Corporate Credit Unions

NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Part 704

Corporate Credit Unions

AGENCY: National Credit Union Administration (NCUA).

ACTION: Advance notice of proposed rulemaking.

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SUMMARY: Many corporate credit unions are closely tied to credit union

leagues or trade associations through interlocking boards of directors

or common management. The NCUA Board requests comment on whether to

amend its regulations to require that a corporate credit union's board

of directors be independently elected by its members, that the board

represent primarily the interests of those members that are credit

unions, and that management report only to the corporate credit union's

board of directors.

DATES: Comments must be postmarked by June 20, 1994.

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

National Credit Union Administration, 1775 Duke Street, Alexandria, VA

22314-3428.

FOR FURTHER INFORMATION CONTACT:

D. Michael Riley, Director, Office of Examination and Insurance, (703)

518-6360, or Robert M. Fenner, General Counsel, (703) 518-6540, at the

above address.

SUPPLEMENTARY INFORMATION:

A. Introduction

The corporate credit union system today consists of 44 corporate

credit unions serving the nation's 13,000 natural person credit unions,

with U.S. Central Credit Union in turn serving the corporate credit

unions. The corporate credit union system provides liquidity,

investment, and payment services to credit unions. As of December 31,

1993, the 44 corporate credit unions held about $41 billion in assets,

half of which was reinvested in shares in U.S. Central. Approximately

half of the corporate credit unions are closely tied to state credit

union leagues, either through interlocking boards, management

relationships, or both. In the case of U.S. Central, six of nine board

seats are allotted to trade association representatives: three to the

Credit Union National Association (CUNA), two to the Association of

Credit Union League Executives, and one to the Kansas Credit Union

Association. In addition, U.S. Central's CEO reports to the CEO of

CUNA.

For the reasons discussed below, the NCUA Board is requesting

comment on whether a corporate credit union's board of directors should

be independently elected by its members, primarily represent the

interests of the corporate's member credit unions, and have sole

authority over the management of the corporate credit union. These and

other corporate credit union issues, including investment powers and

capital levels, are currently under review by NCUA as part of a 180-day

study of the corporate system, and the Board may propose specific

regulatory changes at the completion of the study.

B. Background

The history of the ties between corporate credit unions and trade

associations is a long and, for the most part, successful one. It stems

from the credit union movement's long struggle for a national solution

to its liquidity problems. A review of these efforts is essential in

understanding how the present system, with its unusual combination of

private and government entities, was established.

The original draft of the 1934 Federal Credit Union Act contained a

section for a central bank for credit unions. It was dropped in

exchange for a grant of authority for federal credit unions to make

deposits in, and to borrow from, federal reserve banks. Opposition from

the Federal Reserve System led to the striking of this authority.

Federal credit unions were led to believe that, as a compromise, they

would be included in the upcoming legislation to create the Federal

Deposit Insurance Corporation (FDIC). When the legislation was adopted,

however, credit unions were not included.

During the 1940's, credit unions experienced a number of liquidity

problems, especially during the war years of 1941-1945. In response,

the first corporate credit union was organized by credit union leaders

in Kansas in 1951. Also in 1951, the credit union movement secured the

introduction of a bill for a national central bank and seven regional

banks, but Congress failed to address the issue. In the late 1950's,

several bills were considered by Congress for the chartering of central

credit unions which could accept the deposits of federal credit unions.

None of these was adopted.

Forced to address liquidity problems on their own, credit union

leagues began to establish additional state-chartered corporate credit

unions. League officials lent their expertise in helping to start these

corporate credit unions and serving on their boards.

Following severe liquidity problems in 1966 and 1969, the credit

union movement again petitioned Congress for a central bank.

Congressman Wright Patman (D-TX) introduced a bill to create a national

credit union bank in 1971, but did not secure enactment. He tried again

in 1973, once more unsuccessfully.

Realizing that credit union system liquidity and investment needs

would continue to be addressed in the private sector, CUNA worked to

establish a central institution to serve corporate credit unions,

securing a charter for U.S. Central Credit Union from the State of

Kansas in 1974. In 1980, legislation was passed enabling U.S. Central

and the other corporate credit unions to be designated as ``bankers

banks,'' with access to the Federal Reserve System. By the early

1980's, most states had established corporate credit unions.

The financial reform bills of the early to mid-1970's advanced the

concept of a central liquidity facility for credit unions, rather than

a central bank. The credit union movement eventually supported the

establishment of such a facility to serve as a backup for the private

system. The Central Liquidity Facility (CLF) was officially established

November 1978 and continues in its role of providing a government-

operated source of liquidity for the credit union system.

The credit union movement must be acknowledged for successfully

establishing a private system which has met the liquidity needs of

credit unions and provided services in the areas of investments,

securities safekeeping, payment systems, and correspondent services.

This corporate credit union system, while encountering some problems,

has nevertheless done an admirable job of meeting the needs of credit

unions over an extended period of time.

C. Regulatory History

The history of NCUA's regulatory efforts in this area reflects its

concern regarding the control and direction of corporate credit unions.

Until 1979, only natural person members of a corporate credit union

were permitted to serve on the board of directors. In 1979 the NCUA

Board issued a final rule permitting member credit unions to appoint

representatives to the corporate credit union. See 44 FR 58496, Oct.

10, 1979. A representative was empowered to attend meetings, vote, and

stand for election on behalf of the member credit union.

In 1980 the Board issued Interpretive Ruling and Policy Statement

(IRPS) 80-3, which clarified that although other non-natural person

members of corporate credit unions were entitled to vote through

agents, such agents could not stand for election in place of the non-

natural person member and were not eligible to serve in any elective or

appointive capacity in the corporate credit union. 45 FR 14202, Mar. 5,

1980.

In 1983 the Board adopted the standard corporate federal credit

union (FCU) bylaws. Article XV, Section 2, addresses conflicts of

interest of officials and employees and is identical to Article XIX,

Section 4, of the standard FCU bylaws for natural person FCUs. It

provides, in relevant part:

No director, committee member, officer, agent, or employee of

this credit union shall in any manner, directly or indirectly,

participate in the deliberation upon or the determination of any

question affecting his/her pecuniary interest or the pecuniary

interest of any corporation, partnership, or association (other than

this credit union) in which he/she is directly or indirectly

interested.

In response to concerns about the implications for a corporate

credit union official who is the designated representative of a member

credit union acting upon matters which may affect that credit union,

the Board noted that the provision was not intended to preclude an

official from participating in the establishment of policy and general

direction of the corporate credit union. The Board stated that it was

intended to preclude an official from taking part in actions which

would represent a true conflict of interest in a meaningful sense

pertaining to his or her credit union.

In 1984 the Board issued a final rule permitting all non-natural

person members of corporate credit unions to designate representatives

to stand for election and hold elective and appointive office. 49 FR

50368, Dec. 28, 1984. In the preamble to the proposed rule, the Board

stated that the restrictions of the regulation and IRPS 80-3 were at

variance with the underlying philosophy of one-member-one-vote. 49 FR

17953, Apr. 26, 1984. In the preamble to the final rule, the Board

stated that because corporate credit unions must primarily serve other

credit unions, the credit union members would continue to influence the

direction, policy, and priorities of the corporates through the

democratic process. The Board also acted to officially repeal IRPS 80-

3, stating that it addressed matters that were either superseded by or

incorporated in the rule.

Over time, a limited number of corporate credit unions developed

financial problems resulting in part from poor quality, preferential

loans made to affiliated leagues, less than arms-length transactions

involving the purchase or lease of league's fixed assets, and the

payment of other league expenses. These incidents occurred in

corporates that were closely tied to leagues at either the board or

management level. In response, the NCUA Board issued a proposed rule in

1991 requiring that at least three members of the corporate credit

union board be individuals who were independent of any organization

with which the corporate credit union was associated, excluding member

credit unions. See 56 FR 11952, Mar. 21, 1991. The Board noted that

many corporate credit unions shared physical space, personnel, and

officials with other organizations, often leagues and service

organizations, creating an environment in which conflicts of interest,

or the appearance of conflicts of interest, could develop. The proposed

rule also contained a recusal provision identical to Article XV,

Section 2, of the standard corporate FCU bylaws.

The final rule, issued on May 7, 1992, see 57 FR 22626, May 28,

1992, gave corporate credit unions an option with regard to board

representation. Section 704.12(a) states that the board of directors of

a corporate credit union is determined as stipulated in the corporate

credit union's bylaws, provided that: (1) At least three directors are

not officers, directors, or employees of an affiliated organization; or

(2) elections are open and independent, with procedures for nominations

by petition and mail balloting.

The proposed recusal provision was also changed. Section

704.12(c)(1) requires recusal for matters involving personal pecuniary

interest. For matters involving the pecuniary interest of an entity in

which an official or employee is interested, Section 704.12(c)(2)

requires recusal only when the amount in question exceeds 5 percent of

the corporate credit union's capital, when measured annually as an

aggregate of business arrangements with the entity. The conflict faced

by corporate FCUs, between the new recusal provision and the bylaws,

was not addressed.

D. Re-examining the System

Although the new regulations have resulted in greater independence

of corporate credit unions, the leagues and trade associations still

wield considerable influence in some institutions. A number of factors

have led the Board to consider whether additional steps should be taken

to ensure that boards of directors and management of corporate credit

unions operate independently of credit union trade associations and

represent the interests of the corporate's member credit unions.

One important factor is the dramatic increase in the scrutiny of

financial institutions by the public, the press, and Congress as a

result of the savings and loan disaster. A primary example of this

scrutiny is the exhaustive General Accounting Office study of credit

unions. This 371-page report was the longest and most detailed of any

financial institution sector and was done at a time when the credit

union movement was recording record growth, record health, and was

experiencing no identifiable problems.

This atmosphere of intense scrutiny, while fully understandable,

means that measures must be taken to ensure that safety and soundness,

and the perception of safety and soundness, are maintained at the

highest possible level. Public confidence in the financial system is

based, after all, more on public perception than on an intimate

knowledge of the workings of the system. The crash of the savings and

loan industry and temporary problems at the FDIC have increased public

scrutiny and mistrust of the financial services industry. In this

atmosphere, it is essential that credit union members and the public be

assured that corporate credit union decision makers act only with the

interests of the corporate credit union's members in mind.

The second factor is a function of credit union growth. The asset

level of corporate credit unions is almost as high as that of the

entire credit union movement when the CLF was created. The magnitude of

the asset growth within the corporate system attracts outside attention

and warrants continuous re-examination for possible weaknesses and/or

areas of improvement.

Third, as previously mentioned, the interrelationships between

corporate credit unions and state trade associations have in some cases

led to the misuse of corporate credit unions' resources to address

budgetary or financial constraints in the trade associations. The NCUA

Board is concerned that such conflicts, or even the appearance of

conflicts in these areas, may threaten the survival of a strong and

independent credit union system.

Finally, the recent publicity concerning U.S. Central's foreign

investments has focused considerable attention to the corporate credit

union system. The Board is concerned that if the system is perceived as

having areas of potential conflict, Congress will introduce legislative

proposals to address them. As mentioned earlier, the Board has

undertaken a study of the corporate credit union system which should

allay these concerns if they are unfounded. If changes are needed,

however, the Board believes it is preferable to address them by

regulation, rather than await Congressional action over which NCUA and

credit unions may have little or no control.

E. Request for Comment

Election of Directors

In consideration of the above factors, the Board requests comment

on changes to NCUA's regulation of corporate credit unions, 12 CFR Part

704, to require that the board of directors of a corporate credit union

be independently elected by its members, with the condition that at

least a majority of the board seats be held by representatives of

member credit unions.

Recognizing that in many instances interlocks exists as a result of

the same representative(s) being separately elected to both the

corporate credit union board of directors and the board of a league or

other association, the NCUA Board also requests comment on whether it

should establish a requirement that all or a majority of the corporate

board be comprised of representatives who do not serve in dual

capacities other than as officials of both the corporate and a member

credit union.

The Board requests comments on other issues related to how best to

accomplish majority representation by credit unions. For example,

elections could be open, with unrestricted nominations. However, once

the maximum number of seats permitted to representatives of non-credit

union members was filled, the remaining seats would go to credit union

representatives, even if a non-credit union representative received

more votes. As an alternative, the Board could revise the regulations

to revert to the limitations of IRPS 80-3, i.e., that non-credit union

members have full voting rights but are not eligible to hold seats or

place representatives on the board of directors. The Board seeks

comments on these and other methods to assure a corporate credit

union's board is representative primarily of the interests of the

corporate's member credit unions.

The Board is aware that this is a departure from the democratic

ideal of equal rights for all members, but believes for the reasons

described above, that it may be in the best interests of credit unions.

As the history of part 704 shows, the rights of various types of

corporate credit union members frequently have differed, as the role of

corporate credit unions has evolved over the years.

In the case of U.S. Central Credit Union, the Board has some

concern that majority representation by its member credit unions may

not be the best solution. While U.S. Central serves other corporate

credit unions, it ultimately has great responsibilities, because of its

central and national role, to natural person credit unions and credit

union members. The Board requests comment on whether classes of

directors should be established at U.S. Central in order to ensure

representation by natural person credit unions and others broadly

representative of the public interest.

Non-natural Person Representation

The Board also seeks comment on whether election or appointment of

a non-natural person member representative to a position in a corporate

credit union should be considered to be an election or appointment of

the individual or the non-natural person member. In IRPS 80-3 the Board

took the position that election or appointment was of the individual,

not the non-natural person member. The Board stated that while the

board of directors of a member credit union (at that time the only non-

natural person member permitted to designate a representative to stand

for election) was free to change its designated representative at any

time, where that representative had been elected to the corporate

credit union's board of directors or elected or appointed to a

committee, revocation of the designation meant that any position held

by that individual must be declared vacant. Such vacancies were to be

filled in accordance with the Article VII, Section 3, of the FCU bylaws

(the corporate FCU bylaws had not yet been issued), which provides that

vacancies on the board, credit committee, or supervisory committee

shall be filled by vote of a majority of the directors then holding

office. The member credit union's new representative did not

automatically assume the old representative's elected or appointed

position.

As discussed above, IRPS 80-3 was repealed in the 1984 revision to

the regulation. However, there was no discussion of NCUA's position on

filling a position when a non-natural person member's designated can no

longer serve or the non-natural person member wishes to change its

designate. Subsequently, NCUA informally took the position that it was

a matter to be determined by each corporate.

The Board notes that there are sound arguments for each position.

In IRPS 80-3, it was observed that where the designated representative

of a non-natural member has been elected or appointed to a position in

the corporate credit union, the voters or appointing official were, at

least in part, swayed by the qualifications of the individual. It was

reasoned that to permit the board of directors of the non-natural

person member to substitute another individual in the place of a

representative who has been elected or appointed to an office defeats

the purpose of an election in the one case and usurps the power of the

appointing official in the other. On the other hand, it is the non-

natural person entity that is the actual member of the corporate credit

union, not the representative, so it can be argued that it is the non-

natural person member that holds the elected or appointed position. As

such the member should have the right to determine who serves as its

representative. The Board seeks comment on whether all corporates

should be required to take the same approach to non-natural person

members and which approach is preferable.

Recusal Provision

Requiring that a majority of the board of directors of a corporate

credit union, but not all, be representatives of member credit unions

means that some board members may be either representatives of other

non-natural person members, such as leagues and service organizations,

or natural person members with ties to such entities. Also, depending

on the Board's ultimate decision on the issue, individual

representatives of member credit unions may, in some cases, continue to

serve on the corporate board and, at the same time, serve on the board

of a league or other association. Finally, conflicts will continue to

arise when matters come before the board of a corporate credit union

that directly involve a member credit union whose representative serves

on the board. Accordingly, the NCUA Board believes that to avoid even

the appearance of a conflict of interest, it is important to have a

strong recusal provision.

To address these concerns, the Board is considering returning to

the language of Article XV, Section 2, of the standard corporate FCU

bylaws, which prohibits directors, committee members, officers, agents,

or employees of corporate credit unions from participation in any

question affecting the pecuniary interest of any organization in which

those individuals are interested. Adopting this language would resolve

the conflict, for corporate FCUs, between the bylaw and the regulation,

and would make the standard uniform for all corporate credit unions.

The Board seeks comment on this idea and on the appropriate definition

of ``interested.''

Management Accountability

Finally, as previously mentioned, the NCUA Board is concerned about

situations in which management of a corporate credit union reports to

the officials of an affiliated league or trade association. For

corporate FCUs, this may violate several provisions of the standard

corporate FCU bylaws. Article VI, Section 5, provides that the board

shall have the general direction and control of the affairs of the

credit union. The bylaw states that the board may delegate the

performance of administrative duties but is not relieved of its

responsibility for their performance. Article VII, Section 6, provides

that the board may employ a management official who shall not be a

member of the board and who shall be under the direction and control of

the board. Although the Board cannot speak to the bylaws of state-

chartered corporate credit unions, the practice of the management of

one entity reporting to officials of another entity violates

fundamental principles of general corporate law. Accordingly, the Board

is considering amending its regulations to require that management of a

corporate credit union report solely to the board of directors of that

credit union.

The Board welcomes comment on these and any other considerations

with respect to the management and control of corporate credit unions.

F. Effect on State-Chartered Corporate Credit Unions

Part 704 applies to all federally insured corporate credit unions.

Further, non-federally insured corporate credit union must agree to

comply with NCUA's corporate credit union regulation as a condition of

receiving funds from natural person FCUs. Thus, the regulatory changes

will affect all corporate credit unions. The Board believes this result

is essential, given that the vast majority of funds held in the

corporate system represent investments by federally insured credit

unions.

By the National Credit Union Administration Board on April 12,

1994.

Becky Baker,

Secretary of the Board.

[FR Doc. 94-9324 Filed 4-18-94; 8:45 am]

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