Loren P. Hansen, Esq.
Knecht & Hansen
1301 Dove St., Suite 900
Newport Beach, CA 92660

Dear Ms. Hansen:

This is in response to your letter of April 23, 1997, to Rick Heyke of my staff with regard to the Board's Regulation Q (12 C.F.R. 217), which prohibits the payment of interest on demand deposits. In particular, you are inquiring whether a proposed arrangement among the [words deleted] (Bank), [words deleted] (Title Company), and [words deleted] (Service Provider) would violate Regulation Q.

Regulation Q states:

No member bank of the Federal Reserve System shall, directly or indirectly, by any device whatsoever, pay any interest on any demand deposit.

"Interest" is defined as:

. . . any payment to or for the account of any depositor as compensation for the use of funds constituting a deposit. A member bank's absorption of expenses incident to providing a normal banking function or its forbearance from charging a fee in connection with such a service is not considered a payment of interest.

A staff opinion points out that such absorption:

would not constitute the payment of interest, since the bank does not actually pay funds to the depositor, although the customer does benefit from the charges absorbed. This should be distinguished, however, from instances in which a rebate is actually paid to the customer based on a deposit balance maintained at the bank.

Your letter raises three principal issues: normal banking services, payments to an affiliate of the depositor, and payments for the account of the depositor. Bank proposes to provide escrow accounting services, general ledger accounting services, and reconciliation services. Staff has previously opined that automated escrow closing trust accounting and bank reconciliation, monthly general ledger and financial statements pertaining specifically to escrow accounting service (including FDIC requirements where appropriate) constitute normal banking services in the context of deposits by title and escrow companies. See my letter dated April 26, 1994 responding to a letter dated March 15, 1994 requesting guidance with respect to payment of interest on demand deposits of escrow companies in light of a letter dated March 9, 1994 from the Federal Reserve Bank of San Francisco (April 1994 Letter). The April 1994 Letter is summarized by the San Francisco Reserve Bank in its memorandum to member banks in its district dated May 3, 1994.

You state in your letter that Service Provider is a wholly-owned subsidiary of Title Company. If that were the case, then payments to Service Provider would be attributed to Title Company. According to the April 1994 Letter,

Payment to a wholly-owned subsidiary of the depositor is imputed to the depositor because it is a direct financial benefit to the depositor. . . . However, staff believes that payment to an affiliate of the depositor that is not a subsidiary does not constitute payment to or for the account of the depositor . . . [e]ven if the affiliate is wholly owned by a person or company which wholly owns the depositor . . . .

Id. We understand, however, that both Service Provider and Title Company were in late 1995 wholly owned subsidiaries of [words deleted]. Assuming that is still true, then payments to Service Provider need not be deemed payments to Title Company as a result of the structure of the group.

As noted above, payments for the account of the depositor, as well as payments directly to the depositor, are prohibited as compensation for the use of funds constituting a deposit. The exception for absorbing the expense of normal banking services is therefore limited to services provided by the depository institution and does not include paying the contractual obligations of the depositor. Although the service may be outsourced, it must remain the depository institution's service. This can only be determined in light of the facts and circumstances of the particular case. The draft contract you have furnished does not enable staff to conclude that Service Provider is acting as Bank's agent in providing accounting services to Bank. Paragraph 7 specifically states that no party is appointed agent of either of the other parties. The contract does not make Bank responsible for errors committed by Service Provider. Moreover, paragraphs 3, 4, and 5, taken together, seem to imply that Title Company is liable to Service Provider for any shortfall resulting from limitations on Bank's payments resulting from inadequate earnings credits under the earnings program.

Accordingly, staff is unable to conclude that the proposed arrangement among Bank, Service Provider, and Title Company would not result in a violation of the Board's Regulation Q. I hope this information is helpful. Further questions may be addressed to me or to Rick Heyke of my staff (202/452-3688).

Very truly yours,

(signed) Oliver Ireland

Oliver Ireland