Here’s the background to an issue recently discussed by Canada’s IFRS Discussion Group:
- “The marketplace has evolved such that there are new types of entities emerging that have non-traditional structures in terms of raising capital (for example, crowd funding) or being structured as an investment (for example, closed-end funds).
- Crowd funding is the raising of funds through the collection of small contributions from the general public using the Internet and social media. More recently, the concept of crowd funding has been extended to raise money for commercial purposes, often to fund the development of singular projects (for example, products which have reached a certain stage of design and development, but require additional funding to be brought into commercial production).”
The group considered whether these types of entities are “publicly accountable entities” as defined in the CPA Canada handbook – that is, whether they’re required to prepare their financial statements in compliance with IFRS. A publicly accountable entity is one that:
- (i) has issued, or is in the process of issuing, debt or equity instruments that are, or will be, outstanding and traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets); or
- (ii) holds assets in a fiduciary capacity for a broad group of outsiders as one of its primary businesses.
Group members noted that no bright line test exists here, and judgment is required, particularly perhaps in non-traditional markets that “appear to be blurring the distinction between private and public” enterprises. Here are some factors relevant to exercising this judgment:
- “….comments were made on whether the assessment of an “outsider” would change when an individual starts to receive detailed project updates after investing in the entity, and whether the platform used for raising capital would continue to exist to facilitate public market trading. Another comment was made about the need to consider the motive of the investor involved in these non-traditional forms of raising capital to determine if the entity has fiduciary responsibility. For example, are these investors expecting a return such that it lends towards an equity model or do they only want to see this value proposition succeed such that it is like a donation-type model? It was also noted that the four Parts of the CPA Canada Handbook – Accounting were created to serve the needs of users that have a different purpose in the way they use financial statements. Thus, it is important to consider what the financial reporting objective is of these non-traditional structured entities and the effect that objective would have on their users.”
In my non-technical way of looking at this, the distinction between publicly accountable and other entities goes to the quality of the necessary conversation between them and their stakeholders. The IASB summed it up in its basis for conclusions to the IFRS for small and medium-sized enterprises:
- “Public securities markets, by their nature, bring together entities that seek capital and investors who are not involved in managing the entity and who are considering whether to provide capital, and at what price. Although those public investors often provide longer-term risk capital, they do not have the power to demand the financial information they might find useful for investment decision-making. They must rely on general purpose financial statements.
- An entity’s decision to enter a public capital market makes it publicly accountable—and it must provide the outside debt and equity investors with a broader range of financial information than may be needed by users of financial statements of entities that obtain capital only from private sources…. Similarly, a primary business of banks, insurance companies, securities brokers/dealers, pension funds, mutual funds and investment banks is to hold and manage financial resources entrusted to them by a broad group of clients, customers or members who are not involved in the management of the entities.
- Because such an entity acts in a public fiduciary capacity, it is publicly accountable.”
Clearly, the distinction is driven by a concept of proximity, and by the presumed ability of IFRS to somewhat compensate for a lack of proximity in a way that a simplified form of financial reporting doesn’t do. In a crowd-funding situation, the lack of proximity between investor and entity appears no less than that in any other public market. However, it also appears (although the OSC hasn’t published its final rules on the area yet) that crowd-funding is inherently premised on a distinct kind of appetite for and willingness to accept risk (and a different notion of the benefits – the OSC proposal would allow a crowdfunding issuer to offer non-securities awards and perks). The point raised above about the distinction between equity and donation-type models is true enough, but doesn’t really seem like the basis for a workable approach, if only because such motivations might vary from one investor to the next (and anyway, it doesn’t necessarily follow that a “donor” in such a situation is any less entitled to accountability from the recipient). The key question should be, perhaps, whether the distinct kind of risk assessment involved in a crowdfunding investment should include, as an inherent element of that risk, lack of access to the more comprehensive financial reporting provided by IFRS. I’m not sure such a question can be perpetually treated as one of entity-specific judgment though – it seems to call out for definitional clarity from somewhere at some point…
The opinions expressed are solely those of the author