The Volcker Rule and Hedge Funds, Private Equity and Venture Capital Funds
The “Volcker Rule” is named after former Federal Reserve Chairman Paul Volcker. Broadly speaking it is a rule against banks making certain speculative kinds of investments if they are not on behalf of their customers. The Volcker Rule is embodied in Section 619 of the Dodd-Frank Act. Among other things, that section prohibits a “banking entity” from:
- engaging in “proprietary trading;” and
- acquiring or retaining any equity, partnership or other ownership in or sponsoring a “hedge fund” or “private equity fund.”
Section 619(h)(2) of the Dodd-Frank Act defines the terms “hedge fund” and “private equity fund” to mean an issuer that would be an investment company as defined in the Investment Company Act but for Section 3(c)(1) or 3(c)(7) of the Investment Company Act. As a result, the Volcker Rule is probably applicable to ownership in a venture capital fund as well.
There are complicated exemptions to the Volcker Rule provisions of the Dodd-Frank Act. For instance, a banking entity may organize and offer a hedge fund or a private equity fund if, among other things:
- the banking entity provides bona fide trust, fiduciary, or investment advisory services;
- the fund is organized and offered only in connection with the provision of bona fide trust, fiduciary, or investment advisory services and only to persons that are customers of such services of the banking entity;
- only a de minimus amount of ownership is retained as further specified in the Dodd-Frank Act;
- the banking entity does not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or performance of the hedge fund or private equity fund or of any hedge fund or private equity fund in which such hedge fund or private equity fund invests;
- the banking entity does not share with the hedge fund or private equity fund, for corporate, marketing, promotional, or other purposes, the same name or a variation of the same name; and
- the banking entity discloses to prospective and actual investors in the fund, in writing, that any losses in such hedge fund or private equity fund are borne solely by investors in the fund and not by the banking entity and otherwise complies with certain additional rules to ensure the same.
The Volcker Rule will become effective upon the earlier of 12 months after the issuance of rules that implement the provisions of the Dodd-Frank Act or two years after enactment. Generally banking institutions will have about two years after the effective date to bring operations into compliance with the Volcker Rule.
The Financial Stability Oversight Council, or FSOC, recently posted its roadmap with respect to regulatory initiatives. It indicates FSOC and the related agencies intend to complete rulemaking in this area by October 2011.
Section 619 of the Dodd-Frank Act requires FSOC to study and make recommendations on implementing the Volcker Rule. Under Section 619, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Board of Governors of the Federal Reserve System, the Securities and Exchange Commission and the Commodity Futures Trading Commission must consider the recommendations of the FSOC study in developing and adopting regulations to implement the Volcker Rule. To assist the FSOC in conducting the study and formulating its recommendations, FSOC has issued a request for information through public comment.
Check dodd-frank.com frequently for updates on the Dodd-Frank Act.
Contact Steve Quinlivan for more information.