Financial Regulatory Reform Heads Down the Homestretch

A final compromise on the Volcker Rule headlines a climate change in the regulation of financial institutions.

On June 25, Congress concluded its conference committee process for a bill that entails sweeping financial reforms. As was the case following the banking crisis of the 1980s, Congress appears poised to enact an assortment of miscellaneous reforms aimed at correcting perceived deficiencies in the existing regulatory structure, and arming regulators with increased authority going forward.

The codification of the "Volcker Rule," the elimination of the Office of Thrift Supervision, and heightened regulatory scrutiny for many financial institutions are just a few of the changes to financial institution regulation contained in the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

Changes such as the establishment of the Financial Stability Oversight Council (the Council), a financial services oversight body charged with identifying systemic risks and strengthening the regulation of financial holding companies and certain nonbank companies; the creation of a new Bureau of Consumer Financial Protection, corporate governance changes for public companies; increased enforcement capability for the U.S. Securities and Exchange Commission (SEC); changes to executive compensation; regulatory changes in retail brokerage and private client services; derivative reform; and changes to the Sarbanes-Oxley whistleblower protections have been discussed in previous Morgan Lewis LawFlashes. Additional aspects of this legislation will be discussed in future LawFlashes.1

The Volcker Rule

Former Federal Reserve Chairman and White House economic adviser Paul Volcker has been a major proponent of limiting certain capital market activities of banks, including the ownership or sponsorship of hedge funds and private equity funds and proprietary trading. Volcker has described the focus of his concern as those activities that "plac[e] bank capital at risk in the search of speculative profit rather than in response to customer needs." Although derivatives activity conducted by banks has in large part been focused on customer facilitation and needs, Volcker's recommendations included restrictions on derivatives activities by banks.

The proposal to limit bank capital markets activity concept was introduced relatively late into the financial reform debate in Congress. The proposal was not included in the original House bill but was part of the financial reform bill passed by the Senate. The proposal resonated with the conference committee, which adopted a version of the "Volcker Rule" that roughly tracks the Senate version but includes some limited ability for banks to invest in hedge funds and private equity funds.

The final version of the Volcker Rule adopted by the conference committee applies to proprietary trading activity conducted by a banking entity or nonbank financial company supervised by the Federal Reserve as a systemically important nonbank. "Proprietary trading" activity was defined as involving transactions by the banking entity or nonbank, as principal, to "purchase or sell, or otherwise acquire or dispose of, any security, any derivative, any contract of sale of a commodity for future delivery, any option on any such security, derivative, or contract, or any other security or financial instrument that the appropriate Federal banking agencies, the Securities and Exchange Commission and the Commodity Futures Trading commission may, by rule . . . determine."

A "banking entity" is defined by the bill as any insured depository...