The Federal Reserve Board (Fed) released on April 23 a notice of proposed rulemaking to clarify the standards and criteria under which one company “controls” another company under the Bank Holding Company Act (BHCA) and the Savings and Loan Holding Company Act (SLHCA). This long-awaited proposal, which Fed officials have stated for some time was in the works, is notable for several reasons—primarily because if adopted, it will bring much-needed clarity to an area of banking law that historically has been notoriously opaque.
The “control” determination is a core element of the BHCA and SLHCA regulatory and supervisory framework because it is the legal basis on which the Fed asserts BHCA/SLHCA jurisdiction over the activities of a company that controls a banking organization, or a banking organization that controls a nonbanking company. The base statutory and regulatory standards for determinations of control are concisely stated, consisting of a company’s (1) ownership or control of the voting shares of another company, (2) authority to elect or appoint a majority of directors or similar officials of another company, or (3) exercise of a “controlling influence” over the management or policies of another company. As banking organizations and practitioners are well aware, however, the basic statutory and regulatory standards are only the tip of a very large regulatory iceberg. In fact, the Fed’s complex and variegated “control” determination guidance is found not only in many orders and interpretations—not all of which are readily available—issued over a lengthy period, but also is effectively buried in internal staff memoranda and even unwritten policies that the Fed and its staff have developed over the years.
Now, the Fed has proposed to unlock what Fed Governor Randal Quarles colorfully describes as its “Gnostic secrets” to provide a series of clear criteria for the assessment of control or noncontrol under the BHCA and the SLHCA, with minor adjustments to take into account differences in BHCA and SLHCA control requirements and factors. The essence of the Fed’s proposal is the creation of specific control presumptions and noncontrol presumptions that are applied to different tiers of a company’s ownership of voting shares in another company. These ownership tiers—less than 5% voting shares, less than 10%, less than 15%, and less than 25% —would be assessed for the presence of “control” through the application of other factors that the Fed historically has applied in making its BHCA and SLHCA control determinations. These factors include the acquiring company’s “total equity” investment in another company; its authority to appoint management officials of another company; director, officer, and employee interlocks; proxy voting authority; management agreements between the two companies; and other business relationships between the two companies.
In addition, the Fed proposes to create a series of rebuttable presumptions of control, as well as rebuttable presumptions of noncontrol, which again are based on the Fed's historical interpretations of control factors under the BHCA and the SLHCA, and provide specific guidance on the meaning of important terms such as “total equity.” Further, the Fed proposes more specific criteria to determine whether, in the context of a company’s divestiture of another company's securities, the first company continues to exercise control over the second company.
The key advantage in what the Fed proposes is simply that the Fed would articulate specific criteria and standards for making BHCA and SLHCA control determinations, thus presumably taking most of the guesswork out of these determinations. In the Fed’s view, more transparent control criteria would facilitate capital raising for banking organizations, in particular, community banks. While that may be true, a statement of clearer control standards would be broadly beneficial to banking organizations, their investors, and their advisers in facilitating compliance with a complicated regulatory framework that is key to their organizational structures and activities.
While the Fed has proposed a more transparent regulatory control framework, at this time it has not proposed to change in material respects the basic benchmarks (e.g., voting equity percentage thresholds) that have formed the bases of its historical control determinations. Further, whether the clarity that the Fed proposes to bring to the table on this matter is desirable in all respects is a topic for another discussion, and one that we will address in greater detail as we report further on this important—and welcome—development.