Many financial institutions, particularly community banks, have enhanced the experience level of their boards by adding a director who is a banker or serves on the board of another financial institution. In general, utilizing a director who has current experience with another financial institution is a great way to add valuable perspective to a variety of issues that the board may encounter. In addition, as private equity funds made substantial investments in financial institutions, they often bargained for guaranteed board seats. The individuals selected by private equity firms as board representatives often serve on a number of different bank boards. As market conditions have led to increased bank failures, however, a problem has resurfaced that may cause some financial institutions to take a closer look at nominating directors who also serve other financial institutions: cross-guarantee liability to the FDIC.
The concept of cross-guarantee liability was added to the Federal Deposit Insurance Act by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA). The pertinent provision states that any insured depository institution shall be liable for any loss incurred by the FDIC in connection with:
- the default (failure) of a “commonly controlled” insured depository institution; or
- open bank assistance provided to a “commonly controlled” institution that is in danger of failure.
This means that if two banks are “commonly controlled” and one of them fails, the other bank can be held liable to the FDIC for the amount of its losses or estimated losses in connection with the failure. As many of us see each Friday, the amounts of these estimated losses are often quite high. In fact, the FDIC’s estimated losses for 2011 bank failures were approximately 20 percent of total failed bank assets for the year. Accordingly, the prospect of cross-guarantee liability can be a tremendous financial issue for the surviving bank.
On March 27, 2012, the House of Representatives approved the version of the JOBS Act, as amended by the Senate, by a vote of 380 to 41. Accordingly the legislation has been sent to President Obama for signature, who has previously indicated his support of the legislation. The White House has indicated that the President anticipates signing the JOBS Act early in the week of April 2, 2012.
The text of the final JOBS Act is available here. We have previously summarized the provisions of the JOBS Act generally applicable to the community banks, as well as the impact of the Senate amendment to the JOBS Act. In this post we focus on the timing implications for effectiveness of the amendments to Regulation D and shareholder thresholds for SEC registration and deregistration.
With regard to Regulation D, Section 201 of the JOBS Act requires the SEC to eliminate the prohibitions on general solicitation and general advertising in connection with Rule 506 and Rule 144A offerings, so long as the securities are only sold to accredited investors and qualified institutional buyers, respectively. The JOBS Act requires the SEC to implement these changes no later than 90 days after the JOBS Act is signed by the President. Until the SEC amends the existing regulations, general solicitation and general advertising will remain prohibited.
With regard to the shareholder threshold changes, Sections 501 and 601 of the JOBS Act immediately amend the statutory provisions related to the number of shareholders of record at which a company must register and when the company is permitted to register. The statutory changes are effective immediately upon enactment of the JOBS Act. However, the SEC has also adopted regulatory requirements based on the original statutory language that will likely need to be amended in order to fully take advantage of the revised thresholds.
On March 22, 2012, the U.S. Senate adopted H.R. 3606, the Jumpstart Our Business Startups Act (a.k.a., the JOBS Act) by a vote of 73 to 26. Prior to its passage, the U.S. Senate adopted Amendment 1884 proposed by Senators Merkley and Brown that replaced the “Crowdfunding” exemption contained in the house-passed legislation with a narrower provision. As the Senate and the House have adopted different versions, the House will have to consider and pass the Senate amendment before a bill could become law, or convene a conference committee to reconcile the House and Senate versions of the bill. (The Senate rejected by a voice vote Amendment 1931 proposed by Senator Reed that would have changed the SEC’s shareholder counting rules from record holders to beneficial owners.)
As the bulk of the JOBS Act was approved without change, our summary of the impact of the JOBS Act on community banks remains accurate.
The amended “Crowdfunding” provision includes significant restrictions on the potential utility of the new exemption, particularly for how it may have utilized by community banks. The ultimate utility of the Crowdfunding exemption will largely be tied to the implementing regulations to be adopted by the SEC. Under the Senate’s version of the JOBS Act, the Crowdfunding exemption would be available for up to $1 million in issuances in any 12-month period, require investors to purchase no more than 5-10% of their net worth in the issuance, and require the use of either a broker or “funding portal” as that term is defined in the bill.
While still in proposed form, and subject to significant political uncertainty, we offer this summary of the impact of the Jumpstart Our Business Startups Act (a.k.a., the JOBS Act). This summary is based on the version that passed the House on March 8, 2012, and was brought to the Senate floor on March 19, 2012. On March 20, 2012, the Senate failed to achieve sufficient votes to substitute the JOBS Act for the INVEST in America Act of 2012 (technically, it would have been the “Invigorate New Ventures and Entrepreneurs to Succeed Today in America Act of 2012,” but I think the acronym is a LOT better in this case), which contained some similar, but not identical, provisions. Accordingly, it appears that the JOBS Act, as adopted in the House, may be voted upon by the Senate this week.
Emerging Growth Companies
The bulk of the JOBS Act, and focus of most of the congressional debate, is on the creation of a new class of registered companies deemed “Emerging Growth Companies.” These registrants are not limited by business operations, and banks and bank holding companies could quality. An Emerging Growth Company would generally consist of newly public companies (IPO registration statement effective after December 8, 2011), with market caps of less than $750 million and total gross annual revenues (presumably interest income plus non-interest income for banks) of less than $1 billion. New registrants could quality for Emerging Growth Company status for up to five years following their IPO, at which time they would lose the advantages of being an Emerging Growth Company even if they otherwise continued to qualify.
An Emerging Growth Company would be exempt for the say on pay vote, as well as pay vs. performance and pay equality disclosures, and would not be required to have independent auditors attestations regarding internal controls under SOX 404. In addition, they would be eligible to generally rely on the scaled disclosures otherwise permitted for smaller reporting companies. In addition, an Emerging Growth Company would be provided the opportunity to initially file their draft IPO materials confidentially with the SEC and otherwise have greater flexibility in communications with regard to their IPO.
Modification of Securities Offering Exemptions
Within 90 days of passage, the SEC would be required to amend Regulation D and Rule 144A to permit general solicitation and advertising in Rule 506/Rule 144A offerings so long as the securities are only sold to accredited investors or qualified institutional buyers, respectively.
The Dodd-Frank Wall Street Reform and Consumer Protection Act codified a form of the Transaction Account Guarantee (TAG) program initiated by the FDIC that extended unlimited deposit insurance coverage to certain no- or low-interest transaction accounts. Under the Dodd-Frank version, which expires on December 31, 2012, there is no cap on FDIC insurance for “noninterest-bearing transaction accounts.” As we have explained, qualifying accounts must meet the statutory definition and cannot have even the potential to be paid interest. Congress modified this definition at the end of 2010 in order to extend coverage for IOLTA accounts (which may pay interest).
The industry is beginning to draw attention to the statutory expiration of this unlimited coverage. As originally initiated by the FDIC in 2008, the program was intended to stabilize large deposits in a time of crisis within the financial system. The Dodd-Frank extension of TAG was completely paid for by financial institutions under the general deposit insurance assessment framework. Community banks have arguably benefitted the most from the unlimited coverage provisions because the corporate, non-profit, and government depositors holding most of the affected accounts may have more concerns (real or imagined) about the continued solvency of small banks than of big banks. Without the guarantee, smaller banks may have to rely more on pricing in order to retain these depositors, potentially exposing the insurance fund to greater risk.
By one industry estimate, more than half of all TAG account balances (over $500 billion) are already held by just 19 banks over $100 billion in assets. According to the FDIC, more than three-quarters ($191.2 billion) of Q4 2011 growth in domestic deposits was attributable to account balances subject to the guarantee. The 10 largest insured banks accounted for 73.6 percent ($140.7 billion) of the growth in these balances during this period. As of December 31, 2011, the average institution with less than $1 billion in assets had 15 covered accounts worth an average of $713,000. Although liquidity is generally less of a concern than it was in 2008, these large depositors are more likely to seek loans and otherwise bank with institutions holding their TAG-size accounts.
The questions, then, are whether the industry and its regulators are unified around this issue and whether legislators will have the stomach to extend the program in an environment where initiatives seens to benefit banks are politically sensitive. The original FDIC manifestation was optional, with participating banks paying for the coverage. Although the Dodd-Frank version is universal, again, banks have picked up the tab through the assessment process. Nonetheless, it is always possible that an extension of the program will be marred as a boon to banks and a burden to taxpayers.
Notwithstanding the position of former Chairman Sheila Bair and some currently within the agency that the program should only be further extended by Congress, the FDIC stands at the center of the issue and could always extend the program administratively. FDIC’s 2008 program was authorized under the FDI Act by a determination by the Secretary of the Treasury in consultation with the FDIC and the Federal Reserve that conditions of ”systemic risk” justified an exception to the least-cost-resolution requirements of the Act. It was extended by the FDIC in 2009 as a continued response to this finding, although at that time the agency also cited as “additional authority” more general statutory language relating to its mission. We believe there is footing for a similar, transitional extension of the program under this broader authority. In fact, when the FDIC extended the program in 2010 through the end of that year, it reserved the right to extend the program through 2011 without additional rulemaking. This was ultimately not necessary in light of Dodd-Frank, and we think an additional regulatory extension is unlikely to occur here without significant advocacy for it. The Independent Community Bankers of America and the American Bankers Association, for their part, have recently outlined their views on the issue.
Meanwhile, examiners are beginning to ask how banks are planning for the expiration of the program. Many institutions are balancing this expiration with Dodd-Frank’s repeal of the prohibition on the payment of interest on business checking accounts (and by extension Regulation Q). Challenging as this may be in a time of regulatory uncertainty, these considerations should also be evaluated along with Regulation D’s reserve requirements (where restructured accounts may become demand deposits).
On January 6, 2012, the Advisory Committee on Small and Emerging Companies established by the Securities and Exchange Commission (“SEC”) recommended that the SEC take immediate action to permit general solicitation and general advertising in private offerings of securities under Rule 506 of Regulation D where securities are sold only to accredited investors. Relaxing the current restrictions on general solicitation and advertising would facilitate the ability of companies to raise capital from accredited investors, who are generally viewed as able to fend for themselves. For example, relaxing these restrictions would make it easier for companies to publicize their financing plans and seek funding from investors without any pre-existing relationship.
Rule 506 of Regulation D provides a widely-used safe harbor from the registration requirements of the Securities Act of 1933 for qualifying private offerings. Under current Rule 506, neither the issuer nor any person acting on the issuer’s behalf may offer or sell securities by any form of “general solicitation or general advertising,” and securities sold pursuant to Rule 506 may only be sold to “accredited investors” or persons who, either alone or with a representative, have sufficient knowledge and experience in financial and business matters to make them capable of evaluating the merits and risks of a prospective investment.
The Advisory Committee is of the view that the restrictions on general solicitation and advertising prevent many privately held small businesses and smaller public companies from gaining sufficient access to capital sources and thereby materially limit their ability to raise capital through private offerings. The Advisory Committee noted that the investor protections afforded by the existing restrictions on general solicitation and general advertising are not necessary in private offerings where the securities are sold solely to accredited investors. Because the concepts of general solicitation and advertising are vague, the prohibition increases compliance and diligence costs for issuers of securities who seek to avoid potential activities that might be deemed to constitute general solicitation or advertising and thereby destroy the availability of the Rule 506 safe harbor.
While any relief still has a long (and uncertain) path before it would be effective, on October 26, 2011, the House Financial Services Committee approved four bills (with bipartisan support) that would remove regulatory federal securities law obstacles to capital formation.
H.R. 1965 would, for banks and bank holding companies, raise the SEC registration threshold to 2,000 shareholders and the deregistration threshold to 1,200 shareholders.
H.R. 2167, the “Private Company Flexibility and Growth Act,” would raise the SEC registration threshold for all companies to 1,000 shareholders and would exclude accredited investors and certain employees from the definition of “held of record” for registration purposes.
H.R. 2940, the “Access to Capital for Job Creators Act,” would permit general solicitation and general advertising for private offerings conducted under Rule 506, so long as all purchasers were accredited investors.
On June 13, 2011, the Federal Reserve published an interim final rule nominally offering some relief from the capital effects of the Tier 2 treatment for SBLF funds for Sub S and Mutual bank holding companies.
As recognized by the Federal Reserve, “the SBLF Subordinated Securities, like the CPP Subordinated Securities, are issued to Treasury as part of a nationwide program to provide capital to eligible banking organizations that are in generally sound financial condition in order to increase the capital available for lending to small businesses, thereby mitigating the ongoing effects of the financial crisis on small business and promoting financial stability.” The Federal Reserve also acknowledged that “the SBLF Subordinated Securities are in terms and substance substantially equivalent to the CPP Subordinated Securities.” (more…)
A year ago today, the Dodd-Frank Act was signed into law. Today the Consumer Financial Protection Bureau “stands up,” the Office of Thrift Supervision has 90 days to live, and the Comptroller General’s study on the independence of presidentially appointed inspectors general of certain federal entities was due to Congress (don’t worry if you missed that last one). For many provisions of the Act, the legislation requires that implementing rules were to be finalized by today. As few of the hundreds of required rules have actually been proposed yet alone finalized, there is an argument that those aspects of the law requiring rules by today are not yet effective. Provisions of the law that are certainly effective today:
- Preemption standard for national banks and federal thrifts is altered
- Codification of the requirement that a bank holding company act as a “source of strength” for any subsidiary that is a depository institution
- Federal Reserve is authorized to issue orders and regulations relating to the capital requirements of holding companies
- Heightened capital requirements for interstate acquisitions
- New restrictions on insider asset sales and lending
- Truth in Lending Act exemption threshold for certain credit transactions and consumer leases is increased from $25,000 to $50,000 (i.e., TILA coverage is increased)
- Repeal of Regulation Q and the underlying statute (permitting payment of interest on demand deposit accounts)
- Increase in next-day availability requirement for deposit items not themselves subject to next-day availability under the Expedited Funds Availability Act from first $100 to first $200
- Required credit score disclosure under the Fair Credit Reporting Act where adverse action is based in whole or part on a consumer report
We will continue to follow rulemaking and enforcement of the Act and provide updates linked to our dedicated Dodd-Frank page. Regulators (and Barney Frank) are celebrating the law’s milestone today by testifying before the U.S. Senate on how the Act has improved supervision. Stay tuned.
On May 11, 2011, Georgia Governor Nathan Deal signed House Bill 30 into law, ushering in a new era for non-competition agreements (non-competes), non-disclosure agreements (NDAs), and non-solicitation covenants under Georgia law. Historically, Georgia courts have not been friendly to such agreements and have made enforceability unclear. The new statute clarifies and strengthens the ability of parties to restrict conduct during and after employment or a deal. Perhaps most importantly, the law expressly authorizes courts to cure or “blue pencil” such agreements signed on or after May 11, 2011. Under the previous regime, one faulty provision generally invalidated an entire restrictive covenant in Georgia. In addition, the new law makes clear that NDAs need not specify a time limit on a requirement to maintain information as confidential so long as the information otherwise remains confidential.
In Georgia, new consideration is not required to execute new non-competes, so employers are in a good position to strengthen their competitive protections under the revised statute, but action is required as only new agreements will enjoy the benefits of the new law. The new law also governs restrictive covenants between distributors and manufacturers, lessors and lessees, partnerships and partners, franchisors and franchisees, sellers and purchasers of a business or a commercial enterprise, and two or more employers.
In-Term Covenants Generally
The bill codifies many aspects of the law in this area that had developed in the Georgia courts. This includes the presumption that any restriction within an agreement that operates during the term of the underlying employment or business relationship is not unreasonable because it lacks any specific limitation on the scope of activity, duration, or geographic area as long as it promotes or protects the purpose of the agreement or deters any potential conflict of interest.