presentation strategies for strengthening credit union...

Strategies for Strengthening Credit Union Supervisory Committees

ABA Business Law Section Sponsor: Credit Union Committee

Spring Meeting, Orlando, FLApril 12, 2018

Participants

Program Chair• Brenda Barrett, Partner, Duggins, Wren, Mann & Romero, LLP and Chair

of the ABA Business Law Section Credit Union Committee

Speakers

• Christopher Pippett, Partner, Fox Rothschild, LLP and Chair of the Corporate Governance Subcommittee of the ABA Business Law Section Credit Union Committee

• Meredith Ritchie, Vice President, General Counsel & Chief Ethics Officer, Alliant Credit Union and Chair of the Operations Subcommittee of the ABA Business Law Section Credit Union Committee

• Peter Woods, Associate General Counsel, ESL Federal Credit Union (Moderator) and a Vice Chair of the ABA Business Law Section Credit Union Committee

Agenda

• Credit Union Supervisory Committee within the CU Organization

• Supervisory Committee Duties• Credit Union Fraud and the Supervisory Committee

• Bank Audit Committees• State Charter Variations• Strategies, Options and Solutions to Strengthen Supervisory Committees

Why are we here?• “The biggest surprise that came out of [the study] was that when

you consider the importance of a balanced, constructive partnership among the board, CEO and supervisory committee —the three‐legged stool of good governance — there were a number of areas where boards and CEOs had different perceptions on the quality of governance,” noted Christopher Stevenson, SVP and chief learning officer at CUES. – Credit Union Journal, February 16, 2018 (“How to get credit union

boards and CEOs back on the same page”)– The State of Credit Union Governance 2018

• Credit Union Executives Society • Quantum Governance L3C

• 200 CU’s failed in the last 10 years ‐ 80 caused by fraud.• 85% of losses to NCUSIF were related to fraud.

© 2018 Fox Rothschild

Strategies for Strengthening Credit

Union Supervisory CommitteesChristopher J. Pippett, Esquire

Fox Rothschild, LLP

ABA Credit Union CommitteeSpring Meeting, Orlando, FL

April 12, 2018

Credit Union Organizational Reporting/Supervision Chart

Internal Auditor

Supervisory Committee

Board Committees

Rank and File Employees

Department/Branch Managers

Senior Management

CEO/Manager

Board of Directors

Members

Fiduciary Duties

Same as for directors and officers:

• DUTY OF CARE• DUTY OF LOYALTY• DUTY OF OBEDIENCE TO THE LAW

Liability for Actions

• Business Judgment Rule - In most jurisdictions, board members and officers are protected from liability to shareholders for their decisions under what is known as the Business Judgment Rule. This rule generally protects a disinterested director from liability where the director:

– Acted in good faith;– Was reasonably informed; and– Rationally believed the action that was taken was in the best

interests of the entity.

Specific Duties (NCUA SCG)

Supervisory Committee must ensure:

•Management’s financial reporting objectives have been met.

•Management practices and procedures safeguard member assets.

Specific Duties (NCUA SCG cont’d.)

Supervisory Committee must determine whether credit union managers have:

•Established effective internal controls.•Promptly prepared accounting records and financial reports to accurately reflect operations and results.

Specific Duties (NCUA SCG cont’d.)

Supervisory Committee must determine whether credit union managers have:

•Properly administered plans, policies and control procedures established by the board.

•Established policies and procedures that safeguard against error, carelessness, conflict of interest, self dealing and fraud.

General Duties• Duties and Obligations (see NCUA SCG)

–Generally the same as those of directors and officers – expanding rapidly!

–Additional duty to monitor the activities of the board and management to ensure safety and soundness of the credit union.

–Ensure board is functioning.–Ensure management is properly carrying out

board policies and directives.

Board and Management Performance

• Main Questions:

– What should they be doing?– Are they actually doing it?– Are they doing it well?– Is there room for improvement?


Board Performance –Is the board a good board or bad board?–Are policies regularly reviewed and up to

date?–Is board ensuring that management is

performing its function pursuant to its directives?


Board Performance (cont’d.)– Is the board addressing security (especially data

security) in a responsible manner?– Is there a succession plan for both the board and

management official?– Is the board up to date with regard to finance,

technology, data security and regulatory compliance?

• If not their own knowledge, are they properly advised?


• Access to Information:– Committee members have the right to:

• Access books and records; • Communicate with key employees;

and• Hire auditors and other advisors.

– Committee members may attend board meetings.


• Independent Audit – who performs it will depend on the size of your credit union. Access to Information:

– Make sure you change individual auditors every five years.

– Even if you stay with the same firm ask for a different auditor.

– Internal auditor may be an option but cost and continued independence may be an issue.


• Independent Audit (cont’d.)– You should not rely on NCUA examiners to

perform this function!– Committee must retain and interact with

auditors and thoroughly review the auditors reports.

– Make sure board provides appropriate resources to do so.

Board and Management Performance• Preparing for the Independent Audit.

– Review:• Last audit report and notes.• Findings, DORs and LUAs from last

exam.• Member complaints forwarded by

NCUA since last audit as well as investigations and responses.


• Preparing for the Independent Audit(cont’d.)– Review:

• Whistleblower/Employee complaints since last audit as well as investigations and responses.

• Reports regarding losses and delinquencies


• Preparing for the Independent Audit (cont’d.)– Confer with and seek input from Risk Management

and Board.– Meet with Independent Auditors prior to Audit to

map out strategy for:• Scope of Audit.• Areas of Risk.• Specific Items to be reviewed.


• Review and verify:– Member Accounts - at least every 2 years.– Related party transactions.– Loan approval and funding.– Investments.– Security Plan.

Board and Management Performance• Review and verify:

– Separation of duties.– Access to employee/family member accounts.– Expense reimbursement and policies.– Cash in vaults and teller drawers.– Loan and other loss reports.


• What if you find a problem?–First verify with appropriate documentation.– If fraud is ever raised as an issue consult

with counsel before proceeding.– If the problem is at management level, take

it to the board.– If problem is at board level, take it to board

chair or consult counsel.

Board and Management Performance• What if you find a problem (cont’d.)?

–Make sure executive management and/or the board develop an action plan to address the issue promptly.

–Follow up to ensure plan has been executed.–Hold them accountable to execute the plan.– If appropriate, make sure bond carrier is

notified.– If appropriate, make sure NCUA is notified.

Board and Management PerformanceWhat if you find a problem (cont’d)?–Supervisory Committee has authority to

suspend any executive officer, credit committee or board member.

• Must hold a special meeting within 7 – 10 days at which suspended person shall have the opportunity to be heard.

• This power should be used with discretion and only with regard to serious matters.

Supervisory Committee Work Plan – Why?

• 200 CU’s failed in the last 10 years - 80 caused by fraud.

• 85% of losses to NCUSIF were related to fraud.

• 50% of claims paid by CUNA Mutual were related to fraud (by employees).

– Fraudulent Loans - $118.7M– Cash - $17.7M– Investments - $6M

Credit Union Fraud Since 2013Asset Size Credit Union Fraud Type Amount Alleged Perpetrator

$7M Borinquen FCU Loans/Theft of Funds $2.3M CEO

$2M Women’s Southwest FCU

Loans/Theft of Funds $3.4M Manager

$303K United Catholic FCU Aliases/Forged Checks

$2.1M Manager

$270K Associated Blind of Oklahoma/Texas

Theft of Funds $200K Manager

$3.1M Border Lodge CU Theft of Funds $300K CEO

$2.5M Lawrence County School EE’s FCU

Theft of Funds $285K Employee

$630K H.B.E. CU Unauthorized Checks $636K Manager

$1.6M Enterprise CU Theft of Funds $800K Manager

$16M GIC FCU Theft of Funds/False CDs

$2M Manger

$24M Taupa Lithuanian Cu Loans/Theft of Funds $15M CEO, Teller, 5 Others


$60M WesTex FCU Theft of Funds $500K Assistant Accountant

$1.9M Aurora Firefighters CU

Theft of Funds $36K CEO

$13.8M Lynrocten FCU Loan Participation Fraud

$1M Manager, 2 Employees

$42M Toledo Metro FCU Corporate Expenses $234K CEO

$186M St. Paul Croatian FCU

Loans $70M CEO, 30 Others

$38M Wilkes Barre City EE’s FCU

Loans $16M Mgr, Asset Mgr, Members

$16.3M Shoreline FCU Cash Theft from Vault

$1.9M Manager

$10.4M Centra Health CU Theft From Corp. Account

$1.7M CEO, 2 Others

$13B$924M$1.1B

Boeing EE’s CUTwinstar CUSound CU

Stolen Check $987K Members


$639M$17B$20M$246M

Great Lakes CUPentagon FCUSherwin Williams CUCU 1

Car Loans $853K Members

$24.5M Georgia Power Valdosta FCU

Accounting Fraud $500K Operations Manager

$13.5M Parsons Pittsburg CU Embezzlement/Transfer of Funds

$10M Manager

$1B Scott Credit Union Loan Falsification $12M Business Relationship Manager

$68M Clarkson Brandon Community CU

Accounting Fraud $20M CFO

$603M Houston Police FCU Stale Checks $1.2M VP

$223M Pantex FCU Check Fraud/Theft From Teller Drawer

$826K AVP

$2.1M SCIAP CU Embezzlement $2.5M Bookkeeper

February 2017 NCUA OIG Report• Reviewed a significant loss that caused the failure

of six credit unions in the Philadelphia Area.• Among the conclusions was a statement that “We

believe the examiners failed to identify the Supervisory Committees as ineffective” citing a lack of meeting minutes and Supervisory Committee Audits.

• NCUA’s response was to revise examination procedures to include review of Supervisory Committee Audit process and procedures.

Bank/Corporation Audit Committee Duties

• Not that much different than the duties of a Supervisory Committee. Typical statement of duties includes:

– Serve as an independent and objective party to monitor the integrity of the company’s financial reporting process and its associated and internal control and risk management systems.

– Review and appraise the audit efforts of the company’s independent accountant and internal auditing department. In doing so, monitor the independence of the public accounting firm including any fees paid for non-audit services.

– Provide an open avenue of communication among the independent accountants, financial and senior management, the internal auditing department, and the Board of Directors.

– Monitor compliance by the company with legal and regulatory requirements.

Bank/Corporation Audit Committee Requirements under FDIC Regulations

• Similar to Supervisory Committee requirements under NCUA Regulations

– Reviewing with management and the independent public accountant the scope of services required by the audit, significant accounting policies, and audit conclusions regarding significant accounting estimates;

– Reviewing with management and the accountant their assessments of the effectiveness of internal control over financial reporting, and the resolution of identified material weaknesses and significant deficiencies in internal control over financial reporting, including the prevention or detection of management override or compromise of the internal control system;

– Reviewing with management the institution's compliance with the Designated Laws and Regulations;

– Discussing with management and the independent public accountant any significant disagreements between management and the independent public accountant; and

– Overseeing the internal audit function. *

*12 C.F.R. §363.5 Appendix A

Bank/Corporation Audit Committee Recommendations (cont’d.)• Committee charter. The charter should be reviewed on a

regular basis to ensure that the committee is complying. It is also useful for setting agendas.

• Oversight. The primary role of the audit committee is to evaluate the audit process, oversee financial reporting, and assess the risk and control environment. Members typically ask detailed questions, requesting feedback and regularly discussing concerns.

• Committee composition. Banks typically look to local CPAs to fill audit committee. That experience is useful, consider having members with a wide range of expertise.

Bank/Corporation Audit Committee Recommendations (cont’d.)

• Rotation of members. Rotation of members after an extended period of time to ensure fresh perspective but avoid the risk of losing members who are well trained and effective.

• Relationship with the external auditors. Communication with auditors is important. Review of reports and materials ahead of time, and use the review session to ask them questions, get their perspectives on market trends, and request recommendations.

• Internal audit reviews. Whether this function is internal or outsourced, a major red flag is a report with no findings. Ask why. Make sure people are not just going through the motions.

• Setting the agenda. The agenda should follow the committee charter as well as include an annual checklist.

State Chartered Credit Union Supervisory Committee Differences

Meredith Ritchie,Vice President, General Counsel & Chief Ethics Officer, Alliant Credit Union

ABA Credit Union CommitteeSpring Meeting, Orlando, FL

April 12, 2018

Overview

State chartered credit unions:

Different Supervisory Committee Requirements than Federally Chartered Credit Unions such as:

a. Whether or not committee members are on the Board or not on the Board

b. Number of Committee Membersc. Meeting frequencyd. Dutiese. Interaction with Management and Boardf. Relationship to Audit - Internal and Externalg. Interaction with Regulators

Illinois Example:

In Illinois, the Illinois Credit Union Act dictates the parameters of the Supervisory Committee.

Supervisory Committee members must be on the Board of Directors.

There are three Supervisory Committee Members at Alliant.

Best practices and new ideas

Consider engaging a professional search firm to place Board members and Supervisory Committee Members to garner qualified, and diverse individuals who are also the right cultural fit for the credit union.

As counsel, assist Internal Audit create an annual calendar with deliverables for the Supervisory Committee.

As counsel, ensure that the Supervisory Committee has a Charter and that the committee is adhering to the requirements designated in its charter.

Ensure that areas of risk are presented to the Supervisory Committee.

Best Practices and new ideas

Assist Internal Audit with creating meeting agendas.

Ensure that Internal Audit, Risk, Compliance and Fraud are coordinating so that agenda is complete and no areas are omitted.

Consider suggesting that the committee take a self-assessment on its skills, strengths and areas of opportunity- this survey should go through inhouse counsel or outside counsel to preserve confidentiality.

Strategies, Options and Solutions to Strengthen Supervisory Committees• Recruiting

– Set standards like directors

• Committee Operations– Plan ahead

• Board of Directors Communications and Interactions– Attend meetings

• Bank Audit Committee Powers

• Senior Management Interactions– General Counsel: In‐house v. Outside counsels– Anti‐fraternization policies?

• Safe and Sound Operations/Detection of Fraud– Best practices for member complaints

• Paying Supervisory Committee Members or conferences (in Hawaii) are enough?

HypotheticalAs a partner at Ritchie and Pippett LLP, you get a call from the Chair of the Board of Directors of UH OH FCU. She tells you that the FCU has just signed a Letter of Understanding and Agreement with the NCUA. The LUA requires the credit union to hire counsel to help them fix corporate governance at the FCU, including strengthening the Supervisory Committee. She adds in an aside, the Supervisory Committee has no current members; it needs to be re‐built from scratch.

• What is your advice to UH OH FCU in establishing a viable Supervisory Committee?

Recruiting: Set Standards Like Directors• Directors and Management should always have their eyes

and ears open to possible Supervisory Committee candidate– Important to maintain good contacts within membership and

community for candidates to find a sufficient pool to select from– Consider use of outside placement firm: Cost may be worth the

results especially for larger/sophisticated credit unions• Credit Union Strategic Plan

– Consider current strategic plan and skill sets needed to perform or engage/review auditor reports and responses

– Determine the desired backgrounds and experience needed– Consider future strategic plans to recruit members to fill actual

or perceived gaps

Recruiting: Set Standards Like Directors

• Job Descriptions– Create and regularly review job description(s) for Supervisory Committee members

– Consider separate description for committee chair– Create Supervisory Committee “Charter” to help guide activities

• Make distinction between roles of Board of Directors and Supervisory Committee

– Need people who can ask the right questions• Evaluations

– Self‐evaluations by Supervisory Committee members– Nominating committee evaluations– Have plans for how to address performance issues

• Board can suspend, but as a meeting of the members is required need to consider less costly solutions

Recruiting: Set Standards Like Directors

• Training– Establish minimum training requirements– Focus on the fiduciary duties (care/loyalty)– Include meeting standards in evaluation process– Continuing education is a must

• Changing environmental risks• Changing business plans

Hypothetical

Thanks to your efforts, UH OH FCU has nominated and filled all of the members of the Supervisory Committee. You are invited to the first meeting of the newly constituted Supervisory Committee to train them and provide advice on how they will work.

• What is your advice to the Supervisory Committee on how to get started?

Committee Operations

• Planning– Plan the year in advance, preferably on a rolling annual basis

– Use as a checklist for all activities required and wanted to be reviewed

• Agendas– Whether monthly or quarterly, must have an agenda

• The Chair should keep to it!– Will help in communications with Directors– But when issues arise between meetings, need flexibility to jump in and deal with serious, unexpected events

– Review minutes for existence and accuracy

HypotheticalWhile in this meeting, a Supervisory Committee member tells you he is planning to attend all of the credit union’s Board of Directors meetings and “wants to be sure the Supervisory Committee’s concerns are heard” at every meeting.

• What is your advice to this Supervisory Committee Member?

• Will you pull the Chair of the Supervisory Committee aside and tell her anything?

• How about the Chair of the Board of Directors?

This same Supervisory Committee member also talks about his prior experience as a member of a local community bank’s Audit Committee. He wants to know if he can bring some of the practices from that group to the credit union.

• Can he?

Board of Directors: Strong communications and access• Boards would do well to invite Supervisory

Committee members to regularly attend Board meetings– Tension Point: Supervisory Committee members would be well advised to remember they are observers and are not there to set the agenda or to make business decisions

– Healthy Culture: Supervisory Committee member should be able to ask questions (and maybe even participate in the discussions)

• Regular and open communications between the Board Chair and the Supervisory Committee Chair– When problems are discovered, that is not the time for the two chairs to start to get to know each other

Banking Audit Committee Ideas

• Committee Charter and Annual Agenda• CPAs and Rotation of committee members

– Need strong recruiting to make this work

• External auditor relationship– Need strong communication skills

• Internal audit department oversight– Need strong communication skills

HypotheticalGood news! Your training session was a success. UH OH FCU’s Supervisory Committee has gotten off to a great start. They have understood their duties and have started to perform the tasks they are required to do and have found many issues to resolve.

It’s that “resolve” that has lead the Chair of the Board of Directors to call you, again. The Supervisory Committee is asking lots of questions about Board strategy, Board member’s lack of involvement at meetings and even questioning whether the CU’s Management Team is up to snuff. The Chair of the Supervisory Committee and the Head of Audit are no longer on speaking terms.

• What is your advice in dealing with the interactions between the Supervisory Committee and the Head of Audit?

• Does your positioning of the advice change if you are an in‐house counsel and a member of the Management Team?

• What are your thoughts about how the Management Team, the Board of Directors and the Supervisory Committee should interact, both officially and unofficially?

Other Area of Concern: Senior Management Interactions

– Head of Audit Department• Cooperative or Skeptical?

– General Counsel• In‐house v. Outside counsels differences

– CEOs and Future CEOs/succession plans• Anti‐fraternization policies?

HypotheticalYou attend the next Supervisory Committee meeting and talk the group through these issues. After you have completed that discussion but before you can leave, the Supervisory Committee starts reviewing the member complaints report. The groans from the committee members are quite audible. You distinctly hear the Chair of the Supervisory Committee say “We should get paid for having to deal with these members.”

Against your better judgment, you sit back down.

• What questions do you ask the Supervisory Committee about their experiences with managing member comments? What advice do you expect to give them about best practices?

• What do you share with the Supervisory Committee about paying “volunteers”? Will pay really solve any of the problems with Supervisory Committees?

Other Area of Concern: Safe and Sound Operations and Detection of Fraud

– Best practices for member complaints

Paying Supervisory Committee Members: Real Solution or Red Herring for Good Corporate Governance?

• To Pay• Not To Pay

If you were advising Congress and NCUA …

• Consider revising Federal Credit Union Act to clarify “management” roles between Board of Directors and Supervisory Committee– The management of a Federal credit union shall be by a board of directors, a supervisory committee, and where the bylaws so provide, a credit committee. 12 USC 1761(a)

– Some states have amended state statutes to help clarify roles

• Washington narrowing Supervisory Committee power to recall a board member through a special membership meeting; requiring notice to the Board of Directors

– Though, beware of what you ask for…

Questions

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