You look different. Have you changed something? We’re not talking about your hair color or those new wrinkles at the corners of your eyes. Those are laugh lines and nothing to be ashamed of. What on earth are we hinting at? Well, we’re trying to help you look at yourself through regulatory eyes.
When it comes to changes, specifically in the realm of ownership interest (and the control exerted through that interest), regulators have an interest in knowing exactly where things stand with your bank or bank holding company. It might seem like a pretty cut and dried situation, but it is ridiculously easy for ownership changes to occur without so much as a flicker on your radar. These changes could have just taken place, or unwittingly taken place a decade ago. Here’s a sample of how such changes occur in your shareholder group:
• Gifting of shares to a relative
• Transfer of shares through inheritance
• Creation of a trust or partnership to hold shares
• Transfer of shares in satisfaction of a debt previously contracted in good faith
If any of the above situations have occurred within your shareholder group, then the next question is this: Did you submit a Change in Control filing? If not, your institution could well be in violation of the Change in Bank Control Act (CIBCA). If you’re not sure, it’s worth looking into and confirming, one way or another.
We bring this up, because at DD&F, we have observed a recent emphasis by federal bank regulators on zeroing in on change in control. In fact, based on our experience, we estimate anywhere from 25% – 35% of banks/BHCs are in violation of the CIBCA simply because ownership (aka “control”) of the institution has not been properly reported to its regulators.
The control of an institution, regularly involving family control groups, often changes over time and can trigger a change in control requiring a Notice of Change in Control to be filed with the institution’s federal bank regulators. What happens if you don’t bother with this step? Being in violation of the CIBCA can have significant consequences, including disruption to M&A or other Change in Control transactions.
To shed more light on Change in Control and the potential impact this important regulatory matter could have on your institution and its shareholders, we have put together the following summary.
Understanding Change in Control
As one regulator put it, “The rules and regulations regarding bank control take 10 minutes to read and a lifetime to understand.” At DD&F, we’ve spent the past 30 years working with all types of financial institutions and banking regulators, and studying the regulations themselves, and we feel like we’re well on our way to making sense of bank control regulations. There’s nothing we’d like more than to help our clients gain the same understanding.
Our particular focus here is to discuss circumstances in which an individual’s investment in a bank or bank holding company (BHC) triggers a control analysis under the Change in Bank Control Act. The term “individual” here includes natural persons, companies, trusts, partnerships, or any other entity.
In contrast, investments in a bank or BHC by a banking or non-banking organization may trigger a control analysis under the Bank Holding Company Act, rather than the Change in Bank Control Act.
When is a Change in Control filing required?
Under the Change in Bank Control Act, prior notice to the Federal Reserve is required when an individual, alone or acting together with others, acquires “control” of a state member bank, BHC, or savings and loan holding company.
The standards of what constitutes “control” under U.S. banking laws are complex, and the complexity of a control determination is compounded by the fact that there are several, often overlapping, definitions and guidelines relating to control, depending on the nature of the transaction.
In general, control is when an individual or a group acting in concert owns, controls, or holds with power to vote (as in a trustee) 25% or more of any class of a banking entity’s voting securities, or when an individual or group owns, controls, or holds with power to vote 10% or more of any class of voting securities, if no other individual or group controls a greater percentage of any class of voting securities.
Who is Impacted?
DD&F has observed a recent uptick in the instances where bank or BHC shareholders, particularly those involved in a control group (family members or persons who the regulators presume are acting in concert) – including trusts or partnerships within control groups – found themselves needing to file a Notice of Change in Control with their regulators, be it the Federal Reserve, FDIC, OCC, or their respective State Bank Department. The Federal Reserve, which has authority over BHC’s and member banks, has more stringent control rules than other regulatory agencies, particularly when it comes to family control groups.
The general definitions of control, defined above, serve as guidelines for when ownership interest changes trigger a filing requirement, but the instances may not be necessarily obvious to shareholders. The implication of legal terminology is crucial. For instance, in a situation where a group of related individuals (“immediate family” as defined by the regulation) together controls 10% or more of the stock of an institution (with no other individual shareholder controlling a larger percentage), this requires a Change in Control filing. It is important to know how “immediate family” is defined and who is considered part of a control group. Perhaps stock ownership was shifted around back in 2011, ahead of estate planning tax changes, without anyone realizing there may have been a need to submit a prior notice to the regulators for a change in control.
A common occurrence is when an existing control group adds a family member, (as a result of stock ownership, whether by purchase, gift, transfer, etc.) who was not previously established as part of the control group through a notice filed with the regulators. Each time a family member of an established control group member gains control of bank or BHC stock, even if it is just by one share, prior notice must be filed with the regulators for the new shareholder to be added to the control group.
Another common misstep of banks/BHCs is the failure to ensure stockholders file a notice of change in control due to a misunderstanding that such a filing, when involving gifts or transfers, is exempt. The regulations on prior notice exemptions for bank stock gifts or transfers through inheritance are narrow and are still subject to the acquiring person notifying the regulators within 90 days after the acquisition.
When bank/BHC stock is placed into a trust and unknowingly violates regulatory guidelines, this is also a change in control issue. Certain federal regulators have limitations on what assets a trust can hold, if that trust controls a certain percentage of a bank/BHC. For instance, if a trust controls 5% or more of a bank/BHC, certain federal regulators will only allow 25% or less of the aggregate assets held by that trust to be impermissible assets for a bank or BHC. As an example, if a trust holds $400,000 worth of BHC stock, which represents 5% or greater ownership of the BHC, and the trust’s only other asset is a personal residence valued at $600,000 (which represents 60% of the trust’s total assets), the residence, considered an impermissible asset, exceeds the 25% limit. In such a scenario there would essentially be three options: 1) the trust either must be approved as a BHC (most shareholders will not want this); 2) the real estate would have to be divested out of the current trust; or 3) a separate, qualified trust would need to be established to hold the bank/BHC stock.
When are the Filings Required?
These are just a few of the numerous scenarios that could trigger a change in control. When it comes to control of an institution, there are many factors to consider, both in the relationship of individuals who own the stock and who/what controls the stock. While prior notice is required before a change in control occurs – typically 60 days advance notice – it is important to understand that if a change in control has already occurred, an after-the-fact notice is still required to be filed with one or more of the institution’s regulators providing notice.
At DD&F, we are aware of recent instances where an applicant bank/BHC was forced to withdraw M&A related applications because there was an existing change in control for which prior notice was never submitted. Regulators may require that a notice for the change in control be filed (even if retroactively) prior to accepting and acting upon proposed M&A or Change in Control filings. Although M&A activity may not be on your bank’s radar at this time, who knows what the future holds?
How do I know where I stand?
Please contact Kyle Shadid at 501-374-2600 or firstname.lastname@example.org with any questions.
Authors: Kyle Shadid, Principal and Ashley Floyd, Senior Consultant