United States: Observation 1.1.1 On The Volcker Rule: Community Banks – Compliance

Last Updated: January 13 2014
Article by Frank A. Mayer, III and Jonathan L. Levin

On December 10, 2013, the federal banking agencies jointly issued final regulations to implement the "Volcker Rule," added to the Bank Holding Company Act by Section 619 of the Dodd-Frank Act, to prohibit banking entities and nonbank financial companies from engaging in proprietary trading and severely restrict investments in covered funds. As we noted in the first Pepper Point in Observation 1.1 on the Volcker Rule: Community Banks – Size Does Matter, the regulations appear to treat banking entities holding collateral debt obligations (CDOs) backed by trust preferred securities (TruPS) as owning "covered funds," which they must divest. This result was a surprise to the community banking community. When Congress enacted the Administrative Procedure Act and the Regulatory Flexibility Act, among the policy goals was elimination of surprises.

Did the Federal Banking Agencies Comply with the Regulatory Flexibility Act?

The Regulatory Flexibility Act (RFA) applies to rules published in the Federal Register pursuant to 5 USC 553(b) or any other law for which the agency provides notice and opportunity for public comment. Agency means an agency as defined in 5 USC 551(1). While there are exemptions1 and emergency rules,2 they should be inapplicable to the Volcker rulemaking process.

The RFA requires agencies to consider the economic impact of actions on small entities when promulgating regulations. The RFA was enacted because Congress was concerned about regulations that were unduly burdensome for small entities since regulations can adversely affect competition, discourage innovation and entrepreneurship, restrict improvements in productivity, and require small entities to comply with regulations that eradicate problems not caused by them.

Did Community Banks Cause the Great Recession?

The major goals of the RFA are to: (i) increase agency awareness and understanding of the impact of their regulations on small entities; (ii) require that agencies communicate and explain their findings to the public; (iii) encourage agencies to use flexibility and to provide regulatory relief to small entities; and (iv) provide a level playing field to allow small entities to compete.

The RFA requires a regulatory flexibility analysis if a rule will have a significant economic impact on a substantial number of small entities. The agency should perform a threshold analysis to determine the economic impact of a proposed rule, and the RFA requires an agency certification to be published in the Federal Register along with an explanation of the factual basis for the certification. An Initial Regulatory Flexibility Analysis (IRFA) provides a description of the nature of the impact; description of reasons action is being considered; statement of objectives and legal basis for the rule; description of the number of small entities to which the proposed rule will apply; description of the projected reporting, recordkeeping, and other compliance requirements; identification of relevant federal rules that may duplicate, overlap, or conflict with the proposed rule; and a description of alternatives.

A Final Regulatory Flexibility Analysis (FRFA), which must be published and cannot be waived, requires: (i) a discussion of the comments received, the alternatives considered and the rationale for the final rule; (ii) a statement of the need for and objectives of the rule; (iii) a summary of the significant issues raised by public comments in response to the IRFA, a summary of the agency's assessment of such issues and a statement of any changes made in the proposed rule as a result of such comments; (iv) a description and an estimate of the number of small businesses to which the rule will apply or an explanation of why no such estimate is available; (v) a description of the projected reporting, recordkeeping and other compliance requirements of the rule; (vi) a description of the steps the agency has taken to minimize the significant economic impacts on small entities consistent with the stated objectives of applicable statutes, including a statement of the factual, policy and legal reasons for selecting the alternative adopted in the final rule, and the reasons for rejecting each of the other significant alternatives; and (vii) a response to any comments filed by the Small Business Administration Chief Counsel for Advocacy in response to a proposed rule and a detailed statement of any changes made in response to the comments.

Have the Federal Banking Agencies Met the Requirements of the RFA?

It appears from the Volcker rulemaking record that the unintended consequence of deeming TruPS as a "covered fund" was not vetted through the RFA process. Because the proposed rule did not fully define certain key terms, the problem did not surface until the final rule laid out specific elements that would cause an ownership interest in TruPS-backed CDOs to be prohibited. There is clear indication that the agencies did not intend this consequence, given that they have consistently advocated for alleviation of the regulatory burden on community banks and expressly found the regulations to have no significant economic impact on smaller banking entities.

If allowed to stand, this unexpected result of the Volcker Rule is potentially calamitous, since many community banks count TruPS-backed CDOs as a significant part of their Tier 1 capital.

In an effort to block enforcement of the regulation, the American Bankers Association (ABA) together with several community banks brought a court action on December 24, 2013, seeking a temporary restraining order (TRO) against the federal banking agencies. On December 27 the agencies issued a joint statement acknowledging their recent awareness of this problem and announced that they are reviewing whether or not to subject these instruments as prohibited investments. The agencies are committed to address the matter by January 17, which is critical in light of the affected banking entities' reporting requirements. In response, the ABA has withdrawn its request for a TRO, though the underlying claim is still pending before the court.

While the current situation3 is undeniably troubling, any future course of action should await the imminent agency response.

We foresee several possible outcomes. Besides reaffirming the current regulatory setup, which we consider highly unlikely, the agencies could choose to exempt TruPS-backed CDOs from the definition of covered funds when such instruments are held by banking entities with less than $15 billion in total assets. That would align the regulations with the Collins Amendment (Section 171) of the Dodd-Frank Act, which allows community banks of that size to continue to count TruPS issued before May 10, 2010 as Tier 1 capital. Alternatively, the agencies might exempt these instruments for banking entities of any size, recognizing that the Collins Amendment will prevent banking entities with more than $15 billion in assets to count TruPS as Tier 1 capital after 2015. The agencies might adopt an even broader exemption covering other types of CDOs. In any event, we expect the real challenge for the agencies to be how to define the limits of any exemption so as to combat abuse while achieving the desired relief.

Pepper Points:

What are the consequences of noncompliance?

As the Volcker Rule currently stands, any community bank that engages in an activity or makes an investment in violation of the Volcker Rule or acts in a manner that functions as an evasion of the Volcker Rule shall, upon discovery, promptly terminate such activity and, as relevant, dispose of the "covered fund."

The Volcker Rule provides the federal banking agencies with authority to take any action permitted by law to enforce compliance, "including directing the banking entity to restrict, limit or terminate any or all activities [under the Volcker Rule] ... and dispose of any investment." Please note that this provision was revised from the proposed rule to remove an opportunity for a "hearing" and it applies to "any and all activities" as opposed to "the activity" that is the subject of a violation (as was the case in the proposed rule). See Preamble to Volcker Rule at pg. 855-856.

The federal banking agencies also note in the Preamble to the Volcker Rule that they may rely on their inherent authorities under otherwise applicable provisions of banking, securities and commodities laws to bring enforcement actions against banking entities, their officers and directors, and other institution-affiliated parties for violations of law. See Preamble to Volcker Rule at pg. 858.

As a compliance reminder, the Volcker Rule currently requires community banking entities with total consolidated assets of $10 billion or less that engage in covered proprietary trading or "covered fund activities" to satisfy the compliance program requirement by including appropriate Volcker Rule-specific references in their existing compliance policies and procedures.

Footnotes

1. Exemptions include rulemakings involving military or foreign affairs functions; matters relating to agency management or personnel; matters relating to management of public property, loans, grants, benefits, or contracts; interpretive rules, general statements of policy, or rules where notice and comment are impracticable, unnecessary, or contrary to public interest.

2. Agency head may waive or delay completion of the Initial Regulatory Flexibility Analysis, if timely compliance is impracticable; but must publish the reasons for finding an emergency.

3. Nearly two dozen Democratic lawmakers, led by Rep. Maxine Waters, D-Calif., the ranking member on the banking panel, are warning that a more limited change is warranted for banks with less than $15 billion in assets, citing a provision in the Dodd-Frank Act that addressed treatment of TruPS for small banks.

"For many small banks, ability to pool via a CDO structure was a prerequisite for issuance of TruPS, and we appreciate that regulators have taken that into account as they review whether they can provide guidance to restructure TruPS CDOs such that banks may be able to continue to hold them," Waters and the other Democrats wrote in a letter Tuesday.

'Consistent with Section 171 of the Dodd-Frank Act, we believe regulators have the authority to exempt banks with less than $15 billion in assets from the requirement to divest of TruPS CDOs, providing important relief to the community banking sector.'

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Frank A. Mayer, III
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

    Disclaimer

    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

    Registration

    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

    Cookies

    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

    Links

    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

    Mail-A-Friend

    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

    Emails

    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

    Security

    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions