SPEs, QSPEs, VIEs and Sarbanes Oxley Audits After the Market Crisis

According to the Staff Audit Practice Alert No 3 from the Public Company Accounting Oversight Board, auditors of public firms that have to comply with the Sarbanes Oxley Act of 2002 should give specific consideration to the new and elevated risks after the current market crisis, and should adjust their audit procedures.

One of the areas of concern: Off-balance-sheet arrangements and Special Purpose Entities (again), especially the entities known as Qualifying Special Purpose Entity (QSPEs) and Variable Interest Entities (VIEs).

Qualifying Special Purpose Entity (QSPE)

According to the Statement of Financial Accounting Standards No. 140 from the Financial Accounting Standards Board, a QSPE is a legal vehicle (like a trust) that:

- It is distinct from the transferor

- Performs significantly limited activities (so banks, insurance firms, pension plans and investment firms are not sufficiently limited and can not become qualifying SPEs).

- May hold only financial assets transferred to it that are passive (the holder in making decisions only about servicing). Examples are passive derivative financial instruments, guarantees or rights to collateral.

Variable Interest Entities (VIE)

A VIE is often a holding company, created by another legal entity to hold assets or debt, to carry out operations or handle corporations, partnerships, trusts and limited liability companies. A VIE usually does not have the capital to support itself, so by design it is supported by another entity. The "primary beneficiary" (that has a controlling financial interest in the variable interest entity) consolidates the VIE (assets, liabilities, and profit).

There are several types of "variable interest" like loans, leases, call options, equity investments, written put options, forward contracts, derivatives, guarantees, credit enhancements etc.

According to the FASB Staff Position (FSP) FAS 140-4 and FIN 46(R)-8, public companies must disclose more about transfers of financial assets to QSPEs and VIEs.

Primary beneficiaries, servicers, holders of significant variable interests, transferors and sponsors are primarily affected.

According to the Public Company Accounting Oversight Board, the tough economic environment after the current market crisis led public companies to provide guarantees and financial support to QSPEs and VIEs. They have a "variable interest" or have increased their exposure to the above described entities, and perhaps they gave become a "primary beneficiary".

Their investors have a need to know. Their auditors have the obligation to ask the proper questions. The disclosures about transfers of financial assets in VIEs and QSPEs are meaningful and necessary.

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