The Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act, or the Act) signed into law by President Obama on July 21, 2010 will have a significant impact on the regulation of all types of financial institutions. This Alert discusses the supervisory regulation that will result from the passage of the Act for industrial banks, credit card banks and trust banks.1 The Act maintains the exception from the Bank Holding Company Act (BHCA) for industrial banks, credit card banks and trust banks,2 but it does subject them and the companies that control them to a variety of new regulatory limitations.
Moratorium on FDIC Insurance and Change of Control
The Act establishes a three-year moratorium on the provision of insurance by the Federal Deposit Insurance Corporation (FDIC) for industrial banks, credit card banks and trust banks.3 The Act states that the FDIC "may not approve an application for deposit insurance ... that is received after November 23, 2009, for an industrial bank, a credit card bank, or a trust bank that is directly or indirectly owned or controlled by a commercial firm."4 For purposes of this portion of the Act, a commercial firm is a firm whose annual gross revenues, including gross revenues of all of its affiliates, from activities that are financial in nature (as defined in Section 4(k) of the Bank Holding Company Act of 1956 (12 U.S.C. 1843(k)) and, if applicable, from the ownership or control of one or more insured depository institutions, represent less than 15 percent of the consolidated annual gross revenues of the company.5 The Act also restricts for three years the ability of industrial banks, credit card banks and trust banks to experience a change in control, stating that "the appropriate Federal banking agency shall disapprove a change in control, as provided in Section 7(j) of the Federal Deposit Insurance Act [the "FDIA"] (12 U.S.C. 1817(j)), of an industrial bank, a credit card bank, or a trust bank if the change in control would result in direct or indirect control of the industrial bank, credit card bank, or trust bank by a commercial firm."6
Based on a Senate colloquy between Sen. Susan Collins (R-Maine) and Sen. Christopher J. Dodd (D-Connecticut), the insurance and change of control moratoriums do not apply to "nondepository trust companies."7 Dodd stated that the moratorium under Section 603(a) "does not apply to a nondepository trust company that does not have FDIC insurance and that does not offer demand deposit accounts or other deposits that may be withdrawn by check or similar means for payment to third parties."8 According to Dodd, the moratorium only applies to "an institution that is directly or indirectly owned or controlled by a commercial firm that functions solely in a trust or fiduciary capacity and is exempt from the definition of a bank in the [BHCA]."9 Both the FDIC insurance moratorium and the change of control moratorium provisions shall expire three years after the date of enactment of the Act.10
The Act provides three exceptions to the prohibition on a commercial firm gaining control of an industrial bank, credit card bank or trust bank:
- if such an institution "is in danger of default, as determined by the appropriate banking agency"
- a change in control of such an institution results "from the merger or whole acquisition of a commercial firm that directly or indirectly controls the industrial bank, credit card bank, or trust bank in a bona fide merger with or acquisition by another commercial firm, as determined by the appropriate Federal Banking Agency," or
- a change in control of such an institution "results from an acquisition of voting shares of a publicly traded company that controls an industrial bank, credit card bank, or trust bank, if, after the acquisition, the acquiring shareholder (or group of shareholders acting in concert) holds less than 25 percent of any class of the voting shares of the company."11
The parties must also obtain all regulatory approvals otherwise required for such change of control under applicable federal or state law.12
Source of Strength Obligation
The Act also subjects the commercial firm parents of insured industrial banks, credit card banks and trust banks to a new statutory source of financial strength obligation.13 This obligation requires the parents to provide financial assistance to insured depository institution subsidiaries if the subsidiaries experience financial distress.14 The Act states that "[i]f an insured depository institution is not the subsidiary of a bank holding company or savings and loan holding company, the appropriate Federal banking agency for the insured depository institution shall require any company that directly or indirectly controls the insured depository institution to serve as a source of financial strength for such institution."15
The Volcker Rule
Industrial banks, credit card banks and their parent companies are also subject to a provision of the Act, the "Volcker Rule," that significantly curbs the ability of banking institutions to engage in proprietary trading and sponsor or invest in private equity or hedge funds.16 Industrial banks, credit card banks and their parents are subject to the Volcker Rule because they are considered "banking entities" for purposes of the Volcker Rule.17 The term "banking entity" with regard to the Volcker Rule includes "any insured depository institution ... [and] any company that controls an insured depository institution."18 The Act also states that the term "banking entity" does not include an institution that functions solely in a trust or fiduciary capacity if the institution meets certain conditions.19 These conditions are identical to the conditions in the BHCA that a trust institution can satisfy in order to be excepted from the definition of a bank.20 For the sake of internal consistency this Alert will refer to this type of institution as a trust bank, as Section 603 of the Act refers to an institution that is excepted under Section 1841(c)(2)(D) (the same language that is used to except an institution from coverage under the Volcker Rule) as a trust bank.21 The Volcker Rule will be effective within two years after enactment of the Act, at which time there will be a two-year divestiture period for entities subject to the rule to bring their activities in compliance with the Act.22
Government Accountability Office Studies
The Act requires the Government Accountability Office (GAO) to conduct a study to "determine whether it is necessary, in order to strengthen the safety and soundness of institutions or the stability of the financial system, to eliminate [certain of] the exceptions under Section 2 of the [BHCA]."23 The Act lists six exceptions that the GAO should study, including the exceptions for industrial banks, credit card banks and trust banks.24 For these three types of institutions and two other institutions excepted from the definition of bank,25 the study shall:
- identify the types and number of institutions
- generally describe the size and geographic locations of such institutions
- determine the extent to which the institutions are held by holding companies that are commercial firms
- determine whether such institutions have any affiliates that are commercial firms
- identify the federal banking agency responsible for the supervision of such institutions on and after July 22, 2010 (if necessary, the Secretary of the Treasury could make this a later date)
- determine the adequacy of the federal bank regulatory framework applicable to these institutions, including any restrictions that apply to transactions between an institution, the holding company of the institution, and any other affiliate of the institution, and
- evaluate the potential consequences of subjecting such institutions to the requirements of the BHCA, including with respect to the availability and allocation of credit, the stability of the financial system and the economy, the safe and sound operation of each category of institution, and the impact on the types of activities in which such institutions, and the holding companies of such institutions, may engage.26
The Act requires the study about the sixth type of institution, federal savings associations or federal savings banks, to determine the adequacy of the federal bank regulatory framework applicable to such institutions and to evaluate the potential consequences of subjecting such institutions to the requirements of the BHCA.27 Not later than 18 months after the date of enactment of the Act, the GAO shall submit the report to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives.28
Credit Card Bank Small Business Loans
The Act permits credit card banks to make credit card loans to small businesses without endangering their exclusion from the definition of bank under the BHCA.29 Currently, a credit card bank is excluded from the definition of bank under the BHCA only if it does not engage in making commercial loans.30 The Act amends the BHCA by adding a provision that allows credit card banks to make credit card loans to businesses that meet the criteria for a small business concern to be eligible for business loans under regulations established by the Small Business Administration.31 This will allow credit card companies to make credit card loans to small businesses and still maintain their exemption from the definition of bank.
Although the Dodd-Frank Act does not bring industrial banks, credit card banks and trust banks within the definition of "bank" under the BHCA, it nonetheless subjects such institutions and their parents to a number of regulatory requirements. The Act places a three-year moratorium on the ability of such institutions to obtain insurance from the FDIC and experience a change of control except under certain circumstances. The Act also requires the commercial firm parents of such institutions to serve as a source of financial strength should the subsidiary experience financial distress. Finally, the Act subjects industrial banks, credit card banks and their parents to the Volcker Rule, which restricts their ability to engage in proprietary trading and to sponsor or invest in private equity or hedge funds. In addition to these regulatory requirements, the Act also requires the GAO to conduct studies that could ultimately bring about even more regulatory requirements and restrictions for industrial banks, credit card banks and trust banks.