Full text of District Notices (Federal Reserve Bank of Dallas) : Proposed Interpretation of Regulation G, Securities Credit by Persons other than Banks, Brokers or Dealers, Circular No. 85-152

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Federal Reserve Bank
OF DALLAS
WILLIAM H. WALLACE
F IR S T VICE p r e s i d e n t

DALLAS,TEXA

^ .

December 18, 1985
Circular 85-152

TO: The Chief Executive Officer of all
member banks and others concerned in
the Eleventh Federal Reserve District
SUBJECT
Proposed interpretation of Regulation G, Securities Credit by Persons
Other Than Banks, Brokers or Dealers
DETAILS
The Board of Governors of the Federal Reserve System has issued for
public comment an interpretation applying margin requirements to some debt
securities issued by shell corporations involved in takeover acquisitions.
The interpretation is to be effective December 31, 1985.
Any comments concerning this interpretation should be submitted no
later than December 23, 1985 in writing to William W. Wiles, Secretary, Board
of Governors of the Federal Reserve System, 20th and Constitution Avenue,
N.W., Washington, D.C., 20551. All materials submitted should refer to Docket
No. R-0562.
ATTACHMENTS
The Board's press release, notice as published in the
Federal Register and an explanatory letter sent to members of Congress are
attached.
MORE INFORMATION
For further information, please contact David W. Dixon of this Bank's
Legal Department at (214) 651-6228.
Sincerely yours,

For additional copies of any circular please contact the Public Affairs Department at (214) 651-6289. Banks and others are
encouraged to use the following incoming WATS numbers in contacting this Bank (800) 442-7140 (intrastate) and (800)
527-9200 (interstate).

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

FEDERAL RESERVE press release

For immediate release

The
comment

an

Federal

December 6, 1985

Reserve

Board

today

interpretation applying margin

limited class of transactions

issued

for

public

requirements

used to secure

credit

to

for

a

the

purpose of acquiring margin stock.
The

proposed

(Securities Credit
Dealers)

interpretation

by Persons Other

of

Than

Regulation
Banks,

affects a specific class of borrowing

securities

Brokers

or

involving debt

issued by a shell corporation that is used as an

acquisition
company.

G

vehicle

The

for purchasing

interpretation

the

clarifies

issued by such a shell corporation are

stock
that

of
debt

the

target

securities

indirectly secured by

the stock to be acquired and are thus subject to the margin
regulations.
This conclusion is based on the fact that the shell
corporation would have substantially no assets other

than the

margin stock of the company to be acquired and no significant
business

functions

facilitate

an

other

than

acquisition.

to hold

This

the

margin

interpretation

stock
wpuld

to
only

apply when there is no evidence that the stock is being secured
in another manner,
shell corporation.

such as a guaranty by the parent

of

the

-

2-

The proposed interpretation will impact only a limited
class

of

borrowing

companies —
regulations.
respect

transactions —

those

involving

shell

that clearly come within the scope of the present
No

new

interpretation

to a broader

class

of

has

been proposed

transactions

in

which

obligations are incurred by a company with other

with
debt

income and

substantial assets.
Although a comment period is not required,

the Board

is allowing a short period of public comment on the proposed
interpretation,

ending

on

December 23,

1985,

in

order

to

provide full assurance of no unintended effects.
Presently, the Board has a 50 percent margin on margin
stocks and convertible bonds.

This means that a lender may

extend credit for half the value of the stock to be purchased.
Attached is a copy of the proposed interpretation of
Regulation G,
members

together

of Congress

with

who

an

asked

explanatory
the

Board

to

letter
look

question of the use of below-mvestment-grade debt
to finance takeovers.
comment,

the

sent
into

to
the

securities

Subject to final review of the public

interpretation

will

take

effect

for

written

contracts to extend credit entered into after December 31, 1985.

-0Attachments

FEDERAL RESERVE SYSTEM
12 CFR Part 207
[Regulation G; Docket No. R-0562]
SECURITIES CREDIT BY PERSONS OTHER THAN BANKS,
BROKERS, OR DEALERS
Purchase of Debt Securities to Finance Corporate Takeovers

AGENCY:

Board of Governors of the Federal Reserve System

ACTION:

Proposed Interpretative Rule? request for comment.

SUMMARY:

Questions have been raised as to whether the margin

requirements

in Regulation G apply to the purchase

of debt

securities that are issued to finance the acquisition of the
margin stock of a target company by a shell corporation as part
of

a

takeover

attempt.

clearly involves
and

does

not

Because

"purpose credit"

involve

any

direct

this

type

of

as defined
security

transaction

in Regulation G

agreement,

the

resolution of the issue turns on whether the purchaser of these
securities
"indirectly

would

be

secured"

viewed
by

as

the

a

person

margin

extending

stock.

The

credit

Board

has

proposed an interpretation of Regulation G that concludes that
this type of transaction does constitute an extension of credit
that is

"indirectly secured"

by the target company's margin

stock unless there is specific evidence,
the parent
contrary

of

the

shell corporation,

conclusion.

The

proposed

such as a guaranty by

that would lead
interpretation

states that for purposes of the interpretation,

to a

further

there

is no

difference between privately placed and publicly distributed
debt securities.

-

2-

The proposed interpretation declines to conclude that
debt securities issued by an operating company with income and
substantial

assets

should

be

presumed

to

be

"indirectly

secured" by the margin stock of the target company.
circumstance,

the proposal

In that

states that the purchasers of the

debt securities may be relying on sources of repayment other
than the margin stock for repayment of the credit.
While the proposed

interpretation,

to deal with a relatively limited factual

which is intended
situation,

is not

ordinarily a matter for public comment,

in order to assure that

there

of

are

no

unanticipated

interpretation,

the

Board

public

on

the

comment

effects

is providing

terms

of

the

consideration of the public comments,
final

action

with

respect

to

a

the

proposed

short

period

proposal.

for

After

the Board intends to take

this

interpretation

by

December 31, 1985.
The

proposed

interpretation,

if adopted,

would

not

apply to written contracts to extend credit entered into prior
to

the

effective

date

of

the

interpretation.

See

Federal

Reserve Regulatory Service H 5-306.
DATE:

Comments must be received by December 23, 1985.

ADDRESS:
R-0562,
of

All

comments,

which

should

refer

should be mailed to William W. Wiles,

Governors

of

the

Federal

Reserve

Constitution Avenue, N.W., Washington,

to Docket
Secretary,

System,
D.C.

No.

20th

20551,

Board

and
or should

be delivered to the Office of the Secretary, Room 2200, Eccles
Building,

20th and Constitution Avenue, N.W., between the hours

-3-

of 8:45 a.m. and 5:15 p.m. weekdays.

Comments may be inspected

in Room 1122, Eccles Building between 8:45 a.m. and 5:15 p.m.
weekdays.
FOR

FURTHER

INFORMATION

CONTACT:

Laura

Homer,

Securities

Credit Officer, Division of Banking Supervision and Regulation,
(202)

452-2781;

or James Michaels,

Attorney,

Legal

Division,

(202) 452-3582.
LISTS OF SUBJECTS IN 12 CFR PART 207:
requirements,

Reporting

and

Credit,

recordkeeping

Margin,

Margin

requirements,

Securities.
Pursuant to the Board's authority under sections 7 and
23 of the Securities Exchange Act of 1934 as amended (15 U.S.C.
78g

and

w)

the

interpretation

Board

and

to

proposes
amend

to

12 CFR

adopt
207

the

by

following

adding

a

new

§ 207.112 to read as follows:

S 207.112 —

Purchase of Debt Securities to Finance
Corporate Takeovers

(a)

Questions

have been

raised

as

to whether

the

margin requirements in Regulation G apply to the purchase of
debt securities that are issued to finance the acquisition of
stock of a target company as part of a takeover attempt.
(b)
securities,

In some
the debt

corporate

takeovers

securities would be

financed

by

debt

issued by a shell

corporation that is an affiliate of the acquiring company.

The

-4-

typical shell corporation has virtually no operations,
significant business function other
stock of a target company.

and no

than to acquire and hold

The shell vehicle would use the

proceeds of the debt securities to finance a tender offer for
the stock of
stock.

If

the target company,
the

tender

offer

which

is

typically

successful,

is margin

the

shell

corporation seeks to merge with the target company.
(c)
stock
debt

Where the stock of the target company is margin

(as defined in section 207.2(D),
securities

issued

to

involves apurpose credit"

finance

the

the purchase of
acquisition

the

clearly

(as defined in section 207.2(1)).

In

addition, such debt securities typically are purchased only by
sophisticated investors in very large minimum denominations, so
that

the

purchasers

Regulation G.
securities
involving

See

12

typically
the

margin

may

be

C.F.R.
contain
stock,

"lenders"
§
no

for

207.2(h).
direct

purposes
Since

security

applicability

of

of

the

debt

agreement

the

lending

restrictions of the Regulation 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
serve to protect

respect

the

to margin

lenders'

stock

interest

collateral

in assuring

that

that

a

credit is repaid where the lenders do not have a conventional

-5-

direct

security

5 221.113.

interest

However,

in

the

a credit

collateral.

is

not

See

indirectly

12 C.F.R.
secured

by

margin stock if the lender in good faith has not relied on the
margin stock as collateral in extending or maintaining credit.
See 12 C.F.R. S 207.2(f)(2)(iv).
(e)
described

The Board is of the view that,

above,

the

the

margin

secured by

acquisition vehicle.

debt

securities

stock
The

to be

staff

in the situation

would

be

indirectly

acquired

by

the

has

expressed

the

shell

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.
Regulatory Service

K 5-917.12.

investment

has

company

See Federal Reserve

This opinion

substantially

no

notes

assets

that

other

the

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.
(f)

The Board believes that this rationale applies to

the debt securities
described above.

issued by the shell

acquisition

vehicle

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

-6-

shell

may

hold

the

margin

stock

for

a

significant

and

indefinite period of time, if defensive measures by the target
prevent

consummation

of

the

acquistion.

Because

of

the

difficulty in predicting the outcome of a contested takeover at
the time that credit is extended 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.
The presumption that the credit is indirectly secured by margin
stock

in

these

circumstances

would

not

apply

if

there

is

additional, specific evidence that lenders could in good faith
rely on other assets to support the credit, such as a guaranty
by the shell's parent company that has substantial non-margin
stock assets.
(g)
fact

that

The Board's conclusion is also supported by the

in

these

circumstances

there

is

a

practical

restriction on the ability of a shell corporation to dispose of
the margin stock of the target company,

"Indirectly secured"

is defined in section 207.2(f) of the regulation 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

outstanding.

restricted while

The purchasers

of debt

the credit

securities

remains

issued by a

shell acquisition vehicle to finance a takeover attempt clearly
understand that the shell intends to acquire the margin stock
of the target company in order to effect the acquisition of
that

company.

This

understanding

represents

a

practical

-7-

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 addition,

questions

have been

raised as

to

whether

themargin regulations would apply where an operating

company,

rather than a shell acquisition vehicle,

securities

to finance

particular company.

the acquisition

of margin

issues debt
stock

of

a

The Board is of the opinion that in this

context, these debt securities, as a general matter, should not
necessarily

be

presumed

to be

"indirectly

margin stock of the target company.
business

operations

would

secured"

by

the

A borrowing company with

ordinarily

have

income

and

substantial assets, without regard to the target's stock,

and

therefore the purchasers may be relying on sources of repayment
other than the target's stock for repayment of the credit.

The

circumstances of a particular transaction, however, may provide
specific evidence,
that alender
(i)

in accordance with 12 C.F.R.

S 207.2(f)(1),

has relied upon the margin stock as collateral.
For purposes of this

interpretation,

the Board

does not recognize any difference between privately placed and
publicly
through

distributed
the purchase

debt
of

securities.

debt

securities

Any

credit

issued

provided

by a

shell

acquisition vehicle to facilitate a corporate takeover, that is
in excess of the threshold levels specified in Regulation G,

-8-

may

require

lender

that

and that

the
the

purchaser
credit

register

comply

with

as
the

a Regulation
conditions

G

and

limitations of the Regulation.
Board

of

Governors

of

the

Federal

Reserve

System,

December 6, 1985.

AX

Wiles
Secretary of the Board

BOARD

OF G O V E R N O R S
OF THE

F E D E R A L R E S E R V E SYSTEM
W A S H IN G T O N , D. C. 2 0 5 5 1
P A U L A. V O L C K E R
CHAIRMAN

December 6, 1985

This is in response to your letter dated October 1,
J.985, concerning the use of debt securities to finance the
acquisition of stock as part of a corporate takeover attempt.
Your letter expresses concern about the growth of debt
security-financed takeover attempts and their effect on the
economy and financial system.
You request that the Board use
its authority under section 7 of the Securities Exchange Act of
1934 to restrict the use of such debt securities in connection
with the financing of corporate takeovers,
either by
interpreting existing margin rules or by adopting additional
specific rules to deal with this matter.
Many of the issues raised in your letter have also
been raised in petitions filed with the Board by corporations
that are targets of hostile takeover attempts financed in large
part by below-investment-grade debt securities.
These
petitions have requested the Board to find that the lending
restrictions contained in the Board's Regulation G apply to
debt securities that are issued by a shell corporation set up
by the acquiring firm to effect the acquisition or that are
issued by the acquiring firm m amounts that greatly exceed its
net worth.
The lending restrictions in the Board's Regulation G
apply to credit extended by a lender (other than a bank or a
broker/dealer) for the purpose of buying margin stock where the
credit is directly or indirectly secured by margin stock.
Typically, debt securities issued in connection with the
acquisition of a target company's stock are purchased in large
minimum denominations by large commercial firms and other
sophisticated purchasers that may be lenders for purposes of
Regulation G.
Such transactions clearly involve “purpose
credit" as defined in the Regulation.
Since such securities

-

2-

typically are not directly secured by margin stock or other
collateral, the lending restrictions in Regulation G would
apply only if the credit extended by the purchasers of the debt
securities is indirectly secured by the margin stock.
The Board has considered the applicability of the
margin rules to the purchase of debt securities to finance
takeover attempts and has proposed an interpretation of the
existing regulation, a copy of which is enclosed for your
convenience.
While public comment on such an interpretation is
not required and would normally not be expected, particularly
in the light of the limited application of the interpretation,
in this instance in order to provide full assurance of no
unintended effects, the Board is allowing a short period of
public comment, ending on December 23, 1985.
Subject to final
review after such comment, the interpretation will take effect
for written contracts to extend credit entered into after
December 31, 1985.
The interpretation states that, absent compelling
evidence to the contrary, one limited class of transactions are
subject to margin requirements.
That class involves only those
debt securities issued by a shell corporation that is used as
an acquisition vehicle in the context of a corporate takeover.
Such debt securities are indirectly secured by the stock to be
acquired and thus subject to the restrictions of the margin
regulations.
This conclusion is based on the fact that the shell
corporation would have substantially no assets other than the
margin stock of the company to be acquired and no significant
business function other than to hold the margin stock to
facilitate the acquisition of the target company.
Therefore,
loans to such companies cannot, in good faith, be made without
reliance on the stock as security.
The interpretation is also
supported by the fact that there is a practical restriction on
the shell corporation's ability to dispose of the margin stock
acquired in light of the clear understanding of the lenders
that the proceeds of the credit will be used by the shell
corporation to acquire sufficient margin stock to control a
particular target company.
The presumption that the borrowing
was indirectly secured In these circumstances would not apply
if there is additional, specific evidence that lenders could in
good faith rely on other assets to support the credit, such as
a guaranty by the shell's parent company that has substantial
non-margin stock assets.
In considering this
recognized that more commonly

interpretation,
the Board
takeovers financed with debt

-3-

securities do not entail use of a shell corporation.
Instead,
the debt is issued by a company engaged in an ongoing business
and having substantial assets other than margin stock.
The
Board has considered the applicability of the margin rules to
such debt securities and is of the opinion that the purchase of
these debt securities should not be presumed to be "indirectly
secured" by the margin stock of the company to be acquired.
Since the borrowing company ordinarily would have income and
substantial assets in addition to the margin stock to
be
acquired, the purchasers of the debt securities should not be
presumed to be relying solely on the margin stock as the source
of repayment of the credit.
Thus, the proposed interpretation will impact only a
limited class of borrowing transactions —
those involving
shell companies — that appear quite clearly to come within the
scope of the present regulations.
On the other hand, the Board
did not conclude that a broader class of transactions fall
within the margin regulations — those where the debt
obligation is that of a borrowing company with income
and
substantial assets.
The Board believes it is not possible to
establish a presumption that such a company's borrowings are
indirectly secured by the margin stock.
Accordingly,
the
interpretation which the Board has proposed deals with one
limited financing technique, and would not affect borrowing by
other methods to accomplish merger or acquisition transactions.
More generally, earlier this year the Board testified
before Congress regarding the effect of the recent increase in
merger and takeover activity on the credit markets.
The Board
expressed its concern about debt-financed acquisition activity
and indicated its intent to continue to monitor merger and
takeover activity and its effects on the financial markets.
The Board does share your concern about the broad movement
toward higher leverage, because of the implied reduction in the
financial strength of business firms.
Margin regulations do
not appear well adapted todealing with
the broader problem.
However, I would point out
that, among other factors, present
provisions of the tax code do greatly favor the use of debt
rather than equity instruments, and could be addressed directly.
I should also note in a letter
to various members of
Congress dated January 11,
1985, a copy
of which is enclosed
for your convenient reference, the Board stated that there are
at present serious questions as to the need for continuing
federal regulation to further the objectives originally sought
by Congress when it enacted section 7 of the Securities
Exchange Act of 1934.
The current takeover controversy points
up the need for Congressional reexamination of those goals in

-4-

light of the structural and technological changes
occurred in financial markets in the past 50 years.

that have

Two members of the Board dissented from this
interpretation, specifically noting that margin requirements
need to be reassessed as the appropriate means of carrying out
the objectives that Congress has sought to achieve through
these requirements and, accordingly, felt new interpretations
of margin requirements were inappropriate at this time.
Moreover, they noted that the approach adopted by the Board was
also likely to be ineffective as a means of addressing problems
associated with debt financing of takeovers in view of the
variety of techniques that can and will be employed to finance
corporate acquisitions and that fall outside the scope of the
regulations.
Finally, the dissenting members do not believe
that the Board should presume that debt securities issued by a
shell corporation in a corporate takeover are indirectly
secured by the stock of the target company, since the
purchasers of such securities may be relying on the income and
assets of the target company, rather than its stock, for
repayment of the debt.
Sincerely,

ist P&d A. Voisksi

Enclosure

B O A R D OF G O V E R N O R S

F E D E R A L R E S E R V E SY ST E M
WA SH I N GT O N, 0- C- 2 0 5 S I

January 11, 1985

w u l a .volc« r
Chairman

The Honorable Jesse Helms
Cha irman
Committee on Agriculture, Nutrition
and Forestry
United States Senate
Washington, D. C. 20510
Dear Chairman Helms:
The Federal Reserve Board is pleased to submit for the
consideration of the Congress the enclosed study, A Review and
Evaluation of Federal Margin Regulation, that has been prepared
by its staff.
The origins of this study can be traced to the April
1982 hearings of the Subcommittee on Telecommunications, Con­
sumer Protection and Finance of the House Committee on Energy
and Commerce, which focused on the reauthorization of the
Commodity Futures Trading Commission (CFTC) and on associated
legislation to resolve jurisdictional issues between that agency
and the Securities and Exchange Commission (SEC). In those
hearings, Governor J. Charles Partee, representing the Board,
indicated that, in light of the development of new financial
futures and options instruments, the Board intended to undertake
a reassessment of federal margin regulation.
The enclosed study was started soon after the hearings
and was well underway bv late 1982 when the Congress, in the
Futures Trading Act of 1982, directed the CFTC; SEC and Federal
Reserve Board to conduct a study of the economic implication of
futures and options markets, a study that was submitted to the
Congress at the end of last year.
In plpnning for the Congressionally mandated study, participating agencies decided that the
Board's staff should carry through on the margin study it had in
progress--supported by the input of other agencies--and that
margin-related issues would not be addressed in the general
study of futures and options markets.
It was further agreed,
however, that the study of margin regulation would be sent to
the U.S. Treasury, the CFTC and the SEC to obtain their comments
and recommendations before the study was submitted to the
Congress. Letters sent to the Board from the agencies, pre­
senting their comments, are attached to the study. The specific
approaches proposed in this letter have not been reviewed by
those agencies.

The Honorable Jesse Helms
Page Two

Chapter I of the study includes a summary of the major
findings and also reviews alternative approaches that might be
adopted with regard to the regulation of margins in securities
and related markets. Later chapters examine in depth the range
of issues pertaining to federal margin regulation. Conse­
quently, this letter contains only a brief sketch of the con­
siderations that led the Board to the recommendations set out
below.
In the Securities Exchange Act of 1934, which directed
the Federal Reserve to regulate margin arrangements in securi­
ties markets, the Congress sought three main objectives:
(A) to
constrain the diversion of credit into stock market speculation
fron uses in commerce, industry, and agriculture? (B) to protect
unsophisticated investors; and’ (C) to forestall excessive price
fluctuations in the stock market. A reading of the legislative
history indicates that Congress was considerably less concerned
about protecting brokers and other lenders against loss, because
experience during the 1929 stock market crash, as well as in
earlier periods of market strain, appeared to demonstrate that
the providers of credit to finance securities purchases gen­
erally had followed practices that enabled them to avoid serious
losses. An important point to be noted from this brief review
is that the Federal Reserve, in endeavoring to achieve the
objectives sought by the Congress, has always set initial margin
requirements at levels higher than seemed necessary to provide
brokers and other lenders adequate protection against loss.
After a review of the staff's analysis, the Board has
concluded that high governmentally set margins are not needed to
help achieve balance in the distribution of available credit.
Credit-financed purchases of stock do not permanently absorb the
savings of the economy (a point relating to objective A). The
flows of funds in these transactions typically simply facilitate
the transfer of ownership of existing corporate assets.
7f
margin borrowings are large, there could be market frictions
that could alter, in a marginal way, the flow of credit to
different borrower groups, but the total availability of funds
for real capital formation is not likely to be materially af­
fected.
In any event, the direct use of credit to finance stock
portfolios has become much less important relative to the size
of the economy and financial markets than it was in the early
1930s.
With regard to objective B, the Board has concluded
that the relatively high margin requirements that result from

The Honorable Jesse Helms
Page Three

federal margin regulation do have the desirable effect of pro­
viding protection for unsophisticated investors. However, there
are alternative ways of investing or speculating in stocks,
including obtaining unsecured credit or loans secured by assets
other than stock, and trading in other financial instruments for
which lower margins are required. In effect, margin require­
ments are avoided, to some degree, at greater cost and incon­
venience. Uniform margin requirements also are uneven in the
protection they provide in that the same margin ratio is
required to acquire a stock whose price is highly volatile--and
thus highly risky--as one whose price is relatively stable.
In
the face of these drawbacks and inefficiencies, the Board
believes that it is preferable to rely on methods other than
high federal margin requirements--including disclosure--to
protect unsophisticated market participants.
In the Board*s view, the study's findings also cast
significant doubt on the need to retain high initial margins to
prevent excessive fluctuations of stock prices. This conclusion
is based on the study's review of the results of a considerable
volume of research carried out by financial analysts and econo­
mists over the past 30 years or so. In particular, evidence
presented in the study suggests that credit-financed trading
does not have an important influence on the behavior of stock
prices. This appears to be an implication of the fact that over
the past 50 years, when margin requirements have been relatively
high and the volume of margin credit outstanding relatively low,
the amplitude of fluctuations in stock prices has not differed
greatly from that recorded before the imposition of federal
margin regulation, with the exception of the late 1920s. The
character of the stock market also has changed, in that insti­
tutions that do not trade on margin are now a much larger
factor. And the call loan market no longer serves, as it did in
the 1920s and before, as a place where banks and corporations
maintain a substantial portion of their liquidity reserves.
Thus, abrupt shifts in liquidity needs do not appear to have the
same potential for causing problems for the stock market during
times of financial strain.
To sum up, the analysis presented in the staff study
raises serious doubts as to the need for continuing federal
regulation to foster the objectives originally sought by the
Congress in passing this legislation.
In the Board's view, the
primary purpose of margin regulation today should be to ensure
the integrity of the marketplace, in large part by seeing that
there are adequate protections against significant credit loss
for brokers, banks, and other lenders.

The Honorable Jesse Helms
Page Four

There is, however, another consideration that needs to
be taken into account.
Stock-based futures and options con­
tracts can serve as close substitutes for establishing leveraged
positions in common stocks for some important purposes. More­
over, markets for these "derivative" instruments are tightly
linked with the underlying cash market for stocks by the
activities of arbitrageurs. Consequently, it would appear that
considerations of competitive equity and of establishing a
logically consistent structure of regulation would point to the
desirability of margins on the cash market and on these "deriva­
tive" instruments being in closer alignment.
Thus, if high
margins were to continue to be required in the cash market, it
would seem appropriate to raise margins in these "derivative’1
markets by a significant amount.
At some point, the imposition
of markedly higher margins in these latter markets might veil
adversely affect their trading volume and liquidity, with
adverse implications for the useful economic functions that were
discussed in the inter-agency study of futures and options.
But, should requirements on "derivative" instruments remain at
or near their current levels, competitive considerations point
toward significantly lower requirements for the cash markets.
For the above reasons, the Board has concluded that,
except in extraordinary circumstances, there no longer remains
sufficient justification for maintaining securities margins at
levels substantially higher than needed to protect brokers and
other lenders against loss from customer default.
Accordingly,
the Board recommends that the Congress give serious considera­
tion to adopting a new approach toward margin regulation.
One
such approach might be to repeal existing regulation, effec­
tively turning over responsibility for setting margins to the
members of the various securities exchanges and other insti­
tutions that make margin loans. As previously noted, past
experience suggests that such entities, independently or through
self-regulatory organizations, generally have maintained margins
adequate to protect themselves against loss, and in extra­
ordinary circumstances they could be raised.

In the Board's view, however, a preferable approach
would be for the Congress to amend existing legislation in a way
that, while assigning authority for setting margins specifically
to the various self-regulatory organizations (SROs), would en­
courage the organizations to coordinate their margin-setting
activities to ensure that the structure of margin requirements
established is consistent with maintaining the safety of the

The Honorable Jesse Helms
Page Five
marketplace and avoiding unreasonable and unnecessary competi­
tive advantages. The legislation might also require that banks,
savings and loans, and other lenders not extend securities
credit on terms more favorable than those permitted by the SROs.
Conceivably, the above arrangement might be carried out
without the involvement of any federal agency. In the Board’s
view, however, such coordination would be difficult to achieve,
and would risk a "least common denominator" approach, without
some element of federal oversight of the process. Such involvemept could be carried out by a council of federal agencies whose
responsibility mainly would be to monitor the actions of the
SROs. The council should have the power to veto actions being
taken by the SROs, should it deem that appropriate. Beyond mere
notification, however, it does not seem necessary that the SROs
be required to obtain the council's prior approval before chang­
ing margin arrangements.
In addition to this responsibility, it
may be desirable to assign to the council standby powers that
would allow it to step in and take appropriate actions in the
event that coordinating efforts of SROs fail or of any unfore­
seen emergency.
If the Congress were to decide to establish such a
council, it would seem clear that the CFTC and the SEC, given
their close involvement in the day-to-day workings of the mar­
kets and their responsibilities for establishing and overseeing
the general regulatory framework in place in these markets,
should be members of the council. Most certainly it would seem
appropriate to assign these agencies the responsibility for the
day-to-day monitoring of the cooperative actions of the SROs.
There would seen clear advantages to be gained, however, if one
other agency were designated to sit on the council. A third
agency would provide a tie-breaking vote and thus tend to foster
expeditious decision-making.
Still another reason for a third
member would be that a substantial amount of securities credit
is provided by banks and other lenders not subject to the juris­
diction of the various exchanges and the SEC and CFTC, so that a
bank regulatory agency could add a needed element of expertise
to the council’s deliberations. Given the Federal Reserve's
long experience in regulating margins, it is a logical candidate
to serve in this capacity. However, consideration could be
given to assigning the function to the U.S. Treasury, which also
has broad responsibility in the financial sphere.

Enclosure