Director, AFMD
| Decision Date | 07 July 1988 |
| Docket Number | B-159292 |
| Parties | Director, AFMD |
| Court | Comptroller General of the United States |
MISCELLANEOUS TOPICS - Finance Industry - Financial institutions - Stocks - Refunds DIGEST: 1. Under section 406(d) of Rural Electrification Act of 1936, as amended (REA Act), 7 U.S.C Sec. 946(d), patronage refunds on Class B stock of Rural Telephone Bank (Bank) may only be made in B stock of Bank. Only way in which B stockholders can obtain cash from their stock is through stock redemption. While matter is not free from doubt, such redemptions may be viewed as constructive dividends. Cash dividends on Class B stock are prohibited by section 406(d) of Act. MISCELLANEOUS TOPICS - Finance Industry - Financial institutions - Stocks - Retirement 2. Current Bylaws of Bank established vested right of prior redemption for Bank's Class A stock which would be impaired by proposal to amend Bylaws to permit retirement of Class B stock before retirement of Class A stock. 3. Neither Secretary of Agriculture nor Administrator of Rural Electrification Administration has authority under section 403(a) of REA Act, 7 U.S.C. Sec. 943(a), to consent to Bank's amendment of its Bylaws to change government's right of prior redemption for its Class A stock. Any such consent should be specifically authorized by the Congress. Authority of Rural Telephone Bank to Amend Bank's Bylaws to Redeem B Stock In Cash (File B-159292; Code 916947)
This memorandum addresses legal questions which have arisen in connection with your July 23, 1987, testimony on the interest rate policies of the Rural Telephone Bank (Bank) before the Subcommittee on Government Information, Justice and Agriculture, House Committee on Government Operations.
We have been asked whether the Act permits the Bank to pay patronage refunds on its Class B stock in cash. Also, we have been asked whether redemption by the Bank of its Class B stock in cash would impair vested rights of the Government as Class A stockholder.
These issues are addressed in the context of an April 1987 proposal by the Bank's staff to its board of directors (Board) to establish a patronage refund system for retirement of Class B stock. Under the proposal, the Bank's Bylaws would be amended to allow the Board to retire patronage capital accumulated for a particular year, and to include in that retirement both the Class B stock issued at the end of that year as a deferred patronage refund and the amount which was placed in the Bank's Reserve for Contingencies for the year in which that Class B stock was issued. Thus, each year's addition to the Reserve for Contingencies would at a future date, first be converted to Class B stock and then redeemed along with the Class B stock issued as a deferred patronage refund for the same year. On August 4 1987, the Board considered and failed to pass this proposal.
Since we began addressing the issues presented, Congress passed the Omnibus Budget Reconciliation Act of 1987, Pub. L. No 100-203, enacted December 22, 1987. Section 1413 of the Reconciliation Act replaces the Bank's Reserve for Contingencies with a new reserve for interest rate fluctuation and directs GAO to study and make recommendations with respect to the Bank's operations, including the appropriate level of funding of the new reserve and the disposition of the excess reserves.
Section 1413 of the Reconciliation Act would have preempted much of the Bank's proposal to convert unexpended amounts in the Reserve for Contingencies to Class B stock by limiting the availability of those funds for use as proposed by the Board. Subsection 1413(a) of the Reconciliation Act, adding subsection (h) to section 406 of the Rural Electrification Act, provides that the interest rate fluctuation reserve may be used to cover operating losses of the Bank, only.
Subsection 1413(b) of the Reconciliation Act directs GAO to study the Bank's operations and report on its recommendations in 6 months to the House Committee on Agriculture and Government Operations and the Senate Committee on Agriculture, Nutrition, and Forestry. The GAO study must make recommendations with respect to (1) the appropriate level of funding for the reserve for losses due to interest rate fluctuations, (2) the circumstances under which amounts in this new reserve should be expended, (3) the circumstances under which amounts should be added to this new reserve, and (4) the disposition of excess reserves. Under this statutory directive, your staff is considering proposing a recommendation for retirement of the Bank's Class B patronage stock which is similar in essential respects to the Board's proposal. Therefore, the legal issues presented and our analysis of those issues are applicable to both the Board's proposal and your staff's proposed recommendations.
It is our conclusion that the Secretary of Agriculture needs specific and new legislative authority to implement any proposal to redeem with cash Class B stock paid as patronage refunds and to retire Class B patronage stock before all Class A stock is retired. While the Board has voted down the Bank's proposal to retire patronage refunds, further consideration of this matter awaits the recommendations of the GAO study. In this regard, the significance of our analysis is the adequacy of the authority of the Secretary of Agriculture and the Board to effectuate changes administratively to the Bank's operations regarding retirement of its patronage capital.
In conducting our analysis, we examined the positions presented by the Department of Agriculture's General Counsel as to the legal validity of the Board's proposal to retire the Bank's Class B stock.
A detailed discussion is attached.
Answer: We do not believe the Board may redeem its Class B stock in cash before retiring Class A stock without impairing vested rights of Class A stock. The current Bylaws appear to establish a contractural, vested right of prior redemption for the government's Class A stock. Such rights would be unlawfully impaired by the Board's proposal to amend the Bank's Bylaws to permit retirement of Class B stock before retirement of Class A stock.
A detailed analysis is attached.
Attachment
cc: Mr. Kepplinger, OGC
Mr. Bedrick, OGC
Mr. Duquette, AFMD
Mr. Jackson, OGC
Mr. Stoltz, AFMD
ATTACHMENT
ANALYSIS
In 1971, Congress created the Rural Telephone Bank ("Bank") as a corporate body and agency and instrumentality of the United States to meet the growing capital needs of rural telephone systems. Pub. L. No. 92-15, 85 Stat. 29 (1971) (). The Bank's purposes are to obtain funds through the sale of stock and debentures to supplement the Rural Electrification Administration's (REA) telephone loan program, and to make loans to providers of telephone service in rural areas which either have received REA loans or loan commitments or have been certified eligible for such loans by the Administrator of REA.
The Act provides for three (3) distinct classes of stock: A, B, and C.[1] Class A stock may only be held by the Administrator of REA on behalf of the United States, 7 U.S.C. Sec. 946(c). As originally chartered, Congress provided that the United States would purchase $300, 000, 000 of Class A stock and accordingly authorized an annual appropriation of $30, 000, 000 for such purposes. In 1981, the amount of Class A stock the United States was authorized to purchase was changed to $600, 000, 000. See 7 U.S.C. Sec. 946(a). The bank must begin redeeming its Class A stock in 1995.
Class B stock may be issued only to borrowers of the Bank. This stock is obtained under two (2) circumstances. First, borrowers are required to purchase Class B stock in amounts equal to 5 percent of any loan obtained from the Bank. 7 U.S.C. Sec. 946(d). Second, after certain expenditures are made each year, patronage refunds may be allocated from patronage capital assignable in the form of Class B stock under terms and conditions specified in the Bank's Bylaws. Under the Bylaws, patronage refunds in Class B stock are paid in the proportion that the amount of interest earned on the loans of each borrower bears to the total interest earned on the loans of all borrowers during the fiscal year.[2]
Section 2.2(b) of the Bylaws currently provides that Class B stock can be redeemed and retired only after all shares of Class A stock have been redeemed and retired. In addition, section 8.2 of the Bylaws provides that the Board may establish procedures for the full or partial retirement of Class B stock at any time after all Class A stock has been retired.
In April 1987, Bank staff presented to the Board a proposal to establish a patronage capital retirement plan. Under the proposed plan, the Bylaws would be amended to allow Class B stock issued as patronage refunds to be retired before some or all of the Class A stock is retired. The proposal would require the Board, whenever it decided to retire Class B stock issued as patronage refunds, to reduce the Reserve for Contingencies by any...
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