Proposed Exemptions; Harris Nesbitt Corporation (Harris Nesbitt)
and Its Affiliates (the Affiliates)
[02/13/2006]
Volume 71, Number 29, Page 7627-7654
[[Page 7627]]
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Part II
Department of Labor
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Employee Benefits Security Administration
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Proposed Exemptions; Harris Nesbitt Corporation (Harris Nesbitt) and
Its Affiliates (the Affiliates); Notice
[[Page 7628]]
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DEPARTMENT OF LABOR
Employee Benefits Security Administration
[Application No. D-11281, et al.]
Proposed Exemptions; Harris Nesbitt Corporation (Harris Nesbitt)
and Its Affiliates (the Affiliates)
AGENCY: Employee Benefits Security Administration, Labor.
ACTION: Notice of Proposed Exemptions.
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SUMMARY: This document contains notices of pendency before the
Department of Labor (the Department) of proposed exemptions from
certain of the prohibited transaction restrictions of the Employee
Retirement Income Security Act of 1974 (the Act) and/or the Internal
Revenue Code of 1986 (the Code).
Written Comments and Hearing Requests
All interested persons are invited to submit written comments or
requests for a hearing on the pending exemptions, unless otherwise
stated in the Notice of Proposed Exemption, within 45 days from the
date of publication of this Federal Register Notice. Comments and
requests for a hearing should state: (1) The name, address, and
telephone number of the person making the comment or request, and (2)
the nature of the person's interest in the exemption and the manner in
which the person would be adversely affected by the exemption. A
request for a hearing must also state the issues to be addressed and
include a general description of the evidence to be presented at the
hearing.
ADDRESSES: All written comments and requests for a hearing (at least
three copies) should be sent to the Employee Benefits Security
Administration (EBSA), Office of Exemption Determinations, Room N-5649,
U.S. Department of Labor, 200 Constitution Avenue, NW., Washington, DC
20210. Attention: Application No. ----, stated in each Notice of
Proposed Exemption. Interested persons are also invited to submit
comments and/or hearing requests to EBSA via e-mail or FAX. Any such
comments or requests should be sent either by e-mail to:
``moffitt.betty@dol.gov'', or by FAX to (202) 219-0204 by the end of
the scheduled comment period. The applications for exemption and the
comments received will be available for public inspection in the Public
Documents Room of the Employee Benefits Security Administration, U.S.
Department of Labor, Room N-1513, 200 Constitution Avenue, NW.,
Washington, DC 20210.
Notice to Interested Persons
Notice of the proposed exemptions will be provided to all
interested persons in the manner agreed upon by the applicant and the
Department within 15 days of the date of publication in the Federal
Register. Such notice shall include a copy of the notice of proposed
exemption as published in the Federal Register and shall inform
interested persons of their right to comment and to request a hearing
(where appropriate).
SUPPLEMENTARY INFORMATION: The proposed exemptions were requested in
applications filed pursuant to section 408(a) of the Act and/or section
4975(c)(2) of the Code, and in accordance with procedures set forth in
29 CFR part 2570, subpart B (55 FR 32836, 32847, August 10, 1990).
Effective December 31, 1978, section 102 of Reorganization Plan No. 4
of 1978, 5 U.S.C. App. 1 (1996), transferred the authority of the
Secretary of the Treasury to issue exemptions of the type requested to
the Secretary of Labor. Therefore, these notices of proposed exemption
are issued solely by the Department.
The applications contain representations with regard to the
proposed exemptions which are summarized below. Interested persons are
referred to the applications on file with the Department for a complete
statement of the facts and representations.
Harris Nesbitt Corporation (Harris Nesbitt) and Its Affiliates (the
Affiliates) (collectively, the Applicant) Located in New York, NY
[Application No. D-11281]
Proposed Exemption
Based on the facts and representations set forth in the
application, the Department is considering granting an exemption under
the authority of section 408(a) of the Act and section 4975(c)(2) of
the Code and in accordance with the procedures set forth in 29 CFR part
2570, subpart B (55 FR 32836, August 10, 1990).\1\
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\1\ For purposes of this proposed exemption, references to
provisions of Title I of the Act, unless otherwise specified, refer
also to the corresponding provisions of the Code.
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Section I. Covered Transactions
A. Effective for transactions occurring on or after October 15,
2004, the restrictions of sections 406(a) and 407(a) of the Act and the
taxes imposed by sections 4975(a) and (b) of the Code, by reason of
section 4975(c)(1)(A) through (D) of the Code, shall not apply to the
following transactions involving issuers (Issuers) and securities
(Securities) evidencing interests therein:
(1) The direct or indirect sale, exchange or transfer of Securities
in the initial issuance of Securities between the sponsor (Sponsor) or
underwriter (Underwriter) and an employee benefit plan when the
Sponsor, servicer (Servicer), trustee (Trustee) or insurer (Insurer) of
an Issuer, the Underwriter of the Securities representing an interest
in the Issuer, or an obligor (Obligor) is a party in interest with
respect to such plan.
(2) The direct or indirect acquisition or disposition of Securities
by a plan in the secondary market for such Securities; and
(3) The continued holding of Securities acquired by a plan pursuant
to subsection I.A.(1) or (2).
Notwithstanding the foregoing, Section I.A. does not provide an
exemption from the restrictions of sections 406(a)(1)(E), 406(a)(2) and
407 of the Act for the acquisition or holding of a Security on behalf
of an excluded plan (the Excluded Plan), by any person who has
discretionary authority or renders investment advice with respect to
the assets of that Excluded Plan.\2\
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\2\ Section I.A. provides no relief from sections 406(a)(1)(E),
406(a)(2) and 407 of the Act for any person rendering investment
advice to an Excluded Plan within the meaning of section
3(21)(A)(ii) of the Act and regulation 29 CFR 2510.3-21(c).
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B. Effective for transactions occurring on or after, October 15,
2004, the restrictions of section 406(b)(1) and 406(b)(2) of the Act
and the taxes imposed by sections 4975(a) and (b) of the Code, by
reason of section 4975(c)(1)(E) of the Code shall not apply to:
(1) The direct or indirect sale, exchange or transfer of Securities
in the initial issuance of Securities between the Sponsor or
Underwriter and a plan when the person who has discretionary authority
or renders investment advice with respect to the investment of plan
assets in the Securities is (a) an Obligor with respect to 5 percent or
less of the fair market value of obligations or receivables contained
in the Issuer, or (b) an Affiliate of a person described in (a); if
(i) The plan is not an Excluded Plan;
(ii) Solely in the case of an acquisition of Securities in
connection with the initial issuance of the Securities, at least 50
percent of each class of Securities in which plans have invested is
acquired by persons independent of the members of the restricted group
(Restricted Group), and at least 50 percent of the aggregate interest
in the Issuer is
[[Page 7629]]
acquired by persons independent of the Restricted Group;
(iii) A plan's investment in each class of Security does not exceed
25 percent of all of the Securities of that class outstanding at the
time of the acquisition; and
(iv) Immediately after the acquisition of the Securities, no more
than 25 percent of the assets of a plan with respect to which the
person has discretionary authority or renders investment advice are
invested in Securities representing an interest in an Issuer containing
assets sold or serviced by the same entity.\3\ For purposes of this
paragraph B.(1)(iv) only, an entity will not be considered to service
assets contained in an Issuer if it is merely a Subservicer of that
Issuer;
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\3\ For purposes of this exemption, each plan participating in a
commingled fund (such as a bank collective trust fund or insurance
company pooled separate account) shall be considered to own the same
proportionate undivided interest in each asset of the commingled
fund as its proportionate interest in the total assets of the
commingled fund as calculated on the most recent preceding valuation
date of the fund.
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(2) The direct or indirect acquisition or disposition of Securities
by a plan in the secondary market for such Securities, provided that
conditions set forth in paragraphs (i), (iii) and (iv) of subsection
I.B.(1) are met; and
(3) The continued holding of Securities acquired by a plan pursuant
to subsection I.B.(1) or (2).
C. Effective for transactions occurring on or after October 15,
2004, the restrictions of sections 406(a), 406(b), and 407(a) of the
Act and the taxes imposed by sections 4975(a) and (b) of the Code by
reason of Code section 4975(c), shall not apply to the transactions in
connection with the servicing, management and operation of an Issuer,
including the use of the any eligible swap transaction (the Eligible
Swap Transaction); or the defeasance of a mortgage obligation held as
an asset of the Issuer through the substitution of a new mortgage
obligation in a commercial mortgage-backed designated transaction (the
Designated Transaction), provided:
(1) Such transactions are carried out in accordance with the terms
of a binding pooling and servicing agreement (the Pooling and Servicing
Agreement);
(2) The Pooling and Servicing Agreement is provided to, or
described in all material respects in the prospectus or private
placement memorandum provided to, investing plans before they purchase
Securities issued by the Issuer; \4\ and
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\4\ In the case of a private placement memorandum, such
memorandum must contain substantially the same information that
would be disclosed in a prospectus if the offering of the securities
were made in a registered public offering under the Securities Act
of 1933. In the Department's view, the private placement memorandum
must contain sufficient information to permit plan fiduciaries to
make informed investment decisions. For purposes of this proposed
exemption, references to ``prospectus'' include any related
prospectus supplement thereto, pursuant to which Securities are
offered to investors.
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(3) The defeasance of a mortgage obligation and the substitution of
a new mortgage obligation in a commercial mortgage-backed Designated
Transaction meet the terms and conditions for such defeasance and
substitution as are described in the prospectus or private placement
memorandum for such Securities, which terms and conditions have been
approved by a rating agency (the Rating Agency) and does not result in
the Securities receiving a lower credit rating from the Rating Agency
than the current rating of the Securities.
Notwithstanding the foregoing, Section I.C. does not provide an
exemption from the restrictions of section 406(b) of the Act or from
the taxes imposed by reason of section 4975(c) of the Code for the
receipt of a fee by a Servicer of the Issuer from a person other than
the Trustee or Sponsor, unless such fee constitutes a qualified
administrative fee (Qualified Administrative Fee).
D. Effective for transactions occurring after October 15, 2004, the
restrictions of sections 406(a) and 407(a) of the Act and the taxes
imposed by sections 4975(a) and (b) of the Code, by reason of Code
section 4975(c)(1)(A) through (D) of the Code shall not apply to any
transactions to which those restrictions or taxes would otherwise apply
merely because a person is deemed to be a party in interest or
disqualified person (including a fiduciary), with respect to the plan
(or by virtue of having a relationship to such service provider
described in section 3(14)(F), (G), (H) or (I) of the Act or section
4975(e)(2)(F), (G), (H) or (I) of the Code), solely because of the
plan's ownership of Securities.
Section II. General Conditions
A. The relief provided under Section I. is available only if the
following conditions are met:
(1) The acquisition of Securities by a plan is on terms (including
the Security price) that are at least as favorable to the plan as such
terms would be in an arm's length transaction with an unrelated party;
(2) The rights and interests evidenced by the Securities are not
subordinated to the rights and interests evidenced by other Securities
of the same Issuer unless the Securities are issued in a Designated
Transaction;
(3) The Securities acquired by the plan have received a rating from
Rating Agency at the time of such acquisition that is in one of the
three (or in the case of Designated Transactions, four) highest generic
rating categories.
(4) The Trustee is not an Affiliate of any member of the Restricted
Group, other than an Underwriter. For purposes of this requirement:
(a) The Trustee shall not be considered to be an Affiliate of a
Servicer solely because the Trustee has succeeded to the rights and
responsibilities of the Servicer pursuant to the terms of a Pooling and
Servicing Agreement providing for such succession upon the occurrence
of one or more events of default by the Servicer; and
(b) Subsection II.A.(4) will be deemed satisfied notwithstanding a
Servicer becoming an Affiliate of the Trustee as a result of a merger
or acquisition involving the Trustee, such Servicer and/or their
Affiliates which occurs after the initial issuance of the Securities
provided that:
(i) Such Servicer ceases to be an Affiliate of the Trustee no later
than six months after the date such Servicer became an Affiliate of the
Trustee; and
(ii) Such Servicer did not breach any of its obligations under the
Pooling and Servicing Agreement, unless such breach was immaterial and
timely cured in accordance with the terms of such agreement, during the
period from the closing date (the Closing Date) of such merger or
acquisition transaction through the date the Servicer ceased to be an
Affiliate of the Trustee;
(5) The sum of all payments made to and retained by the
Underwriters in connection with the distribution or placement of
Securities represents not more than reasonable compensation (Reasonable
Compensation) for underwriting or placing the Securities; the sum of
all payments made to and retained by the Sponsor pursuant to the
assignment of obligations (or interests therein) to the Issuer
represents not more than the fair market value of such obligations (or
interests); and the sum of all payments made to and retained by the
Servicer represents not more than Reasonable Compensation for the
Servicer's services under the Pooling and Servicing Agreement and
reimbursement of the Servicer's reasonable expenses in connection
therewith;
(6) The plan investing in such Securities is an ``accredited
investor'' as defined in Rule 501(a)(1) of Regulation
[[Page 7630]]
D of the Securities and Exchange Commission (SEC) under the Securities
Act of 1933; and
(7) In the event that the obligations used to fund an Issuer have
not all been transferred to the Issuer on the Closing Date, additional
obligations as specified in subsection III.B.(1) may be transferred to
the Issuer during the pre-funding period (Pre-Funding Period) in
exchange for amounts credited to the pre-funding account (Pre-Funding
Account), provided that:
(a) The pre-funding limit (Pre-Funding Limit) is not exceeded;
(b) All such additional obligations meet the same terms and
conditions for eligibility as the original obligations used to create
the Issuer (as described in the prospectus or private placement
memorandum and/or Pooling and Servicing Agreement for such Securities),
which terms and conditions have been approved by a Rating Agency.
Notwithstanding the foregoing, the terms and conditions for determining
the eligibility of an obligation may be changed if such changes receive
prior approval either by a majority vote of the outstanding
securityholders (Securityholders) or by a Rating Agency;
(c) The transfer of such additional obligations to the Issuer
during the Pre-Funding Period does not result in the Securities
receiving a lower credit rating from a Rating Agency, upon termination
of the Pre-Funding Period than the rating that was obtained at the time
of the initial issuance of the Securities by the Issuer;
(d) The weighted average annual percentage interest rate (the
average interest rate) for all of the obligations in the Issuer at the
end of the Pre-Funding Period will not be more than 100 basis points
lower than the average interest rate for the obligations which were
transferred to the Issuer on the Closing Date;
(e) In order to ensure that the characteristics of the receivables
actually acquired during the Pre-Funding Period are substantially
similar to those which were acquired as of the Closing Date, the
characteristics of the additional obligations will either be monitored
by a credit support provider or other insurance provider which is
independent of the Sponsor or an independent accountant retained by the
Sponsor will provide the Sponsor with a letter (with copies provided to
the Rating Agency, the Underwriter and the Trustee) stating whether or
not the characteristics of the additional obligations conform to the
characteristics of such obligations described in the prospectus,
private placement memorandum and/or Pooling and Servicing Agreement. In
preparing such letter, the independent accountant will use the same
type of procedures as were applicable to the obligations which were
transferred on the Closing Date;
(f) The Pre-Funding Period shall be described in the prospectus or
private placement memorandum provided to investing plans; and
(g) The Trustee of the Trust (or any agent with which the Trustee
contracts to provide Trust services) will be a substantial financial
institution or trust company experienced in trust activities and
familiar with its duties, responsibilities, and liabilities as a
fiduciary under the Act. The Trustee, as the legal owner of the
obligations in the Trust, will enforce all the rights created in favor
of Securityholders of the Issuer, including employee benefit plans
subject to the Act.
(8) In order to ensure that the assets of the Issuer may not be
reached by creditors of the Sponsor in the event of bankruptcy or other
insolvency of the Sponsor:
(a) The legal documents establishing the Issuer will contain:
(i) Restrictions on the Issuer's ability to borrow money or issue
debt other than in connection with the securitization;
(ii) Restrictions on the Issuer merging with another entity,
reorganizing, liquidating or selling assets (other than in connection
with the securitization);
(iii) Restrictions limiting the authorized activities of the Issuer
to activities relating to the securitization;
(iv) If the Issuer is not a Trust, provisions for the election of
at least one independent director/partner/member whose affirmative
consent is required before a voluntary bankruptcy petition can be filed
by the Issuer; and
(v) If the Issuer is not a Trust, requirements that each
independent director/partner/member must be an individual that does not
have a significant interest in, or other relationships with, the
Sponsor or any of its Affiliates; and
(b) The Pooling and Servicing Agreement and/or other agreements
establishing the contractual relationships between the parties to the
securitization transaction will contain covenants prohibiting all
parties thereto from filing an involuntary bankruptcy petition against
the Issuer or initiating any other form of insolvency proceeding until
after the Securities have been paid; and
(c) Prior to the issuance by the Issuer of any Securities, a legal
opinion is received which states that either:
(i) A ``true sale'' of the assets being transferred to the Issuer
by the Sponsor has occurred and that such transfer is not being made
pursuant to a financing of the assets by the Sponsor; or
(ii) In the event of insolvency or receivership of the Sponsor, the
assets transferred to the Issuer will not be part of the estate of the
Sponsor;
(9) If a particular class of Securities held by any plan involves a
ratings dependent swap (the Ratings Dependent Swap) or a non-ratings
dependent swap (the Non-Ratings Dependent Swap) entered into by the
Issuer, then each particular swap transaction relating to such
Security:
(a) Shall be an eligible swap (the Eligible Swap);
(b) Shall be with an eligible swap counterparty (the Eligible Swap
Counterparty);
(c) In the case of a Ratings Dependent Swap, shall provide that if
the credit rating of the counterparty is withdrawn or reduced by any
Rating Agency below a level specified by the Rating Agency, the
Servicer (as agent for the Trustee) shall, within the period specified
under the Pooling and Servicing Agreement:
(i) Obtain a replacement swap agreement with an Eligible Swap
Counterparty which is acceptable to the Rating Agency and the terms of
which are substantially the same as the current swap agreement (at
which time the earlier swap agreement shall terminate); or
(ii) Cause the swap counterparty to establish any collateralization
or other arrangement satisfactory to the Rating Agency such that the
then current rating by the Rating Agency of the particular class of
Securities will not be withdrawn or reduced.
In the event that the Servicer fails to meet its obligations under
this subsection II.A.(9)(c), plan Securityholders will be notified in
the immediately following Trustee's periodic report which is provided
to Securityholders, and sixty days after the receipt of such report,
the exemptive relief provided under section I.C. will prospectively
cease to be applicable to any class of Securities held by a plan which
involves such Ratings Dependent Swap; provided that in no event will
such plan Securityholders be notified any later than the end of the
second month that begins after the date on which such failure occurs.
(d) In the case of a Non-Ratings Dependent Swap, shall provide
that, if the credit rating of the counterparty is withdrawn or reduced
below the lowest level specified in Section III.GG., the Servicer (as
agent for the Trustee) shall within a specified period after such
rating withdrawal or reduction:
[[Page 7631]]
(i) Obtain a replacement swap agreement with an Eligible Swap
Counterparty, the terms of which are substantially the same as the
current swap agreement (at which time the earlier swap agreement shall
terminate); or
(ii) Cause the swap counterparty to post collateral with the
Trustee in an amount equal to all payments owed by the counterparty if
the swap transaction were terminated; or
(iii) Terminate the swap agreement in accordance with its terms;
and
(e) Shall not require the Issuer to make any termination payments
to the counterparty (other than a currently scheduled payment under the
swap agreement) except from excess spread (the Excess Spread) or other
amounts that would otherwise be payable to the Servicer or the Sponsor;
(10) Any class of Securities, to which one or more swap agreements
entered into by the Issuer applies, may be acquired or held in reliance
upon the underwriter exemptions (the Underwriter Exemptions) only by
qualified plan investors (Qualified Plan Investors); and
(11) Prior to the issuance of any debt securities, a legal opinion
is received which states that the debt holders have a perfected
security interest in the Issuer's assets.
B. Neither any Underwriter, Sponsor, Trustee, Servicer, Insurer,
nor any Obligor, unless it or any of its Affiliates has discretionary
authority or renders investment advice with respect to the plan assets
used by a plan to acquire Securities, shall be denied the relief
provided under Section I., if the provision in subsection II.A.(6) is
not satisfied with respect to acquisition or holding by a plan of such
Securities, provided that (1) such condition is disclosed in the
prospectus or private placement memorandum; and (2) in the case of a
private placement of Securities, the Trustee obtains a representation
of each initial purchaser which is a plan that it is in compliance with
such condition, and obtains a covenant from each initial purchaser to
the effect that, so long as such initial purchaser (or any transferee
of such initial purchaser's Securities) is required to obtain from its
transferee a representation regarding compliance with the Securities
Act of 1933, any such transferees will be required to make a written
representation regarding compliance with the condition set forth in
Section II.A.(6).
Section III. Definitions
For purposes of this exemption:
A. ``Security'' means:
(1) A pass-through certificate or trust certificate that represents
a beneficial ownership interest in the assets of an Issuer which is a
Trust and which entitles the holder to payments of principal, interest
and/or other payments made with respect to the assets of such Trust; or
A security which is denominated as a debt instrument that is issued
by, and is an obligation of, an Issuer; with respect to which the
Underwriter is either (i) the sole underwriter or the manager or co-
manager of the underwriting syndicate, or (ii) a selling or placement
agent; or
(2) A Certificate denominated as a debt instrument that represents
an interest in either a Real Estate Mortgage Investment Conduit (REMIC)
or a Financial Asset Securitization Investment Trust (FASIT) within the
meaning of the section 860D(a) or section 860L of the Internal Revenue
Code; and that is issued by and is an obligation of a Trust, with
respect to Certificates defined in Section III.A. (1) and (2) above,
for which the Underwriter is either (i) the sole Underwriter or the
manager or co-manager of the Underwriting syndicate, or (ii) a selling
or placement agent.
For purposes of this exemption, references to ``Certificates
representing an interest in a Trust'' include Certificates denominated
as debt, which are issued by a Trust.
B. ``Issuer'' means an investment pool, the corpus or assets of
which are held in trust (including a grantor or owner Trust) or whose
assets are held by a partnership, special purpose corporation or
limited liability company (which Issuer may be a Real Estate Mortgage
Investment Conduit (REMIC) or a Financial Asset Securitization
Investment Trust (FASIT) within the meaning of section 860D(a) or
section 860L, respectively, of the Code); and the corpus or assets of
which consists solely of:
(1)(a) Secured consumer receivables that bear interest or are
purchased at a discount (including, but not limited to, home equity
loans and obligations secured by shares issued by a cooperative housing
association); and/or
(b) Secured credit instruments that bear interest or are purchased
at a discount in transactions by or between business entities
(including, but not limited to, qualified equipment notes secured by
leases (Qualified Equipment Notes Secured by Leases)); and/or
(c) Obligations that bear interest or are purchased at a discount
and which are secured by single-family residential and commercial real
property (including obligations secured by leasehold interest on
residential or commercial real property); and/or
(d) Obligations that bear interest or are purchased at a discount
and which are secured by motor vehicles or equipment, or qualified
motor vehicle leases (Qualified Motor Vehicle Leases; and/or
(e) Guaranteed governmental mortgage pool certificates, as defined
in 29 CFR 2510.3-101(1)(2); \5\ and/or
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\5\ In Advisory Opinion 99-05A (Feb. 22, 1999), the Department
expressed its view that mortgage pool certificates guaranteed and
issued by the Federal Agricultural Mortgage Corporation (Farmer Mac)
meet the definition of a guaranteed governmental mortgage pool
certificate as defined in 29 CFR 2510.3-101(i)(2).
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(f) Fractional undivided interests in any of the obligations
described in clauses (a)-(e) of this subsection B.(1); \6\
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\6\ It is the Department's view that the definition of
``Issuer'' contained in Section III.B. includes a two-tier structure
under which Securities issued by the first Issuer, which contains a
pool of receivables described above, are transferred to a second
Issuer which issues Securities that are sold to plans. However, the
Department is of the further view that, since the Underwriter
Exemptions generally provide relief for the direct or indirect
acquisition or disposition of Securities that are not subordinated,
no relief would be available if the Securities held by the second
Issuer were subordinated to the rights and interests evidenced by
other Securities issued by the first Issuer, unless such Securities
were issued in a Designated Transaction.
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Notwithstanding the foregoing, residential and home equity loan
receivables issued in Designated Transactions may be less than fully
secured, provided that (i) the rights and interests evidenced by
Securities issued in such Designated Transactions (as defined in
Section III.DD.) are not subordinated to the rights and interests
evidenced by Securities of the same Issuer; (ii) such Securities
acquired by the plan have received a rating from a Rating Agency at the
time of such acquisition that is in one of the two highest generic
rating categories; and (iii) any obligation included in the corpus or
assets of the Issuer must be secured by collateral whose fair market
value on the Closing Date of the Designated Transaction is at least
equal to 80% of the sum of: (I) the outstanding principal balance due
under the obligation which is held by the Trust and (II) the
outstanding principal balance(s) of any other obligation(s) of higher
priority (whether or not held by the Issuer) which are secured by the
same collateral.
(2) Property which had secured any of the obligations described in
subsection III.B.(1);
(3)(a) Undistributed cash or temporary investments made therewith
maturing no later than the next date on which distributions are to be
made to Securityholders; and/or
[[Page 7632]]
(b) Cash or investments made therewith which are credited to an
account to provide payments to Securityholders pursuant to any eligible
swap agreement (Eligible Swap Agreement) meeting the conditions of
subsection II.A.(9) or pursuant to any eligible yield supplement
agreement (Eligible Yield Supplement Agreement), and/or
(c) Cash transferred to the Issuer on the Closing Date and
permitted investments made therewith which:
(i) Are credited to a Pre-Funding Account established to purchase
additional obligations with respect to which the conditions set forth
in paragraph (a)-(g) of subsection II.A.(7) are met; and/or
(ii) Are credited to a capitalized interest account (the
Capitalized Interest Account); and
(iii) Are held by the Issuer for a period ending no later than the
first distribution date to Securityholders occurring after the end of
the Pre-Funding Period.
For purposes of this clause (c) of subsection III.B.(3), the term
``permitted investments'' means investments which: (i) are either (x)
direct obligations of, or obligations fully guaranteed as to timely
payment of principal and interest by, the United States or any agency
or instrumentality thereof, provided that such obligations are backed
by the full faith and credit of the United States, or (y) have been
rated (or the Obligor has been rated) in one of the three highest
generic rating categories by a Rating Agency; (ii) are described in the
Pooling and Servicing Agreement; and are permitted by the Rating
Agency.
(4) Rights of the Trustee under the Pooling and Servicing
Agreement, and rights under any insurance policies, third-party
guarantees, contracts of suretyship, Eligible Yield Supplement
Agreements, Eligible Swap Agreements meeting the conditions of
subsection II.A.(9) or other credit support arrangements with respect
to any obligations described in section III.B.(1).
Notwithstanding the foregoing, the term ``Issuer'' does not include
any investment pool unless: (i) The investment pool consists only of
assets of the type described in paragraph (a)-(f) of subsection
III.B.(1) which have been included in other investment pools, (ii)
Securities evidencing interests in such other investment pools have
been rated in one of the three (or in the case of Designated
Transactions, four) highest generic rating categories by a Rating
Agency for at least one year prior to the plan's acquisition of
Securities pursuant to this exemption, and (iii) Securities evidencing
interests in such other investment pools have been purchased by
investors other than plans for at least one year prior to the plan's
acquisition of Securities pursuant to the Underwriter Exemptions.
C. ``Underwriter'' means
(1) Harris Nesbitt;
(2) Any U.S.-domiciled person directly or indirectly, through one
or more intermediaries, controlling, controlled by or under common
control with such investment banking firm; and
(3) Any member of an underwriting syndicate or selling group of
which such firm or person described in subsections III.C.(1) or (2)
above is a manager or co-manager with respect to the Securities.
D. ``Sponsor'' means the entity that organizes as an Issuer by
depositing obligations therein in exchange for Securities.
E. ``Master Servicer'' means the entity that is a party to the
Pooling and Servicing Agreement relating to assets of the Issuer and is
fully responsible for servicing, directly or through Subservicers, the
assets of the Issuer.
F. ``Subservicer'' means an entity which, under the supervision of
and on behalf of the Master Servicer, services loans contained in the
Issuer, but is not a party to the Pooling and Servicing Agreement.
G. ``Servicer'' means any entity which services loans contained in
the Issuer, including the Master Servicer and any Subservicer.
H. ``Trust'' means an Issuer, which is a trust (including an owner
trust, grantor trust or a REMIC or FASIT which is organized as a
Trust).
I. ``Trustee'' means the Trustee of any Trust, which issues
Securities, and in the case of Securities which are denominated as debt
instruments, also means the Trustee of an indenture trust (the
Indenture Trust). ``Indenture Trustee'' means the Trustee appointed
under the indenture pursuant to which the subject Securities are
issued, the rights of holders of the Securities are set forth and a
security interest in the Trust assets in favor of the holders of the
Securities is created. The Trustee or the Indenture Trustee is also a
party to or beneficiary of all the documents and instruments
transferred to the Trust, and as such, has both the authority to, and
the responsibility for, enforcing all the rights created thereby in
favor of holders of the Securities, including those rights arising in
the event of default by the Servicer.
J. ``Insurer'' means the insurer or guarantor of, or provider of
other credit support for, an Issuer. Notwithstanding the foregoing, a
person is not an Insurer solely because it holds Securities
representing an interest in an Issuer, which are of a class
subordinated to Securities representing an interest in the same Issuer.
K. ``Obligor'' means any person, other than the Insurer, that is
obligated to make payments with respect to any obligation or receivable
included in the Trust. Where an Issuer contains Qualified Motor Vehicle
Leases or Qualified Equipment Notes Secured by Leases, ``Obligor''
shall also include any owner of property subject to any lease included
in the Issuer, or subject to any lease securing an obligation included
in the Issuer.
L. ``Excluded Plan'' means any plan with respect to which any
member of the Restricted Group is a ``plan sponsor'' within the meaning
of Section 3(16)(B) of the Act.
M. ``Restricted Group'' with respect to a class of Securities
means:
(1) Each Underwriter;
(2) Each Insurer;
(3) The Sponsor;
(4) The Trustee;
(5) Each Servicer;
(6) Any Obligor with respect to obligations or receivables included
in the Issuer constituting more than 5 percent of the aggregate
unamortized principal balance of the assets in the Issuer, determined
on the date of the initial issuance of Securities by the Issuer; or
(7) Each counterparty in an Eligible Swap Agreement;
(8) Any Affiliate of a person described in III.M. (1)-(7) above.
N. ``Affiliate'' of another person includes:
(1) Any person, directly or indirectly, through one or more
intermediaries, controlling, controlled by or under common control with
such other person;
(2) Any officer, director, partner, employee, relative (as defined
in section 3(15) of the Act), a brother, a sister, or a spouse of a
brother or sister of such other person; and
(3) Any corporation or partnership of which such other person is an
officer, director or partner.
O. ``Control'' means the power to exercise a controlling influence
over the management or policies of a person other than an individual.
P. A person will be ``independent'' of another person only if:
(1) Such person is not an Affiliate of that other person; and
(2) The other person, or an Affiliate thereof, is not a fiduciary
who has investment management authority or renders investment advice
with respect to assets of such person.
Q. ``Sale'' includes the entrance into a forward delivery
commitment
[[Page 7633]]
(Forward Delivery Commitment), provided:
(1) The terms of the Forward Delivery Commitment (including any fee
paid to the investing plan) are no less favorable to the plan than they
would be in an arm's length transaction with an unrelated party;
(2) The prospectus or private placement memorandum is provided to
an investing plan prior to the time the plan enters into the Forward
Delivery Commitment; and
(3) At the time of the delivery, all conditions of this exemption
applicable to sales are met.
R. ``Forward Delivery Commitment'' means a contact for the purchase
or sale of one or more Securities to be delivered at an agreed future
settlement date. The term includes both mandatory contracts (which
contemplate obligatory delivery and acceptance of the Securities) and
optional contracts (which give one party the right but not the
obligation to deliver Securities to, or demand delivery of Securities
from, the other party).
S. ``Reasonable Compensation'' has the same meaning as that term is
defined in 29 CFR 2550.408c-2.
T. ``Qualified Administrative Fee'' means a fee which meets the
following criteria:
(1) The fee is triggered by an act or failure to act by the Obligor
other than the normal timely payment of amounts owing in respect of the
obligations;
(2) The Servicer may not charge the fee absent the act or failure
to act referred to in subsection III.T.(1);
(3) The ability to charge the fee, the circumstances in which the
fee may be charged, and an explanation of how the fee is calculated are
set forth in the Pooling and Servicing Agreement; and
(4) The amount paid to investors in the Issuer will not be reduced
by the amount of any such fee waived by the Servicer.
U. ``Qualified Equipment Note Secured By a Lease'' means an
equipment note:
(1) Which is secured by equipment which is leased;
(2) Which is secured by the obligation of the lessee to pay rent
under the equipment lease; and
(3) With respect to which the Issuer's security interest in the
equipment is at least as protective of the rights of the Issuer as
would be the case if the equipment note were secured only by the
equipment and not the lease.
V. ``Qualified Motor Vehicle Lease'' means a lease of a motor
vehicle where:
(1) The Issuer owns or holds a security interest in the lease;
(2) The Issuer owns or holds a security interest in the leased
motor vehicle; and
(3) The Issuer's interest in the leased motor vehicle is at least
as protective of the Issuer's rights as the Issuer would receive under
a motor vehicle installment loan contract.
W. ``Pooling and Servicing Agreement'' means the agreement or
agreements among a Sponsor, a Servicer and the Trustee establishing a
Trust. In the case of Securities which are denominated as debt
instruments, ``Pooling and Servicing Agreement'' also includes the
indenture entered into by the Issuer and the Indenture Trustee.
X. ``Rating Agency'' means Standard & Poor's Ratings Services, a
division of The McGraw-Hill Companies, Inc., Moody's Investors Service,
Inc., Fitch, Inc. or any successors thereto.
Y. ``Capitalized Interest Account'' means an Issuer account:
(i) which is established to compensate Securityholders for
shortfalls, if any, between investment earnings on the Pre-Funding
Account and the pass-through rate payable under the Securities; and
(ii) which meets the requirements of clause (c) of subsection
III.B.(3).
Z. ``Closing Date'' means the date the Issuer is formed, the
Securities are first issued and the Issue's assets (other than those
additional obligations which are to be funded from the Pre-Funding
Account pursuant to subsection II.A.(7)) are transferred to the Issuer.
AA. ``Pre-Funding Account'' means an Issuer account: (i) which is
established to purchase additional obligations, which obligations meet
the conditions set forth in clauses (a)-(g) of subsection II.A.(7); and
(ii) which meets the requirements of clause (c) of subsection
III.B.(3).
BB. ``Pre-Funding Limit'' means a percentage or ratio of the amount
allocated to the Pre-Funding Account, as compared to the total
principal amount of the Securities being offered which is less than or
equal to 25 percent.
CC. ``Pre-Funding Period'' means the period commencing on the
Closing Date and ending no later than the earliest to occur of: (i) the
date the amount on deposit in the Pre-Funding Account is less than the
minimum dollar amount specified in the Pooling and Servicing Agreement;
(ii) the date on which an event of default occurs under the Pooling and
Servicing Agreement; or (iii) the date which is the later of three
months or 90 days after the Closing Date.
DD. ``Designated Transaction'' means a securitization transaction
in which the assets of the Issuer consist of secured consumer
receivables, secured credit instruments or secured obligations that
bear interest or are purchased at a discount and are: (i) Motor
vehicle, home equity and/or manufactured housing consumer receivables;
and/or (ii) motor vehicle credit instruments in transactions by or
between business entities; and/or (iii) single-family residential,
multi-family residential, home equity, manufactured housing and/or
commercial mortgage obligations that are secured by single-family
residential, multi-family residential, commercial real property or
leasehold interests therein. For purposes of this Section III.DD., the
collateral securing motor vehicle consumer receivables or motor vehicle
credit instruments may include motor vehicles and/or Qualified Motor
Vehicle Leases.
EE. ``Ratings Dependent Swap'' means an interest rate swap, or (if
purchased by or on behalf of the Issuer) an interest rate cap contract,
that is part of the structure of a class of Securities where the rating
assigned by the Rating Agency to any class of Securities held by any
plan is dependent on the terms and conditions of the swap and the
rating of the counterparty, and if such Securities rating is not
dependent on the existence of the swap and rating of the counterparty,
such swap or cap shall be referred to as a ``Non-Ratings Dependent
Swap.'' With respect to a Non-Ratings Dependent Swap, each Rating
Agency rating the Securities must confirm, as of the date of issuance
of the Securities by the Issuer that entering into an Eligible Swap
with such counterparty will not affect the rating of the Securities.
FF. ``Eligible Swap'' means a Ratings Dependent or Non-Ratings
Dependent Swap:
(1) Which is denominated in U.S. dollars;
(2) Pursuant to which the Issuer pays or receives, on or
immediately prior to the respective payment or distribution date for
the class of Securities to which the swap relates, a fixed rate of
interest, or a floating rate of interest based on a publicly available
index (e.g., LIBOR or the U.S. Federal Reserve's Cost of Funds Index
(COFI)), with the Issuer receiving such payments on at least a
quarterly basis and obligated to make separate payments no more
frequently than the counterparty, with all simultaneous payments being
netted;
(3) Which has a notional amount that does not exceed either: (i)
The principal balance of the class of Securities to which the swap
relates, or (ii) the portion of the principal balance of such class
represented solely by those types of corpus or assets of the Issuer
referred to in subsections III.B.(1), (2) and (3);
[[Page 7634]]
(4) Which is not leveraged (i.e., payments are based on the
applicable notional amount, the day count fractions, the fixed or
floating rates designated in subsection III.FF.(2), and the difference
between the products thereof, calculated on a one to one ratio and not
on a multiplier of such difference);
(5) Which has a final termination date that is either the earlier
of the date on which the Issuer terminates or the related class of
Securities is fully repaid; and
(6) Which does not incorporate any provision which could cause a
unilateral alteration in any provision described in subsections
III.FF.(1) through (4) without the consent of the Trustee.
GG. ``Eligible Swap Counterparty'' means a bank or other financial
institution which has a rating, at the date of issuance of the
Securities by the Issuer, which is in one of the three highest long-
term credit rating categories, or one of the two highest short-term
credit rating categories, utilized by at least one of the Rating
Agencies rating the Securities; provided that, if a swap counterparty
is relying on its short-term rating to establish eligibility under the
Underwriter Exemptions, such swap counterparty must either have a long-
term rating in one of the three highest long-term rating categories or
not have a long-term rating from the applicable Rating Agency, and
provided further that if the class of Securities with which the swap is
associated has a final maturity date of more than one year from the
date of issuance of the Securities, and such swap is a Ratings
Dependent Swap, the swap counterparty is required by the terms of the
swap agreement to establish any collateralization or other arrangement
satisfactory to the Rating Agencies in the event of a ratings downgrade
of the swap counterparty.
HH. ``Qualified Plan Investor'' means a plan investor or group of
plan investors on whose behalf the decision to purchase Securities is
made by an appropriate independent fiduciary that is qualified to
analyze and understand the terms and conditions of any swap transaction
used by the Issuer and the effect such swap would have upon the credit
ratings of the Securities. For purposes of the Underwriter Exemptions,
such a fiduciary is either:
(1) A ``qualified professional asset manager'' (QPAM),\7\ as
defined under Part V(a) of PTE 84-14, 49 FR 9494, 9506 (March 13,
1984);
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\7\ PTE 84-14 provides a class exemption for transactions
between a party in interest with respect to an employee benefit plan
and an investment fund (including either a single customer or pooled
separate account) in which the plan has an interest, and which is
managed by a QPAM, provided certain conditions are met. QPAMs (e.g.,
banks, insurance companies, registered investment advisers with
total client assets under management in excess of $85 million) are
considered to be experienced investment managers for plan investors
that are aware of their fiduciary duties under ERISA.
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(2) An ``in-house asset manager'' (INHAM),\8\ as defined under Part
IV(a) of PTE 96-23, 61 FR 15975, 15982 (April 10, 1996); or
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\8\ PTE 96-23 permits various transactions involving employee
benefit plans whose assets are managed by an INHAM, an entity which
is generally a subsidiary of an employer sponsoring the plan which
is a registered investment adviser with management and control of
total assets attributable to plans maintained by the employer and
its affiliates which are in excess of $50 million.
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(3) A plan fiduciary with total assets under management of at least
$100 million at the time of the acquisition of such Securities.
II. ``Excess Spread'' means, as of any day funds are distributed
from the Issuer, the amount by which the interest allocated to
Securities exceeds the amount necessary to pay interest to
Securityholders, servicing fees and expenses.
JJ. ``Eligible Yield Supplement Agreement'' means any yield
supplement agreement, similar yield maintenance arrangement or, if
purchased by or on behalf of the Issuer, an interest rate cap contract
to supplement the interest rates otherwise payable on obligations
described in subsection III.B.(1). Such an agreement or arrangement may
involve a notional principal contract provided that:
(1) It is denominated in U.S. dollars;
(2) The Issuer receives on, or immediately prior to the respective
payment date for the Securities covered by such agreement or
arrangement, a fixed rate of interest or a floating rate of interest
based on a publicly available index (e.g., LIBOR or COFI), with the
Issuer receiving such payments on at least a quarterly basis;
(3) It is not ``leveraged'' as described in subsection III.FF.(4);
(4) It does not incorporate any provision which would cause a
unilateral alteration in any provision described in subsections
III.JJ.(1)-(3) without the consent of the Trustee;
(5) It is entered into by the Issuer with an Eligible Swap
Counterparty; and
(6) It has a notional amount that does not exceed either: (i) the
principal balance of the class of Securities to which such agreement or
arrangement relates, or (ii) the portion of the principal balance of
such class represented solely by those types of corpus or assets of the
Issuer referred to in subsections III.B.(1), (2) and (3).
Effective Date: If granted, this proposed exemption will be
effective for all transactions described herein which occurred on or
after October 15, 2004.
Summary of Facts and Representations
1. Harris Nesbitt (or the Applicant), a Delaware corporation, is an
indirect, wholly owned subsidiary of the Bank of Montreal. Harris
Nesbitt maintains its principal office at 3 Times Square, New York, New
York and it also maintains branch sales offices in seven states. Harris
Nesbitt is a registered broker-dealer, a registered investment adviser,
and a member of the New York Stock Exchange, the National Association
of Securities Dealers, Inc., and other major securities exchanges, as
well as the Securities Investor Protection Corporation.
Harris Nesbitt engages in the purchase and sale of securities for
the account of its customers which include individual and institutional
accounts. Harris Nesbitt also purchases and sells securities for its
own proprietary trading accounts and for the accounts of its
Affiliates. Harris Nesbitt engages in trading mortgage-related and
other securities, including pass-through certificates issued by GNMA,
FNMA and FHLMC, callable agency debt, and collateralized mortgage
obligations for the account of its customers and for its own accounts.
Issuer Assets
2. Harris Nesbitt seeks exemptive relief to permit employee benefit
plans to invest in pass-through securities representing undivided
interests in the following categories of investments, which are held by
an Issuer: \9\ (a) Single and multi-family residential or commercial
mortgages; (b) motor vehicle receivables; (c) consumer or commercial
receivables; and (d) guaranteed governmental mortgage pool
certificates.\10\
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\9\ An issuer is an investment pool, the corpus or assets of
which are held in trust or whose assets are held by a partnership,
special purpose corporation or limited liability company.
\10\ Guaranteed governmental mortgage pool certificates are
mortgage-backed securities with respect to which interest and
principal payable is guaranteed by the Government National Mortgage
Association (GNMA), the Federal Home Loan Mortgage Corporation
(FHLMC), or the Federal National Mortgage Association (FNMA). The
Department's regulation relating to the definition of plan assets
(29 CFR 2510.3-101(i)) provides that where a plan acquires a
guaranteed governmental mortgage pool certificate, the plan's assets
include the certificate and all of its rights with respect to such
certificate under applicable law, but do not, solely by reason of
the plan's holding of such certificate, include any of the mortgages
underlying such certificate. The Applicant is requesting exemptive
relief for trusts containing guaranteed governmental mortgage pool
certificates because the certificates in such trusts may be plan
assets.
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[[Page 7635]]
Commercial mortgage investment trusts may include mortgages on
ground leases of real property. Commercial mortgages are frequently
secured by ground leases on the underlying property, rather than by fee
simple interests. The separation of the fee simple interest and the
ground lease interest is generally done for tax reasons. Properly
structured, the pledge of the ground lease to secure a mortgage
provides a lender with the same level of security as would be provided
by a pledge of the related fee simple interest. The terms of the ground
leases pledged to secure leasehold mortgages will in all cases be at
least ten years longer than the terms of such mortgages.\11\
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\11\ Trust assets may also include obligations that are secured
by leasehold interests on residential real property. But see PTE 90-
32 involving Prudential-Bache Securities, Inc., 55 FR 23147, 23150
(June 6, 1990). The Department received one comment from an
affiliate of the applicant with respect to the notice of proposed
exemption for PTE 90-32. The comment requested clarification that
the definition of trust in section III.B. would include trusts
containing certain obligations secured by leasehold interests on
residential real property (Residential Leasehold Mortgages or RLMs).
The comment noted that RLMs are originated in jurisdictions such as
Hawaii in which they are a ``necessary alternative to mortgages
secured by fee simple interests'' and that these RLMs are ``in
essence, the same as, and provide substantially the same degree of
security to investors as, mortgages secured by fee simple
interests.''
The comment represented that both the Federal Home Loan Mortgage
Corporation (Freddie Mac) and the Federal National Mortgage
Association (Fannie Mae) have purchase programs for these RLMs and
that such RLMs included in pools underlying mortgage pass-through
certificates would ``generally conform'' with either Freddie Mac or
Fannie Mae leasehold guidelines. In this regard, the term of the
leasehold underlying such RLMs would extend for at least five years
beyond the term of the RLM. The comment noted that the affiliate of
the applicant would ``comply with the requirement under the Freddie
Mac and Fannie Mae leasehold guidelines that such mortgages
constitute obligations secured by real property or an interest in
real estate.''
In PTE 90-32, the Department concurred with the views expressed
by the affiliate of the applicant that the definition of trust
includes RLMs as described in the comment.
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Residential and home equity loan receivables which are issued in
certain Designated Transactions, may be less than fully secured,
provided that: (a) The rights and interests evidenced by the Securities
issued in such Designated Transactions are not subordinated to the
rights and interests evidenced by the Securities of the same Issuer;
(b) such Securities acquired by the plan have received a rating from a
Rating Agency at the time of such acquisition that is in one of the two
highest generic rating categories; and (c) any obligation included in
the corpus or assets of the Issuer must be secured by collateral whose
fair market value on the Closing Date of the Designated Transaction is
at least equal to 80% of the sum of: (i) The outstanding principal
balance due under the obligation which is held by the Issuer; and (ii)
the outstanding principal balance(s) of any other obligation(s) of
higher priority (whether or not held by the Issuer) which are secured
by the same collateral. Securitization transactions in which the assets
of the securitization vehicle reflect the following categories of
receivables (all of which are also described in more detail below) are
referred to herein as ``Designated Transactions': (a) Automobile and
other motor vehicle loans, (b) residential and home equity loans (which
may have HLTV ratios in excess of 100%), (c) manufactured housing loans
and (d) commercial mortgages.
Issuer Structure
3. Each Issuer is established under a Pooling and Servicing
Agreement between a Sponsor, a Servicer and a Trustee. Prior to the
Closing Date under the Pooling and Servicing Agreement, the Sponsor or
Servicer of an Issuer establishes the trust, partnership, the special
purpose corporation or limited liability company, designates an entity
as Trustee, and, except to the extent a Pre-Funding Account, as
described below, will be used, selects assets to be included in the
Issuer. The assets are receivables, which may have been originated by a
Sponsor or Servicer of an Issuer, an Affiliate of the Sponsor or
Servicer, or by an unrelated lender and subsequently acquired by the
Issuer, Sponsor or Servicer.\12\
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\12\ It is the Applicant's understanding that the Department has
indicated that the definition of the term ``trust'' includes rights
under any yield supplement or similar arrangement which obligates
the Sponsor or Master Servicer, or another party specified in the
relevant Pooling and Servicing Agreement, to supplement the interest
rates otherwise payable on the permissible obligations held in the
trust, in accordance with the terms of a yield supplement
arrangement described in the Pooling and Servicing Agreement,
provided that such arrangements do not involve certain swap
agreements or other notional principal contracts.
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Typically, on or prior to the Closing Date, the Sponsor acquires
legal title to all assets selected for the Issuer. In some cases, legal
title to some or all of such assets continues to be held by the
originator of the receivable until the Closing Date. On the Closing
Date, the Sponsor and/or the originator of the receivables conveys to
the Issuer legal title to the assets, and the Trustee issues Securities
representing fractional undivided interests in the Issuer's assets. The
Applicant, alone or together with other broker-dealers, acts as
Underwriter or placement agent with respect to the sale of the
Securities. The Applicant currently anticipates that the public
offerings of Securities will be underwritten by it on a firm commitment
basis. In addition, the Applicant anticipates that it may privately
place Securities on both a firm commitment and an agency basis. The
Applicant may also act as the lead or co-managing Underwriter for a
syndicate of securities Underwriters.
4. Securityholders will be entitled to receive distributions of
principal and/or interest, or lease payments due on the receivables,
adjusted, in the case of payments of interest, to a specified rate--the
pass-through rate--which may be fixed or variable and paid monthly,
quarterly, or semi-annually as specified in the related prospectus or
private placement memorandum.
When installments or payments are made on a semi-annual basis,
funds are not permitted to be commingled with the Servicer's assets for
longer than would be permitted for a monthly-pay security. A segregated
account is established in the name of the Trustee (on behalf of
Securityholders) to hold funds received between distribution dates. The
account is under the sole control of the Trustee, who invests the
account's assets in short-term securities, which have received a rating
comparable to the rating assigned to the Securities. In some cases, the
Servicer may be permitted to make a single deposit into the account
once a month. When the Servicer makes such monthly deposits, payments
received from Obligors by the Servicer may be commingled with the
Servicer's assets during the month prior to deposit. Usually, the
period of time between receipt of funds by the Servicer and deposit of
these funds in a segregated account does not exceed one month.
Furthermore, in those cases where distributions are made semiannually,
the Servicer will furnish a report on the operation of the Trust to the
Trustee on a monthly basis. At or about the time this report is
delivered to the Trustee, it will be made available to Securityholders
and delivered to or made available to each Rating Agency that has rated
the Securities.
A Trust may elect to be treated as a real estate mortgage
investment conduit (REMIC) or a financial asset securitization
investment trust (FASIT), or may be treated as a grantor trust or a
partnership, for Federal income tax purposes.
5. Some of the Securities will be multi-class Securities. Harris
Nesbitt requests exemptive relief for two types
[[Page 7636]]
of multi-class Securities: ``strip'' Securities and ``senior/
subordinate'' (also sometimes referred to as ``fast pay/slow pay'')
Securities. Strip Securities are a type of Security in which the stream
of interest payments on receivables is split from the flow of principal
payments and separate classes of Securities are established, each
representing rights to disproportionate payments of principal and
interest.\13\
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\13\ When a plan invests in REMIC ``residual'' interest
Securities to which this exemption applies, some of the income
received by the plan as a result of such investment may be
considered unrelated business taxable income to the plan, which is
subject to federal income tax under the Code. The prudence
requirement of section 404(a)(1)(B) of the Act would require plan
fiduciaries to carefully consider this and other tax consequences
prior to causing plan assets to be invested in Securities pursuant
to this exemption.
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``Senior/subordinate'' Securities involve the issuance of classes
of Securities having different stated maturities or the same maturities
with different payment schedules. Interest and/or principal payments
received on the underlying receivables are distributed first to the
class of Securities having the earliest stated maturity of principal,
and/or earlier payment schedule, and only when that class of Securities
has been paid in full (or has received a specified amount) will
distributions be made with respect to the second class of Securities.
Distributions on Securities having later stated maturities will proceed
in like manner until all the Securityholders have been paid in full.
The only difference between this multi-class pass-through arrangement
and a single-class pass-through arrangement is the order in which
distributions are made to Securityholders. In each case,
Securityholders will have a beneficial ownership interest in the
underlying assets. Except as permitted in a Designated Transaction, the
rights of a plan purchasing a Security will not be subordinated to the
rights of another Securityholder in the event of default on any of the
underlying obligations. In particular, unless the Securities are issued
in a Designated Transaction, if the amount available for distribution
to Securityholders is less than the amount required to be so
distributed, all senior Securityholders then entitled to receive
distributions will share in the amount distributed on a pro rata
basis.\14\
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\14\ If an Issuer issues subordinated Securities, holders of
such subordinated Securities may not share in the amount distributed
on a pro rata basis with the senior Securityholders. The Department
notes that the proposed exemption does not provide relief for plan
investments in such subordinated Securities, unless issued in a
Designated Transaction.
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6. For tax reasons, the Issuer will be maintained as an essentially
passive entity. Therefore, both the Sponsor's discretion and the
Servicer's discretion with respect to assets included in an Issuer are
severely limited. Pooling and Servicing Agreements provide for the
substitution of receivables by the Sponsor only in the event of defects
in documentation discovered within a short time after the issuance of
investor Securities (within 120 days, except in the case of obligations
having an original term of 30 years, in which case the period will not
exceed two years). Any receivable so substituted is required to have
characteristics substantially similar to the replaced receivable and
will be at least as creditworthy as the replaced receivable.
In some cases, the affected receivable would be repurchased, with
the purchase price applied as a payment on the affected receivable and
passed through to Securityholders.
Conditions to Interest Rate Swaps
7. The Applicant requests relief for both ratings dependent and
non-ratings dependent swaps as described in Prohibited Transaction
Exemption 2000-58 (65 FR 67765, November 13, 2000) (PTE 2000-58),
subject to the same terms and conditions regarding interest rate swaps
contained in that exemption.
In this regard, an Eligible Swap will be a swap transaction:
(a) Which is denominated in U.S. Dollars;
(b) Pursuant to which the Issuer pays or receives, on or
immediately prior to the respective payment or distribution date for
the applicable class of Securities, a fixed rate of interest or a
floating rate of interest based on a publicly available index (e.g.,
LIBOR or the U.S. Federal Reserve's Cost of Funds Index (COFI)), with
the Issuer receiving such payments on at least a quarterly basis and
being obligated to make separate payments no more frequently than the
counterparty, with all simultaneous payments being netted;
(c) Which has a notional amount that does not exceed either: (i)
The principal balance of the class of Securities to which the swap
relates, or (ii) The portion of the principal balance of such class
represented solely by those types of corpus or assets of the Issuer
referred to in subsections III.B.(1), (2) and (3) of the requested
exemption;
(d) Which is not leveraged (i.e., payments are based on the
applicable notional amount, the day count fractions, the fixed or
floating rates designated in item (b) above and the difference between
the products thereof, calculated on a one-to-one ratio and not on a
multiplier of such difference);
(e) Which has a final termination date that is the earlier of the
date on which the Issuer terminates or the related class of Securities
is fully repaid; and
(f) Which does not incorporate any provision which could cause a
unilateral alteration in any provision described in items (a) through
(e) above without the consent of the Trustee.
In addition, any Eligible Swap entered into by the Issuer will be
with an ``Eligible Swap Counterparty,'' which will be a bank or other
financial institution with a rating at the date of issuance of the
Securities by the Issuer which is in one of the three highest long-term
credit rating categories, or one of the two highest short-term credit
rating categories, utilized by at least one of the Rating Agencies
rating the Securities; provided that, if a swap counterparty is relying
on its short-term rating to establish its eligibility, such
counterparty must either have a long-term rating in one of the three
highest long-term rating categories or not have a long-term rating from
the applicable Rating Agency, and provided further that if the class of
Securities with which the swap is associated has a final maturity date
of more than one year from the date of issuance of the Securities, and
such swap is a Ratings Dependent Swap, the swap counterparty is
required by the terms of the swap agreement to establish any
collateralization or other arrangement satisfactory to the Rating
Agencies in the event of a ratings downgrade of the swap counterparty.
Under any termination of a swap, the Issuer will not be required to
make any termination payments to the swap counterparty (other than a
currently scheduled payment under the swap agreement) except from
Excess Spread or other amounts that would otherwise be payable to the
Servicer or the Sponsor.
With respect to a Rating Dependent Swap, the Servicer shall either
cause the eligible counterparty to establish certain collateralization
or other arrangements satisfactory to the Rating Agencies in the event
of a rating downgrade of such swap counterparty below a level specified
by the Rating Agency (which will be no lower than the level which would
make such counterparty an eligible counterparty), or the Servicer shall
obtain a replacement swap with an Eligible Swap Counterparty acceptable
to the Rating Agencies with substantially similar terms. If the
Servicer fails to do so, the plan Securityholders will be notified in
the immediately following Trustee's
[[Page 7637]]
periodic report to Securityholders and will have a 60-day period
thereafter to dispose of the Securities, at the end of which period the
exemptive relief provided under Section I.C. of the requested exemption
(relating to the servicing, management and operation of the Issuer)
would prospectively cease to be available. With respect to Non-Ratings
Dependent Swaps, each Rating Agency rating the Securities must confirm,
as of the date of issuance of the Securities by the Issuer that
entering into the swap transactions with the eligible counterparty will
not affect the rating of the Securities.
Any class of Securities to which one or more swap agreements
entered into by the Issuer applies will be acquired or held only by
Qualified Plan Investors. Qualified Plan Investors will be plan
investors represented by an appropriate independent fiduciary that is
qualified to analyze and understand the terms and conditions of any
swap transaction relating to the class of Securities to be purchased
and the effect such swap would have upon the credit rating of the
Securities to which the swap relates.
For purposes of the proposed exemption, such a qualified
independent fiduciary will be either:
(a) A ``qualified professional asset manager'' (i.e., QPAM), as
defined under Part V(a) of PTE 84-14;
(b) An ``in-house asset manager'' (i.e., INHAM), as defined under
Part IV(a) of PTE 96-23; or
(c) A plan fiduciary with total assets under management of at least
$100 million at the time of the acquisition of such Securities.
Yield Supplement Agreements
8. A yield supplement agreement (the Yield Supplement Agreement) is
a contract under which the Issuer makes a single cash payment to the
contract provider in return for the contract provider promising to make
certain payments to the Issuer in the event of market fluctuations in
interest rates. For example, if a class of Securities promises an
interest rate which is the greater of 7% or LIBOR and LIBOR increases
significantly, the Yield Supplement Agreement might obligate the
contract provider pay to the Issuer the excess of LIBOR over 7%. In
some circumstances, the contract provider's obligation may be capped at
a certain aggregate maximum dollar liability under the contract.
Alternatively, a cap could be placed on the supplemental interest that
would be paid to a Securityholder from monies paid under the Yield
Supplement Agreement. For example, the Yield Supplement Agreement would
provide the difference between LIBOR and 7% but only to the extent that
the Securityholder would be paid a total of 9%. The interest to be paid
by the contract provider to the Issuer under the Yield Supplement
Agreement is usually calculated based on a notional principal balance
which may mirror the principal balances of those classes of Securities
to which the Yield Supplement Agreement relates or some other fixed
amount. This notional amount will not exceed either: (a) The principal
balance of the class of Securities to which such agreement or
arrangement relates, or (b) the portion of the principal balance of
such class represented solely by those types of corpus or assets of the
Issuer referred to in subsections III.B.(1), (2) and (3) of the
proposed exemption. In all cases, the Issuer makes no payments other
than the fixed purchase price for the Yield Supplement Agreement and
may, therefore, be distinguished from an interest rate swap agreement,
notwithstanding that both types of agreements may use an International
Swaps and Derivatives Association, Inc. (ISDA) form of contract.
The Applicant notes that no ``plan assets'' within the meaning of
the plan asset regulation (under 29 CFR 2510-3-101) are utilized in the
purchase of the Yield Supplement Agreement, as the Sponsor or some
other third party funds such arrangement with an up-front single-sum
payment. The Issuer's only obligation is to receive payments from the
counterparty if interest rate fluctuations require them under the terms
of the contract and to pass them through to Securityholders. The Rating
Agencies examine the creditworthiness of the counterparty in a ratings
dependent yield supplement agreement.
Pre-Funding Accounts
9. Although many transactions occur as described above, it is also
common for other transactions to be structured using a Pre-Funding
Account and/or a Capitalized Interest Account as described below.
The Pre-Funding Period for any Issuer will be defined as the period
beginning on the Closing Date and ending on the earliest to occur of
(a) the date on which the amount on deposit in the Pre-Funding Account
is less than a specified dollar amount, (b) the date on which an event
of default occurs under the related Pooling and Servicing Agreement
\15\ or (c) the date which is the later of three months or ninety days
after the Closing Date. If pre-funding is used, the Sponsor or
originator will transfer to the Issuer on the Closing Date cash
sufficient to purchase the receivables to be transferred after the
Closing Date. During the Pre-Funding Period, such cash and temporary
investments, if any, made therewith will be held in a Pre-Funding
Account and used to purchase the additional receivables, the
characteristics of which will be substantially similar to the
characteristics of the receivables transferred to the Issuer on the
Closing Date. Certain specificity and monitoring requirements described
below must be met and will be disclosed in the Pooling and Servicing
Agreement and/or the prospectus \16\ or private placement memorandum.
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\15\ The minimum dollar amount is generally the dollar amount
below which it becomes too uneconomical to administer the Pre-
Funding Account. An event of default under the Pooling and Servicing
Agreement generally occurs when: (a) A breach of a covenant or a
breach of a representation and warranty concerning the Sponsor, the
Servicer or certain other parties occurs which is not cured; (b) a
required payment to Securityholders is not made; or (c) the Servicer
becomes insolvent.
\16\ References to the term ``prospectus'' herein shall include
any prospectus supplement related thereto, pursuant to which
Securities are offered to investors.
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For transactions involving an Issuer using pre-funding, on the
Closing Date, a portion of the offering proceeds will be allocated to
the Pre-Funding Account generally in an amount equal to the excess of
(a) the principal amount of Securities being issued over (b) the
principal balance of the receivables being transferred to the Issuer on
such Closing Date. In certain transactions, the aggregate principal
balance of the receivables intended to be transferred to the Issuer may
be larger than the total principal balance of the Securities being
issued. In these cases, the cash deposited in the Pre-Funding Account
will equal the excess of the principal balance of the total receivables
intended to be transferred to the Issuer over the principal balance of
the receivables being transferred on the Closing Date.
On the Closing Date, the Sponsor transfers the assets to the Issuer
in exchange for the Securities. The Securities are then sold to an
Underwriter for cash or to the Securityholders directly if the
Securities are sold through an initial purchaser or placement agent.
The cash received by the Sponsor from the Securityholders (or the
Underwriter) from the sale of the Securities issued by the Issuer in
excess of the purchase price for the receivables and certain other
Issuer expenses such as underwriting or placement agent fees and legal
and accounting fees, constitutes the cash to be deposited in the Pre-
Funding Account. Such funds are either held in the Issuer and accounted
for separately, or held in a
[[Page 7638]]
sub-account or sub-trust. In either event, these funds are not part of
assets of the Sponsor.
Generally, the receivables are transferred at par value, unless the
interest rate payable on the receivables is not sufficient to service
both the interest rates to be paid on the Securities and the
transaction fees (i.e., servicing fees, Trustee fees and fees to credit
support providers). In such cases, the receivables are sold to the
Issuer at a discount, based on an objective, written, mechanical
formula which is set forth in the Pooling and Servicing Agreement and
agreed upon in advance between the Sponsor, the Rating Agency and any
credit support provider or other Insurer. The proceeds payable to the
Sponsor from the sale of the receivables transferred to the Issuer may
also be reduced to the extent they are used to pay transaction costs
(which typically include underwriting or placement agent fees and legal
and accounting fees). In addition, in certain cases, the Sponsor may be
required by the Rating Agencies or credit support providers to set up
Issuer reserve accounts to protect the Securityholders against credit
losses.
The percentage or ratio of the amount allocated to the Pre-Funding
Account, less the principal amount of any loan specifically identified
for subsequent delivery to the Issuer as of the Closing Date, as
compared to the total principal amount of the Securities being offered
(the Pre-Funding Limit) will not exceed 25%. The Pre-Funding Limit
(which may be expressed as a ratio or as a stated percentage or as a
combination thereof) will be specified in the prospectus or the private
placement memorandum.
Any amounts paid out of the Pre-Funding Account are used solely to
purchase receivables and to support the Securities pass-through rate
(as explained below). Amounts used to support the pass-through rate are
payable only from investment earnings and are not payable from
principal. However, in the event that, after all of the requisite
receivables have been transferred into the Issuer, any funds remain in
the Pre-Funding Account, such funds will be paid to the Securityholders
as principal prepayments. Upon termination of the Issuer, if no
receivables remain in the Issuer and all amounts payable to
Securityholders have been distributed, any amounts remaining in the
Issuer would be returned to the Sponsor.
A dramatic change in interest rates on the receivables to be
transferred to an Issuer using a Pre-Funding Account is handled as
follows. If the receivables (other than those with adjustable or
variable rates) had already been originated prior to the Closing Date,
no action would be required, as the fluctuations in market interest
rates would not affect the receivables transferred to the Issuer after
the Closing Date. In contrast, if interest rates fall after the Closing
Date, receivables originated after the Closing Date will tend to be
originated at lower rates, with the possible result that the
receivables will not support the interest rate payable on the
Securities. In such situations, the Sponsor could sell the receivables
into the Issuer at a discount and more receivables will be used to fund
the Issuer in order to support the pass-through rate. In a situation
where interest rates drop dramatically and the Sponsor is unable to
provide sufficient receivables at the requisite interest rates, the
pool of receivables would be closed. In this latter event, under the
terms of the Pooling and Servicing Agreement, the Securityholders would
receive a repayment of principal from the unused cash held in the Pre-
Funding Account. In transactions where the pass-through rates of the
Security are variable or adjustable, the effects of market interest
rate fluctuations are mitigated. In no event will fluctuations in
interest rates payable on the receivables affect the pass-through rate
for fixed rate Securities.
The cash deposited into the Issuer and allocated to the Pre-Funding
Account is invested in certain permitted investments, which may be
commingled with other accounts of the Issuer. The allocation of
investment earnings to each Issuer account is made periodically as
earned in proportion to each account's allocable share of the
investment returns. As Pre-Funding Account investment earnings are
required to be used to support (to the extent authorized in the
particular transaction) the pass-through amounts payable to the
Securityholders with respect to a periodic distribution date, the
Trustee is necessarily required to make periodic, separate allocations
of the Issuer's earnings to each Issuer account, thus ensuring that all
allocable commingled investment earnings are properly credited to the
Pre-Funding Account on a timely basis.
Capitalized Interest Accounts
10. When a Pre-Funding Account is used, the Sponsor and/or
originator may also transfer to the Issuer additional cash on the
Closing Date, to be deposited in a Capitalized Interest Account and
used during the Pre-Funding Period to compensate the Securityholders
for any shortfall between the investment earnings on the Pre-Funding
Account and the pass-through interest rate payable under the
Securities.
Because the Securities are supported by the receivables in the
Issuer and the earnings on the Pre-Funding Account, the Capitalized
Interest Account is needed when the investment earnings on the Pre-
Funding Account and the interest paid on the receivables are less than
the interest payable on the Securities. The Capitalized Interest
Account funds are paid out periodically to the Securityholders as
needed on distribution dates to support the pass-through rate. In
addition, a portion of such funds may be returned to the Sponsor from
time to time as the receivables are transferred into the Issuer and the
need for the Capitalized Interest Account diminishes. Any amounts held
in the Capitalized Interest Account generally will be returned to the
Sponsor and/or originator either at the end of the Pre-Funding Period
or periodically as receivables are transferred and the proportionate
amount of funds in the Capitalized Interest Account can be reduced.
Generally, the Capitalized Interest Account terminates no later than
the end of the Pre-Funding Period. However, there may be some cases
where the Capitalized Interest Account remains open until the first
date distributions are made to Securityholders following the end of the
Pre-Funding Period.
In other transactions, a Capitalized Interest Account is not
necessary because the interest paid on the receivables exceeds the
interest payable on the Securities at the applicable interest rate and
the fees payable by the Issuer. Such excess is sufficient to make up
any shortfall resulting from the Pre-Funding Account earning less than
the interest rate payable on the Securities. In certain of these
transactions, this occurs because the aggregate principal amount of
receivables exceeds the aggregate principal amount of Securities.
Pre-Funding Account and Capitalized Interest Account Payments and
Investments
11. Pending the acquisition of additional receivables during the
Pre-Funding Period, it is expected that amounts in the Pre-Funding
Account and the Capitalized Interest Account will be invested in
certain permitted investments or will be held uninvested. Pursuant to
the Pooling and Servicing Agreement, all permitted investments must
mature prior to the date the actual funds are needed. The permitted
types
[[Page 7639]]
of investments in the Pre-Funding Account and Capitalized Interest
Account are investments which either: (a) Are direct obligations of, or
obligations fully guaranteed as to timely payment of principal and
interest by, the United States or any agency or instrumentality
thereof, provided that such obligations are backed by the full faith
and credit of the United States or (b) have been rated (or the Obligor
has been rated) in one of the three highest generic rating categories
(or four, in the case of Designated Transactions) by a Rating Agency,
as set forth in the Pooling and Servicing Agreement and as required by
the Rating Agencies. The credit grade quality of the permitted
investments is generally no lower than that of the Securities. The
types of permitted investments will be described in the Pooling and
Servicing Agreement.
The ordering of interest payments to be made from the Pre-Funding
and Capitalized Interest Accounts is pre-established and set forth in
the Pooling and Servicing Agreement. The only principal payments which
will be made from the Pre-Funding Account are those made to acquire the
receivables during the Pre-Funding Period and those distributed to the
Securityholders in the event that the entire amount in the Pre-Funding
Account is not used to acquire receivables. The only principal payments
which will be made from the Capitalized Interest Account are those made
to Securityholders if necessary to support the Security pass-through
rate or those made to the Sponsor either periodically as they are no
longer needed or at the end of the Pre-Funding Period when the
Capitalized Interest Account is no longer necessary.
The Characteristics of the Receivables Transferred During the Pre-
Funding Period
12. In order to ensure that there is sufficient specificity as to
the representations and warranties of the Sponsor regarding the
characteristics of the receivables to be transferred after the Closing
Date:
(a) All such receivables will meet the same terms and conditions
for eligibility as those of the original receivables used to create the
Issuer (as described in the prospectus or private placement memorandum
and/or Pooling and Servicing Agreement for such Securities), which
terms and conditions have been approved by a Rating Agency. However,
the terms and conditions for determining the eligibility of a
receivable may be changed if such changes receive prior approval either
by a majority vote of the outstanding Securityholders or by a Rating
Agency; \17\
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\17\ In some transactions, the Insurer and/or credit support
provider may have the right to veto the inclusion of receivables,
even if such receivables otherwise satisfy the underwriting
criteria. This right usually takes the form of a requirement that
the Sponsor obtain the consent of these parties before the
receivables can be included in the Issuer. The Insurer and/or credit
support provider may, therefore, reject certain receivables or
require that the Sponsor establish certain Issuer reserve accounts
as a condition of including these receivables. Virtually all Issuers
which have Insurers or other credit support providers are structured
to give such veto rights to these parties. The percentage of Issuers
that have Insurers and/or credit support providers, and accordingly
feature such veto rights, varies.
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(b) The transfer of the receivables acquired during the Pre-Funding
Period will not result in the Securities receiving a lower credit
rating from the Rating Agency upon termination of the Pre-Funding
Period than the rating that was obtained at the time of the initial
issuance of the Securities by the Issuer;
(c) The weighted average annual percentage interest rate (the
average interest rate) for all of the obligations in the Issuer at the
end of the Pre-Funding Period will not be more than 100 basis points
lower than the average interest rate for the obligations which were
transferred to the Issuer on the Closing Date;
(d) The Trustee of the Trust (or any agent with which the Trustee
contracts to provide trust services) will be a substantial financial
institution or trust company experienced in Issuer activities and
familiar with its duties, responsibilities, and liabilities as a
fiduciary under the Act. The Trustee, as the legal owner of the
receivables in the Issuer or the holder of a security interest in the
receivables, will enforce all the rights created in favor of
Securityholders of such Issuer, including employee benefit plans
subject to the Act.
In order to ensure that the characteristics of the receivables
actually acquired during the Pre-Funding Period are substantially
similar to receivables that were acquired as of the Closing Date, the
characteristics of the additional receivables subsequently acquired
will either be monitored by a credit support provider or other
insurance provider which is independent of the Sponsor or an
independent accountant retained by the Sponsor will provide the Sponsor
with a letter (with copies provided to the Rating Agency, the
Underwriter and the Trustees) stating whether or not the
characteristics of the additional receivables acquired after the
Closing Date conform to the characteristics of such receivables
described in the prospectus, private placement memorandum and/or
Pooling and Servicing Agreement. In preparing such letter, the
independent accountant will use the same type of procedures as were
applicable to the obligations which were transferred as of the Closing
Date.
Each prospectus, private placement memorandum and/or Pooling and
Servicing Agreement will set forth the terms and conditions for
eligibility of the receivables to be included in the Issuer as of the
related Closing Date, as well as those to be acquired during the Pre-
Funding Period, which terms and conditions will have been agreed to by
the Rating Agencies which are rating the applicable Securities as of
the Closing Date. Also included among these conditions is the
requirement that the Trustee be given prior notice of the receivables
to be transferred, along with such information concerning those
receivables as may be requested. Each prospectus or private placement
memorandum will describe the amount to be deposited in, and the
mechanics of, the Pre-Funding Account and will describe the Pre-Funding
Period for the Issuer.
Parties to Transactions
13. The originator of a receivable is the entity that initially
lends money to a borrower (Obligor), such as a homeowner or automobile
purchaser, or leases property to a lessee. The originator may either
retain a receivable in its portfolio or sell it to a purchaser, such as
a Sponsor.
Originators of receivables held by the Issuer will be entities that
originate receivables in the ordinary course of their business,
including finance companies for whom such origination constitutes the
bulk of their operations, financial institutions for whom such
origination constitutes a substantial part of their operations, and any
kind of manufacturer, merchant, or service enterprise for whom such
origination is an incidental part of its operations. Each Issuer may
contain assets of one or more originators. The originator of the
receivables may also function as the Sponsor or Servicer.
14. The Sponsor will be one of three entities: (a) A special-
purpose or other corporation unaffiliated with the Servicer, (b) a
special-purpose or other corporation affiliated with the Servicer, or
(c) the Servicer itself. Where the Sponsor is not also the Servicer,
the Sponsor's role will generally be limited to acquiring the
receivables to be held by the Issuer, establishing the Issuer,
designating the Trustee, and assigning the receivables to the Issuer.
[[Page 7640]]
15. The Trustee of a Trust (or the Issuer if it is not a Trust) is
the legal owner of the obligations held by the Issuer and would hold a
security interest in the collateral securing such obligations. The
Trustee is also a party to or beneficiary of all the documents and
instruments transferred to the Issuer, and as such is responsible for
enforcing all the rights created thereby in favor of Securityholders,
including those rights arising in the event of default by the Servicer.
The Trustee generally will be an independent entity, although the
Trustee may be related to the Applicant.\18\ The Applicant represents
that the Trustee will be a substantial financial institution or trust
company experienced in trust activities. The Trustee receives a fee for
its services, which will be paid from cash flows in the Trust. The
method of compensating the Trustee, which is specified in the Pooling
and Servicing Agreement, will be disclosed in the prospectus or private
placement memorandum relating to the offering of the Securities.
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\18\ See PTE 2002-41 (67 FR 54487, August 22, 2002), an
amendment to the prior individual exemptions granted for mortgage-
backed and other asset-backed securities (the Underwriter
Exemptions), which permits the trustee of the trust to be an
affiliate of the Underwriter of the certificates.
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The rights and obligations of the Indenture Trustee are no
different than those of the Trustee of an Issuer which is a Trust. The
Indenture Trustee is obligated to oversee and administer the activities
of all of the ongoing parties to the transaction and possesses the
authority to replace those entities, sue them, liquidate the collateral
and perform all necessary acts to protect the interests of the debt
holders. If debt is issued in a transaction, there may not be a Pooling
and Servicing Agreement. Instead, there is a sales agreement and
servicing agreement (or these two agreements are sometimes combined
into a single agreement). The agreement(s) set(s) forth, among other
things, the duties and responsibilities of the parties to the
transaction relating to the administration of the Issuer. The Indenture
Trustee is often a party to these agreements. At a minimum, the
Indenture Trustee acknowledges its rights and responsibilities in these
agreements or they are contractually set forth in the indenture
agreement pursuant to which the Indenture Trustee is appointed.
16. The Servicer of an Issuer administers the receivables on behalf
of the Securityholders. The Servicer's functions typically involve,
among other things, notifying borrowers of amounts due on receivables,
maintaining records of payments received on receivables and instituting
foreclosure or similar proceedings in the event of default. In cases
where a pool of receivables has been purchased from a number of
different originators and transferred to an Issuer, the receivables may
be ``subserviced'' by their respective originators and a single entity
may ``master service'' the pool of receivables on behalf of the owners
of the related series of Securities. Where this arrangement is adopted,
a receivable continues to be serviced from the perspective of the
borrower by the local Subservicer, while the investor's perspective is
that the entire pool of receivables is serviced by a single, central
Master Servicer who collects payments from the local Subservicers and
passes them through to Securityholders.
A Servicer's default is treated in the same manner whether or not
the Issuer is a Trust. The original Servicer can be replaced, and the
entity replacing the Servicer varies from transaction to transaction.
In certain cases, it may be the Trustee (or Indenture Trustee if the
Issuer is not a Trust) or it may be a third party satisfactory to the
Rating Agencies and/or credit support provider. In addition, there are
transactions where the Trustee or Indenture Trustee will assume the
Servicer's responsibilities on a temporary basis until the permanent
replacement takes over. In all cases, the replacement entity must be
capable of satisfying all of the duties and responsibilities of the
original Servicer and must be an entity that is satisfactory to the
Rating Agencies.
If, after the initial issuance of Securities, a Servicer of
receivables held by an Issuer which has issued Securities in reliance
upon the Underwriter Exemptions (or an Affiliate thereof) merges with
or is acquired by (or acquires) the Trustee of such Trust (or an
Affiliate thereof), and thereby becomes an Affiliate of the Trustee,
the requirement that the Trustee not be an Affiliate of the Restricted
Group (other than the Underwriter) will not be violated, provided that:
(a) Such Servicer ceases to be an Affiliate of the Trustee no later
than six months after the date such Servicer became an Affiliate of the
Trustee; and (b) such Servicer did not breach any of its obligations
under the Pooling and Servicing Agreement, unless such breach was
immaterial and timely cured in accordance with the terms of such
agreement, during the period from the Closing Date of such merger or
acquisition transaction through the date the Servicer ceased to be an
Affiliate of the Trustee.
The Underwriter will be a U.S. registered broker-dealer that acts
as Underwriter or placement agent with respect to the Sale of the
Securities. Public offerings of Securities are generally made on a firm
commitment basis. Private placements of Securities may be made on a
firm commitment or agency basis. It is anticipated that the lead and
co-managing Underwriters will make a market in Securities offered to
the public.
In most cases, the originator and Servicer of receivables to be
held in an Issuer and the Sponsor of the Issuer (although they may
themselves be related) will be unrelated to Harris Nesbitt. In other
cases, however, Affiliates of Harris Nesbitt may originate or service
receivables held by an Issuer or may Sponsor a Trust.
Certificate Price, Interest Rate and Fees
17. In some cases, the Sponsor will obtain the receivables from
various originators pursuant to existing contracts with such
originators under which the Sponsor continually buys receivables. In
other cases, the Sponsor will purchase the receivables at fair market
value from the originator or a third party pursuant to a purchase and
Sale agreement related to the specific offering of Securities. In other
cases, the Sponsor will originate the receivables, itself.
As compensation for the receivables transferred to the Issuer, the
Sponsor receives Securities representing the entire beneficial interest
in the Issuer, or the cash proceeds of the sale of such Securities. If
the Sponsor receives Securities from the Issuer, the Sponsor sells all
or a portion of these Securities for cash to investors or securities
underwriters.
18. The price of the Securities, both in the initial offering and
in the secondary market, is affected by market forces, including
investor demand, the specified interest rate on the Securities in
relation to the rate payable on investments of similar types and
quality, expectations as to the effect on yield resulting from
prepayment of underlying receivables, and expectations as to the
likelihood of timely payment.
The interest rate for Securities is typically equal to the interest
rate on receivables included in the Issuer minus a specified servicing
fee.\19\ This rate is
[[Page 7641]]
generally determined by the same market forces that determine the price
of a Security. The price of a Security and its interest, or coupon,
rate together determine the yield to investors. If an investor
purchases a Security at less than par, that discount augments the
stated interest rate; conversely, a Security purchased at a premium
yields less than the stated coupon.
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\19\ The interest rate on Securities representing interests in
Issuers holding leases is determined by breaking down lease payments
into ``principal'' and ``interest'' components based on an implicit
interest rate. Securities issued by Issuers that are classified as
REMICs for Federal income tax purposes may use different formulas
for setting the specified interest rate with respect to Securities.
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19. As compensation for performing its servicing duties, the
Servicer (who may also be the Sponsor or an Affiliate thereof, and
receive fees for acting in that capacity) will retain the difference
between payments received on the receivables held by an Issuer and
payments payable (at the interest rate) to Securityholders, except that
in some cases a portion of the payments on receivables may be paid to a
third party, such as a fee paid to a provider of credit support.
The Servicer may receive additional compensation by having the use
of the amounts paid on the receivables between the time they are
received by the Servicer and the time they are due to the Issuer (which
time is set forth in the Pooling and Servicing Agreement). The Servicer
typically will be required to pay the administrative expenses of
servicing the Issuer, including in some cases the Trustee's fee, out of
its servicing compensation.
20. The Servicer is also compensated to the extent it may provide
credit enhancement to the Issuer or otherwise arrange to obtain credit
support from another party. This ``credit support fee'' may be
aggregated with other servicing fees, and is either paid out of the
interest income received on the receivables in excess of the pass-
through rate or paid in a lump sum at the time the Issuer is
established.
The Servicer may be entitled to retain certain administrative fees
paid by a third party, usually the Obligor. These administrative fees
fall into three categories: (a) Prepayment fees; (b) late payment and
payment extension fees; and (c) expenses, fees and charges associated
with foreclosure or repossession, or other conversion of a secured
position into cash proceeds, upon default of an obligation.
Compensation payable to the Servicer will be set forth or referred to
in the Pooling and Servicing Agreement and described in reasonable
detail in the prospectus or private placement memorandum relating to
the Securities.
21. Payments on receivables may be made by Obligors to the Servicer
at various times during the period preceding any date on which pass-
through payments to the Issuer are due. In some cases, the Pooling and
Servicing Agreement may permit the Servicer to place these payments in
non-interest bearing accounts maintained with itself or to commingle
such payments with its own funds prior to the distribution dates. In
these cases, the Servicer would be entitled to the benefit derived from
the use of the funds between the date of payment on a receivable and
the pass-through date. Commingled payments may not be protected from
the creditors of the Servicer in the event of the Servicer's bankruptcy
or receivership. In those instances when payments on receivables are
held in non-interest bearing accounts or are commingled with the
Servicer's own funds, the Servicer is required to deposit these
payments by a date specified in the Pooling and Servicing Agreement
into an account from which the Issuer makes payments to
Securityholders.
22. The Underwriter will receive a fee in connection with the
Securities underwriting or private placement of Securities. In a firm
commitment underwriting, this fee would consist of the difference
between what the Underwriter receives for the Securities that it
distributes and what it pays the Sponsor for those Securities. In a
private placement, the fee normally takes the form of an agency
commission paid by the Sponsor. In a best efforts underwriting in which
the Underwriter would sell Securities in a public offering on an agency
basis, the Underwriter would receive an agency commission rather than a
fee based on the difference between the price at which the Securities
are sold to the public and what it pays the Sponsor. In some private
placements, the Underwriter may buy Securities as principal, in which
case its compensation would be the difference between what it receives
for the Securities that it sells and what it pays the Sponsor for these
Securities.
Purchase of Receivables by the Servicer
23. As the principal amount of the receivables held in an Issuer is
reduced by payments, the cost of administering the Issuer generally
increases, making the servicing of the Issuer prohibitively expensive
at some point. Consequently, the Pooling and Servicing Agreement
generally provides that the Servicer may purchase the receivables
remaining in the Issuer when the aggregate unpaid balance payable on
the receivables is reduced to a specified percentage (usually 5 to 10
percent) of the initial aggregate unpaid balance. The purchase price of
a receivable is specified in the Pooling and Servicing Agreement and
generally will be at least equal to: (a) The unpaid principal balance
on the receivable plus accrued interest, less any unreimbursed advances
of principal made by the Servicer; or (b) the greater of (i) the amount
in (a) or (ii) the fair market value of such obligations in the case of
a REMIC, or the fair market value of the receivables in the case of an
Issuer that is not a REMIC.
Securities Ratings
24. The Securities for which exemptive relief is requested will
have received one of the three highest ratings (four, in the case of
Designated Transactions) available from the Rating Agency. Insurance or
other credit support (such as surety bonds, letters of credit,
guarantees, or overcollateralization) will be obtained by the Sponsor
to the extent necessary for Securities to attain the desired rating.
The amount of this credit support is set by the Rating Agencies at a
level that is a multiple of the worst historical net credit loss
experience for the type of obligations included in the Issuer.
Subordination
25. The Applicant explains that the market has now evolved to the
point where asset-backed securities/mortgage-backed securities (ABS/
MBS) offerings typically include multiple tranches of senior and
subordinated investment-grade securities.
The Applicant believes that Rating Agencies can rate subordinated
classes of securities with a high level of expertise, thereby ensuring
the safety of these investments for plans through the use of other
credit support (including increased levels of non-investment-grade
securities). The subordination of a Security, while factored into the
evaluation made by the Rating Agencies in their assessment of credit
risk, is not indicative of whether a Security is more or less safe for
investors. In fact, there are ``AAA'' rated subordinated
Securities.\20\ Subordination is simply another form of credit support.
The Rating Agencies, after determining the level of credit support
required to achieve a given rating level, are essentially indifferent
as to how these credit support requirements are implemented--whether
through subordination or other means. If
[[Page 7642]]
subordination is used, however, the subordinated class will have no
greater credit risks or fewer legal protections in comparison with
other credit-supported classes that possesses the same rating.
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\20\ For example, a transaction may have two classes of ``AAA''
rated Securities and one is subordinated to the other. The
subordinated class would be required to have more credit support to
qualify for the ``AAA'' rating than the more senior ``AAA'' rated
class.
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26. The Applicant represents that there is much benefit to plan
investors in having subordinated Securities eligible for exemptive
relief. First, credit support provided through third-party credit
providers is more expensive than an equal amount of credit support
provided through subordination. As a result, the ability to use
subordinated tranches to provide credit support for the more senior
classes (which may or may not themselves be subordinated) creates
economic savings for all the parties to the transaction which, in turn,
can allow greater returns to investors. In addition, if the credit
rating of a third-party credit support provider is downgraded, the
rating of the Securities is also downgraded. Second, the yields
available on subordinated Securities are often higher than those paid
on comparably rated non-subordinated Securities because investors
expect to receive higher returns for subordinated Securities. Third,
subordinated Securities are usually paid after other more senior
Securities, which results in their having longer terms to maturity.
This is appealing to many investors who are looking for medium-term
fixed income investments to diversify their portfolios. The combination
of these factors benefits investors by making available Securities
which can provide higher yields for longer periods. It should be noted
that as the rating of a Security generally addresses the probability of
all interest being timely paid and all principal being paid by maturity
under various stress scenarios, the Rating Agencies are particularly
concerned with the ability of the pool to generate sufficient cash flow
to pay all amounts due on subordinated tranches, and several features
of the credit support mechanisms discussed below are designed to
protect subordinated classes of Securities.
Provision and Types of Credit Support
27. Credit support consists of two general varieties: external
credit support and internal credit support. The Applicant notes that
the choice of the type of credit support depends on many factors.
Internal credit support, which is generated by the operation of the
Issuer, is preferred because it is less expensive than external credit
support which must be purchased from outside third parties. In
addition, there is a limited number of appropriately rated third-party
credit support providers available. Further, certain types of credit
support are not relevant to certain asset types. For example, there is
generally little or no Excess Spread available in residential or CMBS
transactions because the interest rates on the obligations being
securitized are relatively low. Third, the Ratings Agencies may require
certain types of credit support in a particular transaction. In this
regard, the selection of the types and amounts of the various kinds of
credit support for any given transaction are usually a product of
negotiations between the Underwriter of the securities and the Ratings
Agencies. For example, the Underwriter might propose using Excess
Spread and subordination as the types of credit support for a
particular transaction and the Rating Agency might require cash reserve
accounts funded up front by the Sponsor, Excess Spread and a smaller
sized subordinated tranche than that proposed by the Underwriter. In
addition, market forces can affect the types of credit support. For
example, there may not be a market for subordinated tranches because
the transaction cannot generate sufficient cash flow to pay a high
enough interest rate to compensate investors for the subordination
feature, or the market may demand an insurance wrap on a class of
securities before it will purchase certain classes of securities. All
of these considerations interact to dictate which particular
combination of credit support will be used in a particular transaction.
External Credit Support
28. The Applicant represents that in the case of external credit
support, credit enhancement for principal and interest repayments is
provided by a third party so that if required collections on the pooled
receivables fall short due to greater than anticipated delinquencies or
losses, the credit enhancement provider will pay the Securityholders
the shortfall. Examples of such external credit support features
include: Insurance policies from ``AAA'' rated monoline \21\ insurance
companies (referred to as ``wrapped'' transactions), corporate
guarantees, letters of credit and cash collateral accounts. In the case
of wrapped or other credit supported transactions, the Insurer or other
credit provider will usually take a lead role in negotiating with the
Sponsor concerning levels of overcollateralization and selection of
receivables for inclusion into the pool as it is the Insurer or credit
provider that will bear the ultimate risk of loss. As mentioned above,
one disadvantage of insurance, corporate guarantees and letters of
credit is that they are relatively expensive in comparison with other
types of credit support. The Applicant also notes that, if the credit
rating of the insurance company or other credit provider is downgraded,
the rating of the Securities is correspondingly downgraded because the
Rating Agencies will only rate the Securities as highly as the credit
rating of the credit support provider. However, there are only a
handful of ``AAA'' monoline insurance providers, and investors do not
want to have too high a concentration of Securities which are backed by
such insurers. There are also few providers of letters of credit or
corporate guarantees that have sufficiently high long-term debt credit
ratings. These disadvantages are some of the reasons why subordination
is often used as an alternative form of credit support. Cash collateral
accounts include reserve accounts which are funded, usually by the
Sponsor, on the Closing Date and are available to cover principal and/
or interest shortfalls as provided in the documents.
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\21\ The term ``monoline'' is used to describe such insurance
companies because writing these types of insurance policies is their
sole business activity.
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Internal Credit Support
29. The Applicant explains that internal credit support relies upon
some combination of utilization of excess interest generated by the
receivables, specified levels of overcollateralization and/or
subordination of junior classes of Securities. Transactions that look
almost exclusively to the underlying pooled assets for cash payments
(or ``senior/subordinated'' transactions) will contain multiple classes
of Securities, some of which bear losses prior to others and,
therefore, support more senior Securities. A subordinate Security will
absorb realized losses from the asset pool, and have its principal
amount ``written down'' to zero, before any losses will be allocated to
the more senior classes. In this way, the more senior classes will
receive higher rating classifications than the more subordinate
classes. However, the Rating Agencies require cash flow modeling of all
senior/subordinated structures. These cash flows must be sufficient so
that all rated classes, including the subordinated classes, will
receive timely payment of interest and ultimate repayment of principal
by the maturity date. The cash flow models are tested assuming a
variety of stressed prepayment speeds, declining weighted average
interest payments and loss assumptions. Other structural mechanisms to
assure payment to subordinated classes are to allow collections held in
the reserve account for the next payment date to be used if necessary
to pay current interest to the
[[Page 7643]]
subordinated class or to create a separate interest liquidity reserve.
The collections held in the reserve account are from principal and
interest paid on the underlying mortgages or other receivables held in
the Issuer and are not from the Securities issued by the Issuer.\22\
Also, some structures allow both principal and interest to be applied
to all payments to Securityholders, and in others, principal can be
used to pay interest to the subordinate tranches.
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\22\ A collections reserve account is established for almost all
transactions to hold interest and principal payments on the
mortgages or receivables as they are collected until the necessary
amounts are paid to Securityholders on the next periodic
distribution date. In some transactions, the Rating Agencies or
other interested parties may require, in order to protect the
interests of the Securityholders, that excess interest in amount(s)
equal to a specified number of future period anticipated collections
be retained in the collection account. This protects both senior and
subordinated Securityholders in situations where there are
shortfalls in collections on the underlying obligations because it
provides an additional source of funds from which these
Securityholders can be paid their current distributions before the
holders of the residual or more subordinated Securities receive
their periodic distributions, if any. Accordingly, any reference to
``collections'' from principal and interest paid on the mortgages is
intended to describe such excess interest or principal not required
to cover current payments to the senior and subordinated class
eligible to be purchased by plans. Thus, this mechanism is not
harmful to the interests of senior Securityholders.
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Interest which is received but is not required to make monthly
payments to Securityholders (or to pay servicing or other
administrative fees or expenses) can be used as credit support. This
excess interest is known as ``Excess Spread'' or ``excess servicing''
and may be paid out to holders of certain Securities, returned to the
Sponsor or used to build up overcollateralization or a loss reserve.
The credit given to Excess Spread is conservatively evaluated to ensure
sufficient cash flow at any one point in time to cover losses. The
Rating Agencies reduce the credit given to Excess Spread as credit
support to take into account the risk of higher coupon loans prepaying
first, higher than expected total prepayments, timing mismatching of
losses with Excess Spread collections and the amounts allowed to be
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