§ 208.127 - Payment of dividends exceeding net profits to date of declaration.

(a) Section 5199(b) of the Revised Statutes of the United States (12 U.S.C. 60) and the sixth paragraph of section 9 of the Federal Reserve Act (12 U.S.C. 324), provide in effect that “the approval of the Comptroller of the Currency (or the Board of Governors) shall be required if the total of all dividends declared by such association (a national bank or a member State bank) in any calendar year shall exceed the total of its net profits of that year combined with its retained net profits of the preceding two years.”

(b) The question has been presented whether the Board's approval must be obtained when the amount of a dividend proposed to be declared by a member State bank, prior to the end of the calendar year, would exceed the total of the bank's net profits up to the date of the declaration, combined with its retained net profits of the preceding 2 years.

(c) If the question related only to the literal meaning of words, divorced from the statute's underlying purpose and from the factual situations to which it relates, it might be contended that since the statute refers to “all dividends declared * * * in any calendar year” and “the total of its net profits of that year”, its applicability cannot be determined until the calendar year is completed. As explained below, however, such an interpretation is not required by the language of the statute and would substantially defeat its purpose, as revealed by the legislative history; and consequently it is believed that the statute should be construed as relating to dividends declared, and to net profits, in the calendar year up to the date of such declaration.

(d) The purpose of the statute was described as follows by the Senate Banking Committee:

(1) It seems that Congress had in mind the following test: At the time the dividend is declared, does the bank have available, from profits of the current calendar year and the 2 preceding calendar years, enough profits to cover the dividend? If not, the dividend may not be declared and paid unless the Comptroller or the Board of Governors specifically approves, in view of the circumstances of the particular case.

(2) Bearing in mind the Senate Committee's reference to “dissipating needed capital funds,” it is obvious that the danger that a proposed dividend would unduly weaken a bank's capital structure is just as great if the dividend is declared in June as if it is declared in December. If a bank does not have profits on hand sufficient to cover a proposed dividend, the fact that the declaration is made in 1 month rather than in another has little or no bearing on the extent to which payment of the dividend may unduly diminish the capital “cushion” on which depend the bank's continued existence and the safety of its depositors.

(e) An illustration may be helpful. For simplicity, let us assume that a member State bank opened for business on January 1, 1959, with a capital structure of $300,000, as required by the supervisory authorities. The bank had no net profit in 1959 or 1960. Up to June 30, 1961, it still has no net profits, but nevertheless the directors declare a dividend of $20,000 on that date. The bank's capital structure is thereby reduced from $300,000 to $280,000. It seems that this was precisely what Congress intended should not happen unless the Board of Governors approved the dividend, for adequate reasons. An undesirable situation would exist, and the Congressional purpose would be defeated, if such a weakening of the bank's capital structure were permissible if the dividend was declared and paid (without supervisory approval) in June, whereas the same action would involve a violation of the statute if the dividend was declared and paid, instead, in December. This might actually mean that no violation of section 5199(b) could occur except with respect to end-of-year dividends—unless, perhaps, it could be established that the bank's directors, when they declared the dividend earlier in the year, knew (or had reason to believe) that the bank's net profits for the entire year would not be sufficient.

(f) The statutory reference to “all dividends declared * * * in any calendar year” can be interpreted, even from the viewpoint of literal meaning, as referring to dividends declared in a calendar year up to the date of declaration. Particularly because the clear Congressional purpose would otherwise be largely defeated, it is concluded that this is the correct interpretation and that, consequently, the declaration by the member State bank, without the Board's approval, of a dividend in the amount of $20,000 would be in violation of the applicable statutes, since the amount of that dividend would exceed “the total of (the bank's) net profits of that year combined with its retained net profits of the preceding two years.”