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A federal savings association (FSA) supervised by the Office of the Comptroller of the Currency (OCC) filed a second-tier formal appeal with the Ombudsman. The FSA disputed a matter requiring attention (MRA) issued in a report of examination (ROE) that directed it to divest certain equity shares.
The appeal asserted that the decision for the first-tier appeal filed with the Deputy Comptroller incorrectly relied on the Home Owners’ Loan Act (HOLA) and ignored OCC guidance on the powers of an FSA. The appeal asserted there is “no express precedential determination” regarding the ability of an FSA to retain equity interests that are a byproduct of permissible activity.
The appeal asserted that the directive to divest was inconsistent with 12 USC 24(7), as interpreted by Interpretive Letter (IL) 1075, and that IL 1075 could also apply to FSAs based on the OCC’s comparison of powers of FSAs and national banks. The appeal further stated that the equity shares did not violate 12 CFR 1.6, which prohibits ownership of securities convertible into stock at the option of the issuer, because the conversion was at the option of the bank. The appeal continued to assert that the bank relied on the absence of any explicit prohibitions or advisories from the supervisory office (SO) to determine whether the activity was permissible.
Finally, the appeal asserted that the forced divestiture of the converted equity shares could result in considerable financial losses for the bank and did not allow for an orderly or strategic divestiture that could mitigate potential negative outcomes. As such, the appeal requested that the Ombudsman stay the SO’s determination pending the outcome of the appeal.
The Ombudsman conducted a comprehensive review of the appeal using the following supervisory standards in effect at the time of the examination including:
The Ombudsman concurred with the SO’s decision to issue the MRA. The Ombudsman determined it was not appropriate to apply an additional stay on the direction provided to the bank to divest the shares because during the first-tier formal appeal, the Deputy Comptroller granted an extension on the divestiture that extended beyond the second-tier appeal decision period.
The Ombudsman determined that section 5 of the HOLA was the correct governing statute for an FSA setting forth permissible loans and investments. The equity investments authorized under section 5 of the HOLA do not include equity shares of a publicly traded corporation. In addition, 12 CFR 1 is not applicable to FSAs because the regulation addresses investments national banks can hold. Therefore, absent some other source of authority, the converted equity shares cannot be held for investment purposes.
The factual circumstances in this matter, including the bank’s proactive participation in the exchange offer and the lack of meaningful transfer restrictions on the converted equity shares, are materially different than those considered by the OTS as “incidental powers” in the Chief Counsel’s opinion letters, and run counter to the analytical framework set forth in those letters. The bank did not automatically obtain the converted equity shares from passively holding the shares the bank previously held. Instead, the bank initiated a new transaction when it participated in the share exchange whereby the bank acquired a new unit of ownership in the corporation (the converted equity shares) with a fundamentally different characteristic (units of equity ownership that are freely transferable to any person).
There is no persuasive basis for the appeal’s position that IL 1075 is applicable to FSAs and their distinct statutory authorities. IL 1075 was specifically applicable to national banks and their relevant statutory authorities. The factual record in IL 1075 is significantly different in comparison to the circumstances involving the bank. IL 1075 opined on the permissibility for a national bank to automatically receive equity shares with transfer restrictions when those shares were received because of the national bank’s membership in a payments network system that converted to a stock form of ownership. Conversely, the bank received its converted equity shares with materially no transfer restrictions and through a voluntary and proactive participation in an exchange offer that was partially premised on providing liquidity to shareholders. Moreover, the bank is specifically holding these shares for investment purposes.
The Ombudsman stated that potential financial loss and permissibility of the investment are separate issues. Potential financial loss, from holding an investment, does not change the conclusion regarding the legal permissibility of retaining the converted equity shares. The share exchange was to provide liquidity to banks, not to hold the converted equity shares for speculative purposes. Further, the appeal provided no basis to support the claim that the sale of converted equity shares would result in financial loss.
The Ombudsman noted that the OCC’s comparison of powers of FSAs and national banks should be used as a general guide and not relied on to make investment decisions. The document contains the disclaimer, “this chart is intended to provide a summary of basic powers . . . (and) is not intended to be a complete inventory of the activities permitted for either type of charter. The chart should not be cited as precedent. The powers identified in this document are evolving and the statutes and regulations cited may be revised in the future. Different facts than those presented in relevant precedent may lead to different results. Institutions should not engage in activities relying on this document and instead should review the authorities cited here and other relevant law, precedent, and [OCC] guidance before engaging in an activity.”
The Ombudsman stated that it is ultimately the responsibility of the bank to determine legal permissibility for itself. The record showed the examiner did not state the activity was permissible and requested to be kept informed of the bank’s considerations, which the bank did not do.
