The Securities and Exchange Commission approved two more rule proposals under the Dodd-Frank Act on Wednesday: one requiring financial firms to retain at least 5 percent credit risk in the asset-backed securities they issue, the other to impose new independence standards for boards' compensation committees.

Credit Risk Retention

Given that the proposed rule “contemplates few and narrow exemptions to the credit risk retention requirements,” many sponsors of asset-backed securities transactions—registered and unregistered—will be subject to risk retention requirements, said Jay Knight, of the Division of Corporation Finance, while presenting the proposal at the hearing.

“In order to provide flexibility to sponsors in the securitization markets generally, the proposed rules would permit a sponsor to choose from a menu of risk retention options,” said Knight. “The options are intended to provide flexibility to sponsors of different classes of assets and are subject to certain terms and conditions to ensure that the amount of risk retained by the sponsor remains meaningful.”

Commissioner Luis Aguilar raised concerns about this menu option format for issuers to structure their risk retention. “While this permits some benefits of flexibility to the sponsor, the proposal specifically seeks public input into whether this approach could be gamed.”

Aguilar also highlighted three questions asked in the proposal: “First, are there any kind of securitizations for which a particular form of risk retention is not appropriate? Second, are there ways that sponsors could avoid risk retention requirements in an effort to reduce or eliminate the risk retention requirements? And lastly, do the conditions and limitations in the proposed rules effectively limit the ability of the sponsor to structure away his risk exposure?”

Listing Requirements for Compensation Committees

The Commission also approved a rule proposal requiring new listing standards at the major stock exchanges that address compensation consultant independence. However, the SEC recommended  broadening the scope of the disclosure requirements to non-listed companies.

“We note that while section 10c only mandates these new disclosure requirements for listed issuers, we recommend that the requirements apply to all exchange act registrants subject to the proxy disclosure requirements, so that there's one set of disclosure rules about use of compensation consultants,” said Nandini Acharya of the Division of Corporation Finance, who presented the proposal.

SEC Commissioner Kathleen Casey said she would like comment letters to discuss whether extending the requirements to non-listed companies is appropriate.

Casey also said that her first choice would not be “to impose or to use the stock exchange as a poxy to impose” these requirements, at all. “In the absence of Dodd-Frank provisions that require additional disclosures, a wiser choice would be to monitor disclosures under those still-new requirements, before imposing additional disclosure requirements,” she said.

With so little leeway under the Congressional mandate for reform, the SEC seems to have no choice but to move forward with these two proposals. It will be very interesting to see what kind of comments they will get—and whether any case can be made strongly enough to affect the final rule.

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