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FASB One Step Closer to Eliminating QSPEs

Tammy Whitehouse | April 8, 2008

The Financial Accounting Standards Board hammered the first nail into the coffin of qualified special purpose entities, the centerpiece accounting conundrum that has complicated and muddied visibility into the full scope of the credit market meltdown.

At its board meeting last week, FASB voted to begin a short-term project to wipe the concept of QSPEs out of U.S. Generally Accepted Accounting Principles.

The QSPE is a concept permitted in Financial Accounting Standard No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and in Financial Interpretation No. 46R, Consolidation of Variable Interest Entities. The intention when FAS 140 was issued in 2000 was to allow a means for companies to isolate control and decision making around certain assets and liabilities into a subsidiary company as a way to isolate risk.

As the complexity of financial instruments has morphed into products that didn’t exist at that time—blurring the lines between what constitutes liability, equity, and control over assets—the QSPE increasingly became a haven for shuttling risky investments off the balance sheet.


FASB Chairman Robert Herz said the concept has been so stretched in recent years he “wholeheartedly” endorses elimination of QSPEs. “The crescendo has been the latest round of very problematic assets securitized using this approach,” he said, involving “hundreds of billions, if not trillions, of dollars in assets.”

FASB member Larry Smith agreed. “For five years, we’ve been struggling with the application of [FAS] 140,” he said. “We have a concept that really isn’t working … We have to come up with some other way for investors to evaluate what these transactions are.”

Not Necessarily a Panacea

The markets got their first taste of the potential for special-purpose entities to obscure the risk a company undertakes when Enron unraveled in 2001. The Securities and Exchange Commission targeted off-balance-sheet treatment permitted by special-purpose entities in a 2005 report calling for changes.

Also in 2005, FASB published an exposure draft to address the shortcomings of FAS 140, which was heavily criticized in the comment letter process. The project has stalled in various iterations of redeliberation, with discussions in 2007 focused on whether the board could establish a reporting model that would somehow link the presentation of related assets and liabilities.

Since then, the current credit crisis has stepped up the pace at FASB. As credit markets began reeling under the weight of failing sub-prime mortgages, the SEC—at the urging of Congress—stepped in with a determination that troubled mortgages held in securitized assets off the balance sheet could be worked out with the original borrowers to prevent default.

While the measure was seen in some circles as a way to minimize damage to housing and credit markets, it raised eyebrows about to what extent securitized assets held in SPEs were in fact beyond the seller’s control and decision-making authority. SEC guidance allowing the off-balance-sheet workouts instructed FASB at the same time to address the QSPE problem by the end of 2008.

While FASB’s decision to eliminate QSPEs was nearly unanimous, some members expressed dissension and hesitation on whether the short-term fix may in some way sully longer-term plans for overhauling accounting for transfers of financial assets and liabilities.


The following 2007 FAS 140 update summarizes decisions reached about FASB's plans to amend the standard.

The Board agreed that the following issues in the Exposure Draft be redeliberated:

1. Reconsideration of the concept of requiring that an entire financial asset first be transferred to a qualifying SPE (or other entity that is not consolidated with the transferor) to meet the requirements for sale accounting for transactions that involve transfers of portions of financial assets unless the resulting portions meet the definition of a participating interest.

2. Consideration of issues related to the definition of a participating interest.

3. Consideration of issues related to isolation.

4. Consideration of issues related to the application of paragraph 9(b).

5. Consideration of whether a qualifying SPE must issue more than 10 percent of the fair value of its beneficial interests to outside parties in order to meet the requirements of a qualifying SPE.

6. Reconsideration of provisions for initial measurement of a transferor’s beneficial interest.

7. Consideration of whether to provide additional measurement guidance on the subsequent measurement of a transferor’s beneficial interest.

8. Consideration of the removal of paragraph 40 in its entirety and the modification of paragraph 35(c) of Statement 140 to remove the restriction on a qualifying SPE from holding derivative financial instruments that do not pertain to the beneficial interests of the qualifying SPE.

9. Reconsideration of the restrictions on rollovers of beneficial interests.

10. Consideration of whether to provide additional guidance on the permitted activities of a qualifying SPE.

11. Consideration of permitting a qualifying SPE to hold certain equity instruments such as titling trust certificates and money-market investments.

12. Reconsideration of the effective date and transition provisions.


FASB (Oct. 19, 2007).


Board member Leslie Seidman, for example, said that while the QSPE concept made sense when it was introduced as a way to isolate control and still protect the interests of investors, questions remain about how the originators of securitized assets will derecognize, or transfer control, of the assets when purchased by investors. “I don’t think this is necessarily a panacea for the things that are out there today,” she said. “But it is a critical step for us to try to start improvement in the short term in the accounting of securitizations.”

She added: “We owe that to investors, and we owe that to practitioners, to stabilize the accounting in this area. It is a massive market, and it is unacceptable to have uncertainty about accounting treatment.”


FASB member Tom Linsmeier, too, expressed reservation about how future changes to the accounting will go forward. “My primary objective would be to get better derecognition of proper assets as a consequence of our activities,” he said.

The board did agree to amend FAS 140 criteria for derecognition and to provide guidance on the transfer of a partial or proportional interest in an asset, to further cement language on the extent to which the party transferring an asset has in fact surrendered control over the asset.

Added Linsmeier: “We have a series of difficult decisions to make. When the package gets completed, a very important aspect should be to check to make sure the outcomes we see are a good reflection of the economics of what’s happening.”

Move to Improve Credit Derivatives

In a separate but equally timely action given the credit market turmoil, Herz announced during last week’s meeting he was adding a project to the Board’s agenda to improve disclosures around credit derivatives, including credit default swaps.

“The credit market has grown to something over $40 trillion in value,” he said. “I’ve asked the staff to look at what the current disclosure requirements around these instruments were. Based on the staff analysis, it seems like some improvements might be possible to existing requirements for derivatives.”

Herz was exercising his newly appointed authority that was extended to him recently in a swift, sweeping change to FASB’s governance implemented by the Board’s overseer, the Financial Accounting Foundation. Previously, projects could only be added to the technical agenda by a board vote.

Herz indicated during his announcement he’d consulted with other board members in reaching his decision. “I believe we’re all in agreement that this is something we need to look at,” he said.