CUSO Legal Update – Reporting Requirements

    By , Credit Union

    As you are aware, on November 21, 2013, the NCUA Board implemented changes to the regulations governing federally insured credit unions’ obligations when involved with a credit union service organization (“CUSO”). The final rule requires action by both federally insured credit unions and CUSOs. The rule goes into effect on June 30, 2014. Although CUSOs and credit unions must abide by the regulations starting June 30, CUSOs are not required to submit reports until December 31, 2015, when the NCUA’s reporting system is expected to be fully operational.

    According to the NCUA, these changes were made to protect credit unions and the National Credit Union Share Insurance Fund (‘NCUSIF’). We have thoroughly reviewed the final rule and the necessary actions for you as a CUSO. Below we provide a short list highlighting the changes and then follow with a detailed account of the new requirements. The requirements are more substantive for those CUSOs engaged in complex or high-risk activities.

    As some background, the NCUA stated that the current regulations jeopardize the NCUSIF and credit unions because the current information it has related to CUSOs is incomplete. This inadequacy is a result of how it receives CUSO information: it is reported from a CUSO’s credit union clients rather than directly from the CUSO itself. The NCUA is unable to determine which CUSOs maintain relationships with which credit union, financial and operational information about CUSOs, and the total number of CUSOs that are in existence.

    The rule makes existing parts of the CUSO rule applicable to all federally insured credit unions (‘FICU’) that previously applied only to federal credit unions (‘FCU’), adds several new requirements that apply to both FCUs and federally insured, state-chartered credit unions (‘FISCU’), and clarifies the applicability of regulations to subsidiary CUSOs by codifying existing policy. The rule clearly defines a FICU to include an FCU and an FISCU.

    Main aspects of the new rule include:

    1. Prior to investment in CUSOs by less than adequately capitalized FICUs, the FICU must obtain written approval from the NCUA or the applicable state supervisory authority.
    2. CUSO accounting and reporting changes: Prior to receiving an investment or loan from an FICU, the CUSO must agree in writing that it will abide by the accounting and auditing requirements and that the CUSO will submit an annual report to the NCUA, or state supervisory authority if applicable.
    3. The requirement for a credit union to maintain a separate corporate identity from a CUSO now applies to all FICUs.
    4. FICUs are prohibited from investing in a CUSO unless all subsidiaries of the CUSO also agree to follow the applicable rules and regulations related to accounting, auditing, and reporting.

    The detailed, substantive changes are as follows:

    1. Investment in CUSOs by less than adequately capitalized FICUs (712.2)

      : Since 2008, this restriction was already in place for FCUs. The final rule now applies this to all FICUs.

      1.1 If an FICU is currently less than adequately capitalized or wherethe making of an investment in a CUSO would render the FICU less than adequately capitalized, action must be taken before making an investment in a CUSO

      (a) FCU: must obtain prior written approval from the appropriate NCUA regional office if the making of the investment would result in an aggregate cash outlay, measured on a cumulative basis, but limited to the immediately preceding 7 years, in an amount that is in excess of 1% of its paid-in and unimpaired capital and surplus

      (b) FISCU: must obtain prior written approval from the appropriate state supervisory authority if the making of the investment would result in an aggregate cash outlay, measured on a cumulative basis, but limited to the immediately preceding 7 years, in an amount that is in excess of the investment limit in the state in which it is chartered

      (i) if there is no limit in the state, then the 1% applicable to FCUs applies

      (ii) Must simultaneously submit a copy of the request to the appropriate NCUA regional office, but the state supervisory authority ultimately decides the request

      1.2. Impact on CUSOs: This does not require direct action from CUSOs, but it will likely lengthen the amount of time it takes for certain FICUs to invest in a CUSO. The stated purpose is to prevent losses to both FCUs and FISCUs that attempt to invest in insolvent CUSOs.

    2. CUSO accounting and reporting changes- all FICUs must obtain written agreement from CUSO that it will follow accounting and auditing standards and CUSO must submit annual report to NCUA (712.3)

      Note: (a), (b), (c), and (d) listed in 2.1 below were already requirements for FCUs. The new rule expands this requirement to apply to all FICUs. The requirement for CUSOs to submit an annual report, listed in (e) below, is new.

      2.1. Prior to investing in or lending to a CUSO, an FICU must obtain a written agreement from a CUSO that the CUSO will:

      (a) Account for all transactions in accordance with GAAP

      (b) Prepare quarterly financial statements

      (c) Obtain an annual financial statement audit of its financial statements by a licensed certified public accountant in accordance with generally accepted auditing standards %u2003

      (d) Provide NCUA, its representatives, and the state supervisory authority having jurisdiction over any FISCU with an outstanding loan to, investment in or contractual agreement for products or services with the CUSO with complete access to any books and records of the CUSO and the ability to review the CUSO’s internal controls

      (e) Submit an annual report directly to the NCUA and the appropriate state supervisory authority (if applicable)

      (i) Report will include: basic registration information, legal name, tax identification number, physical address, telephone number, website, primary contact, services offered, name and charters of credit unions investing in, lending to, or receiving services from the CUSO, investor and subsidiary CUSOS

      2.2. CUSOs that engage in high-risk activities are required to report additional information in this annual report, which will include audited financial statements and more specific customer information

      (a) High risk activities include:

      (i) credit and lending (includes: business loan origination; consumer mortgage loan origination; loan support services (including servicing); student loan origination; and credit card loan origination)

      (ii) information technology (includes: electronic transaction services; record retention, security, and disaster recovery services; and payroll processing services)

      (iii) custody, safekeeping, and investment management services

      (b) Report must contain these additional items:

      (i) list of services provided to each credit union

      (ii) investment amount, loan amount, or level of activity of each credit union

      (iii) CUSO’s most recent year-end audited financial statements

      (iv) If engaged in lending and credit services: (i) total dollar amount of loans outstanding, (ii) total number of loans outstanding, (iii) total dollar amount of loans granted year-to-date, and (iv) total number of loans granted year-to-date

      2.3. State supervisory authorities are permitted to apply for an exemption for the requirements listed in 2.1 (a), (b), (c), and (d) above on behalf of FISCUs

      (i) The NCUA may only grant this exemption if state law is equal to, or more stringent than, the NCUA’s requirements

      (ii) There is no exemption for the annual report that must be submitted to the NCUA

      2.4. Impact on CUSOs:

      (a) This amendment creates the largest burden on CUSOs. If you currently serve FCUs, then the only new requirement is the submission of the annual report to the NCUA. You will have to submit a written agreement to do so with all FCUs that invest in or lend to you.

      (b) If you currently serve FISCUs, this amendment has a large impact on you. You are now required to (i) account for all transactions in accordance with GAAP, (ii) prepare quarterly financial statements, (iii) obtain an annual audit by a CPA, (iv) provide complete access to any books and records to the NCUA or applicable state authority, and (iv) submit an annual report directly to the NCUA and state authority if applicable.

      (c) If you are engaged in complex or high-risk activities, you are required to submit the additional information in your annual report

    3. Maintaining Separate Corporate Identities for the credit union and the CUSO now applies to all FICUs (712.4)

      3.1. There are no substantive changes to this section (712.4), but the language has been amended to now apply to all FICUs. Previously it only applied to FCUs.

      3.2. If you provide services to a FISCU, it is important that the FISCU and the CUSO are operated in a manner that demonstrates to the public the separate corporate existence of the two entities. We are happy to review these requirements with you. Two important items from this regulation include:

      (a) Ensure the FICU does not dominate the CUSO to the extent that the CUSO is treated as a department of the credit union

      (b) Prior to investing in a CUSO, the FISCU must obtain written legal advice as to whether the CUSO is established in a manner that will limit potential exposure of the credit union to no more than the loss of funds invested in, or loaned to, the CUSO

    4. FICUs are prohibited from investing in a CUSO unless all subsidiaries of the CUSO also agree to follow the applicable rules and regulations ( 712.11)

      4.1. Subsidiary is defined as an entity that is engaged in primarily providing products or services to credit unions or credit union members and a CUSO has an ownership in any amount

      4.2. If providing service to FCUs: the subsidiary CUSO must satisfy all requirements that a CUSO must satisfy

      4.3. If providing service to FISCUs: the subsidiary CUSO must comply with (a) all applicable state laws and rules regarding CUSOS, and (b) all requirements of Part 712 that apply to FISCUs (which includes the requirements under the new rule following GAAP, conducting financial statement audits, and submission of the annual report)

      4.4. Recommended Action: If you have ownership in any amount in an entity that is engaged in primarily providing services or products to credit unions or its members, that entity must follow the same rules and requirements related to accounting, audits, and annual reporting. The subsidiary will be required to enter into the same agreement with FICUs that you are required, guaranteeing to follow the regulations.

    Please note, some intricacies of the final rule may not be included above in an effort to avoid reciting the entire regulation. We welcome any questions regarding the final rule and assisting you in the transition to comply by June 30.

    The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2022.