- Volcker Rule Restricting Proprietary Trading Passes
- December 13, 2013 | Authors: Erica L. Green; Suzana K. Koch
- Law Firms: Brouse McDowell A Legal Professional Association - Cleveland Office ; Brouse McDowell A Legal Professional Association - Akron Office
Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act, in part to prevent the excessive risk taking that led to the Great Recession. The Volcker Rule was a last-minute addition to the Dodd-Frank Act and is designed to restrict banks from making certain types of speculative investments. Named after former Federal Chairman Paul Volcker, the Volcker Rule was written to prohibit proprietary trading by banks, including short-term trading of any security, derivatives and certain other financial instruments where banks use funds from their own accounts to make a profit. The Rule was also constructed to prohibit banks from owning, sponsoring or having certain relationships with hedge funds or private equity funds and to limit the liabilities of the largest banks.
Although Congress passed the Dodd-Frank Act, it left the major responsibility of drafting the specific provisions of the Volcker Rule to financial regulators. Despite many delays, five regulatory agencies approved the Volcker Rule on December 10, 2013. Although banks had hoped for a less stringent version than what was first proposed in 2011, the adopted Rule will have a significant effect on the revenues of the largest banks.
The Volcker Rule has faced major scrutiny. Banks have argued that the implementation of the Rule would be too costly and have sought to delay its effective date for the past two years. Proponents of the Rule have argued that it is too weak and contains too many loopholes to be effective, arguing for restrictions that were once in place under the Glass-Steagall Act, a law born out of the Depression era that separated commercial and investment banking.
Prior to the approval of the Volcker Rule, it was argued that these restrictions may still not be effective. Regulators have eased these concerns by adopting tighter exemptions for legitimate trades and strictly limited portfolio hedging; a practice used by banks to offset potential losses.
Despite multi-agency approval, the Rule may face challenges ahead of its 2015 effective date. First, because the final draft of the Rule contains changes from its original proposal, banks could challenge the Rule on procedural grounds arguing that they were not given adequate opportunity to comment on any new major elements. Second, banks may try to assert that regulators failed to analyze the costs and benefits of the Rule to a sufficient extent because the OCC did not prepare a budgetary statement. Additionally, if the Rule inadvertently restricts activities Congress intended to permit, banks may argue that it contradicts the Dodd-Frank Act.
There is no “bright line” to distinguish between disallowed proprietary trading or permitted client-based trading. Without further clarity, banks may challenge the Rule on the grounds of being “arbitrary and capricious” leading to future litigation which may further stall the Rule’s implementation. The Volcker Rule proponents hope to restrict the activities of federally insured banks, while those banks criticize the Rule as overly complex and burdensome. It will take some time until the 71 page Rule is sorted out.