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FED ER AL RESERVE BANK O F NEW YORK [ Circular No. 803 3 1 January 12, 1977 J INTERPRETATION OF REGULATION Y Acquisition of Shares Pursuant to §4(c) (6) of the Bank Holding Company Act To A ll Bank Holding Companies, and Others Concerned, in the Second Federal Reserve District: The Board of Governors of the Federal Reserve System has issued an interpre tation of its Regulation Y, “Bank Holding Companies,” in connection with a pro posal under which a number of bank holding companies would each purchase a stock interest representing less than 5 per cent of the voting shares of an insurance com pany that would engage in underwriting or reinsuring credit life and credit accident and health insurance sold in connection with extensions of credit by each stockholder. The Board has determined that a bank holding company wishing to become a stock holder in the company would be required to obtain the Board’s prior approval to do so, and that the exemption from such approval provided by section 4 (c )(6 ) of the Bank Holding Company Act was intended to be limited to passive investments. Enclosed is a copy of the interpretation. Any inquiries thereon may be directed to our Domestic Banking Applications Department. Additional copies of the enclo sure will be furnished upon request. P a u l A. V olcker , President. Board of Governors of the Federal Reserve System BANK HOLDING COMPANIES IN TER PR ETA TIO N OF REGULATION Y §225.137—Acquisitions of shares pursuant to §4(c)(6) of the Bank Holding Company Act. ing bank holding companies may acquire such interests in the company without prior approval of the Board. (a) The Board has received a request for an interpretation of §4(c) (6) of the Bank Hold ing Company Act ( “Act” )* in connection with a proposal under which a number of bank hold ing companies would purchase interests in an insurance company to be formed for the pur pose of underwriting or reinsuring credit life and credit accident and health insurance sold in connection with extensions of credit by the stockholder bank holding companies and their affiliates. (d) On the basis of a careful review of the documents submitted, in light of the purposes and provisions of the Act, the Board has con cluded that §4(c) (6) of the Act is inapplicable to this proposal and that a bank holding com pany must obtain the approval of the Board be fore participating in such a proposal in the manner described. The Board’s conclusion is based upon the following considerations: (b) Each participating holding company would own no more than 5 per cent of the out standing voting shares of the company. How ever, the investment of each holding company would be represented by a separate class of voting security, so that each stockholder would own 100 per cent of its respective class. The participating companies would execute a formal “Agreement Among Stockholders” under which each would agree to use its best efforts at all times to direct or recommend to customers and clients the placement of their life, accident and health insurance directly or indirectly with the company. Such credit-related insurance placed with the company would be identified in the records of the company as having been origi nated by the respective stockholder. A separate capital account would be maintained for each stockholder consisting of the original capital contribution increased or decreased from time to time by the net profit or loss resulting from the insurance business attributable to each stock holder. Thus, each stockholder would receive a return on its investment based upon the claims experience and profitability of the insurance business that it had itself generated. Dividends declared by the board of directors of the com pany would be payable to each stockholder only out of the earned surplus reflected in the re spective stockholder’s capital account. (c) It has been requested that the Board issue an interpretation that §4(c) (6) of the Act provides an exemption under which participat * Section 4 (c)(6 ) of the Act provides an exemption from the Act’s prohibitions on ownership of shares in nonbanking companies for “shares of any company which do not include more than S per centum of the outstanding voting shares of such company.” [Enc. Cir. No. 8033] (1) Section 2 (a )(2 )(A ) of the Act pro vides that a company is deemed to have control over a second company if it owns or controls “25 per centum or more of any class of voting securities” of the second company. In the case presented, the stock interest of each participant would be evidenced by a different class of stock and each would, accordingly, own 100 per cent of a class of voting securities of the company. Thus, each of the stockholders would be deemed to “control” the company and prior Board ap proval would be required for each stockholder’s acquisition of stock in the company. The Board believes that this application of § 2 (a)(2 )(A ) of the Act is particularly ap propriate on the facts presented here. The com pany is, in practical effect, a conglomeration of separate business ventures each owned 100 per cent by a stockholder the value of whose eco nomic interest in the company is determined by reference to the profits and losses attributa ble to its respective class of stock. Further more, it is the Board’s opinion that this ap plication of §2(a )(2 )(A ) is not inconsistent with §4(c)(6). Even assuming that §4(c)(6) is intended to refer to all outstanding voting shares, and not merely the outstanding shares of a particular class of securities, §4(c)(6) must be viewed as permitting ownership of 5 per cent of a company’s voting stock only when that ownership does not constitute “control” as otherwise defined in the Act. For example, it is entirely possible that a company could exer cise a controlling influence over the manage ment and policies of a second company, and thus “control” that company under the Act’s definitions, even though it held less than 5 per cent of the voting stock of the second company. To view §4(c ) ( 6 ) as an unqualified exemption PRINTED IN NEW YORK (OVER) for holdings of less than 5 per cent would thus create a serious gap in the coverage of the Act. (2) The Board believes that §4(c)(6) should properly be interpreted as creating an exemption from the general prohibitions in §4 on ownership of stock in nonbank companies only for passive investments amounting to not more than 5 per cent of a company’s outstand ing stock, and that the exemption was not in tended to allow a group of holding companies, through concerted action, to engage in an ac tivity as entrepreneurs. Section 4 of the Act, of course, prohibits not only owning stock in nonbank companies, but engaging in activities other than banking or those activities permitted by the Board under §4(c)(8) as being closely related to banking. Thus, if a holding company may be deemed to be engaging in an activity through the medium of a company in which it owns less than 5 per cent of the voting stock it may nevertheless require Board approval, des pite the §4(c)(6) exemption. (e) To accept the argument that §4( c ) (6) is an unqualified grant of permission to a bank holding company to own 5 per cent of the shares of any nonbanking company, irrespec tive of the nature or extent of the holding com pany’s participation in the affairs of the non banking company would, in the Board’s view, create the potential for serious and widespread evasion of the Act’s controls over nonbanking activities. Such a construction would allow a group of 20 bank holding companies — or even a single bank holding company and one or more nonbank companies — to engage in entrepre neurial joint ventures in businesses prohibited to bank holding companies, a result the Board believes to be contrary to the intent of Congress. (f) In this proposal, each of the participat ing stockholders must be viewed as engaging in the business of insurance underwriting. Each stockholder would agree to channel to the com pany the insurance business it generates, and the value of the interest of each stockholder would be determined by reference to the profit ability of the business generated by that stock holder itself. There is no sharing or pooling among stockholders of underwriting risks as sumed by the company, and profit or loss from investments is allocated on the basis of each bank holding company’s allocable underwriting profit or loss. The interest of each stockholder is thus clearly that of an entrepreneur rather than that of an investor. (g) Accordingly, on the basis of the factual situation before the Board, and for the reasons summarized above, the Board has concluded that §4(c ) ( 6 ) of the Act cannot be interpreted to exempt the ownership of 5 per cent of the voting stock of a company under the circum stances described, and that a bank holding com pany wishing to become a stockholder in a com pany under this proposal would be required to obtain the Board’s approval to do so. Board of Governors of the Federal Reserve System, December 23, 1976.
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