Bank Notes

Harmonizing Reg. O with SBA rules for making PPP loans to Directors and Principal Shareholders

April 20, 2020

By: Charles D. Dunbar and Mark A. Mangano

The Federal Reserve brought Regulation O¹ (Reg. O) into substantial harmony with the Small Business Administration (SBA) Interim Final Rule² authorizing SBA lenders to extend Payroll Protection Program (PPP) loans to businesses owned or controlled by a lender’s directors and shareholders holding a less than 30 percent equity interest in the lender.  (SBA Interim Rule).  On April 17, 2020, the Federal Reserve issued an interim final rule titled “Loans to Executive Officers, Directors, and Principal Shareholders of Member Banks”³ (Fed Interim Final Rule).

Reg. O governs any extension of credit made by a bank to an executive officer, director, or principal shareholder of the bank, of any company of which the member bank is a subsidiary, and of any other subsidiary of that company (Insiders). It also applies to extensions of credit to a company owned by an Insider.

The SBA Interim Rule modified the regulations relating to PPP loans made under section 7(a) of the Small Business Act. It modified the normal prohibition of a lender making loans to itself or any of its “Associates”. An Associate of a lender is an officer, director, key employee, or holder of 20 percent or more of the value of the lender’s stock or debt instruments. The Associate definition also includes any entity in which an Associate, or certain relatives of the Associate owns or controls at least 20 percent.

The SBA determined:

“that SBA regulations shall not apply to prohibit an otherwise eligible business  owned (in whole or part) by an outside director or holder of a less than 30 percent equity interest in a PPP Lender from obtaining a PPP loan from the PPP lender on whose board the director serves or in which the equity owner holds an interest, provided that the eligible business owned by the director or equity holder follows the same process as any similarly situated customer or account holder of the Lender…The Administrator cautions, however, that Lenders should comply with all other applicable state and federal regulations concerning loans to associates of the  Lender.

The foregoing paragraph does not apply to a director or owner who is an officer or key employee of the PPP lender.”⁴

The Fed Interim Final Rule provides, except for loans to the lender’s executive officers, that loans made under the PPP program from February 15, 2020 through June 30, 2020 and consistent with the SBA’s interpretations of lender and lender associate eligibility are excluded from the definition of an extension of credit under Reg. O. Banks and their Insiders are relieved of Reg. O obligations for such loans including prior approval and reporting.

The Federal Reserve determined that in order to be consistent with the SBA Interim rule, Reg. O should continue to apply to PPP loans made to Executive Officers of the lending bank and any lender Associates prohibited by the SBA. Reg O provides significant restrictions on the amount, purpose and collateral for loans made to an executive officer.  An executive officer is defined as:

1. Executive officer of a company or bank means a person who participates or has authority to participate (other than in the capacity of a director) in major policymaking functions of the company or bank, whether or not: the officer has an official title; the title designates the officer an assistant; or the officer is serving without salary or other compensation. The chairman of the board, the president, every vice president, the cashier, the secretary, and the treasurer of a company or bank are considered executive officers, unless the officer is excluded, by resolution of the board of directors or by the bylaws of the bank or company, from participation (other than in the capacity of a director) in major policymaking functions of the bank or company, and the officer does not actually participate therein.⁵ 

The SBA and the Federal Reserve have substantially clarified rules for making PPP loans to the bank’s Insiders.  However, we continue to recommend caution in making PPP loans to the bank’s directors, principal shareholders, and their related interests.  If the applicant can be considered an executive officer of the lender, continued application of Reg. O could make it very difficult to make a PPP loan that complies with banking law even if it is permitted by the SBA rules.

¹  12 CFR 215
²  Interim Final Rule: “Business Loan Program Temporary Changes; Paycheck Protection Program-Additional Eligibility Criteria and Requirements for Certain Pledges of Loans” (April 14, 2020)
³  Interim Final Rule: “Loans to Executive Officers, Directors, and Principal Shareholders of Member Banks.” (April 17, 2020), https://www.federalreserve.gov/newsevents/pressreleases/files/bcreg20200417a1.pdf
⁴  Interim Final Rule: “Business Loan Program Temporary Changes; Paycheck Protection Program-Additional Eligibility Criteria and Requirements for Certain Pledges of Loans” (April 14, 2020)
⁵  12 CFR 215.2(e)