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FED ER A L RESERVE BAN K O F DALLAS DALLAS. TEXAS December 20, 1965 INTERPRETATIONS OF REGULATION F To All State Member Banks in the Eleventh Federal Reserve District: Enclosed are two interpretations by the Board of Governors, under Federal Reserve Regulation F (Securities of Member State Banks), relating to: (1) Financial statements to be included in annual reports to security holders pursuant to the provisions of section 206.5(c) of the regulation, and (2) Disclosure of loans to insiders in management proxy statements furnished in accordance with the requirements of section 206.5(a) of the regulation. The interpretations will be published shortly in the Federal Register and Federal Reserve Bulletin. They are being forwarded at this time so that you may have prompt notice of their contents. Additional copies of the interpretations are available upon request. Yours very truly, Watrous H. Irons President This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM REGULATION F FINANCIAL STATEMENTS TO BE INCLUDED IN AN N U AL REPORTS TO SECURITY HOLDERS Since 1966 will generally be the first time that banks subject to the public disclosure require ments o f the Securities Exchange A ct of 1934 will be soliciting proxies in accordance with such requirements, the Board of Governors directs the attention of registrant banks to section 206.5(c) o f Federal Reserve Regulation F, “ Securities o f Member State Banks” . It is provided therein that a bank’s proxy statement (or the statement that must be distributed where management does not solicit proxies) which relates to an annual meeting of security holders at which directors are to be elected, shall be accompanied or preceded by an annual report to such security holders “ containing such financial statements fo r the last fiscal year as will, in the opinion o f the management, ade quately reflect the financial position and operations of the bank.” Adherence to the following reporting standards, prescribed in Regulation F, is considered necessary to reflect adequately the financial position and results of operations o f registrant banks in such annual reports to security holders: 1. Financial statements should be prepared on a consolidated basis to the extent required by Regulation F. 2. A statement o f income should be furnished in a form providing for the determination o f the “ amount transferred to undivided profits” as a result o f all activity related to the pre ceding year. 3. A statement o f changes in capital accounts, including capital reserves, should be included. 4. Valuation reserves should be reported as reductions o f related asset values. 5. A reconciliation of valuation reserves should be presented, showing material charges and credits. Section 206.5 (c) further provides that — “ The financial statements included in the annual report may omit details or summarize information if such statements, considered as a whole in the light of other information contained in the report and in the light of the financial statements o f the bank filed or to be filed with the Board, will not by such procedure omit any material information necessary to a fair presentation or to make the financial statements not misleading under the cir cumstances. Subject to the foregoing requirements with respect to financial statements, the annual report to security holders may be in any form deemed suitable by the man agement.” Pursuant to these provisions, the financial statements included in annual reports to security holders should not be inconsistent with the financial reporting prescribed by Regulation F and they should conform in all material respects to the accounting principles stated therein. However, annual reports to security holders need not include the detailed information required in annual reports filed with the Federal Reserve Board on Federal Reserve Form F-2. BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM REGULATION F PROXY SOLICITATION BY BANK MANAGEMENT — DISCLOSURE OF LOANS TO “ INSIDERS” The Board of Governors has recently been asked to clarify its position with respect to disclosure o f loans to “ insiders” — that is, officers, directors, and persons holding more than 10 per cent of the bank’s stock — in management proxy statements furnished in accordance with the requirements o f section 206.5 o f Federal Reserve Regulation F (“ Securities o f Member State Banks” ) and Federal Reserve Form F-5. This interpretation is also applicable to disclosure of such transactions under comparable provisions relating to registration o f bank securities (Federal Reserve Form F -l) under section 12 o f the Securities Exchange A ct o f 1934. Item 7 ( f ) of Form F-5 and Item 12 of Form F -l in effect require a description o f any material1 interest o f any insider or any of his “ associates” 2 in any material transaction to which the bank was, or is to be, a party. These Items contain a number o f specific exemptive instructions — for example, no disclosure is required where the only interlock is that a director o f a bank is a director a n d /or officer of another corporation that is a party to the transaction. Generally, these Items require disclosure o f loans to a corporate borrower only where insiders, individually or with members of their immediate families3, own at least 10 per cent o f the borrower’s outstanding stock. The Board does not regard loans and other extensions o f credit by a registrant bank in the ordinary course o f its business as “ material” for the purposes of Regulation F (and therefore required to be disclosed unless otherwise specifically exempted by the instructions in these Items) if such loans (a) are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time fo r comparable transactions with other than insiders, (b) at no time aggregate more than 10 per cent o f the equity capital accounts of the bank or $10 million, whichever is less, and (c) do not involve more than the normal risk of collectibility or present other unfavorable features. Item 7 (e ) of Form F-5 requires disclosure of indebtedness to the bank of each director or officer o f the bank and each nominee for election as a director. An instruction to this Item specifically excludes indebtedness resulting from transactions in the ordinary course o f the bank’s business. The effect o f this instruction is to exempt the bank from reporting under Item 7 (e) normal exten sions o f credit to such persons, of types and amounts customarily made by the bank in the usual course o f its operations. However, even if disclosure of indebtedness is not required by Item 7(e), consideration must be given to whether it must be reported in the light of the provisions of Item 7 ( f ) , referred to above. It should also be noted that Item 7 (e) requires disclosure of any liability to the bank that appears to have arisen under section 16 o f the Securities Exchange Act o f 1934 as a result of “ insider” transactions in the bank’ s stock (or other equity security). 1 “ The term ‘material’, when used to qualify a requirement fo r furnishing o f information as to any subject, limits the information required to those matters as to which an average prudent investor ought reasonably to be informed before buying or selling the security registered.” Regulation F, section 206.2 (n ). 2 “ The term ‘associate’, when used to indicate a relationship with any person, means (1) any corporation or organi zation (other than the bank or a majority-owned subsidiary o f the bank) o f which such person is an officer or partner or is, directly or indirectly, either alone or together with one or more members o f his immediate family, the beneficial owner o f 10 per cent or more o f any class o f equity securities, (2) any trust or other estate in which such person has a substantial beneficial interest or as to which such person serves as a trustee or in a similar fiduciary capacity, and (3) any relative or spouse o f such person, or any relative o f such spouse, who has the same home as such person or who is a director or officer o f the bank or any o f its parents or subsidiaries.” Regulation F, section 206.2(d). 3 “ The term ‘immediate fam ily’ includes a person’s (1) spouse; (2) son, daughter, and descendant of either; (3) father, mother, and ancestor of either; (4) stepson and stepdaughter; and (5) stepfather and stepmother. For the purpose o f determining whether any o f the foregoing relationships exist, a legally adopted child shall be considered a child by blood.” Regulation F, section 206.2 (k ).