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federal Reserve b a n k o f Dallas DALLAS, TEXAS 75222 C ircular No. 76-61 A pril 20, 1976 QUESTIONS AND ANSWERS ILLUSTRATING APPLICATION OF REGULATION U Credit by Banks for the Purpose Of Purchasing or Carrying Margin Stocks AND OTHERS CONCERNED IN THE ELEVENTH FEDERAL RESERVE DISTRICT: The Board of Governors of the Federal Reserve System has revised the booklet entitled "Questions and Answers Illustrating Application of Regula tion U" as of February 1976. The revised booklet replaces a similar booklet issued by the Board in May 1963. The booklet has been prepared primarily for the benefit and guid ance of banks subject to the regulation. It should, however, also be useful to prospective borrowers who may be subject to the regulations by reason of liabilities created under Regulation X, "Rules Governing Borrowers Who Obtain Securities Credit." Of course, the booklet cannot be expected to cover in detail all aspects of the regulation. References to specific sections of the regulation are provided on a selective basis. In any given case, the answer to any particular question must necessarily depend on the specific facts and cir cumstances involved. Therefore, the following Questions and Answers should be regarded as general aids to a better understanding of the principal features of the regulation, rather than an exhaustive, detailed explanation of the appli cation of its various provisions. Please address any question concerning the regulation to our Regulations Departmental (214) 651-6319 or 651-6325 ifany problems arise. ; Additional copies of the enclosed booklet will be available upon request to the Secretary's Office of this Bank. Sincerely yours, T. W. Plant First Vice President Enclosure This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org) QUESTIONS AND ANSWERS ILLU STR A TIN G A P P L IC A T IO N of REG U LA TIO N U C R E D IT BY BANKS F O R T H E P U R P O S E O F PURCHASING OR CARRYING MARGIN STOCKS BOARD O F GOVERNORS of th e F E D E R A L R E S E R V E SYSTEM F e b r u a r y 1976 C o p ie s of th is m a n u a l, a s w e ll a s th e r e g u l a t i o n s , r e l a t e d f o r m s and d o c u m e n ts r e f e r r e d to in th is m a n u a l, c a n b e o b tain ed f r o m any F e d e r a l R e s e r v e B ank . C O N TEN TS Page No. P r e f a c e .................................................................................................... 1 G e n e r a l F e a t u r e s of R e g u la tio n U ........................................... 1 P e r s o n s R e g u l a t e d ................................................................... 1 T h r e s h o ld C o n s i d e r a t i o n s - - F o r m U - l ........................ 1 " P u r p o s e " C r e d i t .................................................................. 2 S e c u re d " I n d i r e c t l y " .............................................................. 2 " R e g u la te d " C r e d i t ................................................................... 3 D efin itio n of " S t o c k " .............................................................. 5 " M a rg in " S t o c k ....................................................................... 5 " C a r r y in g " M a rg in S t o c k .................................................... 6 N a tu r e of C r e d i t R e s t r ic t io n s and O th e r L im ita tio n s of R e g u la tio n U .................................................... 6 C r e d i t R e s t r i c t i o n s .............................................................. 6 E x te n sio n of C r e d i t .................................................... 6 M a x im u m L o a n V a l u e s ........................................... 6 M ax im u m L o a n V alue of S t o c k ........................ 6 M a x im u m L o a n V a lu e o f O th e r C o l l a t e r a l . 8 M a r k e t V alu e of S e c u r i t i e s ...................................... 8 "S ingle C r e d i t " R u l e ................................................ 8 S e g re g a tio n of C o l l a t e r a l ...................................... 9 M ixed C o l l a t e r a l ......................................................... 10 S h rin k a g e of L o an V alu e of S t o c k s ................... 10 R e n e w a ls and E x t e n s i o n s ...................................... 10 i Page N o. R e te n tio n R e q u ir e m e n ts - - S u b s t it u tio n s and W i t h d r a w a l s .................................................... 11 S a m e -D a y T r a n s a c t i o n s - - E q u i t y R a tio . . . 13 R e o r g a n iz a tio n s and R e c a p ita liz a tio n s . . . . 14 T r a n s f e r s of C r e d i t .................................................... 14 F r o m B ank to B a n k ........................................... 14 F r o m B o r r o w e r to B o r r o w e r ........................ 15 E x e m p t C r e d i t ................................................................................. 15 E x e m p te d S e c u r i t i e s ................... .... ..................................... 16 * E x c e p tio n s to th e G e n e r a l R u l e ...................................... 16 P r o h ib itio n A g a in s t A r r a n g in g f o r M o re F a v o r a b le T e r m s ............................................................................................... 17 P r o c e d u r a l R e q u i r e m e n t s .............................................................. 18 M is c e lla n e o u s P r o v i s i o n s .............................................................. 18 M is ta k e s in Good F a i t h ........................................................ 18 A ctio n T a k e n f o r Bank P r o t e c t i o n ................................. 19 L ia b ili ti e s f o r V i o l a t i o n s .................................................... 19 T r a n s a c t i o n s by B ank a s T r u s t e e ........................................... 19 E x e m p t T r a n s a c t i o n s w ith and f o r B r o k e r - D e a l e r s 19 . . . P r o m p t D e liv e r y C l e a r a n c e L o a n s ................................. 20 S e c u r it ie s in T r a n s i t o r T r a n s f e r .................................. 20 Day L o a n s ................................................................................. 20 T e m p o r a r y F in a n c in g of D i s t r i b u t i o n s ........................ 21 A rb itra g e T ra n sa c tio n s 21 .................................................... C r e d i t E x te n d ed P u r s u a n t to H y p o th e c a tio n ii . . . 21 P age No. E m e r g e n c y C r e d i t ................................................................... 22 S p e c i a l i s t s ................................................................................. 22 O d d - L o t D e a l e r s ................................................................... 22 OTC M a rk e t M a k e r s .............................................................. 22 T h ir d M a rk e t M a k e r s ......................................................... 23 B l o c k - P o s i t i o n e r s ........................ .... ................................ 23 L o a n s f o r C a p ita l C o n t r i b u t i o n s ................................. 24 G e n e r a l P r o h ib itio n s A g a in s t C r e d i t to B r o k e r - D e a l e r s by N o n m e m b e r B a n k s - R e lie f f r o m P r o h i b i t i o n s .................................................... 24 iii QUESTIONS AND ANSWERS ILLU STR A TIN G A P P L IC A T IO N O F REGULATION U P reface T h e follow ing Q u e s tio n s and A n s w e r s h av e b e e n p r e p a r e d p r i m a r i l y f o r th e b e n e fit and g u id an ce of b a n k s s u b je c t to th e r e g u la tio n . T h e y sh o u ld , h o w e v e r , a ls o be u s e fu l to p r o s p e c tiv e b o r r o w e r s who m a y b e s u b je c t to th e r e g u la tio n by r e a s o n of l i a b i l i t i e s c r e a t e d u n d e r R e g u la tio n X, " R u le s G o v e rn in g B o r r o w e r s Who O b tain S e c u r it ie s C r e d it . " Of c o u r s e , th e Q u e s tio n s and A n s w e rs c a n n o t b e e x p ected to c o v e r in d e ta il a ll a s p e c ts of th e r e g u la tio n . R e f e r e n c e s to s p e c if ic s e c t io n s of th e r e g u la tio n s a r e p ro v id e d on a s e le c ti v e b a s i s . In any g iv en c a s e th e a n s w e r to a p a r t i c u l a r q u e s tio n m u s t n e c e s s a r i l y dep en d on th e s p e c ific f a c ts and c i r c u m s ta n c e s in v o lv ed . T h e r e f o r e , th e follow ing Q u e s tio n s and A n s w e rs sho uld b e r e g a r d e d as g e n e r a l a id s to a b e t t e r u n d e r s ta n d in g of th e p r in c ip a l f e a t u r e s of th e r e g u la tio n , r a t h e r th an an e x h a u s tiv e , d e ta ile d e x p la n a tio n of the a p p lic a tio n of its v a r io u s p r o v is io n s . F u r t h e r q u e s tio n s c o n c e r n in g th e r e g u la tio n shou ld b e r a i s e d w ith s ta ff of th e n e a r e s t F e d e r a l R e s e r v e Bank. G e n e r a l F e a t u r e s of R e g u la tio n U P e r s o n s R e g u la te d 1. Q u e s tio n . - -W ho i s g o v e rn e d by R e g u la tio n U ? A n s w e r . - - A l l b a n k s , in clu d in g m u tu a l s a v in g s b an k s and b an k s th a t a r e not m e m b e r s of th e F e d e r a l R e s e r v e S y ste m (ex cep t b a n k s w hich a r e m e m b e r s of a n a tio n a l s e c u r i t i e s ex ch an g e and t h e r e f o r e s u b je c t to R e g u la tio n T ). T h r e s h o ld C o n s i d e r a t i o n s - - F o r m U - l 2. Q u e s tio n . - - U n d e r R e g u la tio n U, w hat i s th e f i r s t s te p a bank m u s t ta k e b e f o r e ex ten d in g c r e d i t s e c u r e d d i r e c t l y o r in d ir e c tl y by any s to c k ? (See a n s w e r to q u e s tio n 10 f o r d efin itio n of " s to c k . ") A n s w e r . - - T h e bank m u s t o b tain a p r o p e r l y c o m p le te d s t a te m e n t on F o r m U - l ( s o m e tim e s r e f e r r e d to a s a " p u rp o s e s ta te m e n t " ) s e ttin g fo rth th e b o r r o w e r 's p u r p o s e in o b tain in g th e c r e d it . 3. Q u e s tio n . - - M u s t a F o r m U - l s t a te m e n t b e ob tain ed if a lo a n i s not s e c u r e d , d i r e c t l y o r in d ir e c t ly , b y s to c k ? ( F o r m U - l i s d i s c u s s e d f u r t h e r in a n s w e r s to q u e s tio n s 35, 36 and 37 u n d e r " P r o c e d u r a l R e q u ir e m e n ts . ") A n s w e r . - -N o . "P u rp o s e " C re d it 4. Q u e s tio n . - -W hy i s the b o r r o w e r 's p u r p o s e im p o r t a n t? A n s w e r . - - I f th e b o r r o w e r 's p u r p o s e i s to p u r c h a s e o r c a r r y any " m a r g in sto c k , " th e lo a n i s a " p u r p o s e c r e d i t . " If p u r p o s e c r e d i t i s s t o c k - s e c u r e d , it b e c o m e s s u b je c t to th e c r e d i t li m i ta t io n s and o th e r r e s t r i c t i o n s of R e g u la tio n U. (D e ta ils of t h e s e l im i ta ti o n s and r e s t r i c t i o n s a r e d i s c u s s e d b elo w u n d e r th e ca p tio n " N a tu r e of C r e d i t R e s t r i c t i o n s and O th e r L im ita tio n s of R e g u la tio n U. " T h e t e r m " m a r g i n s to c k " is d efin ed in th e a n s w e r to q u e s tio n 11. ) 5. Q u e s tio n . - -D o any of th e R e g u la tio n U r e s t r i c t i o n s and li m i ta tio n s a p p ly to s t o c k - s e c u r e d c r e d i t if th e b o r r o w e r 's p u r p o s e i s n o t th e p u r c h a s in g o r c a r r y i n g of m a r g in s to c k ? A n sw e r. --N o . In th a t c a s e , th e only r e q u i r e m e n t i s to o b ta in th e b o r r o w e r 's F o r m U - l s t a te m e n t . H o w e v e r, it is i m p o r t a n t to n o te th a t th e b o r r o w e r 's s ta te m e n t to th a t effe c t c a n n o t b e a c c e p te d at f a c e v a lu e if t h e r e a r e any in d ic a tio n s to th e c o n t r a r y , s in c e th e b a n k 's a c c e p ta n c e of a p u r p o s e s ta te m e n t m u s t b e in "good fa ith . " F o r e x a m p le , f u r t h e r in q u ir y should b e m a d e if th e b o r r o w e r i n s t r u c t s th e ban k to m a k e p a y m e n t to a n a m e d b r o k e r - d e a l e r upon d e l i v e r y of m a r g i n s to c k . S e c u re d " in d ir e c tly " 6. Q u e s tio n . - - M u s t a F o r m U - 1 s ta te m e n t b e o b ta in e d f ro m a b o r r o w e r if th e b a n k 's c r e d i t to th e b o r r o w e r i s " in d ir e c tly " s e c u r e d b y s to c k ? A nsw er. --Y es. 7. Q u e s tio n . - - U n d e r w hat c i r c u m s t a n c e s i s r e c t l y s e c u r e d b y s to c k ? c r e d i t in d i A n s w e r . - - R e s o lu t io n of th is q u e s tio n m u s t n e c e s s a r i l y d ep en d on th e f a c t s an d c i r c u m s t a n c e s of ea c h c a s e . In g e n e r a l . c r e d i t is in d i r e c t ly s e c u r e d by s to c k if t h e r e i s an u n d e r s ta n d in g b e tw e e n th e b o r r o w e r and th e bank (1) w hich i s d e s ig n e d to m a k e th e s to c k m o r e a v a ila b le to th e b an k in c a s e of d e fa u lt th a n to th e b o r r o w e r 's o th e r c r e d i t o r s , o r (2) w hich l i m i t s th e b o r r o w e r f r o m e x e r c i s i n g full d o m in io n o v e r th e s to c k to s e l l, p le d g e , o r d o n ate it, o r d e te r m in in g w h e r e it s h a ll b e p la c e d p h y s ic a lly . H o w ev er, in th e a b s e n c e of any su ch r e s t r i c t i o n s o r a r r a n g e m e n t s w ith th e b o r r o w e r , th e m e r e fa c t th a t th e bank h o ld s th e s to c k a s c u s to d ia n o r t r u s t e e d o es not in and o f i t s e l f r e n d e r th e c r e d i t i n d i r e c t l y s e c u r e d . If t h e r e i s any q u e s tio n a s to w h e th e r a p a r t i c u l a r c r e d i t i s to b e " in d i r e c tly " s e c u r e d , f u r t h e r a d v ic e sh o uld b e s o lic ite d . Som e e x a m p le s of " i n d ir e c tly " s e c u r e d lo a n s follow: A. B. A t a tim e w hen th e b an k i s th e c u s to d ia n of th e s e c u r i t i e s p o r tfo lio of an in v e s tm e n t c o m p an y , th e bank m a k e s an o s te n s ib ly u n s e c u r e d lo a n to th e co m p an y upon th e co n d itio n th a t, u n til th e lo a n i s fu lly p a id , th e bank w ill r e t a i n i t s c u s to d ia n s h ip and no p a r t of th e sto c k w ill b e p led g ed o r o th e r w is e e n c u m b e r e d e x c e p t w ith th e b an k . T h e ad d itio n a l a r r a n g e m e n t w ould r e n d e r th e c r e d i t i n d ir e c t ly s e c u r e d b y th e s to c k in th e s e c u r i t i e s p o r tfo lio . A b ank lo a n s m o n ey a lle g e d ly on an u n s e c u r e d b a s i s . H o w e v e r, th e b o r r o w e r s ig n s a p le d g e not to s e l l o r e n c u m b e r h is a s s e t s , w hich c o n s i s t p r i m a r i l y of s to c k s , d u rin g th e life of th e lo an . T h is a r r a n g e m e n t c o m m o n ly know n a s a " n e g a tiv e p le d g e " would r e n d e r th e c r e d i t i n d i r e c t ly s e c u r e d . 8. Q u e s tio n . - -If an e x te n s io n of c r e d i t is i n d i r e c tl y s e c u r e d b y s to c k , how i s t h is to b e r e f le c t e d in th e F o r m U - l p u r p o s e s ta te m e n t ? A n s w e r . - - W h e r e an e x te n s io n of c r e d i t i s in d ir e c tl y s e c u r e d b y sto c k , th e c o l l a t e r a l should b e l i s t e d on P a r t II w ith a b r i e f d e s c r i p ti o n , by footn ote o r o th e r w is e , of th e a g r e e m e n t o r a r r a n g e m e n t p u r s u a n t to w hich th e s e c u r i t i e s a r e h e ld . "R e g u la te d " C r e d it 9. Q u e s tio n . - -W hat i s " r e g u la te d " c r e d i t ? A n s w e r . - - " R e g u la te d " c r e d i t i s th e t e r m u s e d in th is p a m p h le t (but n o t in th e r e g u la tio n ) w ith r e s p e c t to p u r p o s e c r e d i t w hich is s u b je c t to th e R e g u la tio n U c r e d i t r e s t r i c t i o n s and o th e r lim i ta tio n s . It in c lu d e s : -4- A. C r e d i t o b tain ed by a b o r r o w e r f r o m a bank f o r th e p u r p o s e of p u r c h a s in g o r c a r r y i n g m a r g i n s to c k if th e c r e d i t i s d i r e c t l y o r in d i r e c t l y s e c u r e d by any sto c k , w h e th e r o r n o t by m a r g i n s to c k . (See a n s w e r to q u e s tio n 12 on d e fin tio n of " c a r r y i n g " m a r g in s t o c k . ) B. C r e d i t ex te n d e d b y a ban k to a b o r r o w e r not s u b je c t to R e g u la tio n T (the r e g u la tio n w hich a p p lie s only to b r o k e r s and d e a l e r s ) o r to R e g u la tio n U, if th e b o r r o w e r 's b u s i n e s s in im p o r ta n t p a r t i n c lu d e s th e ex ten d in g of c r e d i t to o th e r p e r s o n s fo r th e p u r p o s e of p u r c h a s in g o r c a r r y i n g m a r g i n s to c k s . A b o r r o w e r r e c e iv in g su ch c r e d i t is s o m e tim e s r e f e r r e d to as a " c o l l a t e r a l l e n d e r " and m a y b e s u b je c t to th e B o a r d 's R e g u la tio n G, " S e c u r itie s C r e d i t b y P e r s o n s O th e r T h an B a n k s, B r o k e r s , o r D e a l e r s . " T h e c r e d i t s a r e d e e m e d to b e f o r th e p u r p o s e of p u r c h a s in g o r c a r r y i n g m a r g i n s to c k s and m a y n o t be ex ten d ed w ithou t c o l l a t e r a l , u n l e s s th e c r e d i t and it s p u r p o s e a r e u n m is ta k a b ly s e p a r a t e d and d i s a s s o c i a t e d f ro m any p u r p o s e c r e d i t . C r e d i t s s e c u r e d b y o t h e r th a n sto c k m u s t b e s e c u r e d to th e s a m e ex ten t a s would be r e q u i r e d if th e y w e r e s e c u r e d by s to c k and, th e r e f o r e , m a y not e x c e e d the m a x im u m lo an v alu e of su c h n o n - s to c k c o l l a t e r a l a s d e te r m in e d by th e b an k in "good fa ith . " Such c r e d i t s a r e s u b je c t to a ll of th e o t h e r p r o v is io n s of th e r e g u la tio n in clu d in g th o s e r e l a t in g to w ith d ra w a l and s u b s titu tio n of c o l l a t e r a l . (See a ls o a n s w e r to q u e s tio n 1 5 .) C. S to c k - s e c u r e d c r e d i t in itia lly ex ten d ed to p u r c h a s e n o n m a r g in s e c u r i t i e s w ould su b s e q u e n tly b e c o m e r e g u la te d c r e d i t if th o s e s e c u r i t i e s (by b eco m in g r e g i s t e r e d on a n a tio n a l s e c u r i t i e s ex ch an g e o r by being in c lu d e d in th e OTC m a r g i n sto c k l i s t ) b e co m e m a r g i n s to c k . In su c h a c a s e , th e b ank n eed do nothin g e x c e p t to r e q u i r e th e b o r r o w e r to a d h e r e to a p p lic a b le r e te n tio n r e q u i r e m e n t s in the event of s u b s titu tio n o r w ith d ra w a l of c o l l a t e r a l . (See R e te n tio n R e q u ir e m e n t s - - S u b s ti tu t io n s and W ith d r a w a ls b e l o w . ) C o n v e r s e ly , if the c r e d i t w as given to p u r c h a s e m a r g i n sto c k , th e c r e d i t would no lo n g e r be r e g u la te d if su c h sto c k w e r e no lo n g e r m a r g i n s to c k , a s w h e r e , f o r e x a m p le , it i s r e m o v ed f r o m th e OTC l i s t . (See th e a n s w e r to q u e s tio n 11 defin in g " m a r g in s to c k . ") D efin itio n of "Stock" 10. Q u e s tio n . --W h a t i s " s to c k " ? A n s w e r . - - T h e t e r m " s to c k " g e n e r a ll y m e a n s any s e c u r it y c o m m o n ly know n a s sto c k . O th e r i n s t r u m e n t s e n c o m p a s s e d by th e t e r m " s to c k " in clu d e (1) any vo ting t r u s t c e r t i f i c a t e o r o th e r i n s tr u m e n t r e p r e s e n t i n g s to c k , (2) any s e c u r i t y c o n v e r tib le a t any tim e and on any t e r m s in to su c h a s e c u r i t y , c e r t i f i c a t e o r i n s t r u m e n t, (3) any s e c u r i t y c a r r y i n g a w a r r a n t o r r ig h t to s u b s c r i b e to o r p u r c h a s e su c h s e c u r i t y , (4) an y su c h w a r r a n t o r r i g h t and (5) any put, c a ll o r s i m i l a r option g iving th e h o ld e r th e r i g h t to p u r c h a s e o r s e l l sto c k . In a d d itio n , th e t e r m " s to c k " could in clu d e an i n s t r u m e n t w hich e n title s th e h o ld e r to s h a r e o r p a r t i c i p a t e in any p r o f it s of th e is s u i n g c o m p an y , su c h a s a lim ite d p a r t n e r s h i p in te re st. C o u n s e l 's opinion sh ould be o b tain ed w hen t h e r e is a q u e s tio n a s to when an in s tr u m e n t is an " in v e s tm e n t c o n t r a c t" and, t h e r e f o r e , " s to c k . " " M a rg in " Stock 11. Q u e s tio n . - -W h a t i s " m a r g in " s to c k ? (See a n s w e r to q u e s tio n 10 f o r d e fin itio n of " s to c k . ") A n s w e r . - - " M a r g i n " sto c k in c lu d e s : A. Stock r e g i s t e r e d ( lis te d ) on any n a tio n a l s e c u r i t i e s ex ch an g e. B. OTC m a r g i n s t o c k - - t h a t i s - - s t o c k not t r a d e d on a n a tio n a l s e c u r i t i e s ex ch an g e b u t w hich th e B o a rd h a s d e te r m in e d to h av e c h a r a c t e r i s t i c s g e n e r a l ly s i m i l a r to a l i s t e d sto c k . T h e B o a rd p u b lish e s a l i s t of OTC m a r g i n s to c k s w hich i s g e n e r a l ly a v a ila b le to a ll i n t e r e s t e d p e r s o n s . T h is l i s t is r e v i s e d p e r i o d i c a ll y and i s a v a ila b le f r o m the B o a rd o r any R e s e r v e Bank. C. S e c u r it ie s c o n v e r tib le in to a m a r g i n sto c k , o r c a r r y i n g any w a r r a n t o r r i g h t to s u b s c r i b e to o r p u r c h a s e a m a r g in sto c k , o r any su c h w a r r a n t o r r ig h t. D. M a rg in s to c k a ls o in c lu d e s any s e c u r i t y is s u e d by an in v e s tm e n t co m p an y r e g i s t e r e d w ith th e S e c u r i t i e s and E x ch an g e C o m m is s io n u n l e s s th e i n v e s t m e n t com p an y i s li c e n s e d u n d e r th e S m a ll B u s in e s s In v e s tm e n t C o m p an y A c t, in w hich c a s e , i t s s e c u r i t i e s a r e not m a r g in s to c k . (One o th e r ex cep tio n c o v e r s s e c u r i t i e s i s s u e d b y an in v e s tm e n t com p any, 95 p e r c e n t o r m o r e of w h o se p o r tfo lio c o n s i s t s of e x e m p te d s e c u r i t i e s , s u c h a s U. S. G o v e rn m e n t, ag en cy , S tate and m u n ic ip a l o b l i g a t i o n s . ) " C a r r y in g " M a rg in Stock 12. Q u e s tio n . - -W h at is m e a n t by th e t e r m m a r g in s to c k ? "c a rry in g " A n s w e r . - - T h e only e x a m p le of " c a r r y i n g " s p e c ifie d in th e r e g u la tio n is th a t of c r e d i t to e n a b le a b o r r o w e r to r e d u c e o r r e t i r e in d e b te d n e s s o r ig in a lly i n c u r r e d to p u r c h a s e m a r g in sto c k . N a tu r e of C r e d i t R e s t r ic t i o n s and O th e r L im ita tio n s of R e g u la tio n U C r e d i t R e s t r ic t io n s E x te n s io n of C r e d i t 13. Q u e s tio n . - -W h a t a r e th e li m i ta t io n s of R e g u la tio n U on ex ten d in g r e g u la te d c r e d i t ? (See a n s w e r to q u e s tio n 9 f o r d e fin itio n of " r e g u la te d " c r e d i t . ) A n s w e r . - - A t th e t i m e w hen r e g u la te d c r e d i t i s e x te n d e d , th e a m o u n t of su c h c r e d i t m a y n o t e x c e e d th e " m a x im u m lo a n v a lu e " of th e c o l l a t e r a l s e c u r i n g th e c r e d i t . If th e m a x im u m lo an v a lu e of sto c k c o ll a t e r a l i z i n g p u r p o s e c r e d i t sh ould l a t e r e x c e e d th e am o u n t of th e c r e d i t (fo r w h a te v e r r e a s o n ) a t th e tim e w hen m o r e c r e d i t is so u g h t, th e bank m a y i n c r e a s e th e c r e d i t to eq u a l th e m a x im u m lo an v a lu e of th e c o l l a t e r a l . M a x im u m L o an V a lu e s M a x im u m L o an V alue of Stock 14. Q u e s tio n . - -W h a t i s th e " m a x im u m lo a n v a lu e " of " s to c k " (as d efin ed in s e c tio n 221. 3(1) and g e n e r a l ly d e s c r ib e d in th e a n s w e r to q u e s tio n 10) u s e d to c o l l a t e r a l i z e r e g u l a te d c r e d i t ? A n s w e r . - - T h e m a x im u m lo a n v a lu e of s to c k is a p e r c e n ta g e of c u r r e n t m a r k e t v a lu e , w hich th e c r e d i t m a y not e x c e e d a t th e ti m e th e c r e d i t is e x ten d ed . P e r c e n t a g e s a r e fixed by th e B o a rd f r o m tim e to tim e and a r e s e t f o rth in a S u p p le m e n t to R e g u la tio n U. C u r r e n t l y (as of F e b r u a r y 1, 1976) th e m a x im u m lo an v a lu e s of th e v a r io u s c a t e g o r i e s of s to c k a r e as follow s: A. F o r sto c k in g e n e r a l th e m a x im u m lo a n v a lu e is 50 p e r c e n t of t h e i r c u r r e n t m a r k e t v a lu e . -7- B . T h e m a x im u m lo a n valu e of d eb t s e c u r i t i e s c o n v e r ti b le into sto c k i s 50 p e r c e n t of th e c u r r e n t m a r k e t v a lu e of su c h s e c u r i t i e s . S p e c ia l p r o v is io n s th a t ap p ly to lo a n s on c o n v e r tib le debt s e c u r i t i e s a r e s e t f o r th in s e c tio n 221. 3(t) of th e re g u la tio n . C . P u t s , c a l l s o r c o m b in a tio n s th e r e o f h a v e no loan v a lu e , ev en though th e y m a y b e r e g i s t e r e d on a n a tio n a l s e c u r i t i e s ex ch an g e and a r e t h e r e f o r e m a r g i n s to c k . D. If th e c r e d i t is to e n ab le th e b o r r o w e r to e x e r c i s e a s to c k s u b s c r ip t io n r ig h t, e x p ir in g w ith in 90 d a y s of is s u a n c e , a m a x im u m lo a n v a lu e of 75 p e r c e n t of th e c u r r e n t m a r k e t v alu e of th e s to c k to be a c q u ir e d i s p e r m i s s i b l e , p ro v id e d th e ad d itio n a l c o n d itio n s s e t f o rth in s e c tio n 221. 3(p) a r e m e t. E . I n s u r a n c e p r e m iu m funding c r e d i t s (as d e s c r i b e d in s e c tio n 2 2 1 . 3(x)) can n o t e x c e e d th e am o u n t n e c e s s a r y to p a y th e i n s u r a n c e p r e m iu m p lu s any a p p lic a b le i n t e r e s t , and in an y ev e n t, c an n o t e x c e e d 40 p e r c e n t of th e c u r r e n t m a r k e t v a lu e of th e s e c u r i t i e s p led g ed a s c o l l a t e r a l , a s s e t f o rth in s e c tio n 2 2 1 . 3(x). F u r t h e r in f o rm a tio n on th is ty pe of c r e d i t i s c o n ta in e d in a s e p a r a t e s e t of q u e s tio n s and a n s w e r s a v a ila b le th ro u g h the R e s e r v e B a n k s. F . A lthough a ll sto c k of a g iven c l a s s i s e lig ib le fo r the m a x im u m lo a n valu e p e r m i tte d by th e r e g u la tio n , a b an k sh o u ld b e a l e r t to d e te r m in e w h e th e r sto c k r e c e i v e d a s c o l l a t e r a l i s " r e s t r i c t e d s to c k . " If su c h is th e c a s e th e b an k m a y h a v e d iffic u lty in r e a liz in g on it sh o u ld s a l e b e r e q u i r e d and, in f a c t, m a y be u n a b le to do so w ithout v io la tio n of th e F e d e r a l s e c u r i t i e s la w s . F u r t h e r a d v ic e sh ould b e s o lic ite d w hen t h e r e i s s u s p ic io n t h a t th e s to c k to b e p led g ed m a y b e " r e s t r i c t e d . " In g e n e r a l, " r e s t r i c t e d sto c k " c a n b e c l a s s i f i e d a s (1) sto c k owned by any p e r s o n who d i r e c t l y o r i n d ir e c tl y c o n tr o ls th e i s s u e r o r (2) sto c k r e c e iv e d f r o m an i s s u e r , o r c o n tr o llin g p e r s o n of th e i s s u e r , in a nonpu blic tr a n s a c t i o n and w hich m a y o r m a y not b e a r a le g e n d a d v is in g th a t it h a s n o t b e e n r e g i s t e r e d p u r s u a n t to the S e c u r i ti e s A c t of 1933. M a x im u m L o an V alue of O th e r C o l l a t e r a l 15. Q u e s tio n . - - I f a bank ex ten d s c r e d i t to a b o r r o w e r f o r th e p u r p o s e of p u r c h a s in g o r c a r r y i n g m a r g i n s to c k s on c o l l a t e r a l w hich d o e s not in c lu d e any s e c u r i t y id e n tifie d in th e a n s w e r to q u e s tio n 14, w h at i s th e m a x im u m lo a n v a lu e of su c h c o l l a t e r a l ? A n s w e r . - - T h e m a x im u m lo a n v a lu e of su c h c o l l a t e r a l is d e te r m in e d b y th e bank in "good fa ith . " T h is p r o c e d u r e a p p lie s a s w e ll to " c o l l a t e r a l l e n d e r " c r e d i t ( s e e a n s w e r B to q u e stio n 9). M a rk e t V a lu e of S e c u r i ti e s 16. Q u e s tio n . --H o w i s th e c u r r e n t m a r k e t v a lu e of s e c u r itie s a sc e rta in e d ? A n s w e r . - - T h e c u r r e n t m a r k e t v a lu e of s e c u r i t i e s m a y b e a s c e r t a i n e d b y any r e a s o n a b l e m e th o d . F o r ex am p le: A. B. In th e c a s e of a s e c u r i t y r e g i s t e r e d on a n a tio n a l s e c u r i t i e s ex c h a n g e , th e c u r r e n t m a r k e t v a lu e would b e (1) th e a c tu a l c u r r e n t p u r c h a s e o r s a l e p r i c e of su c h s e c u r i t y o r (2) in th e a b s e n c e of su c h c u r r e n t p u r c h a s e o r s a l e , th e l a s t c lo s in g s a l e p r i c e . If th e s e c u r i t y is not r e g i s t e r e d on su c h an ex ch an g e, th e c u r r e n t m a r k e t v a lu e w ould b e (1) th e a c tu a l c u r r e n t p u r c h a s e o r s a le p r i c e of su c h s e c u r i t y as a s c e r t a i n e d b y any r e a s o n a b l e m e th o d o r (2) in th e a b s e n c e of in f o rm a tio n on su c h c u r r e n t p u r c h a s e o r s a l e , th e c u r r e n t p r e v a ilin g bid q u o tatio n s a s r e f le c te d in th e NASDAQ s y s te m o r , in th e a b s e n c e of a NASDAQ q u o tatio n , in any o th e r r e c o g n iz e d i n t e r d e a l e r q u o tatio n s e r v i c e . " S ingle C r e d i t " R u le 17. Q u e s tio n . - - I s the m a x im u m lo an v a lu e of sto c k , e x c e p t c o n v e r tib le d eb t s e c u r i t i e s , d e p o s ite d w ith th e b an k to c o l l a t e r a l i z e a r e g u la te d lo an a ffe c te d b y th e f a c t th a t th e b o r r o w e r h a s an e x is tin g o u ts ta n d in g u n s e c u r e d p u r p o s e lo a n ? A n s w e r . - -N o. H o w ev er, s e v e r a l ad d itio n a l r u l e s apply. T h e r e g u la tio n p r o v id e s th a t a ll " p u r p o s e " c r e d i t to th e s a m e b o r r o w e r s h a ll b e d e e m e d a " s in g le c r e d i t . " A c c o rd in g ly , a ll sto c k , e x c e p t c o n v e r tib le d e b t s e c u r i t i e s , u s e d to c o l l a t e r a l i z e th e su b s e q u e n t p u r p o s e c r e d i t i s d e e m e d to c o l l a t e r a l i z e b o th th a t c r e d i t a s w e ll a s th e p r e v io u s ly u n s e c u r e d p u r p o s e c r e d i t . (The r e g u la tio n p r o v id e s a s e p a r a t e s in g le c r e d i t r u l e f o r " p u r p o s e " c r e d i t to th e s a m e b o r r o w e r th a t is s e c u r e d b y c o n v e r tib le d ebt s e c u r i t i e s . ) T hese p r in c i p le s m a y b e i l l u s t r a t e d b y th e follow ing ex a m p le : A s s u m e a ban k h a s e x te n d e d a $5, 000 p u r p o s e c r e d i t on an u n s e c u r e d b a s i s to a b o r r o w e r in good fa ith . S u b seq u e n tly , th e b an k e x te n d s a $ 5 ,0 0 0 s t o c k - s e c u r e d p u r p o s e c r e d i t to th e s a m e b o rro w er. A. If th e sto c k c o l l a t e r a l h a s a c u r r e n t m a r k e t v a lu e of $ 1 0 ,0 0 0 s u ffic ie n t to c a r r y th e se c o n d c r e d i t of $5, 000, th is c o l l a t e r a l would b e s u ffic ie n t f o r th e ex te n s io n of th e se c o n d c r e d i t . B. H o w e v e r, th e b o r r o w e r 's a c c o u n t w ould th e n b e u n d e r m a r g i n e d - - t h a t i s , u n d e r th e " s in g le c r e d i t " r u l e th e $10, 000 of s to c k i s d e e m e d not only to c o l l a t e r a l i z e the $5, 000 se c o n d c r e d i t b u t th e p r e v io u sly u n s e c u r e d p u r p o s e c r e d i t of $5, 000 a s w ell. C. B e c a u s e both c r e d i t s w e r e p r o p e r l y e x ten d ed on t h e i r r e s p e c t i v e o c c a s io n s , th e r e g u la tio n d o e s not r e q u i r e th e bank to d e m a n d m o r e th a n th e $ 1 0 ,0 0 0 sto c k c o l l a t e r a l f o r th e se c o n d $5, 000 c r e d i t . H o w e v e r, s in c e th e a c c o u n t i s u n d e r m a r g i n e d , it i s g o v e rn e d b y th e li m it a t io n s of th e " r e te n tio n r e q u i r e m e n t s " in th e e v e n t th e b o r r o w e r s e e k s to s u b s t it u t e o r w ith d ra w any c o l l a t e r a l . (See R e te n tio n R e q u i r e m e n t s - - S u b s t it u ti o n s and W ith d ra w a ls b e l o w . ) 18. Q u e s tio n . - - I f a ban k h a s ex te n d e d a r e g u la te d lo a n to a b o r r o w e r , m a y it th e n e x ten d an u n s e c u r e d p u r p o s e lo a n to th e s a m e b o rro w er ? A n s w e r . - -N o. U n d e r th e s in g le c r e d i t r u l e , s to c k c o l l a t e r a l f o r any p u r p o s e c r e d i t i s c o l l a t e r a l f o r a ll p u r p o s e c r e d i t ex ten d ed to th e s a m e c u s t o m e r . T h e e ffe c t of th e s in g le c r e d i t r u l e i s to m a k e th e se c o n d lo a n s e c u r e d . A d d itio n al c o l l a t e r a l would b e r e q u i r e d in an am ount su ffic ie n t to m e e t th e m a r g i n r e q u ir e m e n t on th e new c r e d i t . S e g re g a tio n of C o l l a t e r a l 19. Q u e s tio n . - - I f a b o r r o w e r h a s a p u r p o s e lo an s e c u r e d by sto c k , how m uch o th e r c o l l a t e r a l (w h e th e r s to c k o r n o n - s to c k ) m u s t b e d e p o s ite d by th e b o r r o w e r to s e c u r e a n o n r e g u la te d lo a n ? A n s w e r . - -T h e r e g u la tio n r e q u i r e s a bank w hich h a s o th e r c o l l a t e r a l f r o m the s a m e b o r r o w e r s e c u r i n g a n o n p u rp o se lo a n to m a in ta in c o l l a t e r a l f o r the n o n p u rp o s e lo a n a t a le v e l w hich it w ould in good fa ith r e q u i r e f o r th a t lo a n in th e a b s e n c e of th e p u r p o s e c r e d it . -10- 20. Q u e s tio n . - -M a y a b ank e x ten d to th e s a m e c u s to m e r a n o n p u rp o s e lo a n s e c u r e d b y sto c k and a p u r p o s e lo a n e i th e r u n s e c u r e d o r s e c u r e d b y c o l l a t e r a l c o n s is tin g of o th e r th a n s to c k ? A n s w e r . - - F o r R e g u la tio n U p u r p o s e s , w h e n e v e r a bank ex te n d s two lo a n s to th e s a m e c u s t o m e r , one a p u r p o s e lo an and th e o th e r n o n p u rp o s e , any s to c k c o l l a t e r a l w ould f i r s t b e id e n tifie d w ith th e p u r p o s e lo a n . Any e x c e s s c o l l a t e r a l , w h e th e r s to c k o r n o n - s to c k , not so id e n tifie d w ith th e p u r p o s e lo a n could b e u tiliz e d f o r th e c o l l a t e r a l r e q u i r e m e n t a s to th e n o n p u rp o s e lo a n , if d e e m e d n e c e s s a r y by th e bank. M ixed C o l l a t e r a l 21. Q u e s tio n . - - I s it p o s s ib le f o r a ban k to m a k e a p u r p o s e lo a n s e c u r e d in p a r t by sto c k c o l l a t e r a l and in p a r t b y n o n - s to c k c o lla te ra l ? A n s w e r . - - A bank m a y m a k e a lo a n on m ix e d c o l l a t e r a l p ro v id in g th e t r a n s a c t i o n i s t r e a t e d f o r R e g u la tio n U p u r p o s e s a s if it w e r e two s e p a r a t e and d i s t in c t lo a n s , even if a s in g le lo an i n s tru m e n t is used. T h e s to c k c o l l a t e r a l p o r tio n can b e g iv en no g r e a t e r lo a n v a lu e th a n th e c u r r e n t m a r g in r e q u i r e m e n t s p e r m i t . T h e n o n - s to c k p o r tio n of th e c o l l a t e r a l m a y b e a s s ig n e d no m o r e th a n good fa ith lo a n v a lu e . T h e r e c o r d s of the bank m u s t b e m a i n ta in e d so th a t ea c h p o r tio n of th e c r e d i t and th e c o l l a t e r a l u n d e r ly in g it a r e i r r e v o c a b l y id e n tifie d f o r th e p u r p o s e of c o m p lia n c e w ith th e s u b s titu tio n and w ith d ra w a l p r o v is i o n s of th e r e g u la tio n . S h rin k a g e of L oan V alu e of Stocks 22. Q u e s tio n . - - I f th e sto c k s e c u r in g a p u r p o s e c r e d i t had a p p r o p r i a t e m a x im u m lo a n v alu e w hen th e c r e d i t w as e x ten d ed , d o e s th e r e g u la tio n r e q u i r e th e bank to ta k e any s te p s if th e m a r k e t valu e of th e s to c k h a s d e c lin e d to a p o in t w h e r e th e p r e s c r i b e d m a x im u m lo a n v a lu e b e c o m e s l e s s th a n th e o u ts ta n d in g am o u n t of th e c r e d i t o r if th e B o a rd h a s ta k e n a c tio n su b s e q u e n tly to r e d u c e th e m a x im u m lo a n v a lu e w h ile th e c r e d i t is o u tsta n d in g ? A n s w e r . - - F o r R e g u la tio n U p u r p o s e s , th e bank i s not r e q u i r e d to ta k e any a c tio n in t h e s e c i r c u m s t a n c e s . H o w e v e r, th e c r e d i t i s s u b je c t to r e t e n t io n r e q u i r e m e n t s if th e b o r r o w e r w is h e s to s u b s tit u te o r w ith d ra w c o l l a t e r a l . R e n e w a ls and E x te n s io n s 23. Q u e s tio n . --H o w d o es th e r e g u la tio n ap p ly if th e b o r r o w e r w is h e s a r e n e w a l o r e x te n s io n of m a t u r i ty in c o n n e c tio n w ith a r e g u la te d c r e d i t ? A n s w e r . - - T h e r e g u la tio n d o e s n ot r e q u i r e th e b an k to t r e a t th e r e n e w a l o r e x te n s io n of m a t u r i t y of a c r e d i t a s a new e x te n s io n of c r e d i t if th e am o u n t is not i n c r e a s e d e x c e p t by th e a d d itio n of r e l a t e d i n t e r e s t o r s e r v i c e c h a r g e s and t r a n s a c t i o n a l ta x e s . T h e r e n e w a l o r e x te n s io n of m a t u r i ty m a y b e m a d e even though th e m a r k e t v alu e of th e sto c k c o l l a t e r a l m a y h a v e d e c lin e d to a point w h e r e th e p r e s c r i b e d m a x im u m lo a n v a lu e b e c o m e s l e s s than th e o u ts ta n d in g am o u n t of th e c r e d i t o r the B o a rd h a s ta k e n a c tio n to r e d u c e th e m a x im u m lo an v a lu e w h ile th e c r e d i t i s o u tsta n d in g . R e te n tio n R e q u ir e m e n t s - - S u b s ti tu t io n s and W ith d ra w a ls 24. Q u e s tio n . - -W h a t a r e r e te n t io n r e q u i r e m e n t s and how do th ey ap p ly to a lo a n in an " u n d e r m a r g in e d " s t a tu s w h e r e th e c u r r e n t m a x im u m lo an v a lu e of th e c o l l a t e r a l i s l e s s th an th e b a la n c e of th e lo a n ? A n s w e r . - -R e te n tio n r e q u i r e m e n t s r e f e r to th e am o u n t by w hich a lo an b a la n c e m u s t b e r e d u c e d when t h e r e i s a s u b s titu tio n o r w ith d ra w a l of c o l l a t e r a l f r o m an a c c o u n t. T h e r e te n t io n r e q u i r e m e n t i s c o m p u te d on th e b a s i s of a p e r c e n t a g e of th e c u r r e n t m a r k e t v a lu e of th e c o l l a t e r a l a s s e t by th e B o a rd and show n in th e s u p p le m e n t to th e r e g u la tio n . T h e follo w in g e x a m p le s show how th is p r o v is io n a p p lie s to a lo an in an " u n d e r m a r g in e d " s ta tu s u n d e r th e c u r r e n t 70 p e r c e n t r e te n t io n r e q u i r e m e n t: A. T h e b a la n c e of th e lo a n i s $15, 000, and th e c o l l a t e r a l c o n s i s t s of s to c k w ith a c u r r e n t m a r k e t v a lu e of $25, 000, a t a tim e w hen th e m a x im u m lo an value of s e c u r i t i e s i s 50 p e r c e n t of th e m a r k e t p r i c e . In su c h a c a s e th e m a x im u m lo a n v a lu e of th e c o l l a t e r a l is only $12, 500, and th e c r e d i t of $ 1 5 ,0 0 0 i s t h e r e f o r e u n d e r m a r g in e d b y $2, 500. In th a t p o s tu r e , if th e b o r r o w e r w is h e s to w ith d ra w $5, 000 of s e c u r i t i e s h e m u s t r e d u c e th e c r e d i t by th e r e t e n t io n r e q u i r e m e n t (which c u r r e n t l y i s 70 p e r c e n t of th e c u r r e n t m a r k e t v a lu e of th e w ith d ra w n s e c u r it y ) , n a m e ly b y $3, 500 ($5, 000 x 70% = $3, 500), le a v in g a lo a n b a la n c e of $11, 500. B. A s in th e p r e v io u s e x a m p le , th e lo an b a la n c e is $15, 000 and th e c u r r e n t m a r k e t v a lu e o f th e s to c k i s $25, 000, w ith th e c r e d i t b ein g u n d e r m a r g in e d by $2, 500. The b o r r o w e r d e s i r e s to w ith d ra w $7, 000 of s e c u r i t i e s and d e p o s it o th e r s e c u r i t i e s i n th e a m ount of $5, 000. T h e r e te n ti o n r e q u i r e m e n t (of 70 p e r c e n t ) a s to th e $7, 000 w ith d ra w n s e c u r i t i e s is $4, 900, and th e s e c u r i t i e s d e p o s ite d h a v e a m a x im u m lo an v a lu e of only $2, 500. In th is c a s e , th e m a x im u m lo an v a lu e of th e s u b s titu te d s e c u r i ti e s is $ 2 ,4 0 0 l e s s th a n th e r e te n tio n r e q u i r e m e n t of th e w ith d ra w n s e c u r i t i e s . A c c o rd in g ly , th e c r e d i t m u s t b e r e d u c e d by $2, 400, w ith a r e s u l t a n t lo a n b a la n c e of $12, 600. C . A g a in , th e lo a n b a la n c e i s $15, 000 and th e c u r r e n t m a r k e t v alu e of th e c o l l a t e r a l i s $25, 000, w ith th e c r e d i t b e in g u n d e r m a r g in e d b y $ 2 ,5 0 0 . T h e b o r r o w e r d e s i r e s to w ith d ra w $ 5 ,0 0 0 of s e c u r i t i e s and d e p o s it o t h e r s in th e am o u n t of $6, 000. The r e t e n ti o n r e q u i r e m e n t (of 70 p e r c e n t ) a s to th e $5, 000 w ith d ra w n i s $3, 500, and th e s e c u r i t i e s d e p o s ite d h a v e a m a x im u m lo a n valu e of $3, 000. T h e m a x im u m lo a n v a lu e of th e s u b s titu te d s e c u r i t i e s is $500 l e s s th an th e r e t e n t io n r e q u i r e m e n t of th e w ith d ra w n s e c u r i t i e s . A c c o rd in g ly , th e lo a n m u s t b e r e d u c e d b y $500, w ith a r e s u l t a n t b a la n c e of $14, 500. 25. Q u e s tio n . - - T o w h at e x te n t, if any, would r e t e n t io n r e q u i r e m e n t p r o v is io n s apply in th e c a s e of a s u b s titu tio n o r w ith d r a w a l in an a c c o u n t th a t i s n o t in an " u n d e r m a r g in e d " s ta tu s ; th a t i s , th e c u r r e n t m a x im u m lo an valu e of th e c o l l a t e r a l in th e a c c o u n t e q u a ls o r e x c e e d s th e b a la n c e of th e lo a n ? A n s w e r . - - T h e r e t e n t io n r e q u i r e m e n t w ould ap p ly on ly if th e s u b s titu tio n o r w ith d ra w a l would r e s u l t in r e d u c in g th e c u r r e n t m a x im u m lo a n v a lu e of th e r e s i d u a l c o l l a t e r a l below th e b a la n c e of th e lo a n . S om e e x a m p le s follow: A. C u r r e n t m a r k e t v alu e of c o l l a t e r a l i s $ 1 0 ,0 0 0 , th e c u r r e n t m a x im u m lo a n v a lu e is $5, 000 and th e b a la n c e of th e lo an i s $5, 000. The b o rro w er w is h e s to w ith d ra w $2, 000 of c o l l a t e r a l . The s t a tu s of th e lo a n a c c o u n t is c u r r e n t l y r i g h t on m a rg in . T h e r e f o r e , th e b a la n c e of th e lo a n m u s t b e r e d u c e d b y an am o u n t eq u al to th e c u r r e n t m a x im u m lo a n valu e ( c u r r e n t ly 50 p e r c e n t) o r $ 1 ,0 0 0 . T h e c u r r e n t m a r k e t v a lu e of c o l l a t e r a l w ould th e n b e $8, 000, th e c u r r e n t m a x im u m lo a n v a lu e w ould b e $4, 000 and th e b a la n c e of th e loan w ould b e $4, 000. B. C u r r e n t m a r k e t v alu e of c o l l a t e r a l is $11, 000, th e c u r r e n t m a x im u m lo a n v a lu e i s $5, 500 and th e lo an b a la n c e is $5, 000. T h e b o r r o w e r w ith d ra w s $ 2 ,0 0 0 of c o l l a t e r a l . T h e lo a n b a la n c e m u s t b e r e d u c e d b y $500 so th a t it w ill not e x c e e d th e c u r r e n t -13- m a x im u m lo an v alu e of th e c o l l a t e r a l a f t e r th e w ith d r a w a l. T h e c u r r e n t m a r k e t v a lu e of th e c o l l a t e r a l would th en b e $9, 000, th e c u r r e n t m a x im u m loan v a lu e would b e $4, 500 and th e b a la n c e of th e lo an would be $4, 500. C. C u r r e n t m a r k e t v alu e of th e c o l l a t e r a l i s $ 1 2 ,0 0 0 , th e c u r r e n t m a x im u m lo a n v a lu e i s $6, 000 and the lo a n b a la n c e i s $ 5 ,0 0 0 . T h e b o r r o w e r w ith d ra w s $2, 000 of c o l l a t e r a l . T h e lo a n b a la n c e n e e d not b e r e d u c e d b e c a u s e it w ill not e x c e e d th e c u r r e n t m a x — im u m loan v a lu e of th e c o l l a t e r a l a f t e r th e w ith d r a w a l. T h e c u r r e n t m a r k e t v a lu e of th e c o l l a t e r a l would th e n b e $ 1 0 ,0 0 0 , th e c u r r e n t m a x im u m lo a n v a lu e would b e $5, 000 and th e lo an b a la n c e would be $5, 000. S a m e - P a y T r a n s a c t i o n s - - E q u i t y R a tio 26. Q u e s tio n . - -W h a t a r e th e l i m i t s on s u b s titu tio n s w ith d r a w a ls of c o l l a t e r a l when th e y r e s u l t f r o m p u r c h a s e s and s a l e s on th e s a m e b u s i n e s s d a y ? A n s w e r . - -In c e r t a i n s itu a tio n s a s ex p lain ed b elo w , if s p e c ific c o n d itio n s a r e m e t, a b o r r o w e r m a y w ithou t l i m i t e ffe c t w ith d r a w a ls and s u b s titu tio n s of c o l l a t e r a l b y r e a s o n of p u r c h a s e s and s a l e s if a ll of th e m a r e e x e c u te d w ithin th e s a m e d ay, and if t h e r e i s no n e t d im in u tio n o f th e lo a n v a lu e of th e c o l l a t e r a l . H ow e v e r , b e f o r e th is m a y b e p e r m i tte d , th e "e q u ity r a t i o " of th e c r e d i t m u s t b e a s c e r t a i n e d , s in c e th e b o r r o w e r cannot a v a il h im s e l f of th e s a m e - d a y s u b s titu tio n p r iv ile g e u n l e s s th e e q u ity r a t i o i s eq u al to o r g r e a t e r th a n th e " m in im u m equity r a t i o " w hich th e B o a rd fix e s f r o m tim e to tim e . C u r r e n t l y (as of F e b r u a r y 1, 1976), a s s e t f o rth in a S u p p lem en t to R e g u la tio n U, the m in im u m eq u ity r a t io of a c r e d i t i s 30 p e r c e n t. T h e e x a m p le s f u rn is h e d below c o v e r not only s itu a tio n s w h e r e the p u r c h a s e and s a l e am o u n ts b a la n c e o ut, but a ls o th o s e w h e r e th e am o u n t of th e one e x c e e d s th a t of th e o th e r: .A. T he m in im u m equity r a t i o of th e c r e d i t is 30 p e r c e n t a t th e ti m e . T h e c r e d i t is $17, 500, th e c u r r e n t m a r k e t v alu e of th e c o l l a t e r a l i s $25, 000, and th e d if f e r e n c e (o r equity) i s t h e r e f o r e $7, 500. T h is e q u a ls th e m in im u m equ ity r a t i o of 30 p e r c e n t of th e c o l l a t e r a l v alu e of $25, 000. In th e s e c i r c u m s t a n c e s , th e b o r r o w e r is f r e e to en g ag e in any n u m b e r of " s a m e - d a y " t r a n s a c t i o n s in eq u al o ff s e ttin g a m o u n ts . B. A s s u m in g th e s a m e f a c ts a s th e fo re g o in g , if th e p r o c e e d s of s a l e s of w ith d ra w n s e c u r i t i e s e x c e e d and th e to ta l c o s t of th e p u r c h a s e s of s u b s titu te d s e c u r i t i e s , th e c r e d i t m u s t be r e d u c e d in a c c o r d a n c e w ith a f o r m u la w hich w o r k s o ut th is w ay. If th e r e te n tio n r e q u i r e m e n t ( c u r r e n t l y 70 p e r c e n t of m a r k e t v alu e) of $7, 000 of s e c u r i t i e s w ith d ra w n i s $4, 900, and th e r e te n ti o n r e q u i r m e n t f o r th e $5, 000 of s e c u r i t i e s s u b s titu te d is $3, 500, th e $17, 500 c r e d i t m u s t b e r e d u c e d by th e d if f e r e n c e , n a m e ly $ 1 ,4 0 0 , le a v in g a n e t b a la n c e in th e c r e d i t of $16, 100. C . If th e to ta l c o s t of p u r c h a s e s i s $7, 000 and th e to ta l p r o c e e d s of s a l e s a r e $ 5 ,0 0 0 , th e am o u n t of th e c r e d i t m a y b e i n c r e a s e d upon th e follow ing c o m p u ta tio n . T h e m a x im u m lo a n v a lu e (at 50 p e r c e n t) of th e s e c u r i t i e s p u r c h a s e d (s u b s titu te d ) i s $ 3 ,5 0 0 , and th e m a x im u m lo an v a lu e of th e s e c u r i t i e s so ld (w ithdraw n) i s $2, 500. T h e d if f e r e n c e of $ 1 ,0 0 0 m a y b e added to th e $17, 500 c r e d i t , w ith th e r e m a in in g $ 1 ,0 0 0 b ein g s u p p lie d by th e b o r r o w e r . T h e r e s u l t is th a t th e c r e d i t h a s b e e n in c r e a s e d only to th e e x te n t th a t th e m a x im u m lo a n v a lu e of th e c o l l a t e r a l h a s b e e n i n c r e a s e d . T h is is p e r m i s s i b l e . R e o r g a n iz a tio n s and R e c a p ita liz a tio n s 27. Q u e s tio n . —A r e t h e r e any e x c e p tio n s to th e s u b s titu tio n and w ith d ra w a l r e s t r i c t i o n s w hich ap p ly to an u n d e r m a r g in e d a c c o u n t? A n s w e r . - - I n th e c a s e of th e r e o r g a n iz a tio n o r r e c a p ita liz a tio n of a co m p an y w hich w a s th e i s s u e r of s e c u r i t i e s d e p o s ite d by th e b o r r o w e r a s c o l l a t e r a l f o r th e c r e d i t , th e b o r r o w e r m a y w ith d r a w su c h s e c u r i t i e s a s h e m u s t s u r r e n d e r in o r d e r to r e c e i v e new s e c u r i t i e s in lie u th e r e o f as p a r t of th e r e o r g a n iz a t io n o r r e c a p i t a l iz a tio n . In su ch an ev e n t, th e b o r r o w e r m u s t d e p o s it th e new s e c u r i t i e s in p la c e of th e s e c u r i t i e s w ith d ra w n . T r a n s f e r s of C r e d it F r o m B ank to B ank 28. Q u e s tio n . —U n d e r w hat c i r c u m s t a n c e s m a y a b an k , at th e i n s ta n c e of a b o r r o w e r , ta k e o v e r th e b o r r o w e r 's u n d e r m a r g in e d r e g u la te d c r e d i t f r o m a n o th e r b a n k ? A n s w e r . - -If s a t is f ie d th a t th e b o r r o w e r 's r e q u e s t f o r th e t r a n s f e r is not a m e a n s f o r ev ad in g R e g u la tio n U r e q u i r e m e n t s and th a t th e o th e r b a n k 's e x te n s io n of c r e d i t w as in c o m p lia n c e w ith th e r e g u la tio n , th e t r a n s f e r e e bank m a y ta k e o v e r th e o t h e r b a n k 's c r e d i t b y p ayin g th e o th e r bank th e e x is tin g b a la n c e of th e c r e d i t and r e c e iv in g th e c o l l a t e r a l s e c u r in g th a t c r e d i t . D e s p ite th e fa c t th a t th e c r e d i t i s u n d e r m a r g in e d , th e t r a n s f e r e e b ank is u n d e r no o b lig a tio n to ta k e any a f f ir m a tiv e s te p s w ith r e s p e c t to th e c r e d i t o r c o l l a t e r a l w hich th e o th e r b an k did not h a v e to ta k e . H o w ev er, b e in g u n d e r m a r g in e d , th e c r e d i t w ould co n tin u e to b e s u b je c t to th e r e t e n t io n r e q u i r e m e n t p r o v is io n s g o v e rn in g s u b s titu tio n s and w ith d r a w a ls . It sh o u ld b e e m p h a s iz e d th a t, in ex ten d in g th e c r e d i t to th e b o r r o w e r in c o n n e c tio n w ith th e t r a n s f e r , th e t r a n s f e r e e bank m u s t m a k e p a y m e n t of th e c r e d i t d i r e c t l y to th e o t h e r b a n k . The p r iv ile g e to th e b o r r o w e r of t r a n s f e r r i n g h i s o b lig atio n to the t r a n s f e r e e b an k d o e s not ap p ly if th e p a y m e n t to r e d u c e o r r e t i r e h is in d e b te d n e s s to th e o th e r ban k is m a d e d i r e c tl y to th e b o r r o w e r . In su c h a c a s e , th e t r a n s a c t i o n i s a new e x te n s io n of c r e d i t w hich would b e lim ite d to th e m a x im u m lo a n v a lu e of th e c o l l a t e r a l . A m ong th e o t h e r c o n d itio n s to b e c o m p lie d w ith i s th a t th e t r a n s f e r e e b an k m u s t s a t i s f y i t s e l f th a t, w hen o r ig in a lly e x te n d ed b y th e o th e r bank, th e c r e d i t w as in c o m p lia n c e w ith th e r e g u l a tio n , and it m u s t e x a m in e th e b o r r o w e r 's p u r p o s e s t a te m e n t to a s c e r t a i n w h e th e r an o f fic e r of th e bank sig n e d th a t s ta te m e n t a s h av in g b e e n a c c e p te d in good f a ith . In a d d itio n , th e t r a n s f e r e e bank m a y not i n c r e a s e th e c r e d i t and m u s t ta k e th e s a m e c o l l a t e r a l w hich th e o th e r bank h a d . If on ly p a r t of th e c r e d i t is t r a n s f e r r e d , th e n a p r o r a t a p o rtio n of th e c o l l a t e r a l m u s t b e ta k e n . (Note th a t th is p r o v is io n is lim ite d to in te r b a n k t r a n s f e r s . ) F r o m B o r r o w e r to B o r r o w e r 29. Q u e s tio n . - - M a y a b a n k t r a n s f e r u n d e r m a r g in e d r e g u la te d c r e d i t f r o m one of it s b o r r o w e r s to o t h e r s ? A n s w e r . - - Y e s , p ro v id e d th e tr a n s a c t i o n i s not d e s ig n e d to e n ab le th e t r a n s f e r e e b o r r o w e r to avoid d e p o s itin g th e am o u n t of c o l l a t e r a l w hich would b e r e q u i r e d f o r an in itia l e x te n s io n of c r e d i t to h im . T h e b ank m u s t r e c e i v e a s t a te m e n t by th e t r a n s f e r o r d e s c r i b i n g th e c i r c u m s t a n c e s giving r i s e to the t r a n s f e r and n e g a tin g any in te n tio n of avo id in g th e m a x im u m lo a n v alu e r e q u i r e m e n t of th e r e g u la tio n . T h a t s t a te m e n t m u s t b e sig n e d b y an o f fic e r of th e bank in good fa ith and k e p t w ith e a c h t r a n s f e r e e a c c o u n t. E xem pt C re d it 30. Q u e s tio n . - -W hat kind of s e c u r i t i e s and t r a n s a c t i o n s a r e e x e m p t f r o m R e g u la tio n U m a r g in r e q u i r e m e n t s ? A n s w e r . - - S t o c k - s e c u r e d c r e d i t is e x e m p t f r o m th e m a r g i n r e q u i r e m e n t s if ex ten d ed to p u r c h a s e o r c a r r y e x e m p te d s e c u r i t i e s o r n o n m a r g in s to c k s ; h o w e v e r, it sh ould be n o ted th a t a F o r m U - l p u r p o s e s ta te m e n t m u s t b e o b ta in e d . O th e r e x a m p le s of e x e m p t c r e d i t a r e (1) c e r t a i n t r a n s a c t i o n s w ith b r o k e r - d e a l e r s (s e e a n s w e r to q u e s tio n 42 on " E x e m p t T r a n s a c t i o n s w ith and f o r B r o k e r - D e a l e r s " ) and (2) s o m e o th e r s p e c ifie d k in d s of m i s c e lla n e o u s t r a n s a c t i o n s (s e e a n s w e r to q u e s tio n 32 on " E x c e p tio n s to th e G e n e r a l R u le " ). E x e m p te d S e c u r itie s 31. Q u e s tio n . - -W hat i s an e x e m p te d s e c u r i t y ? A n s w e r . - - T h e g e n e r a l c a t e g o r i e s of e x e m p te d s e c u r i t i e s a r e a s follow s: A. D i r e c t o b lig a tio n s of, o r o b lig a tio n s g u a r a n te e d as to p r in c ip a l and i n t e r e s t by, (1) th e U nited S ta te s , (2) any S tate, (3) any a g e n c y o r in s t r u m e n t a l i t y of a S ta te , (4) an y p o litic a l su b d iv is io n of a S ta te o r of a S tate a g en cy o r i n s t r u m e n t a li ty o r (5) any m u n ic ip a l c o r p o r a t e in s t r u m e n t a l i t y of one o r m o r e S ta te s . B. S e c u r i ti e s is s u e d o r g u a r a n te e d b y c o r p o r a t io n s in w hich th e U nited S ta te s h a s a d i r e c t o r i n d i r e c t i n t e r e s t and w hich th e S e c r e t a r y of th e T r e a s u r y h a s d e s ig n a te d a s e x e m p te d s e c u r i t i e s . C. S e c u r i ti e s d e s ig n a te d by r u l e o r r e g u la tio n of th e S e c u r itie s and E x ch an g e C o m m is s io n to b e " e x e m p t ed s e c u r i t i e s " f o r th e p u r p o s e of th e p r o v is io n s of S ection 7(d) of th e S e c u r it ie s E x c h a n g e A ct of 1934. D. (1) L im ite d k in d s of i n d u s t r i a l d e v e lo p m e n t b ond s m e e tin g s p e c ifie d r e q u i r e m e n t s of th e I n te r n a l R e v en u e C o d e , (2) i n t e r e s t s in co m m o n t r u s t funds a d m i n is te r e d by b an k s in c e r t a i n f id u c ia ry c a p a c i ti e s and (3) i n t e r e s t s in s p e c ifie d lim ite d " s e p a r a t e a c c o u n ts , " m a in ta in e d b y i n s u r a n c e c o m p a n ie s w hich a r e is s u e d in c o n n e c tio n with d e s ig n a te d kinds of s to c k b o n u s, p en sio n , p r o fit s h a r in g o r an nu ity p la n s m e e tin g s p e c ifie d r e q u i r e m e n t s of th e I n te rn a l R ev en u e C ode. E x c e p tio n s to th e G e n e r a l R ule 32. Q u e s tio n . - -W h at t r a n s a c t i o n s a r e e x e m p t f r o m R e g u la tio n U o th e r th a n c e r t a i n t r a n s a c t i o n s w ith b r o k e r - d e a l e r s ? ( F o r t r a n s a c t i o n s w ith b r o k e r - d e a l e r s , s e e a n s w e r to q u e s tio n 4 2 .) A n s w e r . - - T h e follow ing e x a m p le s r e p r e s e n t s o m e of th e s e m i s c e lla n e o u s e x e m p t tr a n s a c t i o n s : A. C r e d i t e x ten d ed o u ts id e th e S ta te s of th e U nited S ta te s and th e D i s t r i c t of C o lu m b ia is e x e m p t c r e d i t . T h e b o r r o w e r , if a U. S. c itiz e n , m u s t, h o w e v e r , c o n fo rm to th e p r o v is io n s of th e B o a r d 's R e g u la tio n X " R u le s G o v ern in g B o r r o w e r s Who O b tain S e c u r itie s C r e d i t . " B. C r e d i t is e x e m p t c r e d i t if ex te n d e d to a bank o r a f o re ig n ban k in g in s titu tio n . A s p e c ia l p r o v is io n of R e g u la tio n U p r o v id e s th a t th e t e r m "b an k " d o e s n o t in c lu d e one w hich i s a m e m b e r of a n a tio n a l s e c u r i t i e s ex ch an g e. C . E x e m p t c r e d i t m a y b e ex ten d ed b y a bank to a " p la n le n d e r " to fin a n c e s to c k optio n and e m p lo y e e sto c k p u r c h a s e p la n s to o f f i c e r s and e m p lo y e e s of a c o r p o r a tio n , i t s s u b s i d i a r i e s o r a f f ilia te s , u n d e r p la n s w hich c o m p ly w ith s e c tio n 207. 4(a) of R e g u la tio n G; w ith th e p r o v is o th a t th e bank s h a ll h a v e no r e c o u r s e to any s to c k p u r c h a s e d u n d e r su c h a plan. P r o h ib itio n A g a in s t A r r a n g in g fo r M o re F a v o r a b le T e r m s 33. Q u e s tio n . - - C a n a bank a r r a n g e w ith o th e r s ( e . g . , u n r e g u la te d in d iv id u a ls , f o re ig n b an k in g o r o th e r u n r e g u la te d c o m p a n ie s and in s titu tio n s o r l e n d e r s s u b je c t to R e g u la tio n G) to ex tend c r e d i t to any p e r s o n s to p u r c h a s e o r c a r r y m a r g in s to c k s on t e r m s m o r e g e n e r o u s th a n R e g u la tio n U p e r m i t s ? A n s w e r . - -N o . T h e r u l e c o n ta in s an a b s o lu te p ro h ib itio n a g a in s t su c h a c tiv ity . In a d d itio n , R e g u la tio n X g e n e r a lly p r o h ib its a d o m e s tic b o r r o w e r f r o m r e c e iv in g c r e d i t on t e r m s m o r e le n ie n t th a n th o s e allow ed by th e B o a r d 's m a r g i n r e g u l a ti o n s . F u r t h e r , a bank w hich a r r a n g e d su c h c r e d i t m ig h t be lia b le f o r aidin g and a b e ttin g a v io la tio n of R e g u la tio n X. 34. Q u e s tio n . - -W hat k in d s of a c tiv ity a r e e n c o m p a s s e d by th e t e r m " a r r a n g in g " ? A n s w e r . - - F o r th e p u r p o s e of th e r u l e , p ro h ib ite d " a r r a n g in g " e m b r a c e s a c tiv ity w hich m a y f a ll s h o r t of a c tu a l n e g o tia tio n s to p r o c u r e c r e d i t f o r th e b o r r o w e r f r o m th e o th e r person. F o r e x a m p le , a r r a n g in g w ould in c lu d e any a c t on th e p a r t of a bank , su c h a s an in tro d u c tio n , le a d in g to an e x te n s io n of c r e d i t fro m a th ird p erso n . F u r t h e r , a bank c a n n o t r e f e r a b o r r o w e r o r p o te n tia l b o r r o w e r to a n o th e r le n d e r n o t s u b je c t to R e g u la tio n U, su c h a s th e b a n k 's p a r e n t h o ld in g co m p a n y o r an a f filia te d fin a n c e c o m p a n y , f o r a p u r p o s e lo a n s e c u r e d b y n o n m a r g in s to c k in an am o u n t g r e a t e r th a n i s p e r m i t te d by R e g u la tio n U. H o w e v e r, th e p ro h ib itio n a g a in s t a r r a n g in g w ould n o t p r e c lu d e a b an k f r o m f u r n is h in g c r e d i t in f o r m a tio n c o n c e r n in g a c u s t o m e r in a c c o r d a n c e w ith it s g e n e r a l b u s in e s s p r a c t i c e . P r o c e d u r a l R e q u ir e m e n ts 35. Q u e s tio n . - - M u s t a b a n k o b ta in a s t a te m e n t on F o r m U - l f r o m e v e r y b o r r o w e r to w hom it e x te n d s s t o c k - s e c u r e d c r e d i t ? A n s w e r . - - Y e s . H o w e v e r, an e x c e p tio n to t h is r e q u ir e m e n t r e l a t e s to good fa ith c r e d i t ex ten d ed to b r o k e r - d e a l e r s w ith o u t r e f e r e n c e to m a r g in r e q u i r e m e n t s . (See a n s w e r to q u e stio n 4 2 .) 36. Q u e s tio n . —W hat o t h e r e x te n s io n s of p u r p o s e c r e d i t do not re q u ire a F o rm U - l ? A n s w e r . - - A F o r m U - l w ould not b e r e q u i r e d in c o n n e c tio n w ith c r e d i t e x ten d ed p u r s u a n t to s e c tio n 2 2 1 .2 , e x cep t f o r c r e d i t ex ten d ed to a p e r s o n who i s n o t a b r o k e r o r d e a l e r in c o n n e c tio n w ith "D ay L o a n s , " " P r o m p t D e liv e r y C l e a r a n c e " o r " S e c u r iti e s in T r a n s i t o r T r a n s f e r " a s d e s c r i b e d in s e c tio n 221. 2(f), (g) and (h). 37. Q u e s tio n . —U n d e r w hat c i r c u m s t a n c e s would a b o r r o w e r who w is h e s to s u b s titu te s to c k c o l l a t e r a l on a n e x is tin g lo a n be r e q u i r e d to e x e c u te a n ew F o r m U - l p u r p o s e s t a te m e n t ? A n s w e r . - - A new p u r p o s e s ta te m e n t would b e r e q u i r e d only if th e am o u n t of th e lo a n w e r e i n c r e a s e d b e c a u s e a d d itio n a l fun ds w e r e a d v a n c e d to th e b o r r o w e r . W hen a new p u r p o s e s t a t e m e n t i s n o t r e q u i r e d , th e b an k m a y w ish to r e c o r d th e ch an g e in c o l l a t e r a l in i t s f i le s by a tta c h in g an a p p r o p r i a t e r e c o r d to th e e x is tin g F o r m U - l . M is c e lla n e o u s P r o v i s i o n s M is ta k e s in Good F a ith 38. Q u e s tio n . - - C a n a b an k b e h e ld a c c o u n ta b le f o r n o n c o m p lia n c e w ith R e g u la tio n U r e q u i r e m e n t s if th e n o n c o m p lia n c e w a s th e r e s u l t of a m i s ta k e ? A n s w e r . - -N ot if th e m is t a k e w a s in good f a ith . Good fa ith r e q u i r e s th a t th e bank sh o u ld b e a l e r t to th e c i r c u m s t a n c e s s u r r o u n d in g th e lo a n . If a t th e t i m e a lo a n i s m a d e th e b an k h a s k n o w led g e, f r o m any s o u r c e , r e a s o n a b ly s u ffic ie n t to put th e bank on n o tic e th a t a c o n te m p la te d t r a n s a c t i o n w ould r e s u l t in a v io la tio n of th e r e g u la tio n , it w ill b e d e e m e d not to h a v e a c te d in good fa ith . A ctio n T a k e n f o r B ank P r o t e c t io n 39. Q u e s tio n . - - U n d e r w h at c i r c u m s t a n c e s o th e r th a n a m i s t a k e in good fa ith m a y n o n c o m p lia n c e w ith R e g u la tio n U r e q u i r e m e n ts b e e x c u s a b le ? A n s w e r . - -In c i r c u m s t a n c e s u n d e r w hich th e ban k , a c tin g in good fa ith , d e e m s su ch a c tio n n e c e s s a r y f o r i t s own p r o te c tio n . L ia b ili ti e s f o r V io latio n s 40. Q u e s tio n . —W hat a r e th e p o te n tia l l i a b i l i t i e s of a bank o r a b o r r o w e r f o r v io la tio n of R e g u la tio n U? A n s w e r . - - A s to th e ban k , S ectio n 29(b) of th e S e c u r i t i e s E x ch an g e A c t of 1934 d e c l a r e s c o n t r a c t s m a d e in v io la tio n of r e g u la t io n s is s u e d th e r e u n d e r void a s to th e r i g h ts of th e v io la to r . T h e p a r t y n o t r e s p o n s i b l e f o r th e v io la tio n m a y r e s c i n d th e c o n t r a c t and, in a p r o p e r c a s e , s u e f o r d a m a g e s . F u r t h e r , th e b an k m a y b e c r i m i n a l l y lia b le u n d e r v a r io u s s t a t u t e s , in c lu d in g th o s e c ite d in th e F o r m U - l p u r p o s e s t a te m e n t , and as an a i d e r and a b e t t e r of v io la tio n s of R e g u la tio n X . A b o r r o w e r m a y h a v e c r i m i n a l l ia b ility u n d e r v a r io u s s t a tu t e s , in c lu d in g th o s e c ite d in th e F o r m U - l p u r p o s e s t a te m e n t, and u n d e r R e g u la tio n X. T r a n s a c t i o n s by Bank a s T r u s t e e 41. Q u e s tio n . - - I f a - b a n k e x te n d s s t o c k - s e c u r e d p u r p o s e c r e d i t in i t s c a p a c ity a s t r u s t e e , i s th e t r a n s a c t i o n s u b je c t to R e g u la tio n U r e q u i r e m e n t s ? A n sw er. - -Y es. T h is p r in c ip le c a n h a v e a p p lic a tio n w h e r e , f o r e x a m p le , th e ban k i s th e t r u s t e e of an e m p lo y e e s ' s a v in g s p la n w hich in c lu d e s s to c k s and w hich p r o v id e s th a t any p a r tic ip a n t m a y b o r r o w f r o m th e p la n w ithin c e r t a i n l i m i t s and th a t h is s to c k s in th e p lan a r e to s e r v e as s e c u r i t y . E x e m p t T r a n s a c t i o n s w ith and f o r B r o k e r - D e a l e r s 42. Q u e s tio n . - - W h a t a r e th e k in d s of s t o c k - s e c u r e d p u r p o s e t r a n s a c t i o n s w ith and f o r b r o k e r - d e a l e r s th a t a r e e x e m p t f r o m th e m a r g in r e s t r i c t i o n s of R e g u la tio n U? A n s w e r . - - T h e s e in c lu d e th e follow ing: A. P r o m p t D e liv e r y C le a r a n c e L o a n s . C r e d i t i s e x em p t if ex ten d ed to fin a n c e th e p u r c h a s e o r s a le of s e c u r i t i e s f o r p r o m p t d e l iv e r y and if th e c r e d i t is to b e r e p a id in th e o r d in a r y c o u r s e of b u s i n e s s upon c o m p le tio n of th e t r a n s a c t i o n . T h is kind of c r e d i t i s ex te n d e d a s a t e m p o r a r y a d v a n c e u n d e r th e b r o k e r - d e a l e r 's i n s tr u c ti o n s to th e bank to m a k e p a y m e n t to a s e l l e r a g a in s t d e li v e r y of s e c u r i t i e s , w hich a r e d e s tin e d f o r a c u s t o m e r of the b r o k e r - d e a l e r upon a r r a n g e m e n t w ith th e c u s t o m e r to m a k e p a y m e n t p r o m p tly on d e li v e r y (COD o r POD). T h e u n d e r s ta n d in g w ith th e bank i s th a t th e b r o k e r - d e a l e r w ill r e p a y p r o m p tly a s so o n a s th e c u s t o m e r on a COD o r POD b a s i s ta k e s d e liv e r y and p a y s fo r th e s e c u r i t i e s . C a u tio n : T h is e x e m p tio n is f o r c l e a r a n c e p u r p o s e s only and it m a y not be u s e d by a b r o k e r - d e a l e r if h e h a s an in v e n to r y of s e c u r i t i e s of lik e kind w hich could b e d e liv e r e d to h is c u s t o m e r o r if th e b r o k e r - d e a l e r 's a r r a n g e m e n t w ith h is c u s t o m e r is not on a s t r i c t COD o r POD b a s i s w ith in s e c tio n 4(c)(5) of R e g u la tio n T (12 C F R 220 .4 (c)(5 )). If a b r o k e r - d e a l e r m a k e s p u r c h a s e s of s e c u r i t i e s f o r an i s s u e r in te n d in g to r e t i r e th e m , th e b r o k e r - d e a l e r can r e c e i v e th is e x e m p t c l e a r a n c e c r e d i t , p ro v id e d th e i s s u e r h a s a c tu a lly m a d e a c a ll f o r r e t i r e m e n t , and th e b r o k e r d e a l e r d e l i v e r s the s e c u r i t i e s p r o m p tly to th e i s s u e r a g a in s t p ay m e n t fo r su c h p u r p o s e , upon th e u n d e r s ta n d in g th a t th e bank i s to b e r e p a i d in th e o r d i n a r y c o u r s e f r o m th e p r o c e e d s e m a n a tin g f ro m su c h d e l iv e r y , upon c o m p le tio n of th e t r a n s a c tio n . • B. S e c u r i ti e s in T r a n s i t o r T r a n s f e r . T h is r e f e r s in th e m a in to c r e d i t ex ten d ed b y a bank w hich h a s r e c e i v e d , p r in c ip a lly f r o m a s e llin g b r o k e r - d e a l e r , s e c u r i t i e s w ith s ig h t d r a f t a tta c h e d w ith i n s tr u c ti o n s to d e li v e r th e m to th e p u r c h a s in g b r o k e r - d e a l e r 's bank (u su a lly out of tow n) a g a in s t p a y m e n t. The c r e d i t i s ex ten d ed to th e s e llin g b r o k e r - d e a l e r f o r th e am o u n t of th e s ig h t d r a f t , pen d in g h is b a n k 's r e c e i p t of p a y m e n t f r o m th e p u r c h a s e r 's bank; and th e c r e d i t is to b e r e p a i d w ith th e p r o c e e d s of such p a y m e n t. C. Day L o a n s . C r e d i t w hich i s to b e and i s r e p a id on th e s a m e d a y i s e x e m p t c r e d i t u n d e r c e r t a i n -21- c i r c u m s t a n c e s . T h e s e a r e t e r m e d " d a y lo a n s " and a r e m a d e p r in c i p a l ly to e n ab le a b r o k e r - d e a l e r to pay f o r s e c u r i t i e s bought f o r c u s t o m e r s on the a n tic ip a tio n by th e b r o k e r - d e a l e r of funds to be o b tain ed in th e o r d i n a r y c o u r s e of b u s i n e s s d u rin g th e d ay. R e p a y m e n t of th e lo an m u s t b e m a d e on th e s a m e d ay. T h is would p r e c lu d e r e p a y m e n t w ith the p r o c e e d s of a se c o n d ( re g u la te d ) lo an f ro m th e bank l a t e r th e s a m e d ay . D. T e m p o r a r y F in a n c in g of D i s t r i b u t i o n s . C r e d i t is e x e m p t if ex ten d ed to one o r m o r e b r o k e r - d e a l e r s eng ag ed in th e d is tr ib u tio n of s e c u r i t i e s not th ro u g h th e m e d iu m of a n a tio n a l s e c u r i t i e s ex ch an g e. C r e d i t is n o t e x e m p t u n d e r th is it e m if th e p r o c e e d s a r e u s e d to f a c il it a te open m a r k e t p u r c h a s e s (w h e th e r off o r on an ex ch an g e) f o r l a t e r d is p o s itio n th ro u g h s a l e s m e n o v e r - t h e - c o u n t e r ; and e x e m p t c r e d i t is not a v a ila b le u n d e r th is ite m f o r o r d i n a r y a c t iv it ie s of an o v e r - t h e - c o u n t e r b r o k e r - d e a l e r . E. A rb itra g e T ra n s a c tio n s . E xem pt c re d it can be ex ten d ed to a m e m b e r of a n a tio n a l s e c u r i t i e s ex ch a n g e to fin a n c e h i s o r h is c u s t o m e r s ' bona fid e a r b i t r a g e t r a n s a c t i o n s . A b o n a fid e a r b i t r a g e t r a n s a c t i o n c o n s i s ts of e i t h e r (11 tHe p u r c h a s e o r s a l e of a s e c u r i t y in one m a r k e t , to g e th e r w ith an o ffs e ttin g s a l e o r p u r c h a s e of th e s a m e s e c u r i t y in a d if fe r e n t m a r k e t a t o r about th e s a m e t im e , in o r d e r to p ro fit f r o m a d if f e r e n c e in p r i c e b e tw e e n th e two m a r k e t s o r (2) th e p u r c h a s e of a s e c u r i t y w hich is (without r e s t r i c t i o n o th e r th an th e p a y m e n t of m on ey) e x c h a n g e a b le o r c o n v e r tib le w ith in 90 c a l e n d a r d ay s of th e d a te of p u r c h a s e into a se c o n d s e c u r i ty , to g e th e r w ith an o ffs e ttin g s a l e of th e se co n d s e c u r i t y at o r about th e s a m e t im e , in o r d e r to p r o f it f ro m the d i s p a r i t y in p r i c e s of th e two s e c u r i t i e s . T h e tim e of e x c h a n g e a b ility o r c o n v e r tib ility m a y be 180 c a le n d a r d ay s if th e s e c u r i t y p u r c h a s e d is s o le ly a due b ill o r o th e r ev id e n c e of th e r ig h t to r e c e i v e only th e s e c u r i t y th a t is so ld , and if the s e c u r i t y th a t is sold is t r a d in g a s a w h e n - is s u e d se c u rity . F. C r e d i t E x te n d e d P u r s u a n t to H y p o th e c a tio n . A bank m a y exten d c r e d i t to a m e m b e r of a n a tio n a l s e c u r i t i e s ex ch an g e o r a b r o k e r - d e a l e r c o l la t e r a l iz e d -22- by c u s t o m e r s ' s e c u r i t i e s . T o extend th e c r e d i t , th e ban k m u s t r e c e i v e f r o m su c h m e m b e r o r b r o k e r d e a l e r a s t a te m e n t c o n fo rm in g to a r u l e of th e S e c u r itie s and E x c h a n g e C o m m is s io n c o n c e r n in g th e h y p o th e c a tio n of c u s t o m e r s ' s e c u r i t i e s . The am o u n t of c r e d i t so ex ten d ed is lim ite d to th e a m o u n t of d eb t owed by th e c u s t o m e r of su c h m e m b e r o r b ro k e r-d e a le r. G. E m e r g e n c y C r e d i t . Good fa ith e x e m p t c r e d i t m a y be ex ten d ed to a b r o k e r - d e a l e r in e x c e p tio n a l c i r c u m s ta n c e s to m e e t h i s e m e r g e n c y n e e d s . In o r d e r to s u b s ta n tia te th e b a s i s f o r su c h c r e d i t , th e b a n k 's r e c o r d s sh ould d o c u m e n t th e c i r c u m s t a n c e s u n d e r w hich th is kind of lo a n w a s m a d e . H. S p e c i a l i s t s . A bank m a y in good fa ith w ithou t r e f e r e n c e to m a r g i n r e q u i r e m e n t s exten d c r e d i t on any s to c k to a r e g i s t e r e d s p e c i a l i s t of a n a tio n a l s e c u r i ti e s ex ch an g e e x c lu s iv e ly to fin a n c e su c h b r o k e r d e a l e r 's a c ti v it ie s as a s p e c i a l i s t , so long as th e ex ch an g e s u p p lie s a p p r o p r ia te r e p o r t s to th e B o a rd . Stock id e n tifie d b y a s p e c i a l i s t a s h e ld f o r i n v e s t m e n t u n d e r an I n te r n a l R e v e n u e r u l e is not e lig ib le fo r exem pt c re d it. I. O d d - L o t D e a l e r s . C r e d i t ex ten d ed to a r e g i s t e r e d o d d -lo t d e a l e r of a n a tio n a l s e c u r i t i e s ex ch an g e to f in a n c e h is t r a n s a c t i o n s a s such o d d - lo t d e a l e r is e x e m p t c r e d i t. J. OTC M a rk e t M a k e r s . F o r th e p u r p o s e of th is s p e c ia l c r e d i t p r o v is io n , an OTC m a r k e t m a k e r is a b r o k e r - d e a l e r who is a m a r k e t m a k e r fo r one o r m o r e OTC m a r g in s to c k s w hich a p p e a r on a l i s t p u b lish e d f r o m tim e to tim e by th e B o a rd . An OTC m a r k e t m a k e r m a y be extend ed c r e d i t by a bank on a good fa ith lo a n value b a s i s on any OTC m a r g i n sto c k w ithout r e f e r e n c e to m a r g in r e q u i r e m e n t s if h e f u r n is h e s th e ban k w ith in f o rm a tio n on F o r m U - 2, duly e x ecu ted by th e b r o k e r - d e a l e r and a c c e p te d b y th e bank in good f a ith , to th e effe c t th a t h e is a m a r k e t m a k e r of th e OTC m a r g i n s to c k s id e n tifie d on th a t f o r m and on S e c u r itie s and E x ch an g e C o m m is s io n F o r m X -1 7 A -1 2 (1 ) file d w ith th a t a g e n c y . T h e ban k m u s t r e t a i n th e F o r m U -2 s ta te m e n t am ong its r e c o r d s f o r at l e a s t t h r e e y e a r s a f t e r su c h e x em p t -23- c r e d i t is t e r m in a t e d . L is te d s to c k s and OTC n o n m a r g in s to c k s do not qualify f o r good faith lo a n valu e u n d e r th is p r o v is io n . An OTC m a r k e t m a k e r in a n o n m a r g in s to c k m a y , h o w e v e r, o b ta in good fa ith c r e d i t on any s to c k b e c a u s e th e lo an to fin a n c e su c h m a r k e t m a k in g a c tiv ity w ould b e f o r a p u r p o s e o th e r th a n to p u r c h a s e o r c a r r y m a r g i n s e c u r i t i e s . K. T h ir d M a rk e t M a k e r s . A th ird m a rk e t m a k e r is a b r o k e r - d e a l e r who m a k e s an o v e r - t h e - c o u n t e r m a r k e t in s e c u r i t i e s r e g i s t e r e d on a n a tio n a l s e c u r i t i e s e x ch an g e. C r e d i t m a y be ex ten d ed to a t h ir d m a r k e t m a k e r in good faith on an y sto c k w ithout r e f e r e n c e to m a r g i n r e q u i r e m e n t s if r e q u i r e d i n f o r m a tio n i s f u r n is h e d to th e bank on F o r m U -3 . T h e co n d itio n s of th e t h ir d m a r k e t m a k e r e x e m p tio n a r e h ig h ly te c h n ic a l and f u r t h e r a d v ic e sh o u ld b e s o lic ite d b e f o r e c r e d i t is ex ten d ed . T h e F o r m U -3 filin g s m u s t be r e t a in e d b y th e bank f o r t h r e e y e a r s a f t e r th e e x e m p t c r e d i t h a s been te rm in a te d . L . B l o c k - P o s i t i o n e r s . T o qualify f o r a b lo c k - p o s itio n e r ' s e x e m p tio n f o r c r e d i t on any m a r g i n sto c k a c q u ir e d in th e o r d i n a r y c o u r s e of th e a c tiv ity of b lo c k -p o s itio n in g , a b r o k e r - d e a l e r m u s t f i r s t (1) file an e x e c u te d F o r m U -5 , a c c e p te d in good faith by a duly a u th o r iz e d o f fic e r of th e b ank and (2) h a v e file d w ith th e S e c u r i ti e s and E x ch an g e C o m m is s io n a n o tic e th a t h e w ill en gage in th a t a c tiv ity (which is lim ite d by h ig h ly te c h n ic a l c r i t e r i a ) . F u r t h e r a d v ic e should b e s o lic ite d b e f o r e c r e d i t is ex ten d ed in r e l i a n c e on th is e x e m p tio n . E x e m p t c r e d i t on a given b lo c k m u s t b e e x tin g u ish e d and r e p a id o r c o n fo rm e d to n o r m a l m a r g in r e q u i r e m e n t s if any p o r tio n t h e r e o f is o u tsta n d in g co n tin u o u sly fo r 20 b u s in e s s d a y s . T h is 2 0 -d a y p e r io d m a y b e ex ten ded f o r one o r m o r e 5 - d a y p e r io d s in e x c e p tio n a l c a s e s by a r e g u l a r l y c o n s titu te d c o m m itte e of an ex ch an g e of which th e b r o k e r - d e a l e r is a m e m b e r o r th ro u g h w hich the b lo ck t r a n s a c t i o n w as e ffe c te d , o r , if e ffe c te d o v e r - t h e - c o u n t e r , b y a c o m m itte e of th e NASD, upon b e in g s a t is f ie d t h a t th e b l o c k - p o s it io n e r is a c tin g in good faith and th a t th e c i r c u m s t a n c e s w a r r a n t su c h an e x te n s io n . A ll su c h e x te n s io n s m u s t b e s u p p o rte d by a filin g b y th e b lo c k - p o s itio n e r and th e a p p r o p r i a t e c o m m itte e w ith th e bank on F o r m U - 6 s e ttin g f o rth th e r e a s o n s f o r th e e x te n sio n . T h e b ank m u s t a c t in good fa ith and h a v e no in f o rm a tio n w hich m ig h t c o n tr a d ic t th o s e r e p r e s e n ta tio n s . T h e F o r m U -5 and U -6 filin g s m u s t b e r e ta i n e d b y th e bank f o r a t l e a s t t h r e e y e a r s a f t e r th e c r e d i t to w hich it r e l a t e s h a s b e e n e x tin g u ish e d . M. L o an s f o r C a p ita l C o n tr ib u tio n s . C re d it is ex e m p t f r o m th e r e g u la tio n if ex ten d ed to o r m a i n ta in e d f o r a p e r s o n to u s e th e p r o c e e d s (1) f o r m a k in g a lo a n o r c a p ita l c o n trib u tio n to a b r o k e r d e a l e r w hich (u n d er th e c a p ita l r e q u i r e m e n t r u l e s of th e S e c u r iti e s and E x ch an g e C o m m is s io n ) i s s u b je c t to a " s a t i s f a c t o r y s u b o r d in a tio n a g r e e m e n t" o r an a g r e e m e n t of a p a r t n e r of a b r o k e r - d e a l e r to in c lu d e th e e q u ity in h is p a r t n e r s h i p a c c o u n t a s p a r t of th e b r o k e r - d e a l e r 's c a p ita l o r (2) f o r p u r c h a s in g s to c k d i r e c t l y f r o m a c o r p o r a te b r o k e r - d e a l e r , but n o t a s p a r t of a pu blic d is tr ib u tio n . T h is e x e m p tio n i s s u b je c t to c e r t a i n co n d itio n s s p e c ifie d in s e c tio n 221. 2(m). E x e m p t c r e d i t m a y a ls o b e ex te n d e d to a b r o k e r - d e a l e r if (1) th e S e c u r itie s I n v e s to r P r o t e c ti o n C o r p o r a tio n c e r t i f i e s to th e B o a rd th a t s u c h c r e d i t is a p p r o p r i a te in th e c i r c u m s t a n c e s and (2) th e B o a rd by o r d e r e x e m p ts th e lo a n f r o m re g u la tio n . G e n e r a l P ro h ib itio n s A g a in st C r e d i t to B r o k e r - D e a l e r s by N o n m e m b e r B a n k s - - R e li e f f r o m P ro h ib itio n s 43. Q u e s tio n . - - M a y a bank w hich is not a m e m b e r of th e F e d e r a l R e s e r v e S y s te m extend c r e d i t to a b r o k e r - d e a l e r fo r b o r ro w in g s in h is o r d i n a r y c o u r s e of b u s i n e s s ? A n s w e r . - -N o, u n l e s s th e bank f i le s w ith th e B o a rd an u n d e r ta k in g to co m p ly w ith th e S e c u r it ie s E x ch an g e A c t of 1934, th e F e d e r a l R e s e r v e A ct a s a m e n d e d , and th e B anking A c t of 1933, a s th ey apply to m e m b e r b a n k s and w hich r e l a t e to th e u s e of c r e d i t to fin a n c e t r a n s a c t i o n s in s e c u r i t i e s , a s w ell as w ith a ll a p p lic a b le r u l e s and r e g u la tio n s u n d e r t h o s e la w s . F o r m s T - l and T - 2 of th e B o a rd a r e th e f o r m s to b e f ile d by a n o n m e m b e r bank to r e f l e c t su ch u n d e r ta k in g .
@FedFRASER