Federal Reserve Raises Concerns with Shareholder Protection Agreements

By Mike W. Lochmann

Recently issued Federal Reserve regulatory guidance is critical of certain shareholder protection arrangements typical in private equity investments. Such arrangements raise regulatory concerns because they could limit a holding company's ability to raise capital in the future.

Objectionable shareholder protection arrangements include:

  • "Down-Round" Protection – Cash Payment: A holding company agrees to provide an investor with a cash payment equal to the difference between the price paid by the investor and any lower price per share paid by future investors.
  • "Down-Round" Protection – Additional Shares: A holding company agrees to provide an investor with additional shares for nominal consideration if shares are subsequently issued at a price below the price paid by the investor.
  • Poison Pills: Existing shareholders of the holding company are given the right to acquire additional shares at a significant discount to market value if any shareholder crosses a specific ownership threshold.
  • Minority Shareholder Control: Investors with less than majority control are given the right to prevent the holding company from issuing additional shares.
  • Mandatory Share Repurchases: Contracts that require a holding company to repurchase shares from a transferee in a secondary market sale.

    This final regulatory guidance applies to all privately-owned and publicly-traded bank holding companies and savings and loan holding companies, regardless of their size.

The guidance states that the Federal Reserve may direct the holding company's board of directors to modify or remove a shareholder protection arrangement that gives rise to safety and soundness concerns. Retroactive changes to vested contract rights, or corporate charter or bylaw provisions, can be quite problematic and could lead to litigation regarding the holding company's ability to invalidate such negotiated arrangements.

If you have questions about the new guidance or a specific shareholder protection arrangement, contact Mike Lochmann or the Stinson Leonard Street attorney with whom you regularly work.  

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