The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
35?
S-11
Rl3g.
U-16
INTERPRETATION OF LAW OR REGULATION
{Copies to be sent to all Federal reserve banks)
June 25, 1957.
Mr. ------------------'
---------------------'
---------------------'
---------------------·
Dear Mr.
Reference is made to your lett~r of April 26, 1937, regarding
the inquiry of
lta tional Bank,
,
,
as to the possible effect under Regulation U of the substitution of
rogisterod stocks as collateral. for a loan originally supposed to
have been made for tho purpose of purchasing unregistered stocks.
The question is presented in the following excerpt which you quote
from the bank's letter:
"Another point has been raised by one of our officers
in connection with a substantial loan which was made for the
purpose of purchasing unllsted stocks which are pledged, as
security with an additional margin of unlisted stocks- The
borrower subsequently withdrew on trust reoeipt part ot the
unlisted stocks, sold the same and purchased listed stecks
which were substituted as part of the collateral. The original loan of course was not interpreted as being subject to
Regulation u, and the question now arises as to whether this
substitution of listed stocks for unlisted stocks,. ·without
aey change in the amount of the principal of the loan,
creates a situation which involves Regulation·U in any
manner."
r
This question was considered when Regulation U was being prepared, and it was realized that there would be same possibili~ of
evasion of-the rogulation if the original purpose of the loan was
made the determining factor. Howevar, this possibili~ did not
seom to be so great as to justify the increased difficulties which
would be caused banks in operating under the regulation if a different rule were followed; and, accordingly, the regulation was
drafted so that, at least for the present, the original purpose
of the loan is controlling.
It should be borne in mind in this connection, however, that
the original purpose or the loan should not be determined upon a
358
-2-
S-11
Reg. U-16
narrow ana.lysis of th$ iDIIlediate use to which the proceeds of the
loan are put. Instead, the fundamental purpose or the loan should
·.be considered to be controlling. As you state in your letter:
"* *
·.
•
* it might be eatabli~hcd that the purpose of
the borrower f1~m tho outset was the purchase of registered
·stocks. In this case, tho regulation would probably apply
if the bank were 'aware of tho intontion. At any rate, it
might be concluded that any repetition of tho practice would
overcome th~ presumption of ti1o bank that the purpose was
correctly stated by tho borrower. The bank might not be
considered a.s acting 'in good .t'ai th 1 if it accepted. a statemcnt by tho bOrrower that the loan was not subject to the
regulation."
In the case presented by
National Bank the question of whether the loan was originally subject to Regulation U
would depend upon the intention of' the borrower when tbe loan was
obtained. If' the loan was obtained with the idea of' purchasing
the unregistered stocks merely as a temporary expedient and shortly thereafter selling tho unregistered stocks and purcbas~g registered stocks, the loan should be considered to be a loan .t'or the
purpose of' purchasing or carcyj.ng registered stocks. The ~ircum
stances related would seem to raise at least some question as to
whether the loan was not of this type.
or course, a bank would not be responsible for misrepresentations made to it b,y its borrowers if the bank operates diligently
and in entire good faith; but a bank should carefully Elcrutinize
cases in which there is e:n:y indication that the b()rrower is concealing the true purpose of the loan and, as you suggest, there
would be reason .t'or special vigilance if registered stocks are substi tuted for unregistered stocks soon a.t'ter the loan is made, or on
mora than one occasion.
Very truly yours,
(Signed)
Chester Morrill
Chester Morrill,
Secretary.
. '
1
1
@FedFRASER