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Traps and Pitfalls For Bank Officers and Directors When Buying Stock of Their Bank or Bank Holding Company From Other Shareholders

A bank officer or director is often one of the first to learn about the availability of shares from a shareholder of the officer’s or director’s bank or bank holding company (for purposes of the remainder of this post, the word “bank” includes bank holding company).  Clearly, it is desirable for management and directors of the bank to be invested in the bank and to share that common interest with other shareholders, but frequently there is a process the bank officer or director (for purposes of this post “bank officer or director” will be called “bank insider”) should follow before purchasing stock of his or her bank from other shareholders. 

In general, for the reasons discussed below, it would be best for the bank insider to first inform the Board of Directors of the availability of the shares and to give the Board the opportunity to direct the process for acquiring those shares.

  1. Some community banks include restrictions in their articles of incorporation on the transfer of their stock.  One common restriction grants the bank a right of first refusal to purchase shares from its shareholders interested in selling shares.  A bank insider who purchases those shares without the Board first waiving the bank’s right of first refusal may be in violation of the articles of incorporation and the transfer may be invalid.  The bank insider interested in the purchase of shares from another shareholder should first review the bank’s articles of incorporation to determine whether there are any applicable restrictions on the transfer of stock.
  2. Some community banks express to their shareholders that the bank is willing to repurchase shares from time to time based upon an established price formula and process.  This intention may be stated in a written stock policy adopted by the Board.  Such a practice is consistent with a primary purpose for the community bank holding company, and that is to help maintain a market for the stock.  In this case, it may be inappropriate for the bank insider to compete with the bank for the repurchase of shares.  Such an act by the bank insider could be deemed interference with a corporate opportunity and result in potential liability for the bank insider. 
  3. Finally, a stock policy approved by the Board may expressly require that any director learning of a shareholder’s intentions to sell his or her stock first make that opportunity to purchase available to the bank by notifying the full Board.  Any director consummating a transaction to purchase those shares without first informing the Board may be deemed in violation of that Board policy. 

Importantly, these provisions in bank holding company articles of incorporation and Board stock policies often exempt transfers of shares between immediate family members. 

There may be other legal issues which could affect such a transaction not addressed in this short post.  Those other legal concerns may include, among others, the following:

  1. The aggregation of shares among the bank insider’s immediate family could trigger a change in bank control application to the Federal Reserve.
  2. The bank insider needs to be careful about the possible misuse of insider information when buying or selling stock of the bank, and the potential liability that may arise from any misuse of insider information.  A good example of the possible misuse of insider information may include the fact that the Board is currently entertaining on a confidential basis an offer or proposal from another banking organization for the purchase of the bank.  In such a case, I suggest the Board place a temporary hold on stock transactions by officers and directors with any such insider information and by the bank holding company itself. 
  3. Another concern may arise from a transaction involving a bank insider if the bank makes a loan to the bank insider to finance the purchase of the stock, and that is the applicability of Federal Reserve Regulation O governing loans to insiders and Federal Reserve Regulation W governing loans to insiders secured by the holding company stock.  Regulations O and W should be carefully reviewed to make certain the proposed loan is not in violation of those regulations.
  4. The bank insider involved in the stock transaction should abstain from participating in the Board’s discussion on the merits and abstain from the Board vote because of the bank insider’s apparent conflict of interest in the matter. 

In summary, a better practice for the bank insider under these circumstances is to first inform the Board of the opportunity to acquire shares of the bank.  The Board can then address the matter and determine whether the bank should buy the stock under a right of first refusal, if it has one, or because it is interested as a matter of policy in repurchasing stock of the bank for the benefit of all shareholders.  If the Board decides not to repurchase the stock it may then elect to approve the purchase of the stock by the bank insider.  

DISCLAIMER: The information provided is for general informational purposes only. This post is not updated to account for changes in the law and should not be considered tax or legal advice. This article is not intended to create an attorney-client relationship. You should consult with legal and/or financial advisors for legal and tax advice tailored to your specific circumstances.

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