This week, the FDIC and SEC approved the Volcker Rule and released a draft for public comments. Bank regulators will have to solidify the Rule in the coming months, as the Rule is set to take effect in July, 2012 – although banks would have three years to comply with the Rule.
Part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Volcker Rule limits the type of investments that banks can make with their own money. A result of the financial crisis, the Rule seeks to reign in the behavior that caused banks to fail in 2008. The Rule is named after former Federal Reserve Chairman Paul Volcker, a man who criticized bank practices long before the financial crisis. The Rule applies to banks that have government guarantees and may even impose limits on financial companies supervised by the Federal Reserve Board.
The Volcker Rule places two big limitations on banks. First, the Rule prohibits banks from owning or controlling hedge funds and private equity funds: a bank cannot own more than three percent of a hedge fund or private equity fund, and cannot invest more than three percent of its capital in such funds.
Second, the Rule prohibits banks from engaging in proprietary trading. Proprietary trading occurs when a bank makes trades for its own benefit, rather than for the benefit of a customer. There are a few exceptions to this rule though, including trades of foreign currencies, commodities, and government bonds. Additionally, banks can engage in proprietary trading if they are hedging while trading on behalf of a customer. And banks may still act as market-makers and underwriters.
The Rule is not without problems though. Even its supporters claim note that the Rule may not be strict enough, and may contain loopholes. Also, it can be difficult to draw a line between proprietary trades and trades made for customers.
Wall Street is certainly not happy with the additional regulations. Compliance will create new costs; the Rule requires banks to create internal compliance programs overseen by executives. And Moody's noted that the Rule gives certain companies, like investment firms and offshore banks, a competitive advantage because they are not subject to the regulations.
At almost 300 pages, the Volcker Rule will likely receive several public comments in the next few months, including some very loud ones from Wall Street.
William F. Auther is a partner with an active trial practice in business litigation and Kelly M. McInroy is a law clerk in the Phoenix office of Bowman and Brooke LLP.