Loan Syndications v. Sec. & Exch. Comm'n

• Decision Date: 22 December 2016
• Docket Number: Civil Action No. 16–652 (RBW)
• Citation: 223 F.Supp.3d 37
• Court: U.S. District Court — District of Columbia
• Parties: THE LOAN SYNDICATIONS and Trading Association, Plaintiff, v. SECURITIES AND EXCHANGE COMMISSION and Board of Governors of the Federal Reserve System, Defendants.

223 F.Supp.3d 37

THE LOAN SYNDICATIONS and Trading Association, Plaintiff,

v.SECURITIES AND EXCHANGE COMMISSION and Board of Governors of the Federal Reserve System, Defendants.

Civil Action No. 16–652 (RBW)

United States District Court, District of Columbia.

Filed December 22, 2016

Peter Douglas Keisler, Richard D. Klingler, Sidley Austin LLP, Washington, DC, for Plaintiff.

Sarah R. Prins, U.S. Securities and Exchange Commission, Washington, DC, Joshua P. Chadwick, Board of Governors of the Federal Reserve System, Washington, DC, for Defendants.

MEMORANDUM OPINION

REGGIE B. WALTON, United States District Judge

The plaintiff, the Loan Syndications and Trading Association, "a not-for-profit trade association representing members participating in the syndicated corporate loan market," Plaintiff's Motion for Summary Judgment ("Pl.'s Mot"), Exhibit ("Ex.") A (Opening Brief of Petitioner ("Pet'r's Br.")) at iii, brings this action against the defendants, the Securities and Exchange Commission ("SEC") and the Board of Governors of the Federal Reserve System (the "Board"), seeking review of the final rules adopted by these and other agencies pursuant to Section 941 of the Dodd–Frank Wall Street Reform and Consumer Protection Act. Complaint ("Compl."), Ex. A (Petition for Review) at 1. Currently before the Court are the Plaintiff's Motion for Summary Judgment and the Defendants' Motion for Summary Judgment ("Defs.' Mot.").¹ After carefully considering these motions and the Administrative Record ("A.R."), the Court concludes for the reasons that follow that it must deny the plaintiff's motion and grant the defendants' motion.²

I. BACKGROUND

A. The Dodd–Frank Act

This case concerns the Office of the Comptroller of the Currency's, the Board of Governors of the Federal Reserve System's, the Federal Deposit Insurance Corporation's, and the SEC's ("the agencies' ")³ joint implementation of an amendment to the Securities Exchange Act of 1934, added by Section 941 of the extensive Dodd–Frank Wall Street Reform and Consumer Protection Act ("Dodd–Frank Act"). See Pub. L. No. 111–203, § 941, 124 Stat. 1376 (2010) (codified at 15 U.S.C. § 78o –11 (2012) ). This amendment requires the agencies to "jointly prescribe regulations to require any securitizer to retain an economic interest in a portion of the credit risk for any asset that the securitizer, through the issuance of an asset-backed security, transfers, sells, or conveys to a third party."⁴ 15 U.S.C. § 78o –11(b)(1). Congress defined a "securitizer" as: "(A) an issuer of an asset-backed security; or (B) a person who organizes and initiates an asset-backed securities transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuer." Id. § 78o –11(a)(3). Congress further directed the agencies to require that securitizers retain "not less than [five] percent of the credit risk", id. § 78o –11(c)(1)(B)(i), for all applicable assets, and to "establish appropriate standards for retention of an economic interest with respect to collateralized debt obligations, securities collateralized by collateralized debt obligations, and similar instruments collateralized by other asset-backed securities," id. § 78o –11(c)(1)(F). In addition, the agencies are permitted to provide "total or partial exemption[s]" for securitizations "as may be appropriate in the public interest and for the protection of investors." Id. § 78o –11(c)(1)(G).

B. Open Market Collateralized Loan Obligations

The core of this case concerns the operation of the term "securitizer" and the corresponding joint regulation issued by the agencies to implement the credit risk retention mandate in relation to the entities and processes associated with collateralized loan obligations ("CLOs"). As the Court understands from the parties' filings, a CLO is a type of securitization or asset-backed security, backed by loans that are typically made from banks to commercial borrowers with low credit ratings or large debt obligations. See Pl.'s Mot., Ex. A (Pet'r's Br.) at 2 ("CLOs are securitizations backed by large loans generally originated by the largest U.S. banks and provided to large commercial enterprises with relatively high levels of debt ...."); Defs.' Mot., Ex. A (Brief for Respondents ("Resp'ts' Br.")) at 5 ("A collateralized loan obligation ... is a type of collateralized debt obligation ... that is primarily backed by loans made to corporate borrowers without strong credit."). The type of CLOs involved here are the so-called "open market CLOs." Pl.'s Mot., Ex. A (Pet'r's Br.) at 7.

Open market CLOs "securitize assets purchased on the primary or secondary markets based on the CLO's particular investment guidelines." Defs.' Mot., Ex. A (Resp'ts' Br.) at 5–6; see also Pl.'s Mot., Ex. A (Pet'r's Br.) at 7. Open market CLOs are distinguished from "balance-sheet CLOs, which are instead designed by the owner of leveraged loans," Pl.'s Mot., Ex. A (Pet'r's Br.) at 7, and "generally securitize loans already held in an institution's portfolio, including assets it has originated," Defs.' Mot., Ex. A (Resp'ts' Br.) at 5. Essentially, managers of open market CLOs direct the purchase of loans in accordance with certain "investment parameters" negotiated with investors, Pl.'s Mot., Ex. A (Pet'r's Br.) at 7, through a special purpose vehicle, which is "formed expressly to issue the [asset-backed security]," Defs.' Mot., Ex. A (Resp'ts' Br.) at 6. An open market CLO manager has a certain level of discretion in selecting loans on the market and later "operates the CLO and manages its loan portfolio." Pl.'s Mot., Ex. A (Pet'r's Br.) at 8; see also Defs.' Mot., Ex. A (Resp'ts' Br.) at 6.

C. The Agencies' Rulemaking

The dispute before the Court evolves from the agencies' decision to regulate open market CLO managers pursuant to Section 941 of the Dodd-Frank Act. The defendants, along with the other relevant agencies identified earlier, supra at 44, issued a joint notice of proposed rulemaking and solicited comments on the Dodd–Frank Act's credit risk retention provisions. A.R. at JA0176 (Credit Risk Retention, 76 Fed. Reg. 24090, 24090–91 (Apr. 29, 2011) (the "initial proposed rule")). In this initial proposed rule, "[t]he Agencies noted that the second prong of" the statutory definition of "securitizer"⁵ "is substantially identical to the definition of a ‘sponsor’ of a securitization transaction in the [SEC's regulation] governing disclosures for [asset-backed security] offerings registered under the Securities Act."Id. at JA0184 (76 Fed. Reg. at 24098 ). This pre-existing regulation defines "a ‘sponsor’ as a person who organizes and initiates an asset-backed securities transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuing entity." Id. at JA0184 (76 Fed. Reg. at 24098 n.40 (citing 17 C.F.R. § 229.1101 (2014) )). The agencies specifically noted that a "CLO manager generally acts as the sponsor by selecting the commercial loans to be purchased by an agent bank for inclusion in the CLO collateral pool, and then manages the securitized assets once deposited in the CLO structure." Id. at JA0184 (76 Fed. Reg. at 24098 n.42 ). Accordingly, the agencies decided that the definition of "securitizer" included open market CLO managers, and thus these managers would be subject to the statute's credit risk retention mandate. Id.

The agencies also proposed a "menu of options approach" with regard to the statute's credit risk retention mandate. Id. at JA0187 (76 Fed. Reg. at 24101 ). A securitizer could therefore satisfy its risk retention requirement under the proposed rules by either: (1) "retaining at least five percent of each class of [asset-backed security] interests issued as part of the securitization transaction" ("vertical risk retention"); (2) "retaining an ‘eligible horizontal residual interest’ in the issuing entity in an amount that is equal to at least five percent of the par value of all [asset-backed security] interests as part of the securitization transaction" ("horizontal risk retention"); (3) retaining risk through "an equal combination of vertical risk retention and horizontal risk retention" ("L–shaped risk retention"); or (4) retaining risk in accordance with several other approaches not relevant here. Id. at JA0187–89 (76 Fed. Reg. at 24101–03 ). The vertical risk retention option originally did not specify by what measurement the retention requirement would be satisfied "because the amount retained [in each class], regardless of method of measurement, should equal at least five percent of the par value (if any), fair value, and number of shares or units in each class." Id. at JA0187 (76 Fed. Reg. at 24101 ).

The initial proposed rule garnered "comments from over 10,500 persons, institutions, or groups, including nearly 300 unique comment letters." Id. at JA 1203, 1208 (Credit Risk Retention, 78 Fed. Reg. 57928, 57933 (Sept. 20, 2013) (the "modified proposed rule"). The agencies considered these comments, modified the original proposal, and requested comment on the modified proposed rule. Id. In issuing these modified proposed rules, the agencies noted that many commenters were concerned about how several of the original proposed rules would affect open market CLOs. Id. at JA 1208 (78 Fed. Reg. at 57933 ) ("Several commenters criticized application of the original proposal to managers of certain collateralized loan obligation (CLO) transactions and argued that the original proposal would lead to more concentration in the industry and reduce access to credit for many businesses."); JA1236 (78 Fed. Reg. at 57961 ) ("Many commenters, including several participants in CLOs, raised concerns regarding the impact of the proposal on certain types of CLO securitizations, particularly CLOs that are securitizations of commercial loans originated and syndicated by third parties and selected for purchase on the open market by...