MUTUAL-TO-STOCK CONVERSIONS

FRIDAY, FEBRUARY 25, 1994

U.S. SENATE,

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,

Washington, DC.

The committee met in room 538, of the Dirksen Senate Office Building at 10:12 a.m., Senator Donald W. Riegle, Jr. (chairman of the committee) presiding.

OPENING STATEMENT OF CHAIRMAN DONALD W. RIEGLE, JR. The CHAIRMAN. The committee will come to order.

Let me welcome all those in attendance this morning. I see some faces that I saw yesterday here. So, welcome back.

We are meeting this morning to conduct a hearing on the issue of mutual-to-stock bank conversions.

Senator D'Amato and I recently introduced S. 1801, which is entitled the Mutual Depository Institution Conversion Protection Act, in order to address insider abuses in these transactions. Unlike stock institutions, mutual depository institutions are nominally owned by their depositors. As such they are able to raise capital only through retained earnings. This can be problematic particularly if the mutual institution is not profitable. By converting to stock form, hundreds of such institutions have been able to obtain over $16 billion in vital capital in the last 20 years.

More recently, however, management and insiders at well-capitalized mutuals appear to be abusing the conversion process to reap substantial personal gain. Generous stock and option plans for insiders have become commonplace, along with systematic underpricing of the conversion stock itself.

I am particularly concerned by reports that some mutuals are switching from Federal to State charters in order to take advantage of more-lax State conversion rules. This sort of competition in laxity benefits no one, and is, at least, not in the public interest and should not be tolerated.

The bill that Senator D'Amato and I have introduced represents a measured response to these problems. It is not designed to eliminate conversions but rather to ensure that proper incentives drive the transactions. The bill would establish Federal regulations as the floor for all conversions but allow the States to adopt further restrictions as they desire. At the same time, it limits management and insiders to benefits available to all eligible depositors in a conversion. If there are depositors, management may receive the same preferential treatment provided to other depositors and nothing more than that.

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Finally, the bill prohibits the institution from approving compensation proposals for management such as stock options packages for 1 year. Such incentive compensation is best evaluated after a conversion by stockholders who truly own the converted institution.

The Federal Deposit Insurance Corporation and the Office of Thrift Supervision have moved to stop some of the abuses in mutual-to-stock conversions. The OTS has announced a general review of its regulations and a moratorium on conversions involving mergers. At the same time, the FDIC, as the Federal regulator of Statechartered mutual savings banks, has announced that it will "generally" apply the OTS regulations to conversions of State-chartered institutions.

While I commend the regulators for their actions, more work needs to be done here. The FDIC proposal remains vague, and it lacks measurable standards for evaluating a proposed conversion. More generally, questions have also been raised about the extent of the agency's statutory authority to regulate conversions. For its part, the OTS has not yet announced the changes it will consider to its conversion process. Until these issues are settled, we will continue to press forward with legislation in this area.

I want to take this opportunity to express my appreciation to my good friend and distinguished colleague, Senator D'Amato. Our work on this issue, as so many others, has been truly a bipartisan effort, and we will continue to work together in that fashion.

So, I want to welcome our witnesses, and before we go to them, let me call on Senator D'Amato.

OPENING COMMENTS OF SENATOR ALFONSE M. D'AMATO Senator D'AMATO. I am going to ask in the interest of time that my full statement be entered into the record as if read in its entirety.

The CHAIRMAN. Without objection, so ordered.

Senator D'AMATO. Mr. Chairman, my own State of New York has dealt with the problem, and I think, to put it succinctly, what we are really trying to do is say that conversions for the most part are beneficial. I know Senator Riegle joins with me. If we can get capital into the system, we want to do that. But a handful of people on certain occasions should not be blinded by their being able to make windfall profits at the expense of the depositors. That is not what this is about. And that is just wrong.

Let me say to the Banking Commissioner of New York-Derrick Cephas-I think you did an outstanding job in stopping what would have been one of those situations where basically a handful of insiders would have just made a huge windfall, not in regard to service or whatever, but just because they were able to control the process. Again, that is wrong.

So that is what this is an attempt to deal with: keeping people from taking advantage of the system that was not intended to enrich them. If stockholders later want to give them compensation, fine. But when the depositors in these mutuals have little, if any, power, they have to have certain protections. That is what we really seek to do. We are not saying this is all perfect. We are not say

ing that this bill is written in stone. It certainly isn't. But that is where I am coming from, in any event.

Now, I don't know if my staff is going to go at me later for saying that, but that is the way I feel about it.

So, staff, forgive me.

[Laughter.]

The CHAIRMAN. This morning we have got Jonathan Fiechter, who is the Acting Director of the Office of Thrift Supervision, here with us. And we also have the Acting Chairman of the FDIĆ, Andrew Hove, whom we had, of course, yesterday.

Gentlemen, we will make your full statements a part of the record.

Senator D'AMATO. Mr. Chairman, I just would like to take this opportunity because, you know, Mr. Hove was under a lot of pressure. This room at this time yesterday was a cauldron, and I want to tell you I think he has been a dedicated public official. Let us make no mistake about that.

But I want to thank you for your response as it relates to the Whitewater matter that you have indeed directed the Inspector General to review those issues that we called to your attention. And today he has advised me and the Chairman of that with a letter. So let me underscore the fact that I want to commend you for moving as you have.

The CHAIRMAN. Mr. Hove, why don't we start with you?

STATEMENT OF ANDREW C. HOVE, ACTING CHAIRMAN, FEDERAL DEPOSIT INSURANCE CORPORATION, WASHINGTON, DC

Mr. HOVE. Thank you very much, Chairman Riegle and Senator D'Amato. On behalf of the Federal Deposit Insurance Corporation, I appreciate this opportunity to testify regarding institutions that convert from mutual-to-stock form.

I believe there are important and difficult issues that need to be addressed with respect to conversions. Currently, the FDIC has an internal task force reviewing the entire conversion process. Members of this task force are conferring with staff at the Office of Thrift Supervision. We also have an interim regulation in place, and we have solicited comments from the public on both the interim regulation and a proposed policy statement on this subject. Our interim regulation should permit the FDIC to halt the abusive practices that have recently plagued the conversion process and to protect more fully the interests of depositors in a converting institution.

However, we have to do more than simply curb abuses in the current process. We need to reexamine the process generally to determine whether it should be redesigned and, if so, how best to achieve that result. In our experience, conversion is often a very good idea for the institution in question. It allows the weak institutions to recapitalize. It allows institutions to participate in a consolidation occurring in the bank and thrift industries.

There are major flaws in the existing conversion process as it operates when the institutions in question are healthy. The economic value of the converting institution flows to those who are wealthy enough and knowledgeable enough to stand in line to buy it. The

process may need to be redesigned so that the economic value can be distributed directly to those who should get it. Who should receive its value is ultimately a legal and political question for legislators.

The FDIC has several efforts under way with respect to mutualto-stock conversions. First, we are reviewing conversion applications under our new interim regulation to determine whether to object to a transaction for safety and soundness reasons, violations of law or breaches of fiduciary duty. This process involves a case-bycase determination based upon the facts of each proposed conversion transaction. The current standards used in the FDIC's review of the proposed conversions under our new interim rule will not necessarily be affected by the potential long-term reforms mentioned in this testimony.

Second, we have formed a task force to review the entire conversion process, and we will work with the OTS on an approach for regulating the conversion process in the long term. While the task force has just begun its work, our testimony will outline our preliminary thinking on the issue, assuming the mechanics can be satisfactorily worked out.

No. 1, the essence of the conversion process should be a distribution to depositors, or others if they are deemed to be appropriate, of the transferable stock purchase rights, accompanied by appropriate disclosure documents.

No. 2, depositors should have a vote on the transaction even where State law does not require it. General proxies granted by depositors when they open accounts should not be valid.

No. 3, depositors' eligibility for receipt of rights should be based on an existing relationship of some specific duration. And that raises a host of issues that need further consideration.

No. 4, we are uncertain whether the distribution of rights should or should not reflect amounts on deposits, such as one right per $100 on deposit up to a maximum of ten rights per individual. Again, this subject calls for further study.

No. 5, the proxy statement and/or the disclosure statements should probably include the opinion of an independent financial adviser regarding the fairness of the transaction to depositors from a financial point of view. It should be clearly stated that this opinion does not address the question of whether the stock of the converting institution, or the acquirer in the case of merger conversions, is an appropriate investment for any particular depositor.

No. 6, as I indicated earlier, the ability of depositors and other recipients who do not wish to become stockholders to obtain fair value for their rights depends on the participation of underwriters or other dealers. We look forward to hearing from Wall Street and others about how the conversion process can be made fair and effective in this area.

No. 7, the amount of capital to be raised in the conversion process should be appropriate to the institution's condition and the reasonable business plan.

No. 8, the distribution of rights should not be a taxable event, but the basis of the rights in the hands of initial recipients should be zero, and they should be capital assets. When depositors or other recipients sell their rights and when they sell the underlying

shares, the Government will then obtain a portion of the economic value of the converting institution by taxing the gain on that sale. No. 9, with depositor approval, the boards of converting institutions should be able to contribute some portion of the economic value of the institution by contributing rights to the new or existing charitable trusts or organizations whose focus is the community in which the institution serves.

No. 10, with the depositor approval, it should be possible to contribute rights to a qualified employee stock ownership plan.

No. 11, in addition to meeting the test of no excessive compensation, any awards to officers and directors at the time of the conversion should be in the form of stock, not options, to avoid the conflict of interest of negotiating a transaction with the objective of giving the stock as high a value as possible while having a personal interest in a low value.

No. 12, the merger conversion should, in essence, be exchanges of acquirer stock or cash for depositors' stock purchase rights. It should be feasible for potential acquirers to propose such transactions subject to appropriate State and Federal laws. And how this might work obviously requires further study.

Mr. Chairman, you asked for our comments on S. 1801, the Mutual Depository Institution Protection Act of 1994, which was introduced by you and Senator D'Amato. In that regard, I would make two comments.

First, we believe that the FDIC does, in fact, have sufficient authority to curb abuses in the current process. We would, however, need additional statutory authority if we proceed to reform the conversion process along some of the lines described above. We would strongly urge that our legislative mandate be general and that the details be allowed to emerge from our rulemaking process.

Second, we believe that the FDIC and the OTS should each retain responsibility for supervising conversions of those institutions for which each is primary Federal regulator, but will work together to assure comparable rules and procedures.

I thank you very much for the opportunity to testify, and I look forward to answering your questions.

The CHAIRMAN. Thank you.

Mr. Fiechter.

STATEMENT OF JONATHAN L. FIECHTER, ACTING DIRECTOR, OFFICE OF THRIFT SUPERVISION, WASHINGTON, DC

Mr. FIECHTER. Good morning, Mr. Chairman and Senator D'Amato. Thank you for inviting me to provide the Office of Thrift Supervision's views on regulating mutual-to-stock_conversions and on your bill, S. 1801. I want to compliment you, Mr. Chairman, on initiating hearings on this issue.

For the past 20 years mutual-to-stock conversions have been a successful vehicle for bringing new capital into the thrift industry. Since 1974 over 1,000 mutual savings associations have converted to stock institutions, in the process raising over $16 billion in new capital. As these numbers suggest, the principal benefit of an institution converting from the mutual to the stock form is raising capital, a result that can otherwise be difficult for mutuals to achieve. Unlike stock institutions, mutual associations can increase their