SEC Seeks Public Comment on Asset-Backed Issuers and Mortgage-Related Pools Under Investment Company Act

August 31, 2011

The SEC is seeking comment on the treatment of asset-backed issuers as well as real estate investment trusts (REITs) and other mortgage-related pools under the Investment Company Act of 1940 (1940 Act).  Additionally, through a separate concept release, the SEC is seeking public comment on interpretations of a provision in the 1940 Act – Section 3(c)(5)(C) – that may be used by some companies engaged in the business of acquiring mortgages and mortgage-related instruments such as some REITs. The SEC describes a concept release to be an SEC-approved document that poses an idea or ideas to the public to get their views.

The SEC is soliciting comment on possible amendments to Rule 3a-7 including the role, if any, that credit ratings should continue to play in the rule.

The SEC covers the following areas in the Concept Release:

  • Revising the Conditions in the Rule: To be able to use Rule 3a-7, an issuer must meet the rule’s conditions including the existing rating condition. The SEC seeks input about possibly removing the rating condition and replacing it with new conditions. Rather than rely on rating agencies to assess the issuer’s structure and operations, such new conditions could address the structure and operations of asset-backed issuers. Possible new conditions also could require the issuer to undergo an independent review to protect investors in the asset-backed securities from self-dealing and overreaching by insiders. Additional possible conditions could help ensure that the issuer preserves and safeguards its assets and cash flow.
  •  How the Rule is Used: Rule 3a-7 excludes from the definition of “investment company” any asset-backed issuer that holds specified assets and meets the rule’s conditions, so that the issuer does not have to comply with the requirements of the 1940 Act. The SEC Notice asks whether Rule 3a-7 issuers should still be considered “investment companies” for the limited purpose of determining whether an entity investing in Rule 3a-7 issuers is itself an “investment company” that should comply with the requirements of the 1940 Act.
  • Availability of Section 3(c)(5) to Asset-Backed Issuers: The 1940 Act contains a provision – Section 3(c)(5) – that may be used instead of Rule 3a-7 by some asset-backed issuers, including certain issuers of mortgage-backed securities. This provision was not specifically intended to be used by asset-backed issuers. The SEC asks whether Section 3(c)(5) should be amended to limit the ability of asset-backed issuers to rely on that section, or whether the SEC should use its rulemaking authority to define the relevant terms in that provision so as to limit its availability to those companies that are intended to be encompassed by that section.

The companion Concept Release also asks, for example, whether a test could be devised to differentiate companies that are primarily engaged in the real estate and mortgage banking business from those companies that look like traditional investment companies, and what factors the SEC should consider in such a test.

Commenters have 60 days to submit their comments.

Please click here to access the Concept Release regarding the proposed amendments to Rule 3a-7.

Please click here to access the Concept Release regarding the interpretation of Section 3(c)(5)(C).


Exchange-Traded Funds (ETFs), Investment Companies, Regulatory