Mutual fund disclosure update. January 21, 2014

Transcription

1 Mutual fund disclosure update January 21, 2014

2 Today s presenters Bob Mulhall, Partner Adeel Jivraj, Partner Matt Forstenhausler, Partner Rob Meiner, Partner Page 2

3 Agenda Mutual Fund Disclosures: PCAOB proposal on auditor reporting model Tax disclosures Balance sheet offset disclosures about offsetting assets and liabilities Fair value measurements and disclosures Page 3

4 PCAOB proposal on auditor reporting model Current pass/fail model would stay the same Auditor independence and tenure What information would be new? Responsibilities for footnotes and risk of material misstatement due to fraud Responsibilities for, and results of, auditor s evaluation of information outside of the financial statements Critical audit matters Page 4

5 PCAOB proposal on auditor reporting model (cont.) Critical audit matters (CAMs): Matters involving most difficult, subjective or complex judgements Posed most difficulty in obtaining sufficient appropriate evidence Posed most difficulty in forming an opinion on the financial statements Audit report would identify CAMs and: Considerations that led to that determination Relevant financial statement accounts or disclosures Page 5

6 PCAOB proposal on auditor reporting model (cont.) Considerations Disclosure of auditor tenure Determined at the individual fund level, registrant level or overall complex level? Evaluation of information outside of the financial statements Management s discussion of fund performance Expense example Form N-CSR disclosures CAMs Subjectivity in determination of CAMs Lack of consistency in reported CAMs could create investor misunderstanding Increase in audit effort and cost Comments were due December 11, 2013 Page 6

7 Return of Capital Statement of Position 93-2 Intended to provide guidance on financial reporting by investment companies for distributions to shareholders, including returns of capital Presentation of the retained earnings of the fund on a tax basis undistributed net investment income accumulated undistributed realized gain/loss What would the shareholders receive as a distribution if the fund were to liquidate? Page 7

8 ROC-SOP adjustments key concepts ROC-SOP adjustments are reclass entries between the following components of capital: Paid in capital Undistributed net investment income Undistributed net realized ROC-SOP adjustments do not affect net assets Page 8

9 ROC SOP (cont d) Under SOP 93-2 and the Audit Guide, a reclassification is made between the composition of net asset accounts for the permanent differences, not for the temporary differences Page 9

10 ROC SOP (cont d) SOP 93-2 requires an understanding of permanent vs. temporary book-to-tax differences Sample permanent differences: Reclassification between income and gains Foreign currency gains/losses Paydown gains/losses Distribution redesignations NOL offset with STCG Basis adjustments on PFIC sales CLCO expired Nondeductible expenses NOL s Tax return of capital distributions Page 10

11 ROC SOP (cont d) Sample temporary differences Wash sales Straddle loss deferrals PFIC mark-to-market IRC 1256 mark-to-market Post-October/ late year ordinary losses Dividends Payable Page 11

12 Financial statement disclosures Status of the fund as a regulated investment company Example disclosure: The Fund intends to qualify as a regulated investment company, to distribute substantially all of its income and to comply with the other requirements of the Internal Revenue Code applicable to regulated investment companies. Accordingly, no provision for federal income taxes is required. In addition, by distributing during each calendar year substantially all of its net investment income, net realized capital gains and certain other amounts, if any, the Fund intends not to be subject to a federal excise tax. Page 12

13 Financial statement disclosures (cont.) Cost of investments for federal income tax purposes Gross appreciation, gross depreciation and net appreciation on a tax basis Significant book-tax differences: Disclose effect on components of net assets Example disclosure: To reflect reclassifications arising from permanent book/tax differences for the year ended October 31, 20XX, undistributed net investment income was decreased by $41,000, undistributed net realized gain was increased by $30,000 and additional paid in capital was increased by $11,000. These differences are primarily due to return of capital adjustments from real estate investment trusts and net operating losses. These reclassifications had no effect on net assets. Page 13

14 Financial statement disclosures (cont.) Tax character of distributions Disclose the tax basis components of dividends paid: Ordinary income Tax-exempt income Long-term capital gain Tax return of capital Short-term capital gain distributions will be reflected as distributions from ordinary income The total tax basis distributions should generally agree to the total book basis distributions as shown on the statement of changes Both P/Y as well as C/Y information should be presented Page 14

15 Financial statement disclosures (cont.) Tax basis components of distributable earnings /(deficit) Undistributed ordinary income Undistributed tax-exempt income Undistributed long-term gain Unrealized appreciation/depreciation Accumulated Realized Capital and other Losses Example disclosure At October 31, 20XX, the components of accumulated earnings/(deficit) on a tax basis were as follows: Undistributed ordinary income $1,020,599 Undistributed long-term capital gains 441,226 Accumulated realized capital and other losses <12,062,595> Net unrealized appreciation of investment 31,430,615 Total accumulated earnings $20,829,845 Page 15

16 Financial statement disclosures (cont.) Capital loss carry forward (CLCF) Prior to RIC Modernization Act of 2010 Capital losses RIC s were allowed to carryover accumulated capital losses for a period up to 8 years Ordinary losses No carryover provisions were allowed. Ordinary losses may be offset against short term gains, but otherwise may need to be written off against capital Post RIC Modernization Act (new provisions apply to net capital losses for taxable years beginning after December 22, 2010) Capital losses may be carried forward indefinitely (no limit on # of years) Capital losses retain their character (ST/LT) and are deemed to arise on the first day of the next tax year Losses without expiration must be utilized before old carryovers can be used Page 16

17 Financial statement disclosures (cont.) Late year loss deferrals Example disclosure: In accordance with US Treasury regulations, the Fund has incurred and elected to defer the following post-october capital losses incurred after October 31, 20XX. Such losses are treated for tax purposes as arising on November 1, 20XX; furthermore, the fund has incurred and elected to defer the following qualified late year ordinary losses incurred after December 31, 20XX. Such losses are treated as arising on January 1, 20XX. Qualified ST Capital LT Capital Ordinary losses Losses Losses $86,000 $2,000 $1,000 Page 17

18 Financial statement disclosures (cont.) Accounting for uncertainty in income taxes (ASC 740) Example disclosure: As of and during the period ended October 31, 20XX, the Fund did not have any liabilities for any unrecognized tax benefits. The Fund recognizes interest and penalties, if any, related to unrecognized tax benefits as income tax expense in the Statement of Operations. During the period, the Fund did not incur any interest or penalties. Each of the tax years in the four year period ended October 31, 20XX, remains subject to examination by the Internal Revenue Service and state taxing authorities. Page 18

19 Disclosures about offsetting assets and liabilities New reporting requirements aimed to bridge the gap between US Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) IASB and FASB initially issued a joint exposure draft, but decided to pursue different approaches IFRS: Requires entities to present separately recognized financial assets and recognized liabilities at gross amounts in balance sheet and therefore treat offsetting as exception Entity must offset its financial assets and financial liabilities in its balance sheet when it intends to offset and has legally enforceable right to do so in the normal course of business, default and bankruptcy Page 19

20 Disclosures about offsetting assets and liabilities (cont.) US GAAP: Provides a further exception for offsetting Permits an entity to offset its derivative assets and liabilities in balance sheet if there is an agreement to offset, even if that right of offset is only available in the case of bankruptcy or default In December 2011, FASB issued ASU : Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities, which was clarified by ASU Effective for periods beginning on or after January 1, 2013 Applied retrospectively (i.e., for all periods presented on the balance sheet) Does not require a change to balance sheet presentation; impact is to the notes to the financial statements Page 20

21 Disclosures about offsetting assets and liabilities (cont.) New disclosures required for: Derivatives accounted for in accordance with Topic 815 (including bifurcated embedded derivatives) Sale and repurchase agreements and reverse sale and repurchase agreements Securities borrowing and lending arrangements Applies to above transactions that are: Offset on the balance sheet in accordance with offsetting guidance Subject to enforceable master netting arrangements or similar agreements regardless of whether or not they are presented in accordance with offsetting guidance Page 21

22 Disclosures about offsetting assets and liabilities (cont.) Information to enable users to evaluate the effect or potential effect of netting arrangements of an entity: 1. Gross amounts of assets and liabilities 2. Amounts offset in the balance sheet 3. Net amounts 4. Amounts subject to a netting arrangement not included in #2 (i.e., collateral or positions not offset) 5. Remaining net amount Assets and liabilities separately presented in tabular format Page 22

23 Disclosures about offsetting assets and liabilities (cont.) Example disclosure direct from Page 23

24 Disclosures about offsetting assets and liabilities (cont.) Column iii v may be presented by counterparty Disclosure of counterparty legal name not required Insignificant counterparties grouped in other Page 24

25 Disclosures about offsetting assets and liabilities (cont.) Disaggregation for sophisticated entities with significant derivative activity Page 25

26 Fair value measurements and disclosures ASC Topic 820 Fair value measurement (formerly FAS 157) Effective for fiscal years beginning after November 15, 2007 Defines fair value and provides a framework for measuring fair value Requires disclosures about fair value measurements Fair value hierarchy Level 1 Quoted prices in active markets for identical assets/liabilities Level 2 Significant unobservable inputs Level 3 Significant unobservable inputs For Level 3 measurements, the effect on earnings (or changes in net assets) for the period Page 26

27 Fair value measurements and disclosures (cont.) ASU Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs Effective for fiscal years beginning after December 15, 2011 Significant amendments: For Level 3 fair value measurements, disclosure requirements: Quantitative information about the significant unobservable inputs used in the valuation of Level 3 measurements (tabular format) Description of valuation processes surrounding Level 3 measurements Page 27

28 Fair value measurements and disclosures (cont.) ($ in millions) Quantitative information about Level 3 fair value measurements Fair value at 12/31/X9 Valuation technique(s) Unobservable input Range (weighted average) Residential mortgage-backed securities 125 Discounted cash flow constant prepayment rate 3.5% - 5.5% (4.5%) probability of default 5% - 50% (10%) loss severity 40% - 100% (60%) Commercial mortgage-backed securities 50 Discounted cash flow constant prepayment rate 3.0% - 5.0% (4.1%) probability of default 2% - 25% (5%) loss severity 10% - 50% (20%) Collateralised debt obligations 35 Consensus pricing offered quotes comparability adjustments (%) -10% - +15% (+5%) Venture capital investments: healthcare 53 Discounted cash flow weighted average cost of capital 7% - 16% (12.1%) long-term revenue growth rate 2% - 5% (4.2%) long-term pre-tax operating margin 3% - 20% (10.3%) discount for lack of marketability (a) 5% - 20% (17%) control premium (a) 10% - 30% (20%) Market comparable companies EBITDA multiple (b) (11.3) revenue multiple (b) (1.7) discount for lack of marketability (a) 5% - 20% (17%) control premium (a) 10% - 30% (20%) Venture capital investments: energy 32 Discounted cash flow weighted average cost of capital 8% - 12% (11.1%) long-term revenue growth rate 3% - 5.5% (4.2%) long-term pre-tax operating margin 7.5% - 13% (9.2%) discount for lack of marketability (a) 5% - 20% (10%) control premium (a) 10% - 20% (12%) Market comparable companies EBITDA multiple (b) (9.5) revenue multiple (b) (2.0) discount for lack of marketability (a) 5% - 20% (10%) control premium (a) 10% - 20% (12%) Credit contracts 38 Option model annualised volatility of credit (c) 10% - 20% counterparty credit risk (d) 0.5% - 3.5% own credit risk (d) 0.3% - 2.0% (a) Represents amounts used when the reporting entity has determined that market participants would take these premiums and discounts into account in a fair value measurement. (b) Represents amounts used when the reporting entity has determined that market participants would use such multiples when measuring the fair value of these investments. (c) Represents the range of the volatility curves used in the valuation analysis that the reporting entity has determined market participants would use when measuring the fair value of these contracts. (d) Represents the range of the credit default swap spread curves used in the valuation analysis that the reporting entity has determined market participants would use when measuring the fair value of these contracts. (Note: For liabilities, a similar table should be presented.) Page 28

29 Fair value measurements and disclosures (cont.) Description of valuation processes surrounding Level 3 measurements Description of the group responsible for valuation policies and procedures, to whom that group reports, and the internal reporting procedures in place (e.g., how pricing, risk management, or audit committees discuss and assess the fair value measurements) Frequency and methods for calibration, back testing and other testing procedures of pricing models Process for analyzing changes in fair value measurements from period to period Methods used to develop and substantiate the unobservable inputs used in a fair value measurement Narrative description of the sensitivity of recurring Level 3 measurements to changes in the unobservable inputs disclosed, including the inter-relationship between these inputs (only public companies) The significant unobservable inputs used in the fair value measurement of the reporting entity s residential mortgage-backed securities are prepayment rates, probability of default, and loss severity in the event of default. Significant increases in any of those inputs in isolation would result in a significantly lower fair value measurement. Generally, a change in the assumption used for the probability of default should be accompanied by a directionally-similar change in the assumption used for the loss severity and a directionally-opposite change in the assumption for prepayment rates. Page 29

30 Fair value measurements and disclosures (cont.) ASU significant amendments (continued): Public entities shall also disclose all transfers between Levels 1 and 2 (not only significant transfers). Private companies are exempt from disclosing any information about transfers. Page 30