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4000 - Advisory Opinions
Whether Well-Capitalized Institution Offering Variable-Rate,
College Cost Linked CD and Agents Who Place CD Are Deposit Brokers
FDIC--93--31
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%).
{{4-29-94 p.4764}}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
{{4-29-94 p.4765}}
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
{{4-29-94 p.4766}}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.
The FDIC recently had occasion to consider whether certain
"Affinity Groups" that endorse the deposit products of a
particular insured bank are deposit brokers. Based upon the particular
facts presented in that case, we concluded that the Affinity Groups
were not deposit brokers. We regarded the following factors to be
relevant in determining whether the Affinity Groups were deposit
brokers:
(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
{{4-29-94 p.4767}}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
{{4-29-94 p.4768}}requirements applicable to deposit
brokers are outlined in the enclosed Financial Institutions Letter
42--92. Notices should be sent to the following address:
FDIC
Office of Specialty Examinations and Financial
Reporting 9
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:
[A]ny insured depository institution, and any
employee of any insured depository institution, which engages, directly
or indirectly, in the solicitation of deposits by offering rates of
interest (with respect to such deposits) which are significantly higher
than the prevailing rates of interest on deposits offered by other
insured depository institutions having the same type of charter in such
depository institution's normal market area.
12 U.S.C. § 1831f(g)(3); 12 C.F.R.
§ 337.6(a)(5)(iii). Go Back to Text
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
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