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Staying on the Right Side of Regulation O

Staying on the Right Side of Regulation O

Oct 30, 2017

Although Regulation O has been around since the 1930s, it is still sometimes easy to forget some of the requirements. This article includes some common mistakes to avoid and will help keep your Regulation O program compliant.

Regulation O 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, unless the officer is 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 the officer does not actually participate therein.” Oftentimes, this part of the regulation is forgotten and an employee such as a vice president or the secretary or the cashier has not been treated as an executive officer for Regulation O purposes, and a board resolution was not made or was not updated to accommodate changes in employee titles or positions. Make sure to obtain an annual board resolution to specify which employees participate in major policymaking functions of the bank, irrespective of title, and which have a title meeting the definition of an executive officer for Regulation O but do not actually participate in major policymaking functions.

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, but an individual who participates in the formulation and implementation of such policies and is not merely applying policies already established by another person would be considered to have “authority to participate” 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. 

Another Regulation O area that is problematic deals with overdrafts. “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 5 business days, and the insider is charged the same fee as any other customer of the bank. The $1,000 limit is sometimes forgotten, and the account is overdrawn by more than the exception allows. This is still a violation even if the insider is charged the normal fee. Also, 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.

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 a detailed current financial statement of the executive officer. 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 to 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 to identify all insiders of the bank are another requirement of Regulation O. In addition, the bank must maintain records of extensions of credit to insiders of the bank’s affiliates. This can be done through an annual survey or through borrower inquiry.  An annual survey helps to identify all related interest of executive officers, directors, and principal shareholders. Often we find the recordkeeping requirement can be misunderstood and annual surveys are not taken, not documented, or sometimes only directors are required to compete the survey, but executive officers and principal shareholders are missed. Be sure to put annual surveys of insiders on the board agenda every year, preferably 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.

One final Regulation O requirement to consider is the preapproval rules. 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 percent of the bank’s unimpaired capital and unimpaired surplus, but in no event 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. An extension of credit is the making or renewing of any loan, a granting of a line of credit, or extending 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. Also, make sure that the board minutes explicitly state that the insider for whom the credit is being pre-approved abstained from the vote. This will avoid any confusion.

In conclusion, Regulation O still has some areas that can trip you up if you’re not careful. By ensuring a board resolution is in place to define the bank’s executive officers, monitoring overdrafts and returning any items that would cause an overdraft exceeding $1,000, ensuring executive officers have current financial statements on file, obtaining annual surveys from every insider, and reviewing maturity dates to ensure applicable loans coming up for renewal receive prior board approval, you can reduce your risk of getting caught on one of these troublesome areas. 

Author(s)

Downey_Teri
Teri Downey, CRCM, CAMS, CFSA, CFIRS
Senior Manager
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