Release No. 34-10828

May 28, 1974

Securities Exchange Act of 1934 Release No. 10828

Adoption of Rule 3a12-4 Defining Certain Mortgage Securities As Exempted Securities for Purposes of Subsections (a) and (c)(3) of Section 15; Rescission of Rule 15a-1

The Securities and Exchange Commission today announced the adoption of Rule 3a12-4 (17 CFR 240.3a12-4) and rescission of Rule 15a-1 (17 CFR 240.15a-1) under the Securities Exchange Act of 1934 (the "Act"). The rule was originally released for public comment on December 13, 1973 ¹ and has been revised in line with some of the comments received. The principal effect of the new rule will be to exempt broker-dealers dealing solely in mortgage securities (as defined) under specified conditions and other exempted securities from the operation of subsections (a) and (c)(3) of Section 15 of the Act which provide, respectively, for registration of broker-dealers and for regulation of their financial responsibility by the Commission. Rule 15a-1 currently provides only for an exemption from the operation of the registration requirement.

Background of Proposed Rule

The Federal Home Loan Mortgage Corporation ² ("FHLMC") has determined to implement its Congressional mandate ³ to create a liquid secondary market in residential mortgages by establishing a pilot project for an automated trading information system that would list offerings to buy and sell: (1) government guaranteed and non-guaranteed aggregated and individual whole loan mortgages; (2) participation interests (as defined) in such mortgages; (3) commitments for such mortgages; ⁴ FHLMC guaranteed participation certificates; and (5) Government National Mortgage Association pass-through securities ⁵. FHLMC will supervise, monitor and coordinate with the Commission on the regulation of the system.

In view of the Congressionally determined public need for more capital to be made available for real estate mortgages, the Commission has been working with FHLMC in clarifying the applicability of the Federal securities laws to the establishment and operation of the pilot system. ⁶ The Commissions action today is related directly to this joint effort.

There has been some question as to whether broker-dealers who were exempt from registration because they dealt solely in whole loan mortgages, as provided in Rule 15a-1, were still required to comply with other provisions of the Act applicable to brokers and dealers, particularly the various financial responsibility rules under Section 15(c)(3). In view of the special nature of the mortgage market and the participants in that market, the Commission has not sought to establish a unique regulatory structure governing the financial responsibility of such firms. The Commission believes it appropriate to exempt all brokers and dealers who deal solely in mortgage securities, where the entire evidence of indebtedness is transferred and the unpaid principal amount of the individual loan or aggregate loans involved in the transaction is at least $50,000, from the operation of Section 15(c)(3) of the Act. In this regard, it should be noted that FHLMC has devised certain financial standards that must be maintained by the participants in its proposed automated system. Since there are mortgage brokers and dealers who may not participate in FHLMCs automated system and therefore may not be subject to financial responsibility oversight of FHLMC, the Commission believes that where a broker-dealer sells exempted mortgage securities there should be a minimum cash requirement applicable to each separate sale of a mortgage security. Thus, in order to maintain the status quo with respect to the sophistication of the participants in the mortgage market, the exemption under the rule is available in the case of a sale of the mortgage security by a broker-dealer, if at the time of such sale such mortgage security is not in default and has an unpaid principal amount of at least $50,000. The words "is not in default" have been added to the rule to make clear that a mortgage in default would not be an exempted security.

At the same time, the Commission rescinds Rule 15a-1, which had provided only for an exemption from the operation of the registration requirement for broker-dealers who deal in whole loan mortgages under certain conditions, and places the substance of its provisions within Rule 3a12-4. ⁷

Rule 3a12-4 as originally proposed would have included only whole loan mortgages. In view of the comments received the rule has been revised to add certain mortgage participation interests and advance commitments to the exempted category. Trading in participation interests that represent one of two undivided interests in a whole loan or an aggregated whole loan (of which one interest is retained by the originator) presently amounts to over $10 billion annually. Trading in commitments, which are contracts to purchase mortgages or participation interest in the future (generally within 2 years), comprises approximately one-half of the mortgage sales in the existing secondary mortgage market and are issued for the purpose of shifting the long-term market risks such as interest rate fluctuations.

It should be noted that Rule 3a12-4 does not exempt transactions in qualified mortgage securities from other provisions of the Act (i.e., other than subsections (a) and (c)(3) of Section 15) and implementing Commission rules under those provisions. For example, these transactions are not exempt from the margin and antifraud provisions.

It should also be noted that the exemptions afforded by the rule may be inapplicable if the mortgage security is sold as part of an "investment contract." For example, the following is a list of accompanying services retained (i.e., not transferred with the mortgage) and other attributes afforded by the seller or someone other than the buyer that the Commission has previously indicated ⁸ may result in a mortgage constituting a part of an investment contract.

1. Complete investigation and placing service.

2. Servicing collection, payments, foreclosures, etc.

3. Implied or express guarantee against loss at any time or providing a market for the underlying security.

4. Making advances of funds to protect the security of the investment.

5. Acceptance of small uniform or continuous investments.

6. Implied or actual guarantee of specified yield or return.

7. Continual reinvestment of funds.

8. Payment of interest prior to actual purchase of the mortgage or trust note.

9. Providing for fractional interests in mortgages or deeds of trust (other than as provided for by the rule).

10. Circumstances which necessitate complete reliance upon the seller.

11. Sellers selection of the mortgage or deed of trust for the investor.

The Commission notes, however, that it does not generally consider the retention of attribute no. 2 alone sufficient to change a mortgage transaction into one involving an investment contract.

Statutory Basis

Because the above described revisions in Rule 3a12-4 (17 CFR 240.3a12-4) are technical in nature or relax certain of the requirements of the Securities Exchange Act of 1934 the Securities and Exchange Commission finds that, for good cause, the notice and procedures specified in the Administrative Procedure Act, 5 U.S.C. 553 are unnecessary. Accordingly the Securities and Exchange Commission, acting pursuant to the provisions of the Securities Exchange Act of 1934, and particularly Sections 3(a)(12), 15(a)(2), 15(c)(3) and 23(a) thereof, and deeming it necessary and appropriate in the public interests and for the protection of investors hereby rescinds Rule 15a-1 in its entirety and adopts Rule 3a12-4 effective July 1, 1974.

TEXT OF RULE

Rule 3a12-4

Exemptions from Sections 15(a) and 15(c)(3) for Certain Mortgage Securities

(a) When used in this Rule the following terms shall have the meetings indicated:

(1) The term "whole loan mortgage" means an evidence of indebtedness secured by mortgage, deed of trust, or other lien upon real estate or upon leasehold interests therein where the entire mortgage, deed or other lien is transferred with the entire evidence of indebtedness.

(2) The term "aggregated whole loan mortgage" means two or more whole loan mortgages that are grouped together and sold to one person in one transaction.

(3) The term "participation interest" means an undivided interest representing one of only two such interests in a whole loan mortgage or in an aggregated whole loan mortgage, provided that the other interest is retained by the originator of such participation interest.

(4) The term "commitment" means a contract to purchase a whole loan mortgage, an aggregated whole loan mortgage or a participation interest which by its terms requires that the contract be fully executed within 2 years.

(5) The term "mortgage security" means a whole loan mortgage, an aggregated whole loan mortgage, a participation interest, or a commitment.

(b) A mortgage security shall be deemed an "exempted security" for purposes of subsections (a) and (c)(3) of Section 15 of the Act provided that, in the case of and at the time of any sale of the mortgage security by a broker or dealer, such mortgage security is not in default and has an unpaid principal amount of at least $50,000.

(Secs. 3(a)(12), 15(a)(2), 15(c)(3), 23(a); 48 Stat. 882, 895, 901; as amended 49 Stat. 1379, 52 Stat. 1075, 78 Stat. 565, 84 Stat. 1653; 15 U.S.C. 78(c), 78o(a), 78o(c)(3), 78w(a).)

By the Commission.

George A. Fitzsimmons

Secretary

²FHLMC was established by Title III of the Emergency Home Finance Act of 1970, cited as the "Federal Home Loan Mortgage Corporation Act," codified as 12 U.S.C. Sections 1451-1459. FHLMCs capital stock consists solely of non-voting common stock held by the twelve Federal Home Loan Banks and its Board of Directors is composed of the three members of the Federal Home Loan Bank Board. It is an integral part of the Federal Home Loan Bank System.

³The Emergency Home Finance Act of 1970 was enacted following a determination by Congress that the nation needed more capital in residential mortgages and that this could be best accomplished by the establishment of a liquid market for such securities. FHLMC was established by this Act with the power "to make and enforce such by-laws, rules and regulations as may be necessary or appropriate to carry out the purposes or provisions of this title." 12 U.S.C. §1452(b)(3).

⁴Non-guaranteed whole loan mortgages, participation interests and commitments must be registered under the Securities Act of 1933 unless they are exempt from such registration. FHLMC has received a "no-action" letter from the Division of Corporation Finance with respect to such listings on its system under certain conditions. Letter to Thomas R. Bomar, Chairman of FHLMC from Neal S. McCoy Associate Director, Division of Corporation Finance dated May 22, 1974.

⁵The Government National Mortgage Association, pursuant to Section 306(g) of the Federal National Mortgage Association Charter Act, as amended (12 U.S.C. (Supp. IV) 1721 (g), issues securities (referred to as "pass-through" securities) which are guaranteed as to timely payment of principal and interest with the full faith and credit of the United States. These securities are collateralized by pools of Federal Housing Administration (FHA) and/or Veterans Administration (VA) guaranteed mortgages.

⁶See Securities Exchange Act Release No. 9865 (November 17, 1972), relating to the adoption of Rule 3a12-1.

⁷A question has been raised as to whether whole loan mortgages can be aggregated and sold without losing their exempt status under Rule 15a-1. The exemption afforded by Rule 3a12-4 is not lost by such aggregation.

⁸See Securities Exchange Act Release No. 5633 (January 31, 1958) (interpretation of Rule 15a-1 noting these eleven attributes).