Regulation, Communication, Trust and Ethics All Linked
The full effect of the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank) is still to be felt in the financial sector. Dodd-Frank creates an environment of increased scrutiny and heightened sensitivity by regulators and consumers.
Perhaps credit unions should not be treated in the same way as other financial firms; however, regulators are reacting to this environment. With this in mind, senior management and their boards must be on top of their game today in addressing compliance issues.
Volunteer board members and management need a common sense approach to regulation and compliance. To assist them, the Credit Union Leadership Forum recently hosted a Web seminar on “The Future of Regulation and Compliance: What You Need to Know to Successfully Prepare Your Organization.”
- See the webinar online: “Future of Regulation and Compliance”
Fully, two thirds of the participants believed that Dodd-Frank would play a significant role in their 2013 planning. Indeed, many credit unions will be allocating additional funds to the regulatory effort.
About 30% of participating credit unions indicated that they would be spending $10,000 to $50,000 more on regulatory compliance in 2013 than in 2012, and about 10% said they would allocate an additional $50,000 or more.
Tim Segerson, deputy director of the Office of Examination and Insurance of the NCUA, participated in the Web seminar. He predicted that addressing the legislation would take time for credit unions to sort out. Much of Dodd-Frank deals with financial institutions aside from credit unions, but the legislation itself affects the markets in which credit unions operate.
For example, the mortgage industry is an area where there will be rulemaking. The Consumer Financial Protection Board will soon announce regulations for qualified mortgages and for the secondary market for mortgages. These regulations will affect the credit union industry.
The CFPB is mandated to write a significant number of consumer related protections affecting the financial services industry, including credit unions. Changes to truth in lending and mortgage regulation are forthcoming.
The NCUA does not write regulations; other agencies, such as CFPB, do so. NCUA usually has some input and at times a voice at the table. NCUA uses the regulations in its normal examination process to assure that credit unions are in compliance. There is a particular focus on managing risky activities that could have an impact on the NCUA insurance fund.
Tim pointed out that the diversity in size of credit unions makes rule writing difficult. To give some context, the largest credit union has more than $51 billion in assets and over 9,000 employees, while the smallest has less than $15,000, with no employees, only volunteers. The NCUA oversees both; so one size regulation cannot fit all.
Tim explained the importance of scalability. Rules must apply appropriately across the spectrum of credit union sizes. Rule writing must not be so complex as to set smaller firms up for failure, but it must appropriately address risks associated with large institutions.
The NCUA has a focus on modernization, asking “Are the rules of the past appropriate for the future?” There is an emphasis on streamlining regulations, with a fresh look at making the process less burdensome.
The trend is towards fewer, larger and more sophisticated credit unions. Larger institutions will have a greater impact on the risk associated with the insurance fund. Tim reiterated that many regulations relate to the protection of the insurance fund.
Anne C. Flannery, senior counsel with Morgan Lewis’s litigation practice was another Web seminar participant. She emphasized that it is critical that management and boards show that good governance practices are in place and are being followed. This is critical for two reasons:
First, this actually prevents mishaps. Following routine control measures and methodically following processes that are in place can correct problems before they become major issues for the credit union. Testing the code of ethics and comparing a firm’s practices to new developments to assure that the firm is testing for the right things, often leads to discovering minor problems and at times major ones before they escalate. The process works.
Secondly, organizations must prove to regulators that there is a process in place. Being able to show that management and the board were staying abreast of best practices demonstrates that the credit union was, in fact, living up to the standard of duty of loyalty and duty of care.
Duty of Loyalty requires a director to act in good faith in the best interest of the organization and not in the director’s own interest. Accordingly, the director avoids all conflicts of interest. The board should review its Code of Ethics at least annually. Board members must fully understand the Code of Ethics and the issues involving conflicts of interests. Signing the ethics disclosure form should be part of the board’s regular duties.
Management compensation is an important element of the duty of care. The board must be engaged and assure that the compensation committee is well functioning. Board oversight means that management is paid fairly and appropriately. It means that the board sees that compensation is aligned with the mission of the organization and the strategic plan.
Design of management compensation systems should be independently verified with boards and their compensation committees having access to independent counsel.
Of the Web seminar credit union participants, about 60% agreed that transparency was good. Anne noted the importance of transparency between management and their compliance groups and with regulators. Credit unions will be in a stronger position when confronting a significant regulatory challenge, when it has developed the relationship with its regulators before a problem occurs; they know in advance what the credit union is trying to accomplish and the challenges that it faces.
Tim agreed that discussions with the regulators build the trust relationship. Continual communication can minimize regulatory problems if an issue does arise.
Quality communication among management, the board and regulators is important for risk management. This conversation must be based on sound values that support the firm’s mission. Addressing any regulatory problem must be done at the highest intellectual level. No one should fear “retribution or payback”.
Tim explained that there are systems in place to avoid any semblance of regulatory retribution or payback. Debbie Matz, the chair of the NCUA Board, has explicitly stated that this will not be tolerated.
Anne pointed out that now there is much more communication among the regulatory agencies, and much less compartmentalization than in the past. For example, if the SEC were to receive a complaint related to a credit union, it would communicate that complaint to the NCUA.
Creating a culture of common sense ethics in the credit union industry will benefit it in a number of ways. It will help in the competition for talent, with credit unions attracting smart and decent people. A focus on the mission of the credit union and their dedication to values will attract talent with character and good independent judgment. These are the qualities that will help the industry succeed during a time of heightened scrutiny.
Values require that management has the self-confidence to engage the board at a strategic level on issues of ethics and compliance. The character of the board members sets the tone for the CEO and for the firm. The values are the foundation upon which service to the members is built.
Stuart R. Levine is chairman/CEO of Stuart Levine & Associates. He can be reached at (516) 465-0800 or stuartlevine.com.