Sweep Accounts and Transfer Restrictions from MMDAs

The Federal Reserve Board Summary, May 2007

The summary states that although the accounts may be referred to as “subaccounts,” the institution must establish “legally two distinct accounts and not just one account ‘subdivided’ in name only.” This is accomplished by having separate entries for each account in the institution’s official books and records that show the transfers of funds from one account to the other on days when sweep activity occurs.

The summary does not seem to necessarily require two account numbers nor that the account owners sign two separate account agreements.

Use of Messenger Service to Make Daily Transfers

Recall that the depositor is limited in the number of transfers out of a savings deposit that can be made by preauthorized or automatic transfer or by telephone. However, there are no restrictions on the number of transfers the depositor can make in person at the teller window. One bank saw this as an opportunity. It allowed the depositor to open a noninterest-bearing checking account with no balance. It also allowed the depositor to open an MMDA with a balance. At the end of each day, the bank would total the checks it had paid on the checking account that day, and communicate that amount to a messenger service by telephone. The messenger service had been given authority by the depositor to make funds transfers on the depositor’s behalf. The bank absorbed the cost of the messenger service. The messenger service would prepare a transfer order in the amount communicated by the bank, and would then deliver it in person to the bank. The transfer order would direct that funds be transferred from the MMDA to the checking account. Since the transfers were made “in person,” thought the bank, no Regulation D restrictions applied.

The Federal Reserve staff opinion concluded that this arrangement violated both Regulation D and the prohibition against paying interest on a demand deposit. It violated Regulation D because the MMDA was functioning as a transaction account and yet the institution was treating it as a savings deposit for reserve requirement purposes. It violated the prohibition against paying interest on demand deposits because the arrangement as a whole resulted in exactly that—a checking account bearing interest for a depositor not eligible to hold a NOW account. [Staff Op. Of Nov. 16, 1984; Fed. Res. Reg. Serv., 2-342.12]

Weekly Transfers to Cover Demand Deposit Overdrafts

Another staff opinion dealt with an even more clever arrangement. Here the institution allowed the depositor to open an MMDA and a checking account that had an overdraft protection plan. The overdraft plan allowed the depositor to overdraw the checking account and the institution would charge interest on the amount of the overdraft. The rate of interest charged on the overdraft balance equaled the rate of interest paid on the MMDA. At the end of the week, the institution would automatically transfer funds from the MMDA to pay off the overdraft balance. In this way, the number of automatic transfers would never exceed the six-per-month maximum on savings deposits. The institution considered the balance of the checking account to be $0 for reserve requirement purposes and treated the MMDA as a savings deposit.

The staff at the Federal Reserve Board disapproved of this arrangement as well. [Fed. Res. Reg. Serv., 2-345.24] They pointed out that the definition of transaction account includes arrangements which allow the depositor to obtain credit through the drawing of checks or drafts. (We referred to these as “accounts linked to certain credit plans” in our Regulation D section in this chapter.) Therefore, the MMDA was functioning as a transaction account and should have been reported as such. The staff did not address whether this arrangement violated the prohibition against paying interest on a demand deposit. However, it likely does. Had the MMDA been treated as a transaction account, it would have been either a demand deposit or a NOW account. If the depositor were ineligible to hold a NOW account, it would have to have been a demand deposit. If that were the case, the arrangement allowed the depositor to earn interest on a demand deposit.

Transfers by Facsimile (fax) Machine

This staff opinion dealt with whether a depositor could make an unlimited number of transfers out of an MMDA into a demand deposit if the transfers were initiated by orders transmitted to the institution by facsimile machine. The transfer restrictions on MMDAs do not limit transfers made by mail, and the institution felt that transfers made by facsimile machine were functionally equivalent to those made by mail.

The staff disagreed. They pointed out that Regulation D limits transfers made by “telephonic (including data transmission) agreement, order or instruction….” Orders sent by facsimile machine were a form of telephonic data transmission, said the staff, and, therefore, must be counted toward the maximum of six preauthorized, automatic, and telephone transfers per-month limit. [Staff Op. Of January 30, 1991; Fed. Res. Reg. Serv., 2-342.18]

As we pointed out in the Regulation D section of this chapter, the restrictions on telephone transfers also apply to transfers initiated by remote or home computer or other telecommunications access device. The source for this statement is language which supplemented changes to Regulation D, published in the March 20, 1986, Federal Register at page 9632. The rationale for including these as telephone transfers or withdrawals is that there is no practical difference between the depositor using data signals from a site remote from the institution to order transfers and using oral commands over the telephone to do so.

Splitting a Customer’s Deposit into Multiple Accounts

Can a customer avoid the six-checks-per-month limitation on MMDAs by opening more than one of them at the same institution? For example, suppose John Doe had $10,000 to deposit and needed to be able to write twelve checks per month. Could he open two MMDAs at the same institution and put $5,000 in each one? The FRB decided that a customer could set up such an arrangement, but if the customer did so at the suggestion of the institution, the MMDAs would be considered transaction accounts for reserve requirement purposes. (If the customer is not eligible to hold a NOW account, the resulting account would, presumably, be a demand deposit and the institution would be prohibited from paying interest on it. The Board did not address this issue, however.) If the customer established the accounts for a legitimate purpose without any suggestion to do so by the institution, the accounts would still be considered savings deposits for reserve requirement purposes. [12 CFR 204.133]

Sweeping Into and Out of a Series of Seven-day Time Deposits

A group of customers pool their funds into a series of seven-day time deposits. One or more of the time deposits matures on each business day. The funds from the mature time deposit(s) are divided into the customers’ transaction accounts to cover checks presented for payment that day. At the end of the day, the excess in the transaction accounts is swept into a new seven-day time deposit. Whether a particular customer’s checks are paid depends on whether the customer has contributed more to the plan than he/she has withdrawn. No early-withdrawal penalties are incurred unless the total amount of checks paid on a given day is greater than the amount of mature time deposits.

The FRB concluded that such an arrangement allowed the customers to earn time deposit interest rates with no restriction on the customers’ ability to withdraw or write checks. Therefore, said the Board, the institution would have to consider the time deposits as transaction accounts for reserve requirement purposes. [12 CFR 204.134]

“Sixth Sweep Clean-out”

This arrangement involves a single account with two “subaccounts”: (1) an MMDA subaccount, and (2) a NOW subaccount. (We can think of no reason why you could not substitute a demand deposit checking subaccount for the NOW subaccount, although the interpretation deals only with a NOW subaccount.) The institution sweeps funds from the MMDA subaccount to the NOW subaccount as needed. But the sixth sweep in any statement cycle transfers the entire MMDA balance. This makes a seventh sweep—and a violation of the transfer restriction—impossible. At the beginning of the next statement cycle, funds in the account are reallocated among the two subaccounts according to the customer’s typical use patterns and average low balance for the preceding three months.

The Federal Reserve Board Staff reviewed this arrangement and stated that it would not consider the MMDA subaccount to be a transaction account. [See Letter from Oliver Ireland, Associate General Counsel, August 1, 1995.] The letter cautioned, however, that the institution would be revising its contractual relationship with its customers when it converted existing accounts into such an arrangement, and that the institution would need to follow whatever contract amendment procedures were required by existing account contracts.

Sweeps Between the Institution and an Unaffiliated Third Party

Commercial customers of a bank maintain checking accounts, each with a certain “threshold” balance. Each day, funds above the threshold balance are swept into a pooled money-market mutual fund investment account maintained by a third party that is not affiliated with the bank. Also each day, funds necessary to maintain the threshold amounts in customers’ checking accounts are transferred from the investment account into the individual checking accounts. The issue was whether such an arrangement violated the prohibition against paying interest on a demand deposit account.

According to FDIC Advisory Opinion 98-4, January 23, 1998, this arrangement does not violate the prohibition.

First, the investment account was not a “deposit” as the regulations normally use that term, and so payment of interest on that account did not constitute payment of interest on a demand deposit.

Second, the arrangement as a whole did not violate the prohibition because the customers did not have immediate access to the funds in the investment account and because the investment account was maintained by a nonaffiliated third party. The Advisory Opinion contrasted this with an earlier Advisory Opinion [Advisory Opinion 92-27, April 25, 1992], which found that a violation had occurred where funds were swept between a deposit account and an uninsured investment account administered by the bank and where the customers had unlimited access to all the funds, including those in the investment account.

Sweeps between the institution and an unaffiliated third party, part II

In an Advisory Opinion very similar to the preceding one, the FDIC determined that the following arrangement did not violate the prohibition against paying interest on a demand deposit. [FDIC Advisory Opinion 00-2, April 4, 2000]

The bank offered an account linked to an investment account at the Asset Management Fund’s Money Market Portfolio (the money-market fund), which was distributed, underwritten, and advised by unaffiliated third parties. When the checking account balance exceeded a particular amount, the excess would be electronically transferred to an account at the money-market fund. When the checking account balance was below a particular amount, funds from the money-market fund would be transferred into the checking account. The customer could also request, at any time, that funds be transferred from the money-market fund into the checking account.

The Advisory Opinion first concluded that the investment account was not a “deposit” since it was not maintained at a “bank.” Since, by definition, a demand deposit is a form of deposit, the money-market fund was not a demand deposit.

Second, the Advisory Opinion concluded that the bank was not paying “interest” under the arrangement. Interest is defined as “any payment to or for the account of any depositor as compensation for the use of funds constituting a deposit.” The earnings were paid by the money-market fund while the money was in the investment account. The bank did not have the use of the funds during those periods, so the earnings were not compensation for the use of funds.

Since the investment account was not a demand deposit, and the customer’s earnings were not interest, the arrangement did not constitute the payment of interest on a demand deposit.