In connection with the contemplated pooled auction of TARP CPP securities, Treasury has explicitly reminded potential participants that purchasers are responsible for compliance with the Bank Holding Company Act of 1956, as amended. The Form of Bid Letter includes a representation that each bidder is “aware of the potential implications of a purchase of any CPP securities under the Bank Holding Company Act, in particular, with respect to holding certain percentages of “voting securities” or more than one third of a financial institutions total equity.”
These statements have led to a number of questions regarding the impact of the Bank Holding Company Act vis-a-vis the TARP CPP securities.
We understand that the Federal Reserve Board is considering providing updated guidance specific to the CPP securities, but the contents of that guidance have not been finalized.
However, the Federal Reserve’s historic guidance sheds a significant light on how the TARP CPP securities should be treated under the Bank Holding Company Act. We further understand that this historic guidance is expected to be consistent with any guidance to be published by the Federal Reserve Board.
Voting or Nonvoting Securities
Under the terms of the Bank Holding Company Act, an entity is deemed to control a bank if it owns 25% or more of any class of the bank’s voting securities, among other circumstances. The Federal Reserve begins to examine control relationship at ownership levels as low as 5% of a class of voting securities. Similarly, under the Change in Bank Control Act, an entity or individual is conclusively presumed to control a bank if it owns more than 24.9% of any class of the bank’s voting securities (and a rebuttable presumption exists if more than 9.9% of any class of voting securities is owned), and must seek non-objection from the applicable federal regulator to acquire and retain such voting securities.
The TARP CPP securities are generally nonvoting securities, except: (i) the right to elect two directors in the event that the institution has deferred six quarterly dividend payments; and (ii) with regard to certain matters that could adversely and significantly affect the rights or preferences of the preferred stock.
In the adopting release for amendments to Regulation Y adopted in 1984, the Federal Reserve provided that with respect to nonvoting preferred stock that has the right to elect directors upon failure to pay preferred dividends, such nonvoting stock would be considered a voting security only at the time the right to vote arises. On a number of occasions, the Federal Reserve has also accepted commitments not to exercise the voting right, or to exercise the right only after obtaining the Federal Reserve’s prior approval. (In contrast, the Federal Reserve has consistently held that a company holds voting securities if it purchases voting common stock, even if the company commits not to exercise the voting rights associated with these securities or where the voting rights are extinguished so long as the company holds the securities.)
Under both the adopting release and Regulation Y itself, preferred shares are not deemed voting securities so long as any voting rights are limited solely to the type provided by statute with regard to matters that would significantly and adversely affect the rights or preferences of the security.
Accordingly, investors should feel comfortable, particularly with an institution that is current in its dividend payment, that the Federal Reserve will treat the TARP CPP securities as nonvoting securities.
One-Third Total Equity
In 2008, the Federal Reserve Board issued a policy statement allowing investors to acquire up to 33% of the total equity of a bank holding company (as opposed to the prior limit of 24.9%), provided that the investment does not include ownership of 15% or more of any class of voting securities of the target and certain other conditions are met. Accordingly, so long as the TARP CPP securities are treated as nonvoting securities, an investor in the TARP CPP securities may generally avoid bank holding company status by limiting its ownership of the CPP securities to less than 1/3 of the total equity of the bank.
The Federal Reserve has provided little guidance on how the total equity calculation should be implemented in the case of the resale of previously outstanding non-convertible preferred stock. However, based on discussions with the Federal Reserve, we believe, subject to future Federal Reserve guidance issued with respect to the CPP securities, that the calculation is based on the values assigned to the various instruments in the GAAP financial statements of the issuer. In other words, the TARP CPP securities are generally valued at approximately their liquidation value, while the common stock is valued at the total of common stock, surplus or additional paid in capital and retained earnings. The Federal Reserve has noted that the FR Y-9′s include as a line item the institution’s “total equity capital,” and that such calculation is an appropriate starting point for measuring “total equity.”
FDIC’s Cross-Guaranty Liability
Although not mentioned in the Treasury’s release, the FDIC’s ability to assert cross-guaranty liabilities in the event of receivership is also based on the concept of “control” under the Bank Holding Company Act. The FDIC is not bound to the Federal Reserve’s interpretation of the Bank Holding Company Act, and has been quite aggressive in asserting the existence of a cross-guaranty under certain circumstances.
Hopefully, the Federal Reserve will issue updated guidance confirming their interpretations of the Bank Holding Company Act (and the FDIC will publicly concur) to minimize any uncertainties, particularly before the Treasury commences pooled auctions. Until that time, investors should consult with counsel to ensure an awareness of the risks involved.