In late 2006, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) No. FAS 126-1, Applicability of Certain Disclosure and Interim Reporting Requirements for Obligors for Conduit Debt Securities, which extended the reach of the definition of a public entity. The FSP amended several FASB Statements, an APB Opinion, and two AICPA Audit and Accounting Guides to “clarify” the definition of a public entity. A nonpublic or not-for-profit entity that meets the definition of public entity under FSP No. FAS 126-1 must include certain additional financial statement disclosures from which it had previously been exempt. This FSP necessitates that management may need to assess whether their entity is, indeed, not public.
Is an entity a conduit bond obligor?
A not-for-profit entity (for example, a hospital or museum), or a for-profit entity (of any size, ownership structure, or type of business), may raise cash through a governmental entity. A state or unit of a local government or an agency or instrumentality of a state or local government (governmental entity) can raise funds in the capital markets by issuing municipal bonds. As permitted by the Internal Revenue Code, a governmental entity can issue conduit debt securities, which are frequently called municipal bonds or industrial revenue bonds. A conduit debt security is an offering by a governmental entity that is not for its own use but for the use of a private party that becomes a conduit bond obligor. In these types of transactions, the governmental entity is the issuer of the security but normally has no subsequent liability or continuing involvement. The private party that receives the proceeds in the transaction is the obligor and is required to make or fund all interest and principal payments as they come due and also is required to satisfy future financial reporting requirements.
Examples of conduit bond obligors include a nonprofit senior living organization that has an industrial development revenue bond used to expand existing facilities and a refuse collection operation with industrial revenue bonds to fund construction of a transfer station and purchase new trucks and equipment. The following examples further illustrate the concept of conduit bond obligors:
- Manufacturer, Inc. is constructing a new plant in Mini, USA. Mini Municipality has issued a $25 million industrial development revenue bond to fund the construction of this facility. Manufacturer, Inc. is required to make all interest and principal payments as they come due and must satisfy any future financial reporting requirements. Manufacturer, Inc. is a conduit bond obligor.
- Heath & Educational Facilities Authority issued $150,000 in conduit municipal bonds to pay for the purchase of land and equipment to expand First Charter School, a not-for-profit organization. First Charter School is required to make all interest and principal payments as they come due and must satisfy any future financial reporting requirements. First Charter School is a conduit bond obligor.
In the financing transactions described in the preceding paragraphs the entity that receives the proceeds makes no filing with a state or federal regulatory agency, such as the SEC, nor does it need to meet any of the requirements for an exempt transaction, such as the sale of securities to accredited investors. Nevertheless, the FSP concludes that an entity that is an obligor for conduit debt securities that are traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local or regional markets) meets the definition of a public entity. Thus, if an entity (either a for-profit or a not-for-profit) is involved in a financing transaction as an obligor for conduit debt securities that are traded in a public market, it must include certain additional financial statement disclosures from which it had previously been exempt.
Are those conduit debt securities publicly traded?
Once a determination has been made that an entity is a conduit bond obligor, an assessment must be made as to whether those conduit debt securities are traded in a public market. The FSP specifies that a public market is a domestic or foreign stock exchange or an over-the-counter market, including local or regional markets. The evaluation of whether a conduit debt security is being traded in a public market can often be difficult and will likely require additional investigation and use of judgment. The following are procedures and considerations which may be helpful in determining whether conduit bond securities are traded in a public market:
- Conversations with trustees or attorneys involved with the securities to inquire about the following:
- Were the bonds issued in a private placement? If so, the bonds are not likely to be publicly traded.
- Do the bonds trade in a public market? If so, which market(s)?
- Are there any on-going reporting requirements such as providing annual audited financial statements to a municipal securities information repository? If there are no reporting requirements, it is unlikely the obligations trade in a public market.
- Review of the offering document or prospectus. The prospectus should indicate whether the securities trade or not.
- Additional information on conduit bonds which are sold in secondary markets to institutional investors and to accredited investors can be found on Web sites such as www.investinginbonds.com which indicate trading activity, if any, for municipal bonds with CUSIP numbers. A CUSIP number is an identification number assigned to help facilitate the identification and clearance of securities. The CUSIP number may be found in the information return that is filed with the IRS for the bond issue. To be considered traded in a public market, we would expect there to actually be trading activity, since the criteria of the FSP is whether the bonds are traded.
The January 23, 2007, issue of Insights provides a list of the pronouncements for which the definition of a public company was amended by the FSP and for which additional disclosures may now be required together with a brief explanation of how those disclosures would affect the entity. The FSP is also available in full at http://www.fasb.org/pdf/fsp_fas126-1.pdf.
The FSP is effective for fiscal periods, including interim periods, beginning after December 15, 2006. |
