Financial Reporting Alert 08-3 (Revised): Member Bank Accounting Issues Related to the Reorganization of Visa Inc.
Updated February 12, 2008 (Original Release January 15, 2008)
|Editor’s Note: After the original issuance of this Financial Reporting Alert on January 15, 2008, the Visa USA Member Working Group submitted a letter to Mr. Eric West of the SEC. The letter, which was based on discussions with the SEC staff, summarizes the Working Group’s understanding of the SEC staff’s positions on various accounting matters related to the Visa Inc. reorganization and proposed initial public offering for Visa Inc. Member Banks. The conclusions in this alert remain unchanged from those in the original issuance.|
This Financial Reporting Alert pertains to financial institutions that are members of Visa Inc. Visa Inc. has announced its intention to become a public company, with an initial public offering (IPO) expected sometime this year. In preparation for the IPO, Visa has undergone a worldwide reorganization.
The reorganization and IPO raise several accounting issues whose resolution is described below. These issues have been discussed among several major banks with interests in Visa Inc., their independent auditors, and the SEC’s Office of the Chief Accountant. Final resolution of certain details of these issues is pending; we will publish an update to this alert if necessary. For more information about the restructuring and the proposed IPO, please see Visa Inc.’s public securities filings on the SEC’s Web site.
Visa Restructuring Accounting
Before October 3, 2007, certain Visa member banks had membership interests in Visa USA, which were typically accounted for at historical cost (which was often near zero). Membership interests provided member banks with a number of rights, including voting; participation in dividends, distributions, and liquidations; and the right to use the Visa payment system. Membership also conferred "affirmation rights and obligations"; the Visa USA bylaws required that member banks indemnify, and hold harmless, Visa USA for damages related to each member bank’s respective participation in the Visa payment system, as well as claims against Visa related to Visa’s operation of the payment system. These indemnification provisions would generally be within the scope of FASB Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. However, the transition provisions in paragraph 20 of Interpretation 45 would exempt indemnification obligations arising before a member bank’s adoption of Interpretation 45, as long as those obligations remained unmodified. Before the restructuring, member banks were required to use FASB Statement No. 5, Accounting for Contingencies, to account for their indemnification obligations.
On October 3, 2007, the Visa enterprise was restructured and members of the regional Visa organizations (i.e., Visa USA, Visa International, Visa Europe, Visa Canada, and Inovant LLC) exchanged their respective membership interests for common stock in Visa Inc., a newly formed corporation, corresponding to their applicable Visa region. Accordingly, member banks exchanged their membership interests in Visa USA for Class USA common stock in Visa Inc. As of the restructuring date, the former Visa USA member banks owned a majority of the common stock of Visa Inc. Because the restructuring is a business combination and Visa USA represents the acquirer for accounting purposes, member banks using the cost method to account for their prior membership interests should not recognize any gain as a result of the reorganization. The member banks should record their Visa Inc. shares at their prior basis in their membership interests 1
In conjunction with the restructuring, changes were also made to the bylaws of Visa USA, which has become a subsidiary of Visa Inc. Broadly speaking, member banks are only required to indemnify Visa USA for damages related to each member bank’s respective past and future participation in the Visa payment system, as well as specifically identified claims (the "covered litigation") brought against Visa USA relating to the operation of the Visa payment system through the date of restructuring. These bylaw changes represent a modification of the indemnification obligations of member banks that makes Interpretation 45’s transitional scope exception no longer applicable.
Accordingly, member banks need to apply Interpretation 45, including its fair value recognition provisions, to indemnification obligations as of October 3, 2007. Any resulting incremental liability would result in a charge to the member bank’s earnings. After October 3, 2007, member banks need to continue to evaluate their indemnification obligations under Statement 5 and recognize additional charges to earnings if the then-current Statement 5 liability exceeds the fair value liability recognized as of October 3, 2007. Certain member banks have also been separately named as defendants in certain cases in the covered litigation. Statement 5 (rather than Interpretation 45) would apply to such cases. 2 Determining the best estimate under Statement 5 3 and the initial fair value under Interpretation 45, of a member bank’s indemnification obligation liability will require significant judgment that is based on the best information available to the member bank at the time.
Visa Inc.’s IPO will offer a newly formed Class A common stock to the general public. Before the IPO, each regional class of Visa Inc. stock will be converted into newly formed classes of stock (Class USA common stock will convert into Class B common stock, and all other regional classes of common stock will convert into Class C common stock). The Class B and Class C common stock ultimately will be convertible into Class A common stock (subject to various restrictions) at an initial conversion ratio of 1:1. The conversion feature is not subject to FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities.
If the IPO is consummated, the funds received from the sale of Class A common stock will be used to (1) establish an escrow account, the funds of which can be used to settle claims or judgments related to the covered litigation; (2) assist with working capital needs of Visa Inc.; and (3) redeem some shares of Class B and Class C common stock. As of the redemption date, member banks should have recognized a gain on the redemption of their common shares for the excess of the cash redemption proceeds received over their carrying basis in the stock redeemed (which may be near zero).
Upon the funding of the escrow account, the conversion ratio will be lowered according to a formula; each Class B share will be convertible into less than one Class A share. If the funds in the escrow account are insufficient to settle all the covered litigation, Visa may sell additional Class A shares, use the proceeds to settle litigation, and further reduce the Class B conversion ratio accordingly. If funds remain in the escrow account after all covered litigation is settled, the Class B conversion ratio will be increased to reflect that surplus. We understand that the SEC staff would not object to a member bank’s reducing its previously recognized indemnification liability 4 on the escrow funding date for a proportionate amount of the funds deposited in the escrow account. The corresponding credit to the income statement can be recorded as a gain or as a reduction of litigation expense. Member banks should make disclosures in their financial statements that clearly denote which balance sheet and income statement line items reflect the accounting for their interest in the escrow account.
Readers should consider consulting their continuing accountants about this matter. Deloitte professionals can contact Susan Freshour, industry professional practice director, National Office — Accounting Consultation, or James Mountain, securitization professional practice director, for assistance.
1 See EITF Issue No. 91-5, "Nonmonetary Exchange of Cost-Method Investments."
2 Because of the potential joint-and-several liability associated with the covered litigation, a member bank that is separately named in a particular case could conceivably be liable for the entire judgment amount. Therefore, that member bank’s indemnity obligation with respect to the particular case could be viewed as simply guaranteeing its own future performance obligation. Paragraph 4 of Interpretation 45 states, in part, "[T]he scope of this Interpretation does not encompass indemnifications or guarantees of an entity’s own future performance . . . ."
AICPA Statement of Position 96-1, Environmental Remediation Liabilities, permits an entity to record only its proportionate amount of a joint-and-several liability. We understand that the SEC staff would not object to an analogy such that "net" recognition is acceptable for a member bank’s indemnification obligation liability, even though "gross" recording of the entire estimated settlement or judgment amount might be preferable.
3 See also paragraph 3 of FASB Interpretation No. 14, Reasonable Estimation of the Amount of a Loss.
4 The escrow account is, and will remain, an asset of Visa Inc.; member banks will have no direct legal interest in it. However, Visa Inc. should only use the escrow account to settle covered litigation, and member banks should not be called upon to separately fund covered litigation settlements until the escrow account is fully depleted. Accordingly, the funding of the escrow account reduces the indemnification obligations of member banks. Recording a separate asset representing an indemnification asset from Visa Inc. to the member bank for an amount not to exceed the recorded liability would also be acceptable.