June 3, 2009
Authored by: Jerry Blanchard
Earlier this year the FDIC published its Final Rule on Processing Deposit Accounts in the Event of an Insured Depository Institution Failure. One of the requirements of the Rule is that financial institutions are required to provide sweep account customers with information about what would happen to the customer’s funds in the event the institution failed. As a byproduct of the attention being paid to the new sweep account disclosure rules, the FDIC has also focused on the terms of the Master Repurchase Agreement used in certain sweep arrangements where the institution serves as the customer’s custodial agent for securities held at another financial intermediary.
The standard industry Repurchase Agreement contains a provision which allows the financial institution to substitute the originally purchased securities with different securities of the same type. The FDIC has recently taken the position that the right of substitution renders a Repurchase Agreement used in connection with such a sweep account defective based on the fact that the institution retains excessive control over the securities. The result of this is that the customer’s funds will be treated as if they never left the deposit account from which they originated. This could be devastating to a customer in the event of the failure of the institution.
In addition to the risk which a customer runs of having significant uninsured deposits, the financial institution runs the risk that the funds should have been reported on a Call or Thrift Financial Report as deposits for purposes of reserves and assessments. This then in turn raises issues of whether the financial institution has been in violation of Reg Q which prohibits the payment of interest on demand deposits.