Banking reform updater: Federal Reserve Board issues proposal to clarify and simplify “control”

Introduction

In this latest banking reform updater, we discuss a recent proposal from the United States Board of Governors of the Federal Reserve System (Federal Reserve Board) to clarify the standards for “control” under the U.S. Bank Holding Company Act of 1956 (BHCA).

On May 14, 2019, the Federal Reserve Board published a proposed rule that it feels would simplify and make more transparent the standards under which the Federal Reserve Board determines that a company controls a banking organization or another company. The concept of control is important for determining if an investment is permissible under the federal banking laws. The press release announcing the proposed rule notes that “the proposal would reduce complexity and burden for banking organizations and their investors, and provide clarity so that a wide range of stakeholders can better understand the control rules.”

Current law

Under the BHCA, a company is considered to have control of a bank or other company if

• the company directly or indirectly or acting through one or more other persons owns, controls, or has power to vote 25 per cent or more of any class of voting securities of the bank or company.
• the company controls in any manner the election of a majority of the directors or trustees of the bank or company; orc) the Federal Reserve Board determines, after notice and opportunity for hearing, that the company directly or indirectly exercises a controlling influence over the management or policies of the bank or company.
• If a company is found to control a bank, then the company would be considered to be a bank holding company (BHC), and as such, it must receive prior approval from the Federal Reserve Board and register as a bank holding company once approved.

A bank holding company is restricted in the types of activities in which it can engage.  Activities of bank holding companies are restricted to activities permissible for a bank holding company (generally, banking or activities closely related to banking) or a financial holding company (FHC) (generally, activities financial in nature or incidental to a financial activity), if it qualifies for the latter designation because of capital and management ratings.

The test also is applicable to any companies the BHC might want to acquire because it can only gain control of another company if it can engage in the activities in which a BHC or FHC can engage.

At the other end of the spectrum, there is a presumption that any company that directly or indirectly owns, controls, or has power to vote less than 5 per cent of any class of voting securities of a given bank or company does not have control over that bank or company.

While the first two prongs of control – 25 per cent or more of any class of voting securities and controlling the election of a majority of the directors – are objective determinations of control, ownership of between 5 per cent and 25 per cent of any class of voting securities requires that the Federal Reserve Board review all the facts and circumstances on a case-by-case basis in order to make a control determination.

Proposed regulation

Over the years, Federal Reserve Board staff have developed some general standards that were used to evaluate such “in-between” transactions, but these standards were not set forth in a formally promulgated regulation. The proposed regulation would do just that, while at the same time, the Federal Reserve Board reserves the right in a particular case to make a control/non-control determination that might deviate from any new regulatory standards.

The proposal adds new sections to the Bank Holding Company Act regulations detailing the standards. Among other proposed revisions, rebuttable presumptions of control would arise at the following ownership or control levels between 5 per cent and 25 per cent of the outstanding securities of any class of voting securities: per cent

Ownership or control by the first company of 5 per cent or more of the outstanding securities of any class of voting securities of the second company and any of the following factors

• Director representatives of the first company or any of its subsidiaries comprise 25 per cent or more of the directors of the second company or any of its subsidiaries, or (ii) the director representatives of the first company or any of its subsidiaries are able to make or block the making of major operational or policy decisions of the second company or any of its subsidiaries (a “director representative” is any individual that serves on the board of directors of the second company and was nominated or proposed by the first company, is a current employee, director or agent of the first company or served as such during the immediately preceding two years, or is a member of the immediate family of any employee, director or agent of the first company)
• Two or more employees or directors of the first company or any of its subsidiaries serve as senior management officials of the second company or any of its subsidiaries
• An employee or director of the first company or any of its subsidiaries serves as the chief executive officer or in a similar capacity of the second company or any of its subsidiaries
• The first company or any of its subsidiaries enters into transactions or has business relationships with the second company or any of its subsidiaries that generate in the aggregate 10 per cent or more of the total annual consolidated revenues or expenses of the first company or the second company
• The first company or any of its subsidiaries has any limiting contractual right with respect to the second company or any of its subsidiaries, unless (i) such limiting contractual right is part of an agreement to merge with or make a controlling investment in the second company that is reasonably expected to close within one year, and (ii) such limiting contractual right is designed to ensure that the second company continues to operate in the ordinary course until the merger or investment is consummated, or such limiting contractual right requires the second company to take an action necessary for the merger or investment to be consummated; or
• Senior management officials and directors of the first company and its subsidiaries, together with their immediate family members and the first company and its subsidiaries, own, control, or have power to vote 25 per cent or more of any class of voting securities of the second company, unless (i) the first company and its subsidiaries control less than 15 per cent of each class of voting securities of the second company and (ii) the senior management officials and directors of the first company and its subsidiaries, together with their immediate family members, own, control, or have power to vote 50 per cent or more of each class of voting securities of the second company.

Ownership or control by the first company of 10 per cent or more of the outstanding securities of any class of voting securities of the second company and any of the following factors

• The first company or any of its subsidiaries propose a number of director representatives to the board of directors of the second company or any of its subsidiaries, in opposition to the nominees proposed by the management or board of director of the second company or any of its subsidiaries that, together with any director representatives of the first company or any of its subsidiaries already serving on the board of directors of the second company or any of its subsidiaries, would exceed the number of director representatives that the first company or any of its subsidiaries could have without the first company being presumed to control 25 per cent or more of the board of directors of the second company
• Director representatives of the first company and its subsidiaries comprise more than 25 per cent of any board committee of the second company or any of its subsidiaries that  can take actions that bind the second company or any of its subsidiaries
• The first company or any of its subsidiaries enters into transactions or has business relationships with the second company or any of its subsidiaries that (i) are not on market terms; or (ii) generate in the aggregate 5 per cent or more of the total consolidated annual revenues or expenses of the first company or the second company.

Finally, ownership or control by the first company of 15 per cent or more of the outstanding securities of any class of voting securities of the second company and any of the following factors

• The first company controls 25 per cent or more of the total equity of the second company
• A director representative of the first company or of any of its subsidiaries serves as the chair of the board of directors of the second company or any of its subsidiaries
• One or more employees or directors of the first company or any of its subsidiaries serves as a senior management official of the second company or any of its subsidiaries
• The first company or any of its subsidiaries enters into transactions or has business relationships with the second company or any of its subsidiaries that generate in the aggregate 2 per cent or more of the total annual consolidated revenues or expenses of the first company or the second company.

Also proposed is a rebuttable presumption of non-control by the first company of the second company if the first company owns less than 10 per cent of the outstanding securities of any class of voting securities of the second company and otherwise does not meet any of the rebuttable presumptions of control discussed above.

The announcement of the proposal contained a chart summarizing the proposal. There also is a memorandum from Federal Reserve Board staff to the Board of Governors explaining the proposal.

Similar changes would be made to the regulations for savings and loan holding companies, which control thrift institutions such as savings banks and savings and loan associations.

Deadline for comments

Comments to the Federal Reserve Board on the proposed rule are due by July 15, 2019.  Over 50 questions are posed in the supplementary material accompanying the text of the proposed regulations for the public to focus on in formulating their comments, although comments are welcome on any part of the proposal.