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7500 - FRB Regulations
{{2-27-98 p.7759}}
PART 221CREDIT BY BANKS AND PERSONS OTHER THAN BROKERS OR
DEALERS FOR THE PURPOSE OF PURCHASING OR CARRYING MARGIN STOCK
(REGULATION U)
Sec. 221.1
Authority, purpose, and scope.
221.2
Definitions.
221.3
General requirements.
221.4
Employee stock option, purchase, and ownership plans.
221.5
Special purpose loans to brokers and dealers.
221.6
Exempted transactions.
221.7
Supplement: Maximum loan value of margin stock and other collateral.
Interpretations
221.101
Determination and effect of purpose of loan.
221.102
Application to committed credit where funds are disbursed thereafter.
221.103
Loans to brokers or dealers.
221.104
Federal credit unions.
221.105
Arranging for extensions of credit to be made by a bank.
221.106
Reliance in ``good faith'' on statement of purpose of loan.
221.107
Arranging loan to purchase open-end investment company shares.
221.108
Effect of registration of stock subsequent to making of loan.
221.109
Loan to open-end investment company.
221.110
Questions arising under this part.
221.111
Contribution to joint venture as extension of credit when the
contribution is disproportionate to the contributor's share in the
venture's profits or losses.
221.112
Loans by bank in capacity as trustee.
221.113
Loan which is secured indirectly by stock.
221.114
Bank loans to purchase stock of American Telephone and Telegraph
Company under Employees' Stock Plan.
221.115
Accepting a purpose statement through the mail without benefit of
face-to-face interview.
221.116
Bank loans to replenish working capital used to purchase mutual fund
shares.
221.117
When bank in ``good faith'' has not relied on stock as collateral.
221.118
Bank arranging for extension of credit by corporation.
221.119
Applicability of plan-lender provisions to financing of stock options
and stock purchase rights qualified or restricted under Internal
Revenue Code.
221.120
Allocation of stock collateral to purpose and nonpurpose credits to
same customer.
221.121
Extension of credit in certain stock option and stock purchase plans.
221.122
Applicability of margin requirements to credit in connection with
Insurance Premium Funding Programs.
221.123
Combined credit for exercising employee stock options and paying income
taxes incurred as a result of such exercise.
221.124
Purchase of debt securities to finance corporate takeovers.
221.125
Credit to brokers and dealers.
Authority: 15 U.S.C.
78c, 78g,
78q, and
78w.
Source: The provisions of this Part 221 appear at 63 Fed. Reg. 2827,
January 16, 1998, effective April 1, 1998, except as otherwise
noted.
§ 221.1 Authority, purpose, and scope.
(a) Authority. Regulation U (this part) is issued by the
Board of Governors of the Federal Reserve System (the Board) pursuant
to the Securities Exchange Act of 1934 (the Act) (15 U.S.C. 78a
et seq.).
(b) Purpose and scope. (1) This part imposes credit
restrictions upon persons other than brokers or dealers (hereinafter
lenders) that extend credit for the purpose of buying or
{{2-27-98 p.7760}}carrying margin stock if
the credit is secured directly or indirectly by margin stock. Lenders
include ``banks'' (as defined in § 221.2) and other persons who are
required to register with the Board under § 221.3(b). Lenders may not
extend more than the maximum loan value of the collateral securing such
credit, as set by the Board in § 221.7 (the Supplement).
(2) This part does not apply to clearing agencies regulated by
the Securities and Exchange Commission or the Commodity Futures Trading
Commission that accept deposits of margin stock in connection with:
(i) The issuance of, or guarantee of, or the clearance of
transactions in, any security (including options on any security,
certificate of deposit, securities index or foreign currency); or
(ii) The guarantee of contracts for the purchase or sale of a
commodity for future delivery or options on such contracts.
(3) This part does not apply to credit extended to an exempted
borrower.
(c) Availability of forms. The forms referenced in this
part are available from the Federal Reserve Banks.
[Codified to 12 C.F.R. § 221.1]
§ 221.2 Definitions.
The terms used in this part have the meanings given them in section
3(a) of the Act or as defined in this section as follows:
Affiliate means:
(1) For banks:
(i) Any bank holding company of which a bank is a subsidiary
within the meaning of the Bank Holding Company Act of 1956, as amended
(12 U.S.C. 1841(d));
(ii) Any other subsidiary of such bank holding company; and
(iii) Any other corporation, business trust, association, or
other similar organization that is an affiliate as defined in section
2(b) of the Banking Act of 1933 (12 U.S.C. 221a(c));
(2) For nonbank lenders, affiliate means any person
who, directly or indirectly, through one or more intermediaries,
controls, or is controlled by, or is under common control with the
lender.
Bank. (1) Bank. Has the meaning given to it
in section 3(a)(6) of the Act (15 U.S.C.
78c(a)(6)) and includes:
(i) Any subsidiary of a bank;
(ii) Any corporation organized under section 25(a) of the Federal
Reserve Act (12 U.S.C. 611); and
(iii) Any agency or branch of a foreign bank located within the
United States.
(2) Bank does not include:
(i) Any savings and loan association;
(ii) Any credit union;
(iii) Any lending institution that is an instrumentality or
agency of the United States; or
(iv) Any member of a national securities exchange.
Carrying credit is credit that enables a customer to
maintain, reduce, or retire indebtedness originally incurred to
purchase a security that is currently a margin stock.
Current market value of:
(1) A security means:
(i) If quotations are available, the closing sale price of the
security on the preceding business day, as appearing on any regularly
published reporting or quotation service; or
(ii) If there is no closing sale price, the lender may use any
reasonable estimate of the market value of the security as of the close
of business on the preceding business day; or
{{2-27-98 p.7761}}
(iii) If the credit is used to finance the purchase of the
security, the total cost of purchase, which may include any commissions
charged.
(2) Any other collateral means a value determined by any
reasonable method.
Customer excludes an exempted borrower and includes any
person or persons acting jointly, to or for whom a lender extends or
maintains credit.
Examining authority means:
(1) The national securities exchange or national securities
association of which a broker or dealer is a member; or
(2) If a member of more than one self-regulatory organization,
the organization designated by the Securities and Exchange Commission
as the examining authority for the broker or dealer.
Exempted borrower means a member of a national securities
exchange or a registered broker or dealer, a substantial portion of
whose business consists of transactions with persons other than brokers
or dealers, and includes a borrower who:
(1) Maintains at least 1000 active accounts on an annual basis
for persons other than brokers, dealers, and persons associated with a
broker or dealer;
(2) Earns at least $10 million in gross revenues on an annual
basis from transactions with persons other than brokers, dealers, and
persons associated with a broker or dealer; or
(3) Earns at least 10 percent of its gross revenues on an annual
basis from transactions with persons other than brokers, dealers, and
persons associated with a broker-dealer.
Good faith with respect to:
(1) The loan value of collateral means that amount (not exceeding
100 per cent of the current market value of the collateral) which a
lender, exercising sound credit judgment, would lend, without regard to
the customer's other assets held as collateral in connection with
unrelated transactions.
(2) Making a determination or accepting a statement concerning a
borrower means that the lender or its duly authorized representative is
alert to the circumstances surrounding the credit, and if in possession
of information that would cause a prudent person not to make the
determination or accept the notice or certification without inquiry,
investigates and is satisfied that it is correct;
In the ordinary course of business means occurring or
reasonably expected to occur in carrying out or furthering any business
purpose, or in the case of an individual, in the course of any activity
for profit or the management or preservation of property.
Indirectly secured. (1) Includes any arrangement with
the customer under which:
(i) The customer's right or ability to sell, pledge, or
otherwise dispose of margin stock owned by the customer is in any way
restricted while the credit remains outstanding; or
(ii) The exercise of such right is or may be cause for
accelerating the maturity of the credit.
(2) Does not include such an arrangement if:
(i) After applying the proceeds of the credit, not more than 25
percent of the value (as determined by any reasonable method) of the
assets subject to the arrangement is represented by margin
stock;
(ii) It is a lending arrangement that permits accelerating the
maturity of the credit as a result of a default or renegotiation of
another credit to the customer by another lender that is not an
affiliate of the lender;
(iii) The lender holds the margin stock only in the capacity of
custodian, depositary, or trustee, or under similar circumstances, and,
in good faith, has not relied upon the margin stock as collateral; or
(iv) The lender, in good faith, has not relied upon the margin
stock as collateral in extending or maintaining the particular credit.
Lender means:
(1) Any bank; or
(2) Any person subject to the registration requirements of this
part.
{{2-27-98 p.7762}}
Margin stock means:
(1) Any equity security registered or having unlisted trading
privileges on a national securities exchange;
(2) Any OTC security designated as qualified for trading in the
National Market System under a designation plan approved by the
Securities and Exchange Commission (NMS security);
(3) Any debt security convertible into a margin stock or carrying
a warrant or right to subscribe to or purchase a margin stock;
(4) Any warrant or right to subscribe to or purchase a margin
stock; or
(5) Any security issued by an investment company registered under
section 8 of the Investment Company Act of 1940
(15 U.S.C. 80a--8), other than:
(i) A company licensed under the Small Business Investment
Company Act of 1958, as amended (15 U.S.C. 661); or
(ii) A company which has at least 95 percent of its assets
continuously invested in exempted securities (as defined in
15 U.S.C. 78c(a)(12)); or
(iii) A company which issues face-amount certificates as defined
in 15 U.S.C. 80a--2(a)(15),
but only with respect of such securities; or
(iv) A company which is considered a money market fund under SEC
Rule 2a--7 (17 CFR 270.2a--7).
Maximum loan value is the percentage of current market
value assigned by the Board under § 221.7 (the Supplement) to
specified types of collateral. The maximum loan value of margin stock
is stated as a percentage of its current market value. Puts, calls and
combinations thereof that do not qualify as margin stock have no loan
value. All other collateral has good faith loan value.
Nonbank lender means any person subject to the
registration requirements of this part.
Purpose credit is any credit for the purpose, whether
immediate, incidental, or ultimate, of buying or carrying margin stock.
[Codified to 12 C.F.R. § 221.2]
§ 221.3 General requirements.
(a) Extending, maintaining, and arranging
credit--(1) Extending credit. No lender, except a
plan-lender, as defined in § 221.4(a), shall extend any purpose
credit, secured directly or indirectly by margin stock, in an amount
that exceeds the maximum loan value of the collateral securing the
credit.
(2) Maintaining credit. A lender may continue to
maintain any credit initially extended in compliance with this part,
regardless of:
(i) Reduction in the customer's equity resulting from change in
market prices;
(ii) Change in the maximum loan value prescribed by this part; or
(iii) Change in the status of the security (from nonmargin to
margin) securing an existing purpose credit.
(3) Arranging credit. No lender may arrange for the
extension or maintenance of any purpose credit, except upon the same
terms and conditions under which the lender itself may extend or
maintain purpose credit under this part.
(b) Registration of nonbank lenders; termination of
registration; annual report--(1) Registration. Every
person other than a person subject to part 220 of this chapter or a
bank who, in the ordinary course of business, extends or maintains
credit secured, directly or indirectly, by any margin stock shall
register on Federal Reserve Form FR G--1 (OMB control number
7100--0011) within 30 days after the end of any calendar quarter during
which:
(i) The amount of credit extended equals $200,000 or more; or
(ii) The amount of credit outstanding at any time during that
calendar quarter equals $500,000 or more.
(2) Deregistration. A registered nonbank lender may
apply to terminate its registration, by filing Federal Reserve Form FR
G--2 (OMB control number 7100--0011), if the
{{2-27-98 p.7763}}lender has not, during the
preceding six calendar months, had more than $200,000 of such credit
outstanding. Registration shall be deemed terminated when the
application is approved by the Board.
(3) Annual report. Every registered nonbank lender
shall, within 30 days following June 30 of every year, file Form FR
G--4 (OMB control number 7100--0011).
(4) Where to register and file applications and reports.
Registration statements, applications to terminate registration,
and annual reports shall be filed with the Federal Reserve Bank of the
district in which the principal office of the lender is located.
(c) Purpose statement--(1) General
rule--(i) Banks. Except for credit extended under
paragraph (c)(2) of this section, whenever a bank extends credit
secured directly or indirectly by any margin stock, in an amount
exceeding $100,000, the bank shall require its customer to execute Form
FR U--1 (OMB No. 7100--0115), which shall be signed and accepted by a
duly authorized officer of the bank acting in good faith.
(ii) Nonbank lenders. Except for credit extended under
paragraph (c)(2) of this section or § 221.4, whenever a nonbank
lender extends credit secured directly or indirectly by any margin
stock, the nonbank lender shall require its customer to execute Form FR
G--3 (OMB control number 7100--0018), which shall be signed and
accepted by a duly authorized representative of the nonbank lender
acting in good faith.
(2) Purpose statement for revolving-credit or multiple-draw
agreements or financing of securities purchases on a
payment-against-delivery basis--(i) Banks. If a bank
extends credit, secured directly or indirectly by any margin stock, in
an amount exceeding $100,000, under a revolving-credit or other
multiple-draw agreement, Form FR U--1 must be executed at the time the
credit arrangement is originally established and must be amended as
described in paragraph (c)(2)(iv) of this section for each disbursement
if all of the collateral for the agreement is not pledged at the time
the agreement is originally established.
(ii) Nonbank lenders. If a nonbank lender extends
credit, secured directly or indirectly by any margin stock, under a
revolving-credit or other multiple-draw agreement, Form FR G--3 must be
executed at the time the credit arrangement is originally established
and must be amended as described in paragraph (c)(2)(iv) of this
section for each disbursement if all of the collateral for the
agreement is not pledged at the time the agreement is originally
established.
(iii) Collateral. If a purpose statement executed at
the time the credit arrangement is initially made indicates that the
purpose is to purchase or carry margin stock, the credit will be deemed
in compliance with this part if:
(A) The maximum loan value of the collateral at least equals the
aggregate amount of funds actually disbursed; or
(B) At the end of any day on which credit is extended under the
agreement, the lender calls for additional collateral sufficient to
bring the credit into compliance with § 221.7 (the Supplement).
(iv) Amendment of purpose statement. For any purpose
credit disbursed under the agreement, the lender shall obtain and
attach to the executed Form FR U--1 or FR G--3 a current list of
collateral which adequately supports all credit extended under the
agreement.
(d) Single credit rule. (1) All purpose credit extended
to a customer shall be treated as a single credit, and all the
collateral securing such credit shall be considered in determining
whether or not the credit complies with this part, except that
syndicated loans need not be aggregated with other unrelated purpose
credit extended by the same lender.
(2) A lender that has extended purpose credit secured by margin
stock may not subsequently extend unsecured purpose credit to the same
customer unless the combined credit does not exceed the maximum loan
value of the collateral securing the prior credit.
(3) If a lender extended unsecured purpose credit to a customer
prior to the extension of purpose credit secured by margin stock, the
credits shall be combined and treated as a single credit solely for the
purposes of the withdrawal and substitution provision of paragraph (f)
of this section.
{{2-27-98 p.7764}}
(4) If a lender extends purpose credit secured by any margin
stock and nonpurpose credit to the same customer, the lender shall
treat the credits as two separate loans and may not rely upon the
required collateral securing the purpose credit for the nonpurpose
credit.
(e) Exempted borrowers. (1) An exempted borrower that
has been in existence for less than one year may meet the definition of
exempted borrower based on a six-month period.
(2) Once a member of a national securities exchange or registered
broker or dealer ceases to qualify as an exempted borrower, it shall
notify its lenders of this fact. Any new extensions of credit to such a
borrower, including rollovers, renewals, and additional draws on
existing lines of credit, are subject to the provisions of this part.
(f) Withdrawals and substitutions. (1) A lender may
permit any withdrawal or substitution of cash or collateral by the
customer if the withdrawal or substitution would not:
(i) Cause the credit to exceed the maximum loan value of the
collateral; or
(ii) Increase the amount by which the credit exceeds the maximum
loan value of the collateral.
(2) For purposes of this section, the maximum loan value of the
collateral on the day of the withdrawal or substitution shall be used.
(g) Exchange offers. To enable a customer to participate
in a reorganization, recapitalization or exchange offer that is made to
holders of an issue of margin stock, a lender may permit substitution
of the securities received. A nonmargin, nonexempted security acquired
in exchange for a margin stock shall be treated as if it is margin
stock for a period of 60 days following the exchange.
(h) Renewals and extensions of maturity. A renewal or
extension of maturity of a credit need not be considered a new
extension of credit if the amount of the credit is increased only by
the addition of interest, service charges, or taxes with respect to the
credit.
(i) Transfers of credit. (1) A transfer of a credit
between customers or between lenders shall not be considered a new
extension of credit if:
(i) The original credit was extended by a lender in compliance
with this part or by a lender subject to part 207 of this chapter in
effect prior to April 1, 1998, (See part 207 appearing in the 12 CFR
parts 200 to 219 edition revised as of January 1, 1997), in a manner
that would have complied with this part;
(ii) The transfer is not made to evade this part;
(iii) The amount of credit is not increased; and
(iv) The collateral for the credit is not changed.
(2) Any transfer between customers at the same lender shall be
accompanied by a statement by the transferor customer describing the
circumstances giving rise to the transfer and shall be accepted and
signed by a representative of the lender acting in good faith. The
lender shall keep such statement with its records of the transferee
account.
(3) When a transfer is made between lenders, the transferee shall
obtain a copy of the Form FR U--1 or Form FR G--3 originally filed with
the transferor and retain the copy with its records of the transferee
account. If no form was originally filed with the transferor, the
transferee may accept in good faith a statement from the transferor
describing the purpose of the loan and the collateral securing it.
(j) Action for lender's protection. Nothing in this
part shall require a bank to waive or forego any lien or prevent a bank
from taking any action it deems necessary in good faith for its
protection.
(k) Mistakes in good faith. A mistake in good faith in
connection with the extension or maintenance of credit shall not be a
violation of this part.
[Codified to 12 C.F.R. § 221.3]
§ 221.4 Employee stock option, purchase, and ownership plans.
(a) Plan-lender; eligible plan. (1) Plan-lender means
any corporation, (including a wholly-owned subsidiary, or a lender that
is a thrift organization whose membership is limited to employees and
former employees of the corporation, its subsidiaries or
affiliates)
{{2-27-98 p.7765}}that extends or maintains
credit to finance the acquisition of margin stock of the corporation,
its subsidiaries or affiliates under an eligible plan.
(2) Eligible plan. An eligible plan means any employee
stock option, purchase, or ownership plan adopted by a corporation and
approved by its stockholders that provides for the purchase of margin
stock of the corporation, its subsidiaries, or affiliates.
(b) Credit to exercise rights under or finance an eligible
plan. (1) If a plan-lender extends or maintains credit under an
eligible plan, any margin stock that directly or indirectly secured
that credit shall have good faith loan value.
(2) Credit extended under this section shall be treated
separately from credit extended under any other section of this part
except § 221.3(b)(1) and (b)(3).
(c) Credit to ESOPs. A nonbank lender may extend and
maintain purpose credit without regard to the provisions of this part,
except for § 221.3(b)(1) and (b)(3), if such credit is extended to an
employee stock ownership plan (ESOP) qualified under section 401 of the
Internal Revenue Code, as amended (26 U.S.C. 401).
[Codified to 12 C.F.R. § 221.4]
§ 221.5 Special purpose loans to brokers and dealers.
(a) Special purpose loans. A lender may extend and
maintain purpose credit to brokers and dealers without regard to the
limitations set forth §§ 221.3 and 221.7, if the credit is for any
of the specific purposes and meets the conditions set forth in
paragraph (c) of this section.
(b) Written notice. Prior to extending credit for more
than a day under this section, the lender shall obtain and accept in
good faith a written notice or certification from the borrower as to
the purposes of the loan. The written notice or certification shall be
evidence of continued eligibility for the special credit provisions
under the borrower notifies the lender that it is no longer eligible or
the lender has information that would cause a reasonable person to
question whether the credit is being used for the purpose specified.
(c) Types of special purpose credit. The types of credit
that may be extended and maintained on a good faith basis are as
follows:
(1) Hypothecation loans. Credit secured by
hypothecated customer securities that, according to written notice
received from the broker or dealer, may be hypothecated by the broker
or dealer under Securities and Exchange Commission (SEC) rules.
(2) Temporary advances in payment-against-delivery
transactions. Credit to finance the purchase or sale of securities
for prompt delivery, if the credit is to be repaid upon completion of
the transaction.
(3) Loans for securities in transit or transfer.
Credit to finance securities in transit or surrendered for
transfer, if the credit is to be repaid upon completion of the
transaction.
(4) Intra-day loans. Credit to enable a broker or
dealer to pay for securities, if the credit is to be repaid on the same
day it is extended.
(5) Arbitrage loans. Credit to finance proprietary or
customer bona fide arbitrage transactions. For the purpose of this
section bona fide arbitrage means:
(i) Purchase or sale of a security in one market, together with
an offsetting sale or purchase of the same security in a different
market at nearly the same time as practicable, for the purpose of
taking advantage of a difference in prices in the two markets; or
(ii) Purchase of a security that is, without restriction other
than the payment of money, exchangeable or convertible within 90
calendar days of the purchase into a second security, together with an
offsetting sale of the second security at or about the same time, for
the purpose of taking advantage of a concurrent disparity in the price
of the two securities.
(6) Market maker and specialist loans. Credit to a
member of a national securities exchange or registered broker or dealer
to finance its activities as a market maker or specialist.
(7) Underwriter loans. Credit to a member of a
national securities exchange or registered broker or dealer to finance
its activities as an underwriter.
{{2-27-98 p.7766}}
(8) Emergency loans. Credit that is essential to meet
emergency needs of the broker-dealer business arising from exceptional
circumstances.
(9) Capital contribution loans. Capital contribution
loans include:
(i) Credit that Board has exempted by order upon a finding that
the exemption is necessary or appropriate in the public interest or for
the protection of investors, provided the Securities Investor
Protection Corporation certifies to the Board that the exemption is
appropriate; or
(ii) Credit to a customer for the purpose of making a
subordinated loan or capital contribution to a broker or dealer in
conformity with the SEC's net capital rules and the rules of the
broker's or dealer's examining authority, provided:
(A) The customer reduces the credit by the amount of any
reduction in the loan or contribution to the broker or dealer; and
(B) The credit is not used to purchase securities issued by the
broker or dealer in a public distribution.
(10) Credit to clearing brokers or dealers. Credit to a
member of a national securities exchange or registered broker or dealer
whose nonproprietary business is limited to financing and carrying the
accounts of registered market makers.
[Codified to 12 C.F.R. § 221.5]
§ 221.6 Exempted transactions.
A bank may extend and maintain purpose credit without regard to the
provisions of this part if such credit is extended:
(a) To any bank;
(b) To any foreign banking institution;
(c) Outside the United States;
(d) To an employee stock ownership plan (ESOP) qualified under
section 401 of the Internal Revenue Code (26 U.S.C. 401);
(e) To any plan lender as defined in § 221.4(a) to finance an
eligible plan as defined in § 221.4(b), provided the bank has no
recourse to any securities purchased pursuant to the plan;
(f) To any customer, other than a broker or dealer, to temporarily
finance the purchase or sale of securities for prompt delivery, if the
credit is to be repaid in the ordinary course of business upon
completion of the transaction and is not extended to enable the
customer to pay for securities purchased in an account subject to
part 220 of this chapter;
(g) Against securities in transit, if the credit is not extended to
enable the customer to pay for securities purchased in an account
subject to part 220 of this chapter; or
(h) To enable a customer to meet emergency expenses not reasonably
foreseeable, and if the extension of credit is supported by a statement
executed by the customer and accepted and signed by an officer of the
bank acting in good faith. For this purpose, emergency expenses include
expenses arising from circumstances such as the death or disability of
the customer, or some other change in circumstances involving extreme
hardship, not reasonably foreseeable at the time the credit was
extended. The opportunity to realize monetary gain or to avoid loss is
not a ``change in circumstances'' for this purpose.
[Codified to 12 C.F.R. § 221.6]
§ 221.7 Supplement: Maximum loan value of margin stock and
other collateral.
(a) Maximum loan value of margin stock. The maximum loan
value of any margin stock is fifty per cent of its current market
value.
(b) Maximum loan value of nonmargin stock and all other
collateral. The maximum loan value of nonmargin stock and all
other collateral except puts, calls, or combinations thereof is their
good faith loan value.
(c) Maximum loan value of options. Except for options
that qualify as margin stock, puts, calls, and combinations thereof
have no loan value.
[Codified to 12 C.F.R. § 221.7]
{{2-27-98 p.7767}}
Interpretations
§ 221.101 Determination and effect of purpose of loan.
(a) Under this part the original purpose of a loan is
controlling. In other words, if a loan originally is not for the
purpose of purchasing or carrying margin stock, changes in the
collateral for the loan do not change its exempted character.
(b) However, a so-called increase in the loan is necessarily on an
entirely different basis. So far as the purpose of the credit is
concerned, it is a new loan, and the question of whether or not it is
subject to this part must be determined accordingly.
(c) Certain facts should also be mentioned regarding the
determination of the purpose of a loan. Section 221.3(c) provides in
that whenever a lender is required to have its customer execute a
``Statement of Purpose for an Extension of Credit Secured by Margin
Stock,'' the statement must be accepted by the lender "acting in
good faith." The requirement of "good faith" is of vital
importance here. Its application will necessarily vary with the facts
of the particular case, but it is clear that the bank must be alert to
the circumstances surrounding the loan. For example, if the loan is to
be made to a customer who is not a broker or dealer in securities, but
such a broker or dealer is to deliver margin stock to secure the loan
or is to receive the proceeds of the loan, the bank would be put on
notice that the loan would probably be subject to this part. It could
not accept in good faith a statement to the contrary without obtaining
a reliable and satisfactory explanation of the situation.
(d) Furthermore, the purpose of a loan means just that. It cannot
be altered by some temporary application of the proceeds. For example,
if a borrower is to purchase Government securities with the proceeds of
a loan, but is soon thereafter to sell such securities and replace them
with margin stock, the loan is clearly for the purpose of purchasing or
carrying margin stock.
[Codified to 12 C.F.R. § 221.101]
§ 221.102 Application to committed credit where funds are
disbursed thereafter.
The Board has concluded that the date a commitment to
extend credit becomes binding should be regarded as the date when the
credit is extended, since:
(a) On that date the parties should be aware of law and facts
surrounding the transaction; and
(b) Generally, the date of contract is controlling for purposes of
margin regulations and Federal securities law, regardless of the
delivery of cash or securities.
[Codified to 12 C.F.R. § 221.102]
§ 221.103 Loans to brokers or dealers.
Questions have arisen as to the adequacy of statements
received by lending banks under § 221.3(c), ``Purpose Statement,''
in the case of loans to brokers or dealers secured by margin stock
where the proceeds of the loans are to be used to finance customer
transactions involving the purchasing or carrying of margin stock.
While some such loans may qualify for exemption under
§§ 221.1(b)(2), 221.4, 221.5 or 221.6, unless they do qualify for
such an exemption they are subject to this part. For example, if a loan
so secured is made to a broker to furnish cash working capital for the
conduct of his brokerage business (i.e., for purchasing and carrying
securities for the account of customers), the maximum loan value
prescribed in § 221.7 (the Supplement) would be applicable unless the
loan should be of a kind exempted under this part. This result would
not be affected by the fact that the margin stock given as security for
the loan was or included margin stock owned by the brokerage firm. In
view of the foregoing, the statement referred to in § 221.3(c) which
the lending bank must accept in good faith in determining the purpose
of the loan would be inadequate if the form of statement accepted or
used by the bank failed to call for answers which would indicate
whether or not the loan was of the kind discussed elsewhere in this
section.
[Codified to 12 C.F.R. § 221.103]
{{2-27-98 p.7768}}
§ 221.104 Federal credit unions.
For text of the interpretation on Federal credit unions, see 12 CFR
220.110.
[Codified to 12 C.F.R. § 221.104]
§ 221.105 Arranging for extensions of credit to be made by a
bank.
For text of the interpretation on Arranging for extensions of credit
to be made by a bank, see 12 CFR 220.111.
[Codified to 12 C.F.R. § 221.105]
§ 221.106 Reliance in ``good faith'' on statement of purpose
of loan.
(a) Certain situations have arisen from time to time under this
part wherein it appeared doubtful that, in the circumstances, the
lending banks may have been entitled to rely upon the statements
accepted by them in determining whether the purposes of certain loans
were such as to cause the loans to be not subject to the part.
(b) The use by a lending bank of a statement in determining the
purpose of a particular loan is, of course, provided for by
§ 221.3(c). However, under that paragraph a lending bank may accept
such statement only if it is ``acting in good faith.'' As the Board
stated in the interpretation contained in § 221.101, the
``requirement of good faith' is of vital importance''; and, to
fulfill such requirement, ``it is clear that the bank must be alert to
the circumstances surrounding the loan.''
(c) Obviously, such a statement would not be accepted by the bank
in ``good faith'' if at the time the loan was made the bank had
knowledge, from any source, of facts or circumstances which were
contrary to the natural purport of the statement, or which were
sufficient reasonably to put the bank on notice of the questionable
reliability or completeness of the statement.
(d) Furthermore, the same requirement of ``good faith'' is to be
applied whether the statement accepted by the bank is signed by the
borrower or by an officer of the bank. In either case, ``good faith''
requires the exercise of special diligence in any instance in which the
borrower is not personally known to the bank or to the officer who
processes the loan.
(e) The interpretation set forth in § 221.101 contains an example
of the application of the ``good faith'' test. There it was stated
that ``if the loan is to be made to a customer who is not a broker or
dealer in securities, but such a broker or dealer is to deliver margin
stock to secure the loan or is to receive the proceeds of the loan, the
bank would be put on notice that the loan would probably be subject to
this part. It could not accept in good faith a statement to the
contrary without obtaining a reliable and satisfactory explanation of
the situation''.
(f) Moreover, and as also stated by the interpretation contained in
§ 221.101, the purpose of a loan, of course, ``cannot be altered by
some temporary application of the proceeds. For example, if a borrower
is to purchase Government securities with the proceeds of a loan, but
is soon thereafter to sell such securities and replace them with margin
stock, the loan is clearly for the purpose of purchasing or carrying
margin stock''. The purpose of a loan therefore, should not be
determined upon a narrow analysis of the immediate use to which the
proceeds of the loan are put. Accordingly, a bank acting in ``good
faith'' should carefully scrutinize cases in which there is any
indication that the borrower is concealing the true purpose of the
loan, and there would be reason for special vigilance if margin stock
is substituted for bonds or nonmargin stock soon after the loan is
made, or on more than one occasion.
(g) Similarly, the fact that a loan made on the borrower's
signature only, for example, becomes secured by margin stock shortly
after the disbursement of the loan usually would afford reasonable
grounds for questioning the bank's apparent reliance upon merely a
statement that the purpose of the loan was not to purchase or carry
margin stock.
(h) The examples in this section are, of course, by no means
exhaustive. They simply illustrate the fundamental fact that no
statement accepted by a lender is of any value for the
{{2-27-98 p.7769}}purposes of this part unless the
lender accepting the statement is ``acting in good faith'', and that
``good faith'' requires, among other things, reasonable diligence to
learn the truth.
[Codified to 12 C.F.R. § 221.106]
§ 221.107 Arranging loan to purchase open-end investment
company shares.
For text of the interpretation on Arranging loan to purchase
open-end investment company shares, see 12 CFR 220.112.
[Codified to 12 C.F.R. § 221.107]
§ 221.108 Effect of registration of stock subsequent to making
of loan.
(a) The Board recently was asked whether a loan by a bank to enable
the borrower to purchase a newly issued nonmargin stock during the
initial over-the-counter trading period prior to the stock becoming
registered (listed) on a national securities exchange would be subject
to this part. The Board replied that, until such stock qualifies as
margin stock, this would not be applicable to such a loan.
(b) The Board has now been asked what the position of the lending
bank would be under this part if, after the date on which the stock
should become registered, such bank continued to hold a loan of the
kind just described. It is assumed that the loan was in an amount
greater than the maximum loan value for the collateral specified in
this part.
(c) If the stock should become registered, the loan would then be
for the purpose of purchasing or carrying a margin stock, and, if
secured directly or indirectly by any margin stock, would be subject to
this part as from the date the stock was registered. Under this part,
this does not mean that the bank would have to obtain reduction of the
loan in order to reduce it to an amount no more than the specified
maximum loan value. It does mean, however, that so long as the loan
balance exceeded the specified maximum loan value, the bank could not
permit any withdrawals or substitutions of collateral that would
increase such excess; nor could the bank increase the amount of the
loan balance unless there was provided additional collateral having a
maximum loan value at least equal to the amount of the increase. In
other words, as from the date the stock should become a margin stock,
the loan would be subject to this part in exactly the same way, for
example, as a loan subject to this part that became under-margined
because of a decline in the current market value of the loan collateral
or because of a decrease by the Board in the maximum loan value of the
loan collateral.
[Codified to 12 C.F.R. § 221.108]
§ 221.109 Loan to open-end investment company.
In response to a question regarding a possible loan by a bank to an
open-end investment company that customarily purchases stocks
registered on a national securities exchange, the Board stated that in
view of the general nature and operations of such a company, any loan
by a bank to such a company should be presumed to be subject to this
part as a loan for the purpose of purchasing or carrying margin stock.
This would not be altered by the fact that the open-end company had
used, or proposed to use, its own funds or proceeds of the loan to
redeem some of its own shares, since mere application of the proceeds
of a loan to some other use cannot prevent the ultimate purpose of a
loan from being to purchase or carry registered stocks.
[Codified to 12 C.F.R. § 221.109]
§ 221.110 Questions arising under this part.
(a) This part governs ``any purpose credit'' extended by a lender
``secured directly or indirectly by margin stock'' and defines
``purpose credit'' as ``any credit for the purpose, whether
immediate, incidental, or ultimate, of buying or carrying margin
stock,'' ``with
{{2-27-98 p.7770}}certain exceptions, and
provides that the maximum loan value of such margin stock shall be
fixed percentage ``of its current market value.''
(b) The Board of Governors has had occasion to consider the
application of the language in paragraph (a) of this section to the two
following questions:
(1) Loan secured by stock. First, is a loan to
purchase or carry margin stock subject to this part where made in
unsecured form, if margin stock is subsequently deposited as security
with the lender, and surrounding circumstances indicate that the
parties originally contemplated that the loan should be so secured? The
Board answered that in a case of this kind, the loan would be subject
to this part, for the following reasons:
(i) The Board has long held, in the closely related purpose area,
that the original purpose of a loan should not be determined upon a
narrow analysis of the technical circumstances under which a loan is
made. Instead, the fundamental purpose of the loan is considered to be
controlling. Indeed, ``the fact that a loan made on the borrower's
signature-only, for example, becomes secured by registered stock
shortly after the disbursement of the loan'' affords reasonable
grounds for questioning whether the bank was entitled to rely upon the
borrower's statement as to the purpose of the loan. 1953 Fed. Res.
Bull. 951 (See, § 221.106).
(ii) Where security is involved, standards of interpretation
should be equally searching. If, for example, the original agreement
between borrower and lender contemplated that the loan should be
secured by margin stock, and such stock is in fact delivered to the
bank when available, the transaction must be regarded as fundamentally
a secured loan. This view is strengthened by the fact that this part
applies to a loan ``secured directly or indirectly by margin stock.''
(2) Loan to acquire controlling shares. (i) The second
question is whether this part governs a margin stock-secured loan made
for the business purpose of purchasing a controlling interest in a
corporation, or whether such a loan would be exempt on the ground that
this part is directed solely toward purchases of stock for speculative
or investment purposes. The Board answered that a margin stock-secured
loan for the purpose of purchasing or carrying margin stock is subject
to this part, regardless of the reason for which the purchase is made.
(ii) The answer is required, in the Board's view, since the
language of this part is explicitly inclusive, covering ``any purpose
credit, secured directly or indirectly by margin stock.'' Moreover,
the withdrawal in 1945 of the original section 2(e) of this part, which
exempted ``any loan for the purpose of purchasing a stock from or
through a person who is not a member of a national securities exchange
. . .'' plainly implies that transactions of the sort described are
now subject to the general prohibition of § 221.3(a).
[Codified to 12 C.F.R. § 221.110]
§ 221.111 Contribution to joint venture as extension of credit
when the contribution is disproportionate to the contributor's share
in the venture's profits or losses.
(a) The Board considered the question whether a joint venture,
structured so that the amount of capital contribution to the venture
would be disproportionate to the right of participation in profits or
losses, constitutes an ``extension of credit'' for the purpose of
this part.
(b) An individual and a corporation plan to establish a joint
venture to engage in the business of buying and selling securities,
including margin stock. The individual would contribute 20 percent of
the capital and receive 80 percent of the profits or losses; the
corporate share would be the reverse. In computing profits or losses,
each participant would first receive interest at the rate of 8 percent
on his respective capital contribution. Although purchases and sales
would be mutually agreed upon, the corporation could liquidate the
joint portfolio if the individual's share of the losses equaled or
exceeded his 20 percent contribution to the venture. The corporation
would hold the securities, and upon termination of the venture, the
assets would first be applied to repayment of capital
contributions.
{{2-27-98 p.7771}}
(c) In general, the relationship of joint venture is created when
two or more persons combine their money, property, or time in the
conduct of some particular line of trade or some particular business
and agree to share jointly, or in proportion to capital contributed,
the profits and losses of the undertaking.
(d) The incidents of the joint venture described in paragraph (b)
of this section, however, closely parallel those of an extension of
margin credit, with the corporation as lender and the individual as
borrower. The corporation supplies 80 percent of the purchase price of
securities in exchange for a net return of 8 percent of the amount
advanced plus 20 percent of any gain. Like a lender of securities
credit, the corporation is insulated against loss by retaining the
right to liquidate the collateral before the securities decline in
price below the amount of its contribution. Conversely, the
individual--like a customer who borrows to purchase securities--puts up
only 20 percent of their cost, is entitled to the principal portion of
any appreciation in their value, bears the principal risk of loss
should that value decline, and does not stand to gain or lose except
through a change in value of the securities purchased.
(e) The Board is of the opinion that where the right of an
individual to share in profits and losses of such a joint venture is
disproportionate to his contribution to the venture:
(1) The joint venture involves an extension of credit by the
corporation to the individual;
(2) The extension of credit is to purchase or carry margin stock,
and is collateralized by such margin stock; and
(3) If the corporation is not a broker or dealer subject to
Regulation T (12 CFR part
220), the credit is of the kind described by § 221.3(a).
[Codified to 12 C.F.R. § 221.111]
§ 221.112 Loans by bank in capacity as trustee.
(a) The Board's advice has been requested whether a bank's
activities in connection with the administration of an employees'
savings plan are subject to this part.
(b) Under the plan, any regular, full-time employee may participate
by authorizing the sponsoring company to deduct a percentage of his
salary and wages and transmit the same to the bank as trustee.
Voluntary contributions by the company are allocated among the
participants. A participant may direct that funds held for him be
invested by the trustee in insurance, annuity contracts, Series E
Bonds, or in one or more of three specified securities which are listed
on a stock exchange. Loans to purchase the stocks may be made to
participants from funds of the trust, subject to approval of the
administrative committee, which is composed of five participants, and
of the trustee. The bank's right to approve is said to be restricted
to the mechanics of making the loan, the purpose being to avoid
cumbersome procedures.
(c) Loans are secured by the credit balance of the borrowing
participants in the savings fund, including stock, but excluding (in
practice) insurance and annuity contracts and government securities.
Additional stocks may be, but, in practice, have not been pledged as
collateral for loans. Loans are not made, under the plan, from bank
funds, and participants do not borrow from the bank upon assignment of
the participants' accounts in the trust.
(d) It is urged that loans under the plan are not subject to this
part because a loan should not be considered as having been made by a
bank where the bank acts solely in its capacity of trustee, without
exercise of any discretion.
(e) The Board reviewed this question upon at least one other
occasion, and full consideration has again been given to the matter.
After considering the arguments on both sides, the Board has reaffirmed
its earlier view that, in conformity with an interpretation not
published in the Code of Federal Regulations which was published at
page 874 of the 1946 Federal Reserve Bulletin (See 12 CFR
261.10(f) for information on how to obtain Board publications.), this
part applies to the activities of a bank when it is acting in its
capacity as trustee. Although the bank in that case had at best a
limited discretion with respect to loans
{{2-27-98 p.7772}}made by it in its
capacity as trustee, the Board concluded that this fact did not affect
the application of the regulation to such loans.
[Codified to 12 C.F.R. § 221.112]
§ 221.113 Loan which is secured indirectly by stock.
(a) A question has been presented to the Board as to whether a loan
by a bank to a mutual investment fund is ``secured * * * indirectly
by margin stock'' within the meaning of § 221.(3)(a), so that the
loan should be treated as subject to this part.
(b) Briefly, the facts are as follows. Fund X, an open-end
investment company, entered into a loan agreement with Bank Y, which
was (and still is) custodian of the securities which comprise the
portfolio of Fund X. The agreement includes the following terms, which
are material to the question before the Board:
(1) Fund X agrees to have an ``asset coverage'' (as defined in
the agreements) of 400 percent of all its borrowings, including the
proposed borrowing, at the time when it takes down any part of the
loan.
(2) Fund X agrees to maintain an ``asset coverage'' of at least
300 percent of its borrowings at all times.
(3) Fund X agrees not to amend its custody agreement with Bank Y,
or to substitute another custodian without Bank Y's consent.
(4) Fund X agrees not to mortgage, pledge, or otherwise encumber
any of its assets elsewhere than with Bank Y.
(c) In § 221.109 the Board stated that because of ``the general
nature and operations of such a company'', any ``loan by a bank to an
open-end investment company that customarily purchases margin stock
* * * should be presumed to be subject to this part as a loan for the
purpose of purchasing or carrying margin stock'' (purpose credit). The
Board's interpretation went on to say that: ``this would not be
altered by the fact that the open-end company had used, or proposed to
use, its own funds or proceeds of the loan to redeem some of its own
shares * * *.''
(d) Accordingly, the loan by Bank Y to Fund X was and is a
``purpose credit''. However, a loan by a bank is not subject to this
part unless: it is a purpose credit; and it is ``secured directly or
indirectly by margin stock''. In the present case, the loan is not
``secured directly'' by stock in the ordinary sense, since the
portfolio of Fund X is not pledged to secure the credit from Bank Y.
But the word ``indirectly'' must signify some form of security
arrangement other than the ``direct'' security which arises from the
ordinary ``transaction that gives recourse against a particular
chattel or land or against a third party on an obligation'' described
in the American Law Institute's Restatement of the Law of Security,
page 1. Otherwise the word ``indirectly'' would be superfluous, and a
regulation, like a statute, must be construed if possible to give
meaning to every word.
(e) The Board has indicated its view that any arrangement under
which margin stock is more readily available as security to the lending
bank than to other creditors of the borrower may amount to indirect
security within the meaning of this part. In an interpretation
published at § 221.110 it stated: ``The Board has long held, in the
* * * purpose area, that the original purpose of a loan should not be
determined upon a narrow analysis of the technical circumstances under
which a loan is made * * *. Where security is involved, standards of
interpretation should be equally searching.'' In its pamphlet issued
for the benefit and guidance of banks and bank examiners, entitled
``Questions and Answers Illustrating Application of Regulation U'',
the Board said: ``In determining whether a loan is ``indirectly''
secured, it should be borne in mind that the reason the Board has thus
far refrained * * * from regulating loans not secured by stock has
been to simplify operations under the regulations. This objective of
simplifying operations does not apply to loans in which arrangements
are made to retain the substance of stock collateral while sacrificing
only the form''.
{{2-27-98 p.7773}}
(f) A wide variety of arrangements as to collateral can be made
between bank and borrower which will serve, to some extent, to protect
the interest of the bank in seeing that the loan is repaid, without
giving the bank a conventional direct ``security'' interest in the
collateral. Among such arrangements which have come to the Board's
attention are the following:
(1) The borrower may deposit margin stock in the custody of the
bank. An arrangement of this kind may not, it is true, place the bank
in the position of a secured creditor in case of bankruptcy, or even of
conflicting claims, but it is likely effectively to strengthen the
bank's position. The definition of indirectly secured in
§ 221.2, which provides that a loan is not indirectly secured if the
lender ``holds the margin stock only in the capacity of custodian,
depositary or trustee, or under similar circumstances, and, in good
faith has not relied upon the margin stock as collateral,'' does not
exempt a deposit of this kind from the impact of the regulation unless
it is clear that the bank ``has not relied'' upon the margin stock
deposited with it.
(2) A borrower may not deposit his margin stock with the bank,
but agree not to pledge or encumber his assets elsewhere while the loan
is outstanding. Such an agreement may be difficult to police, yet it
serves to some extent to protect the interest of the bank if only
because the future credit standing and business reputation of the
borrower will depend upon his keeping his word. If the assets covered
by such an agreement include margin stock, then, the credit is
``indirectly secured'' by the margin stock within the meaning of this
part.
(3) The borrower may deposit margin stock with a third party who
agrees to hold the stock until the loan has been paid off. Here, even
though the parties may purport to provide that the stock is not
``security'' for the loan (for example, by agreeing that the stock
may not be sold and the proceeds applied to the debt if the borrower
fails to pay), the mere fact that the stock is out of the borrower's
control for the duration of the loan serves to some extent to protect
the bank.
(g) The three instances described in paragraph (f) of this section
are merely illustrative. Other methods, or combinations of methods, may
serve a similar purpose. The conclusion that any given arrangement
makes a credit ``indirectly secured'' by margin stock may, but need
not, be reinforced by facts such as that the stock in question was
purchased with proceeds of the loan, that the lender suggests or
insists upon the arrangement, or that the loan would probably be
subject to criticism by supervisory authorities were it not for the
protective arrangement.
(h) Accordingly, the Board concludes that the loan by Bank Y to
Fund X is indirectly secured by the portfolio of the fund and must be
treated by the bank as a regulated loan.
[Codified to 12 C.F.R. § 221.113]
§ 221.114 Bank loans to purchase stock of American Telephone
and Telegraph Company under Employees' Stock Plan.
(a) The Board of Governors interpreted this part in connection with
proposed loans by a bank to persons who are purchasing shares of stock
of American Telephone and Telegraph Company pursuant to its Employees'
Stock Plan.
(b) According to the current offering under the Plan, an employee
of the AT&T system may purchase shares through regular deductions from
his pay over a period of 24 months. At the end of that period, a
certificate for the appropriate number of shares will be issued to the
participating employee by AT&T. Each employee is entitled to purchase,
as a maximum, shares that will cost him approximately three-fourths of
his annual base pay. Since the program extends over two years, it
follows that the payroll deductions for this purpose may be in the
neighborhood of 38 percent of base pay and a larger percentage of
``take-home pay.'' Deductions of this magnitude are in excess of the
saving rate of many employees.
(c) Certain AT&T employees, who wish to take advantage of the
current offering under the Plan, are the owners of shares of AT&T stock
that they purchased under previous
{{2-27-98 p.7774}}offerings. A bank
proposed to receive such stock as collateral for a ``living
expenses'' loan that will be advanced to the employee in monthly
installments over the 24-month period, each installment being in the
amount of the employee's monthly payroll deduction under the Plan. The
aggregate amount of the advances over the 24-month period would be
substantially greater than the maximum loan value of the collateral as
prescribed in § 221.7 (the Supplement).
(d) In the opinion of the Board of Governors, a loan of the kind
described would violate this part if it exceeded the maximum loan value
of the collateral. The regulation applies to any margin stock-secured
loan for the purpose of purchasing or carrying margin stock
(§ 221.3(a)). Although the proposed loan would purport to be for
living expenses, it seems quite clear, in view of the relationship of
the loan to the Employees' Stock Plan, that its actual purpose would
be to enable the borrower to purchase AT&T stock, which is margin
stock. At the end of the 24-month period the borrower would acquire a
certain number of shares of that stock and would be indebted to the
lending bank in an amount approximately equal to the amount he would
pay for such shares. In these circumstances, the loan by the bank must
be regarded as a loan ``for the purpose of purchasing'' the stock,
and therefore it is subject to the limitations prescribed by this part.
This conclusion follows from the provisions of this part, and it may
also be observed that a contrary conclusion could largely defeat the
basic purpose of the margin regulations.
(e) Accordingly, the Board concluded that a loan of the kind
described may not be made in an amount exceeding the maximum loan value
of the collateral, as prescribed by the current § 221.7 (the
Supplement).
[Codified to 12 C.F.R. § 221.114]
§ 221.115 Accepting a purpose statement through the mail
without benefit of face-to-face interview.
(a) The Board has been asked whether the acceptance of a purpose
statement submitted through the mail by a lender subject to the
provisions of this part will meet the good faith requirement of
§ 221.3(c). Section 221.3(c) states that in connection with any
credit secured by collateral which includes any margin stock, a nonbank
lender must obtain a purpose statement executed by the borrower and
accepted by the lender in good faith. Such acceptance requires that the
lender be alert to the circumstances surrounding the credit and if
further information suggests inquiry, he must investigate and be
satisfied that the statement is truthful.
(b) The lender is a subsidiary of a holding company which also has
another subsidiary which serves as underwriter and investment advisor
to various mutual funds. The sole business of the lender will be to
make ``non-purpose'' consumer loans to shareholders of the mutual
funds, such loans to be collateralized by the fund shares. Most mutual
funds shares are margin stock for purposes of this part. Solicitation
and acceptance of these consumer loans will be done principally through
the mail and the lender wishes to obtain the required purpose statement
by mail rather than by a face-to-face interview. Personal interviews
are not practicable for the lender because shareholders of the funds
are scattered throughout the country. In order to provide the same
safeguards inherent in face-to-face interviews, the lender has
developed certain procedures designed to satisfy the good faith
acceptance requirement of this part.
(c) The purpose statement will be supplemented with several
additional questions relevant to the prospective borrower's investment
activities such as purchases of any security within the last 6 months,
dollar amount, and obligations to purchase or pay for previous
purchases; present plans to purchase securities in the near future,
participations in securities purchase plans, list of unpaid debts, and
present income level. Some questions have been modified to facilitate
understanding but no questions have been deleted. If additional inquiry
is indicated by the answers on the form, a loan officer of the lender
will interview the borrower by telephone to make sure the loan is
``non-purpose''. Whenever the
{{2-27-98 p.7775}}loan exceeds the ``maximum
loan value'' of the collateral for a regulated loan, a telephone
interview will be done as a matter of course.
(d) One of the stated purposes of Regulation X
(12 CFR part 224) was to
prevent the infusion of unregulated credit into the securities markets
by borrowers falsely certifying the purpose of a loan. The Board is of
the view that the existence of Regulation X (12 CFR part 224), which
makes the borrower liable for willful violations of the margin
regulations, will allow a lender subject to this part to meet the good
faith acceptance requirement of § 221.3(c) without a face-to-face
interview if the lender adopts a program, such as the one described in
paragraph (c) of this section, which requires additional detailed
information from the borrower and proper procedures are instituted to
verify the truth of the information received. Lenders intending to
embark on a similar program should discuss proposed plans with their
district Federal Reserve Bank. Lenders may have existing or future
loans with the prospective customers which could complicate the efforts
to determine the true purpose of the loan.
[Codified to 12 C.F.R. § 221.115]
§ 221.116 Bank loans to replenish working capital used to
purchase mutual fund shares.
(a) In a situation considered by the Board of Governors, a business
concern (X) proposed to purchase mutual fund shares, from time to time,
with proceeds from its accounts receivable, then pledge the shares with
a bank in order to secure working capital. The bank was prepared to
lend amounts equal to 70 percent of the current value of the shares as
they were purchased by X. If the loans were subject to this part, only
50 percent of the current market value of the shares could be lent.
(b) The immediate purpose of the loans would be to replenish X's
working capital. However, as time went on, X would be acquiring mutual
fund shares at a cost that would exceed the net earnings it would
normally have accumulated, and would become indebted to the lending
bank in an amount approximately 70 percent of the prices of said
shares.
(c) The Board held that the loans were for the purpose of
purchasing the shares, and therefore subject to the limitations
prescribed by this part. As pointed out in § 221.114 with respect to
a similar program for putting a high proportion of cash income into
stock, the borrowing against the margin stock to meet needs for which
the cash would otherwise have been required, a contrary conclusion
could largely defeat the basic purpose of the margin regulations.
(d) Also considered was an alternative proposal under which X would
deposit proceeds from accounts receivable in a time account for 1 year,
before using those funds to purchase mutual fund shares. The Board held
that this procedure would not change the situation in any significant
way. Once the arrangement was established, the proceeds would be
flowing into the time account at the same time that similar amounts
were released to purchase the shares, and over any extended period of
time the result would be the same. Accordingly, the Board concluded
that bank loans made under the alternative proposal would similarly be
subject to this part.
[Codified to 12 C.F.R. § 221.116]
§ 221.117 When bank in ``good faith'' has not relied on stock
as collateral.
(a) The Board has received questions regarding the circumstances in
which an extension or maintenance of credit will not be deemed to be
``indirectly secured'' by stock as indicated by the phrase, ``if the
lender, in good faith, has not relied upon the margin stock as
collateral,'' contained in paragraph (2)(iv) of the definition of
indirectly secured in § 221.2.
(b) In response, the Board noted that in amending this portion of
the regulation in 1968 it was indicated that one of the purposes of the
change was to make clear that the definition of indirectly
secured does not apply to certain routine negative covenants in
loan
{{2-27-98 p.7776}}agreements. Also, while the
question of whether or not a bank has relied upon particular stock as
collateral is necessarily a question of fact to be determined in each
case in the light of all relevant circumstances, some indication that
the bank had not relied upon stock as collateral would seem to be
afforded by such circumstances as the fact that:
(1) The bank had obtained a reasonably current financial
statement of the borrower and this statement could reasonably support
the loan; and
(2) The loan was not payable on demand or because of fluctuations
in market value of the stock, but instead was payable on one or more
fixed maturities which were typical of maturities applied by the bank
to loans otherwise similar except for not involving any possible
question of stock collateral.
[Codified to 12 C.F.R. § 221.117]
§ 221.118 Bank arranging for extension of credit by
corporation.
(a) The Board considered the questions whether:
(1) The guaranty by a corporation of an ``unsecured'' bank loan
to exercise an option to purchase stock of the corporation is an
``extension of credit'' for the purpose of this part;
(2) Such a guaranty is given ``in the ordinary course of
business'' of the corporation, as defined in § 221.2; and
(3) The bank involved took part in arranging for such credit on
better terms than it could extend under the provisions of this part.
(b) The Board understood that any officer or employee included
under the corporation's stock option plan who wished to exercise his
option could obtain a loan for the purchase price of the stock by
executing an unsecured note to the bank. The corporation would issue to
the bank a guaranty of the loan and hold the purchased shares as
collateral to secure it against loss on the guaranty. Stock of the
corporation is registered on a national securities exchange and
therefore qualifies as ``margin stock'' under this part.
(c) A nonbank lender is subject to the registration and other
requirements of this part if, in the ordinary course of his business,
he extends credit on collateral that includes any margin stock in the
amount of $200,000 or more in any calendar quarter, or has such credit
outstanding in any calendar quarter in the amount of $500,000 or more.
The Board understood that the corporation in question had sufficient
guaranties outstanding during the applicable calendar quarter to meet
the dollar thresholds for registration.
(d) In the Board's judgment a person who guarantees a loan, and
thereby becomes liable for the amount of the loan in the event the
borrower should default, is lending his credit to the borrower. In the
circumstances described, such a lending of credit must be considered an
``extension of credit'' under this part in order to prevent
circumvention of the regulation's limitation on the amount of credit
that can be extended on the security of margin stock.
(e) Under § 221.2, the term in the ordinary course of
business means ``occurring or reasonably expected to occur in
carrying out or furthering any business purpose. * * *'' In general,
stock option plans are designed to provide a company's employees with
a proprietary interest in the company in the form of ownership of the
company's stock. Such plans increase the company's ability to attract
and retain able personnel and, accordingly, promote the interest of the
company and its stockholders, while at the same time providing the
company's employees with additional incentive to work toward the
company's future success. An arrangement whereby participating
employees may finance the exercise of their options through an
unsecured bank loan guaranteed by the company, thereby facilitating the
employees' acquisition of company stock, is likewise designed to
promote the company's interest and is, therefore, in furtherance of a
business purpose.
(f) For the reasons indicated, the Board concluded that under the
circumstances described a guaranty by the corporation constitutes
credit extended in the ordinary course of business under this part,
that the corporation is required to register pursuant to § 221.3(b),
and that such guaranties may not be given in excess of the maximum loan
value of the collateral pledged to secure the guaranty.
{{2-27-98 p.7777}}
(g) Section 221.3(a)(3) provides that ``no lender may arrange for
the extension or maintenance of any purpose credit, except upon the
same terms and conditions on which the lender itself may extend or
maintain purpose credit under this part''. Since the Board concluded
that the giving of a guaranty by the corporation to secure the loan
described above constitutes an extension of credit, and since the use
of a guaranty in the manner described could not be effectuated without
the concurrence of the bank involved, the Board further concluded that
the bank took part in ``arranging'' for the extension of credit in
excess of the maximum loan value of the margin stock pledged to secure
the guaranties.
[Codified to 12 C.F.R. § 221.118]
§ 221.119 Applicability of plan-lender provisions to financing
of stock options and stock purchase rights qualified or restricted
under Internal Revenue Code.
(a) The Board has been asked whether the plan-lender provisions of
§ 221.4(a) and (b) were intended to apply to the financing of stock
options restricted or qualified under the Internal Revenue Code where
such options or the option plan do not provide for such financing.
(b) It is the Board's experience that in some nonqualified plans,
particularly stock purchase plans, the credit arrangement is distinct
from the plan. So long as the credit extended, and particularly, the
character of the plan-lender, conforms with the requirements of the
regulation, the fact that option and credit are provided for in
separate documents is immaterial. It should be emphasized that the
Board does not express any view on the preferability of qualified as
opposed to nonqualified options; its role is merely to prevent
excessive credit in this area.
(c) Section 221.4(a) provides that a plan-lender may include a
wholly-owned subsidiary of the issuer of the collateral (taking as a
whole, corporate groups including subsidiaries and affiliates). This
clarifies the Board's intent that, to qualify for special treatment
under that section, the lender must stand in a special
employer-employee relationship with the borrower, and a special
relationship of issuer with regard to the collateral. The fact that the
Board, for convenience and practical reasons, permitted the employing
corporation to act through a subsidiary or other entity should not be
interpreted to mean the Board intended the lender to be other than an
entity whose overriding interests were coextensive with the issuer. An
independent corporation, with independent interests was never intended,
regardless of form, to be at the base of exempt stock-plan lending.
[Codified to 12 C.F.R. § 221.119]
§ 221.120 Allocation of stock collateral to purpose and
nonpurpose credits to same customer.
(a) A bank proposes to extend two credits (Credits A and B) to its
customer. Although the two credits are proposed to be extended at the
same time, each would be evidenced by a separate agreement. Credit A
would be extended for the purpose of providing the customer with
working capital (nonpurpose credit), collateralized by margin stock.
Credit B would be extended for the purpose of purchasing or carrying
margin stock (purpose credit), without collateral or on collateral
other than stock.
(b) This part allows a bank to extend purpose and nonpurpose
credits simultaneously or successively to the same customer. This rule
is expressed in § 221.3(d)(4) which provides in substance that for
any nonpurpose credit to the same customer, the lender shall in good
faith require as much collateral not already identified to the
customer's purpose credit as the lender would require if it held
neither the purpose loan nor the identified collateral. This rule in
§ 221.3(d)(4) also takes into account that the lender would not
necessarily be required to hold collateral for the nonpurpose credit
if, consistent with good faith banking practices, it would normally
make this kind of nonpurpose loan without collateral.
(c) The Board views § 221.3(d)(4), when read in conjunction with
§ 221.3(c) and (f), as requiring that whenever a lender extends two
credits to the same customer, one a purpose credit and the other
nonpurpose, any margin stock collateral must first be identified
with
{{2-27-98 p.7778}}and attributed to the
purpose loan by taking into account the maximum loan value of such
collateral as prescribed in § 221.7 (the Supplement).
(d) The Board is further of the opinion that under the foregoing
circumstances Credit B would be indirectly secured by stock, despite
the fact that there would be separate loan agreements for both credits.
This conclusion flows from the circumstance that the lender would hold
in its possession stock collateral to which it would have access with
respect to Credit B, despite any ostensible allocation of such
collateral to Credit A.
[Codified to 12 C.F.R. § 221.120]
§ 221.121 Extension of credit in certain stock option and stock
purchase plans.
Questions have been raised as to whether certain stock option and
stock purchase plans involve extensions of credit subject to this part
when the participant is free to cancel his participation at any time
prior to full payment, but in the event of cancellation the participant
remains liable for damages. It thus appears that the participant has
the opportunity to gain and bears the risk of loss from the time the
transaction is executed and payment is deferred. In some cases brought
to the Board's attention damages are related to the market price of
the stock, but in others, there may be no such relationship. In either
of these circumstances, it is the Board's view that such plans involve
extensions of credit. Accordingly, where the security being purchased
is a margin security and the credit is secured, directly or indirectly,
by any margin security, the creditor must register and the credit must
conform with either the regular margin requirements of § 221.3(a) or
the special ``plan-lender'' provisions set forth in § 221.4,
whichever is applicable. This assumes, of course, that the amount of
credit extended is such that the creditor is subject to the
registration requirements of § 221.3(b).
[Codified to 12 C.F.R. § 221.121]
§ 221.122 Applicability of margin requirements to credit in
connection with Insurance Premium Funding Programs.
(a) The Board has been asked numerous questions regarding purpose
credit in connection with insurance premium funding programs. The
inquiries are included in a set of guidelines in the format of
questions and answers. (The guidelines are available pursuant to the
Board's Rules Regarding Availability of Information, 12 CFR part 261.)
A glossary of terms customarily used in connection with insurance
premium funding credit activities is included in the guidelines. Under
a typical insurance premium funding program, a borrower acquires mutual
fund shares for cash, or takes fund shares which he already owns, and
then uses the loan value (currently 50 percent as set by the Board) to
buy insurance. Usually, a funding company (the issuer) will sell both
the fund shares and the insurance through either independent
broker/dealers or subsidiaries or affiliates of the issuer. A typical
plan may run for 10 or 15 years with annual insurance premiums due. To
illustrate, assuming an annual insurance premium of $300, the
participant is required to put up mutual fund shares equivalent to 250
percent of the premium or $600 ($600 x 50 percent loan value equals
$300 the amount of the insurance premium which is also the amount of
the credit extended).
(b) The guidelines referenced in paragraph (a) of this section
also:
(1) Clarify an earlier 1969 Board interpretation to show that the
public offering price of mutual fund shares (which includes the front
load, or sales commission) may be used as a measure of their current
market value when the shares serve as collateral on a purpose credit
throughout the day of the purchase of the fund shares; and
(2) Relax a 1965 Board position in connection with accepting
purpose statements by mail.
(c) It is the Board's view that when it is clearly established
that a purpose statement supports a purpose credit then such statement
executed by the borrower may be accepted by mail, provided it is
received and also executed by the lender before the credit is extended.
[Codified to 12 C.F.R. § 221.122]
{{2-27-98 p.7779}}
§ 221.123 Combined credit for exercising employee stock options
and paying income taxes incurred as a result of such exercise.
(a) Section 221.4(a) and (b), which provides special treatment for
credit extended under employee stock option plans, was designed to
encourage their use in recognition of their value in giving an employee
a proprietary interest in the business. Taking a position that might
discourage the exercise of options because of tax complications would
conflict with the purpose of § 221.4(a) and (b).
(b) Accordingly, the Board has concluded that the combined loans
for the exercise of the option and the payment of the taxes in
connection therewith under plans complying with § 221.4(a)(2) may be
regarded as purpose credit within the meaning of § 221.2.
[Codified to 12 C.F.R. § 221.123]
§ 221.124 Purchase of debt securities to finance corporate
takeovers.
(a) Petitions have been filed with the Board raising questions as
to whether the margin requirements in this part apply to two types of
corporate acquisitions in which debt securities are issued to finance
the acquisition of margin stock of a target company.
(b) In the first situation, the acquiring company, Company A,
controls a shell corporation that would make a tender offer for the
stock of Company B, which is margin stock (as defined in § 221.2).
The shell corporation has virtually no operations, has no significant
business function other than to acquire and hold the stock of Company
B, and has substantially no assets other than the margin stock to be
acquired. To finance the tender offer, the shell corporation would
issue debt securities which, by their terms, would be unsecured. If the
tender offer is successful, the shell corporation would seek to merge
with Company B. However, the tender offer seeks to acquire fewer shares
of Company B than is necessary under state law to effect a short form
merger with Company B, which could be consummated without the approval
of shareholders or the board of directors of Company B.
(c) The purchase of the debt securities issued by the shell
corporation to finance the acquisition clearly involves purpose credit
(as defined in § 221.2). In addition, such debt securities would be
purchased only by sophisticated investors in very large minimum
denominations, so that the purchasers may be lenders for purposes of
this part. See § 221.3(b). Since the debt securities
contain no direct security agreement involving the margin stock,
applicability of the lending restrictions of this part turns on whether
the arrangement constitutes an extension of credit that is secured
indirectly by margin stock.
(d) As the Board has recognized, indirect security can encompass a
wide variety of arrangements between lenders and borrowers with respect
to margin stock collateral that serve to protect the lenders' interest
in assuring that a credit is repaid where the lenders do not have a
conventional direct security interest in the collateral. See
§ 221.124. However, credit is not ``indirectly secured'' by
margin stock if the lender in good faith has not relied on the margin
stock as collateral extending or maintaining credit. See
§ 221.2.
(e) The Board is of the view that, in the situation described in
paragraph (b) of this section, the debt securities would be presumed to
be indirectly secured by the margin stock to be acquired by the shell
acquisition vehicle. The staff has previously expressed the view that
nominally unsecured credit extended to an investment company, a
substantial portion of whose assets consist of margin stock, is
indirectly secured by the margin stock. See Federal Reserve
Regulatory Service 5--917.12. (See 12 CFR 261.10(f) for
information on how to obtain Board publications.) This opinion notes
that the investment company has substantially no assets other than
margin stock to support indebtedness and thus credit could not be
extended to such a company in good faith without reliance on the margin
stock as collateral.
(f) The Board believes that this rationale applies to the debt
securities issued by the shell corporation described in paragraph (b)
of this section. At the time the debt securities are issued, the shell
corporation has substantially no assets to support the credit other
than the margin stock that it has acquired or intends to acquire and
has no significant business function other than to hold the stock of
the target company in order to facilitate the
{{2-27-98 p.7780}}acquisition. Moreover,
it is possible that the shell may hold the margin stock for a
significant and indefinite period of time, if defensive measures by the
target prevent consummation of the acquisition. Because of the
difficulty in predicting the outcome of a contested takeover at the
time that credit is committed to the shell corporation, the Board
believes that the purchasers of the debt securities could not, in good
faith, lend without reliance on the margin stock as collateral. The
presumption that the debt securities are indirectly secured by margin
stock would not apply if there is specific evidence that lenders could
in good faith rely on assets other than margin stock as collateral,
such as a guaranty of the debt securities by the shell corporation's
parent company or another company that has substantial non-margin stock
assets or cash flow. This presumption would also not apply if there is
a merger agreement between the acquiring and target companies entered
into at the time the commitment is made to purchase the debt securities
or in any event before loan funds are advanced. In addition, the
presumption would not apply if the obligation of the purchasers of the
debt securities to advance funds to the shell corporation is contingent
on the shell's acquisition of the minimum number of shares necessary
under applicable state law to effect a merger between the acquiring and
target companies without the approval of either the shareholders or
directors of the target company. In these two situations where the
merger will take place promptly, the Board believes the lenders could
reasonably be presumed to be relying on the assets of the target for
repayment.
(g) In addition, the Board is of the view that the debt securities
described in paragraph (b) of this section are indirectly secured by
margin stock because there is a practical restriction on the ability of
the shell corporation to dispose of the margin stock of the target
company. Indirectly secured is defined in § 221.2 to include any
arrangement under which the customer's right or ability to sell,
pledge, or otherwise dispose of margin stock owned by the customer is
in any way restricted while the credit remains outstanding. The
purchasers of the debt securities issued by a shell corporation to
finance a takeover attempt clearly understand that the shell
corporation intends to acquire the margin stock of the target company
in order to effect the acquisition of that company. This understanding
represents a practical restriction on the ability of the shell
corporation to dispose of the target's margin stock and to acquire
other assets with the proceeds of the credit.
(h) In the second situation, Company C, an operating company with
substantial assets or cash flow, seeks to acquire Company D, which is
significantly larger than Company C. Company C establishes a shell
corporation that together with Company C makes a tender offer for the
shares of Company D, which is margin stock. To finance the tender
offer, the shell corporation would obtain a bank loan that complies
with the margin lending restrictions of this part and Company C would
issue debt securities that would not be directly secured by any margin
stock. The Board is of the opinion that these debt securities should
not be presumed to be indirectly secured by the margin stock of Company
D, since, as an operating business, Company C has substantial assets or
cash flow without regard to the margin stock of Company D. Any
presumption would not be appropriate because the purchasers of the debt
securities may be relying on assets other than margin stock of Company
D for repayment of the credit.
[Codified to 12 C.F.R. § 221.124]
§ 221.125 Credit to brokers and dealers.
(a) The National Securities Markets Improvement Act of 1996 (Pub.
L. 104--290, 110 Stat. 3416) restricts the Board's margin authority by
repealing section 8(a) of the Securities Exchange Act of 1934 (the
Exchange Act) and amending section 7 of the Exchange Act (15 U.S.C.
78g) to exclude the borrowing by a member of a national securities
exchange or a registered broker or dealer ``a substantial portion of
whose business consists of transactions with persons other than brokers
or dealers'' and borrowing by a member of a national securities
exchange or a registered broker or dealer to finance its activities as
a market maker or an underwriter. Notwithstanding this exclusion, the
Board may impose such rules
{{12-31-07 p.7781}}and regulations if it
determines they are ``necessary or appropriate in the public interest
or for the protection of investors.''
(b) The Board has not found that it is necessary or appropriate in
the public interest or for the protection of investors to impose rules
and regulations regarding loans to brokers and dealers covered by the
National Securities Markets Improvement Act of 1996.
[Codified to 12 C.F.R. § 221.125]
[The page following this is 7785.]
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