5/20/08

Art Doten Attorney, Wolters Kluwer Financial Services

The long-standing general rule is that banks generally are prohibited from paying interest on demand deposits, such as checking accounts. See, 12 CFR 217.3 and 329.2. Banks can avoid this prohibition with respect to individuals, not-for-profit charitable organizations, and government entities through the use of NOW accounts, which are interest bearing savings deposits on which any number of checks can be written. See, 12 U.S.C. 1832(a). However, for-profit corporations and partnerships are not allowed to have NOW accounts. Ibid. Thus, the prohibition against banks paying interest on checking accounts continues with respect to for-profit corporations and partnerships.

Banks have attempted to avoid this prohibition with respect to for-profit corporations and partnerships by employing sweep agreements under which excess funds are swept from checking accounts into interest bearing savings deposits and then back into the checking accounts again as needed to cover checks written. However, these attempts have had only limited success, because of the Reg D prohibition against more than six preauthorized, automatic, or telephone transfers from a savings deposit per calendar month. See, 12 CFR 204.2(d)(2). Bills have frequently been introduced to increase the number of preauthorized, automatic, or telephone transfers from savings deposits per calendar month for-profit corporations and partnerships can have, but such bills have never passed both houses of Congress. Consequently, sweep agreements involving savings deposits are not an entirely effective means of avoiding the prohibition against banks paying interest on corporate or partnership checking accounts.

However, there is no reason why sweep agreements involving non-deposit investments like repurchase agreements or money market mutual funds, rather than savings deposits, can’t be an effective means of avoiding the prohibition against banks paying interest on corporate or partnership checking accounts. This is because the Reg D prohibition against more than six preauthorized, automatic, or telephone transfers per calendar month applies only to savings deposits and not to non-deposit investments.

Under a typical sweep repurchase agreement a bank and a checking account owner agree (a) that excess funds will be swept out of the checking account at the end of each day in payment for government securities sold by the bank to the checking account owner, and (b) that funds will be swept back into the checking account at the end of the next business day by the bank repurchasing the government securities from the checking account owner at a price consisting of the original sale price plus interest at an agreed rate.    

Under a typical money market mutual fund sweep agreement a bank and a checking account owner agree (a) that excess funds will be swept out of the checking account at the end of each day by the bank initiating purchases on behalf of the checking account owner of shares in a money market mutual fund, and (b) that to the extent possible at the end of each day funds will be swept back into the checking account as needed to restore its balance to an agreed level by the bank initiating sales of the shares thus purchased on behalf of the checking account owner.

Since repurchase agreements and money market mutual finds are not deposits, they are not insured by the Federal Deposit Insurance Corporation. Consequently, this fact must be conspicuously disclosed in the sweep repurchase agreement and the money market mutual fund sweep agreement.

Serious consideration should be given to sweep repurchase agreements and money market mutual fund sweep agreements as a means of better serving your corporate or partnership customers by avoiding the prohibition against banks paying interest on corporate or partnership checking accounts, since these non-deposit investments permit the account owners to receive earnings on excess funds, while still keeping the funds available as needed to cover checks written.

Note to Credit Unions: There is no regulation expressly prohibiting credit unions from paying dividends on share draft accounts.  To the contrary, 12 U.S.C. 1763 provides that a federally chartered credit union can accrue “(d)ividends...on share draft accounts”.  Moreover, 12 U.S.C. 1785(f)(1) states that “(e)xcept as provided in paragraph (2)”, federally insured credit unions “may pay dividends on share draft accounts”.

However, 12 U.S.C. 1785(f)(2) provides that “(p)aragraph (1) shall apply only...to share draft accounts in which the entire beneficial interest is held by one or more individuals or members or by...[certain not-for-profit charitable or government entities]”.

Moreover, the banking provisions regarding NOW accounts (12 U.S.C. 1832(a)) do not apply to credit unions.

Finally, if credit unions use sweep repurchase agreements and/or money market mutual fund sweep agreements, they should disclose that such investments are not insured by the National Credit Union Share Insurance Fund.

The ARTA® Deposit Dynamic Disclosure Program runs the ARTA Deposit Documentation System with the Deposit E-Forms Module to provide dynamic disclosures quickly and cost-effectively.

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