With the costs of compliance on the rise, we are seeing some significant consolidation in the banking industry, particularly among community banks. In a recent article on www.bankdirector.com, Rick Maroney writes that although bank M&A has been tepid thus far in 2013, some key drivers of M&A activity are starting to emerge and he predicts that we are likely to see increased merger and consolidation activity in the industry as smaller banks need to grow to remain viable. Additionally, the heightened regulatory capital requirements that are expected to be adopted as a result the Basel III accord may be an additional driver of consolidation in the banking sector.
In these merger transactions, it is fairly common for acquiring institutions to offer its common stock to target shareholders as part of the consideration to be paid. Depending on the organizational structure of the acquiring institution, there are a few options for offering stock to target shareholders as merger consideration. If the acquiror is a bank with a holding company structure, the stock portion of the merger consideration is almost always common stock of the holding company. The most significant issue when offering bank holding company stock is that the transaction must either (i) be registered on an S-4 registration statement, which involves substantial time and cost for the acquiror and would subject the acquiror to periodic reporting requirements under the Securities Exchange Act of 1934 or (ii) alternatively, the holding company stock must be issued pursuant to an exemption from registration (typically the Rule 506 safe-harbor for the Section 4(a)(2) private offering exemption). Many smaller banks, to the extent possible, will attempt to avoid registering the transaction due to the high costs and rely on an exemption to registration. If an acquiror considers privately placing holding company securities in a merger transaction, there are a number of considerations to address, some of which may be slightly alleviated by the recent changes under the JOBS Act as described in Kobi Kasitel’s recent blog post regarding stock issuances in M&A transactions after the JOBS Act.
For state-chartered banks regulated by the FDIC that do not have a holding company, the issuance of bank stock in connection with an acquisition may, at first glance, appear simpler. Under section 3(a)(2) of the Securities Act of 1933, securities issued or guaranteed by a bank are exempt securities and may be issued without compliance with the registration requirements of Section 5 of the Securities Act. Furthermore, because bank stock is an exempt security, it may be freely resold in the secondary market without restriction, as opposed to stock issued pursuant to the Section 4(a)(2) private offering exemption which would be subject to transfer restrictions including minimum holding periods. This seems to make matters fairly straightforward, but as you might imagine, nothing can be that easy in the highly regulated banking industry.
In 1994, the FDIC issued a statement of policy regarding the issuance of exempt bank stock by state-chartered nonmember banks. This was adopted to address potential safety and soundness concerns related to the issuance of exempt bank stock, particularly regarding potential securities lawsuits alleging fraud or misrepresentation by a bank issuing securities without the use of an offering circular or other disclosure document. This policy “recommends” (which in regulator speak really means “requires”) that FDIC–regulated banks use an offering circular in connection with the public offering of exempt bank stock. Because of the stringent standards, most merger transactions will likely be deemed to be public, rather than private, offerings especially if the target has a large shareholder base.
To comply with the requirements of the FDIC’s policy, the offering circular must satisfy one of a number of available disclosure standards. For example, an issuing bank may elect to comply with disclosure requirements of Regulation A, Regulation S-B (which is no longer in existence), Regulation D, Rule 701 (for issuance pursuant to certain employee benefit plans) or the Offering Circular regulation (12 C.F.R. 563g) promulgated by the Office of Thrift Supervision (which was merged with the OCC).
Most of the time, an acquiring bank will choose to comply with the Regulation D disclosure requirements because these are the most familiar. The FDIC’s statement of policy specifically notes that the disclosure goals will be met if a bank complies with the disclosure requirements of Regulation D, “relating to private offers and/or sales to accredited investors.” However, this is where some confusion lies.
Interestingly, private offerings to accredited investors under Rule 506 of Regulation D do not have any disclosure requirements other than providing (1) a description of resale restrictions (which, for bank stock would be none since they are exempt securities under Section 3(a)(2) of the Securities Act and may be freely transferred) and (2) the opportunity for each investor to ask questions and receive answers or other information from management. Presumably the FDIC intended for the disclosure requirements for private offerings under Rule 506 that involve nonaccredited investors, as opposed to accredited investors, to be the applicable standard in their policy. This would require disclosure similar to what would be contained in Part I of the applicable registration form or the Regulation A narrative disclosure, plus certain financial information depending on the size of the offering. However, this is not what the policy statement says. Read literally, this option, technically, would not require a bank to disclose anything to target shareholders who are being offered stock of the acquiring bank in a merger transaction. Of course, the anti-fraud provisions would still apply notwithstanding the fact there may not be a disclosure obligation.
Given the significant changes in the SEC rules and regulations since the implementation of its policy in 1994, the FDIC should consider revisions to modernize its policy and, at a minimum, to remove out-of-date references. Also, given the considerable amounts of information concerning banking institutions available to the public, the FDIC should also consider a more streamlined approach to its disclosure requirements related to the public offering of exempt bank stock.