Liability for deals involving mortgage-backed securities issues may have been shifted from the brokers of these instruments to investment bankers and other underwriters that issue the instruments, thanks to a no-action letter granted to Kidder, Peabody & Co. from the Securities and Exchange Commission.
The letter, issued May 20 from the agencys Division of Corporate Finance, has many in the financial services industry, including chief financial officers, quietly blaming the agency for adding a huge administrative reporting burden to the prospectus process. They argue the letter to Kidder indirectly changes the landscape of disclosure requirements and leaves the issuers of the securities open to liability lawsuits.
Issuers of these securities are in somewhat of an uproar over this, said one industry attorney. Issuers want SEC to consider an approach without a filing requirementthat will solve the liability issue.
Some industry analysts contend Kidders request for a no- action letter from the commission stemmed from Kidders impatience with the Public Securities Associations attempts at getting SEC to amend its disclosure requirements. Kidder independently sought its own approval, a move that the securities industry has collectively frowned upon.
Other analysts say the move may stem from recent SEC scrutiny that has been placed on Kidder over its rapidly declining investment portfolio, which is reportedly threatening the investment firms financial stability. The firms parent, General Electric Co., has been subsidizing the firm for now, but analysts predict that the Kidder will take a big hit, and could fail, when Kidder moves to liquidate its holdings.
The letter grants Kidder permission to provide written material about its MBS issues, referred to as computational materials, while the deal is being structured. Industry analysts say that providing information before the prospectus was filed was commonly done in the industry, but technically violated Section 5 of the Securities Act that allows these pre-market materials to be delivered to the client only after the prospectus has been filed with the commission.
PSAs main argument with the SEC was that security laws do not reflect the practices of the marketplace. Generally MBS and ABS issues are tailored to a particular clients financial needs, making the need of pre-market information essential in structuring a deal.
Under SEC rules governing securities transactions, issuers are barred from furnishing certain information to prospective investors prior to the availability of a final prospectus. The no-action letter, in effect, requires issuers to file pre-marketing materials after the effective date of a registration statement and before availability of the final prospectus, an industry attorney maintained.
Prospective investors require this information in tangible form for their own protection in order to meet regulatory requirements, to compare potential structures and to compete on equal terms with those prospective investors who have adequate computer resources to process relevant data without the underwriters assistance, Kidder attorneys Brown & Wood said.
Restrictions on freedom of communication between such investors and underwriters serves to frustrate, and not advance the purposes of the [Securities] Act, Kidder attorneys argued.
Another knotty issue with bankers and others issuing these instruments is the reporting burdens the disclosures are expected to cause. The commission stated in its letter that the pre-deal information that it would allow underwriters to distribute had to be included in the banks final prospectus of the issue. This requirement, bankers say, creates an enormous reporting burden for these transactions.
Industry attorneys believe issuance of such information by the bank, rather than the broker, puts the liability for truth in information squarely on the bank issuing the security. This creates a problem, lawyers warned, because any errors in the final prospectus can give prospective buyers what amounts to a one-year right to give the securities back to the bank.