Securitization

Venture Capitalists Seek “Safe Harbor” for Virtual Currencies

By Jimena Rubio, LL.M. Candidate 2018 | Posted on

In the wake of further developments by the SEC, many key players in the industry are currently combining efforts to petition federal authorities to see certain virtual currencies in a “different light.” The Venture Capital Working Group is led by Andreessen Horowitz, which includes another significant VC firm, Union Square Ventures, and lawyers from Cooley LLP, McDermott Will & Emery LLP, and Perkins Coie LLP.

The primary purpose of the Group is to deter regulators from categorizing cryptocurrencies, such as Bitcoin and Ether, as securities. On March 28th, the Group met with the U.S. Securities Exchange and proposed a “safe harbor” for some cryptocurrencies.

The proposal suggests that digital tokens should generally be exempt from securities laws if they achieve “full decentralization” or “full functionality.” It adds that full decentralization could occur under several conditions, including when the token creator no longer has control of the network based on its ability to make unilateral changes to the functionality of the tokens. It can also be used, not just as a speculative investment, but for its intended purpose on a computer network.

The group notes that these definitions are only suggestions, but the “proposed safe harbor has been vetted by, and has the support of, many of the key players in the industry.” People briefed on the meeting said that regulators did not immediately embrace the safe harbor proposal.

Many entrepreneurs and law firms have been creating new ways for virtual currency projects to issue their tokens as securities and some exchanges have talked about getting registered as official securities exchanges. It is still unclear what will happen to tokens that did not register as securities but are later categorized as securities.

Furthermore, on April 26, a congressional hearing with testimony from the SECs Division of Corporation Finance took place to develop more reasonable approaches toward token sales and their classifications. The discussion marked a new attitude amongst SEC members and addressed how certain utility tokens could not be securities if purchased with no investment intention.

In the hearing, the SEC division head, William Hinman, stated:

“They can certainly imagine a token where the holder is buying a token for its utility, not as an investment; especially if it’s a decentralized network where it’s used, and not central actors where there would be information asymmetries where they would know more than token investors.”

Hinman — likely referring to the Venture Capital Working Group — replied that one of the steps that the SEC was taking was “meeting with participants that have these ideas of a token that shouldn’t be regulated as a security” and working with them on how they should be structured. Hinman pointed out that the SEC is heavily engaged with academics and other departments to better explore how everything might work, and that in the long run, the U.S. is “pragmatic” in its support of new technology.

Venture Capitalists Seek “Safe Harbor” for Virtual Currencies

Regulators Turn to Subprime Auto Lending

By Yu Tanebe, J.D. Candidate 2017 | Posted on

The Federal Trade Commission (FTC) announced on January 30 that it reached a settlement with two companies engaged in subprime auto lending. The two car title lenders – First American Title Lending and Finance Select – were alleged to have misled borrowers in their advertisements by failing to disclose the actual terms and costs of loans.

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Tomorrow’s Fantasy Football: Owning Stock in Players

By Austin T. Holtsclaw, J.D. Candidate 2015 | Posted on

A San Francisco-based startup has created a new financial product that may push sports betting to a new level, challenging regulators and existing law.

Fantex, Inc. wants you to buy stock in Arian Foster, the Houston Texan’s Running Back. As an investor, you can receive up to 20% of Foster’s future earnings from his playing contracts, endorsement deals, broadcasting contracts, or any other income that he receives from contracts attributed to his brand.

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Firm Advice: Your Weekly Update

By Joseph Santiesteban, J.D. Candidate 2014 | Posted on

Federal Reserve Governor, Daniel Tarullo, recently discussed an upcoming proposal to alter the regulation of foreign banks in the U.S. The proposal would require large foreign banks to establish “a separately capitalized top-tier U.S. intermediate holding company.” The holding company would be “required independently to meet all U.S. capital and liquidity requirements as well as other enhanced prudential standards required by the Dodd-Frank Act.” In a recent Client Memorandum, Davis Polk suggests that the proposal “could have profound negative consequences” for both foreign banks in the U.S. and U.S. banks abroad by adding “fuel to the growing trend toward regionalization of global banking.” The proposal is still under consideration and more details are anticipated “in the coming weeks.”

The Dodd-Frank Act amended the Commodities Exchange Act to require clearing of certain swaps through a derivatives clearing organization. This includes fixed-to-floating swaps, basis swaps, forward rate agreements, and overnight index swaps. The CFTC recently issued final rules to implement this requirement and issued two no-action letters “that provide time-limited relief from the clearing requirement for certain swaps.” In a recent Legal Alert, Bingham McCutchen details the requirements, the timing of their implementation, and safe harbors provided by the no-action letters.

In a recent Corporate Finance Alert, Skadden provides guidance on how to avoid prohibited communications when contemplating a securities offering. Section 5 of the Securities Act prohibits “activities intended to stimulate interest in a securities offering prior to the filing of registration statement.” Violations of this prohibition are commonly referred to as “gun jumping.” The Alert outlines the types and timing of permitted and prohibited communications, as well as suggestions for a company policy on relevant social media communications.

Banks and Industry Groups Continue to Question the Soundness of Volcker Rule

By Rebecca Kwan, J.D. Candidate 2014 | Posted on

The Volcker Rule, which bans banks from participating in proprietary trading, is still worrying bankers.  Financial industry groups are now focusing on an exemption from the rule that allows banks to make certain investments as a part of a legitimate liquidity management program. Regulators will have to distinguish between liquidity trading and proprietary trading. Unfortunately, liquidity trading and proprietary trading are not such discrete activities, making regulators’ jobs difficult, if not impossible.

Banks and industry groups argue that the exemption is so narrow that legitimate liquidity trades could be mistakenly labeled proprietary trades by regulators. In any case, bankers know that the narrower the exemption is, the more trading activity they will have to defend to regulators down the line. According to Berkeley Law Assistant Professor, Stavros Gadinis, “The more flexibility [banks] manage at this stage, the less negotiation they will have to do at a later stage, so this is where it’s at stake, where they can nip it in the bud.” Bankers have to be able to hedge to protect themselves, and the exemption is an attempt to allow that activity while prohibiting the kinds of risky trades that destabilize the market.

Regulators take the opposite view, arguing that the exemption is too broad, and that banks will easily disguise proprietary trading activities as liquidity trading. They worry that the exemption will function as a loophole and allow for risky whale-like trades. But the Volcker Rule, Gadinis said, “would not have stopped the [London] Whale trades. The question of what is a hedge is subject to interpretation. There are things that are definitely hedges, but there are things where it could be, but it’s doubtful.” (more…)

SEC Issues Controversial Rule Regulating Asset-Backed Securities

By by Andrew Sioson, J.D. Class of 2013 | Posted on

The SEC will soon put the finishing touches on a rule stemming from one of the most infamous cases of fraud from the 2007-08 financial crisis. The new rule prohibits certain material conflicts of interest between those who create or distribute asset-backed securities (ABS), including synthetic ABS, and the investors in the ABS. This proposal takes direct aim at a transaction that, within the securities industry, has become a symbol of greed and profiteering: Goldman Sachs’s Abacus transaction.

Abacus 2007-AC1 (“Abacus 2007” or “Abacus”) was an investment vehicle designed to fail. It was created in February 2007 at the request of John Paulson, the hedge fund manager who made billions of dollars during the recession by shorting subprime mortgage-backed securities (MBS). Paulson selected the pieces of toxic subprime MBS that he wanted to short which were then packaged together and sold by Goldman to its clients, including German bank IKB and Dutch bank ABN Amro. The buyers were not aware that Paulson selected Abacus’s underlying portfolio; in fact, these banks were led to believe that an independent third party selected the mortgages. The Abacus 2007 transaction resulted in massive losses for IKB and ABN Amro, while Paulsen profited from the investment vehicle’s demise to the tune of over $1 billion.

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SEC Rolls Out the “Skin in the Game” Regulation to Mitigate Moral Hazard for Lenders and Bond Issuers Involved in Asset-Backed Securities

By Peter Benesch, J.D. Class of 2013 | Posted on

On March 31 the SEC began seeking public comment on its proposed “skin in the game” regulation, which would require lenders and bond issuers of asset-backed securities (ABS’s) to retain 5% of the credit risk of the securities they issue. This requirement would apply to each of the tiers of ABS’s issued individually, preventing a lender or bond issuer from issuing a large proportion of risky securities and yet only retaining its 5% stake in those safer, higher-grade securities it issues. In the alternative, a lender or bond issuer could also comply with the regulation by retaining 5% of the first-loss residual interest of all ABS’s issued or a 5% interest in a representative sample of the underlying securities.

The rule is one of the many proposed by the SEC in accordance with the mandates of the Dodd-Frank Act. The rule was motivated by the public perception that there was an incentive problem, often referred to as a moral hazard, inherent in lending practice that became hegemonic in the mortgaged-backed securities (MBS’s) market. The potential problem lies in the fact that the banks and lenders extending loans to home buyers may not fully appreciate the credit risk of doing so because of their ability to turn around and easily sell these mortgages on the secondary market (commonly referred to as the “originate-and-distribute” model). Large financial institutions, acting as intermediaries between these lenders and investors, would buy mortgages and combine many of them into an investment tool, dividing the pool of mortgages into traunches (with returns on investment commensurate with the perceived security of the traunch invested in). While this securitization process is effective at providing greater liquidity in the mortgage market (as more investors will be willing to invest in the industry if the risk of default can be managed and mitigated through diversification and stratification inherent in the securitization process) the process also debased the incentive for lenders and bond issuers to ensure that borrowers were truly credit-worthy and able to sustain their mortgage payments.

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Live Blogging at the Dodd-Frank Symposium: Tracking Securitized Residential Mortgages

By James Nguyen, J.D. Class of 2013 | Posted on

Nancy Wallace from the Haas School of Business followed her fellow Haas colleague with a talk on the evolution of residential mortgage recording and tracking and the legal implications of MERS.

Some Key Highlights:

  • Residential Mortgage Recording and Tracking has Diverged: while so-called “Shoebox” technology continue to be used to record and track property interest transfers (property sales) at county-level recording offices, the MERS system has supplanted the old technology and now comprises over 60% of the recording/tracking market.
  • Chain of Title and Chain of Mortgage (Promissory Note) Separated Under MERS: the MERS system has detached the dual-recording/tracking of both property title and mortgage, which has significant complications for determining property ownership and mortgage liability.
  • Transfer Language in Pooling-Servicing Agreement (PSA): the property transfer language MERS-tracked PSAs use stock MERS language that some courts have not given full recognition.
  • Why does this matter: participants in the market for mortgage-backed securities may suffer significant financial losses if the validity of MERS transfers cannot be upheld.

A complete description of the presentation can be found here.

Live Blogging from the Dodd-Frank Symposium: Bank Regulation and Mortgage Market Reform

By James Nguyen, J.D. Class of 2013 | Posted on

We’re blogging live from today’s Dodd-Frank Symposium!

Dwight Jaffee from the Haas School of Business kicked off the first set of Securitization and Governance panel presentations with a talk on Bank Regulation and Mortgage Market Reform.Key Highlights from the presentation:

  • Moral Hazard in Securitization is wrong: Jaffee says that the hoopla over securitization causing the mortgage bubble and financial crisis is misplaced and the 5% risk-retention requirement will do nothing but restrict fundamental value of securitization, which is to spread out and segment risks.
  • The private market can fully replace the GSEs: Jaffee thinks the proposals to wind down the GSE are generally a good thing and believes that the private market is more than capable of meeting the credit demand the GSEs currently now provide.  Citing Europe, which Jaffee says has similar rates of homeownership as the U.S., Jaffee says that the GSEs have had minimal if any impact on spurring additional homeownership.
  • Mortgage Contracts will Default to Safe, Low Risk Terms: Jaffee argues that in the absence of GSEs in housing market, the lack of conforming loan standards would nonetheless push borrowers toward the safest, least risky loan terms (i.e., the market would correct itself and move away from costly terms like prepayment penalties.

For a full read of Dwight Jaffee’s ideas, see his working paper on mortgage market reform.

Bigger than Fannie and Freddie: Defining Qualifying Residential Mortgages

By James Nguyen, J.D. Class of 2013 | Posted on

A prominent feature of the Dodd-Frank Act is the risk-retention provision in Title IX (Subtitle D, § 941).  It requires banks that originate mortgages to retain 5 percent of the credit risk in their portfolios.  The risk-retention requirement was created in direct response to the oft-cited lending practice that contributed to the housing bubble where mortgage originators would sell off the securitized loans without retaining any of the credit risk.  A key exception to the provision concern “qualified residential mortgages” (QRM) and loans designated as QRMs are exempt from the risk-retention requirement.

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