Absorption of Exchange Or Collection Charges by Member Banks, Hearings Before ..., 78-2 on S. 1642 and H.R. 3956 ..., December 7... 15, 1944

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bill which has been carried on by the Reserve Board controlled Federal Reserve banks, one of which, on March 10, 1944, wrote all of the operating banks in its district stating: "If the Senate joins the House in enacting this legislation within the next week or two, the progress made in the past 30 years in building a parcollection system will be reversed. The two Senators from your State as well as the members of the Senate Committee on Banking and Currency undoubtedly will wish to understand the significance of the Maybank bill (S. 1642). No one is better able to interpret its possible effects than you. As for ourselves, it is our considered judgment that this legislation is not in the public interest." Moreover, the Board's disclaimer must be viewed in light of the past history of its attitude toward absorption of exchange. In 1936, the Board of Governors requested the Federal Advisory Council for its opinion as to whether the promul gation and enforcement of regulation Q, with the inclusion therein of the definition outlawing absorption of exchange as a payment of interest, would have an adverse effect upon membership in the Federal Reserve System; and the Federal Advisory Council replied that it would not (1936 Annual Report of the Federal Reserve Board, p. 233). If the motive of the Federal Reserve Board was enforcement of the law and not the achievement of par clearance, why, it is fair to ask, was it concerned with the effect of its ruling forbidding absorption of exchange upon membership in the Federal Reserve System? If the law prohibiting interest upon demand deposits compelled such a ruling, then whether membership in the Federal Reserve System was affected or not it would seem that the Reserve Board was required to make that ruling. We may justly ask, would the Federal Reserve Board have persisted in its attitude had it been advised by the Federal Advisory Council that such a ruling would have a detrimental effect upon membership in the System? Moreover, the Federal Advisory Council's reply is not consistent with the Board's present statement that it was confronted with the unhappy possibility that such a ruling would result in member banks withdrawing from the System.

The ruling of the Board has singled out absorption of exchange charges alone, of all expenses identifiable with a depositor's account, for classification as a prohibited interest payment; while other rulings hold that other expenses, equally identifiable, such as intangible property taxes against depositors based upon their bank balances, bond premiums and expenses of clearing checks, may be absorbed without violation of the law. Thus, for example, the Federal Reserve Board has held that member banks may pay and absorb intangible property taxes upon depositor's bank balances such as those levied in the States of Michigan, Indiana, and Kentucky without violating the interest statute. It is to be noted that these taxes are laid on the depositors and not on the banks and are in every sense "out-of-pocket" expenses insofar as the bank is concerned. Nevertheless, the Federal Reserve Board has ruled that the term "interest" includes the payment or absorption of exchange and collection charges "but does not include the payment or absorption of taxes upon deposits whether levied against the bank or the depositor" (Federal Reserve Bulletin (1935), p. 864; id. (1944), p. 13).

INTERPRETATION OF INTEREST-PROHIBITION STATUTE

Mindful of this turbulent history of the par-clearance issue, we pass to consideration of the question whether Congress intended that absorption of exchange be deemed the payment of interest.

What did Congress mean by the term "interest" as used in the laws prohibiting payment of interest on demand deposits? The laws themselves contain no definition.

The Banking Act of 1933 became law on June 16, 1933. The Senate bill contained a provision prohibiting interest payments on demand deposits; the House bill contained only a provision for regulating interest rates on savings and time deposits. The reports on these bills cast no light on the question under consideration here, but we do learn from the Congressional Record that the purpose of the Senate provision was to attract surplus bank money away from the large money markets, where it had been used for speculative purposes, and return it to the home communities of the banks where it could be loaned out. It was thus explained to the Senate:

66e * * The payment of interest on demand deposits has resulted for years and years in stripping the country banks of all their spare funds, which have been sent to the money centers for stock-speculative purposes. * * * If they have abundant funds and credits they can lower the rate of interest in order to stimulate business and industry and farming activities.

ed. 1183, 1187; Jones v. Magruder (D. C. Md., 1941) 42 F. Supp. 193, 199; Railroad Federal Savings and Loan Association v. United States, 135 F. (2d) 290, 293 (C. C. A. 2, 1943)). But in almost all cases it will be found that the administrative regulation was in existence a considerable length of time and usually through several statutory reenactments. Where the regulation is only of short life, the rule is not applied (Commissioner of Internal Revenue v. Sun Pipe Line Co., 126 F. (2d) 888 (C. C. A. 3, 1942)). The theory upon which the rule is based is that there is a presumption that the legislature is aware of the administrative ruling and impliedly adopts it by failing to legislate against it. This presumption, however, is thoroughly overcome as far as the 1935 act is concerned, since Congress actually was kept in complete ignorance of any ruling on this subject. As an eminent authority has said: "While the acquiescence of the legislature seems to be of small matter where there is no evidence to the effect that the statute or contemporaneous interpretation was called to the legislature's attention, it is believed that when action has been taken upon a statute by the legislature, and where a practical and contemporaneous interpretation was called to its attention, the failure of the legislature to change the interpretation should be regarded as presumptive evidence of its correctness" (2 Sutherland, Statutory Construction (3d ed.), 525). Even had the legislative record been such as to warrant the conclusion that Congress did intend to adopt the Reserve Board's views, its rulings on the subject were so confusing and contradictatory that no clarification of the issues could have resulted. Thus, the Board had held that absorption of exchange charges by a bank for depositors who maintained balances of $1,000 or more was not a violation of the law; this, notwithstanding the interest statute prohibits the payment of any interest on demand deposits. Yet in another case it held that absorption of exchange charges by a bank "up to an amount equivalent to a certain specified percentage of the amount of the collected balance" of its correspondent bank customers was a violation of the law (Federal Reserve Bulletin (1934), p. 395). Furthermore, these rulings appear to have been entirely precatory to the extent that they declared exchange absorption to be illegal, as the practice continued to be indulged in by member banks throughout the system without interference by the Board until 1944.

We think it cannot reasonably be said that Congress, in passing this legislation, could have had any intention of prohibiting the long-established banking practice which was so completely wrapped up in the explosive par clearance issue without some mention having been made of the problem in the debates, the reports on the bills or the testimony upon which the congressional committees acted.

There are certain well-established rules for determining legislative intent. One of these is that penal statutes must be strictly construed and the statutes in this case are plainly penal. The one governing insured nonmember banks carries with it the specific penalty of $100 for each violation as well as the general penalty of the forfeiture-of-deposit insurance. The one governing member banks carries the general penalty of forfeiture of charter, in the case of national banks, and forfeiture of membership in the Federal Reserve System, in the case of State member banks, as well as the loss of Federal deposit insurance, or the removal from office of the bank officers responsible for the viclations. Statutes which provide for forfeitures upon their violation are penal (State of Maryland v. The B. & O. R. Co. (1845) 3 How. (U. S.) 534, 11 L. ed. 714; Chase v. Curtis, et al. (1885) 113 U. S. 452, 28 L. ed. 1038; Hall v. Norfolk & W. R. Co. 44 W. Va. 36, 28 S. E. 754 (1897); Vestal Co. v. Robertson, 277 III. 425, 115 N. E. 629 (1917); Manhattan Trust Co. v. Davis, 23 Mont. 273, 58 P. 718 (1899)).

Another of these rules is that words having a precise and well-settled meaning in common usage are to be understood in the same sense when used in statutes. This rule has been applied to the use of the word "interest" in statutes in two decisions of the United States Supreme Court involving provisions of the Internal Revenue Code (Deputy v. DuPont (1940) 308 U. S. 488, 84 L. ed. 416; Old Coloncy R. Co. v. Commissioner of Internal Revenue (1932) 284 U. S. 552, 76 L. ed. 484). In Deputy v. DuPont, the Court, speaking through Mr. Justice Douglas, said: *** In the business world 'interest on indebtedness' means compensation for the use or forbearance of money. In absence of clear evidence to the contrary, we assume that Congress has used these words in that sense. In sum, we cannot sacrifice the 'plain, obvious and rational meaning' of the statute even for 'the exigency of a hard case.'"

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In the Old Colony case the Court, speaking through Mr. Justice Roberts, said: * as respects 'interest,' the usual import of the term is the amount which

one has contracted to pay for the use of borrowed money. We cannot believe that Congress used the word having in mind any concept other than the usual, ordinary, and everyday meaning of the term, or that it was acquainted with the accountants' phrase 'effective rate' of interest and intended that as the measure of the permitted deduction."

Furthermore, judicial precedents concerning interest for the purpose of determining whether usury has been practiced, establish that the question whether a particular payment by a borrower to a lender is interest or reimbursement of an expense, involves intent. There is no presumption of an illegal or usurious intent, but on the contrary the burden rests upon the party seeking to impeach the transaction for usury to prove the illegal intent (Brown v. Robinson (1918), 224 N. Y. 301, 314, 120 N. E. 694, 698). Here, however, for purposes of administrative disposition, it appears that the Reserve Board has reversed the presumption and burden of proof by ruling (Federal Reserve Bulletin (1934), p. 396) —

* * that, in any case in which a member bank pays or absorbs exchange or collection charges or other expenses in connection with any deposit payable on demand, the burden will be upon it to show that such payment or absorption of charges is not a device to evade the provisions of section 19 of the Federal Reserve Act forbidding the payment of interest on deposits payable on demand."

The extensive hearings which were had before the House Banking and Currency Committee on the present measure have clearly demonstrated the importance of absorption to many bankers and the intensity of their opposition to any restriction of this practice, which was a well-known banking custom and was separate and distinct from the payment of interest. That the two practices are different both in origin and economic effect is borne out also by numerous witnesses who testified at those hearings.

It is significant that just as bankers have long differentiated between the payment of interest which they consider compensation and the absorption of exchange which they consider expense, so have courts in usury cases similarly differentiated between the payment of interest and exchange (Cayuga County Bank v. Hunt, 2 Hill (N. Y.) 635; Holford v. Blatchford, 2 Sandf. Ch. (N, Y.) 149).

In Buckingham v. McLean ((1851) 13 How. (U. S.) 151, 14 L. ed. 91), the Supreme Court said: "The reason why the addition of the current rate of exchange to the legal rate of interest does not constitute usury is, that the former is a just and lawful compensation for receiving payment at a place where the money is expected to be less valuable than at the place where it is advanced and lent."

ABSORPTION OF EXCHANGE-ADMINISTRATIVE INTERPRETATIONS

Let us now consider the historical development of the administrative concept that absorption of exchange constitutes payment of interest in violation of section 19 of the Federal Reserve Act.

In 1935 the Reserve Board revised its regulation Q (effective January 1, 1936) to include the following definition of interest:

Section I (f): "The term "interest' means a payment, credit, service, or other think of value which is made or furnished by a bank as consideration for the use of the funds constituting a deposit and which involves the payment or absorption by the bank of out-of-pocket expenses (i. e., expenses arising out of specific transactions for specific customers and definitely attributable to such transactions as distinguished from overhead and general operating expenses), regardless of whether such payment, credit, service, or other thing of value varies with or bears a substantially direct relation to the amount of the depositor's balance.

"The term 'interest' includes the payment or absorption of exchange and collection charges which involve out-of-pocket expenses, but does not include the payment or absorption of taxes upon deposits whether levied against the bank or the depositor nor the payment or absorption of premiums on bonds securing deposits where such bonds are required by or under authority of law. "Notwithstanding the foregoing, the payment or absorption of isolated items of out-of-pocket expense in trivial amounts and not of a regularly recurrent na

3 The provision permitting banks to pay and absorb the taxes for their depositors is supported by later specific rulings of the Board to the same effect. Why the Board permits taxes to be paid and absorbed but prohibits banks from absorbing exchange can be explained only by the fact that the former has no bearing upon the issue of par clearance. The provision relative to bond premiums constituted a reversal of an earlier ruling by the Board (Federal Reserve Bulletin (1933), p. 500).

There are certain well-established rules for determining legislative intent. One of these is that penal statutes must be strictly construed and the statutes in this case are plainly penal. The one governing insured nonmember banks carries with it the specific penalty of $100 for each violation as well as the general penalty of the forfeiture-of-deposit insurance. The one governing member banks carries the general penalty of forfeiture of charter, in the case of national banks, and forfeiture of membership in the Federal Reserve System, in the case of State member banks, as well as the loss of Federal deposit insurance, or the removal from office of the bank officers responsible for the violations. Statutes which provide for forfeitures upon their violation are penal (State of Maryland v. The B. & O. R. Co. (1845) 3 How. (U. S.) 534, 11 L. ed. 714; Chase v. Curtis, et al. (1885) 113 U. S. 452, 28 L. ed. 1038; Hall v. Norfolk & W. R. Co. 44 W. Va. 36, 28 S. E. 754 (1897); Vestal Co. v. Robertson, 277 Ill. 425, 115 N. E. 629 (1917); Manhattan Trust Co. v. Davis, 23 Mont. 273, 58 P. 718 (1899)).

Another of these rules is that words having a precise and well-settled meaning in common usage are to be understood in the same sense when used in statutes. This rule has been applied to the use of the word "interest" in statutes in two decisions of the United States Supreme Court involving provisions of the Internal Revenue Code (Deputy v. DuPont (1940) 308 U. S. 488, 84 L. ed. 416; Old Coloncy R. Co. v. Commissioner of Internal Revenue (1932) 284 U. S. 552, 76 L. ed. 484). In Deputy v. DuPont, the Court, speaking through Mr. Justice Douglas, said: **** In the business world 'interest on indebtedness' means compensation for the use or forbearance of money. In absence of clear evidence to the contrary, we assume that Congress has used these words in that sense. In sum, we cannot sacrifice the 'plain, obvious and rational meaning' of the statute even for 'the exigency of a hard case.'"

In the Old Colony case the Court, speaking through Mr. Justice Roberts, said: * as respects 'interest,' the usual import of the term is the amount which

We cannot

one has contracted to pay for the use of borrowed money. believe that Congress used the word having in mind any concept other than the usual, ordinary, and everyday meaning of the term, or that it was acquainted with the accountants' phrase 'effective rate' of interest and intended that as the measure of the permitted deduction."

ABSORPTION OF EXCHANGE-ADMINISTRATIVE INTERPRETATIONS

Let us now consider the historical development of the administrative concept that absorption of exchange constitutes payment of interest in violation of section 19 of the Federal Reserve Act.

In 1935 the Reserve Board revised its regulation Q (effective January 1, 1936) to include the following definition of interest:

Section I (f): "The term 'interest' means a payment, credit, service, or other think of value which is made or furnished by a bank as consideration for the use of the funds constituting a deposit and which involves the payment or absorption by the bank of out-of-pocket expenses (i. e., expenses arising out of specific transactions for specific customers and definitely attributable to such transactions as distinguished from overhead and general operating expenses), regardless of whether such payment, credit, service, or other thing of value varies with or bears a substantially direct relation to the amount of the depositor's balance.

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