In an article appearing in The Review of Banking and Financial Services, Weil attorneys Heath Tarbert and Alex Radetsky provide a summary of the Volcker Rule’s intended effects on private equity activities, review the Financial Stability Oversight Council’s guidance materials, and note key provisions that still require clarification by regulators. The piece is entitled “The Volcker Rule and the Future of Private Equity.”
“Adapting Your Compliance Programs to Key Portions of Dodd-Frank”
American Conference Institute, Regulatory Compliance & Risk Management for Financial Services
May 5-6, 2011, New York, NY | Register Now
Weil’s Heath Tarbert will participate in the 3:50 p.m. panel on May 5 titled “Adapting Your Compliance Programs to Key Portions of Dodd-Frank.” The panel will address new and evolving regulation on proprietary trading (Volcker Rule), whistleblower and “bounty” strategies, risk retention, and international regulatory frameworks, including Basel III requirements.
On February 9th, the Board of Governors of the Federal Reserve System (“Fed”) issued a Final Rule (the “Final Rule”) relating to the conformance periods for section 619 of Dodd-Frank, more commonly known as the “Volcker Rule.” The Volcker Rule prohibits banking entities from investing in, sponsoring, or having certain relationships with a hedge fund or private equity fund, subject to certain exceptions. Nonbank financial companies that are supervised by the Fed that engage in such activities may be subject to additional capital requirements, quantitative limits, or other restrictions, but they are not precluded, as are banking entities, from investing in, or sponsoring, a hedge fund or private equity fund. As explained further below, the Volcker Rule does not immediately come into effect and, even when it does, there may be extended periods before full compliance with the Volcker Rule is mandatory. These potential “conformance periods” are the sole subject of the Final Rule.
The Volcker Rule’s implementation period commenced on January 18, 2011, when the Financial Stability Oversight Council (“FSOC”) published its 79-page study on how best to implement the Volcker Rule. As a result, the Fed along with a number of other agencies must then adopt implementing rules within 9 months of the completion of the FSOC’s Volcker Rule study. The restrictions and prohibitions of the Volcker Rule then would become effective 12 months after issuance of the final rules by the agencies, or July 18, 2012, whichever is earlier. (Note that we anticipate the Volcker Rule will become effective on July 18, 2012 because the final rules are not required to be issued until October 18, 2011.) Once the restrictions and prohibitions of the Volcker Rule become effective, however, banking entities and nonbank financial companies will have a period of time to bring their affected activities into conformance with the rule. This conformance period generally extends through the date that is two years after the date on which the prohibitions become effective or, in the case of a nonbank financial company supervised by the Fed, two years after the company is designated by the FSOC for supervision by the Fed, if that period is later. In addition to the statutory conformance period of two years, the Volcker Rule permits the Fed to extend the conformance period by up to three additional one-year periods, for an aggregate conformance period of five years. In the case of illiquid funds, the Fed may extend the conformance period for an additional five-years beyond the three one-year extensions, for an aggregate conformance period of 10 years (including the two-year statutory conformance period).
Extension of Conformance Period
The Fed, by rule or by order, generally may extend the two-year conformance period by up to three additional one-year periods, for an aggregate conformance period of five years. For each additional extension of one year, a banking entity must submit a request to the Fed: (1) in writing at least 180 days prior to the expiration of the applicable time period; (2) provide the reasons why the extension should be granted; and (3) provide a detailed explanation of the banking entity’s plan for divesting or conforming the investment(s). Once the request is submitted, the Fed must determine that the extension is consistent with the purposes of the Volcker Rule and would not be detrimental to the public interest or the safety and sounding of the banking entity or the financial stability of the United States, including analyzing the circumstances surrounding the request through a series of factors laid out in the Final Rule. The Fed will seek to take action with respect to an extension request no later than 90 days after receipt of all necessary information relating to the request. If an extension is granted, the Final Rule would allow the Fed to impose any additional conditions on the extension that the Fed finds appropriate. In cases where the banking entity is primarily supervised by another Federal banking agency, the SEC, or the CFTC, or the Fed will consult with such agency prior to approving any extension request by the banking entity, as well as before imposing conditions in connection with the approval of any extension request by the banking entity. The Fed may only grant up to three separate one-year extensions of the general conformance period, and the Fed may not grant all three one-year extensions at once.
On January 18, 2011, the Financial Stability Oversight Council (“FSOC”) issued a report entitled “Study & Recommendations on Prohibitions on Proprietary Trading & Certain Relationship with Hedge Funds & Private Equity Funds” (the “Volcker Rule Study”). Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, otherwise known as the “Volcker Rule,” prohibits banking entities from engaging in proprietary trading and from investing in or sponsoring hedge funds and private equity funds, subject to certain exceptions.
In the Volcker Rule Study, the FSOC sets forth recommendations that seek to identify and eliminate prohibited proprietary trading activities and investments in, or sponsorships of hedge funds and private equity funds by banking entities. The proprietary trading section of the Volcker Rule Study outlines criteria for defining prohibited activities and develops tests for identifying activities that should remain permitted. In addition, the FSOC establishes grounds for classifying activities that may involve or result in a material conflict of interest, result in a material exposure to a high-risk asset or high-risk trading strategies, pose a threat to the overall stability of a banking entity, or pose a systemic risk to the financial system of the United States as prohibited activities under the Volcker Rule.