Mergers or Conversions of Federally-Insured Credit Unions to Non Credit Union Status: NCUA Approval

SUMMARY: The final rule applies to any credit union that is insured by

the National Credit Union Share Insurance Fund (NCUSIF) and that

proposes to merge into or convert to any non credit union institution.

The rule imposes new substantive requirements. The purposes of these

requirements are to ensure that such transactions take place only

pursuant to an informed vote of the credit union's members/owners, to

prevent self-dealing and other abuses by individuals involved in the

transactions and to ensure that these transactions do not present

safety and soundness risks to the NCUSIF and the credit union system.

State chartered NCUSIF insured credit unions may, on a case-by-case

basis, obtain a waiver from NCUA's rules if state laws and procedures

are determined to adequately address these concerns.

EFFECTIVE DATE: April 1, 1995.

FOR FURTHER INFORMATION CONTACT: Mary F. Rupp, Staff Attorney, Office

of General Counsel, National Credit Union Administration, 1775 Duke

Street, Alexandria, Virginia 22314-3428 or telephone: (703) 518-6553.

SUPPLEMENTARY INFORMATION:

Background

In June 1994, the NCUA requested comments on proposed changes to

part 708 of its regulations. At that time, part 708 only addressed

situations where an NCUSIF insured credit union dropped NCUSIF

insurance, either through a merger into a non NCUSIF insured credit

union or through a voluntary termination or conversion of insurance. It

did not cover the merger or conversion of a credit union into a non

credit union institution. The Federal Credit Union Act, however, vests

the NCUA Board with the responsibility to regulate such mergers or

conversions. 12 U.S.C. 1785(b). The proposed changes to part 708

clarified that NCUA approval requirements apply to all mergers and

conversions where the continuing institution is not insured by NCUSIF.

59 FR 33702 (June 30, 1994).

The proposal was in response to abuses that had occurred with bank

and thrift conversions, some isolated instances in the credit union

system, and recent solicitations by outside consultants and attorneys

to federally insured credit unions for conversion to non credit union

charters. The solicitations often appeared motivated by benefits to the

attorneys, consultants and insiders, rather than the members. The

amendment was deemed necessary ``to provide NCUA with clear authority

to prevent abuses in connection with conversions of insured status.''

59 FR 33702. The comments to the proposal were generally positive and

consistently stressed that the members need to be properly informed and

that the NCUA needs to ensure that safety and soundness and members'

interests are protected.

On September 16, 1994, the NCUA Board issued an interim final rule

and request for further comment. The rule was effective upon

publication on September 23, 1994. 59 FR 48790. The new rule, part

708a, established that the NCUA Board must approve any merger or

conversion of a federally-insured credit union to any non credit union

institution, including preapproval of any notices to members that are

sent out in connection with the merger or conversion. At the same time,

the Board requested further comment on a number of issues related to

the application and approval process.

Summary of Comments and Discussion of Issues

In the June 1994, proposal, the NCUA Board requested comment on the

general issue of NCUA regulation in this area and on the specific issue

of uniform member notice. In the interim rule, comment was requested on

a number of issues that the Board felt required further consideration

and review. The NCUA received 16 comments on the proposed rule: 10 from

credit unions; 4 from credit union trade groups; 1 from a bank trade

group; and 1 from a credit union league. The NCUA received 19 comments

on the interim rule: 6 from federal credit unions; 6 from federally

insured state chartered credit unions (FISCUs); 3 from credit union

trade groups; 2 from bank trade groups; and 2 from state regulators.

The following is a combined summary of the comments received on the

proposed rule and the interim final rule.

1. NCUA Oversight

In the proposed rule, 14 commenters addressed the issue of NCUA

oversight. Twelve expressed general support for NCUA oversight and two

expressed general opposition. The supportive commenters cited the

following benefits of NCUA regulation: Eliminate confusion, prevent

unnecessary litigation, protect the members from potential abuse,

assure that the members know the advantages and disadvantages of any

proposal, protect the assets and integrity of the NCUSIF and assure

that financial benefits to insiders are fully disclosed. The two

negative commenters were a bank trade group and a state chartered

credit union. The bank trade group characterized the proposal as an

overreaction by NCUA to a few isolated examples.

The issue of NCUA's jurisdiction over mergers or conversions by

federally-insured state credit unions (FISCUs) was raised by 5

commenters on the interim rule. The five consisted of the professional

group that represents state credit union supervisors (the National

Association of State Credit Union Supervisors, or NASCUS), two FISCUs

and two state regulators. All strongly opposed any NCUA regulation of

mergers or conversions of FISCUs.

NASCUS made the point that only seven of the 48 states which

charter credit unions allow them to merge with other financial

institutions and only four states allow credit unions to convert into

another form of financial institution. NASCUS' comment also recognized,

however, that several states have statutes that are silent on the

issue. It is those states which cause the Board the most concern.

Without specific [[Page 12660]] regulations in this area, there is

potential for abuse.

The NCUA Board believes that basic regulatory standards applicable

to all NCUSIF insured credit unions are necessary to safeguard the

integrity of the process and to ensure that issues of safety and

soundness and fiduciary duty are properly addressed. The Board has

attempted, however, to balance these concerns with a deference to the

important role of the state supervisors. As it is NCUA's intention to

work with the state supervisor in cases involving federally-insured

state credit unions, the Board has crafted a final rule that would

allow FISCUs to merge or convert if they have the state's authority to

do so. In those instances, the FISCU may file a written request with

the NCUA Board for a waiver of compliance with the procedural portions

of part 708a and instead follow the applicable state regulation. The

request would have to demonstrate that the waiver would not be

detrimental to the safety and soundness of the credit union, that there

is no possibility of self-dealing or other breach of fiduciary duty by

the credit union's management or others involved in the transaction,

and that the members' interests are adequately protected.

2. Insider Preferences

The proposed rule asked 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. The ten commenters responding to this

question agreed that directors and management should not be allowed to

receive any compensation in excess of that available to other members.

Several commenters suggested NCUA enact strong regulations in this

area. As well as limiting the compensation available to insiders, one

commenter suggested individuals should not be guaranteed employment at

the continuing institution, noting that this would remove the incentive

for insiders encouraging a merger that is not in the best interest of

the members.

A related issue is that of what post-merger or post-conversion

controls are needed to protect against improper insider preferences

after the transaction is completed. Some of the suggestions of the five

commenters who commented on this issue were that NCUA should prohibit

stock acquisition by insiders for a period of five years and that both

pre- and post-merger or conversion controls are necessary to prevent

insider abuse. One of the trade groups suggested a way to avoid the

problem would be to condition approval of the transaction ``on a return

of equal shares of equity to all members before the execution of the

charter change.''

The recommendations of the commenters have been modified and

incorporated into the final rule as follows: For a period of two years

after the transaction, directors may not receive any benefits not

otherwise equally available to other members, and directors and senior

management officials may not acquire stock in the continuing

institution or its successor on terms not available to the other

members of the credit union. These prohibitions on directors and senior

management officials must remain in effect for at least two years

following the merger. In order to enable NCUA to ensure compliance with

these prohibitions, the affected individuals will be required to enter

into written agreements with NCUA. The NCUA Board decided not to

require a distribution of reserves and undivided earnings to members,

as such a requirement would have the practical effect of prohibiting

the transactions covered by the rule. Among the disclosures required to

be provided to the members, however, is a clear explanation of the

change in the nature of their ownership interest in reserves and

undivided earnings that will result from the transaction.

3. Majority Approval

NCUA requested comment on whether a majority of eligible voting

members should be required to approve the transaction. Comment was

further requested on whether majority should be defined as a simple

majority or a super majority, and, if a super majority, how it should

be defined. The six commenters that addressed the issue all agreed that

a majority of the voting members should be required for approval. Two

defined majority as over 50%, two defined it as 60% to 63\1/3\%, one

defined it as 70% to 80% and the other commenter did not define it.

Recognizing the importance of a clear mandate on an issue of such

significance to the members, the final rule requires that a majority of

all eligible voters approve any transaction covered by the rule.

4. Appraisal

In those cases the Board is aware of where credit unions have

considered conversions or mergers to non credit union charters, the

first step of the transaction would be to move from a credit union

charter to a mutual savings bank charter. In cases where the ultimate

goal is to become a stock institution, conversion from mutual to stock

would be proposed as a second, but virtually simultaneous step.

For those cases involving this second step, the Board specifically

asked for comment on how to properly appraise the value of the credit

union for purposes of issuing stock. This issue is important to the

members, who, as noted above, are entitled to acquire stock on the same

terms and conditions as directors and senior management officials.

Seven commenters had suggestions on this issue. One recommended that a

professional appraisal be performed, three recommended that the value

of the stock include accumulated capital and one suggested the new

regulator determine the value of the stock. One trade group suggested

it be handled as a liquidation and payout and another suggested NCUA

turn to state law for guidance.

After considering the comments and reviewing the other agencies'

rules in this area, the Board has determined to simply require that an

appraisal be performed and included in the application. The Board will

review the appraisal as part of its review of the application.

5. Uniform Member Notice

The proposal requested comment on whether the rule should include a

uniform member notice. Nine of the ten commenters responding to this

issue supported a uniform notice. Commenters suggested that a uniform

notice would provide clear and consistent guidelines for merging

institutions, ensure that important information is not withheld from

the members and require less individual review. The Board agrees with

these goals, but believes they can be accomplished more effectively

through a listing of the information that must be included in the

notice to members, rather than a form which may become outdated or not

apply to all transactions.

Overview of Final Rule

The final rule adopts with minor modifications the interim rule and

expands upon it to impose substantive and procedural requirements that

the Board has determined are necessary to ensure an informed membership

vote, to safeguard against potential safety and soundness problems and

to prevent breaches of fiduciary duty. The final rule, part 708a,

tracks in large part the current part 708b. Its key provisions are as

follows: NCUA Board approval is required in advance of any transaction

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

its [[Page 12661]] members' shares or similar accounts to any non

credit union institution; a majority of all members of record must vote

to approve the transaction; directors must agree to receive no benefits

in excess of those available to the members; notice to members must be

preapproved by the NCUA Board and must include all pertinent

information required by the rule as well as any additional information

deemed necessary on a case by case basis; FISCUs may only engage in the

transaction if they obtain approval from the state authority to proceed

with the merger or conversion; and FISCUs must follow part 708a unless

they obtain a waiver from NCUA.

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 substantial number of small credit unions. It is highly

unlikely that small credit unions (those under $1 million in assets)

would be engaged in a merger or conversion to a non credit union

institution. 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 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.

Recognizing the interests of states and state regulators in supervising

state chartered credit unions, the NCUA Board has included a provision

in the final rule that allows FISCUs, on a case-by-case basis, to

obtain a waiver from NCUA's rule and follow state procedures if those

procedures are determined to adequately address the concerns of NCUA's

rule. With this provision, 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 March 1,

1995. ---

Becky Baker,

Secretary of the Board.

Accordingly, the interim rule adding a new regulation in 12 CFR

part 708a which was published at 59 FR 48790 on September 23, 1994, is

adopted as a final rule with changes as follows:

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

UNIONS TO NON CREDIT UNION STATUS: NCUA APPROVAL

1. The authority citation for part 708a continues to read as

follows:

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

2. Sections 708a.1 and 708a.2 are revised to read as follows:

Sec. 708a.1 NCUA Board Approval.

Section 205(b)(1) of the Federal Credit Union Act requires NCUA

Board approval in advance of any transaction whereby a federally-

insured credit union transfers all or any part of its members' accounts

to any non credit union institution. This part establishes rules and

procedures for any merger, conversion or other transaction in which a

federally-insured credit union's share accounts or similar member

accounts are transferred to a non credit union institution.

Transactions where a federally-insured credit union transfers member

accounts to another credit union are subject to the provisions of part

708b of this chapter. Compliance with this part 708a is in addition to

any other federal or state laws and regulations which may be applicable

to the proposed transaction, including state corporate laws and state

and federal securities laws.

Sec. 708a.2 Plan for Merger or Conversion to a Non Credit Union

Institution.

(a) Proposition for merger or conversion. The board of directors of

the credit union shall approve a proposition for merger or conversion.

(b) Plan for merger or conversion. Upon approval of a proposition

for merger or conversion by the board of directors, a plan for the

transaction shall be prepared. The plan shall include:

(1) Current financial reports;

(2) Current delinquent loan schedules annotated to reflect

collection problems;

(3) Combined financial report, if applicable;

(4) Contingencies;

(5) Explanation of any provisions for reserves, undivided earnings

or dividends;

(6) Analyses of share values and explanation of any adjustments to

member's share accounts;

(7) Analyses of the regulatory effect of the merger or conversion

brought about by the change in government regulator;

(8) Explanation of any other relevant effects on the members; and

(9) Any additional information, as required by the NCUA Regional

Director.

(c) Nonpreferential treatment. The plan for merger or conversion

shall provide that, for a period of at least two years after the

effective date of the transaction: -

(1) No director of the credit union may receive any compensation or

any benefits not provided or available to other members; and

(2) No director or senior management official of the credit union

shall be allowed to acquire stock in the resulting or continuing

institution or any successor institution, on any terms other than those

readily available to all members of the former credit union. This

prohibition would include stock issued for services rendered prior to

the merger or conversion. For purposes of this section, senior

management official means the credit union's chief executive officer,

any assistant chief executive officers and the chief financial officer.

3. Sections 708a.3, 708a.4, 708a.5, 708a.6 and Appendix A are added

to read as follows:

Sec. 708a.3 Submission of Proposal to NCUA.

(a) Submissions to the NCUA Regional Director. Upon approval of the

plan by the board of directors of the credit union, the following will

be submitted to the appropriate NCUA Regional Director:

(1) The plan, as described in Sec. 708a.2(b) of this part;

(2) A resolution of the board of directors approving the plan;

(3) A written agreement from each member of the board of directors

and each senior management official to comply with the terms of

Sec. 708a.2(c) (the agreement shall be executed by NCUA as well, in the

event of approval of the transaction);

(4) A proposed merger or conversion agreement;

(5) A proposed Notice of Meeting, as described in Appendix A of

this part;

(6) A copy of the form ballot and any accompanying materials to be

sent to the members, as described in Appendix A of this part;

(7) A complete copy of the package [to be] submitted to any other

regulatory agencies involved in the merger or conversion;

(8) A copy of an appraisal of the value of the credit union, if the

proposal is to [[Page 12662]] convert or merge the credit union either

directly or indirectly into a stock institution, and any plan for sale

or distribution of stock to the credit union's members, officials and

employees; and

(9) In the case of a federally-insured state chartered credit

union, evidence that the state supervisory authority is in agreement

with the merger or conversion proposal.

(b) Coordination with State Supervisory Authority. In the event the

proposal is filed with the NCUA prior to receiving consent from the

state supervisory authority:

(1) The Board will coordinate with the state supervisory authority;

and

(2) The Board will not approve any merger or conversion unless it

is approved by the state supervisory authority.

(c) Waiver of NCUA rules and approval by state supervisory

authority. A federally-insured state credit union may, on a case-by-

case basis, request a waiver of this part 708a from the Board and

receive authority to proceed under state rules and procedures. In

making such a request, the credit union shall demonstrate that the

concerns underlying this part 708a are adequately addressed and, in

particular that:

(1) Proceeding under state rules present no financial risk to the

credit union or the NCUSIF;

(2) Adequate safeguards exist against breach of duty by, or

preferential treatment of directors, committee members and others

involved in the transaction; and

(3) The transaction is otherwise fair to members and carried out

pursuant to an informed and decisive membership vote.

Sec. 708a.4 Approval of Proposal by NCUA.

If NCUA finds that the proposal complies with the provisions of

this part and does not present an undue risk to the NCUSIF or unduly

prejudice the members, it may approve the proposal subject to such

other specific requirements as may be prescribed to fulfill the stated

purposes of the proposal. No proposal will be approved that does not

clearly inform the members of the fundamental rights they would be

giving up if their credit union converts or merges into a non credit

union institution.

Sec. 708a.5 Approval of Proposal by Members.

(a) Notification of members. The members shall:

(1) Have the option of voting on the proposal either in person at a

membership meeting or by mail ballot.

(2) Be given advance notice of the membership meeting in accordance

with the provisions of Appendix A of this part. The notice shall be

delivered in person to each member, or mailed to each member at the

address for such member as it appears on the records of the credit

union, not more than 30 days nor less than 14 days prior to the date

for the vote. The ballot to be used for the membership vote shall be in

accordance with the provisions of Appendix A of this part. The notice

and ballot shall be provided to the members at the same time. If

applicable, the notice and ballot shall be provided in both English as

well as the native language of the majority of the members.

(3) Be made aware that the complete application and proposal are

available for inspection at the credit union's branch offices during

normal business hours.

(b) Vote by members. The proposal must be approved by the

affirmative vote of a majority of the credit union's members.

(c) Notice of Approval to members. If the proposal for merger or

conversion is approved by the membership and the NCUA Board, prompt and

reasonable notice shall be given to all members.

Sec. 708a.6 Certification and Completion of Merger or Conversion.

(a) Certification of vote. The board of directors shall certify the

results of the membership vote to the Regional Director within 10 days

after the vote is taken.

(b) Completion. Upon approval of the proposal by NCUA, the state

supervisory authority (where the credit union is state chartered), the

members and any federal agency with approval or regulatory authority

for the transaction, the credit union may complete the merger or

conversion.

(c) Certification of completion. Within 30 days after the effective

date of the merger or conversion, the board of directors of the

continuing institution shall certify the completion of the transaction

to the Regional Director.

(d) Cancellation of charter and insurance. Upon NCUA's receipt of

certification that the transaction has been completed, the charter of

the federal credit union (if applicable) and the insurance certificate

of the federally insured credit union will be canceled.

Appendix A to Part 708a--Notice to Members of Special Meeting,

Disclosure and Ballot

(1) The Notice of Special Meeting must include the following:

(a) The date, time and place of the Meeting;

(b) A description of the matters to be voted upon at the Special

Meeting;

(c) A statement in a prominent location in bold letters that ``A

DISCLOSURE STATEMENT HAS BEEN PROVIDED TO YOU WITH THIS NOTICE OF

SPECIAL MEETING. THE DISCLOSURE MUST BE READ BEFORE VOTING ON THE

PROPOSED (``CONVERSION'' or ``MERGER'', as appropriate)'', and

(d) A statement that a Mail Ballot for the Special Meeting is

enclosed.

(2) The Disclosure provided with the Notice must at a minimum

provide the following information to the members:

(a) Factual information about the credit union, i.e. name and

address of credit union and telephone number of contact person;

(b) Summary of the proposal which shall contain but not

necessarily be limited to current financial reports for the credit

union and the other institution if a merger is proposed; a projected

financial report for the continuing institution; analyses of share

values; an explanation of any proposed share adjustments; and an

explanation of any changes relative to insurance such as insurance

of member accounts and life savings and loan protection insurance.

(c) Summary of the direct and indirect benefits to the credit

union members, as well as any disadvantages, including a clear

explanation of the nature of the change in the members' ownership

interest in the reserves and undivided earnings of the credit union

as a result of the merger or conversion;

(d) Summary of the direct and indirect benefits to management

and other key persons at the credit union and at the new

institution, including a comparison of salaries for those

individuals employed by both the credit union and the new

institution; copies of the certifications from the directors and

committee members that they will receive no compensation either

directly or indirectly from the new institution for a period of two

years; and disclosure of any relationship by blood or marriage, of

any of the officers, directors, key personnel or principal

stockholders of the proposed institution to any officials or

employees of the credit union.

(e) For each director, officer, key employee and consultant of

the proposed institution, state in detail the names, positions,

addresses, age and description of employment and educational

background. Include any petitions for bankruptcy, civil judgments

(indicate the plaintiff and the amount of the judgment), criminal

conviction (indicate the nature of the charge) and any

administrative action taken by a federal or state agency.

(f) Description of how the proposed merger/conversion results in

a new financial institution without the unique characteristics of a

credit union, for example, that the board of directors (that is, any

new board members, since Sec. 708a.2(c) prohibits compensation for a

period of 2 years) may be compensated as officials instead of

offering volunteer services, that the credit union will lose its tax

exempt status, and any changes in the voting power of members.

(g) A dollar expenditure comparison chart of the estimated

increases/decreases in regulatory and insurance fees;

[[Page 12663]]

(h) Itemized expenses incurred to date in the conversion process

with an estimate as to future expenses;

(i) Management's discussion and analysis of the proposed

conversion, including its economic advisability and how it will

serve the needs of the members of the merging or converting credit

union;

(j) Business and properties of the proposed institution--

describe in detail the assets of the credit union and whether these

assets will be transferred to the proposed institution and how the

members will or will not benefit from the transfer;

(k) Description and comparison of the competition of the

proposed institution and why the proposed institution believes it

can effectively compete;

(l) In any transaction where the new or resulting institution is

a stock institution, identify the principal owners of the proposed

stock institution (those who will beneficially own directly or

indirectly 1% or more of the common and preferred stock outstanding)

starting with the largest common stockholder. Indicate by footnote

if the price paid was for a consideration other than cash and the

nature of any such consideration. Indicate the number of shares to

be individually owned by officers, directors and key personnel of

the new institution; and

(m) State in bold on the cover ``PLEASE READ THIS DISCLOSURE

DOCUMENT. IT CONTAINS IMPORTANT INFORMATION ABOUT YOUR CREDIT

UNION.''

(3) The Mail Ballot must:

(a) State at the top in bold letters using 12 point pitch or

greater that ``THE ATTACHED DISCLOSURE STATEMENT MUST BE READ BEFORE

VOTING ON THE PROPOSED (``CONVERSION'' or ``MERGER'', as

appropriate)'';

(b) The issues for the member to vote on should be stated as

follows:

Please vote for either (a) or (b) by checking the appropriate

box.

(a) Approve the merger {time}

(b) Disapprove the merger {time}

(c) Advise the member of the right to terminate the mail ballot

and attend and vote at the Special Meeting.

[FR Doc. 95-5593 Filed 3-7-95; 8:45 am]

BILLING CODE 7535-01-P