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TESTIMONY OF
ROGER A. HOOD
ASSISTANT GENERAL COUNSEL
FEDERAL DEPOSIT INSURANCE CORPORATION
WASHINGTON, D.C.
ON
DEPOSIT INSURANCE PROVIDED FOR
"457 PLAN" DEPOSITS
BEFORE THE
SUBCOMMITTEE ON GENERAL OVERSIGHT AND INVESTIGATIONS
COMMITTEE ON BANKING, FINANCE AND URBAN AFFAIRS
U.S. HOUSE OF REPRESENTATIVES
August 7, 1990
Sacramento, California
Good morning, Mr. Chairman and members of the Subcommittee.
name is Roger A. Hood.
My
I am an Assistant General Counsel with
the Federal Deposit Insurance Corporation in Washington, D.C..
I
am pleased to testify this morning, on behalf of the FDIC,
concerning the deposit insurance provided for "457 Plan” deposits
in FDIC-insured institutions.
For the record, I should clarify
that when we say a "457 Plan” we mean a deferred compensation
pi^ri established for the benefit of employees of a state
government, local government or tax-exempt organization, that
qualifies under section 457 of the Internal Revenue Code.
The FDIC recently adopted comprehensive amendments to its deposit
insurance regulations.
Those amendments were adopted, in part,
to comply with section 402(c) of the Financial Institutions
Reform, Recovery and Enforcement Act of 1989 ("FIRREA").
Section
402(c) required the FDIC to adopt uniform deposit insurance
regulations so that the insurance provided for deposits in banks,
insured by the Bank Insurance Fund ("BIF"), would be the same as
the insurance provided for deposits in savings institutions,
insured by the Savings Association Insurance Fund ("SAIF”).
Section 402(c) also mandated that, in promulgating such uniform
regulations, the FDIC take into account the regulations,
Principles and interpretations for deposit insurance coverage
utilized by the former Federal Savings and Loan Insurance
Corporation ("FSLIC").
In addition, the FDIC was directed to
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consider all relevant factors necessary to promote safety and
soundness, depositor confidence, and the stability of deposits in
insured depository institutions.
After considering all of the necessary factors, the FDIC's Board
of Directors adopted the uniform deposit insurance regulations on
April 30, 1990.
Those regulations became effective, for the most
part, on July 29, 1990.
Section 330.12(e) of the regulations
governs 457 Plan deposits.
Under section 330.12(e), all 457 Plan
deposits will be aggregated, added to any other deposits of like
kind maintained by the same official custodian of a public unit
sny deposits maintained by the same tax exempt organization)
at the same insured institution, and the total will be insured up
to $100,000.
Section 330.12(e) follows an FDIC staff interpretation under the
previous regulations and thus represents no change in the manner
in which such deposits in FDIC—insured banks have traditionally
been insured.
The regulation is, however, contrary to the manner
in which 457 Plan deposits in savings and loan associations
previously insured by the FSLIC ("S&Ls") had been insured.
1982, such deposits in S&Ls have been afforded pass-through
insurance coverage (insurance coverage on a per-participant
basis) pursuant to a FSLIC regulation.
The difference in
Since
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insurance coverage has been quite substantial;
a 457 Plan
deposit in an S&L could be insured for several million dollars
while a 457 Plan deposit in an FDIC insured bank could only be
insured for up to $100,000.
The FDIC has long recognized pass-through insurance for deposits
of private sector deferred compensation plans qualifying under
section 401(k) of the Internal Revenue Code and most public and
private pension plans, because such plans involve the transfer of
funds by the employer to a trustee.
The trustee holds title to,
and administers, those funds for the exclusive benefit of the
employee/beneficiaries.
The insurance for such deposits is
similar to that afforded deposits of other irrevocable trusts
where ownership of the funds is transferred from the settlor or
trustor to a trustee who is considered to be holding the funds in
a separate trust capacity as to each beneficiary.
The trustee is
separately insured up to the maximum amount of $100,000 in each
such trust capacity.
FDIC Prior Staff Interpretation on 457 Plan Deposits
Prior to the adoption of the uniform regulations there was no
specific provision on 457 Plan deposits in the FDIC's deposit
insurance regulations.
noted above
However, the FDIC staff interpretation
which had been in existence for more than a decade
stated that deposit accounts maintained by a ”457 Plan” with
sri insured bank were not entitled to pass-through insurance
coverage (insurance coverage on a per-participant basis).
The
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interpretation was based on the fact that, under section 457 of
the Internal Revenue Code, 457 Plan funds are required to "remain
(until made available to the participant or other beneficiary)
solely the property and rights of the employer (without being
restricted to the provision of benefits under the plan). . .
subject only to the claims of the employer's general creditors."
[emphasis added]
This provision enables the employer (i .e.. the
state government, local government or non-profit organization) to
utilize 457 Plan funds for its own purposes and makes those funds
subject to the claims of the employer's creditors.
The employer,
rather than the employees, is the sole owner of the funds until
they are distributed.
Accordingly, the FDIC staff has maintained that the employees
(the participants) do not have any ownership interests in the
funds upon which insurance coverage could be based.
Thus, the
funds cannot be insured on a pass-through basis under current
law.
FSLIC and NCUA Positions on 457 Plan Deposits
Prior to 1982, both the FSLIC and the NCUA staffs maintained the
same position as the FDIC staff with respect to 457 Plan
deposits.
Neither agency had a specific regulation which
mentioned deferred compensation plan deposits, although informal
discussions with staff members from both agencies in 1980
confirmed that their interpretations were the same as the FDIC
staff interpretation.
In other words, prior to 1982, all three
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insurers maintained that under their respective regulations
(which did not specifically mention deferred compensation plans),
457 Plan accounts were not insured on a per-participant basis.
On March 5, 1982, the Federal Home Loan Bank Board, as operating
head of the FSLIC, proposed amendments to its regulations to
provide that the interest of each participant in a deferred
compensation plan (including a 457 Plan) would be insured up to
$100,000.
The FHLBB received 514 comments on the proposal.
According to the FHLBB, only one commenter (an individual)
objected to the proposal "apparently on the mistaken belief that
such action would require a large and immediate outlay of
taxpayers' funds."
The FSLIC's final regulations were adopted on May 6, 1982 and
published in the Federal Register on May 14, 1982.
In adopting
the final regulations, the FHLBB recognized that "the funds in a
deferred compensation plan typically remain the sole property of
the employer."
Nevertheless, the FHLBB decided to insure the
accounts of such plans on a per-participant basis because the
FHLBB concluded that "there is no substantive difference between
the interest of a participant in a deferred compensation plan and
the interest of a beneficiary in a trusteed employee benefit
plan.|
The NCUA issued a final rule amending its regulations, effective
July 12, 1982, to provide insurance coverage for deferred
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compensation plan accounts in the amount of up to $100,000 per*participant.
The final rule was published in the Federal
Register on July 14, 1982.
In the preamble to the final rule,
the NCUA recognized that "the funds in a deferred compensation
plan usually remain the sole property of the employer.”
The NCUA
further recognized that "if the employer becomes insolvent ...
the funds would become depleted and would no longer be available
to the employee.”
The NCUA concluded, nonetheless, that "the
differences between [the interest of a participant in] a deferred
compensation plan and the interest of a beneficiary in a trusteed
employee benefit plan are not significant."
On that basis, the
NCUA adopted its final rule providing insurance coverage to each
individual participant in a deferred compensation plan.
FDIC's Proposed Regulation and Summary of Comment Letters
Our proposed uniform regulations indicated that the FDIC was
contemplating formal adoption of the existing staff position on
457 Plan deposits.
The FDIC received in excess of 3,750 letters
in response to the proposed uniform regulations.
More than 90
percent of the comment letters addressed the proposed rule
affecting 457 Plan deposits.
opposed.
The vast majority of those were
Many government units (including state and local
governments and political subdivisions thereof), government
employee organizations, savings and loan associations, trade
organizations and numerous individuals objected to the FDIC's
proposed regulation because it provided for substantially less
insurance coverage than was previously provided by the FSLIC.
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Most commenters advocated the adoption of the FSLIC's rule, which
insured 457 Plan deposits in S&Ls on a per-participant basis.
The most frequent arguments were:
(1)
deposit insurance was an important factor in the 457
Plan participant's decision to participate in the deferred
compensation plan and it would be unfair to eliminate that
insurance at this juncture;
(2)
elimination of per-participant insurance coverage would
have a serious effect on the participant's retirement plans and
financial security;
(3) adoption of the proposed rule discriminates against
state and local government employees who participate in 457
Plans, when compared with private sector employees in 401(k)
plans which have pass-through insurance coverage; and
(4) the FDIC's proposal is in direct conflict with President
Bush's efforts to encourage citizens to save more money.
Moreover, objections were expressed regarding the FDIC's literal
reading of the Internal Revenue Code for determining "ownership”
of deposits in 457 Plan accounts.
Some commenters suggested that
practical and public policy reasons exist for recognizing that
such funds "constructively" belong to the employees
(participants) and thus should be insured on a per-participant
basis, like other types of employee benefit plan accounts.
Other
objections emphasized the potential disintermediation of funds
out of S&Ls.
Numerous commenters urged the FDIC to adopt some
type of "grandfather" provision for the benefit of those
adversely affected by the new rule.
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Public Hearing on the Proposed 457 Plan Rule
In view of the volume of comment letters received and the FDIC's
desire for further information on various aspects of 457 Plan
deposits —
including the size of the market affected and the
ownership rights of various parties in such deposits —
the
FDIC's Board of Directors authorized, and the staff held, a
public hearing on March 14, 1990.
Twelve witnesses testified.
They represented various state and municipal organizations, labor
unions, savings and loans associations, and banks.
All but one of the witnesses (the IRS representative) testified
in opposition to the proposed rule.
The witnesses' testimony
raised primarily public policy arguments, rather than legal
arguments.
They asserted that the public policy issues are very
significant and have some legal basis in FIRREA's mandate to
consider "all relevant factors necessary to promote safety and
soundness, depositor confidence, and the stability of deposits in
insured depository institutions."
The major public policy
arguments include:
(1)
the proposed rule would eliminate the only safe haven
for public employees to invest their 457 Plan funds and, thus,
would discourage public employees from saving for their
retirement or cause investment in higher risk instruments;
(2)
457 Plan accounts provide a very stable source of
funding and liquidity for certain savings and loan institutions
and the proposed rule could eliminate that stable source of
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funding or cause liquidity constraints by effectively requiring
collateralization of existing Plan deposits;
(3) the proposed rule would cause a massive outflow of funds
from numerous savings and loan institutions which might cause
certain institutions to become insolvent and thus add to the
inventory of the Resolution Trust Corporation ("RTC");
(4) there are no valid public policy reasons for treating
457 Plans differently from other deferred compensation plans;
(5) the proposed rule is inconsistent with President Bush's
recent initiatives which would encourage greater saving by the
public (e .q ., the President's proposal to establish "Family
Savings Accounts”).
Many of the witnesses acknowledged that 457 Plan funds are
legally owned by the employer.
However, they argued that the
funds are constructively held for the benefit of the employees.
To support the "constructive trust" theory, the witnesses made
several points-.
Among them were that the employee earns the
funds, controls the deferral of income, directs the investment of
the funds, and benefits from any gains and suffers from any
losses resulting from those investments.
In addition, the
witnesses indicated that most employers maintain separate deposit
accounts for each employee, do not commingle 457 Plan funds with
other employer funds, and would not utilize 457 Plan funds for
purposes other than to pay the deferred compensation.
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The IRS representative was the only witness who did not oppose
the proposed rule.
His testimony was based on legal, rather than
public policy, grounds.
He contended that FSLIC's rule (which
insured 457 Plan accounts on a per-participant basis) was based
on a misunderstanding of section 457.
He asserted that, under
section 457 of the Internal Revenue Code, 457 Plan assets cannot
be set aside for the benefit of the employees without producing
immediate taxation of the employees.
The employer must retain
control over the deferred amounts and cannot be required to use
them to pay the deferred compensation.
Therefore, he asserted
that 457 Plans are much different from trusteed employee benefit
plans (such as 401(k) Plans) and that the employees' ownership
interests are not at all alike.
He concluded that FSLIC was
wrong in drawing an analogy between those plans for purposes of
justifying their rule.
Several witnesses at the hearing indicated that the size of the
457 Plan market is not specifically ascertainable.
Most agreed,
however, that approximately $4-5 billion is currently invested in
savings deposits nationwide under 457 Plans.
Of that amount,
approximately $2.2 billion is deposited with Great Western
Financial Corporation, Beverly Hills, California.
Final Rule on 457 Plan Deposits
The FDIC staff carefully reviewed the comment letters and the
testimony presented at the public hearing.
That review resulted
in no change in the staff's legal analysis that existing law
11
precluded the FDIC from providing pass-through insurance for 457
Plan deposits.
As noted above, testimony by a representative of
the IRS supported the staff's legal interpretation of the
language in section 457 of the Internal Revenue Code.
Section
3(m)(l) of the Federal Deposit Insurance Act requires the FDIC to
aggregate, for insurance purposes, all deposits held in the same
"right and capacity."
The phrase "right and capacity" relates to
the manner in which funds are legally owned.
Since the employee
benefit plans under discussion are created to qualify under
section 457 of the Internal Revenue Code, the FDIC must assume
that qualified plans are structured to provide ownership
interests as required by that section of the tax code.
above, the statutory mandate of section 457 is clear:
As noted
the assets
of the plans must be owned by the employer (i .e .. the state
government, local government, or non-profit organization) that
sponsors the plans.
However, the FDIC was mindful of FIRREA's mandate that, in
promulgating the uniform regulations, the FDIC must consider all
relevant factors necessary to promote safety and soundness,
depositor confidence, and the stability of deposits in insured
institutions.
This requirement, and the testimony presented at
the public hearing, suggested that the FDIC should not adopt a
final rule which would result in an immediate outflow of funds
from those S&Ls that maintain 457 Plan accounts.
The FDIC
believed that adopting the rule as proposed but including a
lengthy "grandfather" period for deposits of existing 457 Plans
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would address the legal constraints as well as the policy
concerns.
The "grandfather" period was structured as follows.
As required
by FIRREA, the final regulations were effective on July 29,
1990 —
90 days from the date the regulations were promulgated in
final form.
During that 90-day period, deposit insurance
continued to be provided on a per-participant basis (for both
existing and new participants^ for accounts in S&Ls previously
insured by the FSLIC.
For 18 months following the effective date of the insurance
regulations, or the earliest maturity date of any time deposit
thereafter, deposits of existing 457 Plans in S&Ls will continue
to be covered on a per-participant or pass-through basis.
Thus,
for participants in 457 Plans existing on the effective date, any
account balances, any new money deposited and any interest earned
within 21 months following adoption of these rules (up until
January 29, 1992) will continue to be insured on a pass-through
basis until January 29, 1992, or, in the case of a time deposit,
the first maturity date thereafter.
However, any funds deposited
by a 457 Plan established after July 29, 1990 will not be insured
on a pass-through basis.
Any new money deposited after January 29, 1992 will not be
insured on a pass-through basis.
Any 457 Plan time deposits that
mature prior to January 29, 1992 and that are renewed on the same
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terms and conditions will continue to be insured on a pass
through basis until January 29, 1992 or the first maturity date
thereafter.
Any rollovers subsequent to January 29, 1992 will no
longer be insured on a pass-through basis.
The FDIC believes this extended "grandfather" period is warranted
given the consequences if most of the $4-5 billion dollars in 457
Plan deposits had become uninsured after only 90 days.
The
extended "grandfather" period permits ample time for plan
participants and participating S&Ls to adjust to the new rules.
In addition, to the extent that there are compelling public
policy reasons to provide pass-through insurance for 457 Plan
deposits, the extended "grandfather" period provides Congress
with sufficient time to enact legislation to address the issue.
Proposed Legislation
The FDIC does not believe that it has the authority unilaterally
to provide pass-through insurance for 457 Plan deposits under the
existing statutory provisions.
In our judgement, some action by
Congress is required for the FDIC to be able to change the
insurance rules that apply to 457 Plan deposits.
If Congress decides to amend the law so as to provide pass
through insurance for 457 Plan deposits, the FDIC respectfully
requests that the amendment be carefully crafted so as to leave
no doubt as to Congress' intent.
Some of the bills that have
been drafted to provide pass-through insurance for 457 Plan
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deposits fall short of achieving their stated purpose.
If
Congress desires to provide pass-through insurance for 457 Plan
accounts, we believe it should enact a statutory provision that
specifically extends deposit insurance to 457 Plans based on the
respective values of each participating employee's deferred
compensation up to the maximum amount of $100,000 per employee.
In our judgment, H.R. 5008 would effect that result.
Incorporating the amendments into section 11(a)(3) of the Federal
Deposit Insurance Act, however, may have an undesired effect.
Section 11(a)(3) extends separate deposit insurance only to time
and savings deposits of Keogh Plans and IRAs.
By amending
Section 11(a)(3), this restriction also would apply to 457 Plans,
thus, the amendment would not extend pass-through coverage to 457
Plan demand deposits.
Demand deposits often are used by 457
Plans to make disbursements of funds to employees under the
Plan.
Since the bill would recognize each employee's imputed
interest in a Plan's time or savings deposit, it should do the
same for demand deposits.
A stand alone provision under
Section 11 providing for insurance coverage of all eligible
deposits of 457 Plans would better achieve the legislative intent
of H.R. 5008.
Conclusion
As was stated in our February, 1990, Report to Congress (entitled
"Findings and Recommendations Concerning 'Pass-Through' Deposit
Insurance"), the FDIC believes that there are no economic or
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policy reasons why 457 Plan deposits should not be afforded the
same pass-through insurance coverage that is provided for the
deposits of most other trusteed employee benefit plans.
However,
it has been a longstanding legal staff opinion that section 457
denies plan participants any ownership interests in the funds of
such plans upon which insurance coverage could be based.
As we
concluded in our Report to Congress, if Congress were to amend
the Internal Revenue Code, or to enact some other statutory
provision, to provide that 457 plan participants have ownership
interests in the funds of such plans, a basis would exist for
extending insurance coverage to plan participants.
I want to emphasize, however, that the FDIC is not advocating
that Congress change the law to provide per—participant insurance
coverage for 457 Plan deposits.
such a change in the law.
Nor are we recommending against
We believe this is a fundamental
policy decision that Congress must make.
@FedFRASER