The staff of the Federal Deposit Insurance Corporation (“FDIC”) recently added a question and answer to its FAQs interpreting the brokered deposit regulations amended in January 2021 (“Amended Regulations”). The additional response interprets the definition of “matchmaking” and explains that, in the context of a broker-dealer’s bank sweep program, a third party is a matchmaker (and thus a deposit broker) if the third party identifies the banks into which customer funds should be deposited even if the broker determines the list of banks to receive deposits and the order in which the banks should receive reposits.
The staff’s guidance is overly broad and inconsistent with the FDIC’s approach to the Amended Regulations. As a general matter, the Amended Regulations narrow the circumstances in which a third party is a deposit broker and expand the possible exceptions from the definition. But the new FAQ effectively makes third parties performing administrative functions deposit brokers – a result at odds with the previous version of the regulations.
The Federal Deposit Insurance Act defines a deposit broker as a person engaged in the business of (i) placing deposits or (ii) facilitating the placement of deposits. Until the adoption of the Amended Regulations, the FDIC staff gave the broadest possible interpretation to the term “facilitate,” resulting in a wide range of third parties being deemed deposit brokers.
The Amended Regulations contain a definition of “facilitating” the placement of deposits that narrows the meaning to certain specified actions, i.e., negotiating the terms of deposit accounts and having the authority to close a deposit account or move funds to another bank. However, the Amended Regulations introduce a new term not previously included in the regulations or in staff interpretations: “matchmaking.”
Pursuant to the Amended Regulations, a third party is a matchmaker if that person “proposes deposit allocations” at or between more than one bank on the basis of both the particular deposit objectives of a depositor or depositor’s agent and the particular deposit objectives of specific banks. The matchmaking definition does not apply if a third party is proposing allocations to a bank that is an affiliate of the person placing the deposits, e.g., a broker-dealer that, as part of its sweep program, places customer deposits into affiliated banks.
It should be noted that the FDIC did not include this term, or this concept, in its proposal to amend the existing brokered deposit regulations (the “Proposed Regulations”). Indeed, the Proposed Regulations included an exemption for broker-dealer sweep programs that deposit funds into affiliated banks, unaffiliated banks, or both, upon application to the FDIC, regardless of whether a third party provided services in connection with the program.
Under the Amended Regulations, a broker-dealer offering a sweep program to its customers need only file a notice with the FDIC to qualify for an exemption from being a deposit broker. However, the broker must list in the notice any third parties providing services to the broker. If the broker is depositing customer funds in unaffiliated banks, the broker will need to note any third parties providing services to the broker and describe the services provided by the third party in order to justify a conclusion that the services that do not constitute matchmaking.
The plain language of the definition of “matchmaking” in the Amended Regulations would appear to exclude a third party that is merely implementing the terms of a sweep program established by the broker-dealer. In other words, if the third party has no discretion over which banks customer funds will be deposited, it would not be matchmaking under the text of the regulation. This would be the case where a broker has designated the banks in the program, the amount of each customer’s funds to be deposited in a bank and the priority order of the banks into which funds are deposited. In such case, if a third party merely implemented these terms by processing customer information and reporting to the broker where customer funds should be allocated under the terms established by the broker, the third party would not be matchmaking.
New FAQ on Matchmaking
Notwithstanding the fact that the text of the regulation seems to exclude from the matchmaking definition third parties that have no discretion to allocate deposits to banks in the broker’s sweep program, New FAQ 7a. (the “Matchmaking FAQ”) interprets the regulation to mean just that.
The Matchmaking FAQ provides the FDIC staff’s view on the meaning of “proposing deposit allocations”:
Question: Under the “matchmaking” definition, what is an example of a person “proposing deposit allocations”?
Example: If, as part of a broker dealer sweep program, a person identifies at which banks to place the funds of individual customers of the broker dealer, the person is, for purposes of the “matchmaking” definition, “proposing deposit allocations”. This is true even if the broker dealer determines the group of banks, or the order of banks, at which the person can propose placing individual depositors’ funds or the maximum amount that can be placed at each bank. If a person that is “proposing deposit allocations” at, or between, more than one bank also satisfies the other criteria in the “matchmaking” definition, the person would meet the “facilitation” part of the “deposit broker” definition.
Concerningly, FAQ 7. (the “Anti-Evasion FAQ”), published on July 6, 2021, provides that “a third party that attempts to modify its existing business arrangements in a way to evade the matchmaking definition could potentially result in the third party meeting the matchmaking definition.” This appears to preclude third parties from modifying their activities to satisfy the staff’s interpretation.
1. The Matchmaking FAQ is Overly Broad and Unreasonable
The staff’s interpretation is inconsistent with the FDIC’s stated purpose in adopting the matchmaking definition. As noted in the FDIC’s adopting release for the Amended Regulations, the “matchmaking” definition
captures certain entities that utilize their relationships with prospective depositors or depositor’s agents and banks to propose deposit allocations at particular banks. These activities indicate that the person has influence over the movement of deposits between insured depository institutions. These activities also indicate that the person is not only satisfying the deposit objectives of the depositor or its agent but also of the insured depository institution. Such a relationship could allow less than well capitalized institutions to utilize a third party to bid for considerable volumes of funding, quickly, which could present heightened risks to the [deposit insurance fund]. Additionally, such a relationship could increase the likelihood of a third party withdrawing funds from a less than well capitalized institution (or under other circumstances, such as in the event an institution is the subject of an enforcement action), which could present sudden liquidity concerns. (Emphasis added).
The Matchmaking FAQ does not describe why a person without influence over the movement of deposits should be considered to be “proposing deposit allocations” for purposes of the definition. The staff’s position, therefore, is a significant departure from the position the FDIC took in the Amended Regulations less than a year ago.
Moreover, the Amended Regulations exclude providers of purely administrative services from the definition of “facilitation.”1 The staff does not explain why data processing services provided to a broker in connection with a sweep program are more than purely administrative services.
2. The Matchmaking FAQ is Inconsistent with the Policy Goals of the Amended Regulations
The Matchmaking FAQ marks a departure from the FDIC’s purpose in adopting the Amended Regulations. As a general matter, the FDIC narrowed the definition of “deposit broker” and created new exceptions to the definition in the Amended Regulations in order to narrow the application of the regulations to arrangements involving less stable deposits or permit weak institutions to grow rapidly.
For example, the Amended Regulations provide a new exception from the deposit broker definition for “exclusive deposit placement arrangements” when a third party, usually a FinTech firm, places deposits with one bank only. Deposits resulting from this type of arrangement were assumed by the FDIC to be stable. In the Amended Regulations, the FDIC also codified a dozen circumstances in which a deposit arrangement would meet the “primary purpose exception” from the deposit broker definition.
Yet, without justification or explanation, the position taken by the staff in the Matchmaking FAQ significantly broadens the deposit broker definition, putting it at odds with the purposes of the Amended Regulations. It is unclear whether this represents a disagreement within the agency regarding brokered deposit policy or whether it is a reaction to the first wave of primary purpose exception notices and applications received by the staff. Nonetheless, the changing staff tone is concerning and necessitates close monitoring.
3. The Anti-Evasion FAQ is Unreasonable
The purpose of a regulation is to require parties to confine their conduct within the regulation’s bounds. This means that a party whose conduct falls outside the permissible bounds of a new regulation must change its conduct to conform with the regulation. However, the FDIC states in the Anti-Evasion FAQ that a party whose conduct falls within the matchmaking definition may still be deemed a matchmaker even if the party changes its conduct to fall outside the matchmaking definition.
Such an interpretation would deprive the party of any opportunity to avoid being deemed a matchmaker regardless of its conduct. Under the Administrative Procedure Act (“APA”), an agency decision that is the product of “illogical” or inconsistent reasoning; that fails to consider an important factor relevant to its action, such as the policy effects of its decision or vital aspects of the problem in the issue before it; or that fails to consider “less restrictive, yet easily administered” regulatory alternatives, is arbitrary and capricious, and may be set aside.2 It would seem to be illogical and overly restrictive for the FDIC to impose an additional regulatory burden on a party if that party has no way to avoid the additional burden by conforming its conduct to regulatory expectations. A court could therefore consider such an additional burden to be arbitrary and capricious under the APA.
4. The Matchmaking Definition May Be Vulnerable to Legal Challenge
The matchmaking definition was inserted at a late stage in the regulatory process and did not appear in the notice of proposed rulemaking that preceded the Amended Regulations. The public was therefore arguably deprived of any meaningful opportunity to comment on the substance of the definition, as is required under the APA.3 Accordingly, an insured depository institution may be able to successfully challenge any attempted FDIC enforcement of the matchmaking provision as arbitrary and capricious.
Seward & Kissel LLP will continue to provide insight on developments regarding brokered deposits. If you have any questions about this or any other aspect of the Amended Regulations, please contact Paul T. Clark, Casey J. Jennings, or Nathan S. Brownback in the Washington, DC office at 202-737-8833.