The Federal
Reserve Board has announced its much-anticipated final rule that addresses the
often-confusing question of when a company controls a bank and when a bank
controls another company.

The rule
revises existing regulations that address the concept of “controlling
influence” for purposes of the Bank Holding Company Act or the Home Owner’s
Loan Act. It goes into effect on April 1.

The control rule is important: any entity in control of, or controlled by, a bank is subject to the same regulatory supervision and limitations as the bank. These limitations have created hurdles for bank investments by private equity firms and other entities, and have made partnerships between banks and fintech firms difficult to negotiate and structure.

Under the
current Bank Holding Company Act, an investor is deemed to control another
company if (1) the investor directly or indirectly owns, controls, or has power
to vote 25% or more of any class of a target’s voting securities, (2) the
investor controls in any manner the election of a majority of a target’s
directors or trustees, or (3) the Federal Reserve determines, after notice and
opportunity for a hearing, that the investor directly or indirectly exercises a
“controlling influence” over the management or policies of the target.

Under the
Bank Holding Company Act, there is a presumption that directly or indirectly
owning, controlling, or having the power to vote less than 5% of any class of a
target’s voting securities is not considered control. Where a transaction
created ownership that exceeded the 5% threshold, it was necessary to address
the question of whether there was a controlling influence. Since that term
wasn’t defined, parties relied on the Fed’s interpretations in similar
situations or sought informal guidance of Fed staff on a case-by-case basis,
which led to uncertainty.

Previously, control reviews have been situation-specific and often followed precedents that were not available to firms or to the public,” the Fed notes in its press release announcing the new rule.

This made
business planning difficult, if not impossible. Seeking feedback in the
proposal stage often resulted in excessive delays and left the parties with
uncertainty as to acceptable structure and permissible relationships going

The new rule
seeks to provide more bright-line guidance with a tiered approach to determining
 control based on the ownership of voting
shares. The indicia of control used for ownership are similar to those applied
by the Federal Reserve under the old rule when providing guidance on individual
transactions, and vary based on the following levels:

  • less
    than 5%;
  • 5%
    to 9.99%;
  • 10%
    to 14.9%; and
  • 15%
    to 24.9%.

There are more relationship restrictions as the ownership percentage increases. Those restrictions relate to director representation; officer and employee overlaps; business relationships (including size and terms of relationships); and contractual powers or limitations on operation of the organization. The Federal Reserve outlined the interplay between percentage ownership and restrictions in a chart that was included in the press release.

investors will have more power to influence a bank’s business, which may spur
the influx of capital from new sources. Banks, however, may encounter that
influence and the increased rights of investors through proxy solicitations
challenging the board. 

From the
perspective of banks investing in other companies, the industry had hoped for
more relief from the limitations on business and contractual relationships.
Large banks have shown interest in investing in fintech startups and limiting their
competitor’s ability to participate.

There are
other areas the new rule does not address. It does not impact existing
investments that have been approved because the parties have agreed with the
Fed not to take certain actions (referred to as passivity commitments). The regulator
stated it will no longer require or seek those commitments but will consider
relieving firms from any existing commitments. 

The new rule also does not impact the concept of control for purposes of other regulations, including the Change in Bank Control Act, Regulation O and Regulation W. So a person or entity will still be required to obtain approval to acquire control of a bank or a bank holding company with the presumption that the acquisition of 10% or more of voting securities being considered a change in control.

There are other aspects of the rule that will need to be considered, including calculating equity ownership, accounting rules and the impact of convertible securities. While the new rule does not provide the level of relief that some in the industry had hoped for, it does provide much-needed guidance that will allow parties to create business relationships with more certainty and efficiency.


Paul Reynolds