Securities offering reform legislation passed unanimously by the Securities and Exchange Commission last Wednesday that aims to broaden the ability for written information sharing prior to the final prospectus was the adoption of a rule that will expose Wall Street firms and issuers to liability based on a determination of the completeness and accuracy of information an investor receives at the time he or she purchases a security. The rule, dating back to 1933, was most recently in the public eye when Google Inc.'s initial public offering was nearly derailed following an article featuring its founders that appeared in Playboy Magazine. And while the liberalization of information sharing may be good for equity IPOs, the liabilities that come along with it could be a hindrance to the ABS market, which commonly maintains a pre-investment dialogue between issuers, underwriters and investors in order to structure a deal's underlying collateral and cash flows, for example, prior to the issuance of a final prospectus.
"This is going to change how all of Wall Street conducts itself in offering securities, particularly structured finance securities," said Mark Adelson, head of structured finance research at Nomura Securities. The process of doing deals may slow down to where we don't actually start taking or accepting orders until final disclosure materials are prepared, alternatively, street firms will have to just get comfortable with the idea that preliminary materials have a lot more liability associated with them than they used to. The idea of flexing or tuning a deal is really curtailed." Using the analogy of a bake sale, Adelson explained that, essentially, investors can't buy bonds when they are still baking in the oven. "We can't take orders for cookies until we take them out of the oven, and put them in the box," he added.
The position of the American Securitization Forum and others is that the liability could outweigh the benefit of information sharing. In earlier statements to the SEC, ASF members had voiced concern that the rule, which overarches all registered securities offerings, may be too broad. A written version of the rule, however, was not available as of press time. As well, how and when the rule will be implemented in relation to securities contracts is yet to be determined, said George Miller, executive director of the ASF.
"They are basically saying it is fine and they encourage and promote the free writing prospectuses, but they are saying that to the extent that it informs the basis of an investment decision, liability for any misstatements or omissions is going to be measured only with respect to that information provided up to the point that an investment decision will be made," Miller said. "You don't have the opportunity to correct or cure that information with a final prospectus," he added.
For example, if deal information provided in a term sheet is later altered by additional or supplemental information within the final prospectus, a determination could be made that the term sheet is either materially inaccurate or incomplete, Miller said.
The rule change will have a particular impact on mortgage-backed securities because of the complexities of the transactions, based on the various mortgage product types and associated cash flows, the deals entail a high level of structuring on individual bonds, Adelson said. For example, a deal that shifts after sale to include a larger portion of interest-only loans, or a smaller portion of adjustable-rate mortgages, could be subject to liability if the cash flows on the securitization are altered enough to create a material impact. Collateralized debt obligations may receive a lesser effect from the new regulation, because the deals are usually not fully ramped at time of sale and already have previously outlined investment standards in place with the deals at time of sale, Adelson said.
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