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 FINANCIAL CRISIS INQUIRY COMMISSION REPORT

the loans in the remainder of the mortgage pool that were not sampled (as much as
), Clayton and the securitizers had no information, but one could reasonably ex-
pect them to have many of the same deficiencies, and at the same rate, as the sampled
loans. Prospectuses for the ultimate investors in the mortgage-backed securities did
not contain this information, or information on how few loans were reviewed, raising
the question of whether the disclosures were materially misleading, in violation of
the securities laws.
CDOs were issued under a different regulatory framework from the one that ap-
plied to many mortgage-backed securities, and were not subject even to the minimal
shelf registration rules. Underwriters typically issued CDOs under the SEC’s Rule
A, which allows the unregistered resale of certain securities to so-called qualified
institutional buyers (QIBs); these included investors as diverse as insurance compa-
nies like MetLife, pension funds like the California State Teachers’ Retirement Sys-
tem, and investment banks like Goldman Sachs. 
The SEC created Rule A in , making securities markets more attractive to
borrowers and U.S. investment banks more competitive with their foreign counter-
parts; at the time, market participants viewed U.S. disclosure requirements as more
onerous than those in other countries. The new rule significantly expanded the mar-
ket for these securities by declaring that distributions which complied with the rule
would no longer be considered “public offerings” and therefore would not be subject
to the SEC’s registration requirements. In , Congress reinforced this exemption
with the National Securities Markets Improvements Act, legislation that Denise Voigt
Crawford, a commissioner on the Texas Securities Board, characterized to the Com-
mission “as prohibit[ing] the states from taking preventative actions in areas that we
now know have been substantial contributing factors to the current crisis.” Under

this legislation, state securities regulators were preempted from overseeing private
placements such as CDOs. In the absence of registration requirements, a new debt
market developed quickly under Rule A. This market was liquid, since qualified
investors could freely trade Rule A debt securities. But debt securities when Rule
A was enacted were mostly corporate bonds, very different from the CDOs that
dominated the private placement market more than a decade later. 
After the crisis unfolded, investors, arguing that disclosure hadn’t been adequate,
filed numerous lawsuits under federal and state securities laws. As we will see, some
have already resulted in substantial settlements.

REGULATORS: “MARKETS WILL ALWAYS SELFCORRECT”

Where were the regulators? Declining underwriting standards and new mortgage
products had been on regulators’ radar screens in the years before the crisis, but dis-
agreements among the agencies and their traditional preference for minimal interfer-
ence delayed action.
Supervisors had, since the s, followed a “risk-focused” approach that relied

extensively on banks’ own internal risk management systems. “As internal systems
improve, the basic thrust of the examination process should shift from largely dupli-