The absence of market liquidity is a common source of frustration for privately held community bank shareholders. In response, banks may be tempted to facilitate or otherwise become more directly involved in shareholder trading. Such involvement may benefit shareholder relations, but it also involves risk. Banks should be aware of those risks and structure liquidity programs to comply with applicable securities laws.
The Risk of Direct Involvement in Shareholder Trading
As a general rule, the more direct involvement a bank or bank holding company has in its own shareholder liquidity program, the higher the risk that (1) the institution could be subject the broker-dealer registration requirements under the Securities Exchange Act of 1934, (2) trades of the institution’s stock under the liquidity program could require registration under the Securities Act of 1933 and (3) the liquidity program could subject the institution to liability under the Exchange Act’s anti-fraud provisions.
Liquidity Program Alternatives
In light of these risks, banks desiring to implement shareholder liquidity programs should minimize exposure by limiting direct involvement. To avoid broker-dealer and Securities Act registration, banks should ensure that they do not (1) directly handle shareholder funds or securities during the course of a trade (except through an escrow account as discussed below); (2) make any recommendations to shareholders regarding trades; (3) participate in price negotiations among shareholders; or (4) accept any compensation for services provided in connection with the liquidity program. In addition, banks should limit their involvement in liquidity programs to ministerial activities, such as communicating the availability of the program and possibly holding related shareholder funds in escrow. Alternatives for programs that incorporate these recommendations are discussed in more detail below.
Limited Involvement Shareholder Matching Service
One low-risk alternative for a liquidity program is a shareholder matching service in which the bank has limited direct involvement. Under this alternative, an institution could maintain a list of shareholders that have expressed an interest in purchasing additional shares of its stock. When approached by shareholders desiring to sell, it could direct the selling shareholders to the persons included on the prospective purchaser list. Shareholders would then negotiate directly with each other regarding the possible trade. Upon consummation, the institution should record the trades in its stock records as a direct trade between the buying and selling shareholders. The bank should not handle the related funds or securities, except possibly to hold them in escrow on behalf of the selling shareholder pending final closing of the transaction.
Stock Repurchase Program and Re-Offering of Securities
Another alternative for providing shareholder liquidity is to implement a periodic stock repurchase program. Under this type of program, the board of directors will adopt a standing resolution authorizing the institution to repurchase shares of its common stock from shareholders over a specified period of time and for a specified price. The repurchase program should be subject to limitations, including limitations based upon available funding, insider blackout periods and compliance with applicable laws and regulations. In addition, the bank should not make any representations regarding the value of its stock to a selling shareholder. After shares of an institution’s stock have been purchased in a repurchase program, the institution could make those shares available for purchase by its shareholders or others through periodic offerings. Those offerings would have to be conducted under an available exemption from registration under the Securities Act.
Another alternative for enhancing shareholder liquidity is for the bank to have its stock quoted on an over-the-counter market, such as the OTCQX for Banks (OTCQX). The OTCQX is a quotation service that facilitates trading in securities that are not listed or traded on the NASDAQ, NYSE or any other national securities exchange. By having its stock quoted over-the-counter, a bank could provide more liquidity for its shareholders while avoiding risks arising out of its direct involvement in such trades. Those benefits, however, must be weighed against the costs. To have its stock quoted over-the-counter, the bank generally would be required to engage a corporate broker, satisfy certain eligibility requirements and provide certain financial and other disclosures on an ongoing basis.
Privately held community banks are increasingly confronted with shareholder demands for liquidity. A bank may respond to such demands, but in doing so, its board of directors should be mindful of the risks and consider all available alternatives. Shareholder liquidity programs should be carefully structured to fit within the institution’s overall capital strategy and to comply with federal and state securities laws.