Banking and Finance Law Daily Fed proposes tiered framework for determining control under BHC Act
Tuesday, April 23, 2019

Fed proposes tiered framework for determining control under BHC Act

By Lisa M. Goolik, J.D.

The Federal Reserve Board has issued a proposed rule that would clarify the Fed’s standards for determining "control" under the Bank Holding Company Act and the Home Owners’ Loan Act. The proposed rule introduces tiered presumptions of control and a new presumption of "noncontrol."

At an open meeting of the Federal Reserve Board April 23, 2019, the Fed voted to approve a proposed rule that is intended to clarify the Fed’s standards for determining whether a company has control over another company for purposes of the Bank Holding Company Act and the Home Owners’ Loan Act. The proposed rule would create a new, comprehensive framework for determining control based on ownership and voting control between two companies. Comments on the proposed rule are due 60 days after publication in the Federal Register.

Current standards. Companies that control a bank or savings association are bank holding companies or savings and loan holding companies and subject to the Fed's supervision and regulation. For purposes of the BHC Act, a company has control over another company if the first company: (1) 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; (2) controls in any manner the election of a majority of the directors of the other company; or (3) directly or indirectly exercises a controlling influence over the management or policies of the other company. The definition of control in HOLA is substantially similar.

While the first two criteria involve relatively straightforward, bright-line rules, the third prong involves a fact-based determination regarding whether a company has the ability to exercise a controlling influence over another company. Currently, a wide variety of factors are considered, including the size and structure of the company’s voting and total equity investment, the company’s rights to director representation, any common management, any covenants or other agreements that allow a company to influence or restrict management decisions of the other company, the nature and scope of their business relationship, and any other indicia of the company’s ability to control the other company.

However, as the Fed’s staff noted, the general framework is not provided in a single document and many of the specific standards have not been issued publicly. The proposed rule is intended to bring transparency and consistency to issues of control and clarify when common situations may give rise to control concerns.

Presumption of control. The proposed framework introduces a series of "presumptions of control," where a company would be presumed to be in control of another company if certain conditions are met. The tiered presumptions would be based on a company’s level of voting securities of another company and would be based on three levels of voting ownership: 5 percent, 10 percent, and 15 percent.

In addition to the level of voting ownership, the tiered framework would look at the following factors: the size of a company’s total equity investment; rights to director representation; the use of proxy solicitations; individuals serving as management, employees, and directors at both companies; restrictive rights to influence management or operational decisions; and the scope of business relationships.

The proposal also contains a handful of additional presumptions of control that would differ from the Fed’s past practice. Historically, the Fed generally has applied a stricter standard when evaluating whether a company seeking to divest control over another company has been successful, compared to the standard applied when evaluating a new investment by a company that has not previously been in control. Typically, this has required the divesting company to reduce its voting ownership below 10 percent to effectively divest itself of control. Under the proposal, a company generally would be required to divest to less than 15 percent to no longer control, or to divest to less than 25 percent and allow two years to pass.

Presumption of "noncontrol." The proposal would contain a new presumption of "noncontrol." Under the BHC Act, a company that owns less than 5 percent of the voting securities of another company is presumed not to control the other company. Under the proposal, a new presumption of noncontrol would be established that would apply where a company that owns less than 10 percent of the voting securities of a second company and does not trigger any of the presumptions of control. According to the Fed staff, proposal generally reflects the current practice of the Fed.

Increased transparency. In his opening statement, Fed Chairman Jerome H. Powell said that the proposal is "an important step forward" toward enhancing the Fed's transparency and accountability and clearer control standards will "responsibly reduce regulatory burden." Randal K. Quarles, the Fed’s Vice Chair for Supervision, added that many of the Fed’s current standards are unwritten or written but not well publicized and that they have never gone through "the crucible of a public comment process."

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