Mutual-to-Stock Conversions: Tips for Investor
Oct. 6, 2011
Many banks and insurance companies in the U.S. are organized as “mutual companies.” A mutual company is one that is owned — and sometimes governed — by its members instead of being owned by public or private shareholders. In the case of a mutual savings bank or a mutual savings association, the members are the financial institution’s depositors. In the case of a mutual insurance company, the members are the insurance company’s policyholders.
Over the past two decades, a number of mutual companies have converted to a stock form of ownership — either to raise money, to expand operations, to enhance employee benefit options, or for some combination of these or other reasons. A host of federal and state banking laws govern “mutual-to-stock” conversions of banks and savings associations, including the rights — and responsibilities — of depositors. Similarly, state insurance laws govern insurance company conversions.
This alert briefly describes how mutual-to-stock conversions work in the context of banks and savings associations and provides tips for investors who participate in these transactions.
How Bank and Savings Association Mutual-to-Stock Conversions Work
When a bank or savings association converts from mutual to stock form, the financial institution (or its holding company) generally issues stock in an initial public offering (or “IPO”). Historically, individual investors have had a difficult time purchasing shares in IPOs — largely because of the way those deals are structured and sold. With a bank or savings association mutual-to-stock conversion, however, eligible depositors have a unique opportunity to participate and purchase shares because federal and state banking regulations require that the bank or savings association give depositors first priority to purchase the stock over all other interested investors. These priority subscription rights allow depositors to purchase up to a set amount of shares at the “subscription price,” which is the value the company assigns to its shares before the shares trade publicly. Stock offered as a result of a conversion sometimes generates significant investor interest because of the potential for the stock price to increase. If the IPO is over-subscribed — that is, if depositors and others who have been given priority under federal and state banking regulations collectively sign up to purchase more shares than the converting bank or savings association plans to offer — then the general public will not have a chance to take part in the IPO.
To ensure that only depositors benefit from their priority stock subscription rights, federal and state banking regulations prohibit depositors from transferring ownership of their subscription rights — or of the stock itself — prior to completion of the conversion. These restrictions on depositors — and any additional restrictions that the financial institution imposes — will always appear in the prospectus for the conversion. In addition, converting banks and savings associations typically require depositors to sign a “subscription agreement” or “stock order form” that contains written certification (signed under penalty of perjury) that the depositor is purchasing the conversion stock for his or her “own account” and that he or she has “no agreement or understanding regarding the sale or transfer of” any shares he or she receives.
But, as several SEC enforcement actions in this area confirm, opportunists (or “fraudsters”) periodically attempt to circumvent these laws and participate illegally in mutual bank or savings association conversions. Links to these enforcement actions are included at the end of this alert.
How Fraudsters Take Advantage
The rare ability for ordinary individuals to get in on the ground floor of an IPO makes mutual-to-stock conversions ripe for abuse. Although there are many variations of this type of scheme, in the typical case, the fraudster will identify and approach a depositor who has non-transferable subscription rights, offering to “loan” the depositor the money required to purchase the maximum number of shares. Converting financial institutions typically require depositors to pay up front and in full for the shares they request at the time they submit their subscription agreements or stock order forms. Those sums can easily be tens or hundreds of thousands of dollars — amounts that many depositors cannot afford on their own.
In exchange for funding the purchase, the fraudster typically will require the depositor to either (1) transfer the conversion stock to an account that the fraudster controls or (2) sell the stock and give the fraudster a majority of the profits. The fraudster will further persuade the depositor to keep secret their arrangement and to submit subscription documents or stock order forms that falsely (or misleadingly) represent to the bank or savings association that the depositor is the true purchaser of the stock, has not transferred his or her subscription rights to any person or entity, and has entered into no agreement regarding the sale or transfer of the stock. After the conversion occurs, the fraudster typically will determine when to sell the stock (but sometimes lets the depositor decide when to sell) and will split any profits with the depositor. In most cases, the fraudster gets well over half the profits, and frequently the fraudster gets over 75% of the profits.
Mutual depositors who enter into agreements with such fraudsters should be aware that these fraudsters may be violating not only state and federal banking laws, but also the antifraud provisions of the federal securities laws and various federal criminal laws. Moroever, mutual depositors should be aware that, by entering into such agreements, they may be violating these laws themselves and may be subject to civil enforcement actions or criminal prosecution. In fact, in the last few years several individuals have faced both civil enforcement actions and criminal prosecution in connection with such agreements.
What Investors Need to Know
Key concepts for investors to bear in mind when considering whether to participate in a mutual bank conversion include the following:
- Know the Rules — By law, depositors cannot sell or transfer their priority subscription rights, or the stock itself, prior to the completion of a financial institution’s conversion. Moreover, depositors cannot enter into agreements or arrangements to sell or transfer either their subscription rights or the underlying conversion stock.
Read the Prospectus and Stock Order Forms Carefully — These documents may contain broader, more explicit restrictions than the threshold set by applicable state and federal banking laws. Typically, prospectuses prohibit any agreements regarding the sale or transfer of the stock. Financial institutions have the right to reject any stock order forms that do not comply with either the letter of the law or the wording of the prospectus.
“Neither a Borrower nor a Lender Be” — Shakespeare’s words ring especially true in the context of mutual bank conversions. If someone offers to lend you money so that you can participate — or participate more fully — in the conversion, be extremely wary. Be even more wary if the source of the money is someone you do not know. The loan agreement may make you unable to certify truthfully that you are the true holder of the subscription rights and the true purchaser of the stock and that you have no agreements regarding the sale or transfer of the stock.
Watch Out for Opportunists — The opportunist may tell you that he or she is a lawyer — or a consultant or a professional investor or some similarly impressive tale — who has experience with similar mutual bank conversion transactions. The opportunist may even approach you through one of your friends or family members. But if the people proposing a deal stand to profit from it, take their words and promises with a grain (or perhaps a pound) of salt. Fraudsters rarely act in the “best interests” of anyone but themselves.
Be Wary of Guarantees — Some fraudsters will go to extreme lengths to assure you that the arrangement you’re entering into is perfectly legitimate. They might tell you that they’ve done scores of these transactions and that this is simply how they work. Or they might downplay the warnings or restrictions in the prospectus or order form, telling you that “everyone” enters into such agreements or that the deal they’re offering is legitimate. They may also tell you that you have no risk in the transaction. The cold, hard truth is that fraudsters lie.
Get the Facts from the Source — If you have any questions about a mutual conversion transaction, ask the bank or savings association for more information. If you have any doubts about a transaction proposed to you by someone else, ask the bank or savings association whether the proposed arrangement is proper. You may be able to find helpful resources on the institution’s website or by visiting a branch office.
The bottom line for investors is always to remember that if an opportunity sounds too good to be true, it probably is too good to be true.
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Complaints or Problems?
If you have any doubts or concerns relating to a mutual bank conversion transaction, be sure to contact your state banking regulator or the federal banking regulator that oversees the bank or savings association.
If you are eligible to purchase stock in a mutual bank or savings association conversion, and someone proposes some sort of “mutually beneficial arrangement” involving your subscription rights or the stock itself, please file a detailed complaint with the SEC using our online Complaint Center. Be sure to include the name of the bank or savings association and provide any contact information for each individual involved. You should also send your information to the appropriate state and federal banking authorities.
For more information about investing wisely, please visit the Investor Information section of the SEC’s website.
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SEC Enforcement Actions
Here are some pending or past SEC enforcement actions brought against individuals in connection with mutual bank conversions (with links to litigation releases posted on the SEC’s website):
- SEC v. Bert Fingerhut et al.:
- SEC v. Jay Slesinger et al and SEC v. Jay Rice:
- SEC v Robert R. Ross, et al.:
- SEC v. Jakubowski: http://www.sec.gov/litigation/litreleases/lr15580.txt
- SEC v. Parnes, et al.: http://www.sec.gov/litigation/litreleases/lr16877.htm ; http://www.sec.gov/litigation/litreleases/lr17865.htm
- In the Matter of Henry Salzhauer, et al.: http://www.sec.gov/litigation/litreleases/lr17215.htm; http://www.sec.gov/litigation/admin/34-45005.htm
- SEC v. James D. Sterling: http://www.sec.gov/litigation/litreleases/2010/lr21714.htm