Peter T. Grauer
Credit Suisse First Boston
CFSB Private Equity, Inc.
Eleven Madison Avenue
New York, New York 10010
Dear Mr. Grauer:
This responds to your recent letter concerning the restrictions in the Gramm-Leach-Bliley (GLB) Act and the Board's Regulation Y on a financial holding company (FHC) routinely managing or operating a portfolio company held under the Act's merchant banking authority.1 The GLB Act generally prohibits an FHC from routinely managing or operating a portfolio company the shares of which are owned or controlled by the FHC under the Act's merchant banking authority (12 U.S.C. § 1843(k)(4)(H)). Your letter requests confirmation that an FHC would not be deemed to routinely manage or operate a portfolio company if the FHC and portfolio company entered into contractual provisions that required the portfolio company to receive the FHC's approval to engage in certain types of actions described in your letter.
Section 225.171(d) of Regulation Y identifies a variety of relationships that an FHC may have with a portfolio company that would not involve the FHC in routinely managing or operating the portfolio company. Among other things, the rule permits an FHC to enter into covenants or other written agreements with a portfolio company that restrict the ability of the portfolio company to take actions that are outside the ordinary course of business, or that require the portfolio company to consult with or obtain the FHC's approval prior to taking actions outside the ordinary course of business.
The rule also contains examples of the types of actions that typically are considered to be outside the ordinary course of business of a portfolio company and, thus, may be subject to these types of covenants or agreements. As the Board and Treasury previously noted in the preamble to the merchant banking rule, the examples included in section 225.171(d) of the rule do not reflect a complete list of the types of actions that may be subject to a covenant between an FHC and a portfolio company.2 The full scope of covenants that may be permissible under the Act and rule would depend on the facts and circumstances of each investment.
You have asked for the staff's view on some additional examples of covenants that may be permissible without involving the FHC in routinely managing or operating the portfolio company. In considering your request, staff also has consulted with staff of the Department of the Treasury, which agrees with the views expressed herein. We believe that the following are examples of covenants that an FHC may have with a portfolio company consistent with the GLB Act and section 225.171(d) of Regulation Y. These examples were drawn in part from examples you have provided or on which you requested the staff's views. Covenants that restrict matters beyond those described below also may be permissible.
Examples of covenants that the staff believes would generally be permissible under the GLB Act and section 225.171(d) of the rule include covenants that restrict the ability of the portfolio company to:
As the foregoing illustrates, some actions by their very nature are outside the ordinary course of business of a portfolio company and, thus, may be subject to a covenant with the portfolio company. For example, covenants restricting the ability of a portfolio company to issue or redeem its equity or debt securities or hire or fire its executive officers are unusual actions that typically are taken only by or in consultation with the company's board of directors.
Covenants concerning other types of actions may, or may not, involve the financial holding company in routine business decisions of the portfolio company depending on the specific scope of actions covered by the covenant and the size and characteristics of the portfolio company. In light of these facts, and to provide financial holding companies maximum flexibility in structuring their relationships with portfolio companies to the extent permitted by the GLB Act, several of the examples included above permit a financial holding company to restrict the ability of a portfolio company to take certain actions whenever the actions are significant.
The measure of "significant" in this context would depend on the size, capital, condition, business and other characteristics of the portfolio company. One rule of thumb would be that any action that would, under ordinary business practices, be presented to the board of directors of the portfolio company for approval or consideration could also be subject to a covenant that requires review and approval of the action by the financial holding company investor. In this way, the rule permits a financial holding company investor to exercise the same type of review and approval rights through a covenant that the financial holding company could exercise directly through representation on the board of directors of the portfolio company.5 As with a director representative, however, a financial holding company may not use a covenant as a means to become involved in routine business decisions made in the ordinary course of the portfolio company's day-to-day business activities.
Staff recognizes that there also may be situations where a covenant is permissible even though the actions involved are ones that, under ordinary business practices, would not be considered by the board of directors of the portfolio company. Staff expects that these situations would be unusual and the permissibility of such a covenant likely would depend on the particular facts and circumstances involved in the case.
I hope this information is helpful. If you have any questions concerning this letter or whether a particular covenant with a portfolio company would, in light of the facts associated with the investment, involve your organization in routinely managing or operating the portfolio company, please feel free to contact Scott G. Alvarez, Associate General Counsel (202-452-3583), or Kieran J. Fallon, Senior Counsel (202-452-5270), of my staff.
- Alter its capital structure through the issuance, redemption, authorization or sale of any equity or debt securities of the portfolio company;3
- Establish the general purpose for funds sought to be raised through the issuance or sale of any equity or debt securities of the portfolio company (e.g., retirement of existing debt, acquisition of another company, or for general corporate use);
- Amend the terms of any equity or debt securities issued by the company;
- Declare a dividend on any class of securities of the portfolio company or change the dividend payment rate on any class of securities of the portfolio company;
- Engage in a public offering of securities of the portfolio company;
- Register a class of securities of the portfolio company under Federal or state securities laws;
- List (or de-list) any securities of the portfolio company on a securities exchange;
- Create, incur, assume, guarantee, refinance or prepay any indebtedness outside the ordinary course of business of the portfolio company;
- Voluntarily file for bankruptcy, or consent to the appointment of a receiver, liquidator, assignee, custodian or trustee of the portfolio company for purposes of winding up its affairs;
- Significantly alter the regulatory, tax, or liability status of the portfolio company. Examples of actions that would significantly alter the regulatory, tax, or liability status of the portfolio company include the registration of the portfolio company as an investment company under the Investment Company Act of 1940, or the conversion of the portfolio company from a corporation to a partnership or limited liability company;
- Make, or commit to make, any capital expenditure that is outside the ordinary course of business of the portfolio company such as, for example, the purchase or lease of a significant manufacturing facility, office building, asset or other company;
- Engage in, or commit to engage in, any purchase, sale, lease, transfer, or other transaction outside the ordinary course of business of the portfolio company. Examples of such actions may include:
- Entering into a contractual arrangement (including a property lease or consulting agreement) that imposes significant financial obligations on the portfolio company;
- The sale of a significant asset of the portfolio company (e.g., a significant patent, manufacturing facility or parcel of real estate);
- The establishment of a significant new subsidiary by the portfolio company;
- The transfer by the portfolio company of significant assets to a subsidiary or to a person affiliated with the portfolio company; or
- The establishment by the portfolio company of a significant new joint venture with a third party;
- Hire, remove or replace any or all of the executive officers of the portfolio company;4
- Establish, accept or modify the terms of an employment agreement with an executive officer of the portfolio company, including the terms setting forth the executive officer's salary, compensation and severance;
- Adopt or significantly modify the portfolio company's policies or budget concerning the salary, compensation or employment of the officers and/or employees of the portfolio company generally;
- Adopt or significantly modify any benefit plan covering officers and/or employees of the portfolio company, including defined benefit and defined contribution retirement plans, stock option plans, profit sharing, employee stock ownership plans, or stock appreciation rights plans;
- Alter significantly the business strategy or operations of the portfolio company such as, for example, by entering or discontinuing a significant line of business, or altering significantly the tax, cash management, dividend, or hedging policies of the portfolio company; or
- Establish, dissolve, or materially alter the duties of, a committee of the board of directors of the portfolio company.
(Signed) J. Virgil Mattingly
J. Virgil MattinglyGeneral Counsel
1. See 12 C.F.R. §§ 225.170 et seq. Return to text
2. See 66 Federal Register 8466, 8472 (Jan. 31, 2001). Return to text
3. For these purposes, the phrase "equity and debt securities" includes options, warrants, obligations or other instruments that give the holder the right to acquire securities of the portfolio company. Return to text
4. The term "executive officer" is defined in section 225.177(d) of Regulation Y. Return to text
5. See 12 C.F.R. 225.171(d)(1) Return to text