SEC’s Conflicts of Interest Rule Proposal Preserves Considerable SEC Discretion and Creates Market Uncertainty

Summary:  The SEC’s proposed Conflicts of Interest rule for asset-backed securities is so broad that, if adopted as proposed, it would by itself provide little guidance as to its scope and would leave industry participants dependent on further SEC interpretations and proceedings to determine the types of actions that might violate the rule. Even with the benefit of the commentary in the proposing release, many questions remain unanswered, including the following:

• Will transactions specifically designed to have investors in a securitization knowingly take risk for the benefit of a sponsor or third party (e.g., synthetic securitizations or catastrophe bonds) still be possible?
• How can one design a hedging strategy which adequately protects against risk, and is a portfolio hedging strategy still permitted?
• In what cases might disclosure or information barriers be adequate to prevent a violation of the rule?

This client memorandum provides a quick summary and analysis of the potential impact of the proposed rule.