Organization and Operations of Federal Credit Unions

NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Part 701

Organization and Operations of Federal Credit Unions

AGENCY: National Credit Union Administration (NCUA).

ACTION: Final rule

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SUMMARY: Currently, NCUA Rules and Regulations prohibit officials and

certain employees of federally insured credit unions from receiving

either incentive pay or outside compensation for certain activities

related to credit union lending. To reduce regulatory burden, the NCUA

Board is amending the regulations to give member-elected credit union

boards more flexibility to determine compensation policies, including

the use of incentive pay.

EFFECTIVE DATE: October 4, 1995.

ADDRESSES: National Credit Union Administration, 1775 Duke Street,

Alexandria, VA 22314-3428.

FOR FURTHER INFORMATION CONTACT: Lisa Henderson, Staff Attorney, (703)

518-6561, at the above address.

SUPPLEMENTARY INFORMATION:

Background

Section 701.21(c)(8) of the NCUA Rules and Regulations, 12 CFR

701.21(c)(8), prohibits federal credit unions from making a loan if,

either directly or indirectly, any commission, fee, or other

compensation is to be received by the credit union's directors,

committee members, senior management employees, loan officers, or any

immediate family members of such individuals, in connection with

underwriting, insuring, servicing, or collecting the loan. However,

non-commission salary may be paid to employees. As a condition of

federal insurance pursuant to Sec. 741.3(a) of the Regulations, 12 CFR

741.3(a), the prohibition applies to federally insured state-chartered

credit unions. As a consequence of the regulation, federally insured

credit unions may not provide incentive compensation to officials and

loan officers.

Noting that credit union management had become increasingly

interested in implementing lending-related incentive pay programs, the

NCUA Board, on March 9, 1994, issued a Request for Comment on whether

Sec. 701.21(c)(8) should be amended to permit loan officers and/or

senior management to receive incentive pay for underwriting and

insuring loans. 59 FR 11937 (March 15, 1994). A total of 252 comments

was received, 177 of which expressed support for allowing incentive pay

for loan officers.

On April 13, 1995, the Board issued a proposed regulation which

would amend Sec. 701.21(c)(8) to authorize lending-related compensation

in certain situations where it is currently prohibited. 60 FR 19690

(April 20, 1995). A total of 105 comments was received, 48 from federal

credit unions, 29 from state-chartered credit unions, 19 from national

and state credit union leagues, 3 from insurance companies, 2 from

state credit union regulators, and 1 each from a banking trade

association, Member of Congress, law firm, and individual.

Seventy-four commenters felt that the proposed regulation was too

restrictive. Seven commenters expressed unqualified support for the

proposed regulation and nine expressed qualified support. Seven

commenters stated that credit unions should not be permitted to pay

incentives, period. Six commenters urged that the current regulation be

retained, expressing concern that additional authority to pay

incentives could create safety and soundness problems.

Final Rule

In response to the comments, and to reduce regulatory burden, the

Board has determined to give member-elected boards of directors more

flexibility in determining compensation policies for lending-related

activities, including the use of incentive pay. Accordingly, the final

rule will allow federal credit unions to pay: (1) To any employee,

including a senior management employee, an incentive or bonus based on

the overall financial performance of the credit union; and (2) to any

employee, except a senior management employee, an incentive based on a

loan made by the credit union, provided that the board of the credit

union has established written policies and internal controls in

connection with the incentive or bonus and monitors compliance with

them at least annually. In addition, the final rule will allow a credit

union's volunteer officials and non senior management employees, and

family members of officials and all employees, to receive compensation

from an outside party for a service or activity performed outside the

credit union, provided that neither the credit union nor the official,

employee, or family member has ``steered'' anyone to the other party.

This will allow for ``incidental'' situations resulting from the fact

that volunteer officials, non senior management employees, such as

part-time employees, and family members of employees, may have jobs

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outside the credit union in areas such as insurance or real estate,

where customers of the outside business choose to obtain loans from the

credit union.

The Board wishes to make clear that this action is not intended to

encourage lending-related incentives. In the preamble to the proposed

rule, the Board expressed some of its concerns regarding incentive pay,

particularly for lending activities. However, this liberalization and

deregulation reflects the recognition that there are good arguments and

strongly held beliefs on both sides of the incentive pay issue. It is

the Board's determination, in light of those considerations and the

comments received, that NCUA should structure a rule that involves

basic controls and safety and soundness standards and that, beyond

that, allows a member-elected board of directors to decide whether to

use incentives. Of course, NCUA reserves the right to take exception to

any compensation plan for safety and soundness reasons.

Analysis

The supplementary information section of the preamble stated that

the structure of the regulation had been changed to make it easier to

interpret and administer. The preamble noted that it had been difficult

to determine, in the current regulation, whether an activity was part

of ``underwriting, insuring, servicing, or collecting'' a loan. The

proposed regulation only required that an activity be ``in connection

with'' a loan. The preamble stated that NCUA would take a

reasonableness approach to that determination.

In an effort to illustrate the distinction between activities in

connection and not in connection with lending, the preamble provided

examples. The following were presented as being not in connection with

lending: (1) Purchasing loan application forms from a company owned by

an official; and (2) Financing a home (already) built by a construction

company owned by an official. In contrast, the following were presented

as being in connection with lending: (1) Obtaining a credit report from

a credit bureau owned by an official; and (2) Referring a member to a

construction company owned by an official to have a home built and

financing the construction of the home.

Eleven commenters stated that the phrase ``in connection with'' was

too broad or too vague. Two commenters stated that the examples

provided did little to clarify the scope of coverage of the regulation.

The Board continues to believe that the proposed prohibition would

be easier to administer than the current regulation and has therefore

retained it in the final rule. The Board acknowledges, however, that

the examples provided were not helpful. Rather than trying to determine

whether an activity is significant enough to be considered ``in

connection with'' a loan, the Board has concluded that any activity

that is directly linked to lending should be considered to be ``in

connection with'' a loan. Under that analysis, each of the four

examples discussed above involves an activity that is in connection

with a loan.-

Proposed paragraph (8)(ii) set forth definitions, only three of

which elicited comment. The proposed regulation defined

``compensation'' as including non monetary items, and a few commenters

stated that items of nominal value should be excluded. The Board

agrees, and has changed the definition accordingly. Items of nominal

value are those with a value so small as to make accounting for them

unreasonable or administratively impracticable. The board of directors

of a credit union may look to Internal Revenue Service law regarding

income and de minimus fringe benefits, 26 USC 132, for guidance in this

area.

The proposed regulation defined ``employee'' to include independent

contractor. The intent was to prevent credit unions from evading the

rule by calling an individual who is essentially an employee an

independent contractor. Several commenters objected to including

independent contractors in the definition of employee. They said that

it would have the effect of prohibiting any lending-related

compensation to any independent contractors or third parties. The Board

agrees and has deleted the term ``independent contractor'' from the

final rule. The Board notes, however, that NCUA will treat an

individual functioning as an employee as such for the purposes of

Sec. 701.21(c)(8).

The proposed regulation defined ``senior management employee'' as

it is defined elsewhere in the NCUA regulations (the chief executive

officer, any assistant chief executive officers, and the chief

financial officer) but added the phrase, ``and any other employee who

sets policy for the credit union.'' Several commenters objected to this

addition, arguing that it was too broad and muddied the distinction

between senior management and other employees. The Board agrees and has

deleted the phrase from the final rule.

Finally, in the final rule the Board has deleted the definition of

``workout loan'' as unnecessary and added a definition for ``volunteer

official.'' A volunteer official is a director or committee member who

is not compensated as such. Federal credit unions are permitted to

compensate one director solely for his or her service on the board, and

many state-chartered credit unions are permitted by state law to

compensate one or more directors for such service. Under the final

rule, a director so compensated would not be considered a volunteer

official.

Paragraph (8)(iii) of the proposed regulation set forth five

exceptions to the prohibition against lending-related compensation.

Exception (A), salary for employees, was met with universal approval

from the commenters. Exception (B) was an incentive or bonus to an

employee, including a senior management employee, based on the credit

unions overall financial performance. This codified a position that had

been taken in an opinion letter from NCUA and also was supported by the

commenters. Accordingly, exceptions (A) and (B) have been retained in

the final rule.

Exceptions (C), (D), and (E) authorized payment of an incentive to

an employee in connection with processing a loan, making a decision to

approve or disapprove a loan, and collecting a loan, respectively,

provided that no incentive or bonus was paid to a supervisor of the

employee, a senior management employee, or an immediate family member

of a supervisor or senior management employee. Exception (D)

additionally required that an incentive paid in connection with making

a loan decision not be based on the number or dollar amount of loans

approved and be structured in a manner that demonstrably protected

against an increase in problem loans.

Sixteen commenters said that non senior management should be

permitted to receive incentives. Many said that the prohibition against

payment of incentives to supervisors would disproportionately affect

large credit unions. They argued that lower level supervisors would be

caught between senior management, who receive bonuses based on overall

performance, and front-line employees, who are eligible for incentive

pay. In response to the comments, the Board has removed the prohibition

against supervisors receiving incentive pay from the final rule.

Thirty-eight commenters objected to the prohibition against basing

incentives on the number or dollar amount of loans approved. Most said

there were no other reasonable measures on which to base incentives for

loan officers. As

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discussed above, the Board has determined to deregulate this issue and

allow credit unions to structure their own incentive plans. This is

provided for in Exception (C) in the final rule, which simply provides

that a federal credit union may pay an incentive or bonus to a non

senior management employee in connection with a loan made by the credit

union. This includes incentives for any activity connected with

lending, including processing and collecting loans, making credit

decisions, and selling credit life, credit disability, and mechanical

breakdown insurance. The only limitation is that the board of directors

of the credit union must have established written policies and internal

controls in connection with the incentive or bonus and must monitor

those policies and controls annually.

The final rule's requirement of annual monitoring of policies and

controls is a change from paragraph (8)(iv) of the proposed regulation,

which required quarterly monitoring. Thirteen commenters said that

quarterly review was too frequent, arguing that it would put the board

of the credit union in the role of micro-managing the credit union. In

response to the comments, the change was made. The Board notes,

however, that the supervisory committee, or internal auditor in larger

credit unions, should consider reviewing the effectiveness of incentive

pay policies and controls more frequently than annually.

Paragraph 8(iv) of the proposed rule also required that

documentation of the monitoring be made available to the supervisory

committee and NCUA. There was some confusion about this requirement.

Several commenters asked whether documentation should be made available

to examiners during exams or sent to NCUA. There also was a question as

to whether state-chartered credit unions should provide documentation

to the state regulator. The Board has deleted this requirement as

unnecessary. Under the final rule, a credit union wishing to provide

incentive pay must establish written policies. These are by definition

part of the books and records of the credit union, which are open to

the supervisory committee of the credit union and to NCUA examiners.

The preamble to the proposed rule discussed a number of policy

changes the regulation would make. It first noted that the current

regulation had been interpreted to permit a credit union official or

employee to receive compensation for acting as an agent in the sale of

property securing a loan made by a credit union, on the rationale that

listing or selling a property on which a loan is granted is not

included in underwriting, insuring, servicing, or collecting the loan.

Since listing or selling property financed by the credit union is ``in

connection with'' the loan, however, the proposed rule would prohibit

compensation for such activity.

The preamble also noted that the current regulation had been

interpreted to prohibit a credit union official or employee from, for

example, owning an insurance company that sells car insurance to

members who finance their cars at the credit union. An argument had

been made, however, that the regulatory language prohibited the receipt

of compensation in connection with insuring the loan but not in

connection with insuring collateral securing the loan. The preamble

stated that NCUA was concerned about the opportunity for credit union

officials and employees to steer members to a particular insurance

agency and that the proposed regulation therefore would prohibit all

officials and employees from receiving compensation for insuring

collateral securing a loan made by the credit union.

A number of commenters stated that the prohibition against

receiving compensation for outside activities might restrict members

from volunteering to serve on a credit unions board. The NCUA Board

shares that concern and has determined to permit volunteer officials

and non senior management employees of a federal credit union, and the

family members of officials and all employees, to receive compensation

from an outside party for an activity performed outside the credit

union, as long as neither the credit union nor the official, employee,

or family member refers any person to the other party. Thus, the

borrower's receipt of a loan from the credit union should be

unconnected to his or her participation in the outside activity of the

official, employee, or family member. The Board believes the

prohibition should remain in effect for senior management employees in

order to prevent situations where subordinate employees feel pressure

to make loans to customers of the outside business interest of the

senior management employee. The exception will ensure, at the same

time, that NCUA's rules do not interfere with the livelihoods of

volunteer officials, non senior management employees, such as part-time

employees, and the family members of officials and employees. This is

set forth in Exception (D) of the final rule. -

Regulatory Procedures

Regulatory Flexibility Act

The NCUA Board certifies that this rule will not have a significant

impact on a substantial number of small credit unions (those under $1

million in assets). Accordingly, a Regulatory Flexibility Analysis is

not required.

Paperwork Reduction Act

NCUA has determined that the requirement to establish a written

policy in connection with the payment of lending-related incentives

does constitute a collection of information under the Paperwork

Reduction Act. The Paperwork Reduction Act of 1995 and regulations of

the Office of Management and Budget (OMB) require that the public be

provided an opportunity to comment on information collection

requirements, including an agency's estimate of the burden of the

collection of information. NCUA estimates that no more than 1000

federally insured credit unions will seek to implement lending-related

incentive compensation policies. It is NCUA's view that the time a

credit union spends developing a responsible policy is not a burden

created by this regulation but rather is necessary to the safe and

sound payment of lending-related incentives. The paperwork burden

created by this rule is the requirement that such policy be put in

writing. NCUA estimates that it should take at most one hour to put an

incentive policy in written form. Therefore, 1000 total burden hours

are required to comply with the collection requirement.

The NCUA Board invites comment on: (1) Whether the collection of

information is necessary for the proper performance of the functions of

NCUA, including whether the information will have practical utility;

(2) The accuracy of NCUA's estimate of the burden of the collection of

information; (3) Ways to enhance the quality, utility, and clarity of

the information to be collected; and (4) Ways to minimize the burden of

the collection of information. Send comments to Suzanne Beauchesne,

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

22314-3428. Comments should be postmarked by December 4, 1995.

After 60 days, NCUA will submit the paperwork requirement to OMB

for review under the Paperwork Reduction Act and will publish a notice

to that effect in the Federal Register. NCUA will also publish a notice

in the Federal Register once OMB takes action on the submitted request.

Until NCUA receives an OMB control number indicating approval of the

requirement that

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incentive policies be put in writing, a credit union is not required to

comply with that requirement.

Regulatory Burden--

Section 302 of the Riegle Community Development and Regulatory

Improvement Act of 1994 requires the federal regulators of banks and

savings associations to make all regulations that impose new

requirements take effect on the first date of the calendar quarter

following publication of the rule unless good reason exists for some

other effective date. Although NCUA is not formally subject to this

requirement, Letter to Credit Unions #158 stated that the requirement

would be beneficial to credit unions and that NCUA planned to implement

it whenever practicable. NCUA believes that an immediate effective date

is appropriate since the final rule relieves a regulatory burden on

credit unions that wish to implement lending-related incentive

compensation programs by permitting them to do so. Although the final

rule also imposes a recordkeeping requirement, the primary effect of

the rule is to relieve regulatory burden.

Executive Order 12612

Executive Order 12612 requires NCUA to consider the effect of its

actions on state interests. The preamble to the proposed rule

acknowledged that the proposed rule would impose some requirements on

state-chartered, federally insured credit unions but stated that any

effect on the distribution of power and responsibilities among the

various levels of government was justified by the potential risk to the

NCUSIF. Several commenters argued that no risk to the NCUSIF had been

demonstrated and that, for state-chartered credit unions, the matter

should be left to state regulators to determine.

The final rule imposes significantly less regulatory burden on

credit unions than either the proposed rule or the currently effective

rule. Therefore, the effect on state regulatory authority is

considerably diminished. The Board continues to believe, however, that

any remaining effect on that authority is justified by the potential

risk to the NCUSIF without such a rule.

The Board notes that this rule is not intended to expand the

authority of state-chartered credit unions. If state law imposes

greater restrictions on lending-related compensation than does this

rule, state-chartered credit unions must comply with state law.

List of Subjects in 12 CFR Part 701

Federal credit unions, Organization and operations.

By the National Credit Union Administration Board on September

28, 1995.

Becky Baker,

Secretary of the Board.

For the reasons set forth in the preamble, NCUA amends 12 CFR part

701 as follows:

PART 701--ORGANIZATION AND OPERATION OF FEDERAL CREDIT UNIONS

1. The authority citation for part 701 continues to read as

follows:

Authority: 12 USC 1752(5), 1755, 1756, 1757, 1759, 1761a, 1761b,

1766, 1767, 1782, 1784, 1787, 1789, and Pub. L. 101-73. Section

701.6 is also authorized by 31 USC 3717. Section 701.31 is also

authorized by 15 USC 1601, et seq., 42 USC 1981, and 42 USC 3601-

3610. Section 701.35 is also authorized by 12 USC 4311-4312.

Sec. 701.21 [Amended]

2. Section 701.21(c)(8) is revised to read as follows:

* * * * *

(c) * * *

(8)(i) Except as otherwise provided herein, no official or employee

of a Federal credit union, or immediate family member of an official or

employee of a Federal credit union, may receive, directly or

indirectly, any commission, fee, or other compensation in connection

with any loan made by the credit union.

(ii) For the purposes of this section:

Compensation includes non monetary items, except those of nominal

value.

Immediate family member means a spouse or other family member

living in the same household.

Loan includes line of credit. -

Official means any member of the board of directors or a volunteer

committee.

Person means an individual or an organization.--- -

Senior management employee means the credit union's chief executive

officer (typically, this individual holds the title of President or

Treasurer/Manager), any assistant chief executive officers (e.g.,

Assistant President, Vice President, or Assistant Treasurer/Manager),

and the chief financial officer (Comptroller).

Volunteer official means an official of a credit union who does not

receive compensation from the credit union solely for his or her

service as an official.

(iii) This section does not prohibit:

(A) Payment, by a Federal credit union, of salary to employees; - -

(B) Payment, by a Federal credit union, of an incentive or bonus to

an employee based on the credit union's overall financial performance;

(C) Payment, by a Federal credit union, of an incentive or bonus to

an employee, other than a senior management employee, in connection

with a loan or loans made by the credit union, provided that the board

of directors of the credit union establishes written policies and

internal controls in connection with such incentive or bonus and

monitors compliance with such policies and controls at least annually.

(D) Receipt of compensation from a person outside a Federal credit

union by a volunteer official or non senior management employee of the

credit union, or an immediate family member of a volunteer official or

employee of the credit union, for a service or activity performed

outside the credit union, provided that no referral has been made by

the credit union or the official, employee, or family member.

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[FR Doc. 95-24688 Filed 10-3-95; 8:45 am]

BILLING CODE 7535-01-P