Source: https://business-finance-restructuring.weil.com/dodd-frank/fdic-proposed-rule-will-determine-which-companies-are-covered-by-the-new-orderly-liquidation-authority/
Timestamp: 2019-04-19 18:57:03+00:00

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On March 23, the FDIC published a second Notice of Proposed Rulemaking with respect to the Orderly Liquidation Authority (“OLA”) created by Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The proposed rule, which is now in a 60-day public comment period, addresses critical aspects of the OLA, which is intended to address the problem of how to wind down large financial institutions that, if left to receivership, bankruptcy, or other traditional restructuring mechanisms, would pose systemic risks to the financial markets. These companies have been called, colloquially, “Too Big to Fail,” and the Dodd-Frank provisions on orderly liquidation were intended to avoid repetition of the situation faced in the 2008 financial crisis where the government was forced to choose between two unpalatable options – letting troubled financial institutions fail and risking collapse of the entire financial system or committing hundreds of billions of dollars in taxpayer money either directly or to backstop a private acquisition. In this blog entry – the first in a series in which Weil’s Financial Reform Regulatory Center analyzes the impact of the NPR – we address a significant gating question: What companies are potentially subject to the OLA?
a U.S. subsidiary of any of the above engaged in activities that the Board has determined are financial in nature or incidental thereto for purposes of the BHCA (other than insurance companies or federally insured depository institutions).
See § 201(a)(11). Under this definition, a “financial company” includes a broker/dealer registered with the Securities and Exchange Commission (“SEC”) that is also a member of the Securities Investor Protection Corporation (“SIPC”).
A financial company that becomes subject to the OLA is defined as a “covered financial company, ” see § 201(a)(8), (unless the company is a broker/dealer, in which case the company is a “covered broker or dealer,” see § 201(a)(7)). If a covered financial company has U.S. subsidiaries, they may become subject to the OLA as subsidiaries of a covered financial company, which are defined as “covered subsidiaries.” See § 201(a)(9). Certain entities are excluded from these classifications, and therefore, cannot become subject to the OLA. Specifically, an insured depository institution cannot be a covered financial company, and an insurance company, insured depository institution, or covered broker/dealer cannot be a covered subsidiary.
Presumably, by excluding “an insurance company” from the definition of “covered subsidiary,” Congress intended to exclude regulated insurance companies – but this is not clear from the statute. It is clear, however, that while an “insurance company” cannot become subject to the OLA merely because it is the subsidiary of a covered financial company, an insurance company itself can be a covered financial company, and therefore can itself be placed into orderly liquidation under Title II, provided that the requisite “three keys” (set forth below) are turned.
In addition, certain other entities are excluded from the definition of “financial company,” and therefore, also from the OLA; these are a Farm Credit System institution, and a governmental entity, or regulated entity, as defined under section 1303(20) of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 (i.e., Fannie Mae and Freddie Mac, and any Federal Home Loan Bank).
For determining whether a company is predominantly engaged in activities that the Board has determined are financial in nature or incidental thereto for purposes of the BHCA, section 201(b) of Dodd-Frank further provides that “[n]o company shall be deemed to be predominantly engaged in activities that the [Board] has determined are financial in nature or incidental thereto for purposes of section 4(k) of the [BHCA], if the consolidated revenues of such company from such activities constitute less than 85 percent of the total consolidated revenues of such company, as the [FDIC], in consultation with the Secretary [of the Treasury], shall establish by regulation.” See § 201(b).
Further refining the 85% rule set forth above, the NPR specifies a time period during which a company’s consolidated revenues may be considered by the FDIC for the purposes of the 85% calculation. Specifically, a company may be defined as being “predominantly engaged” in financial activities under one of two circumstances. First, understanding that in any given year, a company could experience a decline in “financially derived” revenues, the NPR provides that a company meets the definition of “predominantly engaged” if in either of its two most recent completed fiscal years, at least 85% of the total consolidated revenues of the company were derived, directly or indirectly, from financial activities. Alternatively, given that a company’s revenue sources could change dramatically and suddenly on account of various types of transactions, such as a merger, consolidation, acquisition, or the establishment of a new business line, the NPR provides that a company is “predominantly engaged” if at any point in time, based upon all the relevant facts and circumstances, and the full range of information available concerning the company, the FDIC determines that the consolidated revenues of the company from financial activities constitute 85% or more of the total consolidated revenues of the company. This would allow the FDIC to consider, for example, the percentage of a company’s consolidated revenues derived from financial activities during such time period of the FDIC’s choosing subsequent to the company’s most recently competed fiscal year.
The NPR defines “total consolidated revenues” as the total gross revenues of a company and all entities subject to consolidation with the company for a fiscal year, as determined in accordance with applicable accounting standards, which are defined as the standards used by the company in preparing its consolidated financial statements, provided that they are (i) US GAAP, (ii) International Financial Reporting Standards, or (iii) such other accounting standards that the FDIC determines to be appropriate. Although the FDIC believes that the NPR’s definition of “applicable accounting standards” will prevent companies from arbitraging the 85% rule by using different accounting standards solely for the purposes of the NPR, it is unclear how the FDIC will prevent companies from changing their accounting standards (or even their organizational structure) to achieve arbitrage. Even if the FDIC cannot prevent companies from making such changes, the FDIC may specify under what circumstances it may consider a change in accounting standards to be for the purpose of evading the 85% rule, and what, in such circumstances, the FDIC may do in order to provide an accurate basis for determining whether a company is a “financial company” for the purposes of the OLA.
The NPR defines “financial activity” to include (i) any activity, wherever conducted, described in section 225.86 of the Board’s Regulation Y or any successor regulation; (ii) ownership or control of one or more depository institutions; and (iii) any other activity, wherever conducted, determined by the Board of Governors – in consultation with the Secretary of the Treasury (the “Secretary”) – under section 4(k)(1)(A) of the BHCA, to be financial in nature or incidental to financial activity. Between section 225.86 of Regulation Y and section 4(k)(4) of the BHCA, “financial activities” include, among other things, banking; lending; underwriting; insurance; safeguarding money or securities; providing financial or investment advisory services; providing administrative or other services to mutual funds; owning shares of a securities exchange; acting as a certification authority for digital signatures; check cashing; providing wire transmission services; providing real estate title services; and organizing, sponsoring and managing a mutual fund.
Under the NPR, “financial activities” includes all financial or incidental activities, regardless of where the activity takes place, whether a bank holding company or foreign banking organization could conduct the same activity under some legal authority other than section 4(k) of the BHCA, or whether any federal or state law other than section 4(k) of the BHCA may prohibit or restrict the conduct of the activity. Thus, for example, all securities underwriting and dealing activities are “financial activities” even if the “Volker Rule” limits the permissible amount of such activity by a bank holding company or affiliate of a depository institution.
The NPR sets forth two “rules of construction” that govern the two-year test for revenues derived from a company’s minority, non-controlling equity investments in unconsolidated entities. Under the non-consolidating investment rule, the revenues derived from a company’s equity investment in another company (the “Investee Company”) the financial statements of which are not consolidated with those of the company under the applicable accounting standards, would be considered as revenues derived from a financial activity if the Investee Company itself is predominantly engaged in financial activities under the revenue test of the Proposed Rule. This rule is similar to the approach proposed by the Board for determining whether a non-bank company is predominantly engaged in financial activities under Title I of Dodd-Frank. See 76 Fed. Reg. 7731 (February 11, 2011).
the aggregate amount of revenues treated as non-financial under the de minimis rule in any year does not exceed 5% of the company’s total consolidated financial revenues.
The FDIC’s definition of “predominantly engaged” looks only at revenues, while the Board considers assets as well as revenues.
The FDIC test refers to the ownership and control of depository institutions, while the Board refers to the ownership, control, and activities of insured depository institutions.
any other risk-related factors that the FSOC deems appropriate.
Dodd-Frank’s “financial company” and “nonbank financial company” categories are potentially quite large and appear to capture any entity predominantly engaged in financial services. For example, these categories could possibly extend to thrifts and their holding companies, broker-dealers, investment advisers (potentially including managers of hedge funds and private equity funds), investment banks, and other asset management firms. In addition, it is possible that certain subsidiaries of a company could fall within the definition of a “financial company,” while others – including the parent company – do not.
When considering the impact of these definitional categories, it is important to distinguish between a company that merely falls within the definition of a “financial company,” and that actually becomes subject to the “three keys” determination (described below) for the commencement of an orderly liquidation under the OLA. In other words, there is a significant difference between merely being eligible for orderly liquidation under the OLA, and actually being placed into orderly liquidation. The former is relatively easy, and does not require a finding that the company is systemically important or poses systemic risk to the financial system – only that the company engages predominantly in financial activities. The latter determination is more difficult to establish, and does require a finding of systemic risk.
As discussed below, this latter determination will not be made until the eve of a company’s OLA liquidation, which leaves creditors and other parties in interest uncertain whether a failed financial company will be resolved under the OLA or the Bankruptcy Code (or, in the case of a broker/dealer, the Securities Investor Protection Act).
The FDIC alone may determine that a company is a “financial company,” but placing such a company into orderly liquidation requires the so-called “three keys” to be turned. Specifically, even if the FDIC determines that a company qualifies as a “financial company” (or the FSOC designates a company as a nonbank financial company), the OLA requires that the Board and the FDIC consider, either at their own initiative or at the request of the Secretary, whether to make a written recommendation (the “Recommendation”) that the Secretary should appoint the FDIC as the receiver of the financial company. The Recommendation must be made upon a vote of not less than two-thirds of each of both the Board and the board of directors of the FDIC. If the decision involves a financial company that is a broker/dealer, or whose largest U.S. subsidiary is a broker/dealer, the SEC replaces the FDIC as the appropriate federal agency to make the Recommendation along with the Board (the two-thirds voting requirements are the same). If the decision involves a financial company that is an insurance company, or whose largest U.S. subsidiary is an insurance company, then the Director of the Federal Insurance Office must make the Recommendation together with two-thirds of the Board. See § 203(a)(1).
(g) The financial company satisfies the definition of “financial company” under section 201.
Notably, there is no reason why the FDIC could not determine that a company qualifies as a “financial company” on the eve of voting in favor of the Recommendation. Because of this, it should not be assumed that a company is ineligible for the OLA merely because the FDIC has not yet explicitly or publicly determined it to be a “financial company” or the FSOC has not designated it as a “nonbank financial company” for purposes of Title I of Dodd-Frank. The FDIC’s determination could be made at any time, even as part of the “three keys” process. Thus, whether a company is assessing its own, or its counterparties’ susceptibility to the OLA, it should rely on its own analysis, and err on the side of caution, assuming that if a company engages predominantly in activities that are financial in nature, the OLA is among the possible statutory frameworks under which that company ultimately could be liquidated.

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