Regulation O guide: Practical tips to keep you in compliance

Although Regulation O has been in place since the 1930s, many banks still struggle with its requirements. However, failure to comply can lead to significant penalties and reputational risk.

This guide covers common questions about Regulation O, regulatory requirements, common mistakes banks make and practical steps for compliance:

What is Regulation O?

Regulation O is a U.S. banking regulation issued by the Federal Reserve Board that governs loans to insiders of a bank. Specifically, it sets rules and restrictions on extensions of credit to executive officers, directors, principal shareholders and their related interests to prevent conflicts of interest and ensure safe banking practices.

What is the purpose of Regulation O?

The purpose of Regulation O in banking is to prevent preferential treatment in lending by banks to their own insiders. It also covers related interests of bank insiders and insiders of any affiliates.

It’s designed to ensure that credit extended to these individuals is made on terms no more favorable than those offered to other borrowers, thereby:

• Promoting fairness.
• Reducing conflicts of interest.
• Ensuring the banking system’s safety and soundness.

Who is considered an insider under Regulation O?

Regulation O defines an insider as an executive officer, director or principal shareholder and includes any related interest of such a person.

The regulation further defines an executive officer as:

• A person who participates or has authority to participate (other than in the capacity of a director) in major policymaking functions of the company or bank, whether or not: the officer has an official title; the title designates the officer an assistant; or the officer is serving without salary or other compensation.
• The chairman of the board, the president, every vice president, the cashier, the secretary and the treasurer of a company or bank are considered executive officers. However, they would not be considered executive officers if excluded, by resolution of the board of directors or by the bylaws of the bank or company, from participation (other than in the capacity of a director) in major policymaking functions of the bank or company, and they do not actually participate therein.

Does Regulation O have reporting requirements?

According to section Regulation O, section 215.10,  “each executive officer or director of a member bank the shares of which are not publicly traded shall report annually to the board of directors of the member bank the outstanding amount of any credit that was extended to the executive officer or director and that is secured by shares of the member bank.”

What are the penalties for violating Regulation O?

According to section 215.11, “any member bank, or any officer, director, employee, agent, or other person participating in the conduct of the affairs of the bank, that violates any provision of this part (other than section 215.9) is subject to civil penalties as specified in section 29 of the Federal Reserve Act.”

Regulation O implementation

Implementing Regulation O effectively starts with understanding who qualifies as an insider.

Make sure to obtain an annual board resolution to specify which employees participate in major policymaking functions of the bank, irrespective of title. You’ll also need to identify employees who have a title meeting the definition of an executive officer for Regulation O but do not actually participate in major policymaking functions.

Oftentimes, the chairman of the board, the president, every vice president, the cashier, the secretary and the treasurer of a company or bank are overlooked.

Unfortunately, “authority to participate” and “major policymaking functions” are not defined by Regulation O; however, there was an advisory opinion published by the FDIC (Advisory Opinion 94-22) in 1994.

The opinion provided that an employee whose sole responsibility is the administration of bank policy would not be considered an executive officer. However, an individual would be considered to have “authority to participate” if they participate in the formulation and implementation of such policies and do not merely apply policies already established by another person. This would be the case even if the decisions are subject to review and approval by a board or designated executive officer. 

The opinion also advises that major policymaking functions are not limited to just lending policies but may also include bank functions such as audit, investments and trust activities. This is not an exhaustive list, and the FDIC will look at each bank individually to determine areas of the bank’s operations and policies that cover these key areas.

Regulation O overdraft rules

Another section of Regulation O where banks face challenges addresses overdrafts.

The regulation states that “No bank may pay an overdraft of an executive officer or director of the bank or executive officer or director of its affiliates on an account at the bank, unless the payment of funds is made in accordance with a written, preauthorized, interest-bearing extension of credit plan that specifies a method of repayment or a written, preauthorized transfer of funds from another account of the account holder at the bank.”

Regulation O does provide an exception allowing the payment of inadvertent overdrafts as long as:

• The aggregate debt does not exceed $1,000.
• The account is not overdrawn for more than five business days.
• The insider is charged the same fee as any other customer of the bank.

In cases where the $1,000 limit is forgotten, and the account is overdrawn by more than the exception allows, it would still be considered a violation even if the insider is charged the normal fee.

Some banks have a practice of contacting the insider to “cover” the amount before the cutoff time to make the pay or return decision. Unless the bank is also contacting all non-insiders to cover their overdrafts as well, this could possibly be considered preferential treatment.

Also, be sure to monitor overdrafts on accounts where the insider is not the primary account holder. It is common for the insider to be an owner of an account with their children or perhaps a joint account holder with a spouse. When the child or spouse overdraws the account, this would still be a Regulation O violation unless it meets one of the exception requirements noted above.

Regulation O requirements

Some additional Regulation O requirements include:

Current financial statement submission

One of the extra requirements applicable only to executive officers is that extensions of credit to executive officers must be preceded by the submission of their detailed, current financial statement.  

The regulation does not define what is considered “current.” Typically, a financial statement would be considered current if it was no more than one year old. However, the bank should look at its internal policies on financial statements to determine what is required of non-insiders and ensure the executive officer’s financial statement follows those same requirements.

Annual surveys

Under Regulation O, banks must perform annual surveys to identify all related interests of executive officers, directors and principal shareholders.

This recordkeeping requirement is often misunderstood, and annual surveys are not taken or not documented. In some cases, only directors are required to complete the survey, while executive officers and principal shareholders are missed.

Be sure to put annual surveys of insiders on the board agenda every year, preferably during the same month each year, to make it less likely to be forgotten. Also, be sure to obtain an annual survey response from every director, executive officer and principal shareholder.

Preapproval rules

One final Regulation O requirement to consider is the preapproval rules for an extension of credit.

An extension of credit is the making or renewing of any loan, the granting of a line of credit or the extension of credit in any manner whatsoever. Many times, loans are renewed, and the bank forgets to obtain board approval for the renewal prior to actually renewing the credit when the aggregate debt amount would require preapproval.

Regulation O states that no bank may extend credit to any insider of the bank or insider of its affiliates in an amount that, when aggregated with the amount of all other extensions of credit to that person and to all related interests of that person, exceeds the higher of $25,000 or 5% of the bank’s unimpaired capital and unimpaired surplus.

In no event can they extend credit more than $500,000 unless the extension of credit has been approved in advance by a majority of the entire board of directors of that bank, and the interested party has abstained from participating directly or indirectly in the voting.

Also, make sure that the board minutes explicitly state that the insider for whom the credit is being pre-approved has abstained from the vote to avoid any confusion.

Why Wipfli

Ready to strengthen your Regulation O compliance? Wipfli’s team includes former bank professionals who understand your industry and regulatory challenges. Reach out to our financial services team today to learn how we can help you simplify compliance and protect your institution.

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