[Federal Register Volume 60, Number 238 (Tuesday, December 12, 1995)]
[Proposed Rules]
[Pages 63660-63663]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-30131]



 ========================================================================
 Proposed Rules
                                                 Federal Register
 ________________________________________________________________________
 
 This section of the FEDERAL REGISTER contains notices to the public of 
 the proposed issuance of rules and regulations. The purpose of these 
 notices is to give interested persons an opportunity to participate in 
 the rule making prior to the adoption of the final rules.
 
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 

  Federal Register / Vol. 60, No. 238 / Tuesday, December 12, 1995 / 
Proposed Rules  

[[Page 63660]]


FEDERAL RESERVE SYSTEM

12 CFR Part 221

[Regulation U; Docket No. R-0905]
RIN 7100-AB65


Securities Credit Transactions; Review of Regulation U, ``Credit 
by Banks for the Purpose of Purchasing or Carrying Margin Stocks''

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Proposed rule.

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SUMMARY: The Board is proposing amendments to Regulation U, the 
regulation that covers extensions of credit by banks that are secured 
in whole or in part by those publicly traded securities defined as 
``margin stock''. These amendments are being proposed as part of the 
Board's program to periodically review its regulations as well as to 
fulfill the requirements of section 303 of the Riegle Community 
Redevelopment and Regulatory Improvement Act of 1994. Two of the most 
important effects of the proposed amendments would be to provide: 
Explicit guidance for banks financing margin stock purchased by their 
customers through a broker-dealer on a delivery-versus-payment (or 
C.O.D.) basis; and greater flexibility for withdrawals and 
substitutions of collateral when margin stock is pledged along with 
cash equivalents and other securities by treating the entire credit as 
a single loan. In addition, amendments would conform Regulation U to 
changes recently proposed for Regulation T regarding increased loan 
value for exchange-traded options and money market mutual funds. 
Technical amendments would update the regulation to reflect a 1991 
Board interpretation allowing lead banks to apply Regulation U to 
syndicated loans independent of other credit extended by syndicate 
banks and restore language indicating that the exemption for temporary 
financing of customer securities transactions does not apply to 
securities purchased at a broker-dealer.

DATES: Comments should be received on or before February 15, 1996.

ADDRESSES: Comments should refer to Docket No. R-0905, and may be 
mailed to William W. Wiles, Secretary, Board of Governors of the 
Federal Reserve System, 20th Street and Constitution Avenue, NW., 
Washington, DC 20551. Comments also may be delivered to Room B-222 of 
the Eccles Building between 8:45 a.m. and 5:15 p.m. weekdays, or to the 
guard station in the Eccles Building courtyard on 20th Street, NW. 
(between Constitution Avenue and C Street, NW.) at any time. Comments 
received will be available for inspection in Room MP-500 of the Martin 
Building between 9 a.m. and 5 p.m. weekdays, except as provided in 12 
CFR 261.8 of the Board's rules regarding availability of information.

FOR FURTHER INFORMATION CONTACT: Scott Holz, Senior Attorney, or Angela 
Desmond, Senior Counsel, Division of Banking Supervision and 
Regulation, (202) 452-2781. For users of Telecommunications Device for 
the Deaf (TDD), please contact Dorothea Thompson, (202) 452-3544.

SUPPLEMENTARY INFORMATION: The Board is proposing amendments to 
Regulation U (12 CFR part 221), ``Credit by Banks for the Purpose of 
Purchasing or Carrying Margin Stocks,'' as part of its program to 
periodically review its regulations and to satisfy requirements under 
section 303 of the Riegel Community Redevelopment and Regulatory 
Improvement Act of 1994. The proposed amendments include coverage of 
bank financing of securities purchased by customers through a broker-
dealer on a cash basis and treatment of mixed-collateral loans (loans 
secured in part by margin stock and in part by other collateral) as a 
single loan if all collateral consists of securities and cash 
equivalents. Conforming amendments are proposed in light of the 
recently published amendments to Regulation T (12 CFR part 220), 
``Credit by Brokers and Dealers'' (see 60 FR 33763; June 29, 1995) that 
would increase the loan value of exchange-traded options and money 
market mutual funds. Two technical amendments are discussed below.
    In addition to the amendments described in this proposal, comment 
is invited on all areas of Regulation U, including (but not limited to) 
whether the regulation can be eliminated, simplified, or the burdens 
imposed thereunder eased.

1. Financing of Securities Purchased on a DVP Basis

    Banks often act as custodians for their customers' securities. 
These securities are generally purchased via a registered broker-dealer 
in a cash account and sent to the bank on a delivery-versus-payment 
(DVP) basis.1 Banks traditionally have not accepted securities in 
a DVP transaction if the customer does not have the funds to make full 
payment on hand at the bank. Accepting securities without having the 
customer's full payment on hand involves a credit relationship similar 
to a customer using a margin account at a broker-dealer.

    \1\  Customers purchase securities at a broker-dealer on either 
a cash or margin basis, using either a cash or margin account. When 
a customer purchases a security on a cash basis, he either deposits 
the full purchase price in the cash account or asks to have the 
security sent to his agent (usually a custodial bank) against full 
payment of the purchase price. This latter method is described in 
section 220.2(e) of Regulation T as a delivery against payment, 
payment against delivery, or C.O.D. transaction and is generally 
referred to by the industry as a DVP transaction.
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    In the past few years, System examiners and staff of the Securities 
and Exchange Commission have alleged that certain banks were financing 
these DVP purchases without documentation and in excess of margin 
requirements contained in Regulation U. The banks were found in 
violation of Regulation U or settled charges without admitting or 
denying their culpability.2

    \2\  See, e.g., SEC v. Hansen, 726 F. Supp. 74 (S.D.N.Y. 1989).
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    Provided customers have sufficient collateral, Board staff believes 
financing of securities purchases can be accommodated within the 
existing provision for revolving-credit agreements found in 
Sec. 221.3(c) of Regulation U, with the addition of some clarifying 
language.3 However, it should be noted that this will not result 
in exactly equal regulation between banks and broker-dealers because 
the combination of Board, SEC, and SRO rules applicable to broker-
dealers in this area cannot be recreated in Regulation 

[[Page 63661]]
U.4 Board staff believes that the supervisory structure for 
banking institutions and the requirement that banks establish credit 
agreements before financing these transactions will lead banks to 
impose some additional limitations themselves, but because the 
additional requirements applicable to broker-dealers are not contained 
in Regulation T, they cannot be imposed by Regulation U.

    \3\ Applying the section on revolving-credit agreements will 
ensure that banks financing such purchases establish credit limits 
for their customers, including limits on intraday trading.
    \4\ Although the Board does not have a maintenance margin in its 
regulations, broker-dealers are required to monitor extensions of 
securities credit under SRO rules, call for additional collateral 
when market values fall below a specified percentage, and sell some 
of the customer's securities if the additional collateral is not 
received. In addition, SRO rules require customers opening margin 
accounts to deposit a minimum amount of equity in cash or securities 
(generally $2000).
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2. Mixed-Collateral Loans

    Regulation U does not apply to extensions of securities credit that 
are not secured at least in part by margin stock. Loans secured in part 
by margin stock and in part by other collateral are known as ``mixed-
collateral'' loans and Regulation U has always required some kind of 
separation for these types of loans. Although a single credit agreement 
may be used,5 Sec. 221.3(e) of Regulation U states that a loan 
secured in part by margin stock and in part by other collateral ``shall 
be treated as two separate loans.'' This separation requirement has 
been the subject of numerous inquiries since the last revision of 
Regulation U and has led to this proposal for a relaxation of the 
regulation in this area.6

    \5\ The ability of a bank to use a single credit agreement was a 
reform instituted in 1983. Before that time, separate credit 
agreements were required for the stock collateral and the nonstock 
collateral.
    \6\ Before 1983, Regulation U covered loans secured by any 
stock. A ``mixed-collateral'' loan was one secured in part by stock 
and in part by other collateral. Now that the regulation's scope has 
been reduced to cover only loans secured by margin stock, a ``mixed-
collateral'' loan is one secured in part by margin stock and in part 
by other collateral. ``Other collateral'' may include stock that 
would have been covered under the previous version of Regulation U 
and therefore not subject to the provisions covering mixed-
collateral loans. This reduction in the scope of the regulation had 
the unintended effect of reducing the flexibility for withdrawals 
and substitutions of collateral for mixed-collateral loans.
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    The section on mixed-collateral loans does not present a problem 
when first applied at the time the loan commitment is made, as it 
merely requires a bank to determine the loan value of margin stock 
collateral and then verify that the other collateral has a good faith 
loan value sufficient to make up the difference between the loan value 
of the margin stock and the amount of credit being extended and to 
allocate the credit secured by each tranche.
    There have been, however, a number of inquiries concerning the 
interplay of Sec. 221.3(e) (mixed-collateral loans) and Sec. 221.3(f) 
(withdrawals and substitutions) of Regulation U. As an example, suppose 
the value of a customer's nonmargin stock collateral has increased over 
time but the value of the margin stock has not. In spite of the fact 
that the overall value of the collateral has increased, the customer 
cannot withdraw margin stock because this ``separate'' loan does not 
have sufficient loan value to permit the withdrawal. In other words, 
changes in collateral value in one tranche have no effect on the other 
tranche. This separation requirement makes collateral management 
extremely difficult.
    Board staff has tried to respond to inquiries in this area through 
interpretation of the existing regulation.7 However, in light of 
the growth of revolving credit agreements secured by more than just 
margin stock, it appears that the current rule is unnecessarily 
burdensome to effectuate the statutory scheme of regulation.8

    \7\ See, e.g., Federal Reserve Regulatory Service 5-923.2, 5-
923.41, and 5-923.42.
    \8\ Many customers who have securities to pledge as collateral 
have more than just margin stock (they often have debt securities as 
well). The section on mixed-collateral loans presumes there will be 
no change in the collateral once it has been pledged. The number of 
inquiries in this area is an indication that this is often not the 
case.
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    The proposed amendment to the section on mixed collateral loans 
would still require the regulatory segregation of collateral, but would 
expand the types of collateral that could be securing loans that 
currently can only be secured by margin stock to include all financial 
instruments (stocks, bonds, and cash equivalents).9 Acting in good 
faith, a bank would be able to value all financial instruments in 
accordance with the margin requirements in the Supplement to Regulation 
U (Sec. 221.8) and permit substitutions within this group in conformity 
with the section on withdrawals and substitutions, meaning the 
aggregate loan value of the substituted collateral must at least equal 
the aggregate loan value of the collateral withdrawn. Under the 
proposed amendment, credit secured by nonfinancial collateral, such as 
real estate, would continue to be treated as a separate loan. Comment 
is invited on the continuing need for separation of collateral between 
financial instruments and other collateral.

    \9\ One of the goals of the section on mixed-collateral loans is 
to ensure that a lender does not inflate the loan value of nonmargin 
collateral to offset the fact that the margin regulations limit the 
value of margin stock to 50 percent of its current market value. 
Most financial instruments have readily available prices, lessening 
the possibility for evasion of the margin requirements. Other 
collateral, such as real estate, boats and automobiles, is more 
likely to have a less well agreed upon market value.
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3. Conforming Amendments

    Although the Board's margin regulations provide a level playing 
field for lenders extending purpose credit secured by margin stock, 
statutory and other considerations have always made the scope of 
Regulations G and U less broad than that of Regulation T.10 Two of 
the proposed amendments to Regulation T would make it less restrictive 
than Regulation U, leading the Board to propose conforming amendments. 
The two amendments would allow 50 percent margin for exchange-traded 
options (currently given no loan value) and good faith loan value for 
money market mutual funds (currently given 50 percent loan value). In 
addition, the definitions of ``cash equivalent'' and ``examining 
authority'' would be added from the Regulation T proposal to the 
definitional section of Regulation U.

    \10\ For example, although the Securities Exchange Act of 1934 
requires the Board to set margins for all purchases of securities, 
it specifically excludes bank loans on nonconvertible debt 
securities.
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4. Technical Amendments

    Two technical amendments are proposed. The first would add a 
sentence to the ``single-credit rule'' to reflect a 1991 Board 
interpretation allowing the lead bank to perform Regulation U 
compliance for syndicated loans. The other would reinsert language 
inadvertently deleted in 1983 from one of the Regulation U exemptions 
for credit extended to persons other than broker-dealers.11

    \11\  The exemption for credit to a customer to temporarily 
finance the purchase or sale of securities for prompt delivery 
contained a restriction prohibiting its use for securities purchased 
at a broker-dealer. This restriction was inadvertently dropped in 
1983 and it is being reinserted.
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5. Section-by-Section Explanation of Proposed Changes to Regulation U

Section 221.1  Authority, Purpose and Scope.

    No substantive changes.

Section 221.2  Definitions.

    (1) Eliminate letter designations for definitions in Sec. 221.2 and 
references thereto in Secs. 221.1(b), 221.3(a) and 221.7(c)(2).
    (2) Add definitions (from Regulation T) for cash equivalent and 
examining authority (referred to in Sec. 221.5(c)(9)(ii)). 

[[Page 63662]]

    (3) Exclude money market funds from definition of margin stock so 
as to give allow them good faith loan value.
    (4) Edit statement in definition of maximum loan value that 
``[p]uts, calls and combinations thereof have no loan value'' to 
reflect loan value for exchange-traded options.

Section 221.3  General Requirements

221.3(a)--General Rule
    (1) Edit statement in general rule that collateral other than 
margin stock has good faith loan value to reflect fact that puts and 
calls that do not qualify as margin stock have no loan value.
221.3(c)--Revolving-Credit or Multiple-Draw Agreements
    (2) Expand subsection to cover financing of securities purchased on 
a payment-against-delivery (or DVP) basis.
    (3) Clarify that FR U-1 is always taken when arrangement is 
established and must be amended for subsequent disbursements if (i) all 
collateral is not pledged up front, or (ii) collateral has been 
withdrawn or substituted between disbursements.
221.3(d)--Single Credit Rule
    (4) Clarify that single credit rule does not cover syndicated loans 
(see Board Interpretation on loan participations in section 221.124 of 
Regulation U).
221.3(e)--Mixed Collateral Loans
    (5) Alter application of rule so that instead of separating margin 
stock collateral from nonmargin stock collateral, securities and cash 
equivalents are separated from other types of collateral.

Section 221.4  Agreements of Nonmember Banks

    Editorial change reflects combining of Forms FR T-1 and FR T-2.

Section 221.5   Special Purpose Loans to Brokers and Dealers

    No substantive changes.

Section 221.6   Exempted Transactions

    Restore language to 221.6(f) that credit is not to be used by a 
customer to purchase securities from a broker-dealer.

Section 221.7   OTC List

    No substantive changes.

Section 221.8  Supplement

    Allow options that qualify as margin stock the same loan value as 
other margin stock.

Regulatory Flexibility Act

    As noted in the summary, the proposed amendments should improve the 
regulation by providing explicit guidance on certain lending practices 
and greater flexibility in verifying compliance for certain types of 
loans. The Board believes there will be a beneficial economic impact if 
this proposal is adopted. Comments are invited on this statement.

Paperwork Reduction Act

    In accordance with section 3506 of the Paperwork Reduction Act of 
1995 (44 U.S.C. Ch. 35; 5 CFR 1320 Appendix A.1), the Board reviewed 
the proposed rule under the authority delegated to the Board by the 
Office of Management and Budget. Comments on the collections of 
information should be sent to the Office of Management and Budget, 
Paperwork Reduction Project (7100-0115), Washington, DC 20503, with 
copies of such comments to be sent to Mary M. McLaughlin, Federal 
Reserve Board Clearance Officer, Division of Research and Statistics, 
Mail Stop 97, Board of Governors of the Federal Reserve System, 
Washington, DC 20551.
    The collection of information requirements in this proposed 
regulation are found in 12 CFR part 221. This information is required 
by Regulation U and authorized by the Securities Exchange Act of 1934 
(15 U.S.C. 78g and 78w). The respondents are for-profit financial 
institutions. Records must be retained for three years after the credit 
is extinguished.
    The Federal Reserve may not conduct or sponsor, and an organization 
is not required to respond to, this information collection unless it 
displays a currently valid OMB control number. The OMB control number 
is 7100-0115.
    No additional reporting requirements or modifications to existing 
recordkeeping requirements are proposed. The current estimated burden 
is 4 minutes per response. There are 10,637 subject respondents making 
an estimated average of 212 of the subject loans annually, for a total 
of 157,853 hours of annual burden for recordkeeping. Based on an hourly 
cost of $20, the annual cost to the public is estimated to be 
$3,157,060.
    Because the records would be maintained at banks and the notices 
are not provided to the Federal Reserve, no issue of confidentiality 
under the Freedom of Information Act arises.
    Comments are invited on: (a) Whether the proposed collection of 
information is necessary for the proper performance of the Federal 
Reserve's functions; including whether the information has practical 
utility; (b) the accuracy of the Federal Reserve's estimate of the 
burden of the proposed information collection, including the cost of 
compliance; (c) ways to enhance the quality, utility, and clarity of 
the information to be collected; and (d) ways to minimize the burden of 
information collection on respondents, including through the use of 
automated collection techniques or other forms of information 
technology.

List of Subjects in 12 CFR Part 221

    Banks, banking, Brokers, Credit, Federal Reserve System, Margin, 
Margin requirements, Investment companies, Investments, Reporting and 
recordkeeping requirements, Securities.

    For the reasons set out in the preamble, the Board proposes to 
amend 12 CFR Part 221 as follows:

PART 221--CREDIT BY BANKS FOR THE PURPOSE OF PURCHASING OR CARRYING 
MARGIN STOCK (REGULATION U)

    1. The authority citation for Part 221 is revised to read as 
follows:

    Authority: 15 U.S.C. 78c, 78g, 78h, 78q, and 78w.


Sec. 221.1  [Amended]

    2. Section 221.1(b) is amended by removing the word 
``Sec. 221.2(b)'' and adding ``Sec. 221.2'' in its place.
    3. Section 221.2 is amended as follows:
    a. By removing the alphabetic paragraph designations from the 
definitions and placing the definitions in alphabetical order;
    b. By removing the paragraph designation (1) in front of the 
definition of Bank, by designating the text following the work Bank as 
paragraph (1), by revising newly designated paragraph (1) introductory 
text and paragraph (2) introductory text;
    c. By adding new definitions in alphabetical order for Cash 
equivalent and Examining authority;
    d. By removing the period at the end of paragraph (6)(iii) and 
adding ``; or'' in its place, and by adding new paragraph (6)(iv) to 
the definition of Margin stock;
    e. By revising the third sentence of the definition of Maximum loan 
value.
    The additions and revisions read as follows:


Sec. 221.2  Definitions.

* * * * *
    Bank (1) Has the meaning given to it in section 3(a)(6) of the Act 
(15 U.S.C. 78c(a)(6)) and includes:
* * * * *
    (2) Bank does not include:
* * * * * 

[[Page 63663]]

    Cash equivalent means negotiable bank certificates of deposit, 
bankers acceptances issued by banking institutions in the United States 
and payable in the United States, and 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 a money market fund in compliance 
with all applicable requirements of SEC Rule 2a-7 (17 CFR 270.2a-7).
* * * * *
    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 (SEC) 
as the examining authority for the creditor.
* * * * *
    Margin stock * * *
    (6) * * *
    (iv) A company which is a money market fund in compliance with all 
applicable requirements of SEC Rule 2a-7 (17 CFR 270.2a-7).
    Maximum loan value * * * Puts, calls and combinations thereof that 
do not qualify as margin stock have no loan value. * * *
* * * * *
    4. Section 221.3 is amended as follows:
    a. By revising the last sentence of paragraph (a)(1);
    b. By revising paragraph (c);
    c. By adding a sentence to the end of paragraph (d)(1);
    d. By revising paragraph (e). The revisions and additions read as 
follows:


Sec. 221.3  General requirements.

    (a) * * * (1) * * * All other collateral, except for puts and 
calls, has good faith loan value, as defined in Sec. 221.2 of this 
part.
* * * * *
    (c) Purpose statement for agreements involving revolving or 
multiple-draw credit or financing of securities purchases on a payment-
against-delivery basis. (1) If a bank extends credit, secured directly 
or indirectly by any margin stock, in an amount exceeding $100,000, 
under an agreement involving revolving or other multiple-draw credit or 
financing of securities purchases on a payment-against-delivery basis, 
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) 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.
    (2) 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 the maximum loan value of the collateral at least equals 
the aggregate amount of funds actually disbursed or at the end of any 
day on which credit is extended under the agreement, the bank calls for 
additional collateral sufficient bring the credit into compliance with 
Sec. 221.8 (the Supplement). For any purpose credit disbursed under the 
agreement, the bank shall obtain and attach to the executed Form FR U-1 
a current list of collateral which adequately supports all credit 
extended under the agreement.
    (d) * * * (1) * * * Syndicated loans need not be aggregated with 
other unrelated purpose credit extended by the same bank.
* * * * *
    (e) Mixed collateral loans. (1) A purpose credit secured in part by 
margin stock and in part by collateral other than securities and cash 
equivalents shall be treated as two separate loans, one secured by 
margin stock and any other securities and cash equivalents and one by 
all other collateral. A bank may use a single credit agreement, if it 
maintains records identifying each portion of the credit and its 
collateral.
    (2) A purpose credit secured entirely by securities and cash 
equivalents may be treated as a single loan.
* * * * *
    5. Section 221.4 is amended by revising the parenthetical phrase in 
the middle of paragraph (a) to read as follows:


Sec. 221.4  Agreements of nonmember banks.

    (a) * * * (See Form FR T-1, T-2) * * *
* * * * *
    6. Section 221.6 is amended by revising paragraph (f) to read as 
follows:


Sec. 221.6  Exempted transactions.

* * * * *
    (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;
* * * * *
    7. Section 221.7 is amended by revising paragraph (c)(2) to read as 
follows:


Sec. 221.7  Requirements for the list of OTC margin stocks.

* * * * *
    (c) * * *
    (2) No longer substantially meets the provisions of paragraph (b) 
of this section or the definition of OTC margin stock in Sec. 221.2 of 
this part.
* * * * *
    8. Section 221.8 is amended by revising paragraphs (a) and (c) to 
read as follows:


Sec. 221.8  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 percent of its current market value.
* * * * *
    (c) Maximum loan value of options. Except for options that qualify 
as margin stock, puts, calls, and combinations thereof have no loan 
value.

    By order of the Board of Governors of the Federal Reserve 
System, December 6, 1995.
William W. Wiles,
Secretary of the Board.
[FR Doc. 95-30131 Filed 12-11-95; 8:45 am]
BILLING CODE 6210-01-P