The Perfect Storm for Scuttling a Merger

The National Credit Union Administration’s May 7 proposal to revise the rules governing mergers of federal credit unions raises a number of challenges in its implementation. The two main components of this proposed rule—transparency of compensation for CU management and open member-to-member communication before the merger-related special meeting—are intended to address the perceived conflict of interest that arises between the best interests of the members and the financial stake that leadership may have in the merger.

In this advisor’s opinion, including these two components in the final rule could create the perfect storm for scuttling a merger that might have been in the best interests of the members and the respective credit unions.

Compensation Transparency

The word on the street is that certain management officials have been persuaded to “deliver” their CUs to a merger in exchange for a handsome compensation package that is not disclosed to the members. As the owners of the institution in the minds of many, including NCUA, credit union members should be informed of such interests. This type of disclosure is, of course, required by the Securities and Exchange Commission for the shareholders of a public company.

In the NCUA rule revision on the table, any “merger-related financial arrangement” must be disclosed in the materials provided to members, soliciting their vote on a CU’s merger proposal. This will capture any increase in indirect or direct compensation that a “covered person” received during the 24 months prior to the approval of the merger plan by the boards of directors of the merging credit unions, even if that increase were based upon an existing contractual obligation. In contrast, under the current regulation, only a “material” increase—exceeding the greater of $10,000 or 15 percent of the senior management official’s or director’s current compensation—triggers a disclosure requirement. 

NCUA is also proposing to expand the scope of individuals covered to include the chief executive officer, the four other most highly paid employees of the CU and any member of the board of directors or the supervisory committee. NCUA is considering whether this group should be further expanded to a greater number of CU leaders or even to all employees. The regulator also is examining whether the proposal should extend to state-chartered federally insured credit unions.

Member-to-Member Communication

The member-to-member communication portion of the rule is based on the existing regulation that applies in credit union-to-bank conversion transactions and bank acquisitions of credit unions. It is intended to permit members to communicate their opinions about the merger to other members before the special meeting or to use some other method, such as mass media or presence at the branches. 

Ideally, the rule will be used to communicate useful information on the merger. NCUA has limited experience in administering this rule, however, because it has only been used in the bank conversion context. A critical aspect of this rule is the restriction that it not be used as a vehicle to, among other things, air personal grievances, advance false or misleading information, impugn a person’s character, or question the safety and soundness of the credit union. 

NCUA must strictly enforce these standards or the rule will have no viable purpose other than to disrupt an orderly merger process. 

The Perfect Storm

Unlike shareholders who are accustomed to reading the financial benefits to the board and executive management in connection with a merger, the members of a credit union generally are not accustomed to seeing this information. In addition, the members of a merging credit union, unlike the shareholders of a corporation, have no direct economic stake in the merger—there is no payment, whether in stock or cash, to the members of the credit union. Members may therefore question why the management financially benefits from the merger while they do not.

Thus, in the perfect storm scenario when the members of the disappearing credit union read what the executive officers are receiving in the merger, even if it is pursuant to an existing contract, they may react quite negatively. They then can transmit that opinion through the member-to-member communication process with all the attendant criticism. 

Even though the credit union has the opportunity to comment on a submitted member message to the Office of National Examinations and Supervision, it has no ability to directly rebut the claims of the member in the message and is not allowed to add information to the message without permission from ONES. One can surmise that the odds of a successful vote will likely greatly be diminished. 

If enacted, which is likely, this rule will become a regulatory laboratory evaluating whether more information is beneficial or just rocket fuel for a disruptive merger process. Stay tuned.

Richard Garabedian is counsel at Hunton & Williams LLP, Washington, D.C. and advises credit unions in a number of matters, including field of membership expansions, mergers and cross-industry acquisitions.