This week, the Federal Reserve Board (“Board”) announced proposed rulemaking (to be published in 12 C.F.R. Parts 225 and 238) (“Proposed Rule”) that would revise the Board’s regulations governing determinations of whether a company “controls” another company for purposes of the Bank Holding Company Act (“BHCA”) or the Home Owners’ Loan Act (“HOLA”).
We expect these changes will make investments in Banking Organizations more attractive to investors (including private equity funds, hedge funds and activist investors) and better facilitate joint ventures and minority investments by Banking Organizations.
In part, the Proposed Rule would codify much of the Board’s historical practice regarding control determinations, which currently does not appear in the Board’s regulations and, therefore, is primarily known only by experienced practitioners. As indicated by the Board:
The proposed revisions are intended to provide bank holding companies, savings and loan holding companies, depository institutions, [referred to herein, collectively, as “Banking Organizations”] investors and the public with a better understanding of the facts and circumstances the Board generally considers most relevant when assessing controlling influence. The increase in transparency due to the proposed rule should provide greater clarity and ensure consistency of decision-making, thereby reducing regulatory burden for banking organizations and investors.
However, under certain circumstances, the Proposed Rule would also significantly expand the relationships and rights an investor could have while still being deemed noncontrolling.
Why Is Being Deemed Noncontrolling Important?
Under U.S. banking law, an entity that is deemed to control a Banking Organization must register as a holding company with the Board. Becoming a holding company subjects the entity to regulatory supervision, capital requirements, “source of strength” obligations, and potentially significant activity and investment restrictions. Similarly, if a Banking Organization is deemed to control another entity, that entity will generally become subject to the laws applicable to the Banking Organization.
How Would the Proposed Rule Change the Level of Investment and/or Involvement Permissible for a Noncontrolling Investor?
Under the BHCA, a company has control over another company if the first company (i) directly or indirectly, or acting through one or more other persons owns, controls, or has power to vote 25 percent or more of any class of voting securities of the other company; (ii) controls in any manner the election of a majority of the directors of the other company; or (iii) directly or indirectly exercises a controlling influence over the management or policies of the other company. HOLA contains a substantially similar test for control.
However, under the Board’s recent historical practice applying the third prong, an entity possessing as little as 5 percent of any class of a second entity’s voting stock or 25 percent of its total equity (even if it does not hold any voting rights) could also be deemed a controlling shareholder, depending on its overall relationship with the second entity. The Proposed Rule would provide increased flexibility in several areas that would allow noncontrolling investors to maintain increased total equity stakes and greater relationships without being deemed to be in control of an entity. The chart below provides a brief summary of the Board’s historical practice with regard to the major potential indicia of control and, where applicable, the potential changes contained in the Proposed Rule. It is important to note, however, that most of the lines drawn by the Proposed Rule are merely presumptions. Thus, the Board would retain the discretion to find (after notice and opportunity for hearing) that a particular situation amounts to control based on the totality of the circumstances, despite the applicability of one or more presumptions of noncontrol.
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Authored by Joseph P. Vitale.
 The Proposed Rule is available here.
 12 U.S.C. § 1841 et seq.
 12 U.S.C. § 1461 et seq.
 See 12 U.S.C. § 1841(a)(2); 12 CFR 225.2(e).
 See 12 U.S.C. § 1467a(a)(2); 12 CFR 238.2(e).
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