AICPA Investment Companies Expert Panel
May 12, 2011 Expert Panel Meeting Highlights
I.
Administrative items/AICPA matters:
1. AICPA staff communicated the status of the April Expert Panel (EP) call highlights.
When available, they will be posted on the AICPA website at the link below:
http://www.aicpa.org/interestareas/frc/industryinsights/pages/expert_panel_investmen
t_companies.aspx
2. The AICPA staff discussed with the Expert Panel members various comments made
during the conforming changes review of the Audit and Accounting Guide Investment
Companies (the “Guide”). These comments included how to best incorporate AICPA
and PCAOB auditing and attestation guidance into the Guide going forward and
potentially removing or editing Appendix C “Internal Revenue Code Worksheets” in
future editions of the Guide as some financial instruments (especially derivatives)
have more complex tax diversification issues than is apparent from the worksheet.
Further, the “Illustrative Report of Independent Registered Public Accounting Firm
on Management’s Assertion Regarding Controls at a Custodian Pursuant to Rule
206(4)-2 and Release No. IA-2969 Under the Investment Advisers Act of 1940”
contained in chapter 11 (and posted on www.aicpa.org) is titled “Report of
Independent Registered Public Accounting Firm”. EP members noted that the
custody rules require a PCAOB registered and inspected accounting firm for this
engagement; however, the report is in accordance with the AICPA attestation
standards, not PCAOB attestation standards. The EP member expressed a view that
the reports are explicit that they are done under AICPA attestation standards, and not
under PCAOB standards, and the intent of the title was to demonstrate that the firm
was registered, because users are required to report to the SEC that the examination
was performed by a registered firm; therefore, the report title in the Guide should be
retained.
The EP members also discussed the illustrative Statement of Cash Flows in paragraph
7.183 of the Guide and that the line items “Decrease in receivables for securities
sold” and “Decrease in payable for securities purchased” generally would not be
necessary as the true cash impact would already be reflected in the purchases and
sales of investments. The EP considered updating the illustrative Statement of Cash
Flows in the future edition of the Guide by removing “Decrease in receivables for
securities sold” and “Decrease in payable for securities purchased” from the cash
flow statement and those amounts would be reflected in the purchase and sales of
investments balances.
3. The EP members and AICPA staff discussed the timing of upcoming meetings and
conference calls.
II.
Accounting/Reporting Issues
1. EP members discussed derivative disclosures in financial statements, particularly the
application of Rules 6-04 and 12-13 under Regulation S-X which require disclosures
of investments other than securities.
2. EP members discussed whether there would be a benefit to adding clarifying
language in Chapter 3 of the Guide around whether certain financial instruments are
derivatives. For example, there have been questions about whether purchased options
were derivatives; the EP members expressed a view that purchased options would
generally be considered a derivative. The EP members also discussed some
considerations as to when rights and warrants would qualify as derivatives. The EP
members will form a separate task force to consider expanding derivatives guidance
in the Guide.
3. EP members discussed how registered investment companies (RICs) fair value their
international securities while considering the closure of a foreign market. For
example, if a foreign market is closed and a registered investment company hits its
fair value trigger, would one add the factor to the last closing price of the security on
the closed foreign market or continue to price using the last traded price and look for
significant events to determine if an adjustment is needed. EP members believed that
registered investment companies would benefit from having a policy on this that they
apply consistently.
4. The EP members discussed new fees associated with certain provisions of the DoddFrank Act, specifically the Transaction and Clearing fees associated with swaps that
are paid monthly (and accrued based on activity). These charges will generally be
associated with individual swap transactions, but there are some complications as
they may have volume discounts. The EP members discussed considerations to
evaluate if these are expensed or allocated to the cost of the trade. The EP members
indicated they will continue discussing this topic at future meetings. In addition, the
EP members discussed the Purchased Adjustment Interest (PAI) charges. EP
members noted these are currently being discussed in the industry as to whether they
are part of the cost basis. Some EP members analogized this to broker commissions
and rebates for achieving certain volume discounts and how funds have historically
accounted for them.
5. The EP members continued discussing the proposed Accounting Standards Update
Topic 210 – Balance Sheet Offsetting and IASB Exposure Draft Offsetting Financial
Assets and Liabilities and the comments the Expert Panel members, their firms and
others in the industry submitted. An EP member also shared observations from
informal discussions with the FASB staff. The AICPA comment letter on this
proposal is available
athttp://www.aicpa.org/advocacy/financialreporting/downloadabledocuments/aicpa_o
ffsetting_comment_letter.pdf
6. EP members discussed situations where an investment company holds investments in
multiple classes of an investee fund. For instance, a fund of funds holds $3,000,000 in
Class A of the investee, and $500,000 in Class S (a side pocket class) of the investee.
For the purposes of leveling in the ASC 820 hierarchy, a question arises whether the
investment should be bifurcated if the investment into Class A meets the criteria for
Level 2, but the investment into Class S is illiquid, and, therefore, a Level 3
investment. The EP discussed industry practice in leveling such investments and
noted that the EP members generally believe that in the situation of a unitized fund as
described above, there could be multiple units of account for an interest in an investee
fund, and that a similar analogy would apply to investments in partnerships where a
portion of the investment is locked up or has other varying liquidity characteristics.
7. The EP members discussed views whether private equity funds should continue to
account for management fee waiver programs in a manner consistent with the fee
waivers guidance set forth in the Guide (ASC 946) or in accordance with ASC 718
and related guidance on stock-based compensation. The EP considered whether the
development of a Technical Practice Aid (TPA) may help to provide guidance to
financial statement preparers and auditors. The EP will not develop a TPA on this
matter at this time.
8. The EP members discussed recognition of loan origination fees received on deals that
certain investment companies, including business development companies (BDCs),
invest in. Many BDCs have historically amortized loan origination fees amounts over
the life of the loan. EP members indicated that the fair value guidance in ASC 82510-25-3 (previously paragraph 3 of FASB Statement No. 159) would potentially
indicate that immediate recognition of the loan origination fees is the more
appropriate accounting under a full fair value model. EP members also acknowledged
that the guidance in ASC 825-10-25-3 pertains to the recognition of expense by the
borrower and not the recognition of income by a lender/investor. [Note: Subsequent
to the meeting it was confirmed that FASB Statement No. 159 did not change the
guidance for income recognition from that already provided by FASB Statement No.
91.]
9. The EP members shared their views regarding the accounting treatment for
distribution of securities in-kind rather than cash to an investor. EP members agreed
that generally in-kind redemptions to an investor would trigger a realized gain or loss
at the fund level. Therefore, the sale would be reflected based on the fair value of the
investments and the associated realized gain or loss would be recorded.
10. The Financial Accounting Standards Board (FASB) directed its staff to draft a
proposed Accounting Standards Update (ASU) on Investment Properties. Currently,
international accounting standards allow entities to value its investment in real estate
at fair value, while US GAAP does not provide such an option. It is anticipated that
the proposed ASU would be issued in the second quarter of 2011. The AICPA staff
learned that the FASB anticipates issuing this proposed ASU together with the
proposed ASU on Consolidations of Investment Companies. The AICPA staff and
the EP members held a discussion on whether and how the Expert Panel should
comment on these proposals, once issued.
11. The EP members discussed matters relating to recent views expressed by the SEC
staff that it may be appropriate for BDCs to consolidate special-purpose vehicles
(SPVs) that are considered non-investment companies in certain circumstances. The
EP members shared that accounting firms and advisers have been analyzing the
consolidation scenarios on a case by case basis for new registration filings and
acknowledged that diversity in practice exists and that guidance received by BDCs
from the SEC staff represents a change from historical views and practices. EP
members noted that questions arise as to whether SPVs are considered investment
companies and, if so, whether consolidation of a non-investment company SPV by a
BDC is appropriate. If the SPV is not considered an investment company, the BDC
would generally not consolidate the SPV. The EP members also discussed whether a
change in consolidation accounting by a BDC without a change in facts (e.g., change
in level of control) would represent a change in accounting principle or the correction
of an error, and, if an error, whether it would be indicative of a material weakness in
internal control over financial reporting. The EP members agreed to continue
discussion on BDCs and consolidation of non-registered investment companies with
the SEC and the EP members in the future.
12. The EP members discussed the potential impact of the FASB Revenue Recognition
project to investment advisers/distributors. Specifically, the EP discussed deferred
commission assets and whether these will need to be charged to expense or continue
to be capitalized.
13. The EP members discussed commodity funds registered with the SEC Division of
Corporation Finance (Corp Fin) and the EP members’ views with respect to the recent
update to the SEC Financial Reporting Manual (FRM) requiring that financial
statements be prepared at both the trust and series level. An EP member, who had
recently been involved with this issue with Corp Fin staff, noted that their position is
based on the requirement in Article 3 of Regulation S-X to provide financial
statements of "the registrant" (which legally is the full trust), and that Article 6 of
Regulation S-X specifically exempts registered investment companies from this rule
and allows presentation of only individual series. EP members discussed potential
concerns with the presentation required by Corp Fin as it may imply cross-liability
where none legally exists.
14. The EP members discussed foreign jurisdictions that have short-term capital gains tax
(that is, a tax on securities held less than one year). The EP members discussed
divergence in practice on the accounting treatment. EP members noted that some
funds record the entire tax liability as a tax accrual and then, when the short term
holding period expires, reverse the accrual, where others make a probability
assessment to estimate a tax liability on a blended rate.
15. The EP members discussed accounting considerations for TBA forward
purchases/TBA dollar rolls and whether these are regarded as derivatives. The EP
will continue discussing this matter in future meetings.
16. The EP reviewed a Dollar Roll example to determine if the transaction was a dollar
roll subject to secured borrowing accounting treatment or was a purchase and sale and
considered certain aspects of the technical guidance, especially ASC 860-10-55-17
(TBA transactions) and 860-10-55-59 (effective control Guidance). The EP will
schedule a follow-up conference call to review proposed scenarios and analysis.
III.
Audit and Attestation Issues
1. The EP members discussed some procedures accounting firms used to comply with
Rule 204-2(b) of the Investment Advisers Act of 1940 for the surprise examination in
relation to the books and records provision. The EP members discussed how the
reconciliation of confirmation responses against the adviser’s books and records may
assist the accounting firms in complying with this provision.
2. The Expert Panel discussed disclosure requirements and control weaknesses
regarding a situation where there were NAV errors for a period of several months.
The Expert Panel discussed that since the error was identified and corrected in
connection with the preparation of the interim financial statements, it would appear
that the controls over financial reporting were effective, and that, because year-end
auditor control reports issued for Form N-SAR purposes are "as of" year-end, no
material weakness would have existed at the year-end date. The Expert Panel also
discussed the general control framework that would allow for NAV errors to exist for
some period of time and what impact that could have on both the auditor’s assessment
of controls and management's certification as to whether significant changes in the
control structure had occurred during the period.
IV.
SEC Update
These highlights are not authoritative positions or interpretations issued by the SEC
or its staff. The highlights were not transcribed by the SEC and have not been
considered or acted upon by the SEC or its staff. Accordingly, these highlights do
not constitute a statement of the views of the Commission or the staff of the
Commission.
The SEC Assistant Chief Accountants for the Office of the Chief Accountant, Division of
Investment Management (the “staff”), joined the EP Meeting. The staff provided a
summary to the EP members about projects they are currently working on, questions they
are receiving and their involvement on regulatory matters and in assisting other Divisions
and Offices within the SEC as questions arise. The staff also shared that they recently
observed the Pricing Sources Task Force Meeting among the PCAOB, issuers, pricing
services and public accounting firms to discuss pricing procedures.
The staff also highlighted that they are currently reviewing new registration statements
for BDCs. An issue that they continue to focus on related to BDCs is consolidation of
nonregistered investment company subsidiaries. The staff also indicated that the project
to amend SEC Regulation S-X is currently on hold. The staff also summarized the notice
of the order raising the asset and income thresholds for "qualified investors" that was
recently released. They encouraged interested parties to submit comments on the
proposal, which are due in July 2011.
1. The staff shared the general themes of the content of material discrepancy [with Rule
206(4)-2] communications the SEC has received to date from auditors:
a) Failure of the qualified custodian (QC) to send quarterly statements to
investors when the adviser is not relying on the Audit Provision.
b) Adviser used the privately offered securities exception related to safekeeping of assets requirements when the audit provision is utilized, but the
securities did not meet the definition of privately offered securities.
c) There were client funds and securities held by an entity that is not a
qualified custodian.
2. The Expert Panel members and the staff discussed areas of focus or findings during
Office of Compliance Inspections and Examinations (OCIE)’s inspections of
investment advisers:
a) Valuation of investments, including the documented policies and procedures
for valuing client assets and calculating NAV;
b) Conflicts of interest, particularly related to fees expensed and compensation
paid to the advisers;
c) Custody, noting that during inspections OCIE is continuing to use some
level of confirmation of client assets, and for private funds, OCIE may
request access to review the auditor’s work papers to avoid sending
confirmations, although this is less common.
d) Specific recent Custody Rule violations found in inspections include the
following:
1. Advisers are not permitted to maintain client funds or securities in
accounts in their names or an adviser employee’s name, as the Custody
Rule requires client funds and securities to be maintained by a
qualified custodian in a separate account for each client under that
client's name or in accounts that contain only the adviser’s clients'
funds and securities, under the adviser’s name as agent or trustee for
the clients.
a. For example, there was a situation where the adviser held client
funds in an account in the employees' names.
b. In other cases, an adviser temporarily deposited client assets in
commingled accounts, or accounts held by affiliates of the
adviser.
2. The adviser, who was not a qualified custodian, received stock
certificates from clients and instead of returning them to the clients,
forwarded them to the qualified custodian. This violated Rule 206(4)-
2(a)(1) because the adviser should have returned the stock certificates
to the clients within three business days.
3. For an adviser of a pooled investment vehicle that was planning to use
the audit provision, it was noted that the audited financial statements
were not distributed in time (120 days after year end, or 180 days for a
fund of fund). The reasonable belief position that is included in the
SEC’s Responses to Frequently Asked Questions
(http://www.sec.gov/divisions/investment/custody_faq_030510.htm)
on the custody rule could not be applied because the audited
statements had been significantly delayed for multiple years.
3. The staff and EP members continued to discuss the process of uploading surprise
examination reports into IARD. The staff investigated if the IARD system could be
modified to accept the upload of multiple documents. This would mitigate challenges
that accountants are having in uploading a single, text-searchable document that
contains both the signed accountant’s report and signed management’s assertion
statement. The staff indicated that one submission is preferred, and indicated two
options to accomplish this:
a) The accountant can produce its surprise examination report, and obtain
management’s assertion statement, in Word format and merge the two
documents into one Word document; type in the signature (//Accounting
Firm X LLP//, and //Adviser XX Name//) as applicable, within the surprise
examination report and management’s assertion statement, respectively. The
Word document can then be converted into a PDF document, and then be
uploaded to IARD. The staff suggested that accountants retain a physically
signed copy of management’s assertion statement for their records.
b) Prepare the signed accountant’s report in a text-searchable pdf document,
and include the signed management assertion statement within the
attachment as a picture image.
4. On Form ADV Schedule D, SEC registered investment advisers (RIAs) must identify,
among other things, the name and address of the public accountant who audited a
private fund and whether the accountant issued an unqualified opinion. For entities
that have audit opinions issued on their financial statements out of the US for
purposes of the Custody Rule and out of the Cayman Islands due to local auditor
requirements, the staff indicated that both the US and Cayman Islands accounting
firms should be listed in Form ADV Schedule D.
5. During the April 2011 conference call, the staff informed the EP about a letter issued
by the SEC, which indicates that the Commission may consider extending the
registration deadline imposed by the Private Fund Investment Advisers Registration
Act of 2010, which was initially July 21, 2011, to the 1st quarter of 2012. The letter
is available at http://www.sec.gov/rules/proposed/2010/ia-3110-letter-to-nasaa.pdf
The EP members, however, expressed a concern that even an extension of registration
requirements until the first quarter of 2012 would not necessarily provide complete
relief for advisers and their accounting firms regarding the transition from AICPA
independence rules to SEC independence rules. For example, the EP members noted
that, for pooled investment vehicles that intend to use the Audit Provision to satisfy
the Custody Rule for fiscal year 2012, if the accounting firm is not SEC-independent
on January 1, 2012, the auditor would not be considered SEC-independent for the
entire 2012 year. The EP members and the staff will continue discussions regarding
auditor independence with respect to newly registered advisers, and revisit the issue
once the final rule is issued with regards to the registration deadline.
6. The staff noted that OCIE is looking into the methodology that advisers use to report
"SEC yields" on Treasury Inflation Protection Securities (TIPS) funds based on
recent news articles.
7. The staff noted a fund that recently launched which had a form of principal
protection. In those situations, the fund should consider whether the related contract
providing the protection is a derivative that also needs to be fair valued. An EP
member noted that the inclusion of the contract's fair value in a net asset value
determination for redemption purposes may (at least theoretically) cause the contract
itself to be violated, as some contracts do not allow payment of any contract value to
a redeeming shareholder before the completion of a defined holding period.
However, an EP member also noted that, when a contract is "out of the money", the
fair value of the contract (net of future fees payable) is usually negligible, if not zero.
8. The staff noted that when an auditor performs a 206(4)-2 surprise examination or an
examination pursuant to either Rule 17f-1 or 17f-2 and attests directly on the entity’s
compliance, and not on management’s assertion about the compliance, that
management’s assertion would not need to be filed with the SEC.
9. The staff shared a summary of the comment letters related to the President’s Working
Group on Financial Markets and Money Market Fund Reform. There was a recent
roundtable meeting for the Commission to gather more information on money market
funds which was recorded and is available on the SEC’s website. There is no set time
table right now, but this is an area the Commission continues to be focused on and is
considering multiple options and factors.
10. The staff shared the following comments related to the Form N-MFP:
a) The staff noted that Item 27 requires the title or description of the security to
include the interest rate, coupon, and maturity.
b) The staff noted that Item 44 requires the adviser to identify illiquid securities,
which would include term repurchase agreements that extend beyond 5
business days.
c) The staff noted that Items 17 and 24 require that the yield needs to be entered
as a decimal point and not as a percentage (that is, if the yield is 13 percent,
“.13” should be entered rather than “13”). The system assumes the registrant
puts in the actual amount and will automatically adjust it to a percentage.
11. The staff provided an XBRL Update. Provisions for filing certain prospectus data
became effective January 1, 2011 and to date, over 800 filings have been received
using XBRL. The SEC has received numerous questions, which were summarized
into three themes:
a) Filing process - related to which form and how the filing should be made. As
advice on the filing process for XBRL, the staff reminded the panel that
registrants have an opportunity to perform a test filing before each actual
filing within EDGAR, which will allow the adviser to (1) put the XBRL
submission through EDGAR’s validation process and (2) preview the
submission to ensure data integrity and completeness.
b) The viewer – the staff noted this should be used as a tool and should not be
looked at as the end goal for XBRL. In utilizing the viewer, the adviser
should ensure that all data contained in the HTML version of the Risk/Return
Summary is in the XBRL filing. Advisers should also note that there are
certain limitations to the viewer, most of which relate to formatting, (such as,
indentation, bolding, underlines). Thus, in certain instances, the XBRL data
viewed in the viewer will not exactly match how it has been disclosed in its
HTML version.
c) Website postings - A fund is required to post what has been submitted to the
Commission as an XBRL filing to its website. If the fund does not have a
website, the SEC expects that it would be posted on the website from which
an investor obtains financial information or fund literature. Typically that
would be a website of the fund’s sponsor, distribution agent or another
appropriate third party.
The staff noted there is no time table currently as to when it will be mandatory to
include the Schedule of Investments as an XBRL submission. The staff
encouraged users to submit any XBRL-related questions via email to Askoid@sec.gov.
12. The EP members and staff continued to discuss consolidation of nonregistered
investment companies (including special-purpose vehicles) by BDCs. The staff has
requested advisers and accounting firms to consult with the SEC, as necessary, with
specific fact patterns.
13. The EP members and the staff discussed BDCs which are being formed through
contribution of an existing private fund portfolio, or portions of multiple portfolios,
upon launch. The issue has arisen regarding what information should be included in
the registration statement and what pro-forma information should be provided. The
staff indicated that the appropriate disclosures may vary depending on facts and
circumstances and advisers should consult with the SEC, as necessary.
14. The staff described how the SEC and CFTC are meeting to discuss proposed CFTC
rules (for example, Rule 4.5 proposal that impacts RICs, including proposal to rescind
sections 4.13(a)(3) and (a)(4) exemptions from registration as a commodity pool
operator (CPO)). Currently, the CFTC exempts RICs from registration with the
CFTC, but under the proposed rules, certain funds and advisers may also be required
to register with the CFTC as CPOs. The SEC acknowledged there were some
disclosure and reporting requirements in the proposed rules that would be duplicative
and conflicting, thus the SEC is working with the CFTC to mitigate these conflicting
or duplicative requirements.
15. The staff discussed the article “SEC Looks for Ways to Improve Fund Shareholder
Reports” published on Ignites.com on April 28, 2011. The article describes testimony
of Lori Schock, Director of the SEC Office of Investor Education and Advocacy, on
gathering feedback from investors on what types of information is useful, whether
disclosure in fund shareholder reports is adequate, and how it can be improved.