In a letter to the SEC and the broader Financial Stability Oversight Council, eighteen Senators provided detailed guidance to regulators to help them effectively implement and enforce the statutory language of the Volcker provisions of the Dodd-Frank Act. Senators Carl Levin and Jeff Merkley, who co-authored the Volcker provisions, were signatories of the letter. Section 619 of Dodd-Frank establishes the basic principle that a bank must not engage in proprietary trading or acquire or retain ownership interests in or sponsor a hedge fund or private equity fund. Section 621 prohibits financial firms from engaging in transactions involving or resulting in material conflicts of interest. According to the Senators, the broad intent of the Volcker provisions is to protect investors and the financial system from the distortion caused by proprietary trading practices and from conflicts of interest that place a firm’s own interests ahead of the interests of its clients
The Senators envision implementing the Volcker provisions by establishing a regulatory structure capable of meaningful enforcement. The Council and the SEC were urged to establish a two-tier, cooperative regulatory structure. At the first tier, regulators should conduct real-time monitoring and enforcement. In the Senators’ view, the SEC and the CFTC are in the best position to take a leadership role in monitoring trading and positions, much like they do for insider trading, position limits, and other trading provisions. The newly-created Office of Financial Research may assist in standardizing the data collection and review efforts. At the second tier, regulators should review firms’ policies and procedures and conduct in-depth portfolio-level examinations. Banking regulators, such as the FDIC and the Federal Reserve Board, are best positioned to conduct these broader reviews of firms. This type of two-tier, cooperative approach would enable regulators to share the implementation burdens and also play to their traditional strengths, reasoned the Senators.
More specifically, the Senators believe that the term “trading account” should cover all types of accounts that may be used to conduct proprietary trading. Also, the extent of permitted activities, particularly market making and risk mitigating hedging, should be strictly and clearly delineated to ensure that high-risk proprietary trading stops, while economically beneficial and risk-reducing activities continue. Capital charges governing these permitted activities should also be vigorous enough to protect the economy and U.S. taxpayers from risks arising from them. In addition, the relationships between covered financial firms and the private funds they manage or sponsor should be carefully circumscribed to prevent those private funds from being used to circumvent the law’s limits.
The SEC and other regulators are urged to meaningfully define the terms “material conflicts of interest” and “high risk” assets and trading strategies so as to safeguard U.S. taxpayers from unfair practices and systemic risk. Moreover, capital charges and quantitative limits for systemically significant hedge funds and other nonbank financial companies should be vigorous so as both to discourage and to reduce the risks and conflicts of interest from proprietary trading at these entities. Importantly, Dodd-Frank’s anti-evasion provisions should be implemented to ensure that the SEC and other regulators have clear authority to prevent abusive and evasive tactics from undermining the Volcker-Merkley-Levin provisions.
The Financial Stability Oversight Council is a collaborative body established as part of the Dodd-Frank Act to monitor and address risks to financial stability. The FSOC, chaired by the Secretary of the Treasury, and including the SEC and CFTC, is authorized to facilitate regulatory coordination, recommend stricter standards, and break up firms that pose a grave threat to financial stability, among other responsibilities. The FSOC is currently requesting comments to inform a study of the implementation of the Volcker-Merkley-Levin provisions of Dodd-Frank, to be completed by January 2011 as required by the Dodd-Frank Act. The SEC is also seeking public comment in aid of its adoption of regulations implementing these provisions.