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Delaware Trusts Gain Favor With SEC Ruling
Asset Backed Alert, Harrison Scott Publications Inc. (November 22, 2002)

The SEC is no longer requiring audited financial statements for a commonly used type of securitization vehicle.

The agency recently informed the Bond Market Association that it would stop telling sponsors of so-called Delaware business trusts to draft the statements when they sell asset-backed securities. While the SEC never had a formal rule requiring audited financial statements for the trusts, it maintained that generally accepted accounting principals called for their inclusion with offering documents. What's more, its enforcement of the practice was sporadic - leaving market players confused about what they should consider official policy.

The shift is good news for issuers, many of whom feared that the SEC might ban them from using the issuing vehicles because they weren't performing the audits. It also translates into lower costs for issuers that had been conducting the reviews on a regular basis. The statements were intended to disclose issuing vehicles' assets and liabilities before they purchased new receivables or sold new bonds.

Delaware business trusts are commonly employed for securitizations of auto loans and leases, credit-card receivables, equipment loans and leases, student loans and aircraft leases, as well as some residential-mortgage issues.

Issuers complained that the audited financial statements had little or no value, and caused needless hassles and expenses. They argued that any relevant information was already contained in the prospectuses, including the nature of the underlying assets, their servicing, past and expected performance, cashflow structures and residuals.

Edward Fine, a partner at the law firm of Sidley Austin in New York, said he hadn't heard of cases where ABS investors actually asked for the information that was included in the audits. In fact, some buysiders complained that the statements contained information that could be misleading.

The SEC's decision is especially helpful to companies that want to securitize their auto leases through registered offerings, since the "titling trusts" involved in those transactions were often too cumbersome to document in the audits. Issuers found it particularly difficult to peg the titling trusts' values, since they accounted for leases that weren't included in the securitizations and therefore had no impact on the deals.

Auto-lease issues were among the types of transactions for which the SEC always demanded audited financial statements.

Volkswagen Credit was among the first to take advantage of the new policy when it sold $1.5 billion of SEC-registered bonds on Nov. 7.

Next up for companies that securitize auto leases: convincing the SEC to allow the use of shelf entities for the deals. Stuart Litwin, a partner at Mayer Brown in Chicago who represented Volkswagen in its transaction, said the SEC hasn't been allowing those issuers to file shelf registrations because the values of the underlying automobiles at the ends of lease terms are too hard to peg.

In the meantime, others are expected to follow Volkswagen's lead. When Ford Motor cancelled an auto-lease securitization in 2000, for example, the rumor was that it based its decision on the SEC's demands for audited financial statements.

Certain market players prefer Delaware business trusts because they offer tax advantages for issuers and investors while ensuring bankruptcy-remote status and facilitating ownership of issuing entities by more than one party. In many cases, they are favorable to the two other most-commonly used securitization vehicles: common-law trusts and real estate mortgage investment conduits, or Remics. The SEC doesn't require audited financial statements for transactions conducted through either of those entities.

As for the Delaware business trusts, the SEC changed its policy in response to a letter that the Bond Market Association sent a year ago. Late last month, the association informed its membership that the SEC's division of corporate finance had made a verbal agreement to stop sending "comment letters" asking issuers to perform the audits. It has also stopped demanding that issuers submit separate confirmation that their accountants had performed the audits.

The SEC won't hand down a written ruling until next year, at which point it will also enact a broader set of securitization-specific rules that participants in the asset-backed market have been lobbying for over the past few years. "It is the first step in recognition that asset-backed issuers are different from corporate bond issuers, and need to be regulated as such," said Nadine Cancell, the Bond Market Association's assistant general counsel.



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