The Federal Reserve is investigating allegations that Royal Bank of Canada teamed up improperly with City National Corp. to make a loan to a client while the proposed combination of the two banks is still pending.
The probe could delay the planned $5.4-billion takeover of the big Los Angeles bank by RBC, one of Canada's largest financial firms.
A letter from the Fed, obtained by the National Post of Toronto, asks the banks to respond to questions raised in written comments by Matthew R. Lee, an East Coast public interest lawyer.
The central bank must rule on the banks' application to merge, deciding whether the merger is safe and lawful and benefits all segments of the community.
Under U.S. law, a bank making an acquisition is limited in its ability to participate in the target bank's operations until regulators approve the deal, said V. Gerard Comizio, who heads the global banking practice at law firm Paul Hastings in Washington.
Until approval is granted, the acquirer is barred from exercising control over the target, Comizio said.
Spokesmen for the banks declined to comment.
It wasn't clear exactly how the challenge might affect the takeover of City National, an L.A. fixture known for its deep ties to the entertainment business and its large wealth-management business.
Lee, head of Fair Finance Watch, a New York advocacy group for minorities, questioned a deal between the banks in a June 11 comment letter to the Fed. In it, he cited a report in the Toronto Globe and Mail.
The story described how City National Chairman Russell Goldsmith received a call in May, four months after the proposed merger was announced, from a client who wanted hundreds of millions of dollars to do an acquisition.
That was far more than City National normally would lend on its own, Goldsmith was quoted as saying.
The report said City National worked closely with Blair Fleming, head of Royal Bank's U.S. capital markets unit, and the two banks signed off on the loan within 72 hours.
"This is entirely inappropriate and the [Fed] must act, now," Lee wrote. "The application must be denied."
The merger had appeared to have clearer sailing as of three weeks ago when the National Diversity Coalition, a California advocacy group for minorities, dropped its objections.
Two other advocacy groups, the Greenlining Coalition and the California Reinvestment Coalition, had earlier negotiated a pledge from City National to devote $11 billion in loans and other support over five years to help low-income neighborhoods and small businesses.
The report Tuesday in the National Post said the Fed had asked Royal Bank to address Lee's claim that the Canadian bank "collaborated" improperly to extend credit to Goldsmith's client before regulators had approved the acquisition.
The newspaper said it had obtained a letter sent to Royal Bank's New York law firm from Carol Evans, assistant director in the consumer and community affairs branch of the Fed's board of governors.
"In your response, discuss in detail whether RBC exercises a controlling influence over the management or policies of [City National] without prior approval of the board," the letter said.