[Federal Register Volume 63, Number 43 (Thursday, March 5, 1998)]
[Rules and Regulations]
[Pages 10743-10758]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-5450]
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Rules and Regulations
Federal Register
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Federal Register / Vol. 63, No. 43 / Thursday, March 5, 1998 / Rules
and Regulations
[[Page 10743]]
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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
[[Page 10744]]
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.
[[Page 10745]]
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
[[Page 10747]]
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
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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
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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