REFRESHER ON REGULATION O A Presentation To The Bank Compliance Association of CT September 29, 2010 Arthur T. Corey David J. Wiese 860-331-2624 860-331-2714 email@example.com@haslaw.com
General Overview • Regulation O is a Federal Regulation Promulgated by the Board of Governors of the Federal Reserve (the "Fed") • Generally Governs "Extensions of Credit" by a "Member Bank" (and Its Subsidiaries) to an "Executive Officer", "Director" or "Principal Shareholder" of • That "Member Bank" • The "Affiliates" of That Member Bank • Also Governs Extensions of Credit to the "Related Interests" of All Such Executive Officers, Directors and Principal Shareholders
General Overview (cont.) • The Member-Bank "Affiliates" Include • Holding Company of That Member Bank • Other Subsidiaries of That Holding Company • But "Affiliates" Do Not Include Subsidiaries of Member-Bank • Special Rules Allow Bank to Exclude Directors and Executive Officers of Certain Affiliates From the Coverage of Some Parts of Reg O if Certain Conditions are Satisfied
General Overview (cont.) • Reg O is Not "Directly" Applicable to So-Called "Non-Member Banks" • Instead, Non-Member Banks are Subject to FDIC Regulation Part 337.3 • Imposes Parts of Reg O "As Though They Were Member Banks" • Imposes Separate Requirements on Loans to Executive Officers • Technical Drafting Glitches • Practical Interplay is That Non-Member Banks Are "Generally" Subject to the Functional Equivalent of Reg O
Other Related Provisions • Connecticut Banking Law Contains Its Own Insider Loan Provisions • C.G.S. § 36a-263 • Applicable Only to State-Chartered Banks • Functional Impact is to Require State Chartered Banks to Comply with Federal Insider Loan Laws • As a Matter of State Law • Enforceable by the Commissioner • Some Technical Glitches Exist • Schedule IOM Requirements Repealed in 2008
Other Related Provisions (cont.) • Bank Holding Company Act Amendments of 1970 Prohibit Certain Preferential Lending Arrangements Relative to "Correspondent Banks" • 12 USC 1972(2) • In 2006, Fed Repealed Subpart B of Reg O Which Had Imposed Disclosure and Reporting Responsibilities on Member-Banks With Respect to Correspondent Bank Relationships • In Same Year, FDIC Repealed Section 349 (Which Contained Similar Correspondent Bank Provisions for Non-Member Banks) • But Substantive Statutory Prohibitions on Preferential Lending Relationships Remain Intact
Some Key Definitions "Director" Means Any Director of the Bank or Other Covered Entity • Whether or Not Receiving Compensation • Sometimes Called "Trustees" • Corporators of Mutual Savings Banks Not Covered (Unless Also a Director) • Advisory Director Not a "Director" If • Not Elected By Shareholders • Not Authorized to Vote On Board Matters • Solely Provides General Policy Advice
Some Key Definitions (cont.) "Executive Officer" Means a Person Who Participates or Has the Authority to Participate (Other Than As a Director) in Major Policy-Making Functions of the Company or Bank • The Following Are Automatically Presumed to Be "Executive Officers" • Chairman of the Board • President • Vice President(s) • Comptroller • Secretary • Treasurer • Unless the Officer is Excluded By Board Resolution or Bylaws From Participating in Major Policy-Making Functions • And Does Not Actually Participate
Key Definitions (cont.) "Extension of Credit" Means the Making or Renewal of Any Loan, the Granting of a Line of Credit, and the Extending of Credit in Any Manner • Includes Many Transactions (Examples) • Overdraft Advances • Letters of Credit • Guaranty Obligation • Advances of Unearned Salary • Any Transaction Where a "Person Becomes Obligated to Pay Money (or Its Equivalent) to the Member-Bank"
Key Definitions (cont.) • Extensions of Credit Do Not Include (Examples) • Advances Against Accrued Salary • Endorsements or Guarantees for the Protection of the Bank With Respect to Loans Previously Acquired by Bank in Good Faith • Indebtedness of $5000 or Less Arising by Reason of an Interest-Bearing Overdraft Protection Plan That Specifies a Method of Payment • Certain Inadvertent Overdrafts • Aggregate Amount of $1000 or Less • Not Overdrawn For More Than 5 Business Days • Customary Fees Charged
Key Definitions (cont.) • Extension of Credit May Also Be "Deemed" to Be Made" to an Insider To the Extent That the Proceeds of the Extension Are Used for the Tangible Economic Benefit of, or Are Transferred to, the Insider (Even Though the Insider May Not Be Obligated on the Debt) • However, Not Deemed to Be Made to the Insider If the Credit is Extended • Without Preferential Terms • Without Preferential Underwriting • Without Abnormal Risk of Repayment • Without Abnormal Features • And the Proceeds Are Used in Bona Fide Transaction to Acquire Property, Goods or Services From the Insider
Key Definitions (cont.) "Principal Shareholder" Generally Means Any Person That Directly or Indirectly Owns, Controls, or Has the Power to Vote More Than 10% of Any Class of Voting Securities of the Bank or Company • Does Not Include An Insured Bank or a Holding Company That Owns the Member-Bank as Subsidiary • Special Definition For Public Disclosures • Generally, Shares Owned or Controlled By a Member of an Individual’s "Immediate Family" Are Presumed to Be Owned By the Individual • "Immediate Family" Means the Spouse, All Minor Children, and Any Other Children Residing in the Individual’s Home
Key Definitions (cont.) "Related Interest" of a Person Means: • A Company That is "Controlled" By That Person • A Political or Campaign Committee That is Controlled By That Person (or the Funds or Services of Which Will Benefit That Person)
Key Definitions (cont.) "Control" of a Company or Bank Generally Means That a Person, Directly or Indirectly, or Acting Through or in Concert With One or More Persons • Owns, Controls or Has the Power to Vote 25% or More of Any Class of Voting Securities • Controls the Election of a Majority of the Directors • Has the Power to "Exercise a Controlling Influence Over Management or Policies" • Very Technical Definition With Other Inclusions and Exclusions (Definition Needs to Be Reviewed in Its Entirety When Coverage Questions Arise)
Prohibition on Knowing Violations “No Executive Officer, Director, or Principal Shareholder of Member Bank or Any of Its Affiliates Shall Knowingly Receive (or Knowingly Permit Any of That Person’s Related Interests to Receive) From a Member Bank, Directly or Indirectly, Any Extension of Credit Not Authorized Under This Part.”
Prohibition on Preferential Terms • Covers All Extensions of Credit By a Member-Bank (or Its Subsidiaries) to the Directors, Executive Officers or Principal Shareholders of the Bank or Its Affiliates (and Their Respective Related Interests) • Must Be Made on Substantially the Same Terms (Including Interest Rates and Collateral) as Those Prevailing at the Time For Comparable Transactions With Non-Insiders Who Are Not Employed By the Bank or Its Subsidiaries
Prohibition on Preferential Terms (cont.) • This Prohibition Also Applies to Loan Administration and Collection Functions • Waivers, Modifications, Forbearance, Forgiveness and Other Relationship Management Decisions Must Not Be Preferential in Nature
Prohibition on Preferential Underwriting; Abnormal Risk of Repayment; and Other Unfavorable Features • All Extensions of Credit by Member-Bank (or Its Subsidiaries) to the Directors, Executive Officers or Principal Shareholders of the Bank or Its Affiliates (or to their respective Related Interests) must • Be Made Following Credit Underwriting Procedures That Are No Less Stringent Than Those Prevailing at the Time For Comparable Transactions With Other Non-Insiders Who Are Not Employed By That Bank or Its Subsidiaries • Not Involve "More Than the Normal Risk of Repayment" • Or Present "Other Unfavorable Features"
Prohibition on Preferential Underwriting; Abnormal Risk of Repayment; and Other Unfavorable Features (cont.) • This Requirement Also Carries Over to Loan Administration and Collection Functions • Waivers, Modifications, Forbearance, Forgiveness and Other Underwriting Management Decisions Must Not Be Preferential in Nature (or Involve Abnormal Risk of Repayment or Other Unfavorable Features)
Employee Benefit Or Compensation Programs • Regulation O Provides An Exception to the Prohibitions on Preferential Terms and Preferential Underwriting, Abnormal Risk of Repayment and Unfavorable Features in Cases Involving Extensions of Credit Made Pursuant to An Employee Benefit or Compensation Program • For Purposes of Making Comparability Determinations, the Bank May Look to Loans Made Pursuant to These Types of Programs, Provided: (i) the Benefit or Compensation Program is Widely Available to Employees of the Bank; and (ii) the Program Does Not Give Preference to the Insider Over the Applicable Employees
Prior Approval • For Certain Extensions, Regulation O Requires Prior Approval By the Entire Board of Directors (Excluding Interested Directors) • For Any Extension of Credit to An Insider If the Extension of Credit, When Aggregated With All Other Extensions of Credit to That Person and All Related Interests of That Person, Equals or Exceeds a Particular Dollar Threshold • Threshold Calculated By Reference to a Specified Formula (Which For Most Banks is $500,000)
Prior Approval (cont.) • Prior Approval is Not Required For Each Individual Advance Made Pursuant to a Line Of Credit That Was Properly Approved Within 14 Months of the Advance • An Extension of Credit is "Considered to Have Been Made At the Time the Bank Enters Into a Binding Commitment to Make the Extension of Credit." As a Result, Prior Approval Must Be Obtained Before Such a Binding Commitment is Undertaken
Prior Approval (cont.) • "Interested Party" Must Abstain From Participating Directly or Indirectly in the Voting • This Includes "Participation in the Discussions or Any Attempt to Influence the Voting" • The Phrase "Interested Party" Can Include Interested Directors or Interested Executive Officers (e.g., If Such Officers Might Otherwise Participate in Discussions at Board Meetings)
Prior Approval (cont.) • Note, However, That Individual Directors and Executive Officers May, in Some Cases, Have a Separate Legal Duty to Disclose Facts That Are Material to the Transaction • Those Duties May Arise Under State Law, Including, For Example, Laws Related to the Duty of Loyalty (Requiring Candor and Honesty in Personal Dealings With the Corporation) and Laws Related to "Conflicting Interests"
Individual Lending Limits • A Member-Bank May Not Extend Credit to Any Insider of That Bank or An Insider of An Affiliate in An Amount That, When Aggregated With the Amount of All Other Extensions of Credit to That Person and All Related Interests of That Person, Exceeds a Specified Lending Limit • Limit is Generally Equal to 15 Percent of Unimpaired Capital and Unimpaired Surplus in the Case of Loans That Are Not "Fully Secured" • Plus An Additional 10 Percent of Unimpaired Capital and Unimpaired Surplus in the Case of Loans That Are "Fully Secured"
Individual Lending Limits (cont.) • "Fully Secured" Means Secured By Readily Marketable Collateral Having a Market Value, As Determined By Reliable and Continuously Available Price Quotations, At Least Equal to the Amount of the Loan • Exceptions to This Limit Are Permitted For Certain Types of Obligations (Those Exceptions Are Provided in 12 U.S.C. § 84)
Aggregate Lending Limits • The Aggregate Amount of All Extensions of Credit By a Member-Bank (and Its Subsidiaries) to All the Insiders of the Bank and Its Affiliates (and Their Related Interests) May Not Exceed 100 Percent of the Bank's Unimpaired Capital and Unimpaired Surplus • Banks With Deposits of Less Than $100 million May Establish Higher Aggregate Limit (Up to Double the Normal Limit) If Certain Stringent Conditions Are Satisfied • Additional Exceptions Available For • Certain Highly Collateralized Obligations • Recourse Obligations Related to Consumer Installment Paper Meeting Certain Conditions
Overdrafts • Regulation O Contains Special Restrictions Concerning Overdrafts Involving Executive Officers and Directors of the Bank and Its Affiliates • Payments on Overdrafts By a Director or Executive Officer Are Permitted Only If the Payment of Funds Are Made Pursuant to: • (i) A Written, Preauthorized, Interest-Bearing Extension of Credit Plan That Specifies a Method of Repayment (an "Overdraft Protection Plan"); or • (ii) A Written, Preauthorized Transfer of Funds From Another Account of the Account Holder at the Applicable Bank ("Preauthorized Overdraft Transfer")
Overdrafts (cont.) • The Special Restrictions Do Not Apply to Payments of Inadvertent Overdrafts of $1000 or Less • If The Account is Not Overdrawn For More Than Five (5) Business Days, and • As Long As the Executive Officer or Director is Charged the Same Fee As is Charged For Any Other Customer in Similar Circumstances ("Inadvertent Overdrafts")
Overdrafts (cont.) • The Special Restrictions Only Apply to Directors and Executive Officers • Principal Shareholders and Related Interests Are Not Subject to These Special Restrictions • However, to the Extent That the Payment of An Overdraft Otherwise Constitutes An Extension of Credit, Then the Extension of Credit Would Otherwise Be Subject to the Other General Compliance Requirements (e.g., No Preferential Terms, No Preferential Underwriting, Prior Approval, Etc.)
Overdrafts (cont.) • These General Restrictions Apply to All Extensions of Credit to Directors, Executive Officers, Principal Shareholders and the Related Interests of These Persons • But Note, While The Definition of Extension of Credit Includes An "Advance By Means of An Overdraft", It Excludes Overdraft Indebtedness of $5000 or Less Pursuant to An "Overdraft Protection Plan" and "Inadvertent Overdrafts"
Executive Officers - Limitations On Types And Amounts Of Loans • There Are Special Rules on the Types and Amounts of Extensions of Credit That May Be Made to Executive Officers of Member-Banks • Special Rules Do Not Apply to EO’s of Affiliates • These Are in Addition to the More General Rules (e.g., Prohibition on Preferential Terms, Prohibition on Preferential Underwriting, Individual Lending Limits, Aggregate Lending Limits, Etc.) • With the Exception of Certain Partnership Interests, These Special Rules Do Not Apply to the Related Interests of Executive Officers
Executive Officers - Limitation On Types And Amounts Of Loans (cont.) • In Particular, Extensions of Credit to Executive Officers Are Generally Limited to the Following Types and, Where Applicable, Amounts • Extensions of Credit For the Education of the Executive Officer's Children; and • Extensions of Credit to Finance or Refinance the Purchase, Construction, Maintenance or Improvement of a Residence of the Executive Officer, Subject to CertainConditions
Executive Officers - Limitation On Types And Amounts Of Loans (cont.) • Those Conditions Are: • Such Extension is Secured By a First Lien on That Residence, and the Residence is Owned (or Expected to Be Owned After the Extension of Credit) By the Executive Officer; and • In the Case of a Refinancing, the Principal Borrowed is Limited to Only the Amount Used to Repay the Original Extension of Credit, Plus the Closing Costs of the Refinancing, Plus Any Additional Amount Used For Permitted Purposes (e.g., Construction, Maintenance, or Improvement of That Residence)
Executive Officers - Limitation On Types And Amounts Of Loans (cont.) • The Following Secured Extensions of Credit Are Also Permitted For Executive Officers: • Extensions of Credit Secured By a Perfected Security Interest in Bonds, Notes, Certificates or Indebtedness, or Treasury Bills of the United States or in Other Such Obligations Fully Guaranteed As to Principal and Interest By the United States. • Extensions of Credit Secured By Unconditional Takeout Commitments or Guarantees of Any Department, Agency, Bureau, Board, Commission or Establishment of the United States or Any Corporation Wholly-Owned Directly or Indirectly By the United States. • Extensions of Credit Secured By a Perfected Security Interest in a Segregated Deposit Account Maintained at the Bank.
Executive Officers - Limitation On Types And Amounts Of Loans (cont.) • Executive Officers Are Also Permitted to Have Certain Additional Extensions of Credit For Other Purposes ("Other Purpose Loans") • More Specifically, Extensions of Credit Are Permitted For Any Other Purpose or Category Not Specified Above, As Long As the Aggregate Amount of Other Purpose Loans to the Executive Officer Do Not Exceed At Any One Time An Amount Calculated Pursuant to a Prescribed Formula (Which For Most Banks is $100,000)
Executive Officers - Acceleration Feature In Loan Documents • Any Extension of Credit Made to An Executive Officer Must Be Made Subject to the Following Written Acceleration Feature • The Extension of Credit Can, At the Option of the Bank, Become Due and Payable At Any Time That the Executive Officer is Indebted to Any Other Bank or Banks in Connection With Other Purpose Loans in An Amount Which Exceeds a Specified Formula Amount (Which For Most Banks is $100,000)
Executive Officers - Acceleration Feature In Loan Documents (cont.) • Addendum to Promissory Notes • Relationship to Other Sections (What Do You Do With Acceleration Feature)? • Elimination of Reporting Requirements in 2006 • TILA Implications
Executive Officers - Submission Of Financial Statements • Any Extension of Credit to An Executive Officer Must Be Preceded By the Submission, By Such Executive Officer, of a "Detailed Current Financial Statement" • It is OK to Implement Special Protocols to Protect Privacy of Executive Officer. But Be Careful Not to Violate Prohibition Against Preferential Underwriting
Executive Officers - Reports To Board • An Executive Officer is Required to Report to the Board of Directors Any Extension of Credit to the Executive Officer By His/Her Employer-Bank • That Report Must Be Submitted "Promptly"
Executive Officers -Special Rule For Partnerships • A Dollar Limit is Imposed on Extensions of Credit to a Partnership in Which One or More of the Bank's Executive Officers Are Partners and, Either Individually or Together, Hold a Majority Interest • When An Extension of Credit is Granted to Such a Partnership, the Bank Must Attribute the Total Amount of the Indebtedness to Each Individual Executive Officer, and Such An Extension of Credit May Only Be Made If the Extension Would Otherwise Comply With the Aggregate Limit For "Other Purpose Loans" to That Executive Officer (Which For Most Banks is $100,000)
Records – General • Regulation O Requires Banks to "Maintain Records Necessary For Compliance With This Part". • Some Sections of Regulation O Have Specific Recordkeeping Requirements. Others Do Not. • As a General Rule, Under Regulation O, Any Recordkeeping Method Adopted By a Bank Must: (1) Identify, Through An Annual Survey, All Insiders of the Bank; and (2) Maintain Records of All Extensions of Credit to Insiders of the Bank. • The Records Must Include the Amount and Terms of Each Extension of Credit.
Annual Survey And Other Controls • Practical Considerations • Insider Education • Related Interests • Extensions of Credit "Deeming" Rules • Annually? • New Hires, Promotions and Retirements • New Board Members • New Shareholdings • Data Bases & Flagging Relationships
Disclosures to Public • Applies to Executive Officers and Principal Shareholders of Member-Bank (Including Bank Subsidiary) • Includes Their Related Interests • Excludes Directors • Requires Disclosure of Certain Insider Borrowing Relationships
Disclosures to Public (cont.) • If Requested By Member of Public, Bank Must Disclose Certain Information Related to • Its Executive Officers (and EO’s of Subsidiaries) • Its Principal Shareholders • Their Related Interests • But Not Directors or Their Related Interests • Special Definition of "Principal Shareholder"
Disclosures to Public (cont.) • Must Disclose Names of Executive Officers, Principal Shareholders to Whom (or to Whose Related Interests) the Bank Had Outside Aggregate Indebtedness Exceeding Certain Formula Thresholds (Which For Most Banks is $500,000) • Must Keep Records of Public Requests and Disposition Thereof • For Two Years
Other Reporting Requirements (Debt Secured By Bank Stock) • Applies to Stock Banks That Are Not Publicly Traded • Applies to Each Executive Officer And Director • Must Report Annually to the Board of Directors the Outstanding Amount of Extensions of Credit Secured By Bank Stock
Correspondent Bank Relationships – Prohibition On Preferential Relationships • The Bank Holding Company Act Amendments of 1970 Prohibit • Preferential Lending By a Bank to the Executive Officers, Directors and Principal Shareholders of Another Bank When There is a Correspondent Account Relationship Between the Banks, and • The Opening of a Correspondent Account Relationship Between Banks When There is a Preferential Extension of Credit By One of the Banks to An Executive Officer, Director or Principal Shareholder of the Other Bank
Regulatory Disclosure and Reporting Requirements Repealed (But Statute Remains Intact) • Practical Compliance Concerns • Still Need to Educate Insiders (e.g., Periodic Reminders As to Which Banks Are "Correspondent Banks") • When You Establish New Correspondent Relationships, You Need to Survey Insiders to Identify Preferential Issues • What About the Insiders of the Other Bank?
Concluding Remarks Questions & Answers