This October 21st alert is an update to the original alert issued on August 4, 2008.

Safeguarding Your Deposits and Other Financial Assets

Substantial earnings hits to various financial institutions resulting from nonperforming subprime and other loans, the insolvencies of IndyMac Federal Bank and Lehman Brothers, system-wide banking liquidity problems, the freeze up of global credit markets and subsequent intervention by multiple governments, and the volatility of bank and other stocks have together caused individuals and businesses recently to focus on something that they typically take for granted—how safe are their cash and other financial assets held in FDIC-insured depository institutions? 

A.   FDIC Insurance.  The Economic Emergency Stabilization Act of 2008, enacted October 3, 2008, increased insured deposit limits from $100,000 to $250,000 through December 31, 2009.  As a result, until the end of 2009, every person (which includes individuals, corporations, partnerships, limited liability companies, associations, and other similar business enterprises) who maintains one or more accounts at an FDIC-insured depository institution has $250,000 of insurance for its aggregate deposits at such depository institution.
 
Joint ownership accounts held by individuals (including those owned by a husband and wife) at an FDIC-insured depository institution are generally insured separately from individually owned accounts, and each joint owner has $250,000 of insurance coverage in the aggregate for his or her deposits in all joint accounts on which such joint owner is named at that FDIC-insured depository institution.  As a result, an individual with a deposit account in his or her own name and with one or more joint accounts with others can have up to $500,000 in deposits at a single institution protected by FDIC insurance.  In the case of a husband and wife, they together can have up to $1,000,000 in FDIC insurance coverage at a single financial institution when their accounts are appropriately structured.
 
Certain individual retirement plan deposits are also insured by the FDIC, up to a limit of $250,000 in the aggregate per account owner.  Employee benefit plan deposit accounts are also insured by the FDIC, up to a limit of $250,000 per participating employee’s non-contingent interest in such plan.

Without renewal of these increased limits, effective January 1, 2010 FDIC insurance limits will revert to their pre-October 2008 levels. 

Special rules, beyond the scope of this summary, specify insurance for deposits maintained by different types of trusts.  Please call us and we will be pleased to provide guidance regarding the FDIC insurance rules for any particular type of trust in which you may have an interest. 

In addition to increasing insured deposit limits, the FDIC announced October 14 that it will also temporarily insure the entire balance of all personal and business non-interest-bearing transaction accounts held in FDIC insured banks through December 31, 2009.  Two examples of protected accounts are business payroll accounts and personal non-interest bearing checking accounts.  It is necessary to verify that your bank is a participant in this extended insurance program as FDIC-insured banks may opt out of this additional protection to avoid paying higher FDIC premiums. 

B.   What are insured deposits?  Insured deposits include (1) money held in commercial, checking, savings, time, and thrift accounts, (2) certificates of deposit, thrift certificates, and similar certificates, (3) outstanding bank drafts, cashier’s checks, and money orders, and (4) commercial letters of credit (but not standby letters of credit).  Stocks, bonds, mutual funds, life insurance policies, annuities, and municipal securities are treated as investment assets, not as deposits. 

C.   Protections for Investment Assets.  Many FDIC-insured depository institutions today have an associated broker-dealer organization at which customers can open and maintain securities accounts for investments in stocks, bonds, mutual funds, and other assets that are deemed to be securities entitlements.  The broker-dealer organization acts only as agent for the customer that opened the securities account.  The securities in such an account are owned by the customer, not the broker-dealer.  Such securities are generally not subject to claims of creditors of the broker-dealer.   

Nearly all broker-dealers registered with the Securities and Exchange Commission are required to participate in insurance maintained by the Securities Investor Protection Corporation (“SIPC”).  SIPC insurance protects owners of investment accounts from shortfalls in assets that a failed broker-dealer was required to maintain in such an account.  In other words, if a failed broker-dealer was supposed to have 100 shares of ABC Company in a customer’s securities account and only 95 shares were actually in such account, the customer would own and be entitled to 95 ABC Company shares, and SIPC insurance would be available for the 5 share shortfall.  SIPC insurance coverage amounts to $500,000 per broker-dealer client.  SIPC insurance protects against assets missing from the custody of a failed broker-dealer.  It does not protect investors from declines in the value of their investments.   

D.   A Word of Warning Regarding Ownership of Deposit and Securities Accounts.  Each individual and business should be alert to how its financial institution and broker-dealer reports ownership of its accounts.  For purposes of determining insurance eligibility and limits, both the FDIC and SIPC presume that accounts are owned precisely in the manner indicated on the account records of the depository institution and broker-dealer.

E.   Strategies for Attempting to Protect Uninsured Deposits
 
An individual or business with deposits at a financial institution that are in excess of FDIC insurance limits may pursue several strategies to attempt to alleviate its risks relating to potential insolvency of the financial institution: 

1.   Have Multiple Account Holders or Use Multiple Financial Institutions.  The FDIC insurance limits are per person per FDIC-insured financial institution.  If a business consists of multiple entities (that is, parents, subsidiaries, and similar affiliates, and not mere divisions), each entity that has one or more accounts at a failed FDIC-insured institution separately receives the benefit of FDIC insurance as long as the entity was not formed simply as a ruse to obtain the additional FDIC insurance coverage.  Similarly, individuals and businesses can protect themselves by spreading their deposits to several financial institutions so that their deposits at any single institution do not exceed FDIC insurance limits.  Before moving deposits to affiliated entities or to other financial institutions, care should be taken to ensure that such actions do not violate contractual commitments (such as restrictions in credit or security instruments) or result in financial penalties (such as early termination fees for certificates of deposit). 

2.   CDARS®.  CDARS®  is the Certificate of Deposit Account Registry Service.  This service allows persons to access FDIC insurance of up to $50 million by enabling a depositor to take advantage of up to the maximum in FDIC-insured deposits at each CDARS member financial institution.  Basically, a depositor signs an agreement with any participating financial institution that provides for the depositor’s deposit accounts to be spread among other member banks in the form of certificates of deposit issued by those member banks.  The depositor may choose from various CD maturities and will receive one monthly statement detailing all of the depositor’s various holdings at each member financial institution.  Most national and regional banks are not members of the CDARS network.  Rather, CDARS is predominantly made up of small banks with few locations.  A list of CDARS members may be found at www.cdars.com.   

3.   Setting off uninsured deposits owed to a customer against the customer’s obligations to the failed financial institution.  Historical precedent as well as sound policy to protect depositors and to perpetuate confidence in the banking system suggest that a depositor may have the right to offset its uninsured deposits in an insolvent bank against obligations owed by such depositor to the insolvent bank.  For example, if a depositor had $400,000 in deposits at a failed bank, the depositor received $250,000 in FDIC insurance proceeds toward such deposits, and the depositor owed $1,000,000 in loan repayment obligations to the failed bank, the depositor would claim that it only owes $850,000 on the outstanding loan (that is, the original $1,000,000 repayment amount less the $150,000 that the customer is owed by the bank).  Various court cases as well as an almost 20 year FDIC advisory opinion support this argument.  Nonetheless, the FDIC might claim that its broad authority when acting as a receiver of a failed financial institution as well as its goal of preserving its insurance fund act as sufficient countervailing arguments to deny a depositor setoff rights.  Care should be taken in relying on rights of setoff, and depositors should consider the effectiveness and practicality of other strategies to protect their uninsured deposits.

4.   Moving deposits in excess of FDIC insurance limits into securities accounts.   Many financial institutions will offer sweep products that will automatically move deposit account balances in excess of $250,000 into a securities account at an associated broker-dealer organization for investments in stocks, bonds, mutual funds, and similar assets.  As outlined above, these securities account assets are generally not subject to claims of creditors of the broker-dealer.  They are, however, subject to the market fluctuations and risks associated with the chosen types of investments. 

For more detailed information or to address a specific question regarding safeguarding your deposits and other financial assets, please contact any member of Taft’s newly-formed Business Recovery Solutions Team.