The Board of Governors of the Federal Reserve ("FRB") has promulgated new presumptions of "control" under the Bank Holding Company Act ("BHC Act") that may make it easier for bank holding companies ("BHCs") to invest in FinTech companies. Although the final rule was originally scheduled to become effective on April 1, 2020, the FRB recently delayed the effective date to September 30, 2020 to allow companies affected by the new rule additional time to analyze the impact of the rule on existing investments and relationships and to consult with FRB staff as necessary.
By way of background, the BHC Act limits the permissible activities of BHCs and their affiliates. A company is deemed to be a BHC if it directly or indirectly "controls" a bank or another BHC. The definition of an "affiliate" of a BHC, meanwhile, includes a company that is "controlled" by a BHC. The activities of BHCs and their affiliates are restricted to: 1) owning, managing, and controlling banks, and 2) engaging in activities that are "so closely related to banking as to be a proper incident thereto." (Financial holding companies have additional authority to make financial investments.) The BHC's definition of "control" is thus critical to understanding the permissible activities of BHCs and their affiliates.
Under the BHC Act, "control" is defined by a three-pronged test: a company has control over another company if the first company: (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 or trustees of the other company; or (iii) directly or indirectly exercises a "controlling influence" over the management or policies of the other company. (In addition, a company that controls less than 5 percent of the voting securities of another company is presumed not to control the second company under the BHC Act). While the first two prongs of the BHC Act's "control" test are relatively straightforward, the third prong – commonly applied in situations involving control of 5 to 24.9% of voting securities of a company – has been harder to understand given that neither the BHC Act nor the FRB's implementing regulations define "controlling influence."
According to a report issued by the Treasury Department in July 2018, uncertainty over the BHC Act's definition of "control" has discouraged BHC investments in FinTech companies for two reasons. First, FinTech companies are wary of accepting BHC investments that might lead them to becoming BHC affiliates subject to BHC-related regulations – including the BHC limitation of activities to banking or activities that are "closely related" to banking. Second, uncertainty over what sorts of business relationships may rise to the level of a "controlling influence" has discouraged BHCs from investing in FinTechs. In light of these concerns, the Treasury Department recommended "that the Federal Reserve consider how to reassess the definition of BHC control to provide firms a simpler and more transparent standard to facilitate innovation-related investments."
The FRB's final rule attempts to meet the Treasury Department's challenge to promulgate a simpler and more transparent standard for BHC control. The final rule specifies tiered rebuttable presumptions that the FRB will consider in determining whether a "controlling influence" exists. As noted above, there was already a presumption of non-control under the BHC Act where a company controls less than 5 percent of the voting securities of another company, and the BHC Act already provided that company that owns, controls, or has power to vote 25 percent or more of any class of voting securities of another company has control of that company. The FRB's new rebuttable presumptions of control will apply where the first company has at least a specified level of voting securities in a second company (i.e., 5 percent, 10 percent, or 15 percent) as well as another specified relationship with the second company (e.g., a specified level or quality of director representation). For example, the final rule provides that company that controls 5 percent or more of the outstanding securities of any class of voting securities of a second company and whose director representatives comprise 25 percent or more of the second company's board of directors will be presumed to control the second company.
Critically, while the FRB will retain the ability to find a controlling influence based on the facts and circumstances presented by a particular case, it has also stated that it "generally does not expect to find that a company controls another company unless the first company triggers a regulatory presumption of control with respect to the second company." Thus, a BHC that is careful to avoid triggering the new presumptions of control with respect to an investment in a FinTech company in the 5-to-24.9%-of-voting-securities range will have increased comfort that it will not be deemed to control the FinTech company.
In the FRB's words, "the final rule significantly improves the transparency and predictability around questions of controlling influence." The final rule will allow FinTech companies to have greater comfort that by accepting or allowing a carefully structured investment of 5 to 24.9 percent of a class of voting securities by a BHC, a FinTech company will not be deemed to be a BHC affiliate subject to BHC-related regulations – including the limitation of activities to banking or activities that are closely related to banking. BHCs and FinTech companies should benefit from the increased clarity on the meaning of "controlling influence" provided by the new rule.
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