The Securities and Exchange Commission has recently demonstrated greater scrutiny of chief executive officer certifications of publicly offered asset-backed securities, as shown by a revision to Regulation AB that went into effect late last year. The requirement now imposes personal liability on the CEO of a securitization's depositor, encouraging closer examination of collateral assets by the CEO's institution.
While it isn't criminal liability, the certification does expose the CEO to ongoing personal liability to civil lawsuits by investors and to SEC charges of civil violations of securities law for up to 10 years.
This type of certification requires the CEO of a securitization's depositor (the entity that deposits all collateral assets into the securitization trust fund) to complete and sign a one-page statement confirming that they have personally reviewed the prospectus and are familiar in all material respects with the collateral assets and all material underlying transaction agreements; that the prospectus is free from material misstatements and omissions; and that there is a reasonable basis to conclude that the securitization is structured to produce enough cash flow for the payment of interest and ultimate repayment of principal on the securities.
The certification addresses all collateral assets being deposited into the securitization trust fund, which means that the CEO is assuming liability both on behalf of their own institution, as well as on behalf of all the securitization's other contributing loan sellers.
The certification must be signed at the time of each public offering of securities for a securitization, and may not be altered in any way.
Despite industry lobbying, the SEC would not permit the CEO to stipulate that they were relying on information provided by other parties.
Because of this, issuers are re-evaluating their relationships: How long have we been partnering with this loan seller? What processes and procedures do they have in place for collecting information on loans and what documents reflect due diligence?
What is their reputation — have they been identifying all disclosures and representation exceptions that the issuer would identify?
What is their track record — have there been issues with loans placed with other depositors? This scrutiny may strain small conduit lenders as issuers elect not to take on the potential associated liability.
Issuers will continue to ask their securitization partners more questions. They will want their partners to ensure that all loans comply with the certification's requirements and see how different their loan documentation, closing and due diligence procedures are.
This may cause issuers to re-evaluate, deepen and streamline their own due diligence procedures to ensure that they are providing as much comfort and protection possible for the CEO; and conduct peer reviews of both the other loan seller's loan documentation, closing and due diligence procedures, and any additional documentation and information generated from due diligence.
Full compliance, consistency and efficiency will involve hiring additional internal personnel and/or engaging third parties to complete reviews of all collateral assets contributed into a securitization.
It will also call for issuers requiring loan sellers to adopt the issuer's own loan documentation, closing and due diligence procedures and resulting documentation, as well as closer uniformity of underwriting standards by and between an issuer and the loan sellers. Last, compliance will require a more conservative approach to, and broader disclosures within, a prospectus.
Issuers may also consider how to protect the CEO from personal liability. Some protections are already established, such as directors and officers liability insurance and standard institutional indemnification of its officers and directors; however, issuers have been discussing requiring any contributing loan seller to execute a subcertification that would create accountability for those contributing loan sellers to the issuer and mitigating risk to the CEO. One question is whether issuers would require the subcertification to be executed by an individual or by the loan seller institution — evaluating the financial stability and long-term viability of the loan sellers.
Securitization costs will likely increase as issuers scrutinize collateral assets. Issuers will likely dedicate more internal resources, engage third parties to perform reviews and require more time between when loans have to be closed or the cutoff date and printing the book.
Since due diligence has always been an integral part of the offering process, the likely impact of the CEO certification requirement will not be materially adverse for commercial mortgage-backed securities, but the CEO certification requirement suggests that the SEC is concerned that loan sellers and issuers do not possess sufficient knowledge of their collateral assets.
Tricia Baker is a partner, and Rachel Pignatiello is an associate, in the finance group at Alston & Bird LLP.