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4000 - Advisory Opinions
"Affiliate" Relationship with Credit Union
FDIC-82-20
October 20, 1982
Pamela E. F. LeCren, Senior Attorney
Background:
As requested by the regional office, the Legal Division has reviewed
the transactions involving *** whereby *** established an
"affiliate" relationship with *** Credit Union, Nashville,
Tennessee ***. That relationship poses a number of legal issues with
regard to which you seek the advice and recommendations of the Legal
Division, among which are the application of § 23A of the Federal
Reserve Act and The Depository Institution Management Interlocks Act.
The facts concerning the transaction are essentially as follows.
In July of 1982, *** Bank through eight of its executive officers
sought approval by the state of Tennessee to establish *** Credit
Union. The bylaws for the credit union were filed with the state on
July 6, 1982 and approval was subsequently granted on July 20, 1982.
*** is a state-chartered, state-insured credit union. On July 22, 1982
*** and *** Credit Union, also a state-chartered, state-insured credit
union, entered into an Agreement of Merger whereby *** would merge into
*** Credit Union with *** surviving. The merger transpired on July 23,
1982. On July 30, 1982 a subordinated capital note agreement was
entered into between the surviving *** Credit Union and *** Bank. By
the terms of that agreement, *** issued to *** Bank subordinated notes
in the principal amount of $600,000 with interest at the *** Bank prime
rate plus 2%, interest adjusted quarterly. Interest is payable
quarterly and principal due and payable on July 30, 1992.
In addition to the above, *** Bank and *** executed a management
agreement designating the bank the "managing agent" for the
credit union. Under that agreement, *** delegated to the managing agent
the general authority to direct, supervise and manage the day-to-day
operations of the credit union. The agreement specifically provided
for, among
{{4-28-89 p.4113}}other things, that the managing agent
would: (1) supervise preparation of annual budgets; (2) supervise,
direct, and maintain the operation of a suitable accounting system; (3)
in conjunction with the credit union's credit committee, and in
accordance with policies established by the board of directors,
supervise the lending activities of *** (specifically recruit, hire,
train, promote, assign, set the compensational level for, and discharge
all loan officers and assist and advise the credit committee on all
credit decisions and in setting policies of the credit committee); and
(4) recruit, hire, train, promote, assign, set the compensational level
for, and discharge all operating and service personnel for the credit
union who shall be carried on the managing agent's payroll and not be
credit union employees. For its services, the managing agent is to be
paid all direct and indirect costs and expenses in addition to
reasonable compensation. The agreement has a ten-year term, is to be
automatically extended for additional ten-year terms, and may be
assigned to a wholly or majority owned subsidiary of the managing
agent.
According to the Credit Union's bylaws, the membership of the Credit
Union consists of all stockholders, directors, employees,
and customers of *** Bank or employees of such affiliated
entities and the members of the families of all such persons eligible
for membership. Pursuant to the merger agreement with *** Credit Union,
*** field of membership has been expanded to include the employees or
members of thirteen different religious organizations and institutions.
The bylaws provide for preferred shares and participating shares.
The preferred shares receive payment of an annual dividend not to
exceed 6% and are entitled to preferential distribution up to their
par value of $5 upon liquidation of the credit union. Participating
shares are entitled to receive such dividends as may be declared; are
entitled to receive subordinated but unlimited distribution upon
liquidation of the credit union; and have a $5 par value. According to
correspondence from the bank, there are a total of 9 participating
shares all of which are held by *** Bank. Each member of the credit
union has one vote regardless of the number of shares held. The credit
union may be dissolved by the majority vote of all members or by the
vote of all participating shareholders.
The board of directors of the credit union consists of five members
of the credit union who are elected at the first meeting of the
incorporators. Vacancies are thereafter filled at annual meetings. The
directors serve for ten-year terms. The present board of directors
consists of five of the credit union's incorporators who, as stated
earlier, are all executive officers of the bank. The credit committee
consists of three members of the credit union elected from a slate
proposed by the board of directors. The credit committee members serve
for a ten-year term. All present members of the credit committee are
bank personnel. The supervisory committee likewise consists of three
members of the credit union elected from a slate proposed by the board
of directors. The members serve for a ten-year term. The present
members of the supervisory committee are bank personnel. The officers
of the credit union are elected by the board of directors from their
own number.
According to correspondence from the bank, the business operations
of *** will "in some instances" be operated from the same
physical location occupied by a *** Bank branch. The bank indicates,
however, that the services and products offered by the credit union
will be advertised, offered, and delivered to the public in such a
manner as to clearly identify the credit union as a distinct entity
from the bank.
Questions presented to Legal
Division: *
1. Whether or not *** is an "affiliate" of *** Bank for
the purposes of section 23A of the Federal Reserve Act which restricts
extensions of credit to, and investments in, affiliates.
{{4-28-89 p.4114}}
2. Whether or not the relationship between *** and *** Bank as
described above violates the Depository Institution Management
Interlocks Act.
Discussion:
1. Application of section 23A.
We are in agreement with Regional Counsel Gerrish's conclusion that
*** and *** Bank are "affiliates" for the purposes of Section
23A. We note that bank counsel concedes the application of this
provision and only argues that issuance of the capital notes to the
bank by *** should be considered an investment and not an extension of
credit. The result of classifying the issuance of the notes as an
investment rather than as an extension of credit is that the
requirement contained in Section 23A that extensions of credit be
secured by collateral does not apply.
We find that the bank and the credit union are affiliates based upon
the definition of the term contained in section 2b of the Banking Act
of 1933 as amended (12 U.S.C. § 221a(b)) which in (b)(1) defines
affiliate to include a corporation, business, trust, association or
other similar organization of which a member bank controls in any
manner the election of a majority of its directors, trustees or other
persons exercising similar functions. Inasmuch as the incorporators of
the credit union elect the directors of the credit union at their first
meeting, and the incorporators are executive officers of the bank, we
feel that the language referenced in (b)(1) is applicable. The bank and
credit union are therefore, in our opinion, affiliated for the purposes
of section 23A.
We also conclude, after consultation with the Federal Reserve Board,
that the issuance of a capital note is properly considered an
investment and not an extension of credit. The result of our
determination is that we are in agreement with bank counsel that the
investment qua issuance of capital notes is not required to be secured
by collateral.
2. Management Official Interlock
The Depository Institution Management Interlocks Act ("Interlocks
Act" 12 U.S.C. § 3201 et seq.) prohibits management
interlocks between depository institutions depending upon their size
and location. Affiliated institutions are not covered by the
prohibitions. The term "depository institution" is specifically
defined to include commercial banks and credits unions.
A management official interlock clearly exists at the present time
between *** Bank and *** Credit Union. An exemption contained in Part
348 of FDIC's regulations (Part 348 implements the Interlocks Act)
which specifically pertains to management interlocks between a
sponsoring depository institution and a credit union is not available
in this instance. See section 348.4(b)(4). That provision only extends
to interlocks between, for example, a bank and a credit union sponsored
by the bank "primarily" to serve the employees and
solely the employees of the bank. As the field of membership for ***
Credit Union extends beyond the employees of *** the exemption
contained in that provision is not available.
Bank counsel sets forth several elaborate arguments designed to
establish that *** Bank and *** are affiliated for the purposes of the
Interlocks Act and thus the management official interlock between the
bank and the credit union is not prohibited. We have considered those
arguments at length in conjunction with an assessment of the purpose
and express language of the Interlocks Act and are unable to agree with
bank counsel's assessment.
The Interlocks Act defines affiliated institutions more
narrowly than section 23A of the Federal Reserve Act. For the purposes
of the Interlocks Act two institutions may be characterized as
affiliated if they are "subsidiaries" of the same "bank
holding company" (as those terms are defined in the Bank Holding
Company Act of 1956) or if more than 50% of the voting stock
of both organizations is beneficially owned by the same person or
group of persons. Neither definition is applicable in this instance.
*** Bank is not part of a holding company system nor do credit unions
have voting stock. Despite bank counsel's argument that to construe
the Interlocks Act strictly with reference to the necessity for voting
stock serves no purpose where, as in the instant case, there is a clear
commonality of
{{4-28-89 p.4115}}control between the bank and the credit
union, we find the relationship as described to present numerous
conflicts of interests that mitigate against broadly reading the
statute in the manner Bank counsel puts forth.
Credit union shares are not the equivalent of voting stock as they
carry no voting rights. Each member in a credit union has one vote in
the annual meeting of shareholders regardless of the amount of shares
held. Affiliation under the Interlocks Act requires some sort of
"ownership interest in an organization" that gives the individual
owners the ability to control the election of directors and thereby the
policies formed and followed by that
organization. **
Although the Bank in this instance has the ability to control the
election of directors and formation of policy at the credit union, that
ability does not derive from any ownership interest but rather from the
structure of the bylaws of the credit union and the management
agreement. Were we to find that the bylaws and management agreement,
which in essence create dual management between the institutions,
warrants a finding that the institutions are affiliated, we would be
defeating the purposes of the Interlocks Act. The existence of the
ownership interest out of which arises the ability to control must come
first. We therefore conclude that the bank and *** are not affiliates
for the purpose of the Interlocks Act.
Conclusion
1. *** Bank and *** are affiliates for the purposes of § 23A of
the Federal Reserve Act.
2. The capital note agreement running between *** and the bank
constitutes an investment in an affiliate under § 23A and as such is
not subject to the collateral requirements imposed on extensions of
credit.
3. Although *** Credit Union is an affiliate of *** Bank for the
purposes of section 23A, the credit union is not affiliated with the
bank within the meaning of that term under the Interlocks Act. As the
institutions are not affiliated, the existing management official
interlock is in violation of FDIC's regulations. The violation can be
cured, however, if the existing credit union directors and the members
of the credit and supervisory committees are replaced by other members
of the credit union who do not have management official positions at
the bank. Additionally, the management agreement will either have to be
terminated or assigned as provided for by section 7.8 of the Management
Agreement.
* We can only assume that the entire transaction comports with
state law as the state has approved the credit union's bylaws and the
subsequent merger. We will simply observe in passing, however, that the
ability of the participating shareholders (i.e., the bank) to dissolve
the credit union does not seem to comport with § 45-4-981 of the
Tennessee Code (Tenn. Code Ann. § 45-4-981). Additionally, the bylaws
seem to conflict with § 45-4-902 of the Tennessee Code (Tenn. Code
Ann. § 45-4-902) which specifies that, upon liquidation, assets
remaining after satisfaction of all liabilities and redemption of share
accounts and special accounts should be distributed to all
members. Article 23, § 2 of *** bylaws gives the right to share
in such assets solely to the participating shareholders. Go Back to Text
** This statement is not inconsistent with the Legal Division's
previously announced opinion that a trustee of a voting trust can be
considered to beneficially own the voting stock he or she controls.
Such a trustee has been given the voting rights that attach to the
ownership interests of each of the members of the trust. Go Back to Text
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