Summary: The Federal Reserve Board has issued a notice of proposed rulemaking proposing revisions to Regulations Y and Regulations LL. The proposal would revise and clarify the standards for determining when a company exercises controlling influence over another company for purposes of the Bank Holding Company Act and the Home Owners' Loan Act.

On April 23, 2019, the Federal Reserve Board ("Fed") issued a notice of proposed rulemaking proposing revisions to Regulations Y and Regulations LL.1 The rulemaking would revise the standards for determining when a company exercises controlling influence over another company for purposes of the Bank Holding Company ("BHC") Act and the Home Owners' Loan Act ("HOLA"). In particular, the rulemaking would codify several presumptions for determining when one company's relationship with another company rises to the level of controlling influence. The stated aim of the Fed's proposal is to provide clearer and more transparent control rules for banks and companies that are considering forming economic relationships with banks.

Control is a critical concept under the BHC Act and HOLA. The application of both statutes often turns on whether a financial institution controls, or is controlled by, another company.2 Under both statutes, an entity controls another entity if the first entity "(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 of the other company; or (iii) directly or indirectly exercises a controlling influence over the management or policies of the other company."3 While the share ownership and director election thresholds are relatively straightforward, the third standard—whether a company "directly or indirectly exercises a controlling influence" over another company—can pose significant challenges for institutions attempting to navigate the control test. The Fed's proposal is intended to clarify that standard.

The Fed's proposal would revise Regulations Y and LL to identify tiered presumptions of control based on seven factors:

  • The size of the first company's voting equity investment in the second company;
  • The size of the first company's total equity investment in the second company;
  • The first company's rights to director representation and committee representation on the board of directors of the second company;
  • The first company's use of proxy solicitations with respect to the second company;
  • Management, employee, or director interlocks between the companies;
  • Covenants or other agreements that allow the first company to influence or restrict management or operational decisions of the second company; and
  • The scope of the business relationships between the companies.

Each of these factors would be assessed in combination with the level of voting share ownership. For example, a company with between 5 and 10% voting shares would be presumed to control a second company if the first company 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. In this circumstance, the control presumption would also be triggered if the first company's representation on the second company's board of directors exceeds 25%. The proposed rulemaking outlines how these tiered presumptions would apply.4

Summary of Tiered Presumptions

Presumption of control triggered if any relationship exceeds the amount:

Although the tiered presumptions are not dispositive, the Fed's proposal states that "the Board generally would not expect to find that a company controls another company unless the first company triggers a presumption of control with respect to the second company."

As the proposal notes, the Fed has used these or similar factors to identify control in the past. What is significant here is the proposal of a prescribed framework for applying these factors to determine a presumption of control. The proposal includes additional provisions intended to reduce uncertainty about the control test. Notably, the rule would add a new presumption of noncontrol where "the first company controls less than 10 percent of every class of voting securities of the second company" and none of the specified factors create a presumption of control under the proposed tiered framework. The proposal also reaffirms that the Fed would continue to make a presumption of control based on the existence of management agreements, a company serving as another company's investment advisor, the consolidation of accounting, or ownership of a first company by management and officers of a second company. The proposal additionally amends Regulation Y and Regulation LL to update various definitions, and provides a serious of technical updates to determinations of how to calculate of equity holdings and the right to vote shares.

This proposal represents a significant development for banks and for companies considering economic relationships with banks. The proposed rulemaking would bring significantly greater certainty to an area previously subject to uncertainty and regulator discretion. In particular, the proposed tiered thresholds should in principle provide institutions with a clearer understanding of how to structure their relationships consistent with their obligations under the BHC Act and HOLA.This would have particular implications for investments by banks in fintech companies, as well as for private equity investments in banking institutions.

Comments on the proposal will likely be due in late June, sixty days after the date the proposal is published in the Federal Register.

WilmerHale will continue to monitor the proposal and related issues.

Footnotes

1. See FEDERAL RESERVE, Federal Reserve Board invites public comment on proposal to simplify and increase the transparency of rules for determining control of a banking organization (April 23, 2019).

2. See 12 U.S.C. § 1841; 12 U.S.C. § 1461.

3. 12 U.S.C. § 1467a(a)(2); § 1841(a)(2); 12 CFR § 225.2(e), 238.2(e).

4. See FEDERAL RESERVE, Appendix, Summary of Tiered Presumptions.

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