This article was printed on April 5, 2011 in Complinet (Reuters). It is reprinted here with permission.

 A factor that the FRB may consider that should be of particular interest for banking entities that may engage in activities that could be subject to the Rule is the date that the banking entity's contractual obligation to make or retain an investment in a fund was incurred and when it expires. It may be unlikely that banking entities that engage in activities subject to the Rule after the passage of the Dodd-Frank Act would receive extensions from the FRB, since the investments would be made numerous months after passage on July 21, 2010. As such, entities that are considering engaging in activities subject to the Rule should ensure that they develop a plan to unwind such an activity to be in compliance within the conformance period without needing an extension from the FRB.

The FRB may also consider the additional factors listed below:

  • market conditions
  • the nature of the activity or investment
  • contractual terms governing the banking entity's interest in a fund
  • the degree of control held by the banking entity over investment decisions of a fund
  • the types of assets held by a fund, including whether any assets that were illiquid when first acquired have become liquid
  • the date on which a fund is expected to wind up its activities and liquidate
  • 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 divesting or disposing of the activity or investment
  • whether the divesture or conformance of the activity or investment would involve or result in a material conflict of interest between the banking entity and unaffiliated clients, customers or counterparties to which it owes a duty
  • the banking entity's prior efforts to divest or conform the activity, and
  • any other factor that the FRB believes appropriate.

Entities that may consider a request for an extended conformance period should carefully review and analyze all of the factors that the FRB will review. It is critical for an entity to understand the factors and anticipate possible FRB reactions to requests so it can adequately plan investment activities going forward, which should include potential strategies to exit an investment without material risk to the institution.

The Rule also contains a provision for extending the transition period for "illiquid funds." The provision permits an entity to request approval from the FRB for an additional extension of up to five years to permit the entity to meet contractual commitments in place as of May 1, 2010, to a hedge fund or private equity fund that qualifies as an "illiquid fund." The final rule requires that an entity's investment in, or relationship with, a hedge fund or private equity fund meet two sets of criteria to qualify for this extended transition period. The first set of criteria focuses on the nature, assets and investment strategy of the fund itself. The second set of criteria focuses on the terms of the entity's investment in the fund.

A company that first becomes a banking entity after July 21, 2010, must come into compliance with the Rule by the later of one of two dates. The first is the date the Rule's prohibitions would otherwise have become effective with respect to the company. The second is two years after the date on which the company first becomes a banking entity. The FRB notes that its final rule does not address definitional or other aspects of the Rule that are subject to separate interagency rulemaking to be conducted under the Dodd-Frank Act. For example, the final rule incorporates without modification the definitions of "hedge fund" and "private equity fund" contained in the Dodd-Frank Act. As such, entities that may fall under the purview of the Rule should monitor interagency rulemaking to fully understand what investments and activities will be restricted once the Rule is effective.