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The SEC has ABS Servicers on their Radar

Charles Denyer is a senior manager with DuPont & Morgan LLP, a national provider for attestation and compliances service for the real estate finance industry. Firmwide services include SAS 70 attestation, Regulation AB compliance, real estate consulting, tax consulting, IT consulting and compliance, along with other specialty areas. To learn more, visit the firm at www.dupontmorgan.com.

Regulation AB is a comprehensive set of new rules and amendments which address the registration, disclosure and reporting requirements for asset-backed securities under the Securities Act of 1933 and the Securities Exchange Act of 1934. With the asset-backed security sector being a relatively new and fast-growing component of the U.S. capital markets, regulators and industry professionals alike sought to bring about transparency and clarity regarding registration, disclosure and reporting requirements for asset backed securities.

Understanding Item 1122

One of the most contentious issues currently facing the ABS industry is Regulation AB Item 1122 compliance for servicers. Considered costly, time-consuming and laborious by many, Item 1122, titled "Report on Assessment of Compliance with Servicing Criteria for ABS and Accountant's Attestation," also commonly called "Section 1122 or Item 1122" by many in the industry, consists of a number of activities that must be undertaken by servicers for ensuring they meet compliance for Regulation AB. Item 1122 should not be regarded as a simple, standalone process; rather it is a multifaceted, collaborative effort by servicers that yields a number of deliverables throughout various stages of the 1122 roadmap to compliance. Because of the sheer growth of asset-backed securities, the Securities and Exchange Commission clearly recognized the important role servicer's play, stating that "... one of the most important elements affecting an investor's assessment of a particular asset-backed security is the performance of the servicer ..."

Item 1122 puts forth a number of requirements that must be undertaken and achieved, culminating with two deliverables that are to be included with Form 10-K filings. These two deliverables, one a collection of statements and a brief assessment, the other, an actual attestation report, are collectively known as Form 10-K Reports on Assessments of Compliance with Servicing Criteria and Accountant's Attestation. These two reports should be looked upon as the final deliverables in the overall Item 1122 roadmap to compliance for servicers.

So What's the Problem?

Many servicers have pushed back on Regulation AB Item 1122 compliance, either out of not having a clear understanding of its requirements along with the supposedly high costs of becoming compliant. The problem is that if the current water-cooler talk holds true and a vast number of servicers in the ABS market are not Item 1122 compliant, there could be consequences. Though the SEC has not issued any penalties directly aimed at servicers for noncompliance, self-registration suspension could become a hot topic when the first Form 10-K reports are due in with their assessment and attestation reports.

USAP: The End of an Era

Unfortunately, servicers cannot rely on the antiquated USAP report for sufficing for Regulation AB compliance. Thus, at the heart of Item 1122 is the newly adopted servicing criteria put forth by the SEC. The minimum servicing criteria as outlined in Regulation AB for Item 1122 consist of four main categories:

* General Servicing Considerations

* Cash Collection and Administration

* Investor Remittances and Reporting

* Pool Asset Administration

These categories describe major components of the servicing function, with each category containing servicing criteria that have been designed to have general applicability to the servicing of all asset-backed securities.

These newly adopted minimum servicing criteria are geared towards today's ever-growing and complex asset-backed securities industry. Previous servicing criteria, such as the USAP audit, was simply "... not designed for the breadth of asset classes included in ABS offerings ... and does not address aspects of the servicing function that may be important in servicing asset-backed securities."

Additionally, these newly adopted servicing criteria are much more in-depth and far-reaching than that of the Uniform Single Attestation Program, known as USAP. According to the SEC, the USAP has "... significant limitations in the context of ABS reporting."

* Some of the USAP criteria may not be applicable to other asset types, such as criteria regarding property tax escrow accounts.

* Because it was written to address compliance criteria for residential mortgages, it does not adequately address other ABS areas, such as auto loans.

* There is no consistency as to which USAP criteria are applied to a particular asset type outside of residential mortgages. Thus, the list of exceptions varies from issuer to issuer.

* Rarely in the USAP is substituted criteria included that would be relevant to that asset class.

* The USAP does not clearly address the totality of activities and parties involved in servicing an ABS transaction.

Where to From Here?

It is imperative that servicers begin to take Regulation AB Item 1122 and Item 1123 compliance seriously. Continued noncompliance will only further the problem, requiring additional costs and time. Additionally, specialty firms for Regulation AB compliance are beginning to emerge and are thus likely a cost-effective alternative to larger, national firms.

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