Effective March 4, 2009 (except for certain disclosure requirements effective July 1, 2009), the FDIC adopted a final rule (the "Failed Bank Rule"), 12 C.F.R. Part 360, establishing the FDIC's practices for determining deposit and other liability account balances at a failed bank.  Among other things, the Rule requires banks to disclose the extent to which sweep account programs will be honored by the FDIC in receivership.  In one common type of sweep account program involving bank repurchase agreements ("sweep-repos"), the FDIC's recently announced position conflicts with long-standing Treasury Regulations implementing the Government Securities Act ("GSA Treasury Regs"), with which banks must also comply in offering sweep-repos to its customers.
 
Summary of the FDIC Failed Bank Rule
 
When an FDIC-insured bank fails, the FDIC must determine the total insured account balances for each depositor.  To do that, the FDIC must ascertain the balances of all deposit accounts owned by the same depositor in the same ownership capacity at that bank as of the day of failure.  In the past, that determination was relatively straightforward, but today, the increasing complexity of bank products and practices (such as sweep accounts) has made the determination of end-of-day balances on the day of closing a failed bank much more complicated.  The Failed Bank Rule addresses this issue by describing the methods the FDIC will use for determining deposit and other liability account balances generally at a failed bank.
 
In that connection the Failed Bank Rule requires that banks must give initial and annual disclosures to their customers explaining the extent to which every account held by a customer has FDIC-insured deposit status, versus general unsecured or secured creditor status.  The Failed Bank Rule further requires that in all sweep account programs, banks must prominently disclose whether swept funds are deposits insured by the FDIC.  If the funds are not deposits, the bank must also disclose the status such funds would have if the bank failed - for example, general creditor status or secured creditor status. Such disclosures must be consistent with how the institution reports such funds on its Call Reports.
 
Impact on Sweep-Repo Accounts
 
Determining whether funds in sweep-repo accounts are deposits and, if not, what status the sweep-repo account customer would have with respect to the underlying funds or government securities that collateralize the repo, can be difficult, since funds may be deposits for some period of time and then be swept into non-depositary repo investments.  In providing guidance on this subject, the FDIC particularly noted that with respect to repurchase agreement or sweep-repos, "some institutions' repo arrangements are not properly executed.  In those situations, the sweep customer obtains neither an ownership interest nor a perfected security interest in the applicable securities."  Were that to occur, the FDIC would treat the customer as a general unsecured creditor of the failed bank to the extent of the repo-invested funds, meaning the customer would likely lose all of these funds in a failed bank situation.
 
In late May, at an ABA-sponsored Webinar, the FDIC summarily announced its view that if a bank offering sweep-repos reserved the right in the bank's repurchase agreement to substitute securities - a right authorized by the GSA Treasury Regs as long as the right of substitution was prominently disclosed - the FDIC would nevertheless consider the bank's repurchase agreement to be "not properly executed."
 
Martin Ellis of Shumaker Williams negotiated directly with the FDIC to resolve the conflict between the FDIC's Failed Bank Rule and the GSA Treasury Regs, at least with respect to overnight sweep-repo programs where funds are swept overnight out of deposit status into repo status and returned to deposit status the next banking day.  In the FDIC's just promulgated "Q's and A's" on its Failed Bank Rule, the FDIC is taking the position that overnight sweep-repos constitute newly executed repurchase agreements each banking day, thus obviating the need on the part of a bank to reserve a right of collateral securities substitution.  Nevertheless, banks must insure that overnight sweep-repo documentation is consistent with this new FDIC position, and that no collateral substitution right remains in such documentation.
 
For more information and legal advice, please contact:
 
Keith A. Clark

717-763-1121

 

Martin B. Ellis

 
Reginald S. Evans

717-763-1121