On September 22, 2008, the Federal Reserve Board (“FRB”) released a Policy Statement on Equity Investments in Banks and Bank Holding Companies (12 C.F.R. § 225.144). While it clarifies and catalogues interpretations of the elements of control that have been developed as a result of the FRB’s approvals of recent transactions, the Policy Statement, while helpful in many respects, is not likely to be viewed as addressing certain of the major concerns of equity investors who find banks and thrifts attractive targets for investment.
The Policy Statement is a discussion of factors that the FRB has taken into consideration in past transactions when weighing the existence of or absence of control, and takes several important steps forward in the evolution of the concept of bank control. Most importantly, it emphasizes that determinations about what constitutes a controlling influence should be decided within the relevant context of the investment, and be guided in part by the amount of influence that an investor “in fact exercises” over a banking organization. In addition, it clarifies that minority investors are able to advocate positions and views as a shareholder to bank management without triggering control issues.
The Policy Statement does not, however, add any further clarification to the question of when equity investors should be considered to be acting in concert for control purposes with other parallel investors, such as limited partner investors they have previously invested with in other transactions, or which have invested in separate funds. It also does not change regulatory presumptions concerning control once an investor passes the 10% of voting securities threshold, nor significantly change the FRB’s view of the kinds of security interests and other financial contracts that may trigger or impact control issues. Finally, it does not directly mention the extent to which the Policy Statement affects the need for or terms of a passivity agreement.
It should be noted that the Policy Statement only speaks to control issues involving statechartered, member banks and bank holding companies. The OTS handles control issues related to federal savings associations and savings and loan holding companies, the FDIC deals with control of state non-member banks and ILCs, and the OCC is responsible for control questions involving national banks of all types (e.g., credit card or trust banks).
Each of these agencies oversees its own rules, and all of the rules, to the extent reduced to writing, differ from each other in various ways. It is unclear at this time whether and to what extent these other agencies will conform their practices to the Policy Statement to the extent they are currently more restrictive than the Policy Statement.
To assist in understanding the full background and import of the Policy Statement, you should review our book, “Equity Investments and Controlling Acquisitions Involving US Financial Institutions,” and recent articles that we have published on this subject.
Specifics of the Policy Statement That Warrant Attention
The Policy Statement, when read in context with the FRB’s prior case determinations, suggests the following approach with regard to future equity investment transactions:
- Minority equity investors should now be able to have a representative on the board of directors of a bank or bank holding company (“banking organization”), as long as they control less than 25% of the voting securities. This matches the OTS’ traditional position. Typically, the FRB had restricted board representation to a single director where the investor owned 15% or less of the voting stock and another shareholder held a larger block of voting stock.
- Minority investors may be able to have a second board seat as long as (i) the investor’s aggregate director representation is proportionate (rounding up) to its total interest in the banking organization (the greater of the investor’s voting interest or total equity interest), (ii) it does not exceed 25% of the voting members on the board of directors, and (iii) another shareholder is a registered bank holding company that controls the banking organization.1
- Minority investor board representatives should not serve as the chairman of the board or of a committee of the board, nor serve on any committee if they want to avoid investor control, unless they do not occupy more than 25% of the seats on the committee and do not have the practical ability unilaterally to make or block policy or other decisions that bind the board or management.
- A minority investor that owns a combination of voting and non-voting shares that, when aggregated, represents less than one-third of the total equity of the organization and of any class of voting securities (assuming conversion of all convertible shares held by the investor), should not be found to be in control of the organization as long the investor is not allowed to hold or vote 15% or more of any class of voting securities.
- A non-controlling minority investor can communicate with management and advocate for changes without triggering control issues with regard to policies and operations, including dividend policies, strategies for raising additional debt or equity, potential new lines of business or subsidiary activities, or the merits of a merger, as long as such communications are not accompanied by explicit or implicit threats to dispose of shares or to sponsor a proxy solicitation.
- Business relationships between a minority investor and the banking organization will continue to be reviewed to determine where they create a controlling influence over management or policies. In the past, this has been an easier determination for the FRB to make where the investor’s voting securities percentage was closer to 10% than 25% of the banking organization’s voting securities.
- The FRB believes that covenants that allow the investor to have access to limited financial information, or prohibit the banking organization from issuing senior securities, borrowing on a senior basis, modifying the terms of the investor’s security or liquidating the banking organization, should not generally raise control issues in and of themselves.