§ 221.3

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Miscellaneous provisions.

(a) In determining whether or not a loan is for the purpose specified in § 221.1 or for any of the purposes specified in § 221.2, a bank may rely upon a statement with respect thereto only if such statement (1) is signed by the borrower; (2) is accepted in good faith and signed by an officer of the bank as having been so accepted; and (3) if it merely states what is not the purpose of the loan, is supported by a memorandum or notation of the lending officer describing the purpose of the loan. To accept the statement in good faith, the officer must be alert to the circumstances surrounding the loan and the borrower and must have no information which would put a prudent man upon inquiry and if investigated with reasonable diligence would lead to the discovery of the falsity of the statement.

(b) (1) A loan made to a borrower when he has owned a stock registered on a national securities exchange free of any lien for a continuous period of as much as one year need not be treated as a loan for the purpose of "carrying" that stock unless the loan is for the purpose of reducing or retiring indebtedness incurred to purchase that stock. A loan also need not be treated as a loan for the purpose of "carrying" a stock registered on a national securities exchange if the loan is for the purpose of meeting emergency expenses not reasonably foreseeable or meeting recurring expenses the borrower has customarily met by temporary borrowing.

(m) Indebtedness "subject to § 221.1" is indebtedness which is secured directly or indirectly by any stock (or made to a person described in paragraph (q) of this section), is for the purpose of purchasing or carrying any stock registered on a national securities exchange, and is not excepted by § 221.2.

(n) (1) The bank shall identify all the collateral used to meet the collateral requirements of § 221.1 (entire indebtedness being considered a single loan and collateral being similarly considered, as required by § 221.1) and shall not cancel the identification of any portion thereof except in circumstances that would permit the withdrawal of that portion. Such identification may be made by any reasonable method. and in the case of indebtedness outstanding at the opening of business on June 15, 1959 need not be made until immediately before some change in that or other indebtedness of the borrower or in collateral therefor.

(2) Only the collateral required to be so identified shall have loan value for purposes of § 221.1 or be subject to the restrictions therein specified with respect to withdrawals and substitutions; and

(3) For any indebtedness of the same borrower that is not subject to § 221.1 (other than a loan described in § 221.2 (d), (f), (g), or (h)), the bank shall in good faith require as much collateral not so identified as the bank would require

(if any) if it held neither the indebtedness subject to § 221.1 nor the identified collateral. This shall not be construed, however, to require the bank, after it has made any loan, to obtain any collateral therefor because of any deficiency in collateral already existing at the opening of business on June 15, 1959, or any decline in the value or quality of the collateral or in the credit rating of the borrower. It also does not require a bank to waive or forego any lien. In addition, it shall not apply to a loan to enable the borrower to meet emergency expenses not reasonably foreseeable, provided the loan is supported by a statement of the borrower describing the circumstances, accepted in good faith and signed by an officer of the bank as having been so accepted.

(q) Any loan to a person not subject to this part (Regulation U) or to Part 220 of this chapter (Regulation T) engaged principally, or as one of the person's important activities, in the business of making loans for the purpose of purchasing or carrying stocks registered on a national securities exchange, is a loan for the purpose of purchasing or carrying stocks so registered unless the loan and its purposes are effectively and unmistakably separated and disassociated from any financing or refinancing, for the borrower or others, of any purchasing or carrying of stocks so registered. Any loan to any such borrower, unless the loan is so separated and disassociated or is excepted by § 221.2, is a loan "subject to § 221.1" regardless of whether or not the loan is secured by any stock; and no bank shall make any such loan subject to § 221.1 to any such borrower on or after June 15, 1959, without collateral or without the loan being secured as would be required by this part if it were secured by any stock. Any such loan subject to § 221.1 to any such borrower, whether or not made after June 15, 1959, shall be subject to the other provisions of this part applicable to loans subject to § 221.1, including provisions regarding withdrawal and substitution of collateral.

(r) If, on or after June 15, 1959, a loan is made for the purpose of purchasing or carrying a security other than a stock registered on a national securities exchange and the loan is secured by the security, but subsequently there is sub

stituted as direct or indirect collateral for the loan a stock so registered which is acquired by the borrower through the conversion or exchange of the security pursuant to its terms, the loan shall thereupon be deemed to be for the purpose of purchasing or carrying a stock so registered. In any such case, the amount of the outstanding loan, or such amount plus any increase therein to enable the borrower to acquire the stock so registered, shall not be permitted on the date such stock is substituted as collateral to exceed the maximum loan value of the collateral for the loan on such date, and thereafter such indebtedness shall be treated as subject to § 221.1: Provided, however, That any reduction in the loan or deposit of collateral required on that date to meet this requirement may be brought about within 30 days of such substitution

CODIFICATION: § 221.3 was amended as follows by Regulation U, 24 F.R. 3868, May 14, 1959:

1. Paragraphs (a), (b)(1), (d), (j), (m), and (n) were amended as set forth above. 2. Paragraphs (q) and (r) was added. § 221.4 Supplement.

(a) Maximum loan value of stocks. For the purpose of § 221.1, the maximum loan value of any stock, whether or not registered on a national securities exchange, shall be 10 percent of its current market value, as determined by any reasonable method.

(b) Retention requirement. For the purpose of § 221.1, in the case of a loan which would exceed the maximum loan value of the collateral following a withdrawal of collateral, the "retention requirement" of a stock, whether or not registered on a national securities exchange, shall be 50 percent of its current market value, as determined by any reasonable method.

(Sec. 11, 38 Stat. 262; 12 U.S.C. 248. Interprets or applies secs. 2, 3, 7, 17, 23, 48 Stat. 881, 882, 886, 897, 901, as amended; 15 U.S.C. 78b, 78c, 78g, 78q, 78w) [Reg. U, 24 F.R. 3689 May 14, 1959]

Stat. 881) and in accordance with § 221.3 (j), the Board has, effective December 15, 1959, adopted Form FR 728,1 to be used by persons (other than banks, as defined in § 221.3 (k), and creditors, as defined in § 220.2(b) (Reg. T)) who are engaged in the business of extending credit and who, in the ordinary course of business, extend credit for the purpose of purchasing or carrying securities registered on a national exchange. Persons

whose activities as of December 15, 1959 bring them within the scope of the above definition must return the filled-in form to the Federal Reserve Bank in their district on or before March 15, 1960. Persons who were not extending credit on or before December 15, 1959 for the said purpose, but whose activities at any time or from time to time thereafter bring them within the scope of the above definition, must file filled-in forms within 90 days after the first extension of credit for such purpose. Requests for extensions of time for filing must be made in writing, setting forth the reasons for the request, addressed to the Federal Reserve Bank in the District of the person requesting the extension. [Reg. U, 24 F.R. 10331, Dec. 22, 1959]

§ 221.110

INTERPRETATIONS

Questions arising under Regulation U.

(a) Regulation U governs "any loan" made by a bank "secured directly or indirectly by any stock for the purpose of purchasing or carrying any stock registered on a national securities exchange", with certain exceptions, and provides that the maximum loan value of such stock shall be a fixed percentage "of its current market value, as determined by any reasonable method."

(b) The Board of Governors has recently had occasion to consider the application of this language to the three following questions:

(1) Loan secured by stock. First, is a loan to purchase or carry registered stock subject to Regulation U where made in unsecured form, if stock is subsequently deposited as security with the

1 Filed as part of the original document. Copies available upon request to the Board of Governors of the Federal Reserve System, Washington 25, D.C., or to any Federal Reserve Bank.

lending bank, 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 the Regulation, 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 Bull. 951.

(ii) Where security is involved, standards of interpretation should be equally searching. If, for example, the original agreement between borrower and bank contemplated that the loan should be secured by registered 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 the regulation applies to a loan "secured directly or indirectly by any stock".

(2) Loan to acquire controlling shares. (i) The second question is whether the Regulation governs a 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 the Regulation is directed solely toward purchases of stock for speculative or investment purposes. The Board answered that a stock-secured loan for the purpose of purchasing or carrying registered stock is subject to the Regulation, regardless of the reason for which the purchase is made.

Regulation, 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 section 1.

(3) Determination of "current market value." (i) The third question is how to determine the "current market value" of a block of registered stock which represents a controlling interest in a corporation where the block is purchased at a price in excess of the average of bid and asked prices on the Exchange for the day of the purchase, and also in excess of the average price on the Exchange over recent months, while the parties to the loan, on the other hand, believe the purchase to be a bargain and report opportunities to resell at a price which is higher still. In a case of this kind, the Board believes that the current market value of the block is the price at which the actual purchase was made.

(ii) The Supplement to Regulation U states that current market value shall be determined by "any reasonable method". Regulation T, which, while not controlling, may throw some light on the problem, provides that the current market value of a security "throughout the day of its purchase or sale" shall be "total cost or the net proceeds of its sale." The Board is of the opinion that actual sale price in an arm's length transaction provides the best evidence of value. ticularly in circumstances such as those indicated above, it must be assumed that this price reflects intangible factors including control.

Par

over the maximum loan value is not thereby increased and the substitution occurs in the form of a purchase and sale of collateral, both the purchase and sale orders being executed on the same day.

(b) The bank may permit such a purchase-and-sale substitution under the amended part without additional collateral or reduction in the loan if it reasonably ascertains, and has evidence thereof in its records, that the purchase and sale orders were executed on the same day. The controlling events which must occur on the same day are the executions of the purchase order and sale order, and not the bank's receipt or release of stock certificates. It may be noted that the result is substantially similar to that under the June 15, 1959, amendments to Part 220 of this subchapter. Substitutions that do not involve a same-day purchase and sale are subject to the withdrawal limitations under both parts.

[Reg. U, 24 F.R. 4698, June 10, 1959]

§ 222.110

Loans of "Federal funds" between banks in same holding company system.

(a) The questions has been asked whether "sales" of Federal funds, at current rates of interest, between bank subsidiaries of a holding company would constitute loans or extensions of credit within the purview of sections 6(a) (4) of the Bank Holding Company Act, which forbids a bank "to make any loan, discount or extension of credit to a bank holding company of which it is a subsidiary or to any other subsidiary of such bank holding company."

(b) For many years the Federal Reserve System and other bank supervisory authorities have regarded such inter-bank transfers of Federal Reserve credit as loans (see 1930 Fed. Res. Bul

letin 81), and the Board finds no reason

to infer that these transactions have a different status under the Holding Company Act. Accordingly, in the Board's opinion, a sale of Federal funds would constitute a prohibited "loan" or extension of credit" under section 6(a) (4).

(c) It is also the Board's view that sales of Federal funds are not exempted from the prohibitions of section 6(a) by the following provision of the last paragraph of that subsection:

Noninterest-bearing deposits to the credit of a bank shall not be deemed to be a loan or advance to the bank of deposit

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The 1930 ruling, cited above, clearly indicates that funds so transferred are not deposits in the "purchasing" bank. Accordingly, the quoted exception would not exempt Federal-funds transactions even if such transactions were on a noninterest-bearing basis.

(Sec. 5(b), 70 Stat. 137; 12 U.S.C. 1844) [Reg. Y, 24 F.R. 279, Jan. 13, 1959]

§ 222.111

Percentage limitation on acquisition of stock in small-business investment company.

(a) An interpretation of the Board (§ 222.107) published at 23 F.R. 7813 dealt with the question of whether, and to what extent, the Bank Holding Company Act of 1956 permits a bank holding company or its subsidiary banks to acquire shares in a small business investment company ("SBIC") organized pursuant to the Small Business Investment Act of 1958 ("SBI Act").

(b) That interpretation pointed out that the general prohibition in section 4 of the Bank Holding Company Act against a bank holding company's acquiring "direct or indirect ownership or control of any voting shares of any company which is not a bank or a bank holding company" is subject to an exemption in section 4(c) (4) for stocks of the kinds and amounts eligible for investment by a national bank; that section 302(b) of the SBI Act permits a national bank to purchase shares of stock in SBIC's "in an amount aggregating [not] more than one per cent of [the bank's] capital and surplus"; and that, accordingly, a bank holding company may invest in stock of an SBIC up to the specified one per cent. The interpretation also expressed the view, however, that section 6(a)(1) of the Bank Holding Company

Act applies a further limitation to banking subsidiaries of a bank holding company; and that under that section such a subsidiary bank could not invest in the stock of an SBIC if the SBIC is, or would become by the investment, a "subsidiary" of the bank's parent holding company.

(c) Two further questions have arisen concerning the amount of stock of an SBIC that may be acquired by a bank holding company. The first relates to the definition of "capital and surplus" under the one percent limitation of section 302 (b) of the SBI Act. Since the amount of SBIC stock eligible for investment by a national bank under the SBI Act is limited to one percent of the bank's capital and surplus, it is the Board's view that the amount eligible for investment by a bank holding company is similarly limited to one percent of the holding company's capital and surplus. In order to apply this limitation, however, it is necessary to define the term "capital and surplus." While the matter is not entirely free from doubt, it is the opinion of the Board that, since neither the SBI Act nor its legislative history supplies a definition, the term should be interpreted in accordance with generally accepted accounting and reporting procedures applicable to the investing entity, in the present case, the bank holding company.

(d) The second question concerns the method of applying the one percent limitation stated in section 302 (b) of the SBI Act when ali or part of the shares of the SBIC are owned by a subsidiary of the bank holding company. For example, the SBIC shares might be owned by a bank holding company which is a subsidiary of another bank holding company, or by a subsidiary bank in a case where the SBIC is not a subsidiary of the bank's parent holding company. Since ownership or control of stock by a subsidiary should be regarded as indirect ownership or control of such stock by the parent, the Board is of the opinion that the amount invested in an SBIC by the holding company and by its subsidiaries must be added together to determine whether the total amount directly and indirectly invested by the holding company exceeds the amount permissible, that is to say, exceeds one percent of the holding company's capital and surplus. Assuming that no other