[Federal Register Volume 60, Number 192 (Wednesday, October 4, 1995)]
[Rules and Regulations]
[Pages 51886-51889]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-24688]



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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: Final rule

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SUMMARY: Currently, 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. To reduce regulatory burden, the NCUA 
Board is amending the regulations to give member-elected credit union 
boards more flexibility to determine compensation policies, including 
the use of incentive pay.

EFFECTIVE DATE: October 4, 1995.

ADDRESSES: National Credit Union Administration, 1775 Duke Street, 
Alexandria, VA 22314-3428.

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 Sec. 741.3(a) of the Regulations, 12 CFR 
741.3(a), the prohibition applies to federally insured state-chartered 
credit unions. As a consequence of the regulation, federally insured 
credit unions may not provide incentive compensation to officials and 
loan officers.
    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.
    On April 13, 1995, the Board issued a proposed regulation which 
would amend Sec. 701.21(c)(8) to authorize lending-related compensation 
in certain situations where it is currently prohibited. 60 FR 19690 
(April 20, 1995). A total of 105 comments was received, 48 from federal 
credit unions, 29 from state-chartered credit unions, 19 from national 
and state credit union leagues, 3 from insurance companies, 2 from 
state credit union regulators, and 1 each from a banking trade 
association, Member of Congress, law firm, and individual.
    Seventy-four commenters felt that the proposed regulation was too 
restrictive. Seven commenters expressed unqualified support for the 
proposed regulation and nine expressed qualified support. Seven 
commenters stated that credit unions should not be permitted to pay 
incentives, period. Six commenters urged that the current regulation be 
retained, expressing concern that additional authority to pay 
incentives could create safety and soundness problems.

Final Rule

    In response to the comments, and to reduce regulatory burden, the 
Board has determined to give member-elected boards of directors more 
flexibility in determining compensation policies for lending-related 
activities, including the use of incentive pay. Accordingly, the final 
rule will allow federal credit unions to pay: (1) To any employee, 
including a senior management employee, an incentive or bonus based on 
the overall financial performance of the credit union; and (2) to any 
employee, except a senior management employee, an incentive based on a 
loan made by the credit union, provided that the board of the credit 
union has established written policies and internal controls in 
connection with the incentive or bonus and monitors compliance with 
them at least annually. In addition, the final rule will allow a credit 
union's volunteer officials and non senior management employees, and 
family members of officials and all employees, to receive compensation 
from an outside party for a service or activity performed outside the 
credit union, provided that neither the credit union nor the official, 
employee, or family member has ``steered'' anyone to the other party. 
This will allow for ``incidental'' situations resulting from the fact 
that volunteer officials, non senior management employees, such as 
part-time employees, and family members of employees, may have jobs 

[[Page 51887]]
outside the credit union in areas such as insurance or real estate, 
where customers of the outside business choose to obtain loans from the 
credit union.
    The Board wishes to make clear that this action is not intended to 
encourage lending-related incentives. In the preamble to the proposed 
rule, the Board expressed some of its concerns regarding incentive pay, 
particularly for lending activities. However, this liberalization and 
deregulation reflects the recognition that there are good arguments and 
strongly held beliefs on both sides of the incentive pay issue. It is 
the Board's determination, in light of those considerations and the 
comments received, that NCUA should structure a rule that involves 
basic controls and safety and soundness standards and that, beyond 
that, allows a member-elected board of directors to decide whether to 
use incentives. Of course, NCUA reserves the right to take exception to 
any compensation plan for safety and soundness reasons.

Analysis

    The supplementary information section of the preamble stated that 
the structure of the regulation had been changed to make it easier to 
interpret and administer. The preamble noted that it had been difficult 
to determine, in the current regulation, whether an activity was part 
of ``underwriting, insuring, servicing, or collecting'' a loan. The 
proposed regulation only required that an activity be ``in connection 
with'' a loan. The preamble stated that NCUA would take a 
reasonableness approach to that determination.
    In an effort to illustrate the distinction between activities in 
connection and not in connection with lending, the preamble provided 
examples. The following were presented as being not in connection with 
lending: (1) Purchasing loan application forms from a company owned by 
an official; and (2) Financing a home (already) built by a construction 
company owned by an official. In contrast, the following were presented 
as being in connection with lending: (1) Obtaining a credit report from 
a credit bureau owned by an official; and (2) Referring a member to a 
construction company owned by an official to have a home built and 
financing the construction of the home.
    Eleven commenters stated that the phrase ``in connection with'' was 
too broad or too vague. Two commenters stated that the examples 
provided did little to clarify the scope of coverage of the regulation.
    The Board continues to believe that the proposed prohibition would 
be easier to administer than the current regulation and has therefore 
retained it in the final rule. The Board acknowledges, however, that 
the examples provided were not helpful. Rather than trying to determine 
whether an activity is significant enough to be considered ``in 
connection with'' a loan, the Board has concluded that any activity 
that is directly linked to lending should be considered to be ``in 
connection with'' a loan. Under that analysis, each of the four 
examples discussed above involves an activity that is in connection 
with a loan.-
    Proposed paragraph (8)(ii) set forth definitions, only three of 
which elicited comment. The proposed regulation defined 
``compensation'' as including non monetary items, and a few commenters 
stated that items of nominal value should be excluded. The Board 
agrees, and has changed the definition accordingly. Items of nominal 
value are those with a value so small as to make accounting for them 
unreasonable or administratively impracticable. The board of directors 
of a credit union may look to Internal Revenue Service law regarding 
income and de minimus fringe benefits, 26 USC 132, for guidance in this 
area.
    The proposed regulation defined ``employee'' to include independent 
contractor. The intent was to prevent credit unions from evading the 
rule by calling an individual who is essentially an employee an 
independent contractor. Several commenters objected to including 
independent contractors in the definition of employee. They said that 
it would have the effect of prohibiting any lending-related 
compensation to any independent contractors or third parties. The Board 
agrees and has deleted the term ``independent contractor'' from the 
final rule. The Board notes, however, that NCUA will treat an 
individual functioning as an employee as such for the purposes of 
Sec. 701.21(c)(8).
    The proposed regulation defined ``senior management employee'' as 
it is defined elsewhere in the NCUA regulations (the chief executive 
officer, any assistant chief executive officers, and the chief 
financial officer) but added the phrase, ``and any other employee who 
sets policy for the credit union.'' Several commenters objected to this 
addition, arguing that it was too broad and muddied the distinction 
between senior management and other employees. The Board agrees and has 
deleted the phrase from the final rule.
    Finally, in the final rule the Board has deleted the definition of 
``workout loan'' as unnecessary and added a definition for ``volunteer 
official.'' A volunteer official is a director or committee member who 
is not compensated as such. Federal credit unions are permitted to 
compensate one director solely for his or her service on the board, and 
many state-chartered credit unions are permitted by state law to 
compensate one or more directors for such service. Under the final 
rule, a director so compensated would not be considered a volunteer 
official.
    Paragraph (8)(iii) of the proposed regulation set forth five 
exceptions to the prohibition against lending-related compensation. 
Exception (A), salary for employees, was met with universal approval 
from the commenters. Exception (B) was an incentive or bonus to an 
employee, including a senior management employee, based on the credit 
unions overall financial performance. This codified a position that had 
been taken in an opinion letter from NCUA and also was supported by the 
commenters. Accordingly, exceptions (A) and (B) have been retained in 
the final rule.
    Exceptions (C), (D), and (E) authorized payment of an incentive to 
an employee in connection with processing a loan, making a decision to 
approve or disapprove a loan, and collecting a loan, respectively, 
provided that no incentive or bonus was paid to a supervisor of the 
employee, a senior management employee, or an immediate family member 
of a supervisor or senior management employee. Exception (D) 
additionally required that an incentive paid in connection with making 
a loan decision not be based on the number or dollar amount of loans 
approved and be structured in a manner that demonstrably protected 
against an increase in problem loans.
    Sixteen commenters said that non senior management should be 
permitted to receive incentives. Many said that the prohibition against 
payment of incentives to supervisors would disproportionately affect 
large credit unions. They argued that lower level supervisors would be 
caught between senior management, who receive bonuses based on overall 
performance, and front-line employees, who are eligible for incentive 
pay. In response to the comments, the Board has removed the prohibition 
against supervisors receiving incentive pay from the final rule.
    Thirty-eight commenters objected to the prohibition against basing 
incentives on the number or dollar amount of loans approved. Most said 
there were no other reasonable measures on which to base incentives for 
loan officers. As 

[[Page 51888]]
discussed above, the Board has determined to deregulate this issue and 
allow credit unions to structure their own incentive plans. This is 
provided for in Exception (C) in the final rule, which simply provides 
that a federal credit union may pay an incentive or bonus to a non 
senior management employee in connection with a loan made by the credit 
union. This includes incentives for any activity connected with 
lending, including processing and collecting loans, making credit 
decisions, and selling credit life, credit disability, and mechanical 
breakdown insurance. The only limitation is that the board of directors 
of the credit union must have established written policies and internal 
controls in connection with the incentive or bonus and must monitor 
those policies and controls annually.
    The final rule's requirement of annual monitoring of policies and 
controls is a change from paragraph (8)(iv) of the proposed regulation, 
which required quarterly monitoring. Thirteen commenters said that 
quarterly review was too frequent, arguing that it would put the board 
of the credit union in the role of micro-managing the credit union. In 
response to the comments, the change was made. The Board notes, 
however, that the supervisory committee, or internal auditor in larger 
credit unions, should consider reviewing the effectiveness of incentive 
pay policies and controls more frequently than annually.
    Paragraph 8(iv) of the proposed rule also required that 
documentation of the monitoring be made available to the supervisory 
committee and NCUA. There was some confusion about this requirement. 
Several commenters asked whether documentation should be made available 
to examiners during exams or sent to NCUA. There also was a question as 
to whether state-chartered credit unions should provide documentation 
to the state regulator. The Board has deleted this requirement as 
unnecessary. Under the final rule, a credit union wishing to provide 
incentive pay must establish written policies. These are by definition 
part of the books and records of the credit union, which are open to 
the supervisory committee of the credit union and to NCUA examiners.
    The preamble to the proposed rule discussed a number of policy 
changes the regulation would make. It first noted that the current 
regulation had 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. 
Since listing or selling property financed by the credit union is ``in 
connection with'' the loan, however, the proposed rule would prohibit 
compensation for such activity.
    The preamble also noted that the current regulation had been 
interpreted to prohibit a credit union official or employee from, for 
example, owning an insurance company that sells car insurance to 
members who finance their cars at the credit union. An argument had 
been made, however, that the regulatory language prohibited the receipt 
of compensation in connection with insuring the loan but not in 
connection with insuring collateral securing the loan. The preamble 
stated that NCUA was concerned about the opportunity for credit union 
officials and employees to steer members to a particular insurance 
agency and that the proposed regulation therefore would prohibit all 
officials and employees from receiving compensation for insuring 
collateral securing a loan made by the credit union.
    A number of commenters stated that the prohibition against 
receiving compensation for outside activities might restrict members 
from volunteering to serve on a credit unions board. The NCUA Board 
shares that concern and has determined to permit volunteer officials 
and non senior management employees of a federal credit union, and the 
family members of officials and all employees, to receive compensation 
from an outside party for an activity performed outside the credit 
union, as long as neither the credit union nor the official, employee, 
or family member refers any person to the other party. Thus, the 
borrower's receipt of a loan from the credit union should be 
unconnected to his or her participation in the outside activity of the 
official, employee, or family member. The Board believes the 
prohibition should remain in effect for senior management employees in 
order to prevent situations where subordinate employees feel pressure 
to make loans to customers of the outside business interest of the 
senior management employee. The exception will ensure, at the same 
time, that NCUA's rules do not interfere with the livelihoods of 
volunteer officials, non senior management employees, such as part-time 
employees, and the family members of officials and employees. This is 
set forth in Exception (D) of the final rule. -

Regulatory Procedures

Regulatory Flexibility Act

    The NCUA Board certifies that this 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

    NCUA has determined that the requirement to establish a written 
policy in connection with the payment of lending-related incentives 
does constitute a collection of information under the Paperwork 
Reduction Act. The Paperwork Reduction Act of 1995 and regulations of 
the Office of Management and Budget (OMB) require that the public be 
provided an opportunity to comment on information collection 
requirements, including an agency's estimate of the burden of the 
collection of information. NCUA estimates that no more than 1000 
federally insured credit unions will seek to implement lending-related 
incentive compensation policies. It is NCUA's view that the time a 
credit union spends developing a responsible policy is not a burden 
created by this regulation but rather is necessary to the safe and 
sound payment of lending-related incentives. The paperwork burden 
created by this rule is the requirement that such policy be put in 
writing. NCUA estimates that it should take at most one hour to put an 
incentive policy in written form. Therefore, 1000 total burden hours 
are required to comply with the collection requirement.
    The NCUA Board invites comment on: (1) Whether the collection of 
information is necessary for the proper performance of the functions of 
NCUA, including whether the information will have practical utility; 
(2) The accuracy of NCUA's estimate of the burden of the collection of 
information; (3) Ways to enhance the quality, utility, and clarity of 
the information to be collected; and (4) Ways to minimize the burden of 
the collection of information. Send comments to Suzanne Beauchesne, 
National Credit Union Administration, 1775 Duke Street, Alexandria, VA 
22314-3428. Comments should be postmarked by December 4, 1995.
    After 60 days, NCUA will submit the paperwork requirement to OMB 
for review under the Paperwork Reduction Act and will publish a notice 
to that effect in the Federal Register. NCUA will also publish a notice 
in the Federal Register once OMB takes action on the submitted request. 
Until NCUA receives an OMB control number indicating approval of the 
requirement that 

[[Page 51889]]
incentive policies be put in writing, a credit union is not required to 
comply with that requirement.

Regulatory Burden--

    Section 302 of the Riegle Community Development and Regulatory 
Improvement Act of 1994 requires the federal regulators of banks and 
savings associations to make all regulations that impose new 
requirements take effect on the first date of the calendar quarter 
following publication of the rule unless good reason exists for some 
other effective date. Although NCUA is not formally subject to this 
requirement, Letter to Credit Unions #158 stated that the requirement 
would be beneficial to credit unions and that NCUA planned to implement 
it whenever practicable. NCUA believes that an immediate effective date 
is appropriate since the final rule relieves a regulatory burden on 
credit unions that wish to implement lending-related incentive 
compensation programs by permitting them to do so. Although the final 
rule also imposes a recordkeeping requirement, the primary effect of 
the rule is to relieve regulatory burden.

Executive Order 12612

    Executive Order 12612 requires NCUA to consider the effect of its 
actions on state interests. The preamble to the proposed rule 
acknowledged that the proposed rule would impose some requirements on 
state-chartered, federally insured credit unions but stated that any 
effect on the distribution of power and responsibilities among the 
various levels of government was justified by the potential risk to the 
NCUSIF. Several commenters argued that no risk to the NCUSIF had been 
demonstrated and that, for state-chartered credit unions, the matter 
should be left to state regulators to determine.
    The final rule imposes significantly less regulatory burden on 
credit unions than either the proposed rule or the currently effective 
rule. Therefore, the effect on state regulatory authority is 
considerably diminished. The Board continues to believe, however, that 
any remaining effect on that authority is justified by the potential 
risk to the NCUSIF without such a rule.
    The Board notes that this rule is not intended to expand the 
authority of state-chartered credit unions. If state law imposes 
greater restrictions on lending-related compensation than does this 
rule, state-chartered credit unions must comply with state law.

List of Subjects in 12 CFR Part 701

    Federal credit unions, Organization and operations.

    By the National Credit Union Administration Board on September 
28, 1995.
Becky Baker,
Secretary of the Board.
    For the reasons set forth in the preamble, NCUA amends 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 Pub. L. 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.


Sec. 701.21  [Amended]

    2. Section 701.21(c)(8) is revised to read as follows:
* * * * *
    (c) * * *
    (8)(i) Except as otherwise provided herein, no official or employee 
of a Federal credit union, or immediate family member of an official or 
employee of a Federal credit union, may receive, directly or 
indirectly, any commission, fee, or other compensation in connection 
with any loan made by the credit union.
    (ii) For the purposes of this section:
    Compensation includes non monetary items, except those of nominal 
value.
    Immediate family member means a spouse or other family member 
living in the same household.
    Loan includes line of credit. -
    Official means any member of the board of directors or a volunteer 
committee.
    Person means an individual or an organization.--- -
    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), 
and the chief financial officer (Comptroller).
    Volunteer official means an official of a credit union who does not 
receive compensation from the credit union solely for his or her 
service as an official.
    (iii) This section does not prohibit:
    (A) Payment, by a Federal credit union, of salary to employees; - -
    (B) Payment, by a Federal credit union, of an incentive or bonus to 
an employee based on the credit union's overall financial performance;
    (C) Payment, by a Federal credit union, of an incentive or bonus to 
an employee, other than a senior management employee, in connection 
with a loan or loans made by the credit union, provided that the board 
of directors of the credit union establishes written policies and 
internal controls in connection with such incentive or bonus and 
monitors compliance with such policies and controls at least annually.
    (D) Receipt of compensation from a person outside a Federal credit 
union by a volunteer official or non senior management employee of the 
credit union, or an immediate family member of a volunteer official or 
employee of the credit union, for a service or activity performed 
outside the credit union, provided that no referral has been made by 
the credit union or the official, employee, or family member.
* * * * *
[FR Doc. 95-24688 Filed 10-3-95; 8:45 am]
BILLING CODE 7535-01-P