Financial Institutions

FDIC Statement of Policy on Bank Stock OfferingsWith 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, 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 Continue Reading The FDIC should consider updating its outdated statement of policy on bank stock offerings

Investment advisers vs broker-dealersWhen managing investments and strategies for personal financial goals, retail investors often seek guidance from their investment advisers, and on an increasing basis, from their broker-dealers.  Broker-dealers and investment advisers are regulated extensively, but the regulatory requirements differ.  Broker-dealers and investment advisers are also subject to different standards under federal law when providing investment advice about securities.

The Investment Advisers Act of 1940 regulates specified financial professions, including financial planners, money managers, and investment consultants.  Under the Advisers Act, an investment adviser is any person who, for compensation, is engaged in a business of providing advice to others or issuing reports or analyses regarding securities.  With regard to the required standard of care applied to investment advisers when providing advice to their clients, applicable case law requires a fiduciary standard which, essentially, requires that the advisor put the client’s interests first, ahead of his or her own interest.

The Securities Exchange Act of 1934 and its implementing rules comprise the most central regulatory apparatus for broker-dealers. The Exchange Act defines a broker as a “person engaged in the business of effecting transactions in securities for the account of others,” while a dealer is a “person engaged in the business of buying and selling securities for his own account.” In comparison to the fiduciary obligation of an investment advisor, broker-dealers currently have a less stringent “suitability standard” that requires that investment products they sell fit an investor’s financial needs and risk profile.

Under the Investment Advisers Act, registered broker-dealers are excluded from its terms so long as Continue Reading Uniform fiduciary standard for broker-dealers and investment advisers? Proceed with caution!

With newer methods to communicate and interact with the so-called social network popping up on almost a daily basis, securities regulators have been giving more and more attention to social media and how companies and certain regulated professionals are employing it. As we discussed in a previous blog, the SEC has signed off on public companies utilizing social media for disclosure purposes, provided that, among other things, companies disclose to investors the types of social media outlets they will employ for such purposes. The SEC has issued guidance on the use of social media by public companies for Regulation FD and other disclosure purposes, which can be found in this SEC Press Release and in the SEC’s report on its investigation of the Facebook postings made by Netflix’s CEO.

Now it appears that social media is gaining the attention of FINRA as well, the primary self-regulatory organization for registered broker-dealers. As reported in a recent article on CNN, FINRA wants state privacy laws to provide exemptions for registered broker-dealer firms that would permit such firms to access Facebook and other social media accounts of their associated persons (i.e., stockbrokers). Because of the prominence and proliferation of Facebook and the personal or sensitive nature of the information contained on an individual’s Facebook page and other social media accounts, state legislatures have proactively enacted legislation that prevent or restrict companies from monitoring employees through social media. According to the National Conference on State Legislatures, six states enacted legislation in 2012 that prohibits employers from requesting or requiring an employee, student or applicant to disclose a user name or password for a personal social media account.

FINRA is concerned, however, that prohibiting access to employee social media accounts may affect a registered broker-dealer’s ability to fully comply with its mandated supervisory duties under federal laws and regulations. For example, registered broker-dealers are required to maintain copies of all “business communications” as discussed in guidance issued by FINRA in Regulatory Notice 11-39. Under Rule 17a-4(b)(4) of the Exchange Act, “business communication” includes “[o]riginals of all communications received and copies of all communications sent (and any approvals thereof) by the member, broker or dealer (including inter-office memoranda and communications) relating to its business as such, including all communications which are subject to rules of a self-regulatory organization of which the member, broker or dealer is a member regarding communications with the public.” Thus, if a stockbroker is using social media to Continue Reading Social media and brokers: FINRA wants broker-dealers to be “friends” with their employees

seed moneyThis is the second part of our Securities Law 101 series.  Because capital raising is such a critical function for emerging start-up companies, we designed this series to introduce their management teams to some of the fundamental concepts in securities law.  We hope that this series will prevent some of the most common mistakes management teams of start-up companies make.  We will periodically publish posts examining different aspects of securities law. 

So your company would like to raise money?  These days it seems like every company is in need of more capital, even banks that are in the business of lending their funds out to others.  Whether your business needs new funding for growth, or more funding to meet regulatory capital requirements, or your company has not been able to secure that loan the business needs, there are a lot of reasons to consider a private placement.  Here, we will explore the use of the private placement to raise funds and the recent changes in securities laws that make this a better alternative than it was before.

We all know that there are many ways to raise money out there (and sales of stock through crowdfunding isn’t one of them yet), but one typical way would be to sell equity in your company to private investors.  All securities offerings must be registered unless an exemption exists.  Therefore, these deals are generally set up as private placements exempt from registration under SEC Rule 506, which allows an unlimited amount of money to be raised from an unlimited number of accredited investors (and up to 35 non-accredited investors).  Accredited investors are those individuals whose joint net worth with their spouse is at least $1 million, excluding the value of any equity in personal residences but including any mortgage debt to the extent it exceeds the fair market value of the residences.  The term also includes individuals with income exceeding $200,000 in each of the two most recent years, or joint income with their spouse exceeding $300,000 in each of those years, plus a reasonable expectation of reaching these income levels in the current year.  There are also other types of accredited investors such as companies with total assets in excess of $5 million.  Consequently, there are several categories of accredited investors out there that can potentially help with funding.

We recommend limiting the offer of securities in a private offering to only accredited investors.  The reason for this is that Continue Reading Securities Law 101 (Part II): Avoiding the pitfalls in a private placement

Just when it appeared that small banks and their holding companies could simply go private or “go dark” under the new rules in the Jumpstart Our Business Startups (JOBS) Act, legacy rules are significantly slowing the process for some.  Under the JOBS Act, banks and bank holding companies may now go dark if they have fewer than 1,200 shareholders, but the process can be delayed.  Sometimes the delay can last up to a full year, and during that time, the expenses of remaining a public company continue to add up. 

The main reason for the delay is that the JOBS Act does not expressly provide full relief from reporting obligations.  While banks and bank holding companies can deregister from Section 12(g) of the Securities Exchange Act of 1934 if they have less than 1,200 shareholders, there is only limited relief from Section 15(d).  Section 15(d) contains reporting requirements for issuers that file or update a registration statement during the current fiscal year.  Under this section that was amended by the JOBS Act, a banking company going dark could suspend its reporting obligations, effective as of the beginning of the current fiscal year, provided that it did not update or file a registration statement during its current fiscal year.  If the banking company filed a registration statement or updated one as required by Section 10(a)(3) of the Securities Act of 1933 (updating a registration statement on Form S-3 or Form S-8 can be accomplished by merely filing a Form 10-K), Section 15(d) would then require continued public filings (i.e., all Form 10-Qs and the Form 10-K) for the current fiscal year. 

Recognizing the problem, the SEC is providing some relief.  In recent situations where a public bank has an outstanding registration statement, like a shelf registration or a benefit plan S-8, the SEC has been granting no-action relief and allowing the companies to go dark so long as there are no sales of securities under the registration statement during the current fiscal year.

This relief, however, does not go far enough to help some banking companies.  Particularly, those that have sales under a registration statement will be required to continue reporting for the remainder of the fiscal year.  In the past the SEC has given no action relief allowing companies to suspend their Section 15(d) reporting obligations when the number of shares sold in the fiscal year was nominal; however, the SEC has informed us that its current position is that no relief can be granted.  It is the SEC’s position that any sales in the current fiscal year makes the company ineligible for no action relief from its reporting obligations under Section 15(d).  This apparent change in position causes a significant expense and delay for banking companies that otherwise have been targeted for relief under the JOBS Act.  Considering the intent of the JOBS Act (i.e., to relieve the huge burdens on smaller companies), it would seem that the SEC should provider even greater relief in this area.

Bowing to industry pressure, FINRA has adopted vastly scaled back private placement requirements under FINRA Rule 5123.  Originally proposed in October 2011, the proposed rule was highly controversial because it significantly infringed on the capital raising process.  In particular, the originally proposed rules would require each offering to have an offering document, which must include anticipated use of proceeds and the amount of expenses to be paid to the participating broker-dealer.  The offering document would have had to be filed with FINRA and at least 85% of the proceeds must have been used for the business purposes required to be disclosed in the offering document.  After receiving scathing criticism, FINRA proposed various amendments with each amendment softening the originally proposed rule.

The final Rule 5123, which the SEC has granted accelerated approval, now requires each FINRA member firm that participates in a private placement of securities to file a copy of any private placement memorandum (PPM), term sheet, or other offering document used in connection with a sale, within 15 days of the date of the first sale. Where no such documents are created or used in connection with a covered offering, the rule requires that the participating member provide FINRA with notice that no disclosure documents were used. I believe that this watered-down version of FINRA Rule 5123 is much more consistent with Congress’s intent in making capital raising not a burdensome process.

FINRA Rule 5123 does provide confidential treatment to the offering documents.  In addition, FINRA has made it clear that the filing requirement is merely a notice filing and the offering is not subject to a review or approval process by FINRA.  The filing obligations rest with each participating member in an offering and not with the issuer.  Certain offerings are exempt from the notice filings, including offerings made of bank (not bank holding company) securities.

Generally, I strongly object to any obstacles to capital raising.  While I do not agree with the addition of this notice filing, I applaud the industry’s collective effort to largely curtail the original burdensome requirements.

With the passing of the Jumpstart Our Business Startups (JOBS) Act, the thresholds for whether a company must be public changed dramatically. This is particularly true for smaller banks and bank holding companies. 

The prior rule required registration with the SEC if the institution reached 500 or more holders of a single class of stock and had $10 million in assets. After the JOBS Act, the ownership number increased to 2,000 shareholders. Further, banks and bank holding companies may now deregister with fewer than 1,200 shareholders, a number previously set at 300. 

So the race is on for many smaller banks and bank holding companies to go private and save the high costs associated with being a public company.

At first glance, it may appear obvious that going private is the best thing to do. However, this is not necessarily the case. 

  • Many investors prefer having regular and comprehensive disclosures about their investments. This is required for public companies, but not for private ones. 
  • Also, investors like liquidity in their stocks. However, stocks in private companies are harder to trade, if they can be traded at all. 
  • Merger prospects can also be reduced by going private because it is harder to use private company stock as currency in a deal. 

For these reasons, the decision to go private should be considered carefully on a case-by-case basis.

The SEC Division of Corporate Finance recently issued guidance to smaller financial institutions concerning Management’s Discussion and Analysis and accounting policy disclosures. The guidance can be found in CF Disclosure Guidance: Topic No. 5, dated April 20, 2012 and amounts to rules to follow for future filings that should not be ignored.

The Division focused on the following areas:

  • Allowance for Loan Losses
  • Charge-off and Nonaccrual Policies
  • Commercial Real Estate
  • Loans Measured for Impairment Based on Collateral Value
  • Credit Risk Concentrations
  • Troubled Debt Restructurings and Modifications
  • Other Real Estate Owned
  • Deferred Taxes
  • Federal Deposit Insurance Corporation Assisted Transactions

The Division made it clear that the guidance is not one-size-fits-all so registrants will need to carefully analyze the guidance and how it may apply to them. While the guidance is too lengthy to summarize here, the Division appears to be focused on making the disclosures in the areas above more transparent and meaningful. For example, the Division wants more disclosure on how a registrant calculates the allowance for loan losses and the components of the allowance. Given the financial difficulties facing financial institutions over the past several years, this guidance is not surprising.

The guidance essentially provides a list of issues for each category above that needs to be addressed in a registrant’s Management’s Discussion and Analysis and accounting policy disclosures. This roadmap will be a useful tool for small financial institutions with their future SEC filings. Make sure to consider it when drafting your next registration statement or periodic report to help avoid comments from the SEC.

Last Friday, the SEC’s Division of Corporate Finance issued its fourth topic in its CF Disclosure Series, which periodically provides the SEC’s views on various topics.  This time, the SEC addressed, what it believes to be, inconsistent disclosures on European sovereign debt holdings.  The SEC reminds registrants, particularly bank holding companies, of their obligations to identify known trends or known demands, commitments, events, or uncertainties in their MD&A.  Generally, the SEC expects supplemental disclosure to be provided by country, segregated between sovereign and non-sovereign exposure, and financial statement category.  Registrants must focus on countries that are “experiencing significant economic, fiscal and/or political strains such that the likelihood of default would be higher than would be anticipated when such factors do no exist.”  In addition, the SEC expects to see additional risk factors addressing European sovereign debt exposure and heightened disclosures in the market risk discussion.

For a more detailed outline of what disclosure is relevant and appropriate, click here to view the SEC’s complete guidance.

Considering the time and expense it takes to comply with many of the Federal Reserve rules, it seems odd that any company would volunteer to be regulated.  But some want to sign up.  In particular, some foreign companies that own a securities broker or dealer are required to register in the U.S. to do business here.  These companies are known as securities holding companies and may be required by their foreign regulators to be supervised in the U.S. on a consolidated basis.

Historically, these companies registered with the SEC, but the Dodd-Frank Act moved this responsibility to the Federal Reserve.  This change will effectively consolidate the regulation of holding companies under the Federal Reserve, which is the U.S. regulator that is best equipped to regulate these entities because it already regulates bank holding companies.  For this reason alone, the move makes sense.

To implement the move, the Federal Reserve recently put out proposed rules for comment.  The proposed rules lay out the procedures for electing to be regulated and other requirements, including the filing of the election, the provision of additional information, and a 45 day waiting period that may be shortened in the Federal Reserve’s discretion.  Comments on the proposed rules must be received by October 11, 2011.