ABA Section of Business Law
Business Law Today
March/April 1999
Joint ventures
Is it a true sale?
For those lawyers practicing in the securitization area, the following is of vital importance in accounting for the distinction between a financing transaction and a true sale. It also clarifies the lawyer’s role.
In June 1996, the Financial Accounting Standards Board (FASB) promulgated a statement of financial accounting standards #125, which accounts for transferring and servicing financial assets and extinguishing liabilities. A major issue involved determining whether the assets transferred by an entity to another — where certain elements in the transaction involved the retention of some rights by the transferor — could be accounted for as a sale. Paragraph 9 of the standard states in part:
9. A transfer of financial assets (or all or a portion of a financial asset) in which the transferor surrenders control over those financial assets shall be accounted for as a sale to the extent that consideration other than beneficial interests in the transferred assets is received in exchange. The transferor has surrendered control over transferred assets if and only if all of the following conditions are met:
a. The transferred assets have been isolated from the transferor — put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership . . .
Paragraphs 116 to 123 of the background information and basis for conclusions appendix to SFAS 125 indicate that conformance with the test of paragraph 9.a. is essentially a legal issue that the FASB developed, in large part, by referring to securitization practices in rated transactions. In order to provide guidance to auditors on the subject, the Auditing Standards Board (ASB) of the American Institute of Certified Public Accountants issued an interpretation to its Statement on Auditing Standards #73, Using the Work of a Specialist , which requires that the auditor have access to a legal opinion on the subject furnished to the entity being audited. The Interpretation, AU Section 9336, Interpretation of AU Section 336, Using the Work of a Specialist, (essentially in question and answer form) states, inter alia, as follows:
.15 Question — Are legal opinions that restrict the use of the opinion to the client, or to third parties other than the auditor, acceptable audit evidence?
.16 Interpretation — No. Footnote 5 to Section 336.09 states: "In some cases, the auditor may decide it is necessary to contact the specialist to determine that the specialist is aware that his or her work will be used for evaluating the assertions in the financial statements." Given the importance of the legal opinion to the assertion in this case, and the precision that legal specialists use in drafting such opinions, an auditor should not use as evidence a legal opinion that he or she deems otherwise adequate if the letter restricts use of the findings expressed therein to the client or to third parties other than the auditor. In that event, the auditor should request that the client obtain the legal specialist’s written permission for the auditor to use the opinion for the purpose of evaluating management’s assertion that a transfer of financial assets meets the isolation criterion of SFAS 125. In view of the interpretation’s requirement of access by the auditor to the opinion on the subject given to the management of the entity, the Committee on Legal Opinions of the Section was concerned that making the legal opinion accessible to the auditor might create a privity relationship between the lawyer and the auditor.
Accordingly, the Committee on Legal Opinions and the Committee on Law and Accounting in consultation with the ASB drafted the following form letter. They suggest that it accompany all opinions issued by lawyers to clients and made available to auditors on the subject of "sale" vs. "secured transaction" and the related issue of isolation from bankruptcy:
Law firm letterhead
Dated: ________
[Addressee — law firm client]
Re: [Reference transaction]
Ladies and Gentlemen:
Notwithstanding any language to the contrary in our opinions of even date with respect to certain bankruptcy issues relating to the above-referenced transaction, you are authorized to make available to your auditors such opinions solely as evidential matter in support of their evaluation of management’s assertion that the transfer of the receivables meets the isolation criterion of SFAS 125, provided a copy of this letter is furnished to them in connection therewith. In authorizing you to make copies of such opinions available to your auditors for such purpose, we are not undertaking or assuming any duty or obligation to your auditors or establishing any lawyer-client relationship with them. Further, we do not undertake or assume any responsibility with respect to financial statements of you or your affiliates.
The ASB has amended the interpretation, effective Oct. 1, 1998, to reflect acceptance of the above form letter.
