Consistent with the Act's requirements for protection of the taxpayers' investment, Treasury must acquire securities of each financial institution that sells troubled assets. The type of security and structure of the investment depends on whether the financial institution has publicly traded securities.
Public Companies: A financial institution that is traded on a national securities exchange will be required to provide Treasury with equity securities. These can be in the form of warrants for non-voting common stock or preferred stock, or warrants for voting common stock. In the case of voting stock, Treasury will agree not to exercise voting rights, other than class voting rights on matters that could adversely affect the shares. If Treasury later sells the warrant, the voting rights would transfer to the purchaser. The warrant of any public company must contain a provision protecting Treasury if the financial institution is no longer publicly traded; either a provision converting it to senior debt, or "appropriate protections" against that risk.
Non-public Companies: A financial institution without listed securities may sell Treasury a warrant fo common or preferred stock, or senior debt.
Where a holding company has publicly traded common stock, we would expect its troubled assets to be held at a subsidiary in most, if not all, cases. Given the benefit of holding publicly traded securities of the parent institution, we would expect Treasury, looking at the purposes of the Act and its responsibility to protect the taxpayer investment, to establish procedures to accept securities of the parent financial institution.
Exceptions. Treasury may establish a de minimis exception to the requirement that the financial institution issue securities. However, the Act requires that Treasury cannot establish a threshold higher than $100 million; any financial institution selling more than $100 million of troubled assets, or such lower amount as Treasury may establish, must issue securities. Additionally, there is an exception for issuers that are legally unable to provide securities to Treasury. Treasury shall arrange an "appropriate alternative requirement" for that seller of troubled assets that does not have the legal authority to issue securities. An example would include a purchase by Treasury of troubled assets from a foreign financial authority or foreign central bank that had acquired those troubled asset from a financial institution it had rescued. Finally, in the event a financial institution does not have a sufficient number of authorized shares to issue warrants, senior debt will be acceptable, if the terms will provide equivalent value.
Structuring Warrants. With respect to the equity underlying warrants, financial institutions may have limitations in their organizational documents authorizing only one class of common stock, rendering them unable to issue non-voting common stock. As a result, we would expect that these financial institutions will prefer a preferred stock structure. All warrants must contain market standard anti-dilution provisions to provide for adjustments in the event of stock splits, stock distributions, dividends and other distributions, mergers and other forms of reorganization or recapitalization. In structuring warrants, the initial financial institutions will need to avoid 'death spiral' provisions. Any increase in the number of shares that results from a decline in the trading price of common stock will result in the Treasury, or the third party to whom it subsequently sells the warrants, taking an ownership interest larger and with greater dilution for existing holders than initially planned.
Participating financial institutions will also need to look carefully at their other limitations on issuing equity securities, in addition to their authorized amounts. For example, financial institutions will need to consider stock exchange limitations, triggers in poison pills or other limitations or triggers in corporate agreements. We expect the initial warrants issued will be duplicated quickly and a limited number of 'standard' forms of Treasury-held warrants will be established.
The terms and conditions of the individual securities granted under this provision will be largely in the discretion of Treasury, subject to compliance with the purposes of the requirement. Treasury is charged with acquiring assets that protect the taxpayers' investment through participation in the appreciation of equity securities or the return of a reasonable premium. Additionally, the investment provides additional economic protection against losses incurred through sales of troubled assets as well as the administrative expense of running TARP. We expect that the other TARP programs will mirror the TARP Capital Purchase Program, including the requirement for registration statements with respect to the securities received by Treasury. For private companies, the terms will need to provide similar economic benefit to Treasury. Treasury has the authority to sell, exercise or surrender any security received under these provisions, but must protect taxpayers when acting under the programs.
Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.
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