The FRB, FDIC, OCC, OTS and NCUA (the “Agencies”) jointly issued guidance (the “Guidance”) to financial institutions (“FIs”) concerning the appropriate treatment of registered warrants (the “Warrants”) issued by the State of California.  California, which is experiencing financial difficulties and has not yet adopted a budget, is issuing Warrants to pay for certain obligations.  California has, for example, issued Warrants to pay individuals for income tax refunds, local governments for social services and vendors for goods and services.  The Attorney General of California has opined that the Warrants are valid and binding obligations of California.

The Agencies state in the Guidance that since general obligation claims on a state receive a 20 percent risk weight for regulatory capital purposes, the Warrants will also receive a 20 percent risk weight.  Moreover, the Guidance cautions that FIs must understand, manage and control the risks related to accepting and holding the Warrants, and “risk management practices should include evaluating the credit quality of the Warrants, establishing appropriate concentration limits and ensuring appropriate liquidity risk management.”

Separately, the SEC issued a release stating that the Warrants are “securities” for purposes of the federal securities laws and, thus, holders of Warrants are protected by the antifraud provisions of the federal securities laws in connection with the purchase or sale of the Warrants.  The California Bankers Association said that California banks are not expected to accept Warrants after July 10, 2009.

This Goodwin Procter Client Alert discusses the issues surrounding firms – ranging from American Express to Goldman Sachs to Merrill Lynch – which have either chosen to become bank holding companies (”BHCs”) or have become subsidiaries of BHCs. These choices typically have been dictated by the benefits of BHC status, including opportunities to participate in the U.S. Treasury Department’s Troubled Asset Relief Program, greater access to the Federal Reserve’s various funding and liquidity sources, and market perceptions regarding stability in this challenging economic environment. These benefits, however, are coupled with costs and restrictions. Chief among them, banking laws, in particular the federal Bank Holding Company Act (”BHC Act”), restrict the ability of BHCs and their affiliates to engage in non-banking activities (”activities restrictions”) and acquire and hold non-banking assets and interests in companies engaged in non-banking activities (”investment restrictions”). A copy of the Client Alert is available here.