TRUST SERVICES—Zero-Interest Time-Deposit Open Account

The Office of the Comptroller of the Currency asked the Board staff for its views on the appropriateness of the use of a zero-interest time-deposit open account (TDOA) by bank trust departments, particularly in light of prior Board and staff interpretations concerning the treatment of such accounts for Regulation D purposes.

Over the years, as permitted by state law, commercial banks with trust departments have deposited fiduciary-account balances in their own institutions’ deposit accounts. These deposit accounts usually consist of commingled, uninvested trust and agency monies and enable fiduciaries to ease the administration of individual trust-account cash balances. These accounts are classified as deposit liabilities, and banks are obligated under Regulation D to maintain reserves against them. Under Regulation D, if a deposit liability is classified as a demand deposit, reserves up to 12 percent must be maintained against it. If a deposit is classified as a time deposit, the reserve ratio is zero percent.

In the past, in order to lower their reserve requirements, banks conceived of the practice of separating from the demand deposit account a portion of the aggregate amount of trust funds awaiting investment or distribution and classifying such sums as a time deposit (or TDOA). The time deposit thus created was subject to a written agreement between the two departments that imposed conditions necessary to comply with the requirements set forth in the definition of “time deposit” in Regulation D. It was general practice not to pay interest on these time-deposit accounts, and these arrangements were not typically disclosed to the beneficiaries of the participating accounts. The Regulation D aspects of the TDOA were considered and sanctioned by the Board in 1950 (1950 Fed. Res. Bull. 44) and again in 1959, when the earlier interpretation was held also to apply to funds held in an agency capacity (1959 Fed. Res. Bull. 1475). These interpretations were rescinded in December of 1987 when Regulations D and Q were updated and the definition of time deposit was revised (see section 204.2(c)(1) of Regulation D).

These interpretations specifically stated that the use of a time deposit for fiduciary funds should be consistent with sound trust-department administration, that the use of such a deposit must be within the authority of a bank in its capacity as a trustee or agent, and that the practice may not be inconsistent with any applicable state law or the terms of any trust instrument or court order. In spite of the cautionary language, it appears that banks relied on these interpretations to aggregate all trust cash under their administration into a demand portion and a time portion on which interest was not paid. Thus, the practice not only provided funds at zero interest for the banks but also benefitted them by reducing the amount of reserves required by Regulation D.

At the time these interpretations were written, banks did not have the ability, without incurring considerable expense, to sweep excess cash balances into temporary investment vehicles prior to their being needed for disbursement. Since that time, there have been dramatic technological advances in cash management so that today most banks have the ability to sweep all but small amounts of cash into various short-term trust-quality investment vehicles without undue burden or cost. Consequently, in the current marketplace, the standard of prudence for making trust cash productive is fast approaching the point where almost all the principal and income cash in individual trust accounts can be invested in trust-quality vehicles at competitive market rates daily.

In Scott on Trusts, section 170, the duty of a trustee is stated to be to administer the trust solely (emphasis added) in the interest of the beneficiaries. Trustees are not permitted to place themselves in a position where it would be for their own benefit to violate their duty to the beneficiaries. See also Carey v. Safe Deposit & Trust Co., 168 Md. 501, 178 A. 242 (1935);Hughes v. McDaniel, 202 Md. 626, 98 A.2d 1 (1953); and Van de Kamp v. Bank of America, 204 Cal. App. 3d 819, 251 Cal. Rptr. 530 (2nd Dist. 1988).

The Employee Retirement Income Security Act of 1974 (ERISA) incorporates the principles of fiduciary responsibility (see, for example, sections 404(a)(1) and 406(b)). Section 408(b)(4) states that prohibited transactions do not include—

It therefore seems clear that the practice of aggregating a portion of trust demand deposits and classifying those funds as zero-interest time deposits in order to reduce reserve requirements is inconsistent with basic fiduciary responsibilities and sound trust-department administration.

Regulation D does not prohibit a fiduciary from opening a time account to and from which periodic deposits and withdrawals are made provided other requirements are met, and Regulation Q does not prohibit interest from being paid on such deposits, although there is no general requirement to do so. However, the appropriateness of zero-interest time deposits of trust cash is a question to be determined by individual circumstances, local law, and general fiduciary principles. Beneficiaries have successfully claimed that the trustee has a duty to deposit trust money in an interest-bearing account (see, e.g., Maryland National Bank v. Carol H. Cummins, et al., 322 Md. 570, 588 A.2d 1205 (1991)). Trustees who hold trust cash in zero-interest accounts in their own commercial bank when it is possible and reasonably prudent to earn interest on those monies are, in the staff’s opinion, breaching their fiduciary duty and risk surcharge in individual and class actions, unless appropriate disclosure is made and written authorization or consent is received from all relevant account parties.

The question was also raised whether it is permissible for a trustee to intentionally leave cash in a zero-interest time deposit as a compensating balance pursuant to an agreement with certain trust customers if the bank’s use of these deposits is factored into the fee arrangement between the customer and the trust department. In these circumstances bank trust departments may use zero-interest time deposits if (1) the deposit meets the requirements for a time deposit under Regulation D and (2) all potential conflicts of interest are properly resolved through appropriate disclosure and specific authorizations by the account parties. It should be noted, however, that even with appropriate disclosures and authorizations, accounts subject to ERISA are probably prohibited from such arrangements unless the Department of Labor grants an exemption. ERISA section 408(b)(4) requires a reasonable rate of interest to be paid in order for own-bank deposits to be exempt from section 406(b) self-dealing prohibitions.

Board regulations neither prohibit nor require payment of interest on time deposits. Fiduciary principles, however, require payment of interest at competitive interest rates on all cash over nominal amounts not immediately necessary for disbursement, unless specific consent or authorization is obtained. STAFF OP. of May 17, 1991.