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August 20, 2009 3:31 PM

Big Firms Line Up Against FDIC Private Equity Rules

Posted by Zach Lowe

Several Am Law 200 firms have submitted letters urging the FDIC to back off proposed requirements for private equity funds interested in buying stakes in failed banks--rules designed to address fears the funds won't be conservative enough in their lending practices, leading to another economic collapse.

Firms that have lined up in opposition to the proposals include: Davis Polk & WardwellSkadden, Arps, Slate, Meagher & Flom; Paul, Hastings, Janofsky & Walker; Fried, Frank, Harris, Shriver & Jacobson; Goodwin Procter; and Jones Day.

The firms, which represent top private equity funds, argue the FDIC's proposed regulations are so strict they will discourage the PE industry from investing in troubled banks--investment the FDIC should want.

"We are perplexed that the FDIC would propose requirements that would discourage a potentially significant source of new capital--private capital investors--from investing in the banking system," the Davis Polk memo says.

Dissuading private equity groups would result in "increasing the costs of failed bank resolutions for the [federal] Deposit Insurance Fund and, ultimately, U.S. taxpayers," Skadden partner William Sweet, Jr., writes.

Among the proposals the firms have come out against:

• Private equity groups interested in buying a stake in a bank would be required to carry a Tier 1 capital ratio of 15 percent--three times higher than the 5 percent ratio required for banks designated "well-capitalized companies" and new banks.

• In some cases private equity investors would be liable if a bank suffers losses--even if the individual investor owns a tiny portion of the bank and is not involved in its management. (The investor would have to provide additional capital to make up for the losses.)

• Banks could not lend money to private equity funds that own stakes in those banks. The banks also couldn't lend to investment vehicles tied to those funds.

• Private equity investors would have to hold onto its stake in a bank for at least three years to eliminate the incentive to pursue short-term gains.

• Private equity funds based in offshore locations often used as (legal) tax havens would not be allowed to invest in a bank. (Many U.S. private equity funds have parallel offshore operations and only pursue investment opportunities open to both branches.)

• Private equity funds would be prohibited from creating spin-off funds for the sole purpose of buying a stake in a bank to protect the parent fund from increased government regulations that come with bank ownership. 

The firms argue that current FDIC regulations for bank ownership are sufficient for private equity funds. The good news for the firms and their clients: The FDIC, despite some tough talk earlier this summer, appears prepared to loosen some of these requirements. The agency will vote on the proposal on Aug. 26.

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