After nearly three and a half years, five federal agencies^[1] issued final regulations regarding Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, more commonly known as the “Volcker Rule.” The Volcker Rule prohibits covered insured depository institutions and companies that control or are affiliated with those institutions (banking entities) from engaging in two main activities: (1) engaging in proprietary trading of certain securities, derivatives, commodity futures and options on these instruments, for their own account; and (2) acquiring or retaining an ownership in, sponsoring or having certain relationships with hedge funds or private equity funds (covered fund). The Volcker Rule also requires that banking entities make a “good faith effort” to start developing and implementing compliance programs and preparing for the various applicable reporting requirements.

The final regulatory rules through which the Volcker Rule will be implemented and enforced (Volcker Regulations) were release in December 2013, and went into effect on April 1, 2014. Banking entities covered by the Volcker Rule will need to implement various programs to address these regulations by July 1, 2014; however, banking entities are not required to be in full compliance with all activities and investments until July 21, 2015. While it has not done so, the Federal Reserve Board has the discretion to further extend the compliance deadline for additional one-year periods to a maximum end-date of July 21, 2017.

Are You A “Banking Entity?” - Coverage of the Volcker Rule

The Volcker Rule applies to any “banking entity.” That term is defined generally to include:

(1)  any “insured depository institution,” meaning any bank or savings association the deposits of which are insured by the FDIC;

(2)  all companies that control insured depository institutions or are otherwise treated as bank holding companies or savings and loan holding companies;

(3)  any company that is treated as a bank holding company for purposes of Section 8 of the IBA (e.g. a foreign bank that has a U.S. branch); and

(4)  any affiliate or subsidiary of the foregoing.

If you fall within this broad definition then, in general, you are subject to all of the requirements of the Volcker Rule with respect to prohibited and permitted activities. However, as discussed below, the compliance requirements of the Volcker Rule vary significantly depending on the size of the banking entity and its level of trading activities.

Prohibition on Proprietary Trading

The Volcker Rule and Regulations prohibit banking entities from engaging in “proprietary trading” of certain debt and equity securities, derivatives, commodities and options on these instruments. Proprietary trading is defined as engaging as principal for the trading account of a banking entity in a transaction to purchase or sell certain financial instruments. The key term “trading account” includes an account used for the purchase or sale of certain financial instruments principally for short-term resale, benefitting from short-term arbitrage profits, or hedging another trading account position. The rule includes a rebuttable presumption that the purchase or sale of a financial instrument by a banking entity is for its “trading account” if the entity holds the instrument for less than 60 days.

The rule and regulations provide for a number of exemptions to its prohibition on proprietary trading, including certain repurchase or reverse repurchase arrangements, underwriting and market making –related activities, securities lending transactions, domestic and non-U.S. government obligations and certain risk-mitigating hedging, including portfolio hedging.

Prohibition on Ownership or Sponsorship Interests in Covered Funds

The Volcker Rule and Regulations also prohibit or restrict a banking entity from acquiring or retaining an ownership interest in, or sponsoring or having certain relationships with a covered fund. By definition, a “covered fund” includes hedge funds and private equity funds, certain commodity pools, and certain asset-backed securitizations (other than loan securitizations). Again, certain exceptions are provided including, foreign public funds, wholly-owned subsidiaries, joint ventures, foreign pension or retirement funds, insurance company separate accounts, bank-owned life insurance, loan securitizations, qualifying asset-backed commercial paper conduits, and qualifying covered bonds.

Compliance Requirements

The Volcker Regulations (which weigh in at a substantial 900 pages in length) impose a number of detailed and highly intricate reporting requirements and compliance programs on covered banking entities. For example, the Volcker Regulations generally require that covered banking entities establish and maintain an internal compliance program that is reasonably designed to ensure and monitor compliance with the Volcker Regulations. Such a compliance program could require CEO attestation to compliance, detailed documentation of covered activities sufficient to allow government regulatory agencies to monitor activities for instances of evasion, and reporting of quantitative measurements related to investments designed to monitor certain trading activities.

While the Volcker Regulations have the potential to be burdensome for covered entities, the final version of the Regulations also seek to reduce the burden of compliance on smaller, less complex banking institutions by limiting their compliance and reporting requirements. In essence, the reporting requirements operate on a relatively sliding scale, with the burden of the requirements increasing based on the size of the banking entity and the scope of the entities participation in regulated activities. Significantly, a banking entity that does not participate in trading activity regulated by the Volcker Rule does not need to establish any reporting or compliance program at all.

The following table summarizes generally the criteria for these compliance programs and the dates by which a banking entity that engages in covered activities must establish a compliance program.

Again, the Volcker Rule contains a number of exclusions and exceptions that could shield you from or reduce your compliance requirements. These exceptions, like the Volcker Rule itself, are complex and varied. If you think the Volcker Rule may apply to you, now is the time to begin planning for compliance and to evaluate whether any exceptions apply to your organization.

_{[1] The final regulatory rules were developed by a partnership of five government regulatory agencies – the Board of Governors of the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission and the Commodity Futures Trading Commission. Each of the five agencies has authority to administer and enforce the final rule with respect to different types of banking entities. A banking entity and its affiliates may together be under the Volcker Rule jurisdiction of multiple agencies.}