a synthetic ABS transaction where, for example, the relevant special purpose entity that issues the synthetic ABS enters into a security-based swap that collateralizes the synthetic ABS that it is issuing. However, the standalone security-based swap in such example is not a synthetic ABS; it is only one component of the broader synthetic ABS transaction. Under the final rule, whether a transaction is a “synthetic ABS” subject to Rule 192 will depend on the nature of the transaction's structure and characteristics of the underlying or referenced assets. 94 A similar analysis will be necessary to determine whether a transaction constitutes a hybrid cash and synthetic ABS, which would have characteristics of both cash ABS and synthetic ABS. 91 See, e.g., letters from SFA II; SIFMA I; SIFMA II. 92 See, e.g., letters from ABA; SFA II; SIFMA I; SIFMA II. 93 See also Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, Release No. 33-9338 (July 18, 2012) [77 FR 48208 (Aug. 13, 2012)] (establishing that a credit default swap or total-return swap on a single loan or narrow-based index is a security-based swap). 94 For example, such transactions generally should be analyzed to determine whether the assets that are transferred to or otherwise part of the asset pool are self-liquidating. Additionally, we note that a synthetic transaction could be effectuated through the use of derivates or swaps but could also use some other feature or structure that replicates the terms of a derivate or swap. c. Cross-Border Application of Rule 192 The Commission received several comments relating to the potential cross-border application of Rule 192. 95 Before addressing those comments, we are providing the following guidance as to Rule 192's cross-border scope. As a threshold matter, Rule 192's cross-border scope is co-extensive with the cross-border scope of Securities Act Section 27B(a), which this rule implements pursuant to the mandate in Section 27B(b). It is therefore appropriate to consider Section 27B(a)'s cross-border scope when determining whether Rule 192 applies in a cross-border context. 95 See, e.g., letters from ABA; AFME; AIC; SFA I; SFA II; SIFMA I; SIFMA II. Our understanding of Section 27B(a)'s cross-border scope is based on the territorial approach that the Commission has applied when adopting rules to implement other provisions of the securities laws. 96 Consistent with that territorial approach, which is based on U.S. Supreme Court precedent, including Morrison v. National Australia Bank, Ltd, 97 the Commission understands the relevant domestic conduct that triggers the application of Section 27(B)(a)'s prohibition to be the sale in the United States of the ABS. 98 If there are ABS sales in the United States to investors, the prohibition of Section 27B(a)—as implemented through the provisions of Rule 192—applies. Put simply, the existence of domestic ABS sales to investors means that securitization participants are prohibited pursuant to the terms of Rule 192 from engaging in their own separate transactions that would cause a material conflict with the ABS investors. 99 And when domestic ABS sales exist, the prohibition on securitization participants engaging in separate transactions that would cause the material conflicts of interest applies even if the securitization participants seek to engage in those prohibited transactions exclusively overseas or if the securitization participant is itself a non-U.S. entity. 100 In this way, Section 27B(a) and Rule 192 further the statutory objective of prophylactically protecting ABS investors in the U.S. securities markets from ABS transactions that would involve material conflicts of interest. 101 96 See, e.g., Regulation SBSR—Reporting and Dissemination of Security-Based Swap Information, Release No. 34-74244 (Feb. 11, 2015), [80 FR 14563, 14649 (Mar. 19, 2015)] (“2015 Regulation SBSR Adopting Release”) (discussing the territorial approach to the cross-border application of Title VII requirements for regulatory reporting and public dissemination of security-based swap transactions). 97 Morrison v. National Australia Bank, Ltd. et al., 561 U.S. 247 (2010). 98 See generally 561 U.S. 247. See, e.g., Abitron Austria GmbH v. Hetronix Int'l, Inc, No. 21-1043, 2023 WL 4239255, at *4 (U.S. June 29, 2023) (stating that “[the Supreme Court has] repeatedly and explicitly held that courts must “identif[y] `the statute's “focus”' and as[k] whether the conduct relevant to that focus occurred in United States territory”). 99 Securitization participants are advised that even if there is no domestic sale to an investor that would trigger Rule 192's regulatory prohibition, the Commission still retains broad cross-border antifraud authority that will apply when securities participants engage in fraudulent or manipulative conduct that has a sufficient nexus to the United States. Specifically, the Commission's antifraud authorities will apply if a securities participant engages in securities fraud that involves: (1) conduct within the United States that constitutes significant steps in furtherance of the fraud, even if the securities transaction occurs outside the United States and involves only foreign investors; or (2) conduct occurring entirely outside the United States that has a foreseeable substantial effect within the United States. See Section 27(b) of the Exchange Act (15 U.S.C. 78aa). See also SEC v. Scoville, 913 F.3d 1204, 1215-1219 (10th Cir. 2019) (holding “that Congress has `affirmatively and unmistakably' indicated that the antifraud provisions of the federal securities acts apply extraterritorially when the statutory conduct-and-effects test is met”). 100 See Abitron Austria GmbH, 2023 WL 4239255, at *2529 (explaining that “[i]f the conduct relevant to the statute's focus occurred in the United States, then the case involves a permissible domestic application of the statute, even if other conduct occurred abroad” (citations and internal quotation marks omitted)). 101 See, e.g., Section I.C. Having provided the foregoing general guidance regarding Rule 192's cross-border scope, we turn to address those comments that raised cross-border considerations. Some commenters expressed concerns that the Commission did not address cross-border application of the proposed rule in the Proposing Release, 102 with some stating that, without guidance regarding cross-border applicability, together with the proposed definition of affiliates and subsidiaries, the proposed rule could potentially apply to all affiliates and subsidiaries of the named securitization participants anywhere in the world, regardless of their knowledge of, or participation in, the transaction. 103 One commenter further stated that such application could have a significant adverse effect on the ability of market participants in non-U.S. jurisdictions to satisfy the prudential and capital requirements regulations related to permissible securitization transactions used for capital optimization and balance sheet management in those jurisdictions. 104 For example, this commenter stated that certain synthetic securitizations are permitted in the European Union and the United Kingdom under the European Banking Authority's Simple, Transparent and Standardized (“STS”) framework. 105 The commenter further stated that, to the extent that such framework could be inconsistent with final Rule 192, cross-border applicability of Rule 192 could result in those transactions being impermissible, which could have undesirable consequences for European markets. 106 102 See, e.g., letters from AFME, AIC; SFA I. 103 See, e.g., letter from AFME. One commenter also stated that it is unclear whether the Commission has authority over foreign entities apart from legal and practical issues regarding supervision and enforcement and that Rule 192 could put U.S. entities at a competitive disadvantage in relation to their international peers. See letter from AIMA/ACC. In addition to the changes discussed in this section, we believe that the revisions to the rule's coverage of affiliates and subsidiaries, as discussed in Section II.B.3.c. below, will mitigate such concerns. 104 See letter from AFME. 105 Id. 106 Id. The Commission also received comments requesting that the final rule include a safe harbor for foreign transactions and securitization participants to provide clarity to the market. 107 These commenters stated that such an approach would be consistent with other Commission rules applicable to securitizations that were promulgated under the Securities Act and Exchange Act, such as Regulation RR 108 and Exchange Act Rule 15Ga-2. 109 Some of these commenters further suggested that the final rule include a foreign transaction safe harbor that states specifically that the prohibition in Rule 192 does not apply to an asset-backed security if the offer and sale of the ABS was or is not required to be registered (and is/was not registered) under the Securities Act of 1933, the offer and sale of all of the ABS is or was made outside the United States, and the issuing entity of the ABS is a foreign issuer, 110 which is similar to the safe harbor included in Rule 15Ga-2 and incorporates principles contained in Regulation S. 111 107 See, e.g., letters from ABA; AFME; AIC (requesting that the Commission adopt a safe harbor for foreign entities and transactions and suggesting that it could do so by exempting foreign entities from the definition of “securitization participant” and excluding securities issued pursuant to Regulation S from the definition of “asset-backed security”); SFA I; SFA II; SIFMA I (citing Morrison v. Nat'l Austl. Bank Ltd., 561 U.S. 247 (2010) as the existing law on the extent of the rule's extraterritorial reach and seeking a safe harbor to provide clarity in order to facilitate compliance); SIFMA II. 108 See 12 CFR 246.20. 109 17 CFR 240.15Ga-2. See, e.g., letters from ABA; AIC; AFME; SFA I; SFA II; SIFMA I; SIFMA II. 110 See, e.g., letters from SFA II; SIFMA II. 111 See 17 CFR 240.15Ga-2(e) (“Rule 15Ga-2(e)”) and 17 CFR 230.901 and 902(e). After considering these suggestions, we are including a foreign transaction safe harbor in final Rule 192 to provide additional certainty with regard to the territorial approach discussed above. Moreover, we agree with commenters that including a foreign transaction safe harbor is consistent with other securitization rules promulgated by the Commission, such as Regulation RR and Exchange Act Rule 15Ga-2, and that commenters' suggestions to rely on the principles contained in Regulation S in adopting such a safe harbor are consistent the Commission's cross-border authority. 112 We also agree with commenters that it is appropriate to model the safe harbor provision in Rule 192 on existing Rule 15Ga-2(e). 113 Therefore, the prohibition in final Rule 192(a)(1) will not apply to an asset-backed security (as defined by this rule) if it is not issued by a U.S. person (as that term is defined in Rule 902 of Regulation S) 114 and the offer and sale of such asset-backed security is in compliance with Regulation S. 115 The inclusion of this safe harbor for certain foreign securitizations will help address commenters' concerns with respect to application of the rule to extraterritorial transactions and securitization participants. 112 See Morrison v. Nat'l Austl. Bank Ltd., 561 U.S. 247 (2010). 113 Rule 15Ga-2(e) generally states that the requirements of Rule 15Ga-2 would not apply to an offering of an asset-backed security if certain conditions are met, including (1) the offering is not required to be, and is not, registered under the Securities Act, (2) the issuer of the rated security is not a U.S. person (as defined in Rule 902 of Regulation S), and (3) all offers and sales of the ABS is in compliance with Regulation S. 114 17 CFR 230.902(k). 115 17 CFR 230.901 through 905. See Rule 192(e). Securitization participants are advised that even if the safe harbor conditions are met, the Commission still retains broad cross-border antifraud authority that will apply when securities participants engage in fraudulent or manipulative conduct that has a sufficient nexus to the United States. See supra note 99. B. Scope: Securitization Participants 1. Proposed Scope of Securitization Participants Consistent with Section 27B(a), the Commission proposed that the prohibition in Rule 192 would apply to transactions entered into by an underwriter, placement agent, initial purchaser, or sponsor of a covered ABS, as well as any of their affiliates or subsidiaries, each of which would be a “securitization participant” as defined in Rule 192(c). 116 The Commission proposed definitions for the terms “underwriter,” “placement agent,” “initial purchaser,” and “sponsor” that are generally based on existing definitions and reflect the functions of these market participants in ABS transactions and not merely their formal labels. 117 In addition, the proposed definition of “sponsor” was based on the definition of sponsor in Regulation AB as well as, subject to certain exceptions, any person that directs or causes the direction of the structure, design, or assembly of the ABS or the composition of the pool of assets underlying the ABS or that has the contractual right to do so. 118 As explained in the Proposing Release, such a person is in a unique position to structure the ABS and/or construct the underlying asset pool or reference pool in a way that would position the person to benefit from the actual, anticipated, or potential adverse performance of the of the relevant ABS or its underlying asset pool if such person were to enter in a conflicted transaction. 119 The Commission also proposed certain limited exclusions from the definition of “sponsor” for persons that perform only administrative, legal, due diligence, custodial, or ministerial acts related to the structure, design, or assembly of an asset-backed security or the composition of the pool of assets underlying the ABS, 120 as well as for certain U.S. Federal Government entities and the Enterprises, subject to certain conditions. 121 116 See Proposing Release Section II.B. 117 Id. The Commission also proposed that “affiliate” and “subsidiary” would have the same meaning as set forth in Securities Act Rule 405 (17 CFR 230.405). 118 See Proposing Release Section II.B. 119 See Proposing Release Section II.B. 120 See Proposing Release Section II.B.2.b. 121 See Proposing Release Section II.B.2.c. 2. Comments Received Commenters generally supported the proposal to define the securitization participants subject to the prohibition in the final rule. 122 While some commenters agreed with the proposed approach of defining the covered persons with respect to their functions in securitization markets, 123 several commenters expressed significant concerns regarding the scope of the proposed definition of “sponsor,” stating that it could potentially capture market participants that Section 27B did not intend to include. 124 For example, several commenters stated that the proposed definition of “sponsor” was overly broad and exceeded the intent of Section 27B. 125 As discussed below, some of these commenters stated that including any person that directs or has the contractual right to direct the structure, design, or assembly of an ABS could result in nearly every participant in a securitization transaction being a sponsor, including, for example, investors in the relevant ABS. 126 Many commenters acknowledged that Section 27B specifically identifies affiliates and subsidiaries of other named securitization participants as being subject to the rule's prohibition, but also expressed concern that the inclusion of certain affiliates and subsidiaries would make the rule unworkable. 127 Accordingly, several commenters requested that the rule permit the use of information barriers to address these challenges. 128 The Commission also received comments requesting revisions to the proposed exclusion for persons that perform only administrative, legal, due diligence, custodial, or ministerial acts related to the ABS or its underlying or referenced asset pool 129 and the proposed exclusion for certain U.S. Federal Government entities and the Enterprises, which we discuss in greater detail below. 130 Finally, one commenter stated that a securitization participant should only come within the scope of the prohibition in Rule 192 if such participant intended to profit from the securitization transaction to the detriment of investors or otherwise designed an ABS to fail. 131 122 See, e.g., letters from AFR; ICI. The Commission also proposed a definition of “distribution” as used in the underwriter and placement agent definition but did not receive comment addressing the proposed definition of “distribution.” 123 See, e.g., letters from AFR; Better Markets (expressing support for the definition of “sponsor” as proposed). 124 See, e.g., letters from ABA; AIMA/ACC; CREFC I, MBA; MFA II; NAMA; U.S. Representatives Wiley Nickel, Bryan Steil, Josh Gottheimer, Blaine Luetkemeyer, Jim Himes, Michael V. Lawler, Juan Vargas, Scott Fitzgerald, Vicente Gonzalez, Young Kim, Ritchie Torres, Zach Nunn, Gregory W. Meeks, Andy Barr, Steven Horsford, Andrew R. Garbarino, Brittany Pettersen, Ann Wagner, David Scott, Bill Huizenga, Brad Sherman (Ranking Member, Subcommittee on Capital Markets), Byron Donalds, Bill Foster, Emanuel Cleaver, II, and Sean Casten dated Oct. 31, 2023 (“Representative Nickel et al.”) (referring generally to the definition of “securitization participant”); SFA I; SIFMA I. Some commenters also stated that certain underwriters, placement agents, and initial purchasers that were not part of the design of the ABS could be scoped in as well. See Sections II.B.2. and II.B.3.a. 125 See, e.g., letters from ABA; AIC; AIMA/ACC; AFME; Loan Syndications & Trading Association dated May 2, 2023 (“LSTA III”); MBA; MFA II; NAMA; Representatives Wagner and Huizenga; Senator Kennedy; SFA I; SIFMA I; Wulff Hansen. 126 See, e.g., letters from ABA; AFME; CREFC I; International Association of Credit Portfolio Managers dated Mar. 27, 2023 (“IACPM”); MBA; SFA I. 127 See, e.g., letters from ABA; AIC; AFME; ICI; LSTA III; Loan Syndications & Trading Association dated Oct. 30, 2023 (“LSTA IV”); MFA II; SFA I; SIFMA I. 128 See, e.g., letters from ABA; AIMA/ACC; AFME; AIC; ICI; LSTA II; LSTA III; MFA II; Pentalpha Surveillance LLC dated Mar. 27, 2023 (“Pentalpha”); SFA I; SIFMA I. 129 See, e.g., letters from CREFC I; LSTA III; SFA I; SIFMA I. 130 See, e.g., letters from Fannie Mae and Freddie Mac dated Mar. 27, 2023 (“Fannie and Freddie”); Housing Policy Council dated Mar. 27, 2023 (“HPC”); Mark Calabria, Former FHFA Director, dated Mar. 25, 2023 (“M. Calabria”). 131 See letter from HPC. 3. Final Rule As discussed below, we are adopting the definitions of “underwriter,” “placement agent,” “initial purchaser,” and “distribution” as proposed. We are modifying the proposed definition of “sponsor” to address commenter concerns regarding the scope of the definition with respect to a person who acts solely pursuant to such person's contractual rights as a holder of a long position in an asset-backed security and a person's administrative and ministerial activities related to the ongoing administration of an ABS. 132 Also, as discussed in greater detail in Section II.B.3.b.ii. below, we are not adopting proposed paragraph (ii)(B) of the “sponsor” definition, which would have captured any person that directs or causes the direction of the structure, design, or assembly of an asset-backed security or the composition of the pool of assets underlying the asset-backed security. In response to comments received relating to confusion with respect to the proposed rule's treatment of credit risk transfer transactions, we are removing the specific exclusion for the Enterprises in favor of addressing those comments through the risk-mitigating hedging exception, which we discuss in more detail in Sections II.B.3.b.iv. and II.E., below. To address concerns about the rule's applicability to affiliates and subsidiaries, we are adopting revisions to the definition of “securitization participant” regarding when an affiliate or subsidiary of an underwriter, placement agent, initial purchaser, or sponsor is subject to the prohibition against engaging in conflicted transactions. 133 Final Rule 192 does not include a requirement that the securitization participant intended to profit from a transaction to the detriment of investors or otherwise designed the ABS to fail. As discussed in greater detail in Sections II.A.3. and II.D., we believe that narrowing the scope of the final rule to add an element of intent is inappropriate and it is not relevant for purposes of the final rule whether the securitization participant makes (or intended to make) a profit. Narrowing the scope of the rule to require knowledge or intent would frustrate the statutory mandate of Section 27B. 132 See Section II.B.3.b. for a detailed discussion of the comments received and the revised definition. 133 See Section II.B.3.c. a. Placement Agent, Underwriter, and Initial Purchaser Consistent with the proposal, final Rule 192(c) defines “placement agent” and “underwriter” as a person who has agreed with an issuer or selling security holder to: • Purchase securities from the issuer or selling security holder for distribution; • Engage in a distribution for or on behalf of such issuer or selling security holder; or • Manage or supervise a distribution for or on behalf of such issuer or selling security holder. 134 134 17 CFR 230.192(c). These definitions are focused on the functional role that a person would assume in connection with a distribution of securities. 135 Also consistent with the proposal, 136 final Rule 192(c) defines “distribution” as used in the definitions for “underwriter” and “placement agent” to mean: 135 The definition of underwriter for purposes of Rule 192 has no impact on the definition, responsibility, or liability of an underwriter under Securities Act Section 2(a)(11). Additionally, while these definitional prongs are also used for the definition of “underwriter” in the Volcker Rule (17 CFR 255.4(a)(4)) and Regulation M (17 CFR 242.100(b)), the definition we are adopting in Rule 192(c) has no impact on the definition of “underwriter” in either of those rules. See also Proposing Release Section II.B.1. 136 The Commission did not receive any comments addressing the proposed definition of “distribution.” • An offering of securities, whether or not subject to registration under the Securities Act, that is distinguished from ordinary course trading transactions by the presence of special selling efforts and selling methods; or • An offering of securities made pursuant to an effective registration statement under the Securities Act. 137 137 17 CFR 230.192(c). As the Commission noted in the Proposing Release, activities generally indicative of special selling efforts and methods include, but are not limited to, greater than normal sales compensation arrangements, delivering a sales document ( e.g., a prospectus or offering memorandum), and conducting road shows. A primary offering of ABS pursuant to an effective Securities Act registration statement would also be captured because such an offering is a primary issuance by an issuer immediately following the creation of the ABS, which is clearly distinguishable from an ordinary secondary trading transaction. See Proposing Release at 9683. The definition of “initial purchaser” is similarly focused on a person's function in a securities offering and includes, as proposed, “a person who has agreed with an issuer to purchase a security from the issuer for resale to other purchasers in transactions that are not required to be registered under the Securities Act in reliance upon Rule 144A or that are otherwise not required to be registered because they do not involve any public offering.” 138 138 The definition of “initial purchaser” in Rule 192(c) has no impact on the application of Rule 144A (17 CFR 230.144A). Some commenters requested that we limit the definition of “underwriter,” “placement agent,” and “initial purchaser” to capture only those persons who are directly involved in structuring the relevant ABS or selecting the assets underlying the ABS, stating as an example that underwriting syndicate co-managers generally rely on lead managers and have little direct involvement with the aforementioned securitization activities. 139 While it may be the case that underwriters, placement agents, or initial purchasers are involved in the issuance of an ABS in varying degrees, the prohibition in Rule 192(a)(1) only applies to such persons if they have entered into an agreement 140 with an issuer (or, with respect to underwriters and placement agents, a selling security holder) because those persons would likely be privy to certain information about the ABS or underlying assets. Conversely, underwriters, placement agents, and initial purchasers with no such agreement with the issuer or selling security holder (“selling group members”), as applicable, may help facilitate a successful distribution of securities to a wider variety of purchasers, but these selling group members do not have a direct relationship with the issuer or selling security holder and, thus, are unlikely to have the same ability to influence the design of the relevant ABS. Therefore, selling group members who do not have such an agreement are not underwriters, placement agents, or initial purchasers as defined in Rule 192(c). 141 Moreover, such a limitation could have the unintended consequence of creating uncertainty about whether an underwriter, placement agent, or initial purchaser is subject to the rule's prohibition because it would require a determination of whether such person is “directly involved” in structuring an ABS or selecting the underlying assets. For purposes of Rule 192, therefore, it is sufficient that a person who otherwise meets the definitions of “underwriter,” “placement agent,” or “initial purchaser” in Rule 192(c) has an agreement with the issuer or selling security holder, as applicable, to perform the enumerated functions because, as stated above, such persons would likely be privy to information about the ABS or underlying assets, giving them the opportunity to influence the structure of the relevant ABS and engage in a bet against it. No factual determination of whether such person actually had “direct involvement” in the structure or design of the ABS is required. 139 See letters from SFA I; SIFMA I. Another commenter stated that underwriters and other participants should be defined to include persons who make a “material contribution” to the economic structure, composition, management, or sale of an ABS. See letter from AFR. 140 See Section II.C.3. for a discussion of what constitutes an “agreement” for purposes of Rule 192(a)(1). 141 See also Proposing Release Section II.B.1. b. Sponsor We are adopting the definition of “sponsor” with certain modifications from the proposal in response to comments received. The definition of “sponsor” will differ in four ways from the proposal. First, we are not adopting proposed paragraph (ii)(B) of the “sponsor” definition, which would have captured any person that directs or causes the direction of the structure, design, or assembly of an asset-backed security or the composition of the pool of assets underlying the asset-backed security. Second, we are revising the text of the final rule to state that persons who act solely pursuant to their contractual rights as holders of a long position in the relevant ABS are excluded from paragraph (ii) of the definition of sponsor, as discussed below. Third, we are revising the text to specifically exclude persons who perform only administrative, legal, due diligence, custodial, or ministerial activities related to the ongoing administration of the ABS or the composition of the pool of assets underlying or referenced by the ABS. 142 Fourth, we are deleting the proposed exclusion from the “sponsor” definition for the Enterprises while they are operating under the conservatorship or receivership of FHFA with capital support from the United States, which we discuss in Section II.B.3.b.iv., below. 143 Accordingly, for purposes of Rule 192, “sponsor” means: 142 The inclusion of the language “or referenced by the asset-backed security” in the definition of sponsor and other aspects of final Rule 192 is designed to address activities related to the reference pool for a synthetic ABS. 143 As discussed below, final Rule 192 includes the proposed exclusion from definition of “sponsor” for the United States or any agency of the United States with respect to its fully insured or fully guaranteed ABS. • Any person who organizes and initiates an asset-backed securities transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the entity that issues the asset-backed security (a “Regulation AB-based Sponsor”); or • Any person with a contractual right to direct or cause the direction of the structure, design, or assembly of an asset-backed security or the composition of the pool of assets underlying or referenced by the asset-backed security (a “Contractual Rights Sponsor”), other than a person who acts solely pursuant to such person's contractual rights as a holder of a long position in the ABS (a “Long-only Investor”) • But not including: ○ A person who performs only administrative, legal, due diligence, custodial, or ministerial acts related to the structure, design, assembly, or ongoing administration of an asset-backed security or the composition of the pool of assets underlying or referenced by the asset-backed security (the “Service Provider Exclusion”); or ○ The United States or an agency of the United States with respect to an asset-backed security that is fully insured or fully guaranteed as to the timely payment of principal and interest by the United States (“U.S. Government Exclusion”). 144 144 See Sections II.B.2. and II.B.3.b.iv. for a discussion of comments received and the final U.S. Government Exclusion. As with the definitions discussed above, we are adopting a functional definition of “sponsor” that will apply regardless of the person's title and that instead focuses on the person's activities with respect to the ABS transaction. Accordingly, a person who organizes and initiates an ABS transaction, or who has a contractual right to direct or cause the direction of the structure, design, or assembly of an ABS or the composition of the pool of assets underlying or referenced by the ABS whether before or after the initial issuance of the relevant ABS, is a sponsor under Rule 192 (unless one of the exceptions described below applies). For example, an “issuer” of a municipal securitization will be a “sponsor” if its activities meet the definition. This definition also includes, for example, a portfolio selection agent for a collateralized debt obligation (“CDO”) transaction with a contractual right to direct or cause the direction of the composition of the pool of assets on behalf of the CDO or a collateral manager for a collateralized loan obligation (“CLO”) transaction with the contractual right to direct or cause the direction of asset purchases or sales on behalf of the CLO. 145 145 See also Sections II.A.2. and II.A.3. for a discussion of the comments received and the final definition of “asset-backed security” as it applies to municipal securitizations. i. Regulation AB-Based Sponsor We are adopting paragraph (i) of the definition of “sponsor” as proposed. For purposes of Rule 192, therefore, a sponsor includes, but is not limited to, any person who organizes and initiates an asset-backed securities transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the entity that issues the asset-backed security. 146 This portion of the definition is derived from the definition of the term “sponsor” in Regulation AB and was generally supported by commenters, who stated that it is consistent with the use of the term in both Regulation AB 147 and Regulation RR, 148 as well as market understanding of what a securitization sponsor is. 149 146 17 CFR 230.192(c). 147 17 CFR 229.1101(l). 148 17 CFR 246. 149 See, e.g., letters from AIC; SFA I; SIFMA I. Some commenters requested that we exclude states and their political subdivisions from the definition of “sponsor” under the final rule. 150 These commenters generally stated that application of Rule 192's prohibition to municipal issuers is unnecessary because these issuers engage in transactions pursuant to enabling legislation that is designed specifically to aid in the furtherance of important government functions and other public purposes, are restricted from engaging in speculative investments, and are not driven by a profit motive that would lead to the type of behavior that Section 27B is intended to address. 151 While municipal issuers may be subject to other provisions that regulate their conduct, we are not persuaded that issuers of municipal ABS are uniquely different from other securitization participants such that they should be excluded from the final rule. Similarly, the fact that municipal entities are subject to investment policies that limit the ability of such entities as investors to engage in speculative investments is not a reason to exempt these entities from the definition of “sponsor.” While the outcome of such policies may be that the entities may not, for example, take a short position against their municipal ABS, the objectives of those policies are typically focused on protection of the entity's investment portfolio. 152 Being subject to various laws and regulations that may intersect is not a position that is unique to issuers of municipal ABS. Additionally, the prohibition in Rule 192 is designed to prophylactically protect investors in U.S. securities markets from ABS transactions tainted by material conflicts of interest, regardless of whether a securitization participant has a profit motive or actually does profit from such transactions. 153 As such, while it may be unlikely, as some commenters stated, that issuers of municipal ABS would engage in the type of conduct that Section 27B prohibits for the reasons discussed above, 154 we do not believe that an exclusion from the definition of “securitization participant” or “sponsor” would be appropriate because investors are entitled to the protections afforded by the statute regardless of how likely the securitization participant is to engage in a conflicted transaction. 150 See, e.g., letters from NABL et al.; NAHEFFA (also requesting that 501(c)(3) organizations and the issuers of qualified 501(c)(3) conduit bonds to such organizations be excluded from the definition); NAMA; SIFMA I; Wulff Hansen (expressing support for the comments submitted by NAMA). 151 Id. One of these commenters also stated that application of the prohibition in Rule 192 to State and local governmental issuers would be a breach of the principles of federalism and intergovernmental comity. See SIFMA I. The U.S. Supreme Court has held that State and local governments “must find their protection from congressional regulation through the national political process, not through judicially defined spheres of unregulable state activity.” See Garcia v. San Antonio Metropolitan Transit Authority, 469 U.S. 528 (1985); South Carolina v. Baker, 485 U.S. 505 (1988). Congress enacted Section 621 of the Dodd-Frank Act, adding Section 27B of the Securities Act. Rule 192 implements Section 27B of the Securities Act with respect to certain activities undertaken by State and local governmental issuers that fall within its proscriptions. It follows, therefore, as provided in Garcia and Baker, that the application of Rule 192 to State and local governmental issuers is not inconsistent with principles of federalism and intergovernmental comity. 152 See letter from NABL et al. (stating that municipal investment policies are “centered on preservation of principal or moderate growth.”) 153 See Section II.D.3 154 See, e.g., letters from NABL et al.; NAHEFFA; NAMA; SIFMA I. Some commenters went on to state that, because municipal ABS issuers are unlikely to engage in conflicted transactions for the reasons discussed above, these entities would need to expend administrative and financial resources to “prove a negative” ( i.e., that they do not engage in conflicted transactions), especially if securitization participants were to be required to have documented policies and procedures in place to prevent violation of the prohibition, adding compliance costs without a clear regulatory benefit. 155 Although the Commission requested comment in the Proposing Release about whether the final rule should include a requirement that a securitization participant have documented policies and procedures reasonably designed to prevent a violation of the rule's prohibition on conflicted transactions, 156 the Commission did not receive any comments in support of such a requirement. Commenters, however, expressed concerns about the potential costs associated with such a provision, 157 and therefore, final Rule 192 does not include a requirement that securitization participants have documented policies and procedures reasonably designed to prevent a violation of the rule's prohibition. As such, while we recognize that compliance with the prohibition against engaging in conflicted transactions may result in increased compliance costs to municipal issuers subject to Rule 192, we expect that such costs will be modest because the final rule does not include a general requirement for policies and procedures. 158 155 See, e.g., letters from NAHEFFA; NAMA. 156 See Proposing Release Request for Comment 59. 157 See, e.g., letters from NAHEFFA, NAMA. 158 See Section IV for a discussion of the Commission's economic analysis of the impacts of Rule 192 and a discussion of alternatives considered. For these reasons, we continue to believe that any such costs will be justified because investors in municipal securitizations should be entitled to the same legal protections as investors in other types of ABS that meet the definition of “asset-backed security” in Rule 192(c). Accordingly, if a municipal security meets the definition of Exchange Act ABS, 159 then the municipal issuer that organizes and initiates such an offering 160 is a sponsor for purposes of Rule 192. 161 159 See Section II.A.3.a. 160 Or, in the case of a municipal advisor, if the advisor has a contractual right to direct or cause the direction of the structure, design, or assembly of a municipal ABS, such person is a sponsor under paragraph (ii) of the “sponsor” definition in final Rule 192(c). See Section II.B.3.b.ii. 161 The same analysis will apply for issuers of single-asset conduit bonds that meet the definition of Exchange Act ABS or otherwise meet the definition of “asset-backed security” in Rule 192(c). See Section II.A.3.a. ii. Contractual Rights Sponsor We are adopting the definition of “Contractual Rights Sponsor” that was proposed in paragraph (ii)(A) of the proposed definition of “sponsor” with certain modifications in response to comments received. Also, in response to comments received, we are not adopting the definition of “Directing Sponsor” that was proposed in paragraph (ii)(B) of the proposed definition of “sponsor.” Accordingly, paragraph (ii) of the definition of “sponsor” for purposes of Rule 192 captures, subject to certain exceptions discussed below, any person with a contractual right to direct or cause the direction of the structure, design, or assembly of an asset-backed security or the composition of the pool of assets underlying or referenced by the asset-backed security (a Contractual Rights Sponsor), other than a person who acts solely pursuant to such person's contractual rights as a holder of a long position in the asset-backed security (a Long-only Investor). 162 The revision to explicitly exclude Long-only Investors from the definition of sponsor by deleting the proposed “Directing Sponsor” definition is consistent with the Commission's stated intent in the Proposing Release that an ABS investor (that does not otherwise meet any of the other definitions of parties covered by the rule) would not be a sponsor under the rule merely because such investor expresses its preferences regarding the assets that would collateralize its ABS investment. 163 Also, Rule 192 is not designed to discourage ABS investors from exercising contractual rights as a holder of a long position in an ABS. As discussed below, the final rule excludes any person who acts solely pursuant to such person's contractual rights as a holder of a long position in the ABS. 162 As discussed in more detail below, we are also adopting an exclusion from the “sponsor” definition for any person who performs only administrative, legal, due diligence, custodial, or ministerial acts related to the ABS and for the United States or an agency of the United States with respect to ABS that is fully insured or fully guaranteed as to the timely payment of principal and interest by the United States. See Sections II.B.3.b.iii. and II.B.3.b.iv. 163 See Proposing Release Section II.B.2.b. The Commission proposed a comprehensive definition of “sponsor” that would include a person that is in a unique position to structure the ABS and/or construct the underlying asset pool or reference pool in a way that would position the person to benefit from the actual, anticipated, or potential adverse performance of the relevant ABS or its underlying asset pool if such person were to enter in a conflicted transaction. 164 Some commenters supported this approach, citing the significant role that such parties play in securitization transactions. 165 As discussed in greater detail below, a number of commenters, however, opposed the proposed inclusion of Contractual Rights Sponsors and Directing Sponsors as too broad. 166 Some of these commenters requested that the “sponsor” definition be limited to paragraph (i) ( i.e., a Regulation AB-based sponsor), 167 while others stated that such a definition would not be sufficient to capture the key transaction parties that have a significant role in asset selection for ABS transactions. 168 Some commenters also stated that defining “sponsor” to include functions beyond the scope of the Regulation AB-based Sponsor definition extends beyond the “ordinary and natural meaning” of the term, which they state is understood by market participants to be the definition that was codified in Regulation AB. 169 These commenters stated that the Commission codified the “ordinary and natural meaning” of the term “sponsor” when it adopted the definition in Regulation AB in 2004 and that, because Section 27B uses the term “sponsor” without separately defining it, any other definition for purposes of Rule 192 would be inconsistent with Congressional intent. 170 164 See Proposing Release Section II.B. 165 See letters from AFR; Better Markets. 166 See, e.g., letters from ABA; AIMA/ACC; AFME; CREFC I, CRE Finance Council dated July 5, 2023 (“CREFC II”); NAMA; Representatives Wagner and Huizenga; Senator Kennedy; SFA I; SFA II; SIFMA I. 167 See, e.g., letters from ABA; AIC; SIFMA I. letters from ABA; AIC; SIFMA I. See Section II.B.3.b.i. above for a discussion of paragraph (i) of the “sponsor” definition in Rule 192(c). 168 See, e.g., letters from Better Markets (expressing support for the scope of the definition and stating that collateral managers should be subject to the rule because they play a significant role in selecting and managing the assets underlying an ABS); SFA II (acknowledging the Commission's desire to scope in CLO managers that are not sponsors for purposes of Regulation RR). 169 See, e.g., letters from ABA; AIC; SIFMA I. 170 See, e.g., letters from ABA; AIC; SIFMA I. Regulation AB is a set of disclosure items that form the basis for disclosure in Securities Act registration statements and Exchange Act reports for asset- backed securities and identify the transaction parties responsible for making that disclosure. 171 When the Commission adopted these specialized registration, disclosure, and reporting requirements in Regulation AB for certain types of asset-backed securities, it explained that those requirements were specifically designed for asset-backed securities that have certain characteristics ( i.e., ABS as defined in Regulation AB). 172 At that time, the Commission acknowledged that the types of ABS that would meet the definition in Regulation AB were a subset of the full spectrum of ABS in the market. 173 For example, synthetic securitizations are not eligible for registration and reporting under Regulation AB because such securitizations are primarily based on the performance of assets or indices not included in the ABS. 174 As such, the concept of a sponsor “selling or transferring assets . . . to the entity that issues the [ABS]” in the “sponsor” definition under Regulation AB would not be applicable in a synthetic ABS because, as described in Section II.A.3.b. above, a synthetic ABS is designed to create exposure to an asset that is not sold, transferred to, or otherwise part of the asset pool. Rule 192, consistent with the express language of Section 27B, applies to a wider spectrum of ABS ( i.e., Exchange Act ABS, synthetic ABS, and hybrid cash and synthetic ABS) 175 than Regulation AB and—as discussed throughout this section—the characteristics of the structure, assets, and the role of transaction parties involved in those types of ABS may differ significantly from those in Regulation AB ABS. We do not believe the concept of “sponsor” in Section 27B is limited to the Regulation AB definition of that term, as that would mean that there is no “sponsor” for synthetic asset-backed securities, even though Congress explicitly referenced those participants in the statute. It is therefore appropriate for Rule 192 to define the securitization participants subject to the rule's prohibition to align with the characteristics of that wider spectrum of ABS. Accordingly, we continue to believe that, while it is appropriate for the final rule to incorporate a definition based on the Regulation AB definition of sponsor, defining “sponsor” for purposes of Rule 192 as a Regulation AB-based sponsor alone would not be sufficient to address the full range of securitization activities involved in asset-backed securities transactions that Section 27B addresses. 171 See Sections III.A.2. and III.B.3. of the 2004 Regulation AB Adopting Release. 172 See Section III.A.2. of the 2004 Regulation AB Adopting Release. 173 Id. (stating, for example, that a default application of the traditional disclosure regime might not be appropriate for some structured securities, but that treating them the same as ABS as defined in Regulation AB may not be appropriate either and that, depending on the structure of the transaction and the terms of the securities, it might be most appropriate to apply some aspects of both regimes in combination). The Commission also acknowledged in that release that there may be securities developed in the future that are not contemplated in Regulation AB, which would similarly require consideration of which regulatory regime would be most appropriate. 174 See also Section III.A.2. of the 2004 Regulation AB Adopting Release. 175 See Section II.A.3. One commenter also cited to the holding of the U.S. Court of Appeals for the District of Columbia Circuit that the application of the term “securitizer” 176 to CLO collateral managers in Regulation RR was an overreach of its authority. 177 The Court's analysis was centered around the statutory text that directed the Commission, together with several other Federal agencies, to issue regulations to require any securitizer to “retain” an economic interest in a portion of the credit risk for any asset that the securitizer, through the issuance of an asset-backed security, “transfers, sells, or conveys” to a third party. 178 The Court held that, because open-market CLO managers do not “hold” the securitized loans in a CLO transaction at any point, they can neither “transfer” those loans, nor “retain” credit risk in the loans because such terms require that the “securitizer” has control over the assets via possession or ownership. 179 We believe a different analysis is applicable to Section 27B, which directs the Commission to prohibit securitization participants of Exchange Act ABS and synthetic ABS from engaging in transactions that would involve or result in a material conflict of interest. Section 941 of the Dodd-Frank Act added Section 15G of the Exchange Act, 180 in which Congress provided a statutory definition for the term “securitizer” that incorporated from the Regulation AB definition of sponsor the general concept of transferring or selling assets into a special purpose entity. In the case of Section 15G, therefore, the statutory text specified the functions that Congress intended to be captured by the term “securitizer.” In Section 27B, however, Congress did not define “sponsor,” but it did specify the types of ABS ( i.e., Exchange Act ABS and synthetic ABS) that are subject to the prohibition. Moreover, as evidenced by statutory text in other laws, where Congress intended to refer to a portion of Regulation AB, it did so explicitly. 181 176 The statutory term at issue in the case was “securitizer,” which was defined by Congress as an issuer of an ABS or a person who organizes and initiates an ABS transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuer. See Section 15G(a)(3) of the Securities Exchange Act of 1934 (15 U.S.C. 78 o -11(a)(3)), which was added by Section 941 of the Dodd-Frank Act (Pub. L. 111-203). 177 See letter from AIC (citing The Loan Syndications and Trading Association v. Securities and Exchange Commission et al., 882 F.3d 220 (D.C. Cir. 2018) (the “LSTA Decision”) and stating that, by proposing to define “sponsor” in Rule 192 to refer to functions beyond the scope of the Regulation AB-based Sponsor definition, the Commission failed to heed the D.C. Circuit's guidance and exceeded the scope of its authority). 178 See LSTA Decision. See also 15 U.S.C. 78 o -11(b)(1). 179 See LSTA Decision, 882 F.3d at 223. 180 15 U.S.C. 78 o -11(a)(3). 181 See, e.g., Credit Rating Agency Reform Act of 2006 (Pub. L. 109-291) (referring specifically to “issuers of asset-backed securities (as that term is defined in section 1101(c) of part 229 of title 17, Code of Federal Regulations, as in effect on the date of enactment of this paragraph)”). We also note that the term “sponsor” appears in several other places throughout the securities laws with varying meanings. For example, in Item 901 of Regulation S-K, a sponsor is defined in the context of roll-up transactions as “the person proposing the roll-up transaction.” See 17 CFR 901(d). As we discussed above, the characteristics of the structure, assets, and the role of transaction parties involved in the wider spectrum of ABS covered by Section 27B (including synthetic asset-backed securities) differ significantly from those ABS subject to Regulation AB, and therefore the definitions adopted by the Commission in Regulation AB do not capture the types of ABS that Congress determined should be subject to Rule 192's prohibition. Accordingly, we believe that the statutory inclusion of these types of ABS requires that Rule 192 define the market participants and their roles in such ABS in congruence with the structures and characteristics specific to the relevant ABS. A number of commenters also expressed concern that paragraph (ii) of the “sponsor” definition includes activities that could be attributed to a wide variety of transaction parties and could therefore be understood to scope in, as a Contractual Rights Sponsor or Directing Sponsor, almost any party with any role in the structuring of the transaction. 182 Commenters stated that the definition could include entities such as investors, 183 asset managers 184 and other investment advisers, 185 servicers, 186 and warehouse lenders, 187 each of which we discuss below. 182 See, e.g., letters from ABA; AIMA/ACC; AFME, CREFC I; CREFC II; NAMA; Representatives Wagner and Huizenga; Senator Kennedy; SFA I; SFA II; SIFMA I. 183 See, e.g., letters from ABA; CREFC I; CREFC II; SFA I; SFA II; SIFMA I. 184 See, e.g., letter from ABA; LSTA IV. 185 See, e.g., letter from ICI. 186 See, e.g., letters from MBA; SFA I; CREFC I. We discuss the final rule's applicability to servicers in Section II.B.3.b.iii., below. 187 See, e.g., letter from ABA. Many commenters expressed concern that ABS investors could be captured by the definition of sponsor by virtue of the iterative negotiation process between deal participants and investors. 188 These commenters recognized the stated intent in the Proposing Release 189 that investors acquiring a long position in an ABS would not be Directing Sponsors merely because they express their preferences regarding the structure of the ABS or the underlying assets, but requested that this be codified in rule text to avoid the unintended consequence of discouraging investors from actively participating in discussions about deal structures and underlying asset pools in their ABS investments and to help ensure that they are not unnecessarily subject to additional costs associated with developing compliance programs under Rule 192. 190 In current market practice, investors in ABS transactions may receive information about collateral (including, for example, specific loan data and due diligence results) and may specify preferences or requirements for a given deal structure or terms of the security. 191 Commenters stated, and we agree, that these negotiations are important and beneficial market functions. 192 Consequently, as requested by commenters and to help ensure that Rule 192 is not an impediment to an investor's negotiating power, we are not adopting paragraph (ii)(B) (Directing Sponsor) of the proposed definition of “sponsor.” 188 See, e.g., letters from ABA; AFME; CREFC I; CREFC II; IACPM; ICI; MBA; MFA II; LSTA III; LSTA IV; Representatives Wagner and Huizenga; Senator Kennedy; SFA I; SFA II; SIFMA I; SIFMA II. 189 See Proposing Release Section II.B.2. 190 See, e.g., letters from ABA; AFME; CREFC I; CREFC II; IACPM; ICI; MBA; MFA II; LSTA III; Representatives Wagner and Huizenga; Senator Kennedy; SFA I; SFA II; SIFMA I; SIFMA II. 191 For example, investors may specify a certain rating, yield, or maturity on the bonds, require particular levels of subordination or credit enhancement, or may request that assets be added or removed to satisfy preferences with respect to asset quality, concentration levels, etc. 192 See, e.g., letters from CREFC I; ICI; SFA II. Some commenters suggested that the regulatory text should specify that long investors are also excluded from proposed paragraph (ii)(A) (Contractual Rights Sponsor). 193 Relatedly, some commenters stated that the exercise of contractual rights inherent to the purchase of the ABS should not be conflicted transactions under Rule 192(a)(3). 194 In securitizations, it is often the case that long investors purchasing the most senior or the most subordinated tranche of the relevant ABS negotiate for certain rights that are exercisable over the life of the securitization. A person's contractual rights as a holder of a long position in the ABS could include, for example, consent rights over major decisions such as initiating foreclosure proceedings with respect to assets underlying the ABS, the right to replace the special servicer of the ABS, or the right to direct or cause the direction of an optional redemption of outstanding interests in the ABS. Rule 192 is not designed to impair an ABS investor's ability to negotiate for such contractual rights as a holder of a long position in the ABS. Nor is it designed to discourage investors from exercising such rights as a holder of a long position in the ABS. Therefore, we are adopting paragraph (ii) of the definition of “sponsor” to exclude from the definition of Contractual Rights Sponsor any person who acts solely pursuant to such person's contractual rights as a holder of a long position in the ABS. 193 See, e.g., letters from CREFC I; SFA II; SIFMA II. 194 See, e.g., letter from CREFC I; SFA I. Whether a long investor is acting “solely” pursuant to its contractual rights as a holder of a long position in the relevant ABS will depend on the relevant facts and circumstances, including what other roles the long investor may have in the transaction. For example, some commenters requested that the rule specify that the holders of “B-piece” bonds (the “B-piece buyer”) in commercial mortgage backed securities (“CMBS”) transactions 195 are not ”sponsors” as defined by the final rule or, alternatively, that the B-piece buyers be otherwise excluded because they should be considered long investors. 196 Whether a B-piece buyer in a CMBS transaction is a “sponsor” for purposes of Rule 192 or satisfies the condition of the exclusion for Long-only Investors will depend on the facts and circumstances of a given transaction and B-piece buyer. 197 Generally, the B-piece buyer purchases the most subordinate tranches of the ABS and, in connection with this investment, performs extensive due diligence on the underlying loans and negotiates with the deal sponsor for changes to pool composition and to increase credit quality of the pool. As a holder of a long position in the relevant ABS, a B-piece buyer will generally have additional ongoing rights in an ABS transaction. For example, transaction agreements may dictate that certain actions with respect to the asset pool underlying the ABS (such as releasing a property from a lien) are subject to the approval of the B-piece buyer, 198 giving the B-piece buyer a contractual right to direct or cause the direction of the composition of the pool. As such, absent the exclusion we are adopting for Long-only Investors, a B-piece buyer could be subject to the prohibition of Rule 192(a)(1) as a Contractual Rights Sponsor. Under the final rule, if the B-piece buyer exercises such rights solely pursuant to its contractual rights as a holder of a long position in the ABS, then the B-piece buyer will satisfy the conditions for the Long-only Investor carve-out from the definition of Contractual Rights Sponsor as adopted and, therefore, will not be subject to the prohibition in Rule 192(a)(1). 195 As is the case with most ABS, CMBS securities are offered in tranches, with each tranche representing a different risk profile. The top tranche (referred to as “AAA”) represents the lowest risk investment while the lower tranches (typically non-investment grade) represent the highest risk profile because they are the first to incur losses in the event that there are shortfalls in collections on the underlying assets. In CMBS, the “B-piece” bonds are the lowest tranche(s) of the CMBS ( i.e., the most subordinate tranche(s), meaning that holders are purchasing the first-loss position) and the holders of those bonds are typically third-party purchasers, commonly referred to as the “B-piece buyer.” See, e.g., Section III.B.5. of the RR Adopting Release. 196 See, e.g., letters from ABA; CREFC I; Fannie and Freddie; MBA. 197 The same analysis applies for the directing noteholder in a commercial real estate collateralized loan obligation (“CRE CLO”), which functions similarly to the B-piece buyer in CMBS transactions. 198 See, e.g., letter from CREFC I. In some circumstances, however, the B-piece buyer can also act as a special servicer for the securitization ( i.e., a contractual party to the transaction) or may be an affiliate or subsidiary of the special servicer. Whether a special servicer's activities satisfy the conditions of the exclusion for persons that perform only administrative, legal, due diligence, custodial, or ministerial acts with respect to the relevant ABS will depend on the nature of the special servicer's activities. 199 Accordingly, if a B-piece buyer is also a special servicer for an ABS transaction, the B-piece buyer will not be acting “solely” pursuant to its rights as a holder of a long position in the relevant ABS and will need to then consider whether the performance of its contractual obligations as special servicer will be sufficiently administrative or custodial in nature to be excluded from the definition. 200 Similarly, if the B-piece buyer is an affiliate or subsidiary, as defined by this rule, of another securitization participant in the relevant ABS, then it will also be a securitization participant subject to the prohibition in Rule 192(a)(1). 201 For the foregoing reasons, whether a B-piece buyer is a “sponsor” for purposes of Rule 192, or is eligible for the Long-only Investor exclusion, will depend on the facts and circumstances of the particular ABS and the roles of the B-piece buyer and its affiliates and subsidiaries in the ABS transaction. 199 See Section II.B.3.b.iii. for a discussion of the final rule's application to special servicers. 200 Id. As discussed in Section II.D.3.c., however, the exercise of such contractual rights and obligations will not themselves be conflicted transactions under the final rule. Also, if the performance of the B-piece buyer's contractual obligations as special servicer is sufficiently administrative or custodial in nature to rely on the Service Provider Exclusion and the B-piece buyer's only other role in the transaction is as a Long-only Investor, then the B-piece buyer will not be a sponsor under the final rule. 201 See Section II.B.3.c. Some commenters requested that market participants acting subject to a fiduciary duty to a client or customer, such as open-market CLO collateral managers, municipal advisors, 202 or other investment advisers be excluded from the definition of “sponsor” because such participants are already subject to various laws and regulations that regulate their conduct and address conflict management. 203 Rule 192 will complement the existing federal securities laws, including those that govern a market participant's Federal fiduciary duties. As discussed earlier, the fact that an entity is subject to other rules, laws, or regulatory policies pertaining to its conduct, including the existence and management of conflicts of interest, does not preclude such entity from satisfying the conditions of other regulatory requirements. Additionally, we recognize, as one commenter stated, that securitization participants in an ABS subject to Rule 192 do not owe a fiduciary duty to the investors in an ABS because the securitization participants' advisory clients are the deal sponsors rather than the ABS investors. 204 In cases where a sale of an ABS does not involve the sale of an interest in a private fund 205 or other vehicle advised by an investment adviser, there is no advisory relationship creating a Federal fiduciary duty owed between a purchaser and seller. In cases where the private fund issues ABS (such as tranches of a CLO), the private fund's adviser owes a Federal fiduciary duty to the fund and the antifraud provisions of the Advisers Act and the rules thereunder (the “Antifraud Provisions”) apply. 206 Such advisers include CLO collateral managers who will also be subject to Rule 192. Although the application of an adviser's Federal fiduciary duty, which requires the adviser to serve the best interests of its clients, 207 and the Antifraud Provisions provide protections relating to conflicts of interest that act in harmony with Rule 192, these duties and provisions do not necessarily require elimination of conflicted transactions. Accordingly, a fiduciary duty-based exclusion from Rule 192 would frustrate Section 27B's prophylactic investor protection objectives to eliminate certain conflicted transactions. 202 See Section II.B.3.b.i. for additional discussion about Rule 192's application to municipal advisors. 203 See, e.g., letters from ABA; ICI; LSTA IV; NAMA; Wulff Hansen. 204 See letter from SIFMA I. 205 Section 202(a)(29) of the Investment Advisers Act of 1940 (the “Advisers Act”) defines the term “private fund” as an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940 (15 U.S.C. 80a-3), but for section 3(c)(1) or 3(c)(7) of that Act. 206 See 17 CFR 275.206(4)-8 (“Advisers Act Rule 206(4)-8”), which prohibits investment advisers to a pooled investment vehicle from (1) making untrue statements of a material fact or omitting to state a material fact necessary to make the statements made, in the light of the circumstances under which they were made, not misleading, to any investor or prospective investor in the pooled investment vehicle; or (2) otherwise engaging in any act, practice, or course of business that is fraudulent, deceptive, or manipulative with respect to any investor or prospective investor in the pooled investment vehicle). See also Prohibition of Fraud by Advisers to Certain Pooled Investment Vehicles, Release No. IA-2628 (Aug. 3, 2007) [72 FR 153 (Aug. 9, 2007)]). 207 See Commission Interpretation Regarding Standard of Conduct for Investment Advisers, Release No. IA-5248 (June 5, 2019) [84 FR 33669 (July 12, 2019)] (“IA Interpretation”). Some commenters also stated that an adviser's Federal fiduciary duty may address conflicts of interest, including through appropriate disclosure and informed client consent. 208 As the Comm [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2023-26430. Public record. Not legal advice.