structured finance industry group (sfig) market …...on august 27, 2014, the sec adopted final...

STRUCTURED FINANCE INDUSTRY GROUP (SFIG)

MARKET GUIDE TO QUESTIONS REGARDINGIMPLEMENTATION OF SEC DUE DILIGENCE RULES REGARDING

NATIONAL RECOGNIZED STATISTICAL RATING ORGANIZATIONS

June 12, 2015

The market guide is intended for SFIG members only.

TABLE OF CONTENTS

Page

i SFIG NRSRO Market Guide

I. Introduction........................................................................................................................ 1

II. New Diligence Rules ......................................................................................................... 1

III. Application of New Diligence Rules to Non-U.S. Transactions ....................................... 2

IV. Form 15G: Required for Initial Ratings Actions Only ...................................................... 4

V. Form 15E: Required for All Due Diligence Performed throughout the Life of theExchange Act ABS (Initial and Subsequent Ratings Actions) .......................................... 6

VI. Application of the New Diligence Rules to Special Service Providers ............................. 7

VII. Application of the New Diligence Rules to ABCP Conduits .......................................... 10

VIII. Application of the New Diligence Rules to certain Asset Classes .................................. 11

IX. Interim Reports ................................................................................................................ 11

X. Disclosure of Loan Level Data ........................................................................................ 11

XI. Compliance Dates ............................................................................................................ 11

Appendix A Application of New Diligence Rules to CMBS Transactions............................... A-1

Appendix B Application of New Diligence Rules to RMBS Transactions ............................... B-1

Appendix C Application of New Diligence Rules to CLO Transactions .................................. C-1

1 SFIG NRSRO Market Guide

I. Introduction

This market guide is limited to issues relating to the scope and basic terms of the NewDiligence Rules (as defined below) and is not intended to address all implementation issues,particularly those where the facts and circumstances surrounding a particular transaction orsecurity may bear on the issue. This market guide should not prevent SFIG members fromdeveloping their own interpretations of the New Diligence Rules or approaching regulators forclarification or guidance in the New Diligence Rules. The views set forth in this market guide donot constitute legal advice and do not necessarily reflect the views of the authors but insteadreflect industry views and consensus positions on the questions presented based on variousresources and numerous group discussions, including discussions with groups specializing inasset-backed transactions of certain asset classes. All of the views set forth in this market guideare subject to change as market practices develop and/or if additional guidance from theSecurities and Exchange Commission (the “SEC”) and its staff becomes available.

This market guide is intended for SFIG members only.

II. New Diligence Rules

Section 932(a)(8) of the Dodd-Frank Wall Street Reform and Consumer Protection Act(the “Dodd-Frank”) amended Section 15E of the Securities Exchange Act of 1934 (as amended,the “Exchange Act”) to add requirements to disclose due diligence services for rated ABS,regardless of whether the securities are offered in publicly registered or exempted transactions(“Exchange Act ABS”).1 The amendments require the issuer or underwriter of any ExchangeAct ABS to make the findings of any third-party due diligence report publicly available. Suchfindings must be made available regardless of what entity pays a nationally recognized statisticalrating organization (“NRSRO”) for its credit rating and regardless of whether any NRSRO usesthe third-party due diligence report in determining its credit rating. If any third-party duediligence provider is employed by an NRSRO, issuer or underwriter, such third-party duediligence provider must provide a written certificate in the form prescribed by Section15E(s)(4)(C) to any NRSRO that produces a rating to which the third-party due diligenceprovider’s services related. The amendments also require the SEC to establish the appropriateform and content for such written certifications and require NRSROs, at the time at which itproduces a credit rating, to disclose the certification to the public “in a manner that allows thepublic to determine the adequacy and level of diligence services provided by a third-party.”

On August 27, 2014, the SEC adopted final rules to implement its mandate under DoddFrank.2 The rules adopt (i) amendments to existing rules and new rules that apply to NRSROs,(ii) new rules and forms for providers of third-party due diligence services and (iii) amendmentsto existing rules and new rules that require issuers and underwriters of asset-backed securities to

1 See Pub. L. No. 111-203, 932(a)(8), 124 Stat. 1376, H.R. 4173 (July 21, 2010).2 See http://www.sec.gov/rules/final/2014/34-72936.pdf (the “Adopting Release”).


make publicly available the findings and conclusions of third-party due diligence providers(collectively, the “New Diligence Rules”). The New Diligence Rules are intended to improvethe quality and transparency of credit ratings and increase the accountability of NRSROs thatprovide such ratings. While the New Diligence Rules set forth many requirements for NRSROs,certain new requirements will have a direct impact on asset-backed transactions. Specifically,Section 15E(s)(4) of, and Rule 15Ga-2 and Rule 17g-10 under, the Exchange Act relate to thedisclosure of third-party due diligence findings and reports in Exchange Act ABS transactions,which may include certain agreed upon procedure letters (“AUP”) and certain Rule 193 reviews.Both rules will become effective on June 15, 2015.3

III. Application of New Diligence Rules to Non-U.S. Transactions

Securitizers located outside the United States are affected by the New Diligence Rules.Paragraph (e) of Rule 15Ga-2, however, exempts non-U.S. transactions if:

(i) the offering is not required to be, and is not, registered under the Securities Act of1933 (the “Securities Act”);

(ii) the issuer of the rated security is not a U.S. person (as defined under SecuritiesAct Rule 902(k)); and

(iii) the security issued by the issuer will be offered and sold upon issuance, and thatany underwriter or arranger linked to the security will effect transactions of thesecurity after issuance, only in transactions that occur outside the United States(emphasis added).

Market participants have reached a consensus that the “after issuance” language in thethird requirement should generally apply only to transactions in which a securities firm continuesto act as an underwriter or arranger in respect of a distribution of securities (such as in the case ofan unsold allotment), not to ordinary course secondary market transactions by that entity after theinitial distribution is completed, on the following grounds:

a) By its terms, the requirement applies to transactions in the securities, both upon and afterissuance, by an underwriter or arranger. The Adopting Release states that an“underwriter” is “the entity that underwrites the offering of asset-backed securities andsells them to investors,”4 and an “arranger” is “an entity that organizes and arranges asecuritization transaction, but does not sell or transfer the assets to the issuing entity. Italso structures the transaction and may act as an underwriter for the deal.”5 A securitiesfirm that has served in one of these capacities in connection with a securities offeringceases to be an underwriter or arranger once the initial distribution is completed.

b) Nothing in the third requirement would prevent the securities from entering the U.S.

3 17 CFR Parts 232, 240, 249, et al., September 15, 2014. See Part XI of this market guide for details regardingcompliance dates.4 Release 34-72936, footnote 27.5 Id.


market in compliance with applicable laws (for example, once any applicable distributioncompliance period has expired, or pursuant to an available exemption from theregistration requirements of the Securities Act). Therefore, a more stringentinterpretation extending the third requirement to secondary market sales by an entity thatformerly served as an underwriter or arranger (perhaps in the distant past) would serve asan unwarranted penalty on that entity. It is difficult to envision what policy purposeswould be advanced by such interpretation.

c) According to the Adopting Release, this exemption is intended to be consistent with thesimilar exemption adopted under Rule 17g-7, and “the disclosure requirement [of thatrule] should not apply to rating actions involving credit ratings of obligors or issuerswhose securities or money market instruments will be offered or sold in transactions thatoccur exclusively outside the United States”. Regulation S transactions are deemed tohave occurred outside the United States. Market participants question whether extendingthe application of Section 15E(s)(4)(A) of the Exchange Act (which creates the obligationimplemented by the New Diligence Rules) to transactions that, by virtue of their fullcompliance with Regulation S, are deemed to have occurred outside the United Stateswould be consistent with the principles announced by the Supreme Court in Morrison v.Bank of Australia.6 It would be an odd result if transactions that for purposes of theSecurities Act are deemed to occur outside the United States could be retrospectivelycharacterized as within the reach of the Exchange Act, solely because of conduct engagedin (potentially many years later) by a securities firm that at one point in the past was theunderwriter or arranger in the securitization transaction.

d) The exemptions from Rules 17g-7 and 15Ga-2 are both derived from the SEC’s order fora temporary conditional exemption from the requirements of Rule 17g-5,7 which requiresan NRSRO to have a reasonable basis to conclude that any issuer, sponsor or underwriter(each referred to in the Exemptive Order as an “arranger”) linked to the security willeffect transactions in the security after issuance, only in transactions that occur outsidethe United States. Market participants acknowledge the SEC’s statement (quoted in theAdopting Release) that in determining the application of Rule 17g-5, an NRSRO shoulddiscuss with arrangers “how they intend to engage in any secondary market activities.”8

However, despite this language, market practices subsequent to the adoption of thetemporary conditional exemption have not imposed any additional restrictions on thesecondary market activities of arrangers, other than those required by Regulation S.Market participants do not believe that more stringent market practices are required here,for the reasons described above.

Market participants believe that any party that would otherwise be required to furnish aForm 15G pursuant to paragraph (a) of Rule 15Ga-2 is entitled to rely on an assumption thatunderwriters and arrangers in a Regulation S transaction will comply with the selling restrictions

6 561 U.S. 247 (2010) (holding that extraterritorial application of the Exchange Act (under which, weobserve, Rule 15Ga-2 was adopted) is limited to instances where Congress clearly indicates that such application isintended.)7 SEC Rel. No. 34-62120 (hereafter, the “Exemptive Order”).8 See Adopting Release, footnote 1108.


customarily imposed in those offerings, and that compliance with such restrictions suffices tomeet the third requirement of paragraph (e) of Rule 15Ga-2, unless the assumption issubsequently shown to have been unreasonable (for instance, because of a history of theunderwriter or arranger of failure to comply with similar restrictions, if other facts orcircumstances make such reliance unreasonable, or in the case of transactions that, although intechnical compliance with the requirements of the exemption, are designed for the purpose ofevading compliance with the New Diligence Rules).9

IV. Form 15G: Required for Initial Ratings Actions Only

Section 15E(s)(4)(A) requires the issuer10 or underwriter of any Exchange Act ABS thatis to be rated by an NRSRO to make publicly available the findings and conclusions of any third-party diligence report obtained by it in connection with a securitization. Rule 15Ga-2, whichimplements Section 15E(s)(4)(A), requires the issuer or underwriter of any such Exchange ActABS to furnish Form ABS-15G (“Form 15G”) on the SEC’s EDGAR System at least fivebusiness days prior to the first sale of the Exchange Act ABS. A Form 15G is only required tobe furnished for third-party due diligence services performed prior to any initial ratings actionsand is not required for any subsequent ratings actions that may occur throughout the life of theExchange Act ABS.11

A. Issuer expected to be primary furnisher of Form 15G

Although either the issuer or underwriter of an Exchange Act ABS transaction can satisfyRule 15Ga-2 by furnishing a Form 15G to the SEC, many issuers expressed a desire to controlthe content and timing of a Form 15G. Accordingly, issuers, rather than underwriters, areexpected to undertake the obligation to furnish Form 15G with the SEC. Even if theunderwriters or loan sellers directly engage third-parties to conduct due diligence services, it isexpected that the issuer would furnish the related Form 15G since underwriters and loan sellershistorically have not made filings for Exchange Act ABS transactions. It is expected that varioustransaction documents, including memorandums of understanding, loan seller indemnificationagreements, underwriting agreements and note purchase agreements will contain the parties’understandings with respect to the division of these responsibilities.

B. Must include the “findings and conclusions” of Due Diligence Services

Rule 15Ga-2 requires that issuers or underwriters disclose the third-party due diligenceprovider’s findings and conclusions. The Adopting Release was explicit that a summary of thosefindings and conclusions was insufficient to satisfy the disclosure obligation under DoddFrank.12 Because of this requirement, many issuers intend to attach the entire diligence report to

9 Cf. Preliminary Note 2 to Regulation S (“Regulation S is not available with respect to any transaction orseries of transactions that, although in technical compliance with these rules, is part of a plan or scheme to evade theregistration provisions of the Act.”)10 Per Rule 17g-10(d)(2), the term “issuer” in the New Diligence Rules includes a sponsor or depositor, in each caseas defined in Item 1101 of Regulation AB, that participates in the issuance of an asset backed security.11 See Adopting Release pg. 273, which clearly states that once the information has been disclosed in connectionwith an initial credit rating, it does not need to be furnished again in connection with any subsequent rating actionsissued by any NRSRO.12 See Adopting Release pg. 374-375.


the Form 15G although there is no explicit obligation to do so in the New Diligence Rules.Many third-party service providers are comfortable with this approach and will craft their reportswith full expectations that they will be made publicly available.13

C. No Requirement to Name Third-Party Provider

While the findings and conclusions of the due diligence performed need to be disclosedon Form 15G, there is no requirement in Rule 15Ga-2 to name the third-party provider of the duediligence services. However, since due diligence providers will be named in the disclosures theNRSROs are required to make under Rule 17g-7 when issuing ratings, investors will be able toidentify the provider by cross-referencing the Form 15G with the NRSRO disclosure.Nonetheless, it is expected that many third-party providers will negotiate whether they can benamed in the Form 15G in connection with their initial engagement for services.

Even if the third-party provider is named in the Form 15G, so long as the Form 15G isnot explicitly incorporated by reference into a registration statement or prospectus, the third-party would avoid being deemed an “expert” under the Securities Act.14 From the AdoptingRelease, it is clear that the SEC does not intend for all third-party diligence providers to consentto being named an expert solely because an issuer or underwriter furnishes Form 15G to theSEC.15 Therefore, the New Diligence Rules should not change the current analysis of whether athird-party due diligence provider needs to be named in the offering document. For example,many accounting firms currently conduct due diligence services in connection with the issuer’sreview required under Rule 193. Unless the findings of the review are being attributed to thethird-party provider, Rule 193 would not require disclosure of the name of the third-partyconducting the diligence services.16 Similarly, the New Diligence Rules do not require naming athird-party diligence provider in either the offering document or Form 15G.

Further, the New Diligence Rules do not require that the related offering documentreference a Form 15G that has been furnished. In other rules, including Rule 15Ga-1, the SEChas expressly required that the relevant filing be referenced in the prospectus.17 Absent anexplicit disclosure requirement, issuers should assess the materiality of the information containedin a Form 15G to determine if the Form 15G or the findings and conclusions of the related duediligence services should be referenced in the offering document.18 Certain issuers may chooseto disclose, without referring to the name of the third-party provider or incorporating the Form

13 For example, the AICPA issued an interpretation of the professional conduct rules governing accountants thatwould permit AUPs to be furnished to the SEC in accordance with the New Diligence Rules. Seehttp://www.aicpa.org/Research/Standards/AuditAttest/DownloadableDocuments/AT_9201_1.pdf.14 See Rule 436 under the Securities Act regarding expert liability.15 See footnote 1458 of Adopting Release.16 See 17 CFR 230.193. Rule 193, as a disclosure rule, may require disclosure about the nature and findings of thedue diligence performed.17 See Rule 15Ga-2.18 Issuers will asses this in light of potential liability under Rule 10b-5 under the Exchange Act (it shall be unlawful .. . “to make any untrue statement of a material fact or to omit to state a material fact necessary in order to make thestatements made, in the light of the circumstances under which they were made, not misleading”) and Section 12under the Securities Act (where liability attaches generally in connection with a prospectus or other communication“which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make thestatements, in the light of the circumstances under which they were made, not misleading”).


15G, the existence of the Form 15G in the available information section of the offeringdocument. Because this decision hinges on materiality and preference, it is expected thatwhether the Form 15G is referenced in an offering document will vary by asset class and issuer.

V. Form 15E: Required for All Due Diligence Performed throughout the Life of theExchange Act ABS (Initial and Subsequent Ratings Actions)

Section 15E(s)(4)(B) of the Exchange Act requires that, in any case in which third partydue diligence services are employed by an NRSRO, an issuer or an underwriter, the third-partydue diligence provider must provide, to any NRSRO that produces a rating to which suchservices relate, a certificate in accordance with rules promulgated by the SEC. Rule 17g-10prescribes the form of certification required and provides a safe harbor under which a third-partydue diligence provider is deemed to have satisfied its obligations to deliver the certificationunder Section 15E(s)(4)(B) of the Exchange Act.

Rule 17g-10 requires that, in any case in which third-party due diligence serviceproviders are employed by an NRSRO, an issuer or an underwriter, the third-party due diligenceprovider must complete Form ABS Due Diligence-15E (“Form 15E”). The third-party duediligence provider must promptly provide the completed Form 15E to any NRSRO thatspecifically requests the form stating that the services relate to a credit rating the NRSRO isproducing, and also to the issuer or underwriter of the Exchange Act ABS for which the duediligence services relate for posting to the related Rule 17g-5 website, if any. Rule 17g-5(a)(3)(iii)(E) under the Exchange Act requires an NRSRO to obtain from the issuer, sponsor orunderwriter a representation that it will post any executed Form 15E delivered to it by a third-party due diligence provider on the Rule 17g-5 website. The Form 15E is required for any third-party diligence report produced in connection with the initial rating as well as if the third-partydue diligence provider is subsequently hired by an NRSRO, issuer or underwriter to performadditional due diligence services with respect to the Exchange Act ABS throughout the life ofthe transaction.

A. Timing of Delivery

Rule 17g-10 requires that the third-party due diligence provider “promptly” deliver Form15E “after completion of due diligence services.” While each third-party due diligence providerwill most likely develop its own compliance procedure regarding delivery of Form 15E, it isreasonable to conclude that the due diligence services are completed when the report related tosuch services is issued. The Adopting Release notes that the SEC considered establishingspecific time frames for delivery of the report, but determined that this was not appropriate giventhat the specifics of each transaction should drive the interpretation of “promptly” in Rule 17g-10. However, as long as the Form 15E is delivered within five business days of the final report,the requirement to deliver the form “promptly” should be satisfied. When hiring third-party duediligence providers, issuers may want to negotiate shorter delivery deadlines to facilitate thetiming of the transaction.


B. NRSROs to disclose all Form 15Es with publication of their rating

Rule 17g-7 requires each NRSRO to make certain public disclosures when it issues aninitial rating or takes any subsequent ratings action. If the NRSRO used a due diligence servicereport in connection with taking a ratings action it must publish either (i) a summary of thefindings and conclusions of such report or (ii) a cross reference to a Form 15E related to suchreport19 Additionally, any Form 15E received20 by the NRSRO or obtained by the NRSRO froma 17g-5 site must also be published.21 Certain NRSROs indicated that they are reluctant tosummarize any findings and conclusions and therefore expect to instead attach any Form 15E totheir disclosures. Rule 17g-7 requires NRSROs to disclose or summarize a Form 15E for eachdue diligence report they receive or use. Accordingly, pursuant to Rule 17g-5(a)(3) under theExchange Act, NRSROs are expected to include in their engagement letters a statement orrepresentation from the engaging party that it will ensure that any applicable Form 15E is postedon the 17g-5 site in accordance with the New Diligence Rules. Certain NRSROs have indicatedthat they will defer to the transaction parties regarding what constitutes due diligence servicesand in what instances a Form 15E is required from the third party service provider rather thanmaking their own independent determination. Nonetheless, to avoid an NRSRO from declaringservices as due diligence services when issuers or third-party providers believe otherwise,discussions should be had with the NRSROs during the engagement process.

VI. Application of the New Diligence Rules to Special Service Providers

Although the New Diligence Rules do not make any distinction regarding theirapplication to any specific type of third-party due diligence provider, certain third-parties thattypically perform services in Exchange Act ABS transactions pose unique challenges forinterpreting the New Diligence Rules.

A. Lawyers

Lawyers currently provide a variety of services in connection with Exchange Act ABStransactions. Some examples of typical legal services include: (1) providing legal opinions thataddress certain characteristics of assets underlying an Exchange Act ABS transactions, (2)reviewing the documents governing the underlying asset to determine impediments tosecuritization, (3) analyzing contractual provisions of the Exchange Act ABS transaction and (4)confirming satisfaction of certain eligibility criteria and/or funding limitations. Although eachlegal service should be independently analyzed, generally these types of activities would notmeet any of the five prongs of the definition of “due diligence services” in the New DiligenceRules.22 Most work performed by lawyers is done to provide legal opinions and negative

19 See Rule 17g-7(a)(1)(F).20 The New Diligence Rules, however, are not clear regarding when the Form 15E is considered “received” by theNRSROs. If the report was only posted to the 17g-5 website, without the NRSRO accessing the site (or the reportotherwise delivered to an NRSRO), the “received” requirement would not be satisfied and such report would nothave to be publicly disclosed by such NRSRO. The New Diligence Rules do not create any obligation for NRSROsto access 17g-5 websites to check for due diligence reports.21 See Rule 17g-7(a)(2).22 Rule 17g-10 defines “due diligence services” as “a review of the assets underlying an asset-backed security …. forthe purposes of making findings with respect to: (i) The accuracy of the information or data about the assetsprovided, directly or indirectly, by the securitizer or originator of the assets, (ii) Whether the origination of the assets


assurance letters to the issuer and underwriters of the transaction, and is not done for the purposeof making findings with respect to the assets underlying the transaction. While the intent of theNew Diligence Rules is to allow investors access to third-party diligence materials, these legalopinions and letters are traditionally delivered only to a specific list of recipients and makingthese opinions publicly available is contrary to the professional standards of the legal practice.The New Diligence Rules neither carves out nor includes legal work within the definition of duediligence services and does not reference it as an example of due diligence services, whereasaccountants and appraisal services are specifically referenced. Although legal work and the legalopinions provided by law firms would generally not fall under the New Diligence Rules, theconsideration should nonetheless be made on a fact specific basis.

B. Appraisers

The third prong of the definition of “due diligence services” in the New Diligence Rulesincludes a review of the assets for the purpose of making findings with respect to “the value ofthe collateral securing the assets.” The text of the Adopting Release also makes explicit referenceto appraisals performed in the RMBS context. An interpretation of this text in the AdoptingRelease may suggest that appraisals of mortgaged properties, as distinct from a review of theappraisals, would not constitute a due diligence service under the New Diligence Rules. TheAdopting Release states that a review conducted by a third-party diligence provider in the RMBScontext to “assess the validity of the appraised value of the property indicated on the loan tape”(emphasis added) in connection with purchasing a pool of mortgage loans for the purpose ofsecuritizing them are due diligence services.23 Because this review assesses the validity of theappraised value of the underlying asset and does not itself establish the appraised value, theunderlying appraisals being reviewed may not be considered due diligence services because theyare not “findings” with respect to the underlying assets. The Adopting Release does not indicateor imply that the underlying appraisals being reviewed are in and of themselves a separate duediligence service. Industry participants in the RMBS space agree with this interpretation andnote that all the NRSRO publications cited in the Adopting Release discussing this point requirethe assessment of the validity of existing appraisals.24 While issuers in RMBS transactions willlikely conclude that appraisals are not due diligence services, securitizers in other asset classesshould conduct a facts and circumstances analysis to determine whether an appraisal met thedefinition of “due diligence services” in their transactions.

C. Asset Representations Reviewers

An asset representations reviewer is a third-party hired by the sponsor or issuer of apublicly registered securitization transaction to conduct a review of the 60-days delinquent assetsin the pool for compliance with the representations and warranties made about the assets if both(1) delinquencies exceed a certain threshold and (2) the requisite number of investors vote to

conformed to, or deviated from, stated underwriting or credit extension guidelines, standards, criteria, or otherrequirements; (iii) The value of collateral securing the assets; (iv) Whether the originator of the assets complied withfederal, state, or local laws or regulations; or (v) Any other factor or characteristic of the assets that would bematerial to the likelihood that the issuer of the asset-backed security will pay interest and principal in accordancewith applicable terms and conditions.”23 See pages 406-407 of the Adopting Release.24 See footnote 1580 of the Adopting Release.


conduct a review. The asset representations reviewer must produce a report that contains itsfindings. Given the nature of the review, the asset representations reviewer’s report does not fallunder the types of services contemplated as “due diligence” for purposes of the New DiligenceRules. As such, the asset representations reviewer does not need to complete Form 15E.Additionally, since the activities performed by an asset representations review will occur afterthe initial rating of the transaction has been issued, issuers or underwriters, as applicable, will notneed to undertake to furnish any Form 15G.

D. Custodians

Although custodians are not specifically exempt from the New Diligence Rules, certainof their reviews in typical Exchange Act ABS transactions as further described in this marketguide should not be considered due diligence services under the New Diligence Rules. In certaincategories of securitizations, including in particular mortgage securitizations, the transactiondocuments will provide that a custodian (who may be the trustee) will hold specified documentsrelating to the assets during the term of the transaction. The custodian will generally confirmthat it has received the specified documents for each asset (i.e. “checking in” the asset files)immediately prior to the closing, at closing or within a specified period of time afterclosing. The checking in and holding of asset files does not fall into the categories of activitiesdescribed in clause (i) through (iv) of the definition of due diligence services in the NewDiligence Rules and, since this activity has not historically been viewed as due diligenceservices, should not be covered by the catchall provision in clause (v) of the definition.

In connection with checking in the asset files, a custodian may also compare certaininformation contained on certain documents in an asset file to the information about the relatedasset in an electronic schedule or data tape provided by the issuer or sponsor. While comparingthe asset files to the data tape is similar to the asset review function performed by accountants inAUP letters (which is explicitly scoped into the New Diligence Rules), the purpose of acustodian’s review may be different from that of the accountants.25 Custodians believe that theirreview of the data tape is being completed only to make sure that the correct asset file has beendelivered to the custodian, the correct asset is described on the data tape and/or the correctdocuments are included in the asset file. Unlike the review performed by the accountants, thecustodian’s comparison may not be done for the purpose of verifying the accuracy of theinformation in the data tape and, if that were the case, should not be considered due diligenceservices under the New Diligence Rules. Because this conclusion hinges on the purpose of thecustodian’s engagement, a custodian should analyze the facts and circumstances of eachtransaction to determine whether their work goes beyond identifying the appropriate underlyingasset and holding the related asset files. To avoid misunderstandings about the role of thecustodian in a transaction, issuers and custodians should have discussions regarding the purposeand use of any review performed by the custodian. To avoid the custodian’s review from beingused for an unintended purpose and thus scoped into the definition of due diligence services, it isadvisable to document that the purpose of the custodian’s review is only to identify and hold thecorrect asset files in any applicable engagement letter or custodial agreement. The issuer and thecustodian should also consider limiting the number of fields that the custodian reviews on anydata tape to only those necessary to identify the asset.

25 See footnote 1540 of the Adopting Release, which discusses the purpose of accountant’s review of the loan tape.


E. Third-Party Valuation Providers

Often times in auto securitizations, the values of the underlying vehicles are determinedby reference to certain third-party valuation benchmarks. These benchmarks are typicallyderived from information that is already published in a guide that is periodically delivered andnot published for the specific purpose of providing valuation services for securitized vehicles inspecific transactions. In some instances, however, a transaction party in the ordinary course ofbusiness may specifically request a valuation on a type of model of vehicle that is not included ina guide. In both of these cases, these valuations would not constitute due diligence since they arevaluations done in the ordinary course of business and do not assess the validity of thedetermined value of the vehicle. While issuers in auto securitizations will likely conclude thatthird-party valuation benchmarks generally are not due diligence services, securitizers should,nonetheless, conduct a facts and circumstances analysis to determine whether such services meetthe definition of “due diligence services”, similar to the analysis referenced above in VI.B.

VII. Application of the New Diligence Rules to ABCP Conduits

Application of the New Diligence Rules to existing ABCP conduits will be somewhatlimited as compared to traditional term ABS transactions or ABCP conduits created after June15, 2015. Issuers must furnish Form 15G only in connection with initial ratings actions. Thus,existing ABCP conduits that have already received initial ratings would not have to furnish anyForm 15G with the SEC. Although NRSROs affirm ABCP conduit’s ongoing ratings when aconduit-funded client transaction is initially closed or renewed, such affirmation is notconsidered an initial rating for the conduit. Any third-party due diligence service done after theissuance of the initial rating, however, will trigger the posting of Form 15E on the ABCPconduit’s 17g-5 website in the event that the issuer or sponsor initiates any third-party duediligence services.26

In addition to compliance for the ABCP conduit, compliance with the New DiligenceRules may be required at the customer level based on the structure of the transaction. In theevent that the customer/borrower issues Exchange Act ABS, then the customer/borrower willalso need to comply with furnishing requirements on EDGAR and the posting requirements onits 17g-5 website.

VIII. Application of the New Diligence Rules to certain Asset Classes

There are certain asset-specific considerations for CMBS, RMBS and CLOs. Theseconsiderations are set forth on Appendix A, B and C, respectively.

26 Note that the issuer in an ABCP conduit-funded client transaction is the borrower and the sponsor is the personthat organizes and initiates the asset-backed securities transaction by selling or transferring assets. Accordingly, aconduit administrator or liquidity provider would not be the issuer or sponsor under Regulation AB and therefore, nodue diligence services that were performed for these entities would be subject to delivery of a Form 15E.


IX. Interim Reports

Interim due diligence reports are within the scope of the New Diligence Rules. The NewDiligence Rules explicitly state that the findings and conclusions of both final and interim reportsmust be furnished on Form 15G. However, neither a draft report nor the back and forthexchange between the issuer and the third-party provider in the course of conducting the reviewwould constitute an interim report. Furnishing multiple drafts of the same report or makingquestions regarding the services publicly available would conflict the stated purpose of the NewDiligence Rules. Too many Form 15Gs would dilute investor clarity and potentially causeconfusion. As such, it is a reasonable interpretation that only reports (both interim and final)signed and delivered by a third-party due diligence provider or otherwise delivered by a third-party due diligence provider would constitute reports subject to the disclosures of Form 15G andForm 15E.

X. Disclosure of Loan Level Data

While diligence conducted by third-party due diligence providers on the loan level datadisclosure required by Regulation AB falls within the scope of the New Diligence Rules, issuerswill likely redact this data to remove any private obligor information before including any suchprivate data on Form 15G. Third-party due diligence providers are expected to do the samewhen preparing Form 15E. Issuers and third-party providers should work together to limitreferences to personally identifiable information in diligence reports or include such informationonly in exhibits to such reports in order to easily exclude such information from the requiredfurnishings and other postings. The New Diligence Rules do not require issuers to include thefull due diligence report in Form 15G or Form 15E. Accordingly, redaction of personalidentifiable information should be permissible even without an official confidential treatmentrequest so long as the findings and conclusions of the due diligence services can be reportedwithout reference to such information.

XI. Compliance Dates

The New Diligence Rules are effective on June 15, 2015. Because Rule 15Ga-2 requiresthat a Form 15G be furnished to the SEC five business days prior to the first sale in the offering,deals that price any Exchange Act ABS on or after June 22, 2015 (5 business days after June 15,2015) require compliance with the New Diligence Rules.27 Rule 17g-10 requires a Form 15Ecertification from any third-party diligence service providers for due diligence servicescompleted28 on or after June 15, 2015, regardless of when the deal priced or closed.29

27 This conclusion is based on verbal guidance obtained from the SEC.28 See Section V.A. of this market guide for a discussion on what constitutes completion.29 This conclusion is based on verbal guidance obtained from the SEC. NRSROs may request due diligenceproviders to submit a Form 15E certification with respect to due diligence services performed prior to June 15th ifthe initial rating for the related security has not yet been issued.


----------------------------------------------------------------------------------For more information, please contact the working group leaders for this market guide:

Amanda L. [email protected]

Jan C. [email protected]

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Appendix A

Application of New Diligence Rules to CMBS Transactions

What agreed-upon procedures services are considered due diligence for purposes ofsatisfying the requirements of SEC Rule 15Ga-2 and SEC Rule 17g-10?

The overall objective of SEC Rule 15Ga-2 and SEC Rule 17g-10 is to allow for increasedtransparency amongst the NRSROs and general investor population. This would includeproviding information related to the procedures performed by due diligence providers on theunderlying assets in the collateral pool in connection with a securitization in order to provide theNRSROs, and ultimately investors, with access to information that has historically only beenavailable to other issuance participants (i.e., the issuer and the underwriter).

Accounting firms have traditionally provided two forms of agreed-upon procedures servicesfor CMBS transactions. The first service (Service 1, described below) is the comparison ofcertain mortgage loan information set forth on a data file to (i) legal or third-party documentation(collectively, the “Loan File”), (ii) issuer or mortgage loan seller generated documentation (the“Issuer Provided Schedules,” together with the Loan File, collectively, the “Source Documents”)or (iii) recalculated information that is derived from other characteristics on the data file. Thesecond service (Service 2, described below) is the further comparison of mortgage loaninformation set forth in the offering document to various supporting documentation, therecalculation of mortgage loan information using information on the data file, and therecalculation of information relating to the securities offered by the securitization.

Service 1

Service 1 includes a comparison of information set forth on a data file prepared by theissuer, or the mortgage loan sellers on behalf of the issuer, to the corresponding information thatis (i) located in the Source Documents or (ii) recalculated using other characteristics on the datafile. The Source Documents used for these comparisons and the calculation methodologies usedfor these recalculations are provided by the issuer, or the applicable mortgage loan seller onbehalf of the issuer. The information on the data file is then used by the issuer for variouspurposes, including, but not limited to, populating certain information relating to the mortgageloans in the securitization offering documents, providing information related to the mortgageloans to the NRSROs, and providing certain information relating to the mortgage loans toinvestors.

The data file comparison procedures described above in Service 1 constitute “due diligenceservices” under SEC Rule 15Ga-2 and SEC Rule 17g-10, and will be included on the Form ABS DueDiligence 15E that is prepared by the accounting firm performing these services, as well as the FormABS-15G that will be furnished by the issuer on EDGAR. The comparison of information on thedata file to the information on the Source Documents have traditionally been viewed as “duediligence” services within the CMBS industry.

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Although certain specific procedures that are part of Service 1 may not be considered “due diligenceservices” on their own (i.e., procedures involving (i) comparing information on the data file to IssuerProvided Schedules and (ii) recalculations of certain characteristics on the data file using othercharacteristics on the data file), these procedures are generally considered by the CMBS industry asbeing part of the accountant’s “due diligence” and, consistent with the commentary accompanying theSEC rules release, these procedures will be included on the Form ABS Due Diligence 15E and FormABS-15G, as such procedures “are commonly understood in the securitization market to be third-party due diligence services.”

Service 2

Service 2 consists of certain agreed-upon procedures relating to the comparison orrecalculation of mortgage loan information and bond information that is shown in thesecuritization offering documents. The information that is compared or recalculated is availableto all issuance participants (including issuer / underwriter / NRSROs and potential investors),who all receive copies of the securitization offering documents. In addition, such information ismade available to the NRSROs at the same time as other transaction participants (through theprinting of the offering documents). Finally, the information in the securitization offeringdocuments is not typically used by the NRSROs in their ratings determinations, as thepreliminary ratings for a securitization are provided prior to the finalization of the preliminaryoffering documents.

The procedures described above in Service 2 do not constitute “due diligence services”under SEC Rule 15Ga-2 and SEC Rule 17g-10, and will not be included on Form ABS DueDiligence 15E or Form ABS-15G, as these services have not traditionally been viewed as “duediligence” services within the CMBS industry. Additionally, the SEC rules release states that (i)recalculating projected future cash flows due to investors and (ii) performing procedures thataddress other information included in the securitization offering documents are not considered“due diligence services” under the New Diligence Rules. In some cases, certain SourceDocuments used in Service 1 may also be used for certain comparison or recalculationprocedures that are part of Service 2, however, the use of such Source Documents for thesesecuritization offering document procedures, by itself, does not classify such procedures as “duediligence services” under the New Diligence Rules.

The position outlined above allows for a consistent and standardized approach for third-party due diligence providers, issuers and underwriters to follow with respect to the applicationof SEC Rule 15Ga-2 and SEC Rule 17g-10 to CMBS agreed-upon procedures.

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Appendix B

Application of New Diligence Rules to RMBS Transactions

1. What types of services obtained in RMBS transactions are due diligence serviceswithin scope of the New Diligence Rules?

(a) The New Diligence Rules were designed to cover “traditional” third-party duediligence services of the type that have been performed for years in the RMBSarea. The Adopting Release describes the industry that provides these services.

(b) Accountant's AUP letters, while not “traditional” third-party due diligenceservices as described in the New Diligence Rules, to the extent that that the workinvolves comparison of the loan level data file to the loan document files, areviewed as within scope of the New Diligence Rules. Statements in the AdoptingRelease addressing this point refer to “comparing the information on a loan tapewith the information contained on hard-copy documents in a loan file.” There is agood argument that comparing information in the offering document againstpublicly available information (for example, information on Bloomberg inconnection with an RMBS resecuritization) is not the kind of due diligenceservice intended to be within the scope of the New Diligence Rules. In addition,certain follow up work may properly be viewed as not part of the due diligenceservices. For example, if a tape to file review results in a checklist of correctionsto be made to the tape, follow up work in which the corrected tape is checkedagainst the checklist of corrections need not be considered part of the duediligence services as this work does not involve any additional review of theassets themselves.

2. What types of services obtained in RMBS transactions should be considered furtheras to whether they may be due diligence services within scope of the New DiligenceRules?

(a) As discussed in Section VI.D. of the market guide, work performed by custodiansas holders of the loan document files, to the extent the work includes acomparison of the loan level data file to the loan document files, may beconsidered a due diligence service depending on the facts and circumstances. SeeSection VI.D. of the market guide for a further discussion about custodians.

(b) Title review services should be considered further.

(c) Services that confirm the payment status of real estate taxes and assessments, andinsurance premiums, should be considered further.

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3. What types of services obtained in RMBS transactions should not be considered duediligence services within scope of the New Diligence Rules?

(a) As discussed in Section VI.A. of the market guide, legal services performed byoutside counsel in connection with RMBS generally should not be within thescope of the New Diligence Rules, but consideration to this issue should be madeon a fact specific basis. Generally, these legal services do not include activitiesdescribed in clauses (i) - (iv) of the definition of “due diligence services”. Inparticular, a review of representative or sample forms of legal documents used inthe origination of the assets in connection with the provision of legal advice aboutthe assets does not appear to fall within the definition of due diligence services.Generally, legal services performed by outside counsel in connection with RMBSare not commonly understood in the securitization market to be third-party duediligence services as described in the Adopting Release. In addition, as noted inSection VI.A. of the market guide disclosure of attorney work product mayviolate the attorneys' ethical duties to clients.

(b) BPOs and AVMs, in and of themselves should not be due diligence services, asthey are merely single data points and not a review of the assets. Using a currentBPO or AVM to estimate the current property value for a seasoned loan poolshould not be considered a due diligence service, if the BPO or AVM is not beingused to review or verify another valuation. However, if a BPO or AVM is usedby a third-party due diligence service provider to review another valuation for thepurpose of making a finding about that other valuation, then such use of the BPOor AVM by the third-party due diligence service provider to make such reviewwould generally be considered a due diligence service. In that circumstance, theproviding or collecting of the BPOs or AVMs would not in and of itself be a duediligence service, and the New Diligence Rules do not appear to impose on theperson providing or collecting the BPOs or AVMs a separate duty to execute aForm 15E. Generally in RMBS, full new appraisals are not used to evaluate aprevious appraisal. See Section VI.B. of the market guide for a further discussionabout appraisals.

(c) In some instances, a BPO or AVM may be obtained solely for the purpose ofdetermining the eligibility of the asset under a loan-to-value test relevant to thecharacterization of the RMBS for tax (including REMIC), ERISA or SMMEApurposes. The use of a BPO or AVM for this purpose appears to be outside thescope of the New Diligence Rules.

(d) Updated credit scores, in and of themselves should not be due diligence services,as they are merely single data points and not a review of the assets. In addition,credit reports and credit scores are not commonly understood in the securitizationmarket to be third-party due diligence services as described in the AdoptingRelease.

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(e) Data capture services, in which raw information is extracted from origination andservicing files (for example, data about loan modification activity, or paymenthistory), should not be considered a due diligence service.

4. What are some specific issues and concerns regarding traditional residentialmortgage due diligence services under the New Diligence Rules?

(a) Reports produced by a traditional residential mortgage due diligence servicesprovider typically include the following (see the most recent SFIG RMBS 3.0Green Paper for further detail)30, although the actual reports provided in anyspecific instance may vary significantly:

(i) Narrative Report: This provides an overview of the diligence servicesperformed, and contains the findings and conclusions of the servicesperformed in an aggregated format, generally without asset level detail.

(ii) Rating Agency Grading Spreadsheet (Conditions Report): This is aspreadsheet with a separate line for each loan, showing data such as theinitial and final grade, including the composite grade and the grade foreach component of the review. Information about all exceptions areshown, including back-and-forth commentary about the exception andcompensating factors.

(iii) Additional reports: Additional reports providing loan level information asto specific areas of the diligence performed, including valuation, tape tofile, and qualified mortgage testing.

(b) What are the findings and conclusions of traditional residential mortgage duediligence services that are within scope of the New Diligence Rules?

(i) One view is that the Narrative Report is a sufficient description of thefindings and conclusions to satisfy the requirements of the New DiligenceRules. However, if the Narrative Report does not include asset levelinformation about exceptions and compensating factors, it would appearthat the Narrative Report alone would not suffice. (Note: if the NarrativeReport does include any asset level detail, then references to the NarrativeReport in this section are subject to redaction to address privacy concerns(see 5. below).)

(ii) A second view is that the Conditions Report and additional reports maycontain asset level detail that constitutes findings and conclusions that donot appear in the Narrative Report, and that therefore out of an abundanceof caution all of these reports should be filed, subject to redaction toaddress privacy concerns (see 5. below).

30 The Green Paper can be found at www.sfindustry.org.

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(iii) A third view is that the New Diligence Rules could be satisfied with theNarrative Report together with a streamlined version of the ConditionsReport, where the latter document includes all findings and conclusions asto each asset, as well as exception details and compensating factors orother reasons for permitting the exception (redacted for information thatraises privacy concerns), but would be presented in buckets or categoriesto minimize duplication. This approach would eliminate the need forincluding back-and-forth communication while presenting all materialinformation.

(iv) A fourth view is that the New Diligence Rules could be satisfied byfurnishing i) the Narrative Report, ii) the Conditions Report subject toredaction to address privacy concerns, and iii) any other reports thatcontain findings and conclusions or exceptions or compensating factorsthat do not appear in the Conditions Report. Under this approach, theadditional reports would also be redacted to address privacy concerns.Information in the additional reports that did not constitute findings andconclusions potentially could also be removed. For example, in avaluation report for newly originated loans, the findings and conclusionsmay be considered to be the updated value, the variance from the value atorigination, whether the variance was in tolerance, and if not in tolerance,whether the loan was left in the pool, and if left in the pool, thecompensating factors. Other information, such as sale price, propertyspecifications, and information about comparables might be considered tonot be “findings and conclusions” and therefore not required to be in thereport furnished on Form ABS-15G

(c) In SFIG hosted conference calls that discussed this issue, there was broad supportin favor of the second and fourth views. Additional or revised views may emerge.It is understood that the requirement under Rule 15Ga-2 is to furnish the findingsand conclusions of the relevant third-party due diligence reports, and that therequirement is not to furnish the relevant third-party due diligence reports in theirentirety. The Adopting Release provides very little guidance as to what portionsof the reports constitute findings and conclusions, other than the instruction toparagraph (a) of Rule 15Ga-2. The fact that the requirement is to furnish findingsand conclusions, and not the reports in their entirety, creates an opening thatmakes possible a number of alternate viewpoints as to what specifically isrequired to be furnished or what is appropriate to furnish, and also makes possiblea view under which specific information can be redacted to address privacyconcerns as long as all findings and conclusions are being furnished.

(d) In addition, some participants in the discussions support the view that only thefinal versions of the reports need to be provided, as long as all information in theinitial versions of the reports appears in the final versions as to the loans includedin the final securitization pool. (As discussed in this paragraph, “initial reports”are not drafts, but rather are reports provided with respect to the initial pool beingconsidered for securitization.) This would generally be the case where the final

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reports show both the initial and the final grades for each component as well asthe composite grades, and any exceptions and compensating factors, for each loanin the final securitization pool. In practice however, it may be burdensome todetermine that all such information in the initial versions in fact appears in thefinal versions. In addition, in light of express language in the Adopting Releaseabout providing all reports and not just "final reports", in practice sponsors mayelect to furnish all versions of the reports. Many members of the working groupbelieved that furnishing of the findings and conclusions of the due diligenceservices does not appear to be required as to assets that were removed from thefinal pool, although this view could merit further consideration. However, thereports provided or other sponsor disclosure should include a full description ofthe scope of the review including the number of assets removed from the poolalong with the general reasons for removal.

5. How can privacy concerns be addressed with respect to the furnishing on EDGARof findings and conclusions of traditional residential mortgage due diligenceservices?

(a) The Conditions Report and other reports referenced above in some cases includepersonally identifying information of the borrower(s) under the related mortgageloan. In addition, there is concern that some information may be present thatcould potentially pose a risk of reidentification of the borrower(s) when combinedwith other data. Typically, this information may appear in compensating factors,for example that the borrower has a given number of years experience in a certainposition at a named company.

(b) Consideration should be given to general guidelines as to the types of informationthat should be redacted to protect the borrowers’ privacy. For example, thefollowing could be deleted:

(i) Personally identifying information such as borrower and co-borrowername and SSNs, property address, city, county, MSA, ZIP, mailingaddress, and account number, including originator and servicer loannumber. Geographic indicator should be limited to state.

(ii) Information that poses a risk or reidentification that may appear incompensating factors or exception detail, such as:

Names of borrowers or any other individuals (including attorneys, brokersand agents)Company and entity namesFinancial institution namesJob position titlesAny addressAny location information (other than state), including city, county, MSAand ZIPAny telephone number

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Any e-mail addressAccount numbers of any typeInsurance claim numbersInsurance policy numbersForeclosure action dates and case numberBankruptcy action dates and case number

(iii) Any additional fields that pose a significant risk of directly or indirectlyre-identifying the borrower. Consideration should be given to the types offields that might be removed from a residential mortgage loan data filebeing provided to a recipient who did not agree to a restricted useagreement.

(c) Consideration should also be given as to whether a redacted report created usingstandardized redaction guidelines would be sufficient for NRSRO use. If not,then the result would be different versions of the reports on the Rule 17g-5website and on the Form ABS-15G. While as a general rule it would be desirablefor the versions of the reports on the Rule 17g-5 website and on the Form ABS-15G to be as similar as possible, it is understood that there may be differencesbetween these versions, for example if the NRSROs require granularity and detailthat is not necessary to be shown in the versions furnished on Form ABS-15G inorder to comply with Rule 15Ga-2.

(d) It is recommended that issuers and third-party due diligence service providerswork together to develop protocols for the creation of the due diligence reportsthat incorporate general guidelines of the types described above, in order to avoidincluding potentially identifying information in the reports as and when they areinitially created. In other words, it would be preferable for the reports to bescrubbed before being made, rather than redacted after having been made. (Allreferences above to the redaction of reports include alternatively the reportshaving been scrubbed before being made under such protocols.)

6. Is diligence performed for acquisition or financing within scope of the NewDiligence Rules?

(a) Certain provisions of the New Diligence Rules, as well as statements in theAdopting Release, imply that the duty to furnish the findings and conclusionsonly arises if the third-party due diligence report relates to the asset-backedsecurity.

(b) If a person obtained a due diligence report in connection with the purchase orfinancing of the assets, and that person later becomes an issuer or underwriter ofRMBS backed by those assets, then depending on the facts and circumstances theoriginal due diligence may or may not relate to the RMBS.

(c) One approach in these circumstances could be for the third-party due diligenceprovider to create a new version of the due diligence report that was used in

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connection with the purchase or financing, where the asset level information inthe new report is limited to those assets that were selected for inclusion in theRMBS pool.

7. Should reference to the Form ABS-15G report under Rule 15Ga-2 that pertains toan RMBS offering be made in the prospectus or other offering document for theRMBS offering?

(a) Many working group participants were of the view that some reference to theForm ABS-15G report may be made in the offering document, including in Rule144A offerings, in order to protect against a possible omissions claim. It isunderstood however that such a reference is not required by the new Rules, andalso is not required under Regulation AB II or Rule 193.

(b) This reference would not be an incorporation by reference, but merely a statementthat the Form ABS-15G report has been made and can be found on EDGAR. Inorder for the reference to enable easily finding the report on EDGAR, the CIKnumber and the date(s) of the filing could be provided.

(c) Notwithstanding the intent that the reference not result in an incorporation byreference, there remain concerns that such reference to the Form ABS-15G reportmay cause the report to become an offering communication or otherwise result inadditional potential liability. Therefore, it is not clear at this time whether inpractice such reference will be made.

(d) Given that the Form ABS-15G report may be made prior to the delivery of theoffering document, a similar reference may also appear in any term sheet for theoffering

(e) It may be preferable to include this reference in a free-standing section, and not aspart of the section covering the pre-offering review of the assets, to avoid anyinference that all findings and conclusions furnished on the Form ABS-15G arenecessarily part of the pre-offering review.

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Appendix C

Application of New Diligence Rules to CLO Transactions

What is considered due diligence for purposes of satisfying the requirements of Rule 17g-10and thereby included in Form ABS Due Diligence-15E for Collateralized Loan Obligations(CLO)?

The overall objective of the New Diligence Rules is to allow for increased transparency amongstthe NRSROs and general investor population. This would include providing information relatedto the procedures performed by third party due diligence providers on the underlying assets inthe collateral pool in connection with a securitization.

The purpose of Rule 17g-10 is to provide the NRSROs, and ultimately investors, withinformation that is typically available to other issuance participants (issuer/underwriter) in orderfor NRSROs and/or investors to determine whether such information is relevant in determining acredit rating or investment decision related to securities issued.

Accounting firms have traditionally been engaged to provided services throughout the life-cycleof a CLO and deliver the findings of such services using an AUP issued pursuant to AICPAprofessional standards AT 201.

A CLO’s governing document (indenture) may require that a CLO Issuer engage accountants toprovide services for a CLO’s (1) closing date, (2) effective / ramp-up date, and (3) quarterinvestor payment dates. There may also be additional services required/requested during a CLOlifecycle (i.e. Optional Redemption, Re-Pricing, Liquidation, Event of Default) or at the requestby the CLO’s investment banks, at closing.

Below is a summary of typical AUP services performed for each of the three main CLO lifecycleevents followed by an indication as to whether such services may be viewed as third party duediligence services under the New Diligence Rules:

1. Closing Date Services:

a. Comparisons of certain portfolio asset characteristics using third party sources, asset

specific deal document sources and or utilizing methodology and definitions within

the indenture.

b. Comparisons of recalculations related to hypothetical capital structure debt and/or

equity scenario return analysis performed at the request of CLO investment banks.

These procedures are not a requirement of a CLO’s indenture.

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2. Effective Date / Ramp-Up Date Services

After the closing date and once the CLO asset manager has purchased or entered contracts topurchase additional assets that in the aggregate equal or exceed a defined target par amount,the asset manager will declare the CLO’s effective and compliant with the indenturerequirements in order for the NRSROs to confirm the CLO securities initial ratings assignedat close.

The Indenture requires that accountants perform AUP on the effective date portfolio oncethe deal is declared effective. These services include:

a. Comparisons of certain portfolio asset characteristics using third party sources, asset

specific deal document sources and or utilizing methodology and definitions within

the indenture.

b. Comparisons of recalculations of indenture portfolio aggregate principal balance and

threshold requirements (target par condition, collateral quality tests, coverage test

and concentration limitations) disclosed in a trustee’s effective date report.

3. Quarterly Investor Payment Date Services

Following a CLO’s effective date, investors are typically paid quarterly throughout the life-cycle of a CLO. Prior to available funds being distributed, the CLO indentures typicallyrequire that accountants perform AUP on each trustee investor payment date report relatedto the following:

a. Comparisons of recalculations of the allocation of available funds pursuant to an

indentures priority of payments.

b. Comparisons of recalculations of the portfolio threshold requirements (collateral

quality tests, coverage test and concentration limitations) being reported in the CLO

trustee’s investor payment date.

Conclusion of the New Diligence Rules for CLO Services Scope

The portfolio characteristic data verification procedures, described above in services 1.a and 2.a,would most likely constitute “due diligence” services under the New Diligence Rules, requiring adue diligence provider to file a 15-E Certificate; even though the NRSROs have access to thisinformation prior to a due diligence provider and sources utilized to verify such information arefrom NRSROs respective websites and methodology, rather than source documents. However,since service 1. a., if required, is a condition to close and service 2. a. is required for an NRSROto confirm its rating, it would be difficult to argue that such services do not fall under the NewDiligence Rules.

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If the procedures described in 1.a. are performed prior to the initial rating of the securities, theissuer or underwriter would be required to furnish of a Form ABS Due Diligence 15-G to theSEC at least five business days prior to pricing of the security. Since the effective dateprocedures described in 2.a. are performed after the initial rating of the securities, no Form 15Gis required.

The recalculation and comparison procedures, described above in Services 1. b., 2. b., 3.a and 3.bdo not constitute due diligence services for purposes of issuing the 15-E Certificate. Theseservices have NOT traditionally been viewed as “due diligence” services within the industry andare not related to the asset level disclosures of procedures typically considered due diligenceservices under the New Diligence Rules.

While the commentary related to Rule 17g-10 relates specifically to RMBS, the approachdescribed is consistent with the description of traditional AUP engagements. In addition, webelieve that the approach is also consistent with what has been commonly understood to be duediligence within the industry, another guideline described in the commentary.

The position outlined above allows for a consistent and standardized approach for third party duediligence providers assessing the accuracy of the underlying data to fulfill its obligation underRule 17g-10.

Incorporating the New Diligence Rules in Governing Document

Edits to a transaction’s governing document may be needed to clarify scope, compliance andreporting under the New Diligence Rules.