When the Gloves Come Off

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shareholder-12-1-17.pngShareholder lawsuits are relatively common for the banking industry, but the reverse—a bank suing one of its shareholders—is fairly unique. On October 31, 2017, Nashville, Tennessee-based CapStar Financial Holdings, with $1.3 billion in assets, sued its second-largest shareholder, Gaylon Lawrence Jr. The bank alleges that the investor and his holding company, The Lawrence Group, violated the Change in Bank Control Act, which requires written notice and approval from the Federal Reserve before owning more than 10 percent of a financial institution, as well as a related Tennessee law. CapStar also maintains that Lawrence violated the Securities Exchange Act of 1934 by failing to disclose plans to acquire additional CapStar stock.

Passing the 10 percent ownership mark without the proper approvals is more common than one might think, according to Jonathan Hightower, a partner at the law firm Bryan Cave LLP. And often the violators of these rules are directors who are simply enthusiastic about their bank’s stock and want more of it. “They’re interested in the bank. They may know of shares that are available in the community and buy them up without realizing they’ve crossed the threshold where they need regulatory approval,” says Hightower.

How the Fed interprets these regulations and the steps required of shareholders is a specialized area, adds Hightower. “Given that, the Fed’s approach, assuming there’s not an intentional violation, is more permissive than might be expected.” The Fed is unlikely to levy penalties against a shareholder acting in good faith.

Lawrence filed a motion to dismiss the lawsuit on November 13, 2017, and maintains that he has complied where necessary and that, as an individual investor, the Tennessee code requiring a bank holding company to acquire control of the bank isn’t relevant.

What’s unique in the CapStar case is that it’s the bank taking action against the investor, rather than the regulator. In a letter dated November 20, 2017, CapStar asked the Fed to reject Mr. Lawrence’s stake in the bank and require that Lawrence divest “all illegally acquired CapStar shares,” in addition to a request for a cease-and-desist order and the levying of civil money penalties against Lawrence.

Requiring Lawrence to divest will likely harm what is, in CapStar’s own words, a “thinly traded” stock, according to Stephen Scouten, a managing director at Sandler O’Neill + Partners. Without Lawrence’s acquisitions of large amounts of stock, “the stock would be appreciably lower than it is today,” says Scouten. The stock price rose 6.95 percent year-over-year as of November 27, 2017, and 17 percent in the three months in which Lawrence has been accumulating a sizeable number of shares.

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Filings by CapStar indicate that Lawrence attempted to acquire the bank in the summer of 2016. When that attempt was unsuccessful, CapStar alleges that Lawrence approached two of the bank’s largest stockholders to buy their combined 30 percent stake. That attempt also failed, and Lawrence began acquiring CapStar stock on the open market after the bank’s initial public offering last year. From August through October 2017, Lawrence rapidly increased his stake in CapStar from 6.2 to 10.2 percent, paying a total of $82.7 million for 4.6 million shares. CapStar alleges that Lawrence has “coveted control” of CapStar, and it’s easy to see how the bank arrived at that conclusion.

Lawrence is a long-term investor who appears to like what he sees in the Nashville market. He even recently purchased a home there. He’s certainly an experienced bank investor. He owns seven community banks, including two in the Nashville area: F&M Bank, with $1 billion in assets, and Tennessee Bank & Trust, formerly a division of $510 million asset Farmers Bank & Trust in Blytheville, Arkansas, which is also owned by Lawrence. “He’s got a lot of money to put to work, [and] he thinks banks are a good investment for his capital,” says Scouten. Right now, that looks to be as much as 15 percent of CapStar. Whether that turns into a full-fledged bid for the bank, as he sought in 2016, is anyone’s guess. Bank Director was unable to reach a representative of Gaylon Lawrence Jr., and CapStar CEO Claire Tucker declined to comment.

Bank boards frequently deal with active investors, and in most cases, Hightower recommends focusing on shareholder engagement and ensuring that large investors understand the broad strokes of the bank’s strategic plan. “More often than not, it’s people not understanding what they’ve invested in, and where it’s going,” he says.

Are Your Owners Violating the Change in Bank Control Act?

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Change-in-Control-10-18-16.pngMore people probably violate the Change in Bank Control Act (CBCA) than any other banking statute, as it is complicated and easy to do. But knowing the law and helping your shareholders keep up with their ownership filings is important. The law requires regulatory approvals before a person or group of persons “acting in concert” may take actions to directly or indirectly “control” a bank or savings association. Consequently, the CBCA impacts both bank and thrift holding companies and, with minor variations, all of the federal regulators have implementing regulations for the CBCA. Although the focus of this article is the Federal Reserve Board regulations regarding changes in control of bank holding companies, it is fair to say that given the intricacy of control determinations, the CBCA is likely one of the most inadvertently violated banking statutes currently on the books. The inadvertent CBCA violations often occur because of the presumption that certain groups are “acting in concert,” and the application of the CBCA requirements to these groups.

The CBCA requires that any person or groups of persons “acting in concert” must file change in bank control notices with the applicable federal regulator if the individual or group reaches an ownership level of 25 percent or more of any class of voting securities of an institution. The definition of “person” under the CBCA is very broad and includes individuals, corporations, partnerships, trusts, associations and other forms of business entities. Acting in concert is defined as knowing participation in a joint activity or parallel action towards a common goal of acquiring control of a bank or bank holding company, whether or not pursuant to an express agreement.

There is a rebuttable presumption that an acquisition of voting securities of a bank holding company is the acquisition of control under the CBCA, requiring a notice filing, if, immediately after the transaction, the acquiring person or persons acting in concert will control 10 percent or more of any class of voting securities of the institution, and if the institution has registered securities under the Securities Exchange Act of 1934 or if no other person will own, control, or hold the power to vote a greater percentage of that class of voting securities immediately after the transaction.

In determining whether persons are engaging in concerted action, there is a rebuttable presumption that the following groups are acting in concert:

  • A company and any controlling shareholder, partner, trustee, or management official of the company, if both the company and the person own voting securities of the institution;
  • An individual and the individual’s immediate family, which includes a person’s father, mother, stepfather, stepmother, brother, sister, stepbrother, stepsister, son, daughter, stepson, stepdaughter, grandparent, grandson, granddaughter, father-in-law, mother-in-law, brother-in-law, sister-in-law, son-in-law, daughter-in-law, the spouse of any of the foregoing, and the person’s spouse;
  • Companies under common control;
  • Persons that are parties to any agreement, contract, understanding, relationship, or other arrangement, whether written or otherwise, regarding the acquisition, voting, or transfer of control of voting securities of an institution, other than through certain types of a revocable proxy;
  • Persons that have made, or propose to make, a joint filing under certain sections of the Securities Exchange Act of 1934; and
  • A person and any trust for which the person serves as trustee.

With respect to inadvertent CBCA violations, the most likely “acting in concert” scenario is the consolidation of voting securities held by an individual and the individual’s “immediate family” members. To the extent a family group owns at least 10 percent of a bank holding company, a new notice filing may be required any time the family group or ownership mix changes. Violations of the CBCA are inadvertently committed literally all the time by family groups as ownership is realigned at death, through estate planning or gifting, as minors age into formal ownership stakes and by birth or marriage.

Although the burden of obtaining regulatory approval is on the person or group of persons acquiring control, not the institution, the issue has recently been arising with great frequency when bank holding companies seek to acquire other institutions. As part of the review process, the Federal Reserve has requested current shareholder lists to compare them to prior control determinations made by the Federal Reserve. If a review of the shareholder list indicates changes, even intra-family changes, in the control group, the Federal Reserve may require that a new notice be filed.

Although at least in the family context, CBCA issues are generally easily resolved by filing an after-the-fact corrective notice, reviewing your bank holding company shareholder lists for technical changes in family group ownership may prevent a holdup down the line as you seek approval for future expansion.

Preparing for the New Reality of Bank Activism

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activism-4-8-16.pngFrom 2000 to 2014, activist hedge fund assets under management are reported to have swelled from less than $5 billion to nearly $140 billion. This sharp rise in assets under management is reflected in a 57 percent increase in activist campaign activity over the last five years. And while performance can vary greatly by fund, reports are that activist hedge funds have generally outperformed other alternative investment strategies in recent years. The upshot for the banking industry is clear: as more activist investors with more dry powder are looking for investment opportunities, activists have moved beyond the “low-hanging fruit” into regulated industries, including financial services, which had previously been considered too complex.

Banks historically were viewed as unlikely targets for activist investors. The burdens are significant on an investor deemed to “control” the bank (from a bank regulatory perspective). The investor must be concerned with an intrusive Change in Bank Control Act filing and fundamental changes may be mandated by the Bank Holding Company Act if the investor’s voting, director and activist activities result in it crossing often less than well-defined “control” thresholds. However, today’s activists have learned that even small holdings of a bank’s stock—for example less than 5 percent of voting stock—often suffice to generate the desired change and provide the desired return. Many activists thus have successfully achieved their objectives without triggering bank regulatory consequences.

As activist investors sharpen their focus on the banking sector, their criteria for which entities to target remain the same. Target companies generally share several key characteristics: underperforming (on a relative basis), broadly held ownership structures and/or easily exercisable shareholder rights. An underperforming business presents the potential for economic upside, while a dispersed ownership structure and easily exercisable shareholder rights provide access to the boardroom, or at least the ability to make demands. Activist stakes are often small as a percentage of overall capital and many activist campaigns rely on winning over institutional and other investors on measures to improve the performance of the business and, ultimately, the stock price. These measures can range from those intended to result in a sale of the bank, such as changing directors, to less disruptive, but nonetheless material changes, such as enhancing clawback features in executive compensation plans.

While no two activist campaigns are alike, activist engagement generally begins with a private approach to the board of directors or management. If the activist does not succeed in private conversations, more public disclosure of the activist’s campaign can take the form of public letters to the board of directors or management, public letters to stockholders, white papers laying out the activist proposal, or filings with the Securities and Exchange Commission related to ownership of the target’s stock. Finally, and at greater cost to the activist and target alike, activists can commence a proxy contest or litigation.

So how is a bank to know whether an activist has taken a position in its stock? For smaller, privately held banks, it is more important than ever to maintain close oversight of investor rolls. Publicly traded banks need to monitor Schedule 13D and Form 13F filings. An investor that accumulates beneficial ownership of more than 5 percent of a voting class of a company’s equity securities must file a Schedule 13D within 10 days. In an activist campaign, however, 10 days can represent a very long time and an activist can build up meaningful economic exposure through derivatives without triggering a Schedule 13D filing obligation. 13F filings are made quarterly by institutional investment managers. On the antitrust front, and likely more relevant to midsize and larger banks, an investor that intends to accumulate more than $78.2 million of a company’s equity securities must generally make a Hart-Scott-Rodino (HSR) filing with the Federal Trade Commission and notify the issuer of the securities. As with Schedule 13D filings, an activist can use derivative investments to avoid triggering an HSR filing. Given the limits of these regulatory filings, many publicly traded companies turn to proxy solicitors and other advisors who offer additional data analytics services to track a company’s shareholder base.

Boards must proactively prepare for such events. Any activist response plan will address a handful of key issues, including an assessment of the bank’s vulnerabilities, an analysis of the bank’s shareholder rights profile, engagement with shareholders on strategic priorities generally, identification of the proper team to respond to an activist approach, and ongoing analysis and monitoring of the shareholder base. No plan will address all potential activist approaches, but the planning exercise alone, done well in advance without pressures of an activist campaign, can position a bank to minimize exposure to activist pressures and to respond quickly, proactively and effectively to activist approaches.