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4000 - Advisory Opinions


Effect of Proposed Holding Company Formation on the "Grandfathered" Status of a Subsidiary for Purposes of § 24(d) of the FDI Act

FDIC--94--36

July 13, 1994

Hong Le Nguyen, Attorney

This letter is in response to your recent request for guidance concerning a proposed holding company formation by an insured state bank (Bank) that owns a subsidiary (Subsidiary) with grandfathered insurance underwriting powers under section 24(d)(2)(B) of the Federal Deposit Insurance Act (FDI Act). 12 U.S.C. 1831(d)(2)(B). You asked whether the proposed holding company formation would affect the grandfathered status of the Subsidiary for purposes of section 24(d).

As pointed out in your letter, there is no express reference in section 24 to the effect of a corporate reorganization on a state bank which has a subsidiary that has grandfathered rights under section 24(d)(2)(B). For the reasons discussed below, I conclude that the proposed holding company formation should not affect the grandfathered status of the Subsidiary for purposes of section 24(d)(2)(B).

I.  The Statutory Construction of Section 24

Section 24 of the FDI Act was added by section 303 of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). The section's legislative history indicates, among other things, that Congress was concerned over the risks posed by insurance underwriting activities and the ability of state legislatures to leverage the federal deposit insurance guarantee by permitting state-chartered banks to undertake risks regarded as imprudent for national banks.

Section 24(a) and 24(d)(1) generally prohibit state-chartered institutions and their subsidiaries from undertaking activities not permissible for national banks unless the bank meets its minimum capital requirements and the FDIC determines that the activity does not present a significant risk to the deposit insurance funds. Section 24(b) and 24(d)(2)(A) specifically prohibit state banks and their subsidiaries from engaging in insurance underwriting activities except to the extent permissible for national banks. Thus, section 24(b) and 24(d)(2)(A) effectively deprive the FDIC, in the insurance underwriting context, of the limited waiver authority granted it by section 24(a) and 24(d)(1) for other activities of state banks and their subsidiaries. The restrictions of section 24(b) and 24(d)(2)(A) are subject to a limited grandfather exception in section 24(d)(2)(B). Section 24(d)(2)(B) permits a well-capitalized insured state bank or its subsidiary that was engaged in insurance underwriting, as principal, in a state on November 21, 1991, to continue underwriting the same type of insurance on behalf of residents and individuals employed in such state.

Section 24(d)(2)(C) contains another narrow exception to the prohibition against insurance underwriting for subsidiaries of state banks. That section allows a subsidiary of a state bank to underwrite title insurance if the bank was required, before June 1, 1991, to provide title insurance as a condition of its charter and control of the bank has not changed since that date. Similar language providing for loss of grandfathered activities under section 24 is found in section 24(f)(5), where a state bank loses its exception to acquire and retain ownership of securities upon any change in the bank's control or any conversion of its charter.

II.  Facts

The Bank is a well-capitalized state nonmember bank which owns all the issued and outstanding stock of the Subsidiary. The Subsidiary engages, as principal, in insurance underwriting activities and is grandfathered under section 24(d)(2)(B) of the FDI Act. The Bank is considering forming a holding company under the following scenario: (1) the Bank will organize a corporate subsidiary (Company); (2) the Company will organize a subsidiary state nonmember bank (Phantom); (3) the Bank and Phantom merge (Phantom survives the merger); and (4) Bank stock will be converted into Company stock. As a result of these transactions, which would occur roughly simultaneously, the Bank's shareholders become the Company's shareholders without any actual change in control. The converted Bank shareholders will continue to maintain control over the Subsidiary. There would be no material change in the assets, liabilities, operations, or articles of incorporation of the Bank. The only difference between the structure before and after the holding company formation is the existence of a holding company interposed between the Bank and its shareholders, and the operation of the Bank under a new state certificate of authorization.

III.  Discussion

As pointed out in your letter, there is no express reference in section 24 to the treatment of a corporate reorganization involving a state bank with a subsidiary that has grandfathered rights under section 24(d). You argue that in the absence of such a reference, a holding company formation by the Bank that owns the Subsidiary, which has grandfathered powers under section 24(d), should not affect the grandfathered status of the Subsidiary for purposes of section 24(d). In addition, you note that sections 24(d)(2)(C) and 24(f) have provisions which expressly terminate grandfathered rights under those sections upon a change in control and/or conversion of the bank's charter. You argue that the absence of an express termination provision in section 24(d)(2)(B) implies that no such termination was intended for grandfathered insurance activities. Furthermore, you argue that even if the express change in control language of section 24(f) were applied to section 24(d)(2)(B), the proposed holding company formation would result in no change in control of the Subsidiary, and thus, would not affect the grandfathered rights of the Subsidiary under section 24(d).

On its face, section 24(d)(2)(B) neither prohibits the proposed bank holding company formation nor addresses the effect of such activities on the grandfathered insurance underwriting powers of banks and their subsidiaries. Furthermore, the legislative history of section 24 is silent on this issue. What is more, as you point out, other portions of section 24 expressly indicate that certain grandfather rights are lost upon a change in control or a conversion of charter. Based on the foregoing, I agree with your analysis that the apparent, literal reading of section 24 is that a corporate reorganization of a state bank which has a subsidiary that has grandfathered rights under section 24(d)(2)(B) should not affect the subsidiary's rights under that section.

As stated above, section 24(d)(2)(C) permits a subsidiary of a state bank to underwrite title insurance if the bank was required, before June 1, 1991, to provide title insurance as a condition of its charter and control of the bank has not changed since that date. Similar language providing for the loss of grandfathered activities under section 24 is also found in section 24(f)(5), which states that an exception allowing a state bank to acquire and retain ownership of securities "shall cease to apply . . . upon any change in control of such bank or any conversion of the charter of such bank." 12 U.S.C. § 1831(f)(5). The fact that language providing for the loss of grandfathered status appears in two subsections of section 24 and is absent in section 24(d)(2)(B) leads me to concur with your argument that no such termination of status was intended for grandfathered insurance activities. Thus, it seems reasonable to conclude that the bank holding company formation would not affect the subsidiary's grandfathered status under section 24(d)(2)(B).

Even if we were to assume that the change in control provisions of sections 24(d)(2)(C) and 24(f)(5) were applicable to section 24(d)(2)(B), the FDIC has concluded that a holding company formation "in which all or substantially all of the shares of the holding company will be owned by persons who were shareholders of the bank" would not be treated as a change in control. 12 C.F.R. 362.3(b)(4)(ii). As stated in your letter, the proposed bank holding company formation does not result in an actual change in control of the Subsidiary that is engaged in grandfathered insurance activities. Thus, you are correct in concluding that the proposed bank holding formation would not affect the grandfathered rights of the Subsidiary under section 24(d)(2)(B) even if the change in control provisions were applied to section 24(d)(2)(B).

Furthermore, if we were to consider that the change in control provisions of sections 24(d)(2)(C) and 24(f)(5) apply to section 24(d)(2)(B), we should also consider that the language under section 25(f)(5) providing for loss of grandfathered status upon "any conversion of [the bank's] charter" may also be applied to section 24(d)(2)(B). If so, we would have to determine if the bank holding company formation would cause the bank "to operate under a different form of charter than that under which it operated. . . ." See 12 C.F.R. § 362.2(g). Based upon your statement that Phantom, which survives the merger, will not be materially different than the Bank in terms of its assets, liabilities, operations and articles of incorporation, we conclude that the holding company formation should not be considered to cause the Bank to operate under a different form of charter than under which it previously operated.

If you have any further questions, please write me at the above address or call me at (202) 898-3757.


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