B-200951 O/M, MAY 6, 1982

B-200951 O/M, MAY 6, 1982

DIGEST: 1. NATIONAL CONSUMER COOPERATIVE BANK (NCCB) ACT (12 U.S.C. SEC. 3001 ET SEQ.), AS AMENDED BY SECTION 391 OF PUBLIC LAW 97-35, PROVIDES THAT ON A DATE DENOMINATED AS THE "FINAL GOVERNMENT EQUITY REDEMPTION DATE," ALL CLASS A STOCK SHALL BE REDEEMED BY NCCB IN EXCHANGE FOR CLASS A NOTES. AFTER THAT DATE NCCB WILL NO LONGER BE A MIXED OWNERSHIP GOVERNMENT CORPORATION BUT RATHER A PRIVATE INSTITUTION. 2. SECTION 391(B)(1) OF THE NATIONAL CONSUMER COOPERATIVE BANK (NCCB) ACT AMENDMENTS PROVIDES THAT CLASS A NOTES OF THE BANK SHALL BE DEEMED TO BE PAID-IN CAPITAL OF NCCB FOR CERTAIN PURPOSES. WE CONCLUDE THAT IT IS ONLY FOR PURPOSES OF QUALIFYING THE LIMITATION ON NCCB'S BORROWING AUTHORITY CONTAINED IN 12 U.S.C. SEC. 3017(A) THAT THE NOTES ARE TO BE TREATED AS EQUITY. 3. NEITHER LANGUAGE NOR LEGISLATIVE HISTORY OF SECTION 391(B)(1) OF NATIONAL CONSUMER COOPERATIVE BANK ACT INDICATE CONGRESS INTENDED TO DICTATE MANNER OF PRESENTING BANK'S FEDERAL FUNDING IN FINANCIAL STATEMENTS IN ANY WAY INCONSISTENT WITH FACT THAT FUNDING IS NOW IN FORM OF A LOAN. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES CALL FOR FULL DISCLOSURE AND FAIR PRESENTATION, AND PROVIDE RELEVANT GUIDANCE FOR PROPER CHARACTERIZATION OF BANK'S FEDERAL FUNDING. SPECIFICALLY, OBLIGATION TO UNITED STATES REFERRED TO IN STATUTE AS NOTES AND HAVING GENERAL CHARACTERISTICS OF DEBT (FIXED REPAYMENT SCHEDULE FOR EXAMPLE) SHOULD BE SHOWN IN FINANCIAL STATEMENTS AS DEBT RATHER THAN EQUITY.

GAO AUDIT OF NATIONAL CONSUMER COOPERATIVE BANK: 916091):

THIS RESPONDS TO THE QUESTION, RAISED BY DENNIS DUQUETTE OF YOUR STAFF, INCIDENT TO GAO'S AUDIT OF THE NATIONAL CONSUMER COOPERATIVE BANK (THE BANK), ABOUT THE EFFECT OF RECENTLY ENACTED AMENDMENTS TO THE NATIONAL CONSUMER COOPERATIVE BANK ACT (THE ACT) ON THE PROPER PRESENTATION OF THE BANK'S FEDERAL FUNDING IN ITS FINANCIAL STATEMENTS. THE AMENDMENTS EFFECTIVELY PROVIDE THAT ON DECEMBER 31, 1981, ALL CLASS A STOCK OF THE BANK, NOW HELD BY THE TREASURY, WILL BE REDEEMED IN EXCHANGE FOR CLASS A NOTES. FEDERAL FUNDING WILL THUS BE CONVERTED TO DEBT, LOANS TO THE BANK, RATHER THAN EQUITY, TREASURY PURCHASES OF BANK STOCK, AS HAD BEEN THE CASE. OFFICIALS OF THE BANK CONTEND THAT THE NEW AMENDMENTS NEVERTHELESS REQUIRE PRESENTATION OF THE FEDERAL LOANS AS "PAID-IN CAPITAL" OR EQUITY FOR PURPOSES OF ITS FINANCIAL STATEMENTS. WE DISAGREE.

AS EXPLAINED IN THE ACCOMPANYING DETAILED ANALYSIS, THE LAW REQUIRES THAT THE PROMISSORY NOTES EVIDENCING THE LOANS "BE DEEMED TO BE PAID-IN CAPITAL" ONLY FOR PURPOSES OF 12 U.S.C. SEC. 3017(A), WHICH DEALS WITH CALCULATING THE LIMIT OF THE BANK'S BORROWING AUTHORITY, THE AMOUNT OF OBLIGATIONS RELATIVE TO PAID-IN CAPITAL WHICH CONGRESS HAS AUTHORIZED THE BANK TO INCUR. SECTION 3017(A) PROVIDES THAT THE BANK MAY NOT OBTAIN FUNDS BY ISSUING OBLIGATIONS IN EXCESS OF 10 TIMES THE AMOUNT OF ITS PAID- IN CAPITAL. WE READ THE AMENDMENT AS DIRECTING ONLY THAT THE BANK'S CLASS A NOTES BE DEEMED TO BE PAID-IN CAPITAL WHEN DETERMINING THIS LIMIT ON OUTSTANDING OBLIGATIONS. ALTHOUGH SECTION 3017(A) SPEAKS GENERALLY OF THE BANK'S AUTHORITY TO ISSUE OBLIGATIONS AND THE BANK CONTENDS THAT PRESENTING THE GOVERNMENT'S INTEREST AS DEBT WOULD IMPAIR ITS ABILITY TO RAISE FUNDS IN THE PRIVATE MARKET, WE DO NOT UNDERSTAND THE AMENDMENT AS REQUIRING CHARACTERIZATION OF THE NOTES AS PAID-IN CAPITAL FOR PURPOSES OF GAO'S AUDIT OF THE BANK'S FINANCIAL POSITION. INDEED, WE FIND NO BASIS IN THE STATUTE FOR PRESENTATION OF THE NOTES OTHER THAN AS DEBT.

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES PROVIDE GUIDANCE FOR PROPER PRESENTATION OF THE BANK'S FEDERAL FUNDING. THOSE PRINCIPLES GENERALLY DIRECT FULL DISCLOSURE AND FAIR PRESENTATION. IN LIGHT OF THIS, WE THINK IT WOULD BE UNFAIR TO PROSPECTIVE PURCHASERS OF THE BANK'S STOCK TO PRESENT THE FEDERAL INTEREST AS THAT OF ANOTHER SHAREHOLDER WHEN IN FACT THE FEDERAL INTEREST AS A CREDITOR IS PARAMOUNT TO THAT OF OTHER SHAREHOLDERS. IT WOULD, HOWEVER, BE IN KEEPING WITH FULL DISCLOSURE PRINCIPLES FOR FINANCIAL STATEMENTS TO REFLECT IN FOOTNOTES, FOR EXAMPLE, THAT THE NOTES SHOWN AS DEBT ARE, BY THEIR TERMS, SUBORDINATE TO SUBSEQUENTLY ISSUED OBLIGATIONS, AND FURTHERMORE, THAT THE NOTES ARE TO BE INCLUDED AS PAID-IN CAPITAL OF THE BANK IN CALCULATING ITS STATUTORY BORROWING LIMIT.

ATTACHMENT

GAO AUDIT OF NATIONAL CONSUMER COOPERATIVE BANK

QUESTION: DO RECENT AMENDMENTS TO THE NATIONAL CONSUMER COOPERATIVE BANK ACT (THE ACT) REQUIRE THAT THE BANK'S DEBT TO THE UNITED STATES BE CHARACTERIZED AS PAID-IN CAPITAL FOR PURPOSES OF THE BANK'S FINANCIAL STATEMENTS?

ANSWER: NO. THE ACT AS AMENDED DOES NOT PROVIDE ANY BASIS FOR THE PRESENTATION OF THE GOVERNMENT'S INTEREST AS EQUITY RATHER THAN DEBT.

ANALYSIS

BEFORE DECEMBER 31, 1981, THE NATIONAL CONSUMER COOPERATIVE BANK (THE BANK) WAS A MIXED-OWNERSHIP GOVERNMENT CORPORATION THAT RECEIVED FEDERAL FUNDING THROUGH TREASURY PURCHASES OF SHARES OF ITS CLASS A STOCK. PUBLIC LAW NO. 95-351, SEC. 104, 31 U.S.C. SEC. 3014 (SUPP. III 1979). RECENT AMENDMENTS TO THE ACT PROVIDE THAT ON A DATE DENOMINATED AS THE "FINAL GOVERNMENT EQUITY REDEMPTION DATE," ALL CLASS A STOCK OF THE BANK THEN HELD BY THE SECRETARY OF THE TREASURY "SHALL BE REDEEMED BY THE BANK IN EXCHANGE FOR CLASS A NOTES." PUBLIC LAW NO. 95-351, SEC. 116(A)(3)(A), AS AMENDED BY SEC. 391(A)(1) OF PUBLIC LAW NO. 97-35, 95 STAT. 433 (AUGUST 13, 1981). THE DATE OF FINAL REDEMPTION WAS LATER DETERMINED TO BE DECEMBER 31, 1981. PUBLIC LAW NO. 97-101, SEC. 501(36), 95 STAT. 1440 (DECEMBER 23, 1981).

WE UNDERSTAND THAT THE REDEMPTION PROCESS HAS BEEN COMPLETED, AND THE FEDERAL INTEREST IN THE BANK IS NOW THAT OF A CREDITOR, NOT A SHAREHOLDER. THE BANK IS NO LONGER CONSIDERED TO BE A MIXED-OWNERSHIP GOVERNMENT CORPORATION BUT IS RATHER A FEDERALLY CHARTERED PRIVATE INSTITUTION. PUBLIC LAW NO. 97-35, SUPRA, SEC. 396(H); SEE ALSO H.R. REP. NO. 97-208, 718 (1981).

THE BANK ACT AMENDMENTS GO ON TO PROVIDE THAT THE CLASS A NOTES WILL BE TREATED AS PAID-IN CAPITAL OF THE BANK FOR CERTAIN PURPOSES. WHAT MUST BE RESOLVED IS WHEN SUCH TREATMENT IS REQUIRED BY THE AMENDMENTS. BANK OFFICIALS CONTEND THAT THE AMENDMENTS SHOW CONGRESSIONAL INTENT THAT THE FEDERAL FUNDS NOW SECURED BY THE CLASS A NOTES BE TREATED AS EQUITY OF THE BANK IN PRESENTING THE BANK'S FINANCIAL STATEMENTS. WE MUST DISAGREE.

THE AMENDMENT IN QUESTION IS SECTION 391(B)(1) OF PUBLIC LAW NO. 97-35. IT STATES:

"ONLY FOR PURPOSES OF SECTION 107(A) OF THE NATIONAL CONSUMER COOPERATIVE BANK ACT (12 U.S.C. 3017 (A)), CLASS A NOTES SHALL BE DEEMED TO BE PAID-IN CAPITAL OF THE BANK."

THE PHRASE "ONLY FOR PURPOSES OF SECTION 107(A)" INDICATES THAT THE NOTES ARE TO BE DEEMED PAID-IN CAPITAL ONLY FOR CERTAIN PURPOSES. IT IS NECESSARY TO CONSIDER SECTION 107(A) OF THE BANK ACT TO ASCERTAIN THOSE PURPOSES. THAT SECTION STATES:

"THE BANK IS AUTHORIZED TO OBTAIN FUNDS THROUGH THE PUBLIC OR PRIVATE SALE OF ITS BONDS, DEBENTURES, NOTES, AND OTHER EVIDENCES OF INDEBTEDNESS. SUCH OBLIGATIONS SHALL BE ISSUED AT SUCH TIMES, BEAR INTEREST AT SUCH RATES, AND CONTAIN SUCH TERMS AND CONDITIONS AS THE BOARD SHALL DETERMINE: PROVIDED, HOWEVER, THAT THE AMOUNT OF SUCH OBLIGATIONS WHICH MAY BE OUTSTANDING AT ANY ONE TIME PURSUANT TO THIS SECTION SHALL NOT EXCEED TEN TIMES THE PAID-IN CAPITAL AND SURPLUS OF THE BANK." U.S.C. SEC. 3017 (SUPP. III 1979, AS AMENDED BY PUBLIC LAW NO. 97-35, SECTION 394(G)(1)).

SECTION 107(A) THUS DEFINES THE BORROWING AUTHORITY OF THE BANK. GIVES THE BANK GREAT LATITUDE TO OBTAIN FUNDS BY INCURRING OBLIGATIONS IN THE PRIVATE MARKET. THE ONLY RESTRICTION IS THAT THE AMOUNT OF OUTSTANDING DEBT OBLIGATIONS NOT EXCEED 10 TIMES THE PAID-IN CAPITAL AND SURPLUS OF THE BANK. THE ONLY EXPRESS REFERENCE TO PAID-IN CAPITAL IN SECTION 107(A) IS THUS FOR PURPOSES OF LIMITING THE TOTAL AMOUNT OF DEBT THAT THE BANK IS AUTHORIZED TO INCUR, EVIDENCING CONGRESS' CONCERN THAT THE BANK NOT OVEREXTEND ITS BORROWING POSITION IN LIGHT OF ITS CAPITAL. SECTION 391(B)(1) CAN THEN BE READ AS AUTHORIZING THE BANK TO DEEM ITS CLASS A NOTES AS PAID-IN CAPITAL, RATHER THAN LIABILITIES, FOR PURPOSES OF DETERMINING ITS AUTHORITY TO ISSUE DEBT OBLIGATIONS UNDER SECTION 107(A). IT DOES NOT FOLLOW THAT THE NOTES ARE TO BE DEEMED TO BE PAID-IN CAPITAL FOR OTHER PURPOSES.

ANY OTHER INTERPRETATION OF SECTION 391(B)(1) YIELDS A RESULT INCONSISTENT WITH THE TRUE NATURE OF THE NOTES AS PROVIDED FOR IN THE BANK ACT AMENDMENTS. SECTION 116(A)(3)(C) OF THE ACT, AS ADDED BY THE AMENDMENTS (PUBLIC LAW NO. 97-35, SECTION 391(A)(1)) REQUIRES THE BANK TO MAINTAIN A REPAYMENT SCHEDULE TO RETIRE ITS CLASS A NOTES, A REQUIREMENT CHARACTERISTIC OF DEBT AS OPPOSED TO EQUITY. SECOND, SECTION 104(C) OF THE ACT, AS AMENDED BY SECTION 396(C)(2) OF THE AMENDMENTS, PROVIDES THAT PAYMENTS TO THE HOLDER OF CLASS A NOTES (THE TREASURY) ARE TO BE CHARACTERIZED AS INTEREST PAYMENTS, NOT DIVIDENDS, A CHARACTERIZATION WHICH MAY LEAD TO DIFFERENT TAX CONSEQUENCES FOR THE BANK AND WHICH IS CONSISTENT WITH THE VIEW THAT THE NOTES ARE INDEED LIABILITIES AND NOT EQUITY. FINALLY, SECTION 104(C) OF THE ACT, AS FURTHER AMENDED BY SECTION 396(C)(2) OF THE AMENDMENTS, EFFECTIVELY PROVIDES THAT, UPON DISSOLUTION OF THE BANK, THE HOLDER OF CLASS A NOTES IS ENTITLED TO RECEIVE PAYMENT PRIOR TO ANY DISTRIBUTIONS TO SHAREHOLDERS. TO PRESENT THE BANK'S CLASS A NOTES AS PAID-IN CAPITAL IN A FINANCIAL STATEMENT WOULD, EVEN WITH A CLARIFYING NOTE, TEND TO OBSCURE THE FACT THAT THEY REPRESENT A SUBSTANTIAL OBLIGATION OWED TO THE UNITED STATES, TO BE SATISFIED BEFORE SHAREHOLDERS COULD RECEIVE DISTRIBUTIONS UPON DISSOLUTION. SUCH A CHARACTERIZATION IS AT ODDS WITH THE CONGRESSIONAL INTENT, AS EXPRESSED IN THE CONFERENCE REPORT ON THE AMENDMENTS, THAT POTENTIAL INVESTORS BE GIVEN FULL AND ACCURATE DISCLOSURE OF THE BANK'S CONDITION:

"IT IS ALSO THE INTENTION OF THE CONFEREES THAT STOCKHOLDERS, POTENTIAL INVESTORS, AND CONSUMER COOPERATIVES BE PROVIDED THE FULLEST DISCLOSURE ABOUT THE ACTIVITIES, FINANCIAL CONDITION, AND FUTURE PLANS OF *** THE BANK *** AT ALL TIMES." H.R. REP. NO. 97-208, SUPRA, 721.

ALTHOUGH WE BELIEVE THAT THE LANGUAGE OF SECTION 391(B)(1) IS CLEAR ON ITS FACE AND IN THE CONTEXT OF THE ACT AS AMENDED, WE HAVE EXAMINED THE LEGISLATIVE HISTORY OF THE AMENDMENTS IN LIGHT OF THE BANK'S CONTENTIONS. WE ARE UNABLE TO FIND ANYTHING IN THAT LEGISLATIVE HISTORY, NOR DOES THE BANK CITE ANYTHING, THAT WOULD INDICATE THAT CONGRESS INTENDED TO DICTATE THE MANNER OF PRESENTING THE BANK'S FEDERAL FUNDING IN FINANCIAL STATEMENTS IN ANY WAY INCONSISTENT WITH THE FACT THAT FUNDING IS NOW IN THE FORM OF A LOAN.

THE BANK RELIES ESSENTIALLY ON INFERENCE FROM OTHER LEGISLATIVE HISTORY, SPECIFICALLY ON A DISCUSSION DURING HEARINGS ON APRIL 7, 1981, BEFORE THE SUBCOMMITTEE ON HUD-INDEPENDENT AGENCIES OF THE HOUSE APPROPRIATIONS COMMITTEE, CONCERNING THE BANK'S 1982 APPROPRIATION REQUEST AND ON A HOUSE APPROPRIATIONS COMMITTEE REPORT. IN A DISCUSSION AT THE HEARING OF THE LEVEL OF CAPITALIZATION NEEDED BY THE BANK TO BE "SELF-SUFFICIENT," THE PRESIDENT OF THE BANK SAID THAT THE MINIMUM LEVEL WOULD BE $200 MILLION, AND THAT WITH THAT LEVEL OF CAPITALIZATION, THE BANK COULD BORROW UP TO $1 BILLION IN THE PRIVATE MARKET AND COULD OPERATE AS A NATIONAL INSTITUTION.

THE HOUSE COMMITTEE REPORT ON THE 1982 APPROPRIATION NOTED THAT THE ADDITIONAL FUNDS PROVIDED (THE HOUSE VERSION WOULD HAVE BROUGHT THE BANK'S CAPITALIZATION CLOSE TO $200 MILLION) WOULD "ENSURE THAT THE BANK CAN GO 'PRIVATE'," AND WOULD "ALLOW THE BANK TO BORROW ADDITIONAL FUNDS IN THE PRIVATE MARKETS." IT SAID THAT THIS ADDITIONAL FUNDING IS NEEDED TO INSURE THAT THE BANK CAN BE A NATIONAL BANK. H.R. REP. NO. 97-162, 36, 37 (1981). THE CONGRESS ULTIMATELY APPROPRIATED ENOUGH TO BRING THE BANK'S CAPITALIZATION TO $184 MILLION. PUBLIC LAW 97-101, 95 STAT. 1429.

FROM THIS, THE BANK ARGUES THAT THE CONGRESS INTENDED IT TO BE A NATIONAL INSTITUTION, THAT TO DO SO IT NEEDS TO BORROW ABOUT $1 BILLION, AND THAT IT CANNOT BORROW THAT AMOUNT IF ITS FINANCIAL STATEMENTS SHOW A DEBT TO THE GOVERNMENT, RATHER THAN A GOVERNMENT INVESTMENT, OF $200 MILLION. THEREFORE, THE BANK CONTENDS, SECTION 391(B)(1) OF PUBLIC LAW NO. 97-35, REQUIRING THAT CLASS A NOTES BE DEEMED TO BE PAID-IN CAPITAL OF THE BANK FOR PURPOSES OF SECTION 107(A), MUST HAVE BEEN INTENDED TO ALLOW IT TO SHOW ITS DEBT TO THE GOVERNMENT AS PAID-IN CAPITAL IN ITS FINANCIAL STATEMENTS FOR PURPOSES OF BORROWING ON THE PRIVATE MARKET.

THE BANK'S ARGUMENT DEPENDS ON A CHAIN OF INFERENCE WHICH, IN THE ABSENCE OF EXPRESS LEGISLATIVE DIRECTION, IS SIMPLY TOO TENUOUS TO SUPPORT A DEPARTURE FROM GENERALLY ACCEPTED ACCOUNTING PRINCIPLES.

THOSE PRINCIPLES, WHICH GENERALLY DIRECT FULL DISCLOSURE AND FAIR PRESENTATION, PROVIDE THE RELEVANT GUIDANCE FOR PROPER PRESENTATION OF THE BANK'S FEDERAL FUNDING. /1/ HOWEVER, AS LONG AS THE GOVERNMENT'S INVESTMENT IS SHOWN AS DEBT, IT WOULD BE IN KEEPING WITH FULL DISCLOSURE PRINCIPLES FOR THE FINANCIAL STATEMENTS TO REFLECT IN FOOTNOTES, FOR EXAMPLE, THAT THE NOTES ARE, BY THEIR TERMS, SUBORDINATE TO SUBSEQUENTLY ISSUED OBLIGATIONS, AND FURTHERMORE, AS THE LAW PROVIDES, THAT THE AMOUNTS OF THE NOTES ARE TO BE INCLUDED AS PAID-IN CAPITAL OF THE BANK IN CALCULATING THE BANK'S STATUTORY BORROWING LIMIT.

WE ARE AWARE OF THE BANK'S CONCERN THAT CHARACTERIZATION OF THE NOTES AS LIABILITIES MAY DISCOURAGE PRIVATE INVESTMENT, A RESULT AT ODDS WITH CONGRESS' DESIRE THAT THE BANK GO PRIVATE. IT IS NOT CLEAR TO US WHY THIS SHOULD BE THE CASE SINCE THE UNDERLYING NATURE OF THE OBLIGATION IS THE SAME, WHETHER SHOWN AS DEBT OR EQUITY. WE SUGGEST, HOWEVER, THAT THIS IS A MATTER FOR THE CONGRESS TO CONSIDER. OUR PRIMARY CONCERN IS IN PRESENTING THE FINANCIAL POSITION OF THE BANK IN AN ACCURATE MANNER.

/1/ SECTION 202 OF THE GOVERNMENT CORPORATION CONTROL ACT AS AMENDED, 31 U.S.C. SEC. 857 (1976), REQUIRES THAT MIXED-OWNERSHIP GOVERNMENT CORPORATIONS BE AUDITED BY GAO "IN ACCORDANCE WITH THE PRINCIPLES AND PROCEDURES APPLICABLE TO COMMERCIAL CORPORATE TRANSACTIONS AND UNDER SUCH RULES AND REGULATIONS AS MAY BE PRESCRIBED BY THE COMPTROLLER GENERAL OF THE UNITED STATES." WHILE THE BANK IS NO LONGER A MIXED-OWNERSHIP GOVERNMENT CORPORATION FORMALLY SUBJECT TO THAT ACT, WE BELIEVE CONGRESS UNDERSTOOD THAT SUCH PRINCIPLES WOULD CONTINUE TO BE APPLIED BY GAO IN CONDUCTING ITS AUDITS OF THE BANK UNDER SECTION 115 OF THE BANK ACT AS AMENDED.