The Commodity Futures Trading Commission, or CFTC, has proposed rules implementing the so-called “Volcker Rule” requirements of Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Section 619 of the Dodd-Frank Act, among other things, generally prohibits two activities of banking entities.

• It prohibits federally insured depository institutions, bank holding companies, and their subsidiaries or affiliates (banking entities) from engaging in short-term proprietary trading of any security, derivative, and certain other financial instruments for a banking entity’s own account, subject to certain exemptions.
• It prohibits owning, sponsoring, or having certain relationships with a hedge fund or private equity fund, subject to certain exemptions.

Section 619 also prohibits banking entities from entering into any transaction or engaging in any activity that would:

• Involve or result in a material conflict of interest,
• Result in a material exposure to high-risk assets or high-risk trading strategies,
• Pose a threat to the safety and soundness of the banking entity, or
• Pose a threat to the financial stability of the United States.

According to the CFTC, its proposal to implement Section 619 is substantively similar to the joint rule proposal issued by the Board of Governors of the Federal Reserve System; OCC, the FDIC and the SEC in October of 2011.

According to CFTC Commissioner Scott O’Malia, quoting Sheila Bair, the former Chairman of the FDIC, and a former Acting Chairman and Commissioner of the CFTC, the proposed rules are aptly described as a “300-page Rube Goldberg contraption of a regulation.”

Commissioner O’Malia believes the proposal is overly complex. Firms must first assess whether they are a regulated banking entity, whether or not they are dealing in covered financial positions, evaluate whether their activities are legitimate market-making, underwriting, or hedging (which is different than hedging under the Commodity Exchange Act) and finally determine whether or not the asset is an acceptable interest. Once these parameters are defined, the regulated entity must establish a compliance program, which depending on their book of business, will be tiered accordingly.

Commissioner O’Malia stated that upon reviewing the proposal’s discussion of the compliance metrics, he couldn’t help but notice the number of questions inquiring whether or not these were the correct metrics. He said if he didn’t  know better, he would say even the CFTC has reservations about these metrics.

Commissioner O’Malia also noted that after publishing 300 pages of preamble and rule text, one would expect the CFTC to have a very clear regulatory mandate and enforcement responsibility, but that isn’t the case. Broadly speaking, Commissioner O’Malia stated it is unclear what role the CFTC has in enforcing the gamut of rules that will ultimately comprise the Volcker Rule.

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