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The Dodd-Frank Act’s Prohibition against Conflicts of Interests in Securitizations: The Authors Respond

February 5, 2012

Photo by Fernando Zuleta. Some rights reserved.

On September 19, 2011, the SEC published for comment proposed rules implementing Section 621 of the Dodd-Frank Act, which prohibits conflicts of interest in connection with asset-backed securities (“ABS”). Originally, the comment period for the proposal expired on December 19, 2011. The SEC extended the comment period twice, with the current comment period ending on February 13, 2012. The rule is intended to prohibit underwriters, sponsors, and others who assemble ABS from packaging and selling those securities and profiting from the securities’ failures. See Blogmosaic’s earlier summary of the proposal.

Given the apparent straightforward nature of the proposal, it may come as no surprise that only 14 comments have been submitted and only one agency meeting noted (with the bulk of the comments being of the “securitizations are evil” variety). But the dearth of comments belies an underlying struggle evidenced by the Commission’s decision to extend the comment period twice.

Although not posted as a comment to this specific SEC proposal, the Securities Industry and Financial Markets Association (“SIFMA”) wrote the Commission in 2010 to present its views on Section 621 of the Dodd-Frank Act.  Citing the Act’s legislative history, SIFMA suggested a rule that required intent; in order to find that a securitization participant engaged in a prohibited material conflict of interest, it would have to be found that the securitization participant intended to benefit from the transaction’s failure.

As proposed, the rule does not require intent.

The SEC’s proposed interpretive guidance explicitly provides that liability can attach even if the securitization participant did not act intentionally. Similarly, a conflict could be material even if the securitization participant’s actions only indirectly affect the price of the ABS. Moreover, disclosure of a material conflict would not necessarily immunize a securitization participant.And the authors of Section 621, Senators Jeff Merkley and Carl Levin, say that’s exactly what they intended. Three weeks ago the Senators submitted a letterto the SEC reiterating their views and suggesting a rule which borders on strict liability. Not only would the securitization participant’s intent be irrelevant, but so would investor loss.The Senators seek a broad, flexible rule that encompasses anyone who could be considered a securitization participant and anything that could be considered “adverse performance,” including adverse performance arising out of price volatility. They commend the SEC for refraining from defining what would constitute a “material conflict of interest,” and suggest the addition of an anti-abuse provision prohibiting securitization participants from using hedging or market-making activities to circumvent the conflicts of interest prohibition.The last word remains to be written.
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