An opinion that an extension of credit does not violate margin regulations is sometimes requested in loan transactions and certain debt offerings as an aspect of an opinion that the transaction does not violate applicable laws. A typical opinion expressly covering margin regulations may be stated as follows:
The execution and delivery by [the Company] of each [Loan Document] to which it is a party do not, and the performance by [the Company] of its obligations thereunder will not, result in violation of Regulations T, U or X of the Board of Governors of the Federal Reserve System.
Opinion Coverage As a Matter of Customary Practice
The laws that a lawyer exercising customary professional diligence would identify as being applicable when giving an opinion depend on the type of the transaction. In a lending transaction, particularly a loan that will be used to acquire margin stock or that is secured by margin stock, a lawyer might identify the margin regulations as being applicable, and a lender might reasonably expect those regulations to be addressed by the opinion letter, but the coverage of the margin regulations, as part of the securities laws in general, in an opinion letter is not entirely clear. For that reason, when the margin regulations may be applicable to the transaction, a lender may request the margin regulations to be expressly addressed in the opinion letter. On the other hand, if the transaction does not involve margin stock, the opinion letter may not be expected to address the margin regulations. In that case, although the margin regulations may be understood as a matter of customary practice not to be covered unless done so expressly, some lawyers choose to exclude expressly the margin regulations from the opinion letter’s covered law, especially when they are expressly excluding other laws from coverage.
Margin Regulations; Applicability and Definitions
The margin regulations are Federal Reserve Regulations T, U and X, 12 C.F.R. §220.1 et seq., §221.1 et seq. and §224.1 et seq., respectively, issued by the Federal Reserve Board under Section 7 of the Securities Exchange Act of 1934 (the “Exchange Act”). That section authorizes the Board to issue rules and regulations “for the purpose of preventing excessive use of credit for the purchase and carrying of securities.” Section 7 of the Exchange Act also prohibits banks and broker dealers, with certain exceptions, from extending credit or arranging the extension of credit in contravention of those rules and regulations, and prohibits U.S. persons and foreign persons controlled by or acting on behalf of a U.S. person from obtaining such credit.
Regulation T applies to brokers and dealers as defined in the Exchange Act and members of a national securities exchange, and certain related persons. Regulation U applies to banks and to non-bank lenders who in the ordinary course of business extend credit secured directly or indirectly by margin stock in the amount of $200,000 or more during a calendar quarter or have $500,000 or more of such credit outstanding at any time during a calendar quarter. Regulation X applies to borrowers. It was added to the margin regulations after some borrowers tried to use a violation of the margin regulations applicable to lenders as a defense to payment of the credit.
Regulations T and U prohibit a covered lender from entering into or arranging an extension of credit for the purpose of purchasing or carrying margin stock in an amount in excess of the maximum loan value of the margin stock if the loan is secured directly or indirectly by margin stock. Regulation X prohibits a borrower from entering into a transaction that violates the margin regulations. Credit that is extended for the purpose of buying or carrying margin stock is referred to as “purpose credit.” Margin stock includes equity securities listed or traded on a national securities exchange or qualified for trading in the National Market System. Margin stock also includes warrants or rights to subscribe to margin stock or debt securities convertible into margin stock or carrying a warrant or right to subscribe to margin stock, and certain securities issued by a registered investment company. Margin stock does not include the stock of a borrower’s wholly-owned operating subsidiaries that is not traded in the market.
An opinion that an extension of credit does not violate the margin regulations will turn on whether the credit is purpose credit and whether the credit is directly or indirectly secured by margin stock.