FDIC Federal Register Citations

Re: Insurance of State Banks Chartered as Limited Liability Companies
 

Dear Mr. Feldman:

The Independent Community Bankers of America (ICBA)¹ appreciates the opportunity to comment on the proposal by the FDIC to clarify that a limited liability company chartered under state law would be considered "incorporated" under state law and therefore eligible for deposit insurance under the Federal Deposit Insurance Act (FDI Act).

The ICBA believes that it is fully appropriate to give community banks a variety of options for structuring their operations. Since the LLC form of corporate structure provides another option for community banks, and because the proposal addresses any safety and soundness concerns, the ICBA generally supports the FDIC proposal, and recommends certain modifications for the final rule.

Background

Under the terms of the FDI Act, a state bank that is engaged in the business of receiving deposits other than trust funds and is incorporated under state law is eligible for deposit insurance. The FDI Act does not define the term "incorporated," and neither the Congressional record nor judicial precedent provides guidance.

The proposal lists four traditional attributes of a corporation: perpetual succession, centralized management, limited liability and free transferability of ownership interests. The FDIC notes that these same four attributes have been used by the Internal Revenue Service (IRS) to determine whether an entity should be taxed as a corporation instead of being taxed as a partnership.

In the last 25 years, a number of variants on the corporate and partnership structure have appeared for a variety of reasons, but these new creations have blurred the distinction between a corporation and a partnership.² For example, the Internal Revenue Code creates the concept of a Subchapter S corporation. A Subchapter S corporation has all of the attributes of a corporation, such as limited liability, centralized management, free transferability of interests and perpetual succession (using the FDIC term). However, by statute, a Subchapter S corporation is not taxed as a corporation but as a partnership, with income not taxed at the business level but passed through and taxed as income to the individual owners of the corporation.

One variant of the corporate structure is the limited liability company (LLC). As with corporations, LLCs are creatures of individual state law. Originally created in Wyoming in 1997, every state and the District of Columbia now has some variation of the LLC on its statutes. The issue before the FDIC is whether such an entity qualifies as "incorporated" under terms of the FDI Act and therefore is eligible for deposit insurance coverage.

The Proposal

Because different states have different requirements for LLCs, the FDIC proposes to determine that an LLC must have the four key components of corporate structure in order to be considered "incorporated." In other words, an LLC must have perpetual succession, centralized management, limited liability and free transferability of interests in order to meet the FDI Act definition of "incorporated." The FDIC has enumerated specific reasons for requiring each attribute in order to ensure the safety and soundness of the bank. For example, perpetual succession ensures the continuity of the bank and public confidence; centralized management is key to identify a discrete group of individuals responsible for the operation of the bank; and limited liability and free transferability of interests encourage investment in the business and facilitate the raising of capital. Any LLC with the four identified corporate attributes would be deemed a corporation under the proposal and therefore eligible for deposit insurance.

ICBA Position

The ICBA believes that it is appropriate to provide individual banks with the flexibility to structure their business operations as each individual bank sees fit, within the parameters of safety and soundness.

The use of the term "incorporated" is an unfortunate one. The FDIC has focused on the "corporate" element, but this is not the only approach. Webster's Third New International Dictionary defines incorporated as "united in one body" or "made a legal entity" as well as "formed into a corporation." Rather than continually assess whether a particular structural form is appropriate or unduly limiting banking industry choices regarding legal structure, the ICBA believes that the FDIC should focus on the element of "made a legal entity" under the definition, and therefore allow individual banks to elect any structure that is permitted for them under state law within the bounds of safety and soundness. In other words, the state charter and not the corporate structure should be controlling.

The ICBA does not disagree with the FDIC's analysis regarding the attributes of corporate status. However, as FDIC Chairman Donald Powell noted in a recent speech, the process of innovation and market evolution has yielded benefits that were impossible to predict,³ and the limited liability company is a legal variant resulting from an individual state's experiment with the corporate structure. While the FDIC can consider the enumerated factors in assessing whether a particular structure can be operated safely and soundly, ultimately the question should be whether the structure is recognized as a legal entity under state law.

Some of the factors are important to safe and sound operation, and therefore should be accorded greater weight. For example, perpetual succession is a factor that is important to ensure the entity will be an ongoing one. Unlike the traditional partnership, a bank and its customers should be assured that the entity will continue in operation barring any unforeseen circumstances. Similarly, centralized management assures the FDIC that the entity will be run properly.

However, other factors are less important for safety and soundness. Free transferability has been traditionally associated with the corporate structure. However, many existing banks operate as closely held companies, and it is common for a closely held corporation or its shareholders to place restrictions on the sale of stock, perhaps the most common being a requirement that stock be offered to other shareholders of the corporation before being sold to others. Moreover, since closely held company stock is almost never traded on a public exchange, valuing that stock can present hurdles that limit its transferability. Similarly, many thrifts are chartered as mutual companies, where free transferability does not apply. Therefore, the ICBA disagrees that free transferability should be accorded the same weight as continued existence.

Finally, while the Internal Revenue Service has used the four enumerated factors to assess whether an entity should be taxed as a corporation, the ICBA believes that federal taxation should be irrelevant to the FDIC assessment whether an entity qualifies for deposit insurance under the FDI Act.

Conclusion

The ICBA believes that the FDIC should permit a state bank organized as an LLC to obtain federal deposit insurance. While it may be appropriate for the FDIC to consider the four traditional corporate attributes as factors, the ICBA does not believe these factors should be given equal weight or should necessarily all be requisites. Fundamentally, the FDIC assessment should be whether the entity is properly chartered under state law and whether it can operate in a safe and sound manner.

Thank you for the opportunity to comment. If you have any questions or need any additional information, please contact ICBA's regulatory counsel, Robert Rowe, at 202-659-8111 or robert.rowe@icba.org.
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[1] ICBA is the nation’s leading voice for community banks and the only national trade association dedicated exclusively to protecting the interests of the community banking industry. ICBA has 5,000 members with branches in 17,000 locations nationwide. Our members hold nearly $511 billion in insured deposits, $624 billion in assets and more than $391 billion in loans for consumers, small businesses, and farms. They employ more than 239,000 citizens in the communities they serve.

[2] Generally, a partnership is a creature of common law, although most states have codified their existence.  Partnerships are distinguished from corporations in that there is no centralized management (each partner can make decisions), no transferability of interests or perpetual succession (the departure of one partner constitutes a dissolution of the partnership), and no limited liability (each partner is fully liable for the debts of the partnership).

[3] Speech by Chairman Powell to the Exchequer Club, Washington, DC, October 16, 2002.

Sincerely,
Kenneth A. Guenther
President and CEO