How Dodd-Frank Changed “Reg O”
March 31, 2014
It is difficult (if not impossible) for a community bank to stay current on all the new rules spawned by Dodd-Frank. (For example, the rules promulgated under Dodd-Frank could fill approximately 32 copies of the great but very, very long novel, War and Peace.) Naturally, certain rules have garnered most of the attention, but this does not mean those are the most impactful to community banks. Unfortunately, it only means other rules may have slipped by and may now just be lying in wait to catch you unaware. I fear that Dodd Frank’s amendments to Regulation O or Reg O (12 CFR 215) are one such trap. These rules may not have been the hot topic around the water cooler, but violations could still be very costly to both the individual and the bank.
Reg O limits the ability of banks to extend credit to its (or its parent’s, subsidiaries’ or affiliates’) executive officers, directors or principal shareholders (“Insiders”). Myriad rules, prohibitions and tests affect Reg O’s applicability to a specific transaction; each almost deserves its own article. But this article is not meant as a comprehensive overview of Reg O. It is only intended to address how Dodd-Frank changed it. To that end, this article discusses two of the main ways Dodd-Frank changed the analysis of Reg O transactions.
1. Dodd-Frank expanded the definition of what it means to extend credit to an Insider. “Extension of credit” is broadly defined as making or renewing a loan, granting a line of credit or extending credit in any manner (12 CFR 215.3). Furthermore, the regulations list specific examples of “extensions of credit.” These examples are a purchase under a repurchase agreement of certain securities, or other assets or obligations, advances, standby letters of credit, acquisitions of notes where the Insider is liable, increasing existing debt obligations, unearned salary advances for more than 30 days, certain loan participations, and guarantees and similar types of obligation. Dodd Frank added to this detailed list of what will constitute “extensions of credit.” Those additions include 1) derivative transactions, 2) repurchase agreements, 3) reverse repurchase agreements, 4) securities lending transactions, and 5) securities borrowing transactions. The broadening of the definition underscores that almost any transaction between a bank and its Insider should be thoroughly reviewed in the context of Reg O.
This revision came into effect on July 1, 2013.
2. Dodd-Frank further restricted the purchase or sell of an asset to an Insider. This is a common-sense type of rule and just good business practice (How often can one say that about a Dodd-Frank regulation?). The amendment prohibits a bank from purchasing an asset from an Insider or selling an asset to an Insider unless it is on market terms, and approved in advance by a majority of the bank’s board of directors not having an interest in the transaction if the proposed transaction represents more than 10% of the capital stock and surplus of the bank. This new provision reaffirms a dominant theme of Reg O by spelling out again that Insiders should not get preferential terms from their bank. It may seem to be common sense, but it happens all too often, as shown in excruciating detail by a recent American Banker article. If there are transactions with Insiders, then they should be at market terms – no “blue light” special or even a “Groupon” deal for Insiders. If an Insider wants a great deal or believes something is worth more than the bank determines is market, then the Insider should try to get that deal somewhere else.
These requirements became effective on July 21, 2011.
Reg O and the Dodd Frank amendments to it are detailed – much more detailed and comprehensive than I have the space to describe in this article. If you are dealing with an Insider transaction, consult Reg. O or a capable regulatory attorney. But regardless, I hope this article reminds you that in the post-Dodd-Frank world, one cannot rest on past knowledge or assumptions but must be constantly vigilant of changes to whatever regulatory regime that they are addressing. To paraphrase Donald Rumsfeld, “I know what I know, I know what I don’t know, but what really scares me are the things that I don’t know that I don’t know.”