98-871. Securities Credit Transactions; Borrowing by Brokers and Dealers

[Federal Register Volume 63, Number 11 (Friday, January 16, 1998)]
[Rules and Regulations]
[Pages 2806-2839]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-871]

[[Page 2805]]

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Part III

Federal Reserve System

_______________________________________________________________________

12 CFR Parts 207, 220, 221, 224, and 265

Securities Credit Transactions; Borrowing by Brokers and Dealers; Final
Rule

12 CFR Parts 207, 220, 221, 224, and 265

Securities Credit Transactions; Proposed Rule

Federal Register / Vol. 63, No. 11 / Friday, January 16, 1998 / Rules
and Regulations

[[Page 2806]]

FEDERAL RESERVE SYSTEM

12 CFR Parts 207, 220, 221, 224 and 265

[Regulations G, T, U and X; Docket Nos. R-0905, R-0923 and R-0944]

Securities Credit Transactions; Borrowing by Brokers and Dealers

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Final rule.

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SUMMARY: The Board is adopting final amendments to Regulations G, T and
U, the Board's securities credit regulations. These amendments are
based on proposed amendments issued for comment by the Board in
December 1995 (Docket R-0905), April 1996 (Docket R-0923) and November
1996 (Docket R-0944). The final amendments include the extension of
Regulation U to cover lenders formerly subject to Regulation G and the
elimination of Regulation G. The amendments reduce regulatory
distinctions between broker-dealers, banks, and other lenders and
implement changes to the Board's securities credit regulations to
reflect changes to the Board's statutory authority under the Securities
Exchange Act of 1934, as amended by the National Securities Markets
Improvement Act of 1996. Conforming changes are also made to Regulation
X, ``Borrowers of Securities Credit'' and the Board's Rules Regarding
Delegation of Authority.

DATES: Effective date: April 1, 1998.
Compliance date: Compliance with the revised Regulation T (12 CFR
part 220) is optional until July 1, 1998.

FOR FURTHER INFORMATION CONTACT: Oliver Ireland, Associate General
Counsel (202) 452-3625; Scott Holz, Senior Attorney (202) 452-2966,
Jean Anderson, Staff Attorney, (202) 452-3707, Legal Division; for the
hearing impaired only, Telecommunications Device for the Deaf (TDD),
Diane Jenkins (202) 452-3544.

SUPPLEMENTARY INFORMATION: Discussed below are final amendments to the
Board's securities credit regulations based on three requests for
comment issued in 1995 and 1996. The December 1995 request (Docket R-
0905; 60 FR 63660, Dec. 12, 1995) covered only Regulation U and dealt
with mixed collateral loans and the financing of purchases effected on
a delivery-versus-payment basis. The April 1996 request (Docket R-0923;
61 FR 20399, May 6, 1996) dealt primarily with credit extended to
customers by broker-dealers and other lenders, such as loan value for
securities under Regulations G, T and U and the account structure of
Regulation T. The November 1996 request (Docket R-0944; 61 FR 60168,
Nov. 26, 1996) was issued in response to the changes in the Board's
margin authority contained in the National Securities Markets
Improvement Act of 1996 (NSMIA) and dealt primarily with borrowing by
broker-dealers from any lender and the borrowing and lending of
securities by broker-dealers.
The statutory changes from NSMIA regarding borrowing by broker-
dealers require parallel amendments to the Board's various margin
regulations and are discussed first. The second section deals with
amendments to Regulation T and the third section with amendments to
Regulations G and U. The final section describes a conforming change to
Regulation X.
In a separate document published elsewhere in today's Federal
Register the Board is issuing an advance notice of proposed rulemaking
to solicit views on any further amendments to its margin regulations
that should be proposed to complete the Board's periodic review of
these regulations.

Table of Contents

I. Borrowing by Broker-Dealers
A. All Regulations: Implementation of NSMIA
1. Scope section vs. the definition of customer
2. Appropriateness of adopting a ``substantial'' test
3. Test for determining ``substantial'' customer business
a. Description of test
b. ``Safe harbor'' status of test
c. Burden of proof for exempt borrower status
4. Borrowing exemption for other broker-dealers
B. Regulations G and U
1. Need for separate regulations
2. Special purpose loans to broker-dealers
3. Board interpretations
C. Regulation T
a. Broker-dealer accounts
b. Borrowing and lending of securities a. Collateral test b.
Purpose test
(1) Foreign securities exception
(2) ``Pre-borrowing''
(3) Dividend reinvestment and purchase plans
c. Exempted borrowers
II. Regulation T
A. Debt Securities and Portfolio Margining
1. Loan value
a. Good faith loan value for all non-equity securities
b. ``Equity-linked'' and preferred securities
2. Good faith account
a. Appropriateness
b. Prohibition on transactions causing a deficit
c. Money market and other financial instruments
d. Merging non-equity account into other accounts
3. Portfolio margining
a. Portfolio margining as an alternative to Regulation T
b. Definition of good faith margin
c. Separation of accounts
d. Retention of the special memorandum account
B. Equity Securities and Options
1. Domestic stocks
2. Foreign stocks
3. Options: short sales and arbitrage transactions
C. Miscellaneous Issues
1. Foreign Issues
a. Credit by foreign branches of U.S. broker-dealers
b. Foreign currency
2. Technical amendments
a. Definition of covered option transaction
b. Definition of margin equity security
c. Definition of current market value
3. Cash account: 90-day freeze
4. Board interpretations
III. Regulations G AND U
A. Loan Value
1. Over-the-counter stocks
2. Options
3. Money market mutual funds
B. Financing of Securities Purchased on a DVP Basis
C. Mixed Collateral Loans
IV. Regulation X
V. Regulatory Flexibility Act
VI. Paperwork Reduction Act

I. Borrowing By Broker-Dealers

A. All Regulations: Implementation of NSMIA

The National Securities Markets Improvement Act of 1996 (``NSMIA'')
\1\ repealed section 8(a) of the Securities Exchange Act of 1934 (the
``'34 Act'') and exempted the extension of credit to certain broker-
dealers from the Board's margin regulations. Section 8(a) of the '34
Act had required broker-dealers obtaining credit against the collateral
of exchange-traded equity securities to borrow from only other broker-
dealers, banks that were members of the Federal Reserve System, or
banks that agreed to abide by certain restrictions applicable to member
banks. After the enactment of NSMIA, the Board proposed to delete
Sec. 220.15 of Regulation T and Sec. 221.4 of Regulation U, the
regulatory sections that implemented section 8(a) of the '34 Act. No
adverse comments were received, and the Board is deleting the sections
as proposed. The Board is also deleting the definition of nonmember
bank from Sec. 220.2 of Regulation T because the term was used only in
Sec. 220.15 of Regulation T. Finally, the Board is deleting its
delegation of authority to the Reserve Banks to accept agreements filed
under section 8(a) of the '34 Act.
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\1\ Pub. L. 104-290, 110 Stat. 3416.
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NSMIA amended section 7 of the '34 Act to grant a transactional
exemption

[[Page 2807]]

for credit extended to a broker-dealer ``to finance its activities as a
market maker or an underwriter.'' NSMIA also granted a status exemption
for all borrowing by broker-dealers ``a substantial portion of whose
business consists of transactions with persons other than brokers or
dealers.'' These statutory exemptions apply to borrowers, although the
Board's margin regulations generally apply to lenders. It is therefore
necessary for the Board to amend Regulations G, T and U to provide
uniform treatment for broker-dealers whose borrowings are exempted from
the Board rules under NSMIA.
1. Scope Section vs. the Definition of Customer
The Board sought comment on whether broker-dealers who qualify for
an exemption from the Board's margin regulations when borrowing
(``exempted borrowers'') should be excluded from the scope provisions
in the first section of each regulation or the definition of customer
in the second section of each regulation. All but two of the responsive
commenters preferred the use of the scope section. The Board is
amending the scope section to exclude loans to an ``exempted borrower''
and adding a definition of ``exempted borrower'' to cover those broker-
dealers who have a substantial portion of their business conducted with
persons other than broker-dealers (when they borrow for any purpose).
The Board is also excluding an ``exempted borrower'' from the
definition of ``customer'' in each regulation.
2. Appropriateness of Adopting a ``Substantial'' Test
The Board sought comment on whether it needs to provide a test to
identify exempted borrowers. Only one commenter expressed its belief
that a ``substantial'' test was not needed. The Board is adopting
several safe harbor tests to provide guidance to lenders as to those
broker-dealers who qualify under NSMIA for exempted borrower status.
One commenter stated that once the Board has decided on an
appropriate test, but before it is implemented, the self regulatory
organizations (SROs) \2\ should survey their member firms to ascertain
how many would be qualified. The Board is not adopting this suggestion
as the Board believes that it would delay unnecessarily the ability of
some exempted borrowers to take advantage of the Board's implementation
of the NSMIA.
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\2\ All SEC-registered broker-dealers belong to one or more SRO,
such as the New York Stock Exchange, Chicago Board Options Exchange,
or the National Association of Securities Dealers. If a broker-
dealer belongs to more than one SRO, one of the SROs is designated
as its examining authority and becomes its primary regulator at the
SRO level. ``Examining authority'' is defined in Sec. 220.2 of
Regulation T.
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3. Test for Determining ``Substantial'' Customer Business
a. Description of test: The Board is adopting three alternative
tests for broker-dealers to qualify as exempted borrowers. Exempted
borrowers are being defined to include registered brokers or dealers or
members of a national securities exchange who have at least: (1) 1000
active accounts for persons other than brokers, dealers, or persons
associated with a broker or dealer; or (2) $10 million in annual gross
revenues from transactions with such persons; or (3) 10 percent of
their annual gross revenues derived from transactions with such
persons. These tests will be included in the definition of ``exempted
borrower'' in Secs. 220.2 of Regulation T and 221.2 of Regulation U.
The Board believes that these tests should not be excessively onerous
to satisfy or monitor, but they should exceed the levels that an entity
is likely to be willing or able to achieve artificially merely to
obtain exempt credit. The first test provides a straightforward
mechanism for large, customer-oriented firms to determine that they
meet the substantial customer business requirement. The second test
covers large firms that have made a substantial commitment to
transacting business with persons other than broker-dealers, but do not
have a large number of customer accounts. The third test compares the
relative size of a broker-dealer's customer-related securities business
to its overall securities business.
The Board believes these tests meet the statutory standard that a
substantial portion of an exempted borrower's business consist of
transactions with persons other than brokers or dealers. The Board
believes that 10 percent of gross revenues is a substantial portion of
a broker-dealer's business. Similarly, the Board believes that 1000
customer accounts is a substantial number of accounts, and therefore
broker-dealers with this many customer accounts have a substantial
portion of their business with persons other than broker-dealers.
Finally, the Board believes that having $10 million in gross customer
revenues is a substantial amount of revenue, and therefore these
broker-dealers have a substantial portion of their business with
customers.
Two of the three tests adopted by the Board today refer to
``revenue.'' Two commenters suggested that the Board adopt its own
definition of ``revenue,'' although one of these commenters suggested
that the Board build upon the definition of ``gross revenues from the
securities business'' in section 16(9) of the Securities Investor
Protection Act of 1970. The Board believes it would be more appropriate
for broker-dealers to determine ``revenue'' in accordance with
generally accepted accounting principles (GAAP). This should be easier
than a new standard because broker-dealers are required under SEC rules
to file annual reports that have been audited by an independent public
accountant \3\ and these reports are prepared according to GAAP.
Although the Board is not specifying a methodology for comparing
customer revenues to gross revenues, it expects that broker-dealers
will develop appropriate methods for doing so and apply them
consistently over time.
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\3\ SEC Rule 17a-5(d); 17 CFR 240.17a-5(d).
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The Board believes that the statutory requirement that a
substantial portion of an exempted borrower's business must consist of
transactions with persons other than ``brokers or dealers'' should be
interpreted to require that these transactions also be effected with
persons other than ``persons associated with a broker or dealer'' as
defined in the '34 Act.\4\ This exclusion is included in the Board's
definition of ``exempted borrower'' and will prevent a firm from
qualifying as an exempted borrower by engaging in transactions only
with related persons and corporate entities.
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\4\ Section 3(a)(18) of theSec. '34 Act, 15 U.S.C. 78c(a)(18).
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Several commenters responding to the Board's request for
appropriate tests to identify exempted borrowers focused on the
appropriate period of time over which to measure whether a broker-
dealer has a substantial customer business. Some commenters suggested a
broker-dealer should be deemed to have a substantial customer business
if it meets one of the Board's tests on an annual basis while others
suggested using a six month period. The Board believes an annual test
is appropriate. Therefore, to meet any one of the tests, a broker-
dealer must have met the test on average for a 12 month period.
However, the Board will permit a newly registered broker-dealer to
qualify as an exempted borrower if it meets one of the Board's tests
after six months.\5\
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\5\ See Section 220.3(j) of the revised Regulation T and
Sec. 221.3(e) of the revised Regulation U.
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The Board believes that broker-dealers with exempt borrowing status
should reevaluate their status on an annual basis. If a broker-dealer
determines that it is no longer an exempted borrower, it

[[Page 2808]]

should notify its lenders before obtaining additional credit. Once a
broker-dealer ceases to be an exempted borrower, credit obtained in
reliance on the exempted borrower exception cannot be rolled over or
renewed and the lines of credit should be adjusted appropriately as
positions are liquidated. If the borrowing broker-dealer maintains its
positions, the lender can continue to maintain the credit extended on
an exempt basis. Once a borrowing broker-dealer is no longer an
exempted borrower any new securities transactions requiring financing
must be effected in conformity with the provisions of the Board's
margin regulations other than the exempted borrower exception.\6\
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\6\ See Section 220.3(j) of the revised Regulation T and
Sec. 221.3(e) of the revised Regulation U.
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b. ``Safe harbor'' status of test: The term exempted borrower will
be defined to ``include'' the three tests described above. Each of the
three alternatives therefore will be a non-exclusive safe harbor. This
will allow broker-dealers who meet any one of the three tests to borrow
on an exempt basis, but will not preclude the possibility of
demonstrating a substantial customer business in other ways.
c. Burden of proof for exempted borrower status: A commenter stated
that a lender should be able to rely on a borrowing broker-dealer's
representation of its exempted status ``irrespective of what additional
facts are known by the lender.'' Two other commenters recommended that
lenders be able to use a ``good faith'' standard in accepting a
borrowing broker-dealer's representation of its exempted status. The
Board believes lenders should be required to apply a ``good faith''
standard in determining whether the Board's margin regulations apply to
borrowings by specific broker-dealers. Under former Regulations G and
U, ``good faith'' in accepting a representation required a lender to be
``alert to the circumstances surrounding the credit, and if in
possession of information that would cause a prudent person not to
accept the notice or certification without inquiry, investigates and is
satisfied that it is truthful.'' \7\ The Board believes that in certain
situations a lender may be able to determine whether a broker-dealer
qualifies as an exempted borrower without requiring a statement from
the borrower. Therefore, the Board is modifying the definition of good
faith in Sec. 221.2 of Regulation U (which will also cover lenders
formerly subject to Regulation G) in a way that will allow lenders to
use their judgment as to whether a statement is necessary. The Board is
adopting the same definition of good faith in Sec. 220.2 of Regulation
T so that all lenders will be subject to a uniform standard.
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\7\ This language was found in the definitional section of each
regulation (Sec. 207.2 of Regulation G and Sec. 221.2 of Regulation
U).
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4. Borrowing Exemption for Other Broker-Dealers
CBOE requested the creation of a borrowing exception in Regulations
G and U for broker-dealers whose business consists of financing and
carrying the accounts of registered market makers.\8\ CBOE noted that
while some broker-dealers that carry the accounts of market makers also
engage in a general customer business and may qualify for the exempted
borrower exception created under NSMIA, there are a few clearing firms
virtually all of whose business consists of carrying the accounts of
options market makers. CBOE explained that it has encouraged these
firms to refrain from carrying the accounts of public customers so that
such firms would not be subject to liquidation proceedings under SIPA,
which CBOE believes would make the transfer of market maker accounts to
other clearing firms more difficult. CBOE stated its belief that
failure of these firms to obtain an exempt borrowing status under
Regulations G and U will have negative consequences for the safety and
liquidity of the options markets.
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\8\ Although CBOE refers to these member firms as ``market
makers,'' the firms qualify as ``specialists'' under the '34 Act.
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The Board is adopting an exception from certain of its margin rules
for broker-dealers whose nonproprietary business is limited to
transactions with market makers and specialists. This exemption will be
found in Sec. 221.5(c)(10) of Regulation U (which is being amended to
cover all lenders other than brokers and dealers) and not in Regulation
T. This means that broker-dealers who qualify for the exception will
not be limited by the Board's margin regulations if they borrow from a
lender other than another broker-dealer, but borrowings from broker-
dealers will be subject to the provisions of Regulation T. CBOE did not
request an exemption in Regulation T for loans to market maker clearing
firms and the Board's authority to grant exemptions under Regulations G
and U is greater than its ability to grant exemptions under Regulation
T. NSMIA amended section 7(d) of the '34 Act (the section which applies
to lenders other than broker-dealers and under which the Board has
adopted Regulations G and U) to allow the Board to exempt such credit
``as it may deem necessary or appropriate in the public interest or for
the protection of investors.'' The Board believes that establishing a
Regulation U borrowing exception for broker-dealers actively engaged in
clearing and carrying the accounts of market makers is appropriate in
the public interest by enhancing market liquidity and protecting that
liquidity in times of market volatility.

B. Regulations G and U

1. Need for Separate Regulations
The Board noted last year that the current structure of its margin
regulations is based in part on the requirements of recently repealed
section 8(a) of the '34 Act. Section 8(a) mandated a distinction
between bank and nonbank lenders with respect to loans to broker-
dealers. In light of the repeal of section 8(a), the Board sought
comment on whether it is still appropriate to distinguish between
Regulation G and Regulation U lenders and whether the regulations
should be combined. No commenters believed there is a need for
differing substantive regulation of banks and Regulation G lenders. The
Board is merging Regulation G into Regulation U. Except as otherwise
noted, substantive provisions of Regulation G have been incorporated
into Regulation U.
On a technical level, the title of Regulation U is being changed to
reflect its coverage of persons other than banks, brokers and dealers.
Entities that were known as ``lenders'' under Regulation G will be
known as ``nonbank lenders'' under Regulation U and the term ``lender''
will be used in Regulation U to refer to banks and former Regulation G
lenders collectively. Similar but not identical provisions, such as the
definition of ``affiliate'' in Sec. 221.2 and the requirements for
obtaining a purpose statement in Sec. 221.3(c), have been left with
their differences intact. The Board is soliciting comment via an
advance notice of proposed rulemaking published elsewhere in today's
Federal Register to determine whether and how to harmonize further the
treatment of bank and nonbank lenders. The Board is also amending its
rules regarding delegation of authority to eliminate references to
Regulation G.
2. Special Purpose Loans to Broker-Dealers
Regulation U has always included an exemption for loans to broker-
dealers in

[[Page 2809]]

specific circumstances.\9\ In response to the Board's request for
appropriate amendments to Regulation U to reflect the broader exemption
for broker-dealer borrowing contained in the NSMIA, two commenters
stated their belief that the following special purpose loans to brokers
and dealers found in Sec. 221.5(c) of Regulation U no longer need to be
listed separately: loans to specialists, OTC market makers, third
market makers, block positioners, and odd-lot dealers; and distribution
loans.\10\ The Board is deleting these provisions as unnecessarily
detailed in light of the NSMIA amendments to section 7 of the '34 Act
and replacing them with a general exclusion for market makers,
specialists and underwriters in Secs. 221.5(c)(6) and 221.5(c)(7) of
Regulation U based on the language of NSMIA. Lenders formerly subject
to Regulation G will also be able to extend special-purpose loans to
broker-dealers under all of the exemptions contained in Sec. 221.5(c)
of Regulation U. As proposed, the Board is adding the definition of
examining authority currently found only in Regulation T to Sec. 221.2
of Regulation U because the term appears in Sec. 221.5(c)(9) of
Regulation U.
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\9\ See Section 221.5(c) of Regulation U.
\10\ These loans were described in paragraphs (c)(6), (7), (10),
(11), (12) and (13) of former Sec. 221.5 of Regulation U.
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3. Board Interpretations
Before its merger into Regulation U, Regulation G contained 14
Board interpretations codified as 12 CFR 207.101-207.114. Seven of
these interpretations \11\ were already codified in Regulations T or U
as well and will be unaffected by the elimination of Regulation G. The
interpretation concerning credit extended to purchase mutual shares
before July 8, 1969, which has been codified at 12 CFR 207.107 (and 12
CFR 221.119), is being deleted as obsolete. The remaining six
Regulation G interpretations are being moved to Regulation U.
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\11\ The Regulation G citations for these interpretations were
12 CFR 207.102, 207.103, 207.106, 207.108, 207.110, 207.113, and
207.114.
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The Board has reviewed the 25 interpretations in Regulation U (at
12 CFR 221.101-125) and decided to delete six of them. As noted in the
previous paragraph, the interpretation at 12 CFR 221.119 is being
deleted as obsolete. The same is true of the interpretation at 12 CFR
221.111, which deals with ``retention requirements'' eliminated by the
Board the last time the margin regulations were comprehensively
revised. The interpretations at 12 CFR 221.102 and 221.121 are being
deleted because they have been superceded by NSMIA. Deletion of the
interpretation at 12 CFR 221.123 (also codified in Regulation T at 12
CFR 220.126) is discussed below in the Regulation T section on the use
of options in short sales and arbitrage transactions (See section II.
B. 3). The interpretation at 12 CFR 221.124 (``Application of the
single-credit rule to loan participations'') is being deleted because
the Board amended the single-credit rule (Sec. 221.3(d) of Regulation
U) in 1996 to incorporate this interpretation. The six remaining
Regulation G interpretations will replace the six Regulation U
interpretations being deleted today.

C. Regulation T

1. Broker-Dealer Accounts
The former Regulation T required that all financial relations
between a broker-dealer and its customer (which may include another
broker-dealer) be recorded in one of the eight accounts described in
the regulation. The Board requested comment on whether the NSMIA
eliminated the need for the following Regulation T accounts that were
generally limited to broker-dealers: omnibus account (former
Sec. 220.10), broker-dealer credit account (former Sec. 220.11), and
the market functions account (former Sec. 220.12). Most commenters
requested retention of the omnibus account, which allows financing of a
broker-dealer's customers' positions, for broker-dealers who do not
have a ``substantial'' customer business but nevertheless finance some
customer transactions. Most commenters also requested retention of the
broker-dealer credit account, which permits certain extensions of
credit to SEC-registered broker-dealers and allows certain other
transactions to be effected without regard to the ``90-day freeze''
provision contained in the cash account.\12\ In support of their
request to retain the broker-dealer credit account, commenters cited
the provisions of the account that may be used by persons who are not
SEC-registered broker-dealers (and therefore not affected by the NSMIA)
and stated their belief that the Board should not eliminate the ability
of these persons to avail themselves of the account. These provisions
allow foreign broker-dealers to buy and sell securities on a delivery-
versus-payment (DVP) basis \13\ and allow the use of this account for
``prime-broker'' customers.\14\ Most commenters recommended repeal of
the market functions account, which permits good faith credit to be
extended to broker-dealers who perform a market function such as acting
as a specialist, as long as the Board indicates that its action is
based on its belief that the NSMIA exemptions covers all transactions
previously recorded in this account.
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\12\ Section 220.8(c) of Regulation T.
\13\ Former Sec. 220.11(a)(1) of Regulation T.
\14\ For a description of ``prime-broker'' arrangements, see SEC
no-action letter of January 25, 1994, reprinted in CCH Fed. Sec. L
Rptr para. 76,819.
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The Board is eliminating the market functions account because the
transactions previously permitted therein have been exempted from Board
regulation by the NSMIA, with one exception.\15\ The Board is also
deleting the definitions of in or at the money, in the money, overlying
option, permitted offset, and specialist joint account from Sec. 220.2
of Regulation T because the terms were used only in the market
functions account. Consistent with its action regarding customer
accounts,\16\ the Board believes that additional flexibility for
broker-dealers can be achieved by merging the omnibus account into the
broker-dealer credit account. The different types of credit are
described in separate paragraphs; the SEC and/or the SROs may require
that broker-dealers keep separate records within this account, for
example to segregate omnibus credit (for customers) from other types of
(proprietary) broker-dealer credit. The provision allowing certain
``prime broker'' transactions to be effected in the broker-dealer
credit account will be moved to the new good faith account to reflect
the fact that these transactions are effected on behalf of non-broker-
dealer customers. Former Sec. 220.11(b), which defined the term
affiliated corporation, is being moved to the definitional section of
the regulation (Sec. 220.2).
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\15\ See 220.12(b)(2)(ii) of former Regulation T provided that
the margin for the purchase or short sale of a security that does
not qualify as a specialist or permitted offset position shall be
the margin required by the Supplement. Purchases on credit and short
sales of such securities by specialists will henceforth be required
to be effected in the margin or good faith account.
\16\ See the discussion in section II. A. 2. d of the
Supplementary Information.
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A commenter recommended that the Board allow foreign broker-dealers
to open omnibus accounts at U.S. broker-dealers. This practice was
permitted under Regulation T until 1969, as long as the foreign broker-
dealer certified that it made its customers margin their transactions
in conformity with the requirements of Regulation T. The Board then
amended Regulation T to require that the broker-dealer obtaining
omnibus credit be registered with the SEC and therefore subject to the
jurisdiction of the SEC and SROs to

[[Page 2810]]

ensure Regulation T compliance for customer margin transactions. The
Board believes that it is extremely difficult to ensure that an
unregulated entity complies with its regulations and does not believe
it is appropriate to impose Regulation T on foreign broker-dealers'
transactions with customers. Therefore, the Board is not amending the
omnibus account at this time.
In response to the Board's request for comment on appropriate
amendments to Regulation T to reflect the changes contained in the
NSMIA, one commenter recommended incorporation of Sec. 221.5 of
Regulation U (``Special purpose loans to brokers and dealers'') into
Regulation T, so that broker-dealers may make loans to other broker-
dealers on the same basis as other lenders. The Board is adding those
portions of Sec. 221.5 of Regulation U that are not already in
Regulation T to the broker-dealer credit account. These provisions
allow the following types of credit without regard to other Regulation
T requirements: credit to finance the purchase or sale of securities
for prompt delivery or to finance securities in transit, if the credit
is to be repaid upon completion of the transaction, and intraday
credit. The broker-dealer credit account is also being amended to allow
its use for loans to exempted borrowers, market makers, specialists,
and underwriters for those broker-dealers who wish to record such
credit in a Regulation T account.
2. Borrowing and Lending of Securities
The Board has regulated the borrowing and lending of securities to
prevent a customer from evading the margin requirements by
recharacterizing a margin loan from the broker-dealer to the customer
(which requires a deposit of 50 percent of the stock's value by the
customer) as the lending of securities by the customer to the broker-
dealer (in return for which the customer can receive 100 percent of the
stock's value in cash from the broker-dealer). With the exception of
U.S. government securities,\17\ former Regulation T on its face applied
to any loan of securities in which a creditor was either borrowing or
lending. The Regulation T provision that covers borrowing and lending
securities (formerly Sec. 220.16; now Sec. 220.10) has traditionally
contained collateral requirements (the ``collateral test'') and limited
the situations for which securities may be borrowed or lent (the
``purpose test''). With the adoption of the good faith account,
Regulation T restrictions on the borrowing and lending of securities
will only apply to those securities not entitled to good faith loan
value.
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\17\ Borrowing and lending of government (exempted) securities
has been permitted in the government securities account without
regard to the borrowing and lending of securities provision of
Regulation T.
---------------------------------------------------------------------------

a. Collateral test: Regulation T has reflected industry practice by
requiring 100 percent collateral against a borrowing of securities,
with the collateral limited to cash and cash equivalents. Although the
Board believes requiring 100 percent liquid collateral is consistent
with prudent securities lending practices, it sought comment on whether
the existing collateral requirements are necessary for Regulation T
purposes and proposed three alternatives. Two of the alternatives would
retain the 100 percent collateral requirement. Of those two
alternatives, one would allow any security as collateral as long as it
was valued at its regulatory loan value \18\ and the other would allow
any collateral without specifying limits as to how the collateral is to
be valued. The third alternative would eliminate the collateral
requirements in their entirety.
---------------------------------------------------------------------------

\18\ The regulatory loan value of a security is the difference
between 100 percent and the margin required by the Supplement to
Regulation T (formerly Sec. 220.18, now Sec. 220.12).
---------------------------------------------------------------------------

No commenter opposed an expansion of the types of collateral
permitted for borrowing and lending securities. Two commenters
supported allowing all securities at their regulatory loan value and
three commenters supported allowing all collateral. Total elimination
of collateral requirements in connection with the borrowing and lending
of securities was explicitly supported by four commenters (including
two who also supported one of the other alternatives) and specifically
opposed by two commenters. One of the opposing commenters gave no
reason for its opposition, while the other expressed dissatisfaction
with the purpose test and suggested that the collateral test was
necessary to make up this deficiency. Commenters supporting elimination
of the collateral requirements stated that the purpose test adequately
limits circumvention of the margin requirements by limiting the
situations in which securities may be lent. The commenters stated that
the current collateral requirement of 100 is at odds with the 50
percent requirement for margin loans on equity securities. Commenters
also noted that the SEC's customer protection rule specifies acceptable
collateral for securities lending transactions conducted by broker-
dealers with customers. The Board notes that in addition to the SEC's
customer protection rules and the reasons cited above, the SROs may
choose to impose safety and soundness requirements on the borrowing and
lending of securities by their member firms. The Board is eliminating
the collateral requirements for borrowing and lending securities.
b. Purpose test: In addition to the collateral test, Regulation T
also contains a ``purpose test'' generally limiting the borrowing or
lending of securities by broker-dealers to situations involving short
sales or ``fails'' to receive securities needed for delivery. Although
the Board did not specifically propose to amend the purpose test,
several commenters recommended modifications to the purpose test. These
recommendations included: (1) Broadening the exception added last year
for foreign securities to cover those that trade in the United States,
(2) broadening the exception added last year to permit borrowing of
securities before a short sale has occurred to cover fail transactions
and to allow more time to borrow foreign securities, and (3) expanding
the purpose test to cover dividend reinvestment plans.
(1) Foreign Securities Exception
Last year the Board created an exception to its general rule
regarding the borrowing and lending of securities for certain foreign
securities. Under former Sec. 220.16(b) of Regulation T, foreign
securities that are not publicly traded in the United States could be
lent to foreign persons without regard to the purpose test and on any
collateral.¹⁹ Although several commenters responding to the
Board's proposal of this exception in 1995 objected to the fact that it
did not cover foreign securities listed on a U.S. securities exchange
or the Nasdaq Stock Market, other commenters, including U.S. securities
exchanges, stressed the importance of equal treatment in this area for
all securities that are publicly traded in the United States. One
commenter responding to last year's request for public comment repeated
its earlier comment requesting that the Board eliminate this limitation
on the foreign security exception and added an alternative request that
the Board narrow this limitation to U.S. traded foreign securities
being lent for short sales effected in the United States. The

[[Page 2811]]

commenter pointed out that (1) the foreign securities exception only
applies to securities lent to foreign persons and therefore ``equal
treatment'' for all U.S. traded securities is already assured for
securities lent to U.S. persons; (2) denying the foreign securities
exception to U.S. traded foreign securities could create a disincentive
to foreign companies considering a dual listing arrangement in the
United States; and (3) U.S. broker-dealers are disadvantaged vis-a-vis
foreign broker-dealers if their ability to lend foreign securities is
curtailed once those securities are listed for trading in the United
States. In light of these considerations, the Board is amending the
foreign securities exception from the purpose test to cover all foreign
securities without regard to whether the securities are traded in the
United States.
---------------------------------------------------------------------------

\19\ When the foreign securities exception was adopted, it
permitted the use of any legal collateral, but required that the
collateral's value be at all times at least equal to the value of
the securities being lent. The requirement for 100 percent
collateral against a loan of these securities is being eliminated in
conjunction with the Board's elimination of the collateral test for
all securities lending transactions.
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(2) ``Pre-borrowing''
Last year the Board also amended Regulation T to allow the
borrowing of a security up to one standard settlement cycle
²⁰ in advance of the trade date of a short sale. Two
commenters requested that the Board allow creditors to borrow
securities three days before the trade date of a transaction they
reasonably anticipate will result in a fail to deliver. The Board sees
no reason to maintain a different time frame for borrowings to
accommodate fails versus short sales, as long as the fail is not
intended to evade the requirements of Regulation T. The last sentence
of Sec. 220.10(a) of Regulation T (former Sec. 220.16(a)) is therefore
being amended to cover fails as well as short sales.
---------------------------------------------------------------------------

\20\ The phrase ``standard settlement cycle'' refers to SEC Rule
15c6-1 (17 CFR 240.17c6-1) which currently sets this period at three
business days.
---------------------------------------------------------------------------

Three commenters also requested that the Board allow creditors to
borrow foreign securities with extended settlement periods (i.e., more
than three business days) up to one foreign settlement period in
advance of the trade date of a short sale or fail to deliver
transaction. The Board is not adopting such an amendment. The three day
period adopted by the Board last year was an attempt to balance the
need to complete short sales and fail transactions while guarding
against the potential for manipulative transactions such as squeezes.
The Board does not believe there is a compelling reason to treat
foreign securities differently.
(3) Dividend Reinvestment and Purchase Plans
Last year, the Board declined to adopt a suggestion by commenters
that the purpose test for borrowing and lending securities be expanded
to allow creditors to borrow securities in order to take advantage of
dividend reinvestment programs. Three commenters in this docket
repeated the suggestion. The Board continues to believe that allowing a
broker-dealer to borrow customer securities to take advantage of a
dividend reinvestment and purchase plan could allow customers to obtain
greater credit than could be obtained via a conventional margin loan
and unlike borrowing to cover a short sale or fail is not necessary for
efficient functioning and clearing of transactions in the securities
market. Therefore, the Board is not amending Regulation T to
accommodate dividend reinvestment and purchase plans.
c. Exempted borrowers: In its request for comment on appropriate
amendments to implement the changes contained in the NSMIA, the Board
stated that it appeared that Regulation T's requirements for borrowing
and lending securities no longer applied to the borrowing and lending
of securities between two exempted borrowers. The Board requested
comment on how to amend the rules regarding borrowing and lending of
securities to reflect the NSMIA. Although the SROs that commented
responded by stating their belief that borrowing and lending of
securities by brokers and dealers should still be subject to a
``purpose test,'' all other responsive commenters supported the Board's
view that Regulation T no longer appears to apply to securities lending
transactions between exempt broker-dealers. Three commenters suggested
that Regulation T also should not apply when only one party to the
securities lending transaction is an exempt broker-dealer; however, the
commenters were not in agreement as to how this principal should be
applied. Following the Board's stated logic that Regulation T has
covered the borrowing and lending of securities to prevent a customer
from lending securities against 100 percent cash in order to evade the
50 percent maximum otherwise allowed, the Board is amending Regulation
T by adding a new paragraph (c) to the section entitled ``Borrowing and
lending securities'' (Sec. 220.10) to exclude a broker-dealer that is
an exempted borrower from the restrictions of Regulation T if it is
lending securities, but not if it is borrowing securities. In order to
prevent circumvention of the Board's margin rules for nonexempted
equity securities, a broker-dealer that is an exempted borrower and is
therefore entitled to lend securities without regard to Regulation T
will not be permitted to borrow securities from a customer or a broker-
dealer that is not an exempted borrower in order to relend them unless
the relending is for a permitted purpose such as a short sale or fail
transaction.

II. Regulation T

A. Debt Securities and Portfolio Margining

1. Loan Value
Debt securities listed on a national securities exchange have
always had loan value under Regulation T.²¹ Beginning in
1978, the Board created the concept of an ``OTC (over-the-counter)
margin bond'' to allow loan value for unlisted debt securities that
meet Board established criteria. These criteria have been expanded over
the years. Nevertheless, not all OTC debt securities qualify as ``OTC
margin bonds.'' Debt securities that are neither exchange-listed nor
OTC margin bonds have no loan value in a margin account.
---------------------------------------------------------------------------

\21\ From 1934 until 1968, exchange-listed debt securities were
subject to the same margin requirements as exchange-listed equity
securities. Since 1968, marginable debt securities have been subject
to a good faith margin requirement.
---------------------------------------------------------------------------

a. Good faith loan value for all non-equity securities: Last year,
the Board amended Regulation T to include all investment-grade debt
securities under the definition of OTC margin bond and therefore
ensured good faith loan value for these securities.²² At the
same time, the Board proposed to grant good faith loan value to all
non-equity securities.²³ The Board noted that banks and
other lenders are not subject to the Board's margin requirements when
extending credit on non-equity securities.
---------------------------------------------------------------------------

\22\ Many investment-grade debt securities were already covered
under the existing definition of ``OTC margin bond.'' However, some
classes of debt securities, such as domestic debt securities exempt
from SEC registration, were unable to qualify under the existing
definition.
\23\ Formerly, debt securities met the definition of margin
security and were entitled to good faith loan value only if they
were registered on a national securities exchange, rated investment-
grade, or otherwise qualified as OTC margin bonds.
---------------------------------------------------------------------------

The Board's proposal was supported by all responsive commenters
except for one commenter. This commenter argued that broker-dealers
have a ``salesman's stake'' not shared by non-broker-dealer lenders and
this difference justifies the continuation of denying loan value to
certain non-investment-grade debt securities. On the other hand,
another commenter stated that there is no policy justification for
distinguishing between broker-dealers and other U.S. lenders and
several commenters noted that allowing good faith loan value for non-
equity securities would increase the

[[Page 2812]]

ability of U.S. broker-dealers to compete with other domestic and
foreign lenders.
The Board is amending Regulation T as proposed to permit broker-
dealers to extend good faith credit against all non-equity securities.
Broker-dealers should be no less competent to determine the loan value
of non-investment-grade debt securities than a bank or other lender
would be. In addition, self regulatory organizations (SROs) such as the
New York Stock Exchange will still be able to set margin requirements
for non-equity security transactions effected by their member brokerage
firms. To implement this change, the Board is amending Sec. 220.2 of
Regulation T by deleting the definition of OTC margin bond, replacing
paragraph (3) of the definition of margin security (currently ``any OTC
margin bond'') with ``any non-equity security'' and changing the
Supplement \24\ that provides good faith loan value for these
securities to refer to any ``non-equity security'' where the regulation
currently specifies ``registered nonconvertible debt security or OTC
margin bond.'' The Board is also adding the word ``equity'' to
paragraph (e) of the Supplement to make clear that the only securities
that have no loan value under Regulation T are nonmargin nonexempted
equity securities.
---------------------------------------------------------------------------

\24\ The Supplement, which contains the margin requirements for
various securities transactions, is the last section of each of the
Board's margin regulations. The Supplement was formerly Sec. 220.18;
the Supplement under the revised Regulation T adopted today is
Sec. 220.12.
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b. ``Equity-linked'' and preferred securities: The Board proposed
to define non-equity security as ``a security that is not an equity
security.'' \25\ Under the proposed definition, debt securities that
are equity-linked securities still would be afforded good faith loan
value. The Board also sought comment on whether it should modify this
proposed definition to exclude ``equity-linked securities,'' and if so,
what securities should be excluded. Modification of the proposed
definition of non-equity security to exclude ``equity-linked''
securities would result in their being treated as equity securities and
therefore subject to either a 50 percent or 100 percent margin
requirement.
---------------------------------------------------------------------------

\25\ The term equity security is defined in section 3(a)(11) of
the Securities Exchange Act of 1934 (15 U.S.C. 78(c)(a)(11)).
---------------------------------------------------------------------------

Comment on the appropriate treatment of equity-linked securities
was mixed. Several commenters stated that equity-linked securities
trade like equity securities and are often priced in reliance on equity
securities and therefore should be subject to the same margin
requirements as equity securities.\26\ Other commenters stated that it
was unnecessary for the Board to exclude equity-linked securities from
its proposed definition of non-equity security in light of the SEC's
authority to elaborate on the definition of ``equity security'' under
the '34 Act to address questions that may arise regarding novel or
hybrid products whose status might otherwise be unclear. Staff of the
SEC commented that equity-linked securities, because they present many
of the same type of risks as equity securities, should be treated as
equity securities for purposes of the Board's margin regulations. SEC
staff further commented that they view a equity-linked security as one
under which any part of the issuer's obligations is contingent upon, or
requires the delivery on an optional or forward basis of, an equity
security or group or index of equity securities. The Board is adopting
the definition of the term non-equity security that was proposed, with
the result that equity-linked securities which do not meet the '34 Act
definition of equity security will be entitled to good faith loan
value. The Board will defer to the SEC on the appropriate definition of
equity security.
---------------------------------------------------------------------------

\26\ Some of these commenters included convertible debt
securities in their discussion of the types of ``equity-linked''
securities they believe should be subject to equity margin
requirements. The Board has always treated convertible debt
securities as equity securities because section 3(a)(11) of the
Securities Exchange Act of 1934 defines ``equity security'' to
include a security convertible into an equity security.
---------------------------------------------------------------------------

One commenter suggested that preferred stock be margined at a good
faith level because its dividend rate is generally tied to current
interest rates. Another commenter sought confirmation that the term
non-equity security would include all mortgage and other asset-backed
securities, including debt instruments, trust certificates, or
partnership/participation interests. As noted above, the Board is
deferring to the SEC on the exact parameters of the definition of
equity security.
2. Good Faith Account
a. Appropriateness: In addition to proposing good faith loan value
for all non-equity securities, the Board proposed creating an account
separate from the margin account described in Sec. 220.4 of Regulation
T to effect transactions involving these securities. The new account
would allow purchases and sales of non-equity securities on a credit or
cash basis, repurchase and reverse repurchase agreements on non-equity
securities and the purchase or sale of options on non-equity
securities. All commenters supporting good faith loan value for all
debt securities supported creation of a new account. The Board is
adopting its proposal for a non-equity account and, as discussed below,
is merging it with the government securities account and other accounts
and naming it the ``good faith account.'' The good faith account
replaces the government securities account formerly found in Sec. 220.6
of Regulation T.
b. Prohibition on transactions causing a deficit: The Board has
generally viewed section 7 of the '34 Act as prohibiting broker-dealers
from extending purpose credit \27\ that is either unsecured or secured
by collateral other than securities. In proposing to create a new non-
equity account, the Board included a prohibition on transactions that
would cause the account to liquidate to a deficit (i.e., cause the
market value of the collateral to fall below the customer's debit
balance). This proposed provision was included to prevent broker-
dealers from extending unsecured purpose credit, which might be an
evasion of the good faith margin requirement. Commenters generally
opposed the proposal to prohibit transactions that would cause the
account to liquidate to a deficit, stating that the restriction would
seriously undermine the usefulness of the proposed account for
transactions in fixed-income securities because it would present
substantial uncertainty with respect to bilateral extensions of credit
such as reverse repurchase agreements, which may liquidate to a
deficit, and would continue to place broker-dealers at a disadvantage
vis-a-vis banks and other lenders.
---------------------------------------------------------------------------

\27\ ``Purpose credit'' is defined as credit for the purpose of
buying, carrying, or trading in securities.
---------------------------------------------------------------------------

Several commenters argued that section 7(c)(1)(B)(ii) of the '34
Act does not prohibit unsecured credit if the credit is either ``not
for the purpose of purchasing or carrying securities'' or not extended
for the purpose of ``evading or circumventing'' the Board's rules
regarding credit secured by securities. This reading of the statute
allows broker-dealers to extend unsecured purpose credit if the Board
concludes that such credit is not for the purpose of evading or
circumventing its rules regarding secured credit. The Board believes
that this interpretation is consistent with the statute and therefore
is eliminating the proposed ``liquidate to a deficit'' prohibition for
the good faith account. The Board believes that permitting transactions
in a non-equity securities account to liquidate to a deficit is not
necessarily an evasion or circumvention of the rules permitting

[[Page 2813]]

good faith loan credit for these securities as a lender extending good
faith credit may consider factors other than the immediate liquidation
value of the collateral.
c. Money market and other financial instruments: In commenting on
the Board's proposal to grant good faith loan value to non-equity
securities, many commenters sought good faith loan value for money
market and other financial instruments such as bankers acceptances,
certificates of deposit, and commercial paper when used in a margin
account.\28\ In effect, commenters argued that broker-dealers should be
able to consider the collateral value of these financial instruments in
extending good faith credit on non-equity securities. The Board
believes section 7 of the '34 Act permits the extension of unsecured
purpose credit if the Board concludes that such credit is not for the
purpose of evading or circumventing its rules regarding credit
collateralized by securities. This reasoning also applies to purpose
credit secured by collateral that may not meet the definition of a
``security'' in the '34 Act. The Board believes that allowing good
faith loan value for all assets other than equity securities in the new
good faith account does not evade or circumvent its rules requiring
good faith margin for transactions involving non-equity securities. The
Board therefore is expressly allowing the inclusion of such assets in
the good faith account described below.
---------------------------------------------------------------------------

\28\ Money market and other financial instruments that may not
meet the definition of ``security'' in the '34 Act are currently
valued at good faith when used as collateral for nonpurpose credit
in the nonsecurities credit account. These instruments currently
have no loan value when used in a margin account.
---------------------------------------------------------------------------

d. Merging non-equity account into other accounts: The Board sought
comment on merging the non-equity account into the government
securities account (former Sec. 220.6) and/or the nonsecurities credit
account (former Sec. 220.9). Several commenters supported merging the
proposed non-equity account into the government securities account. One
commenter opposed merging the new account into any existing account
because it believes transactions in the proposed non-equity account
should be subject to a requirement for timely payment, a requirement
not imposed for the other two accounts suggested by the Board. A second
commenter opposed allowing purpose and non-purpose credit in the same
account, although another commenter noted that purpose and nonpurpose
credit could be segregated within the account.
In order to provide maximum flexibility, the Board is merging all
three accounts for purposes of Regulation T. The new account will be
called the ``good faith account'' and will be described in Sec. 220.6
of the revised Regulation T. Creditors may keep separate records for
each type of credit extended within the account. In addition, the Board
is amending Regulation T to allow other customer transactions for which
the Board does not specify margin or payment requirements to be
effected in the good faith account. These include all transactions
currently effected in the arbitrage account ²⁹ and those
transactions effected in the broker-dealer credit account pursuant to a
``prime brokerage'' arrangement.³⁰ This merger of accounts
will leave most customers with three possible accounts: a cash account,
a margin account (with the possibility of a linked special memorandum
account) and a good faith account.³¹ The good faith account
could be used for transactions involving securities entitled to good
faith margin (including the borrowing and lending thereof), as well as
nonpurpose credit, bona fide arbitrage,³² and prime broker
transactions. Rules of the SROs and individual brokerage firms may
require separation of specific types of credit within the new account
for their own administrative or regulatory purposes, but this would not
be required by Regulation T. All credit extended by a broker-dealer to
a non-broker-dealer customer that is either subject to good faith
margin or not specifically subject to any Regulation T margin
requirement could be recorded in the new account. Transactions formerly
effected in the margin account could continue to be effected there, and
the restrictions contained in the margin account, such as the
requirement for timely deposit of payment or margin, would continue to
apply to transactions conducted in that account.
---------------------------------------------------------------------------

\29\ The arbitrage account was formerly found in Sec. 220.7 of
Regulation T.
\30\ This provision was formerly found in Sec. 220.11(a)(5) of
Regulation T. ``Prime brokerage'' is an arrangement involving a
customer and at least two broker-dealers, one of whom is the ``prime
broker.'' Transactions on behalf of the customer are effected by the
non-prime broker-dealer (known as an ``executing broker'') and
immediately sent to the prime broker. The prime broker enforces
Regulation T vis-a-vis the customer for all transactions, wherever
executed. The broker-dealer credit account is used by the executing
broker to record the customers transactions because recordkeeping
requirements are less onerous than if the transaction were recorded
in a cash or margin account. The new good faith account will
eliminate the need to record these customer transactions in the
broker-dealer credit account.
\31\ Customers who are broker-dealers will be able to have a
fourth possible account if they take advantage of the broker-dealer
credit account.
\32\ The Board is not modifying the scope of transactions that
may be effected as ``bona fide arbitrage.'' One commenter suggested
permitting margin-free arbitrage that is not based on locking in a
profit from a current disparity in the prices of the two securities,
and lesser or no margin on transactions that would qualify as
arbitrage if they had been effected simultaneously. The Board is not
adopting these two suggestions, as they do not comport with the
underlying policy of the arbitrage account of allowing special
credit for transactions that perform a market function by
eliminating real-time disparities in pricing between identical or
closely related securities.
---------------------------------------------------------------------------

3. Portfolio Margining
Regulation T prescribes margin requirements for each security held
in a margin account. Certain positions involving more than one
security, such as a long position in a convertible bond coupled with a
short position in the underlying security, are defined as a single
position and given lower margin requirements than would be required
individually. Any combination of securities not specifically identified
in Regulation T must be margined without regard to any possible
offsetting positions. The Board noted last year that commenters have
requested greater flexibility to engage in cross-margining (using
financial futures to offset securities margin requirements) and more
broadly ``portfolio'' or ``risk-based'' margining of customer assets.
The Board identified several provisions in Regulation T that are
impediments to the possible adoption of a portfolio margining system.
These include: the definition of good faith margin, the requirement
that items in one account not be considered in meeting requirements in
another account (see Sec. 220.3(b), ``Separation of accounts''), and
the special memorandum account (SMA).
a. Portfolio margining as an alternative to Regulation T: The Board
sought comment on any implementation problems that might arise with a
partial or complete move to portfolio margining, including the need for
delaying the effective date of any final rule in order to allow the
SROs time to amend their rules. A commenter suggested an amendment to
Regulation T that would permit a creditor, in lieu of compliance with
Regulation T, to comply with any portfolio margining system permitted
by an SRO under SEC-approved rules. This would not require a delay
between Board action and SRO implementation. The Board is amending the
scope provision of Regulation T \33\ to allow portfolio margining to be
developed by the industry and approved by the SEC as an alternative to

[[Page 2814]]

compliance with Regulation T by broker-dealers.
---------------------------------------------------------------------------

\33\ Section 220.1(b) of Regulation T.
---------------------------------------------------------------------------

b. Definition of good faith margin: The Board stated that a revised
definition of good faith margin \34\ is a necessary prerequisite to
eventual implementation of a portfolio margining system. The Board
requested comment on a proposed amendment that would modify the
definition of good faith margin by deleting references to a specific
security and eliminating the requirement that the credit be extended
without regard to the customer's other assets.\35\ This change would
facilitate portfolio margining on good faith basis. Almost all of the
responsive commenters supported this proposal. One commenter suggested
that the Board determine what type of portfolio margining systems
should be adopted before modifying the definition of good faith. The
Board believes that broker-dealers will be afforded greater flexibility
by changing the definition of good faith at this time while permitting
portfolio margining to be developed and implemented at a later date
when agreed upon by the SEC and SROs. The Board therefore is adopting a
definition of ``good faith with respect to margin'' in Sec. 220.2 of
Regulation T that substantially follows the proposal.
---------------------------------------------------------------------------

\34\ Margin is the amount of equity a customer must have against
a given position and the complement of the security's loan value. A
margin requirement of 60 percent for a security is the same as
assigning it a loan value of 40 percent. In determining good faith
margin, a broker-dealer is assigning a ``good faith'' loan value to
a specific non-equity security.
\35\ The Board proposed to modify the current definition to read
as follows: ``good faith margin means the amount of margin which a
creditor would require in exercising sound credit judgment.''
---------------------------------------------------------------------------

The Board also sought comment on whether an amended definition of
good faith should be limited to the proposed non-equity account or made
applicable for all accounts. All of the commenters expressing an
opinion supported modifying the definition of good faith for all
accounts. The new definition of ``good faith with respect to margin''
in Sec. 220.2 of Regulation T will cover transactions recorded in the
good faith account. The Board is retaining the requirements of the
former definition of good faith margin for transactions recorded in the
margin account by adding a new paragraph, ``sound credit judgment''
(Sec. 220.4(b)(8)), to the provisions concerning the margin account.
Allowing a broker-dealer to determine margin requirements by taking
into account the customer's other unrelated assets or securities
positions is inconsistent with limiting the loan value of equity
securities to 50 percent of its current market value. Therefore,
securities entitled to ``good faith'' margin treatment, if used in a
margin account, must be valued without regard to the customer's other
assets and securities positions held in connection with unrelated
transactions.
c. Separation of accounts: Section 220.3(b) of Regulation T,
``Separation of accounts,'' generally provides that requirements for an
account may not be met by considering items in any other account.\36\
Consistent with its action last year to allow financial futures to
serve in lieu of margin for securities options pursuant to SRO rules,
the Board proposed to modify the separation of accounts provision to
allow commodities and foreign exchange positions in the nonsecurities
credit account to be considered in calculating margin for any
securities transaction in the proposed good faith account for non-
equity securities transactions or the margin account for any securities
transaction. Responsive commenters supported the Board's proposal. The
Board is adopting the amendment to Sec. 220.3(b) of Regulation T as
proposed.
---------------------------------------------------------------------------

\36\ An exception is provided for maintaining a special
memorandum account (SMA) with a margin account.
---------------------------------------------------------------------------

The Board also invited comment on whether it should modify further
the separation of accounts provision in Sec. 220.3(b) of Regulation T
to facilitate portfolio margining. Several commenters pointed out that
the separation of accounts provision will have to be relaxed if
portfolio margining is made part of Regulation T. One commenter
supported complete elimination of the separation of accounts provision,
while two other commenters did not believe broker-dealers should be
required to link accounts, but should be permitted to do so if they
wish. The Board is not taking any additional action with respect to
Sec. 220.3(b) of Regulation T at this time, as the development of
portfolio margining systems can be accommodated as an alternative to
compliance with the account-based system contained within Regulation T,
as is provided in Sec. 220.1(b)(3)(i) of the revised regulation.
Further, the Board notes that the reduction in the number of customer
accounts resulting from combining the proposed good faith account with
the arbitrage, government securities, nonsecurities credit and prime
brokerage portion of the broker-dealer credit account will result in
fewer situations in which the separation of accounts provision of
Regulation T will apply.
d. Retention of the special memorandum account: Section 220.5 of
Regulation T provides that a broker-dealer may maintain a special
memorandum account (SMA) for a customer in conjunction with the
customer's margin account and use the SMA to hold customer moneys not
required to be maintained in the margin account. The Board sought
comment on eliminating the SMA in conjunction with adoption of a
portfolio margining system. Several commenters expressed support for
retaining the SMA and one commenter noted that the SMA could be
recreated by use of the cash account, which it believes would be less
efficient. This commenter also pointed out that the concept of the SMA
would not be necessary under a portfolio margining system because
initial and maintenance margin requirements would be the same. Another
commenter wanted broker-dealers to be able to establish multiple margin
accounts for the same person in cases other than those identified in
Regulation T ³⁷ and operate separate SMAs for each account.
---------------------------------------------------------------------------

\37\ The Board allows multiple margin accounts for a single
customer under conditions found in Sec. 220.4(a)(2) of Regulation T.
These margin accounts may be operated with separate SMAs.
---------------------------------------------------------------------------

The Board is not making any changes to the SMA at this time. The
SMA will continue to be available for use in conjunction with a margin
account, but will not be available for use in conjunction with a good
faith account. The concept of locking in ``buying power'' from the
appreciated value of securities held in an account or monies not
required by Regulation T is inconsistent with the revised definition of
``good faith with respect to margin'' which is based on the creditor's
judgment of the customer's creditworthiness and collateral at a given
time. The issue of using an SMA in connection with adoption of
portfolio margining systems may be addressed by the SEC, SROs and
securities industry.

B. Equity Securities and Options

1. Domestic Stocks
Prior to the adoption of today's amendments, the following United
States traded stocks ³⁸ were subject to the Board's 50
percent margin requirement: ³⁹ (1) Stocks traded on a

[[Page 2815]]

national securities exchange, (2) stocks in the National Market tier of
the Nasdaq Stock Market (``NMS'' securities), and (3) stocks in the
Small Capitalization (``SmallCap'' securities) tier of the Nasdaq Stock
Market that are identified by the Board as ``OTC margin stocks.'' These
stocks were subject to the same margin requirements regardless of
whether the lender is a broker-dealer, bank, or other
lender.⁴⁰
---------------------------------------------------------------------------

\38\ Stocks that are not traded in the United States are subject
to Regulation T (although they are not covered by Regulations G and
U) and their margin status is discussed in section II.B.2 of the
Supplementary Information.
\39\ Although section 7 of the '34 Act instructs the Board to
limit the amount of credit that can be extended against nonexempted
securities, it does not require the Board to make individualized
determinations for every security.
Section 7 originally mandated that the Board prescribe rules
with respect to the amount of credit that may be extended on ``any
security (other than an exempted security) registered on a national
securities exchange.'' The Board originally subjected all securities
registered on a national securities exchange to the same margin
requirement. It later established different margin requirements for
convertible and nonconvertible debt securities, but at no time
denied loan value (i.e., required 100 percent margin) to exchange-
listed securities (with the exception of options).
In 1968, Congress amended section 7 of the '34 Act to delete the
reference to exchange listed securities so that the Board is now
instructed to prescribe rules with respect to the amount of credit
that may be extended on ``any security (other than an exempted
security).'' The Board chose to implement this authority to
establish margin requirements for securities not traded on a
national securities exchange by subjecting every over-the-counter
stock to a set of Board-established criteria and publishing a list
of those OTC securities which meet these criteria. However, in 1983
the Board deferred to the listing requirements of Nasdaq's National
Market tier as an additional method of qualifying as a margin
security. Thereafter, domestic stocks that were not listed on a
national securities exchange qualified for margin treatment either
by being listed on Nasdaq's National Market tier or by appearing on
the Board's List of Marginable OTC Stocks after meeting the Board's
criteria formerly found in Sec. 220.17 of Regulation T.
\40\ Lenders other than broker-dealers and banks are responsible
for applying Federal Reserve margin requirements only after they
have extended margin stock secured credit in an amount that
surpasses one of two dollar thresholds: $200,000 in credit extended
in one calendar quarter or $500,000 in credit outstanding at any
time.
---------------------------------------------------------------------------

In its request for comment issued last year, the Board noted that
although the definition and treatment of domestic margin stocks is
currently the same in Regulations G, T and U, nonmargin stocks are
treated differently at broker-dealers (where they have no loan value)
than at banks and other lenders (where the Board's margin rules do not
limit their value). The Board sought comment on the possibility of
expanding the types of securities with loan value at broker-dealers by
amending the definition of margin security in Sec. 220.2 of Regulation
T to cover all domestic equity securities that have a ``ready market''
for purposes of the SEC's net capital rule.⁴¹ This would
cover all Nasdaq SmallCap stocks ⁴² and thousands of
additional over-the-counter (``OTC'') stocks not traded on Nasdaq. In
light of the disparate treatment of nonmargin stock at broker-dealers
versus other lenders, the Board also sought comment on the appropriate
definition of margin stock under Regulations G and U and on possible
solutions to the current structure of its margin regulations that
results in an increase in burden for lenders other than broker-dealers
whenever burden is reduced for broker-dealers. The Board suggested its
regulations might be amended to cover more securities for broker-
dealers and fewer securities for banks and other lenders.
---------------------------------------------------------------------------

\41\ 17 CFR 240.15c3-1, ``Net capital requirements for brokers
or dealers.''
\42\ The SmallCap tier of the Nasdaq Stock Market contains over
1800 stocks, of which approximately 442 are currently marginable at
broker-dealers.
---------------------------------------------------------------------------

The proposal to make all domestic ``ready market'' stocks
marginable under Regulation T was supported by four commenters and
opposed by four commenters, while another commenter stated its belief
that further clarification is needed before such an amendment could be
adopted. Three commenters suggested expanding the definition of OTC
margin stock at least to cover all stocks listed on the Nasdaq Stock
Market.
Regulation T has always included all securities (other than
options) registered on any national securities exchange as margin
securities.⁴³ In allowing loan value for certain over-the-
counter securities, the Board has attempted through its criteria to
ensure similar levels of liquidity and transparency.⁴⁴ The
NASD has recently raised listing requirements for both the National
Market and SmallCap tiers of the Nasdaq Stock Market.⁴⁵ The
minimum standards for listing on Nasdaq (i.e., the SmallCap tier)
generally equal or exceed those of the American, Boston, Chicago,
Pacific, and Philadelphia Stock Exchanges. The Board believes that
Nasdaq SmallCap issues, which meet or exceed many national securities
exchange requirements, should not be denied margin status solely
because they are not traded on an ``exchange.'' Therefore the Board is
including all Nasdaq listed issues in its definition of margin
security.⁴⁶ The Board's quarterly OTC List will no longer be
necessary for broker-dealers because the Board will no longer choose
which Nasdaq stocks are marginable, but will instead rely on Nasdaq
listing standards to the same extent it relies on the listing standards
of U.S. securities exchanges.
---------------------------------------------------------------------------

\43\ Although the term ``national securities exchange'' is not
defined in the Board's margin regulations or section 3(a) of the '34
Act (whence terms are incorporated by reference into the Board's
margin regulations), the Board has always understood the term to
mean a securities exchange registered with the SEC under section 6
of the '34 Act (``National securities exchanges,'' 15 U.S.C. 78f).
In a separate document published elsewhere in today's Federal
Register, the Board is requesting comment on whether it should
propose to incorporate this definition into its margin regulations.
\44\ The Board definition of OTC margin stock in the second
(definitional) section of Regulations G, T and U referred to stock
``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 traded on a national securities exchange.''
\45\ SEC approval was received on August 22, 1997.
\46\ The definition of margin security formerly included ``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)'' as well as ``any OTC margin
stock.'' The former referred to Nasdaq listed stocks trading in the
National Market tier, while the latter referred to those Nasdaq
listed stocks trading in the SmallCap tier that the Board identified
on a quarterly basis as meeting the requirements found in Sec. 207.6
of Regulation G, Sec. 220.17 of Regulation T, and Sec. 221.7 of
Regulation U. These two paragraphs have been replaced with a
reference to ``any security listed on the Nasdaq Stock Market.''
---------------------------------------------------------------------------

SEC staff have asked for a delay in the effective date of the
amendment giving 50 percent loan value to all Nasdaq securities to
address possible sales practice issues. The Board is delaying the
effectiveness of this provision until January 1, 1999 and will cease
publication of its quarterly OTC List for U.S. traded securities after
publication of the November 1998 list.⁴⁷ The Board may
revisit the issue of allowing credit on other equity securities at a
later date.
---------------------------------------------------------------------------

\47\ For a discussion of the effect of the elimination of the
OTC List for lenders other than broker-dealers, see section III. A.
1. In the Supplementary Information.
---------------------------------------------------------------------------

2. Foreign Stocks
The Board has been identifying those foreign equity securities that
are eligible for margin at broker-dealers since 1990 by publishing a
List of Foreign Margin Stocks (``Foreign List'') on a quarterly basis.
As in the case of OTC margin stocks, the Board has based its decisions
on criteria aimed at ensuring liquidity and price transparency for all
margin securities. Last year, the Board amended its criteria for
foreign margin stocks to encompass foreign stocks deemed to have a
``ready market'' under the SEC's net capital rule.⁴⁸ This
action allowed the inclusion of hundreds of additional foreign stocks
on the Foreign List, based on a ``no action'' position from the SEC
that effectively treats all stocks on the Financial Times/Standard &
Poor's World Actuaries Indices (``FT/S&P Indices'') as having a ``ready
market'' for capital purposes.⁴⁹ Although there was
considerable overlap between stocks on the FT/S&P Indices and the
Board's Foreign List, there were also a significant number of foreign
stocks that appeared on the Foreign List but not the FT/S&P Indices.
The Board sought comment on whether it should phase

[[Page 2816]]

out its original criteria and Foreign List and rely exclusively on the
SEC's ``ready market'' test.
---------------------------------------------------------------------------

\48\ 17 CFR 240.15c3-1.
\49\ See, 58 FR 44310; August 20, 1993.
---------------------------------------------------------------------------

Most commenters opposed the idea of phasing out the Board's
original eligibility requirements for foreign margin stocks in favor of
reliance on the FT/S&P Indices or the SEC's ``ready market'' concept
because they did not want to eliminate the marginability of stocks that
appear on the Board's Foreign List but that may not meet the other
tests. The Board therefore is retaining its Foreign List to identify
those foreign stocks that have been found to meet the Board's original
eligibility and continued listing requirements and amending the
definition of foreign margin stock in Sec. 220.2 of Regulation T to
include both securities on the Board's Foreign List and those deemed to
have a ``ready market'' for capital purposes, as determined by the SEC.
This will allow a stock appearing on the FT/S&P Indices to qualify as a
margin security without the need to be included on the Board's Foreign
List, a request made by several commenters. Several other commenters
also requested the ability to have broker-dealers make their own
determination that a specific foreign stock has a ``ready market'' and
should therefore be a margin security. The Board views the process of
increasing the coverage of its definition of margin security as an
incremental one and believes it is appropriate at this time to limit
the margin status of foreign stocks to those that either meet the
Board's original criteria for foreign margin stock and therefore appear
on the Board's Foreign List or are deemed by the SEC to have a ``ready
market'' for purposes of their net capital rule.⁵⁰
---------------------------------------------------------------------------

\50\ In this regard, the Board is confirming that broker-dealers
may rely on written ``no action'' or interpretative letters issued
by the SEC or its staff regarding its ``ready market'' criteria.
---------------------------------------------------------------------------

3. Options: Short Sales and Arbitrage Transactions
When options first began trading on a national securities exchange
in 1973, the Board issued an interpretation concluding that options may
not be considered securities ``exchangeable or convertible into other
securities, within 90 calendar days, without restriction other than the
payment of money.'' ⁵¹ The quoted language appears in the
bona fide arbitrage provision of the good faith account (Sec. 220.6(b)
of Regulation T, formerly the arbitrage account in Sec. 220.7) and in
the Supplement (Sec. 220.12 of Regulation T, formerly Sec. 220.18)
under the margin required for short sales. The effect of the
interpretation was to preclude the possibility of effecting ``bona fide
arbitrage'' (which requires no margin under Regulation T) between
options and their underlying securities and to preclude the use of an
option in lieu of the 50 percent margin required for short sales in
addition to the short sale proceeds. Last year, the Board proposed to
rescind the 1973 interpretation. A majority of commenters supported
this proposal, although the Treasury Department commented that this may
have merit for certain options but is premature until an approach is
more fully developed.
---------------------------------------------------------------------------

\51\ 12 CFR 220.126 and 12 CFR 221.123, reprinted in the Federal
Reserve Regulatory Service at 5-488.
---------------------------------------------------------------------------

The Board is rescinding its interpretation that options are not
convertible securities and amending the Supplement of Regulation T to
allow a listed call option to serve as partial margin for short sales
of the underlying security. To ensure that a call option adequately
covers a customer's obligation in a short sale, the Supplement of
Regulation T requires that a call option serving in lieu of part of the
required margin is an American style option ⁵² issued by a
registered clearing corporation and traded on a national securities
exchange with an exercise (strike) price that is not greater than the
price at which the underlying security was sold short. This will ensure
that the short sale proceeds and option can be used to cover the short
position in the underlying security if necessary. In addition,
rescission of the Board interpretation will allow ``bona fide''
arbitrage between options and their underlying securities to be
effected without further regulatory changes in the good faith account
on the same basis as other convertible securities such as convertible
bonds.
---------------------------------------------------------------------------

\52\ American style options are exercisable on any business day
until expiration. European style options may be exercised only at
expiration.
---------------------------------------------------------------------------

In response to the Board's request for comment on using long calls
to offset some of the required margin for a short sale, several
commenters also suggested that the Board should not require margin for
the long purchase of a security if the customer has a long put on that
security. The Board believes the use of a put option in lieu of margin
for the purchase of a security may be appropriate in the context of a
future portfolio margining system, which is permitted as an alternative
to Regulation T.⁵³
---------------------------------------------------------------------------

\53\ See Section 220.1(b)(3)(i) of the revised Regulation T.
---------------------------------------------------------------------------

When the Board adopted amendments to Regulation T in 1996, it made
several provisions of the regulation concerning options effective only
until June 1, 1997.⁵⁴ These provisions have been replaced
with SRO rules and the Board is deleting the provisions from the
revised Regulation T.
---------------------------------------------------------------------------

\54\ See e.g., Secs. 220.4(b)(9) and 220.12(b)(6) of the former
Regulation T.
---------------------------------------------------------------------------

C. Miscellaneous Issues

1. Foreign Issues
a. Credit by foreign branches of U.S. broker-dealers: The Board
proposed to amend Regulation T to exempt credit extended by foreign
branches of U.S. broker-dealers if the credit is extended to foreign
persons against foreign securities. This proposal was supported by all
responsive commenters, although one commenter expressed concern about
foreign securities whose principal trading market is in the United
States and another commenter suggested exempting all credit extended by
U.S. broker-dealers outside the United States. The Board is adopting
its proposal and amending the scope section of Regulation T to exclude
financial relations between a foreign branch of a U.S. broker-dealer
and a foreign person involving foreign securities. ⁵⁵ This
will remove restrictions from foreign branches of U.S. broker-dealers
that are not imposed on foreign branches of U.S. banks or foreign
affiliates of U.S. lenders.
---------------------------------------------------------------------------

\55\ See Section 220.1(b)(3)(iv) of the revised Regulation T.
---------------------------------------------------------------------------

b. Foreign currency: The Board is moving former Sec. 220.4(b)(8) of
Regulation T, which permits a creditor to extend credit in a margin
account denominated in any freely convertible foreign currency, to the
general provisions section of the regulation (specifically,
Sec. 220.3(i)). This will make clear that creditors may also extend
credit denominated in any freely convertible currency in the good faith
account and the broker-dealer credit account.
2. Technical Amendments
There were no negative comments on the first two technical
amendments described below, which were proposed by the Board in April
1996. The third amendment is also technical in nature and was suggested
by a commenter.
a. Definition of covered option transaction: The Board proposed to
amend the definition of covered option transaction in Sec. 220.2 of
Regulation T to shorten the list of permissible options transactions in
the cash account by referring to SRO rules generically. These rules
were most recently amended in June of this year and the Board's action
should result in a shorter and simpler

[[Page 2817]]

Regulation T without having a substantive effect for broker-dealers.
The Board is adopting the amendment as proposed.
b. Definition of margin equity security: The Board proposed to add
a definition of the term margin equity security, which appears in the
Supplement to Regulation T. No adverse comments were received. The
definition, which is being adopted as proposed, states that a margin
equity security means a margin security (as defined in Regulation T)
that is an equity security (as defined in section 3(a) of the '34 Act,
whence definitions are incorporated into the Board's margin regulations
if not otherwise defined by the Board).
c. Definition of current market value: Regulations G and U each
contained a definition of the phrase ``current market value'' used to
determine the loan value of margin securities. Regulation T did not
contain a definition of current market value but addressed the same
issue in former Sec. 220.3(g), ``Valuing securities.'' One commenter
noted that while Regulation T contains several references to a
security's ``current market value,'' it does not contain a definition
of this term as do Regulations G and U. The Board is adding a
definition of current market value to Sec. 220.2 of Regulation T that
is the equivalent of former Sec. 220.3(g) and is deleting former
Sec. 220.3(g) from Regulation T. This action will have no substantive
effect, but will make the structure of the Board's margin regulations
more consistent.
3. Cash Account: 90-Day Freeze
Customers who do not have sufficient funds in their cash account to
pay for a security on trade date must agree to pay for the security
before selling it. According to Sec. 220.8(c)(1) of Regulation T, if a
nonexempted security ``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.'' This is known as a ``90-day freeze.'' However,
Sec. 220.8(c)(2) says the freeze ``shall not apply'' if full payment is
received within the required payment period and the proceeds from the
sale are not withdrawn before payment is received. In response to
requests for clarification from commenters, the Board is of the view
that when a customer sells or delivers out securities that have not
been paid for, the 90-day freeze contained in Sec. 220.8(c) of
Regulation T need not be applied until the permissible payment period
has passed.
4. Board Interpretations
The Board is reviewing its interpretations of Regulation T as part
of its periodic review. In 1996, the Board deleted eleven
interpretations that had either been incorporated directly into the
regulation or had become moot due to subsequent amendments. As
discussed above in section II.B.3, the Board is deleting an additional
interpretation today that prevented the use of options as margin for
short sales of the underlying security and prevented the use of the
bona fide arbitrage provision for transactions involving options and
their underlying securities.
In an advance notice of proposed rulemaking published elsewhere in
today's Federal Register, the Board is also specifically soliciting
comment on whether it should propose amendments to incorporate and
broaden two additional interpretations: a 1962 interpretation
⁵⁶ regarding the retirement of stock by an issuer and a 1990
interpretation ⁵⁷ regarding the application of the arranging
provision ⁵⁸ to broker-dealer activities under SEC Rule
144A.
---------------------------------------------------------------------------

\56\ 12 CFR 220.119, reprinted in the FRRS at 5-490.
\57\ 12 CFR 220.131, reprinted in the FRRS at 5-470.1.
\58\ As proposed in 1996, the Board is moving the arranging
provision from former Sec. 220.13 of Regulation T to the general
provisions found in Sec. 220.3.
---------------------------------------------------------------------------

III. Regulations G and U

A. Loan Value

1. Over-the-Counter Stocks
Prior to the adoption of today's amendments, all of the Board's
securities credit regulations permitted 50 percent loan value for: (1)
Stocks traded on a national securities exchange, (2) stocks in the
National Market tier of the Nasdaq Stock Market (``NMS'' securities),
and (3) stocks in the Small Capitalization (``SmallCap'' securities)
tier of the Nasdaq Stock Market that are identified by the Board as
``OTC margin stocks.''
In its request for comment issued last year, the Board noted that
although the definition and treatment of domestic margin stocks is
currently the same in Regulations G, T and U, nonmargin stocks are
treated differently at broker-dealers (where they have no loan value)
than at banks and other lenders (where the Board's margin rules do not
limit their value). In light of the disparate treatment of nonmargin
stock at broker-dealers versus other lenders, the Board sought comment
on the appropriate definition of margin stock under Regulations G and U
and on possible solutions to the current structure of its margin
regulations. This structure results in an increase in burden for
lenders other than broker-dealers whenever burden is reduced for
broker-dealers if the definition of margin stock in Regulations G and U
is expanded whenever the definition of margin security is expanded in
Regulation T. The Board suggested its regulations might be amended to
cover more securities for broker-dealers and fewer securities for banks
and other lenders.
Although three commenters argued for uniform coverage of equity
securities under the Board's margin regulations, most commenters
opposed increasing the coverage of Regulations G and U if Regulation T
is amended to permit broker-dealers to extend credit against more
securities. Because banks and other lenders already have experience in
valuing smaller issues, the Board believes that definition of margin
stock in Regulation U (which incorporates Regulation G) can be amended
to exclude stocks trading in the SmallCap tier of the Nasdaq Stock
Market.⁵⁹ The Board's quarterly OTC List will no longer be
required for banks and other nonbroker lenders because the Board will
no longer choose which Nasdaq stocks qualify as a margin stock for
purposes of Regulation U. These lenders can determine whether an OTC
stock is in Nasdaq's National Market tier by consulting a newspaper,
contacting the NASD or SEC, or checking the NASD's web site at http://
www.nasdaq.com. The Board is therefore deleting the requirements for
inclusion on the OTC List formerly found in Sec. 221.7 of Regulation U,
the definition of OTC margin stock in Sec. 221.2 of Regulation U, and
the provision concerning ``lack of notice of NMS security designation''
formerly found in Sec. 221.3(j) of Regulation U.
---------------------------------------------------------------------------

\59\ Approximately 442 SmallCap issues qualify as ``OTC margin
stock'' under the Board's criteria formerly found in Sec. 221.7 of
Regulation U. If today's amendments were adopted with an immediate
effective date, these stocks would no longer be subject to a 50
percent loan value limitation when used as collateral for purpose
loans. The number of stocks that will actually be affected when the
new regulation goes into effect is likely to be somewhat smaller
once the new Nasdaq listing requirements are fully phased in.
---------------------------------------------------------------------------

2. Options
Options, whether traded on an exchange (also known as listed
options) or over-the-counter (also known as unlisted options), have
traditionally had no loan value under the Board's margin

[[Page 2818]]

regulations. ⁶⁰ In 1995, the Board proposed giving listed
options 50 percent loan value at broker-dealers (under Regulation T)
and banks (under Regulation U).⁶¹ Based on comments received
in connection with the proposed amendments to Regulation T, the Board
decided in 1996 to incorporate rules of the options exchanges (also
known as self-regulatory organizations or SROs) regarding options loan
value into Regulation T instead of the 50 percent requirement it had
proposed. At the same time, the Board proposed to amend Regulations G
and U to allow these lenders to extend credit against listed options to
the extent permitted by the rules of the options exchanges. The Board
sought comment on the practicality of requiring banks and others to
comply with rules of SROs of which they are not members.⁶²
Five commenters supported uniform margin requirements for all lenders,
while four other commenters opposed making lenders who are not broker-
dealers, and therefore not members of a securities SRO, comply with SRO
rules. The SRO margin rules for options are complex and the Board does
not believe it is practical to require banks to comply with the rules
of national securities exchanges of which they are not members, nor to
expect bank examiners to be familiar with these rules in verifying
compliance with Regulation U. The Board is therefore adopting the
original 1995 Regulation U proposal and amending the Supplement to
Regulation U to allow lenders other than broker-dealers to extend 50
percent loan value against listed options. Unlisted options continue to
have no loan value when used as part of a mixed-collateral loan.
However, banks and other lenders can extend credit against unlisted
options if the loan is not subject to Regulation U. The Board is
requesting comment on the future status of unlisted options under
Regulation U in an advance notice of proposed rulemaking published
elsewhere in today's Federal Register.
---------------------------------------------------------------------------

\60\ Listed options were the only securities denied loan value
by the Board under all of its securities credit regulations, in
spite of the fact that they qualify as margin stock because they are
listed on a national securities exchange. Although unlisted options
do not qualify as margin stock and most nonmargin stock has good
faith loan value under Regulation U, unlisted options have no loan
value if the loan is a purpose credit secured at least in part by
margin stock. Of course, Regulations G and U by their terms would
not cover a loan that was solely secured by an unlisted option.
\61\ The Regulation T proposal for broker-dealers was part of
Docket No. R-0772 and appeared at 60 FR 33763 (June 29, 1995). The
Regulation U proposal for banks was part of Docket No. R-0905 and
appeared at 60 FR 63660 (December 12, 1995).
\62\ The final action on Regulation T and revised proposal for
Regulations G and U appeared at 61 FR 20385 (May 6, 1996).
---------------------------------------------------------------------------

3. Money Market Mutual Funds
Although Regulation U treats most mutual funds as margin stock
subject to 50 percent loan value, it has always allowed good faith loan
value for mutual funds whose portfolios consist of exempted
securities.⁶³ In 1995, the Board proposed to extend this
treatment to all money market mutual funds under both Regulations T and
U. All responsive commenters supported this proposal, which was adopted
for Regulation T purposes in 1996. The Board is therefore amending the
definition of margin stock in Regulation U to exclude money market
mutual funds. This will have the effect of permitting good faith loan
value for these securities when they are used as collateral for a
purpose loan that is secured in part by margin stock.⁶⁴
---------------------------------------------------------------------------

\63\ Section 221.2 of Regulation U excludes from the definition
of ``margin stock'' any security issued by an investment company
registered under section 8 of the Investment Company Act of 1940
``which has at least 95 percent of its assets continuously invested
in exempted securities.''
\64\ Regulation T was amended last year to provide similar
treatment for money market mutual funds. The Board is using the same
definition used at that time, i.e., a security issued by a
registered investment company that is considered a money market fund
under SEC Rule 2a-7 (17 CFR 270.2a-7, ``Money market funds'').
---------------------------------------------------------------------------

B. Financing of Securities Purchased on a DVP Basis

Banks may act as custodians for their customers' securities. These
securities are often purchased at registered broker-dealers and
delivered to the bank on a delivery-versus-payment (DVP) basis. In the
late 1980s and early 1990s, Federal Reserve System examiners and staff
of the SEC alleged that certain banks were accepting the delivery of
customer margin securities without having the customer's full payment
on hand, thereby extending purpose credit in excess of the Regulation U
margin requirements. In many cases, payment for the customer's purchase
was made in reliance on the proceeds of the sale of the same
security.⁶⁵
---------------------------------------------------------------------------

\65\ In response to banks who argued that they were relying on
the sale proceeds of the unpaid-for security, Board staff opined
that reliance on sale proceeds is tantamount to reliance on the
security itself.
---------------------------------------------------------------------------

The purchase and same-day sale of a security without independent
funds to pay for the purchase is prohibited at a broker-dealer if
effected in a cash account (where it is known as ``free-riding''),
because the customer is obtaining intraday credit from the broker-
dealer to pay for the security so it can own the security in order to
sell it. This practice, however, is not prohibited at a broker-dealer
if effected in a margin account, because the broker-dealer has entered
into a credit relationship with the customer before extending credit to
cover the purchase. In order to allow banks to extend credit in a
manner similar to broker-dealers using a margin account, the Board
proposed to amend the existing provision in Sec. 221.3(c) of Regulation
U for revolving credit agreements to include such credit. The Board
stated its belief that applying the revolving credit provision would
ensure that banks financing customer securities transactions establish
credit limits for their customers, including limits on intraday
trading.
Ten commenters, including five Reserve Banks, supported the Board's
proposal. Two bank trade associations opposed the proposal. The trade
associations made similar arguments. Each acknowledged that in
providing custodial services banks sometimes extend credit to pay for
customer securities and this credit may be intraday or extend for a
longer period of time. The trade associations stated that this credit
is extended by a bank in its own discretion and not pursuant to an
agreement with their customer. The trade associations stated banks do
not have written agreements with their customers because they do not
want to be required to extend this type of credit. The trade
associations stated that custodial banks generally have a lien only on
the assets in a customer's account, and they believed it would be
inconsistent for a bank to demand that a customer post additional
assets to cover overdraft extensions of credit. The trade associations
were also concerned that the Board's proposal might be seen as
superseding staff opinions in this area permitting some overdrafts when
banks carefully monitor their customer's transactions.
As an alternative to the Board's proposal to cover extensions of
credit used to finance a customer's purchase of securities on a DVP
basis under the provision for revolving lines of credit, the trade
associations suggested exempting these transactions by amending
Sec. 221.6(f) of Regulation U. Section 221.6(f) provides that a bank
may extend and maintain purpose credit without regard to the
requirements of Regulation U if the credit is 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.'' The Board proposed to amend this section to restore
language inadvertently deleted in 1983 that

[[Page 2819]]

makes clear the exception cannot be used to finance the purchase of
securities at a broker-dealer (see, e.g. staff opinions at FRRS 5-
884.68 and 5-942.2). The trade associations suggested that if the
Board's primary concern in this area is preventing banks from aiding
and abetting free-riding violations by their customers, Sec. 221.6(f)
of Regulation U should be amended not by restating that it cannot be
used to finance transactions effected at a broker-dealer, but by
stating that the exception is not available if the bank ``knowingly''
relies on the proceeds of a security's sale as a source of payment for
the security.
The Board is amending the revolving credit agreement provision in
Sec. 221.3(c)(2)(iii)(B) of Regulation U as proposed to require a
lender to call for additional collateral when the lender is relying on
margin stock which is insufficient to cover an extension of purpose
credit. This will clarify that a lender who has an agreement with its
customer covering credit extended in connection with custodial or
clearing services is properly secured or truly unsecured and should
therefore be free from allegations of aiding and abetting customer
free-riding violations. The Board is also readopting the language
inadvertently dropped from Sec. 221.6(f) of Regulation U, as proposed.
The exemption in Sec. 221.6(f) of Regulation U has never been available
to cover the same-day purchase and sale of a security bought in a cash
account at a broker-dealer, and the restoration of the former language
will eliminate any ambiguity. Finally, the Board notes that its action
is not intended to supersede the staff opinions in this area.
In the advance notice of proposed rulemaking published elsewhere in
today's Federal Register, the Board is soliciting comment on proposals
to address the supervisory and credit implications of free-riding.

C. Mixed Collateral Loans

Regulation U does not apply to extensions of securities credit that
are not secured at least in part by margin stock. Purpose 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.\66\ Section 221.3(e) of
Regulation U provided that mixed collateral loans ``shall be treated as
two separate loans.'' This was intended to prevent a bank from
inflating the value of nonmargin stock collateral to make up for the 50
percent limitation for purpose loans secured by margin stock.
---------------------------------------------------------------------------

\66\ The mixed-collateral loan provision does not apply to
nonpurpose loans.
---------------------------------------------------------------------------

The provision for mixed collateral loans did not present a problem
when applied at the time the loan commitment is made, as it merely
required 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 allocate the
credit secured by each tranche.
The Board has received a number of inquiries about the interplay of
the provision for mixed-collateral loans and Sec. 221.3(f) of
Regulation U, which covers withdrawals and substitution of collateral.
For example, if the value of a customer's nonmargin stock collateral
has increased since a mixed collateral loan was made, but the value of
the margin stock has stayed the same, the customer cannot withdraw
margin stock even though the overall value of the collateral has
increased, because the ``separate'' loan secured by margin stock does
not have excess value that would permit its withdrawal. In other words,
changes in collateral value in one tranche have no effect on the other.
Noting that the separation requirement for mixed collateral loans
makes collateral management extremely difficult, the Board proposed to
modify the provision on mixed-collateral loans so that instead of
separating margin stock from all other collateral, a bank would
separate margin stock and other financial instruments such as nonmargin
stock, bonds, and cash equivalents. This collateral would secure one
loan and nonfinancial instruments (such as real estate), if any, would
be treated as securing a ``separate'' loan. The Board noted that
financial instruments generally have readily available prices and are
therefore less susceptible to being assigned an inflated value to
offset the 50 percent loan value limitation for margin stock. The Board
also invited comment on the continuing need for separation of financial
and nonfinancial collateral.
Ten commenters supported the Board's proposal and no commenter
expressed a preference for maintaining the status quo. One commenter
suggested providing additional flexibility by amending the regulation
to provide that margin stock and other financial instruments may be
treated as a single loan. Three commenters supported complete
elimination of any separation requirements.
The Board is deleting the mixed collateral loan provision in former
Sec. 221.3(e) of Regulation U. Banks will still be required to make a
good faith determination that nonmargin stock collateral, if any, has
sufficient good faith loan value to make up the difference between the
regulatory loan value of margin stock and the amount of credit extended
for a purpose loan. Although nonfinancial instruments are often more
difficult to value than securities, the Board believes the requirement
of good faith on the part of the lender is sufficient to guard against
circumvention of the Board's margin requirements for equity securities.
With the elimination of the requirement to separate purpose loans
secured by margin stock from other purpose loans will allow a bank to
release any type of collateral if the overall loan value of the pool of
collateral is greater than the amount required under Regulation U.

IV. Regulation X

Regulation X (``Borrowers of securities credit'') applies the
Board's margin regulations to United States persons and related parties
who obtain credit outside the United States to purchase or carry United
States securities. Borrowers must conform the credit they receive with
one of the Board's other margin regulations, according to the lender
involved. The regulation also applies to borrowers who obtain credit
within the United States to purchase or carry any security if the
borrower willfully causes the credit to be extended in contravention of
the Board's other margin regulations. Both of these provisions refer to
Regulation G. The Board is amending Regulation X to remove the
references to Regulation G. Borrowers obtaining credit outside the
United States who were formerly required to conform their credit to
Regulation G will now be required to conform their credit to Regulation
U as it applies to nonbank lenders.

V. Regulatory Flexibility Act

The amendments being adopted are intended to accomplish two goals.
As discussed in the preamble, some of the amendments have been
developed to implement the National Securities Markets Improvement Act
(Pub. L. 104-290), which reduced the scope of the Board's statutory
authority for margin regulation. The others are intended to simplify
regulatory requirements and eliminate restrictions currently imposed on
broker-dealers, other lenders of securities credit, and their
customers. For example, smaller companies whose stock is listed on
Nasdaq's Small Capitalization market will no longer be

[[Page 2820]]

subject to Regulation G registration and reporting requirements if they
extend credit to employees secured by company stock. The Board believes
the amendments will not have a substantial adverse effect on a
significant number of small lenders.

VI. Paperwork Reduction Act

In accordance with the Paperwork Reduction Act of 1995 (44 U.S.C.
3506; 5 CFR 1320 Appendix A.1), the Board reviewed the rule under the
authority delegated to the Board by the Office of Management and
Budget. The Federal Reserve may not conduct or sponsor, and an
organization is not required to respond to, an information collection
unless it displays a currently valid OMB control number. The OMB
control numbers are listed below.
The collections of information that may be affected by this
rulemaking are found in 12 CFR 207 and 12 CFR 221. These information
collections are mandatory (15 U.S.C. 78g and 78w). The respondents and
recordkeepers are for-profit financial institutions, including banks
and nonbank lenders. The Federal Reserve collects the information in
order to identify lenders subject to Regulation G, to verify compliance
with Regulation G, and to monitor the size of the market for margin
credit. The purpose statements collect information on the amount and
purpose of the loans secured by margin stock. The burden associated
with the FR U-1 and the FR G-3 is recordkeeping burden. Because the
records would be maintained by respondents and are not provided to the
Federal Reserve, no issue of confidentiality under the Freedom of
Information Act arises. The FR G-2 does not contain confidential
information. The information in the FR G-1 and the FR G-4 are given
confidential treatment under the Freedom of Information Act (5 U.S.C.
Sec. 552 (b)(4)).
In a separate document published elsewhere in today's Federal
Register, the Board is soliciting comment on the disposition of certain
reporting forms currently used by Regulation G lenders, the FR G-1, FR
G-2, and FR G-4, and on further amendments to Regulation U that would
affect the margin credit ``purpose statements,'' the FR G-3 and the FR
U-1. Accordingly, until the Board has collected and analyzed such
comments as may be forthcoming, it will extend for three years, without
revision, under delegated authority by the Office of Management and
Budget, the following collections of information: FR G-1 (OMB No. 7100-
0011), FR G-2 (OMB No. 7100-0011), FR G-3 (OMB No. 7100-0018), FR G-4
(OMB No. 7100-0011), and FR U-1 (OMB No. 7100-0115). The Board
anticipates that these information collections will be revised before
the full three-year period has ended.
In proposed amendments issued for comment by the Board in December
1995 (Docket R-0905), April 1996 (Docket R-0923), and November 1996
(Docket R-0944), no comments specifically addressing the burden
estimates for these information collections were received.
The estimated annual burden for these information collections is
summarized in the table below.

----------------------------------------------------------------------------------------------------------------
Estimated Estimated Estimated
number of Annual average hours annual burden
respondents frequency per response hours
----------------------------------------------------------------------------------------------------------------
FR G-1.......................................... 81 1 2.50 203
FR G-2.......................................... 68 1 0.25 17
FR G-3.......................................... 700 20 0.16 2,240
FR G-4.......................................... 629 1 2.00 1,258
FR U-1.......................................... 10,637 212 0.07 157,853
---------------------------------------------------------------
Total..................................... .............. .............. .............. 161,571
----------------------------------------------------------------------------------------------------------------

The Federal Reserve has a continuing interest in the public's
opinions of our collections of information. At any time, comments
regarding the burden estimate, or any other aspect of this collection
of information, including suggestions for reducing the burden, may be
sent to: Secretary, Board of Governors of the Federal Reserve System,
20th and C Streets, N.W., Washington, DC 20551; and to the Office of
Management and Budget, Paperwork Reduction Projects (7100-0011, 7100-
0018, and 7100-0115), Washington, DC 20503.

List of Subjects

12 CFR Part 207

Banks, banking, Credit, Federal Reserve System, Reporting and
recordkeeping requirements, Securities.

12 CFR Part 220

Banks, banking, Brokers, Credit, Federal Reserve System, Reporting
and recordkeeping requirements, Securities.

12 CFR Part 221

Banks, banking, Brokers, Credit, Federal Reserve System, Reporting
and recordkeeping requirements, Securities.

12 CFR Part 224

Banks, banking, Brokers, Credit, Federal Reserve System, Reporting
and recordkeeping requirements, Securities.

12 CFR Part 265

Authority delegations (Government agencies), Banks, banking,
Federal Reserve System.

For the reasons set out in the preamble, and under the authority of
12 U.S.C. 78c, 78g, 78q, and 78w, 12 CFR chapter II is amended as
follows:

PART 207--[REMOVED]

1. Part 207 is removed.

PART 220--CREDIT BY BROKERS AND DEALERS (REGULATION T)

2. The authority citation for part 220 continues to read as
follows:

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

3. Sections 220.1 through 220.12 are revised to read as follows:

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

[[Page 2821]]

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;
(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.

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.
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

[[Page 2822]]

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 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.

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.
(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

[[Page 2823]]

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.

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:
(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 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

[[Page 2824]]

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.

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
(4) Margin excess transferred from the margin account under
Sec. 220.4(e)(2).

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.

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
(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

[[Page 2825]]

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.

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;
(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.

[[Page 2826]]

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 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.

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.

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 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

[[Page 2827]]

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 stocks on those lists shall be an unlawful
representation.

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.

Secs. 220.13--220.18 [Removed]

4. Sections 220.13 through 220.18 are removed.

Sec. 220.126 [Removed and Reserved]

5. Section 220.126 is removed and reserved.
6. Part 221 is revised to read as follows:

PART 221--CREDIT BY BANKS AND PERSONS OTHER THAN BROKERS OR DEALERS
FOR THE PURPOSE OF PURCHASING OR CARRYING MARGIN STOCK (REGULATION
U)

Sec.
221.1 Authority, purpose, and scope.
221.2 Definitions.
221.3 General requirements.
221.4 Employee stock option, purchase, and ownership plans.
221.5 Special purpose loans to brokers and dealers.
221.6 Exempted transactions.
221.7 Supplement: Maximum loan value of margin stock and other
collateral.

Interpretations

221.101 Determination and effect of purpose of loan.
221.102 Application to committed credit where funds are disbursed
thereafter.
221.103 Loans to brokers or dealers.
221.104 Federal credit unions.
221.105 Arranging for extensions of credit to be made by a bank.
221.106 Reliance in ``good faith'' on statement of purpose of loan.
221.107 Arranging loan to purchase open-end investment company
shares.
221.108 Effect of registration of stock subsequent to making of
loan.
221.109 Loan to open-end investment company.
221.110 Questions arising under this part.
221.111 Contribution to joint venture as extension of credit when
the contribution is disproportionate to the contributor's share in
the venture's profits or losses.
221.112 Loans by bank in capacity as trustee.
221.113 Loan which is secured indirectly by stock.
221.114 Bank loans to purchase stock of American Telephone and
Telegraph Company under Employees' Stock Plan.
221.115 Accepting a purpose statement through the mail without
benefit of face-to-face interview.
221.116 Bank loans to replenish working capital used to purchase
mutual fund shares.
221.117 When bank in ``good faith'' has not relied on stock as
collateral.
221.118 Bank arranging for extension of credit by corporation.
221.119 Applicability of plan-lender provisions to financing of
stock options and stock purchase rights qualified or restricted
under Internal Revenue Code.
221.120 Allocation of stock collateral to purpose and nonpurpose
credits to same customer.
221.121 Extension of credit in certain stock option and stock
purchase plans.
221.122 Applicability of margin requirements to credit in
connection with Insurance Premium Funding Programs.
221.123 Combined credit for exercising employee stock options and
paying income taxes incurred as a result of such exercise.
221.124 Purchase of debt securities to finance corporate takeovers.
221.125 Credit to brokers and dealers.

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

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

[[Page 2828]]

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
(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;
(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);

[[Page 2829]]

(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.
(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

[[Page 2830]]

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 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).
(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

[[Page 2831]]

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
(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 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

[[Page 2832]]

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
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 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.

[[Page 2833]]

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.
(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

[[Page 2834]]

authorizing the sponsoring company to deduct a percentage of his salary
and wages and transmit the same to the bank as trustee. Voluntary
contributions by the company are allocated among the participants. A
participant may direct that funds held for him be invested by the
trustee in insurance, annuity contracts, Series E Bonds, or in one or
more of three specified securities which are listed on a stock
exchange. Loans to purchase the stocks may be made to participants from
funds of the trust, subject to approval of the administrative
committee, which is composed of five participants, and of the trustee.
The bank's right to approve is said to be restricted to the mechanics
of making the loan, the purpose being to avoid cumbersome procedures.
(c) Loans are secured by the credit balance of the borrowing
participants in the savings fund, including stock, but excluding (in
practice) insurance and annuity contracts and government securities.
Additional stocks may be, but, in practice, have not been pledged as
collateral for loans. Loans are not made, under the plan, from bank
funds, and participants do not borrow from the bank upon assignment of
the participants' accounts in the trust.
(d) It is urged that loans under the plan are not subject to this
part because a loan should not be considered as having been made by a
bank where the bank acts solely in its capacity of trustee, without
exercise of any discretion.
(e) The Board reviewed this question upon at least one other
occasion, and full consideration has again been given to the matter.
After considering the arguments on both sides, the Board has reaffirmed
its earlier view that, in conformity with an interpretation not
published in the Code of Federal Regulations which was published at
page 874 of the 1946 Federal Reserve Bulletin (See 12 CFR 261.10(f) for
information on how to obtain Board publications.), this part applies to
the activities of a bank when it is acting in its capacity as trustee.
Although the bank in that case had at best a limited discretion with
respect to loans 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 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

[[Page 2835]]

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.

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 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

[[Page 2836]]

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 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 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

[[Page 2837]]

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.
(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

[[Page 2838]]

loan value equals $300 the amount of the insurance premium which is
also the amount of the credit extended).
(b) The guidelines referenced in paragraph (a) of this section
also:
(1) Clarify an earlier 1969 Board interpretation to show that the
public offering price of mutual fund shares (which includes the front
load, or sales commission) may be used as a measure of their current
market value when the shares serve as collateral on a purpose credit
throughout the day of the purchase of the fund shares; and
(2) Relax a 1965 Board position in connection with accepting
purpose statements by mail.
(c) It is the Board's view that when it is clearly established that
a purpose statement supports a purpose credit then such statement
executed by the borrower may be accepted by mail, provided it is
received and also executed by the lender before the credit is extended.

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
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

[[Page 2839]]

takeover attempt clearly understand that the shell corporation intends
to acquire the margin stock of the target company in order to effect
the acquisition of that company. This understanding represents a
practical restriction on the ability of the shell corporation to
dispose of the target's margin stock and to acquire other assets with
the proceeds of the credit.
(h) In the second situation, Company C, an operating company with
substantial assets or cash flow, seeks to acquire Company D, which is
significantly larger than Company C. Company C establishes a shell
corporation that together with Company C makes a tender offer for the
shares of Company D, which is margin stock. To finance the tender
offer, the shell corporation would obtain a bank loan that complies
with the margin lending restrictions of this part and Company C would
issue debt securities that would not be directly secured by any margin
stock. The Board is of the opinion that these debt securities should
not be presumed to be indirectly secured by the margin stock of Company
D, since, as an operating business, Company C has substantial assets or
cash flow without regard to the margin stock of Company D. Any
presumption would not be appropriate because the purchasers of the debt
securities may be relying on assets other than margin stock of Company
D for repayment of the credit.

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)

7. The authority citation for part 224 is revised to read as
follows:

Authority: 15 U.S.C. 78g.

Sec. 224.1 [Amended]

8. Section 224.1 is amended as follows:
a. Remove ``G,'' and ``207,'' from the last sentence in paragraph
(a).
b. Remove ``G,'' from paragraph (b)(1).

Sec. 224.2 [Amended]

9. Section 224.2 is amended by removing ``G,'' from the
introductory text.
10. Section 224.3 is revised to read as follows:

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.

PART 265--RULES REGARDING DELEGATION OF AUTHORITY

11. The authority citation for part 265 continues to read as
follows:

Authority: 12 U.S.C. 248(i) and (k).

12. Section 265.11(f) is revised to read as follows:

Sec. 265.11 Functions delegated to Federal Reserve Banks.

* * * * *
(f) Securities. To approve applications by a registered lender for
termination of the registration under Sec. 221.3(b)(2) of Regulation U
(12 CFR 221.3(b)(2)).
* * * * *
By order of the Board of Governors of the Federal Reserve
System, January 8, 1998.
William W. Wiles,
Secretary of the Board.
[FR Doc. 98-871 Filed 1-15-98; 8:45 am]
BILLING CODE 6210-01-P

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Document Information

Published:: 01/16/1998
Department:: Federal Reserve System
Entry Type:: Rule
Action:: Final rule.
Document Number:: 98-871
Pages:: 2806-2839 (34 pages)
Docket Numbers:: Regulations G, T, U and X, Docket Nos. R-0905, R-0923 and R-0944
PDF File:: 98-871.pdf
CFR: (61): 12 CFR 221.3(a); 12 CFR 221.4(a); 12 CFR 221.3(b); 12 CFR 221.3(b)(1); 12 CFR 221.3(c); More ...