SAN DIEGO — Ask any of the principals affiliated with XCUCapital Corp., a credit union homegrown broker-dealer andinvestment advisory firm, for the factors that led to its demiseand most agree on one reality: lack of scope and resources tocompete.

After a 20-year run, XCU Capital slipped under the radar andinto obscurity when in August 2007 it was acquired for $3.62million by LPL Financial Corp., an independent broker-dealer giantwith more than 800 clients and $235 billion in assets undermanagement (CU Times, May 7, 2008). All but one of its 24 creditunions made the transition over to LPL convinced that aligning withthe investment conglomerate would not only bring more technology,products and services but a proven track record of serving themovement with a current roster of more than 200 credit unionclients.

“As a broker-dealer, you're forced to spend money on technology.The most costly thing is ensuring you're in compliance withregulations from [Financial Industry Regulatory Authority] …. TheSEC requires you to monitor your business closely. All that fallson technology,” said Mark Hoaglin, XCU Capital's former CEO, whowas hired by LPL Financial Institution Services as senior vicepresident of credit unions, a new role created to oversee thedivision charged with building more alliances within themovement.

Founded in 1987 by then Xerox Federal Credit Union (now $771million Xceed Financial CU) it made history when it became thefirst in the movement to form a broker-dealer and insurance agency,said Jon Fate, executive vice president of the credit union. Itstarted out with 10 credit union clients and in 2002, XceedFinancial, which owned 99% of the broker-dealer, sold its stake toMountain America CU, Premier America CU, SAFE CU, Schools FinancialCU, State Employees' CU, The Golden One CU, Travis CU, TRW CU(later merged with Western FCU) and WesCorp. All entered into apurchase agreement for 60% of XCU Capital and its subsidiary, FocusInsurance Agency, together investing $2.3 million in the firm. Thetransaction doubled the number of XCU clients through credit unionsto more than 50,000 and assets under administration to $1.5billion.

“It was quite successful,” Fate said. “Back in the day when wewere operating this by ourselves, we were able to retain thoserelationships that may have otherwise gone to other thirdparties.”

Fate said even though the broker-dealer grew, because ofeconomies of scale and methods of efficiencies, putting additionalmoney in to expand service became a consideration. LPL, along witha few others were interested in XCU Capital.

“It's a great company. We have a great relationship and we lookforward to a great future with them,” Fate said.

Meanwhile, WesCorp saw its new ownership stake as fuel to drivethe development of mutual funds, unit investment trusts and otherproprietary investment products. In a March 2002 press release, thecorporate credit union touted its established marketing andtechnological capabilities and payment systems as more avenues tobuild XCU Capital's presence. At one point, WesCorp owned aninstitutional broker-dealer that underwrote securities for theFederal Home Loan Bank. That firm has since been outsourced to CUInvestment Solutions Inc., a subsidiary of U.S. Central CU, saidBob Burrell, executive vice president and chief investment officerat WesCorp.

“We weren't heavily impacted by the [XCU Capital] decision,”Burrell said. “WesCorp had a marketing initiative. We were the onlyone that didn't have a core business with them.”

Burrell said all of XCU Capital's investors were WesCorp membersand the corporate, believing wealth management was an importantarea, offered its support to those credit unions. Even thoughWesCorp didn't have any business to shift to LPL, he said thecorporate has had early discussions with the broker-dealer on areasthe two might be able to collaborate in.

XCU Capital set out on a path to diversify. It created FocusInsurance Agency and began offering trust services through apartnership with BNY Trust. It also teamed up with Pershing LLC, aBNY Securities Group and subsidiary of the Bank of New York Co., in1998 for its clearing services. In 2005, XCU Capital partnered withAmeritrade Inc. to offer online trading. Along the way, thebroker-dealer rolled out several services including CU Broker, abranch sales automation platform. At one point, the broker-dealeroffered CUNA Mutual Group's debt cancellation product to itsclients to protect them and their members from loan delinquencies,chargeoffs, and collection costs.

Mark Allen initially served at XCU Capital's helm since 1991 buttook an administrative leave of absence in 2005. Hoaglin was namedas interim before becoming the permanent CEO in June 2006.

Toward the end, all of XCU Capital's efforts to grow may nothave been enough. Hoaglin said with just $17 million in revenue,the board faced two choices: align with a company that had theresources needed to serve clients or go out and raise capital. Theformer won out. The broker-dealer spent roughly a year talking withpotential partners. A commitment to the credit union model wasparamount followed by the ability to offer cutting edge technology,support for financial advisors and ultimately providing return oninvestments to shareholders, Hoaglin explained.

“The overriding desire was to serve the end user, which wascredit unions now, and going forward,” Hoaglin said.

LPL met the criteria and in August 2007, the deal was agreedupon and consummated the following month. With mainly fixedannuities and some life insurance products, Focus Insurance wasdissolved. Hoaglin said the subsidiary didn't have enough marketvalue to warrant a sale. The $15 billion State Employees' CU wasthe only credit union that decided not to follow the others afterthe LPL acquisition. Instead, in a move to keep most of itsprograms in-house, it bought XCU's shell for $40,000 in late 2007and moved its 6,000 accounts totaling approximately $30 millionin-house, said Jim Blaine, president/CEO of SECU (CU Times, May 14,2008). XCU Capital's shareholders voted to accept a negotiatedpurchase offer from LPL in the fourth quarter of 2007 and the dealwas finalized earlier this year, Hoaglin said.

Shell sales are common in the broker-dealer space, Hoaglin said.Purchase transactions are typically handled on an asset sale basisor as an outright purchase of the broker-dealer. Companies seekingto avoid the

start-up costs, licensing paperwork and time for regulatoryapproval associated with starting a new broker dealer often opt topurchase a shell.

“Depending on the dynamics of the transaction it may make sensefor the acquiring broker-dealer to simply purchase the assets ofthe selling broker dealer which for the most part consists of theclient accounts of the seller,” Hoaglin said. “When this type oftransaction takes place the seller is left with a licensed shell,which is stripped of all assets.”

In fact, about a decade ago, Xceed Financial bought the shell ofa small broker-dealer, Fate said.

Unlike SECU, the $6.7 billion The Golden 1 CU continued on withLPL but did look at other firms as its contract came to a close inAugust 2007, said Teresa Halleck, president. LPL's size, technologyand credit union reputation were unmatched, she acknowledged. TheGolden 1 amassed $399 million in assets for a total of 14,426accounts through XCU Capital and now LPL. Halleck is confident thatthe credit union will continue to grow its AUM each year.

“We have no regrets. [LPL] has the scale and the technology. Wedidn't have that under XCU,” Halleck said. “We wanted to do whatwas in the best interest of the members.”

To those critics who may say that XCU Capital sold out, Hallecksaid everyone has different philosophies but reality trumpednaysayers.

“Those that are passionate about keeping everything in the[credit union] industry, if you keep that type of approach, youwill not be able to serve your members,” Halleck said. “Banking isso huge. You have to go after what is cost efficient and whatserves the members. I don't think XCU Capital sold out. I thinkselling your credit card portfolio is selling out but that'sanother story.”

Bill Cheney has seen XCU Capital evolve from several viewpoints.Cheney, president/CEO of the California Credit Union League, waspresident/CEO of Xceed Financial when XCU Capital launched. He alsoserved as chairman of the broker-dealer.

XCU Capital's board spent a considerable amount of time weighingits options and another six to 10 months reviewing the firms it hadcontacted, he said.

“I don't think we sold out,” said Cheney, adding once the LPLsale and SECU shell transaction concluded, his only role wasassisting with shutting down obligations. “The best move for XCUwas to go with LPL. We found what we felt was the bestsolution.”

Violations may have also impacted XCU Capital's growth.According to FINRA and National Association of Securities recordsdated July 29, 2007, XCU Capital submitted a letter of acceptance,waiver and consent and was censured and fined $87,000 for severaloffenses.

Without admitting or denying the allegations, the firm consentedto the entry of findings acting through its agents, recommended andeffected, or caused to be effected, purchases of large positions ofClass B mutual fund shares in customer accounts without areasonable basis for believing them to be suitable for thecustomers, according to FINRA.

The findings also stated that XCU Capital, acting through itsagents, failed to establish, maintain, and enforce a supervisorysystem “reasonably designed” to enable the firm and its supervisorsto prevent and detect unsuitable large Class B share positions.

According to FINRA, XCU Capital, acting through a registeredrepresentative, utilized sales materials that consisted of a“hypothetical sales charge projection that was unbalanced andfailed to provide prospective investors with a sound basis forevaluating the facts.” NASD also found that the firm failed to filethe projection with NASD's Advertising Regulation Department.

“That really killed the forward momentum,” said Henry Wirz,president/CEO of $1.3 billion of SAFE CU, about the FINRA findings.“It was a period of time when a lot of credit unions wanted topartner with XCU. It was a significant blow to the company.”

Still, everyone, including shareholder SAFE CU, saw the promisein XCU Capital. But to get over the hump, a broker-dealer needs atleast $150,000 in gross commissions each year, Wirz said.

“We could never get there as a group,” he lamented.

Credit union representatives that provide investment informationto members work considerably different than independent reps, Wirzsaid. More members are seen on a daily basis, there is an impliedtrust and cold calls are not the norm, he added.

“We quickly found that this was a different kind of business,”Wirz said. “Mark Hoaglin used his expertise to build a strong base.He's a fabulous leader. If he had been CEO from the beginning, weprobably wouldn't be where we are now.”

LPL is probably the best in the game right now to help SAFEincrease its investment penetration to 10% or 13,000 of its 127,000member base, Wirz said. The credit union is also striving to bumpits average investment account from $25,000 to between $30,000 and$50,000. He admitted that there's been some struggle because creditunion reps do much higher volume than LPL's. But the broker-dealermakes up for that with a top notch compliance department andresearch resources for both reps and members.

“We couldn't make it work in the credit union space,” Wirz saidabout XCU Capital. “You have to get credit unions to join andsupport it. We have since found that there are other credit unionsthat have their own broker-dealers. I can tell you that it's notgoing to work. We picked the best vendor that was out there.”

Looking forward, Hoaglin said LPL is making good on its promiseto deliver to credit unions. At a recent program managers'conference in Las Vegas, a session devoted just to credit unionsconvened for the first time. Hoaglin is also head of a 10-membercredit union advisory council that held its inaugural meeting inlate April. As the “voice for credit unions” at LPL, the programmanagers plan to meet four times a year to discuss serviceimprovements and legislative and regulatory issues.

“While not a credit union-owned entity, we felt there is asignificant commitment to credit unions, more than any otheroptions we had,” Hoaglin said. “At the end of the day, we feel wecan silence those critics [that say XCU Capital sold out] becausewe are in fact aligned with our colleagues in the credit unionindustry with the formation of this channel.”

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