4000 - Advisory Opinions
Whether Well-Capitalized Institution Offering Variable-Rate, College Cost Linked CD and Agents Who Place CD Are Deposit Brokers
June 17, 1993
Valerie J. Best, Counsel
This is in response to your request for clarification of the interest rate restrictions and the registration requirements imposed by the brokered deposit statutes (12 U.S.C. §§ 1831f and 1831f-1) as implemented by section 337.6 of the FDIC's Rules and Regulations (12 C.F.R. § 337.6). You asked whether offering the variable-rate "[tuition-linked] CD" causes *** (the "Bank") to be a "deposit broker" within the meaning of the FDIC's brokered deposit regulation. You also asked if the financial planners and other agents who place the [tuition-linked] CD are "deposit brokers" within the meaning of the same regulation.
I. DESCRIPTION OF BANK'S PROGRAM.
The Bank offers a floating-rate certificate of deposit (the [tuition-linked] CD) which pays a rate of return linked to increases in the cost of college, as measured by the Independent College 500 Index ("IC 500"), subject to a minimum, fixed interest rate (for example, 4%). Generally, each [tuition-linked] CD pays interest on July 31 each year the [tuition-linked] CD is outstanding "at a rate linked to the annual change in the dollar value of the IC 500" since the prior July 31, subject to the minimum interest rate.
II. STATUTORY AND REGULATORY RESTRICTIONS.
The statute and implementing regulations restrict the acceptance of deposits obtained by or through any "deposit broker"1 (i.e., brokered deposits) by any insured depository institution that is not well capitalized.2 Deposit brokers are prohibited from soliciting or placing any deposit with an insured depository institution unless the deposit broker has provided the FDIC with written notice that it is a deposit broker. The statute and implementing regulations also limit the rate of interest that may be paid by institutions that are not well capitalized.3
Please note that the acceptance of brokered deposits by an institution that is not well capitalized is restricted regardless of the amount of interest paid on those deposits. Likewise, the interest-rate restrictions apply to both funds that are directly solicited by a depository institution that is not well capitalized and to funds that are obtained by such an institution through a deposit broker.
III. APPLICATION OF INTEREST RATE RESTRICTIONS TO VARIABLE RATE INSTRUMENTS.
Your letter raises the question of whether the interest rate restrictions contained in the FDIC's regulations--as currently formulated--restrict depository institutions that are not well capitalized from offering deposit instruments featuring a variable rate of interest where that rate of interest is unknown when offered and cannot be determined until some future point in time.4
According to the regulation, the moment at which a rate of interest is to be compared to the prevailing rate of interest is at the moment the rate is offered. With respect to variable rate instruments tied to an index or event beyond the institution's control however, no one can predict at the time the deposit is offered what the interest rate for the deposit would be. Thus, no one can perform the calculation demanded by the brokered deposit regulation; that is, no one can determine whether the interest rate at the deposit's time of offering was more than 75 basis points above the prevailing rate, and thus, "significantly higher" than the prevailing rate.
The current regulation could be applied in one of several ways to resolve this problem. First, all institutions except those that are well capitalized could be barred from offering such instruments. Second, the FDIC could adopt a wait-and-see attitude. That is, if the amount of interest paid at maturity was significantly higher than the prevailing rate when the deposit was opened, the institution would be found in violation of the regulation. Third, the amount of interest to be paid at maturity could be capped at a maximum of the prevailing rate at the time of offering plus no more than 75 basis points.
None of these possible interpretations appear to be contemplated by the current regulation. I do not find any support in the regulation for the argument that variable rate instruments were intended to be banned for all but well capitalized institutions.
I do not question the FDIC's authority to do so under the statute, but the current regulations do not specifically address this situation. The second alternative leads to the untenable result that an institution would not know that it had violated the regulation until the deposit matured. The third alternative eliminates the attractiveness of variable rate deposits and would essentially result in their elimination for all but well capitalized institutions.
Based on the foregoing, I conclude that the current regulations do not prohibit adequately capitalized or undercapitalized institutions from offering variable rate instruments tied to an index or event beyond the institution's control. This does not mean such institutions may offer variable rate instruments without limit, however. For example, an institution that becomes adequately capitalized or undercapitalized and then offers a deposit linked to an index that has consistently demonstrated high growth may be found in violation of current regulations. Likewise, a deposit instrument that pays a variable rate of interest plus a fixed number of basis points will be scrutinized when offered by an institution that is not well capitalized to determine if it is consistent with current regulations.
Please be advised that FDIC staff may recommend to the FDIC Board of Directors that they adopt regulations that more specifically regulate the amount of interest payable under variable rate instruments by any depository institution that is not well capitalized.
IV. APPLICATION OF INTEREST RATE RESTRICTIONS TO COLLEGESURE CD.
The [tuition-linked] CD is not simply a variable rate instrument. It pays a fixed, minimum rate of interest in lieu of the variable rate should the variable rate fail to exceed the minimum rate. The fixed or minimum rate of interest must be evaluated at the time the CD is offered to determine whether or not it is significantly higher (more than 75 basis points) than the prevailing rate. If the fixed or minimum rate is significantly higher, then an institution could not offer the deposit instrument unless it is well capitalized at the time the deposit is offered. In addition, the variable rate component would be evaluated as outlined under heading III, above.
It is my understanding that the Bank is currently well capitalized. Consequently, the brokered deposit statute and implementing regulations do not limit the interest rate the Bank may offer.
With regard to your specific question concerning whether the Bank needs to register with the FDIC as a deposit broker, even if the Bank would be deemed to be a deposit broker solely because it offers high-rate deposits directly to its customers, it is not required to notify the FDIC of its status as a deposit broker.5
V. STATUS OF AGENTS AS DEPOSIT BROKERS.
Next, there is the question of whether the Bank's financial planners and other agents are deposit brokers according to the placing or facilitating test quoted above. Based upon the information provided in your letters, it is my view that the following entities are not deposit brokers: the State of ***; the colleges and universities; the corporation making the deposit available as part of its employee benefit plan. The following entities are deposit brokers: the financial planners and investment advisers; the brokerage houses; the accountants and lawyers.
A. The State of *** and the Colleges and Universities.
(a) All of the Affinity Groups were non-financial institutions, and the vast majority were non-profit organizations; (b) none of the Affinity Groups directly marketed the deposit products for the bank; (c) Affinity Group members who decide to place deposits with the bank do so directly with the bank (the Affinity Groups did not receive funds from their members for deposit with the bank or otherwise process any member deposits); (d) the Affinity Groups have exclusive relationships with the bank, and they do not endorse deposit products of other institutions; (e) most, but not all, of the Affinity Groups received royalties for endorsing the bank's deposit products, the amount of which represent a small fraction of the market rates paid to others who are considered deposit brokers within the meaning of the brokered deposit statute; (f) the deposits are regarded by the bank as core deposits of the bank and are not used to replace core deposit run-off--the deposits have a high retention rate; and (g) the Affinity Groups do not know which members have made deposits with the bank, nor do they keep any records of the amounts, rates or maturities of the deposits.
When considered together, we believed these facts tended to support the conclusion that the Affinity Groups are neither "engaged in the business of placing deposits" nor "facilitating the placement of deposits" with the bank, as contemplated by the statute. By contract, each Affinity Group permitted the bank to use its name to market the bank's deposit products to its members with its endorsement. Such activity, we believed, and the nature of the particular arrangement can reasonably be characterized as passive and indirect and, therefore, outside the scope of the brokered deposit statute and regulations.
Based upon my understanding of the facts, it appears that the State of *** and the colleges and universities satisfy the above parameters. Consequently, the State of *** and the colleges and universities would not be deposit brokers.
B. The Financial Planners and Brokerage Houses.
The financial planners and investment advisers, and brokerage houses are considered to be deposit brokers. The *** letter states that the financial planning firms offer a full array of financial planning and investment advisory services to their customers, only a very small part of which relates to the [tuition-linked] CD. The letter argues that the financial planners should not be considered brokers because of the "limited" amount of deposits placed with the Bank. The letter also argues that the primary function of the relationship is the provision of advisory services. The *** letter emphasizes the small, average amount of [tuition-linked] CDs placed by PaineWebber and three other broker-dealers, stating that the average size of the deposits they placed was $1,092. The letter goes on to say that even if, for the sake of the argument, one assumes that these broker-dealers are deposit brokers under the placing or facilitating test, such agents would come under the "primary purpose" exception since "all of [Bank's] contacts are with the financial planning divisions of the brokerage houses," not their money desk operations.
Essentially, you contend that the financial planners do not fall within the statutory definition of deposit broker because the business they generate for the Bank is a small percentage of their over-all business. You argue that the brokerage houses do not fall within the definition of deposit broker because they generate small-dollar accounts. Even if the financial planners and brokerage houses are deposit brokers, you argue that they qualify for one of the exclusions to the definition because their primary purpose is financial planning and advisory services.
The FDIC has previously rejected the argument that a financial intermediary is not a deposit broker if a small percentage of its business involves the placement of deposits.6 Further, the placing or facilitating test does not provide for a de minimis exception for small-dollar accounts. Those who engage in financial planning activities do not automatically come under the "primary purpose" exception. The letter gives a total for the average commissions paid to each of the four broker-dealers, presumably by [Bank], for the placement of deposits. Because, among other things, the broker-dealers are receiving commissions and because they are financial intermediaries, they would be deposit brokers under the placing or facilitating test, and the "primary purpose" exception would not be available to them. The FDIC has issued a number of Advisory Opinions that provide a more detailed analysis of these issues.7
C. Corporation--Employee Benefit Plan.
Based on available information, we do not consider the corporation to be a broker. [Bank] currently has a relationship with one corporation which offers its employees the [tuition-linked] CD as one investment option within a "cafeteria plan" of employee benefits. The corporation does not receive any commission from the Bank or its employees in connection with the plan. The payroll deduction plan for the [tuition-linked] CD is said to be part of an employee benefit plan that would qualify the corporation for exception (E)--"[a] person acting as a plan administrator or an investment adviser in connection with a pension plan or other employee benefit plan provided that person is performing managerial functions with respect to the plan." 12 C.F.R. § 337.6(a)(5)(ii)(E). If, in fact, the corporation meets this definition with regard to the CD, exception (E) will be met, and the corporation will not be considered a deposit broker.
The *** letter mentions that the Bank is hopeful of establishing similar programs with other corporations, some of which may involve the payment of commissions. We do not have sufficient facts to determine whether the proposed programs qualify for the exception applicable to persons performing managerial functions with respect to a pension plan or employee benefit plan.
D. Accountants and Lawyers. The *** letter describes the services of certain accountants and lawyers, who refer their clients to [Bank] in exchange for a commission. As discussed above, such accountants and lawyers would be deemed deposit brokers, and the "primary purpose" exception would not be available to them."8
Please share a copy of this letter with the entities identified herein as deposit brokers, or advise them of our views as to their status as deposit brokers. The notification requirements applicable to deposit brokers are outlined in the enclosed Financial Institutions Letter 42--92. Notices should be sent to the following address:
Office of Specialty Examinations and Financial Reporting9
Division of Supervision
Washington, D.C. 20429
(FAX number 202-898-3909)
A notice from a deposit broker to the FDIC is effective upon receipt by the FDIC.
I hope this is fully responsive to your inquiry. If I can be of any further help, I can be reached at (202) 898-3812. I apologize for the delay in responding to your inquiry.
1The term "deposit broker" is broadly defined by statute
and includes "any person engaged in the business of placing
deposits, or facilitating the placement of deposits, of third parties
with insured depository institutions." 12 U.S.C. § 1831f(g); 12
C.F.R. § 337.6(a)(5). Several exceptions to the definition of deposit
broker are set out in the statute. Notwithstanding these exceptions,
the term "deposit broker" also includes:
2Undercapitalized insured depository institutions are prohibited from accepting funds obtained by or through any deposit broker. Adequately capitalized insured depository institutions are prohibited from accepting funds obtained by or through any deposit broker unless they first obtain a waiver from the FDIC. Well capitalized insured depository institutions, however, may accept such funds without restriction. 12 U.S.C. § 1831f; 12 C.F.R. § 337.6. Go back to Text
3The interest rate restrictions applicable to undercapitalized institutions are set out at 12 C.F.R. § 337.6(b)(3)(ii). The interest rate restrictions applicable to adequately capitalized institutions that accept brokered deposits pursuant to a waiver from the FDIC can be found at 12 C.F.R. § 337.6(b)(2)(ii). By "deeming" an insured depository institution to be a deposit broker when it offers significantly higher rates, the effect of 12 U.S.C. § 1831f(g)(3) is to limit the rate of interest adequately capitalized institutions may offer on directly solicited deposits. 12 C.F.R. § 337.6(a)(5)(iii). The import of 12 U.S.C. § 1831f(g)(3) and the interest rate restrictions are discussed in detail in the following Advisory Opinions: FDIC--93--6 (January 28, 1993); FDIC--93--20 (March 11, 1993); FDIC--93--21 (March 11, 1993). Also see discussion at 57 Fed. Reg. 23933--34 (June 5, 1992). Go back to Text
4The interest rate paid under a variable rate instrument may be (1) tied to an interest rate index beyond the institution's control, such as U.S. Treasury Bill rates or the Standard & Poor's 500 Composite Stock Price Index, (2) tied to an event beyond the institution's control, such as the outcome of a sporting event, or (3) entirely within the institution's control. This discussion is limited to the first two types of instruments--those linked to an index or event beyond the institution's control. Go back to Text
5See FDIC Advisory Opinion 93--18 (March 8, 1993). That letter concerns a well-capitalized institution but the reasons outlined therein also apply to adequately capitalized institutions. The opinion is limited to those situations where the depository institution is soliciting and accepting deposits on its own behalf and not through a third-party intermediary. Go back to Text
6FDIC Advisory Opinion 90--21 (May 29, 1990). Go back to Text
7See, among others: FDIC--90--21; FDIC--92--52; FDIC--92--53; letter dated Nov. 21, 1992 concerning municipal funds. Go back to Text
8The situation you describe is different from those situations where an attorney or accountant holds funds on behalf of a client (such as an escrow account). Go back to Text
9Formerly the Office of Compliance and Special Activities. Go back to Text