Funding and Fiscal Affairs, Loan Policies and Operations, and Funding Operations; Disclosure to Shareholders; Director Elections

FARM CREDIT ADMINISTRATION

12 CFR Parts 615 and 620

RIN 3052-AB60

Funding and Fiscal Affairs, Loan Policies and Operations, and

Funding Operations; Disclosure to Shareholders; Director Elections

AGENCY: Farm Credit Administration.

ACTION: Final rule.

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SUMMARY: The Farm Credit Administration (FCA), by the Farm Credit

Administration Board (Board), adopts amendments to the regulations

relating to the implementation of cooperative principles to allow

greater flexibility in the method by which directors of Farm Credit

System (System) associations and banks for cooperatives are elected,

consistent with cooperative principles. The amendments permit regional

election of directors.

EFFECTIVE DATE: The regulations shall become effective upon the

expiration of 30 days after publication during which either or both

houses of Congress are in session. Notice of the effective date will be

published in the Federal Register.

FOR FURTHER INFORMATION CONTACT: John J. Hays, Policy Analyst,

Regulation Development, Office of Examination, (703) 883-4498, TDD

(703) 883-4444; or Rebecca S. Orlich, Senior Attorney, Regulatory

Enforcement Division, Office of General Counsel, (703) 883-4020, TDD

(703) 883-4444.

SUPPLEMENTARY INFORMATION: On June 9, 1995, the FCA Board published

proposed amendments to its regulations governing the election of

directors. See 60 FR 30470 (June 9, 1995). The FCA received 9 comment

letters in response

[[Page 57920]]

to this proposal. A description of the existing and proposed

regulations, comments on major issues, and the FCA's response follow.

I. Existing Regulation and Proposed Regulation

The existing regulation was promulgated by the FCA in 1988 to

implement changes effected by the Agricultural Credit Act of 1987. It

provided for the at-large election of directors of associations and

banks for cooperatives (BCs) but permitted associations that, in 1988,

had bylaws providing for regional elections of directors to continue to

do so until January 1, 1993. These associations were districtwide

associations that had been formed in the 1980s through mergers of most

or all of the associations in a bank's district. In response to the

desire for regional representation expressed in the comments to the

existing regulations when they were proposed in 1988, the FCA placed no

restrictions on the institution's ability to provide for geographic

representation on the board by geographic designation of director

positions; the Agency also provided for cumulative voting unless

shareholders approved bylaws providing otherwise. However, the FCA

decided to prohibit regional voting because of Agency concerns

regarding director accountability and equitable voting power.

Subsequent to implementation of that regulation, and in response to

requests from institutions to permit regional election of directors,

the FCA reviewed its position and determined that its concerns could be

addressed in a less burdensome way that would permit regional

elections, consistent with cooperative principles.

The FCA proposed amendments to Sec. 615.5230(a)(1)(ii) to permit

the regional election of directors of associations and BCs subject to

the following conditions:

1. To ensure that a director can be held accountable by all

shareholders, institutions with bylaws providing for shareholder

removal of directors must provide that each director may be removed by

a majority vote of all voting shareholders and may not be removed by a

vote of only the shareholders in his or her region; and

2. The bylaws provide for the apportionment of the institution's

territory into voting regions with approximately equal numbers of

voting shareholders and ensure equitable representation from each

voting region through an annual evaluation by the institution's board

of directors.

The FCA also proposed a conforming amendment to Sec. 620.21(d)(1)

of the FCA regulations to require disclosures regarding regional voting

in the association's annual information statement.

II. Comments on Major Issues

Comments were received from the Farm Credit Council (FCC),

representing the interests of its membership except for one bank; a

Farm Credit Bank; five System associations; a law firm representing two

pairs of jointly managed System associations (four associations); and

one System association board member. The Farm Credit Bank stated its

belief that it was not appropriate for a bank to express a position on

the regulation of the internal affairs of associations. Two commenters

fully supported the proposal, one commenter objected to the proposal,

and others expressed varying degrees of support and/or criticism as

described below:

1. Shareholder approval of bylaw establishing regional elections.

An association objected to this requirement as being burdensome and

costly, and a responsibility for association boards. The FCC stated

that it strongly opposed this provision as being unnecessary, a matter

for the association board to decide, prohibitively expensive for some

associations, and a barrier to having regional elections before 1997.

2. ``Approximately equal number of voting shareholders'' in each

region. This issue was commented on by the FCC and five others. The FCC

asserted that, as a practical matter, this requirement would preclude

the drawing of regional boundaries along state, county, or other

political or geographic lines. The FCC asserted that it would likely

result in the elimination or curtailment of certain ``grass roots''

programs, because regions based on equal numbers of shareholders would

mean that some regions will be very large and the large size would make

travel to the local meetings difficult, if not impossible. The FCC

further stated that the number of shareholders per region should not be

the controlling factor, or even necessarily of greater weight than

other factors.

One association supported additional flexibility on this issue and

asked for ``board variance to the percent of stockholders located in

each region in order to achieve clear understanding of each regions'

boundaries.'' The law firm recommended that association boards be

permitted to draw boundaries along county or territorial lines

``consistent with standards provided in the bylaw to assure

`substantial parity' of voting control among shareholders across

regions but without requiring coupling of non-contiguous counties into

a single region.'' The comment does not suggest what the standard for

``substantial parity'' would or should be, other than that it must be

provided for in the bylaws. Another association stated that ``regions

with disproportionate numbers of stockholders can be equitably served

by differential numbers of director positions per region, resulting in

reasonably balanced representation of stockholders per director.'' An

association also suggested that ``approximately equal'' be defined to

mean a shareholder variance of 10 percent more or less than other

regions. Another association expressly supported the ``approximately

equal'' standard.

3. Annual evaluation to assure that regions remain approximately

equal. The FCC and three associations were critical of the annual

evaluation requirement. The FCC pointed out that, since many or most

associations elect directors on a staggered-term basis, the voting

region electing a particular director could change while he or she is

in office; it also said that an annual evaluation could result in

frequent changes in regional boundaries. The law firm made a similar

comment and stated that, ``[t]o the extent there is now any sense of

connection between a stockholder and a director from his or her region,

it would certainly be lost in this shuffle.'' One association stated

its belief that evaluations should be necessary only every 3 years. Two

associations expressly supported the proposed annual evaluation.

III. FCA's Response to Comments

On the issue of shareholder approval to determine the method of

electing their directors, the Board strongly believes that the right of

shareholders to vote for all of the directors who owe them fiduciary

duties should not be limited in any way without their consent. A

regional voting bylaw, if adopted with the approval of only directors

of the institution, could be viewed as serving primarily the interest

of furthering director position and influence and disenfranchising

shareholders. Shareholder ratification will serve to negate any such

inference and assure concurrence by the owners of the association as to

the benefits to be derived from the bylaw provision. The Board

recognizes that there are costs associated with any shareholder vote

but does not believe that the cost would be prohibitively expensive for

any institution, as was asserted by a commenter. Therefore, after

weighing

[[Page 57921]]

the costs and benefits, the Board adopts the shareholder approval

requirement as proposed.

In response to comments regarding the requirement to have an

``approximately equal'' number of voting shareholders per region, the

Board has carefully considered the arguments against such standard. The

Board has concluded that the equalization of the number of voters per

region ensures democratic control of an association. The Board is not

persuaded that ``approximately equal'' voting would reduce or curtail

grass-roots participation in institution business, particularly since

at present the directors are elected on an at-large basis.

However, in response to some of the comments received asserting

that precise equalization would be overly burdensome, the Board has

made several changes to this provision of the proposed regulations.

First, the final regulation retains the ``approximately equal''

standard but specifies that the standard is met if no region contains

more than 25 percent more voting shareholders than in any other region.

After implementation, the institution must periodically count the

number of voting shareholders in each region and, if the

``approximately equal'' standard is no longer being met, must adjust

the boundaries or adjust the ratio of borrowers to directors in order

to meet the standard. Second, the final regulation provides that the

evaluation of the number of voting shareholders and any resulting

adjustments must take place at least once every 3 years. This is a

relaxation of the proposed regulation's requirement for an evaluation

every year.

The Board is aware, as some commenters noted, that revisions of the

regional boundaries, in cases where board members serve staggered

terms, could be viewed as depriving some shareholders of representation

who may, after a boundary change, be in the region of a board member

for whom they did not have the opportunity to vote. Such a result would

appear to be unacceptable in a situation where a board member is

obligated to represent only the interests of shareholders from his or

her region. However, that is not the case here. Institution board

members have a fiduciary duty to represent the interests of all of the

shareholders in the institution's territory, even when they are elected

on a regional basis.1 An institution may, of course, choose to

elect all of its directors annually, or may decide not to have regional

voting.

\1\ Moreover, the combination of yearly boundary revisions and

directors with staggered terms may not be uncommon among

cooperatives. See, e.g., the model bylaw provision set forth in

Legal Phases of Farmer Cooperatives, Information 100, Farmer

Cooperative Service, U.S. Dept. of Agriculture (1976), at 572-73.

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The Board has also made several clarifications to the proposed

regulations. Proposed Sec. 615.5230(a)(3)(ii) stated that, if there is

a bylaw providing for shareholder removal of directors, it must give

all voting shareholders the right to vote to remove a director and not

limit the right to the shareholders in the director's region. In the

Board's view, this language implied that the bylaws could deprive

shareholders of the right to remove directors. It was not the intention

of the Board to imply this, since stockholders have a common law right

to remove directors for cause.2 Therefore, to avoid any confusion

on this issue, the Board has revised the proposal to provide, in the

final regulations, that bylaws establishing regional voting must give

all voting shareholders the right to vote in any shareholder vote to

remove a director.

\2\ See Harry G. Henn & John R. Alexander, Laws of Corporations

Sec. 205 (1983). Common law also provides that the board of

directors may not remove a director for cause unless the bylaws so

state; it appears that the board of directors cannot remove a

director without cause. Id.

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The Board has also added a clarifying amendment to

Sec. 620.21(d)(3). The existing regulation requires that, if an

association's annual meeting is held in more than one session, the

annual meeting information statement must contain a statement that

nominations from the floor must be made at the first session. The

clarifying amendment adds that, for associations that elect directors

by region, there must be a statement that nominations from the floor

for a director from a particular region must be made at the first

session in that region if stockholders do not vote solely by mail

ballot. If stockholders vote solely by mail ballot, the information

statement must state that nominations from the floor may be made at any

session of the annual meeting held in a region, unless the bylaws

provide otherwise.

No specific comments were received on regional elections for BC

directors or on the proposed conforming amendment to Sec. 620.21(d)(1),

the disclosure regulation. The disclosure provision is adopted as

proposed.

List of Subjects

12 CFR Part 615

Accounting, Agriculture, Banks, banking, Government securities,

Investments, Rural areas.

12 CFR Part 620

Accounting, Agriculture, Banks, banking, Reporting and recording

requirements, Rural areas.

For the reasons stated in the preamble, parts 615 and 620 of

chapter VI, title 12 of the Code of Federal Regulations are amended as

follows:

PART 615--FUNDING AND FISCAL AFFAIRS, LOAN POLICIES AND OPERATIONS,

AND FUNDING OPERATIONS

1. The authority citation for part 615 continues to read as

follows:

Authority: Secs. 1.5, 1.7, 1.10, 1.11, 1.12, 2.2, 2.3, 2.4, 2.5,

2.12, 3.1, 3.7, 3.11, 3.25, 4.3, 4.9, 4.14B, 4.25, 5.9, 5.17, 6.20,

6.26, 8.0, 8.4, 8.6, 8.7, 8.8, 8.10, 8.12 of the Farm Credit Act (12

U.S.C. 2013, 2015, 2018, 2019, 2020, 2073, 2074, 2075, 2076, 2093,

2122, 2128, 2132, 2146, 2154, 2160, 2202b, 2211, 2243, 2252, 2278b,

2278b-6, 2279aa, 2279aa-4, 2279aa-6, 2279aa-7, 2279aa-8, 2279aa-10,

2279aa-12); sec. 301(a) of Pub. L. 100-233, 101 Stat. 1568, 1608.

Subpart I--Issuance of Equities

2. Section 615.5230 is amended by adding a new paragraph

(a)(1)(iii) and revising paragraphs (a)(1)(ii) and (a)(3) to read as

follows:

Sec. 615.5230 Implementation of cooperative principles.

(a) * * *

(1) * * *

(i) * * *

(ii) Unless regional election of directors is provided for in the

bylaws pursuant to Sec. 615.5230(a)(3), be accorded the right to vote

in the election of each director (except for a director that is elected

by the other directors);

(iii) Unless regional election of directors is provided for in the

bylaws, or unless otherwise provided in the bylaws, be allowed to

cumulate such votes and distribute them among the candidates in the

shareholder's discretion.

(2) * * *

(3) Regional election of directors is permitted under the following

conditions:

(i) A bylaw establishing regional elections is approved by a

majority of voting shareholders, voting in person or by proxy, prior to

implementation;

(ii) The bylaw provides that all voting shareholders of the

institution, whether or not they reside in the director's region, have

the right to vote in any shareholder vote to remove each director;

(iii) There are an approximately equal number of voting

shareholders in each of the institution's voting regions. The

[[Page 57922]]

regions shall be deemed to have an approximately equal number of voting

shareholders if no region contains more than 25 percent more voting

shareholders than in any other region. At least once every 3 years, the

institution shall count the number of voting shareholders in each

region and, if the regions do not have an approximately equal number of

shareholders, shall adjust the regional boundaries to achieve such

result; and

(iv) An institution may provide for more than one director to

represent a region. In such case, for purposes of determining whether

the regions have an approximately equal number of voting shareholders,

the number of voting shareholders in the region with more than one

director shall be divided by the number of director positions

representing that region, and the resulting quotient shall be the

number that is compared to the number of voting shareholders in other

regions.

* * * * *

PART 620--DISCLOSURE TO SHAREHOLDERS

3. The authority citation for part 620 continues to read as

follows:

Authority: Secs. 5.17, 5.19, 8.11 of the Farm Credit Act (12

U.S.C. 2252, 2254, 2279aa-11); sec. 424 of Pub. L. 100-233, 101

Stat. 1568, 1656.

Subpart D--Association Annual Meeting Information Statement

4. Section 620.21 is amended by adding the words ``or elected''

after the word ``nominated'' in the first sentence of paragraph (d)(1);

and by revising paragraph (d)(3) to read as follows:

Sec. 620.21 Contents of the information statement and other

information to be furnished in connection with the annual meeting.

* * * * *

(d) * * *

* * * * *

(3) State that nominations shall be accepted from the floor.

(i) If directors are not elected by region, the following shall

apply:

(A) If the annual meeting is to be held in more than one session

and mail balloting will be conducted upon the conclusion of all

sessions, state that nominations from the floor may be made at any

session or, if the association's bylaws so provide, state that

nominations from the floor shall be accepted only at the first session.

(B) If shareholders will not vote solely by mail ballot upon

conclusion of all sessions, state that nominations from the floor may

be made only at the first session.

(ii) If directors are elected by region, the following shall apply:

(A) If more than one session of an annual meeting is held in a

region, and if mail balloting will be conducted at the end of all

sessions in a region, state that nominations from the floor may be made

at any session in the region or, if the association's bylaws so

provide, state that nominations from the floor shall be accepted only

at the first session held in the region.

(B) If shareholders will not vote solely by mail ballot upon

conclusion of all sessions in a region, state that nominations from the

floor may be made only at the first session held in the region.

* * * * *

Dated: November 17, 1995.

Floyd Fithian,

Secretary, Farm Credit Administration Board.

[FR Doc. 95-28587 Filed 11-22-95; 8:45 am]

BILLING CODE 6705-01-P