Investment Company Notebook

Practical insight and analysis on the accounting, audit and tax issues impacting investment companies.

Investment Management Group

Tax Consequences Associated With Option Strategies- Part I | BBD, LLP

Posted by Investment Management Group Oct 7, 2011 11:40:05 AM

As the investment world becomes more and more complex, we here at BBD are beginning to see more and more funds being created that employ alternative investment strategies. Although, it is not a new concept by any means, some of the new funds we see employ option oriented strategies (particularly covered call writing) to enhance total returns. This post begins a four-part series that explores some of the tax consequences involved with writing covered calls against a long investment portfolio. The primary tax concerns center around rules that defer the deductibility of capital losses on “straddles”; holding period suspensions for stocks subject to written calls which can cause what might otherwise be a tax favored long-term capital gain to be treated as a short term capital gain; and limitations on the ability to characterize dividends on stocks subject to written calls as either eligible for the corporate dividends received deduction (“DRD”) or the favored tax rates afforded to qualified dividend income (“QDI”). This post will present the basics of the straddle rules.

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ETFs Need Their Own Accounting Rules- Part III- Emerging Markets ETFs

Posted by Investment Management Group Sep 27, 2011 5:56:03 PM

There are several emerging markets that do not allow for in-kind transfers of securities, for example Brazil and India. Additionally, some countries, such as Brazil, impose a tax on new purchases of their currency. When units are created in ETFs that focus on these emerging markets, cash is contributed by the authorized participant (“AP”) in lieu of securities since an in-kind transfer is not possible. The ETF then uses this cash to purchase the securities requested at creation. Along with this cash in lieu, the ETF and the AP typically agree to lock in the price of the securities at the time of creation. If the price of the securities rise from the time of creation until the time the Fund is actually able to purchase the securities, the AP makes an additional cash contribution to the Fund to cover the increase in cost. If the prices decrease, the Fund returns cash to the AP. Additionally, the AP typically agrees to reimburse the Fund for costs incurred to acquire securities that were not able to be transferred in kind, such as transaction costs and taxes (i.e.Brazil currency).

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PCAOB Proposes Changes to the Auditor's Reporting Model

Posted by Investment Management Group Sep 21, 2011 11:38:44 PM

On June 21, 2011, the PCAOB issued a concept release that may change the auditor’s reporting model as we know it. The concept release results from an “outreach” project concerning the effectiveness of the auditor’s reporting model conducted by the PCAOB staff from October 2010 through March 2011. The purpose of the concept release is to present a number of alternative potential changes to the auditor’s reporting model with a goal of increasing transparency and proving more relevant information to investors. The concept release offers four alternative changes to the current reporting model. Included among them, and easily viewed as the largest component of the proposed concept with the potential to drastically change the reporting model, is the addition of an auditor’s discussion and analysis of the financial statements (“AD&A”). The AD&A will give the auditor the ability to discuss significant matters that may not otherwise be expressed in the strict layout of the opinion language. This could include an explanation of the audit procedures performed, a statement stressing the independence of the auditor, or even the auditor’s overall view of the statements themselves. Other potential modifications to the reporting model included in the concept release are the expanded use of emphasis paragraphs, required auditor assurance on information ranging beyond the financial statements, and modification of the standard wording used throughout the opinion. All of these proposed concepts have one thing in mind: to ensure auditor’s communications are transparent to the investor. Further, the concept release makes it clear that these four alternatives are not mutually exclusive. Any changes to the auditing standards could include one or any combination of these components. The PCAOB also notes that there may be other alternative changes to consider, which will presumably come through the comment process. Written comments on the concept release are due to the PCAOB by September 30, 2011.

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Sensitivity Analysis- It Could Have Been Worse

Posted by Investment Management Group Aug 31, 2011 11:44:46 PM

During the 2009 ICI Tax and Accounting Conference “Sensitivity Analysis” or “Stress Test” was all the buzz. At that time, there were a lot of unanswered questions, and everyone was dreading the future implementation. Then in 2010, we received a bit of good news. Implementation would be postponed until 2011/2012. Unfortunately 2011/2012 is here (effective for interim and annual periods beginning after December 15, 2011)- however there is some good news that has come out of ASU 2011-4 which modifies Topic 820.

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Recent Changes to Rule 2a-7 for Money Market Funds

Posted by Investment Management Group Jul 21, 2011 8:17:57 PM

Last year, the Securities and Exchange Commission ( "SEC") implemented amendments to Rule 2a-7 compliance procedures for money market funds. The amendments are meant to provide better protection for money market fund investors.

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Initial Response to the Revised Custody Rule

Posted by Investment Management Group Jul 21, 2011 7:50:27 PM

Effective March 12, 2010, the Securities and Exchange Commission (“SEC”) adopted amendments to Rule 206(4)-2 of the Investment Advisors Act of 1940 (the “Custody Rule”). These amendments are designed to provide additional safeguards when a registered advisor is deemed to have custody of client funds or securities by requiring the advisor to undergo an annual surprise examination by an independent public accountant who is subject to regular inspection by the Public Company Accounting Oversight Board. The annual surprise examination procedures are designed to verify that client funds and securities, of which an investment advisor has custody, are held by a qualified custodian and either in a separate account for each client or under the advisor’s name as agent or trustee for the client.

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ETFs Need Their Own Accounting Rules- Part II- The ETF Fair Value Dilemma

Posted by Investment Management Group Apr 16, 2010 9:48:26 AM

It is imperative for open-end investment companies to value their investments at fair value when determining their net asset value ("NAV"). For investment companies that invest a significant portion of their investments in foreign securities, the importance of fair value is magnified. Due to different time zones, many foreign exchanges close well before the close of the U.S. markets. If significant events occur after the close of the foreign markets, but before the close of the U.S. markets, the closing price of the foreign investments will not be reflective of the current market value. This creates arbitrage opportunities for market timers. Market timers look to profit from these arbitrage opportunities and do so at the expense of the remaining shareholders of the fund. To combat market timers, most mutual funds that invest in foreign securities utilize fair value factors to adjust closing foreign prices to reflect events occurring after the close of the foreign markets but before the close of the U.S. markets. Some funds establish a threshold or trigger of movement that must occur before applying the fair value factors, but more and more funds are beginning to apply fair value factors on a zero threshold basis.

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ETFs Need Their Own Accounting Rules- Part I

Posted by Investment Management Group Apr 15, 2010 11:10:17 AM

As I am starting to work with more and more Exchange Traded Funds (ETFs), it is becoming increasingly apparent that they need their own specific set of accounting and reporting rules. Currently, an ETF falls under the guise of an open-end management investment company registered under the Investment Company Act of 1940. While this classification is technically correct, there are certain rules / guidance for open-end 40 Act investment companies that really do not make sense for an ETF. One example is the method by which Total Return is required to be calculated. Another, while admittedly more debatable, is the use of fair value adjustment factors when valuing investments domiciled on foreign exchanges for the purposes of determining the daily net asset value (NAV) of the ETF.

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