Updated Brokered Deposit Guidance: FDIC Revises Frequently Asked Questions on Identifying, Accepting and Reporting Brokered Deposits

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On June 30, 2016, the Federal Deposit Insurance Corporation (the “FDIC”) issued a Financial Institutions Letter (FIL-42-2016) providing revised guidance regarding brokered deposits in the form of Frequently Asked Questions (the “2016 FAQs”). The 2016 FAQs followed the FDIC’s issuance of brokered deposit FAQs in January 2015, which created substantial industry concerns regarding the breadth of the definition of “brokered deposits,” and the issuance of “updated” FAQs in November 2015 combined with a request for comment. The 2016 FAQs retained all of the proposed FAQs issued for comment, but with some key clarifications and new FAQs regarding, among other matters, application of excepNew York Washington, D.C. Los Angeles Palo Alto London Paris Frankfurt Tokyo Hong Kong Beijing Melbourne Sydney www.sullcrom.com July 5, 2016 Updated Brokered Deposit Guidance FDIC Revises Frequently Asked Questions on Identifying, Accepting and Reporting Brokered Deposits SUMMARY On June 30, 2016, the Federal Deposit Insurance Corporation (the “FDIC”) issued a Financial Institutions Letter (FIL-42-2016) providing revised guidance regarding brokered deposits in the form of Frequently Asked Questions (the “2016 FAQs”). The 2016 FAQs followed the FDIC’s issuance of brokered deposit FAQs in January 2015, which created substantial industry concerns regarding the breadth of the definition of “brokered deposits,” and the issuance of “updated” FAQs in November 2015 combined with a request for comment. The 2016 FAQs retained all of the proposed FAQs issued for comment, but with some key clarifications and new FAQs regarding, among other matters, application of exceptions to the “deposit broker” definition, duration of brokered status and implications of Prompt Correction Action (“PCA”) on retention of brokered deposits. These revisions should alleviate a number of the industry concerns with the January 2015 FAQs. The 2016 FAQs amend the guidance regarding the scope and application of certain exceptions to the “brokered deposit” definition and should result in a more rational application of several statutory exceptions:  Application of the “primary purpose exception” will no longer require a specific “determination” by the FDIC that the exception is applicable in a given instance;  The “employee exception” is applicable to “dual-hatted” employees – i.e., persons who are exclusively employed by an insured depository institution (“IDI”) but who may be licensed to sell securities and financial products on behalf of affiliates;  “Call center” personnel (including dual employees and contractors) will generally not be classified as “deposit brokers”; and -2- Updated Brokered Deposit Guidance July 5, 2016  Federal, state and local government agencies may receive a fee for administrative costs and still qualify for application of the primary purpose exception in connection with deposits that are part of a debit or prepaid card program. The 2016 FAQs also provide that brokered deposits may be reclassified as non-brokered after a 12- month period during which no third party is involved with the account. The addition of a single word in one FAQ, however, appears to require that IDIs that lose their status as “well capitalized” institutions for purposes of PCA are no longer allowed to retain indefinitely their existing brokered deposits without obtaining a waiver from the FDIC. BACKGROUND Section 29 of the Federal Deposit Insurance Act (“Section 29”), as implemented by the FDIC’s regulations at 12 C.F.R. § 337.6, places restrictions on the acceptance by certain IDIs of deposits that are obtained through “deposit brokers”1 and therefore are deemed to be “brokered deposits.”2 IDIs that are not well capitalized may not accept (which includes not only actual acceptance, but also solicitation, renewal or rollover of) brokered deposits. Although an IDI that is adequately capitalized may request a waiver of this prohibition, these waivers cannot be sought in advance, the waiver process itself can take considerable time, and the FDIC appears increasingly reluctant to grant such waivers. IDIs that are not well capitalized also are subject to restrictions under Section 29 on the interest rates they may offer on deposits. The classification of deposits as brokered can have a significant adverse impact on IDIs—including those that are well capitalized—that extends well beyond these statutory disqualifications and limitations. First, the amount of an IDI’s brokered deposits can affect the following components of its deposit insurance assessment rate:  for a large or highly complex institution, its core deposits ratio;  for a small institution (generally under $10 billion in assets) that has experienced a more than 40% growth in assets over the past four years, its adjusted brokered deposit ratio; and  for any institution that is either not well capitalized or that has a composite CAMELS rating below a “2,” and that has a ratio of brokered deposits to domestic deposits greater than 10 percent, an additional brokered deposit adjustment. Second, for a banking organization subject to the federal banking agencies’ proposed minimum Liquidity Coverage Ratio (“LCR”) requirement (generally applicable to banking organizations with at least $50 billion in assets), the assumed outflow rate applied to many brokered deposits is higher than that applied to other deposits.3 For example, brokered deposits that are not reciprocal brokered or brokered sweep deposits are assigned a 100% outflow rate if they have no maturity or mature within the LCR’s 30-day window. Third, federal banking agency guidance indicates that IDIs that “rely upon” brokered deposits should incorporate PCA-related downgrade triggers into their contingency funding plans; an IDI may not be able to renew or roll over existing brokered deposits upon such a downgrade and, consequently, may -3- Updated Brokered Deposit Guidance July 5, 2016 need to access other sources of funding.4 Fourth, brokered deposits—as defined in the liquidity coverage ratio rule5—are included as a source of short-term wholesale funding in measuring a U.S. global systemically important bank’s (“G-SIB”) reliance on short-term wholesale funding for purposes of assessing a risk-based capital surcharge on a U.S. G-SIB’s common equity under the U.S. implementation of the Basel Committee’s G-SIB capital surcharge framework. Section 29 generally defines a “deposit broker” as a person “engaged in the business of placing deposits, or facilitating the placement of deposits,” of third parties with IDIs.6 The FDIC does not appear to require a person to be “engaged in the business” of facilitating the placement of deposits to satisfy the second prong of this definition.7 The statutory definition of “deposit broker” is subject to certain enumerated exceptions; among others, these exceptions apply to an IDI (with respect to funds placed with that IDI itself); an employee of an IDI, with respect to funds placed with the employing institution; and an agent or nominee whose primary purpose is not the placement of funds with depository institutions.8 The FDIC has sought to provide more clarity with respect to these definitions and the corresponding exceptions through its implementing regulations at 12 C.F.R. § 337.6, as well as through a number of staff advisory letters issued over the years. Particular areas of focus have included determining whether certain activities constituted “placing deposits” or “facilitating the placement of deposits,” and determining whether a person or entity otherwise involved in facilitation comes within the primary purpose exception.9 In addition, in response to a Congressional mandate in the Dodd-Frank Wall Street Reform and Consumer Protection Act, the FDIC issued the Core and Brokered Deposit Study in July 2011 (the “2011 Study”). Although reiterating that “there should be no particular stigma attached to the acceptance by well-capitalized banks of brokered deposits per se and that the proper use of such deposits should not be discouraged,” the 2011 Study also expressed concerns about brokered deposits and recommended that Congress neither amend nor repeal the brokered deposit statute.10 The 2011 Study reviewed the FDIC’s prior brokered deposit guidance and set forth its position with respect to certain interpretive issues. The FDIC staff had repeatedly advised, since the publication of the 2011 Study and prior to the January 2015 FAQs, that the study represented the FDIC’s definitive positions on brokered deposits. The positions set forth in the 2016 FAQs now supersede those taken in the 2011 Study in certain respects. DISCUSSION The 2016 FAQs are attached as Appendix I to this memorandum, and our blackline showing changes from the November 2015 FAQs is attached as Appendix II. The revisions and/or clarifications from the November 2015 FAQs of particular significance include the following. A. NEW GUIDANCE ON EXCEPTIONS TO THE DEFINITION OF DEPOSIT BROKER The 2016 FAQs (i) expand the scope and practical application of the primary purpose exception; (ii) clarify the application of the employee exception to “dual-hatted” employees; (iii) provide factors under -4- Updated Brokered Deposit Guidance July 5, 2016 which “call center” personnel (including dual employees and contractors) will not be classified as deposit brokers; and (iv) limit the circumstances under which federal, state and local government agencies will be classified as deposit brokers for using debit or prepaid cards to deliver funds to beneficiaries of government programs. 1. General Application of the Primary Purpose Exception The 2016 FAQs provide that the “FDIC considers each request to review and interpret” the primary purpose exception “on a case-by-case basis,” deleting language in the November 2015 FAQs stating that the primary purpose exception (i) “applies only infrequently” and (ii) “typically requires a specific request for a determination by the FDIC.” As had been argued by industry participants, none of Section 29, the FDIC’s brokered deposit regulations, its advisory opinions, or the 2011 Study had mentioned this stringent application of the exception. The 2016 FAQs are now consistent with Section 29 and previous advisory opinions, neither requiring a specific determination from the FDIC or its staff in order to apply the primary purpose exception nor stating that the exception will only apply on “rare occasions.” 2. Application of the Primary Purpose Exception to Limited Referral Programs The 2016 FAQs appear to expand application of the primary purpose exception to certain affiliated employees who have “ongoing involvement” with a deposit account opened through a referral program. The November 2015 FAQs established a framework for addressing application of the primary purpose exception to deposits resulting from customer interactions with certain dual or affiliated employees who may assist a customer in opening a deposit account at the affiliated IDI, including through a referral. In determining whether the program was sufficiently limited in scope so as not to be deemed a brokered deposit arrangement, the November 2015 FAQs stated that the FDIC would consider whether (i) the program is designed to significantly drive deposit growth at the IDI; (ii) the cost of the incentive package is relatively small and the fee to the recipient de minimis; (iii) the payments are capped in total or limited in frequency; and (iv) the employees involved, if employed by an affiliate or subsidiary of the IDI, have ongoing involvement with the deposit account after it is opened. This fourth factor raised the concern that the framework did not account for the possibility that ongoing involvement by an affiliated employee may be evidence of the provision of “one-stop” banking services, as opposed to evidence that the employee is engaged in the business of placing or facilitating the placement of deposits. In the 2016 FAQs, the fourth factor has been deleted, alleviating this concern and establishing a framework for when affiliated employees may participate in limited referral arrangements without the deposits placed under those arrangements being classified as brokered that is consistent with modern, “one-stop” banking services. 3. Application of the Employee Exception to “Dual-Hatted” Employees The 2016 FAQs provide that “dual-hatted” employees (persons who are exclusively employed by an IDI but who may be licensed to sell securities and financial products on behalf of an affiliate) who open deposit accounts on behalf of the IDI are not considered deposit brokers solely because they are licensed -5- Updated Brokered Deposit Guidance July 5, 2016 to sell securities or other financial products to bank customers. The relevant FAQ, FAQ E4, clarifies that “dual-hatted” employees generally qualify for the statutory exception for employees of the IDI set forth in Section 29, which provides that a person is not a “deposit broker”: (i) who is employed exclusively by the IDI; (ii) whose compensation is primarily in the form of a salary; (iii) who does not share such employee’s compensation with a deposit broker; and (iv) whose office space or place of business is used exclusively for the benefit of the IDI that employs such person. Notably, the 2016 FAQs do not address industry concerns that the fourth prong of the employee exception may be interpreted to exclude certain “dual-hatted” employees who share office space with employees of affiliates or other entities. In a comment letter to the FDIC submitted by a collection of industry groups, it was pointed out that employees of IDIs that share office space with affiliate or thirdparty employees should qualify for the statutory exception provided that, consistent with existing regulatory restrictions on shared space,11 the space used by the employee for banking activities is used solely for the benefit of the IDI, while the portion of the space used to perform functions for a subsidiary or an affiliate of the IDI or a third-party entity, is used solely for the benefit of that entity.12 Such “dualhatted” IDI employees are no differently situated than IDI employees, such as tellers, with respect to sharing office space with employees of affiliates or other entities for purposes of the employee exception, and thus should also be able to satisfy this prong of the statutory test. Because the 2016 FAQs do not specifically address this issue, the concern remains that the FDIC could find “dual-hatted” employees who work in such shared spaces to be ineligible for the employee exception. 4. Factors for Determining Classification of “Call Center” Personnel A new FAQ also addresses the classification of “call center” personnel who primarily provide customer service support on behalf of the IDI by answering questions about accounts or bank-provided services or by transferring callers to appropriate areas of the IDI. In cases where “call center” personnel are exclusively employed by the IDI, the statutory employee exception will likely apply, exempting them from classification as a deposit broker. Where such personnel are dual employees or contractors and thus ineligible under the employee exception, these employees will nevertheless not be considered deposit brokers if (i) they merely transfer callers or provide general information and do not participate in the placement of deposits and (ii) their compensation is not based on the number of accounts opened or amount of deposits placed or maintained as a result of their contact with callers. 5. Modified Factors for Classifying Government Agencies That Disburse Funds Through Pre-Paid Cards The November 2015 FAQs created new factors for determining whether federal, state or local government agencies that use debit or prepaid cards to deliver funds to the beneficiaries of government programs would be classified as deposit brokers. Under that guidance, an agency disbursing funds through debit or prepaid cards would be eligible for application of the primary purpose exception only when the agency (i) was mandated by law to disburse the funds to the beneficiaries; (ii) was the sole -6- Updated Brokered Deposit Guidance July 5, 2016 source of funding for the deposit accounts; and (iii) did not receive any fees from the IDI. Under that framework, if a government agency received any fee from an IDI (including to cover administrative costs) in connection with choosing an IDI or opening an account with an IDI as part of a debit or prepaid cards program, the primary purpose exception would not apply to the deposits placed at the IDI. Under the 2016 FAQs, this final factor has been qualified and allows for the collection of fees “necessary to help cover the agency’s administrative costs.” B. RECLASSIFICATION OF DEPOSITS AS NON-BROKERED Another new FAQ provides that a brokered deposit that is not a time deposit (that is, a demand deposit, also known as a non-maturity deposit) can be reclassified as non-brokered after a 12-month period during which no third party (i.e., a party other than the IDI and the depositor) is involved with the account. The FDIC based the 12-month period on the term historically offered for a certificate of deposit. The FDIC notes that this treatment of non-maturity deposits will create parity with the reclassification of most brokered CDs when they are renewed without involvement of a third party. “Third-party involvement” includes (i) holding the account in the name of the deposit broker as agent for one or more customers; (ii) the deposit broker continuing to receive account fees after the account is opened; (iii) the deposit broker having the authority to make withdrawals or additional deposits; or (iv) the deposit broker having continued access to the account information, i.e., access to the customer’s account information that has been provided for the purpose of offering guidance to the customer as to the investment of the funds in the account. The FDIC notes that involvement in non-maturity accounts could cease and then restart after a 12-month period lapse in involvement had resulted in the deposits being reclassified as non-brokered, which would then result in the deposits being reclassified as brokered. C. WAIVER FOR AN ADEQUATELY CAPITALIZED IDI HOLDING BROKERED DEPOSITS A new word in the 2016 FAQs suggests that an IDI that holds brokered nonmaturity deposits and loses its PCA well-capitalized status will not be permitted to hold its existing nonmaturity deposits indefinitely without obtaining a waiver from the FDIC. Under the 2016 FAQs, “[i]f an [IDI] is adequately capitalized for PCA purposes, the [IDI] may request a waiver from the FDIC to retain or accept brokered deposits” (emphasis added). This sentence, with the new “retain or” language, appears in 2016 FAQ F6, which addresses the treatment of nonmaturity deposits by an IDI that ceases to be well capitalized. FAQ F6 also states, before the sentence with the new language, that an IDI that ceases to be well capitalized “should contact its primary federal regulator to establish an appropriate supervisory plan for addressing how brokered demand deposits can comply with Section 29.” It is not clear how the FDIC intends to apply in practice the interplay between establishment of an appropriate supervisory plan addressing nonmaturity deposits after an IDI ceases to be well capitalized and the possible need for a waiver for the IDI to continue to hold such deposits indefinitely. -7- Updated Brokered Deposit Guidance July 5, 2016 * * * ENDNOTES 1 12 U.S.C. § 1831f; 12 C.F.R. § 337.6. Deposit brokers formerly were required by Section 29A of the FDIA to provide written notification to the FDIC that they were acting as such, but Congress repealed this requirement through the Financial Regulatory Relief and Economic Efficiency Act of 2000. As a result, the primary importance of the statutory definition of “deposit broker” is to characterize the deposits obtained by an IDI through such a deposit broker as “brokered deposits.” 2 Certain high-interest-rate deposits offered by IDIs that are less than well capitalized are considered “brokered deposits” even without any third-party involvement, as in those situations where the offering IDI itself is considered the “deposit broker” under the statute. See 12 U.S.C. § 1831f(g)(3). 3 See 78 Fed. Reg. 71,818, 71,840 (Nov. 29, 2013). Generally, the outflow rate applied to a particular deposit depends in part on whether that deposit is brokered and, if so, whether it is a reciprocal brokered deposit, brokered sweep deposit, or other type of brokered deposit. The outflow rate applied to a particular brokered deposit also may depend on whether the deposit is fully insured, as well as its maturity. 4 See Interagency Policy Statement on Funding and Liquidity Risk Management (March 17, 2010), at 13, available at http://www.federalreserve.gov/boarddocs/srletters/2010/sr1006a1.pdf. 5 12 C.F.R. § 249.3. 6 12 U.S.C. § 1831f(g)(1). A “deposit broker” also includes a person engaged in the business of placing deposits with IDIs for the purpose of selling interests in those deposits to third parties, and an agent or trustee who establishes a deposit account to facilitate a business arrangement to use the proceeds of the account to fund a prearranged loan. Id. 7 Cf. FDIC Advisory Opinion 93-30 (June 15, 1993) (“When considered together, we believe these facts tend 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 section 29.”). 8 12 U.S.C. § 1831f(g)(2). 9 See, e.g., FDIC Advisory Opinion 04-04 (July 28, 2004) (finding that an Internet listing service that met certain criteria was not “facilitating the placement of deposits”); FDIC Advisory Opinion 05-02 (Feb. 3, 2005) (finding the “primary purpose” exception to apply in the case of a brokerage firm that swept idle customer funds into transaction accounts at affiliated banks, provided certain conditions were met). 10 2011 Study at 3. 11 See 12 C.F.R. § 7.3001. Banks’ use of dual-hatted IDI employees to meet the breadth of customer needs in the context of modern banking represents prevailing industry practice and is recognized as such in various bank regulations and other guidance, including those of the FDIC, the Office of the Comptroller of the Currency, and the Federal Reserve Board. Examples include the OCC’s regulations on bank activities and operations (12 C.F.R. § 7), the Federal Reserve Board’s Regulation W, which governs transactions between member banks and their affiliates (12 C.F.R. § 223), and the FDIC’s supervisory guidance on transactions between banks and affiliated businesses. FDIC, Risk Management Manual of Examination Policies, § 4.3 – Related Organizations, available at: https://www.fdic.gov/regulations/safety/manual/section4-3.html. Further, the Interagency Statement on Retail Sales of Nondeposit Investment Products acknowledges the use of third-party arrangements and establishes expectations on how those relationships should be managed. The FDIC has previously adopted this guidance without any suggestion that these relationships could have implications on the nature of deposits accepted at locations where these third-party arrangements exist. -8- Updated Brokered Deposit Guidance July 5, 2016 ENDNOTES (CONTINUED) 12 See Letter from The Clearing House, American Bankers Association, the Financial Services Roundtable, the Independent Community Bankers of America and the Institute of International Bankers, regarding November 13, 2015 Financial Institutions Letter (FIL-51-2015) (Dec. 28, 2015). Copyright © Sullivan & Cromwell LLP 2016 -9- Updated Brokered Deposit Guidance July 5, 2016 ABOUT SULLIVAN & CROMWELL LLP Sullivan & Cromwell LLP is a global law firm that advises on major domestic and cross-border M&A, finance, corporate and real estate transactions, significant litigation and corporate investigations, and complex restructuring, regulatory, tax and estate planning matters. Founded in 1879, Sullivan & Cromwell LLP has more than 800 lawyers on four continents, with four offices in the United States, including its headquarters in New York, three offices in Europe, two in Australia and three in Asia. CONTACTING SULLIVAN & CROMWELL LLP This publication is provided by Sullivan & Cromwell LLP as a service to clients and colleagues. The information contained in this publication should not be construed as legal advice. 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Torchiana +33-1-7304-5890 [email protected] Melbourne Robert Chu +61-3-9635-1506 [email protected] Burr Henly +61-3-9635-1508 [email protected] Tokyo Keiji Hatano +81-3-3213-6171 [email protected] -11 - Updated Brokered Deposit Guidance July 5, 2016 -12 - Updated Brokered Deposit Guidance July 5, 2016 -13 - Updated Brokered Deposit Guidance July 5, 2016 -14 - Updated Brokered Deposit Guidance July 5, 2016 -15 - Updated Brokered Deposit Guidance July 5, 2016 -16 - Updated Brokered Deposit Guidance July 5, 2016 -17 - Updated Brokered Deposit Guidance July 5, 2016 -18 - Updated Brokered Deposit Guidance July 5, 2016 -19 - Updated Brokered Deposit Guidance July 5, 2016 -20 - Updated Brokered Deposit Guidance July 5, 2016 -21 - Updated Brokered Deposit Guidance July 5, 2016 -22 - Updated Brokered Deposit Guidance July 5, 2016 -23 - Updated Brokered Deposit Guidance July 5, 2016 -24 - Updated Brokered Deposit Guidance July 5, 2016 -25 - Updated Brokered Deposit Guidance July 5, 2016 -26 - Updated Brokered Deposit Guidance July 5, 2016 -27 - Updated Brokered Deposit Guidance July 5, 2016 -28 - Updated Brokered Deposit Guidance July 5, 2016 -29 - Updated Brokered Deposit Guidance July 5, 2016 -30 - Updated Brokered Deposit Guidance July 5, 2016 -31 - Updated Brokered Deposit Guidance July 5, 2016 -32 - Updated Brokered Deposit Guidance July 5, 2016 -33 - Updated Brokered Deposit Guidance July 5, 2016 -34 - Updated Brokered Deposit Guidance July 5, 2016 -35 - Updated Brokered Deposit Guidance July 5, 2016 -36 - Updated Brokered Deposit Guidanc e July 5, 2016 -37 - Updated Brokered Deposit Guidance July 5, 2016 -38 - Updated Brokered Deposit Guidance July 5, 2016 -39 - Updated Brokered Deposit Guidance July 5, 2016 -40 - Updated Brokered Deposit Guidance July 5, 2016 -41 - Updated Brokered Deposit Guidance July 5, 2016 -42 - Updated Brokered Deposit Guidance July 5, 2016 -43 - Updated Brokered Deposit Guidance July 5, 2016 -44 - Updated Brokered Deposit Guidance July 5, 2016 -45 - Updated Brokered Deposit Guidance July 5, 2016 -46 - Updated Brokered Deposit Guidance July 5, 2016tions to the “deposit broker” definition, duration of brokered status and implications of Prompt Correction Action (“PCA”) on retention of brokered deposits. These revisions should alleviate a number of the industry concerns with the January 2015 FAQs.