SECURITIES AND EXCHANGE COMMISSION

Release No. IC- 29779; File Nos. S7-35-11 

 17 CFR Part 270 

RIN 3235-AL03

Treatment of Asset-Backed Issuers under the Investment Company Act

AGENCY: Securities and Exchange Commission. 

ACTION: Advance notice of proposed rulemaking; withdrawal. 

SUMMARY: The Commission is considering proposing amendments to Rule 3a-7 under the 

Investment Company Act of 1940 ("Investment Company Act" or "Act"), the rule that provides 

certain asset-backed issuers with a conditional exclusion from the definition of investment 

company. Amendments to Rule 3a-7 that the Commission may consider could reflect market 

developments since 1992, when Rule 3a-7 was adopted, and recent developments affecting assetbacked issuers, including the passage of the Dodd-Frank Wall Street Reform and Consumer 

Protection Act (the “Dodd-Frank Act”) and the Commission's recent rulemakings regarding the 

asset-backed securities markets. The Commission is withdrawing its 2008 proposal to amend 

Rule 3a-7, which was published at 73 FR 40124 (July 11, 2008). 

DATES: Comments should be received on or before November 7, 2011.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic comments:

• Use the Commission’s Internet comment form (http://www.sec.gov/rules/concept.shtml); 

or 

• Send an e-mail to rule-comments@sec.gov. Please include File Number S7-35-11 on the 

subject line; or
2 

• Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the 

instructions for submitting comments.

Paper comments: 

• Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and 

Exchange Commission, 100 F Street, NE, Washington, DC 20549-1090. 

All submissions should refer to File Number S7-35-11. This file number should be included on 

the subject line if e-mail is used. To help us process and review your comments more efficiently, 

please use only one method. The Commission will post all comments on the Commission’s 

website (http://www.sec.gov/rules/concept.shtml). Comments also are available for website 

viewing and printing in the Commission’s Public Reference Room, 100 F Street, NE, 

Washington, DC 20549, on official business days between the hours of 10:00 am and 3:00 pm. 

All comments received will be posted without change; we do not edit personal identifying 

information from submissions. You should submit only information that you wish to make 

publicly available.

FOR FURTHER INFORMATION CONTACT: Rochelle Kauffman Plesset, Senior Counsel, 

at (202) 551-6840 or Nadya Roytblat, Assistant Chief Counsel, at (202) 551-6825, Office of the 

Chief Counsel, Division of Investment Management, Securities and Exchange Commission, 100 

F Street, NE, Washington, DC 20549. 
3 

TABLE OF CONTENTS

I. Introduction and Executive Summary 

II. Background 

A. Asset-Backed Issuers as Investment Companies

B. Rule 3a-7 

III. Discussion

A. Revisiting Rule 3a-7 

 1. Rating Requirements

 2. Possible New Conditions for Rule 3a-7 

 a. Structure and Operation of the Issuer 

 b. Independent Review 

 c. Preservation and Safekeeping of Eligible Assets and Cash Flow 

 d. Other Possible Investor Protections 

 i. Other Commission Rules

 ii. Eligibility to Use Rule 3a-7 

 3. Standard for Acquisition and Disposition of Eligible Assets 

 B. The Effect of the Exclusion Provided by Rule 3a-7 

 1. Holders of an Asset-Backed Issuer's Securities

 2. Eligible Portfolio Company

 C. Asset-Backed Issuers Relying on Section 3(c)(5) 

IV. General Request for Comment

I. INTRODUCTION AND EXECUTIVE SUMMARY

Asset-backed issuers

1 typically meet the definition of investment company under the 

Investment Company Act, but generally cannot operate under certain of the Act’s requirements

and restrictions.2 In 1992, the Commission adopted Rule 3a-7 under the Investment Company 

Act specifically to exclude from the definition of investment company certain asset-backed 

issuers that meet the rule’s conditions.3

 

1

 We use the term "asset-backed issuer" in this release to refer generally to any issuer of fixed-income 

securities the payments on which depend primarily on the cash flows generated by a specified pool of underlying 

financial assets. See also infra section III.A.2.d.ii for a discussion of the definition of "asset-backed securities" 

under other federal securities laws. 

 These conditions were designed to incorporate thenexisting practices in the asset-backed securities market that we believed served to distinguish 

2

 See infra note 29. 

3 17 CFR 270.3a-7. 
4 

asset-backed issuers from registered investment companies and addressed investor protection 

under the Investment Company Act.4

Rule 3a-7 includes several conditions that refer to credit ratings by nationally recognized 

statistical rating organizations ("NRSROs" or "rating agencies"). One such condition is that 

certain of the asset-backed issuer's fixed-income securities receive certain credit ratings by at 

least one rating agency. These conditions were included in Rule 3a-7 not principally as 

standards of credit-worthiness, but, because we believed that rating agencies, when providing a 

rating assessing the credit risk of an asset-backed issuer, evaluated whether the issuer was

structured in a manner that also addressed investor protection under the Investment Company 

Act.

 

5

The Dodd-Frank Act,

 

6

 enacted in 2010, generally requires the Commission to review any 

references to or requirements regarding credit ratings in its regulations, remove these references 

or requirements and substitute other appropriate standards of credit-worthiness in place of the 

credit ratings.7

 

4 The conditions also were intended to accommodate future innovations in the securitization market, 

consistent with investor protection. See Exclusion from the Definition of Investment Company for Structured 

Financings, Investment Company Act Release No. 19105 (Nov. 19, 1992) [57 FR 56248 (Nov. 27, 1992)] 

(“Adopting Release”) at text accompanying n.8. Rule 3a-7 effectuated the recommendation made by the Division of 

Investment Management’s staff in its report, Protecting Investors: A Half Century of Investment Company 

Regulation, The Treatment of Structured Finance under the Investment Company Act 1-101 (May 1992) 

(“Protecting Investors Report”). The Protecting Investors Report contains a discussion of the issues raised by assetbacked issuers under the Investment Company Act and the state of the asset-backed securities market prior to the 

Rule’s adoption.

 Even though the ratings-related conditions in Rule 3a-7 generally were not 

intended to serve as standards of credit-worthiness, we are issuing this advance notice of 

5

 See Adopting Release, supra note 4 at n.42 and accompanying text. See also infra note 38. 

6 Pub. L. No. 111-203, 124 Stat. 1376 (2010). 

7

 Section 939A of the Dodd-Frank Act.
5 

proposed rulemaking in response to these requirements and in light of market developments 

since Rule 3a-7 was adopted. We also are withdrawing our 2008 proposal to amend Rule 3a-7.8

The Dodd-Frank Act also directed the Commission to undertake a number of rulemakings 

related to the asset-backed securities market.9 Prior to the passage of the Dodd-Frank Act, in 

April 2010, the Commission proposed comprehensive revisions to the offering process, 

disclosure, and reporting requirements for asset-backed securities under the Securities Act of 

1933 (“Securities Act”) and the Securities Exchange Act of 1934 (“Exchange Act”).10

 

8 In 2008, the Commission proposed to replace the references to credit ratings in Rule 3a-7 with a prohibition 

on the sale of securities of issuers relying on Rule 3a-7 to anyone other than certain institutional investors (“retail 

sales prohibition”). References to Ratings of Nationally Recognized Statistical Rating Organizations, Investment 

Company Act Release No. 28327 (July 1, 2008) [73 FR 40124 (July 11, 2008)] (“2008 NRSRO Proposing Release”) 

at nn.36-47 and accompanying text. Commenters generally opposed the retail sales prohibition, suggesting, among 

other things, that the retail sales prohibition would have unnecessarily precluded offerings to retail investors and 

impeded the liquidity and growth of the asset-backed securities market. See, e.g., comment letter from Dechert LLP 

to the Commission (Sept. 5, 2008), File No. S7-19-08 (“Dechert Comment Letter”); comment letter from Mayer 

Brown LLP to Florence E. Harmon, Acting Secretary (Sept. 4, 2008), File No. S7-19-08; comment letter from the 

American Bar Association to Florence E. Harmon, Acting Secretary (Sept. 12, 2008), File No. S7-19-08. In a 2009 

release, the Commission deferred consideration of this proposal. See References to Ratings of Nationally 

Recognized Statistical Rating Organizations, Investment Company Act Release No. 28940 (Oct. 5, 2009) [74 FR 

52374 (Oct. 9, 2009)] at text following n.64. Based, in part, on the comments received, we have decided to 

withdraw from further consideration the amendments to Rule 3a-7 proposed in the 2008 NRSRO Proposing Release. 

 The 

Commission recognized that many of the problems giving rise to the recent financial crisis 

involved structured finance and proposed a number of changes designed to improve investor 

9

 A summary of these Dodd-Frank Act provisions is available at http://www.sec.gov/spotlight/doddfrank/assetbackedsecurities.shtml. See also Proposed Rules for Nationally Recognized Statistical Rating 

Organizations, Securities Exchange Act Release No. 64514 (May 18, 2011) [76 FR 33420 (June 9, 2011)] (proposal 

requiring third parties retained to conduct due diligence related to asset-backed securities to provide a certification

containing specified information to the NRSRO that is producing a rating for the asset-backed securities); 

Disclosure for Asset-Backed Securities Required by Section 943 of the Dodd-Frank Wall Street Reform and 

Consumer Protection Act, Securities Act Release No. 9175 (Jan. 20, 2011) [76 FR 4489 (Jan. 26, 2011)] ("Section 

943 Release") (adopting rules requiring securitizers of asset-backed securities to disclose the history of fulfilled and 

unfulfilled repurchase requests related to their outstanding asset-backed securities and disclosure by NRSROs of 

representations, warranties and enforcement mechanisms available to investors in an asset-backed securities 

offering); Issuer Review of Assets in Offerings of Asset-Backed Securities, Securities Act Release No. 9176 (Jan. 20, 

2011) [76 FR 4231 (Jan. 25, 2011)] (adopting rules requiring issuers of asset-backed securities to conduct a review 

of the assets underlying those securities and make certain disclosures about those reviews).

10 Asset-Backed Securities, Securities Act Release No. 9117 (Apr. 7, 2010) [75 FR 23328 (May 3, 2010)] 

("2010 ABS Proposing Release").
6 

protection and promote more efficient asset-backed markets.

11 Among other things, the 

Commission proposed to amend: the disclosure requirements of Regulation AB to require that

more information be provided to investors about the assets being securitized; the eligibility 

requirements for public offerings of asset-backed securities conducted through “shelf 

registration” by replacing the existing requirement that the securities receive an investment grade 

rating with new requirements; and the safe harbors under the Securities Act for exempt offerings 

and exempt resales of asset-backed securities.12 In light of the requirements of the Dodd-Frank 

Act and the comments subsequently received on the 2010 ABS Proposing Release, the 

Commission has issued a release revising and re-proposing certain of the proposals in the 2010 

ABS Proposing Release.

13

 The Commission also believes that it is appropriate to consider amending Rule 3a-7, 

among other things, to determine the role, if any, that credit ratings should continue to play in the 

context of Rule 3a-7. In the aftermath of the recent financial crisis, NRSROs' credit rating 

procedures and methodologies raised a number of concerns in light of the role the NRSROs played in 

determining credit ratings for securities collateralized by or linked to subprime residential mortgages, 

and the Commission has engaged in various regulatory initiatives to address these concerns.

 The 2011 ABS Re-proposal requests comment on whether, to be 

eligible for shelf registration under the Securities Act, an asset-backed issuer should, among 

other requirements, meet the conditions of Rule 3a-7. 

14

 

11 Id.

 The

12 Id. See infra section III.A.2.d.

13 Re-proposal of Shelf Eligibility Conditions for Asset-Backed Securities and Other Additional Requests for 

Comment, Securities Act Release No. 9244 (July 26, 2011) [76 FR 47948 (Aug. 5, 2011)] (“2011 ABS Reproposal”).

14 See, e.g., 2008 NRSRO Proposing Release, supra note 8. See also Summary Report of Issues Identified in 

the Staff’s Examinations of Select Credit Rating Agencies (July 2008). The report can be accessed at 

http://www.sec.gov/news/studies/2008/craexamination070808.pdf. 
7 

potential amendments to Rule 3a-7 could include replacing references to credit ratings with 

conditions that are tailored to address Investment Company Act-related concerns. The 

Commission also is considering amending Rule 3a-7 to address two issues, detailed below, that 

have arisen relating to the potential Investment Company Act status of certain holders of 

securities of asset-backed issuers that rely on Rule 3a-7. 

To assist the Commission in its review of the treatment of asset-backed issuers under the 

Investment Company Act, the Commission is issuing this advance notice of proposed 

rulemaking and soliciting broad public comment on these issues. The Commission also invites 

commenters to address any other issues relating to the treatment of asset-backed issuers, the 

protection of investors under the Investment Company Act and capital formation that they 

believe may warrant Commission attention.

II. BACKGROUND

A. Asset-Backed Issuers as Investment Companies

An issuer of asset-backed securities typically is a special purpose entity that acquires and 

holds a pool of income-producing financial assets and issues non-redeemable debt obligations or 

equity securities with debt-like characteristics (“fixed-income securities”), the payment of which 

depends primarily on the cash flow generated by the pooled financial assets. An asset-backed 

issuer that has more assets, or expects to receive more income, than needed to make full payment 

on the fixed-income securities also may sell interests in the residual or additional cash flow.

15

 

15 For a more complete explanation of the structure of an asset-backed issuer and the roles of the various 

parties that may be involved in the organization and operation of the issuer, see, e.g., 2010 ABS Proposing Release, 

supra note 

 

13; Kravitt, Securitization of Financial Assets, (2d ed. 2009) ("Kravitt"); Asset-Backed Securities, 

Securities Act Release No. 8518 (Dec. 22, 2004) [70 FR 1506 (Jan. 7, 2005)] (“2004 ABS Release”); Exclusion 

from the Definition of Investment Company for Certain Structured Financings, Investment Company Act Release 

No. 18736 (May 29, 1992) [57 FR 23980 (June 5, 1992)] (“Proposing Release”).
8 

An asset-backed issuer typically meets the definition of investment company under 

Section 3(a)(1) of the Investment Company Act because it issues securities16 and is engaged in 

the business of investing in, owning or holding financial assets that are securities17 under the 

Investment Company Act.18 With respect to investment companies generally, as set forth in 

Section 1(b) of the Act,19 Congress was concerned, among other things, about companies that 

were: (i) organized, operated, managed, or their portfolio securities selected, in the interest of

company insiders;20(ii) issuing excessive amounts of senior securities;

21

 

16 Section 2(a)(36) of the Investment Company Act broadly defines "security" as "any note, stock, treasury 

stock, security future, bond, debenture, evidence of indebtedness, certificate of interest or participation in any profitsharing agreement, collateral-trust certificate, preorganization certificate or subscription, transferable share, 

investment contract, voting-trust certificate, certificate of deposit for a security, fractional undivided interest in oil, 

gas, or other mineral rights, any put, call, straddle, option, or privilege on any security (including a certificate of 

deposit) or on any group or index of securities (including any interest therein or based on the value thereof), or any 

put, call, straddle, option, or privilege entered into on a national securities exchange relating to foreign currency, or, 

in general, any interest or instrument commonly known as a 'security', or any certificate of interest or participation 

in, temporary or interim certificate for, receipt for, guarantee of, or warrant or right to subscribe to or purchase, any 

of the foregoing." 

(iii) when computing the 

17 See, e.g., SEC, Report on the Public Policy Implications of Investment Company Growth, H.R. Rep. No. 

2337, 89th Cong., 2d Sess. 328 (1966) (stating that notes representing the sales price of merchandise, loans to 

manufacturers, wholesalers, retailers and purchasers of merchandise or insurance, and mortgages and other interests 

in real estate are investment securities for purposes of the Investment Company Act). See also Protecting Investors 

Report, supra note 4, at n. 339 and accompanying text. 

18 Section 3(a)(1)(A) of the Act defines an investment company as any issuer which “is or holds itself out as 

being engaged primarily, or proposes to engage primarily, in the business of investing, reinvesting or trading in 

securities.” Section 3(a)(1)(C) defines an investment company as any issuer which “is engaged or proposes to 

engage in the business of investing, reinvesting, owning, holding, or trading in securities, and owns or proposes to 

acquire investment securities [as defined by Section 3(a)(2) of the Investment Company Act] having a value 

exceeding 40 per centum of the value of [its] total assets (exclusive of Government securities and cash items) on an

unconsolidated basis” (“40% investment securities test”). Section 3(a)(2) of the Investment Company Act defines

“investment securities” to include all securities except (A) Government securities, (B) securities issued by 

employees’ securities companies, and (C) securities issued by majority-owned subsidiaries that are not themselves

(i) investment companies and (ii) are not relying on the private investment company exclusions of that Act. Assetbacked issuers typically meet the definition of investment company in Section 3(a)(1)(A) and/or Section 3(a)(1)(C). 

15 U.S.C. 80a-3(a)(1). See also infra note 30 (discussing statutory exclusions from the definition of investment 

company that may be available to certain asset-backed issuers).

19 15 U.S.C. 80a-1(b).

20 A study conducted prior to the adoption of the Act documented numerous instances in which investment 

companies were managed for the benefit of their sponsors and affiliates to the detriment of investors. Investment 

Trusts and Investment Companies: Hearings on S.3580 Before a Subcomm. of the Senate Comm. On Banking and 

Currency, 3d Sess. 89 (1940) ("Investment Trusts Study"). Section 17 of the Investment Company Act prohibits 

certain transactions involving investment companies and their affiliates. 15 U.S.C. 80a-17(a). Other provisions of 

the Investment Company Act also effectively limit opportunities for overreaching by investment company sponsors 

and affiliates. See, e.g., Section 10(f) of the Investment Company, which generally prohibits a registered investment 
9 

asset value of their outstanding securities, employing unsound or misleading methods, or not 

being subjected to adequate independent scrutiny;22 and (iv) operating without adequate assets.

23

In addition, the Investment Company Act reflected concerns that the assets of investment 

companies were not adequately protected, with controlling persons of investment companies 

commingling the investment company’s assets with their own and then proceeding to 

misappropriate them.24

Like most investment companies, asset-backed issuers typically have no employees and 

must rely for their operations on their sponsors, servicers and other persons, each of whom has 

its own separate and distinct set of financial and other interests. Furthermore, with the exception

of the role typically assigned to the trustee, the sponsor, or a person affiliated with the sponsor, 

potentially could be responsible for most, if not all, of the operations of an asset-backed issuer.

 

25

 

company from knowingly purchasing, during the existence of any underwriting or selling syndicate, any security a 

principal underwriter of which is an affiliated person of the investment company. 15 U.S.C. 80a-10(f). 

 

This structure presents significant potential for conflicts of interest. Thus, for example, one 

Investment Company Act-related concern is the possibility of a sponsor intentionally 

21 Prior to 1940, some investment companies were highly leveraged through the issuance of “senior 

securities” in the form of debt or preferred stock, which often resulted in the companies being unable to meet their 

obligations to the holders of their senior securities. See id. Excessive leverage also greatly increased the speculative 

nature of the common stock of the companies. Id. Section 18 of the Investment Company Act limits the ability of 

registered investment companies to engage in borrowing and to issue senior securities. 15 U.S.C. 80a-18.

22 Prior to 1940, investment companies often valued their portfolios inaccurately, resulting in unfair and 

discriminatory practices in the pricing of their securities. See Investment Trusts Study, supra note 20. The 

Investment Company Act governs the manner in which registered investment companies value their portfolios, 

including defining "value" in Section 2(a)(41), with respect to securities held by a registered investment company, to 

be (a) market value for securities for which market quotations are readily available or (b) for other securities or 

assets, fair value as determined in good faith by the company's board of directors. 15 U.S.C. 80a-2(a)(41).

23 See Investment Trusts Study, supra note 20. 

24 See, e.g., Investment Trusts Study, supra note 20. Prior to 1940, investment company assets were not 

adequately protected from misuse by investment company insiders. Id. In many cases, controlling persons of 

investment companies commingled the investment companies’ assets with the investment advisers’ assets and then 

proceeded to misuse the assets themselves. Id. Section 17(f) of the Investment Company Act and the rules 

thereunder set forth requirements with respect to the custody of investment company assets. 15 U.S.C. 80a-17(f). 

See, e.g., Rule 17f-2 under the Investment Company Act governing custody of investments by a registered 

investment company. 17 CFR 270.17f-2.

25 See, e.g., Proposing Release, supra note 15 at n.95 and accompanying text. 
10 

overvaluing assets or “dumping” into the asset-backed issuer assets that are insufficient to 

produce the cash flow needed to meet the issuer’s obligations to its securities holders, contrary to 

representations made to investors.26 Another Investment Company Act-related concern is that a 

sponsor potentially could substitute inferior assets for the assets transferred to the issuer at the 

time of securitization.

27 Still another Investment Company Act-related concern relates to the 

safeguarding of the issuer’s assets and the cash flow derived from such assets from being 

jeopardized, among other things, by the servicer or the trustee commingling the assets and the 

cash flow with their own assets or by the servicer or trustee investing the issuer’s cash flow in a 

speculative manner.28

B. Rule 3a-7 

 

Although asset-backed issuers typically meet the definition of investment company, as a 

practical matter, they cannot operate under certain of the Investment Company Act’s 

requirements and restrictions.

29 As a result, asset-backed issuers often rely on Rule 3a-7 under 

the Investment Company Act to be excluded from regulation under the Act.30

 

26 See, e.g., SEC v. Patrick Quinlan, et al., 2008 Fed. Sec. L. Rep. (CCH) ¶95,005 (E.D. Mich. Nov.7, 2008), 

aff’d, 373 Fed. Appx. 581 (6th Cir., 2010) (the Commission brought an enforcement action against the sponsor of a 

mortgage-backed issuer that placed in the issuer a large number of mortgages that the sponsor itself had originated 

whose loan-to-value ratios exceeded the maximum loan-to-value ratios stated in the issuer's prospectus, significantly 

increasing the riskiness of the investment).

 The Commission 

27 See Protecting Investors Report, supra note 4 at text following n.281. 

28 See id. at text following n.289.

29 For example, Section 17(a) of the Investment Company Act generally would prohibit the sponsor’s sale of

assets to the asset-backed issuer. 15 U.S.C. 80a-17(a). In addition, certain asset-backed issuers could not comply 

with Section 18 of the Act, which generally limits the extent to which registered investment companies may issue 

senior securities, including debt. 15 U.S.C. 80a-18. See Proposing Release, supra note 15 at n.36; Protecting 

Investors Report, supra note 4 at n.253 and accompanying text. 

30 Certain asset-backed issuers alternatively may seek to rely on the exclusion from the definition of 

investment company set forth in Section 3(c)(5)(A), (B) or (C) of the Investment Company Act. 15 U.S.C. 80a3(c)(5). See infra section III.C. The Commission today is issuing a concept release concerning companies that rely 

on Section 3(c)(5)(C). Companies Engaged in the Business of Acquiring Mortgages and Mortgage-Related 

Instruments, Investment Company Act Release No. 29778 (Aug. 31, 2011) (the "Section 3(c)(5)(C) Concept 

Release”). That release may be relevant to certain asset-backed issuers that rely on that Section. See infra section 

III.C.
11 

adopted Rule 3a-7 in 1992 specifically to exclude from the definition of investment company 

certain asset-backed issuers that meet the rule’s conditions.31 These conditions were intended to 

reflect the structural and operational distinctions between registered investment companies and 

asset-backed issuers,

32 and incorporated what we believed to be then-existing practices in the 

asset-backed securities market that addressed investor protection under the Investment Company 

Act and promoted capital formation.33 The conditions also were intended to accommodate future 

developments in the asset-backed securities market, consistent with investor protection.34

III. DISCUSSION

 

A. Revisiting Rule 3a-7 

To rely on Rule 3a-7, an asset-backed issuer must issue fixed-income securities or other 

securities which entitle the holders to receive payments that depend primarily on the cash flow 

 As yet another alternative, asset-backed issuers that privately offer and sell their securities may seek to rely 

on Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act, commonly referred to as the “private 

investment company exclusions.” 15 U.S.C. 80a-3(c)(1); 15 U.S.C. 80a-3(c)(7). Section 3(c)(1) generally excludes 

from the definition of investment company any issuer whose outstanding securities (other than short-term paper) are 

beneficially owned by not more than 100 investors and which is not making and does not presently propose to make 

a public offering of its securities. 15 U.S.C. 80a-3(c)(1). Section 3(c)(7) of the Investment Company Act generally 

excludes from the definition of investment company any issuer whose outstanding securities are owned exclusively 

by persons who, at the time of acquisition of such securities, are certain sophisticated investors, called “qualified 

purchasers,” and which is not making and does not at that time propose to make a public offering of its securities. 15 

U.S.C. 80a-3(c)(7). See Section 2(a)(51) of the Investment Company Act (defining the term qualified purchaser). 

15 U.S.C. 80a-2(a)(51). Section 3(c)(7) may be a particularly useful exclusion for asset-backed issuers that 

privately offer and sell their securities because, unlike Section 3(c)(1), it does not limit the number of investors that 

may hold the issuer’s securities and many investors in asset-backed securities are large institutional investors that 

meet the definition of qualified purchaser under the Act. See, e.g., Kravitt, supra note 15 at 12.03[D].

31 Prior to the adoption of Rule 3a-7, the Commission had issued approximately 125 orders under Section 

6(c), the Investment Company’s Act general exemptive provision, which provided exemptive relief to certain assetbacked issuers, primarily those holding mortgage-related assets. 15 U.S.C. 80a-6(c). See, e.g., Mortgage Bankers 

Financial Corp. I, et al., Investment Company Act Release Nos. 16458 (June 28, 1988), 53 FR 25226 (notice of 

application) and 16497 (July 25, 1988), 41 SEC Docket 814 (order); Shearson Lehman CMO, Inc., Investment 

Company Act Release Nos. 15796 (June 11, 1987), 52 FR 23246 (notice of application) and 15852 (July 2, 1987), 

38 SEC Docket 1403 (order). The Commission has not issued any such orders since Rule 3a-7 was adopted in 1992.

32 For example, an issuer relying on Rule 3a-7 may not issue redeemable securities, because "investors could 

confuse the securities with those issued by open-end management investment companies." Proposing Release, 

supra note 15, at n. 61 and accompanying text. 

33 Adopting Release, supra note 4 at text following n.8.

34 Id.
12 

from eligible assets.35 The rule provides that the issuer’s fixed-income securities generally must 

be rated by at least one NRSRO in one of the four highest ratings categories.36 At the time the 

rule was adopted, the Commission understood that NRSROs, in providing credit ratings for 

fixed-income securities of asset-backed issuers, typically expected the issuers to have certain 

structural safeguards.37 The Commission viewed these safeguards as addressing investor 

protection under the Investment Company Act.38

For example, in providing a credit rating for certain asset-backed securities, the NRSROs, 

among other things, were understood to typically: review the specific assets to be transferred to 

the issuer or the method by which the assets were selected; expect an independent auditor to 

confirm that the asset pool was representative of the sponsor’s portfolio; and evaluate limitations 

placed on the substitution of the issuer’s assets and the reinvestment of the cash flow derived 

from the assets.39

 

35 Rule 3a-7(b)(1) defines eligible assets to be financial assets, either fixed or revolving, that by their terms 

convert into cash within a finite time period plus any rights or other assets designed to assure the servicing or timely 

distribution of proceeds to security holders.

 Such expected review by an NRSRO had the perceived benefit of mitigating 

36 Rule 3a-7(a)(2). When Rule 3a-7 was adopted, almost all publicly offered fixed-income securities issued 

by asset-backed issuers were rated by at least one rating agency, with most issuing at least one class of fixed-income 

securities rated in one of the top two categories. See Protecting Investors Report, supra note 4 at nn. 187-188 and 

accompanying text. Rule 3a-7 contains an exception from the rating requirement that permits non-investment grade 

or unrated fixed-income securities to be sold to institutional accredited investors and any security, without regard to 

type or rating, to be sold to qualified institutional buyers or to persons involved in the organization or operation of 

the issuer and their affiliates, provided that the issuer and its underwriters use reasonable care to ensure that all 

excepted sales and resales are to such persons. See Rule 3a-7(a)(2). The exception reflected then-existing industry 

practice that subordinate tranches of fixed-income asset-backed securities issuances, which typically were not highly 

rated, if rated at all, and residual interests in the issuer, were placed with certain sophisticated investors. Proposing 

Release, supra note 15 at n.77 and accompanying text.

37 Adopting Release, supra note 4, at text following n. 42. As noted above, the recent financial crisis has 

exposed various problems with the ratings process and the NRSROs' procedures and methodologies. See supra note 

14. 

38 Adopting Release, supra note 4. The Commission also explained that the rating requirement also served as 

a means of distinguishing asset-backed issuers from registered investment companies. The Commission, however, 

emphasized that, “although ratings generally reflect evaluations of credit risk, the rating requirement [was] not 

intended to address investment risks associated with the credit quality of a financing.” Adopting Release, supra note 

4 at text following n.41.

39 Protecting Investors Report, supra note 4 at nn. 208-211 and accompanying text, n. 218 and accompanying 

text, and text following n.292 and prior to n.293.
13 

opportunities for self-dealing and overreaching by the sponsor or other insiders of the assetbacked issuer.40 In addition, the NRSROs were understood to analyze the potential performance 

of the issuer’s assets, the risks related to the issuer’s cash flow and the cash flow allocation with 

respect to the payment of the fixed-income securities. Such analysis was viewed as addressing

potential concerns relating to misvaluation of the issuer’s assets and inadequate asset coverage.

41 

The NRSROs also were understood to review whether the asset-backed issuer’s assets would be 

available in the event of the sponsor’s insolvency, and evaluate the processes and controls 

regarding the custody of the issuer’s assets and cash flow. Such review was viewed as 

addressing concerns relating to the safekeeping of the issuer’s assets.

42

Rule 3a-7 also imposes limitations on the acquisition and disposition of the eligible assets 

that were intended to help ensure that any changes in the issuer’s assets would not adversely 

affect the outstanding fixed-income securities holders and guard against self-dealing and 

overreaching by the issuer’s sponsor or servicer.

 

43 The restrictions also were intended to prevent 

activities that resemble the portfolio management practices employed by registered management 

investment companies.44 Under the rule, an issuer generally may acquire additional eligible 

assets or dispose of such assets only if that action complies with the terms and conditions set 

forth in the issuer’s organizational documents.45

 

40 Id. at text following n.292.

 In addition, any acquisition or disposition of 

eligible assets may not result in a downgrading of the rating of the issuer’s fixed-income 

41 Id. at nn.212, 220-221and 293 and accompanying text.

42 Id. at nn.294-295 and accompanying text.

43 See Adopting Release, supra note 4 at n. 66 and accompanying text. 

44 Id. at n.62 and accompanying text. See also infra section III.A.3. For example, Rule 3a-7 does not permit 

the acquisition or disposition of eligible assets for the primary purpose of recognizing gains or losses resulting from 

market changes. Rule 3a-7(a)(3)(iii). 

45 Rule 3a-7(a)(3)(i). 
14 

securities.46 The rule also does not permit the acquisition or disposition of eligible assets for the 

primary purpose of recognizing gains or losses resulting from market changes.47

Finally, the rule includes conditions addressing the safekeeping of the issuer’s eligible 

assets and the cash flow derived from such assets. Among other things, the issuer generally must 

take reasonable steps to cause an independent trustee

 

48 to have a perfected security interest or 

ownership interest valid against any third parties in the eligible assets that principally generate 

the cash flow needed for payment on the fixed-income securities.49 In addition, the cash flow 

derived from the eligible assets that is received by the servicer must be deposited periodically in 

a segregated account that is maintained or controlled by the independent trustee, “consistent with 

the rating of the outstanding fixed-income securities.”50 This reference to the rating reflected 

what the Commission understood to be the practice of NRSROs, in issuing the rating, to review 

the capability of the issuer's servicer to perform its duties, including the risk of loss from the 

servicer holding the cash flow derived from the eligible assets.

51

 

46 Rule 3a-7(a)(3)(ii). The Commission explained that tying the management of the issuer’s eligible assets to 

the rating of the fixed-income securities addressed the danger of self-dealing, because any addition or removal of 

assets that adversely affected the fixed-income securities holders was understood to result in a downgrading of the 

issuer’s outstanding fixed-income securities. See Adopting Release, supra note 4 at n.66 and accompanying text.

47 Rule 3a-7(a)(3)(iii).

48 Rule 3a-7(a)(4)(i) generally requires that the trustee be a bank that meets the requirements of Section 

26(a)(1) of the Investment Company Act and that is not affiliated, as that term is defined in Rule 405 under the 

Securities Act, with the issuer or with any person involved in the organization or operation of the issuer, that does 

not offer or provide credit or credit enhancement to the issuer, and that executes an agreement or instrument 

concerning the issuer's securities containing provisions to the effect set forth in Section 26(a)(3) of the Investment

Company Act, limiting when the trustee may resign. 15 U.S.C. 80a-26(a)(3).

49 Rule 3a-7(a)(4)(ii).

50 Rule 3a-7(a)(4)(iii).

51 See Proposing Release, supra note 15 at n.31. See also Adopting Release, supra note 4 at text following 

n.82; Kravitt, supra note 15 at 7.03[E].
15 

1. Rating Requirements 

As discussed above, Rule 3a-7 contains references to ratings in three of the rule's 

conditions. Specifically, an asset-backed issuer relying on Rule 3a-7 generally must have its 

fixed-income securities rated by at least one NRSRO in one of the four highest ratings 

categories.52 In addition, any acquisition or disposition of eligible assets may not result in a 

downgrading of the rating of the issuer’s fixed-income securities.53 Finally, the cash flow 

derived from the eligible assets that is received by the servicer must be deposited periodically in 

a segregated account that is maintained or controlled by an independent trustee, “consistent with 

the rating of the outstanding fixed-income securities.”54 In each case, the reference to ratings 

was intended to be a type of proxy for the relevant investor protections afforded by the 

Investment Company Act.55 The condition that the fixed-income securities be rated also was 

viewed as a means of distinguishing asset-backed issuers from most registered investment 

companies.56

The Commission is considering eliminating the references to ratings in Rule

 

3a-7. We question whether such references have served, as intended, as a proxy to address 

Investment Company Act-related concerns, and whether it continues to be appropriate for Rule 

3a-7 to make use of ratings in this manner. Accordingly, we ask for comment on the type of 

analysis that rating agencies currently conduct in providing credit ratings for the fixed-income 

securities of asset-backed issuers, and the types of structural safeguards that rating agencies 

expect asset-backed issuers to have, that also address Investment Company Act-related 

 

52 Rule 3a-7(a)(2). 

53 Rule 3a-7(a)(3)(ii). 

54 Rule 3a-7(a)(4)(iii).

55 See supra note 38 and accompanying text.

56 Id.
16 

concerns.

57

● Do ratings today serve as a proxy for addressing Investment Company Act-related

concerns? If so, are there mechanisms in place that help ensure that NRSROs conduct the type 

of analysis and review of asset-backed issuers' structures and operations that serve to address 

Investment Company Act-related concerns? 

 Please provide a full explanation of whether, and if so how, the actions and 

expectations of the rating agencies today mitigate the potential for the types of abuses otherwise 

addressed by the Investment Company Act.

● Did the revelations concerning the NRSROs' processes, policies and 

methodologies arising out of the recent financial crisis also suggest that ratings failed to serve as 

a proxy for addressing Investment Company Act-related concerns? 

● Even if the actions and expectations of the rating agencies with respect to assetbacked issuers today mitigate the potential for Investment Company Act-related concerns, does it 

continue to be appropriate to rely on ratings as a proxy for addressing Investment Company Actrelated concerns in Rule 3a-7? 

● Should some or all of the references to ratings be removed from the rule? Should 

the references to ratings be replaced with other conditions? What would be the economic impact 

of removing the references to ratings in Rule 3a-7 and of any suggested new conditions? 

● Should Rule 3a-7 continue to require that the fixed-income securities be rated 

regardless of whether any other conditions are added to the rule? To the extent that the ratings 

requirements in the rule are perceived to be or are useful as a measure of credit-worthiness, what 

 

57 See supra section III.A.1 (describing the types of review we believed was conducted by the rating agencies 

when the rule was adopted).
17 

substitute standards should the Commission consider adopting in accordance with Section 939A 

of the Dodd-Frank Act?58

We note that, as discussed in greater detail below, various provisions of the Dodd-Frank 

Act and Commission rules thereunder, as well as the 2010 ABS Proposing Release and 2011 

ABS Re-proposal, set forth requirements relating to certain asset-backed issuers and certain 

persons involved in the organization and operation of asset-backed issuers, that may serve to 

address the same Investment Company Act-related concerns as those that underlie the references 

to ratings in Rule 3a-7.

 We ask commenters to fully explain their views.

59 As detailed below, we ask for comment on whether any such 

requirements should be included as conditions to the exclusion from the definition of investment 

company provided by Rule 3a-7.60

We also note that, although Rule 3a-7 generally states that fixed-income securities of an 

asset-backed issuer must be rated by at least one NRSRO in one of the four highest rating 

categories, the text of the rule does not require fixed-income securities of a Rule 3a-7 issuer to be 

rated, provided that the securities are sold and resold only to certain sophisticated investors.

 

61

 

 

We request comment on whether and, if so, to what extent, any issuer has relied on Rule 3a-7 to 

offer fixed-income securities to the sophisticated investors specified in the rule without any 

tranche of the issuer's fixed-income securities being rated in the categories specified in the rule. 

If so, please explain whether these securities were offered publicly or privately. 

 

58 See supra note 7 and accompanying text (Section 939A of the Dodd-Frank Act generally requires the 

Commission to review any references to or requirements regarding credit ratings in its regulations, remove these 

references or requirements and substitute other appropriate standards of credit-worthiness in place of the credit 

ratings). 

59 See infra section III.A.2.d.

60 Id.

61 See supra note 36. 
18 

2. Possible New Conditions for Rule 3a-7

 We ask for comment on the conditions that should be added to Rule 3a-7 to directly 

address investor protection under the Investment Company Act.62

Each of these investor protection issues is discussed in greater detail below. Although 

the Commission has identified these particular issues, the Commission requests and encourages 

commenters to provide both thoughts about the types of investor protection concerns under the 

Investment Company Act presented by asset-backed issuers and suggestions as to the types of 

conditions that should be included in Rule 3a-7 to address these concerns. We also ask for 

comment on the changes in the asset-backed securities market since 1992, whether such changes 

present other issues or concerns under the Investment Company Act that we have not described, 

and how Rule 3a-7 should address them. We ask that commenters fully explain their 

recommendations, including how any suggested conditions would directly address investor 

protection under the Investment Company Act, and well as how such suggestions might affect 

capital formation. We also ask commenters to provide suggested rule text. 

 These investor protection 

issues generally can be characterized as falling into the following areas: (i) concerns about selfdealing by insiders, misvaluation of assets and inadequate asset coverage as they relate to the 

structure and operation of the asset-backed issuer; (ii) the benefits of an independent review of 

the asset-backed issuer's structure and intended operations in addressing these concerns; and (iii) 

preservation and safekeeping of the asset-backed issuer's eligible assets and cash flow.

 

62 We note that this approach was suggested by a commenter that had responded to the Commission’s request 

for comment in the 2008 NRSRO Proposing Release. See comment letter from Shearman & Sterling LLP (on behalf 

of its client Merrill Lynch Depositor Inc.) to Florence E. Harmon, Acting Secretary (Sept. 24, 2008), File Nos. S7-

18-08 and S7-19-08 (“if the Commission feels it necessary that Rule 3a-7 be amended, our client feels that the 

Commission’s proposal that the rating requirement be replaced with alternative specific requirements regarding 

abuses that the Investment Company Act is designed to address, such as self-dealing and overreaching by issuers, 

misvaluation of assets, and inadequate asset coverage, is worth further consideration by the Commission . . .”). 
19 

a. Structure and Operation of the Issuer

In many respects, the Investment Company Act is generally intended to address the 

structural and operational integrity of an issuer in relation to the securities being issued.63 In the 

context of an asset-backed issuer that may use the exclusion provided by Rule 3a-7, the concern 

is with the possibility of abusive practices, such as self-dealing and overreaching by insiders, 

misvaluation of assets, and inadequate asset coverage.64

There are various approaches that the Commission could take to address these types of 

concerns in Rule 3a-7. The rule could impose specific requirements or limitations on the 

structure and operations of an asset-backed issuer relying on the rule in order to prevent these

potential types of abuses from occurring. For example, the rule could specify the particular 

manner in which the issuer's assets should be selected and valued to avoid potential "dumping" 

of assets and misvaluation. The rule also could specify the particular manner in which the 

issuer's depositor and sponsor may structure the issuer to help guard against self-dealing and 

overreaching by these insiders. The rule further could prohibit any person involved in the 

 For example, the asset-backed issuer's 

sponsor, among other things, might potentially engage in intentional misvaluation of assets or in 

a form of “dumping” by transferring assets insufficient to produce the cash flow needed to meet 

the issuer’s obligations to its securities holders, contrary to representations made to investors. In 

addition, once the securities are issued, any person involved in the operation of the issuer 

potentially might engage in activities that could adversely affect payment of the outstanding 

fixed-income securities. Such activities might include, for example, substituting assets in the 

pool after the time of securitization with lower quality assets, investing the issuer’s cash flow in 

a speculative manner, or other activities that present potential conflicts of interest. 

 

63 See e.g., supra notes 19-24 and accompanying text. 

64 See Proposing Release, supra note 15, at nn. 69 and 70 and accompanying text.
20 

operation of the issuer from engaging in specific activities that may adversely affect payment of 

the fixed-income securities consistent with their terms. 

 Alternatively, the rule could take a principles-based approach that would be less 

prescriptive. For example, among other things, the rule could require that the parameters of the 

issuer’s organization and operations be set forth in its organizational documents, with the goal 

of mitigating potential opportunities for self-dealing and overreaching on the part of the issuer 

and any person involved in the organization or operation of the issuer. To this end, the rule 

could require that the issuer’s organizational documents set forth: (i) the specific roles and 

responsibilities of any person involved in the organization or operation of the issuer; (ii) the 

specific terms and conditions pursuant to which the issuer may acquire or dispose of eligible 

assets; and (iii) policies and procedures that are reasonably designed to prevent insiders from 

engaging in activities that may adversely affect payment of the fixed-income securities after the 

securities are sold. We understand that the current industry practice of publicly-offered assetbacked issuers is to set forth the parameters of the issuer’s organization and operations in the 

issuer’s organizational documents,65 with varying degrees of specificity.66

 The Commission requests comment on the types of conditions that may be appropriate 

for Rule 3a-7 to provide structural and operational safeguards for asset-backed issuers that seek 

to rely on the rule.

 

 

65 An issuer's organizational documents must be filed as exhibits to the registration statement. See Item 60 of 

Regulation S-K [17 CFR 229.60]. 

66 We note, for example, that Regulation AB generally requires asset-backed issuers to describe much of this 

information in their registration statements, although perhaps not with the same degree of specificity that could be 

required under this approach. See, e.g., Item 1104(d) (requiring a description of the sponsor’s material roles and 

responsibilities in its securitization program); Item 1107(b) (requiring a description of the permissible activities of 

the issuer); Item 1108(a)(1) (requiring a description of the roles, responsibilities and oversight requirements of the 

servicers involved in a transaction) [17 CFR 229.1104(d), 1107(b), 1108(a)(1)]. In addition, as discussed 

previously, under current Rule 3a-7, an issuer generally may acquire additional eligible assets or dispose of such 

assets only if that action complies with the terms and conditions set forth in the issuer’s organizational documents . 

See supra note 45 and accompanying text.
21 

● Is one of the possible approaches discussed above more consistent with investor 

protection than, or otherwise preferable to, the other? If so, which one and why? What would be 

the impact of such an approach on capital formation? 

● What would be the potential economic impact of the approaches discussed above? 

● If the rule were to impose specific requirements or limitations on the structure and 

operations of an asset-backed issuer relying on the rule, what should those requirements or 

limitations be, and what would be the likely benefits and costs of such requirements or 

limitations? 

● Should the rule require an issuer's organizational documents to set forth the types 

of information suggested above? How would such a requirement change current practice? 

● Rule 3a-7(a)(3)(i) currently provides that an issuer generally may acquire 

additional eligible assets or dispose of eligible assets only in accordance with the specific terms 

and conditions of the issuer’s organizational documents. Should that condition be expanded to 

cover the initial transfer of eligible assets to the issuer at the time of securitization, in order to 

mitigate opportunities for dumping and other potential abuses by insiders that exist both at the 

time of the initial transfer of the assets to the issuer and over the course of the operation of the 

issuer? If the condition were so expanded, would it help mitigate such potential abuses? 

● Are there other approaches that the Commission should consider that would 

adequately address Investment Company Act-related concerns such as self-dealing and 

overreaching, misvaluation, and inadequate asset coverage?67

 

67 One approach to addressing these concerns might be to include a condition in Rule 3a-7 that provides for 

an independent third party review of the issuer's structure and intended operations. We discuss such a condition in 

the next section. See infra section III.A.2.b.

 If so, what types of approaches,

why and with what economic impact? We ask commenters to fully explain their views and, if 

appropriate, provide rule text and supporting data. 
22 

● Are there other Investment Company Act-related concerns that Rule 3a-7 should 

address besides self-dealing, misvaluation and inadequate asset coverage? If so, what are those 

concerns and how should the rule address them? For example, one of the Investment Company 

Act-related concerns is the pyramiding of investment companies.68 Should Rule 3a-7 address 

this concern?69

b. Independent Review

 If so, why and how should the rule address it? Should the rule restrict the ability 

of an issuer relying on the rule to invest in other asset-backed issuers? If so, what restrictions 

should the rule impose? 

The concept of independent oversight or independent review is fundamental to the 

regulatory framework of the Investment Company Act.70 Registered investment companies 

typically rely for their structure and operations on third parties that have their own financial 

interests separate and distinct from those of the investment companies and their shareholders, 

presenting potential conflicts of interest that require independent oversight. The independent 

oversight in the case of registered management investment companies is provided by the 

company's board of directors, and in particular the independent board members, as required by 

the Act.71

 

68 See Section 1(b)(4) of the Investment Company Act. Cf. Fund of Funds Investments, Investment Company 

Act Release No. 26198 (Oct. 1, 2003) ("The complex structures that resulted from pyramiding created additional 

problems for shareholders. These structures permitted acquiring funds to circumvent investment restrictions and 

limitations, and made it impossible for shareholders to understand who really controlled the fund or the true value of 

their investments.”). 

69 We note, for example, that the Financial Crisis Inquiry Commission found that investments by issuers of 

collateralized debt obligations ("CDOs) in other CDOs magnified total leverage and increased exposure to loss. 

Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report (Jan. 2011) at 132-134, 155. See also

The Report of the Counterparty Risk Management Policy Group III, Containing Systemic Risk: The Road to Reform 

(Aug. 6, 2008) at 55 (discussing CDOs that invested in other CDOs).

70 See generally Section 1(b) of the Investment Company Act.

71 See Section 10 of the Investment Company Act governing the composition of a registered investment 

company's board of directors. 
23 

Asset-backed issuers are similar to registered investment companies in that they also 

typically rely for their structure and operations on third parties that have their own financial 

interests separate and distinct from those of the asset-backed issuers and their fixed-income 

securities holders.72

We note that, in the 2011 ABS Re-proposal, we proposed replacing the investment grade 

ratings criterion for shelf eligibility for asset-backed securities offerings with a requirement that 

 We are considering whether to replace the rating condition currently 

contained in Rule 3a-7, in part, with a condition that would provide for an independent review of 

the asset-backed issuer and its intended operations prior to the sale of the fixed-income 

securities. Such a condition could require the asset-backed issuer to obtain an opinion from an 

independent evaluator that the independent evaluator reasonably believes, based on information 

available at the time the fixed-income securities are first sold and taking into account the 

characteristics of the securitized assets underlying the offering, that the asset-backed issuer is

structured and would be operated in a manner such that the expected cash flow generated from 

the underlying assets, would likely allow the asset-backed issuer to have the cash flow at times 

and in amounts sufficient to service expected payments on the fixed-income securities. Such an 

opinion would not serve as a guarantee that the securitization will produce such cash flow. 

Alternatively, the rule could require the issuer itself to provide a similar certification in its 

offering documents, but to do so only after considering the views of an independent evaluator 

that has reviewed the structure and the intended operations of the issuer. For purposes of such a 

condition, potentially any independent person, including an NRSRO, that has the expertise and 

experience in the structuring or evaluating of asset-backed issuers and their securities, could 

serve as the independent evaluator. 

 

72 See supra note 25 and accompanying text.
24 

a certification be provided by either the chief executive officer of the depositor or the executive 

officer in charge of securitization of the depositor.73 As we stated in the 2011 ABS Re-proposal, 

such a certification may cause these officials to review more carefully the disclosure and the 

transaction, and to participate more extensively in the oversight of the transaction. In the 2011 

ABS Re-proposal, we also requested comment on whether an asset-backed issuer should have 

the flexibility to engage an independent evaluator to perform the review necessary to give the 

certification, and the type of opinion that the independent evaluator would provide.74

If Rule 3a-7 were to be amended to include a condition requiring independent review, 

the amendment would be premised on the need to address concerns arising under the Investment 

Company Act about self-dealing and overreaching by insiders.75 Thus, the purpose of the 

independent review under Rule 3a-7 would be different from that which might be performed in 

connection with the certification requirement proposed in the 2011 ABS Re-proposal. 

Nevertheless, the scope of the review under any independent review provisions in the shelf 

eligibility conditions and those in Rule 3a-7 could be consistent so that one review could satisfy 

both purposes.76

We request comment on whether Rule 3a-7 should require an independent review of the 

structure and intended operations of the asset-backed issuer.

● Would such a review serve to address Investment Company Act-related concerns? 

 

73 As proposed, such certification would state, among other things, that based on the officer's knowledge, 

“taking into account the characteristics of the securitized assets underlying the offering, the structure of the 

securitization, including internal credit enhancements, and any other material features of the transaction, in each 

instance, as described in the prospectus, the securitization is designed to produce, but is not guaranteed by this 

certification to produce, cash flows at times and in amounts sufficient to service expected payments on the assetbacked securities offered and sold pursuant to the registration statement.” See 2011ABS Re-proposal, supra note 13

at proposed Item 601(b)(36) of Regulation AB.

74 See 2011 ABS Re-proposal, supra note 13 at text following n. 58. 

75 As discussed above, within the framework of the Investment Company Act, these concerns are addressed 

through independent review. See supra note 70 and accompanying text. 

76 See also infra section III.A.2.d.
25 

● What should be the scope of the independent review under Rule 3a-7? What 

should be the standard(s) for the conclusion(s) reached by the independent evaluator for purposes 

of Rule 3a-7? 

● What should be the independence requirements for an entity to serve as an 

independent evaluator for purposes of Rule 3a-7? We note that the 2011 ABS Re-proposal 

requests comment on certain potential independence requirements for an independent evaluator, 

such as prohibitions on affiliation with the issuer or any person involved in the organization or 

operation of the issuer, on ownership of the issuer's securities or underlying assets, and on certain 

material business relationships.

77

● The 2011 ABS Re-proposal also requests comment on whether it would be 

appropriate to define an independent evaluator as a person that has the expertise and experience 

in the structuring or evaluating of asset-backed securities. Would this be an appropriate 

definition of an independent evaluator for purposes of Rule 3a-7? 

 Would similar requirements be appropriate in the context of

Rule 3a-7? 

• Should we impose any additional or different requirements on an independent 

evaluator? For example, should consideration be given to whether the independent evaluator is 

subject to federal regulation or how the independent evaluator is regulated? 

• What steps should the asset-backed issuer be required to take to determine 

whether a prospective independent evaluator meets the qualifications to serve as an independent 

evaluator under Rule 3a-7? Should the asset-backed issuer be able to rely on a statement of the

prospective independent evaluator, for example, that the prospective independent evaluator has 

 

77 2011 ABS Re-proposal, supra note 13 at nn.60-61and accompanying text.
26 

the required expertise and experience? Should the asset-backed issuer perform some level of due 

diligence?

● What types of entities may likely serve as independent evaluators under 

Rule 3a-7? We are interested in particular in hearing from commenters that may meet the 

possible independent evaluator qualifications discussed above whether they might be interested 

in serving as independent evaluators if such a condition were to be included in Rule 3a-7, and if 

not, why not. 

● Should rating agencies be allowed to serve as independent evaluators under Rule 

3a-7? Why or why not? 

● If an independent evaluator condition were to be included in Rule 3a-7, should the 

rule also require the asset-backed issuer to include the independent evaluator’s opinion as an 

exhibit to its registration statement thereby requiring the independent evaluator to consent to 

being named as an “expert” in the registration statement and being subject to potential liability 

under Section 11 of the Securities Act? 

● What would be the economic impact of including an independent evaluator 

condition in Rule 3a-7 and what would be the factors affecting the economic impact? Would the 

economic impact depend on whether the independent evaluator is subject to expert liability? If 

so, how? How may the risk of expert liability affect the willingness of an entity to serve as an 

independent evaluator and the price it may charge for its services? 

● Is the alternative that the asset-backed issuer itself must provide a certification 

about its structure and intended operations, but only after considering the views of an 

independent evaluator, preferable? Why or why not? 
27 

● If Rule 3a-7 were to include an independent evaluator condition, would there be 

circumstances in which compliance with such condition may not be necessary for investor 

protection? For example, should such a condition not apply with respect to an asset-backed 

issuer that offers and sells its securities solely to investors that meet certain objective standards, 

such as being “qualified institutional buyers” within the meaning of Rule 144A under the Securities 

Act? If such a condition should not apply to certain asset-backed issuers, should such issuers be 

required to disclose in their offering documents that they are not complying with the independent 

evaluator condition and explain why? Should such issuers be subject to other, alternative conditions 

under Rule 3a-7 that would address Investment Company Act- related concerns, including selfdealing and overreaching by insiders? 

● Are there other considerations that should factor into the Commission’s 

determinations on the appropriateness and the details of an independent review in the context of 

Rule 3a-7? We ask commenters to fully explain their views and provide supporting data, if 

appropriate. 

 c. Preservation and Safekeeping of Eligible Assets and Cash Flow 

Like registered investment companies, asset-backed issuers are pools of financial assets 

that are subject to the risk of misappropriation. In addition, unless the asset-backed issuer is 

structured appropriately, its assets and cash flow might not be insulated in the event of the 

sponsor’s or depositor's bankruptcy or insolvency. The issuer’s assets and cash flow also might

be endangered if the servicer or trustee commingles them with its own assets. The availability of 

the issuer’s cash flow to the fixed-income securities holders also could be endangered if the cash 

flow is invested in a speculative manner. 

Rule 3a-7 contains several conditions designed to address the safekeeping of the issuer’s 

eligible assets and the cash flow derived from such assets. Under the rule, the issuer must take 
28 

reasonable steps to cause an independent trustee to have a perfected security interest or 

ownership valid against third parties in the eligible assets.

78 The rule also provides for the cash 

flow from such assets to be deposited periodically in a segregated account maintained or 

controlled by the independent trustee “consistent with the rating of the outstanding securities.”79 

In addition, the rule’s condition that the issuer’s fixed-income securities generally receive a 

rating in one of the four highest rating categories also touches on concerns relating to the 

safekeeping of the issuer’s assets and cash flow. For example, we understand that asset-backed 

securities often could not achieve an investment grade rating unless the issuer was structured in 

such a manner that the assets and cash flow are insulated in the event of the sponsor’s or 

depositor’s bankruptcy or insolvency.80

We ask for comment on whether Rule 3a-7 should be amended to strengthen the 

provisions relating to the preservation and safekeeping of the asset-backed issuer's assets and 

cash flow. For example, the current rule does not limit the practice of servicers commingling the 

cash flow of asset-backed issuers with their own assets for periods of time prior to transferring it 

to the trustee.

 

81

 

78 Rule 3a-7(a)(4)(ii).

 We ask for comment on whether such practice may be unnecessarily putting the 

cash flow at risk. The current rule also does not address the treatment of the cash flow when 

there is a timing mismatch between the receipt of collections from the eligible assets and the 

79 Rule 3a-7(a)(4)(iii).

80 See, e.g., Proposing Release, supra note 15 at n.33 and accompanying text.

81 Current Rule 3a-7(a)(4) differs significantly from the condition that was initially proposed. The 

Commission proposed that the cash flow derived from the eligible assets be transferred to the trustee within a 

reasonable period from the time of receipt. See Proposing Release, supra note 15 at nn.90-92 and accompanying 

text. The Commission explained that the proposed provision was intended to prohibit a servicer from commingling 

the cash flow with its own assets, arguing that “investor protection concerns outweigh any benefit resulting from the 

commingling of a servicer’s assets with those of the issuer.” Id. at text following n.92. Commenters argued that 

transferring the cash flow “within a reasonable period of time” was inconsistent with industry practice and that 

whether a servicer commingled the cash flow with its own assets, and if so, for how long, depended on the type of 

assets being securitized and the capabilities of the servicer’s computer systems to track the cash flow. See Adopting 

Release, supra note 4 at n.77 and accompanying text. 
29 

distributions to the fixed-income securities holders. Are there other aspects of the rule we should 

consider amending in order to help preserve and protect the asset-backed issuer's assets and cash 

flow? If so, please provide specific suggestions for such amendments, including, where possible, 

suggested rule text. 

We also note the irregularities that had recently surfaced that have caused difficulties in 

determining the ownership of certain mortgages that had been securitized.82 As discussed, under 

Rule 3a-7, the issuer must take reasonable steps to cause an independent trustee to have a 

perfected security interest or ownership valid against third parties in the eligible assets.83

 We invite commenters to provide us with information about current practices with 

respect to the safekeeping of eligible assets under Rule 3a-7. 

 We ask 

for comment on whether and how this requirement in Rule 3a-7 should be strengthened in light 

of these events. 

● Does the current rule contain safeguards that adequately protect the eligible 

assets?

● Should stronger safeguards be adopted with respect to these assets? If so, what 

should these safeguards be? 

We also invite commenters to provide us with information about current practices under 

Rule 3a-7 with respect to the management of the cash flow that is derived from an asset-backed 

issuer’s eligible assets.

 

82 See, e.g., November Oversight Report -- Examining the Consequences of Mortgage Irregularities for 

Financial Stability and Foreclosure Mitigation, Congressional Oversight Panel 19 (Nov. 16, 2010) ("Various 

commentators have begun to ask whether the poor recordkeeping and error-filled work exhibited in foreclosure 

proceedings, described above, is likely to have marked earlier stages of the process as well. If so, the effect could be 

that rights were not properly transferred during the securitization process such that title to the mortgage and the note 

might rest with another party in the process other than the trust.") 

83 Rule 3a-7(a)(4)(ii).
30 

● How long do servicers typically hold the cash flow prior to transferring the cash 

flow to the trustee? What are the benefits, if any, to servicers from holding the cash flow? What 

are the benefits and risks to asset-backed issuers from servicers holding the cash flow? 

● We note that the rule does not specify that the servicer must keep the cash flow in 

a segregated account prior to transferring the cash flow to the trustee. Should such a condition 

be included in the rule and what would be its economic impact if included? Is the answer 

dependent on the time period that the servicer has, under the asset-backed issuer's organizational 

documents or otherwise, in which to transfer the cash flow to the trustee? 

● Should the rule be amended to prescribe a time period in which the servicer must 

transfer the cash flow to the trustee and what would be the economic impact of such a provision? 

If so, what should that time period be? Commenters suggesting specific time periods should 

address the costs and benefits associated with their suggestions. 

● Regulation AB requires that servicers provide an annual assessment of 

compliance with servicing criteria enumerated in Item 1121(d) of Regulation AB, so that 

investors may identify those aspects of standard servicing criteria that are in material compliance 

in order to better evaluate servicing responsibilities and performance and reliability of the 

information they receive.84 In particular, servicers must assess compliance with the servicing 

criterion that payments on pool assets are deposited into the appropriate custodial bank accounts 

and related bank clearing accounts within no more than two business days of receipt, or such 

other number of days as specified in the transaction agreements.85

 

84 17 CFR 229.1122(d).

 Consistent with this

provision, should the time period set forth in Rule 3a-7 be no more than two business days of 

85 See Item 1122(d)(2)(i) of Regulation AB [17 CFR 229.1122(d)(2)(i)].
31 

receipt? Why or why not? What would be the effect if the time period were greater than or less 

than two business days? 

We are also interested in obtaining information about how the cash flow is invested under 

Rule 3a-7 and who receives the returns from such an investment. 

● Should the rule contain a condition that restricts the manner in which the cash 

flow may be invested? If so, what should this condition provide? 

● Should the rule limit who may receive the benefit of the returns of such 

investment? Why or why not? What economic benefits and costs would be associated with such 

a limitation? 

As discussed previously, we understand that asset-backed securities often could not 

achieve an investment grade rating unless the issuer was structured in such a manner that the 

assets and cash flow are insulated in the event of the bankruptcy or insolvency of the sponsor or 

depositor.86

● Does our understanding hold true? 

● Should the rule include a condition specifying that the eligible assets and the cash 

flow generated from such assets be available to pay the fixed-income securities consistent with 

their terms, notwithstanding the bankruptcy or insolvency of the sponsor or depositor? 

● Should any such condition also extend to the bankruptcy of the servicer? Does 

the answer depend on whether the servicer needs to hold the eligible assets for servicing 

purposes and is not required to transfer the cash flow to the independent trustee immediately 

upon receipt? What would be the potential economic impact of so extending the condition? 

 

86 See supra note 80. 
32 

The Commission also requests comment on any other concerns relating to the 

safekeeping of the issuer’s assets and cash flow that we have not contemplated under Rule 3a-7. 

● If there are such concerns, what are they and how should the rule address them? 

● Does the asset-backed market generally impose safeguards that are intended to 

ensure the safety of the issuer’s eligible assets and cash flow? Should the rule reflect these 

safeguards? If so, what are the safeguards, how should they be reflected, and what would be the 

economic impact of reflecting them in the rule? 

 d. Other Possible Investor Protections

The exclusion from the definition of investment company provided by Rule 3a-7 is one of 

many regulations under the federal securities laws addressing asset-backed issuers. Assetbacked issuers also are subject to various regulations under the Securities Act and the Exchange 

Act. We recognize that there may be existing or proposed provisions under these other federal 

securities laws applicable to asset-backed issuers which, although intended for different 

purposes, also may help mitigate potential Investment Company Act-related concerns. Such 

provisions could be considered for inclusion in Rule 3a-7 in lieu of the rating condition.87

 

87 We note that not all asset-backed issuers that rely on Rule 3a-7 are subject to the same provisions under the 

federal securities laws. For example, asset-backed issuers that rely on Rule 3a-7 may include those issuers that offer 

and sell their securities under an exemption from registration under the Securities Act or that are not subject to the 

Exchange Act reporting requirements. Therefore, if we determine that certain existing or proposed provisions 

under the federal securities laws help mitigate potential Investment Company Act-related concerns, such provisions 

may need to be included as conditions in Rule 3a-7 to ensure that all asset-backed issuers relying on the rule are 

subject to the same conditions, regardless of their status under the other federal securities laws.
33 

 i. Other Commission Rules

 

For example, Rule 193 under the Securities Act generally requires an asset-backed issuer 

to perform a review of the assets underlying any asset-backed securities that will be registered 

under the Securities Act that, at a minimum, provides reasonable assurance that the disclosure in 

the issuer's prospectus regarding the assets is accurate in all material respects.

88 Section 945 of 

the Dodd-Frank Act directed the Commission to enact Rule 193 so that due diligence was "reintroduced" into the offering process.89

Similarly, as part of the 2011 ABS Re-proposal, we proposed to include, as part of the 

shelf eligibility requirements for asset-backed issuers, a requirement that the issuer’s underlying 

transaction agreements provide for a "credit risk manager" to review the underlying assets in 

specified circumstances.

 This provision, if included in Rule 3a-7, might help 

mitigate some of the concerns underlying the Investment Company Act, such as the "dumping" 

of assets and the potential opportunities for overreaching and self-dealing.

90

As another example, we note that the Dodd-Frank Act added Section 27B to the 

Securities Act generally to prohibit an underwriter, placement agent, initial purchaser, sponsor, 

or any affiliate or subsidiary of any such entity, of an asset-backed security, as defined in the 

Exchange Act, from engaging in any transaction that would involve or result in any material 

 That proposal addresses concerns about enforceability of 

representations and warranties regarding the assets, but such a requirement also might serve to 

mitigate potential Investment Company Act abuses relating to misvaluation of assets and 

inadequate asset coverage for asset-backed securities and therefore could be considered for 

inclusion in Rule 3a-7. 

 

88 17 CFR 230.193.

89 See Section 943 Release, supra note 9. 

90 See 2011 ABS Re-proposal, supra note 13 at section II.B.1.b.
34 

conflict of interest with respect to any investor in a transaction arising out of such activity for a 

period of one year after the date of the first closing of the sale of the asset-backed security.91 

This provision “prohibits firms from packaging and selling asset-backed securities to their clients 

and then engaging in transactions that create conflicts of interest between them and their 

clients.”92

Yet another example of requirements under the federal securities laws concerning certain 

asset-backed issuers that may be considered for inclusion in Rule 3a-7 are the risk retention 

requirements for sponsors of asset-backed issuers, such as the requirements recently proposed by 

the Commission in a joint rulemaking with other federal regulators.

 To the extent that this provision also may help guard against certain of the Investment 

Company Act-related concerns, such as the potential for self-dealing and overreaching by 

insiders, it could be considered for incorporation into Rule 3a-7. 

93

We ask for comment on whether these or any other existing or proposed provisions under 

other federal securities laws applicable to asset-backed issuers also may help mitigate potential 

Investment Company Act-related concerns and could serve, in whole or in part, as substitutes for 

the references to ratings in Rule 3a-7. Commenters should be specific in identifying the relevant 

 These requirements may 

be appropriate as conditions for issuers that wish to rely on Rule 3a-7, if they serve to mitigate 

the Investment Company Act-related concerns about self-dealing by insiders, misvaluation of 

assets, and the safekeeping of assets and cash flow. 

 

91 Section 621 of Dodd-Frank Act. The Dodd-Frank Act also directed the Commission to issue rules for the 

purpose of implementing this provision, and the prohibition described above takes effect only upon the effective 

date of such rules. Id.

92 Letter from Senators Jeffrey Merkley and Carl Levin to Commission Chairman Mary Schapiro, et al. (Aug. 

3, 2010) (“Merkley-Levin Letter”) at p. 1, available at http://www.sec.gov/comments/df-title-vi/conflicts-ofinterest/conflictsofinterest-2.pdf . 

93 Credit Risk Retention, Securities Exchange Act Release No. 64148 (Mar. 30, 2011) [76 FR 24090 (Apr. 29, 

2011)].
35 

provision and the Investment Company Act-related concern, and explaining how the provision 

may help mitigate the Investment Company Act-related concern. 

 ii. Eligibility to Use Rule 3a-7 

Currently, any issuer generally may rely on Rule 3a-7 provided that it is in the business 

of purchasing or otherwise acquiring and holding "eligible assets," issues securities which entitle 

their holders to receive payments that depend primarily on the cash flow from the eligible assets, 

and meets the other conditions of the rule. When the Commission adopted Rule 3a-7, the 

Commission stated that the definition of "eligible assets" in Rule 3a-7 -- in part, "financial assets, 

either fixed or revolving, that by their terms convert into cash within a finite time period" -- was 

based on the definition of "asset-backed security" under the Securities Act.94

 

94 See Adopting Release, supra note

 We understand that 

asset-backed commercial paper programs that issue securities in reliance on an exemption from 

registration under the Securities Act, and other asset-backed issuers that offer and sell their 

securities in reliance on an exemption from registration under the Securities Act, often rely on 

Rule 3a-7 to be excluded from regulation under the Investment Company Act. Conversely, an 

asset-backed issuer that cannot meet the conditions of Rule 3a-7 (and is unable to qualify for any 

other exclusion from regulation under the Investment Company Act, such as Section 3(c)(5), or 

4 at n.12 and accompanying text. Regulation AB generally defines 

"asset-backed security" as "a security that is primarily serviced by the cash flows of a discrete pool of receivables or 

other financial assets, either fixed or revolving, that by their terms convert into cash within a finite time period, plus 

any rights or other assets designed to assure the servicing or timely distributions of proceeds to the security holders; 

provided that in the case of financial assets that are leases, those assets may convert to cash partially by the cash 

proceeds from the disposition of the physical property underlying such leases." See Item 1101(c)(1) of Regulation 

AB. Regulation AB considers certain types of master-trusts and issuers with prefunding periods and revolving 

accounts to be discrete pools of assets. See Item 1101(c)(3) of Regulation AB. In the 2010 April ABS Proposal, the 

Commission proposed to restrict the use of Regulation AB by master trust issuers backed by non-revolving assets, 

limit the number of years for revolving periods of non-revolving accounts from three years to one year, and decrease 

the limit on the amount of prefunding permitted by the prefunding exception from 50% to 10%. See 2010 ABS 

Proposing Release, supra note 10 at section IV. The definition of "asset-backed security" in Regulation AB also 

contains limits on the amounts of delinquent and non-performing assets in the asset pool. See Item 1101(c)(2). The 

shelf eligibility requirements on Form S-3 further limits the amount of delinquent assets and certain leases that may 

be held in the asset pool. See Form S-3.
36 

register under the Act) generally may not register the issuance of its securities even if the issuer 

and its securities meet the other offering requirements under the Securities Act. 

● We request comment on whether the requirements of Regulation AB or the shelf 

eligibility requirements may serve, in whole or in part, to address the Investment Company Act 

concerns underlying Rule 3a-7 and therefore be a basis for meeting some or all of the rule's 

conditions, including the rating condition and any conditions that may replace it. Should the 

conditions of Rule 3a-7 distinguish between issuers that meet the shelf eligibility requirements 

and those that do not? If so, why and how should the conditions differ? We ask commenters to 

be specific in their responses and to provide data and statistics, if possible. 

● Would certain asset-backed issuers that currently are able to publicly offer their 

securities no longer be able to do so if Rule 3a-7 were limited to issuers that meet the shelf 

eligibility requirements? If so, please explain. With respect to such issuers, commenters also 

should address any alternative exclusion(s) from regulation under the Investment Company Act 

that may be available, and the advantages and disadvantages of the issuers' using these 

exclusions if Rule 3a-7 were not available to them. We ask commenters to provide data in 

support of their responses, if possible. 

● Is our understanding correct that some asset-backed issuers that privately offer 

their securities rely on Rule 3a-7? If so, would certain of these issuers no longer be able to rely 

on Rule 3a-7 if the rule was limited in this manner? If not, why not? We also ask commenters to 

provide similar information and data about asset-backed issuers that rely on the private 

investment company exclusions from regulation under the Investment Company Act, and any 

alternative exclusion(s) from regulation under the Investment Company Act that may be 

available, and the advantages and disadvantages of the issuers' using these exclusions if 
37 

Rule 3a-7 were not available to them. The Commission also requests that commenters provide 

any available data about the sizes and types of asset-backed issuers that privately offer their 

securities that rely on Rule 3a-7. 

● What would be the effect on the asset-backed securities market in general, on 

capital formation, and on investors if the availability of Rule 3a-7 were limited to issuers of 

asset-backed securities as defined in Regulation AB or included the further limitations found in 

the shelf eligibility requirements? 

● Are there alternative approaches that the Commission should consider to an 

issuer's eligibility to use Rule 3a-7 that would address Investment Company Act-related 

concerns? Commenters that offer alternative approaches should be as specific as possible in 

explaining their approach and the effect such an approach would have on asset-backed issuers, 

on the asset-backed securities market in general, on capital formation, and on investors.

3. Standard for Acquisition and Disposition of Eligible Assets

With respect to the type and amount of activity related to the acquisition and disposition 

of an issuer’s eligible assets that may take place under Rule 3a-7, the Commission has stated that 

Rule 3a-7 was intended to permit only those activities “that do not in any sense parallel typical 

‘management’ of registered investment company portfolios.”95 Thus, according to the Adopting 

Release, permitted activities under the rule include selling or substituting eligible assets when 

documentation is defective or for nonconformity with representations or warranties, disposing of 

assets in default or in imminent default, and removing excess credit support.96

 

95 See supra note 

 We request 

comment on the management activities of asset-backed issuers under Rule 3a-7. 

44 and accompanying text.

96 See Adopting Release, supra note 4 at n.68 and accompanying text. 
38 

● What changes, if any, should be made to the rule's conditions addressing the 

acquisition and disposition of eligible assets? What would be the economic impact of any such 

changes?

● Does the current rule adequately preclude activities “that do not in any sense 

parallel typical ‘management’ of registered investment company portfolios"? If not, should 

additional conditions be added to the rule that would limit the acquisition and disposition of the 

issuer’s eligible assets, and if so, what types of conditions? What would be the economic impact 

of such conditions?

B. The Effect of the Exclusion Provided by Rule 3a-7 

Current Rule 3a-7 excludes from the definition of investment company any issuer that 

meets the rule's conditions. The rule does not address how a holder of securities of a Rule 3a-7 

issuer should treat those securities for purposes of determining the holder's own status under the 

Investment Company Act. In light of certain developments in the asset-backed securities 

markets in recent years, detailed below, we request comment whether we should consider 

limiting or clarifying the manner in which the exclusion provided by Rule 3a-7 may be used by 

certain holders of securities issued by Rule 3a-7 issuers. 

 1. Holders of an Asset-Backed Issuer’s Securities 

As a general matter, the status of an issuer under the Investment Company Act matters 

not only to the issuer itself, but also to the holders of the issuer's securities. A holder's own 

status under the Investment Company Act may depend on the investment company status of the 

issuers of securities that it owns.97

 

97 For example, the holder may be an investment company under Section 3(a)(1)(C) of the Investment 

Company if it owns or proposes to acquire investment securities, which generally include, among others, securities 

issued by an investment company, having a value exceeding 40% of the value of the holder's total assets (exclusive 

of Government securities and cash items) on an unconsolidated basis. See supra note 

 When the Commission adopted Rule 3a-7, the Commission 

30. 
39 

focused on providing an exclusion from regulation under the Act for the asset-backed issuer, and 

not on the manner in which such an exclusion may affect a holder of the asset-backed issuer's 

securities. 

We are interested in better understanding the manner in which the exclusion provided by 

Rule 3a-7 affects the status under the Investment Company Act of various types of holders of 

securities issued by Rule 3a-7 issuers. For example, in the last decade, many asset-backed 

issuers that relied on Rule 3a-7 were established by companies that sought to capture, by holding 

the equity or residual interest in these issuers, the spread between the yield of the assets being 

securitized and the financing cost of the fixed-income securities being issued.98 The potential for 

returns on such investments led to companies being established whose business focused on 

purchasing equity and residual interests in collateralized loan obligations (“CLOs”) and CDOs of 

issuers that relied on Rule 3a-7.99 The activities of some of these companies suggest that they 

are in the business of investing in securities.100

 

98 More generally, in 2007, for example, only approximately 11.5% of CDOs issued globally were issued to 

remove assets from the balance sheet of the originator. The rest of the CDO market consisted of arbitrage CDOs, 

which are CDOs that attempt to capture the difference between the yield of its assets and the financing costs of the 

CDO tranches. See, e.g., Securities Industry and Financial Markets Association: Research at http:// 

archives1.sifma.org/story.asp?id=2375 (“SIFMA”).

 However, because current Rule 3a-7 excludes 

issuers relying on the rule from the definition of investment company, such companies that 

99 See, e.g., Jody Shenn, Bear Stearns Funds Own 67 Percent Stake in Everquest (Update3), BLOOMBERG, 

May 11, 2007, http://www.bloomberg.com/apps/news?pid=newsarchive&sid= (describing various investment 

vehicles formed to invest in residual interests of CDOs). 

100 In contrast, when Rule 3a-7 was adopted, most private sector sponsors of asset-backed issuers typically 

securitized financial assets that they themselves had originated to facilitate the financing and operation of their noninvestment company businesses. For example, some sponsors securitized their financial assets in order to manage 

more effectively their loan portfolios and, in turn, their balance sheets. In addition, securitization allowed sponsors 

to gain access to alternative, usually cheaper, funding sources. Commercial banks and savings and loan associations 

also securitized financial assets to facilitate compliance with regulatory capital requirements. As the Commission 

noted when adopting Rule 3a-7, the purpose and operation of asset-backed issuers therefore were fundamentally 

different from investment companies. See Proposing Release, supra note 15 at n.18 and accompanying text; 

Protecting Investors Report, supra note 4 at nn.49-62 and accompanying text.
40 

invest in Rule 3a-7 issuers may not meet the definition of investment company in the Investment 

Company Act. 

Specifically, under the Investment Company Act, any company that holds 50% or more 

of the outstanding voting securities of an issuer may treat such issuer as its majority-owned 

subsidiary.101 Securities of majority-owned subsidiaries that are not investment companies, in 

turn, are not “investment securities”102 for purposes of determining whether the parent meets the 

definition of investment company in Section 3(a)(1)(C) of the Act. Since a Rule 3a-7 issuer is 

not an investment company by virtue of the exclusion provided by the rule,103 any company that 

holds 50% or more of the outstanding voting securities of a Rule 3a-7 issuer may treat the Rule 

3a-7 issuer as its majority-owned subsidiary and is not required to treat any of the securities 

issued by the Rule 3a-7 issuer as “investment securities” for purposes of determining the 

company’s own status under Section 3(a)(1)(C) of the Investment Company Act. Such a 

company therefore may have virtually all of its assets invested in securities of Rule 3a-7 

majority-owned subsidiaries and not meet the definition of investment company under Section 

3(a)(1)(C).104

 

101 Section 2(a)(24) of the Investment Company Act states that a “majority-owned subsidiary” of a person 

“means a company 50 per centum or more of the outstanding voting securities of which are owned by such person, 

or by a company which, within the meaning of this paragraph, is a majority-owned subsidiary of such person.” 

Section 2(a)(42) of the Act defines “voting security,” in relevant part, to mean “any security presently entitling the 

owner or holder thereof to vote for the election of directors of a company.” 

102 See supra note 18. 

103 See Rule 3a-7(a) (“Notwithstanding section 3(a) of the Act, any issuer who is engaged in the business of 

purchasing, or otherwise acquiring, and holding eligible assets (and in activities related or incidental thereto), and 

who does not issue redeemable securities will not be deemed to be an investment company . . .”).

104 We note that, depending on the facts and circumstances, some of these companies may meet the definition 

of investment company in Section 3(a)(1)(A). See supra note 18. Companies that meet the definition of investment 

company in Section 3(a)(1)(A) are subject to the requirements of the Investment Company Act unless they meet an 

exclusion or an exemption, even if they do not meet the other definitions of investment company in Section 3(a)(1).

We also note that the idea of a company being in the business of investing in securities, even though the 

securities the company holds are those of its non-investment company majority-owned subsidiaries, is not novel. 

We have concluded, for example, that a company may be a “special situation investment company” that should be 

regulated under the Investment Company Act, even though the company holds securities of its majority-owned 
41 

 If the exclusion provided by Rule 3a-7 specified that an issuer relying on Rule 3a-7 

would be deemed an investment company for the limited purpose of the definition of 

“investment securities” in Section 3(a)(2)(C)(i) of the Investment Company Act, any company 

that holds 50% or more of the outstanding voting securities of a Rule 3a-7 issuer would be 

required to treat such securities, as well as any other securities of that Rule 3a-7 issuer, as 

“investment securities” for purposes of determining its own status under Section 3(a)(1)(C) of 

the Investment Company Act.105

 The Commission requests comment on the extent to which various types of holders of 

securities of Rule 3a-7 issuers use the exclusion to determine their own status under the 

Investment Company Act. 

 With respect to certain types of holders of securities issued by 

Rule 3a-7 issuers, such as companies discussed above whose business focused on establishing 

Rule 3a-7 subsidiaries to capture the spread between the yield of the assets being securitized and 

the financing cost of the fixed-income securities being issued, and which may be engaged in the 

business of investing in securities, such an approach may serve to more accurately reflect their 

status under Section 3(a)(1)(C) of the Investment Company Act and afford their investors the 

appropriate protections. 

● What would be the potential economic impact if the exclusion from the definition 

of investment company provided by Rule 3a-7 were modified so that it did not extend to the 

definition of "investment securities" in Section 3(c)(1)(C)(i)? 

 subsidiaries that are not investment securities. See Certain Prima Facie Investment Companies, Investment 

Company Act Release No. 10937 (Nov. 13, 1979) [44 FR 66608 (Nov. 20, 1979)] at nn.18-20 and accompanying 

text. A special situation investment company generally is a company that secures control of other companies

primarily for the purpose of making a profit in the sale of the controlled companies’ securities. Id.

105 See supra note 18. Under this approach, securities of a majority-owned subsidiary relying on Rule 3a-7 

would be treated in the same manner as securities of a majority-owned subsidiary that is an investment company or 

that relies on Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act. See supra notes 18, 30. 
42 

● Would such a modification adversely affect those sponsors that form Rule 3a-7 

issuers to facilitate the operation of their non-investment company business? Are such sponsors 

typically invested in their Rule 3a-7 majority-owned subsidiaries to such an extent that this

approach would cause a sponsor to have more than 40% of its assets in investment securities and 

therefore fall within the definition of investment company in Section 3(a)(1)(C)?106

● Rule 3a-7 alternatively could be recast such that a Rule 3a-7 issuer would be an 

investment company but would be exempted from the Act’s requirements, provided that the 

issuer meets the rule’s conditions. Under this approach, because the asset-backed issuer would 

not be excluded from the definition of investment company, but exempted from the Investment 

Company Act, a holder of the issuer’s securities would be required to treat such securities as 

"investment securities" for purposes of determining the holder's own status under the Act, as 

under the approach discussed above. Is this approach preferable? If so, why? 

● Are there reasons not to modify the exclusion provided by Rule 3a-7 to address 

this issue? Please explain and, if possible, provide data in support of your responses. 

2. Eligible Portfolio Company 

The Commission also has become aware of an interest among business development 

companies ("BDCs") to sponsor and invest in securities of issuers relying on Rule 3a-7. 

 

106 Sponsors that are banks, bank holding companies, broker-dealers, savings and loans and insurance 

companies are excluded from the definition of the Investment Company Act by Section 3(c) of the Investment 

Company Act and would be unaffected by a provision narrowing the effect of the exclusion provided by Rule 3a-7. 

In addition, other sponsors could conclude, based on an appropriate analysis of their primary business, that they are

not investment companies pursuant to Section 3(b)(1) of the Investment Company Act or seek a Commission order 

under Section 3(b)(2) of that Act. Section 3(b)(1) of the Investment Company Act generally excludes an issuer from 

the definition of investment company in Section 3(a)(1)(C) of the Act if it is primarily engaged, directly or through 

wholly-owned subsidiaries, in a business other than investing, reinvesting, owning, holding or trading securities. 

Section 3(b)(2) of the Investment Company Act generally excludes from the definition of investment company in

Section 3(a)(1)(C) of the Act any issuer which the Commission, upon application by the issuer, finds and by order 

declares to be primarily engaged in a business other than that of investing, reinvesting, owning, holding, or trading 

in securities either directly or through majority-owned subsidiaries or through controlled companies conducting 

similar type of businesses.
43 

Congress established BDCs in 1980 as a type of closed-end investment company the primary 

purpose of which was to make capital more readily available to small, developing and financially 

troubled businesses.107 To accomplish this purpose, Congress added a special set of provisions 

to the Investment Company Act that govern closed-end investment companies that elect BDC 

status.108 In amending the Investment Company Act, Congress underscored that the new 

provisions would apply only to BDCs that are operated for the purpose of investing in the 

securities of certain issuers and that make available significant managerial assistance to those 

issuers.109 Accordingly, the Investment Company Act generally prohibits a BDC from making 

any investment unless, at the time of the investment, at least 70% of the BDC's total assets (other 

than certain specified non-investment assets) are invested in securities of certain specified issuers 

(“70% basket”).110 The 70% basket includes, among other things, certain securities of “eligible

portfolio companies,” as defined by the Act.111 Among other criteria, issuers qualifying as 

eligible portfolio companies must be organized under the laws of, and have their principal place 

of business in, the United States,112

 

107 Small Business Investment Incentive Act of 1980, Pub. L. No. 96-477, 94 Stat. 2275 (1980) (codified at 

scattered sections of the United States Code)(“SBIIA”). 

 and must not meet the definition of investment company in 

108 See Sections 54-65 of the Investment Company Act. 

109 See H.R. Rep. No. 1341, 96th Cong., 2d Sess. 22 (1980) (“BDC House Report”).

110 Section 55(a) of the Investment Company Act. See BDC House Report, supra note 109 at 23 (“The 

restrictions are designed to assure that companies electing special treatment as [BDCs] are in fact those that [the 

SBIIA] is intended to aid – companies providing capital and assistance to small, developing or financially troubled 

businesses that are seeking to expand, not passive investors in large, well-established businesses.”). BDCs may 

invest in certain other assets that would not count toward the 70% basket, provided that such investments are 

consistent with the overall purpose behind the BDC provisions of the Investment Company Act. Id. at 39-40.

111 Section 2(a)(46) of the Investment Company Act. 

112 Section 2(a)(46)(A) of the Investment Company Act.
44 

Section 3 of the Investment Company Act or be excluded from the definition of investment 

company under Section 3(c) of that Act.113

By virtue of the exclusion from the definition of investment company provided by Rule 

3a-7, a BDC might seek to treat a Rule 3a-7 issuer as an eligible portfolio company, provided 

that certain other criteria are met.

 

114

● What would be the effect on BDCs if Rule 3a-7 were amended to expressly 

provide that an issuer relying on Rule 3a-7 is not an eligible portfolio company? 

 As a general matter, the Commission presently does not 

believe that Rule 3a-7 issuers are the type of small, developing and financially troubled 

businesses in which Congress intended BDCs primarily to invest. Accordingly, the Commission 

requests comment on whether Rule 3a-7 should be amended to provide expressly that an issuer 

relying on Rule 3a-7 is an investment company for purposes of the definition of eligible portfolio 

company under the Investment Company Act. 

● What would be the effect on Rule 3a-7 issuers if Rule 3a-7 were amended to 

expressly provide that an issuer relying on Rule 3a-7 is not an eligible portfolio company? 

● We understand that BDCs that invest in Rule 3a-7 issuers typically do not treat 

such issuers as eligible portfolio companies. Is our understanding correct? If not, please explain. 

 C. Asset-Backed Issuers Relying on Section 3(c)(5)

As noted above, certain asset-backed issuers rely on the exclusion from the definition of 

investment company in Section 3(c)(5) of the Investment Company Act rather than on Rule 3a-

 

113 Section 2(a)(46)(B) of the Investment Company Act. Section 2(a)(46)(B) also includes as an eligible 

portfolio company a small BDC which is licensed by the Small Business Administration and which is a whollyowned subsidiary of a BDC. In addition to meeting the requirements set forth in Sections 2(a)(46)(A) and 

2(a)(46)(B), a company qualifying for eligible portfolio company status must also meet one of the criteria set forth 

in Section 2(a)(46)(C) or in Rule 2a-46 under the Investment Company Act.

114 See Section 55(a) of the Investment Company Act.
45 

7.115 Section 3(c)(5) was intended to exclude from the definition of investment company certain 

factoring, discounting and mortgage companies,116 and did not specifically contemplate assetbacked issuers, which generally did not exist at the time Congress adopted the Investment 

Company Act in 1940.117 Nevertheless, certain asset-backed issuers, including those that 

securitize retail automobile installment contracts, credit card receivables, trade receivables, boat 

loans or equipment leases, have sought to rely on the provisions of Section 3(c)(5).118 In 

addition, many issuers of mortgage-backed securities have sought to rely on Section 3(c)(5). 

These asset-backed issuers include issuers of securities backed by whole residential mortgage 

loans and home equity loans (two of the most commonly securitized assets),119 whole 

commercial mortgages, participated mortgage interests, and “whole pool certificates”120

 

115 See supra note 

 issued 

or guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae.

30 discussing the 3(c)(5)(C) Concept Release. Section 3(c)(5) excludes from the definition 

of investment company “[a]ny person who is not engaged in the business of issuing redeemable securities, faceamount certificates of the installment type or periodic payment plan certificates, and who is primarily engaged 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 sales 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.”

116 S. Rep. No. 1775, 76th Cong. 3d. 13 (1940); H.R. Rep. No. 2639, 76th Cong., 3d Sess. 12(1940); S. Rep. 

No. 184, 91st Cong., 1st Sess. 37 (1969); H.R. Rep. No. 1382, 91st Cong., 2d Sess. 17 (1970). See Proposing Release, 

supra note 15 at text following n.5 (“section 3(c)(5)] . . . originally was intended to exclude issuers engaged in the 

commercial finance and mortgage banking industries.”). See also Section 3(c)(5)(C) Concept Release, supra note 

30. 

117 See Kravitt, supra note 15 at 12.03[G][4] (“The exceptions stated in Section 3(c)(5) predate by many years 

the securitization industry. The ‘original intent’ of the drafters of Section 3(c)(5) could not possibly have 

anticipated financial products such as collateralized mortgage obligations and receivables-backed securities. As 

with many of the Section 3 exceptions, issuers that do not, or arguably do not, fall within the original intent of the 

provisions have attempted to rely on the . . . exception.”) 

118 See Kravitt, supra note 15 at 12.03[G]; Protecting Investors Report, supra note 4 at n.261 and 

accompanying text. Note, however, that an asset-backed issuer that securitizes these types of assets may be unable 

to rely on these exclusions if the issuer's structure allows for the holding of cash or similar instruments in such 

amounts that the issuer may not be “primarily engaged” in holding the asset being securitized. See Kravitt, supra

note 15 at 12.03[G]. 

119 See Kravitt, supra note 15 at 12.03[G].

120 A whole pool certificate is a security that represents the entire ownership interest in a particular pool of 

mortgage loans. See Protecting Investors Report, supra note 4 at n.267. 
46 

Unlike the exclusion provided by Rule 3a-7, the exclusion provided by Section 3(c)(5) is 

not subject to any conditions specifically addressing the Investment Company Act-related 

concerns presented by asset-backed issuers.121 Whether an asset-backed issuer has the option of 

relying on Section 3(c)(5) as an alternative to Rule 3a-7 generally depends on whether the issuer 

is primarily engaged in purchasing or otherwise acquiring a particular type of financial assets.

122

When first considering Rule 3a-7 in 1992, the Commission noted that, absent a statutory 

amendment precluding asset-backed issuers from relying on Section 3(c)(5), asset-backed issuers 

that rely on that section and those that rely on Rule 3a-7 would be subject to somewhat disparate 

treatment based solely on the type of the financial assets that they held. Accordingly, when the 

Commission proposed Rule 3a-7 in 1992, it also requested comment on, among other things, 

whether it should seek statutory amendments to Section 3(c)(5) that would preclude asset-backed 

issuers from continuing to rely on the Section.

Rule 3a-7, in contrast, was generally designed to encompass any asset-backed issuer that meets 

the rule’s conditions, regardless of the type of financial assets that it holds. 

123 Most commenters then argued that it would be 

inappropriate to narrow the scope of Section 3(c)(5), at least until both the market and the 

Commission gained experience with Rule 3a-7.124 In response to commenters’ concerns, the 

Commission decided not to pursue any regulatory changes with respect to Section 3(c)(5) at that 

time.125

Now that the market and the Commission have gained almost twenty years of experience 

with Rule 3a-7, we believe that it is appropriate to revisit this issue as part of our review of the 

 

 

121 See supra section III.A. See also supra note 115. 

122 See supra note 115. 

123 Proposing Release, supra note 15 at section II.B. 

124 Adopting Release, supra note 4 at n.88 and accompanying text.

125 Id. at text following n.89.
47 

rule. We also believe that revisiting the ability of asset-backed issuers to rely on the exclusion 

provided by Section 3(c)(5) is appropriate in the aftermath of the recent financial crisis and the 

role that issuers of mortgage-backed securities have played in that crisis.126 Accordingly, the 

Commission once again is seeking comment on whether Section 3(c)(5) should be amended to 

limit the ability of asset-backed issuers to rely on Section 3(c)(5).127

● If there are such structural or operational reasons, what are they? 

 The Commission also 

requests comment on whether it should engage in any rulemaking, consistent with Section 

3(c)(5), that would define terms used in that section so as to limit its availability to those 

companies that are intended to be encompassed by the statutory exclusion. We also seek 

comment on whether are there any structural or operational reasons that make it necessary for 

certain asset-backed issuers to rely on Section 3(c)(5) rather than Rule 3a-7. 

● What types of asset-backed issuers rely on Section 3(c)(5)? 

● What would be the effect on asset-backed issuers, the securitization market and 

on capital formation if asset-backed issuers could no longer rely on Section 3(c)(5)? 

● Are there revisions to Rule 3a-7 that could be made to better facilitate assetbacked issuers' reliance on the rule rather than on Section 3(c)(5) and what would be the 

economic impact of such revisions? 

Commenters also are requested to provide any other observations, suggestions and data 

on the interplay between Rule 3a-7 and Section 3(c)(5) today and as the asset-backed securities 

markets may develop in the future. 

 

126 See generally 2010 ABS Proposing Release, supra note 10. 

127 See also Section 3(c)(5)(C) Concept Release, supra note 30; 2011 ABS Re-proposal, supra note 13 at n.110 

and accompanying text (requesting comment on whether compliance with Rule 3a-7 should be one of the shelf 

eligibility requirements). 
48 

IV. General Request for Comment 

In addition to the issues raised in this release, the Commission requests and encourages 

all interested persons to submit their views on any issues relating to the treatment of asset-backed 

issuers under the Investment Company Act. This release is not intended in any way to limit the 

scope of comments, views, issues or approaches to be considered. The Commission particularly 

welcomes statistical, empirical, and other data from commenters that may support their views 

and/or support or refute the views or issues raised in this release.

By the Commission.

 Elizabeth M. Murphy 

 Secretary 

August 31, 2011