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February 25, 1997

Kevin J. Hiniker, Esq.
Associate General Counsel
MIMLIC Asset Management Company
400 Robert Street North
St. Paul, MN 55101-2098

Dear Mr. Hiniker:

This responds to your letter of July 29, 1996, as supplemented by your submission of August 29, 1996. At issue is the margin status of the purchasers of certain privately-placed notes. The purchasers are primarily insurance companies; none are banks or broker-dealers. Regulation G (12 CFR Part 207, "Securities Credit by Persons Other than Banks, Brokers, or Dealers") is therefore the margin regulation that is potentially applicable to the purchasers.

As you know, the Board views the purchase of a nonconvertible debt security in a private placement as an extension of credit to the issuer (see, e.g., 12 CFR 207.112(c)). If the debenture is secured directly or indirectly by any margin stock (and assuming the dollar thresholds in section 207.3(a)(1) of Regulation G are met), a purchaser other than a broker-dealer or bank must register with the Federal Reserve under Regulation G. Registration is required whether or not the credit is used to purchase margin stock.

Your July 29, 1996, letter lists 17 clients of your firm who have purchased two series of notes issued by Jubilee Limited Partnership (the "borrower"). The notes are guaranteed by Schottenstein Stores Corporation (the "guarantor"), which owns almost 70 percent of the stock of Value City Department Stores (the "margin stock"). The note agreements specifically provide the note purchasers with the option of accelerated prepayment of the notes if the guarantor engages in any issue, sale, or other disposition of the margin stock which results in the guarantor no longer owning 50 percent of the voting stock of the issuer of the margin stock.

Chapman and Cutler, in their role as your outside counsel, have provided a legal opinion that the notes are indirectly secured by the margin stock owned by the guarantor. Your clients therefore registered as lenders pursuant to Regulation G when they purchased the notes. Since the note proceeds will not be used to purchase margin stock, Regulation G imposes no limitation on the amount of credit that may be extended; the only applicable requirements involve recordkeeping (i.e., a registration statement, a purpose statement, and annual reports). Your letters seek a determination by Board staff that the notes are not indirectly secured by the margin stock and that your clients may therefore deregister pursuant to section 207.3(a)(2) of Regulation G.

After a review of the note agreements, Board staff is unable to confirm your request for deregistration of your clients. Section 207.2(f) of Regulation G defines indirectly secured to include any arrangement under which a "customer's right or ability to sell, pledge, or otherwise dispose of margin stock owned by the customer is in any way restricted while the credit remains outstanding; or the exercise of such right is or may be cause for accelerating the maturity of the credit." The notes are indirectly secured by the margin stock because the note purchasers can accelerate repayment of the notes pursuant to 2.4 of the note agreements if the guarantor fails to maintain a 50 percent voting interest in the issuer of the margin stock.

Your letters lists several reasons why you believe that the notes are not indirectly secured by the guarantor's margin stock assets. Your first reason ("Presumption that the Notes are 'indirectly secured' by margin stock does not apply") is based on the Board's 1986 interpretation of Regulation G entitled "Purchase of debt securities to finance corporate takeovers" (12 CFR 207.112). We note that the borrower in your case is not financing an acquisition and the presumptions raised in the interpretation are not applicable to your clients' transactions. The interpretation raises a presumption that privately placed debt securities issued by a shell acquisition vehicle are indirectly secured by any margin stock owned by the shell. The presumption is based on the fact that the issuer of the debt securities (i.e., the borrower) owns no assets other than margin stock and has no cash flow other than dividends. The language you cite from the interpretation states that this presumption does not apply if the debt securities are guaranteed by a company with substantial nonmargin stock assets or cash flow. Board staff agrees that in your situation there is no presumption regarding the assets of the borrower. Your situation involves the margin stock assets of the guarantor, which serve as indirect security for the debt securities, not because they are the only assets owned by the guarantor, but because the note agreements specifically provide for accelerated payment of the notes if the guarantor sells more than a certain percentage of the margin stock it owns.

The second reason you believe the notes are not indirectly secured by the guarantor's margin stock ("Regulation G does not apply to routine negative covenants in loan agreements") is based on a 1968 Board interpretation (12 CFR 207.102 and 12 CFR 221.117) of the indirect security concept of Regulations G and U and a reference therein to "recent" Board amendments. The amendments referred to were the adoption of a revised definition of "indirectly secured" in section 207.2(g) of Regulation G (currently section 207.2(f)) and section 221.3(c) of Regulation U (currently section 221.2(g)). You note that the interpretation indicates that one of the purposes of the amendments was to make clear that the definition of indirectly secured "does not apply to certain routine negative covenants in loan agreements." The revised definition added an exception to the general concept of indirectly secured that provided the term did not apply "if such restriction arises solely by virtue of an arrangement with the customer which pertains generally to the customer's assets unless a substantial part of such assets consists of registered equity securities." In 1982, the phrase "a substantial part of such assets" was replaced with "not more than 25 percent of the value of the assets." The legal opinion provided by your outside counsel indicates their understanding that the margin stock owned by the guarantor comprises more than 25 percent of the guarantor's assets. This exception, which is currently found in section 207.2(f)(2)(i) of Regulation G, is therefore unavailable for your clients.

The third reason you believe the notes are not indirectly secured by the guarantor's margin stock ("Lenders have not in 'good faith' relied on margin stock as collateral") is based on section 207.2(f)(2)(iv) of Regulation G, which provides that the term indirectly secured does not include an arrangement "if the lender, in good faith, has not relied upon the margin stock as collateral in extending or maintaining the credit." You refer to the 1968 Board interpretation cited in the previous paragraph, which indicated two circumstances that provide "some indication" that the lender had not relied upon stock as collateral: the obtaining of current financial statements that could reasonably support the loan and the structuring of the loan as payable on one or more fixed maturities rather than as payable on demand or because of fluctuations in the market value of the stock. Board staff's understanding of your clients' note agreements is that the loans are payable on demand if the guarantor sells more than 20 percent of the margin stock it owns (bringing its ownership in the issuer of the margin stock below 50 percent). This ability of the lenders to demand repayment based on the guarantor's percentage of margin stock ownership distinguishes your clients' transactions from the 1968 Board interpretation.

In conclusion, Board staff agrees with your outside counsel that the privately-placed notes purchased by your clients are indirectly secured by margin stock and that your clients are required to be registered under Regulation G. Pursuant to 2.4 of the note agreements, the sale of a certain percentage of the margin stock owned by the guarantor "is or may be cause for accelerating the maturity of the credit" (section 207.2(f)(1)(ii) of Regulation G). Although you assert that the lenders in good faith have not relied upon the margin stock as collateral (section 207.2(f)(2)(iv) of Regulation G), Board staff believes this assertion is inconsistent with the ability of your clients to demand repayment of the notes if the guarantor sells as little as 20 percent of the margin stock it owns.

This is a staff opinion only, as the matter has not been presented to the Board, and is limited to the facts presented. Different facts could compel a different conclusion.

Yours truly,

(signed) Scott Holz

Scott Holz

Senior Attorney

cc: Ms. Susan M. Fleege - FRB Minneapolis

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