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Author Topic: 2008 and 2011 S-1s and other docs  (Read 2680 times)

AmCap

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2008 and 2011 S-1s and other docs
« on: January 26, 2013, 05:54:17 PM »
I found myself w/ some free time today, so I took some time comparing the Registration Statement LC filed in 2008 with the one currently in effect, filed in 2011 and amended from time to time.  I thought I would start a topic to post anything interesting or unusual that I found. 

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I've noticed some confusion as to exactly which document does what.  The docs that are going to be important to you as investors are as follows:

The Prospectus:  The prospectus is the disclosure document that discloses all material information about the member payment dependent notes ("Notes").  Generally, a prospectus must be made available to the potential buyer of any securities by the '33 Act.

The Registration Statement (S-1):  The Registration Statement is the document that registers the Notes with the SEC.  The Registration Statement is also required by the '33 Act, and for the most part contains the same information that the Prospectus contains.  There are some differences between the two however.  There are different standards of liability and damages for material misrepresentations in a prospectus and a registration statement; generally the standards for a registration statement is stricter (that is, harder on the issuer (Lending Club)) than the standards for a prospectus.  Also, a registration statement contains information that might not be required in a prospectus.

The Indenture:  The Indenture (which is a document that I think receives far too little attention) is the legal contract between the issuer (Lending Club) and the holders (investors) of the Notes.  The Indenture is incorporated by reference in the Investor Agreement.  The difference between the Indenture and the previous two documents is key: the indenture is the document that governs the legal rights between the investors and LC.  The Registration Statement and the Prospectus are disclosure documents; although material misrepresentations do create liability, they do not themselves create any contractual obligations between investors and LC.

Probably you'll care about the Investor Agreement too, but it really just seems to incorporate the Indenture.

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Since I am a tax guy, I thought I'd first post about something near and dear to my heart: the tax consequences of the Notes!  In 2008, the secondary market for the Notes had yet to be developed, so the Registration Statement had no discussion on the tax treatment of Notes that were bought or sold on the secondary market.  The 2011 S-1 adds the following language (summary below for the TLDR people):

Quote
Sale, Retirement or Other Taxable Disposition of Notes
Upon the sale, retirement or other taxable disposition of a Note, a U.S. Holder generally will recognize gain or loss equal to the difference, if any, between the amount realized upon the sale, retirement or other taxable disposition and the U.S. Holder’s adjusted tax basis in the Note. In general, the U.S. Holder’s adjusted tax basis of the Note will equal the U.S. Holder’s cost for the Note, increased by the OID and market discount previously included in gross income by the holder, as discussed below, and reduced by any payments previously received by the holder in respect of the Note.

Except as described below with respect to any Note acquired at a market discount or, as discussed above, treated as a contingent payment debt instrument, such gain or loss generally will be capital gain or loss and will be long-term capital gain or loss if at the time of sale, retirement or other taxable disposition, such Note has been held for more than one year. Under current U.S. federal income tax law (presently effective for taxable years beginning before January 1, 2013), certain non-corporate U.S. Holders, including individuals, are eligible for preferential rates of U.S. federal income taxation in respect of long-term"

So why did LC tell us that, why didn't they tell us that in 2008, and what did they tell us. The second question is easy - they didn't tell us in 2008 because you couldn't buy a note except at origination, and you couldn't sell a note period.


This disclosure is a long way of saying this: you'll include as income (or deduct as a loss, subject to the Code) the difference between what you paid for the Note plus OID or market discount accrued and minus payments you received on the note and the amount that you sold it for.  The disclosure also says that the gain or loss is a capital gain or loss (generally taxed at a preferential rate), unless it is a contingent payment debt instrument.  I will get into the market discount rules another day, but to make a long story short, the above discussion is not quite the same if you bought a note at discount.

Finally, note that, under the Code, when a note is paid in full it is treated as a taxable exchange.  But, for a note that is paid on time, your adjusted basis should be equal to the amount realized.

On the deductability of a worthless Note:

Quote
Losses as a result of Worthlessnes
In the event that a Note becomes wholly worthless, a U.S. Holder generally should be entitled to deduct the holder’s adjusted tax basis in the Note as a capital loss in the taxable year the Note becomes wholly worthless. The portion of the U.S. Holder’s adjusted tax basis attributable to accrued but unpaid OID may be deductible as an ordinary loss, although such treatment is not entirely free from doubt. U.S. Holders should consult their own tax advisors regarding the character and timing of losses attributable to Notes that become worthless.

In the 2008 prospectus, the word "wholly" does not appear before worthless; this could indicate a change in LC's tax position.  It might be that they wanted to be sure that investors didn't think they could claim a deduction for a worthless note until it was completely worth zero (e.g., a charge-off) rather than partially worthless (e.g., when the note is 31 days late). 

Also, the old prospectus had distinguished between non-corporate U.S. holders of the notes, and corporate holders of the U.S. notes.  Generally, if you hold the notes as a part of a trade or business, you can deduct the worthless notes as ordinary losses rather than capital losses, allowing you to shelter your other ordinary income from tax.  I'm curious to know why this change was made. 

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Please let me know if information like this is helpful, or interesting.  If so, I'll continue to post on it periodically.  If not, I'll just go to happy hour earlier!

Vulture Guy


Lloigor

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Re: 2008 and 2011 S-1s and other docs
« Reply #1 on: January 27, 2013, 09:49:34 AM »
Thanks, I found it educational.  I'm rather dreading the tax season this year because this is my first investment account that's not an IRA.

veggivet

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Re: 2008 and 2011 S-1s and other docs
« Reply #2 on: January 27, 2013, 07:08:23 PM »
I'm glad I went into medicine, and not something as complicated as tax law! Thanks for your insights.