On November 26, the Federal Reserve Board published a proposed rule setting forth a timeframe for compliance with the "Volcker Rule" provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). The proposed rule would, by default, allow two years from the Volcker Rule's effective date for compliance, and allow extensions of such time under certain circumstances, discussed below. Comments on the proposal must be submitted by January 10, 2011. Dodd-Frank directs the Federal Reserve to issue final rules on the transition period by January 21, 2011.

The proposal is available at:


What the Volcker Rule does

Section 619 of Dodd-Frank, commonly known as the Volcker Rule, generally prohibits banking entities1 from engaging in proprietary trading2 in securities, derivatives, or certain other financial instruments, and from investing in, sponsoring, or having certain relationships with a hedge fund or private equity fund3. (The statute also provides for a number of exceptions to that general rule.) The Volcker Rule will also restrict transactions between a banking entity and a hedge fund or private equity fund for which it serves, directly or indirectly, as the investment manager, investment adviser, or sponsor. Nonbank financial institutions that fall under Federal Reserve supervision – such as those that are deemed "systemically important" – also will have restrictions on proprietary trading and hedge fund and private equity investments, and will be subject to additional capital requirements to be determined by the Federal Reserve.

These substantive restrictions of the Volcker Rule become effective 12 months after final regulations are issued or on July 21, 2012, whichever comes first.

What you need to know

While the Federal Reserve Board's proposed rule sets a timeframe for compliance, it does not address the substantive aspects of how to actually comply with the Volcker Rule. Those aspects will be addressed in future Volcker Rule rulemakings involving not only the Federal Reserve, but the other federal banking agencies, the Commodity Futures Trading Commission, and the Securities and Exchange Commission. No such rules have yet been proposed. Indeed, it is clear from public comments made by federal banking agency staff that, as yet, even they are not certain what it will take to comply with many aspects of the Volker Rule.

The proposed transition period

The Federal Reserve's proposed rule states that, generally, a banking entity would be required to comply with the Volcker Rule's provisions no later than two years after the effective date4. A nonbank financial company that becomes subject to supervision of the Federal Reserve would be required to comply with the Volker Rule no later than two years after the date the company became a nonbank financial company supervised by the Federal Reserve.

Additionally, under the proposed rule, the banking entity or nonbank financial company may request up to three one-year extensions of the general conformance period.

Banking entities would also be allowed to request one extension of up to five years to divest certain ownership interests in a hedge fund or private equity fund that qualifies as an "illiquid fund"5 under the statute and proposed rule and where the extension is necessary to fulfill a contractual obligation of the banking entity that was in effect on May 1, 2010. The extension would terminate automatically upon expiration of the contractual obligation, whether or not five years had yet passed.

The proposed rule also lists the following criteria that the Federal Reserve may use in considering requests for extensions of time:

  • Whether the activity or investment:
    • involves or results in material conflicts of interest between the banking entity and its clients, customers or counterparties
    • would result, directly or indirectly, in a material exposure by the banking entity to high-risk assets or high-risk trading strategies
    • would pose a threat to the safety and soundness of the banking entity
    • would pose a threat to the financial stability of the United States
  • Market conditions
  • The nature of the activity or investment
  • The date that the banking entity's contractual obligation to make or retain an investment in the fund was incurred and when such obligation expires
  • The contractual terms governing the banking entity's interest in the fund
  • The degree of control held by the banking entity over investment decisions of the fund
  • The types of assets held by the fund
  • The date on which the fund is expected to wind up its activities and liquidate, or the date on which its investments may be redeemed or sold
  • The total exposure of the banking entity to the activity or investment and the risks that disposing of, or maintaining, the investment or activity may pose to the banking entity or the financial stability of the United States
  • The cost to the banking entity of disposing of the activity or investment within the applicable period
  • Any other factor that the Federal Reserve believes appropriate.