On April 23, the Federal Reserve released a proposed rule focused on control and divestitures.
The proposed rule revises its regulations concerning when one company has the ability to exercise a controlling influence over another company for purposes of the Bank Holding Company Act (BHCA) and the Home Owners’ Loan Act (HOLA), as implemented by Regulations Y and LL, respectively. While there are countless ramifications for a revised framework on control, based on the specific facts and circumstances of any situation, there are four significant and broad implications for banks and investors.
1. More transparent guideposts on indicia of control. The proposed rule incorporates the most common historical considerations of the Fed when determining whether one company has the ability to exert a controlling influence over a second company for purposes of the BHCA and HOLA. These considerations, or indicia of control, and the rebuttable presumptions outlined in the proposed rule are based on the types and levels of relationships between the companies.
The most important of these considerations has been, and will continue to be, the amount of voting securities owned or controlled by one company in a second company. Indeed, the percentage of voting securities owned or controlled forms the basis of a proposed tiered system to examine the indicia of control. The percentage of voting securities owned or controlled determines the extent to which other relationships between the companies may exist without one company having a controlling influence – at least in the eyes of the Fed.
Significant indicia of control include: the first company’s total equity owned or controlled in the second company; rights to board of directors or committee representation; use of proxy solicitations; common directors, management or employees between the companies; contractual rights that restrict or influence the management or operations of the second company; and the scope of business relationships between the companies.
2. Increased flexibility for banks and investors. The potential transparency on control determinations and indicia of control means more flexibility for banks and potential investors. The outline of the proposed rule provides banks and investors, such as minority equity investors, more flexibility in raising money and structuring investments, especially where there are limited indicia of control otherwise present.
While the proposed rule would not affect potential filings required under the Change in Bank Control Act, the potential clarity and flexibility under the BHCA may offer companies the ability to raise money and close deals quicker and with more limited discussions about control with the Fed.
3. New presumption on noncontrol. The proposed rule contains a new threshold for the Fed’s presumption of noncontrol. Under the BHCA, a company that owns less than 5% of the voting securities of a second company is presumed not to control the second company. The proposed rule would increase the threshold for this presumption of noncontrol to 10%, assuming no other indicia of control are present.
4. New presumption of control related to divestitures. The proposed rule includes a new presumption on divesting control that diverts from the Fed’s historical practice. As banks and investors know, it can be extremely challenging to successfully divest control once the Fed determines you have it.
The analysis traditionally focused on reducing the ownership or control of voting securities to below 10% if not significantly less than that. The proposed rule has added flexibility in proposing that a company may successfully divest control of a second company by reducing its ownership or control of voting securities in that second company to less than 15% – or alternatively, reducing ownership or control of voting securities to between 15 and 25% and waiting for two years without again exceeding the 25% threshold.
These changes are currently in the proposal stage, and the release and effective date of a final rule is uncertain. But it is clear that the Fed is looking to provide significant transparency into its historical practices and consistency, where possible, for future control determinations. The industry would welcome any additional transparency or consistency on control determinations from the Fed.