Organization and Operations of Federal Credit Unions; Corporate Credit Unions; Credit Union Service Organizations; Advertising

NATIONAL CREDIT UNION ADMINISTRATION

12 CFR Parts 701, 704, 712 and 740

Organization and Operations of Federal Credit Unions; Corporate

Credit Unions; Credit Union Service Organizations; Advertising

AGENCY: National Credit Union Administration (NCUA).

ACTION: Final rule.

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SUMMARY: The final regulation updates, clarifies and streamlines

existing rules concerning credit union service organizations (CUSOs), a

common means of outside provision of services to federal credit unions

(FCUs) and to credit union members. The final rule clarifies NCUA's

authority to review CUSO books, records, and operations, adds corporate

separateness requirements and additional permissible services, changes

the legal opinion requirements, maintains safety and soundness

criteria, and ensures the continuity and growth of services to FCUs and

their members conducted through CUSOs. Related conforming changes are

also made to credit union service contract, fixed asset, and corporate

credit union rules.

DATES: This rule is effective April 1, 1998, except for Sec. 712.3(d)

which is effective December 31, 1998.

ADDRESSES: National Credit Union Administration, 1775 Duke Street,

Alexandria, Virginia 22314-3428.

FOR FURTHER INFORMATION CONTACT: Martin ``Sparky'' Conrey, Staff

Attorney, Division of Operations, Office of General Counsel, at the

above address or telephone: (703) 518-6540; or Linda Groth, Program

Officer, Division of Supervision, Office of Examination and Insurance,

at the above address or telephone: (703) 518-6360.

SUPPLEMENTARY INFORMATION:

I. Background

A. General

In 1977, Section 107 of the Federal Credit Union Act (12 U.S.C.

1757(5)(D) and (7)(I)) was amended to authorize FCUs to invest in, and

make loans to, CUSOs subject to certain funding limits and other

regulatory restrictions. The first CUSO rule was promulgated in 1979;

the last major revision of this rule was in 1986. In general, the

results of the 1986 revision have been positive. Nonetheless, over ten

years of experience with the regulation indicated that there was a need

for additional simplification, clarification, and improvement.

B. Proposed Rule

On March 7, 1997, the NCUA Board issued a proposed rule to revise

its CUSO rules, Secs. 701.26(b), 701.27, and 740.3(c). 62 FR 11779

(March 13, 1997). The proposal recodified the CUSO rules in part 701

into a new part 712 using a plain English format, streamlined existing

requirements, added eight new CUSO services, and suggested other

technical changes. In addition, the proposal suggested a change to

required service center advertising to reduce regulatory burden. The

purpose of the proposed rulemaking was to request public comment on

reducing regulatory burden and increasing the flexibility and

usefulness of CUSOs, while ensuring the safety and soundness of FCUs

and the National Credit Union Share Insurance Fund (NCUSIF). The

comment period was extended from May 12, 1997, to June 12, 1997, in

order to give commenters more time to consider their comments. 62 FR

19702 (April 23, 1997).

C. Comments

The Board received 90 comments: 24 from FCUs; 10 from state

chartered credit unions; 2 from corporate credit unions; 31 from CUSOs;

6 from national trade associations; 12 from state credit union leagues;

1 from an insurance company; and 4 from law firms. The majority of

commenters supported the general approach of the proposed rule, but

suggested specific changes. Where a majority of commenters disagreed

with the proposed rule, NCUA has made efforts to address the

commenters' concerns. NCUA thoroughly evaluated the comments and

incorporated many of the suggested changes into this final rule. In

addition, NCUA staff researched NCUA's experiences with CUSOs and the

relevant regulations, guidance, legal interpretations and reporting

requirements of NCUA and the other federal financial institution

regulators in composing this final rule.

D. Final Rule

The final rule establishes limits on FCU investments in, and loans

to, CUSOs. Inasmuch as is possible within the boundaries of safety and

soundness, NCUA will permit FCUs and CUSOs to operate flexibly within

the new limits of this rule. At the same time, the final rule attempts

to minimize the regulatory burden on those FCUs with CUSO involvement.

The purposes of this final rule are in accord with the Regulatory

Reinvention Initiative of the Vice President's National Performance

Review and the NCUA Board's Regulatory Relief Project.

An underlying premise of the regulation is that an FCU will use

good business practices and maintain proper safeguards in transactions

involving CUSOs. Many FCUs will, as part of their standard business

practice, establish policies and procedures which properly go beyond

the minimum requirements of this rule. NCUA encourages good business

practices, even if not required by this rule.

E. Small Credit Unions

NCUA requested comment on how small credit unions, especially

community development and low-income designated credit unions and their

members, could best be served by CUSOs. CUSOs can enable smaller credit

unions to expand the types of products and services offered to their

memberships, offer economies of scale, enhance members' lives, and

increase hours of service and locations through automated teller

machines (ATMs), service centers, and other CUSO services. In addition,

CUSOs can result in more favorable penetration rates of potential

members through the broader availability of financial services. CUSOs

can also facilitate a transfer of knowledge and expertise from larger,

full-service credit unions to smaller, more limited service credit

unions, which can have long-term positive implications upon safety and

soundness.

Most comments regarding small credit unions shared NCUA's concerns

and support CUSO incentives for small credit unions. Seven out of the

eight relevant comments agreed that small credit unions should have

reduced

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minimum CUSO investment requirements. Also, nine out of the eleven

relevant comments agreed that small credit unions should have reduced

or waived transaction costs. Commenters not in favor were opposed to

additional government regulation. One commenter suggested that CUSOs

consider creating special ownership programs for small credit unions

that would enable them to participate and use the CUSO's services. Many

of the small credit union comments favored an industry solution instead

of additional government regulation and the attendant compliance

burdens. Allowing the CUSO industry to be creative and address the

small credit union issues on a case-by-case basis depending upon each

CUSO, the services offered, and the credit unions involved could lead

to unfettered flexibility and economically sound policies, according to

these comments. NCUA is in agreement with these comments. With NCUA's

review authority over CUSOs, NCUA will be in a good position to monitor

these independent efforts and to address any abuses it finds.

Therefore, the Board has decided not to impose any CUSO rule

requirements regarding small credit union CUSO activities at this time.

Other commenters requested special regulatory relief for small

credit unions. One commenter suggested allowing any credit union with

under $250,000 in assets to be considered an ``affiliated credit

union.'' Another commenter suggested that credit unions with less than

$50 million in assets should be subject to an easier, less restrictive

set of NCUA regulations. A third commenter advised NCUA to be cautious

in treating different classes of credit unions differently due to the

possibility of splitting the credit union movement into two groups,

with potentially negative tax and field of membership legislative

consequences. Some of these solutions are outside of the scope of this

rulemaking. Therefore, the Board will take these suggestions under

advisement for possible future regulatory action.

F. Plain English Format

The rule was proposed as part 712 of NCUA's regulations and

presented in a plain English question and answer format. The goal of

plain language drafting is to decrease confusion, inadvertent errors,

the need to seek clarification in correspondence and phone calls, and

the amount of staff time credit unions must devote to understanding the

regulations. As in the proposal, the final rule has no separate

paragraph for definitions; instead, definitions appear next to their

primary use in the regulatory text. Eighteen of the twenty relevant

comments received supported the use of the plain English format. One

commenter held that the CUSO section should remain in part 701,

Organization and Operations of FCUs, and found the plain language

format unnecessary. Another commenter found that the section headings

in question format did not give a complete understanding of the

regulatory requirements contained in the answer portion of the section.

The Board agrees with the majority of the comments that the plain

language format increases regulatory comprehension, user compliance,

and administrative efficiency. Therefore, with minor modifications, the

format used in the proposed rule is also used in the final rule.

One modification made by the Board concerns the substitution of the

term ``you'' for the term ``FCU.'' Several commenters agreed with

NCUA's statement in the proposed rule preamble that the use of the term

``you'' was confusing, as the same term variously applied to affiliated

credit unions, FCUs with investments in CUSOs, and all FCUs with loans

or investments in CUSOs. In order to avoid potential confusion, the

Board has deleted the term ``you'' from the final regulation. Instead,

the final rule uses the term ``FCU.'' When rule language is applicable

to a limited class of FCUs the specific limitation is noted in adjacent

rule language. For example, the legal opinion requirements of

Sec. 712.4(b) apply to ``an FCU investing in a CUSO.''

In addition, a few comments requested that the Board produce a

commentary on the new CUSO rule. The Supplementary Information to the

revised rule provides substantial guidance, and additional commentary

is not necessary. NCUA may consider issuing additional commentary in

the future if the need appears.

G. Section-by-Section Analysis

Section 701.26(b), Credit Union Service Contracts

NCUA solicited comments on whether Sec. 701.26(b) is outdated,

imposes regulatory burden, and is unnecessary. Thirty-nine out of 40

commenters agreed with the removal of the section, which currently

mandates that a vendor service contract requiring the advance payment

of more than 3 months converts the advance payment into an investment

in a CUSO. Comments confirmed that the business practices of many

vendors, especially data processors and ATM providers, either require

such payments or give a discount to the purchasing credit union for

paying in advance. In addition, some comments argued that removal would

give FCUs the opportunity to conduct their own business analysis of the

costs and benefits of such pricing arrangements without being subject

to the service rule limit. The rule, applicable to FCUs, also did not

sufficiently establish authority over third party vendors and was

rarely enforced. For these reasons, the Board removes Sec. 701.26(b).

Sections 701.36 and 704.11

Cross-referencing changes are made to the fixed asset rule,

Sec. 701.36(a)(4)(iv) and to Sec. 704.11(e) by revising ``Sec. 701.27''

to read ``part 712.'' No change in meaning is intended by these

amendments.

Part 712

In order to assist readers, NCUA proposed the substitution of

Sec. 701.27 with part 712. The rule applies to FCUs, but is of much

interest to other parties such as CUSOs and other CUSO investors. It is

hoped that, by giving CUSOs their own section of NCUA's Rules and

Regulations, the rule will be better known, resulting in increased

compliance and a reduction of NCUA staff time spent interpreting the

regulation. Raising the rule to a part also results in more convenient

citations with fewer subsections. Comments received on the substitution

were generally favorable and the Board adopts part 712 for CUSOs.

Section 712.1, What Does This Part Cover?

Proposed Sec. 712.1 condensed Sec. 701.27(a), Scope, by eliminating

statutory citations and a summary of rule requirements contained

elsewhere in the rule. Several changes were made in response to various

comments.

NCUA proposed an expansion of the term ``affiliated credit union''

in order to enable credit unions being served by a CUSO through NCUA's

group purchasing rule, 12 CFR part 721, to count for purposes of the

customer base requirement. The intent of the proposal was not to

penalize CUSOs for serving members of credit unions that may be

permissibly served under the group purchasing rule. Forty-two out of 52

commenters addressing the issue supported the proposal. Favorable

comments stressed that this was a matter of equity and fairness well

within NCUA's authority to interpret the FCU Act. Opposing comments

argued that the proposal was either too liberal or too conservative in

scope.

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One opposing comment held that the addition diluted the field of

membership common bond rules applicable to FCUs and was beyond NCUA's

statutory authority to grant. NCUA strongly disagrees with both of

these arguments. First, common bond laws apply only to FCUs, not to

CUSOs. 12 U.S.C. 1759 and NCUA Interpretive Ruling and Policy Statement

No. 94-1, 59 FR 29066 (June 3, 1994), as modified. Second, the Board

has authority to prescribe rules for the administration of the FCU Act.

12 U.S.C. 1766(a). The loan authority for CUSOs in the FCU Act

specifically reads: ``[a] credit union organization means any

organization as determined by the Board, which is established primarily

to serve the needs of its member credit unions, and whose business

relates to the daily operations of the credit unions they serve.'' 12

U.S.C. 1757(5)(D) (emphasis added). Similarly, the investment authority

for CUSOs in the FCU Act defines CUSOs as: ``any other organization,

providing services which are associated with the routine operations of

credit unions . . . with the approval of the Board.'' 12 U.S.C.

1757(7)(I) (emphasis added). It is clear that the Board has ample

authority to define customer base requirements for CUSOs.

Nine opposing comments stated that the proposal was too limiting

and should be even broader in order to apply to all credit unions and

their members. Some of these comments suggested that, instead of

changing the definition of ``affiliated credit unions,'' it would be

simpler to change the customer base requirements to capture these

credit unions. After due consideration, and in light of the comments on

potential reader confusion detailed in Sec. F, Plain English Format, of

this Supplementary Information, the Board has decided to adopt this

approach. The term ``affiliated credit union'' has been deleted from

the rule. Instead, the term ``FCU'' is used and any conditions on the

types of FCUs affected (e.g., investing FCUs) is placed in adjacent

regulatory language. This approach should be clearer, avoid confusion,

and result in administrative efficiency. Furthermore, this change moots

several comments proposing alternate language for the ``affiliated

credit union'' definition.

Eight comments asked that NCUA clarify in Sec. 712.1 the extent to

which state-chartered credit unions and their subsidiaries would be

affected by this revision. Part 712 applies only to FCUs and to CUSOs

with FCU investment or loans. Part 712 does not apply to state-

chartered credit union subsidiaries that have no FCU investments or

loans. The Board makes this clarification in the final rule by adding a

statement to this effect in Sec. 712.1. However, if an FCU invests in,

or loans to, a state-chartered credit union subsidiary it will trigger

compliance with Part 712. These hybrid CUSOs will need to comply with

both state laws and applicable federal laws, especially Part 712.

Two commenters criticized NCUA's special reserve requirements for

state-chartered credit union CUSO services that are not required for an

FCU's CUSO. As NCUA has previously stated many times, ``[f]or safety

and soundness reasons, this requirement is and for many years has been

imposed on federally insured, state-chartered credit unions (FISCUs) by

the Agreement for Insurance of Accounts signed and agreed to by all

insured state chartered credit unions as a condition of insurance.'' 60

FR 58502 (November 28, 1995, adopting new 12 CFR Part 741). Subsection

741.3(a)(3), Special reserve for nonconforming investments, will

continue to apply to investments by FISCUs in subsidiaries of state-

chartered credit unions providing services that cannot be provided by

CUSOs having FCU investments or loans. Any revision regarding special

reserves is outside the scope of this rulemaking.

In the proposed rule preamble, NCUA noted that its new corporate

credit union rule contains a new section on corporate CUSOs that would

apply instead of the provisions of the natural person credit union CUSO

rule, as is the case currently. 12 CFR 704.11. Three commenters asked

NCUA to add this cross-reference to Sec. 712.1 and to provide

clarifying guidance for CUSOs that have both natural person credit

union and corporate credit union involvement. Since the comments did

not identify any specific problems, it is difficult to provide guidance

on any potential conflicts that might arise. NCUA believes that it is

unlikely any conflicts will arise, and, if they do, the conflicts can

be handled using standard supervisory tools on a case-by-case basis.

Therefore, NCUA will not speculate on any potential conflicts at this

time. However, the Board has decided to add a specific cross-reference

to aid CUSOs with dual corporate and natural person involvement.

Additionally, the proposed sentence reading: ``[t]his part does not

regulate CUSOs directly, but rather establishes conditions of your

[FCU] investments in, and loans to, CUSOs'' has been deleted. Its

replacement reads: ``CUSOs are subject to review by NCUA.'' The reasons

for this change are discussed in Sec. 712.3(d), under the subheading

``NCUA Access to Information,'' in this Supplementary Information.

Section 712.2, How Much Can an FCU Invest in, or Loan to, CUSOs, and

What Parties May Be Involved?

NCUA proposed elimination of Sec. 701.27(b)(1-2), which is a

reprinting of the FCU Act provisions relating to CUSOs to avoid

repetition of regulatory requirements. A few commenters requested that

the statute continue to be reprinted with the new rule. This seems

contrary to plain language precepts and an unnecessary practice when

the statutory requirements are all contained in other rule provisions.

Therefore, the Board removes the reprinting of FCU Act language from

the new rule.

Limits on Funding

The funding limitations contained in proposed Sec. 712.2 (a) and

(b) are statutory in nature and required by Sec. 107(5)(D) and (7)(I)

of the FCU Act. 12 U.S.C. 1757(5)(D) and (7)(I). An FCU cannot invest

more than one percent of its paid-in and unimpaired capital and surplus

in CUSOs. Nor can an FCU loan more than one percent of its paid-in and

unimpaired capital and surplus to CUSOs. Paid-in and unimpaired capital

and surplus means shares and undivided earnings.

Four commenters asked NCUA to change the FCU investment and loan

limitations. It is beyond the authority of the NCUA Board to change the

FCU Act; only Congress has that authority. Other commenters asked for

NCUA to clarify that FCUs can use their CUSO investment and lending

authorities at the same time. To avoid any potential confusion on this

issue, a clarification that the 1% investment and 1% loan authority are

separate and independent has been added to Sec. 712.2(b), Loans.

One comment asked that NCUA clarify how FCUs could invest in

corporations, limited partnerships, and limited liability companies. To

address this important issue, NCUA has added clarification to the end

of Sec. 712.2(a), Investments, stating that an FCU can only invest in a

CUSO as a stockholder of a corporation, as a member of a limited

liability company, or as a limited partner of a limited partnership.

The terms ``corporation,'' ``limited liability company,'' and ``limited

partnership'' have the meanings attributed to them in Sec. 712.3(a) of

this part. For liability reasons, FCUs are prohibited from investing as

a general partner in a general partnership, either directly or

indirectly.

The NCUA Board would like to clarify the scope of covered CUSO

investments and loans. In the past, NCUA has

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deemed all of the following to be either loan or investment equivalents

in the context of the CUSO rule: standby letters of credit issued by

FCUs to cover a CUSO; sale and leaseback transactions; installment

sales and other similar equipment financings; payments of CUSO expenses

by FCUs, such as subsidies; guarantees of CUSO debt or purchase of CUSO

debentures; FCU pledges and guarantees of loans from other entities to

the CUSO; and FCU spin-offs of assets to CUSOs. All of these loan and

investment cash equivalents are used in determining the actual

aggregate cash outlay figure.

For compliance purposes, FCUs should generally use the aggregate

cash outlay figure to compute the statutory CUSO investment and loan

limits. This number would equal the total amount of FCU funds either

invested in, lent to, or available to be lent under a line of credit

with the FCU to the CUSO. If an FCU accounts for its CUSO using the

cost method consistent with Generally Accepted Accounting Principles

(GAAP) and writes down the investment because of other than temporary

impairment, the written down amount becomes the new basis and computes

into the new aggregate cash outlay figure. If FCUs have questions

calculating the aggregate cash outlay, they should contact their

regional office for appropriate guidance.

Calculation of the CUSO funding limits is a separate issue from

reporting CUSO investments and loans under GAAP. GAAP requires one of

three measurement options--the cost method, equity method, or

consolidated financial statements--depending upon the degree of

ownership an FCU has in a CUSO. FCU financial reporting of CUSO

activity should follow GAAP. The definition of ``paid-in and unimpaired

capital and surplus'' is unchanged from the current definition in

Sec. 701.27(c)(4).

Parties

Recently a federally-insured credit union involved with a credit

union service center CUSO applied to convert to a mutual savings and

loan association. The board of directors of the converting credit union

indicated that, after conversion, the savings and loan wanted to

continue its participation in the credit union service center. If this

had been permitted, it could have led to massive credit union member

confusion when both NCUSIF and FDIC signs would be required to be

posted together in service center locations. NCUA denied the

institution the ability to proceed with this plan on the basis that a

thrift could not participate in a ``credit union service center.''

However, NCUA wants to clarify this issue further in this final rule.

The FCU Act prohibits a CUSO from being involved with non-credit union

depository institutions, and this prohibition is reiterated in

Sec. 712.6(a). NCUA's position is that any intermingling of bank,

thrift, and credit union share, deposit, or loan accounts at a CUSO

credit union service center location is impermissible. To clarify this

prohibition, NCUA has changed the phrase ``non-credit union parties''

to ``non-depository institution parties not otherwise prohibited by

Sec. 712.6 of this part.'' By stressing the impermissibility of

depository institution involvement in CUSOs, and cross-referencing the

statutory prohibition on certain parties' involvement in CUSOs, the

Board intends to prevent impermissible party involvement in CUSOs. In

addition, to prevent credit union member confusion, prevent unsafe and

unsound activities, and provide notice and comment for non-CUSO credit

union service centers, NCUA staff plans to study credit union service

center activities for possible future Board consideration.

Section 712.3, What are the Characteristics of and What Requirements

Apply to CUSOs?

Structure

NCUA proposed the addition of the limited liability company (LLC)

format to the two existing permissible CUSO entity structures of

corporation and limited partnership. When the new corporate rules

become effective, corporate credit unions will be allowed to use LLC

format CUSOs. 12 CFR 704.11. Thirty-nine of the 50 comments addressing

LLCs favored the addition of LLCs. Many of these commenters noted that

NCUA's concerns of a lack of standardized state laws and tax treatment

of LLCs could be handled by appropriate legal, accounting, and tax

advisors. In addressing NCUA's concerns, comments stated that: (1) the

IRS did not issue hypothetical opinions and, therefore, it was not

possible to obtain an IRS ruling unless and until NCUA permitted use of

the LLC format; (2) LLC members withdrawing their capital can be

restricted under an LLC agreement or a buy/sell agreement providing

liquidity protections; (3) voting rights and powers of LLC members can

be changed by the organization articles or by operating agreement; (4)

limitations on LLC management transferability are little different from

those applying to limited partnerships; and (5) state laws on

corporations and limited partnerships also vary widely, and yet NCUA

has not experienced any difficulties with state law variations

regarding those formats. Commenters also noted that, by requiring an

FCU to obtain written legal advice prior to investing in a CUSO formed

as an LLC, NCUA could confirm that the laws of a particular state would

insulate an FCU from liability as well as the older permissible

corporation and limited partnership formats. This is the approach

adopted by the Board in adopting LLCs as an additional permissible CUSO

structure. In order for an FCU to invest in, or loan to, a CUSO

structured as a LLC, the FCU must obtain written legal advice that the

LLC is a recognized legal entity under the applicable laws of the state

of formation and that the LLC is established in a manner that will

limit potential exposure of the FCU to no more than the amount of funds

invested in, or loaned to, the CUSO. Investing FCUs also must comply

with the legal opinion requirements of Sec. 712.4(b).

Comments opposed to LLCs believed that the LLC format was not

needed in light of the existing corporation and limited partnership

formats and the ability of CUSOs to make various taxation choices, such

as the Subchapter S or cooperative tax elections. However, one of the

purposes of this rulemaking was to give greater flexibility to CUSOs,

and the majority of commenters approved adding LLCs with the legal

opinion caveat.

The addition of the LLC format does not change NCUA's policy

regarding multiple CUSOs. NCUA stresses that the CUSO rule applies to

all levels or tiers of a CUSO's structure. In other words, all tiers of

a CUSO, no matter what corporate format is used, are also CUSOs subject

to part 712.

Customer Base

Twenty-four out of the 30 comments addressing the issue agreed that

NCUA should not give a safe harbor definition of the meaning of

``primarily serves'' in the customer base requirement. Those in favor

of a brightline definition believed that it would be useful, but could

not agree on what the standard should be. In the past, NCUA's

definition of the term ``primarily serves'' has depended upon several

variables, such as: type of business(es) provided; number of affiliated

members served; gross or net revenues derived from affiliated members;

amount of affiliated members' assets under management; number of

policies sold to affiliated members; number of services provided to

affiliated members; and availability/access of services to affiliated

members. Since CUSO permissible services and activities vary so much by

business, and

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since many CUSOs are engaged in multiple permissible services and

activities, coming to a simple standard applicable to all lines of

business and all CUSOs is problematic. In the 1986 final CUSO rule

preamble, the Board stated that defining the term as a percentage of

business or percentage of customers could prove arbitrary.

The Board is convinced by the comments that, if anything, defining

the term ``primarily serves'' is even more difficult than in 1986, and

declines to do so. NCUA will continue to monitor the customer base

requirement on a case-by-case basis using a totality of the

circumstances test.

One comment stated that NCUA should determine whether a CUSO

``primarily serves'' only at the time an FCU investment or loan is made

to a CUSO and not revisit the test again thereafter. This is contrary

to long-standing NCUA policy. The Board, as required by statute, must

vigilantly reassess the customer base requirement on a constant basis.

To do otherwise would permit a large loophole in the CUSO rule,

allowing negligent or unscrupulous CUSOs to ignore the customer base

requirements once fully funded from FCUs. This practice could easily

lead to safety and soundness problems, and perhaps even threaten the

NCUSIF. The Board disagrees with the comment and declines to change its

position.

As previously discussed in the Supplementary Information under

Sec. 712.1, in lieu of using the term ``affiliated credit union,'' the

Board has opted to restate the customer base requirement. CUSOs must

primarily serve credit unions in a corporate capacity (e.g., check

processing, data processing, or supervisory committee audits), or the

natural person membership of those FCUs or FISCUs investing in, or

lending to, the CUSO, or the membership of FCUs and FISCUs contracting

with the CUSO. Any services provided to any entities or persons outside

of this scope will be considered services to others which cannot be

counted towards the CUSO's credit union customer base requirement.

NCUA also requested comments on CUSO activities, such as ATM

services, that began as a service primarily to credit unions, but as a

result of ATM network and switch consolidations, arguably no longer

meet the CUSO rule ``primarily serves'' customer base requirements. In

some of these situations, it is NCUA's understanding that an

institution must hold stock in the ATM network or switch to participate

in the ATM network or switch provider. NCUA does not want to deny

credit union members ATM services due to a rule restriction. All eight

of the comments addressing this subject stated that NCUA should allow

CUSOs to buy and hold stock necessary to provide permissible services.

To do otherwise might have serious long-term effects on the abilities

of FCUs and CUSOs to compete, which could eventually erode the long-

term financial conditions and generate safety and soundness concerns.

To prevent these negative outcomes and promote regulatory flexibility,

the Board has added a sentence to Sec. 712.3(b). If it is necessary for

an CUSO to purchase a minimum amount of stock to provide a permissible

service, the purchase of the stock will not violate the customer base

requirement so long as the other requirements of the CUSO rule are met.

NCUA wants CUSOs to understand clearly that this provision does not

give FCUs a right to purchase stock or securities in any company in any

amount. CUSOs may purchase only the minimal amount of stock absolutely

necessary for the CUSO to provide a permissible service. If a CUSO owns

more than the minimal amount of stock necessary, NCUA will require

divestment of any stock in excess of the nominal amount needed for

service provision. CUSOs may not invest in stocks and securities for

speculative purposes.

FCU and CUSO Accounting

After consideration of the comments, NCUA made a few changes to the

wording of Sec. 712.3(c), FCU accounting, and (d), CUSO accounting;

audits and financial statements; NCUA access to books and records. The

changes clarify NCUA's CUSO review authority and make the rule clearer

and easier to follow.

Ten of the 12 comments addressing the issue asked NCUA to continue

the requirement for a CPA audit for CUSOs. The two comments opposed to

the CPA audit stated that it would be better handled as a business

decision by the CUSO's management. After consideration of the comments,

NCUA continues to hold that the current requirement for a CPA audit

means an opinion audit of the financial statements, performed by an

independent, licensed CPA, and nothing less. The audit must be an audit

of the separate CUSO entity and not simply an audit of the FCU's

financial statements prepared on a consolidated basis, unless the CUSO

is a wholly-owned CUSO. The reason for this long-standing position is

that all credit unions investing in the CUSO need to be aware of any

potential risks in their CUSO. This clarification reflects current

practice and policy.

In the proposal, NCUA asked for comments regarding the AICPA's

Statement on Auditing Standards (SAS) No. 70, Reports on the Processing

of Transactions by Service Organizations. Six of the 10 comments

addressing SAS No. 70 approved of NCUA's position of not requiring SAS

No. 70 reviews in the CUSO rule, but leaving it to the judgment of the

CPA conducting the CUSO audit. Comments were concerned about adding

significant costs to the CPA CUSO audit if the SAS No. 70 review was

required. Four comments suggested that the reviews should be required

to put CUSOs on notice that NCUA will expect a SAS No. 70 review when

one is necessary under AICPA guidelines. After weighing the comments,

NCUA retains its recommendation that a CPA performing an opinion audit

of the financial statements of an FCU that uses a CUSO to process

transactions consider the guidance in SAS No. 70 when planning and

performing the audit. SAS No. 70 provides guidance when an FCU obtains

either or both of the following services from a CUSO: (1) executing

transactions and maintaining the related accountability; and (2)

recording transactions and processing related data. The AICPA

recommends SAS 70 reports be completed in CUSO trust companies that

invest and hold assets for FCU employee benefit plans; CUSO mortgage

bankers that service mortgages for FCUs; electronic data processing

(EDP) service centers that process transactions and related data for

FCUs; and other situations in which a CUSO develops, provides and

maintains the software used by FCUs. The SAS 70 report on policies and

procedures placed in operation and tests of operating effectiveness are

crucial in keeping FCUs informed of internal control weaknesses of

CUSOs performing core functions of the FCU.

Additionally, FCUs and CUSOs are reminded that CUSOs must follow

GAAP for financial reporting purposes and FCUs must follow GAAP or

alternative accepted regulatory accounting practices (RAP). Further,

CUSOs must obtain audits consistent with generally accepted auditing

standards (GAAS). NCUA interprets GAAP to mean compliance with

standards of the Financial Accounting Standards Board (FASB) and

related hierarchy, and GAAS to mean auditing standards issued by the

American Institute of Certified Public Accountants (AICPA), unless

otherwise determined by NCUA.

[[Page 10748]]

NCUA reminds FCUs and CUSOs that GAAP requires that entities (FCUs)

holding a controlling financial interest, generally assumed at fifty

percent or greater of the voting common stock, in another company

(e.g., a CUSO) file consolidated financial statements with their

subsidiary (e.g., CUSO). FCUs that do not control more than a 50%

interest but that have the ability to exert significant influence,

generally assumed at 20%-50% of the voting common stock of a CUSO, are

advised to use the equity method of accounting. In both cases

(consolidated financial statements and the equity method), inter-

company transactions should be eliminated. While these specific

requirements are not made a part of the final rule, they are required

under GAAP. They are noted here because of their importance in

representing the relationship between a CUSO and an FCU.

NCUA Access to CUSO Information

NCUA solicited comment on whether NCUA examination and supervision

authority over CUSOs should be strengthened. Both the Office of Thrift

Supervision (OTS), which charters and supervises federal savings

associations, and the Office of the Comptroller of the Currency (OCC),

which charters and supervises national banks, subject their regulated

financial institutions' subsidiaries to examination and supervision

``in the same manner and to the same extent'' as the parent financial

institution. 12 CFR 5.34(d)(3)(OCC) and 559.3(o)(OTS).

Commenters were also asked to address issues concerning a middle

ground, such as requiring CUSOs to adhere contractually to any

conditions in writing imposed upon their business by the NCUA.

Currently, both OTS and OCC may impose conditions in writing upon the

subsidiaries of their regulated financial institutions. 12 CFR

5.34(d)(4)(OCC) and 559.1(b)(OTS). Another possibility raised by NCUA

was to consider strengthening the existing audit and reporting

requirements further, or to require CUSOs to adopt specified policies,

procedures, and other internal safety and soundness controls.

Sixty-five of the 70 commenters addressing the supervision issue

stated that NCUA did not need additional examination authority. Many of

these comments considered additional government regulation time-

consuming, costly to both NCUA and to the CUSO, and obtrusive. Some

comments said that NCUA staff did not have the expertise to supervise

and examine the various types of for profit CUSO businesses. Several

comments advised that a reliance on various legal, accounting, and tax

professionals would be preferable to NCUA regulation. A few comments

distinguished bank and thrift subsidiaries regulated by OCC and OTS

from CUSOs, which have not been directly regulated by NCUA. For

instance, both federal thrifts and national banks may invest more in

their subsidiaries, and must have higher percentages of ownership than

the FCU Act or current Sec. 701.27 permit. Other comments held that it

would be unfair to regulate CUSOs providing core services, but not

other vendors providing the same services to FCUs. Comments in favor

echoed NCUA's reasons in support of examination authority in the

proposed rule preamble. Seven comments asked NCUA to require CUSOs to

adopt internal safety and soundness controls.

After due consideration of the comments on the available options,

the Board has decided to adopt modifications to paragraph (d)(3) of

this section, clarifying that NCUA has access to CUSO books, records,

and the ability to review CUSO internal controls. This authority

ratifies existing NCUA CUSO review procedures and practices. Currently,

NCUA examiners perform a CUSO review to determine the degree of risk

the CUSO poses to investor, borrower, and customer credit unions. The

examiner must assess the financial condition of the CUSO, verify the

accuracy of the financial statements, assess the adequacy of controls,

determine the viability of operations and service to member credit

unions, and confirm compliance with applicable laws and regulations. In

the course of the CUSO review, the examiner may arrange to review

records such as the CUSO's policies, procedures, budgets, business

plan, goals and objectives, CPA opinion audit and related workpapers,

general ledger, attorney opinions, reporting processes, board minutes,

investment and loan documents, personnel documents, organization

documents, and bylaws. The examiner may discuss with CUSO management

the nature and extent of managerial planning, the overall

reasonableness of the business plan, and budgetary projections. An on-

site CUSO review provides the examiner an opportunity to observe and

ascertain management's ability to effectively direct and control the

CUSO's operations. It is critical for examiners to be able to review

books and records, interview staff, and observe practices and

procedures to determine the CUSO's ability to meet its goals,

objectives, and financial projections; analyze its prospects for future

success; and assess the risk to credit unions.

NCUA believes that this approach enhances the current approach of a

contractual access to CUSO books and records in several ways. The

ability to review CUSO internal controls enables NCUA to assess CUSO

safety and soundness more quickly. Enhanced CUSO review authority helps

protect CUSOs and participating credit unions from concentration and

operation risk. It will also enable NCUA to better protect the NCUSIF

from potential FCU losses due to CUSO losses. Presently, NCUA's main

recourse is to require FCUs to divest CUSO interests and loans. NCUA is

also concerned that, if CUSOs perform critical, core functions \1\ for

credit unions, it could disastrously affect affiliated credit union

services. For example, where member transactions flow through the CUSO,

credit unions are at substantial risk of losing much more than the

amount of their CUSO investment or loan. Credit unions could also lose

operational capability, which could detrimentally affect member

services.

---------------------------------------------------------------------------

\1\ As a point of beginning, NCUA considers the following a list

of such critical, core services and activities: (1) Share-related

core services. Data processing of share deposits, withdrawals, and

other account transactions; Operations conducting member share

transactions for credit unions, including service center branches,

remote service operations and ATMs; Provision of share account

related clerical, professional, or management services; Share draft

and deposit posting, sorting, and processing; ACH services;

Advertising, brokerage, and other services to procure and retain

share accounts; Computation and posting of dividends and other

credits and charges; Preparation and mailing of share drafts,

statements, notices, and similar items; (2) Credit-related core

services. Data processing of loan applications, evaluations,

extensions, collections, and payments; Making, acquiring, servicing,

warehousing or otherwise processing member loans or other extensions

of credit for a credit union, including consumer loans, credit card

loans, mortgage loans, student loans, business loans, and loan

equivalents, such as leasing and indirect lending programs;

Operations conducting lending activity for credit unions, including

service center branches, remote service operations, ATMs, and loan

production offices; Advertising, brokerage, and other services to

procure and retain loans; Advising, structuring, and arranging

extensions of credit; Provision of credit analysis services;

Provision of credit account related clerical, professional, or

management services; and (3) Other related core services. General

ledger data processing; Auditing and accounting; Management,

development, sale or lease of affiliated credit union fixed assets;

Record retention, security, and disaster recovery services;

Provision of investment advice, counseling, or services; Provision

of liquidity management, investment, advisory, and consulting

services; Development and administration of personnel benefit

programs, including life insurance, health insurance, and pension

and retirement plans.

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NCUA believes that the enhanced CUSO review approach has few

drawbacks. It is unlikely to be a factor a court could consider in

piercing the corporate veil and imputing liability to a credit union

investor or lender. NCUA

[[Page 10749]]

examiners are well qualified by experience and training to conduct CUSO

reviews. While NCUA encourages CUSOs to use professional legal,

accounting, and other services when needed, the Board believes that, in

certain cases, a CUSO review conducted by an examiner best meets NCUA's

needs. The current CUSO review, which is consensually scheduled, is

specifically designed to result in minimal burden upon CUSOs. CUSO

review authority is especially crucial in light of NCUA's extensive

Year 2000 compliance program.

NCUA's Year 2000 compliance program necessitates extensive

cooperation between data processor entities, credit unions, and the

NCUA if it is to accomplish its goals in the available time remaining.

The enhanced review authority ensures this cooperation between NCUA and

CUSOs engaging in data processing activities. NCUA does not intend to

use its right of access to CUSO information to roll out a comprehensive

CUSO review program. NCUA plans to continue to use CUSO reviews

sparingly, usually when a potential systemic risk is present, as with

the Year 2000 compliance program, or when other facts and circumstances

raise operational, concentration, or financial risk issues that might

detrimentally affect credit unions and their members.

The NCUA Board considers the requirements set forth in the rule to

be necessary for the safety and soundness of FCUs and ultimately the

NCUSIF. The Board believes that it has properly exercised its authority

in preserving access to CUSO information. Section 204(a) of the FCU

Act, 12 USC 1784(a), authorizes the NCUA Board to examine any insured

credit union. Examiners are authorized to ``make a thorough examination

of all the affairs of the credit union.'' Section 204(b) of the FCU

Act, 12 USC 1784(b), further authorizes the NCUA Board or its

representatives to ``take and preserve testimony under oath as to any

matter in respect to the affairs of any such [insured credit union],

and to issue subpoenas and subpoenas duces tecum.'' [Emphasis added.]

Such subpoenas are to be enforced by the United States District Court

``where the principal office of the credit union is located or in which

the witness resides or carries on business.'' [Emphasis added.]

It is clear that FCU investments in and loans to CUSOs are matters

within the ``affairs of the credit union.'' Under Secs. 204(a) and (b)

of the FCU Act, NCUA is authorized to examine such credit union affairs

and, if testimony and records cannot be obtained through such

examination, to issue subpoenas and subpoenas duces tecum. This

authority extends to those individuals and entities that are involved

with insured credit unions, as evidenced by the reference to

``principal office . . . in which the witness . . . carries on

business'' in Sec. 204(b). Therefore, under the Board's authority to

promulgate regulations, examine insured credit unions, and issue

subpoenas and subpoenas duces tecum, the Board has the authority to

require the FCUs that invest in or lend to a CUSO to obtain a written

agreement granting NCUA access to CUSO information. 12 USC 1766(a) and

1789(a)(11). Creditor and investor FCUs in CUSOs are advised to obtain

amendments to their required, written agreements with CUSOs as soon as

possible. FCUs will have until December 31, 1998, to obtain the revised

agreements with their CUSOs. The Board believes that the delayed

effective date of December 31, 1998, which is ten months from the date

of the adoption of the new rule, will give all FCUs sufficient time to

obtain revised CUSO agreements in compliance with Sec. 712.3(d).

Commenters were also requested to comment on whether NCUA should

charge a review or examination fee for conducting CUSO examination

activities. Thirty out of 36 comments opposed a fee contending it would

financially burden CUSOs, many of which are start-up businesses, run at

a loss, or disburse any profits back to their investor FCUs. The six in

favor of a fee noted the reasons NCUA stated in the preamble: the need

for more NCUA staff time; resultant increased agency expenses; and the

fairness of charging users of NCUA examination services. After

consideration of the comments, the Board has decided not to require a

CUSO review or examination fee at this time. The Board believes that

all credit unions and their members will benefit from the review of

CUSOs, whether or not every FCU or FISCU uses the CUSOs reviewed.

Therefore, it is more equitable to pay any of these costs out of the

FCU operating fee and NCUSIF overhead transfer.

Compliance With Other Laws

This subsection remains unchanged from the proposal. NCUA has

interpreted this requirement to apply, not only to laws applicable to

the proper maintenance of either corporate or limited partnership

format, such as fee, filing and tax requirements, but also to any other

laws applicable to the nature of the CUSO's business. For instance, an

insurance agency CUSO must comply with state insurance laws and

regulations. Any CUSO that is a franchise would need to follow federal

and state franchising laws. Any CUSO service center would need to

follow all applicable federal consumer protection laws related to its

activities, as well as other relevant laws applicable to FCUs, such as

those relating to supervisory committee access (12 CFR 701.12-.13);

loans to members (12 CFR 701.21); truth in savings (12 CFR Part 707);

advertising (12 CFR Part 740); share insurance (12 CFR Part 745);

security program, report of suspicious activity, and bank secrecy act

compliance (12 CFR Part 748); records preservation and retention (12

CFR Part 749); and relevant bylaw requirements, such as those relating

to the confidentiality of member records (Standard Federal Credit Union

Bylaws, NCUA Publication No. 8001) .

Section 712.4, What Must an FCU and a CUSO do to Maintain Separate

Corporate Identities?

Separate Corporate Existence

In the proposal, NCUA requested comment on the use of corporate

separateness guidelines in Sec. 712.4(a)(1-6), which, in turn, were

based upon the OTS rules applicable to federal savings and loan service

corporations. 12 CFR 559.10. Eight of the 14 comments were opposed to

the addition of corporate separateness requirements. Several of these

comments said that these principles addressing good business practices

would be more appropriately included in NCUA guidance in a rule

commentary rather than in the rule. Other comments stated that state

law controlled whether the corporate veil would be pierced between a

CUSO and an FCU and, therefore, the proposed corporate separateness

guidance was not useful. The five comments in favor believed that the

addition of the corporate separateness guidelines into the rule would

better publicize guidance to all CUSOs, not all of which might read

supplementary NCUA guidance presented in another format. One commenter

asked that NCUA prohibit FCUs and CUSOs from sharing directors, and

require a CUSO to disclose on its documents that it is a separate

entity from any FCUs.

The Board has decided to include the guidelines, but clarify that

the guidelines are merely evidence of good business practices

reflecting corporate separateness. This way the guidelines could not be

used to supersede any individual state's laws regarding imputed

liability. The Board has not otherwise modified the guidelines from the

proposal. Although NCUA does not

[[Page 10750]]

ban FCU/CUSO interlocked boards, NCUA cautions FCUs and CUSOs that

interlocking boards are often a critical factor in a court piercing a

corporate veil. Likewise, although NCUA will not require CUSOs to

disclose in their documents that they are separate entities, NCUA

strongly encourages CUSOs to do so as a prudent business practice,

especially if the CUSO and any FCUs share similar names that might

potentially cause credit union member and public confusion. This is

often another critical factor in courts considering liability between

two entities.

Legal Opinion

In the proposal, NCUA solicited comment on whether the legal

opinion requirement should be expanded from requiring an opinion on the

establishment of the CUSO to require additional legal opinions when the

CUSO changes its structure, such as from a corporation to an LLC, or

when the CUSO adds an additional permissible service. Sixteen of the 24

comments addressing this issue opposed these changes on grounds of

regulatory burden. Some of these comments also thought the terms used

in the proposal ``10% or greater equity interest'' and ``maintained''

needed more clarification. Eight of the comments favored expanding the

legal opinion requirement to structure changes, but five of these

opposed obtaining legal opinions when new permissible services were

added to a pre-existing CUSO. These comments reasoned that there should

be nothing inherently dangerous or speculative to an existing CUSO in

adding an additional permissible service or activity related to the

daily, routine operations of FCUs. One comment stressed that NCUA

should clarify that it would require legal opinions prior to the

establishment or structure change of a CUSO. A few comments asked that

NCUA adopt the detailed legal opinion requirements provided for

corporate CUSOs in Sec. 704.11(b) to assist drafters and beneficiaries

of the content of the required legal opinion.

Additionally, to reduce the regulatory burden of obtaining legal

opinions, NCUA proposed that legal opinions will only be required for

FCUs owning a 10% or greater equity interest in a CUSO. NCUA roughly

estimated that such a limitation would reduce the number of legal

opinions needed by as much as 80%. Sixteen out of the 28 comments

addressing this issue favored requiring legal opinions only for FCUs

holding a 10% or greater equity interest in a CUSO, giving regulatory

relief as the reason. Comments opposed to the proposed measure either

wanted the threshold raised, or the legal opinion requirement left as

is.

After due consideration of the comments, NCUA has revised the legal

opinion requirement in several respects. First, NCUA deletes the legal

opinion requirement for an existing CUSO that adds new permissible

services or activities. Second, NCUA clarifies that legal opinions for

CUSO establishment and structure change are due before, and not after,

the CUSO is established or changes its structure from one permissible

form to another (e.g. from a corporation to an LLC). Third, NCUA adds

additional guidance on the content of the required legal opinions,

which it borrows from Sec. 704.11(b). Fourth, NCUA clarifies that all

investing FCUs, regardless of their percentage of equity ownership,

must obtain required legal opinions. FCUs lending to CUSOs should be

protected from losses by following their usual credit policies.

However, the risk is greater for FCUs investing in CUSOs. Limiting the

legal opinion only to those FCUs with ``10% equity interest'' exposes

smaller CUSO equity holders, who arguably need the assurances supplied

by a legal opinion more than larger CUSO equity holders, to more of a

potential risk due to defects in CUSO formation. By eliminating the

legal opinion requirement for creditor FCUs, the Board remains able to

provide a significant reduction in an FCU's paperwork burden. Fifth,

NCUA clarifies that the legal opinion may be provided by independent

legal counsel either of the investing FCU or of the CUSO. Currently,

often the attorney for the CUSO, who actually performs the legal work

creating the CUSO, provides the required legal opinion to participating

CUSOs. The rule clarification sanctions this practice.

NCUA believes these changes will help strengthen corporate

separateness, provide clear guidelines for compliance, and provide

continuing guidance during the life of the CUSO without the drawbacks

of the current legal opinion requirement. NCUA encourages legal,

accounting, tax advisor, and other consultant involvement in matters

affecting CUSO investments and loans. The changes in the final rule to

the legal opinion requirement will aid FCUs in ensuring CUSOs are

properly formed and given advice on how to function under state law in

order to avoid imputed liability from a CUSO to an FCU.

Section 712.5, What Activities and Services are Preapproved for CUSOs?

General

NCUA solicited comment on a proposed provision which reserved to

NCUA the right to limit any CUSO's activities or to refuse to permit

activities for supervisory, legal, or safety and soundness reasons. The

provision was derived from OCC and OTS subsidiary requirements (12 CFR

5.34(d)(3) and 559.1(b)). All of the eight comments addressing the

issue were opposed. These comments stated that the sentence was

ambiguous, burdensome, and unnecessary in light of NCUA's divestment

authority. One comment suggesting that NCUA could achieve its intent by

rephrasing the sentence to state that NCUA could limit an FCU's loan or

investment in a CUSO or refuse to approve new CUSO activities under

Sec. 712.7.

NCUA disagrees with the commenters and adopts a slightly modified

version of the proposal, reordering the words without changing content.

NCUA sees the sentence as a clarification of existing NCUA practice,

and as necessary given NCUA's decision to enhance CUSO review authority

in Sec. 712.3(d)(3). Currently, NCUA provides interpretations of the

limits of existing permissible CUSO activities through the issuance of

legal opinion letters and regional and central office correspondence.

As the proposed amendment provides, these current NCUA pronouncements

are based upon examination, legal, and safety and soundness grounds.

The provision puts FCUs and CUSOs on notice that NCUA does have the

right to interpret the limits of permissible CUSO services and

activities. If transgressions are discovered after the fact, NCUA will

work with the credit unions and CUSOs involved to arrive at a mutually

satisfactory conclusion through the CUSO review and available

enforcement processes. In an extreme case, NCUA can order the

affiliated credit union to divest its CUSO investment or dispose of its

CUSO loan or use other enforcement tools at its disposal against the

FCU, such as prohibitions, removal orders, cease-and-desist orders, or

civil money penalties. NCUA may also exercise these remedies against

the FCU if the normally permissible CUSO services and activities are

improperly, imprudently, or recklessly conducted.

A few comments asked that NCUA add the word ``only'' to the last

sentence of the introduction to Sec. 712.5 so that the phrase would

read that CUSOs can ``only provide one or more of the following

activities and services.'' The

[[Page 10751]]

purpose of this change, derived from current Sec. 701.27(d)(5), would

be to clarify that the permissible activity and service list is

exclusive, in other words, services that are not on the list cannot be

performed by a CUSO. The Board agrees with this comment and makes this

change in the final rule. However, the Board would like to point out

that parties can use Sec. 712.7 to petition the Board for additional

activities or services not already listed in Sec. 712.5.

Insurance and Bonding

In the proposal, NCUA solicited comment on whether an insurance or

bonding requirement should be imposed upon CUSOs. Of the 33 comments

addressing this issue, 23 stated that insurance and bonding decisions

should be left as a management decision of the CUSO, consistent with

any state requirements. The 10 comments supporting the insurance and

bonding requirement believed insurance or bonding was a good business

decision that helped to protect investor, borrower, and contracting

FCUs from any CUSO liability. A few comments stressed that a CUSO

fidelity bond or basic commercial crime insurance coverage could be

especially critical to service center CUSOs and other CUSOs providing

core services to FCUs. One commenter asked that NCUA provide

flexibility and not require any types of coverage not available to

CUSOs in the marketplace, mentioning that one major mutual insurance

company no longer sold CUSO endorsements on its credit union bonds.

After considering the comments, the Board decided to add a

requirement that all CUSOs be ``sufficiently bonded or insured for

their specific operations.'' Because a major mutual insurance company

commented that it does not consider the credit union fidelity bond to

cover CUSO activities and services, the Board believes it should

address CUSO insurance in the rule. Comments confirmed the insurance

industry makes a wide variety of insurance products available to CUSOs

that are similar to the FCU fidelity bond in coverage. A basic

Commercial Crime Policy can include coverage for employee dishonesty,

theft, disappearance and destruction, and depositor's forgery.

Similarly, mortgage service CUSOs generally must have a bond

meeting secondary mortgage market requirements, such as a Financial

Institutions Bond Standard Form No. 15 (Mortgage Bankers Blanket Bond

Policy). Likewise, a securities brokerage CUSO often will be a member

of the National Association of Securities Dealers (NASD), and will meet

NASD bonding requirements through a Financial Institutions Bond

Standard Form No. 14 (Security Brokers Blanket Bond). Although some of

these coverages may be required by other state or federal laws, the

Board strongly believes that in order to protect FCUs and credit union

members served by CUSOs that CUSOs must maintain business insurance

adequate to meet the CUSO's needs as determined by each CUSO's board of

directors and management, and as verified by NCUA staff. This

regulatory language will protect FCUs that receive CUSO services and

provide flexibility for CUSOs to choose the best insurance or bonding

option available for the particular services and activities conducted

by them. CUSOs are encouraged to analyze their insurance needs whenever

adding a new service or activity, changing their structure, or, in any

event at least on an annual basis.

Permissible Activities and Services

CUSOs, according to the FCU Act, are to provide ``services which

are associated with the routine operations of credit unions.'' 12

U.S.C. 1757(7)(I). In addition, CUSOs are to be ``established primarily

to serve the needs of its member credit unions, and whose business

relates to the daily operations of the credit unions they serve.'' 12

U.S.C. 1757(5)(B). In providing these daily, routine services of need

to credit unions, CUSOs must avoid investments in depository financial

institutions, insurance companies, trade associations, liquidity

facilities, and similar entities. 12 U.S.C. 1757(7)(I). In the past,

NCUA has interpreted this statutory authority broadly to encompass most

services and activities a credit union can provide to itself and its

members through use of express authority, incidental authority, or

goodwill authority. NCUA feels this interpretation is supported by the

language of the FCU Act, which sets forth a clear boundary of CUSO

services, namely, services fulfilling credit union and credit union

member needs. Congress did not choose to limit CUSO activities by

cross-reference to statutory FCU powers or by specifically listing CUSO

powers in the statute. This background on NCUA's CUSO policy is germane

to the following discussion of permissible CUSO powers.

Eight new services, reflecting current NCUA interpretations of

existing services, were contained in the proposed rule. First, in

proposed paragraph (a)(3), under checking and currency services, NCUA

proposed to add ``money order, savings bonds, travelers checks, and

purchase and sale of U.S. Mint commemorative coins services.'' Second,

in proposed paragraph (b)(2), under clerical, professional and

management services, NCUA proposed to add ``courier services.'' Third,

in proposed paragraph (b)(4), also under clerical, professional and

management services, NCUA proposed to add ``facsimile transmissions and

copying services.'' Fourth, in proposed paragraph (b)(10), also under

clerical, professional and management services, NCUA proposed to add

``supervisory committee audits.'' Fifth, in proposed paragraph (d)(5),

under electronic transaction services, NCUA proposed to add

``electronic income tax filing.'' Sixth, in proposed paragraph (h)(2),

under leasing, NCUA proposed to add ``real estate leasing of excess

CUSO property.'' This covers real estate leasing only of premises

acquired for CUSO business, and otherwise mainly used in CUSO business,

that may later be used for future CUSO expansion. CUSOs are still

otherwise obligated to demonstrate that the purchase of any real

property will be used for CUSO purposes. NCUA expects that any real

property purchased by a CUSO for future expansion should have a future

benefit to the CUSO as evidenced by a business plan discussing future

use of the real property. Although ``personal property leasing'' and

``real estate leasing of excess CUSO property'' are listed as the only

two permissible leasing services in proposed paragraph (h), fixed asset

leasing is also permitted, but retained with the other permissible

fixed asset activities in proposed paragraph (f)(1). Seventh, in

proposed paragraph (j)(2), under record retention, security, and

disaster recovery services, NCUA proposed to add ``disaster recovery

services.'' Eighth, in proposed paragraph (j)(3), also under record

retention, security and disaster recovery services, NCUA proposed to

add ``optical imaging, CD-ROM data storage and retrieval services'' to

current ``microfilm and microfiche services.'' Thirty-two of the 33

comments addressing this issue agreed that all eight services should be

added to the rule for the reasons NCUA expressed in the proposed rule.

The one opposing commenter gave no explanation for her position. The

Board, finding that these services are self-explanatory and only codify

existing permissible services and activities not currently in the rule

itself, adopts them in the final rule.

NCUA also solicited comments on whether to add consumer loan

originations to the list of permissible activities. Thirty of the 39

comments addressing this issue desired addition of

[[Page 10752]]

consumer loan origination authority. Some of these comments stated that

the authority would enable FCUs to seek out new sources for loans, help

increase FCU growth, avoid predatory dealer financing practices on

members, be more efficient, allow FCUs to make riskier loans through

the CUSO, help reduce funding risk by facilitating use of secondary

market packaged loans, and would otherwise complement an FCU's lending

program. Two comments specifically asked for student loan origination

authority, as an analog to the already approved consumer mortgage loan

authority. Student lending is technical, complex, staff-intensive,

heavily regulated by government, and involves dealing with

universities, students, specialized processors, and various branches of

local, state, and federal government. Nine comments opposed consumer

loan origination based on the opinion of the commenters that consumer

loan activity was beyond NCUA's statutory authority to approve, would

dilute an FCU's common bond requirements, and would take the lending

decision away from credit union board of directors.

Comments were also solicited on whether consumer loan origination

services would be helpful to small, low-income, or community

development credit unions. Commenters were asked to address whether

consumer loan services should be permissible only for credit unions of

a certain asset size and how such a class should be defined. Of the 11

comments received on this issue, 6 supported consumer loan origination

authority for small credit unions and 5 opposed. The reasons given were

similar to those used in support of, and opposition to, general

consumer loan origination authority. NCUA received no suggestions as to

how to define the applicable group of small credit unions.

After due consideration of the comments, NCUA remains opposed to

this addition. Unlike consumer mortgage loan origination, which

requires a specialized lending staff, must follow strict secondary

mortgage market rules, and requires economies of scale in order to be

viable, consumer loans are relatively easy to offer and process. In

addition, NCUA is apprehensive in granting CUSOs the authority to

provide consumer loans to the general public, as it may be perceived as

a dilution of the common bond by Congress and the public. However, the

Board is inclined to approve the addition of student loan origination

to the list. Like consumer mortgage loan origination authority, in

order to be properly performed in a competitive manner within

applicable laws, student loan operations can greatly benefit from

specialized staff familiar with this complicated, specialized form of

lending. Like mortgages, student loans also readily lend themselves to

packaging and sales. It is already permissible for CUSOs to engage in

loan processing, servicing, sales, and collections. Combining these

pre-existing authorities with student loan origination authority should

enable FCUs and FISCUs to become more involved with student lending.

NCUA also stresses that while CUSOs can only approve and fund

consumer mortgages and student loans, CUSOs can engage in many back

office aspects of lending. CUSOs can provide loan support services,

such as loan processing, servicing and sales, as well as debt

collection and collateral repossession services. The FCU, however, must

make the decision whether or not to grant the loan in accordance with

the FCU's loan policies. In essence, CUSOs can provide back office

underwriting, processing and servicing functions to enable a credit

union to offer loans. In addition, if a CUSO has lending personnel on

its staff involved in making and administering business loans with a

minimum of 2 years direct experience with lending, then FCUs using the

CUSO for back office business loan functions can use the CUSO's staff

to fulfill its obligation to have an experienced lender on the FCU's

staff, as is required by Sec. 701.21(h)(2)(i)(F). In other words, FCUs

are permitted to leverage their member business loan expertise with

CUSO business loan personnel. This clarification is made to assist FCUs

in expanding the number and type of business loans made to its members

in conjunction with the member business loan amendments proposed in 62

FR 41313 (August 1, 1997).

In the proposed rule, NCUA solicited comment on whether three

services currently permissible for CUSOs should remain permissible: (1)

data processing services to the general public; (2) travel-related

services; and (3) real estate brokerage services. Thirty-five of 36

comments addressing the issue favored the retention of data processing

services to the general public. Comments stated that other federal

financial institution regulators were considering changing their rules

to allow these data processing services and providing services to

others helped pay for data processing computer equipment and services

and helped keep costs down. Similarly, 35 of 36 comments addressing the

issue favored the retention of travel-related services. Comments stated

that travel-related services had been traditionally provided in FCUs

for many years and helped to promote thrift in the form of vacation

share savings accounts and promote lending in the form of vacation

loans. The single comment opposing the retention of data processing

services and travel-related services was based on the grounds that the

service is impermissible and legally insupportable. NCUA disagrees with

this one comment on the grounds that the Board has constructed an

adequate administrative record to support the inclusion of these

services within the context of the CUSO rule, based upon the Board's

statutory authority and the Administrative Procedure Act. Therefore,

the Board will retain data processing services and travel-related

services in the CUSO rule.

All 26 comments addressing the issue favored the retention of real

estate brokerage services. Comments stated that the service was

complementary to FCU and FISCU mortgage loan operations and programs.

Despite the comments, NCUA has been troubled by cases involving

conflicts and the appearance of conflicts between real estate brokerage

CUSOs and the credit unions such CUSOs serve. In one instance, the

NCUSIF suffered a large loss due to a real estate brokerage service,

and several FCUs and FISCUs have suffered losses due to conflicts

arising between the credit union and a real estate brokerage. Because

of these concerns, the Board has decided to remove ``real estate

brokerage services'' from the list of permissible CUSO activities and

services. This removal is set forth in Sec. 712.6(b). However, CUSOs

with current investments or loans to real estate brokerage service

CUSOs as of the effective date of this rule will be allowed to continue

to offer the service under a 3 year grandfather provision under

Sec. 712.9. For similar reasons regarding impairment of appraiser

independence and possible conflicts of interest, the Board declines to

add real estate appraisal activities in the list of permissible

activities.

NCUA also requested comments regarding any aspects of any other

currently allowable, or potentially allowable, CUSO activity or

service. One comment suggested adding ``electronic imaging'' to the

list of record retention imaging services listed under the ``Record

Retention, security and disaster recovery services'' category to cover

future imaging technologies. The Board adopts this comment in the final

rule.

Another comment asked that NCUA permit business lending services,

[[Page 10753]]

certificate of deposit brokerage services, medical savings accounts,

telemarketing services, EFT services (point of sale, remote banking,

and smart cards), executive/private banking services and correspondent

banking services including cash letter processing and remittance lock

box services. Some of these services can be provided under current

authority: CD brokerage services can be provided by a securities

brokerage CUSO; telemarketing is a form of permissible marketing

services; the EFT services seem permissible; and it is possible that

some of the other services, other than business lending, could be

provided by a trust company CUSO. Member business loan origination is

rejected for the same reasons described under consumer loan

origination. Without more detail on these suggested services, the Board

declines to add any of them to the permissible activities and services

list at this time.

One comment suggested changing the heading of paragraph (g) from

``Insurance brokerage or agency'' to ``Providing group purchasing

programs.'' The comment stated that in some states the subsidiary of a

financial institution cannot be licensed as an insurance brokerage or

agency, but the financial institution may still want to make available

to their members a legal insurance product, such as mortgage life

insurance. The comment contemplated various insurance group purchasing

programs, such as vehicle warranty programs, home warranties, gap

insurance (protects any gap between the original cost of a vehicle and

the actual cash value in the event the vehicle is destroyed), debt

cancellation programs, and motor club programs. The Board is of the

opinion that the addition of ``provision of group purchasing programs''

under the existing category ``(g) Insurance brokerage or agency'' is

sufficient to allow CUSOs to engage in the contemplated programs. The

CUSO rule does not preempt state licensing laws, therefore, it is

beyond NCUA's authority to permit CUSOs, which must be properly

established and operated under applicable state law, to offer or

provide a service or product that is impermissible under state law. In

addition, the Board is wary of how others would treat the potentially

broad, vague, and troubling category of ``group purchasing programs''

without limiting it in some fashion, as the Board has done here, by

limiting it to insurance-type group purchasing services.

One comment recommended that paragraph (d), ``electronic

transaction services,'' be expanded to include electronic payment

systems, such as stored value cards, e-cash, e-checks, and any other

developing or emerging technology through which financial services may

be delivered. Another comment suggested that paragraph (d) should be

renamed ``electronic currency and electronic delivery systems'' to

include electronic payment systems to permit the delivery of financial

services, transactions and value, including stored value cards, e-cash,

e-checks, stamps, coupons or similar payment forms; and that paragraph

(d)(3), ``data processing,'' be renamed ``data processing and multi-

media communication and information systems'' to facilitate delivery of

financial services through emerging and future technologies such as

smart phones, interactive televisions, video screens and terminals,

electronic conferencing centers, automated video financial centers, and

digital signature certification centers, and to also act as Internet

service providers. The Board indicates its approval of services that

are currently performed in a credit union branch, but can now be

performed by computer-based means, by adding the term ``Cyber financial

services'' as new paragraph (d)(8) to the permissible services list.

The Board cautions CUSOs that permissible CUSO ``Cyber financial

services'' only includes credit union member financial services that

are analogous to services performed for credit union members in a

credit union branch and not unrelated services.

A few comments asked that NCUA provide a list of impermissible

activities and allow anything not on that list to be permissible. Other

comments asked that NCUA let the board of directors of each CUSO decide

what services to offer instead of providing a list of permissible

activities and services. The Board believes that it is better to have a

list of permissible activities and services than either no list or a

list of impermissible activities and services. A permissible activities

and services list is easier to administer, more familiar to users, and

is less likely to be misinterpreted. Therefore, the Board declines to

adopt these comments' proposals.

To summarize, the proposed rearrangement of the list of permissible

activities and services has been adopted with a few changes based upon

comments received and staff investigation. First, ``Cyber financial

services'' has been added as new paragraph (d)(8) to the category of

``Electronic transaction services.'' Second, ``Provision of group

purchasing programs'' is added as new paragraph (g)(3) to the category

of ``Insurance brokerage or agency.'' Third, the category ``Real estate

brokerage services'' is removed. Fourth, ``electronic imaging'' is

added to the list of record retention imaging services listed under the

new paragraph ``(j) Record Retention, security and disaster recovery

services.'' Fifth, a new category, ``Student loan origination'' is

added as new paragraph (m). Sixth, all eight proposed rule services and

activities have been added, and data processing and travel services

have been retained as permissible CUSO services.

The Board adopts the rearrangement of the list of permissible

activities and services for ease of understanding and citation, to

reflect changes in CUSO activities and services, and to provide

flexibility for future CUSO growth. The final categories of permissible

services and activities are as follows: checking and currency services;

clerical, professional and management services; consumer mortgage loan

origination; electronic transaction services; financial counseling

services; fixed asset services; insurance brokerage or agency; leasing;

loan support services; record retention, security and disaster recovery

services; securities brokerage services; shared credit union branch

(service center) services; student loan origination; travel agency

services; and trust and trust-related services. The category headings

are solely descriptive in nature and not meant to convey authority for

additional services and activities beyond the specific services and

activities listed.

Section 712.6, What Activities and Services are Prohibited for CUSOs?

The proposed section rephrased the statutory prohibition of 12

U.S.C. 1757(7)(I). The four comments addressing this section opposed

the proposed wording. Comments found the rephrasing vague, ambiguous

and not supported by the statute. Comments pointed out that the statute

did not prohibit insurance company involvement with CUSOs and found

NCUA's prior policy prohibiting insurance company involvement to be

unfounded, unnecessary, and insupportable under the statute. After

further review, the Board agrees and has reworded this section to

follow the language used in the statute verbatim.

In addition, as discussed under the supplementary information for

Sec. 712.5, Permissible Services, a new paragraph (b) has been added to

set forth that any new FCU investments or loans in a CUSO involved with

real estate brokerage services cannot be made after April 1, 1998, and

any existing investments or loans must be phased-out over a three year

period as provided in Sec. 712.9.

[[Page 10754]]

Section 712.7, What Must an FCU Do To Add Activities or Services That

are Not Preapproved?

The comments addressing this section agreed that it is useful to

have a regulatory mechanism to add unpreapproved activities and

services under an expedited 60-day consideration time frame. This would

allow Board consideration of potential CUSO activities and services

that are not included in the permissible CUSO activities and services

list in Sec. 712.5. The proposed language is adopted as revised for

plain language reasons previously discussed in this Supplementary

Information. The terms ``NCUA Board,'' and ``Secretary of the Board,''

have the meanings ascribed to them in Part 790 of the NCUA Rules and

Regulations. 12 CFR Part 790.

Section 712.8, What Transaction and Compensation Limits Might Apply to

Individuals Related to Both an FCU and a CUSO?

Conflict of Interest

NCUA requested comments on means to enable NCUA to better police

potential CUSO/FCU conflicts, including NCUA's proposal to eliminate

the ability of a CUSO to reimburse an FCU for the services of the FCU's

officials and senior management employees. Seventy-one of the 72

comments received on this issue opposed NCUA's proposed reimbursement

prohibition. Many comments stated that this one factor would not be

controlling to a court in determining whether or not to pierce the

corporate veil to find an FCU liable for acts or omissions of a CUSO.

Other comments stated that a prohibition would have the effect of

severely hampering, if not making it nearly impossible, for small and

start-up CUSOs, that could not otherwise afford to pay for non-credit

union employees, to function. Some comments stressed that shared

employees were helpful in maintaining communication between an FCU and

a CUSO, which aided in furthering their shared mission of providing

member services. Many comments stated that for profit, taxable CUSOs

are eligible for a tax deduction for business expenses for

reimbursements made to an FCU on account of shared employees, while

dividends are not deductible. One comment suggested that NCUA should

encourage prudent management by requiring arms' length transactions

through means of required contractual agreements. Several comments

stressed that the reimbursement does not by itself raise concerns. It

is the actions of a few individuals that cause NCUA concerns, and these

individuals should be handled by increasing implementation of NCUA

fraud detection programs and policies. Comments stated that the

combined effect of the proposed ban would be to prevent formation of

new CUSOs, impede expansion of CUSO services to other credit unions,

and jeopardize the operations and finances of existing CUSOs. In sum,

elimination of the ability to reimburse would seriously hinder CUSOs'

ability to perform and deprive credit union members of additional

revenues and services.

Many of the comments clarified for NCUA the extent and nature of

FCU services used by CUSOs: facilities (space, utilities, maintenance

services, and janitorial services); systems support (telephone,

computer, Internet access); shared employees and staff (accounting,

human resources, call center, marketing) and direct services like

attorney and advertising services. After gaining a better understanding

of the CUSO industry through due consideration of the comments, the

Board has decided to continue to allow CUSOs to reimburse FCUs for the

services of FCU officials, senior management employees, and employees

under one condition. The condition is that the FCU accounts payable,

due from the CUSO on account of the CUSO's use of FCU officials, senior

management employees, and employees, must be cleared and paid in full

at least every 120 days. NCUA has experienced a recurring problem of

CUSO nonpayment of the funds owed to the FCU on account of the CUSO's

use of FCU officials and employees. In several cases, the account

receivable due from the CUSO has been allowed to accumulate for several

years, triggering safety and soundness issues. In some of these cases,

the FCU has been unable to collect the accumulated account receivable

from the CUSO resulting in a write-down of the account receivable as an

impaired asset. This practice threatens the safety and soundness of

FCUs and the NCUSIF. Examiners will be instructed to review the

accounts receivable due from CUSOs to ensure compliance with this

requirement after this rule becomes effective.

The primary purpose of the conflict of interest section is to

prevent insider abuse and self-dealing that could lead to losses at the

CUSO, affiliated credit unions, and the NCUSIF. It is the

responsibility and fiduciary duty of FCU volunteers and employees to

make decisions based on the best interests of the FCU and its members.

Motivations of personal financial gain from CUSO activities could

present an inherent conflict of interest. Such motivations in various

CUSO cases have led to personal gain by FCU officials and resulted in

FCU losses, occasionally even resulting in the liquidation or merger of

the FCU. In addition, CUSO compensation of FCU volunteers could serve

as a means to subvert the prohibitions on compensation for volunteer

officials contained in the FCU Act. 12 U.S.C. 1761 and 1761a. Moreover,

compensation of shared CUSO/FCU officials might be a factor that a

court could evaluate in deciding to pierce the corporate veil to impute

liability from a CUSO to an FCU. For these reasons, NCUA is committed

to maintaining strong conflicts of interest provisions for CUSOs and

FCUs.

FCU officials and employees, and their immediate family members,

who also work in CUSOs engaging in FCU loan-related services, should be

careful to comply with 12 CFR Sec. 701.21(c)(8), NCUA's loan conflicts

rule. Individual compensation related to FCU loans can trigger

application of the loan conflicts rule. CUSO loan-related services

include loan support services, such as debt collection services; loan

processing, servicing and sales; or the sale of repossessed collateral;

as well as leasing, consumer mortgage loan, or student loan origination

activities.

Section 712.9, When Must You Begin Compliance With the Revised Rule?

NCUA solicited comment on when FCUs and CUSOs should begin

compliance with a revised final part 712. The few comments received on

this issue varied from the effective date to 6 months to 9 months to 1

year. After consideration of these comments, and in light of the few

changes to the CUSO rule, the Board is adopting the April 1, 1998,

effective date as the compliance date, as it proposed. Any conversion

compliance problems should be brought to the attention of the

appropriate NCUA Region immediately upon discovery for expeditious

handling and resolution. FCUs will have three years, until April 1,

2001, to divest or close-out any nonconforming investments or loans

made nonconforming by this new rule, such as FCU investments in, and

loans to, CUSOs engaging in real estate brokerage services.

Section 740.3(c), Mandatory Requirements With Regard to the Official

Sign and Its Display

Federally-insured credit unions are not permitted to receive

account funds at any teller's station or window where any non-federally

insured credit union or institution receives shares or deposits. Credit

union service centers

[[Page 10755]]

and branches servicing more than one credit union where only some of

the credit unions are insured by NCUA are currently exempt from this

requirement. However, in a service center context a sign is required

immediately above or beside each official NCUA sign stating ``Only the

following credit unions serviced by the facility are federally insured

by the NCUA ________.'' (The full name of each credit union insured is

to follow the word NCUA). The lettering is to be of such size and print

to be clearly legible to all members conducting share or deposit

transactions. The intent of this requirement was to inform credit union

members using a service center that share insurance was dependent upon

their credit union and not upon the location of their transactions (the

service center).

To reduce the paperwork and compliance burdens on service centers,

which service mainly federally-insured credit unions, NCUA proposed to

change this disclosure requirement to a disclosure of non-federally

insured credit unions serviced at a service center. Twelve of the 17

relevant comments supported this approach. Five of the comments

preferred the current requirement.

After further consideration, the Board has decided not to revise

the service center posting requirement. The Board is very concerned

about credit union member confusion about account insurance. The NCUSIF

is backed by the full faith and credit of the United States. Private

insurance is backed only by the assets of the insurance company. Since

1990, concerns with privately-provided primary, non-excess account

insurance has led to elimination of private account insurers in

Florida, Georgia, Massachusetts, Rhode Island, Tennessee, Texas, and

Washington State. While NCUA is aware of the statutorily-mandated

disclosures that nonfederally insured credit unions must give to their

members, 12 U.S.C. 1831t, NCUA is concerned that some member confusion

might still exist leading the member of a nonfederally insured credit

union to believe that his or her deposits were federally insured by the

NCUSIF. Therefore, the signage requirement will remain unchanged.

Private, non-federally insured credit union members may believe

that their accounts are federally-insured and backed by the full faith

and credit of the United States if they transact business where the

blue, NCUA Insurance of Accounts sticker is used, such as at service

center locations. NCUA's concern is heightened by the recent

proliferation of the use of service center outlets. Outlets are

existing federally-insured and non-federally insured credit union

branches that are wired to handle simple deposit and withdrawal teller

window transactions for any member of any other credit union

participating in that service center company. Plans are currently

underway to link various service center locations to facilitate a

national service center business using existing credit union branches

as outlets. Thus, privately-insured credit union members will soon be

able to transact credit union business in federally-insured credit

union branches, perhaps on a national basis. The Board is concerned

over this situation and has directed staff to study the issue.

H. Derivation Table

----------------------------------------------------------------------------------------------------------------

Original provision New provision Comment

----------------------------------------------------------------------------------------------------------------

701.27(a)............................ 712.1........................ Modified.

701.27(b)............................ 712.6(a)..................... Modified.

701.27(c)............................ N/A.......................... Removed.

701.27(d)(1)......................... 712.2(a-c)................... Modified.

701.27(d)(2)(i-ii)................... 712.3(a)..................... Significantly Changed

701.27(d)(3)......................... 712.4(b)..................... Significantly Changed.

701.27(d)(4)......................... 712.3(b)..................... Modified.

701.27(d)(5)(i-ii)................... 712.5(a-o)................... Modified.

701.27(d)(5)(iii).................... 712.7........................ Modified.

701.27(d)(6)(i-iii).................. 712.8(a-c)................... Modified.

701.27(d)(7)(i)...................... 712.3(c)..................... Modified.

701.27(d)(7)(ii)(A-C)................ 712.3(d)(1-3)................ Modified.

701.27(d)(8)(i-ii)(A-B).............. 712.9(a-b)(1-2).............. Modified.

701.27(e)............................ 712.3(e)..................... No change.

N/A.................................. 712.4(a)..................... Added.

N/A.................................. 712.6(b)..................... Added.

----------------------------------------------------------------------------------------------------------------

II. Regulatory Procedures

A. Regulatory Flexibility Act

The Regulatory Flexibility Act requires the NCUA to prepare any

analysis to describe any significant economic impact any proposed

regulation may have on a substantial number of small entities

(primarily those under $1 million in assets). The CUSO and service

contract rule revisions reduce existing regulatory burdens. No

commenters commented on Regulatory Flexibility Act issues. Therefore,

the NCUA Board has determined and certifies that the final rule does

not have a significant economic impact on a substantial number of small

credit unions. Accordingly, the Board has determined that a Regulatory

Flexibility Analysis is not required.

B. Paperwork Reduction Act

The reporting requirements in Part 712 have been submitted to the

Office of Management and Budget. A notice will be published in the

Federal Register once approval is received from OMB. Under the

Paperwork Reduction Act of 1995, no persons are required to respond to

a collection of information unless it displays a valid OMB control

number. The control number will be displayed in the table at 12 CFR

Part 795.

C. Executive Order 12612

Executive Order 12612 requires NCUA to consider the effect of its

actions on state interests. The final CUSO regulation applies only to

FCUs. The NCUA Board has determined that the final rule does not

constitute a ``significant regulatory action'' for purposes of the

Executive Order. However, as in the past, NCUA will work with the state

credit union supervisors to achieve shared goals involving viability,

flexibility, parity, conformity and safety and soundness

[[Page 10756]]

concerning CUSOs with both FCU and state-chartered credit union

participation.

D. Small Business Regulatory Enforcement Fairness Act

The Small Business Regulatory Enforcement Fairness Act of 1996

(Public Law 104-121) provides generally for Congressional review of

agency rules. The reporting requirement is triggered in instances where

NCUA issues a final rule as defined by Section 551 of the

Administrative Procedures Act, 5 U.S.C. 551.

OMB has determined that this final rule on Part 712 does not

constitute a ``major'' rule as defined by the statute. A ``major'' rule

is defined as being any final rule that the Administrator of the Office

of Information and Regulatory Affairs of OMB finds has resulted in or

is likely to result in: (1) an annual effect on the economy of $100

million or more; (2) a major increase in costs or prices for consumers,

individual industries, Federal, State, or local government agencies, or

geographic regions; or (3) significant adverse effects on competition,

employment, investment, productivity, innovation, or on the ability of

United States based enterprises to compete with foreign-based

enterprises in domestic and export markets.

List of Subjects

12 CFR Part 701

Credit, Credit unions, Insurance, Reporting and recordkeeping

requirements, Surety bonds.

12 CFR Part 704

Credit unions, Reporting and recordkeeping requirements.

12 CFR Part 712

Administrative practice and procedure, Credit, Credit unions,

Investments, Reporting and recordkeeping requirements.

12 CFR Part 740

Advertising, Bank deposit insurance, Credit unions, Reporting and

recordkeeping requirements, Signs and symbols.

By the National Credit Union Administration Board on February

25, 1998.

Becky Baker,

Secretary of the Board.

For the reasons set forth in the preamble, 12 CFR chapter VII is

amended 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 U.S.C. 1752(5), 1755, 1756, 1757, 1759, 1761a,

1761b, 1766, 1767, 1782, 1784, 1787, 1789 and 1798. Section 701.6 is

also authorized by 31 U.S.C. 3717. Section 701.31 is also authorized

by 15 U.S.C. 1601 et seq.; 42 U.S.C. 1861 and 3601-3610. Section

701.35 is also authorized by 42 U.S.C. 4311-4312.

2. Section 701.26 is amended by removing paragraph (b) and removing

the paragraph designation (a).

Sec. 701.27 [Removed]

3. Section 701.27 is removed.

Sec. 701.36 [Amended]

4. Section 701.36 is amended in paragraph (a)(4)(iv) by revising

``Sec. 701.27'' to read ``part 712.''

PART 704-CORPORATE CREDIT UNIONS

5. The authority citation for part 704 continues to read as

follows:

Authority: 12 U.S.C. 1762, 1766(a), 1781 and 1789.

Sec. 704.11 [Amended]

6. Section 704.11 is amended in paragraph (e) by revising

``Sec. 701.27'' to read ``part 712.''

7. Part 712 is added to read as follows:

PART 712--CREDIT UNION SERVICE ORGANIZATIONS (CUSOs)

Sec.

712.1 What does this part cover?

712.2 How much can a Federal credit union (FCU) invest in, or loan

to, CUSOs, and what parties may be involved?

712.3 What are the characteristics of and what requirements apply

to CUSOs?

712.4 What must an FCU and a CUSO do to maintain separate corporate

identities?

712.5 What activities and services are preapproved for CUSOs?

712.6 What activities and services are prohibited for CUSOs?

712.7 What must an FCU do to add activities or services that are

not preapproved?

712.8 What transaction and compensation limits might apply to

individuals related to both an FCU and a CUSO?

712.9 When must an FCU begin compliance with this part?

Authority: 12 U.S.C. 1756, 1757(5)(D) and (7)(I), 1766, 1782,

1784, 1785, and 1786.

Sec. 712.1 What does this part cover?

This part establishes when a Federal credit union (FCU) can invest

in and make loans to CUSOs. CUSOs are subject to review by NCUA. This

part does not apply to corporate credit unions that have CUSOs subject

to Sec. 704.11 of this title. This part does not apply to state-

chartered credit unions or the subsidiaries of state-chartered credit

unions that do not have FCU investments or loans.

Sec. 712.2 How much can an FCU invest in, or loan to, CUSOs, and what

parties may be involved?

(a) Investments. An FCU's total investments in CUSOs must not

exceed, in the aggregate, 1% of its paid-in and unimpaired capital and

surplus as of its last calendar year-end financial report. For purposes

of paragraphs (a) and (b) of this section, ``paid-in and unimpaired

capital and surplus'' means shares and undivided earnings. An FCU can

only invest in a CUSO as an equityholder of a corporation, as a member

of a limited liability company, or as a limited partner of a limited

partnership.

(b) Loans. An FCU's total loans to CUSOs must not exceed, in the

aggregate, 1% of its paid-in and unimpaired capital and surplus as of

its last calendar year-end financial report. Loan authority is

independent and separate from the 1% investment authority of subsection

(a) of this section.

(c) Parties. An FCU may invest in, or loan to, a CUSO by itself, or

with other credit unions, or with non-depository institution parties

not otherwise prohibited by Sec. 712.6 of this part.

Sec. 712.3 What are the characteristics of and what requirements apply

to CUSOs?

(a) Structure. An FCU can invest in or loan to a CUSO only if the

CUSO is structured as a corporation, limited liability company, or

limited partnership. For purposes of this part, ``corporation'' means a

legally incorporated corporation as established and maintained under

relevant state law. For purposes of this part, ``limited partnership''

means a legally established limited partnership as established and

maintained under relevant state law. For purposes of this part,

``limited liability company'' means a legally established limited

liability company as established and maintained under relevant state

law, provided that the FCU obtains written legal advice that the

limited liability company is a recognized legal entity under the

applicable laws of the state of formation and that the limited

liability company is established in a manner that will limit potential

exposure of the FCU to no more than the amount of funds invested in, or

loaned to, the CUSO.

(b) Customer base. An FCU can invest in or loan to a CUSO only if

the CUSO primarily serves credit unions, its membership, or the

membership of credit unions contracting with the

[[Page 10757]]

CUSO. However, if in order for the CUSO to provide a permissible

service it is necessary for the CUSO to own stock in a service provider

not meeting the customer base requirement, then the CUSO can buy and

own the minimal amount of service provider stock necessary to provide

the service without violating the customer base requirement.

(c) Federal credit union accounting. An FCU must account for its

investments in or loans to a CUSO in conformity with ``generally

accepted accounting principles'' (GAAP).

(d) CUSO accounting; audits and financial statements; NCUA access

to information. An FCU must obtain written agreements from a CUSO,

prior to investing in or lending to the CUSO, that the CUSO will:

(1) Account for all its transactions in accordance with GAAP;

(2) Prepare quarterly financial statements and obtain an annual

opinion audit, by a licensed Certified Public Accountant, on its

financial statements in accordance with ``generally accepted auditing

standards'' (GAAS); and

(3) Provide NCUA and its representatives with complete access to

any books and records of the CUSO and the ability to review CUSO

internal controls, as deemed necessary by NCUA in carrying out its

responsibilities under the Act.

(e) Other laws. A CUSO must comply with applicable Federal, state

and local laws.

Sec. 712.4 What must an FCU and a CUSO do to maintain separate

corporate identities?

(a) Corporate separateness. An FCU and a CUSO must be operated in a

manner that demonstrates to the public the separate corporate existence

of the FCU and the CUSO. Good business practices dictate that each must

operate so that:

(1) Its respective business transactions, accounts, and records are

not intermingled;

(2) Each observes the formalities of its separate corporate

procedures;

(3) Each is adequately financed as a separate unit in the light of

normal obligations reasonably foreseeable in a business of its size and

character;

(4) Each is held out to the public as a separate enterprise;

(5) The FCU does not dominate the CUSO to the extent that the CUSO

is treated as a department of the FCU; and

(6) Unless the FCU has guaranteed a loan obtained by the CUSO, all

borrowings by the CUSO indicate that the FCU is not liable.

(b) Legal opinion. Prior to an FCU investing in a CUSO, the FCU

must obtain written legal advice as to whether the CUSO is established

in a manner that will limit potential exposure of the FCU to no more

than the loss of funds invested in, or lent to, the CUSO. In addition,

if a CUSO in which an FCU has an investment plans to change its

structure under Sec. 712.3(a), an FCU must also obtain prior, written

legal advice that the CUSO will remain established in a manner that

will limit potential exposure of the FCU to no more than the loss of

funds invested in, or loaned to, the CUSO. The legal advice must

address factors that have led courts to ``pierce the corporate veil''

such as inadequate capitalization, lack of separate corporate identity,

common boards of directors and employees, control of one entity over

another, and lack of separate books and records. The legal advice may

be provided by independent legal counsel of the investing FCU or the

CUSO.

Sec. 712.5 What activities and services are preapproved for CUSOs?

NCUA may at any time, based upon supervisory, legal, or safety and

soundness reasons, limit any CUSO activities or services, or refuse to

permit any CUSO activities or services. Otherwise, an FCU may invest

in, loan to, and/or contract with only those CUSOs that are

sufficiently bonded or insured for their specific operations and only

provide one or more of the following activities and services related to

the routine, daily operations of credit unions:

(a) Checking and currency services:

(1) Check cashing;

(2) Coin and currency services; and

(3) Money order, savings bonds, travelers checks, and purchase and

sale of U.S. Mint commemorative coins services;

(b) Clerical, professional and management services:

(1) Accounting services;

(2) Courier services;

(3) Credit analysis;

(4) Facsimile transmissions and copying services;

(5) Internal audits for credit unions;

(6) Locator services;

(7) Management and personnel training and support;

(8) Marketing services;

(9) Research services; and

(10) Supervisory committee audits;

(c) Consumer mortgage loan origination;

(d) Electronic transaction services:

(1) Automated teller machine (ATM) services;

(2) Credit card and debit card services;

(3) Data processing;

(4) Electronic fund transfer (EFT) services;

(5) Electronic income tax filing;

(6) Payment item processing;

(7) Wire transfer services; and

(8) Cyber financial services;

(e) Financial counseling services:

(1) Developing and administering Individual Retirement Accounts

(IRA), Keogh, deferred compensation, and other personnel benefit plans;

(2) Estate planning;

(3) Financial planning and counseling;

(4) Income tax preparation;

(5) Investment counseling; and

(6) Retirement counseling;

(f) Fixed asset services:

(1) Management, development, sale, or lease of fixed assets; and

(2) Sale, lease, or servicing of computer hardware or software;

(g) Insurance brokerage or agency:

(1) Agency for sale of insurance;

(2) Provision of vehicle warranty programs; and

(3) Provision of group purchasing programs;

(h) Leasing:

(1) Personal property; and

(2) Real estate leasing of excess CUSO property;

(i) Loan support services:

(1) Debt collection services;

(2) Loan processing, servicing, and sales; and

(3) Sale of repossessed collateral;

(j) Record retention, security and disaster recovery services:

(1) Alarm-monitoring and other security services;

(2) Disaster recovery services;

(3) Microfilm, microfiche, optical and electronic imaging, CD-ROM

data storage and retrieval services;

(4) Provision of forms and supplies; and

(5) Record retention and storage;

(k) Securities brokerage services;

(l) Shared credit union branch (service center) operations;

(m) Student loan origination;

(n) Travel agency services; and

(o) Trust and trust-related services:

(1) Acting as administrator for prepaid legal service plans;

(2) Acting as trustee, guardian, conservator, estate administrator,

or in any other fiduciary capacity; and

(3) Trust services.

Sec. 712.6 What activities and services are prohibited for CUSOs?

(a) General. CUSOs must not acquire control of, either directly or

indirectly, another depository financial institution, nor invest in

shares, stocks, or obligations of an insurance company, trade

association, liquidity facility or

[[Page 10758]]

similar organization, corporation, or association.

(b) Real estate brokerage CUSO. An FCU may not invest in, or loan

to, a CUSO engaged in real estate brokerage services after April 1,

1998, except as provided in Sec. 712.9.

Sec. 712.7 What must an FCU do to add activities or services that are

not preapproved?

In order for an FCU to invest in and/or loan to a CUSO that offers

an unpreapproved activity or service, the FCU must first receive NCUA

Board approval. The request for NCUA Board approval of an unpreapproved

activity or service must include a full explanation and complete

documentation of the activity or service and how that activity or

service is associated with routine credit union operations. The request

must be submitted jointly to your Regional Office and to the Secretary

of the Board. The request will be treated as a petition to amend

Sec. 712.5 and NCUA will request public comment or otherwise act on the

petition within 60 days after receipt.

Sec. 712.8 What transaction and compensation limits might apply to

individuals related to both an FCU and a CUSO?

(a) Officials and Senior Management Employees. The officials,

senior management employees, and their immediate family members of an

FCU that has outstanding loans or investments in a CUSO must not

receive any salary, commission, investment income, or other income or

compensation from the CUSO either directly or indirectly, or from any

person being served through the CUSO. This provision does not prohibit

such FCU officials or senior management employees from assisting in the

operation of a CUSO, provided the officials or senior management

employees are not compensated by the CUSO. Further, the CUSO may

reimburse the FCU for the services provided by such FCU officials and

senior management employees only if the account receivable of the FCU

due from the CUSO is paid in full at least every 120 days. For purposes

of this paragraph (a), ``official'' means affiliated credit union

directors or committee members. For purposes of this paragraph (a),

``senior management employee'' means affiliated credit union 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). For purposes of

this paragraph (a), ``immediate family member'' means a spouse or other

family members living in the same household.

(b) Employees. The prohibition contained in paragraph (a) of this

section also applies to FCU employees not otherwise covered if the

employees are directly involved in dealing with the CUSO unless the

FCU's board of directors determines that the FCU employees' positions

do not present a conflict of interest.

(c) Others. All transactions with business associates or family

members of FCU officials, senior management employees, and their

immediate family members, not specifically prohibited by paragraphs (a)

and (b) of this section must be conducted at arm's length and in the

interest of the FCU.

Sec. 712.9 When must an FCU comply with this part?

(a) Investments. An FCU's investments in CUSOs in existence prior

to April 1, 1998, must conform with this part not later than April 1,

2001, unless the Board grants prior approval to continue such

investment for a stated period.

(b) Loans. An FCU's loans to CUSOs in existence prior to April 1,

1998, must conform with this part not later than April 1, 2001, unless:

(1) The Board grants prior approval to continue the FCU's loan for

a stated period; or

(2) Under the terms of its loan agreement, the FCU cannot require

accelerated repayment without breaching the agreement.

[FR Doc. 98-5450 Filed 3-4-98; 8:45 am]

BILLING CODE 7535-01-P