In a world of ever-increasing and changing bank regulation and compliance burden, there is yet another regulatory initiative underway. The Federal Reserve is increasing its focus on the “Change in Bank Control” rules. These rules have been around a very long time, but historically were not heavily monitored by the Federal Reserve. This is no longer the case. Although the language of the Change in Control statutes and regulations has not changed, the requirements for compliance are currently in flux, and are growing. Many of the specific compliance requirements are not written down in any statute, regulation or interpretive guidance issued by the Federal Reserve.

Technically, it is shareholders who must comply with the Change in Control rules, not banks and their holding companies. However, the Federal Reserve will provide holding companies with notifications about shareholder violations of the Change in Control Act, and generally appears to expect holding companies to work with their shareholders to become compliant. In addition, holding company and bank management and directors often are members of family groups that are subject to (and often inadvertently violate) the Change in Control rules.

What triggers an obligation to file a Change in Control application with the Federal Reserve?

Under the Change in Control rules, prior approval from the Federal Reserve is generally required before any one person or group of persons “acting in concert” acquires “control” of a bank holding company. There are a few exceptions, discussed below, when shareholders can instead notify the Federal Reserve after the Change in Control has occurred.

Under the regulations, it is presumed that a shareholder and his or her “immediate family” are “acting in concert”. This means the Federal Reserve presumes that immediate family members coordinate and cooperate on how they vote their shares, and vote together as a group. “Immediate family” includes all of the following: a shareholder and his or her father, mother, stepfather, stepmother, brother, sister, stepbrother, stepsister, son, daughter, stepson, stepdaughter, grandparent, grandson, granddaughter, father-in-law, mother-in-law, brother-in-law, sister-in-law, daughter-in-law, the spouse of any of the foregoing, and the person’s spouse.

Included in the list of family members “acting in concert” is any entity or trust which holds shares if the voting of those shares is controlled by any of these family members. Consequently, to determine the number of shares a family group controls, you need to include all shares a family member holds in his or her revocable trust or IRA, for example, if the family member controls how those shares are voted. You will also need to include the shares held by a company if a family member either i) controls how those shares are voted or ii) is a controlling shareholder, partner or management official of the company and also separately holds shares in his or her individual capacity.

Although the Federal Reserve presumes that immediate family members vote their holding company shares in a concerted way, the regulations say that the presumption is “rebuttable”. The regulations provide a process for rebutting the presumption. A family group is allowed to present views to the Federal Reserve in writing or orally stating why the group should not be presumed to vote the shares in a coordinated way. Unfortunately, we have been told that the Federal Reserve has never agreed with arguments trying to rebut the presumption. We recommend that families do not waste time trying to argue that they are not “acting in concert”.

There are various scenarios that trigger a Change in Control filing:

  • If the upcoming acquisition of shares by any member of an “immediate family” as defined above will take the total family ownership above 10% of the outstanding shares of the holding company, and no other person owns, controls or holds the power to vote a greater percentage of the outstanding shares, a filing for prior approval is required.
  • If the upcoming acquisition of shares by one person will take that one person over 10% ownership, and no other person owns, controls or holds the power to vote a greater percentage of the outstanding shares, a filing for prior approval is required. The Federal Reserve notes that if two or more persons, not acting in concert, each propose to acquire simultaneously equal percentages of 10% or more of a class of voting securities, and no other shareholder owns more than that percentage, each person must file for approval.
  • If the upcoming acquisition of shares by one person or a group acting in concert will take the person or the group over 25% ownership, regardless of what anyone else owns, controls or holds, a filing for prior approval is required.

Even if a family group has been approved as a “control group”, if another family member is added to the group (such as a transfer of shares to a new grandchild, which happens often), a new filing is required. Similarly, if a member of the family control group decides to put shares in a revocable trust as part of estate planning (also common), because the trust is a separate legal entity, it is considered a new member of the group and a new filing is required.

Any current member of an approved family control group can acquire more shares without triggering a new filing, unless those shares will take that person individually over 10% (and no other shareholder owns or controls more than that person), or over 25% (regardless of what other shareholders own or control). If the acquisition takes the person over these thresholds, a new filing will be required even if the family group is already approved.

Certain stock acquisitions which result in one of the Change in Control transactions described in the bullets above will require an after the fact notice to the Federal Reserve, which must be filed within 90 days of the transaction:

  • Acquisition of voting securities through inheritance.
  • Acquisition of voting securities through a bona fide gift.
  • Acquisition of voting securities in satisfaction of a debt previously contracted in good faith.

The filing requirements are virtually the same for these after the fact notices. The only meaningful difference is the timing.

A very common filing in the past few years is known as a “clean-up” filing. A “clean-up” filing is not explicitly addressed in the statutes or regulations. It is essentially a mechanism created by the Federal Reserve to “fix” a violation of the Change in Control rules. A clean-up filing is an after the fact Change in Control application (filed once the violation is discovered) requesting that the Federal Reserve grant approval for a shareholder or family group to “retain” its controlling interest in shares. Clean-up filings are common because shareholders typically have no idea these rules exist and often inadvertently violate them. A clean-up filing will be required even when the family has held a controlling interest since the formation of the bank or holding company, if any changes have occurred in the family control group since that time (often the addition of new family members through gifts or inheritance, or of trusts through estate planning).

In the clean-up application, the family group should explicitly acknowledge that they know they are in violation of the Change in Control rules, and state that the violation was inadvertent and not intentional. The family group should also commit to make all family members aware of the Change in Control requirements, and to follow the requirements in the future. To date, we are not aware of any adverse action taken by the Federal Reserve against a family group in connection with a “clean up” filing.

If a filing is required, what are the steps to seek approval?

The Change in Control approval process is lengthy, and requires the compilation and filing of alarge amount of information. What the Federal Reserve requires now is much more detailed and complex than in years past. Here are the components of a Change in Control filing:

Interagency Notice of Change in Bank Control: filed with the Federal Reserve, and contains information about the holding company, the terms of the stock acquisition, the resultant ownership of shares by the shareholder or the control group, and very basic biographical information about the shareholder or control group.

Interagency Biographical and Financial Report (IBFR): filed with the Federal Reserve, and contains extremely detailed information about larger shareholders’ biographical and employment history and current financial holdings (including real estate, investments, debt). Note that shareholders should explicitly request in the filing, and will receive, confidential treatment for this very personal non-public information. The Federal Reserve will require an IBFR from larger shareholders, whether they hold the shares individually or through a trust, IRA or other mechanism. Shareholders should consult with the Federal Reserve in advance to discuss the holdings of the shareholders within the group and get direction about which shareholders need to file the biographical and financial information.

Public notice of the request to become a controlling shareholder or family group, or to retain a controlling ownership (in the case of a clean-up filing), which is published in the newspaper in the community where the holding company’s main office is located. This notice names the shareholder and members of the family group, and where they live (by city and state).

The Federal Reserve will review the filing and invariably request additional information. For certain larger shareholders, they will require fingerprint cards and run background checks. In one recent filing, a bank president’s very elderly mother was required to go to the police station to be fingerprinted, despite protest. Once the Federal Reserve is satisfied with the information provided, and after the 30 day public comment period has expired, the Federal Reserve will provide an approval letter (assuming it is comfortable allowing the shareholder or family group to gain or retain a controlling interest in the holding company). To date, we have not seen the Federal Reserve deny a Change in Control request by any shareholder or family group.

Holding companies may run into problems if shareholders do not want to cooperate. The information requested is very personal, and shareholders often do not want to turn over this information to the government. Some shareholders have gotten very angry in this process, and others have simply refused to cooperate with family members who are trying to file the family’s Change in Control application. The Federal Reserve has taken the position that it has the right to this information under the Change in Control laws, and therefore presumably has the right to sanction non-cooperative shareholders. We have not yet seen the Federal Reserve take any adverse action against a non-cooperating shareholder (although there are cases ongoing that have not yet been resolved). As more and more Change in Control violations by families are identified by the Federal Reserve, we may see more instances of non-compliance by shareholders. This may eventually trigger Federal Reserve action.

Are there any other components of the Change in Control process that are proving difficult with the Federal Reserve?

Trusts. When members of a current or prospective family control group own shares through their estate planning trusts, or if a trust is seeking to hold or holds a controlling interest in a bank holding company, shareholders and bankers should be aware that trusts have become the subject of intense scrutiny during the Change in Control review process. As discussed below, review of larger trust shareholders may also emerge as a component of Federal Reserve merger and acquisition applications at some point in the near future.

In connection with Change in Control filings, the Federal Reserve is now requiring any trust that is part of a family control group which holds at least 2% of the outstanding stock of the holding company to file copies of its trust documents and all amendments. The trust also needs to provide, with specificity, a list of current assets in the trust and the current value of each of those assets. Often, the Federal Reserve will ask for the size of the trust’s holdings of securities of other businesses (for example, “the trust owns 3.5% of the outstanding shares of ABC, Inc.”)

There are specific things that the Federal Reserve evaluates when looking at trust or prospective trust shareholders. They want to know who controls the voting of bank holding company shares held by a trust. Sometimes it is not entirely clear whovotes the shares. If there are two trustees, does the trust allow either to vote? If so, who actually does the voting? Is the consent of both trustees required to vote? Sometimes an independent trustee votes the shares, which means that trustee will be subject to scrutiny if the trust holds a sufficiently large number of shares. This can raise concerns if the independent trustee is, for example, another bank.

The Federal Reserve will also evaluate whether the trust is itself a bank holding company that is subject to registration and all of the other rules governing bank holding companies. The first question they ask is whether the trust is a “company” under the Bank Holding Company Act and Federal Reserve regulations. Here are the operative guidelines about when a trust is a “company”:

  • A business trust is a company. “Business trust” is not defined, and is discussed in more detail below.
  • Any other trust is a company, unless by its terms it terminates either within 25 years, or within 21 years and 10 months after the death of individuals living on the effective date of the trust (commonly known as the “rule against perpetuities” language).

Unless the Federal Reserve determines that a trust is being operated as a business trust or company, a trust is presumed not to be a company if the trust:

  • Terminates within 21 years and 10 months after the death of grantors or beneficiaries of the trust living on the effective date of the trust or within 25 years;
  • Is a testamentary or inter vivos trust established by an individual or individuals for the benefit of natural persons (or trusts for the benefit of natural persons) who are related by blood, marriage or adoption;
  • Contains only assets previously owned by the individual or individuals who established the trust;
  • Is not a Massachusetts business trust; and
  • Does not issue shares, certificates, or any other evidence of ownership.

If a shareholder holds a significant number of shares of a bank holding company, the very safest approach to estate planning from the perspective of avoiding becoming a bank holding company is to structure the trust to qualify for the presumption described above.

One way the Federal Reserve evaluates the activities of the trust to determine if the trust is more than just a passive estate planning vehicle (and therefore may be a “business trust”) is to review the value and nature of the assets in the trust. This is the reason they ask for lists of trust assets. There is an unwritten but important rule that the trust can have no more than 25% of what the Federal Reserve calls “impermissible assets” and 75% of what it calls “permissible assets.” The Federal Reserve has not defined “impermissible” and “permissible” assets, and will not provide a definitive list of what are impermissible and permissible. Generally, the Federal Reserve appears to consider assets related to nonbanking activities that are prohibited to banks and their holding companies to be “impermissible” (such as holding the shareholder’s primary residence or vacation home, or a controlling interest in a privately held small business), and assets related to exempt or permissible nonbanking activities that are permitted for banks and their holding companies to be “permissible” (such as permissible investment securities). The stock of a bank holding company is considered a “permissible asset.”

If the value of the impermissible assets exceeds 25%, the Federal Reserve will direct the trust to take steps to either alter the balance of the assets or, more commonly, to set up a “mirror trust” (i.e. an identical trust) and move the bank holding company stock to the mirror trust so it is the only asset in that trust. We do not know exactly what the Federal Reserve would do if a trust were to refuse to take steps to correct the balance of assets in the trust, as we have never had a trust shareholder refuse to cooperate.

What should bankers do now?

Bankers should evaluate their current holding company shareholder lists, and try to identify large shareholder family control groups. They should reach out to representatives of a family control group to determine whether one or more Change in Control filings should have been made, but were not. They should also let those family representatives know about the requirements for new filings if the composition of the family control group changes (such as by transferring shares to new members, or putting shares into a trust), and can direct shareholders to get legal assistance from a banking attorney when structuring an estate planning trust. These steps can help avoid inadvertent violations.

These violations and the requirement to do a clean-up filing are generally coming up these days in the context of Federal Reserve applications for a merger or an acquisition of another bank or holdingcompany. The Federal Reserve evaluates the ownership of the holding company. It tries to determine if the proposed transaction itself will trigger a Change in Control, and also whether historic Change in Control violations have taken place in the past. So far, the Federal Reserve has allowed transactions to proceed even if there has been a violation, but requires a clean-up filing promptly after the transaction has closed. Holding companies will often connect representatives of the shareholder family group with banking counsel to assist with this complicated and frustrating process.

Why this regulatory focus?

This is a question bankers and shareholders often ask. We have not yet received meaningful answers. We have been told that this focus on Change in Control and trusts has come down from the Federal Reserve Board in Washington, but that is all we know. At this point, we can only speculate about the reasons.

Spira is an Attorney with Boardman & Clark LLP, a WBA Gold Associate Member.