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Reg W Overview · The Money and Banking Law Podcast with Joe Silvia

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Hello and welcome to the Money and Banking Law
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Podcast with Joe Sylvia, brought to you by Duane
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Morris, an international law firm with roughly
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30 offices and a thousand lawyers all over the
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world. I'm your host Joe Sylvia. I'm a former
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Federal Reserve lawyer who represents banks,
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fintechs, and financial services clients on M
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&A, payments, and regulatory matters at Duane
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Morris. I'm also a core member of our banking,
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Now, while we can't provide legal, financial,
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to inform and educate our clients and friends
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on both the fundamental concepts and structure
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of the banking ecosystem, as well as critical
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developments in the law and regulation of money
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and banking. Thanks for joining us today. As
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always, if you have any questions from any of
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our podcast episodes, please reach out to me
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at jsylvia at duanemorris .com. Hey guys, coming
1:03
to you live from Boca. I've been talking and
1:07
writing on the Dwayne Morris blog a lot lately
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about very specific issues related to Regulation
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W, which relates to affiliate transactions, Section
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23A and B, but really 23A of the Federal Reserve
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Act. I'll do a quick episode here on Reg W a
1:26
little bit. I also got done just this past week
1:31
teaching a class on lending restrictions. And
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one of the main topics was regulation W. It was
1:38
also on Reg O and lending limits and so forth
1:40
for banks in the United States. Did an earlier
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pod episode on Reg O, so check it out. Probably
1:48
have to do a new one when they finalize whatever
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rules they're going to finalize to modernize
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Reg O and increase some of the thresholds. With
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respect to Reg W, there's a couple of really
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key components to it, right? So it says that,
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look, we can't have an unlimited or unrestricted
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ability as a bank to conduct transactions with
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our affiliates. So what does that mean? Well,
2:14
it means you got to figure out if you're a financial
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institution or you're a bank subject to Regulation
2:19
W, who are your affiliates? Think of companies
2:23
under common control. If you have a holding company,
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does that holding company own any other companies,
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any other non -bank companies? If you are an
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individual that owns a bank, for example, what
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other businesses does that individual have? Um,
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in our class last week, we talked, like I mentioned
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about lending limits, Rego, Reg W, and they have
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kind of different terms of art related to things
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like related interests. Um, basically third parties
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that have some connection to the financial institution
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board member. If you're talking about insider
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lending under Rego. Um, we have, uh, kind of
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a. an attribution rule that I'll get to in a
3:01
minute under Reg W and similar rules apply under
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other lending restrictions for banks, but Reg
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W, you know, first up is figure out really is
3:12
there, what kind of transaction are we talking
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about? Do we have an affiliate? Are we looking
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at a covered transaction? Okay, so terms of our
3:21
definitions in really all of bank regulatory
3:25
land are absolutely critical when you're looking
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at very specific issues. Bank regulation is complicated.
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It's fun, at least for me, but it is complicated
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because there are a lot of definitions and you
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have to check all the definitions to make sure
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that you're talking about the right type of entity,
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the right type of issue, for example. So there's
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definitions around what's an affiliate. Just
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give a couple of examples coming up under common
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control. The definition of a covered transaction
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obviously because The basis of Reg W is to essentially
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limit or restrict the amount of covered transactions
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or covered transaction exposure that a bank has
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to its affiliates. So you need to understand
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what a covered transaction is. In most cases,
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for most banks, we're talking about extensions
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of credit. So loans to affiliates. Really, when
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I teach it and I talk to younger lawyers or lawyers
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that just aren't as familiar with Reg W, I try
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and... give them the view that you want to understand
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if the transaction involves, obviously, an affiliate
4:39
or a covered transaction, but first and foremost,
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I think, is money leaving the bank? Is the bank
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becoming exposed to some kind of liability? And
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so is money leaving the bank? Is the bank making
4:56
a loan to an affiliate, right? Is money going
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from the bank to the affiliate? If that's the
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case, then okay, we may be in in covered transaction
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land. You need to determine whether it's a covered
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transaction, whether it's an affiliate, and whether
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it complies with the limitations and restrictions.
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So basically under Reg W you can make, you can
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have any amount of covered transactions up to
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10 % of your capital and surplus with one affiliate.
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Okay. There's a 20 % threshold if you're talking
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about all of the covered transactions that you
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have with all affiliates. Another thing to think
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through is you know, with extensions of credit,
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it's pretty clear, but when you get to talking
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about guarantees and other types of esoteric
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covered transactions, you need to understand
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the valuation of it. So if you're talking about
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a loan, for example, you make $100 ,000 loan,
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that's the exposure is $100 ,000 essentially,
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okay, to think of it simply. That's the exposure,
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that's the money that leaves the bank, goes to
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the affiliate. That has to fit within that 10
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% bucket for that one affiliate. but it also
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has to fit within the 20 % bucket overall for
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all affiliate transactions, all affiliate covered
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transactions. The largest financial institutions
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in the country and in the world have sophisticated
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processes and tracking for this. But even they
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get, you know, tripped up on things sometimes,
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but they also have a lot of internal attorneys,
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some of whom are good friends, and they use really
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great external attorneys, some of whom, many
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of whom are really good friends. many of whom
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I work with and have gotten to know very well
6:34
through the ABA banking law committee. So shout
6:36
out to the banking law committee. If you're interested
6:38
in banking law and you're an attorney here in
6:40
the U S join the ABA, give me a shout, talk about
6:43
the banking law committee. Um, you can find us
6:45
on LinkedIn and so forth. Anyway, tangent. Um,
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so reg W can get really complicated because you
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got to understand what affiliates are. You have
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to understand what covered transactions are and
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what they're not. Um, there are certain exceptions
6:59
for. Covered dirt for transactions that would
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otherwise be covered if you're talking about
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for example sister banks So a holding company
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that owns two different bank charters Transactions
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between those two banks are not covered. They're
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not covered transactions excuse me Another example
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is a bank's transactions with an operating subsidiary
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An operating subsidiary of a bank is really just
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a subsidiary that can engage in the same kinds
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of activities that the bank could otherwise engage
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in directly itself. So we don't consider those
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covered transactions because the bank is really
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not engaging, in theory, with a third party that's
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an affiliate. It's part and parcel of the bank.
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That's how it's viewed, essentially. However,
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covered transactions with a financial subsidiary,
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which is a little bit different, are considered
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covered transactions if we're talking about extensives
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of credit and so forth that fit within the definition
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again. Financial subsidiaries are kind of a specialized
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type of subsidiary for a bank that engages in
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activities kind of outside the normal banking
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scope, right? So because of that, because of
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that unique relationship, because of those types
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of subsidiaries and the activities that they
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can engage in, we do consider that to be, quote
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unquote, a third party affiliate. In that case,
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those transactions with that affiliate will be
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covered by Reg W, should be considered covered
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transactions to the extent that they satisfy
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the definition of covered transactions. Talking
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a lot about definitions, guys. Sorry about that,
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but that's part of bank regulatory law and that's
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how it works. So do we have a covered transaction?
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Do we have an affiliate? Another wrinkle to Reg
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W is what's called the attribution rule. And
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it's very similar to how it sounds. It operates
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the same way. You attribute a characteristic
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to a company, characteristic being the affiliate
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designation, to a company that's essentially
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related to an affiliate, right? Or has some connection
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to the affiliate, what's a related interest.
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And the way that that works is you attribute
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the transaction to them to the extent that the
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benefit... of the covered transaction essentially
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passes directly to that affiliate. Okay, so maybe
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a transaction to a non -affiliate or with a non
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-affiliate, but at the end of the day, the proceeds
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of the loan, for example, are used to pay the
9:35
affiliate. Okay, so the bank is simply doing
9:38
a transaction with a third party, but that third
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party is then passing on the funds, the proceeds,
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whatever, the transaction value to an affiliate.
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So therefore we attribute that transaction to
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that affiliate because the affiliate is getting
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the benefit of the transaction. There's similar
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types of rules that I've talked about before
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in legal lending limit restrictions and then
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rego insider restrictions related interests and
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so forth. So that attribution rule is something
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to consider. You want to make sure that you understand
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what kinds of transactions are going on with
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a potential affiliate, understand whether that
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company is an affiliate. Um, also understand
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what is happening with the proceeds, right? Is
10:21
someone taking out a loan to pay for, um, something,
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some services provided by your affiliate broker
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dealer, um, is, is someone taking out a loan
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to pay off a loan owed to a different affiliate,
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um, refinancing a debt, different types of things
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like that, that, that may be attributed to an
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affiliate because the proceeds or the benefit
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of the transaction essentially goes to the affiliate.
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Um, so we got to think about that and we got
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to think. in terms of money leaving the bank,
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the exposure to the bank. That's really the primary
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focus is what's happening from a bank perspective.
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Is the bank becoming exposed to some kind of
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liability or potential monetary loss? When we're
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thinking about things like lines of credit, the
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bank issues a line of credit to an affiliate.
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If the affiliate only uses 20 % of the line of
11:11
credit, the full amount of the line of credit
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still applies as a covered transaction value
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because you want to have a conservative approach.
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You have to have a conservative approach when
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it comes to understanding what your potential
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exposure could be at any one time because that
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borrower, that affiliate borrower, has the ability
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to pull down 100 % of the line. And so because
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of that we consider the value for that transaction
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to be the full amount of the line of credit.
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There's a ton of different examples. There's
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a ton of regulatory guidance and speeches, pronouncements,
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whatever you want to call it, that talk about
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affiliate transactions. It's very interesting
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to me. It's something that every bank has to
11:58
consider. You know, one thing that banks really
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ought to remind themselves of sometimes, especially
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if you're not really familiar with Reg W or you
12:07
don't deal with it a lot, is that your holding
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company is your affiliate if you're the bank.
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Okay, so if you're engaging with the holding
12:14
company in a covered transaction, for example,
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For example, the bank lending money to its parent
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company, its holding company. That's a covered
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transaction. That holding company is an affiliate
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of the bank for purposes of REG W. In many common
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structures in the United States, you have a bank
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holding company that owns one bank and doesn't
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have any other subsidiaries. Sounds very structured,
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very easy, straightforward. But the transactions
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between those two, you need to double check on
12:43
things like REG W for sure. are important, other
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things are important, but you double check if
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there's money going from the bank to the holding
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company, what kind of transaction is that? Does
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that qualify as a covered transaction? Reg W
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also includes certain types of collateral requirements,
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right? So there's quantitative requirements,
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there's qualitative requirements, you know, banks
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can't purchase low quality assets from affiliates,
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basically period, full stop. There's a couple
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of limited exceptions there, but we don't want
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banks buying crap assets, right? This is kind
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of how I put it to the students last week and
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got a little chuckle, but that's the reality.
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We don't want banks purchasing assets that are
13:24
already in a delinquency status or default status
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or are low quality or considered low quality
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for some other reason. So there's a lot of restrictions
13:34
around banks conducting transactions with affiliates.
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We have a lot of these restrictions and I'll
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kind of end in the next couple minutes here with
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this. We have a lot of these restrictions in
13:47
place in bank regulatory world because essentially
13:51
banks in the United States are special. Okay,
13:54
and there's been articles written about it with
13:57
that kind of title and people have talked about
13:59
it. So I'm not coming up with that phrasing.
14:03
It came from Jerry Corrigan in 1982 from the
14:08
Federal Reserve. So it's not me, but... Banks
14:11
are special in the United States. And why are
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they special? Well, one reason that they're special
14:15
in my mind is that they have the benefit of offering
14:18
deposit insurance to the depositors, right? And
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what does that mean? That means the FDIC insures
14:22
deposits up to $250 ,000 per depositor per account.
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It's very complicated if you have a lot of money
14:29
and a lot of different accounts to figure out
14:31
how you're covered. Banks will help you do that
14:32
usually. But in bank regulatory world, there's
14:37
an extreme sensitivity to this because what it
14:39
means is that essentially at the end of the day
14:42
if you follow it through the full progression
14:45
you know the taxpayer supports essentially that
14:50
subsidy that we give to the banks right because
14:53
they have a very very low cost of funds because
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at the end of the day the funds are in a way
14:59
guaranteed through that fdic insurance up to
15:02
250 000 per depositor per account and so because
15:05
of that backing The banks can offer very, very
15:09
low interest rates, if interest rates at all,
15:12
on things like checking accounts. They may offer
15:14
zero, right? But they don't have to offer a lot
15:17
because the real benefit is that you can put
15:19
your money in the bank account and up to that
15:21
$250 ,000 cap, your money is insured, it's safe,
15:25
it's guaranteed by the federal government. That
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subsidy essentially comes from the taxpayer.
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So we don't want the banks that get the benefit
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from a taxpayer subsidy to be using their funds
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in what are considered riskier or potentially
15:43
inappropriate ways that are contrary to the safety
15:46
and soundness of the financial institution. There's
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a lot to unpack there too, but that's essentially
15:51
why we have a lot of these restrictions around
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not only the covered transactions and the affiliates,
15:58
affiliate transactions under regulation W. But
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insider lending under Rego, lending limits more
16:03
generally. We don't want to have too much exposure,
16:06
too much concentration to any one person, any
16:08
one borrower, any one industry. If we can't,
16:11
we can avoid it. Any one type of product like
16:15
commercial real estate lending, we don't want
16:17
to have over concentrations in that. There's
16:19
all these restrictions because at the end of
16:21
the day, we want to make sure that our banks
16:22
are operating in a safe and sound manner, that
16:24
they're limiting risk, they're managing risk
16:25
appropriately because the taxpayer is supporting
16:29
their ability to make money on a very low cost
16:33
of funds. And that's the basis for a lot of why
16:39
we have such strict rules in place for our financial
16:43
institutions here in the United States. Some
16:46
people argue that we don't need it. Some people
16:48
argue that it should be loosened. There's a lot
16:51
on each side, right? But at the end of the day,
16:53
because that taxpayer subsidy exists in the form
16:56
of FDIC insurance for accounts, we want to make
17:00
sure that banks operating a safe and sound manner
17:02
so that we don't have to tap the FDNC insurance,
17:05
we don't have to tap the taxpayer, we don't have
17:07
to do assessments or special assessments on other
17:09
banks that are operating safe and soundly to
17:12
pay for the banks that fail and perhaps fail
17:18
because of inadequate lending considerations,
17:23
restrictions, risk mitigants, and so forth. Anyway,
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I'll end the pod there. Hope you guys are doing
17:28
well. It's a beautiful day here in Boca. It's
17:30
early morning. I'm gonna get to work here. I've
17:33
got a presentation on AML coming up for a knowledge
17:35
group. So give me a shout. Let me know if I can
17:38
help. Until then, take a look at Reg W. Learn
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those definitions and make sure you bolster your
17:45
compliance program around affiliate transactions
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if you can. Give me a shout if you need any help.
17:51
We'll talk soon.