Fidelity Bonds Refresher

Nick St. John

Fidelity bond coverage can insure a credit union against losses such as fraud, theft and embezzlement. Obtaining a fidelity bond is crucial for a credit union, not just to protect against financial losses, but because it is also a regulatory requirement. The Federal Credit Union Act (FCU Act) requires federally insured credit unions (FICUs) to obtain fidelity bond coverage for employees or elected officials of the FICU that hold a position requiring the receipt, payment or custody of funds or collateral. Failure to obtain a fidelity bond can result in severe consequences, such as the revocation of a federal charter, or in the loss of share insurance coverage for state-chartered FICUs.

NCUA regulations state that a fidelity bond should cover, at a minimum, “fraud and dishonesty by all employees, directors, officers, supervisory committee members and credit committee members.” Additionally, an FICU may obtain optional bond endorsements that cover a director or officer’s liability, audit expenses and other fraud-related losses. Additionally, NCUA regulations allow FICUs to obtain joint coverage with entities in which the FICU has at least a 50 percent ownership interest, such as the FICU’s CUSO.

Under the rules, a FICU’s board of directors and management play distinct roles in the process of obtaining and managing fidelity bond coverage. NCUA has stated the board of directors should ensure the adequacy of coverage at all stages, and therefore requires an FICU’s board to review the policy at several points. First, section 713.2(b) requires the FICU’s board to review any applications to purchase fidelity bond and other insurance coverage. The rule also requires the board to review any applications to renew coverage. Finally, section 713.2(a) of the regulations also requires the board to review the coverage “at least annually” to ensure that it’s “adequate in relation to the potential risks facing the [FICU] and the minimum requirements” set by NCUA.

When reviewing an initial application to purchase coverage or an application for renewal, Chapter 7 of the NCUA Examiner’s Guide states that the board may consider the credit union’s loss exposure, internal controls, and financial resources when determining the amount and the type of coverage necessary. This can include reviewing factors such as the size of the credit union’s asset portfolio, the effectiveness of internal controls, the types of services offered and the overall risk of the institution.

The minimum amount of coverage that an FICU is required to purchase is determined based on the credit union’s assets. For example, a FICU with over $500 million in assets has a minimum bond of one percent of assets, rounded to the nearest hundred million, to a maximum of $9,000,000. The rule also states a FICU “should purchase additional or enhanced coverage” if warranted by the FICU’s circumstances. When deciding if additional coverage is needed, the rule indicates that the board of directors should “consider its own internal risk assessment, its fraud trends and loss experience, and factors such as its cash on hand, cash in transit, and the nature and risks inherent in any expanded services it offers such as wire transfer and remittance services.” In some situations, NCUA may require an FICU to purchase additional or enhanced coverage.

Once the board of directors has determined that coverage is adequate, the rule requires the board to pass a resolution that not only approves the application or renewal, but which also designates a member of the board of directors to “sign the purchase or renewal agreement and all attachments.” The rule requires that this designation rotate through the board, by prohibiting a board member from being the signatory on consecutive purchase or renewal agreements for the same policy. The regulation also states that the signatory cannot be an employee of the FICU.

As for the FICU’s management, their level of involvement may vary from one FICU to another but generally includes being responsible for the day-to-day management of the policy. For example, at some FICUs, the management is heavily involved in reviewing the coverage available and the FICU’s needs, and then making suggestions to the board of directors.

In addition to the requirements in the FCU Act and NCUA regulations, the fidelity bond provider may have its own requirements that an FICU must satisfy to obtain coverage. Some providers require the FICU to have policies and procedures in place to prevent fraud as a condition for coverage. Bond issuers may also require the FICU to provide periodic training to the FICU’s directors. FICUs may want to check the agreement with their existing or prospective bond issuers to determine what additional requirements may apply.

Finally, state-chartered FICUs may also want to check the laws and regulations in their state to determine if state law imposes any additional requirements for bond coverage.

Nick St. John is compliance counsel for NAFCU.