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April 17, 1998

Gilbert T. Schwartz, Esq.
Schwartz & Ballen
1200 19th Street, N.W.
Washington, DC 20036-2424

Dear Mr. Schwartz:

This is in response to your letter concerning the ability of a bank under Regulation U to extend credit against an investor's margin account maintained at a broker-dealer when the credit is used to meet the short sale margin requirements of Regulation T. The bank is affiliated with the broker-dealer.

We understand the facts to be as follows. The investors wish to purchase margin equity securities on credit and sell other margin equity securities short. For their long positions, the investors borrow up to 50 percent of the purchase price of margin equity securities from their broker-dealer. The investor satisfies the 50 percent margin requirement for this transaction without borrowing from the bank.

The short sale of other margin equity securities results in a Regulation T margin requirement of 150 percent of the current market value of those securities. One hundred percent of this 150 percent is satisfied by the short sale proceeds that come into the account upon settlement of the short sale transaction. The investors would like to borrow the remaining 50 percent from the bank in reliance on a second lien on the "equity" involved in the short transaction.

Your letter takes the position that the bank is not limited in its ability to lend to the customer because credit to meet a Regulation T margin requirement for a short sale is not "purpose credit" under Regulation U. "Purpose credit" is defined in section 221.2 of Regulation U as credit for the purpose of "buying or carrying margin stock." Board staff agrees that when a bank extends credit to a customer for the purpose of meeting a margin call issued as a result of a short sale by the customer, the bank is not extending "purpose credit" as defined in Regulation U.

Both Regulations T and U prohibit a single lender from relying on the same collateral when extending both purpose and nonpurpose credit to the same customer. Under Regulation T, a broker-dealer extending purpose credit against equity securities and nonpurpose credit to a customer must record the two loans in separate accounts. Purpose credit for equity securities must be recorded in the margin account (§ 220.4) and nonpurpose credit in the good faith account (§ 220.6(e)) and section 220.3(b) provides that the requirements of one account may not be met by considering items in any other account. Under section 221.3(d)(4) of Regulation U, a lender extending purpose and nonpurpose credit to the same customer must "treat the credits as two separate loans and may not rely upon the required collateral securing the purpose credit for the nonpurpose credit."

In effect, the transaction you propose is a joint arrangement between the investor, bank, and broker-dealer designed to enable the customer to obtain purpose and nonpurpose credit from two affiliated parties in a way that, while not violating the express language of the Board's margin regulations, would not be permitted under either Regulation T or Regulation U if the investor were dealing with just one lender. For this reason, Board staff believes that the proposed transaction is structured to evade the Board's margin regulations. This is a staff opinion only, as the matter has not been presented to the Board.

Very truly yours,

(signed) Scott Holz

Scott Holz

Senior Attorney

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Last update: June 19, 1998, 3:00 PM