Federal Reserve Goes After Anti-Takeover and Shareholder Protection Tools
The U.S. Federal Reserve Board (FRB) has become sensitized to safety and soundness concerns relating to shareholder protection arrangements. These arrangements are generally designed to protect existing shareholders of bank and savings and loan holding companies in the event of future capital raises by the holding company.
In a recent supervisory release (SR 15-15), the FRB noted that such arrangements may: negatively impact a holding company’s capital or financial position; limit its financial flexibility and capital raising capacity; or otherwise impair its ability to raise additional capital. In short, if these arrangements impede the ability of a holding company to serve as a source of strength to its insured depository subsidiaries as now required by Dodd-Frank, the FRB would view the arrangements as unsafe and unsound.
What Shareholder Protection Arrangements May Raise Issues?
Examples of shareholder protection arrangements that the FRB indicates may raise supervisory issues include:
- “Down-round” provisions designed to protect existing shareholders, whereby the holding company makes cash payments to such shareholders, which reflect the difference between the prices paid by new investors in the event a holding company’s stock price declines in a subsequent effort to raise capital or to sell the holding company.
- “Poison pills” that defend against contested acquisitions by increasing the ownership interest of shareholders other than a buyer of a significant block of shares, thereby diluting the interests of the buyer. Poison pill structures have also been applied in the context of tax benefit preservation plans, which, in general terms, are designed to preserve net operating losses within the requirements of section 382 of the Internal Revenue Code.
- Agreements by a holding company to provide an investor with additional shares of stock for minimal or no additional cost, in the event that the holding company subsequently issues shares at a price below that paid by the investor.
- Provisions that grant a contractual right to investors with less-than-majority control to restrict or prevent the holding company from issuing additional shares.
- Authority provided to the board of directors to: nullify share purchases under certain circumstances; require the holding company to repurchase the shares of the company from a new owner of the shares; or take other actions that would significantly inhibit secondary market transactions in the shares of the holding company.
The FRB sees these arrangements as having the potential to impose additional financial obligations on a holding company, or restricting in some way the primary or secondary market for the holding company’s shares. According to the FRB, these arrangements often protect the value of the initial investment made by a particular subset of shareholders rather than the viability of the issuing holding company, or, in other ways, provide current shareholders with an advantage over future, similarly situated investors.
Shareholder protection arrangements might also impact an instrument’s regulatory capital treatment if the instrument has characteristics or terms that diminish its ability to absorb losses, or otherwise presents safety-and-soundness concerns. Therefore, certain shareholder protection provisions may preclude Tier 1 capital treatment when instruments contain limits or disincentives to future capital issuances, compensate existing investors if new instruments are issued at a lower price, create incentives to redeem, or interfere with the full discretion of the issuer to cancel dividend payments except under limited circumstances.
What does all this mean? For one thing, institutions are now on notice that the FRB may object to a shareholder protection arrangement based on facts and circumstances and the features of the particular arrangement. The FRB has instructed staff to review such arrangements should they become aware of the arrangements in the context of a proposed capital raise or during the course of normal supervisory activity (e.g., during discussions with holding company management or in the conduct of an examination). While this is an area that will clearly be fleshed out over the coming years, holding companies would be well advised to review any existing shareholder protection arrangements to determine whether they raise any of the concerns expressed in SR 15-15 and, if so, consider what corrective actions and/or discussions with the regulators might be appropriate.
A more in-depth analysis of this and other bank control and holding company issues will be provided in our new book that will be published in June: “The Bank Investor’s Survival Guide: A Guide for Private Equity, Hedge Fund, Mutual Fund and Activist Investors to Navigate U.S. Federal Bank Investment Rules.”