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Case number 14-1240 at L, the Loan Syndications and Trading Association Petitioner versus Securities and Exchange Commission at L. Mr. Klingler for the petitioner and Mr. Chadwick for the respondents.

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Excuse me, we're going to take just a brief break while you guys change.

[00:00:53] Speaker ?:
Okay.

[00:01:25] Speaker ?:
Thank you.

[00:02:52] Speaker 06:
Stand please.

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Be seated, please.

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Please the court petitioner you have to speak into the mic and surface department.

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Can you hear me now?

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As they say in the commercials, that's right I'd be pleased to address jurisdictional issues initially if that would assist the court at this juncture it would it would good jurisdiction exists because both the board and the Commission each expressly relied in part on authorities making the joint rule of

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an order of the board for purposes of section 1848, and an order of the commission for purposes of at least section 77i, besting this court with jurisdiction over challenges to such orders.

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Are you arguing that?

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citation or reference to a provision triggering jurisdiction is enough, even though there is no, and you may contest this proposition, even though there is no substantive reliance on those provisions.

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Our position is that as long as it's not advanceable in some way, it's sufficient.

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You asked if you were loud enough, but the answer now is more.

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I apologize.

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Yes, our position that the express invocation, the express reliance is sufficient.

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Even if the provision doesn't give them any authority to do what they've done in the case?

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If it's fanciful, the court can certainly test whether it's absolutely without any basis.

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I think the obverse of this was immediate access, where it was disavowed that the court did, I'm sorry, the agency did expressly invoke, but said no, don't give that any effect on the court.

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tested to see whether, in addition to the Information Reform Act that issued there, the express reliance on that could have had any basis for supporting a portion of the rule.

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You're talking about media access?

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Pardon?

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You're talking about media access?

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I am.

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So there we say that it could have issued the challenge rule under the other, under the jurisdictional provision, right?

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That's right.

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Right.

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And in, let's see the other one.

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in the international brotherhood of Teamsters the same, both the Safety Act and the FHWA authorized

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regulations about drivers and their competence.

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But here, we have something that seems quite different.

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You don't think that, who are the four agencies here, by the way?

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The OCC, the FDIC, the board, and the commission.

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And the OCC and the FDIC don't have authority, do they?

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Is there a provision?

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They do cite additional authority.

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They do.

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If those were the only authorities, would the rule be possible?

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If those were the only authorities and there weren't the statute involved here, could they have issued this rule?

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Well, the board would have had a very good claim to issuing a rule with equivalent effect.

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It would have had to have been structured slightly differently.

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I think the test is not whether the entire rule as a whole could have been issued pursuant to the other authority, a but-for test, as it were, but rather whether it was a legitimate source of authority for portions.

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Why is it?

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They're supposed to issue, according to Dodd-Frank, they have to issue a joint rule.

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That's right.

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And they all have to agree on that rule.

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And does the board have authority over all the possible entities that are SPVs here?

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Or they don't?

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It does not.

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They plainly don't.

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So in fact, how many – the board only has authority over bank holding companies, right?

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Well, and some savings and loans, but that's right.

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Fine.

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So and how many SPVs are bank holding companies?

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Uh, banks do securitizations.

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Yes, bank holding companies.

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Pardon?

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And their subsidiaries.

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Are they the SPVs here?

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They aren't the SPVs here.

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They are sponsors, though, under the rule.

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And all of the sponsors are banks or banks holding companies?

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No, only a portion of the sponsors.

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So the rule, which purports to affect all

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sponsors could not have been authorized under, that's what we're agreed on, right?

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Yes, the entirety of the rule, none of the individual agencies could have separately passed the entirety of the rule.

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Now in the cases in which we've allowed this sort of thing, though,

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The entirety of the rule was doable under the other statute.

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Media access appears to have reached that conclusion.

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That's not clear that International Brotherhood did.

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Well, let's see.

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And they did not go on to...

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They did not go on to address that issue and to parse whether the entire rule could have been because... Sorry, go ahead.

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Well, they say the... I mean, it describes the Commercial Motor Vehicle Safety Act.

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It requires the Secretary to issue regulations to establish minimum federal standards for testing and ensuring the fitness of persons who operate a commercial motor vehicle.

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And that is what the rule is about.

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Now, of course, it didn't go

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For the jurisdictional question, I don't think we're suggesting that you have to resolve the merits before you can resolve whether we have jurisdiction.

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But on its face, a rule that would require commercial drivers license to pass driver's tests in Mexico fits within their authority to issue a regulation about the minimum requirements for commercial drivers.

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But here, you are challenging a rule that affects not only banks and bank holding companies, but many other kinds of entities.

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And Congress has required specifically that everybody agree and that it be a joint rule.

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And yet, nobody, none of the four, has the authority to do that except under Dodd-Frank.

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And that strikes me as it fits very well with what he said in American Petroleum, which was, well, look, Congress could have added that section to 25.

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It did not add Section 13Q to the list of provisions contained in 25B.

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And we would say exactly the same thing here.

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It did not add 15G.

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And it could have.

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So that suggests we should begin in the district court, however much we might like to hear you today.

[00:11:15] Speaker 03:
Two points.

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On international brotherhood, I don't believe that the court did go and resolve.

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It may appear on the face that it did, but the court didn't rest its decision on that.

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It rested it upon the express reliance.

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The one way to think about this particular issue is in terms of the joint rule and in terms of the rules that are in the particular CFR provisions that we would be challenging enforcement in relation to, the joint rule can be thought of as an order of the board and an order of the commission and as an order of the two other agencies.

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whether the entire rule becomes an order of the board or not is ambiguous.

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That it could be viewed as a portion of the order.

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In other words, we say that the entire order becomes an order of the board because it relied on the alternative authority for a portion of its action.

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But you agree that if

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If that were what it was relying on, and the board tried to enforce against a non-bank, and that was the only statute it had, it would not be able to do that, right?

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It could not enforce against a non-bank.

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it could not enforce against a non-bank, but what it could do was to contribute its, using two sources of authority, contribute its assent to a joint rule that then affects all of the entities and

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used its alternative authority to promulgate the rules that did apply to the banks.

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And we do, of course, for the commission and for the banks, challenge the particular rules that apply respectively to the entities regulated by the commission.

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The provision that gives it authority is the amendment to the Securities and Exchange Act.

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That's the part that gives the board authority to issue a joint rule.

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That's expressly, anyway.

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It clearly does do that.

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It does do that.

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And I think the argument is that so does, at least for portions of the rules, so does the alternative authority that the board and the commission invoked.

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And that's what triggers the ambiguity about it.

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When we then start thinking about the case and what we now have jurisdiction over, we don't have jurisdiction over the provisions in the Exchange Act.

[00:14:01] Speaker 02:
And that is outside of our jurisdiction.

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So anything that authority is only provided by the Exchange Act, we would have to not talk about.

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That depends upon the construction order of the board.

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If the order of the board is just those subparts of the order that the board had authority to issue independently, rather than the order that's published in the Federal Register that included the common rule as a whole, then the fact that it had authority to

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implement portions of the rule would be enough to make it an order of the board for purposes of section 1848.

[00:14:46] Speaker 00:
And those ambiguities... Okay, well, I'm sorry, go ahead and finish.

[00:14:51] Speaker 03:
No, no, just there's two presumptions then that kick in.

[00:14:53] Speaker 00:
Okay.

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The Republican State Committee indicates that if there's an ambiguity in relation to order, that that's to be resolved

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in favor of appellate jurisdiction where there's to be review on the record.

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And Florida Power and Light versus Lorian also indicates that there's uncertainty about the scope of the action and the appellate jurisdiction.

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That, too, is to be resolved.

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And I think that the City of Rochester versus Bond also bears on this.

[00:15:18] Speaker 00:
I was just trying to figure out why you are now focusing on this being an order and presumably you're doing that because orders can be reviewed directly and that takes us out from under the direct review provision for rules.

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So you started off talking about explicit reliance.

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And so I'm trying to figure out that analytical move.

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What was the segue between those two?

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Right.

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So the board undertook, the board, for example, undertook acting.

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It expressly relied on authority to take that action.

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And you're right.

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It was a rule that issued under investment company and Republican State Committee, though, that

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The board-related rule is to be treated as an order for purposes of determining the jurisdiction over the board's action.

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OK.

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This is under 1848.

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Pardon?

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Under 1848.

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Yes, this is absolutely under 1848.

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And if I could go back to API and the framework that's.

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Can I just pause on this for one second, because I'm the same confusion.

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The board called what it did in order or a rule?

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The board took a vote.

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I don't know whether they called it an order or a rule.

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They did issue, I mean, what is in the Federal Register is referred to as the common rule.

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It is a rule.

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And that's what Dodd-Frank authorized issuance of, a joint rule, right?

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That's correct.

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So maybe where it's unclear whether what's going on is a rule or an order, but

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That's not unclear in this circumstance.

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This was issued pursuant to notice and comment and everything else.

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There's no doubt that an order of the board under normal circumstances is reviewable under 1848, without regard to rule or not.

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As an order, it's reviewable under any ambiguity in that respect, both Republican

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state committee indicates that the investment companies took their law.

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That's what establishes that proposition.

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Why do you think it's ambiguous?

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I mean, it seems to me the ambiguity here is not coming from what they did, but from the attempt to expand jurisdiction.

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Right.

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The ambiguity arises because the board took an action that

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for the reasons we just discussed is an order, because it relied upon the alternative authority.

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And then the question is, for purposes of 1848, is that order limited only to those portions of the joint rule that it could have independently

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authorized, or does the express reliance trigger appellate jurisdiction over the order as a whole?

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That's the ambiguity.

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In City of Rochester versus Bond, discussed in media access, indicates that the court's not to focus on what the core of the challenge is or the core of the

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or to parse the true nature of the underlying action.

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So there, it was the Privacy Act.

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Just as for media access, it was the Information Reform Act.

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And clearly, that would have been independent and sufficient authority.

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The commission also invoked

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the additional authority.

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And City of Rochester versus Bond says that we're going to focus on, we're going to treat the order as a whole.

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We're not going to parse its particular portions on that.

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And the resolution of that ambiguity, I do think, triggers both presumptions.

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If once you're in the world of construing what the order is, the Republican State Committee is quite strong about the

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the absolute presumption or the result that any challenge that's reviewable on the record is going to be construed to be within the order.

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The Lorian presumption has the same effect.

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An API, with respect, simply didn't have before it anything other than the Exchange Act.

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It set out the default rule that said in the absence of some appellate court generating jurisdictional provision, the default is to the district court.

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And then it considered only whether the Exchange Act itself generated or triggered jurisdiction, concluded it did not.

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It didn't pass on whether if there is an additional

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authority that does generate appellate jurisdiction, that that's in some way eliminated or limited.

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In terms of congressional intent, you could equally think that Congress intended, not at drawing a negative inference from its failure to amend 15G, but rather that Congress understood that agencies act

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or have at least the power to act under dual authorities, and that this Court's decisions indicate that when they do so, when they both expressly rely upon the additional authority, then this Court will have jurisdiction over that.

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And that there are revisions like Section 1848 that express Congress's desire that once the agency expressly relies upon that authority, that there's timely and comprehensive review of, in this case, the Board action.

[00:20:52] Speaker 05:
I know what you think section 25 D does not mean, at least I think I know that, but I'm not sure what you would argue it affirmatively does mean.

[00:21:09] Speaker 03:
What D1 indicates is that it operates for the purpose of the preceding subsections.

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Those subsections are affirmative grants of authority.

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that subsection D does not directly speak to the non-listed rules, and it certainly doesn't speak in any limitation form to the effect of other authorities.

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So what it affirmatively does is allows the board, when it acts pursuant to one of the appellate jurisdiction granting provisions, to take advantage of those provisions as well.

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So it doesn't have a negative implication.

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And if they were down on that point, Lorian again pushes the result toward appellate jurisdiction.

[00:22:00] Speaker 02:
Any further questions on jurisdiction?

[00:22:02] Speaker 00:
Well, I guess, again, I'm not sure that I'm understanding what you're arguing.

[00:22:13] Speaker 00:
Is your argument that this direct review provision really wasn't Congress's attempt to limit direct review to certain board actions, but rather was giving the board the

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the option of deciding whether it wanted to rely on that?

[00:22:36] Speaker 03:
For purposes of D1, that's right.

[00:22:38] Speaker 03:
Had the board simply relied only on the non-listed authority, you know, leaving aside our broker-dealer argument that

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that that would have resolved the issue that the board wouldn't have been able to take advantage of that.

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But once the board, as it normally does, invokes authority for this court's review of orders of the board and that authority is related to the

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order that was enacted, then Congress would have presumed that that additional authority under international brotherhood takes precedence and the reviews to be held in the appellate court.

[00:23:19] Speaker 02:
Well, I'd have to read International Brotherhood in a way that distinguishes it on the ground that you read it, because it says that the court has, that the agency had authority under both statutes.

[00:23:37] Speaker 02:
This could be distinguished on the ground that didn't look very hard.

[00:23:40] Speaker 02:
This may be a step too far for Congress's careful legal study of our 1994 decision.

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But I don't know.

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With respect, I think that there is authority under both sources here.

[00:23:57] Speaker 03:
Not authority necessarily for the full rule, but certainly authority for the full rule.

[00:24:01] Speaker 02:
No, no, I understand.

[00:24:02] Speaker 02:
But in that case, on the face of the rules, there was authority for the full rule.

[00:24:06] Speaker 03:
Right.

[00:24:07] Speaker 03:
But in terms of what the court relied upon, it was the express invocation of the authority.

[00:24:11] Speaker 03:
And API is actually helpful on this point when, in its discussion,

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you know, albeit victim, when it's addressing C5 and C6, it indicates that because the agency, the commission in that case, didn't rely on C5 and C6, that wasn't an issue.

[00:24:28] Speaker 03:
Suggesting that it had it done so.

[00:24:31] Speaker 02:
Actually, that's the problem.

[00:24:33] Speaker 02:
It doesn't suggest had it done so.

[00:24:34] Speaker 02:
It suggests the opposite because it says,

[00:24:38] Speaker 02:
their decision not to rely makes perfect sense because subsections 15C5 and 6 regulate brokers and dealers, while 15D requires issuers.

[00:24:50] Speaker 02:
So this is very similar to what we have here, which is we have a board authorization which gives it authority over bank holding companies and their subs.

[00:25:03] Speaker 02:
But this rule is not limited in that way.

[00:25:07] Speaker 02:
It covers all other kinds of entities.

[00:25:09] Speaker 03:
But I understand that.

[00:25:11] Speaker 03:
And I think the language you just quoted was the court saying, yes, we agree with the commission that it was acting pursuant to another provision of 78-0.

[00:25:22] Speaker 03:
In other words, it was rejecting conditioners.

[00:25:25] Speaker 03:
Right, that it could not have relied on that section.

[00:25:28] Speaker 03:
And after having consulted the commission and the commission said, no, we're not.

[00:25:32] Speaker 03:
We're not relying on that point.

[00:25:33] Speaker 03:
And they said, yes, that makes sense that they're not relying.

[00:25:36] Speaker 03:
But here the board and the commission are relying upon those authorities.

[00:25:40] Speaker 02:
Well, no, no, but it made sense because they couldn't have relied on those authorities is what this this indicates.

[00:25:47] Speaker 02:
Not that they simply weren't relying well.

[00:25:53] Speaker 05:
that the board could have relied on the cited provisions of the Van Colen Company Act with respect to the generation of some such rule according to the details of it.

[00:26:12] Speaker 05:
and with respect to certain entities.

[00:26:15] Speaker 03:
That's right.

[00:26:16] Speaker 03:
The court, it was, well, absolutely, we have here the bank affirmatively saying, I'm sorry, the board affirmatively saying the Bank Holding Company Act is enough.

[00:26:25] Speaker 03:
It gives us power to issue portions of this rule, at least.

[00:26:29] Speaker 03:
It doesn't claim the entire... Which portions?

[00:26:31] Speaker 02:
Assuming that it can't do anything other than banks and bank holding.

[00:26:36] Speaker 02:
The statute gives it authority over capital requirements for bank holding companies.

[00:26:43] Speaker 02:
Right, not just capital requirements.

[00:26:46] Speaker 02:
Okay, regulations and orders relating to the capital requirements for bank holding.

[00:26:50] Speaker 02:
Is this not what you're looking at B, 1844B?

[00:26:54] Speaker 03:
What is the... It's the general rules and regulations to enforce the provisions of this act.

[00:27:00] Speaker 03:
I'm sorry, I don't have that.

[00:27:03] Speaker 02:
Which general rules and regulations?

[00:27:05] Speaker 02:
Let me just ask you as the petitioner here.

[00:27:08] Speaker 02:
Do you think that the Fed could have issued the identical rule here covering only banks and bank holding companies?

[00:27:15] Speaker 03:
No, again, not the entire rule, but it could have.

[00:27:19] Speaker 03:
it could have very extensively regulated the credit risk allocation and the alignment of risk that whenever a bank holding company undertakes a securitization or participates in formulating a securitization or sells loans into a securitization, and the CLO orders themselves regulate directly leader rangers.

[00:27:43] Speaker 03:
Those are bank holding companies.

[00:27:44] Speaker 03:
So bank holding companies... They could have issued the same rule

[00:27:48] Speaker 02:
If a bank or a bank holding company were the organizer in the SEC's interpretation of the word.

[00:27:56] Speaker 03:
As banks are all the time.

[00:28:10] Speaker 05:
In the arguments in the briefs and also the characterizations in the rulemaking, it's not only to get it clear, but model how the quote managers unquote function.

[00:28:25] Speaker 05:
And it seems to me it's at least possible to imagine managers playing a role under which it's hard to see any fit

[00:28:38] Speaker 05:
between them and what Congress could possibly have had in mind.

[00:28:44] Speaker 05:
On the other hand, it's also quite possible to see them behaving in ways that seem functionally just like perfectly standard security.

[00:29:03] Speaker 05:
I mean, we've been reduced to looking at the web, which, as you know, the Seventh Circuit is deeply divided, but that's even proper for a court of appeals to look at the web and find out something about reality.

[00:29:19] Speaker 05:
So is there a particular place in the record where we would find a clear statement of how the managers function?

[00:29:35] Speaker 03:
In the fact section of our brief, we tried to go through what the structuring and the securitization is.

[00:29:41] Speaker 03:
I think it's undisputed that the manager acts as an agent of the special purpose vehicle.

[00:29:48] Speaker 05:
Yes, but they're agents and agents.

[00:29:51] Speaker 03:
We don't dispute the agency's views that pursuant to the loan documents, the manager can select the assets to be purchased and thereafter controls them.

[00:30:09] Speaker 03:
In fact, an important part of our argument related to whether the transfer language actually applies to the manager is that

[00:30:19] Speaker 03:
There's a passage of control, a vesting of control.

[00:30:22] Speaker 03:
Transfer means the divestment or giving over of control of possession.

[00:30:27] Speaker 03:
The manager afterwards does have control over the asset.

[00:30:31] Speaker 03:
There's an investment period, and there is discussion in the record of the investment period, where the manager can sell the loan thereafter.

[00:30:40] Speaker 02:
So if that's the case, you're saying that the manager does control the assets before they're transferred to the SBB?

[00:30:48] Speaker 03:
No, it's after the transfer.

[00:30:49] Speaker 03:
So before the transfer, again, this is in the instance of a two-sided transaction at arm's length, the open market CLOs, that there is, before the transaction, the manager has no ownership, possession, or control.

[00:31:05] Speaker 03:
Well, there's also no SPV yet.

[00:31:08] Speaker 02:
Often there's no, according at least to the Federal Register notice, there's no, often there's no SPV at all.

[00:31:14] Speaker 03:
Well, by the time the purchase is completed, there needs to be an SPV because the SPV holds the loan.

[00:31:22] Speaker 02:
But you're right, there can be a, well, no, there's... Is there not a, I don't know how to say this, maybe a warehousing period in which the loans are sort of collected and then

[00:31:36] Speaker 03:
I'm not going to use the word transfer, but shifted over, or whatever is another word that doesn't have a... Related to, that's usually related to the bank financing, where the purchase of the loan is financed and it is... Financed by... By bank.

[00:31:54] Speaker 02:
Yes, and who's on the other side of that transaction?

[00:32:01] Speaker 03:
The I guess the SPV is actually entered into.

[00:32:04] Speaker 02:
But I thought you at least nodded when I said that there were occasions at least where there's not yet an SPV.

[00:32:12] Speaker 02:
So if somebody is getting some kind of bridge loan or something in order to finance the acquisition of these loans, which are then

[00:32:22] Speaker 05:
Or at least an interest in.

[00:32:23] Speaker 02:
Or an interest in, or control over, or something.

[00:32:26] Speaker 02:
This doesn't happen magically, and we are having a lot of, I'm with Judge Williams here, we are having a lot of difficulty understanding, I don't want to say physically how the loan moves, but how the designation on somebody's books or electronically the loan ultimately moves either from the open market or from a bank.

[00:32:47] Speaker 03:
to through the manager to through until the SPV is set up.

[00:32:54] Speaker 03:
Well, again, generally, I believe the SPV is set up beforehand.

[00:32:58] Speaker 03:
I don't want to speak beyond my expertise here, but my understanding is that upon closing of the transaction, there has to be loans transferred into the SPV.

[00:33:09] Speaker 03:
If it doesn't close, then it unwinds, and the loans are... Where are they before that happens, the loans?

[00:33:18] Speaker 03:
Well, for the...

[00:33:21] Speaker 03:
an open market transaction, they're at the broker-dealer desk of the seller.

[00:33:27] Speaker 03:
And so the loans, I don't think, get parked before, well, I just simply don't know whether the loans get parked.

[00:33:37] Speaker 03:
Neither do we.

[00:33:38] Speaker 03:
Yes, I apologize.

[00:33:45] Speaker 02:
Well, you can continue.

[00:33:46] Speaker 02:
Questions?

[00:33:48] Speaker 02:
Okay, and we have no more further questions.

[00:33:53] Speaker 02:
Can I ask one clever question here?

[00:33:56] Speaker 02:
So, imagine we decide we don't have a jurisdiction.

[00:34:00] Speaker 02:
What do you want us to do with the case?

[00:34:03] Speaker 03:
If we don't have jurisdiction, please transfer the case.

[00:34:05] Speaker 03:
What was that word you just used?

[00:34:06] Speaker 03:
Please?

[00:34:07] Speaker 03:
No.

[00:34:08] Speaker 07:
Transfer.

[00:34:11] Speaker 02:
You're asking an entity that has no jurisdiction over a case to transfer it to another entity.

[00:34:21] Speaker 02:
Isn't that not consistent with the government's view of the word transfer?

[00:34:26] Speaker 03:
I guess it's a trick question.

[00:34:28] Speaker 03:
No, I think you do have control over the jurisdiction.

[00:34:30] Speaker 02:
We have no jurisdiction.

[00:34:31] Speaker 02:
We probably have control over something we have no jurisdiction on.

[00:34:34] Speaker 03:
Well, you would be sending it, directing it to the district court at that point.

[00:34:39] Speaker 03:
You have control over the case in that we are now before you.

[00:34:42] Speaker 02:
Yeah, so they describe the, it's not just a rhetorical question, the government describes the organizers here as directing, just the same word again that you use,

[00:34:54] Speaker 02:
the loan to the SPV.

[00:34:58] Speaker 02:
In what way are they directing it?

[00:35:01] Speaker 02:
That's different than what we would be doing.

[00:35:05] Speaker 03:
Well, the manager would be on the receiving end.

[00:35:08] Speaker 03:
The manager would be the equivalent of the district court in requesting the receipt of it.

[00:35:14] Speaker 03:
So the control is the party that would be sending, and the divestment or transfer of control or possession would then come into the manager's possession.

[00:35:24] Speaker 03:
So I think you're in the position of the seller of the loan rather than the manager.

[00:35:30] Speaker 03:
Okay.

[00:35:32] Speaker 03:
Thanks.

[00:35:33] Speaker 05:
Thank you.

[00:35:47] Speaker 04:
Morning.

[00:35:48] Speaker 04:
May it please the Court, Joshua Chadwick, the Federal Reserve Board and the Securities and Exchange Commission.

[00:35:53] Speaker 04:
I'd intended to get right to the merits, Your Honor, but if you have further questions on jurisdiction, I think we're basically in agreement on the jurisdictional question with the petitioner.

[00:36:00] Speaker 04:
So I would move to the merits unless you'd like to ask questions.

[00:36:03] Speaker 05:
Do you have anything to add on the meaning of Section 25 D1?

[00:36:11] Speaker 04:
I don't think I have anything to add to that, Your Honor.

[00:36:15] Speaker 04:
I think that to the extent that this was issued as an order under the Bank Holding Company Act, that it, even if it's, the Bank Holding Company Act authorizes regulations, but the review provision speaks of orders.

[00:36:32] Speaker 04:
And when the publication of the rule, if you look at the last page,

[00:36:38] Speaker 04:
of the federal insurance notice.

[00:36:39] Speaker 04:
You'll see by order of the board there.

[00:36:41] Speaker 04:
So I think I don't have anything to add to that.

[00:36:46] Speaker 02:
Okay.

[00:36:50] Speaker 02:
Okay.

[00:36:51] Speaker 02:
What about transfer?

[00:36:52] Speaker 02:
Well, what about the facts?

[00:36:54] Speaker 02:
That would be very helpful to us, I think.

[00:36:56] Speaker 05:
Yes, that's true.

[00:36:57] Speaker 02:
Yeah.

[00:36:59] Speaker 02:
So which specific question, Your Honor, about the facts?

[00:37:00] Speaker 02:
Well, it's a question of what happens.

[00:37:02] Speaker 07:
How does it work?

[00:37:03] Speaker 02:
Yeah.

[00:37:04] Speaker 02:
Yeah.

[00:37:04] Speaker 02:
How does it work?

[00:37:05] Speaker 02:
That is, how is it that the government's description in the rule is that

[00:37:13] Speaker 02:
Somehow the manager has, if not ownership, has something like possession, control, authority, ability to direct something like that with respect to the loans on their way from the open market or from the bank to the SPV or CLO.

[00:37:41] Speaker 02:
So how does that happen?

[00:37:43] Speaker 04:
So my understanding, Your Honor, of the way this happens is that the asset manager, CLO manager, works with an investment bank typically to set up a warehouse facility and that a line of credit is extended to, now this is an area of precision I'm not sure I can speak to, but a line of credit is extended that will allow the purchase of the loans to be placed into the

[00:38:10] Speaker 04:
warehouse facility which is housed as an affiliate of the investment bank.

[00:38:16] Speaker 04:
The special purpose vehicle is created by the CLO manager to clean an offshore jurisdiction and the funding from the investors is used to pay off that line of credit and the SPV

[00:38:37] Speaker 04:
as a technical matter, purchases those loans and they're moved into the... Purchases them from the broker dealers who have the loans.

[00:38:46] Speaker 04:
That's my understanding.

[00:38:49] Speaker 02:
But the description suggests you often don't have the... sometimes you have the investors who are going to ultimately get these loans.

[00:38:59] Speaker 02:
It can't be that all of the tranches have been decided

[00:39:03] Speaker 02:
before the loans get to the SPB, because it hasn't even been divided into tranches yet.

[00:39:10] Speaker 04:
Well, typically, I think the way this works, Your Honor, is that the CLO manager who's driving the train may bring certain investors to the table, whether or not that's an investor for the sort of high-risk, high-reward equity tranche or the more secure AAA-rated

[00:39:30] Speaker 04:
top tranche will bring an investor to the table, not always, but typically that will help.

[00:39:37] Speaker 04:
Maybe they will work together to come up with the investment strategy or

[00:39:43] Speaker 04:
the way that this particular securitization is going to work.

[00:39:47] Speaker 04:
So a certain amount of these assets, securitized assets, are spoken for.

[00:39:54] Speaker 04:
But the investment bank, the other role besides the warehousing that the investment bank assists with is the placement potentially of those additional shares.

[00:40:05] Speaker 02:
Does the investment bank first obtain these loans, or what?

[00:40:09] Speaker 02:
What's the role of the investment bank?

[00:40:12] Speaker 04:
The investment bank offers services to the CLO manager, to warehousing facilities, so I think I would be speaking beyond my expertise to say exactly what the structure of those warehouse facilities are.

[00:40:23] Speaker 02:
Who is the investment bank working for?

[00:40:26] Speaker 04:
The investment bank is

[00:40:30] Speaker 04:
is working with the, sometimes they're affiliated, it could be, with CLO manager, depending on, so these may all be under the umbrella of a bank holding company or a financial institution, so they may be affiliated, or if it's an independent CLO manager, they're working together, and I'm not exactly sure of the fee structure, everyone's getting some fees out of this, or they wouldn't be doing it, certainly.

[00:40:53] Speaker 02:
The loans that we're talking about,

[00:40:56] Speaker 02:
our loans from our commercial loans from banks to entities that can't get

[00:41:09] Speaker 02:
loans in other ways, right?

[00:41:11] Speaker 02:
That can't get, that are already highly leveraged and therefore need lower quality loans to begin with.

[00:41:21] Speaker 04:
That's right, Your Honor.

[00:41:21] Speaker 04:
They can't, they can neither issue equity in the equity or bonds, or investment-grade bonds.

[00:41:27] Speaker 04:
So this is essentially having banks come together in a syndicate to each share some level of the risk.

[00:41:35] Speaker 04:
is the only way that they can get this financing.

[00:41:40] Speaker 02:
But this is not, when we're talking about that loan that's the original underlying loan here, that is not a loan that the investment bank has made.

[00:41:49] Speaker 02:
That's a loan that

[00:41:51] Speaker 02:
some other bank has made to some corporation.

[00:41:55] Speaker 04:
That's right.

[00:41:57] Speaker 04:
I mean, I can't say for every case, but generally speaking, we're talking about commercial banks lending to their commercial clients.

[00:42:02] Speaker 04:
The lead arranger is typically the relationship bank.

[00:42:05] Speaker 04:
So if it's a corporation that typically does most of its banking with a certain commercial bank.

[00:42:10] Speaker 04:
They will act as a lead arranger.

[00:42:11] Speaker 04:
They will bring in other banks as part of the syndicate to put together the loan syndication.

[00:42:18] Speaker 04:
The investment bank and the warehousing is a separate question that facilitates the securitization transaction.

[00:42:24] Speaker 04:
Or, as you would describe it, the transfer.

[00:42:27] Speaker 04:
Is that right?

[00:42:28] Speaker 04:
Yes, Your Honor.

[00:42:29] Speaker 04:
There's a number of different transfers in the process.

[00:42:33] Speaker 00:
So, if I understand the disagreement between you and the petitioner, it's over how you should define transfer, correct?

[00:42:43] Speaker 04:
I believe that that's the core difference, Your Honor, yes.

[00:42:46] Speaker 00:
In other words, they're saying the CLOs shouldn't come under this definition because they don't really fit this idea of what a transfer is.

[00:42:57] Speaker 00:
And they're focusing on this originate to distribute model, which they say is Congress's focus in doing this, correct?

[00:43:06] Speaker 04:
That's what they say, Your Honor.

[00:43:08] Speaker 00:
Well, you can tell me if you disagree, and I assume that you do.

[00:43:15] Speaker 00:
But the Senate report does say that that model, that originate-to-distribute model, they describe it as a major contributing factor.

[00:43:25] Speaker 04:
That's absolutely correct.

[00:43:26] Speaker 00:
in the financial crisis and when the rule begins, you also describe that model as something that you're focusing on.

[00:43:39] Speaker 00:
So if in fact that was what Congress was trying to do,

[00:43:46] Speaker 00:
and that model involved ownership of assets, then what's wrong with the argument that petitioners are making here that that narrower definition is what should apply?

[00:44:02] Speaker 04:
Well, let me start with the originate to distribute, point of honor.

[00:44:06] Speaker 04:
Yes, the Senate report talks about originate to distribute, which is clearly no one disagrees that originate to distribute was a major contributor to the financial crisis.

[00:44:16] Speaker 04:
We say the agencies said that in the rulemaking.

[00:44:19] Speaker 04:
It was not Congress's only concern, as I think petitioners also concede.

[00:44:23] Speaker 04:
The petitioners focus on the robustness of the securitization markets as being another congressional concern, which is also the case.

[00:44:32] Speaker 04:
In terms of the originate to distribute, one thing the agencies made clear in the rulemaking is that this model, the CELO model, shares many of the characteristics.

[00:44:42] Speaker 04:
In fact, the whole leverage loan industry, the idea of commercial bank bringing other banks in to loan to these highly leveraged companies who cannot otherwise obtain financing, and then moving those assets off their balance sheets

[00:45:01] Speaker 04:
to all different sources, but a big place where they go is into CLOs.

[00:45:05] Speaker 04:
As the agencies pointed out, that's very akin to originate-distribute.

[00:45:10] Speaker 04:
The idea is they don't have to hold them.

[00:45:13] Speaker 04:
They can originate.

[00:45:14] Speaker 02:
So is there a difference between balance sheet CLOs and open market CLOs in this respect, or is there really not?

[00:45:21] Speaker 02:
The way you're describing what actually happened sounds like there's not really much of a difference between the two.

[00:45:26] Speaker 02:
What's actually happening here are the banks that have made these loans are getting together, trying to create a intermediary, which will then securitize the loans and ship off their risk.

[00:45:39] Speaker 02:
Is that correct?

[00:45:40] Speaker 02:
They're very similar in that respect, Your Honor.

[00:45:42] Speaker 05:
I mean, the banks... But at least I understand what you're saying.

[00:45:46] Speaker 05:
It is the commercial banks originally making the loans

[00:45:54] Speaker 05:
to distribute, right?

[00:45:58] Speaker 04:
That's right.

[00:45:59] Speaker 05:
The manager here is different.

[00:46:03] Speaker 05:
The overlaps of legal interest is different from the loan generating banks.

[00:46:12] Speaker 04:
Only in a narrow spectrum.

[00:46:14] Speaker 04:
In both cases, whether or not it's an in-house balance sheet seal manager who's assisting its parent bank to clear loans off the bank's balance sheet,

[00:46:25] Speaker 04:
In the case of open market CLOs who are dealing with the more complex leverage loans, the open market CLO manager, who may or may not be an affiliate, may be independent, is serving the same purpose.

[00:46:35] Speaker 04:
Affiliate of?

[00:46:37] Speaker 04:
Affiliate of the overall bank holding company or financial institution, but typically, typically an open market CLO.

[00:46:43] Speaker 05:
That is originating the loans.

[00:46:46] Speaker 05:
You often don't give us the... I'm sorry, Your Honor.

[00:46:48] Speaker 05:
...depositional phrase that would make it add up.

[00:46:53] Speaker 04:
Who the originator of the loan is in a syndicated leverage loan is more complex because there are many originators.

[00:47:04] Speaker 04:
There's a lead arranger, but there's a large number of banks who are participating in the syndication of the loan.

[00:47:11] Speaker 04:
Each one is taking a piece of the risk of that loan.

[00:47:16] Speaker 04:
So in the case of a balance sheet seal,

[00:47:20] Speaker 04:
one commercial bank issues loans to its own, non-sivicated loans, issues loans to its own customers, and then it puts them into a securitization vehicle.

[00:47:31] Speaker 04:
It transfers them into a securitization vehicle to be sold to investors.

[00:47:36] Speaker 04:
An open market seal manager is doing the same thing.

[00:47:42] Speaker 04:
He's just taking these leveraged loans off of

[00:47:45] Speaker 04:
off of the balance sheets of, could it be that commercial bank who's participating in a syndicate or any number of banks participating in a syndicate?

[00:47:52] Speaker 04:
The bottom line is, in the end, they've originated loans that are being cleared from their balance sheets.

[00:48:00] Speaker 04:
The commercial banks.

[00:48:02] Speaker 04:
In either case, whether it's a syndicated loan or it's just a loan made by a single commercial bank,

[00:48:08] Speaker 04:
In both cases, the end result is that the risk inherent in those assets is transferred off their balance sheets and into the securitization market to be purchased by investors, who are the primary concern.

[00:48:23] Speaker 04:
I mean, systemic risk and stability of the economy, but the protection of investors was a critical component of what Congress was concerned about.

[00:48:31] Speaker 05:
You are saying that these risky loans are ever on the balance sheet of the manager.

[00:48:38] Speaker 04:
They never put them on their balance sheet.

[00:48:40] Speaker 04:
That's correct.

[00:48:43] Speaker 05:
I'm not sure whether that makes a big substantive difference, but it is different.

[00:48:46] Speaker 05:
So your talk about getting them off the balance sheet seems interesting.

[00:49:03] Speaker 04:
Are you still concerned with the transfer question?

[00:49:05] Speaker 04:
Do we want to talk more about the transfer question?

[00:49:07] Speaker 04:
I'm sorry, your honor.

[00:49:08] Speaker 05:
You didn't limit it to the pure linguistic issue.

[00:49:12] Speaker 05:
I really want to get the picture.

[00:49:14] Speaker 04:
Okay, of how it actually works.

[00:49:20] Speaker 04:
The open market seal manager is setting up, let's use the

[00:49:28] Speaker 04:
the managers that the visitor is most concerned about, the open market seal managers, they're setting up these special purpose vehicle.

[00:49:35] Speaker 04:
They're coordinating with investors to transfer assets off of bank balance sheets to be put into a special purpose vehicle, which is essentially a tranching machine, for lack of a better word.

[00:49:49] Speaker 04:
It concentrates risk and reward in different classes of securities and then sells them to investors.

[00:49:57] Speaker 04:
There we go.

[00:49:59] Speaker 04:
Yes.

[00:50:00] Speaker 04:
Well, certainly the SPV sells them to investors.

[00:50:05] Speaker 05:
Yes.

[00:50:08] Speaker 05:
Let me ask you this question.

[00:50:10] Speaker 05:
Suppose there were instances, maybe this never happens, where a bunch of investors get together and say, we think for our purposes

[00:50:24] Speaker 05:
loan obligations, which makes sense.

[00:50:28] Speaker 05:
And they go out, they identify someone as a clever assessor of risks in the loan market.

[00:50:37] Speaker 05:
And they ask this person or firm to gather together a parcel of loans to be sliced up in this way.

[00:50:51] Speaker 05:
Initiative comes entirely from them.

[00:50:54] Speaker 05:
They choose this person or firm.

[00:50:59] Speaker 05:
A person or firm acts continuously under their direction.

[00:51:07] Speaker 05:
That happens.

[00:51:09] Speaker 05:
Does the rule apply to that transaction?

[00:51:16] Speaker 05:
I guess I'll stop there.

[00:51:17] Speaker 05:
Does the rule apply to that transaction?

[00:51:18] Speaker 05:
If not, why not?

[00:51:21] Speaker 04:
I believe the rule would apply, that that would fit the even.

[00:51:26] Speaker 04:
So your question, Your Honor, just to clear, is that a single investor is going to purchase all of the different?

[00:51:31] Speaker 05:
No, it's a group of investors, in my hypothetical.

[00:51:34] Speaker 04:
Yes, Your Honor.

[00:51:35] Speaker 05:
You have a single manager.

[00:51:37] Speaker 04:
Right.

[00:51:37] Speaker 05:
We've been calling a manager.

[00:51:38] Speaker 04:
Right.

[00:51:39] Speaker 04:
Yes, Your Honor, but the rule would apply.

[00:51:42] Speaker 05:
Does it, in that scenario, does it fit the purposes that Congress had in mind?

[00:51:51] Speaker 05:
In other words, these are investors who pick this guy for his or its skill in identifying loans for this purpose.

[00:52:06] Speaker 04:
Yes, perhaps, Your Honor.

[00:52:11] Speaker 04:
But that same structure, the idea that an investment manager could

[00:52:18] Speaker 04:
They all have expertise.

[00:52:19] Speaker 04:
They're getting paid a lot of money for their expertise.

[00:52:22] Speaker 04:
So it's true that they have ability and knowledge in terms of selecting loans, but so did the investment managers who compiled CDOs of CDOs, so-called CDOs squared during the financial crisis, some of the most risky and toxic assets.

[00:52:35] Speaker 04:
They're the same structures as CLOs.

[00:52:37] Speaker 04:
People thought that, investors thought that they had expertise in these and that their ability to select and package and securitize these loans

[00:52:45] Speaker 04:
that they were adding a valuable service.

[00:52:47] Speaker 04:
And as it turns out, those loans were vastly riskier than the investment managers thought, or the credit rating agencies thought, for that matter.

[00:52:56] Speaker 04:
So the rule, you're correct, Your Honor, you could envision a hypothetical where the concern is less, but the concern

[00:53:06] Speaker 04:
is there throughout the different types of these securitizations.

[00:53:09] Speaker 05:
Congress was concerned about it and directed the agencies to take very specific action.

[00:53:24] Speaker 05:
at the rule as adopted will have, to some extent, at the margin, a clouding effect on the availability of CREC.

[00:53:38] Speaker 05:
That's correct.

[00:53:39] Speaker 05:
That is correct.

[00:53:43] Speaker 05:
I believe it is also correct that they recognize that a rule dealing with the horizontal ownership approach that the one actually selected contributes to that and that a rule dealing

[00:54:03] Speaker 05:
directed at the horizontal slice and framed in terms of 5% credit risk would have less detrimental effect on credit availability.

[00:54:18] Speaker 04:
Is that correct?

[00:54:20] Speaker 04:
correct, Your Honor, that were less risk required to be retained, substantially less risk, which is what visionaries advocated for.

[00:54:31] Speaker 04:
If substantially less risk was required to be retained, then it is possible that credit would flow slightly more freely.

[00:54:37] Speaker 05:
Yes, yes, slowly, slowly.

[00:54:37] Speaker 05:
Less risk than under the rule you adopted.

[00:54:40] Speaker 05:
But the rule you adopted for the horizontal slice seems to involve

[00:54:46] Speaker 05:
In some applications, it's simply 5% interest in the total value and a considerably greater percentage of the credit risk, right?

[00:55:01] Speaker 05:
And I understand your argument.

[00:55:02] Speaker 05:
We didn't have to do this at all.

[00:55:05] Speaker 05:
The vertical provisions are fine.

[00:55:07] Speaker 05:
They do it all.

[00:55:08] Speaker 05:
This horizontal slice issue came up.

[00:55:12] Speaker 05:
You entertained it.

[00:55:14] Speaker 05:
As I understand it, you recognize a downside to that as opposed to a horizontal risk framed in terms of

[00:55:27] Speaker 05:
credit risk, but you reject that.

[00:55:31] Speaker 05:
And I guess what I would like to see is what you regard as the best passage in the order explaining that rejection.

[00:55:50] Speaker 04:
I think it's important to understand, just to step back one second, because I will point back to the record and answer your question.

[00:55:58] Speaker 04:
What they're talking about is an estimate of credit risk.

[00:56:01] Speaker 04:
It is true, of course, that credit risk is generally, the way these creditization transactions are structured is such that credit risk is generally pushed down, but there is some credit risk

[00:56:14] Speaker 04:
in every tranche of the securitization.

[00:56:16] Speaker 04:
So in order to be exposed to all of the credit risk, you would have to hold some portion of the very top tranche in order to at least have your interest aligned.

[00:56:28] Speaker 04:
There is some credit risk in every tranche.

[00:56:31] Speaker 05:
Yeah, but the maximum credit risk is in the lowest tranche.

[00:56:37] Speaker 04:
That's correct, Your Honor.

[00:56:38] Speaker 04:
That's correct, Your Honor.

[00:56:39] Speaker 04:
But what they're advocating is that the agency should have taken a very aggressive

[00:56:45] Speaker 04:
use of models the way credit rating agencies do to try to predict the risk as to where exactly, how far up those tranches the risk will really go.

[00:56:54] Speaker 04:
But we don't know that.

[00:56:55] Speaker 04:
Credit rating agency model, or the models that they would urge, their expert says use the Moody's model.

[00:57:01] Speaker 04:
And that's at JA 1164, I believe, Your Honor.

[00:57:06] Speaker 04:
Yes.

[00:57:07] Speaker 04:
Use the Moody's model.

[00:57:10] Speaker 04:
That's just an effort to predict the credit risk.

[00:57:14] Speaker 04:
Standard and Poor's may predict it very differently.

[00:57:16] Speaker 04:
Fitch may predict it very differently.

[00:57:17] Speaker 04:
They all may predict it woefully under what the actual inherent credit risk is in the securitization.

[00:57:23] Speaker 04:
In fact, that's one of the great lessons of the financial crisis was that these very, very high-risk assets were rated AAA.

[00:57:29] Speaker 04:
As it turned out, there was tremendous risk in the higher trials.

[00:57:33] Speaker 04:
Right, okay, sorry.

[00:57:35] Speaker 04:
So the agencies and J82271 is one place where at least the commission identifies this quite clearly, talks about how the agency models did not appropriately evaluate the credit risk.

[00:57:51] Speaker 04:
And at J82221,

[00:57:56] Speaker 05:
In a way, you seem to be saying that the mission that Congress gave the agencies was a hopeless and self-contradictory one.

[00:58:06] Speaker 04:
How so, Your Honor?

[00:58:07] Speaker 04:
They said 5% exposed.

[00:58:08] Speaker 02:
They said, actually, the statute says at least, not less than 5%.

[00:58:13] Speaker 02:
It says 5% or more.

[00:58:14] Speaker 02:
And no one disputes, as I understand it, that your 5% fair value horizontal tranche is at least

[00:58:22] Speaker 02:
5%.

[00:58:24] Speaker 04:
That's correct.

[00:58:29] Speaker 02:
So it completely fits the statute.

[00:58:32] Speaker 02:
It's not a hopeless task.

[00:58:33] Speaker 02:
Everybody agrees you've said exactly what the statute says.

[00:58:36] Speaker 02:
That's exactly right.

[00:58:37] Speaker 04:
The vertical option minimizes it to the exact 5% petitioners.

[00:58:43] Speaker 04:
affirmatively concede that.

[00:58:44] Speaker 04:
And then the horizontal option is 5% or more.

[00:58:47] Speaker 04:
Their dispute is it's too much more.

[00:58:49] Speaker 04:
But the agencies went to pains to explain why market participants might want to use that option.

[00:58:55] Speaker 04:
Agencies did not have to afford that option.

[00:58:58] Speaker 04:
They did so.

[00:58:58] Speaker 04:
It's 5% or more, which is what the language that Congress selected.

[00:59:02] Speaker 04:
And so it wasn't hopeless, Your Honor.

[00:59:04] Speaker 04:
I mean, the agencies did exactly what Congress had.

[00:59:06] Speaker 05:
There is a state farm, at least a potential state farm, in terms of

[00:59:10] Speaker 05:
the agency's explanation of why they go for this model, which, in fact, as to the horizontal slice, appears to involve far more than a 5% credit risk.

[00:59:29] Speaker 04:
Well, I don't think this is a state farm problem, Your Honor.

[00:59:35] Speaker 04:
And I think.

[00:59:37] Speaker 05:
Because of what language in the policy?

[00:59:44] Speaker 04:
Let me go back to the language I was pointing you to before, Your Honor.

[00:59:48] Speaker 04:
Hold on.

[00:59:52] Speaker 04:
At page JA-2221, the agency says, the agency say, structural protections, this is, I'm sorry, JA-2221 at the top of the center column, Your Honor.

[01:00:13] Speaker 04:
And this is talking about in the context of CLOs.

[01:00:17] Speaker 04:
But bear in mind, Your Honor, the fact that some of these issues were addressed in the CLO context is because the CLOs were the ones talking about these issues.

[01:00:25] Speaker 04:
No one else was raising these.

[01:00:27] Speaker 04:
So this is the first paragraph at the very top.

[01:00:33] Speaker 04:
All the structural features can offer protections – and this is talking about the structural features of CLOs – can offer protections to investors and senior tranches.

[01:00:41] Speaker 04:
In senior tranches, those are the investment-grade, high-quality debt.

[01:00:45] Speaker 04:
Such protections are exhausted when a portfolio's default rate significantly exceeds anticipated losses, as was the case for CDOs of asset-backed securities during the financial crisis.

[01:00:58] Speaker 04:
And earlier, I think on the earlier column, or the first column on that page,

[01:01:04] Speaker 04:
The agencies talk very specifically about the petitioner in this case's proposal that just 5% of the lowest tranche would be sufficient.

[01:01:13] Speaker 04:
And they get to that by using the expert modeling, the same type of models that the credit rating agencies use.

[01:01:21] Speaker 04:
But again, Your Honor.

[01:01:22] Speaker 05:
The credit rating agencies, as a practical matter, build in endless appreciation of real estate values.

[01:01:31] Speaker 04:
Well, there were a lot of assumptions that went into those models that were not very strong.

[01:01:37] Speaker 04:
In fact, the Dodd-Frank Act, Section 939A, specifically requires agencies to go back through their regulations and scrub them of references to the credit rating agencies.

[01:01:48] Speaker 04:
So that's not to say that there's never a case where the estimation of credit risk

[01:01:54] Speaker 04:
is useful.

[01:01:55] Speaker 04:
In some cases, agencies do endeavor or require regulated entities to estimate the credit risk.

[01:02:00] Speaker 04:
But that's because they had no, if you're trying to assess the risk of assets you're holding, there may be purposes to do that.

[01:02:08] Speaker 04:
But here, Congress, they have a mandate.

[01:02:10] Speaker 04:
Ensure that 5%, 5% or more, shall be retained.

[01:02:15] Speaker 04:
And in the most extreme scenarios, granted they may be rare,

[01:02:21] Speaker 04:
The horizontal option ensures, as does the vertical option, ensures that 5% of the credit risk must be maintained.

[01:02:29] Speaker 04:
And the agencies were quite clear in saying that the purpose of the rule was to ensure that that 5% was.

[01:02:36] Speaker 05:
I'm not sure I fully understand you, but it sounds to me as if you're

[01:02:40] Speaker 05:
You're talking about risk in two different periods of time.

[01:02:46] Speaker 05:
There's risk at the outset when it's predicted and therefore possibly mistakenly predicted risk.

[01:02:53] Speaker 05:
And then there's risk when the whole thing goes belly up.

[01:02:58] Speaker 05:
And of course, at that point, if the whole thing literally goes belly up, credit risk

[01:03:05] Speaker 05:
Well, I'm not sure you need to divide it up into ex ante and ex post.

[01:03:22] Speaker 04:
What I would say, Your Honor, is there's an inherent amount of risk there.

[01:03:26] Speaker 04:
The models attempt to predict where that risk is, but that risk could be 100%.

[01:03:31] Speaker 04:
This is an extreme scenario, but imagine a securitization of student loans that were fraudulently issued.

[01:03:37] Speaker 04:
There is no chance of any principal or interest payments being paid on those loans.

[01:03:41] Speaker 04:
There's no chance of any recovery.

[01:03:43] Speaker 04:
So under any definition of credit risk, and the agencies did offer a credit risk definition, under any definition,

[01:03:51] Speaker 04:
100% credit risk would mean a certainty of total loss of all those assets.

[01:03:56] Speaker 04:
The agency's definition of the rule, which petitioners do not take issue with, is tied to the risk of loss of assets in the securitization, or the diminution in market value.

[01:04:06] Speaker 04:
That's what the rule says.

[01:04:07] Speaker 02:
So there must be some... The credit risk is the amount of the diminution, or how much is left after the diminution?

[01:04:19] Speaker 04:
I would not argue that you can just go to the end and say, well, this is how much is left.

[01:04:24] Speaker 04:
That's credit risk.

[01:04:26] Speaker 04:
Credit risk is hard to put into a single metric.

[01:04:28] Speaker 04:
That's why the credit rating agencies use

[01:04:31] Speaker 04:
In their estimations, they use AAA, AA.

[01:04:34] Speaker 04:
It's not amenable to an easy metric.

[01:04:37] Speaker 04:
And there's lots of people have studied this, and there's lots of experts on it.

[01:04:41] Speaker 04:
But the point being, under the agency's definition of credit risk, it wasn't defined in the statute.

[01:04:46] Speaker 04:
The agencies defined it as the risk of loss on the asset, on the securitized assets, or the diminution in market value of the securitized assets.

[01:04:55] Speaker 04:
Under that definition, the credit risk necessarily ranges somewhere between no credit risk, which is a certainty that there will be no loss of securitized assets, and 100 percent or complete credit risk, in other words, a certainty that there will be complete loss on the asset pool.

[01:05:11] Speaker 02:
So, it's not a matter of... When it comes to determining an amount of money that we're talking about, because they have to take 5% of some amount of money, right?

[01:05:21] Speaker 02:
Not 5% of some probability, but 5% of some amount.

[01:05:24] Speaker 02:
That's right.

[01:05:25] Speaker 02:
What's the amount of money?

[01:05:27] Speaker 04:
So, petitioners have urged, and I think this is a fairly fair estimate, that 500 million would be, half a billion dollars would be a typical value of the securitization, so 5% of that would be 25 million dollars.

[01:05:41] Speaker 04:
That's five percent of the face amount of the... Well, in the horizontal option we used, the agencies used fair value, which is an accounting measure.

[01:05:53] Speaker 04:
But whether you say face value, par value, which is tied to the face value of the loans, or fair value, which is

[01:06:03] Speaker 04:
Essentially, the value of discretization is all quite close.

[01:06:07] Speaker 04:
The petitioner is not drawing a distinction between the face or par value of discretization and the fair value, which they may be slightly different but are not leagues apart.

[01:06:18] Speaker 04:
What they're arguing is that we shouldn't have taken economic value, either one, but only through economic value, by taking some percentage of that, can you be certain to expose

[01:06:31] Speaker 04:
a risk retention candidate to a specified percentage of risk, in this case, 5% or more.

[01:06:38] Speaker 04:
5% of what?

[01:06:41] Speaker 04:
Well, so let's look at the vertical option real quick, Your Honor.

[01:06:44] Speaker 01:
I got the vertical option.

[01:06:45] Speaker 01:
OK, you got the vertical option.

[01:06:46] Speaker 01:
And they don't seem to be disputing the vertical option.

[01:06:49] Speaker 01:
So it could stop there, Your Honor, but if we're going to understand.

[01:06:53] Speaker 05:
But not consistently with your state farm obligation.

[01:06:58] Speaker 04:
But when you look at just the horizontal option,

[01:07:02] Speaker 04:
It's the value of the securitization.

[01:07:04] Speaker 04:
There is, let's move a different way.

[01:07:07] Speaker 04:
In order to hold 100% of the credit risk in that securitization, 100%, all the credit risk, you have to

[01:07:17] Speaker 04:
hold all the assets, because there is some credit risk remaining.

[01:07:21] Speaker 04:
Even if it gets smaller and smaller as you go up the tranches, when you get to that top rated AAA tranche, credit risk remains.

[01:07:28] Speaker 04:
And so it's perfectly reasonable for the agencies to use the value of the securitization as the metric, and it works for both the vertical and the horizontal.

[01:07:37] Speaker 04:
at 100% credit risk or a complete, if a certainty of total loss on the asset pool, those options can work.

[01:07:45] Speaker 04:
And again, even if that weren't true, and I submit that it's a statement of fact, just to illustrate the operation of the rule.

[01:07:53] Speaker 05:
Where is the agency's definition of credit risk?

[01:08:06] Speaker 04:
It's at JA2306, Your Honor.

[01:08:12] Speaker 04:
Or if you're looking, it's 79FR77741.

[01:08:39] Speaker 04:
and it's the first column toward the bottom.

[01:09:01] Speaker 05:
It seems to me a strange idea of

[01:09:05] Speaker 05:
percentage of risk, which to work out in your case, applies only in the case of the total collapse of the, every asset turns out to be absolutely worthless.

[01:09:28] Speaker 05:
Well, there's a certain risk of that, obviously, and you would want a 5% risk to share in the risk of that, but to calculate the holder required holding in terms of that

[01:09:48] Speaker 05:
in reliance on that scenario, and reliance on that scenario not as simply one chance in, I assume, a million, we can't say that, but one in a thousand, say, or a hundred, is a curious idea of credit risk to me.

[01:10:09] Speaker 04:
Well, Your Honor, it's conceded the agencies recognize this repeater and of course we're making that.

[01:10:15] Speaker 04:
that oftentimes, typically, there is more risk being retained in the horizontal option.

[01:10:22] Speaker 04:
But under the scenario we just discussed, as rare and remote as that is, the agency is under an obligation, a mandate, to ensure that sufficient risk was retained.

[01:10:32] Speaker 04:
The petitioners suggest that 0.4% or 0.5%, they're able to put a value on what they think, an economic value, what they think amounts to 5% of the credit risk.

[01:10:42] Speaker 04:
Agencies don't agree with that approach.

[01:10:45] Speaker 04:
And it requires, as you get into highly risky or, you know, securitizations that turned out to have had very high credit risk, you reach a point where, as you approach those high boundaries, that .4% is a very insignificant amount.

[01:11:04] Speaker 04:
And it's not, it certainly cannot ensure

[01:11:09] Speaker 04:
that 5% of the credit risk is retained, which is what Congress directed the agencies to do.

[01:11:14] Speaker 02:
Just to keep maybe overdoing this, is the credit risk the expected value of the loss, given all the possible probabilities and multiplied by

[01:11:26] Speaker 02:
of the various amounts and the different charges.

[01:11:28] Speaker 02:
Is that like a, you have a, you know, $100 total CLO and the expected value of the losses after some calculation in a magic black box is $20.

[01:11:43] Speaker 02:
That's the risk, the $20, the likely risk that $20 will be lost.

[01:11:50] Speaker 02:
Or is it

[01:11:52] Speaker 02:
Is the credit risk $80?

[01:11:54] Speaker 02:
That is, that your $100 investment actually is now only worth $80 because there's a reasonable probability that you're going to lose $20.

[01:12:05] Speaker 02:
Is it either of those numbers?

[01:12:06] Speaker 04:
I don't think it's necessarily either one of those numbers, Your Honor.

[01:12:12] Speaker 04:
I guess if you're looking at the agencies where

[01:12:21] Speaker 04:
looking at the value of the asset pool because the credit risk definition they gave, which petitioner has adopted or at least not taken issue with, is tied to the overall value of the asset pool.

[01:12:36] Speaker 04:
So I'm not sure that agencies did not undertake to take a specific measure of credit risk, but to ensure that

[01:12:46] Speaker 04:
is of either the value of the assets in the asset pool, that sufficient 5% or more of the risk can be retained.

[01:12:54] Speaker 02:
When the statute says credit risk for any asset, does that mean each tranche?

[01:13:03] Speaker 02:
Does that mean the CLO as a whole?

[01:13:06] Speaker 02:
I mean, any particular investor may only buy a particular tranche.

[01:13:12] Speaker 02:
So what does it mean?

[01:13:13] Speaker 04:
I think I should step back a little bit.

[01:13:16] Speaker 04:
So what the SPV does and what the tranching does is it doesn't change the risk on the asset pool.

[01:13:23] Speaker 04:
The asset pool is composed of a certain number of loans.

[01:13:26] Speaker 02:
That's why I'm asking whether the word asset means the pool as a whole.

[01:13:32] Speaker 02:
Yes, I would say it means the pool as a whole.

[01:13:36] Speaker 02:
not a particular asset that it issues, PSPV issues?

[01:13:42] Speaker 04:
Well, I don't think there's any way to, it's any securitized asset, but in total they become the pool of securitized assets.

[01:13:51] Speaker 04:
The third definition talks about asset or ABS interest, which would be the value of the security that's being issued.

[01:14:04] Speaker 02:
So, and what is that?

[01:14:06] Speaker 02:
When a security is issued, is it issued as one collateralized loan obligation, or is it issued as five by the fifth, the lowest tranche, because I'm not risk-inverse and I want to make a lot more money.

[01:14:28] Speaker 02:
Is the asset I've bought that right to the fifth tranche, or is it something else?

[01:14:36] Speaker 04:
You've got a right to the principal and interest income stream that's coming from the loans in conjunction with the payment waterfall.

[01:14:44] Speaker 02:
I understand.

[01:14:45] Speaker 02:
I get that.

[01:14:46] Speaker 02:
But my question is, is that the quote asset in the meaning of the statute that I've bought?

[01:14:53] Speaker 02:
Or is the question of what the asset is, what the securitizer transfers to the SPV?

[01:15:01] Speaker 04:
I believe the term asset there, Your Honor, is referring to the underlying assets in the credit pool, but the ABS interest is referring to the security.

[01:15:10] Speaker 02:
So that would be what the securitizer transfers to the SPV, but it's any asset.

[01:15:17] Speaker 02:
It doesn't say all the assets.

[01:15:20] Speaker 02:
What does that mean?

[01:15:23] Speaker 04:
Well, Your Honor, there is an interesting question that I hadn't actually thought about, but I think that it

[01:15:30] Speaker 04:
There's no real way to parse out.

[01:15:31] Speaker 04:
The way these managed CLOs in particular work is these loans are defaulting all the time, or not all the time, but sometimes they default.

[01:15:39] Speaker 04:
The manager can invest in other loans.

[01:15:42] Speaker 04:
So the asset pool, at least for a period of years, is not static.

[01:15:46] Speaker 04:
So some loans come in, some loans come out.

[01:15:49] Speaker 04:
At a certain number of years, say three years into what may be a 10-year

[01:15:53] Speaker 04:
course of payments to the investors, then the asset pool becomes more or less static.

[01:15:59] Speaker 04:
So it's really hard to tie any one asset.

[01:16:02] Speaker 04:
The pool, essentially, is what we're having to talk about.

[01:16:06] Speaker 04:
Are there further questions?

[01:16:09] Speaker 05:
I just wanted to pursue Judge Garland's hypothesis that the credit risk was the expected value of the loss

[01:16:22] Speaker 05:
So that 100% of the credit risk would be the entire expected value of the loss on the totality.

[01:16:40] Speaker 05:
Putting aside the questions about asset, would that not be true?

[01:16:48] Speaker 04:
That is correct, Your Honor.

[01:16:49] Speaker 04:
That it would be, the expected value would be zero in the 100% credit risk scenario.

[01:16:59] Speaker ?:
Right?

[01:16:59] Speaker 05:
I don't know exactly how I framed it.

[01:17:03] Speaker 05:
100% of the credit risk would be the expected value of the loss.

[01:17:09] Speaker 05:
Now, is the agency's argument why it couldn't allow a horizontal, some ownership in the horizontal tranche less than 5% of its value to be the measure of credit risk?

[01:17:30] Speaker 05:
The proposition that there's no way of figuring out the

[01:17:36] Speaker 05:
in figuring out conservatively what the credit risk and the value of the loss on the asset, the aggregate asset, no way of figuring that out even conservatively.

[01:17:57] Speaker 04:
You could attempt to do it, your honor.

[01:18:01] Speaker 04:
That's whether or not you would be successful.

[01:18:04] Speaker 05:
But of course, the value, whether you talk about fair value or par value or anything else, is also just a prediction, a calculation, right?

[01:18:13] Speaker 05:
Maybe more solid, but... More solid, your honor.

[01:18:17] Speaker 00:
I want to go back to the jurisdiction question for a moment, because we have the interesting situation of both petitioner and respondent agreeing about jurisdiction.

[01:18:29] Speaker 00:
So my question is, without 941,

[01:18:34] Speaker 00:
Could any of these agencies pursuant to the general statutes that they've invoked impose this 5% credit risk retention?

[01:18:45] Speaker 00:
In other words, this specific rule?

[01:18:50] Speaker 04:
Our position is that, with respect, now I won't speak for the absent agencies, they've invoked their own authorities.

[01:18:57] Speaker 04:
With respect to the board, is the board's position that we could have issued

[01:19:04] Speaker 04:
a substantially similar, not identical rule under the Bank Holding Company Act that may have had more limited reach.

[01:19:12] Speaker 00:
Okay, so you're saying under 1844, is that?

[01:19:16] Speaker 04:
Yes, Your Honor.

[01:19:17] Speaker 00:
Okay.

[01:19:18] Speaker 00:
All right.

[01:19:18] Speaker 00:
And so, but that, the heading of that is reports and examinations.

[01:19:24] Speaker 00:
So it seems fairly specific, but you're saying that as to

[01:19:32] Speaker 00:
Banks generally are bank holding companies.

[01:19:36] Speaker 00:
You think that the retention of 5% credit risk would be something the board could do even if there were no Dodd-Frank.

[01:19:47] Speaker 04:
Yes, your honor.

[01:19:48] Speaker 04:
I think there's a different vision, and I have it written for me at this moment, of 1844 that sets out the board's ability to issue regulations.

[01:19:56] Speaker 04:
And yes, your honor, it is the position of the board that the board could have issued.

[01:20:02] Speaker 04:
And you just never thought of that before, is that?

[01:20:05] Speaker 04:
Well, your honor, clearly the Congress's

[01:20:12] Speaker 04:
the Dodd-Frank Act, which came in the wake of the financial crisis and provided this specific mandatory rule.

[01:20:18] Speaker 04:
The board had to issue the rule, as did all the other agencies, had to issue some other rule, whether or not the board would have or otherwise, let's say.

[01:20:25] Speaker 02:
Well, the SEC couldn't have issued it, right?

[01:20:29] Speaker 02:
The SEC doesn't have authority to impose capital requirements on public corporations or anything else.

[01:20:37] Speaker 04:
I think that's right, Your Honor.

[01:20:40] Speaker 04:
In our papers, certainly, we've taken a much broader position with respect to the board's authority than the commission's authority.

[01:20:46] Speaker 05:
The board has general authority, doesn't it, to assure the safety and soundness of the banks under its regulatory umbrella?

[01:20:57] Speaker 04:
Yes, Your Honor, the Bank Holding Company Act, and some of these amendments came through Dodd-Frank, but it speaks of safety and soundness of both the bank holding company system and the stability of the financial system of the United States.

[01:21:11] Speaker 00:
And just one other question.

[01:21:14] Speaker 00:
Obviously, the preference is for direct review in the appellate court, but what horrible thing happens if this court were to transfer this case to the district court?

[01:21:25] Speaker 04:
You're not too well aware of the certain efficiencies that would come from that.

[01:21:29] Speaker 04:
But obviously, the jurisdictional question supersedes that.

[01:21:34] Speaker 04:
There is some question as to whether or not the district court could afford full relief.

[01:21:42] Speaker 04:
For example, if the district court accepts that

[01:21:48] Speaker 04:
that there's a problem with the rule, depends on what the district court held or how it addressed the issues, but that if there's a problem under the joint rule, that there may still be, the board may still retain the argument that the rule stands under the Bank Holding Company Act, which would be outside of the district court's jurisdiction and could only be raised in the first instance in this court.

[01:22:10] Speaker 02:
OK.

[01:22:10] Speaker 02:
I'm not sure I'm following.

[01:22:15] Speaker 02:
Under our reading of the Exchange Act,

[01:22:19] Speaker 02:
anything under the exchange act goes to the district court.

[01:22:23] Speaker 02:
Yes.

[01:22:24] Speaker 02:
Right?

[01:22:25] Speaker 02:
So it has full jurisdiction over anything issued under the exchange act.

[01:22:30] Speaker 02:
And this is Congress's direction to all the agencies to issue a joint rule.

[01:22:36] Speaker 02:
Right?

[01:22:37] Speaker 02:
That's correct.

[01:22:37] Speaker 02:
The district court strikes down the joint rule.

[01:22:40] Speaker 02:
That's the end of the joint rule.

[01:22:42] Speaker 02:
That's correct, John.

[01:22:44] Speaker 02:
But so far, anyway, the board hasn't said

[01:22:48] Speaker 02:
that it would do this without a joint rule.

[01:22:53] Speaker 04:
I'm certainly not representing on behalf of the board.

[01:22:55] Speaker 04:
That would be a question put to the vote of the board, which they've not authorized me to make.

[01:22:59] Speaker 04:
I don't think what the board would do, Your Honor.

[01:23:01] Speaker 02:
But in any case, it would then be reviewed by us.

[01:23:03] Speaker 02:
So it's not like it ends with the district court.

[01:23:06] Speaker 04:
That's correct, Your Honor.

[01:23:07] Speaker 04:
But there would be essentially balkanized rulings on it.

[01:23:11] Speaker 04:
I mean, it would not necessarily be an appeal of district court's ruling.

[01:23:15] Speaker 04:
The district court may hear the case

[01:23:18] Speaker 04:
in one sense, and then a separate direct appeal in a bank holding company.

[01:23:24] Speaker 04:
That seems so very unlike.

[01:23:28] Speaker 02:
I understand why this is a problem often where some aspects of a rule are only authorized by one provision and some are only authorized by another.

[01:23:41] Speaker 02:
And therefore, we've said you could end up with a problem.

[01:23:45] Speaker 02:
That is not this case.

[01:23:46] Speaker 02:
In this case, Dodd-Frank specifically authorizes a joint rule

[01:23:53] Speaker 04:
And puts that authorization in the exchange act and the that provision of the exchange act goes to the district court to begin so Well, I'll just maybe I'll just give you one possible scenario where this could potentially occur imagine that the district court was concerned with the Commission's economic analysis, which was adopted by the Commission but not concerned with the

[01:24:22] Speaker 04:
the text of the rule itself.

[01:24:25] Speaker 04:
The district court could rule on those grounds, and the board could theoretically, I'm not, sort of not suggesting that it would, take the position that the bank holding, the rule remains in effect, even if the district court vacated because that's an obligation of the commission, potentially an obligation of the joint rule, but not an obligation of the Bank Holding Company Act.

[01:24:44] Speaker 02:
Well, you could take that position here too.

[01:24:49] Speaker 02:
Right?

[01:24:49] Speaker 02:
You could take the position.

[01:24:50] Speaker 02:
I mean, I don't actually, so far, the opening brief of the petitioners doesn't even raise the requirement of the cost benefit analysis.

[01:25:00] Speaker 02:
It's not raised until the reply.

[01:25:03] Speaker 02:
But had they raised it, I would assume that the board could have made whatever argument that we're talking about now that that provision only has to be done by the board, by the SEC.

[01:25:15] Speaker 02:
But you didn't make that argument.

[01:25:17] Speaker 02:
So we're pretty much in speculation land here.

[01:25:20] Speaker 04:
That's right.

[01:25:21] Speaker 04:
I'm not just purely discussing the jurisdictional question from a hypothetical.

[01:25:27] Speaker 04:
Okay.

[01:25:30] Speaker 04:
Thank you.

[01:25:31] Speaker 02:
I know they don't have any time, but we'll give you another two minutes anyway.

[01:25:40] Speaker ?:
Um,

[01:25:43] Speaker 03:
If I could just address credit risk.

[01:25:44] Speaker 02:
Only if you talk into the microphone.

[01:25:47] Speaker 03:
Thank you.

[01:25:49] Speaker 03:
Credit risk isn't a confusing concept.

[01:25:51] Speaker 03:
It's the expected loss of an asset or an asset class based on historical performance.

[01:25:58] Speaker 03:
In the way that it addresses what the amount would be, it's simply for $1 billion securitization, the fair value that would have to be held would be 5% of that, or $50 million.

[01:26:13] Speaker 03:
If, however, the credit loss, so that was the benchmark that the current rule requires.

[01:26:20] Speaker 03:
If the anticipated credit loss for the asset class, and it's the assets held by the SBB, it's not the assets that are, it's not the notes that are distributed, were 10%.

[01:26:32] Speaker 03:
That would be $100 million.

[01:26:33] Speaker 03:
5% of that is $5 million.

[01:26:35] Speaker 03:
So the difference and the gist of the objection here is that the CLO managers at issue, which as you say, they're representatives of investors.

[01:26:44] Speaker 03:
Groups of investors, at least for open market CLOs, hire an expert who's a fund manager at base to purchase on the open market

[01:26:54] Speaker 02:
Do the managers not go out and try to market these to themselves?

[01:26:59] Speaker 02:
Is it always coming in the direction that you're talking about?

[01:27:03] Speaker 02:
That is the investors first somehow all get together and then find, I mean that doesn't strike me as the way it works.

[01:27:09] Speaker 03:
They're very large companies that do open market CLOs that can work with and get investors, but they are separate from

[01:27:17] Speaker 03:
the loan origination side.

[01:27:20] Speaker 03:
That's the point that I thought you were driving at, Judge Williams, in terms of the model.

[01:27:25] Speaker 03:
And in terms of the vertical versus horizontal problem, the key issue, it is a, you were calling it a state farm problem, I would call it a Michigan VEPA problem, that there's absolutely nothing in this order or rule that indicates why a fair value is an appropriate assessment of credit risk.

[01:27:44] Speaker 03:
It wasn't in the order.

[01:27:46] Speaker 03:
It couldn't point anything in the order.

[01:27:47] Speaker 03:
It wasn't in the agency's brief.

[01:27:48] Speaker 03:
They essentially conceded that they are two separate concepts.

[01:27:51] Speaker 02:
You don't dispute that it is at least.

[01:27:54] Speaker 02:
The using fair market value guarantees that you get at least 5% of the credit risk, right?

[01:28:00] Speaker 03:
In fact, your argument is way more.

[01:28:04] Speaker 03:
We don't dispute that under the rules written, there would be at least, but we also note that the agencies made a determination at 2176 of what the appropriate benchmark is.

[01:28:17] Speaker 03:
And they said the benchmark that we're going to apply is 5%.

[01:28:20] Speaker 03:
We are going to decline to require more than 5% for any asset class.

[01:28:25] Speaker 03:
We're just going to require the minimum amount

[01:28:27] Speaker 03:
not above.

[01:28:28] Speaker 03:
And we're going to do that because, for reasons they explained elsewhere, overcapitalization increases costs, reduces credit availability, and hurts competition.

[01:28:38] Speaker 02:
But they don't think this is overcapitalization because they think that if they have a lower number, even a fair market value, it's too risky.

[01:28:45] Speaker 02:
They don't know whether it's going to be 5% of the loss or not.

[01:28:51] Speaker 02:
It's the case that any rule about retention of

[01:28:56] Speaker 02:
credit risk is going to increase capital costs, right?

[01:28:59] Speaker 02:
Any rule.

[01:29:03] Speaker 03:
Yes, that's right.

[01:29:04] Speaker 03:
And the agency's reasoning was if we go too, it's a trade-off, if we go too far, then we incur these costs.

[01:29:09] Speaker 03:
If we don't go far enough, there's not sufficient alignment.

[01:29:11] Speaker 02:
Congress has to have understood that

[01:29:16] Speaker 02:
rules they impose for the safety of all kinds of investment vehicles raise the cost because you can't get the cheapest possible.

[01:29:25] Speaker 02:
So then the only question is whether they've done this in a reasonable way.

[01:29:29] Speaker 02:
They've offered you the vertical slice

[01:29:33] Speaker 02:
which you don't dispute, correct?

[01:29:36] Speaker 02:
That's not quite right.

[01:29:37] Speaker 02:
Well, you don't dispute that it represents 5% of the credit risk.

[01:29:40] Speaker 03:
That's correct.

[01:29:40] Speaker 03:
We don't agree that it's an appropriate implementation of the statute.

[01:29:43] Speaker 02:
But still, of the statute?

[01:29:45] Speaker 03:
That's right.

[01:29:45] Speaker 02:
Why is that?

[01:29:46] Speaker 02:
Why doesn't it fit the rules?

[01:29:48] Speaker 05:
I thought it was inappropriate.

[01:29:49] Speaker 02:
Yeah.

[01:29:49] Speaker 05:
I'm sorry.

[01:29:51] Speaker 05:
Yes.

[01:29:51] Speaker 05:
Not the appropriate.

[01:29:53] Speaker 02:
But it is an appropriate interpretation of the words

[01:29:58] Speaker 02:
require a securitizer to retain not less than five percent of the credit risk for any asset.

[01:30:02] Speaker 02:
It does that.

[01:30:03] Speaker 02:
It does that.

[01:30:03] Speaker 02:
Okay.

[01:30:04] Speaker 02:
So I am having difficulty.

[01:30:08] Speaker 02:
We have other cases where we say the agency offers options.

[01:30:13] Speaker 02:
One of the options indisputably fits within the statute, and the others may have some problems.

[01:30:19] Speaker 02:
that that is not a state farm problem.

[01:30:22] Speaker 02:
That may be a failure to sufficiently consider alternatives problem, which is your third argument.

[01:30:29] Speaker 02:
But your second argument, I'm a little difficult to do.

[01:30:32] Speaker 02:
They've satisfied the statute.

[01:30:34] Speaker 02:
They've heard from commentators that some managers want to retain the lowest horizontal because that gives confidence to investors.

[01:30:48] Speaker 02:
And they say, OK, we'll do that, but we really don't know how to evaluate that.

[01:30:51] Speaker 02:
So we're going to have a hefty set of protections there.

[01:30:56] Speaker 02:
And if you don't like it, don't take it.

[01:30:57] Speaker 03:
Take the vertical.

[01:31:00] Speaker 03:
The rule, the horizontal component is integrated into the rule.

[01:31:03] Speaker 03:
A baseline requirement was that a sponsor can mix and match the horizontal and vertical up to 5%.

[01:31:10] Speaker 03:
The rationale for, that's a third option.

[01:31:15] Speaker 03:
well they gave me three options you can take the vertical you can take the horizontal or you can mix and match the vertical only is a zero horizontal and that's right but it's integral to the rule and they justified the rule as a whole they did so without any analysis of credit risk that's what i would call the michigan v e p a or the state farm issue

[01:31:42] Speaker 03:
Michigan EPA indicates not only that the agency has to rely upon the correct statutory factor, but even if it can be justified in terms of, even if the resulting rule can be justified in terms of the statutory factor that they overlooked or didn't apply, that doesn't save the rule.

[01:32:01] Speaker 03:
They treat that as a basic application of chenery, and this Court's decision

[01:32:05] Speaker 03:
in National Mining Association indicates the rule isn't saved simply because one or a handful of applications may accord with the underlying statutory framework.

[01:32:19] Speaker 03:
The rule as a whole has to do so.

[01:32:22] Speaker 03:
The difference is that the credit risk analysis would have generated a different rule.

[01:32:28] Speaker 03:
The vertical holding, the top 80% of that contains virtually no credit risk.

[01:32:35] Speaker 03:
99.9 plus percent is in the bottom 20%.

[01:32:39] Speaker 03:
An example of one of the alternatives that wasn't addressed even by the agency was offered by an industry group that proposed just 1% of fair value, held, which you can think of as the bottom portion of the vertical.

[01:32:55] Speaker 03:
1% of fair value.

[01:32:56] Speaker 03:
That's 10% of credit risk.

[01:32:58] Speaker 03:
It meets the statutory standard, and it avoids the harms to competition and credit availability and so on that the agencies identify.

[01:33:08] Speaker 03:
The agency's reasoning for rejecting that had nothing to do with any appropriate evaluation of credit risk.

[01:33:15] Speaker 03:
It was that it's not 5% of fair value.

[01:33:17] Speaker 03:
The holding is smaller than that.

[01:33:20] Speaker 03:
And they said there's no buffer for the senior note holders.

[01:33:24] Speaker 03:
But that's not part of the rationale for the vertical at all and wasn't part of the congressional design.

[01:33:33] Speaker 02:
Further questions?

[01:33:34] Speaker 03:
If I could say just a word on warehousing to try to retain that.

[01:33:38] Speaker 03:
The record doesn't have a great deal about that, but at 1155 is the discussion of warehousing.

[01:33:47] Speaker 03:
And the other, I think, the key aspect is the definition in the rule itself at 2315 of what an open market transaction is.

[01:33:59] Speaker 03:
And both are indicating that it's an arm's length independent transaction.

[01:34:03] Speaker 03:
Now, what I'm going to say is not in the record, but by our understanding is that this warehousing, to the extent it exists for open market CLOs, that there are equity holders.

[01:34:16] Speaker 03:
The SBB is set up beforehand.

[01:34:19] Speaker 03:
The equity holders put in equity.

[01:34:21] Speaker 03:
The loan as such is to the equity holders.

[01:34:24] Speaker 03:
Those equity holders

[01:34:26] Speaker 03:
may or may not be the same parties that take the equity interest once the CLO is actually up and going, the deal is closed.

[01:34:39] Speaker 03:
The distinction in this context between open market CLOs and balance sheet CLOs is essential.

[01:34:46] Speaker 03:
The business model is simply different.

[01:34:48] Speaker 03:
That it's the arm's length, again as the rules definition indicates, it's an arm's length transaction with the open market CLO manager acting on behalf of a group of investors.

[01:34:59] Speaker 03:
The Council frankly was blurring the distinction between a balance sheet and an open market CLO.

[01:35:05] Speaker 03:
The crucial element here is that the CLO manager acts essentially like an expert fund manager.

[01:35:12] Speaker 03:
They're not in the business of running a balance sheet.

[01:35:14] Speaker 03:
They're not in the business of originating loans.

[01:35:17] Speaker 03:
And that's why the open market CLO

[01:35:20] Speaker 03:
is a positive force for creating the right incentives for loan origination.

[01:35:26] Speaker 03:
And that's the only link to the origination to distribute model.

[01:35:29] Speaker 03:
There's no, the CLO manager's not doing any origination to distribute.

[01:35:36] Speaker 03:
It is purchasing loans on the open market that banks, on the secondary market, that banks would have originated before.

[01:35:44] Speaker 03:
So if you have expert managers evaluating those loans, that increases the incentives on the banks to originate well underwritten rather than not well underwritten loans.

[01:35:55] Speaker 02:
Can I pause over this?

[01:35:56] Speaker 02:
You're talking about the

[01:35:58] Speaker 02:
Definition of open market transaction, which is at 2315.

[01:36:01] Speaker 02:
Is that, that's I at the very bottom there.

[01:36:05] Speaker 02:
Is that, are they talking about the, again, these were word, the transfer of the loan to the manager, or are they talking about the ultimate sale of the secured asset?

[01:36:27] Speaker 03:
They're discussing, as I understand it, the selling and purchasing of the loan that goes into the SPV.

[01:36:36] Speaker 03:
In other words, they're defining what open market needs to be.

[01:36:39] Speaker 02:
So it does say arm's length, but it also says which perspective purchasers include that are not limited to entities that are not affiliated with the seller.

[01:36:48] Speaker 02:
That's right.

[01:36:48] Speaker 02:
Which means that it could include ones that are affiliated with the seller.

[01:36:51] Speaker 03:
It can include those.

[01:36:53] Speaker 03:
And there are certain banks that have independent affiliates that do run open market CLOs.

[01:37:03] Speaker 02:
OK.

[01:37:03] Speaker 02:
Any other questions?

[01:37:05] Speaker 02:
All right.

[01:37:05] Speaker 02:
You've all given us a lot to think about.

[01:37:06] Speaker 02:
We'll take it under submission.