| February 6, 2003 |
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H. Rodgin Cohen, Esq. This is in response to the request by The Goldman Sachs Group, Inc., New York, New York ("Goldman"), for the Board's views regarding whether Goldman would be deemed to control Sumitomo Mitsui Financial Group, Inc., Tokyo, Japan ("Sumitomo"), for purposes of the Bank Holding Company Act ("BHC Act") as a result of Goldman's proposed investment in, and business relationships with, Sumitomo. Sumitomo is a bank holding company under the BHC Act because it controls Manufacturers Bank, Los Angeles, California. Goldman is not a bank holding company. The proposal has three inter-related parts: an investment by Goldman in Sumitomo; the execution of several letters of credit ("L/Cs") by Sumitomo in favor of Goldman; and an agreement by Goldman and Sumitomo to have certain additional business relationships over the next five years. Goldman and Sumitomo have indicated that they would not consummate any of the proposed transactions unless they all were consummated. The Investment. Goldman proposes to invest approximately $1.28 billion in nonvoting convertible preferred stock ("Preferred Stock") of Sumitomo. We understand that the Preferred Stock would represent approximately 5 percent of Sumitomo's total equity, would not be considered voting securities for purposes of the BHC Act,1 and would not be transferable (other than to an affiliate of Goldman or to an acquirer of all Goldman's assets). In addition, the Preferred Stock initially would be convertible into about 7.4 percent of Sumitomo's common stock but would convert into a greater percentage of Sumitomo's common stock (up to a maximum of 19.4 percent) if the market price of the common stock falls. The Preferred Stock would become convertible into Sumitomo's common stock two years after its issuance, and the right to transfer the underlying common stock would vest in three equal installments on the second, third, and fourth anniversaries of the issuance of the Preferred Stock. In connection with the market-rate conversion feature, Goldman has committed to limit its ability to hold, vote, or transfer any shares of Sumitomo's common stock that Goldman could receive in excess of 10 percent of the common stock. In particular, Goldman has committed that, in the event that there is such a decline in the market price of Sumitomo's common stock that the Preferred Stock would represent, on a pro forma basis, 10 percent or more of Sumitomo's outstanding common stock, (i) Goldman would not convert Preferred Stock to the extent Goldman would itself hold more than 9.9 percent of Sumitomo's outstanding common stock (although Goldman could hold more than 9.9 percent on a temporary basis in order to sell the common stock and, in such case, Goldman would not vote more than 9.9 percent of the common stock); and (ii) any sales by Goldman of shares of Sumitomo's common stock that exceed 10 percent would be made only in a widely dispersed public offering, in private sales in which no purchaser or group of related purchasers would acquire from Goldman more than 2 percent of Sumitomo's common stock, to a purchaser acquiring majority control of Sumitomo, or as otherwise approved by the Board. The Credit Arrangements. As a condition to Goldman's investment in the Preferred Stock, Sumitomo has agreed to issue several L/Cs for the benefit of Goldman that would allow Goldman to hedge the credit risk arising from a standby lending program that Goldman intends to offer. Under the program, a Goldman affiliate would extend approximately $[ ] billion in credit facilities to Goldman clients. Sumitomo's L/Cs would hedge Goldman's credit risk from program credits that are made to certain borrowers ("Eligible Borrowers"). The vast majority of the Eligible Borrowers would be investment-grade U.S. and European companies. Goldman has indicated that most of the credits covered by the L/Cs ("Covered Credits") would be unfunded commitments backing commercial paper issuances by current and prospective customers of Goldman. Sumitomo would provide two sets of L/Cs to Goldman. First, Sumitomo would issue a 20-year L/C concurrently with Goldman's investment in the Preferred Stock (the "First L/C"). Under the First L/C, Goldman would be entitled to draw amounts equal to 95 percent of its first losses on the Covered Credits, up to $1 billion. Second, Sumitomo would issue one or more additional L/Cs (each having a term of five years or less) over the next 20 years (the "Second L/Cs"). Under the Second L/Cs, which must be rated at least Baa2 by Moody's or BBB by S&P, Goldman would be entitled to draw amounts equal to 70 percent of its losses on the Covered Credits above certain loss thresholds, up to an aggregate of $1.125 billion. Sumitomo initially must secure its obligations under the L/Cs by purchasing and pledging to Goldman $1.375 billion of Goldman demand notes. Sumitomo also must purchase and pledge additional Goldman demand notes as Sumitomo issues Second L/Cs to ensure that the aggregate principal amount of the Goldman demand note collateral is at least equal to Sumitomo's maximum obligation under outstanding L/Cs. The interest rate on the notes would be below Goldman's current five-year funding rate.2 In the event that Goldman suffers a loss on a Covered Credit, Goldman would be obligated to prepay the demand notes to the extent of its right to draw on the relevant L/C, and Sumitomo would use the proceeds of the prepayment to satisfy Goldman's draw on the L/C. Sumitomo would have no obligation to make payment to Goldman on the L/Cs in the event that Goldman defaults in prepaying principal on the demand notes. The credit arrangements contain a number of provisions that allow Sumitomo to participate in selecting Eligible Borrowers. Prior to issuing the L/Cs, Sumitomo would have the right to approve the selection of Eligible Borrowers and the maximum amount and maximum term of any Covered Credit for each Eligible Borrower. In addition, no borrower may subsequently become an Eligible Borrower, and no existing Eligible Borrower may have its maximum amount or maximum term increased, without the approval of Sumitomo. Moreover, if both Moody's and S&P downgrade the rating of an Eligible Borrower to below investment grade, further extensions of credit to such borrower would no longer be considered Covered Credits. Sumitomo also has the right every five years to suspend the Eligible Borrower status of any borrower if (i) Sumitomo's internal credit rating for the borrower is below BB-; and (ii) either Goldman or a neutral arbitrator agrees with Sumitomo's assessment; and (iii) Sumitomo agrees to add a new borrower recommended by Goldman. Although there are no comparable transactions in the market, the L/Cs, when viewed by themselves, have terms that are favorable to Goldman. In addition, under the L/C agreements, Sumitomo may not enter into similar credit arrangements with Goldman's competitors. The Other Business Relationships. Goldman and Sumitomo also have proposed to enter into a five-year business cooperation agreement relating to financial services for Japanese companies and individuals and other Japan-based financial transactions. The business cooperation agreement gives Goldman a priority in (i) selling certain investment products to Sumitomo's retail customers; (ii) providing investment banking services to Sumitomo; (iii) purchasing certain Japan-based assets from Sumitomo; and (iv) co-investing with Sumitomo in Japan-based merchant banking investments. In addition, the agreement obligates Goldman to make efforts to include Sumitomo in certain Japan-related loan syndications and to encourage Goldman's customers to use Sumitomo for Japanese commercial banking services. Under the agreement, neither Sumitomo nor Goldman is obligated to give the other party most of the priorities or referrals set forth in the agreement in any circumstances where it would not be practically possible, legally permissible, or economically reasonable to do so. The Board understands that Sumitomo would not be obligated, for example, to give Goldman a particular investment banking mandate if Sumitomo were able to obtain a better deal from a competitor of Goldman. In addition, Goldman's priorities are in many circumstances subject to a superseding priority granted to Sumitomo's securities affiliate, Daiwa Securities SMBC Co. Ltd. Moreover, under the agreement, Sumitomo would be prevented from entering into similar arrangements with Goldman's competitors. Goldman has indicated that annual revenues arising from the credit arrangements and the business cooperation agreement are expected to represent less than 1 percent of the total annual revenues of each of Goldman and Sumitomo. Goldman and Sumitomo have had a long-standing relationship. Sumitomo acquired more than 20 percent of Goldman's equity capital in 1986 in a transaction approved by the Board and remained Goldman's largest institutional investor until 2000.3 Although Sumitomo no longer has an equity interest in Goldman,4 the two companies continue to have business relationships. According to Goldman and Sumitomo, the business cooperation agreement largely would put into writing the current informal business cooperation relationships between the two parties. Legal Framework. For purposes of the BHC Act, a company has control over a bank holding company if the company (i) directly or indirectly or acting through one or more other persons owns, controls, or has power to vote more than 25 percent of any class of voting securities of the bank holding company; (ii) controls in any manner the election of a majority of the directors of the bank holding company; or (iii) directly or indirectly exercises a controlling influence over the policies or management of the bank holding company.5 The Board's Regulation Y also sets forth a set of rebuttable presumptions of control.6 Under the proposed transactions, Goldman would only be deemed to control Sumitomo for purposes of the BHC Act if the Board were to find that Goldman exercised a controlling influence over the policies or management of Sumitomo. Goldman would not own, control, or hold with power to vote more than 25 percent of a class of voting securities of, or control the election of a majority of the directors of, Sumitomo. In addition, Goldman would not trigger any of the rebuttable presumptions of control in Regulation Y. Discussion and Analysis. The size and nature of Goldman's proposed equity investment in Sumitomo, when combined in particular with the terms and unique nature of the proposed L/Cs, raise the issue of whether Goldman has a significant influence over the policies and management of Sumitomo. The Board typically has been concerned that a company has acquired control of a bank holding company for BHC Act purposes if the company (i) acquires more than 10 percent (or instruments convertible into more than 10 percent) of a class of voting securities of the bank holding company; and (ii) has significant business relationships or off-market business relationships with the bank holding company.7 To address concerns that it might already have exercised or might have the ability to exercise a controlling influence over Sumitomo, Goldman points to the following features of the proposal:
In view of all the facts of record in this case--including in particular the passivity commitments made by Goldman, the small relative size of Goldman's equity investment, the presence of a significantly larger Sumitomo shareholder, and the limited extent of the proposed business relationships--the Board would not find that the proposed investment and business relationships would cause Goldman to control Sumitomo for purposes of the BHC Act.9 Normally, the involvement of an organization with U.S. banking offices in these types of transactions would require consideration of several supervisory issues. The proposed transactions are reciprocal in nature, and the collateralized L/Cs result in the issuing bank assuming the first-loss position on a sizable portfolio of credits, thereby utilizing a significant amount and possibly all of the additional capital received from the issuance of the Preferred Stock. Consequently, a U.S. banking organization offering L/Cs of this type in connection with receiving an equity investment like the Preferred Stock would be required either to exclude the Preferred Stock from regulatory capital or to hold dollar-for-dollar regulatory capital against the face amount of the First L/C. In addition, supervisory issues would be raised if a U.S. depository institution were to grant credit protection to a significant shareholder of the institution as part of a reciprocal transaction. Because no U.S. offices of Sumitomo were involved in the proposed transactions, however, the Board's determination in this case was based solely on the issue of control. In reaching the determinations set forth in this letter, the Board relied on all the facts of record, including all the representations and commitments made by or on behalf of Goldman and Sumitomo (whether noted in this letter or otherwise contained in your correspondence with the Board). These representations and commitments are deemed to be conditions imposed in writing by the Board in connection with its determinations and, as such, may be enforced in proceedings under applicable law. Any change in the terms or circumstances of the proposed transactions may result in a different decision. In this regard, you should advise Board staff before making any material modification to the proposal and should provide Board staff with a copy of the final documentation regarding the proposal when it has been completed. To address the possibility of a controlling influence developing in the future, the Board retains the authority to review the investment and relationships regularly to determine whether, under all the facts and circumstances, Goldman is acting in a manner that suggests it has a controlling influence over Sumitomo for purposes of the BHC Act. Sincerely yours,
[signed] Robert deV. Frierson Deputy Secretary of the Board Attachment
Footnotes 1. We understand that any voting rights associated with the Preferred Stock would be limited solely to the type customarily provided by statute with regard to matters that would significantly and adversely affect the rights or preferences of the Preferred Stock. See 12 C.F.R. 225.2(q). Although the holders of the Preferred Stock would vote pari passu with the holders of common stock in the event of a missed or reduced dividend on the Preferred Stock, each share of Preferred Stock would be entitled to one vote, and the voting rights of the Preferred Stock would account for less than 1 percent of the aggregate voting rights of the holders of Preferred Stock and common stock.Return to text 2. Sumitomo has the right to substitute other collateral if it pays Goldman the difference between the interest rate on the notes and Goldman's then-current five-year funding rate.Return to text 3. See Letter dated November 25, 1986, from William W. Wiles, Secretary of the Board, to John L. Carr (authorizing Sumitomo to make a 24.9 percent nonvoting equity investment in Goldman and to maintain certain limited business relationships with Goldman). Sumitomo owned more than 6 percent of Goldman's shares until as recently as 2000.Return to text 4. Sumitomo sold its last remaining shares of Goldman in January 2002.Return to text 5. 12 U.S.C. � 1841(a)(2); 12 C.F.R. 225.2(e).Return to text 6. See 12 C.F.R. 225.31(d).Return to text 7. See, e.g., Letter dated May 28, 1985, from James McAfee, Associate Secretary of the Board, to Mark L. Starcher; Letter dated April 30, 1986, from James McAfee, Associate Secretary of the Board, to Thomas M. Shoaff.Return to text 8. These passivity commitments are set forth in the attachment to this letter.Return to text 9. Goldman also has requested the Board's views regarding whether Goldman would be deemed to have acquired control of Sumitomo for purposes of the Change in Bank Control Act ("CIBC Act"). For purposes of the CIBC Act, Goldman is presumed by Regulation Y to control Sumitomo if (i) Goldman will own, control, or hold with power to vote 10 percent or more of any class of voting securities of Sumitomo; and (ii) Sumitomo has registered securities or no other person owns or controls a greater percentage of the same class of voting securities. 12 C.F.R. 225.41(c). Although Goldman's investment in Sumitomo would be convertible into more than 10 percent of a class of voting securities of Sumitomo in certain circumstances, Sumitomo does not have a class of registered securities in the United States, and Goldman would not control the largest percentage of Sumitomo's common stock. As discussed above, the Japanese government would have a much larger equity interest in Sumitomo than Goldman, and, under all conversion scenarios, the Japanese government's preferred stock would convert into more shares of Sumitomo's common stock than would the Preferred Stock. In addition, in all circumstances, Goldman would own and control the disposition of less than 20 percent of Sumitomo's common stock and would vote less than 10 percent of the common stock. Moreover, as noted above, Goldman has agreed to limit its ability to transfer any shares of common stock that exceed 10 percent of Sumitomo's common stock. Based on all the facts of record, considered in light of the presumption of control in Regulation Y, the Board would not find that the proposed transactions would cause Goldman to acquire control of Sumitomo for purposes of the CIBC Act.Return to text |
