FDIC Law, Regulations, Related Acts
4000 - Advisory Opinions
Question Concerning a Deposit Program
FDIC--13--01 August 15, 2013 Christopher L. Hencke, Counsel
You have requested an opinion about a deposit program developed by X. This program is the successor to a program developed by Y.1 In regard to the X program, you have raised two issues. First, an issue exists as to whether the deposits in this program would qualify as "brokered deposits." Second, an issue exists as to whether the deposits would be insurable (up to the $250,000 limit) to each of multiple "business trusts."
The X Program
In connection with the X program, you will organize a series of "business trusts" under State law. Each of these entities will be a subtrust of a "Master Trust."2 After its creation, the business trust will issue notes (i.e., securities) to institutional investors. The business trust, however, will not deal with the investors directly. Rather, the business trust will sell the notes to the investors through a community bank.
After selling the notes, the community bank--as agent for the business trust--will place the proceeds on deposit at the community bank. The deposit accounts at the community bank will be titled in the name of the business trust or in the name of the "[Community] Bank as Custodian or Escrow Agent for the Benefit of the Trust." The deposits will not be held in accounts owned by the investors. Thus, the investors will possess claims against the business trust (for payment on its notes), but will possess no direct ownership interest in any deposit accounts. Not owning any deposit accounts, the investors will receive no direct insurance coverage from the FDIC. The investors will receive indirect insurance coverage, however, because the notes issued to the investors will be secured by the deposit accounts owned by the business trust. Moreover, inasmuch as notes will be issued by multiple business trusts, an investor will be able to obtain indirect insurance coverage in excess of $250,000 by purchasing notes from multiple trusts (assuming each business trust is eligible for separate insurance coverage).
In short, the program is designed so that an investor may receive indirect deposit insurance coverage (at a single insured depository institution) in excess of the $250,000 limit. By expanding insurance coverage in this manner, the program is designed to produce greater funding for the community bank. At the same time, as discussed in greater detail below, the program is designed to produce charitable contributions to designated charities and nonprofit associations.
In issuing notes through the X program, the business trust will promise to pay interest equal to the interest payable by the community bank on the corresponding deposit account (i.e., the account pledged as security for the note). According to your letter dated May 1, 2013, certain fees also shall be payable by the community bank for the benefit of designated charities and nonprofit associations. Also, licensing fees shall be payable to X. . . .
All of the transactions described above, including the selection of the charities and nonprofit associations, will be effected through an online software program licensed to the bank by X.
As previously mentioned, the X program raises two issues. Each of these issues is discussed in turn below.
First Issue: Whether the Deposits Would Qualify as "Brokered Deposits"
Section 29 of the Federal Deposit Insurance Act ("FDI Act") provides in part as follows: "An insured depository institution that is not well capitalized may not accept funds obtained, directly or indirectly, by or through any deposit broker for deposit into 1 or more deposit accounts." 12 U.S.C. § 1831f(a). In the case of an insured depository institution that is adequately capitalized (though not well capitalized), the FDIC may waive this statutory prohibition. See 12 U.S.C. § 1831f(c). In the case of an institution that is undercapitalized, the prohibition cannot be waived.
As quoted above, section 29 restricts the acceptance of deposits through "deposit brokers." The term "deposit broker" is defined as "any person engaged in the business of placing deposits, or facilitating the placement of deposits, of third parties with insured depository institutions or the business of placing deposits with insured depository institutions for the purpose of selling interests in those deposits to third parties." 12 U.S.C. § 1831f(g)(1)(A). If a deposit is accepted by an insured depository institution through a "deposit broker," the deposit is a "brokered deposit." Otherwise, the deposit is not a "brokered deposit." See 12 C.F.R. § 337.6(a)(2).
In summary, subject to certain exceptions, a "brokered deposit" is simply a deposit accepted by an insured depository institution by or through a third party (i.e., a party other than the owner of the deposit).
In this case, you have argued that the deposits in the X program will not be accepted by the community banks by or through a third party. Rather, the deposits will be accepted directly from the owners of the deposits, i.e., the business trusts. Therefore, the deposits should not be classified as "brokered deposits". . . .
[W]e agree with you that the business trusts will not be "deposit brokers" with respect to their own deposits. Please note, however, that the business trusts will not act alone in placing their deposits at the community banks. Indeed, as subtrusts of the "Master Trust," the business trusts will be incapable of taking any independent actions. Rather than acting alone, the business trusts will be assisted (i.e., controlled) by you as trustee of the "Master Trust" and president of X. In addition, the business trusts may be assisted by the charities and nonprofit associations. The roles played by these parties are discussed below.
X and the "Master Trust."
In your letters, you stated that X will provide no marketing for the community banks in connection with the program. Though X may provide no marketing, this company and the "Master Trust" and yourself (as president of X and trustee of the "Master Trust") will be involved in other ways. Most notably, one or more of these parties will create the business trusts. In addition, one or more of these parties will recruit community banks for participation in the program. Through these actions, these third parties will connect the depositor (the business trust) with the insured depository institution (the community bank). By connecting the depositor with the bank, these third parties will "facilitate the placement of [the] deposits." See, e.g., FDIC Advisory Opinion No. 92--79 (November 10, 1992) ("[T]he broad definition of deposit broker used in the FDI Act encompasses . . . match-making' or finder' activities").3 Indeed, without the involvement of third parties, the placement of deposits by any of the business trusts into any of the community banks would be impossible because the business trusts do not function as independent businesses. They function solely as components of the X program. Under these circumstances, X and the "Master Trust" would qualify as "deposit brokers." Consequently, the deposits would qualify as "brokered deposits."
The Charities and Nonprofit Associations.
You have stated that the charities and nonprofit associations will provide no marketing for the community banks. Rather, the charities and nonprofit associations will be passive recipients of some of the earnings produced by the deposits. Assuming the accuracy of this characterization, the charities and nonprofit associations would not qualify as "deposit brokers". . . . In any event, given that X itself would be a "deposit broker," the status of the charities is unimportant.
In summary, for the reasons explained above, the deposits in the X program would be "brokered deposits."
Second Issue: Whether Each of the Business Trusts Would Be Eligible for Separate Insurance Coverage
You have described the "business trusts" as "unincorporated associations" under State law.4 Under the FDIC's insurance regulations, an unincorporated association is entitled to separate insurance coverage for its deposits (up to the $250,000 limit) provided that the association is engaged in an "independent activity." See 12 C.F.R. § 330.11(c). The term "independent activity" is defined as follows: "A corporation, partnership or unincorporated association shall be deemed to be engaged in an independent activity' if the entity is operated primarily for some purpose other than to increase deposit insurance." 12 C.F.R. § 330.1(g).
In this case, the alleged "independent activity" of each business trust is to support the charity or nonprofit association that has been designated to receive part of the interest (or fees) produced by the trust's deposits. The activity of supporting the charity, however, cannot be separated from the activity of holding the FDIC-insured deposits. Indeed, the holding of the deposits is the very activity that produces the earnings that support the charity. Under these circumstances, we have concluded that the holding of FDIC-insured deposits by the business trusts is the primary activity of the business trusts. This means that the business trusts do not satisfy the FDIC's "independent activity" test. As a consequence, the business trusts would not be entitled to separate insurance coverage.
In addition, though the X program may be designed with the goal of supporting charities, the program also is designed with the goal of providing the investors with indirect FDIC insurance coverage in excess of the $250,000 limit. (Otherwise, X could create a single business trust to issue the notes instead of creating multiple business trusts to issue the notes.) When the purpose of a business entity is to hold FDIC-insured deposits so that other parties will enjoy expanded (though indirect) FDIC insurance coverage, the business entity does not satisfy the FDIC's "independent activity" test.5
For the reasons explained above, we conclude that the deposits in the X program would be "brokered deposits." Also, we conclude that the business trusts in this program would not be engaged in an "independent activity." Therefore, the deposits of each business trust would not be eligible for separate insurance coverage.
The opinions expressed herein represent the views of the Legal Division staff and should be considered advisory in nature. Staff opinions are not binding upon the FDIC or its Board of Directors. This opinion is based upon the facts presented. Any changes in the facts or circumstances could result in different conclusions.
Rescission of Advisory Opinion No. 02-05 and Advisory Opinion No. 04--03, Involving Separate Insurance Coverage for Business Entities That Are Created for the Sole Purpose of Issuing Notes Backed by FDIC-Insured Deposits
FDIC--13--02 August 23, 2013 Christopher L. Hencke, Counsel
On a few occasions, the FDIC has been asked to review deposit programs in which a series of business entities (such as corporations or limited liability companies) is organized to issue notes (i.e., securities) secured by FDIC-insured deposits. Though the notes themselves (owned by investors) will not be insured by the FDIC, the deposits (owned by the business entities) will be insured (up to the insurance limit). Being secured by FDIC-insured deposits, the notes are marketed to investors as a means of obtaining indirect FDIC insurance coverage.
The FDIC reviewed such a program in Advisory Opinion No. 02--05 (December 19, 2002). In that program, a series of limited liability companies ("LLCs") was organized under state law for the purpose of issuing "funding certificates" secured by FDIC-insured certificates of deposit ("CDs"). The "funding certificates" were owned by investors; the CDs were owned by the LLCs (or "Issuers"). Thus, the investors received no insurance protection from the FDIC except indirect protection through the CDs owned by the LLCs. The program was designed so that an investor, by purchasing "funding certificates" from multiple LLCs, could obtain indirect FDIC insurance protection in excess of the insurance limit even if the various LLCs placed their deposits (securing the "funding certificates") at the same insured depository institution. Of course, such indirect FDIC insurance coverage (in excess of the insurance limit) would not be possible unless each LLC was eligible for its own separate coverage.
Under the FDIC's insurance regulations, corporations (including LLCs) are not eligible for separate insurance coverage unless they are engaged in an "independent activity." See 12 C.F.R. § 330.11(a)(1). The term "independent activity" is defined as follows: "A corporation, partnership or unincorporated association shall be deemed to be engaged in an 'independent activity' if the entity is operated primarily for some purpose other than to increase deposit insurance." 12 C.F.R. § 330.1(g).
In Advisory Opinion No. 02--05, the FDIC staff found that the LLCs were engaged in an "independent activity." The staff explained this conclusion as follows: "Without doubt, an obvious component of the Program is the investment safety provided by FDIC insurance. The primary purpose of the Program (and, hence, for the existence of the Issuer), however, is to enable investors to purchase securities, in high dollar increments, backed by CDs issued by FDIC-insured institutions." In other words, the staff found that the LLCs were operated for the primary purpose of issuing securities and not for the primary purpose of holding deposits or increasing deposit insurance coverage. Having found that the LLCs were engaged in an "independent activity," the staff concluded that each LLC was entitled to separate insurance coverage for its deposits.
Advisory Opinion No. 02--05 was qualified by Advisory Opinion No. 04--03 (July 26, 2004). In the latter opinion, the FDIC staff expressed concern that the LLC program could lead to an inappropriate expansion of deposit insurance coverage. The staff explained this concern as follows: "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." To allay this concern, the company that operated the program (and controlled all of the LLCs) promised to disburse investors' funds to no fewer than 100 banks per offering of "funding certificates." With this modification to the program, the FDIC staff agreed 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."
The FDIC has reconsidered Advisory Opinion No. 02--05 and Advisory Opinion No. 04--03. In those opinions, as discussed above, the FDIC found that the primary purpose of the LLCs was to issue securities (or "funding certificates") and not to hold deposits or increase deposit insurance coverage. The securities could not be marketed to the investors, however, without the promise of indirect FDIC insurance coverage. Thus, the securities and the FDIC-insured deposits were inseparable (regardless of the number of banks involved in each "offering"). Under these circumstances, and contrary to the staff's previous analysis of the LLCs, we do not believe that the primary purpose of the LLCs was simply to issue securities.
In fact, the issuance of securities cannot be the primary purpose of any business because the money collected from investors must be repaid to the investors (with interest). The issuance of securities is simply a means of borrowing money; it is not a line of business unto itself. The activity of issuing securities (borrowing money) cannot be separated from the activity of using the borrowed money.
As for the LLCs in Advisory Opinion Nos. 02-05 and 04-03, we believe that the actual primary purpose of the LLCs was not simply to issue securities (i.e., borrow money). Rather, we believe that the primary purpose of the LLCs was to hold FDIC-insured deposits for the benefit of (or as a substitute for) the investors. In return for providing the investors with the beneficial ownership (if not legal ownership) of FDIC-insured deposits, the LLCs would earn a portion of the interest produced by those deposits. When the purpose of a business entity is to hold FDIC-insured deposits in this manner, so that other parties will enjoy expanded (though indirect) FDIC insurance coverage, the business entity does not satisfy the FDIC's "independent activity" test.
In short, we believe that the LLCs in Advisory Opinion Nos. 02--05 and 04--03 were not engaged in an "independent activity." Therefore, Advisory Opinion Nos. 02--05 and 04--03 must be rescinded. Questions about this subject may be directed to Christopher Hencke in the FDIC's Legal Division, whose number is (202) 898--8839.
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[Next page is 4984.89] ("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.
1In a letter dated August 2, 2011, the FDIC staff informed Y that the deposits in its program would qualify as "brokered deposits." Go back to Text
2For purposes of this letter, we have assumed that each "business trust" (i.e., each subtrust) will qualify as a separate unincorporated association under State law as stated in your letters. Please note, however, that we have not analyzed the applicable State laws and regulations. Go back to Text
3Advisory Opinion No. 92--79 involved marketing by "affinity groups" for an insured depository institution; the opinion did not involve the creation of business trusts or other entities for the purpose of expanding insurance coverage. If "match-making" through marketing is sufficient to qualify a third party as a "deposit broker," we believe that "match-making" through the creation of business trusts, and the recruitment of community banks, is more than sufficient. Indeed, the level of involvement by the "affinity groups" in Advisory Opinion No. 92--79 (and other similar opinions) was insignificant compared to the level of involvement by X in attracting deposits for community banks through the X program. Go back to Text
4For purposes of this letter, we have accepted this characterization as accurate but we have not researched the applicable State laws. Go back to Text
5The deposit program in this case is similar though not identical to the deposit program analyzed by the FDIC staff in Advisory Opinion No. 02--05 (December 19, 2002) and Advisory Opinion No. 04--03 (July 26, 2004). In the earlier program, business entities (in the form of limited liability companies) were organized for the purpose of issuing securities backed by FDIC-insured deposits. The FDIC staff found that the "primary purpose" of the LLCs was to issue the securities, not to hold the FDIC-insured deposits. No argument was made that the "primary purpose" of the business entities was to support charities or nonprofit associations. In light of the similarity between the two programs, the FDIC is continuing to evaluate the earlier program. Go back to Text