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Federal Agencies Finalize the Volcker Rule

Five financial regulatory agencies adopted final rules implementing a provision of the Dodd-Frank Act, commonly referred to as the Volcker Rule. The final rules generally prohibit banking entities from:

  • engaging in short-term proprietary trading of securities, derivatives, commodity futures and options on these instruments for their own account; and
  • owning, sponsoring or having certain relationships with hedge funds or private equity funds (referred to as “covered funds”).

As required by the Dodd-Frank Act, the final rules provide exemptions for certain activities, including market making, underwriting, hedging, trading in certain government obligations and organizing and offering a hedge fund or private equity fund, among others. Like the Dodd-Frank Act, the final rules limit these exemptions if they involve a material conflict of interest; a material exposure to high-risk assets or trading strategies; or a threat to the safety and soundness of the banking entity or to U.S. financial stability.

Covered Funds. Unless done in compliance with the conditions discussed below under “Permitted Activities”, the final rules prohibit banking entities from owning and sponsoring covered funds. Under the final rules, the definition of “covered funds” encompasses any issuer that would be an investment company under the Investment Company Act if it were not otherwise excluded by sections 3(c)(1) or 3(c)(7) of that Act. The final rules also include in the definition of covered funds certain foreign funds and commodity pools.

Registered Investment Companies. Registered investment companies and business development companies are not treated as covered funds under the final rules. The five federal agencies finalizing the rules did not believe it would be appropriate to treat as covered funds entities that are regulated by the SEC as investment companies. The final rules also exclude from the definition of covered funds certain entities with more general corporate purposes such as wholly-owned subsidiaries, joint ventures and acquisition vehicles.

Permitted Activities. The final rules permit a banking entity to invest in or sponsor a covered fund, subject to the following conditions:

  • the banking entity must provide bona fide trust, fiduciary, investment advisory or commodity trading advisory services to the covered fund;
  • the covered fund must be offered in connection with the provision of the bona fide trust, fiduciary, investment advisory or commodity trading advisory services and only to persons who are customers of the banking entity;
  • the banking entity and its affiliates must comply with limitations that generally restrict ownership in the covered fund to no more than three percent of the outstanding ownership interests in the covered fund within one year of the establishment of the covered fund; 
  • the banking entity cannot enter into a transaction with a covered fund that would be a covered transaction as defined in Section 23A of the Federal Reserve Act;
  • the banking entity is prohibited from guaranteeing, assuming or otherwise insuring the obligations or performance of the covered fund;
  • the covered fund is prohibited from sharing the name or a variation of the same name with the banking entity that relies on the exemption and is not permitted to use the word “bank” in its name;
  • directors and employees of the banking entity are prohibited from acquiring or retaining an ownership interest in the covered fund, except for any director or employee who is directly engaged in providing investment advisory or other services to the covered fund; and
  • the banking entity must provide written disclosure to investors and prospective investors that clearly (i) indicates that all investors should read the fund offering documents; (ii) describes the role of the banking entity and its affiliates and employees in sponsoring or providing any services to the covered fund; and (iii) contains certain representations that ownership interests are not guaranteed by the FDIC and that losses are borne solely by investors in the fund.

The final rules become effective on April 1, 2014 and banks must conform their activities, investments, relationships and transactions to the Volcker Rule by no later than July 21, 2015.

Sources: Agencies Issue Final Rules Implementing the Volcker Rule, SEC Press Release 2013-258 (December 10, 2013); Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds, SEC Release No. BHCA-1 (December 10, 2013); Industry Dodges Volcker Rule Bullet, Ignites, Joe Morris (December 11, 2013).

Copyright © 2020 Godfrey & Kahn S.C.National Law Review, Volume IV, Number 42


About this Author

Susan Hoaglund, Investment Management Attorney, Godfrey Kahn law firm

Susan Hoaglund is a member of the Investment Management Practice Group. Susan provides advice to investment advisers, investment companies, broker-dealers and banks regarding legal, regulatory and compliance matters.

Chris Cahlamer Investment Management Attorney

Chris Cahlamer is the team leader of the firm’s Investment Management Practice Group, where he practices in investment management and securities law, focusing on investment companies, investment advisers, regulatory examinations, new product development, SEC compliance and reporting obligations, CCO support, private fund formation and operation, investment company reorganizations, investment advisor mergers and acquisitions, and general corporate and board fiduciary issues.

Chris earned his law degree, summa cum laude, at Marquette University Law School. While there, he received the Corporate Practice Institute Award and served as senior articles editor on the Marquette Law Review. He completed his undergraduate education at St. Norbert College, graduating as a member of the honors program and earning his bachelor’s degree, summa cum laude, in international economics and political science.

Chris is a member of the State Bar of Wisconsin and the American Bar Association.

Carol A. Gehl, Securities Law Attorney, Godfrey and Kahn law firm

Carol Gehl is a shareholder and the team leader of the Securities Practice Group in the Milwaukee office.

Carol’s practice is focused on investment management entities, including mutual funds, hedge funds, investment advisers and broker-dealers throughout the nation. During the last number of years, Carol has facilitated the organization of numerous mutual funds, hedge funds and investment advisers; assisted in SEC and FINRA examinations of regulated entities; provided ongoing advice to mutual fund Boards of Directors; and assisted with several mergers of investment advisers and...