January 28, 2011

Well publicized within the credit union community are the new National Credit Union Administration rules (12 Code of Federal Regulations § 701.4(b)(3)) that establish and codify, among other matters, fiduciary standards of conduct that the directors of federally chartered institutions must meet. One of these rules addresses an aspect of the fiduciary “duty of care.”

The rule specifically requires that directors have a sufficient level of financial and accounting education to enable them to carry out their duties at an appropriate level of performance. Specifically, the rule requires directors:

...[a]t the time of election or appointment, or within a reasonable time thereafter, not to exceed six months, have at least a working familiarity with basic accounting and finance practices, including the ability to read and understand the Federal credit union’s balance sheet and income statement and to ask, as appropriate, substantive questions of management and the internal and external auditors....

The foregoing raises three questions for consideration. First, what is the “duty of care”? Second, to whom does the rule apply? And, third, how can the obligation be fulfilled?

The “duty of care” has been defined in various ways, some having a legalistic tone to them; others more practical.

In reference to a legal expression of the duty, it has been observed that “...a director is under an obligation to discharge his or her duties in good faith, with the care an ordinarily prudent person in like position would exercise, and in a manner the director reasonably believes to be in the best interest of the corporation.”

When expressed in personal terms, courts have taken the view that the duty of care is a responsibility, which “...prudent persons, prompted by self-interest, would exercise in the management of their own affairs.”

From a pragmatic standpoint, it makes no difference what activity an individual is involved in; he or she will learn and understand the ramifications associated with the endeavor. It matters not whether it is: buying a car, purchasing food, or deciding on a vacation trip.

Education and understanding will be critical to decisions, just as it is and should be with serving as the director of a credit union. One can’t be a policy maker without a basic understanding of operational activities and health.

NCUA expressly answered the second question (to whom does the rule apply?) in a media release dated Dec. 22, 2010.

• Directors elected or appointed on or before Jan. 27, 2011, including those directors serving prior to NCUA finalization of the rule, must be in compliance with the financial literacy requirements by July 27, 2011. Directors elected or appointed after Jan. 27, 2011 must satisfy the financial literacy requirements within six months following seating.

The final question is how can a basic state of financial literacy in relation to credit union operations as described in the new rule be achieved?

Directors can acquire the requisite education in a variety of ways, as NCUA elaborates in Letter 11-FCU-02 These run the gamut from on-the-job education to formal classes provided by a third-party trainer.

Directors who have provided service over a period of time may very well have the educational background required by the rule. This may have come through self-study, formal educational briefings by other directors or management, or simply through listening to explanations of institutional financial operations coupled with relevant questioning.

Notably, the rule does not mandate a particular type of training; it only establishes the requirement for a level of understanding, that is, “a working familiarity with basic accounting and finance practices.”

Another approach to complying with the new rule would be to have formal training sessions for board members. In this connection, the sessions may be by management experts or third parties brought in to teach.

Financial education may also be achieved by taking formal general educational classes, either in the classroom or over the Internet, such as by Webinar. Indeed, both NCUA and credit union associations are offering classes specifically tailored to meet the rule’s demands. (For example, begin your study with a free course from CUES and the Center for Credit Union Board Excellence.)

Moreover, correspondence courses focused on financial literacy are available for directors to take at their own pace and at a location of their choosing, including from home.

To play off the words of a fairly well-known commercial for Syms clothing stores, “An educated consumer is our best customer." Most certainly “an educated director is a credit union’s best policy maker”!

In short, board members now have a written federal standard they must meet. And that level of competence and understanding is one that should have been met in the past.

CUES member Stephen A.J. Eisenberg is EVP/general counsel for $15 billion Pentagon Federal Credit Union, Alexandria, Va.

You May Also Be Interested In:

To Read more articles by or including Stephen A.J. Eisenberg visit our Credit Union Management Archive.

CUES Suggests Three-Tiered Approach to Director Education

Proposed Director Education, Liability Rule a Good First Step