§ 220.132 12 CFR Ch. II (1–1–21 Edition)

that involve the public 221.5 Special purpose to brokers and distribution of an with dealers. installment or other deferred-payment 221.6 Exempted transactions. provisions.’’ To comply with Regula- 221.7 Supplement: Maximum value of margin and other . tions G and U where the proceeds of securities sold under Rule 144A INTERPRETATIONS may be used to purchase or carry mar- 221.101 Determination and effect of purpose gin stock and the debt securities are of loan. secured in whole or in part, directly or 221.102 Application to committed indirectly by margin stock (see 12 CFR where funds are disbursed thereafter. 207.2(f), 207.112, and 221.2(g)), the mar- 221.103 Loans to brokers or dealers. gin requirements of the regulations 221.104 Federal credit unions. must be met. 221.105 Arranging for extensions of credit to (e) The SEC’s objective in adopting be made by a bank. Rule 144A is to achieve ‘‘a more liquid 221.106 Reliance in ‘‘good faith’’ on state- and efficient institutional resale mar- ment of purpose of loan. 221.107 Arranging loan to purchase open-end ket for unregistered securities.’’ To investment company shares. further this objective, the Board be- 221.108 Effect of registration of stock subse- lieves it is appropriate for Regulation quent to making of loan. T purposes to characterize the partici- 221.109 Loan to open-end investment com- pation of broker-dealers in this unique pany. and limited market as an ‘‘investment 221.110 Questions arising under this part. banking service.’’ The Board is there- 221.111 Contribution to joint venture as ex- fore of the view that the purchase by a tension of credit when the contribution of debt securities for resale is disproportionate to the contributor’s share in the venture’s profits or losses. pursuant to SEC Rule 144A may be con- 221.112 Loans by bank in capacity as trust- sidered an service ee. under the arranging section of Regula- 221.113 Loan which is secured indirectly by tion T. The market-making activities stock. of broker-dealers who hold themselves 221.114 Bank loans to purchase stock of out to other institutions as willing to American Telephone and Telegraph Com- buy and sell Rule 144A securities on a pany under Employees’ Stock Plan. regular and continuous basis may also 221.115 Accepting a purpose statement through the mail without benefit of face- be considered an arranging of credit to-face interview. permissible under § 220.13(a) of Regula- 221.116 Bank loans to replenish working tion T. capital used to purchase mutual fund [Reg. T, 55 FR 29566, July 20, 1990] shares. 221.117 When bank in ‘‘good faith’’ has not § 220.132 Credit to brokers and deal- relied on stock as collateral. ers. 221.118 Bank arranging for extension of credit by corporation. For text of this interpretation, see 221.119 Applicability of plan-lender provi- § 221.125 of this subchapter. sions to financing of stock options and stock purchase rights qualified or re- [Reg. T, 61 FR 60167, Nov. 26, 1996, as amend- stricted under Internal Revenue Code. ed at 72 FR 70486, Dec. 12, 2007] 221.120 Allocation of stock collateral to pur- pose and nonpurpose to same cus- PART 221—CREDIT BY BANKS AND tomer. PERSONS OTHER THAN BROKERS 221.121 Extension of credit in certain stock option and stock purchase plans. OR DEALERS FOR THE PURPOSE 221.122 Applicability of margin require- OF PURCHASING OR CARRYING ments to credit in connection with Insur- MARGIN STOCK (REGULATION ance Premium Funding Programs. U) 221.123 Combined credit for exercising em- ployee stock options and paying income taxes incurred as a result of such exer- Sec. cise. 221.1 Authority, purpose, and scope. 221.124 Purchase of debt securities to fi- 221.2 Definitions. nance corporate . 221.3 General requirements. 221.125 Credit to brokers and dealers. 221.4 Employee stock option, purchase, and ownership plans. AUTHORITY: 15 U.S.C. 78c, 78g, 78q, and 78w.

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SOURCE: Reg. U, 63 FR 2827, Jan. 16, 1998, (ii) Any other subsidiary of such unless otherwise noted. bank holding company; and (iii) Any other corporation, business § 221.1 Authority, purpose, and scope. trust, association, or other similar or- (a) Authority. Regulation U (this ganization that is an affiliate as de- part) is issued by the Board of Gov- fined in section 2(b) of the Banking Act ernors of the Federal Reserve System of 1933 (12 U.S.C. 221a(c)); (the Board) pursuant to the Securities (2) For nonbank lenders, affiliate Exchange Act of 1934 (the Act) (15 means any person who, directly or indi- U.S.C. 78a et seq.). rectly, through one or more inter- (b) Purpose and scope. (1) This part mediaries, controls, or is controlled by, imposes credit restrictions upon per- or is under common control with the sons other than brokers or dealers lender. (hereinafter lenders) that extend credit Bank—(1) Bank. Has the meaning for the purpose of buying or carrying given to it in section 3(a)(6) of the Act margin stock if the credit is secured di- (15 U.S.C. 78c(a)(6)) and includes: rectly or indirectly by margin stock. (i) Any subsidiary of a bank; Lenders include ‘‘banks’’ (as defined in (ii) Any corporation organized under § 221.2) and other persons who are re- section 25(a) of the Federal Reserve Act quired to register with the Board under (12 U.S.C. 611); and § 221.3(b). Lenders may not extend more (iii) Any agency or branch of a for- than the maximum loan value of the eign bank located within the United collateral securing such credit, as set States. by the Board in § 221.7 (the Supple- (2) Bank does not include: ment). (i) Any savings and loan association; (2) This part does not apply to clear- (ii) Any credit union; ing agencies regulated by the Securi- (iii) Any lending institution that is ties and Exchange Commission or the an instrumentality or agency of the Commodity Futures Trading Commis- United States; or sion that accept deposits of margin (iv) Any member of a national securi- stock in connection with: ties exchange. (i) The issuance of, or guarantee of, Carrying credit is credit that enables or the clearance of transactions in, any a customer to maintain, reduce, or re- security (including options on any se- tire indebtedness originally incurred to curity, certificate of deposit, securities purchase a security that is currently a index or foreign currency); or margin stock. (ii) The guarantee of contracts for Current market value of: the purchase or sale of a commodity (1) A security means: for future delivery or options on such (i) If quotations are available, the contracts. closing sale price of the security on the (3) This part does not apply to credit preceding business day, as appearing on extended to an exempted borrower. any regularly published reporting or quotation service; or (c) Availability of forms. The forms (ii) If there is no closing sale price, referenced in this part are available the lender may use any reasonable esti- from the Federal Reserve Banks. mate of the market value of the secu- § 221.2 Definitions. rity as of the close of business on the preceding business day; or The terms used in this part have the (iii) If the credit is used to finance meanings given them in section 3(a) of the purchase of the security, the total the Act or as defined in this section as cost of purchase, which may include follows: any commissions charged. Affiliate means: (2) Any other collateral means a (1) For banks: value determined by any reasonable (i) Any bank holding company of method. which a bank is a subsidiary within the Customer excludes an exempted bor- meaning of the Bank Holding Company rower and includes any person or per- Act of 1956, as amended (12 U.S.C. sons acting jointly, to or for whom a 1841(d)); lender extends or maintains credit.

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Examining authority means: Indirectly secured. (1) Includes any ar- (1) The national securities exchange rangement with the customer under or national securities association of which: which a broker or dealer is a member; (i) The customer’s right or ability to or sell, , or otherwise dispose of (2) If a member of more than one self- margin stock owned by the customer is regulatory organization, the organiza- in any way restricted while the credit tion designated by the Securities and remains outstanding; or Exchange Commission as the exam- (ii) The exercise of such right is or ining authority for the broker or deal- may be cause for accelerating the ma- er. turity of the credit. Exempted borrower means a member (2) Does not include such an arrange- of a national securities exchange or a ment if: registered broker or dealer, a substan- (i) After applying the proceeds of the tial portion of whose business consists credit, not more than 25 percent of the of transactions with persons other than value (as determined by any reasonable brokers or dealers, and includes a bor- method) of the assets subject to the ar- rower who: rangement is represented by margin (1) Maintains at least 1000 active ac- stock; counts on an annual basis for persons (ii) It is a lending arrangement that other than brokers, dealers, and per- permits accelerating the maturity of sons associated with a broker or dealer; the credit as a result of a or re- (2) Earns at least $10 million in gross negotiation of another credit to the revenues on an annual basis from customer by another lender that is not transactions with persons other than an affiliate of the lender; brokers, dealers, and persons associ- (iii) The lender holds the margin ated with a broker or dealer; or stock only in the capacity of custo- (3) Earns at least 10 percent of its dian, depositary, or trustee, or under gross revenues on an annual basis from similar circumstances, and, in good transactions with persons other than faith, has not relied upon the margin brokers, dealers, and persons associ- stock as collateral; or ated with a broker-dealer. (iv) The lender, in good faith, has not Good faith with respect to: relied upon the margin stock as collat- (1) The loan value of collateral means eral in extending or maintaining the that amount (not exceeding 100 per particular credit. cent of the current market value of the Lender means: collateral) which a lender, exercising sound credit judgment, would lend, (1) Any bank; or without regard to the customer’s other (2) Any person subject to the reg- assets held as collateral in connection istration requirements of this part. with unrelated transactions. Margin stock means: (2) Making a determination or ac- (1) Any equity security registered or cepting a statement concerning a bor- having unlisted trading privileges on a rower means that the lender or its duly national securities exchange; authorized representative is alert to (2) Any OTC security designated as the circumstances surrounding the qualified for trading in the National credit, and if in possession of informa- Market System under a designation tion that would cause a prudent person plan approved by the Securities and not to make the determination or ac- Exchange Commission (NMS security); cept the notice or certification without (3) Any debt security convertible into inquiry, investigates and is satisfied a margin stock or carrying a that it is correct; or right to subscribe to or purchase a In the ordinary course of business margin stock; means occurring or reasonably ex- (4) Any warrant or right to subscribe pected to occur in carrying out or fur- to or purchase a margin stock; or thering any business purpose, or in the (5) Any security issued by an invest- case of an individual, in the course of ment company registered under section any activity for profit or the manage- 8 of the Investment Company Act of ment or preservation of . 1940 (15 U.S.C. 80a–8), other than:

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(i) A company licensed under the under which the lender itself may ex- Small Business Investment Company tend or maintain purpose credit under Act of 1958, as amended (15 U.S.C. 661); this part. or (b) Registration of nonbank lenders; ter- (ii) A company which has at least 95 mination of registration; annual report— percent of its assets continuously in- (1) Registration. Every person other vested in exempted securities (as de- than a person subject to part 220 of this fined in 15 U.S.C. 78c(a)(12)); or chapter or a bank who, in the ordinary (iii) A company which issues face- course of business, extends or main- amount certificates as defined in 15 tains credit secured, directly or indi- U.S.C. 80a–2(a)(15), but only with re- rectly, by any margin stock shall reg- spect of such securities; or ister on Federal Reserve Form FR G–1 (iv) A company which is considered a (OMB control number 7100–0011) within money market fund under SEC Rule 30 days after the end of any calendar 2a–7 (17 CFR 270.2a–7). quarter during which: Maximum loan value is the percentage (i) The amount of credit extended of current market value assigned by equals $200,000 or more; or the Board under § 221.7 (the Supple- (ii) The amount of credit outstanding ment) to specified types of collateral. at any time during that calendar quar- The maximum loan value of margin ter equals $500,000 or more. stock is stated as a percentage of its current market value. Puts, calls and (2) Deregistration. A registered combinations thereof that do not qual- nonbank lender may apply to termi- ify as margin stock have no loan value. nate its registration, by filing Federal All other collateral has good faith loan Reserve Form FR G–2 (OMB control value. number 7100–0011), if the lender has not, Nonbank lender means any person during the preceding six calendar subject to the registration require- months, had more than $200,000 of such ments of this part. credit outstanding. Registration shall Purpose credit is any credit for the be deemed terminated when the appli- purpose, whether immediate, inci- cation is approved by the Board. dental, or ultimate, of buying or car- (3) Annual report. Every registered rying margin stock. nonbank lender shall, within 30 days following June 30 of every year, file § 221.3 General requirements. Form FR G–4 (OMB control number (a) Extending, maintaining, and ar- 7100–0011). ranging credit—(1) Extending credit. No (4) Where to register and file applica- lender, except a plan-lender, as defined tions and reports. Registration state- in § 221.4(a), shall extend any purpose ments, applications to terminate reg- credit, secured directly or indirectly by istration, and annual reports shall be margin stock, in an amount that ex- filed with the Federal Reserve Bank of ceeds the maximum loan value of the the district in which the principal of- collateral securing the credit. fice of the lender is located. (2) Maintaining credit. A lender may (c) Purpose statement—(1) General continue to maintain any credit ini- rule—(i) Banks. Except for credit ex- tially extended in compliance with this tended under paragraph (c)(2) of this part, regardless of: section, whenever a bank extends cred- (i) Reduction in the customer’s eq- it secured directly or indirectly by any uity resulting from change in market margin stock, in an amount exceeding prices; $100,000, the bank shall require its cus- (ii) Change in the maximum loan tomer to execute Form FR U–1 (OMB value prescribed by this part; or No. 7100–0115), which shall be signed (iii) Change in the status of the secu- and accepted by a duly authorized offi- rity (from nonmargin to margin) secur- cer of the bank acting in good faith. ing an existing purpose credit. (ii) Nonbank lenders. Except for credit (3) Arranging credit. No lender may extended under paragraph (c)(2) of this arrange for the extension or mainte- section or § 221.4, whenever a nonbank nance of any purpose credit, except lender extends credit secured directly upon the same terms and conditions or indirectly by any margin stock, the

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nonbank lender shall require its cus- (d) Single credit rule. (1) All purpose tomer to execute Form FR G–3 (OMB credit extended to a customer shall be control number 7100–0018), which shall treated as a single credit, and all the be signed and accepted by a duly au- collateral securing such credit shall be thorized representative of the nonbank considered in determining whether or lender acting in good faith. not the credit complies with this part, (2) Purpose statement for revolving- except that syndicated loans need not credit or multiple-draw agreements or fi- be aggregated with other unrelated nancing of securities purchases on a pay- purpose credit extended by the same ment-against-delivery basis—(i) Banks. If lender. a bank extends credit, secured directly (2) A lender that has extended pur- or indirectly by any margin stock, in pose credit secured by margin stock an amount exceeding $100,000, under a may not subsequently extend unse- revolving-credit or other multiple-draw cured purpose credit to the same cus- agreement, Form FR U–1 must be exe- tomer unless the combined credit does cuted at the time the credit arrange- not exceed the maximum loan value of ment is originally established and the collateral securing the prior credit. must be amended as described in para- (3) If a lender extended unsecured graph (c)(2)(iv) of this section for each purpose credit to a customer prior to disbursement if all of the collateral for the extension of purpose credit secured the agreement is not pledged at the by margin stock, the credits shall be time the agreement is originally estab- combined and treated as a single credit lished. solely for the purposes of the with- (ii) Nonbank lenders. If a nonbank drawal and substitution provision of lender extends credit, secured directly paragraph (f) of this section. or indirectly by any margin stock, (4) If a lender extends purpose credit under a revolving-credit or other mul- secured by any margin stock and non- tiple-draw agreement, Form FR G–3 purpose credit to the same customer, must be executed at the time the credit the lender shall treat the credits as arrangement is originally established two separate loans and may not rely and must be amended as described in upon the required collateral securing paragraph (c)(2)(iv) of this section for the purpose credit for the nonpurpose each disbursement if all of the collat- credit. eral for the agreement is not pledged at (e) Exempted borrowers. (1) An exempt- the time the agreement is originally ed borrower that has been in existence established. for less than one year may meet the (iii) Collateral. If a purpose statement definition of exempted borrower based executed at the time the credit ar- on a six-month period. rangement is initially made indicates (2) Once a member of a national secu- that the purpose is to purchase or rities exchange or registered broker or carry margin stock, the credit will be dealer ceases to qualify as an exempted deemed in compliance with this part if: borrower, it shall notify its lenders of (A) The maximum loan value of the this fact. Any new extensions of credit collateral at least equals the aggregate to such a borrower, including rollovers, amount of funds actually disbursed; or renewals, and additional draws on ex- (B) At the end of any day on which isting lines of credit, are subject to the credit is extended under the agree- provisions of this part. ment, the lender calls for additional (f) Withdrawals and substitutions. (1) A collateral sufficient to bring the credit lender may permit any withdrawal or into compliance with § 221.7 (the Sup- substitution of cash or collateral by plement). the customer if the withdrawal or sub- (iv) Amendment of purpose statement. stitution would not: For any purpose credit disbursed under (i) Cause the credit to exceed the the agreement, the lender shall obtain maximum loan value of the collateral; and attach to the executed Form FR or U–1 or FR G–3 a current list of collat- (ii) Increase the amount by which the eral which adequately supports all credit exceeds the maximum loan value credit extended under the agreement. of the collateral.

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(2) For purposes of this section, the ing the purpose of the loan and the col- maximum loan value of the collateral lateral securing it. on the day of the withdrawal or substi- (j) Action for lender’s protection. Noth- tution shall be used. ing in this part shall require a bank to (g) Exchange offers. To enable a cus- waive or forego any or prevent a tomer to participate in a reorganiza- bank from taking any action it deems tion, or exchange offer necessary in good faith for its protec- that is made to holders of an issue of tion. margin stock, a lender may permit sub- stitution of the securities received. A (k) Mistakes in good faith. A mistake nonmargin, nonexempted security ac- in good faith in connection with the ex- quired in exchange for a margin stock tension or maintenance of credit shall shall be treated as if it is margin stock not be a violation of this part. for a period of 60 days following the ex- change. § 221.4 Employee stock option, pur- (h) Renewals and extensions of matu- chase, and ownership plans. rity. A renewal or extension of matu- (a) Plan-lender; eligible plan. (1) Plan- rity of a credit need not be considered lender means any corporation, (includ- a new extension of credit if the amount ing a wholly-owned subsidiary, or a of the credit is increased only by the lender that is a thrift organization addition of interest, service charges, or whose membership is limited to em- taxes with respect to the credit. ployees and former employees of the (i) Transfers of credit. (1) A transfer of corporation, its subsidiaries or affili- a credit between customers or between ates) that extends or maintains credit lenders shall not be considered a new to finance the acquisition of margin extension of credit if: stock of the corporation, its subsidi- (i) The original credit was extended by a lender in compliance with this aries or affiliates under an eligible part or by a lender subject to part 207 plan. of this chapter in effect prior to April (2) Eligible plan. An eligible plan 1, 1998, (See part 207 appearing in the 12 means any employee stock option, pur- CFR parts 200 to 219 edition revised as chase, or ownership plan adopted by a of January 1, 1997), in a manner that corporation and approved by its stock- would have complied with this part; holders that provides for the purchase (ii) The transfer is not made to evade of margin stock of the corporation, its this part; subsidiaries, or affiliates. (iii) The amount of credit is not in- (b) Credit to exercise rights under or fi- creased; and nance an eligible plan. (1) If a plan-lend- (iv) The collateral for the credit is er extends or maintains credit under an not changed. eligible plan, any margin stock that di- (2) Any transfer between customers rectly or indirectly secured that credit at the same lender shall be accom- shall have good faith loan value. panied by a statement by the trans- feror customer describing the cir- (2) Credit extended under this section cumstances giving rise to the transfer shall be treated separately from credit and shall be accepted and signed by a extended under any other section of representative of the lender acting in this part except § 221.3(b)(1) and (b)(3). good faith. The lender shall keep such (c) Credit to ESOPs. A nonbank lender statement with its records of the trans- may extend and maintain purpose cred- feree account. it without regard to the provisions of (3) When a transfer is made between this part, except for § 221.3(b)(1) and lenders, the transferee shall obtain a (b)(3), if such credit is extended to an copy of the Form FR U–1 or Form FR employee stock ownership plan (ESOP) G–3 originally filed with the transferor qualified under section 401 of the Inter- and retain the copy with its records of nal Revenue Code, as amended (26 the transferee account. If no form was U.S.C. 401). originally filed with the transferor, the transferee may accept in good faith a statement from the transferor describ-

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§ 221.5 Special purpose loans to bro- pose of taking advantage of a dif- kers and dealers. ference in prices in the two markets; or (a) Special purpose loans. A lender (ii) Purchase of a security that is, may extend and maintain purpose cred- without restriction other than the pay- it to brokers and dealers without re- ment of money, exchangeable or con- gard to the limitations set forth in vertible within 90 calendar days of the §§ 221.3 and 221.7, if the credit is for any purchase into a second security, to- of the specific purposes and meets the gether with an offsetting sale of the conditions set forth in paragraph (c) of second security at or about the same this section. time, for the purpose of taking advan- (b) Written notice. Prior to extending tage of a concurrent disparity in the credit for more than a day under this price of the two securities. section, the lender shall obtain and ac- (6) Market maker and specialist loans. cept in good faith a written notice or Credit to a member of a national secu- certification from the borrower as to rities exchange or registered broker or the purposes of the loan. The written dealer to finance its activities as a notice or certification shall be evi- market maker or specialist. dence of continued eligibility for the (7) Underwriter loans. Credit to a special credit provisions until the bor- member of a national securities ex- rower notifies the lender that it is no longer eligible or the lender has infor- change or registered broker or dealer mation that would cause a reasonable to finance its activities as an under- person to question whether the credit writer. is being used for the purpose specified. (8) Emergency loans. Credit that is es- (c) Types of special purpose credit. The sential to meet emergency needs of the types of credit that may be extended broker-dealer business arising from ex- and maintained on a good faith basis ceptional circumstances. are as follows: (9) Capital contribution loans. Capital (1) Hypothecation loans. Credit se- contribution loans include: cured by hypothecated customer secu- (i) Credit that Board has exempted by rities that, according to written notice order upon a finding that the exemp- received from the broker or dealer, tion is necessary or appropriate in the may be hypothecated by the broker or public interest or for the protection of dealer under Securities and Exchange investors, provided the Securities In- Commission (SEC) rules. vestor Protection Corporation certifies (2) Temporary advances in payment- to the Board that the exemption is ap- against-delivery transactions. Credit to propriate; or finance the purchase or sale of securi- (ii) Credit to a customer for the pur- ties for prompt delivery, if the credit is pose of making a subordinated loan or to be repaid upon completion of the capital contribution to a broker or transaction. dealer in conformity with the SEC’s (3) Loans for securities in transit or net capital rules and the rules of the transfer. Credit to finance securities in broker’s or dealer’s examining author- transit or surrendered for transfer, if ity, provided: the credit is to be repaid upon comple- (A) The customer reduces the credit tion of the transaction. by the amount of any reduction in the (4) Intra-day loans. Credit to enable a broker or dealer to pay for securities, if loan or contribution to the broker or the credit is to be repaid on the same dealer; and day it is extended. (B) The credit is not used to purchase (5) Arbitrage loans. Credit to finance securities issued by the broker or deal- proprietary or customer bona fide arbi- er in a public distribution. trage transactions. For the purpose of (10) Credit to clearing brokers or this section bona fide arbitrage means: dealers. Credit to a member of a na- (i) Purchase or sale of a security in tional securities exchange or registered one market, together with an offset- broker or dealer whose nonproprietary ting sale or purchase of the same secu- business is limited to financing and rity in a different market at nearly the carrying the accounts of registered same time as practicable, for the pur- market makers.

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§ 221.6 Exempted transactions. (b) Maximum loan value of nonmargin stock and all other collateral. The max- A bank may extend and maintain imum loan value of nonmargin stock purpose credit without regard to the and all other collateral except puts, provisions of this part if such credit is calls, or combinations thereof is their extended: good faith loan value. (a) To any bank; (c) Maximum loan value of options. Ex- (b) To any foreign banking institu- cept for options that qualify as margin tion; stock, puts, calls, and combinations (c) Outside the United States; thereof have no loan value. (d) To an employee stock ownership plan (ESOP) qualified under section 401 INTERPRETATIONS of the Internal Revenue Code (26 U.S.C. 401); § 221.101 Determination and effect of (e) To any plan lender as defined in purpose of loan. § 221.4(a) to finance an eligible plan as (a) Under this part the original pur- defined in § 221.4(b), provided the bank pose of a loan is controlling. In other has no recourse to any securities pur- words, if a loan originally is not for the chased pursuant to the plan; purpose of purchasing or carrying mar- (f) To any customer, other than a gin stock, changes in the collateral for broker or dealer, to temporarily fi- the loan do not change its exempted nance the purchase or sale of securities character. for prompt delivery, if the credit is to (b) However, a so-called increase in be repaid in the ordinary course of the loan is necessarily on an entirely business upon completion of the trans- different basis. So far as the purpose of action and is not extended to enable the credit is concerned, it is a new the customer to pay for securities pur- loan, and the question of whether or chased in an account subject to part not it is subject to this part must be 220 of this chapter; determined accordingly. (g) Against securities in transit, if (c) Certain facts should also be men- the credit is not extended to enable the tioned regarding the determination of customer to pay for securities pur- the purpose of a loan. Section 221.3(c) chased in an account subject to part provides in that whenever a lender is 220 of this chapter; or required to have its customer execute a (h) To enable a customer to meet ‘‘Statement of Purpose for an Exten- emergency expenses not reasonably sion of Credit Secured by Margin foreseeable, and if the extension of Stock,’’ the statement must be accept- credit is supported by a statement exe- ed by the lender ‘‘acting in good faith.’’ cuted by the customer and accepted The requirement of ‘‘good faith’’ is of and signed by an officer of the bank vital importance here. Its application acting in good faith. For this purpose, will necessarily vary with the facts of emergency expenses include expenses the particular case, but it is clear that arising from circumstances such as the the bank must be alert to the cir- death or disability of the customer, or cumstances surrounding the loan. For some other change in circumstances in- example, if the loan is to be made to a volving extreme hardship, not reason- customer who is not a broker or dealer ably foreseeable at the time the credit in securities, but such a broker or deal- was extended. The opportunity to real- er is to deliver margin stock to secure ize monetary gain or to avoid loss is the loan or is to receive the proceeds of not a ‘‘change in circumstances’’ for the loan, the bank would be put on no- this purpose. tice that the loan would probably be subject to this part. It could not accept § 221.7 Supplement: Maximum loan in good faith a statement to the con- value of margin stock and other col- trary without obtaining a reliable and lateral. satisfactory explanation of the situa- (a) Maximum loan value of margin tion. stock. The maximum loan value of any (d) Furthermore, the purpose of a margin stock is fifty per cent of its loan means just that. It cannot be al- current market value. tered by some temporary application of

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the proceeds. For example, if a bor- ed or used by the bank failed to call for rower is to purchase Government secu- answers which would indicate whether rities with the proceeds of a loan, but or not the loan was of the kind dis- is soon thereafter to sell such securi- cussed elsewhere in this section. ties and replace them with margin stock, the loan is clearly for the pur- § 221.104 Federal credit unions. pose of purchasing or carrying margin For text of the interpretation on stock. Federal credit unions, see 12 CFR 220.110. § 221.102 Application to committed credit where funds are disbursed § 221.105 Arranging for extensions of thereafter. credit to be made by a bank. The Board has concluded that the For text of the interpretation on Ar- date a commitment to extend credit ranging for extensions of credit to be becomes binding should be regarded as made by a bank, see 12 CFR 220.111. the date when the credit is extended, since: § 221.106 Reliance in ‘‘good faith’’ on (a) On that date the parties should be statement of purpose of loan. aware of law and facts surrounding the (a) Certain situations have arisen transaction; and from time to time under this part (b) Generally, the date of contract is wherein it appeared doubtful that, in controlling for purposes of margin reg- the circumstances, the lending banks ulations and Federal securities law, re- may have been entitled to rely upon gardless of the delivery of cash or secu- the statements accepted by them in de- rities. termining whether the purposes of cer- tain loans were such as to cause the § 221.103 Loans to brokers or dealers. loans to be not subject to the part. Questions have arisen as to the ade- (b) The use by a lending bank of a quacy of statements received by lend- statement in determining the purpose ing banks under § 221.3(c), ‘‘Purpose of a particular loan is, of course, pro- Statement,’’ in the case of loans to vided for by § 221.3(c). However, under brokers or dealers secured by margin that paragraph a lending bank may ac- stock where the proceeds of the loans cept such statement only if it is ‘‘act- are to be used to finance customer ing in good faith.’’ As the Board stated transactions involving the purchasing in the interpretation contained in or carrying of margin stock. While § 221.101, the ‘‘requirement of ‘good some such loans may qualify for ex- faith’ is of vital importance’’; and, to emption under §§ 221.1(b)(2), 221.4, 221.5 fulfill such requirement, ‘‘it is clear or 221.6, unless they do qualify for such that the bank must be alert to the cir- an exemption they are subject to this cumstances surrounding the loan.’’ part. For example, if a loan so secured (c) Obviously, such a statement is made to a broker to furnish cash would not be accepted by the bank in working capital for the conduct of his ‘‘good faith’’ if at the time the loan brokerage business (i.e., for purchasing was made the bank had knowledge, and carrying securities for the account from any source, of facts or cir- of customers), the maximum loan cumstances which were contrary to the value prescribed in § 221.7 (the Supple- natural purport of the statement, or ment) would be applicable unless the which were sufficient reasonably to put loan should be of a kind exempted the bank on notice of the questionable under this part. This result would not reliability or completeness of the be affected by the fact that the margin statement. stock given as security for the loan (d) Furthermore, the same require- was or included margin stock owned by ment of ‘‘good faith’’ is to be applied the brokerage firm. In view of the fore- whether the statement accepted by the going, the statement referred to in bank is signed by the borrower or by an § 221.3(c) which the lending bank must officer of the bank. In either case, accept in good faith in determining the ‘‘good faith’’ requires the exercise of purpose of the loan would be inad- special diligence in any instance in equate if the form of statement accept- which the borrower is not personally

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known to the bank or to the officer good faith’’, and that ‘‘good faith’’ re- who processes the loan. quires, among other things, reasonable (e) The interpretation set forth in diligence to learn the truth. § 221.101 contains an example of the ap- plication of the ‘‘good faith’’ test. § 221.107 Arranging loan to purchase There it was stated that ‘‘if the loan is open-end investment company to be made to a customer who is not a shares. broker or dealer in securities, but such For text of the interpretation on Ar- a broker or dealer is to deliver margin ranging loan to purchase open-end in- stock to secure the loan or is to receive vestment company shares, see 12 CFR the proceeds of the loan, the bank 220.112. would be put on notice that the loan would probably be subject to this part. § 221.108 Effect of registration of stock It could not accept in good faith a subsequent to making of loan. statement to the contrary without ob- (a) The Board recently was asked taining a reliable and satisfactory ex- whether a loan by a bank to enable the planation of the situation’’. borrower to purchase a newly issued (f) Moreover, and as also stated by nonmargin stock during the initial the interpretation contained in over-the-counter trading period prior § 221.101, the purpose of a loan, of to the stock becoming registered (list- course, ‘‘cannot be altered by some ed) on a national securities exchange temporary application of the proceeds. would be subject to this part. The For example, if a borrower is to pur- Board replied that, until such stock chase Government securities with the qualifies as margin stock, this would proceeds of a loan, but is soon there- not be applicable to such a loan. after to sell such securities and replace (b) The Board has now been asked them with margin stock, the loan is what the position of the lending bank clearly for the purpose of purchasing or would be under this part if, after the carrying margin stock’’. The purpose of date on which the stock should become a loan therefore, should not be deter- registered, such bank continued to hold mined upon a narrow analysis of the a loan of the kind just described. It is immediate use to which the proceeds of assumed that the loan was in an the loan are put. Accordingly, a bank amount greater than the maximum acting in ‘‘good faith’’ should carefully loan value for the collateral specified scrutinize cases in which there is any in this part. indication that the borrower is con- (c) If the stock should become reg- cealing the true purpose of the loan, istered, the loan would then be for the and there would be reason for special purpose of purchasing or carrying a vigilance if margin stock is substituted margin stock, and, if secured directly for bonds or nonmargin stock soon or indirectly by any margin stock, after the loan is made, or on more than would be subject to this part as from one occasion. the date the stock was registered. (g) Similarly, the fact that a loan Under this part, this does not mean made on the borrower’s signature only, that the bank would have to obtain re- for example, becomes secured by mar- duction of the loan in order to reduce gin stock shortly after the disburse- it to an amount no more than the spec- ment of the loan usually would afford ified maximum loan value. It does reasonable grounds for questioning the mean, however, that so long as the bank’s apparent reliance upon merely a loan balance exceeded the specified statement that the purpose of the loan maximum loan value, the bank could was not to purchase or carry margin not permit any withdrawals or substi- stock. tutions of collateral that would in- (h) The examples in this section are, crease such excess; nor could the bank of course, by no means exhaustive. increase the amount of the loan bal- They simply illustrate the funda- ance unless there was provided addi- mental fact that no statement accept- tional collateral having a maximum ed by a lender is of any value for the loan value at least equal to the amount purposes of this part unless the lender of the increase. In other words, as from accepting the statement is ‘‘acting in the date the stock should become a

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margin stock, the loan would be sub- a case of this kind, the loan would be ject to this part in exactly the same subject to this part, for the following way, for example, as a loan subject to reasons: this part that became under-margined (i) The Board has long held, in the because of a decline in the current closely related purpose area, that the market value of the loan collateral or original purpose of a loan should not be because of a decrease by the Board in determined upon a narrow analysis of the maximum loan value of the loan the technical circumstances under collateral. which a loan is made. Instead, the fun- damental purpose of the loan is consid- § 221.109 Loan to open-end investment ered to be controlling. Indeed, ‘‘the company. fact that a loan made on the borrower’s In response to a question regarding a signature only, for example, becomes possible loan by a bank to an open-end secured by registered stock shortly investment company that customarily after the disbursement of the loan’’ af- purchases registered on a na- fords reasonable grounds for ques- tional securities exchange, the Board tioning whether the bank was entitled stated that in view of the general na- to rely upon the borrower’s statement ture and operations of such a company, as to the purpose of the loan. 1953 Fed. any loan by a bank to such a company Res. Bull. 951 (See, § 221.106). should be presumed to be subject to (ii) Where security is involved, stand- this part as a loan for the purpose of ards of interpretation should be equal- purchasing or carrying margin stock. ly searching. If, for example, the origi- This would not be altered by the fact nal agreement between borrower and that the open-end company had used, lender contemplated that the loan or proposed to use, its own funds or should be secured by margin stock, and proceeds of the loan to redeem some of such stock is in fact delivered to the its own shares, since mere application bank when available, the transaction of the proceeds of a loan to some other must be regarded as fundamentally a use cannot prevent the ultimate pur- secured loan. This view is strengthened pose of a loan from being to purchase by the fact that this part applies to a or carry registered stocks. loan ‘‘secured directly or indirectly by margin stock.’’ § 221.110 Questions arising under this (2) Loan to acquire controlling shares. part. (i) The second question is whether this (a) This part governs ‘‘any purpose part governs a margin stock-secured credit’’ extended by a lender ‘‘secured loan made for the business purpose of directly or indirectly by margin stock’’ purchasing a controlling interest in a and defines ‘‘purpose credit’’ as ‘‘any corporation, or whether such a loan credit for the purpose, whether imme- would be exempt on the ground that diate, incidental, or ultimate, of buy- this part is directed solely toward pur- ing or carrying margin stock, ‘‘ with chases of stock for speculative or in- certain exceptions, and provides that vestment purposes. The Board an- the maximum loan value of such mar- swered that a margin stock-secured gin stock shall be a fixed percentage loan for the purpose of purchasing or ‘‘of its current market value.’’ carrying margin stock is subject to (b) The Board of Governors has had this part, regardless of the reason for occasion to consider the application of which the purchase is made. the language in paragraph (a) of this (ii) The answer is required, in the section to the two following questions: Board’s view, since the language of this (1) Loan secured by stock. First, is a part is explicitly inclusive, covering loan to purchase or carry margin stock ‘‘any purpose credit, secured directly subject to this part where made in un- or indirectly by margin stock.’’ More- secured form, if margin stock is subse- over, the withdrawal in 1945 of the quently deposited as security with the original section 2(e) of this part, which lender, and surrounding circumstances exempted ‘‘any loan for the purpose of indicate that the parties originally purchasing a stock from or through a contemplated that the loan should be person who is not a member of a na- so secured? The Board answered that in tional securities exchange . . .’’ plainly

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implies that transactions of the sort retaining the right to liquidate the col- described are now subject to the gen- lateral before the securities decline in eral prohibition of § 221.3(a). price below the amount of its contribu- tion. Conversely, the individual—like a § 221.111 Contribution to joint venture customer who borrows to purchase se- as extension of credit when the con- tribution is disproportionate to the curities—puts up only 20 percent of contributor’s share in the venture’s their cost, is entitled to the principal profits or losses. portion of any appreciation in their (a) The Board considered the ques- value, bears the principal risk of loss tion whether a joint venture, struc- should that value decline, and does not tured so that the amount of capital stand to gain or lose except through a contribution to the venture would be change in value of the securities pur- disproportionate to the right of partici- chased. pation in profits or losses, constitutes (e) The Board is of the opinion that an ‘‘extension of credit’’ for the pur- where the right of an individual to pose of this part. share in profits and losses of such a (b) An individual and a corporation joint venture is disproportionate to his plan to establish a joint venture to en- contribution to the venture: gage in the business of buying and sell- (1) The joint venture involves an ex- ing securities, including margin stock. tension of credit by the corporation to The individual would contribute 20 per- the individual; cent of the capital and receive 80 per- (2) The extension of credit is to pur- cent of the profits or losses; the cor- chase or carry margin stock, and is porate share would be the reverse. In computing profits or losses, each par- collateralized by such margin stock; ticipant would first receive interest at and the rate of 8 percent on his respective (3) If the corporation is not a broker capital contribution. Although pur- or dealer subject to Regulation T (12 chases and sales would be mutually CFR part 220), the credit is of the kind agreed upon, the corporation could liq- described by § 221.3(a). uidate the joint portfolio if the individ- ual’s share of the losses equaled or ex- § 221.112 Loans by bank in capacity as ceeded his 20 percent contribution to trustee. the venture. The corporation would (a) The Board’s advice has been re- hold the securities, and upon termi- quested whether a bank’s activities in nation of the venture, the assets would connection with the of first be applied to repayment of capital an employees’ savings plan are subject contributions. to this part. (c) In general, the relationship of (b) Under the plan, any regular, full- joint venture is created when two or time employee may participate by au- more persons combine their money, thorizing the sponsoring company to property, or time in the conduct of deduct a percentage of his salary and some particular line of trade or some wages and transmit the same to the particular business and agree to share jointly, or in proportion to capital con- bank as trustee. Voluntary contribu- tributed, the profits and losses of the tions by the company are allocated undertaking. among the participants. A participant (d) The incidents of the joint venture may direct that funds held for him be described in paragraph (b) of this sec- invested by the trustee in insurance, tion, however, closely parallel those of annuity contracts, Series E Bonds, or an extension of margin credit, with the in one or more of three specified secu- corporation as lender and the indi- rities which are listed on a stock ex- vidual as borrower. The corporation change. Loans to purchase the stocks supplies 80 percent of the purchase may be made to participants from price of securities in exchange for a net funds of the trust, subject to approval return of 8 percent of the amount ad- of the administrative committee, vanced plus 20 percent of any gain. which is composed of five participants, Like a lender of securities credit, the and of the trustee. The bank’s right to corporation is insulated against loss by approve is said to be restricted to the

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mechanics of making the loan, the pur- agreement includes the following pose being to avoid cumbersome proce- terms, which are material to the ques- dures. tion before the Board: (c) Loans are secured by the credit (1) Fund X agrees to have an ‘‘asset balance of the borrowing participants coverage’’ (as defined in the agree- in the savings fund, including stock, ments) of 400 percent of all its bor- but excluding (in practice) insurance rowings, including the proposed bor- and annuity contracts and government rowing, at the time when it takes down securities. Additional stocks may be, any part of the loan. but, in practice, have not been pledged (2) Fund X agrees to maintain an as collateral for loans. Loans are not ‘‘asset coverage’’ of at least 300 percent made, under the plan, from bank funds, of its borrowings at all times. and participants do not borrow from (3) Fund X agrees not to amend its the bank upon assignment of the par- custody agreement with Bank Y, or to ticipants’ accounts in the trust. substitute another custodian without (d) It is urged that loans under the Bank Y’s consent. plan are not subject to this part be- (4) Fund X agrees not to mortgage, cause a loan should not be considered pledge, or otherwise encumber any of as having been made by a bank where its assets elsewhere than with Bank Y. the bank acts solely in its capacity of trustee, without exercise of any discre- (c) In § 221.109 the Board stated that tion. because of ‘‘the general nature and op- (e) The Board reviewed this question erations of such a company’’, any upon at least one other occasion, and ‘‘loan by a bank to an open-end invest- full consideration has again been given ment company that customarily pur- to the matter. After considering the ar- chases margin stock * * * should be guments on both sides, the Board has presumed to be subject to this part as reaffirmed its earlier view that, in con- a loan for the purpose of purchasing or formity with an interpretation not carrying margin stock’’ (purpose cred- published in the Code of Federal Regu- it). The Board’s interpretation went on lations which was published at page 874 to say that: ‘‘this would not be altered of the 1946 Federal Reserve Bulletin by the fact that the open-end company (See 12 CFR 261.10(f) for information on had used, or proposed to use, its own how to obtain Board publications.), funds or proceeds of the loan to redeem this part applies to the activities of a some of its own shares * * *.’’ bank when it is acting in its capacity (d) Accordingly, the loan by Bank Y as trustee. Although the bank in that to Fund X was and is a ‘‘purpose cred- case had at best a limited discretion it’’. However, a loan by a bank is not with respect to loans made by it in its subject to this part unless: it is a pur- capacity as trustee, the Board con- pose credit; and it is ‘‘secured directly cluded that this fact did not affect the or indirectly by margin stock’’. In the application of the regulation to such present case, the loan is not ‘‘secured loans. directly’’ by stock in the ordinary sense, since the portfolio of Fund X is § 221.113 Loan which is secured indi- not pledged to secure the credit from rectly by stock. Bank Y. But the word ‘‘indirectly’’ (a) A question has been presented to must signify some form of security ar- the Board as to whether a loan by a rangement other than the ‘‘direct’’ se- bank to a mutual investment fund is curity which arises from the ordinary ‘‘secured * * * indirectly by margin ‘‘transaction that gives recourse stock’’ within the meaning of against a particular chattel or land or § 221.(3)(a), so that the loan should be against a third party on an obligation’’ treated as subject to this part. described in the American Law Insti- (b) Briefly, the facts are as follows. tute’s Restatement of the Law of Secu- Fund X, an open-end investment com- rity, page 1. Otherwise the word ‘‘indi- pany, entered into a loan agreement rectly’’ would be superfluous, and a with Bank Y, which was (and still is) regulation, like a statute, must be con- custodian of the securities which com- strued if possible to give meaning to prise the portfolio of Fund X. The every word.

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(e) The Board has indicated its view the bank ‘‘has not relied’’ upon the that any arrangement under which margin stock deposited with it. margin stock is more readily available (2) A borrower may not deposit his as security to the lending bank than to margin stock with the bank, but agree other of the borrower may not to pledge or encumber his assets amount to indirect security within the elsewhere while the loan is out- meaning of this part. In an interpreta- standing. Such an agreement may be tion published at § 221.110 it stated: difficult to police, yet it serves to some ‘‘The Board has long held, in the * * * extent to protect the interest of the purpose area, that the original purpose bank if only because the future credit of a loan should not be determined standing and business reputation of the upon a narrow analysis of the technical borrower will depend upon his keeping circumstances under which a loan is his word. If the assets covered by such made * * * . Where security is involved, an agreement include margin stock, standards of interpretation should be then, the credit is ‘‘indirectly secured’’ equally searching.’’ In its pamphlet by the margin stock within the mean- issued for the benefit and guidance of ing of this part. banks and bank examiners, entitled (3) The borrower may deposit margin ‘‘Questions and Answers Illustrating stock with a third party who agrees to Application of Regulation U’’, the hold the stock until the loan has been Board said: ‘‘In determining whether a paid off. Here, even though the parties loan is ‘‘indirectly’’ secured, it should may purport to provide that the stock be borne in mind that the reason the is not ‘‘security’’ for the loan (for ex- Board has thus far refrained * * * from ample, by agreeing that the stock may regulating loans not secured by stock not be sold and the proceeds applied to has been to simplify operations under the debt if the borrower fails to pay), the regulation. This objective of sim- the mere fact that the stock is out of plifying operations does not apply to the borrower’s control for the duration loans in which arrangements are made of the loan serves to some extent to to retain the substance of stock collat- protect the bank. eral while sacrificing only the form’’. (g) The three instances described in (f) A wide variety of arrangements as paragraph (f) of this section are merely to collateral can be made between illustrative. Other methods, or com- bank and borrower which will serve, to binations of methods, may serve a some extent, to protect the interest of similar purpose. The conclusion that the bank in seeing that the loan is re- any given arrangement makes a credit paid, without giving the bank a con- ‘‘indirectly secured’’ by margin stock ventional direct ‘‘security’’ interest in may, but need not, be reinforced by the collateral. Among such arrange- facts such as that the stock in question ments which have come to the Board’s was purchased with proceeds of the attention are the following: loan, that the lender suggests or insists (1) The borrower may deposit margin upon the arrangement, or that the loan stock in the custody of the bank. An would probably be subject to criticism arrangement of this kind may not, it is by supervisory authorities were it not true, place the bank in the position of for the protective arrangement. a secured creditor in case of bank- (h) Accordingly, the Board concludes ruptcy, or even of conflicting claims, that the loan by Bank Y to Fund X is but it is likely effectively to strength- indirectly secured by the portfolio of en the bank’s position. The definition the fund and must be treated by the of indirectly secured in § 221.2, which pro- bank as a regulated loan. vides that a loan is not indirectly se- cured if the lender ‘‘holds the margin § 221.114 Bank loans to purchase stock stock only in the capacity of custo- of American Telephone and Tele- dian, depositary or trustee, or under graph Company under Employees’ similar circumstances, and, in good Stock Plan. faith has not relied upon the margin (a) The Board of Governors inter- stock as collateral,’’ does not exempt a preted this part in connection with deposit of this kind from the impact of proposed loans by a bank to persons the regulation unless it is clear that who are purchasing shares of stock of

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American Telephone and Telegraph amount approximately equal to the Company pursuant to its Employees’ amount he would pay for such shares. Stock Plan. In these circumstances, the loan by the (b) According to the current offering bank must be regarded as a loan ‘‘for under the Plan, an employee of the the purpose of purchasing’’ the stock, AT&T system may purchase shares and therefore it is subject to the limi- through regular deductions from his tations prescribed by this part. This pay over a period of 24 months. At the conclusion follows from the provisions end of that period, a certificate for the of this part, and it may also be ob- appropriate number of shares will be served that a contrary conclusion issued to the participating employee by could largely defeat the basic purpose AT&T. Each employee is entitled to of the margin regulations. purchase, as a maximum, shares that (e) Accordingly, the Board concluded will cost him approximately three- that a loan of the kind described may fourths of his annual base pay. Since not be made in an amount exceeding the program extends over two years, it the maximum loan value of the collat- follows that the payroll deductions for eral, as prescribed by the current § 221.7 this purpose may be in the neighbor- (the Supplement). hood of 38 percent of base pay and a larger percentage of ‘‘take-home pay.’’ § 221.115 Accepting a purpose state- Deductions of this magnitude are in ex- ment through the mail without ben- cess of the saving rate of many employ- efit of face-to-face interview. ees. (a) The Board has been asked wheth- (c) Certain AT&T employees, who er the acceptance of a purpose state- wish to take advantage of the current ment submitted through the mail by a offering under the Plan, are the owners lender subject to the provisions of this of shares of AT&T stock that they pur- part will meet the good faith require- chased under previous offerings. A ment of § 221.3(c). Section 221.3(c) states bank proposed to receive such stock as that in connection with any credit se- collateral for a ‘‘living expenses’’ loan cured by collateral which includes any that will be advanced to the employee margin stock, a nonbank lender must in monthly installments over the 24- obtain a purpose statement executed month period, each installment being by the borrower and accepted by the in the amount of the employee’s lender in good faith. Such acceptance monthly payroll deduction under the requires that the lender be alert to the Plan. The aggregate amount of the ad- circumstances surrounding the credit vances over the 24-month period would and if further information suggests in- be substantially greater than the max- quiry, he must investigate and be satis- imum loan value of the collateral as fied that the statement is truthful. prescribed in § 221.7 (the Supplement). (b) The lender is a subsidiary of a (d) In the opinion of the Board of holding company which also has an- Governors, a loan of the kind described other subsidiary which serves as under- would violate this part if it exceeded writer and investment advisor to var- the maximum loan value of the collat- ious mutual funds. The sole business of eral. The regulation applies to any the lender will be to make ‘‘non-pur- margin stock-secured loan for the pur- pose’’ consumer loans to shareholders pose of purchasing or carrying margin of the mutual funds, such loans to be stock (§ 221.3(a)). Although the pro- collateralized by the fund shares. Most posed loan would purport to be for liv- mutual funds shares are margin stock ing expenses, it seems quite clear, in for purposes of this part. Solicitation view of the relationship of the loan to and acceptance of these consumer the Employees’ Stock Plan, that its ac- loans will be done principally through tual purpose would be to enable the the mail and the lender wishes to ob- borrower to purchase AT&T stock, tain the required purpose statement by which is margin stock. At the end of mail rather than by a face-to-face the 24-month period the borrower interview. Personal interviews are not would acquire a certain number of practicable for the lender because shares of that stock and would be in- shareholders of the funds are scattered debted to the lending bank in an throughout the country. In order to

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provide the same safeguards inherent § 221.116 Bank loans to replenish in face-to-face interviews, the lender working capital used to purchase has developed certain procedures de- mutual fund shares. signed to satisfy the good faith accept- (a) In a situation considered by the ance requirement of this part. Board of Governors, a business concern (c) The purpose statement will be (X) proposed to purchase mutual fund supplemented with several additional shares, from time to time, with pro- questions relevant to the prospective ceeds from its accounts receivable, borrower’s investment activities such then pledge the shares with a bank in as purchases of any security within the order to secure working capital. The last 6 months, dollar amount, and obli- bank was prepared to lend amounts gations to purchase or pay for previous equal to 70 percent of the current value purchases; present plans to purchase of the shares as they were purchased by securities in the near future, participa- X. If the loans were subject to this tions in securities purchase plans, list part, only 50 percent of the current of unpaid , and present income market value of the shares could be level. Some questions have been modi- lent. fied to facilitate understanding but no (b) The immediate purpose of the questions have been deleted. If addi- loans would be to replenish X’s work- tional inquiry is indicated by the an- ing capital. However, as time went on, swers on the form, a loan officer of the X would be acquiring mutual fund lender will interview the borrower by shares at a cost that would exceed the telephone to make sure the loan is net earnings it would normally have ‘‘non-purpose’’. Whenever the loan ex- accumulated, and would become in- debted to the lending bank in an ceeds the ‘‘maximum loan value’’ of amount approximately 70 percent of the collateral for a regulated loan, a the prices of said shares. telephone interview will be done as a (c) The Board held that the loans matter of course. were for the purpose of purchasing the (d) One of the stated purposes of Reg- shares, and therefore subject to the ulation X (12 CFR part 224) was to pre- limitations prescribed by this part. As vent the infusion of unregulated credit pointed out in § 221.114 with respect to into the securities markets by bor- a similar program for putting a high rowers falsely certifying the purpose of proportion of cash income into stock, a loan. The Board is of the view that the borrowing against the margin the existence of Regulation X (12 CFR stock to meet needs for which the cash part 224), which makes the borrower would otherwise have been required, a liable for willful violations of the mar- contrary conclusion could largely de- gin regulations, will allow a lender sub- feat the basic purpose of the margin ject to this part to meet the good faith regulations. acceptance requirement of § 221.3(c) (d) Also considered was an alter- without a face-to-face interview if the native proposal under which X would lender adopts a program, such as the deposit proceeds from accounts receiv- one described in paragraph (c) of this able in a time account for 1 year, be- section, which requires additional de- fore using those funds to purchase mu- tailed information from the borrower tual fund shares. The Board held that and proper procedures are instituted to this procedure would not change the verify the truth of the information re- situation in any significant way. Once ceived. Lenders intending to embark on the arrangement was established, the a similar program should discuss pro- proceeds would be flowing into the posed plans with their district Federal time account at the same time that Reserve Bank. Lenders may have exist- similar amounts were released to pur- ing or future loans with the prospec- chase the shares, and over any ex- tive customers which could complicate tended period of time the result would the efforts to determine the true pur- be the same. Accordingly, the Board concluded that bank loans made under pose of the loan. the alternative proposal would simi- larly be subject to this part.

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§ 221.117 When bank in ‘‘good faith’’ (b) The Board understood that any has not relied on stock as collateral. officer or employee included under the (a) The Board has received questions corporation’s stock option plan who regarding the circumstances in which wished to exercise his option could ob- an extension or maintenance of credit tain a loan for the purchase price of will not be deemed to be ‘‘indirectly se- the stock by executing an unsecured cured’’ by stock as indicated by the note to the bank. The corporation phrase, ‘‘if the lender, in good faith, would issue to the bank a guaranty of has not relied upon the margin stock the loan and hold the purchased shares as collateral,’’ contained in paragraph as collateral to secure it against loss (2)(iv) of the definition of indirectly se- on the guaranty. Stock of the corpora- cured in § 221.2. tion is registered on a national securi- (b) In response, the Board noted that ties exchange and therefore qualifies as in amending this portion of the regula- ‘‘margin stock’’ under this part. tion in 1968 it was indicated that one of (c) A nonbank lender is subject to the the purposes of the change was to registration and other requirements of make clear that the definition of indi- this part if, in the ordinary course of rectly secured does not apply to certain his business, he extends credit on col- routine negative covenants in loan lateral that includes any margin stock agreements. Also, while the question of in the amount of $200,000 or more in whether or not a bank has relied upon particular stock as collateral is nec- any calendar quarter, or has such cred- essarily a question of fact to be deter- it outstanding in any calendar quarter mined in each case in the light of all in the amount of $500,000 or more. The relevant circumstances, some indica- Board understood that the corporation tion that the bank had not relied upon in question had sufficient guaranties stock as collateral would seem to be af- outstanding during the applicable cal- forded by such circumstances as the endar quarter to meet the dollar fact that: thresholds for registration. (1) The bank had obtained a reason- (d) In the Board’s judgment a person ably current financial statement of the who guarantees a loan, and thereby be- borrower and this statement could rea- comes liable for the amount of the loan sonably support the loan; and in the event the borrower should de- (2) The loan was not payable on de- fault, is lending his credit to the bor- mand or because of fluctuations in rower. In the circumstances described, market value of the stock, but instead such a lending of credit must be consid- was payable on one or more fixed ma- ered an ‘‘extension of credit’’ under turities which were typical of matu- this part in order to prevent cir- rities applied by the bank to loans oth- cumvention of the regulation’s limita- erwise similar except for not involving tion on the amount of credit that can any possible question of stock collat- be extended on the security of margin eral. stock. § 221.118 Bank arranging for extension (e) Under § 221.2, the term in the ordi- of credit by corporation. nary course of business means ‘‘occurring or reasonably expected to occur in car- (a) The Board considered the ques- tions whether: rying out or furthering any business (1) The guaranty by a corporation of purpose. * * *’’ In general, stock option an ‘‘unsecured’’ bank loan to exercise plans are designed to provide a com- an option to purchase stock of the cor- pany’s employees with a proprietary poration is an ‘‘extension of credit’’ for interest in the company in the form of the purpose of this part; ownership of the company’s stock. (2) Such a guaranty is given ‘‘in the Such plans increase the company’s ordinary course of business’’ of the cor- ability to attract and retain able per- poration, as defined in § 221.2; and sonnel and, accordingly, promote the (3) The bank involved took part in ar- interest of the company and its stock- ranging for such credit on better terms holders, while at the same time pro- than it could extend under the provi- viding the company’s employees with sions of this part. additional incentive to work toward

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the company’s future success. An ar- lender, conforms with the requirements rangement whereby participating em- of the regulation, the fact that option ployees may finance the exercise of and credit are provided for in separate their options through an unsecured documents is immaterial. It should be bank loan guaranteed by the company, emphasized that the Board does not ex- thereby facilitating the employees’ ac- press any view on the preferability of quisition of company stock, is likewise qualified as opposed to nonqualified op- designed to promote the company’s in- tions; its role is merely to prevent ex- terest and is, therefore, in furtherance cessive credit in this area. of a business purpose. (c) Section 221.4(a) provides that a (f) For the reasons indicated, the plan-lender may include a wholly- Board concluded that under the cir- owned subsidiary of the issuer of the cumstances described a guaranty by collateral (taking as a whole, corporate the corporation constitutes credit ex- groups including subsidiaries and affili- tended in the ordinary course of busi- ates). This clarifies the Board’s intent ness under this part, that the corpora- that, to qualify for special treatment tion is required to register pursuant to under that section, the lender must § 221.3(b), and that such guaranties may stand in a special employer-employee not be given in excess of the maximum relationship with the borrower, and a loan value of the collateral pledged to special relationship of issuer with re- secure the guaranty. gard to the collateral. The fact that (g) Section 221.3(a)(3) provides that the Board, for convenience and prac- ‘‘no lender may arrange for the exten- tical reasons, permitted the employing sion or maintenance of any purpose corporation to act through a subsidiary credit, except upon the same terms and or other entity should not be inter- conditions on which the lender itself preted to mean the Board intended the may extend or maintain purpose credit lender to be other than an entity whose under this part’’. Since the Board con- overriding interests were coextensive cluded that the giving of a guaranty by with the issuer. An independent cor- the corporation to secure the loan de- poration, with independent interests scribed above constitutes an extension was never intended, regardless of form, of credit, and since the use of a guar- to be at the base of exempt stock-plan anty in the manner described could not lending. be effectuated without the concurrence of the bank involved, the Board further § 221.120 Allocation of stock collateral concluded that the bank took part in to purpose and nonpurpose credits ‘‘arranging’’ for the extension of credit to same customer. in excess of the maximum loan value of (a) A bank proposes to extend two the margin stock pledged to secure the credits (Credits A and B) to its cus- guaranties. tomer. Although the two credits are § 221.119 Applicability of plan-lender proposed to be extended at the same provisions to financing of stock op- time, each would be evidenced by a sep- tions and stock purchase rights arate agreement. Credit A would be ex- qualified or restricted under Inter- tended for the purpose of providing the nal Revenue Code. customer with working capital (non- (a) The Board has been asked wheth- purpose credit), collateralized by mar- er the plan-lender provisions of gin stock. Credit B would be extended § 221.4(a) and (b) were intended to apply for the purpose of purchasing or car- to the financing of stock options re- rying margin stock (purpose credit), stricted or qualified under the Internal without collateral or on collateral Revenue Code where such options or other than stock. the option plan do not provide for such (b) This part allows a bank to extend financing. purpose and nonpurpose credits simul- (b) It is the Board’s experience that taneously or successively to the same in some nonqualified plans, particu- customer. This rule is expressed in larly stock purchase plans, the credit § 221.3(d)(4) which provides in substance arrangement is distinct from the plan. that for any nonpurpose credit to the So long as the credit extended, and par- same customer, the lender shall in ticularly, the character of the plan- good faith require as much collateral

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not already identified to the cus- credit is secured, directly or indirectly, tomer’s purpose credit as the lender by any margin security, the creditor would require if it held neither the pur- must register and the credit must con- pose loan nor the identified collateral. form with either the regular margin re- This rule in § 221.3(d)(4) also takes into quirements of § 221.3(a) or the special account that the lender would not nec- ‘‘plan-lender’’ provisions set forth in essarily be required to hold collateral § 221.4, whichever is applicable. This as- for the nonpurpose credit if, consistent sumes, of course, that the amount of with good faith banking practices, it credit extended is such that the cred- would normally make this kind of non- itor is subject to the registration re- purpose loan without collateral. quirements of § 221.3(b). (c) The Board views § 221.3(d)(4), when read in conjunction with § 221.3(c) and § 221.122 Applicability of margin re- (f), as requiring that whenever a lender quirements to credit in connection extends two credits to the same cus- with Insurance Premium Funding Programs. tomer, one a purpose credit and the other nonpurpose, any margin stock (a) The Board has been asked numer- collateral must first be identified with ous questions regarding purpose credit and attributed to the purpose loan by in connection with insurance premium taking into account the maximum loan funding programs. The inquiries are in- value of such collateral as prescribed cluded in a set of guidelines in the for- in § 221.7 (the Supplement). mat of questions and answers. (The (d) The Board is further of the opin- guidelines are available pursuant to ion that under the foregoing cir- the Board’s Rules Regarding Avail- cumstances Credit B would be indi- ability of Information, 12 CFR part rectly secured by stock, despite the 261.) A glossary of terms customarily fact that there would be separate loan used in connection with insurance pre- agreements for both credits. This con- mium funding credit activities is in- clusion flows from the circumstance cluded in the guidelines. Under a typ- that the lender would hold in its pos- ical insurance premium funding pro- session stock collateral to which it gram, a borrower acquires mutual fund would have access with respect to Cred- shares for cash, or takes fund shares it B, despite any ostensible allocation which he already owns, and then uses of such collateral to Credit A. the loan value (currently 50 percent as set by the Board) to buy insurance. § 221.121 Extension of credit in certain Usually, a funding company (the stock option and stock purchase issuer) will sell both the fund shares plans. and the insurance through either inde- Questions have been raised as to pendent broker/dealers or subsidiaries whether certain stock option and stock or affiliates of the issuer. A typical purchase plans involve extensions of plan may run for 10 or 15 years with an- credit subject to this part when the nual insurance premiums due. To illus- participant is free to cancel his partici- trate, assuming an annual insurance pation at any time prior to full pay- premium of $300, the participant is re- ment, but in the event of cancellation quired to put up mutual fund shares the participant remains liable for dam- equivalent to 250 percent of the pre- ages. It thus appears that the partici- mium or $600 ($600 × 50 percent loan pant has the opportunity to gain and value equals $300 the amount of the in- bears the risk of loss from the time the surance premium which is also the transaction is executed and payment is amount of the credit extended). deferred. In some cases brought to the (b) The guidelines referenced in para- Board’s attention damages are related graph (a) of this section also: to the market price of the stock, but in (1) Clarify an earlier 1969 Board inter- others, there may be no such relation- pretation to show that the public offer- ship. In either of these circumstances, ing price of mutual fund shares (which it is the Board’s view that such plans includes the front load, or sales com- involve extensions of credit. Accord- mission) may be used as a measure of ingly, where the security being pur- their current market value when the chased is a margin security and the shares serve as collateral on a purpose

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credit throughout the day of the pur- which, by their terms, would be unse- chase of the fund shares; and cured. If the is successful, (2) Relax a 1965 Board position in con- the shell corporation would seek to nection with accepting purpose state- merge with Company B. However, the ments by mail. tender offer seeks to acquire fewer (c) It is the Board’s view that when it shares of Company B than is necessary is clearly established that a purpose under state law to effect a short form statement supports a purpose credit merger with Company B, which could then such statement executed by the be consummated without the approval borrower may be accepted by mail, pro- of shareholders or the board of direc- vided it is received and also executed tors of Company B. by the lender before the credit is ex- (c) The purchase of the debt securi- tended. ties issued by the shell corporation to finance the acquisition clearly involves § 221.123 Combined credit for exer- purpose credit (as defined in § 221.2). In cising employee stock options and addition, such debt securities would be paying income taxes incurred as a purchased only by sophisticated inves- result of such exercise. tors in very large minimum denomina- (a) Section 221.4(a) and (b), which tions, so that the purchasers may be provides special treatment for credit lenders for purposes of this part. See extended under employee stock option § 221.3(b). Since the debt securities con- plans, was designed to encourage their tain no direct security agreement in- use in recognition of their value in giv- volving the margin stock, applicability ing an employee a proprietary interest of the lending restrictions of this part in the business. Taking a position that turns on whether the arrangement con- might discourage the exercise of op- stitutes an extension of credit that is tions because of tax complications secured indirectly by margin stock. would conflict with the purpose of (d) As the Board has recognized, indi- § 221.4(a) and (b). rect security can encompass a wide va- (b) Accordingly, the Board has con- riety of arrangements between lenders cluded that the combined loans for the and borrowers with respect to margin exercise of the option and the payment stock collateral that serve to protect of the taxes in connection therewith the lenders’ interest in assuring that a under plans complying with § 221.4(a)(2) credit is repaid where the lenders do may be regarded as purpose credit with- not have a conventional direct security in the meaning of § 221.2. interest in the collateral. See § 221.124. However, credit is not ‘‘indirectly se- § 221.124 Purchase of debt securities cured’’ by margin stock if the lender in to finance corporate takeovers. good faith has not relied on the margin (a) Petitions have been filed with the stock as collateral extending or main- Board raising questions as to whether taining credit. See § 221.2. the margin requirements in this part (e) The Board is of the view that, in apply to two types of corporate acqui- the situation described in paragraph (b) sitions in which debt securities are of this section, the debt securities issued to finance the acquisition of would be presumed to be indirectly se- margin stock of a target company. cured by the margin stock to be ac- (b) In the first situation, the acquir- quired by the shell acquisition vehicle. ing company, Company A, controls a The staff has previously expressed the shell corporation that would make a view that nominally unsecured credit tender offer for the stock of Company extended to an investment company, a B, which is margin stock (as defined in substantial portion of whose assets § 221.2). The shell corporation has vir- consist of margin stock, is indirectly tually no operations, has no significant secured by the margin stock. See Fed- business function other than to acquire eral Reserve Regulatory Service 5– and hold the stock of Company B, and 917.12. (See 12 CFR 261.10(f) for informa- has substantially no assets other than tion on how to obtain Board publica- the margin stock to be acquired. To fi- tions.) This opinion notes that the in- nance the tender offer, the shell cor- vestment company has substantially poration would issue debt securities no assets other than margin stock to

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support indebtedness and thus credit presumed to be relying on the assets of could not be extended to such a com- the target for repayment. pany in good faith without reliance on (g) In addition, the Board is of the the margin stock as collateral. view that the debt securities described (f) The Board believes that this ra- in paragraph (b) of this section are in- tionale applies to the debt securities directly secured by margin stock be- issued by the shell corporation de- cause there is a practical restriction on scribed in paragraph (b) of this section. the ability of the shell corporation to At the time the debt securities are dispose of the margin stock of the tar- issued, the shell corporation has sub- get company. Indirectly secured is de- stantially no assets to support the fined in § 221.2 to include any arrange- credit other than the margin stock ment under which the customer’s right that it has acquired or intends to ac- quire and has no significant business or ability to sell, pledge, or otherwise function other than to hold the stock dispose of margin stock owned by the of the target company in order to fa- customer is in any way restricted while cilitate the acquisition. Moreover, it is the credit remains outstanding. The possible that the shell may hold the purchasers of the debt securities issued margin stock for a significant and in- by a shell corporation to finance a definite period of time, if defensive attempt clearly understand measures by the target prevent con- that the shell corporation intends to summation of the acquisition. Because acquire the margin stock of the target of the difficulty in predicting the out- company in order to effect the acquisi- come of a contested takeover at the tion of that company. This under- time that credit is committed to the standing represents a practical restric- shell corporation, the Board believes tion on the ability of the shell corpora- that the purchasers of the debt securi- tion to dispose of the target’s margin ties could not, in good faith, lend with- stock and to acquire other assets with out reliance on the margin stock as the proceeds of the credit. collateral. The presumption that the (h) In the second situation, Company debt securities are indirectly secured C, an operating company with substan- by margin stock would not apply if tial assets or cash flow, seeks to ac- there is specific evidence that lenders quire Company D, which is signifi- could in good faith rely on assets other cantly larger than Company C. Com- than margin stock as collateral, such pany C establishes a shell corporation as a guaranty of the debt securities by the shell corporation’s parent company that together with Company C makes a or another company that has substan- tender offer for the shares of Company tial non-margin stock assets or cash D, which is margin stock. To finance flow. This presumption would also not the tender offer, the shell corporation apply if there is a merger agreement would obtain a bank loan that complies between the acquiring and target com- with the margin lending restrictions of panies entered into at the time the this part and Company C would issue commitment is made to purchase the debt securities that would not be di- debt securities or in any event before rectly secured by any margin stock. loan funds are advanced. In addition, The Board is of the opinion that these the presumption would not apply if the debt securities should not be presumed obligation of the purchasers of the debt to be indirectly secured by the margin securities to advance funds to the shell stock of Company D, since, as an oper- corporation is contingent on the shell’s ating business, Company C has sub- acquisition of the minimum number of stantial assets or cash flow without re- shares necessary under applicable state gard to the margin stock of Company law to effect a merger between the ac- D. Any presumption would not be ap- quiring and target companies without propriate because the purchasers of the the approval of either the shareholders debt securities may be relying on as- or directors of the target company. In sets other than margin stock of Com- these two situations where the merger pany D for repayment of the credit. will take place promptly, the Board be- lieves the lenders could reasonably be

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§ 221.125 Credit to brokers and deal- Subpart D—Medical Information ers. 222.30 Obtaining or using medical informa- (a) The National Securities Markets tion in connection with a determination Improvement Act of 1996 (Pub. L. 104– of eligibility for credit. 290, 110 Stat. 3416) restricts the Board’s 222.31 Limits on redisclosure of informa- margin authority by repealing section tion. 8(a) of the Securities Exchange Act of 222.32 Sharing medical information with af- 1934 (the Exchange Act) and amending filiates. section 7 of the Exchange Act (15 Subpart E—Duties of Furnishers of U.S.C. 78g) to exclude the borrowing by Information a member of a national securities ex- change or a registered broker or dealer 222.40 Scope. ‘‘a substantial portion of whose busi- 222.41 Definitions. ness consists of transactions with per- 222.42 Reasonable policies and procedures sons other than brokers or dealers’’ and concerning the accuracy and integrity of borrowing by a member of a national furnished information. securities exchange or a registered 222.43 Direct disputes. broker or dealer to finance its activi- ties as a market maker or an under- Subpart F [Reserved] writer. Notwithstanding this exclusion, Subpart H—Duties of Users Regarding Risk- the Board may impose such rules and Based Pricing regulations if it determines they are ‘‘necessary or appropriate in the public 222.70 Scope. interest or for the protection of inves- 222.71 Definitions. tors.’’ 222.72 General requirements for risk-based (b) The Board has not found that it is pricing notices. necessary or appropriate in the public 222.73 Content, form, and timing of risk- based pricing notices. interest or for the protection of inves- 222.74 Exceptions. tors to impose rules and regulations re- 222.75 Rules of construction. garding loans to brokers and dealers covered by the National Securities Subpart I—Duties of Users of Consumer Re- Markets Improvement Act of 1996. ports Regarding Address Discrep- ancies and Records Disposal PART 222—FAIR CREDIT REPORTING 222.80–222.81 [Reserved] (REGULATION V) 222.82 Duties of users regarding address dis- crepancies. Subpart A—General Provisions 222.83 Disposal of consumer information.

Sec. Subpart J—Identity Theft Red Flags 222.1 Purpose, scope, and effective dates. 222.2 Examples. 222.90 Duties regarding the detection, pre- 222.3 Definitions. vention, and mitigation of identity theft. 222.91 Duties of card issuers regarding Subpart B [Reserved] changes of address. APPENDIX A TO PART 222 [RESERVED] Subpart C—Affiliate Marketing APPENDIX B TO PART 222—MODEL NOTICES OF FURNISHING NEGATIVE INFORMATION 222.20 Coverage and definitions. APPENDIX C TO PART 222—MODEL FORMS FOR 222.21 Affiliate marketing opt-out and ex- OPT-OUT NOTICES ceptions. APPENDIX D TO PART 222 [RESERVED] 222.22 Scope and duration of opt-out. APPENDIX E TO PART 222—INTERAGENCY 222.23 Contents of opt-out notice; consoli- GUIDELINES CONCERNING THE ACCURACY dated and equivalent notices. AND INTEGRITY OF INFORMATION FUR- 222.24 Reasonable opportunity to opt out. NISHED TO CONSUMER REPORTING AGEN- 222.25 Reasonable and simple methods of CIES opting out. APPENDIX F–G TO PART 222 [RESERVED] 222.26 Delivery of opt-out notices. APPENDIX H TO PART 222—MODEL FORMS FOR 222.27 Renewal of opt-out. RISK-BASED PRICING AND CREDIT SCORE 222.28 Effective date, compliance date, and DISCLOSURE EXCEPTION NOTICES prospective application. APPENDIX I TO PART 222 [RESERVED]

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