Publications

---

The Obama Administration has announced two new proposals aimed at placing additional limits on financial institutions.

The reform proposals seek to curb excessive risks that these institutions may incur by imposing limits on their size and new activities. The President’s proposals would:

1. Limit the scope of an institution’s activities. The so-called Volcker Rule would prohibit banks, or financial institutions owning banks, from owning, investing in or sponsoring a hedge fund, private equity fund or proprietary trading operation for its own profit.

2. Limit the size of insured depository institutions. Under the proposal, a cap would be set to limit the market share (of a market, presumably to be defined) that a single financial firm would be allowed to control.

Several factors were noted by the President as support for the Volcker Rule. These factors included the competitive advantage banks operating hedge funds, private equity funds and proprietary trading operations have over non-banks engaged in such activities. Examples of these competitive advantages include the federal safeguards and guarantees – such as deposit insurance and access to lower-cost capital. Banks and their holding companies are able to leverage these advantages to their own profit. The argument continues that, under the current system, financial institutions are able to place the risks associated with such activities on depositors or taxpayers. The proposal is intended to correct this perceived inequity.

The President also voiced concerns that these activities can operate as a direct conflict with the interests of a bank’s customers and US taxpayers. In short, the President has argued that hedge funds, private equity funds and proprietary trading operations are inherently risky activities and that banks and their holding companies engaged in these activities increase the risk level of their entire organization. These risks then conflict with the general expectation of bank customers in a stable and reliable banking system operated in a safe and sound manner to protect their deposits. Of further concern, the President noted that, while losses due to these activities would be sustained by the taxpayers (if a bank failed), the economic benefits of such activities redound to the financial institution’s shareholders.

As proposed, it appears that the maintenance of a hedge fund, private equity fund or proprietary trading operation for the purpose of “serving customers” by a bank or its holding company would not be prohibited. Presumably this reference permits operations that would otherwise be prohibited except to the extent that they are utilized by the bank or its holding company to service existing depository and lending customers. Greater clarity on the exact scope of this exemption is expected. In addition, greater clarity will be needed regarding the ability of financial institutions to engage in proprietary trading with respect to their own permissible security investments.

The President’s second proposal would seek to limit the risks associated with large financial institutions becoming “too big to fail.” The new restriction would limit the ability of large financial firms to engage in further consolidation of the financial markets. It would do so by placing caps on the market share a single institution is permitted to control. Under existing law, federal banking agencies are prohibited from approving an interstate merger of banks if the resulting institution would control 10 percent or more of the total amount of deposits of insured depository institutions in the United States following the consummation of the transaction. The President’s proposal has been couched as a supplement to this existing requirement. No guidance has been provided, however, regarding the category of assets or other liabilities to which the market share cap would apply. Again, further specificity on the operation of these limits is anticipated.

Both proposals would require federal legislation in order to be implemented. House Financial Services Committee Chairman Barney Frank (D-MA) issued a statement in support of the President’s proposal and noted that provisions of the Wall Street Reform and Consumer Protection Act, passed by the House on December 11, “give the regulators the power to do everything the President has proposed.” According to Chairman Frank, the provisions adopted by the House provide regulators with discretionary authority to take actions beyond those proposed by the President and, by implementing them legislatively, would be binding on future administrations. Republican leaders have announced their opposition to the President’s proposals.

We will continue to monitor these developments, including the proposed legislative language once it is available, for insights on the practical consequences of these initiatives, as well as on the expected path to be followed in the US Congress.

If you have questions about the impact of the President’s proposals on your business, we would be pleased to discuss them with you. Please contact:

Rusty Conner 

Richard Coll 

Andrew Eskin 

Jeffrey L. Hare

James Kaplan 

Megan Kraai 

David Krohn 

Michael Reed

Christopher N. Steelman