[Federal Register Volume 60, Number 76 (Thursday, April 20, 1995)]
[Proposed Rules]
[Pages 19690-19693]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-9616]
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NATIONAL CREDIT UNION ADMINISTRATION
12 CFR Part 701
Organization and Operations of Federal Credit Unions
Agency: National Credit Union Administration (NCUA).
Action: Proposed rule.
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Summary: National Credit Union Administration (NCUA) Rules and
Regulations prohibit officials and certain employees of federally
insured credit unions from receiving either incentive pay or outside
compensation for certain activities related to credit union lending.
The regulations are ambiguous in places and have proved difficult to
interpret. Further, the regulations may be too restrictive in some
instances and too broad in others. The NCUA Board is proposing to amend
the regulations to make them clearer, to authorize lending-related
compensation in certain situations where it is currently prohibited,
and to prohibit it in other situations. If amended as proposed, it
should be easier for credit unions to determine when incentives may be
paid and easier for officials and employees to determine whether they
may accept compensation for outside activities.
Dates: Comments must be postmarked or posted on NCUA's electronic
bulletin board by June 19, 1995.
Addresses: Mail comments to Becky Baker, Secretary of the Board,
National Credit Union Administration, 1775 Duke Street, Alexandria, VA
22314-3428. Send comments to Ms. Baker via the bulletin board by
dialing 703-518-6480.
For Further Information Contact: Lisa Henderson, Staff Attorney, (703)
518-6561, at the above address.
SUPPLEMENTARY INFORMATION:
Background
Section 701.21(c)(8) of the NCUA Rules and Regulations, 12 CFR
701.21(c)(8), prohibits federal credit unions from making a loan if,
either directly or indirectly, any commission, fee, or other
compensation is to be received by the credit union's directors,
committee members, senior management employees, loan officers, or any
immediate family members of such individuals, in connection with
underwriting, insuring, servicing, or collecting the loan. However,
non-commission salary may be paid to employees. As a condition of
federal insurance pursuant to Section 741.3(a) of the Regulations, 12
CFR 741.3(a), the prohibition applies to federally insured state-
chartered credit unions. The purpose of Section 701.21(c)(8) is to
ensure that an individual who is in a position of authority in a credit
union does not put self-interest ahead of the credit union's interest
in making good loans and providing good service to its members. The
provision prohibits compensation from third parties and from the credit
union itself, in the form of commissions, incentive pay, or bonuses.
Under the current regulation, a ``loan officer'' is an individual
who has the authority to approve a loan. A loan officer may or may not
be involved in taking and processing loan applications. ``Underwriting
the loan'' means approving or disapproving it. Thus, an individual who
has any part in approving a loan is prohibited for receiving incentive
pay in connection with that loan. An individual who is involved in
processing a loan, but who has no role in its approval or disapproval,
may receive incentive pay in connection with the loan.
The prohibition against making a loan if a commission or fee is to
be received by a loan officer in connection with insuring the loan
means, for example, that the individual who has the authority to
approve a loan may not receive an incentive for selling credit life or
disability insurance on it.
Noting that credit union management had become increasingly
interested in implementing lending-related incentive pay programs, the
NCUA Board, on March 9, 1994, issued a Request for Comment on whether
Sec. 701.21(c)(8) should be amended to permit loan officers and/or
senior management to receive incentive pay for underwriting and
insuring loans, 59 FR 11937 (March 15, 1994). A total of 252 comments
was received, 177 of which expressed support for allowing incentive pay
for loan officers. Most of the latter suggested that incentive pay be
permitted only with controls in place.
A number of commenters described the success their credit unions
had had with incentive programs involving employees other than loan
officers; they argued that even greater benefits would accrue from
paying incentives to loan officers. Most of these programs seem to have
been implemented in the past few years, however, and some of the
information submitted to the Board raises questions about whether they
will be successful in the long run.
For example, information submitted by one commenter cites research
which has shown that incentive programs can fail in the long term
because employees become preoccupied with meeting goals and fail to
carry out their normal routines. When management sets a specific goal,
and offers a reward for meeting it, work or problems that do not relate
to that goal are ignored. Cooperative spirit between people often
diminishes because each has different goals and becomes wrapped up in
his or her own work. Incentive pay can actually work to undermine an
employee's internal motivation to perform well, as employees end up
working for the incentive rather than the satisfaction of the work
itself. Employees can also be demoralized by the underlying assumption
that they are not working hard and need incentives to perform.
One credit union commenter learned about the risks of incentive
programs the hard way. He reported that his credit union's incentive
program for loan officers was unsuccessful for the following reasons:
(1) Despite controls being in place, some loan officers exceed their
authority in approving [[Page 19691]] loans. The commenter noted that
even if a loan officer can be disciplined for poor judgment, ``once a
loan is made, you can't take it back.''; (2) Incentives caused disputes
among loan officers, each of whom thought the others were receiving
more favorable treatment from management by having more creditworthy
loans routed to them; and (3) Incentives caused some animosity between
employees who were eligible for incentive pay, such as those in the
loan department, and those who were not.
Other commenters argued that incentives are not necessary for
successful loan programs. One commenter provided details of how his
credit union had dramatically improved productivity after eliminating
all incentives. He reported that the credit union's consumer loan
approval ratio had increased from 62% to 84% as a result of
centralizing the origination function and implementing a credit scoring
system. The credit union also improved service to members by providing
loan decisions within 24 hours and making the terms and pricing of its
products more competitive. In two years, the consumer loan portfolio
increased by 38% while loan delinquencies and charge-off ratios
remained better than the credit union's peer group. As a result of
improved terms and pricing of mortgage products, originations increased
from $62 million in 1991 to $161 million in 1993.
Despite misgivings about incentive pay, the Board recognizes the
strong arguments made by many commenters that if incentive pay can be
offered in a manner that protects against abuses, the decision whether
to do so should be a management decision, not one that is precluded by
an overly restrictive regulation. Therefore, the Board is proposing to
allow credit unions to provide incentive pay to some employees,
including loan officers, in certain circumstances, as described below.-
Proposed Regulation
The proposed rule changes the structure of the regulation to a
broad prohibition, with specific exceptions, against an official or
employee receiving compensation in connection with any loan made by the
credit union. The Board believes that this structure will be easier to
interpret and administer. It has proved difficult to determine, in the
current regulation, whether certain activities are part of
``underwriting, insuring, servicing, or collecting'' a loan,
particularly ``underwriting'' and ``insuring.'' Proposed paragraph 8(i)
only requires that an activity be determined to be ``in connection
with'' a loan. NCUA would take a reasonableness approach to that
determination.
For example, suppose an official owns a company that manufactures
forms. In this example, a credit union could purchase loan application
forms from the company, even if it resulted in compensation to the
official, since the purchase of loan application forms is not
reasonably ``in connection with'' making a loan.\1\ On the other hand,
if an official owned a credit bureau, a credit union could not obtain
credit reports from the company, resulting in compensation to the
official, because providing credit reports is reasonably ``in
connection with'' making a loan.
\1\Other legal restrictions would apply, however. For example,
common law principles would require that the transaction be at arms
length and in the credit union's best interest, and the standard FCU
Bylaws would require that the interested director recuse himself or
herself from the decision to purchase the forms.
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Similarly, a credit union could finance a home built by a
construction company owned by an official, as long as the credit union
was not financing the construction of the home, as building a home is
not reasonably in connection with making a loan. However, a credit
union would be prohibited from referring a member to the construction
company to have a home built, as in that case, the construction would
be in connection with making a loan.
In the context of incentive pay, rather than outside compensation,
loan processing and making credit decisions on loans are clearly
activities in connection with making loans. Thus, an employee would be
prohibited from receiving incentive pay for performing those activities
unless covered by an exception.
Exception (A) would allow credit unions to pay salary to employees
who perform activities in connection with making loans. This is in the
current regulation and needs no discussion.
Exception (B) would clarify that an incentive may be paid to an
employee based on the overall financial performance of the credit
union, which of course depends in part on its lending activities. While
it could be argued that such an incentive is not truly ``in connection
with'' a loan made by the credit union, the Board has included the
exemption to avoid confusion. The Board believes that this type of
incentive presents fewer problems than does an incentive based on the
performance of a single individual, as it is focused on the interests
of the credit union as a whole. However, incentives based on an
organization's overall performance must still be monitored closely to
avoid the problems discussed above. NCUA of course reserves the right
to take exception to overall performance related incentive plans for
safety and soundness reasons, for example, and plans where incentive
pay is based on asset growth with no consideration of factors such as
capital and asset quality.
Despite the concerns raised about incentives based on an
individual's performance, the Board is proposing to allow credit unions
to develop incentive programs with that feature. The Board is
responsive to the significant interest on the part of credit unions to
implement such programs. Proposed exceptions (C), (D), and (E) would
allow credit unions to make incentive payments to employees for
processing loans, making recommended or final decisions to approve or
disapprove loans, and collecting loans, respectively. In order for an
employee to be eligible for an incentive, there must be a supervisory
level above the employee that does not receive incentive pay for the
activity in question. Furthermore, a senior management employee may not
receive incentive pay for any of the activities. Supervisors and senior
management employees are excluded from direct incentive pay in the
interests of sound internal control. However, the proposed rule would
allow such employees to receive bonuses based on broad measures of
management skill, such as profitability.
Credit unions already have the authority to provide incentive pay
for processing and collecting loans. The real change is the proposal to
allow loan officers to receive incentive pay. To address the concern
regarding loan quality, the proposed rule provides that incentives for
making recommended or final decisions to approve or disapprove loans
may not be based on the number or dollar amount of loans approved. The
Board requests comment on this restriction. Commenters who believe that
it is not necessary should provide evidence to that effect.
The proposed rule also requires that there be sufficient controls
in place to prevent an increase in problem loans. A credit union would
have the responsibility of structuring its incentive pay program to
meet this requirement.
Finally, proposed paragraph (8)(iv) of the regulation would require
that the board of directors establish written policies and controls for
any incentive plan and monitor compliance on at least a quarterly
basis. [[Page 19692]]
Policy Changes
In addition to allowing incentive pay for loan officers under
certain circumstances, the proposed rule would make additional policy
changes. The current regulation has been interpreted to permit a credit
union official or employee to receive compensation for acting as an
agent in the sale of property securing a loan made by a credit union,
on the rationale that listing or selling a property on which a loan is
granted is not included in underwriting, insuring, servicing, or
collecting the loan. Under this interpretation, an official or employee
not only could receive a commission from an outside party for selling
property financed by the credit union, he or she could also act as
listing agent for the credit union's sale of foreclosed properties
financed by the credit union. While listing or selling property
financed by a credit union is not included in underwriting, insuring,
etc., it is reasonably ``in connection with'' a loan made by the credit
union. Thus, compensation for such activity would be prohibited unless
the activity is covered by an exception. Since compensating an official
or employee for listing or selling property financed by the credit
union presents potential conflicts of interest, no exception is
provided.
The current regulation also permits employees who are not senior
managers or loan officers to receive incentives, from either the credit
union or an insurance company, for selling credit life and disability
insurance. Senior managers and loan officers may not receive such
incentives because of the prohibition against compensation for
``insuring'' a loan. Since selling credit insurance is an activity
reasonably ``in connection with'' a loan, the proposed rule prohibits
all employees from receiving compensation for the activity, unless it
is covered by an exception. The Board believes members should be
allowed to make their own informed decisions about credit insurance and
should not be pressured into purchasing it by employees who are
motivated by incentive pay. Accordingly, no exception is provided. Lest
there be any misunderstanding, however, credit unions are allowed to
sell credit insurance and to generate income for the credit union from
the activity.
The proposed regulation also clarifies another issue related to
insuring loans. The current regulation has always been interpreted to
prohibit, for example, a credit union official from owning an insurance
company that sells car insurance to members who finance their cars at
the credit union. Recently, it has been argued that the regulatory
language prohibits compensation in connection with insuring the loan
but not in connection with insuring collateral securing the loan. Under
this argument, the regulation clearly would apply to credit life and
disability insurance but would not appear to apply to ordinary car or
homeowners insurance. NCUA is concerned about the inherent conflict
that arises if an owner of an insurance agency that insures collateral
securing loans made by a credit union serves as a credit union
official, because of the opportunity to ``steer'' members to the
official's agency. Since insuring collateral is reasonably ``in
connection with'' a loan, the proposed regulation continues the
prohibition against a director receiving compensation for such
activity.
The Board also notes that ``insuring the loan'' recently has been
interpreted to include the sale of vehicle warranties (also called
insured vehicle service contracts and mechanical breakdown insurance)
in states in which such products are considered insurance. Thus, credit
union employees have been prohibited from receiving incentive pay for
selling vehicle warranties in those states. Since such products
generally are sold at the time a loan is made, they are reasonably ``in
connection with'' a loan. Therefore, the proposed regulation would
prohibit the payment of incentives to employees for the sale of these
products, regardless of whether they are considered insurance in a
particular state.
Regulatory Procedures
Regulatory Flexibility Act
The NCUA Board certifies that this final rule will not have a
significant impact on a substantial number of small credit unions
(those under $1 million in assets). Accordingly, a Regulatory
Flexibility Analysis is not required.
Paperwork Reduction Act
This proposed rule, if adopted, will impose no additional
collection requirements and, therefore, need not be sent to the Office
of Management and Budget for approval.
Executive Order 12612 -
Executive Order 12612 requires NCUA to consider the effect of its
actions on state interests. It states that: ``Federal action limiting
the policy-making discretion of the states should be taken only where
constitutional authority for the action is clear and certain, and the
national activity is necessitated by the presence of a problem of
national scope.'' The risks to federally insured credit unions are
concerns of national scope. The NCUA Board believes that the protection
of the NCUSIF warrants this rule. It will not unduly burden federally
insured state-chartered credit unions. This rule does not impose
additional costs or burdens on the state, nor does it affect the
states' ability to discharge traditional state government functions. -
The benefits provided and protection afforded by the NCUSIF are the
same for federally insured state-chartered credit unions as for
federally chartered credit unions. It is protection afforded through a
federal system. The responsibility for administering that system lies
with the NCUA Board. The NCUA Board believes that all federally insured
credit unions should continue to be subject to the same conflict
provisions in the area of lending. The NCUA Board, pursuant to
Executive Order 12612, has determined that this rule may have an
occasional direct effect on the states, on the relationship between the
national government and the states, or on the distribution of power and
responsibilities among the various levels of government. However, the
potential risk to the NCUSIF without these changes justifies them.
List of Subjects in 12 CFR Part 701
Credit unions.
By the National Credit Union Administration Board on April 13,
1995.
Becky Baker,
Secretary of the Board.
For the reasons set forth in the preamble, NCUA proposes to amend
12 CFR part 701 as follows:
PART 701--ORGANIZATION AND OPERATION OF FEDERAL CREDIT UNIONS
1. The authority citation for part 701 continues to read as
follows:
Authority: 12 USC 1752(5), 1755, 1756, 1757, 1759, 1761a, 1761b,
1766, 1767, 1782, 1784, 1787, 1789, and Public Law 101-73. Section
701.6 is also authorized by 31 USC 3717. Section 701.31 is also
authorized by 15 USC 1601, et seq., 42 USC 1981, and 42 USC 3601-
3610. Section 701.35 is also authorized by 12 USC 4311-4312.
2. Section 701.21(c)(8) is revised to read as follows:
Sec. 701.21 Loans to members and lines of credit to members.
* * * * *
(c) * * *
(8) Prohibited fees; exceptions.
(i) Except as otherwise provided in this section, no official or
employee of a Federal credit union, or immediate family member of an
official or [[Page 19693]] employee of a Federal credit union, may
receive, directly or indirectly, from an outside party or the credit
union, any commission, fee, or other compensation in connection with
any loan made by the credit union.
(ii) For the purposes of this section:
(A) Compensation includes non monetary items.
(B) Employee includes an independent contractor.
(C) Immediate family member means a spouse or other family member
living in the same household.
(D) Loan includes line of credit and workout loan.
(E) Official means any member of the board of directors or a
volunteer committee.
(F) Senior management employee means the credit union's chief
executive officer (typically, this individual holds the title of
President or Treasurer/Manager), any assistant chief executive officers
(e.g., Assistant President, Vice President, or Assistant Treasurer/
Manager), the chief financial officer (Comptroller), and any other
employee who sets policy for the credit union.
(G) Workout loan means a loan which has had its original terms
changed due to nonperformance or anticipated nonperformance.
(iii) This section does not prohibit a Federal credit union from
paying:
(A) Salary to employees; - -
(B) An incentive or bonus to an employee based on the credit
union's overall financial performance;
(C) An incentive or bonus to an employee in connection with
processing loans, provided that no such incentive or bonus is paid to a
supervisor of the employee, a senior management employee, or an
immediate family member of a supervisor or senior management employee;
(D) An incentive or bonus to an employee in connection with making
recommended or final decisions to approve or disapprove loans, provided
that:
(1) No such incentive or bonus is paid to a supervisor of the
employee, a senior management employee, or an immediate family member
of a supervisor or senior management employee; and
(2) The incentive or bonus may not be based on the number or dollar
amount of loans approved and must be structured in a manner that
demonstrably protects against an increase in problem loans;
(E) An incentive or bonus to an employee in connection with
collecting loans, provided that no such incentive or bonus is paid to a
supervisor of the employee, a senior management employee, or an
immediate family member of a supervisor or senior management employee.
(iv) The board of directors of a Federal credit union shall
establish and implement written policies, procedures, and internal
controls for any payment of incentives or bonuses to employees in
connection with loans made by the credit union. At least quarterly, the
board shall monitor compliance with such policies, procedures, and
controls. Documentation of such monitoring shall be made available to
the supervisory committee and NCUA.
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[FR Doc. 95-9616 Filed 4-19-95; 8:45 am]
BILLING CODE 7535-01-U