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This analysis focuses on the risks the legal entity was designed create and pass along to variable interest holders, and which party, if any, has the power to make decisions that significantly affect the legal entity’s activities that impact those risks. This evaluation should consider the impacts the decisions have on cash flows, the level of exposure to designed risks, operational measures (e.g., revenue, profit and loss, margins), asset fair values, the entity’s overall fair value, among others. The analysis should also take into consideration the nature and timing of expected decisions during the life of the entity. The analysis should also take into account any contingent decisions that must be made only upon occurrence of a future event. For a tightly structured, self-contained legal entity with limited operations, contingent decisions may be the only significant decisions expected. Additionally, contingent events may trigger changes in activities, decision makers and/or expected decisions that should be evaluated relative to those prior to the contingent event.

Design and purpose – The legal entity’s design and purpose are fundamental to the determination of the primary beneficiary. The risks that the legal entity was designed to create and pass along to its variable interest holders are key markers of the activities related to those risks. And those activities are in most cases the activities that most significantly affect the legal entity’s economic performance. The primary beneficiary analysis focuses on the party, or parties, that control those activities. In analyzing the legal entity’s risks, there may be cases where one or more risks has no related activities. If this is the case, those activities can be ignored for purposes of the primary beneficiary analysis.

Fiduciary service contract – There may be cases where the decision-making power of the legal entity is vested in a fiduciary service contract that is not a variable interest. In this case, there is no primary beneficiary. This should be extremely rare and would need to be re-evaluated if and when the terms of the service contract expire or are modified.

Multiple parties have power – If multiple parties exercise power over the legal entity, the party that has power over activities that most significantly impact economic performance is the primary beneficiary. This determination should again be based on the design and purpose of the legal entity.

Changes to powers or activities over time – A VIE’s activities and/or control powers may shift over time due any number of reasons, including contingent events. As these shifts occur, the primary beneficiary may change. Evaluation of the primary beneficiary should be monitored continuously since a change in primary beneficiary is not tied to reconsideration events.

Contingent decisions – Determining which party is the primary beneficiary can be difficult when the legal entity’s decision maker(s) can shift as result of contingent events. The evaluation should consider the significance of the decisions that can be made before and after contingent events. For some VIEs, the decisions made prior to a contingent event are minor or there may be none required at all. The decisions made after the contingent event may be the only significant decisions the VIE will ever face. In this situation, the party controlling the contingent decisions is probably the primary beneficiary, particularly if that party exercises any level of control or influence over the occurrence of the event. That type of control, however, is not a requirement.

Also, the probability of contingent events occurring is not a consideration. This is primarily a qualitative evaluation and the presence of contingent decisions is significant to the analysis, not the probability that they or may not occur.

In some cases, the noncontingent and contingent decisions are both considered significant. In this situation, look to the design and purpose of the legal entity and the significance of the sets of decisions throughout the life of the VIE. You would also look at the ability of the variable interest holders to control or influence the contingent event. If these considerations are not determinative, then you would in this case take into consideration the probability of the event occurring.

Some examples of contingent events include the expiration of kickout and participation rights, events that make kick-out rights and participation rights exercisable, buyout of variable interest(s) by third parties, concentrations of variable interests through transactions between or among variable interest holders, and new contracts involving the VIE or involving parties involved with the VIE.

Shared power – If no party meets the power criterion, then the entity has no primary beneficiary. This can occur when two or more unrelated parties have power to direct the VIE’s significant activities. For there to be shared power, however, there must be a requirement for each party to consent to the decisions made by any one party and the consent requirement must be substantive. The analysis must look at all levels of shared powers including the board of directors and operational management. The analysis must also evaluate decision making powers vested other interests held, not just variable interests, such as service contracts.

In most cases, there will be a tie-breaker. The party with power over the most (majority) activities would be the primary beneficiary. But, if no party has majority, there is no primary beneficiary.

By design power – A VIE may grant decision making powers that are largely meaningless. This would occur when the VIE’s activities are very limited or nonexistent. In this case, the initial design of the legal entity is the place to look for power. The party with the incentive to act is the party with power in a situation like this.

Call options – Call options on variable interests or other interests may impact but usually only if the strike price and other terms of the option provide an economic incentive to the holder (or if not exercising is not economical). Other considerations including: a) the importance of the legal entity to the option holder, b) the overall level of control held by the option holder before and after exercise, c) importance of the option holder to the activities of the VIE, d) any economical and other barriers that would prevent exercise or make exercise infeasible, e) any conditions making exercise infeasible or imprudent and f) any substantive exercise contingencies (which would render the call option moot as a control factor until the contingencies are resolved).

Kick-out rights and participation rights – Kick-out rights and participation rights should be disregarded unless 1) the rights are substantive and 2) can be exercised by a single party (including de facto agents and related parties). Evaluation of these rights should also consider disincentives to exercise such as finding a qualified replacement, contractual limits and financial penalties.KO and P (ability to block actions) rights – must be exercisable by a single reporting entity (including de facto agents and related parties) and only if substantive. Look at barriers to exercise (available replacements, contractual, penalties

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