Federal Reserve Board Takes Control

Financial Services Law

Following years of uncodified interpretive guidance, the Board of Governors of the Federal Reserve System (the Board) adopted a final rule addressing the issue of how to determine whether one company has “control” over another company for purposes of the Bank Holding Company (BHC) Act and the Home Owners’ Loan Act (HOLA).

Largely tracking the proposed rule published last year, the final rule will take effect on April 1, 2020 and will provide greater certainty and clarity around investors making noncontrolling investments in banks and bank holding companies, and banking organizations making investments in non-bank companies.

What happened

Under the BHC Act, a company has control over a banking organization (and generally becomes subject to the Board’s rules and regulations) if the first company (i) directly or indirectly or acting through one or more other persons owns, controls or has power to vote 25% 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 or trustees of the other company; or (iii) directly or indirectly exercises a controlling influence over the management or policies of the other company. A similar definition can be found in the HOLA.

While the first two tests have generally been more clear-cut, the third requires a facts and circumstances determination by the Board, leaving it difficult for investors to predict whether they will be considered controlling by the Board and, correspondingly, subject to Board regulation and supervision.

Over the years, the Board developed factors and thresholds that it believed were generally indicative of the ability or inability of a company to exercise a controlling influence over another company, and used this experience to create the final rule.

“The Board believes that the final rule … will increase the transparency and consistency of the Board’s control framework,” according to the Federal Register notice. “As a result, the final rule should help to facilitate permissible investments in banking organizations and by banking organizations.”

The final rule establishes a series of tiered presumptions of control, based on the level of voting share ownership assessed in combination with relationship-based factors (such as director representation on the second company’s board and business relationships with the second company), with thresholds fixed at 5%, 10% and 15% of voting securities. The greater the level of equity ownership, the fewer the relationships required to create a rebuttable presumption of control.

The final rule also outlines the limitations on the number of business relationships a bank may have with another company (i.e., a fintech company) before being considered to be in control of it. For example, if a bank owns between 15% and 24.99% of a fintech or other company’s voting shares, the bank itself cannot have business relationships with that company that equal or exceed 2% of the company’s revenues or expenses. If the relationships exceed that percentage threshold, the other company will be subject to Board regulation. Practically, these thresholds will limit the ability of a bank to be both a significant investor in a fintech company and a significant customer.

The Board has provided a helpful chart summarizing the various equity ownership thresholds and other factors that will trigger a control presumption, which can be viewed here.

Other rebuttable controlling-influence presumptions were also included in the final rule. For example, certain types of management agreements create a presumption of control, as do companies consolidated under U.S. GAAP. The final rule does not include the Board’s long-standing “5-25 presumption,” where a company that controls 5% or more of any class of voting securities of another company would be presumed to control that company if the senior management officials and directors of the first company, and their immediate family members, together with the first company, own 25% or more of a class of voting securities of the second company. Instead, the presumption has been integrated into the standard of control over securities, with an exclusion for any company that controls less than 15% of each class of voting securities of the second company if its senior management officials, directors and controlling shareholders, together with their immediate family members, control 50% or more of each voting class.

The final rule substantially revises the Board’s historical “tear-down” standards regarding divestiture of control. Under the final rule, a divesting company, assuming no other presumptions of control apply, generally would no longer be presumed to control a company that it previously controlled if (i) it promptly divests to less than 15% of each class of voting securities or less than 25% of each voting class for two years, or (ii) an unaffiliated person controls 50% or more of the outstanding securities of each voting class of the company being divested.

To read the final rule, here.

Why it matters

Based on a series of tiered presumptions, the final rule contains intricacies in and changes to how the Board determines control, provides an outline for passive and activist investors looking to secure ownership in bank holding companies, and allows bank holding companies themselves to determine when they may be in control over another company. Similarly, the final rule provides guidance for companies that previously had control of another company and want to divest from that “control” determination. To learn more about the final rule, be sure to join us for a webinar in June 2020—details will follow.



pursuant to New York DR 2-101(f)

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