Proposed Statement of Policy on Mutual to Stock Conversions

FEDERAL DEPOSIT INSURANCE CORPORATION

Proposed Statement of Policy on Mutual to Stock Conversions

AGENCY: Federal Deposit Insurance Corporation (FDIC).

ACTION: Notice of Proposed Policy Statement.

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SUMMARY: The FDIC solicits comments on a proposed policy statement

setting forth guidance with respect to the conversion from mutual to

stock ownership of State chartered savings banks and the FDIC's

supervisory concerns on the matter.

DATES: Comments must be received by March 18, 1994.

ADDRESSES: Send comments to the Executive Secretary, FDIC, 550 17th

Street, NW., Washington, DC 20429. Comments may be hand delivered to

room F-400, 1776 F Street NW., Washington, DC on business days between

8:30 a.m. and 5 p.m. [Fax number (202) 898-3838]. Comments will be

available for inspection and photocopying in room 7118, 550 17th

Street, NW., Washington, DC between 9 a.m. and 4:30 p.m. on business

days.

FOR FURTHER INFORMATION CONTACT: Robert F. Miailovich, Associate

Director (202-898-6918), Garfield Gimber III, Examination Specialist

(202-898-6913), Division of Supervision, or Walter P. Doyle, Counsel

(202-898-3682), Legal Division, FDIC, 550 17th Street, NW., Washington,

DC 20429.

SUPPLEMENTARY INFORMATION:

I. Request for Public Comment

The FDIC is considering adoption of a policy statement on

conversion from mutual to stock form of ownership. Comment is requested

on all aspects of the subject and, in particular, the proposed policy

statement.

All state authorities provide some degree of oversight over mutual

to stock conversion transactions involving institutions under their

jurisdiction, and a number of statutes exist that deal with securities

disclosure and changes of management and/or control and acquisitions.

With respect to state oversight, comment is requested on whether or not

such oversight is sufficiently uniform and adequate across states to

protect the interests of the public, or whether federal oversight is

necessary.

In light of existing federal and state securities laws and state

conversion laws, comment is requested on what abusive practices are

prevalent or likely and whether and why the FDIC should take action. If

so, should the focus of FDIC attention be on the long-standing

accountholders/members or are other interests, such as those of

borrowers, trustees, management and employees, also important?

Comment is requested on whether the following proposed policy

statement contains enough specificity to be effective in providing

worthwhile guidance and preventing potentially objectionable practices.

If the proposed or even a strengthened policy statement providing

guidance to the industry is not considered adequate, should mutual to

stock conversions be governed by an enforceable regulation? If so,

should such a regulation closely follow the existing regulation of the

Office of Thrift Supervision on this subject, with specific percentage

limitations, such as on insider investments, or should a regulation

more closely resemble a guidance format as embodied in the proposed

policy statement? Should the FDIC seek or support congressional action

in this matter?

II. Background

In recent years a number of state chartered mutual savings banks

have converted to stockholder owned state savings banks. Many of these

institutions first converted from federally chartered mutual savings

associations to state chartered savings banks. In some cases, the

conversion results in an acquisition by or merger into another

institution, with accountholders/members obtaining stock in the

acquiring institution and not the converting savings bank.

One consequence of these conversions to state charter is that the

FDIC may replace the Office of Thrift Supervision as the primary

federal regulator. The mutual to stock conversion process is then

subject to the rules and protections of state law. The Office of Thrift

Supervision regulations governing conversions from mutual to stock form

were enacted in 1974 in reaction to instances of abusive conversion

transactions wherein insiders and their interests captured a large

share of the converting institution's capital stock for considerably

less than fair market value. The Office of Thrift Supervision

regulation was structured to protect the interest of the converting

mutual's accountholders/members in the current equity and perceived

future value of the institution against abusive insiders and

opportunistic depositors.

III. Reasons for FDIC Policy

Conversion rules under state law are not identical to and may be

less stringent than Office of Thrift Supervision regulations. Absent

effective state laws or some federal oversight over state mutual

savings banks converting to capital stock form, the opportunity for

inconsistency and abuse is ever present.

The areas of particular concern for potential abuse in conversion

include: (1) Pricing the shares, (2) Apportioning the stock

subscription rights, and (3) Disclosure of information needed to make

an informed investment decision.

Offering the shares at too low of a price may unjustly enrich the

recipients, increase the temptation by insiders to acquire more shares

than they are fairly entitled to, and deny the institution all of the

additional capital it should receive to protect depositors and the

insurance fund. Setting the share price too high may result in poor

investment decisions by accountholders/ members that may lack

investment expertise.

In some conversion transactions insiders may appear to have

received preferential treatment over the interests of accountholders/

members who have supported the mutual savings bank. Management and

directors, it can be argued, should not be preempted from receiving a

fair portion of the stock rights since they have contributed to the

value of the institution and should properly be induced to remain with

the institution. However, management and directors also will continue

to receive salaries and fees for their services to the institution.

In addition, mutual savings banks that convert to stock form

undertake a major restructuring that possibly can lead to significant

changes in the nature or volume of business conducted. In the past,

some institutions, in leveraging capital raised through a conversion

and reaching for a return on equity, have vigorously competed for loans

and liberalized underwriting standards which led to loan losses that in

many instances depleted more capital than was raised through

conversion. Because of this potential, the FDIC feels the need to know

at an early date the institution's business plan for post-conversion

operation, growth and investment of any newly injected capital.

IV. Statement of Policy

Proposed Statement of Policy on Mutual To Stock Conversions By State

Chartered Banks

State chartered mutual savings banks converting to capital stock

ownership should afford adequate protection to the interests of long-

standing accountholders/members in the current equity and perceived

future value of the institution against insiders and opportunistic

depositors. Such protection should include: (1) Correctly pricing the

shares, (2) Equitably apportioning the stock subscription rights, and

(3) Adequately and timely disclosing all relevant and pertinent

information needed to make an informed investment decision.

A thorough independent appraisal by a qualified appraiser is

appropriate in order to establish and justify a fair offering price for

the shares of stock in the converted institution. The appraisal should

include consideration of earnings projections, future prospects for a

rate of return including any new capital, other recent stock offerings

and conversion transactions, and the historic and current relationship

of market price to book value and price/earnings ratio for nearby and

similar sized institutions.

Accountholders/members who have supported the mutual savings bank

over some reasonable period should be given considerable deference in

the apportionment of stock subscription rights. Management and

directors who are accountholders/members are entitled to the same

rights as non-insider accountholders/members. Any additional deference

accorded to insiders, including employment contracts and other benefits

in an acquisition or merger into another institution, should be only as

part of an adequate compensation program and thus be limited, justified

and documented. Apportioning that leads to individual windfall gains

should be avoided. Directors are reminded of their duty of loyalty to

the converting institution.

The holders of stock subscription rights should be adequately and

timely notified of their rights to buy. Offering the shares through a

firm that is independent of the converting institution's insiders and

their interests is one way to help insure that this takes place. Full

disclosure of all relevant information should be made. Accountholders/

members should be able to easily use funds on deposit to fund their

purchases. In addition, accountholders/members should be fully informed

of the risk inherent in purchasing stock. If stock sales are conducted

on the institution's premises, care should be exercised to make sure

accountholders/members clearly understand that stock purchases are not

deposits and are not insured by FDIC.

State chartered mutual savings banks that contemplate converting to

stock form are requested to notify the FDIC region in which the head

office is located at an early date and submit for comment all the

relevant terms and conditions, financial information and documents

inherent in the conversion, including a business plan for post-

conversion operation, growth and investment of any newly injected

capital. The FDIC will work closely with the state authority in

preparing any comments.

The FDIC review of transactions on a case-by-case basis will

include consideration of whether the directors and management of the

institution have fairly and effectively discharged their fiduciary

duties of due care and loyalty to the institution and its

accountholders/members.

Should the FDIC determine that the proposed conversion may raise

safety and soundness concerns, or otherwise subject the bank to

substantial legal liability, it may request additional information from

the bank and/or may seek appropriate modifications in the terms and

conditions of the proposal to alleviate those concerns. In situations

where abusive insider self-dealing, fraud or other violations are

suspected, stronger enforcement measures may be considered.

Depending on the terms and outcome of the transaction, the

conversion may require formal federal approval under the Bank Holding

Company Act or the Bank Merger Act, or appropriate notice under the

Change in Bank Control Act.

Conversions to stock form, involving undercapitalized institutions,

at the direction or control of a regulatory authority are sometimes

called ``supervisory conversions''. This FDIC statement applies equally

to such conversions.

By order of the Board of Directors. Dated at Washington, DC this

day of January, 1994.

Federal Deposit Insurance Corporation.

Robert E. Feldman,

Acting Executive Secretary.

[FR Doc. 94-2235 Filed 1-31-94; 8:45 am]

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