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Dodd-Frank

Proposed Volker Rule Entails Significant Compliance Programs

by   |   October 11, 2011

The Federal Deposit Insurance Corporation requested public comment on a proposed regulation implementing the so-called “Volcker Rule” requirements of section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.  The proposal will be issued jointly with the Federal Reserve Board, the Office of the Comptroller of the Currency, and the Securities and Exchange Commission.  It is anticipated that the Commodity Futures Trading Commission will issue a comparable proposal in the near future.

The relevant provision of the Dodd-Frank Act generally prohibits two activities of banking entities. First, it prohibits insured depository institutions, bank holding companies, and their subsidiaries or affiliates (banking entities) from engaging in short-term proprietary trading of any security, derivative, and certain other financial instruments for a banking entity’s own account, subject to certain exemptions. Second, it prohibits owning, sponsoring, or having certain relationships with, a hedge fund or private equity fund, subject to certain exemptions.

The proposed rule would require banking entities to establish an internal compliance program that is designed to ensure and monitor compliance with the statute’s prohibitions and restrictions, and implementing regulations. The internal compliance program would be subject to oversight by the banking entity’s board of directors and appropriate federal supervisory agency. The proposal also requires banking entities with significant trading operations to report to the appropriate federal supervisory agency certain quantitative measurements designed to assist the federal supervisory agencies and banking entities in identifying prohibited proprietary trading in the context of exempt activities.

Subpart D of the proposed rule requires a banking entity engaged in covered trading activities or covered fund activities to develop and implement a program reasonably designed to ensure and monitor compliance with the prohibitions and restrictions on covered trading activities and covered fund activities and investments set forth in section 13 of the Bank Holding Company Act of 1956, or BHC Act, and the proposed rule.  The proposed rule specifies six elements that each compliance program established under subpart D must, at a minimum, include:

  • Internal written policies and procedures reasonably designed to document, describe, and monitor the covered trading activities and covered fund activities and investments of the banking entity to ensure that such activities comply with section 13 of the BHC Act and the proposed rule;
  • A system of internal controls reasonably designed to monitor and identify potential areas of noncompliance with section 13 of the BHC Act and the proposed rule in the banking entity’s covered trading and covered fund activities and to prevent the occurrence of activities that are prohibited by section 13 of the BHC Act and the proposed rule;
  • A management framework that clearly delineates responsibility and accountability for compliance with section 13 of the BHC Act and the proposed rule;
  • Independent testing for the effectiveness of the compliance program, conducted by qualified banking entity personnel or a qualified outside party;
  • Training for trading personnel and managers, as well as other appropriate personnel, to effectively implement and enforce the compliance program; and
  • Making and keeping records sufficient to demonstrate compliance with section 13 of the BHC Act and the proposed rule, which a banking entity must promptly provide to the relevant regulatory authority upon request and retain for a period of no less than 5 years.

For a banking entity with significant covered trading activities or covered fund activities and investments, the compliance program must also meet a number of minimum standards that are specified in Appendix C of the proposed rule.  The application of detailed minimum standards for these types of banking entities is intended to reflect the heightened compliance risks of large covered trading activities and covered fund activities and investments and to provide clear, specific guidance to such banking entities regarding the compliance measures that would be required for purposes of the proposed rule. For banking entities with smaller, less complex covered trading activities and covered fund activities and investments, these detailed minimum standards are not applicable, though the regulatory authorities expect that such smaller entities will consider these minimum standards as guidance in designing an appropriate compliance program.

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