Volcker Bans Prop Trading, Permits Utter Confusion

NEW YORK ( TheStreet) -- Federal regulators on Tuesday released proposed rules to implement the "Volcker Rule," but failed to define the short-term "proprietary trading" from which banks would be banned; a main objective of the regulation.

A draft of the proposed rule was leaked last week.

As part of the Dodd-Frank Wall Street Reform and Consumer Protection Act -- signed into law by President Obama last July -- the Volcker Rule prohibits bank holding companies from engaging in most forms of proprietary trading while severely limiting banks' investments in private equity funds and hedge funds. The rule was proposed by the president and supported by former Federal Reserve Chairman Paul Volcker and the "exemptions" to the short-term trading ban will be the scene of a major battle between the large banks, the regulators, and members of Congress.
Paul Volcker

Investment banks Goldman Sachs ( symbol) and Morgan Stanley ( symbol) and the "big four" bank holding companies, including Bank of America ( symbol), JPMorgan Chase ( symbol), Wells Fargo ( symbol) and Citigroup ( symbol) are facing major changes as the work to understand the rules, eliminate most proprietary trading, and put complicated compliance systems in place.

The proposed rules have been jointly proposed by the U.S. Treasury Department, the Federal Reserve, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp.

One major change from the leaked draft was that the regulators extended the public comment period to Jan. 13 from Dec. 16. Kevin L. Petrasic -- a partner in the Paul Hastings Global Banking practice in the firm's Washington, D.C. office - said that a "full 90-day comment period is an important indication that the agencies are taking this quite seriously and giving the industry and the public an opportunity to digest the proposal."

While the draft proposal outlines plenty of "exemptions" from the Volcker Rule's ban on short-term proprietary trading by banks, the regulators steered clear from providing a clear definition of what "short term" actually means.

According to Petrasic, this means that the regulators have been purposely vague, so that "near term and short term can be as long or short as they care to make it, depending on the circumstances."

During the comment period, "there will be a desire for as much of a bright line as possible," he said.

Petrasic went on to say that at this point, "everybody's focused on proprietary trading," since the Volcker Rule's ban on private equity and hedge fund investments, with certain exceptions, is much easier to understand.

"The proposal represents the agencies' understanding that daylight is needed for banks to be able to understand what the requirements are. At this point the regulators recognize that they are driving through fog," he said.

Frank A. Mayer, III -- a partner in the Financial Services Practice Group of Pepper Hamilton LLP - said that the lengthening of the comment period and the "350 questions" asked by regulators in the prosed rules mean that "the regulators are having difficulty defining precisely in their rule making what is impactful to safety and soundness of insured depository institutions" regarding "mitigation hedging activities for customers and the financial institution."

"I predict this will end up being a compliance issue at the institutional level with roughly hewn safe harbors," he said.

-- Written by Philip van Doorn in Jupiter, Fla.

To contact the writer, click here: Philip van Doorn.

To follow the writer on Twitter, go to http://twitter.com/PhilipvanDoorn.
Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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