On December 20, 2022, the New York Department of Financial Services (“NYDFS”) requested comment on how it applies the presumptions of control in New York Banking Law to investment managers that acquire interests in certain New York financial institutions on behalf of their securities portfolio (the “Control RFC”).1 This control guidance is important because acquiring control of a regulated institution often requires prior approval from NYDFS.
Comments on the Control RFC must be submitted by March 3, 2023.
In this Legal Update, we provide background on the presumptions of control in New York Banking Law and discuss the Control RFC.
Under federal banking law, control is a foundational concept that defines the regulatory perimeter, determines the application of certain restrictions, and may trigger notice or application filing requirements. (Please refer to our recent presentation on control for a further discussion of the federal definitions.)
In New York, control is an equally important concept for banks and nonbank financial institutions. Under various sections of New York Banking Law, an acquirer is presumed to control a regulated institution if the acquirer holds a certain percentage of the voting stock of the institution. Acquiring control of a regulated institution often requires prior approval from NYDFS and may impose ongoing obligations on the acquirer. For these purposes, a regulated institution is a New York-chartered bank, trust company, stock-form savings bank, or stock-form savings and loan association or a New York-licensed transmitter of money, casher of checks, licensed lender, sales finance company, insurance premium finance agency, budget planner, mortgage banker, mortgage broker, mortgage servicer, or student loan servicer.2
Except for New York-licensed transmitters of money, a presumption of control with respect to a regulated institution is triggered when a person acquires, directly or indirectly, 10 percent or more of that regulated institution’s voting stock. For licensed transmitters of money, the presumption of control is triggered when a person acquires 25 percent or more of a licensed money transmitter’s voting stock.
In recent years, control of financial institutions has become a significant issue for the investment management industry. This is because certain investment managers may acquire significant positions in a financial institution as part of the operation of funds, other pooled investment vehicles, and institutional investment accounts. This is particularly acute for operators of mutual and exchange-traded funds, which may be required to acquire large positions in certain financial institutions as part of the investment strategy of the fund (e.g., index funds). At the federal level, this had been dealt with through bespoke and time-limited relief.3 However, states have not generally addressed this point.
Control RFC and Questions for Comment
The Control RFC states that certain investment managers have approached NYDFS regarding positions in regulated institutions and asserted that they should not be deemed to control a regulated institution even if they acquire and hold an amount of voting stock of a regulated institution that would trigger a presumption of control. They maintain this view because they hold voting stock of these regulated institutions solely as passive investors and they have no intent or desire to exercise control over any regulated institution.4 They have sought to establish a process with NYDFS for demonstrating that a position in a regulated institution is passive and offered a number of passivity commitments in order to facilitate a determination of non-control by NYDFS.
The Control RFC contains a sample passivity commitment that NYDFS may consider when evaluating a request for a determination of non-control by an investment manager when ownership of voting stock of a regulated institution triggers a presumption of control. The sample includes provisions indicating that the investment manager would effectively give up voting rights with respect to stock held in excess of the presumption of control and would impose restrictions on the disposition of the stock. The sample also includes provisions that would limit an investment manager’s involvement in the regulated institution’s board of directors and management and would restrict an investment manager from engaging in a broad set of transactions with a regulated institution. Further, an investment manager would need to commit to an upper limit on the amount of voting stock that it may acquire in the future.
The Control RFC contains 13 questions related to investment manager investment in regulated institutions. These primarily relate to defining the outer limits of the passivity commitments and otherwise ensuring that investment managers do not attempt to exercise control over a regulated institution. There are also questions about how to calculate or set a limit on the amount of certain types of holdings of voting stock that are held by an investment manager.
One somewhat surprising question suggests that investment managers could use derivatives to synthetically acquire exposure to a regulated institution without acquiring voting stock. This technique for acquiring exposure is novel and has been a source of concern for federal banking regulators in certain circumstances.5
Interestingly, NYDFS also asks about situations in which an investment manager might abruptly dispose of the stock of the regulated institution. While historically this was a factor that indicated a controlling influence at the federal level, the Federal Reserve expressly abandoned it as a control factor in 2020 when it revised Regulation Y.6 A different approach by NYDFS could present some challenges.
The issuance of the Control RFC appears to have been driven by trends in passive investing by investment managers that are unlikely to change in the near-term. As a general principle, it is preferable to deal with control issues in a transparent and consistent manner for all participants. Therefore, asset managers and New York regulated institutions may view the Control RFC as a positive instance of outreach from NYDFS.
However, aspects of the passivity commitments put forward in the Control RFC may differ from the view of federal banking regulators. Given that New York banks are included in the financial institutions that the Control RFC applies to, NYDFS may seek convergence with federal banking regulators, at least with respect to federally regulated banks. Comments should seek some degree of clarity on this point.
Finally, while much of the regulatory onus rests with the investment managers, regulated institutions should consider how the Control RFC will affect their operations—particularly nonbank financial institutions, which may be less familiar with negotiating control matters with regulators and investment managers. For example, a regulated institution might be asked to forgo or terminate business relationships because an investment manager has entered into passivity commitments with NYDFS. Therefore, we expect to see comments from regulated institutions and investment managers who may invest in them.
1 NYDFS, Request for Public Comments regarding the Presumption of Control of a New York-Chartered or Licensed Depository or Non-Depository Institution (Dec. 20, 2022), https://dfs.ny.gov/industry_guidance/industry_letters/il20221220_req_public_comments_presumption_control.
2 This definition notably omits foreign banking corporations that maintain a state-licensed branch or agency in New York. These institutions are required to report changes of control on an after-the-fact basis. See N.Y. Banking L. § 201-c. However, that requirement does not contain an explicit presumption of control and has been interpreted generally to be congruent with the definition of control in the federal Bank Holding Company Act.
3 E.g., Federal Reserve, SR 22-11 (Dec. 22, 2022); 85 Fed. Reg. 12,398, 12,420 (Mar. 2, 2020)(“The Board will continue to obtain control-related commitments in specific contexts, such as commitments from employee stock ownership plans and mutual fund complexes”).
4 The Control RFC discusses in detail the circumstances in which an investment manager may acquire voting stock (e.g., investment discretion over individual managed accounts, managed funds, advised funds). For ease of reading, we use “investment manager” to refer to all situations in which an investment manager may exercise voting discretion over stock of a regulated institution.