Financial Services Investment Companies (Topic 946)

Transcription

1 Proposed Accounting Standards Update Issued: October 21, 2011 Comments Due: January 5, 2012 Financial Services Investment Companies (Topic 946) Amendments to the Scope, Measurement, and Disclosure Requirements This Exposure Draft of a proposed Accounting Standards Update of Topic 946 is issued by the Board for public comment. Comments can be provided through an electronic feedback form accessible from the Investment Companies project page of the FASB website. Written comments can also be provided and should be addressed to: Technical Director File Reference No

2 The FASB Accounting Standards Codification is the source of authoritative generally accepted accounting principles (GAAP) recognized by the FASB to be applied by nongovernmental entities. An Accounting Standards Update is not authoritative; rather, it is a document that communicates how the Accounting Standards Codification is being amended. It also provides other information to help a user of GAAP understand how and why GAAP is changing and when the changes will be effective. Notice to Recipients of This Exposure Draft of a Proposed Accounting Standards Update The Board invites individuals and organizations to send comments on all matters in this Exposure Draft of a proposed Accounting Standards Update. Responses from those wishing to comment on the Exposure Draft must be received by January 5, Interested parties can submit comments through an electronic feedback form or in the form of a written letter. The electronic feedback form can be accessed through the Investment Companies project page on the FASB s website at (see Projects tab/technical Plan and Project Updates page). Comments in the form of a written letter should be submitted by to director@fasb.org, File Reference No Those without should send their written comments to Technical Director, File Reference No , FASB, 401 Merritt 7, PO Box 5116, Norwalk, CT Do not send responses by fax. All comments received constitute part of the FASB s public file. The FASB will make all comments publicly available by posting them to the online public reference room portion of its website. An electronic copy of this Exposure Draft is available on the FASB s website. Copyright 2011 by Financial Accounting Foundation. All rights reserved. Permission is granted to make copies of this work provided that such copies are for personal or intraorganizational use only and are not sold or disseminated and provided further that each copy bears the following credit line: Copyright 2011 by Financial Accounting Foundation. All rights reserved. Used by permission. Financial Accounting Standards Board of the Financial Accounting Foundation 401 Merritt 7, PO Box 5116, Norwalk, Connecticut

3 Proposed Accounting Standards Update Financial Services Investment Companies (Topic 946) Amendments to the Scope, Measurement, and Disclosure Requirements October 21, 2011 Comment Deadline: January 5, 2012 CONTENTS Page Numbers Summary and Questions for Respondents Amendments to the FASB Accounting Standards Codification Background Information, Basis for Conclusions, and Alternative View Amendments to the XBRL Taxonomy... 64

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5 Summary and Questions for Respondents Why Is the FASB Issuing This Proposed Accounting Standards Update (Update)? Topic 946, Financial Services Investment Companies, contains specialized accounting and disclosure requirements for investment companies. The requirements to qualify as an investment company under Topic 946 were included originally in the AICPA s Audit and Accounting Guide for investment companies. In June 2007, the AICPA issued AICPA Statement of Position 07 1, Clarification of the Scope of the Audit and Accounting Guide Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies, to clarify practice issues on whether certain entities qualify as investment companies. However, in December 2007, SOP 07-1 was deferred indefinitely by the FASB for those entities that had not already adopted the SOP to allow the Board time to consider a number of implementation issues that arose from applying the SOP. This proposed Update is a result of the efforts of the FASB and the International Accounting Standards Board (IASB) (collectively, the Boards) to develop a common, high-quality standard on consolidation policy. Investment companies carry all of their investments in operating entities at fair value, even if they hold a controlling financial interest in the investee. Therefore, the Boards agreed that, as part of the development of a consolidation standard, they would look to develop consistent criteria for determining whether an entity is an investment company. The amendments in this proposed Update would amend the guidance in Topic 946 for determining whether an entity is an investment company. Who Would Be Affected by the Amendments in This Proposed Update? The amendments in this proposed Update would affect entities currently within the scope of Topic 946 that do not meet the revised definition of an investment company in the proposed amendments. In addition, an entity that invests in real estate properties and meets the criteria to be an investment property entity under the proposed Accounting Standards Update, Real Estate Investment Property Entities (Topic 973), would not be an investment company. The Board recommends that stakeholders review this proposed Update on investment companies concurrently with the proposed Update on investment property entities. 1

6 The proposed amendments also would affect those entities that do not meet the current criteria to be an investment company or are currently excluded specifically from the scope of Topic 946 (that is, real estate investment trusts) and would meet the revised criteria to be within the scope of Topic 946. Finally, investment companies that have controlling financial interests in other investment companies would also be affected by the proposed amendments, because they would be required to consolidate their investment company subsidiaries. The proposed Accounting Standards Update, Consolidation (Topic 810): Principal versus Agent Analysis, may affect an investment company s assessment as to whether it holds a controlling financial interest in another investment company. The Board recommends that stakeholders review this proposed Update on investment companies concurrently with the proposed Update on consolidations. What Are the Main Provisions? The amendments in this proposed Update would affect the scope, measurement, presentation, and disclosure requirements for investment companies in U.S. generally accepted accounting principles (GAAP). The proposed amendments would: 1. Amend the investment company definition in Topic 946 and provide comprehensive guidance for assessing whether an entity is an investment company. 2. Require an investment company to consolidate another investment company or an investment property entity if it holds a controlling financial interest in the entity in a fund-of-funds structure. The investment company parent would retain the specialized guidance when consolidating another investment company or an investment property entity. 3. Amend the financial statements and financial highlights presentation requirements for situations in which an investment company consolidates a less-than-wholly-owned investment company or a lessthan-wholly-owned investment property entity. 4. Prohibit an investment company that is able to exercise significant influence over another investment company or an investment property entity from accounting for its interest using the equity method of accounting. Rather, those investments would be measured at fair value. 5. Require additional disclosures including changes in an entity s status as an investment company, whether the investment company has provided support to any of its investees, and any significant restrictions on an investee s ability to transfer funds to the investment company. 2

7 How Would the Main Provisions Differ from Current U.S. Generally Accepted Accounting Principles (GAAP) and Why Would They Be an Improvement? The amendments in this proposed Update would change the definition of an investment company. Specifically, the criteria within the definition would be expanded and additional implementation guidance would be provided. The proposed amendments would result in a more appropriate reflection of the characteristics of an investment company and capture the appropriate population of entities for which fair value for investments is the most relevant measurement attribute for the entity s financial statement users. In addition, the proposed amendments would improve the comparability of investment company financial statements prepared in accordance with U.S. GAAP and those prepared in accordance with the IASB s proposed amendments to IFRS in Exposure Draft , Investment Entities. The proposed amendments would require that an investment company account for its controlling financial interests in other investment companies and investment property entities in a fund-of-funds structure in accordance with Topic 810 on consolidations. Current U.S. GAAP generally does not permit consolidation of a controlling financial interest in a noninvestment company. However, Topic 946 is silent on consolidation of a controlling financial interest in another investment company. The proposed amendments would improve the consistency between investment companies that report under U.S. GAAP and also increase the transparency of the underlying assets and liabilities of an investment company s investees. The proposed amendments also include additional disclosure requirements and changes to the financial highlights requirements that would provide financial statement users with additional useful information about an investment company s activities and obligations. When Would the Amendments Be Effective? The effective date will be determined after the Board considers the feedback on the amendments in this proposed Update. The proposed amendments would be effective for an entity s interim and annual reporting periods in fiscal years that begin after the effective date. Earlier application would be prohibited. Upon adoption of the proposed amendments, an entity would discontinue the application of the guidance in Topic 946 if the entity no longer meets the criteria to be an investment company. The entity would present the change in its status as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption by calculating the carrying amounts of its investees as though it had always accounted for its investments in conformity with other applicable 3

8 U.S. GAAP, if practicable. If not practicable, the entity would apply the proposed amendments as of the beginning of the period of adoption. If an entity that historically was not an investment company meets the criteria of an investment company as a result of adopting the proposed amendments, the entity would report the effect of applying the guidance in Topic 946 as a cumulative-effect adjustment to net assets (or a similar account) as of the beginning of the period of adoption. An investment company may be required to consolidate another investment company or an investment property entity as a result of the proposed amendments. In such situations, the investment company shall apply the requirements in Topic 810 prospectively when the proposed amendments become effective. Any difference between the net assets required to be recognized and the amount previously recognized shall be recognized as a cumulative-effect adjustment to net assets (or similar account) as of the beginning of the period of adoption. How Do the Proposed Provisions Compare with International Financial Reporting Standards (IFRS)? The amendments in this proposed Update are the result of the Boards efforts to develop consistent criteria for an entity to be an investment company. Consequently, these proposed amendments would improve the comparability between entities that meet the criteria to be investment companies under U.S. GAAP and those that meet the criteria to be investment entities under the proposed amendments to IFRS. Although the proposed definition of an investment company under U.S. GAAP would be similar to the definition in the proposed amendments to IFRS, there are two significant differences in the proposed scope of entities that would be an investment company under U.S. GAAP compared with IFRS. First, under the amendments in this proposed Update, an entity that is regulated as an investment company under the Securities and Exchange Commission s (SEC) Investment Company Act of 1940 would be an investment company. Because the regulatory requirements may differ depending on a particular jurisdiction, the IASB decided not to base its definition of an investment company on whether the entity qualifies as an investment company under local regulations. The other significant difference in the investment company scope is that under the amendments in this proposed Update, if an investment company meets the criteria to be an investment property entity in the FASB s proposed Update on investment property entities, it would apply the requirements in that proposed Update. The IASB has not proposed specific guidance to define an investment property entity. Therefore, the entity would apply the proposed investment 4

9 company requirements under IFRS that would require the entity to account for its investment properties in accordance with IAS 40, Investment Property. In addition, although the definition of an investment company would be similar under the amendments in this proposed Update and the proposed amendments to IFRS, differences would exist between the accounting requirements for investment companies that report under U.S. GAAP and IFRS. For example, under the amendments in this proposed Update, an investment company would be required to consolidate another investment company in a fund-of-funds structure if it holds a controlling financial interest. Under the IASB s proposal, an investment company s controlling financial interest in another investment company would be measured at fair value, even in a fund-of-funds structure. The basis for conclusions to this proposed Update highlights some of the potential differences between U.S. GAAP and IFRS for accounting by investment companies. In addition to differences in the standalone financial statements of an investment company, there also would be differences in how a noninvestment company parent would account for its interests in an investment company. Consistent with current U.S. GAAP, the amendments in this proposed Update would require a noninvestment company parent to retain the specialized accounting in Topic 946 for an investment company subsidiary in consolidation. In contrast, the IASB s proposal would not allow a noninvestment company parent to retain the specialized accounting for investment companies when consolidating an investment company subsidiary. However, under the amendments in this proposed Update and the IASB s proposal, the specialized accounting would be retained when a noninvestment company entity is accounting for its interest in an investment company over which it has significant influence. The Boards will continue their discussions after considering the comments received on the amendments in this proposed Update. Questions for Respondents The Board invites individuals and organizations to comment on all matters in this proposed Update, particularly on the issues and questions below. Comments are requested from those who agree with the proposed guidance as well as from those who do not agree. Comments are most helpful if they identify and clearly explain the issue or question to which they relate. Those who disagree with the proposed guidance are asked to describe their suggested alternatives, supported by specific reasoning. 5

10 Scope Question 1: The proposed amendments would require an entity to meet all six of the criteria in paragraph to qualify as an investment company. Should an entity be required to meet all six criteria, and do the criteria appropriately identify those entities that should be within the scope of Topic 946 for investment companies? If not, what changes or additional criteria would you propose and why? Question 2: The definition of an investment company in the proposed amendments includes entities that are regulated under the SEC s Investment Company Act of Are you aware of any entities that are investment companies under U.S. regulatory requirements that would not meet all of the proposed criteria in paragraph ? If so, please identify those types of entities and which of the criteria they would not meet. Question 3: The proposed amendments would remove the scope exception in Topic 946 for real estate investment trusts. Instead, a real estate investment trust that meets the criteria to be an investment property entity under the proposed Update on investment property entities would be excluded from the scope of Topic 946. Do you agree that the scope exception in Topic 946 for real estate investment trusts should be removed? In addition, do the amendments in the proposed Updates on investment companies and investment property entities appropriately identify the population of real estate entities that should be investment companies and investment property entities? Question 4: The proposed amendments would require an entity to reassess whether it is as an investment company if there is a change in the purpose and design of the entity. Is this proposed requirement appropriate and operational? If not, why? Nature of the Investment Activities Question 5: An entity may be an investment company when it performs activities that support its investing activities. As a result, a real estate fund or real estate investment trust (that is not an investment property entity) could be an investment company if the entity (directly or indirectly through an agent) manages only its own properties. However, the entity would be precluded from being an investment company if the other activities were considered more than supporting the entity s investment activities (for example, construction). Is this requirement operational, and could it be consistently applied? Question 6: The proposed implementation guidance includes examples of relationships or activities that would indicate that an entity obtains or has the objective of obtaining returns from its investments that are not capital appreciation or investment income. Do you agree with these examples? If not, how would you modify the examples while still addressing the Board s concerns identified in paragraphs BC15 and BC16? 6

11 Unit Ownership and Pooling of Funds Question 7: To be an investment company, the proposed amendments would require an entity to have investors that are not related to the entity s parent (if there is a parent) and those investors, in aggregate, must hold a significant ownership interest in the entity. Is this criterion appropriate? If not, why? Question 8: The proposed unit-ownership criterion would require an entity to have ownership interests in the form of equity or partnership interests to be an investment company. The entity would consider only those interests in determining whether it meets the proposed pooling-of-funds criterion. Therefore, a securitization vehicle, such as a collateralized debt obligation, may not qualify as an investment company under the proposed amendments because it may not meet the unit-ownership or the pooling-of-funds criterion. The entity would not consider interests held by its debt holders when evaluating these criteria to be an investment company. For entities that do not have substantive equity interests (for example, those considered variable interest entities under Subtopic ), should the unit-ownership and pooling-of-funds criteria to be an investment company consider interests held by debt holders? Please explain. Question 9: Certain entities may meet all of the other criteria to be an investment company but have only a single investor (for example, a pension plan). The amendments in FASB s proposed Update on investment property entities provides that if the parent of an entity is required to measure its investments at fair value under U.S. GAAP or the parent entity is a not-for-profit entity under Topic 958 that measures its investments at fair value, the entity would not need to meet the unit-ownership and pooling-of-funds criteria to be an investment property entity. Considering the Board s concerns identified in paragraph BC24, should the criteria in this proposed Update be amended to address situations in which the entity has a single investor? Question 10: The unit-ownership and pooling-of-funds criteria in the proposed amendments do not consider the nature of the entity s investors for evaluating if an entity is an investment company. That is, the criteria do not differentiate between passive investors and other types of investors. Do you agree that the nature of the investors should not be considered in evaluating the unit-ownership and pooling-of-funds criteria? Fair Value Management Question 11: The proposed amendments would require that substantially all of an investment company s investments are managed, and their performance evaluated, on a fair value basis. Do you agree with this proposal? If not, why? Is this proposed amendment operational and could it be consistently applied? If not, why? 7

12 Interests in Other Entities Question 12: The proposed amendments would retain the requirement that an investment company should not consolidate or apply the equity method for an interest in an operating company unless the operating entity provides services to the investment company. However, the proposed amendments would require an investment company to consolidate controlling financial interests in another investment company in a fund-of-funds structure. An investment company would not consolidate controlling financial interests in a master-feeder structure. Do you agree with this proposed requirement for fund-of-funds structures? If not, what method of accounting should be applied and why? Should a feeder fund also consolidate a controlling financial interest in a master fund? Please explain. Question 13: The proposed amendments would require an investment company to consolidate a controlling financial interest in an investment property entity. Should an investment company be subject to the consolidation requirements for controlling financial interests in an investment property entity? If not, what method of accounting should be applied and why? Question 14: The proposed amendments would prohibit an investment company from applying the equity method of accounting in Topic 323 to interests in other investment companies and investment property entities. Rather, such interests would be measured at fair value. Do you agree with this proposal? If not, why? Presentation and Disclosure Question 15: An investment company with a controlling financial interest in a less-than-wholly-owned investment company subsidiary or an investment property entity subsidiary would exclude in its financial highlights amounts attributable to the noncontrolling interest. Do you agree that the amounts attributable to the noncontrolling interest should be excluded from the calculation of the financial highlights? If not, why? Question 16: If an investment company consolidates an investment property entity, the proposed amendments require the investment company to disclose an additional expense ratio that excludes the effects of consolidating its investment property entity subsidiaries from the calculation. Do you agree? If not, why? Question 17: Do you agree with the additional proposed disclosures for an investment company? If not, which disclosures do you disagree with, and why? Would you require any additional disclosures and why? Retention of Specialized Accounting Question 18: The proposed amendments would retain the current requirement in U.S. GAAP that a noninvestment company parent should retain the specialized accounting of an investment company subsidiary in consolidation. Do you agree that this requirement should be retained? If not, why? 8

13 Effective Date and Transition Question 19: An entity that no longer meets the criteria to be an investment company would apply the proposed amendments as a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption by calculating the carrying amounts of its investees as though it had always accounted for its investments in conformity with other applicable U.S. GAAP, unless it is not practicable. If not practicable, the entity would apply the proposed amendments as of the beginning of the period of adoption. Do you agree with this proposal? If not, why? Question 20: How much time would be necessary to implement the proposed amendments? Question 21: The proposed amendments would prohibit early adoption. Should early adoption be permitted? If yes, why? Nonpublic Entities Question 22: The proposed amendments would apply to both public and nonpublic entities. Should the proposed amendments apply to nonpublic entities? If not, how should the proposed amendments differ for nonpublic entities and why? 9

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15 Amendments to the FASB Accounting Standards Codification Summary of Proposed Amendments to the Accounting Standards Codification 1. The following table provides a summary of the proposed amendments to the Accounting Standards Codification. Codification Subtopic Action Financial Services Investment Companies Overall (946-10) Financial Services Investment Companies Investment Company Activities (946-20) Financial Services Investment Companies Presentation of Financial Statements ( ) Financial Services Investment Companies Balance Sheet ( ) Financial Services Investment Companies Investments Debt and Equity Securities ( ) Amend Amend Amend Conforming Amendments Amend Description of Changes The proposed amendments would amend the scope, measurement, and disclosure requirements for investment companies. The proposed amendments would require additional disclosures for investment companies. The proposed amendments would require additional disclosures for investment companies. The substance of the requirements in this Subtopic would not be changed by the proposed amendments. The proposed amendments would clarify the initial measurement requirements for investment companies. 11

16 Codification Subtopic Action Financial Services Investment Companies Investments Equity Method and Joint Ventures ( ) Financial Services Investment Companies Investments Other ( ) Financial Services Investment Companies Property, Plant, and Equipment ( ) Financial Services Investment Companies Revenue Recognition ( ) Financial Services Investment Companies Consolidation ( ) Investments Equity Method and Joint Ventures Overall (323-10) Consolidation Overall (810-10) Amend Add Add Amend Amend Conforming Amendments Conforming Amendments Description of Changes The proposed amendments would prohibit an investment company from applying the equity method of accounting for its interests in other investment companies and investment property entities. Those interests would be measured at fair value. The proposed amendments would provide guidance on the accounting for other investments held by investment companies. The proposed amendments would provide additional measurement and disclosure guidance for real estate properties held by investment companies. The proposed amendments would require an investment company to recognize rental revenue related to real estate properties when lease payments are received or as lease payments become receivable in accordance with the contractual terms of the related lease. The proposed amendments would require an investment company to consolidate a controlling financial interest in another investment company or an investment property entity. The substance of the requirements in this Subtopic would not be changed by the proposed amendments. The substance of the requirements in this Subtopic would not be changed by the proposed amendments. 12

17 Introduction 2. The Accounting Standards Codification is amended as described in paragraphs In some cases, to put the change in context, not only are the amended paragraphs shown but so are the preceding and following paragraphs. Terms from the Master Glossary are in bold type. Added text is underlined, and deleted text is struck out. The newly added Subtopics and Master Glossary terms are not underlined to enhance readability. Amendments are made to the current content instead of the pending content because the pending content in Subtopics , , and is being superseded as of the effective date of this Update. Therefore, the pending content is not shown here as struck-out text. Amendments to the Master Glossary 3. Add the following Master Glossary terms to Subtopic as follows: Affiliate A party that, directly or indirectly through one or more intermediaries, controls, is controlled by, or is under common control with an entity. Parent An entity that has a controlling financial interest in one or more subsidiaries. (Also, an entity that is the primary beneficiary of a variable interest entity.) Related Parties Related parties include: a. Affiliates of the entity b. Entities for which investments in their equity securities would be required, absent the election of the fair value option under the Fair Value Option Subsection of Section , to be accounted for by the equity method by the investing entity c. Trusts for the benefit of employees, such as pension and profit-sharing trusts that are managed by or under the trusteeship of management d. Principal owners of the entity and members of their immediate families e. Management of the entity and members of their immediate families f. Other parties with which the entity may deal if one party controls or can significantly influence the management or operating policies of the other to an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests g. Other parties that can significantly influence the management or operating policies of the transacting parties or that have an ownership interest in one of the transacting parties and can significantly influence 13

18 the other to an extent that one or more of the transacting parties might be prevented from fully pursuing its own separate interests. 4. Add the following Master Glossary term to Subtopics and as follows: Parent An entity that has a controlling financial interest in one or more subsidiaries. (Also, an entity that is the primary beneficiary of a variable interest entity.) Amendments to Subtopic Amend paragraphs through 05-3, with a link to transition paragraph , as follows: Financial Services Investment Companies Overall Overview and Background The Financial Services Investment Companies Topic includes the following Subtopics: a. Overall b. Investment Company Activities c. Presentation of Financial Statements d. Balance Sheet e. Income Statement f. Statement of Cash Flows g. Notes to Financial Statements h. Cash and Cash Equivalents i. Receivables j. Investments Debt and Equity Securities k. Investments Equity Method and Joint Ventures kk. Investments Other kkk. Investments Property, Plant, and Equipment l. Liabilities m. Equity n. Revenue Recognition o. Income Taxes p. Consolidation q. Foreign Currency Matters. 14

19 An investment company, as used in this Topic, generally is an entity that pools shareholders investors funds to provide the shareholdersinvestors with professional investment management. Typically, an investment company sells its shares to the publicownership units, invests the proceeds, mostly in securities, to achieve its investment objectives, and distributes provides returns to its shareholdersinvestors from the net income earned on its investments and net gains realized on the saledisposal of its investments. Investments typically consist of securities of other entities, but also may include commodities, securities based on indexes, securities sold short, derivative instruments, real estate properties, and other forms of investments. In this Topic, the term investment company refers to an entity with the attributes described in paragraph This term is not used to conform with the legal definition of an investment company in the federal securities laws Several kinds of investment companies exist: management investment companies, unit investment trusts, common (collective) trust funds, investment partnerships, certain separate accounts of life insurance companies, and offshore funds. Management investment companies may be open-end funds, usually known as mutual funds,and closed-end funds (commonly known as mutual funds), special purpose funds, venture capital investment companies, small business investment companies, and business development companies. Investment companies are organized as corporations (in the case of mutual funds, under the laws of certain states that authorize the issuance of common shares redeemable on demand of individual shareholders), common law trusts (sometimes called business trusts), limited partnerships, limited liability investment partnerships and companies, and other more specialized entities, such as separate accounts of insurance companies that are not in themselves entities. entities at all except in the technical definition of the Investment Company Act of Amend paragraphs through 15-3, with a link to transition paragraph , as follows: Scope and Scope Exceptions > Overall Guidance The Financial Services-Investment Companies Topic only provides incremental industry-specific guidance for the entities defined in this Scope Section, or as further defined in the Scope Sections of the individual Financial Services Investment Companies Subtopics. Entities within the scope of this Topic also shall also comply with the applicable guidance not included in this Topic. The Scope Section of the Overall Subtopic establishes the pervasive scope for all Subtopics of the Financial Services Investment Companies Topic. Unless explicitly addressed within specific Subtopics, the following scope guidance applies to all Subtopics of the Financial Services Investment 15

20 Companies Topic, with the exception of Subtopic , which has its own discrete scope. > Entities The accounting principles discussed in this the Financial Services Investment Companies Topic apply to all investment companies. An entity is required to consider its purpose and design when determining whether it is an investment company. An investment company as Investment companies discussed in this Topic Topic areis an entity that is regulated under the Investment Company Act of 1940 required to report their investment assets at fair value and have or is an entity that meets all of the following attributes criteria: a. Nature of the Investment investment activity activities. The investment company s only substantive activities are investing in multiple investments for returns from primary business activity involves investing its assets, usually in the securities of other entities not under common management, for current income, capital appreciation, investment income (such as dividends or interest), or both. aa. Express business purpose. The express business purpose of the investment company is investing to provide returns from capital appreciation, investment income (such as dividends or interest), or both. b. Unit ownership. Ownership in the {remove glossary link} investment company {remove glossary link} is represented by units of investments, such as shares of stock in the form of equity or partnership interests, to which a portion of the proportionate shares of net assets can be are attributed. c. Pooling of funds. The funds of the investment company s owners investors are pooled to avail owners investors of professional investment management. The entity has investors that are not related to the parent (if there is a parent) and those investors, in aggregate, hold a significant ownership interest in the entity. cc. Fair value management. Substantially all of the investment company s investments are managed, and their performance evaluated, on a fair value basis. d. Reporting entity. The investment company provides financial results about its investment activities to its investors. The entity can be but does not need to be a legal is the primary reporting entity. The implementation guidance in Section is an integral part of evaluating whether an entity meets each criterion above to be an investment company. Further, an investment company (other than a separate account of an insurance company as defined in the Investment Company Act of 1940) must be a separate legal entity to be within the scope of the Financial Services Investment Companies Topic. That is, the guidance in this Topic should be applied only if the 16

21 investment is held by an investment company that is a separate legal entity. Though many aspects of venture capital investment companies, including small business investment companies and business development companies, differ from aspects of other types of investment companies, the provisions of this Topic generally apply The guidance in this Topic does not apply to real estate investment trusts investment property entities, which have some of the attributes of investment companies but are covered by other generally accepted accounting principles (GAAP)Topic 973. [See the FASB s proposed Update on investment property entities.] 7. Add paragraphs through 25-3, with a link to transition paragraph , as follows: Recognition > Reassessment The initial determination of whether an entity is an investment company within the scope of this Topic shall be made upon formation of the entity. The entity shall reassess whether it meets (or does not meet) the criteria of an investment company in this Topic only if there is a subsequent change in the purpose and design of the entity An entity that no longer meets the criteria to be an investment company under this Topic shall discontinue applying the guidance in this Topic and shall account for the change in its status prospectively by accounting for its investments in accordance with other Topics as of the date of the change in status. The fair value of the investment at the date of the change in status (as opposed to the reporting date) shall be the investment s initial carrying amount An entity that subsequently meets the criteria to be an investment company under this Topic shall account for the effect of the change in status from the date of the change in status. The effect of applying this Topic shall be recognized as a cumulative-effect adjustment to net assets at the date of the change in status. The cumulative-effect adjustment shall be included in the net asset value at the beginning of the period in the per-share information included in the financial highlights. The adjustment to net assets represents both of the following: a. The difference between the fair value and the carrying amount of the entity s investees (or parent s portion of the assets minus liabilities for consolidated investments) at the date of the change in status b. Any changes in the fair value of the investees net assets previously recognized in accumulated other comprehensive income. 17

22 8. Amend paragraphs through 50-2 by adding the following new text, with a link to transition paragraph , as follows: Disclosure An entity with a change in status (as described in paragraphs through 25-3) shall disclose the fact that a change in status occurred and the reasons for that change An entity that previously was not an investment company under this Topic and becomes an investment company under this Topic shall disclose the effect of the change in status on the reported amounts of investments as of the date of the change in status. 9. Amend paragraphs through and related headings by adding the following new text, with a link to transition paragraph , as follows: Implementation Guidance and Illustrations > Implementation Guidance > > Definition of an Investment Company This Section provides guidance on implementing the definition of an investment company and is organized as follows: a. Nature of the investment activities b. Express business purpose c. Unit ownership d. Pooling of funds e. Fair value management f. Reporting entity. > > > Nature of the Investment Activities An investment company should have no substantive activities other than its investing activities and should not have significant assets or liabilities other than those relating to its investment activities, subject to the exceptions in the following paragraph If an investment company provides (or holds an investment in an entity that provides) services that relate only to the investment company s own investment activities (for example, investment advisory or transfer agent services), even if those activities are substantive, the investment company can still meet the nature-of-the-investment-activities criterion. An investment 18

23 company also may provide services to other entities only if those activities are not substantive. > > > > Multiple Investments An investment company is required to hold multiple investments at the same time, directly or indirectly through another investment company. For example, a feeder fund could hold multiple investments indirectly through a master fund in a master-feeder structure, or an investment company could hold multiple investments indirectly in a fund-of-funds structure if the underlying fund holds multiple investments. Investments typically consist of securities of other entities, but also may include commodities, securities based on indexes, securities sold short, derivative instruments, real estate properties, and other forms of investments Although an investment company must hold multiple investments, an investment company is not required to hold multiple investments at all times throughout its existence. For example, an entity is not precluded from being an investment company in each of the following situations, provided it meets the other criteria of an investment company in paragraph : a. The entity s initial offering period has not expired. b. The entity has not yet identified suitable investments and, therefore, has not yet fully executed its investment plan to acquire multiple investments. c. The entity has not yet made other investments to replace those it has disposed of. d. The entity is in the process of liquidation Investment companies may hold a single investment in circumstances in which they are formed (for legal, regulatory, tax, or other reasons) in conjunction with another investment company that holds multiple investments (directly or indirectly). For example, investment companies sometimes establish subsidiary investment companies to hold certain individual investments for legal reasons. An entity is not precluded from being an investment company in these circumstances, if the entity otherwise meets the definition of an investment company. > > > > Returns An entity would not meet the nature-of-the-investment-activities criterion if the entity or its affiliates obtain or have the objective of obtaining returns from its investments other than capital appreciation or investment income in entities other than an investment company or an investment property entity as defined in Topic 973. Examples of relationships and activities between (1) the entity or its affiliates and (2) an investee or its affiliates (other than an investment company or an investment property entity as defined in Topic 973) that 19

24 demonstrate that an entity is investing for other than capital appreciation or investment income include the following: a. The entity or its affiliates acquire, use, exchange, or exploit the processes, intangible assets, or technology of the investee or its affiliates. b. There are other arrangements to jointly develop, produce, market, or provide products or services. c. There are transactions that meet any of the following: 1. They are on terms that are unavailable to entities that are not affiliates of the investee. 2. They are not at fair value at the measurement date or are not conducted at arm s length. 3. They represent a significant portion of the investee s or the entity s business activity, including business activities of affiliates of the entity or affiliates of the investee. d. The entity or its affiliates have disproportionate rights, or exclusive rights, to purchase or otherwise acquire assets, technology, products, or services of an investee or its affiliates (for example, an affiliate of the entity holds an option to purchase an asset from an investee of the entity if the asset s development is deemed successful). e. The investee or its affiliates provide financing guarantees or assets to serve as collateral for borrowing arrangements of the entity or its affiliates to provide returns or with the objective of providing returns other than capital appreciation or investment income. This paragraph does not prohibit an investment company from using its investments in its investees as collateral for any of its borrowings. f. An affiliate of the entity holds an option to purchase ownership interests in the entity s investees from the entity at an amount other than fair value. > > > Express Business Purpose The definition of an investment company requires the entity to have made a commitment to a group of investors or potential investors that the purpose of the entity is investing for returns from capital appreciation, investment income (such as dividends or interest), or both. An entity that has an express business purpose that includes activities other than investing for returns from capital appreciation, investment income (such as dividends or interest), or both does not meet the definition of an investment company Evidence of the entity s business purpose may be included in the entity s offering memorandum, publications distributed by the entity, and other corporate or partnership documents that indicate the investment objectives of the entity. Evidence of the entity s express business purpose also may include the manner in which the entity presents itself to other parties (such as potential investors or potential investees). For example, an entity that presents its 20

25 business to its investors as having the objective of investing for capital appreciation has an express business purpose that is consistent with the express business purpose of an investment company. Alternatively, an entity that presents itself as an investor whose objective is jointly developing, producing, or marketing products with its investees has an express business purpose that is inconsistent with the business purpose of an investment company An entity s express business purpose also is evidenced through its investment plans. Accordingly, an investment company whose express business purpose includes realizing capital appreciation should have an exit strategy for how it plans to realize the capital appreciation of its investments. Although the investment company may not yet have determined the specific method or timing of disposing of an investment, the fact that the investment company has identified potential exit strategies through which it can realize capital appreciation provides evidence that its express business purpose is consistent with the definition of an investment company. Disposal of investments only during liquidation or to satisfy investor redemptions are not exit strategies. Therefore, an entity should have a plan to dispose of its investments before liquidation when its express business purpose includes realizing capital appreciation. An investment company whose express business purpose is only to invest for returns from investment income does not require an exit strategy for its investments. > > > Unit Ownership The definition of an investment company requires that investors acquire ownership units in the form of equity or partnership interests in the investment company. Each unit of ownership represents a specifically identifiable portion of the net assets of the investment company, although each unit does not have to represent a proportionate interest in all of the underlying investments of the investment company Having multiple classes of equity instruments, such as shares with distinct rights, does not preclude an entity from being an investment company. > > > Pooling of Funds An investment company sells its ownership interests to investors and invests the proceeds to achieve its investment objectives. To meet the definition of an investment company, an entity must have investors that are not related parties of the entity s parent (if there is a parent) and those investors, in aggregate, must hold a significant ownership interest in the entity. Investors that are related to the parent should be combined and treated as a single investor, along with the parent, for the purposes of applying this criterion. An entity is not precluded from meeting the pooling-of-funds criterion in each of the following situations: a. The entity s initial offering period has not expired, and the entity is actively identifying suitable investors. 21