Fiduciary Duties: An Overview and Action Plan for NCUA s New Rule

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2 Fiduciary Duties: An Overview and Action Plan for NCUA s New Rule

3 Today s Agenda The Current Climate An Overview of Corporate Governance and Fiduciary Duties Detailed Review of NCUA s Rule Fiduciary Duties Volunteer and Employee Indemnification Merger and Conversion Issues A Framework for Meeting the New Expectations

4 The Current Climate

5 The Current Climate Credit Union Failures The NCUA Office of Inspector General Material Loss reviews Every credit union that was the subject of a Material Loss Review had ineffective management (poor planning and weak oversight)

6 From the Banking World During a recent meeting with OTS and OCC senior executive staff, it was noted that that every major bank failure involved the following: 1. Lax underwriting 2. Concentration risks 3. An overbearing management official (board or management team) that stifled discussions, critical feedback, and due diligence efforts.

7 Regulator Lawsuits NCUA s lawsuit regarding WesCorp directors As of December 14, 2010, the FDIC has authorized 109 lawsuits against individuals

8 The Current Climate: Conclusion Expect additional attention to corporate governance and the role of the board Expect examiners to dig deeper into corporate governance issues Risk management Concentration risk Internal controls

9 Overview of Corporate Governance

10 Overview of Corporate Governance Corporate governance and boards Credit union world FCU Act, regulations, bylaws, guidance The board of directors shall meet at least once a month and shall have the general direction and control of the affairs of the Federal credit union. (Federal Credit Union Act)

11 Ever-present Duties The Duty of Care Preparation and due diligence Examples: Policies, strategic planning The Duty of Loyalty Removal of conflicts Examples: Recusal, loan requirements

12 What if you breach? Breach of duty + damages = potential liability Indemnification, insurance Who would sue? NCUA, members with uninsured shares, disgruntled ex employees Business judgment defense Volunteer nature not a shield

13 NCUA s Fiduciary Duties Regulation

14 Overview of Rule Creation of federal duties Indemnification changes Credit union conversions and mergers

15 Fiduciary Duties Fiduciary duties portion applies to federal credit union directors Other provisions apply more broadly Effective dates: January 27, 2011 in general July 27, 2011 for financial literacy *

16 Fiduciary Duties Thumbnail Sketch Clarification that directors are responsible for general direction and control. Four specific FCU director duties 1. Directors must carry out duty in good faith, in best interests of membership 2. Administer affairs fairly, impartially and without discrimination in favor or against any particular member 3. Financial literacy 4. Ensure management s operation comply with all applicable rules

17 Fiduciary Duties 12 CFR General direction and control Board is ultimately responsible. Delegation of execution? Yes. Delegation of responsibility? No. Carry out duties In good faith Reasonably belief that actions are in best interest of membership as a whole Use same care as ordinary prudent person in similar situation

18 Fiduciary Duties 12 CFR Administer affairs of CU: Fairly Impartially Without discrimination in favor or against any particular member

19 Fiduciary Duties 12 CFR Financial Literacy (Within six months of joining board) Have at least a working familiarity with basic finance and accounting, including the ability to read and understand the FCU s balance sheet and income statement, and to ask appropriate questions of management and internal and external auditors So, is training mandatory?

20 Fiduciary Duties 12 CFR Direct management s operations in conformity with the requirements of: The Federal Credit Union Act NCUA regulations Other applicable laws Sound business practices Training requirement? FDIC Monterey Bank Consent Order

21 Fiduciary Duties 12 CFR Outside Staff and Consultants Boards are empowered to retain staff and outside consultants as needed Boards may rely on staff, officers, committees or outside consultants if directors reasonably believe the person is reliable and competent in that area Higher standard for legal counsel, public accountants and others retained for their skills or expertise?

22 Indemnification 12 CFR FCUs may not indemnify officials or employees for personal liability Related to decisions affecting fundamental rights/interests of members Where decision giving rise to claim is determined by a court to have constituted Gross negligence Recklessness Willful misconduct

23 Indemnification 12 CFR Exception will allow advance of funds before final disposition if Disinterested board members/supervisory committee deem official acted in good faith Disinterested individuals determine that payment will not harm safety and soundness Employee/official provides in writing that they acted in good faith and that they ll repay credit union to the extent that payments are not covered by insurance or if the employee/official is not entitled to indemnification due to judge s decision

24 Credit Union to MSB Conversions Revises Part 708a of NCUA s Regulations Member votes on conversions must be by secret ballot overseen by independent entity Enhanced member disclosures Statement regarding future version to stock institution or mutual holding company Estimated cost of conversion, and affect on availability of services, facilities and consumer loans

25 Merger of Insured Credit Unions Into Banks 12 CFR 708a Due diligence to determine how merger is in best interest of membership Determination of merger value of CU Determination by majority of board that merger (after first two steps) is the best choice available Notice to NCUA and request for member vote Vote: 20% of eligible members must vote in secret ballot managed by independent entity NCUA approval

26 Merger of Insured Credit Unions or Termination/Conversion of Insured Status Additional information in merger plan when merging credit union has a higher net worth than surviving credit union Disclosure of merger-related financial arrangements for officials/managers When increase exceeds the greater of 15% or $10,000 Including name and title

27 A Framework for Meeting the New Expectations

28 Fiduciary Duties Thumbnail Sketch Clarification that directors are responsible for general direction and control. Four specific FCU director duties 1. Directors must carry out duty in good faith, in best interests of membership 2. Administer affairs fairly, impartially and without discrimination in favor or against any particular member 3. Financial literacy 4. Ensure management s operation comply with all applicable rules

29 Board Composition and Governance Recruiting Nominating Committees Credit Union Committee Structure Associate Board Members Directors Emeritus Board Governance/Ethics Policies

30 Board Resources Access to Outside Experts and Audits Board Packets Training Financial Literacy Ensuring Compliance Training on effective board governance Strategic planning

31 Board Resources NAFCU Freebies Quarterly President s Report The NAFCU Flash Report The Federal Credit Union NAFCU Update NAFCU Today

32 Parting Thoughts Culture Board composition Acceptance of role and responsibility Inquisitive, risk-minded, forward-thinking Provides oversight, but allows management to do its job Credit union comes first Board/Management relationship

33 Questions? Anthony Demangone NAFCU Vice President of Regulatory Compliance (703)

34 Basic finance, accounting principles and financial reports Dan Clark Associates LLC in plain English

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36 Three targets of this material 1. Understand what is on a Balance Sheet 2. Learn what makes up an the Income or Performance Statement 3. Uncover relevant accounting practices

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38 Agenda Your personal balance sheet as a familiar place to start We ll look at familiar arrangements for the balance sheet, and what s on it We ll look at the income statement Q & A -- and along the way

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40 In your study guide, next to this image 1. Enter a few asset items you own and their approximate market values, to the nearest thousand ($000) Home value Total value of vehicles Retirement funds Savings checking

41 In your study guide, next to this image 2. Enter some of your liabilities and their approximate balances in thousands Home mortgage balance Loans on vehicles CC Debt

42 In your study guide, next to this image 3. Subtract Sub-Total Liability total from Sub-Total Assets. The result is your estimated personal Net Worth.

43 Typical Credit Union Balance Sheet Layouts Assets Assets Liabilities & Member Shares Liabilities & Member Shares Net Worth Net Worth Over-Under Side-By-Side

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45 Balance Sheet / Statement of Condition Cash Shares When the first member deposited Total Assets Total Liab. & NW

46 Assets Member Shares, Liabilities and Net Worth

47 Transactions also balance: debits = credits

48 Balance Sheet / Statement of Condition Primarily Debt Balance Accounts Primarily Credit Balance Accounts Net Worth Total Assets Total Liab. & NW

49 Balance Sheet / Statement of Condition Application of funds Sources of Funds Net Worth Total Assets Total Liab. & NW

50 How Your Personal Balance sheet and the Credit Union s Differ fixed assets Market value Depreciated Book Value

51 Depreciation Matching principle: match revenue with portions of the cost of an asset over the period served by that asset; A.K.A. Useful life. $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $

52 Balance Sheet / Statement of Condition Acquisition of CU assets involves trading other assets for it. CASH & INVESTMENTS Total Assets Net Worth Total Liab, Capital & NW

53 Balance Sheet / Statement of Condition Acquisition of CU assets involves trading other assets for it. FIXED ASSETS CASH INVESTMENTS Total Assets Net Worth Total Liab, Capital & NW

54 Accumulated Depreciation is a contra or negative- balance asset. Balance Sheet / Statement of Condition FIXED ASSETS Contra Asset Accumulated Depreciation CASH INVESTMENTS Net Worth Total Assets Total Liab, Capital & NW

55 How Your Personal Balance sheet and the Credit Union s Differ - investments Personal = market values Market Values help you keep current tabs on your estimated net worth. Book Values and Notes are more consistent for evaluating investment opportunities.

56 How Your Personal Balance sheet and the Credit Union s Differ - investments an investment reserve or loss allowance is another contra or negativebalance asset to explore. Balance Sheet / Statement of Condition Investments Contra Asset Market devaluation Net Worth Total Assets Total Liab, Capital & NW

57 Investments Training

58 How Your Personal Balance sheet and the Credit Union s Differ Accounting Formula: Personal formula Assets liabilities = net worth Business formula Assets = liabilities + net worth

59 The Allowance for Loan Losses Loans - Allowance Balance Sheet / Statement of Condition = Net Loans Loans Contra Asset Allowance Net Worth Total Assets Total Liab, Capital & NW

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61 Balance Sheet / Statement of Condition Secured loans Unsecured loans Allowance Net Worth Total Assets Total Liab, Capital & NW

62 Balance Sheet / Statement of Condition Potential loan losses based on borrower risk category A B C D E Allowance Net Worth Total Assets Total Liab, Capital & NW

63 The Allowance as a Bucket When charging off a loan the ALL Bucket figuratively springs a leak and drains the amount of the charged off loan.

64 The Allowance as a Bucket When the ALL When the ALL balance falls below the ALL requirement, post a PLL expense with the same amount to figuratively refill the Bucket.

65 Liquidity Balance Sheet / Statement of Condition Member Secured Loans Member Shares L-T CDs S-T CDs Retirement Unsecured Loans Allowance FIXED ASSETS Accumulated Depreciation CASH & INVESTMENTS Total Assets Regular Shares Share Draft Liabilities Net Worth Total Liab, Capital & NW

66 Income / Performance Statement + Interest Incomes - Cost of Funds = Gross Margin - provision for loan losses

67 Income / Performance Statement + Interest Incomes - Cost of Funds = Gross Margin + non-interest Inc - Operating Exp. - provision for loan losses

68 Income / Performance Statement + Interest Incomes - Cost of Funds = Gross Margin + non-interest Inc - Operating Exp. - provision for loan losses = Net Income

69 Final Questions? Contact Dan Clark at or call