Understanding Regulation U - Updated 12/02/2015


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Legislative History on Regulation U


As a result of the stock market crash of 1929, the Board of Governors of the Federal Reserve System (the “FRB”) was given the authority and the duty under Section 7 of the Securities Exchange Act of 1934 to regulate margin lending.


The margin regulations were adopted for the purpose of preventing the excessive use of credit “for the purchase or carrying of securities.”

Basic Overview of Regulation U


Regulation U

  • Credit extended by U.S. banks and other non-broker-dealer lenders that is secured directly or indirectly by “margin stock”.
  • Substantive limits apply when such credit is “purpose credit”.

Regulation T

  • Credit extended by broker-dealers.

Regulation X

  • U.S. persons (and foreign persons controlled by or acting on behalf of or in conjunction with U.S. persons) who obtain credit either
    • within the U.S. to purchase or carry any securities;
    • outside the U.S. to purchase or carry U.S. securities (in such cases Regulation X applies substantive limitations of Reg. T or U, as applicable, through borrower).

The general purpose of Regulation U is to regulate extension of credit (“loans”) by certain types of lenders, including banks, that are:

  1. Made “for the purpose, whether immediate, incidental or ultimately, of buying or carrying margin stock” (“purpose loans”); and 
  2. Secured directly or indirectly by margin stock.

To the extent a credit* is both...

  • A purpose credit; and
  • Secured by margin stock;

Then the credit extended may not exceed the “maximum loan value” of the margin stock and the non-margin stock assets securing the credit.

  • The maximum loan value of margin stock is currently 50% of the margin of the stock’s “current market value.”
  • The maximum loan value of all other collateral is its “good faith” loan value. Note: Puts, calls and options that are not margin stock do not have any good faith loan value.

*There are certain exemptions from this collateral requirement under Regulation U based on the type of loan or the status of the customer (e.g. special purpose loans and loans to exempt customers).

Note: Even though Regulation U does not contain a maintenance test, Regulation U does require re-testing in certain limited situations.

For example, Regulation U requires the lender to re-test the value of the collateral on withdrawals and substitutions.

Elements of Regulation U


What lenders are within the scope of Regulation U?

  • U.S. bank lenders.
  • U.S. non-bank lenders (old Regulation G) other than broker-dealers.

What lenders are outside the scope of Regulation U?

  • U.S. broker-dealers (covered under Regulation T).
  • Foreign banking institutions (subject to certain exceptions).
  • Foreign non-bank lenders.

What customers are within the scope of Regulation U?

Most borrowers (including individuals) will qualify as customers under Regulation U. There are few limitations to this general rule.

Primary exceptions are for (i) certain “Clearing Agencies” (see Section 2201.1(b)(2) for exact criteria) and (ii) “Exempted Borrowers” which means a member of national security exchange or registered broker or dealer, a substantial portion of business consist of transaction with non- brokers or deals (see Section 221.2 for exact definition/criteria and Section 221.3(e)).

What does it mean to extend or maintain credit?

Extending Credit:

  • Traditional loans.
  • Non-traditional credit (e.g., guaranty or joint venture, etc.).
  • Reverse Repurchase Agreements.
  • Case by case review for potential re-characterization.

Maintaining Credit:

  • Maintaining purpose credit previously extended.

Margin Stock

What is margin stock?

Section 221.2 (Definition of Margin Stock)

  • Equity security registered or having unlisted trading privileges on a national securities exchange; or
  • Debt security convertible into a margin stock or carrying a warrant or right to subscribe to or purchase a margin stock; or
  • Warrant or right to subscribe to or purchase a margin stock; or
  • Security issued by an investment company registered under Section 8 of the Investment Company Act of 1940, other than (i) a company licensed under the Small Business Investment Act of 1958, as amended; (ii) a company which has at least 95% of its assets continuously invested in exempted securities; (iii) a company which issues face-amount certificates, but only with respect of such securities; or (iv) a company which is considered a money market fund under SEC Rule 2a-7.

“Margin stock” does not include:

  • Securities quoted in the “pink sheets” or the “over-the-counter bulletin board” (that do not otherwise qualify as margin stock);
  • Foreign securities (that do not otherwise qualify as margin stock); Note: Shares underlying American Depository Receipts are treated as “margin stock” for purposes of Regulation U;
  • Nonconvertible debt securities;
  • OTC options (but does include listed options); or
  • OTC convertible equity (note – see FRB opinions on a bifurcated treatment).

Purpose Credit

What is purpose credit?

Purpose credit is “any credit extended for the purpose, whether immediate, incidental or ultimate, of buying or carrying margin stock.”

Carrying Margin Stock

Carrying credit under Regulation U “is credit that enables a customer to maintain, reduce, or retire indebtedness originally incurred to purchase a security that is currently margin stock.”

Specific Issues on Analyzing Purpose Credit:

  • Customer’s Line of Business
  • Retirement
  • “But For” Test
  • Short Sales

Secured by Margin Stock

What does it mean to be secured by margin stock?

Directly or Indirectly Secured

An extension of credit will be deemed to be secured for purposes of Regulation U if the credit is either directly or indirectly secured by margin stock.

  • On a basic level, a loan is indirectly secured if the loan documentation restricts the use of the obligor’s assets.

Examples of common provisions and situations that can cause a credit to be indirectly secured:

  • Negative pledges.
  • Cross-defaults/cross-collateralization.
  • Scope of customer’s trading/investment activities.
  • Certain liquidity maintenance requirements.
  • Certain assets with a value derived from margin stock.

Note: Case by case basis analysis required due to the vast amount of opinions on indirectly secured and the broad scope of certain opinions.

Safe Harbors

The FRB has adopted certain safe harbors so that the definition of indirectly secured excludes arrangements in which the margin stock is not a substantial portion of the restricted assets.

The primary safe harbor is a percentage test: if not more than 25% of the value of the restricted assets are margin stock, then such restrictions (e.g., negative covenants) will not make the loan indirectly secured.

Formal Rules of Regulation U

Withdrawal and Substitution Rule

The withdrawal and substitution rule requires a lender to re-evaluate a purpose loan secured by margin stock when collateral is either withdrawn or substituted.

Specific rules for two scenarios:

  1. If a loan does not exceed the Maximum Loan Value of the collateral, then a withdrawal and substitution is only permitted if it would not cause the loan to exceed the Maximum Collateral Value of the remaining collateral.
  2. If a loan exceeds the Maximum Loan Value of the collateral, then a withdrawal and substitution is only permitted if it would not increase the amount the loan exceeds the Maximum Collateral Value of the remaining collateral.

Single Credit Rule

What happens when a lender makes multiple loans to a customer and at least one of the loans is a purpose credit?

  • If a lender makes a purpose loan and then later makes an additional purpose loan to the same customer, all of the purpose loans must be aggregated into one purpose credit.

Exception: Syndicated loans need not be aggregated with unrelated purpose credit.

  • If a lender makes a margin stock secured purpose loan and later wants to make an unsecured purpose loan to the same customer, the second loan is prohibited unless there is sufficient collateral to cover both advances.
  • If a lender makes an unsecured purpose loan and later makes a margin stock secured purpose loan to the same customer, all of the purpose loans (secured and unsecured) must be aggregated when evaluating a withdrawal or substitution.
  • If a lender makes a nonpurpose loan and then makes a purpose loan secured by margin stock to the same customer, the two loans must be treated as separate loans.
    • The collateral from the purpose credit may not be relied upon as collateral for the nonpurpose credit and the margin stock collateral generally must be allocated first to the purpose credit and then to the nonpurpose credit.
    • Alternative: The lender may treat both loans as purpose credit and combine the collateral.

Exempted Transactions

Special Purpose Credit” (See Section 221.5):

  1. Regulation U contains exemptions for “special purpose credits” extended to broker-dealers. These credits can be extended on a good faith basis (i.e., margin stock does not need to be discounted to 50%) and the single credit rule does not apply.
  2. Lenders must obtain good faith certification from the broker-dealer that credit is a special purpose loan.
  3. If purpose of credit ceases to be a special purposes credit based on notice from borrower or lender obtaining information, then the credit will cease to be exempt.

Note: An “Exempted Borrower” will not need these exemptions, since already exempted from Regulation U.

These exemptions apply to:

  • Hypothecation Loans
  • Temporary Advances and DVP Transactions
  • Securities in transit
  • Intraday credit
  • Arbitrage Credit
  • Market Maker and Underwriter Credit
  • Clearing broker-dealers
  • Emergency Loans
  • Capital contribution/subordinated loans

Exempted Transaction for Banks

  1. A bank lender can extend purpose credit without regard to Regulation U if the credit is extended in certain specific circumstances.
  2. For a complete list of these exempted transaction see Section 221.6.

Note: these exemptions do not apply to non-bank lenders.

Lender Protection Clause

Regulation U states in Section 221.3(j) that “nothing in this part shall require a bank to waive or forego any lien or prevent a bank from taking any action it deems necessary in good faith for its protection.”

There are specific FRB opinions on the applicability of this clause.

Filing Rules

Bank Lenders:

Bank lenders must have a Form U-1 executed by the customer when the loan is greater than $100,000 is secured by margin stock. Note: there are FRB opinions on revolving loans and Form U-1s.

Non-Bank Lenders:

Non-bank lenders who extend or maintain credit secured by margin stock are required to register with the FRB on Form G-1 if they reach certain thresholds.

Non-bank lenders use a Form G-3 instead of a Form U-1.

Lender’s Obligations

The FRB opinions impose a duty on the lender to be, among other things, aware of the circumstances surrounding a loan and to make inquiries before accepting a purpose statement.

Consequences If a Lender Violates Regulation U

  • Commission Enforcement.
  • Criminal Prosecution Against Lender and Officers of Lender.
  • Avoidance under Exchange Act Section 29(b).
  • Civil Liability.

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