**Interpretive Letter #1020**

February 8, 2005 **March 2005**

#### 12 USC 72

###  Re: \[ \] National Bank, \[ *City, State* \]

###  Opinion Request on Trust Preferred Stock Qualifying as Directors' Qualifying Shares

###  

Dear **\[ \]**:

This letter responds to your inquiry about whether national bank
directors may purchase trust preferred stock ("TPS") to meet the
requirement that they own directors' qualifying shares under 12 U.S.C.
§ 72. Based on the specifics of your proposal, as described herein, we
believe the TPS will qualify as directors' qualifying shares.

**\[ \]** National Bank, **\[ *City, State* \]** (the "Bank") is seeking
to add directors to its board. Under your proposal, the bank holding
company for the Bank (the "Holding Company") will form **\[ \]** (the
"LLC") and purchase all of the LLC's common membership units. The LLC
will issue trust preferred stock ("TPS") to the new Bank directors in
exchange for \$3,000,000 in cash. The LLC will then use the \$3,000,000
to purchase \$3,000,000 in junior subordinated debentures from the
Holding Company, which will be the sole asset of the LLC. The junior
subordinated debentures will have a fixed maturity of at least 30 years,
and will be subordinated to all other debts of the Holding Company and
superior only to the Holding Company's preferred and common stock. The
new directors will treat the TPS as qualifying shares under 12 U.S.C. §
72. This transaction is structured so the TPS qualifies as tier 1
capital for the Holding Company.

Twelve U.S.C. § 72 generally requires that "\[e\]very director must
own...capital stock of the association of which he or she is a director
the aggregate par value of which is not less than \$1,000, or an
equivalent interest, as determined by the Comptroller of the Currency,
in any company which has control over such association \[as determined
by the Bank Holding Company Act\]." The purpose of the statute is to
ensure that a national bank director has a financial stake in the
operations of the bank (or its parent company) so that the director will
have the incentive to be vigilant in protecting the bank's
interests.[^1]

Twelve C.F.R. § 7.2005 generally provides that (i) a national bank
director must own a qualifying equity interest of common or preferred
stock with a value of \$1,000 in the national bank or in a company that
controls the national bank; and (ii) the OCC may consider whether other
interests in a company controlling a national bank constitute an
interest equivalent to \$1,000 par value of national bank stock.

The OCC has found that a variety of different holdings can provide a
national bank director with an "equivalent interest" that satisfies the
qualifying share requirement of 12 U.S.C. § 72. For example, the OCC has
permitted directors to invest in a bank's preferred stock to meet the
qualifying shares requirement.[^2] In one instance, the OCC excused a
director from owning any stock where the bank was able to structure an
arrangement effectively giving the director the same type of incentives
as is contemplated under 12 U.S.C. § 72.[^3]^,^[^4]

The overriding principle the OCC has consistently applied to its
interpretations of 12 U.S.C.

§ 72 has been that the interest must assure that bank directors have a
financial stake in the operations of the bank, evidenced by an equity or
an equivalent interest. An "equivalent interest" includes a financial
interest in a bank or holding company that creates incentives similar to
stock ownership for directors to be vigilant in overseeing the bank's
operations.

The proposed TPS investments have characteristics similar to equity
holdings and create comparable incentives for bank directors to be
vigilant. TPS has a long life approaching economic perpetuity since
investors are repaid from income on a 30-year subordinated debenture.
TPS holders also have considerable risk of loss of dividends if the Bank
performs poorly since dividends may be deferred up to 20 consecutive
quarters to provide financial support to troubled subsidiaries.
Moreover, TPS investors hold a position that is subordinate to all
obligations of the Holding Company, other than common and preferred
shareholders. Due to their deeply subordinate position, directors owning
TPS have substantial risk of loss if their oversight results in the
Bank's failure.[^5] Altogether, the long life, potential dividend
deferral and a substantially subordinate position of TPS create
incentives similar to equity holdings for directors to assure the
financial success of the bank.

The treatment of TPS for capital purposes by the Federal Reserve Board
(the " FRB") further supports the view that TPS is an "equivalent
interest" for purposes of § 72 because the FRB treats TPS for capital
purposes similarly to the way it treats other risk capital (e.g.,
preferred and common stock). The FRB permits the TPS to qualify for
inclusion in the Holding Company's tier 1 capital.[^6] Treating TPS as
tier 1 capital is consistent with the notion that TPS represents funds
that are put "at risk" in the bank, giving the holders (*i.e.,*
directors) a financial stake tied to the success or failure of the
enterprise. In fact, the FRB's recent proposed rule on the treatment of
TPS as tier 1 capital is based in large part on the features of TPS that
make it an investment tied to the performance of the bank. These
features include having a long life that approaches economic perpetuity,
permitting the issuer to defer dividends, and being deeply
subordinated.[^7] The proposed TPS holdings meet these criteria, as
noted in the preceding paragraph.

While the TPS holdings are issued by the LLC, they represent a financial
"interest" in the Holding Company. The sole asset of the LCC is the
junior subordinated debenture issued by the Holding Company. As a
result, the LLC will be solely and completely dependent on the ability
of the Holding Company to pay interest and principal on the junior
subordinated debentures in order for the LLC to pay dividends and a
return of capital on the TPS. TPS is effectively an investment in the
Holding Company and certainly an interest in the Holding Company for
purposes of Section 72.

Accordingly, based on the foregoing, we believe the TPS will qualify as
directors' qualifying shares. If you have any questions on the
foregoing, or need any additional information, please feel free to
contact Eugene H. Cantor, Counsel, Securities & Corporate Practices
Division, at 202-874-5202.

Sincerely,

/s/ Daniel P. Stipano

Daniel P. Stipano

Acting Chief Counsel

[^1]: *See* OCC Interpretive Letter No. 83 (May 29, 1979), citing *Cupo
    v. Community National Bank and Trust Company, 324 F. Supp. 1390
    (E.D.N.Y. 1971);* *see also* OCC unpublished letter from Peter
    Liebesman, Assistant Director, Legal Advisory Services Division
    dated May 29, 1985, and unpublished from Christopher Manthey, Senior
    Attorney, Legal Advisory Services Division letter dated September 5,
    1989. Qualifying shares must constitute both legal and beneficial
    interests. OCC Interpretive Letter No. 83 (May 29, 1979), *citing*
    *Transamerica Corporation v. Parrington,* 115 Cal.App.2d 346, 252
    P.2d 388 *(1953).*

[^2]: ^?^ Unpublished letter from Emory W. Rushton, Deputy Comptroller
    for Multinational Banking, dated April 11, 1988. ("Although it may
    have preferences as to dividends, voting or liquidation rights, bank
    preferred shares, like common shares, represent an equity interest
    in the bank sufficient to induce the holder 'to be vigilant in
    protecting the banks interests,' " quoting *Cupo*, *supra*.)

[^3]: Unpublished letter from Michael J. Linowes, Attorney, dated
    November 21, 1994. The situation involved a nun who had taken a vow
    of poverty and was prohibited for religious purposes from meeting
    the ownership requirement. The OCC found the qualifying share
    requirement was met where a charitable organization for which the
    nun served as a member of the board owned stock in the bank and the
    nun had the exclusive right to vote the stock.

[^4]: While one older OCC staff letter found that a subordinated
    debenture was not comparable to an equity interest in a bank and did
    not qualify as an "equivalent interest" under Section 72, letter
    dated May 29, 1985 from Peter Liebesman, Assistant Director, Legal
    Advisory Services Division, Section 72 does not require the holding
    to be an equity interest, only an "equivalent interest." Moreover,
    the letter does not reflect the OCC's current views, described in
    more recent precedents permitting non-equity interests that provide
    similar incentives. *See* unpublished letter from Michael J.
    Linowes, Attorney, dated November 21, 1994.

[^5]: While directors holding the TPS are paid prior to equity holders,
    their position is so subordinate that they have similar incentives
    to act affirmatively to maintain the financial health of the bank.

[^6]: FRB Press Release, October 21, 1996. Although there have been
    recent changes in the treatment of TPS for financial accounting
    purposes, the FRB under a recent proposal will continue to treat TPS
    as tier 1 capital of bank holding companies, subject to certain new
    quantitative limitations. 69 Fed. Reg. 28851, *et seq.* (May 19,
    2004).

[^7]: 69 Fed. Reg. 28851 at 28852.