DC Circuit Upholds OTS Limit on MHC Subsidiary Minority Ownership

A federal appeals panel upheld an Office of Thrift Supervision regulation that allows subsidiaries of mutual holding companies to limit their minority shareholders to 10 percent of the subsidiary’s total minority stock. In response to a challenge from an investor, the court held that the rule was "reasonable and reasonably explained" and that the OTS "struck a permissible balance between the goals of deterring management’s self-dealing and preventing abusive short-term investment strategies." Click here for the opinion in Stillwell v. OTS.

Federal law allows mutual savings associations to raise outside capital if they first convert to a mutual holding company structure. After the conversion, an MHC may sell a minority stake of its subsidiary to the public in a stock offering. In such an offering, the MHC may raise capital while retaining a majority stake in and control of the subsidiary. This structure also allows directors, officers, and employees of the mutual association to receive compensation in the form of stock in the subsidiary.

The OTS has promulgated rules governing the process by which MHC subsidiaries may create stock benefit plans for the benefit of their directors, officers, and employees. To prevent management’s self-dealing, OTS required that a majority of the minority shareholders in the MHC subsidiary approve the benefit plans. The agency was concerned, however, that such minority holders could abuse their leverage in voting on those plans to make demands on management.

In response, OTS adopted a rule that allows (but does not require) MHC subsidiaries to prohibit any person or entity from acquiring more than 10 percent of the subsidiary’s total minority stock within five years after the minority stock issuance. The petitioner, Joseph Stillwell, objected to the measure during the rulemaking process on the grounds that it inappropriately favored the interests of MHC management, disenfranchised minority shareholders and undermined sound corporate governance. Before the D.C. Circuit, Stillwell argued that the rule was arbitrary and capricious under the Administrative Procedure Act because the OTS failed to present any substantial empirical evidence justifying the new regulation, and that the rule would worsen the problem of allowing management to give itself generous stock plan awards.

An initial question involved the standard of review. Because Stillwell did not argue that the rule violated any statutory provision, the court stated that the rule would stand the rule was both reasonable and reasonably explained by the agency. The court rejected Stillwell's contention concerning the lack of empirical evidence. The APA imposes no such obligation, stated the court. Agencies need only justify their rules with reasoned explanations. According to the panel, under this relatively deferential review standard, "OTS thoroughly explained its concern that minority shareholders could use and were using their leverage to `take unfair advantage' of the proceeds resulting from the stock offering."

While the rule may make it more difficult for some minority shareholders to prevent MHC subsidiaries from adopting stock compensation plans, the court found that this alone did not establish that the rule was arbitrary and capricious. The optional charter provision did not affect the separate OTS regulation requiring that a majority of minority shareholders approve stock benefit plans. Accordingly, minority shareholders as a class retained power to vote down stock benefit plans.

The court noted that the agency was attempting as a matter of policy to balance the interests of both majority and minority holders. The competing goals were to prevent majority shareholders from granting themselves overly generous stock packages while preventing minority shareholders from taking advantage of their veto power over such packages to the possible harm of the institution. The panel concluded that while "[o]ne can certainly quibble with the balance struck by OTS...we find no basis under the arbitrary and capricious test for overturning its assessment."

Stillwell v. OTS
.