INTRODUCTION

On July 21, 2010 (the "Enactment Date"), President Obama signed into law The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Act"). The legislative changes mandated by the Act, which is named after Senate Banking Committee Chairman Christopher Dodd (D-Conn.) and House Financial Services Committee Chairman Barney Frank (D-Mass.), are intended to shield the financial system from systemic risk and to address weaknesses in financial services law and regulation that contributed to the severe economic downturn and the related disruption in the financial markets in 2008.

The Act is sweeping in the range of topics it covers, including, to name just a few: (i) the creation of a new regulatory agency that will focus exclusively on the protection of consumers who purchase financial services; (ii) restriction of proprietary trading by banking institutions; (iii) new monitoring and controls of large, systemically significant financial institutions (which include non-banks as well as banks); (iv) heightened capital and liquidity standards for banking institutions and certain other financial institutions; (v) revised and strengthened regulation of trading in derivatives; (vi) federal deposit insurance reform; (vii) changes in investment adviser registration requirements, including elimination of the "private adviser" exemption; and (viii) increased regulation of executive compensation. This Special Edition of the Financial Services Alert provides a summary (the "Summary") of the key provisions of the Act. Despite its length, the Summary does not cover every provision of the Act, and, of course, is not a substitute for a review of the applicable provisions of the Act.

As is frequently the case for regulatory reform legislation of this breadth, the legislation itself is only the starting point. The Act directs various regulatory bodies to draft, adopt and implement more than 240 regulations, many of which will influence dramatically the scope, substance and practical impact of the Act. In addition, the Act calls for the GAO and other agencies to complete an aggregate of almost 70 studies regarding a broad range of issues concerning the financial services industry that were raised during the legislative process. Regulatory bodies may also choose to exercise permissive rulemaking authority granted by Congress without an accompanying mandate under various provisions of the Act.

Accordingly, while some aspects of the Act will be effective immediately, others will take months or years to unfold. Future editions of the Financial Services Alert will include more detailed examinations of the different topics covered by the Act and will summarize related regulatory activity and other relevant developments as they occur.

I. BANKING REFORM AND FINANCIAL STABILITY

A. Regulation of Systemic Risk (Title I)

In response to the financial crisis, the Act creates a new supervisory regime designed to monitor and regulate systemic risk in the U.S. financial system. Banking organizations subject to this new regime are referred to in this Summary as "Systemically Significant Bank Holding Companies"; other companies subject to the new regime are referred to as "Systemically Significant Nonbank Financial Companies;" and together such companies are referred to as "Systemically Significant Financial Companies."

1. Newly Established Agencies to Regulate Systemic Risk

(a) Financial Stability Oversight Council.

The Act establishes the Financial Stability Oversight Council (the "Council") to identify systemic risks to the financial stability of the United States, end the expectation that some institutions are "too big to fail" and respond to emerging threats to the U.S. financial system. The Council is composed of ten voting members and five non-voting members. The ten voting members of the Council are the Treasury Secretary (who serves as the chair of the Council), the FRB Chairperson, the Comptroller of the Currency, the Bureau of Consumer Financial Protection ("Bureau") Director, the SEC Chairperson, the FDIC Chairperson, the CFTC Chairperson, the FHFA Director, the NCUA Chairperson and an independent member having insurance expertise appointed by the President with the advice and consent of the Senate. The five non-voting members of the Council are the Office of Financial Research ("OFR") Director, the Federal Insurance Office ("FIO") Director, a state insurance commissioner, a state banking supervisor and a state securities commissioner.

The Council will collect information to assess risks to the U.S. financial system, monitor systemic risks and identify regulatory gaps. The Council will facilitate information sharing among its members and other state and federal agencies as well as coordinate general supervisory priorities and principles among its members and resolve disputes between them. The Council is also responsible for identifying Systemically Significant Nonbank Financial Companies to be supervised by the FRB and systemically important financial market utilities (discussed further below). The Council may make recommendations to the financial regulatory agencies concerning heightened prudential standards for Systemically Significant Financial Companies or to the SEC and the Financial Accounting Standards Board regarding existing or proposed accounting principles and standards. The Council may also make recommendations regarding new or heightened and broadened prudential standards and safeguards for activities the Council determines create systemic risk (including payment, clearing and settlement activities, as discussed below) regardless of the size of the financial company participating in such activities.

(b) Office of Financial Research

The Act establishes the OFR as a largely independent, self-funded (through fees on Systemically Significant Financial Companies) agency within the U.S. Treasury Department, to serve as the information gathering arm of the Council. The OFR has broad powers, including subpoena authority, to gather information and require reports from all financial companies. The information collected by the OFR is subject to the Freedom of Information Act.

2. Regulation of Systemically Significant Financial Companies

(a) Systemically Significant Bank Holding Companies

Bank holding companies with $50 billion or more in assets are subject to the heightened and broadened prudential standards and other requirements of the Act for Systemically Significant Financial Companies. In order to prevent certain companies from deregistering as bank holding companies to avoid the systemically significant designation, the Act provides (Section 117) that any entity that was a bank holding company with assets of $50 billion or greater on January 1, 2010 and received financial assistance under the Capital Purchase Program will be automatically treated as a Systemically Significant Nonbank Financial Company should it cease to be a bank holding company. Foreign banks and bank holding companies may be designated as Systemically Significant Bank Holding Companies.

(b) Systemically Significant Nonbank Financial Companies

As discussed above, the Council (Section 113), by a 2/3 vote, may designate a nonbank financial company as a Systemically Significant Nonbank Financial Company subject to regulation by the FRB, including heightened and broadened prudential standards and other restrictions. To be considered a nonbank financial company, 85% or more of the company's annual gross revenues or consolidated assets must be related to activities that are predominantly financial in nature, as defined by section 4(k) of the Bank Holding Company Act (the "BHC Act") or related to ownership or control of an insured depository institution. The definition of nonbank financial company excludes certain companies, including Farm Credit institutions, national securities exchanges, clearing agencies, security-based swap execution facilities and data repositories, and boards of trade designated as contract markets. To be designated as systemically significant, the Council must determine that the failure, nature, scope, size, scale, concentration, interconnectedness or mix of activities of the nonbank financial company could pose a threat to the financial stability of the United States. The factors that the Council must consider when making such a determination include the company's leverage, the nature of the assets and liabilities of the company, the company's reliance on short-term funding, the nature of the company's activities, its interconnectedness with other Systemically Significant Financial Companies and its importance as a source of credit and liquidity. Unlike Systemically Significant Bank Holding Companies, there is no asset threshold for Systemically Significant Nonbank Financial Companies. The designation that a company is a Systemically Significant Nonbank Financial Company is subject to notice and hearing procedures and judicial review. Foreign nonbank financial companies may be designated as Systemically Significant Nonbank Financial Companies.

Upon the determination that a nonbank financial company is a Systemically Significant Nonbank Financial Company, the FRB may require such a company to establish an intermediate holding company through which to conduct its financial activities, and the Act mandates that the FRB impose such a requirement in certain circumstances. The Act (Section 167(b)) requires the parent company of such an intermediate holding company to act as a source of strength to the intermediate holding company.

Systemically Significant Nonbank Financial Companies are subject to supervision by the FRB, including reporting requirements, examinations and enforcement actions. Systemically Significant Nonbank Financial Companies are treated as bank holding companies for purposes of the Depository Institutions Management Interlocks Act (Section 164). As discussed in greater detail below, Systemically Significant Nonbank Financial Companies are subject to restrictions on proprietary trading and investments and sponsorship of hedge funds and private equity funds.

(c) Heightened and Broadened Prudential Standards and Other Requirements for Systemically Significant Financial Companies

(i) Heightened and Broadened Prudential Standards

Under the Act, Systemically Significant Financial Companies are subject to heightened and broadened prudential standards. The Council (Section 115) may make recommendations regarding these heightened and broadened standards, however, the FRB will promulgate and enforce such standards and has supervisory authority over all Systemically Significant Financial Companies. Generally, the FRB must issue the regulations implementing such standards by January 21, 2012. The FRB is required (Section 165) to prescribe heightened and broadened prudential standards for Systemically Significant Financial Companies, including risk-based capital requirements and leverage limits, liquidity requirements, risk management requirements, resolution plan and credit report requirements and concentration limits. Such standards must be more stringent than the prudential standards for other financial companies, including the capital and leverage standards discussed below. The Act further requires that Systemically Significant Financial Companies include off-balance sheet activities in their computations of capital for purposes of meeting such capital standards. The Council must submit a report regarding the feasibility, benefits, costs and structure of a contingent capital requirement for Systemically Significant Financial Companies by July 21, 2012. Subject to this report, the FRB is authorized to require that Systemically Significant Financial Companies maintain a minimum amount of contingent capital that is convertible to equity "in times of financial stress."

In order to limit the risk profile of Systemically Significant Financial Companies, the FRB must establish (Section 165) credit exposure concentration limits and may establish short-term debt limits for Systemically Significant Financial Companies. Upon the determination of the Council that a Systemically Significant Financial Company poses a grave threat to U.S. financial stability, the FRB must require such company to maintain a debt to equity ratio of no greater than 15 to 1. The Act further requires the FRB, in conjunction with other appropriate regulators, to conduct annual stress tests of Systemically Significant Financial Companies that are designed to evaluate whether such companies have enough capital, on a consolidated basis, to absorb projected losses in the event of adverse economic conditions.

(ii) Other Requirements

The Act requires (Section 165) Systemically Significant Financial Companies to submit resolution plans and periodic credit exposure reports to the FRB, and the Council, through the OFR, may require (Section 116) periodic certified reports from Systemically Significant Financial Companies or their subsidiaries relating to such company's financial condition, risk monitoring systems, transactions with depository institution affiliates, and the extent that, under adverse conditions, its activities and operations could disrupt financial markets or U.S. financial stability. Moreover, as discussed below, in order to limit potential conflicts of interest, the Act (Section 726) authorizes the CFTC to limit the control of derivatives clearing organizations, swap execution facilities or boards of trade designated as contract markets by Systemically Significant Financial Companies.

The Act restricts the ability of certain Systemically Significant Financial Companies to make a significant acquisition without first obtaining the approval of the FRB (Section 163). Specifically, a Systemically Significant Financial Company with total consolidated assets of $50 billion or more must provide notice to and obtain approval from the FRB in accordance with the procedures set forth at Section 4(j) of the BHC Act (except that the exception from such notice requirement provided by Section 4(j)(3) is inapplicable) before acquiring direct or indirect ownership or control of any voting shares of any company (other than an insured depository institution) with $10 billion or greater in assets that is engaged in activities described in Section 4(k) of the BHC Act (e.g., financial activities). In addition to the standards for review described in Section 4(j)(2) of the BHC Act, the FRB must consider the extent to which the proposed acquisition would result in greater or more concentrated risks to global or U.S. financial stability before determining whether to approve or disapprove a notification. Financial holding companies with total assets of $50 billion or more will also be subject to this notice requirement. The Act also provides that transactions subject to this notification requirement are subject to Hart-Scott-Rodino filing requirements, regardless of the exception for transactions for which FRB approval is required. Transactions involving an acquisition of an interest in an insured depository institution remain subject to applicable requirements of the BHC Act, the Home Owners' Loan Act (the "HOLA") and the Federal Deposit Insurance Act (the "FDIA").

(iii) Mitigation Authority

The Act requires (Section 166) the FRB, in consultation with the Council and the FDIC, to prescribe regulations requiring the early remediation of distressed Systemically Significant Financial Companies. The Act also provides (Section 121) that if the FRB determines that a Systemically Significant Financial Company poses a grave threat to U.S. financial stability, upon a 2/3 vote of the Council, the FRB may limit such company's ability to merge with or acquire another company, restrict such company's ability to offer a financial product or products, require such company to terminate one or more activities, impose conditions on the activities of such company, or require the company to sell or otherwise transfer assets or off-balance sheet items to unaffiliated entities.

The FDIC is authorized (Section 172) to examine Systemically Significant Financial Companies in order to determine the condition of any such company for purposes of implementing its authority under Title II of the Act, which is discussed further below.

3. Regulation of Systemic Risk

As discussed above, the Council may recommend (Section 120) new or heightened prudential standards and safeguards for activities the Council determines create systemic risk. Such standards with respect to such a systemically significant financial activity could be similar to the heightened and broadened prudential standards imposed generally on Systemically Significant Financial Companies; however, such standards would apply to any bank holding company or nonbank financial company subject to the jurisdiction of a member of the Council, regardless of size. In order to designate a financial activity as systemically significant, the Council must determine that the conduct, scope, nature, size, scale, concentration, or interconnectedness of the activity or practice could create or increase the risk of significant liquidity, credit or other problems spreading among bank holding companies and nonbank financial companies, U.S. financial markets or low-income, minority or underserved communities. In addition, the Act (Section 123) requires the Council to study the effects of size and complexity of financial institutions on capital market efficiency and economic growth and regularly report to Congress the findings of such study.

B. Orderly Liquidation Authority (Title II)

1. Introduction

The orderly liquidation authority provisions set forth in Title II of the Act give the Treasury Secretary the ability ("Liquidation Authority") to resolve the failure of a "covered financial company" in the United States by appointing the FDIC as receiver for such a company. As receiver, the FDIC has powers and duties with respect to such company that are similar to those granted to it to resolve depository institutions under the FDIA. Such a receivership conducted under the Liquidation Authority must terminate within certain time limits.

2. Scope

The Treasury Secretary may utilize the Liquidation Authority with respect to any covered financial company. The term "financial company" is defined as any company that is incorporated or organized under U.S. federal or state law that is: (a) a bank holding company, as defined by the BHC Act; (b) a Systematically Significant Nonbank Financial Company, including an insurance company or a securities broker-dealer; (c) any company that is predominantly engaged in activities that are financial in nature or incidental thereto, as such term is defined in Section 4(k)of the BHC Act ("financial activities"); or (d) any subsidiary of any of the foregoing that is predominantly engaged (at least 85%) in financial activities other than a subsidiary that is an insured depository institution or an insurance company. There is an exclusion for certain governmental entities.

3. Designation as Covered Financial Company

Covered Financial Company. A financial company (other than a broker-dealer or an insurance company, as discussed below) will be designated as a covered financial company, and the FDIC will be appointed as its receiver, if at any time the Treasury Secretary makes the following determinations, upon the recommendation of 2/3 of the Governors of the FRB and 2/3 of the FDIC Board, and in consultation with the President: (a) the financial company is in default or in danger of default; (b) the failure of the financial company and its resolution under otherwise applicable insolvency law would have serious adverse effects on financial stability in the United States; (c) no viable sector alternative is available to prevent the default of the financial company; (d) any effect of using the Liquidation Authority on the claims or interests of creditors, counterparties and shareholders of the financial company and other market participants would be appropriate given the beneficial impact of using the Liquidation Authority on U.S. financial stability; (e) the use of the Liquidation Authority would avoid or mitigate the adverse effects that would result from resolving the financial company under otherwise applicable insolvency law; (f) a Federal regulatory agency has ordered the financial company to convert all of its convertible debt instruments that are subject to being converted by regulatory order; and (g) the company satisfies the definition of "financial company" as described above. The Treasury Secretary must obtain an order from the U.S. District Court for the District of Columbia before appointing the FDIC as receiver of any covered financial company unless the financial company's board of directors acquiesces or consents to the appointment.

If the FDIC is appointed as receiver of a covered financial company, it may appoint itself as receiver of any subsidiary of the covered financial company, other than an insured depository institution, insurance company or covered broker-dealer, if the FDIC and the Treasury Secretary jointly make certain determinations regarding the probability of default and the significance of the subsidiary.

Effect of Appointment of FDIC as Receiver. With the exceptions described below regarding covered broker-dealers or covered insurance companies, the FDIC will apply the provisions of the Liquidation Authority instead of applicable insolvency law in connection with liquidating any covered financial company. If the FDIC is appointed as receiver, it succeeds to all of the rights and obligations of the covered financial company subject to the provisions of the Liquidation Authority. The Liquidation Authority will apply whether or not the appointment of the FDIC as receiver occurs before or after the commencement of bankruptcy proceedings.

4. Powers of the FDIC

Core Resolution Powers, Merger and Transfer. The FDIC, acting as receiver, will have full powers to operate the covered financial company throughout the period of the receivership. The FDIC also has the power to transfer all or any portion of the assets or liabilities of the financial company to a third party or a bridge financial company, or to merge the covered financial company with any other company, in each case without consent or review.

Financial Assistance. The FDIC may provide a wide range of financial assistance in connection with the resolution of a covered financial company, including making loans to, or purchasing debt, purchasing assets, assuming or guaranteeing obligations, taking liens on assets, and selling or transferring assets or liabilities of, the covered financial company, subject to an orderly liquidation plan approved by the Treasury Secretary and certain other conditions.

Ipso Facto Clauses. Ipso facto clauses are not enforceable against the FDIC in its capacity as receiver, except in the case of qualified financial contracts ("QFCs"), director or officer liability insurance contracts and depository institution bonds.

Repudiation of Contracts. The FDIC, acting as receiver, has the right to disaffirm or repudiate any contract or lease, including a QFC, to which a covered financial company in receivership is a party if the FDIC determines within a reasonable period of time that the contract would be burdensome and repudiation of the contract would promote the orderly administration of the covered financial company's affairs. If the FDIC disaffirms or repudiates a contract, the counterparty would have a claim against the receivership estate for actual direct compensatory damages, with certain exceptions.

Preferential or Fraudulent Transfers. The FDIC, acting as receiver, may set aside a security interest or other transfer of property if it amounts to a preferential or fraudulent transfer under standards set forth in the Act.

5. Claims Process

The Act requires the FDIC, acting as receiver, to administer an orderly claims process.

Power to Temporarily Stay Litigation. The FDIC may request a stay of up to 90 days of any judicial action or proceeding to which a covered financial company in receivership is or becomes a party, and the relevant court is required to grant such stay.

Maximum and Minimum Payments on Claims. Generally, each creditor of a covered financial company that is in receivership is entitled to receive no more and no less than it would have received in a liquidation under Chapter 7 of Title 11 of the United States Code (the "Bankruptcy Code"). However, the FDIC is authorized to pay more than the minimum on any claim in order to minimize any losses to the FDIC, provided that no payment on a claim may exceed the face amount of such claim.

Priority of Claims and Set-Off. Subject to the modifications discussed below, unsecured claims that are proved to the satisfaction of the receiver will be given priority according to a ranking established by the Liquidation Authority. Claims of creditors with otherwise enforceable setoff rights will rank senior to general unsecured claims to the extent the FDIC destroys the mutuality of any offsetting claims by transferring one of the otherwise offsetting claims to a third party or bridge financial company. Post-receivership financing incurred by the FDIC on behalf of a covered financial company will rank senior to all other unsecured claims. Claims of similarly situated creditors shall be treated in a similar manner, provided that the FDIC may treat similarly situated creditors differently as necessary to achieve certain FDIC objectives. The priority structure shall not affect the rights of secured creditors. The Liquidation Authority generally recognizes the enforceability of setoff rights subject to certain conditions.

6. Qualified Financial Contracts

QFCs include securities contracts, commodity contracts, forward contracts, repurchase agreements, swap agreements and master agreements for any of the foregoing. QFCs receive special treatment under the Liquidation Authority. The FDIC has the option to transfer all, but not less than all, of the QFCs between a covered financial company and a particular counterparty and its affiliates to a single third-party financial institution. If the FDIC exercises this option, the counterparty is not permitted to terminate, accelerate or otherwise exercise its rights to close out the contract solely by virtue of the FDIC's appointment as receiver, the insolvency of the covered financial company or the transfer to the third party or bridge financial company. However, the counterparty may exercise such close-out rights upon the occurrence of another type of default. Furthermore, if the FDIC does not transfer all such QFCs, the counterparty may, after 5:00 p.m. on the business day following the date of the appointment of the FDIC as receiver, terminate, accelerate or otherwise exercise its rights to close out such a contract solely by virtue of such appointment. An otherwise enforceable and perfected security interest that collateralizes a QFC obligation may not be set aside unless the security interest was taken with intent to defraud.

7. Bridge Financial Companies

The Act authorizes the FDIC to establish one or more companies known as a bridge financial company in connection with a receivership. A bridge financial company has the authority to purchase assets and assume liabilities from a covered financial company free of equity interests. A bridge financial company will operate under the management of a board of directors appointed by the FDIC. The FDIC may also make funds available to the bridge financial company for its operations in lieu of capital. The same principles discussed above in regard to the treatment of creditors of a covered financial company apply in connection with the transfer of assets and liabilities to a bridge financial company. A bridge financial company is authorized to obtain unsecured credit, and, subject to certain conditions and procedures, issue secured and senior secured debt. No credit or debt obtained or issued by a bridge financial company may impair the rights of a counterparty to a QFC other than with respect to the priority of any unsecured claim. Bridge financial company status is subject to statutory duration limits.

8. Covered Broker-Dealers and Insurance Companies

Determination of Covered Financial Company Status. If a financial company is a securities broker-dealer or its largest U.S. subsidiary is a securities broker-dealer, the designation as a covered financial company must be recommended by 2/3 of the Commissioners of the SEC and 2/3 of the Governors of the FRB, and the FDIC must be consulted. If the financial company is an insurance company or its largest U.S. subsidiary is an insurance company, the designation must be approved by the Director of the FIO and 2/3 of the Governors of the FRB, and the FDIC must be consulted.

SIPC As Trustee. In the case of a covered financial company that is an SEC-registered broker-dealer and a member of the Securities Investor Protection Corporation ("SIPC"), the FDIC must appoint SIPC as trustee for the liquidation of the covered broker-dealer under the Securities Investor Protection Act ("SIPA"). However, the FDIC will have control over the orderly liquidation of any assets or liabilities transferred to a bridge financial company. Counterparty rights on QFCs with the covered broker-dealer will be governed by the Liquidation Authority and not by SIPA.

SIPC's Powers and Duties. Except as provided in the Liquidation Authority, SIPC would have the same powers and duties with respect to a covered broker-dealer that it would otherwise have under SIPA. SIPC would not be permitted to exercise its powers under SIPA in a manner that impedes or impairs the FDIC's major powers and objectives under the Liquidation Authority.

Satisfaction of Customer Claims. SIPC, the FDIC or the bridge financial company, as applicable, is required to promptly discharge all obligations of a covered broker-dealer or any bridge financial company to customers in the same manner as in a proceeding under SIPA. SIPC is required to pay all other types of claims in accordance with the priority rules under the Liquidation Authority.

Insurance Companies. The liquidation or rehabilitation of any insurance company that itself is, or is the subsidiary of, a covered financial company would be carried out by the appropriate state regulator under applicable state law, rather than the FDIC under the Liquidation Authority, unless such regulator fails to do so in a timely manner.

9. Orderly Liquidation Fund

The FDIC may borrow funds from the Treasury's Orderly Liquidation Fund to carry out its mission under the Liquidation Authority. The FDIC may fund the costs of resolving a covered financial company by issuing limited amounts of debt securities to the Treasury. The FDIC is required to repay its borrowings from Treasury by, if necessary, imposing assessments as follows: (a) as soon as practicable on any claimant that received payments that exceed the minimum amounts described above, subject to certain exceptions; (b) if such amounts are insufficient, on eligible financial companies and other financial companies with total consolidated assets of $50 billion or more.

In imposing any assessments on eligible financial companies and other large financial companies, the FDIC must use a risk matrix as recommended by the Council. The risk matrix shall take into account a number of factors, such as the risk presented by the financial company to U.S. financial stability and the prevailing economic conditions. The FDIC may not use any of its funding as receiver for any covered financial company unless subject to an orderly liquidation plan acceptable to the Treasury Secretary. The Liquidation Authority prohibits taxpayer funds from being used to prevent liquidation of a covered financial firm.

10. Executives and Directors

Directors and executive officers of a covered financial company may be held personally liable for monetary damages in any civil actions by the FDIC with respect to gross negligence or a greater disregard of a duty of care. The FDIC is permitted to recover from senior executives or directors substantially responsible for the failed condition of a covered financial company any compensation received during the two year period prior to the date the FDIC is appointed as receiver. In the case of fraud committed by such executive or director, no such time limit will apply. The FRB or the FDIC are permitted to ban a senior executive or director of a covered financial company from participation in the financial industry for a period of time if such executive or director benefited from certain illegal, unsafe, or dishonest acts which contributed to the failure of the company.

C. Volcker Rule and Other Prudential Limitations (Title VI)

1. Volcker Rule

The Act (Section 619) amends the BHC Act to add a new Section 13 to the BHC Act that bars banking organizations from engaging in proprietary trading and sponsoring and investing in hedge funds and private equity funds, except as permitted under certain limited exceptions. This provision has become commonly known as the "Volcker Rule."

(a) Banking Entities Subject to the Volcker Rule's Restrictions

The bar on proprietary trading and sponsoring and investing in private equity funds and hedge funds applies to banking entities. BHC Act § 13(h)(1) defines a "banking entity" as:

  • Any insured depository institution, as defined in Section 3 of the FDIA;
  • Any company that controls an insured depository institution;
  • Any company treated as a bank holding company for purposes of Section 8 of the International Banking Act of 1978, as amended; and
  • Any affiliate or subsidiary of such a company.

Systemically Significant Nonbank Financial Companies are not automatically subject to the bars on proprietary trading and sponsoring and investing in hedge funds and private equity funds (unless such companies are otherwise described in the definition of banking entity). However, BHC Act § 13(f)(4) requires the appropriate Federal banking agencies, the SEC and the CFTC to adopt rules imposing additional capital charges or other restrictions for Systemically Significant Nonbank Financial Companies to address the risks to and conflicts of interests of banking entities addressed by the Volcker rule. BHC Act § 13(h)(1) contains an important exception for companies that control an insured depository institution that "functions solely in a trust or fiduciary capacity" and that meets certain requirements identical to those currently contained in Section 2(c)(2)(D) of the BHC Act.

(b) Definition of Proprietary Trading

BHC Act § 13(h)(4) defines "proprietary trading", when used with respect to a banking entity or Systemically Significant Nonbank Financial Company, as "engaging as principal for the trading account of the banking entity or nonbank financial entity in any transaction 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 such security, derivative, or contract, or any other security or financial instrument that the appropriate Federal banking agencies, the [SEC], and the [CFTC] may, by rule . . . determine." For this purpose, BHC Act § 13(h)(6) defines a "trading account" as any account used for acquiring or taking positions in the securities or instruments referenced in the definition of "proprietary trading" "principally for the purpose of selling in the near term (or otherwise with the intent to resell in order to profit from short term price movements), and any such other accounts as the appropriate Federal banking agencies, the [SEC] and the [CFTC] may by rule...determine."

(c) Exceptions to the Bar on Proprietary Trading and Investment Activities that do not Constitute Proprietary Trading

BHC Act § 13(d) would permit certain types of activities, including the following:

  • The purchase, sale, acquisition or disposition of obligations of the U.S. or any agency thereof and certain government-sponsored entity obligations;
  • The purchase, sale, acquisition or disposition of securities and other instruments referenced in the definition of proprietary trading in connection with underwriting or market making related activities, to the extent that any such activities are designed not to exceed the reasonably expected near term demands of clients, customers or counterparties;
  • Risk mitigating hedging activities;
  • Trading on behalf of customers;

Investments in small business investment companies, community welfare investments of the type permissible for national banks pursuant to Section 24(Eleventh) of the

National Bank Act, and qualified rehabilitation expenditures with respect to a qualified rehabilitated building or certified historic structure;

  • " Certain investments by or on behalf of insurance companies;
  • " Certain trading by foreign companies outside of the United States; and
  • " Other activities permitted by regulation.

(d) Definition of Hedge Fund and Private Equity Fund

BHC Act § 13(h)(2) defines the terms "hedge fund" and "private equity fund" as any issuer that would be an investment company, as defined in the 1940 Act, but for Section 3(c)(1) (not more than 100 investors) or Section 3(c)(7) (qualified purchasers) of the 1940 Act, or such similar funds as the appropriate Federal banking agencies, the SEC and the CFTC designate by regulation.

(e) Definition of to "Sponsor" a Hedge Fund or Private Equity Fund

BHC Act § 13(h)(5) defines the term to "sponsor" a fund as to (i) serve as general partner, managing member or trustee of the fund, (ii) in any manner to select or control (or to have employees, officers or directors or agents who constitute) a majority of the directors, trustees, or management of the fund, or (iii) to share with the fund for corporate, marketing, promotional or other purposes, the same name or a variation of the same name.

(f) Exceptions to the Prohibition on Sponsoring and Investing in Hedge Funds and Private Equity Funds

BHC Act § 13(d) permits certain activities, including the following:

  • The organizing and offering of a private equity or hedge fund in connection with certain fiduciary activities;
  • Investments in certain funds by a foreign company outside of the United States;
  • Making a de minimis investment in a hedge fund or private equity fund that the banking entity organizes and offers; and
  • Other activities permitted by regulation, following a determination that such activities would promote and protect the safety and soundness of the banking entity and the financial stability of the United States.

(g) Other Restrictions or Requirements with Respect to Permitted Activities

A banking entity may only engage in activities excepted from the bar on proprietary trading and sponsoring or investing in hedge funds or private equity funds if otherwise authorized to do so under applicable law. In addition, under BHC Act § 13(d)(1), the appropriate federal banking agencies, the SEC and the CFTC may impose "restrictions or limitations" on permitted activities as they "may determine."

Even if an activity is otherwise permitted under the exceptions described above and authorized under otherwise applicable law, BHC Act § 13(d)(2) would provide that no activity is permissible if (i) it would involve or result in a material conflict of interest (as defined by rulemaking) between the banking entity and its clients, customers or counterparties, (ii) would result in material exposure by the banking entity to "high-risk assets" or "high-risk trading strategies" (these terms are not defined in the Act but are to be defined by regulation); (iii) would pose a threat to the safety and soundness of the banking entity, or (iv) would pose a threat to the financial stability of the United States.

In addition, BHC Act § 13(d)(3) requires the appropriate Federal banking agencies, the SEC and the CFTC to adopt rules imposing additional capital requirements and quantitative limitations, including diversification requirements, regarding the activities permitted under BHC Act § 13 if they determine that such requirements and limitations are appropriate to protect the safety and soundness of banking entities engaged in such activities.

(h) Other Restrictions on Relationships between a Banking Entity or a Nonbank Financial Company Supervised by the Board and a Hedge Fund or Private Equity Fund

BHC Act § 13(f)(1) provides that a banking entity that serves, directly or indirectly, as the investment manager, investment adviser, or sponsor to a hedge fund or private equity fund and its affiliates may not enter into a transaction with any such fund or any hedge fund or private equity fund controlled by such fund that would be a "covered transaction" for purposes of Section 23A of the Federal Reserve Act, applied as if such banking entity or affiliate were a member bank and such fund were an affiliate.

(i) Anti-Evasion

BHC Act § 13(e)(2) provides that whenever an appropriate Federal banking agency, the SEC or the CFTC has reasonable cause to believe that a banking entity or Systemically Significant Nonbank Financial Company supervised by the FRB under the respective agency's jurisdiction has made an investment or engaged in an activity in a manner that functions as an evasion of the requirements of BHC Act § 13 (including through abuse of any permitted activity) or otherwise violates the restrictions under BHC Act § 13, it shall order (after due notice and opportunity for hearing) the banking entity to terminate the activity and, as relevant, dispose of the investment.

(j) Rulemaking Process and Effective Date

The Act establishes (Section 619) a timeline for the appropriate Federal banking agencies to issue rules implementing the prohibitions on proprietary trading and investing in and sponsoring private equity funds and hedge funds, and it provides certain transition periods and extensions for banking entities to conform their activities to these requirements.

By January 21, 2011, the Council must study and make recommendations in implementing the provisions of the Volcker Rule. Within nine months following completion of the study, the appropriate Federal banking agencies, the SEC and the CFTC must consider the findings of the study and adopt implementing regulations.

The prohibitions in new BHC Act Section § 13 will take effect on the earlier of (i) 12 months after issuance of final rules, or (ii) July 21, 2012. Therefore, the effective date will be some time after July 21, 2011, but no later than July 21, 2012. The Act provides for a two year transition period with the possibility of up to three one year extensions, and it provides for a one time five year extension for preexisting commitments to invest in certain illiquid funds.

2. Restrictions on Transactions with Affiliates

The Act makes certain changes (Section 608) to Section 23A of the Federal Reserve Act ("Section 23A"). The changes include: (1) amendments to the definitions of "affiliate" and "covered transaction" that broaden the scope of transactions subject to affiliate transaction restrictions; (2) changes to the collateral requirements for "covered transactions"; and (3) a requirement that the FRB receive input from the OCC or the FDIC before providing exemptions to affiliate transaction requirements. The amendments will be effective one year after the Transfer Date (as defined in Section I.G.1 below).

(a) Amendments to Definitions of "Affiliate" and "Covered Transaction"

The Act (Section 608(a)) amends Section 23A to:

  • Expand the definition of affiliate for purposes of Section 23A to include any "investment fund" to which a member bank or an affiliate is an investment adviser;
  • Provide that a repurchase agreement transaction in which a member bank purchases assets from an affiliate subject to a repurchase agreement is an extension of credit for purposes of Section 23A rather than an asset purchase covered transaction;
  • Include within the definition of covered transaction (1) the acceptance of "other debt obligations" of an affiliate as collateral for a loan or extension of credit, rather than only including acceptance of "securities" of an affiliate as collateral; and (2) securities borrowing and lending transactions with an affiliate to the extent the transaction creates credit exposure of the bank or a subsidiary of the bank to the affiliate.

The Act also includes credit exposure to an affiliate arising out of derivative transactions, as defined in 12 U.S.C. § 84(b) (as amended by the Act), as a covered transaction, and it contains a provision that authorizes the FRB to issue regulations and interpretations addressing the manner in which a "netting agreement" may be taken into account in determining the amount of covered transactions between a bank and its affiliates, including the extent to which netting agreements may be taken into account in determining whether a covered transaction is fully secured for purposes of an exemption from Section 23A for extensions of credit secured by an earmarked, segregated deposit with the bank or secured by obligations of or fully guaranteed as to principal and interest by the United States government. Any interpretation with respect to a specific member bank, subsidiary or affiliate must be issued by the FRB jointly with the appropriate Federal banking agency for such member bank, subsidiary or affiliate. The term "netting agreement" is not defined.

The Act changes the current collateral requirements in Section 23A to require that the appropriate amount of collateral must be maintained "at all times," which means that a bank that has engaged in a covered credit transaction with an affiliate will be required to obtain additional collateral if the value of the collateral securing the transaction has declined below the amount of the transaction.

(b) Exemptive and Rulemaking Authority

The Act (Section 608(a)) eliminates the authority of the FRB to unilaterally grant exemptions from Section 23A by order or regulation. However, the FRB may continue to provide exemptions from Section 23A by regulation if it finds the exemption to be in the public interest and consistent with the purposes of Section 23A, notifies the FDIC of such finding, and the FDIC does not object within 60 days based on a determination that the exemption presents an unacceptable risk to the Deposit Insurance Fund ("DIF"). The Act also authorizes the FDIC, by order, to exempt a transaction of a state nonmember bank, and the FRB, by order, to exempt a transaction of a state member bank, from the requirements of Section 23A if the FDIC and the FRB jointly find the exemption to be in the public interest and consistent with the purposes of Section 23A, and the FDIC finds that the exemption does not present an unacceptable risk to the DIF. Similarly, the OCC will have authority, by order, to exempt a transaction of a national bank from the requirements of Section 23A if the FRB and the OCC jointly find the exemption to be in the public interest and consistent with the purposes of Section 23A, the FDIC receives notice of such finding, and the FDIC does not object within 60 days based on a determination that the exemption presents an unacceptable risk to the DIF. The FRB may only provide exemptions from Section 23B after providing notice to and not receiving an objection from the FDIC.

The Act also addresses exemptive authority for savings associations. This provision amends Section 11 of the HOLA to permit the OCC, by order, to exempt "a transaction of a Federal savings association from the requirements" of Section 11 if the FRB and the OCC jointly find the exemption to be in the public interest and consistent with the purposes of Section 11 of the HOLA, notify the FDIC of such finding, and the FDIC does not object within 60 days based upon a determination that the exemption presents an unacceptable risk to the DIF. The statute grants the FRB and the FDIC similar exemptive authority with respect to state savings associations.

(c) Transactions with Financial Subsidiaries

The Act (Section 609) repeals the exception for covered transactions between a bank and a financial subsidiary from the 10% of capital and surplus limitation applicable to covered transactions between a bank and any one affiliate. The amendment also eliminates the provision that currently allows a bank to exclude retained earnings of a financial subsidiary from the amount of its investment in the financial subsidiary. The amendment takes effect one year from the Transfer Date, except that it "shall apply with respect to any covered transaction between a bank and a subsidiary of the bank . . . that is entered into on or after [July 21, 2010]."

3. Lending Limit Restrictions

(a) National Bank Lending Limits

The Act (Section 610) amends the statute governing lending limits of national banks (12 U.S.C. § 84) by including within the single borrower limitation any credit exposure of a person arising out of a derivative transaction, repurchase agreement, reverse repurchase agreement, securities lending transaction or securities borrowing transaction between a national bank and the person. For this purpose, a "derivative transaction" includes any transaction that is a contract, agreement, swap, warrant, note or option that is based, in whole or in part, on the value of, any interest in, or any quantitative measure or the occurrence of any event relating to, one or more commodities, securities, currencies, interest or other rates, indices, or other assets.

(b) Lending Limits Applicable to Derivatives Transactions

The Act (Section 611) amends Section 18 of the FDIA by prohibiting an insured state bank from engaging in a derivatives transaction (as defined in 12 U.S.C. § 84(b)) unless the law of the state in which the bank is chartered imposes lending limits that take into consideration credit exposure to derivatives transactions.

(c) Lending Limits to Insiders

The Act (Section 614) amends Section 22(h) of the Federal Reserve Act by including within the definition of extension of credit any credit exposure arising out of a derivatives transaction (as defined in 12 U.S.C. § 84(b)), repurchase agreement, reverse repurchase agreement, securities lending transaction or securities borrowing transaction between the member bank and the person. Thus, derivatives, repurchase, and securities lending and borrowing transactions between a bank and insiders and related interests of the bank and its affiliates will be subject to the requirements applicable to extensions of credit to insiders (including prior approval requirements for transactions exceeding certain amounts and the market terms requirement).

4. Asset Purchases from Insiders

The Act (Section 615) amends Section 18 of the FDIA by adding a new section that prohibits an insured depository institution from purchasing an asset from or selling an asset to an executive officer, director or principal shareholder of the insured depository institution or any related interest of such person (as such terms are defined for purposes of Section 22(h) of the Federal Reserve Act) unless: (i) the transaction is on market terms, and (ii) if the transaction represents more than 10% of the capital stock and surplus of the insured depository institution, it has been approved in advance by a majority of directors who do not have an interest in the transaction.

D. Strengthened Capital Standards

1. Leverage and Risk-Based Capital Requirements

Pursuant to Section 171 ("Section 171") of the Act, often referred to as the Collins Amendment, the leverage and risk-based capital standards currently applicable to U.S. insured depository institutions will, going forward, serve as a floor for the capital requirements for such insured depository institutions as well as depository institution holding companies and Systemically Significant Nonbank Financial Companies.

More specifically, the appropriate Federal banking agencies are required to establish minimum leverage capital and risk-based capital requirements on a consolidated basis for insured depository institutions, depository institution holding companies, and Systemically Significant Nonbank Financial Companies that shall not be less than the "generally applicable leverage capital requirements" and "generally applicable risk-based capital requirements," nor quantitatively lower than the generally applicable leverage capital requirements and generally applicable risk-based capital requirements that were in effect as of July 21, 2010 for insured depository institutions.

The Act defines "generally applicable leverage capital requirements" and "generally applicable risk-based capital requirements" to mean the minimum ratios of Tier 1 capital to average total assets and the risk-based capital requirements, respectively, established by the appropriate Federal banking agencies to apply to insured depository institutions under the prompt corrective action regulations implementing Section 38 of the FDIA, regardless of total consolidated asset size or foreign financial exposure. Such definitions include the regulatory capital components in the numerator of such capital components, the average total assets or risk-weighted assets, as applicable, in the denominator of such capital requirements, and the required ratio of the numerator to the denominator. This requirement will preclude depository institution holding companies from including trust preferred securities in Tier 1 capital.

The Act further provides (Section 171) that investments in financial subsidiaries that are required to be deducted from regulatory capital under the National Bank Act and the FDIA do not need to be deducted from regulatory capital by depository institution holding companies or Systemically Significant Nonbank Financial Companies, unless such capital deduction is required by the FRB or the primary financial regulatory agency in the case of a Systemically Significant Nonbank Financial Company.

Required regulatory capital deductions (i.e., the exclusion of applicable hybrid securities from Tier 1 capital) and certain other requirements of Section 171 are subject to various transition periods and grandfathering exemptions. For example, depository institution holding companies with total consolidated assets of less than $15 billion as of December 31, 2009, and organizations that were mutual holding companies on May 19, 2010, are not required to make any regulatory capital deductions for debt or equity instruments issued before May 19, 2010. Any regulatory capital deductions by other depository institution holding companies or by Systemically Significant Nonbank Financial Companies for debt or equity instruments issued before May 19, 2010 will be phased in incrementally over a three year period, beginning on January 1, 2013.

With respect to debt or equity instruments issued on or after May 19, 2010, all depository institution holding companies and Systemically Significant Nonbank Financial Companies are required to make regulatory capital deductions effective as of May 19, 2010. However, debt or equity instruments issued to the U.S. Federal government or any agency thereof pursuant to the Emergency Economic Stabilization Act of 2008 before October 4, 2010 are exempt from this requirement.

For thrift holding companies, Section 171 will not be effective until July 21, 2015, subject to the phase-in period discussed above for regulatory capital deductions for debt or equity instruments issued before May 19, 2010. In addition, for U.S. bank holding company subsidiaries of foreign banking organizations that have relied on the FRB's Supervision and Regulation Letter SR-01-1, the leverage capital and risk-based capital requirements and the requirements of Section 171 for debt or equity issued before May 19, 2010 will not be effective until July 21, 2015. Small bank holding companies that are subject to the FRB's Small Bank Holding Company Policy Statement are also exempt from the requirements of Section 171.

In addition to the above requirements, Section 171 requires the Federal banking agencies, subject to the recommendations of the Council, to develop capital requirements applicable to insured depository institutions, depository institution holding companies and Systemically Significant Nonbank Financial Companies that address the risks that the activities of such institutions pose both to the institution engaging in the activity and to other public and private stakeholders – including, but not limited to, risks arising from: (i) significant volumes of activity in derivatives, securitized products, financial guarantees, securities borrowing and lending transactions, and repurchase and reverse repurchase agreements; (ii) concentrations in assets for which the values presented in financial reports are based on models rather than historical cost or prices derived from deep and liquid markets; and (iii) concentrations in market share for any activity that would substantially disrupt financial markets if the institution is forced to unexpectedly cease the activity.

2. Requirements for Financial Holding Company Status

The Act also provides (Section 606) that, effective as of the Transfer Date, a bank holding company must be "well capitalized" and "well managed" in order to make an election to become and maintain its qualification as a financial holding company and engage in certain financial and other activities permissible for financial holding companies under Section 4(k) of the BHC Act. In addition, the Act amends the HOLA to provide an additional exemption from its activities limitations that will enable a thrift holding company to conduct the same activities as a financial holding company if it meets the criteria to qualify as a financial holding company and conducts such activities in accordance with the same conditions and requirements applicable to financial holding companies.

3. Additional Changes to Capital Requirements

The Act further provides (Section 616) that the appropriate Federal banking agencies must seek to make capital requirements for insured depository institutions and bank and thrift holding companies countercyclical so that the amount of capital required increases in times of economic expansion and decreases in times of economic contraction, consistent with the safety and soundness of such institutions.

In addition, the appropriate Federal banking agencies must require bank holding companies and savings and loan holding companies, and any company that directly or indirectly controls an insured depository institution that is not a subsidiary of a bank holding company or savings and loan holding company, to serve as a "source of financial strength" for any depository institution subsidiaries.

As discussed above, Systemically Significant Financial Companies will be subject to heightened and broadened prudential standards, which standards may include risk-based capital requirements, liquidity requirements and a contingent capital requirement, and that the computation of capital for purposes of meeting any such capital requirements must take into account any off-balance sheet activities of such Systemically Significant Financial Company.

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