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An implied variable interest is similar to an explicit variable interest, except its absorption of variability is indirect. Explicit variable interests are direct in that they arise out of contracts, ownership and other pecuniary interests directly in or with the legal entity.

Implied variable interests can arise in a number of ways.One common way is for variable interest holders to enter into an agreement among each other that alters the way variability is absorbed by the parties to the contract. This contract is not with the legal entity directly, yet does affect the way variability is absorbed. Such an arrangement could significantly affect the variable interest analysis, particularly when evaluating which party is the legal entity’s primary beneficiary.

A less obvious way to create an implied variable interest is for a party without any direct relationship with the legal entity to nevertheless have an incentive to take action in certain circumstances. A prime example, and not all uncommon, is for reporting entity to form a legal entity to acquire real estate or equipment and lease the assets to the reporting entity. If the legal entity finances the asset purchases with debt, and if the owner of the reporting entity personally guarantees the debt, then the business owner has an implicit variable interest with the legal entity. He has an incentive to prevent the lender from exercising the guarantee should the legal entity default on the loan. The owner of the reporting entity is also a related party of the reporting entity, so this implicit variable interest could significantly affect the determination of the primary beneficiary of the legal entity.

The SEC uses the phrase “activities around the entity” to refer to indirect relationships that create implicit variable interests and/or alter explicit variable interests as noted in a staff presentation at the 2004 AICPA National Conference on Current SEC and PCAOB Developments:

“We have seen a number of questions about whether certain aspects of a relationship that a variable interest holder has with a variable interest entity (VIE) need to be considered when analyzing the application of FIN 46R [codified in ASC 810-10]. These aspects of a relationship are sometimes referred to as “activities around the entity.” It might be helpful to consider a simple example. Say a company (Investor A) made an equity investment in a potential VIE and Investor A separately made a loan with full recourse to another variable interest holder (Investor B). We have been asked whether the loan in this situation can be ignored when analyzing the application of FIN 46R. The short answer is no. First, FIN 46R specifically requires you to consider loans between investors as well as those between the entity and the enterprise in determining whether equity investments are at risk, and whether the at risk holders possess the characteristics . . . defined in paragraph 5 of FIN 46R [codified as ASC 810-10-15-14]. It is often difficult to determine the substance of a lending relationship and its impact on a VIE analysis on its face. You need to evaluate the substance of the facts and circumstances. The presence of a loan between investors will bring into question, in this example, whether Investor B’s investment is at risk and depending on B’s ownership percentage and voting rights, will influence whether the at risk equity holders possess the characteristics of a controlling financial interest.

Other “activities around the entity” that should be considered when applying FIN 46R include equity investments between investors, puts and calls between the enterprise and other investors and noninvestors, service arrangements with investors and non-investors, and derivatives such as total return swaps. There may be other activities around the entity that need to be considered which I have not  specifically mentioned. These activities can impact the entire analysis under FIN 46R including the assessment of whether an entity is a VIE as well as who is the primary beneficiary.

In another situation involving activities around the entity, investors became involved with an entity because of the availability of tax credits generated from the entity’s business. Through an arrangement around the entity, the majority of the tax credits were likely to be available to one specific investor. Accordingly, the staff objected to an analysis by this investor that 1) did not include the tax credits as a component of the investor’s variable interest in the entity and 2) did not consider the impact of the tax credits and other activities around the entity on the expected loss and expected residual return analysis.”


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