Consolidation — Board completes its deliberations

Published on: 11 Dec 2014

At yesterday’s FASB meeting, the Board discussed certain significant items related to its consolidation project that had been raised during the external review process. A significant portion of the discussion focused on (1) how entities that are required to comply with or operate in accordance with the requirements of the Investment Company Act of 1940 (the “1940 Act”) should be evaluated for consolidation and (2) whether kick-out rights held by a general partner (GP) and its related parties should affect the consolidation analysis.

Entities That Are Required to Comply With or Operate in Accordance With the Requirements of the 1940 Act

An asset manager may seed (own 100 percent of the equity interests of) a newly formed fund to establish a performance record before selling interests in the fund to third-party investors. Under the current guidance, asset managers typically consolidate the fund until their equity interest is diluted below a 50 percent ownership threshold (assuming that they have no other exposure to the fund). During the external review process, a concern was raised about whether such a fund would be considered a variable interest entity (VIE) under the proposed amendments and, if so, whether application of the proposed amendments would result in consolidation of the entity by an asset manager until the asset manager's ownership interest decreases below the “potentially significant” threshold for VIEs. The answer to these questions could result in the consolidation of additional 1940 Act funds under the proposed amendments.

Although the Board did not believe that the proposed amendments should result in the consolidation of additional 1940 Act funds, it expressed concern about an approach that would exclude 1940 Act funds from the VIE determination analysis entirely. Ultimately, the Board tentatively decided that these funds (including those in a series fund structure1) should be subject to the VIE consolidation requirements; however, the Board will provide an example that concludes that a typical 1940 Act fund is not considered a VIE as a result of failing to meet the requirement in ASC 810-10-15-14(b)(1) (the “power” criterion).

Editor’s Note: The FASB did not address the diversity in practice related to evaluating whether a fund established in a series fund structure would meet the criteria in ASC 810-10-15-14(a) (the “sufficiency of equity” requirement). Currently, there is diversity in views on whether a series fund structure would be considered a VIE as a result of the trust’s lack of sufficient equity at risk. Some believe that when evaluating whether the trust in a series fund structure has sufficient equity to absorb its expected losses, a reporting entity should consider only the expected losses (excluding the expected losses of the individual series) and the at-risk equity (excluding the at-risk equity of the individual series) of the trust. That is, to determine whether the trust has sufficient equity, the reporting entity should compare the trust’s equity at risk with its expected losses. If the individual series are excluded from the analysis, the remaining trust of the series fund structure is a “shell entity” that many believe would most likely be a VIE.

Kick-Out Rights Held by a GP

The FASB had previously decided that when determining whether kick-out rights should be considered in an evaluation of whether a limited partnership (or similar entity) is a VIE, a reporting entity would consider such rights if they are substantive and capable of being exercised by a single limited partner (LP) or a vote of a simple majority or lower percentage of all partners (including the GP, entities under common control with the GP, and other parties acting on behalf of the GP). In addition, for those partnerships that are not considered VIEs, the evaluation of whether the GP should consolidate the partnership would take into account the rights held by these parties.

At yesterday’s meeting, the FASB tentatively decided that, in a manner consistent with the current requirements in ASC 810-20, rights held by the GP, entities under common control with the GP, and other parties acting on behalf of the GP should not be included in the analysis of whether a partnership is a VIE or whether a GP consolidates a partnership that is not a VIE.


A limited partnership is formed to acquire a real estate property. The partnership has a GP that also holds a 20 percent LP interest in the partnership; eight unrelated LPs equally hold the remaining equity interests. Profits and losses of the partnership (after payment of the GP’s fees, which represent a variable interest in the entity) are distributed in accordance with the partners’ ownership interests. There are no other arrangements between the partnership and the GP/LPs.

The GP is the property manager and has full discretion to buy and sell properties, manage the properties, and obtain financing. In addition, the GP can be removed without cause by a simple majority of all of the LPs.

Under the Proposed Guidance

If the GP interest absorbs and receives only a nominal portion of the profits and losses of the limited partnership as a whole and the GP interest is considered substantively separate from the GP’s LP interest, the GP’s equity interest would not be considered substantive and is not part of the equity at risk. Since a simple majority of the unrelated LPs cannot remove the GP, the partnership would fail to meet the requirements in ASC 810-10-15-14(b)(1) since the LPs (holders of the equity at risk) would not have “power” over the partnership. In this example, the unrelated LPs are unable to remove the GP unless 75 percent (six of the eight unrelated LP investors) vote to do so. Accordingly, the kick-out rights would be ignored.

Editor’s Note: Despite the FASB’s previous decision that simple majority kick-out rights should be considered in the evaluation of whether a partnership is a VIE, the Board has decided that for those partnerships that are considered VIEs, the evaluation of whether the GP should consolidate the partnership would take into account only those kick-out rights that are unilaterally exercisable by a single LP.

Summary of Tentative Decisions

The table below summarizes the remaining tentative decisions reached at the meeting:

Interests held by related parties The FASB tentatively decided that for the purpose of determining whether a reporting entity is the primary beneficiary of a VIE, the reporting entity would include (1) its direct economic interests in the VIE and (2) its indirect economic interests in the VIE held through related parties on a proportionate basis. In addition, the FASB tentatively decided that if the reporting entity and its related party are under common control, the related party’s entire economic interest should be included in the reporting entity’s analysis of whether (1) it has a variable interest in the entity and (2) it is the primary beneficiary of the VIE.
Pro rata consolidation <p >The FASB tentatively decided to retain the guidance in ASC 810-20-15-3(c) that permits a GP in certain limited partnerships (limited partnerships in either the construction industry or an extractive industry) to apply the pro rata method of consolidation permitted for that industry.
Low-income housing tax credits The FASB tentatively decided that interests in limited partnerships within the scope of ASU 2014-012 would not be subject to the related-party guidance in the proposed consolidation amendments. The concern raised during the external review process was whether the LP in such structures would be required to consolidate the limited partnership under the related-party guidance and therefore would be ineligible to apply the guidance in ASU 2014-01.
Related-party tiebreaker test when power is shared The FASB reaffirmed its previous tentative decision to retain the current requirement that related parties (including de facto agents) must perform the related-party tiebreaker test when power is shared among related parties (including de facto agents).
Transition guidance for newly deconsolidated entities The FASB tentatively decided to include a practicability exception for determining the carrying value of the retained interest in an entity when the reporting entity is required to deconsolidate the entity as a result of adopting the proposed guidance. Specifically, the Board tentatively decided to allow a reporting entity to use fair value to initially measure its retained interest.

Next Steps

The Board indicated that it does not plan to hold another meeting before issuing the final standard. It will begin its balloting process and intends to issue the final standard in the first quarter of next year.


1 A series fund is a structure established as a single legal entity (typically, a series trust) comprising multiple series that each operate as a separate investment company for investment purposes.

2 FASB Accounting Standards Update No. 2014-01, Accounting for Investments in Qualified Affordable Housing Projects.

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