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4000 - Advisory Opinions

Section 23A of the Federal Reserve Act


October 12, 1989

Gerald J. Gervino, Senior Attorney

As discussed, you have forwarded correspondence and relevant background information concerning the subject bank ("bank"). The subject bank has been the subject of several previous discussions concerning violations of Section 23A of the Federal Reserve Act, 12 U.S.C. 371c ("Section 23A"), but continues to avoid taking actions that we have suggested would eliminate future violations.

Our examiners found that two loans to affiliates of the subject bank were unsecured and thus in violation of the collateral requirements of Section 23A(c). Affiliation was maintained by a large shareholder who indirectly controlled 98 percent of the bank's stock through ownership of 27.17 percent of the stock of the bank holding company, which owned and continues to own the above 98 percent block of bank stock. In response to our criticism, the bank sold the loans to another financial institution.

The common shareholder then entered into a voting trust agreement with respect to 2.42 percent of the bank's stock, an amount sufficient to lower his ownership percentage to 24.75 percent of the bank's outstanding stock. The agreement states that it has a one-year term.

When the agreement came into effect, the bank repurchased the loans. We criticized the repurchases and the bank resold the loans. They are now questioning our earlier opinions and have submitted an opinion of local counsel. Counsel states that he knows of no reason that the agreement would not, under local law, legally pass control and voting authority of the stock transferred from the principal shareholder to the trustee. Counsel also points out that legal title to the stock is transferred to the trustee. Thus, he maintains, the principal shareholder would be "deemed" to no longer have "control" of the bank or the holding company under Section 23A(b)(3)(A)(i).

Control for Purposes of Section 23A

In the situation presented, the applicable definition of "affiliate" includes any company that is controlled directly or indirectly, by a trust or otherwise, by or for the benefit of shareholders who beneficially or otherwise control, directly or indirectly, by trust or otherwise, the bank or any company that controls the bank. Section 23A(b)(1)(C)(i).

While Section 23A has no definition of "control" as such, it does deem persons to have control over other persons if they own, control or have power to vote 25 per centum or more of any class of voting securities of the other company. Section 23A(b)(3)(A).

Section 23A does not confine its determination of control to situations that are deemed "control" by the statute. The use of control is broader than the absolute presumption established by the statute. For example, a person may control a company through beneficial ownership of that company's stock held in street name by a broker.

In the original citation by our examiners, the presumption of "control" at 25 per centum common ownership was correctly used. When that per centum was reduced through a transfer to a trustee of enough stock to bring the apparent figure below 25 per centum, "control" was not necessarily removed under the above definition of an "affiliate," if actual "control" existed and thus the presumption became unnecessary. We note that the companies cited as affiliates seem to have been able to move their loans in and out of the bank with complete freedom. Thus, the common shareholder(s) might be under actual "control" of the bank and also deemed in "control" of the companies cited as affiliates.

The Attempted Corrective Action

The movement of a very small percentage of voting stock to an independent trustee would show a questionable intent to relinquish control of the bank. However, these shares were transferred to a short-term trust (one-year) whose trustee has a common surname with the common shareholder and has not been represented as independent by the common shareholder(s). Based upon the information presented, we feel that the transfer of voting stock to the trustee, without evidence of his independence, does nothing to correct the situation. The common shareholder apparently still "controls" the stock transferred and thus is deemed in control of the amount of stock in the original examiner's citation. Since subsequent activities have ratified the view that the common shareholder is able to control bank lending, we see no basis for considering the original violation to be corrected.

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