Control and Divestiture Proceedings, 12398-12430 [2020-03398]
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Federal Register / Vol. 85, No. 41 / Monday, March 2, 2020 / Rules and Regulations
FEDERAL RESERVE SYSTEM
12 CFR Parts 225 and 238
[Regulations Y and LL; Docket No. R–1662]
RIN 7100–AF 49
Control and Divestiture Proceedings
Board of Governors of the
Federal Reserve System (Board).
ACTION: Final rule.
AGENCY:
The Board is adopting a final
rule to revise the Board’s regulations
related to determinations of whether a
company has the ability to exercise a
controlling influence over another
company for purposes of the Bank
Holding Company Act or the Home
Owners’ Loan Act. The final rule
expands the number of presumptions
for use in such determinations. By
codifying the presumptions in the
Board’s Regulation Y and Regulation LL,
the Board’s rules will provide
substantial additional transparency on
the types of relationships that the Board
generally views as supporting a
determination that one company
controls another company. The final
rule is largely consistent with the
proposal and includes certain targeted
adjustments to the Board’s historical
practice, as described in detail in the
SUPPLEMENTARY INFORMATION.
DATES: The final rule is effective on
April 1, 2020.
FOR FURTHER INFORMATION CONTACT:
Laurie Schaffer, Deputy General
Counsel, (202) 452–2272, Alison Thro,
Deputy Associate General Counsel,
(202) 452–3236, Mark Buresh, Senior
Counsel, (202) 452–5270, Greg
Frischmann, Senior Counsel, (202) 452–
2803, or Brian Phillips, Senior Attorney,
(202) 452–3321, Legal Division; Melissa
Clark, Lead Financial Institution Policy
Analyst, (202) 452–2277, or Sheryl
Hudson, Lead Financial Institution
Policy Analyst, (202) 912–7839,
Division of Supervision and Regulation,
Board of Governors of the Federal
Reserve System, 20th Street and
Constitution Avenue NW, Washington,
DC 20551. For users of
Telecommunication Device for Deaf
(TDD) only, call (202) 263–4869.
SUPPLEMENTARY INFORMATION:
SUMMARY:
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Table of Contents
I. Background and Summary of the Proposal
A. Description of ‘‘Control’’ Under the
Bank Holding Company Act
B. Summary of the Board’s Historical
Interpretation of ‘‘Control’’ Under the
Bank Holding Company Act
C. Summary of the Proposal
D. Summary of Comments Received on the
Proposal
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II. Final Rule—Presumptions of Control and
Noncontrol
A. Control Hearings and the Role of
Presumptions of Control and Noncontrol
B. Description of the Tiered Presumptions
C. Description of Additional Presumptions
and Exclusions
III. Final Rule—Control-Related Definitions
A. First Company and Second Company
B. Voting Securities and Nonvoting
Securities
C. Control of Securities
D. Calculation of Total Equity Percentage
E. Limiting Contractual Rights
F. Director Representatives
G. Investment Advisers
IV. Application to Savings and Loan Holding
Companies
A. Control Under HOLA Compared to the
BHC Act
B. Revisions to Regulation LL
V. Additional Implementation Matters
VI. Administrative Law Matters
A. Paperwork Reduction Act
B. Regulatory Flexibility Act
C. Plain Language
I. Background and Summary of the
Proposal
In May 2019, the Board issued a
proposal seeking comment on revisions
to its rules regarding the definition of
control in the Bank Holding Company
Act (‘‘BHC Act’’),1 and the Home
Owners’ Loan Act (‘‘HOLA’’).2 The
proposal was published in the Federal
Register on May 14, 2019, and the
period for public comment ended on
July 15, 2019.3 The proposal was
intended to provide bank holding
companies, savings and loan holding
companies, depository institutions,
investors, and the public with a better
understanding of the facts and
circumstances that the Board considers
most relevant when assessing control
and thereby increase transparency
around the Board’s views on control
under the BHC Act and HOLA.
Under the BHC Act, control is defined
by a three-pronged test: A company has
control over another company if the first
company (i) directly or indirectly or
acting through one or more other
persons owns, controls, or has power to
vote 25 percent or more of any class of
voting securities of the other company;
(ii) controls in any manner the election
of a majority of the directors or trustees
of the other company; or (iii) directly or
indirectly exercises a controlling
influence over the management or
policies of the other company.4 HOLA
includes a substantially similar
definition of control.5 While the first
two prongs of the definition of control
U.S.C. 1841 et seq.
U.S.C. 1461 et seq.
3 84 FR 21634 (May 14, 2019).
4 12 U.S.C. 1841(a)(2); 12 CFR 225.2(e).
5 See 12 U.S.C. 1467a(a)(2); 12 CFR 238.2(e).
are easily understood bright-line
standards, the third prong of the
definition of control requires a facts and
circumstances determination by the
Board. As a result, it is often difficult for
an investor that does not meet either of
the first two prongs of the definition of
control to determine whether it will be
considered controlling or
noncontrolling by the Board under the
third prong.
In practice, large minority investors
often seek to protect or enhance their
investments through multiple forms of
engagement with the target company
that provide the investor with an
opportunity to monitor and influence
the target company. This situation in
particular frequently has raised
questions regarding whether the
investor will be able to exercise a
controlling influence over the
management or policies of the target
company when the investment and all
other aspects of the relationship are
considered in the aggregate. These
issues arise for both companies seeking
to invest in banking organizations and
banking organizations seeking to make
investments in other companies.
Under the statutory framework, the
determination of whether a company
has the ability to exercise a controlling
influence over another company is a
factual determination. The Board’s
experience has shown that the variety of
equity investments, negotiated
investment terms, and business and
other arrangements between companies
makes it difficult to prescribe a set of
rigid rules that determine whether one
company exercises a controlling
influence over another company in all
situations. As a result, Board
determinations regarding the presence
or absence of a controlling influence
have taken into account the specific
facts and circumstances of each case.6
Nonetheless, the Board has developed
over time a number of factors and
thresholds that the Board believes
generally are indicative of the ability or
inability of a company to exercise a
controlling influence over another
company.
The Board believes that the final rule,
which is largely consistent with the
proposal, will increase the transparency
and consistency of the Board’s control
framework. As a result, the final rule
should help to facilitate permissible
investments in banking organizations
and by banking organizations.
1 12
2 12
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6 See 12 CFR 225.143; Policy Statement on equity
investments in banks and bank holding companies
(September 22, 2008), www.federalreserve.gov/
newsevents/press/bcreg/20080922c.htm.
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The final rule includes certain
targeted adjustments relative to
historical practice that the Board
believes are appropriate based on its
experience over the past few decades.
The specific provisions of the final rule,
including the targeted adjustments, are
described in detail in this preamble.
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A. Description of ‘‘Control’’ Under the
Bank Holding Company Act
Control is a foundational concept
under the BHC Act and related statutes.7
Most notably, control is used to
determine the scope of application of
the BHC Act because a company is
defined to be a bank holding company
if the company directly or indirectly
controls a bank or bank holding
company.8 Accordingly, a company that
controls a bank or bank holding
company is subject to the Board’s
regulations and supervisory oversight,
which includes examinations,9 regular
financial reporting,10 capital and
liquidity requirements,11 source of
strength obligations,12 activities
restrictions,13 and restrictions on
affiliate transactions.14
In assessing control, the Board
historically has focused on two key
purposes of the BHC Act to guide its
understanding of the meaning of control
and controlling influence. First, the
BHC Act was intended to ensure that
companies that acquire control of banks
have the financial strength and
managerial ability to exercise control in
a safe and sound manner. Second, the
BHC Act was intended to separate
banking from commerce by preventing
companies with commercial interests
from exercising control over banking
organizations and by restricting the
nonbanking activities of banking
organizations.15
Congress enacted the BHC Act in
1956. In the original BHC Act, Congress
defined ‘‘bank holding company’’ to
mean any company that (1) ‘‘directly or
indirectly owns, controls, or holds with
7 The following discussion is limited to the BHC
Act because much of the Board’s experience with
control has arisen in the context of the BHC Act,
rather than HOLA. The final rule generally applies
the same standards in the context of the BHC Act
and HOLA, though the final rule is different in each
context where appropriate to recognize the limited
differences between the BHC Act and HOLA with
respect to the definition of control.
8 12 U.S.C. 1841(a)(1).
9 12 U.S.C. 1844(c); 12 CFR 225.5(c).
10 12 U.S.C. 1844(c); 12 CFR 225.5(b).
11 See, e.g., 12 CFR part 217; 12 CFR 225 app. C;
12 CFR part 249.
12 12 U.S.C. 1831o–1.
13 12 U.S.C. 1843; 12 CFR 225 subpart C.
14 12 U.S.C. 371c and 371c–1; 12 CFR part 223.
15 Bank Holding Company Act Amendments:
Hearing on H.R. 6778 Before H. Comm. on Banking
& Currency, 91st Cong. 85 (1969).
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power to vote, 25 per centum or more
of the voting shares of each of two or
more banks or of a company which is
or becomes a bank holding company by
virtue of this Act, or (2) which controls
in any manner the election of a majority
of the directors of each of two or more
banks.’’ 16
In 1970, Congress made significant
amendments to the BHC Act, including
revisions to the definition of control.
Specifically, Congress added to the
existing two prongs of the definition of
control a new third prong. This third
prong provided that a company has
control over a bank or other company if
the ‘‘Board determines after notice and
opportunity for hearing, that the
company directly or indirectly exercises
a controlling influence over the
management or policies of the bank or
company.’’ 17 Congress added the
controlling influence prong to address
concerns that a company could
structure an investment in a bank below
the two bright-line thresholds of control
while still having the ‘‘power directly or
indirectly to direct or cause the
direction of the management or policies
of any bank.’’ 18
B. Summary of the Board’s Historical
Interpretation of ‘‘Control’’ Under the
Bank Holding Company Act
Since the 1970 amendments to the
BHC Act, the Board has had numerous
occasions to interpret and apply the
controlling influence prong of the BHC
Act. The Board historically has
interpreted controlling influence not to
require that an investor is able to
exercise complete domination or
absolute control over all aspects of the
management and policies of a company.
Instead, the Board has found that a
controlling influence is possible at
lower levels of influence, including
16 Bank Holding Company Act of 1956, Public law
84–511, 70 Stat. 133 (May 9, 1956). The original
BHC Act also defined ‘‘bank holding company’’ to
include a company that holds 25 percent or more
of the voting securities of two or more banks or
bank holding companies, if such securities are held
by trustees for the benefit of the shareholders or
members of the company. This prong of control was
repealed in 1966. See An Act to Amend the Bank
Holding Company Act of 1956, Public Law 89–485,
80 Stat. 236 (July 1, 1966).
17 An Act to Amend the Bank Holding Company
Act of 1956, Public Law 91–607, 84 Stat. 1760, 1761
(December 31, 1970). HOLA, originally enacted in
1933, contains substantially similar language for its
definition of control. As a corollary to the third
prong in the BHC Act, HOLA’s definition of control
of a savings association or other company includes
‘‘if the Board determines after reasonable notice and
opportunity for hearing, that such person directly
or indirectly exercises a controlling influence over
the management or policies of such association or
other company.’’ 12 U.S.C. 1467a(a)(2)(D).
18 Bank Holding Company Act Amendments:
Hearing on H.R. 6778 Before H. Comm. on Banking
& Currency, 91st Cong. 87 (1969).
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where a company is not able to
determine the outcome of a significant
matter under consideration.19 In other
words, control requires only ‘‘the mere
potential for manipulation of a bank.’’ 20
In assessing the controlling influence
prong, the Board has considered a
number of factors, including the size of
a company’s voting and total equity
investment in the other company; the
presence of countervailing shareholders
of the other company; a company’s
representation on the board of directors
or board committees of the other
company; covenants or other
agreements that allow a company to
influence or restrict the management
decisions of the other company; and the
nature and scope of the business
relationships between the companies.21
The Board’s regulations include
procedures for determining controlling
influence, as well as certain standards
for identifying controlling influence.
The Board also has issued guidance
documents related to control on several
occasions. For example, the Board
issued a limited set of regulatory
presumptions of control for use in
control proceedings in 1971 and
updated these presumptions in 1984.22
In addition, the Board issued policy
statements regarding the controlling
influence prong of the BHC Act in 1982
and 2008.23
C. Summary of the Proposal
The proposal established tiered
presumptions of control in the Board’s
regulations. The proposal also provided
several additional presumptions of
control and noncontrol, along with
19 Patagonia Corp., 63 Federal Reserve Bulletin
288 (1977) (citing Detroit Edison Co. v. SEC, 119
F.2d 738, 739 (6th Cir. 1941) (interpreting
‘‘controlling influence’’ in the Public Utility
Holding Company Act, which has a nearly identical
definition of control as in the BHC Act, to not
‘‘necessarily [require] those exercising a controlling
influence [to] be able to carry their point.’’ Rather
a controlling influence can be effective ‘‘without
accomplishing the purpose fully’’)).
20 Interamericas Investments, Ltd. v. Bd. of
Governors of the Fed. Reserve Sys., 111 F.3d 376,
383 (5th Cir. 1997).
21 A relationship between two companies may
raise supervisory or other concerns whether or not
the relationship raises controlling influence
concerns.
22 36 FR 18945 (Sept. 24, 1971); 49 FR 794, 817,
828–29 (Jan. 5, 1984).
23 See 68 Federal Reserve Bulletin 413 (July 1982)
(codified at 12 CFR 225.143); Policy Statement on
equity investments in banks and bank holding
companies (September 22, 2008). The Board has
issued two additional policy statements that are
also relevant to the meaning of control and
controlling influence: ‘‘Statement of policy
concerning divestitures by bank holding
companies’’ (12 CFR 225.138) and ‘‘Presumption of
continued control under section 2(g)(3) of the Bank
Holding Company Act’’ (12 CFR 225.139). These
policy statements remain in effect to the extent not
superseded by the final rule.
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various ancillary provisions such as
definitions of terms used in the
proposed presumptions.
As noted, the BHC Act and HOLA
provide that control due to controlling
influence arises once the Board
determines, based on the facts presented
and after notice and opportunity for a
hearing, that a company controls
another company. The proposal
established presumptions intended to
assist the Board in conducting such a
hearing or other proceeding and to
provide additional information to the
public regarding the circumstances in
which the Board believes that
controlling influence is likely to exist.24
The proposal—like this final rule—
related solely to the issue of whether an
investment, alone or in combination
with other relationships, raises control
concerns. The Board may have safety
and soundness or other concerns arising
out of either controlling or
noncontrolling relationships of a
banking organization. Thus, that an
investment is not presumed to be
controlling does not mean that the
investment and all other aspects of a
relationship are necessarily consistent
with safe and sound banking practices
or other expectations or requirements of
the Board.25 The Board retains the right
to review investments involving
banking organizations under its
jurisdiction for potential safety and
soundness or other concerns.
D. Summary of Comments Received on
the Proposal
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General Comments
Many commenters were supportive of
the Board’s overall efforts to bring
increased transparency, clarity, and
consistency to the Board’s views
regarding controlling influence. Some
commenters noted that the additional
clarity provided by the proposal would
improve the speed with which banking
institutions can raise capital.
Certain commenters argued that the
Board’s presumptions of control
24 Under the final rule, the Board retains the
ability to find a controlling influence based on the
facts and circumstances presented by a particular
case. However, the Board generally does not expect
to find that a company controls another company
unless the first company triggers a regulatory
presumption of control with respect to the second
company.
25 For example, contractual covenants and
business relationships between a banking
organization and a company may raise safety and
soundness or other concerns whether or not the
relationship raises control concerns. In particular,
a contractual provision may not allow a company
to restrict substantially the discretion of a banking
organization, but may impose financial obligations
on the banking organization that are inconsistent
with safe and sound operation of the banking
organization.
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presumed control at levels too low to be
supported by the underlying statutes.26
Several of these commenters contended
that Congress intended the controlling
influence prong of the BHC Act to cover
only situations with higher levels of
influence than the Board has
traditionally considered controlling,
which some commenters referred to as
situations of ‘‘actual control.’’ Many
commenters who supported higher
thresholds for the presumptions of
control argued that unduly low
thresholds would inhibit investments
into and by banking organizations and,
in particular, would inhibit investments
by banking organizations into start-up
technology companies. These
commenters generally argued that there
was no public benefit to limiting such
investments and that there could be a
negative impact on the economy. At
least one commenter also suggested that
a higher threshold for control would be
appropriate in order to mitigate the
extraterritorial application of the BHC
Act on the foreign operations of foreign
firms.
In support of a higher threshold for
control, several commenters suggested
that the Board look to its treatment of
merchant banking investments, as well
as the definition of banking entity under
the Volcker Rule. These commenters
argued that the Board had established
looser definitions of control in these
areas that should be applied to control
more generally. Other commenters
argued that the Board should separate
control in general under the BHC Act
from the definition of banking entity
under the Volcker Rule. In addition,
certain commenters provided
suggestions for revising the Board’s
rules related to merchant banking to
separate merchant banking from
questions of control.
A few commenters objected to the
proposal on the basis that the Board’s
current standards and processes around
controlling influence have functioned
well. Such commenters asserted that the
proposal may have various negative
effects by weakening the existing
framework. Several commenters
objected to the elements of the proposal
that they viewed as raising the threshold
for control for several reasons, including
concern that the proposal could lead to
greater concentration in the banking
industry or to greater concentration in
the shareholder base of the banking
industry. At least one commenter
expressed concern that the proposal
might allow companies to have greater
26 Specific suggestions from commenters are
described in the appropriate sections of this
preamble on specific presumptions.
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influence over banking organizations
without being subject to the bank
regulatory framework and noted that
retaining discretion to review each case
on the facts and circumstances
presented was necessary to address the
wide variety of potential relationships
among companies. At least one
commenter stated that the Board should
consider the economic and competitive
impact of these types of increased
consolidation and should update its
analysis of competitive issues more
generally. At least one commenter also
stated that the Board should carefully
consider the impact of the control
proposal on smaller banking
organizations and the ability of banking
organizations to sponsor and advise
investment funds.
The Board believes that the proposal
reflected an appropriate interpretation
of the controlling influence prong of the
BHC Act and generally conformed to
historical Board practice implementing
and interpreting the statute. The Board’s
historical practice is consistent with the
underlying statutes, the legislative
history, and relevant case law. The
Board has made several changes in the
final rule compared to the proposal, as
described in more detail in the
applicable sections of this preamble, but
the Board is issuing the final rule in a
form substantially consistent with the
proposal. As indicated in the proposal,
the final rule contains certain targeted
adjustments from current practice in
light of the Board’s experience
administering the statute. These changes
are generally technical in nature rather
than fundamental changes to the
Board’s substantive standards for
controlling influence. As the final rule
is generally consistent with current
practice, significant changes in
outcomes are not anticipated and,
therefore, no major impact on the
banking industry is expected.
Importantly, the final rule significantly
improves the transparency and
predictability around questions of
controlling influence.
Some commenters expressed concern
that certain of the presumptions could
have extraterritorial reach by attributing
control over companies outside the
United States, especially by foreign
banking organization. Commenters
recommended that the Board clarify that
lawful home country activities and
relationships currently in existence
should not be upset by the proposal. A
few commenters argued for different
control standards for qualifying foreign
banking organizations, or for foreign
companies more generally. At least one
commenter argued that the Board’s rules
should take foreign control standards
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into account when considering
relationships involving foreign entities
or that the Board should revise its
control standards to not apply to
relationships that are wholly outside the
United States.
The statutory framework for control
does not contemplate different
definitions of control for companies in
different jurisdictions. For this reason,
neither the proposal nor the Board’s
historical practice contains such
distinctions. The final rule is consistent
with the proposal in this regard. As
noted, the final rule is generally
consistent with the Board’s current
practice and, as a result, the final rule
is not expected to result in substantially
different outcomes for questions of
controlling influence involving foreign
companies.
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Comments on Scope of Application
Some commenters suggested that the
final rule should make it clear that an
investment that does not trigger a
presumption of control and is less than
5 percent of any class of voting
securities should be considered passive
for purposes of section 4(c)(6) of the
BHC Act. The final rule is intended to
apply to questions of control under the
BHC Act and HOLA. As a result, the
control framework in the final rule
applies for purposes of section 4(c)(6)
and, in particular, the Board’s
interpretation of section 4(c)(6) located
in section 225.137 of the Board’s
Regulation Y.27
Comments on Interaction With Other
Regulations
Several commenters suggested that
the Board apply the proposed control
standards to control under the Change
in Bank Control Act (‘‘CIBCA’’).28
Several commenters also recommended
that the Board apply the proposed
control standards to the Board’s
Regulation O and Regulation W.29
Commenters suggested that applying the
control standards in the proposal to
these other contexts would improve the
simplicity and efficiency of the Board’s
regulations by establishing a uniform,
trans-regulatory concept of control.
Some commenters noted that, in certain
cases, this could result in a more
permissive control standard than
currently applies under CIBCA,
Regulation O, and Regulation W.
A few commenters also argued that
the threshold for filing a notice under
CIBCA was too low and that the Board
should streamline the CIBCA notice
27 12
CFR 225.137.
U.S.C. 1817(j).
29 12 CFR part 215; 12 CFR part 223.
28 12
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process—in coordination with the FDIC
and OCC—to reduce the burden of
CIBCA filings. These commenters
asserted that the existing CIBCA
regulations restricted investment into
banking organizations and therefore
recommended that the Board revise its
regulations to reduce the number of
filings and the information required in
a filing. Specific recommendations for
reduced burden included creating a
process for investors to rebut the 10
percent presumption of control under
the CIBCA regulations, reducing the
required content of a CIBCA notice, and
increasing reliance on public
information such as public filings with
the Securities and Exchange
Commission (‘‘SEC’’). At least one
commenter stated that the Board should
reduce the scope of CIBCA filing
requirements to remove or limit, for
example, CIBCA filing requirements for
investments in predominantly nonfinancial grandfathered savings and loan
holding companies.
Other commenters argued against
applying the proposed control
framework to contexts other than
control under the BHC Act and HOLA.
These commenters noted that the
control concept under the BHC Act and
HOLA serves a different purpose than
under CIBCA, Regulation O, and
Regulation W. For example, control
under CIBCA requires filing a one-time
notice, while control under the BHC Act
results in a permanent regulatory status
that comes with activity restrictions,
prudential regulation, approval
requirements for major transactions,
periodic examinations, and reporting
requirements. Some commenters also
encouraged the Board to provide
additional clarity about the operation of
the presumptions of control under the
regulations implementing CIBCA.
The final rule applies to questions of
control under the BHC Act and HOLA;
it does not extend to CIBCA, Regulation
O, and Regulation W. The Board may in
the future consider conforming
revisions to other elements of its
regulatory framework, including CIBCA,
Regulation O, and Regulation W. While
common control standards across the
Board’s regulatory framework may
provide efficiency benefits, each of the
regulations identified by commenters
arises out of different provisions of law
and is intended to address different
concerns in specific contexts.
Some commenters suggested that the
Board provide additional guidance for
investments in non-corporate entities,
such as partnerships and limited
liability companies. In certain sections,
the proposal provided for the special
characteristics of non-corporate entities.
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The final rule retains these provisions
but does not contain further information
regarding the treatment of non-corporate
entities because of the wide variety of
forms such entities can take. The Board
generally expects to apply equivalent
control standards to all types of legal
entities while taking into account the
unique features of different entity types.
II. Final Rule—Presumptions of Control
and Noncontrol
A. Control Hearings and the Role of
Presumptions of Control and
Noncontrol
The BHC Act provides that control
due to controlling influence arises
following a Board determination that a
company controls another company.
The presumptions of control in the final
rule are intended to assist the Board in
the context of such a determination and
to provide additional public information
regarding the Board’s views on
controlling influence.
Under the final rule, the Board, in its
discretion, may issue a preliminary
determination of control if it appears
that a company has the power to
exercise a controlling influence over a
bank or other company. A company that
receives a preliminary determination of
control must respond within 30 days
with (i) a plan to terminate the control
relationship; (ii) an application for the
Board’s approval of the control
relationship; or (iii) a response
contesting the preliminary
determination, setting forth supporting
facts and circumstances, and, if desired,
requesting a hearing or other
proceeding. If a company contests a
preliminary determination of control
and requests a hearing or other
proceeding, then the Board shall order
a hearing or other appropriate
proceeding if material facts are in
dispute. The presumptions in the final
rule would apply at such a hearing or
other proceeding in accordance with the
Federal Rules of Evidence and the
Board’s Rules of Practice for Formal
Hearings. After considering all relevant
facts and circumstances, including
information gathered during any hearing
or other proceeding, the Board would
issue a final order stating its
determination on controlling influence.
Under the final rule, as under the
proposal, the procedures differ from the
existing procedures in the Board’s
regulations in only two modest ways.
First, the final rule clarifies that failure
to respond to a preliminary
determination of control from the Board
would constitute waiver of the right to
present additional information to the
Board and waiver of the opportunity to
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request a hearing or other proceeding.
Second, the final rule contains an
express requirement to submit
additional information in writing in
response to a preliminary determination
of control.
Some commenters recommended that
the Board grant additional time to
respond to preliminary determinations
of control. The final rule maintains the
existing 30-day timeframe because 30
days should generally be sufficient time
to respond to a preliminary
determination of control. Thirty days is
consistent with, or, in some cases,
longer than, the procedural timeframes
provided by the Board for similar
administrative processes.30 In addition,
the final rule provides that the Board
may allow for additional time in its
discretion, so firms that need additional
time may request additional time. The
procedures for control proceedings in
the final rule are consistent with the
proposal.
B. Description of the Tiered
Presumptions
As discussed, a core consideration for
control established by Congress in the
BHC Act is the percentage of voting
securities that one company controls of
a second company. Under the statute, a
company that controls 25 percent or
more of any class of voting securities of
a second company controls the second
company.31 Similarly, under the statute,
a company that controls less than 5
percent of any class of voting securities
of a company is presumed not to control
the second company.32 This statutory
framework leaves a space between 5
percent and 25 percent of a class of
voting securities where a company does
not have clear statutory control and is
not presumed not to control. For
companies within this range of voting
securities of 5 percent to less than 25
percent voting, the Board considers the
full facts and circumstances of the
relationship between the two companies
when determining whether the first
company controls the second company,
consistent with the controlling
influence prong of the BHC Act.33
The framework established by
Congress implies that a company with a
level of voting securities at the higher
end of the range—closer to 25 percent—
is more likely to control the second
company, while a company at the lower
end of the range—closer to 5 percent—
is less likely to control the second
company. The Board’s experience
30 See,
e.g., 12 CFR part 263.
U.S.C. 1841(a)(2)(A).
32 12 U.S.C. 1841(a)(3).
33 12 U.S.C. 1841(a)(2)(C).
31 12
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supports these implications. As a result,
where a company’s voting securities
percentage falls within this range is one
of the most salient considerations for
determining whether the first company
controls the second company.
The final rule, like the proposed rule,
establishes a series of tiered
presumptions of control. These
presumptions are arranged in tiers based
on the level of voting securities of the
first company in the second company.
Each of these presumptions applies
where the first company has at least a
specified level of voting securities in a
second company, and another specified
relationship with the second company.
The presumptions use three thresholds
for voting securities: 5 percent, 10
percent, and 15 percent.
Consistent with the proposal, many of
the other control factors referenced in
the final rule also vary in magnitude.
For instance, business relationships
between two companies can range from
minimal to very significant, and more
significant business relationships
provide a greater means of exercising
(and a greater incentive to exercise) a
controlling influence than less
significant business relationships. In
recognition of this, the presumptions in
the final rule effectively assume that
higher levels of business relationships,
combined with higher levels of voting
securities, increase the likelihood of the
ability to exercise a controlling
influence.
Director Representation
The Board has long considered a
company’s level of representation on the
board of directors of a second company
as an important factor for controlling
influence. The importance of director
representation to controlling influence
is supported by the second prong of the
definition of control in the BHC Act,
which provides that control over the
election of a majority of the board of
directors of a company constitutes
control of the company. Traditionally,
the board of directors of a company is
the body that makes strategic decisions
and establishes major policies for the
company. One of the most important
issues that holders of voting securities
can vote on is the selection of the
members of the board of directors of a
company.
For a company that controls 5 percent
or more of any class of voting securities
of a second company, the proposal
presumed control if the first company
controlled a quarter or more of the board
of directors of the second company.
This presumption reflected the view
that the combination of a material level
of voting power combined with control
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over a quarter or more of the board of
directors is generally enough to
constitute a controlling influence. This
element of the proposal reflected a
modest liberalization of practice. Under
the Board’s precedents, a noncontrolling
company that controlled more than 10
percent of a class of voting securities of
another company often was limited to
one or two director representatives at
the second company (regardless of the
size of the board of directors at the
second company).34
In addition, the proposal presumed
that a company that controls 5 percent
or more of any class of voting securities
of a second company controls the
second company if the first company
has director representatives that are able
to make or block the making of major
operational or policy decisions of the
second company. This presumption was
intended to address supermajority
voting requirements, individual veto
rights, or any similar unusual provision
that would allow a minority of the board
of directors of the second company to
control effectively major operational or
policy decisions of the second company.
Commenters generally supported the
proposal to allow a company to have up
to a quarter of the representatives on the
board of directors of another company
without triggering a presumption of
control. Commenters generally also
confirmed that they preferred the
proposal to a standard where companies
with higher levels of voting securities
must have reduced levels of director
representation to avoid triggering a
presumption of control. The final rule is
consistent with the proposal with
respect to the total share of director
representatives that a company may
have on the board of directors of another
company before triggering a
presumption of control.
In addition to the share of director
representatives that one company has
on the board of directors of a second
company, the proposed presumptions
considered particular director
representatives to have outsized ability
to affect the decisions of the second
company. For instance, the chair of the
board of directors of a company is
generally recognized as a leader of the
company and its board of directors, and
the chair may have additional powers,
such as the ability to set the agenda for
meetings of the board of directors.
Similarly, certain committees of the
board of directors may have the power
to take actions that bind the company
without the need for approval by the
34 Policy Statement on equity investments in
banks and bank holding companies (September 22,
2008).
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full board of directors. In these
circumstances, such a committee is
nearly equivalent to the full board of
directors with respect to those decisions
that it is empowered to make
unilaterally.
To recognize the enhanced power
wielded by directors in the positions
described in the paragraph above, the
proposal included a presumption of
control if a company controls 15 percent
or more of any class of voting securities
of a second company and if any director
representative of the first company also
serves as the chair of the board of
directors of the second company. In
addition, the proposal included a
presumption of control if a company
controls 10 percent or more of any class
of voting securities of a second company
and the director representatives of the
first company occupy more than a
quarter of the positions on any board
committee of the second company that
has the power to bind the company
without the need for additional action
by the full board of directors.
With respect to the presumption of
control for a director representative
serving as chair of the board,
commenters suggested that different
standards should apply depending on
whether the company was publically
traded, on the basis that public
companies are subject to heightened
governance standards compared to
private companies. Commenters also
suggested that the Board take the
presence of independent directors into
account because independent directors
could limit the influence of the chair of
the board.
With respect to the presumption of
control for director representatives
serving on certain committees,
commenters generally supported the
distinction drawn in the proposal
between committees with power to act
independently and committees with
only advisory powers. Some
commenters suggested that the
presumption of control should apply
only if the director representatives
occupied 50 percent or more of an
independent committee. At least one
commenter suggested clearly excluding
advisory committees from the
committee presumption.
The final rule is consistent with the
proposal with respect to the
presumptions of control for director
representatives serving as chair of the
board or serving on certain committees.
Distinguishing between public and
private companies, or between
companies that have a high versus low
proportion of independent directors,
would add substantial complexity to the
framework. In addition, incorporating
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such distinctions may increase
uncertainty with respect to control
because the proportion of independent
directors or the public status of a
company may change without action by
an investor. Moreover, as noted above,
the presumption of control related to
director representatives occupying more
than 25 percent of a committee that has
the power to take action to bind the
company is premised on the concern
that such a committee is nearly
equivalent to the full board of directors
with respect to those items that the
committee can act on unilaterally. As a
result, the final rule retains the 25
percent committee standard contained
in the proposal to correspond to the 25
percent entire-board standard for
director representatives. With respect to
the questions on advisory committees,
the standard under the final rule is
whether a committee has the ability to
take action that binds the company or
its subsidiaries. If an advisory
committee does not have that ability, it
is not a committee covered by the
presumption.
The proposal also included a
presumption regarding the solicitation
of proxies for the election of directors,
consistent with Board precedent. Under
the proposal, the Board would have
presumed control if a company that
controls 10 percent or more of any class
of voting securities of a second company
solicits proxies to appoint a number of
directors that equals or exceeds a
quarter of the total directors on the
board of directors of the second
company. This 25 percent standard
aligned the presumption for proxy
solicitations to elect directors with the
proposed presumption for having
director representatives.
The Board did not receive comments
specifically on the presumption of
control related to the solicitation of
proxies to elect directors. The final rule
is consistent with the proposal with
respect to this presumption of control,
though the final rule has been revised
slightly to describe the standard more
clearly.
Business Relationships
The Board has long believed that a
company’s business relationships with
another company provide a mechanism
through which the first company could
exercise a controlling influence over the
second company. For example, a
business relationship between an
investor and another company that
accounts for a substantial portion of the
revenues or expenses of the investor
may create a financial incentive for the
investor to attempt to influence the
second company. Similarly, a business
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relationship between an investor and
another company that accounts for a
substantial portion of the revenues or
expenses of the second company may
create a powerful lever of influence for
the investor over the second company.
Under the proposal, the Board
presumed control in the following
circumstances:
i. If a company controls 5 percent or
more of any class of voting securities of
a second company and has business
relationships with the second company
that generate in the aggregate 10 percent
or more of the total annual revenues or
expenses of the first company or the
second company;
ii. If a company controls 10 percent or
more of any class of voting securities of
a second company and has business
relationships with the second company
that generate in the aggregate 5 percent
or more of the total annual revenues or
expenses of the first company or the
second company; or
iii. If a company controls 15 percent
or more of any class of voting securities
of a second company and has business
relationships with the second company
that generate in the aggregate 2 percent
or more of the total annual revenues or
expenses of the first company or the
second company.
In addition, the Board has long
believed that if a company is able to
enter into a business relationship with
a second company on terms that are not
market terms, it is likely that the first
company has a significant level of
influence over the second company.
Thus, under the proposal, the Board
presumed control if a company controls
10 percent or more of any class of voting
securities of a second company and has
business relationships with the second
company that are not on market terms.
Many commenters suggested that the
Board’s proposed presumptions related
to business relationships used revenue
and expense thresholds that were too
low. These commenters suggested that,
as a consequence, the presumptions
would capture business relationships
that generally would be too small to
provide a controlling influence and that
the rule could therefore unnecessarily
inhibit beneficial business relationships.
Similarly, some commenters argued that
the business relationship presumptions
had the effect of conflating influence
over a business relationship with
influence over the management and
policies of a company. A few
commenters suggested that the
thresholds established in the proposal
for business relationships would create
particular issues for banking
organizations seeking to make minority
investments in smaller companies, such
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as recently formed financial technology
firms.
Various commenters recommended
different thresholds for the control
presumptions based on business
relationships. For example, some
commenters recommended that the
Board revise the business relationship
presumptions such that an investor with
less than 15 percent of any class of
voting securities in a second company
would not be presumed to have control
regardless of the size of business
relationships between the companies.
Similarly, a few commenters
recommended that the business
relationship thresholds for a
presumption of control be raised
substantially at different levels of voting
securities. For example, at least one
commenter stated that the presumptions
of control should be set at 50 percent of
revenues and expenses for an investor
with between 5 and 10 percent of voting
securities, at 33 percent of revenues and
expenses for an investor between 10 and
15 percent of voting securities, and at 25
percent of revenues and expenses for an
investor between 15 and 25 percent of
voting securities. Some commenters also
suggested applying higher thresholds in
certain circumstances, such as if there
were a larger shareholder or a party with
a larger business relationship.
A few commenters suggested that the
Board abandon quantitative metrics for
business relationships and instead
presume control only if a company
threatens to terminate or alter business
relationships with another company for
the purpose of exercising a controlling
influence over the second company’s
management or policies.
As noted, the Board historically has
viewed business relationships as an
important mechanism through which
one company can exercise control over
the management or policies of another
company. The Board’s longstanding
view has required business
relationships to be quantitatively
limited and qualitatively immaterial to
avoid raising control concerns.
Consistent with this principle, the
proposal provided several presumptions
based on voting securities and business
relationships. The Board views the
thresholds at which the proposed
business relationship presumptions of
control were set to be reasonable and
generally consistent with its past
practice. The final rule, therefore,
retains the threshold levels that were
included in the proposal. Further, the
final rule includes the presumption
related to business relationships that are
not on market terms without change
from the proposal, for the reasons
described above.
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Some commenters argued that the
Board should modify the business
relationships thresholds to focus only
on the revenues (not expenses) of the
two companies. These commenters
contended that a business relationship
that is a substantial expense to one party
generally does not provide that party
with any additional ability to exercise
control over the counterparty. While
commenters acknowledged uncommon
exceptions to this general standard—
such as a relationship that cannot be
easily replaced—commenters asked that
the rule not consider expenses or only
consider expenses under circumstances
likely to be relevant to control. A
number of commenters further argued
that the presumptions should only take
into account the scale of business
relationships from the perspective of the
second company and not the first
company. Specifically, these
commenters contended that the fact that
a relationship was significant to a first
company did not mean that it was
significant to a second company and
only relationships that were significant
from the perspective of the second
company would provide the first
company with an ability to exert
influence over the second company.
In response to these comments, the
final rule differs from the proposal in
that the final presumptions of control
related to business relationships only
include thresholds based on the
revenues and expenses of the second
company. As commenters noted, the
significance of business relationships
from the perspective of a first company
is not necessarily indicative of the first
company’s ability to control a second
company, even though it may provide
an incentive for the first company to
attempt to exercise control over the
second company. A business
relationship that is significant to a
second company as a source of revenue
or expense, however, may be leveraged
by the first company to exercise
influence over the second company.35
As a result, under the final rule, a
company would be presumed to control
another company when:
i. The first company controls 5
percent or more of any class of voting
35 Though the final rule is expected to cover most
controlling influence concerns arising out of
business relationships, the Board may raise
controlling influence concerns under specific facts
and circumstances consistent with historical
precedent, such as relationships with special
qualitative significance (for example, relationships
that are difficult to replace and are necessary for
core functions). In addition, the revised business
relationship presumptions of control do not in any
way limit the ability of the Board to take action to
address business relationships that raise safety and
soundness or other concerns.
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securities of the second company and
has business relationships with the
second company that generate in the
aggregate 10 percent or more of the total
annual revenues or expenses of the
second company;
ii. The first company controls 10
percent or more of any class of voting
securities of the second company and
has business relationships with the
second company that generate in the
aggregate 5 percent or more of the total
annual revenues or expenses of the
second company; or
iii. The first company controls 15
percent or more of any class of voting
securities of the second company and
has business relationships with the
second company that generate in the
aggregate 2 percent or more of the total
annual revenues or expenses of the
second company.
Some commenters sought clarification
of concepts used in the business
relationship presumptions, such as total
annual revenues and total annual
expenses, and encouraged the Board to
rely on well-understood and widely
available definitions of these concepts.
Commenters suggested that the Board
provide clear standards for
measurement and attribution of
revenues and expenses, and that the
Board clarify what accounting standards
could be relied upon for such
measurements. Some commenters
argued for a longer period of time over
which to measure the companies’
business relationships, such as two
years or three years. A number of
commenters argued that the thresholds
for business relationships should only
apply with respect to a company and its
consolidated subsidiaries and should
not include business relationships from
unconsolidated subsidiaries.
A few commenters argued for an
exception to the business relationship
presumptions for a company that could
not calculate both sides of the business
relationship but had a good faith basis
for believing that the relationships were
within the limits of the presumptions.
At least one commenter recommended
that business relationships be measured
based only on the financial statements
of a company at the time of an
investment in order to make it easier to
comply with the business relationship
thresholds.
Consistent with the proposal, the
business relationship presumptions in
the final rule include thresholds based
on total consolidated annual revenues
and expenses. Revenues and expenses
are meant to be understood as these
terms are commonly understood in the
context of U.S. generally accepted
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accounting principles (‘‘GAAP’’).36
Principles of consolidation are also
meant to be applied as generally
implemented in the context of GAAP.
Thus, the general expectation is that a
company’s consolidated income
statement for the preceding fiscal year
should contain the necessary
information to determine revenues and
expenses for purposes of the
presumptions. Further, the final rule
maintains annual measurement of
revenues and expenses for purposes of
the presumptions as annual financials
provide an existing and widely relied
upon means to understand the
significance of business relationships.
Many commenters sought specific
exclusions from the business
relationship presumptions. At least one
commenter recommended that the final
rule exclude certain types of business
relationships, such as arm’s-length
lending and deposit relationships, or
non-exclusive business relationships
where alternative service providers are
available. Some commenters sought
clarification regarding specific contexts,
such as whether management fees paid
by limited partners to general partners
should be included as business
relationships. Similarly, commenters
argued that readily marketable debt
securities of a company owned by
another company should not be
included in business relationships if the
terms were not negotiated by the two
companies.
At least one commenter argued that
the presumptions should not take into
account business relationships between
an investment fund and any company in
which the fund makes an investment, to
the extent such relationships are at
arm’s length and non-exclusive. Some
commenters suggested that the business
relationship presumption should take
account of the special circumstances of
start-up companies by measuring
revenues over a longer period or not
considering business relationships
during the first several years of a
company’s existence. Several
commenters argued that business
relationships involving referrals should
not be included for revenue purposes
because the amount of referral fees can
be volatile.
The final rule contains no specific
exclusions from the presumptions for
particular types of business
36 For purposes of the final rule, revenue is
understood to mean gross income, not income net
of expenses. If a company does not prepare
financial statements according to GAAP, the Board
expects to rely on the non-GAAP financial
statements of the company, while taking differences
in accounting standards into account as
appropriate.
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relationships. The final rule establishes
clear and generally applicable standards
that rely on well-understood accounting
principles that aim to capture the
economic significance of business
relationships between two companies.
The introduction of exclusions for
particular types of relationships or
counterparties would add substantial
complexity to the rule.
Some commenters argued that there
should be a temporary transition or
grace period, during which business
relationships could exceed applicable
thresholds without triggering a
presumption of control. As discussed,
the business relationship presumptions
in the final rule are based on annual
consolidated revenues and expenses.
The use of annual measurement allows
for some, but not excessive, day-to-day
volatility in business relationships that
should be sufficient for companies to
manage. As a result, the final rule
includes no additional transition or
grace period.
In addition, consistent with the
proposal, the final rule does not include
a presumption of control based on
threats to alter or terminate business
relationships. Although such actions
may be relevant to determinations of
control, adding such a presumption
would increase the complexity of the
final rule.
Senior Management Interlocks
The officers of a company wield
significant power over the company
because they implement the major
policies set by the board of directors,
make all the ancillary policy decisions
necessary for implementation, and
operate the company on a day-to-day
basis. In addition, officers often make
influential recommendations to the
board of directors regarding major
policy decisions. As a result of this
substantial degree of influence, the
Board historically has viewed situations
where an agent of a significant investor
company serves as a management
official of another company as providing
a significant avenue for the first
company to exercise a controlling
influence over the second company.
The proposal included a presumption
of control where a company that
controls 5 percent or more of any class
of voting securities of a second company
has more than one senior management
interlock with the second company. In
addition, the proposal included a
presumption of control where a
company that controls 15 percent or
more of any class of voting securities of
a second company has any senior
management interlock with the second
company. In order to trigger either of
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these presumptions, the individual must
serve as an employee or director at the
first company and as a senior
management official at the second
company. The proposal defined a senior
management official of a company as
any person who participates or has the
authority to participate (other than in
the capacity as a director) in major
policymaking functions of the company.
In addition, the proposal included a
presumption of control where a
company that controls 5 percent or more
of any class of voting securities of a
second company has an employee or
director who serves as the chief
executive officer (or an equivalent role)
of the second company. The chief
executive officer of a company is
generally the most powerful senior
management official of the company.
Some commenters criticized the
proposed presumption based on senior
management interlocks on the basis that
the scope of individuals treated as
senior management officials was
unclear. These commenters generally
encouraged the Board to limit the scope
of covered senior management officials
to a clearly identifiable group, rather
than using the qualitative standard
included in the proposal. A few
commenters also argued that larger
companies should be permitted to have
more senior management interlocks.
The final rule includes the proposed
presumptions of control for senior
management interlocks without
revision. The Board has long recognized
the potential for senior management
interlocks to be a conduit by which one
company can influence another
company, and the final rule is
consistent with this understanding.
Consistent with the proposal, the
presumptions related to senior
management interlocks in the final rule
include targeted adjustments to
historical practice to refine the scope of
relevant interlocks to focus on senior
officers and, in particular, the chief
executive officer. The focus on senior
management officials leans against the
types of interlocks most likely to raise
controlling influence concerns, but also
permits an investor to have multiple
junior employee interlocks that would
not increase the investor’s ability to
influence operations and policies at the
investee company.
Also consistent with the proposal, the
final rule defines ‘‘senior management
official’’ to be any person with authority
to participate (other than as a director)
in major policy making functions of a
company. This definition is based on
the function that a person serves rather
than a person’s official title. The Board
recognizes that this definition is not
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precise and will consider providing
additional clarity around this definition
after acquiring more experience with the
senior management interlocks
presumptions.
Contractual Limits on Major Operational
or Policy Decisions
A company that controls a material
amount of voting securities of a second
company also may have contractual
arrangements with the second company,
such as investment agreements, debt
relationships, service agreements, or
agreements related to other business
relationships. Often, these contractual
rights do not raise controlling influence
concerns because the rights, for
example, are limited in scope or
reinforce the protections provided to the
investor under the law. However, the
Board has viewed many other
contractual provisions as raising
controlling influence concerns when the
agreement has the effect of substantially
enhancing one company’s influence
over the discretion of another
company.37
Contractual rights often raise
controlling influence concerns when
they provide an investor with the ability
to direct or block major operational or
policy decisions of another company,
whether such decisions are made by
management or by the board of directors
of the other company. The ability of an
investor effectively to veto an important
business decision of a company
generally provides the investor with the
ability to exercise a significant influence
over a major operational or policy
decision of the company.
The Board also has long recognized
that contracts governing business
relationships, including many loan
agreements, contain restrictive
covenants and that the existence of
these covenants has not been sufficient,
in itself, to constitute a controlling
influence. Thus, the Board generally has
not viewed restrictive covenants in the
context of loan transactions or
commercial services to raise controlling
influence concerns. However, when a
company has both control over a
material percentage of the voting
securities of another company and
covenants that significantly restrict the
discretion of the second company, the
covenants have raised controlling
influence concerns. These concerns
37 Contractual covenants also may raise safety and
soundness concerns, such as a covenant that
impairs the ability of a banking organization to raise
additional capital, or a covenant that imposes
substantial financial obligations on a banking
organization. Safety and soundness concerns may
arise in the absence of, or in addition to, controlling
influence concerns.
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have been raised whether the covenants
arise directly from the terms of the
equity investment or from separate
agreements between the companies.
Under the proposal, a company
generally was presumed to control a
second company if the first company (i)
owns 5 percent or more of any class of
voting securities of the second
company; and (ii) has any contractual
right that significantly restricts the
discretion of the second company over
major operational or policy decisions.38
A company with less than 5 percent of
each class of voting securities of a
second company would not have
triggered this presumption of control
even if the first company had covenants
that significantly restricted the
discretion of the second company over
major operational and policy decisions.
Thus, the proposal both recognized the
potentially significant influence that
covenants can provide and recognized
the normal use of restrictive covenants
in loan agreements and other marketterms business relationships.
The presumption of control under the
proposal introduced a new defined
term, ‘‘limiting contractual right,’’
defined as a contractual right that
allows a company to restrict
significantly the discretion of a second
company, including its senior
management officials and directors, over
major operational or policy decisions.
The proposal also included a
nonexclusive list of examples of
contractual rights that are generally
considered to be limiting contractual
rights, as well as a nonexclusive list of
examples of contractual rights that are
generally not considered to be limiting
contractual rights.
Commenters argued that the Board
should either raise the voting securities
threshold at which the presumption of
control based on limiting contractual
rights would apply or remove the
presumption entirely. At least one
commenter argued that the presumption
related to limiting contractual rights
should not apply to an investor that
controls less than 10 percent of each
class of voting securities. In addition,
commenters raised concerns with some
of the specific rights listed in the
proposal as examples of limiting
contractual rights. These comments are
discussed later in this preamble in the
section related to the definition of
limiting contractual rights.
38 The proposal provided an exclusion for
limiting contractual rights in the context of a
pending merger that are designed to ensure that the
target company operates in the ordinary course
while the merger is pending. The final rule includes
this exclusion consistent with the proposal.
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Consistent with the proposal, under
the final rule, a company is presumed
to control another company if the first
company controls 5 percent or more of
any class of voting securities of the
second company and the first company
has a limiting contractual right with
respect to the second company. As
discussed, limiting contractual rights
can allow a company to exercise
significant influence over another
company, such as by providing the first
company with an effective veto over
decisions of the second company,
overriding the discretion of the board of
directors of the second company or the
choices of its shareholders. However,
limiting contractual rights are often
important provisions in commercial
agreements, including many loan
agreements, and the Board has long
recognized the importance of such
contractual provisions in the context of
commercial relationships. Thus,
consistent with the proposal, under the
final rule, a company must also control
a material percentage of the voting
securities of another company—
specifically, at least 5 percent of any
class of voting securities—in order to be
presumed to control the other company
due to a limiting contractual right. In
other words, the final rule reflects that
the Board’s concern with limiting
contractual rights generally arises from
the combination of a limiting
contractual right and control over a
material share of voting securities.39
This approach is intended to balance
the normal use of restrictive covenants
in standard lending and other
commercial relationships, while also
recognizing the power of limiting
contractual rights to enhance the
influence of a company that is a
material equity investor in another
company.
Total Equity
The Board has long subscribed to the
view that the overall size of an equity
investment, including both voting and
nonvoting equity, is an important
indicator of the degree of influence an
investor may have. A company is likely
to pay heed to its large shareholders in
order to maintain stability in its capital
base, enhance its ability to raise
additional equity capital in the future,
and to prevent the negative market
signal that may be created by the sale of
a large block of equity by an unhappy
shareholder. All of these concerns are
present independent of the ability of an
investor to exercise the voting powers of
39 This is different from management agreements,
which raise control concerns regardless of the share
of voting securities controlled.
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equity to attempt to influence the
investee company. Further, an investor
with a large equity investment also has
a powerful incentive to wield influence
over the company in which it has
invested due to the investor’s
substantial economic interest in the
investee company. However, the Board
also has recognized that nonvoting
equity does not provide the same ability
to exercise a controlling influence as
voting equity.
Accordingly, under the proposal, a
company was presumed to control
another company if the first company
controls less than 15 percent of the
voting securities of the second company
but one-third or more of the total equity
of the second company. In addition, a
company was presumed to control
another company if the first company
controls 15 percent or more of the
voting securities of the second company
and 25 percent or more of the second
company’s total equity. This element of
the proposal was consistent with the
total equity standard described in the
Board’s 2008 Policy Statement.
Some commenters argued that total
equity on its own does not provide a
company with a substantial ability to
exercise a controlling influence and
therefore recommended that the Board
increase the amount of total equity the
first company could control in the
second company before triggering a
presumption of control. A few
commenters suggested that the Board
permit all investors to own up to onethird of the total equity of a company
(regardless of voting equity position)
without triggering a presumption of
control. Other commenters advocated
for alternative tiered presumptions
related to total equity, such as
presumptions of control where a
company (i) has 15 percent or more of
the voting securities of the second
company and one-third or more of the
total equity; (ii) has between 10 percent
and 15 percent voting and more than 40
percent total equity; and (iii) has under
10 percent voting and more than 50
percent total equity. Some commenters
suggested that the Board have an
exception to the total equity
presumption if another shareholder has
a significant block of voting securities in
the second company that could prevent
the first company from using total
equity to exercise a controlling
influence over the second company.
In the final rule, the Board is
simplifying its total equity presumption
so that a company will be presumed to
control a second company when the
first company controls one-third or
more of the total equity of the second
company. The threshold of one-third or
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more of total equity would apply
without regard to the first company’s
voting securities percentage. In addition
to simplifying, this adjustment to the
proposal reflects that nonvoting equity,
while a significant mechanism through
which control may be exercised, should
not be capped at the same 25 percent
voting securities level that the statute
identifies as control.
Commenters also raised a variety of
issues around the Board’s proposed
methodology for calculating a
company’s total equity position in
another company. These comments are
discussed below in section III.D. of the
preamble.
Proxies on Issues
The Board historically has raised
controlling influence concerns if a
company with control over 10 percent
or more of a class of voting securities of
a second company solicits proxies from
the shareholders of the second company
on any issue. The Board did not propose
a presumption of control for a company
that controls 10 percent or more of a
class of voting securities of a second
company and solicits proxies from the
shareholders of the second company on
any issue. Many commenters supported
the Board’s decision to not include a
presumption of control based on
soliciting proxies on issues presented to
the shareholders.
Consistent with the proposal, the
Board is not adopting a general
presumption of control for a company
that solicits proxies from the
shareholders of another company.40
Accordingly, under the final rule, a
noncontrolling investor generally may
act as a shareholder and engage with the
target company and other shareholders
on issues through proxy solicitations.
Threats To Dispose of Securities
Historically, the Board has viewed
threats to dispose of large blocks of
voting or nonvoting securities in an
effort to try to affect the policy and
management decisions of another
company as presenting potential
controlling influence concerns. As a
result, the Board traditionally has raised
controlling influence concerns if a
company with control over 10 percent
or more of a class of voting securities of
a second company threatens to dispose
of its investment if the second company
refuses to take some action desired by
the first company. However, the Board
also has recognized that an investor that
40 The final rule includes a presumption of
control related to soliciting proxies for the election
of directors, which is discussed in the section of
this preamble related to the presumptions of control
based on director representation.
PO 00000
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12407
is unhappy or disagrees with the
business decisions of the company in
which it has invested should be able to
exit its investment and that the
possibility of investor exit imposes
important discipline on management.
The Board did not propose a
presumption of control based on threats
to dispose of securities.
Many commenters expressed support
for the Board’s decision to not include
a presumption of control based on
attempts to exercise control by
threatening to dispose of securities.
Consistent with the proposal, the
Board is not adopting a presumption of
control based on one company
attempting to exercise control over
another company by threatening to
dispose of its securities in the second
company. By not adopting a
presumption, the Board recognizes that
investors generally should be able to
exit investments without raising control
concerns.
C. Description of Additional
Presumptions and Exclusions
In addition to the tiered presumption
framework described previously, the
proposal included several additional
presumptions of control. Several of
these presumptions clarified
presumptions already in Regulation Y
and Regulation LL, and others of these
presumptions related to standards that
the Board historically has used to make
control decisions but has not before
included in regulation. This section of
the preamble discusses these additional
presumptions and how they are
reflected in the final rule.
Management Agreements
The Board has long believed that
management agreements under which a
company can direct or exercise
significant influence over the
management or operations of another
company raise significant controlling
influence concerns.41 The proposal
expanded slightly the existing
regulatory presumption to expressly
identify additional types of agreements
or understandings that allow a company
to direct or exercise significant
influence over the core business or
policy decisions of another company.
The proposal also clarified that a
management agreement includes an
agreement where a company is a
managing member, trustee, or general
partner of another company, or
exercises similar functions.
41 See 12 CFR 225.31(d)(2)(i); 12 CFR
238.21(d)(2)(i) (citations are to the Code of Federal
Regulations prior to the amendments made by this
final rule).
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The Board did not receive comment
specifically on the presumption of
control arising from a management
agreement. Accordingly, the Board is
finalizing the presumption as proposed,
including with the clarifications that
expressly include agreements where a
company is a managing member,
trustee, or general partner of another
company.
Investment Advice and Investment
Funds
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The proposal included a presumption
of control where a company serves as
investment adviser to an investment
fund and controls 5 percent or more of
any class of voting securities of the fund
or 25 percent or more of the total equity
of the fund. For purposes of this
presumption, the proposal defined
‘‘investment adviser’’ to include any
person registered as an investment
adviser under the Investment Advisers
Act of 1940 (‘‘Advisers Act’’), any
person registered as a commodity
trading adviser under the Commodity
Exchange Act, or a foreign equivalent of
such a registered adviser.42 Similarly,
‘‘investment fund’’ included a wide
range of investment vehicles, including
investment companies registered under
the Investment Company Act of 1940,
investment companies that are exempt
from registration under the Investment
Company Act, and foreign equivalents
of either registered investment
companies or exempt investment
companies.43 Other investment
vehicles, such as commodity funds and
real estate investment trusts, generally
also were included as investment funds.
However, the proposed presumption
of control would not have applied if the
investment adviser organized and
sponsored the investment fund within
the preceding twelve months. This
provision allowed the investment
adviser to avoid triggering the
presumption of control over the
investment fund during the initial
seeding period of the fund.44
In addition, the proposal provided a
limited exception from the
presumptions of control where the
investment fund was an investment
company registered with the SEC under
the Investment Company Act of 1940
and certain other criteria were
satisfied.45 In order to qualify for this
exception:
• The only permitted business
relationships between the investment
adviser and the investment company
were investment advisory, custodian,
transfer agent, registrar, administrative,
distributor, and securities brokerage
services provided by the investment
adviser to the investment company;
• Representatives of the investment
adviser must occupy 25 percent or less
of the board of directors or trustees of
the investment company; and
• The investment adviser must
control less than 5 percent of each class
of voting securities of the investment
company and less than 25 percent of the
total equity of the investment company.
Corresponding to the seeding period
in the investment adviser presumption,
the last criteria in the registered
investment company exception did not
apply if the investment adviser had
organized and sponsored the investment
company within the preceding twelve
months. This provision allowed the
investment adviser to control greater
percentages of securities of the
investment company during the initial
seeding period of the investment
company.46
Commenters argued that the proposals
with respect to investment funds and
registered investment companies were
inconsistent with prior Board precedent,
most notably a single case where the
Board allowed a bank holding company
to retain up to 25 percent of the voting
securities of an investment company
under certain conditions.47 Many
commenters argued that the rule should
follow this precedent and allow
investment advisers to control up to 25
percent of the voting securities of an
advised investment fund without
triggering a presumption of control,
rather than 5 percent as proposed.
Many commenters also suggested a
one-year seeding period was too short
and should be extended to three years
to be consistent with the Volcker Rule.
In addition, commenters suggested that
the seeding periods should be available
to authorized participants, not just
organizers and sponsors. Some
commenters advocated for an approach
where no seeding period was specified
in the rule and instead the seeding
45 15
U.S.C. 80a et seq.
e.g., Mellon Bank Corporation, 79 Federal
Reserve Bulletin 626 (1993); The Chase Manhattan
Corporation, 81 Federal Reserve Bulletin 883
(1995); Commerzbank AG, 83 Federal Reserve
Bulletin 678 (1997).
47 See Letter to H. Rodgin Cohen, Esq., dated June
24, 1999, https://www.federalreserve.gov/
boarddocs/legalint/BHC_ChangeInControl/1999/
19990624/.
46 See,
42 15
U.S.C. 80b–1 et seq.; 7 U.S.C. 1 et seq.
U.S.C. 80a et seq.
44 The proposed presumption of control for
service as an investment adviser to an investment
fund was intended to be consistent with the Board’s
precedents regarding when an investment adviser
controls an advised investment fund under the
BHC.
43 15
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period would be a reasonable period
determined by fund managers.
A few commenters recommended that
the investment company exception
apply to foreign equivalents of U.S.
registered investment companies and
certain other types of investment funds,
such as exempt investment companies
and business development companies.
Some commenters also requested that
registered investment companies be
excluded from the presumptions of
control without having to satisfy any
conditions. Several commenters further
argued that the Board should apply the
standards of the SEC for independent
directors rather than the Board’s
standards for director representatives for
purposes of determining how many
director representatives a company has
on the board of directors of a registered
investment company. At least one
commenter suggested that the Board
exclude any ordinary-course business
relationships between investment
companies and their advisers from
consideration in the context of control.
The final rule retains the presumption
of control for investment advisers of
investment funds as proposed. The
exception for registered investment
companies is not included in the final
rule. Both the control presumption and
the exception were designed to align
with Board precedent regarding control
over investment funds and thus were
intended to be complementary in scope.
The registered investment company
exception had minimal incremental
information value beyond the general
investment fund presumption, and the
details of the exception raised many
questions regarding how it would
function. Thus, it has been removed
from the final rule to simplify the rule.
The final rule retains the threshold of
5 percent of a class of voting securities
for purposes of the investment adviser
presumption of control. The single
precedent identified by commenters that
permitted ownership of up to 25 percent
of the voting securities of a fund was an
unusual case based in part on statutory
provisions that are no longer in effect.
In addition, in that precedent, the Board
relied on additional constraints to
mitigate control concerns and these
additional constraints were not
included in the proposal. The threshold
of 5 percent of any class of voting
securities is consistent with the
preponderance of Board precedent in
this area.
The final rule retains the one-year
seeding period, consistent with the
proposal. The one-year seeding period is
consistent with the bulk of Board
precedent related to organizing and
sponsoring investment funds and
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provides a reasonable amount of time
for the seeding of most investment
funds. The one-year seeding period is
only available to the company that
organizes and sponsors an investment
fund and not to other early investors in
an investment fund, because only the
sponsor/organizer necessarily controls
all the equity securities of the company
when the fund is formed.48
At least one commenter
recommended that the Board confirm
the ongoing applicability of control
letters from the General Counsel of the
Board to mutual fund families, and
investments made in accordance with
those letters. The application of the final
rule to existing structures is discussed
in more detail elsewhere in this
preamble. The Board does not intend to
revisit existing structures that were
previously reviewed by the Federal
Reserve System and have not changed
materially.
Accounting Consolidation
Under the proposal, the Board
presumed that a company that
consolidates a second company under
GAAP controls the second company.
The presumption was based on an
understanding that GAAP generally
calls for consolidation under
circumstances where the consolidating
entity has a controlling financial interest
over the consolidated entity.
Consolidation is typically required
under GAAP due to ownership of a
majority of the voting securities of a
company, which would significantly
exceed the voting security threshold for
control under the BHC Act and HOLA.
In addition, GAAP requires
consolidation of companies under the
variable interest entity standard (i)
where a company has significant
economic exposure to a variable interest
entity and has the power to direct the
activities of the entity that most
significantly impact the entity’s
economic performance or (ii) where a
company controls a variable interest
entity by contract.49
Many commenters urged the Board to
abandon the proposed presumption of
control where a first company
consolidates a second company for
purposes of GAAP. Commenters also
urged the Board not to expand the
proposed consolidation presumption
based on GAAP to consolidation under
other accounting standards. These
commenters argued that the standards
48 The one-year seeding period in the final rule
does not alter the rules applicable to hedge fund
and private equity fund investments under the
Volcker Rule, including the rules addressing
permissible seeding periods for such funds.
49 See, e.g., ASC 810–10.
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for consolidation for variable interest
entities did not conform to the Board’s
standards for controlling influence.
Commenters also stated that presuming
that consolidated variable interest
entities are controlled could have
unintended consequences for foreign
banking organizations subject to the
Board’s U.S. intermediate holding
company requirements.50 In addition,
commenters expressed concern that the
accounting consolidation rules were
promulgated by a different authority
with different purposes and that the
consolidation standards were subject to
change outside of the control of the
Board. Some commenters requested
exclusions for variable interest entities
in certain contexts, such as an exclusion
for asset-backed commercial paper
conduits or particular types of
ownership or management relationships
between a company and a variable
interest entity.
The final rule establishes a
presumption of control when one
company consolidates a second
company for purposes of GAAP. This
presumption is consistent with the
proposal. A company that consolidates
another company due to control over a
majority of the voting securities of the
second company should control the
second company under the voting
securities control prong of the BHC Act
and HOLA. A company that
consolidates another company under
the variable interest entity standard
must have substantial ability to direct
the activities of the second company (in
addition to having a potentially
significant economic exposure). A
company that is consolidated under the
variable interest entity standard often
would be controlled under one of the
other presumptions of control in the
final rule such as the management
agreement presumption. The inclusion
of the GAAP consolidation presumption
should reduce burden and uncertainty
by allowing companies to identify
presumptive control relationships based
on existing accounting standards.
The presumption of control where
one company consolidates a second
company for purposes of GAAP covers,
by its terms, only those companies that
prepare financial statements under
GAAP. The Board notes, however, that
the Board is likely to have control
concerns where a company consolidates
another company on its financial
statements under another accounting
standard, particularly if the other
accounting standard has consolidation
standards that are similar to the
consolidation standards under GAAP.
50 See
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Regarding the interaction of the final
rule and the intermediate holding
company requirements of the Board’s
Regulation YY, a foreign banking
organization that is required to form a
U.S. intermediate holding company
must hold all ownership interests in
U.S. subsidiaries through its U.S.
intermediate holding company.51 In
general, ownership interest under the
intermediate holding company
requirements does not include
contractual relationships, including
contractual relationships that result in
consolidation of a company under the
variable interest entity standard. Thus,
for example, where a U.S. branch of a
foreign bank has a contract with an
asset-backed commercial paper conduit
that causes the conduit to be
consolidated by the branch under the
variable interest entity standard, the
contract is not an ownership interest
and therefore may remain between the
branch and the conduit.
The proposal sought comment on
whether the Board should presume that
a company controls a second company
if the first company applies the equity
method of accounting with respect to its
investment in the second company.
Many commenters opposed the
introduction of this presumption. These
commenters argued that the standards
for the equity method of accounting
were different than control under the
BHC Act and HOLA and that the
practical effect of such a presumption
would be to presume control over a
company due to control over 20 percent
of a company’s voting securities,
substantially below the statutory
threshold of 25 percent. Similar to
comments regarding accounting
consolidation, commenters also objected
to the Board’s control-based reliance on
accounting standards designed for
different purposes.
The final rule does not include a
presumption of control when one
company applies the equity method of
accounting with respect to its
investment in a second company.
Although equity method accounting
treatment indicates a substantial
relationship between two companies,
unlike consolidation, equity method
accounting is not as closely linked to
the Board’s views on what constitutes a
controlling influence.
Divestiture
The proposal substantially revised the
Board’s standards regarding divestiture
of control. The Board historically has
taken the position that a company that
has controlled another company may be
51 12
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able to exert a controlling influence over
that company even after a substantial
divestiture.52 As a result, the Board
typically has applied a stricter standard
for terminating control than for
establishing new noncontrolling
investments.53
The proposal provided that a
company that previously controlled a
second company during the preceding
two years would be presumed to
continue to control the second company
if the first company owned 15 percent
or more of any class of voting securities
of the second company. The divestiture
presumption did not apply if a majority
of each class of voting securities of the
second company would be controlled by
a single unaffiliated individual or
company after the divestiture by the
first company. Further, the divestiture
presumption generally did not apply in
cases where a company sold a
subsidiary to a third company and
received stock of the third company as
consideration for the sale.54
Many commenters supported the
proposed divestiture presumption.
Other commenters argued that the
threshold for the divestiture
presumption should be raised higher
than 15 percent or that the divestiture
presumption should be entirely
removed from the rule. At least one
commenter requested clarification as to
the conditions required for the
exception to the divestiture
presumption to apply, specifically
whether the other shareholder must
control a majority of every class of
52 See, e.g., ‘‘Statement of policy concerning
divestitures by bank holding companies’’
(divestiture policy statement). 12 CFR 225.138. The
divestiture policy statement indicates that
divestiture is a special consideration for purposes
of control and that the Board’s normal rules and
presumptions regarding control may not always be
appropriate in the context of divestiture. See also
Am. Gas & Elec. Co. v. SEC, 134 F.2d 633, 643 (D.C.
Cir. 1943) (holding that ‘‘controls and influences
exercised for so long and so extensively [under the
Public Utilities Holding Company Act] are not
severed instantaneously, sharply and completely,
especially when powers of voting, consultation and
influence such as have been retained remain’’).
53 See, e.g., 12 CFR 225.139 (‘‘2(g)(3) policy
statement’’). The 2(g)(3) policy statement describes
the implementation of section 2(g)(3) of the BHC
Act (Congress removed section 2(g)(3) from the BHC
Act in 1996). Section 2(g)(3) created a rebuttable
presumption that a transferor continued to control
securities of a company transferred to a transferee
if the transferee was indebted to the transferor or
if there were certain director or officer interlocks
between the transferor and transferee. The 2(g)(3)
policy statement remains relevant because it reflects
the Board’s longstanding position that terminating
control requires reducing relationships to lower
levels than would be consistent with a new
noncontrolling relationship.
54 See, e.g., Letter to Mark Menting, Esq., dated
February 14, 2012, https://www.federalreserve.gov/
bankinforeg/LegalInterpretations/bhc_
changeincontrol20120214.pdf.
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voting securities of the second
company, or only a majority of the
securities of the class of voting
securities that the divesting shareholder
is selling. In addition, commenters
asked the Board to clarify how the
divestiture presumption interacts with
the seeding period in the investment
fund context.
The final rule includes the divestiture
presumption substantially as proposed.
As noted, the possibility of continued
control in the context of a partial
divestiture has been identified as a
concern in Board precedent and case
law. The final rule balances these
concerns with the goal of providing
greater transparency and certainty to the
Board’s consideration of controlling
influence issues.
The final rule does not provide an
exception to the presumption to
facilitate the organization and
sponsorship of investment funds. Such
an exception is not necessary because
an investment adviser must have less
than 5 percent of each class of voting
securities of an investment fund after
the initial one-year seeding period in
order to not trigger the investment fund
presumption of control, and the
divestiture presumption only applies
where a company retains at least 15
percent of any class of voting securities.
Regarding the commenter requests for
clarification of the exception to the
divestiture presumption, the Board
clarifies that the exception only applies
when an unaffiliated person controls 50
percent or more of the outstanding
securities of each class of voting
securities of the company being
divested.
Presumption of Control for the
Combined Ownership of a Company
and Its Senior Management Officials
and Directors
The proposal included a presumption
that a company controls a second
company when (i) the first company
controls at least 5 percent of any class
of voting securities of the second
company and (ii) the senior
management officials and directors of
the first company, together with their
immediate family members and the first
company, own 25 percent or more of a
class of voting securities of the second
company (5–25 presumption). The
proposed presumption reflected the
Board’s historical position that it is
often appropriate to attribute securities
held by management officials of a
company to the company itself for
purposes of measuring control by a
company under the BHC Act. The
management officials of a company are
well positioned to coordinate their
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actions with each other and the
company to act as a single voting bloc
to advance the interests of the company.
The proposal differed from current
practice, however, by providing an
exception to this general presumption.
Specifically, the presumption did not
apply if (i) the first company controls
less than 15 percent of each class of
voting securities of the second company
and (ii) the senior management officials
and directors of the first company,
together with their immediate family
members, control 50 percent or more of
each class of voting securities of the
second company.
The proposed exclusion to the
presumption reflected the Board’s
traditional understanding that, when
individuals control an outright majority
of a class of voting securities of a second
company, it is likely the individuals
who are truly exercising control over the
second company, rather than any
company that employs the individuals.
Under these circumstances, the first
company is generally not a significant
conduit for control over the second
company.55
At least one commenter requested that
the Board clarify how the rule
attributing ownership of securities held
by senior management officials,
directors, or controlling shareholders of
a company to that company (proposed
12 CFR 225.9(c), 238.10(c)) would
operate in conjunction with the 5–25
presumption (proposed 12 CFR
225.32(d)(6), 238.22(d)(6)).
The final rule does not include the 5–
25 presumption of control of a
company. Instead, this presumption of
control of a company has been
integrated into the standard for control
by a company over voting securities.
Specifically, the final rule provides that
a company that controls 5 percent or
more of any class of voting securities of
another company also controls any
securities issued by the second
company that are controlled by the
senior management officials, directors,
or controlling shareholders of the first
company, or immediate family members
of such individuals. In addition, the
final rule incorporates into this standard
for control over securities the exclusion
contained in the proposed 5–25
presumption, as described further in
section III.C of this preamble.
Closely Held Companies and Widely
Held Companies
In developing the proposal, the Board
considered whether there should be
different presumptions for (i) companies
55 See Vickars-Henry Corp. v. Fed. Reserve Sys.,
629 F.2d 629 (9th Cir. 1980).
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that are widely held relative to
companies that are closely held or (ii)
companies that are majority owned by a
third party. The Board considered these
factors because it could be reasonable to
assume that a major investor in a
company that is otherwise widely held
has outsized influence compared to a
context where the major investor is one
of several major investors in a closely
held company. Similarly, in many cases,
it could be reasonable to assume that a
major investor has reduced influence
over a company where another investor
has an outright majority of the voting
securities of the company. The proposal,
however, did not include different
presumptions for widely held
companies versus closely held
companies or for companies under the
majority control of a third party because
such distinctions increased the
complexity of the proposal and could
have made the presumptions more
difficult to apply in practice.
Some commenters argued that the
presence of a larger, third-party
shareholder should create a
presumption of non-control for any
company with a lesser interest.
Commenters provided several different
proposals for how this might be
implemented, ranging from an
exemption from the presumptions of
control where a third party controls a
majority of the securities of a company
to an exemption from the presumptions
of control where a third party controls
a sufficiently large plurality of the
securities of a company. Some
commenters suggested that the presence
of a larger, third-party shareholder
should raise the level of other
relationships, particularly business
relationships, that two companies could
have before triggering a presumption of
control. Commenters also argued that a
majority shareholder should give rise to
a presumption of noncontrol for all
other shareholders.
Other commenters supported the
Board’s proposal not to create different
presumptions depending on the
shareholder composition of the second
company because of the complexity this
would add to the rule.
The presumptions in the final rule do
not differentiate between closely held
and widely held companies and
generally do not turn on the presence of
a majority third-party shareholder.
Although a company’s influence over
another company may vary based on the
shareholder structure of the second
company, adding exceptions to certain
presumptions of control because the
second company is closely held or
majority-controlled by a third party
would significantly increase the
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complexity of the rule. Moreover, the
Board notes that the statutory
framework contemplates that multiple
companies could control a single
company even if there is one company
that has predominant, or even majority,
control over the voting securities of the
company. Finally, having control
determinations turn on the shareholder
structure of the target company may
create practical difficulties for investors.
For example, a first company could
establish a relationship that does not
trigger a presumption of control over a
second company, but the second
company could subsequently become
more widely held, leading the first
company to trigger a presumption of
control without any action of its own.
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section 4 of the BHC Act. The same
exception would apply for purposes of
Regulation LL, to provide parallel
treatment under the BHC Act and
HOLA. The final rule also includes
additional clarifying edits to the
fiduciary exception.
The final rule does not provide
broader clarity around the scope of the
fiduciary exception. The Board notes,
however, that the fiduciary exception in
the final rule is intended to align with
the Board’s traditional understanding of
the scope of the fiduciary exceptions in
the BHC Act and Regulation Y. The
primary example of the role covered by
the fiduciary exception is that of the
trust department of a depository
institution that is authorized to engage
in fiduciary activities. Companies may
contact the Board or its staff to seek
clarification as to whether any
particular holding of securities would
qualify for the fiduciary exception.
Fiduciary Exception
Under the proposal, the presumptions
of control did not apply to the extent
that a company controls voting or
nonvoting securities of a second
company in a fiduciary capacity without
sole discretionary authority to exercise
the voting rights. This exception for
holding securities in a fiduciary
capacity is currently in the control
provisions of Regulation Y and was
retained in full.56
Many commenters argued that the
Board’s proposed exclusion for
securities held in a fiduciary capacity
was overly restrictive because it
included a requirement that the
fiduciary not have sole discretionary
voting authority over the securities.
Commenters noted that, although not
having sole discretionary voting
authority was required for the fiduciary
exemption in section 3 of the BHC Act,
section 4 of the BHC Act excluded
securities held in a fiduciary capacity
without this additional requirement.
Commenters also sought clarification
of when a company would be
considered to have sole discretionary
authority to exercise voting rights. At
least one commenter asked that the
Board provide that an investment
adviser lacks sole discretionary voting
authority where an investment fund has
the right to revoke the adviser’s voting
authority.
In response to the issues raised by
commenters, the fiduciary exception in
the final rule only requires that the
securities of a depository institution or
a depository institution holding
company be held without sole
discretionary voting authority.
Accordingly, the final rule’s fiduciary
exception would parallel the different
fiduciary exceptions in section 3 and
Under the proposal, a company was
presumed not to control a second
company if the first company (i)
controls less than 10 percent of every
class of voting securities of the second
company and (ii) is not presumed to
control the second company under any
of the proposed presumptions of
control. This provision of the proposal
modestly expanded the statutory and
pre-existing regulatory rebuttable
presumption of noncontrol that applies
where a first company controls less than
5 percent of any class of voting
securities of a second company.57
Many commenters supported the
proposed presumption of noncontrol,
arguing that controlling influence would
be especially unusual for companies
with less than 10 percent of each class
of voting securities of another company.
Some commenters argued that the Board
should expand the presumption of
noncontrol further to cover any
company that did not trigger a
presumption of control. At least one
commenter argued that a presumption
of noncontrol should at least apply to
foreign entities that do not trigger a
presumption of control in order to
mitigate extraterritorial application of
the BHC Act. Commenters also raised
concerns with the proposed exclusion
from the presumption of noncontrol for
any company that triggered a
presumption of control, at least as
applied to companies with less than 5
percent of any class of voting securities
of another company.
56 See 12 CFR 225.31(d)(2)(iv); see also 12 U.S.C.
1841(a)(5)(A).
57 12 U.S.C. 1841(a)(3), 12 CFR 225.31(e), and
238.21(e).
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The final rule adopts the rebuttable
presumption of noncontrol as
proposed.58 Thus, a company is
presumed not to control a second
company if the first company (i)
controls less than 10 percent of every
class of voting securities of the second
company and (ii) is not presumed to
control the second company under any
of the presumptions of control. This
approach and calibration of the
noncontrol presumption reflects the
Board’s experience that a company with
less than 10 percent of any class of
voting securities of another company is
unlikely to have a controlling influence
over the second company, absent the
indicia of control specified in the
control presumptions. The additional
changes supported by some commenters
would increase the scope of the
presumption of noncontrol significantly,
well beyond both the presumption of
noncontrol in the BHC Act and the
Board’s experience.
III. Final Rule—Control-Related
Definitions
The proposal proposed to amend
Regulation Y and Regulation LL to
update and clarify the definitions of
various control-related terms. This
section discusses in detail how the final
rule addresses each of these definitions.
Some commenters indicated that the
Board should define additional terms to
provide further clarity regarding the
application of the presumptions of
control. For example, a commenter
suggested that the Board clarify how the
presumptions of control would apply to
an agreement among shareholders that
is designed to preserve a company’s tax
status under the Internal Revenue Code.
In addition, a commenter stated that the
Board should clarify whether a
testamentary trust qualified as a
‘‘company’’ under the proposal.
The final rule does not introduce new
defined terms compared to the proposal,
though certain changes have been made
to the proposed defined terms as
described in detail in this section.
Consistent with the proposal, the final
rule includes defined terms to the extent
appropriate to clarify the application of
the rule, while avoiding overprescription that could limit the Board’s
ability to respond appropriately to
unusual facts and circumstances or to
prevent evasion of the framework.
Specifically with respect to agreements
to preserve tax status under the Internal
58 As under the proposal, the filing requirements
applicable to bank holding companies and savings
and loan holding companies for investments in 5
percent or more of any class of voting securities of
a company are not impacted as a result of the
presumption of noncontrol.
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Revenue Code, the final rule, consistent
with the proposal, clarifies that
covenants to take reasonable steps to
maintain a specific tax status generally
are not limiting contractual rights and
that agreements among shareholders to
preserve a certain tax status generally do
not constitute restrictions on securities
that provide control over the covered
securities. On the status of testamentary
trusts as companies under the BHC Act,
neither the proposal nor the final rule
alters the Board’s standards related to
testamentary trusts.
A. First Company and Second Company
The core of the proposal was the
addition of a series of presumptions of
control that apply in the context of the
Board making a determination that one
company has the ability to exercise a
controlling influence over another
company. To clarify the application of
these presumptions, the proposal
provided definitions of ‘‘first company’’
and ‘‘second company.’’
The proposal defined ‘‘first company’’
as the company whose control over a
second company was the subject of a
determination of control by the Board.
The proposal defined ‘‘second
company’’ as the company the control of
which by a first company was the
subject of a determination of control by
the Board. For many of the proposed
presumptions, the first company was
presumed to control the second
company if the first company, together
with its subsidiaries, had particular
relationships with the second company,
together with its subsidiaries.
In addition, the proposal provided
that, for purposes of the proposed
presumptions, any company that was
both a subsidiary of the first company
and the second company should be
treated as a subsidiary of the first
company but not as a subsidiary of the
second company. This provision
prevented the second company’s
relationships with a joint venture
subsidiary with the first company from
being considered relationships with the
first company for purposes of the
presumptions of control.
Some commenters contended that it
would be more appropriate to consider
only relationships between top-tier
parent companies. Relatedly, a few
commenters stated that first company
and second company should not be
defined to include their subsidiaries.
With respect to joint ventures, some
commenters argued that the language of
the proposal was difficult to apply and
that it would be better not to consider
any relationships with joint ventures
when reviewing for control between
joint venture partners.
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The final rule adopts the definitions
of first company and second company
as proposed.59 For purposes of
controlling influence, the Board
historically has considered the
relationships between one company and
its subsidiaries, on the one hand, and
another company and its subsidiaries,
on the other hand. Grouping a parent
company with its subsidiaries reflects
an understanding that a subsidiary
generally will comply with directions
from its parent company. Considering
only direct relationships between two
companies would ignore this dynamic
and thus the economic realities of
corporate structures. For example, an
investing company may own securities
in a top-tier bank holding company
while having substantial business
relationships with the bank holding
company’s subsidiary bank. Considering
the investing company’s relationships
with the bank holding company alone
and with the bank alone would exclude
important aspects of the combined
relationship between the investing
company, on the one hand, and the
bank holding company and the bank, on
the other hand.
Regarding joint ventures, the Board
historically has recognized that
relationships with joint ventures can be
significant for purposes of controlling
influence analysis because such
relationships can represent a significant
connection between the joint venture
partners. For this reason, the final rule
does not completely exclude
relationships with joint ventures.
Instead, consistent with the proposal,
the final rule provides that a company
that is a subsidiary of both the first
company and the second company is
treated as a subsidiary of the first
company and not of the second
company for purposes of applying the
presumptions of control. The Board
believes that this is a reasonable
standard for recognizing the potential
importance of joint ventures without
overstating such importance.
B. Voting Securities and Nonvoting
Securities
The BHC Act defines control to
include the ownership, control, or
power to vote 25 percent or more of any
class of voting securities of a
company.60 In addition, several of the
proposed presumptions required
identifying the percentage of a class of
59 First company and second company could take
a variety of legal entity forms, including a stock
corporation, limited liability company, partnership,
business trust, or foreign equivalents of such legal
entities. See 12 U.S.C. 1467a(a)(1)(C) and 1841(b).
60 12 U.S.C. 1841(a)(2)(A).
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voting securities controlled by a
company in another company.
Regulation Y and Regulation LL
previously included definitions of
‘‘voting securities’’ and ‘‘nonvoting
shares.’’ 61 The proposal changed the
defined term ‘‘nonvoting shares’’ to
‘‘nonvoting securities’’ and added to the
definition of ‘‘nonvoting securities’’
equity instruments issued by companies
other than stock corporations, such as
limited liability companies and
partnerships. In addition, the proposal
revised the definition of ‘‘nonvoting
securities’’ to clarify that common stock
can be nonvoting securities.62
Regulation Y and Regulation LL also
provide a nonexclusive list of examples
of the types of voting rights that the
Board has considered to be within the
scope of the defensive voting rights that
nonvoting securities may contain.63 The
proposal revised the definition of
nonvoting securities to expressly permit
certain additional defensive voting
rights that are commonly found in
investment funds that are organized as
limited liability companies and limited
partnerships. Specifically, the proposal
provided that defensive voting rights
that do not cause a security to be a
voting security include the right to vote
to remove a general partner or managing
member for cause, the right to vote to
replace a general partner or managing
member that has been removed for
cause or has become incapacitated, and
the right to vote to dissolve the
company or to continue operations
following the removal of a general
partner or managing member. Some
commenters asked that the Board
provide that certain securities—
including limited partnership interests,
REIT investment units, and trust
beneficiary rights—are nonvoting
securities.
The final rule is largely consistent
with the proposal on the definitions of
voting securities and nonvoting
securities. To prevent evasion, the final
rule does not categorically exclude any
specific types of securities issued by
certain legal entities from the definition
of voting securities. Although there is
substantial variability in the terms and
structures of securities in the financial
markets, the definitions of voting
securities and nonvoting securities in
the final rule have been drafted broadly
to apply effectively to all forms of legal
entities.
61 12
CFR 225.2(q).
safety and soundness reasons, the Board
generally believes that voting common
stockholders’ equity should be the dominant form
of equity for a banking organization. See, e.g., 78
FR 62018, 62044 (Oct. 11, 2013).
63 12 CFR 225.2(q)(2)(i); 12 CFR 238.2(r)(2)(i).
62 For
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C. Control of Securities
The proposed rule reflected the
Board’s current practice for determining
whether a company’s securities are
owned, controlled, or held with power
to vote by an investor and provided
rules for determining the percentage of
a class of a company’s voting securities
attributed to a person.
Ownership, Control, and Holding With
Power To Vote
The proposal provided rules for
determining whether a person
‘‘controls’’ a security.64 Specifically, the
proposal provided that a person controls
a security if the person owns the
security or has the power to sell,
transfer, pledge, or otherwise dispose of
the security. In addition, a person
controls a security if the person had the
power to vote the security, other than
due to holding a short-term, revocable
proxy. This proposed definition of
control over securities is consistent with
Board precedent and with the language
of the BHC Act.65
Some commenters suggested that
power to dispose of securities in certain
circumstances should not provide
control over the securities, such as
securities held in a fiduciary capacity or
as collateral that may be
rehypothecated. A few commenters
argued that securities held in a small
business investment company or in a
merchant banking portfolio company
should not be considered controlled.
Commenters also argued that securities
held in an underwriting, dealing, or
market making capacity should not be
considered controlled for purposes of
the presumptions of control.
The final rule makes minor revisions
to the proposal’s provisions on control
over securities. The final rule is
consistent with Board precedent and the
statutory framework. However, the
Board does recognize that securities
held by an underwriter for a very
limited period of time for purposes of
conducting a bona fide underwriting
generally do not raise control concerns.
An underwriter generally would hold
the securities only for a few days and
only for the purpose of prompt resale to
the market.66
The Board does not believe that the
final control rule should make
exceptions for small business
64 These proposed standards effectively replaced
the presumptions for control over voting securities
currently in 12 CFR 225.31(d)(1). In this discussion,
‘‘person’’ has the meaning provided in 12 CFR
225.2(l) and 12 CFR 238.2(j).
65 See, e.g., 12 U.S.C. 1841(a)(2)–(3) and 1842(a).
66 For example, the Board’s capital rule provides
a 5-day holding period for underwriting securities.
12 CFR 217.2.
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investment company investments,
merchant banking portfolio company
investments, or any specific investment
types. The Board’s general regulatory
framework addresses the permissibility
of these investments, and there are no
compelling reasons to treat these
investments differently than other
investments under the Board’s control
framework. For example, if a financial
holding company owns 100 percent of
the securities of a merchant banking
portfolio company, the financial holding
company controls the portfolio
company for purposes of the BHC Act
under the first prong of the definition of
control. The financial holding company
is able to have this ownership interest
under its merchant banking authority,
but must treat the portfolio company as
a controlled subsidiary under
Regulation Y.67
Options, Warrants, and Convertible
Instruments
The proposal provided standards for
deeming a person to control a security
through control of an option or warrant
to acquire the security or through
control of a convertible instrument that
may be converted into, or exchanged
for, the security. Under the proposal’s
‘‘look-through’’ approach, a person
would control all securities that the
person could control upon exercise of
any options or warrants. In addition, a
person would control all securities that
the person could control as a result of
the conversion or exchange of a
convertible instrument controlled by the
person. This approach was consistent
with the Board’s longstanding precedent
of generally considering a person to
control any securities (i) that the person
has a contractual right to acquire now or
in the future; or (ii) that the person
would automatically acquire upon
occurrence of a future event.68
In addition, the proposal provided
that a person controls the maximum
number of securities that could be
obtained under the terms of the option,
warrant, or convertible instrument.
Thus, for example, if the number of
securities that could be acquired upon
exercise of an option varied based on
some metric, such as the market price or
book value of the securities, the person
with the option was considered to
control the highest percentage of the
class of securities that could possibly be
acquired under the terms of the option.
Moreover, for purposes of calculating
a person’s percentage of a class of voting
securities or total equity, the proposal
generally deemed a person to control
67 12
CFR part 225, subpart J.
e.g., 2008 Policy Statement.
68 See,
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the percentage resulting from the
exercise of the person’s options,
warrants, or conversion features,
assuming that no other parties exercised
their options, warrants, or conversion
features. However, if, for example, a
person is only able to exercise an option
when all outstanding options in a class
are simultaneously exercised by all
holders, the percentage controlled by
the person should reflect the exercise of
all the outstanding options in the class,
not just those options held by the
person.
The proposal included several limited
exceptions to this general look-through
approach. Consistent with the 2008
Policy Statement, the proposal
incorporated a limited exception for
financial instruments that may convert
into voting securities but by their terms
may not become voting securities in the
hands of the current holder or any
affiliate of the current holder and may
only convert to voting securities upon
transfer to (i) the issuer or an affiliate of
the transferor, (ii) in a widespread
public distribution, (iii) in transfers
where no transferee or group of
associated transferees would receive 2
percent or more of any class of voting
securities of the issuer, or (iv) to a
transferee that controls 50 percent or
more of every class of voting securities
before the transfer.
The proposal also exempted from the
general look-through approach a
purchase agreement to acquire securities
that had not yet closed. This exemption
allowed parties to enter into securities
purchase agreements pending regulatory
approval, due diligence, and satisfaction
of other conditions to closing.
In addition, the proposal exempted
from the general look-through approach
any options, warrants, or convertible
instruments that permitted an investor
to acquire additional voting securities
only to maintain the investor’s
percentage of voting securities in the
event the issuing company increased the
number of its outstanding voting
securities.
Many commenters suggested that the
Board should apply the look-through
approach only to narrow classes of
options, warrants, and convertible
instruments, or that the Board should
not look through options, warrants, or
convertible instruments at all. Some
commenters suggested that the Board
only look through options or convertible
instruments if they could be freely
exercised within 60 days, are in the
money, or are not subject to a remote
contingency trigger or condition outside
of the holder’s control. Some
commenters argued that the lookthrough approach should not apply to
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options if the investor does not have
control over the exercise of the option.
A few commenters asked the Board to
clarify the application of the standards
from the 2008 Policy Statement under
the proposal. A few commenters
suggested that the Board clarify that
nonvoting securities will remain
nonvoting even if they have the right to
elect directors after six quarterly
dividend payments are missed,
consistent with Board precedent.
The final rule is generally consistent
with the proposal with respect to these
provisions. However, the final rule
includes an additional exception to the
look-through approach that preferred
securities that have no voting rights
unless the issuer fails to pay dividends
for six or more quarters are only
considered to be voting securities if a
sufficient number of dividends are
missed and the voting rights are active.
As noted by commenters, this additional
narrow exception to the look-through
approach is consistent with Board
precedent and helps to address a fairly
common feature of preferred securities.
Securities with springing voting rights
that do not fit into this exception
generally will be considered to be voting
securities under the look-through
approach.
The final rule does not include any of
the other limitations on the lookthrough approach supported by
commenters. The look-through
approach appropriately recognizes that
options, warrants, and convertible
instruments provide the holder of such
instruments with the ability to control
the underlying securities by exercising
the option, warrant, or convertible
instrument, or transferring the option,
warrant, or convertible instrument. In
addition, many of the suggested
limitations on the look-through
approach are not practicable. For
example, looking through in-the-money
options while not looking through outof-the-money options could result in
unpredictable moves from non-control
to control of a bank without the ability
of the investor to apply or receive prior
approval under section 3 of the BHC
Act. Moreover, excluding from the lookthrough approach options, warrants,
and convertible instruments with
remote contingency triggers would
require the Board to adopt an
impracticable measure of remoteness.
The Board notes that the final rule’s
exception to the look-through approach
based on transfer restrictions has been
slightly revised to conform more
precisely to the 2008 Policy Statement.
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Control Over Securities Through
Restrictions on Rights
Consistent with current regulations,
the proposal provided that a person
controls securities if the person is a
party to an agreement or understanding
under which the rights of the owner or
holder of securities are restricted in any
manner, unless the restriction falls
under one of the exceptions specified in
the rule.69
The proposal provided six exceptions
to this general rule, each designed to
accommodate certain common
restrictions on securities that do not
provide the type of control over
securities relevant to this rulemaking.
The first exception was for rights of first
refusal, rights of last refusal, tag-along
rights, drag-along rights, or similar
rights that are on market terms and that
do not impose significant restrictions on
the transfer of the securities. Second,
the proposal provided an exception for
arrangements that restrict the rights of
an owner or holder of securities when
the restrictions are incidental to a bona
fide loan transaction. Third, the
proposal provided that an arrangement
that restricts the ability of a shareholder
to transfer securities pending the
consummation of an acquisition of the
securities does not provide the
restricting party control over the
securities of the restricted party. Fourth,
the proposal generally provided that an
arrangement that requires a current
shareholder of a company to vote in
favor of a proposed acquisition of the
company would not result in the
proposed acquirer controlling the
securities of the current shareholder.
Fifth, the proposal exempted
arrangements among the shareholders of
a company designed to preserve the tax
status or tax benefits of a company, such
as qualifying as a Subchapter S
Corporation 70 or to preserve tax assets
(such as net operating losses) against
impairment.71 Sixth, the proposal
provided that a short-term revocable
proxy would not provide the holder of
the proxy with control over the
securities governed by the proxy.72
69 This standard could result in multiple persons
being considered to have control over the same
securities. This remains possible under the final
rule.
70 See 26 U.S.C. 1361.
71 See 26 U.S.C. 382. In order to qualify for this
exemption, the arrangement was required to not
impose restrictions on securities beyond those
reasonably necessary to achieve the goal of
preserving tax status, tax benefits, or tax assets.
Agreements of this type may raise significant safety
and soundness concerns under certain
circumstances, independent of whether control
concerns are raised.
72 The proposed treatment of short-term revocable
proxies was consistent with the Board’s current
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The Board received very few
comments on this framework and is
adopting the framework as proposed.
Control of Securities Through
Associated Individuals and Subsidiaries
The proposal provided that a
company that owns, controls, or holds
with power to vote 5 percent or more of
any class of voting securities of a second
company controls any securities issued
by the second company that are owned,
controlled, or held with power to vote
by the senior management officials,
directors, or controlling shareholders of
the first company, or by the immediate
family members of such individuals.73
In addition, the proposal provided that
a person controls all voting securities
controlled by any subsidiaries of the
person, and that a person generally does
not control any voting securities
controlled by any non-subsidiary of the
person.
At least one commenter argued that
the Board should not consider securities
held in separate accounts by an
insurance company to be controlled by
the insurance company, or that the
Board should clarify how separate
accounts may be structured so that
securities in such accounts are not
treated as controlled by the insurance
company. One commenter requested
clarification regarding the attribution of
voting securities held in a voting trust.
The final rule defines control over
securities through associated
individuals and subsidiaries in a
manner substantially consistent with
the proposal. The final rule has been
revised, however, to integrate the
standards for control over voting
securities through associated
individuals with the proposed 5–25
presumption. Specifically, the proposed
5–25 presumption substantially
overlapped with the provision
providing that a company should be
attributed the securities of its senior
management officials, directors, and
controlling shareholders, as well as
immediate family members of such
individuals. As a result, as discussed
above, the proposed 5–25 presumption
is not necessary and is not included in
the final rule. However, the Board is
revising the provisions related to control
over voting securities through
associated individuals to incorporate
the exception to the proposed 5–25
presumption when the company
controls less than 15 percent of each
class of voting securities of the other
regulations regarding notices under the Change in
Bank Control Act. See 12 CFR 225.41(d)(4); 12 CFR
225.42(a)(5).
73 See 12 CFR 225.31(d)(2)(ii).
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company and a majority of each class of
voting securities of the other company
are controlled by the first company’s
senior management officials, directors,
and controlling shareholders, as well as
immediate family members of such
individuals.
The final rule does not include the
express statement from the proposal that
a company does not control securities
that are controlled by a non-subsidiary
of the company. Although the Board
continues to believe that a company
generally should not be deemed to
control securities held by a nonsubsidiary of the company, the Board
has removed this provision from the
final rule so as not to create an
expectation that a company would
never be deemed to control securities
held by a non-subsidiary. For example,
a company generally would be deemed
to control securities held by a nonsubsidiary if the company had an option
to acquire those securities.
Reservation of Authority
The proposal included a reservation
of authority to allow the Board to
determine that securities that would
otherwise be considered controlled by a
person under the proposal are not
controlled by the person. Similarly, the
proposed reservation of authority
allowed the Board to determine that
securities that are not considered
controlled by a person under the
proposal are controlled by the person.
The Board received no comments
specifically on this reservation of
authority provision and the final rule
includes the reservation of authority
consistent with the proposal. The
reservation of authority is meant to
allow the Board to deal with rare
circumstances that do not align with the
intent of the rule.
Percentage of a Class of Voting
Securities
The proposal provided a rule for
calculating the percentage of a class of
voting securities controlled by a person.
The proposed rule considered both the
number of securities and the voting
power of those securities. Specifically,
the percentage of a class of voting
securities controlled by a person was
the greater of (i) the number of voting
securities of the class controlled by the
person divided by the number of issued
and outstanding voting securities of the
class (expressed as a percentage) and (ii)
the number of votes that the person
could cast divided by the total number
of votes that may be cast under the
terms of all the voting securities of the
class that are issued and outstanding
(expressed as a percentage).
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Commenters argued that the Board
should not include two voting
ownership tests and should only
calculate voting ownership based on
voting power not on number of voting
securities owned.
The final rule is generally consistent
with the proposal. Considering both
voting power and number of voting
securities is consistent with the text of
the BHC Act, the legislative history, and
Board precedents. This method of
calculation also prevents evasion
through the use of securities with
different voting power.
D. Calculation of Total Equity
Percentage
The proposal provided a methodology
for calculating a company’s total equity
percentage in a second company that
was a stock corporation that prepared
financial statements according to GAAP.
The first step to calculate a company’s
total equity in a second company was to
determine the percentage of each class
of voting and nonvoting common or
preferred stock issued by the second
company that the first company
controlled.74 The second step was to
multiply the percentage of each class of
stock controlled by the first company by
the value of shareholders’ equity
allocated to the class of stock under
GAAP, with retained earnings allocated
to common stock. The third and final
step was to divide the first company’s
dollars of shareholders’ equity by the
total shareholders’ equity of the second
company, as determined under GAAP.
The proposal also provided
adjustments to this general standard for
more complex structures. For example,
a first company was considered to
control all equity securities controlled
by its subsidiaries. The proposal also
provided that a first company controls
a pro rata share of equity securities
controlled by a non-subsidiary of the
first company.
Under the proposal, the total equity
calculation methodology applied by its
terms only to stock corporations that
prepare financials under GAAP.
However, the proposed rule indicated
that the Board generally would apply
the methodology in other circumstances
as well, to the extent appropriate.
The proposal also included several
anti-evasion provisions. Specifically,
where a company controlled debt of a
second company that was functionally
74 For this purpose, all classes of common stock—
whether voting or nonvoting—were treated as a
single class. If certain classes of common stock had
different economic interests per share in the issuing
company, the number of shares of common stock
was adjusted to equalize the economic interest per
share.
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equivalent to equity of the second
company, the debt was counted as
equity for purposes of the total equity
calculation. The proposal provided a
nonexclusive list of factors that the
Board would examine in deciding
whether to treat debt instruments as
functionally equivalent to equity. These
factors included treatment of the debt as
equity under accounting, regulatory, or
tax standards; subordination of the debt;
or long maturity of the debt. Similarly,
the proposal provided that other
interests in a company beyond debt that
were functionally equivalent to equity
may be treated as equity.
In addition to a methodology for
calculating total equity, the proposal
provided a standard for the frequency of
measurement of total equity. Under the
proposal, an investing company was
required to calculate its total equity in
a second company each time the
investing company acquired control
over additional equity interests of the
second company or divested control of
equity interests of the second company.
Many commenters criticized the
proposed total equity calculation
methodology. In particular, commenters
argued that it would lead to a first
company being presumed to control a
second company where the second
company had negative retained earnings
and the first company controlled
preferred securities of the second
company that included a liquidation
preference. Several commenters
recommended that retained earnings
from start-up companies be excluded
from the total equity calculation to
avoid this problem. Some commenters
alternatively recommended that the
final rule include an exception for startup companies where the total equity
presumption would not apply for the
first several years of a company’s
existence.
Certain commenters suggested that
the Board calculate total equity using a
common stock equivalent method as an
alternative to the proposed
methodology. Some commenters argued
that the Board should establish more
flexible rules for investments by and in
investment funds.
Many commenters recommended that
the Board not include debt instruments
or other interests in the total equity
calculation under the proposal’s
functional equivalence standard.
Commenters argued that the standard
was vague and could inhibit the use of
certain common types of debt and other
economic interests. At least one
commenter suggested that the Board
also provide that equity may be treated
as functionally equivalent to debt under
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appropriate circumstances and thus
excluded from total equity.
Various commenters urged the Board
to eliminate or restrict the scope of the
provisions of the total equity
methodology that required a company to
include a pro rata share of equity
securities held by a non-subsidiary.
One commenter suggested that the
Board revise the frequency of
recalculation of total equity to require
recalculation only if a company acquires
control over additional voting equity, or
only if a company controls five percent
or more of a class of voting securities.
Some commenters recommended that
the final rule require recalculation of
total equity only when a company
acquires equity, never in the case of
divestiture of equity.
The final rule’s methodology for
determining a company’s total equity
percentage in another company is
largely consistent with the proposal.
The Board believes that the GAAP-based
core methodology of the final rule is
effective, fit for purpose, wellunderstood, and easy to apply. The final
rule includes a technical correction to
the formula for total equity so that pari
passu classes of preferred stock (i.e.,
classes of preferred securities of the
same seniority in liquidation) are
treated as a single class.
The final rule includes without
change the provision whereby debt or
other interests may be treated as equity
if the interests are functionally
equivalent to equity. The Board expects
to reclassify debt as equity under the
rule only under unusual circumstances
to prevent evasion of the rule. The list
of debt features that support a
reclassification as equity should not be
understood to indicate that a debt
instrument having any one of such
features automatically would be treated
as equity.
In response to concerns raised by
commenters, the final rule provides
flexibility for excluding nominally
equity instruments from total equity if
the equity instruments are determined
to be functionally equivalent to debt.
The final rule also includes a nonexclusive list of characteristics that
could indicate that an equity instrument
may be functionally equivalent to debt,
such as protections generally provided
to creditors, a limited term, a fixed rate
of return or a variable rate of return
linked to a reference interest rate,
classification as debt for tax purposes,
or classification as debt for accounting
purposes.75 This provision is intended
to provide flexibility for unusual
structures and is expected to be used
75 See,
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rarely. Companies should consult with
the Board or its staff in order to
determine whether equity instruments
would be excluded from total equity.
The final rule does not include the
proposed provision that required a
company to include a pro rata share of
equity securities held by a nonsubsidiary Accordingly, a company
must include in the total equity
calculation only equity securities it
controls directly or indirectly through
its subsidiaries.
Also in response to concerns raised by
commenters, the final rule requires
calculation of total equity only when a
first company acquires control over
additional equity of a second company.
The first company is not required to
recalculate its total equity when it sells
or otherwise disposes of equity of the
second company. This change will
prevent a divestiture from causing an
increase in total equity due to balance
sheet changes at the second company.
E. Limiting Contractual Rights
Under the proposal, a company was
presumed to control a second company
if the first company had a contractual
right that significantly restricts, or
allows the first company to significantly
restrict, the discretion of the second
company over major operational or
policy decisions.76 Such contractual
provisions was defined as a limiting
contractual right.
The proposal provided examples of
provisions that generally were
considered limiting contractual rights
and examples of provisions that
generally were not considered limiting
contractual rights. The examples
included in the proposal were not
intended to be a complete list of
provisions that would or would not be
considered limiting contractual rights.
Rather, the provisions were meant as
non-exclusive examples to provide
transparency. The examples of limiting
contractual rights listed in the proposal
were:
• Restrictions on activities in which a
company may engage, including a
prohibition on (i) entering into new
lines of business, (ii) making substantial
changes to or discontinuing existing
lines of business, (iii) entering into a
contractual arrangement with a third
party that imposes significant financial
obligations on the company, or (iv)
materially altering the policies or
procedures of the company;
76 For purposes of this restriction, a contractual
arrangement between the first company and a
subsidiary of the second company, or between a
subsidiary of the first company and the second
company, could constitute a limiting contractual
right of the first company over the second company.
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• Requirements that a company direct
the proceeds of the investment to effect
any action, including to redeem the
company’s outstanding voting
securities;
• Restrictions on hiring, firing, or
compensating senior management
officials of a company, or restrictions on
significantly modifying a company’s
policies concerning the salary,
compensation, employment, or benefits
plan for employees of the company;
• Restrictions on a company’s ability
to merge or consolidate, or its ability to
acquire, sell, lease, transfer, spin-off,
recapitalize, liquidate, dissolve, or
dispose of subsidiaries or major assets;
• Restrictions on a company’s ability
to make significant investments or
expenditures;
• Requirements that a company
achieve or maintain certain fundamental
financial targets, such as a debt-toequity ratio, a net worth requirement, a
liquidity target, or a working capital
requirement;
• Requirements that a company not
exceed a specified percentage of
classified assets or non-performing
loans;
• Restrictions on a company’s ability
to pay or not pay dividends, change its
dividend payment rate on any class of
securities, redeem senior instruments,
or make voluntary prepayment of
indebtedness;
• Restrictions on a company’s ability
to authorize or issue additional junior
equity or debt securities, or amend the
terms of any equity or debt securities
issued by the company;
• Restrictions on a company’s ability
to engage in a public offering or to list
or de-list securities on an exchange;
• Restrictions on a company’s ability
to amend its articles of incorporation or
by-laws, other than limited restrictions
that are solely defensive for the investor;
• Restrictions on the removal or
selection of any independent
accountant, auditor, or investment
banker; or
• Restrictions on a company’s ability
to alter significantly accounting
methods and policies, or its regulatory,
tax, or corporate status, such as
converting from a stock corporation to a
limited liability company.
The proposal’s examples of
contractual provisions that generally
would not be limiting contractual rights
were:
• A restriction on a company’s ability
to issue securities senior to the
securities owned by the investor;
• A requirement that a company
provide the investor with financial
reports of the type ordinarily available
to common stockholders;
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• A requirement that a company
maintain its corporate existence;
• A requirement that a company
consult with the investor on a
reasonable periodic basis;
• A requirement that a company
comply with applicable statutory and
regulatory requirements;
• A requirement that a company
provide the investor with notice of the
occurrence of material events affecting
the company or its significant assets;
• A market standard ‘‘most-favored
nation’’ requirement that the investor
receive similar contractual rights as
those held by other investors in a
company; or
• Drag-along rights, tag-along rights,
rights of first or last refusal, or stock
transfer restrictions related to
preservation of tax benefits of a
company, such as S-corporation status
and tax carry forwards, or other similar
rights.
Commenters suggested that the scope
of the definition of limiting contractual
rights might be inconsistent with past
precedent. Many commenters argued
that the list of limiting contractual rights
was overly broad and encompassed
many standard investor protection
rights. In addition, many commenters
argued that the open-ended definition of
limiting contractual right to include any
right that restricts or allows one
company to exert significant influence
over another was overly vague.
In addition, commenters objected to
including within the scope of limiting
contractual rights various of the
examples provided, including limits on:
The second company’s ability to enter
into new lines of business; how the
second company directs the proceeds of
investments; the second company’s
ability to incur additional debt or raise
additional equity; requirements that the
second company maintain a particular
financial ratio; the second company’s
ability to amend the terms of its debt or
equity securities; the second company’s
ability to engage in a public offering, or
to list or de-list securities on an
exchange; the second company’s ability
to merge or consolidate with another
company; the second company’s ability
to dispose of material subsidiaries or
assets; and the second company’s ability
to alter its accounting methods or
policies or its regulatory, tax, or liability
status.
The final rule’s definition of a
limiting contractual right is generally
consistent with the proposal. Limiting
contractual rights are important indicia
of controlling influence. In particular,
limiting contractual rights provide a
means for a company to cause or
prevent otherwise permissible actions
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by another company, independent of the
first company’s exercise of its voting
rights as a shareholder in the second
company. Using such contractual rights,
a company that has relatively low voting
power may effectively control another
company’s decisions over important
actions, or at least have influence over
such decisions well beyond what the
first company’s voting power would
provide.77
The variety of forms that limiting
contractual rights may take makes the
functional definition included in the
final rule preferable to a prescriptive
definition. The final rule, consistent
with the proposal, includes lists of
contractual rights that generally would
or would not be considered limiting
contractual rights in order to provide
additional clarity around the specific
application of the definition. The lists of
contractual rights reflect a distillation of
the Board’s past practice and current
understanding of the types of
contractual restrictions that likely
would or would not raise controlling
influence concerns. The lists of
contractual rights have not been
changed from the proposal, though the
introductory text of each list has been
revised to make it clear that the listed
provisions are examples of what
generally would or would not be
considered a limiting contractual right.
Whether or not a particular contractual
right is a limiting contractual right
depends on whether the contractual
right meets the functional regulatory
definition of a limiting contractual right.
Commenters argued that a restriction
on new lines of business should not be
considered a limiting contractual right
because such a restriction would help a
bank holding company comply with the
activity limitations in the BHC Act.
Similarly, commenters argued that
covenants to comply with the activities
restrictions under the BHC Act or HOLA
should not be treated as limiting
contractual rights. Under the final rule,
a contractual prohibition on engaging in
particular activities is generally a
limiting contractual right. However, the
Board notes that a contractual provision
that provides a reasonable and nonpunitive mechanism for an investing
company to reduce its investment to
comply with the activities restrictions of
the BHC Act or HOLA generally would
not be a limiting contractual right.
One commenter asked the Board to
clarify whether a contractual right
restricting ‘‘materially altering policies
77 Such limiting contractual rights also may raise
safety and soundness concerns by restricting the
ability of a company to take appropriate actions to
address supervisory issues.
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or procedures’’ would qualify as a
limiting contractual right. A restriction
of this type generally would be
considered a limiting contractual right.
It is similar to the example of a limiting
contractual right provided in the final
rule related to amendments to the
articles or bylaws of a company.
Commenters suggested that the right
to information available to shareholders
should be expanded to include access to
information that is necessary or
appropriate to allow the first company
to monitor its investment and to
monitor regulatory, legal, or other
requirements or standards, including
the presumptions of control in the final
rule. In the Board’s view, an investor’s
right to access information regarding the
relationship between the investor and
the investee company, such as the
information necessary to determine the
application of the presumptions of
control, generally would not be
considered a limiting contractual right.
In addition, the final rule has been
revised to clarify that a contractual right
to information ordinarily available to
common shareholders, whether or not
the information is financial in nature, is
generally not a limiting contractual
right.
Commenters also argued that the
presumption of control based on
limiting contractual rights should be
revised so that the presumption does
not apply if the first company cannot
exercise the right unilaterally or if the
first company is not the largest single
decider of the exercise of the right. One
commenter sought clarification as to
whether, and in what circumstances,
voting rights exercised by a group of
investors (such as a voting right that can
only be exercised by certain preferred
shareholders) would be treated as a
limiting contractual right. To avoid
undue complexity, the final rule does
not specifically address contractual
provisions that incorporate elements of
voting by requiring agreement of a
certain percentage of certain parties.
Companies with questions on a
particular limiting contractual right may
contact the Board or its staff to address
the specific situation.
In addition, commenters expressed
concern that the proposal would treat
standard loan or bond covenants as
limiting contractual rights. Commenters
argued that treating loan covenants as
limiting contractual rights would make
it impossible for a bank to make a loan
to another company if its affiliate had
also made an equity investment in that
company. Some commenters argued that
standard loan covenants should not
trigger a presumption of control when
they are on market terms, there are
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multiple lenders, and the first company
has less than 15 percent voting power in
the second company. The final rule does
not include any revisions in response to
these comments. In the Board’s view, a
contractual provision that significantly
restricts a company’s discretion over
operational and policy decisions ought
to be treated as a limiting contractual
right in the final rule. Whether or not
the limiting contractual right is
embedded in a market-standard loan
agreement does not affect the influence
the limiting contractual right provides
the holder of the right. The Board
generally has controlling influence
concerns when a company, directly or
indirectly, both controls a material
amount of voting securities of another
company and has the ability to
significantly restrict the discretion of
the other company over operational or
policy decisions by contract.
F. Director Representatives
As discussed, the Board has long
taken the position that director
representatives of a company serving on
the board of directors of a second
company are an avenue through which
the first company may exercise a
controlling influence over the second
company. To provide more clarity on
when the Board deems an individual to
be a director representative of a
company, the proposal defined director
representative to be any director who (i)
is a current director, employee, or agent
of the company; (ii) was a director,
employee, or agent of the company
within the preceding two years; or (iii)
is an immediate family member of an
individual who is a current director,
employee, or agent of the company, or
was a director, employee, or agent of the
company within the preceding two
years. In addition, the proposal
provided that a director is a director
representative of a first company if the
director was proposed to serve as a
director by the first company, whether
by exercise of a contractual right or
otherwise. The proposal also specified
that a nonvoting observer is not a
director representative.
Some commenters suggested that the
definition of a director representative
was too broad and could include
directors over which the first company
did not have substantial influence. In
particular, some commenters contended
that director representatives should not
include individuals elected to the board
of directors of a mutual fund by a first
company if the director representatives
are independent of the first company.
A few commenters expressed concern
that the proposed definition might mean
that the Board would attribute a director
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to a company if the company merely
suggested the name of the director to a
nominating committee. Some
commenters also expressed concern
about the ambiguity of treating ‘‘agents’’
of a company as director representatives
and requested that the Board define the
term agent in this context.
Several commenters argued that the
definition of director representative
should include only former directors of
the first company and should not
include former employees. Similarly,
some commenters suggested that a
company should only be attributed a
former officer, director, or employee if
the individual became a director of the
second company while still an officer,
director, or employee of the first
company.
Some commenters argued that the
inclusion of immediate family members
of directors, employees, and agents of
the first company was too broad and
would create compliance difficulties,
especially with respect to employees of
large companies. These commenters
argued that the immediate family
member prong ought to be removed
from the definition of director
representative.
In response to the comments received,
the Board is substantially amending the
definition of a director representative to
be more functional and more narrow.
Specifically, under the final rule,
‘‘director representative’’ is defined as
an individual that represents the
interests of a first company through
service on the board of directors of a
second company. The final rule then
provides a non-exclusive list of
examples of persons who generally
would be considered to be director
representatives for purposes of the final
rule: (i) Individuals who are officers,
employees, or directors of the first
company, (ii) individuals who were
officers, employees, or directors of the
first company within the preceding two
years, and (iii) individuals who were
nominated or proposed by the first
company to be directors of the second
company. Companies may contact the
Board or its staff for guidance in
determining whether or not a particular
individual would be considered to be a
director representative for purposes of
the final rule.
G. Investment Advisers
The proposal defined investment
adviser for purposes of the proposed
presumptions to mean a company that
is registered as an investment adviser
with the SEC under the Investment
Advisers Act,78 a company registered
78 15
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with the Commodity Futures Trading
Commission (‘‘CFTC’’) as a commodity
trading adviser under the Commodity
Exchange Act,79 a company that is a
foreign equivalent of an investment
adviser or commodity trading adviser
registered with the SEC or CFTC,
respectively, or a company that engages
in any of the activities set forth in
section 225.28(b)(6)(i) through (iv) of the
Board’s Regulation Y.
The Board did not receive comments
specifically on the definition of
investment adviser, although the Board
did receive comments on the
presumption of control based on
investment advisory relationships. The
comments on the presumption of
control based on investment advisory
relationships are discussed earlier in
this preamble. The final rule adopts the
definition of investment adviser as
proposed.
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IV. Application to Savings and Loan
Holding Companies
As noted, the proposal applied
equally to bank holding companies and
savings and loan holding companies to
the maximum extent permitted by law.
HOLA defines control in a substantially
similar manner as the BHC Act.80 The
Board previously recognized that the
statutory control framework under the
BHC Act and HOLA are nearly identical
and determined to apply matching
procedures for reviewing controlling
influence cases involving savings and
loan holding companies under
Regulation LL as apply to bank holding
companies under Regulation Y.81
Consistent with this principle, the
proposal incorporated the proposed
control presumptions and related
revisions into the Board’s Regulation LL
for savings and loan holding companies
in essentially the same manner as into
the Board’s Regulation Y for bank
holding companies. The Board is also
amending portions of subpart A of
Regulation LL to incorporate current
§ 238.9 into § 238.8. This does not any
change requirements under these
sections, but is merely a technical edit
to make room for the new section
§ 238.9 adopted by this final rule.
A. Control Under HOLA Compared to
the BHC Act
Although controlling influence is
defined similarly under HOLA and the
BHC Act, there are several differences
between the definitions of ‘‘control’’ in
each statute. Under HOLA, the
definition of control applies to both
individuals and companies controlling
other companies, while control is
limited to companies controlling other
companies under the BHC Act.82 Under
HOLA, a person controls a company if
the person has more than 25 percent of
any class of voting securities of the
company, rather than 25 percent or
more of any class of voting securities
under the BHC Act.83 Unlike the BHC
Act, HOLA specifies that a general
partner of a partnership controls the
partnership, a trustee of a trust controls
the trust, and a person that has
contributed more than 25 percent of the
capital of a company controls the
company.84 Further, HOLA does not
include the BHC Act’s presumption of
noncontrol for a company with a less
than 5 percent voting interest in another
company.85
At least one commenter stated that the
Board should confirm past decisions of
the Office of Thrift Supervision
indicating that contributed capital for
purposes of HOLA was the same as total
equity, or that the Board should
otherwise clarify its interpretation of
contributed capital for purposes of
HOLA. One commenter suggested that
the Board should seek additional public
comment on its interpretation of
contributed capital.
In response to comments received on
the proposal, the final rule has been
revised to reflect that contributed
capital for purposes of HOLA generally
has the same meaning as total equity as
used by the Board in the context of
control under the BHC Act. As a result,
the final rule differs from the proposal
in several respects. Specifically, the
final rule omits the concept of total
equity from subpart C of Regulation LL
because subpart C relates to questions of
controlling influence and contributed
capital is a separate part of the statutory
definition of control under HOLA. The
rules for calculating total equity under
subpart D of Regulation Y reflect how
the Board generally expects to measure
contributed capital for purposes of
HOLA and Regulation LL.
B. Revisions to Regulation LL
Under the proposal, the Board
included in Regulation LL the same
presumptions and related amendments
made to Regulation Y, with limited
changes to reflect the relevant
differences between control under the
BHC Act and HOLA. The proposed
defined terms were located in § 238.2 of
79 7
82 12
80 Compare
83 12
U.S.C. 1 et seq.
12 U.S.C. 1467a(a)(2) (HOLA) with 12
U.S.C. 1841(a)(2) (BHC Act).
81 76 FR 56508, 56509 (Sept. 13, 2011).
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U.S.C. 1467a(a)(2).
U.S.C. 1467a(2)(A)–(B) and 1841(a)(2)(A).
84 12 U.S.C. 1467a(2)(B)–(C).
85 12 U.S.C. 1841(a)(3).
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Regulation LL. The proposed provisions
relating to the calculation of the
percentage of a class of securities
controlled by a person were located in
§ 238.9 of Regulation LL. The proposed
provisions related to control
proceedings, including the proposed
presumptions of control and noncontrol,
were located in subpart C of Regulation
LL.
The Board did not receive any
comments specifically on how the rule
amended Regulation LL, other than the
contributed capital issue described
previously. Accordingly, other than the
provisions related to total equity and the
placement of proposed § 238.10 in
§ 238.9 instead, the final rule creates an
essentially consistent control framework
between Regulation Y and Regulation
LL.
V. Additional Implementation Matters
Use of Passivity Commitments
Some commenters suggested that the
Board abandon its use of passivity
commitments and clarify that such
commitments are not needed going
forward. Other commenters requested
that the Board clarify whether it intends
to continue to seek either the general
passivity commitments or any of the
specialized types of similar
commitments. A few commenters also
requested that the Board provide a
process under which companies that
have provided passivity commitments
may obtain relief from the commitments
to align to the control framework. Some
commenters suggested that investors
that had previously submitted passivity
commitments to the Board should be
allowed to increase their relationships
with the target company without
seeking relief from commitments so long
as the increased relationships would not
trigger a presumption of control under
the final rule.
The Board does not intend to obtain
the standard-form passivity
commitments going forward in the
ordinary course. The Board will
continue to obtain control-related
commitments in specific contexts, such
as commitments from employee stock
ownership plans and mutual fund
complexes, and in special situations.
In the wake of the final rule,
companies that have provided the
standard form of passivity commitments
to the Board may contact the Board or
the appropriate Federal Reserve Bank to
seek relief from these commitments.
Absent unusual circumstances, the
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Board expects to be receptive to such
requests for relief.86
Application of the Final Rule
Several commenters suggested that
the Board’s new control framework
should only apply prospectively.
Similarly, some commenters suggested
that the Board grandfather all existing
investments or more narrowly
grandfather existing investments that
had been reviewed by the Board or its
staff. Some commenters advocated for a
three-year phase-in period for foreign
banking organizations so that these
firms could make adjustments to their
business practices to account for the
final rule.
The final rule provides additional
information regarding the Board’s views
on questions of controlling influence,
but it is generally consistent with the
Board’s current practice. As it is not a
fundamental change to current practice,
the final rule does not grandfather
existing structures and does not provide
a transition period to allow firms to
conform existing investments. The
Board does not expect to revisit
structures that have already been
reviewed by the Federal Reserve System
unless such structures are materially
altered from the facts and circumstances
of the original review. To the extent that
a company previously considered an
existing relationship between two
companies to not constitute control, the
relationship was not reviewed by the
Federal Reserve System, and the
relationship would be presumed to be a
controlling relationship under the final
rule, the company may contact the
Board or its staff to discuss potential
actions.
VI. Administrative Law Matters
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A. Paperwork Reduction Act
In accordance with the requirements
of the Paperwork Reduction Act of 1995
(44 U.S.C. 3501–3521) (PRA), the Board
may not conduct or sponsor, and a
respondent is not required to respond
to, an information collection unless it
displays a currently valid Office of
Management and Budget (OMB) control
number. The Board reviewed the final
rule and determined that it does not
create any new or revise any existing
collection of information under section
3504(h) of title 44.
B. Regulatory Flexibility Act
An initial regulatory flexibility
analysis (IRFA) was included in the
proposal in accordance with section
603(a) of the Regulatory Flexibility Act
(RFA), 5 U.S.C. 601 et seq. (RFA). In the
IRFA, the Board requested comment on
the effect of the proposed rule on small
entities and on any significant
alternatives that would reduce the
regulatory burden on small entities. The
Board did not receive any comments on
the IRFA. The RFA requires an agency
to prepare a final regulatory flexibility
analysis unless the agency certifies that
the rule will not, if promulgated, have
a significant economic impact on a
substantial number of small entities.
Based on its analysis, and for the
reasons stated below, the Board certifies
that the rule will not have a significant
economic impact on a substantial
number of small entities.87
Under regulations issued by the Small
Business Administration, a small entity
includes a bank, bank holding company,
or savings and loan holding company
with assets of $600 million or less and
trust companies with total assets of
$41.5 million or less (small banking
organization).88 As of June 30, 2019,
there were approximately 2,976 small
bank holding companies, 133 small
savings and loan holding companies,
and 537 small SMBs. The final rule may
also have implications for additional
entities that have material relationships
with banking organizations; however,
the scope of potentially affected entities
and thus the extent to which affected
entities are small entities under the
regulations of the Small Business
Administration, is not known.
As discussed in the SUPPLEMENTARY
INFORMATION section, the final rule
establishes a more detailed framework
for the Board to determine whether a
company has control over another
company for purposes of the BHC Act
and HOLA. The final rule consists of a
series of rebuttable presumptions of
control, a rebuttable presumption of
noncontrol, and various ancillary items
such as definitions of terms used in the
presumptions. The presumptions of
control generally would be consistent
with the Board’s current practice with
respect to controlling influence, with
certain targeted adjustments.
A main impact of the final rule will
be to enhance transparency to the public
on the Board’s views on controlling
influence. The final rule most directly
affects bank holding companies and
savings and loan holding companies,
though it also could impact state
member banks and other companies
87 5
U.S.C. 605(b).
13 CFR 121.201. Effective August 19, 2019,
the SBA revised the size standards for banking
organizations to $600 million in assets from $550
million in assets. 84 FR 34261 (July 18, 2019).
88 See
86 Companies that have provided commitments in
connection with TARP securities may also seek
relief.
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with relationships with depository
institutions and depository institution
holding companies. However, the final
rule generally will not impact banking
organizations in the ordinary course;
there are no regular compliance,
recordkeeping, or reporting
requirements associated with the final
rule. Rather, the impact of the final rule
will generally be in the context of
certain types of significant transactions
that companies may decide to engage in.
In addition, any material impact would
be concentrated in companies engaged
in the particular types of investments
where controlling influence is a concern
for the parties involved, which is a
narrow subset of all transactions
banking organizations may be party to.
For the reasons discussed above, the
Board anticipates that any economic
impact of the final rule, including on
small banking organizations, will be a
reduction of burden associated with
structuring transactions to address
control issues. Therefore, the Board
does not expect the rule to have a
significant economic impact on a
substantial number of small entities.
C. Plain Language
Section 722 of the Gramm-LeachBliley Act 89 requires the Federal
banking agencies to use plain language
in all proposed and final rules
published after January 1, 2000. The
Board have sought to present the final
rule in a simple and straightforward
manner, did not receive any comments
on the use of plain language.
List of Subjects
12 CFR Part 225
Administrative practice and
procedure, Banks, Banking, Capital
planning, Holding companies, Reporting
and recordkeeping requirements,
Securities, Stress testing.
12 CFR Part 238
Administrative practice and
procedure, Banks, Banking, Federal
Reserve System, Holding companies,
Reporting and recordkeeping
requirements, Holding companies,
Securities.
Authority and Issuance
For the reasons stated in the
preamble, the Board of Governors of the
Federal Reserve System amends 12 CFR
chapter II as follows:
89 Public Law 106–102, section 722, 113 Stat.
1338, 1471 (1999).
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PART 225—BANK HOLDING
COMPANIES AND CHANGE IN BANK
CONTROL (REGULATION Y)
1. The authority citation for part 225
continues to read as follows:
■
Authority: 12 U.S.C. 1817(j)(13), 1818,
1828(o), 1831i, 1831p–1, 1843(c)(8), 1844(b),
1972(1), 3106, 3108, 3310, 3331–3351, 3906,
3907, and 3909; 15 U.S.C. 1681s, 1681w,
6801 and 6805.
Subpart A—General Provisions
2. In § 225.2:
a. Remove the words ‘‘bank or other
company’’ and add in their place
‘‘company’’ wherever they occur in
paragraphs (e) introductory text and
(e)(1);
■ b. Revise paragraphs (e)(2) and (q)(2);
and
■ c. Add paragraph (u).
The revisions and addition read as
follows:
■
■
§ 225.2
Definitions.
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*
*
*
*
*
(e) * * *
(2) A company is deemed to control
voting securities or assets owned,
controlled, or held, directly or
indirectly:
(i) By the company, or by any
subsidiary of the company;
(ii) That the company has power to
vote or to dispose of;
(iii) In a fiduciary capacity for the
benefit of the company or any of its
subsidiaries;
(iv) In a fiduciary capacity (including
by pension and profit-sharing trusts) for
the benefit of the shareholders,
members, or employees (or individuals
serving in similar capacities) of the
company or any of its subsidiaries; or
(v) According to the standards under
§ 225.9 of this part.
*
*
*
*
*
(q) * * *
(2) Nonvoting securities. Common
shares, preferred shares, limited
partnership interests, limited liability
company interests, or similar interests
are not voting securities if:
(i) Any voting rights associated with
the securities are limited solely to the
type customarily provided by statute
with regard to matters that would
significantly and adversely affect the
rights or preference of the security, such
as the issuance of additional amounts or
classes of senior securities, the
modification of the terms of the
security, the dissolution of the issuing
company, or the payment of dividends
by the issuing company when preferred
dividends are in arrears;
(ii) The securities represent an
essentially passive investment or
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financing device and do not otherwise
provide the holder with control over the
issuing company; and
(iii) The securities do not entitle the
holder, by statute, charter, or in any
manner, to select or to vote for the
selection of directors, trustees, or
partners (or persons exercising similar
functions) of the issuing company;
except that limited partnership interests
or membership interests in limited
liability companies are not voting
securities due to voting rights that are
limited solely to voting for the removal
of a general partner or managing
member (or persons exercising similar
functions at the company) for cause, to
replace a general partner or managing
member (or persons exercising similar
functions at the company) due to
incapacitation or following the removal
of such person, or to continue or
dissolve the company after removal of
the general partner or managing member
(or persons exercising similar functions
at the company).
*
*
*
*
*
(u) Voting percentage. For purposes of
this part, the percentage of a class of a
company’s voting securities controlled
by a person is the greater of:
(1) The quotient, expressed as a
percentage, of the number of shares of
the class of voting securities controlled
by the person, divided by the number of
shares of the class of voting securities
that are issued and outstanding, both as
adjusted by § 225.9 of this part; and
(2) The quotient, expressed as a
percentage, of the number of votes that
may be cast by the person on the voting
securities controlled by the person,
divided by the total votes that are
legally entitled to be cast by the issued
and outstanding shares of the class of
voting securities, both as adjusted by
§ 225.9 of this part.
■ 3. Section 225.9 is added to read as
follows:
§ 225.9
Control over securities.
(a) Contingent rights, convertible
securities, options, and warrants. (1) A
person that controls a security, option,
warrant, or other financial instrument
that is convertible into, exercisable for,
exchangeable for, or otherwise may
become a security controls each security
that could be acquired as a result of
such conversion, exercise, exchange, or
similar occurrence.
(2) If a financial instrument of the
type described in paragraph (a)(1) of this
section is convertible into, exercisable
for, exchangeable for, or otherwise may
become a number of securities that
varies according to a formula, rate, or
other variable metric, the number of
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securities controlled under paragraph
(a)(1) of this section is the maximum
number of securities that the financial
instrument could be converted into, be
exercised for, be exchanged for, or
otherwise become under the formula,
rate, or other variable metric.
(3) Notwithstanding paragraph (a)(1)
of this section, a person does not control
voting securities due to controlling a
financial instrument if the financial
instrument:
(i) By its terms is not convertible into,
is not exercisable for, is not
exchangeable for, and may not
otherwise become voting securities in
the hands of the person or an affiliate of
the person; and
(ii) By its terms is only convertible
into, exercisable for, exchangeable for,
or may otherwise become voting
securities in the hands of a transferee
after a transfer:
(A) In a widespread public
distribution;
(B) To the issuing company;
(C) In transfers in which no transferee
(or group of associated transferees)
would receive 2 percent or more of the
outstanding securities of any class of
voting securities of the issuing
company; or
(D) To a transferee that would control
more than 50 percent of every class of
voting securities of the issuing company
without any transfer from the person.
(4) Notwithstanding paragraph (a)(1)
of this section, a person that has agreed
to acquire securities or other financial
instruments pursuant to a securities
purchase agreement does not control
such securities or financial instruments
until the person acquires the securities
or financial instruments.
(5) Notwithstanding paragraph (a)(1)
of this section, a right that provides a
person the ability to acquire securities
in future issuances or to convert
nonvoting securities into voting
securities does not cause the person to
control the securities that could be
acquired under the right, so long as the
right does not allow the person to
acquire a higher percentage of the class
of securities than the person controlled
immediately prior to the future
acquisition.
(6) Notwithstanding paragraph (a)(1)
of this section, a preferred security that
would be a nonvoting security but for a
right to vote on directors that activates
only after six or more quarters of unpaid
dividends is not considered to be a
voting security until the security holder
is entitled to exercise the voting right.
(7) For purposes of determining the
percentage of a class of voting securities
or the total equity percentage of a
company controlled by a person that
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controls a financial instrument of the
type described in paragraph (a)(1) of this
section:
(i) The securities controlled by the
person under paragraphs (a)(1) through
(6) of this section are deemed to be
issued and outstanding; and
(ii) Any securities controlled by
anyone other than the person under
paragraph (a)(1) through (6) of this
section are not deemed to be issued and
outstanding, unless by the terms of the
financial instruments the securities
controlled by the other persons must be
issued and outstanding in order for the
securities of the person to be issued and
outstanding.
(b) Restriction on securities. A person
that enters into an agreement or
understanding with a second person
under which the rights of the second
person are restricted in any manner
with respect to securities that are
controlled by the second person,
controls the securities of the second
person, unless the restriction is:
(1) A requirement that the second
person offer the securities for sale to the
first person for a reasonable period of
time prior to transferring the securities
to a third party;
(2) A requirement that, if the second
person agrees to sell the securities, the
second person provide the first person
with the opportunity to participate in
the sale of the securities by the second
person;
(3) A requirement under which the
second person agrees to sell its
securities to a third party if a majority
of security holders agrees to sell their
securities to the third party;
(4) Incident to a bona fide loan
transaction in which the securities serve
as collateral;
(5) A short-term and revocable proxy;
(6) A restriction on transferability that
continues only for a reasonable amount
of time necessary to complete an
acquisition by the first person of the
securities from the second person,
including the time necessary to obtain
required approval from an appropriate
government authority with respect to
the acquisition;
(7) A requirement that the second
person vote the securities in favor of a
specific acquisition of control of the
issuing company, or against competing
transactions, if the restriction continues
only for a reasonable amount of time
necessary to complete the transaction,
including the time necessary to obtain
required approval from an appropriate
government authority with respect to an
acquisition or merger; or
(8) An agreement among security
holders of the issuing company
intended to preserve the tax status or tax
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benefits of the company, such as
qualification of the issuing company as
a Subchapter S corporation, as defined
in 26 U.S.C. 1361(a)(1) or any successor
statute, or prevention of events that
could impair deferred tax assets, such as
net operating loss carryforwards, as
described in 26 U.S.C. 382 or any
successor statute.
(c) Securities held by senior
management officials or controlling
equity holders of a company. A
company that controls 5 percent or more
of any class of voting securities of
another company controls all securities
issued by the second company that are
controlled by senior management
officials, directors, or controlling
shareholders of the first company, or by
immediate family members of such
persons, unless the first company
controls less than 15 percent of each
class of voting securities of the second
company and the senior management
officials, directors, and controlling
shareholders of the first company, and
immediate family members of such
persons, control 50 percent or more of
each class of voting securities of the
second company.
(d) Reservation of authority.
Notwithstanding paragraphs (a) through
(c) of this section, the Board may
determine that securities are or are not
controlled by a company based on the
facts and circumstances presented.
■ 4. Subpart D is revised to read as
follows:
Subpart D—Control and Divestiture
Proceedings
Sec.
225.31 Control proceedings.
225.32 Rebuttable presumptions of control
of a company.
225.33 Rebuttable presumption of
noncontrol of a company.
225.34 Total equity.
Subpart D—Control and Divestiture
Proceedings
§ 225.31
Control proceedings.
(a) Preliminary determination of
control. (1) The Board in its sole
discretion may issue a preliminary
determination of control under the
procedures set forth in this section in
any case in which the Board determines,
based on consideration of the facts and
circumstances presented, that a first
company has the power to exercise a
controlling influence over the
management or policies of a second
company.
(2) If the Board makes a preliminary
determination of control under this
section, the Board shall send notice to
the first company containing a
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statement of the facts upon which the
preliminary determination is based.
(b) Response to preliminary
determination of control. (1) Within 30
calendar days after issuance by the
Board of a preliminary determination of
control or such longer period permitted
by the Board in its discretion, the first
company against whom the preliminary
determination has been made shall:
(i) Consent to the preliminary
determination of control and either:
(A) Submit for the Board’s approval a
specific plan for the prompt termination
of the control relationship; or
(B) File an application or notice under
this part, as applicable; or
(ii) Contest the preliminary
determination by filing a response,
setting forth the facts and circumstances
in support of its position that no control
exists, and, if desired, requesting a
hearing or other proceeding.
(2) If the first company fails to
respond to the preliminary
determination of control within 30 days
or such longer period permitted by the
Board in its discretion, the first
company will be deemed to have
waived its right to present additional
information to the Board or to request a
hearing or other proceeding regarding
the preliminary determination of
control.
(c) Hearing and final determination.
(1) The Board shall order a hearing or
other appropriate proceeding upon the
petition of a first company that contests
a preliminary determination of control if
the Board finds that material facts are in
dispute. The Board may, in its
discretion, order a hearing or other
appropriate proceeding without a
petition for such a proceeding by the
first company.
(2) At a hearing or other proceeding,
any applicable presumptions
established under this subpart shall be
considered in accordance with the
Federal Rules of Evidence and the
Board’s Rules of Practice for Formal
Hearings (12 CFR part 263).
(3) After considering the submissions
of the first company and other evidence,
including the record of any hearing or
other proceeding, the Board will issue a
final order determining whether the first
company has the power to exercise a
controlling influence over the
management or policies of the second
company. If a controlling influence is
found, the Board may direct the first
company to terminate the control
relationship or to file an application or
notice for the Board’s approval to retain
the control relationship.
(d) Submission of evidence. (1) In
connection with contesting a
preliminary determination of control
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under paragraph (b)(1)(ii) of this section,
a first company may submit to the Board
evidence or any other relevant
information related to its control of a
second company.
(2) Evidence or other relevant
information submitted to the Board
pursuant to paragraph (d)(1) of this
section must be in writing and may
include a description of all current and
proposed relationships between the first
company and the second company,
including relationships of the type that
are identified under any of the
rebuttable presumptions in §§ 225.32
and 225.33 of this part, copies of any
formal agreements related to such
relationships, and a discussion
regarding why the Board should not
determine the first company to control
the second company.
(e) Definitions. For purposes of this
subpart:
(1) Board of directors means the board
of directors of a company or a set of
individuals exercising similar functions
at a company.
(2) Director representative means any
individual that represents the interests
of a first company through service on
the board of directors of a second
company. For purposes of this
paragraph (e)(2), examples of persons
who are directors of a second company
and generally would be considered
director representatives of a first
company include:
(i) A current officer, employee, or
director of the first company;
(ii) An individual who was an officer,
employee, or director of the first
company within the prior two years;
and
(iii) An individual who was
nominated or proposed to be a director
of the second company by the first
company.
(iv) A director representative does not
include a nonvoting observer.
(3) First company means the company
whose potential control of a second
company is the subject of determination
by the Board under this subpart.
(4) Investment adviser means a
company that:
(i) Is registered as an investment
adviser with the Securities and
Exchange Commission under the
Investment Advisers Act of 1940 (15
U.S.C. 80b–1 et seq.);
(ii) Is registered as a commodity
trading advisor with the Commodity
Futures Trading Commission under the
Commodity Exchange Act (7 U.S.C. 1 et
seq.);
(iii) Is a foreign equivalent of an
investment adviser or commodity
trading advisor, as described in
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paragraph (e)(4)(i) or (ii) of this section;
or
(iv) Engages in any of the activities set
forth in § 225.28(b)(6)(i) through (iv) of
this part.
(5) Limiting contractual right means a
contractual right of the first company
that would allow the first company to
restrict significantly, directly or
indirectly, the discretion of the second
company, including its senior
management officials and directors, over
operational and policy decisions of the
second company.
(i) Examples of limiting contractual
rights may include, but are not limited
to, a right that allows the first company
to restrict or to exert significant
influence over decisions related to:
(A) Activities in which the second
company may engage, including a
prohibition on entering into new lines
of business, making substantial changes
to or discontinuing existing lines of
business, or entering into a contractual
arrangement with a third party that
imposes significant financial obligations
on the second company;
(B) How the second company directs
the proceeds of the first company’s
investment;
(C) Hiring, firing, or compensating
one or more senior management officials
of the second company, or modifying
the second company’s policies or budget
concerning the salary, compensation,
employment, or benefits plan for its
employees;
(D) The second company’s ability to
merge or consolidate, or its ability to
acquire, sell, lease, transfer, spin-off,
recapitalize, liquidate, dissolve, or
dispose of subsidiaries or assets;
(E) The second company’s ability to
make investments or expenditures;
(F) The second company achieving or
maintaining a financial target or limit,
including, for example, a debt-to-equity
ratio, a fixed charges ratio, a net worth
requirement, a liquidity target, a
working capital target, or a classified
assets or nonperforming loans limit;
(G) The second company’s payment of
dividends on any class of securities,
redemption of senior instruments, or
voluntary prepayment of indebtedness;
(H) The second company’s ability to
authorize or issue additional junior
equity or debt securities, or amend the
terms of any equity or debt securities
issued by the second company;
(I) The second company’s ability to
engage in a public offering or to list or
de-list securities on an exchange, other
than a right that allows the securities of
the first company to have the same
status as other securities of the same
class;
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(J) The second company’s ability to
amend its articles of incorporation or
by-laws, other than in a way that is
solely defensive for the first company;
(K) The removal or selection of any
independent accountant, auditor,
investment adviser, or investment
banker employed by the second
company; or
(L) The second company’s ability to
significantly alter accounting methods
and policies, or its regulatory, tax, or
liability status (e.g., converting from a
stock corporation to a limited liability
company); and
(ii) A limiting contractual right does
not include a contractual right that
would not allow the first company to
significantly restrict, directly or
indirectly, the discretion of the second
company over operational and policy
decisions of the second company.
Examples of contractual rights that are
not limiting contractual rights may
include:
(A) A right that allows the first
company to restrict or to exert
significant influence over decisions
relating to the second company’s ability
to issue securities senior to securities
owned by the first company;
(B) A requirement that the first
company receive financial reports or
other information of the type ordinarily
available to common stockholders;
(C) A requirement that the second
company maintain its corporate
existence;
(D) A requirement that the second
company consult with the first company
on a reasonable periodic basis;
(E) A requirement that the second
company provide notices of the
occurrence of material events affecting
the second company;
(F) A requirement that the second
company comply with applicable
statutory and regulatory requirements;
(G) A market standard requirement
that the first company receive similar
contractual rights as those held by other
investors in the second company;
(H) A requirement that the first
company be able to purchase additional
securities issued by the second
company in order to maintain the first
company’s percentage ownership in the
second company;
(I) A requirement that the second
company ensure that any security
holder who intends to sell its securities
of the second company provide other
security holders of the second company
or the second company itself the
opportunity to purchase the securities
before the securities can be sold to a
third party; or
(J) A requirement that the second
company take reasonable steps to ensure
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the preservation of tax status or tax
benefits, such as status of the second
company as a Subchapter S corporation
or the protection of the value of net
operating loss carry-forwards.
(6) Second company means the
company whose potential control by a
first company is the subject of
determination by the Board under this
subpart.
(7) Senior management official means
any person who participates or has the
authority to participate (other than in
the capacity as a director) in major
policymaking functions of a company.
(f) Reservation of authority. Nothing
in this subpart shall limit the authority
of the Board to take any supervisory or
enforcement action otherwise permitted
by law, including an action to address
unsafe or unsound practices or
conditions, or violations of law.
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§ 225.32 Rebuttable presumptions of
control of a company.
(a) General. (1) In any proceeding
under § 225.31(b) or (c) of this part, a
first company is presumed to control a
second company in the situations
described in paragraphs (b) through (i)
of this section. The Board also may find
that a first company controls a second
company based on other facts and
circumstances.
(2) For purposes of the presumptions
in this section, any company that is a
subsidiary of the first company and also
a subsidiary of the second company is
considered to be a subsidiary of the first
company and not a subsidiary of the
second company.
(b) Management contract or similar
agreement. The first company enters
into any agreement, understanding, or
management contract (other than to
serve as investment adviser) with the
second company, under which the first
company directs or exercises significant
influence or discretion over the general
management, overall operations, or core
business or policy decisions of the
second company. Examples of such
agreements include where the first
company is a managing member,
trustee, or general partner of the second
company, or exercises similar powers
and functions.
(c) Total equity. The first company
controls one third or more of the total
equity of the second company.
(d) Ownership or control of 5 percent
or more of voting securities. The first
company controls 5 percent or more of
the outstanding securities of any class of
voting securities of the second
company, and:
(1)(i) Director representatives of the
first company or any of its subsidiaries
comprise 25 percent or more of the
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board of directors of the second
company or any of its subsidiaries; or
(ii) Director representatives of the first
company or any of its subsidiaries are
able to make or block the making of
major operational or policy decisions of
the second company or any of its
subsidiaries;
(2) Two or more employees or
directors of the first company or any of
its subsidiaries serve as senior
management officials of the second
company or any of its subsidiaries;
(3) An employee or director of the
first company or any of its subsidiaries
serves as the chief executive officer, or
serves in a similar capacity, of the
second company or any of its
subsidiaries;
(4) The first company or any of its
subsidiaries enters into transactions or
has business relationships with the
second company or any of its
subsidiaries that generate in the
aggregate 10 percent or more of the total
annual revenues or expenses of the
second company, each on a
consolidated basis; or
(5) The first company or any of its
subsidiaries has any limiting contractual
right with respect to the second
company or any of its subsidiaries,
unless such limiting contractual right is
part of an agreement to merge with or
make a controlling investment in the
second company that is reasonably
expected to close within one year and
such limiting contractual right is
designed to ensure that the second
company continues to operate in the
ordinary course until the merger or
investment is consummated or such
limiting contractual right requires the
second company to take an action
necessary for the merger or investment
to be consummated.
(e) Ownership or control of 10 percent
or more of voting securities. The first
company controls 10 percent or more of
the outstanding securities of any class of
voting securities of the second
company, and:
(1) The first company or any of its
subsidiaries propose a number of
director representatives to the board of
directors of the second company or any
of its subsidiaries in opposition to
nominees proposed by the management
or board of directors of the second
company or any of its subsidiaries that,
together with any director
representatives of the first company or
any of its subsidiaries on the board of
directors of the second company or any
of its subsidiaries, would comprise 25
percent or more of the board of directors
of the second company or any of its
subsidiaries;
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(2) Director representatives of the first
company and its subsidiaries comprise
more than 25 percent of any committee
of the board of directors of the second
company or any of its subsidiaries that
can take action that binds the second
company or any of its subsidiaries; or
(3) The first company or any of its
subsidiaries enters into transactions or
has business relationships with the
second company or any of its
subsidiaries that:
(i) Are not on market terms; or
(ii) Generate in the aggregate 5 percent
or more of the total annual revenues or
expenses of the second company, each
on a consolidated basis.
(f) Ownership or control of 15 percent
or more of voting securities. The first
company controls 15 percent or more of
the outstanding securities of any class of
voting securities of the second
company, and:
(1) A director representative of the
first company or of any of its
subsidiaries serves as the chair of the
board of directors of the second
company or any of its subsidiaries;
(2) One or more employees or
directors of the first company or any of
its subsidiaries serves as a senior
management official of the second
company or any of its subsidiaries; or
(3) The first company or any of its
subsidiaries enters into transactions or
has business relationships with the
second company or any of its
subsidiaries that generate in the
aggregate 2 percent or more of the total
annual revenues or expenses of the
second company, each on a
consolidated basis.
(g) Accounting consolidation. The
first company consolidates the second
company on its financial statements
prepared under U.S. generally accepted
accounting principles.
(h) Control of an investment fund. (1)
The first company serves as an
investment adviser to the second
company, the second company is an
investment fund, and the first company,
directly or indirectly, or acting through
one or more other persons:
(i) Controls 5 percent or more of the
outstanding securities of any class of
voting securities of the second
company; or
(ii) Controls 25 percent or more of the
total equity of the second company.
(2) The presumption of control in
paragraph (h)(1) of this section does not
apply if the first company organized and
sponsored the second company within
the preceding 12 months.
(i) Divestiture of control. (1) The first
company controlled the second
company under § 225.2(e)(1)(i) or (ii) of
this part at any time during the prior
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two years and the first company
controls 15 percent or more of the
outstanding securities of any class of
voting securities of the second
company.
(2) Notwithstanding paragraph (i)(1)
of this section, a first company will not
be presumed to control a second
company under this paragraph if 50
percent or more of the outstanding
securities of each class of voting
securities of the second company is
controlled by a person that is not a
senior management official or director
of the first company, or by a company
that is not an affiliate of the first
company.
(j) Securities held in a fiduciary
capacity. For purposes of the
presumptions of control in this section,
the first company does not control
securities of the second company that
the first company holds in a fiduciary
capacity, except that if the second
company is a depository institution or a
depository institution holding company,
this paragraph (j) only applies to
securities held in a fiduciary capacity
without sole discretionary authority to
exercise the voting rights of the
securities.
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§ 225.33 Rebuttable presumption of
noncontrol of a company.
(a) In any proceeding under
§ 225.31(b) or (c) of this part, a first
company is presumed not to control a
second company if:
(1) The first company controls less
than 10 percent of the outstanding
securities of each class of voting
securities of the second company; and
(2) The first company is not presumed
to control the second company under
§ 225.32 of this part.
(b) In any proceeding under this
subpart, or judicial proceeding under
the Bank Holding Company Act, other
than a proceeding in which the Board
has made a preliminary determination
that a first company has the power to
exercise a controlling influence over the
management or policies of a second
company, a first company may not be
held to have had control over a second
company at any given time, unless the
first company, at the time in question,
controlled 5 percent or more of the
outstanding securities of any class of
voting securities of the second
company, or had already been found to
have control on the basis of the
existence of a controlling influence
relationship.
§ 225.34
Total equity.
(a) General. For purposes of this
subpart, the total equity controlled by a
first company in a second company that
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is organized as a stock corporation and
prepares financial statements pursuant
to U.S. generally accepted accounting
principles will be calculated as
described in paragraph (b) of this
section. With respect to a second
company that is not organized as a stock
corporation or that does not prepare
financial statements pursuant to U.S.
generally accepted accounting
principles, the first company’s total
equity in the second company will be
calculated so as to be reasonably
consistent with the methodology
described in paragraph (b) of this
section, while taking into account the
legal form of the second company and
the accounting system used by the
second company to prepare financial
statements.
(b) Calculation of total equity—(1)
Total equity. The first company’s total
equity in the second company,
expressed as a percentage, is equal to:
(i) The sum of Investor Common
Equity and, for each class of preferred
stock issued by the second company,
Investor Preferred Equity, divided by
(ii) Issuer Shareholders’ Equity.
(2) Investor Common Equity equals
the greater of:
(i) Zero, and
(ii) The quotient of the number of
shares of common stock of the second
company that are controlled by the first
company divided by the total number of
shares of common stock of the second
company that are issued and
outstanding, multiplied by the amount
of shareholders’ equity of the second
company not allocated to preferred
stock under U.S. generally accepted
accounting principles.1
(3) Investor Preferred Equity equals,
for each class of preferred stock issued
by the second company, the greater of:
(i) Zero, and
(ii) The quotient of the number of
shares of the class of preferred stock of
the second company that are controlled
by the first company divided by the
total number of shares of the class of
preferred stock that are issued and
outstanding, multiplied by the amount
of shareholders’ equity of the second
company allocated to the class of
preferred stock under U.S. generally
accepted accounting principles.2
1 If the second company has multiple classes of
common stock outstanding and different classes of
common stock have different economic interests in
the second company on a per share basis, the
number of shares of common stock must be
adjusted for purposes of this calculation so that
each share of common stock has the same economic
interest in the second company.
2 If there are different classes of preferred stock
with equal seniority (i.e., pari passu classes of
preferred stock), the pari passu shares are treated
as a single class. If pari passu classes of preferred
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12425
(c) Consideration of debt instruments
and other interests in total equity. (1)
For purposes of the total equity
calculation in paragraph (b) of this
section, a debt instrument or other
interest issued by the second company
that is controlled by the first company
may be treated as an equity instrument
if that debt instrument or other interest
is functionally equivalent to equity.
(2) For purposes of paragraph (b)(1) of
this section, the principal amount of all
debt instruments and the market value
of all other interests that are
functionally equivalent to equity that
are controlled by the first company are
added to the sum under paragraph
(b)(1)(i) of this section, and the principal
amount of all debt instruments and the
market value of all other interests that
are functionally equivalent to equity
that are outstanding are added to Issuer
Shareholders’ Equity.
(3) For purposes of paragraph (c)(1) of
this section, a debt instrument issued by
the second company may be considered
functionally equivalent to equity if it
has equity-like characteristics, such as:
(i) Extremely long-dated maturity;
(ii) Subordination to other debt
instruments issued by the second
company;
(ii) Qualification as regulatory capital
under any regulatory capital rules
applicable to the second company;
(iii) Qualification as equity under
applicable tax law;
(iv) Qualification as equity under U.S.
generally accepted accounting
principles or other applicable
accounting standards;
(v) Inadequacy of the equity capital
underlying the debt at the time of the
issuance of the debt; or
(vi) Issuance not on market terms.
(4) For purposes of paragraph (c)(1) of
this section, an interest that is not a debt
instrument issued by the second
company may be considered
functionally equivalent to equity if it
has equity-like characteristics, such as
entitling its owner to a share of the
profits of the second company.
(d) Exclusion of certain equity
instruments from total equity. (1) For
purposes of the total equity calculation
in paragraph (b) of this section, an
equity instrument issued by the second
company that is controlled by the first
company may be treated as not an
equity instrument if the equity
instrument is functionally equivalent to
debt.
stock have different economic interests in the
second company on a per share basis, the number
of shares of preferred stock must be adjusted for
purposes of this calculation so that each pari passu
share of preferred stock has the same economic
interest in the second company.
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(2) For purposes of paragraph (d)(1) of
this section, an equity instrument issued
by the second company may be
considered functionally equivalent to
debt if it has debt-like characteristics,
such as protections generally provided
to creditors, a limited term, a fixed rate
of return or a variable rate of return
linked to a reference interest rate,
classification as debt for tax purposes,
or classification as debt for accounting
purposes.
(e) Frequency of total equity
calculation. The total equity of a first
company in a second company is
calculated each time the first company
acquires control over equity instruments
of the second company, including any
debt instruments or other interests that
are functionally equivalent to equity in
accordance with paragraph (c) of this
section.
PART 238—SAVINGS AND LOAN
HOLDING COMPANIES (REGULATION
LL)
5. The authority citation for part 238
continues to read as follows:
■
Authority: 5 U.S.C. 552, 559; 12 U.S.C.
1462, 1462a, 1463, 1464, 1467, 1467a, 1468,
1813, 1817, 1829e, 1831i, 1972; 15 U.S.C. 78l.
Subpart A—General Provisions
6. Amend § 238.2 by revising
paragraphs (e), (r)(2), and (tt) to read as
follows:
■
§ 238.2
Definitions.
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*
*
*
*
*
(e) A person shall be deemed to have
control of:
(1) A savings association if the person
directly or indirectly or acting in
concert with one or more other persons,
or through one or more subsidiaries,
owns, controls, or holds with power to
vote, or holds proxies representing,
more than 25 percent of the voting
shares of such savings association, or
controls in any manner the election of
a majority of the directors of such
association;
(2) Any other company if the person
directly or indirectly or acting in
concert with one or more other persons,
or through one or more subsidiaries,
owns, controls, or holds with power to
vote, or holds proxies representing,
more than 25 percent of the voting
shares or rights of such other company,
or controls in any manner the election
or appointment of a majority of the
directors or trustees of such other
company, or is a general partner in or
has contributed more than 25 percent of
the capital of such other company;
(3) A trust if the person is a trustee
thereof;
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(4) A company if the Board
determines, after reasonable notice and
opportunity for hearing, that such
person directly or indirectly exercises a
controlling influence over the
management or policies of such
association or other company; or
(5) Voting securities or assets owned,
controlled, or held, directly or
indirectly:
(i) By the company, or by any
subsidiary of the company;
(ii) That the company has power to
vote or to dispose of;
(iii) In a fiduciary capacity for the
benefit of the company or any of its
subsidiaries;
(iv) In a fiduciary capacity (including
by pension and profit-sharing trusts) for
the benefit of the shareholders,
members, or employees (or individuals
serving in similar capacities) of the
company or any of its subsidiaries; or
(v) According to the standards under
§ 238.9 of this part.
*
*
*
*
*
(r) * * *
(2) Nonvoting securities. Common
shares, preferred shares, limited
partnership interests, limited liability
company interests, or similar interests
are not voting securities if:
(i) Any voting rights associated with
the securities are limited solely to the
type customarily provided by statute
with regard to matters that would
significantly and adversely affect the
rights or preference of the security, such
as the issuance of additional amounts or
classes of senior securities, the
modification of the terms of the
security, the dissolution of the issuing
company, or the payment of dividends
by the issuing company when preferred
dividends are in arrears;
(ii) The securities represent an
essentially passive investment or
financing device and do not otherwise
provide the holder with control over the
issuing company; and
(iii) The securities do not entitle the
holder, by statute, charter, or in any
manner, to select or to vote for the
selection of directors, trustees, or
partners (or persons exercising similar
functions) of the issuing company;
except that limited partnership interests
or membership interests in limited
liability companies are not voting
securities due to voting rights that are
limited solely to voting for the removal
of a general partner or managing
member (or persons exercising similar
functions at the company) for cause, to
replace a general partner or managing
member (or persons exercising similar
functions at the company) due to
incapacitation or following the removal
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of such person, or to continue or
dissolve the company after removal of
the general partner or managing member
(or persons exercising similar functions
at the company).
*
*
*
*
*
(tt) Voting percentage. For purposes of
this part, the percentage of a class of a
company’s voting securities controlled
by a person is the greater of:
(1) The quotient, expressed as a
percentage, of the number of shares of
the class of voting securities controlled
by the person, divided by the number of
shares of the class of voting securities
that are issued and outstanding, both as
adjusted by § 238.9 of this part; and
(2) The quotient, expressed as a
percentage, of the number of votes that
may be cast by the person on the voting
securities controlled by the person,
divided by the total votes that are
legally entitled to be cast by the issued
and outstanding shares of the class of
voting securities, both as adjusted by
§ 238.9 of this part.
7. Section 238.8 is amended by
revising the section heading and adding
paragraphs (b) and (c) to read as follows:
■
§ 238.8 Safe and sound operations, and
Small Bank Holding Company Policy
Statement.
*
*
*
*
*
(b) The Board’s Small Bank Holding
Company Policy Statement (12 CFR part
225, appendix C) (Policy Statement)
applies to savings and loan holding
companies as if they were bank holding
companies. To qualify or rely on the
Policy Statement, savings and loan
holding companies must meet all
qualifying requirements in the Policy
Statement as if they were a bank holding
company. For purposes of applying the
Policy Statement, the term ‘‘nonbank
subsidiary’’ as used in the Policy
Statement refers to a subsidiary of a
savings and loan holding company other
than a savings association or a
subsidiary of a savings association.
(c) The Board may exclude any
savings and loan holding company,
regardless of asset size, from the Policy
Statement under paragraph (b) of this
section if the Board determines that
such action is warranted for supervisory
purposes.
8. Section 238.9 is revised to read as
follows:
■
§ 238.9
Control over securities.
(a) Contingent rights, convertible
securities, options, and warrants. (1) A
person that controls a security, option,
warrant, or other financial instrument
that is convertible into, exercisable for,
exchangeable for, or otherwise may
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become a security controls each security
that could be acquired as a result of
such conversion, exercise, exchange, or
similar occurrence.
(2) If a financial instrument of the
type described in paragraph (a)(1) of this
section is convertible into, exercisable
for, exchangeable for, or otherwise may
become a number of securities that
varies according to a formula, rate, or
other variable metric, the number of
securities controlled under paragraph
(a)(1) of this section is the maximum
number of securities that the financial
instrument could be converted into, be
exercised for, be exchanged for, or
otherwise become under the formula,
rate, or other variable metric.
(3) Notwithstanding paragraph (a)(1)
of this section, a person does not control
voting securities due to controlling a
financial instrument if the financial
instrument:
(i) By its terms is not convertible into,
is not exercisable for, is not
exchangeable for, and may not
otherwise become voting securities in
the hands of the person or an affiliate of
the person; and
(ii) By its terms is only convertible
into, exercisable for, exchangeable for,
or may otherwise become voting
securities in the hands of a transferee
after a transfer:
(A) In a widespread public
distribution;
(B) To the issuing company;
(C) In transfers in which no transferee
(or group of associated transferees)
would receive 2 percent or more of the
outstanding securities of any class of
voting securities of the issuing
company; or
(D) To a transferee that would control
more than 50 percent of every class of
voting securities of the issuing company
without any transfer from the person.
(4) Notwithstanding paragraph (a)(1)
of this section, a person that has agreed
to acquire securities or other financial
instruments pursuant to a securities
purchase agreement does not control
such securities or financial instruments
until the person acquires the securities
or financial instruments.
(5) Notwithstanding paragraph (a)(1)
of this section, a right that provides a
person the ability to acquire securities
in future issuances or to convert
nonvoting securities into voting
securities does not cause the person to
control the securities that could be
acquired under the right, so long as the
right does not allow the person to
acquire a higher percentage of the class
of securities than the person controlled
immediately prior to the future
acquisition.
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(6) Notwithstanding paragraph (a)(1)
of this section, a preferred security that
would be a nonvoting security but for a
right to vote on directors that activates
only after six or more quarters of unpaid
dividends is not considered to be a
voting security until the security holder
is entitled to exercise the voting right.
(7) For purposes of determining the
percentage of a class of voting securities
of a company controlled by a person
that controls a financial instrument of
the type described in paragraph (a)(1) of
this section:
(i) The securities controlled by the
person under paragraphs (a)(1) through
(6) of this section are deemed to be
issued and outstanding; and
(ii) Any securities controlled by
anyone other than the person under
paragraphs (a)(1) through (6) of this
section are not deemed to be issued and
outstanding, unless by the terms of the
financial instruments the securities
controlled by the other persons must be
issued and outstanding in order for the
securities of the person to be issued and
outstanding.
(b) Restriction on securities. A person
that enters into an agreement or
understanding with a second person
under which the rights of the second
person are restricted in any manner
with respect to securities that are
controlled by the second person,
controls the securities of the second
person, unless the restriction is:
(1) A requirement that the second
person offer the securities for sale to the
first person for a reasonable period of
time prior to transferring the securities
to a third party;
(2) A requirement that, if the second
person agrees to sell the securities, the
second person provide the first person
with the opportunity to participate in
the sale of the securities by the second
person;
(3) A requirement under which the
second person agrees to sell its
securities to a third party if a majority
of security holders agrees to sell their
securities to the third party;
(4) Incident to a bona fide loan
transaction in which the securities serve
as collateral;
(5) A short-term and revocable proxy;
(6) A restriction on transferability that
continues only for a reasonable amount
of time necessary to complete an
acquisition by the first person of the
securities from the second person,
including the time necessary to obtain
required approval from an appropriate
government authority with respect to
the acquisition;
(7) A requirement that the second
person vote the securities in favor of a
specific acquisition of control of the
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issuing company, or against competing
transactions, if the restriction continues
only for a reasonable amount of time
necessary to complete the transaction,
including the time necessary to obtain
required approval from an appropriate
government authority with respect to an
acquisition or merger; or
(8) An agreement among security
holders of the issuing company
intended to preserve the tax status or tax
benefits of the company, such as
qualification of the issuing company as
a Subchapter S corporation, as defined
in 26 U.S.C. 1361(a)(1) or any successor
statute, or prevention of events that
could impair deferred tax assets, such as
net operating loss carryforwards, as
described in 26 U.S.C. 382 or any
successor statute.
(c) Securities held by senior
management officials or controlling
equity holders of a company. A
company that controls 5 percent or more
of any class of voting securities of
another company controls all securities
issued by the second company that are
controlled by senior management
officials, directors, or controlling
shareholders of the first company, or by
immediate family members of such
persons, unless the first company
controls less than 15 percent of each
class of voting securities of the second
company and the senior management
officials, directors, and controlling
shareholders of the first company, and
immediate family members of such
persons, control 50 percent or more of
each class of voting securities of the
second company.
(d) Reservation of authority.
Notwithstanding paragraphs (a) through
(c) of this section, the Board may
determine that securities are or are not
controlled by a company based on the
facts and circumstances presented.
■ 9. Subpart C is revised to read as
follows:
Subpart C—Control Proceedings
Sec.
238.21 Control proceedings.
238.22 Rebuttable presumptions of control
of a company.
238.23 Rebuttable presumption of
noncontrol of a company.
Subpart C—Control Proceedings
§ 238.21
Control proceedings.
(a) Preliminary determination of
control. (1) The Board in its sole
discretion may issue a preliminary
determination of control under the
procedures set forth in this section in
any case in which the Board determines,
based on consideration of the facts and
circumstances presented, that a first
company has the power to exercise a
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controlling influence over the
management or policies of a second
company.
(2) If the Board makes a preliminary
determination of control under this
section, the Board shall send notice to
the first company containing a
statement of the facts upon which the
preliminary determination is based.
(b) Response to preliminary
determination of control. (1) Within 30
calendar days after issuance by the
Board of a preliminary determination of
control or such longer period permitted
by the Board in its discretion, the first
company against whom the preliminary
determination has been made shall:
(i) Consent to the preliminary
determination of control and either:
(A) Submit for the Board’s approval a
specific plan for the prompt termination
of the control relationship; or
(B) File an application or notice under
this part, as applicable; or
(ii) Contest the preliminary
determination by filing a response,
setting forth the facts and circumstances
in support of its position that no control
exists, and, if desired, requesting a
hearing or other proceeding.
(2) If the first company fails to
respond to the preliminary
determination of control within 30 days
or such longer period permitted by the
Board in its discretion, the first
company will be deemed to have
waived its right to present additional
information to the Board or to request a
hearing or other proceeding regarding
the preliminary determination of
control.
(c) Hearing and final determination.
(1) The Board shall order a hearing or
other appropriate proceeding upon the
petition of a first company that contests
a preliminary determination of control if
the Board finds that material facts are in
dispute. The Board may, in its
discretion, order a hearing or other
appropriate proceeding without a
petition for such a proceeding by the
first company.
(2) At a hearing or other proceeding,
any applicable presumptions
established under this subpart shall be
considered in accordance with the
Federal Rules of Evidence and the
Board’s Rules of Practice for Formal
Hearings (12 CFR part 263).
(3) After considering the submissions
of the first company and other evidence,
including the record of any hearing or
other proceeding, the Board will issue a
final order determining whether the first
company has the power to exercise a
controlling influence over the
management or policies of the second
company. If a controlling influence is
found, the Board may direct the first
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company to terminate the control
relationship or to file an application or
notice for the Board’s approval to retain
the control relationship.
(d) Submission of evidence. (1) In
connection with contesting a
preliminary determination of control
under paragraph (b)(1)(ii) of this section,
a first company may submit to the Board
evidence or any other relevant
information related to its control of a
second company.
(2) Evidence or other relevant
information submitted to the Board
pursuant to paragraph (d)(1) of this
section must be in writing and may
include a description of all current and
proposed relationships between the first
company and the second company,
including relationships of the type that
are identified under any of the
rebuttable presumptions in §§ 238.22
and 238.23 of this part, copies of any
formal agreements related to such
relationships, and a discussion
regarding why the Board should not
determine the first company to control
the second company.
(e) Definitions. For purposes of this
subpart:
(1) Board of directors means the board
of directors of a company or a set of
individuals exercising similar functions
at a company.
(2) Director representative means any
individual that represents the interests
of a first company through service on
the board of directors of a second
company. For purposes of this
paragraph (e)(2), examples of persons
who are directors of a second company
and generally would be considered
director representatives of a first
company include:
(i) A current officer, employee, or
director of the first company;
(ii) An individual who was an officer,
employee, or director of the first
company within the prior two years;
and
(iii) An individual who was
nominated or proposed to be a director
of the second company by the first
company.
(iv) A director representative does not
include a nonvoting observer.
(3) First company means the company
whose potential control of a second
company is the subject of determination
by the Board under this subpart.
(4) Investment adviser means a
company that:
(i) Is registered as an investment
adviser with the Securities and
Exchange Commission under the
Investment Advisers Act of 1940 (15
U.S.C. 80b–1 et seq.);
(ii) Is registered as a commodity
trading advisor with the Commodity
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Futures Trading Commission under the
Commodity Exchange Act (7 U.S.C. 1 et
seq.);
(iii) Is a foreign equivalent of an
investment adviser or commodity
trading advisor, as described in
paragraph (e)(4)(i) or (ii) of this section;
or
(iv) Engages in any of the activities set
forth in 12 CFR 225.28(b)(6)(i) through
(iv).
(5) Limiting contractual right means a
contractual right of the first company
that would allow the first company to
restrict significantly, directly or
indirectly, the discretion of the second
company, including its senior
management officials and directors, over
operational and policy decisions of the
second company.
(i) Examples of limiting contractual
rights may include, but are not limited
to, a right that allows the first company
to restrict or to exert significant
influence over decisions related to:
(A) Activities in which the second
company may engage, including a
prohibition on entering into new lines
of business, making substantial changes
to or discontinuing existing lines of
business, or entering into a contractual
arrangement with a third party that
imposes significant financial obligations
on the second company;
(B) How the second company directs
the proceeds of the first company’s
investment;
(C) Hiring, firing, or compensating
one or more senior management officials
of the second company, or modifying
the second company’s policies or budget
concerning the salary, compensation,
employment, or benefits plan for its
employees;
(D) The second company’s ability to
merge or consolidate, or its ability to
acquire, sell, lease, transfer, spin-off,
recapitalize, liquidate, dissolve, or
dispose of subsidiaries or assets;
(E) The second company’s ability to
make investments or expenditures;
(F) The second company achieving or
maintaining a financial target or limit,
including, for example, a debt-to-equity
ratio, a fixed charges ratio, a net worth
requirement, a liquidity target, a
working capital target, or a classified
assets or nonperforming loans limit;
(G) The second company’s payment of
dividends on any class of securities,
redemption of senior instruments, or
voluntary prepayment of indebtedness;
(H) The second company’s ability to
authorize or issue additional junior
equity or debt securities, or amend the
terms of any equity or debt securities
issued by the second company;
(I) The second company’s ability to
engage in a public offering or to list or
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de-list securities on an exchange, other
than a right that allows the securities of
the first company to have the same
status as other securities of the same
class;
(J) The second company’s ability to
amend its articles of incorporation or
by-laws, other than in a way that is
solely defensive for the first company;
(K) The removal or selection of any
independent accountant, auditor,
investment adviser, or investment
banker employed by the second
company; or
(L) The second company’s ability to
significantly alter accounting methods
and policies, or its regulatory, tax, or
liability status (e.g., converting from a
stock corporation to a limited liability
company); and
(ii) A limiting contractual right does
not include a contractual right that
would not allow the first company to
significantly restrict, directly or
indirectly, the discretion of the second
company over operational and policy
decisions of the second company.
Examples of contractual rights that are
not limiting contractual rights may
include:
(A) A right that allows the first
company to restrict or to exert
significant influence over decisions
relating to the second company’s ability
to issue securities senior to securities
owned by the first company;
(B) A requirement that the first
company receive financial reports or
other information of the type ordinarily
available to common stockholders;
(C) A requirement that the second
company maintain its corporate
existence;
(D) A requirement that the second
company consult with the first company
on a reasonable periodic basis;
(E) A requirement that the second
company provide notices of the
occurrence of material events affecting
the second company;
(F) A requirement that the second
company comply with applicable
statutory and regulatory requirements;
(G) A market standard requirement
that the first company receive similar
contractual rights as those held by other
investors in the second company;
(H) A requirement that the first
company be able to purchase additional
securities issued by the second
company in order to maintain the first
company’s percentage ownership in the
second company;
(I) A requirement that the second
company ensure that any security
holder who intends to sell its securities
of the second company provide other
security holders of the second company
or the second company itself the
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opportunity to purchase the securities
before the securities can be sold to a
third party; or
(J) A requirement that the second
company take reasonable steps to ensure
the preservation of tax status or tax
benefits, such as status of the second
company as a Subchapter S corporation
or the protection of the value of net
operating loss carry-forwards.
(6) Second company means the
company whose potential control by a
first company is the subject of
determination by the Board under this
subpart.
(7) Senior management official means
any person who participates or has the
authority to participate (other than in
the capacity as a director) in major
policymaking functions of a company.
(f) Reservation of authority. Nothing
in this subpart shall limit the authority
of the Board to take any supervisory or
enforcement action otherwise permitted
by law, including an action to address
unsafe or unsound practices or
conditions, or violations of law.
§ 238.22 Rebuttable presumptions of
control of a company.
(a) General. (1) In any proceeding
under § 238.21(b) or (c) of this part, a
first company is presumed to control a
second company in the situations
described in paragraphs (b) through (h)
of this section. The Board also may find
that a first company controls a second
company based on other facts and
circumstances.
(2) For purposes of the presumptions
in this section, any company that is a
subsidiary of the first company and also
a subsidiary of the second company is
considered to be a subsidiary of the first
company and not a subsidiary of the
second company.
(b) Management contract or similar
agreement. The first company enters
into any agreement, understanding, or
management contract (other than to
serve as investment adviser) with the
second company, under which the first
company directs or exercises significant
influence or discretion over the general
management, overall operations, or core
business or policy decisions of the
second company. Examples of such
agreements include where the first
company is a managing member,
trustee, or general partner of the second
company, or exercises similar powers
and functions.
(c) Ownership or control of 5 percent
or more of voting securities. The first
company controls 5 percent or more of
the outstanding securities of any class of
voting securities of the second
company, and:
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12429
(1)(i) Director representatives of the
first company or any of its subsidiaries
comprise 25 percent or more of the
board of directors of the second
company or any of its subsidiaries; or
(ii) Director representatives of the first
company or any of its subsidiaries are
able to make or block the making of
major operational or policy decisions of
the second company or any of its
subsidiaries;
(2) Two or more employees or
directors of the first company or any of
its subsidiaries serve as senior
management officials of the second
company or any of its subsidiaries;
(3) An employee or director of the
first company or any of its subsidiaries
serves as the chief executive officer, or
serves in a similar capacity, of the
second company or any of its
subsidiaries;
(4) The first company or any of its
subsidiaries enters into transactions or
has business relationships with the
second company or any of its
subsidiaries that generate in the
aggregate 10 percent or more of the total
annual revenues or expenses of the
second company, each on a
consolidated basis; or
(5) The first company or any of its
subsidiaries has any limiting contractual
right with respect to the second
company or any of its subsidiaries,
unless such limiting contractual right is
part of an agreement to merge with or
make a controlling investment in the
second company that is reasonably
expected to close within one year and
such limiting contractual right is
designed to ensure that the second
company continues to operate in the
ordinary course until the merger or
investment is consummated or such
limiting contractual right requires the
second company to take an action
necessary for the merger or investment
to be consummated.
(d) Ownership or control of 10 percent
or more of voting securities. The first
company controls 10 percent or more of
the outstanding securities of any class of
voting securities of the second
company, and:
(1) The first company or any of its
subsidiaries propose a number of
director representatives to the board of
directors of the second company or any
of its subsidiaries in opposition to
nominees proposed by the management
or board of directors of the second
company or any of its subsidiaries that,
together with any director
representatives of the first company or
any of its subsidiaries on the board of
directors of the second company or any
of its subsidiaries, would comprise 25
percent or more of the board of directors
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of the second company or any of its
subsidiaries;
(2) Director representatives of the first
company and its subsidiaries comprise
more than 25 percent of any committee
of the board of directors of the second
company or any of its subsidiaries that
can take action that binds the second
company or any of its subsidiaries; or
(3) The first company or any of its
subsidiaries enters into transactions or
has business relationships with the
second company or any of its
subsidiaries that:
(i) Are not on market terms; or
(ii) Generate in the aggregate 5 percent
or more of the total annual revenues or
expenses of the second company, each
on a consolidated basis.
(e) Ownership or control of 15 percent
or more of voting securities. The first
company controls 15 percent or more of
the outstanding securities of any class of
voting securities of the second
company, and:
(1) A director representative of the
first company or of any of its
subsidiaries serves as the chair of the
board of directors of the second
company or any of its subsidiaries;
(2) One or more employees or
directors of the first company or any of
its subsidiaries serves as a senior
management official of the second
company or any of its subsidiaries; or
(3) The first company or any of its
subsidiaries enters into transactions or
has business relationships with the
second company or any of its
subsidiaries that generate in the
aggregate 2 percent or more of the total
annual revenues or expenses of the
second company, each on a
consolidated basis.
(f) Accounting consolidation. The first
company consolidates the second
company on its financial statements
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prepared under U.S. generally accepted
accounting principles.
(g) Control of an investment fund. (1)
The first company serves as an
investment adviser to the second
company, the second company is an
investment fund, and the first company,
directly or indirectly, or acting through
one or more other persons, controls 5
percent or more of the outstanding
securities of any class of voting
securities of the second company.
(2) The presumption of control in
paragraph (g)(1) of this section does not
apply if the first company organized and
sponsored the second company within
the preceding 12 months.
(h) Divestiture of control. (1) The first
company controlled the second
company under § 238.2(e)(1) or (2) of
this part at any time during the prior
two years and the first company
controls 15 percent or more of the
outstanding securities of any class of
voting securities of the second
company.
(2) Notwithstanding paragraph (h)(1)
of this section, a first company will not
be presumed to control a second
company under this paragraph if 50
percent or more of the outstanding
securities of each class of voting
securities of the second company is
controlled by a person that is not a
senior management official or director
of the first company, or by a company
that is not an affiliate of the first
company.
(i) Securities held in a fiduciary
capacity. For purposes of the
presumptions of control in this section,
the first company does not control
securities of the second company that
the first company holds in a fiduciary
capacity, except that if the second
company is a depository institution or a
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depository institution holding company,
this paragraph (i) only applies to
securities held in a fiduciary capacity
without sole discretionary authority to
exercise the voting rights of the
securities.
§ 238.23 Rebuttable presumption of
noncontrol of a company.
(a) In any proceeding under
§ 238.21(b) or (c) of this part, a first
company is presumed not to control a
second company if:
(1) The first company controls less
than 10 percent of the outstanding
securities of each class of voting
securities of the second company; and
(2) The first company is not presumed
to control the second company under
§ 238.22 of this part.
(b) In any proceeding under this
subpart, or judicial proceeding under
the Home Owners’ Loan Act, other than
a proceeding in which the Board has
made a preliminary determination that
a first company has the power to
exercise a controlling influence over the
management or policies of a second
company, a first company may not be
held to have had control over a second
company at any given time, unless the
first company, at the time in question,
controlled 5 percent or more of the
outstanding securities of any class of
voting securities of the second
company, or had already been found to
have control on the basis of the
existence of a controlling influence
relationship.
By order of the Board of Governors of the
Federal Reserve System, February 14, 2020.
Ann Misback,
Secretary of the Board.
[FR Doc. 2020–03398 Filed 2–27–20; 8:45 am]
BILLING CODE 6210–01–P
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[Federal Register Volume 85, Number 41 (Monday, March 2, 2020)]
[Rules and Regulations]
[Pages 12398-12430]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-03398]
[[Page 12397]]
Vol. 85
Monday,
No. 41
March 2, 2020
Part II
Federal Reserve System
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12 CFR Parts 225 and 238
Control and Divestiture Proceedings; Final Rule
Federal Register / Vol. 85 , No. 41 / Monday, March 2, 2020 / Rules
and Regulations
[[Page 12398]]
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FEDERAL RESERVE SYSTEM
12 CFR Parts 225 and 238
[Regulations Y and LL; Docket No. R-1662]
RIN 7100-AF 49
Control and Divestiture Proceedings
AGENCY: Board of Governors of the Federal Reserve System (Board).
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: The Board is adopting a final rule to revise the Board's
regulations related to determinations of whether a company has the
ability to exercise a controlling influence over another company for
purposes of the Bank Holding Company Act or the Home Owners' Loan Act.
The final rule expands the number of presumptions for use in such
determinations. By codifying the presumptions in the Board's Regulation
Y and Regulation LL, the Board's rules will provide substantial
additional transparency on the types of relationships that the Board
generally views as supporting a determination that one company controls
another company. The final rule is largely consistent with the proposal
and includes certain targeted adjustments to the Board's historical
practice, as described in detail in the SUPPLEMENTARY INFORMATION.
DATES: The final rule is effective on April 1, 2020.
FOR FURTHER INFORMATION CONTACT: Laurie Schaffer, Deputy General
Counsel, (202) 452-2272, Alison Thro, Deputy Associate General Counsel,
(202) 452-3236, Mark Buresh, Senior Counsel, (202) 452-5270, Greg
Frischmann, Senior Counsel, (202) 452-2803, or Brian Phillips, Senior
Attorney, (202) 452-3321, Legal Division; Melissa Clark, Lead Financial
Institution Policy Analyst, (202) 452-2277, or Sheryl Hudson, Lead
Financial Institution Policy Analyst, (202) 912-7839, Division of
Supervision and Regulation, Board of Governors of the Federal Reserve
System, 20th Street and Constitution Avenue NW, Washington, DC 20551.
For users of Telecommunication Device for Deaf (TDD) only, call (202)
263-4869.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background and Summary of the Proposal
A. Description of ``Control'' Under the Bank Holding Company Act
B. Summary of the Board's Historical Interpretation of
``Control'' Under the Bank Holding Company Act
C. Summary of the Proposal
D. Summary of Comments Received on the Proposal
II. Final Rule--Presumptions of Control and Noncontrol
A. Control Hearings and the Role of Presumptions of Control and
Noncontrol
B. Description of the Tiered Presumptions
C. Description of Additional Presumptions and Exclusions
III. Final Rule--Control-Related Definitions
A. First Company and Second Company
B. Voting Securities and Nonvoting Securities
C. Control of Securities
D. Calculation of Total Equity Percentage
E. Limiting Contractual Rights
F. Director Representatives
G. Investment Advisers
IV. Application to Savings and Loan Holding Companies
A. Control Under HOLA Compared to the BHC Act
B. Revisions to Regulation LL
V. Additional Implementation Matters
VI. Administrative Law Matters
A. Paperwork Reduction Act
B. Regulatory Flexibility Act
C. Plain Language
I. Background and Summary of the Proposal
In May 2019, the Board issued a proposal seeking comment on
revisions to its rules regarding the definition of control in the Bank
Holding Company Act (``BHC Act''),\1\ and the Home Owners' Loan Act
(``HOLA'').\2\ The proposal was published in the Federal Register on
May 14, 2019, and the period for public comment ended on July 15,
2019.\3\ The proposal was intended to provide bank holding companies,
savings and loan holding companies, depository institutions, investors,
and the public with a better understanding of the facts and
circumstances that the Board considers most relevant when assessing
control and thereby increase transparency around the Board's views on
control under the BHC Act and HOLA.
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\1\ 12 U.S.C. 1841 et seq.
\2\ 12 U.S.C. 1461 et seq.
\3\ 84 FR 21634 (May 14, 2019).
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Under the BHC Act, control is defined by a three-pronged test: A
company has control over another company if the first company (i)
directly or indirectly or acting through one or more other persons
owns, controls, or has power to vote 25 percent or more of any class of
voting securities of the other company; (ii) controls in any manner the
election of a majority of the directors or trustees of the other
company; or (iii) directly or indirectly exercises a controlling
influence over the management or policies of the other company.\4\ HOLA
includes a substantially similar definition of control.\5\ While the
first two prongs of the definition of control are easily understood
bright-line standards, the third prong of the definition of control
requires a facts and circumstances determination by the Board. As a
result, it is often difficult for an investor that does not meet either
of the first two prongs of the definition of control to determine
whether it will be considered controlling or noncontrolling by the
Board under the third prong.
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\4\ 12 U.S.C. 1841(a)(2); 12 CFR 225.2(e).
\5\ See 12 U.S.C. 1467a(a)(2); 12 CFR 238.2(e).
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In practice, large minority investors often seek to protect or
enhance their investments through multiple forms of engagement with the
target company that provide the investor with an opportunity to monitor
and influence the target company. This situation in particular
frequently has raised questions regarding whether the investor will be
able to exercise a controlling influence over the management or
policies of the target company when the investment and all other
aspects of the relationship are considered in the aggregate. These
issues arise for both companies seeking to invest in banking
organizations and banking organizations seeking to make investments in
other companies.
Under the statutory framework, the determination of whether a
company has the ability to exercise a controlling influence over
another company is a factual determination. The Board's experience has
shown that the variety of equity investments, negotiated investment
terms, and business and other arrangements between companies makes it
difficult to prescribe a set of rigid rules that determine whether one
company exercises a controlling influence over another company in all
situations. As a result, Board determinations regarding the presence or
absence of a controlling influence have taken into account the specific
facts and circumstances of each case.\6\ Nonetheless, the Board has
developed over time a number of factors and thresholds that the Board
believes generally are indicative of the ability or inability of a
company to exercise a controlling influence over another company.
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\6\ See 12 CFR 225.143; Policy Statement on equity investments
in banks and bank holding companies (September 22, 2008),
www.federalreserve.gov/newsevents/press/bcreg/20080922c.htm.
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The Board believes that the final rule, which is largely consistent
with the proposal, will increase the transparency and consistency of
the Board's control framework. As a result, the final rule should help
to facilitate permissible investments in banking organizations and by
banking organizations.
[[Page 12399]]
The final rule includes certain targeted adjustments relative to
historical practice that the Board believes are appropriate based on
its experience over the past few decades. The specific provisions of
the final rule, including the targeted adjustments, are described in
detail in this preamble.
A. Description of ``Control'' Under the Bank Holding Company Act
Control is a foundational concept under the BHC Act and related
statutes.\7\ Most notably, control is used to determine the scope of
application of the BHC Act because a company is defined to be a bank
holding company if the company directly or indirectly controls a bank
or bank holding company.\8\ Accordingly, a company that controls a bank
or bank holding company is subject to the Board's regulations and
supervisory oversight, which includes examinations,\9\ regular
financial reporting,\10\ capital and liquidity requirements,\11\ source
of strength obligations,\12\ activities restrictions,\13\ and
restrictions on affiliate transactions.\14\
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\7\ The following discussion is limited to the BHC Act because
much of the Board's experience with control has arisen in the
context of the BHC Act, rather than HOLA. The final rule generally
applies the same standards in the context of the BHC Act and HOLA,
though the final rule is different in each context where appropriate
to recognize the limited differences between the BHC Act and HOLA
with respect to the definition of control.
\8\ 12 U.S.C. 1841(a)(1).
\9\ 12 U.S.C. 1844(c); 12 CFR 225.5(c).
\10\ 12 U.S.C. 1844(c); 12 CFR 225.5(b).
\11\ See, e.g., 12 CFR part 217; 12 CFR 225 app. C; 12 CFR part
249.
\12\ 12 U.S.C. 1831o-1.
\13\ 12 U.S.C. 1843; 12 CFR 225 subpart C.
\14\ 12 U.S.C. 371c and 371c-1; 12 CFR part 223.
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In assessing control, the Board historically has focused on two key
purposes of the BHC Act to guide its understanding of the meaning of
control and controlling influence. First, the BHC Act was intended to
ensure that companies that acquire control of banks have the financial
strength and managerial ability to exercise control in a safe and sound
manner. Second, the BHC Act was intended to separate banking from
commerce by preventing companies with commercial interests from
exercising control over banking organizations and by restricting the
nonbanking activities of banking organizations.\15\
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\15\ Bank Holding Company Act Amendments: Hearing on H.R. 6778
Before H. Comm. on Banking & Currency, 91st Cong. 85 (1969).
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Congress enacted the BHC Act in 1956. In the original BHC Act,
Congress defined ``bank holding company'' to mean any company that (1)
``directly or indirectly owns, controls, or holds with power to vote,
25 per centum or more of the voting shares of each of two or more banks
or of a company which is or becomes a bank holding company by virtue of
this Act, or (2) which controls in any manner the election of a
majority of the directors of each of two or more banks.'' \16\
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\16\ Bank Holding Company Act of 1956, Public law 84-511, 70
Stat. 133 (May 9, 1956). The original BHC Act also defined ``bank
holding company'' to include a company that holds 25 percent or more
of the voting securities of two or more banks or bank holding
companies, if such securities are held by trustees for the benefit
of the shareholders or members of the company. This prong of control
was repealed in 1966. See An Act to Amend the Bank Holding Company
Act of 1956, Public Law 89-485, 80 Stat. 236 (July 1, 1966).
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In 1970, Congress made significant amendments to the BHC Act,
including revisions to the definition of control. Specifically,
Congress added to the existing two prongs of the definition of control
a new third prong. This third prong provided that a company has control
over a bank or other company if the ``Board determines after notice and
opportunity for hearing, that the company directly or indirectly
exercises a controlling influence over the management or policies of
the bank or company.'' \17\ Congress added the controlling influence
prong to address concerns that a company could structure an investment
in a bank below the two bright-line thresholds of control while still
having the ``power directly or indirectly to direct or cause the
direction of the management or policies of any bank.'' \18\
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\17\ An Act to Amend the Bank Holding Company Act of 1956,
Public Law 91-607, 84 Stat. 1760, 1761 (December 31, 1970). HOLA,
originally enacted in 1933, contains substantially similar language
for its definition of control. As a corollary to the third prong in
the BHC Act, HOLA's definition of control of a savings association
or other company includes ``if the Board determines after reasonable
notice and opportunity for hearing, that such person directly or
indirectly exercises a controlling influence over the management or
policies of such association or other company.'' 12 U.S.C.
1467a(a)(2)(D).
\18\ Bank Holding Company Act Amendments: Hearing on H.R. 6778
Before H. Comm. on Banking & Currency, 91st Cong. 87 (1969).
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B. Summary of the Board's Historical Interpretation of ``Control''
Under the Bank Holding Company Act
Since the 1970 amendments to the BHC Act, the Board has had
numerous occasions to interpret and apply the controlling influence
prong of the BHC Act. The Board historically has interpreted
controlling influence not to require that an investor is able to
exercise complete domination or absolute control over all aspects of
the management and policies of a company. Instead, the Board has found
that a controlling influence is possible at lower levels of influence,
including where a company is not able to determine the outcome of a
significant matter under consideration.\19\ In other words, control
requires only ``the mere potential for manipulation of a bank.'' \20\
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\19\ Patagonia Corp., 63 Federal Reserve Bulletin 288 (1977)
(citing Detroit Edison Co. v. SEC, 119 F.2d 738, 739 (6th Cir. 1941)
(interpreting ``controlling influence'' in the Public Utility
Holding Company Act, which has a nearly identical definition of
control as in the BHC Act, to not ``necessarily [require] those
exercising a controlling influence [to] be able to carry their
point.'' Rather a controlling influence can be effective ``without
accomplishing the purpose fully'')).
\20\ Interamericas Investments, Ltd. v. Bd. of Governors of the
Fed. Reserve Sys., 111 F.3d 376, 383 (5th Cir. 1997).
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In assessing the controlling influence prong, the Board has
considered a number of factors, including the size of a company's
voting and total equity investment in the other company; the presence
of countervailing shareholders of the other company; a company's
representation on the board of directors or board committees of the
other company; covenants or other agreements that allow a company to
influence or restrict the management decisions of the other company;
and the nature and scope of the business relationships between the
companies.\21\ The Board's regulations include procedures for
determining controlling influence, as well as certain standards for
identifying controlling influence. The Board also has issued guidance
documents related to control on several occasions. For example, the
Board issued a limited set of regulatory presumptions of control for
use in control proceedings in 1971 and updated these presumptions in
1984.\22\ In addition, the Board issued policy statements regarding the
controlling influence prong of the BHC Act in 1982 and 2008.\23\
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\21\ A relationship between two companies may raise supervisory
or other concerns whether or not the relationship raises controlling
influence concerns.
\22\ 36 FR 18945 (Sept. 24, 1971); 49 FR 794, 817, 828-29 (Jan.
5, 1984).
\23\ See 68 Federal Reserve Bulletin 413 (July 1982) (codified
at 12 CFR 225.143); Policy Statement on equity investments in banks
and bank holding companies (September 22, 2008). The Board has
issued two additional policy statements that are also relevant to
the meaning of control and controlling influence: ``Statement of
policy concerning divestitures by bank holding companies'' (12 CFR
225.138) and ``Presumption of continued control under section
2(g)(3) of the Bank Holding Company Act'' (12 CFR 225.139). These
policy statements remain in effect to the extent not superseded by
the final rule.
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C. Summary of the Proposal
The proposal established tiered presumptions of control in the
Board's regulations. The proposal also provided several additional
presumptions of control and noncontrol, along with
[[Page 12400]]
various ancillary provisions such as definitions of terms used in the
proposed presumptions.
As noted, the BHC Act and HOLA provide that control due to
controlling influence arises once the Board determines, based on the
facts presented and after notice and opportunity for a hearing, that a
company controls another company. The proposal established presumptions
intended to assist the Board in conducting such a hearing or other
proceeding and to provide additional information to the public
regarding the circumstances in which the Board believes that
controlling influence is likely to exist.\24\
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\24\ Under the final rule, the Board retains the ability to find
a controlling influence based on the facts and circumstances
presented by a particular case. However, the Board generally does
not expect to find that a company controls another company unless
the first company triggers a regulatory presumption of control with
respect to the second company.
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The proposal--like this final rule--related solely to the issue of
whether an investment, alone or in combination with other
relationships, raises control concerns. The Board may have safety and
soundness or other concerns arising out of either controlling or
noncontrolling relationships of a banking organization. Thus, that an
investment is not presumed to be controlling does not mean that the
investment and all other aspects of a relationship are necessarily
consistent with safe and sound banking practices or other expectations
or requirements of the Board.\25\ The Board retains the right to review
investments involving banking organizations under its jurisdiction for
potential safety and soundness or other concerns.
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\25\ For example, contractual covenants and business
relationships between a banking organization and a company may raise
safety and soundness or other concerns whether or not the
relationship raises control concerns. In particular, a contractual
provision may not allow a company to restrict substantially the
discretion of a banking organization, but may impose financial
obligations on the banking organization that are inconsistent with
safe and sound operation of the banking organization.
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D. Summary of Comments Received on the Proposal
General Comments
Many commenters were supportive of the Board's overall efforts to
bring increased transparency, clarity, and consistency to the Board's
views regarding controlling influence. Some commenters noted that the
additional clarity provided by the proposal would improve the speed
with which banking institutions can raise capital.
Certain commenters argued that the Board's presumptions of control
presumed control at levels too low to be supported by the underlying
statutes.\26\ Several of these commenters contended that Congress
intended the controlling influence prong of the BHC Act to cover only
situations with higher levels of influence than the Board has
traditionally considered controlling, which some commenters referred to
as situations of ``actual control.'' Many commenters who supported
higher thresholds for the presumptions of control argued that unduly
low thresholds would inhibit investments into and by banking
organizations and, in particular, would inhibit investments by banking
organizations into start-up technology companies. These commenters
generally argued that there was no public benefit to limiting such
investments and that there could be a negative impact on the economy.
At least one commenter also suggested that a higher threshold for
control would be appropriate in order to mitigate the extraterritorial
application of the BHC Act on the foreign operations of foreign firms.
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\26\ Specific suggestions from commenters are described in the
appropriate sections of this preamble on specific presumptions.
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In support of a higher threshold for control, several commenters
suggested that the Board look to its treatment of merchant banking
investments, as well as the definition of banking entity under the
Volcker Rule. These commenters argued that the Board had established
looser definitions of control in these areas that should be applied to
control more generally. Other commenters argued that the Board should
separate control in general under the BHC Act from the definition of
banking entity under the Volcker Rule. In addition, certain commenters
provided suggestions for revising the Board's rules related to merchant
banking to separate merchant banking from questions of control.
A few commenters objected to the proposal on the basis that the
Board's current standards and processes around controlling influence
have functioned well. Such commenters asserted that the proposal may
have various negative effects by weakening the existing framework.
Several commenters objected to the elements of the proposal that they
viewed as raising the threshold for control for several reasons,
including concern that the proposal could lead to greater concentration
in the banking industry or to greater concentration in the shareholder
base of the banking industry. At least one commenter expressed concern
that the proposal might allow companies to have greater influence over
banking organizations without being subject to the bank regulatory
framework and noted that retaining discretion to review each case on
the facts and circumstances presented was necessary to address the wide
variety of potential relationships among companies. At least one
commenter stated that the Board should consider the economic and
competitive impact of these types of increased consolidation and should
update its analysis of competitive issues more generally. At least one
commenter also stated that the Board should carefully consider the
impact of the control proposal on smaller banking organizations and the
ability of banking organizations to sponsor and advise investment
funds.
The Board believes that the proposal reflected an appropriate
interpretation of the controlling influence prong of the BHC Act and
generally conformed to historical Board practice implementing and
interpreting the statute. The Board's historical practice is consistent
with the underlying statutes, the legislative history, and relevant
case law. The Board has made several changes in the final rule compared
to the proposal, as described in more detail in the applicable sections
of this preamble, but the Board is issuing the final rule in a form
substantially consistent with the proposal. As indicated in the
proposal, the final rule contains certain targeted adjustments from
current practice in light of the Board's experience administering the
statute. These changes are generally technical in nature rather than
fundamental changes to the Board's substantive standards for
controlling influence. As the final rule is generally consistent with
current practice, significant changes in outcomes are not anticipated
and, therefore, no major impact on the banking industry is expected.
Importantly, the final rule significantly improves the transparency and
predictability around questions of controlling influence.
Some commenters expressed concern that certain of the presumptions
could have extraterritorial reach by attributing control over companies
outside the United States, especially by foreign banking organization.
Commenters recommended that the Board clarify that lawful home country
activities and relationships currently in existence should not be upset
by the proposal. A few commenters argued for different control
standards for qualifying foreign banking organizations, or for foreign
companies more generally. At least one commenter argued that the
Board's rules should take foreign control standards
[[Page 12401]]
into account when considering relationships involving foreign entities
or that the Board should revise its control standards to not apply to
relationships that are wholly outside the United States.
The statutory framework for control does not contemplate different
definitions of control for companies in different jurisdictions. For
this reason, neither the proposal nor the Board's historical practice
contains such distinctions. The final rule is consistent with the
proposal in this regard. As noted, the final rule is generally
consistent with the Board's current practice and, as a result, the
final rule is not expected to result in substantially different
outcomes for questions of controlling influence involving foreign
companies.
Comments on Scope of Application
Some commenters suggested that the final rule should make it clear
that an investment that does not trigger a presumption of control and
is less than 5 percent of any class of voting securities should be
considered passive for purposes of section 4(c)(6) of the BHC Act. The
final rule is intended to apply to questions of control under the BHC
Act and HOLA. As a result, the control framework in the final rule
applies for purposes of section 4(c)(6) and, in particular, the Board's
interpretation of section 4(c)(6) located in section 225.137 of the
Board's Regulation Y.\27\
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\27\ 12 CFR 225.137.
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Comments on Interaction With Other Regulations
Several commenters suggested that the Board apply the proposed
control standards to control under the Change in Bank Control Act
(``CIBCA'').\28\ Several commenters also recommended that the Board
apply the proposed control standards to the Board's Regulation O and
Regulation W.\29\ Commenters suggested that applying the control
standards in the proposal to these other contexts would improve the
simplicity and efficiency of the Board's regulations by establishing a
uniform, trans-regulatory concept of control. Some commenters noted
that, in certain cases, this could result in a more permissive control
standard than currently applies under CIBCA, Regulation O, and
Regulation W.
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\28\ 12 U.S.C. 1817(j).
\29\ 12 CFR part 215; 12 CFR part 223.
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A few commenters also argued that the threshold for filing a notice
under CIBCA was too low and that the Board should streamline the CIBCA
notice process--in coordination with the FDIC and OCC--to reduce the
burden of CIBCA filings. These commenters asserted that the existing
CIBCA regulations restricted investment into banking organizations and
therefore recommended that the Board revise its regulations to reduce
the number of filings and the information required in a filing.
Specific recommendations for reduced burden included creating a process
for investors to rebut the 10 percent presumption of control under the
CIBCA regulations, reducing the required content of a CIBCA notice, and
increasing reliance on public information such as public filings with
the Securities and Exchange Commission (``SEC''). At least one
commenter stated that the Board should reduce the scope of CIBCA filing
requirements to remove or limit, for example, CIBCA filing requirements
for investments in predominantly non-financial grandfathered savings
and loan holding companies.
Other commenters argued against applying the proposed control
framework to contexts other than control under the BHC Act and HOLA.
These commenters noted that the control concept under the BHC Act and
HOLA serves a different purpose than under CIBCA, Regulation O, and
Regulation W. For example, control under CIBCA requires filing a one-
time notice, while control under the BHC Act results in a permanent
regulatory status that comes with activity restrictions, prudential
regulation, approval requirements for major transactions, periodic
examinations, and reporting requirements. Some commenters also
encouraged the Board to provide additional clarity about the operation
of the presumptions of control under the regulations implementing
CIBCA.
The final rule applies to questions of control under the BHC Act
and HOLA; it does not extend to CIBCA, Regulation O, and Regulation W.
The Board may in the future consider conforming revisions to other
elements of its regulatory framework, including CIBCA, Regulation O,
and Regulation W. While common control standards across the Board's
regulatory framework may provide efficiency benefits, each of the
regulations identified by commenters arises out of different provisions
of law and is intended to address different concerns in specific
contexts.
Some commenters suggested that the Board provide additional
guidance for investments in non-corporate entities, such as
partnerships and limited liability companies. In certain sections, the
proposal provided for the special characteristics of non-corporate
entities. The final rule retains these provisions but does not contain
further information regarding the treatment of non-corporate entities
because of the wide variety of forms such entities can take. The Board
generally expects to apply equivalent control standards to all types of
legal entities while taking into account the unique features of
different entity types.
II. Final Rule--Presumptions of Control and Noncontrol
A. Control Hearings and the Role of Presumptions of Control and
Noncontrol
The BHC Act provides that control due to controlling influence
arises following a Board determination that a company controls another
company. The presumptions of control in the final rule are intended to
assist the Board in the context of such a determination and to provide
additional public information regarding the Board's views on
controlling influence.
Under the final rule, the Board, in its discretion, may issue a
preliminary determination of control if it appears that a company has
the power to exercise a controlling influence over a bank or other
company. A company that receives a preliminary determination of control
must respond within 30 days with (i) a plan to terminate the control
relationship; (ii) an application for the Board's approval of the
control relationship; or (iii) a response contesting the preliminary
determination, setting forth supporting facts and circumstances, and,
if desired, requesting a hearing or other proceeding. If a company
contests a preliminary determination of control and requests a hearing
or other proceeding, then the Board shall order a hearing or other
appropriate proceeding if material facts are in dispute. The
presumptions in the final rule would apply at such a hearing or other
proceeding in accordance with the Federal Rules of Evidence and the
Board's Rules of Practice for Formal Hearings. After considering all
relevant facts and circumstances, including information gathered during
any hearing or other proceeding, the Board would issue a final order
stating its determination on controlling influence. Under the final
rule, as under the proposal, the procedures differ from the existing
procedures in the Board's regulations in only two modest ways. First,
the final rule clarifies that failure to respond to a preliminary
determination of control from the Board would constitute waiver of the
right to present additional information to the Board and waiver of the
opportunity to
[[Page 12402]]
request a hearing or other proceeding. Second, the final rule contains
an express requirement to submit additional information in writing in
response to a preliminary determination of control.
Some commenters recommended that the Board grant additional time to
respond to preliminary determinations of control. The final rule
maintains the existing 30-day timeframe because 30 days should
generally be sufficient time to respond to a preliminary determination
of control. Thirty days is consistent with, or, in some cases, longer
than, the procedural timeframes provided by the Board for similar
administrative processes.\30\ In addition, the final rule provides that
the Board may allow for additional time in its discretion, so firms
that need additional time may request additional time. The procedures
for control proceedings in the final rule are consistent with the
proposal.
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\30\ See, e.g., 12 CFR part 263.
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B. Description of the Tiered Presumptions
As discussed, a core consideration for control established by
Congress in the BHC Act is the percentage of voting securities that one
company controls of a second company. Under the statute, a company that
controls 25 percent or more of any class of voting securities of a
second company controls the second company.\31\ Similarly, under the
statute, a company that controls less than 5 percent of any class of
voting securities of a company is presumed not to control the second
company.\32\ This statutory framework leaves a space between 5 percent
and 25 percent of a class of voting securities where a company does not
have clear statutory control and is not presumed not to control. For
companies within this range of voting securities of 5 percent to less
than 25 percent voting, the Board considers the full facts and
circumstances of the relationship between the two companies when
determining whether the first company controls the second company,
consistent with the controlling influence prong of the BHC Act.\33\
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\31\ 12 U.S.C. 1841(a)(2)(A).
\32\ 12 U.S.C. 1841(a)(3).
\33\ 12 U.S.C. 1841(a)(2)(C).
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The framework established by Congress implies that a company with a
level of voting securities at the higher end of the range--closer to 25
percent--is more likely to control the second company, while a company
at the lower end of the range--closer to 5 percent--is less likely to
control the second company. The Board's experience supports these
implications. As a result, where a company's voting securities
percentage falls within this range is one of the most salient
considerations for determining whether the first company controls the
second company.
The final rule, like the proposed rule, establishes a series of
tiered presumptions of control. These presumptions are arranged in
tiers based on the level of voting securities of the first company in
the second company. Each of these presumptions applies where the first
company has at least a specified level of voting securities in a second
company, and another specified relationship with the second company.
The presumptions use three thresholds for voting securities: 5 percent,
10 percent, and 15 percent.
Consistent with the proposal, many of the other control factors
referenced in the final rule also vary in magnitude. For instance,
business relationships between two companies can range from minimal to
very significant, and more significant business relationships provide a
greater means of exercising (and a greater incentive to exercise) a
controlling influence than less significant business relationships. In
recognition of this, the presumptions in the final rule effectively
assume that higher levels of business relationships, combined with
higher levels of voting securities, increase the likelihood of the
ability to exercise a controlling influence.
Director Representation
The Board has long considered a company's level of representation
on the board of directors of a second company as an important factor
for controlling influence. The importance of director representation to
controlling influence is supported by the second prong of the
definition of control in the BHC Act, which provides that control over
the election of a majority of the board of directors of a company
constitutes control of the company. Traditionally, the board of
directors of a company is the body that makes strategic decisions and
establishes major policies for the company. One of the most important
issues that holders of voting securities can vote on is the selection
of the members of the board of directors of a company.
For a company that controls 5 percent or more of any class of
voting securities of a second company, the proposal presumed control if
the first company controlled a quarter or more of the board of
directors of the second company. This presumption reflected the view
that the combination of a material level of voting power combined with
control over a quarter or more of the board of directors is generally
enough to constitute a controlling influence. This element of the
proposal reflected a modest liberalization of practice. Under the
Board's precedents, a noncontrolling company that controlled more than
10 percent of a class of voting securities of another company often was
limited to one or two director representatives at the second company
(regardless of the size of the board of directors at the second
company).\34\
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\34\ Policy Statement on equity investments in banks and bank
holding companies (September 22, 2008).
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In addition, the proposal presumed that a company that controls 5
percent or more of any class of voting securities of a second company
controls the second company if the first company has director
representatives that are able to make or block the making of major
operational or policy decisions of the second company. This presumption
was intended to address supermajority voting requirements, individual
veto rights, or any similar unusual provision that would allow a
minority of the board of directors of the second company to control
effectively major operational or policy decisions of the second
company.
Commenters generally supported the proposal to allow a company to
have up to a quarter of the representatives on the board of directors
of another company without triggering a presumption of control.
Commenters generally also confirmed that they preferred the proposal to
a standard where companies with higher levels of voting securities must
have reduced levels of director representation to avoid triggering a
presumption of control. The final rule is consistent with the proposal
with respect to the total share of director representatives that a
company may have on the board of directors of another company before
triggering a presumption of control.
In addition to the share of director representatives that one
company has on the board of directors of a second company, the proposed
presumptions considered particular director representatives to have
outsized ability to affect the decisions of the second company. For
instance, the chair of the board of directors of a company is generally
recognized as a leader of the company and its board of directors, and
the chair may have additional powers, such as the ability to set the
agenda for meetings of the board of directors. Similarly, certain
committees of the board of directors may have the power to take actions
that bind the company without the need for approval by the
[[Page 12403]]
full board of directors. In these circumstances, such a committee is
nearly equivalent to the full board of directors with respect to those
decisions that it is empowered to make unilaterally.
To recognize the enhanced power wielded by directors in the
positions described in the paragraph above, the proposal included a
presumption of control if a company controls 15 percent or more of any
class of voting securities of a second company and if any director
representative of the first company also serves as the chair of the
board of directors of the second company. In addition, the proposal
included a presumption of control if a company controls 10 percent or
more of any class of voting securities of a second company and the
director representatives of the first company occupy more than a
quarter of the positions on any board committee of the second company
that has the power to bind the company without the need for additional
action by the full board of directors.
With respect to the presumption of control for a director
representative serving as chair of the board, commenters suggested that
different standards should apply depending on whether the company was
publically traded, on the basis that public companies are subject to
heightened governance standards compared to private companies.
Commenters also suggested that the Board take the presence of
independent directors into account because independent directors could
limit the influence of the chair of the board.
With respect to the presumption of control for director
representatives serving on certain committees, commenters generally
supported the distinction drawn in the proposal between committees with
power to act independently and committees with only advisory powers.
Some commenters suggested that the presumption of control should apply
only if the director representatives occupied 50 percent or more of an
independent committee. At least one commenter suggested clearly
excluding advisory committees from the committee presumption.
The final rule is consistent with the proposal with respect to the
presumptions of control for director representatives serving as chair
of the board or serving on certain committees. Distinguishing between
public and private companies, or between companies that have a high
versus low proportion of independent directors, would add substantial
complexity to the framework. In addition, incorporating such
distinctions may increase uncertainty with respect to control because
the proportion of independent directors or the public status of a
company may change without action by an investor. Moreover, as noted
above, the presumption of control related to director representatives
occupying more than 25 percent of a committee that has the power to
take action to bind the company is premised on the concern that such a
committee is nearly equivalent to the full board of directors with
respect to those items that the committee can act on unilaterally. As a
result, the final rule retains the 25 percent committee standard
contained in the proposal to correspond to the 25 percent entire-board
standard for director representatives. With respect to the questions on
advisory committees, the standard under the final rule is whether a
committee has the ability to take action that binds the company or its
subsidiaries. If an advisory committee does not have that ability, it
is not a committee covered by the presumption.
The proposal also included a presumption regarding the solicitation
of proxies for the election of directors, consistent with Board
precedent. Under the proposal, the Board would have presumed control if
a company that controls 10 percent or more of any class of voting
securities of a second company solicits proxies to appoint a number of
directors that equals or exceeds a quarter of the total directors on
the board of directors of the second company. This 25 percent standard
aligned the presumption for proxy solicitations to elect directors with
the proposed presumption for having director representatives.
The Board did not receive comments specifically on the presumption
of control related to the solicitation of proxies to elect directors.
The final rule is consistent with the proposal with respect to this
presumption of control, though the final rule has been revised slightly
to describe the standard more clearly.
Business Relationships
The Board has long believed that a company's business relationships
with another company provide a mechanism through which the first
company could exercise a controlling influence over the second company.
For example, a business relationship between an investor and another
company that accounts for a substantial portion of the revenues or
expenses of the investor may create a financial incentive for the
investor to attempt to influence the second company. Similarly, a
business relationship between an investor and another company that
accounts for a substantial portion of the revenues or expenses of the
second company may create a powerful lever of influence for the
investor over the second company.
Under the proposal, the Board presumed control in the following
circumstances:
i. If a company controls 5 percent or more of any class of voting
securities of a second company and has business relationships with the
second company that generate in the aggregate 10 percent or more of the
total annual revenues or expenses of the first company or the second
company;
ii. If a company controls 10 percent or more of any class of voting
securities of a second company and has business relationships with the
second company that generate in the aggregate 5 percent or more of the
total annual revenues or expenses of the first company or the second
company; or
iii. If a company controls 15 percent or more of any class of
voting securities of a second company and has business relationships
with the second company that generate in the aggregate 2 percent or
more of the total annual revenues or expenses of the first company or
the second company.
In addition, the Board has long believed that if a company is able
to enter into a business relationship with a second company on terms
that are not market terms, it is likely that the first company has a
significant level of influence over the second company. Thus, under the
proposal, the Board presumed control if a company controls 10 percent
or more of any class of voting securities of a second company and has
business relationships with the second company that are not on market
terms.
Many commenters suggested that the Board's proposed presumptions
related to business relationships used revenue and expense thresholds
that were too low. These commenters suggested that, as a consequence,
the presumptions would capture business relationships that generally
would be too small to provide a controlling influence and that the rule
could therefore unnecessarily inhibit beneficial business
relationships. Similarly, some commenters argued that the business
relationship presumptions had the effect of conflating influence over a
business relationship with influence over the management and policies
of a company. A few commenters suggested that the thresholds
established in the proposal for business relationships would create
particular issues for banking organizations seeking to make minority
investments in smaller companies, such
[[Page 12404]]
as recently formed financial technology firms.
Various commenters recommended different thresholds for the control
presumptions based on business relationships. For example, some
commenters recommended that the Board revise the business relationship
presumptions such that an investor with less than 15 percent of any
class of voting securities in a second company would not be presumed to
have control regardless of the size of business relationships between
the companies. Similarly, a few commenters recommended that the
business relationship thresholds for a presumption of control be raised
substantially at different levels of voting securities. For example, at
least one commenter stated that the presumptions of control should be
set at 50 percent of revenues and expenses for an investor with between
5 and 10 percent of voting securities, at 33 percent of revenues and
expenses for an investor between 10 and 15 percent of voting
securities, and at 25 percent of revenues and expenses for an investor
between 15 and 25 percent of voting securities. Some commenters also
suggested applying higher thresholds in certain circumstances, such as
if there were a larger shareholder or a party with a larger business
relationship.
A few commenters suggested that the Board abandon quantitative
metrics for business relationships and instead presume control only if
a company threatens to terminate or alter business relationships with
another company for the purpose of exercising a controlling influence
over the second company's management or policies.
As noted, the Board historically has viewed business relationships
as an important mechanism through which one company can exercise
control over the management or policies of another company. The Board's
longstanding view has required business relationships to be
quantitatively limited and qualitatively immaterial to avoid raising
control concerns. Consistent with this principle, the proposal provided
several presumptions based on voting securities and business
relationships. The Board views the thresholds at which the proposed
business relationship presumptions of control were set to be reasonable
and generally consistent with its past practice. The final rule,
therefore, retains the threshold levels that were included in the
proposal. Further, the final rule includes the presumption related to
business relationships that are not on market terms without change from
the proposal, for the reasons described above.
Some commenters argued that the Board should modify the business
relationships thresholds to focus only on the revenues (not expenses)
of the two companies. These commenters contended that a business
relationship that is a substantial expense to one party generally does
not provide that party with any additional ability to exercise control
over the counterparty. While commenters acknowledged uncommon
exceptions to this general standard--such as a relationship that cannot
be easily replaced--commenters asked that the rule not consider
expenses or only consider expenses under circumstances likely to be
relevant to control. A number of commenters further argued that the
presumptions should only take into account the scale of business
relationships from the perspective of the second company and not the
first company. Specifically, these commenters contended that the fact
that a relationship was significant to a first company did not mean
that it was significant to a second company and only relationships that
were significant from the perspective of the second company would
provide the first company with an ability to exert influence over the
second company.
In response to these comments, the final rule differs from the
proposal in that the final presumptions of control related to business
relationships only include thresholds based on the revenues and
expenses of the second company. As commenters noted, the significance
of business relationships from the perspective of a first company is
not necessarily indicative of the first company's ability to control a
second company, even though it may provide an incentive for the first
company to attempt to exercise control over the second company. A
business relationship that is significant to a second company as a
source of revenue or expense, however, may be leveraged by the first
company to exercise influence over the second company.\35\
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\35\ Though the final rule is expected to cover most controlling
influence concerns arising out of business relationships, the Board
may raise controlling influence concerns under specific facts and
circumstances consistent with historical precedent, such as
relationships with special qualitative significance (for example,
relationships that are difficult to replace and are necessary for
core functions). In addition, the revised business relationship
presumptions of control do not in any way limit the ability of the
Board to take action to address business relationships that raise
safety and soundness or other concerns.
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As a result, under the final rule, a company would be presumed to
control another company when:
i. The first company controls 5 percent or more of any class of
voting securities of the second company and has business relationships
with the second company that generate in the aggregate 10 percent or
more of the total annual revenues or expenses of the second company;
ii. The first company controls 10 percent or more of any class of
voting securities of the second company and has business relationships
with the second company that generate in the aggregate 5 percent or
more of the total annual revenues or expenses of the second company; or
iii. The first company controls 15 percent or more of any class of
voting securities of the second company and has business relationships
with the second company that generate in the aggregate 2 percent or
more of the total annual revenues or expenses of the second company.
Some commenters sought clarification of concepts used in the
business relationship presumptions, such as total annual revenues and
total annual expenses, and encouraged the Board to rely on well-
understood and widely available definitions of these concepts.
Commenters suggested that the Board provide clear standards for
measurement and attribution of revenues and expenses, and that the
Board clarify what accounting standards could be relied upon for such
measurements. Some commenters argued for a longer period of time over
which to measure the companies' business relationships, such as two
years or three years. A number of commenters argued that the thresholds
for business relationships should only apply with respect to a company
and its consolidated subsidiaries and should not include business
relationships from unconsolidated subsidiaries.
A few commenters argued for an exception to the business
relationship presumptions for a company that could not calculate both
sides of the business relationship but had a good faith basis for
believing that the relationships were within the limits of the
presumptions. At least one commenter recommended that business
relationships be measured based only on the financial statements of a
company at the time of an investment in order to make it easier to
comply with the business relationship thresholds.
Consistent with the proposal, the business relationship
presumptions in the final rule include thresholds based on total
consolidated annual revenues and expenses. Revenues and expenses are
meant to be understood as these terms are commonly understood in the
context of U.S. generally accepted
[[Page 12405]]
accounting principles (``GAAP'').\36\ Principles of consolidation are
also meant to be applied as generally implemented in the context of
GAAP. Thus, the general expectation is that a company's consolidated
income statement for the preceding fiscal year should contain the
necessary information to determine revenues and expenses for purposes
of the presumptions. Further, the final rule maintains annual
measurement of revenues and expenses for purposes of the presumptions
as annual financials provide an existing and widely relied upon means
to understand the significance of business relationships.
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\36\ For purposes of the final rule, revenue is understood to
mean gross income, not income net of expenses. If a company does not
prepare financial statements according to GAAP, the Board expects to
rely on the non-GAAP financial statements of the company, while
taking differences in accounting standards into account as
appropriate.
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Many commenters sought specific exclusions from the business
relationship presumptions. At least one commenter recommended that the
final rule exclude certain types of business relationships, such as
arm's-length lending and deposit relationships, or non-exclusive
business relationships where alternative service providers are
available. Some commenters sought clarification regarding specific
contexts, such as whether management fees paid by limited partners to
general partners should be included as business relationships.
Similarly, commenters argued that readily marketable debt securities of
a company owned by another company should not be included in business
relationships if the terms were not negotiated by the two companies.
At least one commenter argued that the presumptions should not take
into account business relationships between an investment fund and any
company in which the fund makes an investment, to the extent such
relationships are at arm's length and non-exclusive. Some commenters
suggested that the business relationship presumption should take
account of the special circumstances of start-up companies by measuring
revenues over a longer period or not considering business relationships
during the first several years of a company's existence. Several
commenters argued that business relationships involving referrals
should not be included for revenue purposes because the amount of
referral fees can be volatile.
The final rule contains no specific exclusions from the
presumptions for particular types of business relationships. The final
rule establishes clear and generally applicable standards that rely on
well-understood accounting principles that aim to capture the economic
significance of business relationships between two companies. The
introduction of exclusions for particular types of relationships or
counterparties would add substantial complexity to the rule.
Some commenters argued that there should be a temporary transition
or grace period, during which business relationships could exceed
applicable thresholds without triggering a presumption of control. As
discussed, the business relationship presumptions in the final rule are
based on annual consolidated revenues and expenses. The use of annual
measurement allows for some, but not excessive, day-to-day volatility
in business relationships that should be sufficient for companies to
manage. As a result, the final rule includes no additional transition
or grace period.
In addition, consistent with the proposal, the final rule does not
include a presumption of control based on threats to alter or terminate
business relationships. Although such actions may be relevant to
determinations of control, adding such a presumption would increase the
complexity of the final rule.
Senior Management Interlocks
The officers of a company wield significant power over the company
because they implement the major policies set by the board of
directors, make all the ancillary policy decisions necessary for
implementation, and operate the company on a day-to-day basis. In
addition, officers often make influential recommendations to the board
of directors regarding major policy decisions. As a result of this
substantial degree of influence, the Board historically has viewed
situations where an agent of a significant investor company serves as a
management official of another company as providing a significant
avenue for the first company to exercise a controlling influence over
the second company.
The proposal included a presumption of control where a company that
controls 5 percent or more of any class of voting securities of a
second company has more than one senior management interlock with the
second company. In addition, the proposal included a presumption of
control where a company that controls 15 percent or more of any class
of voting securities of a second company has any senior management
interlock with the second company. In order to trigger either of these
presumptions, the individual must serve as an employee or director at
the first company and as a senior management official at the second
company. The proposal defined a senior management official of a company
as any person who participates or has the authority to participate
(other than in the capacity as a director) in major policymaking
functions of the company.
In addition, the proposal included a presumption of control where a
company that controls 5 percent or more of any class of voting
securities of a second company has an employee or director who serves
as the chief executive officer (or an equivalent role) of the second
company. The chief executive officer of a company is generally the most
powerful senior management official of the company.
Some commenters criticized the proposed presumption based on senior
management interlocks on the basis that the scope of individuals
treated as senior management officials was unclear. These commenters
generally encouraged the Board to limit the scope of covered senior
management officials to a clearly identifiable group, rather than using
the qualitative standard included in the proposal. A few commenters
also argued that larger companies should be permitted to have more
senior management interlocks.
The final rule includes the proposed presumptions of control for
senior management interlocks without revision. The Board has long
recognized the potential for senior management interlocks to be a
conduit by which one company can influence another company, and the
final rule is consistent with this understanding. Consistent with the
proposal, the presumptions related to senior management interlocks in
the final rule include targeted adjustments to historical practice to
refine the scope of relevant interlocks to focus on senior officers
and, in particular, the chief executive officer. The focus on senior
management officials leans against the types of interlocks most likely
to raise controlling influence concerns, but also permits an investor
to have multiple junior employee interlocks that would not increase the
investor's ability to influence operations and policies at the investee
company.
Also consistent with the proposal, the final rule defines ``senior
management official'' to be any person with authority to participate
(other than as a director) in major policy making functions of a
company. This definition is based on the function that a person serves
rather than a person's official title. The Board recognizes that this
definition is not
[[Page 12406]]
precise and will consider providing additional clarity around this
definition after acquiring more experience with the senior management
interlocks presumptions.
Contractual Limits on Major Operational or Policy Decisions
A company that controls a material amount of voting securities of a
second company also may have contractual arrangements with the second
company, such as investment agreements, debt relationships, service
agreements, or agreements related to other business relationships.
Often, these contractual rights do not raise controlling influence
concerns because the rights, for example, are limited in scope or
reinforce the protections provided to the investor under the law.
However, the Board has viewed many other contractual provisions as
raising controlling influence concerns when the agreement has the
effect of substantially enhancing one company's influence over the
discretion of another company.\37\
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\37\ Contractual covenants also may raise safety and soundness
concerns, such as a covenant that impairs the ability of a banking
organization to raise additional capital, or a covenant that imposes
substantial financial obligations on a banking organization. Safety
and soundness concerns may arise in the absence of, or in addition
to, controlling influence concerns.
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Contractual rights often raise controlling influence concerns when
they provide an investor with the ability to direct or block major
operational or policy decisions of another company, whether such
decisions are made by management or by the board of directors of the
other company. The ability of an investor effectively to veto an
important business decision of a company generally provides the
investor with the ability to exercise a significant influence over a
major operational or policy decision of the company.
The Board also has long recognized that contracts governing
business relationships, including many loan agreements, contain
restrictive covenants and that the existence of these covenants has not
been sufficient, in itself, to constitute a controlling influence.
Thus, the Board generally has not viewed restrictive covenants in the
context of loan transactions or commercial services to raise
controlling influence concerns. However, when a company has both
control over a material percentage of the voting securities of another
company and covenants that significantly restrict the discretion of the
second company, the covenants have raised controlling influence
concerns. These concerns have been raised whether the covenants arise
directly from the terms of the equity investment or from separate
agreements between the companies.
Under the proposal, a company generally was presumed to control a
second company if the first company (i) owns 5 percent or more of any
class of voting securities of the second company; and (ii) has any
contractual right that significantly restricts the discretion of the
second company over major operational or policy decisions.\38\ A
company with less than 5 percent of each class of voting securities of
a second company would not have triggered this presumption of control
even if the first company had covenants that significantly restricted
the discretion of the second company over major operational and policy
decisions. Thus, the proposal both recognized the potentially
significant influence that covenants can provide and recognized the
normal use of restrictive covenants in loan agreements and other
market-terms business relationships.
---------------------------------------------------------------------------
\38\ The proposal provided an exclusion for limiting contractual
rights in the context of a pending merger that are designed to
ensure that the target company operates in the ordinary course while
the merger is pending. The final rule includes this exclusion
consistent with the proposal.
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The presumption of control under the proposal introduced a new
defined term, ``limiting contractual right,'' defined as a contractual
right that allows a company to restrict significantly the discretion of
a second company, including its senior management officials and
directors, over major operational or policy decisions. The proposal
also included a nonexclusive list of examples of contractual rights
that are generally considered to be limiting contractual rights, as
well as a nonexclusive list of examples of contractual rights that are
generally not considered to be limiting contractual rights.
Commenters argued that the Board should either raise the voting
securities threshold at which the presumption of control based on
limiting contractual rights would apply or remove the presumption
entirely. At least one commenter argued that the presumption related to
limiting contractual rights should not apply to an investor that
controls less than 10 percent of each class of voting securities. In
addition, commenters raised concerns with some of the specific rights
listed in the proposal as examples of limiting contractual rights.
These comments are discussed later in this preamble in the section
related to the definition of limiting contractual rights.
Consistent with the proposal, under the final rule, a company is
presumed to control another company if the first company controls 5
percent or more of any class of voting securities of the second company
and the first company has a limiting contractual right with respect to
the second company. As discussed, limiting contractual rights can allow
a company to exercise significant influence over another company, such
as by providing the first company with an effective veto over decisions
of the second company, overriding the discretion of the board of
directors of the second company or the choices of its shareholders.
However, limiting contractual rights are often important provisions in
commercial agreements, including many loan agreements, and the Board
has long recognized the importance of such contractual provisions in
the context of commercial relationships. Thus, consistent with the
proposal, under the final rule, a company must also control a material
percentage of the voting securities of another company--specifically,
at least 5 percent of any class of voting securities--in order to be
presumed to control the other company due to a limiting contractual
right. In other words, the final rule reflects that the Board's concern
with limiting contractual rights generally arises from the combination
of a limiting contractual right and control over a material share of
voting securities.\39\ This approach is intended to balance the normal
use of restrictive covenants in standard lending and other commercial
relationships, while also recognizing the power of limiting contractual
rights to enhance the influence of a company that is a material equity
investor in another company.
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\39\ This is different from management agreements, which raise
control concerns regardless of the share of voting securities
controlled.
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Total Equity
The Board has long subscribed to the view that the overall size of
an equity investment, including both voting and nonvoting equity, is an
important indicator of the degree of influence an investor may have. A
company is likely to pay heed to its large shareholders in order to
maintain stability in its capital base, enhance its ability to raise
additional equity capital in the future, and to prevent the negative
market signal that may be created by the sale of a large block of
equity by an unhappy shareholder. All of these concerns are present
independent of the ability of an investor to exercise the voting powers
of
[[Page 12407]]
equity to attempt to influence the investee company. Further, an
investor with a large equity investment also has a powerful incentive
to wield influence over the company in which it has invested due to the
investor's substantial economic interest in the investee company.
However, the Board also has recognized that nonvoting equity does not
provide the same ability to exercise a controlling influence as voting
equity.
Accordingly, under the proposal, a company was presumed to control
another company if the first company controls less than 15 percent of
the voting securities of the second company but one-third or more of
the total equity of the second company. In addition, a company was
presumed to control another company if the first company controls 15
percent or more of the voting securities of the second company and 25
percent or more of the second company's total equity. This element of
the proposal was consistent with the total equity standard described in
the Board's 2008 Policy Statement.
Some commenters argued that total equity on its own does not
provide a company with a substantial ability to exercise a controlling
influence and therefore recommended that the Board increase the amount
of total equity the first company could control in the second company
before triggering a presumption of control. A few commenters suggested
that the Board permit all investors to own up to one-third of the total
equity of a company (regardless of voting equity position) without
triggering a presumption of control. Other commenters advocated for
alternative tiered presumptions related to total equity, such as
presumptions of control where a company (i) has 15 percent or more of
the voting securities of the second company and one-third or more of
the total equity; (ii) has between 10 percent and 15 percent voting and
more than 40 percent total equity; and (iii) has under 10 percent
voting and more than 50 percent total equity. Some commenters suggested
that the Board have an exception to the total equity presumption if
another shareholder has a significant block of voting securities in the
second company that could prevent the first company from using total
equity to exercise a controlling influence over the second company.
In the final rule, the Board is simplifying its total equity
presumption so that a company will be presumed to control a second
company when the first company controls one-third or more of the total
equity of the second company. The threshold of one-third or more of
total equity would apply without regard to the first company's voting
securities percentage. In addition to simplifying, this adjustment to
the proposal reflects that nonvoting equity, while a significant
mechanism through which control may be exercised, should not be capped
at the same 25 percent voting securities level that the statute
identifies as control.
Commenters also raised a variety of issues around the Board's
proposed methodology for calculating a company's total equity position
in another company. These comments are discussed below in section
III.D. of the preamble.
Proxies on Issues
The Board historically has raised controlling influence concerns if
a company with control over 10 percent or more of a class of voting
securities of a second company solicits proxies from the shareholders
of the second company on any issue. The Board did not propose a
presumption of control for a company that controls 10 percent or more
of a class of voting securities of a second company and solicits
proxies from the shareholders of the second company on any issue. Many
commenters supported the Board's decision to not include a presumption
of control based on soliciting proxies on issues presented to the
shareholders.
Consistent with the proposal, the Board is not adopting a general
presumption of control for a company that solicits proxies from the
shareholders of another company.\40\ Accordingly, under the final rule,
a noncontrolling investor generally may act as a shareholder and engage
with the target company and other shareholders on issues through proxy
solicitations.
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\40\ The final rule includes a presumption of control related to
soliciting proxies for the election of directors, which is discussed
in the section of this preamble related to the presumptions of
control based on director representation.
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Threats To Dispose of Securities
Historically, the Board has viewed threats to dispose of large
blocks of voting or nonvoting securities in an effort to try to affect
the policy and management decisions of another company as presenting
potential controlling influence concerns. As a result, the Board
traditionally has raised controlling influence concerns if a company
with control over 10 percent or more of a class of voting securities of
a second company threatens to dispose of its investment if the second
company refuses to take some action desired by the first company.
However, the Board also has recognized that an investor that is unhappy
or disagrees with the business decisions of the company in which it has
invested should be able to exit its investment and that the possibility
of investor exit imposes important discipline on management. The Board
did not propose a presumption of control based on threats to dispose of
securities.
Many commenters expressed support for the Board's decision to not
include a presumption of control based on attempts to exercise control
by threatening to dispose of securities.
Consistent with the proposal, the Board is not adopting a
presumption of control based on one company attempting to exercise
control over another company by threatening to dispose of its
securities in the second company. By not adopting a presumption, the
Board recognizes that investors generally should be able to exit
investments without raising control concerns.
C. Description of Additional Presumptions and Exclusions
In addition to the tiered presumption framework described
previously, the proposal included several additional presumptions of
control. Several of these presumptions clarified presumptions already
in Regulation Y and Regulation LL, and others of these presumptions
related to standards that the Board historically has used to make
control decisions but has not before included in regulation. This
section of the preamble discusses these additional presumptions and how
they are reflected in the final rule.
Management Agreements
The Board has long believed that management agreements under which
a company can direct or exercise significant influence over the
management or operations of another company raise significant
controlling influence concerns.\41\ The proposal expanded slightly the
existing regulatory presumption to expressly identify additional types
of agreements or understandings that allow a company to direct or
exercise significant influence over the core business or policy
decisions of another company. The proposal also clarified that a
management agreement includes an agreement where a company is a
managing member, trustee, or general partner of another company, or
exercises similar functions.
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\41\ See 12 CFR 225.31(d)(2)(i); 12 CFR 238.21(d)(2)(i)
(citations are to the Code of Federal Regulations prior to the
amendments made by this final rule).
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[[Page 12408]]
The Board did not receive comment specifically on the presumption
of control arising from a management agreement. Accordingly, the Board
is finalizing the presumption as proposed, including with the
clarifications that expressly include agreements where a company is a
managing member, trustee, or general partner of another company.
Investment Advice and Investment Funds
The proposal included a presumption of control where a company
serves as investment adviser to an investment fund and controls 5
percent or more of any class of voting securities of the fund or 25
percent or more of the total equity of the fund. For purposes of this
presumption, the proposal defined ``investment adviser'' to include any
person registered as an investment adviser under the Investment
Advisers Act of 1940 (``Advisers Act''), any person registered as a
commodity trading adviser under the Commodity Exchange Act, or a
foreign equivalent of such a registered adviser.\42\ Similarly,
``investment fund'' included a wide range of investment vehicles,
including investment companies registered under the Investment Company
Act of 1940, investment companies that are exempt from registration
under the Investment Company Act, and foreign equivalents of either
registered investment companies or exempt investment companies.\43\
Other investment vehicles, such as commodity funds and real estate
investment trusts, generally also were included as investment funds.
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\42\ 15 U.S.C. 80b-1 et seq.; 7 U.S.C. 1 et seq.
\43\ 15 U.S.C. 80a et seq.
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However, the proposed presumption of control would not have applied
if the investment adviser organized and sponsored the investment fund
within the preceding twelve months. This provision allowed the
investment adviser to avoid triggering the presumption of control over
the investment fund during the initial seeding period of the fund.\44\
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\44\ The proposed presumption of control for service as an
investment adviser to an investment fund was intended to be
consistent with the Board's precedents regarding when an investment
adviser controls an advised investment fund under the BHC.
---------------------------------------------------------------------------
In addition, the proposal provided a limited exception from the
presumptions of control where the investment fund was an investment
company registered with the SEC under the Investment Company Act of
1940 and certain other criteria were satisfied.\45\ In order to qualify
for this exception:
---------------------------------------------------------------------------
\45\ 15 U.S.C. 80a et seq.
---------------------------------------------------------------------------
The only permitted business relationships between the
investment adviser and the investment company were investment advisory,
custodian, transfer agent, registrar, administrative, distributor, and
securities brokerage services provided by the investment adviser to the
investment company;
Representatives of the investment adviser must occupy 25
percent or less of the board of directors or trustees of the investment
company; and
The investment adviser must control less than 5 percent of
each class of voting securities of the investment company and less than
25 percent of the total equity of the investment company.
Corresponding to the seeding period in the investment adviser
presumption, the last criteria in the registered investment company
exception did not apply if the investment adviser had organized and
sponsored the investment company within the preceding twelve months.
This provision allowed the investment adviser to control greater
percentages of securities of the investment company during the initial
seeding period of the investment company.\46\
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\46\ See, e.g., Mellon Bank Corporation, 79 Federal Reserve
Bulletin 626 (1993); The Chase Manhattan Corporation, 81 Federal
Reserve Bulletin 883 (1995); Commerzbank AG, 83 Federal Reserve
Bulletin 678 (1997).
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Commenters argued that the proposals with respect to investment
funds and registered investment companies were inconsistent with prior
Board precedent, most notably a single case where the Board allowed a
bank holding company to retain up to 25 percent of the voting
securities of an investment company under certain conditions.\47\ Many
commenters argued that the rule should follow this precedent and allow
investment advisers to control up to 25 percent of the voting
securities of an advised investment fund without triggering a
presumption of control, rather than 5 percent as proposed.
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\47\ See Letter to H. Rodgin Cohen, Esq., dated June 24, 1999,
https://www.federalreserve.gov/boarddocs/legalint/BHC_ChangeInControl/1999/19990624/.
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Many commenters also suggested a one-year seeding period was too
short and should be extended to three years to be consistent with the
Volcker Rule. In addition, commenters suggested that the seeding
periods should be available to authorized participants, not just
organizers and sponsors. Some commenters advocated for an approach
where no seeding period was specified in the rule and instead the
seeding period would be a reasonable period determined by fund
managers.
A few commenters recommended that the investment company exception
apply to foreign equivalents of U.S. registered investment companies
and certain other types of investment funds, such as exempt investment
companies and business development companies. Some commenters also
requested that registered investment companies be excluded from the
presumptions of control without having to satisfy any conditions.
Several commenters further argued that the Board should apply the
standards of the SEC for independent directors rather than the Board's
standards for director representatives for purposes of determining how
many director representatives a company has on the board of directors
of a registered investment company. At least one commenter suggested
that the Board exclude any ordinary-course business relationships
between investment companies and their advisers from consideration in
the context of control.
The final rule retains the presumption of control for investment
advisers of investment funds as proposed. The exception for registered
investment companies is not included in the final rule. Both the
control presumption and the exception were designed to align with Board
precedent regarding control over investment funds and thus were
intended to be complementary in scope. The registered investment
company exception had minimal incremental information value beyond the
general investment fund presumption, and the details of the exception
raised many questions regarding how it would function. Thus, it has
been removed from the final rule to simplify the rule.
The final rule retains the threshold of 5 percent of a class of
voting securities for purposes of the investment adviser presumption of
control. The single precedent identified by commenters that permitted
ownership of up to 25 percent of the voting securities of a fund was an
unusual case based in part on statutory provisions that are no longer
in effect. In addition, in that precedent, the Board relied on
additional constraints to mitigate control concerns and these
additional constraints were not included in the proposal. The threshold
of 5 percent of any class of voting securities is consistent with the
preponderance of Board precedent in this area.
The final rule retains the one-year seeding period, consistent with
the proposal. The one-year seeding period is consistent with the bulk
of Board precedent related to organizing and sponsoring investment
funds and
[[Page 12409]]
provides a reasonable amount of time for the seeding of most investment
funds. The one-year seeding period is only available to the company
that organizes and sponsors an investment fund and not to other early
investors in an investment fund, because only the sponsor/organizer
necessarily controls all the equity securities of the company when the
fund is formed.\48\
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\48\ The one-year seeding period in the final rule does not
alter the rules applicable to hedge fund and private equity fund
investments under the Volcker Rule, including the rules addressing
permissible seeding periods for such funds.
---------------------------------------------------------------------------
At least one commenter recommended that the Board confirm the
ongoing applicability of control letters from the General Counsel of
the Board to mutual fund families, and investments made in accordance
with those letters. The application of the final rule to existing
structures is discussed in more detail elsewhere in this preamble. The
Board does not intend to revisit existing structures that were
previously reviewed by the Federal Reserve System and have not changed
materially.
Accounting Consolidation
Under the proposal, the Board presumed that a company that
consolidates a second company under GAAP controls the second company.
The presumption was based on an understanding that GAAP generally calls
for consolidation under circumstances where the consolidating entity
has a controlling financial interest over the consolidated entity.
Consolidation is typically required under GAAP due to ownership of a
majority of the voting securities of a company, which would
significantly exceed the voting security threshold for control under
the BHC Act and HOLA. In addition, GAAP requires consolidation of
companies under the variable interest entity standard (i) where a
company has significant economic exposure to a variable interest entity
and has the power to direct the activities of the entity that most
significantly impact the entity's economic performance or (ii) where a
company controls a variable interest entity by contract.\49\
---------------------------------------------------------------------------
\49\ See, e.g., ASC 810-10.
---------------------------------------------------------------------------
Many commenters urged the Board to abandon the proposed presumption
of control where a first company consolidates a second company for
purposes of GAAP. Commenters also urged the Board not to expand the
proposed consolidation presumption based on GAAP to consolidation under
other accounting standards. These commenters argued that the standards
for consolidation for variable interest entities did not conform to the
Board's standards for controlling influence. Commenters also stated
that presuming that consolidated variable interest entities are
controlled could have unintended consequences for foreign banking
organizations subject to the Board's U.S. intermediate holding company
requirements.\50\ In addition, commenters expressed concern that the
accounting consolidation rules were promulgated by a different
authority with different purposes and that the consolidation standards
were subject to change outside of the control of the Board. Some
commenters requested exclusions for variable interest entities in
certain contexts, such as an exclusion for asset-backed commercial
paper conduits or particular types of ownership or management
relationships between a company and a variable interest entity.
---------------------------------------------------------------------------
\50\ See 12 CFR 252.153.
---------------------------------------------------------------------------
The final rule establishes a presumption of control when one
company consolidates a second company for purposes of GAAP. This
presumption is consistent with the proposal. A company that
consolidates another company due to control over a majority of the
voting securities of the second company should control the second
company under the voting securities control prong of the BHC Act and
HOLA. A company that consolidates another company under the variable
interest entity standard must have substantial ability to direct the
activities of the second company (in addition to having a potentially
significant economic exposure). A company that is consolidated under
the variable interest entity standard often would be controlled under
one of the other presumptions of control in the final rule such as the
management agreement presumption. The inclusion of the GAAP
consolidation presumption should reduce burden and uncertainty by
allowing companies to identify presumptive control relationships based
on existing accounting standards.
The presumption of control where one company consolidates a second
company for purposes of GAAP covers, by its terms, only those companies
that prepare financial statements under GAAP. The Board notes, however,
that the Board is likely to have control concerns where a company
consolidates another company on its financial statements under another
accounting standard, particularly if the other accounting standard has
consolidation standards that are similar to the consolidation standards
under GAAP.
Regarding the interaction of the final rule and the intermediate
holding company requirements of the Board's Regulation YY, a foreign
banking organization that is required to form a U.S. intermediate
holding company must hold all ownership interests in U.S. subsidiaries
through its U.S. intermediate holding company.\51\ In general,
ownership interest under the intermediate holding company requirements
does not include contractual relationships, including contractual
relationships that result in consolidation of a company under the
variable interest entity standard. Thus, for example, where a U.S.
branch of a foreign bank has a contract with an asset-backed commercial
paper conduit that causes the conduit to be consolidated by the branch
under the variable interest entity standard, the contract is not an
ownership interest and therefore may remain between the branch and the
conduit.
---------------------------------------------------------------------------
\51\ 12 CFR 252.153.
---------------------------------------------------------------------------
The proposal sought comment on whether the Board should presume
that a company controls a second company if the first company applies
the equity method of accounting with respect to its investment in the
second company. Many commenters opposed the introduction of this
presumption. These commenters argued that the standards for the equity
method of accounting were different than control under the BHC Act and
HOLA and that the practical effect of such a presumption would be to
presume control over a company due to control over 20 percent of a
company's voting securities, substantially below the statutory
threshold of 25 percent. Similar to comments regarding accounting
consolidation, commenters also objected to the Board's control-based
reliance on accounting standards designed for different purposes.
The final rule does not include a presumption of control when one
company applies the equity method of accounting with respect to its
investment in a second company. Although equity method accounting
treatment indicates a substantial relationship between two companies,
unlike consolidation, equity method accounting is not as closely linked
to the Board's views on what constitutes a controlling influence.
Divestiture
The proposal substantially revised the Board's standards regarding
divestiture of control. The Board historically has taken the position
that a company that has controlled another company may be
[[Page 12410]]
able to exert a controlling influence over that company even after a
substantial divestiture.\52\ As a result, the Board typically has
applied a stricter standard for terminating control than for
establishing new noncontrolling investments.\53\
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\52\ See, e.g., ``Statement of policy concerning divestitures by
bank holding companies'' (divestiture policy statement). 12 CFR
225.138. The divestiture policy statement indicates that divestiture
is a special consideration for purposes of control and that the
Board's normal rules and presumptions regarding control may not
always be appropriate in the context of divestiture. See also Am.
Gas & Elec. Co. v. SEC, 134 F.2d 633, 643 (D.C. Cir. 1943) (holding
that ``controls and influences exercised for so long and so
extensively [under the Public Utilities Holding Company Act] are not
severed instantaneously, sharply and completely, especially when
powers of voting, consultation and influence such as have been
retained remain'').
\53\ See, e.g., 12 CFR 225.139 (``2(g)(3) policy statement'').
The 2(g)(3) policy statement describes the implementation of section
2(g)(3) of the BHC Act (Congress removed section 2(g)(3) from the
BHC Act in 1996). Section 2(g)(3) created a rebuttable presumption
that a transferor continued to control securities of a company
transferred to a transferee if the transferee was indebted to the
transferor or if there were certain director or officer interlocks
between the transferor and transferee. The 2(g)(3) policy statement
remains relevant because it reflects the Board's longstanding
position that terminating control requires reducing relationships to
lower levels than would be consistent with a new noncontrolling
relationship.
---------------------------------------------------------------------------
The proposal provided that a company that previously controlled a
second company during the preceding two years would be presumed to
continue to control the second company if the first company owned 15
percent or more of any class of voting securities of the second
company. The divestiture presumption did not apply if a majority of
each class of voting securities of the second company would be
controlled by a single unaffiliated individual or company after the
divestiture by the first company. Further, the divestiture presumption
generally did not apply in cases where a company sold a subsidiary to a
third company and received stock of the third company as consideration
for the sale.\54\
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\54\ See, e.g., Letter to Mark Menting, Esq., dated February 14,
2012, https://www.federalreserve.gov/bankinforeg/LegalInterpretations/bhc_changeincontrol20120214.pdf.
---------------------------------------------------------------------------
Many commenters supported the proposed divestiture presumption.
Other commenters argued that the threshold for the divestiture
presumption should be raised higher than 15 percent or that the
divestiture presumption should be entirely removed from the rule. At
least one commenter requested clarification as to the conditions
required for the exception to the divestiture presumption to apply,
specifically whether the other shareholder must control a majority of
every class of voting securities of the second company, or only a
majority of the securities of the class of voting securities that the
divesting shareholder is selling. In addition, commenters asked the
Board to clarify how the divestiture presumption interacts with the
seeding period in the investment fund context.
The final rule includes the divestiture presumption substantially
as proposed. As noted, the possibility of continued control in the
context of a partial divestiture has been identified as a concern in
Board precedent and case law. The final rule balances these concerns
with the goal of providing greater transparency and certainty to the
Board's consideration of controlling influence issues.
The final rule does not provide an exception to the presumption to
facilitate the organization and sponsorship of investment funds. Such
an exception is not necessary because an investment adviser must have
less than 5 percent of each class of voting securities of an investment
fund after the initial one-year seeding period in order to not trigger
the investment fund presumption of control, and the divestiture
presumption only applies where a company retains at least 15 percent of
any class of voting securities.
Regarding the commenter requests for clarification of the exception
to the divestiture presumption, the Board clarifies that the exception
only applies when an unaffiliated person controls 50 percent or more of
the outstanding securities of each class of voting securities of the
company being divested.
Presumption of Control for the Combined Ownership of a Company and Its
Senior Management Officials and Directors
The proposal included a presumption that a company controls a
second company when (i) the first company controls at least 5 percent
of any class of voting securities of the second company and (ii) the
senior management officials and directors of the first company,
together with their immediate family members and the first company, own
25 percent or more of a class of voting securities of the second
company (5-25 presumption). The proposed presumption reflected the
Board's historical position that it is often appropriate to attribute
securities held by management officials of a company to the company
itself for purposes of measuring control by a company under the BHC
Act. The management officials of a company are well positioned to
coordinate their actions with each other and the company to act as a
single voting bloc to advance the interests of the company.
The proposal differed from current practice, however, by providing
an exception to this general presumption. Specifically, the presumption
did not apply if (i) the first company controls less than 15 percent of
each class of voting securities of the second company and (ii) the
senior management officials and directors of the first company,
together with their immediate family members, control 50 percent or
more of each class of voting securities of the second company.
The proposed exclusion to the presumption reflected the Board's
traditional understanding that, when individuals control an outright
majority of a class of voting securities of a second company, it is
likely the individuals who are truly exercising control over the second
company, rather than any company that employs the individuals. Under
these circumstances, the first company is generally not a significant
conduit for control over the second company.\55\
---------------------------------------------------------------------------
\55\ See Vickars-Henry Corp. v. Fed. Reserve Sys., 629 F.2d 629
(9th Cir. 1980).
---------------------------------------------------------------------------
At least one commenter requested that the Board clarify how the
rule attributing ownership of securities held by senior management
officials, directors, or controlling shareholders of a company to that
company (proposed 12 CFR 225.9(c), 238.10(c)) would operate in
conjunction with the 5-25 presumption (proposed 12 CFR 225.32(d)(6),
238.22(d)(6)).
The final rule does not include the 5-25 presumption of control of
a company. Instead, this presumption of control of a company has been
integrated into the standard for control by a company over voting
securities. Specifically, the final rule provides that a company that
controls 5 percent or more of any class of voting securities of another
company also controls any securities issued by the second company that
are controlled by the senior management officials, directors, or
controlling shareholders of the first company, or immediate family
members of such individuals. In addition, the final rule incorporates
into this standard for control over securities the exclusion contained
in the proposed 5-25 presumption, as described further in section III.C
of this preamble.
Closely Held Companies and Widely Held Companies
In developing the proposal, the Board considered whether there
should be different presumptions for (i) companies
[[Page 12411]]
that are widely held relative to companies that are closely held or
(ii) companies that are majority owned by a third party. The Board
considered these factors because it could be reasonable to assume that
a major investor in a company that is otherwise widely held has
outsized influence compared to a context where the major investor is
one of several major investors in a closely held company. Similarly, in
many cases, it could be reasonable to assume that a major investor has
reduced influence over a company where another investor has an outright
majority of the voting securities of the company. The proposal,
however, did not include different presumptions for widely held
companies versus closely held companies or for companies under the
majority control of a third party because such distinctions increased
the complexity of the proposal and could have made the presumptions
more difficult to apply in practice.
Some commenters argued that the presence of a larger, third-party
shareholder should create a presumption of non-control for any company
with a lesser interest. Commenters provided several different proposals
for how this might be implemented, ranging from an exemption from the
presumptions of control where a third party controls a majority of the
securities of a company to an exemption from the presumptions of
control where a third party controls a sufficiently large plurality of
the securities of a company. Some commenters suggested that the
presence of a larger, third-party shareholder should raise the level of
other relationships, particularly business relationships, that two
companies could have before triggering a presumption of control.
Commenters also argued that a majority shareholder should give rise to
a presumption of noncontrol for all other shareholders.
Other commenters supported the Board's proposal not to create
different presumptions depending on the shareholder composition of the
second company because of the complexity this would add to the rule.
The presumptions in the final rule do not differentiate between
closely held and widely held companies and generally do not turn on the
presence of a majority third-party shareholder. Although a company's
influence over another company may vary based on the shareholder
structure of the second company, adding exceptions to certain
presumptions of control because the second company is closely held or
majority-controlled by a third party would significantly increase the
complexity of the rule. Moreover, the Board notes that the statutory
framework contemplates that multiple companies could control a single
company even if there is one company that has predominant, or even
majority, control over the voting securities of the company. Finally,
having control determinations turn on the shareholder structure of the
target company may create practical difficulties for investors. For
example, a first company could establish a relationship that does not
trigger a presumption of control over a second company, but the second
company could subsequently become more widely held, leading the first
company to trigger a presumption of control without any action of its
own.
Fiduciary Exception
Under the proposal, the presumptions of control did not apply to
the extent that a company controls voting or nonvoting securities of a
second company in a fiduciary capacity without sole discretionary
authority to exercise the voting rights. This exception for holding
securities in a fiduciary capacity is currently in the control
provisions of Regulation Y and was retained in full.\56\
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\56\ See 12 CFR 225.31(d)(2)(iv); see also 12 U.S.C.
1841(a)(5)(A).
---------------------------------------------------------------------------
Many commenters argued that the Board's proposed exclusion for
securities held in a fiduciary capacity was overly restrictive because
it included a requirement that the fiduciary not have sole
discretionary voting authority over the securities. Commenters noted
that, although not having sole discretionary voting authority was
required for the fiduciary exemption in section 3 of the BHC Act,
section 4 of the BHC Act excluded securities held in a fiduciary
capacity without this additional requirement.
Commenters also sought clarification of when a company would be
considered to have sole discretionary authority to exercise voting
rights. At least one commenter asked that the Board provide that an
investment adviser lacks sole discretionary voting authority where an
investment fund has the right to revoke the adviser's voting authority.
In response to the issues raised by commenters, the fiduciary
exception in the final rule only requires that the securities of a
depository institution or a depository institution holding company be
held without sole discretionary voting authority. Accordingly, the
final rule's fiduciary exception would parallel the different fiduciary
exceptions in section 3 and section 4 of the BHC Act. The same
exception would apply for purposes of Regulation LL, to provide
parallel treatment under the BHC Act and HOLA. The final rule also
includes additional clarifying edits to the fiduciary exception.
The final rule does not provide broader clarity around the scope of
the fiduciary exception. The Board notes, however, that the fiduciary
exception in the final rule is intended to align with the Board's
traditional understanding of the scope of the fiduciary exceptions in
the BHC Act and Regulation Y. The primary example of the role covered
by the fiduciary exception is that of the trust department of a
depository institution that is authorized to engage in fiduciary
activities. Companies may contact the Board or its staff to seek
clarification as to whether any particular holding of securities would
qualify for the fiduciary exception.
Rebuttable Presumption of Noncontrol
Under the proposal, a company was presumed not to control a second
company if the first company (i) controls less than 10 percent of every
class of voting securities of the second company and (ii) is not
presumed to control the second company under any of the proposed
presumptions of control. This provision of the proposal modestly
expanded the statutory and pre-existing regulatory rebuttable
presumption of noncontrol that applies where a first company controls
less than 5 percent of any class of voting securities of a second
company.\57\
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\57\ 12 U.S.C. 1841(a)(3), 12 CFR 225.31(e), and 238.21(e).
---------------------------------------------------------------------------
Many commenters supported the proposed presumption of noncontrol,
arguing that controlling influence would be especially unusual for
companies with less than 10 percent of each class of voting securities
of another company. Some commenters argued that the Board should expand
the presumption of noncontrol further to cover any company that did not
trigger a presumption of control. At least one commenter argued that a
presumption of noncontrol should at least apply to foreign entities
that do not trigger a presumption of control in order to mitigate
extraterritorial application of the BHC Act. Commenters also raised
concerns with the proposed exclusion from the presumption of noncontrol
for any company that triggered a presumption of control, at least as
applied to companies with less than 5 percent of any class of voting
securities of another company.
[[Page 12412]]
The final rule adopts the rebuttable presumption of noncontrol as
proposed.\58\ Thus, a company is presumed not to control a second
company if the first company (i) controls less than 10 percent of every
class of voting securities of the second company and (ii) is not
presumed to control the second company under any of the presumptions of
control. This approach and calibration of the noncontrol presumption
reflects the Board's experience that a company with less than 10
percent of any class of voting securities of another company is
unlikely to have a controlling influence over the second company,
absent the indicia of control specified in the control presumptions.
The additional changes supported by some commenters would increase the
scope of the presumption of noncontrol significantly, well beyond both
the presumption of noncontrol in the BHC Act and the Board's
experience.
---------------------------------------------------------------------------
\58\ As under the proposal, the filing requirements applicable
to bank holding companies and savings and loan holding companies for
investments in 5 percent or more of any class of voting securities
of a company are not impacted as a result of the presumption of
noncontrol.
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III. Final Rule--Control-Related Definitions
The proposal proposed to amend Regulation Y and Regulation LL to
update and clarify the definitions of various control-related terms.
This section discusses in detail how the final rule addresses each of
these definitions.
Some commenters indicated that the Board should define additional
terms to provide further clarity regarding the application of the
presumptions of control. For example, a commenter suggested that the
Board clarify how the presumptions of control would apply to an
agreement among shareholders that is designed to preserve a company's
tax status under the Internal Revenue Code. In addition, a commenter
stated that the Board should clarify whether a testamentary trust
qualified as a ``company'' under the proposal.
The final rule does not introduce new defined terms compared to the
proposal, though certain changes have been made to the proposed defined
terms as described in detail in this section. Consistent with the
proposal, the final rule includes defined terms to the extent
appropriate to clarify the application of the rule, while avoiding
over-prescription that could limit the Board's ability to respond
appropriately to unusual facts and circumstances or to prevent evasion
of the framework. Specifically with respect to agreements to preserve
tax status under the Internal Revenue Code, the final rule, consistent
with the proposal, clarifies that covenants to take reasonable steps to
maintain a specific tax status generally are not limiting contractual
rights and that agreements among shareholders to preserve a certain tax
status generally do not constitute restrictions on securities that
provide control over the covered securities. On the status of
testamentary trusts as companies under the BHC Act, neither the
proposal nor the final rule alters the Board's standards related to
testamentary trusts.
A. First Company and Second Company
The core of the proposal was the addition of a series of
presumptions of control that apply in the context of the Board making a
determination that one company has the ability to exercise a
controlling influence over another company. To clarify the application
of these presumptions, the proposal provided definitions of ``first
company'' and ``second company.''
The proposal defined ``first company'' as the company whose control
over a second company was the subject of a determination of control by
the Board. The proposal defined ``second company'' as the company the
control of which by a first company was the subject of a determination
of control by the Board. For many of the proposed presumptions, the
first company was presumed to control the second company if the first
company, together with its subsidiaries, had particular relationships
with the second company, together with its subsidiaries.
In addition, the proposal provided that, for purposes of the
proposed presumptions, any company that was both a subsidiary of the
first company and the second company should be treated as a subsidiary
of the first company but not as a subsidiary of the second company.
This provision prevented the second company's relationships with a
joint venture subsidiary with the first company from being considered
relationships with the first company for purposes of the presumptions
of control.
Some commenters contended that it would be more appropriate to
consider only relationships between top-tier parent companies.
Relatedly, a few commenters stated that first company and second
company should not be defined to include their subsidiaries. With
respect to joint ventures, some commenters argued that the language of
the proposal was difficult to apply and that it would be better not to
consider any relationships with joint ventures when reviewing for
control between joint venture partners.
The final rule adopts the definitions of first company and second
company as proposed.\59\ For purposes of controlling influence, the
Board historically has considered the relationships between one company
and its subsidiaries, on the one hand, and another company and its
subsidiaries, on the other hand. Grouping a parent company with its
subsidiaries reflects an understanding that a subsidiary generally will
comply with directions from its parent company. Considering only direct
relationships between two companies would ignore this dynamic and thus
the economic realities of corporate structures. For example, an
investing company may own securities in a top-tier bank holding company
while having substantial business relationships with the bank holding
company's subsidiary bank. Considering the investing company's
relationships with the bank holding company alone and with the bank
alone would exclude important aspects of the combined relationship
between the investing company, on the one hand, and the bank holding
company and the bank, on the other hand.
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\59\ First company and second company could take a variety of
legal entity forms, including a stock corporation, limited liability
company, partnership, business trust, or foreign equivalents of such
legal entities. See 12 U.S.C. 1467a(a)(1)(C) and 1841(b).
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Regarding joint ventures, the Board historically has recognized
that relationships with joint ventures can be significant for purposes
of controlling influence analysis because such relationships can
represent a significant connection between the joint venture partners.
For this reason, the final rule does not completely exclude
relationships with joint ventures. Instead, consistent with the
proposal, the final rule provides that a company that is a subsidiary
of both the first company and the second company is treated as a
subsidiary of the first company and not of the second company for
purposes of applying the presumptions of control. The Board believes
that this is a reasonable standard for recognizing the potential
importance of joint ventures without overstating such importance.
B. Voting Securities and Nonvoting Securities
The BHC Act defines control to include the ownership, control, or
power to vote 25 percent or more of any class of voting securities of a
company.\60\ In addition, several of the proposed presumptions required
identifying the percentage of a class of
[[Page 12413]]
voting securities controlled by a company in another company.
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\60\ 12 U.S.C. 1841(a)(2)(A).
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Regulation Y and Regulation LL previously included definitions of
``voting securities'' and ``nonvoting shares.'' \61\ The proposal
changed the defined term ``nonvoting shares'' to ``nonvoting
securities'' and added to the definition of ``nonvoting securities''
equity instruments issued by companies other than stock corporations,
such as limited liability companies and partnerships. In addition, the
proposal revised the definition of ``nonvoting securities'' to clarify
that common stock can be nonvoting securities.\62\
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\61\ 12 CFR 225.2(q).
\62\ For safety and soundness reasons, the Board generally
believes that voting common stockholders' equity should be the
dominant form of equity for a banking organization. See, e.g., 78 FR
62018, 62044 (Oct. 11, 2013).
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Regulation Y and Regulation LL also provide a nonexclusive list of
examples of the types of voting rights that the Board has considered to
be within the scope of the defensive voting rights that nonvoting
securities may contain.\63\ The proposal revised the definition of
nonvoting securities to expressly permit certain additional defensive
voting rights that are commonly found in investment funds that are
organized as limited liability companies and limited partnerships.
Specifically, the proposal provided that defensive voting rights that
do not cause a security to be a voting security include the right to
vote to remove a general partner or managing member for cause, the
right to vote to replace a general partner or managing member that has
been removed for cause or has become incapacitated, and the right to
vote to dissolve the company or to continue operations following the
removal of a general partner or managing member. Some commenters asked
that the Board provide that certain securities--including limited
partnership interests, REIT investment units, and trust beneficiary
rights--are nonvoting securities.
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\63\ 12 CFR 225.2(q)(2)(i); 12 CFR 238.2(r)(2)(i).
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The final rule is largely consistent with the proposal on the
definitions of voting securities and nonvoting securities. To prevent
evasion, the final rule does not categorically exclude any specific
types of securities issued by certain legal entities from the
definition of voting securities. Although there is substantial
variability in the terms and structures of securities in the financial
markets, the definitions of voting securities and nonvoting securities
in the final rule have been drafted broadly to apply effectively to all
forms of legal entities.
C. Control of Securities
The proposed rule reflected the Board's current practice for
determining whether a company's securities are owned, controlled, or
held with power to vote by an investor and provided rules for
determining the percentage of a class of a company's voting securities
attributed to a person.
Ownership, Control, and Holding With Power To Vote
The proposal provided rules for determining whether a person
``controls'' a security.\64\ Specifically, the proposal provided that a
person controls a security if the person owns the security or has the
power to sell, transfer, pledge, or otherwise dispose of the security.
In addition, a person controls a security if the person had the power
to vote the security, other than due to holding a short-term, revocable
proxy. This proposed definition of control over securities is
consistent with Board precedent and with the language of the BHC
Act.\65\
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\64\ These proposed standards effectively replaced the
presumptions for control over voting securities currently in 12 CFR
225.31(d)(1). In this discussion, ``person'' has the meaning
provided in 12 CFR 225.2(l) and 12 CFR 238.2(j).
\65\ See, e.g., 12 U.S.C. 1841(a)(2)-(3) and 1842(a).
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Some commenters suggested that power to dispose of securities in
certain circumstances should not provide control over the securities,
such as securities held in a fiduciary capacity or as collateral that
may be rehypothecated. A few commenters argued that securities held in
a small business investment company or in a merchant banking portfolio
company should not be considered controlled. Commenters also argued
that securities held in an underwriting, dealing, or market making
capacity should not be considered controlled for purposes of the
presumptions of control.
The final rule makes minor revisions to the proposal's provisions
on control over securities. The final rule is consistent with Board
precedent and the statutory framework. However, the Board does
recognize that securities held by an underwriter for a very limited
period of time for purposes of conducting a bona fide underwriting
generally do not raise control concerns. An underwriter generally would
hold the securities only for a few days and only for the purpose of
prompt resale to the market.\66\
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\66\ For example, the Board's capital rule provides a 5-day
holding period for underwriting securities. 12 CFR 217.2.
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The Board does not believe that the final control rule should make
exceptions for small business investment company investments, merchant
banking portfolio company investments, or any specific investment
types. The Board's general regulatory framework addresses the
permissibility of these investments, and there are no compelling
reasons to treat these investments differently than other investments
under the Board's control framework. For example, if a financial
holding company owns 100 percent of the securities of a merchant
banking portfolio company, the financial holding company controls the
portfolio company for purposes of the BHC Act under the first prong of
the definition of control. The financial holding company is able to
have this ownership interest under its merchant banking authority, but
must treat the portfolio company as a controlled subsidiary under
Regulation Y.\67\
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\67\ 12 CFR part 225, subpart J.
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Options, Warrants, and Convertible Instruments
The proposal provided standards for deeming a person to control a
security through control of an option or warrant to acquire the
security or through control of a convertible instrument that may be
converted into, or exchanged for, the security. Under the proposal's
``look-through'' approach, a person would control all securities that
the person could control upon exercise of any options or warrants. In
addition, a person would control all securities that the person could
control as a result of the conversion or exchange of a convertible
instrument controlled by the person. This approach was consistent with
the Board's longstanding precedent of generally considering a person to
control any securities (i) that the person has a contractual right to
acquire now or in the future; or (ii) that the person would
automatically acquire upon occurrence of a future event.\68\
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\68\ See, e.g., 2008 Policy Statement.
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In addition, the proposal provided that a person controls the
maximum number of securities that could be obtained under the terms of
the option, warrant, or convertible instrument. Thus, for example, if
the number of securities that could be acquired upon exercise of an
option varied based on some metric, such as the market price or book
value of the securities, the person with the option was considered to
control the highest percentage of the class of securities that could
possibly be acquired under the terms of the option.
Moreover, for purposes of calculating a person's percentage of a
class of voting securities or total equity, the proposal generally
deemed a person to control
[[Page 12414]]
the percentage resulting from the exercise of the person's options,
warrants, or conversion features, assuming that no other parties
exercised their options, warrants, or conversion features. However, if,
for example, a person is only able to exercise an option when all
outstanding options in a class are simultaneously exercised by all
holders, the percentage controlled by the person should reflect the
exercise of all the outstanding options in the class, not just those
options held by the person.
The proposal included several limited exceptions to this general
look-through approach. Consistent with the 2008 Policy Statement, the
proposal incorporated a limited exception for financial instruments
that may convert into voting securities but by their terms may not
become voting securities in the hands of the current holder or any
affiliate of the current holder and may only convert to voting
securities upon transfer to (i) the issuer or an affiliate of the
transferor, (ii) in a widespread public distribution, (iii) in
transfers where no transferee or group of associated transferees would
receive 2 percent or more of any class of voting securities of the
issuer, or (iv) to a transferee that controls 50 percent or more of
every class of voting securities before the transfer.
The proposal also exempted from the general look-through approach a
purchase agreement to acquire securities that had not yet closed. This
exemption allowed parties to enter into securities purchase agreements
pending regulatory approval, due diligence, and satisfaction of other
conditions to closing.
In addition, the proposal exempted from the general look-through
approach any options, warrants, or convertible instruments that
permitted an investor to acquire additional voting securities only to
maintain the investor's percentage of voting securities in the event
the issuing company increased the number of its outstanding voting
securities.
Many commenters suggested that the Board should apply the look-
through approach only to narrow classes of options, warrants, and
convertible instruments, or that the Board should not look through
options, warrants, or convertible instruments at all. Some commenters
suggested that the Board only look through options or convertible
instruments if they could be freely exercised within 60 days, are in
the money, or are not subject to a remote contingency trigger or
condition outside of the holder's control. Some commenters argued that
the look-through approach should not apply to options if the investor
does not have control over the exercise of the option. A few commenters
asked the Board to clarify the application of the standards from the
2008 Policy Statement under the proposal. A few commenters suggested
that the Board clarify that nonvoting securities will remain nonvoting
even if they have the right to elect directors after six quarterly
dividend payments are missed, consistent with Board precedent.
The final rule is generally consistent with the proposal with
respect to these provisions. However, the final rule includes an
additional exception to the look-through approach that preferred
securities that have no voting rights unless the issuer fails to pay
dividends for six or more quarters are only considered to be voting
securities if a sufficient number of dividends are missed and the
voting rights are active. As noted by commenters, this additional
narrow exception to the look-through approach is consistent with Board
precedent and helps to address a fairly common feature of preferred
securities. Securities with springing voting rights that do not fit
into this exception generally will be considered to be voting
securities under the look-through approach.
The final rule does not include any of the other limitations on the
look-through approach supported by commenters. The look-through
approach appropriately recognizes that options, warrants, and
convertible instruments provide the holder of such instruments with the
ability to control the underlying securities by exercising the option,
warrant, or convertible instrument, or transferring the option,
warrant, or convertible instrument. In addition, many of the suggested
limitations on the look-through approach are not practicable. For
example, looking through in-the-money options while not looking through
out-of-the-money options could result in unpredictable moves from non-
control to control of a bank without the ability of the investor to
apply or receive prior approval under section 3 of the BHC Act.
Moreover, excluding from the look-through approach options, warrants,
and convertible instruments with remote contingency triggers would
require the Board to adopt an impracticable measure of remoteness. The
Board notes that the final rule's exception to the look-through
approach based on transfer restrictions has been slightly revised to
conform more precisely to the 2008 Policy Statement.
Control Over Securities Through Restrictions on Rights
Consistent with current regulations, the proposal provided that a
person controls securities if the person is a party to an agreement or
understanding under which the rights of the owner or holder of
securities are restricted in any manner, unless the restriction falls
under one of the exceptions specified in the rule.\69\
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\69\ This standard could result in multiple persons being
considered to have control over the same securities. This remains
possible under the final rule.
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The proposal provided six exceptions to this general rule, each
designed to accommodate certain common restrictions on securities that
do not provide the type of control over securities relevant to this
rulemaking. The first exception was for rights of first refusal, rights
of last refusal, tag-along rights, drag-along rights, or similar rights
that are on market terms and that do not impose significant
restrictions on the transfer of the securities. Second, the proposal
provided an exception for arrangements that restrict the rights of an
owner or holder of securities when the restrictions are incidental to a
bona fide loan transaction. Third, the proposal provided that an
arrangement that restricts the ability of a shareholder to transfer
securities pending the consummation of an acquisition of the securities
does not provide the restricting party control over the securities of
the restricted party. Fourth, the proposal generally provided that an
arrangement that requires a current shareholder of a company to vote in
favor of a proposed acquisition of the company would not result in the
proposed acquirer controlling the securities of the current
shareholder. Fifth, the proposal exempted arrangements among the
shareholders of a company designed to preserve the tax status or tax
benefits of a company, such as qualifying as a Subchapter S Corporation
\70\ or to preserve tax assets (such as net operating losses) against
impairment.\71\ Sixth, the proposal provided that a short-term
revocable proxy would not provide the holder of the proxy with control
over the securities governed by the proxy.\72\
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\70\ See 26 U.S.C. 1361.
\71\ See 26 U.S.C. 382. In order to qualify for this exemption,
the arrangement was required to not impose restrictions on
securities beyond those reasonably necessary to achieve the goal of
preserving tax status, tax benefits, or tax assets. Agreements of
this type may raise significant safety and soundness concerns under
certain circumstances, independent of whether control concerns are
raised.
\72\ The proposed treatment of short-term revocable proxies was
consistent with the Board's current regulations regarding notices
under the Change in Bank Control Act. See 12 CFR 225.41(d)(4); 12
CFR 225.42(a)(5).
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[[Page 12415]]
The Board received very few comments on this framework and is
adopting the framework as proposed.
Control of Securities Through Associated Individuals and Subsidiaries
The proposal provided that a company that owns, controls, or holds
with power to vote 5 percent or more of any class of voting securities
of a second company controls any securities issued by the second
company that are owned, controlled, or held with power to vote by the
senior management officials, directors, or controlling shareholders of
the first company, or by the immediate family members of such
individuals.\73\ In addition, the proposal provided that a person
controls all voting securities controlled by any subsidiaries of the
person, and that a person generally does not control any voting
securities controlled by any non-subsidiary of the person.
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\73\ See 12 CFR 225.31(d)(2)(ii).
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At least one commenter argued that the Board should not consider
securities held in separate accounts by an insurance company to be
controlled by the insurance company, or that the Board should clarify
how separate accounts may be structured so that securities in such
accounts are not treated as controlled by the insurance company. One
commenter requested clarification regarding the attribution of voting
securities held in a voting trust.
The final rule defines control over securities through associated
individuals and subsidiaries in a manner substantially consistent with
the proposal. The final rule has been revised, however, to integrate
the standards for control over voting securities through associated
individuals with the proposed 5-25 presumption. Specifically, the
proposed 5-25 presumption substantially overlapped with the provision
providing that a company should be attributed the securities of its
senior management officials, directors, and controlling shareholders,
as well as immediate family members of such individuals. As a result,
as discussed above, the proposed 5-25 presumption is not necessary and
is not included in the final rule. However, the Board is revising the
provisions related to control over voting securities through associated
individuals to incorporate the exception to the proposed 5-25
presumption when the company controls less than 15 percent of each
class of voting securities of the other company and a majority of each
class of voting securities of the other company are controlled by the
first company's senior management officials, directors, and controlling
shareholders, as well as immediate family members of such individuals.
The final rule does not include the express statement from the
proposal that a company does not control securities that are controlled
by a non-subsidiary of the company. Although the Board continues to
believe that a company generally should not be deemed to control
securities held by a non-subsidiary of the company, the Board has
removed this provision from the final rule so as not to create an
expectation that a company would never be deemed to control securities
held by a non-subsidiary. For example, a company generally would be
deemed to control securities held by a non-subsidiary if the company
had an option to acquire those securities.
Reservation of Authority
The proposal included a reservation of authority to allow the Board
to determine that securities that would otherwise be considered
controlled by a person under the proposal are not controlled by the
person. Similarly, the proposed reservation of authority allowed the
Board to determine that securities that are not considered controlled
by a person under the proposal are controlled by the person. The Board
received no comments specifically on this reservation of authority
provision and the final rule includes the reservation of authority
consistent with the proposal. The reservation of authority is meant to
allow the Board to deal with rare circumstances that do not align with
the intent of the rule.
Percentage of a Class of Voting Securities
The proposal provided a rule for calculating the percentage of a
class of voting securities controlled by a person. The proposed rule
considered both the number of securities and the voting power of those
securities. Specifically, the percentage of a class of voting
securities controlled by a person was the greater of (i) the number of
voting securities of the class controlled by the person divided by the
number of issued and outstanding voting securities of the class
(expressed as a percentage) and (ii) the number of votes that the
person could cast divided by the total number of votes that may be cast
under the terms of all the voting securities of the class that are
issued and outstanding (expressed as a percentage).
Commenters argued that the Board should not include two voting
ownership tests and should only calculate voting ownership based on
voting power not on number of voting securities owned.
The final rule is generally consistent with the proposal.
Considering both voting power and number of voting securities is
consistent with the text of the BHC Act, the legislative history, and
Board precedents. This method of calculation also prevents evasion
through the use of securities with different voting power.
D. Calculation of Total Equity Percentage
The proposal provided a methodology for calculating a company's
total equity percentage in a second company that was a stock
corporation that prepared financial statements according to GAAP. The
first step to calculate a company's total equity in a second company
was to determine the percentage of each class of voting and nonvoting
common or preferred stock issued by the second company that the first
company controlled.\74\ The second step was to multiply the percentage
of each class of stock controlled by the first company by the value of
shareholders' equity allocated to the class of stock under GAAP, with
retained earnings allocated to common stock. The third and final step
was to divide the first company's dollars of shareholders' equity by
the total shareholders' equity of the second company, as determined
under GAAP.
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\74\ For this purpose, all classes of common stock--whether
voting or nonvoting--were treated as a single class. If certain
classes of common stock had different economic interests per share
in the issuing company, the number of shares of common stock was
adjusted to equalize the economic interest per share.
---------------------------------------------------------------------------
The proposal also provided adjustments to this general standard for
more complex structures. For example, a first company was considered to
control all equity securities controlled by its subsidiaries. The
proposal also provided that a first company controls a pro rata share
of equity securities controlled by a non-subsidiary of the first
company.
Under the proposal, the total equity calculation methodology
applied by its terms only to stock corporations that prepare financials
under GAAP. However, the proposed rule indicated that the Board
generally would apply the methodology in other circumstances as well,
to the extent appropriate.
The proposal also included several anti-evasion provisions.
Specifically, where a company controlled debt of a second company that
was functionally
[[Page 12416]]
equivalent to equity of the second company, the debt was counted as
equity for purposes of the total equity calculation. The proposal
provided a nonexclusive list of factors that the Board would examine in
deciding whether to treat debt instruments as functionally equivalent
to equity. These factors included treatment of the debt as equity under
accounting, regulatory, or tax standards; subordination of the debt; or
long maturity of the debt. Similarly, the proposal provided that other
interests in a company beyond debt that were functionally equivalent to
equity may be treated as equity.
In addition to a methodology for calculating total equity, the
proposal provided a standard for the frequency of measurement of total
equity. Under the proposal, an investing company was required to
calculate its total equity in a second company each time the investing
company acquired control over additional equity interests of the second
company or divested control of equity interests of the second company.
Many commenters criticized the proposed total equity calculation
methodology. In particular, commenters argued that it would lead to a
first company being presumed to control a second company where the
second company had negative retained earnings and the first company
controlled preferred securities of the second company that included a
liquidation preference. Several commenters recommended that retained
earnings from start-up companies be excluded from the total equity
calculation to avoid this problem. Some commenters alternatively
recommended that the final rule include an exception for start-up
companies where the total equity presumption would not apply for the
first several years of a company's existence.
Certain commenters suggested that the Board calculate total equity
using a common stock equivalent method as an alternative to the
proposed methodology. Some commenters argued that the Board should
establish more flexible rules for investments by and in investment
funds.
Many commenters recommended that the Board not include debt
instruments or other interests in the total equity calculation under
the proposal's functional equivalence standard. Commenters argued that
the standard was vague and could inhibit the use of certain common
types of debt and other economic interests. At least one commenter
suggested that the Board also provide that equity may be treated as
functionally equivalent to debt under appropriate circumstances and
thus excluded from total equity.
Various commenters urged the Board to eliminate or restrict the
scope of the provisions of the total equity methodology that required a
company to include a pro rata share of equity securities held by a non-
subsidiary.
One commenter suggested that the Board revise the frequency of
recalculation of total equity to require recalculation only if a
company acquires control over additional voting equity, or only if a
company controls five percent or more of a class of voting securities.
Some commenters recommended that the final rule require recalculation
of total equity only when a company acquires equity, never in the case
of divestiture of equity.
The final rule's methodology for determining a company's total
equity percentage in another company is largely consistent with the
proposal. The Board believes that the GAAP-based core methodology of
the final rule is effective, fit for purpose, well-understood, and easy
to apply. The final rule includes a technical correction to the formula
for total equity so that pari passu classes of preferred stock (i.e.,
classes of preferred securities of the same seniority in liquidation)
are treated as a single class.
The final rule includes without change the provision whereby debt
or other interests may be treated as equity if the interests are
functionally equivalent to equity. The Board expects to reclassify debt
as equity under the rule only under unusual circumstances to prevent
evasion of the rule. The list of debt features that support a
reclassification as equity should not be understood to indicate that a
debt instrument having any one of such features automatically would be
treated as equity.
In response to concerns raised by commenters, the final rule
provides flexibility for excluding nominally equity instruments from
total equity if the equity instruments are determined to be
functionally equivalent to debt. The final rule also includes a non-
exclusive list of characteristics that could indicate that an equity
instrument may be functionally equivalent to debt, such as protections
generally provided to creditors, a limited term, a fixed rate of return
or a variable rate of return linked to a reference interest rate,
classification as debt for tax purposes, or classification as debt for
accounting purposes.\75\ This provision is intended to provide
flexibility for unusual structures and is expected to be used rarely.
Companies should consult with the Board or its staff in order to
determine whether equity instruments would be excluded from total
equity.
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\75\ See, e.g., ASC 480-10.
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The final rule does not include the proposed provision that
required a company to include a pro rata share of equity securities
held by a non-subsidiary Accordingly, a company must include in the
total equity calculation only equity securities it controls directly or
indirectly through its subsidiaries.
Also in response to concerns raised by commenters, the final rule
requires calculation of total equity only when a first company acquires
control over additional equity of a second company. The first company
is not required to recalculate its total equity when it sells or
otherwise disposes of equity of the second company. This change will
prevent a divestiture from causing an increase in total equity due to
balance sheet changes at the second company.
E. Limiting Contractual Rights
Under the proposal, a company was presumed to control a second
company if the first company had a contractual right that significantly
restricts, or allows the first company to significantly restrict, the
discretion of the second company over major operational or policy
decisions.\76\ Such contractual provisions was defined as a limiting
contractual right.
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\76\ For purposes of this restriction, a contractual arrangement
between the first company and a subsidiary of the second company, or
between a subsidiary of the first company and the second company,
could constitute a limiting contractual right of the first company
over the second company.
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The proposal provided examples of provisions that generally were
considered limiting contractual rights and examples of provisions that
generally were not considered limiting contractual rights. The examples
included in the proposal were not intended to be a complete list of
provisions that would or would not be considered limiting contractual
rights. Rather, the provisions were meant as non-exclusive examples to
provide transparency. The examples of limiting contractual rights
listed in the proposal were:
Restrictions on activities in which a company may engage,
including a prohibition on (i) entering into new lines of business,
(ii) making substantial changes to or discontinuing existing lines of
business, (iii) entering into a contractual arrangement with a third
party that imposes significant financial obligations on the company, or
(iv) materially altering the policies or procedures of the company;
[[Page 12417]]
Requirements that a company direct the proceeds of the
investment to effect any action, including to redeem the company's
outstanding voting securities;
Restrictions on hiring, firing, or compensating senior
management officials of a company, or restrictions on significantly
modifying a company's policies concerning the salary, compensation,
employment, or benefits plan for employees of the company;
Restrictions on a company's ability to merge or
consolidate, or its ability to acquire, sell, lease, transfer, spin-
off, recapitalize, liquidate, dissolve, or dispose of subsidiaries or
major assets;
Restrictions on a company's ability to make significant
investments or expenditures;
Requirements that a company achieve or maintain certain
fundamental financial targets, such as a debt-to-equity ratio, a net
worth requirement, a liquidity target, or a working capital
requirement;
Requirements that a company not exceed a specified
percentage of classified assets or non-performing loans;
Restrictions on a company's ability to pay or not pay
dividends, change its dividend payment rate on any class of securities,
redeem senior instruments, or make voluntary prepayment of
indebtedness;
Restrictions on a company's ability to authorize or issue
additional junior equity or debt securities, or amend the terms of any
equity or debt securities issued by the company;
Restrictions on a company's ability to engage in a public
offering or to list or de-list securities on an exchange;
Restrictions on a company's ability to amend its articles
of incorporation or by-laws, other than limited restrictions that are
solely defensive for the investor;
Restrictions on the removal or selection of any
independent accountant, auditor, or investment banker; or
Restrictions on a company's ability to alter significantly
accounting methods and policies, or its regulatory, tax, or corporate
status, such as converting from a stock corporation to a limited
liability company.
The proposal's examples of contractual provisions that generally
would not be limiting contractual rights were:
A restriction on a company's ability to issue securities
senior to the securities owned by the investor;
A requirement that a company provide the investor with
financial reports of the type ordinarily available to common
stockholders;
A requirement that a company maintain its corporate
existence;
A requirement that a company consult with the investor on
a reasonable periodic basis;
A requirement that a company comply with applicable
statutory and regulatory requirements;
A requirement that a company provide the investor with
notice of the occurrence of material events affecting the company or
its significant assets;
A market standard ``most-favored nation'' requirement that
the investor receive similar contractual rights as those held by other
investors in a company; or
Drag-along rights, tag-along rights, rights of first or
last refusal, or stock transfer restrictions related to preservation of
tax benefits of a company, such as S-corporation status and tax carry
forwards, or other similar rights.
Commenters suggested that the scope of the definition of limiting
contractual rights might be inconsistent with past precedent. Many
commenters argued that the list of limiting contractual rights was
overly broad and encompassed many standard investor protection rights.
In addition, many commenters argued that the open-ended definition of
limiting contractual right to include any right that restricts or
allows one company to exert significant influence over another was
overly vague.
In addition, commenters objected to including within the scope of
limiting contractual rights various of the examples provided, including
limits on: The second company's ability to enter into new lines of
business; how the second company directs the proceeds of investments;
the second company's ability to incur additional debt or raise
additional equity; requirements that the second company maintain a
particular financial ratio; the second company's ability to amend the
terms of its debt or equity securities; the second company's ability to
engage in a public offering, or to list or de-list securities on an
exchange; the second company's ability to merge or consolidate with
another company; the second company's ability to dispose of material
subsidiaries or assets; and the second company's ability to alter its
accounting methods or policies or its regulatory, tax, or liability
status.
The final rule's definition of a limiting contractual right is
generally consistent with the proposal. Limiting contractual rights are
important indicia of controlling influence. In particular, limiting
contractual rights provide a means for a company to cause or prevent
otherwise permissible actions by another company, independent of the
first company's exercise of its voting rights as a shareholder in the
second company. Using such contractual rights, a company that has
relatively low voting power may effectively control another company's
decisions over important actions, or at least have influence over such
decisions well beyond what the first company's voting power would
provide.\77\
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\77\ Such limiting contractual rights also may raise safety and
soundness concerns by restricting the ability of a company to take
appropriate actions to address supervisory issues.
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The variety of forms that limiting contractual rights may take
makes the functional definition included in the final rule preferable
to a prescriptive definition. The final rule, consistent with the
proposal, includes lists of contractual rights that generally would or
would not be considered limiting contractual rights in order to provide
additional clarity around the specific application of the definition.
The lists of contractual rights reflect a distillation of the Board's
past practice and current understanding of the types of contractual
restrictions that likely would or would not raise controlling influence
concerns. The lists of contractual rights have not been changed from
the proposal, though the introductory text of each list has been
revised to make it clear that the listed provisions are examples of
what generally would or would not be considered a limiting contractual
right. Whether or not a particular contractual right is a limiting
contractual right depends on whether the contractual right meets the
functional regulatory definition of a limiting contractual right.
Commenters argued that a restriction on new lines of business
should not be considered a limiting contractual right because such a
restriction would help a bank holding company comply with the activity
limitations in the BHC Act. Similarly, commenters argued that covenants
to comply with the activities restrictions under the BHC Act or HOLA
should not be treated as limiting contractual rights. Under the final
rule, a contractual prohibition on engaging in particular activities is
generally a limiting contractual right. However, the Board notes that a
contractual provision that provides a reasonable and non-punitive
mechanism for an investing company to reduce its investment to comply
with the activities restrictions of the BHC Act or HOLA generally would
not be a limiting contractual right.
One commenter asked the Board to clarify whether a contractual
right restricting ``materially altering policies
[[Page 12418]]
or procedures'' would qualify as a limiting contractual right. A
restriction of this type generally would be considered a limiting
contractual right. It is similar to the example of a limiting
contractual right provided in the final rule related to amendments to
the articles or bylaws of a company.
Commenters suggested that the right to information available to
shareholders should be expanded to include access to information that
is necessary or appropriate to allow the first company to monitor its
investment and to monitor regulatory, legal, or other requirements or
standards, including the presumptions of control in the final rule. In
the Board's view, an investor's right to access information regarding
the relationship between the investor and the investee company, such as
the information necessary to determine the application of the
presumptions of control, generally would not be considered a limiting
contractual right. In addition, the final rule has been revised to
clarify that a contractual right to information ordinarily available to
common shareholders, whether or not the information is financial in
nature, is generally not a limiting contractual right.
Commenters also argued that the presumption of control based on
limiting contractual rights should be revised so that the presumption
does not apply if the first company cannot exercise the right
unilaterally or if the first company is not the largest single decider
of the exercise of the right. One commenter sought clarification as to
whether, and in what circumstances, voting rights exercised by a group
of investors (such as a voting right that can only be exercised by
certain preferred shareholders) would be treated as a limiting
contractual right. To avoid undue complexity, the final rule does not
specifically address contractual provisions that incorporate elements
of voting by requiring agreement of a certain percentage of certain
parties. Companies with questions on a particular limiting contractual
right may contact the Board or its staff to address the specific
situation.
In addition, commenters expressed concern that the proposal would
treat standard loan or bond covenants as limiting contractual rights.
Commenters argued that treating loan covenants as limiting contractual
rights would make it impossible for a bank to make a loan to another
company if its affiliate had also made an equity investment in that
company. Some commenters argued that standard loan covenants should not
trigger a presumption of control when they are on market terms, there
are multiple lenders, and the first company has less than 15 percent
voting power in the second company. The final rule does not include any
revisions in response to these comments. In the Board's view, a
contractual provision that significantly restricts a company's
discretion over operational and policy decisions ought to be treated as
a limiting contractual right in the final rule. Whether or not the
limiting contractual right is embedded in a market-standard loan
agreement does not affect the influence the limiting contractual right
provides the holder of the right. The Board generally has controlling
influence concerns when a company, directly or indirectly, both
controls a material amount of voting securities of another company and
has the ability to significantly restrict the discretion of the other
company over operational or policy decisions by contract.
F. Director Representatives
As discussed, the Board has long taken the position that director
representatives of a company serving on the board of directors of a
second company are an avenue through which the first company may
exercise a controlling influence over the second company. To provide
more clarity on when the Board deems an individual to be a director
representative of a company, the proposal defined director
representative to be any director who (i) is a current director,
employee, or agent of the company; (ii) was a director, employee, or
agent of the company within the preceding two years; or (iii) is an
immediate family member of an individual who is a current director,
employee, or agent of the company, or was a director, employee, or
agent of the company within the preceding two years. In addition, the
proposal provided that a director is a director representative of a
first company if the director was proposed to serve as a director by
the first company, whether by exercise of a contractual right or
otherwise. The proposal also specified that a nonvoting observer is not
a director representative.
Some commenters suggested that the definition of a director
representative was too broad and could include directors over which the
first company did not have substantial influence. In particular, some
commenters contended that director representatives should not include
individuals elected to the board of directors of a mutual fund by a
first company if the director representatives are independent of the
first company.
A few commenters expressed concern that the proposed definition
might mean that the Board would attribute a director to a company if
the company merely suggested the name of the director to a nominating
committee. Some commenters also expressed concern about the ambiguity
of treating ``agents'' of a company as director representatives and
requested that the Board define the term agent in this context.
Several commenters argued that the definition of director
representative should include only former directors of the first
company and should not include former employees. Similarly, some
commenters suggested that a company should only be attributed a former
officer, director, or employee if the individual became a director of
the second company while still an officer, director, or employee of the
first company.
Some commenters argued that the inclusion of immediate family
members of directors, employees, and agents of the first company was
too broad and would create compliance difficulties, especially with
respect to employees of large companies. These commenters argued that
the immediate family member prong ought to be removed from the
definition of director representative.
In response to the comments received, the Board is substantially
amending the definition of a director representative to be more
functional and more narrow. Specifically, under the final rule,
``director representative'' is defined as an individual that represents
the interests of a first company through service on the board of
directors of a second company. The final rule then provides a non-
exclusive list of examples of persons who generally would be considered
to be director representatives for purposes of the final rule: (i)
Individuals who are officers, employees, or directors of the first
company, (ii) individuals who were officers, employees, or directors of
the first company within the preceding two years, and (iii) individuals
who were nominated or proposed by the first company to be directors of
the second company. Companies may contact the Board or its staff for
guidance in determining whether or not a particular individual would be
considered to be a director representative for purposes of the final
rule.
G. Investment Advisers
The proposal defined investment adviser for purposes of the
proposed presumptions to mean a company that is registered as an
investment adviser with the SEC under the Investment Advisers Act,\78\
a company registered
[[Page 12419]]
with the Commodity Futures Trading Commission (``CFTC'') as a commodity
trading adviser under the Commodity Exchange Act,\79\ a company that is
a foreign equivalent of an investment adviser or commodity trading
adviser registered with the SEC or CFTC, respectively, or a company
that engages in any of the activities set forth in section
225.28(b)(6)(i) through (iv) of the Board's Regulation Y.
---------------------------------------------------------------------------
\78\ 15 U.S.C. 80b-1 et seq.
\79\ 7 U.S.C. 1 et seq.
---------------------------------------------------------------------------
The Board did not receive comments specifically on the definition
of investment adviser, although the Board did receive comments on the
presumption of control based on investment advisory relationships. The
comments on the presumption of control based on investment advisory
relationships are discussed earlier in this preamble. The final rule
adopts the definition of investment adviser as proposed.
IV. Application to Savings and Loan Holding Companies
As noted, the proposal applied equally to bank holding companies
and savings and loan holding companies to the maximum extent permitted
by law. HOLA defines control in a substantially similar manner as the
BHC Act.\80\ The Board previously recognized that the statutory control
framework under the BHC Act and HOLA are nearly identical and
determined to apply matching procedures for reviewing controlling
influence cases involving savings and loan holding companies under
Regulation LL as apply to bank holding companies under Regulation
Y.\81\ Consistent with this principle, the proposal incorporated the
proposed control presumptions and related revisions into the Board's
Regulation LL for savings and loan holding companies in essentially the
same manner as into the Board's Regulation Y for bank holding
companies. The Board is also amending portions of subpart A of
Regulation LL to incorporate current Sec. 238.9 into Sec. 238.8. This
does not any change requirements under these sections, but is merely a
technical edit to make room for the new section Sec. 238.9 adopted by
this final rule.
---------------------------------------------------------------------------
\80\ Compare 12 U.S.C. 1467a(a)(2) (HOLA) with 12 U.S.C.
1841(a)(2) (BHC Act).
\81\ 76 FR 56508, 56509 (Sept. 13, 2011).
---------------------------------------------------------------------------
A. Control Under HOLA Compared to the BHC Act
Although controlling influence is defined similarly under HOLA and
the BHC Act, there are several differences between the definitions of
``control'' in each statute. Under HOLA, the definition of control
applies to both individuals and companies controlling other companies,
while control is limited to companies controlling other companies under
the BHC Act.\82\ Under HOLA, a person controls a company if the person
has more than 25 percent of any class of voting securities of the
company, rather than 25 percent or more of any class of voting
securities under the BHC Act.\83\ Unlike the BHC Act, HOLA specifies
that a general partner of a partnership controls the partnership, a
trustee of a trust controls the trust, and a person that has
contributed more than 25 percent of the capital of a company controls
the company.\84\ Further, HOLA does not include the BHC Act's
presumption of noncontrol for a company with a less than 5 percent
voting interest in another company.\85\
---------------------------------------------------------------------------
\82\ 12 U.S.C. 1467a(a)(2).
\83\ 12 U.S.C. 1467a(2)(A)-(B) and 1841(a)(2)(A).
\84\ 12 U.S.C. 1467a(2)(B)-(C).
\85\ 12 U.S.C. 1841(a)(3).
---------------------------------------------------------------------------
At least one commenter stated that the Board should confirm past
decisions of the Office of Thrift Supervision indicating that
contributed capital for purposes of HOLA was the same as total equity,
or that the Board should otherwise clarify its interpretation of
contributed capital for purposes of HOLA. One commenter suggested that
the Board should seek additional public comment on its interpretation
of contributed capital.
In response to comments received on the proposal, the final rule
has been revised to reflect that contributed capital for purposes of
HOLA generally has the same meaning as total equity as used by the
Board in the context of control under the BHC Act. As a result, the
final rule differs from the proposal in several respects. Specifically,
the final rule omits the concept of total equity from subpart C of
Regulation LL because subpart C relates to questions of controlling
influence and contributed capital is a separate part of the statutory
definition of control under HOLA. The rules for calculating total
equity under subpart D of Regulation Y reflect how the Board generally
expects to measure contributed capital for purposes of HOLA and
Regulation LL.
B. Revisions to Regulation LL
Under the proposal, the Board included in Regulation LL the same
presumptions and related amendments made to Regulation Y, with limited
changes to reflect the relevant differences between control under the
BHC Act and HOLA. The proposed defined terms were located in Sec.
238.2 of Regulation LL. The proposed provisions relating to the
calculation of the percentage of a class of securities controlled by a
person were located in Sec. 238.9 of Regulation LL. The proposed
provisions related to control proceedings, including the proposed
presumptions of control and noncontrol, were located in subpart C of
Regulation LL.
The Board did not receive any comments specifically on how the rule
amended Regulation LL, other than the contributed capital issue
described previously. Accordingly, other than the provisions related to
total equity and the placement of proposed Sec. 238.10 in Sec. 238.9
instead, the final rule creates an essentially consistent control
framework between Regulation Y and Regulation LL.
V. Additional Implementation Matters
Use of Passivity Commitments
Some commenters suggested that the Board abandon its use of
passivity commitments and clarify that such commitments are not needed
going forward. Other commenters requested that the Board clarify
whether it intends to continue to seek either the general passivity
commitments or any of the specialized types of similar commitments. A
few commenters also requested that the Board provide a process under
which companies that have provided passivity commitments may obtain
relief from the commitments to align to the control framework. Some
commenters suggested that investors that had previously submitted
passivity commitments to the Board should be allowed to increase their
relationships with the target company without seeking relief from
commitments so long as the increased relationships would not trigger a
presumption of control under the final rule.
The Board does not intend to obtain the standard-form passivity
commitments going forward in the ordinary course. The Board will
continue to obtain control-related commitments in specific contexts,
such as commitments from employee stock ownership plans and mutual fund
complexes, and in special situations.
In the wake of the final rule, companies that have provided the
standard form of passivity commitments to the Board may contact the
Board or the appropriate Federal Reserve Bank to seek relief from these
commitments. Absent unusual circumstances, the
[[Page 12420]]
Board expects to be receptive to such requests for relief.\86\
---------------------------------------------------------------------------
\86\ Companies that have provided commitments in connection with
TARP securities may also seek relief.
---------------------------------------------------------------------------
Application of the Final Rule
Several commenters suggested that the Board's new control framework
should only apply prospectively. Similarly, some commenters suggested
that the Board grandfather all existing investments or more narrowly
grandfather existing investments that had been reviewed by the Board or
its staff. Some commenters advocated for a three-year phase-in period
for foreign banking organizations so that these firms could make
adjustments to their business practices to account for the final rule.
The final rule provides additional information regarding the
Board's views on questions of controlling influence, but it is
generally consistent with the Board's current practice. As it is not a
fundamental change to current practice, the final rule does not
grandfather existing structures and does not provide a transition
period to allow firms to conform existing investments. The Board does
not expect to revisit structures that have already been reviewed by the
Federal Reserve System unless such structures are materially altered
from the facts and circumstances of the original review. To the extent
that a company previously considered an existing relationship between
two companies to not constitute control, the relationship was not
reviewed by the Federal Reserve System, and the relationship would be
presumed to be a controlling relationship under the final rule, the
company may contact the Board or its staff to discuss potential
actions.
VI. Administrative Law Matters
A. Paperwork Reduction Act
In accordance with the requirements of the Paperwork Reduction Act
of 1995 (44 U.S.C. 3501-3521) (PRA), the Board may not conduct or
sponsor, and a respondent is not required to respond to, an information
collection unless it displays a currently valid Office of Management
and Budget (OMB) control number. The Board reviewed the final rule and
determined that it does not create any new or revise any existing
collection of information under section 3504(h) of title 44.
B. Regulatory Flexibility Act
An initial regulatory flexibility analysis (IRFA) was included in
the proposal in accordance with section 603(a) of the Regulatory
Flexibility Act (RFA), 5 U.S.C. 601 et seq. (RFA). In the IRFA, the
Board requested comment on the effect of the proposed rule on small
entities and on any significant alternatives that would reduce the
regulatory burden on small entities. The Board did not receive any
comments on the IRFA. The RFA requires an agency to prepare a final
regulatory flexibility analysis unless the agency certifies that the
rule will not, if promulgated, have a significant economic impact on a
substantial number of small entities. Based on its analysis, and for
the reasons stated below, the Board certifies that the rule will not
have a significant economic impact on a substantial number of small
entities.\87\
---------------------------------------------------------------------------
\87\ 5 U.S.C. 605(b).
---------------------------------------------------------------------------
Under regulations issued by the Small Business Administration, a
small entity includes a bank, bank holding company, or savings and loan
holding company with assets of $600 million or less and trust companies
with total assets of $41.5 million or less (small banking
organization).\88\ As of June 30, 2019, there were approximately 2,976
small bank holding companies, 133 small savings and loan holding
companies, and 537 small SMBs. The final rule may also have
implications for additional entities that have material relationships
with banking organizations; however, the scope of potentially affected
entities and thus the extent to which affected entities are small
entities under the regulations of the Small Business Administration, is
not known.
---------------------------------------------------------------------------
\88\ See 13 CFR 121.201. Effective August 19, 2019, the SBA
revised the size standards for banking organizations to $600 million
in assets from $550 million in assets. 84 FR 34261 (July 18, 2019).
---------------------------------------------------------------------------
As discussed in the SUPPLEMENTARY INFORMATION section, the final
rule establishes a more detailed framework for the Board to determine
whether a company has control over another company for purposes of the
BHC Act and HOLA. The final rule consists of a series of rebuttable
presumptions of control, a rebuttable presumption of noncontrol, and
various ancillary items such as definitions of terms used in the
presumptions. The presumptions of control generally would be consistent
with the Board's current practice with respect to controlling
influence, with certain targeted adjustments.
A main impact of the final rule will be to enhance transparency to
the public on the Board's views on controlling influence. The final
rule most directly affects bank holding companies and savings and loan
holding companies, though it also could impact state member banks and
other companies with relationships with depository institutions and
depository institution holding companies. However, the final rule
generally will not impact banking organizations in the ordinary course;
there are no regular compliance, recordkeeping, or reporting
requirements associated with the final rule. Rather, the impact of the
final rule will generally be in the context of certain types of
significant transactions that companies may decide to engage in. In
addition, any material impact would be concentrated in companies
engaged in the particular types of investments where controlling
influence is a concern for the parties involved, which is a narrow
subset of all transactions banking organizations may be party to. For
the reasons discussed above, the Board anticipates that any economic
impact of the final rule, including on small banking organizations,
will be a reduction of burden associated with structuring transactions
to address control issues. Therefore, the Board does not expect the
rule to have a significant economic impact on a substantial number of
small entities.
C. Plain Language
Section 722 of the Gramm-Leach-Bliley Act \89\ requires the Federal
banking agencies to use plain language in all proposed and final rules
published after January 1, 2000. The Board have sought to present the
final rule in a simple and straightforward manner, did not receive any
comments on the use of plain language.
---------------------------------------------------------------------------
\89\ Public Law 106-102, section 722, 113 Stat. 1338, 1471
(1999).
---------------------------------------------------------------------------
List of Subjects
12 CFR Part 225
Administrative practice and procedure, Banks, Banking, Capital
planning, Holding companies, Reporting and recordkeeping requirements,
Securities, Stress testing.
12 CFR Part 238
Administrative practice and procedure, Banks, Banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Holding companies, Securities.
Authority and Issuance
For the reasons stated in the preamble, the Board of Governors of
the Federal Reserve System amends 12 CFR chapter II as follows:
[[Page 12421]]
PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
(REGULATION Y)
0
1. The authority citation for part 225 continues to read as follows:
Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-
1, 1843(c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3906,
3907, and 3909; 15 U.S.C. 1681s, 1681w, 6801 and 6805.
Subpart A--General Provisions
0
2. In Sec. 225.2:
0
a. Remove the words ``bank or other company'' and add in their place
``company'' wherever they occur in paragraphs (e) introductory text and
(e)(1);
0
b. Revise paragraphs (e)(2) and (q)(2); and
0
c. Add paragraph (u).
The revisions and addition read as follows:
Sec. 225.2 Definitions.
* * * * *
(e) * * *
(2) A company is deemed to control voting securities or assets
owned, controlled, or held, directly or indirectly:
(i) By the company, or by any subsidiary of the company;
(ii) That the company has power to vote or to dispose of;
(iii) In a fiduciary capacity for the benefit of the company or any
of its subsidiaries;
(iv) In a fiduciary capacity (including by pension and profit-
sharing trusts) for the benefit of the shareholders, members, or
employees (or individuals serving in similar capacities) of the company
or any of its subsidiaries; or
(v) According to the standards under Sec. 225.9 of this part.
* * * * *
(q) * * *
(2) Nonvoting securities. Common shares, preferred shares, limited
partnership interests, limited liability company interests, or similar
interests are not voting securities if:
(i) Any voting rights associated with the securities are limited
solely to the type customarily provided by statute with regard to
matters that would significantly and adversely affect the rights or
preference of the security, such as the issuance of additional amounts
or classes of senior securities, the modification of the terms of the
security, the dissolution of the issuing company, or the payment of
dividends by the issuing company when preferred dividends are in
arrears;
(ii) The securities represent an essentially passive investment or
financing device and do not otherwise provide the holder with control
over the issuing company; and
(iii) The securities do not entitle the holder, by statute,
charter, or in any manner, to select or to vote for the selection of
directors, trustees, or partners (or persons exercising similar
functions) of the issuing company; except that limited partnership
interests or membership interests in limited liability companies are
not voting securities due to voting rights that are limited solely to
voting for the removal of a general partner or managing member (or
persons exercising similar functions at the company) for cause, to
replace a general partner or managing member (or persons exercising
similar functions at the company) due to incapacitation or following
the removal of such person, or to continue or dissolve the company
after removal of the general partner or managing member (or persons
exercising similar functions at the company).
* * * * *
(u) Voting percentage. For purposes of this part, the percentage of
a class of a company's voting securities controlled by a person is the
greater of:
(1) The quotient, expressed as a percentage, of the number of
shares of the class of voting securities controlled by the person,
divided by the number of shares of the class of voting securities that
are issued and outstanding, both as adjusted by Sec. 225.9 of this
part; and
(2) The quotient, expressed as a percentage, of the number of votes
that may be cast by the person on the voting securities controlled by
the person, divided by the total votes that are legally entitled to be
cast by the issued and outstanding shares of the class of voting
securities, both as adjusted by Sec. 225.9 of this part.
0
3. Section 225.9 is added to read as follows:
Sec. 225.9 Control over securities.
(a) Contingent rights, convertible securities, options, and
warrants. (1) A person that controls a security, option, warrant, or
other financial instrument that is convertible into, exercisable for,
exchangeable for, or otherwise may become a security controls each
security that could be acquired as a result of such conversion,
exercise, exchange, or similar occurrence.
(2) If a financial instrument of the type described in paragraph
(a)(1) of this section is convertible into, exercisable for,
exchangeable for, or otherwise may become a number of securities that
varies according to a formula, rate, or other variable metric, the
number of securities controlled under paragraph (a)(1) of this section
is the maximum number of securities that the financial instrument could
be converted into, be exercised for, be exchanged for, or otherwise
become under the formula, rate, or other variable metric.
(3) Notwithstanding paragraph (a)(1) of this section, a person does
not control voting securities due to controlling a financial instrument
if the financial instrument:
(i) By its terms is not convertible into, is not exercisable for,
is not exchangeable for, and may not otherwise become voting securities
in the hands of the person or an affiliate of the person; and
(ii) By its terms is only convertible into, exercisable for,
exchangeable for, or may otherwise become voting securities in the
hands of a transferee after a transfer:
(A) In a widespread public distribution;
(B) To the issuing company;
(C) In transfers in which no transferee (or group of associated
transferees) would receive 2 percent or more of the outstanding
securities of any class of voting securities of the issuing company; or
(D) To a transferee that would control more than 50 percent of
every class of voting securities of the issuing company without any
transfer from the person.
(4) Notwithstanding paragraph (a)(1) of this section, a person that
has agreed to acquire securities or other financial instruments
pursuant to a securities purchase agreement does not control such
securities or financial instruments until the person acquires the
securities or financial instruments.
(5) Notwithstanding paragraph (a)(1) of this section, a right that
provides a person the ability to acquire securities in future issuances
or to convert nonvoting securities into voting securities does not
cause the person to control the securities that could be acquired under
the right, so long as the right does not allow the person to acquire a
higher percentage of the class of securities than the person controlled
immediately prior to the future acquisition.
(6) Notwithstanding paragraph (a)(1) of this section, a preferred
security that would be a nonvoting security but for a right to vote on
directors that activates only after six or more quarters of unpaid
dividends is not considered to be a voting security until the security
holder is entitled to exercise the voting right.
(7) For purposes of determining the percentage of a class of voting
securities or the total equity percentage of a company controlled by a
person that
[[Page 12422]]
controls a financial instrument of the type described in paragraph
(a)(1) of this section:
(i) The securities controlled by the person under paragraphs (a)(1)
through (6) of this section are deemed to be issued and outstanding;
and
(ii) Any securities controlled by anyone other than the person
under paragraph (a)(1) through (6) of this section are not deemed to be
issued and outstanding, unless by the terms of the financial
instruments the securities controlled by the other persons must be
issued and outstanding in order for the securities of the person to be
issued and outstanding.
(b) Restriction on securities. A person that enters into an
agreement or understanding with a second person under which the rights
of the second person are restricted in any manner with respect to
securities that are controlled by the second person, controls the
securities of the second person, unless the restriction is:
(1) A requirement that the second person offer the securities for
sale to the first person for a reasonable period of time prior to
transferring the securities to a third party;
(2) A requirement that, if the second person agrees to sell the
securities, the second person provide the first person with the
opportunity to participate in the sale of the securities by the second
person;
(3) A requirement under which the second person agrees to sell its
securities to a third party if a majority of security holders agrees to
sell their securities to the third party;
(4) Incident to a bona fide loan transaction in which the
securities serve as collateral;
(5) A short-term and revocable proxy;
(6) A restriction on transferability that continues only for a
reasonable amount of time necessary to complete an acquisition by the
first person of the securities from the second person, including the
time necessary to obtain required approval from an appropriate
government authority with respect to the acquisition;
(7) A requirement that the second person vote the securities in
favor of a specific acquisition of control of the issuing company, or
against competing transactions, if the restriction continues only for a
reasonable amount of time necessary to complete the transaction,
including the time necessary to obtain required approval from an
appropriate government authority with respect to an acquisition or
merger; or
(8) An agreement among security holders of the issuing company
intended to preserve the tax status or tax benefits of the company,
such as qualification of the issuing company as a Subchapter S
corporation, as defined in 26 U.S.C. 1361(a)(1) or any successor
statute, or prevention of events that could impair deferred tax assets,
such as net operating loss carryforwards, as described in 26 U.S.C. 382
or any successor statute.
(c) Securities held by senior management officials or controlling
equity holders of a company. A company that controls 5 percent or more
of any class of voting securities of another company controls all
securities issued by the second company that are controlled by senior
management officials, directors, or controlling shareholders of the
first company, or by immediate family members of such persons, unless
the first company controls less than 15 percent of each class of voting
securities of the second company and the senior management officials,
directors, and controlling shareholders of the first company, and
immediate family members of such persons, control 50 percent or more of
each class of voting securities of the second company.
(d) Reservation of authority. Notwithstanding paragraphs (a)
through (c) of this section, the Board may determine that securities
are or are not controlled by a company based on the facts and
circumstances presented.
0
4. Subpart D is revised to read as follows:
Subpart D--Control and Divestiture Proceedings
Sec.
225.31 Control proceedings.
225.32 Rebuttable presumptions of control of a company.
225.33 Rebuttable presumption of noncontrol of a company.
225.34 Total equity.
Subpart D--Control and Divestiture Proceedings
Sec. 225.31 Control proceedings.
(a) Preliminary determination of control. (1) The Board in its sole
discretion may issue a preliminary determination of control under the
procedures set forth in this section in any case in which the Board
determines, based on consideration of the facts and circumstances
presented, that a first company has the power to exercise a controlling
influence over the management or policies of a second company.
(2) If the Board makes a preliminary determination of control under
this section, the Board shall send notice to the first company
containing a statement of the facts upon which the preliminary
determination is based.
(b) Response to preliminary determination of control. (1) Within 30
calendar days after issuance by the Board of a preliminary
determination of control or such longer period permitted by the Board
in its discretion, the first company against whom the preliminary
determination has been made shall:
(i) Consent to the preliminary determination of control and either:
(A) Submit for the Board's approval a specific plan for the prompt
termination of the control relationship; or
(B) File an application or notice under this part, as applicable;
or
(ii) Contest the preliminary determination by filing a response,
setting forth the facts and circumstances in support of its position
that no control exists, and, if desired, requesting a hearing or other
proceeding.
(2) If the first company fails to respond to the preliminary
determination of control within 30 days or such longer period permitted
by the Board in its discretion, the first company will be deemed to
have waived its right to present additional information to the Board or
to request a hearing or other proceeding regarding the preliminary
determination of control.
(c) Hearing and final determination. (1) The Board shall order a
hearing or other appropriate proceeding upon the petition of a first
company that contests a preliminary determination of control if the
Board finds that material facts are in dispute. The Board may, in its
discretion, order a hearing or other appropriate proceeding without a
petition for such a proceeding by the first company.
(2) At a hearing or other proceeding, any applicable presumptions
established under this subpart shall be considered in accordance with
the Federal Rules of Evidence and the Board's Rules of Practice for
Formal Hearings (12 CFR part 263).
(3) After considering the submissions of the first company and
other evidence, including the record of any hearing or other
proceeding, the Board will issue a final order determining whether the
first company has the power to exercise a controlling influence over
the management or policies of the second company. If a controlling
influence is found, the Board may direct the first company to terminate
the control relationship or to file an application or notice for the
Board's approval to retain the control relationship.
(d) Submission of evidence. (1) In connection with contesting a
preliminary determination of control
[[Page 12423]]
under paragraph (b)(1)(ii) of this section, a first company may submit
to the Board evidence or any other relevant information related to its
control of a second company.
(2) Evidence or other relevant information submitted to the Board
pursuant to paragraph (d)(1) of this section must be in writing and may
include a description of all current and proposed relationships between
the first company and the second company, including relationships of
the type that are identified under any of the rebuttable presumptions
in Sec. Sec. 225.32 and 225.33 of this part, copies of any formal
agreements related to such relationships, and a discussion regarding
why the Board should not determine the first company to control the
second company.
(e) Definitions. For purposes of this subpart:
(1) Board of directors means the board of directors of a company or
a set of individuals exercising similar functions at a company.
(2) Director representative means any individual that represents
the interests of a first company through service on the board of
directors of a second company. For purposes of this paragraph (e)(2),
examples of persons who are directors of a second company and generally
would be considered director representatives of a first company
include:
(i) A current officer, employee, or director of the first company;
(ii) An individual who was an officer, employee, or director of the
first company within the prior two years; and
(iii) An individual who was nominated or proposed to be a director
of the second company by the first company.
(iv) A director representative does not include a nonvoting
observer.
(3) First company means the company whose potential control of a
second company is the subject of determination by the Board under this
subpart.
(4) Investment adviser means a company that:
(i) Is registered as an investment adviser with the Securities and
Exchange Commission under the Investment Advisers Act of 1940 (15
U.S.C. 80b-1 et seq.);
(ii) Is registered as a commodity trading advisor with the
Commodity Futures Trading Commission under the Commodity Exchange Act
(7 U.S.C. 1 et seq.);
(iii) Is a foreign equivalent of an investment adviser or commodity
trading advisor, as described in paragraph (e)(4)(i) or (ii) of this
section; or
(iv) Engages in any of the activities set forth in Sec.
225.28(b)(6)(i) through (iv) of this part.
(5) Limiting contractual right means a contractual right of the
first company that would allow the first company to restrict
significantly, directly or indirectly, the discretion of the second
company, including its senior management officials and directors, over
operational and policy decisions of the second company.
(i) Examples of limiting contractual rights may include, but are
not limited to, a right that allows the first company to restrict or to
exert significant influence over decisions related to:
(A) Activities in which the second company may engage, including a
prohibition on entering into new lines of business, making substantial
changes to or discontinuing existing lines of business, or entering
into a contractual arrangement with a third party that imposes
significant financial obligations on the second company;
(B) How the second company directs the proceeds of the first
company's investment;
(C) Hiring, firing, or compensating one or more senior management
officials of the second company, or modifying the second company's
policies or budget concerning the salary, compensation, employment, or
benefits plan for its employees;
(D) The second company's ability to merge or consolidate, or its
ability to acquire, sell, lease, transfer, spin-off, recapitalize,
liquidate, dissolve, or dispose of subsidiaries or assets;
(E) The second company's ability to make investments or
expenditures;
(F) The second company achieving or maintaining a financial target
or limit, including, for example, a debt-to-equity ratio, a fixed
charges ratio, a net worth requirement, a liquidity target, a working
capital target, or a classified assets or nonperforming loans limit;
(G) The second company's payment of dividends on any class of
securities, redemption of senior instruments, or voluntary prepayment
of indebtedness;
(H) The second company's ability to authorize or issue additional
junior equity or debt securities, or amend the terms of any equity or
debt securities issued by the second company;
(I) The second company's ability to engage in a public offering or
to list or de-list securities on an exchange, other than a right that
allows the securities of the first company to have the same status as
other securities of the same class;
(J) The second company's ability to amend its articles of
incorporation or by-laws, other than in a way that is solely defensive
for the first company;
(K) The removal or selection of any independent accountant,
auditor, investment adviser, or investment banker employed by the
second company; or
(L) The second company's ability to significantly alter accounting
methods and policies, or its regulatory, tax, or liability status
(e.g., converting from a stock corporation to a limited liability
company); and
(ii) A limiting contractual right does not include a contractual
right that would not allow the first company to significantly restrict,
directly or indirectly, the discretion of the second company over
operational and policy decisions of the second company. Examples of
contractual rights that are not limiting contractual rights may
include:
(A) A right that allows the first company to restrict or to exert
significant influence over decisions relating to the second company's
ability to issue securities senior to securities owned by the first
company;
(B) A requirement that the first company receive financial reports
or other information of the type ordinarily available to common
stockholders;
(C) A requirement that the second company maintain its corporate
existence;
(D) A requirement that the second company consult with the first
company on a reasonable periodic basis;
(E) A requirement that the second company provide notices of the
occurrence of material events affecting the second company;
(F) A requirement that the second company comply with applicable
statutory and regulatory requirements;
(G) A market standard requirement that the first company receive
similar contractual rights as those held by other investors in the
second company;
(H) A requirement that the first company be able to purchase
additional securities issued by the second company in order to maintain
the first company's percentage ownership in the second company;
(I) A requirement that the second company ensure that any security
holder who intends to sell its securities of the second company provide
other security holders of the second company or the second company
itself the opportunity to purchase the securities before the securities
can be sold to a third party; or
(J) A requirement that the second company take reasonable steps to
ensure
[[Page 12424]]
the preservation of tax status or tax benefits, such as status of the
second company as a Subchapter S corporation or the protection of the
value of net operating loss carry-forwards.
(6) Second company means the company whose potential control by a
first company is the subject of determination by the Board under this
subpart.
(7) Senior management official means any person who participates or
has the authority to participate (other than in the capacity as a
director) in major policymaking functions of a company.
(f) Reservation of authority. Nothing in this subpart shall limit
the authority of the Board to take any supervisory or enforcement
action otherwise permitted by law, including an action to address
unsafe or unsound practices or conditions, or violations of law.
Sec. 225.32 Rebuttable presumptions of control of a company.
(a) General. (1) In any proceeding under Sec. 225.31(b) or (c) of
this part, a first company is presumed to control a second company in
the situations described in paragraphs (b) through (i) of this section.
The Board also may find that a first company controls a second company
based on other facts and circumstances.
(2) For purposes of the presumptions in this section, any company
that is a subsidiary of the first company and also a subsidiary of the
second company is considered to be a subsidiary of the first company
and not a subsidiary of the second company.
(b) Management contract or similar agreement. The first company
enters into any agreement, understanding, or management contract (other
than to serve as investment adviser) with the second company, under
which the first company directs or exercises significant influence or
discretion over the general management, overall operations, or core
business or policy decisions of the second company. Examples of such
agreements include where the first company is a managing member,
trustee, or general partner of the second company, or exercises similar
powers and functions.
(c) Total equity. The first company controls one third or more of
the total equity of the second company.
(d) Ownership or control of 5 percent or more of voting securities.
The first company controls 5 percent or more of the outstanding
securities of any class of voting securities of the second company,
and:
(1)(i) Director representatives of the first company or any of its
subsidiaries comprise 25 percent or more of the board of directors of
the second company or any of its subsidiaries; or
(ii) Director representatives of the first company or any of its
subsidiaries are able to make or block the making of major operational
or policy decisions of the second company or any of its subsidiaries;
(2) Two or more employees or directors of the first company or any
of its subsidiaries serve as senior management officials of the second
company or any of its subsidiaries;
(3) An employee or director of the first company or any of its
subsidiaries serves as the chief executive officer, or serves in a
similar capacity, of the second company or any of its subsidiaries;
(4) The first company or any of its subsidiaries enters into
transactions or has business relationships with the second company or
any of its subsidiaries that generate in the aggregate 10 percent or
more of the total annual revenues or expenses of the second company,
each on a consolidated basis; or
(5) The first company or any of its subsidiaries has any limiting
contractual right with respect to the second company or any of its
subsidiaries, unless such limiting contractual right is part of an
agreement to merge with or make a controlling investment in the second
company that is reasonably expected to close within one year and such
limiting contractual right is designed to ensure that the second
company continues to operate in the ordinary course until the merger or
investment is consummated or such limiting contractual right requires
the second company to take an action necessary for the merger or
investment to be consummated.
(e) Ownership or control of 10 percent or more of voting
securities. The first company controls 10 percent or more of the
outstanding securities of any class of voting securities of the second
company, and:
(1) The first company or any of its subsidiaries propose a number
of director representatives to the board of directors of the second
company or any of its subsidiaries in opposition to nominees proposed
by the management or board of directors of the second company or any of
its subsidiaries that, together with any director representatives of
the first company or any of its subsidiaries on the board of directors
of the second company or any of its subsidiaries, would comprise 25
percent or more of the board of directors of the second company or any
of its subsidiaries;
(2) Director representatives of the first company and its
subsidiaries comprise more than 25 percent of any committee of the
board of directors of the second company or any of its subsidiaries
that can take action that binds the second company or any of its
subsidiaries; or
(3) The first company or any of its subsidiaries enters into
transactions or has business relationships with the second company or
any of its subsidiaries that:
(i) Are not on market terms; or
(ii) Generate in the aggregate 5 percent or more of the total
annual revenues or expenses of the second company, each on a
consolidated basis.
(f) Ownership or control of 15 percent or more of voting
securities. The first company controls 15 percent or more of the
outstanding securities of any class of voting securities of the second
company, and:
(1) A director representative of the first company or of any of its
subsidiaries serves as the chair of the board of directors of the
second company or any of its subsidiaries;
(2) One or more employees or directors of the first company or any
of its subsidiaries serves as a senior management official of the
second company or any of its subsidiaries; or
(3) The first company or any of its subsidiaries enters into
transactions or has business relationships with the second company or
any of its subsidiaries that generate in the aggregate 2 percent or
more of the total annual revenues or expenses of the second company,
each on a consolidated basis.
(g) Accounting consolidation. The first company consolidates the
second company on its financial statements prepared under U.S.
generally accepted accounting principles.
(h) Control of an investment fund. (1) The first company serves as
an investment adviser to the second company, the second company is an
investment fund, and the first company, directly or indirectly, or
acting through one or more other persons:
(i) Controls 5 percent or more of the outstanding securities of any
class of voting securities of the second company; or
(ii) Controls 25 percent or more of the total equity of the second
company.
(2) The presumption of control in paragraph (h)(1) of this section
does not apply if the first company organized and sponsored the second
company within the preceding 12 months.
(i) Divestiture of control. (1) The first company controlled the
second company under Sec. 225.2(e)(1)(i) or (ii) of this part at any
time during the prior
[[Page 12425]]
two years and the first company controls 15 percent or more of the
outstanding securities of any class of voting securities of the second
company.
(2) Notwithstanding paragraph (i)(1) of this section, a first
company will not be presumed to control a second company under this
paragraph if 50 percent or more of the outstanding securities of each
class of voting securities of the second company is controlled by a
person that is not a senior management official or director of the
first company, or by a company that is not an affiliate of the first
company.
(j) Securities held in a fiduciary capacity. For purposes of the
presumptions of control in this section, the first company does not
control securities of the second company that the first company holds
in a fiduciary capacity, except that if the second company is a
depository institution or a depository institution holding company,
this paragraph (j) only applies to securities held in a fiduciary
capacity without sole discretionary authority to exercise the voting
rights of the securities.
Sec. 225.33 Rebuttable presumption of noncontrol of a company.
(a) In any proceeding under Sec. 225.31(b) or (c) of this part, a
first company is presumed not to control a second company if:
(1) The first company controls less than 10 percent of the
outstanding securities of each class of voting securities of the second
company; and
(2) The first company is not presumed to control the second company
under Sec. 225.32 of this part.
(b) In any proceeding under this subpart, or judicial proceeding
under the Bank Holding Company Act, other than a proceeding in which
the Board has made a preliminary determination that a first company has
the power to exercise a controlling influence over the management or
policies of a second company, a first company may not be held to have
had control over a second company at any given time, unless the first
company, at the time in question, controlled 5 percent or more of the
outstanding securities of any class of voting securities of the second
company, or had already been found to have control on the basis of the
existence of a controlling influence relationship.
Sec. 225.34 Total equity.
(a) General. For purposes of this subpart, the total equity
controlled by a first company in a second company that is organized as
a stock corporation and prepares financial statements pursuant to U.S.
generally accepted accounting principles will be calculated as
described in paragraph (b) of this section. With respect to a second
company that is not organized as a stock corporation or that does not
prepare financial statements pursuant to U.S. generally accepted
accounting principles, the first company's total equity in the second
company will be calculated so as to be reasonably consistent with the
methodology described in paragraph (b) of this section, while taking
into account the legal form of the second company and the accounting
system used by the second company to prepare financial statements.
(b) Calculation of total equity--(1) Total equity. The first
company's total equity in the second company, expressed as a
percentage, is equal to:
(i) The sum of Investor Common Equity and, for each class of
preferred stock issued by the second company, Investor Preferred
Equity, divided by
(ii) Issuer Shareholders' Equity.
(2) Investor Common Equity equals the greater of:
(i) Zero, and
(ii) The quotient of the number of shares of common stock of the
second company that are controlled by the first company divided by the
total number of shares of common stock of the second company that are
issued and outstanding, multiplied by the amount of shareholders'
equity of the second company not allocated to preferred stock under
U.S. generally accepted accounting principles.\1\
---------------------------------------------------------------------------
\1\ If the second company has multiple classes of common stock
outstanding and different classes of common stock have different
economic interests in the second company on a per share basis, the
number of shares of common stock must be adjusted for purposes of
this calculation so that each share of common stock has the same
economic interest in the second company.
---------------------------------------------------------------------------
(3) Investor Preferred Equity equals, for each class of preferred
stock issued by the second company, the greater of:
(i) Zero, and
(ii) The quotient of the number of shares of the class of preferred
stock of the second company that are controlled by the first company
divided by the total number of shares of the class of preferred stock
that are issued and outstanding, multiplied by the amount of
shareholders' equity of the second company allocated to the class of
preferred stock under U.S. generally accepted accounting principles.\2\
---------------------------------------------------------------------------
\2\ If there are different classes of preferred stock with equal
seniority (i.e., pari passu classes of preferred stock), the pari
passu shares are treated as a single class. If pari passu classes of
preferred stock have different economic interests in the second
company on a per share basis, the number of shares of preferred
stock must be adjusted for purposes of this calculation so that each
pari passu share of preferred stock has the same economic interest
in the second company.
---------------------------------------------------------------------------
(c) Consideration of debt instruments and other interests in total
equity. (1) For purposes of the total equity calculation in paragraph
(b) of this section, a debt instrument or other interest issued by the
second company that is controlled by the first company may be treated
as an equity instrument if that debt instrument or other interest is
functionally equivalent to equity.
(2) For purposes of paragraph (b)(1) of this section, the principal
amount of all debt instruments and the market value of all other
interests that are functionally equivalent to equity that are
controlled by the first company are added to the sum under paragraph
(b)(1)(i) of this section, and the principal amount of all debt
instruments and the market value of all other interests that are
functionally equivalent to equity that are outstanding are added to
Issuer Shareholders' Equity.
(3) For purposes of paragraph (c)(1) of this section, a debt
instrument issued by the second company may be considered functionally
equivalent to equity if it has equity-like characteristics, such as:
(i) Extremely long-dated maturity;
(ii) Subordination to other debt instruments issued by the second
company;
(ii) Qualification as regulatory capital under any regulatory
capital rules applicable to the second company;
(iii) Qualification as equity under applicable tax law;
(iv) Qualification as equity under U.S. generally accepted
accounting principles or other applicable accounting standards;
(v) Inadequacy of the equity capital underlying the debt at the
time of the issuance of the debt; or
(vi) Issuance not on market terms.
(4) For purposes of paragraph (c)(1) of this section, an interest
that is not a debt instrument issued by the second company may be
considered functionally equivalent to equity if it has equity-like
characteristics, such as entitling its owner to a share of the profits
of the second company.
(d) Exclusion of certain equity instruments from total equity. (1)
For purposes of the total equity calculation in paragraph (b) of this
section, an equity instrument issued by the second company that is
controlled by the first company may be treated as not an equity
instrument if the equity instrument is functionally equivalent to debt.
[[Page 12426]]
(2) For purposes of paragraph (d)(1) of this section, an equity
instrument issued by the second company may be considered functionally
equivalent to debt if it has debt-like characteristics, such as
protections generally provided to creditors, a limited term, a fixed
rate of return or a variable rate of return linked to a reference
interest rate, classification as debt for tax purposes, or
classification as debt for accounting purposes.
(e) Frequency of total equity calculation. The total equity of a
first company in a second company is calculated each time the first
company acquires control over equity instruments of the second company,
including any debt instruments or other interests that are functionally
equivalent to equity in accordance with paragraph (c) of this section.
PART 238--SAVINGS AND LOAN HOLDING COMPANIES (REGULATION LL)
0
5. The authority citation for part 238 continues to read as follows:
Authority: 5 U.S.C. 552, 559; 12 U.S.C. 1462, 1462a, 1463,
1464, 1467, 1467a, 1468, 1813, 1817, 1829e, 1831i, 1972; 15 U.S.C.
78l.
Subpart A--General Provisions
0
6. Amend Sec. 238.2 by revising paragraphs (e), (r)(2), and (tt) to
read as follows:
Sec. 238.2 Definitions.
* * * * *
(e) A person shall be deemed to have control of:
(1) A savings association if the person directly or indirectly or
acting in concert with one or more other persons, or through one or
more subsidiaries, owns, controls, or holds with power to vote, or
holds proxies representing, more than 25 percent of the voting shares
of such savings association, or controls in any manner the election of
a majority of the directors of such association;
(2) Any other company if the person directly or indirectly or
acting in concert with one or more other persons, or through one or
more subsidiaries, owns, controls, or holds with power to vote, or
holds proxies representing, more than 25 percent of the voting shares
or rights of such other company, or controls in any manner the election
or appointment of a majority of the directors or trustees of such other
company, or is a general partner in or has contributed more than 25
percent of the capital of such other company;
(3) A trust if the person is a trustee thereof;
(4) A company if the Board determines, after reasonable notice and
opportunity for hearing, that such person directly or indirectly
exercises a controlling influence over the management or policies of
such association or other company; or
(5) Voting securities or assets owned, controlled, or held,
directly or indirectly:
(i) By the company, or by any subsidiary of the company;
(ii) That the company has power to vote or to dispose of;
(iii) In a fiduciary capacity for the benefit of the company or any
of its subsidiaries;
(iv) In a fiduciary capacity (including by pension and profit-
sharing trusts) for the benefit of the shareholders, members, or
employees (or individuals serving in similar capacities) of the company
or any of its subsidiaries; or
(v) According to the standards under Sec. 238.9 of this part.
* * * * *
(r) * * *
(2) Nonvoting securities. Common shares, preferred shares, limited
partnership interests, limited liability company interests, or similar
interests are not voting securities if:
(i) Any voting rights associated with the securities are limited
solely to the type customarily provided by statute with regard to
matters that would significantly and adversely affect the rights or
preference of the security, such as the issuance of additional amounts
or classes of senior securities, the modification of the terms of the
security, the dissolution of the issuing company, or the payment of
dividends by the issuing company when preferred dividends are in
arrears;
(ii) The securities represent an essentially passive investment or
financing device and do not otherwise provide the holder with control
over the issuing company; and
(iii) The securities do not entitle the holder, by statute,
charter, or in any manner, to select or to vote for the selection of
directors, trustees, or partners (or persons exercising similar
functions) of the issuing company; except that limited partnership
interests or membership interests in limited liability companies are
not voting securities due to voting rights that are limited solely to
voting for the removal of a general partner or managing member (or
persons exercising similar functions at the company) for cause, to
replace a general partner or managing member (or persons exercising
similar functions at the company) due to incapacitation or following
the removal of such person, or to continue or dissolve the company
after removal of the general partner or managing member (or persons
exercising similar functions at the company).
* * * * *
(tt) Voting percentage. For purposes of this part, the percentage
of a class of a company's voting securities controlled by a person is
the greater of:
(1) The quotient, expressed as a percentage, of the number of
shares of the class of voting securities controlled by the person,
divided by the number of shares of the class of voting securities that
are issued and outstanding, both as adjusted by Sec. 238.9 of this
part; and
(2) The quotient, expressed as a percentage, of the number of votes
that may be cast by the person on the voting securities controlled by
the person, divided by the total votes that are legally entitled to be
cast by the issued and outstanding shares of the class of voting
securities, both as adjusted by Sec. 238.9 of this part.
0
7. Section 238.8 is amended by revising the section heading and adding
paragraphs (b) and (c) to read as follows:
Sec. 238.8 Safe and sound operations, and Small Bank Holding Company
Policy Statement.
* * * * *
(b) The Board's Small Bank Holding Company Policy Statement (12 CFR
part 225, appendix C) (Policy Statement) applies to savings and loan
holding companies as if they were bank holding companies. To qualify or
rely on the Policy Statement, savings and loan holding companies must
meet all qualifying requirements in the Policy Statement as if they
were a bank holding company. For purposes of applying the Policy
Statement, the term ``nonbank subsidiary'' as used in the Policy
Statement refers to a subsidiary of a savings and loan holding company
other than a savings association or a subsidiary of a savings
association.
(c) The Board may exclude any savings and loan holding company,
regardless of asset size, from the Policy Statement under paragraph (b)
of this section if the Board determines that such action is warranted
for supervisory purposes.
0
8. Section 238.9 is revised to read as follows:
Sec. 238.9 Control over securities.
(a) Contingent rights, convertible securities, options, and
warrants. (1) A person that controls a security, option, warrant, or
other financial instrument that is convertible into, exercisable for,
exchangeable for, or otherwise may
[[Page 12427]]
become a security controls each security that could be acquired as a
result of such conversion, exercise, exchange, or similar occurrence.
(2) If a financial instrument of the type described in paragraph
(a)(1) of this section is convertible into, exercisable for,
exchangeable for, or otherwise may become a number of securities that
varies according to a formula, rate, or other variable metric, the
number of securities controlled under paragraph (a)(1) of this section
is the maximum number of securities that the financial instrument could
be converted into, be exercised for, be exchanged for, or otherwise
become under the formula, rate, or other variable metric.
(3) Notwithstanding paragraph (a)(1) of this section, a person does
not control voting securities due to controlling a financial instrument
if the financial instrument:
(i) By its terms is not convertible into, is not exercisable for,
is not exchangeable for, and may not otherwise become voting securities
in the hands of the person or an affiliate of the person; and
(ii) By its terms is only convertible into, exercisable for,
exchangeable for, or may otherwise become voting securities in the
hands of a transferee after a transfer:
(A) In a widespread public distribution;
(B) To the issuing company;
(C) In transfers in which no transferee (or group of associated
transferees) would receive 2 percent or more of the outstanding
securities of any class of voting securities of the issuing company; or
(D) To a transferee that would control more than 50 percent of
every class of voting securities of the issuing company without any
transfer from the person.
(4) Notwithstanding paragraph (a)(1) of this section, a person that
has agreed to acquire securities or other financial instruments
pursuant to a securities purchase agreement does not control such
securities or financial instruments until the person acquires the
securities or financial instruments.
(5) Notwithstanding paragraph (a)(1) of this section, a right that
provides a person the ability to acquire securities in future issuances
or to convert nonvoting securities into voting securities does not
cause the person to control the securities that could be acquired under
the right, so long as the right does not allow the person to acquire a
higher percentage of the class of securities than the person controlled
immediately prior to the future acquisition.
(6) Notwithstanding paragraph (a)(1) of this section, a preferred
security that would be a nonvoting security but for a right to vote on
directors that activates only after six or more quarters of unpaid
dividends is not considered to be a voting security until the security
holder is entitled to exercise the voting right.
(7) For purposes of determining the percentage of a class of voting
securities of a company controlled by a person that controls a
financial instrument of the type described in paragraph (a)(1) of this
section:
(i) The securities controlled by the person under paragraphs (a)(1)
through (6) of this section are deemed to be issued and outstanding;
and
(ii) Any securities controlled by anyone other than the person
under paragraphs (a)(1) through (6) of this section are not deemed to
be issued and outstanding, unless by the terms of the financial
instruments the securities controlled by the other persons must be
issued and outstanding in order for the securities of the person to be
issued and outstanding.
(b) Restriction on securities. A person that enters into an
agreement or understanding with a second person under which the rights
of the second person are restricted in any manner with respect to
securities that are controlled by the second person, controls the
securities of the second person, unless the restriction is:
(1) A requirement that the second person offer the securities for
sale to the first person for a reasonable period of time prior to
transferring the securities to a third party;
(2) A requirement that, if the second person agrees to sell the
securities, the second person provide the first person with the
opportunity to participate in the sale of the securities by the second
person;
(3) A requirement under which the second person agrees to sell its
securities to a third party if a majority of security holders agrees to
sell their securities to the third party;
(4) Incident to a bona fide loan transaction in which the
securities serve as collateral;
(5) A short-term and revocable proxy;
(6) A restriction on transferability that continues only for a
reasonable amount of time necessary to complete an acquisition by the
first person of the securities from the second person, including the
time necessary to obtain required approval from an appropriate
government authority with respect to the acquisition;
(7) A requirement that the second person vote the securities in
favor of a specific acquisition of control of the issuing company, or
against competing transactions, if the restriction continues only for a
reasonable amount of time necessary to complete the transaction,
including the time necessary to obtain required approval from an
appropriate government authority with respect to an acquisition or
merger; or
(8) An agreement among security holders of the issuing company
intended to preserve the tax status or tax benefits of the company,
such as qualification of the issuing company as a Subchapter S
corporation, as defined in 26 U.S.C. 1361(a)(1) or any successor
statute, or prevention of events that could impair deferred tax assets,
such as net operating loss carryforwards, as described in 26 U.S.C. 382
or any successor statute.
(c) Securities held by senior management officials or controlling
equity holders of a company. A company that controls 5 percent or more
of any class of voting securities of another company controls all
securities issued by the second company that are controlled by senior
management officials, directors, or controlling shareholders of the
first company, or by immediate family members of such persons, unless
the first company controls less than 15 percent of each class of voting
securities of the second company and the senior management officials,
directors, and controlling shareholders of the first company, and
immediate family members of such persons, control 50 percent or more of
each class of voting securities of the second company.
(d) Reservation of authority. Notwithstanding paragraphs (a)
through (c) of this section, the Board may determine that securities
are or are not controlled by a company based on the facts and
circumstances presented.
0
9. Subpart C is revised to read as follows:
Subpart C--Control Proceedings
Sec.
238.21 Control proceedings.
238.22 Rebuttable presumptions of control of a company.
238.23 Rebuttable presumption of noncontrol of a company.
Subpart C--Control Proceedings
Sec. 238.21 Control proceedings.
(a) Preliminary determination of control. (1) The Board in its sole
discretion may issue a preliminary determination of control under the
procedures set forth in this section in any case in which the Board
determines, based on consideration of the facts and circumstances
presented, that a first company has the power to exercise a
[[Page 12428]]
controlling influence over the management or policies of a second
company.
(2) If the Board makes a preliminary determination of control under
this section, the Board shall send notice to the first company
containing a statement of the facts upon which the preliminary
determination is based.
(b) Response to preliminary determination of control. (1) Within 30
calendar days after issuance by the Board of a preliminary
determination of control or such longer period permitted by the Board
in its discretion, the first company against whom the preliminary
determination has been made shall:
(i) Consent to the preliminary determination of control and either:
(A) Submit for the Board's approval a specific plan for the prompt
termination of the control relationship; or
(B) File an application or notice under this part, as applicable;
or
(ii) Contest the preliminary determination by filing a response,
setting forth the facts and circumstances in support of its position
that no control exists, and, if desired, requesting a hearing or other
proceeding.
(2) If the first company fails to respond to the preliminary
determination of control within 30 days or such longer period permitted
by the Board in its discretion, the first company will be deemed to
have waived its right to present additional information to the Board or
to request a hearing or other proceeding regarding the preliminary
determination of control.
(c) Hearing and final determination. (1) The Board shall order a
hearing or other appropriate proceeding upon the petition of a first
company that contests a preliminary determination of control if the
Board finds that material facts are in dispute. The Board may, in its
discretion, order a hearing or other appropriate proceeding without a
petition for such a proceeding by the first company.
(2) At a hearing or other proceeding, any applicable presumptions
established under this subpart shall be considered in accordance with
the Federal Rules of Evidence and the Board's Rules of Practice for
Formal Hearings (12 CFR part 263).
(3) After considering the submissions of the first company and
other evidence, including the record of any hearing or other
proceeding, the Board will issue a final order determining whether the
first company has the power to exercise a controlling influence over
the management or policies of the second company. If a controlling
influence is found, the Board may direct the first company to terminate
the control relationship or to file an application or notice for the
Board's approval to retain the control relationship.
(d) Submission of evidence. (1) In connection with contesting a
preliminary determination of control under paragraph (b)(1)(ii) of this
section, a first company may submit to the Board evidence or any other
relevant information related to its control of a second company.
(2) Evidence or other relevant information submitted to the Board
pursuant to paragraph (d)(1) of this section must be in writing and may
include a description of all current and proposed relationships between
the first company and the second company, including relationships of
the type that are identified under any of the rebuttable presumptions
in Sec. Sec. 238.22 and 238.23 of this part, copies of any formal
agreements related to such relationships, and a discussion regarding
why the Board should not determine the first company to control the
second company.
(e) Definitions. For purposes of this subpart:
(1) Board of directors means the board of directors of a company or
a set of individuals exercising similar functions at a company.
(2) Director representative means any individual that represents
the interests of a first company through service on the board of
directors of a second company. For purposes of this paragraph (e)(2),
examples of persons who are directors of a second company and generally
would be considered director representatives of a first company
include:
(i) A current officer, employee, or director of the first company;
(ii) An individual who was an officer, employee, or director of the
first company within the prior two years; and
(iii) An individual who was nominated or proposed to be a director
of the second company by the first company.
(iv) A director representative does not include a nonvoting
observer.
(3) First company means the company whose potential control of a
second company is the subject of determination by the Board under this
subpart.
(4) Investment adviser means a company that:
(i) Is registered as an investment adviser with the Securities and
Exchange Commission under the Investment Advisers Act of 1940 (15
U.S.C. 80b-1 et seq.);
(ii) Is registered as a commodity trading advisor with the
Commodity Futures Trading Commission under the Commodity Exchange Act
(7 U.S.C. 1 et seq.);
(iii) Is a foreign equivalent of an investment adviser or commodity
trading advisor, as described in paragraph (e)(4)(i) or (ii) of this
section; or
(iv) Engages in any of the activities set forth in 12 CFR
225.28(b)(6)(i) through (iv).
(5) Limiting contractual right means a contractual right of the
first company that would allow the first company to restrict
significantly, directly or indirectly, the discretion of the second
company, including its senior management officials and directors, over
operational and policy decisions of the second company.
(i) Examples of limiting contractual rights may include, but are
not limited to, a right that allows the first company to restrict or to
exert significant influence over decisions related to:
(A) Activities in which the second company may engage, including a
prohibition on entering into new lines of business, making substantial
changes to or discontinuing existing lines of business, or entering
into a contractual arrangement with a third party that imposes
significant financial obligations on the second company;
(B) How the second company directs the proceeds of the first
company's investment;
(C) Hiring, firing, or compensating one or more senior management
officials of the second company, or modifying the second company's
policies or budget concerning the salary, compensation, employment, or
benefits plan for its employees;
(D) The second company's ability to merge or consolidate, or its
ability to acquire, sell, lease, transfer, spin-off, recapitalize,
liquidate, dissolve, or dispose of subsidiaries or assets;
(E) The second company's ability to make investments or
expenditures;
(F) The second company achieving or maintaining a financial target
or limit, including, for example, a debt-to-equity ratio, a fixed
charges ratio, a net worth requirement, a liquidity target, a working
capital target, or a classified assets or nonperforming loans limit;
(G) The second company's payment of dividends on any class of
securities, redemption of senior instruments, or voluntary prepayment
of indebtedness;
(H) The second company's ability to authorize or issue additional
junior equity or debt securities, or amend the terms of any equity or
debt securities issued by the second company;
(I) The second company's ability to engage in a public offering or
to list or
[[Page 12429]]
de-list securities on an exchange, other than a right that allows the
securities of the first company to have the same status as other
securities of the same class;
(J) The second company's ability to amend its articles of
incorporation or by-laws, other than in a way that is solely defensive
for the first company;
(K) The removal or selection of any independent accountant,
auditor, investment adviser, or investment banker employed by the
second company; or
(L) The second company's ability to significantly alter accounting
methods and policies, or its regulatory, tax, or liability status
(e.g., converting from a stock corporation to a limited liability
company); and
(ii) A limiting contractual right does not include a contractual
right that would not allow the first company to significantly restrict,
directly or indirectly, the discretion of the second company over
operational and policy decisions of the second company. Examples of
contractual rights that are not limiting contractual rights may
include:
(A) A right that allows the first company to restrict or to exert
significant influence over decisions relating to the second company's
ability to issue securities senior to securities owned by the first
company;
(B) A requirement that the first company receive financial reports
or other information of the type ordinarily available to common
stockholders;
(C) A requirement that the second company maintain its corporate
existence;
(D) A requirement that the second company consult with the first
company on a reasonable periodic basis;
(E) A requirement that the second company provide notices of the
occurrence of material events affecting the second company;
(F) A requirement that the second company comply with applicable
statutory and regulatory requirements;
(G) A market standard requirement that the first company receive
similar contractual rights as those held by other investors in the
second company;
(H) A requirement that the first company be able to purchase
additional securities issued by the second company in order to maintain
the first company's percentage ownership in the second company;
(I) A requirement that the second company ensure that any security
holder who intends to sell its securities of the second company provide
other security holders of the second company or the second company
itself the opportunity to purchase the securities before the securities
can be sold to a third party; or
(J) A requirement that the second company take reasonable steps to
ensure the preservation of tax status or tax benefits, such as status
of the second company as a Subchapter S corporation or the protection
of the value of net operating loss carry-forwards.
(6) Second company means the company whose potential control by a
first company is the subject of determination by the Board under this
subpart.
(7) Senior management official means any person who participates or
has the authority to participate (other than in the capacity as a
director) in major policymaking functions of a company.
(f) Reservation of authority. Nothing in this subpart shall limit
the authority of the Board to take any supervisory or enforcement
action otherwise permitted by law, including an action to address
unsafe or unsound practices or conditions, or violations of law.
Sec. 238.22 Rebuttable presumptions of control of a company.
(a) General. (1) In any proceeding under Sec. 238.21(b) or (c) of
this part, a first company is presumed to control a second company in
the situations described in paragraphs (b) through (h) of this section.
The Board also may find that a first company controls a second company
based on other facts and circumstances.
(2) For purposes of the presumptions in this section, any company
that is a subsidiary of the first company and also a subsidiary of the
second company is considered to be a subsidiary of the first company
and not a subsidiary of the second company.
(b) Management contract or similar agreement. The first company
enters into any agreement, understanding, or management contract (other
than to serve as investment adviser) with the second company, under
which the first company directs or exercises significant influence or
discretion over the general management, overall operations, or core
business or policy decisions of the second company. Examples of such
agreements include where the first company is a managing member,
trustee, or general partner of the second company, or exercises similar
powers and functions.
(c) Ownership or control of 5 percent or more of voting securities.
The first company controls 5 percent or more of the outstanding
securities of any class of voting securities of the second company,
and:
(1)(i) Director representatives of the first company or any of its
subsidiaries comprise 25 percent or more of the board of directors of
the second company or any of its subsidiaries; or
(ii) Director representatives of the first company or any of its
subsidiaries are able to make or block the making of major operational
or policy decisions of the second company or any of its subsidiaries;
(2) Two or more employees or directors of the first company or any
of its subsidiaries serve as senior management officials of the second
company or any of its subsidiaries;
(3) An employee or director of the first company or any of its
subsidiaries serves as the chief executive officer, or serves in a
similar capacity, of the second company or any of its subsidiaries;
(4) The first company or any of its subsidiaries enters into
transactions or has business relationships with the second company or
any of its subsidiaries that generate in the aggregate 10 percent or
more of the total annual revenues or expenses of the second company,
each on a consolidated basis; or
(5) The first company or any of its subsidiaries has any limiting
contractual right with respect to the second company or any of its
subsidiaries, unless such limiting contractual right is part of an
agreement to merge with or make a controlling investment in the second
company that is reasonably expected to close within one year and such
limiting contractual right is designed to ensure that the second
company continues to operate in the ordinary course until the merger or
investment is consummated or such limiting contractual right requires
the second company to take an action necessary for the merger or
investment to be consummated.
(d) Ownership or control of 10 percent or more of voting
securities. The first company controls 10 percent or more of the
outstanding securities of any class of voting securities of the second
company, and:
(1) The first company or any of its subsidiaries propose a number
of director representatives to the board of directors of the second
company or any of its subsidiaries in opposition to nominees proposed
by the management or board of directors of the second company or any of
its subsidiaries that, together with any director representatives of
the first company or any of its subsidiaries on the board of directors
of the second company or any of its subsidiaries, would comprise 25
percent or more of the board of directors
[[Page 12430]]
of the second company or any of its subsidiaries;
(2) Director representatives of the first company and its
subsidiaries comprise more than 25 percent of any committee of the
board of directors of the second company or any of its subsidiaries
that can take action that binds the second company or any of its
subsidiaries; or
(3) The first company or any of its subsidiaries enters into
transactions or has business relationships with the second company or
any of its subsidiaries that:
(i) Are not on market terms; or
(ii) Generate in the aggregate 5 percent or more of the total
annual revenues or expenses of the second company, each on a
consolidated basis.
(e) Ownership or control of 15 percent or more of voting
securities. The first company controls 15 percent or more of the
outstanding securities of any class of voting securities of the second
company, and:
(1) A director representative of the first company or of any of its
subsidiaries serves as the chair of the board of directors of the
second company or any of its subsidiaries;
(2) One or more employees or directors of the first company or any
of its subsidiaries serves as a senior management official of the
second company or any of its subsidiaries; or
(3) The first company or any of its subsidiaries enters into
transactions or has business relationships with the second company or
any of its subsidiaries that generate in the aggregate 2 percent or
more of the total annual revenues or expenses of the second company,
each on a consolidated basis.
(f) Accounting consolidation. The first company consolidates the
second company on its financial statements prepared under U.S.
generally accepted accounting principles.
(g) Control of an investment fund. (1) The first company serves as
an investment adviser to the second company, the second company is an
investment fund, and the first company, directly or indirectly, or
acting through one or more other persons, controls 5 percent or more of
the outstanding securities of any class of voting securities of the
second company.
(2) The presumption of control in paragraph (g)(1) of this section
does not apply if the first company organized and sponsored the second
company within the preceding 12 months.
(h) Divestiture of control. (1) The first company controlled the
second company under Sec. 238.2(e)(1) or (2) of this part at any time
during the prior two years and the first company controls 15 percent or
more of the outstanding securities of any class of voting securities of
the second company.
(2) Notwithstanding paragraph (h)(1) of this section, a first
company will not be presumed to control a second company under this
paragraph if 50 percent or more of the outstanding securities of each
class of voting securities of the second company is controlled by a
person that is not a senior management official or director of the
first company, or by a company that is not an affiliate of the first
company.
(i) Securities held in a fiduciary capacity. For purposes of the
presumptions of control in this section, the first company does not
control securities of the second company that the first company holds
in a fiduciary capacity, except that if the second company is a
depository institution or a depository institution holding company,
this paragraph (i) only applies to securities held in a fiduciary
capacity without sole discretionary authority to exercise the voting
rights of the securities.
Sec. 238.23 Rebuttable presumption of noncontrol of a company.
(a) In any proceeding under Sec. 238.21(b) or (c) of this part, a
first company is presumed not to control a second company if:
(1) The first company controls less than 10 percent of the
outstanding securities of each class of voting securities of the second
company; and
(2) The first company is not presumed to control the second company
under Sec. 238.22 of this part.
(b) In any proceeding under this subpart, or judicial proceeding
under the Home Owners' Loan Act, other than a proceeding in which the
Board has made a preliminary determination that a first company has the
power to exercise a controlling influence over the management or
policies of a second company, a first company may not be held to have
had control over a second company at any given time, unless the first
company, at the time in question, controlled 5 percent or more of the
outstanding securities of any class of voting securities of the second
company, or had already been found to have control on the basis of the
existence of a controlling influence relationship.
By order of the Board of Governors of the Federal Reserve
System, February 14, 2020.
Ann Misback,
Secretary of the Board.
[FR Doc. 2020-03398 Filed 2-27-20; 8:45 am]
BILLING CODE 6210-01-P