4000 - Advisory Opinions
Would Certain Sweep Accounts Violate the Federal Deposit Insurance Act
April 4, 2000
Robert C. Fick, counsel
This letter responds to your recent inquiries regarding the Bank's proposal to establish a certain sweep account for its commercial customers and its higher-net-worth, individual customers. Specifically, you have asked that the FDIC confirm your conclusion that the sweep account that the Bank proposes to offer such customers would not violate the Federal Deposit Insurance Act (the "FDIA") and the regulations promulgated pursuant thereto regarding the payment of interest on demand deposits.
The Bank currently offers its commercial customers a variety of products and services, including checking accounts. The Bank would now like to offer its commercial customers the ability to earn some return on idle cash by means of a sweep account. However, you note that 12 C.F.R. § 329.2 prohibits state nonmember banks from paying interest on commercial checking accounts.
The proposed sweep account would consist of a checking account that is linked with an investment account at the Asset Management Fund's Money Market Portfolio (the "Money Market Fund"). The Bank does not own or operate the Money Market Fund; it is distributed, underwritten, and advised by unaffiliated, third parties. The sweep account will operate such that when the balance in the checking account exceeds a specified amount, the excess funds will be electronically transferred to the investment account. When the balance in the checking account falls below the specified amount, or upon the customer's request, funds will be transferred from the investment account to the checking account. You have stated that the funds in the investment account will be invested only in high quality, short-term assets, such as U.S. government or agency issued or guaranteed obligations, certificates of deposit, bankers' acceptances, and repurchase agreements. As compensation for certain ministerial services, the Bank will receive a fee of .35% of the average aggregate daily net assets of its customers invested in the Money Market Fund.
The primary issue raised by the proposed sweep account is whether the investment account, or the sweep account arrangement as a whole, violates the prohibition on the payment of interest on demand deposits. We believe that for the reasons discussed below neither the investment account, nor the sweep account arrangement as a whole, violates the prohibition on the payment of interest on demand deposits.
First, we do not believe that funds in the investment account constitute a demand deposit. 12 C.F.R. § 329.2 provides that "[n]o bank shall, directly or indirectly, by any device whatsoever, pay interest on any demand deposit." A "demand deposit" is, of course, a particular type of "deposit." See 12 C.F.R. § 329.(1)(b). The term "deposit" is defined in section 3(l) of the FDIA, 12 U.S.C. § 1813(l), to mean any of five categories of obligations. Of those five categories, only the first and third appear to be relevant to the proposed sweep account. As an initial matter, in order to be a "deposit" under those two categories, the item must be money or the unpaid balance of money or its equivalent "received or held by a bank or a savings association." See 12 U.S.C. § 1813(l)(1) and (3).
Under the proposed sweep account any funds in the checking account at the Bank obviously would have been received and are held by a bank and, therefore, constitute "deposits." However, any funds in the investment account would have been received and are held by the Money Market Fund. Since a mutual fund is not a bank, the funds in the investment account are not deposits under section 3(l) of the FDIA and, therefore, cannot be "demand deposits" for purposes of 12 C.F.R. Part 329.
Second, we do not believe that under the proposed sweep account the Bank is paying interest. Part 329 defines "interest" generally as "any payment to or for the account of any depositor as compensation for the use of funds constituting a deposit." See 12 C.F.R. § 329.1(c). To the extent that funds in the investment account earn a net positive return, those earnings are credited to the customer. Those earnings could not be "compensation for the use of funds constituting a deposit" because the Bank does not have the use of the funds while they are in the investment account. Therefore, the earnings could not be compensation for the Bank's use of the funds. Furthermore, it is the Money Market Fund, and not the Bank, that is paying those earnings to the customer. The bank is not paying any of its funds to the customer as compensation or otherwise; rather it is simply transferring to the customer's checking account earnings paid by the Money Market Fund. In summary, we do not believe that the funds in the investment account would constitute "deposits" as that term is defined in the FDIA, nor do we believe that the Bank would be paying interest to the customer. Consequently, the sweep account proposed by the Bank does not violate the prohibition on the payment of interest on demand deposits set forth in 12 C.F.R. § 329.2.1
Finally, we understand that the Bank will disclose to its depositors who utilize the proposed sweep account that funds in the investment account are not insured by the FDIC and, further, will make such other disclosures as may be required by the Interagency Statement on Retail Sales of Nondeposit Investment Products, dated February 15, 1994, and/or other applicable federal or state law.
The opinions expressed herein represent the views of the Legal Division staff and, like all staff opinions, are not binding upon the FDIC or its Board of Directors. In addition, the opinions expressed herein are based upon the facts and circumstances presented in this case. Any change in the facts or circumstances may result in different conclusions.
If you have any questions regarding this matter, please contact me at your convenience.
1FDIC Advisory Opinion #92--27 concluded that a particular sweep account violated the prohibition on the payment of interest on demand deposits; however, that case is distinguishable from the instant case in a number of circumstances. In that earlier case both the demand deposit account and the investment account were accounts maintained at the bank. That fact coupled with the automatic transferability of funds between the accounts led the FDIC to conclude that the customer had unlimited 1Cont. access at any time to all funds, and, therefore, the investment account amounted to nothing more than a mere reclassification of the demand deposit with no substantive difference. In this case the investment account is not an account maintained at the Bank, but rather is an account maintained at the Money Market Fund. Furthermore, while the customer obviously has some access to funds in the investment account, that access is not unlimited at least to the same extent that access to a demand deposit is unlimited. Finally, the Bank is not actually paying interest to the customer in this case; instead the Money Market Fund is paying the customer earnings from the fund's investments. Go back to Text