On July 30, 2024, the Board of Directors of the Federal Deposit Insurance Company (“FDIC”) voted 3-2 to approve a notice of proposed rulemaking (the “proposal” or “proposed rule”) that would revise significantly the FDIC’s brokered deposits regulations, which the FDIC overhauled in late 2020 (the “2020 rule”).
Section 29 of the Federal Deposit Insurance Act (the “FDIA”) generally restricts a less-than-well-capitalized insured depository institution (“IDI”) from accepting funds from deposit brokers, i.e., brokered deposits. Additionally, greater usage of brokered deposits can increase an IDI’s deposit insurance assessment expenses and negatively impact the IDI’s supervisory liquidity ratings. The FDIC adopted the 2020 rule in an effort to provide more transparent and consistent standards for classifying deposits as brokered or non-brokered. These standards are especially important to IDIs that partner with third-party service providers such as fintech companies to offer deposit products, as the involvement of those third parties can make the deposits brokered, and the 2020 rule provided several paths for IDIs to avoid that classification. Now, less than four years later, and against the backdrop of many recent federal banking agency enforcement actions against banks that partner with fintech companies, the FDIC has released the proposal, which would eliminate many of the exemptions on which IDIs and their fintech partners have relied.
1. The proposal would significantly expand the definition of a “deposit broker” by, among other things, capturing exclusive deposit placement arrangements, which would result in more deposits being classified as brokered deposits.
Brokered deposits are deposits obtained, directly or indirectly, from or through the mediation or assistance of a “deposit broker.” In the 2020 rule, the FDIC defined a deposit broker to include: “(A) Any person engaged in the business of placing deposits of third parties with insured depository institutions; (B) Any person engaged in the business of facilitating the placement of deposits of third parties with insured depository institutions.” The 2020 rule provides that a person is engaged in the business of placing deposits, or of facilitating the placement of deposits, of third parties with IDIs if the person does so at more than one IDI. This language creates a de facto exemption for exclusive deposit placement relationships, and because many IDIs that partner with fintechs are the fintechs’ sole IDI partner, they currently rely on this language to classify deposits from such fintechs as non-brokered.
In addition to making the technical change of combining the “placement” and “facilitation” prongs, the proposal would broaden the definition of deposit broker in several ways:
- Elimination of the de facto exemption for exclusive relationships. The revised definition would provide that a person is engaged in the business of placing or facilitating the placement of deposits when the person receives third party funds and deposits those funds at one or more IDIs – rather than more than one IDI. This change would effectively eliminate the de facto exemption for exclusive deposit arrangements on which many IDIs currently rely.
- Classification as a deposit broker based on the receipt of fees. The proposal would provide that a person is engaged in the business of placing or facilitating the placement of deposits from third parties if the person has a “relationship or arrangement with an [IDI] or customer where the [IDI] or the customer pays the person a fee or provides other remuneration in exchange for deposits being placed at one or more [IDIs].” The preamble to the proposal states that passive listing services would not be captured because the fees they charge to customers are for “information on the [deposit] rates gathered by the listing service,” and the fees they charge to banks are for the “opportunity to list or ‘post’ the IDIs’ [deposit] rates.”
- Classification as a deposit broker based on determination of deposit allocations among IDIs. The proposal would eliminate the existing “matchmaking” prong to the deposit broker definition and replace it with broader language that would classify a person as a deposit broker if the person “proposes or determines deposit allocations at one or more [IDIs] (including through operating or using an algorithm, or any other program or technology that is functionally similar).”
These proposed changes would meaningfully expand the definition of a deposit broker and would capture a wide range of businesses that have any involvement in deposit arrangements.
2. The proposal would significantly narrow the primary purpose exception.
Section 29 of the FDIA provides that the term “deposit broker” does not include “an agent or nominee whose primary purpose is not the placement of funds with depository institutions.” Before the 2020 rule, this exemption was interpreted through FDIC staff advisory opinions and published FAQs that generally construed the primary purpose exception to apply when the intent of the third party, in placing deposits or facilitating the placement of deposits, was to promote some other goal. The 2020 rule supplanted that guidance with a new framework that allows IDIs or third parties to apply for a written determination from the FDIC that a specific deposit-placement arrangement qualifies for the primary purpose exception and also includes “designated exceptions” for which only a streamlined notice filing, rather than a full application, is required. These designated exceptions included deposit-placement arrangements where (i) the agent or nominee places 100 percent of depositors’ funds into transactional accounts that do not pay fees, interest, or other remuneration to the depositor (though if fees, interest, or other remuneration are paid to depositors, a full application is required) (the “enabling transactions” exemption), and (ii) the agent or nominee places less than 25 percent of the assets it has under administration with respect to a particular business line for its customers with IDIs (the “25 percent exemption”). This framework, in particular the enabling transactions exemption and the 25 percent exemption, provide an important route for IDIs to avoid classifying deposits from fintech and broker-dealer partners as brokered.
The proposal would alter the 2020 rule’s approach to the primary purpose exemption by eliminating the enabling transactions exemption, narrowing the 25 percent exemption, and modifying the filing processes.
- Elimination of enabling transactions exemption. The proposal would eliminate the enabling transactions exemption and the corresponding notice and application processes. While an IDI could still apply to receive a primary purpose exception for relationships that currently satisfy the enabling transactions exemption, the preamble to the proposal suggests that the IDI would need to make a greater showing to obtain approval, noting that “the current enabling transactions test would not satisfy the proposed primary purpose exception, because placing deposits into accounts with transactional features would not, by itself, prove that the substantial purpose of the deposit placement arrangement is for a purpose other than providing deposit insurance or a deposit placement service.”
- Narrowing of 25 percent exemption. The proposal would narrow the 25 percent exemption and rename it as the “Broker-Dealer Sweep Exception.” This exemption would only be available to a broker-dealer or investment adviser registered with the SEC and “only if less than 10 percent of the total assets that the broker-dealer or investment adviser, as agent or nominee, has under management for its customers, in a particular business line, is placed into non-maturity accounts at one or more IDIs, without regard to whether the broker-dealer or investment adviser and depository institutions are affiliated.” Importantly, not only will the numerator in the metric be reduced from less than 25 percent to less than 10 percent, but the denominator of the metric used in the exemption would be changed from “customer assets under administration” to “customer assets under management,” which could reduce the denominator in many cases. The term “assets under administration” is generally understood to include all the assets that a broker-dealer, advisor, or custodian holds or directs on behalf of its clients, including assets under custody in a directed capacity, while assets under management would be defined to include only the securities portfolios and cash balances with respect to which a broker-dealer or investment advisor provides “continuous and regular supervisory or management services.” The proposal’s filing procedures for the Broker-Dealer Sweep Exception would depend on whether or not an additional third party – for example, another broker-dealer, registered investment advisor, or bank – is involved in the sweep program – if no additional third parties (including any affiliates) are involved in the sweep program, then the IDI would be able to file a designated exception notice for the Broker-Dealer Sweep Exception, but if any additional third parties are involved in the sweep program, then the IDI would need to file an application and obtain prior FDIC approval for the Broker-Dealer Sweep Exception.
- Modifications to filing processes. The proposal would add new factors to be considered as part of a primary purpose exception application, including consideration of fees associated with the arrangements, whether an agent has discretion to choose the IDI(s) at which customer deposits are placed, and whether the agent is mandated by law to disburse funds to customer deposit accounts. The proposal would require IDIs to provide with their applications copies of contracts relating to the deposit placement arrangement, including all third-party contracts. The FDIC also proposes to disallow third parties from applying for a primary purpose exception; instead, each IDI wishing to rely on a primary purpose exception with respect to a third party would be required to submit an application for the specific deposit placement arrangement that it has with the third party.
Notably, the preamble to the proposal provides additional gloss regarding the FDIC’s view of the primary purpose exception. In a footnote, the preamble provides that “the FDIC would view a third-party placing funds for the primary purpose of providing FDIC deposit insurance to third parties as not meeting the statutory exception, as the purpose of providing FDIC insurance coverage is indistinguishable from the placement of deposits.”
In addition to significantly narrowing the primary purpose exception, the proposal would revoke all existing approvals and non-objections rendered under provisions of the primary purpose exception that are being revised, including when the IDI has obtained approval of a primary purpose application or has made a notice filing to rely on the enabling transaction exemption or the 25 percent exemption.
Considering the magnitude of these changes, FDIC Vice Chairman Travis Hill noted when voting against the proposal that “every bank that accepts [deposits that qualify for the primary purpose exception] will have to apply separately to the FDIC. This means, for example, that if an entity works with 10 banks, every single bank would need to apply individually and receive approval from the FDIC to treat the arrangement as non-brokered under the primary purpose exception. Given (1) the number of deposit arrangements that may be newly scoped in by the rule, (2) the more subjective standard by which the FDIC will judge applications, and (3) the lack of grandfathering of existing arrangements, [he] suspect[s] an enormous avalanche of applications may hit the FDIC on day 1, which the agency is completely unequipped to process in any sort of timely or efficient manner.”
3. The proposal could increase the costs associated with bank-fintech partnerships.
When voting in favor of the proposed rule, FDIC Chairman Martin Gruenberg noted that the proposal aims to address the risks associated with bank-fintech partnerships, and specifically highlighted the recent failure of a fintech partner that has exposed customers to risk of loss. Thus, as detailed above, the proposed rule would eliminate or significantly narrow many of the provisions of the 2020 rule that have facilitated bank-fintech partnerships – including the de facto exemption for exclusive arrangements, the enabling transactions exemption, the 25 percent exemption, and the primary purpose application framework. If the rule is finalized as proposed, IDIs that engage in partnerships with fintechs would likely be required to classify a greater amount of their deposits as brokered deposits. An increase in the amount of brokered deposits that these IDIs report could, among other consequences, increase their deposit insurance assessment costs and harm their supervisory liquidity ratings. These concerns are especially acute given that, if adopted as proposed, the rulemaking would not grandfather in deposit arrangements that have already received a primary purpose exception or provide a delayed effective date for implementation of the proposed changes, either of which could potentially mitigate costs, at least in the short run.
IDIs and fintechs currently negotiating program agreements should consider including contingencies in their contracts to address whether and how pricing or other terms should change if the fintech is deemed a deposit broker as a result of this rulemaking or otherwise.
4. Decisions by the Supreme Court this term should encourage interested parties to comment.
Comments on the proposal are due 60 days after publication in the Federal Register, making it likely that the comment deadline will be in mid-October. Administrative law cases that the Supreme Court has recently decided underscore the importance for interested parties to file thoughtful comment letters on the proposal, including comments that discuss material negative impacts that the proposal could have on the banking and fintech industries.
For example, in June 2024, the Supreme Court issued opinions in Loper Bright Enterprises v. Raimondo and Relentless v. Dep’t of Commerce that overruled the Chevron doctrine and held that administrative agencies’ interpretations of ambiguous statutes are not entitled to judicial deference. Instead, agency interpretations may receive so-called Skidmore deference, by which a judge considers the persuasiveness of an agency’s interpretation, looking to factors that include whether the agency’s interpretation has been consistent over time. These cases invite more litigation by parties that are harmed by rules that rest on ambiguous statutory text, and as a result, raise the stakes for agencies to find a balanced approach in their rulemaking – and an approach that is consistent over time.
Also in June, the Supreme Court issued an emergency stay in Ohio v. EPA, and reinforced in its opinion that the Administrative Procedure Act requires federal agencies engaged in notice-and-comment rulemaking to “address [any] important problem the public could and did raise during the comment period.” The Court’s emphasis on the notice-and-comment process may lead agencies to give greater consideration to comment letters that raise important issues, and thus, as a practical matter, agencies may deliberate for longer before finalizing controversial rules that may be a target for litigation.
If you have any questions concerning the material discussed in this client alert, please contact members of our Financial Services Group.
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