Federal Reserve Releases Proposal in Effort to Clarify "Control" Determinations
On April 23, 2019, the Board of Governors of the Federal Reserve System (Federal Reserve) released a highly anticipated proposed rule (the Proposal) aimed at simplifying and increasing the transparency of its rules relating to control determinations under the Bank Holding Company Act of 1956, as amended (BHC Act), as well as under the Home Owners' Loan Act (HOLA).1 The stakes of a control determination are high: a company that is deemed to be in direct or indirect control of a depository institution is deemed to be a bank holding company or savings and loan holding company, as appropriate, and thereby subject to the Federal Reserve's regulations and supervisory oversight, including examinations, reporting obligations, capital and liquidity requirements, source of strength obligations, asset and activities restrictions, and restrictions on certain affiliate transactions.2
Under the BHC Act, "control" under the BHC Act is defined by a three-pronged test, as further discussed below. The first two prongs are straightforward: (i) owning, controlling or having the power to vote 25% or more of any class of voting securities; and (ii) the ability to control in any manner the election of a majority of the directors of a company. However, the third prong, regarding determinations of whether a company has the ability to exercise a "controlling influence" over the management or policies of a company, has been the subject of decades of Federal Reserve guidance, nonbinding policy statements, interpretations, and lore.3 Although the Federal Reserve has codified certain of its considerations in making "control" or "controlling influence" determinations in Regulation Y,4 the banking industry has long been frustrated that the Federal Reserve's "control" considerations can seem non-transparent, arcane, and knowable only by those with decades of experience in control issues.
While to some extent the Proposal would codify, simplify, and even liberalize the Federal Reserve's existing control standards, certain areas of the Proposal raise critical questions and at times introduce new concepts to the control standards that will need to be addressed in a final rule, particularly with respect to the treatment of investment advisers, fiduciaries holding nonbank shares, and the introduction of concepts like director independence and "routine management" under the Merchant Banking Rule.
This Advisory begins by highlighting key considerations for private equity and other non-bank investors in banking organizations as well as banking organizations themselves. The Advisory then summarizes the Proposal and discusses additional policy issues raised therein.
This is the first instance in more than 10 years that the Federal Reserve has proposed to update and codify its regulatory presumptions of control.5 We encourage industry participants to review the Proposal carefully and consider commenting on specific areas of interest during the Federal Reserve's comment period. In particular, this is one of few opportunities for bank investors interested in avoiding treatment as a bank holding company, and nonbank companies with bank shareholders hoping to avoid treatment as an "affiliate," or being deemed under the "control" of a bank, to voice their concerns to the Federal Reserve regarding such investment relationships and to ensure their interests are reflected in the final rule.
Key Considerations for Private Equity Funds and Other Non-Bank Investors
Under the Proposal, entity level (non-individual) investors that have in the past studiously avoided becoming bank holding companies would be able to:
- Invest in banks and bank holding companies at levels greater than 5% and 10% of equity or voting securities without entering passivity commitments so long as they follow the Federal Reserve's tiered structure for rebuttable presumptions of control (although the Proposal does leave open the status of investments in non-banking companies between 5% and 24.99% that are not "controlled" for BHC Act purposes);
- Have greater certainty as to the impact of various contractual protections negotiated into purchase agreements and shareholder rights agreements at the time of investment;
- Have a director representative that serves as the chairman of the board and have director representatives serve on board committees with the authority to bind the banking organization at voting equity ownership up to 14.99% (although representation on the board or a board committee would be limited to less than a quarter of the board or committee for 5% or greater investors);
- Solicit proxies in opposition to board recommendations without automatically being deemed to be exerting a "controlling influence" over the banking organization;
- Have more extensive business relationships tiered to the voting equity ownership level based on the percentage of revenues and expenses of the banking organization; and
- Have up to one senior management interlock with a banking organization in which it holds voting equity ownership between 5% and 14.99%.
On the other hand, the Proposal would:
- Create additional presumptions of control, including an expanded "management agreement" presumption of control, a presumption of control for subsidiaries of a company that are consolidated for GAAP or other accounting purposes, and in certain cases for investment advisers;
- Impose a two-year "cooling off" period during which the Federal Reserve would treat a director representative of one company as creating an interlock with another company based on the director's prior service as a director, employee, or agent of the latter company; and
- Require of any company that wants to avail itself of the "fiduciary exception" under the definition of "control" to pass through the right to exercise the voting rights related to the shares to beneficiaries or a third-party, and to not have sole discretionary authority to exercise the voting rights related to the shares; and
- Definitively clarify that certain protective contractual rights that private equity firms traditionally require for investments in non-bank businesses will not be available for banking organization investments of 10% or more.
Key Considerations for Banking Organizations
Under the Proposal, banking organizations would be able to make larger "toe hold" investments in other companies by:
- Qualifying for the new presumption of non-control by holding voting equity of another banking organization of less than 10% (however, banking organizations must still consider whether other indicia of control exist that would lead to a presumption of control below the 10% level);
- Having one senior management interlock with a company and holding or controlling voting equity of up to 14.99% without being deemed in "control" of the company (which would support the second company not being viewed as an "affiliate" of the banking organization under Section 23A of the Federal Reserve Act and Regulation W); and
- Increasing ownership up to 24.99% of voting equity of a company with board representation up to less than a quarter of the total board, but without management interlocks, provided that no other indicia of control exist. The Federal Reserve previously limited board representation to one or two directors for voting equity ownership of between 10% and 24.99%, and total equity below 33%.
- The changes to "control" would impact the applicability of the Volcker Rule to investment funds that the banking organization advises;
- The Proposal would create separate provisions for advisers to registered investment companies and advisers to private investment funds. This appears to be a step backward for the Federal Reserve in the treatment of "control" considerations for private investment funds, where the banking organization provides additional services to the fund, such as custody, administration, portfolio brokerage, and private placement services of the types provided to registered investment companies without constituting "control."
- The Proposal would affect FDIC determinations of whether two insured depository institutions are considered "commonly controlled" for purposes of imposing cross-guarantee liability under 12 U.S.C. § 1815(e), as the FDIC incorporates the BHC Act definition of "control" in such determinations; and
- The loosening of investment restrictions coupled with the raised asset thresholds for business relationships between investors and banking organizations would provide more opportunities for foreign banking organizations to make non-controlling investments in US banking organizations without necessarily having to enter into restrictive passivity commitments.
Summary of the Proposal
Under the BHC Act, there are three circumstances under which a "company" may be deemed to control a bank or other company for purposes of the Act. First, if the company "directly or indirectly or acting through one or more other persons owns, controls, or has power to vote 25 per centum or more of any class of voting securities" of the other company (including a bank). Second, if the company "controls in any manner the election of a majority of the directors or trustees" of the other company. Third, if the Federal Reserve determines, after notice and opportunity for hearing, that the company directly or indirectly "exercises a controlling influence over the management or policies" of another company. The BHC Act also contains a presumption of non-control if a company directly or indirectly "owns, controls, or has power to vote less than 5 per centum of any class of voting securities" over another company.6
Given the relative straightforwardness of the first two control prongs (the 25% threshold and the ability to elect or control the election of a majority of the board), and the presumption of non-control below 5%, a substantial portion of the Federal Reserve's guidance, nonbinding policy statements, and interpretations have centered around the third control prong regarding the exercise of a controlling influence. Where a company owns, controls or has the power to vote between 5% and 25% of the voting securities of another company, the Federal Reserve has made factual determinations based on certain "indicia" of control in performing a controlling influence analysis and generally required passivity letter commitments for investments in banking organizations at a 10% (and in some cases 5%) or 25% level. Historically, the Federal Reserve has required passivity commitments from investors in banks or bank holding companies with voting interest between 5% and 24.99% of any class of voting securities, restricting the investor's ability to have a controlling influence over the banking organization. The Federal Reserve's standard passivity commitments usually include prohibitions or limitations on an investor's representation on the board of the banking organization, direct and indirect business relationships with the banking organization, management and employee interlocks, acquisition of additional equity of the banking organization, and serving as an investment or management adviser to the banking organization.
In large part, the Proposal maintains the same set of relevant control factors the Federal Reserve has historically considered:
- the size of the first company's voting equity in the second company;
- the size of the first company's total investment, including non-voting and subordinated debt investments, in the second company;
- the first company's rights to director representation and committee representation on the second company's board of directors;
- the first company's use of proxy solicitations with respect to the second company;
- management, employee, and director interlocks between the two companies;
- covenants or other agreements allowing the first company to influence or restrict management or operational decisions of the second company; and
- the nature and scope of business relationships between the two companies.
In some cases, however, the Federal Reserve has proposed to liberalize and clarify its standards with respect to these factors through a proposed set of tiered presumptions (with 5%, 10%, and 15% of voting securities being the key thresholds). In connection with the tiered presumptions, the Federal Reserve released a chart showing, for a given level of voting securities, the threshold for indicia of control above which the Federal Reserve would expect to make a control determination.
Summary of Tiered Presumptions
|Less than 5 % voting||5-9.99% voting||10-14.99% voting||15-24.99% voting|
|Directors||Less than half
||Less than a quarter||Less than a quarter||Less than a quarter|
|Director Service as Board Chair||N/A||N/A||N/A||No director representative is chair of the board|
|Director Service on Board Committees||N/A||N/A||A quarter or less of a committee with power to bind the company||A quarter or less of a committee with power to bind the company|
|Business Relationships||N/A||Less than 10% of revenues or expenses||Less than 5% of revenues or expenses||Less than 2% of revenues or expenses|
|Business Terms||N/A||N/A||Market Terms||Market Terms|
|Officer/Management Interlocks||N/A||No more than 1 interlock, never CEO||No more than 1 interlock, never CEO||No interlocks|
|Contractual Powers||No management agreements||No rights that significantly restrict discretion||No rights that significantly restrict discretion||No rights that significantly restrict discretion|
|Proxy Contests (directors)||N/A||N/A||No solicitation proxies to replace more than permitted number of directors||No solicitation proxies to replace more than permitted number of directors|
|Total Equity||Less than one third||Less than one third||Less than one third||Less than one third|
As noted in the chart, the Proposal would codify the following indicia of control considered by the Federal Reserve with respect to ownership interests above 5% but less than 24.99%.
A. Rebuttable Presumptions of Control
- Total Equity: The Proposal would presume control if an investor controls one third or more of the total equity of a second company, even if the investor has less than 15% of a class of voting securities of the second company. The Proposal also would presume control if an investor has 15% or more of a class of voting securities of a company and 25% or more of that company's total equity.
- Director Representation: Under the BHC Act, a company is deemed to control a second company if it has the ability to control the election of a majority of the board of the second company. Historically, the Federal Reserve has limited a non-controlling investor's direct representation to one or two director representatives of the second company.7 Under the Proposal, the Federal Reserve would only presume that a company controlling more than 5% of a class of voting securities of a second company controls that company if the first company controls a quarter of more of the board of directors of the second company. However, the ability of a company's directors to have veto rights on major operational decisions, serve as chairman of the board, or on board committees with the ability to bind the company without the need for full board approval may trigger other rebuttable presumptions of control under the Proposal.
- Proxy Solicitation: Historically, the Federal Reserve has held the view that a significant investor may raise controlling influence concerns by soliciting proxies contrary to company board recommendations. The Proposal would clarify that soliciting proxies in opposition to a company's current board of directors would only give rise to a control presumption if the soliciting company holds 10% or more of any class of voting securities of the company and is attempting to appoint a number of directors that equals or exceeds a quarter of the total directors on the board of the second company. Importantly, the Proposal does not include a presumption of control upon solicitation of proxies on issues other than the election of directors, even though this historically has been a control factor considered by the Federal Reserve.
- Business Relationships: While maintaining the level of business relationships between two companies (such as supplier, customer, and lender relationships) as an indicia of control, the Proposal allows increased levels of business relationships (as measured by total annual revenues or expenses) at a given voting equity ownership level. For ownership levels above 5% of voting equity of a company, the Federal Reserve proposes to limit business relationships to less than 10% of revenues or expenses, and the threshold reduces to 5% and 2% of revenues at ownership levels of 10% and 15% voting, respectively. This is a departure from the standard passivity commitment letter that the Federal Reserve has used for many years.
- Management Interlocks: A company controlling 15% or more of any class of voting securities will be presumed to control the second company if there are any senior management interlocks.
- Contractual limits: The Proposal would presume control if a company owns 5% or more of any class of voting securities of another company and if the first company has any contractual right that significantly restricts the discretion of the second company with respect to major operational or policy decisions.
- "Limiting Contractual Rights": The Proposal would create a new defined term, "limiting contractual right," defined as "a contractual right of the first company that would allow the first company to restrict significantly, directly or indirectly, the discretion of the second company, including its senior management officials and directors, over operational and policy decisions of the second company." The Proposal would include a nonexclusive list of examples of contractual rights that are considered to be limiting contractual rights, and those that are not. This presumption, however, would not apply to investors with less than 5% of any class of voting securities. A "limiting contractual right" would include, but not be limited to, a right that allows the first company to restrict or to exert significant influence over decisions related to:
- Activities in which the second company may engage, including a prohibition on entering into new lines of business, making substantial changes to or discontinuing existing lines of business, or entering into a contractual arrangement with a third party that imposes significant financial obligations on the second company;
- How the second company directs the proceeds of the first company's investment;
- Hiring, firing, or compensating one or more senior management officials of the second company, or modifying the second company's policies or budget concerning the salary, compensation, employment, or benefits plan for its employees;
- The second company's ability to merge or consolidate, or on its ability to acquire, sell, lease, transfer, spin-off, recapitalize, liquidate, dissolve, or dispose of subsidiaries or assets;
- The second company's ability to make investments or expenditures;
- The second company achieving or maintaining a financial target or limit, including, for example, a debt-to-equity ratio, a fixed charges ratio, a net worth requirement, a liquidity target, a working capital target, or a classified assets or nonperforming loans limit;
- The second company's payment of dividends on any class of securities, redemption of senior instruments, or voluntary prepayment of indebtedness;
- The second company's ability to authorize or issue additional junior equity or debt securities, or amend the terms of any equity or debt securities issued by the second company;
- The second company's ability to engage in a public offering or to list or de-list securities on an exchange, other than a right that allows the securities of the first company to have the same status as other securities of the same class;
- The second company's ability to amend its articles of incorporation or by-laws, other than in a way that is solely defensive for the first company;
- The removal or selection of any independent accountant, auditor, investment adviser, or investment banker employed by the second company; or
- The second company's ability to significantly alter accounting methods and policies, or its regulatory, tax, or liability status (e.g., converting from a stock corporation to a limited liability company).
The following contractual rights would be examples of the types of contractual rights that would not be considered "limiting contractual rights" for control purposes:
- A right that allows the first company to restrict or to exert significant influence over decisions relating to the second company's ability to issue securities senior to securities owned by the first company;
- A requirement that the first company receive financial reports of the type ordinarily available to common stockholders;
- A requirement that the second company maintain its corporate existence;
- A requirement that the second company consult with the first company on a reasonable periodic basis;
- A requirement that the second company provide notices of the occurrence of material events affecting the second company;
- A requirement that the second company comply with applicable statutory and regulatory requirements;
- A market standard requirement that the first company receive similar contractual rights as those held by other investors in the second company;
- A requirement that the first company be able to purchase additional shares issued by the second company in order to maintain the first company's percentage ownership in the second company;
- A requirement that the second company ensure that any shareholder who intends to sell its shares of the second company provide other shareholders of the second company or the second company itself the opportunity to purchase the shares before the shares can be sold to a third party; or
- A requirement that the second company take reasonable steps to ensure the preservation of tax status or tax benefits, such as status of the second company as a Subchapter S corporation or the protection of the value of net operating loss carry-forwards.
B. Other Presumptions of Control
In addition to the tiered presumption structure and the above changes to the Federal Reserve's standards, the Proposal also would recodify several existing presumptions and standards (either as they currently exist in the control rules or in the Federal Reserve's practice) in substantially their current form with some clarifications. These include presumptions relating to management agreements, investment advice, divestiture, and the fiduciary exemption, among others, and are discussed in further detail below.
- Management Agreements: The Federal Reserve's codified rebuttable presumptions of control under Regulation Y include a provision for management agreements, which applies when a first company enters into any agreement or understanding with a second company (other than an investment advisory agreement) such as a management contract, under which the first company or any of its subsidiaries directs or exercises significant influence over the general management or overall operations of the second company.8 The Proposal would expand this presumption to also include other types of agreements or understandings that allow a company to direct or exercise significant influence over the core business or policy decisions of the second company. The Proposal would also clarify that a management agreement includes an agreement where a company is a managing member, trustee, or general partner of a second company, or exercises similar functions.
Aside from the general concerns related to the expansion of the rebuttable presumption, the Federal Reserve has solicited views on the Federal Reserve applying the concepts of "routine management and operation" under the Federal Reserve's Merchant Banking Rule for purposes of expanding this proposed "management agreement presumption." The Federal Reserve's Merchant Banking Rule also has several interpretations of this issue that have yet to be codified or even published. Moreover, the Merchant Banking Rule applies a different statutory standard in a context where BHC Act "control" of the portfolio company already exists. Relying on merchant banking concepts for the "management agreement presumption" would appear to be a step backward in the Federal Reserve's effort to increase transparency around this presumption.
- Investment Adviser: Historically, the Federal Reserve has restricted the ability of a first company to serve as an investment adviser to a second company that is an investment fund where the first company controls 5% or more of any class of voting securities of the second company or 25% or more of the total equity capital of the second company. The Proposal would codify this standard as a rebuttable presumption of control. However, the proposal would create separate provisions for advisers to registered investment companies and advisers to private investment funds. This appears to be potentially a step backward for the Federal Reserve in the treatment of "control" considerations for private investment funds, where the banking organization provides additional services to the fund, such as custody, administration, portfolio brokerage, and private placement services of the types provided to registered investment companies without constituting "control."9
- Accounting Consolidation: The Federal Reserve is proposing a presumption that a company that consolidates a second company for accounting purposes under US generally accepted account principles (GAAP) also controls the second company for BHC Act purposes. The Proposal includes a question as to whether any consolidations for accounting purposes, in the absence of consolidation under GAAP, should trigger a presumption of control.
- Divestitures: Historically, the Federal Reserve has taken the position that a company that has held a controlling position over another company for a significant period of time may be able to exert a controlling influence over that company even after a substantial divestiture. As such the Federal Reserve has applied stricter standards for divestitures of non-control by a previous controlling party, and in certain instances required divestiture of interest to below the 5% non-control presumption threshold to 0% or termination of ongoing business relationships. Under the Proposal, the Federal Reserve is adding a presumption that a company that previously controlled a second company during the preceding two years is presumed to continue to control the second company if the first company owns 15% or more of any class of voting securities of the second company.
- Management Officials and Directors (5-25% Presumption): Regulation Y currently contains a presumption of control in instances where the first company controls at least 5% of a class of voting securities of the second company and the senior management officials and directors of the first company together with their immediate family members and the first company own 25% or more of a class of voting securities of the second company. The Federal Reserve is proposing to revise the presumption not to apply if the first company controls less than 15% of any class of voting securities of the second company, and the senior management officials and directors of the first company, together with their immediate family members, control 50% or more of each class of voting securities of the second company. This exclusion is based on the Federal Reserve's Vickars-Henry precedent, under which the Federal Reserve has attributed control to individuals rather than a company when the individuals control an outright majority of a class of voting securities.10
C. Presumptions of Non-Control
- Voting Equity: A company would be presumed not to control a second company if the first company controls less than 10% of each class of voting securities of the second company, provided that no other presumptions of control are triggered. This is a clarification of prior practice of the Federal Reserve, under which companies normally entered into passivity letter commitments at a 10%-24.99% voting equity ownership level, but under some circumstances at a 5%-10% voting ownership level were required to enter into passivity commitments to avoid triggering a "control" determination under the BHC Act.
- Management Interlocks: The Federal Reserve's codified rebuttable presumptions of control includes a provision related to common management officials with respect to ownership of voting equity above 5%, with no countervailing shareholders with more than 5% voting equity ownership. Under the Proposal, the Federal Reserve would distinguish between general management and senior management officials of a company, and a company controlling between 5% and 15% of any class of voting securities of a second company would be allowed one senior management interlock with the second company without triggering the rebuttable presumption of control, except for an interlock involving a chief executive officer.
- Divestitures: As noted, the Federal Reserve has applied stricter standards for divestiture of control by a company previously determined to control another company than the standards applicable to a company seeking to make a new non-controlling investment. In recognition that significant divestiture of ownership interests as well as the passage of time generally result in a divesting company having a reduced ability to exercise a controlling influence over a second company, the Proposal would modify liberalize the Federal Reserve's existing divestiture standards. Under the Proposal, a divesting company may choose between two options for avoiding a presumption of control: (i) divesting to below 15% of any voting securities of the previously deemed controlled company or (ii) divesting to between 15% and less than 25% for a period in excess of two years
- Investment Company Exception: The Proposal includes a limited exception from all of the rebuttable presumptions of control related to one company controlling a second company if the second company is a registered investment company, provided that certain other qualifying criteria are met.
- Fiduciary Exception: The Proposal includes a fiduciary exception for interest held by a company that controls voting or nonvoting securities of a second company in a fiduciary capacity without sole discretionary authority to exercise the voting rights related to the shares would be retained in full, as currently codified in Regulation Y.
A. Effects on Other Statutory/Regulatory Frameworks:
The Federal Reserve's control standards flow through to multiple related statutory and regulatory regimes, including:
- The Volcker Rule: The term "banking entity" is defined under the Volcker Rule as any insured depository institution, any company that controls an insured depository institution, or any subsidiary or affiliate of any such entity. The Volcker Rule is codified as part of the BHC Act, and as a result, relies upon BHC Act concepts of control.
- Sections 23A/23B of the Federal Reserve Act and Regulation W: "Control" is defined substantially similar under Section 23 A of the Federal Reserve Act as defined under the BHC Act. As such, the Federal Reserve normally applies a similar analysis in making "control" determinations for purposes of imposing restrictions on relations and transactions between banks and affiliates.
- Change in Bank Control Act: Several of the provisions of the Proposal, including the definitional changes and the treatment of fiduciaries, will directly impact the portions of Regulation Y that implement the Change in Bank Control Act. As a practical matter, although expressly limited to the BHC Act and HOLA, the presumptions and standards contained in the Proposal more broadly may become part of the Federal Reserve's thinking in Control Act determinations as well.
- Cross-Guarantee Liability: The Proposal would affect FDIC determinations of whether two insured depository institutions are considered "commonly controlled" for purposes of imposing cross-guarantee liability under 12 U.S.C. § 1815(e), as the FDIC incorporates the BHC Act definition of "control" in such determinations.
- Investment Opportunities for Foreign Banking Organizations: The loosening of investment restrictions coupled with the raised asset thresholds for business relationships between investors and banking organizations provide more opportunities for foreign banking organizations to make non-controlling investments in U.S. banking organizations without necessarily having to enter into restrictive passivity commitments.
B. Open Issues in the Proposal:
Although generally the Proposal adds clarity and transparency to the Federal Reserve's control standards, it does contain certain positions that would be problematic in practice:
- "Look-through" approach to options, warrants, and convertible instruments: The Proposal would largely codify the Federal Reserve's existing standards for deeming a person to control a security through control of an option or warrant to acquire the security or through a convertible instrument. The Proposal unfortunately describes the standard as a "look-through" approach, a term already in use elsewhere in banking regulation with a very different meaning. A term such as "deemed exercised" may be more in keeping with the Federal Reserve's transparency efforts.
- Indirect control over securities controlled by subsidiaries: The Proposal would clarify that a person controls all voting securities controlled by subsidiaries of the person, and does not control any voting securities controlled by any non-subsidiary. But the Proposal would also provide that a person controls all voting securities held by its controlled companies (regardless of whether the company is wholly owned), but would not attribute control of any voting securities held by a non-controlled company to the person. While this appears to set a bright-line rule for indirect control, in practice, determinations of what voting securities are held by controlled entities will continue to be a difficult challenge for parent companies.
- Pass through voting: The Proposal currently suggests that in order to avail itself of the fiduciary exception, a company would need to hold securities of "a second company" without sole discretionary authority to exercise the voting rights. Although this requirement has historically been applied to fiduciaries holding bank and bank holding company securities (in order to avoid holding company status for the fiduciary) the Proposal's apparent application of this principle to securities of any company would be a dramatic expansion of the application of the Federal Reserve's control principles. In our view, the Federal Reserve should clarify in its final rule that fiduciaries (particularly bank fiduciaries) do not control client assets when exercising the voting rights associated with nonbank securities.11
- Cooling off period for directors: In setting bright-line standards for when a director representative of one company will be considered a director representative of a second company for interlock purposes, the Proposal provides that a director is a director representative of the second company if, among other things, the director was a director, employee or agency of the company within the preceding two years. In establishing this two-year "cooling off" period, the Federal Reserve appears to be introducing an independence standard that does not have a clear basis in the BHC Act.
C. Threats to Dispose:
Historically, the Federal Reserve has found controlling influence concerns if a company with control of 10% or more or a class of securities of a second company threatens to dispose of its investment if the second company refuses to take some desired action. The Federal Reserve is not proposing a presumption of control based on such threats to dispose.12 However, the Federal Reserve may continue to consider such threats as indicia of control as part of its overall control analysis of an investment or investment relationship.
Arnold & Porter's Bank Regulatory attorneys have deep experience in control issues affecting banks, federal savings associations, bank holding companies, savings and loan holding companies, and nonbank participants such as private equity funds and fintechs. We strongly encourage industry participants to review the Proposal carefully and to consider commenting on areas of interest. We stand ready to assist all clients affected by the Proposal. The comment period is scheduled to close 60 days after publication of the Proposal in the Federal Register.
© Arnold & Porter Kaye Scholer LLP 2019 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.
As noted in the Proposal, the Federal Reserve limited the discussion under the Proposal to the BHC Act due to the Federal Reserve's historical experience with "control" and "controlling influence" determinations under the BHC Act. The Federal Reserve applies substantially the same principles for control determinations under HOLA as it applies under the BHC Act.
The Federal Reserve provided initial guidance on the "controlling influence" prong of the BHC Act "control" test in 1971, and made some revisions to its presumptions in 1984. The Federal Reserve has not substantially revised its codified regulatory presumptions of control since 1984. The Federal Reserve has issued a number of policy statements regarding control and controlling influence, as noted in the footnote below.
See Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds; Final Rule, 79 Fed. Reg. 5536, 5676 (Jan. 31, 2014). See also letter dated June 24, 1999, regarding First Union Corp. from Jennifer J. Johnson, Secretary of the Board of Governors of the Federal Reserve System (finding that a bank holding company does not control a mutual fund for which it provides investment advisory and other services and that complies with the limitations of section 4(c)(7) of the BHC Act (12 U.S.C. 1843(c)(7)), so long as (i) the bank holding company reduces its interest in the fund to less than 25% of the fund's voting shares after a six-month period, and (ii) a majority of the fund's directors are independent of the bank holding company and the bank holding company cannot select a majority of the board) ; see generally, H.R. Rep. No. 106–434 at 153 (1999) (noting that the BHC Act permits a financial holding company to sponsor and distribute all types of mutual funds and investment companies); see also 12 U.S.C. § 1843(k)(1), & (6).
The requirement that a bank or bank holding company holding shares of a bank in a fiduciary capacity not hold such shares with sole discretionary authority to vote the shares is specifically provided for in the BHC Act. 12 U.S.C. 1841(a)(5)(A). There is no comparable provision regarding shares of nonbank companies and, indeed, in its proposing release revising Regulation Y in 1983, the Federal Reserve appropriately noted only that banks and bank holding companies "are permitted to acquire and hold nonbanking securities and activities in a fiduciary capacity so long as they are not held for the benefit of the bank holding company, its subsidiaries, or its employees." Bank Holding Companies and Change in Bank Control; Proposed Revision of Regulation Y, 48 Fed. Reg. 23520, 23529 (May 25, 1983) (emphasis added).