Part I: Sweep Programs1
I. Introduction
On December 15, 2020, the Board of Directors of the Federal Deposit Insurance Corporation (“FDIC”) adopted amendments to its brokered deposit regulations (the “Amendments”).2 The Amendments, which become effective April 1, 2021, include the most far-reaching change to the definition of “deposit broker” since the regulations were adopted in 1992.
The Amendments were proposed for public comment in December 2019 (“Proposal”).3 The comment period for the Proposal ended in June 2020. The Amendments differ from the Proposal in a number of meaningful respects.
The Amendments clarify the term “facilitation” under the brokered deposit statute and specifically identify arrangements that meet the “primary purpose exception” (“PPE”) in the statute. The Amendments also establish a process by which entities can apply for the PPE if their business arrangements do not otherwise qualify for an enumerated exception.
The Amendments are broad and attempt to provide relief from the brokered deposit regulations by limiting the scope of deposit arrangements that will be deemed “brokered.” However, by introducing a new concept referred to as “matchmaking,” the Amendments would deny that relief to many sweep programs to unaffiliated banks that use third-party service providers to provide deposit allocations among banks in the sweep program.
This Client Alert will focus on the impact of the Amendments on programs offered by broker-dealers and others to automatically deposit, or “sweep,” customer funds into deposit accounts at banks. Future Client Alerts will address other aspects of the Amendments.
II. Overview of Amendments Affecting Sweep Programs
The Amendments make the following changes relevant to sweep programs, discussed in more detail below:
- Deposits qualify for a PPE from the definition of “deposit broker” if, with respect to a particular business line, “less than 25 percent of the total assets that the agent or nominee has under administration for its customers is placed at depository institutions” (the “25 Percent Exception”).4
- An entity placing deposits under the 25 Percent Exception must provide notice to the FDIC that it is placing deposits in reliance on the PPE, but no application is required.5
- Deposits placed at unaffiliated banks through a sweep program will be deemed “brokered” notwithstanding the 25 Percent Exception if a third party provides certain administrative services to a broker-dealer or other others offering sweep programs, and those services are deemed “matchmaking activities.”
- Deposits placed at affiliated banks will not be deemed “brokered” if the 25 Percent Exception is otherwise applicable, even if a third party is providing matchmaking services.
III. The 25 Percent Exception
The Amendments include an exception, targeted at sweep programs, but potentially available to others, where, with respect to a particular business line, “less than 25 percent of the total assets that the agent or nominee has under administration for its customers is placed at depository institutions.”6
A. Background and Overview
The current 10% Test:
Currently, sweep programs offered by broker-dealers can qualify for the PPE pursuant to FDIC Staff guidance7 if:
- The deposits are placed with affiliated banks;
- The deposit balances do not exceed 10% of the value of customer assets;
- The broker’s fee from affiliated bank or banks is a flat, per-account fee, not a fee based on deposit balances; and
- Certain monthly reports are provided to the FDIC.
The 25 Percent Exception in the Proposal:
The Proposal would have clarified the term “primary purpose” to include any person whose deposit placement activities constitute less than 25% of the person’s total “assets under management” in a specific line of business. The Proposal would not have limited fees, but would have required a formal application to be submitted.
The 25 Percent Exception in the Amendments:
The Amendments include a list of “designated business exceptions,” each of which is a business relationship that the FDIC has determined qualifies for the PPE.
The 25 Percent Exception (which is one of the “designated business exceptions”) in the Amendments makes the following changes:
- It applies both to programs that sweep funds to affiliated banks and to programs that sweep funds to unaffiliated banks;
- As in the Proposal, the threshold is increased from the 10% limit under current FDIC Staff guidance to 25%;8
- There are no limitations on fees; and
- Unlike the Proposal, the 25 Percent Exception in the Amendments requires only a notice, not an application, to the FDIC.
B. Key Issues and Open Questions regarding the 25% Test
The 25 Percent Exception expands the current exception in many ways, but it leaves some issues unresolved and creates others.
“Assets under Administration”
The term “assets under administration” is used instead of the Proposal’s term “assets under management” and refers to “both customer assets managed by the agent or nominee and those customer assets for which the agent or nominee provides certain other services but may not exercise deposit placement or investment discretion.”9 This change clarifies that assets held by a broker-dealer in a non-advisory arrangement are included in the term “assets under administration.”
Business Lines
The FDIC will generally defer to entities’ definitions of their business lines.10 Some broker-dealers offer direct deposit programs in addition to deposit sweep programs. In such circumstances, broker-dealers should include such direct deposit programs as part of the “business line” that includes their sweep programs.
Brokered CDs, as set forth in the Proposal and the Amendments, will continue to be treated as brokered deposits in virtually all circumstances. They do not need to be included in the same business line as sweep programs or other deposits.11
Fees
The Amendments do not limit the fees that can be paid by banks in a sweep program to the broker. Such fees do not have to be reported to the FDIC in a notice filing for an entity that relies on the 25 Percent Exception. This leaves open the question of whether the manner in which fees paid to a broker-dealer by a bank are calculated, or the amount of the fees, can ever disqualify the program from the exception.
IV. The Notice Process
Under the Proposal, an entity wishing to qualify for the 25 Percent Exception would have been required to submit an application and wait for approval from the FDIC prior to relying on the PPE. However, under the Amendments, an entity placing deposits pursuant the PPE under the 25 Percent Exception (and certain other exceptions that will be discussed in a future Client Alert) need only file a notice with the FDIC that it is placing deposits in reliance on the PPE.12 The entity may rely on the PPE immediately upon the FDIC’s receipt of the notice.
Date for New Notices:
- The FDIC will accept new notices beginning on April 1, 2021.
- A broker-dealer that qualifies under the existing PPE, and which does not file a notice, may continue to rely on the existing, more limited exception until January 1, 2022, but may not take advantage of the new broader 25% limit unless or until it files a notice.
Who Provides Notices:
- A third party, such as a broker-dealer, that is not a deposit broker pursuant to the 25 Percent Exception may provide the notice on its own behalf, or a bank may provide the notice on behalf of the third party.
- We expect the broker-dealer to provide the notice to the FDIC since a bank participating in a multi-bank sweep program would not know the identity of the other banks participating in the program and would not know the amounts of the broker-dealer’s assets under administration, which the FDIC requires to be included in the notice.
Content of Notices:
All notices must include:
- The designated exception upon which the entity is relying;
- A brief description of the business line;
- A statement that there is no involvement of any additional third party who qualifies as a deposit broker, or a brief description of any additional third party that may qualify as a deposit broker; and
- If the notice is provided by a nonbank entity, a list of the banks that are receiving deposits by or through the particular business line at the time that the notice is filed.13
An entity relying on the 25 Percent Exception must also include:
- The total amount of customer assets under administration by the third party for that particular business line; and
- The total amount of deposits placed by the third party on behalf of its customers, for that particular business line, at all depository institutions.
Ongoing Reporting:
- An entity relying on the 25 Percent Exception must provide quarterly reports to the FDIC updating the figures provided in the original notice.
V. Matchmaking as Facilitation
Facilitation in General
The definition of “deposit broker” in Section 29 of the FDI Act includes those third parties that “facilitate” the placement of deposits. The Amendments provide that “facilitation” includes three prongs, the first two of which were included in the Proposal:
- A “person [that] has legal authority, contractual or otherwise, to close [an] account or move the third party’s funds to another insured depository institution;” and
- A person that “is involved in negotiating or setting rates, fees, terms, or conditions for [a] deposit account.”14
New Definition: Matchmaking Activities
The Amendments also introduce a new definition, not proposed or discussed in the Proposal, expanding on what “facilitate” means.
Under the Amendments, a third party is engaged in the business of facilitating deposit placements if it engages in “matchmaking activities.” A third party is engaged in “matchmaking activities” if:
- The person proposes deposit allocations at, or between, more than one bank based upon both (a) the particular deposit objectives of a specific depositor or depositor’s agent, and (b) the particular deposit objectives of specific banks, except in the case of deposits placed by a depositor’s agent with a bank affiliated with the depositor’s agent. A proposed deposit allocation is based on the particular objectives of:
- a depositor or depositor’s agent when the person has access to specific financial information of the depositor or depositor’s agent and the proposed deposit allocation is based upon such information; and
- a bank when the person has access to the target deposit balance objectives of specific banks and the proposed deposit allocation is based upon such information.15
The definition seems to encompass service providers that support the offering of sweep programs by broker-dealers and others by reviewing customer transaction information and proposing allocations of deposits among banks in the broker-dealers’ sweep programs.
Application to Sweep Programs – Affiliated vs. Unaffiliated Banks
When a broker-dealer that qualifies for the PPE uses a matchmaker, those deposits will not be deemed brokered.16 However, if a broker-dealer uses a matchmaker to place deposits with an unaffiliated bank, those deposits will be deemed brokered.
Administrative Services, Listing Services, and Matchmaking
The FDIC draws a distinction, for purposes of the definition of “facilitation,” between third parties that “provide administrative services as part of a deposit sweep program between a depositor, its broker-dealer, and unaffiliated banks,” on the one hand, and third parties that propose deposit allocations, on the other.17 That is, the FDIC appears to have intended to excludes from the definition of “facilitation” “passive forms of matching depositors and banks, such as those in which traditional listing services often engage.”18 Conversely, as discussed above, the FDIC has included in the definition of facilitation matchmaking; that is, proposing deposit allocations, which the FDIC views as an “active” role for a third-party.
The FDIC does not explain why proposing deposit allocations is the appropriate dividing line between “active” and “passive” third parties. Nor does it explain why “passive” third parties should have relief from the deposit broker definition, but “active” third parties should not.
Further, the FDIC provides no further details or explanation regarding what constitutes administrative services a “passive” third party might provide, except to indicate its position that listing services provide only these administrative services, and should not be viewed as “facilitating” the placement of deposits.
Additional Clarification
We expect certain third-party service providers who may meet the definition of a “matchmaker” to seek clarification of their status under the new matchmaking definition through further interpretive guidance. Such guidance may or may not be available by April 1.
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The full text of the Amendments as posted on the FDIC’s website can be found by clicking here.
Seward & Kissel LLP will continue to provide insight on developments regarding brokered deposits. If you have any questions, please contact Paul Clark, Casey Jennings, or Nathan Brownback in the Washington, DC office at 202-737-8833.
