Federal Reserve raises concerns over shareholder agreements, poison pills and other arrangements impacting stock transfers.
Federal Reserve raises concerns over shareholder agreements, poison pills and other arrangements impacting stock transfers.
The Federal Reserve recently indicated that it would look closely at shareholder agreements and other arrangements designed to protect shareholders’ investments in circumstances that, according to the Fed, could have a negative impact on a bank holding company's financial position or limit its ability to raise capital in the future. The guidance is provided in Supervision and Regulation Letter 15-15 (SR 15-15).
The guidance applies to banks and holding companies of all sizes, whether public or private.
The letter notes that the Fed has observed an increase in the use of agreements designed to benefit certain shareholders and/or provide a disincentive for investors to acquire or increase ownership in a bank holding company's stock. The staff believes that this may have negative implications on the holding company's financial position and limit its flexibility to raise capital in the future. According to the Fed, these factors could impair the company’s ability to serve as a source of strength to its subsidiary banks, as required under Section 616(d) of the Dodd Frank Act.
The guidance provides a nonexclusive list of the types of arrangements that could raise concerns.
These include the following:
(a) Down Rounds – arrangements where the holding company agrees to provide an investor with additional shares or cash payments in the event that a subsequent round of financing occurs at a price below the price paid by that investor (commonly referred to as “down round” protection);
(b) Poison Pills – arrangements where existing shareholders are able to acquire additional shares at a significant discount to market value if any shareholder crosses a specific ownership threshold;
(c) Minority Voting Protections – arrangements allowing minority shareholders to restrict or prevent the company from issuing additional shares or taking other actions; and
(d) Transfer Restrictions and Repurchase Requirements – arrangements under which the holding company's Board has the authority to prevent sales/transfers of shares, requirements that the holding company repurchase shares from designated shareholders, and other situations that would significantly restrict resales of holding company shares.
The Fed believes that these arrangements have the potential to impose additional financial obligations on a holding company or in some way restrict the market for holding company shares. The Fed is focused on arrangements that serve to protect the value of an initial investment made by a particular subset of shareholders and that may be detrimental to future investors and negatively impact the company’s ability to raise additional capital.
It is interesting that the Fed is taking an active interest in these types of arrangements, many of which are very commonly used by holding companies of all sizes. The guidance is unfortunately limited in that the staff does not provide detail as to the specific set of circumstances that will cause an arrangement to be objectionable.
The staff has indicated that they do not intend to question customary restrictions on transfer imposed by S corporations, as those restrictions are necessary to maintain the company’s tax status. Beyond this, however, it remains to be seen how broadly this guidance will be applied. Boards should keep in mind that the Fed may object to a shareholder protection arrangement depending on the relevant circumstances. We encourage clients to review their existing shareholder agreements and similar arrangements, and consult with counsel prior to entering into any additional shareholder protections.
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This Alert is provided to Clients and friends of the Firm. If you have questions regarding any of the items discussed, please contact one of the following attorneys: Paul Benham at (501)370-1517 or [email protected] or Robert Smith at (501)370-1559 or [email protected].