Since the failure of Silicon Valley Bank in March of this year, there has been a renewed focus on Federal Deposit Insurance Corporation (FDIC) deposit insurance coverage, including arrangements that provide so-called “pass-through” deposit insurance coverage for bank deposits. Pass-through deposit insurance covers funds in deposit accounts at FDIC-insured depository institutions where the funds are owned by a principle but held by a nominal depositor in a fiduciary capacity (typically, as an agent or custodian).
Structures that provide pass-through coverage involving a nominal depositor acting as agent or custodian for a principal are commonly employed in a variety of different circumstances, including (i) fintech partnerships, where the fintech company acts as agent for its customers; (ii) deposit placement programs where a customer’s relationship bank places deposits at a panel of receiving banks to maximize deposit insurance; (iii) payroll processing services where funds are transferred from an employer to an account established for the benefit of the payroll company’s customers; and (iv) deposit sweep programs used by broker dealers (see “How Should I Think About Cash Management in Light of Recent Events”).
Structuring these arrangements appropriately is critical to ensuring the availability of pass-through deposit insurance coverage. For pass-through insurance to work:
- Account Records: The agency or custodial relationship must be expressly disclosed on the deposit account records of the depository bank. The records maintained by either the depository bank, the fiduciary, or an authorized third party on behalf of the depositor must identify the actual owner or owners of the funds in the account and their respective ownership interests in the account.
- The records must be maintained in good faith and in the regular course of business.
- In deposit accounts where there are multiple levels of fiduciary relationships, the existence of each and every level of fiduciary relationship must be indicated in the relevant records.
- The FDIC presumes that deposited funds are actually owned in the manner indicated on the deposit account records of the insured depository institution; however, if the FDIC has reason to believe that the depository bank’s account records misrepresent the actual ownership of deposited funds in such a way as to increase deposit insurance coverage, the FDIC may pay claims for insured deposits on the basis of the actual rather than the misrepresented ownership.
- Agency Relationship and Agreement: The agent or custodial relationship must be a bona fide agency relationship. The agreement with the principal should explicitly designate the nominal depositor as the principal’s agent or custodian for the purpose of placing and holding the deposits and indicate that these relationships will be reflected on the records of the depository bank.
- Deposit Terms/Ownership of Funds: The funds must actually be owned by the principal and not the nominal depositor.
- This requirement is not likely to be satisfied if the terms of the deposit account (e.g., interest rate and maturity date) offered to the principal do not match the terms of the deposit account offered at the depository bank.
- The principal cannot split the interest payments with the nominal depositor, but the principal or the depository bank can pay the nominal depositor a fee for its services.
- The terms of the agreement between the parties may not create independent obligations that would create a debtor/creditor relationship between the agent and the principal (e.g. if the principal must look to the agent for payment rather than the depository bank) with respect to the deposits.
If the deposit meets the requirements for pass-through insurance coverage, then the amount of FDIC deposit insurance coverage will be based on the ownership capacity (i.e., under the applicable ownership category) in which each principal holds the funds.
Any principal participating in one of the structures that provides “pass through coverage” should be aware that their deposits held at a particular depository institution in the same “right and capacity” will be aggregated for purposes of determining FDIC deposit insurance coverage. For example, if Person A has $250,000 placed at Bank 1 through a deposit placement service and, in the same right and capacity, has an additional $250,000 placed at the same bank through a fintech service, the FDIC deposit insurance coverage for those accounts will not be $500,000. It will be $250,000 in total. For details, see the question “FDIC deposit insurance is based on the “right and capacity” in which a depositor holds a deposit. What does this mean?” in our “FAQ About Recent Bank Failures in the US.”
Other considerations are also important in establishing or participating in these structures. Among other things, each principal should be provided with the deposit amount and the name of the depository bank at which their deposits are placed; marketing materials, customer statements, and disclosures must be accurate and not misleading and correctly represent FDIC deposit insurance coverage on the accounts; and banks establishing these structures should be aware that deposits received through one of these structures may be treated as “brokered deposits” depending on the role of the intermediary in the arrangement, and other factors.
Different rules may apply if the nominal depositor is a trustee and in the cases of custodian accounts for Indigenous people and mortgage servicing accounts.
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