One of the most difficult aspects of consulting is that people often don't want advice; they want advocacy. Certainly, consultants can never ethically accept jobs that require advocacy over sound operation. That is the function of marketing departments.
The state had imposed an accounting principal known as "lower of cost or market" (LOCOM) because of the nature of the problem the credit unions had created. Though Bert would have preferred me to figure out a way that LOCOM accounting was unreasonable, he accepted the fact that there was nothing we could do about it.
What these managers had done was bought into mutual funds that had grown in value. However, because corporations must show assets at cost, the growth in the fund, though real, was not shown on the balance sheet. In order to address this shortcoming in Generally Accepted Accounting Principles (GAAP), they would sell and buy back the mutual fund at the increased value. The higher sale price was shown as "income," which directly affected the equity accounts (regular reserves and undivided earnings). In reality, the "income" was spent on the increased market price of the fund. Both the income and the growth in equity were a type of book cooking, but it was a bad plan and not a criminal conspiracy.
This looks really good on the books when the market value exceeds the cost of an asset, but it distorts the value of a financial institution when the market value is less than the cost of an asset. Hence, the LOCOM requirement was a sound operating requirement, and Bert just had to accept that my opinion and his opinion differed on that. However, it did create that dynamic one looks for in healthy relationships: complementary ideologies.
For three of the credit unions, the contra account for the lower market value was offset against undivided earnings. However, since the difference in the case of CUPS exceeded the undivided earnings, the offset against equity accounts virtually eliminated the undivided earnings, with the remaining balance offset against the regular reserves.
The long term strategy was to get rid of the investment so the losses could be realized, but the short term objective was to pay dividends to shareholders that quarter. None of the credit unions could use any encumbered undivided earnings for that purpose, which meant that CUPS had to pay its dividends fully from earnings. We trapped the moles because of that requirement, but we still had to meet it.
Bert told me that we had met the objective a day or two before the end of the quarter. He told me to get the state's formal approval to pay the dividends. He had talked to them, and he said that Betty wants any excess put into the contra accounts until they are eliminated. I chuckled at what he said because the contra accounts have to be eliminated by sale or increased market value of the asset. Profits don't affect either the cost or the market of an asset. I told him that I knew what she meant.
I made a call to the Department of Savings and Loans. Betty was not available, but Tom, her deputy supervisor, was available. He told me to get a letter prepared that said that we had met the objective and fax it to them. He would have Betty sign it, but we could go ahead and pay the dividends. Betty, however, called me on the morning of December 31st to let me know that we wouldn't be paying dividends because the letter did not specify how the profits for the quarter would be applied. When I told her that I was following Tom's directions, she told me that will work when he is the supervisor.
Not only did I not have much time to assemble the information, but I needed to bring the original to Betty for her signature. I had one shot to get this done.
What Betty must have meant when Bert heard "put the profits in the contra accounts" was for the contra accounts to be shifted such that any money put into undivided earnings became encumbered until the contra account against the regular reserves was fully eliminated. In other words, the state wanted the credit union to have the same inability to use undivided earnings for the payment of dividends until there was sufficient equity to actually have unemcumbered undivided earnings.
I got the letter prepared that talked about the application of income to expenses, regular reserves, dividends, and undivided earnings (as usual). In order to meet her expectations, the offset of any money put into undivided earnings would be increased by that amount, with a compensatory reduction of the contra account against regular reserves. I got Bert's signature on it, wished everyone a happy new year, and took off for Olympia.
Betty was waiting for me, and she was mostly prepared to find a problem with the plan. She found it immediately.
"I don't know why Bert doesn't listen to me," she asserted. "I told him I wanted the profits to go into the contra accounts."
"I apologize, Betty. I did that," I confessed. "I thought it was him who didn't know what he was talking about." I asked, "Does the contra account reflect the difference between the cost and the market value of an asset?"
"Of course," she replied.
"So, do profits affect cost or market value?"
She called in her deputy. She told me to ask him the same questions. It stymied him, too.
I didn't get paid extra for explaining to those doctors of accounting how to meet their accounting requirements, but the procedure I described to account for profits in those situations became state policy. I did, however, put Betty into the position of having to keep her word on the payment of dividends, or to contend that we had to make the accounting errors she prescribed in order to meet her demands.
This would be my final meeting ever with Betty. She moved on to another department, and I made the biggest mistake of my career by moving on to the Chapter 13 Trustee's office. Despite that, I remained involved in the credit union movement by remaining active in Chapter level education, both as Program Director and Co-Educational Director with Trish.
The state hired Betty's attorney to replace her as the Supervisor of the Division of Savings and Loans. He was ardently supportive of her plan to rid the credit unions of the managers who had perpetrated the scheme. He became the dragon that needed to be slayed in order to ultimately save CUPS.
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Other posts you might enjoy:
Saving CUPS Part 1: Trapping the Moles
Just When I Needed It Most
A Price for Charity
The Kids Are Back!
Remembering Mom: If Her Services Had Been About Her