In my last post I opened a discussion about my new paper, Treasury Inc.: How the Bailout Reshapes Corporate Theory and Practice, which you can download here. My thesis is that corporate law and theory goes haywire when the government, while enjoying sovereign immunity protection from corporate and securities law, takes control of a company by owning shares. But does the government really control TARP companies?
When Treasury initially sold Congress on the bailout, the plan was to create all sorts of nifty market-oriented structures to reinvigorate the market for troubled assets. But once the government got the money, it used most of the first $300 Billion to buy stock in over 600 troubled banks (from Citigroup and Bank of America to your local First State bank). Eric Posner warned us about this sort of surprise. Some of the stock is non-voting preferred stock that gives Treasury the ability to appoint directors in certain circumstances, for other companies like Citigroup the stock is voting common equity. The share purchase program was later extended to the automotive sector by Tim Geithner. The question is whether the government is a controlling shareholder based on its percentage of share ownership, the fact that the government regulates banks, and the fact that it loans them a lot of money.
Control is an elusive concept. What does it mean to control something? Is it the power to dictate demands, to encourage, to threaten, or maybe the power to destroy something if you wanted? Some forms of control require force. Then again, sometimes control can be exhibited more powerfully through a sublime and unspoken understanding, the Godfather-esque “I give him an offer, he don’t refuse.” It is a question not lent to easy answers, and yet corporate and securities law is riddled with special provisions assigning liability, prohibiting transactions, or requiring additional disclosure based on whether a shareholder controls a company.
Analysis of control in business law is unfortunately muddled. For an entirely novel method of determining control, keep an eye out for an article I’m doing with Terry Chorvat sometime next year. For now, here are some basic rules: i) control is exclusive, a corporation may only have one control shareholder, ii) control is usually present for majority shareholders, unless the board has staggered terms (like the U.S. Senate) iii) holding a majority of shares is not required for control, owing to the collective action problems, rational apathy, and regulatory restrictions limiting dispersed shareholder exercise of their votes, and iv) factors indicating control for sub-majority shareholders could include percentage of holdings, special contractual rights, concurrent status as a powerful creditor, or actual exercise of control such as holding corporate office.
With that, let’s turn to the question of whether the federal government is a control shareholder for any of the 600+ companies accepting TARP bailout money. We start with the obvious point that the government stands as both a powerful creditor and shareholder for most of these companies. It also has a power that no other shareholder has, it regulates the companies. For banking, Treasury and the Fed are regulators, for the automotive industry the DOTD, DOE, and other entities do the job. At GM and AIG, Treasury and the Fed are majority shareholders (GM is not currently publicly traded, but soon will be). Fannie and Freddie are not technically TARP bailout owing to their pre-bailout conservatorship (in much the same way that Marcia, Jan, and Cindy are not technically Brady) but in light of their starring roles in the financial crisis, let’s throw them in anyway as former Fortune 500 companies that are presently 100% government owned.
At AIG, the Federal Reserve placed its shares with a trust that it created, the AIG Trust, managed by three trustees selected by the Federal Reserve. The Fed’s position is that this helps to create a buffer between the Fed and AIG. I don’t buy that argument. I had an opportunity to testify about the AIG Trust, along with then AIG CEO Ed Liddy and the three trustees, at a hearing before House Oversight this summer where I urged that the AIG Trust Document actually requires the Trustees to manage the trust in the best interest of the Treasury Department. To read the testimony, see here. I’ve consulted for the Special Inspector General for TARP and the GAO TARP team on this issue for a Corporate Governance Audit requested by Senator Baucus, a very engaged and informed group of folks by the way, hopefully that report will bring this issue to light.
At Citigroup the government holds a 34% interest. For any other shareholder 34% ownership, by itself, is a close call for determining control. When we add the fact that banking is a deeply regulated industry, regulated by same two government entities that control the shares in question, and we also consider the fact that the government is also a substantial creditor of Citi through a number of guarantees it has also offered to Citi’s outstanding liabilities, I feel confident in asserting that the federal government is a control shareholder in Citi. For real world indicia of control, consider that the government has chosen most of Citi’s current directors, and that Citi has been the first to accede to congressional demands on mortgage re-modifications, support for cramdown legislation, and worker visa limitations.
I won’t analyze every one of the 600 companies, but I think you get the point. Treasury and the Federal Reserve are control shareholders of many TARP companies, the only real question is how many.