Source: https://www.federalregister.gov/documents/2012/09/13/2012-22382/unincorporated-business-entities
Timestamp: 2017-08-24 10:51:20
Document Index: 668572669

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A Proposed Rule by the Farm Credit Administration on 09/13/2012
56571-56581 (11 pages)
FCA-2012-0018
III. The Statutory Basis for the Proposed Rule
A. System Institutions' Authority
A. Unincorporated Business Entities [New §§ 611.1150 Through 611.1158]
1. Purpose and Scope [New § 611.1150]
2. Definitions [New § 611.1151]
3. Regulation, Examination, Enforcement, and Assessment Authority [New § 611.1152]
4. General Restrictions and Prohibitions on the Use of UBEs [New § 611.1153]
5. Notice-Only Requirement for Certain UBE Equity Investments [§ 611.1154]
6. Approval Process [New § 611.1155]
7. Ongoing Requirements [New § 611.1156]
9. Grandfather Provision [New § 611.1158]
https://www.federalregister.gov/d/2012-22382 https://www.federalregister.gov/d/2012-22382
Wendy Laguarda, Assistant General Counsel, Office of General Counsel, Farm Credit Administration, McLean, VA 22102-5090, (703) 883-4020, TTY (703) 883-4020.
Affirm FCA's authority to regulate and examine the System institutions' use of UBEs, including the authority to impose any conditions FCA deemed necessary and appropriate on UBE business activity, and to take enforcement action against System institutions' activities involving UBEs;
Prohibit System institutions from using UBEs to engage in direct lending or any activity that exceeds their authority under the Act or circumvents the application of cooperative principles;
The System's existing investment [1] and incidental powers [2] provide the authorities for System institutions to invest in and form UBEs for certain business activity. Specifically, under § 615.5140(e), System institutions may exercise their investment authorities to invest in “other investments approved by the FCA” provided the funding bank has approved the investment. System investments in UBEs fall under this category, and may be approved by FCA upon a request that explains the risk characteristics of the investment and the System institution's purpose and objectives for making the investment.
Unlike the express authority to organize service corporations under sections 4.25 and 4.28(A) of the Act,[3] no provision under the Act explicitly authorizes System institutions to organize entities under State law to engage in business activity. However, Congress has long encouraged coordinated initiatives by System institutions to provide joint products, services or functions to System borrowers. We note that the farmer-owned, cooperative and jointly liable System, by its very establishment, is designed to accomplish the most efficient and effective delivery system of credit and related services to agriculture and its producers and rural communities. Moreover, various provisions in the Act have authorized or directed System institutions to offer joint products or services. The same year that Congress added the service corporation authority to the Act (1980), it also directed System institutions to establish programs for young, beginning and small (YBS) farmers and ranchers “in coordination with other units of the Farm Credit System serving the territory and with other governmental and private sources of credit.” [4] These 1980 additional authorities evidence Congress' intention that System institutions be able to provide coordinated services and products to System borrowers and rural communities using business structures that can best facilitate such efforts.
This proposed rule will provide a more uniform approval and oversight process for the System's continuing use of UBEs. The rule emphasizes that incidental powers can neither be the basis for broadening or circumventing the limitations and restrictions of a System institution's express powers in carrying on the business of the bank or association nor used to engage in activities that are impermissible under the Act. The delivery of System credit, services and other products will still chiefly be provided by System institutions' direct use of their express powers to serve their eligible borrowers and customers. As a Government-sponsored enterprise (GSE) of cooperative institutions owned and controlled by their member-borrowers, it is essential that System institutions maintain their strong cooperative traditions and reputations.[5]
We propose adding a new subpart J to part 611 that would address the purpose and scope of unincorporated business entities organized or invested in by System institutions. Subpart J includes provisions on: (1) Definitions; (2) FCA's regulatory, examination, enforcement, and assessment authorities; (3) general restrictions and prohibitions on the use of UBEs; (4) notice-only requirements for certain activities conducted through UBEs; (5) FCA's review process for UBEs not meeting the notice-only provisions; (6) ongoing requirements; (7) disclosure and reporting requirements; and (8) transparency and conflict of interest requirements. Subpart J also contains a grandfather provision for those UBEs previously approved by FCA on a case-by-case basis and for those UBEs established under the guidance provided in FCA Bookletter BL-057,[6] which may be rescinded once a final rule becomes effective.
Proposed § 611.1150 affirms that System institutions have incidental power as may be necessary or expedient to carry on the business of the bank or association, as applicable. In exercising this incidental power, System institutions may continue to establish UBEs, provided the UBE business activity is necessary or expedient to the System institution's express authorities in carrying on the business of the bank or association and falls within the parameters of the rule.
Except as authorized by this rule, System institutions cannot manage, control, or invest in any State-chartered or organized business entity. The proposed rule would not permit System institutions to make equity investments in UBEs that are organized, controlled or managed by a non-System entity (third-party UBE) except as may be approved by FCA under § 615.5140(e) for de minimis and passive investments. Such approvals would be considered outside of this rule.
As previously stated, this rule is not applicable to any UBEs that System institutions may establish as RBICs under their separate statutory authority. System institutions' activities under the RBIC authority must be carried out in accordance with the authority of and regulations issued by USDA.[7] However, this rule does apply to System institutions that organize UBEs for the express purpose of investing in a RBIC.
We propose a definitions section in § 611.1151 that defines the following relevant terms used in the proposed rule.
Articles of Formation refers to the relevant State documents on the establishment, ownership, and operation of a UBE and includes registration certificates, charters, articles of organization, partnership agreements, membership or trust agreements, operating, administration or management agreements, fee agreements, or any other documentation on the establishment, ownership or operation of a UBE.
Control [8] distinguishes whether a System institution controls the business activities, operations, and actions of the UBE. Control means that one System institution, directly or indirectly, owns more than 50 percent of the UBE's equity or serves as the general partner[9] of an LLLP or constitutes the sole manager or is the managing member of a UBE. However, under generally accepted accounting principles (GAAP), the power to control may also exist with a lesser percentage of ownership, for example, if a System institution is the UBE's primary beneficiary; exercises significant influence over the UBE; or establishes control under other facts and circumstances in accordance with GAAP.
Equity investment means a System institution's contribution of money or assets to the operating capital of a UBE that provides ownership rights in return. The term is meant to include any such contribution of money or assets regardless of the terminology that might be used in an individual State's statute or regulations. The definition of equity investment does not include the costs of organizing a UBE, such as the cost of the articles of formation, attorney fees, filing fees, etc.
UBE is an acronym for Unincorporated Business Entity. As defined for purposes of this proposed rule, the term “UBE” includes unincorporated business entities that are formally established and maintained through applicable State law, such as limited partnerships, limited liability companies, and business or other trust entities.
Proposed § 611.1152 affirms that FCA has full regulatory, supervisory, oversight, examination and enforcement authority over System institutions in connection with their equity investments in and control of UBEs and the services and functions that a UBE performs for the System institution. Such authority includes FCA's right to require a System institution to withdraw from a UBE through dissolution or disassociation or to divest of any investment in a UBE. Sections 5.17(a)(5), 5.17(a)(10), and 5.25(a) of the Act, as well as § 615.5354, also give FCA the authority to condition the approval of a System institution's equity investment in a UBE. The FCA's use of these authorities ensures that System institutions providing certain functions and services through State-organized or chartered UBEs remain safe and sound and operate in accordance with law and regulations.
Proposed § 611.1153 sets forth certain general restrictions on any function, service or activity that a System institution(s) conducts through a UBE. These restrictions would ensure that the System continues to operate in a safe and sound manner and that its status as a cooperative system of lending institutions and a GSE is not jeopardized through the use of UBEs.
We are proposing this limitation for a number of reasons. First, the Agency does not want to set in motion a proliferation of System-controlled UBEs organized for numerous purposes by a single System institution. Such a proliferation could create a costly administrative burden for the Agency and complicate FCA's oversight authority. Moreover, the creation of one-member UBEs does not foster System collaborative efforts aimed at providing more efficient System operations and improved services to agriculture, agricultural producers, and rural America. Just as Congress encouraged System collaboration through the creation of the 4.25 service corporations, the use of UBEs would, generally, be reasonable and supportable from a business perspective when undertaken through System institution partnerships or multi-member limited liability companies. Finally, without reasonable and supportable reasons to form a UBE, including a one-member UBE, System institutions should conduct all aspects of their business activity either directly or through a service corporation under section 4.25 of the Act.
Regardless of the limitations on one-member UBEs, we recognize that the use of a UBE to perform services integral to a System institution's daily internal operations, as noted above, may lessen administrative burdens and reduce costs for a System institution. FCA may determine that some of these integral and internal services that a UBE, including a one-member UBE, could provide would become eligible for the notice provision in proposed § 611.1154. If so, we would inform System institutions of this development through an FCA Bookletter or other similar means.
An eighth restriction would limit the aggregate amount of equity investments that a System institution is authorized to hold in all UBEs to one percent of the institution's total outstanding loans calculated at the time of each investment. The proposed rule allows FCA to approve an exception to this limitation on a case-by-case basis. In addition, FCA may impose a limitation that is lower than the one-percent aggregate limit based on safety or soundness and other relevant concerns. We believe this limit to be reasonable given that such an investment imposes a financial liability on a System institution up to the amount of its total investments in UBEs. Such an investment remains at-risk; it is recovered only after the System institution sells its interest to other investors or the UBE owners receive some of the proceeds from the liquidated assets of the UBE (if any such proceeds remain after satisfying all other obligations of the UBE). To calculate the investment limit under proposed § 611.1153(h), the rule would require that equity investments held by a service corporation be attributed to its System institution bank and association owners based on their percentage of ownership of the service corporation. This limit would not apply to equity investments made in one-member UBEs organized to acquire and manage unusual or complex collateral associated with loans.
The ninth restriction prohibits a System institution from making any equity investment in a third-party UBE except as may be authorized by FCA on a case-by-case basis under § 615.5140(e) for de minimis and passive investment purposes (such requests would be considered outside of this rule). Also, a System institution is prohibited from being named as the general partner, manager or primary beneficiary of a third-party UBE. Such arrangements have the potential to subject a System institution to liability and reputational risks created by the third-party UBE and to result in actual or apparent conflicts of interest that neither a System institution nor FCA could adequately control. Finally, such arrangements could dilute the Agency's oversight of System activities and diminish FCA's ability to ensure the safety and soundness of the System.
In proposed § 611.1154, we describe the specific types of UBEs that a System institution may organize or invest in by providing sufficient advance notice to the FCA. This section also sets forth the specific information that a System institution must include in its notice as well as where the notice must be filed.
b. Those providing hail or multi-peril crop insurance services in accordance with § 618.8040.
FCA may determine that other UBE business activity is also appropriate for this “notice-only” provision and, in such an event, would notify all System institutions by bookletter or other means. Only System institutions with a composite FIRS rating of 1 or 2 would qualify for the “notice-only” provision. All other System institutions that intend to form or invest in a UBE must obtain FCA's prior approval under the provisions in § 611.1155 regardless of the nature or purpose of the intended UBE.
A System institution that qualifies for the “notice-only” provision would be required to submit articles of formation as defined in § 611.1151 that address basic information on the UBE's ownership, control, and operations. The System institution would also need to specify the dollar amount of its investment in the UBE and provide a certified resolution from its board of directors that the board has authorized the UBE investment and business activity and has given its approval to submit the notice to FCA. A letter from the funding bank that the bank has approved such investment would also be required. For those System institutions forming a UBE for hail or multi-purpose crop insurance services, or for other UBE activity that FCA determines appropriate for the “notice-only” provision, the notice would need to include a statement from the board of directors explaining the operating efficiencies and benefits to be gained from the conduct of business through a UBE. The statement must also affirm that the UBE is necessary or expedient to the institution's business; that it will operate with transparency; that it will operate in a manner that prevents conflicts of interest between the UBE and the institution itself; that the UBE will comply with all applicable Federal, State, and local laws; and that the UBE will not be used by the System institution to make direct loans, perform any functions, or provide any services that the System institution is not authorized to provide under the Act and FCA regulations or that go beyond the stated purpose of the UBE. FCA may require additional information under the notice provision or allow the omission of some information. Finally, System institutions that organize or invest in UBEs under this “notice-only” provision must comply with the ongoing requirements and disclosure and reporting requirements of §§ 611.1156 and 611.1157, respectively.
In § 611.1155, we describe the documents that FCA would require to review a request for approval to organize or invest in a UBE if the request would not qualify for the “notice-only” provision in § 611.1154. We would ask a System institution to explain the risk characteristics of the investment, the initial amount of equity it plans to invest in the UBE, the purpose of the UBE, and its objectives. A System institution must provide support for its need to establish or invest in a UBE. We would also ask for a statement on the operating efficiencies that the System institutions expect to achieve and the benefits they expect to derive from using the UBE. A System institution would be required to submit the articles of formation defined in § 611.1151 that address basic information on the UBE's ownership, management structure, and operations. We would also require a certified resolution of the institution's board of directors approving the equity investment in the UBE and the UBE's business activity as well as a letter from the funding bank that it has approved the institution's investment in the UBE. In addition, we would require that an institution's board of directors provide us with a statement that the UBE is necessary or expedient to the institution's business; that it will operate with transparency; that it will operate in a manner that prevents conflicts of interest between the UBE and the institution itself; that the UBE will comply with all applicable Federal, State, and local laws; and that the UBE will not be used by the System institution to make direct loans, perform any functions, or provide any services that the System institution is not authorized to provide under the Act and FCA regulations or that go beyond the stated purpose of the UBE. The institutions may also submit any other information they deem necessary. FCA may require additional information or allow the omission of some information depending on the complexity of the UBE request. If FCA denies approval of the request, we will specify in writing our reasons for denial.
All System institutions that hold equity investments in UBEs would be required to include information about their equity investments and business activities in their annual reports to shareholders. We propose amending § 620.5, which prescribes the content of the annual report to shareholders, to include this requirement. FCA could also direct that System institutions holding equity investments in UBEs make periodic reports to FCA as required by § 621.12.
System institutions with UBEs that are grandfathered under the rule through the provision in § 611.1158 (discussed below) would be subject to the ongoing requirements of § 611.1156 and all disclosure and reporting requirements of § 611.1157.
We propose grandfathering from the Notice and Approval provisions of the rule a System institution's organization of, or investment in, a UBE that received specific, written approval by FCA prior to the date this proposed rule would become effective as a final rule. We would also grandfather those UBEs organized pursuant to the guidance in FCA Bookletter BL-057. All System institutions grandfathered would remain subject to the conditions of approval imposed at the time of FCA's approval and be subject to the ongoing requirements of § 611.1156 and the disclosure and reporting requirements of § 611.1157. System institutions so grandfathered could not change or expand the UBE business activity, ownership interests in, or control of the UBE without providing notice to FCA at least 20 business days in advance of any change. If FCA determined that the proposed change or expansion is material, it could require the System institutions to submit a new approval request under § 611.1155.
a. Revising the heading of § 611.1136; and
7. Part 611 is amended by adding a new subpart J, consisting of §§ 611.1150 through 611.1158, to read as follows:
Approval of equity investment in UBEs.
(b) Scope. Except as authorized under these regulations, no System institution may manage, control, become a member or partner, or invest in a State-organized or chartered business entity. This rule applies to each System institution that organizes or invests in a UBE, including a UBE organized for the express purpose of investing in a Rural Business Investment Company. This rule does not apply to UBEs that one or more System institutions have the authority to establish as Rural Business Investment Companies pursuant to the provisions of title VI of the Farm Security and Rural Investment Act of 2002, as amended (FSRIA) and United States Department of Agriculture regulations implementing FSRIA.
(b) Assessing UBE investments and business activity. In accordance with section 5.15 of the Act and § 607.2(h), the cost of regulating and examining equity investments in UBEs and the services and functions that UBEs can perform for System institutions will be taken into account when assessing a System institution for the cost of administering the Act.
(b) Circumvention of cooperative principles. System institutions are prohibited from using UBEs to engage in direct lending activities or any other activity that would circumvent the application of cooperative principles as determined by FCA, including borrower rights as described in section 4.14A of the Act, or stock ownership, voting rights or patronage as described in section 4.3A of the Act.
(f) Prohibition on UBE subsidiaries. A System institution is prohibited from creating a subsidiary of a UBE that it has organized or invested in under this subpart or from enabling the UBE itself to create a subsidiary or any other type of affiliated entity.
(h) Limit on amount of equity investment in UBEs. The aggregate amount of equity investments that a single System institution is authorized to hold in UBEs must not exceed one percent of the institution's total outstanding loans, calculated at the time of each investment. On a case-by-case basis, FCA may approve an exception to this limitation that would exceed the one-percent aggregate limit. Conversely, FCA may impose a percentage limit lower than the one-percent aggregate limit based on safety or soundness and other relevant concerns. This one-percent aggregate limit does not apply to equity investments in one-member UBEs as permitted in paragraph (d)(1) of this section. Any equity investment made in a UBE by a service corporation must be attributed to its System institution owners based on the ownership percentage of each bank or association.
(1) Making any equity investment in a third-party UBE except as may be authorized on a case-by-case basis under § 615.5140(e) for de minimis and passive investments. Such requests would be considered outside of this rule.
(k) UBEs formed for acquiring and managing collateral. The provisions of paragraphs (i) and (j) in this section do not apply to UBEs formed for the purpose of acquiring and managing unusual or complex collateral associated with multiple-lender loan transactions in which non-System persons or entities are participants.
(a) Applicability. This notice provision is applicable only to System institutions that have a composite Financial Institution Rating System (FIRS) rating of 1 or 2 and wish to make an equity investment in UBEs whose activities are limited to the following purposes:
(2) Providing hail or multi-peril crop insurance services in collaboration with another System institution in accordance with § 618.8040; and
(d) Other requirements. All System institutions under this “notice-only” provision must also comply with the ongoing requirements and disclosure and reporting requirements set forth in §§ 611.1156 and 611.1157, respectively, of this subpart.
(a) Request. System institutions must receive FCA approval before organizing or investing in any UBE that does not qualify for the “notice-only” provision set forth in § 611.1154 of this subpart. A request for approval under this section must include the following information:
(1) A detailed statement of the risk characteristics of the investment, as required by § 615.5140(e) and the initial amount of equity investment;
A System institution that makes an equity investment in a UBE under §§ 611.1154 or 611.1155 of this subpart must also comply with the following requirements:
(a) Annual report to shareholders. In its annual report to shareholders, as set forth in § 620.5(a)(12), a System institution must provide information on its UBE investment and business activity.
(b) Periodic reports as directed. As directed by FCA, a System institution may be required to submit periodic reports to FCA on any equity investment in a UBE or UBE status as provided under § 621.12, and in accordance with §§ 621.13 and 621.14.
(a) Scope. The following equity investments in UBEs are grandfathered from the Notice and Approval provisions under §§ 611.1154 and 611.1155, respectively, of this subpart.
(2) Are subject to the ongoing requirements of § 611.1156 and the disclosure and reporting requirements of § 611.1157 of this subpart; and
(3) May not change or expand the UBE business activity, ownership interests in, or control of the UBE without providing notice of such changes to FCA at least 20 business days in advance of any change or expansion. If the proposed change or expansion is determined to be material, FCA may require the System institution(s) to submit an “Approval” request under § 611.1155 of this subpart.
11. Part 619 is amended by adding a new § 619.9338 to read as follows:
(i) Except as provided in § 620.5(a)(12)(ii) of this section, describe the business relationship with any UBE, as defined in § 611.1151, that was organized by the bank or association or in which the bank or association has an equity interest. Include in the description the name of the UBE, the type of business entity, the purpose for which the UBE was organized, the scope of its activities, and the level of ownership. If the bank or association does not have an equity interest, but manages the operations of a UBE that is controlled by a System institution, describe this business relationship and any fees received.
(ii) If the UBE is a one-member UBE as described in § 611.1153(d)(1), the bank or association need only disclose the name of the UBE, the type of business entity, and the purpose for which the UBE was organized.
16. In § 621.2 paragraph(e) is amended by removing the words “service organization” and adding in their place, the words “service corporation.”
18. In § 622.2 paragraph (d) is amended by removing the words “service organization chartered under part E of title IV of the Act” and adding in their place, the words “service corporation chartered under the Act.”
20. In § 623.2 paragraph (d) is amended by removing the words “service organization chartered under part E of title IV of the Act” and adding in their place, the words “service corporation chartered under the Act.”
22. Section 630.20 is amended by removing the words “service organization” in paragraph (a)(2) and adding in their place, the words “service corporation.”
3. Section 4.25 and 4.28(A), added to the Act in 1980, expressly authorize System banks and associations to organize service corporations. Congress stated that this authority was needed to provide a more efficient way for System banks to coordinate services. Service corporations, like System banks and associations, are federally chartered instrumentalities and subject to the same FCA supervisory, regulatory and enforcement oversight as System banks and associations. Service corporations are authorized to provide the same functions and services as banks and associations with two significant exceptions: they cannot extend credit or provide insurance services.
4. Section 4.19 of the Act.
5. This perspective is noted in the FCA Board's Policy Statement (FCA-PS-80) on Cooperative Operating Philosophy—Serving the Members of Farm Credit System Institutions, dated October 14, 2010, and published in the Federal Register at 75 FR 64728 on October 20, 2010.
6. FCA Bookletter BL-057 on “Use of State-Chartered Business Entities to Hold Acquired Property,” dated April 2, 2009, provides guidance on the System's use of UBEs to acquire and manage unusual or complex collateral associated with loans.
7. Public Law 107-171, title VI, sec. 6029 (2002), as amended by the Food, Conservation, and Energy Act of 2008, Public Law 110-246, title VI, sec. 6027, and USDA regulations at 7 CFR 4290.10 through 4290.3099. FCA has the authority to ensure that a System institution's investment in a RBIC is safe and sound and that they operate the RBIC in accordance with law and regulation.
8. The term control as it is used in the context of this proposed rule is based on the guidance provided in Generally Accepted Accounting Principles (GAAP) under the Financial Accounting Standards Board's Accounting Standards Codification (ASC). See primary discussion of control at ASC 810-10-15 and ASC 810-10-25; significant influence over an investment at ASC 323-10-15; and control for limited partnerships and similar entities, including LLCs, etc. at ASC 810-20-25. See also proposed Accounting Standards Update 2011-220 for possible revisions to these sections.
9. The rule would allow a System institution to serve as a general partner of an LLLP, but not an LP, since the liability for the partnership's debts and obligations is limited to the amount invested by the general partner in an LLLP but not in an LP. We note that an LLP does not have a general partner because all partners in an LLP have limited liability.
[FR Doc. 2012-22382 Filed 9-12-12; 8:45 am]