Financial services CUSOs keeping watch on pending SEC action

<p>LAS VEGAS – Two questions dominate financial services CUSOs’ minds these days – will the SEC decide to extend the license exemption to CUSOs that was granted to them under the Chubbs Securities Letter of 1993 and which is now threatened due to the NCUA’s passage of the Incidental Powers regulation in July 2001? When will the SEC announce its decision? With the jury still out, as many as 90% of credit unions are facing the prospect of being prevented from offering investment services to their members, and CUSOs’ are looking at the likelihood of having their investment program delivery models disrupted since they would no longer be able to share commissions with broker/dealers and enter into networking arrangements unless they were fully licensed by the NASD as broker-dealers. NACUSO President Bob Dorsa estimates that 60% of CUSOs – about 400-500 CUSOs – are involved in investment services. The issue is so critical to the future of financial services CUSOs that NACUSO devoted an open networking discussion to it during the association’s 2002 annual conference here so attendees could hear from and have the opportunity to question invited legal and investment experts on the subject, including Jeffrey Bloch, assistant general counsel for CUNA; Kevin Thompson, securities attorney for CUNA Mutual Group; Mark Allen, president/CEO, XCU Capital Corp.; and Ursala Robinson, associate counsel, Linsco/Private Ledger (LPL), an investment advisor and portfolio management company. NACUSO General Counsel Guy Messick of the law firm of Lastowka & Messick P.C. also addressed the issue during an earlier session during the conference on “The Changing Financial Services Rules and the Role of CUs and CUSOs.” Messick stressed that the SEC situation currently facing CUs “is an unintended consequence of Incidental Powers,” and he told conferees he was sure “NCUA had no intention of this happening when it granted credit unions expanded Incidental Powers.” Still it is CUs’ expanded incidental powers directly, and the Gramm-Leach Bliley Act indirectly, which are responsible for getting CUSOs into the fix they find themselves in. One conferee boldly asked the experts what they thought of the idea of asking NCUA to roll back its incidental powers rule. The consensus was it was not a good idea. So credit unions find themselves indirectly affected by a banking bill, the Gramm-Leach-Bliley Act, which Messick said, “did a lot of positive things for banks, but we are still looking for the good things it did for credit unions.” As a result of a proposed SEC rule issued after the passage of the Gramm-Leach-Bliley Act, banks and thrifts are now required to be the contracting party with the broker-dealer, and bank operating subsidiaries cannot enter into networking arrangements without being fully licensed. The GLB Act also provided banks with certain exemptions from the requirement to register with the SEC for certain securities activities. The SEC proposal clarified these exemptions and extended them to thrifts. The SEC regulation, which has not yet gone into effect, does not include credit unions, but the agency equates CUSOs with bank operating subsidiaries, and it continues to take the position that as a result of Incidental Powers, CUSOs are no longer a “required service corporation” and are no longer able to share commissions. Therefore, says the SEC, all networking arrangements have to be between a broker/dealer and a credit union. NACUSO, CUNA and the NCUA, in separate meetings, have been involved in on-going talks with Katherine McGuire, chief counsel, division of market regulation for the SEC, and her staff to educate the agency on how the member-owned issue of CUs and CUSOs makes them different from bank operating subsidiaries, and to work with the SEC in finding a way for CUs to be granted some of the exemptions that were provided to banks and thrifts under the SEC’s rule to them. CUNA Associate General Counsel Mary Dunn said she was sure the SEC “is not gunning for credit unions.” She said CUNA suggested to McGuire the idea of there being some sort of “hybrid registration” for CUSOs and that McGuire “didn’t dismiss the idea totally.” CUNA President/CEO Dan Mica said the SEC “will likely focus on exemptions for activities that credit unions are now engaged in, such as third party broker arrangements, sweep accounts, safekeeping, and custodian activities.” But Messick candidly told conferees, “I am not certain the SEC is convinced credit unions should be treated any differently than banks, therefore it is likely that the SEC’s rescission of the exemption will happen. The only question is when.” Should-or perhaps more accurately, when-that happens, Messick said he’s received assurances from SEC that CUs will have a transition period. NACUSO, he said, is pushing to have a transfer process that’s as long as possible. CUNA’s Bloch described the SEC’s rule as “a huge rule, it’s the most important rule to come out of Gramm-Leach-Bliley.” But despite the enormity of the ramifications of the SEC’s rule, panelists pointed out to attendees that it is not a done deal yet, and they cited several things CUs and CUSOs have going for them in their favor. For example, said Bloch, the rule is “a controversial rule,” and he added that, “There are a lot of turf battles going on between the Fed, FDIC, SEC, OCC and the OTC that could cause the SEC to delay making its decision on CUSOs.” The SEC is also known for having a high turnover rate, said Bloch, and that could further delay any decision. Thompson urged attendees not to panic and jump to conclusions. “There’s no need to take immediate action yet, there’s still time to consider what everything means.” Thompson said credit unions should consider making an industry-wide response to the SEC that would come from broker/dealers, CUs, CUNA Mutual, CUNA and the NCUA. “We need to drill down further and better understand the SEC’s legal basis for their action so we can formulate an effective response,” said Thompson. Bloch agreed that it would be better for the CU movement to approach the SEC in a concerted way rather than a 100 different ways. “Any time you can make a regulator’s life easier you have a greater chance for success.” But their advice did little to placate CUSOs’ and CUs’ concerns that center around: liability issues – protecting credit unions from the risk involved with selling securities and giving investment advice. compensation issues – for-profit broker/dealer reps who are used to working for the CUSO, would now be employees of the not-for-profit CU. Credit unions may find it harder to attract and retain the reps. CUs’ ability to sell securities to non-members – CUs would not receive income for these services. Attendees such as Renee’ Guerin, president/CEO, RCU Services Group, also are concerned about how CUSOs will pay their expenses since it will be the credit union(s) that own the CUSO that earn the income. Will the CUSO have to bill the CU? What if the CUSO is multiple-owned by several credit unions? Judging from conferees queries, there seems to be more questions than answers at this point. But what is known is this: If the SEC elects to remove the CUSO exemption, federal credit unions would have to enter directly into contracts with broker/dealers. A CUSO could only continue to do this if it were licensed and registered with the NASD. State-chartered credit unions would be treated the same as FCUs as long as their incidental powers were approved by their state regulator, otherwise CUSOs could continued to be used as long as all the CUSO owners were state-chartered for the state in question. Messick told attendees that the finder activity granted FCUs under Incidental Powers eliminates group purchasing and allows revenue sharing with any third party without limiting the CU to the reimbursement of expenses. He reminded them that not all state regulators recognize finder activity as part of their state credit union statute, and he urged them to check with their state regulator to learn if they have parity with FCUs in this area. Faced with so many questions and uncertainties, Robinson and Allen encouraged CUSOs and CUs not to jump to conclusions about the SEC rule, but rather to explore what needs to be done to make it work in their favor. “The SEC is giving the credit union industry an opportunity to move forward in the investment business. We should consider the positive challenges and opportunities that can happen,” said Allen. Meanwhile, Dorsa told Credit Union Times that he plans to meet with CUNA on May 23 to discuss the status of the situation and a strategy. He also intends to apprise NAFCU on the talks NACUSO has had with McGuire. Dorsa said he will invite NAFCU to participate in the effort. See page 22 for further coverage of NACUSO’s 2002 conference. [email protected]</p>