KENSINGTON, Md. -- Documents have come to light which largely substantiate a former executive's account of regulatory barriers which stood in the way of the then $314 million Lafayette Federal Credit Union's attempt to convert to a mutual bank.

Lafayette launched its conversion attempt in the early summer of 2006 and withdrew the application in January of 2007 after an extremely close vote and a withdrawal of an initial certification of the balloting by an outside firm chosen to oversee the balloting.

Questions about the necessity of the vote and the ability of the CU to have even completed the conversion application procedure arose after the CU's chief compliance officer, Lawrence Hart, resigned from the credit union in the spring of this year. Hart said the Office of Thrift Supervision advised Lafayette's leadership in August of 2006 to withdraw its application to convert until after it had managed to correct Bank Secrecy Act compliance problems.

Lafayette leaders never challenged Hart's account of the meeting but said that he had left the CU after not having completed what he had been hired to do, which was to fix the CU's BSA problems. Hart countered that he had developed procedures to bring the CU into compliance with BSA but that the CU had never implemented them.

Now previously unavailable documents from the Office of Thrift Supervision's Southeast Region largely substantiate Hart's account of the CU's problems with BSA and the impediment they presented to the CU's charter conversion. They also speak in considerable detail to the problems the CU faced.

An eight-page report the OTS sent to the CU about a BSA examination the agency conducted at Lafayette on July 31, 2006 notified the CU about numerous errors in the CU's BSA related operations, including failure to notify law enforcement about incidents of wire fraud that the CU reported to its insurer and another where an employee stole money from a member's account.

"Lafayette's BSA program does not currently meet the threshold for compliance" with the agency's BSA regulations, the report said.

The CU has not yet commented on the report but made a response in the weeks after it first arrived, noting that it had purchased software to help it better comply with BSA regulations and hired a specialist to lead the effort (which was Hart). Lafayette has not yet indicated whether it has finished implementing the BSA compliance software or hired a replacement for Hart.

Probably the most eye-catching events the report documented were two incidents of wire fraud which the OTS examiner uncovered and for which Suspicious Activity Reports had been filed in July of 2006. The events took place in May 2006 and were reported to CUNA Mutual Group, but not to the government or even the police.

"One other concern is that the above incident was not reported to the police (or other appropriate law enforcement)," the report said. "We found this true for several SARs where clear criminal activity had occurred. (For example, 3/9/2006 SAR for counterfeit check.) While we would not expect a police report to be made when a SAR is filed for purely suspicious circumstances (e.g., potential structuring), it is appropriate to report incidents involving known fraud, theft, or other criminal activity."

Lafayette replied that its collection department was in charge of following up on fraud cases and that a 2005 audit had identified problems in this area but that the CU's Chief Operations Officer was "taking steps to address the issue."

"We agree that a police report should have been filed. However, it has been our experience that such reports result in little to no follow through by the local police. Nevertheless, the reports should have been and will be filed," Lafayette added.

Likely, one of the more frustrating systemic BSA compliance problems that the CU faced in the report rested with its ATM program.

"The daily cash report has a cutoff of $10,000, which is inadequate to detect structuring," OTS said. "The compliance officer indicated it would take years for the provider to produce a report with a lower cutoff. In addition, the system identifies a number of different transaction types as cash that are not actually cash. For example, all ATM deposits show on the report as cash, but may actually be checks, cash, or a combination thereof. Also, some transfers between accounts are shown as cash."

Lafayette replied that while it was true that all of its ATM deposits were shown on the core system as cash, it questioned whether this was not true of all financial institutions.

"The ATM Department has been trained to recognize when a report is required and to file where needed," the CU replied. "The contents of all incoming deposit envelopes are notated to identify the contents. We do not consider it necessary or feasible for the processor to modify the core system accordingly. We do agree that we are relying too heavily on the ATM Department to follow through. As such, we will schedule this function for audit on a quarterly basis."

Common Problems?

The back and forth between Lafayette and the OTS that the documents reveal also points to the reality that NCUA's regulations might not be the biggest regulatory impediment to credit union-to-bank charter conversions, even though they draw the most attention.

Alan Theriault, CEO of CU Financial Services, a leading consultant in conversions said that the firm pays special attention to any issues with the Bank Secrecy Act, knowledge of loans that a CU might have on its books that other bank regulators might consider "subprime" and any loans from the CU to executives or board members when advising a CU about a possible conversion.

"BSA regulations are nothing new of course and apply to both credit unions and banks," Theriault observed, "but it seems that credit unions are a bit behind other financial institutions when it comes to implementing them completely."

Theriault said that the BSA discussions usually take place in what he called the "feasibility phase" when his firm is working with the CU to get a sense of what it would take for the institution to make the conversion. He also said that on both BSA and subprime issues, there is often a wide discrepancy between the perceptions of the CU's leadership about its BSA compliance and subprime profile the reality.

"When it comes to BSA, we often have CU leaders assure us that they are BSA compliant and then found out later than they really weren't," Theriault said, adding that the subprime issues usually revolved around the CU's knowing which loans in the portfolio met the shared financial regulator definition of subprime and therefore need to be accounted for differently in terms of risk.

Theriault's observations echoed one of first lines from Lafayette's response to the OTS report. "It is important to understand that prior to our last NCUA examination NCUA was quite pleased with our BSA program. Enhanced compliance is entirely new to the credit union industry," Lafayette wrote.

--dmorrison@cutimes.com

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OTS Docs Indicate BSA Problems May Have Prevented Lafayette Conversion

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