91-3

April 9, 1991

Re: Financial Code Section 3372 and Section 215.5 of Regulation O Interpretive Opinion

Dear M ________:

This letter is written in response to your letter of September 19, 1990. A copy of ________ letter dated August 23, 1990 was attached to your letter.

Your letter requests an opinion from the State Banking Department (the “Department”) regarding the issues set forth both in your letter and more specifically in ________ letter of whether Section 215.5 of Regulation O as incorporated into the Banking Law by Financial Code Section 3372 (the “Incorporated Section 215.5 of Regulation O”) is applicable to ________ (the “Bank”) and whether the Bank violated the Incorporated Section 215.5 of Regulation O in making a loan to ________, an executive officer of the Bank, in an amount exceeding $100,000 (the “Loan”).

The Loan has been cited as a violation of state law in the State Report of Examination for the Bank made as of close of business March 31, 1990, on May 21, 1990 (the “Report”). The Report was sent to the Bank on February 25, 1991.

After review of your letter, ________ letter, and the legal authorities cited in ________ letter, we have concluded that the incorporated Section 215.5 of Regulation O is applicable to the Bank and the Bank violated the incorporated Section 215.5 of Regulation O when the Bank made the Loan.

The present Article 2 (commencing with Section 3370) was added to Chapter 18 of the Banking Law effective April 1, 1985 (“Article 2”). According to the Legislative Counsel’s Digest for Assembly Bill No. 2734 enacted as Chapter 975 of the Statutes of 1984, operative April 1, 1985, Article 2 “would incorporate as state law specified provisions of federal regulations with certain designated exceptions relating to loans to executive officers, ________ directors, ________ and principal shareholders of member banks.” (Underscoring added.) This intent is made clear by the plain meaning and express language of Financial Code Section 3372 which expressly provides that certain specified sections of Regulation O, including Section 215.5, are incorporated into Article 2 of Chapter 18 of the Banking Law. Furthermore, Financial Code Section 3372(b) provides that the term “member bank” as used in the referenced sections of Regulation O, shall be construed to have the same meaning as “bank” as defined in Financial Code Section 3371. Financial Code Section 3371 defines “bank” to include any commercial bank or trust company incorporated under the law of this state. Consequently, Financial Code Section 3372 makes applicable to state nonmember banks certain provisions of Regulation O, including Section 215.5, which are also applicable only to member banks in the federal context.

The footnote 5 to Section 215.5 of Regulation O (the “footnote”) which is discussed in _____ letter is only meaningful in the context of federal law where there is a distinction drawn between member banks and non-member banks for purposes of determining the applicability of Federal Reserve regulations. There is no such distinction drawn in the context of Article 2. The footnote is not meaningful in the context of Article 2 as to the Bank since Section 215.5 of Regulation O is made applicable to any commercial bank or trust company pursuant to Article 2.

The main point to be made here is that Article 2 created a statutory scheme whereby certain federal laws and regulations applicable only to member banks of the Federal Reserve System are made applicable to all state-chartered banks and trust companies whether or not members of the Federal Reserve System. The footnote is only explanatory of how the federal statutes carry over into federal regulations and is only operative in the federal context. Outside the federal context, in the state context, the footnote is meaningless since Article 2 applies to all state-chartered bank and trust companies whether or not members of the Federal Reserve System. Seizing upon the footnote and giving it a literal application outside the federal context thwarts the basic statutory scheme. Such a result was not intended by the Legislature and is contrary to the plain meaning of Article 2.

This opinion is limited to the question of whether the Bank violated the Incorporated Section 215.5 of Regulation O in making the Loan. There are also other violations of Regulation O cited in the Report to which this interpretive opinion may also be applicable.

Please contact us if you have any questions regarding this matter.

Very truly yours,

JAMES E. GILLERAN
Superintendent of Banks

By

DIANA H. NISHIURA
Counsel

——————————————————————————–

September l9, 1990

Mr. James Gilleran
State Banking Department
111 Pine Street, Suite 1100
San Francisco, CA 94111-5613

Dear Superintendent Gilleran:

In May of this year, ________ was examined by the State Banking Department. The examination leader was Examiner Don King. In the course of the examination Mr. King criticized our loan to ________ for exceeding a $100,000 limit for executive officers of the bank.

We explained the rationale for our position that the loan did not violate regulations. Mr. King checked with his office and confirmed that the loan would be criticized. We asked for a legal opinion from the State Banking Department that would interpret the regulations. Mr. King informed us that the proper procedure would be for us to secure our own attorney’s opinion and forward it to the State Banking Department for reaction and an opinion from the Legal Department.

We did contact our attorney and requested his opinion. A copy of that opinion is attached to this letter. His opinion supports our position. Therefore, we respectfully request that this letter, together with the attached legal opinion be evaluated by your Legal Department.

Sincerely,

Enclosure

cc: Bill Adams, Deputy Superintendent, Los Angeles Don King, Examiner, Los Angeles

——————————————————————————–

August 23, 1991

Re: Section 215. 5 of Regulation O and Section 3372 of the California Financial Code

Dear M ________:

We have reviewed your memorandum dated August 1, 1990 with regard to Regulation O of the Federal Reserve Board (“Regulation O”) and Section 3370 et seq. of the California Financial Code (the “Code”). As we understand the facts, the Bank has loaned ________, as an individual borrower, who is considered to be an executive officer of the Bank, funds in excess of $100,000. It is our understanding that the examiners of the California State Banking Department (the “Department”) believe that the Bank is subject to the $100,000 limitation contained in Section 215.5 of Regulation O and that the Bank has therefore violated Regulation O and Section 3372 of the Code.

We have reviewed the Federal Reserve Act, as amended, the Code, as amended, the Federal Deposit Insurance Act, as amended, we have reviewed the rules and regulations promulgated thereunder as well as several interpretive rulings of the Federal Deposit Insurance Corporation. Based upon our review of such statutes, rules, regulations, rulings and discussions, we believe a technical reading of the precise statutory language of Section 3372 of the Code supports the Bank’s position that Section 215.5 of Regulation O does not apply to the loan to ________, and that therefore there has been no violation of Regulation O or of Section 3372 of the Code.

In reaching this conclusion, please note, however, that no formal reported case law has developed that interprets this portion of Regulation O or Section 3370 et seq. of the Code.

Although a technical reading of Regulation O and Section 3372 of the Code indicates that a violation has not occurred, it also seems reasonable to question whether Section 3372 of the Code was drafted with the intent to exclude Section 215.5 of Regulation O, especially in light of the language contained in Section 3372.5 of the Code. Since there is no specific legislative history on this point other than the general comments contained in Section 3370 of the Code, the only way to resolve this matter is for the California State Banking Department to issue a formal interpretive ruling or for Section 3372 to be amended by the California legislature. In view of the present statutory language, and the unlikely event of prompt legislative action to amend Section 3372 of the Code, we suggest that the Department be requested to issue a formal interpretative ruling so that the Bank is advised of the Department’s analysis and as to how this issue should be handled. The following paragraphs will review and discuss our analysis.

Federal Reserve Board Regulation O implements Section 22(h) of the Federal Reserve Act which is made applicable to insured non-member banks through Section 18(j) of the Federal Deposit Insurance Act. Section 22(h)(1) generally provides that no member bank shall make any loan or extension of credit to its executive officers or principal shareholders that is in excess of the limits on loans to a single borrower established by Section 5200 of the Revised Statutes. The limit established by Section 5200 is 15% of the Bank’s paid-in capital and unimpaired surplus. 12 CRF Section 215.5 generally provides an overall limitation of loans to executive officers of member-banks of $100,000. This limitation is derived from Section 22(g) of the Federal Reserve Act, which was not made applicable to state non-member banks by the provisions of the Federal Deposit Insurance Act. Therefore, a fair reading of the statutes and regulations indicates that Section 215.5 does not apply to state non-member banks. This conclusion is confirmed in footnote to Section 215.5, and has been confirmed with the legal division of the Federal Deposit Insurance Corporation in San Francisco California. Section 3372 of the California Financial Code incorporates several provisions of Regulation O, including Section 215.4 and Section 215.5, including footnotes thereto. Since such incorporation includes footnotes which exclude the operation of Section 215.5 on state non-member banks, and since the California State Banking Department regulates member banks in which Section 215.5 is applicable, a strong argument can be made that while Section 215.5 applies to state member bans it does not apply to state non-member banks.

However, it appears that the legal division of the California State Banking Department does not apparently share our reading of Section 3370 et seq. My discussions with the Department indicate that the Department believes the footnote excluding operation of Section 215.5 from operation on state non-member banks is a federal footnote that is not applicable to the California Financial Code. This reasoning is very difficult to follow, especially when Section 3372 specifically includes footnotes and does not specifically exclude any particular footnote, such as the footnote to Section 215.5. We would strongly suggest that the Department issue a letter formally describing its interpretation in order to attempt to resolve this issue.

We trust that the information and conclusions set forth herein have answered your inquiry. If you should have any questions, please do not hesitate to contact the undersigned

Very truly yours,