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Fintech in Brief: The Federal Reserve Proposes Revisions to Its Control Determination Framework 

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05.01.2019 | Legal Update

The Board of Governors of the Federal Reserve System (the “Federal Reserve”) has released for public comment a proposal to simplify and clarify rules for determining control of or by a banking organization under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). The proposal, issued on April 23, 2019, if adopted in final form, will clarify the so-called “controlling influence” test and should be of significant interest to Fintechs and their investors considering various bank charter options, particularly those Fintechs with venture capital ownership exploring a full service, FDIC-insured bank charter under a bank holding company structure. The Federal Reserve’s proposal also should be of interest to Fintechs seeking capital investments from bank holding companies and banks and investment funds managed and controlled by or affiliated with those institutions. Finally, community banks seeking investors and additional private capital for growth, lending, investment, or other corporate purposes also should benefit from the proposal.

Under the BHC Act, a company is considered to have control over another company if the first company owns or controls 25% or more of any class of voting securities of the other company or controls in any manner the election of a majority of the board of directors of the other company. In addition to those bright-line tests, a company may be deemed to exercise a “controlling influence” over another company, depending on the facts and circumstances surrounding the particular investment.

If a company “controls” a banking organization, the company becomes subject to, among other things, Federal Reserve regulation and supervision as a bank holding company and the activities and investment restrictions of the BHC Act. If a company is “controlled by” a banking organization, the company also becomes subject to Federal Reserve regulation and supervision and related set of activities and investment restrictions under the BHC Act as a subsidiary of a bank holding company.

The implications of the Federal Reserve’s proposal are significant. Its stated goal in issuing the proposal is to simplify and increase the transparency of its rules for determining whether a company has the ability to exercise a “controlling influence” over another company. Until now, the Federal Reserve has issued policy statements, interpretations, and determinations (both formal and informal), as well as legal opinions and other guidance (both public and nonpublic) on the subject of control under the controlling influence test, resulting in a complex web of public and nonpublic guidance and interpretations developed over time, often leaving banking organizations and investors uncertain about whether a proposed investment is controlling. The Federal Reserve’s proposal would set forth a comprehensive regulatory framework for control determinations and liberalize certain aspects of that guidance.

The proposal formally sets out the several factors and thresholds that the Federal Reserve will use to determine if a company has the ability to exercise a controlling influence over a banking organization or other company. Those factors include, among others, (i) the company’s total voting and non-voting equity investment in the target, (ii) director, officer, and employee interlocks between the company and the target, and (iii) the nature and scope of business relationships between the company and the target. The proposal more clearly describes what combination of those factors would or would not trigger control, and includes a chart detailing how different combinations of the presumptive factors would or would not result in control.

The proposal also would revise determinations of control under the Home Owners’ Loan Act with respect to savings and loan holding companies, which contains substantially similar tests for control as the BHC Act. Comments on the proposal will be accepted for 60 days after publication in the Federal Register.

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