NCUA BOARD REISSUES PROPOSED REGULATION REQUIRING ALL FEDERAL CREDIT UNIONS TO HAVE SUCCESSION PLANS THAT MEET NCUA SPECIFICATIONS AND PROPOSES NEW RULE ON EXECUTIVE INCENTIVE COMPENSATION
Monday, July 22, 2024
The NCUA Board last Thursday at its monthly meeting approved by a vote of 2-1 a revised proposed regulation for boards of directors at all federally credit unions to establish and adhere to processes for succession planning through a required succession plan that meets NCUA examiner expectations.
NCUA Chairman Harper, who has been pushing for such a regulation since it was originally proposed in January 2022, and Board Member Tanya Otsuka voted in favor. Vice-Chairman Kyle Hauptman, who had voted in favor of putting the original proposed rule out for public comment back in 2022, voted against the revised proposed rule.
The stated reasoning for this considerable extension of NCUA regulatory authority into the steps and process a federally insured credit union should follow in preparing for and selecting its next chief executive officer is, according to Chairman Harper, that 30% of small credit union mergers were attributed by NCUA to “either primarily, or secondarily” the lack of succession planning.
“NCUA expects a credit union would develop a succession plan that is consistent with its size and complexity,” said Harper. “Therefore, smaller institutions may have a simple succession plan that addresses a few key leadership positions, while larger more complex institutions would have more extensive plans for a variety of critical roles.”
Chairman Harper had said in 2022 when the original proposal was put out for comment that “small credit unions are at the heart of the movement, and we need to find a better way to preserve them, instead of consolidating them.”
Noble in purpose perhaps, but a bit out of touch with reality in that not 30%, but 100%, of credit union mergers are approved by the fiduciaries of the credit union (the board of directors) and a majority of the members of the credit union voting in a membership vote following extensive disclosures that include the basis or reason for the merger as required by existing NCUA regulation.
To assume that because less than a third of small credit union mergers were determined by NCUA to be tied, at least in part, to the credit union not having someone ready to take over a vacant CEO position or not having the ability to hire someone at today’s executive salary and benefits cost fails to fully recognize the difficulty those same credit unions are having in competing in today’s demanding marketplace.
The members are demanding more services, more technology, more digital, better rates, lower fees…all from a credit union that many times does not have the financial wherewithal to provide what the members are demanding. It seems to be that the directors who recognize this and choose to meet those growing needs by joining through merger with another credit union that can meet those needs should not have to overcome a regulation that first makes them have a plan of how to meet those needs by hiring someone they can’t afford and forcing them to struggle for additional years.
Under the revised proposed rule, credit union directors would also be required to have full and complete knowledge of the federal credit union’s succession plan. The revised proposed rule would provide federal credit unions with what the revised proposed regulation calls “broad discretion in implementing the revised proposed regulatory requirements to minimize any burden.” Yet the NCUA has the right to examine what they determine to be the adequacy of that plan with each examination.
Although the revised proposed rule would apply to all federally insured credit unions, the NCUA Board threw a bone of concession to state chartered credit unions if the state has a different succession planning regulation and defers to the state regulation in those cases. (Most state regulatory agencies do not have a succession planning regulation for state-chartered credit unions, although some may choose to do so now that NCUA seems to be moving toward enacting one.)
In addition to the CEO, the succession plan would be required to cover members of the board, members of the supervisory committee, management officials and assistant management officials, senior executive officers and any other credit union personnel the board of directors deems critical given the size, complexity and risk of operations.
The succession plan would also be required to address the members of the credit committee and loan officers where such officials are involved in the daily review of loans.
Also, the succession plan would be required to address the FICU’s strategy for recruiting candidates.
The strategy must consider how the selection of diversity among the employees covered by the succession plan collectively and individually promote the safe and sound operation of the credit union.
The board of directors would be required to review the succession plan in accordance with the schedule it establishes, but no less than annually. It also recognizes that circumstances might require changes to the plan. In strategic plans it would be expected that the board would be informed of changes, the rationale for the changes and that those changes be documented in its minutes.
The proposed rule would require that directors have a working familiarity with the succession plan no later than six months after appointment.
And, lastly, the expectation of the proposal is for a federally insured credit union to develop a succession plan that is consistent with its size and its complexity.
As can be seen from the provisions above, the NCUA Board chose a much more prescriptive regulatory approach in its revised proposal than it did in its originally proposed rule in 2022.
The 2024 revised proposed rule does include a short template that perhaps a very small credit union can use to develop its own succession plan, but it would not be much help to a credit union of any size or complexity.
The provisions of the proposed rule very clearly require moderate and larger sized credit unions to have a much more fully developed plan than the NCUA template which would include the multiple provisions as outlined earlier.
And the concern, of course, is where this rule will lead over time. Again, regulation always creeps. It often leaps. But it never retreats.
As a credit union consultant, our firm has helped numerous credit unions draft succession plans so we definitely think it is good business practice for credit unions to strategically look at their futures regarding executive leadership.
And, yes, all of the provisions required under the proposed rule are included in the plans we have helped our credit union clients develop.
However, a NCUA regulation telling credit unions how a federal agency thinks they should do their succession planning and what their succession plan should look like – even though we anticipate it could bring our firm a good bit of business – seems to us to be overkill and unnecessary one-size-fits-all thinking.
The assumption behind this regulation, as we have seen by the comments of Harper and Otsuka, is obviously driven by a desire to stifle mergers. They seem to truly believe, although they cited a figure of less than one-third of mergers citing succession planning as a reason, that those mergers are taking place primarily because there is no succession planning at some credit unions. They do not seem to recognize that all mergers occur because credit union boards have determined in their role as fiduciaries that their members would be better served by merging with a credit union that can provide them more products and services than by struggling to survive and trying to find a new CEO in a tough executive recruiting marketplace.
Every merger is strategically thought out by the board and then voted upon by the members, with transparency and extensive disclosures dictated by NCUA, to disclose how the long-term best interests and service needs of the members were evaluated and determined.
It does not seem that a regulation trying to force credit unions that are struggling, not growing, and having trouble competing in the marketplace to go through the cost of developing an executive succession process – when the board as fiduciaries feel it is in the best interests of their members to merge with another credit union so those members can be served better – is consistent with the safety and soundness responsibilities of NCUA to protect the insurance fund.
Most losses to the insurance fund over the past five years have been from smaller credit unions due to fraud or lack of management oversight – not from credit unions with the scale to survive and thrive. If credit unions want to have a succession plan to build and grow for decades to come, they should have one in place and will do so without a regulatory mandate. Current NCUA guidance and Letters to Credit Unions appropriately specify this as a best practice without the necessity of a regulation requiring it and having NCUA examiners enforcing it.
If a credit union’s board and members prefer to join with another credit union through merger that can serve them better and with a more financially strong footing, merger is not necessarily a bad thing and they really don’t need a regulatory mandate to develop a costly succession plan or hire a search firm if merger is the best fiduciary decision for the members. The credit union fiduciaries should decide whether their credit union needs a succession plan or a merger, not the regulator.
In fact, it is quite likely that when a smaller credit union has to spend money to develop a succession plan that they realistically cannot afford to implement when the time comes, it very well could drive that credit union to go ahead and pursue merger now rather than waiting until the CEO is ready to retire or depart.
And even if you take the exaggerated merger reasoning off the table, this regulation will require every federal credit union – large and small – to have a written succession plan that will have to meet NCUA’s approval at examination time. Even larger credit unions will have to draft, probably with consultative support because of how tough the competitive executive compensation and benefits landscape is today, a much more robust succession plan out of fear that the additional scrutiny a regulatory requirement will being might leave them subject to an examiner finding if their current succession plan doesn’t go as far as the examiner might like.
Does this mean credit unions will have to designate CEO successors before there is an opening? What will that do to morale when one senior executive gets named as CEO-in-waiting while the other members of the executive team begin to look for other jobs because they know they are not on the list to move up?
What about the decision to promote from within or to search from outside? Does that decision have to be made years in advance of an opening, even though things may change in the internal pool of candidates in the interim?
Will this lead NCUA into approving or disapproving executive compensation packages and benefits? Will they have to be spelled out in advance in a plan that could change in a matter of months or certainly years before a vacancy occurs?
Just what will be required since every federal credit union, large and small, must now take NCUA examiner scrutiny and preference into consideration when they begin looking at strategic plans for succession?
It seems that both Chairman Harper and Board Member Otsuka, although they acknowledge that there will be costs involved, tried to assure credit unions that they do not desire to see the new regulation be burdensome.
But this reminds me of a question I was asked when I was NCUA Chairman and made statements about what we at the board level expected when a new regulation was implemented, “Are you, Chairman Dollar, going to be at my exam to reign in an examiner who may not have heard your remarks?”
This regulation is going to be in effect, if it is ultimately finalized, for years and decades. Where will today’s supposed “not intended to be burdensome” approach be five years from now? Ten years?
In fact, it would seem to those of us who compare the original proposed rule from 2022 with the revised proposal approved last week that this newest version has already leapt to where it is not as “minimalist” as the original proposal was described.
We must remember that there are already guidance documents and letters to credit unions encouraging federal credit unions to have some plans in place for succession as a best practice. Examiners can already encourage credit unions with CEOs nearing retirement age to be more pro-active in preparing for that coming vacancy.
But did they truly need to pass a regulation that will be on the books twenty years from now because 30% of small credit union mergers today have been determined by NCUA to be partially driven by the lack of succession options. This seems to be regulating to the exception rather than the rule.
Nonetheless, the succession rule is now revised and has been re-proposed.
NCUA has every right to examine a credit union and through its supervisory authority question whether any hiring decision was the right one based upon results, but it is quite a stretch for NCUA to enact a regulation requiring credit unions to get their approval of the steps and options the credit union fiduciaries will follow in making an executive hire.
NCUA should focus on the safety and soundness and compliance impact of the person hired to run a credit union, not the day-to-day options and specifics of the search process.
To use the Federal Aviation Administration (FAA) analogy I used when I was at NCUA.
It is the job the FAA to make sure the planes are safe and sound, that the pilots are trained and qualified and that the routes are spaced properly for safety. It is not the job of the FAA to fly the planes. NCUA should follow that example.
This regulation is getting pretty darned close to NCUA flying the planes when it comes to a decision that should be made by credit union fiduciaries.
From either a merger avoidance perspective or from an executive hiring point of view, moving to a mandatory succession planning regulation rather than a guidance approach as has been the case in the past is placing a federal regulator in the middle of the fiduciary decision-making process rather than its proper role of examining the outcomes of the decision.
This is, in our view, a very clear definition of federal agency overreach.
But the revised proposal is being put out for public comment again. The comment period is not yet open; however, we will in another Client Update in the very near future provide you with the comment period dates for filing a comment letter.
A copy of the revised proposed rule can be accessed at the link below:
https://ncua.gov/files/agenda-items/succession-planning-proposed-rule-20240718.pdf
Included in the link about are the instructions for filing a comment, either online or through a hardcopy letter.
We expect that the comments from credit unions will be extensively and almost uniformly negative to this proposal that is certainly an extension of federal agency authority into the day-to-day operations of a credit union and the fiduciary responsibilities of a credit union board.
We also expect that the final rule will very closely mirror this revised proposed rule despite the opposition that the comment period will likely bring.
AFTER FOURTEEN YEARS, NCUA JOINS OTHER FINANCIAL REGULATORY AGENCIES IN USING THE DODD-FRANK ACT TO THRUST THEMSELVES INTO HOW A LARGER CREDIT UNION COMPENSATES ITS EXECUTIVES
While some type of action on reporting of incentive-based compensation at all financial institutions was required by the 2010 Dodd-Frank Act, this proposed rule – also approved on the same 2-1 vote as the earlier referenced on the succession plan proposal – seems to be over-zealous after fourteen years of doing absolutely nothing to implement this section of a 2010 law based on a financial crisis that was four presidents ago.
Even Dodd and Frank are no longer in Congress, and the examples cited when the NCUA Board took action this week in 2024 to propose this overreaching rule were losses from sixteen years ago in 2008.
Yet, the NCUA joined other federal financial regulators including the FDIC and OCC to finally – a decade and a half later – address this provision of Dodd-Frank that has been left alone since 2010.
This proposed rule, when finalized, will apply to credit unions with $1 billion or more in assets.
And, as regulators often do, the agencies went beyond the monitoring of executive incentive compensation and moved into playing a role – through examiner enforcement of this regulation when it is becomes final – in determining what type of incentive plan a credit union board can establish to reward exemplary achievements by a CEO and even how a CEO can reward other executives for performance.
There is little doubt that the NCUA Board could have approved a less onerous proposal that did not put a federal agency in the middle of the compensation decisions that have historically and appropriately been made by the fiduciaries of a credit union.
Even if FDIC and OCC felt their agencies needed to take a more active approach since their institutions are for-profit and perhaps more subject to excesses in executive incentive compensation, NCUA did not have to take a mirror image approach to the FDIC and OCC.
Credit unions, as not-for-profit, member-owned financial cooperatives should be treated differently in implementing the fourteen-year-old provisions of Dodd-Frank than are the for-profit banks and brokerages that caused the 2008 financial crisis through their excesses.
NCUA has historically issued specific regulations intended to recognize the credit union structural difference that were different than what FDIC and OCC issued for banks – even when Congress required all federal financial regulators to act on a certain issue.
They could have and, in our view, should have done so in this case well. But they chose to join FDIC and OCC in an identical rule.
Now, a couple of things to recognize in this proposed rule. It does not seem now to be aimed at salary or executive benefit programs such as split dollar retirement plans.
Could it creep into the salary and benefits arena if an examiner feels that the salary structure or benefits program has become a hidden form of incentive compensation? Always possible, but hopefully the removal of the Chevron Doctrine would open such an overreach to a successful legal challenge.
The proposal is primarily designed, it seems from review, to require considerably more steps to justify and document any incentive-based bonus plan for a CEO and/or senior executives. It does not outlaw such incentive plans, nor does it say that they cannot be offered.
The proposed rule, rather than prohibiting them, just makes a board or an executive work through an exhaustive list of justification criteria in order to offer and pay incentive-based bonuses.
While the proposed rule outlines the criteria that must be met and the documentation that must be retained for review by the NCUA examiner, it essentially states that a credit union can offer and pay incentive-based bonuses as long as they are structured according to the provisions of this proposed regulation in the view of the credit union examiner.
What will be the impact if this rule is, as expected, finalized before the end of 2024?
Well, first, it states that it does not impact any existing incentive-based bonus plan and gives a transition period of approximately eighteen months for credit unions to adjust for any new or future incentive plans.
Will we see more salary increases based upon performance and fewer incentive-based bonuses? Perhaps.
Will we see more split dollar, 457f and other executive bonus plans adopted to reward executives rather than incentive-based bonuses? Almost certainly.
But the true unfortunate outcome of an overreaching rule such as this is the fact that executive performance is almost exclusively – at least in credit unions – based upon the financial performance and member service evaluation of the credit union itself.
Why would a safety and soundness regulator want to see executives compensated without a financial or member service component involved?
Better run credit unions have better financial performance. Better financial performance builds capital that protects the share insurance fund NCUA administers. Rewarding executives for building that capital and performing better from a financial perspective is a good thing for safety and soundness of credit unions – an outcome NCUA should promote and not discourage.
I expect the comment letters will be overwhelmingly negative on this proposal from credit unions and banks alike since FDIC and OCC has joined NCUA in proposing it. However, I will not be surprised if the final rule disregards the comments and tracks this proposal pretty closely. After all, they have chosen to tie themselves to the FDIC and OCC approach by joining in a joint proposal.
It seems that the Board has elected, after a decade and a half, to take a more intrusive approach than necessary and using as justification a fourteen-year old law that required some action that has been inexplicably delayed for a decade and a half but did not require, from my reading, this level of regulatory agency intrusion in how a credit union compensates its executives as long as it is safe, sound and poses no risk to the credit
Below is a link to the incentive-based compensation proposed rule approved last week and put out for a comment period.
As with the proposed succession rule, we will in a future Client Update provide you with the exact dates of the comment period in the likely event you will want to comment.
Last Thursday was an activist day at the NCUA Board. From my earlier example about the FAA having the job of ensuring the planes are safe and sound, but it is not their job to fly the planes. Well, these two proposed regulations outlined in this Client Update are clear examples of a federal agency taking over for the pilot.
And it does not take much foresight to see how NCUA involvement in succession planning and incentive compensation at a credit union can creep – or perhaps leap – in years to come to the point where a federal agency is controlling to a growing extent the compensation programs at institutions those agencies regulate.
This is an area of concern, appropriately, for credit unions. And, frankly, it is a concern for all federally regulated businesses.
The regulatory environment is crucial to any successful, safe, sound and competitive enterprise. Credit unions are not exempt from concern about their regulatory environment solely because they are not-for-profit, member-owned financial cooperatives.
The credit union regulatory environment is key to a credit union system we can long consider viable to impact the lives of millions of Americans from all walks of life.
Board meeting outcomes like last Thursday’s NCUA Board Meeting are something to watch as we evaluate what the regulatory environment will indeed look like in the decade to come.
Until next time.
Dennis Dollar