On October 24, 2017, the American Institute of CPAs issued a Technical Questions & Answers (TQA) document to provide further clarification on the definition of a public business entity (PBE), which was defined in Accounting Standards Update (ASU) 2013-12, Definition of a Public Business Entity. Whether an entity meets the definition of a PBE is significant, as non-PBEs can use private company accounting alternatives as well as benefit from delayed implementation dates for other significant accounting standards and reduced disclosure requirements. With significant new accounting standards coming as early as 2018 for PBEs, e.g., revenue recognition and financial instruments—recognition and measurement, it’s crucial financial institutions understand whether they’re PBEs as soon as possible.
ASU 2013-12 sets forth five criteria that could make a company a PBE, and questions have been raised over the interpretation of the criteria since ASU 2013-12 was issued. The TQA document is intended to address and hopefully clarify many questions regarding PBE assessments for financial institutions and other entities.
Many of the questions—specifically for community banks subject to the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)—centered on both parts of criterion (e). This criterion contemplates whether the entity has securities not subject to contractual restriction and is required to prepare U.S. generally accepted accounting principles (GAAP) financial statements and make them publicly available. A few clarifications related to this criterion are listed below.
S Corporation Status Alone Serving as a “Contractual Restriction of Transfer”
While most S corp shareholder agreements include explicit contractual restrictions on common stock transfers, the TQA concludes an S corp structure alone doesn’t guarantee such a restriction exists for the purposes of criterion (e). S corps are encouraged to review shareholder agreements to assess whether restrictions exist when assessing their PBE status. The nature of the restriction is important. The TQA notes management approval of a resale or limiting sale only to existing shareholders would represent an explicit restriction. However, a right of first refusal in and of itself wouldn’t represent a contractual restriction because it doesn’t prevent the holder from transferring the security altogether.
Implicit Restriction in a Holding Company Structure
The TQA also provided clarification for instances where a parent holding company owns 100 percent of a subsidiary financial institution’s common stock. In such cases, the holding company’s 100 percent ownership creates an implicit restriction on transfer of the subsidiary institution’s common stock. In this case, the subsidiary FDIC-insured institution wouldn’t meet the first part of criterion (e) and, therefore, wouldn’t meet PBE status when evaluated separately. This is important since the TQA also clarifies the evaluation should be made on an entity-by-entity basis as discussed below.
Publicly Available Financial Statements
The TQA provides clarifications on what financial statements are considered required by law, contract or regulation and considered to be “publicly available” for the purposes of the second part of criterion (e). Although previously clarified, the TQA reiterated Call Reports aren’t considered U.S. GAAP financial statements for purposes of PBE assessment, as they’re not a full set of financial statements with footnotes. However, the requirement for insured depository institutions (IDI) with more than $500 million in assets to file audited comparative financial statements in accordance with FDIC Part 363 does meet the definition for purposes of this assessment.
One area with major clarifications from the TQA deals with evaluating PBE status in tiered organization structures. This is particularly important to many financial institutions with holding company structures that have investments in certain nonconsolidated entities. Some clarifications in the TQA dealing with tiered structures are listed below.
The TQA clarifies that business entities are required to evaluate the criteria related to PBE status on an entity-by-entity basis. This is particularly important for financial institutions with a holding company structure. An example provided in the TQA considered an IDI that has assets in excess of $500 million is subject to the audited financial statement requirement of FDICIA and is 100 percent owned by a holding company. Even though the IDI meets the second part of criterion (e), it has an implicit restriction on its equity securities based on the 100 percent ownership of the holding company and, therefore, doesn’t meet the first part of criterion (e). If the holding company has no other requirement to prepare and make its financial statements publicly available, then it doesn’t meet the second part of criterion (e) as the FDICIA requirement is at the IDI level. Assuming the IDI has no other securities not subject to restriction on transfer and the IDI and holding company don’t meet any of criteria (a)–(d), neither would be considered a PBE.
Trust-Preferred Securities (Non-consolidated VIE)
Trusts used to issue trust-preferred securities are another area where the entity-by-entity analysis becomes important, especially in regard to criterion (d) for over-the-counter (OTC) markets. In the case of a nonconsolidated variable interest entity (VIE)—the typical trust structure—issuers aren’t required to look through to the VIE when assessing their own PBE status. In other words, the sponsor’s PBE assessment isn’t required to consider how the VIE’s securities trade. In this scenario, the sponsor should focus on whether there are any contractual restrictions on transfer of the debt securities issued to the VIE (first part of criterion (e)). If the VIE can’t sell the debt securities issued to the trust without the sponsor’s involvement, that’s considered a restriction, and it wouldn’t meet the first part of criterion (e).
Here are a few other important clarifications we wanted to highlight.
Use of “Over-the-Counter” Market
The use of the term OTC market is clarified in the TQA as it relates to criterion (d). Issuers will be considered PBEs under criterion (d) if their securities are traded on markets accessible to the public to execute trades and prices and other data are publicly available. Therefore, an issuer with securities traded on markets only accessible by certain investors (qualified institutional or accredited investors, for example) wouldn’t meet criterion (d) and wouldn’t be considered a PBE.
Financial Institutions’ Issuance of Brokered Certificates of Deposit (CD)
The TQA clarifies that brokered CDs need to be evaluated based on how they’re ultimately offered and sold. If the brokered CDs are actually traded on an OTC with publicly quoted prices, they would meet criterion (d), and the financial institution would be considered a PBE. If brokered CDs aren’t traded OTC with publicly quoted prices, criterion (d) wouldn’t be met and would need to be evaluated under criterion (e).
The TQA includes other clarifications and examples not covered in this article. While the TQA provides specific clarifications to help entities assess whether they meet the definition of a PBE, it doesn’t eliminate the necessity for entities to formally document their considerations in making final assessments of PBE status. The illustrative examples described in the TQA should help entities through their own entity-by-entity assessments, but formally documenting specific considerations and conclusions reached will be imperative. Finally, it should be reiterated that PBE status can change based on changes with the entity. Entities should review internal control structures to quickly identify any changes that may affect their PBE assessments, e.g., issuance of new debt or equity securities, and consider the potential effect on their original PBE assessments.
Contact your trusted BKD advisor with questions or for more information.