FDIC Law, Regulations, Related Acts
4000 - Advisory Opinions
Enhanced Yield Certificates of Deposits
October 25, 1985
Gerald J. Gervino, Counsel
This is in response to your letter of August 2, 1985, concerning the *** proposal to offer enhanced yield certificates of deposit. As you have emphasized in your original letter and in telephone conversations, your client is eager to ascertain whether the FDIC has a fundamental objection to the issuance of certificates of deposit of the kinds set out in those letters and enclosures. In our previous letter to you, we suggested that you supply us with a copy of the proposed offering materials and other documents that would evidence the relationship between the bank and certificate owners. Instead you have provided memoranda describing the certificates and the asset that would serve as the index for the contingent portion of interest payable to certificate holders.
The bank proposes to offer $5 million in aggregate face amount of certificates of deposit in denominations of $100,000 or integral multiples thereof. The certificates are to be marketed directly by the bank in the same manner as other deposit accounts. Interest on the certificates would have two components. One component would be fixed and guaranteed at an annual rate of seven percent, payable quarterly. The remaining interest would be contingent and could vary from zero up to as much as approximately seven percent on an average annualized basis, although the amount paid in a given period could be at a greater or lesser rate. The maximum aggregate amount of the contingent interest that could become payable would be $1,050,000. This component of interest would be payable quarterly as ***, a wholly owned subsidiary of the bank, realized a net return on its investment in *** (the "Partnership"). The certificates would mature on December 31, 1988, the date by which *** now expects to realize fully its return from the Partnership. If final distribution of Partnership profits is delayed, certificate owners would have the choice of either extending the maturity to another date certain or allowing the certificates to mature as scheduled thus forfeiting any contingent interest that would become payable thereafter.
The indexed asset would be *** investment in the partnership. The partnership is a *** Limited Partnership whose sole partner is *** and sole limited partner is ***. Each partner has a 50 percent equity interest in the Partnership and is entitled to receive one-half of its net profits. The bank has extended a $20 million line of credit to the partnership. Purchasers of the certificates would have the choice of extending the maturity or allowing the certificates to mature. Contingent interest payments will be made at the time distributions are paid by the partnership to ***. Each distribution from *** will entitle certificate holders to 9.3 percent of the amount distributed. (This is subject to the maximum set out above.) We are unclear as to how certificate holders will receive a pro rata share of this distribution, when the holders aggregate less than $5 million in certificates. From the schedule of estimated payments you have provided us, we assume that the estimated profits will be distributed toward the end of the term of the obligation. If the bank or *** disposes of *** interest in the partnership prior to final distribution of partnership profits, any gain realized from the transaction will be treated in the same manner as would the distribution of partnership profits.
You cite 12 C.F.R. § 1204.201(b), the regulation of the Depository Institutions Deregulation Committee, for the proposition that a bank may offer an account at an interest rate that will float in accordance with any index, regardless of whether the index is within the control of the institution. We do not here suggest that the interest rate regulations of the Committee or the FDIC prohibit this sort of transaction.
The primary question you are asking is whether or not the offered investment program would be insured under the Federal Deposit Insurance Act. Section 3(l) of the Federal Deposit Insurance Act defines the term "deposit" to mean the unpaid balance of money or its equivalent received or held by a bank in the usual course of business and for which it has given or is obligated to give credit to an account or which is evidenced by its certificate of deposit or other instrument. The important question is whether or not the money received in exchange for the bank's enhanced yield certificates of deposit was received in the usual course of business by the bank. We are unclear as to whether monies received from investors in this program are held in the usual course of business.
The obligation being offered by the bank appears to represent a debt of the bank in the amount of the money received and an obligation to pay interest thereon as well as a share in the equity proceeds of a separate Limited Partnership interest. Projected earnings available from the investment indicate that an investor would expect to receive nearly equal amounts from bank interest payments and from the earnings participation in the limited partnership over the life of the instrument. Further, materials you have furnished us suggest that an investor would only achieve a full return with respect to the participation in the limited partnership, if the investor renews the instrument to continue until the end of the underlying project's equity payout. This renewal period interest may be the most valuable portion of the anticipated proceeds of the limited partnership. Thus, renewal decisions would be primarily influenced by the performance of the limited partnership.
Because the unit to be marketed appears to depend upon the joint efforts of both a bank and a separate non-bank limited partnership, it would appear to be a "security" under the Securities Act of 1933, 15 U.S.C. 77a et. seq. (1982). Gary Plastic Packaging v. Merrill Lynch, Pierce, 756 F.2d, 230 (2d Cir. 1985). Since the bank does not assume or guarantee the entire obligation, the exception from registration for bank securities contained in the Securities Act appears inapplicable. Accordingly, the units may be subject to registration with the SEC.
Since these matters are within the jurisdiction of the SEC, the above should not be taken as an opinion under the securities law. It is included because of our hesitancy to state an opinion as to the insurance coverage afforded an obligation that might be sold in contravention of the registration provisions of the Securities Act of 1933. Until we can receive some assurance that the unit will be offered in compliance with applicable law, we cannot provide an opinion on the insurance coverage afforded the unit.