Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act contains restrictions on financial institutions ability to engage in "proprietary trading" or be associated with a private equity or hedge fund. The Act required the SEC and federal banking regulatory agencies to promulgate final rules implementing the restrictions by October 21, 2011. The agencies were a late, but on November 7, 2011, issued proposed regulations under Section 619.
History. Known as the "Volcker Rule", these restrictions were the brainchild of former (1979-87) Federal Reserve Board Chairman Paul Volker, who argued proprietary trading by insured banks introduced unacceptable risk to the deposit insurance fund. In 1933, the Glass-Steagall Act required a separation of commercial banking from investment banking and brokerage activities. This division remained until 1999.
Proprietary trading is defined as “trading activity” in which a “banking entity” acts as “principal” in order to profit from “near-term” price changes.
While most community banks do not consider themselves to be engaged in proprietary trading in the sense that Wall Street investment banks trade, they do often take short-term positions in government securities as a risk-management tool. Since investments in government securities are exempt form the Volcker Rule, community banks need not change course.
Trust Department Trading. Trading within the trust department as part of its bona fide fiduciary activity is not proprietary, so the Volcker Rule does not prevent short-term strategies from being employed by the bank in its fiduciary capacity, subject to certain conditions.
Compliance Program Required. The proposed regulations require that even banks not engaged in proprietary trading adopt a policy and procedures to prevent it from engaging in restricted activities without first establishing a compliance program. Examiners are likely to begin looking for these policies in 2012.
Final Rules. The Act calls for the final rules to be effective by the earlier of (a) 12 months after the date of the issuance of the final rules, or (b) two years after the date of enactment of the Dodd-Frank Bill (July 21, 2012). There will be a grace period during which financial institutions may divest impermissible assets. That period should end July 21, 2014.