SEPTEMBER 23, 2008

FINANCIAL INSTITUTIONS UPDATE The Financial Institutions Regulatory Practice Group of Sidley Austin LLP The Financial Institutions Regulatory Practice group offers counseling, transaction and litigation services to depository and nondepository financial institutions and their holding companies. Our lawyers assist domestic and foreign financial institutions and their holding companies, and electronic payment systems, as well as securities, insurance, finance, mortgage and other diversified financial services companies.We represent financial services clients before the U.S. Department of the Treasury, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and state bank regulatory agencies. Our lawyers appear on behalf of clients before the Securities and Exchange Commission, the National Association of Securities Dealers and state securities regulators. In addition, we represent clients before the United States Supreme Court, the federal courts of appeal, federal district courts and state courts.

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Federal Reserve Board Releases Policy on Minority Equity Investments in Banks On September 22, 2008, the Board of Governors of the Federal Reserve System (Fed) issued guidance (Guidance) that further refines, clarifies and, to a limited extent, relaxes the Fed’s prior positions on the circumstances under which it would find a minority equity investment in a bank or bank holding company to constitute a “controlling influence over the management or policies” of the bank or bank holding company.1 The Guidance is an important development for private equity groups, hedge funds and others who are considering taking equity positions in banks. Background

Under the Bank Holding Company Act (BHCA), an investor that makes a minority equity investment (generally, less than 25% of any class of the voting securities) and that does not control the election of a majority of the directors or trustees of a banking organization does not come within the BHCA definition of a “bank holding company” unless the Fed determines that the investor directly or indirectly exercises a “controlling influence over the management or policies” of the banking organization. 12 U.S.C. §1841(a)(2). Investors that make such noncontrolling minority investments are excluded from the restrictions and regulatory supervision applicable to bank holding companies pursuant to the BHCA. Guidance

In the Guidance, the Fed outlines specific circumstances under which, in the absence of other indicia of control, it generally would not find that a minority equity investor exercises a “controlling influence over the management or policies” of a banking organization. However, the Fed also makes clear that it will continue to make all determinations of minority equity investment control on a case-by-case basis in light of the specific facts and circumstances of each situation, including the amount of influence the investor actually exercises over the banking organization. Directors. Previously, the Fed generally took the position that a minority equity investor in a banking organization would be considered to have a “controlling influence” if it 1

The recent Guidance will be codified at 12 C.F.R. §225.144. The Guidance is the Fed’s first policy statement on this topic since it announced its 1982 Policy Statement on Nonvoting Equity Investments by Bank Holding Companies, which is codified at 12 C.F.R. §225.143.

FINANCIAL INSTITUTIONS UPDATE PAGE 2

had a voting representative on the board of directors and owned between 10% and 24.9% of the voting stock of the banking organization. 2 Under the new Guidance, the Fed generally will not find that a minority equity investor exerts a “controlling influence” over a banking organization if, in the absence of other indicia of control:3

own, hold or vote 15% or more of any class of voting securities of the banking organization. Nonvoting Convertible Shares. It should further be noted, however, that the Fed continues to hold to the position that nonvoting shares that are convertible at the election of the holder or that mandatorily convert with the passage of time

•

•

the investor has only one voting representative on the board of directors of the banking organization; or the investor has up to two voting representatives on the board of directors of the banking organization, the investor’s aggregate board representation is proportionate to its total interest in the banking organization (measured as the greater of the investor’s voting interest or total equity interest) but does not exceed 25% of the voting members of the board and another shareholder of the banking organization is a bank holding company that controls the banking organization under the BHCA. Investors may round the calculation of their proportionate interest to the nearest whole number. For example, an investor that holds 15% of the voting shares of a bank would be able to have two directors on a 10-person board but not on a 9-person board.

must be considered voting shares at all times. By contrast, the Fed generally will not consider nonvoting convertible shares to be “voting shares” in the hands of the investor if the shares may not be converted while held by the investor and may only be transferred (i) to an affiliate of the investor 4 or the issuing banking organization, (ii) in a widespread public distribution, (iii) in transfers where no transferee (or associated group of transferees) would receive 2% or more of any class of voting securities, or (iv) to a transferee that would control more than 50% of the voting securities of the banking organization without regard to the transfer from the investor. While not entirely clear on the face of the Guidance, it also appears that the Fed would consider a control issue to be raised if the investor held shares convertible into more than one-third of a class of voting securities, assuming conversion of all convertible voting shares, even if the conversion feature were subject to the

Total Equity. Historically, the Fed considered the ownership of more than 25% of the total equity of the banking organization to create control issues. Under the new Guidance, an investor may own a combination of voting shares and nonvoting shares that, when aggregated, represent up to one-third of the total equity of the organization and does not allow the investor to

limitations set forth in the preceding sentence. Management Consultation. In addition to the foregoing changes, the Guidance also refines and clarifies other circumstances under which the Fed generally (and in the absence of other indicia of control) would find that a minority equity investor does not exert a “controlling influence.” In the area of

2

3

An exception to the prior policy allowed board representation by a minority investor if the investor owned less than 15% of the voting stock and another investor or group of investors owned a larger block of the bank organization’s voting stock. The Fed also states that a representative of a minority investor should not serve as the chairman of the board of directors of the banking organization or any committee. Further, a minority equity investor’s representatives on a board committee should not exceed 25% of the seats on the committee and should not have the authority or practical ability unilaterally to make or block the making of policy decisions that bind the board or management of the banking organization.

consultation between the investor and management of the banking organization, such circumstances include: •

a representative of the investor may attend board of directors meetings as a nonvoting observer; and

4

While not clear on the face of the Guidance, the Fed would require that an affiliate be subject to the same restrictions on exercise of the convertibility features of nonvoting shares.

FINANCIAL INSTITUTIONS UPDATE PAGE 3

•

an investor may advocate changes in policies, operations or management to the board or bank management; provided that (1) the decision of whether to adopt a policy or take an action remains with the banking organization’s shareholders, its board of directors or its management, (2) the investor’s role in making the decision is limited to the exercise of its r ights as a shareholder or the rights of its board representatives (each as limited pursuant to the BHCA, its regulations and the Fed’s policies) and (3) the investor’s communications do not threaten withdrawal of its investment or to sponsor a proxy solicitation as a condition of the action or nonaction of the banking organization or its management.

Business Relationships. The Fed continues to take a case-bycase approach to determining whether business relationships between an investor and the banking organization raise control issues when the investor’s interest exceeds 10%, taking into account the size of the investment, the size and materiality of the proposed business relationship, whether the terms of the proposed relationship reflect market terms, whether the relationship is non-exclusive and whether the banking organization can terminate the relationship without penalty. Relationships that are “quantitatively limited” and “qualitatively non-material” to the banking organization, generally will not raise an issue, particularly when the

investor’s interest in the banking organization’s voting securities is closer to 10% than to 25%. Covenants. Investors may obtain contractual covenants that give the investor certain limited class protections, such as prohibitions on issuing senior securities or senior debt, modifying the terms of the investors security, or liquidating the banking organization, or that provide the investor other noncontrolling rights, such as the right to limited financial information and limited consultation rights. On the other hand, covenants that restrict or inhibit the organization’s discretion over major policies and decisions, such as decisions regarding employment, executive compensation, new business lines, operations, raising capital, restructuring or merging, transferring material subsidiaries or assets, or acquiring material assets or control of another entity will generally be problematic from a control perspective. Conclusion

In sum, while the Guidance is not a dramatic departure from the Fed’s pr ior infor mal advice in the area, the modest loosening of control standards and codification of prior positions will facilitate the structuring of noncontrolling investments in banks and bank holding companies in the future.

If you have any questions regarding this update, please contact: William S. Eckland

David E. Teitelbaum

Joel D. Feinberg

202.736.8267

202.736.8683

202.736.8473

[email protected]

[email protected]

[email protected]

Gretchen E. Lamberg

Ming-Hsuan Elders

202.736.8083

202.736.8801

[email protected]

[email protected]

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Global M&A volume reached $2.5TR on September 1,2008, down 27% from 2007 YTD. Global M&A reached $2.5TT=Rin early September in 2008, compared to mid June in 2007 U Sponsor volume t ~ t a l s$318.58N in 2008 YTD, down 63% f r ~ m$852.6BN in 2007 YTD (sp~nsorinvolvement o,n any side)

D Average deal value, is $47&m in 2008 YTD, d ~ w nfrsm Q14M in 2007

Finance is the most targeted industry in 2008 YTD, with $SQO.ZBN, down 42% from $519,28N, fo_llswedby ~ d e e ~with r n $220.78N, dswn 4 5% fram. $259,8BN Middle East targeted M&A h m been t h e largest gercentgge decline in 2008 M D os vslume totals $l'l.Obn in 2008,YTD, down 52% fmm $35.5bn in 2007 YTD which was led by three f e l e ~ ~deals r n each for over $4.OBN i

U S is the most targeted nation for cross-barder deals in 2008 YTD with $256.7bn, up 8%from $239.OBN in 2007 YTD, followed by the UK with $1 15.3BN, down 17% from $138.8BN

I

Global M&A Reaches $2.5TR Cross-border SWF acquisitions totals $52.1 bn in 2008 M D , almost triple the volume of $18.7BN in 2007 YTD and the highest Yf volume on r e c ~ r d Seven deals over J25BN in 2008 YT'D ~ n exeeds d all greviqu3 M

Global M&A 2007 MD vs 2008 M D

Jan

Feb

Mar

Jun

2007 YTD

Source: Dealogic (as of September 3, 2008).

n 2008 Y l D

Jul

Aug

D

30-Apr-08 19-May-08

26-Sep-08

Origin Energy

BG Group

Australia

United Kingdom

15.3

30-Sep-08

Property Portfolio (Pennsylvania Turnpike)

Albertis Infraestructuras;, Citi Infrastructure Investors;, Criteria CaixaCorp

United States

Spain

12.8

TransAlta

Global Infrastructure Partners;, L S Power Equity Partners

Canada

Canada

10.1

Switzerland

9.5

9-Oct-08 -

-

-

Source: Dealogic (as of October 14, 2008).

.-

5

Germany M&A volume reaches $133.9BN in 2008 YTD,down 1 0 % from $148.4BN in 2007 YTD and exceeds all previous M D volumes except for 2007 M D which was the record y e w for German M&A Financial sponsor M&A buyouts account for 11% of t h e total German M&A vslurne, an par with 2007 YTD and f ~ uper~entage r - psi& &avr the glsbal @vetagesf 7% -*

d

Emerging Markets M&A Activity 2003-2008W D

Fmancial Sponsor M A Buyouts

Source: Dealogic (as of September 5, 2008).

YTD V o l w

- - - - N M e r of

Deals

9

D To date, global Banking M&A volume reaches $264.8BN in 2008 YTD, down 26% from $359.5&N in 2007 YTD

U Monthly Banking M&A volume reash.es$87.2&N in September SQfar and is the third lag&t m ~ n t h l yfigure on res~rd,Three d t h g t ~ five p Banking M&A deals in 2 ~ 0M-a , ~ announced &pternb_gr 2068 a

Global Banking M&A - September 2008 Banking (including S&Ls) M&A volume reaches $125.5BN for September 2008, the second highest monthly total on record, behind snly April 2007, when the $95.6BN acquisition Q ~ A B N Amro by RBS, Banso Santander and Fortis was announced

US targeted Banking M&A totals $63.7BN this month, led by m e $44.4BN acquisition of erri ill-~~neh by Bank of America, is the third large& king MSA rn~nthlytotal & rewrd

an

Mitsubishi UFJ Finoncial Group announced twa acquisitions in September: the $9.OBN $take acquisition (21%) of Morgan Stanley and the $1.4BN stake acquisition (24.2%) of Acom

Completed Financial Sponsor M&A transactions totaled $255.8BN in 2008 M D , down 60% from t h e $637.2BN in 2007 YTD and down 14% from $297.4BN in 2006 YTD

O Completed Sponsor- M&A t r e n s a d e n volume in 2008 YTD wgs t h e iowe~t YTD vslume since 20Q5 with $224.7BN

P U S i s t h e m a s t targeted ngtian with $63,3BN, f ~ l l ~ w by e d t h e UK with 29.4BN and

orm man^ with $14.4BN

P Most active financigl sponsor is TPG Capital with $14.8BN, f~llowedby KKR with $1 1.3BN and Carlyle Group with $8.9BN