[Code of Federal Regulations]
[Title 12, Volume 3]
[Revised as of January 1, 2003]
From the U.S. Government Printing Office via GPO Access
[CITE: 12CFR221.106]

[Page 42-43]
 
                       TITLE 12--BANKS AND BANKING
 
                   CHAPTER II--FEDERAL RESERVE SYSTEM
 
PART 221--CREDIT BY BANKS AND PERSONS OTHER THAN BROKERS OR DEALERS FOR THE PURPOSE OF PURCHASING OR CARRYING MARGIN STOCK (REGULATION U)--Table of Contents
 
Sec. 221.106  Reliance in ``good faith'' on statement of purpose of loan.

    (a) Certain situations have arisen from time to time under this part 
wherein it appeared doubtful that, in the circumstances, the lending 
banks may have been entitled to rely upon the statements accepted by 
them in determining whether the purposes of certain loans were such as 
to cause the loans to be not subject to the part.
    (b) The use by a lending bank of a statement in determining the 
purpose of a particular loan is, of course, provided for by 
Sec. 221.3(c). However, under that paragraph a lending bank may accept 
such statement only if it is ``acting in good faith.'' As the Board 
stated in the interpretation contained in Sec. 221.101, the 
``requirement of `good faith' is of vital importance''; and, to fulfill 
such requirement, ``it is clear that the bank must be alert to the 
circumstances surrounding the loan.''
    (c) Obviously, such a statement would not be accepted by the bank in 
``good faith'' if at the time the loan was made the bank had knowledge, 
from any source, of facts or circumstances which were contrary to the 
natural purport of the statement, or which were sufficient reasonably to 
put the bank on notice of the questionable

[[Page 43]]

reliability or completeness of the statement.
    (d) Furthermore, the same requirement of ``good faith'' is to be 
applied whether the statement accepted by the bank is signed by the 
borrower or by an officer of the bank. In either case, ``good faith'' 
requires the exercise of special diligence in any instance in which the 
borrower is not personally known to the bank or to the officer who 
processes the loan.
    (e) The interpretation set forth in Sec. 221.101 contains an example 
of the application of the ``good faith'' test. There it was stated that 
``if the loan is to be made to a customer who is not a broker or dealer 
in securities, but such a broker or dealer is to deliver margin stock to 
secure the loan or is to receive the proceeds of the loan, the bank 
would be put on notice that the loan would probably be subject to this 
part. It could not accept in good faith a statement to the contrary 
without obtaining a reliable and satisfactory explanation of the 
situation''.
    (f) Moreover, and as also stated by the interpretation contained in 
Sec. 221.101, the purpose of a loan, of course, ``cannot be altered by 
some temporary application of the proceeds. For example, if a borrower 
is to purchase Government securities with the proceeds of a loan, but is 
soon thereafter to sell such securities and replace them with margin 
stock, the loan is clearly for the purpose of purchasing or carrying 
margin stock''. The purpose of a loan therefore, should not be 
determined upon a narrow analysis of the immediate use to which the 
proceeds of the loan are put. Accordingly, a bank acting in ``good 
faith'' should carefully scrutinize cases in which there is any 
indication that the borrower is concealing the true purpose of the loan, 
and there would be reason for special vigilance if margin stock is 
substituted for bonds or nonmargin stock soon after the loan is made, or 
on more than one occasion.
    (g) Similarly, the fact that a loan made on the borrower's signature 
only, for example, becomes secured by margin stock shortly after the 
disbursement of the loan usually would afford reasonable grounds for 
questioning the bank's apparent reliance upon merely a statement that 
the purpose of the loan was not to purchase or carry margin stock.
    (h) The examples in this section are, of course, by no means 
exhaustive. They simply illustrate the fundamental fact that no 
statement accepted by a lender is of any value for the purposes of this 
part unless the lender accepting the statement is ``acting in good 
faith'', and that ``good faith'' requires, among other things, 
reasonable diligence to learn the truth.