Regulation O and Inaccurate Annual Surveys

Issue/Inquiry

Six of the directors of the Bank own a limited liability company that owns a commercial property leased to the Bank. Four of the directors reported their ownership interest on the annual Statement of Interest and two did not. Should the Statement of Interest be updated?

Response Summary

Regulation O is silent with respect to updating the Statement of Interest and only provides that it must be obtained on an annual basis. The Bank, however, should be aware of the ownership interest of the directors in the limited liability company, in the event that the company applies to the Bank for an extension of credit.

Response Detail

Regulation O requires a bank to maintain records necessary for compliance with the requirements of the regulation. 12 CFR 215.8(a).

Any recordkeeping method adopted by a bank must identify, through an annual survey, all insiders of the Bank. 12 CFR 215.8(b)(1). That means that, while the Bank may use other methods permitted by the regulation, it must perform an annual survey.

In this scenario, there is information indicating that six of the directors are members of a limited liability that owns a property leased to the Bank. Each director has an equal interest in the limited liability company. Four of the directors indicated their ownership interest in the annual survey and two did not.

Under Regulation O, the term “insider” refers to an executive officer, director, or principal shareholder, and includes any interest related to such. 12 CFR 215.2(h). The directors are thus insiders of the Bank. The question here is whether the limited liability company is a related interest of these insiders.

A “related interest” is a partnership, company, trust, or other enterprise that is controlled by a person or enterprise, or a political or campaign committee that is controlled by such person or the funds or services benefitting them. 12 CFR 215.2(n). A person or enterprise is deemed to have control over a company or bank if that person or enterprise, directly or indirectly, or acting through or in concert with one or more persons:

• Owns, controls, or has the power to vote 25 percent or more of any class of voting securities of the company or bank;
• Controls in any manner the election of a majority of the directors of the company or bank; or
• Has the power to exercise a controlling influence over the management or policies of the company or bank. 12 CFR 215.2(c)(1).

A person is presumed to have control, including the power to exercise a controlling influence over the management or policies, of a company if:

• The person is an executive officer or director of the company or bank; and
• Directly or indirectly owns, controls, or has the power to vote more than 10 percent of any class of voting securities of the company or bank;

Or:

• The person directly or indirectly own, controls, or has the power to vote more than 10 percent of any class of voting securities of the company or bank; and
• No other person owns, controls, or has the power to vote a greater percentage of that class of voting securities. 12 CFR 215.2(c)(2).

Whether the limited liability company is a related interest of a director of the Bank depends on whether the director has a controlling interest in it. Since each of the directors has a controlling interest in the company, each has 16.66 percent interest. While a limited liability company does not have “voting securities,” each director would have a controlling interest in the limited liability company, in that each has more than a 10 percent interest, but no director has a greater interest than any other director. This means that each director should have indicated in the annual survey that the limited liability company is a related interest. The failure to do so means that the annual survey is inaccurate.

Regulation O does not specify a time when the annual survey must be performed. That is up to the Bank. It is also silent as to whether an inaccurate annual survey can be corrected. In order to comply with the requirements of Regulation O, however, it is necessary for the Bank to be aware of the related interests of its directors and to act accordingly.

Regulation O permits the Bank to use the “borrower inquiry” method as part of its recordkeeping, in which the borrower would be required as part of an extension of credit to indicate whether the borrower is an insider of the Bank, or an alternate method that the appropriate Federal banking agency has determined to be as effective as the annual survey or borrower inquiry method. 12 CFR 215.8(c)(2), (3). This means that if the Bank were to make a loan to the limited liability company, it could use the borrower inquiry method to determine whether the limited liability company is an insider.

If the Bank uses the borrower inquiry method, that fact could be cited as well in order to mitigate the inaccuracy of the annual survey.

This response is for informational purposes only and is not intended for legal guidance.

This entry was posted on Monday, December 9th, 2019 at 6:00 am.