Tuesday, July 21, 2015

SEC Staff Updates Guidance Under the Volcker Rule

By Jacquelyn Lumb

The SEC’s Divisions of Trading and Markets, Investment Management, and Corporation Finance have updated their responses to frequently asked questions about the Volcker Rule to address the seeding period treatment for registered investment companies (RICs) and foreign public funds (FPFs). Section 13 of the Bank Holding Company Act, known as the Volcker Rule, was added by the Dodd-Frank Act and generally prohibits banking entities from engaging in proprietary trading or from acquiring or owning an interest in a hedge fund or a private equity fund, subject to certain exemptions.

RICs and FPFs. RICs and FPFs are not covered funds under the rule implementing Section 13, but a banking entity may own a significant portion of the shares of an RIC or an FPF during a period in which it tests the fund’s investment strategy, establishes a track record of the fund’s performance for marketing purposes, and attempts to distribute the fund’s shares, known as the seeding period.

Seeding period. The staff said that it would not advise its fellow regulatory agencies to treat an RIC or an FPF as a banking entity solely on the basis that either one is established with a limited seeding period, absent evidence that either was being used to evade Section 13 of the Bank Holding Company Act and the implementing rules. The agencies recognize that the seeding period may take time. Three years is the maximum period of time expressly permitted for seeding a covered fund under the implementing rules.

The staff said the seeding period generally would be measured from the date on which the investment adviser or similar entity begins making investments in accordance with the fund’s written investment strategy. Accordingly, the staff would not advise the banking agencies to treat an RIC or an FPF as a banking entity solely on the basis of the level of ownership of the RIC or the FPF during a seeding period, or to expect an application to be submitted to the Federal Reserve Board to determine the length of the seeding period.

In a footnote to the guidance, the staff notes that the final rule requires a vehicle that is a covered fund (as opposed to an RIC or an FPC) during its seeding period, and that is formed and operated under a written plan to become an RIC, to apply to the Federal Reserve Board for an extension of the one-year seeding period granted to covered funds.

Exclusions. The implementing rule also excludes from the definition of a covered fund an issuer that has elected to be regulated as a business development company under the Investment Company Act and has not withdrawn that election, or that is formed and operated under a written plan to become a business development company and complies with the Investment Company Act requirements. Consistent with the parallel treatment of RICs, FPFs, and SEC-regulated BDCs, the staff would not advise the regulatory agencies to treat an SEC-regulated BDC as a banking entity solely on the basis of the level of ownership of the BDC by a banking entity during the seeding period.

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