4000 - Advisory Opinions
Question Concerning Capital Market CD Program
FDIC--04--03 July 26, 2004 Douglas H. Jones, Deputy General Counsel
This is a follow-up to our June 4, 2004, meeting about the Company X ("X") Capital Market CD Program ("Program"). As we discussed, in December 2003 the FDIC received a letter inquiring whether the FDIC would be concerned that, if implemented in a certain way, the Program might be viewed either as inappropriately increasing deposit insurance coverage for investors or as permitting investors to inappropriately depend on FDIC deposit insurance.
As described in your previous letters to us, the Program will involve a series of limited liability companies (each an "Issuer") that will purchase certificates of deposits ("CDs") from a number of "well capitalized" FDIC-insured institutions ("Seller Banks"). Each Issuer will be a separate limited liability company managed by a limited liability company ("Facilitator"), which is owned by X. X will form the Facilitator of which X will be the sole equity member. Each Issuer will be owned either by qualified investors ("Investors") or by the Facilitator. The Facilitator will be the sole manager of each Issuer and will offer "funding certificates" to Investors, which will represent either equity membership interests in the Issuer or debt instruments of that Issuer. Each Issuer will be formed for the limited purpose of acquiring and holding CDs issued by a diverse set of Seller Banks. All investments made by Investors in any Issuer will be used by that Issuer to purchase CDs from the Seller Banks which will be held in that Issuer's funding pool.
In an FDIC staff opinion dated December 19, 2002, we concluded that: (1) the FDIC would regard each of the Issuers as a separately insurable entity; and (2) each Issuer would be insured up to $100,000 in its own ownership capacity, and not be deemed to be acting as a fiduciary for its Investors. In reaching these conclusions, the opinion concurred with the representations made by X that the primary purpose of the Program (and, hence, for the existence of each of the Issuers) is to enable investors to purchase from a single Issuer securities, in high dollar amounts, backed by CDs issued by a number of FDIC-insured institutions. On that basis, the opinion reasoned that each Issuer would be considered a corporation for FDIC-insurance purposes because each such entity would be engaged in an "independent activity" under the FDIC's regulations (12 C.F.R. 330.11). The regulations provide that an entity is engaged in an "independent activity" if it is "operated primarily for some purpose other than to increase deposit insurance." Id. at 330.1(g). The opinion noted that "if instead of purchasing a $1 million funding certificate' from an Issuer each Investor were to purchase a $100,000 CD directly from each of ten FDIC-insured depository institutions, the cumulative deposit insurance coverage would be the same; thus, the formation of the Issuer does not necessarily increase deposit insurance coverage--the chief concern underlying the requirements of section 330.11."
The potential policy issue raised in the December 2003 inquiry is this: If Issuers 1, 2, 3 and 4 each purchase a CD from Bank X and Investor A has an ownership interest in all four Issuers, Investor A could be deemed to have indirect deposit insurance coverage of more than $100,000 relative to the Issuers' deposits in Bank X. In other words, in the aggregate, if the Issuers were disregarded, Investor A's investment in multiple securities backed by different CDs issued by Bank X could be well in excess of $100,000.
After considering the December 2003 letter, and as we discussed with you at our June 4th meeting, the FDIC is concerned that under certain circumstances the use of multiple Issuers that placed CDs with a small universe of FDIC-insured institutions might lead to an abusive expansion of FDIC deposit insurance coverage in contravention of Section 330.11. Deciding whether an entity is engaged in an "independent activity" under the FDIC's deposit insurance regulations is a qualitative determination made by viewing both the legal and policy implications of the activity in which the entity is engaged. The scenario used as an example in the FDIC legal opinion does not raise concerns about an improper expansion of deposit insurance coverage. In that scenario the Program would simply be a means for Investors to obtain effectively the same coverage they each would be entitled to if they dealt directly with the Seller Banks.
The scenario raised in the December inquiry, however, raises policy concerns about a potential improper expansion of deposit insurance coverage. There one investor would be able to indirectly obtain insurance coverage well in excess of $100,000 per Seller Bank simply by investing in multiple Issuers all of whom have purchased CDs from the same Seller Bank. For example, a single investor could in theory invest $100,000 in each of ten Issuers, each of which held as its sole asset a $100,000 CD in Bank A. In that hypothetical situation it seems apparent that the primary purpose of the Issuer's activity is to obtain increased deposit insurance coverage for Investors. Indeed, a potential variation of the Program would be for a Seller Bank itself to establish a series of LLCs from each of which an Investor could purchase an equity or debt interest. In that situation the Investor's indirect deposit insurance coverage could be far in excess of $100,000.
At our meeting, and as confirmed by your letter dated June 9, 2004, you suggested a modification to the Program to allay our concerns about the policy implications of the Program. You suggested that our opinion be conditioned on each Issuer being required to disburse Investors' funds to no fewer than 100 Seller Banks per offering. Hence, Investors' funds would be distributed among a large pool of FDIC-insured institutions. You also noted that under your Program each Investor must be a "qualified institutional buyer" under Rule 144A that is also a "qualified purchaser" within the meaning of Section 2(a)(51)(A) of the Investment Company Act and related rules. Compliance with those requirements means that only institutional investors would be Investors under the Program. You also specified in your June 9th letter "[t]hat no security backed by certificates of deposit owned or controlled by any Issuer may be sold by the Facilitator, or any agent acting on behalf of the Facilitator, to any individual." Thus, only high volume deposits would be involved in the Program, allowing for the wide disbursement of funds contemplated in the proposed modification to the Program, and the Program would be available only to large, institutional investors.
We agree that modifying the Program to require no fewer than 100 Seller Banks per offering will safeguard against the concerns we have raised in that the invested funds would be sufficiently disbursed among many FDIC-insured institutions to negate the notion that each Issuer was created primarily for the purpose of increasing deposit insurance coverage. Also, limiting the Program to "qualified institutional investors" and "qualified purchasers" under the federal securities laws, and the unavailability of the Program to individuals, ensures that the stated purpose of the Program is met. Therefore, as a result of the modifications to the Program, it is my opinion that the Issuers would meet the "independent activity" test in the FDIC's regulations.
Please regard this letter as a supplement to the December 2002 FDIC legal opinion. The conclusions reached in that opinion are conditioned by the views expressed herein on when the Issuers would be deemed to be engaged in an "independent activity" under the FDIC's deposit insurance regulations. Fell free to contact me at (202) 898-3700 with any additional questions or comments.