FDIC Law, Regulations, Related Acts
4000 - Advisory Opinions
"Affiliate" Relationship with Credit Union
October 20, 1982
Pamela E. F. LeCren, Senior Attorney
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 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:*
2. Whether or not the relationship between *** and *** Bank as described above violates the Depository Institution Management Interlocks Act.
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 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.
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