23980 Federal Register I Vol. 57, No. 109 I Friday, June 5, 1992 / Proposed Rules 

Issued in Kansas City, Missouri, on May 29, 

1992. 

LaiTy D. Malir, 

Actins Manaser, Small Airplane Direcwrow. 

Aircraft Certification Service. 

(FR Doc. 9Z...13174 Filed 6-4-92; 8:45am] 

8IUJNG COOl 48tO..tHI 

SECURITIES AND EXCHANGE 

COMMISSION 

17 CFR Part 270 

[Release No.IC-18738, File No. S7· 12·92) 

RIN 3235-AF47 

Exclusion From the Definition of 

Investment Company for Certain 

Structured Flnanclngs 

AGENCY: Securities and Exchange 

Commission. 


ACTION: Proposed rule and request for 


comment. 


SUMMARY: The Commission Is proposing . 

a new rule under the Investment 

Company Act of 1940 (the "Act") to 

exclude certain issuers that pool 

Income-producing assets and issue 

securities backed by those assets 

("structured financings") from the 

definition of "investment company." The 

proposal would pennit structured 

financlngs that meet the conditions of 

the rule to publicly offer their securities 

in the United States without registering 

under the Act and complying with the 

Act's substantive provisions. The 

proposed rule is intended to remove an 

unnecessary and unintended barrier to 

the use of structured financings in all 

sectors of the economy, including the 

small business sector. 

DATES: Comments must be received on or before August 4, 1992. 


ADDRESSES: Comments should be 


submitted In triplicate to Jonathan G. 


Katz, Secretary, Securities and 


Exchange Commission, 450 Fifth Street, 


NW., Washington, DC 20549. All 


comment letters should refer to File No. 


S7- 1z-.92. All comments received wiD be 


available for public inspection and 


copying In the Commission's Public 


Reference Room, 450 Fifth Street. NW., 


Washington, be 20549. 


FOR FURTHER INFORMATION CONTACT: 

Rochelle G. Kauffman, Senior Counsel. 

(202) 272-2038, Elizabeth R. Krentzman, 

Attorney, (202) 272-5416, or Karen L. 

Skidmore, Assistant Director, (202) 272­

2048, Office of Regulatory Policy. 

Division of Investment Management, 450 

Fifth Street, NW.. Washington, DC 

20549. 

SUPPLEMENTARY INFORMATION: The 

Commission today Is requesting public 

comment on proposed rule 3a-7 under 

the Investment Company Act of 1940 (15 

U.S.C. 80a) (the "Act"). Proposed rule · 

3a-7 would effectuate the 

recommend& lion made in Chapter 1 of 

the Division of Investment 

Management's recently issued report, 

Protecting Investors: A Half Century of 

Investment Company Regulation. 1 In 

addition, the Commission is requesting 

public comment on whether section 

3(c)(5) of the Act (15 U.S.C. 80a-3(c)(5)) 

should be amended, particularly In light 

of the proposed rule. 

Table of Contents 

Executive Summary 

I. Background 

A. The Structured Finance Market 

B. The Securitization Process 

C. The Application of the Investment 

Company Act to Structured Flnanclngs 

D. The Effects of the Regulatory Structure 

n. Discussion 

A. Proposed Rule 3a-7 

1. Scope of the Rule 

2. Conditions 

(i) Securities Based on Underlying Cash 

Flows 

(ill Securities Offered to the Public Must Be 

Fixed-Income Securities Rated in the 

Two Highest Investment Grades 

(Ill) lJmlted Management 

(lv) The Independent Trustee 

B. Amending Section 3(c)(5) 


Ill. Cost/Benefit of Proposed Action 


IV. Summary of Initial Regulatory Flexibility 


Analysis 


V. Statutory Authority 


VI. Text of Proposed Rule 


Executive Summary 

Proposed rule 3a-7 would exclude 

from the definition of investment 

company in section 3(a) of the Act 1 

1 SEC Division of Investment Management, 

Protecting Investors: A Half Century of Investment 

Company Regulation. The Tr'BotiTIBnt ofStructured 

Finance under the Investment Company Act 1-101 

(1992) !hereinafter Structured Ptnance Chapter). 

This report concluded a two-yeor examination of 

the regulation of Investment companies and certain 

other pooled Investment vehicles. In the C0111'11e of 

this exarnlnation, the Division of Investment 

Management (the "Division") met with 

representatives of entitles a880Ciated with the 

structured finance Industry to dlecuaa. among other 

things, how structured llnanclngs work, the roles of 

the various partldpante, the status of the etructured 

finance market, likely developments, and lnveator 

protection concel'118. The Structured Finance 

Chapter discusses the Division's flndinge. Many of 

the Division's recommendatlo1111 were based on 

auggestlons made by commentera respondlns to a 

Commiaalon release requesting comment on the 

regulation of Investment companies and related 

Issues, Including tho treatment of atructured 

flnanclnge under the Act. SEC Request for CollU!Iellt 

on the Refonn of Investment Companies. IDvestment 

Company Act Release No. 17534 I W.C. (June 15. 

1990), 56 FR 25322 (June 26, 1990) [herelnaftl!l' Study 

Release~ 

• 15 U.S.C. 80&-3(a). 

certain issuers that pool incomeproducing assets and issue primarily 

debt or debt-like securities backed by 

those <~ssets for the purpose of providing 

their sponsors financing and other 

related benefits. In the last decade, this 

finance technique, called "structured 

finance," 3 has become one of the 

dominant means of capital formation in 

the United States; in 1991, structured 

financing& accounted for approximately 

half of all publicly offered securities In 

the United States.4 

Despite the volume of offerings, the 

Act to some degree has constrained the 

development of the structured finance 

market. Structured financings generally 

fall within the definition of investment 

company under section 3(a), but are 

unable to operate under the Act's 

requirements.& Many private sector 

sponsored financing& have avoided 

regulation under the Act by relying on 

the exception from the definition of 

investment company in section 3(c)(5), 

which originally was intended to 

exclude issuers engaged in the 

commercial finance and mortgage 

banking industries. 11 The Commission 

has exempted by order certain other 

structured flnancings, primarily those 

involving mortgage-related assets, under 

section 6(c], the general exemptive 

provision of the Act. 7 Financlngs that 

• Although structured finance Ia the term matt 

commonly used to deecribe this fmanclng technlqve, 

other tenns, euch as "asset-backed aiTilfl88meota," 

"a88et-backed flnancinga." "asset securitization." 

and "structured eecurltlzed credit," alao have been 

used. . 

• Michael Uebowitz. Reversing four- Year Trend 

ond Swooning Economy, Wall Stret~l Explode. In 

1991, lnv. Dealers Dig., Jan. 6. 1992. at21-23 

(statistic excludes offerings of United Statee 

Treasury obligations). 

• For example, the limitations of 118Ction 18 on the 

laauance of senior aecuritles and the prohlbitlODJ of 

section 17 on transactions lnvolv~ a!flliatea 

conflict with the operations of structured fmaoctng.. 

15 u.s.c. 808-16. -17. 

• B. Rep. No. 1775, 76th Cong.. 3d Seas. 13 (1940Ji 

HJt Rep. No. 2639. 76th Cong .. 3d SeN. 12 {1940). 

In addition. certain federaUy spon110red atructured 

flnanclnga. auch as tbo1111 epo1111ored by the Federal 

National Mortgage Aasoclatlon, are exempted from 

the Act under section 2(b), which exempte. among 

other things, activities of United States Govtm1111ent 

Instrumentalities and wholly-owned corporatlona of 

such Instrumentalities. 15 U.S.C. &OIH!(b). 

'15 U.S.C. 801Hl(c). Section B(c) provide• thai the 

Commission may exempt, by rule or order. 

any penon, security, or transection. or any clau 

or clae&ell of peraone. eecuritiee. or transact! one. 

from any provisions of this IItle or of any rule or 

regulation thereunder, If and to the extent that euch 

exemption Is neceuary or appropriate In the public 

Interest and consletent with the protection of 

Investors and the purposes fairly Intended by the 

policy and provlelone of thle title. 

I d. 
Federal Regleter I Vol. 57, No. 109 I Friday, June 5, 1992 I Proposed Rules 23981 

cannot rely on section 3(c)(5) or obtain 

an exemption must sell their securities 

in private placements in reliance on 

section 3(c)(1),11 the "private" 

investment company exception, or 

outside the United States. 

In sum, under the present regulatory 

framework, a structured financing may 

be entirely exempt from the Act, or it 

may be subject to the Act and thus sold 

overseas or in private placements, 

depending solely on the nature of the 

assets securitized. Ironically, the result 

does not depend on the structure and 

operation of structured financings or the 

credit quality of the securitized assets. 

Many investors may be prevented from 

acquiring sound capital market 

instruments. In addition, some sponsors 

are denied the opportunity to obtain the 

benefits of publicly Qffered structured 

financing&, even though they hold assets 

that, as a financial matter, readily could 

be securitized. 

Application of the Act to structured 

financings has broad economic 

implications. Excepted or exempt 

structured fmancings have increased the 

availability of certain financial assets. 

often at lower costs. Structured finance, 

for example, has been credited with 

making the home mortgage market 

generally resistant to funding 

shortages.11 Due to the applicability of 

the Act, however, some sectors of the 

economy, including small business, 

generally have been unable to use 

structured financings as sources of 

capital. 

Proposed rule 3a-7 would remove an 

unnecessary barrier to the use and 

development of structured financing& by 

excluding structured financings that 

meet certain conditions from the 

definition of investment company under 

the Act. 1 0 These condi lions are 

intended to delineate the operational 

distinctions between registered 

investment companies and structured 

financing&, permit the continued 

evolution of the structured finance 

market, and address any investor 

protection concerns that could arise. 

The proposed rule provides an exclusion 

for structured financing&, regardless of 

the assets securitized. 

1 16 U.S.C. eo.-a(c)(t). 

' See. tt.g., Brent IC. Maller, The Collaterellzed 

MOf18ase Oblisatlon: The Lateet Pltue In the 

Evolution of MortsaRe-Bac.ked Securlliet, 13 Real 

&wta LJ. 2UIJ, 300-301 (19115). 

''Of COIIJ'N, Jlruclured flnanclnp would remain 

aubject to variou1 regulatory requlremanta under the 

Securillee Act of 1933 (16 U.S.C. 77e-77aa), the 

Securille• Exchanse Act of 1934 (15 U.S.C. 78a781/J. and the Trust Indenture Act of 1939(15 U.S.C. 

77aaa-77bbbb) a1 well a• other fedaraland elate 

lawt. 

The Commission also Is requesting 

comment on whether section 3(c)(5) of 

the Act should be amended, either to 

narrow or to expand its scope. Some 

have suggested that certain types of 

issuers should not be able to rely on this 

section. while others have argued that 

the section is urmecessarily narrow. 

I. Background 11 

A. The Structured Finance Market 

The modem structured finance market 

originated in the 1970's with the 

securitization of residential mortgages. 

Since then, structured financings have 

become a major facet of American 

finance. 12 In 1991, securities of 

structured financinga publicly offered in 

the United States totalled approximately 

$292.8 billion, accounting for 

approximately fifty percent of total 

public securities issuances (debt and 

equity) and fifty-seven percent of total 

debt securities issuances in the United 

States. 13 

Structured financings backed by 

residential mortgages dominate the 

structured finance market: in 1991, 

publicly offered mortgage-backed 

securities issuances in the United States 

totalled approximately $246.21 billion. or 

eighty-four percent of the etructured 

finance market. 14 The non-mortgage 

market, which emerged in the mid1980's, also has grown rapidly. Volume 

of non-mortgage asset-backed public 

offerings in 1991 totalled approximately 

$50.8-billion, up from $10 billion in 

1986. 1 a Securities backed by automobile 

loans and credit card account 

receivables represent approximately 

eighty percent of the public nonmortgage structured finance market. 

Other assets presently securitized and 

offered publicly include home equity 

loans, boat loans, computer leases, 

airplane leases, mobile home loans, 

recreational vehicle loans, and hospital 

account receivables. 

A significant domestic private 

placement market for structured finance 

issues also exists. Although aome 

11 Thia aecUon provide• a brief onrvlew of the 

atructured finance market. the organiz&Uon and 

operation of a etructured financing. the appUcation 

of the Act to structured flnancingt, and the effects 

of the Act on the atruclured finance market. A more 

detailed ditcullion 11 Included In the Structured 

Finance Chapter, 1upro note 1, U I-IV. 

aa Aa dltculled below. federelly 1pon10ted 

nnanclns• have played a major role In thl1 

development. Moat of the~a programa ntly on the 

exemption In eectlon 2(b) of tba Act. 11 Uebowltz. eupra note. 4 

··Jd. 

11 Dean Witter Reynold• Inc .. A1eet-Baoked 

Securttiea Reference Guide A-10 [Year Ended 1991). 

&11 al1c Uebowllz. 1upra note 4. at 22{reporting 

$46.6 billion of non-mortsase auet-backad 

aecuritlea la1ued in the United Stat ..). 

private offerings are similar to those 


sold publicly. many private placements 


· involve types of structured financings 

that have never been publicly offered in 

the United States, In part because of the 

Act. 'These financing& include those 

backed by installment loans. future 

royalties, high yield bonds, and 

Medicare receivables. 

Moat public offerings of structured 

financinga are issued under programs 

sponsored by the federal government or 

by government sponsored enterprises. 

Securities issued under programs 

sponsored by the Government National 

Mortgage Association ("GNMA"). the 

Federal National Mortgage Association 

("FNMA"), and the Federal Home Loan 

Mortgage Corporation ("FHLMC") 

dominate the mortgage market. 18 In 1991, 

the Resolution Trust Corporation began 

Issuing securities backed by mortgages, 

junk bonds, and other assets acquired 

from failed savings and loan 

associations. 11 

The private' sector also Is active in 

sponsoring structured financings. The 

most active sponsors in the private 

sector include commercial banks, 

savings and loan associations. 

automobile manufacturers, retailers, 

finance companies, insurance 

companies, and investment banks. 

These sponsors securitize a88ets for a 

variety of reasons. Structured financings 

often enable a sponsor to gain access to an alternative, usually cheaper, funding 

source. In addition, some sponsors find 

that securitizing assets allows them to 

manage their loan portfolios, and in 

tum, their balance sheets more 

effectively. 1s Banks and savings and 

loan associations also securitize assets 

to facilitate compliance with regulatory 

capital requirements. 

B. The Securitization Process 

The basic structures of all structured 

financings, regardless of the underlying 

"In 1990. FHLMC. GNMA. and FNMA sponeored 

program• were reeponeible for 94.~ of mortgagebacked patl·lhroiJ8h •ecurtliet and 82.~ of 

multiclus mortsage-backed aecuritiet issued that 

year. SH Federal Home Loan Mortgage Corp .. 

Databas~. in The Secondary Morl!lase Markets, 

Tables 2. 3 (Winter 1991/19112). 

"In addiltof\, the Federal Asrfcultural Mortgage 

Corpo~atton luues securities backed by agricultural 

mortgasee guaranteed by the Fanners Home 

AdmlnlaiJ'alion. The Small Buslnen Administration 

tecuritizea a amall por11on of the loans It 

perantee~. Plnally, ao dlscuaead In Seclion I.C. 

below, In the late t900'o, the faderel sovemment 

eold port lone of the loan portfoll01 of certain 

sovamment agenciet, which In turn. were pooled 

and securitiEed. 

"By converting financial aueta Into cash (which 

con.be ueed to retire debt or acquire new 

receivable.), ttructured finance enables sponsors to 

reduce lntere11 rAte risk and to dlvereiCy their 

portfolt01. 
23982 Federal Register I Vol. 57, No. 109 I Friday, June 5, 1992 I Proposed Rules 

assets, are remarkably similar." 

Typically, a sponsor transfers a pool of 

homogeneous financial assets to the 

issuer, a special purpose entity, 20 in 

return for the proceeds from the sale of 

one or more classes of securities backed 

by these assets. The securities issued 

generally are debt securities or equity 

securities with debt-like characteristics 

("fixed-income securities"). 21 Payment 

on the securities depends primarily on 

the cash flows generated by the pooled 

assets. 22 Issuers that have more assets 

or that expect to receive more income 

than needed to make full payment on 

the fixed-income securities may sell 

interests in the residual cash flow. 

These interests are typically sold to 

highly sophisticated investors. 23 

"While this seclion diecuuea the bulc 

components of a structured financing. there are a 

wide range of permutations. For a dt&cu&&ion of 

these permutattons. see Structured Finance Chapter, 

supro note, 1 I lll.A. See also Jason H.P. Kravitt, A 

Brief Summary of Structure& Utilized In tho 

Securilit.alton of Pinonctal Assets. in t 

Securilizatton of Pmanc1al Assets I 4 (Jason H.P. 

Kravill ed. 111911 )heremafter Securitization of 

Financial Assets). 10 The spec1al purpose entity may be a 

corporation, a grantor trust. an owner's trust. or a 

partnership. The form of organization depends 

generally on tax conetderauons and the payment 

structure of the financtng and its securities. For a 

genera l discu&slon of payment structures and 

attendant tax tasues. see, e.g.. William A. Schmalz 

eta/., Tax Issues m 1 Securitization of Financial 

Assets, supro note 19, § § 9 .01 - 9.06; Charles M. 

Adelman & ROjler 0. Lorence, Tax Considerotions, 

The Aaaet Secunttzalton Handbook, 4lHI3 (Phillip 

Zweig ed., 19891. 

11 These aecunties typically entitle the holder to a 

specified pnnc1pol amount at maturity and bear 

lntereet at a fixed rate or at on adjustable rate, 

which may be deternuned periodtcally by reference 

to an index. throu11h auctions among investors or 

prospective mvestors. or through the remarketing of 

the instrument. Interest payments also may be 

determined by reference to all or part of the Interest 

received on the underiytng 88sets. 

Generally. thP. type of security issued depends in 

part on the pavment structure. Under a "p888­

through" structure. s SIDRie class of securities Is 

issued. wuh each secunty repreBenting a fractional 

Interest in the undertymg pool. A "pay-through" 

structure perm1ts the tssuance of multiple closaes of 

securities. wuh each class having differing 

maturities and payment schedules. Both structures 

permit the issuance of "otnpped securities" (auch ae 

Interest-only and pnnc1pal-only certificates) and 

clo88e& of senoor and subordi11ate securitiea. 

"Some financms• also include credit 

enhancement&. such as irrevocable standby letters 

of credit ("I.OCs"l, financial guarantee insurance, or 

cash collateral accounts, that could be drown upon 

If the cash now& from the assets prove insufficient 

to meet the tssuer's obligations. 

Not all financmga offer securities backed by the 

cash now from the underlytng assets. As discussed 

In note 65 infro. a few structured financing& have 

employed a "market value" structure, in which 

payment on the securif1ea is derived from the 

aggregate market value of the pooled assets, rather 

than from the cash flow from the underlying assets. 

u As discuased infra note 77, residual intereats 

are highly volatile instruments that bear any losses 

first resulting from an Insufficient cash flow. 

The Issuer's only business activity is 

to acquire the sponsor's assets and issue 

securities. A servicer, which often is the 

sponsor or an affiliate of the sponsor, is 

the primary administrator of the 

financing. Generally, the servicer 

collects payments on the underlying 

assets when due and ensures that funds 

are available so that investors are paid 

in a timely manner. An independent 

trustee, usually a large commercial 

bank, typically holds the issupr's assets, 

or documentation of interest in the 

assets, in a segregated account for the 

benefit of investors. The trustee also 

monitors the issuer's fulfillment of its 

obligations. 

Initially, most financings were 

structured so that their pools were fixed 

at the time of issuance. with 

"management" of the assets (other than 

servicing) generally limited to the 

substitution of new, similar assets for 

defective assets. 24 As the structured 

finance market has evolved, structures 

have been developed that rely to a 

greater degree on management. Many 

financings allow the servicer or trustee 

to reinvest idle cash in short-tenn debt 

obligations when there is a timing 

mismatch between collections and 

payments to investors. In some 

financings, the issuer may acquire 

additional assets if the previously 

designated assets do not generate 

sufficient cash flows t() pay investors. 26 

Finally, recently developed structures 

pennit an issuer to purchase asset's and 

issue securities on an ongoing basis. 26 In 

each case, guidelines governing both the 

level and type(s) of permissible 

management are established prior to the 

issuance of the financing's securities. 

,.Circumstances under which eubatltution may 

occur are descr1bed infra note 80. 11 Credit cord financmgs. for example. are backed 

by current and future receivables generated by 

specifted credit card accounts; the balance of the 

pooled assets fluctuate as new receivables are 

generated and existing amounts are paid or charged 

off as a default. If the accounts do not generate 

sufficient receivables to support the aecuritiee, the 

sponsor may be required to assign receivables from 

other accounts to the pool. 11 These structures Include master trust programs, 

used predominantly in financings backed by credit 

card receivables, and asset-backed commercial 

paper program&. In a master trust program, the 

sponaor lnllially transfers a large amount of assets 

and tho structured financing issues multiple classes 

of securities. often with varying terms. over lime. 

Under certain conditions. assets may be added or 

removed throughout the life of the issuer. Asset· 

backed commercial paper programs iaaue 

commercial paper on an ongoing basis and ore 

backed by a diversified pool of assets, with assets 

added to the pool throughout the life of the program. 

Asset-backed commercial paper progroma generally 

contain a variety of relatively short-term usets. 

such as credit card receivables. automobile lease 

receivables, trade receivables, and ahort-term 

money market Instruments. 

Publicly offered structured financings 

typically issue at least one class of 

securities rated in one of the two highest 

categories by a nationally recognized 

statistical rating organization, or "rating 

agency." 21 As with a traditional 

corporate bond, a rating of a structured 

financing assesses credit risk (i.e., the 

likelihood that the investor will receive 

full and timely payments). 1s 

In rating a structured financing, rating 

agencies generally apply the same basic 

approach, regardless of the assets 

securitized. 6 Rating agencies examine 

(I) the structure of the financing, 

including the risk that the insolvency of 

the financing's sponsor would affect 

payments to investors; 30 (ii) the credit 

risk of the financing, including the 

potential impairment of the cash flows 

from the pooled assets due to borrower 

delinquencies or defaults; 31 and (iii) 

risks related to the actual cash flow 

funding the securities, including the 

allocation of cash flow under the 

financing's payment structure. 32 Based 

on this examination. rating agencies 

determine the amount of credit 

enhancement necessary for the 

structured financing to obtain the rating 

desired by the sponsor. 

Financings typically are structured 

and operated in accordance with criteria 

developed by the rating agencies to 

minimize various risks. Rating agencies. 

for example, may require that the 

transfer of the assets from the sponsor 

to the Issuer be a "true sale" and not a 

., Atleaet four rating agencies, Standard & Poor's 

Corporation. Moody'e Investors Service, Inc., Fitch 

Investors Service. Inc .. and Duff 8o Phelps, Inc .. 

currently are active in rating domestic structured 

financing&. 

Providers of external credit support. such as the 

Issuers of LOCs or financtal guarantee insurers. also 

may play a role in structunng the financwg. As in 

most securities issuances. underwrtters and 

independent auditors also are participants. 

"A rating does not addreaa market risks to 

Investors that may result from changes in intereat 

rate levels or from prepayments on the aBBets in the 

underlying pool. See. e.g.. Standard & Poor's 

Corporation. S&P'e Structured Finance Criteria 101 

(1988) . 10 Aaaet-backed commercial paper programs ore 

subject to somewhat different rating criteria 

because of the nature of the securities they offer. 

For a more detailed discussion of the role of the 

rating agenciee, see, e.s.. Peter V. Darrow. et al.. 

Ratins Agency Requirements in t Securitization of 

Financial Asaets, supro note 19. 10 Rating agencies also examine whether the 

issuer itself could become subject to bankruptcy 

proceedings. Thie. for example, could occur If an 

issuer were to engage in other business activities. 

"Rating agencieealso evaluate the quality of the 

servicer in connection wtth its responsibilities to 

manage and maintain the payment stream on the 

underlying aesets. In addition. rating agencies 

evaluate the capability of the trustee in performing 

its duties. 

11 The "pass-through" and "pay-through" payment 

structures are described supra note 21. 
Feaerel Register I Vol. 57, No. 109 I Friday, June 5, ,199~ .j Proposed Roles 23983 

secured loan, 31 that the pooled assets 

generally be representative of the 

sponsor's portfolio, and that the 

financing's servicer remit the cash flows 

from the financing's assets to the trustee 

within forty-eight hours. 

Once a financing is rated, rating 

agencies typically monitor the 

financing's performance. Downgrades of 

financings have been infrequent, with 

most occurring as a result of 

do"Yngrl)des in the ratings of providers 

of credit support. The Commission is not 

aware of any rated structured financing 

defaulting on its fixed-income 

securities. 34 

C. The Application of the Investment 

Company Act to Structured Financings 

Despite the size of the structured 

finance market, its growth and 

development has been constrained by 

the Act. Structured financings meet the 

definition of investment company under 

section 3(a) because they issue 

securities and are primarily engaged in 

investing in, owning, or holding 

securities. 36 These financings, however, 

are unable to operate under the Act's 

requirements. 36 Accordingly, to be 

offered in the United States, a structured 

financing must either be organized to 

come within one of the exceptions to the 

definition of investment company under 

the Act or seek exemptive relief from 

the Commission. 31 

»structuring the financing as a "true sole" 

reduces the risk that the sponsor's Insolvency will 

affect the issuer's payment• to lnveston. Spon1or1 

not aubject to the Bankruptcy Code, such aa banka 

and savings and loan associations, may be 

pennitted to pledge assets to the Issuer. 

"Unrated financing&, by contrast, have 

experienced defaults. Tile largest and most notable 

occurred in 1985 when Equity Program Investment 

Corporation and certain of its affiliates defaulted on 

approximately $1.4 billion in mortgages and 

privately placed mortgage-backed securitiea. For a 

discussion of the facts underlying the EPIC default. 

see EPIC Mortgage Ins. Litig., 701 F. Supp. 1192 (E.D. 

Va 19BB), off"d 1n part, rev'd in part, sub nom. 

Foremost Guaranty Corp. v. Meritor Sav. Bank, 910 

F.2d 118 (4th Cir. 1990(. 

"Financial instruments generated in commercial 

tranoactions generally have been considered lobe 

securities for purposes of the Act. See, e.s.• SEC, 

Report on the Public Policy Implication• of 

Investment Company Growth, H.R. Rep. No. 2337, 

89th Cong., 2d Se88. 236-39 (1966) (stating that notee 

representmg the sales price of merchandiae, loans to 

manufacturers. wholesalers. retailers and 

purchasers of merchandise or insuranca. and 

mortgages and other interests In real estate are 

securities for purposes of the Act). 

"For example. section 17(a) prohibits certain 

persons affiliated with a registered investment 

company from selling securities and other property 

to the investment company. 15 U.S.C. 80a-17(a). In a 

structured financing, this section would prohibit a 

sponsor's sale of assets to the issuer, as well a• any 

substitution of assets by the sponsor. 

., As discussed supra note 6. most Onancings 

spon~red by the federal government or by 

govomment sponsored enterprises ere exempt 

under section Z(b). 

There are only two exceptions that 

are particularly relevant to private 

sector structured financings: sections 

3{c)(5) and a(c)(1).nsection 3(c)(5) 

excepts: 

(a]ny person who is not engaged in the 

business of issuing redeemable securities 

* * * and who is primarily engaaed In one or 

more of the following businesses: (A) 

purchasing or otherwise acquiring notes, 

drafts, acceptances, open accounts 

receivable, and other obligations representing 

part or all of the saies price of merchandise, 

insurance, and services; (B) making loans to 

manufacturers, wholesalers, and retailers of, 

and to prospective purchasers of, specified 

merchandise, insurance, and services: and 

(C) purchasing or otherwise acquiring 

mortgages and other liens on and interests in 

real estate. 

Section 3(c)(5) was intended to except 

issuers engaged primarily in the 

factoring, discounting, or real estate 

businesses. 39 Many structured 

financings, however, rely on this 

exception due to its broad statutory 

language. A number of no-action letters 

address whether an issuer is primarily 

engaged in one of the businesses 

enumerated in section 3(c)(5). 40 · 

Under these letters, issuers relying on 

subparagraphs (A) or (B) of section 

3(c)(5) must primarily hold receivables, 

loans to refinance receivables, or ·loans 

to manufacturers made in connection 

with the purchase of specified 

merchandise and services. 41 Many nonmortgage financings whose assets meet 

this criteria, such as those backed by 

automobile loans, most credit card 

account receivables, and equipment 

leases, rely on subparagraphs (A) and 

(B). No-action assurance has been 

declined where an issuer's assets are 

not related to the purchase or sale of 

specifie.d ·merchandise, insurance, or 

services. 42 Financings backed by general 

.,Other exceptions may be available for a limited 

number of private sector structured financings. See, 

e.g., Investment Company Act •ections 3(c)(3), {4), 

and (6); 15 U.S.C. 80a·3(c)(3), (4). & (6). See also 

infra note 46. 

"See authorities cited supro note 6. See also S. 

Rep. No. 184, 91st Cong .• tat Scss. 37 (1969); H.R. 

Rep. No. 1382. 918t Cong .. 2d Seas. 17 (1970). 

..Structured financing& meet the first portion of 

section 3(c)(5) because they do not Issue 

redeemable securities. 

"See, e.g.• Ambassador Capital Corporation (pub, 

avail. Oct. 6. 1986) [no·action position taken with 

respect to Iesuer holding airline credit card account 

receivables); Days Inn of America. Inc. (pub . avail. 

Dec. 30. 1988) (no-action po•ition taken with respect 

to isauer holding franchise fee receivables). 

"See. e.g., World Evangelical Development Ltd. 

(pub. avail. Apr. 5. 1979) (no -action position 

declined where entity would issue general purpose 

commercial loans); Educational Loan Marketing 

Associations, Inc. (pub. avail . Peb. 4. 1986)-(no· 

action position declined where entity would issue 

debt secured by the repayment ofatudent loans 

financed by proceeds from the debt offering). 

purpose commercial loans, consumer 

loans, or corporate bonds typically are 

unable to rely& subparagraph (A) or (~. . 

Many Issuers of mortgag~-backed 

securities and similar products rely on 

subparagraph (C) of section 3(c)(5). 

Under no-action letters, an issuer relying 

on this provision must invest at least 

fifty-five percent of its assets in 

mortgages and other liens on and 

interests in real estate ("qualify:ng 

interests"). An additional twenty-five 

percent ofthe issuer's assets must be in 

"real estate related assets." 43 

Qualifying interests have been 

interpreted to include fee interests, 

leaseholds, interests fully secured by 

mortgages solely on real estate, and socalled "whole pool certificates" issued 

by FNMA, GNMA or FHLMC (i.e., 

certificates that represent the entire 

ownership Interest in a particular pool 

of mortgages). 4 So-called "partial pool 

certificates" issued by these agencies 

(i.e., certificates representing less than 

the entire ownership interest in a 

particular pool of mortgages) have not 

been considered to be qualifying . 

interests, although they may be treated 

as real estate related assets for purposes 

of the twenty-five percent test. u 

Structured financings that cannot rely 

on section 3(c)(5) may rely on section 

3(c)(1), the private investment company 

exception. This exception, however, is 

limited to issuers that do not engage in 

public offerings and whose outstanding 

securities (other than short-tenn paper) 

are beneficially owned by not more than 

100 persons. 46 

"This percentage may be reduced to the extent 

that more than 55% of the issuer's assets are 

invested in qualifying interests . See. e.g., Greenwich 

Capital Acceptance, Inc. (pub. avail. Aug. 8, 1991 ); 

United Bankers, Inc. (pub. avail. Mer. 23. 1988). 

Generally, there are no restrictions on the 

investment of the remaining 20% of the issuer's 

assets. See, e.g .. NAB Asset Corp. (pub. avail. June 

20, 1991). 

44 See, e.JJ.• United Bankers, Inc., supra note (fee 

interests); Health Facility Credit Corp. (pub. avail. 

Feb. 6, 1985) (leasehold11) ; Medidentic Mortgage 

Inves.tors [pub. avail. May 23, 1984) (mortgages); 

American Home Finance Corp. (pub. avail. Apr. 9, 

1981) (GNMA whole pool certificates). 

.. See Nottingham Realty Securities. Inc. (pub. 

avail. Apr. 19, 1984). The Division has reasoned that 

agency whole pool certificates should be considered 

Qualifying interests because holders of the&e 

certificates generally have the same economic 

experience as an investor who purchases the 

underlying mortgages directly. Conversely, the 

Division has concluded that an investment In 

agency partial pool certificates is an investment in 

the securities of the issuer, rather than an 

inveetment in the underlying mortgages. and 

accordingly. should not be considered a qualifying 

interest . 

..Legislation has been introduced in Congress 

that would. among other things . creAte a new 

Continu ed 
23984 Federal Register / Vol. 57, No. 109 I Friday, June 5, 1992 I Proposed Rules 

Some structured financings have 

obtained exemptive orders from the 

Commission under sectien 6(c), the Act's 

general exemptive provision. Most of the 

orders have concerned structured 

financings whose assets consisted 

primarily of partial pool certificates and 

other mortgage-related assets that are 

not considered to be qualifying interests 

under section 3(c)(5)(C).H These orders 

have been based, in part, on the 

legislative purpose underlying the 

Secondary Mortgage Market 

Enhancement Act of 1984 {"SMMEA"). 48 

In adopting SMMEA. Congress 

contemplated that the Commission 

would provide appropriate 

administrative relief if the Act 

unnecessarily hindered the development 

of the secondary mortgage market. •a The 

Commission has issued approximately 

125 orders concerning mortgage-related 

financings. 50 

In general, the orders qave required, 

among other things, that lil fixed-income 

securities sold to the public be rated in 

one of the two highest categories by at 

least one rating agency; (ii) substitution 

of assets be limited both quantitatively 

and qualitatively; 51 (iii) the assets be 

section exception for issuers whose securities are 

held exclusively by sophisticated or "qualified" 

purchasers, as defined by rule. If adopted, 

structured financing& could rely on this exception so 

long as their security holders consist of "qualified" 

purchasers. Small Business Incentive Act of 1992, S. 

2518, 102d Cong., 2d Seas. (Apr. 2. 1992): H.R. 4938, 

102 Cong., 2d Sess. (Apr. 9. 1992). Soe Hearings on 

the Small Business Incentive Act of 1992, 102d 

Cong., Zd Seas. (Mar. 28. 1992). 

"Sue, e.s .. Mortgage Bankers Financial Corp. I, 

Investment Company Act Release Nos. 16458 (June 

28. 1988), 53 FR 25226 (July 5, 1088) (Notice of 

Application) and 16497 (July 25, 1988). 41 SEC 

Docket814 (Aug. 9, 1988) (Order); Shearson Lehman 

CMO. Inc., Investment Company Act Release Nos. 

15796 (June 11, 1987), 52 FR Z3Z46 (June 18, 1987) 

(Notice of Application) and 15852 (July 2. 1987), 38 

SEC Docket .1403 (July 21. 1987) (Order). 

"Secondary Mortgage Market Enhancement Act 

of 1984. Pub. L. No. 98-440, 96 Stat. 1689 (1984). 

Congreas enacted SMMEA in an effort to expand 

the participation of the private sector in the 

aecondary mortgage market in response to concerns 

that GNMA. FNMA. and FHI..MC would not be able 

to meet future demands for mortgage credit. 

"SeeS. Rep. No . 293. 98th Cong., 2d Seas. 9 (1983) 

(while the Senate Committee on Banking, Finance 

and Urban Affairs considered whether the Act 

ohould be amended to except issuers investing in 

certain mort~age·backed securities from the 

definition of mvestment company. the Committee 

reported legislation without such an exception In 

light of the Commission'• administrative flexibility) . 10 See supra note 47. 

"For e~ample, the orders generally have 

permitted substitution of pooled assets, provided, 

among other things, that the new assets be of equal 

or better credit quality than the replaced assets. and 

that the new assets have similar payment tel'lll8. In 

addition, some orders have limited substitution to 

no more than 40"6 of the aggregate face amount of 

the assets initiully deposited (with no substitution 

of substituted assets). See. e.g .. Mortgage Bankers 

Financial Corp. I. supro note 47 (with respect to the 

held by an independent trustee qualified 

under the Trust Indenture Act of 1939 

(the "Trust Indenture Act'') 62 who has a 

first priority perfected security interest 

or lien in the collateral; (iv) the servicer 

not be affiliated with the trustee; and (v) 

the issuer be audited annually to · 

determine that the cash flow Is sufficient 

for payment of principal and interest. 

These conditions generally parallel 

.requirements prescribed by rating 

agencies. 53 

The Commission also has granted 

exemptive relief under sections 6(c) and 

6(e) 54 for financings related to the 

federal government loan sales 

program. 55 Under this program, the 

federal government sold portions of the 

loan portfolios of certain government 

agencies during the late 1980's. 66 While 

some of these sales were excepted 

under section 3(c)(5), others could not 

have been completed without exemptive 

relief. A total of seven financings either 

received exemption from most 

provisions of the Act, including the 

registration requirements, or registered 

as closed-end management investment 

companies and received exemption from 

much of the Act. 57 The conditions 

imposed in those orders generally were 

similar to those required for exempting 

mortgage-related financings. 68 

substitution of pooled GNMA. FNMA. and FHLMC 

certificates). 

"The Trust Indenture Acl seta forth requirements 

regarding. among other things. the eligibility and 

qualifications of trustees, the preferenlial collection 

of claims against the issuer, and reporting 

obligations. The Trust Indenture Act also addresses 

the duties of trustees when an issuer defaults. 

"The exemptive orders also have imposed 

conditions limiting the sale of residual interests. 

.. 15 U.S.C. BOa-{!{ e). Section 6(e) provides that If. 

in connection with any order under section 8 

exempting any investment company from the 

registration provisions of section 7 [15 U.S.C. I BOa7), the Commission finds it appropriate that certain 

provisions of the Act pertaining to registered 

investment companies be applicable in respect of 

such company. the specified provisions will apply to 

that company as though it were a registered 

Investment company. See. e .g .. Community Program 

Loan Trust No. 1987 A. Investment Company Act 

Release Nos. 15900 (July ~9. 1967), 52 FR 28828 [July 

31, 1987) [Notice of Application) and 15948 (Aug. 24. 

1987). 39 SEC Docket 65 (Sept. 8. 1987) (Order). 

.. See. e.g .. Community Program Loan Trust No. 1987 A. supra note 54. 

..See Omnibus Budget Reconciliation Act of 1988. 

Pub. L. No. oo-509. 100 Stat. 1674; Omnibus Budget 

Reconciliation Act of 1967, Pub. L. No. 100-203. 101 

Stat. 1330 (1987) . 

•• Some issuers registered as investment 

companies because of tax advantages. See. e.g., 

College and University Faculty Loan Trust. 

Investment Company Act Release Nos. 15903 (July 

31, 1987), 52 FR 28890 (Aug . 4. 1967), (Notice of 

Application) and 15990 (Sept. 18. 1987). 39 SF.C 

Docket 346 (Sept. 29. 1987) (Order). 

••The only other exemptive order issued with 

respect to structured financings involved trusts 

established by the Government of Israel to facilitate 

the financing of its housing program to Soviet 

refugees. Each trust issued non-redeemable pass· 

) 

D. The Effects of the Regulatory 

Structure 

As a practical matter, the Act treats 

similar types of structured financings 

very differently. Some structured 

financings are subject to the Act's 

requirements, while others are excepted 

entirely, depending solely on the assets 

underlying the financing. Most · 

structured financings backed by 

consumer receivables, for example, are 

excepted from the Act under section 

3(c)(5). Structured financings backed by 

general purpose loans, on the other 

hand, are not excepted and cannot be 

sold publicly in the United States, even 

though the financing may be similar to 

those qualifying for an exception or 

receiving exemptive relief. This 

regulatory framework ignores both the 

structure and operation of structured 

financings,. and the credit quality of 

securitized assets.u It also enforces a 

distinction that do·es not reflect the 

economic reality that any asset with a 

relatively predictable cash flow is 

capable of being securitized in a 

generally uniform manner. 

The differing regulatory treatment 

under the Act has adversely affected the 

development of the structured market. 

According to market participants, the 

most widely accepted types of 

structured financings are those sold on 

the domestic public market, while 

financings whose distribution is limited 

to private placements or to overseas 

markets have lagged in development. In 

addition, United States investors are 

denied the opportunity to purchase highquality securities issued by certain types 

of structured financings. Similarly, 

sponsors of financings that cannot be 

offered publicly in the United States are 

prevented from diversifying and 

expanding their investor base. 

through certificates backed by a single promissory 

note, the payment of which was guaranteed by the 

full faith and credit of the United States. See 

Government of Israel , Investment Company Act 

Release Nos . 18047 (Mar. 18. 1991), 58 FR 11806 

(Mar. 20, 1991) (Notice of Application) and 18069 

(Mar. 28, 1991), 46 SEC Docket 943 [Apr. Z, 1991) 

(Order). 

••1n response to the Study Release, supra note 1, 

one commenter noted that "issuers of asset-backed 

securities whose underlying asset• are credit card 

receivables have restrictions limiting the percentage 

or their assets that can be repreaented by cosh 

advances. In many cases. If the percentage of cash 

advance receivables becomes too great, the 

trantaction is liquidated and investments are paid 

earlier than expected • • '. From the point of view 

of the investor, [however], there is no difference 

between the two types of credit card receivables." 

Letter from Cleary. Gotilieb. Steen & Hamilton to 

Jonathan G. Katz, Secretary, SEC 62-83 (Oct. 1Z. 

1990) at File No. S7-1 HlO [hereinafter Cleary, 

Gotilieb Study Comment). 
Federal Register /Vol. 57; No. 109 I Friday, June 5, t~z ·. ; PrOposed Rules 23985 

The regulatory barriers presented by 

the Act also have broader economic 

implications. Many sectors of the 

economy are prevented from fully using 

structured fmance to address capital 

needs. When the Act does not apply, 

structured finance has proved effective 

in Increasing the availability of certain 

financial assets, often at lower costs. 

For example, structured finance has 

increased the availability of home 

mortgage funding by enabling banks and 

savings and loan associations to 

package their loans and sell them in the 

secondary market. 

In the long-term, private sector 

structured finance may prove beneficial as a means of capital formation with 

respect to small businesses. For 

example, general purpose loans to small 

businesses could be securitized in a manner very similar to residential 

mortgages. Suppliers and distributors 

also could securitize small business 

payables. Finally, small businesses 

themselves could pool and sell their 

own assets, such as receivables from 

customers. 110 

11. Discussion 

A. Proposed Rule 3a-7 

Proposed rule 3a-7 would remove 

impediments caused by the Act by 

excluding any structured financing, 

regardless of the type of assets 

securitized, from the definition of 

investment company, provided certain 

conditions are satisfied. It would 

obviate the need for sponsors to attempt 

to fit their financings within the confines 

of section 3(c)(5}-a section that was not 

Intended to cover these arrangements. 

The proposal also would eliminate the 

need to obtain exemptive orders 

covering specific structured financings. 

Proposed rule 3a-7 would have four 

conditions: 

(i} Issuers must primarily issue fixedincome securities, with the holders of all 

such securities entitled to receive 

payments based on the cash flow from 

pooled assets; 

(ii) Securities offered to the public 

must be fixed-income securities (as 

defined under the rule) that are rated at 

the time of sale in one of the two highest 

categories by at least one rating agency; 

(iii) The issuer must hold substantially 

all assets to maturity, except that assets 

may be substituted or added consistent 

with the interests of existing investors; 

and 

(iv) Assets, cash flows, and other 

property of the issuer must be 

•• See Hearings on the Small Bu1iness Incentive 

Act of lfJf/2, supra note 46 (testimony of Myron 

Glucksman. VIce Preaident, Structured Finance 

Division, Ctticorp Securities Markets, Inc.). 

maintained In the custody of an · independent trustee, except to the 

extent necessary to the financing's 

operations. 

These conditions, which are discussed 

in greater detail below, are intended to 

recognize the structural and operational 

distinctions between registered 

investment companies and structured 

financings and to address investor 

protection concerns by codifying 

requirements currently imposed by the 

market itself. The conditions also are 

intended to accommodate future 

Innovations in the structured finance 

market, consistent with investor 

protection. 

1. Scope ofthe Rule 

Proposed rule 3a-7 would exclude 

from the definition of investment 

company any person that is in the 

business of acquiring and holding 

eligible assets, and does not issue 

redeemable securities. •• The proposed 

rule is intended to exclude only 

structured financings from the Act and 

to preclude excluded issuers from acting 

in a marmer similar to registered 

investment companies. Only issuers 

whose sole business Is to hold a pool of 

eligible assets and to issue nonredeemable securities could rely on the 

exclusion. 

Proposed rule 3a-7 would be based on 

the structure and operation of the 

financing and not on the type of assets 

securitized, provided all of the issuer's 

assets consist of eligible assets. 

Proposed paragraph (b)(t} defines the 

term "eligible assets" generally to 

include obligations that have scheduled 

cash flows. 12 This requirement is 

intended to ensure that securitized 

assets produce cash flows of the type 

that may be statistically analyzed by 

rating agencies and investors. 

2. Conditions 

(i) Securities Based on Underlying Cash 

Flows 

Proposed paragraph (a}(l) would 

require issuers relying on the rule to 

issue primarily fixed-income securities, 

interest-only ("10") securities, principalonly ("PO") securities; or other 

" In addition, lssuera seeking to roly on the rule 

muy not Issue debt securities thut entitle holders to 

receive principal and uccrued Interest within a short 

period of time after demand (I.e., within 14 daye). 

Securities with a thorHerm demand feature appear 

morellke redeemable equity eecurillet, and 

Investors could confuse the securities with those 

issued by open-end management lnvettment 

companies. 

.. Under proposed paragraph (b)(l), eligible assete 

also would include assets that serve aolely to 

support the credit of the securities (e.g .. letters of 

credit). See supra nole. 

securities with similar characteristics, 

all of which entitle their holders to 

receive payments that depend on cash 

flows generated by the underlying pool. 

The proposed rule is intended to provide 

issuers with great flexibility in choosing 

the types of debt or debt-like securities 

to issue. • Structured financinss 

presently issue a variety of securities 

based on cash flows from the underlying 

pool, and the proposal is not intended to 

limit that industry practice ... By requiring payment on the securities 

to be based on the cash flows from the 

underlying pool, proposed paragraph 

(a)(l) is Intended to reach the 

predominate types of structured 

financings that are currently offered.~ 

The provision would permit an excluded 

financing to use credit enhancements, 

such as letters of credit or financial 

guaranty insurance, to pay investors if 

the cash flow from pooled eligible assets 

is insufficient to meet the issuer's 

obligations. 

(ii) Securities Offered to the Public Must 

Be Fixed-Income Securities Rated in the 

Two Highest Investment Grades 

Paragraph (a}(2) of the proposed rule 

would require that all securities offered 

to the public be fixed-income securities 

that are rated, at the time of sale by the 

issuer or any underwriter acting on the 

issuer's behalf, in one of the two highest 

categories by at least one natiqnally 

recognized statistical rating 

organizallon, or "rating agency." ec~ 

.. See supra note 21. As discussed below, 

however, 10 tecurilies, PO securities, and securilies 

with similar characteristics could not be told to the 

public. 

"In defining Cixed·income securities, proposed 

subparagraph (b)(2)(i) seeks lo delineete the 

methods currently used to calculate Interest on a 

structured financing's securities . The Commission 

specificully requests comment on whether this 

approach may limit unnecessarily the type• of fixed· 

income aecurltlea that may be offered in the future, 

and whether an oltemotive approuch would be 

appropriate. 

.. Structured financings using o "market value" 

structure. where paymenl on the financing's 

securitiea le derived from the aggregate market 

value of the pooled aueta, would not be able to rely 

on propoted rule 3&·7. Market value tranaaclion• 

present istuet that differ from financing• utilizing 

the cash now tlructure. For example, because 

Investors are paid baaed on the aggregate market 

value of the asaeta . rather than cash Oowa 

. generated from the assels, asset valuallon concerns 

differ with respect to tho two type1 of structures. 

Accordingly, these etrucluree should not be subject 

to the aome regulatory treatment a1 cub now 

transactionl. Since the u1e of the market value 

structure hat diminished in the last few yeartl, this 

limitation thould not signlficanlly affect the 

structured finance market. Of COUJ'tle, financings 

uting the market value structure may sell their 

securities In privute placement• or overt1eas, or moy 

apply for exemptive relief . 

MTbe rating 11goncy could not be an affiliated 

person or the financing's sponsor, servicer. trustee, 

or provider of credil support. 
21986 Federal Register / Vol. 57, No. 109 I Friday, June 5, 1992 I Proposed Rules 

Securities that are not rated In the two 

highest categories, or that are unrated, 

may be sold only to qualified 

institutional buyers, as defined in rule 

144A under the Securities Act of 1933, 87 

or to an affiliated person of the Issuer. 61 

This provision recognizes that rating 

agencies already play an integral role in 

the structured finance market." 

Investors generally rely on rating 

agencies to perform evaluations of 

credit risk. Of course, the Act generally 

is not intended to protect investors 

against credit risk. Nevertheless, due to 

the nature of structured financings, 

rating agency evaluations appear to 

address most of the Act's concerns 

about abusive practices, such as selfdealing and overreaching by insiders, 

misvaluation of assets, and inadequate 

asset coverage. Determining whether a 

financing is structured appropriately has 

become increasingly difficult, due to the 

wide variety and growing complexity of 

these transactiOns. Rating agencies have 

been successful in analyzing various 

structures, without impeding the 

development of the structured finance 

market. 70 Accordingly, a rating 

requirement has been incorporated in 

the proposed rule. The Commission, 

however, requests comment on whether 

rating agencies should be subject to 

additional regulatory requirements and 

whether a rating requirement is 

necessary in proposed rule 3a-7, and, if 

not, on what alternative bases the 

Commission should exclude financings 

from the Act. 

11 17 CI'R 230.144A. Under rule 144A, 1 qualified 

inotitutional buyer generally Include• lnatitutional 

Investors, such as employee benefit plana, Insurance 

companiea, banks, and lnveatment companiea, that 

own or lnveot on a discretionary basil at leoti $100 

million In &ecunlles. 11 Section Z(a)(3) of the Act defines affiliated 

penon of another pe!'11on u: 

(A) Any person directly or Indirectly owning, 

controlling, or holding with power to vote, 5 per 

centum or more of the outstanding voting teCUritiet 

of such other person: (B) any person 5 per centum or more of wb011e outstanding voting securitiea 1re 

directly or Indirectly owned, controlled, or held with 

power to vote. by such other person; (C) any perton 

directly or Indirectly controlling. controlled by, or 

under common control with, 111cb other penon; (D) 

any oft1eer, director, partner, copartner. or employee 

of such other person: (E) If such other perton 11 an 

inve1tment company, any lnvettJMnt adviser 

thereof or any member of an advisory bo6rd thereo(; 

and (F) If tuch person Is an unincorporated 

Investment company not having a board of 

directora, the depositor thereof. 

15 U.S.C. 80a - 2(a)(3). 01 1n adophng SMMEA. Congrns expre11ly 

recosnlzed the role of rating qenclea In the 

structured finance market. by Including In the 

definition of "mortgage related IHICUrity" (the type of 

security that quahf1ea for thlt a)JitCialtrntment 

conferred by SMMEA) a requirement that the 

security be rated in one of the two hlshett ratlns 

categariea by at leaa1 one ratlns asency. See supm note 47. 

•• See supra nate and accompanying text. 

Proposed subparagraph (a)(2) would 

require that securities offered to the 

public be rated in one of the two highest 

categories by at least one rating agency. 

Since most structured financings 

publicly offer only securities that are 

rated in one of these categories, this 

requirement should not materially affect 

the structured finance market. Some 

have argued, however, that a rating 

within one of the four highest categories 

(I.e., an investment grade rating) would 

address investor protection concerns, 

while providing greater flexibility for 

structured financings. 71 Accordingly, the 

Commission specifically requests 

comment on whether an investment 

grade rating requirement would be 

appropriate. 

The Commission also requests' 

comment on whether rule 3a-7 should 

require that excluded financings be 

rated by more than one rating agency. 

Although today most financings are 

rated by two m'more rating agencies, 

the Commission is concerned that 

requiring two ratings would impose 

unnecessary costs. 

Under proposed paragraph (a)(2), an 

issuer may sell to the public only fixedincome securities as defined under 

paragraph (b)(Z) of the proposed rule. As 

proposed, the term "fixed-income 

securities" generally includes any debt 

obligation or instrument with debt-like 

characteristics, other than 10 and PO 

securities or other securities with similar 

characteristics. Thus, an issuer relying 

on the proposed rule would be 

precluded from offering to the public 10 

and PO securities and any other 

securities with similar characteristics. 

10 and POs securities are highly 

volatile, with payment subject to 

extreme prepayment and interest rate 

risks. 72 These securities may be highly 

" In response to the Study Release, supra note 1. 

m most commenters supporting an exemption for 

structured financings suggested a rating in one of 

the two highest categories. Soo. e.g.. Letter from 

Financial Security Assurance Inc. to Jonathan G. 

Katz, Secretary. SEC 4 (Oct. 9, 1990). Pile No. S7-11­

90; Merrill Lynch Study Comment. ~upra note 75. A 

few cornmenters favored an Investment grade 

standard. See. e.g .. Letter from the American Bar 

Asaociation. Se<:tion of Businesa Law. 1940 Act 

Structured Finance Taalt Force to Jonathan G. Katz. 

Se<:retary, SEC 20-Zl (Oct. 16. 1990). File No. S7-11­

90. 

.,. J.P. Morgan, for example, recently Incurred a 

$50 million loss on ita 10 securities as a result of a 

high rate of prepayments on the underlying 

mortgages.J.P Morgan Had$.';(! Million in Los~ In 

Trodina Mortgage-Backed Securities, WaU St. J., 

Mar. 10. 1992. at A4. The Pederal Financial 

Institutions Examination Council adopted a 

supervisory policy atatement that Includes 

restrictions governing the a1:1Julaitlon of 10 and PO 

aecurlties by national banks due to the volatility of 

tbeae lnatrwnenta. Comptroller of the Currency, 

Administrator of Nabonal Banke. Supervisory 

Polley Statement on S<!CIIlitJel Activitiea, Banking 

Circular No. 228 (Rev.) (Jan. 10, 1992). 

rated, since prepayment and interest 

rate risks are not addressed in a 

security's rating. 73 Unsophisticated 

investors, however, may not appreciate 

the risks associated with 10 and PO 

securities, and sales of these 

instruments to such investors may raise 

suitability concerns. In addition, 

financings that offer these securities 

arguably may represent a type of 

complex capital structure that the Act 

was intended to address. 74 Accordingly. 

the Commission proposes that rule 3a-7 

not encompass structured financings 

that selliO and PO securities to the 

public. ~ The Commission requests 

specific comment, however, on whether 

this restriction is appropriate. 76 

The proposed rule would permit any 

class of securities, without regard to the 

nature of the securities or their rating, if 

any, to be sold to qualified institutional 

buyers as defined in rule 144A, or to 

affiliated persons of the issuer. 

Presently. subordinate classes of 

structured financings, which typically 

are not highly rated, if rated at all, and 

interests in residual cash flows 77 are 

"See supra note 28. 

"The legislative history of the Act describM 

Investment companies that offered multiple cluau 

of debt with dlffcrent preferencea and priariliee. 

making it difficult for the ordinary Investor to 

understand the righta and riaks associated with hit 

investment.~ SEC.Inveetment Truata a11d 

lnveatmenl Companlaa, H.R. Doc. 7(11, 75th Cong .• 

3d. Sese. pt. 1 at ~29 (1939): SEC, lnve&tment 

Trusll and lnvMimenl Companle&, H.R. Doc. No. 

279. 78th Cong., let Sese. pt. 3 at ch. V (1939) . 

Section 18 of the Act addreese1 these concem1 by 

Imposing restrictiona on the offering of debt 

aecurltiet by registered Investment companico. 15 

u.s.c. IIOa--18. 

11 In response to the Study Release, Supro note 1, 

some commenten Indicated that aalea of 10 

aecuritiea to the public should be restricted becauae 

of their extreme volatility. See Cleary, Gottlieb 

Study Comment, supro note 59; Letter from Merrill 

Lynch A Co.. Inc. to Jonathan G. Katz, Secretary, 

SEC IX-13 (Oct. 16. 1990). File No. S7-11-«< 

[hereinafter Merrill Lynch Study Comment). 

'"The proposed rule alto would prohibit the 

public aale of any ather securiliea that lll'1l highly 

volatile and pose risks that unsophisticated 

Investors may not appreciate. Por example, realdual 

Interests structured as debt preaent almil8r concerns 

to 10 and PO aecuritlea and, therefore. could not be 

sold to the public. or couree, lOs and POe and 

securltia. with aimllar characteri&tiC8 could be sold 

to qualified Institutional buyers and affiliated 

pe1110ns of the issuer. The Commi~~tioo a lao request• 

comment on thia aapect of the propoaed rule . 

"'Realdualintereatatypically are atructured 111 

equity and are not rated. Theae intereata are hi8bly 

volatile Instruments, with payment depending in 

part on the effect• of prepayments on the underlying 

assets and/or changes Jn the Interest rale{s) on the 

cash flow . Reaidualintereell bear rislta that are 

significantly different from tboae attending fixed· Income securities. In the event of self-dealing or 

overreaching by Insiders. for example. theee 

lntereall (u equity) would be the firtl to bear any 

losses. Reaidual intereata ~lly are retained by 

the spooaor or told to 1111t11uttonalmveaton who 

purchase them for hedging purpolt!tl. 
Federal Register I Vol. 57, No. 109 I Friday, June 5, 1992 /. Proposed Rules 23987 

placed with highly sophisticated 

investors. These investors conduct their 

own due diligence reviews prior to 

investing, and are capable of evaluating 

on their own behalf whether the 

financing is structured so that they. as 

holders of subordinate securities, will 

receive full and timely payment. 

(iii) Limited Management 

Proposed subparagraph (a)(3) would 

require issuers to hold substantially all 

eligible assets, other than any form of 

external credit support (e.g., letters of 

credit), to maturity. With four 

exceptions, issuers relying on the 

proposed rule would be required to hold 

to maturity (i.e., the termination of the 

asset according to its terms) 78 

substantially all assets initially 

deposited in the pool as well as any 

assets added later. 79 

Proposed subparagraph (a)(3)(i) is 

intended to permit asset substitution, 

provided the new assets are of the same 

type and at least as high in credit 

quality as those initially deposited in the 

pool. This provision is intended to 

permit the replacement of assets when 

necessary to the financing's 

operations, 80 but to prevent any change 

in the financing's assets to the detriment 

of investors. 

Proposed subparagraph (a)(3)[ii) 

would allow financings to continue the 

practice of using a defeasance 

mechanism to enable issuers to meet 

their obligations. This mechanism 

permits the trustee to sell assets and use 

the proceeds to purchase Government 

securities, 81 usually Treasury bills, that 

provide sufficient cash flows to pay 

holders of the financing's fixed-income 

securities. 

Proposed subparagraph (a)(3)(iii) 

would permit assets to be added to the 

financing, provided these assets do not 

result in a downgrading of the rating of 

the financing's outstanding fixed-income 

securities. Ttie new assets would not be 

"Thus, an asset would be considered to have 

reached maturity when the asset is prepaid in 

accordance with Its terms. 70 The requirement that eubstantially all eligible 

assets be held to maturity is intended to permit a 

limited amount of additional management 

flexibility, as determined through the no-action 

process. 00 Substitution typically occure when assets are In 

default or subject to imminent default. or when they 

do not conform to the representations and 

warranties made at the time the financing is 

established. 

"Under section 2(a)(16) of the Act. the term 

"Government security" includes any security issued 

or guaranteed as to principal or interest by the 

United States. or by a person controlled or 

supervised by and acting as an Instrumentality of 

the United States Government pursuant to 

Congressional authority. or any certificate of 

deposit of the foregoing . 15 U.S.C. 80a-2(a)(16). 

required to be of the same type as those 

already in the pool. 82 This provision 

would permit financings to add assets to 

support the issuance of new fixedincome securities or to support 

obligations already outstanding. 

83 The 

provision also would allow financ;ings to 

continue the practice of reinvesting idle 

cash in highly rated short-term 

securities. 84 

Proposed subparagraph (a)(3)(iv) 

would permit issuers to dispose of 

assets that have not reached maturity 

only in connection with a financing's 

termination.56 In all other 

circumstances, assets may not be 

removed from the underlying pool 

unless they meet the requirements of 

subparagraphs (a)(3)(i) or (ii). 

The requirements of paragraph (a)(3) 

are intended to limit the amount of 

management permitted in structured 

financings without unduly restricting 

their operations. The provision 

recognizes that most financings require · 

some form of management and that 

more recent structures contemplate 

somewhat greater flexibility in the 

management of pooled assets.88 At the 

same time, proposed paragraph (a)(3) 

seeks to ensure that any changes in a 

financing's assets would not adversely 

affect the holders of the financing's 

outstanding fixed-income securities, and 

that excluded financings would not be 

managed to the same extent and in the 

same manner as management 

Investment companies. 

The Commission requests comment on 

whether paragraph (a)(3) achieves its 

intended purpoQes by permitting the 

proposed types of asset turnover. The 

Commission also requests comment on 

whether other restrictions relating to the 

management of assets should be 

included, and if so, what these 

restrictions should be. For example, it 

may be appropriate to include a general 

/ 

"For example. in asset-backed commercial paper 

programs, diacussedsupro note 26, short-term 

money market instrument& may be added to a pool 

of credit card account receivables. 

"See supra notes 25-26 and accompanying text . 

.. Reinvestment would be limited to eligible 

assets as defined in proposed paragraph (b)(l). The 

Commission aeeke specific comment on whether 

this requirement would limit unnecessarily a · 

financing's reinvestment options. 

•• In the course of winding up its operations. an 

Issuer may diApose of a significant portion of ils 

assets prior to maturity. Excluded financings in tho 

process of lenninating their operations would 

continue to be in compliance with proposed 

subparagraph {a)IJ)(ii), provided the financing is 

concluded within a reasonable period of.time in 

light of the structure of the financing . the assets 

involved, and prevailing market conditions. 

•• See supra notes 24-26 and accompanying text . 

prohibition on the trading of assets for 

profil. 87 

The Commission also requests 

comment on alternative approaches to 

proposed paragraph {a)(3). The 

Commission, for example, could limit 

management objectively by requiring 

that a specified percentage. for example, 

sixty percent, of the aggregate amount of 

pooled eligible assets to be held to 

maturity.88 A specific percentage 

limitation, however, could unnecessarily 

limit flexibility to respond to the specific 

types of financings through the no-action 

process. 

(iv) The Independent Trustee 

~opoeed paragraph (a)(4) would 

require that all eligible assets, cash flow 

derived from such assets, and any other 

property of the issuer not needed for the 

financing's operations, be maintained in 

a segregated account by a trustee 

meeting certain requirements. 89 All 

property of the issuer at the time the 

financing is established, including 

pooled eligible assets {or legal 

documentation of interest in such 

assets) and any documents relating to 

credit support arrangements, would be 

deposited with the trustee. All 

subsequently acquired property, 

including all cash flows, would be 

transferred to the tr:ustee within a 

reasonable period from the time of 

receipt.• 0 Property necessary to the 

financing's operations (e.g., for 

servicing) could be removed from the 

segregated account, provided that the 

property is returned promplly to the 

trustee once il is no longer needed. 91 

Proposed paragraph (a)(4) is intended 

to ensure the safekeeping of the issuer's 

assets. The provision generally is 

intended to codify industry practice, 

except that it would prohibit any 

servicer from commingling the 

financing's cash flows with its own 

11 See Letter of Clticorp to jonathan G.l<att. 

Secretary, SEC (Oct. 10. 1990) File No. S7-11- 90 

(responding to the Study Release, supra note) . 

•• This approach would be consistent with prior 

exemptive orders. See supra note 51. More 

restrictive limits (e.g .. seventy percent. seventy-five 

percent, or eighty percent) also may be appropriate. 

•• In light of the dlvenity of aesets used In 

structured financing•. the Commission requests 

specific comment on whether the physical transfer 

of eligible a88ets to the trustee would present any 

difficulties for particular types of financing•. and if so, what alternative approach would be appropriate 

to accommodate these arrangements. 00 Whether the property is transferred within a 

reasonable period of time would depend on a 

number of factors. including the type of property 

transferred, the circumstances surrounding the 

transfer. and industry practice. 

•• For example. it may be necessary to remove 

documentation for a specific loan to collect 

delinquent payments; the documentation wouid be · 

returned to the trustee following collection. 
23988 Federal Register / Vol. 57, No. 109 I Friday, June 5, 1992 I Proposed Rules 

assets.111 Investor protection concerns 

outweigh any benefit resulting from the 

commingling of a servicer's assets with 

those of the issuer. 

Proposed paragraph (a)(4) would 

require the trustee to be a bank that 

meets the requirements of section 

26(a){1) of the Act governing trustees of 

unit investment trusts. 83 The trustee 

also could not be affiliated with the 

other participants in the financing. 114 

Absent this prohibition, one entity could 

act in all capacities of the financing, 

with no independent party safeguarding 

the financing's assets. 96 Virtually all 

trustees are unaffiliated with the other 

parties involved in a structured 

financing, and this requirement would 

not depart from industry practice. 

Proposed paragraph (a)(4) also would 

require the trustee to execute an 

agreement stating that it will not resign 

until the structured financing has been 

completely liquidated or until a 

successor trustee has been designated. 

The agreement additionally would 

provide that the sponsor or an agent of 

the sponsor keep a record of the 

financing's security holders.'.~& These 

requirements are both consistent with 

industry practice and are imposed under 

the Act with respect to registered unit 

investment trusts. 9 7 

..Rating agencies generally permit a servicer with 

an equal or hiRher rating aa the financing'aofixed· 

income secunllea to commingle the financing's cash 

flows with its own assets. 

•• 1:1 U.S.C. lkla-26{a)(t). Section 26{a)[l) also Is 

incorporated in section 17(0 of the 1\ctaovemlng 

the qualification• of banka that serve ol cuJtodionJ 

for resiltered investment companies. 15 U.S.C. BOa· 

17((). 

•• Rule 406 of the Securitiea Act of 1933 defines 

an "affiliate" of. or a person "affiUated" with. a 

specified penon a1 "a per110n that directly. or 

Indirectly through one or more intermediaries, 

controls or is .controlfed by. or is under common 

control with., the pef'Bon specified." 11 CPR 230.405. 

Subject to the requirement that the trustee remain 

unaffiliated with the financing, the trustee would be 

free to purchase the financing's aecurilies . 

The Trust Indenture Act prohibita an obligor and 

any penon with a control relationahlp to the obligor 

from MrVl"!! as the lrultee for the obligor'• 

securities. 15 U.S.C. 77jjj(a)l5). 

•• for example. banks may act aa IPOMOrt. 

servlcel'!l, and/ or providen of credit support lo 

structured fi1111ncinga. 

•• 11da requirement would not prevent the 

trustee, M an agent of the aponaor. from 

maintaining thl!le reconla. 

•• Sectione 211(a)(3) and 26(aK4){1\) of the Act. 15 

U.S.C. 80a-211(a)(3), ·ZB(a)[4)(A). 

Th~t Commiooion considered but rejected 

proposing that the agreement Include provisions in 

the effect set forth In sections 26{a)f2) and 

26(aK4)(B) of the Act. which elao apply to unit 

Investment tru1ts ("UITs"). 15 U.S.C. 80&-26{a){2). • 

26(a)f4)(8). Section 26fa)(2) contains prohibition• on 

fees that would not be compatible with the fee 

structure used in structured fin11nc:inss. which 

generally are baaed on the cub flow generated by 

the pool. In addition. proposed rule 3&·7 would 

.permit greater flexibility with respect to asset 

substituliona than that allowed UIT1. causing a 

Proposed paragraph (a)(4) would not 

specify other duties for the trustee. It 

would not require the trustee to monitor 

the issuer's obligations to investors or tl' 

represent the interests of investors if the 

financing defaults. These requirements 

are Imposed under the Trust Indenture 

Act,11s which applies to many publicly 

offered financing&. Structured financing& 

not subject to the Trust Indenture Act 

often are structured to conform to the 

requirements of that Act. The 

Commission specifically requests 

comment on whether proposed rule 3a-7 

should specify other duties for trustees, 

Including whether any portion of the 

Trust Indenture Act's requirements 

should be made applicable to financings 

that are not subject to that Act. 

B. Amending Section 3{c}(5} 

The Commission also is requesting 

comment on whether section 3(c)(5) 

should be amended, either to expand or 

narrow its scope. As noted above, 

section 3(c}(5) was enacted to except 

commercial finance and mortgage 

companies from the Act. The activities 

of those entities has evolved 

considerably since 1940, however. In 

addition, a broad range of other issuers, 

including structured financings, not 

anticipated in 1940 (or 1970, when the 

exception was amended) rely on the 

exception.99 

According to one trade group, 

traditional distinctions between 

companies engaged in factoring, sales 

financing, and other types of commercial 

financing activities no longer exist. 

Today, a finance company may be 

engaged in several kinds of financing 

activities or variations thereo£. 100 

Moreover, the trade group has suggested 

that current interpretations of section 

3(c)(5) may unduly constrict legitimate 

financins activities. 1 01 

Others have suggested that the section 

should be narrowed, to prevent 

structured financings and other issuers 

from relying on it. 103 Of course, even 

assuming adoption of proposed rule 3a· 

7, absent an amendment to section 

3(c)(5), structured financings will 

continue to be subject to somewhat 

notice requirement. auch aa thalln section 


26{al(4)fB).Io be Wlduly burdenaome. 


•• See supra note :;z. •• See authorities cited 1upra note• 6 & 39. 

1oo Memorandum accompanying Letter from 

Sidley I: AIISttn. on bebalf of the National 

Commercial Fillance Auociation. to Jonathan G. 

Katz. Seaetary. SEC (Oct. 9. 1990). File No. 57-11­

90. 

101/d. 

101 See. e.g.. M001orandurn from the Investment 


Company Institute on the Regulation of Auet· 


Backed Arrangement• under the Investment 


Company Act (undated), File No. 57-11-90­

disparate treatment. Structured 

financings that come within the section 

will be excepted from the Act, while 

other financing& will have to meet the 

requirements of the proposed rule 

(although these requirements largely 

codify present practice). 

In addition, upon adoption of 

proposed rule 3a-7, the no-action 

position of the Commission's Division of 

Investment Management with respect to 

the treatment of whole pool agency 

certificates will be withdrawn. 103 Both 

whole pool and partial pool certificates. 

which are traded In capital markets. arc 

more In the nature of securities than real 

estate, and should not be deemed to be 

Interests in real estate. Moreover, with 

the adoption of proposed rule 3a-7, 

withdrawal of the position should not 

affect structured financings backed by 

whole pool agency certificates. The 

Commission, however. requests 

comment on the withdrawal of this 

position. 

Ill. Cost/Benefit of Proposed Action 

Proposed rule 3a-7 would remove an 

unnecessary and unintended barrier to 

the use of structured financings in all 

sectors of the economy, including the 

small business sector. Accordingly, it is 

Intended to allow more sponsors to 

obtain the benefits of structured 

financings, including using these 

arrangements as sources of capital. It 

also would obviate the need for 

sponsors to spend unproductive time 

attempting to fit these arrangements 

within the confines of section 3(c)(5). or 

to obtain exemptive orders from the 

Commission. 

The Commission anticipates that for 

virtually all structured financings and 

their sponsors, the cost of compliance 

with proposed rule 3a-7 would be 

minimal because the proposed rule 

essentially codifies industry practice. 

Comments are requested, however, on 

the above assessment of the costs and 

benefits associated with the proposed 

rule. Commenters should submit 

estimates for any costs and benefits 

perceived, together with any supporting 

empirical evidence available. 

IV. Summary of Initial Regulatory 

Flexibility Analysis 

The cOmmission has prepared an 

Initial Regulatory Flexibility Analysis in 

accordance with 5 U.S.C. 603 regarding 

1•• See &up('(J note and accompanyins text. The 

Division of lnveatment t.C.nagement doew not intend 

to recommend that the Comminion commence 

enforcement action aaalntt ttructured financings 

previously eetabliahed In reliante on thit no-aclion 

poaltion 10lely becau11e the position hu been 

withdrawn. 
Federal Register I Vol. 57, No. 109 I Friday. June 5, 1991 I Proposed Rules 23989 

propoaed rule 3a-7. The Analyaia 

explains that the proposed rule i1 

intended to remove an unneceaaary and 

unintended barrier to the use of 

structured fmancing1 in all sectors of the 

economy. including the small business 

sector. The Analysis describe& the 

present regulatory framework, under 

which a structured fmancing may be 

entirely exempt from the Act or subject 

to the Act. depending solely upon the 

assets secllrltized. A structured 

fmancing, however, is not able to 

operate under the Act' a requirement&. 

Thus. failing exclusion or exemption, it 

must be sold in private placements, or 

outside the United States. The Analyais 

explains that this result has impeded the 

development of the structured finance 

industry. The Analysis states that the 

costa of compliance with proposed rule 

. 3a-7 would be minimal becauae the 

proposal essentially would codify 

industry practice. The Analysis abo 

describes certain significant alternatives 

to the proposed rule considered by the 

Commission. A copy of the Initial 

Regulatory Flexibility Analyaia may be 

obtained by contacting Rochelle G. 

Kauffman, Esq .. or FJizabeth R. 

Krentzman. Esq., both at Mail Stop 10-4, 

Securities and Exchange Commission, 

450 Fifth Street, NW., Washington. DC 

20549. 

V. Statutory Authority 

The Commission is proposing rule 3~ 

7 under the exemptive and rulemaking 

authority set forth In sections 6(c) and 

38(a) (15 U.S.C. tl0a-6(c), -37(a)J of the 

Investment Company Act of 1940. The 

authority citations for theae actions 

precede the text of the actions. 

VI. Text of Proposed Rule 


Ust of Subjects in 17 CFR Part Z70 


Investment companies, Reporting and 

recordkeeping requirement&, Securities. 

For the reasons set out in the 

preamble, title 17, chapter II of the Code 

of Federal Regulations is proposed to be 

amended as follows: 

PART 27o-RULES AND 


REGULATIONS, INVESTMENT 


COMPANY ACT OF 1940 


1. The authority citation for part 270 


continues to read, in part, as follows: 


Authority: 15 U.S.C. 80a·1 et seq., 80a-a7, 


OOa-39 unless otherwise noted: 


2. By adding l Z70.:Ja-7 to read as 
 follows: 


§ 270.3a-7 Certain lasuera of aaaet-backed 

aec:urltlea. 

(a) Notwithstanding section 3(al of the 

Act, any issuer who is engaged in the 

business of purcbalins. or oilielwiee 

acquiring. and boklimg eligible assets 

and who doea not Lssue redeemable 

tecurities or debt aecurities with a 

demand feature providingfor paymemt 

within fourteen days of demand will not 

be deemed to be an Investment 

company; provided tilat: 

(1} The issuer primarily issues fiXed· 

Income securities, interest-only 

securities. principal-only securities or 

any other securities with similar 

characteristics, all of which entitle their 

holders to receive payments that depend 

on the cash flow from the eligible assets; 

(Z) All securities offered or sold to 

persons other than qualified inatitutional 

buyers, as defined in rule 144A under 

the SecuriUes Act of 1933 (17 CFR 

230.144A), or affiliated persons of the 

issuer are fixed-income securities that 

are rated, at the time of sale by the 

issuer or any underwriter thereof, in one 

of the two highest rating categorie~ 

assigned debt obligations by at least one 

nationally recognized statistical rating 

organization that is not an affiliated 

person of the ieaer or of any person 

involved in the organization or 

operation of the issuer: 

{3) The issuer holds subttanti&lly all 

pooled eligible assets to maturity, 

except that it may: 

(i) Substitute eligible assets for other 

eligible a11ets of the same type and of 

the 1ame or higher credit quality; 

(ii} Pursuant to a defeasance 

mechanism, sub.titute Government 

securities for eligible assets, provided 

such Government securities produce 

cash flows similar to those expected 

from the replaced asset 

(iii) Acquire additional eligil»e &Meta 

that do not result in a downgrading in 

the rating of the issuer' a outstanding 

fixed-inc:ome aecurities: and 

(iv) Dispoae o£ any eligible astets in 

connection with the issuer' a termination; 

and 

(4) Eligible aasets, cash flow derived 

from auch assets, and any other property 

of the issuer, not needed at the time fOJ' 

the operation of the issuer's business. 

are maintained in a segregated acCtNnt 

by a trustee that meets the requirements 

of section Z6{a}{1) of the Act, that is not 

affiliated, as that term ia defined in rule 

405 under the Secwitiea Act of 1~ [17 

CFR 230.405), with ilie isaoer or with any 

person involved in the organization or 

operation of the iasuer, and that 

executes an agreement Ol' instrwnent 

concerning lbe wsuer'a &ec\Ui,iea 

containing provia.Mma to the effect set 

forth In aectiooa 26(a)(.3} aDd 28(a)(4)(A} 

of the Act. 

(b) For purposes of this Se(:lion: 

(1) Elisible assets mean• obli.gations 


that require scheduled cash payments. 


such at aotea. bondt. debenture&, 

eviden<:es of indebtedness. certif~ates 

of depoait.lea.ses, installment coo\ra.cts. 

interest rate awape, repurchase 

agreement&, guaranteed investment 

contract&. accounts receivable, chaltel 

paper, cumulative preferred stock, 

guarantees, annuities, and participatioos 

or beneficial interests in any of the 

foresOOJi; and other atleta that serve 

solely to auppori the credit of the 

issuer's securities. such lUI letters of 

credit. guarantees. and cash collateral 

accounts. 

(2l Fixed-incame securitJes means any 

securities that entitle the holder to 

receive: 

(i} a stated principal amount and 

either: 

(A) interest based on such principal 

amount calculated by reference to a 

fixed rate or an adjustable rate 

detennined periodically by reference to 

an index that is generally recogniz.ed in 

financial markets as a reference rate (){ 

Interest, through auctiona among holders 

and prospective holders, or through 

remarketillg of the security, or 

(B) an amount equal to specified 

portions of the in.teresl received on the 

assets held by the issuer; 

provided that any interest determined as 

described in paragraphs (b}(2){f)(A} and 

(B) of this section bears a reasonable 

relationship to a market rate of interest; 

or 

(ii) a stated principal amount at 

maturity and no interest payments; but 

do not include interest-only securities or 

principal-only securities or any other 

securities with similar characteristics. 

By the COIIllllil8ion. 

Dalecl: May 29, 1992. 

Margan\ H. MdMiaall, 

Deputy Secretary. 

[FR Doc. 9Z-13150 Filed 6-4-!12: 8:45 am! 


BlUING COD£ 101H1·M 


DEPARTMENT OF HEALTH AND 

HUMAN SERVICES 

Food and Drug Admfnfstratlon 

21 CFR Part 163 

[Docket No. 16P-o2S7) 

Cacao Products; Amendment of tMI 

Standards ot Identity 

AeENCY:' Food and Drug Administration, 


HHS. 


ACTIOtk Tentative fina) rule. 


SUMMARY: The Food and Drug 

Admin~tration (FDA} ia iaauing this 

tentative finahule to amend the U.S.