Full text of District Notices (Federal Reserve Bank of Dallas) : Amendment to Regulation T, Credit by Brokers and Dealers, Circular No. 80-163

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Federal

reserve

Ba n k

DALLAS, TEXAS

of

Dallas

75222

Circular No. 80-163
August 28, 1980

AMENDMENT TO REGULATION T
CREDIT BY BROKERS AND DEALERS

TO ALL MEMBER BANKS, BROKERS/DEALERS,
AND OTHERS CONCERNED IN THE
ELEVENTH FEDERAL RESERVE DISTRICT:
The Board of Governors of the Federal Reserve System has amended,
effective November 3, 1980, its Regulation T, "Credit by Brokers and Dealers."
The amendment will permit brokers and dealers to extend credit on
fully paid mutual fund shares. A broker/dealer would be prohibited under the
provisions of the Securities Exchange Act and rules of the SEC from giving
credit on the initial purchase of mutual fund shares.
Printed on the following pages are the text of the Board's order as
submitted for publication in the Federal Register and the final copy of the
amendment for insertion in your Regulations Binder.
Any questions concerning the amendment should be directed to the
Consumer Affairs Section of our Bank Supervision and Regulations Department,
Ext. 6171.
Sincerely yours,
Robert H. Boykin
First Vice President
Enclosure

Banks and others are encouraged to use the following incoming W A T S numbers in contacting this Bank:
1-800-442-7140 (intrastate) and 1-800-527-9200 (interstate). For calls placed locally, please use 651 plus the
extension referred to above.

This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)

Final Rulemaking
Title 12 - Banks and Banking
Chapter II - FEDERAL RESERVE SYSTEM
SUBCHAPTER A - BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
[Regulation T; Docket No. r -0158]
PART 220 - CREDIT BY BROKERS AND DEALERS
Loan Value for Mutual Fund Shares

AGENCY:
Board of Governors of the Federal Reserve System.
ACTION:
Final rule.
SUMMARY: This amendment will permit brokers and dealers to extend credit
on fully paid for mutual fund shares deposited in a general account. The
present rule permits broker-dealers to extend and maintain credit only on
securities registered on a national securities exchange, or included on
the Board's List of OTC Margin Stock and on certain non-convertible debt
securities which are traded in the over-the-counter market.
The Board intends the proposed rule to reduce significantly the
inequity which exists between broker-dealers and banks, which are currently
permitted to extend credit on mutual fund shares under Regulation U, and
lenders registered with the Board under Regulation G, who have the same
authority. The amendment was published for comment on August 9, 1979
(44 F.R. 47776).
EFFECTIVE DATE: November 3, 1980.
FOR FURTHER INFORMATION CONTACT: Patsy Abelle, Senior Attorney, or
Michael J. Schoenfeld, Senior Securities Regulations Analyst, Securities
Regulation Section, Division of Banking Supervision and Regulation, Board
of Governors of the Federal Reserve System, Washington, D. C. 20551
(202-452-2781).
SUPPLEMENTARY INFORMATION: All of the comments received on the Board's
proposal to permit brokers and dealers to extend and maintain credit on
mutual fund shares were favorable. The rule has been adopted as proposed.
One comnenter recommended that the composition of a fund's
underlying portfolio be the basis for determining the margin requirement.
This suggestion has not been adopted because the Board believes such a
basis would be unworkable in view of the varying composition of some
mutual fund portfolios.
One commenter requested that unit investment trusts be given
good faith loan value since they invest almost exclusively in tax-exempt
bonds. This issue was addressed previously by the Board in 1972 (12 CFR
220.125) when it was decided that shares in registered open-end investment
companies are not themselves exempt securities, even if the portfolio
consists entirely of exempt securities.

- 2 -

Another commenter felt that money market funds which permit
investors to write drafts against them should be excluded since a brokerdealer would never know that money had been borrowed against the shares
in this fashion. Hie Board understands that would not happen. Once the
shares are pledged, it is understood the broker vrould request the fund to
issue a certificate in "street name". Thus if a draft were subsequently
drawn, it would not be honored by the fund since the shares technically
would no longer be in the investor's name. Therefore, the Board believes
that there is no problem in this regard.
It was also suggested that variable annuity contracts which meet
the definition of a mutual fund be excluded, presumably because they are
essentially retirement vehicles. Since this could be said for a number
of securities, the Board believes there is no reason to make such a dis­
tinction.
Accordingly, pursuant to sections 7 and 23 of the Securities
Exchange Act of 1934, as amended (15 U.S.C. 78g and w ) , the Board revises
section 220.2(f) of Regulation T (12 CFR 220.2(f)) to read as follows:
Section 220.2 - Definitions
*

*

*

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

CREDIT BY BROKERS AND DEALERS
A M E N D M E N T S TO R E G U L A T IO N T t
1. Effective July 12, 1978, section 220.4 is
am ended to read as follows:

tered security, O T C m argin stock or O T C m argin
bond.

* * * * *

S E C T IO N 220.4— S P E C IA L A C C O U N T S
*

*

*

*

*

(f) Special miscellaneous account. In a special
m iscellaneous account, a creditor may:

* * * * *
(2) * * *
(ii)— E xtend and m aintain a subordinated
loan to a n o ther creditor fo r capital purposes:
Provided. T h a t
(a ) Either the lender o r the b o rro w er is a firm
or c o rp o ratio n which is a m em ber of a national
securities exchange o r national securities associa­
tion, the o th e r party to the credit is an affiliated
corp oration of such firm o r corpo ratio n, the credit
is n o t in contravention of any rule o f the exchange
or association and the credit has the app rov al
o f ap p ro p riate com m ittees o f the exchange o r
association, o r
( b ) T h e lender as well as the b orrow er is a
creditor as defined in section 220.2(b), the sub­
ordinated loan agreem ent has the approval of the
ap p ro p riate E xam ining A u thority as defined in
Securities an d E xchange C om m ission Rule I5c3-1
(c)(12) (12 C F R 2 4 0 .15c3-l(c)(12)) a nd such Ex­
am ining A utho rity is satisfied, in the case o f a
borrow er who would be considered a cu stom er of
the lender a p a rt from the subordinated loan, that
the loan will not be used to increase the am o un t
of dealing in securities for the acco un t o f the
borrower, his firm o r corporatio n o r an affiliated
co rp o ratio n of such firm o r corporation.
2. E ffective O cto b er 30, 1978, sections 2 20.2
and 220.4 are amended to read as follows:
S E C T IO N 220.2— D E F IN IT IO N S
* * ^ * *

(i)
T h e term “O T C m argin b o n d ” m eans a d ebt
security not trad ed on a national securities ex­
change w hich m eets all o f the following req u ire­
ments:
(1) At the time o f the extension o f credit, a
principal am o u n t o f not less than $25,000,000 of
the issue is outstanding.
(2) T he issue was registered u n d er section 5
of the Securities Act o f 1933 and the issuer either
files periodic reports p u rsu ant to section 13(a) or
15(d) o f the Securities E xchange A ct of 1934 or
is an insurance co m pan y which meets all of the
conditions specified in section 12 (g)(2)(G) o f the
Act.
(3) A t the time o f the extension o f credit,
the cre d ito r has a reasonable basis for believing
that the issuer is not in default on interest or
principal payments.
S E C T IO N 220.4— S P E C IA L A C C O U N T S

* * * * *
(i) Special bond account.
In a special bond account a creditor may extend
and m aintain credit on any exem pted security,
registered non-equity security o r O T C m argin
bond. T h e m ax im u m loan value of securities held
in this account shall be as prescribed from time
to time in § 220.8 (the S upplem ent to R egulation
T). Call options m a y be issued, endorsed o r g u a r­
anteed in this acco u n t on any underlying equity
security which is held in this acco un t because it
is an exem pted security.

(f) T h e term m argin security m eans any regis­

* * * * *

t The complete Regulation comprises:
1) Regulation T, as amended effective June 1, 1977, printed in the
pamphlet "Securities Credit Transactions."
2) The Supplement to Regulation T (section 220.8) dated October 1978,
effective October 30, 1978.
3) This slip sheet. (Destroy slip sheet dated June 1980.)

AUGUST 1980

3.
Effective August 11. 1980, section 220.4(g) is
amended to read as follows:
SECTION 220.4— SPECIAL ACCOUNTS

♦ ♦ ♦ ♦ ♦
(g)
S p e c ia list’s A ccount. (1) Applicability. In a
specialist’s account, a creditor may clear and finance
for a specialist who is a member o f a national securi­
ties exchange the m em ber’s specialist transactions or
transactions o f any joint account in which all partici­
pants, or all participants other than the creditor, are
registered and act as specialists. The provisions of
this subsection are available to a specialist who is a
member o f a national securities exchange which sub­
mits to the Board o f Governors o f the Federal R e­
serve System reports suitable for supplying current
information regarding the use o f specialist credit.
(2) Definitions. For the purpose of this subsec­
tion:
(i) “ Joint acco unt” means an account in which
the creditor may participate and which by written
agreement permits the commingling o f the security
positions o f the participants and provides for a shar­
ing o f profits and losses from the account on some
predetermined ratio;
(ii) “ U nd erly in g se c u rity ” m e a n s the security
which will be delivered upon exercise o f the option
and does not include a security convertible into the
underlying security;
(iii) “ Overlying option” means (A) a put option
purchased or a call option written against an existing
long position in a specialist’s or market-maker’s ac­
count, or (B) a call option purchased or a put option
written against a short position in a specialist’s or
market-maker’s account.
(iv) “ In or at the m o n e y ,” with respect to a call
option, indicates that the current market price o f the
underlying security is not more than one standard
exercise interval below the exercise price o f the op­
tion, and, with respect to a put option, that the cur­
rent market price o f the underlying security is not
more than one standard exercise interval above the
exercise price o f the option.
(v) “ In the m o n e y ,” with respect to a call op­
tion, indicates that the current market price o f the
underlying security is not below the exercise price of
the option and, with respect to a put option, that the
current market price o f the underlying security is not
above the exercise price o f the option.
(3) Permitted offset positions. A specialist in op­
tions is perm itted to establish in this account on a
share-for-share basis a long or short position in the
securities underlying the options in which the spe­

cialist makes a market, and a specialist in securities
other than options is permitted to purchase or write
options overlying the securities in which the special­
ist makes a market, only under one or more of the
following conditions (such positions are referred to
in this paragraph as “ permitted offset positions” ):
(i) T h e a c c o u n t h o ld s a sh o rt o p tio n p o sitio n
which is “ in o r at the m oney” and is not offset by a
long or short option position for an equal or greater
num ber o f shares o f the sam e underlying security
which is “ in the m oney” ;
(ii) T h e a c c o u n t ho ld s a long o p tio n position
which is “ in or at the m o n e y " and is not offset by a
long or short option position for an equal or greater
num ber o f shares o f the sam e underlying security
which is “ in the m o n e y ";
(iii) T h e a c c o u n t held a sh o rt o p tio n position
against which an exercise notice was tendered;
(iv) T h e a c c o u n t h eld a lo n g o p tio n p o sitio n
which was exercised;
(v) The account holds a net long position in a se­
curity (other than an option) in which the specialist
makes a market; or,
(vi) T he account holds a net short position in a
security (other than an option) in which the special­
ist makes a market.
(4) M axim um loan value. T h e m a x im u m loan
value o f securities which may be used as collateral
in the account shall be:
(i) No more than 100 per cent o f the current mar­
ket value o f any long position in a security in which
the specialist m akes a m arket o r a w holly-ow ned
margin security;
(ii) 75 per cent o f the current market value o f any
underlying security o r overlying option purchased
and held in the account as a perm itted offset posi­
tion;
(iii) The m axim um loan value prescribed by the
Board in section 220.8 (the Supplement to Regula­
tion T) w hen a security purchased and held in the
account does not qualify as a specialist or permitted
offset position.
(5) Adjusted debit balance. The amount to be in­
cluded in the adjusted debit balance o f the account
shall be:
(i) Not less than 100 per cent o f the current mar­
ket value o f either a security sold short or an option
written where such position qualifies as a specialist
transaction;
(ii) 125 per cent o f the current m arket value o f
any security sold short or option written and held in
the account as a permitted offset Position;
(iii) T he amount prescribed by the Board in sec­
tion 220.8 (the Supplement to Regulation T) when a
security sold short in the account does not qualify as

a specialist or permitted offset position plus, for a
short position in a security other than an option, the
current market value of the security sold short.
(6) Additional margin; "free-riding.” Except as
required by paragraph (g)(8), on any day when addi­
tional margin is required as a result of transactions
in the account, the creditor shall issue a call for a
deposit of cash or securities having loan value and
may allow the specialist a maximum of five full
business days to make a deposit sufficient to meet
the call. To prevent '■free-riding" in the account, a
creditor who has not obtained this deposit (and is
therefore required to liquidate sufficient securities to
meet the call) is prohibited for a 15 day period from
extending any further credit in the account to finance
transactions in securities in which the specialist is
not registered to make a market. The acquisition or
liquidation of a permitted offset position shall not be
subject to this "free-riding" penalty. The restriction
on ■ ‘free-riding" shall not apply to any national se­
curities exchange, adopting a "free-riding" rule ap­
plicable to specialists which has been approved by
the Securities and Exchange Commission.
(7) Withdrawals. On any day when a specialist
requests a withdrawal of cash or securities from the
account, the creditor shall compute the status of the
account for non-specialist securities positions in ac­
cordance with the provisions of section 220.8 (the
Supplement to Regulation T), permitted offset posi­

tions in accordance with the provisions of para­
graphs (g)(4)(ii) and (g)(5)(ii), and specialist posi­
tions on a "good faith” basis. Withdrawals shall be
permitted to the extent that the adjusted debit bal­
ance in the account does not exceed the maximum
loan value of all of the collateral held in the account
after the withdrawal has been made.
(8)
Deficit accounts. On any day when the ac­
count would liquidate to a deficit, the creditor shall
not extend any further credit in the account, and
shall issue a call for additional cash or collateral,
which shall be met by noon of the following busi­
ness day. In the event sufficient cash or collateral is
not deposited the creditor shall liquidate existing po­
sitions in the account.
Effective November 3. 1980. scction 220.2 is
amended to read as follows:
SECTION 220.2— DEFINITIONS

* * * * *
(f) The term "margin security" means any reg­
istered security. OTC margin stock, OTC margin
bond, or any security issued by an open-end invest­
ment company or unit investment trust registered
under section 8 of the Investment Company Act of
1940 (15 U.S.C. 80a-8).