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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
{{8-31-04 p.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
{{8-31-04 p.4984.90}}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.
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