[Title 12 CFR ]
[Code of Federal Regulations (annual edition) - January 1, 2001 Edition]
[From the U.S. Government Printing Office]
[[Page i]]
12
Parts 220 to 299
Revised as of January 1, 2001
Banks and Banking
Containing a codification of documents of general
applicability and future effect
As of January 1, 2001
With Ancillaries
Published by:
Office of the Federal Register
National Archives and Records
Administration
A Special Edition of the Federal Register
[[Page ii]]
U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 2001
For sale by the Superintendent of Documents, U.S. Government Printing
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Table of Contents
Page
Explanation................................................. v
Title 12:
Chapter II--Federal Reserve System (Continued) 3
Finding Aids:
Table of CFR Titles and Chapters........................ 819
Alphabetical List of Agencies Appearing in the CFR...... 837
List of CFR Sections Affected........................... 847
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Cite this Code: CFR
To cite the regulations in
this volume use title,
part and section number.
Thus, 12 CFR 220.1 refers
to title 12, part 220,
section 1.
----------------------------
[[Page v]]
EXPLANATION
The Code of Federal Regulations is a codification of the general and
permanent rules published in the Federal Register by the Executive
departments and agencies of the Federal Government. The Code is divided
into 50 titles which represent broad areas subject to Federal
regulation. Each title is divided into chapters which usually bear the
name of the issuing agency. Each chapter is further subdivided into
parts covering specific regulatory areas.
Each volume of the Code is revised at least once each calendar year
and issued on a quarterly basis approximately as follows:
Title 1 through Title 16.................................as of January 1
Title 17 through Title 27..................................as of April 1
Title 28 through Title 41...................................as of July 1
Title 42 through Title 50................................as of October 1
The appropriate revision date is printed on the cover of each
volume.
LEGAL STATUS
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HOW TO USE THE CODE OF FEDERAL REGULATIONS
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To determine whether a Code volume has been amended since its
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EFFECTIVE AND EXPIRATION DATES
Each volume of the Code contains amendments published in the Federal
Register since the last revision of that volume of the Code. Source
citations for the regulations are referred to by volume number and page
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OMB CONTROL NUMBERS
The Paperwork Reduction Act of 1980 (Pub. L. 96-511) requires
Federal agencies to display an OMB control number with their information
collection request.
[[Page vi]]
Many agencies have begun publishing numerous OMB control numbers as
amendments to existing regulations in the CFR. These OMB numbers are
placed as close as possible to the applicable recordkeeping or reporting
requirements.
OBSOLETE PROVISIONS
Provisions that become obsolete before the revision date stated on
the cover of each volume are not carried. Code users may find the text
of provisions in effect on a given date in the past by using the
appropriate numerical list of sections affected. For the period before
January 1, 1986, consult either the List of CFR Sections Affected, 1949-
1963, 1964-1972, or 1973-1985, published in seven separate volumes. For
the period beginning January 1, 1986, a ``List of CFR Sections
Affected'' is published at the end of each CFR volume.
CFR INDEXES AND TABULAR GUIDES
A subject index to the Code of Federal Regulations is contained in a
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The Federal Register Index is issued monthly in cumulative form.
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the revision dates of the 50 CFR titles.
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There are no restrictions on the republication of material appearing
in the Code of Federal Regulations.
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[[Page vii]]
The Office of the Federal Register also offers a free service on the
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Raymond A. Mosley,
Director,
Office of the Federal Register.
January 1, 2001.
[[Page ix]]
THIS TITLE
Title 12--Banks and Banking is composed of six volumes. The parts in
these volumes are arranged in the following order: parts 1-199, 200-219,
220-299, 300-499, 500-599, and part 600-end. The first volume containing
parts 1-199 is comprised of chapter I--Comptroller of the Currency,
Department of the Treasury. The second and third volumes containing
parts 200-299 are comprised of chapter II--Federal Reserve System. The
fourth volume containing parts 300-499 is comprised of chapter III--
Federal Deposit Insurance Corporation and chapter IV--Export-Import Bank
of the United States. The fifth volume containing parts 500-599 is
comprised of chapter V--Office of Thrift Supervision, Department of the
Treasury. The sixth volume containing part 600-end is comprised of
chapter VI--Farm Credit Administration, chapter VII--National Credit
Union Administration, chapter VIII--Federal Financing Bank, chapter IX--
Federal Housing Finance Board, chapter XI--Federal Financial
Institutions Examination Council, chapter XIV--Farm Credit System
Insurance Corporation, chapter XV--Department of the Treasury, chapter
XVII--Office of Federal Housing Enterprise Oversight, Department of
Housing and Urban Development and chapter XVIII--Community Development
Financial Institutions Fund, Department of the Treasury. The contents of
these volumes represent all of the current regulations codified under
this title of the CFR as of January 1, 2001.
Redesignation tables appear in the volumes containing parts 1-199,
parts 300-499, parts 500-599, and part 600-end.
[[Page x]]
[[Page 1]]
TITLE 12--BANKS AND BANKING
(This book contains parts 220 to 299)
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Part
chapter ii--Federal Reserve System (Continued).............. 220
Cross References: Farmers Home Administration: See Agriculture, 7 CFR,
chapter XVIII.
Office of Assistant Secretary for Housing--Federal Housing
Commissioner, Department of Housing and Urban Development: See Housing
and Urban Development, 24 CFR, chapter II.
Fiscal Service: See Money and Finance: Treasury, 31 CFR, chapter II.
Monetary Offices: See Money and Finance: Treasury, 31 CFR, chapter I.
Commodity Credit Corporation: See Agriculture, 7 CFR, chapter XIV.
Small Business Administration: See Business Credit and Assistance, 13
CFR, chapter I.
Rural Electrification Administration: See Agriculture, 7 CFR, chapter
XVII.
[[Page 3]]
CHAPTER II--FEDERAL RESERVE SYSTEM
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SUBCHAPTER A--BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Part Page
220 Credit by brokers and dealers (Regulation T) 5
221 Credit by banks and persons other than
brokers or dealers for the purpose of
purchasing or carrying margin stock
(Regulation U).......................... 34
224 Borrowers of securities credit (Regulation
X)...................................... 55
225 Bank holding companies and change in bank
control (Regulation Y).................. 56
226 Truth in lending (Regulation Z)............. 212
227 Unfair or deceptive acts or practices
(Regulation AA)......................... 452
228 Community reinvestment (Regulation BB)...... 455
229 Availability of funds and collection of
checks (Regulation CC).................. 474
230 Truth in savings (Regulation DD)............ 580
231 Netting eligibility for financial
institution (Regulation EE)............. 614
250 Miscellaneous interpretations............... 615
261 Rules regarding availability of information. 646
261a Rules regarding access to personal
information under the Privacy Act of
1974.................................... 663
261b Rules regarding public observation of
meetings................................ 669
262 Rules of procedure.......................... 674
263 Rules of practice for hearings.............. 682
264 Employee responsibilities and conduct....... 724
264a Reserve Bank directors--actions and
responsibilities........................ 724
264b Rules regarding foreign gifts and
decorations............................. 728
265 Rules regarding delegation of authority..... 730
266 Limitations on activities of former members
and employees of the Board.............. 748
267 Rules of organization and procedure of the
Consumer Advisory Council............... 749
268 Rules regarding equal opportunity........... 751
269 Policy on labor relations for the Federal
Reserve banks........................... 788
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269a Definitions................................. 793
269b Charges of unfair labor practices........... 794
SUBCHAPTER B--FEDERAL OPEN MARKET COMMITTEE
270 Open market operations of Federal Reserve
banks................................... 804
271 Rules regarding availability of information. 805
272 Rules of procedure.......................... 812
281 Statements of policy........................ 814
SUBCHAPTER C--FEDERAL RESERVE SYSTEM LABOR RELATIONS PANEL
290-299 [Reserved]
Supplemental Publications: The Federal Reserve Act, as amended through
December 31, 1976, with an Appendix containing provisions of certain
other statutes affecting the Federal Reserve System. Rules of
Organization and Procedure--Board of Governors of the Federal Reserve
System. Regulations of the Board of Governors of the Federal Reserve
System. The Federal Reserve System--Purposes and Functions. Annual
Report. Federal Reserve Bulletin. Monthly. Federal Reserve Chart Book
Quarterly; Historical Chart Book issued in September.
[[Page 5]]
SUBCHAPTER A--BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
PART 220--CREDIT BY BROKERS AND DEALERS (REGULATION T)--Table of Contents
Sec.
220.1 Authority, purpose, and scope.
220.2 Definitions.
220.3 General provisions.
220.4 Margin account.
220.5 Special memorandum account.
220.6 Good faith account.
220.7 Broker-dealer credit account.
220.8 Cash account.
220.9 Clearance of securities, options, and futures.
220.10 Borrowing and lending securities.
220.11 Requirements for the list of marginable OTC stocks and the list
of foreign margin stocks.
220.12 Supplement: margin requirements.
Interpretations
220.101 Transactions of customers who are brokers or dealers.
220.102 [Reserved]
220.103 Borrowing of securities.
220.104 [Reserved]
220.105 Ninety-day rule in special cash account.
220.106-220.107 [Reserved]
220.108 International Bank Securities.
220.109 [Reserved]
220.110 Assistance by Federal credit union to its members.
220.111 Arranging for extensions of credit to be made by a bank.
220.112 [Reserved]
220.113 Necessity for prompt payment and delivery in special cash
accounts.
220.114-220.116 [Reserved]
220.117 Exception to 90-day rule in special cash account.
220.118 Time of payment for mutual fund shares purchased in a special
cash account.
220.119 Applicability of margin requirements to credit extended to
corporation in connection with retirement of stock.
220.120 [Reserved]
220.121 Applicability of margin requirements to joint account between
two creditors.
220.122 ``Deep in the money put and call options'' as extensions of
credit.
220.123 Partial delayed issue contracts covering nonconvertible bonds.
220.124 Installment sale of tax-shelter programs as ``arranging'' for
credit.
220.125-220.126 [Reserved]
220.127 Independent broker/dealers arranging credit in connection with
the sale of insurance premium funding programs.
220.128 Treatment of simultaneous long and short positions in the same
margin account when put or call options or combinations
thereof on such stock are also outstanding in the account.
220.129-220.130 [Reserved]
220.131 Application of the arranging section to broker-dealer
activities under SEC Rule 144A.
220.132 Credit to brokers and dealers.
Authority: 15 U.S.C. 78c, 78g, 78q, and 78w.
Source: Regulation T, Secs. 220.1 through 220.18 appear at 48 FR
23165, May 24, 1983, unless otherwise noted.
Editorial Note: A copy of each form referred to in this part is
filed as a part of the original document. Copies are available upon
request to the Board of Governors of the Federal Reserve System or any
Federal Reserve Bank.
Sec. 220.1 Authority, purpose, and scope.
(a) Authority and purpose. Regulation T (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.).
Its principal purpose is to regulate extensions of credit by brokers and
dealers; it also covers related transactions within the Board's
authority under the Act. It imposes, among other obligations, initial
margin requirements and payment rules on certain securities
transactions.
(b) Scope. (1) This part provides a margin account and four special
purpose accounts in which to record all financial relations between a
customer and a creditor. Any transaction not specifically permitted in a
special purpose account shall be recorded in a margin account.
(2) This part does not preclude any exchange, national securities
association, or creditor from imposing additional requirements or taking
action for its own protection.
(3) This part does not apply to:
(i) Financial relations between a customer and a creditor to the
extent that they comply with a portfolio margining system under rules
approved or amended by the SEC;
[[Page 6]]
(ii) Credit extended by a creditor based on a good faith
determination that the borrower is an exempted borrower;
(iii) Financial relations between a customer and a broker or dealer
registered only under section 15C of the Act; and
(iv) Financial relations between a foreign branch of a creditor and
a foreign person involving foreign securities.
[Reg. T, 63 FR 2820, Jan. 16, 1998]
Sec. 220.2 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:
Affiliated corporation means a corporation of which all the common
stock is owned directly or indirectly by the firm or general partners
and employees of the firm, or by the corporation or holders of the
controlling stock and employees of the corporation, and the affiliation
has been approved by the creditor's examining authority.
Cash equivalent means securities issued or guaranteed by the United
States or its agencies, negotiable bank certificates of deposit, bankers
acceptances issued by banking institutions in the United States and
payable in the United States, or money market mutual funds.
Covered option transaction means any transaction involving options
or warrants in which the customer's risk is limited and all elements of
the transaction are subject to contemporaneous exercise if:
(1) The amount at risk is held in the account in cash, cash
equivalents, or via an escrow receipt; and
(2) The transaction is eligible for the cash account by the rules of
the registered national securities exchange authorized to trade the
option or warrant or by the rules of the creditor's examining authority
in the case of an unregistered option, provided that all such rules have
been approved or amended by the SEC.
Credit balance means the cash amount due the customer in a margin
account after debiting amounts transferred to the special memorandum
account.
Creditor means any broker or dealer (as defined in sections 3(a)(4)
and 3(a)(5) of the Act), any member of a national securities exchange,
or any person associated with a broker or dealer (as defined in section
3(a)(18) of the Act), except for business entities controlling or under
common control with the creditor.
Current market value of:
(1) A security means:
(i) Throughout the day of the purchase or sale of a security, the
security's total cost of purchase or the net proceeds of its sale
including any commissions charged; or
(ii) At any other time, the closing sale price of the security on
the preceding business day, as shown by any regularly published
reporting or quotation service. If there is no closing sale price, the
creditor may use any reasonable estimate of the market value of the
security as of the close of business on the preceding business day.
(2) Any other collateral means a value determined by any reasonable
method.
Customer excludes an exempted borrower and includes:
(1) Any person or persons acting jointly:
(i) To or for whom a creditor extends, arranges, or maintains any
credit; or
(ii) Who would be considered a customer of the creditor according to
the ordinary usage of the trade;
(2) Any partner in a firm who would be considered a customer of the
firm absent the partnership relationship; and
(3) Any joint venture in which a creditor participates and which
would be considered a customer of the creditor if the creditor were not
a participant.
Debit balance means the cash amount owed to the creditor in a margin
account after debiting amounts transferred to the special memorandum
account.
Delivery against payment, Payment against delivery, or a C.O.D.
transaction refers to an arrangement under which a creditor and a
customer agree that the creditor will deliver to, or accept from, the
customer, or the customer's agent, a security against full payment of
the purchase price.
[[Page 7]]
Equity means the total current market value of security positions
held in the margin account plus any credit balance less the debit
balance in the margin account.
Escrow agreement means any agreement issued in connection with a
call or put option under which a bank or any person designated as a
control location under paragraph (c) of SEC Rule 15c3-3 (17 CFR
240.15c3-3(c)), holding the underlying asset or required cash or cash
equivalents, is obligated to deliver to the creditor (in the case of a
call option) or accept from the creditor (in the case of a put option)
the underlying asset or required cash or cash equivalent against payment
of the exercise price upon exercise of the call or put.
Examining authority means:
(1) The national securities exchange or national securities
association of which a creditor is a member; or
(2) If a member of more than one self-regulatory organization, the
organization designated by the SEC as the examining authority for the
creditor.
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 or dealer.
Exempted securities mutual fund means any security issued by an
investment company registered under section 8 of the Investment Company
Act of 1940 (15 U.S.C. 80a-8), provided the company has at least 95
percent of its assets continuously invested in exempted securities (as
defined in section 3(a)(12) of the Act).
Foreign margin stock means a foreign security that is an equity
security that:
(1) Appears on the Board's periodically published List of Foreign
Margin Stocks; or
(2) Is deemed to have a ``ready market'' under SEC Rule 15c3-1 (17
CFR 240.15c3-1) or a ``no-action'' position issued thereunder.
Foreign person means a person other than a United States person as
defined in section 7(f) of the Act.
Foreign security means a security issued in a jurisdiction other
than the United States.
Good faith with respect to:
(1) Margin means the amount of margin which a creditor would require
in exercising sound credit judgment;
(2) Making a determination or accepting a statement concerning a
borrower means that the creditor 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.
Margin call means a demand by a creditor to a customer for a deposit
of additional cash or securities to eliminate or reduce a margin
deficiency as required under this part.
Margin deficiency means the amount by which the required margin
exceeds the equity in the margin account.
Margin equity security means a margin security that is an equity
security (as defined in section 3(a)(11) of the Act).
Margin excess means the amount by which the equity in the margin
account exceeds the required margin. When the margin excess is
represented by securities, the current value of the securities is
subject to the percentages set forth in Sec. 220.12 (the Supplement).
Margin security means:
(1) Any security registered or having unlisted trading privileges on
a national securities exchange;
(2) After January 1, 1999, any security listed on the Nasdaq Stock
Market;
(3) Any non-equity security;
(4) Any security issued by either an open-end investment company or
unit investment trust which is registered
[[Page 8]]
under section 8 of the Investment Company Act of 1940 (15 U.S.C. 80a-8);
(5) Any foreign margin stock;
(6) Any debt security convertible into a margin security;
(7) Until January 1, 1999, any OTC margin stock; or
(8) Until January 1, 1999, 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).
Money market mutual fund means any security issued by an investment
company registered under section 8 of the Investment Company Act of 1940
(15 U.S.C. 80a-8) that is considered a money market fund under SEC Rule
2a-7 (17 CFR 270.2a-7).
Non-equity security means a security that is not an equity security
(as defined in section 3(a)(11) of the Act).
Nonexempted security means any security other than an exempted
security (as defined in section 3(a)(12) of the Act).
OTC margin stock means any equity security traded over the counter
that the Board has determined has the degree of national investor
interest, the depth and breadth of market, the availability of
information respecting the security and its issuer, and the character
and permanence of the issuer to warrant being treated like an equity
security treaded on a national securities exchange. An OTC stock is not
considered to be an OTC margin stock unless it appears on the Board's
periodically published list of OTC margin stocks.
Payment period means the number of business days in the standard
securities settlement cycle in the United States, as defined in
paragraph (a) of SEC Rule 15c6-1 (17 CFR 240.15c6-1(a)), plus two
business days.
Purpose credit means credit for the purpose of:
(1) Buying, carrying, or trading in securities; or
(2) Buying or carrying any part of an investment contract security
which shall be deemed credit for the purpose of buying or carrying the
entire security.
Short call or short put means a call option or a put option that is
issued, endorsed, or guaranteed in or for an account.
(1) A short call that is not cash-settled obligates the customer to
sell the underlying asset at the exercise price upon receipt of a valid
exercise notice or as otherwise required by the option contract.
(2) A short put that is not cash-settled obligates the customer to
purchase the underlying asset at the exercise price upon receipt of a
valid exercise notice or as otherwise required by the option contract.
(3) A short call or a short put that is cash-settled obligates the
customer to pay the holder of an in the money long put or long call who
has, or has been deemed to have, exercised the option the cash
difference between the exercise price and the current assigned value of
the option as established by the option contract.
Underlying asset means:
(1) The security or other asset that will be delivered upon exercise
of an option; or
(2) In the case of a cash-settled option, the securities or other
assets which comprise the index or other measure from which the option's
value is derived.
[Reg. T, 63 FR 2821, Jan. 16, 1998]
Sec. 220.3 General provisions.
(a) Records. The creditor shall maintain a record for each account
showing the full details of all transactions.
(b) Separation of accounts--(1) In general. The requirements of one
account may not be met by considering items in any other account. If
withdrawals of cash or securities are permitted under this part, written
entries shall be made when cash or securities are used for purposes of
meeting requirements in another account.
(2) Exceptions. Notwithstanding paragraph (b)(1) of this section:
(i) For purposes of calculating the required margin for a security
in a margin account, assets held in the good faith account pursuant to
Sec. 220.6(e)(1)(i) or (ii) may serve in lieu of margin;
(ii) Transfers may be effected between the margin account and the
special memorandum account pursuant to Secs. 220.4 and 220.5.
[[Page 9]]
(c) Maintenance of credit. Except as prohibited by this part, any
credit initially extended in compliance with this part may be maintained
regardless of:
(1) Reductions in the customer's equity resulting from changes in
market prices;
(2) Any security in an account ceasing to be margin or exempted; or
(3) Any change in the margin requirements prescribed under this
part.
(d) Guarantee of accounts. No guarantee of a customer's account
shall be given any effect for purposes of this part.
(e) Receipt of funds or securities. (1) A creditor, acting in good
faith, may accept as immediate payment:
(i) Cash or any check, draft, or order payable on presentation; or
(ii) Any security with sight draft attached.
(2) A creditor may treat a security, check or draft as received upon
written notification from another creditor that the specified security,
check, or draft has been sent.
(3) Upon notification that a check, draft, or order has been
dishonored or when securities have not been received within a reasonable
time, the creditor shall take the action required by this part when
payment or securities are not received on time.
(4) To temporarily finance a customer's receipt of securities
pursuant to an employee benefit plan registered on SEC Form S-8 or the
withholding taxes for an employee stock award plan, a creditor may
accept, in lieu of the securities, a properly executed exercise notice,
where applicable, and instructions to the issuer to deliver the stock to
the creditor. Prior to acceptance, the creditor must verify that the
issuer will deliver the securities promptly and the customer must
designate the account into which the securities are to be deposited.
(f) Exchange of securities. (1) To enable a customer to participate
in an offer to exchange securities which is made to all holders of an
issue of securities, a creditor may submit for exchange any securities
held in a margin account, without regard to the other provisions of this
part, provided the consideration received is deposited into the account.
(2) If a nonmargin, nonexempted security is acquired in exchange for
a margin security, its retention, withdrawal, or sale within 60 days
following its acquisition shall be treated as if the security is a
margin security.
(g) Arranging for loans by others. A creditor may arrange for the
extension or maintenance of credit to or for any customer by any person,
provided the creditor does not willfully arrange credit that violates
parts 221 or 224 of this chapter.
(h) Innocent mistakes. If any failure to comply with this part
results from a mistake made in good faith in executing a transaction or
calculating the amount of margin, the creditor shall not be deemed in
violation of this part if, promptly after the discovery of the mistake,
the creditor takes appropriate corrective action.
(i) Foreign currency. (1) Freely convertible foreign currency may be
treated at its U.S. dollar equivalent, provided the currency is marked-
to-market daily.
(2) A creditor may extend credit denominated in any freely
convertible foreign currency.
(j) Exempted borrowers. (1) A member of a national securities
exchange or a registered broker or dealer 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 lender of this fact before obtaining additional credit. 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.
[Reg. T, 63 FR 2822, Jan. 16, 1998]
Sec. 220.4 Margin account.
(a) Margin transactions. (1) All transactions not specifically
authorized for inclusion in another account shall be recorded in the
margin account.
(2) A creditor may establish separate margin accounts for the same
person to:
[[Page 10]]
(i) Clear transactions for other creditors where the transactions
are introduced to the clearing creditor by separate creditors; or
(ii) Clear transactions through other creditors if the transactions
are cleared by separate creditors; or
(iii) Provide one or more accounts over which the creditor or a
third party investment adviser has investment discretion.
(b) Required margin--(1) Applicability. The required margin for each
long or short position in securities is set forth in Sec. 220.12 (the
Supplement) and is subject to the following exceptions and special
provisions.
(2) Short sale against the box. A short sale ``against the box''
shall be treated as a long sale for the purpose of computing the equity
and the required margin.
(3) When-issued securities. The required margin on a net long or net
short commitment in a when-issued security is the margin that would be
required if the security were an issued margin security, plus any
unrealized loss on the commitment or less any unrealized gain.
(4) Stock used as cover. (i) When a short position held in the
account serves in lieu of the required margin for a short put, the
amount prescribed by paragraph (b)(1) of this section as the amount to
be added to the required margin in respect of short sales shall be
increased by any unrealized loss on the position.
(ii) When a security held in the account serves in lieu of the
required margin for a short call, the security shall be valued at no
greater than the exercise price of the short call.
(5) Accounts of partners. If a partner of the creditor has a margin
account with the creditor, the creditor shall disregard the partner's
financial relations with the firm (as shown in the partner's capital and
ordinary drawing accounts) in calculating the margin or equity of the
partner's margin account.
(6) Contribution to joint venture. If a margin account is the
account of a joint venture in which the creditor participates, any
interest of the creditor in the joint account in excess of the interest
which the creditor would have on the basis of its right to share in the
profits shall be treated as an extension of credit to the joint account
and shall be margined as such.
(7) Transfer of accounts. (i) A margin account that is transferred
from one creditor to another may be treated as if it had been maintained
by the transferee from the date of its origin, if the transferee
accepts, in good faith, a signed statement of the transferor (or, if
that is not practicable, of the customer), that any margin call issued
under this part has been satisfied.
(ii) A margin account that is transferred from one customer to
another as part of a transaction, not undertaken to avoid the
requirements of this part, may be treated as if it had been maintained
for the transferee from the date of its origin, if the creditor accepts
in good faith and keeps with the transferee account a signed statement
of the transferor describing the circumstances for the transfer.
(8) Sound credit judgment. In exercising sound credit judgment to
determine the margin required in good faith pursuant to Sec. 220.12 (the
Supplement), the creditor shall make its determination for a specified
security position without regard to the customer's other assets or
securities positions held in connection with unrelated transactions.
(c) When additional margin is required--(1) Computing deficiency.
All transactions on the same day shall be combined to determine whether
additional margin is required by the creditor. For the purpose of
computing equity in an account, security positions are established or
eliminated and a credit or debit created on the trade date of a security
transaction. Additional margin is required on any day when the day's
transactions create or increase a margin deficiency in the account and
shall be for the amount of the margin deficiency so created or
increased.
(2) Satisfaction of deficiency. The additional required margin may
be satisfied by a transfer from the special memorandum account or by a
deposit of cash, margin securities, exempted securities, or any
combination thereof.
(3) Time limits. (i) A margin call shall be satisfied within one
payment period
[[Page 11]]
after the margin deficiency was created or increased.
(ii) The payment period may be extended for one or more limited
periods upon application by the creditor to its examining authority
unless the examining authority believes that the creditor is not acting
in good faith or that the creditor has not sufficiently determined that
exceptional circumstances warrant such action. Applications shall be
filed and acted upon prior to the end of the payment period or the
expiration of any subsequent extension.
(4) Satisfaction restriction. Any transaction, position, or deposit
that is used to satisfy one requirement under this part shall be
unavailable to satisfy any other requirement.
(d) Liquidation in lieu of deposit. If any margin call is not met in
full within the required time, the creditor shall liquidate securities
sufficient to meet the margin call or to eliminate any margin deficiency
existing on the day such liquidation is required, whichever is less. If
the margin deficiency created or increased is $1000 or less, no action
need be taken by the creditor.
(e) Withdrawals of cash or securities. (1) Cash or securities may be
withdrawn from an account, except if:
(i) Additional cash or securities are required to be deposited into
the account for a transaction on the same or a previous day; or
(ii) The withdrawal, together with other transactions, deposits, and
withdrawals on the same day, would create or increase a margin
deficiency.
(2) Margin excess may be withdrawn or may be transferred to the
special memorandum account (Sec. 220.5) by making a single entry to that
account which will represent a debit to the margin account and a credit
to the special memorandum account.
(3) If a creditor does not receive a distribution of cash or
securities which is payable with respect to any security in a margin
account on the day it is payable and withdrawal would not be permitted
under this paragraph (e), a withdrawal transaction shall be deemed to
have occurred on the day the distribution is payable.
(f) Interest, service charges, etc. (1) Without regard to the other
provisions of this section, the creditor, in its usual practice, may
debit the following items to a margin account if they are considered in
calculating the balance of such account:
(i) Interest charged on credit maintained in the margin account;
(ii) Premiums on securities borrowed in connection with short sales
or to effect delivery;
(iii) Dividends, interest, or other distributions due on borrowed
securities;
(iv) Communication or shipping charges with respect to transactions
in the margin account; and
(v) Any other service charges which the creditor may impose.
(2) A creditor may permit interest, dividends, or other
distributions credited to a margin account to be withdrawn from the
account if:
(i) The withdrawal does not create or increase a margin deficiency
in the account; or
(ii) The current market value of any securities withdrawn does not
exceed 10 percent of the current market value of the security with
respect to which they were distributed.
[Reg. T, 63 FR 2823, Jan. 16, 1998]
Sec. 220.5 Special memorandum account.
(a) A special memorandum account (SMA) may be maintained in
conjunction with a margin account. A single entry amount may be used to
represent both a credit to the SMA and a debit to the margin account. A
transfer between the two accounts may be effected by an increase or
reduction in the entry. When computing the equity in a margin account,
the single entry amount shall be considered as a debit in the margin
account. A payment to the customer or on the customer's behalf or a
transfer to any of the customer's other accounts from the SMA reduces
the single entry amount.
(b) The SMA may contain the following entries:
(1) Dividend and interest payments;
(2) Cash not required by this part, including cash deposited to meet
a maintenance margin call or to meet any requirement of a self-
regulatory organization that is not imposed by this part;
(3) Proceeds of a sale of securities or cash no longer required on
any expired or liquidated security position that may be withdrawn under
Sec. 220.4(e); and
[[Page 12]]
(4) Margin excess transferred from the margin account under
Sec. 220.4(e)(2).
[Reg. T, 63 FR 2824, Jan. 16, 1998]
Sec. 220.6 Good faith account.
In a good faith account, a creditor may effect or finance customer
transactions in accordance with the following provisions:
(a) Securities entitled to good faith margin--(1) Permissible
transactions. A creditor may effect and finance transactions involving
the buying, carrying, or trading of any security entitled to ``good
faith'' margin as set forth in Sec. 220.12 (the Supplement).
(2) Required margin. The required margin is set forth in Sec. 220.12
(the Supplement).
(3) Satisfaction of margin. Required margin may be satisfied by a
transfer from the special memorandum account or by a deposit of cash,
securities entitled to ``good faith'' margin as set forth in Sec. 220.12
(the Supplement), any other asset that is not a security, or any
combination thereof. An asset that is not a security shall have a margin
value determined by the creditor in good faith.
(b) Arbitrage. A creditor may effect and finance for any customer
bona fide arbitrage transactions. For the purpose of this section, the
term ``bona fide arbitrage'' means:
(1) A 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 as nearly the same time as practicable for the purpose of taking
advantage of a difference in prices in the two markets; or
(2) A purchase of a security which 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 prices
of the two securities.
(c) ``Prime broker'' transactions. A creditor may effect
transactions for a customer as part of a ``prime broker'' arrangement in
conformity with SEC guidelines.
(d) Credit to ESOPs. A creditor may extend and maintain credit to
employee stock ownership plans without regard to the other provisions of
this part.
(e) Nonpurpose credit. (1) A creditor may:
(i) Effect and carry transactions in commodities;
(ii) Effect and carry transactions in foreign exchange;
(iii) Extend and maintain secured or unsecured nonpurpose credit,
subject to the requirements of paragraph (e)(2) of this section.
(2) Every extension of credit, except as provided in paragraphs
(e)(1)(i) and (e)(1)(ii) of this section, shall be deemed to be purpose
credit unless, prior to extending the credit, the creditor accepts in
good faith from the customer a written statement that it is not purpose
credit. The statement shall conform to the requirements established by
the Board.
[Reg. T, 63 FR 2824, Jan. 16, 1998]
Sec. 220.7 Broker-dealer credit account.
(a) Requirements. In a broker-dealer credit account, a creditor may
effect or finance transactions in accordance with the following
provisions.
(b) Purchase or sale of security against full payment. A creditor
may purchase any security from or sell any security to another creditor
or person regulated by a foreign securities authority under a good faith
agreement to promptly deliver the security against full payment of the
purchase price.
(c) Joint back office. A creditor may effect or finance transactions
of any of its owners if the creditor is a clearing and servicing broker
or dealer owned jointly or individually by other creditors.
(d) Capital contribution. A creditor may extend and maintain credit
to any partner or stockholder of the creditor for the purpose of making
a capital contribution to, or purchasing stock of, the creditor,
affiliated corporation or another creditor.
(e) Emergency and subordinated credit. A creditor may extend and
maintain, with the approval of the appropriate examining authority:
(1) Credit to meet the emergency needs of any creditor; or
[[Page 13]]
(2) Subordinated credit to another creditor for capital purposes, if
the other creditor:
(i) Is an affiliated corporation or would not be considered a
customer of the lender apart from the subordinated loan; or
(ii) Will not use the proceeds of the loan to increase the amount of
dealing in securities for the account of the creditor, its firm or
corporation or an affiliated corporation.
(f) Omnibus credit (1) A creditor may effect and finance
transactions for a broker or dealer who is registered with the SEC under
section 15 of the Act and who gives the creditor written notice that:
(i) All securities will be for the account of customers of the
broker or dealer; and
(ii) Any short sales effected will be short sales made on behalf of
the customers of the broker or dealer other than partners.
(2) The written notice required by paragraph (f)(1) of this section
shall conform to any SEC rule on the hypothecation of customers'
securities by brokers or dealers.
(g) Special purpose credit. A creditor may extend the following
types of credit with good faith margin:
(1) Credit to finance the purchase or sale of securities for prompt
delivery, if the credit is to be repaid upon completion of the
transaction.
(2) Credit to finance securities in transit or surrendered for
transfer, if the credit is to be repaid upon completion of the
transaction.
(3) 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.
(4) Credit to an exempted borrower.
(5) Credit to a member of a national securities exchange or
registered broker or dealer to finance its activities as a market maker
or specialist.
(6) Credit to a member of a national securities exchange or
registered broker or dealer to finance its activities as an underwriter.
[Reg. T, 63 FR 2824, Jan. 16, 1998]
Sec. 220.8 Cash account.
(a) Permissible transactions. In a cash account, a creditor, may:
(1) Buy for or sell to any customer any security or other asset if:
(i) There are sufficient funds in the account; or
(ii) The creditor accepts in good faith the customer's agreement
that the customer will promptly make full cash payment for the security
or asset before selling it and does not contemplate selling it prior to
making such payment;
(2) Buy from or sell for any customer any security or other asset
if:
(i) The security is held in the account; or
(ii) The creditor accepts in good faith the customer's statement
that the security is owned by the customer or the customer's principal,
and that it will be promptly deposited in the account;
(3) Issue, endorse, or guarantee, or sell an option for any customer
as part of a covered option transaction; and
(4) Use an escrow agreement in lieu of the cash, cash equivalents or
underlying asset position if:
(i) In the case of a short call or a short put, the creditor is
advised by the customer that the required securities, assets or cash are
held by a person authorized to issue an escrow agreement and the
creditor independently verifies that the appropriate escrow agreement
will be delivered by the person promptly; or
(ii) In the case of a call issued, endorsed, guaranteed, or sold on
the same day the underlying asset is purchased in the account and the
underlying asset is to be delivered to a person authorized to issue an
escrow agreement, the creditor verifies that the appropriate escrow
agreement will be delivered by the person promptly.
(b) Time periods for payment; cancellation or liquidation. (1) Full
cash payment. A creditor shall obtain full cash payment for customer
purchases:
(i) Within one payment period of the date:
(A) Any nonexempted security was purchased;
(B) Any when-issued security was made available by the issuer for
delivery to purchasers;
(C) Any ``when distributed'' security was distributed under a
published plan;
[[Page 14]]
(D) A security owned by the customer has matured or has been
redeemed and a new refunding security of the same issuer has been
purchased by the customer, provided:
(1) The customer purchased the new security no more than 35 calendar
days prior to the date of maturity or redemption of the old security;
(2) The customer is entitled to the proceeds of the redemption; and
(3) The delayed payment does not exceed 103 percent of the proceeds
of the old security.
(ii) In the case of the purchase of a foreign security, within one
payment period of the trade date or within one day after the date on
which settlement is required to occur by the rules of the foreign
securities market, provided this period does not exceed the maximum time
permitted by this part for delivery against payment transactions.
(2) Delivery against payment. If a creditor purchases for or sells
to a customer a security in a delivery against payment transaction, the
creditor shall have up to 35 calendar days to obtain payment if delivery
of the security is delayed due to the mechanics of the transaction and
is not related to the customer's willingness or ability to pay.
(3) Shipment of securities, extension. If any shipment of securities
is incidental to consummation of a transaction, a creditor may extend
the payment period by the number of days required for shipment, but not
by more than one additional payment period.
(4) Cancellation; liquidation; minimum amount. A creditor shall
promptly cancel or otherwise liquidate a transaction or any part of a
transaction for which the customer has not made full cash payment within
the required time. A creditor may, at its option, disregard any sum due
from the customer not exceeding $1000.
(c) 90 day freeze. (1) If a nonexempted security in the account is
sold or delivered to another broker or dealer without having been
previously paid for in full by the customer, the privilege of delaying
payment beyond the trade date shall be withdrawn for 90 calendar days
following the date of sale of the security. Cancellation of the
transaction other than to correct an error shall constitute a sale.
(2) The 90 day freeze shall not apply if:
(i) Within the period specified in paragraph (b)(1) of this section,
full payment is received or any check or draft in payment has cleared
and the proceeds from the sale are not withdrawn prior to such payment
or check clearance; or
(ii) The purchased security was delivered to another broker or
dealer for deposit in a cash account which holds sufficient funds to pay
for the security. The creditor may rely on a written statement accepted
in good faith from the other broker or dealer that sufficient funds are
held in the other cash account.
(d) Extension of time periods; transfers. (1) Unless the creditor's
examining authority believes that the creditor is not acting in good
faith or that the creditor has not sufficiently determined that
exceptional circumstances warrant such action, it may upon application
by the creditor:
(i) Extend any period specified in paragraph (b) of this section;
(ii) Authorize transfer to another account of any transaction
involving the purchase of a margin or exempted security; or
(iii) Grant a waiver from the 90 day freeze.
(2) Applications shall be filed and acted upon prior to the end of
the payment period, or in the case of the purchase of a foreign security
within the period specified in paragraph (b)(1)(ii) of this section, or
the expiration of any subsequent extension.
[Reg. T, 63 FR 2825, Jan. 16, 1998]
Sec. 220.9 Clearance of securities, options, and futures.
(a) Credit for clearance of securities. The provisions of this part
shall not apply to the extension or maintenance of any credit that is
not for more than one day if it is incidental to the clearance of
transactions in securities directly between members of a national
securities exchange or association or through any clearing agency
registered with the SEC.
(b) Deposit of securities with a clearing agency. The provisions of
this part
[[Page 15]]
shall not apply to the deposit of securities with an option or futures
clearing agency for the purpose of meeting the deposit requirements of
the agency if:
(1) The clearing agency:
(i) Issues, guarantees performance on, or clears transactions in,
any security (including options on any security, certificate of deposit,
securities index or foreign currency); or
(ii) Guarantees performance of contracts for the purchase or sale of
a commodity for future delivery or options on such contracts;
(2) The clearing agency is registered with the Securities and
Exchange Commission or is the clearing agency for a contract market
regulated by the Commodity Futures Trading Commission; and
(3) The deposit consists of any margin security and complies with
the rules of the clearing agency that have been approved by the
Securities and Exchange Commission or the Commodity Futures Trading
Commission.
[Reg. T, 63 FR 2826, Jan. 16, 1998]
Sec. 220.10 Borrowing and lending securities.
(a) Without regard to the other provisions of this part, a creditor
may borrow or lend securities for the purpose of making delivery of the
securities in the case of short sales, failure to receive securities
required to be delivered, or other similar situations. If a creditor
reasonably anticipates a short sale or fail transaction, such borrowing
may be made up to one standard settlement cycle in advance of trade
date.
(b) A creditor may lend foreign securities to a foreign person (or
borrow such securities for the purpose of relending them to a foreign
person) for any purpose lawful in the country in which they are to be
used.
(c) A creditor that is an exempted borrower may lend securities
without regard to the other provisions of this part and a creditor may
borrow securities from an exempted borrower without regard to the other
provisions of this part.
[Reg. T, 63 FR 2826, Jan. 16, 1998]
Sec. 220.11 Requirements for the list of marginable OTC stocks and the list of foreign margin stocks.
(a) Requirements for inclusion on the list of marginable OTC stocks.
Except as provided in paragraph (f) of this section, OTC margin stock
shall meet the following requirements:
(1) Four or more dealers stand willing to, and do in fact, make a
market in such stock and regularly submit bona fide bids and offers to
an automated quotations system for their own accounts;
(2) The minimum average bid price of such stock, as determined by
the Board, is at least $5 per share;
(3) The stock is registered under section 12 of the Act, is issued
by an insurance company subject to section 12(g)(2)(G) of the Act, is
issued by a closed-end investment management company subject to
registration pursuant to section 8 of the Investment Company Act of 1940
(15 U.S.C. 80a-8), is an American Depository Receipt (ADR) of a foreign
issuer whose securities are registered under section 12 of the Act, or
is a stock of an issuer required to file reports under section 15(d) of
the Act;
(4) Daily quotations for both bid and asked prices for the stock are
continously available to the general public;
(5) The stock has been publicly traded for at least six months;
(6) The issuer has at least $4 million of capital, surplus, and
undivided profits;
(7) There are 400,000 or more shares of such stock outstanding in
addition to shares held beneficially by officers, directors or
beneficial owners of more than 10 percent of the stock;
(8) There are 1,200 or more holders of record, as defined in SEC
Rule 12g5-1 (17 CFR 240.12g5-1), of the stock who are not officers,
directors or beneficial owners of 10 percent or more of the stock, or
the average daily trading volume of such stock as determined by the
Board, is at least 500 shares; and
(9) The issuer or a predecessor in interest has been in existence
for at least three years.
(b) Requirements for continued inclusion on the list of marginable
OTC stocks. Except as provided in paragraph (f) of
[[Page 16]]
this section, OTC margin stock shall meet the following requirements:
(1) Three or more dealers stand willing to, and do in fact, make a
market in such stock and regularly submit bona fide bids and offers to
an automated quotations system for their own accounts;
(2) The minimum average bid price of such stocks, as determined by
the Board, is at least $2 per share;
(3) The stock is registered as specified in paragraph (a)(3) of this
section;
(4) Daily quotations for both bid and asked prices for the stock are
continuously available to the general public; ;
(5) The issuer has at least $1 million of capital, surplus, and
undivided profits;
(6) There are 300,000 or more shares of such stock outstanding in
addition to shares held beneficially by officers, directors, or
beneficial owners of more than 10 percent of the stock; and
(7) There continue to be 800 or more holders of record, as defined
in SEC Rule 12g5-1 (17 CFR 240.12g5-1), of the stock who are not
officers, directors, or beneficial owners of 10 percent or more of the
stock, or the average daily trading volume of such stock, as determined
by the Board, is at least 300 shares.
(c) Requirements for inclusion on the list of foreign margin stocks.
Except as provided in paragraph (f) of this section, a foreign security
shall meet the following requirements before being placed on the List of
Foreign Margin Stocks:
(1) The security is an equity security that is listed for trading on
or through the facilities of a foreign securities exchange or a
recognized foreign securities market and has been trading on such
exchange or market for at least six months;
(2) Daily quotations for both bid and asked or last sale prices for
the security provided by the foreign securities exchange or foreign
securities market on which the security is traded are continuously
available to creditors in the United States pursuant to an electronic
quotation system;
(3) The aggregate market value of shares, the ownership of which is
unrestricted, is not less than $1 billion;
(4) The average weekly trading volume of such security during the
preceding six months is either at least 200,000 shares or $1 million;
and
(5) The issuer or a predecessor in interest has been in existence
for at least five years.
(d) Requirements for continued inclusion on the list of foreign
margin stocks. Except as provided in paragraph (f) of this section, a
foreign security shall meet the following requirements to remain on the
List of Foreign Margin Stocks:
(1) The security continues to meet the requirements specified in
paragraphs (c) (1) and (2) of this section;
(2) The aggregate market value of shares, the ownership of which is
unrestricted, is not less than $500 million; and
(3) The average weekly trading volume of such security during the
preceding six months is either at least 100,000 shares or $500,000.
(e) Removal from the list. The Board shall periodically remove from
the lists any stock that:
(1) Ceases to exist or of which the issuer ceases to exist; or
(2) No longer substantially meets the provisions of paragraphs (b)
or (d) of this section or the definition of OTC margin stock.
(f) Discretionary authority of Board. Without regard to other
paragraphs of this section, the Board may add to, or omit or remove from
the list of marginable OTC stocks and the list of foreign margin stocks
an equity security, if in the judgment of the Board, such action is
necessary or appropriate in the public interest.
(g) Unlawful representations. It shall be unlawful for any creditor
to make, or cause to be made, any representation to the effect that the
inclusion of a security on the list of marginable OTC stocks or the list
of foreign margin stocks is evidence that the Board or the SEC has in
any way passed upon the merits of, or given approval to, such security
or any transactions therein. Any statement in an advertisement or other
similar communication containing a reference to the Board in connection
with the lists or
[[Page 17]]
stocks on those lists shall be an unlawful representation.
[Reg. T, 63 FR 2826, Jan. 16, 1998]
Sec. 220.12 Supplement: margin requirements.
The required margin for each security position held in a margin
account shall be as follows:
(a) Margin equity security, except for an exempted security, money
market mutual fund or exempted securities mutual fund, warrant on a
securities index or foreign currency or a long position in an option: 50
percent of the current market value of the security or the percentage
set by the regulatory authority where the trade occurs, whichever is
greater.
(b) Exempted security, non-equity security, money market mutual fund
or exempted securities mutual fund: The margin required by the creditor
in good faith or the percentage set by the regulatory authority where
the trade occurs, whichever is greater.
(c) Short sale of a nonexempted security, except for a non-equity
security:
(1) 150 percent of the current market value of the security; or
(2) 100 percent of the current market value if a security
exchangeable or convertible within 90 calendar days without restriction
other than the payment of money into the security sold short is held in
the account, provided that any long call to be used as margin in
connection with a short sale of the underlying security is an American-
style option issued by a registered clearing corporation and listed or
traded on a registered national securities exchange with an exercise
price that does not exceed the price at which the underlying security
was sold short.
(d) Short sale of an exempted security or non-equity security: 100
percent of the current market value of the security plus the margin
required by the creditor in good faith.
(e) Nonmargin, nonexempted equity security: 100 percent of the
current market value.
(f) Put or call on a security, certificate of deposit, securities
index or foreign currency or a warrant on a securities index or foreign
currency:
(1) In the case of puts and calls issued by a registered clearing
corporation and listed or traded on a registered national securities
exchange or a registered securities association and registered warrants
on a securities index or foreign currency, the amount, or other position
specified by the rules of the registered national securities exchange or
the registered securities association authorized to trade the option or
warrant, provided that all such rules have been approved or amended by
the SEC; or
(2) In the case of all other puts and calls, the amount, or other
position, specified by the maintenance rules of the creditor's examining
authority.
[Reg. T, 63 FR 2827, Jan. 16, 1998]
Interpretations
Sec. 220.101 Transactions of customers who are brokers or dealers.
The Board has recently considered certain questions regarding
transactions of customers who are brokers or dealers.
(a) The first question was whether delivery and payment under
Sec. 220.4(f)(3) must be exactly simultaneous (such as in sight draft
shipments), or whether it is sufficient if the broker-dealer customer,
``as promptly as practicable in accordance with the ordinary usage of
the trade,'' mails or otherwise delivers to the creditor a check in
settlement of the transaction, the check being accompanied by
instructions for transfer or delivery of the security. The Board ruled
that the latter method of setting the transaction is permissible.
(b) The second question was, in effect, whether the limitations of
Sec. 220.4(c)(8) apply to the account of a customer who is himself a
broker or dealer. The answer is that the provision applies to any
``special cash account,'' regardless of the type of customer.
(c) The third question was, in effect, whether a purchase and a sale
of an unissued security under Sec. 220.4(f)(3) may be offset against
each other, or whether each must be settled separately by what would
amount to delivery of the security to settle one transaction and its
redelivery to settle the other. The answer is that it is permissible to
offset the transactions against each other
[[Page 18]]
without physical delivery and redelivery of the security.
[11 FR 14155, Dec. 7, 1946]
Sec. 220.102 [Reserved]
Sec. 220.103 Borrowing of securities.
(a) The Board of Governors has been asked for a ruling as to whether
Sec. 220.6(h), which deals with borrowing and lending of securities,
applies to a borrower of securities if the lender is a private
individual, as contrasted with a member of a national securities
exchange or a broker or dealer.
(b) Section 220.6(h) does not require that the lender of the
securities in such a case be a member of a national securities exchange
or a broker or dealer. Therefore, a borrowing of securities may be able
to qualify under the provision even though the lender is a private
individual, and this is true whether the security is registered on a
national securities exchange or is unregistered. In borrowing securities
from a private individual under Sec. 220.6(h), however, it becomes
especially important to bear in mind two limitations that are contained
in the section.
(c) The first limitation is that the section applies only if the
broker borrows the securities for the purpose specified in the
provision, that is, ``for the purpose of making delivery of such
securities in the case of short sales, failure to receive securities he
is required to deliver, or other similar cases''. The present language
of the provision does not require that the delivery for which the
securities are borrowed must be on a transaction which the borrower has
himself made, either as agent or as principal; he may borrow under the
provision in order to relend to someone else for the latter person to
make such a delivery. However, the borrowing must be related to an
actual delivery of the type specified--a delivery in connection with a
specific transaction that has already occurred or is in immediate
prospect. The provision does not authorize a broker to borrow securities
(or make the related deposit) merely in order that he or some other
broker may have the securities ``on hand'' or may anticipate some need
that may or may not arise in the future.
(d) The ruling in the 1940 Federal Reserve Bulletin, at page 647, is
an example of a borrowing which, on the facts as given, did not meet the
requirement. There, the broker wished to borrow stocks with the
understanding that he ``would offer to lend this stock in the `loan
crowd' on a national securities exchange.'' There was no assurance that
the stocks would be used for the purpose specified in Sec. 220.6(h);
they might be, or they might merely be held idle while the person
lending the stocks had the use of the funds deposited against them. The
ruling held in effect that since the borrowing could not qualify under
Sec. 220.6(h) it must comply with other applicable provisions of the
regulation.
(e) The second requirement is that the deposit of cash against the
borrowed securities must be ``bona fide.'' This requirement naturally
cannot be spelled out in detail, but it requires at least that the
purpose of the broker in making the deposit should be to obtain the
securities for the specified purpose, and that he should not use the
arrangement as a means of accommodating a customer who is seeking to
obtain more funds than he could get in a general account.
(f) The Board recognizes that even with these requirements there is
still some possibility that the provision may be misapplied. The Board
is reluctant to impose additional burdens on legitimate transactions by
tightening the provision. If there should be evidence of abuses
developing under the provision, however, it would become necessary to
consider making it more restricted.
[12 FR 5278, Aug. 2, 1947]
Sec. 220.104 [Reserved]
Sec. 220.105 Ninety-day rule in special cash account.
(a) Section 220.4(c)(8) places a limitation on a special cash
account if a security other than an exempted security has been purchased
in the account and ``without having been previously paid for in full by
the customer * * * has been * * * delivered out to any broker or
dealer.'' The limitation is that during the succeeding 90 days the
customer may not purchase a security in
[[Page 19]]
the account other than an exempted security unless funds sufficient for
the purpose are held in the account. In other words, the privilege of
delayed payment in such an account is withdrawn during the 90-day
period.
(b) The Board recently considered a question as to whether the
following situation makes an account subject to the 90-day
disqualification: A customer purchases registered security ABC in a
special cash account. The broker executes the order in good faith as a
bona fide cash transaction, expecting to obtain full cash payment
promptly. The next day, the customer sells registered security XYZ in
the account, promising to deposit it promptly in the account. The
proceeds of the sale are equal to or greater than the cost of security
ABC. After both sale and purchase have been made, the customer requests
the broker to deliver security ABC to a different broker, to receive
security XYZ from that broker at about the same time, and to settle with
the other broker--such settlement to be made either by paying the cost
of security XYZ to the other broker and receiving from him the cost of
security ABC, or by merely settling any difference between these
amounts.
(c) The Board expressed the view that the account becomes subject to
the 90-day disqualification in Sec. 220.4(c)(8). In the instant case,
unlike that described at 1940 Federal Reserve Bulletin 772, the security
sold is not held in the account and is not to be deposited in it
unconditionally. It is to be obtained only against the delivery to the
other broker of the security which had been purchased. Hence payment can
not be said to have been made prior to such delivery; the purchased
security has been delivered out to a broker without previously having
been paid for in full, and the account becomes subject to the 90-day
disqualification.
[13 FR 2368, May 1, 1948]
Secs. 220.106-220.107 [Reserved]
Sec. 220.108 International Bank Securities.
(a) Section 2 of the Act of June 29, 1949 (Pub. L. 142--81st
Congress), amended the Bretton Woods Agreements Act by adding a new
section numbered 15 providing, in part, that--
Any securities issued by International Bank for Reconstruction and
Development (including any guaranty by the bank, whether or not limited
in scope), and any securities guaranteed by the bank as to both
principal and interest, shall be deemed to be exempted securities within
the meaning of * * * paragraph (a)(12) of section 3 of the [Securities
Exchange] Act of June 6, 1934, as amended (15 U.S.C. 78c). * * *.
(b) In response to inquiries with respect to the applicability of
the margin requirements of this part to securities issued or guaranteed
by the International Bank for Reconstruction and Development, the Board
has replied that, as a result of this enactment, securities issued by
the Bank are now classified as exempted securities under Sec. 220.2(e).
Such securities are now in the same category under this part as are
United States Government, State and municipal bonds. Accordingly, the
specific percentage limitations prescribed by this part with respect to
maximum loan value and margin requirements are no longer applicable
thereto.
[14 FR 5505, Sept. 7, 1949]
Sec. 220.109 [Reserved]
Sec. 220.110 Assistance by Federal credit union to its members.
(a) An inquiry was presented recently concerning the application of
this part or part 221 of this subchapter, to a plan proposed by a
Federal credit union to aid its members in purchasing stock of a
corporation whose subsidiary apparently was the employer of all the
credit union's members.
(b) From the information submitted, the plan appeared to contemplate
that the Federal credit union would accept orders from its members for
registered common stock of the parent corporation in multiples of 5
shares; that whenever orders had been so received for a total of 100
shares, the credit union, as agent for such members, would execute the
orders through a brokerage firm with membership on a national securities
exchange; that the brokerage firm would deliver certificates for the
stock, registered in the names of the individual purchasers, to the
credit union against payment by
[[Page 20]]
the credit union; that the credit union would prorate the total amount
so paid, including the brokerage fee, among the individual purchasers
according to the number of shares purchased by them; and that a savings
in brokerage fee resulting from the 100-lot purchases would be passed on
by the credit union to the individual purchasers of the stock. However,
amounts of the stock less than 100 shares would be purchased by the
credit union through the brokerage firm for any members willing to
forego such savings.
(c) It appeared further that the Federal credit union members for
whom stock was so purchased would reimburse the credit union (1) by cash
payment, (2) by the proceeds of withdrawn shares of the credit union,
(3) by the proceeds of an installment loan from the credit union
collateraled by the stock purchased, or by (4) by a combination of two
or more of the above methods. To assist the collection of any such loan,
the employer of the credit union members would provide payroll
deductions. Apparently, sales by the credit union of any of the stock
purchased by one of its members would occur only in satisfaction of a
delinquent loan balance. In no case did it appear that the credit union
would make a charge for arranging the execution of transactions in the
stock for its members.
(d) The Board was of the view that, from the facts as presented, it
did not appear that the Federal credit union should be regarded as the
type of institution to which part 221 of this subchapter, in its present
form, applied.
(e) With respect to this part, the question was whether the
activities of the Federal credit union under the proposal, or otherwise,
might be such as to bring it within the meaning of the terms ``broker''
or ``dealer'' as used in the part and the Securities Exchange Act of
1934. The Board observed that this, of course, was a question of fact
that necessarily depended upon the circumstances of the particular case,
including the manner in which the arrangement in question might be
carried out in practice.
(f) On the basis of the information submitted, however, it did not
appear to the Board that the Federal credit union should be regarded as
being subject to this part as a ``broker or dealer who transacts a
business in securities through the medium of'' a member firm solely
because of its activities as contemplated by the proposal in question.
The Board stated that the part rather clearly would not apply if there
appeared to be nothing other than loans by the credit union to its
members to finance purchases made directly by them of stock of the
parent corporation of the employer of the member-borrowers. The
additional fact that the credit union, as agent, would purchase such
stock for its members (even though all such purchases might not be
financed by credit union loans) was not viewed by the Board as
sufficient to make the regulation applicable where, as from the facts
presented, it did not appear that the credit union in any case was to
make any charge or receive any compensation for assisting in such
purchases or that the credit union otherwise was engaged in securities
activities. However, the Board stated that matters of this kind must be
examined closely for any variations that might suggest the
inapplicability of the foregoing.
[18 FR 4592, Aug. 5, 1953]
Sec. 220.111 Arranging for extensions of credit to be made by a bank.
(a) The Board has recently had occasion to express opinions
regarding the requirements which apply when a person subject to this
part (for convenience, called here simply a broker) arranges for a bank
to extend credit.
(b) The matter is treated generally in Sec. 220.7(a) and is also
subject to the general rule of law that any person who aids or abets a
violation of law by another is himself guilty of a violation. It may be
stated as a general principle that any person who arranges for credit to
be extended by someone else has a responsibility so to conduct his
activities as not to be a participant in a violation of this part, which
applies to brokers, or part 221 of this subchapter, which applies to
banks.
(c) More specifically, in arranging an extension of credit that may
be subject to part 221 of this subchapter, a broker must act in good
faith and, therefore,
[[Page 21]]
must question the accuracy of any non-purpose statement (i.e., a
statement that the loan is not for the purpose of purchasing or carrying
registered stocks) given in connection with the loan where the
circumstances are such that the broker from any source knows or has
reason to know that the statement is incomplete or otherwise inaccurate
as to the true purpose of the credit. The requirement of ``good faith''
is of vital importance. While the application of the requirement will
necessarily vary with the facts of the particular case, the broker, like
the bank for whom the loan is arranged to be made, must be alert to the
circumstances surrounding the loan. Thus, for example, if a broker or
dealer is to deliver registered stocks to secure the loan or is to
receive the proceeds of the loan, the broker arranging the loan and the
bank making it would be put on notice that the loan would probably be
subject to part 221 of this subchapter. In any such circumstances they
could not in good faith accept or rely upon a statement to the contrary
without obtaining a reliable and satisfactory explanation of the
situation. The foregoing, of course, applies the principles contained in
Sec. 221.101 of this subchapter.
(d) In addition, when a broker is approached by another broker to
arrange extensions of credit for customers of the approaching broker,
the broker approached has a responsibility not to arrange any extension
of credit which the approaching broker could not himself arrange.
Accordingly, in such cases the statutes and regulations forbid the
approached broker to arrange extensions of credit on unregistered
securities for the purpose of purchasing or carrying either registered
or unregistered securities. The approaching broker would also be
violating the applicable requirements if he initiated or otherwise
participated in any such forbidden transactions.
(e) The expression of views, set forth in this section, to the
effect that certain specific transactions are forbidden, of course,
should not in any way be understood to indicate approval of any other
transactions which are not mentioned.
[18 FR 5505, Sept. 15, 1953]
Sec. 220.112 [Reserved]
Sec. 220.113 Necessity for prompt payment and delivery in special cash accounts.
(a) The Board of Governors recently received an inquiry concerning
whether purchases of securities by certain municipal employees'
retirement or pension systems on the basis of arrangements for delayed
delivery and payment, might properly be effected by a creditor subject
to this part in a special cash account under Sec. 220.4(c).
(b) It appears that in a typical case the supervisors of the
retirement system meet only once or twice each month, at which times
decisions are made to purchase any securities wished to be acquired for
the system. Although the securities are available for prompt delivery by
the broker-dealer firm selected to effect the system's purchase, it is
arranged in advance with the firm that the system will not accept
delivery and pay for the securities before some date more than seven
business days after the date on which the securities are purchased.
Apparently, such an arrangement is occasioned by the monthly or
semimonthly meetings of the system's supervisors. It was indicated that
a retirement system of this kind may be supervised by officials who
administer it as an incidental part of their regular duties, and that
meetings requiring joint action by two or more supervisors may be
necessary under the system's rules and procedures to authorize issuance
of checks in payment for the securities purchased. It was indicated also
that the purchases do not involve exempted securities, securities of the
kind covered by Sec. 220.4(c)(3), or any shipment of securities as
described in Sec. 220.4(c).
(c) This part provides that a creditor subject thereto may not
effect for a customer a purchase in a special cash account under
Sec. 220.4(c) unless the use of the account meets the limitations of
Sec. 220.4(a) and the purchase constitutes a ``bona fide cash
transaction'' which complies with the eligibility requirements of
Sec. 220.4(c)(1)(i). One such requirement is that the purchase be made
``in reliance upon an agreement accepted by the creditor (broker-dealer)
in good faith'' that the customer
[[Page 22]]
will ``promptly make full cash payment for the security, if funds
sufficient for the purpose are not already in the account; and, subject
to certain exceptions, Sec. 220.4(c)(2) provides that the creditor shall
promptly cancel or liquidate the transaction if payment is not made by
the customer within seven business days after the date of purchase. As
indicated in the Board's interpretation at 1940 Federal Reserve Bulletin
1172, a necessary part of the customer's undertaking pursuant to
Sec. 220.4(c)(1)(i) is that he ``should have the necessary means of
payment readily available when he purchases a security in the special
cash account. He should expect to pay for it immediately or in any event
within the period (of not more than a very few days) that is as long as
is usually required to carry through the ordinary securities
transaction.''
(d) The arrangements for delayed delivery and payment in the case
presented to the Board and outlined above clearly would be inconsistent
with the requirement of Sec. 220.4(c)(1)(i) that the purchase be made in
reliance upon an agreement accepted by the creditor in good faith that
the customer will ``promptly'' make full cash payment for the security.
Accordingly, the Board said that transactions of the kind in question
would not qualify as a ``bona fide cash transaction'' and, therefore,
could not properly be effected in a special cash account, unless a
contrary conclusion would be justified by the exception in
Sec. 220.4(c)(5).
(e) Section 220.4(c)(5) provides that if the creditor, ``acting in
good faith in accordance with'' Sec. 220.4(c)(1), purchases a security
for a customer ``with the understanding that he is to deliver the
security promptly to the customer, and the full cash payment is to be
made promptly by the customer is to be made against such delivery'', the
creditor may at his option treat the transaction as one to which the
period applicable under Sec. 220.4(c)(2) is not the seven days therein
specified but 35 days after the date of such purchase. It will be
observed that the application of Sec. 220.4 (c)(5) is specifically
conditioned on the creditor acting in good faith in accordance with
Sec. 220.4(c)(1). As noted above, the existence of the arrangements for
delayed delivery and payment in the case presented would prevent this
condition from being met, since the customer could not be regarded as
having agreed to make full cash payment ``promptly''. Furthermore, such
arrangements clearly would be inconsistent with the requirement of
Sec. 220.4(c)(5) that the creditor ``deliver the security promptly to
the customer''.
(f) Section 220.4(c)(5) was discussed in the Board's published
interpretation, referred to above, which states that ``it is not the
purpose of (Sec. 220.4 (c)(5)) to allow additional time to customers for
making payment. The `prompt delivery' described in (Sec. 220.4 (c)(5))
is delivery which is to be made as soon as the broker or dealer can
reasonably make it in view of the mechanics of the securities business
and the bona fide usages of the trade. The provision merely recognizes
the fact that in certain circumstances it is an established bona fide
practice in the trade to obtain payment against delivery of the security
to the customer, and the further fact that the mechanics of the trade,
unrelated to the customer's readiness to pay, may sometimes delay such
delivery to the customer''.
(g) In the case presented, it appears that the only reason for the
delay is related solely to the customer's readiness to pay and is in no
way attributable to the mechanics of the securities business.
Accordingly, it is the Board's view that the exception in
Sec. 220.4(c)(5) should not be regarded as permitting the transactions
in question to be effected in a special cash account.
[22 FR 5954, July 27, 1957]
Secs. 220.114-220.116 [Reserved]
Sec. 220.117 Exception to 90-day rule in special cash account.
(a) The Board of Governors has recently interpreted certain of the
provisions of Sec. 220.4(c)(8), with respect to the withdrawal of
proceeds of a sale of stock in a ``special cash account'' when the stock
has been sold out of the account prior to payment for its purchase.
(b) The specific factual situation presented may be summarized as
follows:
[[Page 23]]
Customer purchased stock in a special cash account with a member
firm on Day 1. On Day 3 customer sold the same stock at a profit. On Day
8 customer delivered his check for the cost of the purchase to the
creditor (member firm). On Day 9 the creditor mailed to the customer a
check for the proceeds of the sale.
(c) Section 220.4(c)(8) prohibits a creditor, as a general rule,
from effecting a purchase of a security in a customer's special cash
account if any security has been purchased in that account during the
preceding 90 days and has then been sold in the account or delivered out
to any broker or dealer without having been previously paid for in full
by the customer. One exception to this general rule reads as follows:
* * * The creditor may disregard for the purposes of this
subparagraph (Sec. 220.4(c) (8)) a sale without prior payment provided
full cash payment is received within the period described by
subparagraph (2) of this paragraph (seven days after the date of
purchase) and the customer has not withdrawn the proceeds of sale on or
before the day on which such payment (and also final payment of any
check received in that connection) is received. * * *
(d) Final payment of customer's check: (1) The first question is:
When is the creditor to be regarded as having received ``final payment
of any check received'' in connection with the purchase?
(2) The clear purpose of Sec. 220.4(c) (8) is to prevent the use of
the proceeds of sale of a stock by a customer to pay for its purchase--
i.e., to prevent him from trading on the creditor's funds by being able
to deposit the sale proceeds prior to presentment of his own check to
the drawee bank. Thus, when a customer undertakes to pay for a purchase
by check, that check does not constitute payment for the purchase,
within the language and intent of the above-quoted exception in
Sec. 220.4(c)(8), until it has been honored by the drawee bank,
indicating the sufficiency of his account to pay the check.
(3) The phrase ``final payment of any check'' is interpreted as
above notwithstanding Sec. 220.6(f), which provides that:
For the purposes of this part (Regulation T), a creditor may, at his
option (1) treat the receipt in good faith of any check or draft drawn
on a bank which in the ordinary course of business is payable on
presentation, * * * as receipt of payment of the amount of such check,
draft or order; * * *
This is a general provision substantially the same as language found in
section 4(f) of Regulation T as originally promulgated in 1934. The
language of the subject exception to the 90-day rule of
Sec. 220.4(c)(8), i.e., the exception based expressly on final ``payment
of any check,'' was added to the regulation in 1949 by an amendment
directed at a specific type of situation. Because the exception is a
special, more recent provision, and because Sec. 220.6(f), if
controlling, would permit the exception to undermine, to some extent,
the effectiveness of the 90-day rule, sound principles of construction
require that the phrase ``final payment of any check'' be given its
literal and intended effect.
(4) There is no fixed period of time from the moment of receipt by
the payee, or of deposit, within which it is certain that any check will
be paid by the drawee bank. Therefore, in the rare case where the
operation of the subject exception to Sec. 220.4(c)(8) is necessary to
avoid application of the 90-day rule, a creditor should ascertain (from
his bank of deposit or otherwise) the fact of payment of a customer's
check given for the purchase. Having so determined the day of final
payment, the creditor can permit withdrawal on any subsequent day.
(e) Mailing as ``withdrawal'': (1) Also presented is the question
whether the mailing to the customer of the creditor's check for the sale
proceeds constitutes a withdrawal of such proceeds by the customer at
the time of mailing so that, if the check for the sale proceeds is
mailed on or before the day on which the customer's check for the
purchase is finally paid, the 90-day rule applies. It may be that a
check mailed one day will not ordinarily be received by the customer
until the next. The Board is of the view, however, that when the check
for sale proceeds is issued and released into the mails, the proceeds
are to be regarded as withdrawn by the customer; a more liberal
interpretation would open a way for circumvention. Accordingly, the
creditor's check should not be mailed nor the sale proceeds otherwise
released to
[[Page 24]]
the customer ``on or before the day'' on which payment for the purchase,
including final payment of any check given for such payment, is received
by the creditor, as determined in accordance with the principles stated
herein.
(2) Applying the above principles to the schedule of transactions
described in the second paragraph of this interpretation, the mailing of
the creditor's check on ``Day 9'' would be consistent with the subject
exception to Sec. 220.4(c)(8), as interpreted herein, only if the
customer's check was paid by the drawee bank on ``Day 8''.
[27 FR 3511, Apr. 12, 1962]
Sec. 220.118 Time of payment for mutual fund shares purchased in a special cash account.
(a) The Board has recently considered the question whether, in
connection with the purchase of mutual fund shares in a ``special cash
account'' under the provisions of this part 220, the 7-day period with
respect to liquidation for nonpayment is that described in
Sec. 220.4(c)(2) or that described in Sec. 220.4(c)(3).
(b) Section 220.4(c)(2) provides as follows:
In case a customer purchases a security (other than an exempted
security) in the special cash account and does not make full cash
payment for the security within 7 days after the date on which the
security is so purchased, the creditor shall, except as provided in
subparagraphs (3)-(7) of this paragraph, promptly cancel or otherwise
liquidate the transaction or the unsettled portion thereof.
Section 220.4(c)(3), one of the exceptions referred to, provides in
relevant part as follows:
If the security when so purchased is an unissued security, the
period applicable to the transaction under subparagraph (2) of this
paragraph shall be 7 days after the date on which the security is made
available by the issuer for delivery to purchasers.
(c) In the case presented, the shares of the mutual fund (open-end
investment company) are technically not issued at the time they are sold
by the underwriter and distributor. Several days may elapse from the
date of sale before a certificate can be delivered by the transfer
agent. The specific inquiry to the Board was, in effect, whether the 7-
day period after which a purchase transaction must be liquidated or
cancelled for nonpayment should run, in the case of mutual fund shares,
from the time when a certificate for the purchased shares is available
for delivery to the purchaser, instead of from the date of the purchase.
(d) Under the general rule of Sec. 220.4 (c)(2) that is applicable
to purchases of outstanding securities, the 7-day period runs from the
date of purchase without regard to the time required for the mechanical
acts of transfer of ownership and delivery of a certificate. This rule
is based on the principles governing the use of special cash accounts in
accordance with which, in the absence of special circumstances, payment
is to be made promptly upon the purchase of securities.
(e) The purpose of Sec. 220.4(c)(3) is to recognize the fact that,
when an issue of securities is to be issued at some fixed future date, a
security that is a part of such issue can be purchased on a ``when-
issued'' basis and that payment may reasonably be delayed until after
such date of issue, subject to other basic conditions for transactions
in a special cash account. Thus, unissued securities should be regarded
as ``made available for delivery to purchasers'' on the date when they
are substantially as available as outstanding securities are available
upon purchase, and this would ordinarily be the designated date of
issuance or, in the case of a stock dividend, the ``payment date''. In
any case, the time required for the mechanics of transfer and delivery
of a certificate is not material under Sec. 220.4(c)(3) any more than it
is under Sec. 220.4(c)(2).
(f) Mutual fund shares are essentially available upon purchase to
the same extent as outstanding securities. The mechanics of their
issuance and of the delivery of certificates are not significantly
different from the mechanics of transfer and delivery of certificates
for shares of outstanding securities, and the issuance of mutual fund
shares is not a future event in a sense that would warrant the extension
of the time for payment beyond that afforded in the case of outstanding
securities. Consequently, the Board has concluded
[[Page 25]]
that a purchase of mutual fund shares is not a purchase of an ``unissued
security'' to which Sec. 220.4(c)(3) applies, but is a transaction to
which Sec. 220.4(c)(2) applies.
[27 FR 10885, Nov. 8, 1962]
Sec. 220.119 Applicability of margin requirements to credit extended to corporation in connection with retirement of stock.
(a) The Board of Governors has been asked whether part 220 was
violated when a dealer in securities transferred to a corporation 4,161
shares of the stock of such corporation for a consideration of $33,288,
of which only 10 percent was paid in cash.
(b) If the transaction was of a kind that must be included in the
corporation's ``general account'' with the dealer (Sec. 220.3), it would
involve an excessive extension of credit in violation of Sec. 220.3
(b)(1). However, the transaction would be permissible if the transaction
came within the scope of Sec. 220.4(f)(8), which permits a ``creditor''
(such as the dealer) to ``Extend and maintain credit to or for any
customer without collateral or on any collateral whatever for any
purpose other than purchasing or carrying or trading in securities.''
Accordingly, the crucial question is whether the corporation, in this
transaction, was ``purchasing'' the 4,161 shares of its stock, within
the meaning of that term as used in this part.
(c) Upon first examination, it might seem apparent that the
transaction was a purchase by the corporation. From the viewpoint of the
dealer the transaction was a sale, and ordinarily, at least a sale by
one party connotes a purchase by the other. Furthermore, other indicia
of a sale/purchase transaction were present, such as a transfer of
property for a pecuniary consideration. However, when the underlying
objectives of the margin regulations are considered, it appears that
they do not encompass a transaction of this nature, where securities are
transferred on credit to the issuer thereof for the purpose of
retirement.
(d) Section 7(a) of the Securities Exchange Act of 1934 requires the
Board of Governors to prescribe margin regulations ``For the purpose of
preventing the excessive use of credit for the purchase or carrying of
securities.'' Accordingly, the provisions of this part are not intended
to prevent the use of credit where the transaction will not have the
effect of increasing the volume of credit in the securities markets.
(e) It appears that the instant transaction would have no such
effect. When the transaction was completed, the equity interest of the
dealer was transmuted into a dollar-obligation interest; in lieu of its
status as a stockholder of the corporation, the dealer became a creditor
of that corporation. The corporation did not become the owner of any
securities acquired through the use of credit; its outstanding stock was
simply reduced by 4,161 shares.
(f) The meaning of ``sale'' and ``purchase'' in the Securities
Exchange Act has been considered by the Federal courts in a series of
decisions dealing with corporate ``insiders'' profits under section
16(b) of that Act. Although the statutory purpose sought to be
effectuated in those cases is quite different from the purpose of the
margin regulations, the decisions in question support the propriety of
not regarding a transaction as a ``purchase'' where this accords with
the probable legislative intent, even though, literally, the statutory
definition seems to include the particular transaction. See Roberts v.
Eaton (CA 2 1954) 212 F. 2d 82, and cases and other authorities there
cited. The governing principle, of course, is to effectuate the purpose
embodied in the statutory or regulatory provision being interpreted,
even where that purpose may conflict with the literal words. U.S. v.
Amer. Trucking Ass'ns, 310 U.S. 534, 543 (1940); 2 Sutherland, Statutory
Construction (3d ed. 1943) ch. 45.
(g) There can be little doubt that an extension of credit to a
corporation to enable it to retire debt securities would not be for the
purpose of ``purchasing * * * securities'' and therefore would come
within Sec. 220.4(f)(8), regardless of whether the retirement was
obligatory (e.g., at maturity) or was a voluntary ``call'' by the
issuer. This is true, it is difficult to see any valid distinction, for
this purpose, between (1) voluntary retirement of an indebtedness
security and (2) voluntary retirement of an equity security.
[[Page 26]]
(h) For the reasons indicated above, it is the opinion of the Board
of Governors that the extension of credit here involved is not of the
kind which the margin requirements are intended to regulate and that the
transaction described does not involve an unlawful extension of credit
as far as this part is concerned.
(i) The foregoing interpretation relates, of course, only to cases
of the type described. It should not be regarded as governing any other
situations; for example, the interpretation does not deal with cases
where securities are being transferred to someone other than the issuer,
or to the issuer for a purpose other than immediate retirement. Whether
the margin requirements are inapplicable to any such situations would
depend upon the relevant facts of actual cases presented.
[27 FR 12346, Dec. 13, 1962]
Sec. 220.120 [Reserved]
Sec. 220.121 Applicability of margin requirements to joint account between two creditors.
(a) The Board has recently been asked whether extensions of credit
in a joint account between two brokerage firms, a member of a national
securities exchange (``Firm X'') and a member of the National
Association of Securities Dealers (``Firm Y'') are subject to the margin
requirements of this part (Regulation T). It is understood that similar
joint accounts are not uncommon, and it appears that the margin
requirements of the regulation are not consistently applied to
extensions of credit in the accounts.
(b) When the account in question was opened, Firm Y deposited $5,000
with Firm X and has made no further deposit in the account, except for
the monthly settlement described below. Both firms have the privilege of
buying and selling specified securities in the account, but it appears
that Firm X initiates most of the transactions therein. Trading volume
may run from half a million to a million dollars a month. Firm X carries
the ``official'' ledger of the account and sends Firm Y a monthly
statement with a complete record of all transactions effected during the
month. Settlement is then made in accordance with the agreement between
the two firms, which provides that profits and losses shall be shared
equally on a fifty-fifty basis. However, all transactions are confirmed
and reconfirmed between the two on a daily basis.
(c) Section 220.3(a) provides that
All financial relations between a creditor and a customer, whether
recorded in one record or in more than one record, shall be included in
and be deemed to be part of the customer's general account with the
creditor, * * *.
and Sec. 220.2(c) defines the term ``customer'' to include
* * * any person, or any group of persons acting jointly, * * * to
or for whom a creditor is extending or maintaining any credit * * *
In the course of a normal month's operations, both Firm X and Firm Y are
at one time or another extending credit to the joint account, since both
make purchases for the account that are not ``settled'' until the
month's end. Consequently, the account would be a ``customer'' within
the above definition.
(d) Section 220.6(b) provides, with respect to the account of a
joint adventure in which a creditor participates, that
* * * the adjusted debit balance of the account shall include, in
addition to the items specified in Sec. 220.3(d), any amount by which
the creditor's contribution to the joint adventure exceeds the
contribution which he would have made if he had contributed merely in
proportion to his right to share in the profits of the joint adventure.
In addition, the final paragraph of Sec. 220.2(c) states that the
definition of ``customer''
* * * includes any joint adventure in which a creditor participates
and which would be considered a customer of the creditor if the creditor
were not a participant.
(e) The above provisions clearly evince the Board's intent that the
regulation shall cover trading accounts in which a creditor
participates. If additional confirmation were needed, it is supplied by
the fact that the Board found it needful specifically to exempt from
ordinary margin requirements
[[Page 27]]
credit extended to certain joint accounts in which a creditor
participates. These include the account in which transactions of odd-lot
dealers may be financed under Sec. 220.4(f) (4), and the specialist's
account under Sec. 220.4(g). Accordingly, the Board concluded that the
joint account between Firm X and Firm Y is a ``customer'' within the
meaning of the regulation, and that extensions of credit in the account
are subject to margin requirements.
[31 FR 7169, May 17, 1966]
Sec. 220.122 ``Deep in the money put and call options'' as extensions of credit.
(a) The Board of Governors has been asked to determine whether the
business of selling instruments described as ``deep in the money put and
call options'' would involve an extension of credit for the purposes of
the Board's regulations governing margin requirements for securities
transactions. Most of such options would be of the ``call'' type, such
as the following proposal that was presented to the Board for its
consideration:
If X stock is selling at $100 per share, the customer would pay
about $3,250 for a contract to purchase 100 shares of X at $70 per share
within a 30-day period. The contract would be guaranteed by an exchange
member, as are standard ``puts'' and ``calls''. When the contract is
made with the customer, the seller, who will also be the writer of the
contract, will immediately purchase 100 shares of X at $100 per share
through the guarantor member firm in a margin account. If the customer
exercises the option, the shares will be delivered to him; if the option
is not exercised, the writer will sell the shares in the margin account
to close out the transaction. As a practical matter, it is anticipated
that the customer will exercise the option in almost every case.
(b) An ordinary ``put'' is an option given to a person to sell to
the writer of the put a specified amount of securities at a stated price
within a certain time. A ``call'' is an option given to a person to buy
from the writer a specified amount of securities at a stated price
within a certain time. To be freely saleable, options must be indorsed,
or guaranteed, by a member firm of the exchange on which the security is
registered. The guarantor charges a fee for this service.
(c) The option embodied in the normal put or call is exercisable
either at the market price of the security at the time the option is
written, or some ``points away'' from the market. The price of a normal
option is modest by comparison with the margin required to take a
position. Writers of normal options are persons who are satisfied with
the current price of a security, and are prepared to purchase or sell at
that price, with the small profit provided by the fee. Moreover, since a
large proportion of all options are never exercised, a person who
customarily writes normal options can anticipate that the fee would be
clear profit in many cases, and he will not be obligated to buy or sell
the stock in question.
(d) The stock exchanges require that the writer of an option deposit
and maintain in his margin account with the indorser 30 percent of the
current market price in the case of a call (unless he has a long
position in the stock) and 25 percent in the case of a put (unless he
has a short position in the stock). Many indorsing firms in fact require
larger deposits. Under Sec. 220.3(a) of Regulation T, all financial
relations between a broker and his customer must be included in the
customer's general account, unless specifically eligible for one of the
special accounts authorized by Sec. 220.4. Accordingly, the writer, as a
customer of the member firm, must make a deposit, which is included in
his general account.
(e) In order to prevent the deposit from being available against
other margin purchases, and in effect counted twice, Sec. 220.3(d)(5)
requires that in computing the customer's adjusted debit balance, there
shall be included ``the amount of any margin customarily required by the
creditor in connection with his endorsement or guarantee of any put,
call, or other option''. No other margin deposit is required in
connection with a normal put or call option under Regulation T.
(f) Turning to the ``deep in the money'' proposed option contract
described above, the price paid by the buyer can be divided into (1) a
deposit of 30 percent of the current market
[[Page 28]]
value of the stock, and (2) an additional fixed charge, or fee. To the
extent that the price of the stock rose during the 30 ensuing days the
proposed instrument would produce results similar to those in the case
of an ordinary profitable call, and the contract right would be
exercised. But even if the price fell, unlike the situation with a
normal option, the buyer would still be virtually certain to exercise
his right to purchase before it expired, in order to minimize his loss.
The result would be that the buyer would not have a genuine choice
whether or not to buy. Rather, the instrument would have made it
possible for him, in effect, to purchase stock as of the time the
contract was written by depositing 30 percent of the stock's current
market price.
(g) It was suggested that the proposed contract is not unusual,
since there are examples of ordinary options selling at up to 28 percent
of current market value. However, such examples are of options running
for 12 months, and reflect expectations of changes in the price of the
stock over that period. The 30-day contracts discussed above are not
comparable to such 12-month options, because instances of true
expectations of price changes of this magnitude over a 30-day period
would be exceedingly rare. And a contract that does not reflect such
true expectations of price change, plus a reasonable fee for the
services of the writer, is not an option in the accepted meaning of the
term.
(h) Because of the virtual certainty that the contract right would
be exercised under the proposal described above, the writer would buy
the stock in a margin account with an indorsing firm immediately on
writing the contract. The indorsing firm would extend credit in the
amount of 20 percent of the current market price of the stock, the
maximum permitted by the current Sec. 220.8 (supplement to Regulation
T). The writer would deposit the 30 percent supplied by the buyer, and
furnish the remaining 50 percent out of his own working capital. His
account with the indorsing firm would thus be appropriately margined.
(i) As to the buyer, however, the writer would function as a broker.
In effect, he would purchase the stock for the account, or use, of the
buyer, on what might be described as a deferred payment arrangement.
Like an ordinary broker, the writer of the contract described above
would put up funds to pay for the difference between the price of
securities the customer wished to purchase and the customer's own
contribution. His only risk would be that the price of the securities
would decline in excess of the customer's contribution. True, he would
be locked in, and could not liquidate the customer's collateral for 30
days even if the market price should fall in excess of 30 percent, but
the risk of such a decline is extremely slight.
(j) Like any other broker who extends credit in a margin account,
the writer who was in the business of writing and selling such a
contract would be satisfied with a fixed predetermined amount of return
on his venture, since he would realize only the fee charged. Unlike a
writer of ordinary puts and calls, he would not receive a substantial
part of his income from fees on unexercised contract rights. The
similarity of his activities to those of a broker, and the dissimilarity
to a writer of ordinary options, would be underscored by the fact that
his fee would be a fixed predetermined amount of return similar to an
interest charge, rather than a fee arrived at individually for each
transaction according to the volatility of the stock and other
individual considerations.
(k) The buyer's general account with the writer would in effect
reflect a debit for the purchase price of the stock and, on the credit
side, a deposit of cash in the amount of 30 percent of that price, plus
an extension of credit for the remaining 70 percent, rather than the
maximum permissible 20 percent.
(l) For the reasons stated above, the Board concluded that the
proposed contracts would involve extensions of credit by the writer as
broker in an amount exceeding that permitted by the current supplement
to Regulation T. Accordingly, the writing of such contracts by a
brokerage firm is presently prohibited by such regulation, and any
brokerage firm that endorses such a contract would be arranging for
[[Page 29]]
credit in an amount greater than the firm itself could extend, a
practice that is prohibited by Sec. 220.7(a).
[35 FR 3280, Feb. 21, 1970]
Sec. 220.123 Partial delayed issue contracts covering nonconvertible bonds.
(a) During recent years, it has become customary for portions of new
issues of nonconvertible bonds and preferred stocks to be sold subject
to partial delayed issue contracts, which have customarily been referred
to in the industry as ``delayed delivery'' contracts, and the Board of
Governors has been asked for its views as to whether such transactions
involve any violations of the Board's margin regulations.
(b) The practice of issuing a portion of a debt (or equivalent)
security issue at a date subsequent to the main underwriting has arisen
where market conditions made it difficult or impossible, in a number of
instances, to place an entire issue simultaneously. In instances of this
kind, institutional investors (e.g., insurance companies or pension
funds) whose cash flow is such that they expect to have funds available
some months in the future, have been willing to subscribe to a portion,
to be issued to them at a future date. The issuer has been willing to
agree to issue the securities in two or more stages because it did not
immediately need the proceeds to be realized from the deferred portion,
because it could not raise funds on better terms, or because it
preferred to have a certain portion of the issue taken down by an
investor of this type.
(c) In the case of such a delayed issue contract, the underwriter is
authorized to solicit from institutional customers offers to purchase
from the issuer, pursuant to contracts of the kind described above, and
the agreement becomes binding at the underwriters' closing, subject to
specified conditions. When securities are issued pursuant to the
agreement, the purchase price includes accrued interest or dividends,
and until they are issued to it, the purchaser does not, in the case of
bonds, have rights under the trust indenture, or, in the case of
preferred stocks, voting rights.
(d) Securities sold pursuant to such arrangements are high quality
debt issues (or their equivalent). The purchasers buy with a view to
investment and do not resell or otherwise dispose of the contract prior
to its completion. Delayed issue arrangements are not acceptable to
issuers unless a substantial portion of an issue, not less than 10
percent, is involved.
(e) Sections 3(a) (13) and (14) of the Securities Exchange Act of
1934 provide that an agreement to purchase is equivalent to a purchase,
and an agreement to sell to a sale. The Board has hitherto expressed the
view that credit is extended at the time when there is a firm agreement
to extend such credit (1968 Federal Reserve Bulletin 328; 12 CFR
207.101; para. 6800 Published Interpretations of the Board of
Governors). Accordingly, in instances of the kind described above, the
issuer may be regarded as extending credit to the institutional
purchaser at the time of the underwriters' closing, when the obligations
of both become fixed.
(f) Section 220.7(a) of the Board's Regulation T (12 CFR 220.7(a)),
with an exception not applicable here, forbids a creditor subject to
that regulation to arrange for credit on terms on which the creditor
could not itself extend the credit. Sections 220.4(c) (1) and (2) (12
CFR 220.4(c) (1) and (2)) provide that a creditor may not sell
securities to a customer except in good faith reliance upon an agreement
that the customer will promptly, and in no event in more than 7 full
business days, make full cash payment for the securities. Since the
underwriters in question are creditors subject to the regulation, unless
some specific exception applies, they are forbidden to arrange for the
credit described above. This result follows because payment is not made
until more than 7 full business days have passed from the time the
credit is extended.
(g) However, Sec. 220.4(c)(3) provides that:
If the security when so purchased is an unissued security, the
period applicable to the transaction under subparagraph (2) of this
paragraph shall be 7 days after the date on which the security is made
available by the issuer for delivery to purchasers.
[[Page 30]]
(h) In interpreting Sec. 220.4(c)(3), the Board has stated that the
purpose of the provision:
* * * is to recognize the fact that, when an issue of securities is
to be issued at some future fixed date, a security that is part of such
issue can be purchased on a ``when-issued'' basis and that payment may
reasonably be delayed until after such date of issue, subject to other
basic conditions for transactions in a special cash account. (1962
Federal Reserve Bulletin 1427; 12 CFR 220.118; para. 5996, Published
Interpretations of the Board of Governors.)
In that situation, the Board distinguished the case of mutual fund
shares, which technically are not issued until the certificate can be
delivered by the transfer agent. The Board held that mutual fund shares
must be regarded as issued at the time of purchase because they are:
* * * essentially available upon purchase to the same extent as
outstanding securities. The mechanics of their issuance and of the
delivery of certificates are not significantly different from the
mechanics of transfer and delivery of certificates for shares of
outstanding securities, and the issuance of mutual fund shares is not a
future event in the sense that would warrant the extension of the time
for payment beyond that afforded in the case of outstanding securities.
(ibid.)
The issuance of debt securities subject to delayed issue contracts, by
contrast with that of mutual fund shares, which are in a status of
continual underwriting, is a specific single event taking place at a
future date fixed by the issuer with a view to its need for funds and
the availability of those funds under current market conditions.
(i) For the reasons stated above the Board concluded that the
nonconvertible debt and preferred stock subject to delayed issue
contracts of the kind described above should not be regarded as having
been issued until delivered, pursuant to the agreement, to the
institutional purchaser. This interpretation does not apply, of course,
to fact situations different from that described in this section.
[36 FR 2777, Feb. 10, 1971]
Sec. 220.124 Installment sale of tax-shelter programs as ``arranging'' for credit.
(a) The Board has been asked whether the sale by brokers and dealers
of tax-shelter programs containing a provision that payment for the
program may be made in installments would constitute ``arranging'' for
credit in violation of this part 220. For the purposes of this
interpretation, the term ``tax-shelter program'' means a program which
is required to be registered pursuant to section 5 of the Securities Act
of 1933 (15 U.S.C. section 77e), in which tax benefits, such as the
ability to deduct substantial amounts of depreciation or oil exploration
expenses, are made available to a person investing in the program. The
programs may take various legal forms and can relate to a variety of
industries including, but not limited to, oil and gas exploration
programs, real estate syndications (except real estate investment
trusts), citrus grove developments and cattle programs.
(b) The most common type of tax-shelter program takes the form of a
limited partnership. In the case of the programs under consideration,
the investor would commit himself to purchase and the partnership would
commit itself to sell the interests. The investor would be entitled to
the benefits, and become subject to the risks of ownership at the time
the contract is made, although the full purchase price is not then
required to be paid. The balance of the purchase price after the
downpayment usually is payable in installments which range from 1 to 10
years depending on the program. Thus, the partnership would be extending
credit to the purchaser until the time when the latter's contractual
obligation has been fulfilled and the final payment made.
(c) With an exception not applicable here, Sec. 220.7(a) of
Regulation T provides that:
A creditor [broker or dealer] may arrange for the extension or
maintenance of credit to or for any customer of such creditor by any
person upon the same terms and conditions as those upon which the
creditor, under the provisions of this part, may himself extend
[[Page 31]]
or maintain such credit to such customer, but only such terms and
conditions * * *
(d) In the case of credit for the purpose of purchasing or carrying
securities (purpose credit), Sec. 220.8 of the regulation (the
Supplement to Regulation T) does not permit any loan value to be given
securities that are not registered on a national securities exchange,
included on the Board's OTC Margin List, or exempted by statute from the
regulation.
(e) The courts have consistently held investment programs such as
those described above to be ``securities'' for purpose of both the
Securities Act of 1933 and the Securities Exchange Act of 1934. The
courts have also held that the two statutes are to be construed
together. Tax-shelter programs, accordingly, are securities for purposes
of Regulation T. They also are not registered on a national securities
exchange, included on the Board's OTC Margin List, or exempted by
statute from the regulation.
(f) Accordingly, the Board concludes that the sale by a broker/
dealer of tax-shelter programs containing a provision that payment for
the program may be made in installments would constitute ``arranging''
for the extension of credit to purchase or carry securities in violation
of the prohibitions of Secs. 220.7(a) and 220.8 of Regulation T.
[37 FR 6568, Mar. 31, 1972]
Sec. 220.125-220.126 [Reserved]
Sec. 220.127 Independent broker/dealers arranging credit in connection with the sale of insurance premium funding programs.
(a) The Board's September 5, 1972, clarifying amendment to
Sec. 220.4(k) set forth that creditors who arrange credit for the
acquisition of mutual fund shares and insurance are also permitted to
sell mutual fund shares without insurance under the provisions of the
special cash account. It should be understood, of course, that such
account provides a relatively short credit period of up to 7 business
days even with so-called cash transactions. This amendment was in
accordance with the Board's understanding in 1969, when the insurance
premium funding provisions were adopted in Sec. 220.4(k), that firms
engaged in a general securities business would not also be engaged in
the sale and arranging of credit in connection with such insurance
premium funding programs.
(b) The 1972 amendment eliminated from Sec. 220.4(k) the requirement
that, to be eligible for the provisions of the section, a creditor had
to be the issuer, or a subsidiary or affiliate of the issuer, of
programs which combine the acquisition of both mutual fund shares and
insurance. Thus the amendment permits an independent broker/dealer to
sell such a program and to arrange for financing in that connection. In
reaching such decision, the Board again relied upon the earlier
understanding that independent broker/dealers who would sell such
programs would not be engaged in transacting a general securities
business.
(c) In response to a specific view recently expressed, the Board
agrees that under Regulation T:
* * * a broker/dealer dealing in special insurance premium funding
products can only extend credit in connection with such products or in
connection with the sale of shares of registered investment companies
under the cash accounts * * * (and) cannot engage in the general
securities business or sell any securities other than shares * * * (in)
registered investment companies through a cash account or any other
manner involving the extension of credit.
(d) There is a way, of course, as has been indicated, that an
independent broker/dealer might be able to sell other than shares of
registered investment companies without creating any conflict with the
regulation. Such sales could be executed on a ``funds on hand'' basis
and in the case of payment by check, would have to include the
collection of such check. It is understood from industry sources,
however, that few if any independent broker/dealers engage solely in a
``fund on hand'' type of operation.
[38 FR 11066, May 4, 1973]
[[Page 32]]
Sec. 220.128 Treatment of simultaneous long and short positions in the same margin account when put or call options or combinations thereof on such stock are also outstanding in the account.
(a) The Board was recently asked whether under Regulation T,
``Credit by Brokers and Dealers'' (12 CFR part 220), if there are
simultaneous long and short positions in the same security in the same
margin account (often referred to as a short sale ``against the box''),
such positions may be used to supply the place of the deposit of margin
ordinarily required in connection with the guarantee by a creditor of a
put or call option or combination thereof on such stock.
(b) The applicable provisions of regulation T are Sec. 220.3(d)(3)
and (5) and Sec. 220.3(g)(4) and (5) which provide as follows:
(d) * * * the adjusted debit balance of a general account * * *
shall be calculated by taking the sum of the following items:
* * * * *
(3) The current market value of any securities (other than unissued
securities) sold short in the general account plus, for each security
(other than an exempted security), such amount as the board shall
prescribe from time to time in Sec. 220.8(d) (the supplement to
regulation T) as the margin required for such short sales, except that
such amount so prescribed in such Sec. 220.8(d) need not be included
when there are held in the general account * * * the same securities or
securities exchangeable or convertible within 90 calendar days, without
restriction other than the payment of money, into such securities sold
short;
* * * * *
(5) The amount of any margin customarily required by the creditor in
connection with his endorsement or guarantee of any put, call, or other
option;
* * * * *
(g) * * * (4) Any transaction which serves to meet the requirements
of paragraph (e) of this section or otherwise serves to permit any
offsetting transaction in an account shall, to that extent, be
unavailable to permit any other transaction in such account.
(5) For the purposes of this part (regulation T), if a security has
maximum loan value under paragraph (c)(1) of this section in a general
account, or under Sec. 220.4(j) in a special convertible debt security
account, a sale of the same security (even though not the same
certificate) in such account shall be deemed to be a long sale and shall
not be deemed to be or treated as a short sale.
(c) Rule 431 of the New York Stock Exchange requires that a creditor
obtain a minimum deposit of 25 percent of the current market value of
the optioned stock in connection with his issuance or guarantee of a
put, and at least 30 percent in the case of a call (and that such
position be ``marked to the market''), but permits a short position in
the stock to serve in lieu of the required deposit in the case of a put
and a long position to serve in the case of a call. Thus, where the
appropriate position is held in an account, that position may serve as
the margin required by Sec. 220.3(d)(5).
(d) In a short sale ``against the box,'' however, the customer is
both long and short the same security. He may have established either
position, properly margined, prior to taking the other, or he may have
deposited fully paid securities in his margin account on the same day he
makes a short sale of such securities. In either case, he will have
directed his broker to borrow securities elsewhere in order to make
delivery on the short sale rather than using his long position for this
purpose (see also 17 CFR 240.3b-3).
(e) Generally speaking, a customer makes a short sale ``against the
box'' for tax reasons. Regulation T, however, provides in Sec. 220.3(g)
that the two positions must be ``netted out'' for the purposes of the
calculations required by the regulation. Thus, the board concludes that
neither position would be available to serve as the deposit of margin
required in connection with the endorsement by the creditor of an
option.
(f) A similar conclusion obtains under Sec. 220.3(d)(3). That
section provides, in essence, that the margin otherwise required in
connection with a short sale need not be included in the account if the
customer has in the account a long position in the same security. In
Sec. 220.3(g) (4), however, it is provided that ``[A]ny transaction
which
[[Page 33]]
* * * serves to permit any offsetting transaction in an account shall,
to that extent, be unavailable to permit any other transaction in such
account.'' Thus, if a customer has, for example, a long position in a
security and that long position has been used to supply the margin
required in connection with a short sale of the same security, then the
long position is unavailable to serve as the margin required in
connection with the creditor's endorsement of a call option on such
security.
(g) A situation was also described in which a customer has purported
to establish simultaneous offsetting long and short positions by
executing a ``cross'' or wash sale of the security on the same day. In
this situation, no change in the beneficial ownership of stock has taken
place. Since there is no actual ``contra'' party to either transaction,
and no stock has been borrowed or delivered to accomplish the short
sale, such fictitious positions would have no value for purposes of the
Board's margin regulations. Indeed, the adoption of such a scheme in
connection with an overall strategy involving the issuance, endorsement,
or guarantee of put or call options or combinations thereof appears to
be manipulative and may have been employed for the purpose of
circumventing the requirements of the regulations.
[38 FR 12098, May 9, 1973]
Secs. 220.129-220.130 [Reserved]
Sec. 220.131 Application of the arranging section to broker-dealer activities under SEC Rule 144A.
(a) The Board has been asked whether the purchase by a broker-dealer
of debt securities for resale in reliance on Rule 144A of the Securities
and Exchange Commission (17 CFR 230.144A) \1\ may be considered an
arranging of credit permitted as an ``investment banking service'' under
Sec. 220.13(a) of Regulation T.
---------------------------------------------------------------------------
\1\ Rule 144A, 17 CFR 230.144A, was originally published in the
Federal Register at 55 FR 17933, April 30, 1990.
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(b) SEC Rule 144A provides a safe harbor exemption from the
registration requirements of the Securities Act of 1933 for resales of
restricted securities to qualified institutional buyers, as defined in
the rule. In general, a qualified institutional buyer is an
institutional investor that in the aggregate owns and invests on a
discretionary basis at least $100 million in securities of issuers that
are not affiliated with the buyer. Registered broker-dealers need only
own and invest on a discretionary basis at least $10 million of
securities in order to purchase as principal under the rule. Section
4(2) of the Securities Act of 1933 provides an exemption from the
registration requirements for ``transactions by an issuer not involving
any public offering.'' Securities acquired in a transaction under
section 4(2) cannot be resold without registration under the Act or an
exemption therefrom. Rule 144A provides a safe harbor exemption for
resales of such securities. Accordingly, broker-dealers that previously
acted only as agents in intermediating between issuers and purchasers of
privately-placed securities, due to the lack of such a safe harbor, now
may purchase privately-placed securities from issuers as principal and
resell such securities to ``qualified institutional buyers'' under Rule
144A.
(c) The Board has consistently treated the purchase of a privately-
placed debt security as an extension of credit subject to the margin
regulations. If the issuer uses the proceeds to buy securities, the
purchase of the privately-placed debt security by a creditor represents
an extension of ``purpose credit'' to the issuer. Section 7(c) of the
Securities Exchange Act of 1934 prohibits the extension of purpose
credit by a creditor if the credit is unsecured, secured by collateral
other than securities, or secured by any security (other than an
exempted security) in contravention of Federal Reserve regulations. If a
debt security sold pursuant to Rule 144A represents purpose credit and
is not properly collateralized by securities, the statute and Regulation
T can be viewed as preventing the broker-dealer from taking the security
into inventory in spite of the fact that the broker-dealer intends to
immediately resell the debt security.
(d) Under Sec. 220.13 of Regulation T, a creditor may arrange credit
it cannot itself extend if the arrangement is an
[[Page 34]]
``investment banking service'' and the credit does not violate
Regulations G and U. Investment banking services are defined to include,
but not be limited to, ``underwritings, private placements, and advice
and other services in connection with exchange offers, mergers, or
acquisitions, except for underwritings that involve the public
distribution of an equity security with installment or other deferred-
payment provisions.'' To comply with Regulations G and U where the
proceeds of debt securities sold under Rule 144A may be used to purchase
or carry margin stock and the debt securities are secured in whole or in
part, directly or indirectly by margin stock (see 12 CFR 207.2(f),
207.112, and 221.2(g)), the margin requirements of the regulations must
be met.
(e) The SEC's objective in adopting Rule 144A is to achieve ``a more
liquid and efficient institutional resale market for unregistered
securities.'' To further this objective, the Board believes it is
appropriate for Regulation T purposes to characterize the participation
of broker-dealers in this unique and limited market as an ``investment
banking service.'' The Board is therefore of the view that the purchase
by a creditor of debt securities for resale pursuant to SEC Rule 144A
may be considered an investment banking service under the arranging
section of Regulation T. The market-making activities of broker-dealers
who hold themselves out to other institutions as willing to buy and sell
Rule 144A securities on a regular and continuous basis may also be
considered an arranging of credit permissible under Sec. 220.13(a) of
Regulation T.
[Reg. T, 55 FR 29566, July 20, 1990]
Sec. 220.132 Credit to brokers and dealers.
For text of this interpretation, see Sec. 207.114 of this
subchapter.
[Reg. T, 61 FR 60167, Nov. 26, 1996]
PART 221--CREDIT BY BANKS AND PERSONS OTHER THAN BROKERS OR DEALERS FOR THE PURPOSE OF PURCHASING OR CARRYING MARGIN STOCK (REGULATION U)--Table of Contents
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
[[Page 35]]
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: Reg. U, 63 FR 2827, Jan. 16, 1998, unless otherwise noted.
Sec. 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 carrying margin stock if the
credit is secured directly or indirectly by margin stock. Lenders
include ``banks'' (as defined in Sec. 221.2) and other persons who are
required to register with the Board under Sec. 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 Sec. 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.
Sec. 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
[[Page 36]]
(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
(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.
Margin stock means:
(1) Any equity security registered or having unlisted trading
privileges on a national securities exchange;
[[Page 37]]
(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 Sec. 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.
Sec. 221.3 General requirements.
(a) Extending, maintaining, and arranging credit--(1) Extending
credit. No lender, except a plan-lender, as defined in Sec. 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 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.
[[Page 38]]
(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 Sec. 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 Sec. 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.
(4) If a lender extends purpose credit secured by any margin stock
and non-purpose 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
[[Page 39]]
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.
Sec. 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) 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
Sec. 221.3(b)(1) and (b)(3).
[[Page 40]]
(c) Credit to ESOPs. A nonbank lender may extend and maintain
purpose credit without regard to the provisions of this part, except for
Sec. 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).
Sec. 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 in Secs. 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 until 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.
(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
[[Page 41]]
(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.
Sec. 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 Sec. 221.4(a) to finance an
eligible plan as defined in Sec. 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.
Sec. 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.
Interpretations
Sec. 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
[[Page 42]]
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.
Sec. 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.
Sec. 221.103 Loans to brokers or dealers.
Questions have arisen as to the adequacy of statements received by
lending banks under Sec. 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 Secs. 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 Sec. 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 Sec. 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.
Sec. 221.104 Federal credit unions.
For text of the interpretation on Federal credit unions, see 12 CFR
220.110.
Sec. 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.
Sec. 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
Sec. 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 Sec. 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
[[Page 43]]
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 Sec. 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
Sec. 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 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.
Sec. 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.
Sec. 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
[[Page 44]]
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.
Sec. 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.
Sec. 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 certain
exceptions, and provides that the maximum loan value of such margin
stock shall be a 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,
Sec. 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.
[[Page 45]]
(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 Sec. 221.3(a).
Sec. 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.
(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
Sec. 221.3(a).
Sec. 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,
[[Page 46]]
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 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.
Sec. 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 Sec. 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 Sec. 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
[[Page 47]]
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 Sec. 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 regulation. 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''.
(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 Sec. 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.
[[Page 48]]
Sec. 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 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 Sec. 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
(Sec. 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 Sec. 221.7 (the
Supplement).
Sec. 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
Sec. 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
[[Page 49]]
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 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 Sec. 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.
Sec. 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 Sec. 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
[[Page 50]]
be the same. Accordingly, the Board concluded that bank loans made under
the alternative proposal would similarly be subject to this part.
Sec. 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 Sec. 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 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.
Sec. 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 Sec. 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 Sec. 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
[[Page 51]]
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 Sec. 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.
(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.
Sec. 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
Sec. 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.
Sec. 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.
[[Page 52]]
(b) This part allows a bank to extend purpose and nonpurpose credits
simultaneously or successively to the same customer. This rule is
expressed in Sec. 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
Sec. 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 Sec. 221.3(d)(4), when read in conjunction with
Sec. 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
and attributed to the purpose loan by taking into account the maximum
loan value of such collateral as prescribed in Sec. 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.
Sec. 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 Sec. 221.3(a) or
the special ``plan-lender'' provisions set forth in Sec. 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 Sec. 221.3(b).
Sec. 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).
[[Page 53]]
(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.
Sec. 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 Sec. 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 Sec. 221.4(a)(2) may be regarded as
purpose credit within the meaning of Sec. 221.2.
Sec. 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 Sec. 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 Sec. 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 Sec. 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
Sec. 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 Sec. 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
[[Page 54]]
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 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 Sec. 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
[[Page 55]]
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.
Sec. 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 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.
PART 224--BORROWERS OF SECURITIES CREDIT (REGULATION X)--Table of Contents
Sec.
224.1 Authority, purpose, and scope.
224.2 Definitions.
224.3 Margin regulations to be applied by nonexempted borrowers.
Authority: 15 U.S.C. 78g.
Source: Reg. X, 48 FR 56572, Dec. 22, 1983, unless otherwise noted.
Editorial Note: See the List of CFR Sections Affected, which appears
in the Finding Aids section of the printed volume and on GPO Access, for
FR citations to Part 224 OTC Margin Stocks changes.
Sec. 224.1 Authority, purpose, and scope.
(a) Authority and purpose. Regulation X (this part) is issued by the
Board of Governors of the Federal Reserve System (the Board) under the
Securities Exchange Act of 1934, as amended (the Act) (15 U.S.C. 78a et
seq.). This part implements section 7(f) of the Act (15 U.S.C. 78g(f)),
the purpose of which is to require that credit obtained within or
outside the United States complies with the limitations of the Board's
Margin Regulations T and U (12 CFR parts 220 and 221, respectively).
(b) Scope and exemptions. The Act and this part apply the Board's
margin regulations to United States persons and foreign persons
controlled by or acting on behalf of or in conjunction with United
States persons (hereinafter borrowers), who obtain credit outside the
United States to purchase or carry United States securities, or within
the United States to purchase or carry any securities (both types of
credit are hereinafter referred to as purpose credit). The following
borrowers are exempt from the Act and this part:
(1) Any borrower who obtains purpose credit within the United
States, unless the borrower willfully causes the credit to be extended
in contravention of Regulations T or U.
(2) Any borrower whose permanent residence is outside the United
States and who does not obtain or have outstanding, during any calendar
year, a total of more than $100,000 in purpose credit obtained outside
the United States; and
(3) Any borrower who is exempt by Order upon terms and conditions
set by the Board.
[Reg. X, 48 FR 56572, Dec. 22, 1983, as amended by Reg. X, 63 FR 2839,
Jan. 16, 1998]
Sec. 224.2 Definitions.
The terms used in this part have the meanings given to them in
sections 3(a) and 7(f) of the Act, and in Regulations T and U. Section
7(f) of the Act contains the following definitions:
(a) United States person includes a person which is organized or
exists under the laws of any State or, in the case of a natural person,
a citizen or resident of the United States; a domestic estate; or a
trust in which one or more of the foregoing persons has a cumulative
direct or indirect beneficial interest in excess of 50 per centum of the
valve of the trust.
[[Page 56]]
(b) United States security means a security (other than an exempted
security) issued by a person incorporated under the laws of any State,
or whose principal place of business is within a State.
(c) Foreign person controlled by a United States person includes any
noncorporate entity in which United States persons directly or
indirectly have more than a 50 per centum beneficial interest, and any
corporation in which one or more United States persons, directly or
indirectly, own stock possessing more than 50 per centum of the total
combined voting power of all classes of stock entitled to vote, or more
than 50 per centum of the total value of shares of all classes of stock.
[Reg. X, 48 FR 56572, Dec. 22, 1983, as amended by Reg. X, 63 FR 2839,
Jan. 16, 1998]
Sec. 224.3 Margin regulations to be applied by nonexempted borrowers.
(a) Credit transactions outside the United States. No borrower shall
obtain purpose credit from outside the United States unless it conforms
to the following margin regulations:
(1) Regulation T (12 CFR part 220) if the credit is obtained from a
foreign branch of a broker-dealer;
(2) Regulation U (12 CFR part 221), as it applies to banks, if the
credit is obtained from a foreign branch of a bank, except for the
requirement of a purpose statement (12 CFR 221.3(c)(1)(i) and
(c)(2)(i)); and
(3) Regulation U (12 CFR part 221), as it applies to nonbank
lenders, if the credit is obtained from any other lender outside the
United States, except for the requirement of a purpose statement (12 CFR
221.3(c)(1)(ii) and (c)(2)(ii)).
(b) Credit transactions within the United States. Any borrower who
willfully causes credit to be extended in contravention of Regulations T
and U (12 CFR parts 220 and 221), and who, therefore, is not exempted by
Sec. 224.1(b)(1), must conform the credit to the margin regulation that
applies to the lender.
[Reg. X, 63 FR 2839, Jan. 16, 1998]
PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL (REGULATION Y)--Table of Contents
Regulations
Subpart A--General Provisions
Sec.
225.1 Authority, purpose, and scope.
225.2 Definitions.
225.3 Administration.
225.4 Corporate practices.
225.5 Registration, reports, and inspections.
225.6 Penalties for violations.
225.7 Exceptions to tying restrictions.
Subpart B--Acquisition of Bank Securities or Assets
225.11 Transactions requiring Board approval.
225.12 Transactions not requiring Board approval.
225.13 Factors considered in acting on bank acquisition proposals.
225.14 Expedited action for certain bank acquisitions by well-run bank
holding companies.
225.15 Procedures for other bank acquisition proposals.
225.16 Public notice, comments, hearings, and other provisions
governing applications and notices.
225.17 Notice procedure for one-bank holding company formations.
Subpart C--Nonbanking Activities and Acquisitions by Bank Holding
Companies
225.21 Prohibited nonbanking activities and acquisitions; exempt bank
holding companies.
225.22 Exempt nonbanking activities and acquisitions.
225.23 Expedited action for certain nonbanking proposals by well-run
bank holding companies.
225.24 Procedures for other nonbanking proposals.
225.25 Hearings, alteration of activities, and other matters.
225.26 Factors considered in acting on nonbanking proposals.
225.27 Procedures for determining scope of nonbanking activities.
225.28 List of permissible nonbanking activities.
Subpart D--Control and Divestiture Proceedings
225.31 Control proceedings.
Subpart E--Change in Bank Control
225.41 Transactions requiring prior notice.
[[Page 57]]
225.42 Transactions not requiring prior notice.
225.43 Procedures for filing, processing, publishing, and acting on
notices.
225.44 Reporting of stock loans.
Subpart F--Limitations on Nonbank Banks
225.52 Limitation on overdrafts.
Subpart G--Appraisal Standards for Federally Related Transactions
225.61 Authority, purpose, and scope.
225.62 Definitions.
225.63 Appraisals required; transactions requiring a State certified or
licensed appraiser.
225.64 Minimum appraisal standards.
225.65 Appraiser independence.
225.66 Professional association membership; competency.
225.67 Enforcement.
Subpart H--Notice of Addition or Change of Directors and Senior
Executive Officers
225.71 Definitions.
225.72 Director and officer appointments; prior notice requirement.
225.73 Procedures for filing, processing, and acting on notices;
standards for disapproval; waiver of notice.
Subpart I--Financial Holding Companies
225.81 What is a financial holding company?
Reg. Y, 65 FR 3791, Jan. 25, 2000, as amended at 65 FR 15055, Mar. 21,
2000]
225.82 How does a company elect to become a financial holding company?
225.83 What are the consequences of failing to continue to meet
applicable capital and management requirements?
225.84 What are the consequences of failing to maintain a satisfactory
or better rating under the Community Reinvestment Act at all
insured depository institution subsidiaries?
225.85 Is notice to or approval from the Board required prior to
engaging in a financial activity?
225.86 What activities are permissible for financial holding companies?
225.87 Is notice to the Board required after engaging in a financial
activity?
225.88 How to request the Board to determine that an activity is
financial in nature or incidental to a financial activity?
225.89 How to request approval to engage in an activity that is
complementary to a financial activity?
225.90 What are the requirements for a foreign bank to be treated as a
financial holding company?
225.91 How may a foreign bank elect to be treated as a financial
holding company?
225.92 How does an election by a foreign bank become effective?
225.93 What are the consequences of a foreign bank failing to continue
to meet applicable capital and management requirements?
225.94 What are the consequences of an insured branch or depository
institution failing to maintain a satisfactory or better
rating under the Community Reinvestment Act?
Interpretations
225.101 Bank holding company's subsidiary banks owning shares of
nonbanking companies.
225.102 Bank holding company indirectly owning nonbanking company
through subsidiaries.
225.103 Bank holding company acquiring stock by dividends, stock splits
or exercise of rights.
225.104 ``Services'' under section 4(c)(1) of Bank Holding Company Act.
225.107 Acquisition of stock in small business investment company.
225.109 ``Services'' under section 4(c)(1) of Bank Holding Company Act.
225.111 Limit on investment by bank holding company system in stock of
small business investment companies.
225.112 Indirect control of small business concern through convertible
debentures held by small business investment company.
225.113 Services under section 4(a) of Bank Holding Company Act.
225.115 Applicability of Bank Service Corporation Act in certain bank
holding company situations.
225.118 Computer services for customers of subsidiary banks.
225.121 Acquisition of Edge corporation affiliate by State member banks
of registered bank holding company.
225.122 Bank holding company ownership of mortgage companies.
225.123 Activities closely related to banking.
225.124 Foreign bank holding companies.
225.125 Investment adviser activities.
225.126 Activities not closely related to banking.
225.127 Investment in corporations or projects designed primarily to
promote community welfare.
225.129 Activities closely related to banking.
225.130 Issuance and sale of short-term debt obligations by bank
holding companies.
225.131 Activities closely related to banking.
225.132 Acquisition of assets.
225.133 Computation of amount invested in foreign corporations under
general consent procedures.
225.134 Escrow arrangements involving bank stock resulting in a
violation of the Bank Holding Company Act.
[[Page 58]]
225.136 Utilization of foreign subsidiaries to sell long-term debt
obligations in foreign markets and to transfer the proceeds to
their United States parent(s) for domestic purposes.
225.137 Acquisitions of shares pursuant to section 4(c)(6) of the Bank
Holding Company Act.
225.138 Statement of policy concerning divestitures by bank holding
companies.
225.139 Presumption of continued control under section (2)(g)(3) of the
Bank Holding Company Act.
225.140 Disposition of property acquired in satisfaction of debts
previously contracted.
225.141 Operations subsidiaries of a bank holding company.
225.142 Statement of policy concerning bank holding companies engaging
in futures, forward and options contracts on U.S. Government
and agency securities and money market instruments.
225.143 Policy statement on nonvoting equity investments by bank
holding companies.
225.145 Limitations established by the Competitive Equality Banking Act
of 1987 on the activities and growth of nonbank banks.
Subpart J--Merchant Banking Investments
225.170 What investments are permitted under this subpart and who may
make them?
225.171 What are the limitations on managing or operating a portfolio
company held as a merchant banking investment?
225.172 What are the holding periods permitted for merchant banking
investments?
225.173 What aggregate limits apply to merchant banking investments?
225.174 What risk management, reporting and recordkeeping policies are
required to make merchant banking investments?
225.175 How do the statutory cross marketing and section 23A and 23B
limitations apply to merchant banking investments?
Conditions to Orders
225.200 Conditions to Board's section 20 orders.
Appendix A to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Risk-Based Measure
Appendix B to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies and State Member Banks: Leverage Measure
Appendix C to Part 225--Small Bank Holding Company Policy Statement
Appendix D to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Tier 1 Leverage Measure
Appendix E to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Market Risk Measure
Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-1,
1843(c)(8), 1843(k), 1844(b), 1972(l), 3106, 3108, 3310, 3331-3351,
3907, and 3909.
Source: Reg. Y, 49 FR 818, Jan. 5, 1984, unless otherwise noted.
Regulations
Subpart A--General Provisions
Source: Reg. Y, 62 FR 9319, Feb. 28, 1997, unless otherwise noted.
Sec. 225.1 Authority, purpose, and scope.
(a) Authority. This part \1\ (Regulation Y) is issued by the Board
of Governors of the Federal Reserve System (Board) under section 5(b) of
the Bank Holding Company Act of 1956, as amended (12 U.S.C. 1844(b))
(BHC Act); sections 8 and 13(a) of the International Banking Act of 1978
(12 U.S.C. 3106 and 3108); section 7(j)(13) of the Federal Deposit
Insurance Act, as amended by the Change in Bank Control Act of 1978 (12
U.S.C. 1817(j)(13)) (Bank Control Act); section 8(b) of the Federal
Deposit Insurance Act (12 U.S.C. 1818(b)); section 914 of the Financial
Institutions Reform, Recovery and Enforcement Act of 1989 (12 U.S.C.
1831i); section 106 of the Bank Holding Company Act Amendments of 1970
(12 U.S.C. 1972); and the International Lending Supervision Act of 1983
(Pub. L. 98-181, title IX). The BHC Act is codified at 12 U.S.C. 1841,
et seq.
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\1\ Code of Federal Regulations, title 12, chapter II, part 225.
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(b) Purpose. The principal purposes of this part are to:
(1) Regulate the acquisition of control of banks by companies and
individuals;
(2) Define and regulate the nonbanking activities in which bank
holding companies and foreign banking organizations with United States
operations may engage; and
(3) Set forth the procedures for securing approval for these
transactions and activities.
(c) Scope--(1) Subpart A contains general provisions and definitions
of terms used in this regulation.
[[Page 59]]
(2) Subpart B governs acquisitions of bank or bank holding company
securities and assets by bank holding companies or by any company that
will become a bank holding company as a result of the acquisition.
(3) Subpart C defines and regulates the nonbanking activities in
which bank holding companies and foreign banking organizations may
engage directly or through a subsidiary. The Board's Regulation K
governs certain nonbanking activities conducted by foreign banking
organizations and certain foreign activities conducted by bank holding
companies (12 CFR part 211, International Banking Operations).
(4) Subpart D specifies situations in which a company is presumed to
control voting securities or to have the power to exercise a controlling
influence over the management or policies of a bank or other company;
sets forth the procedures for making a control determination; and
provides rules governing the effectiveness of divestitures by bank
holding companies.
(5) Subpart E governs changes in bank control resulting from the
acquisition by individuals or companies (other than bank holding
companies) of voting securities of a bank holding company or state
member bank of the Federal Reserve System.
(6) Subpart F specifies the limitations that govern companies that
control so-called nonbank banks and the activities of nonbank banks.
(7) Subpart G prescribes minimum standards that apply to the
performance of real estate appraisals and identifies transactions that
require state certified appraisers.
(8) Subpart H identifies the circumstances when written notice must
be provided to the Board prior to the appointment of a director or
senior officer of a bank holding company and establishes procedures for
obtaining the required Board approval.
(9) [Reserved]
(10) Subpart J governs the conduct by financial holding companies of
merchant banking investment activities permitted under section
4(k)(4)(H) of the Bank Holding Company Act (12 U.S.C. 1843(k)(4)H)).
(11) Appendix A to the regulation contains the Board's Risk-Based
Capital Adequacy Guidelines for bank holding companies.
(12) Appendix B contains the Board's Capital Adequacy Guidelines for
measuring leverage for bank holding companies and state member banks.
(13) Appendix C contains the Board's policy statement governing
small bank holding companies.
(14) Appendix D contains the Board's Capital Adequacy Guidelines for
measuring tier 1 leverage for bank holding companies.
(15) Appendix E contains the Board's Capital Adequacy Guidelines for
measuring market risk of bank holding companies.
Reg. Y, 62 FR 9319, Feb. 28, 1997, as amended at 65 FR 16472, Mar. 28,
2000]
Sec. 225.2 Definitions.
Except as modified in this regulation or unless the context
otherwise requires, the terms used in this regulation have the same
meaning as set forth in the relevant statutes.
(a) Affiliate means any company that controls, is controlled by, or
is under common control with, another company.
(b)(1) Bank means:
(i) An insured bank as defined in section 3(h) of the Federal
Deposit Insurance Act (12 U.S.C. 1813(h)); or
(ii) An institution organized under the laws of the United States
which both:
(A) Accepts demand deposits or deposits that the depositor may
withdraw by check or similar means for payment to third parties or
others; and
(B) Is engaged in the business of making commercial loans.
(2) Bank does not include those institutions qualifying under the
exceptions listed in section 2(c)(2) of the BHC Act (12 U.S.C.
1841(c)(2)).
(c)(1) Bank holding company means any company (including a bank)
that has direct or indirect control of a bank, other than control that
results from the ownership or control of:
(i) Voting securities held in good faith in a fiduciary capacity
(other than as provided in paragraphs (e)(2)(ii) and (iii) of this
section) without sole discretionary voting authority, or as otherwise
exempted under section 2(a)(5)(A) of the BHC Act;
[[Page 60]]
(ii) Voting securities acquired and held only for a reasonable
period of time in connection with the underwriting of securities, as
provided in section 2(a)(5)(B) of the BHC Act;
(iii) Voting rights to voting securities acquired for the sole
purpose and in the course of participating in a proxy solicitation, as
provided in section 2(a)(5)(C) of the BHC Act;
(iv) Voting securities acquired in satisfaction of debts previously
contracted in good faith, as provided in section 2(a)(5)(D) of the BHC
Act, if the securities are divested within two years of acquisition (or
such later period as the Board may permit by order); or
(v) Voting securities of certain institutions owned by a thrift
institution or a trust company, as provided in sections 2(a)(5)(E) and
(F) of the BHC Act.
(2) Except for the purposes of Sec. 225.4(b) of this subpart and
subpart E of this part, or as otherwise provided in this regulation,
bank holding company includes a foreign banking organization. For the
purposes of subpart B of this part, bank holding company includes a
foreign banking organization only if it owns or controls a bank in the
United States.
(d)(1) Company includes any bank, corporation, general or limited
partnership, association or similar organization, business trust, or any
other trust unless by its terms it must terminate either within 25
years, or within 21 years and 10 months after the death of individuals
living on the effective date of the trust.
(2) Company does not include any organization, the majority of the
voting securities of which are owned by the United States or any state.
(3) Testamentary trusts exempt. Unless the Board finds that the
trust is being operated as a business trust or company, a trust is
presumed not to be a company if the trust:
(i) Terminates within 21 years and 10 months after the death of
grantors or beneficiaries of the trust living on the effective date of
the trust or within 25 years;
(ii) Is a testamentary or inter vivos trust established by an
individual or individuals for the benefit of natural persons (or trusts
for the benefit of natural persons) who are related by blood, marriage
or adoption;
(iii) Contains only assets previously owned by the individual or
individuals who established the trust;
(iv) Is not a Massachusetts business trust; and
(v) Does not issue shares, certificates, or any other evidence of
ownership.
(4) Qualified limited partnerships exempt. Company does not include
a qualified limited partnership, as defined in section 2(o)(10) of the
BHC Act.
(e)(1) Control of a bank or other company means (except for the
purposes of subpart E of this part):
(i) Ownership, control, or power to vote 25 percent or more of the
outstanding shares of any class of voting securities of the bank or
other company, directly or indirectly or acting through one or more
other persons;
(ii) Control in any manner over the election of a majority of the
directors, trustees, or general partners (or individuals exercising
similar functions) of the bank or other company;
(iii) The power to exercise, directly or indirectly, a controlling
influence over the management or policies of the bank or other company,
as determined by the Board after notice and opportunity for hearing in
accordance with Sec. 225.31 of subpart D of this part; or
(iv) Conditioning in any manner the transfer of 25 percent or more
of the outstanding shares of any class of voting securities of a bank or
other company upon the transfer of 25 percent or more of the outstanding
shares of any class of voting securities of another bank or other
company.
(2) A bank or other company is deemed to control voting securities
or assets owned, controlled, or held, directly or indirectly:
(i) By any subsidiary of the bank or other company;
(ii) In a fiduciary capacity (including by pension and profit-
sharing trusts) for the benefit of the shareholders, members, or
employees (or individuals serving in similar capacities) of the bank or
other company or any of its subsidiaries; or
(iii) In a fiduciary capacity for the benefit of the bank or other
company or any of its subsidiaries.
[[Page 61]]
(f) Foreign banking organization and qualifying foreign banking
organization have the same meanings as provided in Sec. 211.21(n) and
Sec. 211.23 of the Board's Regulation K (12 CFR 211.21(n) and 211.23).
(g) Insured depository institution includes an insured bank as
defined in section 3(h) of the Federal Deposit Insurance Act (12 U.S.C.
1813(h)) and a savings association.
(h) Lead insured depository institution means the largest insured
depository institution controlled by the bank holding company as of the
quarter ending immediately prior to the proposed filing, based on a
comparison of the average total risk-weighted assets controlled during
the previous 12-month period by each insured depository institution
subsidiary of the holding company.
(i) Management official means any officer, director (including
honorary or advisory directors), partner, or trustee of a bank or other
company, or any employee of the bank or other company with policy-making
functions.
(j) Nonbank bank means any institution that:
(1) Became a bank as a result of enactment of the Competitive
Equality Amendments of 1987 (Pub. L. 100-86), on the date of enactment
(August 10, 1987); and
(2) Was not controlled by a bank holding company on the day before
the enactment of the Competitive Equality Amendments of 1987 (August 9,
1987).
(k) Outstanding shares means any voting securities, but does not
include securities owned by the United States or by a company wholly
owned by the United States.
(l) Person includes an individual, bank, corporation, partnership,
trust, association, joint venture, pool, syndicate, sole proprietorship,
unincorporated organization, or any other form of entity.
(m) Savings association means:
(1) Any federal savings association or federal savings bank;
(2) Any building and loan association, savings and loan association,
homestead association, or cooperative bank if such association or
cooperative bank is a member of the Savings Association Insurance Fund;
and
(3) Any savings bank or cooperative that is deemed by the director
of the Office of Thrift Supervision to be a savings association under
section 10(l) of the Home Owners Loan Act.
(n) Shareholder--(1) Controlling shareholder means a person that
owns or controls, directly or indirectly, 25 percent or more of any
class of voting securities of a bank or other company.
(2) Principal shareholder means a person that owns or controls,
directly or indirectly, 10 percent or more of any class of voting
securities of a bank or other company, or any person that the Board
determines has the power, directly or indirectly, to exercise a
controlling influence over the management or policies of a bank or other
company.
(o) Subsidiary means a bank or other company that is controlled by
another company, and refers to a direct or indirect subsidiary of a bank
holding company. An indirect subsidiary is a bank or other company that
is controlled by a subsidiary of the bank holding company.
(p) United States means the United States and includes any state of
the United States, the District of Columbia, any territory of the United
States, Puerto Rico, Guam, American Samoa, and the Virgin Islands.
(q)(1) Voting securities means shares of common or preferred stock,
general or limited partnership shares or interests, or similar interests
if the shares or interest, by statute, charter, or in any manner,
entitle the holder:
(i) To vote for or to select directors, trustees, or partners (or
persons exercising similar functions of the issuing company); or
(ii) To vote on or to direct the conduct of the operations or other
significant policies of the issuing company.
(2) Nonvoting shares. Preferred shares, limited partnership shares
or interests, or similar interests are not voting securities if:
(i) Any voting rights associated with the shares or interest are
limited solely to the type customarily provided by statute with regard
to matters that would significantly and adversely affect the rights or
preference of the security or other interest, such as the issuance of
additional amounts or
[[Page 62]]
classes of senior securities, the modification of the terms of the
security or interest, the dissolution of the issuing company, or the
payment of dividends by the issuing company when preferred dividends are
in arrears;
(ii) The shares or interest represent an essentially passive
investment or financing device and do not otherwise provide the holder
with control over the issuing company; and
(iii) The shares or interest do not entitle the holder, by statute,
charter, or in any manner, to select or to vote for the selection of
directors, trustees, or partners (or persons exercising similar
functions) of the issuing company.
(3) Class of voting shares. Shares of stock issued by a single
issuer are deemed to be the same class of voting shares, regardless of
differences in dividend rights or liquidation preference, if the shares
are voted together as a single class on all matters for which the shares
have voting rights other than matters described in paragraph (o)(2)(i)
of this section that affect solely the rights or preferences of the
shares.
(r) Well-capitalized--(1) Bank holding company. In the case of a
bank holding company,\2\ well-capitalized means that:
---------------------------------------------------------------------------
\2\ For purposes of this subpart and subparts B and C of this part,
a bank holding company with consolidated assets under $150 million that
is subject to the Small Bank Holding Company Policy Statement in
Appendix C of this part will be deemed to be ``well-capitalized'' if the
bank holding company meets the requirements for expedited/waived
processing in Appendix C.
---------------------------------------------------------------------------
(i) On a consolidated basis, the bank holding company maintains a
total risk-based capital ratio of 10.0 percent or greater, as defined in
Appendix A of this part;
(ii) On a consolidated basis, the bank holding company maintains a
Tier 1 risk-based capital ratio of 6.0 percent or greater, as defined in
Appendix A of this part; and
(iii) The bank holding company is not subject to any written
agreement, order, capital directive, or prompt corrective action
directive issued by the Board to meet and maintain a specific capital
level for any capital measure.
(2) Insured and uninsured depository institutions--(i) Insured
depository institution. In the case of an insured depository
institution, ``well capitalized'' means that the institution has and
maintains at least the capital levels required to be well capitalized
under the capital adequacy regulations or guidelines applicable to the
institution that have been adopted by the appropriate Federal banking
agency for the institution under section 38 of the Federal Deposit
Insurance Act (12 U.S.C. 1831o).
(ii) Uninsured depository institution. In the case of a depository
institution the deposits of which are not insured by the Federal Deposit
Insurance Corporation, ``well capitalized'' means that the institution
has and maintains at least the capital levels required for an insured
depository institution to be well capitalized.
(3) Foreign banks--(i) Standards applied. For purposes of
determining whether a foreign banking organization qualifies under
paragraph (r)(1) of this section:
(A) A foreign banking organization whose home country supervisor, as
defined in Sec. 211.21 of the Board's Regulation K (12 CFR 211.21), has
adopted capital standards consistent in all respects with the Capital
Accord of the Basle Committee on Banking Supervision (Basle Accord) may
calculate its capital ratios under the home country standard; and
(B) A foreign banking organization whose home country supervisor has
not adopted capital standards consistent in all respects with the Basle
Accord shall obtain a determination from the Board that its capital is
equivalent to the capital that would be required of a U.S. banking
organization under paragraph (r)(1) of this section.
(ii) Branches and agencies. For purposes of determining, under
paragraph (r)(1) of this section, whether a branch or agency of a
foreign banking organization is well-capitalized, the branch or agency
shall be deemed to have the same capital ratios as the foreign banking
organization.
(s) Well managed--(1) In general. Except as otherwise provided in
this part, a company or depository institution is well managed if:
(i) At its most recent inspection or examination or subsequent
review by
[[Page 63]]
the appropriate Federal banking agency for the company or institution,
the company or institution received:
(A) At least a satisfactory composite rating; and
(B) At least a satisfactory rating for management and for
compliance, if such a rating is given; or
(ii) In the case of a company or depository institution that has not
received an examination rating, the Board has determined, after a review
of managerial and other resources of the company or depository
institution and after consulting the appropriate Federal banking agency
for the institution, that the company or institution is well managed.
(2) Merged institutions. A depository institution that results from
the merger of two or more depository institutions that are well managed
shall be considered to be well managed unless the Board determines
otherwise after consulting with the appropriate Federal banking agency
for each depository institution involved in the merger.
(3) Foreign banking organizations. Except as otherwise provided in
this part, a foreign banking organization shall qualify under this
paragraph(s) if the combined operations of the foreign banking
organization in the United States have received at least a satisfactory
composite rating at the most recent annual assessment.
[Reg. Y, 62 FR 9319, Feb. 28, 1997, as amended at 65 FR 3791, Jan. 25,
2000; 65 FR 15055, Mar. 21, 2000]
Sec. 225.3 Administration.
(a) Delegation of authority. Designated Board members and officers
and the Federal Reserve Banks are authorized by the Board to exercise
various functions prescribed in this regulation and in the Board's Rules
Regarding Delegation of Authority (12 CFR part 265) and the Board's
Rules of Procedure (12 CFR part 262).
(b) Appropriate Federal Reserve Bank. In administering this
regulation, unless a different Federal Reserve Bank is designated by the
Board, the appropriate Federal Reserve Bank is as follows:
(1) For a bank holding company (or a company applying to become a
bank holding company): the Reserve Bank of the Federal Reserve district
in which the company's banking operations are principally conducted, as
measured by total domestic deposits in its subsidiary banks on the date
it became (or will become) a bank holding company;
(2) For a foreign banking organization that has no subsidiary bank
and is not subject to paragraph (b)(1) of this section: the Reserve Bank
of the Federal Reserve district in which the total assets of the
organization's United States branches, agencies, and commercial lending
companies are the largest as of the later of January 1, 1980, or the
date it becomes a foreign banking organization;
(3) For an individual or company submitting a notice under subpart E
of this part: The Reserve Bank of the Federal Reserve district in which
the banking operations of the bank holding company or state member bank
to be acquired are principally conducted, as measured by total domestic
deposits on the date the notice is filed.
Sec. 225.4 Corporate practices.
(a) Bank holding company policy and operations. (1) A bank holding
company shall serve as a source of financial and managerial strength to
its subsidiary banks and shall not conduct its operations in an unsafe
or unsound manner.
(2) Whenever the Board believes an activity of a bank holding
company or control of a nonbank subsidiary (other than a nonbank
subsidiary of a bank) constitutes a serious risk to the financial
safety, soundness, or stability of a subsidiary bank of the bank holding
company and is inconsistent with sound banking principles or the
purposes of the BHC Act or the Financial Institutions Supervisory Act of
1966, as amended (12 U.S.C. 1818(b) et seq.), the Board may require the
bank holding company to terminate the activity or to terminate control
of the subsidiary, as provided in section 5(e) of the BHC Act.
(b) Purchase or redemption by bank holding company of its own
securities--(1) Filing notice. Except as provided in paragraph (b)(6) of
this section, a bank holding company shall give the Board prior written
notice before purchasing or redeeming its equity securities if
[[Page 64]]
the gross consideration for the purchase or redemption, when aggregated
with the net consideration paid by the company for all such purchases or
redemptions during the preceding 12 months, is equal to 10 percent or
more of the company's consolidated net worth. For the purposes of this
section, ``net consideration'' is the gross consideration paid by the
company for all of its equity securities purchased or redeemed during
the period minus the gross consideration received for all of its equity
securities sold during the period.
(2) Contents of notice. Any notice under this section shall be filed
with the appropriate Reserve Bank and shall contain the following
information:
(i) The purpose of the transaction, a description of the securities
to be purchased or redeemed, the total number of each class outstanding,
the gross consideration to be paid, and the terms and sources of funding
for the transaction;
(ii) A description of all equity securities redeemed within the
preceding 12 months, the net consideration paid, and the terms of any
debt incurred in connection with those transactions; and
(iii) (A) If the bank holding company has consolidated assets of
$150 million or more, consolidated pro forma risk-based capital and
leverage ratio calculations for the bank holding company as of the most
recent quarter, and, if the redemption is to be debt funded, a parent-
only pro forma balance sheet as of the most recent quarter; or
(B) If the bank holding company has consolidated assets of less than
$150 million, a pro forma parent-only balance sheet as of the most
recent quarter, and, if the redemption is to be debt funded, one-year
income statement and cash flow projections.
(3) Acting on notice. Within 15 calendar days of receipt of a notice
under this section, the appropriate Reserve Bank shall either approve
the transaction proposed in the notice or refer the notice to the Board
for decision. If the notice is referred to the Board for decision, the
Board shall act on the notice within 30 calendar days after the Reserve
Bank receives the notice.
(4) Factors considered in acting on notice. (i) The Board may
disapprove a proposed purchase or redemption if it finds that the
proposal would constitute an unsafe or unsound practice, or would
violate any law, regulation, Board order, directive, or any condition
imposed by, or written agreement with, the Board.
(ii) In determining whether a proposal constitutes an unsafe or
unsound practice, the Board shall consider whether the bank holding
company's financial condition, after giving effect to the proposed
purchase or redemption, meets the financial standards applied by the
Board under section 3 of the BHC Act, including the Board's Capital
Adequacy Guidelines (Appendix A of this part) and the Board's Policy
Statement for Small Bank Holding Companies (Appendix C of this part).
(5) Disapproval and hearing. (i) The Board shall notify the bank
holding company in writing of the reasons for a decision to disapprove
any proposed purchase or redemption. Within 10 calendar days of receipt
of a notice of disapproval by the Board, the bank holding company may
submit a written request for a hearing.
(ii) The Board shall order a hearing within 10 calendar days of
receipt of the request if it finds that material facts are in dispute,
or if it otherwise appears appropriate. Any hearing conducted under this
paragraph shall be held in accordance with the Board's Rules of Practice
for Formal Hearings (12 CFR part 263).
(iii) At the conclusion of the hearing, the Board shall by order
approve or disapprove the proposed purchase or redemption on the basis
of the record of the hearing.
(6) Exception for well-capitalized bank holding companies. A bank
holding company is not required to obtain prior Board approval for the
redemption or purchase of its equity securities under this section
provided:
(i) Both before and immediately after the redemption, the bank
holding company is well-capitalized;
(ii) The bank holding company is well-managed; and
(iii) The bank holding company is not the subject of any unresolved
supervisory issues.
[[Page 65]]
(c) Deposit insurance. Every bank that is a bank holding company or
a subsidiary of a bank holding company shall obtain Federal Deposit
Insurance and shall remain an insured bank as defined in section 3(h) of
the Federal Deposit Insurance Act (12 U.S.C. 1813(h)).
(d) Acting as transfer agent or clearing agent. A bank holding
company or any nonbanking subsidiary that is a ``bank,'' as defined in
section 3(a)(6) of the Securities Exchange Act of 1934 (15 U.S.C.
78c(a)(6)), and that is a transfer agent of securities, a clearing
agency, or a participant in a clearing agency (as those terms are
defined in section 3(a) of the Securities Exchange Act (15 U.S.C.
78c(a)), shall be subject to Secs. 208.31-208.33 of the Board's
Regulation H (12 CFR 208.31-208.33) as if it were a state member bank.
(e) Reporting requirement for credit secured by certain bank holding
company stock. Each executive officer or director of a bank holding
company the shares of which are not publicly traded shall report
annually to the board of directors of the bank holding company the
outstanding amount of any credit that was extended to the executive
officer or director and that is secured by shares of the bank holding
company. For purposes of this paragraph, the terms ``executive officer''
and ``director'' shall have the meaning given in Sec. 215.2 of
Regulation O (12 CFR 215.2).
(f) Suspicious activity report. A bank holding company or any
nonbank subsidiary thereof, or a foreign bank that is subject to the BHC
Act or any nonbank subsidiary of such foreign bank operating in the
United States, shall file a suspicious activity report in accordance
with the provisions of Sec. 208.62 of the Board's Regulation H (12 CFR
208.62).
(g) Requirements for financial holding companies engaged in
securities underwriting, dealing, or market-making activities. (1) Any
intra-day extension of credit by a bank or thrift, or U.S. branch or
agency of a foreign bank to an affiliated company engaged in
underwriting, dealing in, or making a market in securities pursuant to
section 4(k)(4)(E) of the Bank Holding Company Act (12 U.S.C.
1843(k)(4)(E)) must be on market terms consistent with section 23B of
the Federal Reserve Act. (12 U.S.C. 371c-1).
(2) A foreign bank that is or is treated as a financial holding
company under this part shall ensure that:
(i) Any extension of credit by any U.S. branch or agency of such
foreign bank to an affiliated company engaged in underwriting, dealing
in, or making a market in securities pursuant to section 4(k)(4)(E) of
the Bank Holding Company Act (12 U.S.C. 1843(k)(4)(E)), conforms to
sections 23A and 23B of the Federal Reserve Act (12 U.S.C. 371c and
371c-1) as if the branch or agency were a member bank;
(ii) Any purchase by any U.S. branch or agency of such foreign bank,
as principal or fiduciary, of securities for which a securities
affiliate described in paragraph (g)(2)(i) of this section is a
principal underwriter conforms to sections 23A and 23B of the Federal
Reserve Act (12 U.S.C. 371c and 371c-1) as if the branch or agency were
a member bank; and
(iii) Its U.S. branches and agencies not advertise or suggest that
they are responsible for the obligations of a securities affiliate
described in paragraph (g)(2)(i) of this section, consistent with
section 23B(c) of the Federal Reserve Act (12 U.S.C. 371c-1(c)) as if
the branches or agencies were member banks.
[Reg. Y, 62 FR 9319, Feb. 28, 1997, as amended at 63 FR 58621, Nov. 2,
1998; 65 FR 14442, Mar. 17, 2000]
Sec. 225.5 Registration, reports, and inspections.
(a) Registration of bank holding companies. Each company shall
register within 180 days after becoming a bank holding company by
furnishing information in the manner and form prescribed by the Board. A
company that receives the Board's prior approval under subpart B of this
part to become a bank holding company may complete this registration
requirement through submission of its first annual report to the Board
as required by paragraph (b) of this section.
(b) Reports of bank holding companies. Each bank holding company
shall furnish, in the manner and form prescribed by the Board, an annual
report
[[Page 66]]
of the company's operations for the fiscal year in which it becomes a
bank holding company, and for each fiscal year during which it remains a
bank holding company. Additional information and reports shall be
furnished as the Board may require.
(c) Examinations and inspections. The Board may examine or inspect
any bank holding company and each of its subsidiaries and prepare a
report of their operations and activities. With respect to a foreign
banking organization, the Board may also examine any branch or agency of
a foreign bank in any state of the United States and may examine or
inspect each of the organization's subsidiaries in the United States and
prepare reports of their operations and activities. The Board shall
rely, as far as possible, on the reports of examination made by the
primary federal or state supervisor of the subsidiary bank of the bank
holding company or of the branch or agency of the foreign bank.
Sec. 225.6 Penalties for violations.
(a) Criminal and civil penalties. (1) Section 8 of the BHC Act
provides criminal penalties for willful violation, and civil penalties
for violation, by any company or individual, of the BHC Act or any
regulation or order issued under it, or for making a false entry in any
book, report, or statement of a bank holding company.
(2) Civil money penalty assessments for violations of the BHC Act
shall be made in accordance with subpart C of the Board's Rules of
Practice for Hearings (12 CFR part 263, subpart C). For any willful
violation of the Bank Control Act or any regulation or order issued
under it, the Board may assess a civil penalty as provided in 12 U.S.C.
1817(j)(15).
(b) Cease-and-desist proceedings. For any violation of the BHC Act,
the Bank Control Act, this regulation, or any order or notice issued
thereunder, the Board may institute a cease-and-desist proceeding in
accordance with the Financial Institutions Supervisory Act of 1966, as
amended (12 U.S.C. 1818(b) et seq.).
Sec. 225.7 Exceptions to tying restrictions.
(a) Purpose. This section establishes exceptions to the anti-tying
restrictions of section 106 of the Bank Holding Company Act Amendments
of 1970 (12 U.S.C. 1971, 1972(1)). These exceptions are in addition to
those in section 106. The section also restricts tying of electronic
benefit transfer services by bank holding companies and their nonbank
subsidiaries.
(b) Exceptions to statute. Subject to the limitations of paragraph
(c) of this section, a bank may:
(1) Extension to affiliates of statutory exceptions preserving
traditional banking relationships. Extend credit, lease or sell property
of any kind, or furnish any service, or fix or vary the consideration
for any of the foregoing, on the condition or requirement that a
customer:
(i) Obtain a loan, discount, deposit, or trust service from an
affiliate of the bank; or
(ii) Provide to an affiliate of the bank some additional credit,
property, or service that the bank could require to be provided to
itself pursuant to section 106(b)(1)(C) of the Bank Holding Company Act
Amendments of 1970 (12 U.S.C. 1972(1)(C)).
(2) Safe harbor for combined-balance discounts. Vary the
consideration for any product or package of products based on a
customer's maintaining a combined minimum balance in certain products
specified by the bank (eligible products), if:
(i) The bank offers deposits, and all such deposits are eligible
products; and
(ii) Balances in deposits count at least as much as nondeposit
products toward the minimum balance.
(3) Safe harbor for foreign transactions. Engage in any transaction
with a customer if that customer is:
(i) A corporation, business, or other person (other than an
individual) that:
(A) Is incorporated, chartered, or otherwise organized outside the
United States; and
(B) Has its principal place of business outside the United States;
or
(ii) An individual who is a citizen of a foreign country and is not
resident in the United States.
[[Page 67]]
(c) Limitations on exceptions. Any exception granted pursuant to
this section shall terminate upon a finding by the Board that the
arrangement is resulting in anti-competitive practices. The eligibility
of a bank to operate under any exception granted pursuant to this
section shall terminate upon a finding by the Board that its exercise of
this authority is resulting in anti-competitive practices.
(d) Extension of statute to electronic benefit transfer services. A
bank holding company or nonbank subsidiary of a bank holding company
that provides electronic benefit transfer services shall be subject to
the anti-tying restrictions applicable to such services set forth in
section 7(i)(11) of the Food Stamp Act of 1977 (7 U.S.C. 2016(i)(11)).
(e) For purposes of this section, bank has the meaning given that
term in section 106(a) of the Bank Holding Company Act Amendments of
1970 (12 U.S.C. 1971), but shall also include a United States branch,
agency, or commercial lending company subsidiary of a foreign bank that
is subject to section 106 pursuant to section 8(d) of the International
Banking Act of 1978 (12 U.S.C. 3106(d)), and any company made subject to
section 106 by section 4(f)(9) or 4(h) of the BHC Act.
Subpart B--Acquisition of Bank Securities or Assets
Source: Reg. Y, 62 FR 9324, Feb. 28, 1997, unless otherwise noted.
Sec. 225.11 Transactions requiring Board approval.
The following transactions require the Board's prior approval under
section 3 of the Bank Holding Company Act except as exempted under
Sec. 225.12 or as otherwise covered by Sec. 225.17 of this subpart:
(a) Formation of bank holding company. Any action that causes a bank
or other company to become a bank holding company.
(b) Acquisition of subsidiary bank. Any action that causes a bank to
become a subsidiary of a bank holding company.
(c) Acquisition of control of bank or bank holding company
securities.
(1) The acquisition by a bank holding company of direct or indirect
ownership or control of any voting securities of a bank or bank holding
company, if the acquisition results in the company's control of more
than 5 percent of the outstanding shares of any class of voting
securities of the bank or bank holding company.
(2) An acquisition includes the purchase of additional securities
through the exercise of preemptive rights, but does not include
securities received in a stock dividend or stock split that does not
alter the bank holding company's proportional share of any class of
voting securities.
(d) Acquisition of bank assets. The acquisition by a bank holding
company or by a subsidiary thereof (other than a bank) of all or
substantially all of the assets of a bank.
(e) Merger of bank holding companies. The merger or consolidation of
bank holding companies, including a merger through the purchase of
assets and assumption of liabilities.
(f) Transactions by foreign banking organization. Any transaction
described in paragraphs (a) through (e) of this section by a foreign
banking organization that involves the acquisition of an interest in a
U.S. bank or in a bank holding company for which application would be
required if the foreign banking organization were a bank holding
company.
Sec. 225.12 Transactions not requiring Board approval.
The following transactions do not require the Board's approval under
Sec. 225.11 of this subpart:
(a) Acquisition of securities in fiduciary capacity. The acquisition
by a bank or other company (other than a trust that is a company) of
control of voting securities of a bank or bank holding company in good
faith in a fiduciary capacity, unless:
(1) The acquiring bank or other company has sole discretionary
authority to vote the securities and retains this authority for more
than two years; or
(2) The acquisition is for the benefit of the acquiring bank or
other company, or its shareholders, employees, or subsidiaries.
(b) Acquisition of securities in satisfaction of debts previously
contracted. The
[[Page 68]]
acquisition by a bank or other company of control of voting securities
of a bank or bank holding company in the regular course of securing or
collecting a debt previously contracted in good faith, if the acquiring
bank or other company divests the securities within two years of
acquisition. The Board or Reserve Bank may grant requests for up to
three one-year extensions.
(c) Acquisition of securities by bank holding company with majority
control. The acquisition by a bank holding company of additional voting
securities of a bank or bank holding company if more than 50 percent of
the outstanding voting securities of the bank or bank holding company is
lawfully controlled by the acquiring bank holding company prior to the
acquisition.
(d) Acquisitions involving bank mergers and internal corporate
reorganizations--(1) Transactions subject to Bank Merger Act. The merger
or consolidation of a subsidiary bank of a bank holding company with
another bank, or the purchase of assets by the subsidiary bank, or a
similar transaction involving subsidiary banks of a bank holding
company, if the transaction requires the prior approval of a federal
supervisory agency under the Bank Merger Act (12 U.S.C. 1828(c)) and
does not involve the acquisition of shares of a bank. This exception
does not include:
(i) The merger of a nonsubsidiary bank and a nonoperating subsidiary
bank formed by a company for the purpose of acquiring the nonsubsidiary
bank; or
(ii) Any transaction requiring the Board's prior approval under
Sec. 225.11(e) of this subpart.
The Board may require an application under this subpart if it
determines that the merger or consolidation would have a significant
adverse impact on the financial condition of the bank holding company,
or otherwise requires approval under section 3 of the BHC Act.
(2) Certain acquisitions subject to Bank Merger Act. The acquisition
by a bank holding company of shares of a bank or company controlling a
bank or the merger of a company controlling a bank with the bank holding
company, if the transaction is part of the merger or consolidation of
the bank with a subsidiary bank (other than a nonoperating subsidiary
bank) of the acquiring bank holding company, or is part of the purchase
of substantially all of the assets of the bank by a subsidiary bank
(other than a nonoperating subsidiary bank) of the acquiring bank
holding company, and if:
(i) The bank merger, consolidation, or asset purchase occurs
simultaneously with the acquisition of the shares of the bank or bank
holding company or the merger of holding companies, and the bank is not
operated by the acquiring bank holding company as a separate entity
other than as the survivor of the merger, consolidation, or asset
purchase;
(ii) The transaction requires the prior approval of a federal
supervisory agency under the Bank Merger Act (12 U.S.C. 1828(c));
(iii) The transaction does not involve the acquisition of any
nonbank company that would require prior approval under section 4 of the
BHC Act (12 U.S.C. 1843);
(iv) Both before and after the transaction, the acquiring bank
holding company meets the Board's Capital Adequacy Guidelines
(Appendixes A, B, C, D, and E of this part);
(v) At least 10 days prior to the transaction, the acquiring bank
holding company has provided to the Reserve Bank written notice of the
transaction that contains:
(A) A copy of the filing made to the appropriate federal banking
agency under the Bank Merger Act; and
(B) A description of the holding company's involvement in the
transaction, the purchase price, and the source of funding for the
purchase price; and
(vi) Prior to expiration of the period provided in paragraph
(d)(2)(v) of this section, the Reserve Bank has not informed the bank
holding company that an application under Sec. 225.11 is required.
(3) Internal corporate reorganizations. (i) Subject to paragraph
(d)(3)(ii) of this section, any of the following transactions performed
in the United States by a bank holding company:
(A) The merger of holding companies that are subsidiaries of the
bank holding company;
[[Page 69]]
(B) The formation of a subsidiary holding company; \1\
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\1\ In the case of a transaction that results in the formation or
designation of a new bank holding company, the new bank holding company
must complete the registration requirements described in Sec. 225.5.
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(C) The transfer of control or ownership of a subsidiary bank or a
subsidiary holding company between one subsidiary holding company and
another subsidiary holding company or the bank holding company.
(ii) A transaction described in paragraph (d)(3)(i) of this section
qualifies for this exception if:
(A) The transaction represents solely a corporate reorganization
involving companies and insured depository institutions that, both
preceding and following the transaction, are lawfully controlled and
operated by the bank holding company;
(B) The transaction does not involve the acquisition of additional
voting shares of an insured depository institution that, prior to the
transaction, was less than majority owned by the bank holding company;
(C) The bank holding company is not organized in mutual form; and
(D) Both before and after the transaction, the bank holding company
meets the Board's Capital Adequacy Guidelines (Appendixes A, B, C, D,
and E of this part).
(e) Holding securities in escrow. The holding of any voting
securities of a bank or bank holding company in an escrow arrangement
for the benefit of an applicant pending the Board's action on an
application for approval of the proposed acquisition, if title to the
securities and the voting rights remain with the seller and payment for
the securities has not been made to the seller.
(f) Acquisition of foreign banking organization. The acquisition of
a foreign banking organization where the foreign banking organization
does not directly or indirectly own or control a bank in the United
States, unless the acquisition is also by a foreign banking organization
and otherwise subject to Sec. 225.11(f) of this subpart.
Sec. 225.13 Factors considered in acting on bank acquisition proposals.
(a) Factors requiring denial. As specified in section 3(c) of the
BHC Act, the Board may not approve any application under this subpart
if:
(1) The transaction would result in a monopoly or would further any
combination or conspiracy to monopolize, or to attempt to monopolize,
the business of banking in any part of the United States;
(2) The effect of the transaction may be substantially to lessen
competition in any section of the country, tend to create a monopoly, or
in any other manner be in restraint of trade, unless the Board finds
that the transaction's anti-competitive effects are clearly outweighed
by its probable effect in meeting the convenience and needs of the
community;
(3) The applicant has failed to provide the Board with adequate
assurances that it will make available such information on its
operations or activities, and the operations or activities of any
affiliate of the applicant, that the Board deems appropriate to
determine and enforce compliance with the BHC Act and other applicable
federal banking statutes, and any regulations thereunder; or
(4) In the case of an application involving a foreign banking
organization, the foreign banking organization is not subject to
comprehensive supervision or regulation on a consolidated basis by the
appropriate authorities in its home country, as provided in
Sec. 211.24(c)(1)(ii) of the Board's Regulation K (12 CFR
211.24(c)(1)(ii)).
(b) Other factors. In deciding applications under this subpart, the
Board also considers the following factors with respect to the
applicant, its subsidiaries, any banks related to the applicant through
common ownership or management, and the bank or banks to be acquired:
(1) Financial condition. Their financial condition and future
prospects, including whether current and projected capital positions and
levels of indebtedness conform to standards and policies established by
the Board.
(2) Managerial resources. The competence, experience, and integrity
of the officers, directors, and principal
[[Page 70]]
shareholders of the applicant, its subsidiaries, and the banks and bank
holding companies concerned; their record of compliance with laws and
regulations; and the record of the applicant and its affiliates of
fulfilling any commitments to, and any conditions imposed by, the Board
in connection with prior applications.
(3) Convenience and needs of community. The convenience and needs of
the communities to be served, including the record of performance under
the Community Reinvestment Act of 1977 (12 U.S.C. 2901 et seq.) and
regulations issued thereunder, including the Board's Regulation BB (12
CFR part 228).
(c) Interstate transactions. The Board may approve any application
or notice under this subpart by a bank holding company to acquire
control of all or substantially all of the assets of a bank located in a
state other than the home state of the bank holding company, without
regard to whether the transaction is prohibited under the law of any
state, if the transaction complies with the requirements of section 3(d)
of the BHC Act (12 U.S.C. 1842(d)).
(d) Conditional approvals. The Board may impose conditions on any
approval, including conditions to address competitive, financial,
managerial, safety and soundness, convenience and needs, compliance or
other concerns, to ensure that approval is consistent with the relevant
statutory factors and other provisions of the BHC Act.
Sec. 225.14 Expedited action for certain bank acquisitions by well-run bank holding companies.
(a) Filing of notice--(1) Information required and public notice. As
an alternative to the procedure provided in Sec. 225.15, a bank holding
company that meets the requirements of paragraph (c) of this section may
satisfy the prior approval requirements of Sec. 225.11 in connection
with the acquisition of shares, assets or control of a bank, or a merger
or consolidation between bank holding companies, by providing the
appropriate Reserve Bank with a written notice containing the following:
(i) A certification that all of the criteria in paragraph (c) of
this section are met;
(ii) A description of the transaction that includes identification
of the companies and insured depository institutions involved in the
transaction \2\ and identification of each banking market affected by
the transaction;
---------------------------------------------------------------------------
\2\ If, in connection with a transaction under this subpart, any
person or group of persons proposes to acquire control of the acquiring
bank holding company for purposes of the Bank Control Act or
Sec. 225.41, the person or group of persons may fulfill the notice
requirements of the Bank Control Act and Sec. 225.43 by providing, as
part of the submission by the acquiring bank holding company under this
subpart, identifying and biographical information required in paragraph
(6)(A) of the Bank Control Act (12 U.S.C. 1817(j)(6)(A)), as well as any
financial or other information requested by the Reserve Bank under
Sec. 225.43.
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(iii) A description of the effect of the transaction on the
convenience and needs of the communities to be served and of the actions
being taken by the bank holding company to improve the CRA performance
of any insured depository institution subsidiary that does not have at
least a satisfactory CRA performance rating at the time of the
transaction;
(iv) Evidence that notice of the proposal has been published in
accordance with Sec. 225.16(b)(1);
(v)(A) If the bank holding company has consolidated assets of $150
million or more, an abbreviated consolidated pro forma balance sheet as
of the most recent quarter showing credit and debit adjustments that
reflect the proposed transaction, consolidated pro forma risk-based
capital ratios for the acquiring bank holding company as of the most
recent quarter, and a description of the purchase price and the terms
and sources of funding for the transaction;
(B) If the bank holding company has consolidated assets of less than
$150 million, a pro forma parent-only balance sheet as of the most
recent quarter showing credit and debit adjustments that reflect the
proposed transaction, and a description of the purchase price, the terms
and sources of funding for the transaction, and the sources and schedule
for retiring any debt incurred in the transaction;
(vi) If the bank holding company has consolidated assets of less
than $300
[[Page 71]]
million, a list of and biographical information regarding any directors
or senior executive officers of the resulting bank holding company that
are not directors or senior executive officers of the acquiring bank
holding company or of a company or institution to be acquired;
(vii) For each insured depository institution whose Tier 1 capital,
total capital, total assets or risk-weighted assets change as a result
of the transaction, the total risk-weighted assets, total assets, Tier 1
capital and total capital of the institution on a pro forma basis; and
(viii) The market indexes for each relevant banking market
reflecting the pro forma effect of the transaction.
(2) Waiver of unnecessary information. The Reserve Bank may reduce
the information requirements in paragraph (a)(1)(v) through (viii) of
this section as appropriate.
(b)(1) Action on proposals under this section. The Board or the
appropriate Reserve Bank shall act on a proposal submitted under this
section or notify the bank holding company that the transaction is
subject to the procedure in Sec. 225.15 within 5 business days after the
close of the public comment period. The Board and the Reserve Bank shall
not approve any proposal under this section prior to the third business
day following the close of the public comment period, unless an
emergency exists that requires expedited or immediate action. The Board
may extend the period for action under this section for up to 5 business
days.
(2) Acceptance of notice in event expedited procedure not available.
In the event that the Board or the Reserve Bank determines after the
filing of a notice under this section that a bank holding company may
not use the procedure in this section and must file an application under
Sec. 225.15, the application shall be deemed accepted for purposes of
Sec. 225.15 as of the date that the notice was filed under this section.
(c) Criteria for use of expedited procedure. The procedure in this
section is available only if:
(1) Well-capitalized organization--(i) Bank holding company. Both at
the time of and immediately after the proposed transaction, the
acquiring bank holding company is well-capitalized;
(ii) Insured depository institutions. Both at the time of and
immediately after the proposed transaction:
(A) The lead insured depository institution of the acquiring bank
holding company is well-capitalized;
(B) Well-capitalized insured depository institutions control at
least 80 percent of the total risk-weighted assets of insured depository
institutions controlled by the acquiring bank holding company; and
(C) No insured depository institution controlled by the acquiring
bank holding company is undercapitalized;
(2) Well-managed organization. (i) Satisfactory examination ratings.
At the time of the transaction, the acquiring bank holding company, its
lead insured depository institution, and insured depository institutions
that control at least 80 percent of the total risk-weighted assets of
insured depository institutions controlled by the holding company are
well-managed;
(ii) No poorly managed institutions. No insured depository
institution controlled by the acquiring bank holding company has
received 1 of the 2 lowest composite ratings at the later of the
institution's most recent examination or subsequent review by the
appropriate federal banking agency for the institution;
(iii) Recently acquired institutions excluded. Any insured
depository institution that has been acquired by the bank holding
company during the 12-month period preceding the date on which written
notice is filed under paragraph (a) of this section may be excluded for
purposes of paragraph (c)(2)(ii) of this section if :
(A) The bank holding company has developed a plan acceptable to the
appropriate federal banking agency for the institution to restore the
capital and management of the institution; and
(B) All insured depository institutions excluded under this
paragraph represent, in the aggregate, less than 10 percent of the
aggregate total risk-weighted assets of all insured depository
institutions controlled by the bank holding company;
[[Page 72]]
(3) Convenience and needs criteria--(i) Effect on the community. The
record indicates that the proposed transaction would meet the
convenience and needs of the community standard in the BHC Act; and
(ii) Established CRA performance record. At the time of the
transaction, the lead insured depository institution of the acquiring
bank holding company and insured depository institutions that control at
least 80 percent of the total risk-weighted assets of insured
institutions controlled by the holding company have received a
satisfactory or better composite rating at the most recent examination
under the Community Reinvestment Act;
(4) Public comment. No comment that is timely and substantive as
provided in Sec. 225.16 is received by the Board or the appropriate
Reserve Bank other than a comment that supports approval of the
proposal;
(5) Competitive criteria--(i) Competitive screen. Without regard to
any divestitures proposed by the acquiring bank holding company, the
acquisition does not cause:
(A) Insured depository institutions controlled by the acquiring bank
holding company to control in excess of 35 percent of market deposits in
any relevant banking market; or
(B) The Herfindahl-Hirschman index to increase by more than 200
points in any relevant banking market with a post-acquisition index of
at least 1800; and
(ii) Department of Justice. The Department of Justice has not
indicated to the Board that consummation of the transaction is likely to
have a significantly adverse effect on competition in any relevant
banking market;
(6) Size of acquisition--(i) In general--(A) Limited Growth. Except
as provided in paragraph (c)(6)(ii) of this section, the sum of the
aggregate risk-weighted assets to be acquired in the proposal and the
aggregate risk- weighted assets acquired by the acquiring bank holding
company in all other qualifying transactions does not exceed 35 percent
of the consolidated risk-weighted assets of the acquiring bank holding
company. For purposes of this paragraph other qualifying transactions
means any transaction approved under this section or Sec. 225.23 during
the 12 months prior to filing the notice under this section; and
(B) Individual size limitation. The total risk-weighted assets to be
acquired do not exceed $7.5 billion;
(ii) Small bank holding companies. Paragraph (c)(6)(i)(A) of this
section shall not apply if, immediately following consummation of the
proposed transaction, the consolidated risk-weighted assets of the
acquiring bank holding company are less than $300 million;
(7) Supervisory actions. During the 12-month period ending on the
date on which the bank holding company proposes to consummate the
proposed transaction, no formal administrative order, including a
written agreement, cease and desist order, capital directive, prompt
corrective action directive, asset maintenance agreement, or other
formal enforcement action, is or was outstanding against the bank
holding company or any insured depository institution subsidiary of the
holding company, and no formal administrative enforcement proceeding
involving any such enforcement action, order, or directive is or was
pending;
(8) Interstate acquisitions. Board-approval of the transaction is
not prohibited under section 3(d) of the BHC Act;
(9) Other supervisory considerations. Board approval of the
transaction is not prohibited under the informational sufficiency or
comprehensive home country supervision standards set forth in section
3(c)(3) of the BHC Act; and
(10) Notification. The acquiring bank holding company has not been
notified by the Board, in its discretion, prior to the expiration of the
period in paragraph (b)(1) of this section that an application under
Sec. 225.15 is required in order to permit closer review of any
financial, managerial, competitive, convenience and needs or other
matter related to the factors that must be considered under this part.
(d) Comment by primary banking supervisor--(1) Notice. Upon receipt
of a notice under this section, the appropriate Reserve Bank shall
promptly furnish notice of the proposal and a copy of the information
filed pursuant to paragraph (a) of this section to the primary
[[Page 73]]
banking supervisor of the insured depository institutions to be
acquired.
(2) Comment period. The primary banking supervisor shall have 30
calendar days (or such shorter time as agreed to by the primary banking
supervisor) from the date of the letter giving notice in which to submit
its views and recommendations to the Board.
(3) Action subject to supervisor's comment. Action by the Board or
the Reserve Bank on a proposal under this section is subject to the
condition that the primary banking supervisor not recommend in writing
to the Board disapproval of the proposal prior to the expiration of the
comment period described in paragraph (d)(2) of this section. In such
event, any approval given under this section shall be revoked and, if
required by section 3(b) of the BHC Act, the Board shall order a hearing
on the proposal.
(4) Emergencies. Notwithstanding paragraphs (d)(2) and (d)(3) of
this section, the Board may provide the primary banking supervisor with
10 calendar days' notice of a proposal under this section if the Board
finds that an emergency exists requiring expeditious action, and may act
during the notice period or without providing notice to the primary
banking supervisor if the Board finds that it must act immediately to
prevent probable failure.
(5) Primary banking supervisor. For purposes of this section and
Sec. 225.15(b), the primary banking supervisor for an institution is:
(i) The Office of the Comptroller of the Currency, in the case of a
national banking association or District bank;
(ii) The appropriate supervisory authority for the State in which
the bank is chartered, in the case of a State bank;
(iii) The Director of the Office of Thrift Supervision, in the case
of a savings association.
(e) Branches and agencies of foreign banking organizations. For
purposes of this section, a U.S. branch or agency of a foreign banking
organization shall be considered to be an insured depository
institution. A U.S. branch or agency of a foreign banking organization
shall be subject to paragraph (c)(3)(ii) of this section only to the
extent it is insured by the Federal Deposit Insurance Corporation in
accordance with section 6 of the International Banking Act of 1978 (12
U.S.C. 3104).
Sec. 225.15 Procedures for other bank acquisition proposals.
(a) Filing application. Except as provided in Sec. 225.14, an
application for the Board's prior approval under this subpart shall be
governed by the provisions of this section and shall be filed with the
appropriate Reserve Bank on the designated form.
(b) Notice to primary banking supervisor. Upon receipt of an
application under this subpart, the Reserve Bank shall promptly furnish
notice and a copy of the application to the primary banking supervisor
of each bank to be acquired. The primary supervisor shall have 30
calendar days from the date of the letter giving notice in which to
submit its views and recommendations to the Board.
(c) Accepting application for processing. Within 7 calendar days
after the Reserve Bank receives an application under this section, the
Reserve Bank shall accept it for processing as of the date the
application was filed or return the application if it is substantially
incomplete. Upon accepting an application, the Reserve Bank shall
immediately send copies to the Board. The Reserve Bank or the Board may
request additional information necessary to complete the record of an
application at any time after accepting the application for processing.
(d) Action on applications--(1) Action under delegated authority.
The Reserve Bank shall approve an application under this section within
30 calendar days after the acceptance date for the application, unless
the Reserve Bank, upon notice to the applicant, refers the application
to the Board for decision because action under delegated authority is
not appropriate.
(2) Board action. The Board shall act on an application under this
subpart that is referred to it for decision within 60 calendar days
after the acceptance date for the application, unless the Board notifies
the applicant that the 60-day period is being extended for a specified
period and states the reasons for the extension. In no event may the
[[Page 74]]
extension exceed the 91-day period provided in Sec. 225.16(f). The Board
may, at any time, request additional information that it believes is
necessary for its decision.
Sec. 225.16 Public notice, comments, hearings, and other provisions governing applications and notices.
(a) In general. The provisions of this section apply to all notices
and applications filed under Sec. 225.14 and Sec. 225.15.
(b) Public notice--(1) Newspaper publication--(i) Location of
publication. In the case of each notice or application submitted under
Sec. 225.14 or Sec. 225.15, the applicant shall publish a notice in a
newspaper of general circulation, in the form and at the locations
specified in Sec. 262.3 of the Rules of Procedure (12 CFR 262.3);
(ii) Contents of notice. A newspaper notice under this paragraph
shall provide an opportunity for interested persons to comment on the
proposal for a period of at least 30 calendar days;
(iii) Timing of publication. Each newspaper notice published in
connection with a proposal under this paragraph shall be published no
more than 15 calendar days before and no later than 7 calendar days
following the date that a notice or application is filed with the
appropriate Reserve Bank.
(2) Federal Register notice. (i) Publication by Board. Upon receipt
of a notice or application under Sec. 225.14 or Sec. 225.15, the Board
shall promptly publish notice of the proposal in the Federal Register
and shall provide an opportunity for interested persons to comment on
the proposal for a period of no more than 30 days;
(ii) Request for advance publication. A bank holding company may
request that, during the 15-day period prior to filing a notice or
application under Sec. 225.14 or Sec. 225.15, the Board publish notice
of a proposal in the Federal Register. A request for advance Federal
Register publication shall be made in writing to the appropriate Reserve
Bank and shall contain the identifying information prescribed by the
Board for Federal Register publication;
(3) Waiver or shortening of notice. The Board may waive or shorten
the required notice periods under this section if the Board determines
that an emergency exists requiring expeditious action on the proposal,
or if the Board finds that immediate action is necessary to prevent the
probable failure of an insured depository institution.
(c) Public comment--(1) Timely comments. Interested persons may
submit information and comments regarding a proposal filed under this
subpart. A comment shall be considered timely for purposes of this
subpart if the comment, together with all supplemental information, is
submitted in writing in accordance with the Board's Rules of Procedure
and received by the Board or the appropriate Reserve Bank prior to the
expiration of the latest public comment period provided in paragraph (b)
of this section.
(2) Extension of comment period--(i) In general. The Board may, in
its discretion, extend the public comment period regarding any proposal
submitted under this subpart.
(ii) Requests in connection with obtaining application or notice. In
the event that an interested person has requested a copy of a notice or
application submitted under this subpart, the Board may, in its
discretion and based on the facts and circumstances, grant such person
an extension of the comment period for up to 15 calendar days.
(iii) Joint requests by interested person and acquiring company. The
Board will grant a joint request by an interested person and the
acquiring bank holding company for an extension of the comment period
for a reasonable period for a purpose related to the statutory factors
the Board must consider under this subpart.
(3) Substantive comment. A comment will be considered substantive
for purposes of this subpart unless it involves individual complaints,
or raises frivolous, previously-considered or wholly unsubstantiated
claims or irrelevant issues.
(d) Notice to Attorney General. The Board or Reserve Bank shall
immediately notify the United States Attorney General of approval of any
notice or application under Sec. 225.14 or Sec. 225.15.
(e) Hearings. As provided in section 3(b) of the BHC Act, the Board
shall order a hearing on any application or notice under Sec. 225.15 if
the Board receives from the primary supervisor of
[[Page 75]]
the bank to be acquired, within the 30-day period specified in
Sec. 225.15(b), a written recommendation of disapproval of an
application. The Board may order a formal or informal hearing or other
proceeding on the application or notice, as provided in Sec. 262.3(i)(2)
of the Board's Rules of Procedure. Any request for a hearing (other than
from the primary supervisor) shall comply with Sec. 262.3(e) of the
Rules of Procedure (12 CFR 262.3(e)).
(f) Approval through failure to act--(1) Ninety-one day rule. An
application or notice under Sec. 225.14 or Sec. 225.15 shall be deemed
approved if the Board fails to act on the application or notice within
91 calendar days after the date of submission to the Board of the
complete record on the application. For this purpose, the Board acts
when it issues an order stating that the Board has approved or denied
the application or notice, reflecting the votes of the members of the
Board, and indicating that a statement of the reasons for the decision
will follow promptly.
(2) Complete record. For the purpose of computing the commencement
of the 91-day period, the record is complete on the latest of:
(i) The date of receipt by the Board of an application or notice
that has been accepted by the Reserve Bank;
(ii) The last day provided in any notice for receipt of comments and
hearing requests on the application or notice;
(iii) The date of receipt by the Board of the last relevant material
regarding the application or notice that is needed for the Board's
decision, if the material is received from a source outside of the
Federal Reserve System; or
(iv) The date of completion of any hearing or other proceeding.
(g) Exceptions to notice and hearing requirements--(1) Probable bank
failure. If the Board finds it must act immediately on an application or
notice in order to prevent the probable failure of a bank or bank
holding company, the Board may modify or dispense with the notice and
hearing requirements of this section.
(2) Emergency. If the Board finds that, although immediate action on
an application or notice is not necessary, an emergency exists requiring
expeditious action, the Board shall provide the primary supervisor 10
days to submit its recommendation. The Board may act on such an
application or notice without a hearing and may modify or dispense with
the other notice and hearing requirements of this section.
(h) Waiting period. A transaction approved under Sec. 225.14 or
Sec. 225.15 shall not be consummated until 30 days after the date of
approval of the application, except that a transaction may be
consummated:
(1) Immediately upon approval, if the Board has determined under
paragraph (g) of this section that the application or notice involves a
probable bank failure;
(2) On or after the 5th calendar day following the date of approval,
if the Board has determined under paragraph (g) of this section that an
emergency exists requiring expeditious action; or
(3) On or after the 15th calendar day following the date of
approval, if the Board has not received any adverse comments from the
United States Attorney General relating to the competitive factors and
the Attorney General has consented to the shorter waiting period.
Sec. 225.17 Notice procedure for one-bank holding company formations.
(a) Transactions that qualify under this section. An acquisition by
a company of control of a bank may be consummated 30 days after
providing notice to the appropriate Reserve Bank in accordance with
paragraph (b) of this section, provided that all of the following
conditions are met:
(1) The shareholder or shareholders who control at least 67 percent
of the shares of the bank will control, immediately after the
reorganization, at least 67 percent of the shares of the holding company
in substantially the same proportion, except for changes in
shareholders' interests resulting from the exercise of dissenting
shareholders' rights under state or federal law; \3\
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\3\ A shareholder of a bank in reorganization will be considered to
have the same proportional interest in the holding company if the
shareholder interest increases, on a pro rata basis, as a result of
either the redemption of shares from dissenting shareholders by the bank
or bank holding company, or the acquisition of shares of dissenting
shareholders by the remaining shareholders.
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[[Page 76]]
(2) No shareholder, or group of shareholders acting in concert,
will, following the reorganization, own or control 10 percent or more of
any class of voting shares of the bank holding company, unless that
shareholder or group of shareholders was authorized, after review under
the Change in Bank Control Act of 1978 (12 U.S.C. 1817(j)) by the
appropriate federal banking agency for the bank, to own or control 10
percent or more of any class of voting shares of the bank; \4\
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\4\ This procedure is not available in cases in which the exercise
of dissenting shareholders' rights would cause a company that is not a
bank holding company (other than the company in formation) to be
required to register as a bank holding company. This procedure also is
not available for the formation of a bank holding company organized in
mutual form.
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(3) The bank is adequately capitalized (as defined in section 38 of
the Federal Deposit Insurance Act (12 U.S.C. 1831o));
(4) The bank received at least a composite ``satisfactory'' rating
at its most recent examination, in the event that the bank was examined;
(5) At the time of the reorganization, neither the bank nor any of
its officers, directors, or principal shareholders is involved in any
unresolved supervisory or enforcement matters with any appropriate
federal banking agency;
(6) The company demonstrates that any debt that it incurs at the
time of the reorganization, and the proposed means of retiring this
debt, will not place undue burden on the holding company or its
subsidiary on a pro forma basis; \5\
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\5\ For a banking organization with consolidated assets, on a pro
forma basis, of less than $150 million (other than a banking
organization that will control a de novo bank), this requirement is
satisfied if the proposal complies with the Board's policy statement on
small bank holding companies (Appendix C of this part).
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(7) The holding company will not, as a result of the reorganization,
acquire control of any additional bank or engage in any activities other
than those of managing and controlling banks; and
(8) During this period, neither the appropriate Reserve Bank nor the
Board objected to the proposal or required the filing of an application
under Sec. 225.15 of this subpart.
(b) Contents of notice. A notice filed under this paragraph shall
include:
(1) Certification by the notificant's board of directors that the
requirements of 12 U.S.C. 1842(a)(C) and this section are met by the
proposal;
(2) A list identifying all principal shareholders of the bank prior
to the reorganization and of the holding company following the
reorganization, and specifying the percentage of shares held by each
principal shareholder in the bank and proposed to be held in the new
holding company;
(3) A description of the resulting management of the proposed bank
holding company and its subsidiary bank, including:
(i) Biographical information regarding any senior officers and
directors of the resulting bank holding company who were not senior
officers or directors of the bank prior to the reorganization; and
(ii) A detailed history of the involvement of any officer, director,
or principal shareholder of the resulting bank holding company in any
administrative or criminal proceeding; and
(4) Pro forma financial statements for the holding company, and a
description of the amount, source, and terms of debt, if any, that the
bank holding company proposes to incur, and information regarding the
sources and timing for debt service and retirement.
(c) Acknowledgment of notice. Within 7 calendar days following
receipt of a notice under this section, the Reserve Bank shall provide
the notificant with a written acknowledgment of receipt of the notice.
This written acknowledgment shall indicate that the transaction
described in the notice may be consummated on the 30th calendar day
after the date of receipt of the notice if the Reserve Bank or the Board
has not objected to the proposal during that time.
(d) Application required upon objection. The Reserve Bank or the
Board may object to a proposal during the notice period by providing the
bank holding company with a written explanation of
[[Page 77]]
the reasons for the objection. In such case, the bank holding company
may file an application for prior approval of the proposal pursuant to
Sec. 225.15 of this subpart.
Subpart C--Nonbanking Activities and Acquisitions by Bank Holding
Companies
Source: Reg. Y, 62 FR 9329, Feb. 28, 1997, unless otherwise noted.
Sec. 225.21 Prohibited nonbanking activities and acquisitions; exempt bank holding companies.
(a) Prohibited nonbanking activities and acquisitions. Except as
provided in Sec. 225.22 of this subpart, a bank holding company or a
subsidiary may not engage in, or acquire or control, directly or
indirectly, voting securities or assets of a company engaged in, any
activity other than:
(1) Banking or managing or controlling banks and other subsidiaries
authorized under the BHC Act; and
(2) An activity that the Board determines to be so closely related
to banking, or managing or controlling banks as to be a proper incident
thereto, including any incidental activities that are necessary to carry
on such an activity, if the bank holding company has obtained the prior
approval of the Board for that activity in accordance with the
requirements of this regulation.
(b) Exempt bank holding companies. The following bank holding
companies are exempt from the provisions of this subpart:
(1) Family-owned companies. Any company that is a ``company covered
in 1970'' (as defined in section 2(b) of the BHC Act), more than 85
percent of the voting securities of which was collectively owned on June
30, 1968, and continuously thereafter, by members of the same family (or
their spouses) who are lineal descendants of common ancestors.
(2) Labor, agricultural, and horticultural organizations. Any
company that was on January 4, 1977, both a bank holding company and a
labor, agricultural, or horticultural organization exempt from taxation
under section 501 of the Internal Revenue Code (26 U.S.C. 501(c)).
(3) Companies granted hardship exemption. Any bank holding company
that has controlled only one bank since before July 1, 1968, and that
has been granted an exemption by the Board under section 4(d) of the BHC
Act, subject to any conditions imposed by the Board.
(4) Companies granted exemption on other grounds. Any company that
acquired control of a bank before December 10, 1982, without the Board's
prior approval under section 3 of the BHC Act, on the basis of a narrow
interpretation of the term demand deposit or commercial loan, if the
Board has determined that:
(i) Coverage of the company as a bank holding company under this
subpart would be unfair or represent an unreasonable hardship; and
(ii) Exclusion of the company from coverage under this part is
consistent with the purposes of the BHC Act and section 106 of the Bank
Holding Company Act Amendments of 1970 (12 U.S.C. 1971, 1972(1)). The
provisions of Sec. 225.4 of subpart A of this part do not apply to a
company exempt under this paragraph.
Sec. 225.22 Exempt nonbanking activities and acquisitions.
(a) Certain de novo activities. A bank holding company may, either
directly or indirectly, engage de novo in any nonbanking activity listed
in Sec. 225.28(b) (other than operation of an insured depository
institution) without obtaining the Board's prior approval if the bank
holding company:
(1) Meets the requirements of paragraphs (c) (1), (2), and (6) of
Sec. 225.23;
(2) Conducts the activity in compliance with all Board orders and
regulations governing the activity; and
(3) Within 10 business days after commencing the activity, provides
written notice to the appropriate Reserve Bank describing the activity,
identifying the company or companies engaged in the activity, and
certifying that the activity will be conducted in accordance with the
Board's orders and regulations and that the bank holding company meets
the requirements of paragraphs (c) (1), (2), and (6) of Sec. 225.23.
[[Page 78]]
(b) Servicing activities. A bank holding company may, without the
Board's prior approval under this subpart, furnish services to or
perform services for, or establish or acquire a company that engages
solely in servicing activities for:
(1) The bank holding company or its subsidiaries in connection with
their activities as authorized by law, including services that are
necessary to fulfill commitments entered into by the subsidiaries with
third parties, if the bank holding company or servicing company complies
with the Board's published interpretations and does not act as principal
in dealing with third parties; and
(2) The internal operations of the bank holding company or its
subsidiaries. Services for the internal operations of the bank holding
company or its subsidiaries include, but are not limited to:
(i) Accounting, auditing, and appraising;
(ii) Advertising and public relations;
(iii) Data processing and data transmission services, data bases, or
facilities;
(iv) Personnel services;
(v) Courier services;
(vi) Holding or operating property used wholly or substantially by a
subsidiary in its operations or for its future use;
(vii) Liquidating property acquired from a subsidiary;
(viii) Liquidating property acquired from any sources either prior
to May 9, 1956, or the date on which the company became a bank holding
company, whichever is later; and
(ix) Selling, purchasing, or underwriting insurance, such as blanket
bond insurance, group insurance for employees, and property and casualty
insurance.
(c) Safe deposit business. A bank holding company or nonbank
subsidiary may, without the Board's prior approval, conduct a safe
deposit business, or acquire voting securities of a company that
conducts such a business.
(d) Nonbanking acquisitions not requiring prior Board approval. The
Board's prior approval is not required under this subpart for the
following acquisitions:
(1) DPC acquisitions. (i) Voting securities or assets, acquired by
foreclosure or otherwise, in the ordinary course of collecting a debt
previously contracted (DPC property) in good faith, if the DPC property
is divested within two years of acquisition.
(ii) The Board may, upon request, extend this two-year period for up
to three additional years. The Board may permit additional extensions
for up to 5 years (for a total of 10 years), for shares, real estate or
other assets where the holding company demonstrates that each extension
would not be detrimental to the public interest and either the bank
holding company has made good faith attempts to dispose of such shares,
real estate or other assets or disposal of the shares, real estate or
other assets during the initial period would have been detrimental to
the company.
(iii) Transfers of DPC property within the bank holding company
system do not extend any period for divestiture of the property.
(2) Securities or assets required to be divested by subsidiary.
Voting securities or assets required to be divested by a subsidiary at
the request of an examining federal or state authority (except by the
Board under the BHC Act or this regulation), if the bank holding company
divests the securities or assets within two years from the date acquired
from the subsidiary.
(3) Fiduciary investments. Voting securities or assets acquired by a
bank or other company (other than a trust that is a company) in good
faith in a fiduciary capacity, if the voting securities or assets are:
(i) Held in the ordinary course of business; and
(ii) Not acquired for the benefit of the company or its
shareholders, employees, or subsidiaries.
(4) Securities eligible for investment by national bank. Voting
securities of the kinds and amounts explicitly eligible by federal
statute (other than section 4 of the Bank Service Corporation Act, 12
U.S.C. 1864) for investment by a national bank, and voting securities
acquired prior to June 30, 1971, in reliance on section 4(c)(5) of the
BHC Act and interpretations of the Comptroller of
[[Page 79]]
the Currency under section 5136 of the Revised Statutes (12 U.S.C.
24(7)).
(5) Securities or property representing 5 percent or less of a
company. Voting securities of a company or property that, in the
aggregate, represent 5 percent or less of the outstanding shares of any
class of voting securities of a company, or that represent a 5 percent
interest or less in the property, subject to the provisions of 12 CFR
225.137.
(6) Securities of investment company. Voting securities of an
investment company that is solely engaged in investing in securities and
that does not own or control more than 5 percent of the outstanding
shares of any class of voting securities of any company.
(7) Assets acquired in ordinary course of business. Assets of a
company acquired in the ordinary course of business, subject to the
provisions of 12 CFR 225.132, if the assets relate to activities in
which the acquiring company has previously received Board approval under
this regulation to engage.
(8) Asset acquisitions by lending company or industrial bank. Assets
of an office(s) of a company, all or substantially all of which relate
to making, acquiring, or servicing loans if:
(i) The acquiring company has previously received Board approval
under this regulation or is not required to obtain prior Board approval
under this regulation to engage in lending activities or industrial
banking activities;
(ii) The assets acquired during any 12-month period do not represent
more than 50 percent of the risk-weighted assets (on a consolidated
basis) of the acquiring lending company or industrial bank, or more than
$100 million, whichever amount is less;
(iii) The assets acquired do not represent more than 50 percent of
the selling company's consolidated assets that are devoted to lending
activities or industrial banking business;
(iv) The acquiring company notifies the Reserve Bank of the
acquisition within 30 days after the acquisition; and
(v) The acquiring company, after giving effect to the transaction,
meets the Board's Capital Adequacy Guidelines (Appendix A of this part),
and the Board has not previously notified the acquiring company that it
may not acquire assets under the exemption in this paragraph.
(e) Acquisition of securities by subsidiary banks--(1) National
bank. A national bank or its subsidiary may, without the Board's
approval under this subpart, acquire or retain securities on the basis
of section 4(c)(5) of the BHC Act in accordance with the regulations of
the Comptroller of the Currency.
(2) State bank. A state-chartered bank or its subsidiary may,
insofar as federal law is concerned, and without the Board's prior
approval under this subpart:
(i) Acquire or retain securities, on the basis of section 4(c)(5) of
the BHC Act, of the kinds and amounts explicitly eligible by federal
statute for investment by a national bank; or
(ii) Acquire or retain all (but, except for directors' qualifying
shares, not less than all) of the securities of a company that engages
solely in activities in which the parent bank may engage, at locations
at which the bank may engage in the activity, and subject to the same
limitations as if the bank were engaging in the activity directly.
(f) Activities and securities of new bank holding companies. A
company that becomes a bank holding company may, for a period of two
years, engage in nonbanking activities and control voting securities or
assets of a nonbank subsidiary, if the bank holding company engaged in
such activities or controlled such voting securities or assets on the
date it became a bank holding company. The Board may grant requests for
up to three one-year extensions of the two-year period.
(g) Grandfathered activities and securities. Unless the Board orders
divestiture or termination under section 4(a)(2) of the BHC Act, a
``company covered in 1970,'' as defined in section 2(b) of the BHC Act,
may:
(1) Retain voting securities or assets and engage in activities that
it has lawfully held or engaged in continuously since June 30, 1968; and
(2) Acquire voting securities of any newly formed company to engage
in such activities.
(h) Securities or activities exempt under Regulation K. A bank
holding company may acquire voting securities or assets
[[Page 80]]
and engage in activities as authorized in Regulation K (12 CFR part
211).
Sec. 225.23 Expedited action for certain nonbanking proposals by well-run bank holding companies.
(a) Filing of notice--(1) Information required. A bank holding
company that meets the requirements of paragraph (c) of this section may
satisfy the notice requirement of this subpart in connection with the
acquisition of voting securities or assets of a company engaged in
nonbanking activities that the Board has permitted by order or
regulation (other than an insured depository institution),\1\ or a
proposal to engage de novo, either directly or indirectly, in a
nonbanking activity that the Board has permitted by order or by
regulation, by providing the appropriate Reserve Bank with a written
notice containing the following:
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\1\ A bank holding company may acquire voting securities or assets
of a savings association or other insured depository institution that is
not a bank by using the procedures in Sec. 225.14 of subpart B if the
bank holding company and the proposal qualify under that section as if
the savings association or other institution were a bank for purposes of
that section.
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(i) A certification that all of the criteria in paragraph (c) of
this section are met;
(ii) A description of the transaction that includes identification
of the companies involved in the transaction, the activities to be
conducted, and a commitment to conduct the proposed activities in
conformity with the Board's regulations and orders governing the conduct
of the proposed activity;
(iii) If the proposal involves an acquisition of a going concern:
(A) If the bank holding company has consolidated assets of $150
million or more, an abbreviated consolidated pro forma balance sheet for
the acquiring bank holding company as of the most recent quarter showing
credit and debit adjustments that reflect the proposed transaction,
consolidated pro forma risk-based capital ratios for the acquiring bank
holding company as of the most recent quarter, a description of the
purchase price and the terms and sources of funding for the transaction,
and the total revenue and net income of the company to be acquired;
(B) If the bank holding company has consolidated assets of less than
$150 million, a pro forma parent-only balance sheet as of the most
recent quarter showing credit and debit adjustments that reflect the
proposed transaction, a description of the purchase price and the terms
and sources of funding for the transaction and the sources and schedule
for retiring any debt incurred in the transaction, and the total assets,
off-balance sheet items, revenue and net income of the company to be
acquired;
(C) For each insured depository institution whose Tier 1 capital,
total capital, total assets or risk-weighted assets change as a result
of the transaction, the total risk-weighted assets, total assets, Tier 1
capital and total capital of the institution on a pro forma basis;
(iv) Identification of the geographic markets in which competition
would be affected by the proposal, a description of the effect of the
proposal on competition in the relevant markets, a list of the major
competitors in that market in the proposed activity if the affected
market is local in nature, and, if requested, the market indexes for the
relevant market; and
(v) A description of the public benefits that can reasonably be
expected to result from the transaction.
(2) Waiver of unnecessary information. The Reserve Bank may reduce
the information requirements in paragraphs (a)(1) (iii) and (iv) of this
section as appropriate.
(b)(1) Action on proposals under this section. The Board or the
appropriate Reserve Bank shall act on a proposal submitted under this
section, or notify the bank holding company that the transaction is
subject to the procedure in Sec. 225.24, within 12 business days
following the filing of all of the information required in paragraph (a)
of this section.
(2) Acceptance of notice if expedited procedure not available. If
the Board or the Reserve Bank determines, after the filing of a notice
under this section, that a bank holding company may not use the
procedure in this section and
[[Page 81]]
must file a notice under Sec. 225.24, the notice shall be deemed
accepted for purposes of Sec. 225.24 as of the date that the notice was
filed under this section.
(c) Criteria for use of expedited procedure. The procedure in this
section is available only if:
(1) Well-capitalized organization--(i) Bank holding company. Both at
the time of and immediately after the proposed transaction, the
acquiring bank holding company is well-capitalized;
(ii) Insured depository institutions. Both at the time of and
immediately after the transaction:
(A) The lead insured depository institution of the acquiring bank
holding company is well-capitalized;
(B) Well-capitalized insured depository institutions control at
least 80 percent of the total risk-weighted assets of insured depository
institutions controlled by the acquiring bank holding company; and
(C) No insured depository institution controlled by the acquiring
bank holding company is undercapitalized;
(2) Well-managed organization--(i) Satisfactory examination ratings.
At the time of the transaction, the acquiring bank holding company, its
lead insured depository institution, and insured depository institutions
that control at least 80 percent of the total risk-weighted assets of
insured depository institutions controlled by such holding company are
well-managed;
(ii) No poorly managed institutions. No insured depository
institution controlled by the acquiring bank holding company has
received 1 of the 2 lowest composite ratings at the later of the
institution's most recent examination or subsequent review by the
appropriate federal banking agency for the institution.
(iii) Recently acquired institutions excluded. Any insured
depository institution that has been acquired by the bank holding
company during the 12-month period preceding the date on which written
notice is filed under paragraph (a) of this section may be excluded for
purposes of paragraph (c)(2)(ii) of this section if:
(A) The bank holding company has developed a plan acceptable to the
appropriate federal banking agency for the institution to restore the
capital and management of the institution; and
(B) All insured depository institutions excluded under this
paragraph represent, in the aggregate, less than 10 percent of the
aggregate total risk-weighted assets of all insured depository
institutions controlled by the bank holding company;
(3) Permissible activity. (i) The Board has determined by regulation
or order that each activity proposed to be conducted is so closely
related to banking, or managing or controlling banks, as to be a proper
incident thereto; and
(ii) The Board has not indicated that proposals to engage in the
activity are subject to the notice procedure provided in Sec. 225.24;
(4) Competitive criteria--(i) Competitive screen. In the case of the
acquisition of a going concern, the acquisition, without regard to any
divestitures proposed by the acquiring bank holding company, does not
cause:
(A) The acquiring bank holding company to control in excess of 35
percent of the market share in any relevant market; or
(B) The Herfindahl-Hirschman index to increase by more than 200
points in any relevant market with a post-acquisition index of at least
1800; and
(ii) Other competitive factors. The Board has not indicated that the
transaction is subject to close scrutiny on competitive grounds;
(5) Size of acquisition--(i) In general--(A) Limited growth. Except
as provided in paragraph (c)(5)(ii) of this section, the sum of
aggregate risk-weighted assets to be acquired in the proposal and the
aggregate risk-weighted assets acquired by the acquiring bank holding
company in all other qualifying transactions does not exceed 35 percent
of the consolidated risk-weighted assets of the acquiring bank holding
company. For purposes of this paragraph, ``other qualifying
transactions'' means any transaction approved under this section or
Sec. 225.14 during the 12 months prior to filing the notice under this
section;
(B) Consideration paid. The gross consideration to be paid by the
acquiring bank holding company in the proposal
[[Page 82]]
does not exceed 15 percent of the consolidated Tier 1 capital of the
acquiring bank holding company; and
(C) Individual size limitation. The total risk-weighted assets to be
acquired do not exceed $7.5 billion;
(ii) Small bank holding companies. Paragraph (c)(5)(i)(A) of this
section shall not apply if, immediately following consummation of the
proposed transaction, the consolidated risk-weighted assets of the
acquiring bank holding company are less than $300 million;
(6) Supervisory actions. During the 12-month period ending on the
date on which the bank holding company proposes to consummate the
proposed transaction, no formal administrative order, including a
written agreement, cease and desist order, capital directive, prompt
corrective action directive, asset maintenance agreement, or other
formal enforcement order is or was outstanding against the bank holding
company or any insured depository institution subsidiary of the holding
company, and no formal administrative enforcement proceeding involving
any such enforcement action, order, or directive is or was pending; and
(7) Notification. The bank holding company has not been notified by
the Board, in its discretion, prior to the expiration of the period in
paragraph (b) of this section that a notice under Sec. 225.24 is
required in order to permit closer review of any potential adverse
effect or other matter related to the factors that must be considered
under this part.
(d) Branches and agencies of foreign banking organizations. For
purposes of this section, a U.S. branch or agency of a foreign banking
organization shall be considered to be an insured depository
institution.
Sec. 225.24 Procedures for other nonbanking proposals.
(a) Notice required for nonbanking activities. Except as provided in
Sec. 225.22 and Sec. 225.23, a notice for the Board's prior approval
under Sec. 225.21(a) to engage in or acquire a company engaged in a
nonbanking activity shall be filed by a bank holding company (including
a company seeking to become a bank holding company) with the appropriate
Reserve Bank in accordance with this section and the Board's Rules of
Procedure (12 CFR 262.3).
(1) Engaging de novo in listed activities. A bank holding company
seeking to commence or to engage de novo, either directly or through a
subsidiary, in a nonbanking activity listed in Sec. 225.28 shall file a
notice containing a description of the activities to be conducted and
the identity of the company that will conduct the activity.
(2) Acquiring company engaged in listed activities. A bank holding
company seeking to acquire or control voting securities or assets of a
company engaged in a nonbanking activity listed in Sec. 225.28 shall
file a notice containing the following:
(i) A description of the proposal, including a description of each
proposed activity, and the effect of the proposal on competition among
entities engaging in each proposed activity in each relevant market with
relevant market indexes;
(ii) The identity of any entity involved in the proposal, and, if
the notificant proposes to conduct the activity through an existing
subsidiary, a description of the existing activities of the subsidiary;
(iii) A statement of the public benefits that can reasonably be
expected to result from the proposal;
(iv) If the bank holding company has consolidated assets of $150
million or more:
(A) Parent company and consolidated pro forma balance sheets for the
acquiring bank holding company as of the most recent quarter showing
credit and debit adjustments that reflect the proposed transaction;
(B) Consolidated pro forma risk-based capital and leverage ratio
calculations for the acquiring bank holding company as of the most
recent quarter; and
(C) A description of the purchase price and the terms and sources of
funding for the transaction;
(v) If the bank holding company has consolidated assets of less than
$150 million:
(A) A pro forma parent-only balance sheet as of the most recent
quarter showing credit and debit adjustments that reflect the proposed
transaction; and
[[Page 83]]
(B) A description of the purchase price and the terms and sources of
funding for the transaction and, if the transaction is debt funded, one-
year income statement and cash flow projections for the parent company,
and the sources and schedule for retiring any debt incurred in the
transaction;
(vi) For each insured depository institution whose Tier 1 capital,
total capital, total assets or risk-weighted assets change as a result
of the transaction, the total risk-weighted assets, total assets, Tier 1
capital and total capital of the institution on a pro forma basis; and
(vii) A description of the management expertise, internal controls
and risk management systems that will be utilized in the conduct of the
proposed activities; and
(viii) A copy of the purchase agreements, and balance sheet and
income statements for the most recent quarter and year-end for any
company to be acquired.
(b) Notice provided to Board. The Reserve Bank shall immediately
send to the Board a copy of any notice received under paragraphs (a)(2)
or (a)(3) of this section.
(c) Notice to public--(1) Listed activities and activities approved
by order--(i) In a case involving an activity listed in Sec. 225.28 or
previously approved by the Board by order, the Reserve Bank shall notify
the Board for publication in the Federal Register immediately upon
receipt by the Reserve Bank of:
(A) A notice under this section; or
(B) A written request that notice of a proposal under this section
or Sec. 225.23 be published in the Federal Register. Such a request may
request that Federal Register publication occur up to 15 calendar days
prior to submission of a notice under this subpart.
(ii) The Federal Register notice published under this paragraph
shall invite public comment on the proposal, generally for a period of
15 days.
(2) New activities--(i) In general. In the case of a notice under
this subpart involving an activity that is not listed in Sec. 225.28 and
that has not been previously approved by the Board by order, the Board
shall send notice of the proposal to the Federal Register for
publication, unless the Board determines that the notificant has not
demonstrated that the activity is so closely related to banking or to
managing or controlling banks as to be a proper incident thereto. The
Federal Register notice shall invite public comment on the proposal for
a reasonable period of time, generally for 30 days.
(ii) Time for publication. The Board shall send the notice required
under this paragraph to the Federal Register within 10 business days of
acceptance by the Reserve Bank. The Board may extend the 10-day period
for an additional 30 calendar days upon notice to the notificant. In the
event notice of a proposal is not published for comment, the Board shall
inform the notificant of the reasons for the decision.
(d) Action on notices--(1) Reserve Bank action--(i) In general.
Within 30 calendar days after receipt by the Reserve Bank of a notice
filed pursuant to paragraphs (a)(1) or (a)(2) of this section, the
Reserve Banks shall:
(A) Approve the notice; or
(B) Refer the notice to the Board for decision because action under
delegated authority is not appropriate.
(ii) Return of incomplete notice. Within 7 calendar days of receipt,
the Reserve Bank may return any notice as informationally incomplete
that does not contain all of the information required by this subpart.
The return of such a notice shall be deemed action on the notice.
(iii) Notice of action. The Reserve Bank shall promptly notify the
bank holding company of any action or referral under this paragraph.
(iv) Close of public comment period. The Reserve Bank shall not
approve any notice under this paragraph (d)(1) of this section prior to
the third business day after the close of the public comment period,
unless an emergency exists that requires expedited or immediate action.
(2) Board action; internal schedule. The Board seeks to act on every
notice referred to it for decision within 60 days of the date that the
notice is filed with the Reserve Bank. If the Board is unable to act
within this period, the Board shall notify the notificant and explain
the reasons and the date by which the Board expects to act.
[[Page 84]]
(3)(i) Required time limit for System action. The Board or the
Reserve Bank shall act on any notice under this section within 60 days
after the submission of a complete notice.
(ii) Extension of required period for action (A) In general.--The
Board may extend the 60-day period required for Board action under
paragraph (d)(3)(i) of this section for an additional 30 days upon
notice to the notificant.
(B) Unlisted activities. If a notice involves a proposal to engage
in an activity that is not listed in Sec. 225.28, the Board may extend
the period required for Board action under paragraph (d)(3)(i) of this
section for an additional 90 days. This 90-day extension is in addition
to the 30-day extension period provided in paragraph (d)(3)(ii)(A) of
this section. The Board shall notify the notificant that the notice
period has been extended and explain the reasons for the extension.
(4) Requests for additional information. The Board or the Reserve
Bank may modify the information requirements under this section or at
any time request any additional information that either believes is
needed for a decision on any notice under this section.
(5) Tolling of period. The Board or the Reserve Bank may at any time
extend or toll the time period for action on a notice for any period
with the consent of the notificant.
[Reg. Y, 62 FR 9332, Feb. 28, 1997, as amended at 62 FR 60640, Nov. 12,
1997; 65 FR 14438, Mar. 17, 2000]
Sec. 225.25 Hearings, alteration of activities, and other matters.
(a) Hearings--(1) Procedure to request hearing. Any request for a
hearing on a notice under this subpart shall comply with the provisions
of 12 CFR 262.3(e).
(2) Determination to hold hearing. The Board may order a formal or
informal hearing or other proceeding on a notice as provided in 12 CFR
262.3(i)(2). The Board shall order a hearing only if there are disputed
issues of material fact that cannot be resolved in some other manner.
(3) Extension of period for hearing. The Board may extend the time
for action on any notice for such time as is reasonably necessary to
conduct a hearing and evaluate the hearing record. Such extension shall
not exceed 91 calendar days after the date of submission to the Board of
the complete record on the notice. The procedures for computation of the
91-day rule as set forth in Sec. 225.16(f) apply to notices under this
subpart that involve hearings.
(b) Approval through failure to act. (1) Except as provided in
paragraph (a) of this section or Sec. 225.24(d)(5), a notice under this
subpart shall be deemed to be approved at the conclusion of the period
that begins on the date the complete notice is received by the Reserve
Bank or the Board and that ends 60 calendar days plus any applicable
extension and tolling period thereafter.
(2) Complete notice. For purposes of paragraph (b)(1) of this
section, a notice shall be deemed complete at such time as it contains
all information required by this subpart and all other information
requested by the Board or the Reserve Bank.
(c) Notice to expand or alter nonbanking activities--(1) De novo
expansion. A notice under this subpart is required to open a new office
or to form a subsidiary to engage in, or to relocate an existing office
engaged in, a nonbanking activity that the Board has previously approved
for the bank holding company under this regulation, only if:
(i) The Board's prior approval was limited geographically;
(ii) The activity is to be conducted in a country outside of the
United States and the bank holding company has not previously received
prior Board approval under this regulation to engage in the activity in
that country; or
(iii) The Board or appropriate Reserve Bank has notified the company
that a notice under this subpart is required.
(2) Activities outside United States. With respect to activities to
be engaged in outside the United States that require approval under this
subpart, the procedures of this section apply only to activities to be
engaged in directly by a bank holding company that is not a qualifying
foreign banking organization, or by a nonbank subsidiary of a bank
holding company approved under this subpart. Regulation K (12
[[Page 85]]
CFR part 211) governs other international operations of bank holding
companies.
(3) Alteration of nonbanking activity. Unless otherwise permitted by
the Board, a notice under this subpart is required to alter a nonbanking
activity in any material respect from that considered by the Board in
acting on the application or notice to engage in the activity.
(d) Emergency savings association acquisitions. In the case of a
notice to acquire a savings association, the Board may modify or
dispense with the public notice and hearing requirements of this subpart
if the Board finds that an emergency exists that requires the Board to
act immediately and the primary federal regulator of the institution
concurs.
[Reg. Y, 62 FR 9333, Feb. 28, 1997, as amended by Reg. Y, 62 FR 60640,
Nov. 12, 1997]
Sec. 225.26 Factors considered in acting on nonbanking proposals.
(a) In general. In evaluating a notice under Sec. 225.23 or
Sec. 225.24, the Board shall consider whether the notificant's
performance of the activities can reasonably be expected to produce
benefits to the public (such as greater convenience, increased
competition, and gains in efficiency) that outweigh possible adverse
effects (such as undue concentration of resources, decreased or unfair
competition, conflicts of interest, and unsound banking practices).
(b) Financial and managerial resources. Consideration of the factors
in paragraph (a) of this section includes an evaluation of the financial
and managerial resources of the notificant, including its subsidiaries
and any company to be acquired, the effect of the proposed transaction
on those resources, and the management expertise, internal control and
risk-management systems, and capital of the entity conducting the
activity.
(c) Competitive effect of de novo proposals. Unless the record
demonstrates otherwise, the commencement or expansion of a nonbanking
activity de novo is presumed to result in benefits to the public through
increased competition.
(d) Denial for lack of information. The Board may deny any notice
submitted under this subpart if the notificant neglects, fails, or
refuses to furnish all information required by the Board.
(e) Conditional approvals. The Board may impose conditions on any
approval, including conditions to address permissibility, financial,
managerial, safety and soundness, competitive, compliance, conflicts of
interest, or other concerns to ensure that approval is consistent with
the relevant statutory factors and other provisions of the BHC Act.
Sec. 225.27 Procedures for determining scope of nonbanking activities.
(a) Advisory opinions regarding scope of previously approved
nonbanking activities--(1) Request for advisory opinion. Any person may
submit a request to the Board for an advisory opinion regarding the
scope of any permissible nonbanking activity. The request shall be
submitted in writing to the Board and shall identify the proposed
parameters of the activity, or describe the service or product that will
be provided, and contain an explanation supporting an interpretation
regarding the scope of the permissible nonbanking activity.
(2) Response to request. The Board shall provide an advisory opinion
within 45 days of receiving a written request under this paragraph.
(b) Procedure for consideration of new activities--(1) Initiation of
proceeding. The Board may, at any time, on its own initiative or in
response to a written request from any person, initiate a proceeding to
determine whether any activity is so closely related to banking or
managing or controlling banks as to be a proper incident thereto.
(2) Requests for determination. Any request for a Board
determination that an activity is so closely related to banking or
managing or controlling banks as to be a proper incident thereto, shall
be submitted to the Board in writing, and shall contain evidence that
the proposed activity is so closely related to banking or managing or
controlling banks as to be a proper incident thereto.
(3) Publication. The Board shall publish in the Federal Register
notice that it is considering the permissibility of a new activity and
invite public
[[Page 86]]
comment for a period of at least 30 calendar days. In the case of a
request submitted under paragraph (b) of this section, the Board may
determine not to publish notice of the request if the Board determines
that the requester has provided no reasonable basis for a determination
that the activity is so closely related to banking, or managing or
controlling banks as to be a proper incident thereto, and notifies the
requester of the determination.
(4) Comments and hearing requests. Any comment and any request for a
hearing regarding a proposal under this section shall comply with the
provisions of Sec. 262.3(e) of the Board's Rules of Procedure (12 CFR
262.3(e)).
Sec. 225.28 List of permissible nonbanking activities.
(a) Closely related nonbanking activities. The activities listed in
paragraph (b) of this section are so closely related to banking or
managing or controlling banks as to be a proper incident thereto, and
may be engaged in by a bank holding company or its subsidiary in
accordance with the requirements of this regulation.
(b) Activities determined by regulation to be permissible--(1)
Extending credit and servicing loans. Making, acquiring, brokering, or
servicing loans or other extensions of credit (including factoring,
issuing letters of credit and accepting drafts) for the company's
account or for the account of others.
(2) Activities related to extending credit. Any activity usual in
connection with making, acquiring, brokering or servicing loans or other
extensions of credit, as determined by the Board. The Board has
determined that the following activities are usual in connection with
making, acquiring, brokering or servicing loans or other extensions of
credit:
(i) Real estate and personal property appraising. Performing
appraisals of real estate and tangible and intangible personal property,
including securities.
(ii) Arranging commercial real estate equity financing. Acting as
intermediary for the financing of commercial or industrial income-
producing real estate by arranging for the transfer of the title,
control, and risk of such a real estate project to one or more
investors, if the bank holding company and its affiliates do not have an
interest in, or participate in managing or developing, a real estate
project for which it arranges equity financing, and do not promote or
sponsor the development of the property.
(iii) Check-guaranty services. Authorizing a subscribing merchant to
accept personal checks tendered by the merchant's customers in payment
for goods and services, and purchasing from the merchant validly
authorized checks that are subsequently dishonored.
(iv) Collection agency services. Collecting overdue accounts
receivable, either retail or commercial.
(v) Credit bureau services. Maintaining information related to the
credit history of consumers and providing the information to a credit
grantor who is considering a borrower's application for credit or who
has extended credit to the borrower.
(vi) Asset management, servicing, and collection activities.
Engaging under contract with a third party in asset management,
servicing, and collection \2\ of assets of a type that an insured
depository institution may originate and own, if the company does not
engage in real property management or real estate brokerage services as
part of these services.
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\2\ Asset management services include acting as agent in the
liquidation or sale of loans and collateral for loans, including real
estate and other assets acquired through foreclosure or in satisfaction
of debts previously contracted.
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(vii) Acquiring debt in default. Acquiring debt that is in default
at the time of acquisition, if the company:
(A) Divests shares or assets securing debt in default that are not
permissible investments for bank holding companies, within the time
period required for divestiture of property acquired in satisfaction of
a debt previously contracted under Sec. 225.12(b); \3\
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\3\ For this purpose, the divestiture period for property begins on
the date that the debt is acquired, regardless of when legal title to
the property is acquired.
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(B) Stands only in the position of a creditor and does not purchase
equity of obligors of debt in default (other
[[Page 87]]
than equity that may be collateral for such debt); and
(C) Does not acquire debt in default secured by shares of a bank or
bank holding company.
(viii) Real estate settlement servicing. Providing real estate
settlement services.\4\
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\4\ For purposes of this section, real estate settlement services do
not include providing title insurance as principal, agent, or broker.
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(3) Leasing personal or real property. Leasing personal or real
property or acting as agent, broker, or adviser in leasing such property
if:
(i) The lease is on a nonoperating basis; \5\
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\5\ The requirement that the lease be on a nonoperating basis means
that the bank holding company may not, directly or indirectly, engage in
operating, servicing, maintaining, or repairing leased property during
the lease term. For purposes of the leasing of automobiles, the
requirement that the lease be on a nonoperating basis means that the
bank holding company may not, directly or indirectly: (1) Provide
servicing, repair, or maintenance of the leased vehicle during the lease
term; (2) purchase parts and accessories in bulk or for an individual
vehicle after the lessee has taken delivery of the vehicle; (3) provide
the loan of an automobile during servicing of the leased vehicle; (4)
purchase insurance for the lessee; or (5) provide for the renewal of the
vehicle's license merely as a service to the lessee where the lessee
could renew the license without authorization from the lessor. The bank
holding company may arrange for a third party to provide these services
or products.
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(ii) The initial term of the lease is at least 90 days;
(iii) In the case of leases involving real property:
(A) At the inception of the initial lease, the effect of the
transaction will yield a return that will compensate the lessor for not
less than the lessor's full investment in the property plus the
estimated total cost of financing the property over the term of the
lease from rental payments, estimated tax benefits, and the estimated
residual value of the property at the expiration of the initial lease;
and
(B) The estimated residual value of property for purposes of
paragraph (b)(3)(iii)(A) of this section shall not exceed 25 percent of
the acquisition cost of the property to the lessor.
(4) Operating nonbank depository institutions--(i) Industrial
banking. Owning, controlling, or operating an industrial bank, Morris
Plan bank, or industrial loan company, so long as the institution is not
a bank.
(ii) Operating savings association. Owning, controlling, or
operating a savings association, if the savings association engages only
in deposit-taking activities, lending, and other activities that are
permissible for bank holding companies under this subpart C.
(5) Trust company functions. Performing functions or activities that
may be performed by a trust company (including activities of a
fiduciary, agency, or custodial nature), in the manner authorized by
federal or state law, so long as the company is not a bank for purposes
of section 2(c) of the Bank Holding Company Act.
(6) Financial and investment advisory activities. Acting as
investment or financial advisor to any person, including (without, in
any way, limiting the foregoing):
(i) Serving as investment adviser (as defined in section 2(a)(20) of
the Investment Company Act of 1940, 15 U.S.C. 80a-2(a)(20)), to an
investment company registered under that act, including sponsoring,
organizing, and managing a closed-end investment company;
(ii) Furnishing general economic information and advice, general
economic statistical forecasting services, and industry studies;
(iii) Providing advice in connection with mergers, acquisitions,
divestitures, investments, joint ventures, leveraged buyouts,
recapitalizations, capital structurings, financing transactions and
similar transactions, and conducting financial feasibility studies;\6\
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\6\ Feasibility studies do not include assisting management with the
planning or marketing for a given project or providing general
operational or management advice.
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(iv) Providing information, statistical forecasting, and advice with
respect to any transaction in foreign exchange, swaps, and similar
transactions, commodities, and any forward contract, option, future,
option on a future, and similar instruments;
[[Page 88]]
(v) Providing educational courses, and instructional materials to
consumers on individual financial management matters; and
(vi) Providing tax-planning and tax-preparation services to any
person.
(7) Agency transactional services for customer investments--(i)
Securities brokerage. Providing securities brokerage services (including
securities clearing and/or securities execution services on an
exchange), whether alone or in combination with investment advisory
services, and incidental activities (including related securities credit
activities and custodial services), if the securities brokerage services
are restricted to buying and selling securities solely as agent for the
account of customers and do not include securities underwriting or
dealing.
(ii) Riskless principal transactions. Buying and selling in the
secondary market all types of securities on the order of customers as a
``riskless principal'' to the extent of engaging in a transaction in
which the company, after receiving an order to buy (or sell) a security
from a customer, purchases (or sells) the security for its own account
to offset a contemporaneous sale to (or purchase from) the customer.
This does not include:
(A) Selling bank-ineligible securities \7\ at the order of a
customer that is the issuer of the securities, or selling bank-
ineligible securities in any transaction where the company has a
contractual agreement to place the securities as agent of the issuer; or
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\7\ A bank-ineligible security is any security that a State member
bank is not permitted to underwrite or deal in under 12 U.S.C. 24 and
335.
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(B) Acting as a riskless principal in any transaction involving a
bank-ineligible security for which the company or any of its affiliates
acts as underwriter (during the period of the underwriting or for 30
days thereafter) or dealer.\8\
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\8\ A company or its affiliates may not enter quotes for specific
bank-ineligible securities in any dealer quotation system in connection
with the company's riskless principal transactions; except that the
company or its affiliates may enter ``bid'' or ``ask'' quotations, or
publish ``offering wanted'' or ``bid wanted'' notices on trading systems
other than NASDAQ or an exchange, if the company or its affiliate does
not enter price quotations on different sides of the market for a
particular security during any two-day period.
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(iii) Private placement services. Acting as agent for the private
placement of securities in accordance with the requirements of the
Securities Act of 1933 (1933 Act) and the rules of the Securities and
Exchange Commission, if the company engaged in the activity does not
purchase or repurchase for its own account the securities being placed,
or hold in inventory unsold portions of issues of these securities.
(iv) Futures commission merchant. Acting as a futures commission
merchant (FCM) for unaffiliated persons in the execution, clearance, or
execution and clearance of any futures contract and option on a futures
contract traded on an exchange in the United States or abroad if:
(A) The activity is conducted through a separately incorporated
subsidiary of the bank holding company, which may engage in activities
other than FCM activities (including, but not limited to, permissible
advisory and trading activities); and
(B) The parent bank holding company does not provide a guarantee or
otherwise become liable to the exchange or clearing association other
than for those trades conducted by the subsidiary for its own account or
for the account of any affiliate.
(v) Other transactional services. Providing to customers as agent
transactional services with respect to swaps and similar transactions,
any transaction described in paragraph (b)(8) of this section, any
transaction that is permissible for a state member bank, and any other
transaction involving a forward contract, option, futures, option on a
futures or similar contract (whether traded on an exchange or not)
relating to a commodity that is traded on an exchange.
(8) Investment transactions as principal--(i) Underwriting and
dealing in government obligations and money market instruments.
Underwriting and dealing in obligations of the United States, general
obligations of states and their political subdivisions, and other
obligations that state member banks of the
[[Page 89]]
Federal Reserve System may be authorized to underwrite and deal in under
12 U.S.C. 24 and 335, including banker's acceptances and certificates of
deposit, under the same limitations as would be applicable if the
activity were performed by the bank holding company's subsidiary member
banks or its subsidiary nonmember banks as if they were member banks.
(ii) Investing and trading activities. Engaging as principal in:
(A) Foreign exchange;
(B) Forward contracts, options, futures, options on futures, swaps,
and similar contracts, whether traded on exchanges or not, based on any
rate, price, financial asset (including gold, silver, platinum,
palladium, copper, or any other metal approved by the Board),
nonfinancial asset, or group of assets, other than a bank-ineligible
security,\9\ if:
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\9\ A bank-ineligible security is any security that a state member
bank is not permitted to underwrite or deal in under 12 U.S.C. 24 and
335.
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(1) A state member bank is authorized to invest in the asset
underlying the contract;
(2) The contract requires cash settlement; or
(3) The contract allows for assignment, termination, or offset prior
to delivery or expiration, and the company makes every reasonable effort
to avoid taking or making delivery; and
(C) Forward contracts, options,\10\ futures, options on futures,
swaps, and similar contracts, whether traded on exchanges or not, based
on an index of a rate, a price, or the value of any financial asset,
nonfinancial asset, or group of assets, if the contract requires cash
settlement.
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\10\ This reference does not include acting as a dealer in options
based on indices of bank-ineligible securities when the options are
traded on securities exchanges. These options are securities for
purposes of the federal securities laws and bank-ineligible securities
for purposes of section 20 of the Glass-Steagall Act, 12 U.S.C. 337.
Similarly, this reference does not include acting as a dealer in any
other instrument that is a bank-ineligible security for purposes of
section 20. A bank holding company may deal in these instruments in
accordance with the Board's orders on dealing in bank-ineligible
securities.
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(iii) Buying and selling bullion, and related activities. Buying,
selling and storing bars, rounds, bullion, and coins of gold, silver,
platinum, palladium, copper, and any other metal approved by the Board,
for the company's own account and the account of others, and providing
incidental services such as arranging for storage, safe custody,
assaying, and shipment.
(9) Management consulting and counseling activities--(i) Management
consulting. (A) Providing management consulting advice: \11\
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\11\ In performing this activity, bank holding companies are not
authorized to perform tasks or operations or provide services to client
institutions either on a daily or continuing basis, except as necessary
to instruct the client institution on how to perform such services for
itself. See also the Board's interpretation of bank management
consulting advice (12 CFR 225.131).
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(1) On any matter to unaffiliated depository institutions, including
commercial banks, savings and loan associations, savings banks, credit
unions, industrial banks, Morris Plan banks, cooperative banks,
industrial loan companies, trust companies, and branches or agencies of
foreign banks;
(2) On any financial, economic, accounting, or audit matter to any
other company.
(B) A company conducting management consulting activities under this
subparagraph and any affiliate of such company may not:
(1) Own or control, directly or indirectly, more than 5 percent of
the voting securities of the client institution; and
(2) Allow a management official, as defined in 12 CFR 212.2(h), of
the company or any of its affiliates to serve as a management official
of the client institution, except where such interlocking relationship
is permitted pursuant to an exemption granted under 12 CFR 212.4(b) or
otherwise permitted by the Board.
(C) A company conducting management consulting activities may
provide management consulting services to customers not described in
paragraph (b)(9)(i)(A)(1) of this section or regarding matters not
described in paragraph (b)(9)(i)(A)(2) of this section, if the total
annual revenue derived from
[[Page 90]]
those management consulting services does not exceed 30 percent of the
company's total annual revenue derived from management consulting
activities.
(ii) Employee benefits consulting services. Providing consulting
services to employee benefit, compensation and insurance plans,
including designing plans, assisting in the implementation of plans,
providing administrative services to plans, and developing employee
communication programs for plans.
(iii) Career counseling services. Providing career counseling
services to:
(A) A financial organization \12\ and individuals currently employed
by, or recently displaced from, a financial organization;
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\12\ Financial organization refers to insured depository institution
holding companies and their subsidiaries, other than nonbanking
affiliates of diversified savings and loan holding companies that engage
in activities not permissible under section 4(c)(8) of the Bank Holding
Company Act (12 U.S.C. 1842(c)(8)).
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(B) Individuals who are seeking employment at a financial
organization; and
(C) Individuals who are currently employed in or who seek positions
in the finance, accounting, and audit departments of any company.
(10) Support services--(i) Courier services. Providing courier
services for:
(A) Checks, commercial papers, documents, and written instruments
(excluding currency or bearer-type negotiable instruments) that are
exchanged among banks and financial institutions; and
(B) Audit and accounting media of a banking or financial nature and
other business records and documents used in processing such media.\13\
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\13\ See also the Board's interpretation on courier activities (12
CFR 225.129), which sets forth conditions for bank holding company entry
into the activity.
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(ii) Printing and selling MICR-encoded items. Printing and selling
checks and related documents, including corporate image checks, cash
tickets, voucher checks, deposit slips, savings withdrawal packages, and
other forms that require Magnetic Ink Character Recognition (MICR)
encoding.
(11) Insurance agency and underwriting--(i) Credit insurance. Acting
as principal, agent, or broker for insurance (including home mortgage
redemption insurance) that is:
(A) Directly related to an extension of credit by the bank holding
company or any of its subsidiaries; and
(B) Limited to ensuring the repayment of the outstanding balance due
on the extension of credit \14\ in the event of the death, disability,
or involuntary unemployment of the debtor.
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\14\ Extension of credit includes direct loans to borrowers, loans
purchased from other lenders, and leases of real or personal property so
long as the leases are nonoperating and full-payout leases that meet the
requirements of paragraph (b)(3) of this section.
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(ii) Finance company subsidiary. Acting as agent or broker for
insurance directly related to an extension of credit by a finance
company \15\ that is a subsidiary of a bank holding company, if:
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\15\ Finance company includes all non-deposit-taking financial
institutions that engage in a significant degree of consumer lending
(excluding lending secured by first mortgages) and all financial
institutions specifically defined by individual states as finance
companies and that engage in a significant degree of consumer lending.
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(A) The insurance is limited to ensuring repayment of the
outstanding balance on such extension of credit in the event of loss or
damage to any property used as collateral for the extension of credit;
and
(B) The extension of credit is not more than $10,000, or $25,000 if
it is to finance the purchase of a residential manufactured home \16\
and the credit is secured by the home; and
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\16\ These limitations increase at the end of each calendar year,
beginning with 1982, by the percentage increase in the Consumer Price
Index for Urban Wage Earners and Clerical Workers published by the
Bureau of Labor Statistics.
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(C) The applicant commits to notify borrowers in writing that:
(1) They are not required to purchase such insurance from the
applicant;
(2) Such insurance does not insure any interest of the borrower in
the collateral; and
(3) The applicant will accept more comprehensive property insurance
in place of such single-interest insurance.
[[Page 91]]
(iii) Insurance in small towns. Engaging in any insurance agency
activity in a place where the bank holding company or a subsidiary of
the bank holding company has a lending office and that:
(A) Has a population not exceeding 5,000 (as shown in the preceding
decennial census); or
(B) Has inadequate insurance agency facilities, as determined by the
Board, after notice and opportunity for hearing.
(iv) Insurance-agency activities conducted on May 1, 1982. Engaging
in any specific insurance-agency activity \17\ if the bank holding
company, or subsidiary conducting the specific activity, conducted such
activity on May 1, 1982, or received Board approval to conduct such
activity on or before May 1, 1982.\18\ A bank holding company or
subsidiary engaging in a specific insurance agency activity under this
clause may:
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\17\ Nothing contained in this provision shall preclude a bank
holding company subsidiary that is authorized to engage in a specific
insurance-agency activity under this clause from continuing to engage in
the particular activity after merger with an affiliate, if the merger is
for legitimate business purposes and prior notice has been provided to
the Board.
\18\ For the purposes of this paragraph, activities engaged in on
May 1, 1982, include activities carried on subsequently as the result of
an application to engage in such activities pending before the Board on
May 1, 1982, and approved subsequently by the Board or as the result of
the acquisition by such company pursuant to a binding written contract
entered into on or before May 1, 1982, of another company engaged in
such activities at the time of the acquisition.
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(A) Engage in such specific insurance agency activity only at
locations:
(1) In the state in which the bank holding company has its principal
place of business (as defined in 12 U.S.C. 1842(d));
(2) In any state or states immediately adjacent to such state; and
(3) In any state in which the specific insurance-agency activity was
conducted (or was approved to be conducted) by such bank holding company
or subsidiary thereof or by any other subsidiary of such bank holding
company on May 1, 1982; and
(B) Provide other insurance coverages that may become available
after May 1, 1982, so long as those coverages insure against the types
of risks as (or are otherwise functionally equivalent to) coverages sold
or approved to be sold on May 1, 1982, by the bank holding company or
subsidiary.
(v) Supervision of retail insurance agents. Supervising on behalf of
insurance underwriters the activities of retail insurance agents who
sell:
(A) Fidelity insurance and property and casualty insurance on the
real and personal property used in the operations of the bank holding
company or its subsidiaries; and
(B) Group insurance that protects the employees of the bank holding
company or its subsidiaries.
(vi) Small bank holding companies. Engaging in any insurance-agency
activity if the bank holding company has total consolidated assets of
$50 million or less. A bank holding company performing insurance-agency
activities under this paragraph may not engage in the sale of life
insurance or annuities except as provided in paragraphs (b)(11) (i) and
(iii) of this section, and it may not continue to engage in insurance-
agency activities pursuant to this provision more than 90 days after the
end of the quarterly reporting period in which total assets of the
holding company and its subsidiaries exceed $50 million.
(vii) Insurance-agency activities conducted before 1971. Engaging in
any insurance-agency activity performed at any location in the United
States directly or indirectly by a bank holding company that was engaged
in insurance-agency activities prior to January 1, 1971, as a
consequence of approval by the Board prior to January 1, 1971.
(12) Community development activities--(i) Financing and investment
activities. Making equity and debt investments in corporations or
projects designed primarily to promote community welfare, such as the
economic rehabilitation and development of low-income areas by providing
housing, services, or jobs for residents.
(ii) Advisory activities. Providing advisory and related services
for programs designed primarily to promote community welfare.
[[Page 92]]
(13) Money orders, savings bonds, and traveler's checks. The
issuance and sale at retail of money orders and similar consumer-type
payment instruments; the sale of U.S. savings bonds; and the issuance
and sale of traveler's checks.
(14) Data processing. (i) Providing data processing and data
transmission services, facilities (including data processing and data
transmission hardware, software, documentation, or operating personnel),
data bases, advice, and access to such services, facilities, or data
bases by any technological means, if:
(A) The data to be processed or furnished are financial, banking, or
economic; and
(B) The hardware provided in connection therewith is offered only in
conjunction with software designed and marketed for the processing and
transmission of financial, banking, or economic data, and where the
general purpose hardware does not constitute more than 30 percent of the
cost of any packaged offering.
(ii) A company conducting data processing and data transmission
activities may conduct data processing and data transmission activities
not described in paragraph (b)(14)(i) of this section if the total
annual revenue derived from those activities does not exceed 30 percent
of the company's total annual revenues derived from data processing and
data transmission activities.
Subpart D--Control and Divestiture Proceedings
Sec. 225.31 Control proceedings.
(a) Preliminary determination of control. (1) The Board may issue a
preliminary determination of control under the procedures set forth in
this section in any case in which:
(i) Any of the presumptions of control set forth in paragraph (d) of
this section is present; or
(ii) It otherwise appears that a company has the power to exercise a
controlling influence over the management or policies of a bank or other
company.
(2) If the Board makes a preliminary determination of control under
this section, the Board shall send notice to the controlling company
containing a statement of the facts upon which the preliminary
determination is based.
(b) Response to preliminary determination of control. Within 30
calendar days of issuance by the Board of a preliminary determination of
control or such longer period permitted by the Board, the company
against whom the determination has been made shall:
(1) Submit for the Board's approval a specific plan for the prompt
termination of the control relationship;
(2) File an application under subpart B or C of this regulation to
retain the control relationship; or
(3) Contest the preliminary determination by filing a response,
setting forth the facts and circumstances in support of its position
that no control exists, and, if desired, requesting a hearing or other
proceeding.
(c) Hearing and final determination. (1) The Board shall order a
formal hearing or other appropriate proceeding upon the request of a
company that contests a preliminary determination that the company has
the power to exercise a controlling influence over the management or
policies of a bank or other company, if the Board finds that material
facts are in dispute. The Board may also in its discretion order a
formal hearing or other proceeding with respect to a preliminary
determination that the company controls voting securities of the bank or
other company under the presumptions in paragraph (d)(1) of this
section.
(2) At a hearing or other proceeding, any applicable presumptions
established by paragraph (d) of this section shall be considered in
accordance with the Federal Rules of Evidence and the Board's Rules of
Practice for Formal Hearings (12 CFR part 263).
(3) After considering the submissions of the company and other
evidence, including the record of any hearing or other proceeding, the
Board shall issue a final order determining whether the company controls
voting securities, or has the power to exercise a controlling influence
over the management or policies, of the bank or other company. If a
control relationship is found, the Board may direct the company to
terminate the control relationship or to
[[Page 93]]
file an application for the Board's approval to retain the control
relationship under subpart B or C of this regulation.
(d) Rebuttable presumptions of control. The following rebuttable
presumptions shall be used in any proceeding under this section:
(1) Control of voting securities--(i) Securities convertible into
voting securities. A company that owns, controls, or holds securities
that are immediately convertible, at the option of the holder or owner,
into voting securities of a bank or other company, controls the voting
securities.
(ii) Option or restriction on voting securities. A company that
enters into an agreement or understanding under which the rights of a
holder of voting securities of a bank or other company are restricted in
any manner controls the securities. This presumption does not apply
where the agreement or understanding:
(A) Is a mutual agreement among shareholders granting to each other
a right of first refusal with respect to their shares;
(B) Is incident to a bona fide loan transaction; or
(C) Relates to restrictions on transferability and continues only
for the time necessary to obtain approval from the appropriate Federal
supervisory authority with respect to acquisition by the company of the
securities.
(2) Control over company--(i) Management agreement. A company that
enters into any agreement or understanding with a bank or other company
(other than an investment advisory agreement), such as a management
contract, under which the first company or any of its subsidiaries
directs or exercises significant influence over the general management
or overall operations of the bank or other company controls the bank or
other company.
(ii) Shares controlled by company and associated individuals. A
company that, together with its management officials or controlling
shareholders (including members of the immediate families of either),
owns, controls, or holds with power to vote 25 percent or more of the
outstanding shares of any class of voting securities of a bank or other
company controls the bank or other company, if the first company owns,
controls, or holds with power to vote more than 5 percent of the
outstanding shares of any class of voting securities of the bank or
other company.
(iii) Common management officials. A company that has one or more
management officials in common with a bank or other company controls the
bank or other company, if the first company owns, controls or holds with
power to vote more than 5 percent of the outstanding shares of any class
of voting securities of the bank or other company, and no other person
controls as much as 5 percent of the outstanding shares of any class of
voting securities of the bank or other company.
(iv) Shares held as fiduciary. The presumptions in paragraphs (d)(2)
(ii) and (iii) of this section do not apply if the securities are held
by the company in a fiduciary capacity without sole discretionary
authority to exercise the voting rights.
(e) Presumption of non-control--(1) In any proceeding under this
section, there is a presumption that any company that directly or
indirectly owns, controls, or has power to vote less than 5 percent of
the outstanding shares of any class of voting securities of a bank or
other company does not have control over that bank or other company.
(2) In any proceeding under this section, or judicial proceeding
under the BHC Act, other than a proceeding in which the Board has made a
preliminary determination that a company has the power to exercise a
controlling influence over the management or policies of the bank or
other company, a company may not be held to have had control over the
bank or other company at any given time, unless that company, at the
time in question, directly or indirectly owned, controlled, or had power
to vote 5 percent or more of the outstanding shares of any class of
voting securities of the bank or other company, or had already been
found to have control on the basis of the existence of a controlling
influence relationship.
[Reg. Y, 49 FR 818, Jan. 5, 1984, as amended at 58 FR 474, Jan. 6, 1993;
Reg. Y, 62 FR 9338, Feb. 28, 1997]
[[Page 94]]
Subpart E--Change in Bank Control
Source: Reg. Y, 62 FR 9338, Feb. 28, 1997, unless otherwise noted.
Sec. 225.41 Transactions requiring prior notice.
(a) Prior notice requirement. Any person acting directly or
indirectly, or through or in concert with one or more persons, shall
give the Board 60 days' written notice, as specified in Sec. 225.43 of
this subpart, before acquiring control of a state member bank or bank
holding company, unless the acquisition is exempt under Sec. 225.42.
(b) Definitions. For purposes of this subpart:
(1) Acquisition includes a purchase, assignment, transfer, or pledge
of voting securities, or an increase in percentage ownership of a state
member bank or a bank holding company resulting from a redemption of
voting securities.
(2) Acting in concert includes knowing participation in a joint
activity or parallel action towards a common goal of acquiring control
of a state member bank or bank holding company whether or not pursuant
to an express agreement.
(3) Immediate family includes a person's father, mother, stepfather,
stepmother, brother, sister, stepbrother, stepsister, son, daughter,
stepson, stepdaughter, grandparent, grandson, granddaughter, father-in-
law, mother-in-law, brother-in-law, sister-in-law, son-in-law, daughter-
in-law, the spouse of any of the foregoing, and the person's spouse.
(c) Acquisitions requiring prior notice--(1) Acquisition of control.
The acquisition of voting securities of a state member bank or bank
holding company constitutes the acquisition of control under the Bank
Control Act, requiring prior notice to the Board, if, immediately after
the transaction, the acquiring person (or persons acting in concert)
will own, control, or hold with power to vote 25 percent or more of any
class of voting securities of the institution.
(2) Rebuttable presumption of control. The Board presumes that an
acquisition of voting securities of a state member bank or bank holding
company constitutes the acquisition of control under the Bank Control
Act, requiring prior notice to the Board, if, immediately after the
transaction, the acquiring person (or persons acting in concert) will
own, control, or hold with power to vote 10 percent or more of any class
of voting securities of the institution, and if:
(i) The institution has registered securities under section 12 of
the Securities Exchange Act of 1934 (15 U.S.C. 78l); or
(ii) No other person will own, control, or hold the power to vote a
greater percentage of that class of voting securities immediately after
the transaction.\1\
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\1\ If two or more persons, not acting in concert, each propose to
acquire simultaneously equal percentages of 10 percent or more of a
class of voting securities of the state member bank or bank holding
company, each person must file prior notice to the Board.
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(d) Rebuttable presumption of concerted action. The following
persons shall be presumed to be acting in concert for purposes of this
subpart:
(1) A company and any controlling shareholder, partner, trustee, or
management official of the company, if both the company and the person
own voting securities of the state member bank or bank holding company;
(2) An individual and the individual's immediate family;
(3) Companies under common control;
(4) Persons that are parties to any agreement, contract,
understanding, relationship, or other arrangement, whether written or
otherwise, regarding the acquisition, voting, or transfer of control of
voting securities of a state member bank or bank holding company, other
than through a revocable proxy as described in Sec. 225.42(a)(5) of this
subpart;
(5) Persons that have made, or propose to make, a joint filing under
sections 13 or 14 of the Securities Exchange Act of 1934 (15 U.S.C. 78m
or 78n), and the rules promulgated thereunder by the Securities and
Exchange Commission; and
(6) A person and any trust for which the person serves as trustee.
(e) Acquisitions of loans in default. The Board presumes an
acquisition of a
[[Page 95]]
loan in default that is secured by voting securities of a state member
bank or bank holding company to be an acquisition of the underlying
securities for purposes of this section.
(f) Other transactions. Transactions other than those set forth in
paragraph (c) of this section resulting in a person's control of less
than 25 percent of a class of voting securities of a state member bank
or bank holding company are not deemed by the Board to constitute
control for purposes of the Bank Control Act.
(g) Rebuttal of presumptions. Prior notice to the Board is not
required for any acquisition of voting securities under the presumption
of control set forth in this section, if the Board finds that the
acquisition will not result in control. The Board shall afford any
person seeking to rebut a presumption in this section an opportunity to
present views in writing or, if appropriate, orally before its
designated representatives at an informal conference.
Sec. 225.42 Transactions not requiring prior notice.
(a) Exempt transactions. The following transactions do not require
notice to the Board under this subpart:
(1) Existing control relationships. The acquisition of additional
voting securities of a state member bank or bank holding company by a
person who:
(i) Continuously since March 9, 1979 (or since the institution
commenced business, if later), held power to vote 25 percent or more of
any class of voting securities of the institution; or
(ii) Is presumed, under Sec. 225.41(c)(2) of this subpart, to have
controlled the institution continuously since March 9, 1979, if the
aggregate amount of voting securities held does not exceed 25 percent or
more of any class of voting securities of the institution or, in other
cases, where the Board determines that the person has controlled the
bank continuously since March 9, 1979;
(2) Increase of previously authorized acquisitions. Unless the Board
or the Reserve Bank otherwise provides in writing, the acquisition of
additional shares of a class of voting securities of a state member bank
or bank holding company by any person (or persons acting in concert) who
has lawfully acquired and maintained control of the institution (for
purposes of Sec. 225.41(c) of this subpart), after complying with the
procedures and receiving approval to acquire voting securities of the
institution under this subpart, or in connection with an application
approved under section 3 of the BHC Act (12 U.S.C. 1842; Sec. 225.11 of
subpart B of this part) or section 18(c) of the Federal Deposit
Insurance Act (Bank Merger Act, 12 U.S.C. 1828(c));
(3) Acquisitions subject to approval under BHC Act or Bank Merger
Act. Any acquisition of voting securities subject to approval under
section 3 of the BHC Act (12 U.S.C. 1842; Sec. 225.11 of subpart B of
this part), or section 18(c) of the Federal Deposit Insurance Act (Bank
Merger Act, 12 U.S.C. 1828(c));
(4) Transactions exempt under BHC Act. Any transaction described in
sections 2(a)(5), 3(a)(A), or 3(a)(B) of the BHC Act (12 U.S.C.
1841(a)(5), 1842(a)(A), and 1842(a)(B)), by a person described in those
provisions;
(5) Proxy solicitation. The acquisition of the power to vote
securities of a state member bank or bank holding company through
receipt of a revocable proxy in connection with a proxy solicitation for
the purposes of conducting business at a regular or special meeting of
the institution, if the proxy terminates within a reasonable period
after the meeting;
(6) Stock dividends. The receipt of voting securities of a state
member bank or bank holding company through a stock dividend or stock
split if the proportional interest of the recipient in the institution
remains substantially the same; and
(7) Acquisition of foreign banking organization. The acquisition of
voting securities of a qualifying foreign banking organization. (This
exemption does not extend to the reports and information required under
paragraphs 9, 10, and 12 of the Bank Control Act (12 U.S.C. 1817(j) (9),
(10), and (12)) and Sec. 225.44 of this subpart.)
(b) Prior notice exemption. (1) The following acquisitions of voting
securities of a state member bank or bank holding company, which would
otherwise require prior notice under this subpart,
[[Page 96]]
are not subject to the prior notice requirements if the acquiring person
notifies the appropriate Reserve Bank within 90 calendar days after the
acquisition and provides any relevant information requested by the
Reserve Bank:
(i) Acquisition of voting securities through inheritance;
(ii) Acquisition of voting securities as a bona fide gift; and
(iii) Acquisition of voting securities in satisfaction of a debt
previously contracted (DPC) in good faith.
(2) The following acquisitions of voting securities of a state
member bank or bank holding company, which would otherwise require prior
notice under this subpart, are not subject to the prior notice
requirements if the acquiring person does not reasonably have advance
knowledge of the transaction, and provides the written notice required
under section 225.43 to the appropriate Reserve Bank within 90 calendar
days after the transaction occurs:
(i) Acquisition of voting securities resulting from a redemption of
voting securities by the issuing bank or bank holding company; and
(ii) Acquisition of voting securities as a result of actions
(including the sale of securities) by any third party that is not within
the control of the acquiror.
(3) Nothing in paragraphs (b)(1) or (b)(2) of this section limits
the authority of the Board to disapprove a notice pursuant to
Sec. 225.43(h) of this subpart.
Sec. 225.43 Procedures for filing, processing, publishing, and acting on notices.
(a) Filing notice. (1) A notice required under this subpart shall be
filed with the appropriate Reserve Bank and shall contain all the
information required by paragraph 6 of the Bank Control Act (12 U.S.C.
1817(j)(6)), or prescribed in the designated Board form.
(2) The Board may waive any of the informational requirements of the
notice if the Board determines that it is in the public interest.
(3) A notificant shall notify the appropriate Reserve Bank or the
Board immediately of any material changes in a notice submitted to the
Reserve Bank, including changes in financial or other conditions.
(4) When the acquiring person is an individual, or group of
individuals acting in concert, the requirement to provide personal
financial data may be satisfied by a current statement of assets and
liabilities and an income summary, as required in the designated Board
form, together with a statement of any material changes since the date
of the statement or summary. The Reserve Bank or the Board,
nevertheless, may request additional information, if appropriate.
(b) Acceptance of notice. The 60-day notice period specified in
Sec. 225.41 of this subpart begins on the date of receipt of a complete
notice. The Reserve Bank shall notify the person or persons submitting a
notice under this subpart in writing of the date the notice is or was
complete and thereby accepted for processing. The Reserve Bank or the
Board may request additional relevant information at any time after the
date of acceptance.
(c) Publication--(1) Newspaper Announcement. Any person(s) filing a
notice under this subpart shall publish, in a form prescribed by the
Board, an announcement soliciting public comment on the proposed
acquisition. The announcement shall be published in a newspaper of
general circulation in the community in which the head office of the
state member bank to be acquired is located or, in the case of a
proposed acquisition of a bank holding company, in the community in
which its head office is located and in the community in which the head
office of each of its subsidiary banks is located. The announcement
shall be published no earlier than 15 calendar days before the filing of
the notice with the appropriate Reserve Bank and no later than 10
calendar days after the filing date; and the publisher's affidavit of a
publication shall be provided to the appropriate Reserve Bank.
(2) Contents of newspaper announcement. The newspaper announcement
shall state:
(i) The name of each person identified in the notice as a proposed
acquiror of the bank or bank holding company;
[[Page 97]]
(ii) The name of the bank or bank holding company to be acquired,
including the name of each of the bank holding company's subsidiary
banks; and
(iii) A statement that interested persons may submit comments on the
notice to the Board or the appropriate Reserve Bank for a period of 20
days, or such shorter period as may be provided, pursuant to paragraph
(c)(5) of this section.
(3) Federal Register announcement. The Board shall, upon filing of a
notice under this subpart, publish announcement in the Federal Register
of receipt of the notice. The Federal Register announcement shall
contain the information required under paragraphs (c)(2)(i) and
(c)(2)(ii) of this section and a statement that interested persons may
submit comments on the proposed acquisition for a period of 15 calendar
days, or such shorter period as may be provided, pursuant to paragraph
(c)(5) of this section. The Board may waive publication in the Federal
Register, if the Board determines that such action is appropriate.
(4) Delay of publication. The Board may permit delay in the
publication required under paragraphs (c)(1) and (c)(3) of this section
if the Board determines, for good cause shown, that it is in the public
interest to grant such delay. Requests for delay of publication may be
submitted to the appropriate Reserve Bank.
(5) Shortening or waiving notice. The Board may shorten or waive the
public comment or newspaper publication requirements of this paragraph,
or act on a notice before the expiration of a public comment period, if
it determines in writing that an emergency exists, or that disclosure of
the notice, solicitation of public comment, or delay until expiration of
the public comment period would seriously threaten the safety or
soundness of the bank or bank holding company to be acquired.
(6) Consideration of public comments. In acting upon a notice filed
under this subpart, the Board shall consider all public comments
received in writing within the period specified in the newspaper or
Federal Register announcement, whichever is later. At the Board's
option, comments received after this period may, but need not, be
considered.
(7) Standing. No person (other than the acquiring person) who
submits comments or information on a notice filed under this subpart
shall thereby become a party to the proceeding or acquire any standing
or right to participate in the Board's consideration of the notice or to
appeal or otherwise contest the notice or the Board's action regarding
the notice.
(d) Time period for Board action--(1) Consummation of acquisition --
(i) The notificant(s) may consummate the proposed acquisition 60 days
after submission to the Reserve Bank of a complete notice under
paragraph (a) of this section, unless within that period the Board
disapproves the proposed acquisition or extends the 60-day period, as
provided under paragraph (d)(2) of this section.
(ii) The notificant(s) may consummate the proposed transaction
before the expiration of the 60-day period if the Board notifies the
notificant(s) in writing of the Board's intention not to disapprove the
acquisition.
(2) Extensions of time period. (i) The Board may extend the 60-day
period in paragraph (d)(1) of this section for an additional 30 days by
notifying the acquiring person(s).
(ii) The Board may further extend the period during which it may
disapprove a notice for two additional periods of not more than 45 days
each, if the Board determines that:
(A) Any acquiring person has not furnished all the information
required under paragraph (a) of this section;
(B) Any material information submitted is substantially inaccurate;
(C) The Board is unable to complete the investigation of an
acquiring person because of inadequate cooperation or delay by that
person; or
(D) Additional time is needed to investigate and determine that no
acquiring person has a record of failing to comply with the requirements
of the Bank Secrecy Act, subchapter II of Chapter 53 of Title 31, United
States Code.
[[Page 98]]
(iii) If the Board extends the time period under this paragraph, it
shall notify the acquiring person(s) of the reasons therefor and shall
include a statement of the information, if any, deemed incomplete or
inaccurate.
(e) Advice to bank supervisory agencies. (1) Upon accepting a notice
relating to acquisition of securities of a state member bank, the
Reserve Bank shall send a copy of the notice to the appropriate state
bank supervisor, which shall have 30 calendar days from the date the
notice is sent in which to submit its views and recommendations to the
Board. The Reserve Bank also shall send a copy of any notice to the
Comptroller of the Currency, the Federal Deposit Insurance Corporation,
and the Office of Thrift Supervision.
(2) If the Board finds that it must act immediately in order to
prevent the probable failure of the bank or bank holding company
involved, the Board may dispense with or modify the requirements for
notice to the state supervisor.
(f) Investigation and report. (1) After receiving a notice under
this subpart, the Board or the appropriate Reserve Bank shall conduct an
investigation of the competence, experience, integrity, and financial
ability of each person by and for whom an acquisition is to be made. The
Board shall also make an independent determination of the accuracy and
completeness of any information required to be contained in a notice
under paragraph (a) of this section. In investigating any notice
accepted under this subpart, the Board or Reserve Bank may solicit
information or views from any person, including any bank or bank holding
company involved in the notice, and any appropriate state, federal, or
foreign governmental authority.
(2) The Board or the appropriate Reserve Bank shall prepare a
written report of its investigation, which shall contain, at a minimum,
a summary of the results of the investigation.
(g) Factors considered in acting on notices. In reviewing a notice
filed under this subpart, the Board shall consider the information in
the record, the views and recommendations of the appropriate bank
supervisor, and any other relevant information obtained during any
investigation of the notice.
(h) Disapproval and hearing--(1) Disapproval of notice. The Board
may disapprove an acquisition if it finds adverse effects with respect
to any of the factors set forth in paragraph 7 of the Bank Control Act
(12 U.S.C. 1817(j)(7)) (i.e., competitive, financial, managerial,
banking, or incompleteness of information).
(2) Disapproval notification. Within three days after its decision
to issue a notice of intent to disapprove any proposed acquisition, the
Board shall notify the acquiring person in writing of the reasons for
the action.
(3) Hearing. Within 10 calendar days of receipt of the notice of the
Board's intent to disapprove, the acquiring person may submit a written
request for a hearing. Any hearing conducted under this paragraph shall
be in accordance with the Rules of Practice for Formal Hearings (12 CFR
part 263). At the conclusion of the hearing, the Board shall, by order,
approve or disapprove the proposed acquisition on the basis of the
record of the hearing. If the acquiring person does not request a
hearing, the notice of intent to disapprove becomes final and
unappealable.
Sec. 225.44 Reporting of stock loans.
(a) Requirements. (1) Any foreign bank or affiliate of a foreign
bank that has credit outstanding to any person or group of persons, in
the aggregate, which is secured, directly or indirectly, by 25 percent
or more of any class of voting securities of a state member bank, shall
file a consolidated report with the appropriate Reserve Bank for the
state member bank.
(2) The foreign bank or its affiliate also shall file a copy of the
report with its appropriate Federal banking agency.
(3) Any shares of the state member bank held by the foreign bank or
any affiliate of the foreign bank as principal must be included in the
calculation of the number of shares in which the foreign bank or its
affiliate has a security interest for purposes of paragraph (a) of this
section.
(b) Definitions. For purposes of paragraph (a) of this section:
[[Page 99]]
(1) Foreign bank shall have the same meaning as in section 1(b) of
the International Banking Act of 1978 (12 U.S.C. 3101).
(2) Credit outstanding includes any loan or extension of credit; the
issuance of a guarantee, acceptance, or letter of credit, including an
endorsement or standby letter of credit; and any other type of
transaction that extends credit or financing to the person or group of
persons.
(3) Group of persons includes any number of persons that the foreign
bank or any affiliate of a foreign bank has reason to believe:
(i) Are acting together, in concert, or with one another to acquire
or control shares of the same insured depository institution, including
an acquisition of shares of the same depository institution at
approximately the same time under substantially the same terms; or
(ii) Have made, or propose to make, a joint filing under section 13
or 14 of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78n), and
the rules promulgated thereunder by the Securities and Exchange
Commission regarding ownership of the shares of the same insured
depository institution.
(c) Exceptions. Compliance with paragraph (a) of this section is not
required if:
(1) The person or group of persons referred to in that paragraph has
disclosed the amount borrowed and the security interest therein to the
Board or appropriate Reserve Bank in connection with a notice filed
under Sec. 225.41 of this subpart, or another application filed with the
Board or Reserve Bank as a substitute for a notice under Sec. 225.41 of
this subpart, including an application filed under section 3 of the BHC
Act (12 U.S.C. 1842) or section 18(c) of the Federal Deposit Insurance
Act (Bank Merger Act, 12 U.S.C. 1828(c)), or an application for
membership in the Federal Reserve System; or
(2) The transaction involves a person or group of persons that has
been the owner or owners of record of the stock for a period of one year
or more; or, if the transaction involves stock issued by a newly
chartered bank, before the bank is opened for business.
(d) Report requirements. (1) The consolidated report shall indicate
the number and percentage of shares securing each applicable extension
of credit, the identity of the borrower, and the number of shares held
as principal by the foreign bank and any affiliate thereof.
(2) A foreign bank, or any affiliate of a foreign bank, shall file
the consolidated report in writing within 30 days of the date on which
the foreign bank or affiliate first believes that the security for any
outstanding credit consists of 25 percent or more of any class of voting
securities of a state member bank.
(e) Other reporting requirements. A foreign bank, or any affiliate
thereof, that is supervised by the System and is required to report
credit outstanding that is secured by the shares of an insured
depository institution to another Federal banking agency also shall file
a copy of the report with the appropriate Reserve Bank.
Subpart F--Limitations on Nonbank Banks
Sec. 225.52 Limitation on overdrafts.
(a) Definitions. For purposes of this section--
(1) Account means a reserve account, clearing account, or deposit
account as defined in the Board's Regulation D (12 CFR 204.2(a)(1)(i)),
that is maintained at a Federal Reserve Bank or nonbank bank.
(2) Cash item means (i) a check other than a check classified as a
noncash item; or (ii) any other item payable on demand and collectible
at par that the Federal Reserve Bank of the district in which the item
is payable is willing to accept as a cash item.
(3) Discount window loan means any credit extended by a Federal
Reserve Bank to a nonbank bank or industrial bank pursuant to the
provisions of the Board's Regulation A (12 CFR part 201).
(4) Industrial bank means an institution as defined in section
2(c)(2)(H) of the BHC Act (12 U.S.C. 1841(c)(2)(H)).
(5) Noncash item means an item handled by a Reserve Bank as a
noncash item under the Reserve Bank's ``Collection of Noncash Items
Operating Circular'' (e.g., a maturing bankers' acceptance or a maturing
security, or a demand item, such as a check, with
[[Page 100]]
special instructions or an item that has not been preprinted or post-
encoded).
(6) Other nonelectronic transactions include all other transactions
not included as funds transfers, book-entry securities transfers, cash
items, noncash items, automated clearing house transactions, net
settlement entries, and discount window loans (e.g., original issue of
securities or redemption of securities).
(7) An overdraft in an account occurs whenever the Federal Reserve
Bank, nonbank bank, or industrial bank holding an account posts a
transaction to the account of the nonbank bank, industrial bank, or
affiliate that exceeds the aggregate balance of the accounts of the
nonbank bank, industrial bank, or affiliate, as determined by the
posting rules set forth in paragraphs (d) and (e) of this section and
continues until the aggregate balance of the account is zero or greater.
(8) Transfer item means an item as defined in subpart B of
Regulation J (12 CFR 210.25 et seq).
(b) Restriction on overdrafts--(1) Affiliates. Neither a nonbank
bank nor an industrial bank shall permit any affiliate to incur any
overdraft in its account with the nonbank bank or industrial bank.
(2) Nonbank banks or industrial banks. (i) No nonbank bank or
industrial bank shall incur any overdraft in its account at a Federal
Reserve Bank on behalf of an affiliate.
(ii) An overdraft by a nonbank bank or industrial bank in its
account at a Federal Reserve Bank shall be deemed to be on behalf of an
affiliate whenever:
(A) A nonbank bank or industrial bank holds an account for an
affiliate from which third-party payments can be made; and
(B) When the posting of an affiliate's transaction to the nonbank
bank's or industrial bank's account at a Reserve Bank creates an
overdraft in its account at a Federal Reserve Bank or increases the
amount of an existing overdraft in its account at a Federal Reserve
Bank.
(c) Permissible overdrafts. The following are permissible overdrafts
not subject to paragraph (b) of this section:
(1) Inadvertent error. An overdraft in its account by a nonbank bank
or its affiliate, or an industrial bank or its affiliate, that results
from an inadvertent computer error or inadvertent accounting error, that
was not reasonably forseeable or could not have been prevented through
the maintenance of procedures reasonably adopted by the nonbank bank or
affiliate to avoid such overdraft; and
(2) Fully secured primary dealer affiliate overdrafts. (i) An
overdraft incurred by an affiliate of a nonbank bank, which affiliate is
recognized as a primary dealer by the Federal Reserve Bank of New York,
in the affiliate's account at the nonbank bank, or an overdraft incurred
by a nonbank bank on behalf of its primary dealer affiliate in the
nonbank bank's account at a Federal Reserve Bank; provided: the
overdraft is fully secured by bonds, notes, or other obligations which
are direct obligations of the United States or on which the principal
and interest are fully guaranteed by the United States or by securities
and obligations eligible for settlement on the Federal Reserve book-
entry system.
(ii) An overdraft by a nonbank bank in its account at a Federal
Reserve Bank that is on behalf of a primary dealer affiliate is fully
secured when that portion of its overdraft at the Federal Reserve Bank
that corresponds to the transaction posted for an affiliate that caused
or increased the nonbank bank's overdraft is fully secured in accordance
with paragraph (c)(2)(iii) of this section.
(iii) An overdraft is fully secured under paragraph (c)(2)(i) when
the nonbank bank can demonstrate that the overdraft is secured, at all
times, by a perfected security interest in specific, identified
obligations described in paragraph (c)(2)(i) with a market value that,
in the judgment of the Reserve Bank holding the nonbank bank's account,
is sufficiently in excess of the amount of the overdraft to provide a
margin of protection in a volatile market or in the event the securities
need to be liquidated quickly.
(d) Posting by Federal Reserve Banks. For purposes of determining
the balance of an account under this section, payments and transfers by
nonbank
[[Page 101]]
banks and industrial banks processed by the Federal Reserve Banks shall
be considered posted to their accounts at Federal Reserve Banks as
follows:
(1) Funds transfers. Transfer items shall be posted:
(i) To the transferor's account at the time the transfer is actually
made by the transferor's Federal Reserve Bank; and
(ii) To the transferee's account at the time the transferee's
Reserve Bank sends the transfer item or sends or telephones the advice
of credit for the item to the transferee, whichever occurs first.
(2) Book-entry securities transfers against payment. A book-entry
securities transfer against payment shall be posted: (i) to the
transferor's account at the time the entry is made by the transferor's
Reserve Bank; and (ii) to the transferee's account at the time the entry
is made by the transferee's Reserve Bank.
(3) Discount window loans. Credit for a discount window loan shall
be posted to the account of a nonbank bank or industrial bank at the
close of business on the day that it is made or such earlier time as may
be specifically agreed to by the Federal Reserve Bank and the nonbank
bank under the terms of the loan. Debit for repayment of a discount
window loan shall be posted to the account of the nonbank bank or
industrial bank as of the close of business on the day of maturity of
the loan or such earlier time as may be agreed to by the Federal Reserve
Bank and the nonbank bank or required by the Federal Reserve Bank under
the terms of the loan.
(4) Other transactions. Total aggregate credits for automated
clearing house transfers, cash items, noncash items, net settlement
entries, and other nonelectronic transactions shall be posted to the
account of a nonbank bank or industrial bank as of the opening of
business on settlement day. Total aggregate debits for these
transactions and entries shall be posted to the account of a nonbank
bank or industrial bank as of the close of business on settlement day.
(e) Posting by nonbank banks and industrial banks. For purposes of
determining the balance of an affiliate's account under this section,
payments and transfers through an affiliate's account at a nonbank bank
or industrial bank shall be posted as follows:
(1) Funds transfers. (i) Fedwire transfer items shall be posted:
(A) To the transferor affiliate's account no later than the time the
transfer is actually made by the transferor's Federal Reserve Bank; and
(B) To the transferee affiliate's account no earlier than the time
the transferee's Reserve Bank sends the transfer item, or sends or
telephones the advice of credit for the item to the transferee,
whichever occurs first.
(ii) For funds transfers not sent or received through Federal
Reserve Banks, debits shall be posted to the transferor affiliate's
account not later than the time the nonbank bank or industrial bank
becomes obligated on the transfer. Credits shall not be posted to the
transferee affiliate's account before the nonbank bank or industrial
bank has received actually and finally collected funds for the transfer.
(2) Book-entry securities transfers against payment. (i) A book-
entry securities transfer against payment shall be posted:
(A) To the transferor affiliate's account not earlier than the time
the entry is made by the transferor's Reserve Bank; and
(B) To the transferee affiliate's account not later than the time
the entry is made by the transferee's Reserve Bank.
(ii) For book-entry securities transfers against payment that are
not sent or received through Federal Reserve Banks, entries shall be
posted:
(A) To the buyer-affiliate's account not later than the time the
nonbank bank or industrial bank becomes obligated on the transfer; and
(B) To the seller-affiliate's account not before the nonbank bank or
industrial bank has received actually and finally collected funds for
the transfer.
(3) Other transactions--(i) Credits. Except as otherwise provided in
this paragraph, credits for cash items, noncash items, ACH transfers,
net settlement entries, and all other nonelectronic transactions shall
be posted to an affiliate's account on the day of the transaction (i.e.,
settlement day for
[[Page 102]]
ACH transactions or the day of credit for check transactions), but no
earlier than the Federal Reserve Bank's opening of business on that day.
Credit for cash items that are required by federal or state statute or
regulation to be made available to the depositor for withdrawal prior to
the posting time set forth in the preceding paragraph shall be posted as
of the required availability time.
(ii) Debits. Debits for cash items, noncash items, ACH transfers,
net settlement entries, and all other nonelectronic transactions shall
be posted to an affiliate's account on the day of the transaction (e.g.,
settlement day for ACH transactions or the day of presentment for check
transactions), but no later than the Federal Reserve Bank's close of
business on that day. If a check drawn on an affiliate's account or an
ACH debit transfer received by an affiliate is returned timely by the
nonbank bank or industrial bank in accordance with applicable law and
agreements, no entry need to be posted to the affiliate's account for
such item.
[Reg. Y, 53 FR 37744, Sept. 28, 1988]
Subpart G--Appraisal Standards for Federally Related Transactions
Source: Reg. Y, 55 FR 27771, July 5, 1990, unless otherwise noted.
Sec. 225.61 Authority, purpose, and scope.
(a) Authority. This subpart is issued by the Board of Governors of
the Federal Reserve System (the Board) under title XI of the Financial
Institutions Reform, Recovery, and Enforcement Act of 1989 (FlRREA)
(Pub. L. No. 101-73, 103 Stat. 183 (1989)), 12 U.S.C. 3310, 3331-3351,
and section 5(b) of the Bank Holding Company Act, 12 U.S.C. 1844(b).
(b) Purpose and scope. (1) Title XI provides protection for federal
financial and public policy interests in real estate related
transactions by requiring real estate appraisals used in connection with
federally related transactions to be performed in writing, in accordance
with uniform standards, by appraisers whose competency has been
demonstrated and whose professional conduct will be subject to effective
supervision. This subpart implements the requirements of title XI, and
applies to all federally related transactions entered into by the Board
or by institutions regulated by the Board (regulated institutions).
(2) This subpart:
(i) Identifies which real estate-related financial transactions
require the services of an appraiser;
(ii) Prescribes which categories of federally related transactions
shall be appraised by a State certified appraiser and which by a State
licensed appraiser; and
(iii) Prescribes minimum standards for the performance of real
estate appraisals in connection with federally related transactions
under the jurisdiction of the Board.
Sec. 225.62 Definitions.
(a) Appraisal means a written statement independently and
impartially prepared by a qualified appraiser setting forth an opinion
as to the market value of an adequately described property as of a
specific date(s), supported by the presentation and analysis of relevant
market information.
(b) Appraisal Foundation means the Appraisal Foundation established
on November 30, 1987, as a not-for-profit corporation under the laws of
Illinois.
(c) Appraisal Subcommittee means the Appraisal Subcommittee of the
Federal Financial Institutions Examination Council.
(d) Business loan means a loan or extension of credit to any
corporation, general or limited partnership, business trust, joint
venture, pool, syndicate, sole proprietorship, or other business entity.
(e) Complex 1-to-4 family residential property appraisal means one
in which the property to be appraised, the form of ownership, or market
conditions are atypical.
(f) Federally related transaction means any real estate-related
financial transaction entered into on or after August 9, 1990, that:
(1) The Board or any regulated institution engages in or contracts
for; and
(2) Requires the services of an appraiser.
(g) Market value means the most probable price which a property
should
[[Page 103]]
bring in a competitive and open market under all conditions requisite to
a fair sale, the buyer and seller each acting prudently and
knowledgeably, and assuming the price is not affected by undue stimulus.
Implicit in this definition is the consummation of a sale as of a
specified date and the passing of title from seller to buyer under
conditions whereby:
(1) Buyer and seller are typically motivated;
(2) Both parties are well informed or well advised, and acting in
what they consider their own best interests;
(3) A reasonable time is allowed for exposure in the open market;
(4) Payment is made in terms of cash in U.S. dollars or in terms of
financial arrangements comparable thereto; and
(5) The price represents the normal consideration for the property
sold unaffected by special or creative financing or sales concessions
granted by anyone associated with the sale.
(h) Real estate or real property means an identified parcel or tract
of land, with improvements, and includes easements, rights of way,
undivided or future interests, or similar rights in a tract of land, but
does not include mineral rights, timber rights, growing crops, water
rights, or similar interests severable from the land when the
transaction does not involve the associated parcel or tract of land.
(i) Real estate-related financial transaction means any transaction
involving:
(1) The sale, lease, purchase, investment in or exchange of real
property, including interests in property, or the financing thereof; or
(2) The refinancing of real property or interests in real property;
or
(3) The use of real property or interests in property as security
for a loan or investment, including mortgage-backed securities.
(j) State certified appraiser means any individual who has satisfied
the requirements for certification in a State or territory whose
criteria for certification as a real estate appraiser currently meet or
exceed the minimum criteria for certification issued by the Appraiser
Qualifications Board of the Appraisal Foundation. No individual shall be
a State certified appraiser unless such individual has achieved a
passing grade upon a suitable examination administered by a State or
territory that is consistent with and equivalent to the Uniform State
Certification Examination issued or endorsed by the Appraiser
Qualifications Board of the Appraisal Foundation. In addition, the
Appraisal Subcommittee must not have issued a finding that the policies,
practices, or procedures of the State or territory are inconsistent with
title XI of FIRREA. The Board may, from time to time, impose additional
qualification criteria for certified appraisers performing appraisals in
connection with federally related transactions within its jurisdiction.
(k) State licensed appraiser means any individual who has satisfied
the requirements for licensing in a State or territory where the
licensing procedures comply with title XI of FIRREA and where the
Appraisal Subcommittee has not issued a finding that the policies,
practices, or procedures of the State or territory are inconsistent with
title XI. The Board may, from time to time, impose additional
qualification criteria for licensed appraisers performing appraisals in
connection with federally related transactions within the Board's
jurisdiction.
(l) Tract development means a project of five units or more that is
constructed or is to be constructed as a single development.
(m) Transaction value means:
(1) For loans or other extensions of credit, the amount of the loan
or extension of credit;
(2) For sales, leases, purchases, and investments in or exchanges of
real property, the market value of the real property interest involved;
and
(3) For the pooling of loans or interests in real property for
resale or purchase, the amount of the loan or the market value of the
real property calculated with respect to each such loan or interest in
real property.
[Reg. Y, 55 FR 27771, July 5, 1990, as amended at 59 FR 29500, June 7,
1994]
[[Page 104]]
Sec. 225.63 Appraisals required; transactions requiring a State certified or licensed appraiser.
(a) Appraisals required. An appraisal performed by a State certified
or licensed appraiser is required for all real estate-related financial
transactions except those in which:
(1) The transaction value is $250,000 or less;
(2) A lien on real estate has been taken as collateral in an
abundance of caution;
(3) The transaction is not secured by real estate;
(4) A lien on real estate has been taken for purposes other than the
real estate's value;
(5) The transaction is a business loan that:
(i) Has a transaction value of $1 million or less; and
(ii) Is not dependent on the sale of, or rental income derived from,
real estate as the primary source of repayment;
(6) A lease of real estate is entered into, unless the lease is the
economic equivalent of a purchase or sale of the leased real estate;
(7) The transaction involves an existing extension of credit at the
lending institution, provided that:
(i) There has been no obvious and material change in market
conditions or physical aspects of the property that threatens the
adequacy of the institution's real estate collateral protection after
the transaction, even with the advancement of new monies; or
(ii) There is no advancement of new monies, other than funds
necessary to cover reasonable closing costs;
(8) The transaction involves the purchase, sale, investment in,
exchange of, or extension of credit secured by, a loan or interest in a
loan, pooled loans, or interests in real property, including mortgaged-
backed securities, and each loan or interest in a loan, pooled loan, or
real property interest met Board regulatory requirements for appraisals
at the time of origination;
(9) The transaction is wholly or partially insured or guaranteed by
a United States government agency or United States government sponsored
agency;
(10) The transaction either:
(i) Qualifies for sale to a United States government agency or
United States government sponsored agency; or
(ii) Involves a residential real estate transaction in which the
appraisal conforms to the Federal National Mortgage Association or
Federal Home Loan Mortgage Corporation appraisal standards applicable to
that category of real estate;
(11) The regulated institution is acting in a fiduciary capacity and
is not required to obtain an appraisal under other law;
(12) The transaction involves underwriting or dealing in mortgage-
backed securities; or
(13) The Board determines that the services of an appraiser are not
necessary in order to protect Federal financial and public policy
interests in real estate-related financial transactions or to protect
the safety and soundness of the institution.
(b) Evaluations required. For a transaction that does not require
the services of a State certified or licensed appraiser under paragraph
(a)(1), (a)(5) or (a)(7) of this section, the institution shall obtain
an appropriate evaluation of real property collateral that is consistent
with safe and sound banking practices.
(c) Appraisals to address safety and soundness concerns. The Board
reserves the right to require an appraisal under this subpart whenever
the agency believes it is necessary to address safety and soundness
concerns.
(d) Transactions requiring a State certified appraiser--(1) All
transactions of $1,000,000 or more. All federally related transactions
having a transaction value of $1,000,000 or more shall require an
appraisal prepared by a State certified appraiser.
(2) Nonresidential transactions of $250,000 or more. All federally
related transactions having a transaction value of $250,000 or more,
other than those involving appraisals of 1-to-4 family residential
properties, shall require an appraisal prepared by a State certified
appraiser.
[[Page 105]]
(3) Complex residential transactions of $250,000 or more. All
complex 1-to-4 family residential property appraisals rendered in
connection with federally related transactions shall require a State
certified appraiser if the transaction value is $250,000 or more. A
regulated institution may presume that appraisals of 1-to-4 family
residential properties are not complex, unless the institution has
readily available information that a given appraisal will be complex.
The regulated institution shall be responsible for making the final
determination of whether the appraisal is complex. If during the course
of the appraisal a licensed appraiser identifies factors that would
result in the property, form of ownership, or market conditions being
considered atypical, then either:
(i) The regulated institution may ask the licensed appraiser to
complete the appraisal and have a certified appraiser approve and co-
sign the appraisal; or
(ii) The institution may engage a certified appraiser to complete
the appraisal.
(e) Transactions requiring either a State certified or licensed
appraiser. All appraisals for federally related transactions not
requiring the services of a State certified appraiser shall be prepared
by either a State certified appraiser or a State licensed appraiser.
[Reg. Y, 55 FR 27771, July 5, 1990, as amended at 58 FR 15077, Mar. 19,
1993; 59 FR 29500, June 7, 1994; 63 FR 65532, Nov. 27, 1998]
Sec. 225.64 Minimum appraisal standards.
For federally related transactions, all appraisals shall, at a
minimum:
(a) Conform to generally accepted appraisal standards as evidenced
by the Uniform Standards of Professional Appraisal Practice promulgated
by the Appraisal Standards Board of the Appraisal Foundation, 1029
Vermont Ave., NW., Washington, DC 20005, unless principles of safe and
sound banking require compliance with stricter standards;
(b) Be written and contain sufficient information and analysis to
support the institution's decision to engage in the transaction;
(c) Analyze and report appropriate deductions and discounts for
proposed construction or renovation, partially leased buildings, non-
market lease terms, and tract developments with unsold units;
(d) Be based upon the definition of market value as set forth in
this subpart; and
(e) Be performed by State licensed or certified appraisers in
accordance with requirements set forth in this subpart.
[Reg. Y, 59 FR 29501, June 7, 1994]
Sec. 225.65 Appraiser independence.
(a) Staff appraisers. If an appraisal is prepared by a staff
appraiser, that appraiser must be independent of the lending,
investment, and collection functions and not involved, except as an
appraiser, in the federally related transaction, and have no direct or
indirect interest, financial or otherwise, in the property. If the only
qualified persons available to perform an appraisal are involved in the
lending, investment, or collection functions of the regulated
institution, the regulated institution shall take appropriate steps to
ensure that the appraisers exercise independent judgment and that the
appraisal is adequate. Such steps include, but are not limited to,
prohibiting an individual from performing appraisals in connection with
federally related transactions in which the appraiser is otherwise
involved and prohibiting directors and officers from participating in
any vote or approval involving assets on which they performed an
appraisal.
(b) Fee appraisers. (1) If an appraisal is prepared by a fee
appraiser, the appraiser shall be engaged directly by the regulated
institution or its agent, and have no direct or indirect interest,
financial or otherwise, in the property or the transaction.
(2) A regulated institution also may accept an appraisal that was
prepared by an appraiser engaged directly by another financial services
institution, if:
(i) The appraiser has no direct or indirect interest, financial or
otherwise, in the property or the transaction; and
(ii) The regulated institution determines that the appraisal
conforms to the requirements of this subpart and is otherwise
acceptable.
[Reg. Y, 55 FR 27771, July 5, 1990, as amended at 59 FR 29501, June 7,
1994]
[[Page 106]]
Sec. 225.66 Professional association membership; competency.
(a) Membership in appraisal organizations. A State certified
appraiser or a State licensed appraiser may not be excluded from
consideration for an assignment for a federally related transaction
solely by virtue of membership or lack of membership in any particular
appraisal organization.
(b) Competency. All staff and fee appraisers performing appraisals
in connection with federally related transactions must be State
certified or licensed, as appropriate. However, a State certified or
licensed appraiser may not be considered competent solely by virtue of
being certified or licensed. Any determination of competency shall be
based upon the individual's experience and educational background as
they relate to the particular appraisal assignment for which he or she
is being considered.
Sec. 225.67 Enforcement.
Institutions and institution-affiliated parties, including staff
appraisers and fee appraisers, may be subject to removal and/or
prohibition orders, cease and desist orders, and the imposition of civil
money penalties pursuant to the Federal Deposit Insurance Act, 12 U.S.C
1811 et seq., as amended, or other applicable law.
Subpart H--Notice of Addition or Change of Directors and Senior
Executive Officers
Source: Reg. Y, 62 FR 9341, Feb. 28, 1997, unless otherwise noted.
Sec. 225.71 Definitions.
(a) Director means a person who serves on the board of directors of
a regulated institution, except that this term does not include an
advisory director who:
(1) Is not elected by the shareholders of the regulated institution;
(2) Is not authorized to vote on any matters before the board of
directors or any committee thereof;
(3) Solely provides general policy advice to the board of directors
and any committee thereof; and
(4) Has not been identified by the Board or Reserve Bank as a person
who performs the functions of a director for purposes of this subpart.
(b) Regulated institution means a state member bank or a bank
holding company.
(c) Senior executive officer means a person who holds the title or,
without regard to title, salary, or compensation, performs the function
of one or more of the following positions: president, chief executive
officer, chief operating officer, chief financial officer, chief lending
officer, or chief investment officer. Senior executive officer also
includes any other person identified by the Board or Reserve Bank,
whether or not hired as an employee, with significant influence over, or
who participates in, major policymaking decisions of the regulated
institution.
(d) Troubled condition for a regulated institution means an
institution that:
(1) Has a composite rating, as determined in its most recent report
of examination or inspection, of 4 or 5 under the Uniform Financial
Institutions Rating System or under the Federal Reserve Bank Holding
Company Rating System;
(2) Is subject to a cease-and-desist order or formal written
agreement that requires action to improve the financial condition of the
institution, unless otherwise informed in writing by the Board or
Reserve Bank; or
(3) Is informed in writing by the Board or Reserve Bank that it is
in troubled condition for purposes of the requirements of this subpart
on the basis of the institution's most recent report of condition or
report of examination or inspection, or other information available to
the Board or Reserve Bank.
Sec. 225.72 Director and officer appointments; prior notice requirement.
(a) Prior notice by regulated institution. A regulated institution
shall give the Board 30 days' written notice, as specified in
Sec. 225.73, before adding or replacing any member of its board of
directors, employing any person as a senior executive officer of the
institution, or changing the responsibilities of any
[[Page 107]]
senior executive officer so that the person would assume a different
senior executive officer position, if:
(1) The regulated institution is not in compliance with all minimum
capital requirements applicable to the institution as determined on the
basis of the institution's most recent report of condition or report of
examination or inspection;
(2) The regulated institution is in troubled condition; or
(3) The Board determines, in connection with its review of a capital
restoration plan required under section 38 of the Federal Deposit
Insurance Act or subpart B of the Board's Regulation H, or otherwise,
that such notice is appropriate.
(b) Prior notice by individual. The prior notice required by
paragraph (a) of this section may be provided by an individual seeking
election to the board of directors of a regulated institution.
Sec. 225.73 Procedures for filing, processing, and acting on notices; standards for disapproval; waiver of notice.
(a) Filing notice--(1) Content. The notice required in Sec. 225.72
shall be filed with the appropriate Reserve Bank and shall contain:
(i) The information required by paragraph 6(A) of the Change in Bank
Control Act (12 U.S.C. 1817(j)(6)(A)) as may be prescribed in the
designated Board form;
(ii) Additional information consistent with the Federal Financial
Institutions Examination Council's Joint Statement of Guidelines on
Conducting Background Checks and Change in Control Investigations, as
set forth in the designated Board form; and
(iii) Such other information as may be required by the Board or
Reserve Bank.
(2) Modification. The Reserve Bank may modify or accept other
information in place of the requirements of Sec. 225.73(a)(1) for a
notice filed under this subpart.
(3) Acceptance and processing of notice. The 30-day notice period
specified in Sec. 225.72 shall begin on the date all information
required to be submitted by the notificant pursuant to Sec. 225.73(a)(1)
is received by the appropriate Reserve Bank. The Reserve Bank shall
notify the regulated institution or individual submitting the notice of
the date on which all required information is received and the notice is
accepted for processing, and of the date on which the 30-day notice
period will expire. The Board or Reserve Bank may extend the 30-day
notice period for an additional period of not more than 60 days by
notifying the regulated institution or individual filing the notice that
the period has been extended and stating the reason for not processing
the notice within the 30-day notice period.
(b) Commencement of service--(1) At expiration of period. A proposed
director or senior executive officer may begin service after the end of
the 30-day period and any extension as provided under paragraph (a)(3)
of this section, unless the Board or Reserve Bank disapproves the notice
before the end of the period.
(2) Prior to expiration of period. A proposed director or senior
executive officer may begin service before the end of the 30-day period
and any extension as provided under paragraph (a)(3) of this section, if
the Board or the Reserve Bank notifies in writing the regulated
institution or individual submitting the notice of the Board's or
Reserve Bank's intention not to disapprove the notice.
(c) Notice of disapproval. The Board or Reserve Bank shall
disapprove a notice under Sec. 225.72 if the Board or Reserve Bank finds
that the competence, experience, character, or integrity of the
individual with respect to whom the notice is submitted indicates that
it would not be in the best interests of the depositors of the regulated
institution or in the best interests of the public to permit the
individual to be employed by, or associated with, the regulated
institution. The notice of disapproval shall contain a statement of the
basis for disapproval and shall be sent to the regulated institution and
the disapproved individual.
(d) Appeal of a notice of disapproval. (1) A disapproved individual
or a regulated institution that has submitted a notice that is
disapproved under this section may appeal the disapproval to
[[Page 108]]
the Board within 15 days of the effective date of the notice of
disapproval. An appeal shall be in writing and explain the reasons for
the appeal and include all facts, documents, and arguments that the
appealing party wishes to be considered in the appeal, and state whether
the appealing party is requesting an informal hearing.
(2) Written notice of the final decision of the Board shall be sent
to the appealing party within 60 days of the receipt of an appeal,
unless the appealing party's request for an informal hearing is granted.
(3) The disapproved individual may not serve as a director or senior
executive officer of the state member bank or bank holding company while
the appeal is pending.
(e) Informal hearing. (1) An individual or regulated institution
whose notice under this section has been disapproved may request an
informal hearing on the notice. A request for an informal hearing shall
be in writing and shall be submitted within 15 days of a notice of
disapproval. The Board may, in its sole discretion, order an informal
hearing if the Board finds that oral argument is appropriate or
necessary to resolve disputes regarding material issues of fact.
(2) An informal hearing shall be held within 30 days of a request,
if granted, unless the requesting party agrees to a later date.
(3) Written notice of the final decision of the Board shall be given
to the individual and the regulated institution within 60 days of the
conclusion of any informal hearing ordered by the Board, unless the
requesting party agrees to a later date.
(f) Waiver of notice--(1) Waiver requests. The Board or Reserve Bank
may permit an individual to serve as a senior executive officer or
director before the notice required under this subpart is provided, if
the Board or Reserve Bank finds that:
(i) Delay would threaten the safety or soundness of the regulated
institution or a bank controlled by a bank holding company;
(ii) Delay would not be in the public interest; or
(iii) Other extraordinary circumstances exist that justify waiver of
prior notice.
(2) Automatic waiver. An individual may serve as a director upon
election to the board of directors of a regulated institution before the
notice required under this subpart is provided if the individual:
(i) Is not proposed by the management of the regulated institution;
(ii) Is elected as a new member of the board of directors at a
meeting of the regulated institution; and
(iii) Provides to the appropriate Reserve Bank all the information
required in Sec. 225.73(a) within two (2) business days after the
individual's election.
(3) Effect on disapproval authority. A waiver shall not affect the
authority of the Board or Reserve Bank to disapprove a notice within 30
days after a waiver is granted under paragraph (f)(1) of this section or
the election of an individual who has filed a notice and is serving
pursuant to an automatic waiver under paragraph (f)(2) of this section.
Subpart I--Financial Holding Companies
Source: Reg. Y, 65 FR 3791, Jan. 25, 2000, unless otherwise noted.
Sec. 225.81 What is a financial holding company?
(a) Definition. A financial holding company is a bank holding
company that meets the requirements of this section.
(b) Requirements to be a financial holding company. In order to be a
financial holding company:
(1) All depository institutions controlled by the bank holding
company must be and remain well capitalized;
(2) All depository institutions controlled by the bank holding
company must be and remain well managed; and
(3) The bank holding company must have made an effective election to
become a financial holding company.
(c) Well managed--(1) In general. For purposes of this subpart, a
depository institution is well managed if:
(i) At its most recent inspection or examination or subsequent
review by the appropriate Federal banking agency for the depository
institution, the institution received:
[[Page 109]]
(A) At least a satisfactory composite rating; and
(B) At least a satisfactory rating for management; or
(ii) In the case of a depository institution that has not received
an examination rating, the Board has determined, after a review of
managerial and other resources of the depository institution and after
consulting the appropriate Federal banking agency for the institution,
that the institution is well managed.
(2) Merged institutions. A depository institution that results from
the merger of two or more depository institutions that are well managed
shall be considered to be well managed unless the Board determines
otherwise after consulting with the appropriate Federal banking agency
for each depository institution involved in the merger.
(d) Requirements for foreign banks that are or are owned by bank
holding companies--(1) Foreign banks with U.S. branches or agencies. A
foreign bank that is a bank holding company and that operates a branch
or agency or owns or controls a commercial lending company in the United
States must comply with the requirements of this section, Sec. 225.82
and Secs. 225.90 through 225.93 in order to be a financial holding
company.
(2) Bank holding companies that own foreign banks with U.S. branches
or agencies. A bank holding company that owns a foreign bank that
operates a branch or agency or owns or controls a commercial lending
company in the United States must comply with the requirements of this
section and Sec. 225.82, and the foreign bank must comply with
Secs. 225.90 through 225.93 in order for the company to be a financial
holding company.
Reg. Y, 65 FR 3791, Jan. 25, 2000, as amended at 65 FR 15055, Mar. 21,
2000]
Sec. 225.82 How does a company elect to become a financial holding company?
(a) Filing requirement. A bank holding company may elect to become a
financial holding company by filing a written declaration with the
appropriate Federal Reserve Bank.
(b) Contents of declaration. The declaration must:
(1) State that the bank holding company elects to be a financial
holding company;
(2) Provide the name and head office address of the company and of
each depository institution controlled by the company;
(3) Certify that all depository institutions controlled by the
company are well capitalized as of the date the company files its
election;
(4) Provide the capital ratios for all relevant capital measures (as
defined in section 38 of the Federal Deposit Insurance Act) as of the
close of the previous quarter for each depository institution controlled
by the company on the date the company files its election; and
(5) Certify that all depository institutions controlled by the
company are well managed as of the date the company files its election.
(c) Under what circumstances will the Board find an election to be
ineffective? An election to become a financial holding company shall not
be effective if, during the period provided in paragraph (f) of this
section, the Board finds that as of the date the election is received by
the appropriate Federal Reserve Bank:
(1) Any insured depository institution controlled by the bank
holding company (except an institution excluded under paragraph (e) of
this section) has not achieved at least a rating of ``satisfactory
record of meeting community credit needs'' under the Community
Reinvestment Act at the institution's most recent examination; or
(2) Any depository institution controlled by the bank holding
company is not both well capitalized and well managed.
(d) May the Board impose supervisory limits on financial holding
companies? The Board may, in the exercise of its supervisory authority,
restrict or limit the commencement or conduct of additional activities
or acquisitions of a financial holding company, or take other
appropriate action, if the Board finds that the financial holding
company does not have the financial resources, including capital
resources, or managerial resources to engage in activities, make
acquisitions, or retain ownership
[[Page 110]]
of companies permitted for financial holding companies.
(e) How is CRA performance of recently acquired insured depository
institutions considered? An insured depository institution will be
excluded for purposes of the review of CRA ratings described in
paragraph (c)(1) of this section if:
(1) The bank holding company acquired the insured depository
institution during the 12-month period preceding the filing of an
election under paragraph (a) of this section;
(2) The bank holding company has submitted an affirmative plan to
the appropriate Federal banking agency for the institution to take
actions necessary for the institution to achieve at least a rating of
``satisfactory record of meeting community credit needs'' under the
Community Reinvestment Act at the next examination of the institution;
and
(3) The appropriate Federal banking agency for the institution has
accepted that plan.
(f) When is an election effective? (1) In general. An election
described in paragraph (a) of this section is effective on the 31st day
after the date that the election was received by the appropriate Federal
Reserve Bank, unless the Board notifies the bank holding company prior
to that time that the election is ineffective.
(2) Earlier notification that an election is effective. The Board or
the appropriate Federal Reserve Bank may notify a bank holding company
that its election to become a financial holding company is effective
prior to the 31st day after the election was filed with the appropriate
Federal Reserve Bank. Such a notification must be in writing.
Sec. 225.83 What are the consequences of failing to continue to meet applicable capital and management requirements?
(a) Notice by the Board. If the Board finds that any depository
institution controlled by a financial holding company ceases to be well
capitalized or well managed, the Board will notify the company in
writing that it is not in compliance with the applicable requirement(s)
for a financial holding company and identify the areas of noncompliance.
(b) Notification by a financial holding company required. Promptly
upon becoming aware that any depository institution controlled by the
financial holding company has ceased to be well capitalized or well
managed, the company must notify the Board and identify the depository
institution involved and the area of noncompliance.
(c) Execution of agreement acceptable to the Board--(1) Agreement
required; time period. Within 45 days after receiving a notice under
paragraph (a) of this section, the company must execute an agreement
acceptable to the Board to comply with all applicable capital and
management requirements.
(2) Extension of time for executing agreement. Upon request by a
company, the Board may extend the 45-day period under paragraph (c)(1)
of this section if the Board determines that granting additional time is
appropriate under the circumstances. A request by a company for
additional time must include an explanation of why an extension is
necessary.
(3) Agreement requirements. An agreement required by paragraph
(c)(1) of this section to correct a capital or management deficiency
must:
(i) Explain the specific actions that the company will take to
correct all areas of noncompliance;
(ii) Provide a schedule within which each action will be taken;
(iii) Provide any other information that the Board may require; and
(iv) Be acceptable to the Board.
(d) Limitations during period of noncompliance. Until the Board
determines that a company has corrected the conditions described in a
notice under paragraph (a) of this section:
(1) The Board may impose any limitations or conditions on the
conduct or activities of the company or any of its affiliates as the
Board finds to be appropriate and consistent with the purposes of the
Bank Holding Company Act; and
(2) The company and its affiliates may not engage in any additional
activity or acquire control or shares of any company under section 4(k)
of the Bank Holding Company Act without prior approval from the Board.
[[Page 111]]
(e) Consequences of failure to correct conditions within 180 days--
(1) Divestiture of depository institutions. If a company does not
correct the conditions described in a notice under paragraph (a) of this
section within 180 days of receipt of the notice or such additional time
as the Board may permit, the Board may order the company to divest
ownership or control of any depository institution owned or controlled
by the company. Such divestiture must be done in accordance with the
terms and conditions established by the Board.
(2) Alternative method of complying with a divestiture order. A
company may comply with an order issued under paragraph (e)(1) of this
section by ceasing to engage (both directly and through any subsidiary
that is not a depository institution or a subsidiary of a depository
institution) in all activities that are not permissible for a bank
holding company to conduct under section 4(c)(8) of the Bank Holding
Company Act. The termination of activities must be done within the time
period referred to in paragraph (e)(1) of this section and subject to
terms and conditions acceptable to the Board.
(f) Consultation with other agencies. In taking any action under
this section, the Board will consult with the relevant Federal and state
regulatory authorities.
Sec. 225.84 What are the consequences of failing to maintain a satisfactory or better rating under the Community Reinvestment Act at all insured depository
institution subsidiaries?
(a) Limitations on activities--(1) In general. Upon receiving a
notice regarding performance under the Community Reinvestment Act in
accordance with paragraph (a)(2) of this section, a financial holding
company may not:
(i) Commence any additional activity under subsection 4(k) or 4(n)
of the Bank Holding Company Act; or
(ii) Directly or indirectly acquire control of a company engaged in
any activity under subsections 4(k) or 4(n) of the Bank Holding Company
Act.
(2) Notification. A financial holding company receives notice for
purposes of this paragraph at the time that the appropriate Federal
banking agency for any insured depository institution controlled by the
company or the Board provides notice to the institution or company that
the institution has received a rating of ``needs to improve record of
meeting community credit needs'' or ``substantial noncompliance in
meeting community credit needs'' in the institution's most recent
examination under the Community Reinvestment Act.
(b) Exception for certain activities--(1) Continuation of investment
activities. The prohibition in paragraph (a) of this section does not
prevent a financial holding company from continuing to make investments
in the ordinary course of conducting investment activities under section
4(k)(4)(H) or insurance company investment activities under section
4(k)(4)(I) of the Bank Holding Company Act if:
(i) The financial holding company lawfully was a financial holding
company and commenced the investment activity under section 4(k)(4)(H)
or the insurance company investment activities under section 4(k)(4)(I)
prior to the time that an insured depository institution controlled by
the financial holding company received a rating below ``satisfactory
record of meeting community credit needs'' under the Community
Reinvestment Act; and (ii) The Board has not, in the exercise of its
supervisory authority, advised the financial holding company that these
activities must be restricted.
(2) Activities that are closely related to banking. The prohibition
in paragraph (a) of this section does not prevent a financial holding
company from commencing any additional activity or acquiring control of
a company engaged in any activity under section 4(c) of the Bank Holding
Company Act, if the company complies with the notice, approval, and
other requirements under that section and section 4(j).
(c) Duration of prohibitions. The prohibitions described in
paragraph (a) of this section shall continue in effect until such time
as each insured depository institution controlled by the financial
holding company has achieved at least a rating of ``satisfactory record
of meeting community credit needs'' under the Community Reinvestment Act
at the most recent examination of the institution.
[[Page 112]]
Sec. 225.85 Is notice to or approval from the Board required prior to engaging in a financial activity?
(a) No prior approval required generally--(1) In general. A
financial holding company and any subsidiary (other than a depository
institution or subsidiary of a depository institution) of the financial
holding company may engage in any activity listed in Sec. 225.86, or
acquire control or shares of a company engaged exclusively in any
activity listed in Sec. 225.86, without providing prior notice to or
obtaining prior approval from the Board unless required under paragraph
(c) of this section.
(2) May a financial holding company acquire a company engaged in
other permissible activities? In addition to the activities listed in
Sec. 225.86, a company acquired or to be acquired by a financial holding
company under paragraph (a)(1) of this section may engage in activities
otherwise permissible for a financial holding company under this part in
accordance with any applicable notice, approval, or other requirement.
(3) May a financial holding company acquire a financial company
engaged in limited nonfinancial activities? A financial holding company
may control or acquire more than 5 percent of the voting shares of a
company that is not engaged exclusively in activities that are financial
in nature or incidental to a financial activity or otherwise permissible
for a financial holding company if:
(i) Substantially all of the activities conducted by the company are
financial in nature, incidental to a financial activity, or otherwise
permissible for the financial holding company;
(ii) As part of the notice provided under Sec. 225.87, the financial
holding company commits to the Board to terminate or divest all
activities that are not financial in nature or incidental to a financial
activity or otherwise permissible for the financial holding company and
the financial holding company completes that termination or divestiture
within 2 years of the date the financial holding company acquires the
company; and
(iii) Following the acquisition of the company by the financial
holding company, the company does not engage in or acquire shares of any
company engaged in any activity that is not permissible for the
financial holding company.
(b) In what locations may a financial holding company conduct
financial activities? A financial holding company may conduct any
activity listed in Sec. 225.86 at any location in the United States or
at any location outside of the United States subject to the laws of the
jurisdiction in which the activity is conducted.
(c) Under what circumstances is prior notice to the Board required?
(1) Acquisition of more than 5 percent of the shares of a savings
association. A financial holding company must obtain Board approval in
accordance with section 4(j) of the Bank Holding Company Act (12 U.S.C.
1843(j)) and either Sec. 225.23 or Sec. 225.24, as appropriate, prior to
acquiring control or more than 5 percent of the voting shares of a
savings association.
(2) Supervisory actions. The Board may, if appropriate in
supervisory cases, including under Sec. 225.82(d) or Sec. 225.83(d) or
other relevant authority, require a financial holding company to provide
prior notice to or obtain prior approval from the Board to engage in any
activity or acquire shares or control of any company.
[Reg. Y, 65 FR 14438, Mar. 17, 2000]
Sec. 225.86 What activities are permissible for financial holding companies?
The following activities are financial in nature or incidental to a
financial activity:
(a) Activities that were closely related to banking. (1) Any
activity that the Board had determined by regulation prior to November
12, 1999, to be so closely related to banking as to be a proper incident
thereto, subject to the terms and conditions contained in this part,
unless modified by the Board. These activities are listed in
Sec. 225.28.
(2) Any activity that the Board had determined by an order that was
in effect on November 12, 1999, to be so closely related to banking as
to be a proper incident thereto, subject to the terms and conditions
contained in this part and those in the authorizing orders. These
activities are:
[[Page 113]]
(i) Providing administrative and other services to mutual funds
(see, e.g., Societe Generale, 84 Federal Reserve Bulletin 680 (1998));
(ii) Owning shares of a securities exchange (J.P. Morgan & Co, Inc.,
and UBS AG, 86 Federal Reserve Bulletin 61 (2000));
(iii) Acting as a certification authority for digital signatures
(Bayerische Hypo-und Vereinsbank AG, et.al., 86 Federal Reserve Bulletin
56 (2000));
(iv) Providing employment histories to third parties for use in
making credit decisions and to depository institutions and their
affiliates for use in the ordinary course of business (Norwest
Corporation, 81 Federal Reserve Bulletin 732 (1995));
(v) Check cashing and wire transmission services (Midland Bank, PLC,
76 Federal Reserve Bulletin 860 (1990) (check cashing); Norwest
Corporation, 81 Federal Reserve Bulletin 1130 (1995) (money
transmission));
(vi) In connection with offering banking services, providing notary
public services, selling postage stamps and postage-paid envelopes,
providing vehicle registration services, and selling public
transportation tickets and tokens (Popular, Inc., 84 Federal Reserve
Bulletin 481 (1998)); and
(vii) Real estate title abstracting (The First National Company, 81
Federal Reserve Bulletin 805 (1995)).
(b) Activities that are usual in connection with the transaction of
banking abroad. Any activity that the Board has determined by regulation
in effect on November 11, 1999, to be usual in connection with the
transaction of banking or other financial operations abroad (see
Sec. 211.5(d) of this chapter), subject to the terms and conditions in
part 211 and Board interpretations in effect on that date regarding the
scope and conduct of the activity. In addition to the activities listed
in paragraphs (a) and (c) of this section, these activities are:
(1) Providing management consulting services, including to any
person with respect to nonfinancial matters, so long as the management
consulting services are advisory and do not allow the financial holding
company to control the person to which the services are provided;
(2) Operating a travel agency in connection with financial services
offered by the financial holding company or others; and
(3) Organizing, sponsoring, and managing a mutual fund, so long as:
(i) The fund does not exercise managerial control over the entities
in which the fund invests; and
(ii) The financial holding company reduces its ownership in the
fund, if any, to less than 25 percent of the equity of the fund within
one year of sponsoring the fund or such additional period as the Board
permits.
(c) Activities permitted under section 4(k)(4) of the Bank Holding
Company Act (12 U.S.C. 1843(k)(4)). Any activity defined to be financial
in nature under sections 4(k)(4)(A) through (E), (H) and (I) of the Bank
Holding Company Act (12 U.S.C. 1843(k)(4)(A) through (E) (H) and (I)).
[Reg. Y, 65 FR 14438, Mar. 17, 2000]
Effective Date Note: At 65 FR 80740, Dec. 22, 2000, Sec. 225.86 was
amended by adding paragraph (d), effective Jan. 22, 2001. For the
convenience of the user, the added text is set forth as follows:
Sec. 225.86 What activities are permissible for financial holding
companies?
* * * * *
(d) Activities determined to be financial in nature or incidental to
financial activities by the Board--(1) Acting as a finder--Acting as a
finder in bringing together one or more buyers and sellers of any
product or service for transactions that the parties themselves
negotiate and consummate.
(i) What is the scope of finder activities? Acting as a finder
includes providing any or all of the following services through any
means--
(A) Identifying potential parties, making inquiries as to interest,
introducing and referring potential parties to each other, and arranging
contacts between and meetings of interested parties;
(B) Conveying between interested parties expressions of interest,
bids, offers, orders and confirmations relating to a transaction; and
(C) Transmitting information concerning products and services to
potential parties in connection with the activities described in
paragraphs (d)(1)(i)(A) and (B) of this section.
(ii) What are some examples of finder services? The following are
examples of the services that may be provided by a finder when done
[[Page 114]]
in accordance with paragraphs (d)(1)(iii) and (iv) of this section.
These examples are not exclusive.
(A) Hosting an electronic marketplace on the financial holding
company's Internet web site by providing hypertext or similar links to
the web sites of third party buyers or sellers.
(B) Hosting on the financial holding company's servers the Internet
web site of--
(1) A buyer (or seller) that provides information concerning the
buyer (or seller) and the products or services it seeks to buy (or sell)
and allows sellers (or buyers) to submit expressions of interest, bids,
offers, orders and confirmations relating to such products or services;
or
(2) A government or government agency that provides information
concerning the services or benefits made available by the government or
government agency, assists persons in completing applications to receive
such services or benefits from the government or agency, and allows
persons to transmit their applications for services or benefits to the
government or agency.
(C) Operating an Internet web site that allows multiple buyers and
sellers to exchange information concerning the products and services
that they are willing to purchase or sell, locate potential
counterparties for transactions, aggregate orders for goods or services
with those made by other parties, and enter into transactions between
themselves.
(D) Operating a telephone call center that provides permissible
finder services.
(iii) What limitations are applicable to a financial holding company
acting as a finder?
(A) A finder may act only as an intermediary between a buyer and a
seller.
(B) A finder may not bind any buyer or seller to the terms of a
specific transaction or negotiate the terms of a specific transaction on
behalf of a buyer or seller, except that a finder may--
(1) Arrange for buyers to receive preferred terms from sellers so
long as the terms are not negotiated as part of any individual
transaction, are provided generally to customers or broad categories of
customers, and are made available by the seller (and not by the
financial holding company); and
(2) Establish rules of general applicability governing the use and
operation of the finder service, including rules that--
(i) Govern the submission of bids and offers by buyers and sellers
that use the finder service and the circumstances under which the finder
service will match bids and offers submitted by buyers and sellers; and
(ii) Govern the manner in which buyers and sellers may bind
themselves to the terms of a specific transaction.
(C) A finder may not--
(1) Take title to or acquire or hold an ownership interest in any
product or service offered or sold through the finder service;
(2) Provide distribution services for physical products or services
offered or sold through the finder service;
(3) Own or operate any real or personal property that is used for
the purpose of manufacturing, storing, transporting, or assembling
physical products offered or sold by third parties; or
(4) Own or operate any real or personal property that serves as a
physical location for the physical purchase, sale or distribution of
products or services offered or sold by third parties.
(D) A finder may not engage in any activity that would require the
company to register or obtain a license as a real estate agent or broker
under applicable law.
(iv) What disclosures are required? A finder must distinguish the
products and services offered by the financial holding company from
those offered by a third party through the finder service.
(2) [Reserved]
Sec. 225.87 Is notice to the Board required after engaging in a financial activity?
(a) Post-commencement notice is generally required to engage in a
financial activity. A financial holding company that commences an
activity or acquires shares of a company engaged in an activity listed
in Sec. 225.86 must notify the appropriate Federal Reserve Bank in
writing within 30 calendar days after commencing the activity or
consummating the acquisition. The notice must describe, as relevant:
(1) The activity commenced and the identity of each subsidiary
engaged in the activity; or
(2) The identity of the company acquired and the activities
conducted by the company.
(b) Are there any cases in which notice to the Board is not
required? (1) Acquisitions that do not result in control of a company. A
notice under paragraph (a) of this section is not required to acquire
shares of a company if, following the acquisition, the financial holding
company does not control the company.
(2) Conduct of certain investment activities. Except as otherwise
provided in this part or as determined by the Board in the exercise of
its supervisory authority, no post-commencement notice is required as
part of the conduct by a
[[Page 115]]
financial holding company or its subsidiary of:
(i) Securities underwriting, dealing, or market making activities as
described in section 4(k)(4)(E) of the Bank Holding Company Act (12
U.S.C. 1843(k)(4)(E));
(ii) Merchant banking activities conducted pursuant to section
4(k)(4)(H) of the Bank Holding Company Act (12 U.S.C. 1843(k)(4)(H)),
except as provided in Sec. 225.174(d); or
(iii) Insurance company investment activities conducted pursuant to
section 4(k)(4)(I) of the Bank Holding Company Act (12 U.S.C.
1843(k)(4)(I)), so long as the financial holding company provides the
notice described in Sec. 225.174(d) in connection with any insurance
company investment that meets the thresholds in that section.
(3) Condition for exceptions. The exception provided in paragraph
(b)(2) of this section applies only if the financial holding company
previously has provided notice to the Board under paragraph (a) of this
section that the financial holding company has commenced or acquired
control of a company engaged in the relevant activity for which an
exception is claimed.
[Reg. Y, 65 FR 14439, Mar. 17, 2000]
Sec. 225.88 How to request the Board to determine that an activity is financial in nature or incidental to a financial activity?
(a) Requests regarding activities that may be financial in nature or
incidental to a financial activity. A financial holding company or other
interested party may request a determination from the Board that an
activity not listed in Sec. 225.86 is financial in nature or incidental
to a financial activity.
(b) What information must the request contain? A request submitted
under this section must be in writing and must:
(1) Identify and define the activity for which the determination is
sought, specifically describing what the activity would involve and how
the activity would be conducted;
(2) Explain in detail why the activity should be considered
financial in nature or incidental to a financial activity; and
(3) Provide information supporting the requested determination and
any other information required by the Board concerning the proposed
activity.
(c) What action will the Board take after receiving a request? (1)
Consultation with the Secretary of the Treasury. Upon receipt of the
request, the Board will provide the Secretary of the Treasury a copy of
the request and consult with the Secretary in accordance with section
4(k)(2)(A) of the Bank Holding Company Act (12 U.S.C. 1843(k)(2)(A)).
(2) Public notice. The Board may, as appropriate and after
consultation with the Secretary, publish a description of the proposal
in the Federal Register with a request for public comment.
(d) When will the Board act on a request? The Board will endeavor to
make a decision on any request filed under paragraph (a) of this section
within 60 days following the completion of both the consultative process
described in paragraph (c)(1) of this section and the public comment
period, if any.
(e) What should a financial holding company do if it has a question
about the scope of a financial activity? (1) Written request. A
financial holding company may request an advisory opinion from the Board
about whether a specific proposed activity falls within the scope of an
activity listed in Sec. 225.86 as financial in nature or incidental to a
financial activity. The request must be submitted in writing and must
contain:
(i) A detailed description of the particular activity in which the
company proposes to engage or the product or service the company
proposes to provide;
(ii) An explanation supporting an interpretation regarding the scope
of the permissible financial activity; and
(iii) Any additional information requested by the Board regarding
the activity.
(2) Board response. The Board will provide an advisory opinion
within 45 days of receiving a complete written request under paragraph
(b) of this section.
[Reg. Y, 65 FR 14439, Mar. 17, 2000]
[[Page 116]]
Sec. 225.89 How to request approval to engage in an activity that is complementary to a financial activity?
(a) Prior Board approval is required. A financial holding company
that seeks to engage in or acquire a company engaged in an activity that
the financial holding company believes is complementary to a financial
activity must obtain prior approval from the Board in accordance with
section 4(j) of the Bank Holding Company Act (12 U.S.C. 1843 (j)). The
notice must be in writing and must:
(1) Identify and define the proposed complementary activity,
specifically describing what the activity would involve and how the
activity would be conducted;
(2) Identify the financial activity for which the proposed activity
would be complementary and provide information sufficient to support a
finding that the proposed activity should be considered complementary to
the identified financial activity;
(3) Describe the scope and relative size of the proposed activity,
as measured by the percentage of the projected financial holding company
revenues expected to be derived from and assets associated with
conducting the activity;
(4) Discuss the risks that conducting the activity may reasonably be
expected to pose to the safety and soundness of the subsidiary
depository institutions of the financial holding company and to the
financial system generally;
(5) Describe the potential adverse effects, including potential
conflicts of interest, decreased or unfair competition, or other risks,
that conducting the activity could raise, and explain the measures the
financial holding company proposes to take to address those potential
effects; and
(6) Provide any information about the financial and managerial
resources of the financial holding company and any other information
requested by the Board.
(b) What standards will the Board apply in evaluating the notice? In
evaluating a notice to engage in a complementary activity, the Board
must consider whether:
(1) The proposed activity is complementary to a financial activity;
(2) The proposed activity would pose a substantial risk to the
safety or soundness of depository institutions or the financial system
generally; and
(3) The proposal meets the standards in section 4(j)(2) of the Bank
Holding Company Act (12 U.S.C. 1843(j)(2)).
(c) How and when will the Board act on a notice? The Board will
inform the financial holding company in writing of the Board's
determination regarding the proposed activity within the period
described in section 4(j) of the Bank Holding Company Act (12 U.S.C.
1843(j)).
[Reg. Y, 65 FR 14440, Mar. 17, 2000]
Sec. 225.90 What are the requirements for a foreign bank to be treated as a financial holding company?
(a) Foreign banks as financial holding companies. A foreign bank
that operates a branch or agency or owns or controls a commercial
lending company in the United States, and any company that owns or
controls such a foreign bank, will be treated as a financial holding
company if:
(1) The foreign bank, and any U.S. depository institution that is
owned or controlled by the foreign bank or company, is and remains well
capitalized and well managed; and
(2) The foreign bank, or the company that owns the foreign bank, has
made an effective election to be treated as a financial holding company
under this subpart.
(b) Standards for ``well capitalized.'' A foreign bank will be
considered ``well capitalized'' if either:
(1)(i) Its home country supervisor, as defined in Sec. 211.21 of the
Board's Regulation K (12 CFR 211.21), has adopted risk-based capital
standards consistent with the Capital Accord of the Basel Committee on
Banking Supervision (Basel Accord);
(ii) The foreign bank maintains a Tier 1 capital to total risk-based
assets ratio of 6 percent and a total capital to total risk-based assets
ratio of 10 percent, as calculated under its home country standard;
(iii) The foreign bank maintains a Tier 1 capital to total assets
leverage ratio of at least 3 percent; and
(iv) The foreign bank's capital is comparable to the capital
required for
[[Page 117]]
a U.S. bank owned by a financial holding company; or
(2) The foreign bank has obtained a determination from the Board
under Sec. 225.91(c) that the foreign bank's capital is otherwise
comparable to the capital that would be required of a U.S. bank owned by
a financial holding company.
(c) Standards for ``well managed.'' A foreign bank will be
considered ``well managed'' if:
(1) Each of the U.S. branches, agencies, and commercial lending
subsidiaries of the foreign bank has received at least a satisfactory
composite rating at its most recent assessment;
(2) The home country supervisor of the foreign bank considers the
overall operations of the foreign bank to be satisfactory or better; and
(3) The management of the foreign bank meets standards comparable to
those required of a U.S. bank owned by a financial holding company.
[Reg. Y, 65 FR 15055, Mar. 21, 2000]
Sec. 225.91 How may a foreign bank elect to be treated as a financial holding company?
(a) Filing requirement. A foreign bank that operates a branch or
agency or owns or controls a commercial lending company in the United
States, or a company that owns or controls such a foreign bank, may
elect to be treated as a financial holding company by filing a written
declaration with the appropriate Reserve Bank.
(b) Contents of declaration. The declaration must:
(1) State that the foreign bank or the company elects to be treated
as a financial holding company;
(2) Provide the risk-based and leverage capital ratios of the
foreign bank as of the close of the most recent quarter and as of the
close of the most recent audited reporting period;
(3) Certify that the foreign bank meets the standards of well
capitalized set out in Sec. 225.90(b)(1)(i), (ii) and (iii) or
Sec. 225.90(b)(2) as of the date the foreign bank or company files its
election;
(4) Certify that the foreign bank is well managed as defined in
Sec. 225.90(c)(1) as of the date the foreign bank or company files its
election;
(5) Certify that all U.S. depository institutions controlled by the
foreign bank or company are well capitalized and well managed as of the
date the foreign bank or company files its election; and
(6) Provide the capital ratios for all relevant capital measures (as
defined in section 38 of the Federal Deposit Insurance Act) as of the
close of the previous quarter for each U.S. depository institution
controlled by the foreign bank or company.
(c) Pre-clearance process. Before filing an election to be treated
as a financial holding company, a foreign bank or company may file a
request for review of its qualifications to be treated as a financial
holding company. The Board will endeavor to make a determination on such
requests within 30 days of receipt. A foreign bank chartered in a
country where no other bank from that country has been reviewed by the
Board for comprehensive consolidated supervision under the Bank Holding
Company Act or the International Banking Act is encouraged to use this
process.
[Reg. Y, 65 FR 15056, Mar. 21, 2000]
Sec. 225.92 How does an election by a foreign bank become effective?
(a) In general. An election described in Sec. 225.91 is effective on
the 31st day after the date that an election was received by the
appropriate Federal Reserve Bank, unless the Board notifies the foreign
bank or company prior to that time that:
(1) The election is ineffective; or
(2) The period is extended with the consent of the foreign bank or
company making the election.
(b) Earlier notification that an election is effective. The Board or
the appropriate Federal Reserve Bank may notify a foreign bank or
company that its election to be treated as a financial holding company
is effective prior to the 31st day after the election was filed with the
appropriate Federal Reserve Bank. Such notification must be in writing.
(c) Under what circumstances will the Board find an election to be
ineffective? An election to be treated as financial holding company
shall not be effective
[[Page 118]]
if, during the period provided in paragraph (a) of this section, the
Board finds that:
(1) The foreign bank certificant, or any foreign bank that operates
a branch or agency or owns or controls a commercial lending company in
the United States and is controlled by a foreign company certificant, is
not both well capitalized and well managed;
(2) Any insured depository institution controlled by the foreign
bank or company (except an institution excluded under paragraph (d) of
this section) or any U.S. branch of a foreign bank that is insured by
the Federal Deposit Insurance Corporation has not achieved at least a
rating of ``satisfactory record of meeting community needs'' under
Community Reinvestment Act at the institution's most recent examination;
(3) Any U.S. depository institution subsidiary of the foreign bank
or company is not both well capitalized and well managed; or
(4) The Board does not have sufficient information to assess whether
the foreign bank or company making the election meets the requirements
of this subpart.
(d) How is CRA performance of recently acquired insured depository
institutions considered? An insured depository institution will be
excluded for purposes of the review of CRA ratings described in
paragraph (c)(2) of this section consistent with the provisions of
Sec. 225.82(e).
(e) Factors used in the Board's determination regarding
comparability of capital and management. In determining whether a
foreign bank is well capitalized and well managed in accordance with
comparable capital and management standards, the Board will give due
regard to national treatment and equality of competitive opportunity. In
this regard, the Board may take into account the foreign bank's
composition of capital, accounting standards, long-term debt ratings,
reliance on government support to meet capital requirements, the extent
to which the foreign bank is subject to comprehensive consolidated
supervision, and other factors that may affect analysis of capital and
management. The Board will consult with the home country supervisor for
the foreign bank as appropriate.
[Reg. Y, 65 FR 15056, Mar. 21, 2000]
Sec. 225.93 What are the consequences of a foreign bank failing to continue to meet applicable capital and management requirements?
(a) Notice by the Board. If a foreign bank or company has made an
effective election to be treated as a financial holding company under
this subpart and the Board finds that the foreign bank, or any U.S.
depository institution owned or controlled by the foreign bank or
company, ceases to be well capitalized or well managed, the Board will
notify the foreign bank or company in writing that it is not in
compliance with the applicable requirement(s) for a financial holding
company and identify the areas of noncompliance.
(b) Notification by a financial holding company required. Promptly
upon becoming aware that the foreign bank, or any U.S. depository
institution owned or controlled by the foreign bank or company, has
ceased to be well capitalized or well managed, the foreign bank, or any
company that controls such foreign bank, must notify the Board and
identify the area of noncompliance.
(c) Execution of agreement acceptable to the Board--(1) Agreement
required; time period. Within 45 days after receiving a notice under
paragraph (a) of this section, the foreign bank or company must execute
an agreement acceptable to the Board to comply with all applicable
capital and management requirements.
(2) Extension of time for executing agreement. Upon request by a
company, the Board may extend the 45-day period under paragraph (c)(1)
of this section if the Board determines that granting additional time is
appropriate under the circumstances. A request by a company for
additional time must include an explanation of why an extension is
necessary.
(3) Agreement requirements. An agreement required by paragraph
(c)(1) of this section to correct a capital or management deficiency
must:
(i) Explain the specific actions that the foreign bank or company
will take to correct all areas of noncompliance;
[[Page 119]]
(ii) Provide a schedule within which each action will be taken;
(iii) Provide any other information that the Board may require; and
(iv) Be acceptable to the Board.
(d) Limitations during period of noncompliance. Until the Board
determines that a company has corrected the conditions described in a
notice under paragraph (a) of this section:
(1) The Board may impose any limitations or conditions on the
conduct or the U.S. activities of the foreign bank or company or any of
its affiliates as the Board finds to be appropriate and consistent with
the purposes of the Bank Holding Company Act; and
(2) The company and its affiliates may not engage in any new
activity in the United States or acquire control or shares of any
company under section 4(k) of the Bank Holding Company Act (12 U.S.C.
1843(k)) without prior approval from the Board.
(e) Consequences of failure to correct conditions within 180 days--
(1) Termination of offices and divestiture. If a foreign bank or company
does not correct the conditions described in a notice under paragraph
(a) of this section within 180 days of receipt of the notice or such
additional time as the Board may permit, the Board may order the foreign
bank or company to terminate the foreign bank's U.S. branches and
agencies and divest any commercial lending companies owned or controlled
by the foreign bank or company. Such divestiture must be done in
accordance with the terms and conditions established by the Board.
(2) Alternative method of complying with a divestiture order. A
foreign bank or company may comply with an order issued under paragraph
(e)(1) of this section by ceasing to engage (both directly and through
any subsidiary) in all activities that are not permissible for a foreign
bank to conduct under sections 2(h) and 4(c) of the Bank Holding Company
Act (12 U.S.C. 1841(h) and 1843(c)). The termination of activities must
be done within the time period referred to in paragraph (e)(1) of this
section and subject to terms and conditions acceptable to the Board.
(f) Consultation with other Agencies. In taking any action under
this section, the Board will consult with the relevant Federal and state
regulatory authorities.
[Reg. Y, 65 FR 15056, Mar. 21, 2000]
Sec. 225.94 What are the consequences of an insured branch or depository institution failing to maintain a satisfactory or better rating under the Community Reinvestment Act?
(a) Insured branch as an ``insured depository institution.'' A U.S.
branch of a foreign bank that is insured by the Federal Deposit
Insurance Corporation shall be treated as an ``insured depository
institution'' for purposes of Sec. 225.84.
(b) Applicability. The provisions of Sec. 225.84, with the
modifications contained in this section, shall apply to a foreign bank
that operates an insured branch referred to in paragraph (a) of this
section or an insured depository institution in the United States, and
any company that owns or controls such a foreign bank, that has made an
effective election under Sec. 225.92 in the same manner and to the same
extent as they apply to a financial holding company.
[Reg. Y, 65 FR 15057, Mar. 21, 2000]
Interpretations
Sec. 225.101 Bank holding company's subsidiary banks owning shares of nonbanking companies.
(a) The Board's opinion has been requested on the following related
matters under the Bank Holding Company Act of 1956.
(b) The question is raised as to whether shares in a nonbanking
company which were acquired by a banking subsidiary of the bank holding
company many years ago when their acquisition was lawful and are now
held as investments, and which do not include more than 5 percent of the
outstanding voting securities of such nonbanking company and do not have
a value greater than 5 percent of the value of the bank holding
company's total assets, are exempted from the divestment requirements of
the Act by the provisions of section 4(c)(5) of the Act.
(c) In the Board's opinion, this exemption is as applicable to such
shares when held by a banking subsidiary of a
[[Page 120]]
bank holding company as when held directly by the bank holding company
itself. While the exemption specifically refers only to shares held or
acquired by the bank holding company, the prohibition of the Act against
retention of nonbanking interests applies to indirect as well as direct
ownership of shares of a nonbanking company, and, in the absence of a
clear mandate to the contrary, any exception to this prohibition should
be given equal breadth with the prohibition. Any other interpretation
would lead to unwarranted results.
(d) Although certain of the other exemptions in section 4(c) of the
Act specifically refer to shares held or acquired by banking
subsidiaries, an analysis of those exemptions suggests that such
specific reference to banking subsidiaries was for the purpose of
excluding nonbanking subsidiaries from such exemptions, rather than for
the purpose of providing an inclusionary emphasis on banking
subsidiaries.
(e) It should be noted that the Board's view as to this question
should not be interpreted as meaning that each banking subsidiary could
own up to 5 percent of the stock of the same nonbanking organization. In
the Board's opinion the limitations set forth in section 4(c)(5) apply
to the aggregate amount of stock held in a particular organization by
the bank holding company itself and by all of its subsidiaries.
(f) Secondly, question is raised as to whether shares in a
nonbanking company acquired in satisfaction of debts previously
contracted (d.p.c.) by a banking subsidiary of the bank holding company
may be retained if such shares meet the conditions contained in section
4(c)(5) as to value and amount, notwithstanding the requirement of
section 4(c)(2) that shares acquired d.p.c. be disposed of within two
years after the date of their acquisition or the date of the Act,
whichever is later. In the Board's opinion, the 5 percent exemption
provided by section 4(c)(5) covers any shares, including shares acquired
d.p.c., that meet the conditions set forth in that exemption, and,
consequently, d.p.c. shares held by a banking subsidiary of a bank
holding company which meet such conditions are not subject to the two-
year disposition requirement prescribed by section 4(c)(2), although any
such shares would, of course, continue to be subject to such requirement
for disposition as may be prescribed by provisions of any applicable
banking laws or by the appropriate bank supervisory authorities.
(g) Finally, question is raised as to whether shares held by banking
subsidiaries of the bank holding company in companies holding bank
premises of such subsidiaries are exempted from the divestment
requirements by section 4(c)(1) of the Act. It is the Board's view that
section 4(c)(1), exempting shares owned or acquired by a bank holding
company in any company engaged solely in holding or operating properties
used wholly or substantially by any subsidiary bank, is to be read and
interpreted, like section 4(c)(5), as applying to shares owned
indirectly by a bank holding company through a banking subsidiary as
well as to shares held directly by the bank holding company. A contrary
interpretation would impair the right that member banks controlled by
bank holding companies would otherwise have to invest, subject to the
limitations of section 24A of the Federal Reserve Act, in stock of
companies holding their bank premises; and such a result was not, in the
Board's opinion, intended by the Bank Holding Company Act.
[21 FR 10472, Dec. 29, 1956. Redesignated at 36 FR 21666, Nov. 12, 1971]
Sec. 225.102 Bank holding company indirectly owning nonbanking company through subsidiaries.
(a) The Board of Governors has been requested for an opinion
regarding the exemptions contained in section 4(c)(5) of the Bank
Holding Company Act of 1956. It is stated that Y Company is an
investment company which is not a bank holding company and which is not
engaged in any business other than investing in securities, which
securities do not include more than 5 per centum of the outstanding
voting securities of any company and do not include any asset having a
value greater than 5 per centum of the value of the total assets of X
Corporation, a bank holding company. It is stated that direct ownership
by X Corporation of voting
[[Page 121]]
shares of Y Company would be exempt by reason of section 4(c)(5) from
the prohibition of section 4 of the Act against ownership by bank
holding companies of nonbanking assets.
(b) It was asked whether it makes any difference that the shares of
Y Company are not owned directly by X Corporation but instead are owned
through Subsidiaries A and B. X Corporation owns all the voting shares
of Subsidiary A, which owns one-half of the voting shares of Subsidiary
B. Subsidiaries A and B each own one-third of the voting shares of Y
Company.
(c) Section 4(c)(5) is divided into two parts. The first part
exempts the ownership of securities of nonbanking companies when the
securities do not include more than 5 percent of the voting securities
of the nonbanking company and do not have a value greater than 5 percent
of the value of the total assets of the bank holding company. The second
part exempts the ownership of securities of an investment company which
is not a bank holding company and is not engaged in any business other
than investing in securities, provided the securities held by the
investment company meet the 5 percent tests mentioned above.
(d) In Sec. 225.101, the Board expressed the opinion that the first
exemption in section 4(c)(5):
* * * is as applicable to such shares when held by a banking
subsidiary of a bank holding company as when held directly by the bank
holding company itself. While the exemption specifically refers only to
shares held or acquired by the bank holding company, the prohibition of
the Act against retention of nonbanking interests applies to indirect as
well as direct ownership of shares of a nonbanking company, and, in the
absence of a clear mandate to the contrary, any exception to this
prohibition should be given equal breadth with the prohibition. Any
other interpretation would lead to unwarranted results.
(e) The Board is of the view that the principles stated in that
opinion are also applicable to the second exemption in section 4(c)(5),
and that they apply whether or not the subsidiary owning the shares is a
banking subsidiary. Accordingly, on the basis of the facts presented,
the Board is of the opinion that the second exemption in section 4(c)(5)
applies to the indirect ownership by X Corporation of shares of Y
Company through Subsidiaries A and B.
[22 FR 2533, Apr. 13, 1957. Redesignated at 36 FR 21666, Nov. 12, 1971]
Sec. 225.103 Bank holding company acquiring stock by dividends, stock splits or exercise of rights.
(a) The Board of Governors has been asked whether a bank holding
company may receive bank stock dividends or participate in bank stock
splits without the Board's prior approval, and whether such a company
may exercise, without the Board's prior approval, rights to subscribe to
new stock issued by banks in which the holding company already owns
stock.
(b) Neither a stock dividend nor a stock split results in any change
in a stockholder's proportional interest in the issuing company or any
increase in the assets of that company. Such a transaction would have no
effect upon the extent of a holding company's control of the bank
involved; and none of the five factors required by the Bank Holding
Company Act to be considered by the Board in approving a stock
acquisition would seem to have any application. In view of the
objectives and purposes of the act, the word ``acquire'' would not seem
reasonably to include transactions of this kind.
(c) On the other hand, the exercise by a bank holding company of the
right to subscribe to an issue of additional stock of a bank could
result in an increase in the holding company's proportional interest in
the bank. The holding company would voluntarily pay additional funds for
the extra shares and would ``acquire'' the additional stock even under a
narrow meaning of that term. Moreover, the exercise of such rights would
cause the assets of the issuing company to be increased and in a sense,
therefore, the ``size or extent'' of the bank holding company system
would be expanded.
(d) In the circumstances, it is the Board's opinion that receipt of
bank stock by means of a stock dividend or stock split, assuming no
change in the class of stock, does not require the Board's prior
approval under the act, but that purchase of bank stock by a
[[Page 122]]
bank holding company through the exercise of rights does require the
Board's prior approval, unless one of the exceptions set forth in
section 3(a) is applicable.
[22 FR 7461, Sept. 19, 1957. Redesignated at 36 FR 21666, Nov. 12, 1971]
Sec. 225.104 ``Services'' under section 4(c)(1) of Bank Holding Company Act.
(a) Section 4(c)(1) of the Bank Holding Company Act, among other
things, exempts from the nonbanking divestment requirements of section
4(a) of the Act shares of a company engaged ``solely in the business of
furnishing services to or performing services for'' its bank holding
company or subsidiary banks thereof.
(b) The Board of Governors has had occasion to express opinions as
to whether this section of law applies to the following two sets of
facts:
(1) In the first case, Corporation X, a nonbanking subsidiary of a
bank holding company (Holding Company A), was engaged in the business of
purchasing installment paper suitable for investment by banking
subsidiaries of Holding Company A. All installment paper purchased by
Corporation X was sold by it to a bank which is a subsidiary of Holding
Company A, without recourse, at a price equal to the cost of the
installment paper to Corporation X, and with compensation to the latter
based on the earnings from such paper remaining after certain reserves,
expenses and charges. The subsidiary bank sold participations in such
installment paper to the other affiliated banks of Holding Company A
which desired to participate. Purchases by Corporation X consisted
mainly of paper insured under Title I of the National Housing Act and,
in addition, Corporation X purchased time payment contracts covering
sales of appliances by dealers under contractual arrangements with
utilities, as well as paper covering home improvements which was not
insured. Pursuant to certain service agreements, Corporation X made all
collections, enforced guaranties, filed claims under Title I insurance
and performed other services for the affiliated banks. Also Corporation
X rendered to banking subsidiaries of Holding Company A various
accounting, statistical and advisory services such as payroll, life
insurance and budget loan installment account.
(2) In the second case, Corporation Y, a nonbanking subsidiary of a
bank holding company (Holding Company B, which was also a bank),
solicited business on behalf of Holding Company B from dealers,
throughout several adjoining or contiguous States, who made time sales
and desired to convert their time sales paper into cash; but Corporation
Y made no loans or purchases of sales contracts and did not discount or
advance money for time sales obligations. Corporation Y investigated
credit standings of purchasers obligated on time sale contracts to be
acquired by Holding Company B, Corporation Y received from dealers the
papers offered by them and inspected such papers to see that they were
in order, and transmitted to Holding Company B for its determination to
purchase, including, in some cases, issuance of drafts in favor of
dealers in order to facilitate their prompt receipt of payment for
installment paper purchased by Holding Company B. Corporation Y made
collections of delinquent paper or delinquent installments, which
sometimes involved repossession and resale of the automobile or other
property which secured the paper. Also, upon request of purchasers
obligated on paper held by Holding Company B, Corporation Y transmitted
installment payments to Holding Company B. Holding Company B reimbursed
Corporation Y for its actual costs and expenses in performing the
services mentioned above, including the salaries and wages of all
Corporation Y officers and employees.
(c) While the term ``services'' is sometimes used in a broad and
general sense, the legislative history of the Bank Holding Company Act
indicates that in section 4(c)(1) the word was meant to be somewhat more
limited in its application. An early version of the bill specifically
exempted companies engaged in serving the bank holding company and its
subsidiary banks in ``auditing, appraising, investment counseling''. The
statute as finally enacted does not expressly mention any specific type
of servicing activity for
[[Page 123]]
exemption. In recommending the change, the Senate Banking and Currency
Committee stated that the types of services contemplated are ``in the
fields of advertising, public relations, developing new business,
organizations, operations, preparing tax returns, personnel, and many
others'', which indicates that latitude should be given to the range of
activities contemplated by this section beyond those specifically set
forth in the early draft of the bill. (84th Cong., 2d Sess., Senate
Report 1095, Part 2, p. 3.) It nevertheless seems evident that Congress
intended such services to be types of activities generally comparable to
those mentioned above from the early bill (``auditing, appraising,
investment counseling'') and in the excerpt from the Committee Report on
the later bill (``advertising, public relations, developing new
business, organization, operations, preparing tax returns, personnel,
and many others''). This legislative history and the context in which
the term ``services'' is used in section 4(c)(1) seem to suggest that
the term was in general intended to refer to servicing operations which
a bank could carry on itself, but which the bank or its holding company
chooses to have done through another organization. Moreover, the report
of the Senate Banking and Currency Committee indicated that the types of
servicing permitted under section 4(c)(1) are to be distinguished from
activities of a ``financial, fiduciary, or insurance nature'', such as
those which might be considered for possible exemption under section
4(c)(6) of the Act.
(d) With respect to the first set of facts, the Board expressed the
opinion that certain of the activities of Corporation X, such as the
accounting, statistical and advisory services referred to above, may be
within the range of servicing activities contemplated by section
4(c)(1), but that this would not appear to be the case with the main
activity of Corporation X, which was the purchase of installment paper
and the resale of such paper at cost, without recourse, to banking
subsidiaries of Holding Company A. This latter and basic activity of
Corporation X appeared to involve essentially a financial relationship
between it and the banking subsidiaries of Holding Company A and
appeared beyond the category of servicing exemptions contemplated by
section 4(c)(1) of the Act. Accordingly, it was the Board's view that
Corporation X could not be regarded as qualifying under section 4 (c)(1)
as a company engaged ``solely in the business of furnishing services to
or performing services for'' Holding Company A or subsidiary banks
thereof.
(e) With respect to the second set of facts, the Board expressed the
opinion that some of the activities engaged in by Corporation Y were
clearly within the range of servicing activities contemplated by section
4(c)(1). There was some question as to whether or not some of the other
activities of Corporation Y mentioned above could meet the test, but on
balance, it seemed that all such activities probably were activities in
which Holding Company B, which as already indicated was a bank, could
itself engage, at the present locations of Corporation Y, without being
engaged in the operation of bank branches at those locations. In the
circumstances, while the question was not free from doubt, the Board
expressed the opinion that the activities of Corporation Y were those of
a company engaged ``solely in the business of furnishing services to or
performing services for'' Holding Company B within the meaning of
section 4(c)(1) of the Act, and that, accordingly, the control by
Holding Company B of shares in Corporation Y was exempted under that
section.
[23 FR 2675, May 23, 1958. Redesignated at 36 FR 21666, Nov. 12, 1971]
Sec. 225.107 Acquisition of stock in small business investment company.
(a) A registered bank holding company requested an opinion by the
Board of Governors with respect to whether that company and its banking
subsidiaries may acquire stock in a small business investment company
organized pursuant to the Small Business Investment Act of 1958.
(b) It is understood that the bank holding company and its
subsidiary banks propose to organize and subscribe for stock in a small
business investment company which would be
[[Page 124]]
chartered pursuant to the Small Business Investment Act of 1958 which
provides for long-term credit and equity financing for small business
concerns.
(c) Section 302(b) of the Small Business Investment Act authorizes
national banks, as well as other member banks and nonmember insured
banks to the extent permitted by applicable State law, to invest capital
in small business investment companies not exceeding one percent of the
capital and surplus of such banks. Section 4(c)(4) of the Bank Holding
Company Act exempts from the prohibitions of section 4 of the Act
``shares which are of the kinds and amounts eligible for investment by
National banking associations under the provisions of section 5136 of
the Revised Statutes''. Section 5136 of the Revised Statutes (paragraph
``Seventh'') in turn provides, in part, as follows:
Except as hereinafter provided or otherwise permitted by law nothing
herein contained shall authorize the purchase by the association for its
own account of any shares of stock of any corporation.
Since the shares of a small business investment company are of a kind
and amount expressly made eligible for investment by a national bank
under the Small Business Investment Act of 1958, it follows, therefore,
that the ownership or control of such shares by a bank holding company
would be exempt from the prohibitions of section 4 of the Bank Holding
Company Act by virtue of the provisions of section 4(c)(4) of that Act.
Accordingly, the ownership or control of such shares by the bank holding
company would be exempt from the prohibitions of section 4 of the Bank
Holding Company Act.
(d) An additional question is presented, however, as to whether
section 6 of the Bank Holding Company Act prohibits banking subsidiaries
of the bank holding company from purchasing stock in a small business
investment company where the latter is a ``subsidiary'' under that Act.
(e) Section 6(a)(1) of the Act makes it unlawful for a bank to
invest any of its funds in the capital stock of any other subsidiary of
the bank holding company. However, section 6(a)(1) was, in effect,
amended by section 302(b) of the Small Business Investment Act (15
U.S.C. 682) as amended by the Act of June 11, 1960 (Pub. L. 86-502) so
as to nullify this prohibition when the ``subsidiary'' is a small
business investment company.
(f) Accordingly, section 6 of the Bank Holding Company Act does not
prohibit banking subsidiaries of the bank holding company from
purchasing stock in a small business investment company organized
pursuant to the Small Business Investment Act of 1958, where that
company is or will be a subsidiary of the bank holding company.
[25 FR 7485, Aug. 9, 1960. Redesignated at 36 FR 21666, Nov. 12, 1971]
Sec. 225.109 ``Services'' under section 4(c)(1) of Bank Holding Company Act.
(a) The Board of Governors has been requested by a bank holding
company for an interpretation under section 4(c)(1) of the Bank Holding
Company Act which, among other things, exempts from the nonbanking
divestment requirements of section 4(a) of the Act, shares of a company
engaged ``solely in the business of furnishing services to or performing
services for'' its bank holding company or subsidiary banks thereof.
(b) It is understood that a nonbanking subsidiary of the holding
company engages in writing comprehensive automobile insurance (fire,
theft, and collision) which is sold only to customers of a subsidiary
bank of the holding company in connection with the bank's retail
installment loans; that when payment is made on a loan secured by a lien
on a motor vehicle, renewal policies are not issued by the insurance
company; and that the insurance company receives the usual agency
commissions on all comprehensive automobile insurance written for
customers of the bank.
(c) It is also understood that the insurance company writes credit
life insurance for the benefit of the bank and its installment-loan
customers; that each insured debtor is covered for an amount equal to
the unpaid balance of his note to the bank, not to exceed $5,000; that
as the note is reduced by regular monthly payments, the amount of
insurance is correspondingly reduced
[[Page 125]]
so that at all times the debtor is insured for the unpaid balance of his
note; that each insurance contract provides for payment in full of the
entire loan balance upon the death or permanent disability of the
insured borrower; and that this credit life insurance is written only at
the request of, and solely for, the bank's borrowing customers. It is
further understood that the insurance company engages in no other
activity.
(d) As indicated in Sec. 225.104 (23 FR 2675), the term
``services,'' while sometimes used in a broad and general sense, appears
to be somewhat more limited in its application in section 4(c)(1) of the
Bank Holding Company Act. Unlike an early version of the Senate bill (S.
2577, before amendment), the act as finally enacted does not expressly
mention any type of servicing activity for exemption. The legislative
history of the Act, however, as indicated in the relevant portion of the
record of the Senate Banking and Currency Committee on amended S. 2577
(84th Cong., 2d Sess., Senate Report 1095, Part 2, p. 3) makes it
evident that Congress had in mind the exemption of services comparable
to the types of activities mentioned expressly in the early Senate bill
(``auditing, appraising, investment counseling'') and in the Committee
Report on the later bill (``advertising, public relations, developing
new business, organization, operations, preparing tax returns,
personnel, and many others''). Furthermore, this Committee Report
expressly stated that the provision of section 4(c)(1) with respect to
``furnishing services to or performing services for'' was not intended
to supplant the exemption contained under section 4 (c)(6) of the Act.
(e) The only activity of the insurance company (writing
comprehensive automobile insurance and credit life insurance) appears to
involve an insurance relationship between it and a banking subsidiary of
the holding company which the legislative history clearly indicates does
not come within the meaning of the phrase ``furnishing services to or
performing services for'' a bank holding company or its banking
subsidiaries.
(f) Accordingly, it is the Board's view that the insurance company
could not be regarded as qualifying as a company engaged ``solely in the
business of furnishing services to or performing services for'' the bank
holding company or banks with respect to which the latter is a bank
holding company.
[23 FR 9017, Nov. 20, 1958. Redesignated at 36 FR 21666, Nov. 12, 1971]
Sec. 225.111 Limit on investment by bank holding company system in stock of small business investment companies.
(a) Under the provisions of section 4(c)(5) of the Bank Holding
Company Act, as amended (12 U.S.C. 1843), a bank holding company may
acquire shares of nonbank companies ``which are of the kinds and amounts
eligible for investment'' by national banks. Pursuant to section 302(b)
of the Small Business Investment Act of 1958 (15 U.S.C. 682(b)), as
amended by Title II of the Small Business Act Amendments of 1967 (Pub.
L. 90-104, 81 Stat. 268, 270), a national bank may invest in stock of
small business investment companies (SBICs) subject to certain
restrictions.
(b) On the basis of the foregoing statutory provisions, it is the
position of the Board that a bank holding company may acquire direct or
indirect ownership or control of stock of an SBIC subject to the
following limits:
(1) The total direct and indirect investments of a bank holding
company in stock of SBICs may not exceed:
(i) With respect to all stock of SBICs owned or controlled directly
or indirectly by a subsidiary bank, 5 percent of that bank's capital and
surplus;
(ii) With respect to all stock of SBICs owned directly by a bank
holding company that is a bank, 5 percent of that bank's capital and
surplus; and
(iii) With respect to all stock of SBICs otherwise owned or
controlled directly or indirectly by a bank holding company, 5 percent
of its proportionate interest in the capital and surplus of each
subsidiary bank (that is, the holding company's percentage of that
bank's stock times that bank's capital and surplus) less that bank's
investment in stock of SBICs; and
(2) A bank holding company may not acquire direct or indirect
ownership or
[[Page 126]]
control of 50 percent or more of the shares of any class of equity
securities of an SBIC that have actual or potential voting rights.
(c) A bank holding company or a bank subsidiary that acquired direct
or indirect ownership or control of 50 percent or more of any such class
of equity securities prior to January 9, 1968, is not required to divest
to a level below 50 percent. A bank that acquired 50 percent or more
prior to January 9, 1968, may become a subsidiary in a holding company
system without any necessity for divesting to a level below 50 percent:
Provided, That such action does not result in the bank holding company
acquiring control of a percentage greater than that controlled by such
bank.
(12 U.S.C. 248. Interprets 12 U.S.C. 1843, 15 U.S.C. 682)
[33 FR 6967, May 9, 1968. Redesignated at 36 FR 21666, Nov. 12, 1971]
Sec. 225.112 Indirect control of small business concern through convertible debentures held by small business investment company.
(a) A question has been raised concerning the applicability of
provisions of the Bank Holding Company Act of 1956 to the acquisition by
a bank holding company of stock of a small business investment company
(``SBIC'') organized pursuant to the Small Business Investment Act of
1958 (``SBI Act'').
(b) As indicated in the interpretation of the Board (Sec. 225.107)
published at 23 FR 7813, it is the Board's opinion that, since stock of
an SBIC is eligible for purchase by national banks and since section
4(c)(4) of the Holding Company Act exempts stock eligible for investment
by national banks from the prohibitions of section 4 of that Act, a bank
holding company may lawfully acquire stock in such an SBIC.
(c) However, section 304 of the SBI Act provides that debentures of
a small business concern purchased by a small business investment
company may be converted at the option of such company into stock of the
small business concern. The question therefore arises as to whether, in
the event of such conversion, the parent bank holding company would be
regarded as having acquired ``direct or indirect ownership or control''
of stock of the small business concern in violation of section 4(a) of
the Holding Company Act.
(d) The Small Business Investment Act clearly contemplates that one
of the primary purposes of that Act was to enable SBICs to provide
needed equity capital to small business concerns through the purchase of
debentures convertible into stock. Thus, to the extent that a
stockholder in an SBIC might acquire indirect control of stock of a
small business concern, such control appears to be a natural and
contemplated incident of ownership of stock of the SBIC. The Office of
the Comptroller of the Currency has informally indicated concurrence
with this interpretation insofar as it affects investments by national
banks in stock of an SBIC.
(e) Since the exception as to stock eligible for investment by
national banks contained in section 4(c)(4) of the Holding Company Act
was apparently intended to permit a bank holding company to acquire any
stock that would be eligible for purchase by a national bank, it is the
Board's view that section 4(a)(1) of the Act does not prohibit a bank
holding company from acquiring stock of an SBIC, even though ownership
of such stock may result in the acquisition of indirect ownership or
control of stock of a small business concern which would not itself be
eligible for purchase directly by a national bank or a bank holding
company.
[24 FR 1584, Mar. 4, 1959. Redesignated at 36 FR 21666, Nov. 12, 1971]
Sec. 225.113 Services under section 4(a) of Bank Holding Company Act.
(a) The Board of Governors has been requested for an opinion as to
whether the performance of certain functions by a bank holding company
for four banks of which it owns less than 25 percent of the voting
shares is in violation of section 4(a) of the Bank Holding Company Act.
(b) It is claimed that the holding company is engaged in
``managing'' four nonsubsidiary banks, for which services it receives
``management fees.'' Specifically, the company engages in the following
activities for the four nonsubsidiary banks: (1) Establishment and
supervision of loaning
[[Page 127]]
policies; (2) direction of the purchase and sale of investment
securities; (3) selection and training of officer personnel; (4)
establishment and enforcement of operating policies; and (5) general
supervision over all policies and practices.
(c) The question raised is whether these activities are prohibited
by section 4(a)(2) of the Bank Holding Company Act, which permits a bank
holding company to engage in only three categories of business: (1)
Banking; (2) managing or controlling banks; and (3) furnishing services
to or performing services for any bank of which the holding company owns
or controls 25 percent or more of the voting shares.
(d) Clearly, the activities of the company with respect to the four
nonsubsidiary banks do not constitute ``banking.'' With respect to the
business of ``managing or controlling'' banks, it is the Board's view
that such business, within the purview of section 4(a)(2), is
essentially the exercise of a broad governing influence of the sort
usually exercised by bank stockholders, as distinguished from direct or
active participation in the establishment or carrying out of particular
policies or operations. The latter kinds of activities fall within the
third category of businesses in which a bank holding company is
permitted to engage. In the Board's view, the activities enumerated
above fall in substantial part within that third category.
(e) Section 4(a)(2), like all other sections of the Holding Company
Act, must be interpreted in the light of all of its provisions, as well
as in the light of other sections of the Act. The expression ``managing
* * * banks,'' if it could be taken by itself, might appear to include
activities of the sort enumerated. However, such an interpretation of
those words would virtually nullify the last portion of section 4(a)(2),
which permits a holding company to furnish services to or perform
services for ``any bank of which it owns or controls 25 per centum or
more of the voting shares.''
(f) Since Congress explicitly authorized the performance of services
for banks that are at least 25 percent owned by a holding company, it
obviously intended that the holding company should not perform services
for banks in which it owns less than 25 percent of the voting shares.
However, if the second category--``managing or controlling banks''--were
interpreted to permit the holding company to perform services for any
bank, including a bank in which it held less than 25 percent of the
stock (or no stock whatsoever), the last clause of section 4(a)(2) would
be meaningless.
(g) It is principally for this reason--that is, to give effective
meaning to the final clause of section 4(a)(2)--that the Board
interprets ``managing or controlling banks'' in that provision as
referring to the exercise of a stockholder's management or control of
banks, rather than direct and active participation in their operations.
To repeat, such active participation in operations falls within the
third category (``furnishing services to or performing services for any
bank'') and consequently may be engaged in only with respect to banks in
which the holding company ``owns or controls 25 per centum or more of
the voting shares.''
(h) Accordingly, it is the Board's conclusion that, in performing
the services enumerated, the bank holding company is ``furnishing
services to or performing services for'' the four banks referred to.
Under the Act such furnishing or performing of services is permissible
only if the holding company owns or controls 25 percent of the voting
shares of each bank receiving such services, and, since the company owns
less than 25 percent of the voting shares of these banks, it follows
that these activities are prohibited by section 4(a)(2).
(i) While this conclusion is required, in the Board's opinion, by
the language of the statute, it may be noted further that any other
conclusion would make it possible for bank holding company or any other
corporation, through arrangements for the ``managing'' of banks in the
manner here involved, to acquire effective control of banks without
acquiring bank stocks and thus to evade the underlying objectives of
section 3 of the Act.
[25 FR 281, Jan. 14, 1960. Redesignated at 36 FR 21666, Nov. 12, 1971]
[[Page 128]]
Sec. 225.115 Applicability of Bank Service Corporation Act in certain bank holding company situations.
(a) Questions have been presented to the Board of Governors
regarding the applicability of the recently enacted Bank Service
Corporation Act (Pub. L. 87-856, approved October 23, 1962) in cases
involving service corporations that are subsidiaries of bank holding
companies under the Bank Holding Company Act of 1956. In addition to
being charged with the administration of the latter Act, the Board is
named in the Bank Service Corporation Act as the Federal supervisory
agency with respect to the performance of bank services for State member
banks.
(b) Holding company-owned corporation serving only subsidiary banks.
(1) One question is whether the Bank Service Corporation Act is
applicable in the case of a corporation, wholly owned by a bank holding
company, which is engaged in performing ``bank services'', as defined in
section 1(b) of the Act, exclusively for subsidiary banks of the holding
company.
(2) Except as noted below with respect to section 5 thereof, the
Bank Service Corporation Act is not applicable in this case. This is
true because none of the stock of the corporation performing the
services is owned by any bank and the corporation, therefore, is not a
``bank service corporation'' as defined in section 1(c) of the Act. A
corporation cannot meet that definition unless part of its stock is
owned by two or more banks. The situation clearly is unaffected by
section 2(b) of the Act which permits a corporation that fell within the
definition initially to continue to function as a bank service
corporation although subsequently only one of the banks remains as a
stockholder in the corporation.
(3) However, although it is not a bank service corporation, the
corporation in question and each of the banks for which it performs bank
services are subject to section 5 of the Bank Service Corporation Act.
That section, which requires the furnishing of certain assurances to the
appropriate Federal supervisory agency in connection with the
performance of bank services for a bank, is applicable whether such
services are performed by a bank service corporation or by others.
(4) Section 4(a)(1) of the Bank Holding Company Act prohibits the
acquisition by a bank holding company of ``direct or indirect ownership
or control'' of shares of a nonbanking company, subject to certain
exceptions. Section 4(c)(1) of the Act exempts from section 4(a)(1)
shares of a company engaged ``solely in the business of furnishing
services to or performing services for'' its bank holding company or
subsidiary banks thereof. Assuming that the bank services performed by
the corporation in question are ``services'' of the kinds contemplated
by section 4(c)(1) of the Bank Holding Company Act (as would be true,
for example, of the electronic data processing of deposit accounts), the
holding company's ownership of the corporation's shares in the situation
described above clearly is permissible under that section of the Act.
(c) Bank service corporation owned by holding company subsidiaries
and serving also other banks. (1) The other question concerns the
applicability of the Bank Service Corporation Act and the Bank Holding
Company Act in the case of a corporation, all the stock of which is
owned either by a bank holding company and its subsidiary banks together
or by the subsidiary banks alone, which is engaged in performing ``bank
services'', as defined in section 1(b) of the Bank Service Corporation
Act, for the subsidiary banks and for other banks, as well.
(2) In contrast to the situation under paragraph (b) of this
section, the corporation in this case is a ``bank service corporation''
within the meaning of section 1(c) of the Bank Service Corporation Act
because of the ownership by each of the subsidiary banks of a part of
the corporation's stock. This stock ownership is one of the important
facts differentiating this case from the first one. Being a bank service
corporation, the corporation in question is subject to section 3 of the
Act concerning applications to bank service corporations by competitive
banks for bank services, and to section 4 forbidding a bank service
corporation from engaging in any activity other than the performance of
bank services
[[Page 129]]
for banks. Section 5, mentioned previously and relating to
``assurances'', also is applicable in this case.
(3) The other important difference between this case and the
situation in paragraph (b) of this section is that here the bank service
corporation performs services for nonsubsidiary banks, as well as for
subsidiary banks. This is permissible because section 2(a) of the Bank
Service Corporation Act, which authorizes any two or more banks to
invest limited amounts in a bank service corporation, removes all
limitations and prohibitions of Federal law exclusively relating to
banks that otherwise would prevent any such investment. From the
legislative history of section 2(a), it is clear that section 6 of the
Bank Holding Company Act is among the limitations and prohibitions so
removed. But for such removal, section 6(a)(1) of that Act would make it
unlawful for any of the subsidiary banks of the bank holding company in
question to own stock in the bank service corporation subsidiary of the
holding company, as the exemption in section 6(b)(1) would not apply
because of the servicing by the bank service corporation of
nonsubsidiary banks.
(4) Because the bank service corporation referred to in the question
is serving banks other than the subsidiary banks, the bank holding
company is not exempt under section 4(c)(1) of the Bank Holding Company
Act from the prohibition of acquisition of nonbanking interests in
section 4(a)(1) of that Act. The bank holding company, however, is
entitled to the benefit of the exemption in section 4(c)(4) of the Act.
That section exempts from section 4(a) ``shares which are of the kinds
and amounts eligible for investment by National banking associations
under the provisions of section 5136 of the Revised Statutes''. Section
5136 provides, in part, that: ``Except as hereinafter provided or
otherwise permitted by law, nothing herein contained shall authorize the
purchase by the association for its own account of any shares of stock
of any corporation.'' As the provisions of section 2(a) of the Bank
Service Corporation Act and its legislative history make it clear that
shares of a bank service corporation are of a kind eligible for
investment by national banks under section 5136, it follows that the
direct or indirect ownership on control of such shares by a bank holding
company are permissible within the amount limitation discussed in
paragraph (d) of this section.
(d) Limit on investment by bank holding company system in stock of
bank service corporation. (1) In the situation presented by paragraph
(c) the bank holding company clearly owns or controls, directly or
indirectly, all of the stock of the bank service corporation. The
remaining question, therefore, is whether the total direct and indirect
investment of the bank holding company in the bank service corporation
exceeds the amount permissible under the Bank Holding Company Act.
(2) The effect of sections 4(a)(1) and 4(c)(4) of the Bank Holding
Company Act is to limit the amount of shares of a bank service
corporation that a bank holding company may own or control, directly or
indirectly, to the amount eligible for investment by a national bank, as
previously indicated. Under section 2(a) of the Bank Service Corporation
Act, the amount of shares of a bank service corporation eligible for
investment by a national bank may not exceed ``10 per centum [of the
bank's] * * * paid-in and unimpaired capital and unimpaired surplus''.
(3) The Board's view is that this aspect of the matter should be
determined in accordance with the principles set forth in Sec. 225.111,
as revised (27 FR 12671), involving the application of sections 4(a)(1)
and 4(c)(4) of the Bank Holding Company Act in the light of section
302(b) of the Small Business Investment Act limiting the amount eligible
for investment by a national bank in the shares of a small business
investment company to two percent of the bank's ``capital and surplus''.
(4) Except for the differences in the percentage figures, the
investment limitation in section 302(b) of the Small Business Investment
Act is essentially the same as the investment limitation in section 2(a)
of the Bank Service Corporation Act since, as an accounting matter and
for the purposes under consideration, ``capital and surplus'' may be
regarded as equivalent in meaning to ``paid-in and unimpaired capital
and
[[Page 130]]
unimpaired surplus.'' Accordingly, the maximum permissible investment by
a bank holding company system in the stock of a bank service corporation
should be determined in accordance with the formula prescribed in
Sec. 222.111.
[27 FR 12918, Dec. 29, 1962. Redesignated at 36 FR 21666, Nov. 12, 1971]
Sec. 225.118 Computer services for customers of subsidiary banks.
(a) The question has been presented to the Board of Governors
whether a wholly-owned nonbanking subsidiary (``service company'') of a
bank holding company, which is now exempt from the prohibitions of
section 4 of the Bank Holding Company Act of 1956 (``the Act'') because
its sole business is the providing of services for the holding company
and the latter's subsidiary banks, would lose its exempt status if it
should provide data processing services for customers of the subsidiary
banks.
(b) The Board understood from the facts presented that the service
company owns a computer which it utilizes to furnish data processing
services for the subsidiary banks of its parent holding company.
Customers of these banks have requested that the banks provide for them
computerized billing, accounting, and financial records maintenance
services. The banks wish to utilize the computer services of the service
company in providing these and other services of a similar nature. It is
proposed that, in each instance where a subsidiary bank undertakes to
provide such services, the bank will enter into a contract directly with
the customer and then arrange to have the service company perform the
services for it, the bank. In no case will the service company provide
services for anyone other than its affiliated banks. Moreover, it will
not hold itself out as, nor will its parent corporation or affiliated
banks represent it to be, authorized or willing to provide services for
others.
(c) Section 4(c)(1) of the Act permits a holding company to own
shares in ``any company engaged solely * * * in the business of
furnishing services to or performing services for such holding company
and banks with respect to which it is a bank holding company * * *.''
The Board has ruled heretofore that the term ``services'' as used in
section 4(c)(1) is to be read as relating to those services (excluding
``closely related'' activities of ``a financial, fiduciary, or insurance
nature'' within the meaning of section 4(c)(6)) which a bank itself can
provide for its customers (Sec. 225.104). A determination as to whether
a particular service may legitimately be rendered or performed by a bank
for its customers must be made in the light of applicable Federal or
State statutory or regulatory provisions. In the case of a State-
chartered bank, the laws of the State in which the bank operates,
together with any interpretations thereunder rendered by appropriate
bank authorities, would govern the right of the bank to provide a
particular service. In the case of a national bank, a similar
determination would require reference to provisions of Federal law
relating to the establishment and operation of national banks, as well
as to pertinent rulings or interpretations promulgated thereunder.
(d) Accordingly, on the assumption that all of the services to be
performed are of the kinds that the holding company's subsidiary banks
may render for their customers under applicable Federal or State law,
the Board concluded that the rendition of such services by the service
company for its affiliated banks would not adversely affect its exempt
status under section 4(c)(1) of the Act.
(e) In arriving at the above conclusion, the Board emphasized that
its views were premised explicitly upon the facts presented to it, and
particularly its understanding that banks are permitted, under
applicable Federal or State law to provide the proposed computer
services. The Board emphasized also that in respect to the service
company's operations, there continues in effect the requirement under
section 4(c)(1) that the service company engage solely in the business
of furnishing services to or performing services for the bank holding
company and its subsidiary banks. The Board added that any substantial
change in the facts that had been presented might require re-examination
of the service company's status under section 4(c)(1).
[29 FR 12361, Aug. 28, 1964. Redesignated at 36 FR 21666, Nov. 12, 1971]
[[Page 131]]
Sec. 225.121 Acquisition of Edge corporation affiliate by State member banks of registered bank holding company.
(a) The Board has been asked whether it is permissible for the
commercial banking affiliates of a bank holding company registered under
the Bank Holding Company Act of 1956, as amended, to acquire and hold
the shares of the holding company's Edge corporation subsidiary
organized under section 25(a) of the Federal Reserve Act.
(b) Section 9 of the Bank Holding Company Act amendments of 1966
(Pub. L. 89-485, approved July 1, 1966) repealed section 6 of the Bank
Holding Company Act of 1956. That rendered obsolete the Board's
interpretation of section 6 that was published in the March 1966 Federal
Reserve Bulletin, page 339 (Sec. 225.120). Thus, so far as Federal
Banking law applicable to State member banks is concerned, the answer to
the foregoing question depends on the provisions of section 23A of the
Federal Reserve Act, as amended by the 1966 amendments to the Bank
Holding Company Act. By its specific terms, the provisions of section
23A do not apply to an affiliate organized under section 25(a) of the
Federal Reserve Act.
(c) Accordingly, the Board concludes that, except for such
restrictions as may exist under applicable State law, it would be
legally permissible by virtue of paragraph 20 of section 9 of the
Federal Reserve Act for any or all of the State member banks that are
affiliates of a registered bank holding company to acquire and hold
shares of the Edge corporation subsidiary of the bank holding company
within the amount limitation in the last sentence of paragraph 12 of
section 25(a) of the Federal Reserve Act.
(12 U.S.C. 24, 248, 335, 371c, 611, 618)
[31 FR 10263, July 29, 1966. Redesignated at 36 FR 21666, Nov. 12, 1971]
Sec. 225.122 Bank holding company ownership of mortgage companies.
(a) The Board of Governors recently considered whether a bank
holding may acquire, either directly or through a subsidiary, the stock
of a so-called ``mortgage company'' that would be operated on the
following basis: The company would solicit mortgage loans on behalf of a
bank in the holding company system, assemble credit information, make
property inspections and appraisals, and secure title information. The
company would also participate in the preparation of applications for
mortgage loans, which it would submit, together with recommendations
with respect to action thereon, to the bank, which alone would decide
whether to make any or all of the loans requested. The company would in
addition solicit investors to purchase mortgage loans from the bank and
would seek to have such investors contract with the bank for the
servicing of such loans.
(b) Under section 4 of the Bank Holding Company Act (12 U.S.C.
1843), a bank holding company is generally prohibited from acquiring
``direct or indirect ownership'' of stock of nonbanking corporations.
The two exceptions principally involved in the question presented are
with respect to (1) stock that is eligible for investment by a national
bank (section 4(c)(5) of the Act) and (2) shares of a company
``furnishing services to or performing services for such bank holding
company or its banking subsidiaries'' (section 4(c)(1)(C) of the Act).
(c) The Board has previously indicated its view that a national bank
is forbidden by the so-called ``stock-purchase prohibition'' of
paragraph ``Seventh'' of section 5136 of the Revised Statutes (12 U.S.C.
24) to purchase ``for its own account * * * any shares of stock of any
corporation'' except (1) to the extent permitted by specific provisions
of Federal law or (2) as comprised within the concept of ``such
incidental powers as shall be necessary to carry on the business of
banking'' referred to in the first sentence of said paragraph
``Seventh''. There is no specific statutory provision authorizing a
national bank to purchase stock in a mortgage company, and in the
Board's view such purchase may not properly be regarded as authorized
under the ``incidental powers'' clause. (See 1966 Federal Reserve
Bulletin 1151; 12 CFR 208.119.) Accordingly, a bank holding company may
not acquire stock in a mortgage
[[Page 132]]
company on the basis of the section 4(c)(5) exemption.
(d) However, the Board does not believe that such conclusion
prejudices consideration of the question whether such a company is
within the section 4(c)(1)(C) ``servicing exemption''. The basic purpose
of section 4 of the Act is to confine a bank holding company's
activities to the management and control of banks. In determining
whether an activity in which a bank could itself engage is within the
servicing exemption, the question is simply whether such activity may
appropriately be considered as ``furnishing services to or performing
services for'' a bank.
(e) As indicated in the Board's interpretation published in the 1958
Federal Reserve Bulletin at page 431 (12 CFR 225.104), the legislative
history of the servicing exemption indicates that it includes the
following activities: ``auditing, appraising, investment counseling''
and ``advertising, public relations, developing new business,
organization, operations, preparing tax returns, and personnel''. The
legislative history further indicates that some other activities also
are within the scope of the exemption. However, the types of servicing
permitted under such exemption must be distinguished from activities of
a ``financial fiduciary, or insurance nature'', such as those that might
be considered for possible exemption under section 4(c)(8) of the Act.
(f) In considering the interrelation of these exemptions in the
light of the purpose of the prohibition against bank holding company
interests in nonbanking organizations, the Board has concluded that the
appropriate test for determining whether a mortgage company may be
considered as within the servicing exemption is whether the company will
perform as principal any banking activities--such as receiving deposits,
paying checks, extending credit, conducting a trust department, and the
like. In other words, if the mortgage company is to act merely as an
adjunct to a bank for the purpose of facilitating the banks operations,
the company may appropriately be considered as within the scope of the
servicing exemption.\1\
---------------------------------------------------------------------------
\1\ Insofar as the 1958 interpretation referred to above suggested
that the branch banking laws are an appropriate general test for
determining the scope of the servicing exemption, such interpretation is
hereby modified. In view of the different purposes to be served by the
branch banking laws and by section 4 of the Bank Holding Company Act,
the Board has concluded that basing determinations under the latter
solely on the basis of determinations under the former is inappropriate.
---------------------------------------------------------------------------
(g) On this basis the Board concluded that, insofar as the Bank
Holding Company Act is concerned, a bank holding company may acquire,
either directly or through a subsidiary, the stock of a mortgage company
whose functions are as described in the question presented. On the other
hand, in the Board's view, a bank holding company may not acquire, on
the basis of the servicing exemption, a mortgage company whose functions
include such activities as extending credit for its own account,
arranging interim financing, entering into mortgage service contracts on
a fee basis, or otherwise performing functions other than solely on
behalf of a bank.
(12 U.S.C. 248)
[32 FR 15004, Oct. 3, 1967, as amended at 35 FR 19662, Dec. 29, 1970.
Redesignated at 36 FR 21666, Nov. 12, 1971]
Sec. 225.123 Activities closely related to banking.
(a) Effective June 15, 1971, the Board of Governors has amended
Sec. 225.4(a) of Regulation Y to implement its regulatory authority
under section 4(c)(8) of the Bank Holding Company Act. In some respects
activities determined by the Board to be closely related to banking are
described in general terms that will require interpretation from time to
time. The Board's views on some questions that have arisen are set forth
below.
(b) Section 225.4(a) states that a company whose ownership by a bank
holding company is authorized on the basis of that section may engage
solely in specified activities. That limitation refers only to
activities the authority for which depends on section 4(c)(8) of the
Act. It does not prevent a holding company from establishing one
subsidiary
[[Page 133]]
to engage, for example, in activities specified in Sec. 225.4(a) and
also in activities that fall within the scope of section 4(c)(1)(C) of
the Act--the ``servicing'' exemption.
(c) The amendments to Sec. 225.4(a) do not apply to restrict the
activities of a company previously approved by the Board on the basis of
section 4(c)(8) of the Act. Activities of a company authorized on the
basis of section 4(c)(8) either before the 1970 Amendments or pursuant
to the amended Sec. 225.4(a) may be shifted in a corporate
reorganization to another company within the holding company system
without complying with the procedures of Sec. 225.4(b), as long as all
the activities of such company are permissible under one of the
exemptions in section 4 of the Act.
(d) Under the procedures in Sec. 225.4(a)(c), a holding company that
wishes to change the location at which it engages in activities
authorized pursuant to Sec. 225.4(a) must publish notice in a newspaper
of general circulation in the community to be served. The Board does not
regard minor changes in location as within the coverage of that
requirement. A move from one site to another within a 1-mile radius
would constitute such a minor change if the new site is in the same
State.
(e) Data processing. In providing packaged data processing and
transmission services for banking, financial and economic data for
installation on the premises of the customer, as authorized by
Sec. 225.4(a)(8)(ii), a bank holding company should limit its activities
to providing facilities that perform banking functions, such as check
collection, or other similar functions for customers that are depository
or other similar institutions, such as mortgage companies. In addition,
the Board regards the following as incidental activities necessary to
carry on the permissible activities in this area:
(1) Providing excess capacity, not limited to the processing or
transmission of banking, financial or economic data on data processing
or transmission equipment or facilities used in connection with
permissible data processing and data transmission activities, where:
(A) Equipment is not purchased solely for the purpose of creating
excess capacity;
(B) Hardware is not offered in connection therewith; and
(C) Facilities for the use of the excess capacity do not include the
provision of any software, other than systems software (including
language), network communications support, and the operating personnel
and documentation necessary for the maintenance and use of these
facilities.
(2) Providing by-products of permissible data processing and data
transmission activities, where not designed, or appreciably enhanced,
for the purpose of marketability.
(3) Furnishing any data processing service upon request of a
customer if such data processing service is not otherwise reasonably
available in the relevant market area; and
In order to eliminate or reduce to an insignificant degree any
possibility of unfair competition where services, facilities, by-
products or excess capacity are provided by a bank holding company's
nonbank subsidiary or related entity, the entity providing the services,
facilities, by-products and/or excess capacity should have separate
books and financial statements, and should provide these books and
statements to any new or renewal customer requesting financial data.
Consolidated or other financial statements of the bank holding company
should not be provided unless specifically requested by the customer.
(Interprets and applies 12 U.S.C. 1843 (c)(8))
[36 FR 10778, June 3, 1971, as amended at 36 FR 11806, June 19, 1971.
Redesignated at 36 FR 21666, Nov. 12, 1971 and amended at 40 FR 13477,
Mar. 27, 1975; 47 FR 37372, Aug. 26, 1982; 52 FR 45161, Nov. 25, 1987]
Sec. 225.124 Foreign bank holding companies.
(a) Effective December 1, 1971, the Board of Governors has added a
new Sec. 225.4(g) to Regulation Y implementing its authority under
section 4(c)(9) of the Bank Holding Company Act. The Board's views on
some questions that have arisen in connection with the meaning of terms
used in Sec. 225.4(g) are set forth in paragraphs (b) through (g) of
this section.
[[Page 134]]
(b) The term ``activities'' refers to nonbanking activities and does
not include the banking activities that foreign banks conduct in the
United States through branches or agencies licensed under the banking
laws of any State of the United States or the District of Columbia.
(c) A company (including a bank holding company) will not be deemed
to be engaged in ``activities'' in the United States merely because it
exports (or imports) products to (or from) the United States, or
furnishes services or finances goods or services in the United States,
from locations outside the United States. A company is engaged in
``activities'' in the United States if it owns, leases, maintains,
operates, or controls any of the following types of facilities in the
United States:
(1) A factory,
(2) A wholesale distributor or purchasing agency,
(3) A distribution center,
(4) A retail sales or service outlet,
(5) A network of franchised dealers,
(6) A financing agency, or
(7) Similar facility for the manufacture, distribution, purchasing,
furnishing, or financing of goods or services locally in the United
States.
A company will not be considered to be engaged in ``activities'' in the
United States if its products are sold to independent importers, or are
distributed through independent warehouses, that are not controlled or
franchised by it.
(d) In the Board's opinion, section 4 (a)(1) of the Bank Holding
Company Act applies to ownership or control of shares of stock as an
investment and does not apply to ownership or control of shares of stock
in the capacity of an underwriter or dealer in securities. Underwriting
or dealing in shares of stock are nonbanking activities prohibited to
bank holding companies by section 4(a)(2) of the Act, unless otherwise
exempted. Under Sec. 225.4(g) of Regulation Y, foreign bank holding
companies are exempt from the prohibitions of section 4 of the Act with
respect to their activities outside the United States; thus foreign bank
holding companies may underwrite or deal in shares of stock (including
shares of United States issuers) to be distributed outside the United
States, provided that shares so acquired are disposed of within a
reasonable time.
(e) A foreign bank holding company does not ``indirectly'' own
voting shares by reason of the ownership or control of such voting
shares by any company in which it has a noncontrolling interest. A
foreign bank holding company may, however, ``indirectly'' control such
voting shares if its noncontrolling interest in such company is
accompanied by other arrangements that, in the Board's judgment, result
in control of such shares by the bank holding company. The Board has
made one exception to this general approach. A foreign bank holding
company will be considered to indirectly own or control voting shares of
a bank if that bank holding company acquires more than 5 percent of any
class of voting shares of another bank holding company. A bank holding
company may make such an acquisition only with prior approval of the
Board.
(f) A company is ``indirectly'' engaged in activities in the United
States if any of its subsidiaries (whether or not incorporated under the
laws of this country) is engaged in such activities. A company is not
``indirectly'' engaged in activities in the United States by reason of a
noncontrolling interest in a company engaged in such activities.
(g) Under the foregoing rules, a foreign bank holding company may
have a noncontrolling interest in a foreign company that has a U.S.
subsidiary (but is not engaged in the securities business in the United
States) if more than half of the foreign company's consolidated assets
and revenues are located and derived outside the United States. For the
purpose of such determination, the assets and revenues of the United
States subsidiary would be counted among the consolidated assets and
revenues of the foreign company to the extent required or permitted by
generally accepted accounting principles in the United States. The
foreign bank holding company would not, however, be permitted to
``indirectly'' control voting shares of the said U.S. subsidiary, as
might be the case if there are other arrangements accompanying its
noncontrolling interest in the foreign parent company that, in the
Board's judgment, result in control of
[[Page 135]]
such shares by the bank holding company.
(Interprets and applies 12 U.S.C. 1843 (a) (1), (2), and (c)(9))
[36 FR 21808, Nov. 16, 1971]
Sec. 225.125 Investment adviser activities.
(a) Effective February 1, 1972, the Board of Governors amended
Sec. 225.4(a) of Regulation Y to add ``serving as investment adviser, as
defined in section 2(a)(20) of the Investment Company Act of 1940, to an
investment company registered under that Act'' to the list of activities
it has determined to be so closely related to banking or managing or
controlling banks as to be a proper incident thereto. During the course
of the Board's consideration of this amendment several questions arose
as to the scope of such activity, particularly in view of certain
restrictions imposed by sections 16, 20, 21, and 32 of the Banking Act
of 1933 (12 U.S.C. 24, 377, 378, 78) (sometimes referred to hereinafter
as the ``Glass-Steagall Act provisions'') and the U.S. Supreme Court's
decision in Investment Company Institute v. Camp, 401 U.S. 617 (1971).
The Board's views with respect to some of these questions are set forth
below.
(b) It is clear from the legislative history of the Bank Holding
Company Act Amendments of 1970 (84 Stat. 1760) that the Glass-Steagall
Act provisions were not intended to be affected thereby. Accordingly,
the Board regards the Glass-Steagall Act provisions and the Board's
prior interpretations thereof as applicable to a holding company's
activities as an investment adviser. Consistently with the spirit and
purpose of the Glass-Steagall Act, this interpretation applies to all
bank holding companies registered under the Bank Holding Company Act
irrespective of whether they have subsidiaries that are member banks.
(c) Under Sec. 225.4(a)(5), as amended, bank holding companies
(which term, as used herein, includes both their bank and nonbank
subsidiaries) may, in accordance with the provisions of Sec. 225.4 (b),
act as investment advisers to various types of investment companies,
such as ``open-end'' investment companies (commonly referred to as
``mutual funds'') and ``closed-end'' investment companies. Briefly, a
mutual fund is an investment company which, typically, is continuously
engaged in the issuance of its shares and stands ready at any time to
redeem the securities as to which it is the issuer; a closed-end
investment company typically does not issue shares after its initial
organization except at infrequent intervals and does not stand ready to
redeem its shares.
(d) The Board intends that a bank holding company may exercise all
functions that are permitted to be exercised by an ``investment
adviser'' under the Investment Company Act of 1940, except to the extent
limited by the Glass-Steagall Act provisions, as described, in part,
hereinafter.
(e) The Board recognizes that presently most mutual funds are
organized, sponsored and managed by investment advisers with which they
are affiliated and that their securities are distributed to the public
by such affiliated investment advisers, or subsidiaries or affiliates
thereof. However, the Board believes that (1) The Glass-Steagall Act
provisions do not permit a bank holding company to perform all such
functions, and (2) It is not necessary for a bank holding company to
perform all such functions in order to engage effectively in the
described activity.
(f) In the Board's opinion, the Glass-Steagall Act provisions, as
interpreted by the U.S. Supreme Court, forbid a bank holding company to
sponsor, organize, or control a mutual fund. However, the Board does not
believe that such restrictions apply to closed-end investment companies
as long as such companies are not primarily or frequently engaged in the
issuance, sale, and distribution of securities. A bank holding company
should not act as investment adviser to an investment company that has a
name similar to the name of the holding company or any of its subsidiary
banks, unless the prospectus of the investment company contains the
disclosures required in paragraph (h) of this section. In no case should
a bank holding company act as investment adviser to an investment
company that has either the same
[[Page 136]]
name as the name of the holding company or any of its subsidiary banks,
or a name that contains the word ``bank.''
(g) In view of the potential conflicts of interests that may exist,
a bank holding company and its bank and nonbank subsidiaries should not
purchase in their sole discretion, in a fiduciary capacity (including as
managing agent), securities of any investment company for which the bank
holding company acts as investment adviser unless, the purchase is
specifically authorized by the terms of the instrument creating the
fiduciary relationship, by court order, or by the law of the
jurisdiction under which the trust is administered.
(h) Under section 20 of the Glass-Steagall Act, a member bank is
prohibited from being affiliated with a company that directly, or
through a subsidiary, engages principally in the issue, flotation,
underwriting, public sale, or distribution of securities. A bank holding
company or its nonbank subsidiary may not engage, directly or
indirectly, in the underwriting, public sale or distribution of
securities of any investment company for which the holding company or
any nonbank subsidiary provides investment advice except in compliance
with the terms of section 20, and only after obtaining the Board's
approval under section 4 of the Bank Holding Company Act and subject to
the limitations and disclosures required by the Board in those cases.
The Board has determined, however, that the conduct of securities
brokerage activities by a bank holding company or its nonbank
subsidiaries, when conducted individually or in combination with
investment advisory activities, is not deemed to be the underwriting,
public sale, or distribution of securities prohibited by the Glass-
Steagall Act, and the U.S. Supreme Court has upheld that determination.
See Securities Industry Ass'n v. Board of Governors, 468 U.S. 207
(1984); see also Securities Industry Ass'n v. Board of Governors, 821
F.2d 810 (D.C. Cir. 1987), cert. denied, 484 U.S. 1005 (1988).
Accordingly, the Board believes that a bank holding company or any of
its nonbank subsidiaries that has been authorized by the Board under the
Bank Holding Company Act to conduct securities brokerage activities
(either separately or in combination with investment advisory
activities) may act as agent, upon the order and for the account of
customers of the holding company or its nonbank subsidiary, to purchase
or sell shares of an investment company for which the bank holding
company or any of its subsidiaries acts as an investment adviser. In
addition, a bank holding company or any of its nonbank subsidiaries that
has been authorized by the Board under the Bank Holding Company Act to
provide investment advice to third parties generally (either separately
or in combination with securities brokerage services) may provide
investment advice to customers with respect to the purchase or sale of
shares of an investment company for which the holding company or any of
its subsidiaries acts as an investment adviser. In the event that a bank
holding company or any of its nonbank subsidiaries provides brokerage or
investment advisory services (either separately or in combination) to
customers in the situations described above, at the time the service is
provided the bank holding company should instruct its officers and
employees to caution customers to read the prospectus of the investment
company before investing and must advise customers in writing that the
investment company's shares are not insured by the Federal Deposit
Insurance Corporation, and are not deposits, obligations of, or endorsed
or guaranteed in any way by, any bank, unless that happens to be the
case. The holding company or nonbank subsidiary must also disclose in
writing to the customer the role of the company or affiliate as adviser
to the investment company. These disclosures may be made orally so long
as written disclosure is provided to the customer immediately
thereafter. To the extent that a bank owned by a bank holding company
engages in providing advisory or brokerage services to bank customers in
connection with an investment company advised by the bank holding
company or a nonbank affiliate, but is not required by the bank's
primary regulator to make disclosures comparable to the disclosures
required to be made by bank holding companies providing such services,
the bank holding company should require
[[Page 137]]
its subsidiary bank to make the disclosures required in this paragraph
to be made by a bank holding company that provides such advisory or
brokerage services.
(i) Acting in such capacities as registrar, transfer agent, or
custodian for an investment company is not a selling activity and is
permitted under Sec. 225.4(a)(4) of Regulation Y. However, in view of
potential conflicts of interests, a bank holding company which acts both
as custodian and investment adviser for an investment company should
exercise care to maintain at a minimal level demand deposit accounts of
the investment company which are placed with a bank affiliate and should
not invest cash funds of the investment company in time deposit accounts
(including certificates of deposit) of any bank affiliate.
[37 FR 1464, Jan. 29, 1972, as amended by Reg. Y, 57 FR 30391, July 9,
1992; 61 FR 45875, Aug. 30, 1996; Reg. Y, 62 FR 9343, Feb. 28, 1997]
Sec. 225.126 Activities not closely related to banking.
Pursuant to section 4(c)(8) of the Bank Holding Company Act and
Sec. 225.4(a) of Regulation Y, the Board of Governors has determined
that the following activities are not so closely related to banking or
managing or controlling banks as to be a proper incident thereto:
(a) Insurance premium funding--that is, the combined sale of mutual
funds and insurance.
(b) Underwriting life insurance that is not sold in connection with
a credit transaction by a bank holding company, or a subsidiary thereof.
(c) Real estate brokerage (see 1972 Fed. Res. Bulletin 428).
(d) Land development (see 1972 Fed. Res. Bulletin 429).
(e) Real estate syndication.
(f) Management consulting (see 1972 Fed. Res. Bulletin 571).
(g) Property management (see 1972 Fed. Res. Bulletin 652).
[Reg. Y, 37 FR 20329, Sept. 29, 1972; 37 FR 21938, Oct. 17, 1972, as
amended at 54 FR 37302, Sept. 8, 1989]
Sec. 225.127 Investment in corporations or projects designed primarily to promote community welfare.
(a) Under Sec. 225.25(b)(6) of Regulation Y, a bank holding company
may, in accordance with the provisions of Sec. 225.23, engage in
``making equity and debt investments in corporations or projects
designed primarily to promote community welfare, such as the economic
rehabilitation and development of low-income areas.'' The Board included
that activity among those the Board has determined to be so closely
related to banking or managing or controlling banks as be a proper
incident thereto, in order to permit bank holding companies to fulfill
their civic responsibilities. As indicated hereinafter in this
interpretation, the Board intends Sec. 225.25(b)(6) to enable bank
holding companies to take an active role in the quest for solutions to
the Nation's social problems. Although the interpretation primarily
focuses on low- and moderate-income housing, it is not intended to limit
projects under Sec. 225.25(b)(6) to that area. Other investments
primarily designed to promote community welfare are considered
permissible, but have not been defined in order to provide bank holding
companies flexibility in approaching community problems. For example,
bank holding companies may utilize this flexibility to provide new and
creative approaches to the promotion of employment opportunities for
low-income persons. Bank holding companies possess a unique combination
of financial and managerial resources making them particularly suited
for a meaningful and substantial role in remedying our social ills.
Section 225.25(b)(6) is intended to provide an opportunity for them to
assume such a role.
(b) Under the authority of Sec. 225.25(b)(6), a bank holding company
may invest in community development corporations established pursuant to
Federal or State law. A bank holding company may also participate in
other civic projects, such as a municipal parking facility sponsored by
a local civic organization as a means to promote greater public use of
the community's facilities.
(c) Within the category of permissible investments under
Sec. 225.25(b)(6)
[[Page 138]]
are investments in projects to construct or rehabilitate multifamily
low- or moderate-income housing with respect to which a mortgage is
insured under section 221(d)(3), 221(d)(4), or 236 of the National
Housing Act (12 U.S.C. 1701) and investments in projects to construct or
rehabilitate low- or moderate-income housing which is financed or
assisted by direct loan, tax abatement, or insurance under provisions of
State or local law, similar to the aforementioned Federal programs,
provided that, with respect to all such projects the owner is, by
statute, regulation, or regulatory authority, limited as to the rate of
return on his investment in the project, as to rentals or occupancy
charges for units in the project, and in such other respects as would be
a ``limited dividend corporation'' (as defined by the Secretary of
Housing and Urban Development).
(d) Investments in other projects that may be considered to be
designed primarily to promote community welfare include but are not
limited to: (1) Projects for the construction or rehabilitation of
housing for the benefit of persons of low- or moderate-income, (2)
projects for the construction or rehabilitation of ancillary local
commercial facilities necessary to provide goods or services principally
to persons residing in low- or moderate-income housing, and (3) projects
designed explicitly to create improved job opportunities for low- or
moderate-income groups (for example, minority equity investments, on a
temporary basis, in small or medium-sized locally-controlled businesses
in low-income urban or other economically depressed areas). In the case
of de novo projects, the copy of the notice with respect to such other
projects which is to be furnished to Reserve Banks in accordance with
the provisions of Sec. 225.23 should be accompanied by a memorandum
which demonstrates that such projects meet the objectives of
Sec. 225.25(b)(6).
(e) Investments in corporations or projects organized to build or
rehabilitate high-income housing, or commercial, office, or industrial
facilities that are not designed explicitly to create improved job
opportunities for low-income persons shall be presumed not to be
designed primarily to promote community welfare, unless there is
substantial evidence to the contrary, even though to some extent the
investment may benefit the community.
(f) Section 6 of the Depository Institutions Disaster Relief Act of
1992 permits state member banks (12 U.S.C. 338a) and national banks (12
U.S.C. 24 (Eleventh)) to invest in the stock of community development
corporations that are designed primarily to promote the public welfare
of low- and moderate-income communities and persons in the areas of
housing, services and employment. The Board and the Office of the
Comptroller of the Currency have adopted rules that permit state member
banks and national banks to make certain investments without prior
approval. The Board believes that these rules are consistent with the
Board's interpretation of, and decisions regarding, the scope of
community welfare activities permissible for bank holding companies.
Accordingly, approval received by a bank holding company to conduct
activities designed to promote the community welfare under section
4(c)(8) of the Bank Holding Company Act (12 U.S.C. 1843(c)(8)) and
Sec. 225.25(b)(6) of the Board's Regulation Y (12 CFR 225.25(b)(6))
includes approval to engage, either directly or through a subsidiary, in
the following activities, up to five percent of the bank holding
company's total consolidated capital stock and surplus, without
additional Board or Reserve Bank approval:
(1) Invest in and provide financing to a corporation or project or
class of corporations or projects that the Board previously has
determined is a public welfare project pursuant to paragraph 23 of
section 9 of the Federal Reserve Act (12 U.S.C. 338a);
(2) Invest in and provide financing to a corporation or project that
the Office of the Comptroller of the Currency previously has determined,
by order or regulation, is a public welfare investment pursuant to
section 5136 of the Revised Statutes (12 U.S.C. 24 (Eleventh));
(3) Invest in and provide financing to a community development
financial institution pursuant to section 103(5) of the Community
Development Banking
[[Page 139]]
and Financial Institutions Act of 1994 (12 U.S.C. 4702(5));
(4) Invest in, provide financing to, develop, rehabilitate, manage,
sell, and rent residential property if a majority of the units will be
occupied by low- and moderate-income persons or if the property is a
``qualified low-income building'' as defined in section 42(c)(2) of the
Internal Revenue Code (26 U.S.C. 42(c)(2));
(5) Invest in, provide financing to, develop, rehabilitate, manage,
sell, and rent nonresidential real property or other assets located in a
low- or moderate-income area provided the property is used primarily for
low- and moderate-income persons;
(6) Invest in and provide financing to one or more small businesses
located in a low- or moderate-income area to stimulate economic
development;
(7) Invest in, provide financing to, develop, and otherwise assist
job training or placement facilities or programs designed primarily for
low- and moderate-income persons;
(8) Invest in and provide financing to an entity located in a low-
or moderate-income area if that entity creates long-term employment
opportunities, a majority of which (based on full time equivalent
positions) will be held by low- and moderate-income persons; and
(9) Provide technical assistance, credit counseling, research, and
program development assistance to low- and moderate-income persons,
small businesses, or nonprofit corporations to help achieve community
development.
(g) For purposes of paragraph (f) of this section, low- and
moderate-income persons or areas means individuals and communities whose
incomes do not exceed 80 percent of the median income of the area
involved, as determined by the U.S. Department of Housing and Urban
Development. Small businesses are businesses that are smaller than the
maximum size eligibility standards established by the Small Business
Administration (SBA) for the Small Business Investment Company and
Development Company Programs or the SBA section 7A loan program; and
specifically include those businesses that are majority-owned by members
of minority groups or by women.
(h) For purposes of paragraph (f) of this section, five percent of
the total consolidated capital stock and surplus of a bank holding
company includes its total investment in projects described in paragraph
(f) of this section, when aggregated with similar types of investments
made by depository institutions controlled by the bank holding company.
The term total consolidated capital stock and surplus of the bank
holding company means total equity capital and the allowance for loan
and lease losses. For bank holding companies that file the FR Y-9C
(Consolidated Financial Statements for Bank Holding Companies), these
items are readily ascertained from Schedule HC--Consolidated Balance
Sheet (total equity capital (line 27h) and allowance for loan and lease
losses (line 4b)). For bank holding companies filing the FR Y-SP (Parent
Company Only Financial Statements for Small Bank Holding Companies), an
approximation of these items is ascertained from the Balance Sheet
(total equity capital (line 16e)) and allowance for loan and lease
losses (line 3b)) and from the Report of Condition for Insured Banks
(Schedule RC--Balance Sheet (line 4b)).
[37 FR 11316, June 7, 1972; 37 FR 13336, July 7, 1972, as amended at
Reg. Y, 59 FR 63713, Dec. 9, 1994]
Sec. 225.129 Activities closely related to banking.
Courier activities. The Board's amendment of Sec. 225.4(a), which
adds courier services to the list of closely related activities is
intended to permit holding companies to transport time critical
materials of limited intrinsic value of the types utilized by banks and
bank-related firms in performing their business activities. Such
transportation activities are of particular importance in the check
clearing process of the banking system, but are also important to the
performance of other activities, including the processing of
financially-related economic data. The authority is not intended to
permit holding companies to engage generally in the provision of
transportation services.
During the course of the Board's proceedings pertaining to courier
services,
[[Page 140]]
objections were made that courier activities were not a proper incident
to banking because of the possibility that holding companies would or
had engaged in unfair competitive practices. The Board believes that
adherence to the following principles will eliminate or reduce to an
insignificant degree any possibility of unfair competition:
a. A holding company courier subsidiary established under section
4(c)(8) should be a separate, independent corporate entity, not merely a
servicing arm of a bank.
b. As such, the subsidiary should exist as a separate, profit-
oriented operation and should not be subsidized by the holding company
system.
c. Services performed should be explicitly priced, and shall not be
paid for indirectly, for example, on the basis of deposits maintained at
or loan arrangements with affiliated banks.
Accordingly, entry of holding companies into courier activities on the
basis of section 4(c)(8) will be conditioned as follows:
1. The courier subsidiary shall perform services on an explicit fee
basis and shall be structured as an individual profit center designed to
be operated on a profitable basis. The Board may regard operating losses
sustained over an extended period as being inconsistent with continued
authority to engage in courier activities.
2. Courier services performed on behalf of an affiliate's customer
(such as the carriage of incoming cash letters) shall be paid for by the
customer. Such payments shall not be made indirectly, for example, on
the basis of imputed earnings on deposits maintained at or of loan
arrangements with subsidiaries of the holding company. Concern has also
been expressed that bank-affiliated courier services will be utilized to
gain a competitive advantage over firms competing with other holding
company affiliates. To reduce the possibility that courier affiliates
might be so employed, the Board will impose the following third
condition:
3. The courier subsidiary shall, when requested by any bank or any
data processing firm providing financially-related data processing
services which firm competes with a banking or data processing
subsidiary of Applicant, furnish comparable service at comparable rates,
unless compliance with such request would be beyond the courier
subsidiary's practical capacity. In this regard, the courier subsidiary
should make known to the public its minimum rate schedule for services
and its general pricing policies thereto. The courier subsidiary is also
expected to maintain for a reasonable period of time (not less than two
years) each request denied with the reasons for such denial.
[38 FR 32126, Nov. 21, 1973, as amended at 40 FR 36309, Aug. 20, 1975]
Sec. 225.130 Issuance and sale of short-term debt obligations by bank holding companies.
For text of interpretation, see Sec. 250.221 of this chapter.
[38 FR 35231, Dec. 26, 1973]
Sec. 225.131 Activities closely related to banking.
(a) Bank management consulting advice. The Board's amendment of
Sec. 225.4(a), which adds bank management consulting advice to the list
of closely related activities, described in general terms the nature of
such activity. This interpretation is intended to explain in greater
detail certain of the terms in the amendment.
(b) It is expected that bank management consulting advice would
include, but not be limited to, advice concerning: Bank operations,
systems and procedures; computer operations and mechanization;
implementation of electronic funds transfer systems; site planning and
evaluation; bank mergers and the establishment of new branches;
operation and management of a trust department; international banking;
foreign exchange transactions; purchasing policies and practices; cost
analysis, capital adequacy and planning; auditing; accounting
procedures; tax planning; investment advice (as authorized in
Sec. 225.4(a)(5)); credit policies and administration, including credit
documentation, evaluation, and debt collection; product development,
including specialized lending provisions; marketing operations,
including research, market development and advertising programs;
personnel operations,
[[Page 141]]
including recruiting, training, evaluation and compensation; and
security measures and procedures.
(c) In permitting bank holding companies to provide management
consulting advice to nonaffiliated ``banks'', the Board intends such
advice to be given only to an institution that both accepts deposits
that the depositor has a legal right to withdraw on demand and engages
in the business of making commercial loans. It is also intended that
such management consulting advice may be provided to the ``operations
subsidiaries'' of a bank, since such subsidiaries perform functions that
a bank is empowered to perform directly at locations at which the bank
is authorized to engage in business (Sec. 250.141 of this chapter).
(d) Although a bank holding company providing management consulting
advice is prohibited by the regulation from owning or controlling,
directly or indirectly, any equity securities in a client bank, this
limitation does not apply to shares of a client bank acquired, directly
or indirectly, as a result of a default on a debt previously contracted.
This limitation is also inapplicable to shares of a client bank acquired
by a bank holding company, directly or indirectly, in a fiduciary
capacity: Provided, That the bank holding company or its subsidiary does
not have sole discretionary authority to vote such shares or shares held
with sole voting rights constitute not more than five percent of the
outstanding voting shares of a client bank.
[39 FR 8318, Mar. 5, 1974; 39 FR 21120, June 19, 1974]
Sec. 225.132 Acquisition of assets.
(a) From time to time questions have arisen as to whether and under
what circumstances a bank holding company engaged in nonbank activities,
directly or indirectly through a subsidiary, pursuant to section 4(c)(8)
of the Bank Holding Company Act of 1956, as amended (12 U.S.C.
1843(c)(3)), may acquire the assets and employees of another company,
without first obtaining Board approval pursuant to section 4(c) (8) and
the Board's Regulation Y (12 CFR 225.4(b)).
(b) In determining whether Board approval is required in connection
with the acquisition of assets, it is necessary to determine (a) whether
the acquisition is made in the ordinary course of business \1\ or (b)
whether it constitutes the acquisition, in whole or in part, of a going
concern.\2\
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\1\ Section 225.4(c)(3) of the Board's Regulation Y (12 CFR
225.4(c)(3)) generally prohibits a bank holding company or its
subsidiary engaged in activities pursuant to authority of section
4(c)(8) of the Act from being a party to any merger ``or acquisition of
assets other than in the ordinary course of business'' without prior
Board approval.
\2\ In accordance with the provisions of section 4(c)(8) of the Act
and Sec. 225.4(b) of Regulation Y, the acquisition of a going concern
requires prior Board approval.
---------------------------------------------------------------------------
(c) The following examples illustrate transactions where prior Board
approval will generally be required:
(1) The transaction involves the acquisition of all or substantially
all of the assets of a company, or a subsidiary, division, department or
office thereof.
(2) The transaction involves the acquisition of less than
``substantially all'' of the assets of a company, or a subsidiary,
division, department or office thereof, the operations of which are
being terminated or substantially discontinued by the seller, but such
asset acquisition is significant in relation to the size of the same
line of nonbank activity of the holding company (e.g., consumer finance
mortgage banking, data processing). For purposes of this interpretation,
an acquisition would generally be presumed to be significant if the book
value of the nonbank assets being acquired exceeds 50 percent of the
book value of the nonbank assets of the holding company or nonbank
subsidiary comprising the same line of activity.
(3) The transaction involves the acquisition of assets for resale
and the sale of such assets is not a normal business activity of the
acquiring holding company.
(4) The transaction involves the acquisition of the assets of a
company, or a subsidiary, division, department or office thereof, and a
major purpose of the transaction is to hire some of the seller's
principal employees who are expert, skilled and experienced in the
[[Page 142]]
business of the company being acquired.
(d) In some cases it may be difficult, due to the wide variety of
circumstances involving possible acquisition of assets, to determine
whether such acquisitions require prior Board approval. Bank holding
companies are encouraged to contact their local Reserve Bank for
guidance where doubt exists as to whether such an acquisition is in the
ordinary course of business or an acquisition, in whole or in part, of a
going concern.
[39 FR 35128, Sept. 30, 1974, as amended at Reg. Y, 57 FR 28779, June
29, 1992]
Sec. 225.133 Computation of amount invested in foreign corporations under general consent procedures.
For text of this interpretation, see Sec. 211.111 of this
subchapter.
[40 FR 43199, Sept. 19, 1975]
Sec. 225.134 Escrow arrangements involving bank stock resulting in a violation of the Bank Holding Company Act.
(a) In connection with a recent application to become a bank holding
company, the Board considered a situation in which shares of a bank were
acquired and then placed in escrow by the applicant prior to the Board's
approval of the application. The facts indicated that the applicant
company had incurred debt for the purpose of acquiring bank shares and
immediately after the purchase the shares were transferred to an
unaffiliated escrow agent with instructions to retain possession of the
shares pending Board action on the company's application to become a
bank holding company. The escrow agreement provided that, if the
application were approved by the Board, the escrow agent was to return
the shares to the applicant company; and, if the application were
denied, the escrow agent was to deliver the shares to the applicant
company's shareholders upon their assumption of debt originally incurred
by the applicant in the acquisition of the bank shares. In addition, the
escrow agreement provided that, while the shares were held in escrow,
the applicant could not exercise voting or any other ownership rights
with respect to those shares.
(b) On the basis of the above facts, the Board concluded that the
company had violated the prior approval provisions of section 3 of the
Bank Holding Company Act (``Act'') at the time that it made the initial
acquisition of bank shares and that, for purposes of the Act, the
company continued to control those shares in violation of the Act. In
view of these findings, individuals and bank holding companies should
not enter into escrow arrangements of the type described herein, or any
similar arrangement, without securing the prior approval of the Board,
since such action could constitute a violation of the Act.
(c) While the above represents the Board's conclusion with respect
to the particular escrow arrangement involved in the proposal presented,
the Board does not believe that the use of an escrow arrangement would
always result in a violation of the Act. For example, it appears that a
transaction whereby bank shares are placed in escrow pending Board
action on an application would not involve a violation of the Act so
long as title to such shares remains with the seller during the pendency
of the application; there are no other indicia that the applicant
controls the shares held in escrow; and, in the event of a Board denial
of the application, the escrow agreement provides that the shares would
be returned to the seller.
[41 FR 9859, Mar. 8, 1976. Correctly designated at 41 FR 12009, Mar. 23,
1976]
Sec. 225.136 Utilization of foreign subsidiaries to sell long-term debt obligations in foreign markets and to transfer the proceeds to their United States parent(s) for domestic purposes.
For text of this interpretation, see Sec. 211.112 of this
subchapter.
[42 FR 752, Jan. 4, 1977]
Sec. 225.137 Acquisitions of shares pursuant to section 4(c)(6) of the Bank Holding Company Act.
(a) The Board has received a request for an interpretation of
section 4(c)(6) of the Bank Holding Company Act
[[Page 143]]
(``Act'') \1\ in connection with a proposal under which a number of bank
holding companies would purchase interests in an insurance company to be
formed for the purpose of underwriting or reinsuring credit life and
credit accident and health insurance sold in connection with extensions
of credit by the stockholder bank holding companies and their
affiliates.
---------------------------------------------------------------------------
\1\ It should be noted that every Board Order granting approval
under section 4(c)(8) of the Act contains the following paragraph:
``This determination is subject . . . to the Board's authority to
require such modification or termination of the activities of a holding
company or any of its subsidiaries as the Board finds necessary to
assure compliance with the provisions and purposes of the Act and the
Board's regulations and orders issued thereunder, or to prevent evasion
thereof.''
The Board believes that, even apart from this Interpretation, this
language preserves the authority of the Board to require the revisions
contemplated in this Interpretation.
---------------------------------------------------------------------------
(b) Each participating holding company would own no more than 5
percent of the outstanding voting shares of the company. However, the
investment of each holding company would be represented by a separate
class of voting security, so that each stockholder would own 100 percent
of its respective class. The participating companies would execute a
formal ``Agreement Among Stockholders'' under which each would agree to
use its best efforts at all times to direct or recommend to customers
and clients the placement of their life, accident and health insurance
directly or indirectly with the company. Such credit-related insurance
placed with the company would be identified in the records of the
company as having been originated by the respective stockholder. A
separate capital account would be maintained for each stockholder
consisting of the original capital contribution increased or decreased
from time to time by the net profit or loss resulting from the insurance
business attributable to each stockholder. Thus, each stockholder would
receive a return on its investment based upon the claims experience and
profitability of the insurance business that it had itself generated.
Dividends declared by the board of directors of the company would be
payable to each stockholder only out of the earned surplus reflected in
the respective stockholder's capital account.
(c) It has been requested that the Board issue an interpretation
that section 4(c)(6) of the Act provides an exemption under which
participating bank holding companies may acquire such interests in the
company without prior approval of the Board.
(d) On the basis of a careful review of the documents submitted, in
light of the purposes and provisions of the Act, the Board has concluded
that section 4(c)(6) of the Act is inapplicable to this proposal and
that a bank holding company must obtain the approval of the Board before
participating in such a proposal in the manner described. The Board's
conclusion is based upon the following considerations:
(1) Section 2(a)(2)(A) of the Act provides that a company is deemed
to have control over a second company if it owns or controls ``25 per
centum or more of any class of voting securities'' of the second
company. In the case presented, the stock interest of each participant
would be evidenced by a different class of stock and each would
accordingly, own 100 percent of a class of voting securities of the
company. Thus, each of the stockholders would be deemed to ``control''
the company and prior Board approval would be required for each
stockholder's acquisition of stock in the company.
The Board believes that this application of section 2(a)(2)(A) of the
Act is particularly appropriate on the facts presented here. The company
is, in practical effect, a conglomeration of separate business ventures
each owned 100 percent by a stockholder the value of whose economic
interest in the company is determined by reference to the profits and
losses attributable to its respective class of stock. Furthermore, it is
the Board's opinion that this application of section 2(a)(2)(A) is not
inconsistent with section 4(c)(6). Even assuming that section (4)(c)(6)
is intended to refer to all outstanding voting shares, and not merely
the outstanding shares of a particular class of securities, section
4(c)(6) must be viewed as permitting ownership of 5 percent of a
company's voting stock only when that ownership does not
[[Page 144]]
constitute ``control'' as otherwise defined in the Act. For example, it
is entirely possible that a company could exercise a controlling
influence over the management and policies of a second company, and thus
``control'' that company under the Act's definitions, even though it
held less than 5 percent of the voting stock of the second company. To
view section 4(c)(6) as an unqualified exemption for holdings of less
than 5 percent would thus create a serious gap in the coverage of the
Act.
(2) The Board believes that section 4(c)(6) should properly be
interpreted as creating an exemption from the general prohibitions in
section 4 on ownership of stock in nonbank companies only for passive
investments amounting to not more than 5 percent of a company's
outstanding stock, and that the exemption was not intended to allow a
group of holding companies, through concerted action, to engage in an
activity as entrepreneurs. Section 4 of the Act, of course, prohibits
not only owning stock in nonbank companies, but engaging in activities
other than banking or those activities permitted by the Board under
section 4(c)(8) as being closely related to banking. Thus, if a holding
company may be deemed to be engaging in an activity through the medium
of a company in which it owns less than 5 percent of the voting stock it
may nevertheless require Board approval, despite the section 4(c)(6)
exemption.
(e) To accept the argument that section 4(c)(6) is an unqualified
grant of permission to a bank holding company to own 5 percent of the
shares of any nonbanking company irrespective of the nature or extent of
the holding company's participation in the affairs of the nonbanking
company would, in the Board's view, create the potential for serious and
widespread evasion of the Act's controls over nonbanking activities.
Such a construction would allow a group of 20 bank holding companies--or
even a single bank holding company and one or more nonbank companies--to
engage in entrepreneurial joint ventures in businesses prohibited to
bank holding companies, a result the Board believes to be contrary to
the intent of Congress.
(f) In this proposal, each of the participating stockholders must be
viewed as engaging in the business of insurance underwriting. Each
stockholder would agree to channel to the company the insurance business
it generates, and the value of the interest of each stockholder would be
determined by reference to the profitability of the business generated
by that stockholder itself. There is no sharing or pooling among
stockholders of underwriting risks assumed by the company, and profit or
loss from investments is allocated on the basis of each bank holding
company's allocable underwriting profit or loss. The interest of each
stockholder is thus clearly that of an entrepreneur rather than that of
an investor.
(g) Accordingly, on the basis of the factual situation before the
Board, and for the reasons summarized above, the Board has concluded
that section 4(c)(6) of the Act cannot be interpreted to exempt the
ownership of 5 percent of the voting stock of a company under the
circumstances described, and that a bank holding company wishing to
become a stockholder in a company under this proposal would be required
to obtain the Board's approval to do so.
[42 FR 1263, Jan. 6, 1977; 42 FR 2951, Jan. 14, 1977]
Sec. 225.138 Statement of policy concerning divestitures by bank holding companies.
(a) From time to time the Board of Governors receives requests from
companies subject to the Bank Holding Company Act, or other laws
administered by the Board, to extend time periods specified either by
statute or by Board order for the divestiture of assets held or
activities engaged in by such companies. Such divestiture requirements
may arise in a number of ways. For example, divestiture may be ordered
by the Board in connection with an acquisition found to have been made
in violation of law. In other cases the divestiture may be pursuant to a
statutory requirement imposed at the time and amendment to the Act was
adopted, or it may be required as a result of a foreclosure upon
collateral
[[Page 145]]
held by the company or a bank subsidiary in connection with a debt
previously contracted in good faith. Certain divestiture periods may be
extended in the discretion of the Board, but in other cases the Board
may be without statutory authority, or may have only limited authority,
to extend a specified divestiture period.
(b) In the past, divestitures have taken many different forms, and
the Board has followed a variety of procedures in enforcing divestiture
requirements. Because divestitures may occur under widely disparate
factual circumstances, and because such forced dispositions may have the
potential for causing a serious adverse economic impact upon the
divesting company, the Board believes it is important to maintain a
large measure of flexibility in dealing with divestitures. For these
reasons, there can be no fixed rule as to the type of divestiture that
will be appropriate in all situations. For example, where divestiture
has been ordered to terminate a control relationship created or
maintained in violation of the Act, it may be necessary to impose
conditions that will assure that the unlawful relationship has been
fully terminated and that it will not arise in the future. In other
circumstances, however, less stringent conditions may be appropriate.
(1) Avoidance of delays in divestitures. Where a specific time
period has been fixed for accomplishing divestiture, the affected
company should endeavor and should be encouraged to complete the
divestiture as early as possible during the specific period. There will
generally be substantial advantages to divesting companies in taking
steps to plan for and accomplish divestitures well before the end of the
divestiture period. For example, delays may impair the ability of the
company to realize full value for the divested assets, for as the end of
the divestiture period approaches the ``forced sale'' aspect of the
divestiture may lead potential buyers to withhold firm offers and to
bargain for lower prices. In addition, because some prospective
purchasers may themselves require regulatory approval to acquire the
divested property, delay by the divesting company may--by leaving
insufficient time to obtain such approvals--have the effect of narrowing
the range of prospective purchases. Thus, delay in planning for
divestiture may increase the likelihood that the company will seek an
extension of the time for divestiture if difficulty is encountered in
securing a purchaser, and in certain situations, of course, the Board
may be without statutory authority to grant extensions.
(2) Submissions and approval of divestiture plans. When a
divestiture requirement is imposed, the company affected should
generally be asked to submit a divestiture plan promptly for review and
approval by the Reserve Bank or the Board. Such a requirement may be
imposed pursuant to the Board's authority under section 5(b) of the Bank
Holding Company Act to issue such orders as may be necessary to enable
the Board to administer and carry out the purposes of the Act and
prevent evasions thereof. A divestiture plan should be as specific as
possible, and should indicate the manner in which divestiture will be
accomplished--for example, by a bulk sale of the assets to a third
party, by ``spinoff'' or distribution of shares to the shareholders of
the divesting company, or by termination of prohibited activities. In
addition, the plan should specify the steps the company expects to take
in effecting the divestiture and assuring its completeness, and should
indicate the time schedule for taking such steps. In appropriate
circumstances, the divestiture plan should make provision for assuring
that ``controlling influence'' relationships, such as management or
financial interlocks, will not continue to exist.
(3) Periodic progress reports. A company subject to a divestiture
requirement should generally be required to submit regular periodic
reports detailing the steps it has taken to effect divestiture. Such a
requirement may be imposed pursuant to the Board's authority under
section 5(b) of the Bank Holding Company Act, referred to above, as well
as its authority under section 5(c) of the Act to require reports for
the purpose of keeping the Board informed as to whether the Act and
Board regulations and order thereunder are being complied with. Reports
should set forth in detail such matters
[[Page 146]]
as the identities of potential buyers who have been approached by the
company, the dates of discussions with potential buyers and the
identities of the individuals involved in such discussions, the terms of
any offers received, and the reasons for rejecting any offers. In
addition, the reports should indicate whether the company has employed
brokers, investment bankers or others to assist in the divestiture, or
its reasons for not doing so, and should describe other efforts by the
company to seek out possible purchasers. The purpose of requiring such
reports is to insure that substantial and good faith efforts being made
by the company to satisfy its divestiture obligations. The frequency of
such reports may vary depending upon the nature of the divestiture and
the period specified for divestiture. However, such reports should
generally not be required less frequently than every three months, and
may in appropriate cases be required on a monthly or even more frequent
basis. Progress reports as well as divestiture plans should be afforded
confidential treatment.
(4) Extensions of divestiture periods. Certain divestiture periods--
such as December 31, 1980 deadline for divestitures required by the 1970
Amendments to the Bank Holding Company Act--are not extendable. In such
cases it is imperative that divestiture be accomplished in a timely
manner. In certain other cases, the Board may have discretion to extend
a statutorily prescribed divestiture period within specified limits. For
example, under section 4(c)(2) of the Act the Board may extend for three
one-year periods the two-year period in which a bank subsidiary of a
holding company is otherwise required to divest shares acquired in
satisfaction of a debt previously contracted in good faith. In such
cases, however, when the permissible extensions expire the Board no
longer has discretion to grant further extensions. In still other cases,
where a divestiture period is prescribed by the Board, in the exercise
of its regulatory judgment, the Board may have broader discretion to
grant extensions. Where extensions of specified divestiture periods are
permitted by law, extensions should not be granted except under
compelling circumstances. Neither unfavorable market conditions, nor the
possibility that the company may incur some loss, should alone be viewed
as constituting such circumstances--particularly if the company has
failed to take earlier steps to accomplish a divestiture under more
favorable circumstances. Normally, a request for an extension will not
be considered unless the company has established that it has made
substantial and continued good faith efforts to accomplish the
divestiture within the prescribed period. Furthermore, requests for
extensions of divestiture periods must be made sufficiently in advance
of the expiration of the prescribed period both to enable the Board to
consider the request in an orderly manner and to enable the company to
effect a timely divestiture in the event the request for extension is
denied. Companies subject to divestiture requirements should be aware
that a failure to accomplish a divestiture within the prescribed period
may in and of itself be viewed as a separate violation of the Act.
(5) Use of trustees. In appropriate cases a company subject to a
divestiture requirement may be required to place the assets subject to
divestiture with an independent trustee under instructions to accomplish
a sale by a specified date, by public auction if necessary. Such a
trustee may be given the responsibility for exercising the voting rights
with respect to shares being divested. The use of such a trustee may be
particularly appropriate where the divestiture is intended to terminate
a control relationship established or maintained in violation of law, or
where the divesting company has demonstrated an inability or
unwillingness to take timely steps to effect a divestiture.
(6) Presumptions of control. Bank holding companies contemplating a
divestiture should be mindful of section 2(g)(3) of the Bank Holding
Company Act, which creates a presumption of continued control over the
transferred assets where the transferee is indebted to the transferor,
or where certain interlocks exist, as well as Sec. 225.2 of Regulation
Y, which sets forth certain additional control presumptions. Where one
of these presumptions has
[[Page 147]]
arisen with respect to divested assets, the divestiture will not be
considered as complete until the presumption has been overcome. It
should be understood that the inquiry into the termination of control
relationships is not limited by the statutory and regulatory
presumptions of control, and that the Board may conclude that a control
relationship still exists even though the presumptions do not apply.
(7) Role of the Reserve Banks. The Reserve Banks have a
responsibility for supervising and enforcing divestitures. Specifically,
in coordination with Board staff they should review divestiture plans to
assure that proposed divestitures will result in the termination of
control relationships and will not create unsafe or unsound conditions
in any bank or bank holding company; they should monitor periodic
progress reports to assure that timely steps are being taken to effect
divestitures; and they should prompt companies to take such steps when
it appears that progress is not being made. Where Reserve Banks have
delegated authority to extend divestiture periods, that authority should
be exercised consistently with this policy statement.
[42 FR 10969, Feb. 25, 1977]
Sec. 225.139 Presumption of continued control under section 2(g)(3) of the Bank Holding Company Act.
(a) Section 2(g)(3) of the Bank Holding Company Act (the ``Act'')
establishes a statutory presumption that where certain specified
relationships exist between a transferor and transferee of shares, the
transferor (if it is a bank holding company, or a company that would be
such but for the transfer) continues to own or control indirectly the
transferred shares.\1\ This presumption arises by operation of law, as
of the date of the transfer, without the need for any order or
determination by the Board. Operation of the presumption may be
terminated only by the issuance of a Board determination, after
opportunity for hearing, ``that the transferor is not in fact capable of
controlling the transferee.'' \2\
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\1\ The presumption arises where the transferee ``is indebted to the
transferor, or has one or more officers, directors, trustees, or
beneficiaries in common with or subject to control by the transferor.''
\2\ The Board has delegated to its General Counsel the authority to
issue such determinations, 12 CFR 265.2(b)(1).
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(b) The purpose of section 2(g)(3) is to provide the Board an
opportunity to assess the effectiveness of divestitures in certain
situations in which there may be a risk that the divestiture will not
result in the complete termination of a control relationship. By
presuming control to continue as a matter of law, section 2(g)(3)
operates to allow the effectiveness of the divestiture to be assessed
before the divesting company is permitted to act on the assumption that
the divestiture is complete. Thus, for example, if a holding company
divests its banking interest under circumstances where the presumption
of continued control arises, the divesting company must continue to
consider itself bound by the Act until an appropriate order is entered
by the Board dispelling the presumption. Section 2(g)(3) does not
establish a substantive rule that invalidates transfers to which it
applies, and in a great many cases the Board has acted favorably on
applications to have the presumption dispelled. It merely provides a
procedural opportunity for Board consideration of the effect of such
transfers in advance of their being deemed effective. Whether or not the
statutory presumption arises, the substantive test for assessing the
effectiveness of a divestiture is the same--that is, the Board must be
assured that all control relationships between the transferor and the
transferred property have been terminated and will not be
reestablished.\3\
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\3\ It should be noted, however, that the Board will require
termination of any interlocking management relationships between the
divesting company and the transferee or the divested company as a
precondition of finding that a divestiture is complete. Similarly, the
retention of an economic interest in the divested company that would
create an incentive for the divesting company to attempt to influence
the management of the divested company will preclude a finding that the
divestiture is complete. (See the Board's Order in the matter of
``International Bank'', 1977 Federal Reserve Bulletin 1106, 1113.)
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[[Page 148]]
(c) In the course of administering section 2(g)(3) the Board has had
several occasions to consider the scope of that section. In addition,
questions have been raised by and with the Board's staff as to coverage
of the section. Accordingly, the Board believes it would be useful to
set forth the following interpretations of section 2(g)(3):
(1) The terms transferor and transferee, as used in section 2(g)(3),
include parents and subsidiaries of each. Thus, for example, where a
transferee is indebted to a subsidiary of the transferor, or where a
specified interlocking relationship exists between the transferor or
transferee and a subsidiary of the other (or between subsidiaries of
each), the presumption arises. Similarly, if a parent of the transferee
is indebted to a parent of the transferor, the presumption arises. The
presumption of continued control also arises where an interlock or debt
relationship is retained between the divesting company and the company
being divested, since the divested company will be or may be viewed as a
subsidiary of the transferee or group of transferees.
(2) The terms officers, directors, and trustees, as used in section
2(g)(3), include persons performing functions normally associated with
such positions (including general partners in a partnership and limited
partners having a right to participate in the management of the affairs
of the partnership) as well as persons holding such positions in an
advisory or honorary capacity. The presumption arises not only where the
transferee or transferred company has an officer, director or trustee in
common with the transferor, but where the transferee himself holds such
a position with the transferor. \4\ It should be noted that where a
transfer takes the form of a pro-rata distribution, or spin-off, of
shares to a company's shareholders, officers and directors of the
transferor company are likely to receive a portion of such shares. The
presumption of continued control would, of course, attach to any shares
transferred to officers and directors of the divesting company, whether
by spinoff or outright sale. However, the presumption will be of legal
significance--and will thus require an application under section
2(g)(3)--only where the total number of shares subject to the
presumption exceeds one of the applicable thresholds in the Act. For
example, where officers and directors of a one-bank holding company
receive in the aggregate 25 percent or more of the stock of a bank
subsidiary being divested by the holding company, the holding company
would be presumed to continue to control the divested bank. In such a
case it would be necessary for the divesting company to demonstrate that
it no longer controls either the divested bank or the officer/director
transferees. However, if officers and directors were to receive in the
aggregate less than 25 percent of the bank's stock (and no other shares
were subject to the presumption), section 2(g)(3) would not have the
legal effect of presuming continued control of the bank.\5\ In the case
of a divestiture of nonbank shares, an application under section 2(g)(3)
would be required whenever officers and directors of the divesting
company received in the aggregate more than 5 percent of the shares of
the company being divested.
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\4\ It has been suggested that the words in common with in section
2(g)(3) evidence an intent to make the presumption applicable only where
the transferee is a company having an interlock with the transferor.
Such an interpretation would, in the Board's view, create an unwarranted
gap in the coverage of section 2(g)(3). Furthermore, because the
presumption clearly arises where the transferee is an individual who is
indebted to the transferor such an interpretation would result in an
illogical internal inconsistency in the statute.
\5\ Of course, the fact that section 2(g)(3) would not operate to
presume continued control would not necessarily mean that control had in
fact been terminated if control could be exercised through other means.
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(3) Although section 2(g)(3) refers to transfers of shares it is
not, in the Board's view, limited to disposition of corporate stock.
General or limited partnership interests, for example, are included
within the term shares. Furthermore, the transfer of all or
substantially all of the assets of a company, or the transfer of such a
significant volume of assets that the transfer may in effect constitute
the disposition
[[Page 149]]
of a separate activity of the company, is deemed by the Board to involve
a transfer of shares of that company.
(4) The term indebtedness giving rise to the presumption of
continued control under section 2(g)(3) of the Act is not limited to
debt incurred in connection with the transfer; it includes any debt
outstanding at the time of transfer from the transferee to the
transferor or its subsidiaries. However, the Board believes that not
every kind of indebtedness was within the contemplation of the Congress
when section 2(g)(3) was adopted. Routine business credit of limited
amounts and loans for personal or household purposes are generally not
the kinds of indebtedness that, standing alone, support a presumption
that the creditor is able to control the debtor. Accordingly, the Board
does not regard the presumption of section 2(g)(3) as applicable to the
following categories of credit, provided the extensions of credit are
not secured by the transferred property and are made in the ordinary
course of business of the transferor (or its subsidiary) that is
regularly engaged in the business of extending credit:
(i) Consumer credit extended for personal or household use to an
individual transferee; (ii) student loans made for the education of the
individual transferee or a spouse or child of the transferee; (iii) a
home mortgage loan made to an individual transferee for the purchase of
a residence for the individual's personal use and secured by the
residence; and (iv) loans made to companies (as defined in section 2(b)
of the Act) in an aggregate amount not exceeding ten per cent of the
total purchase price (or if not sold, the fair market value) of the
transferred property. The amounts and terms of the preceding categories
of credit should not differ substantially from similar credit extended
in comparable circumstances to others who are not transferees. It should
be understood that, while the statutory presumption in situations
involving these categories of credit may not apply, the Board is not
precluded in any case from examining the facts of a particular transfer
and finding that the divestiture of control was ineffective based on the
facts of record.
(d) Section 2(g)(3) provides that a Board determination that a
transferor is not in fact capable of controlling a transferee shall be
made after opportunity for hearing. It has been the Board's routine
practice since 1966 to publish notice in the Federal Register of
applications filed under section 2(g)(3) and to offer interested parties
an opportunity for a hearing. Virtually without exception no comments
have been submitted on such applications by parties other than the
applicant and, with the exception of one case in which the request was
later withdrawn, no hearings have been requested in such cases. Because
the Board believes that the hearing provision in section 2(g)(3) was
intended as a protection for applicants who are seeking to have the
presumption overcome by a Board order, a hearing would not be of use
where an application is to be granted. In light of the experience
indicating that the publication of Federal Register notice of such
applications has not served a useful purpose, the Board has decided to
alter its procedures in such cases. In the future, Federal Register
notice of section 2(g)(3) applications will be published only in cases
in which the Board's General Counsel, acting under delegated authority,
has determined not to grant such an application and has referred the
matter to the Board for decision.\6\
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\6\ It should be noted that in the event a third party should take
exception to a Board order under section 2(g)(3) finding that control
has been terminated, any rights such party might have would not be
prejudiced by the order. If such party brought facts to the Board's
attention indicating that control had not been terminated the Board
would have ample authority to revoke its order and take necessary
remedial action.
Orders issued under section 2(g)(3) are published in the Federal
Reserve ``Bulletin.''
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(12 U.S.C. 1841, 1844)
[43 FR 6214, Feb. 14, 1978; 43 FR 15147, Apr. 11, 1978; 43 FR 15321,
Apr. 12, 1978, as amended at 45 FR 8280, Feb. 7, 1980; 45 FR 11125, Feb.
20, 1980]
Sec. 225.140 Disposition of property acquired in satisfaction of debts previously contracted.
(a) The Board recently considered the permissibility, under section
4 of the
[[Page 150]]
Bank Holding Company Act, of a subsidiary of a bank holding company
acquiring and holding assets acquired in satisfaction of a debt
previously contracted in good faith (a ``dpc'' acquisition). In the
situation presented, a lending subsidiary of a bank holding company made
a ``dpc'' acquisition of assets and transferred them to a wholly-owned
subsidiary of the bank holding company for the purpose of effecting an
orderly divestiture. The question presented was whether such ``dpc''
assets could be held indefinitely by a bank holding company subsidiary
as incidental to its permissible lending activity.
(b) While the Board believes that ``dpc'' acquisitions may be
regarded as normal, necessary and incidental to the business of lending,
the Board does not believe that the holding of assets acquired ``dpc''
without any time restrictions is appropriate from the standpoint of
prudent banking and in light of the prohibitions in section 4 of the Act
against engaging in nonbank activities. If a nonbanking subsidiary of a
bank holding company were permitted, either directly or through a
subsidiary, to hold ``dpc'' assets of substantial amount over an
extended period of time, the holding of such property could result in an
unsafe or unsound banking practice or in the holding company engaging in
an impermissible activity in connection with the assets, rather than
liquidating them.
(c) The Board notes that section 4(c)(2) of the Bank Holding Company
Act provides an exemption from the prohibitions of section 4 of the Act
for bank holding company subsidiaries to acquire shares ``dpc''. It also
provides that such ``dpc'' shares may be held for a period of two years,
subject to the Board's authority to grant three one-year extensions up
to a maximum of five years.\1\ Viewed in light of the Congressional
policy evidenced by section 4(c)(2), the Board believes that a lending
subsidiary of a bank holding company or the holding company itself,
should be permitted, as an incident to permissible lending activities,
to make acquisitions of ``dpc'' assets. Consistent with the principles
underlying the provisions of section 4(c)(2) of the Act and as a matter
of prudent banking practice, such assets may be held for no longer than
five years from the date of acquisition. Within the divestiture period
it is expected that the company will make good faith efforts to dispose
of ``dpc'' shares or assets at the earliest practicable date. While no
specific authorization is necessary to hold such assets for the five-
year period, after two years from the date of acquisition of such
assets, the holding company should report annually on its efforts to
accomplish divestiture to its Reserve Bank. The Reserve Bank will
monitor the efforts of the company to effect an orderly divestiture, and
may order divestiture before the end of the five-year period if
supervisory concerns warrant such action.
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\1\ The Board notes that where the dpc shares or other similar
interests represent less than 5 percent of the total of such interests
outstanding, they may be retained on the basis of section 4(c)(6), even
if originally acquired dpc.
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(d) The Board recognizes that there are instances where a company
may encounter particular difficulty in attempting to effect an orderly
divestiture of ``dpc'' real estate holdings within the divestiture
period, notwithstanding its persistent good faith efforts to dispose of
such property. In the Depository Institutions Deregulation and Monetary
Control Act of 1980, (Pub. L. 96-221) Congress, recognizing that real
estate possesses unusual characteristics, amended the National Banking
Act to permit national banks to hold real estate for five years and for
an additional five-year period subject to certain conditions. Consistent
with the policy underlying the recent Congressional enactment, and as a
matter of supervisory policy, a bank holding company may be permitted to
hold real estate acquired ``dpc'' beyond the initial five-year period
provided that the value of the real estate on the books of the company
has been written down to fair market value, the carrying costs are not
significant in relation to the overall financial position of the
company, and the company has made good faith efforts to effect
divestiture. Companies holding real estate for this extended period are
expected to make active efforts to dispose of it, and should keep the
Reserve Bank advised
[[Page 151]]
on a regular basis concerning their ongoing efforts. Fair market value
should be derived from appraisals, comparable sales or some other
reasonable method. In any case, ``dpc'' real estate would not be
permitted to be held beyond 10 years from the date of its acquisition.
(e) With respect to the transfer by a subsidiary of other ``dpc''
shares or assets to another company in the holding company system,
including a section 4(c)(1)(D) liquidating subsidiary, or to the holding
company itself, such transfers would not alter the original divestiture
period applicable to such shares or assets at the time of their
acquisition. Moreover, to ensure that assets are not carried at inflated
values for extended periods of time, the Board expects, in the case of
all such intracompany transfers, that the shares or assets will be
transferred at a value no greater than the fair market value at the time
of transfer and that the transfer will be made in a normal arms-length
transaction.
(f) With regard to ``dpc'' assets acquired by a banking subsidiary
of a holding company, so long as the assets continue to be held by the
bank itself, the Board will regard them as being solely within the
regulatory authority of the primary supervisor of the bank.
(12 U.S.C. 1843 (c)(1)(d), (c)(2), (c)(8), and 1844 (b); 12 U.S.C. 1818)
[45 FR 49905, July 28, 1980]
Sec. 225.141 Operations subsidiaries of a bank holding company.
In orders approving the retention by a bank holding company of a
4(c)(8) subsidiary, the Board has stated that it would permit, without
any specific regulatory approval, the formation of a wholly owned
subsidiary of an approved 4(c)(8) company to engage in activities that
such a company could itself engage in directly through a division or
department. (Northwestern Financial Corporation, 65 Federal Reserve
Bulletin 566 (1979).) Section 4(a)(2) of the Act provides generally that
a bank holding company may engage directly in the business of managing
and controlling banks and permissible nonbank activities, and in
furnishing services directly to its subsidiaries. Even though section 4
of the Act generally prohibits the acquisition of shares of nonbanking
organizations, the Board does not believe that such prohibition should
apply to the formation by a holding company of a wholly-owned subsidiary
to engage in activities that it could engage in directly. Accordingly,
as a general matter, the Board will permit without any regulatory
approval a bank holding company to form a wholly-owned subsidiary to
perform servicing activities for subsidiaries that the holding company
itself could perform directly or through a department or a division
under section 4(a)(2) of the Act. The Board believes that permitting
this type of subsidiary is not inconsistent with the nonbanking
prohibitions of section 4 of the Act, and is consistent with the
authority in section 4(c)(1)(C) of the Act, which permits a bank holding
company, without regulatory approval, to form a subsidiary to perform
services for its banking subsidiaries. The Board notes, however, that a
servicing subsidiary established by a bank holding company in reliance
on this interpretation will be an affiliate of the subsidiary bank of
the holding company for the purposes of the lending restrictions of
section 23A of the Federal Reserve Act. (12 U.S.C. 371c)
(12 U.S.C. 1843(a)(2) and 1844(b))
[45 FR 54326, July 15, 1980]
Sec. 225.142 Statement of policy concerning bank holding companies engaging in futures, forward and options contracts on U.S. Government and agency securities and money market instruments.
(a) Purpose of financial contract positions. In supervising the
activities of bank holding companies, the Board has adopted and
continues to follow the principle that bank holding companies should
serve as a source of strength for their subsidiary banks. Accordingly,
the Board believes that any positions that bank holding companies or
their nonbank subsidiaries take in financial contracts should reduce
risk exposure, that is, not be speculative.
(b) Establishment of prudent written policies, appropriate
limitations and internal controls and audit programs. If the parent
organization or nonbank subsidiary is taking or intends to take
positions in financial contracts, that
[[Page 152]]
company's board of directors should approve prudent written policies and
establish appropriate limitations to insure that financial contract
activities are performed in a safe and sound manner with levels of
activity reasonably related to the organization's business needs and
capacity to fulfill obligations. In addition, internal controls and
internal audit programs to monitor such activity should be established.
The board of directors, a duly authorized committee thereof or the
internal auditors should review periodically (at least monthly) all
financial contract positions to insure conformity with such policies and
limits. In order to determine the company's exposure, all open positions
should be reviewed and market values determined at least monthly, or
more often, depending on volume and magnitude of positions.
(c) Formulating policies and recording financial contracts. In
formulating its policies and procedures, the parent holding company may
consider the interest rate exposure of its nonbank subsidiaries, but not
that of its bank subsidiaries. As a matter of policy, the Board believes
that any financial contracts executed to reduce the interest rate
exposure of a bank affiliate of a holding company should be reflected on
the books and records of the bank affiliate (to the extent required by
the bank policy statements), rather than on the books and records of the
parent company. If a bank has an interest rate exposure that management
believes requires hedging with financial contracts, the bank should be
the direct beneficiary of any effort to reduce that exposure. The Board
also believes that final responsibility for financial contract
transactions for the account of each affiliated bank should reside with
the management of that bank.
(d) Accounting. The joint bank policy statements of March 12, 1980
include accounting guidelines for banks that engage in financial
contract activities. Since the Financial Accounting Standards Board is
presently considering accounting standards for contract activities, no
specific accounting requirements for financial contracts entered into by
parent bank holding companies and nonbank subsidiaries are being
mandated at this time. The Board expects to review further developments
in this area.
(e) Board to monitor bank holding company transactions in financial
contracts. The Board intends to monitor closely bank holding company
transactions in financial contracts to ensure that any such activity is
consistent with maintaining a safe and sound banking system. In any
cases where bank holding companies are found to be engaging in
speculative practices, the Board is prepared to institute appropriate
action under the Financial Institutions Supervisory Act of 1966, as
amended.
(f) Federal Reserve Bank notification. Bank holding companies should
furnish written notification to their District Federal Reserve Bank
within 10 days after financial contract activities are begun by the
parent or a nonbank subsidiary. Holding companies in which the parent or
a nonbank subsidiary currently engage in financial contract activity
should furnish notice by March 31, 1983.
(Secs. 5(b) and 8 of the Bank Holding Company Act (12 U.S.C. 1844 and
1847); sec. 8(b) of the Financial Institutions Supervisory Act (12
U.S.C. 1818(b))
[48 FR 7720, Feb. 24, 1983]
Sec. 225.143 Policy statement on nonvoting equity investments by bank holding companies.
(a) Introduction. (1) In recent months, a number of bank holding
companies have made substantial equity investments in a bank or bank
holding company (the ``acquiree'') located in states other than the home
state of the investing company through acquisition of preferred stock or
nonvoting common shares of the acquiree. Because of the evident interest
in these types of investments and because they raise substantial
questions under the Bank Holding Company Act (the ``Act''), the Board
believes it is appropriate to provide guidance regarding the consistency
of such arrangements with the Act.
(2) This statement sets out the Board's concerns with these
investments, the considerations the Board will take into account in
determining whether the investments are consistent with the Act, and the
general scope of
[[Page 153]]
arrangements to be avoided by bank holding companies. The Board
recognizes that the complexity of legitimate business arrangements
precludes rigid rules designed to cover all situations and that
decisions regarding the existence or absence of control in any
particular case must take into account the effect of the combination of
provisions and covenants in the agreement as a whole and the particular
facts and circumstances of each case. Nevertheless, the Board believes
that the factors outlined in this statement provide a framework for
guiding bank holding companies in complying with the requirements of the
Act.
(b) Statutory and regulatory provisions. (1) Under section 3(a) of
the Act, a bank holding company may not acquire direct or indirect
ownership or control of more than 5 per cent of the voting shares of a
bank without the Board's prior approval. (12 U.S.C. 1842(a)(3)). In
addition, this section of the Act provides that a bank holding company
may not, without the Board's prior approval, acquire control of a bank:
That is, in the words of the statute, ``for any action to be taken that
causes a bank to become a subsidiary of a bank holding company.'' (12
U.S.C. 1842(a)(2)). Under the Act, a bank is a subsidiary of a bank
holding company if:
(i) The company directly or indirectly owns, controls, or holds with
power to vote 25 per cent or more of the voting shares of the bank;
(ii) The company controls in any manner the election of a majority
of the board of directors of the bank; or
(iii) The Board determines, after notice and opportunity for
hearing, that the company has the power, directly or indirectly, to
exercise a controlling influence over the management or policies of the
bank. (12 U.S.C. 1841(d)).
(2) In intrastate situations, the Board may approve bank holding
company acquisitions of additional banking subsidiaries. However, where
the acquiree is located outside the home state of the investing bank
holding company, section 3(d) of the Act prevents the Board from
approving any application that will permit a bank holding company to
``acquire, directly or indirectly, any voting shares of, interest in, or
all or substantially all of the assets of any additional bank.'' (12
U.S.C. 1842(d)(1)).
(c) Review of agreements. (1) In apparent expectation of statutory
changes that might make interstate banking permissible, bank holding
companies have sought to make substantial equity investments in other
bank holding companies across state lines, but without obtaining more
than 5 per cent of the voting shares or control of the acquiree. These
investments involve a combination of the following arrangements:
(i) Options on, warrants for, or rights to convert nonvoting shares
into substantial blocks of voting securities of the acquiree bank
holding company or its subsidiary bank(s);
(ii) Merger or asset acquisition agreements with the out-of-state
bank or bank holding company that are to be consummated in the event
interstate banking is permitted;
(iii) Provisions that limit or restrict major policies, operations
or decisions of the acquiree; and
(iv) Provisions that make acquisition of the acquiree or its
subsidiary bank(s) by a third party either impossible or economically
impracticable.
The various warrants, options, and rights are not exercisable by the
investing bank holding company unless interstate banking is permitted,
but may be transferred by the investor either immediately or after the
passage of a period of time or upon the occurrence of certain events.
(2) After a careful review of a number of these agreements, the
Board believes that investments in nonvoting stock, absent other
arrangements, can be consistent with the Act. Some of the agreements
reviewed appear consistent with the Act since they are limited to
investments of relatively moderate size in nonvoting equity that may
become voting equity only if interstate banking is authorized.
(3) However, other agreements reviewed by the Board raise
substantial problems of consistency with the control provisions of the
Act because the investors, uncertain whether or when interstate banking
may be authorized, have evidently sought to assure the soundness of
their investments, prevent takeovers by others, and allow for
[[Page 154]]
sale of their options, warrants, or rights to a person of the investor's
choice in the event a third party obtains control of the acquiree or the
investor otherwise becomes dissatisfied with its investment. Since the
Act precludes the investors from protecting their investments through
ownership or use of voting shares or other exercise of control, the
investors have substituted contractual agreements for rights normally
achieved through voting shares.
(4) For example, various covenants in certain of the agreements seek
to assure the continuing soundness of the investment by substantially
limiting the discretion of the acquiree's management over major policies
and decisions, including restrictions on entering into new banking
activities without the investor's approval and requirements for
extensive consultations with the investor on financial matters. By their
terms, these covenants suggest control by the investing company over the
management and policies of the acquiree.
(5) Similarly, certain of the agreements deprive the acquiree bank
holding company, by covenant or because of an option, of the right to
sell, transfer, or encumber a majority or all of the voting shares of
its subsidiary bank(s) with the aim of maintaining the integrity of the
investment and preventing takeovers by others. These long-term
restrictions on voting shares fall within the presumption in the Board's
Regulation Y that attributes control of shares to any company that
enters into any agreement placing long-term restrictions on the rights
of a holder of voting securities. (12 CFR 225.2(b)(4)).
(6) Finally, investors wish to reserve the right to sell their
options, warrants or rights to a person of their choice to prevent being
locked into what may become an unwanted investment. The Board has taken
the position that the ability to control the ultimate disposition of
voting shares to a person of the investor's choice and to secure the
economic benefits therefrom indicates control of the shares under the
Act.\1\ Moreover, the ability to transfer rights to large blocks of
voting shares, even if nonvoting in the hands of the investing company,
may result in such a substantial position of leverage over the
management of the acquiree as to involve a structure that inevitably
results in control prohibited by the Act.
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\1\ See Board letter dated March 18, 1982, to C. A. Cavendes,
Sociedad Financiera.
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(d) Provisions that avoid control. (1) In the context of any
particular agreement, provisions of the type described above may be
acceptable if combined with other provisions that serve to preclude
control. The Board believes that such agreements will not be consistent
with the Act unless provisions are included that will preserve
management's discretion over the policies and decisions of the acquiree
and avoid control of voting shares.
(2) As a first step towards avoiding control, covenants in any
agreement should leave management free to conduct banking and
permissible nonbanking activities. Another step to avoid control is the
right of the acquiree to ``call'' the equity investment and options or
warrants to assure that covenants that may become inhibiting can be
avoided by the acquiree. This right makes such investments or agreements
more like a loan in which the borrower has a right to escape covenants
and avoid the lender's influence by prepaying the loan.
(3) A measure to avoid problems of control arising through the
investor's control over the ultimate disposition of rights to
substantial amounts of voting shares of the acquiree would be a
provision granting the acquiree a right of first refusal before
warrants, options or other rights may be sold and requiring a public and
dispersed distribution of these rights if the right of first refusal is
not exercised.
(4) In this connection, the Board believes that agreements that
involve rights to less than 25 percent of the voting shares, with a
requirement for a dispersed public distribution in the event of sale,
have a much greater prospect of achieving consistency with the Act than
agreements involving a greater percentage. This guideline is drawn by
analogy from the provision in the Act that ownership of 25 percent or
more of the voting securities of a bank constitutes control of the bank.
[[Page 155]]
(5) The Board expects that one effect of this guideline would be to
hold down the size of the nonvoting equity investment by the investing
company relative to the acquiree's total equity, thus avoiding the
potential for control because the investor holds a very large proportion
of the acquiree's total equity. Observance of the 25 percent guideline
will also make provisions in agreements providing for a right of first
refusal or a public and widely dispersed offering of rights to the
acquiree's shares more practical and realistic.
(6) Finally, certain arrangements should clearly be avoided
regardless of other provisions in the agreement that are designed to
avoid control. These are:
(i) Agreements that enable the investing bank holding company (or
its designee) to direct in any manner the voting of more than 5 per cent
of the voting shares of the acquiree;
(ii) Agreements whereby the investing company has the right to
direct the acquiree's use of the proceeds of an equity investment by the
investing company to effect certain actions, such as the purchase and
redemption of the acquiree's voting shares; and
(iii) The acquisition of more than 5 per cent of the voting shares
of the acquiree that ``simultaneously'' with their acquisition by the
investing company become nonvoting shares, remain nonvoting shares while
held by the investor, and revert to voting shares when transferred to a
third party.
(e) Review by the Board. This statement does not constitute the
exclusive scope of the Board's concerns, nor are the considerations with
respect to control outlined in this statement an exhaustive catalog of
permissible or impermissible arrangements. The Board has instructed its
staff to review agreements of the kind discussed in this statement and
to bring to the Board's attention those that raise problems of
consistency with the Act. In this regard, companies are requested to
notify the Board of the terms of such proposed merger or asset
acquisition agreements or nonvoting equity investments prior to their
execution or consummation.
[47 FR 30966, July 16, 1982]
Sec. 225.145 Limitations established by the Competitive Equality Banking Act of 1987 on the activities and growth of nonbank banks.
(a) Introduction. Effective August 10, 1987, the Competitive
Equality Banking Act of 1987 (``CEBA'') redefined the term ``bank'' in
the Bank Holding Company Act (``BHC Act'' or ``Act'') to include any
bank the deposits of which are insured by the Federal Deposit Insurance
Corporation as well as any other institution that accepts demand or
checkable deposit accounts and is engaged in the business of making
commercial loans. 12 U.S.C. 1841(c). CEBA also contained a grandfather
provision for certain companies affected by this redefinition. CEBA
amended section 4 of the BHC Act to permit a company that on March 5,
1987, controlled a nonbank bank (an institution that became a bank as a
result of enactment of CEBA) and that was not a bank holding company on
August 9, 1987, to retain its nonbank bank and not be treated as a bank
holding company for purposes of the BHC Act if the company and its
subsidiary nonbank bank observe certain limitations imposed by CEBA.\1\
Certain of these limitations are codified in section 4(f)(3) of the BHC
Act and generally restrict nonbank banks from commencing new activities
or certain cross-marketing activities with affiliates after March 5,
1987, or permitting overdrafts for affiliates or incurring overdrafts on
behalf of affiliates at a Federal Reserve Bank. 12 U.S.C. 1843(f)(3).\2\
The Board's views regarding
[[Page 156]]
the meaning and scope of these limitations are set forth below and in
provisions of the Board's Regulation Y (12 CFR 225.52).
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\1\ 12 U.S.C. 1843(f). Such a company is treated as a bank holding
company, however, for purposes of the anti-tying provisions in section
106 of the BHC Act Amendments of 1970 (12 U.S.C. 1971 et seq.) and the
insider lending limitations of secton 22(h) of the Federal Reserve Act
(12 U.S.C. 375b). The company is also subject to certain examination and
enforcement provisions to assure compliance with CEBA.
\2\ CEBA also prohibits, with certain limited exceptions, a company
controlling a grandfathered nonbank bank from acquiring control of an
additional bank or thrift institution or acquiring, directly or
indirectly after March 5, 1987, more than 5 percent of the assets or
shares of a bank or thrift institution. 12 U.S.C. 1843(f)(2).
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(b) Congressional findings. (1) At the outset, the Board notes that
the scope and application of the Act's limitations on nonbank banks must
be guided by the Congressional findings set out in section 4(f)(3) of
the BHC Act. Congress was aware that these nonbank banks had been
acquired by companies that engage in a wide range of nonbanking
activities, such as retailing and general securities activities that are
forbidden to bank holding companies under section 4 of the BHC Act. In
section 4(f)(3), Congress found that nonbank banks controlled by
grandfathered nonbanking companies may, because of their relationships
with affiliates, be involved in conflicts of interest, concentration of
resources, or other effects adverse to bank safety and soundness.
Congress also found that nonbank banks may be able to compete unfairly
against banks controlled by bank holding companies by combining banking
services with financial services not permissible for bank holding
companies. Section 4(f)(3) states that the purpose of the nonbank bank
limitations is to minimize any such potential adverse effects or
inequities by restricting the activities of nonbank banks until further
Congressional action in the area of bank powers could be undertaken.
Similarly, the Senate Report accompanying CEBA states that the
restrictions CEBA places on nonbank banks ``will help prevent existing
nonbank banks from changing their basic character * * * while Congress
considers proposals for comprehensive legislation; from drastically
eroding the separation of banking and commerce; and from increasing the
potential for unfair competition, conflicts of interest, undue
concentration of resources, and other adverse effects.'' S. Rep. No.
100-19, 100th Cong., 1st Sess. 12 (1987). See also H. Rep. No. 100-261,
100th Cong., 1st Sess. 124 (1987) (the ``Conference Report'').
(2) Thus, Congress explicitly recognized in the statute itself that
nonbanking companies controlling grandfathered nonbank banks, which
include the many of the nation's largest commercial and financial
organizations, were being accorded a significant competitive advantage
that could not be matched by bank holding companies because of the
general prohibition against nonbanking activities in section 4 of the
BHC Act. Congress recognized that this inequality in regulatory approach
could inflict serious competitive harm on regulated bank holding
companies as the grandfathered entities sought to exploit potential
synergies between banking and commercial products and services. See
Conference Report at 125-126. The basic and stated purpose of the
restrictions on grandfathered nonbank banks is to minimize these
potential anticompetitive effects.
(3) The Board believes that the specific CEBA limitations should be
implemented in light of these Congressional findings and the legislative
intent reflected in the plain meaning of the terms used in the statute.
In those instances when the language of the statute did not provide
clear guidance, legislative materials and the Congressional intent
manifested in the overall statutory structure were considered. The Board
also notes that prior precedent requires that grandfather exceptions in
the BHC Act, such as the nonbank bank limitations and particularly the
exceptions thereto, are to be interpreted narrowly in order to ensure
the proper implementation of Congressional intent.\3\
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\3\ E.g., Maryland National Corporation, 73 Federal Reserve Bulletin
310, 313-314 (1987). Cf., Spokane & Inland Empire Railroad Co. v. United
States, 241 U.S. 344, 350 (1915).
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(c) Activity limitation--(1) Scope of activity. (i) The first
limitation established under section 4(f)(3) provides that a nonbank
bank shall not ``engage in any activity in which such bank was not
lawfully engaged as of March 5, 1987.'' The term activity as used in
this provision of CEBA is not defined. The structure and placement of
the CEBA activity restriction within section 4 of the BHC Act and its
legislative history do, however, provide direction as to certain
transactions that Congress intended to treat as separate activities,
thereby providing guidance as to the meaning Congress intended to
ascribe
[[Page 157]]
to the term generally. First, it is clear that the term activity was not
meant to refer to banking as a single activity. To the contrary, the
term must be viewed as distinguishing between deposit taking and lending
activities and treating demand deposit-taking as a separate activity
from general deposit-taking and commercial lending as separate from the
general lending category.
(ii) Under the activity limitation, a nonbank bank may engage only
in activities in which it was ``lawfully engaged'' as of March 5, 1987.
As of that date, a nonbank bank could not have been engaged in both
demand deposit-taking and commercial lending activity without placing it
and its parent holding company in violation of the BHC Act. Thus, under
the activity limitations, a nonbank bank could not after March 5, 1987,
commence the demand deposit-taking or commercial lending activity that
it did not conduct as of March 5, 1987. The debates and Senate and
Conference Reports on CEBA confirm that Congress intended the activity
limitation to prevent a grandfathered nonbank bank from converting
itself into a full-service bank by both offering demand deposits and
engaging in the business of making commercial loans.\4\ Thus, these
types of transactions provide a clear guide as to the type of banking
transactions that would constitute activities under CEBA and the degree
of specificity intended by Congress in interpreting that term.
---------------------------------------------------------------------------
\4\ Conference Report at 124-25; S. Rep. No. 100-19 at 12, 32; H.
Rep. No. 99-175, 99th Cong., 1st Sess. 3 (1985) (``the activities
limitation is to prevent an institution engaged in a limited range of
functions from expanding into new areas and becoming, in essence, a
full-service bank''); 133 Cong. Rec. S4054 (daily ed. March 27, 1987);
(Comments of Senator Proxmire).
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(iii) It is also clear that the activity limitation was not intended
simply to prevent a nonbank bank from both accepting demand deposits and
making commercial loans; it has a broader scope and purpose. If Congress
had meant the term to refer to just these two activities, it would have
used the restriction it used in another section of CEBA dealing with
nonbank banks owned by bank holding companies which has this result,
i.e., the nonbank bank could not engage in any activity that would have
caused it to become a bank under the prior bank definition in the Act.
See 12 U.S.C. 1843(g)(1)(A). Indeed, an earlier version of CEBA under
consideration by the Senate Banking Committee contained such a provision
for nonbank banks owned by commercial holding companies, which was
deleted in favor of the broader activity limitation actually enacted.
Committee Print No. 1, (Feb. 17, 1987). In this regard, both the Senate
Report and Conference Report refer to demand deposit-taking and
commercial lending as examples of activities that could be affected by
the activity limitation, not as the sole activities to be limited by the
provision.\5\
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\5\ Conference Report at 124-125; S. Rep. No. 100-19 at 32.
---------------------------------------------------------------------------
(iv) Finally, additional guidance as to the meaning of the term
activity is provided by the statutory context in which the term appears.
The activity limitation is contained in section 4 of the BHC Act, which
regulates the investments and activities of bank holding companies and
their nonbank subsidiaries. The Board believes it reasonable to conclude
that by placing the CEBA activity limitation in section 4 of the BHC
Act, Congress meant that Board and judicial decisions regarding the
meaning of the term activity in that section be looked to for guidance.
This is particularly appropriate given the fact that grandfathered
nonbank banks, whether owned by bank holding companies or unregulated
holding companies, were treated as nonbank companies and not banks
before enactment of CEBA.
(v) This interpretation of the term activity draws support from
comments by Senator Proxmire during the Senate's consideration of the
provision that the term was not intended to apply ``on a product-by-
product, customer-by-customer basis.'' 133 Cong. Rec. S4054-5 (daily ed.
March 27, 1987). This is the same manner in which the Board has
interpreted the term activity in the nonbanking provision of section 4
as referring to generic categories
[[Page 158]]
of activities, not to discrete products and services.
(vi) Accordingly, consistent with the terms and purposes of the
legislation and the Congressional intent to minimize unfair competition
and the other adverse effects set out in the CEBA findings, the Board
concludes that the term activity as used in section 4(f)(3) means any
line of banking or nonbanking business. This definition does not,
however, envision a product-by-product approach to the activity
limitation. The Board believes it would be helpful to describe the
application of the activity limitation in the context of the following
major categories of activities: deposit-taking, lending, trust, and
other activities engaged in by banks.
(2) Deposit-taking activities. (i) With respect to deposit-taking,
the Board believes that the activity limitation in section 4(f)(3)
generally refers to three types of activity: demand deposit-taking; non-
demand deposit-taking with a third party payment capability; and time
and savings deposit-taking without third party payment powers. As
previously discussed, it is clear from the terms and intent of CEBA that
the activity limitation would prevent, and was designed to prevent,
nonbank banks that prior to the enactment of CEBA had refrained from
accepting demand deposits in order to avoid coverage as a bank under the
BHC Act, from starting to take these deposits after enactment of CEBA
and thus becoming full-service banks. Accordingly, CEBA requires that
the taking of demand deposits be treated as a separate activity.
(ii) The Board also considers nondemand deposits withdrawable by
check or other similar means for payment to third parties or others to
constitute a separate line of business for purposes of applying the
activity limitation. In this regard, the Board has previously recognized
that this line of businesss constitutes a permissible but separate
activity under section 4 of the BHC Act. Furthermore, the offering of
accounts with transaction capability requires different expertise and
systems than non-transaction deposit-taking and represented a distinct
new activity that traditionally separated banks from thrift and similar
institutions.
(iii) Support for this view may also be found in the House Banking
Committee report on proposed legislation prior to CEBA that contained a
similar prohibition on new activities for nonbank banks. In discussing
the activity limitation, the report recognized a distinction between
demand deposits and accounts with transaction capability and those
without transaction capability:
With respect to deposits, the Committee recognizes that it is
legitimate for an institution currently involved in offering demand
deposits or other third party transaction accounts to make use of new
technologies that are in the process of replacing the existing check-
based, paper payment system. Again, however, the Committee does not
believe that technology should be used as a lever for an institution
that was only incidentally involved in the payment system to transform
itself into a significant offeror of transaction account capability.\6\
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\6\ H. Rep. No. 99-175, 99th Cong., 1st Sess. 13 (1985).
---------------------------------------------------------------------------
(iv) Finally, this distinction between demand and nondemand
checkable accounts and accounts not subject to withdrawal by check was
specifically recognized by Congress in the redefinition of the term bank
in CEBA to include an institution that takes demand deposits or
``deposits that the depositor may withdraw by check or other means for
payment to third parties or others'' as well as in various exemptions
from that definition for trust companies, credit card banks, and certain
industrial banks.\7\
---------------------------------------------------------------------------
\7\ See 12 U.S.C. 1841(c)(2) (D), (F), (H), and (I).
---------------------------------------------------------------------------
(v) Thus, an institution that as of March 5, 1987, offered only time
and savings accounts that were not withdrawable by check for payment to
third parties could not thereafter begin offering accounts with
transaction capability, for example, NOW accounts or other types of
transaction accounts.
(3) Lending. As noted, the CEBA activity limitation does not treat
lending as a single activity; it clearly distinguishes between
commercial and other types of lending. This distinction is also
reflected in the definition of bank in the BHC Act in effect both prior
to
[[Page 159]]
and after enactment of CEBA as well as in various of the exceptions from
this definition. In addition, commercial lending is a specialized form
of lending involving different techniques and analysis from other types
of lending. Based upon these factors, the Board would view commercial
lending as a separate and distinct activity for purposes of the activity
limitation in section 4(f)(3). The Board's decisions under section 4 of
the BHC Act have not generally differentiated between types of
commercial lending, and thus the Board would view commercial lending as
a single activity for purposes of CEBA. Thus, a nonbank bank that made
commercial loans as of March 5, 1987, could make any type of commercial
loan thereafter.
(i) Commercial lending. For purposes of the activity limitation, a
commercial loan is defined in accordance with the Supreme Court's
decision in Board of Governors v. Dimension Financial Corporation, 474
U.S. 361 (1986), as a direct loan to a business customer for the purpose
of providing funds for that customer's business. In this regard, the
Board notes that whether a particular transaction is a commercial loan
must be determined not from the face of the instrument, but from the
application of the definition of commercial loan in the Dimension
decision to that transaction. Thus, certain transactions of the type
mentioned in the Board's ruling at issue in Dimension and in the Senate
and Conference Reports in the CEBA legislation \8\ would be commercial
loans if they meet the test for commercial loans established in
Dimension. Under this test, a commercial loan would not include, for
example, an open-market investment in a commercial entity that does not
involve a borrower-lender relationship or negotiation of credit terms,
such as a money market transaction.
---------------------------------------------------------------------------
\8\ S. Rep. No. 100-19 at 31; Conference Report at 123.
---------------------------------------------------------------------------
(ii) Other lending. Based upon the guidance in the Act as to the
degree of specificity required in applying the activity limitation with
respect to lending, the Board believes that, in addition to commercial
lending, there are three other types of lending activities: consumer
mortgage lending, consumer credit card lending, and other consumer
lending. Mortgage lending and credit card lending are recognized,
discrete lines of banking and business activity, involving techniques
and processes that are different from and more specialized than those
required for general consumer lending. For example, these activities
are, in many cases, conducted by specialized institutions, such as
mortgage companies and credit card institutions, or through separate
organizational structures within an institution, particularly in the
case of mortgage lending. Additionally, the Board's decisions under
section 4 of the Act have recognized mortgage banking and credit card
lending as separate activities for bank holding companies. The Board's
Regulation Y reflects this specialization, noting as examples of
permissible lending activity: consumer finance, credit card and mortgage
lending. 12 CFR 225.25(b)(1). Finally, CEBA itself recognizes the
specialized nature of credit card lending by exempting an institution
specializing in that activity from the bank definition. For purpose of
the activity limitation, a consumer mortgage loan will mean any loan to
an individual that is secured by real estate and that is not a
commercial loan. A credit card loan would be any loan made to an
individual by means of a credit card that is not a commercial loan.
(4) Trust activities. Under section 4 of the Act, the Board has
historically treated trust activities as a single activity and has not
differentiated the function on the basis of whether the customer was an
individual or a business. See 12 CFR 225.25(b)(3). Similarly, the trust
company exemption from the bank definition in CEBA makes no distinction
between various types of trust activities. Accordingly, the Board would
view trust activities as a separate activity without additional
differentiation for purposes of the activity limitation in section
4(f)(3).
(5) Other activities. With respect to activities other than the
various traditional deposit-taking, lending or trust activities, the
Board believes it appropriate, for the reasons discussed above,
[[Page 160]]
to apply the activity limitation in section 4(f)(3) as the term activity
generally applies in other provisions of section 4 of the BHC Act. Thus,
a grandfathered nonbank bank could not, for example, commence after
March 5, 1987, any of the following activities (unless it was engaged in
such an activity as of that date): discount securities brokerage, full-
service securities brokerage investment advisory services, underwriting
or dealing in government securities as permissible for member banks,
foreign exchange transaction services, real or personal property
leasing, courier services, data processing for third parties, insurance
agency activities,\9\ real estate development, real estate brokerage,
real estate syndication, insurance underwriting, management consulting,
futures commission merchant, or activities of the general type listed in
Sec. 225.25(b) of Regulation Y.
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\9\ In this area, section 4 of the Act does not treat all insurance
agency activities as a single activity. Thus, for example, the Act
treats the sale of credit-related life, accident and health insurance as
a separate activity from general insurance agency activities. See 12
U.S.C. 1843(c)(8).
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(6) Meaning of engaged in. In order to be engaged in an activity, a
nonbank bank must demonstrate that it had a program in place to provide
a particular product or service included within the grandfathered
activity to a customer and that it was in fact offering the product or
service to customers as of March 5, 1987. Thus, a nonbank bank is not
engaged in an activity as of March 5, 1987, if the product or service in
question was in a planning state as of that date and had not been
offered or delivered to a customer. Consistent with prior Board
interpretations of the term activity in the grandfather provisions of
section 4, the Board does not believe that a company may be engaged in
an activity on the basis of a single isolated transaction that was not
part of a program to offer the particular product or to conduct in the
activity on an ongoing basis. For example, a nonbank bank that held an
interest in a single real estate project would not thereby be engaged in
real estate development for purposes of this provision, unless evidence
was presented indicating the interest was held under a program to
commence a real estate development business.
(7) Meaning of as of The Board believes that the grandfather date
``as of March 5, 1987'' as used throughout section 4(f)(3) should refer
to activities engaged in on March 5, 1987, or a reasonably short period
preceding this date not exceeding 13 months. 133 Cong. Rec. S3957 (daily
ed. March 26, 1987). (Remarks of Senators Dodd and Proxmire). Activities
that the institution had terminated prior to March 5, 1988, however,
would not be considered to have been conducted or engaged in as of March
5. For example, if within 13 months of March 5, 1987, the nonbank bank
had terminated its commercial lending activity in order to avoid the
bank definition in the Act, the nonbank bank could not recommence that
activity after enactment of CEBA.
(d) Cross-marketing limitation--(1) In general. Section 4(f)(3) also
limits cross-marketing activities by nonbank banks and their affiliates.
Under this provision, a nonbank bank may not offer or market a product
or service of an affiliate unless the product or service may be offered
by bank holding companies generally under section 4(c)(8) of the BHC
Act. In addition, a nonbank bank may not permit any of its products or
services to be offered or marketed by or through a nonbank affiliate
unless the affiliate engages only in activities permissible for a bank
holding company under section 4(c)(8). These limitations are subject to
an exception for products or services that were being so offered or
marketed as of March 5, 1987, but only in the same manner in which they
were being offered or marketed as of that date.
(2) Examples of impermissible cross-marketing. The Conference Report
illustrates the application of this limitation to the following two
covered transactions: (i) products and services of an affiliate that
bank holding companies may not offer under the BHC Act, and (ii)
products and services of the nonbank bank. In the first case, the
restrictions would prohibit, for example, a company from marketing life
insurance or automotive supplies through its affiliate nonbank bank
because these products are not generally
[[Page 161]]
permissible under the BHC Act. Conference Report at 126. In the second
case, a nonbank bank may not permit its products or services to be
offered or marketed through a life insurance affiliate or automobile
parts retailer because these affiliates engage in activities prohibited
under the BHC Act. Id.
(3) Permissible cross-marketing. On the other hand, a nonbank bank
could offer to its customers consumer loans from an affiliated mortgage
banking or consumer finance company. These affiliates could likewise
offer their customers the nonbank bank's products or services provided
the affiliates engaged only in activities permitted for bank holding
companies under the closely-related-to-banking standard of section
4(c)(8) of the BHC Act. If the affiliate is engaged in both permissible
and impermissible activities within the meaning of section 4(c)(8) of
the BHC Act, however, the affiliate could not offer or market the
nonbank bank's products or services.
(4) Product approach to cross-marketing restriction. (i) Unlike the
activity restrictions, the cross-marketing restrictions of CEBA apply by
their terms to individual products and services. Thus, an affiliate of a
nonbank bank that was engaged in activities that are not permissible for
bank holding companies and that was marketing a particular product or
service of a nonbank bank on the grandfather date could continue to
market that product and, as discussed below, could change the terms and
conditions of the loan. The nonbank affiliate could not, however, begin
to offer or market another product or service of the nonbank bank.
(ii) The Board believes that the term product or service must be
interpreted in light of its accepted ordinary commercial usage. In some
instances, commercial usage has identified a group of products so
closely related that they constitute a product line (e.g., certificates
of deposit) and differences in versions of the product (e.g., a one-year
certificate of deposit) simply represent a difference in the terms of
the product.\10\ This approach is consistent with the treatment in
CEBA's legislative history of certificates of deposit as a product line
rather than each particular type of CD as a separate product.\11\
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\10\ American Bankers Association, Banking Terminology (1981).
\11\ During the Senate debates on CEBA, Senator Proxmire in response
to a statement from Senator Cranston that the joint-marketing
restrictions do not lock into place the specific terms or conditions of
the particular grandfathered product or service, stated:
That is correct. For example, if a nonbank bank was jointly
marketing on March 5, 1987, a 3 year, $5,000 certificate of deposit,
this bill would not prohibit offering in the same manner a 1 year,
$2,000 certificate of deposit with a different interest rate. 133 Cong.
Rec. S3959 (daily ed. March 26, 1987).
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(iii) In the area of consumer lending, the Board believes the
following provide examples of different consumer loan products: mortgage
loans to finance the purchase of the borrower's residence, unsecured
consumer loans, consumer installment loans secured by the personal
property to be purchased (e.g. automobile, boat or home appliance
loans), or second mortgage loans.\12\ Under this interpretation, a
nonbank bank that offered automobile loans through a nonbank affiliate
on the grandfather date could market boat loans, appliance loans or any
type of secured consumer installment loan through that affiliate. It
could not, however, market unsecured consumer loans, home mortgage loans
or other types of consumer loans.
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\12\ In this regard, the Supreme Court in United States v.
Philadelphia National Bank, noted that ``the principal banking products
are of course various types of credit, for example: unsecured personal
and business loans, mortgage loans, loans secured by securities or
accounts receivable, automobile installment and consumer goods,
installment loans, tuition financing, bank credit cards, revolving
credit funds.'' 374 U.S. 321, 326 n.5 (1963).
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(iv) In other areas, the Board believes that the determination as to
what constitutes a product or service should be made on a case-by-case
basis consistent with the principles that the terms product or service
must be interpreted in accordance with their ordinary commercial usage
and must be narrower in scope than the definition of activity.
Essentially, the concept applied in this analysis is one of permitting
the continuation of the specific product marketing activity that was
undertaken as
[[Page 162]]
of March 5, 1987. Thus, for example, while insurance underwriting may
constitute a separate activity under CEBA, a nonbank bank could not
market a life insurance policy issued by the affiliate if on the
grandfather date it had only marketed homeowners' policies issued by the
affiliate.
(5) Change in terms and conditions permitted. (i) The cross-
marketing restrictions would not limit the ability of the institution to
change the specific terms and conditions of a particular grandfathered
product or service. The Conference Report indicates a legislative intent
not to lock into place the specific terms or conditions of a
grandfathered product or service. Conference Report at 126. For example,
a nonbank bank marketing a three-year, $5,000 certificate of deposit
through an affiliate under the exemption could offer a one-year $2,000
certificate of deposit with a different interest rate after the
grandfather date. See footnote 11 above. Modifications that alter the
type of product, however, are not permitted. Thus, a nonbank bank that
marketed through affiliates on March 5, 1987, only certificates of
deposit could not commence marketing MMDA's or NOW accounts after the
grandfather date.
(ii) General changes in the character of the product or service as
the result of market or technological innovation are similarly permitted
to the extent that they do not transform a grandfathered product into a
new product. Thus, an unsecured line of credit could not be modified to
include a lien on the borrower's residence without becoming a new
product.
(6) Meaning of offer or market. In the Board's opinion, the terms
offer or market in the cross-marketing restrictions refer to the
presentation to a customer of an institution's products or service
through any type of program, including telemarketing, advertising
brochures, direct mailing, personal solicitation, customer referrals, or
joint-marketing agreements or presentations. An institution must have
offered or actually marketed the product or service on March 5 or
shortly before that date (as discussed above) to qualify for the
grandfather privilege. Thus, if the cross-marketing program was in the
planning stage on March 5, 1987, the program would not quality for
grandfather treatment under CEBA.
(7) Limitations on cross-marketing to in the same manner. (i) The
cross-marketing restriction in section 4(f)(3) contains a grandfather
provision that permits products or services that would otherwise be
prohibited from being offered or marketed under the provision to
continue to be offered or marketed by a particular entity if the
products or services were being so offered or marketed as of March 5,
1987, but ``only in the same manner in which they were being offered or
marketed as of that date.'' Thus, to qualify for the grandfather
provision, the manner of offering or marketing the otherwise prohibited
product or service must remain the same as on the grandfather date.
(ii) In interpreting this provision, the Board notes that Congress
designed the joint-marketing restrictions to prevent the significant
risk to the public posed by the conduct of such activities by insured
banks affiliated with companies engaged in general commerce, to ensure
objectivity in the credit-granting process and to ``minimize the unfair
competitive advantage that grandfathered commercial companies owning
nonbank banks might otherwise engage over regulated bank holding
companies and our competing commercial companies that have no subsidiary
bank.'' Conference Report at 125-126. The Board believes that
determinations regarding the manner of cross-marketing of a particular
product or service may best be accomplished by applying the limitation
to the particular facts in each case consistent with the stated purpose
of this provision of CEBA and the general principle that grandfather
restrictions and exceptions to general prohibitions must be narrowly
construed in order to prevent the exception from nullifying the rule.
Essentially, as in the scope of the term ``product or service'', the
guiding principle of Congressional intent with respect to this term is
to permit only the continuation of the specific types of cross-marketing
activity that were undertaken as of March 5, 1987.
(8) Eligibility for cross-marketing grandfather exemption. The
Conference Report also clarifies that entitlement to
[[Page 163]]
an exemption to continue to cross-market products and services otherwise
prohibited by the statute applies only to the specific company that was
engaged in the activity as of March 5, 1987. Conference Report at 126.
Thus, an affiliate that was not engaged in cross-marketing products or
services as of the grandfather date may not commence these activities
under the exemption even if such activities were being conducted by
another affiliate. Id.; see also S. Rep. No. 100-19 at 33-34.
(e) Eligibility for grandfathered nonbank bank status. In reviewing
the reports required by CEBA, the Board notes that a number of
institutions that had not commenced business operations on August 10,
1987, the date of enactment of CEBA, claimed grandfather privileges
under section 4(f)(3) of CEBA. To qualify for grandfather privileges
under section 4(f)(3), the institution must have ``bec[o]me a bank as a
result of the enactment of [CEBA]'' and must have been controlled by a
nonbanking company on March 5, 1987. 12 U.S.C. 1843(f)(1)(A). An
institution that did not have FDIC insurance on August 10, 1987, and
that did not accept demand deposits or transaction accounts or engage in
the business of commercial lending on that date, would not have become a
bank as a result of enactment of CEBA. Thus, institutions that had not
commenced operations on August 10, 1987, could not qualify for
grandfather privileges under section 4(f)(3) of CEBA. This view is
supported by the activity limitations of section 4(f)(3), which, as
noted, limit the activities of grandfathered nonbank banks to those in
which they were lawfully engaged as of March 5, 1987. A nonbank bank
that had not commenced conducting business activities on March 5, 1987,
could not after enactment of CEBA engage in any activities under this
provision.
[Reg. Y, 53 FR 37746, Sept. 28, 1988, as amended by Reg. Y, 62 FR 9343,
Feb. 28, 1997]
Subpart J--Merchant Banking Investments
Source: Reg. Y, 65 FR 16472, Mar. 28, 2000, unless otherwise noted.
Sec. 225.170 What investments are permitted under this subpart and who may make them?
(a) What investments are permitted under this subpart? Section
4(k)(4)(H) of the Bank Holding Company Act (12 U.S.C. 1843(k)(4)(H)) and
this subpart authorize a financial holding company, directly or
indirectly and as principal or on behalf of one or more persons, to
acquire or control any amount of shares, assets or ownership interests
of a company or other entity that is engaged in any activity not
otherwise authorized for a financial holding company under section 4 of
the Bank Holding Company Act. For purposes of this subpart, shares,
assets or ownership interests acquired or controlled under this subpart
are referred to as ``merchant banking investments.'' A financial holding
company may not directly or indirectly acquire or control any merchant
banking investment except in compliance with the requirements of this
subpart.
(b) Must the investment be a bona fide merchant banking investment?
The acquisition or control of shares, assets or ownership interests
under this subpart is not permitted unless it is part of a bona fide
underwriting or merchant or investment banking activity.
(c) What types of ownership interests may be acquired? Shares,
assets or ownership interests of a company or other entity include any
debt or equity security, warrant, option, partnership interest, trust
certificate or other instrument representing an ownership interest in
the company or entity, whether voting or nonvoting.
(d) Where in a financial holding company may merchant banking
investments be made? A financial holding company and any subsidiary
(other than a depository institution or subsidiary of a depository
institution) may acquire or control merchant banking investments. A
financial holding company and its subsidiaries may not acquire or
control merchant banking investments on behalf of a depository
institution or subsidiary of a depository institution.
(e) May assets other than shares be held directly? A financial
holding company may not under this subpart acquire or control assets,
other than shares or
[[Page 164]]
other ownership interests in a company, unless:
(1) The assets are held within or promptly transferred to a
portfolio company;
(2) The portfolio company maintains policies, books and records,
accounts, and other indicia of corporate, partnership or limited
liability organization and operation that are separate from the
financial holding company and that meet the requirements of
Sec. 225.174(a)(4) for limiting the legal liability of the financial
holding company; and
(3) The portfolio company has management that is separate from the
financial holding company to the extent required by section
Sec. 225.171.
(f) What type of affiliate is required for a financial holding
company to make merchant banking investments? A financial holding
company may not acquire or control merchant banking investments under
this subpart unless the financial holding company qualifies under at
least one of the following paragraphs:
(1) Securities affiliate. The financial holding company controls a
company that is registered with the Securities and Exchange Commission
as a broker or dealer under the Securities Exchange Act of 1934 (15
U.S.C. 78a et seq.); or
(2) Insurance affiliate with an investment adviser affiliate. The
financial holding company controls:
(i) An insurance company that is predominantly engaged in
underwriting life, accident and health, or property and casualty
insurance (other than credit-related insurance), or providing and
issuing annuities; and
(ii) A company that:
(A) Is registered with the Securities and Exchange Commission as an
investment adviser under the Investment Advisers Act of 1940 (15 U.S.C.
80b-1 et seq.); and
(B) provides investment advice to an insurance company.
(g) What do references to a financial holding company include? The
term ``financial holding company'' as used in this subpart means the
financial holding company and each of its subsidiaries, but, except for
Secs. 225.171 and 225.174, does not include a depository institution or
subsidiary of a depository institution. The term includes any private
equity fund controlled by the financial holding company, but does not
include any portfolio company controlled by the financial holding
company.
(h) What do references to a depository institution include? For
purposes of this subpart, the term ``depository institution'' includes a
U.S. branch or agency of a foreign bank that acquires or controls, or is
affiliated with a company that acquires or controls, merchant banking
investments under this subpart.
(i) What is a portfolio company? A portfolio company is any company
or entity:
(1) That is engaged in any activity not authorized for a financial
holding company under section 4 of the Bank Holding Company Act; (12
U.S.C. 1843) and
(2) The shares, assets or ownership interests of which are held,
owned or controlled directly or indirectly by the financial holding
company pursuant to this subpart.
Sec. 225.171 What are the limitations on managing or operating a portfolio company held as a merchant banking investment?
(a) May a financial holding company routinely manage or operate a
portfolio company? Except as provided in paragraph (d) of this section,
a financial holding company may not routinely manage or operate any
portfolio company in which it has a direct or indirect interest and any
portfolio company held by any company (including a private equity fund)
in which the financial holding company has an ownership interest under
this subpart.
(b) What does it mean to routinely manage or operate a company? A
financial holding company routinely manages or operates a portfolio
company if:
(1) Any director, officer, employee or agent of the financial
holding company serves as or has the responsibilities of an officer or
employee of the portfolio company;
(2) Any officer or employee of the portfolio company is supervised
by any director, officer, employee or agent of the financial holding
company (other than in that individual's capacity as a director of the
portfolio company);
[[Page 165]]
(3) Any covenant or other contractual arrangement exists between the
financial holding company and the portfolio company that would restrict
the portfolio company's ability to make routine business decisions, such
as entering transactions in the ordinary course of business or hiring
employees below the rank of the five highest ranking executive officers;
(4) Any director, officer, employee or agent of the financial
holding company, whether in the capacity of a director of the portfolio
company, adviser to the portfolio company, or otherwise, participates
in:
(i) The day-to-day operations of the portfolio company, or
(ii) Management decisions made in the ordinary course of business of
the portfolio company other than decisions in which a director of a
company customarily participates in that individual's capacity as a
director; or (5) Any other arrangement or practice exists by which the
financial holding company routinely manages or operates the portfolio
company.
(c) What arrangements do not involve routinely managing or operating
a company? (1) Director representation at portfolio companies. A
financial holding company may select any or all of the directors of a
portfolio company or have one or more directors, officers, employees or
agents serve as directors of a portfolio company if:
(i) The portfolio company employs officers and employees responsible
for routinely managing and operating the company; and
(ii) The financial holding company does not routinely manage or
operate the portfolio company as described in paragraph (b) of this
section.
(2) Covenants or other provisions regarding extraordinary events. A
financial holding company may, by virtue of covenants or other written
agreements with a portfolio company, require the portfolio company to
consult with or obtain the approval of the financial holding company to
take actions outside of the ordinary course of the business of the
portfolio company, including:
(i) The acquisition of control or significant assets of other
companies;
(ii) Significant changes to the business plan of the portfolio
company;
(iii) The redemption, authorization or issuance of any shares of
capital stock (including options, warrants or convertible shares) of the
portfolio company; and
(iv) The sale, merger, consolidation, spin-off, recapitalization,
liquidation, dissolution or sale of substantially all of the assets of
the portfolio company or any of its significant subsidiaries.
(d) When may a financial holding company manage or operate a
portfolio company? (1) Special circumstances required. A financial
holding company may routinely manage or operate a portfolio company
only:
(i) When intervention is necessary to address a material risk to the
value or operation of the portfolio company, such as a significant
operating loss or loss of senior management; and
(ii) For the period of time as may be necessary to address the cause
of involvement, to obtain suitable alternative management arrangements,
to dispose of the investment, or to otherwise obtain a reasonable return
upon the resale or disposition of the investment.
(2) Approval required for extended involvement. A financial holding
company may not routinely manage or operate a portfolio company for a
period greater than six months without prior approval of the Board.
(3) Documentation required. A financial holding company must
maintain and make available to the Board a written record describing its
involvement in the management or operation of a portfolio company and
the reasons therefor.
(e) May a depository institution or its subsidiary manage or operate
a portfolio company? (1) In general. A depository institution or
subsidiary of a depository institution may not under any circumstances
manage or operate a portfolio company in which an affiliated company
owns or controls an interest under this subpart.
(2) Exceptions. Paragraph (e)(1) of this section does not prohibit--
(i) A director, officer or employee of a depository institution or
subsidiary of a depository institution from serving as a director of a
portfolio company
[[Page 166]]
in accordance with the limitations set forth in this section; or
(ii) A financial subsidiary held in accordance with section 5136A of
the Revised Statutes (12 U.S.C. 24a) or section 46(a) of the Federal
Deposit Insurance Act (12 U.S.C. 1831w) from taking actions in
accordance with the limitations set forth in this section.
Sec. 225.172 What are the holding periods permitted for merchant banking investments?
(a) Must investments be made for resale? A financial holding company
may own or control shares, assets and ownership interests pursuant to
this subpart only for a period of time to enable the sale or disposition
thereof on a reasonable basis consistent with the financial viability of
the financial holding company's merchant banking investment activities.
(b) What period of time is generally permitted for holding merchant
banking investments? (1) In general. A financial holding company may
not, directly or indirectly, own, control or hold any share, asset or
ownership interest pursuant to this subpart for a period that exceeds 10
years, except that an investment in or held through a private equity
fund may be held for the duration of the fund.
(2) Ownership interests acquired from or transferred to companies
held under this subpart. For purposes of paragraph (b)(1) of this
section, any interest in shares, assets or ownership interests--
(i) Acquired by a financial holding company from a company
(including a private equity fund) in which the financial holding company
held an interest under this subpart will be considered to have been
acquired by the financial holding company on the date that the share,
asset or ownership interest was acquired by the company; and
(ii) Acquired by a company (including a private equity fund) from a
financial holding company will be considered to have been acquired by
the company on the date that the share, asset or ownership interest was
acquired by the financial holding company if'
(A) The financial holding company held the share, asset, or
ownership interest under this subpart; and
(B) The financial holding company holds an interest in the acquiring
company under this subpart.
(3) Interests previously held by a financial holding company under
limited authority. For purposes of paragraph (b)(1) of this section, any
shares, assets, or ownership interests previously owned or controlled,
directly or indirectly, by a financial holding company under any other
provision of the Federal banking laws that imposes a limited holding
period will be considered to have been acquired by the financial holding
company under this subpart on the date the financial holding company
first acquired ownership or control of the shares, assets or ownership
interests under such other provision of law. For purposes of this
paragraph (b)(3), a financial holding company includes a depository
institution controlled by the financial holding company and any
subsidiary of such a depository institution.
(4) Approval required to hold investments held in excess of
applicable time limit. A financial holding company may, in extraordinary
circumstances, seek Board approval to own, control or hold shares,
assets or ownership interests of a company under this subpart for a
period that exceeds the applicable period specified in paragraph (b)(1)
of this section. A request for approval must:
(i) Be submitted to the Board no later than 1 year prior to the
expiration of the applicable time period;
(ii) Provide the reasons for the request, including information that
addresses the factors in paragraph (b)(5) of this section; and
(iii) Explain the financial holding company's plan for divesting the
shares, assets or ownership interests.
(5) Factors governing Board determinations. In reviewing any
proposal under paragraph (b)(4) of this section, the Board may consider
all the facts and circumstances related to the investment, including:
(i) The cost to the financial holding company of disposing of the
investment within the applicable period;
(ii) The total exposure of the financial holding company to the
company
[[Page 167]]
and the risks that disposing of the investment may pose to the financial
holding company;
(iii) Market conditions; and
(iv) The extent and history of involvement by the financial holding
company in the management and operations of the company.
(6) Restrictions applicable to investments held beyond applicable
period. A financial holding company that directly or indirectly owns,
controls or holds any share, asset or ownership interest of a company
under this subpart for a total period that exceeds the applicable period
specified in paragraph (b)(1) of this section must:
(i) Deduct an amount equal to 100 percent of the carrying value of
the financial holding company's interest in the share, asset or
ownership interest from the Tier 1 capital of the holding company and
exclude all unrealized gains on the share, asset or ownership interest
from its Tier 2 capital;
(ii) Not enter into any additional transactions, contractual
arrangements or other relationships with the company or extend any
additional credit to the company without Board approval; and
(iii) Abide by any other restrictions that the Board may impose in
connection with granting approval under paragraph (b)(4) of this
section.
(c) What is a private equity fund? (1) Definition of a private
equity fund. For purposes of this subpart, a ``private equity fund'' is
any company that:
(i) Is formed for the purpose of and is engaged exclusively in the
business of investing in shares, assets, and ownership interests of
companies for resale or other disposition;
(ii) Is not an operating company;
(iii) Issues equity ownership interests to at least 10 investors
that are not affiliated with, and are not officers, directors, employees
or principal shareholders of the financial holding company;
(iv) No more than 25 percent of the total equity of which is held,
owned or controlled, directly or indirectly, by the financial holding
company and its directors, officers, employees and principal
shareholders;
(v) That has an initial term of not more than 12 years, which term
may be extended for an additional three 1-year periods with the approval
of persons holding a majority of the equity of the fund;
(vi) Establishes a plan for the resale or disposition of its
investments, and holds, owns or controls investments only for a
reasonable period of time consistent with making merchant banking
investments;
(vii) Maintains policies on diversification of fund investments; and
(viii) Is not formed or operated for the purpose of making
investments inconsistent with the authority granted under section
4(k)(4)(H) of the Bank Holding Company Act (12 U.S.C. 1843(k)(4)(H)) or
evading the limitations contained in this subpart on merchant banking
investments.
(2) What form may a private equity fund take? A private equity fund
may be a corporation, partnership, limited liability company or other
type of company that issues ownership interests in any form.
(3) May a private equity fund manage a portfolio company? A private
equity fund may not routinely manage or operate a portfolio company
except as permitted by this subpart.
Sec. 225.173 What aggregate limits apply to merchant banking investments?
(a) In general. A financial holding company may not, without Board
approval, directly or indirectly acquire any additional shares, assets
or ownership interests under this subpart or make any additional capital
contribution to any company the shares, assets or ownership interests of
which are held by it under this subpart if the aggregate carrying value
of all merchant banking investments held by the financial holding
company under this subpart exceeds:
(1) The lesser of 30 percent of the Tier 1 capital of the company or
$6 billion; or
(2) The lesser of 20 percent of the Tier 1 capital of the company or
$4 billion excluding interests in private equity funds.
(b) Do these limits apply to interests held through a private equity
fund? Paragraph (a) of this section does not prohibit any private equity
fund that a financial holding company controls from
[[Page 168]]
acquiring shares, assets or ownership interests.
Sec. 225.174 What risk management, reporting and recordkeeping policies are required to make merchant banking investments?
(a) What internal controls are necessary? A financial holding
company, including a private equity fund controlled by the financial
holding company, that makes investments under this subpart must
establish and maintain policies, procedures, and systems reasonably
designed to:
(1) Monitor and adequately assess the value of each investment, the
value of the aggregate portfolio, and the diversification of the
portfolio;
(2) Identify and manage the market, credit, concentration and other
risks associated with merchant banking investments;
(3) Monitor and review the terms, amounts and types of transactions
and relationships between the financial holding company (in the
aggregate and separately by affiliate) and each company in which the
financial holding company has an interest under this subpart to assess
the risks and costs of the transactions and relationships, including
whether each transaction or relationship is on market terms, and to
assure compliance with any provisions of law, including any applicable
fiduciary principles, governing those transactions and relationships;
(4) Ensure the maintenance of corporate separateness between the
financial holding company and each company in which the financial
holding company has an interest under this subpart, including policies,
procedures and systems sufficient to protect the financial holding
company and depository institutions controlled by the financial holding
company from legal liability for the conduct of operations and for the
financial obligations of each such company; and
(5) Ensure compliance with the provisions of this subpart governing
merchant banking investments.
(b) What records must be maintained? A financial holding company
must maintain, at a central location, records and supporting information
that:
(1) Are sufficient to enable the Board to review the policies,
procedures and systems described in paragraph (a) of this section;
(2) Detail the cost, carrying value, market value, and performance
data for each investment made under this subpart, including investments
made through private equity funds;
(3) Include copies of the financial statements of any company in
which the financial holding company holds an interest under this
subpart, including investments made through private equity funds, and
any information and valuations provided to any co-investors in such
companies;
(4) Document any transaction or relationship between the financial
holding company and any company in which the financial holding company
holds an interest under this subpart that is not on market terms; and
(5) Document any contingent fee or contingent interest in a private
equity fund or relating to any other investment held under this subpart,
including the carrying value and market value of such fee or interest
and the amount of such fee or interest that has been recognized by the
financial holding company as income but that is contingent on future
performance or asset valuations.
(c) What periodic reports must be filed? (1) Annual reports
regarding merchant banking investments. A financial holding company must
report annually to the appropriate Reserve Bank in such format and at
such time as the Board may prescribe:
(i) For each interest that the financial holding company owns or
controls under this subpart (other than an interest in or held through a
private equity fund) and that it has owned or controlled for a period
that totals longer than five years as of the reporting date:
(A) The identity of the company in which the interest is held, a
description of the investment and, if available, a description of the
other investors and their interests in the company;
(B) The historical cost of the investment;
[[Page 169]]
(C) The market or other valuation of the investment as of the
reporting date; and
(D) The schedule for sale or disposition of the investment;
(ii) For each interest that the financial holding company owns or
controls under this subpart, including an interest in or held through a
private equity fund, and that it has owned or controlled for a period
that totals longer than eight years as of the reporting date:
(A) A detailed explanation of the financial holding company's plan
and schedule for the sale or disposition of the investment; and
(B) The information required under paragraph (c)(1)(i) of this
section;
(iii) Aggregate data describing the number, total historical cost,
total carrying value and total market value for merchant banking
investments, segregated by holding period (in 2 year increments),
geographic distribution (national or regional, as appropriate), and
industrial sector.
(2) Quarterly reporting for all merchant banking investments. A
financial holding company must, within 60 days of the end of each
calendar quarter and in the format prescribed by the Board, submit a
report to the appropriate Reserve Bank of the total number, aggregate
historical cost and aggregate current valuation of all investments held
pursuant to this subpart.
(d) Is notice required for the acquisition of companies?
(1) Fulfillment of statutory notice requirement. Except as required
in paragraph (d)(2) of this section, no post acquisition notice under
section 4(k)(6)) of the Bank Holding Company Act (12 U.S.C. 1843(k)(6))
is required by a financial holding company in connection with an
investment made under this subpart if the financial holding company has
previously filed a notice under Sec. 225.87 indicating that it had
commenced activities under this subpart.
(2) Notice of large individual investments. A financial holding
company must provide written notice to the Board within 30 days after
acquiring more than 5 percent of the shares, assets or ownership
interests of any company, including a private equity fund, at a total
cost that exceeds the lesser of 5 percent of the Tier 1 capital of the
company or $200 million.
(3) Content of notice. A notice under paragraph (d)(2) of this
section must set forth:
(i) The cost of the investment and method for funding the
investment;
(ii) The percentage of Tier 1 capital that the investment
represents;
(iii) A description of the company and the type of investment; and
(iv) An explanation of the risk management measures to be applied by
the financial holding company to the investment.
Sec. 225.175 How do the statutory cross marketing and section 23A and 23B limitations apply to merchant banking investments?
(a) Are cross marketing activities prohibited? (1) In general. A
depository institution, including a subsidiary of a depository
institution, controlled by a financial holding company may not:
(i) Offer or market, directly or through any arrangement, any
product or service of any company if more than 5 percent of the
company's shares, assets or ownership interests are owned or controlled
by the financial holding company pursuant to this subpart; or
(ii) Allow any product or service of the depository institution,
including any product or service of a subsidiary of the depository
institution, to be offered or marketed, directly or through any
arrangement, by or through any company described in paragraph (a)(1)(i)
of this section.
(2) How are financial subsidiaries treated? For purposes of
paragraph (a)(1) of this section, a subsidiary of a depository
institution does not include a financial subsidiary held in accordance
with section 5136A of the Revised Statutes (12 U.S.C. 24a) or section 46
of the Federal Deposit Insurance Act (12 U.S.C. 1831w).
(b) When are companies held under section 4(k)(4)(H) affiliates
under sections 23A and 23B? (1) Rebuttable presumption of control. The
following rebuttable presumption of control shall apply for purposes of
sections 23A and 23B of the Federal Reserve Act (12 U.S.C. 371c, 371c-
1): if a financial holding company holds any shares, assets or ownership
[[Page 170]]
interests of a company pursuant to this subpart, the company shall be
presumed to be an affiliate of any member bank that is affiliated with
the financial holding company if such financial holding company,
directly or indirectly, owns or controls 15 percent or more of the
equity capital of the company.
(2) Request to rebut presumption. A financial holding company may
rebut this presumption by providing information acceptable to the Board
demonstrating that the financial holding company does not control the
company.
(3) Convertible instruments. For purposes of paragraph (b)(1) of
this section, equity capital includes options, warrants and any other
instrument convertible into equity capital.
(4) Application of presumption to private equity funds. A financial
holding company will not be presumed to own or control the equity
capital of a company for purposes of paragraph (b)(1) of this section
solely by virtue of an investment made by the financial holding company
in a private equity fund that owns or controls the equity capital of the
company unless the financial holding company controls or has sponsored
and advises the private equity fund.
(5) Application of sections 23A and 23B to U.S. branches and
agencies of foreign banks. Sections 23A and 23B of the Federal Reserve
Act shall apply to all covered transactions between each U.S. branch and
agency of a foreign bank that acquires or controls, or that is
affiliated with a company that acquires or controls, merchant banking
investments and--
(i) Any portfolio company that the foreign bank or affiliated
company controls or is presumed to control under paragraph (b)(1) of
this section; and
(ii) Any company that the foreign bank or affiliated company
controls or is presumed to control under paragraph (b)(1) of this
section if the company is engaged in acquiring or controlling merchant
banking investments.
Conditions to Orders
Sec. 225.200 Conditions to Board's section 20 orders.
(a) Introduction. Under section 20 of the Glass-Steagall Act (12
U.S.C. 377) and section 4(c)(8) of the Bank Holding Company Act (12
U.S.C. 1843(c)(8)), a nonbank subsidiary of a bank holding company may
to a limited extent underwrite and deal in securities for which
underwriting and dealing by a member bank is prohibited. Pursuant to the
Securities Act of 1933 and the Securities Exchange Act of 1934, these
so-called section 20 subsidiaries are required to register with the SEC
as broker-dealers and are subject to all the financial reporting, anti-
fraud and financial responsibility rules applicable to broker-dealers.
In addition, transactions between insured depository institutions and
their section 20 affiliates are restricted by sections 23A and 23B of
the Federal Reserve Act (12 U.S.C. 371c and 371c-1). The Board expects a
section 20 subsidiary, like any other subsidiary of a bank holding
company, to be operated prudently. Doing so would include observing
corporate formalities (such as the maintenance of separate accounting
and corporate records), and instituting appropriate risk management,
including independent trading and exposure limits consistent with parent
company guidelines.
(b) Conditions. As a condition of each order approving establishment
of a section 20 subsidiary, a bank holding company shall comply with the
following conditions.
(1) Capital. (i) A bank holding company shall maintain adequate
capital on a fully consolidated basis. If operating a section 20
authorized to underwrite and deal in all types of debt and equity
securities, a bank holding company shall maintain strong capital on a
fully consolidated basis.
(ii) In the event that a bank or thrift affiliate of a section 20
subsidiary shall become less than well capitalized (as defined in
section 38 of the Federal Deposit Insurance Act, 12 U.S.C. 1831o), and
the bank holding company shall fail to restore it promptly to the well
capitalized level, the Board may, in its
[[Page 171]]
discretion, reimpose the funding, credit extension and credit
enhancement firewalls contained in its 1989 order allowing underwriting
and dealing in bank-ineligible securities,\1\ or order the bank holding
company to divest the section 20 subsidiary.
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\1\ Firewalls 5-8, 19, 21 and 22 of J.P. Morgan & Co., The Chase
Manhattan Corp., Bankers Trust New York Corp., Citicorp, and Security
Pacific Corp., 75 Federal Reserve Bulletin 192, 214-16 (1989).
---------------------------------------------------------------------------
(iii) A foreign bank that operates a branch or agency in the United
States shall maintain strong capital on a fully consolidated basis at
levels above the minimum levels required by the Basle Capital Accord. In
the event that the Board determines that the foreign bank's capital has
fallen below these levels and the foreign bank fails to restore its
capital position promptly, the Board may, in its discretion, reimpose
the funding, credit extension and credit enhancement firewalls contained
in its 1990 order allowing foreign banks to underwrite and deal in bank-
ineligible securities,\2\ or order the foreign bank to divest the
section 20 subsidiary.
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\2\ Firewalls 5-8, 19, 21 and 22 of Canadian Imperial Bank of
Commerce, The Royal Bank of Canada, Barclays PLC and Barclays Bank PLC,
76 Federal Reserve Bulletin 158, (1990).
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(2) Internal controls. (i) Each bank holding company or foreign bank
shall cause its subsidiary banks, thrifts, branches or agencies \3\ to
adopt policies and procedures, including appropriate limits on exposure,
to govern their participation in transactions underwritten or arranged
by a section 20 affiliate.
---------------------------------------------------------------------------
\3\ The terms ``branch'' and ``agency'' refer to a U.S. branch and
agency of a foreign bank.
---------------------------------------------------------------------------
(ii) Each bank holding company or foreign bank shall ensure that an
independent and thorough credit evaluation has been undertaken in
connection with participation by a bank, thrift, or branch or agency in
such transactions, and that adequate documentation of that evaluation is
maintained for review by examiners of the appropriate federal banking
agency and the Federal Reserve.
(3) Interlocks restriction. (i) Directors, officers or employees of
a bank or thrift subsidiary of a bank holding company, or a bank or
thrift subsidiary or branch or agency of a foreign bank, shall not serve
as a majority of the board of directors or the chief executive officer
of an affiliated section 20 subsidiary.
(ii) Directors, officers or employees of a section 20 subsidiary
shall not serve as a majority of the board of directors or the chief
executive officer of an affiliated bank or thrift subsidiary or branch
or agency, except that the manager of a branch or agency may act as a
director of the underwriting subsidiary.
(iii) For purposes of this standard, the manager of a branch or
agency of a foreign bank generally will be considered to be the chief
executive officer of the branch or agency.
(4) Customer disclosure--(i) Disclosure to section 20 customers. A
section 20 subsidiary shall provide, in writing, to each of its retail
customers,\4\ at the time an investment account is opened, the same
minimum disclosures, and obtain the same customer acknowledgment,
described in the Interagency Statement on Retail Sales of Nondeposit
Investment Products (Statement) as applicable in such situations. These
disclosures must be provided regardless of whether the section 20
subsidiary is itself engaged in activities through arrangements with a
bank that is covered by the Statement.
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\4\ For purposes of this operating standard, a retail customer is
any customer that is not an ``accredited investor'' as defined in 17 CFR
230.501(a).
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(ii) Disclosures accompanying investment advice. A director,
officer, or employee of a bank, thrift, branch or agency may not express
an opinion on the value or the advisability of the purchase or the sale
of a bank-ineligible security that he or she knows is being underwritten
or dealt in by a section 20 affiliate unless he or she notifies the
customer of the affiliate's role.
(5) Intra-day credit. Any intra-day extension of credit to a section
20 subsidiary by an affiliated bank, thrift, branch or agency shall be
on market terms consistent with section 23B of the Federal Reserve Act.
(6) Restriction on funding purchases of securities during
underwriting period. No bank, thrift, branch or agency shall
[[Page 172]]
knowingly extend credit to a customer secured by, or for the purpose of
purchasing, any bank-ineligible security that a section 20 affiliate is
underwriting or has underwritten within the past 30 days, unless:
(i) The extension of credit is made pursuant to, and consistent with
any conditions imposed in a preexisting line of credit that was not
established in contemplation of the underwriting; or
(ii) The extension of credit is made in connection with clearing
transactions for the section 20 affiliate.
(7) Reporting requirement. (i) Each bank holding company or foreign
bank shall submit quarterly to the appropriate Federal Reserve Bank any
FOCUS report filed with the NASD or other self-regulatory organizations,
and any information required by the Board to monitor compliance with
these operating standards and section 20 of the Glass-Steagall Act, on
forms provided by the Board.
(ii) In the event that a section 20 subsidiary is required to
furnish notice concerning its capitalization to the Securities and
Exchange Commission pursuant to 17 CFR 240.17a-11, a copy of the notice
shall be filed concurrently with the appropriate Federal Reserve Bank.
(8) Foreign banks. A foreign bank shall ensure that any extension of
credit by its branch or agency to a section 20 affiliate, and any
purchase by such branch or agency, as principal or fiduciary, of
securities for which a section 20 affiliate is a principal underwriter,
conforms to sections 23A and 23B of the Federal Reserve Act, and that
its branches and agencies not advertise or suggest that they are
responsible for the obligations of a section 20 affiliate, consistent
with section 23B(c) of the Federal Reserve Act.
[62 FR 45306, Aug. 27, 1997, as amended by Reg. Y, 63 FR 14804, Mar. 27,
1998]
Appendix A to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Risk-Based Measure
I. Overview
The Board of Governors of the Federal Reserve System has adopted a
risk-based capital measure to assist in the assessment of the capital
adequacy of bank holding companies (banking organizations).\1\ The
principal objectives of this measure are to: (i) Make regulatory capital
requirements more sensitive to differences in risk profiles among
banking organizations; (ii) factor off-balance sheet exposures into the
assessment of capital adequacy; (iii) minimize disincentives to holding
liquid, low-risk assets; and (iv) achieve greater consistency in the
evaluation of the capital adequacy of major banking organizations
throughout the world.\2\
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\1\ Supervisory ratios that relate capital to total assets for bank
holding companies are outlined in appendices B and D of this part.
\2\ The risk-based capital measure is based upon a framework
developed jointly by supervisory authorities from the countries
represented on the Basle Committee on Banking Regulations and
Supervisory Practices (Basle Supervisors' Committee) and endorsed by the
Group of Ten Central Bank Governors. The framework is described in a
paper prepared by the BSC entitled ``International Convergence of
Capital Measurement,'' July 1988.
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The risk-based capital guidelines include both a definition of
capital and a framework for calculating weighted risk assets by
assigning assets and off-balance sheet items to broad risk categories.
An institution's risk-based capital ratio is calculated by dividing its
qualifying capital (the numerator of the ratio) by its weighted risk
assets (the denominator).\3\ The definition of qualifying capital is
outlined below in section II, and the procedures for calculating
weighted risk assets are discussed in section III. Attachment I
illustrates a sample calculation of weighted risk assets and the risk-
based capital ratio.
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\3\ Banking organizations will initially be expected to utilize
period-end amounts in calculating their risk-based capital ratios. When
necessary and appropriate, ratios based on average balances may also be
calculated on a case-by-case basis. Moreover, to the extent banking
organizations have data on average balances that can be used to
calculate risk-based ratios, the Federal Reserve will take such data
into account.
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In addition, when certain organizations that engage in trading
activities calculate their risk-based capital ratio under this appendix
A, they must also refer to appendix E of this part, which incorporates
capital charges for certain market risks into the risk-based capital
ratio. When calculating their risk-based capital ratio under this
appendix A, such organizations are required to refer to appendix E of
this part for supplemental rules to determine qualifying and excess
capital, calculate risk-weighted assets, calculate market risk
equivalent assets, and
[[Page 173]]
calculate risk-based capital ratios adjusted for market risk.
The risk-based capital guidelines also establish a schedule for
achieving a minimum supervisory standard for the ratio of qualifying
capital to weighted risk assets and provide for transitional
arrangements during a phase-in period to facilitate adoption and
implementation of the measure at the end of 1992. These interim
standards and transitional arrangements are set forth in section IV.
The risk-based guidelines apply on a consolidated basis to bank
holding companies with consolidated assets of $150 million or more. For
bank holding companies with less than $150 million in consolidated
assets, the guidelines will be applied on a bank-only basis unless: (a)
The parent bank holding company is engaged in nonbank activity involving
significant leverage;\4\ or (b) the parent company has a significant
amount of outstanding debt that is held by the general public.
---------------------------------------------------------------------------
\4\ A parent company that is engaged in significant off-balance
sheet activities would generally be deemed to be engaged in activities
that involve significant leverage.
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The risk-based guidelines are to be used in the inspection and
supervisory process as well as in the analysis of applications acted
upon by the Federal Reserve. Thus, in considering an application filed
by a bank holding company, the Federal Reserve will take into account
the organization's risk-based capital ratio, the reasonableness of its
capital plans, and the degree of progress it has demonstrated toward
meeting the interim and final risk-based capital standards.
The risk-based capital ratio focuses principally on broad categories
of credit risk, although the framework for assigning assets and off-
balance sheet items to risk categories does incorporate elements of
transfer risk, as well as limited instances of interest rate and market
risk. The risk-based ratio does not, however, incorporate other factors
that can affect an organization's financial condition. These factors
include overall interest rate exposure; liquidity, funding and market
risks; the quality and level of earnings; investment or loan portfolio
concentrations; the quality of loans and investments; the effectiveness
of loan and investment policies; and management's ability to monitor and
control financial and operating risks.
In addition to evaluating capital ratios, an overall assessment of
capital adequacy must take account of these other factors, including, in
particular, the level and severity of problem and classified assets. For
this reason, the final supervisory judgment on an organization's capital
adequacy may differ significantly from conclusions that might be drawn
solely from the level of the organization's risk-based capital ratio.
The risk-based capital guidelines establish minimum ratios of
capital to weighted risk assets. In light of the considerations just
discussed, banking organizations generally are expected to operate well
above the minimum risk-based ratios. In particular, banking
organizations contemplating significant expansion proposals are expected
to maintain strong capital levels substantially above the minimum ratios
and should not allow significant diminution of financial strength below
these strong levels to fund their expansion plans. Institutions with
high or inordinate levels of risk are also expected to operate above
minimum capital standards. In all cases, institutions should hold
capital commensurate with the level and nature of the risks to which
they are exposed. Banking organizations that do not meet the minimum
risk-based standard, or that are otherwise considered to be inadequately
capitalized, are expected to develop and implement plans acceptable to
the Federal Reserve for achieving adequate levels of capital within a
reasonable period of time.
The Board will monitor the implementation and effect of these
guidelines in relation to domestic and international developments in the
banking industry. When necessary and appropriate, the Board will
consider the need to modify the guidelines in light of any significant
changes in the economy, financial markets, banking practices, or other
relevant factors.
II. Definition of Qualifying Capital for the Risk Based Capital Ratio
An institution's qualifying total capital consists of two types of
capital components: ``core capital elements'' (comprising Tier 1
capital) and ``supplementary capital elements'' (comprising Tier 2
capital). These capital elements and the various limits, restrictions,
and deductions to which they are subject, are discussed below and are
set forth in Attachment II.
To qualify as an element of Tier 1 or Tier 2 capital, a capital
instrument may not contain or be covered by any convenants, terms, or
restrictions that are inconsistent with safe and sound banking
practices.
Redemptions of permanent equity or other capital instruments before
stated maturity could have a significant impact on an organization's
overall capital structure. Consequently, an organization considering
such a step should consult with the Federal Reserve before redeeming any
equity or debt capital instrument (prior to maturity) if such redemption
could have a material effect
[[Page 174]]
on the level or composition of the organization's capital base.\5\
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\5\ Consultation would not ordinarily be necessary if an instrument
were redeemed with the proceeds of, or replaced by, a like amount of a
similar or higher quality capital instrument and the organization's
capital position is considered fully adequate by the Federal Reserve. In
the case of limited-life Tier 2 instruments, consultation would
generally be obviated if the new security is of equal or greater
maturity than the one it replaces.
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A. The Components of Qualifying Capital
1. Core capital elements (Tier 1 capital). The Tier 1 component of
an institution's qualifying capital must represent at least 50 percent
of qualifying total capital and may consist of the following items that
are defined as core capital elements:
(i) Common stockholders' equity.
(ii) Qualifying noncumulative perpetual preferred stock (including
related surplus).
(iii) Qualifying cumulative perpetual preferred stock (including
related surplus), subject to certain limitations described below.
(iv) Minority interest in the equity accounts of consolidated
subsidiaries.
Tier 1 capital is generally defined as the sum of core capital
elements \6\ less goodwill and other intangible assets required to be
deducted in accordance with section II.B.1.b. of this appendix.
---------------------------------------------------------------------------
\6\ During the transition period and subject to certain limitations
set forth in section IV below, Tier 1 capital may also include items
defined as supplementary capital elements.
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a. Common stockholders' equity. For purposes of calculating the
risk-based capital ratio, common stockholders' equity is limited to
common stock; related surplus; and retained earnings, including capital
reserves and adjustments for the cumulative effect of foreign currency
translation, net of any treasury stock; less net unrealized holding
losses on available-for-sale equity securities with readily determinable
fair values. For this purpose, net unrealized holding gains on such
equity securities and net unrealized holding gains (losses) on
available-for-sale debt securities are not included in common
stockholders' equity.
b. Perpetual preferred stock. Perpetual preferred stock is defined
as preferred stock that does not have a maturity date, that cannot be
redeemed at the option of the holder of the instrument, and that has no
other provisions that will require future redemption of the issue.
Consistent with these provisions, any perpetual preferred stock with a
feature permitting redemption at the option of the issuer may qualify as
capital only if the redemption is subject to prior approval of the
Federal Reserve. In general, preferred stock will qualify for inclusion
in capital only if it can absorb losses while the issuer operates as a
going concern (a fundamental characteristic of equity capital) and only
if the issuer has the ability and legal right to defer or eliminate
preferred dividends.
Perpetual preferred stock in which the dividend is reset
periodically based, in whole or in part, upon the banking organization's
current credit standing (that is, auction rate perpetual preferred
stock, including so-called Dutch auction money market, and remarketable
preferred) will not qualify for inclusion in Tier 1 capital.\7\ Such
instruments, however, qualify for inclusion in Tier 2 capital.
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\7\ Adjustable rate perpetual preferred stock (that is, perpetual
preferred stock in which the dividend rate is not affected by the
issuer's credit standing or financial condition but is adjusted
periodically according to a formula based solely on general market
interest rates) may be included in Tier 1 up to the limits specified for
perpetual preferred stock.
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For bank holding companies, both cumulative and noncumulative
perpetual preferred stock qualify for inclusion in Tier 1. However, the
aggregate amount of cumulative perpetual preferred stock that may be
included in a holding company's tier 1 is limited to one-third of the
sum of core capital elements, excluding the cumulative perpetual
preferred stock (that is, items i, ii, and iv above). Stated
differently, the aggregate amount may not exceed 25 percent of the sum
of all core capital elements, including cumulative perpetual preferred
stock (that is, items, i, ii, iii, and iv above). Any cumulative
perpetual preferred stock outstanding in excess of this limit may be
included in tier 2 capital without any sublimits within that tier (see
discussion below).
While the guidelines allow for the inclusion of noncumulative
perpetual preferred stock and limited amounts of cumulative perpetual
preferred stock in tier 1, it is desirable from a supervisory standpoint
that voting common equity remain the dominant form of tier 1 capital.
Thus, bank holding companies should avoid overreliance on preferred
stock or nonvoting equity elements within tier 1.
c. Minority interest in equity accounts of consolidated
subsidiaries. This element is included in Tier 1 because, as a general
rule, it represents equity that is freely available to absorb losses in
operating subsidiaries. While not subject to an explicit sublimit within
Tier 1, banking organizations are expected to avoid using minority
intererst in the equity accounts of consolidated subsidiaries as an
avenue for introducing into their capital
[[Page 175]]
structures elements that might not otherwise qualify as Tier 1 capital
or that would, in effect, result in an excessive reliance on preferred
stock within Tier 1.
2. Supplementary capital elements (Tier 2 capital). The Tier 2
component of an institution's qualifying total capital may consist of
the following items that are defined as supplementary capital elements:
(i) Allowance for loan and lease losses (subject to limitations
discussed below);
(ii) Perpetual preferred stock and related surplus (subject to
conditions discussed below);
(iii) Hybrid capital instruments (as defined below), perpetual debt
and mandatory convertible debt securities;
(iv) Term subordinated debt and intermediate-term preferred stock,
including related surplus (subject to limitations discussed below);
(v) Unrealized holding gains on equity securities (subject to
limitations discussed in section II.A.2.e. of this appendix).
The maximum amount of Tier 2 capital that may be included in an
organization's qualifying total capital is limited to 100 percent of
Tier 1 capital (net of goodwill and other intangible assets required to
be deducted in accordance with section II.B.1.b. of this appendix).
The elements of supplementary capital are discussed in greater
detail below.\8\
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\8\ [Reserved]
---------------------------------------------------------------------------
a. Allowance for loan and lease losses. Allowances for loan and
lease losses are reserves that have been established through a charge
against earnings to absorb future losses on loans or lease financing
receivables. Allowances for loan and lease losses exclude ``allocated
transfer risk reserves,'' \9\ and reserves created against identified
losses.
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\9\ Allocated transfer risk reserves are reserves that have been
established in accordance with Section 905(a) of the International
Lending Supervision Act of 1983, 12 U.S.C. 3904(a), against certain
assets whose value U.S. supervisory authorities have found to be
significantly impaired by protracted transfer risk problems.
---------------------------------------------------------------------------
During the transition period, the risk-based capital guidelines
provide for reducing the amount of this allowance that may be included
in an institution's total capital. Initially, it is unlimited. However,
by year-end 1990, the amount of the allowance for loan and lease losses
that will qualify as capital will be limited to 1.5 percent of an
institution's weighted risk assets. By the end of the transition period,
the amount of the allowance qualifying for inclusion in Tier 2 capital
may not exceed 1.25 percent of weighted risk assets.\10\
---------------------------------------------------------------------------
\10\ The amount of the allowance for loan and lease losses that may
be included in Tier 2 capital is based on a percentage of gross weighted
risk assets. A banking organization may deduct reserves for loan and
lease losses in excess of the amount permitted to be included in Tier 2
capital, as well as allocated transfer risk reserves, from the sum of
gross weighted risk assets and use the resulting net sum of weighted
risk assets in computing the denominator of the risk-based capital
ratio.
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b. Perpetual preferred stock. Perpetual preferred stock, as noted
above, is defined as preferred stock that has no maturity date, that
cannot be redeemed at the option of the holder, and that has no other
provisions that will require future redemption of the issue. Such
instruments are eligible for inclusion in Tier 2 capital without
limit.\11\
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\11\ Long-term preferred stock with an original maturity of 20 years
or more (including related surplus) will also qualify in this category
as an element of Tier 2. If the holder of such an instrument has a right
to require the issuer to redeem, repay, or repurchase the instrument
prior to the original stated maturity, maturity would be defined, for
risk-based capital purposes, as the earliest possible date on which the
holder can put the instrument back to the issuing banking organization.
---------------------------------------------------------------------------
c. Hybrid capital instruments, perpetual debt, and mandatory
convertible debt securities. Hybrid capital instruments include
instruments that are essentially permanent in nature and that have
certain characteristics of both equity and debt. Such instruments may be
included in Tier 2 without limit. The general criteria hybrid capital
instruments must meet in order to qualify for inclusion in Tier 2
capital are listed below:
(1) The instrument must be unsecured; fully paid-up and subordinated
to general creditors. If issued by a bank, it must also be subordinated
to claims or depositors.
(2) The instrument must not be redeemable at the option of the
holder prior to maturity, except with the prior approval of the Federal
Reserve. (Consistent with the Board's criteria for perpetual debt and
mandatory convertible securities, this requirement implies that holders
of such instruments may not accelerate the payment of principal except
in the event of bankruptcy, insolvency, or reorganization.)
(3) The instrument must be available to participate in losses while
the issuer is operating as a going concern. (Term subordinated debt
would not meet this requirement.) To satisfy this requirement, the
instrument must convert to common or perpetual preferred stock in the
event that the accumulated losses exceed the sum of the retained
earnings and capital surplus accounts of the issuer.
[[Page 176]]
(4) The instrument must provide the option for the issuer to defer
interest payments if: a) the issuer does not report a profit in the
preceding annual period (defined as combined profits for the most recent
four quarters), and b) the issuer eliminates cash dividends on common
and preferred stock.
Perpetual debt and mandatory convertible debt securities that meet
the criteria set forth in 12 CFR part 225, appendix B, also qualify as
unlimited elements of Tier 2 capital for bank holding companies.
d. Subordinated debt and intermediate-term preferred stock. (i) The
aggregate amount of term subordinated debt (excluding mandatory
convertible debt) and intermediate-term preferred stock that may be
treated as supplementary capital is limited to 50 percent of Tier 1
capital (net of goodwill and other intangible assets required to be
deducted in accordance with section II.B.1.b. of this appendix). Amounts
in excess of these limits may be issued and, while not included in the
ratio calculation, will be taken into account in the overall assessment
of an organization's funding and financial condition.
(ii) Subordinated debt and intermediate-term preferred stock must
have an original weighted average maturity of at least five years to
qualify as supplementary capital.\12\ (If the holder has the option to
require the issuer to redeem, repay, or repurchase the instrument prior
to the stated maturity, maturity would be defined, for risk-based
capital purposes, as the earliest possible date on which the holder can
put the instrument back to the issuing banking organization.) \13\ In
the case of subordinated debt, the instrument must be unsecured and must
clearly state on its face that it is not a deposit and is not insured by
a Federal agency. Bank holding company debt must be subordinated in the
right of payment to all senior indebtedness of the company.
---------------------------------------------------------------------------
\12\ Unsecured term debt issued by bank holding companies prior to
March 12, 1988, and qualifying as secondary capital at the time of
issuance continues to qualify as an element of supplementary capital
under the risk-based framework, subject to the 50 percent of Tier 1
capital limitation. Bank holding company term debt issued on or after
March 12, 1988, must be subordinated in order to qualify as capital.
\13\ As a limited-life capital instrument approaches maturity it
begins to take on characteristics of a short-term obligation. For this
reason, the outstanding amount of term subordinated debt and limited-
life preferred stock eligible for inclusion in Tier 2 is reduced, or
discounted, as these instruments approach maturity: one-fifth of the
original amount (less redemptions) is excluded each year during the
instrument's last five years before maturity. When the remaining
maturity is less than one year, the instrument is excluded from Tier 2
capital.
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e. Unrealized gains on equity securities and unrealized gains
(losses) on other assets. Up to 45 percent of pretax net unrealized
holding gains (that is, the excess, if any, of the fair value over
historical cost) on available-for-sale equity securities with readily
determinable fair values may be included in supplementary capital.
However, the Federal Reserve may exclude all or a portion of these
unrealized gains from Tier 2 capital if the Federal Reserve determines
that the equity securities are not prudently valued. Unrealized gains
(losses) on other types of assets, such as bank premises and available-
for-sale debt securities, are not included in supplementary capital, but
the Federal Reserve may take these unrealized gains (losses) into
account as additional factors when assessing an institution's overall
capital adequacy.
f. Revaluation reserves. i. Such reserves reflect the formal balance
sheet restatement or revaluation for capital purposes of asset carrying
values to reflect current market values. The Federal Reserve generally
has not included unrealized asset appreciation in capital ratio
calculations, although it has long taken such values into account as a
separate factor in assessing the overall financial strength of a banking
organization.
ii. Consistent with long-standing supervisory practice, the excess
of market values over book values for assets held by bank holding
companies will generally not be recognized in supplementary capital or
in the calculation of the risk-based capital ratio. However, all bank
holding companies are encouraged to disclose their equivalent of
premises (building) and security revaluation reserves. The Federal
Reserve will consider any appreciation, as well as any depreciation, in
specific asset values as additional considerations in assessing overall
capital strength and financial condition.
B. Deductions from Capital and Other Adjustments
Certain assets are deducted from an organization's capital for the
purpose of calculating the risk-based capital ratio.\14\ These assets
include:
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\14\ Any assets deducted from capital in computing the numerator of
the ratio are not included in weighted risk assets in computing the
denominator of the ratio.
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(i)(a) Goodwill--deducted from the sum of core capital elements.
(b) Certain identifiable intangible assets, that is, intangible
assets other than goodwill--deducted from the sum of core capital
elements in accordance with section II.B.1.b. of this appendix.
[[Page 177]]
(ii) Investments in banking and finance subsidiaries that are not
consolidated for accounting or supervisory purposes, and investments in
other designated subsidiaries or associated companies at the discretion
of the Federal Reserve--deducted from total capital components (as
described in greater detail below).
(iii) Reciprocal holdings of capital instruments of banking
organizations--deducted from total capital components.
(iv) Deferred tax assets--portions are deducted from the sum of core
capital elements in accordance with section II.B.4. of this Appendix A.
1. Goodwill and other intangible assets--a. Goodwill. Goodwill is an
intangible asset that represents the excess of the purchase price over
the fair market value of identifiable assets acquired less liabilities
assumed in acquisitions accounted for under the purchase method of
accounting. Any goodwill carried on the balance sheet of a bank holding
company after December 31, 1992, will be deducted from the sum of core
capital elements in determining Tier 1 capital for ratio calculation
purposes. Any goodwill in existence before March 12, 1988, is
``grandfathered'' during the transition period and is not deducted from
core capital elements until after December 31, 1992. However, bank
holding company goodwill acquired as a result of a merger or acquisition
that was consummated on or after March 12, 1988, is deducted
immediately.
b. Other intangible assets. i. All servicing assets, including
servicing assets on assets other than mortgages (i.e., nonmortgage
servicing assets) are included in this Appendix A as identifiable
intangible assets. The only types of identifiable intangible assets that
may be included in, that is, not deducted from, an organization's
capital are readily marketable mortgage servicing assets, nonmortgage
servicing assets, and purchased credit card relationships. The total
amount of these assets included in capital, in the aggregate, cannot
exceed 100 percent of Tier 1 capital. Nonmortgage servicing assets and
purchased credit card relationships are subject, in the aggregate, to a
sublimit of 25 percent of Tier 1 capital.\15\
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\15\ Amounts of mortgage servicing assets, nonmortgage servicing
assets, and purchased credit card relationships in excess of these
limitations, as well as all other identifiable intangible assets,
including core deposit intangibles and favorable leaseholds, are to be
deducted from an organization's core capital elements in determining
Tier 1 capital. However, identifiable intangible assets (other than
mortgage servicing assets, and purchased credit card relationships)
acquired on or before February 19, 1992, generally will not be deducted
from capital for supervisory purposes, although they will continue to be
deducted for applications purposes.
---------------------------------------------------------------------------
ii. For purposes of calculating these limitations on mortgage
servicing assets, nonmortgage servicing assets, and purchased credit
card relationships, Tier 1 capital is defined as the sum of core capital
elements, net of goodwill, and net of all identifiable intangible assets
and similar assets other than mortgage servicing assets, nonmortgage
servicing assets, and purchased credit card relationships, regardless of
the date acquired, but prior to the deduction of deferred tax assets.
iii. The amount of mortgage servicing assets, nonmortgage servicing
assets, and purchased credit card relationships that a bank holding
company may include in capital shall be the lesser of 90 percent of
their fair value, as determined in accordance with this section, or 100
percent of their book value, as adjusted for capital purposes in
accordance with the instructions to the Consolidated Financial
Statements for Bank Holding Companies (FR Y-9C Report). If both the
application of the limits on mortgage servicing assets, nonmortgage
servicing assets, and purchased credit card relationships and the
adjustment of the balance sheet amount for these intangibles would
result in an amount being deducted from capital, the bank holding
company would deduct only the greater of the two amounts from its core
capital elements in determining Tier 1 capital.
iv. Bank holding companies may elect to deduct disallowed servicing
assets on a basis that is net of any associated deferred tax liability.
Deferred tax liabilities netted in this manner cannot also be netted
against deferred tax assets when determining the amount of deferred tax
assets that are dependent upon future taxable income.
v. Bank holding companies must review the book value of all
intangible assets at least quarterly and make adjustments to these
values as necessary. The fair value of mortgage servicing assets,
nonmortgage servicing assets, and purchased credit card relationships
also must be determined at least quarterly. This determination shall
include adjustments for any significant changes in original valuation
assumptions, including changes in prepayment estimates or account
attrition rates. Examiners will review both the book value and the fair
value assigned to these assets, together with supporting documentation,
during the inspection process. In addition, the Federal Reserve may
require, on a case-by-case basis, an independent valuation of an
organization's intangible assets or similar assets.
vi. The treatment of identifiable intangible assets set forth in
this section generally will be used in the calculation of a bank holding
company's capital ratios for supervisory and
[[Page 178]]
applications purposes. However, in making an overall assessment of an
organization's capital adequacy for applications purposes, the Board
may, if it deems appropriate, take into account the quality and
composition of an organization's capital, together with the quality and
value of its tangible and intangible assets.
vii. Consistent with long-standing Board policy, banking
organizations experiencing substantial growth, whether internally or by
acquisition, are expected to maintain strong capital positions
substantially above minimum supervisory levels, without significant
reliance on intangible assets.
2. Investments in certain subsidiaries-- a. Unconsolidated banking
or finance subsidiaries. The aggregate amount of investments in banking
or finance subsidiaries \16\ whose financial statements are not
consolidated for accounting or regulatory reporting purposes, regardless
of whether the investment is made by the parent bank holding company or
its direct or indirect subsidiaries, will be deducted from the
consolidated parent banking organization's total capital components.\17\
Generally, investments for this purpose are defined as equity and debt
capital investments and any other instruments that are deemed to be
capital in the particular subsidiary.
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\16\ For this purpose, a banking and finance subsidiary generally is
defined as any company engaged in banking or finance in which the parent
institution holds directly or indirectly more than 50 percent of the
outstanding voting stock, or which is otherwise controlled or capable of
being controlled by the parent institution.
\17\ An exception to this deduction would be made in the case of
shares acquired in the regular course of securing or collecting a debt
previously contracted in good faith. The requirements for consolidation
are spelled out in the instructions to the FR Y-9C Report.
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Advances (that is, loans, extensions of credit, guarantees,
commitments, or any other forms of credit exposure) to the subsidiary
that are not deemed to be capital will generally not be deducted from an
organization's capital. Rather, such advances generally will be included
in the parent banking organization's consolidated assets and be assigned
to the 100 percent risk category, unless such obligations are backed by
recognized collateral or guarantees, in which case they will be assigned
to the risk category appropriate to such collateral or guarantees. These
advances may, however, also be deducted from the consolidated parent
banking organization's capital if, in the judgment of the Federal
Reserve, the risks stemming from such advances are comparable to the
risks associated with capital investments or if the advances involve
other risk factors that warrant such an adjustment to capital for
supervisory purposes. These other factors could include, for example,
the absence of collateral support.
Inasmuch as the assets of unconsolidated banking and finance
subsidiaries are not fully reflected in a banking organization's
consolidated total assets, such assets may be viewed as the equivalent
of off-balance sheet exposures since the operations of an unconsolidated
subsidiary could expose the parent organization and its affiliates to
considerable risk. For this reason, it is generally appropriate to view
the capital resources invested in these unconsolidated entities as
primarily supporting the risks inherent in these off-balance sheet
assets, and not generally available to support risks or absorb losses
elsewhere in the organization.
b. Other subsidiaries and investments. The deduction of investments,
regardless of whether they are made by the parent bank holding company
or by its direct or indirect subsidiaries, from a consolidated banking
organization's capital will also be applied in the case of any
subsidiaries, that, while consolidated for accounting purposes, are not
consolidated for certain specified supervisory or regulatory purposes,
such as to facilitate functional regulation. For this purpose, aggregate
capital investments (that is, the sum of any equity or debt instruments
that are deemed to be capital) in these subsidiaries will be deducted
from the consolidated parent banking organization's total capital
components.\18\
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\18\ Investments in unconsolidated subsidiaries will be deducted
from both Tier 1 and Tier 2 capital. As a general rule, one-half (50
percent) of the aggregate amount of capital investments will be deducted
from the bank holding company's Tier 1 capital and one-half (50 percent)
from its Tier 2 capital. However, the Federal Reserve may, on a case-by-
case basis, deduct a proportionately greater amount from Tier 1 if the
risks associated with the subsidiary so warrant. If the amount
deductible from Tier 2 capital exceeds actual Tier 2 capital, the excess
would be deducted from Tier 1 capital. Bank holding companies' risk-
based capital ratios, net of these deductions, must exceed the minimum
standards set forth in section IV.
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Advances (that is, loans, extensions of credit, guarantees,
commitments, or any other forms of credit exposure) to such subsidiaries
that are not deemed to be capital will generally not be deducted from
capital. Rather, such advances will normally be included in the parent
banking organization's consolidated assets and assigned to the 100
percent risk category, unless such obligations are backed by recognized
collateral or
[[Page 179]]
guarantees, in which case they will be assigned to the risk category
appropriate to such collateral or guarantees. These advances may,
however, be deducted from the consolidated parent banking organization's
capital if, in the judgment of the Federal Reserve, the risks stemming
from such advances are comparable to the risks associated with capital
investments or if such advances involve other risk factors that warrant
such an adjustment to capital for supervisory purposes. These other
factors could include, for example, the absence of collateral
support.\19\
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\19\ In assessing the overall capital adequacy of a banking
organization, the Federal Reserve may also consider the organization's
fully consolidated capital position.
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In general, when investments in a consolidated subsidiary are
deducted from a consolidated parent banking organization's capital, the
subsidiary's assets will also be excluded from the consolidated assets
of the parent banking organization in order to assess the latter's
capital adequacy.\20\
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\20\ If the subsidiary's assets are consolidated with the parent
banking organization for financial reporting purposes, this adjustment
will involve excluding the subsidiary's assets on a line-by-line basis
from the consolidated parent organization's assets. The parent banking
organization's capital ratio will then be calculated on a consolidated
basis with the exception that the assets of the excluded subsidiary will
not be consolidated with the remainder of the parent banking
organization.
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The Federal Reserve may also deduct from a banking organization's
capital, on a case-by-case basis, investments in certain other
subsidiaries in order to determine if the consolidated banking
organization meets minimum supervisory capital requirements without
reliance on the resources invested in such subsidiaries.
The Federal Reserve will not automatically deduct investments in
other unconsolidated subsidiaries or investments in joint ventures and
associated companies.\21\ Nonetheless, the resources invested in these
entities, like investments in unconsolidated banking and finance
subsidiaries, support assets not consolidated with the rest of the
banking organization's activities and, therefore, may not be generally
available to support additional leverage or absorb losses elsewhere in
the banking organization. Moreover, experience has shown that banking
organizations stand behind the losses of affiliated institutions, such
as joint ventures and associated companies, in order to protect the
reputation of the organization as a whole. In some cases, this has led
to losses that have exceeded the investments in such organizations.
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\21\ The definition of such entities is contained in the
instructions to the Consolidated Financial Statements for Bank Holding
Companies. Under regulatory reporting procedures, associated companies
and joint ventures generally are defined as companies in which the
banking organization owns 20 to 50 percent of the voting stock.
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For this reason, the Federal Reserve will monitor the level and
nature of such investments for individual banking organizations and may,
on a case-by-case basis, deduct such investments from total capital
components, apply an appropriate risk-weighted capital charge against
the organization's proportionate share of the assets of its associated
companies, require a line-by-line consolidation of the entity (in the
event that the parent's control over the entity makes it the functional
equivalent of a subsidiary), or otherwise require the organization to
operate with a risk-based capital ratio above the minimum.
In considering the appropriateness of such adjustments or actions,
the Federal Reserve will generally take into account whether:
(1) The parent banking organization has significant influence over
the financial or managerial policies or operations of the subsidiary,
joint venture, or associated company;
(2) The banking organization is the largest investor in the
affiliated company; or
(3) Other circumstances prevail that appear to closely tie the
activities of the affiliated company to the parent banking organization.
3. Reciprocal holdings of banking organizations' capital
instruments. Reciprocal holdings of banking organizations' capital
instruments (that is, instruments that qualify as Tier 1 or Tier 2
capital) will be deducted from an organization's total capital
components for the purpose of determining the numerator of the risk-
based capital ratio.
Reciprocal holdings are cross-holdings resulting from formal or
informal arrangements in which two or more banking organizations swap,
exchange, or otherwise agree to hold each other's capital instruments.
Generally, deductions will be limited to intentional cross-holdings. At
present, the Board does not intend to require banking organizations to
deduct non-reciprocal holdings of such capital instruments.\22\
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\22\ Deductions of holdings of capital securities also would not be
made in the case of interstate ``stake out'' investments that comply
with the Board's Policy Statement on Nonvoting Equity Investments, 12
CFR 225.143 (Federal Reserve Regulatory Service 4-172.1; 68 Federal
Reserve Bulletin 413 (1982)). In addition, holdings of capital
instruments issued by other banking organizations but taken in
satisfaction of debts previously contracted would be exempt from any
deduction from capital. The Board intends to monitor nonreciprocal
holdings of other banking organizations' capital instruments and to
provide information on such holdings to the Basle Supervisors' Committee
as called for under the Basle capital framework.
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[[Page 180]]
4. Deferred tax assets. The amount of deferred tax assets that is
dependent upon future taxable income, net of the valuation allowance for
deferred tax assets, that may be included in, that is, not deducted
from, a banking organization's capital may not exceed the lesser of (i)
the amount of these deferred tax assets that the banking organization is
expected to realize within one year of the calendar quarter-end date,
based on its projections of future taxable income for that year,\23\ or
(ii) 10 percent of Tier 1 capital. The reported amount of deferred tax
assets, net of any valuation allowance for deferred tax assets, in
excess of the lesser of these two amounts is to be deducted from a
banking organization's core capital elements in determining Tier 1
capital. For purposes of calculating the 10 percent limitation, Tier 1
capital is defined as the sum of core capital elements, net of goodwill,
and net of all identifiable intangible assets other than mortgage
servicing assets, nonmortgage servicing assets, and purchased credit
card relationships, before any disallowed deferred tax assets are
deducted. There generally is no limit in Tier 1 capital on the amount of
deferred tax assets that can be realized from taxes paid in prior
carryback years or from future reversals of existing taxable temporary
differences.
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\23\ To determine the amount of expected deferred tax assets
realizable in the next 12 months, an institution should assume that all
existing temporary differences fully reverse as of the report date.
Projected future taxable income should not include net operating loss
carryforwards to be used during that year or the amount of existing
temporary differences a bank holding company expects to reverse within
the year. Such projections should include the estimated effect of tax
planning strategies that the organization expects to implement to
realize net operating losses or tax credit carryforwards that would
otherwise expire during the year. Institutions do not have to prepare a
new 12 month projection each quarter. Rather, on interim report dates,
institutions may use the future taxable income projections for their
current fiscal year, adjusted for any significant changes that have
occurred or are expected to occur.
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III. Procedures for Computing Weighted Risk Assets and Off-Balance Sheet
Items
A. Procedures
Assets and credit equivalent amounts of off-balance sheet items of
bank holding companies are assigned to one of several broad risk
categories, according to the obligor, or, if relevant, the guarantor or
the nature of the collateral. The aggregate dollar value of the amount
in each category is then multiplied by the risk weight associated with
that category. The resulting weighted values from each of the risk
categories are added together, and this sum is the banking
organization's total weighted risk assets that comprise the denominator
of the risk-based capital ratio. Attachment I provides a sample
calculation.
Risk weights for all off-balance sheet items are determined by a
two-step process. First, the ``credit equivalent amount'' of off-balance
sheet items is determined, in most cases, by multiplying the off-balance
sheet item by a credit conversion factor. Second, the credit equivalent
amount is treated like any balance sheet asset and generally is assigned
to the appropriate risk category according to the obligor, or, if
relevant, the guarantor or the nature of the collateral.
In general, if a particular item qualifies for placement in more
than one risk category, it is assigned to the category that has the
lowest risk weight. A holding of a U.S. municipal revenue bond that is
fully guaranteed by a U.S. bank, for example, would be assigned the 20
percent risk weight appropriate to claims guaranteed by U.S. banks,
rather than the 50 percent risk weight appropriate to U.S. municipal
revenue bonds.\24\
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\24\ An investment in shares of a fund whose portfolio consists
primarily of various securities or money market instruments that, if
held separately, would be assigned to different risk categories,
generally is assigned to the risk category appropriate to the highest
risk-weighted asset that the fund is permitted to hold in accordance
with the stated investment objectives set forth in the prospectus. An
organization may, at its option, assign a fund investment on a pro rata
basis to different risk categories according to the investment limits in
the fund's prospectus. In no case will an investment in shares in any
fund be assigned to a total risk weight of less than 20 percent. If an
organization chooses to assign a fund investment on a pro rata basis,
and the sum of the investment limits of assets in the fund's prospectus
exceeds 100 percent, the organization must assign risk weights in
descending order. If, in order to maintain a necessary degree of short-
term liquidity, a fund is permitted to hold an insignificant amount of
its assets in short-term, highly liquid securities of superior credit
quality that do not qualify for a preferential risk weight, such
securities generally will be disregarded when determining the risk
category into which the organization's holding in the overall fund
should be assigned. The prudent use of hedging instruments by a fund to
reduce the risk of its assets will not increase the risk weighting of
the fund investment. For example, the use of hedging instruments by a
fund to reduce the interest rate risk of its government bond portfolio
will not increase the risk weight of that fund above the 20 percent
category. Nonetheless, if a fund engages in any activities that appear
speculative in nature or has any other characteristics that are
inconsistent with the preferential risk weighting assigned to the fund's
assets, holdings in the fund will be assigned to the 100 percent risk
category.
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[[Page 181]]
B. Collateral, Guarantees, and Other Considerations
1. Collateral. The only forms of collateral that are formally
recognized by the risk-based capital framework are: Cash on deposit in a
subsidiary lending institution; securities issued or guaranteed by the
central governments of the OECD-based group of countries,\25\ U.S.
Government agencies, or U.S. Government-sponsored agencies; and
securities issued by multilateral lending institutions or regional
development banks. Claims fully secured by such collateral generally are
assigned to the 20 percent risk-weight category. Collateralized
transactions meeting all the conditions described in section III.C.1.
may be assigned a zero percent risk weight.
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\25\ The OECD-based group of countries comprises all full members of
the Organization for Economic Cooperation and Development (OECD)
regardless of entry date, as well as countries that have concluded
special lending arrangements with the International Monetary Fund (IMF)
associated with the IMF's General Arrangements to Borrow, but excludes
any country that has rescheduled its external sovereign debt within the
previous five years. As of November 1995, the OECD included the
following countries: Australia, Austria, Belgium, Canada, Denmark,
Finland, France, Germany, Greece, Iceland, Ireland, Italy, Japan,
Luxembourg, Mexico, the Netherlands, New Zealand, Norway, Portugal,
Spain, Sweden, Switzerland, Turkey, the United Kingdom, and the United
States; and Saudi Arabia had concluded special lending arrangements with
the IMF associated with the IMF's General Arrangements to Borrow. A
rescheduling of external sovereign debt generally would include any
renegotiation of terms arising from a country's inability or
unwillingness to meet its external debt service obligations, but
generally would not include renegotiations of debt in the normal course
of business, such as a renegotiation to allow the borrower to take
advantage of a decline in interest rates or other change in market
conditions.
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With regard to collateralized claims that may be assigned to the 20
percent risk-weight category, the extent to which qualifying securities
are recognized as collateral is determined by their current market
value. If such a claim is only partially secured, that is, the market
value of the pledged securities is less than the face amount of a
balance-sheet asset or an off-balance-sheet item, the portion that is
covered by the market value of the qualifying collateral is assigned to
the 20 percent risk category, and the portion of the claim that is not
covered by collateral in the form of cash or a qualifying security is
assigned to the risk category appropriate to the obligor or, if
relevant, the guarantor. For example, to the extent that a claim on a
private sector obligor is collateralized by the current market value of
U.S. Government securities, it would be placed in the 20 percent risk
category and the balance would be assigned to the 100 percent risk
category.
2. Guarantees. Guarantees of the OECD and non-OECD central
governments, U.S. Government agencies, U.S. Government-sponsored
agencies, state and local governments of the OECD-based group of
countries, multilateral lending institutions and regional development
banks, U.S. depository institutions, and foreign banks are also
recognized. If a claim is partially guaranteed, that is, coverage of the
guarantee is less than the face amount of a balance sheet asset or an
off-balance sheet item, the portion that is not fully covered by the
guarantee is assigned to the risk category appropriate to the obligor
or, if relevant, to any collateral. The face amount of a claim covered
by two types of guarantees that have different risk weights, such as a
U.S. Government guarantee and a state guarantee, is to be apportioned
between the two risk categories appropriate to the guarantors.
The existence of other forms of collateral or guarantees that the
risk-based capital framework does not formally recognize may be taken
into consideration in evaluating the risks inherent in an organization's
loan portfolio--which, in turn, would affect the overall supervisory
assessment of the organization's capital adequacy.
3. Mortgage-backed securities. Mortgage-backed securities, including
pass-throughs and collateralized mortgage obligations (but not stripped
mortgage-backed securities), that are issued or guaranteed by a U.S.
Government agency or U.S. Government-sponsored agency are assigned to
the risk weight
[[Page 182]]
category appropriate to the issuer or guarantor. Generally, a privately-
issued mortgage-backed security meeting certain criteria set forth in
the accompanying footnote \26\ is treated as essentially an indirect
holding of the underlying assets, and is assigned to the same risk
category as the underlying assets, but in no case to the zero percent
risk category. Privately-issued mortgage-backed securities whose
structures do not qualify them to be regarded as indirect holdings of
the underlying assets are assigned to the 100 percent risk category.
During the inspection process, privately-issued mortgage-backed
securities that are assigned to a lower risk weight category will be
subject to criteria.
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\26\ A privately-issued mortgage-backed security may be treated as
an indirect holding of the underlying assets provided that: (1) The
underlying assets are held by an independent trustee and the trustee has
a first priority, perfected security interest in the underlying assets
on behalf of the holders of the security; (2) either the holder of the
security has an undivided pro rata ownership interest in the underlying
mortgage assets or the trust or single purpose entity (or conduit) that
issues the security has no liabilities unrelated to the issued
securities; (3) the security is structured such that the cash flow from
the underlying assets in all cases fully meets the cash flow
requirements of the security without undue reliance on any reinvestment
income; and (4) there is no material reinvestment risk associated with
any funds awaiting distribution to the holders of the security. In
addition, if the underlying assets of a mortgage-backed security are
composed of more than one type of asset, for example, U.S. Government-
sponsored agency securities and privately-issued pass-through securities
that qualify for the 50 percent risk weight category, the entire
mortgage-backed security is generally assigned to the category
appropriate to the highest risk-weighted asset underlying the issue, but
in no case to the zero percent risk category. Thus, in this example, the
security would receive the 50 percent risk weight appropriate to the
privately-issued pass-through securities.
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While the risk category to which mortgage-backed securities is
assigned will generally be based upon the issuer or guarantor or, in the
case of privately-issued mortgage-backed securities, the assets
underlying the security, any class of a mortgage-backed security that
can absorb more than its pro rata share of loss without the whole issue
being in default (for example, a so-called subordinated class or
residual interest), is assigned to the 100 percent risk category.
Furthermore, all stripped mortgage-backed securities, including
interest-only strips (IOs), principal-only strips (POs), and similar
instruments, are also assigned to the 100 percent risk weight category,
regardless of the issuer or guarantor.
4. Maturity. Maturity is generally not a factor in assigning items
to risk categories with the exception of claims on non-OECD banks,
commitments, and interest rate and foreign exchange rate contracts.
Except for commitments, short-term is defined as one year or less
remaining maturity and long-term is defined as over one year remaining
maturity. In the case of commitments, short-term is defined as one year
or less original maturity and long-term is defined as over one year
original maturity.\27\
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\27\ Through year-end 1992, remaining, rather than original,
maturity may be used for determining the maturity of commitments.
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5. Small Business Loans and Leases on Personal Property Transferred
with Recourse. a. Notwithstanding other provisions of this appendix A, a
qualifying banking organization that has transferred small business
loans and leases on personal property (small business obligations) with
recourse shall include in weighted-risk assets only the amount of
retained recourse, provided two conditions are met. First, the
transaction must be treated as a sale under GAAP and, second, the
banking organization must establish pursuant to GAAP a non-capital
reserve sufficient to meet the organization's reasonably estimated
liability under the recourse arrangement. Only loans and leases to
businesses that meet the criteria for a small business concern
established by the Small Business Administration under section 3(a) of
the Small Business Act are eligible for this capital treatment.
b. For purposes of this appendix A, a banking organization is
qualifying if it meets the criteria for well capitalized or, by order of
the Board, adequately capitalized, as those criteria are set forth in
the Board's prompt corrective action regulation for state member banks
(12 CFR 208.40). For purposes of determining whether an organization
meets these criteria, its capital ratios must be calculated without
regard to the capital treatment for transfers of small business
obligations with recourse specified in section III.B.5.a. of this
appendix A. The total outstanding amount of recourse retained by a
qualifying banking organization on transfers of small business
obligations receiving the preferential capital treatment cannot exceed
15 percent of the organization's total risk-based capital. By order, the
Board may approve a higher limit.
c. If a bank holding company ceases to be qualifying or exceeds the
15 percent capital limitation, the preferential capital treatment will
continue to apply to any transfers of small business obligations with
recourse that were consummated during the time that
[[Page 183]]
the organization was qualifying and did not exceed the capital limit.
C. Risk Weights
Attachment III contains a listing of the risk categories, a summary
of the types of assets assigned to each category and the risk weight
associated with each category, that is, 0 percent, 20 percent, 50
percent, and 100 percent. A brief explanation of the components of each
category follows.
1. Category 1: zero percent. This category includes cash (domestic
and foreign) owned and held in all offices of subsidiary depository
institutions or in transit and gold bullion held in either a subsidiary
depository institution's own vaults or in another's vaults on an
allocated basis, to the extent it is offset by gold bullion
liabilities.\28\ The category also includes all direct claims (including
securities, loans, and leases) on, and the portions of claims that are
directly and unconditionally guaranteed by, the central governments \29\
of the OECD countries and U.S. Government agencies,\30\ as well as all
direct local currency claims on, and the portions of local currency
claims that are directly and unconditionally guaranteed by, the central
governments of non-OECD countries, to the extent that subsidiary
depository institutions have liabilities booked in that currency. A
claim is not considered to be unconditionally guaranteed by a central
government if the validity of the guarantee is dependent upon some
affirmative action by the holder or a third party. Generally, securities
guaranteed by the U.S. Government or its agencies that are actively
traded in financial markets, such as GNMA securities, are considered to
be unconditionally guaranteed.
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\28\ All other holdings of bullion are assigned to the 100 percent
risk category.
\29\ A central government is defined to include departments and
ministries, including the central bank, of the central government. The
U.S. central bank includes the 12 Federal Reserve Banks, and stock held
in these banks as a condition of membership is assigned to the zero
percent risk category. The definition of central government does not
include state, provincial, or local governments; or commercial
enterprises owned by the central government. In addition, it does not
include local government entities or commercial enterprises whose
obligations are guaranteed by the central government, although any
claims on such entities guaranteed by central governments are placed in
the same general risk category as other claims guaranteed by central
governments. OECD central governments are defined as central governments
of the OECD-based group of countries; non-OECD central governments are
defined as central governments of countries that do not belong to the
OECD-based group of countries.
\30\ A U.S. Governmnt agency is defined as an instrumentality of the
U.S. Government whose obligations are fully and explicitly guaranteed as
to the timely payment of principal and interest by the full faith and
credit of the U.S. Government. Such agencies include the Government
National Mortgage Association (GNMA), the Veterans Administration (VA),
the Federal Housing Administration (FHA), the Export-Import Bank (Exim
Bank), the Overseas Private Investment Corporation (OPIC), the Commodity
Credit Corporation (CCC), and the Small Business Administration (SBA).
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This category also includes claims collateralized by cash on deposit
in the subsidiary lending institution or by securities issued or
guaranteed by OECD central governments or U.S. government agencies for
which a positive margin of collateral is maintained on a daily basis,
fully taking into account any change in the banking organization's
exposure to the obligor or counterparty under a claim in relation to the
market value of the collateral held in support of that claim.
2. Category 2: 20 percent. This category includes cash items in the
process of collection, both foreign and domestic; short-term claims
(including demand deposits) on, and the portions of short-term claims
that are guaranteed by,\31\ U.S. depository institutions \32\ and
foreign banks \33\; and long-term
[[Page 184]]
claims on, and the portions of long-term claims that are guaranteed by,
U.S. depository institutions and OECD banks.\34\
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\31\ Claims guaranteed by U.S. depository institutions and foreign
banks include risk participations in both bankers acceptances and
standby letters of credit, as well as participations in commitments,
that are conveyed to U.S. depository institutions or foreign banks.
\32\ U.S. depository institutions are defined to include branches
(foreign and domestic) of federally-insured banks and depository
institutions chartered and headquartered in the 50 states of the United
States, the District of Columbia, Puerto Rico, and U.S. territories and
possessions. The definition encompasses banks, mutual or stock savings
banks, savings or building and loan associations, cooperative banks,
credit unions, and international banking facilities or domestic banks.
U.S.-chartered depository institutions owned by foreigners are also
included in the definition. However, branches and agencies of foreign
banks located in the U.S., as well as all bank holding companies, are
excluded.
\33\ Foreign banks are distinguished as either OECD banks or non-
OECD banks. OECD banks include banks and their branches (foreign and
domestic) organized under the laws of countries (other than the U.S.)
that belong to the OECD-based group of countries. Non-OECD banks include
banks and their branches (foreign and domestic) organized under the laws
of countries that do not belong to the OECD-based group of countries.
For this purpose, a bank is defined as an institution that engages in
the business of banking; is recognized as a bank by the bank supervisory
or monetary authorities of the country of its organization or principal
banking operations; receives deposits to a substantial extent in the
regular course of business; and has the power to accept demand deposits.
\34\ Long-term claims on, or guaranteed by, non-OECD banks and all
claims on bank holding companies are assigned to the 100 percent risk
category, as are holdings of bank-issued securities that qualify as
capital of the issuing banks.
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This category also includes the portions of claims that are
conditionally guaranteed by OECD central governments and U.S. Government
agencies, as well as the portions of local currency claims that are
conditionally guaranteed by non-OECD central governments, to the extent
that subsidiary depository institutions have liabilities booked in that
currency. In addition, this category also includes claims on, and the
portions of claims that are guaranteed by, U.S. government-sponsored
\35\ agencies and claims on, and the portions of claims guaranteed by,
the International Bank for Reconstruction and Development (World Bank),
the International Finance Corporation, the Interamerican Development
Bank, the Asian Development Bank, the African Development Bank, the
European Investment Bank, the European Bank for Reconstruction and
Development, the Nordic Investment Bank, and other multilateral lending
institutions or regional development banks in which the U.S. government
is a shareholder or contributing member. General obligation claims on,
or portions of claims guaranteed by the full faith and credit of, states
or other political subdivisions of the U.S. or other countries of the
OECD--based group are also assigned to this category.\36\
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\35\ For this purpose, U.S. government-sponsored agencies are
defined as agencies originally established or chartered by the Federal
government to serve public purposes specified by the U.S. Congress but
whose obligations are not explicitly guaranteed by the full faith and
credit of the U.S. government. These agencies include the Federal Home
Loan Mortgage Corporation (FHLMC), the Federal National Mortgage
Association (FNMA), the Farm Credit System, the Federal Home Loan Bank
System, and the Student Loan Marketing Association (SLMA). Claims on
U.S. government-sponsored agencies include capital stock in a Federal
Home Loan Bank that is held as a condition of membership in that Bank.
\36\ Claims on, or guaranteed by, states or other political
subdivisions of countries that do not belong to the OECD-based group of
countries are placed in the 100 percent risk category.
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This category also includes the portions of claims (including
repurchase transactions) collateralized by cash on deposit in the
subsidiary lending institution or by securities issued or guaranteed by
OECD central governments or U.S. government agencies that do not qualify
for the zero percent risk-weight category; collateralized by securities
issued or guaranteed by U.S. government-sponsored agencies; or
collateralized by securities issued by multilateral lending institutions
or regional development banks in which the U.S. government is a
shareholder or contributing member.
3. Category 3: 50 percent. This category includes loans fully
secured by first liens \37\ on 1- to 4-family residential properties,
either owner-occupied or rented, or on multifamily residential
properties,\38\ that meet certain criteria.\39\ Loans included in this
category must have been made in accordance with
[[Page 185]]
prudent underwriting standards;\40\ be performing in accordance with
their original terms; and not be 90 days or more past due or carried in
nonaccrual status. The following additional criteria must also be
applied to a loan secured by a multifamily residential property that is
included in this category: all principal and interest payments on the
loan must have been made on time for at least the year preceding
placement in this category, or in the case where the existing property
owner is refinancing a loan on that property, all principal and interest
payments on the loan being refinanced must have been made on time for at
least the year preceding placement in this category; amortization of the
principal and interest must occur over a period of not more than 30
years and the minimum original maturity for repayment of principal must
not be less than 7 years; and the annual net operating income (before
debt service) generated by the property during its most recent fiscal
year must not be less than 120 percent of the loan's current annual debt
service (115 percent if the loan is based on a floating interest rate)
or, in the case of a cooperative or other not-for-profit housing
project, the property must generate sufficient cash flow to provide
comparable protection to the institution. Also included in this category
are privately-issued mortgage-backed securities provided that:
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\37\ If a banking organization holds the first and junior lien(s) on
a residential property and no other party holds an intervening lien, the
transaction is treated as a single loan secured by a first lien for the
purposes of determining the loan-to-value ratio and assigning a risk
weight.
\38\ Loans that qualify as loans secured by 1- to 4-family
residential properties or multifamily residential properties are listed
in the instructions to the FR Y-9C Report. In addition, for risk-based
capital purposes, loans secured by 1- to 4-family residential properties
include loans to builders with substantial project equity for the
construction of 1-to 4-family residences that have been presold under
firm contracts to purchasers who have obtained firm commitments for
permanent qualifying mortgage loans and have made substantial earnest
money deposits. Such loans to builders will be considered prudently
underwritten only if the bank holding company has obtained sufficient
documentation that the buyer of the home intends to purchase the home
(i.e., has a legally binding written sales contract) and has the ability
to obtain a mortgage loan sufficient to purchase the home (i.e., has a
firm written commitment for permanent financing of the home upon
completion).
\39\ Residential property loans that do not meet all the specified
criteria or that are made for the purpose of speculative property
development are placed in the 100 percent risk category.
\40\ Prudent underwriting standards include a conservative ratio of
the current loan balance to the value of the property. In the case of a
loan secured by multifamily residential property, the loan-to-value
ratio is not conservative if it exceeds 80 percent (75 percent if the
loan is based on a floating interest rate). Prudent underwriting
standards also dictate that a loan-to-value ratio used in the case of
originating a loan to acquire a property would not be deemed
conservative unless the value is based on the lower of the acquisition
cost of the property or appraised (or if appropriate, evaluated) value.
Otherwise, the loan-to-value ratio generally would be based upon the
value of the property as determined by the most current appraisal, or if
appropriate, the most current evaluation. All appraisals must be made in
a manner consistent with the Federal banking agencies' real estate
appraisal regulations and guidelines and with the banking organization's
own appraisal guidelines.
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(1) The structure of the security meets the criteria described in
section III(B)(3) above;
(2) if the security is backed by a pool of conventional mortgages,
on 1- to 4-family residential or multifamily residential properties,
each underlying mortgage meets the criteria described above in this
section for eligibility for the 50 percent risk category at the time the
pool is originated;
(3) If the security is backed by privately-issued mortgage-backed
securities, each underlying security qualifies for the 50 percent risk
category; and
(4) If the security is backed by a pool of multifamily residential
mortgages, principal and interest payments on the security are not 30
days or more past due. Privately-issued mortgage-backed securities that
do not meet these criteria or that do not qualify for a lower risk
weight are generally assigned to the 100 percent risk category.
Also assigned to this category are revenue (non-general obligation)
bonds or similar obligations, including loans and leases, that are
obligations of states or other political subdivisions of the U.S. (for
example, municipal revenue bonds) or other countries of the OECD-based
group, but for which the government entity is committed to repay the
debt with revenues from the specific projects financed, rather than from
general tax funds.
Credit equivalent amounts of derivative contracts involving standard
risk obligors (that is, obligors whose loans or debt securities would be
assigned to the 100 percent risk category) are included in the 50
percent category, unless they are backed by collateral or guarantees
that allow them to be placed in a lower risk category.
4. Category 4: 100 percent. All assets not included in the
categories above are assigned to this category, which comprises standard
risk assets. The bulk of the assets typically found in a loan portfolio
would be assigned to the 100 percent category.
This category includes long-term claims on, and the portions of
long-term claims that are guaranteed by, non-OECD banks, and all claims
on non-OECD central governments that entail some degree of transfer
risk.\41\ This category also includes all claims on foreign and domestic
private sector obligors not included in the categories above (including
loans to nondepository financial institutions and bank holding
companies); claims on commercial firms owned by the public sector;
customer liabilities to the bank on acceptances outstanding involving
standard risk claims\42\ investments in fixed assets,
[[Page 186]]
premises, and other real estate owned; common and preferred stock of
corporations, including stock acquired for debts previously contracted;
commercial and consumer loans (except those assigned to lower risk
categories due to recognized guarantees or collateral and loans for
residential property that qualify for a lower risk weight); mortgage-
backed securities that do not meet criteria for assignment to a lower
risk weight (including any classes of mortgage-backed securities that
can absorb more than their pro rata share of loss without the whole
issue being in default); and all stripped mortgage-backed and similar
securities.
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\41\ Such assets include all non-local currency claims on, and the
portions of claims that are guaranteed by, non-OECD central governments
and those portions of local currency claims on, or guaranteed by, non-
OECD central governments that exceed the local currency liabilities held
by subsidiary depository institutions.
\42\ Customer liabilities on acceptances outstanding involving non-
standard risk claims, such as claims on U.S. depository institutions,
are assigned to the risk category appropriate to the identity of the
obligor or, if relevant, the nature of the collateral or guarantees
backing the claims. Portions of acceptances conveyed as risk
participations to U.S. depository institutions or foreign banks are
assigned to the 20 percent risk category appropriate to short-term
claims guaranteed by U.S. depository institutions and foreign banks.
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Also included in this category are industrial development bonds and
similar obligations issued under the auspices of states or political
subdivisions of the OECD-based group of countries for the benefit of a
private party or enterprise where that party or enterprise, not the
government entity, is obligated to pay the principal and interest, and
all obligations of states or political subdivisions of countries that do
not belong to the OECD-based group.
The following assets also are assigned a risk weight of 100 percent
if they have not been deducted from capital: Investments in
unconsolidated companies, joint ventures, or associated companies;
instruments that qualify as capital issued by other banking
organizations; and any intangibles, including those that may have been
grandfathered into capital.
D. Off-Balance Sheet Items
The face amount of an off-balance sheet item is incorporated into
the risk-based capital ratio by multiplying it by a credit conversion
factor. The resultant credit equivalent amount is assigned to the
appropriate risk category according to the obligor, or, if relevant, the
guarantor or the nature of the collateral.\43\ Attachment IV sets forth
the conversion factors for various types of off-balance sheet items.
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\43\ The sufficiency of collateral and guarantees for off-balance-
sheet items is determined by the market value of the collateral or the
amount of the guarantee in relation to the face amount of the item,
except for derivative contracts, for which this determination is
generally made in relation to the credit equivalent amount. Collateral
and guarantees are subject to the same provisions noted under section
III.B. of this appendix A.
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1. Items with a 100 percent conversion factor.
a. A 100 percent conversion factor applies to direct credit
substitutes, which include guarantees, or equivalent instruments,
backing financial claims, such as outstanding securities, loans, and
other financial liabilities, or that back off-balance sheet items that
require capital under the risk-based capital framework. Direct credit
substitutes include, for example, financial standby letters of credit,
or other equivalent irrevocable undertakings or surety arrangements,
that guarantee repayment of financial obligations such as: commercial
paper, tax-exempt securities, commercial or individual loans or debt
obligations, or standby or commercial letters of credit. Direct credit
substitutes also include the acquisition of risk participations in
bankers acceptances and standby letters of credit, since both of these
transactions, in effect, constitute a guarantee by the acquiring banking
organization that the underlying account party (obligor) will repay its
obligation to the originating, or issuing, institution.\44\ (Standby
letters of credit that are performance-related are discussed below and
have a credit conversion factor of 50 percent.)
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\44\ Credit equivalent amounts of acquisitions of risk
participations are assigned to the risk category appropriate to the
account party obligor, or, if relevant, the nature of the collateral or
guarantees.
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b. The full amount of a direct credit substitute is converted at 100
percent and the resulting credit equivalent amount is assigned to the
risk category appropriate to the obligor or, if relevant, the guarantor
or the nature of the collateral. In the case of a direct credit
substitute in which a risk participation \45\ has been conveyed, the
full amount is still converted at 100 percent. However, the credit
equivalent amount that has been conveyed is assigned to whichever risk
category is lower: the risk category appropriate to the obligor, after
giving effect to any relevant guarantees or collateral, or the risk
category appropriate to the institution acquiring the participation. Any
remainder is assigned to the risk category appropriate to the obligor,
guarantor, or collateral. For example, the portion of a direct credit
substitute conveyed as a risk participation to a U.S. domestic
depository institution or foreign bank is assigned to the risk category
appropriate to claims guaranteed by those institutions, that is, the 20
percent
[[Page 187]]
risk category.\46\ This approach recognizes that such conveyances
replace the originating banking organization's exposure to the obligor
with an exposure to the institutions acquiring the risk
participations.\47\
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\45\ That is, a participation in which the originating banking
organization remains liable to the beneficiary for the full amount of
the direct credit substitute if the party that has acquired the
participation fails to pay when the instrument is drawn.
\46\ Risk participations with a remaining maturity of over one year
that are conveyed to non-OECD banks are to be assigned to the 100
percent risk category, unless a lower risk category is appropriate to
the obligor, guarantor, or collateral.
\47\ A risk participation in bankers acceptances conveyed to other
institutions is also assigned to the risk category appropriate to the
institution acquiring the participation or, if relevant, the guarantor
or nature of the collateral.
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c. In the case of direct credit substitutes that take the form of a
syndication, that is, where each banking organization if obligated only
for its pro rata share of the risk and there is no recourse to the
originating banking organization, each banking organization will only
include its pro rata share of the direct credit substitute in its risk-
based capital calculation.
d. Financial standby letters of credit are distinguished from loan
commitments (discussed below) in that standbys are irrevocable
obligations of the banking organization to pay a third-party beneficiary
when a customer (account party) fails to repay an outstanding loan or
debt instrument (direct credit substitute). Performance standby letters
of credit (performance bonds) are irrevocable obligations of the banking
organization to pay a third-party beneficiary when a customer (account
party) fails to perform some other contractual non-financial obligation.
e. The distinguishing characteristic of a standby letter of credit
for risk-based capital purposes is the combination of irrevocability
with the fact that funding is triggered by some failure to repay or
perform an obligation. Thus, any commitment (by whatever name) that
involves an irrevocable obligation to make a payment to the customer or
to a third party in the event the customer fails to repay an outstanding
debt obligation or fails to perform a contractual obligation is treated,
for risk-based capital purposes, as respectively, a financial guarantee
standby letter of credit or a performance standby.
f. A loan commitment, on the other hand, involves an obligation
(with or without a material adverse change or similar clause) of the
banking organization to fund its customer in the normal course of
business should the customer seek to draw down the commitment.
g. Sale and repurchase agreements and asset sales with recourse (to
the extent not included on the balance sheet) and forward agreements
also are converted at 100 percent.\48\ So-called ``loan strips'' (that
is, short-term advances sold under long-term commitments without direct
recourse) are treated for risk-based capital purposes as assets sold
with recourse and, accordingly, are also converted at 100 percent.
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\48\ In regulatory reports and under GAAP, bank holding companies
are permitted to treat some asset sales with recourse as ``true'' sales.
For risk-based capital purposes, however, such assets sold with recourse
and reported as ``true'' sales by bank holding companies are converted
at 100 percent and assigned to the risk category appropriate to the
underlying obligor or, if relevant, the guarantor or nature of the
collateral, provided that the transactions meet the definition of assets
sold with recourse (including assets sold subject to pro rata and other
loss sharing arrangements), that is contained in the instructions to the
commercial bank Consolidated Reports of Condition and Income (Call
Report). This treatment applies to any assets, including the sale of 1-
to 4-family and multifamily residential mortgages, sold with recourse.
Accordingly, the entire amount of any assets transferred with recourse
that are not already included on the balance sheet, including pools of
1- to 4-family residential mortgages, are to be converted at 100 percent
and assigned to the risk category appropriate to the obligor, or if
relevant, the nature of any collateral or guarantees. The terms of a
transfer of assets with recourse may contractually limit the amount of
the institution's liability to an amount less than the effective risk-
based capital requirement for the assets being transferred with
recourse. If such a transaction is recognized as a sale under GAAP, the
amount of total capital required is equal to the maximum amount of loss
possible under the recourse provision, less any amount held in an
associated non-capital liability account established pursuant to GAAP to
cover estimated probable losses under the recourse provision.
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h. Forward agreements are legally binding contractual obligations to
purchase assets with certain drawdown at a specified future date. Such
obligations include forward purchases, forward forward deposits
placed,\49\ and partly-paid shares and securities; they do not include
commitments to make residential mortgage loans or forward foreign
exchange contracts.
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\49\ Forward forward deposits accepted are treated as interest rate
contracts.
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i. Securities lent by a banking organization are treated in one of
two ways, depending upon whether the lender is at risk of loss. If a
banking organization, as agent for a customer, lends the customer's
securities and does not indemnify the customer against loss, then the
transaction is excluded from
[[Page 188]]
the risk-based capital calculation. If, alternatively, a banking
organization lends its own securities or, acting as agent for a
customer, lends the customer's securities and indemnifies the customer
against loss, the transaction is converted at 100 percent and assigned
to the risk weight category appropriate to the obligor, to any
collateral delivered to the lending banking organization, or, if
applicable, to the independent custodian acting on the lender's behalf.
Where a banking organization is acting as agent for a customer in a
transaction involving the lending or sale of securities that is
collateralized by cash delivered to the banking organization, the
transaction is deemed to be collateralized by cash on deposit in a
subsidiary lending institution for purposes of determining the
appropriate risk-weight category, provided that any indemnification is
limited to no more than the difference between the market value of the
securities and the cash collateral received and any reinvestment risk
associated with that cash collateral is borne by the customer.
2. Items with a 50 percent conversion factor. Transaction-related
contingencies are converted at 50 percent. Such contingencies include
bid bonds, performance bonds, warranties, standby letters of credit
related to particular transactions, and performance standby letters of
credit, as well as acquisitions of risk participation in performance
standby letters of credit. Peformance standby letters of credit
represent obligations backing the performance of nonfinancial or
commercial contracts or undertakings. To the extent permitted by law or
regulation, performance standby letters of credit include arrangements
backing, among other things, subcontractors' and suppliers' performance,
labor and materials contracts, and construction bids.
The unused portion of commitments with an original maturity
exceeding one year,\50\ including underwriting commitments, and
commercial and consumer credit commitments also are converted at 50
percent. Original maturity is defined as the length of time between the
date the commitment is issued and the earliest date on which: (1) The
banking organization can, at its option, unconditionally (without cause)
cancel the commitment;\51\ and (2) the banking organization is scheduled
to (and as a normal practice actually does) review the facility to
determine whether or not it should be extended. Such reviews must
continue to be conducted at least annually for such a facility to
qualify as a short-term commitment.
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\50\ Through year-end 1992, remaining maturity may be used for
determining the maturity of off-balance sheet loan commitments;
thereafter, original maturity must be used.
\51\ In the case of consumer home equity or mortgage lines of credit
secured by liens on 1-4 family residential properties, the bank is
deemed able to unconditionally cancel the commitment for the purpose of
this criterion if, at its option, it can prohibit additional extensions
of credit, reduce the credit line, and terminate the commitment to the
full extent permitted by relevant Federal law.
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Commitments are defined as any legally binding arrangements that
obligate a banking organization to extend credit in the form of loans or
leases; to purchase loans, securities, or other assets; or to
participate in loans and leases. They also include overdraft facilities,
revolving credit, home equity and mortgage lines of credit, and similar
transactions. Normally, commitments involve a written contract or
agreement and a commitment fee, or some other form of consideration.
Commitments are included in weighted risk assets regardless of whether
they contain ``material adverse change'' clauses or other provisions
that are intended to relieve the issuer of its funding obligation under
certain conditions. In the case of commitments structured as
syndications, where the banking organization is obligated solely for its
pro rata share, only the banking organization's proportional share of
the syndicated commitment is taken into account in calculating the risk-
based capital ratio.
Facilities that are unconditionally cancellable (without cause) at
any time by the banking organization are not deemed to be commitments,
provided the banking organization makes a separate credit decision
before each drawing under the facility. Commitments with an original
maturity of one year or less are deemed to involve low risk and,
therefore, are not assessed a capital charge. Such short-term
commitments are defined to include the unused portion of lines of credit
on retail credit cards and related plans (as defined in the instructions
to the FR Y-9C Report) if the banking organization has the unconditional
right to cancel the line of credit at any time, in accordance with
applicable law.
Once a commitment has been converted at 50 percent, any portion that
has been conveyed to U.S. depository institutions or OECD banks as
participations in which the originating banking organization retains the
full obligation to the borrower if the participating bank fails to pay
when the instrument is drawn, is assigned to the 20 percent risk
category. This treatment is analogous to that accorded to conveyances of
risk participations in standby letters of credit. The acquisition of a
participation in a commitment by a banking organization is converted at
50 percent and assigned to the risk category appropriate to the account
party obligor or, if relevant, the nature of the collateral or
guarantees.
[[Page 189]]
Revolving underwriting facilities (RUFs), note issuance facilities
(NIFs), and other similar arrangements also are converted at 50 percent
regardless of maturity. These are facilities under which a borrower can
issue on a revolving basis short-term paper in its own name, but for
which the underwriting organizations have a legally binding commitment
either to purchase any notes the borrower is unable to sell by the roll-
over date or to advance funds to the borrower.
3. Items with a 20 percent conversion factor. Short-term, self-
liquidating trade-related contingencies which arise from the movement of
goods are converted at 20 percent. Such contingencies generally include
commercial letters of credit and other documentary letters of credit
collateralized by the underlying shipments.
4. Items with a zero percent conversion factor. These include unused
portions of commitments with an original maturity of one year or
less,\52\ or which are unconditionally cancellable at any time, provided
a separate credit decision is made before each drawing under the
facility. Unused portions of lines of credit on retail credit cards and
related plans are deemed to be short-term commitments if the banking
organization has the unconditional right to cancel the line of credit at
any time, in accordance with applicable law.
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\52\ Through year-end 1992, remaining maturity may be used for
determining term to maturity for off-balance sheet loan commitments;
thereafter, original maturity must be used.
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E. Derivative Contracts (Interest Rate, Exchange Rate, Commodity-
(including precious metals) and Equity-Linked Contracts)
1. Scope. Credit equivalent amounts are computed for each of the
following off-balance-sheet derivative contracts:
a. Interest Rate Contracts. These include single currency interest
rate swaps, basis swaps, forward rate agreements, interest rate options
purchased (including caps, collars, and floors purchased), and any other
instrument linked to interest rates that gives rise to similar credit
risks (including when-issued securities and forward forward deposits
accepted).
b. Exchange Rate Contracts. These include cross-currency interest
rate swaps, forward foreign exchange contracts, currency options
purchased, and any other instrument linked to exchange rates that gives
rise to similar credit risks.
c. Equity Derivative Contracts. These include equity-linked swaps,
equity-linked options purchased, forward equity-linked contracts, and
any other instrument linked to equities that gives rise to similar
credit risks.
d. Commodity (including precious metal) Derivative Contracts. These
include commodity-linked swaps, commodity-linked options purchased,
forward commodity-linked contracts, and any other instrument linked to
commodities that gives rise to similar credit risks.
e. Exceptions. Exchange rate contracts with an original maturity of
fourteen or fewer calendar days and derivative contracts traded on
exchanges that require daily receipt and payment of cash variation
margin may be excluded from the risk-based ratio calculation. Gold
contracts are accorded the same treatment as exchange rate contracts
except that gold contracts with an original maturity of fourteen or
fewer calendar days are included in the risk-based ratio calculation.
Over-the-counter options purchased are included and treated in the same
way as other derivative contracts.
2. Calculation of credit equivalent amounts. a. The credit
equivalent amount of a derivative contract that is not subject to a
qualifying bilateral netting contract in accordance with section
III.E.3. of this appendix A is equal to the sum of (i) the current
exposure (sometimes referred to as the replacement cost) of the
contract; and (ii) an estimate of the potential future credit exposure
of the contract.
b. The current exposure is determined by the mark-to-market value of
the contract. If the mark-to-market value is positive, then the current
exposure is equal to that mark-to-market value. If the mark-to-market
value is zero or negative, then the current exposure is zero. Mark-to-
market values are measured in dollars, regardless of the currency or
currencies specified in the contract and should reflect changes in
underlying rates, prices, and indices, as well as counterparty credit
quality.
c. The potential future credit exposure of a contract, including a
contract with a negative mark-to-market value, is estimated by
multiplying the notional principal amount of the contract by a credit
conversion factor. Banking organizations should use, subject to examiner
review, the effective rather than the apparent or stated notional amount
in this calculation. The credit conversion factors are:
[[Page 190]]
Conversion Factors
[In percent]
----------------------------------------------------------------------------------------------------------------
Commodity,
Interest Exchange excluding Precious
Remaining maturity rate rate and Equity precious metals,
gold metals except gold
----------------------------------------------------------------------------------------------------------------
One year or less............................... 0.0 1.0 6.0 10.0 7.0
Over one to five years......................... 0.5 5.0 8.0 12.0 7.0
Over five years................................ 1.5 7.5 10.0 15.0 8.0
----------------------------------------------------------------------------------------------------------------
d. For a contract that is structured such that on specified dates
any outstanding exposure is settled and the terms are reset so that the
market value of the contract is zero, the remaining maturity is equal to
the time until the next reset date. For an interest rate contract with a
remaining maturity of more than one year that meets these criteria, the
minimum conversion factor is 0.5 percent.
e. For a contract with multiple exchanges of principal, the
conversion factor is multiplied by the number of remaining payments in
the contract. A derivative contract not included in the definitions of
interest rate, exchange rate, equity, or commodity contracts as set
forth in section III.E.1. of this appendix A is subject to the same
conversion factors as a commodity, excluding precious metals.
f. No potential future exposure is calculated for a single currency
interest rate swap in which payments are made based upon two floating
rate indices (a so called floating/floating or basis swap); the credit
exposure on such a contract is evaluated solely on the basis of the
mark-to-market value.
g. The Board notes that the conversion factors set forth above,
which are based on observed volatilities of the particular types of
instruments, are subject to review and modification in light of changing
volatilities or market conditions.
3. Netting. a. For purposes of this appendix A, netting refers to
the offsetting of positive and negative mark-to-market values when
determining a current exposure to be used in the calculation of a credit
equivalent amount. Any legally enforceable form of bilateral netting
(that is, netting with a single counterparty) of derivative contracts is
recognized for purposes of calculating the credit equivalent amount
provided that:
i. The netting is accomplished under a written netting contract that
creates a single legal obligation, covering all included individual
contracts, with the effect that the banking organization would have a
claim to receive, or obligation to pay, only the net amount of the sum
of the positive and negative mark-to-market values on included
individual contracts in the event that a counterparty, or a counterparty
to whom the contract has been validly assigned, fails to perform due to
any of the following events: default, insolvency, liquidation, or
similar circumstances.
ii. The banking organization obtains a written and reasoned legal
opinion(s) representing that in the event of a legal challenge--
including one resulting from default, insolvency, liquidation, or
similar circumstances--the relevant court and administrative authorities
would find the banking organization's exposure to be the net amount
under:
1. The law of the jurisdiction in which the counterparty is
chartered or the equivalent location in the case of noncorporate
entities, and if a branch of the counterparty is involved, then also
under the law of the jurisdiction in which the branch is located;
2. The law that governs the individual contracts covered by the
netting contract; and
3. The law that governs the netting contract.
iii. The banking organization establishes and maintains procedures
to ensure that the legal characteristics of netting contracts are kept
under review in the light of possible changes in relevant law.
iv. The banking organization maintains in its files documentation
adequate to support the netting of derivative contracts, including a
copy of the bilateral netting contract and necessary legal opinions.
b. A contract containing a walkaway clause is not eligible for
netting for purposes of calculating the credit equivalent amount.\53\
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\53\ A walkaway clause is a provision in a netting contract that
permits a non-defaulting counterparty to make lower payments than it
would make otherwise under the contract, or no payment at all, to a
defaulter or to the estate of a defaulter, even if the defaulter or the
estate of the defaulter is a net creditor under the contract.
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c. A banking organization netting individual contracts for the
purpose of calculating credit equivalent amounts of derivative contracts
represents that it has met the requirements of this appendix A and all
the appropriate documents are in the banking
[[Page 191]]
organization's files and available for inspection by the Federal
Reserve. The Federal Reserve may determine that a banking organization's
files are inadequate or that a netting contract, or any of its
underlying individual contracts, may not be legally enforceable under
any one of the bodies of law described in section III.E.3.a.ii. of this
appendix A. If such a determination is made, the netting contract may be
disqualified from recognition for risk-based capital purposes or
underlying individual contracts may be treated as though they are not
subject to the netting contract.
d. The credit equivalent amount of contracts that are subject to a
qualifying bilateral netting contract is calculated by adding (i) the
current exposure of the netting contract (net current exposure) and (ii)
the sum of the estimates of potential future credit exposures on all
individual contracts subject to the netting contract (gross potential
future exposure) adjusted to reflect the effects of the netting
contract.\54\
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\54\ For purposes of calculating potential future credit exposure to
a netting counterparty for foreign exchange contracts and other similar
contracts in which notional principal is equivalent to cash flows, total
notional principal is defined as the net receipts falling due on each
value date in each currency.
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e. The net current exposure is the sum of all positive and negative
mark-to-market values of the individual contracts included in the
netting contract. If the net sum of the mark-to-market values is
positive, then the net current exposure is equal to that sum. If the net
sum of the mark-to-market values is zero or negative, then the net
current exposure is zero. The Federal Reserve may determine that a
netting contract qualifies for risk-based capital netting treatment even
though certain individual contracts included under the netting contract
may not qualify. In such instances, the nonqualifying contracts should
be treated as individual contracts that are not subject to the netting
contract.
f. Gross potential future exposure, or Agross is
calculated by summing the estimates of potential future exposure
(determined in accordance with section III.E.2 of this appendix A) for
each individual contract subject to the qualifying bilateral netting
contract.
g. The effects of the bilateral netting contract on the gross
potential future exposure are recognized through the application of a
formula that results in an adjusted add-on amount (Anet). The
formula, which employs the ratio of net current exposure to gross
current exposure (NGR), is expressed as:
Anet = (0.4 x Agross) + 0.6(NGR x
Agross)
h. The NGR may be calculated in accordance with either the
counterparty-by-counterparty approach or the aggregate approach.
i. Under the counterparty-by-counterparty approach, the NGR is the
ratio of the net current exposure for a netting contract to the gross
current exposure of the netting contract. The gross current exposure is
the sum of the current exposures of all individual contracts subject to
the netting contract calculated in accordance with section III.E.2. of
this appendix A. Net negative mark-to-market values for individual
netting contracts with the same counterparty may not be used to offset
net positive mark-to-market values for other netting contracts with the
same counterparty.
ii. Under the aggregate approach, the NGR is the ratio of the sum of
all of the net current exposures for qualifying bilateral netting
contracts to the sum of all of the gross current exposures for those
netting contracts (each gross current exposure is calculated in the same
manner as in section III.E.3.h.i. of this appendix A). Net negative
mark-to-market values for individual counterparties may not be used to
offset net positive current exposures for other counterparties.
iii. A banking organization must use consistently either the
counterparty-by-counterparty approach or the aggregate approach to
calculate the NGR. Regardless of the approach used, the NGR should be
applied individually to each qualifying bilateral netting contract to
determine the adjusted add-on for that netting contract.
i. In the event a netting contract covers contracts that are
normally excluded from the risk-based ratio calculation--for example,
exchange rate contracts with an original maturity of fourteen or fewer
calendar days or instruments traded on exchanges that require daily
payment and receipt of cash variation margin--an institution may elect
to either include or exclude all mark-to-market values of such contracts
when determining net current exposure, provided the method chosen is
applied consistently.
4. Risk Weights. Once the credit equivalent amount for a derivative
contract, or a group of derivative contracts subject to a qualifying
bilateral netting contract, has been determined, that amount is assigned
to the risk category appropriate to the counterparty, or, if relevant,
the guarantor or the nature of any collateral.\55\ However,
[[Page 192]]
the maximum risk weight applicable to the credit equivalent amount of
such contracts is 50 percent.
---------------------------------------------------------------------------
\55\ For derivative contracts, sufficiency of collateral or
guarantees is generally determined by the market value of the collateral
or the amount of the guarantee in relation to the credit equivalent
amount. Collateral and guarantees are subject to the same provisions
noted under section III.B. of this appendix A.
---------------------------------------------------------------------------
5. Avoidance of double counting. a. In certain cases, credit
exposures arising from the derivative contracts covered by section
III.E. of this appendix A may already be reflected, in part, on the
balance sheet. To avoid double counting such exposures in the assessment
of capital adequacy and, perhaps, assigning inappropriate risk weights,
counterparty credit exposures arising from the derivative instruments
covered by these guidelines may need to be excluded from balance sheet
assets in calculating a banking organization's risk-based capital
ratios.
b. Examples of the calculation of credit equivalent amounts for
contracts covered under this section III.E. are contained in Attachment
V of this appendix A.
IV. Minimum Supervisory Ratios and Standards
The interim and final supervisory standards set forth below specify
minimum supervisory ratios based primarily on broad credit risk
considerations. As noted above, the risk-based ratio does not take
explicit account of the quality of individual asset portfolios or the
range of other types of risks to which banking organizations may be
exposed, such as interest rate, liquidity, market or operational risks.
For this reason, banking organizations are generally expected to operate
with capital positions well above the minimum ratios.
Institutions with high or inordinate levels of risk are expected to
operate well above minimum capital standards. Banking organizations
experiencing or anticipating significant growth are also expected to
maintain capital, including tangible capital positions, well above the
minimum levels. For example, most such organizations generally have
operated at capital levels ranging from 100 to 200 basis points above
the stated minimums. Higher capital ratios could be required if
warranted by the particular circumstances or risk profiles of individual
banking organizations. In all cases, organizations should hold capital
commensurate with the level and nature of all of the risks, including
the volume and severity of problem loans, to which they are exposed.
Upon adoption of the risk-based framework, any organization that
does not meet the interim or final supervisory ratios, or whose capital
is otherwise considered inadequate, is expected to develop and implement
a plan acceptable to the Federal Reserve for achieving an adequate level
of capital consistent with the provisions of these guidelines or with
the special circumstances affecting the individual organization. In
addition, such organizations should avoid any actions, including
increased risk-taking or unwarranted expansion, that would lower or
further erode their capital positions.
A. Minimum Risk-Based Ratio After Transition Period
As reflected in Attachment VI, by year-end 1992, all bank holding
companies \56\ should meet a minimum ratio of qualifying total capital
to weighted risk assets of 8 percent, of which at least 4.0 percentage
points should be in the form of Tier 1 capital. For purposes of section
IV.A., Tier 1 capital is defined as the sum of core capital elements
less goodwill and other intangible assets required to be deducted in
accordance with section II.B.1.b. of this appendix. The maximum amount
of supplementary capital elements that qualifies as Tier 2 capital is
limited to 100 percent of Tier 1 capital. In addition, the combined
maximum amount of subordinated debt and intermediate-term preferred
stock that qualifies as Tier 2 capital is limited to 50 percent of Tier
1 capital. The maximum amount of the allowance for loan and lease losses
that qualifies as Tier 2 capital is limited to 1.25 percent of gross
weighted risk assets. Allowances for loan and lease losses in excess of
this limit may, of course, be maintained, but would not be included in
an organization's total capital. The Federal Reserve will continue to
require bank holding companies to maintain reserves at levels fully
sufficient to cover losses inherent in their loan portfolios.
---------------------------------------------------------------------------
\56\ As noted in section I above, bank holding companies with less
than $150 million in consolidated assets would generally be exempt from
the calculation and analysis of risk-based ratios on a consolidated
holding company basis, subject to certain terms and conditions.
---------------------------------------------------------------------------
Qualifying total capital is calculated by adding Tier 1 capital and
Tier 2 capital (limited to 100 percent of Tier 1 capital) and then
deducting from this sum certain investments in banking or finance
subsidiaries that are not consolidated for accounting or supervisory
purposes, reciprocal holdings of banking organizations' capital
securities, or other items at the direction of the Federal Reserve. The
conditions under which these deductions are to be made and the
procedures for making the deductions are discussed above in section
II(B).
B. Transition Arrangements
The transition period for implementing the risk-based capital
standard ends on December 31, 1992.\57\ Initially, the risk-based
capital
[[Page 193]]
guidelines do not establish a minimum level of capital. However, by
year-end 1990, banking organizations are expected to meet a minimum
interim target ratio for qualifying total capital to weighted risk
assets of 7.25 percent, at least one-half of which should be in the form
of Tier 1 capital. For purposes of meeting the 1990 interim target, the
amount of loan loss reserves that may be included in capital is limited
to 1.5 percent of weighted risk assets and up to 10 percent of an
organization's Tier 1 capital may consist of supplementary capital
elements. Thus, the 7.25 percent interim target ratio implies a minimum
ratio of Tier 1 capital to weighted risk assets of 3.6 percent (one-half
of 7.25) and a minimum ratio of core capital elements to weighted risk
assets ratio of 3.25 percent (nine-tenths of the Tier 1 capital ratio).
---------------------------------------------------------------------------
\57\ The Basle capital framework does not establish an initial
minimum standard for the risk-based capital ratio before the end of
1990. However, for the purpose of calculating a risk-based capital ratio
prior to year-end 1990, no sublimit is placed on the amount of the
allowance for loan and lease losses includable in Tier 2. In addition,
this framework permits, under temporary transition arrangements, a
certain percentage of an organization's Tier 1 capital to be made up of
supplementary capital elements. In particular, supplementary elements
may constitute 25 percent of an organization's Tier 1 capital (before
the deduction of goodwill) up to the end of 1990; from year-end 1990 up
to the end of 1992, this allowable percentage of supplementary elements
in Tier 1 declines to 10 percent of Tier 1 (before the deduction of
goodwill). Beginning on December 31, 1992, supplementary elements may
not be included in Tier 1. The amount of subordinated debt and
intermediate-term preferred stock temporarily included in Tier 1 under
these arrangements will not be subject to the sublimit on the amount of
such instruments includable in Tier 2 capital. While the transitional
arrangements allow an organization to include supplementary elements in
Tier 1 on a temporary basis, the amount of perpetual preferred stock
that may be included in a bank holding company's Tier 1--both during and
after the transition period--is, as described in section II(A), based
solely upon a specified percentage of the organization's permanent core
capital elements (that is, common equity, perpetual preferred stock, and
minority interest in the equity of consolidated subsidiaries), not upon
total Tier 1 elements that temporarily include Tier 2 items. Once the
amount of supplementary items that may temporarily qualify as Tier 1
elements is determined, goodwill must be deducted from the sum of this
amount and the amount of the organization's permanent core capital
elements for the purpose of calculating Tier 1 (net of goodwill), Tier
2, and total capital.
---------------------------------------------------------------------------
Through year-end 1990, banking organizations have the option of
complying with the minimum 7.25 percent year-end 1990 risk-based capital
standard, in lieu of the minimum 5.5 percent primary and 6 percent total
capital to total assets ratios set forth in appendix B of this part. In
addition, as more fully set forth in appendix D to this part, banking
organizations are expected to maintain a minimum ratio of Tier 1 capital
to total assets during this transition period.
Attachment I--Sample Calculation of Risk-Based Capital Ratio for Bank
Holding Companies
Example of a banking organization with $6,000 in total capital and the
following assets and off-balance sheet items:
Balance Sheet Assets:
Cash................................................... $5,000
U.S. Treasuries........................................ 20,000
Balances at domestic banks............................. 5,000
Loans secured by first liens on 1-4 family residential 5,000
properties............................................
Loans to private corporations.......................... 65,000
------------
Total Balance Sheet Assets........................... $100,000
============
Off-Balance Sheet Items:
Standby letters of credit (``SLCs'') backing general $10,000
obligation debt issues of U.S. municipalities
(``GOs'').............................................
Long-term legally binding commitments to private 20,000
corporations..........................................
------------
Total Off/Balance Sheet Items........................ $30,000
This bank holding company's total capital to total assets (leverage)
ratio would be: ($6,000/$100,000)=6.00%.
To compute the bank holding company's weighted risk assets:
1. Compute the credit equivalent amount of each off-balance sheet
(``OBS'') item.
Credit
OBS item Face value Conversion equivalent
factor amount
----------------------------------------------------------------------------------------------------------------
SLCS backing municipal GOs........................................ $10,000 1.00 = $10,000
x
Long-term commitments to private corporations..................... $20,000 0.50 = $10,000
x
2. Multiply each balance sheet asset and the credit equivalent amount of each
OBS item by the appropriate risk weight.
0% Category:
Cash.......................................................... 5,000
U.S. Treasuries............................................... 20,000
-------------
[[Page 194]]
25,000 0 = 0
x
=============
20% Category:
Balances at domestic banks.................................... 5,000
Credit equivalent amounts of SLCs backing GOs of U.S. 10,000
municipalities...............................................
--------------
15,000 .20 = $3,000
x
=============
50% Category:
Loans secured by first liens on 1-4 family residential 5,000 .50 = $2,500
properties................................................... x
=============
100% Category:
Loans to private corporations................................. 65,000
Credit equivalent amounts of long-term commitments to private 10,000
corporations.................................................
-------------
$75,000 1.00 = 75,000
x
------------
Total Risk-weighted Assets.................................. 80,500
This bank holding company's ratio of total capital to weighted risk assets (risk-based capital ratio) would be:
($6,000/$80,500)=7.45%
Attachment II--Summary Definition of Qualifying Capital for Bank Holding
Companies* (Using the Year-End 1992 Standards)
------------------------------------------------------------------------
Minimum requirements after
Components transition period
------------------------------------------------------------------------
Core Capital (Tier 1).................. Must equal or exceed 4% of
weighted risk assets.
Common stockholders' equity............ No limit.
Qualifying noncumulative perpetual No limit.
preferred stock.
Qualifying cumulative perpetual Limited to 25% of the sum of
preferred stock. common stock, qualifying
perpetual preferred stock, and
minority interests.
Minority interest in equity accounts of Organizations should avoid
consolidated subsidiaries. using minority interests to
introduce elements not
otherwise qualifying for Tier
1 capital.
Less: Goodwill and other intangible
assets required to be deducted from
capital.\1\.
Supplementary Capital (Tier 2)......... Total of Tier 2 is limited to
100% of Tier 1.\2\
Allowance for loan and lease losses.... Limited to 1.25% of weighted
risk assets.\2\
Perpetual preferred stock.............. No limit within Tier 2.
Hybrid capital instruments, perpetual No limit within Tier 2.
debt, and mandatory convertible
securities.
Subordinated debt and intermediate-term Subordinated debt and
preferred stock (original weighted intermediate-term preferred
average maturity of 5 years or more) stock are limited to 50% of
Tier 1;\3\ amortized for
capital purposes as they
approach maturity.
Revaluation reserves (equity and Not included; organizations
building). encouraged to disclose; may be
evaluated on a case-by-case
basis for international
comparisons; and taken into
account in making an overall
assessment of capital.
Deductions (from sum of Tier 1 and Tier
2):
Investments in unconsolidated As a general rule, one-half of
subsidiaries. the aggregate investments will
be deducted from Tier 1
capital and one-half from Tier
2 capital.\4\
Reciprocal holdings of banking
organizations' capital securities
Other deductions (such as other On a case-by-case basis or as a
subsidiaries or joint ventures) as matter of policy after formal
determined by supervisory rulemaking.
authority
Total Capital (Tier 1+Tier 2- Must equal or exceed 8% of
Deductions). weighted risk assets.
------------------------------------------------------------------------
* See discussion in section II of the guidelines for a complete
description of the requirements for, and the limitations on, the
components of qualifying capital.
\1\ Requirements for the deduction of other intangible assets are set
forth in section II.B.1.b. of this appendix.
\2\ Amounts in excess of limitations are permitted but do not qualify as
capital.
\3\ Amounts in excess of limitations are permitted but do not qualify as
capital.
\4\ A proportionately greater amount may be deducted from Tier 1 capital
if the risks associated with the subsidiary so warrant.
[[Page 195]]
Attachment III--Summary of Risk Weights and Risk Categories for Bank
Holding Companies
Category 1: Zero Percent
1. Cash (domestic and foreign) held in subsidiary depository
institutions or in transit.
2. Balances due from Federal Reserve Banks (including Federal
Reserve Bank stock) and central banks in other OECD countries.
3. Direct claims on, and the portions of claims that are
unconditionally guaranteed by, the U.S. Treasury and U.S. Government
agencies \1\ and the central governments of other OECD countries, and
local currency claims on, and the portions of local currency claims that
are unconditionally guaranteed by, the central governments of non-OECD
countries (including the central banks of non-OECD countries), to the
extent that subsidiary depository institutions have liabilities booked
in that currency.
---------------------------------------------------------------------------
\1\ For the purpose of calculating the risk-based capital ratio, a
U.S. Government agency is defined as an instrumentality of the U.S.
Government whose obligations are fully and explicitly guaranteed as to
the timely payment of principal and interest by the full faith and
credit of the U.S. Government.
---------------------------------------------------------------------------
4. Gold bullion held in the vaults of a subsidiary depository
institution or in another's vaults on an allocated basis, to the extent
offset by gold bullion liabilities.
5. Claims collateralized by cash on deposit in the subsidiary
lending institution or by securities issued or guaranteed by OECD
central governments or U.S. government agencies for which a positive
margin of collateral is maintained on a daily basis, fully taking into
account any change in the bank's exposure to the obligor or counterparty
under a claim in relation to the market value of the collateral held in
support of that claim.
Category 2: 20 Percent
1. Cash items in the process of collection.
2. All claims (long- or short-term) on, and the portions of claims
(long- or short-term) that are guaranteed by, U.S. depository
institutions and OECD banks.
3. Short-term claims (remaining maturity of one year or less) on,
and the portions of short-term claims that are guaranteed by, non-OECD
banks.
4. The portions of claims that are conditionally guaranteed by the
central governments of OECD countries and U.S. Government agencies, and
the portions of local currency claims that are conditionally guaranteed
by the central governments of non-OECD countries, to the extent that
subsidiary depository institutions have liabilities booked in that
currency.
5. Claims on, and the portions of claims that are guaranteed by,
U.S. Government-sponsored agencies.\2\
---------------------------------------------------------------------------
\2\ For the purpose of calculating the risk-based capital ratio, a
U.S. Government-sponsored agency is defined as an agency originally
established or chartered to serve public purposes specified by the U.S.
Congress but whose obligations are not explicitly guaranteed by the full
faith and credit of the U.S. Government.
---------------------------------------------------------------------------
6. General obligation claims on, and the portions of claims that are
guaranteed by the full faith and credit of, local governments and
political subdivisions of the U.S. and other OECD local governments.
7. Claims on, and the portions of claims that are guaranteed by,
official multilateral lending institutions or regional development
banks.
8. The portions of claims that are collateralized \3\ by cash on
deposit in the subsidiary lending institution or by securities issued or
guaranteed by the U.S. Treasury, the central governments of other OECD
countries, and U.S. government agencies that do not qualify for the zero
percent risk-weight category, or that are collateralized by securities
issued or guaranteed by U.S. government-sponsored agencies.
9. The portions of claims that are collateralized \3\ by securities
issued by official multilateral lending institutions or regional
development banks.
---------------------------------------------------------------------------
\3\ The extent of collateralization is determined by current market
value.
---------------------------------------------------------------------------
10. Certain privately-issued securities representing indirect
ownership of mortgage-backed U.S. Government agency or U.S. Government-
sponsored agency securities.
11. Investments in shares of a fund whose portfolio is permitted to
hold only securities that would qualify for the zero or 20 percent risk
categories.
Category 3: 50 Percent
1. Loans fully secured by first liens on 1- to 4-family residential
properties or on multifamily residential properties that have been made
in accordance with prudent underwriting standards, that are performing
in accordance with their original terms, that are not past due or in
nonaccrual status, and that meet other qualifying criteria, and certain
privately-issued mortgage-backed securities representing indirect
ownership of such loans. (Loans made for speculative purposes are
excluded.)
2. Revenue bonds or similar claims that are obligations of U.S.
state or local governments, or other OECD local governments,
[[Page 196]]
but for which the government entity is committed to repay the debt only
out of revenues from the facilities financed.
3. Credit equivalent amounts of interest rate and foreign exchange
rate related contracts, except for those assigned to a lower risk
category.
Category 4: 100 Percent
1. All other claims on private obligors.
2. Claims on, or guaranteed by, non-OECD foreign banks with a
remaining maturity exceeding one year.
3. Claims on, or guaranteed by, non-OECD central governments that
are not included in item 3 of Category 1 of item 4 of Category 2; all
claims on non-OECD state or local governments.
4. Obligations issued by U.S. state of local governments, or other
OECD local governments (including industrial development authorities and
similar entities), repayable solely by a private party or enterprise.
5. Premises, plant, and equipment; other fixed assets; and other
real estate owned.
6. Investments in any unconsolidated subsidiaries, joint ventures,
or associated companies--if not deducted from capital.
7. Instruments issued by other banking organizations that qualify as
capital--if not deducted from capital.
8. Claims on commercial firms owned by a government.
9. All other assets, including any intangible assets that are not
deducted from capital.
Attachment IV--Credit Conversion Factors for Off-Balance-Sheet Items for
Bank Holding Companies
100 Percent Conversion Factor
1. Direct credit substitutes. (These include general guarantees of
indebtedness and all guarantee-type instruments, including standby
letters of credit backing the financial obligations of other parties.)
2. Risk participations in bankers acceptances and direct credit
substitutes, such as standby letters of credit.
3. Sale and repurchase agreements and assets sold with recourse that
are not included on the balance sheet.
4. Forward agreements to purchase assets, including financing
facilities, on which drawdown is certain.
5. Securities lent for which the banking organization is at risk.
50 Percent Conversion Factor
1. Transaction-related contingencies. (These include bid-bonds,
performance bonds, warranties, and standby letters of credit backing the
nonfinancial performance of other parties.)
2. Unused portions of commitments with an original maturity
exceeding one year, including underwriting commitments and commercial
credit lines.
3. Revolving underwriting facilities (RUFs), note issuance
facilities (NIFs), and similar arrangements.
20 Percent Conversion Factor
Short-term, self-liquidating trade-related contingencies, including
commercial letters of credit.
Zero Percent Conversion Factor
Unused portions of commitments with an original maturity of one year
or less, or which are unconditionally cancellable at any time, provided
a separate credit decision is made before each drawing.
Credit Conversion for Derivative Contracts
1. The credit equivalent amount of a derivative contract is the sum
of the current credit exposure of the contract and an estimate of
potential future increases in credit exposure. The current exposure is
the positive mark-to-market value of the contract (or zero if the mark-
to-market value is zero or negative). For derivative contracts that are
subject to a qualifying bilateral netting contract, the current exposure
is, generally, the net sum of the positive and negative mark-to-market
values of the contracts included in the netting contract (or zero if the
net sum of the mark-to-market values is zero or negative). The potential
future exposure is calculated by multiplying the effective notional
amount of a contract by one of the following credit conversion factors,
as appropriate:
Conversion Factors
[In percent]
----------------------------------------------------------------------------------------------------------------
Commodity,
Interest Exchange excluding Precious
Remaining maturity rate rate and Equity precious metals,
gold metals except gold
----------------------------------------------------------------------------------------------------------------
One year or less............................... 0.0 1.0 6.0 10.0 7.0
Over one to five years......................... 0.5 5.0 8.0 12.0 7.0
Over five years................................ 1.5 7.5 10.0 15.0 8.0
----------------------------------------------------------------------------------------------------------------
[[Page 197]]
For contracts subject to a qualifying bilateral netting contract,
the potential future exposure is, generally, the sum of the individual
potential future exposures for each contract included under the netting
contract adjusted by the application of the following formula:
Anet = (0.4 x Agross) + 0.6(NGR x
Agross)
NGR is the ratio of net current exposure to gross current exposure.
2. No potential future exposure is calculated for single currency
interest rate swaps in which payments are made based upon two floating
indices, that is, so called floating/floating or basis swaps. The credit
exposure on these contracts is evaluated solely on the basis of their
mark-to-market value. Exchange rate contracts with an original maturity
of fourteen or fewer days are excluded. Instruments traded on exchanges
that require daily receipt and payment of cash variation margin are also
excluded.
Attachment V--Calculating Credit Equivalent Amounts for Derivative Contracts
----------------------------------------------------------------------------------------------------------------
Notional Potential Current Credit
Type of Contract principal Conversion exposure Mark-to- exposure equivalent
amount factor (dollars) market (dollars) amount
----------------------------------------------------------------------------------------------------------------
(1) 120-day forward foreign 5,000,000 .01 50,000 100,000 100,000 150,000
exchange.........................
(2) 4-year forward foreign 6,000,000 .05 300,000 -120,000 0 300,000
exchange.........................
(3) 3-year single-currency fixed & 10,000,000 .005 50,000 200,000 200,000 250,000
floating interest rate swap......
(4) 6-month oil swap.............. 10,000,000 .10 1,000,000 -250,000 0 1,000,000
(5) 7-year cross-currency floating 20,000,000 .075 1,500,000 -1,500,000 0 1,500,000
& floating interest rate swap....
Total....................... ........... ........... 2,900,000 + 300,000 3,200,000
----------------------------------------------------------------------------------------------------------------
a. If contracts (1) through (5) above are subject to a qualifying bilateral netting contract, then the following
applies:
------------------------------------------------------------------------
Potential Credit
Contract future Net current equivalent
exposure exposure amount
------------------------------------------------------------------------
(1).............................. 50,000 ........... ...........
(2).............................. 300,000 ........... ...........
(3).............................. 50,000 ........... ...........
(4).............................. 1,000,000 ........... ...........
(5).............................. 1,500,000 ........... ...........
Total...................... 2,900,000 +0 2,900,000
------------------------------------------------------------------------
Note: The total of the mark-to-market values from the first table is-
$1,370,000. Since this is a negative amount the net current exposure
is zero.
b. To recognize the effects of bilateral netting on potential future
exposure the following formula applies:
Anet = (0.4 x Agross) + 0.6(NGR x
Agross)
c. In the above example, where the net current exposure is zero, the
credit equivalent amount would be calculated as follows:
NGR = 0 = (0/300,000)
Anet = (0.4 x $2,900,000) + .6(0 x $2,900,000)
Anet = $1,160,000
The credit equivalent amount is $1,160,000 + 0= $1,160,000.
d. If the net current exposure was a positive number, for example
$200,000, the credit equivalent would be calculated as follows:
NGR = .67 = ($200,000/$300,000)
Anet = (0.4 x $2,900,000) + 0.6(.67 x $2,900,000)
Anet = $2,325,800
The credit equivalent amount would be $2,325,800 + $200,000 =
$2,525,800.
Attachment VI--Summary
----------------------------------------------------------------------------------------------------------------
Transitional arrangements for bank holding
companies Final arrangement--Year-
------------------------------------------------- end 1992
Initial Year-end 1990
----------------------------------------------------------------------------------------------------------------
1. Minimum standard of total capital None................... 7.25%................. 8.0%.
to weighted risk assets.
[[Page 198]]
2. Definition of Tier 1 capital..... Common equity, Common equity, Common equity, qualifying
qualifying cum. and qualifying cum. and noncumulative and
noncum. perpetual noncum. perpetual cumulative perpetual
preferred stock,\1\ preferred stock,\1\ preferred stock,\1\ and
and minority and minority minority interests less
interests, plus interests, plus goodwill and other
supplementary supplementary intangible assets
elements,\2\ less elements,\4\ less required to be deducted
goodwill.\3\. goodwill.\3\. from capital.\3\
3. Minimum standard of Tier 1 None................... 3.625%................ 4.0%.
capital to weighted risk assets.
4. Minimum standard of stockholders' None................... 3.25%................. 4.0%.
equity to weighted risk assets.
5. Limitations on supplementary
capital elements:
a. Allowance for loan and lease No limit within Tier 2. 1.5% of weighted risk 1.25% of weighted risk
losses. assets. assets.
b. Perpetual preferred stock.... No limit within Tier 2. No limit within Tier 2 No limit within Tier 2.
c. Hybrid capital instruments, No limit within Tier 2. No limit within Tier 2 No limit within Tier 2.
perpetual debt, and mandatory
convertibles.
d. Subordinated debt and Combined maximum of 50% Combined maximum of Combined maximum of 50%
intermediate term preferred of Tier 1. 50% of Tier 1. of Tier 1.
stock.
c. Total qualifying Tier 2 May not exceed Tier 1 May not exceed Tier 1 May not exceed Tier 1
capital. capital. capital. capital.
6. Definition of total capital...... Tier 1 plus Tier 2 Tier 1 plus Tier 2 Tier 1 plus Tier 2 less:
less: less:
--reciprocal holdings --reciprocal --reciprocal holdings
of banking holdings of banking of banking
organizations' organizations' organizations' capital
capital instruments. capital instruments. instruments
--investments in --investments in --investments in
unconsolidated unconsolidated unconsolidated
subsidiaries.\5\. subsidiaries.\5\. subsidiaries.\5\
----------------------------------------------------------------------------------------------------------------
\1\ Cumulative perpetual preferred stock is limited within tier 1 to 25% of the sum of common stockholders'
equity, qualifying perpetual preferred stock, and minority interests.
\2\ Supplementary elements may be included in the Tier 1 up to 25% of the sum of Tier 1 plus goodwill.
\3\ Requirements for the deduction of other intangible assets are set forth in section II.B.1.b. of this
appendix.
\4\ Supplementary elements may be included in Tier 1 up to 10% of the sum of Tier 1 plus goodwill.
\5\ As a general rule, one-half (50%) of the aggregate amount of investments will be deducted from Tier 1
capital and one-half (50%) from Tier 2 capital. A proportionally greater amount may be deducted from Tier 1
capital if the risks associated with the subsidiary so warrant.
[Reg. Y, 54 FR 4209, Jan. 27, 1989; 54 FR 12531, Mar. 27, 1989, as
amended at 55 FR 32832, Aug. 10, 1990; 56 FR 51156, Oct. 10, 1991; 57 FR
2012, Jan. 17, 1992; 57 FR 60720, Dec. 22, 1992; 57 FR 62180, 62182,
Dec. 30, 1992; 58 FR 7980, 7981, Feb. 11, 1993; 58 FR 68739, Dec. 29,
1993; 59 FR 62993, Dec. 7, 1994; 59 FR 63244, Dec. 8, 1994; 59 FR 65926,
Dec. 22, 1994; 60 FR 8182, Feb. 13, 1995; 60 FR 45616, Aug. 31, 1995; 60
FR 46179, 46181, Sept. 5, 1995; 60 FR 39230, 39231, Aug. 1, 1995; 60 FR
66045, Dec. 20, 1995; 61 FR 47372, Sept. 6, 1996; 63 FR 42676, Aug. 10,
1998; 63 FR 46522, Sept. 1, 1998; 63 FR 58621, Nov. 2, 1998; 64 FR
10203, Mar. 2, 1999]
Appendix B to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies and State Member Banks: Leverage Measure
The Board of Governors of the Federal Reserve System has adopted
minimum capital ratios and guidelines to provide a framework for
assessing the adequacy of the capital of bank holding companies and
state member banks (collectively ``banking organizations''). The
guidelines generally apply to all state member banks and bank holding
companies regardless of size and are to be used in the examination and
supervisory process as well as in the analysis of applications acted
upon by the Federal Reserve. The Board of Governors will review the
guidelines from time to time for possible adjustment commensurate with
changes in the economy, financial markets, and banking practices. In
this regard, the Board has determined that during the transition period
through year-end 1990 for implementation of the risk-based capital
guidelines contained in appendix A to this part and in appendix A to
part 208, a banking organization may choose to fulfill the requirements
of the guidelines relating
[[Page 199]]
capital to total assets contained in this Appendix in one of two
manners. Until year-end 1990, a banking organization may choose to
conform to either the 5.5 percent and 6 percent minimum primary and
total capital standards set forth in this appendix, or the 7.25 percent
year-end 1990 minimum risk-based capital standard set forth in appendix
A to this part and appendix A to part 208. Those organizations that
choose to conform during this period to the 7.25 percent year-end 1990
risk-based capital standard will be deemed to be in compliance with the
capital adequacy guidelines set forth in this appendix.
Two principal measurements of capital are used--the primary capital
ratio and the total capital ratio. The definitions of primary and total
capital for banks and bank holding companies and formulas for
calculating the capital ratios are set forth below in the definitional
sections of these guidelines.
Capital Guidelines
The Board has established a minimum level of primary capital to
total assets of 5.5 percent and a minimum level of total capital to
total assets of 6.0 percent. Generally, banking organizations are
expected to operate above the minimum primary and total capital levels.
Those organizations whose operations involve or are exposed to high or
inordinate degrees of risk will be expected to hold additional capital
to compensate for these risks.
In addition, the Board has established the following three zones for
total capital for banking organizations of all sizes:
Total Capital Ratio
[In percent]
Zone 1.................................... Above 7.0.
Zone 2.................................... 6.0 to 7.0.
Zone 3.................................... Below 6.0.
The capital guidelines assume adequate liquidity and a moderate
amount of risk in the loan and investment portfolios and in off-balance
sheet activities. The Board is concerned that some banking organizations
may attempt to comply with the guidelines in ways that reduce their
liquidity or increase risk. Banking organizations should avoid the
practice of attempting to meet the guidelines by decreasing the level of
liquid assets in relation to total assets. In assessing compliance with
the guidelines, the Federal Reserve will take into account liquidity and
the overall degree of risk associated with an organization's operations,
including the volume of assets exposed to risk.
The Federal Reserve will also take into account the sale of loans or
other assets with recourse and the volume and nature of all off-balance
sheet risk. Particularly close attention will be directed to risks
associated with standby letters of credit and participation in joint
venture activities. The Federal Reserve will review the relationship of
all on- and off-balance sheet risks to capital and will require those
institutions with high or inordinate levels of risk to hold additional
primary capital. In addition, the Federal Reserve will continue to
review the need for more explicit procedures for factoring on- and off-
balance sheet risks into the assessment of capital adequacy.
The capital guidelines apply to both banks and bank holding
companies on a consolidated basis.\1\ Some banking organizations are
engaged in significant nonbanking activities that typically require
capital ratios higher than those of commercial banks alone. The Board
believes that, as a matter of both safety and soundness and competitive
equity, the degree of leverage common in banking should not
automatically extend to nonbanking activities. Consequently, in
evaluating the consolidated capital positions of banking organizations,
the Board is placing greater weight on the building-block approach for
assessing capital requirements. This approach generally provides that
nonbank subsidiaries of a banking organization should maintain levels of
capital consistent with the levels that have been established by
industry norms or standards, by Federal or State regulatory agencies for
similar firms that are not affiliated with banking organizations, or
that may be established by the Board after taking into account risk
factors of a particular industry. The assessment of an organization's
consolidated capital adequacy must take into account the amount and
nature of all nonbank activities, and an institution's consolidated
capital position should at least equal the sum of the capital
requirements of the organization's bank and nonbank subsidiaries as well
as those of the parent company.
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\1\ The guidelines will apply to bank holding companies with less
than $150 million in consolidated assets on a bank-only basis unless:
(1) The holding company or any nonbank subsidiary is engaged
directly or indirectly in any nonbank activity involving significant
leverage or
(2) The holding company or any nonbank subsidiary has outstanding
significant debt held by the general public. Debt held by the general
public is defined to mean debt held by parties other than financial
institutions, officers, directors, and controlling shareholders of the
banking organization or their related interests.
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Supervisory Action
The nature and intensity of supervisory action will be determined by
an organization's compliance with the required minimum primary capital
ratio as well as by the zone in which the company's total capital ratio
falls.
[[Page 200]]
Banks and bank holding companies with primary capital ratios below the
5.5 percent minimum will be considered undercapitalized unless they can
demonstrate clear extenuating circumstances. Such banking organizations
will be required to submit an acceptable plan for achieving compliance
with the capital guidelines and will be subject to denial of
applications and appropriate supervisory enforcement actions.
The zone in which an organization's total capital ratio falls will
normally trigger the following supervisory responses, subject to
qualitative analysis:
For institutions operating in Zone 1, the Federal Reserve will:
--Consider that capital is generally adequate if the primary capital
ratio is acceptable to the Federal Reserve and is above the 5.5 percent
minimum.
For institutions operating in Zone 2, the Federal Reserve will:
--Pay particular attention to financial factors, such as asset quality,
liquidity, off-balance sheet risk, and interest rate risk, as they
relate to the adequacy of capital. If these areas are deficient and the
Federal Reserve concludes capital is not fully adequate, the Federal
Reserve will intensify its monitoring and take appropriate supervisory
action.
For institutions operating in Zone 3, the Federal Reserve will:
--Consider that the institution is undercapitalized, absent clear
extenuating circumstances;
--Require the institution to submit a comprehensive capital plan,
acceptable to the Federal Reserve, that includes a program for achieving
compliance with the required minimum ratios within a reasonable time
period; and
--Institute appropriate supervisory and/or administrative enforcement
action, which may include the issuance of a capital directive or denial
of applications, unless a capital plan acceptable to the Federal Reserve
has been adopted by the institution.
Treatment of Intangible Assets for the Purpose of Assessing the Capital
Adequacy of Bank Holding Companies and State Member Banks
In considering the treatment of intangible assets for the purpose of
assessing capital adequacy, the Federal Reserve recognizes that the
determination of the future benefits and useful lives of certain
intangible assets may involve a degree of uncertainty that is not
normally associated with other banking assets. Supervisory concern over
intangible assets derives from this uncertainty and from the possibility
that, in the event an organization experiences financial difficulties,
such assets may not provide the degree of support generally associated
with other assets. For this reason, the Federal Reserve will carefully
review the level and specific character of intangible assets in
evaluating the capital adequacy of state member banks and bank holding
companies.
The Federal Reserve recognizes that intangible assets may differ
with respect to predictability of any income stream directly associated
with a particular asset, the existence of a market for the asset, the
ability to sell the asset, or the reliability of any estimate of the
asset's useful life. Certain intangible assets have predictable income
streams and objectively verifiable values and may contribute to an
organization's profitability and overall financial strength. The value
of other intangibles, such as goodwill, may involve a number of
assumptions and may be more subject to changes in general economic
circumstances or to changes in an individual institution's future
prospects. Consequently, the value of such intangible assets may be
difficult to ascertain. Consistent with prudent banking practices and
the principle of the diversification of risks, banking organizations
should avoid excessive balance sheet concentration in any category or
related categories of intangible assets.
Bank Holding Companies
While the Federal Reserve will consider the amount and nature of all
intangible assets, those holding companies with aggregate intangible
assets in excess of 25 percent of tangible primary capital (i.e., stated
primary capital less all intangible assets) or those institutions with
lesser, although still significant, amounts of goodwill will be subject
to close scrutiny. For the purpose of assessing capital adequacy, the
Federal Reserve may, on a case-by-case basis, make adjustments to an
organization's capital ratios based upon the amount of intangible assets
in excess of the 25 percent threshold level or upon the specific
character of the organization's intangible assets in relation to its
overall financial condition. Such adjustments may require some
organizations to raise additional capital.
The Board expects banking organizations (including state member
banks) contemplating expansion proposals to ensure that pro forma
capital ratios exceed the minimum capital levels without significant
reliance on intangibles, particularly goodwill. Consequently, in
reviewing acquisition proposals, the Board will take into consideration
both the stated primary capital ratio (that is, the ratio without any
adjustment for intangible assets) and the primary capital ratio after
deducting intangibles. In acting on applications, the Board will take
into account the nature and amount of intangible assets and will, as
appropriate, adjust capital
[[Page 201]]
ratios to include certain intangible assets on a case-by-case basis.
State Member Banks
State member banks with intangible assets in excess of 25 percent of
intangible primary capital will be subject to close scrutiny. In
addition, for the purpose of calculating capital ratios of state member
banks, the Federal Reserve will deduct goodwill from primary capital and
total capital. The Federal Reserve may, on a case-by-case basis, make
further adjustments to a bank's capital ratios based on the amount of
intangible assets (aside from goodwill) in excess of the 25 percent
threshold level or on the specific character of the bank's intangible
assets in relation to its overall financial condition. Such adjustments
may require some banks to raise additional capital.
In addition, state member banks and bank holding companies are
expected to review periodically the value at which intangible assets are
carried on their balance sheets to determine whether there has been any
impairment of value or whether changing circumstances warrant a
shortening of amortization periods. Institutions should make appropriate
reductions in carrying values and amortization periods in light of this
review, and examiners will evaluate the treatment of intangible assets
during on-site examinations.
Definition of Capital To Be Used in Determining Capital Adequacy of Bank
Holding Companies and State Member Banks
Primary Capital Components
The components of primary capital are:
--Common stock,
--Perpetual preferred stock (preferred stock that does not have a stated
maturity date and that may not be redeemed at the option of the holder),
--Surplus (excluding surplus relating to limited-life preferred stock),
--Undivided profits,
--Contingency and other capital reserves,
--Mandatory convertible instruments,\2\
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\2\ See the definitional section below that lists the criteria for
mandatory convertible instruments to qualify as primary capital.
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--Allowance for possible loan and lease losses (exclusive of allocated
transfer risk reserves),
--Minority interest in equity accounts of consolidated subsidiaries,
--Perpetual debt instruments (for bank holding companies but not for
state member banks).
Limits on Certain Forms of Primary Capital
Bank Holding Companies. The maximum composite amount of mandatory
convertible securities, perpetual debt, and perpetual preferred stock
that may be counted as primary capital for bank holding companies is
limited to 33.3 percent of all primary capital, including these
instruments. Perpetual preferred stock issued prior to November 20, 1985
(or determined by the Federal Reserve to be in the process of being
issued prior to that date), shall continue to be included as primary
capital.
The maximum composite amount of mandatory convertible securities and
perpetual debt that may be counted as primary capital for bank holding
companies is limited to 20 percent of all primary capital, including
these instruments. The maximum amount of equity commitment notes (a form
of mandatory convertible securities) that may be counted as primary
capital for a bank holding company is limited to 10 percent of all
primary capital, including mandatory convertible securities. Amounts
outstanding in excess of these limitations may be counted as secondary
capital provided they meet the requirements of secondary capital
instruments.
State Member Banks. The composite limitations on the amount of
mandatory convertible securities and perpetual preferred stock
(perpetual debt is not primary capital for state member banks) that may
serve as primary capital for bank holding companies shall not be applied
formally to state member banks, although the Board shall determine
appropriate limits for these forms of primary capital on a case-by-case
basis.
The maximum amount of mandatory convertible securities that may be
counted as primary capital for state member banks is limited to 16\2/3\
percent of all primary capital, including mandatory convertible
securities. Equity commitment notes, one form of mandatory convertible
securities, shall not be included as primary capital for state member
banks, except that notes issued by state member banks prior to May 15,
1985, will continue to be included in primary capital. Amounts of
mandatory convertible securities in excess of these limitations may be
counted as secondary capital if they meet the requirements of secondary
capital instruments.
Secondary Capital Components
The components of secondary capital are:
--Limited-life preferred stock (including related surplus) and
--Bank subordinated notes and debentures and unsecured long-term debt of
the parent company and its nonbank subsidiaries.
Restrictions Relating to Capital Components
To qualify as primary or secondary capital, a capital instrument
should not contain or be covered by any convenants, terms, or
restrictions that are inconsistent with safe and
[[Page 202]]
sound banking practices. Examples of such terms are those regarded as
unduly interfering with the ability of the bank or holding company to
conduct normal banking operations or those resulting in significantly
higher dividends or interest payments in the event of a deterioration in
the financial condition of the issuer.
The secondary components must meet the following conditions to
qualify as capital:
--The instrument must have an original weighted-average maturity of at
least seven years.
--The instrument must be unsecured.
--The instrument must clearly state on its face that it is not a deposit
and is not insured by a Federal agency.
--Bank debt instruments must be subordinated to claims of depositors.
--For banks only, the aggregate amount of limited-life preferred stock
and subordinate debt qualifying as capital may not exceed 50 percent of
the amount of the bank's primary capital.
As secondary capital components approach maturity, the banking
organization must plan to redeem or replace the instruments while
maintaining an adequate overall capital position. Thus, the remaining
maturity of secondary capital components will be an important
consideration in assessing the adequacy of total capital.
Capital Ratios
The primary and total capital ratios for bank holding companies are
computed as follows:
Primary capital ratio:
Primary capital components/Total assets + Allowance for loan and lease
losses (exclusive of allocated transfer risk reserves)
Total capital ratio:
Primary capital components + Secondary capital components/Total assets +
Allowance for loan and lease losses (exclusive of allocated
transfer risk reserves)
The primary and total capital ratios for state member banks are
computed as follows:
Primary capital ratio:
Primary capital components--Goodwill/Average total assets + Allowance
for loan and lease losses (exclusive of allocated transfer
risk reserves)--Goodwill
Total capital ratio:
Primary capital components + Secondary capital components--Goodwill/
Average total assets + Allowance for loan and lease losses
(exclusive of allocated transfer risk reserves)--Goodwill
Generally, period-end amounts will be used to calculate bank holding
company ratios. However, the Federal Reserve will discourage temporary
balance sheet adjustments or any other ``window dressing'' practices
designed to achieve transitory compliance with the guidelines. Banking
organizations are expected to maintain adequate capital positions at all
times. Thus, the Federal Reserve will, on a case-by-case basis, use
average total assets in the calculation of bank holding company capital
ratios whenever this approach provides a more meaningful indication of
an individual holding company's capital position.
For the calculation of bank capital ratios, ``average total assets''
will generally be defined as the quarterly average total assets figure
reported on the bank's Report of Condition. If warranted, however, the
Federal Reserve may calculate bank capital ratios based upon total
assets as of period-end. All other components of the bank's capital
ratios will be based upon period-end balances.
Criteria for Determining the Primary Capital Status of Mandatory
Convertible Securities of Bank Holding Companies and State Member Banks
Mandatory convertible securities are subordinated debt instruments
that are eventually transformed into common or perpetual preferred stock
within a specified period of time, not to exceed 12 years. To be counted
as primary capital, mandatory convertible securities must meet the
criteria set forth below. These criteria cover the two basic types of
mandatory convertible securities: ``equity contract notes''--securities
that obligate the holder to take common or perpetual preferred stock of
the issuer in lieu of cash for repayment of principal, and ``equity
commitment notes''--securities that are redeemable only with the
proceeds from the sale of common or perpetual preferred stock. Both
equity commitment notes and equity contract notes qualify as primary
capital for bank holding companies, but only equity contract notes
qualify as primary capital for banks.
Criteria Applicable to Both Types of Mandatory Convertible Securities
a. The securities must mature in 12 years or less.
b. The issuer may redeem securities prior to maturity only with the
proceeds from the sale of common or perpetual preferred stock of the
bank or bank holding company. Any exception to this rule must be
approved by the Federal Reserve. The securities may not be redeemed with
the proceeds of another issue of mandatory convertible securities. Nor
may the issuer repurchase or acquire its own mandatory convertible
securities for resale or reissuance.
c. Holders of the securities may not accelerate the payment of
principal except in the event of bankruptcy, insolvency, or
reorganization.
[[Page 203]]
d. The securities must be subordinate in right of payment to all
senior indebtedness of the issuer. In the event that the proceeds of the
securities are reloaned to an affiliate, the loan must be subordinated
to the same degree as the original issue.
e. An issuer that intends to dedicate the proceeds of an issue of
common or perpetual preferred stock to satisfy the funding requirements
of an issue of mandatory convertible securities (i.e. the requirement to
retire or redeem the notes with the proceeds from the issuance of common
or perpetual preferred stock) generally must make such a dedication
during the quarter in which the new common or preferred stock is
issued.\3\ As a general rule, if the dedication is not made within the
prescribed period, then the securities issued may not at a later date be
dedicated to the retirement or redemption of the mandatory convertible
securities.\4\
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\3\ Common or perpetual preferred stock issued under dividend
reinvestment plans or issued to finance acquisitions, including
acquisitions of business entities, may be dedicated to the retirement or
redemption of the mandatory convertible securities. Documentation
certified by an authorized agent of the issuer showing the amount of
common stock or perpetual preferred stock issued, the dates of issue,
and amounts of such issues dedicated to the retirement or redemption of
mandatory convertible securities will satisfy the dedication
requirement.
\4\ The dedication procedure is necessary to ensure that the primary
capital of the issuer is not overstated. For each dollar of common or
perpetual preferred proceeds dedicated to the retirement or redemption
of the notes, there is a corresponding reduction in the amount of
outstanding mandatory securities that may qualify as primary capital. De
minimis amounts (in relation to primary capital) of common or perpetual
preferred stock issued under arrangements in which the amount of stock
issued is not predictable, such as dividend reinvestment plans and
employee stock option plans (but excluding public stock offerings and
stock issued in connection with acquisitions), should be dedicated by no
later than the company's fiscal year end.
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Additional Criteria Applicable to Equity Contract Notes
a. The note must contain a contractual provision (or must be issued
with a mandatory stock purchase contract) that requires the holder of
the instrument to take the common or perpetual stock of the issuer in
lieu of cash in satisfaction of the claim for principal repayment. The
obligation of the holder to take the common or perpetual preferred stock
of the issuer may be waived if, and to the extent that, prior to the
maturity date of the obligation, the issuer sells new common or
perpetual preferred stock and dedicates the proceeds to the retirement
or redemption of the notes. The dedication generally must be made during
the quarter in which the new common or preferred stock is issued.
b. A stock purchase contract may be separated from a security only
if: (1) The holder of the contract provides sufficient collateral \5\ to
the issuer, or to an independent trustee for the benefit of the issuer,
to assure performance under the contract and (2) the stock purchase
contract requires the purchase of common or perpetual preferred stock.
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\5\ Collateral is defined as: (1) Cash or certificates of deposit;
(2) U.S. government securities that will mature prior to or simultaneous
with the maturity of the equity contract and that have a par or maturity
value at least equal to the amount of the holder's obligation under the
stock purchase contract; (3) standby letters of credit issued by an
insured U.S. bank that is not an affiliate of the issuer; or (4) other
collateral as may be designated from time to time by the Federal
Reserve.
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Additional Criteria Applicable to Equity Commitment Notes
a. The indenture or note agreement must contain the following two
provisions:
1. The proceeds of the sale of common or perpetual preferred stock
will be the sole source of repayment for the notes, and the issuer must
dedicate the proceeds for the purpose of repaying the notes.
(Documentation certified by an authorized agent of the issued showing
the amount of common or perpetual preferred stock issued, the dates of
issue, and amounts of such issues dedicated to the retirement or
redemption of mandatory convertible securities will satisfy the
dedication requirement.)
2. By the time that one-third of the life of the securities has run,
the issuer must have raised and dedicated an amount equal to one-third
of the original principal of the securities. By the time that two-thirds
of the life of the securities has run, the issuer must have raised and
dedicated an amount equal to two-thirds of the original principal of the
securities. At least 60 days prior to the maturity of the securities,
the issuer must have raised and dedicated an amount equal to the entire
original principal of the securities. Proceeds dedicated to redemption
or retirement of the notes must come only from the sale of common or
perpetual preferred stock.\6\
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\6\ The funded portions of the securities will be deducted from
primary capital to avoid double counting.
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[[Page 204]]
b. If the issuer fails to meet any of these periodic funding
requirements, the Federal Reserve immediately will cease to treat the
unfunded securities as primary capital and will take appropriate
supervisory action. In addition, failure to meet the funding
requirements will be viewed as a breach of a regulatory commitment and
will be taken into consideration by the Board in acting on statutory
applications.
c. If a security is issued by a subsidiary of a bank or bank holding
company, any guarantee of the principal by that subsidiary's parent bank
or bank holding company must be subordinate to the same degree as the
security issued by the subsidiary and limited to repayment of the
principal amount of the security at its final maturity.
Criteria for Determining the Primary Capital Status of Perpetual Debt
Instruments of Bank Holding Companies
1. The instrument must be unsecured and, if issued by a bank, must
be subordinated to the claims of depositors.
2. The instrument may not provide the noteholder with the right to
demand repayment of principal except in the event of bankruptcy,
insolvency, or reorganization. The instrument must provide that
nonpayment of interest shall not trigger repayment of the principal of
the perpetual debt note or any other obligation of the issuer, nor shall
it constitute prima facie evidence of insolvency or bankruptcy.
3. The issuer shall not voluntarily redeem the debt issue without
prior approval of the Federal Reserve, except when the debt is converted
to, exchanged for, or simultaneously replaced in like amount by an issue
of common or perpetual preferred stock of the issuer or the issuer's
parent company.
4. If issued by a bank holding company, a bank subsidiary, or a
subsidiary with substantial operations, the instrument must contain a
provision that allows the issuer to defer interest payments on the
perpetual debt in the event of, and at the same time as the elimination
of dividends on all outstanding common or preferred stock of the issuer
(or in the case of a guarantee by a parent company at the same time as
the elimination of the dividends of the parent company's common and
preferred stock). In the case of a nonoperating subsidiary (a funding
subsidiary or one formed to issue securities), the deferral of interest
payments must be triggered by elimination of dividends by the parent
company.
5. If issued by a bank holding company or a subsidiary with
substantial operations, the instrument must convert automatically to
common or perpetual preferred stock of the issuer when the issuer's
retained earnings and surplus accounts become negative. If an operating
subsidiary's perpetual debt is guaranteed by its parent, the debt may
convert to the shares of the issuer or guarantor and such conversion may
be triggered when the issuer's or parent's retained earnings and surplus
accounts become negative. If issued by a nonoperating subsidiary of a
bank holding company or bank, the instrument must convert automatically
to common or preferred stock of the issuer's parent when the retained
earnings and surplus accounts of the issuer's parent become negative.
[Reg. Y, 50 FR 16066, Apr. 24, 1985, as amended at 51 FR 40969, Nov. 12,
1986. Redesignated and amended at 54 FR 4209, Jan. 27, 1989; 55 FR
32832, Aug. 10, 1990; 58 FR 474, Jan. 6, 1993]
Appendix C to Part 225--Small Bank Holding Company Policy Statement
Policy Statement on Assessment of Financial and Managerial Factors
In acting on applications filed under the Bank Holding Company Act,
the Board has adopted, and continues to follow, the principle that bank
holding companies should serve as a source of strength for their
subsidiary banks. When bank holding companies incur debt and rely upon
the earnings of their subsidiary banks as the means of repaying such
debt, a question arises as to the probable effect upon the financial
condition of the holding company and its subsidiary bank or banks.
The Board believes that a high level of debt at the parent holding
company impairs the ability of a bank holding company to provide
financial assistance to its subsidiary bank(s) and, in some cases, the
servicing requirements on such debt may be a significant drain on the
resources of the bank(s). For these reasons, the Board has not favored
the use of acquisition debt in the formation of bank holding companies
or in the acquisition of additional banks. Nevertheless, the Board has
recognized that the transfer of ownership of small banks often requires
the use of acquisition debt. The Board, therefore, has permitted the
formation and expansion of small bank holding companies with debt levels
higher than would be permitted for larger holding companies. Approval of
these applications has been given on the condition that small bank
holding companies demonstrate the ability to service acquisition debt
without straining the capital of their subsidiary banks and, further,
that such companies restore their ability to serve as a source of
strength for their subsidiary banks within a relatively short period of
time.
In the interest of continuing its policy of facilitating the
transfer of ownership in banks without compromising bank safety and
soundness, the Board has, as described below, adopted the following
procedures and standards for the formation and expansion of small bank
holding companies subject to this policy statement.
[[Page 205]]
1. Applicability of Policy Statement
This policy statement applies only to bank holding companies with
pro forma consolidated assets of less than $150 million that: (i) are
not engaged in any nonbanking activities involving significant leverage
\1\ and (ii) do not have a significant amount of outstanding debt that
is held by the general public.
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\1\ A parent company that is engaged in significant off-balance
sheet activities would generally be deemed to be engaged in activities
that involve significant leverage.
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While this policy statement primarily applies to the formation of
small bank holding companies, it also applies to existing small bank
holding companies that wish to acquire an additional bank or company and
to transactions involving changes in control, stock redemptions, or
other shareholder transactions. \2\
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\2\ The appropriate Reserve Bank should be contacted to determine
the manner in which a specific situation may qualify for treatment under
this policy statement.
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2. Ongoing Requirements
The following guidelines must be followed on an ongoing basis for
all organizations operating under this policy statement.
A. Reduction in parent company leverage: Small bank holding
companies are to reduce their parent company debt consistent with the
requirement that all debt be retired within 25 years of being incurred.
The Board also expects that these bank holding companies reach a debt to
equity ratio of .30:1 or less within 12 years of the incurrence of the
debt.\3\ The bank holding company must also comply with debt servicing
and other requirements imposed by its creditors.
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\3\ The term debt, as used in the ratio of debt to equity, means any
borrowed funds (exclusive of short-term borrowings that arise out of
current transactions, the proceeds of which are used for current
transactions), and any securities issued by, or obligations of, the
holding company that are the functional equivalent of borrowed funds.
The term equity, as used in the ratio of debt to equity, means the
total stockholders' equity of the bank holding company as defined in
accordance with generally accepted accounting principles. In determining
the total amount of stockholders' equity, the bank holding company
should account for its investments in the common stock of subsidiaries
by the equity method of accounting.
Ordinarily the Board does not view redeemable preferred stock as a
substitute for common stock in a small bank holding company.
Nevertheless, to a limited degree and under certain circumstances, the
Board will consider redeemable preferred stock as equity in the capital
accounts of the holding company if the following conditions are met: (1)
The preferred stock is redeemable only at the option of the issuer and
(2) the debt to equity ratio of the holding company would be at or
remain below .30:1 following the redemption or retirement of any
preferred stock. Preferred stock that is convertible into common stock
of the holding company may be treated as equity.
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B. Capital adequacy: Each insured depository subsidiary of a small
bank holding company is expected to be well-capitalized. Any institution
that is not well-capitalized is expected to become well-capitalized
within a brief period of time.
C. Dividend restrictions: A small bank holding company whose debt to
equity ratio is greater than 1.0:1 is not expected to pay corporate
dividends until such time as it reduces its debt to equity ratio to
1.0:1 or less and otherwise meets the criteria set forth in
Secs. 225.14(c)(1)(ii), 225.14(c)(2), and 225.14(c)(7) of Regulation
Y.\4\
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\4\ Dividends may be paid by small bank holding companies with debt
to equity at or below 1.0:1 and otherwise meeting the requirements of
Sec. Sec. 225.14(c)(1)(ii), 225.14(c)(2), and 225.14(c)(7) if the
dividends are reasonable in amount, do not adversely affect the ability
of the bank holding company to service its debt in an orderly manner,
and do not adversely affect the ability of the subsidiary banks to be
well-capitalized. It is expected that dividends will be eliminated if
the holding company is (1) not reducing its debt consistent with the
requirement that the debt to equity ratio be reduced to .30:1 within 12
years of consummation of the proposal or (2) not meeting the
requirements of its loan agreement(s).
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Small bank holding companies formed before the effective date of
this policy statement may switch to a plan that adheres to the intent of
this statement provided they comply with the requirements set forth
above.
3. Core Requirements for All Applicants
In assessing applications or notices by organizations subject to
this policy statement, the Board will continue to take into account a
full range of financial and other information about the applicant, and
its current and proposed subsidiaries, including the recent trend and
stability of earnings, past and prospective growth, asset quality, the
ability to meet debt servicing requirements without placing an undue
strain on the resources of the bank(s), and the record and competency of
management. In addition, the Board will require applicants to meet the
following requirements:
A. Minimum down payment: The amount of acquisition debt should not
exceed 75 percent of the purchase price of the bank(s) or company to be
acquired. When the owner(s)
[[Page 206]]
of the holding company incurs debt to finance the purchase of the
bank(s) or company, such debt will be considered acquisition debt even
though it does not represent an obligation of the bank holding company,
unless the owner(s) can demonstrate that such debt can be serviced
without reliance on the resources of the bank(s) or bank holding
company.
B. Ability to reduce parent company leverage: The bank holding
company must clearly be able to reduce its debt to equity ratio and
comply with its loan agreement(s) as set forth in paragraph 2A above.
Failure to meet the criteria in this section would normally result
in denial of an application.
4. Additional Application Requirements for Expedited/Waived Processing
A. Expedited notices under Secs. 225.14 and 225.23 of Regulation Y:
A small bank holding company proposal will be eligible for the expedited
processing procedures set forth in Secs. 225.14 and 225.23 of Regulation
Y if the bank holding company is in compliance with the ongoing
requirements of this policy statement, the bank holding company meets
the core requirements for all applicants noted above, and the following
requirements are met:
i. The parent bank holding company has a pro forma debt to equity
ratio of 1.0:1 or less.
ii. The bank holding company meets all of the criteria for expedited
action set forth in Secs. 225.14 or 225.23 of Regulation Y.
B. Waiver of stock redemption filing: A small bank holding company
will be eligible for the stock redemption filing exception for well-
capitalized bank holding companies contained in Sec. 225.4(b)(6) if the
following requirements are met:
i. The parent bank holding company has a pro forma debt to equity
ratio of 1.0:1 or less.
ii. The bank holding company is in compliance with the ongoing
requirements of this policy statement and meets the requirements of
Secs. 225.14(c)(1)(ii), 225.14(c)(2), and 225.14(c)(7) of Regulation Y.
[62 FR 9343, Feb. 28, 1997]
Appendix D to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Tier 1 Leverage Measure
I. Overview
a. The Board of Governors of the Federal Reserve System has adopted
a minimum ratio of tier 1 capital to total assets to assist in the
assessment of the capital adequacy of bank holding companies (banking
organizations).\1\ The principal objectives of this measure is to place
a constraint on the maximum degree to which a banking organization can
leverage its equity capital base. It is intended to be used as a
supplement to the risk-based capital measure.
---------------------------------------------------------------------------
\1\ Supervisory ratios that related capital to total assets for
state member banks are outlined in Appendix B of this part.
---------------------------------------------------------------------------
b. The guidelines apply to consolidated basis to banking holding
companies with consolidated assets of $150 million or more. For bank
holding companies with less that $150 million in consolidated assets,
the guidelines will be applied on a bank-only basis unless (i) the
parent bank holding company is engaged in nonbank activity involving
significant leverage \2\ or (ii) the parent company has a significant
amount of outstanding debt that is held by the general public.
---------------------------------------------------------------------------
\2\ A parent company that is engaged is significant off balance
sheet activities would generally be deemed to be engaged in activities
that involve significant leverage.
---------------------------------------------------------------------------
c. The tier 1 leverage guidelines are to be used in the inspection
and supervisory process as well as in the analysis of applications acted
upon by the Federal Reserve. The Board will review the guidelines from
time to time and will consider the need for possible adjustments in
light of any significant changes in the economy, financial markets, and
banking practices.
II. The Tier 1 Leverage Ratio
a. The Board has established a minimum ratio of Tier 1 capital to
total assets of 3.0 percent for strong bank holding companies (rated
composite ``1'' under the BOPEC rating system of bank holding
companies), and for bank holding companies that have implemented the
Board's risk-based capital measure for market risk as set forth in
appendices A and E of this part. For all other bank holding companies,
the minimum ratio of Tier 1 capital to total assets is 4.0 percent.
Banking organizations with supervisory, financial, operational, or
managerial weaknesses, as well as organizations that are anticipating or
experiencing significant growth, are expected to maintain capital ratios
well above the minimum levels. Moreover, higher capital ratios may be
required for any bank holding company if warranted by its particular
circumstances or risk profile. In all cases, bank holding companies
should hold capital commensurate with the level and nature of the risks,
including the volume and severity of problem loans, to which they are
exposed.
[[Page 207]]
b. A banking organization's Tier 1 leverage ratio is calculated by
dividing its Tier 1 capital (the numerator of the ratio) by its average
total consolidated assets (the denominator of the ratio). The ratio will
also be calculated using period-end assets whenever necessary, on a
case-by-case basis. For the purpose of this leverage ratio, the
definition of Tier 1 capital as set forth in the risk-based capital
guidelines contained in Appendix A of this part will be used.\3\ As a
general matter, average total consolidated assets are defined as the
quarterly average total assets (defined net of the allowance for loan
and lease losses) reported on the organization's Consolidated Financial
Statements (FR Y-9C Report), less goodwill; amounts of mortgage
servicing assets, nonmortgage servicing assets, and purchased credit
card relationships that, in the aggregate, are in excess of 100 percent
of Tier 1 capital; amounts of nonmortgage servicing assets and purchased
credit card relationships that, in the aggregate, are in excess of 25
percent of Tier 1 capital; all other identifiable intangible assets; any
investments in subsidiaries or associated companies that the Federal
Reserve determines should be deducted from Tier 1 capital; and deferred
tax assets that are dependent upon future taxable income, net of their
valuation allowance, in excess of the limitation set forth in section
II.B.4 of Appendix A of this part.\4\
---------------------------------------------------------------------------
\3\ Tier 1 capital for banking organizations includes common equity,
minority interest in the equity accounts of consolidated subsidiaries,
qualifying noncumulative perpetual preferred stock, and qualifying
cumulative perpetual preferred stock. (Cumulative perpetual preferred
stock is limited to 25 percent of Tier 1 capital.) In addition, as a
general matter, Tier 1 capital excludes goodwill; amounts of mortgage
servicing assets, nonmortgage servicing assets, and purchased credit
card relationships that, in the aggregate, exceed 100 percent of Tier 1
capital; nonmortgage servicing assets and purchased credit card
relationships that, in the aggregate, exceed 25 percent of Tier 1
capital; all other identifiable intangible assets; and deferred tax
assets that are dependent upon future taxable income, net of their
valuation allowance, in excess of certain limitations. The Federal
Reserve may exclude certain investments in subsidiaries or associated
companies as appropriate.
\4\ Deductions from Tier 1 capital and other adjustments are
discussed more fully in section II.B. in Appendix A of this part.
---------------------------------------------------------------------------
c. Whenever appropriate, including when an organization is
undertaking expansion, seeking to engage in new activities or otherwise
facing unusual or abnormal risks, the Board will continue to consider
the level of an individual organization's tangible tier 1 leverage ratio
(after deducting all intangibles) in making an overall assessment of
capital adequacy. This is consistent with the Federal Reserve's risk-
based capital guidelines an long-standing Board policy and practice with
regard to leverage guidelines. Organizations experiencing growth,
whether internally or by acquisition, are expected to maintain strong
capital position substantially above minimum supervisory levels, without
significant reliance on intangible assets.
[Reg. Y, 59 FR 65926, Dec. 22, 1994, as amended by Reg. Y, 60 FR 39231,
Aug. 1, 1995; Reg. Y, 63 FR 30370, June 4, 1998; Reg. Y, 63 FR 42676,
Aug. 10, 1998]
Appendix E to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Market Risk Measure Link to an amendment published at 65 FR
75859, Dec. 5, 2000.
Section 1. Purpose, Applicability, Scope, and Effective Date
(a) Purpose. The purpose of this appendix is to ensure that banks
with significant exposure to market risk maintain adequate capital to
support that exposure.\1\ This appendix supplements and adjusts the
risk-based capital ratio calculations under appendix A of this part with
respect to those banks.
---------------------------------------------------------------------------
\1\ This appendix is based on a framework developed jointly by
supervisory authorities from the countries represented on the Basle
Committee on Banking Supervision and endorsed by the Group of Ten
Central Bank Governors. The framework is described in a Basle Committee
paper entitled ``Amendment to the Capital Accord to Incorporate Market
Risks,'' January 1996. Also see modifications issued in September 1997.
---------------------------------------------------------------------------
(b) Applicability. (1) This appendix applies to any insured state
member bank whose trading activity \2\ (on a worldwide consolidated
basis) equals:
---------------------------------------------------------------------------
\2\ Trading activity means the gross sum of trading assets and
liabilities as reported in the bank's most recent quarterly Consolidated
Report of Condition and Income (Call Report).
---------------------------------------------------------------------------
(i) 10 percent or more of total assets; \3\ or
---------------------------------------------------------------------------
\3\ Total assets means quarter-end total assets as reported in the
bank's most recent Call Report.
---------------------------------------------------------------------------
(ii) $1 billion or more.
(2) The Federal Reserve may additionally apply this appendix to any
insured state member bank if the Federal Reserve deems it necessary or
appropriate for safe and sound banking practices.
(3) The Federal Reserve may exclude an insured state member bank
otherwise meeting
[[Page 208]]
the criteria of paragraph (b)(1) of this section from coverage under
this appendix if it determines the bank meets such criteria as a
consequence of accounting, operational, or similar considerations, and
the Federal Reserve deems it consistent with safe and sound banking
practices.
(c) Scope. The capital requirements of this appendix support market
risk associated with a bank's covered positions.
(d) Effective date. This appendix is effective as of January 1,
1997. Compliance is not mandatory until January 1, 1998. Subject to
supervisory approval, a bank may opt to comply with this appendix as
early as January 1, 1997.\4\
---------------------------------------------------------------------------
\4\ A bank that voluntarily complies with the final rule prior to
January 1, 1998, must comply with all of its provisions.
---------------------------------------------------------------------------
Section 2. Definitions
For purposes of this appendix, the following definitions apply:
(a) Covered positions means all positions in a bank's trading
account, and all foreign exchange \5\ and commodity positions, whether
or not in the trading account.\6\ Positions include on-balance-sheet
assets and liabilities and off-balance-sheet items. Securities subject
to repurchase and lending agreements are included as if they are still
owned by the lender.
---------------------------------------------------------------------------
\5\ Subject to supervisory review, a bank may exclude structural
positions in foreign currencies from its covered positions.
\6\ The term trading account is defined in the instructions to the
Call Report.
---------------------------------------------------------------------------
(b) Market risk means the risk of loss resulting from movements in
market prices. Market risk consists of general market risk and specific
risk components.
(1) General market risk means changes in the market value of covered
positions resulting from broad market movements, such as changes in the
general level of interest rates, equity prices, foreign exchange rates,
or commodity prices.
(2) Specific risk means changes in the market value of specific
positions due to factors other than broad market movements and includes
event and default risk as well as idiosyncratic variations.
(c) Tier 1 and Tier 2 capital are defined in appendix A of this
part.
(d) Tier 3 capital is subordinated debt that is unsecured; is fully
paid up; has an original maturity of at least two years; is not
redeemable before maturity without prior approval by the Federal
Reserve; includes a lock-in clause precluding payment of either interest
or principal (even at maturity) if the payment would cause the issuing
bank's risk-based capital ratio to fall or remain below the minimum
required under appendix A of this part; and does not contain and is not
covered by any covenants, terms, or restrictions that are inconsistent
with safe and sound banking practices.
(e) Value-at-risk (VAR) means the estimate of the maximum amount
that the value of covered positions could decline during a fixed holding
period within a stated confidence level, measured in accordance with
section 4 of this appendix.
Section 3. Adjustments to the Risk-Based Capital Ratio Calculations
(a) Risk-based capital ratio denominator. A bank subject to this
appendix shall calculate its risk-based capital ratio denominator as
follows:
(1) Adjusted risk-weighted assets. Calculate adjusted risk-weighted
assets, which equals risk-weighted assets (as determined in accordance
with appendix A of this part), excluding the risk-weighted amounts of
all covered positions (except foreign exchange positions outside the
trading account and over-the-counter derivative positions).\7\
---------------------------------------------------------------------------
\7\ Foreign exchange positions outside the trading account and all
over-the-counter derivative positions, whether or not in the trading
account, must be included in adjusted risk weighted assets as determined
in appendix A of this part.
---------------------------------------------------------------------------
(2) Measure for market risk. Calculate the measure for market risk,
which equals the sum of the VAR-based capital charge, the specific risk
add-on (if any), and the capital charge for de minimis exposures (if
any).
(i) VAR-based capital charge. The VAR-based capital charge equals
the higher of:
(A) The previous day's VAR measure; or
(B) The average of the daily VAR measures for each of the preceding
60 business days multiplied by three, except as provided in section 4(e)
of this appendix;
(ii) Specific risk add-on. The specific risk add-on is calculated in
accordance with section 5 of this appendix; and
(iii) Capital charge for de minimis exposure. The capital charge for
de minimis exposure is calculated in accordance with section 4(a) of
this appendix.
(3) Market risk equivalent assets. Calculate market risk equivalent
assets by multiplying the measure for market risk (as calculated in
paragraph (a)(2) of this section) by 12.5.
(4) Denominator calculation. Add market risk equivalent assets (as
calculated in paragraph (a)(3) of this section) to adjusted risk-
weighted assets (as calculated in paragraph (a)(1) of this section). The
resulting sum is the bank's risk-based capital ratio denominator.
(b) Risk-based capital ratio numerator. A bank subject to this
appendix shall calculate its risk-based capital ratio numerator by
allocating capital as follows:
[[Page 209]]
(1) Credit risk allocation. Allocate Tier 1 and Tier 2 capital equal
to 8.0 percent of adjusted risk-weighted assets (as calculated in
paragraph (a)(1) of this section).\8\
---------------------------------------------------------------------------
\8\ A bank may not allocate Tier 3 capital to support credit risk
(as calculated under appendix A of this part).
---------------------------------------------------------------------------
(2) Market risk allocation. Allocate Tier 1, Tier 2, and Tier 3
capital equal to the measure for market risk as calculated in paragraph
(a)(2) of this section. The sum of Tier 2 and Tier 3 capital allocated
for market risk must not exceed 250 percent of Tier 1 capital allocated
for market risk. (This requirement means that Tier 1 capital allocated
in this paragraph (b)(2) must equal at least 28.6 percent of the measure
for market risk.)
(3) Restrictions. (i) The sum of Tier 2 capital (both allocated and
excess) and Tier 3 capital (allocated in paragraph (b)(2) of this
section) may not exceed 100 percent of Tier 1 capital (both allocated
and excess).\9\
---------------------------------------------------------------------------
\9\ Excess Tier 1 capital means Tier 1 capital that has not been
allocated in paragraphs (b)(1) and (b)(2) of this section. Excess Tier 2
capital means Tier 2 capital that has not been allocated in paragraph
(b)(1) and (b)(2) of this section, subject to the restrictions in
paragraph (b)(3) of this section.
---------------------------------------------------------------------------
(ii) Term subordinated debt (and intermediate-term preferred stock
and related surplus) included in Tier 2 capital (both allocated and
excess) may not exceed 50 percent of Tier 1 capital (both allocated and
excess).
(4) Numerator calculation. Add Tier 1 capital (both allocated and
excess), Tier 2 capital (both allocated and excess), and Tier 3 capital
(allocated under paragraph (b)(2) of this section). The resulting sum is
the bank's risk-based capital ratio numerator.
Section 4. Internal Models
(a) General. For risk-based capital purposes, a bank subject to this
appendix must use its internal model to measure its daily VAR, in
accordance with the requirements of this section.\10\ The Federal
Reserve may permit a bank to use alternative techniques to measure the
market risk of de minimis exposures so long as the techniques adequately
measure associated market risk.
---------------------------------------------------------------------------
\10\ A bank's internal model may use any generally accepted
measurement techniques, such as variance-covariance models, historical
simulations, or Monte Carlo simulations. However, the level of
sophistication and accuracy of a bank's internal model must be
commensurate with the nature and size of its covered positions. A bank
that modifies its existing modeling procedures to comply with the
requirements of this appendix for risk-based capital purposes should,
nonetheless, continue to use the internal model it considers most
appropriate in evaluating risks for other purposes.
---------------------------------------------------------------------------
(b) Qualitative requirements. A bank subject to this appendix must
have a risk management system that meets the following minimum
qualitative requirements:
(1) The bank must have a risk control unit that reports directly to
senior management and is independent from business trading units.
(2) The bank's internal risk measurement model must be integrated
into the daily management process.
(3) The bank's policies and procedures must identify, and the bank
must conduct, appropriate stress tests and backtests.\11\ The bank's
policies and procedures must identify the procedures to follow in
response to the results of such tests.
---------------------------------------------------------------------------
\11\ Stress tests provide information about the impact of adverse
market events on a bank's covered positions. Backtests provide
information about the accuracy of an internal model by comparing a
bank's daily VAR measures to its corresponding daily trading profits and
losses.
---------------------------------------------------------------------------
(4) The bank must conduct independent reviews of its risk
measurement and risk management systems at least annually.
(c) Market risk factors. The bank's internal model must use risk
factors sufficient to measure the market risk inherent in all covered
positions. The risk factors must address interest rate risk,\12\ equity
price risk, foreign exchange rate risk, and commodity price risk.
---------------------------------------------------------------------------
\12\ For material exposures in the major currencies and markets,
modeling techniques must capture spread risk and must incorporate enough
segments of the yield curve--at least six--to capture differences in
volatility and less than perfect correlation of rates along the yield
curve.
---------------------------------------------------------------------------
(d) Quantitative requirements. For regulatory capital purposes, VAR
measures must meet the following quantitative requirements:
(1) The VAR measures must be calculated on a daily basis using a 99
percent, one-tailed confidence level with a price shock equivalent to a
ten-business day movement in rates and prices. In order to calculate VAR
measures based on a ten-day price shock, the bank may either calculate
ten-day figures directly or convert VAR figures based on holding periods
other than ten days to the equivalent of a ten-day holding period (for
instance, by multiplying a one-day VAR measure by the square root of
ten).
(2) The VAR measures must be based on an historical observation
period (or effective observation period for a bank using a weighting
scheme or other similar method) of at least one year. The bank must
update data sets at least once every three months or
[[Page 210]]
more frequently as market conditions warrant.
(3) The VAR measures must include the risks arising from the non-
linear price characteristics of options positions and the sensitivity of
the market value of the positions to changes in the volatility of the
underlying rates or prices. A bank with a large or complex options
portfolio must measure the volatility of options positions by different
maturities.
(4) The VAR measures may incorporate empirical correlations within
and across risk categories, provided that the bank's process for
measuring correlations is sound. In the event that the VAR measures do
not incorporate empirical correlations across risk categories, then the
bank must add the separate VAR measures for the four major risk
categories to determine its aggregate VAR measure.
(e) Backtesting. (1) Beginning one year after a bank starts to
comply with this appendix, a bank must conduct backtesting by comparing
each of its most recent 250 business days' actual net trading profit or
loss \13\ with the corresponding daily VAR measures generated for
internal risk measurement purposes and calibrated to a one-day holding
period and a 99 percent, one-tailed confidence level.
---------------------------------------------------------------------------
\13\ Actual net trading profits and losses typically include such
things as realized and unrealized gains and losses on portfolio
positions as well as fee income and commissions associated with trading
activities.
---------------------------------------------------------------------------
(2) Once each quarter, the bank must identify the number of
exceptions, that is, the number of business days for which the magnitude
of the actual daily net trading loss, if any, exceeds the corresponding
daily VAR measure.
(3) A bank must use the multiplication factor indicated in Table 1
of this appendix in determining its capital charge for market risk under
section 3(a)(2)(i)(B) of this appendix until it obtains the next
quarter's backtesting results, unless the Federal Reserve determines
that a different adjustment or other action is appropriate.
Table 1.--Multiplication Factor Based on Results of Backtesting
------------------------------------------------------------------------
Multiplication
Number of exceptions factor
------------------------------------------------------------------------
4 or fewer.............................................. 3.00
5....................................................... 3.40
6....................................................... 3.50
7....................................................... 3.65
8....................................................... 3.75
9....................................................... 3.85
10 or more.............................................. 4.00
------------------------------------------------------------------------
Section 5. Specific Risk
(a) Modeled specific risk. A bank holding company may use its
internal model to measure specific risk. If the organization has
demonstrated to the Federal Reserve that its internal model measures the
specific risk, including event and default risk as well as idiosyncratic
variation, of covered debt and equity positions and includes the
specific risk measures in the VAR-based capital charge in section
3(a)(2)(i) of this appendix, then the organization has no specific risk
add-on for purposes of section 3(a)(2)(ii) of this appendix. The model
should explain the historical price variation in the trading portfolio
and capture concentration, both magnitude and changes in composition.
The model should also be robust to an adverse environment and have been
validated through backtesting which assesses whether specific risk is
being accurately captured.
(b) Partially modeled specific risk. (1) A bank holding company that
incorporates specific risk in its internal model but fails to
demonstrate to the Federal Reserve that its internal model adequately
measures all aspects of specific risk for covered debt and equity
positions, including event and default risk, as provided by section 5(a)
of this appendix, must calculate its specific risk add-on in accordance
with one of the following methods:
(i) If the model is susceptible to valid separation of the VAR
measure into a specific risk portion and a general market risk portion,
then the specific risk add-on is equal to the previous day's specific
risk portion.
(ii) If the model does not separate the VAR measure into a specific
risk portion and a general market risk portion, then the specific risk
add-on is the sum of the previous day's VAR measures for subportfolios
of covered debt and equity positions that contain specific risk.
(2) If a bank holding company models the specific risk of covered
debt positions but not covered equity positions (or vice versa), then
the bank holding company may determine its specific risk charge for the
included positions under section 5(a) or 5(b)(1) of this appendix, as
appropriate. The specific risk charge for the positions not included
equals the standard specific risk capital charge under paragraph (c) of
this section.
(c) Specific risk not modeled. If a bank holding company does not
model specific risk in accordance with section 5(a) or 5(b) of this
appendix, then the organization's specific risk capital charge shall
equal the standard specific risk capital charge, calculated as follows:
(1) Covered debt positions. (i) For purposes of this section 5,
covered debt positions means fixed-rate or floating-rate debt
instruments located in the trading account and instruments located in
the trading account with
[[Page 211]]
values that react primarily to changes in interest rates, including
certain non-convertible preferred stock, convertible bonds, and
instruments subject to repurchase and lending agreements. Also included
are derivatives (including written and purchased options) for which the
underlying instrument is a covered debt instrument that is subject to a
non-zero specific risk capital charge.
(A) For covered debt positions that are derivatives, a bank must
risk-weight (as described in paragraph (c)(1)(iii) of this section) the
market value of the effective notional amount of the underlying debt
instrument or index portfolio. Swaps must be included as the notional
position in the underlying debt instrument or index portfolio, with a
receiving side treated as a long position and a paying side treated as a
short position; and
(B) For covered debt positions that are options, whether long or
short, a bank must risk-weight (as described in paragraph (c)(1)(iii) of
this section) the market value of the effective notional amount of the
underlying debt instrument or index multiplied by the option's delta.
(ii) A bank may net long and short covered debt positions (including
derivatives) in identical debt issues or indices.
(iii) A bank must multiply the absolute value of the current market
value of each net long or short covered debt position by the appropriate
specific risk weighting factor indicated in Table 2 of this appendix.
The specific risk capital charge component for covered debt positions is
the sum of the weighted values.
Table 2.--Specific Risk Weighting Factors for Covered Debt Positions
------------------------------------------------------------------------
Weighting
Remaining maturity factor
Category (contractual) (in
percent)
------------------------------------------------------------------------
Government.......................... N/A.................... 0.00
Qualifying.......................... 6 months or less....... 0.25
Over 6 months to 24 1.00
months.
Over 24 months......... 1.60
Other............................... N/A.................... 8.00
------------------------------------------------------------------------
(A) The government category includes all debt instruments of central
governments of OECD-based countries \14\ including bonds, Treasury
bills, and other short-term instruments, as well as local currency
instruments of non-OECD central governments to the extent the bank has
liabilities booked in that currency.
---------------------------------------------------------------------------
\14\ Organization for Economic Cooperation and Development (OECD)-
based countries is defined in appendix A of this part.
---------------------------------------------------------------------------
(B) The qualifying category includes debt instruments of U.S.
government-sponsored agencies, general obligation debt instruments
issued by states and other political subdivisions of OECD-based
countries, multilateral development banks, and debt instruments issued
by U.S. depository institutions or OECD-banks that do not qualify as
capital of the issuing institution.\15\ This category also includes
other debt instruments, including corporate debt and revenue instruments
issued by states and other political subdivisions of OECD countries,
that are:
---------------------------------------------------------------------------
\15\ U.S. government-sponsored agencies, multilateral development
banks, and OECD banks are defined in appendix A of this part.
---------------------------------------------------------------------------
(1) Rated investment-grade by at least two nationally recognized
credit rating services;
(2) Rated investment-grade by one nationally recognized credit
rating agency and not rated less than investment-grade by any other
credit rating agency; or
(3) Unrated, but deemed to be of comparable investment quality by
the reporting bank and the issuer has instruments listed on a recognized
stock exchange, subject to review by the Federal Reserve.
(C) The other category includes debt instruments that are not
included in the government or qualifying categories.
(2) Covered equity positions. (i) For purposes of this section 5,
covered equity positions means equity instruments located in the trading
account and instruments located in the trading account with values that
react primarily to changes in equity prices, including voting or non-
voting common stock, certain convertible bonds, and commitments to buy
or sell equity instruments. Also included are derivatives (including
written and purchased options) for which the underlying is a covered
equity position.
(A) For covered equity positions that are derivatives, a bank must
risk weight (as described in paragraph (c)(2)(iii) of this section) the
market value of the effective notional amount of the underlying equity
instrument or equity portfolio. Swaps must be included as the notional
position in the underlying equity instrument or index portfolio, with a
receiving side treated as a long position and a paying side treated as a
short position; and
(B) For covered equity positions that are options, whether long or
short, a bank must risk weight (as described in paragraph (c)(2)(iii) of
this section) the market value of the effective notional amount of the
underlying equity instrument or index multiplied by the option's delta.
(ii) A bank may net long and short covered equity positions
(including derivatives) in identical equity issues or equity indices in
the same market.\16\
---------------------------------------------------------------------------
\16\ A bank may also net positions in depository receipts against an
opposite position in the underlying equity or identical equity in
different markets, provided that the bank includes the costs of
conversion.
---------------------------------------------------------------------------
[[Page 212]]
(iii)(A) A bank must multiply the absolute value of the current
market value of each net long or short covered equity position by a risk
weighting factor of 8.0 percent, or by 4.0 percent if the equity is held
in a portfolio that is both liquid and well-diversified.\17\ For covered
equity positions that are index contracts comprising a well-diversified
portfolio of equity instruments, the net long or short position is
multiplied by a risk weighting factor of 2.0 percent.
---------------------------------------------------------------------------
\17\ A portfolio is liquid and well-diversified if: (1) It is
characterized by a limited sensitivity to price changes of any single
equity issue or closely related group of equity issues held in the
portfolio; (2) the volatility of the portfolio's value is not dominated
by the volatility of any individual equity issue or by equity issues
from any single industry or economic sector; (3) it contains a large
number of individual equity positions, with no single position
representing a substantial portion of the portfolio's total market
value; and (4) it consists mainly of issues traded on organized
exchanges or in well-established over-the-counter markets.
---------------------------------------------------------------------------
(B) For covered equity positions from the following futures-related
arbitrage strategies, a bank may apply a 2.0 percent risk weighting
factor to one side (long or short) of each position with the opposite
side exempt from charge, subject to review by the Federal Reserve:
(1) Long and short positions in exactly the same index at different
dates or in different market centers; or
(2) Long and short positions in index contracts at the same date in
different but similar indices.
(C) For futures contracts on broadly-based indices that are matched
by offsetting positions in a basket of stocks comprising the index, a
bank may apply a 2.0 percent risk weighting factor to the futures and
stock basket positions (long and short), provided that such trades are
deliberately entered into and separately controlled, and that the basket
of stocks comprises at least 90 percent of the capitalization of the
index.
(iv) The specific risk capital charge component for covered equity
positions is the sum of the weighted values.
[Reg. Y, 61 FR 47373, Sept. 6, 1996, as amended by Reg. Y, 62 FR 68068,
Dec. 30, 1997; 64 FR 19038, Apr. 19, 1999]
Effective Date Note: At 65 FR 75859, Dec. 5, 2000, appendix E to
part 225, in section 3, paragraph (a)(1) was revised, effective Jan. 4,
2001. For the convenience of the user, the revised text is set forth as
follows:
Appendix E to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies; Market Risk Measure
* * * * *
Section 3. Adjustments to the Risk-Based Capital Ratio Calculations
(a) * * *
(1) Adjusted risk-weighted assets. Calculate adjusted risk-weighted
assets, which equals risk-weighted assets (as determined in accordance
with appendix A of this part), excluding the risk-weighted amounts of
all covered positions (except foreign exchange positions outside the
trading account and over-the-counter derivative positions) \7\ and
receivables arising from the posting of cash collateral that is
associated with securities borrowing transactions to the extent the
receivables are collateralized by the market value of the borrowed
securities, provided that the following conditions are met:
(i) The transaction is based on securities includable in the trading
book that are liquid and readily marketable,
(ii) The transaction is marked to market daily,
(iii) The transaction is subject to daily margin maintenance
requirements,
(iv) The transaction is a securities contract for the purposes of
section 555 of the Bankruptcy Code (11 U.S.C. 555), a qualified
financial contract for the purposes of section 11(e)(8) of the Federal
Deposit Insurance Act (12 U.S.C. 1821(e)(8)), or a netting contract
between or among financial institutions for the purposes of sections
401-407 of the Federal Deposit Insurance Corporation Improvement Act of
1991 (12 U.S.C. 4401-4407), or the Board's Regulation EE (12 CFR Part
231).
* * * * *
\7\ Foreign exchange positions outside the trading account and all
over-the-counter derivative positions, whether or not in the trading
account, must be included in the adjusted risk weighted assets as
determined in appendix A of this part.
PART 226--TRUTH IN LENDING (REGULATION Z)--Table of Contents
Subpart A--General
Sec.
226.1 Authority, purpose, coverage, organization, enforcement and
liability.
226.2 Definitions and rules of construction.
226.3 Exempt transactions.
226.4 Finance charge.
[[Page 213]]
Subpart B--Open-End Credit
226.5 General disclosure requirements.
226.5a Credit and charge card applications and solicitations.
226.5b Requirements for home equity plans.
226.6 Initial disclosure statement.
226.7 Periodic statement.
226.8 Identification of transactions.
226.9 Subsequent disclosure requirements.
226.10 Prompt crediting of payments.
226.11 Treatment of credit balances.
226.12 Special credit card provisions.
226.13 Billing error resolution.
226.14 Determination of annual percentage rate.
226.15 Right of rescission.
226.16 Advertising.
Subpart C--Closed-End Credit
226.17 General disclosure requirements.
226.18 Content of disclosures.
226.19 Certain residential mortgage and variable-rate transactions.
226.20 Subsequent disclosure requirements.
226.21 Treatment of credit balances.
226.22 Determination of annual percentage rate.
226.23 Right of rescission.
226.24 Advertising.
Subpart D--Miscellaneous
226.25 Record retention.
226.26 Use of annual percentage rate in oral disclosures.
226.27 Spanish language disclosures.
226.28 Effect on State laws.
226.29 State exemptions.
226.30 Limitation on rates.
Subpart E--Special Rules for Certain Home Mortgage Transactions
226.31 General rules.
226.32 Requirements for certain closed-end home mortgages.
226.33 Requirements for reverse mortgages.
Appendix A to Part 226--Effect on State Laws
Appendix B to Part 226--State Exemptions
Appendix C to Part 226--Issuance of Staff Interpretations
Appendix D to Part 226--Multiple Advance Construction Loans
Appendix E to Part 226--Rules For Card Issuers That Bill On a
Transaction-By-Transaction Basis
Appendix F to Part 226--Annual Percentage Rate Computations for Certain
Open-End Credit Plans
Appendix G to Part 226--Open-End Model Forms and Clauses
Appendix H to Part 226--Closed-End Model Forms and Clauses
Appendix I to Part 226--Federal Enforcement Agencies
Appendix J to Part 226--Annual Percentage Rate Computations For Closed-
End Credit Transactions
Appendix K to Part 226--Total Annual Loan Cost Rate Computations for
Reverse Mortgage Transactions
Appendix L to Part 226--Assumed Loan Periods for Computations of Total
Annual Loan Cost Rates
Supplement I to Part 226--Official Staff Interpretations
Authority: 12 U.S.C. 3806; 15 U.S.C. 1604 and 1637(c)(5).
Source: Reg. Z, 46 FR 20892, Apr. 7, 1981, unless otherwise noted.
Subpart A--General
Sec. 226.1 Authority, purpose, coverage, organization, enforcement and liability.
(a) Authority. This regulation, known as Regulation Z, is issued by
the Board of Governors of the Federal Reserve System to implement the
Federal Truth in Lending Act, which is contained in title I of the
Consumer Credit Protection Act, as amended (15 U.S.C. 1601 et seq.).
This regulation also implements title XII, section 1204 of the
Competitive Equality Banking Act of 1987 (Pub. L. 100-86, 101 Stat.
552). Information-collection requirements contained in this regulation
have been approved by the Office of Management and Budget under the
provisions of 44 U.S.C. 3501 et seq. and have been assigned OMB number
7100-0199.
(b) The purpose of this regulation is to promote the informed use of
consumer credit by requiring disclosures about its terms and cost. The
regulation gives consumers the right to cancel certain credit
transactions that involve a lien on a consumer's principal dwelling,
regulates certain credit card practices, and provides a means for fair
and timely resolution of credit billing disputes. The regulation does
not govern charges for consumer credit. The regulation requires a
maximum interest rate to be stated in variable-rate contracts secured by
the consumer's dwelling. It also imposes limitations on home equity
plans that are subject to the requirements of Sec. 226.5b and mortgages
that are subject to the requirements of Sec. 226.32.
(c) Coverage. (1) In general, this regulation applies to each
individual or
[[Page 214]]
business that offers or extends credit when four conditions are met: (i)
The credit is offered or extended to consumers; (ii) the offering or
extension of credit is done regularly;\1\ (iii) the credit is subject to
a finance charge or is payable by a written agreement in more than 4
installments; and (iv) the credit is primarily for personal, family, or
household purposes.
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\1\ The meaning of regularly is explained in the definition of
creditor in Sec. 226.2(a).
---------------------------------------------------------------------------
(2) If a credit card is involved, however, certain provisions apply
even if the credit is not subject to a finance charge, or is not payable
by a written agreement in more than 4 installments, or if the credit
card is to be used for business purposes.
(3) In addition, certain requirements of Sec. 226.5b apply to
persons who are not creditors but who provide applications for home
equity plans to consumers.
(d) Organization. The regulation is divided into subparts and
appendices as follows:
(1) Subpart A contains general information. It sets forth: (i) The
authority, purpose, coverage, and organization of the regulation; (ii)
the definitions of basic terms; (iii) the transactions that are exempt
from coverage; and (iv) the method of determining the finance charge.
(2) Subpart B contains the rules for open-end credit. It requires
that initial disclosures and periodic statements be provided, as well as
additional disclosures for credit and charge card applications and
solicitations and for home equity plans subject to the requirements of
Secs. 226.5a and 226.5b, respectively.
(3) Subpart C relates to closed-end credit. It contains rules on
disclosures, treatment of credit balances, annual percentage rate
calculations, rescission requirements, and advertising.
(4) Subpart D contains rules on oral disclosures, Spanish language
disclosure in Puerto Rico, record retention, effect on state laws, state
exemptions, and rate limitations.
(5) Subpart E relates to mortgage transactions covered by
Sec. 226.32 and reverse mortgage transactions. It contains rules on
disclosures, fees, and total annual loan cost rates.
(6) Several appendices contain information such as the procedures
for determinations about state laws, state exemptions and issuance of
staff interpretations, special rules for certain kinds of credit plans,
a list of enforcement agencies, and the rules for computing annual
percentage rates in closed-end credit transactions and total annual loan
cost rates for reverse mortgage transactions.
(e) Enforcement and liability. Section 108 of the act contains the
administrative enforcement provisions. Sections 112, 113, 130, 131, and
134 contain provisions relating to liability for failure to comply with
the requirements of the act and the regulation. Section 1204(c) of title
XII of the Competitive Equality Banking Act of 1987, Pub. L. 100-86, 101
Stat. 552, incorporates by reference administrative enforcement and
civil liability provisions of sections 108 and 130 of the act.
[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 52 FR 43181, Nov. 9,
1987; 54 FR 13865, Apr. 6, 1989; 54 FR 24686, June 9, 1989; 60 FR 15471,
Mar. 24, 1995]
Sec. 226.2 Definitions and rules of construction.
(a) Definitions. For purposes of this regulation, the following
definitions apply:
(1) Act means the Truth in Lending Act (15 U.S.C. 1601 et seq.).
(2) Advertisement means a commercial message in any medium that
promotes, directly or indirectly, a credit transaction.
(3) [Reserved] \2\
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\2\ [Reserved]
---------------------------------------------------------------------------
(4) Billing cycle or cycle means the interval between the days or
dates of regular periodic statements. These intervals shall be equal and
no longer than a quarter of a year. An interval will be considered equal
if the number of days in the cycle does not vary more than 4 days from
the regular day or date of the periodic statement.
(5) Board means the Board of Governors of the Federal Reserve
System.
(6) Business day means a day on which the creditor's offices are
open to the public for carrying on substantially all of its business
functions. However, for purposes of rescission under Secs. 226.15
[[Page 215]]
and 226.23, and for purposes of Sec. 226.31, the term means all calendar
days except Sundays and the legal public holidays specified in 5 U.S.C.
6103(a), such as New Year's Day, the Birthday of Martin Luther King,
Jr., Washington's Birthday, Memorial Day, Independence Day, Labor Day,
Columbus Day, Veterans Day, Thanksgiving Day, and Christmas Day.
(7) Card issuer means a person that issues a credit card or that
person's agent with respect to the card.
(8) Cardholder means a natural person to whom a credit card is
issued for consumer credit purposes, or a natural person who has agreed
with the card issuer to pay consumer credit obligations arising from the
issuance of a credit card to another natural person. For purposes of
Sec. 226.12(a) and (b), the term includes any person to whom a credit
card is issued for any purpose, including business, commercial, or
agricultural use, or a person who has agreed with the card issuer to pay
obligations arising from the issuance of such a credit card to another
person.
(9) Cash price means the price at which a creditor, in the ordinary
course of business, offers to sell for cash the property or service that
is the subject of the transaction. At the creditor's option, the term
may include the price of accessories, services related to the sale,
service contracts and taxes and fees for license, title, and
registration. The term does not include any finance charge.
(10) Closed-end credit means consumer credit other than open-end
credit as defined in this section.
(11) Consumer means a cardholder or a natural person to whom
consumer credit is offered or extended. However, for purposes of
rescission under Secs. 226.15 and 226.23, the term also includes a
natural person in whose principal dwelling a security interest is or
will be retained or acquired, if that person's ownership interest in the
dwelling is or will be subject to the security interest.
(12) Consumer credit means credit offered or extended to a consumer
primarily for personal, family, or household purposes.
(13) Consummation means the time that a consumer becomes
contractually obligated on a credit transaction.
(14) Credit means the right to defer payment of debt or to incur
debt and defer its payment.
(15) Credit card means any card, plate, coupon book, or other single
credit device that may be used from time to time to obtain credit.
Charge card means a credit card on an account for which no periodic rate
is used to compute a finance charge.
(16) Credit sale means a sale in which the seller is a creditor. The
term includes a bailment or lease (unless terminable without penalty at
any time by the consumer) under which the consumer:
(i) Agrees to pay as compensation for use a sum substantially
equivalent to, or in excess of, the total value of the property and
services involved; and
(ii) Will become (or has the option to become), for no additional
consideration or for nominal consideration, the owner of the property
upon compliance with the agreement.
(17) Creditor means: (i) A person (A) who regularly extends consumer
credit \3\ that is subject to a finance charge or is payable by written
agreement in more than 4 installments (not including a downpayment), and
(B) to whom the obligation is initially payable, either on the face of
the note or contract, or by agreement when there is no note or contract.
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\3\ A person regularly extends consumer credit only if it extended
credit (other than credit subject to the requirements of Sec. 226.32)
more than 25 times (or more than 5 times for transactions secured by a
dwelling) in the preceding calendar year. If a person did not meet these
numerical standards in the preceding calendar year, the numerical
standards shall be applied to the current calendar year. A person
regularly extends consumer credit if, in any 12-month period, the person
originates more than one credit extension that is subject to the
requirements of Sec. 226.32 or one or more such credit extensions
through a mortgage broker.
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(ii) For purposes of Secs. 226.4(c)(8) (discounts), 226.9(d)
(Finance charge imposed at time of transaction), and 226.12(e) (Prompt
notification of returns and crediting of refunds), a person that honors
a credit card.
(iii) For purposes of subpart B, any card issuer that extends either
open-end credit or credit that is not subject to a finance charge and is
not payable
[[Page 216]]
by written agreement in more than 4 installments.
(iv) For purposes of subpart B (except for the credit and charge
card disclosures contained in Secs. 226.5(a) and 226.9 (e) and (f), the
finance charge disclosures contained in Secs. 226.6(a) and 226.7 (d)
through (g) and the right of rescission set forth in Sec. 226.15) and
subpart C, any card issuer that extends closed-end credit that is
subject to a finance charge or is payable by written agreement in more
than 4 installments.
(18) Downpayment means an amount, including the value of any
property used as a trade-in, paid to a seller to reduce the cash price
of goods or services purchased in a credit sale transaction. A deferred
portion of a downpayment may be treated as part of the downpayment if it
is payable not later than the due date of the second otherwise regularly
scheduled payment and is not subject to a finance charge.
(19) Dwelling means a residential structure that contains 1 to 4
units, whether or not that structure is attached to real property. The
term includes an individual condominium unit, cooperative unit, mobile
home, and trailer, if it is used as a residence.
(20) Open-end credit means consumer credit extended by a creditor
under a plan in which:
(i) The creditor reasonably contemplates repeated transactions;
(ii) The creditor may impose a finance charge from time to time on
an outstanding unpaid balance; and
(iii) The amount of credit that may be extended to the consumer
during the term of the plan (up to any limit set by the creditor) is
generally made available to the extent that any outstanding balance is
repaid.
(21) Periodic rate means a rate of finance charge that is or may be
imposed by a creditor on a balance for a day, week, month, or other
subdivision of a year.
(22) Person means a natural person or an organization, including a
corporation, partnership, proprietorship, association, cooperative,
estate, trust, or government unit.
(23) Prepaid finance charge means any finance charge paid separately
in cash or by check before or at consummation of a transaction, or
withheld from the proceeds of the credit at any time.
(24) Residential mortgage transaction means a transaction in which a
mortgage, deed of trust, purchase money security interest arising under
an installment sales contract, or equivalent consensual security
interest is created or retained in the consumer's principal dwelling to
finance the acquisition or initial construction of that dwelling.
(25) Security interest means an interest in property that secures
performance of a consumer credit obligation and that is recognized by
State or Federal law. It does not include incidental interests such as
interests in proceeds, accessions, additions, fixtures, insurance
proceeds (whether or not the creditor is a loss payee or beneficiary),
premium rebates, or interests in after-acquired property. For purposes
of disclosure under Secs. 226.6 and 226.18, the term does not include an
interest that arises solely by operation of law. However, for purposes
of the right of rescission under Secs. 226.15 and 226.23, the term does
include interests that arise solely by operation of law.
(26) State means any state, the District of Columbia, the
Commonwealth of Puerto Rico, and any territory or possession of the
United States.
(b) Rules of construction. For purposes of this regulation, the
following rules of construction apply:
(1) Where appropriate, the singular form of a word includes the
plural form and plural includes singular.
(2) Where the words obligation and transaction are used in this
regulation, they refer to a consumer credit obligation or transaction,
depending upon the context. Where the word credit is used in this
regulation, it means consumer credit unless the context clearly
indicates otherwise.
(3) Unless defined in this regulation, the words used have the
meanings given to them by state law or contract.
(4) Footnotes have the same legal effect as the text of the
regulation.
[Reg. Z, 46 FR 20892, Apr. 7, 1981; 46 FR 29246, June 1, 1981, as
amended at 47 FR 7392, Feb. 19, 1982; 48 FR 14886, Apr. 6, 1983; 54 FR
13865, Apr. 6, 1989; 60 FR 15471, Mar. 24, 1995; 61 FR 49245, Sept. 19,
1996]
[[Page 217]]
Sec. 226.3 Exempt transactions.
This regulation does not apply to the following:\4\
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\4\ The provisions in Sec. 226.12 (a) and (b) governing the issuance
of credit cards and the liability for their unauthorized use apply to
all credit cards, even if the credit cards are issued for use in
connection with extensions of credit that otherwise are exempt under
this section.
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(a) Business, commercial, agricultural, or organizational credit.
(1) An extension of credit primarily for a business, commercial or
agricultural purpose.
(2) An extension of credit to other than a natural person, including
credit to government agencies or instrumentalities.
(b) Credit over $25,000 not secured by real property or a dwelling.
An extension of credit not secured by real property, or by personal
property used or expected to be used as the principal dwelling of the
consumer, in which the amount financed exceeds $25,000 or in which there
is an express written commitment to extend credit in excess of $25,000.
(c) Public utility credit. An extension of credit that involves
public utility services provided through pipe, wire, other connected
facilities, or radio or similar transmission (including extensions of
such facilities), if the charges for service, delayed payment, or any
discounts for prompt payment are filed with or regulated by any
government unit. The financing of durable goods or home improvements by
a public utility is not exempt.
(d) Securities or commodities accounts. Transactions in securities
or commodities accounts in which credit is extended by a broker-dealer
registered with the Securities and Exchange Commission or the Commodity
Futures Trading Commission.
(e) Home fuel budget plans. An installment agreement for the
purchase of home fuels in which no finance charge is imposed.
(f) Student loan programs. Loans made, insured, or guaranteed
pursuant to a program authorized by title IV of the Higher Education Act
of 1965 (20 U.S.C. 1070 et seq.).
[46 FR 20892, Apr. 7, 1981, as amended at 48 FR 14886, Apr. 6, 1983; 49
FR 46991, Nov. 30, 1984]
Sec. 226.4 Finance charge.
(a) Definition. The finance charge is the cost of consumer credit as
a dollar amount. It includes any charge payable directly or indirectly
by the consumer and imposed directly or indirectly by the creditor as an
incident to or a condition of the extension of credit. It does not
include any charge of a type payable in a comparable cash transaction.
(1) Charges by third parties. The finance charge includes fees and
amounts charged by someone other than the creditor, unless otherwise
excluded under this section, if the creditor:
(i) requires the use of a third party as a condition of or an
incident to the extension of credit, even if the consumer can choose the
third party; or
(ii) retains a portion of the third-party charge, to the extent of
the portion retained.
(2) Special rule; closing agent charges. Fees charged by a third
party that conducts the loan closing (such as a settlement agent,
attorney, or escrow or title company) are finance charges only if the
creditor:
(i) Requires the particular services for which the consumer is
charged;
(ii) Requires the imposition of the charge; or
(iii) Retains a portion of the third-party charge, to the extent of
the portion retained.
(3) Special rule; mortgage broker fees. Fees charged by a mortgage
broker (including fees paid by the consumer directly to the broker or to
the creditor for delivery to the broker) are finance charges even if the
creditor does not require the consumer to use a mortgage broker and even
if the creditor does not retain any portion of the charge.
(b) Example of finance charge. The finance charge includes the
following types of charges, except for charges specifically excluded by
paragraphs (c) through (e) of this section:
[[Page 218]]
(1) Interest, time price differential, and any amount payable under
an add-on or discount system of additional charges.
(2) Service, transaction, activity, and carrying charges, including
any charge imposed on a checking or other transaction account to the
extent that the charge exceeds the charge for a similar account without
a credit feature.
(3) Points, loan fees, assumption fees, finder's fees, and similar
charges.
(4) Appraisal, investigation, and credit report fees.
(5) Premiums or other charges for any guarantee or insurance
protecting the creditor against the consumer's default or other credit
loss.
(6) Charges imposed on a creditor by another person for purchasing
or accepting a consumer's obligation, if the consumer is required to pay
the charges in cash, as an addition to the obligation, or as a deduction
from the proceeds of the obligation.
(7) Premiums or other charges for credit life, accident, health, or
loss-of-income insurance, written in connection with a credit
transaction.
(8) Premiums or other charges for insurance against loss of or
damage to property, or against liability arising out of the ownership or
use of property, written in connection with a credit transaction.
(9) Discounts for the purpose of inducing payment by a means other
than the use of credit.
(10) Debt cancellation fees. Charges or premiums paid for debt
cancellation coverage written in connection with a credit transaction,
whether or not the debt cancellation coverage is insurance under
applicable law.
(c) Charges excluded from the finance charge. The following charges
are not finance charges:
(1) Application fees charged to all applicants for credit, whether
or not credit is actually extended.
(2) Charges for actual unanticipated late payment, for exceeding a
credit limit, or for delinquency, default, or a similar occurrence.
(3) Charges imposed by a financial institution for paying items that
overdraw an account, unless the payment of such items and the imposition
of the charge were previously agreed upon in writing.
(4) Fees charged for participation in a credit plan, whether
assessed on an annual or other periodic basis.
(5) Seller's points.
(6) Interest forfeited as a result of an interest reduction required
by law on a time deposit used as security for an extension of credit.
(7) Real-estate related fees. The following fees in a transaction
secured by real property or in a residential mortgage transaction, if
the fees are bona fide and reasonable in amount:
(i) Fees for title examination, abstract of title, title insurance,
property survey, and similar purposes.
(ii) Fees for preparing loan-related documents, such as deeds,
mortgages, and reconveyance or settlement documents.
(iii) Notary and credit report fees.
(iv) Property appraisal fees or fees for inspections to assess the
value or condition of the property if the service is performed prior to
closing, including fees related to pest infestation or flood hazard
determinations.
(v) Amounts required to be paid into escrow or trustee accounts if
the amounts would not otherwise be included in the finance charge.
(8) Discounts offered to induce payment for a purchase by cash,
check, or other means, as provided in section 167(b) of the Act.
(d) Insurance and debt cancellation coverage--(1) Voluntary credit
insurance premiums. Premiums for credit life, accident, health or loss-
of-income insurance may be excluded from the finance charge if the
following conditions are met:
(i) The insurance coverage is not required by the creditor, and this
fact is disclosed in writing.
(ii) The premium for the initial term of insurance coverage is
disclosed. If the term of insurance is less than the term of the
transaction, the term of insurance also shall be disclosed. The premium
may be disclosed on a unit-cost basis only in open-end credit
transactions, closed-end credit transactions by mail or telephone under
Sec. 226.17(g), and certain closed-end credit transactions involving an
insurance
[[Page 219]]
plan that limits the total amount of indebtedness subject to coverage.
(iii) The consumer signs or initials an affirmative written request
for the insurance after receiving the disclosures specified in this
paragraph. Any consumer in the transaction may sign or initial the
request.
(2) Premiums for insurance against loss of or damage to property, or
against liability arising out of the ownership or use of property,\5\
may be excluded from the finance charge if the following conditions are
met:
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\5\ This includes single interest insurance if the insurer waives
all right of subrogation against the consumer.
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(i) The insurance coverage may be obtained from a person of the
consumer's choice,\6\ and this fact is disclosed.
---------------------------------------------------------------------------
\6\ A creditor may reserve the right to refuse to accept, for
reasonable cause, an insurer offered by the consumer.
---------------------------------------------------------------------------
(ii) If the coverage is obtained from or through the creditor, the
premium for the initial term of insurance coverage shall be disclosed.
If the term of insurance is less than the term of the transaction, the
term of insurance shall also be disclosed. The premium may be disclosed
on a unit-cost basis only in open-end credit transactions, closed-end
credit transactions by mail or telephone under Sec. 226.17(g), and
certain closed-end credit transactions involving an insurance plan that
limits the total amount of indebtedness subject to coverage.
(3) Voluntary debt cancellation fees. (i) Charges or premiums paid
for debt cancellation coverage of the type specified in paragraph
(d)(3)(ii) of this section may be excluded from the finance charge,
whether or not the coverage is insurance, if the following conditions
are met:
(A) The debt cancellation agreement or coverage is not required by
the creditor, and this fact is disclosed in writing;
(B) The fee or premium for the initial term of coverage is
disclosed. If the term of coverage is less than the term of the credit
transaction, the term of coverage also shall be disclosed. The fee or
premium may be disclosed on a unit-cost basis only in open-end credit
transactions, closed-end credit transactions by mail or telephone under
Sec. 226.17(g), and certain closed-end credit transactions involving a
debt cancellation agreement that limits the total amount of indebtedness
subject to coverage;
(C) The consumer signs or initials an affirmative written request
for coverage after receiving the disclosures specified in this
paragraph. Any consumer in the transaction may sign or initial the
request.
(ii) Paragraph (d)(3)(i) of this section applies to fees paid for
debt cancellation coverage that provides for cancellation of all or part
of the debtor's liability for amounts exceeding the value of the
collateral securing the obligation, or in the event of the loss of life,
health, or income or in case of accident.
(e) Certain security interest charges. If itemized and disclosed,
the following charges may be excluded from the finance charge:
(1) Taxes and fees prescribed by law that actually are or will be
paid to public officials for determining the existence of or for
perfecting, releasing, or satisfying a security interest.
(2) The premium for insurance in lieu of perfecting a security
interest to the extent that the premium does not exceed the fees
described in paragraph (e)(1) of this section that otherwise would be
payable.
(3) Taxes on security instruments. Any tax levied on security
instruments or on documents evidencing indebtedness if the payment of
such taxes is a requirement for recording the instrument securing the
evidence of indebtedness.
(f) Prohibited offsets. Interest, dividends, or other income
received or to be received by the consumer on deposits or investments
shall not be deducted in computing the finance charge.
[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 61 FR 49245, Sept. 19,
1996]
[[Page 220]]
Subpart B--Open-End Credit
Sec. 226.5 General disclosure requirements.
(a) Form of disclosures. (1) The creditor shall make the disclosures
required by this subpart clearly and conspicuously in writing,\7\ in a
form that the consumer may keep.\8\
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\7\ The disclosure required by Sec. 226.9(d) when a finance charge
is imposed at the time of a transaction need not be written.
\8\ The disclosures required under Sec. 226.5a for credit and charge
card applications and solicitations, the home equity disclosures
required under Sec. 226.5b(d), the alternative summary billing rights
statement provided for in Sec. 226.9(a)(2), the credit and charge card
renewal disclosures required under Sec. 226.9(e), and the disclosures
made under Sec. 226.10(b) about payment requirements need not be in a
form that the consumer can keep.
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(2) The terms finance charge and annual percentage rate, when
required to be disclosed with a corresponding amount or percentage rate,
shall be more conspicuous than any other required disclosure.\9\
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\9\ The terms need not be more conspicuous when used under
Sec. 226.5a generally for credit and charge card applications and
solicitations under Sec. 226.7(d) on periodic statements, under
Sec. 226.9(e) in credit and charge card renewal disclosures, and under
Sec. 226.16 in advertisements. (But see special rule for annual
percentage rate for purchases, Sec. 226.5a(b)(1).)
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(3) Certain disclosures required under Sec. 226.5a for credit and
charge card applications and solicitations must be provided in a tabular
format or in a prominent location in accordance with the requirements of
that section.
(4) For rules governing the form of disclosures for home equity
plans, see Sec. 226.5b(a).
(b) Time of disclosures. (1) Initial disclosures. The creditor shall
furnish the initial disclosure statement required by Sec. 226.6 before
the first transaction is made under the plan.
(2) Periodic statements. (i) The creditor shall mail or deliver a
periodic statement as required by Sec. 226.7 for each billing cycle at
the end of which an account has a debit or credit balance of more than
$1 or on which a finance charge has been imposed. A periodic statement
need not be sent for an account if the creditor deems it uncollectible,
or if delinquency collection proceedings have been instituted, or if
furnishing the statement would violate Federal law.
(ii) The creditor shall mail or deliver the periodic statement at
least 14 days prior to any date or the end of any time period required
to be disclosed under Sec. 226.7(j) in order for the consumer to avoid
an additional finance or other charge.\10\ A creditor that fails to meet
this requirement shall not collect any finance or other charge imposed
as a result of such failure.
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\10\ This timing requirement does not apply if the creditor is
unable to meet the requirement because of an act of God, war, civil
disorder, natural disaster, or strike.
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(3) Credit and charge card application and solicitation disclosures.
The card issuer shall furnish the disclosures for credit and charge card
applications and solicitations in accordance with the timing
requirements of Sec. 226.5a.
(4) Home equity plans. Disclosures for home equity plans shall be
made in accordance with the timing requirements of Sec. 226.5b(b).
(c) Basis of disclosures and use of estimates. Disclosures shall
reflect the terms of the legal obligation between the parties. If any
information necessary for accurate disclosure is unknown to the
creditor, it shall make the disclosure based on the best information
reasonably available and shall state clearly that the disclosure is an
estimate.
(d) Multiple creditors; multiple consumers. If the credit plan
involves more than one creditor, only one set of disclosures shall be
given, and the creditors shall agree among themselves which creditor
must comply with the requirements that this regulation imposes on any or
all of them. If there is more than one consumer, the disclosures may be
made to any consumer who is primarily liable on the account. If the
right of rescission under Sec. 226.15 is applicable, however, the
disclosures required by Secs. 226.6 and 226.15(b) shall be made to each
consumer having the right to rescind.
(e) Effect of subsequent events. If a disclosure becomes inaccurate
because of an event that occurs after the creditor mails or delivers the
disclosures, the resulting inaccuracy is not a violation
[[Page 221]]
of this regulation, although new disclosures may be required under
Sec. 226.9(c).
[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 54 FR 13865, Apr. 6,
1989; 54 FR 24686, June 9, 1989; 65 FR 58908, Oct. 3, 2000]
Sec. 226.5a Credit and charge card applications and solicitations.
(a) General rules. The card issuer shall provide the disclosures
required under this section on or with a solicitation or an application
to open a credit or charge card account.
(1) Definition of solicitation. For purposes of this section, the
term solicitation means an offer by the card issuer to open a credit or
charge card account that does not require the consumer to complete an
application.
(2) Form of disclosures. (i) The disclosures in paragraphs (b) (1)
through (7) of this section shall be provided in a prominent location on
or with an application or a solicitation, or other applicable document,
and in the form of a table with headings, content, and format
substantially similar to any of the applicable tables found in appendix
G.
(ii) The disclosures in paragraphs (b)(8) through (11) of this
section shall be provided either in the table containing the disclosures
in paragraphs (b)(1) through (7), or clearly and conspicuously elsewhere
on or with the application or solicitation.
(iii) The disclosure required under paragraph (b)(5) of this section
shall contain the term grace period.
(iv) The terminology in the disclosures under paragraph (b) of this
section shall be consistent with that to be used in the disclosures
under Secs. 226.6 and 226.7.
(3) Exceptions. This section does not apply to home-equity plans
accessible by a credit or charge card that are of the type subject to
the requirements of Sec. 226.5b; overdraft lines of credit tied to asset
accounts accessed by check-guarantee cards or by debit cards; or lines
of credit accessed by check-guarantee cards or by debit cards that can
be used only at automated teller machines.
(4) Fees based on a percentage. If the amount of any fee required to
be disclosed under this section is determined on the basis of a
percentage of another amount, the percentage used and the identification
of the amount against which the percentage is applied may be disclosed
instead of the amount of the fee.
(5) Certain fees that vary by state. If the amount of any fee
referred to in paragraphs (b)(8) through (11) of this section varies
from state to state, the card issuer may disclose the range of the fees
instead of the amount for each state, if the disclosure includes a
statement that the amount of the fee varies from state to state.
(b) Required disclosures. The card issuer shall disclose the items
in this paragraph on or with an application or a solicitation in
accordance with the requirements of paragraphs (c), (d), or (e) of this
section. A credit card issuer shall disclose all applicable items in
this paragraph except for paragraph (b)(7) of this section. A charge
card issuer shall disclose the applicable items in paragraphs (b)(2),
(4), and (7) through (11) of this section.
(1) Annual percentage rate. Each periodic rate that may be used to
compute the finance charge on an outstanding balance for purchases, a
cash advance, or a balance transfer, expressed as an annual percentage
rate (as determined by Sec. 226.14(b)). When more than one rate applies
for a category of transactions, the range of balances to which each rate
is applicable shall also be disclosed. The annual percentage rate for
purchases disclosed pursuant to this paragraph shall be in at least 18-
point type, except for the following: a temporary initial rate that is
lower than the rate that will apply after the temporary rate expires,
and a penalty rate that will apply upon the occurrence of one or more
specific events.
(i) If the account has a variable rate, the card issuer shall also
disclose the fact that the rate may vary and how the rate is determined.
(ii) When variable rate disclosures are provided under paragraph (c)
of this section, an annual percentage rate disclosure is accurate if the
rate was in effect within 60 days before mailing the disclosures. When
variable rate disclosures are provided under paragraph (e) of this
section, an annual percentage rate disclosure is accurate if the rate
was in effect within 30 days before printing the disclosures.
[[Page 222]]
(2) Fees for issuance or availability. Any annual or other periodic
fee, expressed as an annualized amount, or any other fee that may be
imposed for the issuance or availability of a credit or charge card,
including any fee based on account activity or inactivity.
(3) Minimum finance charge. Any minimum or fixed finance charge that
could be imposed during a billing cycle.
(4) Transaction charges. Any transaction charge imposed for the use
of the card for purchases.
(5) Grace period. The date by which or the period within which any
credit extended for purchases may be repaid without incurring a finance
charge. If no grace period is provided, that fact must be disclosed. If
the length of the grace period varies, the card issuer may disclose the
range of days, the minimum number of days, or the average number of days
in the grace period, if the disclosure is identified as a range,
minimum, or average.
(6) Balance computation method. The name of the balance computation
method listed in paragraph (g) of this section that is used to determine
the balance for purchases on which the finance charge is computed, or an
explanation of the method used if it is not listed. The explanation may
appear outside the table if the table contains a reference to the
explanation. In determining which balance computation method to
disclose, the card issuer shall assume that credit extended for
purchases will not be repaid within the grace period, if any.
(7) Statement on charge card payments. A statement that charges
incurred by use of the charge card are due when the periodic statement
is received.
(8) Cash advance fee. Any fee imposed for an extension of credit in
the form of cash.
(9) Late payment fee. Any fee imposed for a late payment.
(10) Over-the-limit fee. Any fee imposed for exceeding a credit
limit.
(11) Balance transfer fee. Any fee imposed to transfer an
outstanding balance.
(c) Direct mail applications and solicitations. The card issuer
shall disclose the applicable items in paragraph (b) of this section on
or with an application or solicitation that is mailed to consumers.
(d) Telephone applications and solicitations--(1) Oral disclosure.
The card issuer shall orally disclose the information in paragraphs (b)
(1) through (7) of this section, to the extent applicable, in a
telephone application or solicitation initiated by the card issuer.
(2) Alternative disclosure. The oral disclosure under paragraph
(d)(1) of this section need not be given if the card issuer either does
not impose a fee described in paragraph (b)(2) of this section or does
not impose such a fee unless the consumer uses the card, and the card
issuer discloses in writing within 30 days after the consumer requests
the card (but in no event later than the delivery of the card) the
following:
(i) The applicable information in paragraph (b) of this section; and
(ii) The fact that the consumer need not accept the card or pay any
fee disclosed unless the consumer uses the card.
(e) Applications and solicitations made available to general public.
The card issuer shall provide disclosures, to the extent applicable, on
or with an application or solicitation that is made available to the
general public, including one contained in a catalog, magazine, or other
generally available publication. The disclosures shall be provided in
accordance with paragraph (e) (1), (2) or (3) of this section.
(1) Disclosure of required credit information. The card issuer may
disclose in a prominent location on the application or solicitation the
following:
(i) The applicable information in paragraph (b) of this section;
(ii) The date the required information was printed, including a
statement that the required information was accurate as of that date and
is subject to change after that date; and
(iii) A statement that the consumer should contact the card issuer
for any change in the required information since it was printed, and a
toll-free telephone number or a mailing address for that purpose.
(2) Inclusion of certain initial disclosures. The card issuer may
disclose on or with the application or solicitation the following:
[[Page 223]]
(i) The disclosures required under Sec. 226.6 (a) through (c); and
(ii) A statement that the consumer should contact the card issuer
for any change in the required information, and a toll-free telephone
number or a mailing address for that purpose.
(3) No disclosure of credit information. If none of the items in
paragraph (b) of this section is provided on or with the application or
solicitation, the card issuer may state in a prominent location on the
application or solicitation the following:
(i) There are costs associated with the use of the card; and
(ii) The consumer may contact the card issuer to request specific
information about the costs, along with a toll-free telephone number and
a mailing address for that purpose.
(4) Prompt response to requests for information. Upon receiving a
request for any of the information referred to in this paragraph, the
card issuer shall promptly and fully disclose the information requested.
(f) Special charge card rule--card issuer and person extending
credit not the same person. If a cardholder may by use of a charge card
access an open-end credit plan that is not maintained by the charge card
issuer, the card issuer need not provide the disclosures in paragraphs
(c), (d) or (e) of this section for the open-end credit plan if the card
issuer states on or with an application or a solicitation the following:
(1) The card issuer will make an independent decision whether to
issue the card;
(2) The charge card may arrive before the decision is made about
extending credit under the open-end credit plan; and
(3) Approval for the charge card does not constitute approval for
the open-end credit plan.
(g) Balance computation methods defined. The following methods may
be described by name. Methods that differ due to variations such as the
allocation of payments, whether the finance charge begins to accrue on
the transaction date or the date of posting the transaction, the
existence or length of a grace period, and whether the balance is
adjusted by charges such as late fees, annual fees and unpaid finance
charges do not constitute separate balance computation methods.
(1)(i) Average daily balance (including new purchases). This balance
is figured by adding the outstanding balance (including new purchases
and deducting payments and credits) for each day in the billing cycle,
and then dividing by the number of days in the billing cycle.
(ii) Average daily balance (excluding new purchases). This balance
is figured by adding the outstanding balance (excluding new purchases
and deducting payments and credits) for each day in the billing cycle,
and then dividing by the number of days in the billing cycle.
(2)(i) Two-cycle average daily balance (including new purchases).
This balance is the sum of the average daily balances for two billing
cycles. The first balance is for the current billing cycle, and is
figured by adding the outstanding balance (including new purchases and
deducting payments and credits) for each day in the billing cycle, and
then dividing by the number of days in the billing cycle. The second
balance is for the preceding billing cycle.
(ii) Two-cycle average daily balance (excluding new purchases). This
balance is the sum of the average daily balances for two billing cycles.
The first balance is for the current billing cycle, and is figured by
adding the outstanding balance (excluding new purchases and deducting
payments and credits) for each day in the billing cycle, and then
dividing by the number of days in the billing cycle. The second balance
is for the preceding billing cycle.
(3) Adjusted balance. This balance is figured by deducting payments
and credits made during the billing cycle from the outstanding balance
at the beginning of the billing cycle.
(4) Previous balance. This balance is the outstanding balance at the
beginning of the billing cycle.
[Reg. Z, 54 FR 13865, Apr. 6, 1989, as amended at 54 FR 24686, June 9,
1989; 54 FR 32954, Aug. 11, 1989; 65 FR 17131, Mar. 31, 2000; 65 FR
58908, Oct. 3, 2000]
Sec. 226.5b Requirements for home equity plans.
The requirements of this section apply to open-end credit plans
secured
[[Page 224]]
by the consumer's dwelling. For purposes of this section, an annual
percentage rate is the annual percentage rate corresponding to the
periodic rate as determined under Sec. 226.14(b).
(a) Form of disclosures--(1) General. The disclosures required by
paragraph (d) of this section shall be made clearly and conspicuously
and shall be grouped together and segregated from all unrelated
information. The disclosures may be provided on the application form or
on a separate form. The disclosure described in paragraph (d)(4)(iii),
the itemization of third-party fees described in paragraph (d)(8), and
the variable-rate information described in paragraph (d)(12) of this
section may be provided separately from the other required disclosures.
(2) Precedence of certain disclosures. The disclosures described in
paragraph (d)(1) through (4)(ii) of this section shall precede the other
required disclosures.
(b) Time of disclosures. The disclosures and brochure required by
paragraphs (d) and (e) of this section shall be provided at the time an
application is provided to the consumer.\10a\
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\10a\ The disclosures and the brochure may be delivered or placed in
the mail not later than three business days following receipt of a
consumer's application in the case of applications contained in
magazines or other publications, or when the application is received by
telephone or through an intermediary agent or broker.
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(c) Duties of third parties. Persons other than the creditor who
provide applications to consumers for home equity plans must provide the
brochure required under paragraph (e) of this section at the time an
application is provided. If such persons have the disclosures required
under paragraph (d) of this section for a creditor's home equity plan,
they also shall provide the disclosures at such time.\10 a\
(d) Content of disclosures. The creditor shall provide the following
disclosures, as applicable:
(1) Retention of information. A statement that the consumer should
make or otherwise retain a copy of the disclosures.
(2) Conditions for disclosed terms. (i) A statement of the time by
which the consumer must submit an application to obtain specific terms
disclosed and an identification of any disclosed term that is subject to
change prior to opening the plan.
(ii) A statement that, if a disclosed term changes (other than a
change due to fluctuations in the index in a variable-rate plan) prior
to opening the plan and the consumer therefore elects not to open the
plan, the consumer may receive a refund of all fees paid in connection
with the application.
(3) Security interest and risk to home. A statement that the
creditor will acquire a security interest in the consumer's dwelling and
that loss of the dwelling may occur in the event of default.
(4) Possible actions by creditor. (i) A statement that, under
certain conditions, the creditor may terminate the plan and require
payment of the outstanding balance in full in a single payment and
impose fees upon termination; prohibit additional extensions of credit
or reduce the credit limit; and, as specified in the initial agreement,
implement certain changes in the plan.
(ii) A statement that the consumer may receive, upon request,
information about the conditions under which such actions may occur.
(iii) In lieu of the disclosure required under paragraph (d)(4)(ii)
of this section, a statement of such conditions.
(5) Payment terms. The payment terms of the plan, including:
(i) The length of the draw period and any repayment period.
(ii) An explanation of how the minimum periodic payment will be
determined and the timing of the payments. If paying only the minimum
periodic payments may not repay any of the principal or may repay less
than the outstanding balance, a statement of this fact, as well as a
statement that a balloon payment may result.\10b\
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\10b\ A balloon payment results if paying the minimum periodic
payments does not fully amortize the outstanding balance by a specified
date or time, and the consumer must repay the entire outstanding balance
at such time.
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[[Page 225]]
(iii) An example, based on a $10,000 outstanding balance and a
recent annual percentage rate,\10c\ showing the minimum periodic
payment, any balloon payment, and the time it would take to repay the
$10,000 outstanding balance if the consumer made only those payments and
obtained no additional extensions of credit.
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\10c\ For fixed-rate plans, a recent annual percentage rate is a
rate that has been in effect under the plan within the twelve months
preceding the date the disclosures are provided to the consumer. For
variable-rate plans, a recent annual percentage rate is the most recent
rate provided in the historical example described in paragraph
(d)(12)(xi) of this section or a rate that has been in effect under the
plan since the date of the most recent rate in the table.
If different payment terms may apply to the draw and any repayment
period, or if different payment terms may apply within either period,
the disclosures shall reflect the different payment terms.
(6) Annual percentage rate. For fixed-rate plans, a recent annual
percentage rate\10 c\ imposed under the plan and a statement that the
rate does not include costs other than interest.
(7) Fees imposed by creditor. An itemization of any fees imposed by
the creditor to open, use, or maintain the plan, stated as a dollar
amount or percentage, and when such fees are payable.
(8) Fees imposed by third parties to open a plan. A good faith
estimate, stated as a single dollar amount or range, of any fees that
may be imposed by persons other than the creditor to open the plan, as
well as a statement that the consumer may receive, upon request, a good
faith itemization of such fees. In lieu of the statement, the
itemization of such fees may be provided.
(9) Negative amortization. A statement that negative amortization
may occur and that negative amortization increases the principal balance
and reduces the consumer's equity in the dwelling.
(10) Transaction requirements. Any limitations on the number of
extensions of credit and the amount of credit that may be obtained
during any time period, as well as any minimum outstanding balance and
minimum draw requirements, stated as dollar amounts or percentages.
(11) Tax implications. A statement that the consumer should consult
a tax advisor regarding the deductibility of interest and charges under
the plan.
(12) Disclosures for variable-rate plans. For a plan in which the
annual percentage rate is variable, the following disclosures, as
applicable:
(i) The fact that the annual percentage rate, payment, or term may
change due to the variable-rate feature.
(ii) A statement that the annual percentage rate does not include
costs other than interest.
(iii) The index used in making rate adjustments and a source of
information about the index.
(iv) An explanation of how the annual percentage rate will be
determined, including an explanation of how the index is adjusted, such
as by the addition of a margin.
(v) A statement that the consumer should ask about the current index
value, margin, discount or premium, and annual percentage rate.
(vi) A statement that the initial annual percentage rate is not
based on the index and margin used to make later rate adjustments, and
the period of time such initial rate will be in effect.
(vii) The frequency of changes in the annual percentage rate.
(viii) Any rules relating to changes in the index value and the
annual percentage rate and resulting changes in the payment amount,
including, for example, an explanation of payment limitations and rate
carryover.
(ix) A statement of any annual or more frequent periodic limitations
on changes in the annual percentage rate (or a statement that no annual
limitation exists), as well as a statement of the maximum annual
percentage rate that may be imposed under each payment option.
(x) The minimum periodic payment required when the maximum annual
percentage rate for each payment option is in effect for a $10,000
outstanding balance, and a statement of the earliest date or time the
maximum rate may be imposed.
(xi) An historical example, based on a $10,000 extension of credit,
illustrating
[[Page 226]]
how annual percentage rates and payments would have been affected by
index value changes implemented according to the terms of the plan. The
historical example shall be based on the most recent 15 years of index
values (selected for the same time period each year) and shall reflect
all significant plan terms, such as negative amortization, rate
carryover, rate discounts, and rate and payment limitations, that would
have been affected by the index movement during the period.
(xii) A statement that rate information will be provided on or with
each periodic statement.
(e) Brochure. The home equity brochure published by the Board or a
suitable substitute shall be provided.
(f) Limitations on home equity plans. No creditor may, by contract
or otherwise:
(1) Change the annual percentage rate unless:
(i) Such change is based on an index that is not under the
creditor's control; and
(ii) Such index is available to the general public.
(2) Terminate a plan and demand repayment of the entire outstanding
balance in advance of the original term (except for reverse mortgage
transactions that are subject to paragraph (f)(4) of this section)
unless:
(i) There is fraud or material misrepresentation by the consumer in
connection with the plan;
(ii) The consumer fails to meet the repayment terms of the agreement
for any outstanding balance;
(iii) Any action or inaction by the consumer adversely affects the
creditor's security for the plan, or any right of the creditor in such
security; or
(iv) Federal law dealing with credit extended by a depository
institution to its executive officers specifically requires that as a
condition of the plan the credit shall become due and payable on demand,
provided that the creditor includes such a provision in the initial
agreement.
(3) Change any term, except that a creditor may:
(i) Provide in the initial agreement that it may prohibit additional
extensions of credit or reduce the credit limit during any period in
which the maximum annual percentage rate is reached. A creditor also may
provide in the initial agreement that specified changes will occur if a
specified event takes place (for example, that the annual percentage
rate will increase a specified amount if the consumer leaves the
creditor's employment).
(ii) Change the index and margin used under the plan if the original
index is no longer available, the new index has an historical movement
substantially similar to that of the original index, and the new index
and margin would have resulted in an annual percentage rate
substantially similar to the rate in effect at the time the original
index became unavailable.
(iii) Make a specified change if the consumer specifically agrees to
it in writing at that time.
(iv) Make a change that will unequivocally benefit the consumer
throughout the remainder of the plan.
(v) Make an insignificant change to terms.
(vi) Prohibit additional extensions of credit or reduce the credit
limit applicable to an agreement during any period in which:
(A) The value of the dwelling that secures the plan declines
significantly below the dwelling's appraised value for purposes of the
plan;
(B) The creditor reasonably believes that the consumer will be
unable to fulfill the repayment obligations under the plan because of a
material change in the consumer's financial circumstances;
(C) The consumer is in default of any material obligation under the
agreement;
(D) The creditor is precluded by government action from imposing the
annual percentage rate provided for in the agreement;
(E) The priority of the creditor's security interest is adversely
affected by government action to the extent that the value of the
security interest is less than 120 percent of the credit line; or
(F) The creditor is notified by its regulatory agency that continued
advances constitute an unsafe and unsound practice.
(4) For reverse mortgage transactions that are subject to
Sec. 226.33, terminate a
[[Page 227]]
plan and demand repayment of the entire outstanding balance in advance
of the original term except:
(i) In the case of default;
(ii) If the consumer transfers title to the property securing the
note;
(iii) If the consumer ceases using the property securing the note as
the primary dwelling; or
(iv) Upon the consumer's death.
(g) Refund of fees. A creditor shall refund all fees paid by the
consumer to anyone in connection with an application if any term
required to be disclosed under paragraph (d) of this section changes
(other than a change due to fluctuations in the index in a variable-rate
plan) before the plan is opened and, as a result, the consumer elects
not to open the plan.
(h) Imposition of nonrefundable fees. Neither a creditor nor any
other person may impose a nonrefundable fee in connection with an
application until three business days after the consumer receives the
disclosures and brochure required under this section.\10d\
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\10d\ If the disclosures and brochure are mailed to the consumer,
the consumer is considered to have received them three business days
after they are mailed.
[Reg. Z, 54 FR 24686, June 9, 1989, as amended at 55 FR 38312, Sept. 18,
1990; 55 FR 42148, Oct. 17, 1990; 57 FR 34681, Aug. 6, 1992; 60 FR
15471, Mar. 24, 1995]
Sec. 226.6 Initial disclosure statement.
The creditor shall disclose to the consumer, in terminology
consistent with that to be used on the periodic statement, each of the
following items, to the extent applicable:
(a) Finance charge. The circumstances under which a finance charge
will be imposed and an explanation of how it will be determined, as
follows:
(1) A statement of when finance charges begin to accrue, including
an explanation of whether or not any time period exists within which any
credit extended may be repaid without incurring a finance charge. If
such a time period is provided, a creditor may, at its option and
without disclosure, impose no finance charge when payment is received
after the time period's expiration.
(2) A disclosure of each periodic rate that may be used to compute
the finance charge, the range of balances to which it is applicable,\11\
and the corresponding annual percentage rate.\12\ When different
periodic rates apply to different types of transactions, the types of
transactions to which the periodic rates apply shall also be disclosed.
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\11\ A creditor is not required to adjust the range of balances
disclosure to reflect the balance below which only a minimum charge
applies.
\12\ If a creditor is offering a variable rate plan, the creditor
shall also disclose: (1) The circumstances under which the rate(s) may
increase; (2) any limitations on the increase; and (3) the effect(s) of
an increase.
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(3) An explanation of the method used to determine the balance on
which the finance charge may be computed.
(4) An explanation of how the amount of any finance charge will be
determined,\13\ including a description of how any finance charge other
than the periodic rate will be determined.
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\13\ If no finance charge is imposed when the outstanding balance is
less than a certain amount, no disclosure is required of that fact or of
the balance below which no finance charge will be imposed.
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(b) Other charges. The amount of any charge other than a finance
charge that may be imposed as part of the plan, or an explanation of how
the charge will be determined.
(c) Security interests. The fact that the creditor has or will
acquire a security interest in the property purchased under the plan, or
in other property identified by item or type.
(d) Statement of billing rights. A statement that outlines the
consumer's rights and the creditor's responsibilities under
Secs. 226.12(c) and 226.13 and that is substantially similar to the
statement found in appendix G.
(e) Home equity plan information. The following disclosures
described in Sec. 226.5b(d), as applicable:
(1) A statement of the conditions under which the creditor may take
certain action, as described in Sec. 226.5b(d)(4)(i), such as
terminating the plan or changing the terms.
(2) The payment information described in Sec. 226.5b(d)(5) (i) and
(ii) for both the draw period and any repayment period.
[[Page 228]]
(3) A statement that negative amortization may occur as described in
Sec. 226.5b(d)(9).
(4) A statement of any transaction requirements as described in
Sec. 226.5b(d)(10).
(5) A statement regarding the tax implications as described in
Sec. 226.5b(d)(11).
(6) A statement that the annual percentage rate imposed under the
plan does not include costs other than interest as described in
Secs. 226.5b(d)(6) and (d)(12)(ii).
(7) The variable-rate disclosures described in Sec. 226.5b(d)(12)
(viii), (x), (xi), and (xii), as well as the disclosure described in
Sec. 226.5b(d)(5)(iii), unless the disclosures provided with the
application were in a form the consumer could keep and included a
representative payment example for the category of payment option chosen
by the consumer.
[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 54 FR 24688, June 9,
1989]
Sec. 226.7 Periodic statement.
The creditor shall furnish the consumer with a periodic statement
that discloses the following items, to the extent applicable:
(a) Previous balance. The account balance outstanding at the
beginning of the billing cycle.
(b) Identification of transactions. An identification of each credit
transaction in accordance with Sec. 226.8.
(c) Credits. Any credit to the account during the billing cycle,
including the amount and the date of crediting. The date need not be
provided if a delay in crediting does not result in any finance or other
charge.
(d) Periodic rates. Each periodic rate that may be used to compute
the finance charge, the range of balances to which it is applicable,\14\
and the corresponding annual percentage rate.\15\ If different periodic
rates apply to different types of transactions, the types of
transactions to which the periodic rates apply shall also be disclosed.
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\14\ See footnotes 11 and 13.
\15\ If a variable rate plan is involved, the creditor shall
disclose the fact that the periodic rate(s) may vary.
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(e) Balance on which finance charge computed. The amount of the
balance to which a periodic rate was applied and an explanation of how
that balance was determined. When a balance is determined without first
deducting all credits and payments made during the billing cycle, that
fact and the amount of the credits and payments shall be disclosed.
(f) Amount of finance charge. The amount of any finance charge
debited or added to the account during the billing cycle, using the term
finance charge. The components of the finance charge shall be
individually itemized and identified to show the amount(s) due to the
appliction of any periodic rates and the amount(s) of any other type of
finance charge. If there periodic rate, the amount of the finance charge
attributable to each rate need not be separately itemized and
identified.
(g) Annual percentage rate. When a finance charge is imposed during
the billing cycle, the annual percentage rate(s) determined under
Sec. 226.14, using the term annual percentage rate.
(h) Other charges. The amounts, itemized and identified by type, of
any charges other than finance charges debited to the account during the
billing cycle.
(i) Closing date of billing cycle; new balance. The closing date of
the billing cycle and the account balance outstanding on that date.
(j) Free-ride period. The date by which or the time period within
which the new balance or any portion of the new balance must be paid to
avoid additional finance charges. If such a time period is provided, a
creditor may, at its option and without disclosure, impose no finance
charge when payment is received after the time period's expiration.
(k) Address for notice of billing errors. The address to be used for
notice of billing errors. Alternatively, the address may be provided on
the billing rights statement permitted by Sec. 226.9(a)(2).
[46 FR 20892, Apr. 7, 1981; 46 FR 29246, June 1, 1981]
[[Page 229]]
Sec. 226.8 Identification of transactions.
The creditor shall identify credit transactions on or with the first
periodic statement that reflects the transaction by furnishing the
following information, as applicable.\16\
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\16\ Failure to disclose the information required by this section
shall not be deemed a failure to comply with the regulation if: (1) The
creditor maintains procedures reasonably adapted to obtain and provide
the information; and (2) the creditor treats an inquiry for
clarification or documentation as a notice of a billing error, including
correcting the account in accordance with Sec. 226.13(e). This applies
to transactions that take place outside a state, as defined in
Sec. 226.2(a), whether or not the creditor maintains procedures
reasonably adapted to obtain the required information.
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(a) Sale credit. For each credit transaction involving the sale of
property or services, the following rules shall apply:
(1) Copy of credit document provided. When an actual copy of the
receipt or other credit document is provided with the first periodic
statement reflecting the transaction, the transaction is sufficiently
identified if the amount of the transaction and either the date of the
transaction or the date of debiting the transaction to the consumer's
account are disclosed on the copy or on the periodic statement.
(2) Copy of credit document not provided--creditor and seller same
or related person(s). When the creditor and the seller are the same
person or related persons, and an actual copy of the receipt or other
credit document is not provided with the periodic statement, the
creditor shall disclose the amount and date of the transaction, and a
brief identification \17\ of the property or services purchased.\18\
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\17\ As an alternative to the brief identification, the creditor may
disclose a number or symbol that also appears on the receipt or other
credit document given to the consumer, if the number or symbol
reasonably identifies that transaction with that creditor, and if the
creditor treats an inquiry for clarification or documentation as a
notice of a billing error, including correcting the account in
accordance with Sec. 226.13(e).
\18\ An identification of property or services may be replaced by
the seller's name and location of the transaction when: (1) The creditor
and the seller are the same person; (2) the creditor's open-end plan has
fewer than 15,000 accounts; (3) the creditor provides the consumer with
point-of-sale documentation for that transaction; and (4) the creditor
treats an inquiry for clarification or documentation as a notice of a
billing error, including correcting the account in accordance with
Sec. 226.13(e).
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(3) Copy of credit document not provided--creditor and seller not
same or related person(s). When the creditor and seller are not the same
person or related persons, and an actual copy of the receipt or other
credit document is not provided with the periodic statement, the
creditor shall disclose the amount and date of the transaction; the
seller's name; and the city, and state or foreign country where the
transaction took place.\19\
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\19\ The creditor may omit the address or provide any suitable
designation that helps the consumer to identify the transaction when the
transaction (1) took place at a location that is not fixed; (2) took
place in the consumer's home; or (3) was a mail or telephone order.
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(b) Nonsale credit. A nonsale credit transaction is sufficiently
identified if the first periodic statement reflecting the transaction
discloses a brief identification of the transaction;\20\ the amount of
the transaction; and at least one of the following dates: the date of
the transaction, the date of debiting the transaction to the consumer's
account, or, if the consumer signed the credit document, the date
appearing on the document. If an actual copy of the receipt or other
credit document is provided and that copy shows the amount and at least
one of the specified dates, the brief identification may be omitted.
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\20\ See Footnote 17.
[46 FR 20892, Apr. 7, 1981; 46 FR 29246, June 1, 1981]
Sec. 226.9 Subsequent disclosure requirements.
(a) Furnishing statement of billing rights--(1) Annual statement.
The creditor shall mail or deliver the billing rights statement required
by Sec. 226.6(d) at least once per calendar year, at intervals of not
less than 6 months nor more than 18 months, either to all consumers or
to each consumer entitled to receive a periodic statement under
Sec. 226.5(b)(2) for any one billing cycle.
[[Page 230]]
(2) Alternative summary statement. As an alternative to paragraph
(a)(1) of this section, the creditor may mail or deliver, on or with
each periodic statement, a statement substantially similar to that in
appendix G.
(b) Disclosures for supplemental credit devices and additional
features--(1) If a creditor, within 30 days after mailing or delivering
the initial disclosures under Sec. 226.6(a), adds a credit feature to
the consumer's account or mails or delivers to the consumer a credit
device for which the finance charge terms are the same as those
previously disclosed, no additional disclosures are necessary. After 30
days, if the creditor adds a credit feature or furnishes a credit device
(other than as a renewal, resupply, or the original issuance of a credit
card) on the same finance charge terms, the creditor shall disclose,
before the consumer uses the feature or device for the first time, that
it is for use in obtaining credit under the terms previously disclosed.
(2) Whenever a credit feature is added or a credit device is mailed
or delivered, and the finance charge terms for the feature or device
differ from disclosures previously given, the disclosures required by
Sec. 226.6(a) that are applicable to the added feature or device shall
be given before the consumer uses the feature or device for the first
time.
(c) Change in terms--(1) Written notice required. Whenever any term
required to be disclosed under Sec. 226.6 is changed or the required
minimum periodic payment is increased, the creditor shall mail or
deliver written notice of the change to each consumer who may be
affected. The notice shall be mailed or delivered at least 15 days prior
to the effective date of the change. The 15-day timing requirement does
not apply if the change has been agreed to by the consumer, or if a
periodic rate or other finance charge is increased because of the
consumer's delinquency or default; the notice shall be given, however,
before the effective date of the change.
(2) Notice not required. No notice under this section is required
when the change involves late payment charges, charges for documentary
evidence, or over-the-limit charges; a reduction of any component of a
finance or other charge; suspension of future credit privileges or
termination of an account or plan; or when the change results from an
agreement involving a court proceeding, or from the consumer's default
or delinquency (other than an increase in the periodic rate or other
finance charge).
(3) Notice for home equity plans. If a creditor prohibits additional
extensions of credit or reduces the credit limit applicable to a home
equity plan pursuant to Sec. 226.5b(f)(3)(i) or Sec. 226.5b(f)(3)(vi),
the creditor shall mail or deliver written notice of the action to each
consumer who will be affected. The notice must be provided not later
than three business days after the action is taken and shall contain
specific reasons for the action. If the creditor requires the consumer
to request reinstatement of credit privileges, the notice also shall
state that fact.
(d) Finance charge imposed at time of transaction. (1) Any person,
other than the card issuer, who imposes a finance charge at the time of
honoring a consumer's credit card, shall disclose the amount of that
finance charge prior to its imposition.
(2) The card issuer, if other than the person honoring the
consumer's credit card, shall have no responsibility for the disclosure
required by paragraph (d)(1) of this section, and shall not consider any
such charge for purposes of Secs. 226.5a, 226.6 and 226.7.
(e) Disclosures upon renewal of credit or charge card--(1) Notice
prior to renewal. Except as provided in paragraph (e)(2) of this
section, a card issuer that imposes any annual or other periodic fee to
renew a credit or charge card account of the type subject to
Sec. 226.5a, including any fee based on account activity or inactivity,
shall mail or deliver written notice of the renewal to the cardholder.
The notice shall be provided at least 30 days or one billing cycle,
whichever is less, before the mailing or the delivery of the periodic
statement on which the renewal fee is initially charged to the account.
The notice shall contain the following information:
(i) The disclosures contained in Sec. 226.5a(b) (1) through (7) that
would
[[Page 231]]
apply if the account were renewed;\20a\ and
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\20a\ These disclosures need not be provided in tabular format or in
a prominent location.
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(ii) How and when the cardholder may terminate credit availability
under the account to avoid paying the renewal fee.
(2) Delayed notice. The disclosures required by paragraph (e)(1) of
this section may be provided later than the time in paragraph (e)(1) of
this section, but no later than the mailing or the delivery of the
periodic statement on which the renewal fee is initially charged to the
account, if the card issuer also discloses at that time that:
(i) The cardholder has 30 days from the time the periodic statement
is mailed or delivered to avoid paying the fee or to have the fee
recredited if the cardholder terminates credit availability under the
account; and
(ii) The cardholder may use the card during the interim period
without having to pay the fee.
(3) Notification on periodic statements. The disclosures required by
this paragraph may be made on or with a periodic statement. If any of
the disclosures are provided on the back of a periodic statement, the
card issuer shall include a reference to those disclosures on the front
of the statement.
(f) Change in credit card account insurance provided--(1) Notice
prior to change. If a credit card issuer plans to change the provider of
insurance for repayment of all or part of the outstanding balance of an
open-end credit card account of the type subject to Sec. 226.5a, the
card issuer shall mail or deliver the cardholder written notice of the
change not less than 30 days before the change in providers occurs. The
notice shall also include the following items, to the extent applicable:
(i) Any increase in the rate that will result from the change;
(ii) Any substantial decrease in coverage that will result from the
change; and
(iii) A statement that the cardholder may discontinue the insurance.
(2) Notice when change in provider occurs. If a change described in
paragraph (f)(1) of this section occurs, the card issuer shall provide
the cardholder with a written notice no later than 30 days after the
change, including the following items, to the extent applicable:
(i) The name and address of the new insurance provider;
(ii) A copy of the new policy or group certificate containing the
basic terms of the insurance, including the rate to be charged; and
(iii) A statement that the cardholder may discontinue the insurance.
(3) Substantial decrease in coverage. For purposes of this
paragraph, a substantial decrease in coverage is a decrease in a
significant term of coverage that might reasonably be expected to affect
the cardholder's decision to continue the insurance. Significant terms
of coverage include, for example, the following:
(i) Type of coverage provided;
(ii) Age at which coverage terminates or becomes more restrictive;
(iii) Maximum insurable loan balance, maximum periodic benefit
payment, maximum number of payments, or other term affecting the dollar
amount of coverage or benefits provided;
(iv) Eligibility requirements and number and identity of persons
covered;
(v) Definition of a key term of coverage such as disability;
(vi) Exclusions from or limitations on coverage; and
(vii) Waiting periods and whether coverage is retroactive.
(4) Combined notification. The notices required by paragraph (f) (1)
and (2) of this section may be combined provided the timing requirement
of paragraph (f)(1) of this section is met. The notices may be provided
on or with a periodic statement.
[Reg. Z, 46 FR 20892, Apr. 7, 1981; 46 FR 29246, June 1, 1981, as
amended at 54 FR 13867, Apr. 6, 1989; 54 FR 24688, June 9, 1989; 54 FR
32954, Aug. 11, 1989; 55 FR 38312, Sept. 18, 1990; 55 FR 42148, Oct. 17,
1990]
Sec. 226.10 Prompt crediting of payments.
(a) General rule. A creditor shall credit a payment to the
consumer's account as of the date of receipt, except
[[Page 232]]
when a delay in crediting does not result in a finance or other charge
or except as provided in paragraph (b) of this section.
(b) Specific requirements for payments. If a creditor specifies, on
or with the periodic statement, requirements for the consumer to follow
in making payments, but accepts a payment that does not conform to the
requirements, the creditor shall credit the payment within 5 days of
receipt.
(c) Adjustment of account. If a creditor fails to credit a payment,
as required by paragraphs (a) and (b) of this section, in time to avoid
the imposition of finance or other charges, the creditor shall adjust
the consumer's account so that the charges imposed are credited to the
consumer's account during the next billing cycle.
Sec. 226.11 Treatment of credit balances.
When a credit balance in excess of $1 is created on a credit account
(through transmittal of funds to a creditor in excess of the total
balance due on an account, through rebates of unearned finance charges
or insurance premiums, or through amounts otherwise owed to or held for
the benefit of a consumer), the creditor shall:
(a) Credit the amount of the credit balance to the consumer's
account;
(b) Refund any part of the remaining credit balance within 7
business days from receipt of a written request from the consumer; and
(c) Make a good faith effort to refund to the consumer by cash,
check, or money order, or credit to a deposit account of the consumer,
any part of the credit balance remaining in the account for more than 6
months. No further action is required if the consumer's current location
is not known to the creditor and cannot be traced through the consumer's
last known address or telephone number.
Sec. 226.12 Special credit card provisions.
(a) Issuance of credit cards. Regardless of the purpose for which a
credit card is to be used, including business, commercial, or
agricultural use, no credit card shall be issued to any person except:
(1) In response to an oral or written request or application for the
card; or
(2) As a renewal of, or substitute for, an accepted credit card.\21\
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\21\ For purposes of this section, accepted credit card means any
credit card that a cardholder has requested or applied for and received,
or has signed, used, or authorized another person to use to obtain
credit. Any credit card issued as a renewal or substitute in accordance
with this paragraph becomes an accepted credit card when received by the
cardholder.
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(b) Liability of cardholder for unauthorized use--(1) Limitation on
amount. The liability of a cardholder for unauthorized use \22\ of a
credit card shall not exceed the lesser of $50 or the amount of money,
property, labor, or services obtained by the unauthorized use before
notification to the card issuer under paragraph (b)(3) of this section.
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\22\ Unauthorized use means the use of a credit card by a person,
other than the cardholder, who does not have actual, implied, or
apparent authority for such use, and from which the cardholder receives
no benefit.
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(2) Conditions of liability. A cardholder shall be liable for
unauthorized use of a credit card only if:
(i) The credit card is an accepted credit card;
(ii) The card issuer has provided adequate notice \23\ of the
cardholder's maximum potential liability and of means by which the card
issuer may be notified of loss or theft of the card. The notice shall
state that the cardholder's liability shall not exceed $50 (or any
lesser amount) and that the cardholder may give oral or written
notification, and shall describe a means of notification (for example, a
telephone number, an address, or both); and
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\23\ Adequate notice means a printed notice to a cardholder that
sets forth clearly the pertinent facts so that the cardholder may
reasonably be expected to have noticed it and understood its meaning.
The notice may be given by any means reasonably assuring receipt by the
cardholder.
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(iii) The card issuer has provided a means to identify the
cardholder on the account or the authorized user of the card.
(3) Notification to card issuer. Notification to a card issuer is
given when steps have been taken as may be reasonably required in the
ordinary course of business to provide the card issuer with the
pertinent information about the loss, theft, or possible unauthorized
[[Page 233]]
use of a credit card, regardless of whether any particular officer,
employee, or agent of the card issuer does, in fact, receive the
information. Notification may be given, at the option of the person
giving it, in person, by telephone, or in writing. Notification in
writing is considered given at the time of receipt or, whether or not
received, at the expiration of the time ordinarily required for
transmission, whichever is earlier.
(4) Effect of other applicable law or agreement. If state law or an
agreement between a cardholder and the card issuer imposes lesser
liability than that provided in this paragraph, the lesser liability
shall govern.
(5) Business use of credit cards. If 10 or more credit cards are
issued by one card issuer for use by the employees of an organization,
this section does not prohibit the card issuer and the organization from
agreeing to liability for unauthorized use without regard to this
section. However, liability for unauthorized use may be imposed on an
employee of the organization, by either the card issuer or the
organization, only in accordance with this section.
(c) Right of cardholder to assert claims or defenses against card
issuer \24\--(1) General rule. When a person who honors a credit card
fails to resolve satisfactorily a dispute as to property or services
purchased with the credit card in a consumer credit transaction, the
cardholder may assert against the card issuer all claims (other than
tort claims) and defenses arising out of the transaction and relating to
the failure to resolve the dispute. The cardholder may withhold payment
up to the amount of credit outstanding for the property or services that
gave rise to the dispute and any finance or other charges imposed on
that amount.\25\
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\24\ This paragraph does not apply to the use of a check guarantee
card or a debit card in connection with an overdraft credit plan, or to
a check guarantee card used in connection with cash advance checks.
\25\ The amount of the claim or defense that the cardholder may
assert shall not exceed the amount of credit outstanding for the
disputed transaction at the time the cardholder first notifies the card
issuer or the person honoring the credit card of the existence of the
claim or defense. To determine the amount of credit outstanding for
purposes of this section, payments and other credits shall be applied
to: (1) Late charges in the order of entry to the account; then to (2)
finance charges in the order of entry to the account; and then to (3)
any other debits in the order of entry to the account. If more than one
item is included in a single extension of credit, credits are to be
distributed pro rata according to prices and applicable taxes.
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(2) Adverse credit reports prohibited. If, in accordance with
paragraph (c)(1) of this section, the cardholder withholds payment of
the amount of credit outstanding for the disputed transaction, the card
issuer shall not report that amount as delinquent until the dispute is
settled or judgment is rendered.
(3) Limitations. The rights stated in paragraphs (c)(1) and (2) of
this section apply only if:
(i) The cardholder has made a good faith attempt to resolve the
dispute with the person honoring the credit card; and
(ii) The amount of credit extended to obtain the property or
services that result in the assertion of the claim or defense by the
cardholder exceeds $50, and the disputed transaction occurred in the
same state as the cardholder's current designated address or, if not
within the same state, within 100 miles from that address.\26\
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\26\ The limitations stated in paragraph (c)(3)(ii) of this section
shall not apply when the person honoring the credit card: (1) Is the
same person as the card issuer; (2) is controlled by the card issuer
directly or indirectly; (3) is under the direct or indirect control of a
third person that also directly or indirectly controls the card issuer;
(4) controls the card issuer directly or indirectly; (5) is a franchised
dealer in the card issuer's products or services; or (6) has obtained
the order for the disputed transaction through a mail solicitation made
or participated in by the card issuer.
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(d) Offsets by card issuer prohibited. (1) A card issuer may not
take any action, either before or after termination of credit card
privileges, to offset a cardholder's indebtedness arising from a
consumer credit transaction under the relevant credit card plan against
funds of the cardholder held on deposit with the card issuer.
(2) This paragraph does not alter or affect the right of a card
issuer acting under state or Federal law to do any of the following with
regard to funds of a
[[Page 234]]
cardholder held on deposit with the card issuer if the same procedure is
constitutionally available to creditors generally: obtain or enforce a
consensual security interest in the funds; attach or otherwise levy upon
the funds; or obtain or enforce a court order relating to the funds.
(3) This paragraph does not prohibit a plan, if authorized in
writing by the cardholder, under which the card issuer may periodically
deduct all or part of the cardholder's credit card debt from a deposit
account held with the card issuer (subject to the limitations in
Sec. 226.13(d)(1)).
(e) Prompt notification of returns and crediting of refunds. (1)
When a creditor other than the card issuer accepts the return of
property or forgives a debt for services that is to be reflected as a
credit to the consumer's credit card account, that creditor shall,
within 7 business days from accepting the return or forgiving the debt,
transmit a credit statement to the card issuer through the card issuer's
normal channels for credit statements.
(2) The card issuer shall, within 3 business days from receipt of a
credit statement, credit the consumer's account with the amount of the
refund.
(3) If a creditor other than a card issuer routinely gives cash
refunds to consumers paying in cash, the creditor shall also give credit
or cash refunds to consumers using credit cards, unless it discloses at
the time the transaction is consummated that credit or cash refunds for
returns are not given. This section does not require refunds for returns
nor does it prohibit refunds in kind.
(f) Discounts; tie-in arrangements. No card issuer may, by contract
or otherwise:
(1) Prohibit any person who honors a credit card from offering a
discount to a consumer to induce the consumer to pay by cash, check, or
similar means rather than by use of a credit card or its underlying
account for the purchase of property or services; or
(2) Require any person who honors the card issuer's credit card to
open or maintain any account or obtain any other service not essential
to the operation of the credit card plan from the card issuer or any
other person, as a condition of participation in a credit card plan. If
maintenance of an account for clearing purposes is determined to be
essential to the operation of the credit card plan, it may be required
only if no service charges or minimum balance requirements are imposed.
(g) Relation to Electronic Fund Transfer Act and Regulation E. For
guidance on whether Regulation Z (12 CFR part 226) or Regulation E (12
CFR part 205) applies in instances involving both credit and electronic
fund transfer aspects, refer to Regulation E, 12 CFR 205.12(a) regarding
issuance and liability for unauthorized use. On matters other than
issuance and liability, this section applies to the credit aspects of
combined credit/electronic fund transfer transactions, as applicable.
[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 65 FR 17131, Mar. 31,
2000]
Sec. 226.13 Billing error resolution.\27\
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\27\ A creditor shall not accelerate any part of the consumer's
indebtedness or restrict or close a consumer's account solely because
the consumer has exercised in good faith rights provided by this
section. A creditor may be subject to the forfeiture penalty under
section 161(e) of the Act for failure to comply with any of the
requirements of this section.
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(a) Definition of billing error. For purposes of this section, the
term billing error means:
(1) A reflection on or with a periodic statement of an extension of
credit that is not made to the consumer or to a person who has actual,
implied, or apparent authority to use the consumer's credit card or
open-end credit plan.
(2) A reflection on or with a periodic statement of an extension of
credit that is not identified in accordance with the requirements of
Secs. 226.7(b) and 226.8.
(3) A reflection on or with a periodic statement of an extension of
credit for property or services not accepted by the consumer or the
consumer's designee, or not delivered to the consumer or the consumer's
designee as agreed.
(4) A reflection on a periodic statement of the creditor's failure
to credit properly a payment or other credit issued to the consumer's
account.
[[Page 235]]
(5) A reflection on a periodic statement of a computational or
similar error of an accounting nature that is made by the creditor.
(6) A reflection on a periodic statement of an extension of credit
for which the consumer requests additional clarification, including
documentary evidence.
(7) The creditor's failure to mail or deliver a periodic statement
to the consumer's last known address if that address was received by the
creditor, in writing, at least 20 days before the end of the billing
cycle for which the statement was required.
(b) Billing error notice.\28\ A billing error notice is a written
notice \29\ from a consumer that:
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\28\ The creditor need not comply with the requirements of
paragraphs (c) through (g) of this section if the consumer concludes
that no billing error occurred and voluntarily withdraws the billing
error notice.
\29\ The creditor may require that the written notice not be made on
the payment medium or other material accompanying the periodic statement
if the creditor so stipulates in the billing rights statement required
by Secs. 226.6(d) and 226.9(a).
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(1) Is received by a creditor at the address disclosed under
Sec. 226.7(k) no later than 60 days after the creditor transmitted the
first periodic statement that reflects the alleged billing error;
(2) Enables the creditor to identify the consumer's name and account
number; and
(3) To the extent possible, indicates the consumer's belief and the
reasons for the belief that a billing error exists, and the type, date,
and amount of the error.
(c) Time for resolution; general procedures. (1) The creditor shall
mail or deliver written acknowledgment to the consumer within 30 days of
receiving a billing error notice, unless the creditor has complied with
the appropriate resolution procedures of paragraphs (e) and (f) of this
section, as applicable, within the 30-day period; and
(2) The creditor shall comply with the appropriate resolution
procedures of paragraphs (e) and (f) of this section, as applicable,
within 2 complete billing cycles (but in no event later than 90 days)
after receiving a billing error notice.
(d) Rules pending resolution. Until a billing error is resolved
under paragraph (e) or (f) of this section, the following rules apply:
(1) Consumer's right to withhold disputed amount; collection action
prohibited. The consumer need not pay (and the creditor may not try to
collect) any portion of any required payment that the consumer believes
is related to the disputed amount (including related finance or other
charges).\30\ If the cardholder maintains a deposit account with the
card issuer and has agreed to pay the credit card indebtedness by
periodic deductions from the cardholder's deposit account, the card
issuer shall not deduct any part of the disputed amount or related
finance or other charges if a billing error notice is received any time
up to 3 business days before the scheduled payment date.
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\30\ A creditor is not prohibited from taking action to collect any
undisputed portion of the item or bill; from deducting any disputed
amount and related finance or other charges from the consumer's credit
limit on the account; or from reflecting a disputed amount and related
finance or other charges on a periodic statement, provided that the
creditor indicates on or with the periodic statement that payment of any
disputed amount and related finance or other charges is not required
pending the creditor's compliance with this section.
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(2) Adverse credit reports prohibited. The creditor or its agent
shall not (directly or indirectly) make or threaten to make an adverse
report to any person about the consumer's credit standing, or report
that an amount or account is delinquent, because the consumer failed to
pay the disputed amount or related finance or other charges.
(e) Procedures if billing error occurred as asserted. If a creditor
determines that a billing error occurred as asserted, it shall within
the time limits in paragraph (c)(2) of this section:
(1) Correct the billing error and credit the consumer's account with
any disputed amount and related finance or other charges, as applicable;
and
(2) Mail or deliver a correction notice to the consumer.
[[Page 236]]
(f) Procedures if different billing error or no billing error
occurred. If, after conducting a reasonable investigation,\31\ a
creditor determines that no billing error occurred or that a different
billing error occurred from that asserted, the creditor shall within the
time limits in paragraph (c)(2) of this section:
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\31\ If a consumer submits a billing error notice alleging either
the nondelivery of property or services under paragraph (a)(3) of this
section or that information appearing on a periodic statement is
incorrect because a person honoring the consumer's credit card has made
an incorrect report to the card issuer, the creditor shall not deny the
assertion unless it conducts a reasonable investigation and determines
that the property or services were actually delivered, mailed, or sent
as agreed or that the information was correct.
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(1) Mail or deliver to the consumer an explanation that sets forth
the reasons for the creditor's belief that the billing error alleged by
the consumer is incorrect in whole or in part;
(2) Furnish copies of documentary evidence of the consumer's
indebtedness, if the consumer so requests; and
(3) If a different billing error occurred, correct the billing error
and credit the consumer's account with any disputed amount and related
finance or other charges, as applicable.
(g) Creditor's rights and duties after resolution. If a creditor,
after complying with all of the requirements of this section, determines
that a consumer owes all or part of the disputed amount and related
finance or other charges, the creditor:
(1) Shall promptly notify the consumer in writing of the time when
payment is due and the portion of the disputed amount and related
finance or other charges that the consumer still owes;
(2) Shall allow any time period disclosed under Secs. 226.6(a)(1)
and 226.7(j), during which the consumer can pay the amount due under
paragraph (g)(1) of this section without incurring additional finance or
other charges;
(3) May report an account or amount as delinquent because the amount
due under paragraph (g)(1) of this section remains unpaid after the
creditor has allowed any time period disclosed under Secs. 226.6(a)(1)
and 266.7(j) or 10 days (whichever is longer) during which the consumer
can pay the amount; but
(4) May not report that an amount or account is delinquent because
the amount due under paragraph (g)(1) of the section remains unpaid, if
the creditor receives (within the time allowed for payment in paragraph
(g)(3) of this section) further written notice from the consumer that
any portion of the billing error is still in dispute, unless the
creditor also:
(i) Promptly reports that the amount or account is in dispute;
(ii) Mails or delivers to the consumer (at the same time the report
is made) a written notice of the name and address of each person to whom
the creditor makes a report; and
(iii) Promptly reports any subsequent resolution of the reported
delinquency to all persons to whom the creditor has made a report.
(h) Reassertion of billing error. A creditor that has fully complied
with the requirements of this section has no further responsibilities
under this section (other than as provided in paragraph (g)(4) of this
section) if a consumer reasserts substantially the same billing error.
(i) Relation to Electronic Fund Transfer Act and Regulation E. If an
extension of credit is incident to an electronic fund transfer, under an
agreement between a consumer and a financial institution to extend
credit when the consumer's account is overdrawn or to maintain a
specified minimum balance in the consumer's account, the creditor shall
comply with the requirements of Regulation E, 12 CFR 205.11 governing
error resolution rather than those of paragraphs (a), (b), (c), (e),
(f), and (h) of this section.
Sec. 226.14 Determination of annual percentage rate.
(a) General rule. The annual percentage rate is a measure of the
cost of credit, expressed as a yearly rate. An annual percentage rate
shall be considered accurate if it is not more than \1/8\ of 1
percentage point above or below the annual percentage rate determined in
accordance with this section.\31a\
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\31a\ An error in disclosure of the annual percentage rate or
finance charge shall not, in itself, be considered a violation of this
regulation if: (1) The error resulted from a corresponding error in a
calculation tool used in good faith by the creditor; and (2) upon
discovery of the error, the creditor promptly discontinues use of that
calculation tool for disclosure purposes, and notifies the Board in
writing of the error in the calculation tool.
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[[Page 237]]
(b) Annual percentage rate for Secs. 226.5a and 226.5b disclosures,
for initial disclosures and for advertising purposes. Where one or more
periodic rates may be used to compute the finance charge, the annual
percentage rate(s) to be disclosed for purposes of Secs. 226.5a, 226.5b,
226.6, and 226.16 shall be computed by multiplying each periodic rate by
the number of periods in a year.
(c) Annual percentage rate for periodic statements. The annual
percentage rate(s) to be disclosed for purposes of Sec. 226.7(d) shall
be computed by multiplying each periodic rate by the number of periods
in a year and, for purposes of Sec. 226.7(g), shall be determined as
follows:
(1) If the finance charge is determined solely by applying one or
more periodic rates, at the creditor's option, either:
(i) By multiplying each periodic rate by the number of periods in a
year; or
(ii) By dividing the total finance charge for the billing cycle by
the sum of the balances to which the periodic rates were applied and
multiplying the quotient (expressed as a percentage) by the number of
billing cycles in a year.
(2) If the finance charge imposed during the billing cycle is or
includes a minimum, fixed, or other charge not due to the application of
a periodic rate, other than a charge with respect to any specific
transaction during the billing cycle, by dividing the total finance
charge for the billing cycle by the amount of the balance(s) to which it
is applicable \32\ and multiplying the quotient (expressed as a
percentage) by the number of billing cycles in a year.\33\
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\32\ If there is no balance to which the finance charge is
applicable, an annual percentage rate cannot be determined under this
section.
\33\ Where the finance charge imposed during the billing cycle is or
includes a loan fee, points, or similar charge that relates to the
opening of the account, the amount of such charge shall not be included
in the calculation of the annual percentage rate.
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(3) If the finance charge imposed during the billing cycle is or
includes a charge relating to a specific transaction during the billing
cycle (even if the total finance charge also includes any other minimum,
fixed, or other charge not due to the application of a periodic rate),
by dividing the total finance charge imposed during the billing cycle by
the total of all balances and other amounts on which a finance charge
was imposed during the billing cycle without duplication, and
multiplying the quotient (expressed as a percentage) by the number of
billing cycles in a year,\34\ except that the annual percentage rate
shall not be less than the largest rate determined by multiplying each
periodic rate imposed during the billing cycle by the number of periods
in a year.\35\
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\34\ See appendix F regarding determination of the denominator of
the fraction under this paragraph.
\35\ See footnote 33.
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(4) If the finance charge imposed during the billing cycle is or
includes a minimum, fixed, or other charge not due to the application of
a periodic rate and the total finance charge imposed during the billing
cycle does not exceed 50 cents for a monthly or longer billing cycle, or
the pro rata part of 50 cents for a billing cycle shorter than monthly,
at the creditor's option, by multiplying each applicable periodic rate
by the number of periods in a year, notwithstanding the provisions of
paragraphs (c)(2) and (3) of this section.
(d) Calculations where daily periodic rate applied. If the
provisions of paragraph (c)(1)(ii) or (2) of this section apply and all
or a portion of the finance charge is determined by the application of
one or more daily periodic rates, the annual percentage rate may be
determined either:
(1) By dividing the total finance charge by the average of the daily
balances and multiplying the quotient by the number of billing cycles in
a year; or
[[Page 238]]
(2) By dividing the total finance charge by the sum of the daily
balances and multiplying the quotient by 365.
[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 47 FR 756, Jan. 7,
1982; 48 FR 14886, Apr. 6, 1983; 54 FR 24688, June 9, 1989]
Sec. 226.15 Right of rescission.
(a) Consumer's right to rescind. (1)(i) Except as provided in
paragraph (a)(1)(ii) of this section, in a credit plan in which a
security interest is or will be retained or acquired in a consumer's
principal dwelling, each consumer whose ownership interest is or will be
subject to the security interest shall have the right to rescind: each
credit extension made under the plan; the plan when the plan is opened;
a security interest when added or increased to secure an existing plan;
and the increase when a credit limit on the plan is increased.
(ii) As provided in section 125(e) of the Act, the consumer does not
have the right to rescind each credit extension made under the plan if
such extension is made in accordance with a previously established
credit limit for the plan.
(2) To exercise the right to rescind, the consumer shall notify the
creditor of the rescission by mail, telegram, or other means of written
communication. Notice is considered given when mailed, or when filed for
telegraphic transmission, or, if sent by other means, when delivered to
the creditor's designated place of business.
(3) The consumer may exercise the right to rescind until midnight of
the third business day following the occurrence described in paragraph
(a)(1) of this section that gave rise to the right of rescission,
delivery of the notice required by paragraph (b) of this section, or
delivery of all material disclosures,\36\ whichever occurs last. If the
required notice and material disclosures are not delivered, the right to
rescind shall expire 3 years after the occurrence giving rise to the
right of rescission, or upon transfer of all of the consumer's interest
in the property, or upon sale of the property, whichever occurs first.
In the case of certain administrative proceedings, the rescission period
shall be extended in accordance with section 125(f) of the Act.
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\36\ The term material disclosures means the information that must
be provided to satisfy the requirements in Sec. 226.6 with regard to the
method of determining the finance charge and the balance upon which a
finance charge will be imposed, the annual percentage rate, the amount
or method of determining the amount of any membership or participation
fee that may be imposed as part of the plan, and the payment information
described in Sec. 226.5b(d)(5)(i) and (ii) that is required under
Sec. 226.6(e)(2).
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(4) When more than one consumer has the right to rescind, the
exercise of the right by one consumer shall be effective as to all
consumers.
(b) Notice of right to rescind. In any transaction or occurrence
subject to rescission, a creditor shall deliver 2 copies of the notice
of the right to rescind to each consumer entitled to rescind. The notice
shall identify the transaction or occurrence and clearly and
conspicuously disclose the following:
(1) The retention or acquisition of a security interest in the
consumer's principal dwelling.
(2) The consumer's right to rescind, as described in paragraph
(a)(1) of this section.
(3) How to exercise the right to rescind, with a form for that
purpose, designating the address of the creditor's place of business.
(4) The effects of rescission, as described in paragraph (d) of this
section.
(5) The date the rescission period expires.
(c) Delay of creditor's performance. Unless a consumer waives the
right to rescind under paragraph (e) of this section, no money shall be
disbursed other than in escrow, no services shall be performed, and no
materials delivered until after the rescission period has expired and
the creditor is reasonably satisfied that the consumer has not
rescinded. A creditor does not violate this section if a third party
with no knowledge of the event activating the rescission right does not
delay in providing materials or services, as long as the debt incurred
for those materials or services is not secured by the property subject
to rescission.
[[Page 239]]
(d) Effects of rescission. (1) When a consumer rescinds a
transaction, the security interest giving rise to the right of
rescission becomes void, and the consumer shall not be liable for any
amount, including any finance charge.
(2) Within 20 calendar days after receipt of a notice of rescission,
the creditor shall return any money or property that has been given to
anyone in connection with the transaction and shall take any action
necessary to reflect the termination of the security interest.
(3) If the creditor has delivered any money or property, the
consumer may retain possession until the creditor has met its obligation
under paragraph (d)(2) of this section. When the creditor has complied
with that paragraph, the consumer shall tender the money or property to
the creditor or, where the latter would be impracticable or inequitable,
tender its reasonable value. At the consumer's option, tender of
property may be made at the location of the property or at the
consumer's residence. Tender of money must be made at the creditor's
designated place of business. If the creditor does not take possession
of the money or property within 20 calendar days after the consumer's
tender, the consumer may keep it without further obligation.
(4) The procedures outlined in paragraphs (d)(2) and (3) of this
section may be modified by court order.
(e) Consumer's waiver of right to rescind. (1) The consumer may
modify or waive the right to rescind if the consumer determines that the
extension of credit is needed to meet a bona fide personal financial
emergency. To modify or waive the right, the consumer shall give the
creditor a dated written statement that describes the emergency,
specifically modifies or waives the right to rescind, and bears the
signature of all the consumers entitled to rescind. Printed forms for
this purpose are prohibited, except as provided in paragraph (e)(2) of
this section.
(2) The need of the consumer to obtain funds immediately shall be
regarded as a bona fide personal financial emergency provided that the
dwelling securing the extension of credit is located in an area declared
during June through September 1993, pursuant to 42 U.S.C. 5170, to be a
major disaster area because of severe storms and flooding in the
Midwest.\36a\ In this instance, creditors may use printed forms for the
consumer to waive the right to rescind. This exemption to paragraph
(e)(1) of this section shall expire one year from the date an area was
declared a major disaster.
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\36a\ A list of the affected areas will be maintained by the Board.
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(3) The consumer's need to obtain funds immediately shall be
regarded as a bona fide personal financial emergency provided that the
dwelling securing the extension of credit is located in an area declared
during June through September 1994 to be a major disaster area, pursuant
to 42 U.S.C. 5170, because of severe storms and flooding in the
South.\36b\ In this instance, creditors may use printed forms for the
consumer to waive the right to rescind. This exemption to paragraph
(e)(1) of this section shall expire one year from the date an area was
declared a major disaster.
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\36b\ A list of the affected areas will be maintained and published
by the Board. Such areas now include parts of Alabama, Florida, and
Georgia.
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(4) The consumer's need to obtain funds immediately shall be
regarded as a bona fide personal financial emergency provided that the
dwelling securing the extension of credit is located in an area declared
during October 1994 to be a major disaster area, pursuant to 42 U.S.C.
5170, because of severe storms and flooding in Texas.\36c\ In this
instance, creditors may use printed forms for the consumer to waive the
right to rescind. This exemption to paragraph (e)(1) of this section
shall expire one year from the date an area was declared a major
disaster.
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\36c\ A list of the affected areas will be maintained and published
by the Board. Such areas now include the following counties in Texas:
Angelina, Austin, Bastrop, Brazos, Brazoria, Burleson, Chambers,
Fayette, Fort Bend, Galveston, Grimes, Hardin, Harris, Houston, Jackson,
Jasper, Jefferson, Lee, Liberty, Madison, Matagorda, Montgomery,
Nacagdoches, Orange, Polk, San Augustine, San Jacinto, Shelby, Trinity,
Victoria, Washington, Waller, Walker, and Wharton.
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(f) Exempt transactions. The right to rescind does not apply to the
following:
[[Page 240]]
(1) A residential mortgage transaction.
(2) A credit plan in which a state agency is a creditor.
[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 54 FR 24688, June 9,
1989; 58 FR 40583, July 29, 1993; 59 FR 40204, Aug. 5, 1994; 59 FR
63715, Dec. 9, 1994]
Sec. 226.16 Advertising.
(a) Actually available terms. If an advertisement for credit states
specific credit terms, it shall state only those terms that actually are
or will be arranged or offered by the creditor.
(b) Advertisement of terms that require additional disclosures. If
any of the terms required to be disclosed under Sec. 226.6 is set forth
in an advertisement, the advertisement shall also clearly and
conspicuously set forth the following:\36d\
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\36d\ The disclosures given in accordance with Sec. 226.5a do not
constitute advertising terms for purposes of the requirements of this
section.
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(1) Any minimum, fixed, transaction, activity or similar charge that
could be imposed.
(2) Any periodic rate that may be applied expressed as an annual
percentage rate as determined under Sec. 226.14(b). If the plan provides
for a variable periodic rate, that fact shall be disclosed.
(3) Any membership or participation fee that could be imposed.
(c) Catalogs and multiple-page advertisements. (1) If a catalog or
other multiple-page advertisement gives information in a table or
schedule in sufficient detail to permit determination of the disclosures
required by paragraph (b) of this section, it shall be considered a
single advertisement if:
(i) The table or schedule is clearly and conspicuously set forth;
and
(ii) Any statement of terms set forth in Sec. 226.6 appearing
anywhere else in the catalog or advertisement clearly refers to that
page on which the table or schedule begins.
(2) A catalog or multiple-page advertisement complies with this
paragraph if the table or schedule of terms includes all appropriate
disclosures for a representative scale of amounts up to the level of the
more commonly sold higher-priced property or services offered.
(d) Additional requirements for home equity plans--(1) Advertisement
of terms that require additional disclosures. If any of the terms
required to be disclosed under Sec. 226.6(a) or (b) or the payment terms
of the plan are set forth, affirmatively or negatively, in an
advertisement for a home equity plan subject to the requirements of
Sec. 226.5b, the advertisement also shall clearly and conspicuously set
forth the following:
(i) Any loan fee that is a percentage of the credit limit under the
plan and an estimate of any other fees imposed for opening the plan,
stated as a single dollar amount or a reasonable range.
(ii) Any periodic rate used to compute the finance charge, expressed
as an annual percentage rate as determined under section Sec. 226.14(b).
(iii) The maximum annual percentage rate that may be imposed in a
variable-rate plan.
(2) Discounted and premium rates. If an advertisement states an
initial annual percentage rate that is not based on the index and margin
used to make later rate adjustments in a variable-rate plan, the
advertisement also shall state the period of time such rate will be in
effect, and, with equal prominence to the initial rate, a reasonably
current annual percentage rate that would have been in effect using the
index and margin.
(3) Balloon payment. If an advertisement contains a statement about
any minimum periodic payment, the advertisement also shall state, if
applicable, that a balloon payment may result.\36e\
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\36e\ See footnote 10b.
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(4) Tax implications. An advertisement that states that any interest
expense incurred under the home equity plan is or may be tax deductible
may not be misleading in this regard.
(5) Misleading terms. An advertisement may not refer to a home
equity plan as ``free money'' or contain a similarly misleading term.
[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 54 FR 13867, Apr. 6,
1989; 54 FR 24688, June 9, 1989; 54 FR 28665, July 7, 1989; 58 FR 40583,
July 29, 1993; 59 FR 40204, Aug. 5, 1994; 59 FR 63715, Dec. 9, 1994]
[[Page 241]]
Subpart C--Closed-End Credit
Sec. 226.17 General disclosure requirements.
(a) Form of disclosures. (1) The creditor shall make the disclosures
required by this subpart clearly and conspicuously in writing, in a form
that the consumer may keep. The disclosures shall be grouped together,
shall be segregated from everything else, and shall not contain any
information not directly related \37\ to the disclosures required under
Sec. 226.18.\38\ The itemization of the amount financed under
Sec. 226.18(c)(1) must be separate from the other disclosures under that
section.
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\37\ The disclosures may include an acknowledgment of receipt, the
date of the transaction, and the consumer's name, address, and account
number.
\38\ The following disclosures may be made together with or
separately from other required disclosures: the creditor's identity
under Sec. 226.18(a), the variable rate example under Sec. 226.18(f)(4),
insurance or debt cancellation under Sec. 226.18(n), and certain
security interest charges under Sec. 226.18(o).
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(2) The terms finance charge and annual percentage rate, when
required to be disclosed under Sec. 226.18 (d) and (e) together with a
corresponding amount or percentage rate, shall be more conspicuous than
any other disclosure, except the creditor's identity under
Sec. 226.18(a).
(b) Time of disclosures. The creditor shall make disclosures before
consummation of the transaction. In certain residential mortgage
transactions, special timing requirements are set forth in
Sec. 226.19(a). In certain variable-rate transactions, special timing
requirements for variable-rate disclosures are set forth in
Sec. 226.19(b) and Sec. 226.20(c). In certain transactions involving
mail or telephone orders or a series of sales, the timing of disclosures
may be delayed in accordance with paragraphs (g) and (h) of this
section.
(c) Basis of disclosures and use of estimates. (1) The disclosures
shall reflect the terms of the legal obligation between the parties.
(2)(i) If any information necessary for an accurate disclosure is
unknown to the creditor, the creditor shall make the disclosure based on
the best information reasonably available at the time the disclosure is
provided to the consumer, and shall state clearly that the disclosure is
an estimate.
(ii) For a transaction in which a portion of the interest is
determined on a per-diem basis and collected at consummation, any
disclosure affected by the per-diem interest shall be considered
accurate if the disclosure is based on the information known to the
creditor at the time that the disclosure documents are prepared for
consummation of the transaction.
(3) The creditor may disregard the effects of the following in
making calculations and disclosures.
(i) That payments must be collected in whole cents.
(ii) That dates of scheduled payments and advances may be changed
because the scheduled date is not a business day.
(iii) That months have different numbers of days.
(iv) The occurrence of leap year.
(4) In making calculations and disclosures, the creditor may
disregard any irregularity in the first period that falls within the
limits described below and any payment schedule irregularity that
results from the irregular first period:
(i) For transactions in which the term is less than 1 year, a first
period not more than 6 days shorter or 13 days longer than a regular
period;
(ii) For transactions in which the term is at least 1 year and less
than 10 years, a first period not more than 11 days shorter or 21 days
longer than a regular period; and
(iii) For transactions in which the term is at least 10 years, a
first period shorter than or not more than 32 days longer than a regular
period.
(5) If an obligation is payable on demand, the creditor shall make
the disclosures based on an assumed maturity of 1 year. If an alternate
maturity date is stated in the legal obligation between the parties, the
disclosures shall be based on that date.
(6)(i) A series of advances under an agreement to extend credit up
to a certain amount may be considered as one transaction.
(ii) When a multiple-advance loan to finance the construction of a
dwelling
[[Page 242]]
may be permanently financed by the same creditor, the construction phase
and the permanent phase may be treated as either one transaction or more
than one transaction.
(d) Multiple creditors; multiple consumers. If a transaction
involves more than one creditor, only one set of disclosures shall be
given and the creditors shall agree among themselves which creditor must
comply with the requirements that this regulation imposes on any or all
of them. If there is more than one consumer, the disclosures may be made
to any consumer who is primarily liable on the obligation. If the
transaction is rescindable under Sec. 226.23, however, the disclosures
shall be made to each consumer who has the right to rescind.
(e) Effect of subsequent events. If a disclosure becomes inaccurate
because of an event that occurs after the creditor delivers the required
disclosures, the inaccuracy is not a violation of this regulation,
although new disclosures may be required under paragraph (f) of this
section, Sec. 226.19, or Sec. 226.20.
(f) Early disclosures. If disclosures required by this subpart are
given before the date of consummation of a transaction and a subsequent
event makes them inaccurate, the creditor shall disclose before
consummation:\39\
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\39\ For certain residential mortgage transactions,
Sec. 226.19(a)(2) permits redisclosure no later than consummation or
settlement, whichever is later.
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(1) Any changed term unless the term was based on an estimate in
accordance with Sec. 226.17(c)(2) and was labelled an estimate;
(2) All changed terms, if the annual percentage rate at the time of
consummation varies from the annual percentage rate disclosed earlier by
more than \1/8\ of 1 percentage point in a regular transaction, or more
than \1/4\ of 1 percentage point in an irregular transaction, as defined
in Sec. 226.22(a).
(g) Mail or telephone orders--delay in disclosures. If a creditor
receives a purchase order or a request for an extension of credit by
mail, telephone, or any other written or electronic communication
without face-to-face or direct telephone solicitation, the creditor may
delay the disclosures until the due date of the first payment, if the
following information for representative amounts or ranges of credit is
made available in written form to the consumer or to the public before
the actual purchase order or request:
(1) The cash price or the principal loan amount.
(2) The total sale price.
(3) The finance charge.
(4) The annual percentage rate, and if the rate may increase after
consummation, the following disclosures:
(i) The circumstances under which the rate may increase.
(ii) Any limitations on the increase.
(iii) The effect of an increase.
(5) The terms of repayment.
(h) Series of sales--delay in disclosures. If a credit sale is one
of a series made under an agreement providing that subsequent sales may
be added to an outstanding balance, the creditor may delay the required
disclosures until the due date of the first payment for the current
sale, if the following two conditions are met:
(1) The consumer has approved in writing the annual percentage rate
or rates, the range of balances to which they apply, and the method of
treating any unearned finance charge on an existing balance.
(2) The creditor retains no security interest in any property after
the creditor has received payments equal to the cash price and any
finance charge attributable to the sale of that property. For purposes
of this provision, in the case of items purchased on different dates,
the first purchased is deemed the first item paid for; in the case of
items purchased on the same date, the lowest priced is deemed the first
item paid for.
(i) Interim student credit extensions. For each transaction
involving an interim credit extension under a student credit program,
the creditor need not make the following disclosures: the finance charge
under Sec. 226.18(d), the payment schedule under Sec. 226.18(g), the
total of payments under Sec. 226.18(h), or the total sale price under
Sec. 226.18(j).
[46 FR 20892, Apr. 7, 1981, as amended at 52 FR 48670, Dec. 24, 1987; 61
FR 49246, Sept. 19, 1996]
[[Page 243]]
Sec. 226.18 Content of disclosures.
For each transaction, the creditor shall disclose the following
information as applicable:
(a) Creditor. The identity of the creditor making the disclosures.
(b) Amount financed. The amount financed, using that term, and a
brief description such as the amount of credit provided to you or on
your behalf. The amount financed is calculated by:
(1) Determining the principal loan amount or the cash price
(subtracting any downpayment);
(2) Adding any other amounts that are financed by the creditor and
are not part of the finance charge; and
(3) Subtracting any prepaid finance charge.
(c) Itemization of amount financed. (1) A separate written
itemization of the amount financed, including:\40\
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\40\ Good faith estimates of settlement costs provided for
transactions subject to the Real Estate Settlement Procedures Act (12
U.S.C. 2601 et seq.) may be substituted for the disclosures required by
paragraph (c) of this section.
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(i) The amount of any proceeds distributed directly to the consumer.
(ii) The amount credited to the consumer's account with the
creditor.
(iii) Any amounts paid to other persons by the creditor on the
consumer's behalf. The creditor shall identify those persons.\41\
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\41\ The following payees may be described using generic or other
general terms and need not be further identified: public officials or
government agencies, credit reporting agencies, appraisers, and
insurance companies.
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(iv) The prepaid finance charge.
(2) The creditor need not comply with paragraph (c)(1) of this
section if the creditor provides a statement that the consumer has the
right to receive a written itemization of the amount financed, together
with a space for the consumer to indicate whether it is desired, and the
consumer does not request it.
(d) Finance charge. The finance charge, using that term, and a brief
description such as ``the dollar amount the credit will cost you.''
(1) Mortgage loans. In a transaction secured by real property or a
dwelling, the disclosed finance charge and other disclosures affected by
the disclosed finance charge (including the amount financed and the
annual percentage rate) shall be treated as accurate if the amount
disclosed as the finance charge:
(i) Is understated by no more than $100; or
(ii) Is greater than the amount required to be disclosed.
(2) Other credit. In any other transaction, the amount disclosed as
the finance charge shall be treated as accurate if, in a transaction
involving an amount financed of $1,000 or less, it is not more than $5
above or below the amount required to be disclosed; or, in a transaction
involving an amount financed of more than $1,000, it is not more than
$10 above or below the amount required to be disclosed.
(e) Annual percentage rate. The annual percentage rate, using that
term, and a brief description such as ``the cost of your credit as a
yearly rate.'' \42\
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\42\ For any transaction involving a finance charge of $5 or less on
an amount financed of $75 or less, or a finance charge of $7.50 or less
on an amount financed of more than $75, the creditor need not disclose
the annual percentage rate.
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(f) Variable rate. (1) If the annual percentage rate may increase
after consummation in a transaction not secured by the consumer's
principal dwelling or in a transaction secured by the consumer's
principal dwelling with a term of one year or less, the following
disclosures:\43\
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\43\ Information provided in accordance with Secs. 226.18(f)(2) and
226.19(b) may be substituted for the disclosures required by paragraph
(f)(1) of this section.
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(i) The circumstances under which the rate may increase.
(ii) Any limitations on the increase.
(iii) The effect of an increase.
(iv) An example of the payment terms that would result from an
increase.
(2) If the annual percentage rate may increase after consummation in
a transaction secured by the consumer's principal dwelling with a term
greater than one year, the following disclosures:
(i) The fact that the transaction contains a variable-rate feature.
[[Page 244]]
(ii) A statement that variable-rate disclosures have been provided
earlier.
(g) Payment schedule. The number, amounts, and timing of payments
scheduled to repay the obligation.
(1) In a demand obligation with no alternate maturity date, the
creditor may comply with this paragraph by disclosing the due dates or
payment periods of any scheduled interest payments for the first year.
(2) In a transaction in which a series of payments varies because a
finance charge is applied to the unpaid principal balance, the creditor
may comply with this paragraph by disclosing the following information:
(i) The dollar amounts of the largest and smallest payments in the
series.
(ii) A reference to the variations in the other payments in the
series.
(h) Total of payments. The total of payments, using that term, and a
descriptive explanation such as ``the amount you will have paid when you
have made all scheduled payments.'' \44\
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\44\ In any transaction involving a single payment, the creditor
need not disclose the total of payments.
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(i) Demand feature. If the obligation has a demand feature, that
fact shall be disclosed. When the disclosures are based on an assumed
maturity of 1 year as provided in Sec. 226.17(c)(5), that fact shall
also be disclosed.
(j) Total sale price. In a credit sale, the total sale price, using
that term, and a descriptive explanation (including the amount of any
downpayment) such as ``the total price of your purchase on credit,
including your downpayment of $____.'' The total sale price is the sum
of the cash price, the items described in paragraph (b)(2), and the
finance charge disclosed under paragraph (d) of this section.
(k) Prepayment. (1) When an obligation includes a finance charge
computed from time to time by application of a rate to the unpaid
principal balance, a statement indicating whether or not a penalty may
be imposed if the obligation is prepaid in full.
(2) When an obligation includes a finance charge other than the
finance charge described in paragraph (k)(1) of this section, a
statement indicating whether or not the consumer is entitled to a rebate
of any finance charge if the obligation is prepaid in full.
(l) Late payment. Any dollar or percentage charge that may be
imposed before maturity due to a late payment, other than a deferral or
extension charge.
(m) Security interest. The fact that the creditor has or will
acquire a security interest in the property purchased as part of the
transaction, or in other property identified by item or type.
(n) Insurance and debt cancellation. The items required by
Sec. 226.4(d) in order to exclude certain insurance premiums and debt
cancellation fees from the finance charge.
(o) Certain security interest charges. The disclosures required by
Sec. 226.4(e) in order to exclude from the finance charge certain fees
prescribed by law or certain premiums for insurance in lieu of
perfecting a security interest.
(p) Contract reference. A statement that the consumer should refer
to the appropriate contract document for information about nonpayment,
default, the right to accelerate the maturity of the obligation, and
prepayment rebates and penalties. At the creditor's option, the
statement may also include a reference to the contract for further
information about security interests and, in a residential mortgage
transaction, about the creditor's policy regarding assumption of the
obligation.
(q) Assumption policy. In a residential mortgage transaction, a
statement whether or not a subsequent purchaser of the dwelling from the
consumer may be permitted to assume the remaining obligation on its
original terms.
(r) Required deposit. If the creditor requires the consumer to
maintain a deposit as a condition of the specific transaction, a
statement that the annual percentage rate does not reflect the effect of
the required deposit.\45\
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\45\ A required deposit need not include, for example: (1) An escrow
account for items such as taxes, insurance or repairs; (2) a deposit
that earns not less than 5 percent per year; or (3) payments under a
Morris Plan.
[46 FR 20892, Apr. 7, 1981; 46 FR 29246, June 1, 1981, as amended at 52
FR 48670, Dec. 24, 1987; 61 FR 49246, Sept. 19, 1996]
[[Page 245]]
Sec. 226.19 Certain residential mortgage and variable-rate transactions.
(a) Residential mortgage transactions subject to RESPA--(1) Time of
disclosures. In a residential mortgage transaction subject to the Real
Estate Settlement Procedures Act (12 U.S.C. 2601 et seq.) the creditor
shall make good faith estimates of the disclosures required by
Sec. 226.18 before consummation, or shall deliver or place them in the
mail not later than three business days after the creditor receives the
consumer's written application, whichever is earlier.
(2) Redisclosure required. If the annual percentage rate at the time
of consummation varies from the annual percentage rate disclosed earlier
by more than \1/8\ of 1 percentage point in a regular transaction or
more than \1/4\ of 1 percentage point in an irregular transaction, as
defined in Sec. 226.22, the creditor shall disclose all the changed
terms no later than consummation or settlement.
(b) Certain variable-rate transactions.\45a\ If the annual
percentage rate may increase after consummation in a transaction secured
by the consumer's principal dwelling with a term greater than one year,
the following disclosures must be provided at the time an application
form is provided or before the consumer pays a non-refundable fee,
whichever is earlier:\45b\
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\45a\ Information provided in accordance with variable-rate
regulations of other federal agencies may be substituted for the
disclosures required by paragraph (b) of this section.
\45b\ Disclosures may be delivered or placed in the mail not later
than three business days following receipt of a consumer's application
when the application reaches the creditor by telephone, or through an
intermediary agent or broker.
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(1) The booklet titled Consumer Handbook on Adjustable Rate
Mortgages published by the Board and the Federal Home Loan Bank Board,
or a suitable substitute.
(2) A loan program disclosure for each variable-rate program in
which the consumer expresses an interest. The following disclosures, as
applicable, shall be provided:
(i) The fact that the interest rate, payment, or term of the loan
can change.
(ii) The index or formula used in making adjustments, and a source
of information about the index or formula.
(iii) An explanation of how the interest rate and payment will be
determined, including an explanation of how the index is adjusted, such
as by the addition of a margin.
(iv) A statement that the consumer should ask about the current
margin value and current interest rate.
(v) The fact that the interest rate will be discounted, and a
statement that the consumer should ask about the amount of the interest
rate discount.
(vi) The frequency of interest rate and payment changes.
(vii) Any rules relating to changes in the index, interest rate,
payment amount, and outstanding loan balance including, for example, an
explanation of interest rate or payment limitations, negative
amortization, and interest rate carryover.
(viii) At the option of the creditor, either of the following:
(A) A historical example, based on a $10,000 loan amount,
illustrating how payments and the loan balance would have been affected
by interest rate changes implemented according to the terms of the loan
program disclosure. The example shall reflect the most recent 15 years
of index values. The example shall reflect all significant loan program
terms, such as negative amortization, interest rate carryover, interest
rate discounts, and interest rate and payment limitations, that would
have been affected by the index movement during the period.
(B) The maximum interest rate and payment for a $10,000 loan
originated at the initial interest rate (index value plus margin,
adjusted by the amount of any discount or premium) in effect as of an
identified month and year for the loan program disclosure assuming the
maximum periodic increases in rates and payments under the program; and
the initial interest rate and payment for that loan and a statement that
the periodic payment may increase or decrease substantially depending on
changes in the rate.
(ix) An explanation of how the consumer may calculate the payments
for
[[Page 246]]
the loan amount to be borrowed based on either:
(A) The most recent payment shown in the historical example in
paragraph (b)(2)(viii)(A) of this section; or
(B) The initial interest rate used to calculate the maximum interest
rate and payment in paragraph (b)(2)(viii)(B) of this section.
(x) The fact that the loan program contains a demand feature.
(xi) The type of information that will be provided in notices of
adjustments and the timing of such notices.
(xii) A statement that disclosure forms are available for the
creditor's other variable-rate loan programs.
[52 FR 48670, Dec. 24, 1987; 53 FR 467, Jan. 7, 1988, as amended at 61
FR 49246, Sept. 19, 1996; 62 FR 63443, Dec. 1, 1997]
Sec. 226.20 Subsequent disclosure requirements.
(a) Refinancings. A refinancing occurs when an existing obligation
that was subject to this subpart is satisfied and replaced by a new
obligation undertaken by the same consumer. A refinancing is a new
transaction requiring new disclosures to the consumer. The new finance
charge shall include any unearned portion of the old finance charge that
is not credited to the existing obligation. The following shall not be
treated as a refinancing:
(1) A renewal of a single payment obligation with no change in the
original terms.
(2) A reduction in the annual percentage rate with a corresponding
change in the payment schedule.
(3) An agreement involving a court proceeding.
(4) A change in the payment schedule or a change in collateral
requirements as a result of the consumer's default or delinquency,
unless the rate is increased, or the new amount financed exceeds the
unpaid balance plus earned finance charge and premiums for continuation
of insurance of the types described in Sec. 226.4(d).
(5) The renewal of optional insurance purchased by the consumer and
added to an existing transaction, if disclosures relating to the initial
purchase were provided as required by this subpart.
(b) Assumptions. An assumption occurs when a creditor expressly
agrees in writing with a subsequent consumer to accept that consumer as
a primary obligor on an existing residential mortgage transaction.
Before the assumption occurs, the creditor shall make new disclosures to
the subsequent consumer, based on the remaining obligation. If the
finance charge originally imposed on the existing obligation was an add-
on or discount finance charge, the creditor need only disclose:
(1) The unpaid balance of the obligation assumed.
(2) The total charges imposed by the creditor in connection with the
assumption.
(3) The information required to be disclosed under Sec. 226.18(k),
(l), (m), and (n).
(4) The annual percentage rate originally imposed on the obligation.
(5) The payment schedule under Sec. 226.18(g) and the total of
payments under Sec. 226.18(h) based on the remaining obligation.
(c) Variable-rate adjustments. \45c\ An adjustment to the interest
rate with or without a corresponding adjustment to the payment in a
variable-rate transaction subject to Sec. 226.19(b) is an event
requiring new disclosures to the consumer. At least once each year
during which an interest rate adjustment is implemented without an
accompanying payment change, and at least 25, but no more than 120,
calendar days before a payment at a new level is due, the following
disclosures, as applicable, must be delivered or placed in the mail:
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\45c\ Information provided in accordance with variable-rate
subsequent disclosure regulations of other federal agencies may be
substituted for the disclosure required by paragraph (c) of this
section.
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(1) The current and prior interest rates.
(2) The index values upon which the current and prior interest rates
are based.
(3) The extent to which the creditor has foregone any increase in
the interest rate.
(4) The contractual effects of the adjustment, including the payment
due after the adjustment is made, and a statement of the loan balance.
[[Page 247]]
(5) The payment, if different from that referred to in paragraph
(c)(4) of this section, that would be required to fully amortize the
loan at the new interest rate over the remainder of the loan term.
[46 FR 20892, Apr. 7, 1981, as amended at 52 FR 48671, Dec. 24, 1987]
Sec. 226.21 Treatment of credit balances.
When a credit balance in excess of $1 is created in connection with
a transaction (through transmittal of funds to a creditor in excess of
the total balance due on an account, through rebates of unearned finance
charges or insurance premiums, or through amounts otherwise owed to or
held for the benefit of a consumer), the creditor shall:
(a) Credit the amount of the credit balance to the consumer's
account;
(b) Refund any part of the remaining credit balance, upon the
written request of the consumer; and
(c) Make a good faith effort to refund to the consumer by cash,
check, or money order, or credit to a deposit account of the consumer,
any part of the credit balance remaining in the account for more than 6
months, except that no further action is required if the consumer's
current location is not known to the creditor and cannot be traced
through the consumer's last known address or telephone number.
Sec. 226.22 Determination of annual percentage rate.
(a) Accuracy of annual percentage rate. (1) The annual percentage
rate is a measure of the cost of credit, expressed as a yearly rate,
that relates the amount and timing of value received by the consumer to
the amount and timing of payments made. The annual percentage rate shall
be determined in accordance with either the actuarial method or the
United States Rule method. Explanations, equations and instructions for
determining the annual percentage rate in accordance with the actuarial
method are set forth in appendix J to this regulation.\45d\
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\45d\ An error in disclosure of the annual percentage rate or
finance charge shall not, in itself, be considered a violation of this
regulation if: (1) The error resulted from a corresponding error in a
calculation tool used in good faith by the creditor; and (2) upon
discovery of the error, the creditor promptly discontinues use of that
calculation tool for disclosure purposes and notifies the Board in
writing of the error in the calculation tool.
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(2) As a general rule, the annual percentage rate shall be
considered accurate if it is not more than \1/8\ of 1 percentage point
above or below the annual percentage rate determined in accordance with
paragraph (a)(1) of this section.
(3) In an irregular transaction, the annual percentage rate shall be
considered accurate if it is not more than \1/4\ of 1 percentage point
above or below the annual percentage rate determined in accordance with
paragraph (a)(1) of this section.\46\
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\46\ For purposes of paragraph (a)(3) of this section, an irregular
transaction is one that includes one or more of the following features:
multiple advances, irregular payment periods, or irregular payment
amounts (other than an irregular first period or an irregular first or
final payment).
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(4) Mortgage loans. If the annual percentage rate disclosed in a
transaction secured by real property or a dwelling varies from the
actual rate determined in accordance with paragraph (a)(1) of this
section, in addition to the tolerances applicable under paragraphs
(a)(2) and (3) of this section, the disclosed annual percentage rate
shall also be considered accurate if:
(i) The rate results from the disclosed finance charge; and
(ii)(A) The disclosed finance charge would be considered accurate
under Sec. 226.18(d)(1); or
(B) For purposes of rescission, if the disclosed finance charge
would be considered accurate under Sec. 226.23(g) or (h), whichever
applies.
(5) Additional tolerance for mortgage loans. In a transaction
secured by real property or a dwelling, in addition to the tolerances
applicable under paragraphs (a)(2) and (3) of this section, if the
disclosed finance charge is calculated incorrectly but is considered
accurate under Sec. 226.18(d)(1) or Sec. 226.23(g) or (h), the disclosed
annual percentage rate shall be considered accurate:
(i) If the disclosed finance charge is understated, and the
disclosed annual percentage rate is also understated but
[[Page 248]]
it is closer to the actual annual percentage rate than the rate that
would be considered accurate under paragraph (a)(4) of this section;
(ii) If the disclosed finance charge is overstated, and the
disclosed annual percentage rate is also overstated but it is closer to
the actual annual percentage rate than the rate that would be considered
accurate under paragraph (a)(4) of this section.
(b) Computation tools. (1) The Regulation Z Annual Percentage Rate
Tables produced by the Board may be used to determine the annual
percentage rate, and any rate determined from those tables in accordance
with the accompanying instructions complies with the requirements of
this section. Volume I of the tables applies to single advance
transactions involving up to 480 monthly payments or 104 weekly
payments. It may be used for regular transactions and for transactions
with any of the following irregularities: an irregular first period, an
irregular first payment, and an irregular final payment. Volume II of
the tables applies to transactions involving multiple advances and any
type of payment or period irregularity.
(2) Creditors may use any other computation tool in determining the
annual percentage rate if the rate so determined equals the rate
determined in accordance with appendix J, within the degree of accuracy
set forth in paragraph (a) of this section.
(c) Single add-on rate transactions. If a single add-on rate is
applied to all transactions with maturities up to 60 months and if all
payments are equal in amount and period, a single annual percentage rate
may be disclosed for all those transactions, so long as it is the
highest annual percentage rate for any such transaction.
(d) Certain transactions involving ranges of balances. For purposes
of disclosing the annual percentage rate referred to in
Sec. 226.17(g)(4) (Mail or telephone orders--delay in disclosures) and
(h) (Series of sales--delay in disclosures), if the same finance charge
is imposed on all balances within a specified range of balances, the
annual percentage rate computed for the median balance may be disclosed
for all the balances. However, if the annual percentage rate computed
for the median balance understates the annual percentage rate computed
for the lowest balance by more than 8 percent of the latter rate, the
annual percentage rate shall be computed on whatever lower balance will
produce an annual percentage rate that does not result in an
understatement of more than 8 percent of the rate determined on the
lowest balance.
[46 FR 20892, Apr. 7, 1981, as amended at 47 FR 756, Jan. 7, 1982; 48 FR
14886, Apr. 6, 1983; 61 FR 49246, Sept. 19, 1996]
Sec. 226.23 Right of rescission.
(a) Consumer's right to rescind. (1) In a credit transaction in
which a security interest is or will be retained or acquired in a
consumer's principal dwelling, each consumer whose ownership interest is
or will be subject to the security interest shall have the right to
rescind the transaction, except for transactions described in paragraph
(f) of this section.\47\
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\47\ For purposes of this section, the addition to an existing
obligation of a security interest in a consumer's principal dwelling is
a transaction. The right of rescission applies only to the addition of
the security interest and not the existing obligation. The creditor
shall deliver the notice required by paragraph (b) of this section but
need not deliver new material disclosures. Delivery of the required
notice shall begin the rescission period.
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(2) To exercise the right to rescind, the consumer shall notify the
creditor of the rescission by mail, telegram or other means of written
communication. Notice is considered given when mailed, when filed for
telegraphic transmission or, if sent by other means, when delivered to
the creditor's designated place of business.
(3) The consumer may exercise the right to rescind until midnight of
the third business day following consummation, delivery of the notice
required by paragraph (b) of this section, or delivery of all material
disclosures,\48\ whichever occurs last. If the required notice or
material disclosures
[[Page 249]]
are not delivered, the right to rescind shall expire 3 years after
consummation, upon transfer of all of the consumer's interest in the
property, or upon sale of the property, whichever occurs first. In the
case of certain administrative proceedings, the rescission period shall
be extended in accordance with section 125(f) of the Act.
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\48\ The term ``material disclosures'' means the required
disclosures of the annual percentage rate, the finance charge, the
amount financed, the total payments, the payment schedule, and the
disclosures and limitations referred to in Sec. 226.32 (c) and (d).
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(4) When more than one consumer in a transaction has the right to
rescind, the exercise of the right by one consumer shall be effective as
to all consumers.
(b)(1) Notice of right to rescind. In a transaction subject to
rescission, a creditor shall deliver 2 copies of the notice of the right
to rescind to each consumer entitled to rescind. The notice shall be on
a separate document that identifies the transaction and shall clearly
and conspicuously disclose the following:
(i) The retention or acquisition of a security interest in the
consumer's principal dwelling.
(ii) The consumer's right to rescind the transaction.
(iii) How to exercise the right to rescind, with a form for that
purpose, designating the address of the creditor's place of business.
(iv) The effects of rescission, as described in paragraph (d) of
this section.
(v) The date the rescission period expires.
(2) Proper form of notice. To satisfy the disclosure requirements of
paragraph (b)(1) of this section, the creditor shall provide the
appropriate model form in Appendix H of this part or a substantially
similar notice.
(c) Delay of creditor's performance. Unless a consumer waives the
right of rescission under paragraph (e) of this section, no money shall
be disbursed other than in escrow, no services shall be performed and no
materials delivered until the rescission period has expired and the
creditor is reasonably satisfied that the consumer has not rescinded.
(d) Effects of rescission. (1) When a consumer rescinds a
transaction, the security interest giving rise to the right of
rescission becomes void and the consumer shall not be liable for any
amount, including any finance charge.
(2) Within 20 calendar days after receipt of a notice of rescission,
the creditor shall return any money or property that has been given to
anyone in connection with the transaction and shall take any action
necessary to reflect the termination of the security interest.
(3) If the creditor has delivered any money or property, the
consumer may retain possession until the creditor has met its obligation
under paragraph (d)(2) of this section. When the creditor has complied
with that paragraph, the consumer shall tender the money or property to
the creditor or, where the latter would be impracticable or inequitable,
tender its reasonable value. At the consumer's option, tender of
property may be made at the location of the property or at the
consumer's residence. Tender of money must be made at the creditor's
designated place of business. If the creditor does not take possession
of the money or property within 20 calendar days after the consumer's
tender, the consumer may keep it without further obligation.
(4) The procedures outlined in paragraphs (d) (2) and (3) of this
section may be modified by court order.
(e) Consumer's waiver of right to rescind. (1) The consumer may
modify or waive the right to rescind if the consumer determines that the
extension of credit is needed to meet a bona fide personal financial
emergency. To modify or waive the right, the consumer shall give the
creditor a dated written statement that describes the emergency,
specifically modifies or waives the right to rescind, and bears the
signature of all the consumers entitled to rescind. Printed forms for
this purpose are prohibited, except as provided in paragraph (e)(2) of
this section.
(2) The need of the consumer to obtain funds immediately shall be
regarded as a bona fide personal financial emergency provided that the
dwelling securing the extension of credit is located in an area declared
during June through September 1993, pursuant to 42 U.S.C. 5170, to be a
major disaster area because of severe storms and flooding in the
Midwest.\48a\ In this instance,
[[Page 250]]
creditors may use printed forms for the consumer to waive the right to
rescind. This exemption to paragraph (e)(1) of this section shall expire
one year from the date an area was declared a major disaster.
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\48a\ A list of the affected areas will be maintained by the Board.
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(3) The consumer's need to obtain funds immediately shall be
regarded as a bona fide personal financial emergency provided that the
dwelling securing the extension of credit is located in an area declared
during June through September 1994 to be a major disaster area, pursuant
to 42 U.S.C. 5170, because of severe storms and flooding in the
South.\48b\ In this instance, creditors may use printed forms for the
consumer to waive the right to rescind. This exemption to paragraph
(e)(1) of this section shall expire one year from the date an area was
declared a major disaster.
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\48b\ A list of the affected areas will be maintained and published
by the Board. Such areas now include parts of Alabama, Florida, and
Georgia.
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(4) The consumer's need to obtain funds immediately shall be
regarded as a bona fide personal financial emergency provided that the
dwelling securing the extension of credit is located in an area declared
during October 1994 to be a major disaster area, pursuant to 42 U.S.C.
5170, because of severe storms and flooding in Texas.\48c\ In this
instance, creditors may use printed forms for the consumer to waive the
right to rescind. This exemption to paragraph (e)(1) of this section
shall expire one year from the date an area was declared a major
disaster.
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\48c\ A list of the affected areas will be maintained and published
by the Board. Such areas now include the following counties in Texas:
Angelina, Austin, Bastrop, Brazos, Brazoria, Burleson, Chambers,
Fayette, Fort Bend, Galveston, Grimes, Hardin, Harris, Houston, Jackson,
Jasper, Jefferson, Lee, Liberty, Madison, Matagorda, Montgomery,
Nacagdoches, Orange, Polk, San Augustine, San Jacinto, Shelby, Trinity,
Victoria, Washington, Waller, Walker, and Wharton.
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(f) Exempt transactions. The right to rescind does not apply to the
following:
(1) A residential mortgage transaction.
(2) A refinancing or consolidation by the same creditor of an
extension of credit already secured by the consumer's principal
dwelling. The right of rescission shall apply, however, to the extent
the new amount financed exceeds the unpaid principal balance, any earned
unpaid finance charge on the existing debt, and amounts attributed
solely to the costs of the refinancing or consolidation.
(3) A transaction in which a state agency is a creditor.
(4) An advance, other than an initial advance, in a series of
advances or in a series of single-payment obligations that is treated as
a single transaction under Sec. 226.17(c)(6), if the notice required by
paragraph (b) of this section and all material disclosures have been
given to the consumer.
(5) A renewal of optional insurance premiums that is not considered
a refinancing under Sec. 226.20(a)(5).
(g) Tolerances for accuracy--(1) One-half of 1 percent tolerance.
Except as provided in paragraphs (g)(2) and (h)(2) of this section, the
finance charge and other disclosures affected by the finance charge
(such as the amount financed and the annual percentage rate) shall be
considered accurate for purposes of this section if the disclosed
finance charge:
(i) is understated by no more than \1/2\ of 1 percent of the face
amount of the note or $100, whichever is greater; or
(ii) is greater than the amount required to be disclosed.
(2) One percent tolerance. In a refinancing of a residential
mortgage transaction with a new creditor (other than a transaction
covered by Sec. 226.32), if there is no new advance and no consolidation
of existing loans, the finance charge and other disclosures affected by
the finance charge (such as the amount financed and the annual
percentage rate) shall be considered accurate for purposes of this
section if the disclosed finance charge:
(i) is understated by no more than 1 percent of the face amount of
the note or $100, whichever is greater; or
(ii) is greater than the amount required to be disclosed.
(h) Special rules for foreclosures--(1) Right to rescind. After the
initiation of foreclosure on the consumer's principal dwelling that
secures the credit obligation, the consumer shall have the right to
rescind the transaction if:
[[Page 251]]
(i) A mortgage broker fee that should have been included in the
finance charge was not included; or
(ii) The creditor did not provide the properly completed appropriate
model form in Appendix H of this part, or a substantially similar notice
of rescission.
(2) Tolerance for disclosures. After the initiation of foreclosure
on the consumer's principal dwelling that secures the credit obligation,
the finance charge and other disclosures affected by the finance charge
(such as the amount financed and the annual percentage rate) shall be
considered accurate for purposes of this section if the disclosed
finance charge:
(i) is understated by no more than $35; or
(ii) is greater than the amount required to be disclosed.
[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 51 FR 45299, Dec. 18,
1986; 58 FR 40583, July 29, 1993; 59 FR 40204, Aug. 5, 1994; 59 FR
63715, Dec. 9, 1994; 60 FR 15471, Mar. 24, 1995; 61 FR 49247, Sept. 19,
1996]
Sec. 226.24 Advertising.
(a) Actually available terms. If an advertisement for credit states
specific credit terms, it shall state only those terms that actually are
or will be arranged or offered by the creditor.
(b) Advertisement of rate of finance charge. If an advertisement
states a rate of finance charge, it shall state the rate as an ``annual
percentage rate,'' using that term. If the annual percentage rate may be
increased after consummation, the advertisement shall state that fact.
The advertisement shall not state any other rate, except that a simple
annual rate or periodic rate that is applied to an unpaid balance may be
stated in conjunction with, but not more conspicuously than, the annual
percentage rate.
(c) Advertisement of terms that require additional disclosures. (1)
If any of the following terms is set forth in an advertisement, the
advertisement shall meet the requirements of paragraph (c)(2) of this
section:
(i) The amount or percentage of any downpayment.
(ii) The number of payments or period of repayment.
(iii) The amount of any payment.
(iv) The amount of any finance charge.
(2) An advertisement stating any of the terms in paragraph (c)(1) of
this section shall state the following terms,\49\ as applicable:
---------------------------------------------------------------------------
\49\ An example of one or more typical extensions of credit with a
statement of all the terms applicable to each may be used.
---------------------------------------------------------------------------
(i) The amount or percentage of the downpayment.
(ii) The terms of repayment.
(iii) The annual percentage rate, using that term, and, if the rate
may be increased after consummation, that fact.
(d) Catalogs and multiple-page advertisements. (1) If a catalog or
other multiple-page advertisement gives information in a table or
schedule in sufficient detail to permit determination of the disclosures
required by paragraph (c)(2) of this section, it shall be considered a
single advertisement if:
(i) The table or schedule is clearly set forth; and
(ii) Any statement of the credit terms in paragraph (c)(1) of this
section appearing anywhere else in the catalog or advertisement clearly
refers to the page on which the table or schedule begins.
(2) A catalog or multiple-page advertisement complies with paragraph
(c)(2) of this section if the table or schedule of terms includes all
appropriate disclosures for a representative scale of amounts up to the
level of the more commonly sold higher-priced property or services
offered.
Subpart D--Miscellaneous
Sec. 226.25 Record retention.
(a) General rule. A creditor shall retain evidence of compliance
with this regulation (other than advertising requirements under
Secs. 226.16 and 226.24) for 2 years after the date disclosures are
required to be made or action is required to be taken. The
administrative agencies responsible for enforcing the regulation may
require creditors under their jurisdictions to retain records for a
longer period if necessary to carry out their enforcement
responsibilities under section 108 of the act.
(b) Inspection of records. A creditor shall permit the agency
responsible for
[[Page 252]]
enforcing this regulation with respect to that creditor to inspect its
relevant records for compliance.
Sec. 226.26 Use of annual percentage rate in oral disclosures.
(a) Open-end credit. In an oral response to a consumer's inquiry
about the cost of open-end credit, only the annual percentage rate or
rates shall be stated, except that the periodic rate or rates also may
be stated. If the annual percentage rate cannot be determined in advance
because there are finance charges other than a periodic rate, the
corresponding annual percentage rate shall be stated, and other cost
information may be given.
(b) Closed-end credit. In an oral response to a consumer's inquiry
about the cost of closed-end credit, only the annual percentage rate
shall be stated, except that a simple annual rate or periodic rate also
may be stated if it is applied to an unpaid balance. If the annual
percentage rate cannot be determined in advance, the annual percentage
rate for a sample transaction shall be stated, and other cost
information for the consumer's specific transaction may be given.
Sec. 226.27 Spanish language disclosures.
All disclosures required by this regulation shall be made in the
English language, except in the Commonwealth of Puerto Rico, where
creditors may, at their option, make disclosures in the Spanish
language. If Spanish disclosures are made, English disclosures shall be
provided on the consumer's request, either in substitution for or in
addition to the Spanish disclosures. This requirement for providing
English disclosures on request shall not apply to advertisements subject
to Secs. 226.16 and 226.24 of this regulation.
Sec. 226.28 Effect on State laws.
(a) Inconsistent disclosure requirements. (1) Except as provided in
paragraph (d) of this section, State law requirements that are
inconsistent with the requirements contained in chapter 1 (General
Provisions), chapter 2 (Credit Transactions), or chapter 3 (Credit
Advertising) of the act and the implementing provisions of this
regulation are preempted to the extent of the inconsistency. A State law
is inconsistent if it requires a creditor to make disclosures or take
actions that contradict the requirements of the Federal law. A State law
is contradictory if it requires the use of the same term to represent a
different amount or a different meaning than the Federal law, or if it
requires the use of a term different from that required in the Federal
law to describe the same item. A creditor, State, or other interested
party may request the Board to determine whether a State law requirement
is inconsistent. After the Board determines that a State law is
inconsistent, a creditor may not make disclosures using the inconsistent
term or form.
(2)(i) State law requirements are inconsistent with the requirements
contained in sections 161 (Correction of billing errors) or 162
(Regulation of credit reports) of the Act and the implementing
provisions of this regulation and are preempted if they provide rights,
responsibilities, or procedures for consumers or creditors that are
different from those required by the Federal law. However, a State law
that allows a consumer to inquire about an open-end credit account and
imposes on the creditor an obligation to respond to such inquiry after
the time allowed in the Federal law for the consumer to submit written
notice of a billing error shall not be preempted in any situation where
the time period for making written notice under this regulation has
expired. If a creditor gives written notice of a consumer's rights under
such State law, the notice shall state that reliance on the longer time
period available under State law may result in the loss of important
rights that could be preserved by acting more promptly under Federal
law; it shall also explain that the State law provisions apply only
after expiration of the time period for submitting a proper written
notice of a billing error under the Federal law. If the State
disclosures are made on the same side of a page as the required Federal
disclosures, the State disclosures shall appear under a demarcation line
below the Federal disclosures, and the Federal disclosures shall be
identified by a heading indicating that they are made in compliance with
Federal law.
[[Page 253]]
(ii) State law requirements are inconsistent with the requirements
contained in chapter 4 (Credit billing) of the Act (other than section
161 or 162) and the implementing provisions of this regulation and are
preempted if the creditor cannot comply with State law without violating
Federal law.
(iii) A State may request the Board to determine whether its law is
inconsistent with chapter 4 of the Act and its implementing provisions.
(b) Equivalent disclosure requirements. If the Board determines that
a disclosure required by state law (other than a requirement relating to
the finance charge, annual percentage rate, or the disclosures required
under Sec. 226.32) is substantially the same in meaning as a disclosure
required under the act or this regulation, creditors in that state may
make the state disclosure in lieu of the federal disclosure. A creditor,
State, or other interested party may request the Board to determine
whether a State disclosure is substantially the same in meaning as a
Federal disclosure.
(c) Request for determination. The procedures under which a request
for a determination may be made under this section are set forth in
appendix A.
(d) Special rule for credit and charge cards. State law requirements
relating to the disclosure of credit information in any credit or charge
card application or solicitation that is subject to the requirements of
section 127(c) of chapter 2 of the act (Sec. 226.5a of the regulation)
or in any renewal notice for a credit or charge card that is subject to
the requirements of section 127(d) of chapter 2 of the act
(Sec. 226.9(e) of the regulation) are preempted. State laws relating to
the enforcement of section 127 (c) and (d) of the act are not preempted.
[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 54 FR 13867, Apr. 6,
1989; 54 FR 32954, Aug. 11, 1989; 60 FR 15471, Mar. 24, 1995]
Sec. 226.29 State exemptions.
(a) General rule. Any State may apply to the Board to exempt a class
of transactions within the State from the requirements of chapter 2
(Credit transactions) or chapter 4 (Credit billing) of the Act and the
corresponding provisions of this regulation. The Board shall grant an
exemption if it determines that:
(1) The State law is substantially similar to the Federal law or, in
the case of chapter 4, affords the consumer greater protection than the
Federal law; and
(2) There is adequate provision for enforcement.
(b) Civil liability. (1) No exemptions granted under this section
shall extend to the civil liability provisions of sections 130 and 131
of the Act.
(2) If an exemption has been granted, the disclosures required by
the applicable State law (except any additional requirements not imposed
by Federal law) shall constitute the disclosures required by this Act.
(c) Applications. The procedures under which a State may apply for
an exemption under this section are set forth in appendix B.
[46 FR 20892, Apr. 7, 1981; 46 FR 29246, June 1, 1981]
Sec. 226.30 Limitation on rates.
A creditor shall include in any consumer credit contract secured by
a dwelling and subject to the act and this regulation the maximum
interest rate that may be imposed during the term of the obligation \50\
when:
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\50\ Compliance with this section will constitute compliance with
the disclosure requirements on limitations on increases in footnote 12
to Secs. 226.6(a)(2) and 226.18(f)(2) until October 1, 1988.
---------------------------------------------------------------------------
(a) In the case of closed-end credit, the annual percentage rate may
increase after consummation, or
(b) In the case of open-end credit, the annual percentage rate may
increase during the plan.
[52 FR 43181, Nov. 9, 1987]
Subpart E--Special Rules for Certain Home Mortgage Transactions
Source: Reg. Z, 60 FR 15471, Mar. 24, 1995, unless otherwise noted.
Sec. 226.31 General rules.
(a) Relation to other subparts in this part. The requirements and
limitations of this subpart are in addition to and
[[Page 254]]
not in lieu of those contained in other subparts of this part.
(b) Form of disclosures. The creditor shall make the disclosures
required by this subpart clearly and conspicuously in writing, in a form
that the consumer may keep.
(c) Timing of disclosure--(1) Disclosures for certain closed-end
home mortgages. The creditor shall furnish the disclosures required by
Sec. 226.32 at least three business days prior to consummation of a
mortgage transaction covered by Sec. 226.32.
(i) Change in terms. After complying with paragraph (c)(1) of this
section and prior to consummation, if the creditor changes any term that
makes the disclosures inaccurate, new disclosures shall be provided in
accordance with the requirements of this subpart.
(ii) Telephone disclosures. A creditor may provide new disclosures
by telephone if the consumer initiates the change and if, at
consummation:
(A) The creditor provides new written disclosures; and
(B) The consumer and creditor sign a statement that the new
disclosures were provided by telephone at least three days prior to
consummation.
(iii) Consumer's waiver of waiting period before consummation. The
consumer may, after receiving the disclosures required by paragraph
(c)(1) of this section, modify or waive the three-day waiting period
between delivery of those disclosures and consummation if the consumer
determines that the extension of credit is needed to meet a bona fide
personal financial emergency. To modify or waive the right, the consumer
shall give the creditor a dated written statement that describes the
emergency, specifically modifies or waives the waiting period, and bears
the signature of all the consumers entitled to the waiting period.
Printed forms for this purpose are prohibited, except when creditors are
permitted to use printed forms pursuant to Sec. 226.23(e)(2).
(2) Disclosures for reverse mortgages. The creditor shall furnish
the disclosures required by Sec. 226.33 at least three business days
prior to:
(i) Consummation of a closed-end credit transaction; or
(ii) The first transaction under an open-end credit plan.
(d) Basis of disclosures and use of estimates--(1) Legal Obligation.
Disclosures shall reflect the terms of the legal obligation between the
parties.
(2) Estimates. If any information necessary for an accurate
disclosure is unknown to the creditor, the creditor shall make the
disclosure based on the best information reasonably available at the
time the disclosure is provided, and shall state clearly that the
disclosure is an estimate.
(3) Per-diem interest. For a transaction in which a portion of the
interest is determined on a per-diem basis and collected at
consummation, any disclosure affected by the per-diem interest shall be
considered accurate if the disclosure is based on the information known
to the creditor at the time that the disclosure documents are prepared.
(e) Multiple creditors; multiple consumers. If a transaction
involves more than one creditor, only one set of disclosures shall be
given and the creditors shall agree among themselves which creditor must
comply with the requirements that this part imposes on any or all of
them. If there is more than one consumer, the disclosures may be made to
any consumer who is primarily liable on the obligation. If the
transaction is rescindable under Sec. 226.15 or Sec. 226.23, however,
the disclosures shall be made to each consumer who has the right to
rescind.
(f) Effect of subsequent events. If a disclosure becomes inaccurate
because of an event that occurs after the creditor delivers the required
disclosures, the inaccuracy is not a violation of Regulation Z (12 CFR
part 226), although new disclosures may be required for mortgages
covered by Sec. 226.32 under paragraph (c) of this section,
Sec. 226.9(c), Sec. 226.19, or Sec. 226.20.
(g) Accuracy of annual percentage rate. For purposes of Sec. 226.32,
the annual percentage rate shall be considered accurate, and may be used
in determining whether a transaction is covered by Sec. 226.32, if it is
accurate according to the requirements and within the tolerances under
Sec. 226.22. The finance charge tolerances for rescission under
[[Page 255]]
Sec. 226.23(g) or (h) shall not apply for this purpose.
[Reg. Z, 60 FR 15471, Mar. 24, 1995, as amended at 60 FR 29969, June 7,
1995; 61 FR 49247, Sept. 19, 1996]
Sec. 226.32 Requirements for certain closed-end home mortgages.
(a) Coverage. (1) Except as provided in paragraph (a)(2) of this
section, the requirements of this section apply to a consumer credit
transaction that is secured by the consumer's principal dwelling, and in
which either:
(i) The annual percentage rate at consummation will exceed by more
than 10 percentage points the yield on Treasury securities having
comparable periods of maturity to the loan maturity as of the fifteenth
day of the month immediately preceding the month in which the
application for the extension of credit is received by the creditor; or
(ii) The total points and fees payable by the consumer at or before
loan closing will exceed the greater of 8 percent of the total loan
amount, or $400; the $400 figure shall be adjusted annually on January 1
by the annual percentage change in the Consumer Price Index that was
reported on the preceding June 1.
(2) This section does not apply to the following:
(i) A residential mortgage transaction.
(ii) A reverse mortgage transaction subject to Sec. 226.33.
(iii) An open-end credit plan subject to subpart B of this part.
(b) Definitions. For purposes of this subpart, the following
definitions apply:
(1) For purposes of paragraph (a)(1)(ii) of this section, points and
fees mean:
(i) All items required to be disclosed under Sec. 226.4(a) and
226.4(b), except interest or the time-price differential;
(ii) All compensation paid to mortgage brokers; and
(iii) All items listed in Sec. 226.4(c)(7) (other than amounts held
for future payment of taxes) unless the charge is reasonable, the
creditor receives no direct or indirect compensation in connection with
the charge, and the charge is not paid to an affiliate of the creditor.
(2) Affiliate means any company that controls, is controlled by, or
is under common control with another company, as set forth in the Bank
Holding Company Act of 1956 (12 U.S.C. 1841 et seq.).
(c) Disclosures. In addition to other disclosures required by this
part, in a mortgage subject to this section the creditor shall disclose
the following:
(1) Notices. The following statement: ``You are not required to
complete this agreement merely because you have received these
disclosures or have signed a loan application. If you obtain this loan,
the lender will have a mortgage on your home. You could lose your home,
and any money you have put into it, if you do not meet your obligations
under the loan.''
(2) Annual percentage rate. The annual percentage rate.
(3) Regular payment. The amount of the regular monthly (or other
periodic) payment.
(4) Variable-rate. For variable-rate transactions, a statement that
the interest rate and monthly payment may increase, and the amount of
the single maximum monthly payment, based on the maximum interest rate
required to be disclosed under Sec. 226.30.
(d) Limitations. A mortgage transaction subject to this section may
not provide for the following terms:
(1)(i) Balloon payment. For a loan with a term of less than five
years, a payment schedule with regular periodic payments that when
aggregated do not fully amortize the outstanding principal balance.
(ii) Exception. The limitations in paragraph (d)(1)(i) of this
section do not apply to loans with maturities of less than one year, if
the purpose of the loan is a ``bridge'' loan connected with the
acquisition or construction of a dwelling intended to become the
consumer's principal dwelling.
(2) Negative amortization. A payment schedule with regular periodic
payments that cause the principal balance to increase.
(3) Advance payments. A payment schedule that consolidates more than
two periodic payments and pays them in advance from the proceeds.
[[Page 256]]
(4) Increased interest rate. An increase in the interest rate after
default.
(5) Rebates. A refund calculated by a method less favorable than the
actuarial method (as defined by section 933(d) of the Housing and
Community Development Act of 1992, 15 U.S.C. 1615(d)), for rebates of
interest arising from a loan acceleration due to default.
(6) Prepayment penalties. Except as allowed under paragraph (d)(7)
of this section, a penalty for paying all or part of the principal
before the date on which the principal is due. A prepayment penalty
includes computing a refund of unearned interest by a method that is
less favorable to the consumer than the actuarial method, as defined by
section 933(d) of the Housing and Community Development Act of 1992.
(7) Prepayment penalty exception. A mortgage transaction subject to
this section may provide for a prepayment penalty otherwise permitted by
law (including a refund calculated according to the rule of 78s) if:
(i) The penalty can be exercised only for the first five years
following consummation;
(ii) The source of the prepayment funds is not a refinancing by the
creditor or an affiliate of the creditor; and
(iii) At consummation, the consumer's total monthly debts (including
amounts owed under the mortgage) do not exceed 50 percent of the
consumer's monthly gross income, as verified by the consumer's signed
financial statement, a credit report, and payment records for employment
income.
(e) Prohibited acts and practices. A creditor extending mortgage
credit subject to this section may not:
(1) Repayment ability. Engage in a pattern or practice of extending
such credit to a consumer based on the consumer's collateral if,
considering the consumer's current and expected income, current
obligations, and employment status, the consumer will be unable to make
the scheduled payments to repay the obligation.
(2) Home improvement contracts. Pay a contractor under a home
improvement contract from the proceeds of a mortgage covered by this
section, other than:
(i) By an instrument payable to the consumer or jointly to the
consumer and the contractor; or
(ii) At the election of the consumer, through a third-party escrow
agent in accordance with terms established in a written agreement signed
by the consumer, the creditor, and the contractor prior to the
disbursement.
(3) Notice to assignee. Sell or otherwise assign a mortgage subject
to this section without furnishing the following statement to the
purchaser or assignee: ``Notice: This is a mortgage subject to special
rules under the federal Truth in Lending Act. Purchasers or assignees of
this mortgage could be liable for all claims and defenses with respect
to the mortgage that the borrower could assert against the creditor.''
[Reg. Z, 60 FR 15472, Mar. 24, 1995, as amended at 60 FR 29969, June 7,
1995]
Sec. 226.33 Requirements for reverse mortgages.
(a) Definition. For purposes of this subpart, reverse mortgage
transaction means a nonrecourse consumer credit obligation in which:
(1) A mortgage, deed of trust, or equivalent consensual security
interest securing one or more advances is created in the consumer's
principal dwelling; and
(2) Any principal, interest, or shared appreciation or equity is due
and payable (other than in the case of default) only after:
(i) The consumer dies;
(ii) The dwelling is transferred; or
(iii) The consumer ceases to occupy the dwelling as a principal
dwelling.
(b) Content of disclosures. In addition to other disclosures
required by this part, in a reverse mortgage transaction the creditor
shall provide the following disclosures in a form substantially similar
to the model form found in paragraph (d) of Appendix K of this part:
(1) Notice. A statement that the consumer is not obligated to
complete the reverse mortgage transaction merely because the consumer
has received the disclosures required by this section or has signed an
application for a reverse mortgage loan.
[[Page 257]]
(2) Total annual loan cost rates. A good-faith projection of the
total cost of the credit, determined in accordance with paragraph (c) of
this section and expressed as a table of ``total annual loan cost
rates,'' using that term, in accordance with Appendix K of this part.
(3) Itemization of pertinent information. An itemization of loan
terms, charges, the age of the youngest borrower and the appraised
property value.
(4) Explanation of table. An explanation of the table of total
annual loan cost rates as provided in the model form found in paragraph
(d) of Appendix K of this part.
(c) Projected total cost of credit. The projected total cost of
credit shall reflect the following factors, as applicable:
(1) Costs to consumer. All costs and charges to the consumer,
including the costs of any annuity the consumer purchases as part of the
reverse mortgage transaction.
(2) Payments to consumer. All advances to and for the benefit of the
consumer, including annuity payments that the consumer will receive from
an annuity that the consumer purchases as part of the reverse mortgage
transaction.
(3) Additional creditor compensation. Any shared appreciation or
equity in the dwelling that the creditor is entitled by contract to
receive.
(4) Limitations on consumer liability. Any limitation on the
consumer's liability (such as nonrecourse limits and equity conservation
agreements).
(5) Assumed annual appreciation rates. Each of the following assumed
annual appreciation rates for the dwelling:
(i) 0 percent.
(ii) 4 percent.
(iii) 8 percent.
(6) Assumed loan period. (i) Each of the following assumed loan
periods, as provided in Appendix L of this part:
(A) Two years.
(B) The actuarial life expectancy of the consumer to become
obligated on the reverse mortgage transaction (as of that consumer's
most recent birthday). In the case of multiple consumers, the period
shall be the actuarial life expectancy of the youngest consumer (as of
that consumer's most recent birthday).
(C) The actuarial life expectancy specified by paragraph
(c)(6)(i)(B) of this section, multiplied by a factor of 1.4 and rounded
to the nearest full year.
(ii) At the creditor's option, the actuarial life expectancy
specified by paragraph (c)(6)(i)(B) of this section, multiplied by a
factor of .5 and rounded to the nearest full year.
Appendix A to Part 226--Effect on State Laws
Request for Determination
A request for a determination that a State law is inconsistent or
that a State law is substantially the same as the Act and regulation
shall be in writing and addressed to the Secretary, Board of Governors
of the Federal Reserve System, Washington, DC 20551. The request shall
be made pursuant to the procedures herein and the Board's Rules of
Procedure (12 CFR Part 262).
Supporting Documents
A request for a determination shall include the following items:
(1) The text of the State statute, regulation, or other document
that is the subject of the request.
(2) Any other statute, regulation, or judicial or administrative
opinion that implements, interprets, or applies the relevant provision.
(3) A comparison of the State law with the corresponding provision
of the Federal law, including a full discussion of the basis for the
requesting party's belief that the State provision is either
inconsistent or substantially the same.
(4) Any other information that the requesting party believes may
assist the Board in its determination.
Public Notice of Determination
Notice that the Board intends to make a determination (either on
request or on its own motion) will be published in the Federal Register,
with an opportunity for public comment, unless the Board finds that
notice and opportunity for comment would be impracticable, unnecessary,
or contrary to the public interest and publishes its reasons for such
decision.
Subject to the Board's Rules Regarding Availability of Information
(12 CFR Part 261), all requests made, including any documents and other
material submitted in support of the requests, will be made available
for public inspection and copying.
[[Page 258]]
Notice After Determination
Notice of a final determination will be published in the Federal
Register, and the Board will furnish a copy of such notice to the party
who made the request and to the appropriate State official.
Reversal of Determination
The Board reserves the right to reverse a determination for any
reason bearing on the coverage or effect of State or Federal law.
Notice of reversal of a determination will be published in the
Federal Register and a copy furnished to the appropriate State official.
[Reg. Z, 46 FR 20892, Apr. 7, 1981; 46 FR 29246, June 1, 1981]
Appendix B to Part 226--State Exemptions
Application
Any State may apply to the Board for a determination that a class of
transactions subject to State law is exempt from the requirements of the
Act and this regulation. An application shall be in writing and
addressed to the Secretary, Board of Governors of the Federal Reserve
System, Washington, DC 20551, and shall be signed by the appropriate
State official. The application shall be made pursuant to the procedures
herein and the Board's Rules of Procedure (12 CFR Part 262).
Supporting Documents
An application shall be accompanied by:
(1) The text of the State statute or regulation that is the subject
of the application, and any other statute, regulation, or judicial or
administrative opinion that implements, interprets, or applies it.
(2) A comparison of the State law with the corresponding provisions
of the Federal law.
(3) The text of the State statute or regulation that provides for
civil and criminal liability and administrative enforcement of the State
law.
(4) A statement of the provisions for enforcement, including an
identification of the State office that administers the relevant law,
information on the funding and the number and qualifications of
personnel engaged in enforcement, and a description of the enforcement
procedures to be followed, including information on examination
procedures, practices, and policies. If an exemption application extends
to federally chartered institutions, the applicant must furnish evidence
that arrangements have been made with the appropriate Federal agencies
to ensure adequate enforcement of State law in regard to such creditors.
(5) A statement of reasons to support the applicant's claim that an
exemption should be granted.
Public Notice of Application
Notice of an application will be published, with an opportunity for
public comment, in the Federal Register, unless the Board finds that
notice and opportunity for comment would be impracticable, unnecessary,
or contrary to the public interest and publishes its reasons for such
decision.
Subject to the Board's Rules Regarding Availability of Information
(12 CFR Part 261), all applications made, including any documents and
other material submitted in support of the applications, will be made
available for public inspection and copying. A copy of the application
also will be made available at the Federal Reserve Bank of each district
in which the applicant is situated.
Favorable Determination
If the Board determines on the basis of the information before it
that an exemption should be granted, notice of the exemption will be
published in the Federal Register, and a copy furnished to the applicant
and to each Federal official responsible for administrative enforcement.
The appropriate State official shall inform the Board within 30 days
of any change in its relevant law or regulations. The official shall
file with the Board such periodic reports as the Board may require.
The Board will inform the appropriate State official of any
subsequent amendments to the Federal law, regulation, interpretations,
or enforcement policies that might require an amendment to State law,
regulation, interpretations, or enforcement procedures.
Adverse Determination
If the Board makes an initial determination that an exemption should
not be granted, the Board will afford the applicant a reasonable
opportunity to demonstrate further that an exemption is proper. If the
Board ultimately finds that an exemption should not be granted, notice
of an adverse determination will be published in the Federal Register
and a copy furnished to the applicant.
Revocation of Exemption
The Board reserves the right to revoke an exemption if at any time
it determines that the standards required for an exemption are not met.
Before taking such action, the Board will notify the appropriate
State official of its intent, and will afford the official such
opportunity as it deems appropriate in the circumstances to demonstrate
that revocation is improper. If the Board ultimately finds that
revocation is proper, notice of the Board's intention to revoke such
exemption will be published in the Federal Register
[[Page 259]]
with a reasonable period of time for interested persons to comment.
Notice of revocation of an exemption will be published in the
Federal Register. A copy of such notice will be furnished to the
appropriate State official and to the Federal officials responsible for
enforcement. Upon revocation of an exemption, creditors in that State
shall then be subject to the requirements of the Federal law.
Appendix C to Part 226--Issuance of Staff Interpretations
Official Staff Interpretations
Officials in the Board's Division of Consumer and Community Affairs
are authorized to issue official staff interpretations of this
regulation. These interpretations provide the protection afforded under
section 130(f) of the Act. Except in unusual circumstances, such
interpretations will not be issued separately but will be incorporated
in an official commentary to the regulation which will be amended
periodically.
Requests for Issuance of Official Staff Interpretations
A request for an official staff interpretation shall be in writing
and addressed to the Director, Division of Consumer and Community
Affairs, Board of Governors of the Federal Reserve System, Washington,
DC 20551. The request shall contain a complete statement of all relevant
facts concerning the issue, including copies of all pertinent documents.
Scope of Interpretations
No staff interpretations will be issued approving creditors' forms,
statements, or calculation tools or methods. This restriction does not
apply to forms, statements, tools, or methods whose use is required or
sanctioned by a government agency.
Appendix D to Part 226--Multiple Advance Construction Loans
Section 226.17(c)(6) permits creditors to treat multiple advance
loans to finance construction of a dwelling that may be permanently
financed by the same creditor either as a single transaction or as more
than one transaction. If the actual schedule of advances is not known,
the following methods may be used to estimate the interest portion of
the finance charge and the annual percentage rate and to make
disclosures. If the creditor chooses to disclose the construction phase
separately, whether interest is payable periodically or at the end of
construction, part I may be used. If the creditor chooses to disclose
the construction and the permanent financing as one transaction, part II
may be used.
Part I--Construction Period Disclosed Separately
A. If interest is payable only on the amount actually advanced for
the time it is outstanding:
1. Estimated interest--Assume that one-half of the commitment amount
is outstanding at the contract interest rate for the entire construction
period.
2. Estimated annual percentage rate--Assume a single payment loan
that matures at the end of the construction period. The finance charge
is the sum of the estimated interest and any prepaid finance charge. The
amount financed for computation purposes is determined by subtracting
any prepaid finance charge from one-half of the commitment amount.
3. Repayment schedule--The number and amounts of any interest
payments may be omitted in disclosing the payment schedule under
Sec. 226.18(g). The fact that interest payments are required and the
timing of such payments shall be disclosed.
4. Amount financed--The amount financed for disclosure purposes is
the entire commitment amount less any prepaid finance charge.
B. If interest is payable on the entire commitment amount without
regard to the dates or amounts of actual disbursement:
1. Estimated interest--Assume that the entire commitment amount is
outstanding at the contract interest rate for the entire construction
period.
2. Estimated annual percentage rate--Assume a single payment loan
that matures at the end of the construction period. The finance charge
is the sum of the estimated interest and any prepaid finance charge. The
amount financed for computation purposes is determined by subtracting
any prepaid finance charge from one-half of the commitment amount.
3. Repayment schedule--Interest payments shall be disclosed in
making the repayment schedule disclosure under Sec. 226.18(g).
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Appendix E to Part 226--Rules For Card Issuers That Bill on a
Transaction-By-Transaction Basis
The following provisions of Subpart B apply if credit cards are
issued and (1) the card issuer and the seller are the same or related
persons; (2) no finance charge is imposed; (3) consumers are billed in
full for each use of the card on a transaction-by-transaction basis, by
means of an invoice or other statement reflecting each use of the card;
and (4) no cumulative account is maintained which reflects the
transactions by each consumer during a period of time, such as a month:
Section 226.6(d), and, as applicable, Sec. 226.6(b) and (c). The
disclosure required by Sec. 226.6(b) shall be limited to those charges
that are or may be imposed as a result of the deferral of payment by use
of the card, such as late payment or delinquency charges.
Section 226.7(b) and Sec. 226.7(k). Creditors may comply by placing
the required disclosures on the invoice or statement sent to the
consumer for each transaction.
Section 226.9(a). Creditors may comply by mailing or delivering the
statement required by Sec. 226.6(d) (See appendix G-3) to each consumer
receiving a transaction invoice during a one-month period chosen by the
card issuer or by sending either the statement prescribed by
Sec. 226.6(d) or an alternative billing error rights statement
substantially similar
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to that in appendix G-4, with each invoice sent to a consumer.
Section 226.9(c).
Section 226.10.
Section 226.11. This section applies when a card issuer receives a
payment or other credit that exceeds by more than $1 the amount due, as
shown on the transaction invoice. The requirement to credit amounts to
an account may be complied with by other reasonable means, such as by a
credit memorandum. Since no periodic statement is provided, a notice of
the credit balance shall be sent to the consumer within a reasonable
period of time following its occurrence unless a refund of the credit
balance is mailed or delivered to the consumer within 7 business days of
its receipt by the card issuer.
Section 226.12 including Sec. 226.12(c) and (d), as applicable.
Section 226.12(e) is inapplicable.
Section 226.13, as applicable. All references to periodic statement
shall be read to indicate the invoice or other statement for the
relevant transaction. All actions with regard to correcting and
adjusting a consumer's account may be taken by issuing a refund or a new
invoice, or by other appropriate means consistent with the purposes of
the section.
Section 226.15, as applicable.
[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 46 FR 60190, Dec. 9,
1981]
Appendix F to Part 226--Annual Percentage Rate Computations for Certain
Open-End Credit Plans
In determining the denominator of the fraction under
Sec. 226.14(c)(3), no amount will be used more than once when adding the
sum of the balances \1\ subject to periodic rates to the sum of the
amounts subject to specific transaction charges. In every case, the full
amount of transactions subject to specific transaction charges shall be
included in the denominator. Other balances or parts of balances shall
be included according to the manner of determining the balance subject
to a periodic rate, as illustrated in the following examples of accounts
on monthly billing cycles:
---------------------------------------------------------------------------
\1\ Where a portion of the finance charge is determined by
application of one or more daily periodic rates, the phrase sum of the
balances shall also mean the average of daily balances.
---------------------------------------------------------------------------
1. Previous balance--none.
A specific transaction of $100 occurs on the first day of the
billing cycle. The average daily balance is $100. A specific transaction
charge of 3% is applicable to the specific transaction. The periodic
rate is 1\1/2\% applicable to the average daily balance. The numerator
is the amount of the finance charge, which is $4.50. The denominator is
the amount of the transaction (which is $100), plus the amount by which
the balance subject to the periodic rate exceeds the amount of the
specific transactions (such excess in this case is 0), totaling $100.
The annual percentage rate is the quotient (which is 4\1/2\%)
multiplied by 12 (the number of months in a year), i.e., 54%.
2. Previous balance--$100.
A specific transaction of $100 occurs at the midpoint of the billing
cycle. The average daily balance is $150. A specific transaction charge
of 3% is applicable to the specific transaction. The periodic rate is
1\1/2\% applicable to the average daily balance. The numerator is the
amount of the finance charge which is $5.25. The denominator is the
amount of the transaction (which is $100), plus the amount by which the
balance subject to the periodic rate exceeds the amount of the specific
transaction (such excess in this case is $50), totaling $150. As
explained in example 1, the annual percentage rate is 3\1/2\% x 12 =
42%.
3. If, in example 2, the periodic rate applies only to the previous
balance, the numerator is $4.50 and the denominator is $200 (the amount
of the transaction, $100, plus the balance subject only to the periodic
rate, the $100 previous balance). As explained in example 1, the annual
percentage rate is 2\1/4\% x 12 = 27%.
4. If, in example 2, the periodic rate applies only to an adjusted
balance (previous balance less payments and credits) and the consumer
made a payment of $50 at the midpoint of the billing cycle, the
numerator is $3.75 and the denominator is $150 (the amount of the
transaction, $100, plus the balance subject to the periodic rate, the
$50 adjusted balance). As explained in example 1, the annual percentage
rate is 2\1/2\% x 12 = 30%.
5. Previous balance--$100.
A specific transaction (check) of $100 occurs at the midpoint of the
billing cycle. The average daily balance is $150. The specific
transaction charge is $.25 per check. The periodic rate is 1\1/2\%
applied to the average daily balance. The numerator is the amount of the
finance charge, which is $2.50 and includes the $.25 check charge and
the $2.25 resulting from the application of the periodic rate. The
denominator is the full amount of the specific transaction (which is
$100) plus the amount by which the average daily balance exceeds the
amount of the specific transaction (which in this case is $50), totaling
$150. As explained in example 1, the annual percentage rate would be
1\2/3\% x 12 = 20%.
6. Previous balance--none.
A specific transaction of $100 occurs at the midpoint of the billing
cycle. The average daily balance is $50. The specific transaction charge
is 3% of the transaction amount or
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$3.00. The periodic rate is 1\1/2\% per month applied to the average
daily balance. The numerator is the amount of the finance charge, which
is $3.75, including the $3.00 transaction charge and $.75 resulting from
application of the periodic rate. The denominator is the full amount of
the specific transaction ($100) plus the amount by which the balance
subject to the periodic rate exceeds the amount of the transaction ($0).
Where the specific transaction amount exceeds the balance subject to the
periodic rate, the resulting number is considered to be zero rather than
a negative number ($50-$100=-$50). The denominator, in this case, is
$100. As explained in example 1, the annual percentage rate is 3\3/4\%
x 12 = 45%.
Appendix G to Part 226--Open-End Model Forms and Clauses
G-1 Balance-Computation Methods Model Clauses (Secs. 226.6 and 226.7)
G-2 Liability for Unauthorized Use Model Clause (Sec. 226.12)
G-3 Long-Form Billing-Error Rights Model Form (Secs. 226.6 and 226.9)
G-4 Alternative Billing-Error Rights Model Form (Sec. 226.9)
G-5 Rescission Model Form (When Opening an Account) (Sec. 226.15)
G-6 Rescission Model Form (For Each Transaction) (Sec. 226.15)
G-7 Rescission Model Form (When Increasing the Credit Limit)
(Sec. 226.15)
G-8 Rescission Model Form (When Adding a Security Interest)
(Sec. 226.15)
G-9 Rescission Model Form (When Increasing the Security) (Sec. 226.15)
G-10(A) Applications and Solicitations Model Forms (Credit Cards)
(Sec. 226.5a(b))
G-10(B) Applications and Solicitations Sample (Credit Card)
(Sec. 226.5a(b))
G-10(C) Applications and Solicitations Model Form (Charge Cards)
(Sec. 226.5a(b))
G-11 Applications and Solicitations Made Available to General Public
Model Clauses (Sec. 226.5a(e))
G-12 Charge Card Model Clause (When Access to Plan Offered by Another)
(Sec. 226.5a(f))
G-13(A) Change in Insurance Provider Model Form (Combined Notice)
(Sec. 226.9(f))
G-13(B) Change in Insurance Provider Model Form (Sec. 226.9(f)(2))
G-14A Home Equity Sample
G-14B Home Equity Sample
G-15 Home Equity Model Clauses
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[Reg. Z, 46 FR 20892, Apr. 7, 1981, as amended at 46 FR 60191, Dec. 9,
1981; 54 FR 13868, Apr. 6, 1989; 54 FR 24689, June 9, 1989; 55 FR 38312,
Sept. 18, 1990; 65 FR 58908, Oct. 3, 2000]
Appendix H to Part 226--Closed-End Model Forms and Clauses
H-1--Credit Sale Model Form (Sec. 226.18)
H-2--Loan Model Form (Sec. 226.18)
H-3--Amount Financed Itemization Model Form (Sec. 226.18(c))
H-4(A)--Variable-Rate Model Clauses (Sec. 226.18(f)(1))
H-4(B)--Variable-Rate Model Clauses (Sec. 226.18(f)(2))
H-4(C)--Variable-Rate Model Clauses (Sec. 226.19(b))
H-4(D)--Variable-Rate Model Clauses (Sec. 226.20(c))
H-5--Demand Feature Model Clauses (Sec. 226.18(I))
H-6--Assumption Policy Model Clause (Sec. 226.18(q))
H-7--Required Deposit Model Clause (Sec. 226.18(r))
H-8--Rescission Model Form (General) (Sec. 226.23)
H-9--Rescission Model Form (Refinancing With Original Creditor)
(Sec. 226.23)
H-10--Credit Sale Sample
H-11--Installment Loan Sample
H-12--Refinancing Sample
H-13--Mortgage with Demand Feature Sample
H-14--Variable-Rate Mortgage Sample (Sec. 226.19(b))
H-15--Graduated Payment Mortgage Sample
H-16--Mortgage Sample (Sec. 226.32)
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H-4(C)--Variable-Rate Model Clauses
This disclosure describes the features of the adjustable-rate
mortgage (ARM) program you are considering. Information on other ARM
programs is available upon request.
How Your Interest Rate and Payment Are Determined
Your interest rate will be based on [an index plus a
margin] [a formula].
Your payment will be based on the interest rate, loan
balance, and loan term.
--[The interest rate will be based on (identification of index) plus our
margin. Ask for our current interest rate and margin.]
--[The interest rate will be based on (identification of formula). Ask
us for our current interest rate.]
--Information about the index [formula for rate adjustments] is
published [can be found] ________________.
--[The initial interest rate is not based on the (index) (formula) used
to make later adjustments. Ask us for the amount of current interest
rate discounts.]
How Your Interest Rate Can Change
Your interest rate can change (frequency).
[Your interest rate cannot increase or decrease more than
______ percentage points at each adjustment.]
Your interest rate cannot increase [or decrease] more than
______ percentage points over the term of the loan.
How Your Payment Can Change
Your payment can change (frequency) based on changes in the
interest rate.
[Your payment cannot increase more than (amount or
percentage) at each adjustment.]
You will be notified in writing ________ days before the
due date of a payment at a new level. This notice will contain
information about your interest rates, payment amount, and loan balance.
[You will be notified once each year during which interest
rate adjustments, but no payment adjustments, have been made to your
loan. This notice will contain information about your interest rates,
payment amount, and loan balance.]
[For example, on a $10,000 [term] loan with an initial
interest rate of ________ [(the rate shown in the interest rate column
below for the year 19 ________)] [(in effect (month) (year)], the
maximum amount that the interest rate can rise under this program is
________ percentage points, to ________%, and the monthly payment can
rise from a first-year payment of $________ to a maximum of $________ in
the __________ year. To see what your payments would be, divide your
mortgage amount by $10,000; then multiply the monthly payment by that
amount. (For example, the monthly payment for a mortgage amount of
$60,000 would be: $60,000 $10,000 = 6; 6 x ________ =
$________ per month.)]
[Example
The example below shows how your payments would have changed under
this ARM program based on actual changes in the index from 1982 to 1996.
This does not necessarily indicate how your index will change in the
future.
The example is based on the following assumptions:
Amount................................... $10,000
Term..................................... __________
Change date.............................. __________
Payment adjustment....................... (frequency)
Interest adjustment...................... (frequency)
[Margin] *............................... ________
Caps ________ [periodic interest rate
cap]
________ [lifetime interest rate cap
________ [payment cap]
[Interest rate carryover]
[Negative amortization]
[Interest rate discount] **
Index.......(identification of index or
formula)
* This is a margin we have used recently, your margin may be different.
** This is the amount of a discount we have provided recently; your loan
may be discounted by a different amount.]
----------------------------------------------------------------------------------------------------------------
Margin
Year Index (%) (Percentage Interest Monthly Remaining
points) Rate (%) Payment ($) Balance ($)
----------------------------------------------------------------------------------------------------------------
1982...................................... ............ ............ ............ ............ ............
1983...................................... ............ ............ ............ ............ ............
1984...................................... ............ ............ ............ ............ ............
1985...................................... ............ ............ ............ ............ ............
1986...................................... ............ ............ ............ ............ ............
1987...................................... ............ ............ ............ ............ ............
1988...................................... ............ ............ ............ ............ ............
1989...................................... ............ ............ ............ ............ ............
1990...................................... ............ ............ ............ ............ ............
1991...................................... ............ ............ ............ ............ ............
1992...................................... ............ ............ ............ ............ ............
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1993...................................... ............ ............ ............ ............ ............
1994...................................... ............ ............ ............ ............ ............
1995...................................... ............ ............ ............ ............ ............
1996...................................... ............ ............ ............ ............ ............
----------------------------------------------------------------------------------------------------------------
Note: To see what your payments would have been during that period, divide your mortgage amount by $10,000; then
multiply the monthly payment by that amount. (For example, in 1996 the monthly payment for a mortgage amount
of $60,000 taken out in 1982 would be: $60,000$10,000=6; 6 x ________=$________ per month.)
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H-9--Rescission Model Form (Refinancing with Original Creditor)
NOTICE OF RIGHT TO CANCEL
Your Right to Cancel
You are entering into a new transaction to increase the amount of
credit previously provided to you. Your home is the security for this
new transaction. You have a legal right under federal law to cancel this
new transaction, without cost, within three business days from whichever
of the following events occurs last:
(1) the date of this new transaction, which is ________________; or
(2) the date you received your new Truth in Lending disclosures; or
(3) the date you received this notice of your right to cancel.
If you cancel this new transaction, it will not affect any amount
that you presently owe. Your home is the security for that amount.
Within 20 calendar days after we receive your notice of cancellation of
this new transaction, we must take the steps necessary to reflect the
fact that your home does not secure the increase of credit. We must also
return any money you have given to us or anyone else in connection with
this new transaction.
You may keep any money we have given you in this new transaction
until we have done the things mentioned above, but you must then offer
to return the money at the address below.
If we do not take possession of the money within 20 calendar days of
your offer, you may keep it without further obligation.
How To Cancel
If you decide to cancel this new transaction, you may do so by
notifying us in writing, at
_______________________________________________________________________
(Creditor's name and business address).
You may use any written statement that is signed and dated by you
and states your intention to cancel, or you may use this notice by
dating and signing below. Keep one copy of this notice because it
contains important information about your rights.
If you cancel by mail or telegram, you must send the notice no later
than midnight of
_______________________________________________________________________
(Date)__________________________________________________________________
(or midnight of the third business day following the latest of the three
events listed above).
If you send or deliver your written notice to cancel some other way,
it must be delivered to the above address no later than that time.
I WISH TO CANCEL
_______________________________________________________________________
Consumer's Signature
_______________________________________________________________________
Date
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H-14--Variable-Rate Mortgage Sample
This disclosure describes the features of the adjustable-rate
mortgage (ARM) program you are considering. Information on other ARM
programs is available upon request.
How Your Interest Rate and Payment Are Determined
Your interest rate will be based on an index rate plus a
margin.
Your payment will be based on the interest rate, loan
balance, and loan term.
--The interest rate will be based on the weekly average yield on United
States Treasury securities adjusted to a constant maturity of 1 year
(your index), plus our margin. Ask us for our current interest rate and
margin.
--Information about the index rate is published weekly in the Wall
Street Journal.
Your interest rate will equal the index rate plus our
margin unless your interest rate ``caps'' limit the amount of change in
the interest rate.
How Your Interest Rate Can Change
Your interest rate can change yearly.
Your interest rate cannot increase or decrease more than 2
percentage points per year.