Ordower v. Office of Thrift Supervision

• Citation: 999 F.2d 1183
• Decision Date: 27 July 1993
• Docket Number: Nos. 91-3816,91-3832,s. 91-3816
• Parties: Lawrence ORDOWER and Bruce J. Goodhart, Petitioners, v. OFFICE OF THRIFT SUPERVISION, et al., Respondents. Lawrence ORDOWER and Bruce J. Goodhart, Plaintiffs-Appellants, v. BELL FEDERAL SAVINGS AND LOAN ASSOCIATION, et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 1183

999 F.2d 1183

Lawrence ORDOWER and Bruce J. Goodhart, Petitioners, v. OFFICE OF THRIFT SUPERVISION, et al., Respondents.

Lawrence ORDOWER and Bruce J. Goodhart, Plaintiffs-Appellants, v. BELL FEDERAL SAVINGS AND LOAN ASSOCIATION, et al.,

Defendants-Appellees.

Nos. 91-3816, 91-3832.

United States Court of Appeals, Seventh Circuit.

Argued Sept. 18, 1992.

Decided July 27, 1993.

Robert A. Holstein, Aron D. Robinson, Jewel N. Klein (argued), Gregory A. Braun, Corey S. Berman, Holstein, Mack & Klein, Chicago, IL, for Lawrence Ordower and Bruce J. Goodhart.

Harris Weinstein, Aaron B. Kahn, Thomas J. Segal, Teresa A. Scott, Office of Thrift Supervision, Washington, DC, for Dept. of Treasury, amicus curiae.

Stuart Brafman, Office of Thrift Supervision, Chicago, IL, for Timothy Ryan.

Aaron B. Kahn, Laurie Romanowich (argued), Office of Thrift Supervision, Washington, DC, for Department of Treasury, Office of Thrift Supervision.

John C. Sciaccotta, Jill A. Dougherty (argued), James M. Rogan, Kelly, Olson, Rogan & Siepker, Chicago, IL, William Donnelly (argued), Joseph P. Daly, Muldoon, Murphy & Faucette, Washington, DC, for Bell Federal Sav. and Loan Ass'n, Bell Bancorp, Inc., Edmond M. Shanahan, Roland J. Barstow, Robert E. Ulbricht, John L. Vitale, C.P.A., Kenneth T. Wessner, Kenneth C. Wagner, C.P.A., Gunther H. Knoedler, Vernon Fryburger and Richard W. Hunzel.

Before CUMMINGS, COFFEY, and EASTERBROOK, Circuit Judges.

EASTERBROOK, Circuit Judge.

In 1991 Bell Federal Savings and Loan Association converted from mutual to stock form. The change required the approval of federal regulators and account holders. Two disgruntled depositors (jointly Ordower) ask us to set aside the order of the Office of Thrift Supervision approving the transaction. See 12 U.S.C. §§ 1464(i)(2)(B), 1467a(j), giving courts of appeals original and exclusive jurisdiction over such challenges. Ordower also filed suit in the district court, seeking damages and an injunction against the conversion. The district court dismissed that action for lack of jurisdiction in light of §§ 1464(i)(2)(B) and 1467a(j). We heard the appeal and petition for review in tandem.

I

The OTS has promulgated detailed regulations distinguishing acceptable from unacceptable conversions. 12 C.F.R. Part 563b. See also Charter Federal Savings & Loan Association v. OTS, 912 F.2d 1569, 1570-76 (11th Cir.1990) (discussing the history of these regulations). Bell applied for approval on September 12, 1991. The OTS twice asked for more information and induced Bell to change aspects of its proposals in order to conform to the rules. After the amendments, the OTS gave its approval on November 12, 1991, subject to certain conditions with which Bell has complied--and subject to the approval of Bell's depositors, a matter to which we return. The approval process is an informal adjudication under the Administrative Procedure Act; the judicial part is to ensure that the agency does not act arbitrarily or capriciously. 5 U.S.C. § 706(2)(A). Citizens to Preserve Overton Park, Inc. v. Volpe, 401 U.S. 402, 416, 91 S.Ct. 814, 823, 28 L.Ed.2d 136 (1971); Charter Federal S & L, 912 F.2d at 1579-80.

The mutual form of organization is an odd duck. Nominally the customers own the mutual, but it is ownership in name only. They cannot sell what they "own", and if they withdraw savings they receive only the nominal value of the account rather than a portion of the mutual's net worth, which is valuable to them only to the extent it permits the bank to pay higher interest. Lack of a firmly defined claim to the residual value leads many thoughtful people to conclude that mutuals are inefficient methods of organization and that it is appropriate to call the managers the real owners. See Eric Rasmusen, Mutual Banks and Stock Banks, 31 J.L. & Econ. 395 (1988); Eugene F. Fama & Michael C. Jensen, Agency Problems and Residual Claims, 26 J.L. & Econ. 327, 337-41 (1983). Increasing competition among financial institutions has led to pressure to replace the mutual form with a stock form that assigns ownership interests more explicitly and makes them transferable. See Lawrence J. White, The S & L Debacle 107 (1991) (showing a steady increase in the number of conversions).

When conversion occurs, what happens to the depositors' "ownership" interest? One way to deal with the interest would be to offer depositors preemptive rights to buy the shares at a low price. The discount would transfer the net worth to the existing customers while still providing an increase in working capital (one of the principal motives for conversion, and the reason why the S & Ls do not just give shares to their depositors). There are, however, two related problems with preemptive rights: first, many account holders will be financially unable or unwilling to make an additional investment in stock, and so will lose the bargain element of the offer; second, the people who will end up with the bargain element, whether other depositors in amounts disproportionate to their accounts, or the public in a general subscription, may have no entitlement to that bonanza. The OTS therefore requires the converting S & L to give the stock a price that equals the pro forma market value. 12 C.F.R. § 563b.3(c)(1). The OTS does not insist on identifying the precise market value, however, permitting the S & L to offer some bargain element to its account holders and other claimants. The stock of newly converted S & Ls regularly increases in price immediately after issue; the increase shows the amount of the bargain element, which account holders can capture if they buy the stock. The OTS requires the converting S & L to offer stock to its account holders ahead of the general public. 12 C.F.R. § 563b.3(c)(2). Existing account holders receive a second entitlement called a "liquidation account." 12 C.F.R. § 563b.3(f). Before conversion, the account holders can obtain a share of the institution's net worth only if the mutual liquidates. The "liquidation account" preserves this entitlement after the conversion. The S & L must keep the net worth at the time of conversion unencumbered and available for distribution to the pre-conversion account holders in the event of liquidation. As the accounts existing on the record date (at least 90 days before the mutual's board approves the conversion, 12 C.F.R. § 563b.3(c)(14)) are drawn down or closed, the liquidation account is correspondingly diminished. As the S & L holds greater amounts of new money (sums deposited after the conversion), the importance of the liquidation account diminishes and the stockholders own more of the net worth.

Ordower contends that Bell undervalued its net worth, and thus its stock, permitting strangers (and managers) to capture an excessive portion of the mutual's value. The OTS disagreed, and that conclusion is neither arbitrary nor capricious. Bell obtained an appraisal from HAS Associates, Inc.; the OTS induced Bell to set its stock price on the assumption that its true net worth was almost $50 million more than the middle of the range HAS originally determined--$187 million rather than $138.4 million. The only asset that Ordower says this procedure missed or undervalued is Bell's leasehold in its headquarters building. The lease, for a 14-story building in the business district of Chicago, runs through 2103 at an annual rental of $74,000. Sub-market rental gives the leasehold a substantial value, which HAS put at $2.269 million. Ordower insists that the leasehold's value is closer to $25 million, but as the OTS points out the valuation of the leasehold is irrelevant. A low rental means that Bell shows higher operating profits, and these profits were taken into account in determining its net worth. A lease with a bargain-basement rental may be valued as a capital asset, or it may be valued indirectly by capitalizing the profit stream to which it gives rise, but it may not be counted twice.

According to Ordower, the evil of the inaccurate net worth is not so much that it produced a low price for the stock (depositors should be happy about the opportunity to buy at a bargain) but that the managers and employees scooped up much of this stock ahead of the depositors. How this injured depositors is unclear; as it turned out, the depositors did not purchase all of the stock allocated to them, so some was sold to the public at large. No matter. OTS permits a large S & L to allocate up to 25% of the stock for officers and directors, and another 10% for an employee stock ownership plan (ESOP). 12 C.F.R. § 563b.3(c)(7), (8). Bell established an ESOP that bought 8% of the stock and reserved another 13.5% for future issuance to officers, directors, and other employees: 4% for an Association Recognition and Retention Plan and 9.5% for stock options. Ordower depicts both the ESOP stock and the reserved shares as "gifts" to employees. The characterization is absurd, and the OTS did not exceed its powers in approving this aspect of the transaction. The ESOP paid cash for its shares, borrowing the money from a bank unrelated to Bell. The shares serve as security for the loan. No gift here, except to the extent of the original-issue discount in the stock. The shares reserved for the Association Recognition and Retention Plan are to be issued over a five-year period to employees, with distributions based on performance. A performance bonus paid in stock is no more a "gift" than is a bonus paid in cash--or for that matter a salary. The stock options, which may not be exercised for five years (and then only if the person holding the option remains in Bell's employ), are likewise a form of compensation for services rendered, a substitute for cash with the benefit of linking the employees' welfare to the success of their firm. Aligning the interests of managers and investors is a much-sought goal of corporate organization. Long ago courts concluded that options to purchase stock at a...