So you think you want to buy a bank?

• Author: Glass, David L.

1. INTRODUCTION

   Among the fallout of the recent financial crisis has been something of a fire sale on weak or failing banks. During 2009, the number of problem banks on the "watch list" maintained by the Federal Deposit Insurance Corporation ("FDIC") reached 552 by September 2009--up from 416 only three months earlier--with some $346 billion in assets, the largest numbers since 1993. (1) With its insurance fund already seriously depleted by resolutions of failing banks, (2) it is no secret that the FDIC is eager to have private investors take some of the remaining ones off its--and, potentially, the taxpayers'--hands. Given the magnitude of the problem, the agency has sought to encourage entities that traditionally have not invested in banks--private equity funds, real estate developers, sovereign wealth funds, and others--to step up to the plate. And in turn, these entities have perceived an opportunity to enter the banking business--which offers, through its base of FDIC-insured deposits, the cheapest and most reliable source of funding available--at bargain basement prices.

   While the FDIC is self-funding through assessments made against insured deposits, the losses sustained on failing bank resolutions since the crisis began have plunged its insurance fund $8.2 billion into the red (including a provision of $21.7 billion for expected losses) (3)--the first time it has been underwater since 1991. Furthermore, the temporary increase from $100,000 to $250,000 per insured account (other than retirement accounts, which are fully insured) adopted by the FDIC as an emergency measure in 2008 was extended through 2013 by the Helping Families Save Their Homes Act, signed into law by President Obama last May, (4) significantly increasing the agency's potential exposure. Beginning September 30, 2009, the FDIC has been permitted by law to base its insurance assessments on the $250,000 figure, and has taken other measures, such as requiring banks to prepay their premiums, in an attempt to ameliorate a funding crisis. (5)

   All of this would suggest that the agency is paving the way for prospective investors to beat a path to its door. To date, however, the path remains relatively untrodden. The reason lies in the thicket of regulation that surrounds any entity that would presume to own or invest in a bank, not to mention the uncertainty surrounding the current legislative climate. Specifically, the objectives of private investors on the one hand, and bank regulators and the laws they administer on the other, are fundamentally at odds. Private equity firms typically seek to obtain a controlling position in struggling or undervalued companies, then "fix them, grow them, and sell them," usually in a period of three to five years. (6) The conundrum is that bank regulatory laws place severe restrictions on entities that control banks--restrictions that are anathema, unless the entity's fundamental business purpose is to operate banks rather than to invest in undervalued companies. Still, for certain classes of investors, the current crisis may represent a historic opportunity that should not be overlooked.

   This article reviews the legal impediments to investing in a bank or thrift institution (7) by a non-banking investor, and the efforts to date by the Federal Reserve ("Fed"), which has authority over all acquisitions of a bank by any company, as well as the FDIC to facilitate such investments. The article concludes by outlining some of the issues such an investor should consider in determining whether to pursue such an investment at this time.

2. BACKGROUND: THE BANK HOLDING COMPANY ACT

   The starting point in the analysis is the Bank Holding Company Act of 1956, as amended ("BHCA"). (8) The BHCA was enacted with the primary objective of separating banking from "commerce"--defined broadly to include basically, any and all non-financial activities. (9) Under the BHCA, any company that controls one or more banks is deemed to be a bank holding company ("BHC") and, as such, cannot engage in any activity other than banking, or a list of activities determined by the Fed to be "so closely related to banking as to be a proper incident thereto." (10) The Gramm-LeachBliley Financial Modernization Act of 1999 ("GLBA") (11)--infamously, if erroneously, referred to as the "repeal of the Glass-Steagall Act" (12)--liberalized the activities permissible for BHCs, if they could meet certain criteria relating to capital adequacy, management, and service to their local communities. A BHC that meets these criteria can elect to be treated as a "financial holding company," and as such can engage in financial activities, including selling insurance and securities, without limitation through subsidiary companies subject to regulation based upon their function (i.e., securities subsidiaries are regulated by the SEC and insurance subsidiaries by the insurance department of the state in which they are located). (13)

   In enacting the GLBA, the Congress rejected a provision which would have allowed FHCs to engage more broadly in non-financial activities--with a narrow exception for activities determined by the Fed to be "complementary" to an existing financial activity, provided the proposed complementary activity does not pose a significant risk to the "financial system generally." (14) The concept of "complementary" means that the FHC already is engaged in a financial activity, to which the proposed non-financial activity is merely complementary. (15) To date, the primary use that has been made of the "complementary" exception is in the area of physical commodities trading. While banks and BHCs are generally prohibited from trading physical commodities, an FHC can do so if it is already engaged in a related financial activity, such as trading derivatives based on that commodity, as long as the FHC receives prior approval from the Fed. As noted in the Fed's Orders approving this activity for certain FHCs, the exception is narrow and is discretionary with the Fed; among other things, the FHC applying for the exception must make the case that it has the infrastructure to manage the activity. (16) Also, the word "complementary" implies that the volume of the commercial activity is not large in relation to the underlying financial activity.

   It should be noted that, apart from the BHC Act, changes in control of an insured bank are subject to the Change in Bank Control Act ("CBC Act"). (17) The CBC Act essentially requires prior notice to the bank's regulator if 10% or more of the bank changes hands. (18) Unlike the BHC Act, however, the CBC Act does not impose any activity restrictions or ongoing regulatory requirements, once the initial notice is given. The CBC Act specifically exempts transactions that are subject to other laws, such as the BHC Actor the Bank Merger Act. (19) Thus, it would pick up an acquisition not covered by these laws--for example, the purchase of a bank by an individual or group of individuals, since the BHC Act applies only to control of bank by a "company." Care must be taken, however; if a group of individuals are acting in concert, there is ample precedent for the Fed to determine that they have formed ah association which is a de facto "company." Thus, the essential dilemma for investors such as private equity or sovereign wealth funds (20) is that if they become BHCs, they will be precluded from investing in assets and industries that stray from the financial field. Furthermore, they will be required to register with and be regulated by the Fed. It follows that investing in a bank generally is only feasible if the fund can avoid becoming a BHC in the process. To do so, it must avoid taking "control" of the bank, directly or indirectly. (21)

   The BHC Act defines "control" in three ways. A company "controls" a bank or a BHC if it: (i) owns 25% or more of any class of voting equity; (ii) has the power to appoint a majority of the board of directors; or (iii) if the Fed determines, under all the facts and circumstances, that it exercises a "controlling influence" over the management and policies of the bank or company. (22) The first two definitions in effect are irrebuttable presumptions--no state of facts can be adduced to rebut the presumption of control if either of these two things are shown. The third definition comes into play only if neither of the first two conditions is met. It can be seen immediately that a company can be deemed to "control" a bank even if, as a practical matter, its ability to control the bank's day-to-day activities is minimal. For example, imagine that the investor owns 25% of the voting equity, while a giant BHC such as Citigroup or BankAmerica owns the remainder. In the real world, control of the bank will be dominated by the 75% owner. Nonetheless, under the law both will be deemed to be BHCs (because they are deemed to be in control as a matter of law) and thus subject to all the restrictions and regulatory requirements of the BHC Act.

   Under the "controlling influence" prong, by contrast, the presumption is one of non-control. In principle, at least, the burden is on the Fed to rebut the presumption that the investor does not control the bank, if the Fed believes this to be the case. In that event, the Fed must provide the investor with notice and an opportunity for a hearing. (23) But the shifting of the burden may be more theoretical than actual; as long as the Fed's interpretation of the statute is reasonable, as a matter of administrative law it will be upheld by the courts. Applying its Chevron doctrine, (24) the Supreme Court repeatedly has made clear that an interpretation of a regulatory statute by the bank regulatory agency charged with its enforcement will not be overturned by a court unless it is found...