By David S. Brown, Esq.
In late July, the National Credit Union Administration (“NCUA”) proposed a rule that would require all Credit Union Service Organizations (“CUSO”) to file financial reports directly with the NCUA and the appropriate state supervisory authority. The rule would require CUSOs to use GAAP accounting, prepare quarterly financial reports and get annual audits.[1] The board also proposed limiting federally insured state-chartered credit unions’ aggregate cash outlays to a CUSO.[2] Finally, the rule would expand the definition of a CUSO to include CUSO subsidiaries.[3] NCUA stated two reasons for regulatory authority over all CUSOs. First, the NCUA desires parity with banks’ regulatory authority over bank operating subsidiaries and third party service providers.[4] Second, NCUA believes that CUSOs are a systemic risk to credit unions as a whole.[5]
As a whole, the credit union movement and CUSOs all across America have voiced a unified opposition to NCUA’s proposed rule. Many have questioned NCUA’s legal authority to approve the proposed rule. Although the NCUA has the authority to examine the books and records of CUSOs under section 712.3(d)(3), it is undisputed that NCUA does not have regulatory authority over CUSOs.[6] Moreover, critics agree that the new rule will put CUSOs at a competitive disadvantage with non-CUSO competitors. Obviously, the regulation will increase costs for CUSOs. More importantly, though, “the requirement to disclose confidential business plans and customer lists, documents that compromise a corporation’s intellectual property, would potentially expose private business secrets to public dissemination through Freedom of Information Act requests. These same risks would not be faced by CUSO competitors and could, in fact, be exploited by them.”[7]
The credit union movement also fears that the new rule will “single-handedly kill the one competitive advantage the credit union has.”[8] After all, CUSOs are “a unique business model that enables collaboration and innovation so credit unions can achieve economies of scale, increase efficiencies, share intellectual capital, provide better service to members, and mitigate risk.”[9] In simpler terms, CUSOs are innovative entities that let the credit unions approach risks collaboratively, minimizing the risk to any single institution.[10]
Finally, the credit union movement questions the need for the new regulation by pointing out that “the aggregate amount invested in and loaned to CUSOs is only 22 [basis points] of industry assets.”[11] “Each credit union’s CUSO investment risk is less than 1% of its assets.”[12] As one opponent said, “[t]his is hardly ‘systemic risk’ to the industry”.
Now that the September 26, 2011 comment deadline has passed, NCUA will consider whether to implement the new rule. The board is in the process of reviewing the more than 140 letters it received in response to the proposed regulation.
David Brown is an associate in Commercial Collections based in the Cleveland office of Weltman, Weinberg & Reis Co., LPA. He can be reached at 216.685.1062 or dbrown@weltman.com.
Footnotes:
[1] Marx, Claude R., NCUA Wants More CUSO Disclosure, Credit Union Times, July 27, 2011, http://www.cutimes.com/2011/07/24/ncua-wants-more-cuso-disclosure.
[2] Samaad, Michelle A., New CUSO Regs Prompt a Mountain of Concern: NACUSO CEO Says Clarifications Needed, Credit Union Times, August 17, 2011, http://www.cutimes.com/2011/08/17/new-cuso-regs-prompt-a-mountain-of-concern; see also Proposed Rule, http://www.ncua.gov/GenInfo/BoardandAction/DraftBoardActions/2011/July21/Item2b11-0721.pdf.
[3] Marx, Claude R., supra.
[4] Letter from NACUSO, Jack M. Antonini to NCUA, Mary Rupp, dated August 4, 2011, https://www.nacuso.org/wp-content/uploads/2011/08/NACUSO_Comment_Letter_to_CUSO_Rule_8_4_2011-FINAL.pdf.
[5] Id.
[6] Letter from CU Direct Corporation, Tony Boutelle to NCUA, Mary Rupp, dated September 2, 2011, https://www.nacuso.org/wp-content/uploads/2011/08/CommentLetter-CUDirect-TonyBoutelle.pdf; see also Letter from Mazuma Credit Union, Brandon Michaels to NCUA, Mary Rupp, dated August 15, 2011, https://www.nacuso.org/wp-content/uploads/2011/08/CommentLetter-MazumaCreditUnion-BrandonMichaels.pdf.
[7] Tony Boutelle, supra.
[8] Samaad, Michelle A., supra.
[9] Id.
[10] Russell, Jeff, Newest NCUA Proposed CUSO Regulation Will Likely Stifle Innovation, September 1, 2011, https://www.nacuso.org/2011/09/01/newest-ncua-proposed-cuso-regulation-will-likely-stifle-innovation/.
[11] Brandon Michaels, supra.
[12] Id.
By Brian Lauer
There are many reasons why a credit union would invest in a Credit Union Service Organization (CUSO) instead of providing the same services directly through the credit union. These reasons may be that the CUSO is a collaboration of several CUSOs to create economies of scale, that it would be too cost prohibitive to initiate the service from the ground up, or that a credit union would not be permitted to perform the service itself like insurance services. One enticing reason to invest in a CUSO is to shield the credit union from the liability associated with the services by moving operations into a CUSO.
This shield has also become important recently because the National Credit Union Administration (NCUA) is questioning the sufficiency of this limitation by stating that CUSOs are creating systemic risk to the credit union industry. However, the only way CUSOs can cause systemic risk to credit unions is if a credit union investor does not maintain this shield and opens itself up to the liabilities of the CUSO. As you can see in Part 712 of the NCUA regulations, this means ensuring that the CUSO is a separate entity from the credit union in the eyes of the legal system preventing third party creditors from attaching the obligations of the CUSO to its credit union owners. If a CUSO does not maintain this separateness, a court may grant a creditor this ability, which is often called “piercing the corporate veil.” The decision to pierce the corporate veil by a court is not black and white. Instead, a judge or jury will look at many factors and weigh each of those factors to determine if the veil should be pierced. Although this doctrine is driven by state law and may be slightly different from state to state, the factors used by the courts in most states are substantially similar.
Before we discuss the factors generally analyzed by the courts, it is important to note why a creditor would feel it necessary to pierce the corporate veil, and as usual, it all comes down to money. Generally, a creditor of the CUSO will seek payment directly from the CUSO for the CUSO’s obligations, but what if the CUSO cannot meet its obligations (i.e. it does not have the money)? A creditor may look through the CUSO to its owners with the objective of getting paid. So, even though a credit union may invest in a CUSO to shield the credit union from the liability of a particular service, a third party creditor of the CUSO may try to break down that barrier to get paid, and as I have said, if it appears to a court that the CUSO is not a separate entity from its owners, the court may not honor this limitation of liability.
This is why one of the most important factors analyzed by a court is capitalization of the CUSO.
A CUSO must be adequately capitalized to meet the reasonably foreseeable obligations of the services provided by such CUSO. This takes the form of both capital infusion and reasonable errors and omissions and/or general liability insurance. If a creditor is trying to pierce the corporate veil, my first guess would be that the entity was not capitalized and insured to meet the present obligations upon it. However, the creditor must show that these obligations were reasonably foreseeable and not extraordinary. Simply not having the capital or insurance to pay every single third party claim is not enough to pierce the veil. It must be shown that the third party claim is a reasonable byproduct of conducting the business of the CUSO. It is also important to note that this is just one factor considered by a court and that not having adequate capital and insurance alone may not be enough to pierce the veil. Obviously, there are many instances where companies become insolvent and this alone is not a license to dig into the pockets of its owners.
The remaining factors deal mostly with the operations of the CUSO. Essentially, the question is whether the CUSO is formally operating as a separate entity. Your CUSO must keep accurate books and records which should include meeting minutes and resolutions of the Board. Furthermore, the CUSO must have a distinct governing body that can be comprised of employees of the credit union, but must act on their own accord. It is also important that the management of the CUSO not be controlled by a majority of the board of directors of the credit union because this gives the impression that the CUSO is merely a department of the credit union. The CUSO’s funds should not be intermingled with the credit union’s funds or misappropriated by an owner. Although this seems like common sense, this may be an issue with CUSOs owned solely by one credit union. You must ensure that the CUSO and credit union have separate operating accounts and that any exchange of funds between the two is formalized in writing and for fair consideration. Similarly, the CUSO should have separate policies and procedures. These can emulate those of a credit union but should be formally adopted by the Board of the CUSO.
As you can see, many of these corporate formalities can be handled through good books and records documenting the operations of the CUSO. There is also one document that relates specifically to examinations and corporate separateness that is incredibly important. For every CUSO investment, the NCUA requires the investor credit union to obtain an attorney opinion letter stating that the CUSO is a separate entity. To draft such a letter, the attorney will review the CUSOs books and records to ensure that the company is maintaining the corporate shield. For examination purposes, this is very important to have on file, but I think it is also important to think about in this current climate. Many companies and credit unions are having trouble, and many creditors are less and less likely to write down losses. This is leading to a lot more litigation, and that litigation is definitely touching the credit union world. You should take the time to think about these issues so that you feel more comfortable with your CUSO and the limitation of liability I am sure the credit union believes it has.
Brian G. Lauer is a partner with Messick & Weber PC in Media, PA. He can be reached at 610- 891-9000 or blauer@cusolaw.com
By Katherine Weber
If you are not involved in a CUSO, what are you waiting for? Are you not interested in making money? Or maybe you are not interested in saving money? It is intriguing to me to see the demographics of the credit unions involved in CUSOs—historically, they tend to be the larger credit unions. This is rather counterintuitive in some ways, as it is the smaller credit unions that could benefit the most from a CUSO. In fact, I would venture to say it is the smaller credit unions that should consider CUSO involvement to be mandatory for their survival! When it comes to the bottom line—which let’s face it—most credit unions are focused on the bottom line these days—CUSOs can either help you save money or generate the non-interest income you are looking for. In this economy, all credit unions should be looking for ways to trim down on expenses. We represent a CUSO the owners of which estimate the CUSO saves them each approximately one million dollars per year. Now that’s what I call trimming the fat! It’s a technology CUSO called OTS. It was originally formed by two credit unions each with over two billion in assets.
If making money or saving money does not convince you, would you like to be able to provide a broader scope of services to your members in a more efficient manner? CUSOs are the collaboration mechanism that enables credit unions together to be able to offer what individually they would not have the economic resources or personnel expertise to do so. Collaborative multi-owned CUSOs provide scale. CU Student Choice Partners, LLC is a perfect example of multiple credit unions of varying sizes collaborating to offer student loan products to members. It is not only an income generator but it is also infusing its credit union owners and users with a new much needed demographic of members. These members in college and graduate school have their entire financial lives ahead of them—from car loans, to mortgage loans to investments.
Still not convinced? Well, how about a combo of one and two—make money and offer an additional service to your members efficiently. CUSO Financial Services, LP is a broker dealer enabling credit unions to do just that. The broker dealer CUSO has 50 credit union owners and has paid out $15 million in distributions to its owners over the past three years. Would a new service along with extra earnings make an impact on your credit union?
This is not an advertisement for any particular CUSO. It hopefully motivates you to start thinking creatively. Start brain storming—where could you collaborate to save some money or make some money? What services do your members want? Whatever the idea, “There’s a CUSO for that!”
Katherine Weber is a partner at Messick & Weber P.C. and a co-host of the Current Issues in Credit Unions podcast.
