A question for the auditors amongst us with some direct recent relevance. A friend asked me to get some comments on it. Corrections to the “facts” below are welcome as it may not be correct in all particulars.
Basis Capital’s (“Basis”) Basis Yield Alpha Fund (“Basis fund”) has substantial holdings of Collaterised Debt Obligations and other instruments that are the subject of considerable uncertainty as to value.
Basis fund is a “hedge fund” which took highly leveraged, and risky, positions in these and other instruments. Investors were allowed buy out of the fund with a month’s notice – giving notice at the end of a month resulted in the refunding of the investment plus profits (or minus losses) at the end of the next month. There was no active secondary market for investments.
On 17 July 2007, but backdated to take effect as at 30 June 2007, Basis suspended redemption from the Basis fund, citing that the fund was not “…currently able to repatriate funds required for the purpose of making payments“. This means that the last possible date for redemptions was 31 May 3007, due to the operation of the one month call discussed above.
The next day (18 July) Basis announced that Grant Thornton had been retained to assist in an orderly realisation process, and said that “that the enforcement action by the financiers of the Master Fund at distressed sale prices would result in a reduction in the net asset value of the shares in the Basis Yield Alpha Fund to below one-half of the level as at 31 May 2007“.
In a letter sent to investors on 15 August 2007, Basis announced that it was unable to “accurately estimate” the net asset value of units in the Basis fund because of “further deterioration of market conditions” and put the estimated losses at “in excess of 80%“.
On 30 August Basis announced that Grant Thornton has been retained to act as provisional liquidators of the Basis fund. Press speculation is that losses in the fund have increased further and that a total loss of investor funds can be expected.
From various sources of market data there appear to have been two distinct phases of the conditions that firstly closed the Basis fund and then drove it into provisional liquidation. The first phase was during the period March to May 2007, where the defaults on the CDOs started appearing and gained both press and regulatory comment. By 20 June the Bear Stearns funds, with apparently similar risk profile to Basis, had been foreclosed on by Merrill’s.
The first defaults recorded by Basis fund were on Monday 16 July, effectively opening the second phase, as the market turmoil and the position of Basis fund made an orderly realisation of the residual assets difficult, if not impossible.
AASB 139 (IAS 39)
AASB 139 gives guidance as to the valuation of the instruments. It is questionable whether, under 139 AG71, there is an active market in the instruments, but Basis did publish redemption values on a regular basis (monthly) and this has become market convention for the valuation of these instruments. In this case, the price used is the last one published – 31 May 2007. There was no redemption price published for 30 June 2007.
AASB 110 (IAS 10)
AASB 110 is the relevant standard for post determining whether the
disclosure should be by way of subsequent events note or through
adjustment of the value in the accounts, with recent guidance being:
AASB 110 requires consideration to be given to two types of events both favourable and unfavourable that occur between the reporting date and the date when the financial report is authorised for issue that:
(i) provide evidence of conditions that existed at the reporting date (adjusting events after reporting date); or
(ii) are indicative of conditions that arose after the reporting date (non adjusting events after the reporting date).
In the managed funds industry, we could well be required to consider both types of events, depending on the circumstances specific to each fund e.g. a fund that has had long term exposure to US sub prime mortgage securities vs. a fund that consists of listed securities in equities traded on recognised exchanges may well have one or both events to deal with.
Given the above facts, should investments in Basis fund be disclosed as a type (ii) event, or incorporated into the accounts as a type (i) event?