Regulation O and Lending to a Child of an Insider

Issue/Inquiry

The Bank is considering making a loan to a child of one of its directors, who is an adult living outside the director’s home. The collateral for the loan will be pledged by the spouse of the director. Is this loan covered by Regulation O?

Response Summary

The child of an insider would not be considered a related interest of the insider, which is limited to a company or political campaign of the insider. However, the Bank should make a determination as to whether any of the loan proceeds will be transferred to the director, or whether the director will obtain a tangible economic benefit from the loan to the child.

Response Detail

Regulation O governs extensions of credit to insiders of a federally-regulated financial institution and their related interests. An “insider” is an executive officer, director, or principal shareholder of the institution and any related interest of such a person. A “related interest” is a company or political campaign controlled by that person. 12 CFR §215.2(h),(n).

The child or spouse of an insider would not be considered an insider on the basis of that person’s relationship with the insider, as neither is a company or political campaign of the insider and, therefore, is not a related interest. To the extent that the spouse was an insider, as through being a principal shareholder, Regulation O covers extensions of credit to an insider, and not pledges of collateral by an insider.

However, under the “beneficial interest” rule of Section 215.3(f) of Regulation O, an extension of credit to someone other than the insider can still be deemed to be to the insider if it appears that the purpose was to “mask” the intended beneficiary:

Tangible economic benefit rule – (1) In general. An extension of credit is considered made to an insider to the extent that the proceeds are transferred to the insider or are used for the tangible economic benefit of the insider.

The FDIC has interpreted this section to mean that if the proceeds of an extension of credit are transferred to someone covered by Regulation O, or if someone subject to Regulation O receives a direct or indirect economic benefit from an extension of credit, that extension of credit will be considered to have been made to such covered person. 12 CFR Part 4000, FDIC 89-36.

There is an exception to the tangible economic benefit rule, in that an extension of credit is not considered to be made to an insider if the proceeds of the extension of credit are used for a bona fide transaction to acquire property, goods, or services. 12 CFR §215.3(f)(2). The Bank should look into the purpose of the loan to determine whether this exception applies.

Barring any facts indicating that the loan proceeds would be transferred to the director, the question would be whether the director obtained a “tangible economic benefit” from their child receiving the loan. For example, if the child was a dependent of the director, such argument could be made since a loan to the child would ease the director’s burden in supporting the child. However, given that the child is an adult living outside the director’s home, this argument would not seem to be applicable.

Other examples of tangible economic benefits include a loan to a non-insider that makes it easier for the non-insider to pay his loan to the insider, or the granting of a line of credit or credit card to the non-insider that the insider was allowed to use.

As such, the Bank should make a determination as to whether the loan to the child of the director will confer a tangible economic benefit on the insider. If it does not, the loan would not be subject to the limitations of Regulation O.

This entry was posted on Monday, November 26th, 2018 at 6:00 am.