The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
335 BOARD OF GOVERNORS S-115 Sec. 5136 R.S.-13 OF" THE FEDERAL RESERVE SYSTEM WASHINGTON ADDRESS OFFICIAl. CORRESPONDENCE September 8, 1938. TO THE BOARD Dear Sir: The Board of Governors recently received from a State member bank a req_uest for an interpretation of section II(6) of the Investment Securities Regulation issued by the Comptroller of the Currency. This section reads as follows: "Purchase of securities covertible into stock at the option of the holder or with stock purchase warrants attached is prohibited if the price paid for such security is in excess of the investment value of the security itself, considered independently of the stock purchase warrants or conversion feature. If it is apparent that the price paid for an otherwise eligible security f':lirly reflects the investment value of the security itself and does not include any speculative value based upon the presence of a stock _purchr1se warrant or conversion option the purchase of such a security is not prohibited." The pertinent portion of the letter from the State member bank reads as follows: "Paragraph 6 of Section 2 states in part, 'If it is apparent that the price ~aid for an otherwise eligible security fairly reflects the investment value of the seCUl•ity itself and does not include any speculative value b~sed upon the presence of B stock purchaso w~rr~nt or conversion option, thE purchase of such n security is not prohibited.' We will first assume, therefore, that r:my convertible bond to be eligible for purch.:J.se mu3t be one in whi.ch the investment char'lcteri.stics :lre not 'distinctly or predominantly speculative'. In short, the obligor's credit status must be such that its security cannot be said to be one in which the speculative ch~rncteristics are predominant. We presum0 that this is an interpretation on which you would ngree? S-115 336 Sec. 5136 R.s. -1~) -2- "The poiut on which we would like to have clarification as to your intention.s in examining procedure concerns that clause in Paragraph 6, Section 2, which states that the purchase of convertible or warrant bonds is prohibited 'if the price paid for such socurity is in excess of the investment value of the security itBelf, considered independently of the stock purchase warrants or conversion feA.ture.' 'l'o bo still more specific, what will be your procedure in determining whether tho price of a security is in excess of the investment V'llue of the security itself, considered independently of the stock purchase warrants or conversion feature? Which of the following proc8durcs or which other procedures will you adopt? "1. Will the price paid for a convertibl8 bond be deemed to reflect tho presence of q conversion option when, and only when, tho security (generally common stock) into which the bond is convertible h'lS P''lSsed in market price the figure at which ths bond is convertible (the parity figure)? "By way of illustration, if o. bond is convertible into common stock at 25 and the bond is purchased when the stock io selling at 24 7/8 or less, will the bone. be eligible under this particular paragraph, assuming always, of' course, that it is 'otherwise eligible'? "2. If a company has two issues of bonds outstanding under the same mortgage, one issue of which is convertible and one issue of v·rhich is not, will the convertible issue be deemed to be reflecting the presence of t~e conversion privilege if it sell~:; to yield any smaller percentage return (that is, at a higher price) than the issue which is not convertible, however remote thE: conversion parity may be. "Assume Series A and Series B bonds ~1re issued under the same mortgage of' a company whose obligations are 'otherwise eligible'. Assume Sories B bonds are convertible in to the stock at 50; ~1ssume Series A bonds are not con-vertible. Assume that the I!k'l.turi ty datos and the coupon rates of both series are identical, both being 4% bonds, say, due 1946. If Series B, the convertible bond, sells at 80 and Series A sells at 75, and the common stock into which they are convertible is at 17 (3:3 points away from the conversion parity), will Series B bonds be r:ligiblo? S-115 Sec. 5136 337 R.S.-1~ -3- "3. Assume a somewhat similar situation as exists in 2 above, but further assume that there is no comparable mortgage bond with which one can compare in order to ascertain what is the true investment merit. What will be the procedure for determinine whether a bond does reflect the existence of a conversion privilege? In short, assume that there was a Series B bond but no Series A bond, what procedure would you use for determining whether the Series B bond reflected the existence of a conversion privilege?" Since the matter involved an interpretation of a regulation issued by the Comptroller of the Currency, a copy of the letter from the State member bank was furnished to the Acting Comptroller with a request for an expression of his views regarding the questions presented therein. Under date of August 29, 1938, the Board of Governors received from the Acting Comptroller a letter which stated the following (the references to paragraphs "1", "2", and "3" are to the abovequoted numbered paragraphs of tho letter from the State member bank): ·"Mr. is correct tn assuming that any convertible bond or bond with stock puz·chase warrants attached to be eligible for purchase must be one in which the investment characteristics ure not distinctly or predominantly speculative; in short, the obligor's credit status, i.e., the credit status of the particular bond issue in question, must be such that the security cannot be said to be one in which the speculative characteristics are predominant. "It is not believed that the illustration recited by in his paragraph "1" at the top of page Mr. 2 of his letter could b·'l used as the sole tost in determining whether a bank h~1.d. p~dd a price for such a security which was in excess of the lnvestmont v~lue of the security itself, considered independently of the st'Jck purchase warrants or conversion feature. If, with all the av'lilable facts before him, the Examiner deemed that a bank ha w.1s examining h"ld paid a .9ri0e for such a securi.ty which was in excess of the investment value of the security itself, considered independently of' the stock purchn.se warrnnts or conversion feature, he would report the security as having been illegally purchased by tho bank. "It would appear to be clear that in the illustration recited by .Mr. in his paragraph "2" on page 2 of his letter that tho '3erios B' bond would not bE., eligible as it would appear to be clear that the bank would h:we paid $5 a hundred i'or the stock purch'lse warrants or conversion privilege. 338 S-115 Sec. 5136 R.S.-13 -4- "In answer to Mr. 's paragraph "3" on page 2, it can only be repeated that whon :m Examiner, with all the available facts before him, deems that the bank he is examining paid a price for such a security which was in excess of the investment v~lue of the security itself, considered independently of the stock purch~se warrants or conversion feature, he would report the security as having been illegally purchased by the bank." Very truly yours, R. Car enter, Assistant Secretary. TO PRESIDID~TS OF ALL FEDERAL RESERVE BANKS
@FedFRASER