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ALL IN 

quire Citigroup to buy back . billion in loans as of November , finding that
the loans Citigroup had sold them did not conform to GSE standards.

SEC: “The elephant in the room is that
we didn’t review the prospectus supplements”
By the time the financial crisis hit, investors held more than  trillion of non-GSE
mortgage-backed securities and close to  billion of CDOs that held mortgage-

backed securities. These securities were issued with practically no SEC oversight.
And only a minority were subject to the SEC’s ongoing public reporting require-
ments. The SEC’s mandate is to protect investors—generally not by reviewing the
quality of securities, but simply by ensuring adequate disclosures so that investors
can make up their own minds. In the case of initial public offerings of a company’s
shares, the work has historically involved a lengthy review of the issuer’s prospectus
and other “offering materials” prior to sale. 
However, with the advent of “shelf registration,” a method of registering securities
on an ongoing basis, the process became much quicker for mortgage-backed securi-
ties ranked in the highest grades by the rating agencies. The process allowed issuers
to file a base prospectus with the SEC, giving investors notice that the issuer intended
to offer securities in the future. The issuer then filed a supplemental prospectus de-
scribing each offering’s terms. “The elephant in the room is that we didn’t review the
prospectus supplements,” the SEC’s deputy director for disclosure in corporation fi-

nance, Shelley Parratt, told the FCIC. To improve disclosures pertaining to mort-
gage-backed securities and other asset-backed securities, the SEC issued Regulation
AB in late . The regulation required that every prospectus include “a description
of the solicitation, credit-granting or underwriting criteria used to originate or pur-
chase the pool assets, including, to the extent known, any changes in such criteria
and the extent to which such policies and criteria are or could be overridden.” 
With essentially no review or oversight, how good were disclosures about mort-
gage-backed securities? Prospectuses usually included disclaimers to the effect that
not all mortgages would comply with the lending policies of the originator: “On a
case-by-case basis [the originator] may determine that, based upon compensating
factors, a prospective mortgage not strictly qualifying under the underwriting risk
category or other guidelines described below warrants an underwriting exception.” 
The disclosure typically had a sentence stating that “a substantial number” or perhaps

“a substantial portion of the Mortgage Loans will represent these exceptions.” Citi-
group’s Bowen criticized the extent of information provided on loan pools: “There
was no disclosure made to the investors with regard to the quality of the files they
were purchasing.” 
Such disclosures were insufficient for investors to know what criteria the mort-
gages they were buying actually did meet. Only a small portion—as little as  to
—of the loans in any deal were sampled, and evidence from Clayton shows that a

significant number did not meet stated guidelines or have compensating factors. On