The adoption of the Volcker Rule by federal financial regulators on December 10, 2013 raises the question of how great a regulatory burden the nation's "main street" banks will bear as a consequence of the business practices of large banks. For most community banks, it will become necessary to know what some of the limits and exemptions in the Rule are, but the cost of compliance and the effects upon their activities should be light, at least relatively speaking.
Background. The Volcker Rule was named after Paul Volcker, a former U.S. Federal Reserve Chairman, who argued that securities trading by large financial institutions was a major contributing factor to the financial collapse in 2007-2008. He also argued that, if the U.S. (and world) economy required an institution to be bailed out by the Federal government, then that institution should not put the taxpayers' money at risk by trading in the securities markets. Congress included the Volcker Rule in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Dodd-Frank Act"), instructing five Federal financial institution regulatory agencies, including three bank regulatory agencies,1 to adopt common regulations prohibiting banking entities regulated by them from engaging in securities trading or investing in hedge funds (the "Volcker Rule"). The text adopted by each of the regulators is identical, except for section references.
The Rule. In broad terms, the Volcker Rule prohibits an FDIC-insured depository institution, or its affiliates, from most kinds of trading in securities. There are several exceptions, including exceptions for trading in obligations issued or guaranteed by the U.S. Government or specified U.S. Government agencies, and State and municipal securities. The Rule allows certain kinds of trading where the financial institution is not itself at risk. The Rule also prohibits investing in a hedge fund or a private equity fund, with exceptions.2
Significantly, the Rule imposes on every financial institution and its affiliates the requirement to have an "appropriate" compliance program; but the Rule specified particular content for a compliance program only if the financial institution has more than $10 billion in total consolidated assets, or if the financial institution trades in non-exempt securities or invests in private equity or hedge funds.
Community banks. The Federal Reserve Board, the FDIC, and the OCC issued a joint statement ("Joint Statement") explaining that the Volcker Rule should not have much effect on most banking entities with less than $10 billion in total consolidated assets, which they called community banks.3 The primary reason, according to the Joint Statement, is that banks below that size usually do not trade in securities, except for trading in permissible U.S. government and agency securities and state and municipal securities, nor do they usually invest in hedge funds or private equity funds. The regulators said that, generally, "a community bank is exempt from all of the compliance program requirements" under the Volcker Rule, so long as it does not engage in activities covered by the Volcker Rule.
Notwithstanding the Joint Statement, as a practical matter community banks will need to review or adopt at least some compliance policies and procedures, to assure that their activities are permitted by exemptions in the Volcker Rule. In particular:
- For the bank's investment portfolio, the bank should not purchase or sell any securities for a "trading account" (defined in the Volcker Rule), except for securities on the Rule's exempt list.
- The bank should make sure that it does not hold, for its own account, any shares of private equity or hedge funds prohibited by the Rule. Money market mutual funds are not prohibited by the Rule, but some collateralized loan or debt obligations (CLOs or CDOs) are.
- If the bank has a liquidity management plan, the Rule sets forth a list of requirements that must be included in the plan.
- The Volcker Rule exempts most traditional bank fiduciary and custodial purchases and sales of securities. The policies and procedures for a community bank's fiduciary and custodial services will need to be checked to assure they come within the Volcker Rule exemptions.
Effective date. The Volcker Rule is scheduled to become effective on April 1, 2014.
If you require further information regarding the information presented in this Legal Alert and its impact on your organization, please contact any member of the Financial Institutions & Lending Practice Area.
1 The agencies are the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"); the Commodity Futures Trading Commission ("CFTC"); the Federal Deposit Insurance Corporation ("FDIC"); the Office of the Comptroller of the Currency ("OCC"); and the Securities and Exchange Commission ("SEC"). Credit unions regulated by the National Credit Union Administration (NCUA) are not subject to the Volcker Rule.
2 For example, a financial institution can own 95% or more of a hedge fund subsidiary if the remaining ownership interests are held by employees, directors, and former employees or directors.
3 That statement was posted by the Federal Reserve Board at: http://www.federalreserve.gov/aboutthefed/boardmeetings/20131210openmaterials.htm.