Mergers or Conversions of Federally-Insured Credit Unions: NCUA Approval

NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Part 708a

Mergers or Conversions of Federally-Insured Credit Unions: NCUA

Approval

AGENCY: National Credit Union Administration (NCUA).

ACTION: Interim final rule with request for comments.

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SUMMARY: The NCUA is adopting a new rule, part 708a, to clarify that

the NCUA Board must approve any merger or conversion of a federally

insured credit union to any non credit union institution. The Board

also requests additional comment on a number of issues related to the

circumstances under which these transactions should be approved and

related to protecting the interests of credit unions and their

membership.

DATES: Effective Date: The interim final rule is effective September

23, 1994.

Comments: Comments must be postmarked or posted on the NCUA

electronic bulletin board by November 22, 1994.

ADDRESSES: Send comments to Becky Baker, Secretary of the Board,

National Credit Union Administration, 1775 Duke Street, Alexandria,

Virginia 22314-3428.

FOR FURTHER INFORMATION CONTACT:

Mary F. Rupp, Staff Attorney, Office of General Counsel, at the above

address or telephone: (703) 518-6553.

SUPPLEMENTARY INFORMATION: Part 708 of the NCUA Rules and Regulations

sets forth procedures and requirements for mergers and for terminations

or conversions of insurance. As presently drafted, part 708 addresses

situations where an insured credit union drops NCUSIF insurance, either

in connection with a merger or through a voluntary termination or

conversion of insurance, but retains its status as a credit union. It

does not, however, address situations where a credit union drops NCUSIF

insurance in connection with a merger with or conversion into a savings

bank or other non credit union institution. In response to recent

solicitations by outside attorneys and consultants to credit unions

encouraging them to merge or convert to a mutual savings bank or a

stock institution, NCUA issued a proposal to amend part 708 in order to

clarify that it applies to all merger and termination or conversion

situations where the continuing institution is not insured by the

National Credit Union Share Insurance Fund (NCUSIF). 59 FR 33702 (June

30, 1994).

Sixteen Comments were received in response to the proposal. Of the

14 that addressed the requirement that a federally-insured credit union

contemplating merger with or conversion to a non credit union

institution comply with part 708, 12 were in favor of the

clarification. The two opposing commenters were a bank trade group and

a state-chartered credit union. The bank trade group characterized the

proposed rule as an effort to ``increase the barriers to exiting the

NCUA system.'' The other opposing commenter offered no rationale for

their opposition. The favorable comments consistently stressed that the

members need to be properly informed and that the NCUA needs to ensure

that the merger or conversion would be in the members' interests. These

commenters argued that there is a need to protect the interests of

credit unions and their membership from the potentially self motivated

interests of lawyers, consultants and credit union insiders.

The issues raised by conversions of credit unions to banks are new

to the NCUA and require further study. The Federal Deposit Insurance

Corporation (FDIC) and the Office of Thrift Supervision (OTS) have

recently addressed similar issues. On May 3, 1994, OTS published an

interim final rule and on August 30, 1994, a final rule strengthening

conversion standards and ensuring integrity in the conversion process.

59 FR 22725 and 59 FR 44615 respectively. The OTS experience has shown

that not all conversions are done in the best interests of the

customers.

Given that mutual savings associations currently seeking to

convert generally are well-capitalized, the OTS has become

increasingly concerned that the association's management may be

undertaking conversions for reasons other than the need for capital.

Some thrift insiders may be sacrificing the interests of their

associations and mutual account holders to acquire significant

amounts of conversion stock and other benefits as cheaply as

possible in the conversion process.

59 FR at 22729.

In view of these concerns, the OTS has adopted detailed rules

concerning conversions from mutual to stock savings associations,

designed to ensure fair evaluation and distribution of the stock of the

resulting institution. 12 CFR Sec. 563b. It is also interesting to note

that the OTS has severely limited other transactions. For example, with

very limited exceptions, the OTS rules require, in the case of a

combination of a savings association and a non savings association

institution (such as a credit union), that the resulting institution be

a savings association. 12 CFR 546.2.

FDIC also recently proposed regulations to tighten control over the

conversion process. 59 FR 30316 (June 13, 1994). FDIC concurred with

the need for OTS's interim final rule and found it ``necessary and

appropriate to adopt regulations similar to OTS Revisions.'' 59 FR at

30318. FDIC was particularly concerned with the same type of insider

abuses cited by OTS and found ``it is necessary to reexamine the

conversion process to explore whether existing economic value of a

converting mutual institution can be better distributed directly to

those who should receive it.'' 59 FR 30318.

The issuance of stock options at the conversion price, rather

than at the aftermarket price, which in recent years has been

substantially higher than the conversion price, creates the

impression that insider enrichment may be the main reason for the

conversion. * * * In fact, it may be an inherent conflict of

interest for management to decide to convert the bank to stock form

when, as part of the proposed conversion, management will reap

significant benefits.

59 FR at 30320.

NCUA cannot afford to ignore these warning signals. It is

significant and not a coincidence that the recent increase in

conversion solicitations from attorneys to credit unions is occurring

at the same time the banking regulators are clamping down on

institutions they regulate.

Interim Rule

The NCUA Board is issuing an interim final rule to immediately and

clearly establish NCUA's jurisdiction over all conversions by insured

credit unions. Upon further reflection, rather than place this rule in

part 708 which focuses on converting from federal to private or no

insurance, a new part 708a has been added to NCUA's Rules and

Regulations. This interim rule sets forth the requirement that all

mergers or conversions, involving one or more federally-insured credit

union, including those where the resulting institution is not a credit

union, must be approved by the NCUA Board. The rule also specifies that

all notices are subject to NCUA approval. Further, current part 708 has

been redesignated as part 708b to provide for a logical progression

from general to a more specific regulation.

Request for Additional Comment

The more NCUA studies these transactions, the more apparent it

becomes that the issues involved in converting to a mutual savings bank

or a stock institution are more complicated than they appear on their

face. A number of issues require further consideration and review.

Questions of insider preferences were addressed in the proposed

regulations. Insider benefits are clearly a major issue with respect to

the motivations for and objectivity of the conversion process. NCUA

questions whether directors and management officials involved in the

conversion process should be allowed to receive any personal financial

benefit from the transaction, other than that available to ordinary

members.

Even assuming adequate safeguards against insider preferences,

however, more basic questions exist concerning the authority for, and

propriety of, a decision by the existing members of the credit union to

convert the credit union to a stock corporation in order to distribute

among themselves the credit union's equity and future earnings power.

Some commenters have suggested that this is inherently unfair to the

overall field of membership, that is, the present and future membership

to be served by the credit union. In effect, these commenters have

suggested that the current members and officials hold the credit union

in trust for the benefit of the overall field of membership, including

present and future members. They question whether existing members

should be allowed to transform the credit union out of existence in

order to personally ``cash in'' on its economic value.

Other issues also require further study if healthy credit unions

are to be allowed to merge or convert to non-credit union status.

Included are how to properly appraise the value of the credit union for

purposes of issuing stock, how to fairly distribute the credit union's

value among members/shareholders (which may include share deposits made

in contemplation of merger), whether there should be a public comment

period on the proposed transaction, whether a majority of eligible

voting members must approve the proposed transaction (and if so, should

majority be defined as a simple majority or a super majority and if a

super majority, how should that be defined), and what post-merger or

post-conversion controls are needed to protect against improper insider

preferences after the transaction is completed.

Until the Board has fully addressed these issues and developed new

specific regulatory standards and procedures for mergers and

conversions to non-credit union status, it may, as a practical matter,

be difficult to take final action on such transactions. Boards of

directors of insured credit unions are urged to carefully consider

whether it is a wise expenditure of credit union funds to pursue these

transactions prior to the establishment of specific standards. Further,

the NCUA Board reiterates its previously expressed intent to hold

boards and management officials fully accountable for any waste of

credit union resources that is motivated by the prospect of personal

gain, rather than the best interests of the credit union and its

members.

The Board hopes to issue permanent rules with specific standards

and procedures within 60 to 90 days after the close of the comment

period on this interim final rule. In developing those rules, the Board

will consider the comments it received in response to its notice of

proposed rulemaking and any comments received in response to this

interim rule. In that connection, nine of the ten commenters previously

addressing the issue of a uniform member notice supported the creation

of a uniform notice. Also, two credit union trade groups on behalf of

state regulators and one state league expressed concern that NCUA may

attempt to usurp the state's power to make the final determination

where a state-chartered credit union is involved. As expressed in the

preamble to the notice of proposed rulemaking, ``the Board values its

positive working relationship with state credit union supervisors * *

*'' and ``will continue to cooperate with state regulators in cases

involving federally insured state chartered credit unions.'' NCUA

remains committed to working with the state regulators to study the

issues and develop any further rulemaking.

Regulatory Procedures

Regulatory Flexibility Act

The Regulatory Flexibility Act requires the NCUA to prepare an

analysis to describe any significant economic impact any regulation may

have on a potential number of small credit unions (primarily those

under $1 million in assets). The final rule merely clarifies statutory

authority. Accordingly, the NCUA Board has determined that a Regulatory

Flexibility Analysis is not required.

Paperwork Reduction Act

These amendments do not change the paperwork requirements.

Executive Order 12612

This rule applies to all federally insured credit unions. The rule

clarifies existing statutory requirements of NCUA Board approval of

certain transactions involving federally insured credit unions. The

NCUA Board has determined that this amendment is not likely to have any

direct effect on states, on the relationship between the states, or on

the distribution of power and responsibilities among the various levels

of government.

List of Subjects in 12 CFR Part 708a

Bank deposit insurance, Credit unions, Reporting and recordkeeping

requirements.

By the National Credit Union Administration Board on September

16, 1994.

Becky Baker,

Secretary of the Board.

For the reasons set forth in the Preamble, pursuant to authority

granted in Section 205(b)(1) of the Federal Credit Union Act (12 U.S.C.

1785(b)(1)), the Board is adding a new regulation in 12 CFR part 708a.

1. Part 708a is added to read as follows:

PART 708a--MERGERS OR CONVERSIONS OF FEDERALLY-INSURED CREDIT

UNIONS: NCUA APPROVAL

Sec.

708a.1 NCUA Board approved.

708a.2 Notice to Members.

Authority: 12 U.S.C. 1766, 12 U.S.C. 1785.

Sec. 708a.1 NCUA Board approval.

Pursuant to Section 205(b)(1) of the Federal Credit Union Act, NCUA

Board approval is required in advance of any merger, consolidation,

insurance conversion, transfer of liabilities or other transaction

whereby a federally-insured credit union transfers all or any part of

its members' accounts to any institution that is not NCUSIF-insured or

assumes responsibility for all or any portion of accounts of an

institution that is not NCUSIF-insured. In transactions involving

federally-insured state chartered credit unions, the Board will

coordinate with the appropriate state regulatory authority.

Sec. 708a.2 Notice to members.

All notices to members will be preapproved by the NCUA Board.

Procedures and forms for the transactions where the remaining

institution continues to be a credit union--mergers involving both

federally-insured credit unions and non federally-insured credit unions

and conversion from federal insurance to nonfederal insurance--are set

forth in Part 708b, Subparts A, B and C.

Part 708 [Redesignated as Part 708b]

2. Part 708 is redesignated as part 708b.

[FR Doc. 94-23546 Filed 9-22-94; 8:45 am]

BILLING CODE 7536-01-M