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4000 - Advisory Opinions


Changing Relationship Does Not Affect Determination of Bank Insider Loan

FDIC-81-1

January 5, 1981

Pamela E. F. LeCren, Attorney

Background and Statement of Issue:

The Legal Division of the Washington, D.C. office has received copies of your correspondence with Regional Director Stanley J. Poling and Regional Counsel John Deal concerning certain loans outstanding as of March 10, 1979 made by *** to *** and ***, a company controlled by ***. It was determined by the Columbus Regional Office that those loans were subject to Federal Reserve Board Regulation O (12 C.F.R. Part 215) in that the loans were made to a principal shareholder and a company controlled by a principal shareholder.1 The loans were further determined to exceed the legal lending limit imposed by Regulation O and therefore subject to section 215.6(a). Section 215.6(a) provides that loans outstanding as of March 10, 1979, that would be in violation of the legal lending limit imposed by Regulation O if made after March 10, 1979, are to be reduced so as to comply with the federal lending limit by March 10, 1980. Two one-year extension periods are available upon a finding of good cause. The authority to grant or deny such extensions was delegated to FDIC regional directors by section 303.11(a)(15) of FDIC's regulations.

Regional Director Poling denied *** request for an extension of time in which to pay down the subject loans. In connection with a subsequent request for reconsideration of the denial, an opinion was sought from the Legal Division regarding whether or not Regulation O is still applicable to the outstanding loans in view of the fact that *** has divested all of his stock in *** In short, you request a ruling on whether or not *** is still required to reduce the subject loans in accordance with section 215.6 even though *** is no longer a principal shareholder.2 In a letter dated September 3, 1980, Regional Counsel Deal informed *** that it was the opinion of the regional office that Regulation O still applied and that section 215.6 was operative.

We have reviewed the arguments presented in your October 3, 1980 letter to John Deal supporting your contention that section 215.6 is no longer applicable. Those arguments can be summarized as follows: (1) the clear purpose of section 22(h) of the Federal Reserve Act and Regulation O is to restrict loan transactions with "current" insiders who exercise practical control or influence over the operations of the banks with which they are associated; not "former" insiders; (2) to apply section 215.6 in instances where the debtor was originally an insider but is no longer leads to an illogical result. Future loans would not be subject to Regulation O therefore the continuation of existing loans should not be subject to Regulation O; and (3) *** is free to obtain loans in excess of the 10 percent lending limit imposed by Regulation O now that he is no longer a principal shareholder, therefore to insist that he pay down the outstanding loan is illogical.

For the reasons detailed below, we do not find your arguments persuasive. In our opinion, section 215.6 is operative despite the fact that *** is no longer a principal shareholder.

Discussion:

We do not dispute that Regulation O and section 22(h) of the Federal Reserve Act restrict loan transactions with bank insiders. We would characterize those restrictions, however, as the means by which the statutory purpose of protecting banks from abusive practices is accomplished. To make the determination your request would not further that purpose. On the contrary, your position would permit what the statute characterizes as an abusive loan to remain on the books of the bank. Your position would in effect permit an individual to use his or her position at a bank to obtain a benefit prohibited by law and to retain that benefit simply by changing the status of his or her relationship to the bank. Any harm posed to the bank by the transaction would continue unabated. If the FDIC were to adopt such a position, the entire framework of Regulation O would be undermined and the statutory purpose thwarted.

The position is also in conflict with FDIC's traditional enforcement posture. In administrative enforcement proceedings under the Federal Deposit Insurance Act and other statutes, the FDIC has proceeded against banks in cases where a bank director, officer, or other person involved in a violation of regulation or an unsafe or unsound banking practice is no longer associated with the bank in the same capacity as he or she was at the time the violation or unsafe or unsound banking practice occurred. In short, violations based on status are not rectified by a change in status nor is the FDIC's authority to address them impaired.

Finally, we will not dispute the fact that any future borrower relationship *** may have with *** is not subject to Regulation O. That fact does not, however, mean that he will be able to borrow in excess of the bank's lending limit. Presumably *** will not be in a position to borrow as much money from *** as was formerly made available to him because (1) he is no longer in a control position, and (2) his credit worthiness is likely to have changed, even changed dramatically, as a result of the stock transfer. For all the above reasons we decline to adopt the position that Regulation O is no longer applicable to a loan simply because the debtor is no longer a bank insider.

1 Section 215.2(j) defines the term principal shareholder to include an individual who directly or indirectly owns or controls more than 10 percent of any class of voting securities of a bank. At the time the subject loans were made, *** directly or indirectly owned or controlled in excess of 10 percent of the voting stock of ***. He presently owns or controls directly or indirectly approximately 59 percent of the stock of *** as reflected by the bank's stock ledger. *** and his wife own the majority of the shares of ***, making *** his related interest as that term is defined by section 215.2(a) and (b)(1)(i) of Regulation O. Go back to Text

2 According to the relevant correspondence, *** has executed deeds of gift to the U.S. Department of Treasury. Several alternate donees were named. We are not prepared to offer any opinion on whether or not the gifts are complete and whether *** is in fact no longer a principal shareholder as that term is defined by Regulation O. We will, however, for the purposes of this opinion, presume that *** is not a principal shareholder. Go back to Text


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