E8-14374. Optional Charter Provisions in Mutual Holding Company Structures

AGENCY:

Office of Thrift Supervision, Treasury.

ACTION:

Final rule.

SUMMARY:

The Office of Thrift Supervision (OTS) is amending its mutual holding company (MHC) regulations to permit certain MHC subsidiaries to adopt an optional charter provision that would prohibit any person from acquiring, or offering to acquire, beneficial ownership of more than ten percent of the MHC subsidiary's minority stock (stock held by persons other than the subsidiary's MHC).

DATES:

Effective Date: This final rule is effective on October 1, 2008.

FOR FURTHER INFORMATION CONTACT:

Donald W. Dwyer, [phone], Director, Applications, Examinations and Supervision—Operations; or David A. Permut, [phone], Senior Attorney, Business Transactions Division, Office of Chief Counsel, Office of Thrift Supervision, 1700 G Street, NW., Washington, DC 20552.

SUPPLEMENTARY INFORMATION:

I. Background

On June 27, 2007, OTS published a notice of proposed rulemaking (NPR) that proposed to amend the MHC Regulations to permit certain MHC subsidiaries to adopt an optional charter provision that would prohibit any person from acquiring, or offering to acquire beneficial ownership of more than ten percent of the MHC subsidiary's minority stock (stock held by persons other than the subsidiary's MHC).^[1]

Under the MHC Regulations, a subsidiary MHC, or, where there is no subsidiary MHC, the former mutual savings association that reorganized into an MHC structure (collectively, Subsidiary Company), may sell less than 50 percent of its voting stock to parties other than the top-tier MHC.^[2]

Under the MHC Regulations, a Subsidiary Company may adopt a charter provision that prohibits any person from acquiring, or offering to acquire, beneficial ownership of more than 10 percent of the Subsidiary Company's stock during the five years after a minority stock issuance.^[3] The purpose of this provision, as is the case with the provision when applied to fully converted associations, is to lessen the vulnerability of the entity to attempts to take unfair advantage of the results of the offering, to protect the integrity of the offering, and to ensure that the offering is completed in a manner that strengthens the issuer.^[4]

OTS has become aware of several situations in which minority stockholders have acquired positions in the minority stock of Subsidiary Companies, and have taken actions that appear intended to influence management to engage in stock repurchases or in a sale of the institution. Because a top-tier MHC is required to retain more than 50 percent of the stock of any Subsidiary Company, holders of minority stock (minority stockholders) cannot control the outcome of most issues presented to the stockholders of a Subsidiary Company. However, there are circumstances where OTS's regulations provide that a majority of the minority stock must approve a proposal.^[5]

Minority stockholders may acquire a significant percentage of the minority stock without involving either the OTS Acquisition of Control Regulations (Control Regulations) or the charter provision discussed above, both of which are triggered by an acquisition of more than ten percent of the outstanding stock. Thus, for example, if a Subsidiary Company issues thirty percent of its stock in a public offering, a minority stockholder could acquire a third of those shares without implicating either the Control Regulations or the charter provision. In such a case, the minority stockholder may obtain a significant amount of influence, based on its ability to vote on the issues that must be presented separately to minority stockholders.

OTS believes that such a result would be contrary to the purposes of the restrictions addressing post-offering acquisitions of stock in the context of conversions and minority stock offerings, that is, lessening the vulnerability of the entity to attempts to take unfair advantage of the results of the offering, to protect the integrity of the offering, and to ensure that the offering is completed in a manner that strengthens the issuer. Therefore, OTS proposed to add a provision to the MHC Regulations, which could be adopted only by Subsidiary Companies, that would provide that no entity, or person or group acting in concert could acquire more than ten percent of the outstanding minority stock of the Subsidiary Company during the five years after a Minority Stock Issuance. If a stockholder violated this charter provision, the stockholder would not be permitted to vote any stock the stockholder acquired in excess of the limit.

OTS proposed that the charter provision would not limit the stockholdings of the parent MHC, because the parent MHC, under the Home Owners' Loan Act, must own more than fifty percent of the Subsidiary Company. In addition, OTS proposed that the charter provision except stock held by the Subsidiary Company's Employee Stock Ownership Plan (ESOP) from this limitation, because ESOP acquisitions do not present the concerns that have resulted in OTS limiting post-conversion acquisitions of stock.^[6]

II. Public Comments

OTS received 8 comments, from 7 commenters, regarding the NPR. Of these comment letters, four were from trade associations, three were from law firms and one was from an investment firm. Five of the comment letters supported the proposal and three (including two letters from one commenter) opposed the proposal. Four of the five comments in favor of the proposal were submitted by trade associations, and one was from a law firm. Of the three comments opposing the proposal, one was from the investment firm, and the other two were from an attorney who wrote on behalf of his client.

All of the comments in favor of the proposal supported OTS's reasoning as set forth in the NPR, and evidenced a belief that the proposal would appropriately limit the amount of influence minority shareholders would have over management. One commenter stated that the proposed restriction was reasonable in order to keep activist shareholders from “engaging in control” over an MHC.

The two commenters who opposed the proposal cited several arguments supporting their position. They asserted that the optional charter provision would make already illiquid stock less liquid; would disenfranchise shareholders, and violate fundamental shareholder rights; was overkill to stop minority shareholders from taking actions to influence management; and was proposed in order to assist management to avoid shareholder accountability and undo the requirement that a majority of minority shareholders vote in favor of management stock benefit plans. These commenters also asserted that the proposed charter provision has no nexus to protecting the conversion (or the minority stock offering process).

In addition, the comments raised technical issues regarding the proposed charter provision.

OTS has carefully considered the public comments. Specific topics addressed by one or more commenters are discussed below. Except as otherwise noted in the discussion below, OTS is adopting the amendments to its regulations as proposed in the NPR.

A. Adoption and Retention of the Charter Provision

Three commenters addressed the time period during which a Subsidiary Company could enact and retain the optional charter provision. Two commenters asked for clarification regarding when the provision could be adopted. In addition, two commenters addressed the length of time for which a charter could include the provision in question. One commenter suggested that Subsidiary Companies should have the ability to determine how long to retain the charter provision, with five years as the outside limit, and another suggested that OTS should permit a Subsidiary Company to retain the charter provision as long as the company considers it appropriate.

OTS is revising the final regulation to provide clearly that, subject to certain limitations discussed below, a Subsidiary Company may adopt the optional charter provision before it conducts its first minority stock offering, at the time of a minority stock offering, or at any time during the five years following the closing of the minority stock offering. However, regardless of when the charter provision is adopted, the charter provision must expire at some time during the five year period that commences upon the closing of the minority stock offering.

OTS has considered the comment requesting that OTS permit the Subsidiary Company to decide for itself how long the charter provision should remain in place. The NPR stresses that the purpose of the charter provision is to lessen attempts to take unfair advantage of the results of an offering, protect the integrity of the offering, and ensure that the offering is completed in a manner that strengthens the issuer. OTS believes that these concerns lessen significantly when more than five years have elapsed since the completion of the offering in question. Accordingly, OTS is retaining the requirement that the provision may be in place only during the five years after the closing of an offering.

B. Applicability of the Charter Provision Where a Shareholder Has Already Acquired More Than Ten Percent of the Minority Stock

The comments that opposed the optional charter provision raised several issues that ultimately related to the manner in which the provision would operate if a shareholder had acquired more than ten percent of the minority stock before the charter provision had been adopted. In this regard, the comments asserted that the rule disenfranchises large stockholders, and that sterilization of shares in excess of ten percent of the minority shares is inappropriate. One of the commenters urged that OTS make the rule applicable only prospectively.

OTS has carefully considered these comments. The NPR did not specifically discuss situations in which a minority shareholder had acquired shares in excess of the limit in the optional charter provision prior to adoption of the provision, and did not contemplate situations in which a shareholder who held shares before adoption of the charter provision would no longer be able to vote those shares.

OTS considered prohibiting a Subsidiary Company from adopting the charter provision only where a party had already acquired more than ten percent of the minority shares, and also considered excepting (“grandfathering”) parties who had acquired more than ten percent of the minority shares at the time of the adoption of the charter provision from the restrictions in the optional charter provision. OTS does not believe that either approach would work well, due to difficulties in knowing how many shares a minority shareholder holds at a particular time. For either approach to work, it would be necessary for shareholders who would not otherwise be subject to reporting requirements to provide information regarding their holdings, and OTS does not believe it is appropriate to impose special reporting requirements on minority shareholders of Subsidiary Companies.

Accordingly, OTS is revising the final regulation to provide that only Subsidiary Companies that have not engaged in minority stock issuance prior to the effective date of the regulation, may adopt the optional charter provision.

OTS is not prohibiting Subsidiary Companies that engage in their initial minority stock offering after the effective date of this regulation from adopting the optional charter provision, even if they do so after a minority stock issuance, and after a minority shareholder acquires more than ten percent of the Subsidiary Company's minority stock. In order to adopt the optional charter provision after a minority stock issuance, however, the Subsidiary Company must provide full disclosure in the offering materials regarding the possibility that the optional charter provision may be adopted at a later time.^[7] Accordingly, even if there was no restriction at the time a shareholder acquires a Subsidiary Company's minority stock, such a shareholder will do so with knowledge that its voting power may be adversely affected if the Subsidiary Company later adopts the optional charter provision.

OTS believes that this approach eliminates concerns that the charter provision inappropriately sterilizes votes,^[8] violates shareholder rights, or is in any way inconsistent with sound corporate governance.

C. Liquidity

The commenter who addressed liquidity stated that the proposed charter provision would reduce liquidity of the stock of recently converted Subsidiary Companies, because acquirors who otherwise wished to purchase more than ten percent of the Subsidiary Company's shares would not be allowed to do so. OTS notes, however, that such purchases may ultimately decrease liquidity, by reducing, possibly significantly, the number of minority shareholders. The proposed rule may ultimately have the effect of increasing the number of minority shareholders over the number that would otherwise be the case, thereby increasing liquidity. Accordingly, the effect of the charter provision on liquidity is unclear. OTS does not believe that the charter provision will raise significant liquidity concerns.

D. Management Accountability

Comments that opposed the proposed charter provision asserted that the provision helps management avoid accountability to shareholders, and conflicts with the final rule promulgated in 2007 that required that a majority of the minority shareholders vote in favor of stock benefit plans proposed by Subsidiary Companies.^[9]

OTS does not believe the charter provision either enables management to avoid shareholder accountability or conflicts with the 2007 final rule requiring a majority of the minority vote in favor of stock benefit plans. The proposed charter provision merely prohibits a single entity from acquiring more than ten percent of the minority shares. Where a separate minority shareholder vote is required, a majority of such shareholders must vote in favor of a matter in order for it to be passed. Accordingly, management remains accountable to shareholders, and the charter provision does not raise the conflict of interest issues that led OTS to continue to require a majority of the minority vote.^[10]

E. Purpose of the Charter Provision

With regard to the comments that the only purpose of the charter provision is to make it easier to pass benefit plans, and that the charter provision is intended to protect insiders' interests, OTS set forth the rationale for the proposed charter provision in the NPR, and has repeated the rationale above. The charter provision does not prevent minority shareholders from voting in opposition to a proposed benefit plan. The charter provision would make it more difficult for a single shareholder to prevent the passage of stock benefit plans, but minority shareholders, as a class, continue to have the power to vote down a stock benefit plan.

F. Treatment of Proxies

One commenter requested clarification regarding whether the charter provision would prohibit a shareholder from soliciting revocable proxies. The regulatory restriction regarding acquisitions of more than ten percent of a class of voting stock after a mutual-to-stock conversion, at 12 CFR 563b.525, provides that “a person acquires beneficial ownership of more than ten percent of a class of shares when he or she holds any combination of * * * stock or revocable or irrevocable proxies under circumstances that give rise to a conclusive control determination or rebuttable control determination under §§ 574.4(a) and (b) of this chapter.” The corresponding optional charter provision at 12 CFR 552.4 has been interpreted to apply to proxies in the same manner.^[11] OTS is not aware of any reason to treat proxies differently in the context of the charter provision addressed herein.

III. Regulatory Findings

A. Paperwork Reduction Act

OTS has determined that the final rule does not involve a change to collections of information previously approved under the Paperwork Reduction Act (44 U.S.C. 3501 et seq.).

B. Executive Order 12866

The Director of OTS has determined that the final rule does not constitute a “significant regulatory action” for purposes of Executive Order 12866.

C. Regulatory Flexibility Act

Pursuant to section 605(b) of the Regulatory Flexibility Act (RFA) (5 U.S.C. 601), the Director certifies that the final rule will not have a significant economic impact on a substantial number of small entities. The final rule would permit Subsidiary Companies to adopt an optional charter provision. Accordingly, OTS has determined that a Regulatory Flexibility Analysis is not required.

D. Unfunded Mandates Reform Act of 1995

OTS has determined that the final rule will not result in expenditures by state, local, or tribal governments or by the private sector of $100 million or more and that a budgetary impact statement is not required under Section 202 of the Unfunded Mandates Reform Act of 1995, Public Law 104-4 (Unfunded Mandates Act). The final rule would permit Subsidiary Companies to adopt an optional charter provision. The final rule changes should not have a significant impact on small institutions. Accordingly, a budgetary impact statement is not required under section 202 of the Unfunded Mandates Act.

List of Subjects in 12 CFR Part 575

• Administrative practice and procedure
• Capital
• Holding companies
• Reporting and recordkeeping requirements
• Savings Associations
• Securities

Authority and Issuance

For the reasons set forth in the preamble, OTS is amending Chapter V of title 12 of the Code of Federal Regulations, as set forth below:

PART 575—MUTUAL HOLDING COMPANIES

1. The authority citation for 12 CFR part 575 continues to read as follows:

Authority: 12 U.S.C. 1462, 1462a, 1463, 1464, 1467a, 1828, 2901.

2. Amend § 575.9 by redesignating paragraph (c) as (d), and adding a new paragraph (c) as follows:

§ 575.9

Charters and bylaws for mutual holding companies and their savings association subsidiaries.

* * * * *

(c) Optional charter provision limiting minority stock ownership. A federal resulting association or federal acquiree association that engages in its initial minority stock issuance after October 1, 2008 may, before it conducts its initial minority stock issuance, at the time of such minority stock issuance, or at any time during the five years following a minority stock issuance that such association conducts in accordance with the purchase priorities set forth in 12 CFR part 563b, include in its charter the following provision. For purposes of this charter provision, the definitions set forth at § 552.4(b)(8) of this chapter apply. This charter provision expires a maximum of five years from the date of the minority stock issuance. The federal resulting association or federal acquiree association may adopt the charter provision after a minority stock issuance only if it provided, in the offering materials related to its previous minority stock issuance or issuances, full disclosure of the possibility that the association might adopt such a charter provision.

Beneficial Ownership Limitation. No person may directly or indirectly offer to acquire or acquire the beneficial ownership of more than 10 percent of the outstanding stock of any class of voting stock of the association held by persons other than the association's mutual holding company. This limitation expires on [insert date of minority stock issuance] and does not apply to a transaction in which an underwriter purchases stock in connection with a public offering, or the purchase of stock by an employee stock ownership plan or other tax-qualified employee stock benefit plan that is exempt from the approval requirements under § 574.3(c)(1)(vii) of the Office's regulations.

In the event a person acquires stock in violation of this section, all stock beneficially owned by such person in excess of 10 percent of the stock held by stockholders other than the mutual holding company shall be considered “excess shares” and shall not be counted as stock entitled to vote and shall not be voted by any person or counted as voting stock in connection with any matters submitted to the stockholders for a vote.

* * * * *

3. Amend § 575.14 by redesignating paragraphs (c)(3) and (4) as (4) and (5), respectively, and add a new (c)(3) to read as follows:

§ 575.14

Subsidiary holding companies.

* * * * *

(3) Optional charter provision limiting minority stock ownership. A subsidiary holding company that engages in its initial minority stock issuance after October 1, 2008 may, before it conducts its initial minority stock issuance, at the time it conducts its initial minority stock issuance, or at any time during the five years following a minority stock issuance that such subsidiary holding company conducts in accordance with the purchase priorities set forth in 12 CFR part 563b, include in its charter the provision set forth below. For purposes of this charter provision, the definitions set forth at § 552.4(b)(8) of this chapter apply. This charter provision expires a maximum of five years from the date of the minority stock issuance. The subsidiary holding company may adopt the charter provision after a minority stock issuance only if it provided, in the offering materials related to its previous minority stock issuance or issuances, full disclosure of the possibility that the association might adopt such a charter provision.

Beneficial Ownership Limitation. No person may directly or indirectly offer to acquire or acquire the beneficial ownership of more than 10 percent of the outstanding stock of any class of voting stock of the association held by persons other than the subsidiary holding company's mutual holding company parent. This limitation expires on [insert date of minority stock issuance] and does not apply to a transaction in which an underwriter purchases stock in connection with a public offering, or the purchase of stock by an employee stock ownership plan or other tax-qualified employee stock benefit plan which is exempt from the approval requirements under § 574.3(c)(1)(vii) of the Office's regulations.

In the event a person acquires stock in violation of this section, all stock beneficially owned in excess of 10 percent shall be considered “excess stock” and shall not be counted as stock entitled to vote and shall not be voted by any person or counted as voting stock in connection with any matters submitted to the stockholders for a vote.

* * * * *

Dated: June 20, 2008.

By the Office of Thrift Supervision.

John M. Reich,

Director.

Footnotes

1.  See 72 FR 35205 (Jun. 27, 2008).

2.  See 12 CFR 575.7 and 575.14(b)(2008). See also 12 U.S.C. 1467a(o)(8)(B).

3.  See 12 CFR 552.4(b)(8) and 575.14(c)(2)(2008).

4.  See, e.g., Federal Home Loan Bank Board Order No. 84-90 (Feb. 23, 1984).

5.  See 12 CFR 563b.500(a)(7), 563b.555, 575.11(i) and 575.12(a)(3) (2008).

6.  See 12 CFR 563b.525(c)(4)(2008), and the optional charter provision at section 552.4, both of which except ESOPs from the post-conversion acquisition restrictions of section 563b.525.

7.  If the Subsidiary Company engages in multiple minority stock issuances, it would have to make the appropriate disclosures in all such offerings.

8.  OTS has long considered sterilization to be appropriate where an acquiror has violated a regulatory or charter restriction. Both the OTS Mutual-to-Stock conversion regulations and the charter provision at 12 CFR 552.4 include sterilization provisions that apply where the acquiror has violated OTS regulations, or a charter provision, and have included such provisions since the 1970s.

9.  See 72 FR 35145 (2007).

10.  See 72 FR 35145, at 35147-35148 (June 27, 2007).

11.  See FHLBB Ops., Dep. G.C. (Aug. 14, 1986, and Oct. 21, 1988).