Tag: NACUSO Articles

by Guy Messick

There is a lot of interest in cooperative CUSOs these days.

Credit unions are finding that it is more effective and economical to offer financial services and operational services on a cooperative basis through CUSOs. The types of services offered by these CUSOs vary widely and include services such as business lending, mortgage lending, information technology, insurance, human resources and trusts. Until a few years ago there were only a handful of cooperative CUSOs, shared branching CUSOs being the most prominent. Since then, credit unions have been eager to find ways to work together to provide services more efficiently and effectively. I believe this changed attitude was the result of economic and competitive factors as well as seeing evidence of successful CUSOs. We can talk at great length on why credit unions should cooperate but that is the subject of another article. This article focuses on how credit unions should structure a cooperative CUSO to prevent organizational issues from interfering with the effectiveness of the CUSO enterprise.

DATING

The first stage of the cooperative relationship is not unlike dating. You wonder what it would be like to partner with particular credit unions. Would they have the same vision, passion and commitment that you do? Do they have the same needs? Do you trust them to do the right thing? Successful partnerships are driven by strong underlying economic and competitive forces to partner but they also require personal synergies. Do you like and trust your partners on an emotional level? If the trust is not there, the partnership will never be successful.

My colleague in CUSO Advisors, Tom Davis, has conducted many visioning sessions with prospective credit union partners. Credit unions gather at visioning sessions to discuss possible joint ventures and drill down to see if there is sufficient commonality of interests and philosophy to continue to discuss a joint venture. Often the most important aspect of these sessions takes place after hours where the senior staff and the boards of the credit unions get to know each other on a personal basis and trust and comfort is found or not found.

Tom has found that it is the board members in particular that need this personal interaction time as they do not have as much of an opportunity to interact with other board colleagues as the senior staff has with their counterparts. This interaction time is most important when the credit unions are not geographically close. There is a trend for geographically diverse credit unions to unite in joint ventures in order to avoid the competitive issues that are becoming common in credit unions with overlapping fields of membership.

If the right fit exists, there will be excitement and passion for the possibilities of the CUSO. This passion translates into mutual support among the credit unions, which will empower the enterprise.

MARRIAGE

Now that marriage looks like a strong possibility, it is time to discuss the nitty-gritty of the relationship. This is not romance. That moment has passed. This is the down and dirty side of determining how this relationship will be structured. Typically, the CUSO will be a limited liability company and the provisions governing the relationship will be contained in the operating agreement. The following is a sample of some of the more critical questions that have to be asked and thoughts on how to deal with them.

Ownership

Are there any limitations on who can be an owner (called members) of the LLC? Will the CUSO be limited to natural person credit unions? Could a League be an owner? Can a non-credit union entity be an owner? Can natural persons be owners? Depending on the strategic goals of the organizers, there could be limitation on who can be an owner. I will note that any time a credit union partners with a non-credit union entity or person, there is the strong potential that there will be different goals among the owners. For example, credit unions are often more concerned with the service function of the CUSO to support the credit union and/or enhance their relationship with their members than they are on the profit motive. Non-credit union owners will most likely be primarily interested in the profit or growth of equity goals. These differences can lead to disputes in the relationship. This is one reason why the exit strategy for owners is very important. How will new owners be admitted and on what terms? Typically, this is an item that requires the unanimous consent of the owners. The owners can establish the admission cost for the new owners at the time of their admission to the LLC. There is no need to try and predict the future. The owners can decide what is appropriate at the time the decision is made. Absent a strong need to bring in new owners for capital or business reasons, there should be a premium for new owners to join above the cost of the original owners who took the bigger investment risk of investing in a start-up business.

Management

How will the board of managers be selected? Credit unions want a say in who manages the CUSO. That is normal and expected. Typically, each owner will be able to appoint at least one manager to the Board. It is common that the person appointed by the credit union is required to be a member of the credit union’s senior management. This will insure a high level of representation and integration between the CUSO and the respective owners. Generally, the appointing owner can remove a manager it has appointed at any time. If the board is limited to a specific number of seats and there are more owners than seats, it is common to have a rotation system where all owners have representation on the board over time. Sometimes there is a desire to establish Class B ownership rights for credit unions making a smaller investment in the CUSO. I call them Associate Members. They have all the rights of owners with some limitations such as in the selection of board members. Associate Members may have a board seat that will represent them as a collective unit or be limited to appointing persons to an advisory board that has no management powers. There are other solutions that can be worked out depending on the goals of the parties. What types of decisions will be required by the owners and not the board? This is not an issue if all the owners have equal representation on the board of managers, as all credit unions will be represented. If that is not the case, some of the very important decisions usually require the concurrence of all the owners.

What types of decisions will require unanimous consent, super majority consent and majority consent? The state LLC statutes usually mandate that some decisions must have the unanimous consent of all members, such as changing the certificate of organization or the operating agreement. There are other significant decisions that CUSOs can elect to require unanimous consent or a super majority to approve. The more routine day-to-day management decisions only require a simple majority. A super majority can be defined as desired. Usually it is two-thirds, 75% or 80% of the owners or board, as the case may be. The advantage of a super majority is that one or two credit unions in a CUSO owned by many credit unions could not block a near consensus of the other owners. The disadvantage is that your credit union might be the credit union that is on the short end of the stick. In CUSOs owned by five or less credit unions, unanimous consent is the norm for the important decisions.

Will the LLC have officers? Officers, such as president and secretary, are not required in LLCs. LLCs are run by managers. However, credit unions like the familiarity of officers and most LLC CUSOs have officers who do not have to be managers.

Services

Will non-owners be served? I recommend that non-owners be served only after the owners are receiving the service they expect. The advantage of serving owners is that owners have a stake in the success of the CUSO and are more likely to be good customers and supporters of the CUSO. This is why CUSOs often permit smaller credit unions to buy into the CUSO as Associate Member. Should the operating agreement limit the services provided? I recommend defining the purposes of the CUSO broadly to permit the greatest flexibility in what services the CUSO can offer the credit unions and their members. However, if there are a lot of owners, it will be more difficult to have multiple services in the CUSO, as it is unlikely that all owners will want all the services. For example, if not all credit union owners participate in all the services how will profits and losses be allocated among the credit union owners? Therefore, we often see credit unions in multiple CUSO relationships with varied credit union partners.

Will there be geographic limitations on the services? This is a strategic question that is tied to the business plan.

DIVORCE

Voluntary Withdrawal

How will an owner withdraw from the LLC? Some LLC operating agreements do not permit withdraw. We think that is a mistake for CUSOs, as most credit unions do not want to stay with a partner that is not supportive. We recommend that a credit union be permitted to withdraw and that the withdrawing credit union receives its net capital account back less any sums due the CUSO. To avoid a financial hardship to the CUSO, the CUSO can be given an election to pay the capital account over time with a stated interest rate. It is not typical that a credit union is paid for equity growth of its ownership interest in this situation.

Involuntary Withdrawal

Will you kick an owner out for non-payment of its obligations or failing to support the CUSO? Many credit unions do not want a credit union as a co-owner unless the credit union is committed to supporting the CUSO. Otherwise, the economies and efficiencies are reduced. Other credit unions don’t mind if credit unions just want to be non-active investors. If credit unions want to remove a credit union for non-support, you should be very specific in the operating agreement on what is meant by non-support. The non-support should be subject to objective measurements. If non-support occurs, we recommend that the non-supporting credit union be given a written notice with a right to cure before the forced divestiture occurs. The amount paid is usually the same as for voluntary withdrawals. We have seen situations where a non-credit union owner is brought on for its expertise, such as an insurance agency that runs the CUSO. The credit union owners have the right to replace the insurance agency, and if they do, the insurance agency would be paid for the growth in equity as an incentive to grow the equity in the CUSO for the benefit of all the owners. Another common reason to cause an involuntary withdraw is if the credit union owner converts to a savings and loan or savings bank. Right of First Refusal In the event that an owner desires to sell its ownership interest to a ready willing and able buyer, it is typical to require the selling owner to first offer its ownership interest to the CUSO and/or the other owners. This provision helps keep the ownership “in the family.”

Profit and Loss

What is the basis for the allocation of profits and losses among the owners? The usual method of splitting profit and loss is based on the percentage of ownership. However, many credit unions want to reward the users of the CUSO services and provide incentives to the owners to use the services. In CUSOs providing operational services, this can be done through a tiered pricing structure that reward heavy usage. The profit and loss model does not have to be adjusted. In CUSOs providing financial services, all or part of the return is sometimes based on the volume of business that is generated by the credit union owners. Caution should be taken to make sure that this method does not violate laws such as RESPA or the state insurance laws. There can be a pay or play component where a credit union that is a more frequent user of the CUSO services does not have to contribute as much in capital or expenses as credit unions who are less frequent users of the service.

Parting Advice

If a credit union finds that a CUSO partnership with other credit unions makes strategic sense, if there is personal trust between the participants and if there is passion for the enterprise, then the dating phase is successful. If the credit union partners can address and agree upon the nitty-gritty details of the marriage at the outset, then they have the organizational basis for a successful relationship. If the CUSO does not work out for a credit union, the operating agreement will serve as a pre-nuptial agreement that will permit the credit union to breakaway gracefully. Breaking up will not be hard to do.

(This story was originally published by The Credit Union Journal.)

by Dalbar, Inc.

The U.S. has been struggling with a frightening truth: Americans are not saving enough for their retirement. This fact holds enormous and potentially disastrous consequences, and the country has begun pointing fingers.

Who is responsible for this ticking bomb? And more importantly to a litigious society, who is liable? Current events have brought this question to the forefront, and the response from employees and their attorneys, and even U.S. legislators, is that the plan sponsor holds much of the blame.

Who exactly is responsible for ensuring that U.S. employees sufficiently fund and prepare for their retirement? While employees in participant-directed 401(k) plans are responsible for the selection of their own individual investment choices, The Employee Retirement Income Security Act of 1974 (ERISA) outlines the fiduciary responsibilities of plan sponsors in offering a plan to help participants achieve their retirement goals. According to ERISA, the plan fiduciary (which can include any or all of the individuals from the plan sponsor’s investment committee, board of directors, plan trustees, benefits managers, etc.) must:

 
1. Operate the plan in the sole interest of the participants and beneficiaries benefits to the participant
2. Exercise care
3. Exercise skill
4. Act prudently
5. Apply knowledge available at the time
6. Rely on experts for available knowledge
7. Prudently select experts
8. Use defined processes
9. Document the process
    

  Under the law, every individual who has fiduciary authority for the retirement plan is personally responsible to the full extent of his or her wealth to manage the plan in accordance with these principles. While these guidelines can be used to determine if a fiduciary has acted properly, their lack of specificity presents a scenario for the plan sponsor (and the lawyers who sue them) in which there is no specific list of requirements that absolve the fiduciary from the risk of loss of personal assets. In fact, a plan sponsor’s fiduciary obligations to employees outweigh even the firm’s fiduciary obligations to its shareholders!

Defining What is Prudent
  What exactly does it mean for a plan sponsor to be prudent? Herein lies the fodder for potential courtroom debates. Consider, for example, how a prudent plan sponsor would be expected to behave when developing and administering a retirement plan for a group of employees with little or no understanding of investment or retirement principles. Would an enrollment meeting and the ability of participants to change investment options via a Web site be sufficient to satisfy the fiduciary responsibility of a prudent plan sponsor? Law firms across the country are preparing to argue “no” as their clients, unprepared for retirement, claim that they were ill-informed and/or misguided by their employer when investing in their retirement plans.

In essence, someone must take the blame for the fact that the average plan participant holds only $42,000 in his or her retirement account. Two pre-eminent Washington DC attorneys who specialize in class action litigation predict that the ones to hold the blame will be plan sponsors. They offer plan sponsors this wake-up call:

“We are nearly completed with litigation against tobacco companies. We are just beginning the major litigation against gun companies, and the next big area for litigation-after guns-is going to be suing 401(k) and 403(b) plan sponsors.”

Why Now?
  Until recently, a couple of circumstances have delayed from scrutiny the effectiveness of 401(k) plans (as currently administered) to fund citizens’ retirement. To begin with, the first generation of 401(k) self-directed plan participants is only now reaching the retirement stage, so there has not been enough time to detect any problems with 401(k) plan effectiveness or breaches in fiduciary responsibility by plan sponsors. In addition, the U.S. most recent bull market worked to hide flaws with participant-directed 401(k) plans, since double-digit returns had many people believing they might retire early and with ease. In both circumstances, however, today’s reality has changed drastically. Not only has the bull market turned into a prolonged bear market, widespread breaches in fiduciary responsibility by plan sponsors have been uncovered. Both turns of event have ignited fear and eventually litigation by U.S. hopeful pre-retirees. Most noteworthy have been the lawsuits ⢠led against the companies Enron and WorldCom. By the time the courts will have settled his case, Enron’s former CEO Kenneth Lay is expected to lose his personal assets for his breach of fiduciary responsibility to employees in his company plan. Sadly, both highly publicized cases have rendered the “prudent” person of today’s world to expect unethical and fraudulent actions from companies and individuals across the spectrum. But even more significantly, perhaps, is the impact of this attention on the majority of this country’s plan sponsors who are not in fact acting unethically, but with neglect.

Facing Today’s Realities
  Plan sponsors would argue that they are simply not in the business of managing 401(k) plans; they are in the business of running their business. This attitude and neglect have inadvertently created an ineffective retirement savings process for employees, and plan sponsors will likely feel the backlash when their employees are literally unable to retire at age 65. In the majority of cases, plan sponsors are breaking their fiduciary responsibility by shelving the problem of poor or ineffective employee participation in their retirement plans. For example, once the Ken Lays of the world have been tried, the more likely case seen in court will be that of a baby boomer who wants to retire but cannot for lack of sufficient retirement funds. Employees like this may sue their employer, not because the sponsor imprudently and unethically forced company stock on the employee (as in the case of Enron and WorldCom and others), but because the employer did not prudently develop a retirement plan that succeeded in helping employees reach retirement goals. Can Plan Sponsors Protect Everyone? First and foremost, today’s employers need to accept their vital role in helping employees to retire, by embracing their responsibility as 401(k) plan sponsors and plan fiduciaries. Employers seem to have forgotten that employers’ responsibility to plan for employees’ retirement is not a concept that has just recently been thrown upon this generation of business owners. In fact, today’s 401(k) plan (which relies on employee contributions) is less costly than its predecessor, the defined benefit plan that relies on contributions from the company to fund employees’ retirement. Not only is the 401(k) plan less costly to employers, it provides a critical benefit to employees that is vital to attracting and retaining high-quality staff. Plan sponsors, who acknowledge the seriousness and importance of their role as plan sponsor, can take comfort in knowing there are prudent steps to administering the plan that will help to manage fiduciary risk. Specifically, faced with today’s realities of corporate malfeasance and the inability of the average citizen to save appropriately for retirement, the prudent plan sponsor will best minimize fiduciary risk by:

 
1. Providing employees with access to unbiased, qualified retirement advice.
2. Performing due diligence on all experts involved with the plan.
    

Providing Advice
  It has finally come time to acknowledge that current and past practices of educating employees to fund for their retirement have not succeeded. Plan participants are making poor investment decisions and are simply not on track to be financially prepared for their retirement by the end of their working years.

Traditionally, fear of fiduciary responsibility has kept plan sponsors from correcting this problem by offering advice to their employees. Yet recent media, legal, and governmental attention on, and documentation of, participants’ inability to prepare for their own retirement is literally changing this risk equation for employers. Now, one could argue that offering participants access to unbiased, qualified advice is not risky, but a form of risk mitigation: “If plan fiduciaries know-or even strongly suspect-that their participants need help, including investment advice, the responsibility for acting is not avoided by not making a decision. From a legal perspective, the greater risk may be to fail to offer investment advice where it is needed. It is far more likely that fiduciaries will be viewed as having fulfilled their responsibilities where participants are advised by reputable investment organizations to create balanced long-term portfolios.”

So far, the U.S. legislature has come out to support the role of advice in 401(k) retirement plans. Already new legislation supporting advice delivery has been proposed, and is on the path to becoming law. Specifically, bill HR1000, which has been passed by Congress and awaits approval by the Senate, permits investment managers to provide advice to plan participants for a fee. Additionally, the SunAmerica opinion letter has paved the way for plan providers to offer advice to plan participants by using models from 3rd parties to ensure that advice is in best interest of participants.

Performing Due Diligence on Experts
  In addition to offering participants access to advice, a prudent plan sponsor will ensure that all parties responsible for managing, administering, contributing, or providing advice to the plan, are acting in the best interest of the plan participant. In the post-Enron era, a prudent person must reasonably expect unethical and fraudulent actions from companies and individuals. The usual practice of narrowly applying due diligence only to investment performance falls short of protecting assets from foreseeable risks-plan sponsors must also perform due diligence to mitigate risk from potential threats such as rogue brokers, inexperienced or sanctioned advisors and the unethical practices of any plan co-fiduciary.

Risk management therefore requires verifying the ethical, unbiased and knowledgeable practices of all experts used by the plan, including but not limited to: investment consultants, fiduciary advisors, third-party administrators, enrollees, and call centers that support plan participants. The most prudent of plan sponsors will best mitigate fiduciary risk by performing due diligence of these experts in areas such as the expert’s regulatory history, ethical practices, quality of customer service, and knowledge of 401(k) principles.

In Conclusion
  The inability of millions of Americans to prepare for their own retirement has developed into a nationwide crisis that is at once political, social and economic. Plan sponsors that accept their share of responsibility in righting this crisis by acting prudently, diligently, and in the best interest of their employees will in return gain the loyalty of their employees, while mitigating the risks facing them in a post-Enron world.

Footnotes: “The Retirement Plan Bomb for Non-Profits” by Mark B Manin; LaRhette Manin Benefits Service Group; Wellesley, MA. Fred Reish; Reish Luftman McDaniel & Reicher law firm; Los Angeles, CA.

This article was originally published by Dalbar, Inc in July 2003. (Used by permission.)