Divided CFTC Issues Volcker Rule Proposal Mirroring Earlier SEC, Banking Regulator Proposal

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Alex Kreonidis | Bloomberg Law CFTC Proposed Rule, Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Covered Funds (Jan. 11, 2012)

  • The CFTC Volcker Rule proposal is substantively similar to an October 2011 proposal by the SEC and banking regulators.
  • The main difference is that the CFTC proposal contains 15 additional questions for public input.
  • Sommers and O'Malia criticized the CFTC proposal for being overly complex, inconsistent with other rulemakings, and difficult to enforce.
Months after the Securities and Exchange Commission (SEC) and banking regulators proposed a joint rule (Joint Rule) that would implement the so-called "Volcker Rule," a divided Commodity Futures Trading Commission (CFTC) proposed a substantively similar rule with certain modifications (CFTC Rule). The Volcker Rule prohibits banking entities from engaging in proprietary trading activities and certain fund activities, subject to a number of exemptions. It also requires the CFTC, SEC, and banking regulators to consult and coordinate with each other in issuing implementing regulations. Although CFTC staff consulted with the SEC and banking regulators in formulating the Joint Rule, the CFTC delay in proposing its own rule was "a matter of capacity," according to recent congressional testimony by CFTC Chairman Gary Gensler (Gensler's Testimony). Comments on the CFTC Rule are due 60 days after the CFTC proposal is published in the Federal Register, and the due date for comments on the Joint Rule has been extended to February 13, 2012.

Overview of Volcker Rule

Named after former Federal Reserve Chairman Paul Volcker, the Volcker Rule is set forth in Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). It generally prohibits any banking entity from engaging in "proprietary trading." At the same time, however, it provides exemptions for market making, underwriting, and risk-mitigating hedging activities, and permits trading in government obligations, trading on behalf of customers, and trading for the general account of insurance companies, among other things. The Volcker Rule also generally prohibits any banking entity from acquiring or retaining an ownership interest in, sponsoring, or having certain other relationships with hedge funds or other covered funds. Nevertheless, as with the ban on proprietary trading, the ban on fund-related activities is subject to a number of exemptions. Among other things, the exemptions permit a banking entity to organize and offer a covered fund, provide bona fide trust, fiduciary, or investment advisory services, and make limited fund investments. The Volcker Rule's prohibitions and restrictions apply to any "banking entity," which is defined broadly in Dodd-Frank to include (1) any insured depository institution (other than certain limited purpose entities that function solely in a trust or fiduciary capacity), (2) any company that controls an insured depository institution, (3) any company that is treated as a bank holding company for purposes of Section 8 of the International Banking Act of 1978, and (4) any affiliate or subsidiary of any of the foregoing.

Joint Rule

The Joint Rule proposed by the SEC and banking regulators is intended to facilitate client-oriented financial services, such as market making, underwriting, and traditional asset management, while implementing the Volcker Rule's restrictions on covered activities. As proposed, it seeks to accomplish this by (1) describing the key characteristics of prohibited and permitted activities; and (2) requiring banking entities engaged in exempted activities to comply with certain reporting, recordkeeping, and/or compliance program requirements. For more on the Joint Rule, see Agencies Issue Much Anticipated Volcker Rule Proposal, Bloomberg Law Reports® – Securities Law, Vol. 5, No. 43 (Oct. 24, 2011).


The proposed CFTC Rule would apply to a banking entity's CFTC-regulated affiliates and subsidiaries, including CFTC-registered commodity pool operators, commodity trading advisors, futures commission merchants, swap dealers, major swap participants, and others identified in Dodd-Frank Section 2(12)(C). According to the CFTC, its proposal is substantively similar to the Joint Rule, except that the CFTC Rule (1) contains 15 additional questions soliciting comment on whether certain provisions of the Joint Rule should be applicable to CFTC-regulated banking entities, and (2) does not include Subpart E of the Joint Rule proposal which only applies to the Board of Governors of the Federal Reserve System. According to Gensler's Testimony, the "CFTC's role regarding the Volcker Rule is significant, but as a supporting member. The bank regulators have the lead role."

Dissenting CFTC Commissioners

CFTC Commissioners Jill E. Sommers and Scott O'Malia voted against the CFTC Rule proposal. Interestingly, Sommers criticized the CFTC for not having joined the SEC and banking regulators in proposing the Joint Rule in October 2011. However, she said that the CFTC was now seeking to propose "rules that are virtually identical to the other agencies' proposed rules well after they have been widely criticized and after many have called for those agencies to start over, including Paul Volker [sic]." She also expressed concern that the CFTC Rule "will needlessly complicate an already convoluted and likely unworkable set of rules." O'Malia provided a more detailed critique of the Volcker Rule proposals. As with Sommers, O'Malia felt the proposals were overly complex. O'Malia also criticized the proposals' reporting provisions, which would require larger banking entities relying on a trading exemption to report and document a variety of quantitative metrics. He expressed reservations regarding their appropriateness and the ability of the CFTC to oversee and verify the validity of reported metrics. Moreover, O'Malia said that the CFTC's enforcement powers under the Volcker Rule may be limited to ordering a CFTC-regulated firm to terminate impermissible activities and liquidate prohibited investments, which he characterized as "hardly a deterrent."1 O'Malia further observed that the CFTC Rule "differs from several proposed and some final [CFTC] rules including rules pertaining to entity definitions, conflicts with internal and external business conduct rules and raises extraterritoriality issues." Lastly, he voiced "serious reservations" about the CFTC Rule's "hedging limitations and the related impact on liquidity as they may apply to the [CFTC's] jurisdictional markets." DisclaimerThis document and any discussions set forth herein are for informational purposes only, and should not be construed as legal advice, which has to be addressed to particular facts and circumstances involved in any given situation. Review or use of the document and any discussions does not create an attorney-client relationship with the author or publisher. To the extent that this document may contain suggested provisions, they will require modification to suit a particular transaction, jurisdiction or situation. Please consult with an attorney with the appropriate level of experience if you have any questions. Any tax information contained in the document or discussions is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code. Any opinions expressed are those of the author. The Bureau of National Affairs, Inc. and its affiliated entities do not take responsibility for the content in this document or discussions and do not make any representation or warranty as to their completeness or accuracy.©2014 The Bureau of National Affairs, Inc. All rights reserved. Bloomberg Law Reports ® is a registered trademark and service mark of The Bureau of National Affairs, Inc.

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