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4000 - Advisory Opinions

"Correction" of Regulation O Violations


November 30, 1981

David J. Peat, Regional Counsel

This responds to your November 16, 1981 letter concerning a violation of Section 215.4(c) of Regulation O which was detailed in a recent FDIC examination. As I understand the facts, two directors received credit from the bank in excess of the lending limit specified in Section 215.2(f) of Regulation O. The directors each own or control more than 18% of the bank's common stock, thus falling under the definition of principal shareholder found in Section 215.2(j) of the regulation. Your letter indicates that the directors are considering a reduction on their stock ownership as a means of resolving this situation. You request our comments and suggestions.

The most common and acceptable method of "correcting" a violation such as is described above, is reduction of the outstanding credit to an amount which does not exceed the limit prescribed in the regulation. One way this can be accomplished is through the use of non-recourse participations. The staff of the Legal Division of the Federal Deposit Insurance Corporation does not consider a change in status as being an effective method of correcting a violation. Disposal of some stock by your directors does not address the excessive loans made when the individuals were principal shareholders. Accordingly, in my opinion, the action being contemplated by your directors is not adequate.

In closing, I offer the following comments concerning the stock ownership plan contemplated by your directors. In defining the term "principal shareholder", Section 215.2(j) of Regulation O indicates that shares owned or controlled by a member of an individual's immediate family are considered to be held by the individual. Accordingly, a transfer of stock to a spouse does not change the relative shareholdings of an individual. Transfers to an independent third party trustee for the benefit of an individual's spouse or minor children might be viewed as a divestiture depending upon the amount of "control" retained by the existing shareholder and/or the family member beneficiaries. If the beneficiary or the settlor can direct the voting of the stock, terminate the trust, remove the trustee or otherwise control the voting of the stock, then the beneficiary or settlor would continue to be considered the "owner" of the stock for purposes of Regulation O.

To summarize, stock transfers of the nature mentioned in your letter would not "correct" the violation. Furthermore, the types of transfers being contemplated might not effectively accomplish the intended result; namely, removal of the directors from the classification as principal shareholders. If you have further questions concerning this matter do not hesitate to write or call me.

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