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Background and Summary of Regulation L

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The Depository Institution Management Interlocks Act was enacted as title II of the Financial Institutions Regulatory and Interest Rate Control Act of 1978. The general purpose of the Interlocks Act and Regulation L is to foster competition among depository institutions, depository holding companies, and their affiliates. The regulation defines terms used in the Interlocks Act and creates exceptions to its prohibitions. The exceptions are designed to foster community benefits that would result from the increased availability of managerial expertise to certain institutions and that would outweigh any adverse effects on competition. The regulation also specifies changes in circumstances that will cause nongrandfathered interlocking relationships to become impermissible under the act and provides for extensions of time for compliance with the act.

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ADMINISTRATION AND ENFORCEMENT

In the administration and enforcement of the Interlocks Act, the Federal Reserve Board has jurisdiction over state member banks, bank holding companies, and their nonbank affiliates; the Comptroller of the Currency has jurisdiction over national banks, banks located in the District of Columbia, and their subsidiaries; the Federal Deposit Insurance Corporation has jurisdiction over insured state nonmember banks and their subsidiaries; the Federal Home Loan Bank Board has jurisdiction over institutions insured by the Federal Savings and Loan Insurance Corporation, savings and loan holding companies, and their affiliates; and the National Credit Union Administration has jurisdiction over federally insured credit unions. The five agencies have adopted identical regulations with only technical variations necessary to accommodate the different organizations regulated by each agency. Each agency may refer prohibited interlocks involving a depository organization subject to its primary jurisdiction to the Attorney General of the United States to enforce compliance with the Interlocks Act and regulations issued thereunder.

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DEFINITIONS

A discussion of certain definitions set forth in Regulation L follows.

“Adjacent”

The Interlocks Act prohibits, among other things, management official interlocks between nonaffiliated depository organizations that are located in the same city, town, or village or in contiguous or adjacent cities, towns, or villages. Under the regulation, cities, towns, or villages are adjacent if they are within 10 road miles of each other. For example, cities located on opposite banks of a river will not be considered adjacent if the distance between them via the nearest bridge is more than 10 miles.

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“Affiliate”

The Interlocks Act permits management official interlocks between affiliates. Section 202(3)(B) of the Interlocks Act defines two depository organizations to be affiliates if the same person or group of persons beneficially own more than 50 percent of the voting shares of the two organizations. The agencies have defined the term “affiliate” in the regulation to prevent the creation of sham affiliations, by the exchange of a nominal number of voting shares of depository organizations. For example, depository organizations many attempt to create an affiliation under section 202(3)(B) of the act, an affiliation could be created between depository organizations if one person who owns 90 percent of the shares of Bank A exchanges one share of the stock of Bank A for one share of the stock of Bank B with another person who owns 90 percent of Bank B located in the same city. A Senate report accompanying a predecessor bill to the Interlocks Act (S. Rept. 323, 95th Cong., 1st sess., 1977, p. 15) recommends that “by rule the Federal Reserve should proscribe the switching of several shares of stock between individuals to defeat the ban which would otherwise obtain on interlocking management or directors between such institutions which are not truly commonly owned.”
Accordingly, under Regulation L, two organizations will not qualify as affiliates for purposes of the Interlocks Act if the agencies determine that the affiliation was established to avoid the prohibitions of the act and does not represent a true commonality of interest between the depository organizations. If a person, including members of his or her immediate family, whose shares are necessary to create a group owning 50 percent of the stock of both organizations, owns a nominal percentage that is substantially disproportionate in relation to that person’s ownership of shares in the other organization, the affiliation may be considered to have been created to avoid the prohibitions of the Interlocks Act.
What constitutes a nominal percentage will vary from case to case. For example, a 2 percent holding in a large, widely held organization may not be nominal, whereas the same percentage may be nominal with respect to a different organization. If a person’s holdings in two organizations are nominal, a sham affiliation will not be found unless the percentage held in one organization is disproportionate. Two organizations are affiliated, for example, if 26 stockholders each own 2 percent of the stock of each organization. Although each person may hold only a nominal number of shares, the disproportionality test has not been met. Two organizations might not be considered to be affiliated if, for example, the common ownership group includes a person who holds 2 percent of the shares of one of the organizations and 16 percent of the shares of the other organization— assuming, of course, that the 2 percent holding in this case is nominal.

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“Depository Institution”

The regulation is intended to subject only management officials servicing U.S. offices of foreign banks to the provisions of the Interlocks Act and not to prohibit certain interlocking relationships outside the United States between two foreign banks with subsidiary banks, branches, or agencies located in the United States. Only institutions chartered in the United States and having a principal office located in the United States, as well as U.S. offices of foreign commercial banks, are depository institutions for the purposes of the Interlocks Act.

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“Management Official”

The term “management official” is defined in section 202(4) of the Interlocks Act to mean an employee or officer with management functions, a director (including an advisory or honorary director), a trustee of a business organization under control of a trustee, or any person who has a representative or nominee serving in any such capacity.
The term “management official” could be construed to include managers of nondepository affiliates of depository organizations even though the affiliate does not in fact compete with any nonaffiliated depository organization. For example, the local manager of a retail merchandising or manufacturing company might be precluded from serving as a director of a local bank because the company is a subsidiary of a diversified savings and loan holding company. The Board does not believe that this is an intended result of the Interlocks Act, and has therefore clarified the definition of management official to exclude a person whose management functions relate exclusively to the business of retail merchandising or manufacturing.
The term “management official” has been defined so as not to include a management official of a foreign commercial bank whose management functions relate principally to the business of that organization outside the United States. Therefore, such a person is not a management official of a U.S. branch or agency of a foreign commercial bank.

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“Person”

The regulation defines the term “person” to include corporations, other businesses, and natural persons, but excludes corporations and other businesses from the definition of “representative or nominee.” As a result, corporations are not regarded as “management officials.” However, the Board reserves its authority pursuant to section 203 of the act to prohibit some or all of such indirect interlocking relationships in the future if new information indicates that such action is justified.

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“Representative or Nominee”

Section 202(4) of the Interlocks Act defines “management official” to include a person who has a representative or nominee serving in the capacity of a management official. Thus, a person may be regarded as a management official of a depository organization without actually serving as a management official. A representative or nominee is a person who has an express or implied duty to act on behalf of another. Under the regulations, family, employment, or agency relationships between two persons may be evidence of an express or implied obligation to carry out management functions on the other’s behalf. Similarly, the ability to elect a director and the exercise of that ability may be evidence of the elected official’s express or implied obligation to the elector. However, neither a relationship nor the election of a director will in itself create an express or implied obligation. Whether or not such an obligation exists will be determined case by case, with all relevant facts being considered; and the determination will be made only after the affected person or persons are given an opportunity to respond.
Example: If A is a management official of a bank in Town X and A’s spouse, B, becomes a management official at another bank in the same town, the appropriate supervisory agency may question whether B is the representative or nominee of A. If the facts indicate that B is not adequately qualified to be a management official and A was instrumental in placing B in the position, and if A and B are given an opportunity to respond and fail to present facts or arguments to refute these findings, the agencies may determine that B is a representative or nominee of A.
Situations that could warrant special scrutiny by the Board include those in which a management official of a depository organization elects a director to the board of directors of another depository organization in the same community, or a major stockholder of two unaffiliated depository organizations in the same community elects directors to both organizations.

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“Total Assets”

The total assets of a depository organization are relevant to the application of the prohibitions of the Interlocks Act. The agencies have defined the term “total assets” to mean total consolidated assets measured as of the close of the organization’s last fiscal year. Under the regulation, the total assets of most depository holding companies include the total assets of all of the individual holding company’s subsidiary affiliates; however, the total assets of diversified savings and loan holding companies and of bank holding companies that are exempt from the provisions of section 4 of the Bank Holding Company Act by virtue of section 4(d) of that act equal only the assets of their depository institution affiliates.

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GENERAL PROHIBITIONS

Regulation L generally restates the prohibitory sections of the Interlocks Act. The regulation, however, narrows the coverage of the act’s community and metropolitan-statistical area prohibitions by applying these prohibitions solely with regard to the location and asset size of depository institutions and by eliminating from consideration the location and asset size of depository holding companies. Thus, the regulation permits depository holding companies to interlock within the same community or relevant metropolitan statistical area unless the major-assets prohibition applies or unless the locations and sizes of the holding companies’ depository-institution affiliates trigger application of the community or metropolitan-statistical-area prohibitions.
As the following examples show, the location and size of certain affiliates of depository organizations may determine whether two depository organizations may interlock without violating the Interlocks Act.

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Community

Example 1: If Bank A is located in the same city as S&LB, then the same person may not serve as a management official of both Bank A and S&LB.
Example 2: If Bank A has a depository institution affiliate located in the same city as a depository institution affiliate of S&LB, then the same person may not serve as a management official of Bank A and S&LB.
Example 3: If Bank A is located in the same city as a depository institution affiliate of S&LB, then the same person may not serve as a management official of Bank A and S&LB.

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Metropolitan Statistical Area

Example 1: If Bank A, with total assets of $20 million or more, is located in the same relevant metropolitan statistical area as Bank B, then, regardless of the assets of Bank B, the same person may not serve as a management official of Bank A and Bank B.
Example 2: If Bank A has an affiliate Bank AA, with total assets of $20 million or more, located in a relevant metropolitan statistical area and Bank B has an affiliate Bank BB located in the same relevant metropolitan statistical area as Bank AA, then, regardless of the total assets of Banks A, B, and BB, the same person may not serve as a management official of Bank A and Bank B.
Example 3: If Bank A, with total assets of $20 million or more, is located in the same relevant metropolitan statistical area as a depository-institution affiliate of Bank B, then the same person may not serve as a management official of Bank A and Bank B.

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Major Assets

Example 1: If Bank A has total assets exceeding $500 million and Bank B has total assets exceeding $1 billion, then the same person may not serve as a management official of Bank A and Bank B.
Example 2: If Bank A has an affiliate, Bank AA, with total assets exceeding $500 million and Bank B has total assets exceeding $1 billion, then the same person may not serve as a management official of Bank A and Bank B.
Example 3: If Bank A has an affiliate, Bank AA, with total assets exceeding $500 million and Bank B has an affiliate, Bank BB, with total assets exceeding $1 billion, then the same person may not serve as a management official of Bank A and Bank B.
Example 4: If a nondepository corporation has an affiliate, Bank Holding Company A, with total assets exceeding $500 million and Bank Holding Company B has total assets exceeding $1 billion, then the same person may not serve as a management official of the nondepository corporation and Bank Holding Company B or any affiliate of Bank Holding Company B.

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INTERLOCKING RELATIONSHIPS PERMITTED BY STATUTE

Regulation L lists six types of organizations that are not subject to the prohibitions contained in sections 203 and 204 of the Interlocks Act. These exceptions are created by section 205 of the Interlocks Act, and their inclusion in the regulation is merely for the purpose of making the regulation comprehensive. The bankers’ bank exception makes clear that a bankers’ bank must have been organized solely, rather than merely specifically, for the purpose of serving depository institutions or solely for the purpose of providing clearing services and services related thereto for depository institutions, securities companies, or both.

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INTERLOCKING RELATIONSHIPS PERMITTED BY BOARD ORDER

Regulation L excepts certain organizations from the prohibitions contained in the Interlocks Act: organizations located in low-income areas, minority and women’s organizations, newly chartered organizations, organizations facing conditions endangering safety or soundness, organizations facing disruptive management loss, and organizations sponsoring credit unions. Exceptions for such organizations must be approved by the primary federal supervisory agency of the institution in need of the management assistance to be provided by the interlock.
The regulation affords relief in certain cases of undue hardship resulting from loss of management officials by providing an extension of the compliance period for depository organizations that are likely to lose 30 percent or more of their directors or total management officials as a result of a change in circumstances, or multiple changes in circumstances occurring within a 15-month period, that require the termination of management interlocks. Under this exception, the agencies may grant a compliance period of up to 30 months from the time of the change in circumstances to minimize the disruption caused by the departure of management officials. If the prospective loss of management officials results from more than one change in circumstances, the 30-month period will be measured from the date of the first change in circumstances within the 15-month period. To qualify for the exception, a depository organization must submit a plan for the orderly termination of service by each affected management official within the 30-month period applicable to the individual management official.
The exception for organizations sponsoring credit unions is based on the recognition that some depository organizations sponsor credit unions as a benefit for their employees. As in all credit unions, the directors must be elected from the field of membership. Since the field of membership in these cases will be the employees of the sponsoring organization, this exception is necessary to provide the credit union full access to qualified management personnel.

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GRANDFATHERED INTERLOCKING RELATIONSHIPS

Section 206 of the Interlocks Act grandfathers, for ten years, management official interlocks in existence on November 10, 1978, that were not in violation of section 8 of the Clayton Act (15 USC 19) immediately prior to that date. To be eligible for grandfather rights, a person’s interlocking service need not be otherwise prohibited under sections 203 and 204 of the Interlocks Act; it is sufficient that the interlock existed before November 10, 1978, and was not in violation of section 8 of the Clayton Act. The regulation grandfathers only a person’s service at two or more depository institutions; a person serving as a management official of only one depository institution or as a management official of only one depository organization and a nondepository corporation has no grandfather rights. The grandfather rights of a management official whose interlocking positions are grandfathered under section 206 of the Interlocks Act will not be terminated as a result of changes in circumstances such as a merger, acquisition, consolidation, or the establishment of an office.

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CHANGES IN CIRCUMSTANCES

Regulation L provides that a nongrandfathered interlock (an interlock created after November 10, 1978, or an interlock in violation of section 8 of the Clayton Act on that date) must be terminated if a change in circumstances causes the management official’s interlocking service to become prohibited. Such changes in circumstances include, but are not limited to, an increase in assets size of an organization due to natural growth; a change in relevant metropolitan statistical area or community boundaries; an acquisition, merger, or consolidation; the establishment of a new office; or a disaffiliation.
An individual whose interlocking service as a management official becomes prohibited as a result of a change in circumstances is allowed a 15-month grace period to comply with the Interlocks Act. The agencies may impose a shorter period for compliance in individual cases.

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EFFECT OF THE INTERLOCKS ACT ON THE CLAYTON ACT

The first three paragraphs of section 8 of the Clayton Act (15 USC 19) generally prohibit employee and director interlocks between member banks and other commercial banks. The Board has concluded that the provisions of the first three paragraphs of section 8 of the Clayton Act have been supplanted by the Interlock Act’s revised and more comprehensive prohibitions on management official interlocks between depository organizations.

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