	The Volcker Rule: Dodd-Frank Act §619

		Overview

On December 10, 2013, more than two years after the statutorily mandated deadline, five federal financial regulators published final regulations (hereinafter, the regulations) implementing Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (hereinafter, Section 619 or the statute). These are practices long condemned by the Rule's namesake, former Federal Reserve Chairman Paul A. Volcker, for being at odds with conventional banking principles and potential risks to overall financial stability that could trigger the need for future bailouts. The Volcker Rule, which according to an analysis by one of the issuing regulators might impose significant costs on covered institutions, prohibits "banking entities" from engaging in "proprietary trading" and from making investments in or having relationships with hedge and similar "covered funds" that fall into certain exemptions from registering with the Commodity Futures Trading Commission (CFTC) as commodity pool operators or with the Securities and Exchange Commission (SEC) under the Investment Advisors Act. In concert with these broad prohibitions, the Rule carves out numerous exclusions and designates myriad activities as permissible so long as various terms and conditions are met. The statutory language provides only general outlines of prohibited activities and exceptions, while empowering the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (FRB), the Federal Deposit Insurance Corporation (FDIC), the SEC, and CFTC (together, the federal financial regulators or the Agencies) to issue coordinated rulemakings to fill in the details and complete the difficult task of crafting regulations to distinguish prohibited activities from activities considered essential to the safety and soundness of banking institutions or to the maintenance of strong capital markets. These excepted activities are designated as permissible under the Rule unless they would involve or result in a material conflict of interest; a material exposure to high-risk assets or high-risk trading strategies; pose a threat to the safety and soundness of the banking entity; or pose a threat to the financial stability of the United States. FDIC-insured depository institutions. 3. Permitted Proprietary Activities

In addition to the above exclusions from the definition of "proprietary trading," the Rule identifies exceptions to the blanket prohibition of proprietary trades by listing permitted activities and setting conditions under which those activities may be conducted. The statute's ban on proprietary trading does not apply to a banking entity's underwriting activities so long as its underwriting position is "designed not to exceed the reasonably expected near term demands of clients, customers, or counterparties." Market Making Activities. Risk Mitigating Hedging Activities . Insurance Company Portfolio Investments. Wholly Owned Subsidiaries. Additionally, certain SEC-registered business development companies, investment companies, and foreign public funds, which generally are excluded from the definition of "covered fund" as described above, will not be considered an affiliate of a banking entity for the purposes of the de minimis seed investment limits if the banking entity 
(1) Does not own, control, or hold with the power to vote 25 percent or more of the voting shares of the company or fund; and 
(2) Provides investment advisory, commodity trading advisory, administrative, and other services to the company or fund.... "

			Organizing and Advising Covered Funds in Connection with Fiduciary or Trust Services

The Volcker Rule authorizes banking entities to acquire ownership interests in, sponsor, organize, and offer covered funds to the extent that (1) the banking entity provides "bona fide trust, fiduciary, or investment advisory services"; (2) "the fund is organized and offered only in connection with bona fide trust, fiduciary, or investment advisory services to persons that are customers of such services of the banking entity"; (3) the banking entity retains only a de minimis interest in the funds; (4) the banking entity and its affiliates engage in no transaction with the fund that would be designated as a "covered transaction" under Federal Reserve Act (FRA) Section 23A and other transactions with the fund are conducted only on terms specified in FRA Section 23B, as if the banking entity were a member bank and the fund an affiliate of that bank; (5) the banking entity does not guaranty the obligations of the covered fund; (6) the covered fund does not have the word "bank" in its name or share a name with the banking entity; (7) no director or employee of the banking entity, other than those directly engaged in providing investment advisory or other services to the covered fund, acquires an interest in the fund; and (8) the banking entity takes certain steps to assure the investors in the covered fund that losses of the fund will be borne solely by its investors.
This report provides an introduction to the Volcker Rule, which is the regulatory regime imposed upon banking institutions and their affiliates under Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (P.L. 111-203). The Volker Rule is designed to prohibit "banking entities" from engaging in all forms of "proprietary trading" (i.e., making investments for their own "trading accounts")—activities that former Federal Reserve Chairman Paul A. Volcker often condemned as contrary to conventional banking practices and a potential risk to financial stability. The statutory language provides only general outlines of prohibited activities and exceptions. Through it, however, Congress has empowered five federal financial regulators with authority to conduct coordinated rulemakings to fill in the details and complete the difficult task of crafting regulations to identify prohibited activities, while continuing to permit activities considered essential to the safety and soundness of banking institutions or to the maintenance of strong capital markets. In December 2014, more than two years after enactment of the law, coordinated implementing regulations were issued by the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), the Board of Governors of the Federal Reserve System (FRB), the Securities and Exchange Commission (SEC), and the Commodity Futures Trading Commission (CFTC).
The Rule is premised on a two-pronged central core restricting activities by "banking entities"—a term that includes all FDIC-insured bank and thrift institutions; all bank, thrift, or financial holding companies; all foreign banking operations with certain types of presence in the United States; and all affiliates and subsidiaries of any of these entities. Specifically, the Rule broadly prohibits banking entities from engaging in "proprietary trading" and from making investments in or having relationships with hedge and similar "covered funds" that are exempt from registering with the CFTC as commodity pool operators or with the SEC under the Investment Advisors Act. The Rule couples its broad prohibitions with numerous exclusions and by designating myriad activities as permissible so long as various terms and conditions are met, unless they otherwise would involve or result in a material conflict of interest; a material exposure to high-risk assets or high-risk trading strategies; pose a threat to the safety and soundness of the banking entity; or pose a threat to the financial stability of the United States.
The exceptions to the ban on proprietary trading include underwriting by securities underwriters; market-making "designed not to exceed the reasonably expected near term demands of clients"; trading in government securities; fiduciary activities; insurance company portfolio investments; and risk-mitigating hedging activities. The ban on investing in and owning "covered funds" exempts certain types of funds, under specified conditions, and permits de minimis investment in any such fund up to 3% of the outstanding ownership interests of the fund with an aggregate cap on the total ownership interest in "covered funds" of 3% of the banking entity's core capital.
To prevent evasion, the Rule has extensive requirements mandating comprehensive compliance programs that include ongoing management involvement, precise metrics measuring risk assessment, verification and documentation of any activities conducted under one of the Rule's exceptions or exclusions, and recurring reports and assessments. Full compliance is required by July 21, 2015, subject to the possibility that further extensions may be provided by the regulators. In the case of investments involving "illiquid funds" subject to contractual provisions seriously impacting their marketability or sale, full divestiture might not be required until July 21, 2022.