I. Introduction

On September 22, 2008, the Board of Governors of the Federal Reserve System (the Board) released a Policy Statement (the New Policy Statement) on non-controlling equity investments in banks and bank holding companies (banking organizations). The New Policy Statement provides additional guidance on the Board's position on equity investments that generally would not be viewed as "control," and therefore would not cause an investor to become a bank holding company subject to restrictions and regulation under the Bank Holding Company Act (the BHC Act). The clarification is a relaxation of the restrictions the Board has traditionally required of minority investments in banking organizations, particularly restrictions on board representation and ownership. As explained below, the Board has clarified in the New Policy Statement that a minority investor may possibly have up to two board representatives and may have up to a one-third equity interest (limited to not more than a 15 percent voting interest under certain circumstances). With the clarifications offered by the New Policy Statement, there is an expectation that new capital will be brought into the banking system at a time when it is greatly needed.

Under the BHC Act, a company controls a banking organization if (i) the company 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 banking organization; (ii) the company controls in any manner the election of a majority of the directors or trustees of the banking organization; or (iii) the Board determines, after notice and opportunity for hearing, that the company directly or indirectly exercises a controlling influence over the management or policies of the banking organization.¹ In 1982, the Board issued the Policy Statement on Nonvoting Equity Investments by Bank Holding Companies (the 1982 Policy Statement)², which, for the first time, outlined the policies that the Board would consider in reviewing whether a minority investment in a banking organization would result in a controlling influence. Although the 1982 Policy Statement focused on issues of particular concern in the 1980s, e.g., regarding interstate transactions, many aspects of the 1982 Policy Statement have broader applicability and have served as the foundation for the Board's review more generally.

Under the 1982 Policy Statement and subsequent Board interpretations, minority investors in banking organizations have taken several steps to avoid acquiring a controlling influence over banking organizations, including:

• Restricting the size of their voting and total equity investment in the banking organization;
• Avoiding covenants that would enable the investor to restrict the ability of the banking organization's management to determine the major policies and operations of the banking organization;
• Not attempting to influence the banking organization's process for making decisions about major policies and operations;
• Limiting director and office interlocks with the banking organization; and
• Limiting business relationships between the investor and the banking organization.

The Board reviewed its interpretations on noncontrolling investments in banking organizations and chose to update its guidance. The Board's new guidance focuses on four areas: (1) director representation; (2) amount of total equity investment; (3) communications between investors and banking organizations; and (4) other indicia of control, including business relationships and covenants.

II. Director Representation

Traditionally, the Board has not permitted a company that acquires between 10 and 24.9 percent of the voting stock of a banking organization to have representation on that organization's board of directors. The principal exception has been when the investor owns less than 15 percent of the voting stock of the banking organization and another person (or group of persons acting together) owns a larger block of voting stock of the banking organization.

With the issuance of the New Policy Statement, the Board has reexamined its position on board membership. The Board's new position appears to be that an investor of up to 24.9 percent of voting stock of a banking organization may have one board representative, absent other indicia of control. In addition, an investor of up to 24.9 percent of voting stock of a banking organization may have up to two board representatives, absent other indicia of control when:

• The investor's aggregate director representation is proportionate to its total interest in the banking organization;
• Such director representation does not exceed 25 percent of the voting members of the board; and
• Another shareholder of the banking organization is a bank holding company that controls the banking organization under the BHC Act.

The Board reasoned that the addition of minority investor representatives on the board will be offset by the presence of the other larger, controlling shareholder of the banking organization who has been approved by the Board, is subject to supervision, and is obligated to serve as a source of strength for the banking organization.

A minority investor's board representative should not, however, serve as chairman of either the board or any committee of the board of the banking organization. The minority investor's board representative may serve as a member of a board committee so long as that representative does not account for more than 25 percent of the total members of the committee and the representative does not otherwise have the authority or practical ability unilaterally to make or block the making of policy or other decisions that bind the board or management of the banking organization.

III. Total Equity—Voting and Nonvoting

Although the statutory control test in the BHC Act makes no explicit reference to nonvoting equity investments, the Board has traditionally taken account of the size of nonvoting equity investments in its controlling influence analysis. For example, in the 1982 Policy Statement, the Board set forth a guideline that a nonvoting equity investment in excess of 25 percent of total equity generally raises control issues. In the New Policy Statement, the Board states that it continues to believe that an investor that owns 25 percent or more of the total equity of a banking organization owns enough of the capital resources of the organization to have a controlling influence over its management or policies.

Nevertheless, the New Policy Statement also recognizes that the ability of an investor to exercise control through nonvoting equity depends on the nature and size of the investment and the overall capital structure. The New Policy Statement provides that the Board does not expect that a minority investor will have a controlling influence over a banking organization if the investor owns a combination of voting shares and nonvoting shares that, when aggregated, represent less than one-third of the total equity of the organization and do not allow the investor to own, hold, or vote 15 percent or more of any class of voting securities of the organization.

IV. Communications Between Investors and Management

In the past, minority investors have undertaken "passivity commitments" designed to ensure the investor would not exercise any controlling influence over the organization.³ The New Policy Statement clarifies that a noncontrolling minority shareholder may generally communicate with and advocate to banking organization management for changes in any of the organization's policies and operations. While these types of discussions are attempts to influence management or the policies of a banking organization, these discussions alone are not the type of controlling influence targeted by the BHC Act. Control for deciding to take a final position or action, however, must remain with the banking organization's shareholders as a group, its board of directors, or its management, as appropriate. The minority investor's role in these decisions is limited to voting its shares as a shareholder or voting as a board member. The minority investor's communications must not be accompanied by either explicit or implicit threats to dispose of shares in the banking organization or to sponsor a proxy solicitation as a condition of action or non-action by the banking organization or its management.

V. Business Relationships and Covenants

The Board has traditionally prohibited noncontrolling minority investors in banking organizations from having any material business transactions or relationships with the banking organization. Over the years, however, the Board has recognized that not all such business relationships, including with a material investment, provide the investor a controlling influence. The New Policy Statement clarifies that although the Board still believes that business relationships should be limited and will be reviewed on a case-by-case basis, the Board will pay particular attention to the size of the proposed business relationship and whether it will be on market-terms, non-exclusive, and terminable without penalty by the banking organization.

The Board also continues to hold the view that covenants that substantially limit the discretion of the banking organization's management over major policies or decisions (e.g., hiring, firing, and compensating executive officers; engaging in new business lines or making substantial changes to operations; raising debt or equity; merging or consolidating; or disposing of material subsidiaries or assets or acquiring significant assets or control of another entity) suggest the exercise of a controlling influence. The Board generally does not, however, object to covenants that give an investor rights permissible for a holder of nonvoting securities as described in section 2(q)(2) of Regulation Y (e.g., restricting the issuance of senior securities or borrowing on a senior basis, modifying the investor's security, or liquidating the banking organization)⁴ or covenants that provide limited financial information and limited consultation rights.

VI. Conclusion

With the New Policy Statement, the Board continues to emphasize that determining whether a minority investor has a controlling influence over a banking organization depends on all the facts and circumstances surrounding the investor's investment in, and relationship with, the organization. The New Policy Statement marks a clear relaxation of the traditional Board limitations on minority investments in banking organizations, with particular attention to restrictions on board representation and equity ownership. The New Policy Statement provides additional clarity on some of the key factors the Board uses to make such determinations, and provides more flexibility and opportunities for new investors, such as private equity firms, to provide capital to the banking system without becoming subject to all the requirements of BHC Act regulation.


1 12 U.S.C. § 1841(a)(2).

2 See, 68 Federal Reserve Bulletin 413 (July 1982) (codified at 12 C.F.R. 225.143).

3 These commitments have included undertakings to not attempt to influence the operations, management, or strategies of the banking organization in which they have invested; not to threaten to sell their shares in the banking organization as a method for influencing decisions of management; and not to solicit proxies on any matter from the other shareholders of the banking organization.

4 12 C.F.R. § 225.2(q)(2).