advisers act assignment change of control

Assigning an Advisory Contract After a Merger: Ask Permission or Beg Forgiveness?

The purchase, sale or merger of an advisory practice involves a whirlwind of tightly-coordinated efforts by a myriad of different parties. In the shuffle of negotiating the deal terms, settling on a valuation methodology, coordinating with custodians and integrating technological systems, when does the client get a say, if any? In the time-honored tradition of attorneys everywhere, my answer is that it depends.

Section 205(a)(2) of the Investment Advisers Act of 1940 prohibits advisers from entering into an investment advisory contract with a client that “fails to provide, in substance, that no assignment of such contract shall be made by the investment adviser without the consent of the other party by the contract.” This is the baseline requirement that an advisory contract must, without exception, afford the client the opportunity to consent to his or her contract being assigned to another adviser.

That said, the SEC has never explicitly defined what constitutes client consent. Must a client affirmatively take some sort of action to provide consent to an assignment, or is the client’s failure to object to an assignment sufficient? It depends, in large part, in what exactly the signed investment advisory agreement states.

If the signed investment advisory contract requires the client’s written consent to an assignment, the assignment cannot occur until the client physically signs something granting his or her approval (i.e., positive consent). If the investment advisory contract does not require written consent, assignment may automatically occur if the client fails to object within the stated period of time (i.e., negative consent). If the investment advisory contract does not address the assignment consent issue, it does not meet the requirements of the Advisers Act.

The important takeaway for advisors, however, is that negative consent is generally permissible in the context of an assignment. The SEC affirmed this view through a series of no-action letters from the 1980s, which were later reaffirmed in further no-action letters from the 1990s.

A workable assignment clause in an investment advisory contract should afford the client a reasonable amount of time to object after receiving written notice of the assignment (typically 30-60 days). Language should make it clear to the client that a failure to object to an assignment within X number of days will be treated as de facto consent to the assignment.

Though it is beyond the scope of this article, an advisor should also carefully review what the SEC considers to be an “assignment.” At a very high level, an assignment occurs if there is a change in control at the adviser. There is an oft-cited rebuttable presumption that “control” constitutes a 25% or more ownership/voting interest in the advisor, but technically the rebuttable presumption exists in the Investment Company Act and not the Investment Advisers Act.

The point is that advisers should be conscious of positive v. negative consent issues even if their entire practice doesn’t change hands. Another word of caution: advisors to mutual funds are indirectly subject to a separate set of rules promulgated under the Investment Company Act, which states that an advisory contract with a fund automatically terminates in the event of an assignment.

Inserting appropriate negative consent assignment provisions into advisory contracts will help prepare an advisory practice for a smooth transition should an acquisition or merger opportunity present itself. Such provisions are also important to consider when creating a workable continuity or succession plan, as obtaining positive client consent is often easier said than done when the plan actually needs to be executed. As the adage goes, “It’s easier to ask forgiveness than it is to get permission.”

* * * This article originally appeared on May 29, 2014 in ThinkAdvisor .

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Advisory agreement statutory requirements: what advisors need to know to stay compliant.

August 17, 2022 07:07 am 1 Comment CATEGORY: Regulation & Compliance

Executive Summary

Registered Investment Advisers (RIAs) are generally required to enter into an advisory agreement with their clients prior to being hired for advisory services. And while there is no standard ‘template’ language applicable to all advisory agreements, there are a number of best practices that RIAs can follow in drafting and reviewing their agreements to ensure they can pass legal and regulatory muster.

In this guest post, Chris Stanley, investment management attorney and Founding Principal of Beach Street Legal, lays out the statutory requirements for RIA advisory agreements and some of the essential elements for advisory agreements to include when describing the RIA’s services and fees.

Advisory agreements for SEC-registered RIAs are governed by Section 205 of the Investment Advisers Act of 1940. In terms of specific advisory agreement language, the Advisers Act focuses essentially on three items:

First, the law restricts RIAs from charging performance-based fees unless the client is a “qualified client” (in most cases, a client with at least $1.1 million under the management of the adviser, or with a total net worth of at least $2.2 million);
Second, advisory agreements are required to give clients the opportunity to consent to their advisory agreement being ‘assigned’ to another adviser (including when an RIA changes ownership by merging with or being acquired by another firm); and
Third, advisory agreements of RIAs organized as partnerships are simply required to contain a clause informing the client of any change in the membership of that partnership “within a reasonable time after such change”.

But even though the specific requirements of the Advisers Act are relatively narrow in scope, a well-crafted advisory agreement will contain additional elements, including descriptions of the RIA’s services and fees.

When describing the RIA’s services, advisory agreements should lay out the specific services – such as discretionary or nondiscretionary asset management, and the scope and duration of any financial planning services – to be included in the arrangement.

When it comes to fees charged to clients, advisory agreements should include – at minimum – the exact amount of the fee (either as a dollar amount or percentage of assets under management), when the fee will be charged, how the fee will be prorated at the beginning and end of the agreement, how the client can pay the fee, and which of the client’s accounts may be billed. For AUM-based fees, agreements should also include breakpoints for multi-tiered fee schedules (and whether breakpoints are applied on a ‘cliff’ or ‘blended’ basis) and how AUM is calculated (and whether it is based on assets at a single point in time or averaged over a specific period, and if it includes cash and/or margin balances). Any fees for third-party advisers or subadvisers should also be described in the agreement. While these constitute only two core elements of advisory agreements, there are numerous other essential components for RIAs to include (so many, in fact, that covering them all will require another separate article!).

The key point, however, is that a good advisory agreement requires a solid grasp of the Federal and state statutory requirements, and clearly lays out the RIA’s services and fees. For established firms, understanding these points more deeply will allow RIA owners to review their existing agreements – to ensure not only that they comply with existing regulations, but that they also include the elements constituting a valid agreement between RIA and client!

Author: Chris Stanley

Chris Stanley is the Founder of Beach Street Legal LLC, a law firm and compliance consultancy that focuses exclusively on legal, regulatory compliance, and M&A matters for registered investment advisers and financial planners. He strives to provide simple, practical counsel to those in the fiduciary community, and to keep that community ahead of the regulatory curve. When he’s not poring over the latest SEC release or trying to meet the minimum word count for a Nerd’s Eye View guest post, you’ll find Chris enjoying the outdoors away from civilization. To learn more about Chris or Beach Street Legal, head over to beachstreetlegal.com .

Section 205 Of The Advisers Act On Investment Advisory Agreements

Relative to the Advisers Act as a whole, Section 205 is fairly short and is the sole section dedicated to “investment advisory contracts”. It focuses on essentially three items:

charging performance-based fees;
client consent to the assignment of the agreement; and
partnership change notifications.

Section 205(f) is also the section of the Advisers Act that reserves the SEC’s authority to restrict an adviser’s use of mandatory pre-dispute arbitration clauses (i.e., that require clients to agree to settle disputes through arbitration before any disputes even arise) – an authority that has yet to be exercised.

Charging Performance-Based Fees

The primary takeaway from Section 205 regarding performance-based fees is that an advisory agreement cannot include a performance-based fee schedule unless the client signing the agreement is a “qualified client”, as such term is defined in Rule 205-3(d)(1) .

A qualified client includes a natural person or company that:

Has at least $1.1 million under the management of the adviser immediately after entering into the advisory agreement;
Has a net worth of at least $2.2 million immediately prior to entering into the advisory agreement; or
Is a “qualified purchaser” as defined in section 2(a)(51)(A) of the Investment Company Act of 1940 at the time the client enters into the advisory agreement.

Qualified clients also include executive officers, directors, trustees, general partners, or those serving in a similar capacity to the adviser, as well as certain employees of the adviser.

Notably, the Dodd-Frank Act requires the SEC to adjust the dollar amount thresholds in the rules set forth by Section 205 every 5 years. The SEC’s most recent inflationary adjustment to these dollar thresholds was released in June 2021 .

For a more fulsome explanation of the restrictions imposed on advisers that charge fees “on the basis of a share of capital gains upon or capital appreciation of the funds or any portion of the funds of the client” (i.e., performance-based fees), refer to this article and the rulemaking history described therein.

The dollar thresholds triggering “qualified client” status may differ in certain states, as the automatic inflationary adjustments made by the SEC do not automatically apply to the states. In other words, state securities rules may include a different definition of what constitutes a qualified client, and/or still be using ‘prior’ thresholds not in line with more recent SEC adjustments. This poses a potentially awkward scenario in that a particular client may be charged a performance fee while an adviser is state registered, but not if the adviser later transitions to SEC registration.

Client Consent To Assignment

Section 205(a)(2) prohibits advisers from entering into an investment advisory agreement with a client that “fails to provide, in substance, that no assignment of such contract shall be made by the investment adviser without the consent of the other party to the contract.” In other words, an advisory agreement must, without exception, afford the client the opportunity to consent to his or her advisory agreement being “assigned” to another adviser.

An “assignment” of an agreement occurs when one party transfers its rights and obligations under the agreement to a third party not previously a signatory to the agreement. The new third-party assignee essentially stands in the shoes of the assigning party to the agreement going forward, and the assigning party is no longer considered a party to the agreement. In the context of an adviser-client relationship, an adviser that assigns its rights and obligations to another adviser is no longer the client’s adviser… such that Section 205(a)(2) requires the client to acquiesce to such a change.

Notably, an assignment to a new “adviser” in this context is in reference to the investment adviser (as a firm), not necessarily to a new investment adviser representative within the firm. Still, though, Section 202(a)(1) broadly defines an assignment to include “any direct or indirect transfer or hypothecation of an investment advisory contract by the assignor or of a controlling block of the assignor’s outstanding voting securities by a security holder of the assignor […]”. There are a few more sentences specific to partnerships in the definition, but the general concept of the “assignment” definition is that there are essentially two situations in which an assignment is deemed to have occurred:

When advisory agreements are transferred to another adviser or pledged as collateral; or
The equity ownership structure of an adviser changes such that a “controlling block” of the adviser’s outstanding voting securities changes hands.

Both scenarios described above would trigger the need for client consent.

Transferring Advisory Agreements To Another Adviser

A transfer of an advisory agreement from one adviser to another most commonly arises in the context of a sale, merger, or acquisition of one adviser by another (which is also often the case upon the execution of a succession plan).

If Adviser X (the ‘buyer’) is to purchase substantially all of the assets of Adviser Y (the ‘seller’) – including the contractual right to become the investment adviser to the seller’s clients going forward – the seller’s clients must either sign a new advisory agreement with the buyer, or otherwise consent (either affirmatively or passively) to the assignment of their existing advisory agreement with the seller to the buyer.

Controlling Block Of Outstanding Voting Securities

With respect to the second scenario contemplated by the Section 202(a)(1) definition of assignment, the logical next question is: what constitutes a “controlling block?” Unfortunately, the Advisers Act does not define what a “controlling block” is, but based on various sources, including the Adviser Act itself, Form ADV, SEC rulings and no-action letters, and the Investment Company Act of 1940 (a law applicable to mutual funds and separate from the Investment Advisers Act of 1940), we can reasonably conclude that such control is having at least 25% ownership or otherwise being able to control management of the company.

Thus, the logistics of client consent to assignment need to be considered both in adviser sale/merger/acquisition scenarios and in adviser change-of-control scenarios. To come full circle, the existing advisory agreement signed by the client must provide that the adviser can’t assign the advisory agreement without the consent of the client.

Importantly, Section 205(a)(2) does not contain the word “written” before the word “consent,” and does not define what constitutes consent. Must the client affirmatively take some sort of action to provide consent to an assignment, or is the client’s failure to object to an assignment within a reasonable period of time sufficient?

If the existing advisory agreement does require the client’s written consent to an assignment, the assignment cannot occur until the client physically signs something granting his or her approval (i.e., “positive” consent). If the existing advisory agreement does not require written consent, an assignment may automatically occur if the client fails to object within the stated period of time after being notified (i.e., “negative” or “passive” consent). If the existing advisory agreement does not address the assignment consent issue, though, it does not meet the requirements of the Advisers Act.

The important takeaway for SEC-registered advisers, however, is that negative/passive consent is generally permissible in the context of an assignment, so long as the advisory agreement is drafted appropriately. The SEC affirmed this view through a series of no-action letters from the 1980s, which were later reaffirmed in further no-action letters from the 1990s (see, e.g., American Century Co., Inc. / J.P. Morgan and Co. (Dec. 23, 1997) .

Many states prohibit negative/passive consent assignment clauses and require clients to affirmatively consent to any assignment. Texas Board Rule 116.12(c), for example, states that “The advisory contract must contain a provision that prohibits the assignment of the contract by the adviser without the written consent of the client.”

Negative/passive ‘consent to assignment’ clauses should afford the client a reasonable amount of time to object after receiving written notice of the assignment (which ideally would be delivered at least 30 days in advance of the planned assignment). The clause should also make it clear to the client that a failure to object to an assignment within X number of days will be treated as de facto consent to the assignment.

Partnership Change Notifications

The third Section 205 provision with respect to advisory agreements is specific to advisers organized as partnerships and simply requires that advisory agreements contain a clause requiring the adviser to notify the client of any change in the membership of such partnership “within a reasonable time after such change.”

Disclosing Services And Fees In Advisory Agreements

With an understanding of the requirements set forth by Section 205 of the Investment Advisers Act, advisers can now supplement those requirements with additional best practices and techniques when creating or reviewing advisory agreements. Two key considerations include providing a good description of the firm’s services and fees. (Established advisory firms may wish to pull out a copy of their own advisory agreement and read through the sections of their own agreement as they explore the sections discussed below.)

Describing The Firm’s Services

The first keystone component of an advisory agreement (or any agreement) is a complete and accurate description of the services to be provided by the adviser in exchange for the fee paid by the client. The exact nature of services will naturally vary on an adviser-by-adviser basis, but good advisory agreements should account for at least the following services:

If rendering asset management services:

For discretionary management services, include a specific limited power of attorney granting the adviser the discretionary authority to buy, sell, or otherwise transact in securities or other investment products in one or more of the client’s designated account(s) without necessarily consulting the client in advance or seeking the client’s pre-approval for each transaction. For non-discretionary management services, state that the adviser must obtain the client’s pre-approval before affecting any transactions in the client’s account(s).
Clarify whether the adviser’s discretionary authority extends to the retention and termination of third-party advisers or subadvisers on behalf of the client.
Consider provisions that discourage or restrict the client’s unilateral self-direction of transactions if they will interfere or contradict with the implementation of the adviser’s strategy (e.g., that the client shall refrain from executing any transactions or otherwise self-directing any accounts designated to be under the management of the adviser due to the conflicts that may arise).
Consider identifying the account(s) subject to the adviser’s management by owner, title, and account number (if available) in a table or exhibit, noting that the client may later add or remove accounts subject to the adviser’s management so long as such additions and removals are made in writing (or pursuant to a separate custodial LPOA form). This is particularly important if some accounts are to be managed on a discretionary basis and others are to be managed on a non-discretionary basis (or if some of the client’s accounts will be unmanaged).
Identify any client-imposed restrictions that the adviser has agreed to (e.g., not investing in certain companies or industries).

If rendering financial planning services:

Describe whether the rendering of financial planning services is for a fixed/limited duration (e.g., if the adviser is simply engaged to prepare a one-time financial plan, after which the agreement will terminate) or whether the financial planning relationship will continue indefinitely until terminated. For ongoing financial planning service engagements, either describe what financial planning services will be rendered on an ongoing basis or consider preparing a separate financial planning services calendar . Advisers can either limit financial planning topics to an identifiable list (if the adviser and/or client want to be very prescriptive in the scope of the relationship) or generally describe that the adviser will render advice with respect to financial planning topics as the client may direct from time to time (if the adviser and/or client want to keep the scope of potential financial planning topics open-ended).
Clarify that the adviser is not responsible for the actual implementation of the adviser’s financial planning recommendations and that the client may independently elect to act or not act on the adviser’s recommendations at their sole and absolute discretion. Even though the adviser may assume responsibility for discretionary management of a client’s investment portfolio, the client remains ultimately responsible for actually implementing any separate financial planning recommendations that the adviser cannot implement on behalf of the client.

Just as important as a description of the services to be provided by the adviser is a description of the services not to be provided by the adviser. While it is impossible to identify by exclusion everything the adviser won’t be doing, it is best practice to clarify that the adviser is not responsible for the following activities if not separately agreed to:

Rendering legal, accounting, or tax advice (unless the adviser is also a CPA, EA, or has otherwise specifically agreed to render accounting and/or tax advice).
Advising on or voting proxies for securities owned by the client (unless the adviser has adopted proxy voting policies and procedures and will vote such proxies on the client’s behalf).
Advising on or making elections related to legal proceedings, such as class actions, in which the client may be eligible to participate.

To the extent that the client is a retirement plan (such as a 401(k) plan), it will be important to distinguish what plan-specific services will be provided and whether the adviser is acting as a non-discretionary investment adviser (under Section 3(21)(A)(ii) of ERISA) or a discretionary investment manager (under Section 3(38) of ERISA) , and what specific plan and/or participant related services are being provided by the adviser.

The nuances of ERISA-specific plan agreements are beyond the scope of this article, but suffice to say that plan agreements should generally be relegated to a separate agreement and should not be combined with a natural-person business owner’s standard advisory agreement, as discussed above.

Advisory Fees

The second keystone component of an advisory agreement, and the one most likely to be scrutinized by SEC exam staff, is the description of the adviser’s fees to be charged to the client. Advisory fees have justifiably received a lot of regulatory attention recently, and advisers should consider reviewing the November 2021 SEC Risk Alert which describes how advisers continue to drop the ball in this respect, from miscalculating fees to failing to include accurate (or sometimes any) disclosures, to lapses in fee-billing policies and procedures and reporting.

At a minimum, an advisory agreement should describe the following with respect to an adviser’s fees:

The exact fee amount itself (e.g., an asset-based fee equal to X%, a flat fee equal to $X, and/or an hourly rate equal to $X per hour).
The frequency with which the fee is charged to the client (e.g., quarterly or monthly).
Whether the fee is charged in advance or in arrears of the applicable billing period (e.g., monthly in advance or quarterly in arrears).
How the fee will be prorated for partial billing periods, both upon the inception and termination of the advisory relationship.
How the fee will be payable by the client (e.g., via automatic deduction from the client’s investment account(s) upon the adviser’s instruction to the qualified custodian, or via check, ACH, credit card, etc., upon presentation of an invoice to the client).
If all fees are to be charged to a specific account and not prorated across all accounts under the adviser’s management, the identity of the account(s) that are the ‘bill to’ accounts. Fees can only be payable from a qualified account(s) specifically for services rendered to such qualified account(s) (e.g., fees associated with a client’s taxable brokerage account should not be payable by the client’s IRA).

Asset-Based Fees

Specifically, with respect to asset-based fees, advisory agreements should include the following:

Whether fees apply to all client assets designated to be under the adviser’s management and whether the client will be entitled to specific asset breakpoints above which the fee will (typically) decrease.
If the fee starts at 1.00% per annum but then decreases to 0.70% per annum if the client maintains a threshold amount of assets under the adviser’s management, clarify whether the 0.70% fee amount applies to all client assets back to dollar zero (i.e., a cliff schedule), or only to the band of assets above a certain threshold, with assets below that certain threshold charged at 1.00% (i.e., a blended or tiered schedule).
If fees are calculated upon assets measured at a single point in time, identify whether fees will be prorated at all for any intra-billing period deposits or withdrawals made by the client.

For example, if fees are payable quarterly in advance based on the value of the client’s assets under the adviser’s management as of the last business day in the prior calendar quarter, will the client be issued any prorated fee refund if the client withdraws the vast majority of his or her assets on the first day of the new quarter? In other words, if the billable account value is $1 million on day one of the billing period but the client immediately withdraws $900,000 on day two of the billing period (such that the adviser is only managing $100,000, not $1 million, during 99% of the billing period), is the client afforded any prorated refund?

Conversely, if fees are payable quarterly in arrears based on the value of the client’s assets under the adviser’s management as of the last business day of the quarter, will the client be charged any prorated fee if the client withdraws the vast majority of his or her assets on the day before the adviser bills? In other words, if the adviser manages $1 million of client assets for 99% of the billing period but the client withdraws $900,000 on the last day before the billable value calculation date (such that the billable value is only $100,000 and not $1 million), is the adviser afforded any prorated fee?

Charging asset-based fees calculated from an average daily balance in arrears can help to avoid either of the potentially awkward scenarios described above and the need/desire to calculate prorated refunds or fees.
Whether cash and/or outstanding margin balances are included in the assets upon which the fee calculation is applied.

Flat Or Subscription Fees

To the extent an adviser charges for investment management services on a flat-fee basis, be aware that both certain states and the SEC may consider the asset-based fee equivalent of the actual flat fee being charged for purposes of determining whether the fee is reasonable or not.

For example, if an adviser manages a client’s $50,000 account and charges an annual flat fee of $5,000 for a combination of financial planning and investment management, a regulator may take the position that the adviser is charging the equivalent of a 10% per annum asset-based fee, which, if viewed in isolation, is well beyond what is informally considered to be unreasonable (generally, an asset-based fee in excess of 2% per annum).

The 2% asset-based fee threshold traces its roots back to various no-action letters from the 1970s, like Equitable Communications Co., SEC Staff No-Action Letter, 1975 WL 11422 (pub. avail. Feb. 26, 1975) ; Consultant Publications, Inc., SEC Staff No-Action Letter, 1975 WL 12078 (pub. avail. Jan. 29, 1975) ; Financial Counseling Corporation, SEC Staff No-Action Letter (Dec. 7, 1974) ; and John G. Kinnard & Co., Inc., SEC Staff No-Action Letter (Nov. 30, 1973) .

In these letters, the SEC’s Division of Investment Management took the position that an asset-based fee greater than 2% of a client’s assets under the adviser’s management is excessive and would violate Section 206 of the Advisers Act (Prohibited Transactions By Investment Advisers) unless the adviser discloses that its fee is higher than that normally charged in the industry.

Setting aside the dubious reasoning underlying the citation of advisory fee practices from nearly a half-century prior, one potential way to combat such logic is to charge separate flat fees purely for investment management (with the asset-based equivalent remaining under 2% of a client’s assets under management), and separate flat fees for financial planning (while adhering to a financial planning service calendar).

Fees Involving Third-Party Advisers Or Subadvisers

To the extent the adviser may retain a third-party adviser or subadviser to manage all or a portion of a client’s assets, and the client will not separately sign an agreement directly with such third-party adviser or subadviser that discloses the additional fees to be charged to the client, it is prudent to include such third-party adviser or subadviser’s fees in the adviser’s agreement.

Advisory agreements should also generally describe the other fees the client is likely to incur from third parties in the course of the advisory relationship (e.g., product fees and expenses like internal expense ratios, brokerage commissions, or transaction charges for non-wrap program clients, custodial/platform fees, etc.).

Several states take a rather ‘creative’ position with respect to what constitutes an ‘unreasonable’ fee and may either explicitly or implicitly prohibit certain types of fee arrangements, especially with respect to flat or hourly fees for financial planning. At least two states have even been known to cap the hourly rate an adviser may charge. Many states require that advisers present clients with an itemized invoice or statement at the same time they send fee deduction instructions to the qualified custodian. Such itemization, to use California as an example, is expected to include the formula used to calculate the fee, the value of the assets under management on which the fee is based, and the time period covered by the fee.

Ultimately, the foundation of a good advisory agreement consists of many components, including a complete and accurate description of the firm’s services and advisory fees. While these are only two essential components, there are also many other equally important elements to include and best practices to follow that should be accounted for in any advisory agreement, which will be addressed in Part 2 of this article.

October 4, 2023 at 3:18 pm

Great article, as usual, thanks for your help!

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Investment Adviser Change of Control Transactions and Obtaining Client Consent

This practice note addresses adviser-assignment and client-consent issues in the context of private funds and separately managed accounts. This practice note also identifies related considerations when structuring, negotiating, and closing transactions involving the change of control of an investment advisory business.

15 U.S. Code § 80b–5 - Investment advisory contracts

For purposes of paragraph (2) of subsection (b), the point from which increases and decreases in compensation are measured shall be the fee which is paid or earned when the investment performance of such company or fund is equivalent to that of the index or other measure of performance, and an index of securities prices shall be deemed appropriate unless the Commission by order shall determine otherwise.

As used in paragraphs (2) and (3) of subsection (a), “ investment advisory contract ” means any contract or agreement whereby a person agrees to act as investment adviser to or to manage any investment or trading account of another person other than an investment company registered under subchapter I of this chapter.

The Commission , by rule or regulation, upon its own motion, or by order upon application, may conditionally or unconditionally exempt any person or transaction, or any class or classes of persons or transactions, from subsection (a)(1), if and to the extent that the exemption relates to an investment advisory contract with any person that the Commission determines does not need the protections of subsection (a)(1), on the basis of such factors as financial sophistication, net worth, knowledge of and experience in financial matters, amount of assets under management, relationship with a registered investment adviser, and such other factors as the Commission determines are consistent with this section. With respect to any factor used in any rule or regulation by the Commission in making a determination under this subsection, if the Commission uses a dollar amount test in connection with such factor, such as a net asset threshold, the Commission shall, by order, not later than 1 year after July 21, 2010 , and every 5 years thereafter, adjust for the effects of inflation on such test. Any such adjustment that is not a multiple of $100,000 shall be rounded to the nearest multiple of $100,000.

The Commission , by rule, may prohibit, or impose conditions or limitations on the use of, agreements that require customers or clients of any investment adviser to arbitrate any future dispute between them arising under the Federal securities laws, the rules and regulations thereunder, or the rules of a self-regulatory organization if it finds that such prohibition, imposition of conditions, or limitations are in the public interest and for the protection of investors.

2018—Subsec. (b)(3). Pub. L. 115–141 substituted “ section 80a–60(a)(4)(B)(iii) of this title ” for “ section 80a–60(a)(3)(B)(iii) of this title ” and “ section 80a–60(a)(4)(B) of this title ” for “ section 80a–60(a)(3)(B) of this title ”.

2010—Subsec. (a). Pub. L. 111–203, § 928 , in introductory provisions, substituted “registered or required to be registered with the Commission” for “, unless exempt from registration pursuant to section 80b–3(b) of this title ,” and struck out “make use of the mails or any means or instrumentality of interstate commerce, directly or indirectly, to” after “shall” and “to” after “in any way”.

Subsec. (e). Pub. L. 111–203, § 418 , inserted at end “With respect to any factor used in any rule or regulation by the Commission in making a determination under this subsection, if the Commission uses a dollar amount test in connection with such factor, such as a net asset threshold, the Commission shall, by order, not later than 1 year after July 21, 2010 , and every 5 years thereafter, adjust for the effects of inflation on such test. Any such adjustment that is not a multiple of $100,000 shall be rounded to the nearest multiple of $100,000.”

Subsec. (f). Pub. L. 111–203, § 921(b) , added subsec. (f).

1996—Subsec. (b)(4), (5). Pub. L. 104–290, § 210(1) , added pars. (4) and (5).

Subsec. (e). Pub. L. 104–290, § 210(2) , added subsec. (e).

1987— Pub. L. 100–181 completely revised and expanded provisions on investment advisory contracts, changing structure of section from a single unlettered paragraph to one consisting of four subsections lettered (a) to (d).

1980— Pub. L. 96–477 provided that par. (1) of this section was not to apply with respect to any investment advisory contract between an investment adviser and a business development company so long as the compensation provided for in such contract did not exceed 20 per cent of the realized capital gains upon the funds of the business development company and such business development company did not have outstanding any option, warrant, or right issued pursuant to section 80a–60(a)(3)(B) of this title and did not have a profit-sharing plan.

1970— Pub. L. 91–547 substituted reference to section “80b–3(b)” for “80b–3” of this title in first sentence, redesignated as second sentence former third sentence, designating existing provisions as cl. (A) and adding cl. (B) and items (i) and (ii) and provision respecting compensation based on asset value of company or fund under management averaged over a specified period in relation to investment record of an index of securities or such other measure of investment performance specified by Commission rules, regulations, or orders, inserted third sentence provision respecting point from which compensation is to be measured, substituted in fourth, formerly third, sentence “paragraphs (2) and (3) of this section” for “this section” and in definition of “investment advisory contract” the words “account of another person other than an investment company registered under subchapter I of this chapter” for “account for a person other than an investment company” .

1960— Pub. L. 86–750 substituted “unless exempt from registration pursuant to” for “registered under”.

Amendment by sections 921(b) and 928 of Pub. L. 111–203 effective 1 day after July 21, 2010 , except as otherwise provided, see section 4 of Pub. L. 111–203 , set out as an Effective Date note under section 5301 of Title 12 , Banks and Banking.

Amendment by section 418 of Pub. L. 111–203 effective 1 year after July 21, 2010 , except that any investment adviser may, at the discretion of the investment adviser, register with the Commission under the Investment Advisers Act of 1940 during that 1-year period, subject to the rules of the Commission, and except as otherwise provided, see section 419 of Pub. L. 111–203 , set out as a note under section 80b–2 of this title .

Amendment by Pub. L. 91–547 effective on expiration of one year after Dec. 14, 1970 , see section 30(1) of Pub. L. 91–547 , set out as a note under section 80a–52 of this title .

For transfer of functions of Securities and Exchange Commission , with certain exceptions, to Chairman of such Commission, see Reorg. Plan No. 10 of 1950, §§ 1, 2, eff. May 24, 1950 , 15 F.R. 3175 , 64 Stat. 1265 , set out under section 78d of this title .

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Exempt Reporting Advisers and SEC Scrutiny

Increasing numbers of small, mid-size and large exempt reporting advisers (ERA) in the investment adviser community have drawn the interest of the U.S. Securities and Exchange Commission's (SEC) Division of Enforcement.
ERAs are required to file with the SEC by providing basic identifying information, details about the size of any funds they advise on and other business interests they and their affiliates have, among other details.
Considering the possibility of heightened scrutiny by the SEC, current and aspiring ERAs should be knowledgeable about applicable filing and compliance requirements, as well as topics of interest to the Division of Enforcement, to avoid violating federal and state regulations.

Exempt reporting advisers (ERA) have become a topic of interest for the U.S. Securities and Exchange Commission's (SEC) Division of Enforcement due in large part to their growing popularity among the investment adviser community. Given the likely prospect of heightened scrutiny, current and aspiring ERAs should be aware of applicable filing and compliance requirements, as well as topics of interest to the SEC's Division of Enforcement, to avoid running afoul of federal and state regulations.

What Is an Exempt Reporting Adviser?

Investment advisers must register with either federal or state securities authorities, depending on the amount of assets under management. "Small advisers," with less than $25 million in regulatory assets under management (RAUM), and "mid-sized advisers," with $25 million to $110 million in RAUM, generally may only register with state securities authorities. "Large advisers," with more than $110 million in RAUM, must register with the SEC unless they fall under the Private Fund Adviser Exemption or Venture Capital Adviser Exemption to registration, each of which was created under the Dodd-Frank Act as amendments to the Investment Advisers Act of 1940, as amended (Advisers Act).

The Private Fund Adviser Exemption is available to advisers based in the U.S. who solely manage private funds and have less than $150 million in RAUM. A "private fund" is an issuer of securities that would be an "investment company" but for the exceptions in Sections 3(c)(1) and 3(c)(7) of the Investment Company Act of 1940, as amended (Investment Company Act) — that is, an investment fund limited to no more than 100 accredited investors or investors who are both accredited investors and qualified purchasers, respectively. The Venture Capital Adviser Exemption is available to investment advisers who solely advise venture capital funds. A "venture capital fund," as defined in the Advisers Act, is a private fund that 1) invests no more than 20 percent of its total capital in assets other than "qualifying investments" 1 and short-term holdings; 2 2) does not incur leverage in excess of 15 percent of its aggregate capital contributions and uncalled committed capital, and any such leverage is for a nonrenewable term of no longer than 120 calendar days; 3) does not offer its investors liquidity rights except in extraordinary circumstances; 4) is not registered under the Investment Company Act; 5) has not elected to be treated as a business development company; and 6) represents that it pursues a venture capital strategy.

Investment advisers who meet either the Private Fund Adviser Exemption or the Venture Capital Adviser Exemption are known as ERAs. ERAs are not subject to the same federal or state registration procedures as other investment advisers, but must still register with and report to securities regulators and satisfy certain compliance requirements.

Federal Registration

An ERA is required to file with the SEC and does so by completing and filing Form ADV, which is the same registration document submitted by registered investment advisers (RIA). However, instead of completing the entire form, ERAs complete only certain items in Part 1A, along with corresponding schedules. These items disclose, among other things, basic identifying information about the ERA (e.g., its legal name, principal office and place of business), details about the size of any private funds it advises, other business interests of the ERA and its affiliates, and disciplinary history of the ERA and its employees. 3 In particular, an ERA must identify "control persons" who directly or indirectly control it.

Form ADV generally is electronically filed, and the information provided on it is available to the public on the Investment Adviser Registration Depository, operated by the Financial Industry Regulatory Authority. An ERA must complete and file Form ADV with the SEC (and pay associated filing fees) within 60 days of the date on which the investment adviser commences an advisory relationship with its first fund. Form ADV must be updated at least annually within 90 days of the ERA's fiscal year end and more frequently following certain material developments as described in the instructions to Form ADV. ERAs relying on the Private Fund Adviser Exemption must include any updates to their valuation of the private fund assets under management to determine whether the exemption is still applicable. If an ERA determines that it no longer manages less than $150 million in RAUM as of Dec. 31, it must file an application for registration as an RIA with the SEC by June 30.

State Registration

Generally, states require ERAs that have a place of business in state to make additional filings, pay fees and report to state securities authorities when filing or amending their Form ADV. Although specific state requirements vary, as a general rule, Advisers Act Rule 222-1(a) defines the term "place of business" as an office or other location held out to the public as a location in which the investment adviser regularly provides investment advisory services or solicits, meets with or otherwise communicates with clients. These "notice filings" may be accomplished by the ERA selecting the relevant states on Item 2.C of Part 1A of Form ADV, which will automatically send the form to those states. It is important for the ERA to determine whether it is subject to notice filing requirements in individual states.

Advisers who are exempt from investment adviser registration with the SEC must still comply with applicable state law. Many states have adopted exemptions that are similar to the federal exemptions for venture capital advisers and private fund advisers. However, in certain cases, state law will have additional requirements (e.g., "qualified client" status for private fund advisers). An ERA should check with the state in which it conducts investment advisory activities to determine whether there is a state exemption and what, if any, compliance requirements exist at that level.

Compliance Requirements and Recent SEC Actions

ERAs are not subject to some of the Advisers Act provisions regarding registration or recordkeeping that apply to RIAs. However, ERAs have fiduciary responsibilities to their clients and must abide by certain other compliance requirements applicable to all investment advisers, including anti-fraud rules and pay-to-play provisions. Some of the compliance requirements applicable to ERAs are summarized below:

Anti-Fraud Requirements: It is unlawful for any investment adviser, whether an ERA or RIA, to use any device, scheme or artifice in order to defraud a client or a prospective client. Investment advisers must also refrain from engaging in any transaction, practice or course of business that operates as a fraud or deceit upon a client or a prospective client. Examples of practices that run afoul of the anti-fraud rules include promising clients a guaranteed return from an equity investment or making false statements about the ERA's investment history. Advisers Act Rule 206(4)-8 (Antifraud Rule) makes it a fraudulent, deceptive, or manipulative act or practice for any investment adviser, whether an ERA or RIA, to make any untrue statement of material fact or omit a material fact such that a statement to an investor or potential investor becomes misleading or otherwise engages in any act, practice or course of business that is fraudulent, deceptive or manipulative with respect to any investor or prospective investor.

Since March 2022, there have been five SEC enforcement actions brought against ERAs citing the Antifraud Rule: two involving the disclosure surrounding and the calculation of management fees; two involving loans and cash transfers between an ERA's various funds that the SEC alleged to be unauthorized and undisclosed; and one involving the failure to audit financial statements where the fund documents provided for annual audits. The recent SEC enforcement actions indicate that the SEC's Enforcement Division will scrutinize investment advisers — whether registered or not — when it comes to compliance with their fiduciary obligations.

Pay-to-Play Requirements: ERAs are subject to Advisers Act Rule 206(4)-5, which prohibits certain investment advisers from engaging in pay-to-play practices (i.e., being compensated for investment advisory services to a government entity or an official after making political contributions to the same). Rule 206(4)-5 imposes three main conditions on ERAs. First, investment advisers and their associates are subject to a two-year "cooling-off" period after making a contribution to an official of a government entity before the adviser can receive compensation for providing advice to the government entity. Second, investment advisers are not allowed to use third-party solicitors who themselves are not subject to pay-to-play restrictions. Finally, investment advisers may not solicit or coordinate campaign contributions from others for officials of a government entity to which the adviser provides or is seeking to provide services.

Since March 2022, there have been three SEC enforcement actions against ERAs involving political contributions made by employees of fund managers to certain public officials occupying positions within government entities that were already invested in the managers' funds. As with the Antifraud Rule, it seems compliance with the pay-to-play rules is also a focus of the SEC's Division of Enforcement in its audits of ERAs.

Anti-Money Laundering Requirements: U.S. investment advisers, including ERAs, are subject to the rules promulgated by the Office of Foreign Asset Control (OFAC) of the U.S. Department of the Treasury, which prohibits investment advisers from doing business with individuals and entities on OFAC's list of "Specially Designated Nationals and Blocked Persons." Investment advisers must ensure that they do not accept those individuals or entities as clients and must notify OFAC of any suspect clients or transactions. Compliance with OFAC is most often accomplished by ERAs and RIAs by establishing and maintaining robust anti-money laundering policies and procedures.

Protecting Investor Privacy: ERAs and RIAs are both subject to rules promulgated under the Gramm-Leach-Bliley Act, including Regulation S-P, that govern maintenance of investors' personal information. Unlike RIAs, which are subject to privacy rules issued by the SEC, ERAs are subject to privacy rules issued by the Federal Trade Commission (FTC). The FTC privacy rules require ERAs to "develop, implement and maintain a comprehensive information security program that is written in one or more readily accessible parts." In particular, ERAs must identify reasonably foreseeable risks to the security, confidentiality and integrity of customer information; design and implement information safeguards; test and monitor these safeguards; and make adjustments as needed. Additionally, one or more employees must be appointed to coordinate the program.

Generally, ERAs are required to send initial privacy notices to investors along with standard fund documents describing their privacy policies and procedures. In addition, ERAs must send investors annual privacy disclosures, except when the ERA: 1) only shares investors' nonpublic personal information with unaffiliated third parties that do not require an opt-out right be provided to investors under the Fixing America's Surface Transportation Act (FAST Act); and 2) has not changed its privacy policies and procedures since its last privacy disclosure. Under the FAST Act, opt-out rights do not need to be provided to investors when information is shared: 1) with insurance rate advisory organizations, ratings agencies, consumer agencies, attorneys, accountants, auditors and others determining industry standards; 2) with unaffiliated third parties providing services for or on behalf of the ERA; or 3) for the purpose of fraud prevention or to comply with federal, state or local laws.

Conclusion and Considerations

As evidenced by the rules and restrictions described in this article, as well as the recent SEC enforcement actions against ERAs, "exempt reporting adviser" is somewhat of a misnomer. Although RIAs may have more onerous registration and reporting requirements, there are many regulatory pitfalls for ERAs at both the federal and state level. The SEC's focus on ERAs has recently become clear. As the SEC continues to focus on investment advisers, it is likely that we will see more ERAs being caught by the SEC's scrutiny. Thus, it is crucial for ERAs to clearly understand the obligations applicable to ERAs, strictly adhere to them and precisely follow the terms of the ERA's agreements (such as the determination of management fees).

1 As defined in 17 C.F.R. Section 275.203(l)-1.

2 As defined in 17 C.F.R. Section 275.203(l)-1.

3 In May 2022, the SEC issued proposed rules under the Adviser Act that, if adopted, would require advisers, including ERAs, that consider environmental, social or governance factors (ESG) as part of one or more of their significant investment strategies to report on Part 1A of Form ADV additional information about those strategies.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.

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Don’t Confuse Change of Control and Assignment Terms

David Tollen
September 11, 2020

An assignment clause governs whether and when a party can transfer the contract to someone else. Often, it covers what happens in a change of control: whether a party can assign the contract to its buyer if it gets merged into a company or completely bought out. But that doesn’t make it a change of control clause. Change of control terms don’t address assignment. They say whether a party can terminate if the other party goes through a merger or other change of control. And they sometimes address other change of control consequences.

Don’t confuse the two. In a contract about software or other IT, you should think through the issues raised by each. (Also, don’t confuse assignment of contracts with assignment of IP .)

Here’s an assignment clause:

Assignment. Neither party may assign this Agreement or any of its rights or obligations hereunder without the other’s express written consent, except that either party may assign this Agreement to the surviving party in a merger of that party into another entity or in an acquisition of all or substantially all its assets. No assignment becomes effective unless and until the assignee agrees in writing to be bound by all the assigning party’s obligations in this Agreement. Except to the extent forbidden in this Section __, this Agreement will be binding upon and inure to the benefit of the parties’ respective successors and assigns.

As you can see, that clause says no assignment is allowed, with one exception:

Assignment to Surviving Entity in M&A: Under the clause above, a party can assign the contract to its buyer — the “surviving entity” — if it gets merged into another company or otherwise bought — in other words, if it ceases to exist through an M&A deal (or becomes an irrelevant shell company).

Consider the following additional issues for assignment clauses:

Assignment to Affiliates: Can a party assign the contract to its sister companies, parents, and/or subs — a.k.a. its “Affiliates”?
Assignment to Divested Entities: If a party spins off its key department or other business unit involved in the contract, can it assign the contract to that spun-off company — a.k.a. the “divested entity”? That’s particularly important in technology outsourcing deals and similar contracts. They often leave a customer department highly dependent on the provider’s services. If the customer can’t assign the contract to the divested entity, the spin-off won’t work; the new/divested company won’t be viable.
Assignment to Competitors: If a party does get any assignment rights, can it assign to the other party’s competitors ? (If so, you’ve got to define “Competitor,” since the word alone can refer to almost any company.)
All Assignments or None: The contract should usually say something about assignments. Otherwise, the law might allow all assignments. (Check your jurisdiction.) If so, your contracting partner could assign your agreement to someone totally unacceptable. (Most likely, though, your contracting partner would remain liable.) If none of the assignments suggested above fits, forbid all assignments.

Change of Control

Here’s a change of control clause:

Change of Control. If a party undergoes a Change of Control, the other party may terminate this Agreement on 30 days’ written notice. (“Change of Control” means a transaction or series of transactions by which more than 50% of the outstanding shares of the target company or beneficial ownership thereof are acquired within a 1-year period, other than by a person or entity that owned or had beneficial ownership of more than 50% of such outstanding shares before the close of such transactions(s).)

Contract terminated, due to change of control.

Termination on Change of Control: A party can terminate if controlling ownership of the other party changes hands.

Change of control and assignment terms actually address opposite ownership changes. If an assignment clause addresses change of control, it says what happens if a party goes through an M&A deal and no longer exists (or becomes a shell company). A change of control clause, on the other hand, matters when the party subject to M&A does still exist . That party just has new owners (shareholders, etc.).

Consider the following additional issues for change of control clauses:

Smaller Change of Ownership: The clause above defines “Change of Control” as any 50%-plus ownership shift. Does that set the bar too high? Should a 25% change authorize termination by the other party, or even less? In public companies and some private ones, new bosses can take control by acquiring far less than half the stock.
No Right to Terminate: Should a change of control give any right to terminate, and if so, why? (Keep in mind, all that’s changed is the party’s owners — possibly irrelevant shareholders.)
Divested Entity Rights: What if, again, a party spins off the department or business until involved in the deal? If that party can’t assign the contract to the divested entity, per the above, can it at least “sublicense” its rights to products or service, if it’s the customer? Or can it subcontract its performance obligations to the divested entity, if it’s the provider? Or maybe the contract should require that the other party sign an identical contract with the divested entity, at least for a short term.

Some of this text comes from the 3rd edition of The Tech Contracts Handbook , available to order (and review) from Amazon here , or purchase directly from its publisher, the American Bar Association, here.

Want to do tech contracts better, faster, and with more confidence? Check out our training offerings here: https://www.techcontracts.com/training/ . Tech Contracts Academy has options to fit every need and schedule: Comprehensive Tech Contracts M aster Classes™ (four on-line classes, two hours each), topical webinars (typically about an hour), customized in-house training (for just your team). David Tollen is the founder of Tech Contracts Academy and our primary trainer. An attorney and also the founder of Sycamore Legal, P.C. , a boutique IT, IP, and privacy law firm in the San Francisco Bay Area, he also serves as an expert witness in litigation about software licenses, cloud computing agreements, and other IT contracts.

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New SEC Interpretation of Advisers Acts

Amran Hussein , Udi Grofman , and Marco V. Masotti are partners at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on a Paul Weiss memorandum by Ms. Hussein, Mr. Grofman, Mr. Masotti, Matthew Goldstein , Conrad van Loggerenberg , and Lindsey Wiersma . Related research from the Program on Corporate Governance includes The Trilateral Dilemma in Financial Regulation by Howell Jackson (discussed on the Forum here ).

The SEC recently issued a final interpretation (the “Interpretation”) [1] of the federal fiduciary duty that an investment adviser owes to its clients under the Advisers Act. [2]

The SEC thought it would be beneficial to address in one release and reaffirm, and in some cases clarify, its understanding of certain aspects of the fiduciary duty. The SEC does not regard the Interpretation as new rulemaking or as the exclusive resource for understanding an investment adviser’s fiduciary duty, but rather views it as a summary of existing law in the area. While many practitioners may disagree with that assessment on various individual points in the Interpretation, the overall fiduciary duty described in the Interpretation is one that private fund advisers will find to be generally in line with their prior understandings. The following are certain highlights of the Interpretation of particular relevance for private fund advisers.

“May” Disclosures . Consistent with other recent statements from the SEC, the Interpretation emphasizes that disclosures stating that an investment adviser “may” have a particular conflict would not be adequate if the conflict actually exists. The Interpretation specifies that the use of a “may” disclosure would be inappropriate: (i) where a conflict actually exists in some, even if not all, of the circumstances being described, unless additional disclosure specifies the circumstances in which the conflict actually exists; and (ii) if it precedes a laundry list of possible or potential conflicts, obscuring actual conflicts that exist. However, the Interpretation states that the word “may” could be appropriately used to disclose a “potential conflict that does not currently exist but might reasonably present itself in the future.”
Disclosure of Practices Inconsistent with Acting in the Client’s Best Interests . The Interpretation notes that the duty of loyalty, and the corresponding obligation to make full and fair disclosure of conflicts of interest, is a part of, and not an exception to, the duty to act in the client’s best interest.
Conflict Management . The Interpretation notes that the inherent nature of certain conflicts of interest (e.g., those involving complex conflicts) may not be addressed simply by describing the conflict alone, but that the disclosure would also need to describe how the investment adviser will manage it. Consistent with the general theme of the Interpretation, ensuring that any such disclosures address the manner in which the underlying conflict will be managed would further support the position that the investment adviser provided full and fair disclosure for purposes of informing a client’s consent.
Dual-Registered Investment Advisers . The Interpretation notes that investment advisers that are also registered as broker-dealers and who serve the same clients in both capacities should be particularly sensitive to ensuring full and fair disclosure to their clients about the circumstances in which they intend to act in each capacity.
Hedge Clauses . The Interpretation withdraws the Heitman No-Action Letter, [3] which held that hedge clauses (i.e., clauses limiting the liability of an investment adviser under an advisory agreement with its client) could be misleading and therefore violate the anti-fraud provisions in §206(1) and §206(2) of the Advisers Act absent clear language that the client was not waiving claims not permitted to be waived under applicable law. In withdrawing the Heitman No-Action Letter, the Interpretation expressly provides that the question of whether a “hedge clause” violates the anti-fraud provisions of the Advisers Act depends on all of the surrounding facts and circumstances, including the particular circumstances of the client (e.g., sophistication). It is unlikely that the SEC’s withdrawal of the Heitman No-Action Letter presents a meaningful change for most private fund advisers.
Specifically, the Interpretation acknowledges that “institutional clients generally have a greater capacity and more resources than retail clients to analyze and understand complex conflicts and their ramifications.”
The Interpretation does not address the SEC’s view regarding the sophistication of retail investors investing in private funds, but investment advisers to private funds with retail investors should consider their disclosures in light of the general principles discussed in the Interpretation.

1 “ Commission Interpretation Regarding Standard of Conduct for Investment Advisers ” (June 5, 2019). (go back)

2 The Investment Advisers Act of 1940, as amended (the “Advisers Act”). (go back)

3 Heitman Capital Management, LLC , SEC Staff No-Action Letter (Feb. 12, 2007). (go back)

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Our Legal Basis for Processing: Generally, we rely on our legitimate interests in order to process your personal information. For example, we rely on this legal ground if we use your personal information to manage your Registration Data and administer our relationship with you; to deliver our Website and Services; understand and improve our Website and Services; report reader analytics to our authors; to personalize your experience on our Website and Services; and where necessary to protect or defend our or another's rights or property, or to detect, prevent, or otherwise address fraud, security, safety or privacy issues. Please see Article 6(1)(f) of the E.U. General Data Protection Regulation ("GDPR") In addition, there may be other situations where other grounds for processing may exist, such as where processing is a result of legal requirements (GDPR Article 6(1)(c)) or for reasons of public interest (GDPR Article 6(1)(e)). Please see the "Your Rights" section of this Privacy Policy immediately below for more information about how you may request that we limit or refrain from processing your personal information.
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Donald J. Trump, wearing a blue suit and a red tie, walks down from an airplane with a large American flag painted onto its tail.

Trump and Allies Forge Plans to Increase Presidential Power in 2025

The former president and his backers aim to strengthen the power of the White House and limit the independence of federal agencies.

Donald J. Trump intends to bring independent regulatory agencies under direct presidential control. Credit... Doug Mills/The New York Times

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By Jonathan Swan Charlie Savage and Maggie Haberman

Published July 17, 2023 Updated July 18, 2023

Donald J. Trump and his allies are planning a sweeping expansion of presidential power over the machinery of government if voters return him to the White House in 2025, reshaping the structure of the executive branch to concentrate far greater authority directly in his hands.

Their plans to centralize more power in the Oval Office stretch far beyond the former president’s recent remarks that he would order a criminal investigation into his political rival, President Biden, signaling his intent to end the post-Watergate norm of Justice Department independence from White House political control.

Mr. Trump and his associates have a broader goal: to alter the balance of power by increasing the president’s authority over every part of the federal government that now operates, by either law or tradition, with any measure of independence from political interference by the White House, according to a review of his campaign policy proposals and interviews with people close to him.

Mr. Trump intends to bring independent agencies — like the Federal Communications Commission, which makes and enforces rules for television and internet companies, and the Federal Trade Commission, which enforces various antitrust and other consumer protection rules against businesses — under direct presidential control.

He wants to revive the practice of “impounding” funds, refusing to spend money Congress has appropriated for programs a president doesn’t like — a tactic that lawmakers banned under President Richard Nixon.

He intends to strip employment protections from tens of thousands of career civil servants, making it easier to replace them if they are deemed obstacles to his agenda. And he plans to scour the intelligence agencies, the State Department and the defense bureaucracies to remove officials he has vilified as “the sick political class that hates our country.”

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Document Details Published Content - Document Details Agency Federal Deposit Insurance Corporation CFR 12 CFR 303 Document Citation 89 FR 67002 Document Number 2024-18187 Document Type Proposed Rule Pages 67002-67009 (8 pages) Publication Date 08/19/2024 RIN 3064-AG04 Published Content - Document Details
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Supplementary information:, i. policy objectives, ii. background, a. the change in bank control act, b. fdic rules and regulation—part 303, c. growth in passive investments and implications, iii. proposed rule, a. section 303.81(e)—definitions, b. section 303.84(a)—transactions that do not require notice, iv. expected effects, v. alternatives considered, vi. request for comments, vii. regulatory analyses, a. regulatory flexibility act, b. paperwork reduction act, c. riegle community development and regulatory improvement act of 1994, d. plain language, e. providing accountability through transparency act of 2023, list of subjects in 12 cfr part 303, authority and issuance, part 303—filing procedures.

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Federal Deposit Insurance Corporation

12 CFR Part 303
RIN 3064-AG04

Federal Deposit Insurance Corporation.

Notice of proposed rulemaking.

The Federal Deposit Insurance Corporation (FDIC) is proposing to amend its filing requirements and processing procedures for notices filed under the Change in Bank Control Act (CBCA) by removing the exemption from the notice requirement for acquisitions of voting securities of a depository institution holding company with an FDIC-supervised subsidiary institution for which the Board of Governors of the Federal Reserve System (FRB) reviews a notice under the CBCA and by making conforming definitional changes. The FDIC also seeks information and comment regarding its approach to change in control notices under the CBCA with regard to persons who may be directly or indirectly exercising control over an FDIC-supervised institution. The FDIC is committed to developing an interagency approach to change in control notices with the FRB and the Office of the Comptroller of the Currency.

Comments must be received by October 18, 2024.

You may submit comments, identified by RIN 3064-AG04, by any of the following methods

Agency website: https://www.fdic.gov/resources/regulations/federal-register-publications/ . Follow instructions for submitting comments on the FDIC's website.
Email: [email protected] . Include “Change in Bank Control Act/RIN 3064-AG04” in the subject line of the message.
Mail: James P. Sheesley, Assistant Executive Secretary, Attention: Change in Bank Control Act—RIN 3064-AG04, Federal Deposit Insurance Corporation, 550 17th Street NW, Washington, DC 20429.
Hand Delivery: Comments may be hand-delivered to the guard station at the rear of the 550 17th Street NW, building (located on F Street NW) on business days between 7:00 a.m. and 5:00 p.m. eastern time.
Public Inspection: Comments received, including any personal information provided, may be posted without change to https://www.fdic.gov/resources/regulations/federal-register-publications/ . Commenters should submit only information that the commenter wishes to make available publicly. The FDIC may review, redact, or refrain from posting all or any portion of any comment that it may deem to be inappropriate for publication, such as irrelevant or obscene material. The FDIC may post only a single representative example of identical or substantially identical comments, and in such cases will generally identify the number of identical or substantially identical comments represented by the posted example. All comments that have been redacted, as well as those that have not been posted, that contain comments on the merits of this document will be retained in the public comment file and will be considered as required under all applicable laws. All comments may be accessible under the Freedom of Information Act.

Annmarie Boyd, Senior Counsel, 202-898-3714, [email protected] ; Gregory S. Feder, Counsel, 202-898-8724, [email protected] ; Nicholas A. Simons, Senior Attorney, 202-898-6785, [email protected] ; Legal Division; Derek Sturtevant, Senior Review Examiner, 202-898-3693, [email protected] ; Division of Risk Management Supervision, 550 17th Street NW, Washington, DC 20429.

The policy objective of the proposed rule is to ensure appropriate review of transactions that would result in control over FDIC-supervised institutions by allowing the FDIC to disapprove of a proposed acquisition if the proposed transaction would fail to satisfy any of the statutory factors enumerated in the CBCA. [ 1 ] Under the FDIC's current regulations, an entity is exempt from a notification requirement when the FRB reviews a notice under the CBCA. However, recent developments in equity markets may be contributing to elevated risk of excessive indirect control or concentration of ownership in FDIC-supervised institutions. Therefore, the FDIC is proposing to amend its regulations governing change in control notifications to remove the current exemption in order to ensure appropriate review of certain transactions, increasing the likelihood that all the statutory factors in the CBCA are met, and reducing the likelihood that certain transactions would result in an adverse effect on the Deposit Insurance Fund (DIF). The FDIC recognizes the importance of interagency collaboration and consistency with respect to the review of transactions under the CBCA and is committed to engaging in dialogue and coordination with the FRB and Office of the Comptroller of the Currency to develop an interagency approach to the issues discussed in this proposal. [ 2 ] The FDIC is also seeking public comment on all aspects of this proposal, including steps that may be taken on an interagency basis to coordinate CBCA notice review.

The Change in Bank Control Act, section 7(j) of the Federal Deposit Insurance Act (FDI Act), generally provides that no person, [ 3 ] acting directly or indirectly, or in concert with other persons, may acquire control of an insured depository institution (IDI) unless the person has provided the appropriate Federal banking agency (AFBA) [ 4 ] prior written notice of the proposed transaction and the AFBA has ( print page 67003) not disapproved the transaction within 60 days, as may be extended. [ 5 ] “Control” for purposes of the CBCA means “the power, directly or indirectly, to direct the management or policies of an insured depository institution or to vote 25 per centum or more of any class of voting securities of an insured depository institution.” [ 6 ] The proposed acquisition may be completed upon receipt of written notice that the AFBA does not disapprove of the acquisition or if the AFBA fails to act on a substantially complete prior notice within the statutory time period.

An AFBA may disapprove a proposed acquisition if it is unable to satisfactorily resolve one or more of the statutory factors enumerated in the CBCA. [ 7 ] An AFBA may disapprove of a proposed acquisition if the acquisition would result in a monopoly or may substantially lessen competition and the anticompetitive effects are not clearly outweighed by the public interest; the financial condition of any acquiring person or the future prospects of the institution is such as might jeopardize the financial stability of the institution or prejudice the interests of its depositors; the competence, experience, or integrity of any acquiring person or any proposed management would not be in the best interests of the depositors or the public; any acquiring person neglects, fails, or refuses to furnish the AFBA with all required information; or the AFBA determines that the proposed transaction would result in an adverse effect on the DIF.

Subpart E of 12 CFR part 303 of the FDIC Rules and Regulations (subpart E) [ 8 ] implements the CBCA and sets forth the FDIC's filing requirements and processing procedures for notices filed pursuant to the CBCA (notices). [ 9 ] Subpart E requires notice to the FDIC before any person, acting directly or indirectly, alone or in concert with others, acquires control of a “covered institution,” unless the acquisition is exempt. The FDIC is the AFBA for insured State nonmember banks and insured State savings associations. [ 10 ] Because the CBCA applies to direct or indirect acquisitions of control, for purposes of the CBCA, the FDIC also may review a notice for an acquisition of control of any company that directly or indirectly controls an insured State nonmember bank or an insured State savings association. [ 11 ] Subpart E therefore defines “covered institution” to include an insured State nonmember bank, an insured State savings association, and any company that controls, directly or indirectly, an insured State nonmember bank or an insured State savings association and exempts certain holding companies in situations for which the FDIC does not currently require a notice. [ 12 ]

While the CBCA does not describe what constitutes the power to direct the management or policies of a covered institution, the Federal banking agencies have determined that a shareholder who owns or controls a significant block of voting securities generally will have influence in a banking organization. Thus, the FDIC's regulations contain a rebuttable presumption that an acquisition of voting securities of a covered institution constitutes control and triggers the notice requirement if, immediately after the transaction, the acquiring person will own, control, or hold the power to vote 10 percent or more of any class of voting securities, and either the institution has registered securities under section 12 of the Securities Exchange Act of 1934, or no other person will own, control, or hold a greater percentage of that class of voting securities after the transaction. [ 13 ] An acquiring person may rebut this presumption of control in writing. [ 14 ]

In practice, for transactions above the regulatory threshold of 10 percent of voting securities but below the 25 percent statutory threshold for control, an acquiring person generally will file a notice with the FDIC or rebut the presumption of control. To rebut the presumption of control, the acquiring person generally will set forth factors that demonstrate that it will not have the power, directly or indirectly, to direct the management or policies of the covered institution. These factors may include, for example, commitments by the acquiring person not to seek representation on the board of directors of the covered institution, not to take certain actions to influence the policies of the institution, or not to acquire further voting securities above a certain threshold. The documents describing the actions the acquiring person will or will not take to rebut the presumption of control may be called “certifications,” “passivity agreements,” or “passivity commitments” (passivity commitments). The FDIC generally is a party to such passivity commitments, and these agreements by their terms constitute a “written agreement” entered into with a Federal banking agency and enforceable under sections 8 and 50 of the FDI Act. [ 15 ] It has long been the policy of the FDIC that any passivity commitments executed in connection with an acquisition of voting securities must be tailored to the facts and circumstances of each situation. [ 16 ]

The FDIC has entered into passivity commitments in limited cases with asset managers investing in publicly traded FDIC-supervised institutions. The FDIC currently has in force four passivity commitments with three asset management companies. These commitments are published on the FDIC's website. [ 17 ]

Certain transactions are exempt from the notice requirements of subpart E pursuant to § 303.84(a). Among the exempt transactions are the acquisition of voting securities of a depository institution holding company for which the FRB reviews a notice. [ 18 ] Subpart E currently codifies the FDIC's policy that it does not require a notice when the FRB actually reviews a notice to acquire voting securities of a depository institution holding company under the CBCA. [ 19 ] However, the exemption does not extend to FRB determinations to accept a passivity commitment in lieu of a notice. In such cases, the FDIC evaluates the facts and circumstances to determine whether a notice is required to be filed with the FDIC for the indirect acquisition of control of an FDIC-supervised institution. [ 20 ]

In recent years, however, the FDIC typically has not determined that notices must be filed with the FDIC when the FRB accepts a passivity commitment in lieu of a notice. For the reasons described below, developments involving institutional investors and FDIC-supervised institutions have prompted the FDIC to reconsider its procedures regarding transactions exempt from notice requirements pursuant to subpart E, the facts and circumstances under which it will require a notice, and how to monitor compliance with passivity commitments entered into to rebut the presumption of control.

Passive investment vehicles such as index mutual funds and exchange-traded funds (ETFs) that aim to replicate the performance of a third-party index such as the S&P 500 Index (collectively, “index funds”) have grown in popularity in recent decades. Index funds do not hand-pick stocks like actively managed funds do in order to provide a return greater than the market; rather, index funds seek to match market returns by investing proportionally across stocks in the desired index or sector of the national economy. To the extent multiple index funds have the same company or related companies that sponsor, manage, or advise them, these companies are called “fund complexes.” By the end of December 2023, according to data released by Morningstar, passive funds exceeded active funds in total assets under management for the first time, with approximately $13.3 trillion in total assets to active funds' $13.2 trillion. [ 21 ] For comparison, when the first ETF was listed in 1993, passive funds represented less than 1 percent of total fund assets. [ 22 ] Index funds have grown in popularity due to lower management fees relative to active funds, the belief that index funds match or outperform active funds more frequently and consistently, and the growth of target-date funds in retirement plans. [ 23 ] Investments in index funds have pulled in more dollars on a net basis than active funds every year since 2013, and if fund flows continue to follow current trends, then they will further exceed total assets in active funds in the future. [ 24 ]

The exponential growth of index funds necessarily implicates the statutory and regulatory schemes of the CBCA and other banking laws that are based on ownership thresholds and control of banking organizations. [ 25 ] As investments in index funds grow, asset management companies and other institutional investors engaging in similar strategies must continue to invest those funds in the universe of stocks that comprise the index, purchasing ever-greater shares of those companies and increasing their ownership stakes. The FDIC has observed that fund complexes have acquired 10 percent or more of the voting securities at FDIC-supervised institutions or their controlling affiliates and have continued to increase their ownership percentages at more institutions. Additionally, the FDIC in recent years has observed a general pattern of more frequent requests for relief to rebut the presumptions of control under subpart E.

These developments have prompted the FDIC to reconsider its policies under the CBCA and implementing regulations so that the FDIC may more appropriately assess the effects of any control exerted over the management and policies of FDIC-supervised institutions. The FDIC is concerned that fund complexes will continue to increase their ownership percentage of FDIC-supervised institutions to potentially significant amounts as investments in their respective index funds grow. Fund complexes owning such high percentages of voting securities of FDIC-supervised institutions may create situations where the investor can have an outsized influence over the management or policies of an institution. [ 26 ] Such outsized influence may flow naturally from exercise of their votes as large shareholders over matters such as mergers, or through other indicia of control, such as engagements with portfolio companies whereby investors meet with directors or management to influence the direction of the company. [ 27 ] Fund complexes may seek board representation or management interlocks depending on the nature of existing passivity commitments.

Additionally, there have been changes to proxy access [ 28 ] and discretionary broker voting [ 29 ] that have given fund complexes more potential for control over the companies in which they hold a large equity stake in voting securities. The potential for fund complexes to exercise significant influence or control over management, business strategies, or ( print page 67005) major policy decisions at publicly traded FDIC-supervised institutions could increase the risk profile at such institutions and lead to excessive risk-taking to enhance profits, investor returns, or stock price. Finally, as fund complexes continue to purchase more shares of banking organizations across the market to match the growth of investments in index funds, there is the potential to create a concentration of ownership that may result in such investors having excessive influence or control over the banking industry as a whole.

In light of these changes to the economic landscape and ownership of FDIC-supervised institutions, the FDIC reviewed its policies under the CBCA and implementing regulations and believes it is appropriate to amend its current regulations to allow it to review certain transactions under the CBCA to address the concerns and potential risks outlined above. The FDIC also recognizes the interest in and need for collaboration among the Federal banking agencies on these issues to ensure consistency in the review of transactions implicating the CBCA. Accordingly, the FDIC is committed to engaging in dialogue and coordination with the FRB and the Office of the Comptroller of the Currency to develop an interagency approach to the issues discussed in this proposal and seeks public comment regarding further interagency coordination in this area.

As noted above, the defined term “covered institution” excludes a holding company that is the subject of an exemption described in either § 303.84(a)(3) or (a)(8). [ 30 ] In accordance with the FDIC's proposal to remove the exemption at § 303.84(a)(8), as described below, the FDIC proposes to remove the reference to holding companies and associated exemptions in the definition of “covered institution.” Therefore, as shown in the proposed regulatory text, the definition of “covered institution” would eliminate the reference to holding companies subject to the regulatory exemptions in § 303.84(a)(3) or (a)(8).

As described below, the FDIC proposes to remove the exemption at § 303.84(a)(8). The FDIC is not proposing to remove the exemption at § 303.84(a)(3), which refers to transactions that are statutorily exempt from the CBCA's notice requirements. However, because the reference to § 303.84(a)(3) in the definition of “covered institution” refers to statutorily exempt transactions and not to holding companies themselves, the FDIC believes it is appropriate to remove this reference in the definition of covered institution as well. Some depository institution holding companies may be considered covered institutions.

Section 303.84(a) currently contains eight transactions that are exempt from providing prior notice to the FDIC. The FDIC proposes to remove the exemption at § 303.84(a)(8), acquisitions of depository institution holding company voting securities for which the Board of Governors of the Federal Reserve System reviews a notice pursuant to the CBCA.

The current regulatory exemption only applies when the FRB actually reviews a notice under the CBCA, as described above. [ 31 ] Under this proposal, investors that propose to acquire voting securities of a depository institution holding company in transactions for which the FRB reviews a notice would no longer automatically be exempt from providing the FDIC prior notice. A change in control at the holding company level conveys indirect control over the IDI for which the FDIC is the AFBA under the CBCA. The proposal to remove the exemption solely because a notice is being reviewed by the FRB would allow the FDIC to exercise its authority under the CBCA to require and approve or disapprove such a notice at the IDI level.

The FDIC has determined that the original purpose of the current exemption, which was to avoid duplicate regulatory review of the same transaction by both the FRB and the FDIC, [ 32 ] is no longer warranted in light of the widespread impacts resulting from growth in, and changes to the nature of, passive investment strategies. As described above, fund complexes' increasingly large ownership of voting securities of FDIC-supervised institutions or companies that control FDIC-supervised institutions, and the evolution of the economic landscape over the past few decades, present new risks. Accordingly, the FDIC has determined that this proposal is necessary in light of the risks created by possible outsized control over and concentration of ownership of FDIC-supervised institutions. The FDIC must have the ability to require a notice so that, as the AFBA for the underlying IDI, it may independently review and determine whether the proposed acquisition satisfies the statutory factors enumerated in the CBCA for the institutions it supervises. [ 33 ] While an acquisition may be disapproved if one or more statutory factors in the CBCA are not met, as the Federal agency that also administers the DIF, the FDIC has a particular interest in reviewing whether a proposed acquisition could result in an adverse effect on the DIF.

While this proposal would allow the FDIC to require a notice to the FDIC when the FRB reviews a notice to acquire voting securities of a depository institution holding company, the FDIC would consider the facts and circumstances when deciding whether to exercise this authority for notices filed with the FRB. The FDIC believes it is appropriate to review proposed acquisitions under the CBCA more closely in order to fully address risks regarding outsized influence and increased concentration of ownership, though the FDIC may not do so for every proposed acquisition. Rather, the FDIC's proposal would allow it to consider the full range of options provided for under the CBCA.

Under the FDIC's current regulations, when the FRB accepts a passivity commitment in lieu of a notice, the FDIC evaluates the facts and circumstances of the case to determine whether a notice is required to be filed with the FDIC for the indirect acquisition of control of an FDIC-supervised institution. Similarly, in cases where the FRB accepts a notice, the FDIC under the proposed rule will evaluate the facts and circumstances to determine whether to require a notice to be filed with the FDIC as well.

The proposed rule would mean that for transactions resulting in the acquiring person owning, controlling, or holding with power to vote 10 percent or more of any class of voting securities of a depository institution holding company with an FDIC-supervised subsidiary institution, the FDIC may exercise one of the following options: (1) based on the facts and circumstances, require prior written notice to the FDIC under the CBCA for the indirect acquisition of control of an FDIC-supervised institution; or (2) allow the acquiring person an opportunity to ( print page 67006) rebut the presumption of control in writing. [ 34 ]

As previously discussed, the proposed rule would remove an existing regulatory exemption that only applies when the FRB reviews a notice under the CBCA. As of the quarter ending March 31, 2024, the FDIC supervised 2,920 insured depository institutions. [ 35 ] This proposed rule, if promulgated, would likely increase the number of change-in-control notices submitted by entities seeking to acquire voting securities of FDIC-supervised institutions or their parent companies, and associated costs. Over the first three months of 2024, the FRB received 13 filings from 11 unique entities to indirectly acquire voting securities of FDIC-supervised institutions by acquiring voting securities of the entity that controls an FDIC-supervised institution. [ 36 ] The FDIC expects to receive 52 notices annually as a result of the proposed rule and one request to rebut the presumption of control annually. [ 37 ] The FDIC estimates that each notice would require 30.5 labor hours at an hourly cost of $142.40 [ 38 ] and that each request to rebut the presumption of control would require 15 labor hours at an hourly cost of $111.40. [ 39 ] Therefore, the FDIC estimates that the proposed rule could result in average annual recordkeeping, reporting, and disclosure compliance costs of up to $227,517.40. [ 40 ] However, the FDIC believes that this estimate likely is conservative because, as previously stated, the FDIC may not exercise this authority for every notice filed with the FRB.

If adopted, the FDIC believes that the proposed rule would facilitate appropriate review of transactions resulting in control of FDIC-supervised institutions and, thereby, would reduce the likelihood of outsized influence or control over FDIC-supervised institutions and any associated costs. As previously discussed, recent developments in equity markets in concert with the FDIC's current practice of exempting entities from a notification requirement when the FRB reviews a notice under the CBCA may be contributing to elevated risk of excessive or indirect control or concentration of ownership of FDIC-supervised institutions. The proposed rule would facilitate the FDIC's review of certain transactions, thereby increasing the likelihood that all the statutory factors in the CBCA are met, and reducing the likelihood that certain transactions would result in an adverse effect on the DIF. The FDIC does not have the information necessary to quantify such effect.

The primary alternative to this proposed rule that the FDIC considered was maintaining the existing regulatory structure in which an entity is exempt from submitting a notice to the FDIC when the FRB actually reviews a notice to acquire voting securities of a depository institution holding company. The FDIC believes that the proposed rule is more appropriate because recent developments in the equity markets, in concert with the FDIC's current policy of not requiring a notice, may be contributing to an elevated risk of excessive indirect control of FDIC-supervised institutions. The FDIC also considered the alternative of compelling an entity to file a notice with the FDIC in each case where the FRB actually reviews a notice to acquire voting securities of a depository institution holding company under the CBCA. However, the FDIC believes that the proposed rule is more appropriate because it would balance the costs associated with duplicate regulatory review of the same transaction with the elevated risks associated with excessive control or concentration of ownership of FDIC-supervised institutions.

The FDIC is seeking comment on all aspects of the proposed rule and existing regulatory framework that applies to the role played by asset managers and other institutional investors with FDIC-supervised institutions in the context of the CBCA and passivity agreements. While the FDIC continues to perform a comprehensive review of its overall regulatory and supervisory approach to issues that arise under the CBCA, this proposed rule asks a number of questions and seeks public comment regarding monitoring of change in control-related issues, the use of passivity commitments, and specific terms and conditions that may be appropriate to incorporate into such commitments or non-objections in the future. In responding to the following questions, the FDIC asks that commenters please include quantitative as well as qualitative support for their responses, as applicable. The FDIC will consider comments submitted anonymously.

Question 1. Should the FDIC require prior written notice at the bank level when a change of control occurs at the holding company level? Why or why not?

Question 2. If the FDIC should require prior written notice when a change of control occurs at the holding company level, what steps should the FDIC take to avoid duplication of regulatory reviews and reduce regulatory burden? What would be the negative impacts of inconsistent approaches across the Federal banking agencies?

Question 3. Should the FDIC and other AFBAs consider an approach whereby a notice would be required at either the bank level or holding company based on specific criteria, such as the percentage of assets of the insured depository institution in relation to the consolidated assets of the holding company?

Question 4. Does the existing and proposed regulatory and supervisory framework properly consider all aspects of the role played by investors with FDIC-supervised institutions in the context of the CBCA? If not, what areas should be addressed?

Question 5. What, if any, additional requirements or criteria should be included in the existing regulatory framework to address the concerns of passive investors exerting control, direct and indirect, over FDIC-supervised institutions?

Question 6. What facts and circumstances should the FDIC consider when determining whether to require a notice to be filed with the FDIC for an indirect acquisition of control of an FDIC-supervised institution? What difference should there be in this determination, if any, when a notice is filed at the FRB versus when the FRB determines to accept a passivity commitment in lieu of a notice?

Question 7. Through what methods should the FDIC address the rebuttable presumption of control other than through passivity commitments? Should the FDIC continue entering into passivity agreements, or should it consider a different approach such as other passivity commitment arrangements, no-action letters, or agency opinions? Please identify the benefits and risks to any proposed method.

Question 8. What should the FDIC consider when determining whether a presumption of control has been successfully rebutted?

Question 9. What types of provisions should passivity commitments include and why?

Question 10. What, if any, provisions should be included in passivity commitments to ensure compliance with the written agreements?

Question 11. Should the FDIC enter into blanket passivity agreements with investors that apply to the entire portfolio of the FDIC-supervised institutions in the fund complex or require separate agreements for each FDIC-supervised institution? What should the FDIC consider when making this determination?

Question 12. Are institutional investors, fund complexes asset managers, or other large, passive shareholders directing the management or policies of FDIC-supervised institutions as a result of their voting securities holdings? If so, how? Are there other situations, investors, or risks that the FDIC should consider?

Question 13. Are investors coordinating voting or otherwise acting in concert in ways that the FDIC should be monitoring more closely? If so, please provide any available quantitative and qualitative data.

Question 14. Are there any other considerations for the FDIC in evaluating its current regulatory framework as it relates to the filing requirements and processing procedures for notices filed under the CBCA?

Question 15. Has concentrated ownership of FDIC-supervised institutions and their affiliates affected banking sector competition? If so, please identify the impact and how it has impacted the sector.

Question 16. Has there been any impact on corporate governance, or other safety and soundness considerations, of concentrated ownership of FDIC-supervised institutions and their affiliates? If so, please identify the impact and how it has impacted these areas.

Question 17. Are there other areas of impact on FDIC-supervised institutions and their affiliates as a result of investors owning large proportions of voting securities of covered institutions that the FDIC should consider?

Question 18. Should the FDIC limit the voting power of persons who acquire 10 percent or more of a class of voting securities of an FDIC-supervised institution or its parent company? If so, how? What are the benefits and costs of various approaches?

Question 19. How can the FDIC and the other Federal banking agencies best ensure consistency in the review of notices under the CBCA? What steps should be taken on an interagency basis to ensure the appropriate review of transactions involving an indirect acquisition of control of an institution?

Question 20. Are there any expected effects of the proposed rule that have not been identified?

The Regulatory Flexibility Act (RFA) generally requires an agency, in connection with a proposed rule, to prepare and make available for public comment an initial regulatory flexibility analysis that describes the impact of the proposed rule on small entities. [ 41 ] However, an initial regulatory flexibility analysis is not required if the agency certifies that the proposed rule will not, if promulgated, have a significant economic impact on a substantial number of small entities. The Small Business Administration (SBA) has defined “small entities” to include banking organizations with total assets of less than or equal to $850 million. [ 42 ]

The proposed rule could impose costs since it would permit the FDIC to require certain entities that acquire control of FDIC-supervised institutions to file notices with the FDIC. Moreover, should these entities rebut the presumption of control, they would likely incur costs in order to do so. As of March 31, 2024, the FDIC supervises 2,920 institutions, of which 2,198 are small entities for the purposes of the RFA. [ 43 ] Over the first three months of 2024, 11 different investors indirectly acquired voting securities of 13 FDIC-supervised institutions, including eight that are small entities for the purposes of the RFA, [ 44 ] by acquiring voting securities of the companies that controlled those institutions. [ 45 ] The FDIC does not have data with which to determine if the acquirers were small entities for the purposes of the RFA.

The FDIC estimates this proposed rule would affect as many as 44 entities annually. [ 46 ] Acquirers of voting securities of FDIC-supervised institutions over the first three months of 2024 included individuals, family trusts, private equity firms, and construction companies. [ 47 ] Given the wide range of potential acquirers of voting securities of FDIC-supervised institutions, the FDIC believes it is unlikely that these 44 entities represent a substantial number of small entities. In light of the foregoing, the FDIC certifies that the proposed rule would not have a significant economic impact on a substantial number of small entities. Accordingly, an initial regulatory flexibility analysis is not required.

The FDIC invites comments on all aspects of the supporting information provided in this RFA section. In particular, would this proposed rule have any significant effects on small entities that the FDIC has not identified?

Certain provisions of the proposed rule contain “collections of information” within the meaning of the Paperwork Reduction Act (PRA) of 1995. [ 48 ] In accordance with the requirements of the PRA, the FDIC may not conduct or sponsor, and the respondent is not required to respond to, an information collection unless it displays a currently valid Office of Management and Budget (OMB) control number. The FDIC's OMB control ( print page 67008) number associated with this proposed rule is 3064-0019 and is titled “Interagency Notice of Change in Control.”

As stated above, over the first three months of 2024, the FRB received 13 filings from 11 unique filers to indirectly acquire voting securities of an FDIC-supervised institution. [ 49 ] The FDIC estimates 43 annual respondents to the information collection (IC) in this ICR that corresponds to notices, [ 50 ] and 52 annual responses [ 51 ] for an average of 1.21 responses per respondent annually. [ 52 ] Subject matter experts (SMEs) at the FDIC recommend retaining the estimate of 30.5 labor hours per response for notices. Further, SMEs at the FDIC estimate that the FDIC will receive one request per year from an acquirer to rebut the presumption of control, and that an entity would spend, on average, 15 labor hours to prepare and submit such a request at an average hourly cost of $111.40. [ 53 ] The FDIC estimates that change in control applicants will incur labor costs at an hourly cost estimate of $142.40. [ 54 ] Therefore, the FDIC estimates that the annual reporting burden hours associated with this NPR, if finalized, would be 1,601 as shown in table 1, and that the annual cost would be $227,517.40. [ 55 ]

Table 1—Summary of Estimated Annual Burden
Information collection (IC) (obligation to respond)	Type of burden (frequency of response)	Number of respondents	Number of responses per respondent	Time per response (HH:MM)	Annual burden (hours)
1. Applications for Change in Bank Control, et seq. (Mandatory)	Reporting (On occasion)	43	1.21	30:30	1,586
2. Requests to rebut the presumption of control (Voluntary)	Reporting (On occasion)	1	1	15:00	15

Source: FDIC.
The estimated annual IC time burden is the product, rounded to the nearest hour, of the estimated annual number of responses and the estimated time per response for a given IC. The estimated annual number of responses is the product, rounded to the nearest whole number, of the estimated annual number of respondents and the estimated annual number of responses per respondent. This methodology ensures the estimated annual burdens in the table are consistent with the values recorded in OMB's consolidated information system.

Comments are invited on:

(a) Whether the collection of information is necessary for the proper performance of the FDIC's functions, including whether the information has practical utility;

(b) The accuracy of the estimate of the burden of the information collection, including the validity of the methodology and assumptions used;

(d) Ways to minimize the burden of the information collection on respondents, including through the use of automated collection techniques or other forms of information technology; and

(e) Estimates of capital or start-up costs and costs of operation, maintenance, and purchase of services to provide information.

All comments will become a matter of public record. Comments on the collection of information should be sent to the address listed in the ADDRESSES section of this document. Written comments and recommendations for this information collection also should be sent within 30 days of publication of this document to www.reginfo.gov/public/do/PRAMain . Find this particular information collection by selecting “Currently under 30-day Review—Open for Public Comments” or by using the search function.

Pursuant to section 302(a) of the Riegle Community Development and Regulatory Improvement Act of 1994 [ 56 ] (RCDRIA), in determining the effective date and administrative compliance requirements for new regulations that impose additional reporting, disclosure, or other requirements on IDIs, each Federal banking agency must consider, consistent with principles of safety and soundness and the public interest, any administrative burdens that such regulations would place on affected depository institutions, including small depository institutions, and customers of depository institutions, as well as the benefits of such regulations. In addition, section 302(b) of the RCDRIA requires new regulations and amendments to regulations that impose additional reporting, disclosures, or other new requirements on IDIs generally to take effect on the first day of a calendar quarter that begins on or after the date on which the regulations are published in final form. [ 57 ] The FDIC invites comments that will further inform its consideration of RCDRIA.

Section 722 of the Gramm-Leach-Bliley Act [ 58 ] requires the Federal banking agencies to use plain language in all proposed and final rules published after January 1, 2000. The FDIC has sought to present the proposed rule in a simple and straightforward manner and invites comment on the use of plain language. For example:

Are the requirements in the proposed rule clearly stated? If not, how could the proposed rule be more clearly stated?

Does the proposed rule contain language or jargon that is not clear? If so, which language requires clarification?

Would a different format make the proposed rule easier to understand? If so, what changes to the format would make the proposed rule easier to understand?

What else could the FDIC do to make the proposed rule easier to understand? ( print page 67009)

The Providing Accountability Through Transparency Act of 2023 [ 59 ] requires that a notice of proposed rulemaking include the internet address of a summary of not more than 100 words in length of a proposed rule, in plain language, that shall be posted on the internet website under section 206(d) of the E-Government Act of 2002. [ 60 ]

The FDIC is proposing to amend the current regulation by removing one exempt transaction from § 303.84(a) that currently does not require prior written notice to the FDIC. Transactions involving the acquisition of voting securities of a depository institution holding company for which the FRB reviews a notice would no longer be an exempt transaction under § 303.84(a). The proposed rule is intended for the FDIC to strengthen its review and approval process for acquisitions of voting securities that involve FDIC-supervised institutions. The proposal and required summary can be found at https://www.fdic.gov/resources/regulations/federal-register-publications/ .

Administrative practice and procedure
Bank deposit insurance
Change in bank control
Filing procedures
Procedure and rules of practice
Reporting and recordkeeping requirements, and Savings associations

For the reasons set forth in the preamble, the Federal Deposit Insurance Corporation proposes to amend 12 CFR part 303 as follows:

1. The authority citation for part 303 continues to read as follows:

Authority: 12 U.S.C. 378 , 1463 , 1467a , 1813 , 1815 , 1817 , 1818 , 1819(a) (Seventh and Tenth), 1820, 1823, 1828, 1831i, 1831e, 1831o, 1831p-1, 1831w, 1831z, 1835a, 1843(l), 3104, 3105, 3108, 3207, 5412; 15 U.S.C. 1601-1607 .

2. Amend § 303.81 by revising paragraph (e) to read as follows:

(e) Covered institution means an insured State nonmember bank, an insured State savings association, and any company that controls, directly or indirectly, an insured State nonmember bank or an insured State savings association.

3. Amend § 303.84 by removing paragraph (a)(8).

By order of the Board of Directors.

Dated at Washington, DC, on July 30, 2024.

James P. Sheesley,

Assistant Executive Secretary.

1. 12 U.S.C. 1817(j)(7) .

2. The FDIC's commitment includes following standard notice and comment rulemaking practices should an interagency approach be developed and adopted.

3. 12 CFR 303.81(g) defines “person” as “an individual, corporation, limited liability company (LLC), partnership, trust, association, joint venture, pool, syndicate, sole proprietorship, unincorporated organization, voting trust, or any other form of entity; and includes each party to a voting agreement and any group of persons acting in concert.”

4. 12 U.S.C. 1813(q) .

5. 12 U.S.C. 1817(j) . The AFBA may, in its discretion, extend an additional 30 days the period during which such a disapproval may be issued. The period of disapproval may be extended two additional times for not more than 45 days each time in certain circumstances. See 12 U.S.C. 1817(j)(1)(A) through (D) .

6. 12 U.S.C. 1817(j)(8)(B) .

7. 12 U.S.C. 1817(j)(7) .

8. 12 CFR 303.80 through 303.88 .

9. The FDIC's requirements and procedures are consistent with those of the other Federal banking agencies. See 12 CFR 5.50 (Office of the Comptroller of the Currency); 12 CFR 225.41 through 225.44 (FRB) .

10. 12 U.S.C. 1813(q) .

11. Industrial loan companies, which in most cases are State nonmember banks, are not “banks” as defined in the Bank Holding Company Act so their parent companies are not required to become bank holding companies. 12 U.S.C. 1841(c)(2)(H) .

12. 12 CFR 303.81(e) (citing 12 CFR 303.84(a)(3) and (8) ). Section 303.84(a)(3) exempts transactions described in sections 2(a)(5), 3(a)(A), or 3(a)(B) of the Bank Holding Company Act ( 12 U.S.C. 1841(a)(5) , 1842(a)(A) , and 1842(a)(B) ) by a person described in those provisions because shares held in such capacities do not confer control upon such holding companies. Section 303.84(a)(8) exempts acquisitions of voting securities of a depository institution holding company for which the FRB reviews a notice pursuant to the CBCA.

13. 12 CFR 303.82(b)(1) . See also 12 CFR 5.50(f)(2)(iii) (OCC) ; 12 CFR 225.41(c)(2) (FRB) .

14. 12 CFR 303.82(b)(4) .

15. 12 U.S.C. 1818 and 1831aa .

16. 80 FR 65889 , 65894 (Oct. 28, 2015).

17. https://www.fdic.gov/regulations/applications/resources/change-in-control.html .

18. 12 CFR 303.84(a)(8) .

19. 80 FR 65897 .

20. Id.

21. U.S. Fund Flows December 2023, Morningstar (Jan. 17, 2024), https://research.morningstar.com/articles/1202332/us-fund-flows-december-2023 ( login required ). See also Adam Sabban, It's Official: Passive Funds Overtake Active Funds, Morningstar (Jan. 17, 2024), https://www.morningstar.com/funds/recovery-us-fund-flows-was-weak-2023 .

22. Sabban, supra note 19.

23. Morningstar, Target-Date Strategy Landscape: 2023 Report (Mar. 28, 2023), https://newsroom.morningstar.com/newsroom/news-archive/press-release-details/2023/Morningstars-Target-Date-Strategy-Landscape-Report-Finds-Investors-Stayed-the-Course-Despite-Market-Volatility-in-2022/default.aspx .

24. Sabban, supra note 19.

25. For example, pursuant to section 22(h) of the Federal Reserve Act, 12 U.S.C. 375b , and Regulation O, 12 CFR part 215 (made applicable to insured nonmember banks by 12 U.S.C. 1828(j)(2) ), extensions of credit by banks to “insiders,” such as principal shareholders, must comply with certain individual and aggregate lending limits and other requirements. Over the past several years, fund complexes have acquired, or have approached acquiring, more than 10 percent of a class of voting securities of banking organizations. Upon acquiring more than 10 percent of a class of voting securities of a banking firm, a fund complex would be considered a “principal shareholder” of the bank for purposes of Regulation O. Any company in which a principal shareholder fund complex owns more than 10 percent of a class of voting securities could, in some instances, be presumed to be a “related interest” of the fund complex. In that event, the fund complex, as a principal shareholder of the bank, and any related interests of the fund complex would be considered insiders of the bank under Regulation O. Accordingly, the bank's lending to the principal shareholder fund complex and its controlled portfolio companies would be subject to the lending limits and other requirements of Regulation O. Certain banking firms expressed concerns about the possible unintended consequences of applying Regulation O to these relationships. In response, the Federal banking agencies issued a temporary no-action position in 2019 to provide time for the FRB, in consultation with the other Federal banking agencies, to consider whether to amend Regulation O to address concerns about unintended consequences of the application of Regulation O to companies that sponsor, manage, or advise investment funds and institutional accounts that invest in voting securities of banking organizations. FIL-85-2019 (Dec. 27, 2019), https://www.fdic.gov/news/inactive-financial-institution-letters/2019/fil19085.html . This interagency statement provided that the Federal banking agencies will exercise discretion to not take enforcement action against either a fund complex that is a principal shareholder of a bank, or a bank for which a fund complex is a principal shareholder, with respect to extensions of credit by the bank to the related interests of such fund complex that otherwise would violate Regulation O, provided the fund complexes and banks satisfy certain conditions that evidence that there is a lack of control by the fund complex over the bank. This statement was extended several times, most recently on December 15, 2023, until January 1, 2025. FIL-63-2023 (Dec. 15, 2023), https://www.fdic.gov/news/financial-institution-letters/2023/fil23063.html .

26. See John Coates, The Problem of Twelve: When a Few Financial Institutions Control Everything, 27-28 (2023).

27. See id. at 47-48 (describing trends of asset managers increasing the number of engagements held with portfolio companies and the companies' responses).

28. See Holly J. Gregory, et al., The Latest on Proxy Access, Harv. L. Sch. F. on Corp. Governance & Fin. Reg. (Feb. 1, 2019) (detailing the increase in proxy access at S&P 500 companies since 2015).

29. Dodd-Frank Wall Street Reform and Consumer Protection Act, Public Law 111-203 , section 957, 124 Stat. 1376, 1906 (2010) (codified at 15 U.S.C. 78f(b)(10) ) (prohibiting broker members from voting shares on executive compensation, boards of directors, and other “significant matter[s]”).

30. 12 CFR 303.81(e) .

31. Supra, note 18 and accompanying text.

32. Id.

33. 12 U.S.C. 1817(j)(7) . The Office of the Comptroller of the Currency is the AFBA for national banks and the FRB is the AFBA for State member banks. Each agency would have a similar interest.

34. Making passivity commitments is one option the FDIC will consider on whether the presumption of control has been rebutted.

35. FDIC Call Report data, March 31, 2024.

36. See 89 FR 471 (Jan. 4, 2024), 89 FR 1575 (Jan. 10, 2024), 89 FR 3403 (Jan. 18, 2024), 89 FR 5235 (Jan. 26, 2024), 89 FR 5544 (Jan. 29, 2024), 89 FR 8681 (Feb. 08, 2024), 89 FR 11276 (Feb. 14, 2024), and 89 FR 18410 (Mar. 13, 2024).

37. Thirteen responses in the first three months of 2024 × (12/3) = 52 estimated change in control notices submitted annually.

38. To derive this estimate, the FDIC used data from the Bureau of Labor Statistics (BLS) Occupational Employment and Wage Statistics for executives and managers, lawyers, compliance officers, financial analysts, and clerical categories in the depository credit intermediation sector as of May 2023. The FDIC increased these estimates by approximately 1.53 using the March 2023 BLS Employer Costs for Employee Compensation data, and then multiplied the resulting values by approximately 1.04 to reflect the change in the BLS Employment Cost Index between March 2023 and March 2024.

39. Id.

40. 52 × 30.5 × $142.40 + 1 × 15 × $111.40 = $227,517.40.

41. 5 U.S.C. 601 , et seq.

42. The SBA defines a small banking organization as having $850 million or less in assets, where an organization's “assets are determined by averaging the assets reported on its four quarterly financial statements for the preceding year.” See 13 CFR 121.201 (as amended by 87 FR 69118 , effective December 19, 2022). In its determination, the “SBA counts the receipts, employees, or other measure of size of the concern whose size is at issue and all of its domestic and foreign affiliates.” See 13 CFR 121.103 . Following these regulations, the FDIC uses an IDI's affiliated and acquired assets, averaged over the preceding four quarters, to determine whether the IDI is “small” for the purposes of RFA.

43. FDIC Call Report data, March 31, 2024.

44. Id.

45. See supra note 33.

46. 11 × (12/3) = 44.

47. See supra note 33.

48. 44 U.S.C. 3501-3521 .

49. See supra note 33.

50. 11 × (12/3) = 44. SMEs at the FDIC estimate that one respondent per year would rebut the presumption of change in control rather than submit a change in control notice. Therefore, the estimated annual number of respondents to the first information collection (IC) is 43 (44—1) and the estimated annual number of respondents to the second IC is 1.

51. 13 × (12/3) = 52.

52. 52/4335 = 1.21.

53. See supra note 35.

54. Id.

55. 1,586 × $142.40 + 15 × $111.40 = $227,517.40.

56. 12 U.S.C. 4802(a) .

57. 12 U.S.C. 4802(b) .

58. Public Law 106-102 , sec. 722, 113 Stat. 1338, 1471 (1999).

59. 5 U.S.C. 553(b)(4) .

60. 44 U.S.C. 3501 note .

[ FR Doc. 2024-18187 Filed 8-16-24; 8:45 am]

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