FASB Makes Decisions on Investment Companies

Published on: 11 Aug 2011

Yesterday, the FASB made a number of decisions related to its investment company project. Most of the decisions were in response to issues identified during the drafting of the upcoming exposure draft (ED).

The Board will reconsider its decisions on whether investment companies should consolidate or report at fair value a controlling financial interest in another entity at its August 24 meeting in conjunction with the investment property project and will not direct the staff to begin balloting until after this meeting. However, the Board still expects to issue an ED in the next couple of weeks, with comments due by mid-December.

The commentary below is based on our observations at the board meeting and may not reflect the proposals ultimately drafted in the ED.

Reporting Under the 1940 Act

At previous meetings, the FASB tentatively decided that an investment company is an entity that meets all of the following criteria:1

  • Business activities — The entity’s only substantive activities are investing in multiple investments for returns from capital appreciation, distributions (such as dividends or interest), or both.
  • Business purpose — The entity makes an explicit commitment to a group of investors that the purpose of the entity is investing to provide returns from capital appreciation, distributions (such as dividends or interest), or both.
  • Unit ownership — Ownership in the entity is represented by units of investments, such as shares or partnership interests, to which proportionate shares of net assets can be attributed.
  • Pooling of funds — The funds of the entity’s investors are pooled to avail the investors of professional investment management. The entity has investors who are unrelated to the parent (if any) and in aggregate hold a significant ownership interest in the entity.
  • Fair value management — Substantially all of the investments of the entity are managed, and their performance evaluated, on a fair value basis.
  • Reporting entity — The entity conducts its activities and reports financial information about those activities to its investors. The entity can but does not need to be a legal entity.

The Board decided to include within the scope of the investment company guidance entities that report under the Investment Company Act of 1940 (the “1940 Act”). Therefore, an entity would be within the scope of the investment company guidance if it:

  • Meets the criteria outlined in the FASB’s and IASB’s tentative decisions on what constitutes an investment company but does not report under the 1940 Act.
  • May not meet all of such criteria but reports under the 1940 Act. Although it is not clear how prevalent this scenario may be in practice, the Board specifically discussed this issue in the context of certain business development companies.
  • Meets all of the criteria and reports under the 1940 Act.

Editor’s Note: Several members of the Board were hesitant to revise their decisions on the criteria that must be met for an entity to qualify as an investment company since doing so would result in divergence from decisions reached with the IASB. Therefore, the Board plans to seek comments on whether to include “U.S.-centric” criteria, such as reporting under the 1940 Act, or whether it would be better to address any concerns by amending the various criteria.

Money Market Funds

The Board also considered, but ultimately rejected, including a specific example of how a money market fund may qualify as an investment company. However, it directed the staff to indicate in the ED’s basis for conclusions that “shadow pricing” may effectively create a practical expedient for fair value and therefore not violate the “fair value management” criterion.

Fair Value Management

The Board also considered, but ultimately rejected, amending the “fair value management” criterion. However, many Board members acknowledged that there could be some confusion about this criterion and directed the staff to include discussion in the ED’s basis for conclusions about how the criterion should be interpreted. For example, one Board member noted that if an investment manager’s fee is based on fair value, this may indicate that the investments themselves are managed on a fair value basis. Other Board members noted that to meet the criterion, entities may not be required to engage in daily or active management on a fair value basis.

Editor’s Note: Several members of the Board were hesitant to amend the “fair value management” criterion since doing so would result in divergence from decisions reached by the IASB. However, other members indicated that “evaluate” or “assessed” on a fair value basis may better reflect their intent with respect to this criterion.

Change in Status

The Board confirmed its decision that if there is change in the status of an entity during the period, it would be reflected as a cumulative-effect adjustment to net assets (retained earnings).

Consolidation Versus Fair Value

The Board also reconsidered its earlier decisions on when to consolidate (as opposed to report at fair value) an investment company’s interest in another entity. As a result, the Board made the following tentative decisions:

  • An investment company that controls a wholly owned or partially owned investment company should consolidate the investment company. This reverses its earlier decisions that an investment company would account for a controlling interest in another investment company at fair value.
  • An investment company that controls a wholly owned or partially owned investment property entity should consolidate the investment property entity.
  • An investment company should account for the following at fair value:
    • Significant influence over another investment company or investment property entity.
    • Any interest in an operating company (including control of a wholly owned operating company).

The Board noted that its decisions on whether investment companies should consolidate or report at fair value were based on the resulting presentation within the financial statements.


[1] Criteria are as outlined in the FASB’s Summary of Decisions Reached to Date (As of July 13, 2011).

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