FDIC's Proposed Rule on Recordkeeping for Custodial Accounts

On September 17^th, the FDIC issued a notice of proposed rulemaking (NPR or Proposed Rule) that would impose on FDIC-insured depository institutions (IDIs) new recordkeeping requirements for custodial deposit accounts with transactional features.

Comments are due 60 days after publication in the Federal Register. In addition to inviting comments on all aspects of the Proposed Rule, the FDIC requests comments on specific questions (see attached).

Background

The Proposed Rule is partially in response to the bankruptcy of Synapse, a technology company that worked with several IDIs and fintech companies. Synapse’s bankruptcy resulted in consumers unable to access their funds placed at IDIs for a number of months. The FDIC received more than a thousand inquiries, complaints, and concerns from consumers regarding the Synapse bankruptcy. These circumstances have raised concerns about the completeness, accuracy and integrity of custodial deposit account records for IDIs’ arrangements with third parties to deliver deposit products and services. If an IDI has an arrangement with a third party where custodial deposit account recordkeeping is inadequate or unreliable, this would impede the FDIC’s ability to promptly make deposit insurance determinations in the event of its failure. In addition, these events also have exposed the risks to consumers of being unable to access funds at IDIs, even in the absence of the failure of an IDI.

Beyond the Synapse case, the FDIC finds that these types of arrangements (using pass-through insurance) between IDIs and fintechs are becoming more prevalent in the market, and the FDIC believes the increased complexity of certain custodial deposit account arrangements warrants strengthened recordkeeping to support a prompt payment of deposit insurance in the event of an IDI’s failure.

Proposed Rule

Custodial Deposit Accounts with Transactional Features and Exemptions

The Proposed Rule’s requirements would apply to IDIs that hold “custodial deposit accounts with transactional features,” subject to specific exemptions. The term “custodial deposit accounts with transactional features” would be defined as a deposit account that meets three requirements:

The account is established for the benefit of beneficial owners;
The account holds commingled deposits of multiple beneficial owners; and
A beneficial owner may authorize or direct a transfer through the account holder from the account to a party other than the account holder or beneficial owner.

The proposed requirements would apply regardless of the date a particular custodial deposit account was established. In other words, custodial deposit accounts with transactional features already in existence would be subject to the Proposed Rule’s requirements.

The following types of custodial deposit accounts would be exempt from the Proposed Rule:

Custodial deposit accounts that hold only trust deposits;
Custodial deposit accounts established by government depositors;
Custodial deposit accounts established by brokers or dealers under the Securities Exchange Act of 1934, and investment advisers under the Investment Advisers Act of 1940;
Custodial deposit accounts established by attorneys or law firms on behalf of clients, commonly known as interest on lawyers trust accounts (IOLTA accounts);
Custodial deposit accounts maintained in connection with employee benefit plans and retirement plans;
Custodial deposit accounts maintained by real estate brokers, real estate agents, title companies, and qualified intermediaries under the Internal Revenue Code;
Custodial deposit accounts maintained by a mortgage servicer in a custodial or other fiduciary capacity;
Custodial deposit accounts for which federal or state law prohibits disclosure of the identities of the beneficial owners of the deposits;
Custodial deposit accounts of deposit placement networks or reciprocal networks (unless the network’s purpose is to enable clients to make payment transactions using funds in the custodial deposit account at the network IDIs); and
Custodial deposit accounts holding security deposits tied to property owners for a homeownership, condominium, or other similar housing association governed by state law, and accounts holding security deposits tied to residential or commercial leasehold interests.

Recordkeeping Requirements, Data Formatting, and Internal Controls

The Proposed Rule would require IDIs that hold custodial deposit accounts with transactional features to maintain certain records related to the account. These records would identify, for each custodial deposit account, the beneficial owners of the custodial deposit account, the balance attributable to each beneficial owner, and the ownership category in which the beneficial owner holds the deposited funds.

The Proposed Rule would provide a specific electronic file format for maintenance of records on beneficial owners and their interests in the deposited funds (proposed Appendix A). This file format would be required regardless of whether the IDI maintains the necessary records itself or through an arrangement with a third party. IDIs would be required to maintain appropriate internal controls that include:

Maintaining accurate deposit account balances, including the respective individual beneficial ownership interests associated with the custodial deposit account; and
Conducting reconciliations against the beneficial ownership records no less frequently than at the close of business daily.

Recordkeeping by Third Parties & Related Contractual Requirements

While the Proposed Rule generally requires that IDIs maintain records of beneficial ownership for custodial deposit accounts, it also would permit those records to be maintained by the IDI through a third party, such as a vendor, software provider, or the account holder, if certain requirements are satisfied.

Specifically, the IDI would be required to have direct, continuous, and unrestricted access to records maintained by the third party (in the file format detailed in proposed Appendix A), including access in the event of a business interruption, insolvency, or bankruptcy of the third party. The IDI also would be required to have continuity plans in place, including backup recordkeeping for the required beneficial ownership records and technical capabilities to ensure compliance with the proposal’s requirements. A third party’s records could only be used to satisfy the Proposed Rule’s requirements if the IDI implements the internal controls noted above – specifically, maintaining accurate deposit account balances, including the respective beneficial ownership interests, and conducting reconciliations against the records no less frequently than at the close of business daily.

Where records are maintained by a third party, the IDI would be required to have a direct contractual relationship with the third party that includes certain risk mitigation measures. The contract would need to clearly define roles and responsibilities for recordkeeping, including assigning to the IDI rights of the third party that are necessary to access data held by other parties.

The contract would need to include an explicit provision requiring the third party to implement appropriate internal controls to be able to accurately determine the beneficial ownership interests represented in the custodial deposit account and conduct reconciliations against the beneficial ownership records no less frequently than as of the close of business daily.

In addition, the contract would need to provide for periodic validations, by a person independent of the third party, to verify that the third party is maintaining accurate and complete records and that reconciliations are being performed consistent with the Proposed Rule’s recordkeeping requirement for beneficial ownership interests. This is intended to proactively identify and address weaknesses, and provide for an independent, unbiased opinion assessing and verifying that the third party is maintaining accurate and complete records.

Compliance Measures

An IDI that holds custodial deposit accounts would be required to establish and maintain written policies and procedures to achieve compliance with the Proposed Rule.

The Proposed Rule would implement an annual certification and reporting process for IDIs holding accounts subject to the Proposed Rule. The CEO, COO, or the highest ranking official of an IDI would be required to annually certify that the IDI has implemented and tested its implementation of the recordkeeping requirements within the preceding twelve months. The certification would be submitted to both the FDIC and the IDI’s primary federal regulator. In addition, an IDI would be required to prepare and submit to the FDIC and its primary federal regulator an annual report containing:

A description of any material changes to the IDI’s information technology systems since the prior annual report that are relevant to the requirements of the Proposed Rule;
A list of the account holders that maintain custodial deposit accounts with transactional features subject to the rule, as well as the total balance of those custodial deposit accounts, and the total number of beneficial owners;
The results of the IDI’s testing of its implementation of the recordkeeping requirements; and
The results of any independent validation of records maintained by third parties as required by the Proposed Rule.

Requests for Comment

The FDIC invites comments on all aspects of the Proposed Rule. In particular, the FDIC requests comment on the following:

Custodial Deposit Accounts with Transactional Features

The proposed definition of “custodial deposit account with transactional features” generally relies on three elements: (1) the account is established for the benefit of beneficial owners; (2) the account contains commingled deposits of multiple beneficial owners; and (3) the beneficial owners may authorize or direct a transfer from the custodial deposit account to a party other than the account holder or beneficial owner. The FDIC believes this definition would include the types of custodial deposit accounts that would present significant complexity in a deposit insurance determination. Should the FDIC consider alternative approaches to defining the “custodial deposit accounts with transactional features” that would generally be subject to the proposed rule?
Should the rule’s recordkeeping requirements instead apply to all custodial deposit accounts, not only to those with “transactional features” as described in the proposed rule? Why and what would be the benefits or challenges of applying the requirements to all custodial deposit accounts?
Are there any other types of deposit accounts that should be included in the scope of the proposed rule? If so, why should they be addressed by the proposal?
Are custodial deposit account arrangements becoming more complex in the industry to the point where it would not be clear who is an account holder in the case of an IDI’s failure? If so, how can the proposal better add clarity to support the FDIC’s policy objectives?
Should there be a minimum threshold for applying the requirements of the rule? If so, what metric, and what threshold? For example, should an IDI only be subject to the rule if its number of unique beneficial owners with custodial deposit accounts with transaction features exceeds a certain threshold? If so, what should the minimum threshold be and why?

Exemptions

Are there other categories of custodial deposit accounts with transactional features that should be expressly exempted from the proposed rule’s recordkeeping requirements? If so, why should they be exempt, and what factors would tend to ensure that complete and accurate records of the beneficial owners of the deposits are readily available for the FDIC in the event of the failure of an IDI holding such custodial deposit accounts?
The proposal would exempt custodial deposit accounts established by or on behalf of one or more brokers or dealers under the Securities Exchange Act of 1934, and investment advisers under the Investment Advisers Act of 1940. Although these entities are already subject to recordkeeping requirements under federal and state laws in addition to regulatory supervision, given the risks described in this proposal, should these entities entirely be exempted from the proposal’s requirements? Are there circumstances where some brokers or dealers or related accounts should not be exempted from the proposal to ensure that the proposal’s policy objectives are being satisfied? If so, why and how should this exemption be revised?
Are there other categories of custodial deposit accounts with transactional features that should be revised or narrowed? If so, why and how should the exemption(s) be revised?

Recordkeeping Requirements

What feedback or additional considerations should be included in the proposed rule in the situation where an IDI maintains records of beneficial ownership itself?
Should the FDIC consider any additional measures where an IDI intends to rely on a third party for keeping the records required by the proposed rule? Should the rule specifically address scenarios where a third party is subject to examination under the Bank Service Company Act?
What additional detail might be useful to IDIs in understanding the provisions of the proposed rule addressing reconciliations?
What are obstacles that would prevent an IDI from being able to reconcile records daily as required by the proposed rule? Could those obstacles be addressed? If not, are there alternative measures that could be used to satisfy the FDIC’s policy objectives of ensuring that IDIs have access to complete and accurate records of beneficial ownership of deposits on a daily basis?
Are there any challenges to an IDI’s abilities to align its internal records with those of the non-bank third party with whom the IDI has a business relationship? How have IDIs addressed these challenges?
Are there legal or other obstacles the FDIC should be aware of with respect to meeting the proposed contractual requirements, where an IDI intends to rely on one or more third parties to maintain the records required by the rule?
Should the rule specify a set of elements that would be required, at a minimum, as part of a contingency plan to address disruptions with respect to a third party that maintains records for custodial deposit accounts?
Are there aspects of part 370 or section 360.9 that the FDIC should give additional consideration to for purposes of this rulemaking?

Compliance Provisions

The proposed rule would require IDIs to maintain written policies and procedures to achieve compliance. Are there any additional or specific criteria, factors, or situations that these policies and procedures should be required to address?
The chief executive officer, chief operating officer, or the highest ranking official of an insured depository institution holding custodial deposit accounts with transactional features that are not specifically exempt from the proposal would be required to sign a certification attesting to the accuracy of the certification. Has the proposal identified the appropriate level of the official at an insured depository institution who should sign the certification? If not, which official(s) should sign a certification for the purposes of achieving the stated goals of the proposal?
Should the compliance report and certification address any additional items, beyond those enumerated in the proposed rule?
Given the proposal’s annual certification and reporting requirements, please provide any feedback on what the potential format, structure, or content of materials should be for the purposes of complying with these requirements.
What system, process or mechanism should be used to transmit such information to the FDIC and the appropriate federal banking agency?
Given the recordkeeping, internal control, and compliance requirements addressed in the proposal, how long would it take to revise systems, processes, and contracts for the purposes of complying with a rule? What would be a reasonable amount of time to achieve compliance with the rule, and why?

Expected Effects

Would the proposed rule have any costs, benefits, or other effects that the FDIC has not identified?

Alternatives

Are there other recordkeeping requirements or approaches that are not reflected in the proposal that could be considered in ensuring the accuracy and availability of beneficial ownership records with respect to custodial deposit accounts with transactional features?