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Each depositor insured to at least $250,000 per insured bank

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4000 - Advisory Opinions

Whether ESOP is an Affiliate for Purposes of Section 23A


October 20, 1993

Gerald J. Gervino, Senior Attorney

You have requested an advisory opinion from our office to the effect that an insured State nonmember bank's ("bank") Employee Stock Ownership Plan ("ESOP") would not be an "affiliate" of the bank which established it under the definition set forth in § 23A of the Federal Reserve Act, 12 U.S.C. § 371c ("§ 23A'').

The bank has previously established the ESOP, which is a "qualified" defined contribution plan under §§ 401 and 4975 of the Internal Revenue Code. The ESOP currently holds a total of 168,349 shares of common stock of the bank or 9.1 percent of the bank's outstanding shares of common stock. In April of 1990, we provided your firm with an opinion indicating, among other things, that the ESOP did not appear to be an "affiliate" of the bank for purposes of § 23A. FDIC Advisory Opinion No. 90--18.

You are now inquiring as to whether or not we would take a similar position under the changed arrangements which you have now presented.

The Guarantee.

The bank intends to cause the ESOP to refinance its loan with the bank by a loan from a third-party lender. The lender would receive a guaranty from the bank secured by United States Treasury Notes or other acceptable collateral. This refinancing transaction would not remove the transaction from the definition of "covered transaction" under § 23A(b) (7), since a guaranty is the equivalent of a loan for purposes of the lending limits set out in § 23A(a) and the collateral requirements of § 23A(c). The bank's guarantee of the ESOP's obligation on the third party loan would not meet the collateral requirements of § 23A(c).

Instead, the willingness of the bank to provide security for its guaranty raises a question under § 23B of the Federal Reserve Act, 12 U.S.C. § 371c--1, ("§ 23B''). The extraordinary issuance of a secured guarantee also raises questions under 12 CFR Part 332 (1993), (proposed to be amended, 58 FR 6448 (1993)). While this type of guaranty might be considered outside the prohibitions of 12 CFR Part 332 because the bank would have an interest in the transaction, the addition of substantial security for the bank's obligation on the guaranty is beyond the precedents with which we are familiar. The extraordinary nature of the guaranty might also raise questions as to the safety and soundness of the transaction.

Increase in Shares.

A second change in the arrangements would be an increase in the shares of bank stock held by the ESOP. It would increase its ownership to about 15 percent of the bank's outstanding stock. Currently, the maximum percentage ownership must be maintained at less than 10 percent. You emphasize the lack of ESOP control in the proposed arrangement because of pass-through voting to employees holding allocated shares and the required voting of allocated and non-voted shares in proportion to the employees' voting of allocated shares.

Proportionate voting could be overridden by the trustees' exercise of their responsibility under the Employee Retirement Income Security Act ("ERISA") to vote the allocated shares in the economic best interests of the ESOP participants and their beneficiaries. The bank will ensure that the percentage of allocated shares will at no time exceed 10 percent.

You also indicate that the bank's board of directors would replace the current insider trustees with trustees who would not be directors, officers, employees, or shareholders of the bank and who would not otherwise be affiliated with the bank.

Requested Opinion.

In your view, the ESOP should not be considered an "affiliate" of the bank for purposes of § 23A and should be considered an "exempt affiliate'' as a non-bank subsidiary of the bank. In an apparent concern that we would view the ESOP as a parent of the bank, you note the absolute presumption of "control" set out at § 23A(b) (3) (A). That presumption of control sets a percentage of ownership equal to 25 percent of the outstanding stock, an ability to control management, or a determination by the Board of Governors of the Federal Reserve System that control exists.

You feel that the ESOP would not control the bank, even if the 10 percent presumption of "control" set out in 12 CFR § 303.4 (1993) would apply, because no one exercises discretionary power over 10 percent of the bank's stock, except in the case where allocated shares would not have been voted and the trustees would have determined, as required by ERISA, that proportionate voting is not in the best economic interests of the ESOP participants.

Under the facts that you have postulated, we are unable to conclude that the ESOP described would not be an "affiliate" of the bank. We also cannot conclude that it would be an exempt affiliate of the bank under § 23A(b) (2) (A).

If you have any further questions, please write or call me at (202) 898-3723. My FAX number is (202) 898-3715.

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