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EXAMINING THE IMPACT OF THE VOLCKER RULE 

ON MARKETS, BUSINESSES, INVESTORS 

AND JOB CREATION, PART II 

HEARING 

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

DECEMBER 13, 2012 

Printed for the use of the Committee on Financial Services 

Serial No. 112–164 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

SPENCER BACHUS, Alabama, Chairman 

JEB HENSARLING, Texas, Vice Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

NAN A. S. HAYWORTH, New York 

JAMES B. RENACCI, Ohio 

ROBERT HURT, Virginia 

ROBERT J. DOLD, Illinois 

DAVID SCHWEIKERT, Arizona 

MICHAEL G. GRIMM, New York 

FRANCISCO ‘‘QUICO’’ CANSECO, Texas 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

FRANK C. GUINTA, New Hampshire 

BARNEY FRANK, Massachusetts, Ranking 

Member 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

ANDRE ́ CARSON, Indiana 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

JAMES H. CLINGER, Staff Director and Chief Counsel 

(III) 

C O N T E N T S 

Page 

Hearing held on: 

December 13, 2012 ........................................................................................... 1 

Appendix: 

December 13, 2012 ........................................................................................... 45 

WITNESSES 

THURSDAY, DECEMBER 13, 2012 

Barth, James R., Lowder Eminent Scholar in Finance, Auburn University; 

Senior Finance Fellow, Milken Institute; and Fellow, Wharton Financial 

Institutions Center ............................................................................................... 9 

Hambrecht, William R., Chairman, WR Hambrecht + Co. .................................. 11 

Kelleher, Dennis M., President and Chief Executive Officer, Better Markets, 

Inc. ......................................................................................................................... 13 

Plunkett, Jeffrey, General Counsel and Executive Vice President, Natixis 

Global Asset Management, on behalf of the Association of Institutional 

INVESTORS ......................................................................................................... 15 

Quaadman, Thomas, Vice President, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce ....................................................................... 16 

Stevens, Paul Schott, President and Chief Executive Officer, the Investment 

Company Institute (ICI) ...................................................................................... 18 

APPENDIX 

Prepared statements: 

King, Hon. Peter ............................................................................................... 46 

Barth, James R. ................................................................................................ 47 

Hambrecht, William R. .................................................................................... 55 

Kelleher, Dennis M. .......................................................................................... 62 

Plunkett, Jeffrey ............................................................................................... 81 

Quaadman, Thomas ......................................................................................... 125 

Stevens, Paul Schott ........................................................................................ 137 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Frank, Hon. Barney: 

BreakingNews article entitled, ‘‘Too big to fail looks on its way to being 

licked,’’ dated December 13, 2012 ................................................................ 161 

Hayworth, Hon. Nan: 

Written statement of the American Council of Life Insurers (ACLI) .......... 162 

Written statement of BBVA Compass ............................................................ 165 

Written statement of the Bond Dealers of America (BDA) ........................... 172 

Written statement of the Institute of International Bankers (IIB) .............. 177 

Miller, Hon. Brad: 

Public Citizen report entitled, ‘‘Business as Usual,’’ dated December 2012 180 

(1) 

EXAMINING THE IMPACT OF 

THE VOLCKER RULE ON MARKETS, 

BUSINESSES, INVESTORS AND 

JOB CREATION, PART II 

Thursday, December 13, 2012 

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The committee met, pursuant to notice, at 9:01 a.m., in room 

2128, Rayburn House Office Building, Hon. Spencer Bachus [chairman of the committee] presiding. 

Members present: Representatives Bachus, Hensarling, Royce, 

Capito, Garrett, Pearce, Posey, Fitzpatrick, Luetkemeyer, 

Huizenga, Duffy, Hayworth, Renacci, Hurt, Dold, Schweikert, 

Canseco, Stivers, Fincher; Frank, Waters, Maloney, Watt, Meeks, 

Capuano, Baca, Lynch, Miller of North Carolina, Green, Cleaver, 

Perlmutter, Himes, and Carney. 

Chairman BACHUS. Good morning. We started this hearing at 9 

a.m., instead of 10 a.m., because we didn’t want votes to interrupt 

what we consider to be a very important hearing. The hearing will 

now come to order. 

As previously agreed with the ranking member, there will be 10 

minutes on each side for the purpose of making opening statements. And without objection, all Members’ written statements will 

be made a part of the record, as well as the witnesses, your entire 

statements will be made a part of the record. 

I recognize myself for 5 minutes for the purpose of making an 

opening statement. This morning, the committee holds its second 

hearing focused exclusively on the Volcker Rule and, specifically, 

its impact on the markets, investors, and job creation. [The first 

hearing was held on January 18, 2012. Serial No. 112–95.] The 

Massachusetts Educational Finance Authority has warned regulators in its comment letter of February 13th that the Volcker Rule 

would increase funding costs for the authority’s bonds, which 

‘‘would be passed along to consumers funding higher education expenses through their loan program.’’ 

In a February 14th comment letter to regulators, the Financial 

Executives International, which represents corporate treasurers of 

both public and private companies, wrote that the Volcker Rule as 

proposed could adversely affect the ability of American businesses 

to grow, create jobs, and contribute to healthy economic recovery. 

Putnam Investments also cautioned regulators in their comment 

letter that the consequences of the Volcker Rule ‘‘may range from 

2 

reduced liquidity in U.S. capital markets in harming their global 

competitiveness to raising the cost of capital to U.S. corporations, 

lowering returns to investors, and curbing the American economy’s 

capacity to grow.’’ 

The Volcker Rule is designed to prevent proprietary trading by 

banks. But no one, not even Paul Volcker himself, argues that proprietary trading was a cost of the financial crisis. The erosion of 

lending standards and the Federal Government’s poorly conceived 

efforts to subsidize mortgage lending caused the financial crisis, 

not proprietary trading. Therefore, the Volcker Rule sticks out as 

an oddly considered afterthought, a solution in search of a problem. 

Even if one attempted to argue that proprietary trading played 

a role in causing the financial crisis, and even if banning proprietary trading would make the financial system safer—propositions, 

by the way, that are simply not supported by the evidence—the 

prospect that regulators have been unable to agree on a single 

version of the Volcker Rule is extremely troubling. 

Competing versions of the Volcker Rule will make it all the more 

difficult for market participants to know what their obligations are 

and how to comply with them, particularly if they find themselves 

subject to conflicting obligations enforced by different regulators. 

The Volcker Rule, or even worse, rules, will not make the financial 

system any safer. But as I said, it will impose significant costs on 

consumers, workers, savers, students, taxpayers, and businesses. 

It will stifle the growth of businesses that operate far from Wall 

Street, and it will hamper the ability of asset managers, pension 

funds, and insurance companies to grow the value of their portfolio 

for millions of individual investors, or retirees. The Volcker Rule is 

a self-inflicted wound that should be repealed. Unfortunately, the 

112th Congress did not do that. Hopefully, the 113th Congress will 

do so. 

I thank all of the witnesses for being here today to offer their 

perspectives, and I look forward to the discussion we will have on 

this important topic. 

At this time, I recognize the ranking member for his opening 

statement. 

Mr. FRANK. Thank you, Mr. Chairman. 

I will yield myself such time as I may consume, because I want 

to consult with my colleagues about their time. I will say that this 

is a very important subject, but not all of the Members are at this 

point in the spirit of full participation in the legislative process. 

That means no disrespect to those who have honored us by coming 

here this morning. 

I want to talk about the Volcker Rule in the context of the broader question of bank regulation. I understand my colleagues on the 

Republican side, this is part of their general approach, that very 

little needs to be done after the financial crisis of 2008 and 2009, 

and I am particularly struck by what seems to be great inconsistency. Many of the Republicans, some of the critics of our legislation, have complained that we didn’t do anything about the too-bigto-fail doctrine, quite contrary to the written language. And some 

have said, well, maybe the banks are too big. The argument is, as 

long as they are as big as they are, probably too-big-to-fail is inevitable. One of the things that has been proposed that I believe will 

3 

go into effect to reduce the size of the banks is the Volcker Rule, 

and it does it, I believe, in a thoughtful way. 

It reduces them not by some arbitrary order by the government 

to sell things off, not to create a fire sale of financial assets, which 

I think would be the result of some of the demands that they simply reduce; it does so in a functional way. 

Now, I do want to address the notion that this will put us at a 

competitive disadvantage. To some extent, my friends in the financial institutions have taken as their model the 14-year-old child of 

divorced parents, who thinks they can play mommy against daddy 

and get a great deal more freedom in their minds. 

When I hear Americans talk about how restrictive the Volcker 

Rule will be, it sounds like what the British are telling the British 

authorities about ring-fencing. In fact, I think there was a good 

deal of coordination and I doubt very much that we are going to 

be far in advance, for instance, of the British or even the EU with 

regard to this kind of separation. It is simply an effort to, as I said, 

play one against the other. It is a functional way to reduce. 

And I want to address this because it is a question I want to ask 

some of my friends when they say that we have not dealt with toobig-to-fail appropriately. The Volcker Rule in context is one of the 

ways to do this. And I was particularly moved to say that by an 

article in Politico yesterday, which is in many ways as close to 100 

percent inaccurate as it is possible linguistically to get. And I believe I have complied with the Rules of the House in saying that. 

For example, it begins—and this is not one of my colleagues—the 

author says, the government’s decision to bail out AIG in 2009— 

wrong by a year and a critical year. In 2009, Barack Obama was 

President. In 2008, when AIG was bailed out, it was bailed out by 

the unilateral decision by the Federal Reserve with the full concurrence of the Bush Administration. It was under Section 13.3 of the 

Federal Reserve Act. 

Mr. Bernanke and Mr. Paulson, I mean no criticism of them; I 

think they behaved very well during this. Many of us on the Democratic side were more supportive of the crisis efforts of President 

Bush and his aides than my Republican colleagues. And it was an 

example of full bipartisanship. I have to say a month before the 

2008 election, the Bush Administration got complete cooperation 

from the Democrats here in dealing with the crisis. But Mr. 

Bernanke and Mr. Paulson came to us and informed us that they 

had decided to advance—Mr. Bernanke did under his statutory authority—$85 billion to AIG. It had nothing to do with TARP. It had 

nothing to do, obviously, with subsequent legislation. It was a decision made by the Federal Reserve. 

And then, I note, some of my Republican colleagues were saying, 

this is an example of a problem with too-big-to-fail and the legislature’s failure to address it. As a matter of fact, the authority under 

which Mr. Bernanke unilaterally gave, lent—because they got the 

money back—$85 billion to AIG has been rescinded. The statutory 

authority, Section 13.3, was repealed. So, in fact, the bailout of 

AIG, that process, was made illegal by the Act; exactly the opposite 

of the suggestion that somehow the Act embodies this. 

The Act goes further and it says that if a financial institution 

gets in trouble, it can be resolved, and there may even be a payVerDate Nov 24 2008 18:57 Apr 26, 2013 Jkt 079694 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 K:\DOCS\79694.TXT TERRI
4 

ment of some of the debts if that is felt necessary—that, by the 

way, suggested to us by Mr. Paulson in particular—but only as 

part of dissolving the institution. And we have this extraordinary 

proposition from some that says if a bank gets into trouble, a very 

large institution—and my colleagues, while they say we haven’t 

done enough about some of this too-big-to-fail, oppose almost everything we propose that would reduce their size and make them less 

of a problem. The Volcker Rule, has, I believe, an operational and 

sensible way to reduce the size by removing some of the functions 

in a way that I think is less disruptive than any other alternative, 

a required sale, et cetera. But what we are told is that if a large 

financial institution gets in trouble, somehow, in some parallel universe, a Secretary of the Treasury would feel political pressure to 

give Federal money to bail them out and keep the institution alive, 

despite the fact that would be a violation of Federal law and despite the fact that politically, it would be exactly the opposite. All 

of the pressure would go the other way. 

Now, obviously, there are still problems with the large institutions. Although I note in an article—I will have to get the article 

and put it in the record—that the investment community is starting to price down what they give the large financial institutions. 

It is from BreakingViews, and I would ask unanimous consent to 

put it into the record. It is entitled, ‘‘Too big to fail looks on its way 

to being licked,’’ and talks about the market finally trying to price 

in the fact that the law clearly states that no large financial institution can receive assistance except as part of its death sentence. 

The final point I would make is about the complexity of—oh, yes, 

there was an article, a complaint in February about the handling 

of some bonds. I believe it will be resolved, but the final point is 

this: When the Volcker Rule was first proposed, many in the financial community asked that it take into account this, that, and the 

other. There has been an effort to try to accommodate this, and 

now that is being used against the people who have listened to 

some of those comments by saying, you make it too complicated. 

I believe it is important that it get done this year. I believe it 

will be. And I think you will see a Volcker Rule that will be adopted uniformly, that will be reasonable, that will not put Americans 

at a competitive disadvantage. And Iwill make a prediction. One of 

the things that frustrates me is that people are able to make all 

kinds of criticisms of all sorts of things, secure in the knowledge 

that 2 and 3 and 4 years later, when the criticisms have been proven to be unfounded, no one will remember what they said. So I 

hope that the media here will not just chronicle what is said, but 

will put it somewhere where you can retrieve it and, in a couple 

of years from now, see how unfounded all of these dire predictions 

have been. 

How much time did I consume, Mr. Chairman? 

Chairman BACHUS. Thank you. 

Mr. FRANK. How much time did I consume? 

Eight minutes? Thank you. 

Chairman BACHUS. Before recognizing the new chairman of the 

full committee, I wanted to say that Chairman Frank and I have 

not always agreed on the issues before the committee, or even before Congress, but I believe at all times we have strived to conduct 

5 

business in a civil manner and to be civil toward one another, and 

I compliment him on that. We try to disagree without being disagreeable. And while we have not always succeeded in that, it has 

not been from the lack of trying. 

I very much enjoyed my association with him both when he was 

chairman and when he was the ranking member. And this is the 

ranking member’s last hearing as a member of this committee, unless we schedule another hearing. 

Mr. FRANK. You were getting people’s hopes up, Mr. Chairman, 

when you said that. 

Chairman BACHUS. But Chairman Frank has served with distinction for 3 decades. And I know all of my colleagues join me in 

wishing Congressman Barney Frank all the best as he moves forward on to other challenges. 

At this time, I would like to give you a round of applause. 

[applause] 

Mr. FRANK. Thank you, Mr. Chairman, and— 

Chairman BACHUS. I recognize you. 

Mr. FRANK. I appreciate that, and I join in your sentiments that 

we have worked together without legitimate profound differences 

becoming personal. 

Let me just take a second and say that one of the things that 

bothers me is this—you never heard the word ‘‘partisan’’ used in 

a group sense. And partisanship is essential to democracy. You 

don’t have self-governance by large numbers of people without political parties. Otherwise, you descend into all kinds of purely personal things. 

The problem with partisanship is not that it exists because there 

are legitimate differences that should be debated. The problem is 

when the differences that are legitimately recognized in a partisan 

alignment become so personally embittering that cooperation is impeded elsewhere. 

And I thank you, Mr. Chairman, because that has never happened under your chairmanship, and I am very pleased that we 

have been able to do that. 

As you said, we have tried to agree without being disagreeable. 

That hasn’t always come naturally to me, but I have worked hard 

at it, and I think that, in the end, that has been the result. So I 

thank you for that consideration, and I look forward to sitting out 

there and watching you guys in the future. 

Chairman BACHUS. Thank you. And this committee has, with the 

good work of both the Minority and the Majority—no matter which 

party was in what position—produced some very good legislation; 

a lot of legislation that has passed by over 400 votes, some of which 

has been adopted into law, and worked very well. We have two 

bills over in the Senate now, the FHA bill and the flood insurance 

bill, both passed by over 400, and I understand that the Senate 

may pass one of our bills today. 

So I applaud Members on both sides. I think this committee sort 

of stood out as being able to work in a bipartisan way through 

some very difficult challenges. At this time, I would like to recognize the new chairman of the committee come January, Mr. Jeb 

Hensarling. 

Mr. HENSARLING. Thank you, Mr. Chairman, and— 

6 

Chairman BACHUS. For 31⁄2 minutes or whatever you want. 

Mr. HENSARLING. I like the ‘‘whatever-you-want’’ part of that. 

With the indulgence of our guests and our witnesses, Mr. Chairman, I wish to add my voice into this moment of respect and admiration. I suppose, selfishly, one day I will be an ex-chairman, and 

I hope somebody chooses to say something nice about me and note 

my passing. 

So today, even though, Mr. Chairman, we may, given the 

progress of the talks in the so-called fiscal cliff, be hanging our 

stockings next to the chimney with care next to our colleagues, or 

celebrating the New Year with them, I sense this is the last hearing of this committee in the 112th Congress. And as the incoming 

chairman of the committee, I would be remiss if I did not note that 

this will be the last hearing for two chairmen who have loomed 

large in this committee’s history: one leaving not only the committee but Congress; and the other one stepping down as chairman. 

First, to ranking member, then Chairman Frank, few have left 

a mark on this committee quite like he has. Few have brought into 

this room and into its proceedings an intellect as keen or a wit as 

clever. I will personally miss our spirited debates, not quite enough 

to ask him to reconsider and stay, but when I think in terms of 

how it is often challenging to say kind things about one in the opposing party. I believe passionately in the ideas that I bring into 

this committee room. And I have the greatest respect and admiration for those who also bring passion and sincerity to their cause 

in their debate, and certainly, Chairman Frank has done that. 

And as a Member of the other party, who has opposed him vigorously for years, as chairman, he always conducted the proceedings 

in this room with fairness and his word was always good. And so 

I know, although we will say goodbye to him today in the Financial 

Services Committee, I sense that his presence will loom large some 

day soon, perhaps over my right shoulder or left shoulder. I am 

sure some competent staffer will one day tell me how these portraits work. And I guess I perhaps look forward to the day where 

I see more of him and have to debate him less. 

Chairman Bachus, you are the epitome of a gentleman. You have 

brought into your style of leadership great kindness, humility, and 

integrity, and particularly those on our side of the aisle, who are 

fond of quoting President Reagan, who said, ‘‘There is no limit to 

what a man can do or where he can go if he doesn’t mind who gets 

the credit.’’ You have also embodied what President Reagan said. 

You have empowered Members. You have led by example, and you 

have taught us all—my 9-year-old son, who takes karate lessons 

back in Dallas, Texas, as part of an oath he recites, he talks about 

character. And he is defining to me, his old man, that character is 

doing the right thing when no one else is watching. And Spencer 

Bachus, our chairman, has character because he has always done 

the right thing. 

Mr. Chairman, we will continue to benefit, fortunately, from your 

wisdom, your counsel, and your leadership, as you soon will take 

your status as chairman emeritus in this committee. So, again, I 

look forward to the day where I have one portrait over one shoulder, the other portrait over the other shoulder, but know someVerDate Nov 24 2008 18:57 Apr 26, 2013 Jkt 079694 PO 00000 Frm 00010 Fmt 6633 Sfmt 6633 K:\DOCS\79694.TXT TERRI
7 

where down the way, you are also there to provide the counsel, wisdom, leadership, and character that you always have. 

And with that, Mr. Chairman, even though the topic at hand is 

terribly important, I will allow other Members to address it in their 

opening statements, and I yield back. 

Chairman BACHUS. Thank you. 

Mrs. Capito? 

Mrs. CAPITO. Thank you, Mr. Chairman. 

I would like to thank you for convening this morning’s hearing, 

and this will be the last time, as we have heard, that my good 

friend Spencer Bachus will be chairing this committee, and I also 

want to thank him. 

And I want to thank the ranking member for his leadership, not 

just in this committee, but in our Nation. He has taken me down 

a few pegs every now and then, so I have enjoyed that—sort of. 

Anyway, I am going to talk about the subject at hand. The majority of the focus on the implementation of the Volcker Rule has 

been on the effect it will have on Wall Street’s ability to conduct 

trading activities. Less attention has been paid to the effect that 

the Volcker Rule could have on Main Street financial institutions 

and the businesses they serve. 

Earlier this year, the Financial Institutions and Consumer Credit Subcommittee held a field hearing in Mr. Renacci’s district, in 

Cleveland, Ohio. One of the witnesses at our hearing was a representative from KeyBank, a regional bank based in Cleveland. 

KeyBank raised significant concerns about the effect compliance 

with the Volcker Rule will have on their ability to meet their client’s liquidity needs. Specifically, their institution is concerned that 

market-making activities and less liquid securities that are demanded by their clients could be construed as proprietary trades. 

Regional banks like KeyBank are serving small- and mid-sized 

businesses across this Nation. If they cannot rely on their local and 

regional financial institutions to provide liquidity, they will not be 

able to help our economy grow. 

We have also heard concerns from the regional banks about the 

substantial cost, both monetary and man-hours, or I will way 

woman-hours, involved just to prove that their market-making activities are not proprietary. These institutions are not the ones engaged in the activities the proponents of the Volcker Rule are seeking to address. 

The regulatory agencies must ensure that the final rule addresses these concerns so small business and regional financial institutions are not adversely affected. 

And I yield back. Thank you. 

Chairman BACHUS. Thank you. 

At this time— 

Mr. FRANK. Thank you, Mr. Chairman. 

I talked longer than normal because people weren’t here, and 

then I offered time to my colleagues, who have really very graciously refused it and yielded it back to me. And I don’t want to 

take up too much of your time, but I did want to address a couple 

more things on the Volcker Rule. 

I understand the difficulty, but I do want to say, in defense of 

the regulators, that they are, to some extent, damned if they do 

8 

and damned if they don’t. If they were to go ahead with a proposal 

generated among themselves, put it out there for comment, and 

then adopt it substantially unchanged, they would be legitimately 

criticized for not listening to the people who had good input. 

When, as they now did, they listen to a very large number of 

comments, and seek to deal with them, and move the rule, then 

people complain that it is taking too long, et cetera. 

I think the amount of time we are talking about is not too long, 

given the importance of this and of doing it right. I also believe 

that the fears that have been expressed, and I understand these, 

but I think they are without basis, that some institutions, because 

of the complexity of this when it is finally done, might inadvertently find itself in trouble; I do not believe we will ever have in this 

country financial regulators so bloodthirsty that they would fall on 

an innocent mistake excessively. In fact, I think it is hard to look 

at the record of enforcement from both parties over all the time 

and find any hanging judges in the midst. 

Clearly, there will be a recognition that this is experimental to 

some extent, that it is new. I am sure, and I will certainly be critical if it isn’t the case, that there will be the kind of forbearance, 

and that, in fact, what the regulators will appropriately do as we 

go forward with this is to say, in some cases, no, that is not what 

you should have done, and there will be no penalty for it, obviously 

exempting cases that were egregious and willful abuse; there will 

be no penalty, but do it differently in the future. 

And as I say again, I would reiterate, there is a complaint, including from some on the Republican side, and many on the Democratic side, in the commentary community that the banks are just 

too big. I challenge people. The Volcker Rule is one way to diminish 

their size. And it diminishes it in a logical and functional way, and 

it is one that is being dealt with by other countries. If you reject 

the Volcker Rule, if there was to be no restriction of this sort and 

you still believe the banks are too big—I read this stuff very diligently up to now. Come January, I am going to forget an awful lot. 

My theme song, taken from the old anti-war days, is, ‘‘ain’t going 

to study derivatives no more.’’ 

But up till now, I have read this, and I have not found any alternative, serious, thoughtful way to reduce the size of the large 

banks. And I believe it is inconsistent logically and bad policy to 

complain that these large financial institutions are too large, to oppose the Volcker Rule and to propose no alternative means of reducing their size. 

And Mr. Chairman, to you and to all of the members of this committee, I am very appreciative for the great and generous tolerance 

of me in all of my facets that we have had, and I am very proud 

to have served here. 

And I just want to close, if I can unanimously ask for another 

30 seconds. In addition to the Members, can I say of the staff on 

both sides, I don’t think the American people understand what a 

great bargain they get in the people who are talented, and dedicated, and creative, and who work for us at a lot less money, with 

harder hours, and not the best working conditions than they could 

get anywhere else. 

9 

And we have alternated. We have been in the Majority and the 

Minority. In the Majority, you get pretty good quarters. All of our 

staffs have been in the Minority, where the quarters are not so hot. 

So I do want to close, as I acknowledge the generosity of my colleagues, to express what I know everybody agrees with, the enormous debt, not just the Members owe our combined staffs, but 

what the American people owe them. 

Thank you, Mr. Chairman. 

Chairman BACHUS. Thank you, and let me just take 15 seconds— 

last night, we had our Republican staff Christmas party that I 

have had every year. We had 86 staffers and former staffers. Several of them who were no longer staffers said, ‘‘I would love to still 

be on the Hill, but I couldn’t turn down an offer,’’ and in almost 

every case, it was for twice as much money. And some of them said, 

‘‘I had children going to college; I just had to do it.’’ But what a 

talented group we have here on both sides, and they work very well 

together. And I know that will continue, or I pray that it will. At 

this time— 

Mr. FRANK. Mr. Chairman, can we get a round of applause for 

the staff? 

Chairman BACHUS. Yes. 

[applause] 

All right, well deserved. At this time, I will introduce the panelists. The first panelist is Professor Jim Barth, who is the Lowder 

Eminent Scholar in Finance at Auburn University and Senior Financial Fellow at the Milken Institute. Some of you may not be familiar with Auburn, but you could consider it either the Yale of the 

South, or the Stanford of the East, I guess. But I went there, so 

that is why I made that remark. It is a very fine school. And Jim, 

it is great to have a friend testifying this morning. 

Mr. William Hambrecht is the founder, chairman, and chief executive officer of WR Hambrecht + Co. And we welcome your attendance. 

Mr. Dennis Kelleher is the president and CEO of Better Markets. 

And we welcome you back to the committee. 

Mr. Jeff Plunkett is the general counsel and executive vice president of Natixis Global Asset Management, testifying on behalf of 

the Association of Institutional INVESTORS; Mr. Thomas 

Quaadman is the vice president of the Center for Capital Market 

Competitiveness at the U.S. Chamber of Commerce; and Mr. Paul 

Stevens is the president and CEO of The Investment Company Institute. 

Welcome, gentlemen. 

At this time, Professor Barth, you can proceed with a 5-minute 

opening statement. 

STATEMENT OF JAMES R. BARTH, LOWDER EMINENT SCHOLAR IN FINANCE, AUBURN UNIVERSITY; SENIOR FINANCE 

FELLOW, MILKEN INSTITUTE; AND FELLOW, WHARTON FINANCIAL INSTITUTIONS CENTER 

Mr. BARTH. Thank you. 

Chairman Bachus, Ranking Member Frank, and members of the 

committee, thank you for the opportunity to testify today on the 

Volcker Rule. My opinions are based on my experience as an acaVerDate Nov 24 2008 18:57 Apr 26, 2013 Jkt 079694 PO 00000 Frm 00013 Fmt 6633 Sfmt 6633 K:\DOCS\79694.TXT TERRI
10 

demic studying financial institutions and markets and as an official 

at bank regulatory agencies. I am now on the faculty of Auburn 

University and previously was on the faculty of George Washington 

University. 

In addition, I have served as Director of the Office of Policy and 

Economic Research, of the Federal Home Loan Bank Board, and 

Chief Economist of the Office of Thrift Supervision. I have also held 

positions as visiting scholar at the Congressional Budget Office, the 

Federal Reserve Bank of Atlanta, the Office of the Comptroller of 

the Currency, and the World Bank. 

In my scholarly research and government service, I have studied 

the performance of hundreds of financial institutions, including the 

causes of distress of many that failed. I believe the Volcker Rule 

is based on an incorrect premise, will be extremely difficult to implement, and, worse, will produce harmful economic effects. 

There is no evidence to support the belief that proprietary trading was the cause of the recent or any other financial crisis. In fact, 

all of the evidence points to the contrary. 

The most recent crisis was triggered by poor lending and underwriting practices in the real estate sector and excessive leverage by 

and insufficient liquidity at banking industries, not by proprietary 

trading by banks. 

The implementation of the Volcker Rule will require regulators 

to distinguish between prohibitive proprietary trading and permissible activities, such as market making, hedging, and underwriting. 

Because these permissible activities sometimes appear similar to 

proprietary trading, it may be virtually impossible for regulators to 

draw a bright line between the prohibited and permissible activities that are not arbitrary. 

To the extent that regulators err on the side of restricting beneficial trading activities or that the regulation deters banks from engaging in some permissible activities, the result will be banks providing less liquidity in the market. This, in turn, will increase the 

bid-ask spread on securities. Issuers will pay higher interest rates 

to raise capital, and investors will pay more to purchase securities 

and receive less when selling them. 

All of these developments harm markets, businesses, investors, 

and job creation. As banks are denied the opportunity to engage in 

profitable trading activities, they may be driven to engage in evermore risky activities in an attempt to provide investors with an acceptable return. The Volcker Rule may, therefore, lead to riskier, 

not less-risky banks. The rule may also place U.S. banks at a competitive disadvantage to banks in other countries. 

In addition, if proprietary trading simply carries on at nonbanks, 

the question then becomes, is the forced migration of proprietary 

trading from banks to nonbanks more likely to increase or decrease 

financial stability? To address this issue, I recently conducted a 

preliminary examination of 22 years of individual trading losses of 

at least $1 billion each. These trading losses were in no way limited to banks or financial services firms; rather, they occurred at 

a range of firms, including banks, investment banks, hedge funds, 

and manufacturing firms. Even a local government authority was 

involved. 

11 

Specifically, for the period of 1990 to 2012, the banks’ losses were 

5 percent of their equity and posed relatively little risk to solvency. 

Investment banks had losses equal to 34 percent of equity. Manufacturing and petrochemical firms, firms that are typically end 

users of derivatives and other financial products, had losses of 48 

percent of equity. Finally, the most risky are hedge funds, which 

experience losses equal to 140 percent of equity. 

These illustrative results suggest that trading appears to be less 

risky when carried out at banks than at nonbanks. The important 

point of this exercise, however, is that one should not focus on trading losses, per se, but on potential trading losses relative to equity 

capital, which reflects a firm’s ability to absorb losses. Excessively 

leveraged firms are clearly less able to absorb trading losses, or 

any losses for that matter. Moreover, some large trading losses did 

occur during the final crisis, but mortgages based on poor lending 

and underwriting quality were largely to blame, rather than the 

trading itself. 

The focus of regulation should, therefore, be on ensuring that 

banking entities have sufficient capital commensurate with risk, 

not on separating some investment banking activities from commercial banking. 

In conclusion, I see very little, if any, upside to the Volcker Rule, 

but substantial cost to markets, businesses, and investors. That the 

rule is well-intentioned, and banks may survive it, is not the issue. 

The issue is whether the benefits exceed the cost. There is no evidence that this is the case, and my reading of the evidence is to 

the contrary. It is therefore difficult to justify such a major organizational change. Thank you very much. 

[The prepared statement of Professor Barth can be found on page 

47 of the appendix.] 

Chairman BACHUS. Mr. Hambrecht? 

STATEMENT OF WILLIAM R. HAMBRECHT, CHAIRMAN, WR 

HAMBRECHT + CO. 

Mr. HAMBRECHT. Thank you, Mr. Chairman. 

I was a member of the Investor’s Working Group, an independent 

task force sponsored by the CFA Institute and the Council of Institutional Investors. It was chaired by two former SEC Chairmen, 

Arthur Levitt, Jr., and William Donaldson. Our report concluded, 

if I may read the quote, ‘‘Proprietary trading creates potentially 

hazardous exposures and conflicts of interest, especially institutions that operate with explicit or implicit government guarantees.’’ 

We came to that conclusion after a lot of debate and a lot of looking at what actually happened. And we thought our charter was, 

first of all, to try and figure out why the six largest banks were 

suddenly in trouble. How did that happen in an environment 

where, for almost 70 years, from the Glass-Steagall Act, there had 

been no crisis of that magnitude, nor had it fallen on the banks? 

There were a lot of trading losses. There were a lot of—we went 

through all different kinds of market cycles, but why did this happen? 

There was a difference of opinion within the committee, and I am 

just giving you my opinion now, because I was designated to be the 

spokesman for this particular issue. And in my mind, the basic 

12 

issue, as it is in almost every major breakdown in the marketplace, 

is one of leverage. If you look at the market for mortgage paper, 

yes, you can say, gee, this was a terrible market. If you look at the 

Shiller-Case index, the real estate market went up about 20 percent in 2004; declined back down to about even; and then in the 

2008–2009 marketplace, declined 20 percent. So it was a major 

move, but the kind of moves in markets that we have had countless 

times. And the thing that really created the crisis, in our opinion, 

was excessive leverage. 

Where did this excessive leverage come from? And the question 

we kept asking the CFOs and the people who ran these companies 

was, hey, what banker in his right mind would lend you $0.97 on 

the dollar against an opaque piece of paper that is hard to understand, that is traded in a market dominated by the guys who create the paper? Who would do that? And frankly, the answer was, 

no one would do that. And the huge leverage, the $700 billion trading position at Lehman Brothers was basically financed with customer deposits in the form of free credit balances, most of them 

from short sales of hedge funds, and also from a repo market; that 

basically you borrow in the evening and you pay it off before the 

market opens up. So there won’t be any real liquidity. 

We focused on, first, how do you create a market that will truly 

reflect price discovery, cannot be dominated by a few people, and 

propping up prices that don’t hold up? And then, second, how do 

you regulate the lending to these trading accounts when there is 

no lending discipline, when they make the decision as to how much 

money that can come because the customer base doesn’t know 

about that? 

We arrived at basically a conclusion that there had to be regulation, that it had to focus on functionality as former Chairman Barney Frank said, but it should also focus on the leverage factor, and 

how do you control that leverage? 

So we came out with a recommendation that it be included in 

whatever regulatory framework would evolve out of this crisis, but 

that it focus, as the Glass-Steagall Act did, on leverage and control 

of leverage, so that when we do hit these inevitable market declines and excesses, the Fed and other people can control the 

amount of leverage that is inherent in the business. 

My statement—I could go through it in great detail, but I will 

say there is some detail on the mechanics of how it works because 

we found that very few people really understood where the money 

came from. Investment banks’ balance sheets are remarkably 

opaque. It is very difficult to understand where the money comes 

from. So I apologize for the technicalities in the paper, but they are 

based on a career of over 50 years in raising capital and dealing 

with traders and dealing with trading departments. And I find 

there are certain characteristics of trading departments and traders that seem to reoccur in every kind of market. 

And the committee and, of course, as many of us did, focused on 

how do you separate, or how do you determine what is a proprietary trade, and what is a trade that is really providing liquidity 

to a customer and adding value in the after market? I can walk 

into a trading department, and take a look at the compensation 

scale, and you can say okay, those are the prop traders and those 

13 

are the agency traders. You can just take a look at the pattern of 

trading, and you can smell it. Basically, people who operate as specialists, with specialists’ responsibilities, will be there to participate 

in the market, normally contrary, against the market, to provide 

some liquidity to avoid some of the excesses. 

The prop traders will almost always go with the trend because 

they are on a profit-and-loss basis. When they see a raft of selling 

orders coming in, they want to get ahead of those orders and be 

short. They don’t want to sit there and buy them. So that is your 

essential problem. And I have no idea how you cure it forever, but 

you sure can’t give them unlimited money. Thank you. 

[The prepared statement of Mr. Hambrecht can be found on page 

55 of the appendix.] 

Chairman BACHUS. Thank you. 

Mr. Kelleher? 

STATEMENT OF DENNIS M. KELLEHER, PRESIDENT AND 

CHIEF EXECUTIVE OFFICER, BETTER MARKETS, INC. 

Mr. KELLEHER. Good morning, Chairman Bachus, Ranking Member Frank, and members of the committee. Thank you for your invitation to Better Markets to testify today. I am the president and 

CEO of Better Markets. It is a nonprofit, nonpartisan organization 

that promotes the public interest in the domestic and global financial markets. It advocates for transparency, oversight, and accountability with the goal of a stronger, safer financial system that is 

less prone to crisis and failure, thereby eliminating or minimizing 

the need for taxpayer-funded bailouts. 

I have detailed my background and what Better Markets does in 

my written testimony. It is also available on our Web site, 

bettermarkets.com, and I won’t repeat that here. 

For those who say that high-risk speculative proprietary trading 

by the handful of too-big-to-fail banks is not a problem, I say look 

at JPMorgan Chase and the so-called London Whale trade, that so 

far has cost the bank more than $6 billion and might cost it as 

much as $9 billion. That doesn’t include the more than $20 billion 

in shareholder market capitalization losses, which are never mentioned. Those billions in losses resulted from a huge speculative 

proprietary trade using federally-insured depositors’ money, which 

was done to generate profits for JPMorgan. JPMorgan bet around $100 billion of federally-insured depositors’ 

money, and remember, JPMorgan and its CEO admitted, including 

right here before this committee, that the risks taken by the traders when they were betting their depositors’ money were done 

without anyone in senior executive, financial, legal, compliance, 

risk, or others even knowing what the risks of the trade were. 

That admission shows that these gigantic banks are not only toobig-to-fail, but they are too-big-to-manage. For those who say that 

the JPMorgan London Whale prop trade had nothing to do with the 

financial crisis, I say, one, it doesn’t matter because the issue is 

eliminating or reducing high-risk, speculative trading that could 

prove lethal to taxpayer-backed banks and require taxpayer bailouts; and two, there are plenty of examples of prop trading in connection with the financial crisis, with Citigroup being the poster 

child and having to write off almost $40 billion just due to the CDO 

14 

positions on its trading book. Because time is short, I won’t go into 

details here, but they are detailed in my written testimony and in 

the four comment letters Better Markets has filed in connection 

with the regulators’ consideration of the Volcker Rule. 

It is important to remember that the Volcker Rule is narrow in 

application and limited in scope. It prohibits the handful of biggest 

too-big-to-fail banks from making huge high-risk, speculative bets 

usually, but not always, with the bank’s own or borrowed money. 

This type of trading is in stark contrast to banks investing and 

trading their customers’ money on their customers’ behalf. 

Proprietary trading by the biggest banks is nothing more than 

gambling. Now big-bank gambling like this would be fine if it only 

threatened the betting bank and if only the bank suffered the consequences of its betting. But that is not the case with high-risk, 

proprietary trading by the biggest too-big-to-fail banks. Those gigantic banks are backed by taxpayers. Their failure threatens our 

financial system and the entire economy, and as a result, the banks 

get the upside of the gambling and taxpayers get the downside, as 

evidenced by the last crisis. And the downside can be enormous. 

Better Markets recently did a study showing that the crisis will 

cost the United States more than $12.8 trillion, and that is a conservative number. Now, banning proprietary trading isn’t the only 

solution, but it is an important part of a solution, along with capital, liquidity, leverage standards, resolution authority, and much 

more. 

Finally, implementing the Volcker Rule, in our view, is not complex or difficult if you follow two keys: Key number one, focus—Bill 

just alluded to this focus on compensation to break the link between proprietary trading and banker bonuses. We detailed it in 

our testimony and in our comment letters. You deconstruct and 

disaggregate the bonus pool, and you will know right where the 

proprietary trading is, both before and after. That is easy for them 

to follow, easy for regulators to follow, and easy to police. 

Second, and most importantly, the law has to be backed up with 

swift, certain, and significant penalties for traders, supervisors, 

and, yes, finally executives. 

If those two keys are followed, implementing the Volcker Rule 

can be done and it can be done without interfering with the permitted activities of market-making, risk-mitigating hedging, and 

the other permissible activities without prop trading. 

As a result, if you do it that way, the ban on prop trading will 

not harm customers, credit or job creators; indeed, removing the 

threat posed by these biggest too-big-to-fail banking giants to our 

financial system and our economy is likely to unleash a renaissance 

in our financial industry, as transparency, competition, and fairness create numerous opportunities for current and new market 

participants. 

And in closing, I would just like to say, as a native of Massachusetts, and one who has had the privilege of watching the career of 

Chairman Frank for, it seems like more than 30 years, but I guess 

it is just 30 years, that I wanted to thank him for his public service. The people of Massachusetts, and the people of the country, I 

think owe him a great debt. 

15 

And Chairman Bachus, I would like to second everything that 

has been said about you as a gracious, smart, tremendous contributor to the mission over the years, in any capacity here, and your 

courtesy has been most appreciated. 

Thank you. 

[The prepared statement of Mr. Kelleher can be found on page 

62 of the appendix.] 

Chairman BACHUS. Thank you, Mr. Kelleher. 

Mr. Plunkett? 

STATEMENT OF JEFFREY PLUNKETT, GENERAL COUNSEL 

AND EXECUTIVE VICE PRESIDENT, NATIXIS GLOBAL ASSET 

MANAGEMENT, ON BEHALF OF THE ASSOCIATION OF INSTITUTIONAL INVESTORS 

Mr. PLUNKETT. Chairman Bachus, Ranking Member Frank, and 

members of the Financial Services Committee, thank you for inviting me to participate in today’s hearing. My name is Jeff Plunkett. 

I am general counsel and executive vice president of Natixis Global 

Asset Management. Today, I am testifying on behalf of the Association of Institutional INVESTORS, an association that includes 

some of the oldest, largest, and most trusted investment managers 

in the United States. Collectively, the association’s members manage pension funds, 401(k) funds, mutual funds, and personal investments on behalf of more than 100 million American workers 

and retirees. 

The association supports the Volcker Rule’s core objective of limiting risky behavior at banks. However, the current proposed rule 

is burdensome and goes beyond congressional intent. This could 

have far-reaching, negative consequences for investors. 

Asset managers and their clients rely on banks to execute trades. 

The regulators’ proposed rule will discourage banks from engaging 

in these transactions, due to compliance costs and uncertainty regarding what is permitted under the rule. In part, this uncertainty 

comes from the rule’s complex, after-the-fact tests for determining 

what is proprietary trading, which do not reflect the realities of financial markets. 

The regulators are doing their best to implement the statute as 

written, however, unless changes are made, there will be significant disruptions to the market. 

The association also includes bank-owned asset managers. We 

believe the covered-fund restrictions could be focused in a manner 

that addresses systemic risk, without creating a competitive disadvantage that would lead to fewer choices for investors and less 

innovation in the marketplace. 

In order to address these concerns, the association has offered 

the committee specific technical corrections. While our written testimony discusses these suggestions in more detail, today I would 

like to touch on several of our main concerns. 

First, with regard to proprietary trading, we support clarification 

that regulators should focus on trading activities that do not have 

any connection to customer facilitation. This change would be consistent with former Federal Reserve Chairman Paul Volcker’s 

statements that proprietary trading should be easy to recognize. 

16 

Second, with regard to the market-making exemption, Congress 

must provide clarification to regulators on the definition of ‘‘near 

term.’’ ‘‘Near term’’ means different things in different markets. 

For certain liquid markets, the near term may be much longer than 

in other markets. The market-making exemption should apply to 

market-making activities in illiquid markets or markets that have 

only episodic liquidity. 

Third, in the covered-fund restrictions, Congress should revise 

and narrow the definition of ‘‘hedge fund’’ and ‘‘private equity fund’’ 

to exclude all registered investment companies, and specifically 

identify the factors that must exist in other pooled vehicles before 

the regulators may designate them as similar funds. 

Foreign funds that are not actively marketed to U.S. investors 

should be excluded from the definition, as should non-U.S. funds, 

which are subject to supervisory regulation in their foreign jurisdictions. 

Finally, Congress should amend the naming prohibition in the 

Volcker Rule, to allow hedge funds and private equity funds to continue to identify themselves as manager of the fund so long as the 

fund does not use the word ‘‘bank’’ or the same name as an insured 

depository institution in the name of the fund. 

This restriction, along with the rule’s existing disclaimers and 

anti-bailout provisions, should ensure that the entities are viewed 

separately in the marketplace. 

Mr. Chairman, a technical corrections bill would provide regulators with a clear statement of congressional intent and would go 

a long way to mitigate the potential unintended consequences that 

will harm millions of Americans who are saving for their retirement. The changes that we lay out in our written testimony would 

ensure that we can continue to serve their needs while still meeting the goals of the Volcker Rule. 

We commend the committee for considering taking such actions 

to address industry concerns, particularly prior to further rulemaking from the financial regulators. Thank you for your time 

today, and I look forward to answering your questions. 

[The prepared statement of Mr. Plunkett can be found on page 

81 of the appendix.] 

Chairman BACHUS. Thank you. 

Mr. Quaadman? 

STATEMENT OF THOMAS QUAADMAN, VICE PRESIDENT, CENTER FOR CAPITAL MARKETS COMPETITIVENESS, U.S. CHAMBER OF COMMERCE 

Mr. QUAADMAN. Thank you, Chairman Bachus, and first, let me 

thank you, Chairman Bachus, and Ranking Member Frank, for 

your leadership and work on this committee and for your service. 

We have enjoyed working with both of you. 

And Mr. Hensarling, and Ms. Waters, as you embark on your 

leadership on the committee, we look forward to working with you 

as well. 

The Chamber agrees with the intent of the Volcker Rule, and 

that is to stabilize the financial system as well as to protect against 

federally-insured deposits. We believe, however, that capital and liVerDate Nov 24 2008 18:57 Apr 26, 2013 Jkt 079694 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 K:\DOCS\79694.TXT TERRI
17 

quidity requirements are a better pro-growth means of achieving 

that goal. 

Congress was right to include a market-making and underwriting exemption to the Volcker Rule. Market making and underwriting are important critical tools for non-financial businesses to 

raise capital. However, regulators are constructing a system to engage in a trade-by-trade analysis to discern the intent of a trade 

and to determine if it is compliant with the Volcker Rule. This will 

raise cost of capital formation for all businesses and, in fact, will 

shut some businesses out of capital markets altogether. 

The Volcker Rule must also be viewed in conjunction with other 

major financial regulatory initiatives, many of which actually converge on the desk of the corporate treasurer. Derivatives rules directly impact the ability of a corporate treasurer to mitigate risk, 

and lock in prices, as well as ensure access of raw materials for a 

corporation. My new market fund initiatives, which are currently 

being discussed, affect the ability of a corporate treasurer to sell 

commercial paper as well as to employ effective cash-management 

techniques. The Volcker Rule impacts the ability of a treasurer to 

enter capital markets as well as raises costs, while Basel III impacts the ability of a corporate treasurer to obtain bank loans, as 

well as tap commercial lines of credit. 

So, one example that a mid-sized corporate treasurer told me is 

that when they go out and sell their commercial paper, their entire 

cost for that sale is 46 basis points. Since they believe that the 

Volcker Rule will prohibit them from entering the commercial 

paper market, they then have to tap their commercial lines of credit, which are prime plus 1 percent or about 425 basis points or a 

tenfold increase in their capital costs. 

However, you have to remember that commercial lines of credit 

on the Basel III have a negative risk weight to them so there is 

a disincentive for banks to actually provide commercial lines of 

credit. Therefore, the only alternative that is open to the corporate 

treasurer is to increase their cash reserves. 

Corporate cash reserves in the United States are currently $2 

trillion, about 14 percent of GDP, which is a historic high number 

here in the United States. If, because of the Volcker Rule, we have 

to morph to a higher European level of cash reserves, that would 

be $3 trillion, or 21 percent of GDP. That means that corporate 

treasurers will have to idle $1 trillion in cash that could otherwise 

be used for more productive economic means. 

So, because of those impacts as well as the complexity of the 

Volcker Rule, we believe that the regulators need to repropose a 

rule to allow all stakeholders the opportunity to view the final rule, 

give regulators informed comments, and avoid adverse unforeseen 

consequences before they occur. 

We also believe that the Bachus-Hensarling initiative to propose 

an extension of the conformance period will also allow regulators 

the time to get it right. At the request of the committee, we provided a letter in September on Volcker Rule alternatives. We believe there are certain legislative alternatives as well as a means 

of fixing the rule itself. 

First off, as I said before, if the Volcker Rule were to be repealed, 

the higher capital and liquidity requirements in Dodd-Frank will 

18 

actually allow regulators to deal with financial institutions which 

choose to engage in proprietary trading if they choose to do so. 

When President Obama first proposed the Volcker Rule in 2010, 

the rule was envisioned to be an international rule that all major 

financial players around the globe would follow. However, other 

players have decided not to go down that route. We believe the legislation introduced by Congressman Peter King, which would stay 

the enforcement of the Volcker Rule until there is international coordination compliance with a similar Volcker Rule policy, is an important means of protecting American competitiveness. 

Finally, we have also listed a number of different specific fixes 

that we think are important to the Volcker Rule, if it is to go forward; namely, that if financial institutions, and by financial institutions, I also mean nonfinancial institutions that may own a bank 

or a financing arm, that if they did not engage in proprietary trading, they should not have to construct a costly, intrusive compliance program; that illiquid issuances in both debt and equity, 

which Congress also recognizes as a problem in passing the JOBS 

Act, should be exempt; that there should be a clear exemption for 

joint ventures to protect American competitiveness abroad. There 

should be an exemption for State and municipal debt issuances, 

which are key means of financing for infrastructure projects. And 

finally, 11 months ago, Governor Trujillo sat in this seat and said 

that regulators did not understand what normal market-making 

and underwriting practices are. 

We believe that there should be a further study of those marketmaking and underwriting practices so that regulators understand 

how non-financial businesses access capital markets and to ensure 

that those businesses are not adversely impacted. Thank you. And 

I’m happy to take any questions you may have. 

[The prepared statement of Mr. Quaadman can be found on page 

125 of the appendix.] 

Chairman BACHUS. Thank you, Mr. Quaadman. 

Mr. Stevens? 

STATEMENT OF PAUL SCHOTT STEVENS, PRESIDENT AND 

CHIEF EXECUTIVE OFFICER, THE INVESTMENT COMPANY 

INSTITUTE (ICI) 

Mr. STEVENS. Thank you, Mr. Chairman. 

For ICI, let me add our own salute to you and to former chairman Barney Frank for your leadership of the committee during a 

period of extraordinary challenges. America’s mutual fund investors owe you both a great debt of gratitude. 

Mr. Hensarling, Ms. Waters, we look forward to working with 

you and all the members of the committee in the 113th Congress. 

I appear today on behalf of the Investment Company Institute. 

We’re the national association of mutual funds, exchange traded 

funds, closed-end funds, and other registered investment companies. Our members, as you know, manage almost $14 trillion on behalf of 90 million American investors. 

Mr. Chairman, by rights, our membership should have few, if 

any, concerns about the Volcker Rule. Congress enacted Section 

619 of the Dodd-Frank Act to restrict banks from engaging in proprietary trading and from sponsoring or investing in hedge funds 

19 

or private equity funds. The Volcker Rule was not directed at the 

Institute’s members, that is, at registered investment companies, 

and yet, unfortunately, the ways in which the five regulatory agencies propose to implement the Volcker Rule would expand the reach 

of Section 619 beyond what Congress intended. This raises a number of serious concerns for registered funds, for our members. 

Chief among the concerns is the fact that the proposed implementing rule could treat many registered funds as hedge funds, a 

result that contradicts the plain language of the statute that Congress passed. The statute restricts bank’s relationships with hedge 

funds, private equity funds, and ‘‘similar funds,’’ as defined by the 

regulators. The statute defines hedge funds and private equity 

funds by reference to the fact that these investment vehicles are 

not registered under the Investment Company Act of 1940, nor regulated under that Act. Clearly, registered funds, which are organized and operated under that Act’s strict requirements, are not remotely similar to the funds Congress intended to cover in the 

Volcker Rule. Yet the definition of ‘‘covered funds’’ offered by the 

agencies would sweep in many registered funds under the rule. 

The same definition would also sweep in all non-U.S. retail 

funds. Even though these non-U.S. retail funds are comprehensively regulated in their home jurisdictions, just as mutual funds 

here are in the United States. And, therefore, are not the type of 

funds that Congress meant to reach. In addition, some U.S.-registered funds and non-U.S. retail funds could be traded under certain circumstances as banking entities, which would anomalously 

subject them to all the prohibitions and restrictions of the Volcker 

Rule itself. 

Implementing the Volcker Rule in this way will impede the organization, sponsorship, and very normal activities of U.S.-registered 

funds and of non-U.S. retail funds alike. And investors will suffer 

as a result. Now, in detailed written submissions and numerous 

meetings, ICI and its international affiliate, ICI Global, have urged 

the agencies to provide explicit exclusions from the Volcker Rule 

for U.S.-registered funds and non-U.S. retail funds, as well as clarification that these funds are not ‘‘banking entities.’’ 

Registered funds also must look at the Volcker Rule and its implementation from our perspective as investors in the capital markets. We do not believe that the proprietary trading restrictions as 

currently proposed will achieve their apparently narrow intended 

goal of addressing risky and speculative trading by banks. Instead, 

they are likely to have broader adverse impacts on the financial 

markets in the United States and abroad, and in the process, will 

penalize registered funds and other investors who participate in 

these markets. 

The proposed trading restrictions could decrease liquidity, especially for those markets that rely most on banking entities to act 

as market makers, such as the fixed-income and derivative markets and the less liquid portions of the equities markets. A reduction of liquidity could ultimately lead to higher costs for funded 

shareholders and for other investors. Similarly, the proprietary 

trading restrictions call into question whether banking entities 

could, for example, continue to serve as authorized participants and 

market makers for exchange traded funds. 

20 

Banks play a critical role in ETF trading to help maintain efficient pricing and to protect ETF investors. We recommend that the 

rule be clarified to spell out that banking entities can continue to 

support the efficient functioning of the ETF market. 

Now, in this and many other areas of our concern, we believe the 

agencies implementing the Volcker Rule have it within their power 

to avoid all of these harmful consequences for funds and their investors. Given the number and seriousness of the issues that need 

to be addressed, however, we have recommended and we continue 

to urge that the agencies issue a revised proposal for public comment before adopting any final rules. 

Further, we are deeply concerned about recent press reports that 

raise the possibility that agencies will adopt final Volcker Rule regulations that substantially differ one from another. This would be 

a true disaster. And it would fly in the face of Congress’ express 

direction that the agencies coordinate their rulemakings. We urge 

that the committee do all that it can to ensure the consistency of 

any final rules issued by the agencies. 

Finally, if the serious adverse consequences for registered funds 

are not addressed through the regulatory process, ICI has suggested potential legislative changes to address several of our concerns. We stand ready to work with the committee and interested 

Members in this regard. 

Mr. Chairman, thank you for the opportunity to present our 

views. I would welcome any of your questions. 

[The prepared statement of Mr. Stevens can be found on page 

137 of the appendix.] 

Chairman BACHUS. Thank you. At this time, we will have questioning by the Members. 

I would like to recognize Mr. Brad Miller, who is retiring. Mr. 

Miller really was a leader in this Congress in highlighting 

subprime lending practices in the early 2000s. And I commend him 

for that. Some of his predictions unfortunately came true. 

At this time—would you like a minute? 

Mr. MILLER OF NORTH CAROLINA. Thank you, Mr. Chairman. I 

have appreciated the chance to serve on this committee for a decade and I have appreciated the relationships, valued the relationships that I have had with other Members, with our staff, and with 

the folks who sit back there, some of you, anyway. The folks who 

sit over there, as well. 

Mr. Chairman, I would like to join in the kind of general spirit 

of this meeting and say nice things about you. But the last time 

I did that, it didn’t work out well. Three or 4 years ago, someone 

who sits over there stopped me in the hallway and said they were 

writing an article about you and asked me to comment. And I said 

nice things. And then a day or two later, the article came out. And 

the lead was that some Republicans did not trust Spencer Bachus 

because he got along too well with Democrats. And the second 

paragraph quoted me, saying how well I got along with you. 

And, Mr. Chairman, in the next several meetings after that, you 

seemed to go out of your way to pick a fight with me about something or another, showing that we really didn’t get along. And I 

wanted you to know that since that time, whenever anybody has 

21 

asked me publicly what I think of you, I have said, ‘‘I don’t like 

that son of a bitch.’’ 

And, Mr. Chairman, I want you to know that I have done that 

as a personal favor to you. 

Chairman BACHUS. Thank you. And, Mr. Miller, it helped me in 

my primary. 

At this time, I would like to recognize Mr. Quico Canseco for 2 

minutes for questions. 

Mr. CANSECO. I, too, want to thank you, Mr. Chairman, for your 

leadership on this committee. It has been a privilege serving on the 

Financial Services Committee, albeit for a short 2 years. It has 

been quite an honor to serve on this committee and regrettably, I 

won’t be here in the next Congress. 

And thank you for the opportunity to ask some questions here. 

Professor Barth, is there even a practical way to distinguish between proprietary trading and market making? 

Mr. BARTH. In answer, I would say that it is going to be extremely difficult. And my concern is that the attempt to do so may 

actually eliminate beneficial trading activities by banking entities. 

The other part of my answer would be that to the extent that 

banks are concerned about whether or not they are indeed engaging in proprietary trading, it may deter them from beneficial trading activities. I think it is extremely difficult to judge the intent of 

banking entities when it comes to proprietary trading. As we all 

know, there is the time factor over which one is going to try to determine whether or not a bank is engaged in proprietary trading 

or speculative trading activities and other legitimate and permissible trading activities. That is my biggest concern. 

Mr. CANSECO. So even if regulators were to somehow make this 

distinction, which is unlikely, as you say, in your opinion, would a 

final regulation make the financial system any safer? 

Mr. BARTH. No. I don’t think there is any evidence whatsoever, 

despite what some people claim, that proprietary trading has or 

will cause those sort of problems. As pointed out in my testimony, 

it turns out it was basically poor underwriting and lending practices relating to the real estate sector that really triggered the crisis and is the major concern. 

And one should not talk about losses per se. Whether or not JPMorgan Chase incurred a loss of $6 billion or $9 billion is not 

the issue. The issue is really whether or not there is sufficient 

owner-contributed equity capital on the part of that bank to cover 

that loss. One can talk, as I did in my testimony, about losses, but 

it is losses relative to equity capital which is the issue, not just big 

numbers to throw out and say there are big losses. Is there sufficient equity at financial institutions to cover those losses? And that 

indeed has been the case, as I point out, I think, in a little more 

detail in my testimony. 

Chairman BACHUS. Thank you. 

At this time, the gentlelady from New York, Ms. Hayworth, is 

recognized for 2 minutes. 

Dr. HAYWORTH. Thank you, Mr. Chairman. And I echo the lavish 

and well-deserved praise that you have received this morning. And 

I know that you are going to continue to illuminate our proceedings 

as you retire to emeritus status. 

22 

And with that, Professor Barth, I couldn’t agree with you more 

about the root causes of the crisis that precipitated the passage of 

Dodd-Frank and this attempt to create barriers that are obviously 

very, very difficult to define. 

Mr. Hambrecht, I was reading your testimony. And you refer, of 

course, to one of the primary problems being unlimited leverage, 

essentially taxpayer-backed, low-cost financing. 

So we are looking at—and you speak of exerting market discipline. Eventually, market discipline did come to bear in a fairly 

catastrophic way, as we know, in 2008, because you can’t repeal 

the laws of gravity, so to speak, you can’t repeal the laws of economic physics. 

What would the most elegant solution to this problem be, given 

what you have said, Professor Barth, and what you have said, Mr. 

Hambrecht? Should we be exerting energy, because there is a cost 

of capital here, there is a cost of effort, should we be exerting all 

this energy on trying to create these barriers or should we go back 

to the root cause and devote our energies to withdrawing the Federal Government from activities that create market risks to begin 

with in unnatural ways? 

Mr. HAMBRECHT. There are a lot of solutions, I am sure, that 

might work. I still think that the key to it will be the recognition 

of what functionality those trades are in. And I maintain you can 

have a reasonable basis of judgment as to what is a proprietary 

trading account and what is a market making. 

To me, the best solution would be to go back to the original margin requirements and approach that Glass-Steagall took. And, basically, what they said is margin is allowed on exchange-based trading, where you have specialists who have obligations to make an 

orderly market. And you have the right to say how much you can 

borrow against that piece of paper. 

So to me, the Glass-Steagall pattern of transparent, open markets and margin requirements that are basically enforced on a realtime basis, so that you are sold out before you can get your other 

parts of your balance sheet in trouble, I think that would be the 

most elegant solution. 

Chairman BACHUS. Thank you. 

Dr. HAYWORTH. Thank you, Mr. Chairman. 

Chairman BACHUS. Mr. Schweikert for 2 minutes. 

Mr. SCHWEIKERT. Thank you, Mr. Chairman. 

First, Mr. Chairman, thank you for your kindness. And also to 

Scott Garrett as my subcommittee chairman. Thank you for tolerating me. My greatest joy I have had in my 2 years here in Congress is this committee, and I am going to miss it. 

Quick question, and I will try not to repeat other ones who have 

come through. 

Mr. Quaadman, you sort of touched on this. I have a great concerned interest in liquidity of fixed-income markets, particularly 

municipal, quasi-municipal debt. A lot of the bigger institutions 

often as good community players will be the ones that step in, either when we have done a defeasance or other things, and player. 

Will that type of concentration start to play in the margins of the 

Volcker Rule? 

23 

Mr. QUAADMAN. In the legislation, there are certain disincentives, actually, for State and municipal debt. So it will be more difficult for State and municipalities to go into capital markets and 

raise bonds in certain instances because they are going to be subject to the Volcker Rule. So that will entail larger costs and, in fact, 

may actually shut them out of certain markets. 

The Conference of Mayors actually passed a resolution on this 

several months ago highlighting those concerns and asking that 

this be fixed. 

So we believe that this is something that Congress should go 

back to in order to address. And this particularly impacts education 

projects, and transportation projects. The University of Massachusetts system would be affected by $150 million— 

Mr. SCHWEIKERT. Thank you, Mr. Quaadman. 

This one, Mr. Chairman, both right and left, this may be one of 

those areas where we can all agree that we may have to do a fix 

because it affects a lot of our communities, our sewer districts, our 

States, and our communities, and I think it is something we could 

fix in a bipartisan manner. 

Thank you, Mr. Chairman. 

Chairman BACHUS. Thank you. 

At this time, Ms. Waters recognized for 6 minutes. 

Ms. WATERS. Thank you very much, Mr. Chairman. 

Since this is a moment where we have an opportunity to share 

our thoughts and our feelings about you and Mr. Frank, I just 

want to tell you that I have appreciated so much working with you. 

And even though we have worked together on this committee, our 

work outside of this committee where we worked on debt relief was 

extremely important. We were successful in helping to alleviate 

some of the pain and poverty in some of those countries that we 

spent time on. And I want to thank you so very much for that. And 

I won’t say very much more because I don’t want anybody to get 

the idea that we are really friends. You have been in enough trouble without that. 

Barney Frank, let me just say that having worked with you has 

been an extraordinary experience and having served on the DoddFrank Conference Committee was a highlight of your work and my 

work on this committee. 

Most everyone here has said how much we are going to miss you 

and that is really an understatement, because this institution has 

been able to solve some great problems with your leadership, and 

we have all learned so very much from you. And we expect that 

you will be by the telephone and we may call you, even in the middle of a committee hearing, a markup, when we need to. And you 

don’t have to answer that now because you may tell me where to 

go. Thank you very much. 

Okay. Let us get to Volcker. 

Mr. Kelleher, you gave such passionate and strong testimony just 

a few minutes ago about Volcker. And I am very appreciative of 

that. And, I have been leaning in that direction. But I have also 

heard today some criticisms that seem to be based in some facts 

or documentation. And I would like you to take time to address 

some of what I heard, particularly from Mr. Stevens—from all of 

the members who have testified in opposition to your thoughts. 

24 

Would you please share that with us? 

Mr. KELLEHER. Thank you. I think one of the things that is most 

surprising is the collective amnesia that has run rampant on Wall 

Street since the Volcker Rule came in. There was a time—and 

Chairman Frank can appreciate how amnesia comes and goes, it is 

not just in this building. 

But, if you go back to 2007 or 2006, there didn’t seem to be a 

massive problem with distinguishing between proprietary trading 

and market making or risk-mitigating hedging. People knew what 

it was. After all, these were supposed to be the smartest people in 

the world making the most money in the world; the best of the 

best, the brightest of the brightest. And since the Volcker Rule, 

there has been this massive problem: What is proprietary trading? 

What is it not? 

And, frankly, it is more of a problem in Washington. I talk to 

traders and bankers all the time. I had a breakfast the other morning with a very senior executive banker. These people laugh at the 

concept that they can’t tell the difference between proprietary trading and market making or hedging. 

Frankly, if they couldn’t, that means they couldn’t segregate customer funds. It means they couldn’t comply with many laws, rules, 

and regulations on compliance and risk and capital. Do you think 

it is true that the executives at any one of these big banks has no 

idea at their trading desk that the trader or the desk doesn’t have 

capital, risk, and compliance requirements? No. They all have their 

risk limits, their capital limits—they can’t be putting the bank’s 

money at risk and putting the bank itself at risk without everybody 

knowing exactly what it is moment by moment. And as it gets 

rolled up, they also know it on the aggregate level, not just at the 

desk level, but at the division level and department level by P&L 

and otherwise. 

So I think many of the complaints that we hear are really attacking financial reform and attacking— 

Ms. WATERS. What do you say about the competition argument 

that is being presented here? 

Mr. KELLEHER. I think there is something to be said in terms of 

a transition period of any new rules and how they disparately affect market players across countries. But that means that we need 

integrated harmonization, not that we need to lower the bar. There 

should be a race to the top, not a race to the bottom. The cross border rules are going to be very important in that. 

But as was alluded to earlier, every country is trying to struggle 

with trying to limit this high-risk speculative trading by the banks. 

In the U.S., it is Volcker; in the U.K., it is Vickers; in the E.U., 

it is the Liikanen report. 

So I think the problem with competitive concerns are more of a 

transition period than an ultimate issue. And the sooner we get to 

final rules and harmonization, the better off we all are. 

Ms. WATERS. It was attested in the King legislation that was 

brought up that we should delay implementation of the Volcker 

Rule until there is harmonization. What do you say about that? 

Mr. KELLEHER. I would say that the schizophrenia of the complaints are just astonishing—I almost get whiplash. Originally, it 

was like, ‘‘Our problem is lack of certainty. We need certainty. We 

25 

need clarity.’’ And now that they are going to get certainty and 

clarity, ‘‘We don’t like that, so we need you to delay it so we can 

have a longer period of uncertainty and lack of clarity.’’ 

Let’s gets certainty, clarity. Let the regulators do their job. They 

are really on the cusp of putting in a very substantial architecture 

in the derivative space and in the Volcker Rule and other areas. 

Let them get the job done. Let’s see how it works. It works together 

or it doesn’t. And then, let’s revisit it with the actual knowledge, 

other than self-serving statements by market participants that are 

really no more than guessing. 

But let’s protect the American people. It has been 4 years and 

3 months almost to the day since the Lehman failure. Our job is 

to protect the American people from another financial collapse and 

a potential second Great Depression brought on by a financial collapse. Let’s get the rules in place, get the clarity. And where it 

needs to be fixed, let’s wait to see how it works or doesn’t work and 

fix it then. 

Ms. WATERS. Just lastly, I have been told that Chairman Shapiro 

has entered into some negotiations, some talks with the other regulators, and that she is bringing something to the table that is going 

to help wrap this all up very soon. Do you know anything about 

that? 

Mr. KELLEHER. I only know what I read. And, of course, if I read 

it, it must be true. Because it was in the papers. Right? 

But I do think that if they focus clearly on compensation—if you 

eliminate the compensation incentive for prop trading, which can 

be easily policed and easily followed both in the banks and by regulators, and then you back it up with swift and clear sanctions, they 

can get the Volcker Rule in place quickly with very little market 

disruption and very little regulator intrusion into the business of 

the banks. 

Chairman BACHUS. Thank you. 

Ms. WATERS. Thank you very much. 

Chairman BACHUS. Of course, what Ms. Waters is referring to is 

the article in yesterday’s Wall Street Journal and about those conversations. 

Mr. Hensarling for 5 minutes. 

Mr. HENSARLING. Thank you, Mr. Chairman. 

Kind of a stock and trade often in these committee hearings is 

to try to separate purported benefits of rules from their actual benefits and certainly weigh them against their actual cost, and to essentially determine whether the cure may not prove to be worse 

than the illness. 

I think we have all taken note of Chairman Volcker’s statements 

that, number one, proprietary trading in commercial banks was not 

central to the crisis. And then he has expressed concern with the 

rule bearing his name, ‘‘I don’t like it but there it is. I would write 

a much simpler bill.’’ I don’t think quite think he has put his offspring up for adoption, but he doesn’t seem to be too pleased with 

it. 

Mr. Kelleher, in your written testimony you state the Volcker 

Rule ‘‘is narrow in application and limited in scope.’’ You further 

testify, ‘‘it only applies to a few banks.’’ 

26 

And yet as the vice chairman of this committee, I have noted not 

a few, not hundreds, but literally thousands of negative comments 

that have either arrived to this committee or to the regulators from 

entities that supposedly are not negatively impacted. 

One of them being TIAA-CREF, which I believe to be one of the 

largest pension funds in the Nation, taking care of numerous teachers. And they wrote a letter to regulators, ‘‘Depriving the insurance 

companies that invest on behalf of those pensioners, the returns 

available through investments in covered fund impairs the ability 

of those pensioners to maintain their retirement security.’’ 

I have a cousin who spent her entire life teaching in a small 

town in central Texas, who is now retired. I note that the Federal 

Reserve hasn’t done her and other pensioners any favor as of recent, including their actions yesterday. 

So when I think about her and her husband also, somebody who 

spent their entire life in teaching, getting by on pretty much of a 

fixed income, I am wondering at the end of the day, I hear much 

language here about the big banks. But to what extent are we 

thinking about the little teachers? 

I also think about one other comment we received from the Public Utility Commission of Texas, in my home State, ‘‘The Texas 

PUC is concerned that the wholesale and retail power markets 

within the electricity, electric, or reliability council of Texas are 

likely to be materially and adversely affected from the approach 

taken by the agencies. The limitation will result in higher and 

more volatile electric prices to end-user customers.’’ 

These are two comments that literally are representative of thousands of comments that we have received. 

And so with the onset of winter—I know that perhaps Massachusetts might be colder than Texas—but I think about a lot of lowincome people in the Fifth Congressional District of Texas, who 

struggle in this economy to pay these utility bills. And now, I am 

hearing from not a big Wall Street bank, but a government entity 

in my home State, saying that the current iteration of the Volcker 

Rule is going to make winter more challenging for them. 

Mr. Kelleher, how have thousands got it wrong and you got it 

right? I will give you a moment to explain. 

Mr. KELLEHER. I think there are a couple of things. First of all, 

we obviously are not looking forward to or advocating policies that 

we think are going to disrupt the markets. Well-functioning, deep, 

liquid markets are the basis of our economy; we need them to 

work; and we need them to work for everybody from the teacher 

in Texas to the banker on Wall Street, to everybody else on Main 

Street. So what we need to do is design a system that serves all 

those interests and not primarily a narrow sector of that. 

There is no cost that—this is a slight overstatement—I can think 

of associated with the Dodd-Frank Act that comes anywhere close 

to the cost imposed on the American people and the economic 

wreckage from the last financial crisis or the next one. 

And that is what we have to be focused on. That is the cost that 

is already inflicted— 

Mr. HENSARLING. I see my time— 

Mr. KELLEHER. Second, most of those complaints ignore entry by 

new market participants. 

27 

Mr. HENSARLING. My time has expired. I yield back. 

Chairman BACHUS. Mr. Baca? 

Mr. BACA. Thank you, Mr. Chairman. First, I would like to thank 

you. It was an honor serving here in the Financial Services Committee. I would like to also thank Chairman Frank—Barney, too, 

as well. I thank you very much. And of course, I look forward to 

continuing to stay active in some of these issues that are important 

to a lot of us. And it has been an honor not only for me to have 

served here, but those who are currently serving right now. Because these issues that are impacting us in Financial Services impact the market and where we are going to be in terms of the future, not to mention housing and other areas, as well. 

But let me ask this question of the panel, and anyone on the 

panel can answer: Are there any particular transactions or positions to which applications of proposed definitions of trading account that is unclear? 

Mr. STEVENS. Congressman, if I might, one specific point that is 

covered in my testimony has to do with the ambiguity of the application for proprietary trading restrictions to the activities that 

banking entities engage in as authorized participants and market 

makers to support exchange-traded funds. Those are an extraordinarily popular and growing part of the registered fund industry 

in the United States. And it is not clear under the rules whether 

that would or would not be regarded as proprietary trading. 

I will say that in response to Mr. Kelleher’s comment— 

Mr. BACA. Does it need to be made clear? 

Mr. STEVENS. Yes, it does. And we have urged that it be made 

clear. 

You must understand, the way that the rule as proposed works, 

there is a presumption that any trading activity that the bank engages in is proprietary trading, unless it is proved otherwise. 

In other words, you are guilty unless proven innocent. And getting that wrong has very serious compliance implications. 

Mr. Kelleher’s colorful comments are not grounded in actually 

the rule proposal. Our comments are not amnesiac. Ours are 

grounded in exactly what the agencies have put forward. And unless it is clarified, it will, for example, potentially impact this market, in which millions of ordinary Americans participate. 

Mr. BACA. So the innocent are guilty before proven. 

Mr. STEVENS. The rule, as written, as proposed, presumes that 

everything a bank engages in is proprietary trading. 

Mr. BACA. Thank you. And this is another question for the whole 

panel. Do you think the proposed rule approach to implementing 

the hedging exemption is effective? If not, what alternative approach do you think would be more effective? 

Mr. HAMBRECHT. Let me try. First of all, I want to second Mr. 

Kelleher’s statement that people know what is a prop trade and 

what is an agency trade. Historically, it used to be divided by 

whether you acted as principal or whether you acted as agent. If 

you acted as agent, clearly, that was not a prop trade. You had no 

economic interest in the trade. 

The minute you become a principal trader, you have an economic 

interest in the success of the trade; you don’t get a commission, it 

is based on the success of the trade. 

28 

So I think anybody can define that very clearly. 

I think the problems become much more complex when you go 

into derivative markets or you go into other markets where the definition of the risk is hard to understand. And the definition of the 

impact on counterparties is hard to understand. 

And I think the only way you can really do that is to have transparent trades and have much more standardization of derivative 

trading, hopefully, on exchanges. 

Mr. BARTH. May I add that the issue is not whether or not bankers can distinguish between proprietary trade and through principal trading activities, can regulators make that distinction and 

determine the intent of the bankers. I think that is an important 

point that hasn’t been made. So we are not talking about bankers 

trying to distinguish between proprietary trading and permissible 

trading activities. Regulators, and does anyone have sufficient confidence that regulators would make the right distinction? 

Mr. KELLEHER. It is not so much intent. It is economic interest, 

which is tracked to the penny at these banks. So your intent is almost irrelevant. People say you need a lawyer and a psychologist 

on your shoulders. It is not true. Look and see how the trader is 

running his book and look at the book on the desk. They track to 

the penny whether or not it is the bank’s money or a customer’s 

money. And whether—which side they are on, and how it changes 

minute to minute. Once they take a position, they monitor it very 

closely. That is because their money is at risk. They know it. So 

it is not an issue of intent. It is an issue of clearly identifiable contemporaneous economic interest. 

Mr. BACA. And if it isn’t done, then it could impact the consumer. 

I think that is the question that was asked earlier in terms of some 

of the residents in the area. Is that correct? 

Dr. HAYWORTH [presiding]. The gentleman’s time has expired. I 

would like to ask unanimous consent to enter into the record statements from the American Council of Life Insurers; the Bond Dealers of America; BBVA Compass; and the Institute of International 

Bankers. 

Without objection, it is so ordered. 

And now, 5 minutes to the gentleman from New Mexico, Mr. 

Pearce. 

Mr. PEARCE. Thank you, Madam Chairwoman. 

I would like to associate myself with the comments that Mr. 

Schweikert made about the need for financing for local projects and 

small States since that is a very key thing and I think this question pertains to that. 

Mr. Kelleher, I was interested in your comments that the regulator’s job is to protect the American people. And if you have 

watched any of my recent questioning in the area, you find I have 

a fascination with MF Global. 

Do you have an opinion about the regulators and their protection 

of the American people in the application of that—those final hours 

of MF Global? 

Mr. KELLEHER. I only know what is in the public record. And so 

far, I think the answer has to be that the public record isn’t really 

complete enough yet to have an opinion. 

Mr. PEARCE. Let me complete a little bit of it for you. 

29 

As they were sitting there, both the CFTC and the FTC sitting 

in the room, were counting down the last hours before this billion, 

billions of dollars corporation fails. They have been taking the 

funds from segregated accounts to float the deal. 

The regulators decided at the urging of the FTC, at 5:20 in the 

morning, to declare it a securities firm, not a futures trading firm, 

not a commodities market—30,000 commodity accounts and 318 security accounts. I think the two guys who were responsible for the 

decision—this is my thoughts, they have never exactly confirmed it. 

They didn’t confirm it yesterday when they were hearing, but they 

were in the room making the recommendations—that their recommendations, it was declared a securities firm, not a futures, not 

a commodities firm—318 to 30,000, and they decided for the 318. 

The bankruptcy proceedings then favored the investors, not the 

30,000. 

So I guess my question is, when you assure us all that the 

Volcker Rule is going to be good, it is going to protect the American 

people, we had the guys here yesterday who made those decisions 

to not protect the American people but to protect the 1 percent. 

Now, if my assertions are correct, and neither one of the gentlemen yesterday who apparently were in the room or on the telephone with the people in the room would contend with it, do you 

have an opinion now about the regulators doing their jobs? 

Mr. KELLEHER. I don’t think there is any question that regulators, like legislators and everybody else, are not perfect and are 

going to make mistakes. And one of the reasons we advocate clear 

rules, particularly on Volcker, focusing on compensation, is because 

discretion and judgment are largely taken out of it. And it would 

be a rule that would both be easy to comply with and easy to police. We try and find, take the ambiguity out of the rules— 

Mr. PEARCE. Reclaiming my time, I really did want an answer, 

because you are very articulate and you are very opinionated. You 

are willing to use the words ‘‘amnesia’’ and ‘‘schizophrenic’’ in regard to businesses, but you are unwilling to describe activities on 

the part of regulators as maybe preferential— 

Mr. KELLEHER. Don’t get me wrong; I am perfectly happy to join 

in criticism of regulators. 

Ms. PEARCE. I am trying to give you a chance to respond. And 

I didn’t find that clarity in the response. So if you don’t mind, it 

would make my observations— 

As you describe the perfect world of regulators, I worry that the 

protection of our consumers is not going to be any closer under the 

Volcker Rule than it is under the SEC, the CFTC, the REMC, the 

ABC, nothing. 

I think that people are always going to find their way out. Just 

looking yesterday at the HSBC, we sent Martha Stewart to jail for 

4,000 shares of stock, whatever happened there, 4,000 shares. But 

billions of dollars over multiple years for the HSBC laundering 

money in our judicial department didn’t seem to find a reason. 

So I don’t think—I know there are mistakes made by businesses. 

But I am not sure in your perfect world of regulations and regulators to where we regulate the very last common denominator will 

end up choking off investments to small towns in New Mexico. I 

30 

am just not sure your process is going to get us any closer than 

what we are doing now. 

Thank you. I yield back. 

Dr. HAYWORTH. Thank you, Mr. Pearce. 

The Chair now recognizes Mr. Miller of North Carolina for 5 

minutes. 

Mr. MILLER OF NORTH CAROLINA. Thank you, Madam Chairwoman. 

Before I begin, I would like to ask unanimous consent to introduce into the record a report from Public Citizen which finds that 

99.9 percent of banks would not be affected by the Volcker Rule. 

Mr. Kelleher— 

Mr. FRANK. Madam Chairwoman, is that going to be in the 

record? We need to have an order. 

Dr. HAYWORTH. Without objection, it is so ordered. 

Mr. MILLER OF NORTH CAROLINA. Thank you. 

Mr. Kelleher, the Volcker Rule is one of the provisions in DoddFrank designed to make banks simpler, less likely to fail, and if 

they do fail, to fail without such catastrophic consequences to the 

financial system and for the broader economy. 

But just in the last couple of weeks, William Dudley has spoken 

on the first versions of living wills and said we have a long way 

to go before we have a financial system that will not—that a major 

bank can fail, the kind of banks that would be subject to the 

Volcker Rule could fail without catastrophic consequences to the financial system. And even more strikingly—and that it was the beginning of an iterative process, that we would get there eventually. 

Even more strikingly, HSBC, just in the last couple of days, has 

entered into a settlement for $1.9 billion in fines for money—for 

laundering $800 million in drug money, in addition to having 

laundered money for the Iranian regime and the repugnant genocidal regime in Sudan. And the stated reason what they said right 

out loud in front of God and everybody was that they weren’t going 

to bring criminal charges because of the disruptive effect it would 

have on the global financial system. 

I think Chairman Frank was correct when he said earlier that 

Dodd-Frank has made many of the extraordinary interventions of 

4 years ago no longer within the law. But is it—do you think that 

the biggest banks can fail without significant consequences for the 

financial system or the broader economy? 

Mr. KELLEHER. Not yet. We still have a long way to go under 

Dodd-Frank. We need not just living wills and resolution authority. 

At the front end, the Fed has to get in place a whole variety of liquidity, capital, leverage requirements. That has to be married up 

to the back end on resolution authority, which is the FDIC’s Orderly Liquidation Authority. They have gone very far on that. They 

have just announced recently an international agreement with the 

U.K. on resolution. And the president of the Bank of England was 

just here discussing that with the head of the FDIC publicly. 

But you take all of these things and you put them in place, if 

they get put in place in good faith by people intending to achieve 

the objective of ending too-big-to-fail, including, importantly, banning proprietary trading and limiting the investments in hedge 

31 

funds, et cetera, you could be at a place, at a point in time, where 

you do eliminate too-big-to-fail. 

Mr. MILLER OF NORTH CAROLINA. I am puzzled by the handwringing, though, at the idea that intent could be a factor in the 

law. Oliver Wendell Holmes said intent is the concept that runs 

throughout the law, that a dog knows whether he has been kicked 

or stumbled over. It is something we deduce from circumstances all 

the time in our ordinary lives. And it is a common legal concept 

that we frequently have to have deduce for consequences. 

Can you think of other areas in the law in which important consequences may depend upon determinations of intent? 

Mr. KELLEHER. Every single criminal prosecution. Every single 

civil litigation, contracts. It is a fairly routine concept, intent. But 

the important thing about this—I think it is a phony argument, 

that you have to discern the intent of a trader to find out whether 

it is a prop trade or not. That is not factually accurate. Don’t take 

my word for it. Talk to real traders. Talk to people who run desks 

about how it really works. There is documentation. So intent isn’t 

involved there. 

But, where intent is interestingly involved is if you are going to 

hold somebody accountable under the law. And we haven’t seen 

that happen in connection with the financial crisis at the largest 

banks. There are no executives who have been held accountable in 

any serious way. Basically, the banks have used shareholder 

money to pay big fines to move on. 

So it would be nice, actually, if people who were worried about 

intent would think about determining the intent of people who engaged in some pretty egregious conduct before the financial crisis, 

took billions of dollars in bonuses, and stuck the American people 

with the bill. They might want to look at the intent of those actions. 

Mr. MILLER OF NORTH CAROLINA. The proposed rules or some of 

the discussion, does it—do they outline circumstances that might 

suggest what the intent was, whether it is proprietary trading or 

market making or hedging? And what are some of the circumstances that might indicate what the intent was? 

Mr. KELLEHER. You are going to know, because if you look at the 

trader’s book, the trader has an allocation as to risk— 

Dr. HAYWORTH. The gentleman’s time has expired. 

Mr. Luetkemeyer is recognized for 5 minutes. 

Mr. LUETKEMEYER. Thank you, Madam Chairwoman. 

Mr. Stevens, I will start with you. 

You handled a mutual fund investment company and are the director for the Investment Company Institute. And I know that you 

talked in your testimony with regards to mutual funds and they 

need to be out of the Volcker Rule umbrella. 

Can you elaborate on it a little bit? Can you differentiate between mutual funds and hedge funds and why you think—how 

they don’t interplay and shouldn’t be considered here, and the effects of the rule? 

Mr. STEVENS. Tough question, Congressman. 

This is really a very bright line, and I think everyone understands it quite well. And Congress drew it in the Volcker Rule. 

32 

Mutual funds and other registered investment companies under 

the Investment Company Act of 1940 are subject to all of the major 

Federal securities laws. In fact, there is no more heavily-regulated 

financial product in the market today. Mutual funds are required, 

for example, to—under the statute, to avoid the full range of potential conflicts of interests with their sponsors. They are subject to 

a very specific governance regime. They are subject to an enormous 

amount of transparency in terms of their disclosure to investors. 

They are subject restrictions in the way that their portfolios work 

and the kinds of investment strategies that they can pursue. 

Hedge funds, on the other hand, are subject to none of that. They 

are private investment companies. Their advisors, after DoddFrank, have to be registered with the SEC. But the hedge fund can 

pursue whatever strategies it wishes, provided only that it is either 

sold to a sophisticated group of investors—and I put quotes around 

‘‘sophisticated,’’ because that is another issue that needs to be addressed at some point—or to a very limited number of investors. 

Now, the key thing in addition is that other markets outside of 

the United States are subject to similar sorts of dichotomies in 

terms of the funds that are made available in the market. 

So that there are, for many purposes, funds that look very much 

like U.S.-registered funds, U.S. mutual funds that are sold outside 

of the United States and in very many instances are sponsored by 

American fund advisors. 

Our point is that both of those kinds of funds, both the U.S. 

funds and the non-U.S. funds that look like American mutual 

funds, should be outside of the covered funds provisions and the 

banking entity provisions of the Volcker Act. And we hope the regulatory agencies will clarify that. 

Mr. LUETKEMEYER. Mr. Plunkett, do you agree with that? You 

handled investments of a similar nature. 

Mr. PLUNKETT. Yes, Congressman. 

Foreign funds, many foreign funds such as UCITS funds in Europe and certain funds, OEICs in the U.K., are already heavily regulated and very similar to U.S. mutual funds. 

The regulators need to make a distinction between what types of 

funds are really sought to be covered by the Volcker Rule and what 

should be excluded—the exclusion should include all U.S. mutual 

funds. 

Mr. LUETKEMEYER. Mr. Quaadman, we have hardly talked at all 

today, yet with regard to getting an extension for all of the entities 

which are going to have to comply with the Volcker Rule because 

at this point, not all the rules are out there. Not all the rules—the 

final rule hasn’t been set, and interpretation of it, there is a sort 

of a nebulous framework out there. 

But you have 2 years to comply from July 21st, and the clock is 

ticking. And yet there is nothing there for you to comply with, technically. At least from my understanding of it. 

So my question to you is: Are all of you working in coordination 

to try and get an extension of the Federal Reserve compliance period here so—until the rules are promulgated and finalized, that 

you actually know what you are going to be doing so you can have 

the proper amount of time to comply? 

33 

Mr. QUAADMAN. I think that is a great question. That is why I 

mentioned in my opening statement why we think the BachusHensarling request for an extension time is important. 

One thing I want to say as well, because I think this has been 

bandied about a bit, but I think it is also is emblematic of the problems with the Volcker Rule itself. One of the examples that has 

been used here has been the London Whale example. Right? And 

with the financial institution where that occurred, there are dozens 

of regulators who are embedded in that institution go there every 

day, are supposed to be looking at the activities of that bank. To 

this day, they can’t tell you if that was a proprietary trade or not. 

So if they cannot tell you if that was a proprietary trade or not, 

for a corporate treasurer who has to go to the capital markets 

every day who is going to have to go through intense regulatory 

scrutiny as to when they go out and sell their bonds or their stocks, 

how are they going to have any certainty for how the market is 

going to react or the regulator is going to react? 

Mr. LUETKEMEYER. I appreciate your comments. My time is up. 

Thank you. I yield back. 

Dr. HAYWORTH. Mr. Lynch of Massachusetts is recognized for 5 

minutes. 

Mr. LYNCH. Thank you, Madam Chairwoman. 

Let me ask you on that point, Mr. Kelleher, is there a legitimate 

claim here that some folks couldn’t distinguish between proprietary 

and nonproprietary? 

Mr. KELLEHER. My answer would be, it is clearly proprietary. 

And JPMorgan Chase CEO Jamie Dimon, who testified both in the 

House and the Senate, agreed when he said, ‘‘I can’t tell you if it 

is or it is not.’’ 

I guarantee you if it was not, he would have said that. 

Mr. LYNCH. Right. 

Mr. KELLEHER. I don’t think there is really any doubt of anybody 

who is independent, looking at what happened there and what the 

trade was, based on what we now know—there is still a lot we 

don’t know—but based on what we know, it was pretty clearly a 

proprietary trade. 

Mr. LYNCH. Mr. Kelleher, what I really want to do is follow up 

on my friend’s line of questioning, Mr. Miller from North Carolina, 

regarding the HSBC case that was announced yesterday. 

We really aren’t talking about just too-big-to-fail in this case. 

Now, just to sort of regurgitate the facts here, HSBC yesterday entered into a deferred prosecution agreement with the Justice Department after they had admitted that they violated the Bank Secrecy Act and the International Emergency Economic Powers Act 

and the Trading With the Enemy Act. They actually conducted illegal transactions with Cuba, Iran, Libya, Sudan, and Burma, all 

countries that were subject to the sanctions enforced by the Office 

of Foreign Asset Control at the time of the transaction. 

And there is no question that they knew what they were doing. 

They actually scrubbed some of the reports so that it wouldn’t flag 

what they were doing. 

But what troubles me greatly is they agreed to a $1.92 million 

penalty, but the Justice Department agreed not to prosecute beVerDate Nov 24 2008 18:57 Apr 26, 2013 Jkt 079694 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 K:\DOCS\79694.TXT TERRI
34 

cause they were afraid of what the financial reverberations would 

be to the market. 

So these folks aren’t just too-big-to-fail, they are ‘‘too-big-to-indict,’’ to steal a phrase from The New York Times editorial yesterday. 

And it would seem to me that the Volcker Rule would be very 

helpful in stopping these banks from getting so enormous that 

any—that they become immune from prosecution, which defeats 

the entire purpose here. 

How do we get at that? How do we get at that situation where 

these banks are clearly violating, knowingly violating the law? And 

doing so at risk to the entire markets? How do we not prosecute 

these guys and just put a little slap on them and allow them to 

continue to do what they have been doing? 

Mr. KELLEHER. Everybody knows that unpunished crime does 

not deter crime. In fact, unpunished crime incentivizes and rewards crime and ends up with more crime. So it may be the case 

that HSBC or other banks are ‘‘too-big-to-indict,’’ because you don’t 

want to have them collapse. And there is the consummate example 

of the Arthur Andersen accounting firm. 

But that doesn’t mean that individuals can’t and shouldn’t be 

prosecuted and put in jail. A bank may be ‘‘too-big-to-indict,’’ but 

there is no banker who is ‘‘too-big-to-indict.’’ And without accountability, be it for egregious conduct engaged in a run-up to the financial crisis, or be it HSBC or otherwise, the failure to hold senior 

executives accountable and other executives, officers, and employees who knowingly break the law, if you don’t do that, you greenlight them to do it more. 

And you are exactly right in terms of proprietary trading. The 

problem with proprietary trading is the riches and the rewards are 

so massive, the temptation is so huge because the rewards are so 

high, that it has to be limited. And it is one of the key ways to cut 

down on high-risk activity at taxpayer-backed banks that risk failure and taxpayer bailout. But both of those go together. Some accountability and prosecution of individuals, whether they are a 

banker or not, should not be limited because you are concerned 

about the institution itself. 

Mr. LYNCH. I haven’t read the entire deferred prosecution agreement. But the only thing that I can see through in these documents 

is that there was a partial claw-back of some of the bonuses that 

were given to some of the officers of the bank. That was it. Now, 

I understand that the Brits are also going to move forward with 

their own prosecution. So maybe, maybe because it is a Londonbased institution, maybe it will come during that prosecution. 

But I still think—I agree with your statement that there should 

have been much more severe consequences for these folks. Actually, 

money laundering for Cuba, Iran, Libya, Sudan, and Burma, in the 

face of the sanctions that Congress has placed— 

Dr. HAYWORTH. And the gentleman’s time has expired. 

Mr. LYNCH. Thank you, Madam Chairwoman. 

Dr. HAYWORTH. Thank you, sir. 

Mr. Stivers is recognized by the Chair for 5 minutes. 

Mr. STIVERS. Thank you, Madam Chairwoman. 

35 

My first question is for Mr. Quaddman. Why do you think it is 

important to look at the Volcker Rule in conjunction with other 

regulatory structures such as the Basel III? 

Mr. QUAADMAN. Sure. Because all of those actually work in conjunction with one another. That is why I tried to describe that in 

our opening statement of all the different ways that a corporate 

treasurer has to either raise cash or mitigate risk. Each one of 

those plays off one another, which is why the only alternative they 

would have, if those markets start to get shut down or they are 

shut out of markets or costs are too high, that they just have to 

have part cash. And that actually has other economic consequences 

to it. 

Mr. STIVERS. Does the impact of these multiple regulatory structures make the United States more or less competitive in global financial markets? 

Mr. QUAADMAN. It makes it less competitive. Because the Volcker 

Rule is a unilateral action by United States, which is why we think 

there should be international coordination if we are go down that 

road. 

But we have also seen, even with Basel III, while we started to 

look at the implementing regulations, European regulators were already saying that they had to delay it. So we need to make sure 

everybody is playing on the same playing field. And that hasn’t 

been the case so far. 

Mr. STIVERS. Thank you. 

And I guess this question is for Mr. Hambrecht. You talked a little bit about a different solution. But you have experience in the 

capital markets. I am just curious, do you believe that market making is proprietary trading? 

Mr. HAMBRECHT. No, I don’t. 

Mr. STIVERS. Okay. Whose money is at risk in market making? 

Mr. HAMBRECHT. Let me try and answer your question this way: 

I personally think that trading efficiency has increased enormously 

because of technology, not because of market makers. So the rise 

of these so-called dark pools, for example, which are really computer-matching systems, they match the buyer and seller and they 

take the dealer out of the equation. I think they are the people who 

have lowered trading costs and equity. And I do think that will 

happen in debt. This is the BlackRock approach that they have just 

announced. So, to me, market making the matching the buyer with 

the seller at the least possible cost. 

Mr. STIVERS. And I did that. I worked at the Ohio Company in 

the 1990s, and I can assure you that it was the Ohio Company’s 

money at risk. It was—its proprietary. Market make the property 

trading. It is the only example inside of—I agree with Mr. Kelleher, 

with a lot of everything he said. And I get I will let Mr. Kelleher, 

and maybe the whole panel tell me if you think—because clearly 

market making is a company putting their money at risk. To provide liquidity in the markets, they have to offer both a bid and an 

ask. And they are supposed to make money on the spread. But they 

have inventory and it is their money at risk. 

And does anybody believe that these companies that are market 

makers don’t have inventory and, therefore, their assets are not at 

risk? 

36 

Let me ask it that way, all the way down the panel. A yes-orno answer is fine with me. 

Mr. BARTH. I don’t believe that market making is speculative 

trading. 

Mr. STIVERS. I didn’t ask if it was speculative trading. I asked 

if it was proprietary trading. I asked if they had their money at 

risk, which is the whole point here. 

Mr. BARTH. Yes. 

Mr. STIVERS. Thank you. 

Mr. HAMBRECHT. I would answer it, if they choose so. I think 

most market makers try to come out flat. 

Mr. STIVERS. I agree, but—okay. 

Mr. KELLEHER. And much of it is matching. And we put in our 

comment letters in connection with this rule, showing that, for example, the big banks actually don’t keep inventories hardly at all 

anymore. If you look at the actual facts, they don’t. So it is a 

matching— 

Mr. STIVERS. The goal is to not have inventory, I will give you 

that. The goal is to not have inventory. 

Mr. KELLEHER. As a fact, they don’t have them. 

Mr. STIVERS. Right. They meet their— 

Mr. KELLEHER. So there really isn’t much proprietary trading 

left. 

Mr. STIVERS. But their goal is to provide, they are in the market 

to provide liquidity. Therefore, if there is a big short-term imbalance, they could obviously end up with inventory at the end of the 

day; therefore, they have money at risk. Let’s keep going down the 

panel. 

Mr. PLUNKETT. Congressman, I think it is important to note that 

the Volcker Rule is intended to prohibit proprietary trading, not 

every instance of principal trading, when banks do take on their 

books to create inventory in order to have securities that they can 

sell to asset managers, for instance, or other clients and investors. 

Mr. QUAADMAN. I think the regulators are having problems distinguishing between the two, which is why it has been so problematic to even come up with the rule. 

Mr. STEVENS. I think Mr. Plunkett hit the nail on the head. It 

is not so simple a world. There are kinds of principal trading that 

would be market making, and kinds of principal trading that would 

be proprietary trading as the Congress sought to address in the 

provision. And drawing the line between two different kinds of 

principal trading can be hard. 

Dr. HAYWORTH. And the gentleman’s time has expired. 

Mr. STIVERS. Thank you, Mr. Stevens. My time has expired, but 

that illustrates how difficult this is. I yield back. 

Dr. HAYWORTH. Mr. Green of Texas is recognized for 5 minutes. 

Mr. GREEN. Thank you, Madam Chairwoman. I would like to join 

those in saluting Chairman Bachus for his outstanding work with 

the committee, and of course, my very dear friend, Ranking Member Frank, for his outstanding service to the committee and to our 

country. 

And I would also like to just mention Mr. Himes, because of 

some very thoughtful comments he made yesterday on the question 

of derivatives. Mr. Kelleher, are you of the opinion that 

37 

intentionality trumps overt manifestations when it comes to 

ascertaining whether or not we have proprietary trading versus 

market making, or are overt manifestations what we look for in the 

actions of those who engage in these practices? 

Mr. KELLEHER. I don’t think we need to define the intent of a 

trader. I think that you can tell by looking at their book and the 

desk’s book, and you check with compliance and risk and capital, 

and then you look at the bonus pool as it gets rolled up week by 

week, quarter by quarter, and you can find out exactly what type 

of trade it was. You don’t have to figure out what somebody is 

thinking in their head as to whether it is proprietary or not. That 

doesn’t mean 100 percent of the time. 

Mr. GREEN. Yes, sir, that is just if there is someone who does believe that we have to understand what the person was actually intending to do, as opposed to what the person’s overt manifestations 

indicate. 

Mr. QUAADMAN. Mr. Green, if I could just answer, as I said in 

my opening statement, we believe the capital requirements are actually an easier way to go. One example with the Volcker Rule is 

the Volcker Rule establishes a bright line of the 60-day period, that 

if you hold a security for more than 60 days, it is presumed to be 

proprietary trading. 

Now, you can have a company that has hundreds of bonds that 

may not even move for 90 days. So there is no ability to move, to 

match a buyer and a seller for a 90-day period. That is not unusual. And in fact, that is not unusual in the stock market either, 

which is why with the JOBS Act, Congress actually has mandated 

that the SEC look at whether or not that motivation should be 

needed for smaller issuances because they can’t move over a specific period of time. 

Mr. GREEN. I take it from what you have said that it is the actions that really count, not the intentionality? 

Mr. QUAADMAN. We think it is difficult for the regulators to define rules that give markets the certainty that they need, and that 

is why we think that the capital requirements are an easier way 

to go. 

Mr. GREEN. I understand, but you and I seem to be talking past 

each other. So let me try to focus. If we have a circumstance wherein the actor indicates, yes, I did it, but I didn’t intend to do it, are 

you concluding that this would not be proprietary trading? 

Mr. QUAADMAN. I think as the example I used earlier, with the 

London trade example, the regulators who were embedded in that 

institution cannot tell you whether or not there was a proprietary 

trading months after that occurred. And that hasn’t been disputed 

here, so I think that shows exactly why it is almost impossible to 

define if something is proprietary or not. 

Mr. GREEN. Mr. Kelleher, let me allow you to respond, please. 

Mr. KELLEHER. In terms of the London Whale, I don’t think there 

is really any dispute, and the dispute, if there is one, comes to the 

timing of the trade. When the trade was originally put on, it appears from the public record that there was an argument to be 

made that it was a hedge. It was congruent with an existing portfolio. And the CEO refers to it as kind of ambiguous, but he says 

it morphed into something else. The truth is, at banks, things don’t 

38 

morph. People make decisions and then they execute those decisions. And what happened, decisions were made at JPMorgan 

Chase, to change a highly liquid, low risk, what appears to be an 

actual hedge, into something that was a straight-out, flat prop 

trade in a very complex derivative play. 

So at the end of the day, what they were in and what they 

couldn’t get out of and what cost them money was a prop trade. 

I don’t have any doubt it is going to come out that way. What it 

was originally—we don’t have the evidence yet because it is not on 

the public record. It appears that may well have been a hedge, a 

hedge then and it looks like it would have even been a hedge under 

the Volcker Rule and the law if it was applicable at the time, but 

not what it supposedly, what it was changed into. 

Mr. QUAADMAN. Mr. Green, if I could just add for one second and 

maybe this would help is that is one of the reasons why we think 

there should be a reproposal, because you have had this proposal 

out there for so long. The regulators have asked so many different 

questions. It is important, I think, for everybody that if they can 

repropose the rule, allow everybody to take another look at it, determine whether or not there is turnkey there, then we can figure 

out if it needs to be fixed or not. 

Mr. KELLEHER. There were 18,000 comment letters, something 

around 2,000 meetings, 99 percent of them with industry. They 

need more input? And I will note for the record, anyway, because 

the answer was that Mr. Quaadman agrees with me and you, and 

when it comes to proprietary trading, actions will tell you what you 

need to know. 

Dr. HAYWORTH. And the gentleman’s time has expired. Thank 

you, Mr. Green. 

Mr. GREEN. Madam Chairwoman, I yield back. 

Dr. HAYWORTH. Thank you, Mr. Green. Mr. Huizenga is recognized for 5 minutes. 

Mr. HUIZENGA. Thank you, Madam Chairwoman, and at this 

point, I would like to actually turn it over to my good friend and 

colleague from Texas, Quico Canseco, for the balance of my time. 

Dr. HAYWORTH. The gentleman yields to Mr. Canseco. 

Mr. CANSECO. Thank you. Thank you for yielding. Mr. Barth, I 

want to pick up where we left off, and as I understand the way the 

rule is currently drafted, it says that a firm could not make money 

if an asset they hold increases in value after they acquire it. So a 

firm would have to have no incentive whatsoever to acquire an 

asset that is priced very low. Wouldn’t that add to systemic risk in 

the financial system, especially in a time of crisis when asset values plummet? 

Mr. BARTH. Yes, asset values, indeed, do fluctuate a great deal 

over short periods of time, and that is, in my view, a problem with 

the Volcker Rule. It talks about a relatively short period of time, 

in which the intent is to gain from the price increase rather than 

serve a customer. I think that is the problem. 

I think there is still difficulty despite what some other people believe about the Volcker Rule. May I just add, if one is worried 

about too-big-to-fail, the issue is capital. If institutions have too little capital, of course, they could have a lot of assets. So I think capital requirements, liquidity requirements, are a way to deal with 

39 

too-big-to-fail. I don’t think the Volcker Rule is a way to deal with 

too-big-to-fail. 

Mr. CANSECO. So you mention in your testimony that you believe 

that the Volcker Rule is based on an incorrect premise, or an incorrect assumption. Why is it an incorrect premise, and is there anywhere where the Volcker Rule can be implemented that would 

avoid problems in the future? 

Mr. BARTH. I think I, perhaps, should say, is, or may be an incorrect premise. And the reason I say that, based upon the hearings 

that were held earlier this year, there was talk about the fact that 

many people now are willing to concede the fact that the proprietary trading was not the cause of the financial crisis, which was 

severe in the United States. And nobody has presented any evidence suggesting that of all the costs associated with the crisis, 

proprietary trading accounted for a large proportion of those costs. 

Now, the concern that is going forward in the future, it is speculative, in my view. What is really speculative is to say that the 

Volcker Rule is going to prevent a future crisis. I think that is 

sheer speculation. There is no evidence whatsoever, based upon its 

role in the previous crises in this country or any other country 

around the world. 

Mr. CANSECO. Do you believe that if other countries do not implement a Volcker-like rule, then trading that would be prohibited in 

the United States will move overseas? 

Mr. BARTH. Yes, I think that is a distinct possibility. I know Mr. 

Kelleher did talk about the Liikanen Report, and the Vickers Report, and one might describe them as ‘‘Volcker Light,’’ but clearly, 

I do not believe that the solution to the future crises is the Volcker. 

And indeed, I think business could migrate across national borders, 

go into other countries. And that would be a concern for U.S. banks 

in terms of the competitiveness. 

Mr. CANSECO. Thank you, Professor. Mr. Quaadman, there are 

reports that regulators could potentially come out with three different versions of the so-called Volcker Rule. Could you comment 

on the confusion that would result if that were the case? 

Mr. QUAADMAN. Let me give you one example. We took a group 

of corporate treasurers up to meet with all the regulators involved 

in the Volcker Rule earlier this year, and the day literally started 

with one regulator saying, we are going to look at this by tradeby-trade analysis, and we ended the day with the regulators saying, if you develop principles and you are in conformance with the 

principles, you are going to conform with the rule, you are going 

to be compliant with the rule. They are talking about the same 

rule. 

What I think is important here is, I think we need to have a rule 

that works. We need to have regulators on the same page, and we 

are not getting there. That is one of the reasons why last year, actually a year ago now, we sent a letter in just on cost-benefit analysis, because you had five regulators with five different legal standards, and we thought they should conform to the economic analysis 

and rigorous economic analysis that was proposed by President 

Obama in Executive Order 13563 so that they were all looking at 

it in the same way. 

40 

And unfortunately, as this Volcker Rule consideration has continued on, we are just seeing divergence instead of convergence, and 

unfortunately, a system that may not work. 

Mr. CANSECO. Thank you very much. I yield back the balance of 

my time. 

Dr. HAYWORTH. Thank you, Mr. Canseco. Mrs. Maloney of New 

York is recognized for 5 minutes. 

Mrs. MALONEY. I thank all of the panelists. I would like to put 

in the record a series of articles that points out how proprietary 

trading was really prosecuted, and some of our most respected 

banks had to pay fines of over $500 million for what was described 

as an abuse, knowingly selling to their customers products that 

they knew were faulty, and then shorting them. 

So how you say that is not part of the financial crisis, I beg to 

differ. There are many parts of the financial crisis. The subprime 

crisis was part of it. But those who took those instruments, those 

subprime documents and then sold them to their trusted clients, 

causing their loss and making a profit, is not a policy that I would 

like to see continued in our great country. I think markets run on 

trust, and we have to restore the trust of our great country. 

I would like to say that I would like to place into the record a 

list of banks that have voluntarily given up proprietary trading, 

conforming to the Volcker Rule before it takes effect. I wrote both 

the Federal Reserve, and the OCC asking, what is the status of the 

Volcker Rule? What are our banks doing? The OCC wrote back and 

said that six of the largest banks in our great country are already 

adhering to the Volcker Rule. And these institutions are Citibank, 

JPMorgan Chase, Bank of America, Wells Fargo, and PNC Bank. 

I have not heard from the Federal Reserve, even though I wrote 

my letter in September, they haven’t gotten back to me. But they 

have unwound, they have the trading moved off. They are no 

longer doing proprietary trading in many of the banks in the district that I am privileged to represent. So it is being taken seriously by the financial sector and financial leaders of some of our 

major institutions. They are adhering to it. 

I have three major points that I would like to put in the record 

for this purpose of the hearing on the Volcker Rule. And some of 

you have underscored them. First, a stable financial system with 

robust financial markets can only exist with clear comprehensible 

rules of the road. And as proposed, the regulations implementing 

the Volcker Rule would not follow this simple principle of clarity. 

The complexity of the regulatory proposals to implement the 

Volcker Rule must not be carried forward into its final form. Many 

of you have talked about the complexity. It has to be very clear to 

the market, and I believe that our regulators can do it. 

Second, the five agencies responsible for implementing this rule 

should resolve their differences and put forward a consistent set of 

regulations. Several different and potentially conflicting sets of expectations could leave the American financial industry in total disarray, an outcome that is both undesirable and unnecessary. So I 

speak to the regulators that they have to be coordinated on this. 

And finally, our regulators must remain mindful of the important 

exceptions that Congress clearly provided in the Volcker Rule for 

market-making and hedging activities for the purpose of helping 

41 

their clients. In respect to market making, Congress understood 

that adequate liquidity is absolutely essential to well-functioning financial markets, and banks play an essential role in providing that 

liquidity. 

Banks must have clear authority to engage in customer-related 

trading in order to make markets and strong U.S. financial markets so critical to growing companies and our economy and our 

jobs. And also, the hedging is also an essential tool that financial 

institutions use to safely manage their exposure and ultimately, to 

protect the American investors and depositors. 

So I wanted to talk about that, and the one person’s testimony 

that I didn’t hear—I had to go testify at the Transportation Committee—was Mr. Stevens. So I want to point out that when the 

Senate added the Volcker Rule to Dodd-Frank, it did not come out 

of this body, but the Senate added it. The clear intent was to limit 

a bank’s ability to sponsor or invest in hedge funds and private equity funds. And Mr. Stevens, can you describe some of the key consumer protections that are different from registered mutual funds 

and from the kinds of entities that the Volcker Rule is intended to 

prevent banks from— 

Dr. HAYWORTH. The gentlelady’s time has expired. Mr. Stevens, 

can you answer very quickly? I apologize for that. 

Mr. STEVENS. In very simple terms, we are subject to a very comprehensive scheme of regulation under all the Federal securities 

laws. The hedge funds are subject to none of that. 

Mrs. MALONEY. Very briefly, may I say one thing? 

Dr. HAYWORTH. Mrs. Maloney, your time has expired. We want 

to get to Mr. Carney if we can. 

Mrs. MALONEY. Oh, sorry. 

Dr. HAYWORTH. Mrs. Maloney’s documents will be entered into 

the record, without objection. 

Mr. Carney is recognized for 5 minutes. 

Mr. CARNEY. Thank you, Madam Chairwoman. I thank the panel 

for coming today. I have been fascinated by this discussion, and a 

little confused by some of it. We have a vote, so I will try to be 

quick. I want to come back to Congressman Stivers’ line of questioning around the distinction between proprietary trading and 

market making. 

Mr. Kelleher and, I think, Mr. Hambrecht, I believe you both believe that it is pretty simple to determine that, and that you don’t 

really need to look at intent. But doesn’t the proposed rule call for 

a plan that the entity would submit and describe what their intent 

would be in these kinds of practices? Isn’t that what the proposed 

rule suggests? 

Mr. KELLEHER. I don’t believe so, but even if one were to argue, 

and many have argued that is what it does require, there is going 

to be a final rule and there are several ways—we filed four separate comments letters on this suggesting— 

Mr. CARNEY. So your view is, you don’t have to focus on intent. 

You can do it by looking at the compensation, deconstructing the 

compensation package? 

Mr. KELLEHER. And the economic interest at the time. I am told 

by people who make a living, an incredibly good living trading and 

42 

running desks at the biggest banks in this country, that this is not 

a complex problem. 

Mr. CARNEY. It is not a hard problem. 

Mr. KELLEHER. It is pretty clear at the time. 

Mr. CARNEY. The complaints that I have heard from market participants is that it is a distinction between a permitted activity, 

market making, and a prohibitive activity, prop trading. Clearly, 

prop desks, and all that, they have been eliminated. That is easy. 

But holding, buying securities to hold and to sell later, is much 

more difficult to determine, but you don’t think so? 

Mr. KELLEHER. Even for market making, the traders and the 

desk that the traders work for, all have allocations as to how much 

risk they can take on for the firm. So they are not willy-nilly trading in terms of market making. They know it and are tracking it 

minute to minute. The other thing at a macro level, any bank can 

do all of the market making they want. All they have to do is run 

basically a hedged book, or a flat book. Even a hedged book, a legitimately hedged book, you can do all of the market making and 

anything you want. 

The other thing is and we laid this out in the comment letters, 

much of the complaints about the need for inventory, particularly 

in the derivative space, there is no evidence that the banks are 

keeping that inventory anyway today, never mind tomorrow. So 

when you actually look at the facts as opposed to the claims, the 

application of the rule to the actual market making activities that 

they claim to engage in, either are actually being done at a very 

low level and can be done relatively easily in compliance with the 

law. 

Mr. CARNEY. So you don’t think it is big—Mr. Hambrecht, your 

view of that? 

Mr. HAMBRECHT. I agree with Mr. Kelleher. I think it is normally 

very clear what the goal of making a market is. And if it is to keep 

an orderly market and to keep basically the right to get most of 

the order flow, as it is for most specialists, there is an obligation 

to put out some capital to keep an orderly market. But that is always based on the premise that you are going to move the stock 

along. 

Mr. CARNEY. It will be as obvious to the regulator as it is to the 

manager of the— 

Mr. HAMBRECHT. Oh, yes, I think the idea that regulators can’t 

figure it out just isn’t true. We deal with the SEC all the time. 

They know how capital markets work. 

Mr. CARNEY. Fair enough. So what about Mr. Quaadman’s notion 

that we should approach it through capital requirements as opposed to prohibitions, I guess? 

Mr. HAMBRECHT. My position would be any exemption you give 

should have additional capital requirements or margin requirements placed on them as an added safeguard. 

Mr. CARNEY. So you don’t dismiss it as an effective tool? 

Mr. HAMBRECHT. No, I think it is an added safeguard that someone can’t build these massive positions and suddenly people find 

out about it when it is too late. 

Mr. KELLEHER. Capital has to be a complement to the other 

rules. 

43 

Mr. CARNEY. Right. Fair enough. So one more question about 

that. What would you say to Mr. Quaadman’s concerns about the 

company treasurers, and what they would have to do with respect 

to holding more capital, given the various rules and regulations 

that are coming down? 

Mr. HAMBRECHT. Oh, I think it has very little effect on cash balances in a corporation. That is much more a function of taxes and 

future needs of capital. I think, basically, most corporate treasurers 

would tell you that the technology that has been brought into markets today has made transaction costs come down significantly, and 

that they can raise money now on a much lower cost. Equity trading has gone from what used to be anywhere from 1 to 5 percent, 

down to 10 percent of 1 percent. And that will happen in the debt 

markets. 

Mr. CARNEY. Thank you very much to the whole panel. I found 

your testimony very helpful. 

Dr. HAYWORTH. And the gentleman’s time has expired. The Chair 

thanks the panel for their testimonies. 

The Chair notes that some Members may have additional questions for the panel, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 30 days 

for Members to submit written questions to these witnesses and to 

place their responses in the record. 

The hearing is adjourned. 

[Whereupon, at 11:22 a.m., the hearing was adjourned.] 

(45) 

A P P E N D I X 

December 13, 2012 

46 


79694.001

Rep. Peter King: Statement for the Record, Dec. 13, 2012 

FSC Hearing: "Examining the Impact of the Volcker Rule on Markets, Businesses, 

Investors and Job Creation, Part II" 

Mr. Chairman, thank you for caIling today's hearing. The Volcker Rule, enacted as a 

part of the Dodd-Frank Act, carries significant implications for my home state of New York as 

well as for the national economy and U.S. financial markets. The complexity and cost of this 

rule is evident in the regulators' 298-page proposal, which elicited some 18,000 comment letters 

and would require some 6.2 million private sector man-hours to achieve compliance. 

Furthermore, there is no date certain for finalization - so businesses are left guessing what 

activities will be prohibited and which will be deemed appropriate, and when. 

IfVolcker is put into place as currently written, it could sap market liquidity, depress the 

value of pension plans and retirement accounts, make it costlier for state and local govemments 

to raise funds, and place U.S. financial firms at a competitive disadvantage with foreign 

counterparts. It could even jeopardize New York's role as the financial capital of the world, 

which would carry economic repercussions well beyond the state. 

To address some of the many concerns regarding the Volcker Rule, I introduced the U.S. 

Financial Services Global Viability Act (!f.R. 6524). My legislation would suspend enforcement 

of the Volcker Rule at least until <?ther international competitors have adopted similar statutory 

restrictions. As many here are well aware, the Volcker Rule prohibits proprietary trading, but as 

written willlikeIy have the unintended consequence of preventing U.S. firms from engaging in 

market-making and underwriting activities for their customers. This will place the U.S. at a 

competitive disadvantage in a global financial marketplace - causing capital and certain trading 

operations to move offshore. To prevent this potential harm to the American economy and to 

provide for a level international playing field, the enforcement of the Volcker Rule should, at a 

minimum, be suspended until other international competitors have adopted and are abiding by 

similar statutory rules. 

The Volcker Rule was originally conceptualized for adoption on an international scale. 

But while other nations' regulators balked at putting it into place, Section 619 of the Dodd-Frank 

Act applies it to a wide range of U.S. financial institutions. Any insured bank or bank holding 

company, as well as nonbank financial companies regulated by the Federal Reserve, will be 

burdened with this new level of compliance. With our economy still struggling to regain its 

footing, this is not the time to give businesses a reason to cut their U.S. workforce or move 

investments to foreign competitors overseas. 
47 


79694.002

United States House of Representatives 

Committee on Financial Services 

Ezll.1:D.iniLlg the ItnPllct oftbe Volcket'Rule on Mukets, 

Businesses, Investors, lind Job Ct:elltion, Put II 

Written Testimony by James R. Barth, Lowder Eminent Scholar in Finance, Auburn University; 

Senior Finance Fellow, Milken Institute; and Fellow, Whatton Financial Institutions Center 

December 13, 2012 

Chairman Bachus, Ranking Member Frank and members of the committee, thank you for the 

oppottunity to testify today on section 619 of the Dodd-Frank Wall Street Reform and Consumer 

Protection Act, also known as the Volcker Rule. I would like to note that my testimony is not 

offered on behalf of any institutions that I am affiliated with but represents my own view. 

My opinions are based on my experience as an academic studying financial institutions and markets 

and as an official at bank regulatory agencies. I am now on the faculty at Auburn University and 

previously was on the faculty at George Washington University. In addition, I have served as 

director of the Office of Policy and Economic Research of the Federal Home Loan Bank Board and 

chief economist of the Office of Thrift Supervision. I have also held positions as visiting scholar at 

the Congressional Budget Office, the Federal Reserve Bank of Atlanta, the Office of the 

Comptroller of the Currency, and the World Bank. In my scholarly research and government 

service, I have studied the performance of hundreds of financial institutions, including the causes of 

distress for many that failed. In addition, I recently published several articles and books on financial 

crises, their causes, and their lessons. 

The Volcker Rule prohibits banking entities from engaging in proprietary trading activities and limits 

their ability to invest in, or have certain relationships, with hedge funds and private equity funds. 

Certain activities are exempted from these prohibitions subject to prudential backstop provisions. 

The rule's purpose is to prohibit activities that could create excessive risks for banking entities and 

conflicts of interest. 

I believe the Volcker Rule is based on an incorrect premise, will be extremely difficult to 

implement, and, worse, will produce harmful economic effects. 
48 


79694.003

There is no evidence to support the belief that proprietary trading was a cause of the recent or any 

other financial crisis. In fact, all the evidence points to the contrary. The most recent crisis was 

triggered by poor lending and underwriting practices in the real estate sector, and excessive leverage 

by and insufficient liquidity at banking entities, not by proprietary trading by banks. 

The implementation of the Volcker Rcle will require regclators to distinguish between prohibited 

proprietary trading and permissible activities such as market marking, hedging, and underwriting on 

behalf of customers. Because these permissible activities sometimes appear similar to proprietary 

trading, it may be virtually impossible for regclators to draw a bright line between the prohibited and 

permissible activities that is not arbitrary. To the extent that regu1ators err on the side of restricting 

beneficial trading activities, or that the regclation deters banks from engaging in some permissible 

activities, the resclt will be banks providing less liquidity in the market. This, in turn, will increase the 

bid-ask spread on securities: Issuers will pay higher interest rates in the primary market to raise 

capital, and investors will pay more to purchase securities and receive less when selling them in the 

secondary market. All these developments harm markets, businesses, investors, and job creation. 

As banks are denied the opportunity to engage in profitable trading activities, they may be driven to 

engage in ever more risky activities in an attempt to provide investors with an acceptable return. The 

Volcker Rcle may therefore lead to riskier, not less risky, banks. The ru1e may also place U.s. banks 

at a competitive disadvantage to banks in other countries. In addition, the ru1e-while attempting to 

limit risk-taking at banks-may shift this risk-taking to less-regclated parts of the financial system 

that are less resilient shocld losses arise. 

Let me elaborate on this last point. The January 2012 Report of the Financial Stability Oversight 

Council notes that even before the ru1e has been imposed, "major banking entities have taken or 

announced steps to sell, spin off, or close down their standalone 'bright line' proprietary trading 

businesses." What will happen to these proprietary trading businesses? They will be conducted at 

non-banks. This seems to be starting already. The media has reported on proprietary traders moving 

from banks to non-banks and to hedge funds in particular, with headlines like "Banks move high 

risk traders ahead of U.S. ru1e" (Reuters), "Billion-Dollar Traders Quit Wall Street for Hedge Funds" 

(Bloomberg), "Deutsche Bank Head Debt Trader Cornut Leaves for Hedge Fund" (Bloomberg) and 

"Traders flee big-bank regclations to start own hedge funds" (New York Post). 
49 


79694.004

If proprietary trading simply carries on at hedge funds and other non-banks including non-financial 

finns, the question then becomes: Is the forced migration of proprietary trading from banks to nonbanks more likely to increase or decrease financial stability? To address this issue, I recendy 

conducted a preliminary examination of 22 years of very large individual trading losses with Donald 

McCarthy, an economist based at Econ One Research. We found that these trading losses were in 

no way limited to banks or financial services finns. Rather, they occurred at a range of firms, 

including banks, investment banks, hedge funds, and manufacturing firms. Even a local government 

authority was involved. We also found that these individual losses at banks -while as large as or 

larger than losses at non-banks -were smaller by far as a share of equity capital. That is, the losses 

at banks were less threatening to solvency than the losses at non-banks. 

lbis raises the possibility that instead of increasing financial stability, the Volcker Rule may actually 

decrease financial stability by shifting risk-taking activities from banks, which by and large have been 

more successful at absorbing the trading losses identified, to non-banks, which have been much less 

successful at absorbing losses, judging by our examination of the past several decades. 

Since 1990, we identified at least 15 instances when individual traders lost at least $1 billion (in 2011 

dollars). These 15 trading losses totaled nearly $60 billion and ranged from a low of $1.1 billion on 

ill-fated foreign exchange derivatives at a Japanese Shell Oil subsidiary to a high of $9 billion on 

credit default swaps at Morgan Stanley. News coverage of trading losses tends to focus on their size; 

and it is this information that I present in Table One. 

It should be noted that just four of the 15 finns were banks: Societe Generale, JPMorgan Chase, 

Union Bank of Switzerland (UBS), and Deutsche Bank. The rest were non-banks. Two were 

investment banks (Morgan Stanley, which became a bank the year after the loss, and Barings Bank); 

two were hedge funds (Long Term Capital Management and Amaranth Advisors); and one was a 

local government (Orange County). Fully six of the 15 were manufacturing or petrochemical firms: 

Surnitomo Corporation (a Japanese diversified industrial conglomerate), Aracruz Cellulose (a 

Brazilian wood pulp processor), Kashima Oil (a Japanese oil refiner), CITIC Pacific (a Chinese 

diversified industrial conglomerate), Metallgesellschaft (a German manufacturer), and Showa Shell 

Sekiyu (a Japanese oil refining subsidiary of Shell). 
50 


79694.005

Name of Come!!l 

(1) 

1.MDflIIIIlS_ 

2.SociOI6-. 

3 . .JP MDflIIIIlChase 

4. Amaanth AcNaors LtC 

5. Long Term C8pita1_ 6. $umitomo Corporation 

7. UBS 

8. Aractuz Celulose 

9. Orange C<>Unty 

10. Kashima Oil 

11. Barings a ..... 

12. cmcPacilc 

13._eIIschalt 

14. Deutsche Bank 

15. Showa Shatl Sekiyu 

Table One 

Magnitude of Trading Losses 

Absolute Losses 1990 - 2012 

Tl!!!of~ Year on.OSS 

(2) (3) 

hnestment Bank 2007 

a ..... 2008 

aank 2012 

~Fund 2008 

~Fund 1998 

MI¥UlfactulerJ Oil refiner 1998 

Sri 2011 

Manufacturer f Oil refiner 2008 

- 1994 

Ma'lUfacturerJQilrefiner 1994 

Imestment Bank 1995 

Manufacturer J Oil tefiner 2008 

Manufacturer / Oil refiner 1993 

Sri 2008 

ManufactuJer I Oil refiner 1993 

Size ~Loss 

(2011 00fIIn) 

(-..) 

(.) 

9,605 

7,546 

7,500 

6,567 

5,828 

3,544 

2,300 

2,224 

2.121 

2,127 

2,028 

1,963 

1,662 

1,879 

1,520 

58,661 

Sources: Press reports. company annual Md quarterty reports. 

StaeofTotai 

(5) 

16% 

13% 

13% 

11% 

10% 

6% 

4% 

4% 

4% 

4% 

3% 

3% 

3% 

3% 

3% 

It is perhaps surprising that almost half the losses by individual traders were not at financial services 

firms but at the types of institutions that typically are thought to use financial products not for 

speculation but for hedging purposes with very little risk. However, in both the number of trading 

losses and the size of these losses, non-financial firms 100m large. In terms of total losses, 26 percent 

occurred at manufacturing or petrochemical firms or local governments, and 74 percent occurred at 

financial services firms. Of this 74 percent, 33 percent of losses occurred at banks, 21 percent at 

hedge funds, and 20 percent at investment banks. The losses of non-financial firms tended to be 

smaller in absolute terms than the losses of financial services firms. Yet, it is quite clear that the 

trading problem is not limited to Wall Street or the City of London; Main Street firms are at risk of 

trading losses as welL 

While the magnitude of these losses is staggering, some perspective is appropriate. Trading losses 

that risk eroding a firm's capital in its entirety are more important-to the institution, to other 

market participants, and (in the case of banks) to the federal deposit insurance fund or to 

taxpayers-than bigger losses at larger and better-capitalized firms. Other things being equal, a 

better-capitalized institution can sustain bigger trading losses, so it is less likely to fail and impose 

costs on counterparties, taxpayers, and (in the case of systemically important institutions) the 

financial system in general and perhaps on the economy as a whole. 

4 
51 


79694.006

(1) 

1.Morgan5_ 

1. Soci8t6 Gen6raIe 

2. JP Morgan Chase 

3. Amawlth AcWSOfS LLC 

4.l.ongTennCapltalMIr18gI!RI8!I1 

5. Sumitomo Corporalion 

6. UBS 

7. AIaeruz: Cefulose 

8. Ononoe County 

9. Kashima Oil 

10._Bank 

11. 12. cmc 

__ Pacilc 

13. 0eu1 .... Bank 

14. S'-" Shell 5ekiyu 

Table Two 

Magnitude of Trading Losses 

Relative Losses 1990 • 2012 

Si%eofloss p.,.,.".", 

(2011 Dollars) Assets 

( .... ) 

(2) (3) 

9,605 0.9% 

7,546 0.4% 

7,500 0.5% 

6,567 65.0% 

5,829 3.4% 

3,544 5.2% 

2,300 0.1% 

2,224 19.1% 

2.127 7.3% 

2.1Z7 nlo 

2,ll29 nlo 

1,983 16.8% 

1,662 13.0% 

1,879 0.1% 

1.520 13.2% 

loSs as Share of 

Percent E_ of 

(-) 

(4) 

29."" 

12.0% 

6.1% 

260.0% 

93.6% 

nlo 

3."" 

52.0% 

19.7% 

nlo 

296.7% 

36.9% 

nlo 

'.0% 

66.2% 

Sources: Press reports, company annuaIa'KI quartefty reports. 

Pen:enl of Tier 1 

Captial 

(5) 

26.2% 

15.4% 

8.5% 

nlo 

nlo 

nlo 

5.3% 

nlo 

nlo 

nlo 

nlo 

nlo 

nlo 

3.9% 

nlo 

Table Two presents the same 15 trading losses from a different perspective. In addition to the 

absolute magnitude of the losses, they are presented relative to the total assets, equity, and-for 

banks-tier one (core) capital the institutions had at the time the losses were recognized. Both 

equity and tier one capital are measures of a firm's ability to absorb losses without being pushed into 

insolvency, which occurs when the value of a firm's total assets is less than the value of its total 

liabilities. When a firm has a large equity cushion, other things being equal, it is more able to absorb 

trading losses. Tier one capital essentially consists of equity and retained earnings less certain types 

of intangible assets, Regulators in the United States and abroad set capital adequacy standards based 

on tier one capital and monitor the ratio of a bank's tier one capital to total assets. Seen through this 

lens, the losses at banks appear less worrisome than those at non-banks. 

Three of the 12 firms for which we have information about their equity suffered individual trading 

losses of at least $1 billion nearly equal to or greater than their equity cushions. All three were nonbanks (hedge funds Amaranth Advisors and LTCM and investment bank Barings Bank), and all 

three either failed or were bailed out. LTCM was bailed out by a government-arranged consortium 

of its trading counterparties, while Amaranth Advisors arranged a transaction whereby JPMorgan 

Chase and hedge fund Citadel Investment Group took over its energy portfolio and then liquidated 
52 


79694.007

the rest of its holdings-a failure in form if not in name. Barings Bank-one of the UK's oldest 

financial institutions at the time-was allowed to fail by the Bank of England, and administrators 

were called in to dispose of its assets. 

All of the remaining firms for which we have information about their equity suffered losses smaller 

than their equity cushions. Four of the nine had losses of 25 percent or more of equity, and two had 

losses between 10 percent and 25 percent of equity. All four institutions with losses of 25 percent or 

more of equity were non-banks: Showa Shell Sekiyu, Morgan Stanley, Aracruz Celulose, and CITIC 

Pacific. All survived, however, with the possible exception of Japanese oil refiner Showa Shell 

Sekiyu, although each was forced to seek additional funding from outside investors to rebuild its 

capital or to seek capital from its parent corporation. 

Of the two institutions with losses between 10 percent and 25 percent-Orange County and Societe 

Generale-one failed. Orange County suffered bankruptcy despite the fact that its counterparty in 

the ill-fated trades-Merrill Lynch-loaned Orange County $2 billion of a $2.5 billion credit line 

after the losses. Societe Generale was the only bank to suffer an individual trading loss of this 

magnitude relative to its capital, and it increased its capital by some 5.5 billion euros (more than $8 

billion) after the discovery of the losses by issuing additional rights to stockholders at a steep 

discount to the market price. 

The remaining three institutions-JPMorgan Chase, UBS, and Deutsche Bank-suffered losses of 

less than 10 percent of equity. JPMorgan Chase's losses, while vast, were not large enough relative to 

its equity cushion to present a solvency problem and did not compel the bank to raise additional 

capital. Similarly, the huge losses at UBS were substantially less than its equity capital and presented 

no solvency problem for the Swiss banking giant. Thus, while the Swiss Financial Market 

Supervisory Authority (in conjunction with the U.K.'s Financial Services Authority) initiated formal 

administrative enforcement proceedings against UBS in February, the focus was on "assess[tng] ... 

the adequacy of the controls that were in place to prevent and detect unauthorized trading," and 

UBS has not been required to raise additional capital. Deutsche Bank's losses also presented no 

solvency problems and did not require it to raise additional capital. In addition, the "tier [one] capital 

ratio [to risk weighted total assets] of the bank has remained at over 10%" in 2008, according to its 

financial statements. As with UBS and JPMorgan Chase, the losses primarily presented an earnings 

problem for the bank, which lost 5.7 billion euros in 2008 before taxes (about $8.4 billion). 

6 
53 


79694.008

Table Three compares the relative magnitude of the individual trading losses identified at particular 

types of firms to the relative magnitude of losses in general for the period 1990-2012. It is no 

surprise that the banks' losses, accounting for 0.2 percent of toral assets and 5.3 percent of their 

equity, posed relatively little risk to solvency. Investment banks are considerably riskier with losses 

equal to 0.9 percent of total assets and 34 percent of equity. This suggests that the leverage of the 

investment banks experiencing losses between 1990 and 2012 was considerably higher than that of 

the banks with losses over the same period. 

It may surprise critics of the financial services industry that the next most risky firms in terms of 

solvency are manufacturing and petrochemical firms-firms that typically are end-users of 

derivatives and other financial products. However, this class of institutions experienced average 

losses of 9.5 percent of total assets and 47.9 percent of equity. Unlike investment banks that lost 

money, the issue is not clearly one of leverage, but of the size of the losses relative to both total 

assets and equity of the firms. Finally, the most risky are hedge funds, which experienced losses 

equal to 7 percent of total assets and 140 percent of equity. The issues would appear to be largely 

one of debt for LTCM, which was leveraged about 25 times, and one of the size oflosses relative to 

total assets for Amaranth Advisors, which was leveraged just four times. 

Bank 

Hedge Fund 

_""""'Bank 

MMufacturer I Oil reIner 

Gowmment 

Tot" 

Table Three 

Magnitude ofTrading Losses 

Relative Losses 1990·2012 

Sizedloas Share cATotai 

(2011 00IIanI) losses 

(....,.) 

19.225 33% 

12.395 21% 

11.633 20% 

13.281 23% 

2.127 .% 

58,661 100% 

Loues as Shtn fA 

Tdal Not 

Assets 

E_ 0.2% 6.5% 

6.8% 141.6% 

0.9% 34.2% 

9.5% 47.9% 

7.3% 19,]% 

0.6% 142% 

Sources: Press reports, compWly amuaI and quarterty reports. 

Table Three should give pause to those who believe the Volcker Rule will enhance our country's 

financial stability. Trading appears to be less risky when carried out at banks than at non-banks. The 

important point of this exercise, however, is that one should not focus on trading losses per se, but 

on potential trading losses relative to equity capital, which reflects a firm's ability to absorb losses. 

Excessively leveraged firms are clearly less able to absorb trading losses~r any losses, for that 

matter. Moreover, some large trading losses did occur during the financial crisis, but mortgages 

7 
54 


79694.009

based on poor lending and underwriting quality were largely to blame rather than the trading itself. 

And the most leveraged firms suffering these losses were in the greatest jeopardy of insolvency. 

The focus of regulation should therefore be on ensuring that banking entities have sufficient 

capital commensurate with their risk, not on separating some investment bank activities 

from commercial banking. 

Furthermore, as noted earlier, proprietary trading per se was in no way the cause of the last financial 

crisis, nor was it the cause of any financial crisis in the United States or abroad of which I am aware. 

The more regulators prohibit or limit banking activities, the more they may create incentives for 

these activities to move to non-banking firms. In addition, such regulations may make banks less 

profitable and more willing to engage in other more risky activities. This may well have the effect of 

making banks less sound and decreasing overall financial stability. 

In conclusion, I see very little, if any, upside to the Volcker Rule, but substantial costs to markets, 

businesses, and investors. That the rule is well-intentioned and banks may survive it is not the issue. 

The issue is whether the benefits exceed the costs. There is no evidence that this is the case, and my 

reading of the evidence is to the contrary. It is therefore difficult to justify such a major 

organizational change in banking. 

8 
55 


79694.010

WR HI.'IECHT+CI 

December 11, 2012 < 

Spencer Bachus, Al, Chairman 

Barney Frank, MA, Ranking Member 

U.S. House of Representatives 

Committee on Financial Services 

Washington, DC 20515 

Dear Sirs, 

Thank you for your invitation to testify at the hearing. "Examining the Impact of the Voleker Rule on 

Markets, Businesses§ Investors and Job Creation, Part II" on Thursday, December 13, 2012. 

I was a member of the Investors' Working Group, an independent taskforce sponsored by CFA Institute 

Centre for Financial Market Integrity and Council of Institutional Investors. which was co-chaired by 

Arthur levitt and William Donaldson. The committee was founded in 2008 and submitted its report in 

July 2009. Our report recommended imposing careful constraints on proprietary trading at depository 

institutions and their holding companies. "Proprietary trading creates potentially hazardous exposures 

and conflicts of interest, especially at institutions that operate with explicit or implicit government 

guarantees."l When the committee was disbanded, I was asked to respond to questions about 

proprietary trading and provide continuity to interested parties. 

The Volcker Rule 

The Volcker Rule was first proposed in the wake of the FinanCial Crisis of 2008, and called for a direct 

ban on proprietary trading. However, as the crisis began to subside, the proposal's inclusion in the 

Dodd~Frank Act was changed to allow banks to continue proprietary trading with defined limitations. Its 

intent, or course, was to limit the major banks from engaging in speculative trading that would endanger 

customer deposits or accounts; and in particular, limit the bank's scope of trading and any systemic risk 

that would create a "too big to fail" crisis. 

The subsequent debate and incluSion of exemptions has led to much inquiry on how to define certain 

aspects of the Act. At the most basic level, the vital question is whether a trade is providing liquidity to 

the marketplace to help a client, or whether it is a proprietary trade. In today's environment of 

sophisticated derivative instruments and algorithms, this question Is incredibly difficult to answer. 

Congress has expended great effort to limit systemic risk from proprietary trading, yet still keep as much 

liquiditv as possible in the current market system. 

The Volcker Rule permits a number of client-oriented trading by banking entities. But those so<alled 

"permitted activities" are also subject by the statute to additional capital charges, leverage limits, or 

other restrictions as the regulators deem appropriate. My testimony today will focus on how to 

improve The Volcker Rule by enhancing and clarifying the role of restrictions on leverage. 

1 US. Financia! Regulatory Reform: The investors' Perspective (A Report by the Investors' Working Group, 

Sponsored by CFA Institute Centre for Financial Market Integrity and Coundl of Institutional Investors, July 2009} 

page 3 
56 


79694.011

WRHlM •• UHT+CI 

Financial Crisis 

The repeal of The Glass-Steagall Act in 1999 allowed for the combination of Investment Banks and 

Commercial Banks. SignifICant consolidation followed and in 2002, these broker-dealers were allowed 

by the Securities Exchange Commission to increase their leverage from 12-13x to 30x the value of their 

equity, a freedom that no other financial institution was afforded. The leverage limits were regulatory 

guidelines, not statutory requirements, as the existing net capital rules allowed almost unlimited 

leverage. This increase in large part led to a catastrophic financial failure felt the world-over in 2008. 

While the Financial Crisis of 2008 had far-reaching and deleterious effects throughout virtually every 

level of the global economy. the epicenter of the crisis itself was largely confined to six "bulge" brokerdealers: The Bear Stearns Companies, Inc.; Citigroup, Inc.; Goldman Sachs Group, Inc.; JPMorgan Chase 

& Co.; lehman Brothers Holding Inc.; and Morgan Stanley. In the wake of this crisis, two ofthe above 

broker-dealers failed. three came perilously close to failure, and one had a strong enough commercial 

bank balance sheet to weather the storm. Today, they are all bank holding companies, some with 

significant depository banks within the group. 

Also caught up in the wake of this crisis were literally hundreds of hedge funds, broker~dealers, and 

commercial banks, which although sorely wounded. survived the bubble with minimum or no 

government support. Because of the existing market discipline on these "small enough to fail" firms, 

there were no failures that threatened the financial system as a whole. 

The Key to Almost Unlimited leverage - The Broker-Dealer Exemption 

Broker-dealers liquidity is measured by a daily capital Adequacy Rule which is designed to limit capital 

commitments. They are allowed to net--out their longs and shorts to calculate their net capital 

requirements on the assumption that as market makers, ~hey are providing liquidity to the market. As 

such, they are exempt from normal margin rules that control the leverage of other active trading hedge 

funds and indiViduals. This "dealer exemption" created a vehicle that allowed almost unlimited leverage 

and the dealer's ability to borrow stock from his customer base gave him an extremely low cost of 

capital. In practice, however, even though they had to get "down" to 30x leverage by market close. 

many traded up to 3 or 4 times that during the course of the trading day, which provided a substantial 

loophole as capital adequacy is calculated at the end of the day. During the financial crisis of 2008, 

these enormous capital risks were rationalized by hedges of large short positions that were assumed to 

act rationally, but in reality seldom do In a crisis environment. 

A great deal of trading today has moved to so called "dark pools" which are essentially providing a 

"matching" platform for buyers and sellers. While it is difficult to find reliabfe data, we estimate that 

specialist trading has ranged from 3~9% of total volume, and bulge firms now account for 2SR 30% of dark 

pool trading in competition with customer matching orders. Agency fees have fallen to 1()"20 mils per 

share, indicating that equity trading is a very competitive market. Debt and other instruments have 

much less transparency, so it is difficult to estimate volumes, but the recent Blackstone announcement 

of a crossing system for debt suggests the same kind of matching platforms will add to liquidity and 

competitiveness in debt markets. 
57 


79694.012

WRU.IIECRT+CO 

The Key to "Free" Money and leverage - The Prime Brokerage Business 

Most of the 6 broker-dealers that were seriously affected during the financial crisis were major players 

in the "prime brokerage" business. Since most hedge funds are short sellers to protect against major 

declines, these prime brokers were the overwhelming beneficiaries of the credit balances created by 

short sales. 

OeUversstoc:k 

,:>"J!tlY:~1"0"~\i:,~j[/+----- onto.!:"of 

Hedge Fund 

The process described above created cash balances at the prime brokerage that effectiVely helped 

finance the broker--dealers' massive trading accounts without paying interest and without any lender 

discipline. The remaining cash needed to finance these accounts came largely from the repo market and 

overnight loans. These loans are largely governed by balance sheet scale and are generally made only to 

the very large banks. 

Both sources of cash are subject to little lender discipline and as such, at any signs of trouble, the market 

shuts down quickly. In this case, the repo market will "dry up" after the morning repayment, and the 

hedge funds will move their accounts to a "safer" home, forcing the prime broker to return the collateral 

cash when the short position is moved to another broker. 

This constitutes a proverbial "run on the bank;" not by commercial bank depositors, but by hedge funds 

and repo lenders. This is why the CEO of Bear, Stearns In February 2008 could claim over $20 billion of 

cash at the start of the week, and have virtually run out of cash by the end of the same week (see Exhibit 

1, lehman Brothers and Bear, Steams Balance Sheets). 
58 


79694.013

WRHIMIIECHT+C8 

Non-Transparent Markets - Where the Market Fails 

In a normal market environment, when leverage reaches a certain threshold, the owner of the trading 

position is forced to liquidate or reduce his position and payoff the lender. In the 2008 financial crisis, 

this did not occur as the mortgage securitization market was on over~the--counter market dominated by 

a small number of firms where tacit cooperation and selfMinterest among traders led to markets being 

maintained at unrealistic valuation despite the underlying assets of the mortgage securities steady 

deciine. 

Dealers when acting as specialists on an exchange platform must abide by specialist rules that generally 

include an obligation to maintain a market in diffICult environments. In a dealer market off the 

exchange, there are no such obligations and a combination of order flow knowledge and profit 

incentives for traders, generally means that traders move in front of or with trading direction. Instead 

of providing liquidity against flow orders, in practice they add to the volatility. 

In the case of OTC trading in securitized products and swaps, by the time that the risk was identified, 

there was no one in the marketplace willing to buy the positions, and therefore, the traders tried to hold 

pricing levels in the hope that other firms or funds would step in and purchase the positions. When no 

buyers materialized, these firms were forced to liquidate, resulting in huge and dramatic losses. For 

example, Merrill lynch's COO assets were valued at $30.6 billion as of mid~June of 2008, yet were sold in 

July 2008 for $7 billion. This downturn should not have been so dramatic and a more transparent 

market place should have reflected a more moderate market decline over a longer period of time. 

A Solution that Worked in the Past 

The Volcker Rule has often been compared to the Glass-Steagall Act of 1933, which was enacted as a 

result of the stock market crash in 1929. And, many observers of the Glass-Steagall Act point out that 

the underwriting abuses that it purportedly targeted were not the real problem. The Securities 

Exchange Act of 1934 passed control of margin requirements to the Federal Reserve System in order to 

give them control over leverage. Thus, the commercial banks were separated from the investment 

banks, and the investment banks were subject to market discipline on how much risk and leverage they 

could take. This worked reasonably well for almost 70 years, and during that time the United States 

enjoyed global leadership in equity and debt markets. 

The governing principles for the majority of those seven decades were as follows: 

(1) lending only on exchange traded instruments; and 

(2) Immediately selling out those positions that exceeded explicit margin requirements. 

In the final analysis, allowing a small group of systemically Significant broker~dealers, especially bankback ones, unlimited leverage and with essentially tax payer~backed, Iow~cost financing. ultimately 

created a systemic risk that almost brought the whole financial system down. 

When the market finally reflected the declining values in the mortgage market the short-term borrowing 

disappeared, and the hedge funds moved their short positions with the cash collateral, which created a 

proverbial "run on the bank." 

4 
59 


79694.014

WRHlMIIECHT+t:O 

The underlying concept of margin requirements is to limit possible losses to the amount of resources 

pledged against the loan, and would help insure that the broker~dealer balance sheet, which includes 

customer credit balances, would not be put at risk. 

It is important to recognize that the leverage created in the system by the six aforementioned broker~ 

dealers was legal, and the participants were not some rogue operators, but rather were the leading 

financial institutions in the marketplace. As trading technology commoditized traditional broker-dealer 

agency activity and eroded brokerage fees, the major firms moved aggressively towards proprietary 

activities to maintain their financial scale. 

Summary 

While broker~dealer balance sheets are remarkably opaque, it is now clear that the excessive leverage 

on the balance sheets of the too-big-to fail broker-dealers, now banks, were created by an absence of 

debt discipline and a dealer market that did not reflect true price discovery. 

The bankruptcy of MF Global Holdings only reinforces the weakness of the capital adequacy rule, which 

allowed a broker-dealerto use its own balance sheet to support large trading positions. MF Global was 

leveraged by 34x its equity and used these funds to take a large position in European debt, yet was likely 

in compliance with the net capital rule. The "london Whale" incident at JPMorgan highlights how 

Similar trading losses remain a problem in the core banking world as well. 

The Volcker Rule, when it is finalized, should help restore some of the market discipline. It is important 

to remember that the law appUes to both bank-affiliated firms and to systemically signifttant non-bank 

financial companies - thus ensuring that should any large stand-alone broker-dealers re-emerge, they 

will be covered too. However, to enhance The Volcker Rule's efficacy, the final version should also 

include limitations in leverage and additional capital charges to those activities that it permits, such as 

market making, along the line of what I have discussed today. 

Respectfully submitted, 

William R. Hambrecht 

Chairman 

WR Hambrecht + Co 

Attached: Exhibit 1, Balance Sheets for lehman Brothers and Bearl Steams 
60 


79694.015

WRUI.IUHT+C8 

lehman Brothers 

~ 

""'''''-

:!.s.::~ 

==~U\cIt!rAQrMm,T\lcRa<JII 

--

GmtsPn>petly.PIant&~ 

--

NIoIPn!ptny,,,,,,,,, .. ~ 

...... -,- 1 ..... ,inOR(_~~ 

==-

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===-

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Exhibit 1 

Lehman Brothers and Bear, Stearns Balance Sheets 

itS.lIUI 

37,14110 

5,716.0 

(2.191.0 

"10U! 

2*,542..0 

35.711.0 

, .... , 1z.r43.0 

162,636.0 

136,59lI.O 

<13.271.0 

""'., 

!2,438.!I! 

:J.MU 

3,::: 

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&,317.0 20,0+4.0 21.917.0 

2.3($.0 

7.5&'_0 t,lI1UI 

1$. •. 0 13.031.0 

218,010,0 2211U1M 

, ..... 0 

1!S8~15.0 124,$42.0 

M,.3'IIII.O 41,121.0 

6.758.0 11.01$.0 

!2.iIG1.O} \2.M7.!J) 

"' •. 0 ...... 

13.51i15.0 5.6811.0 3.0t7_0 114,.451.0 48,8M.O 

SO,41UI 

15.112.0 

203,IJgUI 

17.14411 

11,157.11 

2Y.3M.O 

1"3,907.0 

120.331.\1 

64.301.0 

l$,oaO 

'''''''' 16,IIOUI 

6.1.0116.(1 

1I.8CQ,Q 

222.m.1I 

123.118.0 

5,004.0 '.',507.(1 30,014,11 24.0350 29,3&111 2$,828.11 28.355.11 

1.~.1I 2,99a.O 

1,"$.0 ,-, 

". O,IMO.O 9.7».0 

18.1330 111.'1511 10,$08.0 I\U0111 

(II.seo.O) (11,11$8.0) (II.524.0) (5.1(11.0) (4,m.0) 

E,210.0) 12.482'11} (U73.O) (Ui82D! (:4,025.0) :to,-., .. "., 2f,:tI!.O 2.1,I3t.O '1,20.0 

6 
61 


79694.016

WR RlIIIECIT+CI 

Bear, Steams 

~:~~~, 

~ ....... 

"""""- CIIItI&s-dIa~ 

....... ""'" SIcIIr1IIMPun:/tU\dlr~ToRlHll 

------

GfouPfoperty,PIant&E~ 

--

NlIIPnIpMty,PIInt&£quIpnItIIt 

lrwuI.lnOllllt..-lEqulysea.!tles 

~T ... ~,LT 

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l.orIg-T_oe.tt 

TIVItPref.1IecuI'IIM -_ """"""'-...... , ... -

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--''-''-~l!Ic.andOOW 

TOIaI Common EquIty 

~,595.0 11.178.3 iB,itt6 21,406.0 2O,M.0 

$.80(.0 8,125,9 4.652.6 13.$,8 1:2,81)0.0 14.9100 

1119200.0 134,410.3 136,'101 12!1,869.8 122.518.0 118.201.0 

38.838.0 31,2480 4'2,271.1 32.1 .... .2 27.878.0 26,88&0 

80,523.0 92,049·1 80,039.0 82,!MS.O 87.1"'.0 

35,80UI "."" 42,2&'-5 52.m.O 52,1M4.0 

745.0 1,ISS.0 1.055.9 

1.632,(1 1,700.3 1,601.0 1.688.8 1,75oU 1.804.0 !1,:t! {l.~lJ (109.!! 11,:s~ (I,WI.O) 

..,., ('.1:'~ .... 0 

31Jl!7.o 41,482.6 42,&55.2 304,530.0 

1,431.0 1,464.0 

38,lU.O 41.1008 3U$4.0 39.&1<1.5 ~O -46,098.0 

8O,9B<l5 8II.56li,8 73,.80$.1 87,305.0 ,7,27'-0 

".018.0 2,016.0 2,9$&.8 3,060.8 2,952.0 1,213.0 

122,128.0 143,080.3 152,i5li.8 '"-084..4 143.804..0 lM.t720 

1.382.0 9.586.0 1,111$.0 

13,&50.0 91.880.9 1011,<1.51.0 102,169.1 8$,294.0 91,0113.0 

2$2,5 2&2.5 262.5 263.0 2lU0 

32,14'.3 33.$33.1 33,398.8 3O,:U5.0 35,O:WO 

21,130.0 24,1!II:IM 22.210.4 21,941.3 2O,0IS0.0 11.114.0 

;ori 

185.0 lU.8 1M.e lB5.0 135.0 

4,579.0 4,!IQ2.7 4,9lM 4.1166.3 4,988.0 5,819.0 

U85.0 9,894.11 10,211.3 10,338.2 9.4410 11.419.0 

(4,445.0) (4,610.8) (4.888,2) (S,33U} (5,6(Ul) (2.1113.0) 

2,0e6.1l 2.543.0 2,504.1 2.49O.1l 2.470.1l (!f!0) 

12,91 .... n.lI41.1 12,641.1 11,4011.0 ",SM.O 

7 
62 


79694.017

Dennis M. Kelleher 

President and CEO 

Better Markets, Inc. 

Testimony on "Examining the Impact of the Volcker Rule on Markets, Businesses, 

Investors and Job Creation, Part II" 

The Committee on Financial Services 

December 13, 2012 

Good morning Mr. Chairman Bachus, Ranking Member Frank and members of the 

Committee. Thank you for the invitation to Better Markets to testify today. 

Better Markets is a nonprofit, nonpartisan organization that promotes the public 

interest in the domestic and global capital and commodity markets. It advocates for 

transparency, oversight and accountability with the goal of a stronger, safer financial 

system that is less prone to crisis and failure, thereby, eliminating or minimizing the need 

for more taxpayer backed or funded bailouts. Better Markets has filed more than 110 

comment letters in the U.S. rulemaking process related to implementing the financial 

reform law and has had dozens of meetings with regulators. Our website, 

www.bettermarkets.com , includes information on these and the many other activities of 

Better Markets. 

My name is Dennis Kelleher and I am the President and CEO of Better Markets. 

Prior to that, I was a senior staffer in the Senate. Prior to the Senate, I was a litigation 

partner at Skadden, Arps, Slate, Meagher & Flom, where I specialized in securities and 

financial markets in the U.S. and Europe. Prior to obtaining degrees at Brandeis 

University and Harvard Law School, I enlisted in the U.S. Air Force while in high school 

and served four years active duty as a crash-rescue firefighter. I grew up in central 

Massachusetts. 

INTRODUCTION 

The Volcker Rule is, in many ways, very simple: it prohibits the handful of biggest 

too-big-to-fail banks from making high risk speculative bets, typically very, very big bets, 

usually but not always 1 with the banks' own money as distinguished from investing and 

trading their customers' money on their customers' behalf. This type of trading is nothing 

more than gambling. The reason for the rule is also simple: banks making such big 

speculative bets, usually with enormous amounts of borrowed money (i.e., the bets are 

highly leveraged), are very high risk and can pose a threat to the stability and solvency of 

JP Morgan's so-called "London Whale" loss arose from a bUill speculative prQJUietaO' trade usjD& 

federally jnsured depositors' mopey which was done to generate profits for JP Morgan yet which 

generated more than $6 billion in gross losses for the bank so far. This is a stark example of why a ban on 

proprietary trading by systemically significant too big to fail banks is so essential to protecting investors, 

taxpayers, the financial system and, indeed, banks themselves. This is discussed in detail below. 

1 
63 


79694.018

not just the particular gigantic bank making the bet, but also that bank's counterparties, 

creditors, customers and, indeed, the financial system as a whole and, ultimately, the 

taxpayers who will be called on to bailout the bank when the bet loses. 

Big banks gambling like this would be fine if it only threatened the betting bank 

and only the bank suffered the consequences. But that is not the case with proprietary 

trading by the biggest, taxpayer-backed, too-big-to-fail banks: they get the upside of their 

gambling and taxpayers get the downside when the bets go bad and the losses are lethal. 

as was evidenced in the recent financial crisis. It is only this type of very high risk 

speculative gambling by the biggest banks with their own or borrowed money for their 

own profit maximization that the Volcker Rule prohibits. Importantly, the rule expressly 

permits market making, risk mitigating hedging and other important legitimate types of 

banking activities. 2 

It is important to remember that the Volcker Rule is narrow in application 

and limited in scope: it only applies to the few banks that are so big that their failure 

would threaten the entire financial system and the country's economy - as they did in the 

financial crisis of 2008. Thus, it only applies to those banks that the federal government 

would spend any amount of money to prevent them from failing so that the country 

would not have to suffer a Second Great Depression, which almost happened as a 

consequence of the financial collapse of 2008. 3 

The Volcker Rule's prohibition is also narrowly targeted at a particularly 

pernicious, dangerous and, indeed, lethal type of big bank behavior: proprietary trading, 

where banks place huge bets with lots of borrowed money that promise enormous 

upside, but risk even greater downside. This type of conduct, a key reason for huge losses 

Better Markets has filed four comment letters with various regulatory agencies in connection with the 

proposed Volcker Rule, which detail and elaborate on the topics discussed here. Links to those comment 

letters are below and they are incorporated as if fuHy set forth here: ·Public Input for the Study 

Regarding the Implementation of the Prohibitions on Proprietary Trading and Certain Relationships With 

Hedge Funds and Private Equity Funds· (Nov. 5, 2010) available at 

httjr IIwww bettermarJsets com/sites/default/files/FSOC-%20Comment%20Letter·%20Volcker%2011· 

.5:1ll.i1J;!£ ·Prohibition on Proprietary Trading and Certain Relationships With Hedge Funds and Private 

Equity Funds" (Feb. 13, 2012) available at http'/Iwwwbettermarkets com/sites/default/files/SEC-

%20CI.-%20Volcker%20Rule-%202-13-12 pdf ·Prohibitions and Restrictions on Proprietary Trading 

and Certain Interests in, and Relationships With, Hedge Funds and Covered Funds (Apr. 16, 2012) 

available at 

~ 

http'llwww bettermar!rets com/sjtes/default/fiIes/CL%20CEfC%20FINAI.%20Volcker%20RuIe%204-

and "Prohibition on Proprietary Trading and Certain Relationships with Hedge Funds and 

Private Equity Funds (June 19, 2012) available at 

http:UwwwbettermarJsetscom/sjtes/default/files/SEC-%20CL-

%20Supplewental%20I&tter%200n%20V0lcker%20Rule%206-19-12.pdf. 

Better Markets did a comprehensive review of the costs of the crisis and, using lost and avoided lost GOP, 

concluded that the cost of the crisis will be no less than $12.8 trillion. See BETTER MARKETS, THE COST 

OF THE WALL STREET-CAUSED FINANCIAL COLLAPSE AND ONGOING ECONOMIC CRISIS IS MORE THAN 

$12.8 TRILLION (Sept 15, 2012)("Cost of Crisis Report"), available at 

bttp:llbettermarkets.com/sites/default/fiIes/Cost%200fl',f,20Tbe%20Crisjs 0 pdf. 

2 
64 


79694.019

in the 2008 financial crisis, is the equivalent of Russian roulette for any other firm or 

business in America where bad bets mean bankruptcy and, often, losing everything. The 

only place in American that doesn't happen is Wall Street: the biggest banks know that, if 

their bets lose and the roulette bullet hits them, they don't die or go bankrupt. Rather, 

the taxpayers will pick up the bill for their losses and prevent their failure, as 

demonstrated in the 2008 crisis. 

And, that bill can be gigantic. Any unbiased analysiS shows that the costs of the 

last financial crisis to the United States alone have been in the trillions of dollars, with 

many continuing to this day as the worst recession since the Great Depression ravages 

the country.4 Depending on when it happens and what form it takes, the next financial 

crisis will likely cost at least as much, if not significantly more. 

Those massive and debilitating costs are what financial reform generally and the 

VoIcker Rule in particular are intended and designed to eliminate or reduce. The 

American people should never again have to pay trillions of dollars for another Wall 

Street bailout due to its reckless trading and investment activities. 

Notwithstanding a relentless, comprehensive disinformation campaigns, 

implementing the VoIcker Rule is not complex or difficult. The two keys are: 

1. Focusing on compensation to break the link between proprietary trading and 

banker bonuses (via the bonus pool); 

2. Backing up the law with swift, certain and significant penalties for traders, 

supervisors and executives; and 

If the link between proprietary trading and banker bonuses is removed, then the 

incentive for proprietary trading will be gone. This can be readily accomplished by 

requiring that all compensation for the permitted activity of market making, for example, 

to be limited to the historic, well-known and free market, industry determined methods 

of fees and commissions. 

This can then be easily policed after the fact by analyzing the bonus pool - after all, 

that is the entire purpose for proprietary trading: getting the biggest bonuses possible. 

Nothing is tracked more carefully on Wall Street than the bonus pool, which is a roadmap 

to where every penny was made or lost. Conveniently, this can be cross-referenced by 

the many individuals and desks that assiduously track this. 

Because proprietary trading is banned and illegal, the firm cannot be allowed to 

profit from it either. A real market maker's trading book is fully hedged and, therefore, 

does not generate profits in excess of fees and commissions (other than in rare and 

extraordinary market conditions, when gains are as probilble as losses, and either should 

be consistent industry wide). If such profits are somehow generated anyway, then 

See Better Markets' Costs of the Crisis Report, cited above note 3. 

3 
65 


79694.020

increased prudential standards must be applied to bring the bank back into compliance 

with the law. 

Some who attack the VoIcker Rule say that is not possible to distinguish between 

proprietary trading and market making for customers. This is a very dubious claim given 

the oft heard claim that the smartest people on the planet work on Wall Street (and get 

paid unprecedentedly high compensation for being so smart). If they can't distinguish 

between proprietary trading for their own pocket and trading for their customers, then a 

very thorough investigation of their businesses is required and quickly. The logic of this 

argument against the VoIcker Rule is that the banks today do not and cannot comply with 

the most basic investor protection rules regarding client funds as well as basic rules 

relating to risk, capital and legal compliance. 

Importantly,limiting all trading compensation to fees and commissions will not be 

enough to end illegal proprietary trading. There is simply too much money at stake, 

especially bonus money, to expect people to follow the law unless there are very 

significant penalties for violating the law and a reasonable expectation that they will be 

caught Those penalties have to be as significant as the potential gains if they are to be 

effective. If not, the cost of violating the law will become a cost of doing business and the 

illegal profits from proprietary trading will continue to flow, albeit diminished for the 

rare or occasional paltry fine. Even worse, the destabilizing risks that the VoJcker Rule is 

intended to reduce or eliminate will remain, threatening our financial system, our 

taxpayers, our treasury and our economy. That is why very substantial penalties must be 

spelled out in the rule or it will be rewarding illegal conduct and inviting systemic risk. 

The VoJcker Rule is a reasonable response to a foreseeable and severe threat that 

materialized in the last crisis and contributed to systemic failure, which precipitated 

massive bailouts. Avoiding those trillions of dollars in costs (not to mention the equally 

high human costs arising from unemployment, foreclosure, etc.)5 or, put another way, 

gaining the benefits of avoiding such a crisis, are why it is so important to implement the 

VoJcker Rule as strong. effective and quick as possible. 

Thus, for the reasons detailed below, the Volcker Rule is unlikely to reduce 

liqUidity of U.S. capital markets, make it more expensive for businesses and consumers to 

borrow, depress the price of financial assets, impede the ability of U.S. financial 

institutions to compete against their foreign counterparts or dampen U.S. economic 

growth. To the contrary, removing the threat posed by these biggest too-big-to-fail 

banking giants to our financial system and economy is likely to unleash a renaissance in 

our financial industry as transparency, competition, and fairness create untold 

opportunities for current and new market participants. That will be good for our 

markets, financial system, economy, taxpayers and, indeed, the entire financial industry. 

See Better Markets' Costs of the Crisis Report, n. 3 above. 

4 
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79694.021

The Hip Risk and Dalliers of Proprietary Tradjnr: 

There are many concrete examples of the dangers of speculative proprietary 

gambling by big systemically significant banks. While most examples relate to the too big 

to fail banks gambling their own or borrowed money, the most recent publicly disclosed 

example of a speculative prop trading going wildly wrong is JP Morgan's loss from trading 

by its Chief Investment Office (CIO) in London, the so-called "London Whale" trading 

debacle.6 In this case, JP Morgan gambled with federally insured depositors' money, 

reportedly more than $100 billion of federally insured depositors' money. 

JP Morgan's Multi-BUlion Dollar London Whale Loss Due to High Risk Speculative 

Trading with Federally Insured Deposits 

The recently reported trading by JP Morgan London whale would have violated the 

letter and not just the spirit of the law and proposed Volcker Rule if it were in effect First, 

given the enormous net gains (reportedly 25% of the bank's net income for 2010) and 

losses (which now reportedly could be as high as $9 billion 7) arising from this trading 

activity, it cannot properly be described as "hedging." And, given the swings in net profits 

and losses, it cannot properly be characterized as "risk-mitigating hedging," which is the 

definition of the permitted activity in the law and the rule.8 

Moreover, it has been widely reported that JP Morgan's CEO personally transformed 

the CIO from a low-risk, highly liquid actual hedging operation into a high risk, speculative 

"profit seeking" operation; real "risk-mitigating hedging" does not generate net profits, 

which is what the CEO reportedly structured and staffed the CIO operations to create.9 

SeeAprll6, 2012, Wall Street Journal, page Al, "'London Whale' Rattles Debt Markets" and April 10, 2012, 

Bloomberg, homepage, "Making Waves Against the 'Whale,'" These articles provided specific details 

about the London CIO's high risk trading, how it was being done, who was doing it and that billions in 

losses were possible. On April 13, 2012, JP Morgan's CEO and CFO held an earnings call for the bank's 

first quarter results and emphatically dismissed these reports as inaccurate and provided comprehensive 

comfort to the public, regulators and investors. In fact, CEO Jamie Dimon said the reports were nothing 

but a "tempest in a teapot." Almost thirty days later, on May 10, 2012, Jamie Dimon disclosed, among 

other things, that the Wall Street Journal and Bloomberg reports from a month prior were in fact 

accurate. 

The actual gross losses thus far appear to be $6.2 billion, but JP Morgan disclosed that the losses could be 

as high as $9 billion. However, that is an incomplete picture of the losses created by this speculative high 

risk trading: JP Morgan's lost about $20 billion in market capitalization when this trading loss was first 

disclosed (and when the loss was said to be only about $2 to $3 billion). Added to that is more than 850 

million shares ofJP Morgan stock that was traded between the first press reports of the London Whale 

trades in early April 2010 and JP Morgan's first public admission that those reports were largely accurate 

about 30 days later. The net result is real, multi-billion losses for investors in addition to the actual losses 

from the trading. 

"(C) Risk-mitigating hedging activities in connection with and related to individual or aggregated 

positions, contracts, or other holdings of a banking entity that are designed to reduce the specific risks to 

the banking entity in connection with and related to such positions, contracts, or other holdings." 

"Dimon pushed [the CIOj, which invests deposits the bank hasn't loaned, to seek profit by speculating on 

higher-yielding assets such as credit derivatives, according to five former executives. The CEO suggested 

positions, a current executive said. Profits surged over the next five years as assets quadrupled to $356 

5 
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(While losses and profits may be generated, they should be largely offsetting. resulting in 

little net profit or loss, as discussed further below.) It was also reported that "the CIO ... 

housed a lot of former traders from the bank's proprietary trading business, according to 

people who work there. "10 This personnel shuffle and hide-and-disguise "rebranding" of 

prop traders and trading was a key concern when the legislation was drafted and when the 

rule was proposed. Nonetheless, that is what is reported to have happened here and at the 

direction of the CEO. 

In addition, the JP Morgan CIO's trading certainly involved "high-risk assets" and 

"high-risk trading strategies," which are also expressly prohibited by the law. 11 This is 

proved not only by the net profits and losses generated, but also by the fact that the CIO 

had to wager vast amounts of money to create those profits and losses, reportedly 

involving hundreds of billions of federally insured depositors' dollars. The CIO had, by the 

CEO's admissions, more than $350 billion under its control and much of that was 

apparently bet by the "London Whale" seeking to make a big splash and get a huge bonus, if 

not other rewards. Further proving the high-risk nature of these assets and trading 

strategies, they apparently involved relatively illiquid securities because the bank couldn't 

exit the investments in any reasonable period of time to minimize its losses. This too 

would violate the law and rule. 

As if all that wasn't enough to demonstrate beyond a doubt that JP Morgan's trading 

would have violated the law and rule if they were in effect, it is also the case - as the CEO 

himself has admitted - that those very high risks were unknown to the bank; the bank's 

CEO, CFO, and other executives; as well as being unknown to the banks' risk. capital, legal 

and operational management.12 The narrow permitted activity of "risk-mitigating hedging" 

cannot, by definition, occur by accident, which is why the proposed rule has detailed 

procedures to establish that such hedging is in fact risk mitigating and in fact bone fide 

(although, as set forth in Better Markets February 13, 2012 comment letter, those 

procedures need to be strengthened). 

The fact that this particular example of high risk speculative proprietary gambling 

with federally insured depositors' money did not result in a loss to those depositors or 

require a federal bailout is irrelevant to the consideration of the Volcker Rule. First, it 

billion and employees were given proprietary-trading accounts, current and former executives said: 

Dimon Fortress Breached as Push from Hedging to Betting Blows Up, Bloomberg. May 14, 2012. 

10 ·How JPMorgan Shock Hit the War on Volcker; Financial Times, May 11, 2012 

11 The VoIcker Rule prohibits, among other things, any "transaction, class of transactions or activity ... if the 

transaction, class of transactions or activity ... would result, directly or indirectly, in a material exposure 

by the banking entity to high-risk assets or high-risk trading strategies ..... 

12 The accuracy of these claims is still being investigated and there are a number of reasons to conclude 

otherwise: "Staff from the bank's investolent banking arm privately told management - including chief 

executive Jamie Dimon - that the bank's CIO was an 'accident waiting to happen." JP Morgan's $2bn loss 

was an 'accident waiting to happen: TheTelegraph, May 11, 2012; see also, HJP Morgan Pressed by SEC 

on Prop Trading Before Whale Loss: Bloomberg. December 11, 2012; JP Morgan's CEO Jamie Dimon: 

Incompetent or Culpable? http://bettermarketscom/bloiS/jp-mown%E2%80%99s-ceo-jamje-djmonjncompetent-or-culnable#.UMiduYPAdyw; Questions for Jamie Dimon's House Testimony, 

http'llbettermarkets com/bloiS/Qyestions-jamje-djmons-hoyse-testimooy# I!MitMYPAdyw 

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appears to be largely accidental that JP Morgan management even found out about this 

massive betting when it did: press reports brought it to their attention. Absent that, 

there's no reason to conclude that this trading loss would have multiplied many times over 

before it was discovered by management That is what happened to the Barings Bank in 

1995, which lost $1.3 billion and collapsed after 233 years, and the recent UBS $2 billion 

loss, among many others. Traders in big losing bets usually double down if presented with 

the opportunity. 

Second, there is no reason to believe that the next prop trade gone bad will result in 

non-lethal losses either before or after doubling down. Third, letting after the fact losses 

influence before the fact policy making would be to turn law-making on its head. Fourth, as 

set forth below, there are plenty of examples of prop trading gone bad that were lethal or 

almost lethal but for federal rescues and bailouts. 

Citigroup's Speculative Proprietary Trading caused More Than $40 Billion in Losses 

The damage inflicted on Citigroup by its broker dealer subsidiary vividly 

illustrates the threat that proprietary trading poses to even the largest banks. During the 

run-up to the crisis, Citigroup traders were among the largest creators and sellers of 

collateralized debt obligations ("COOs"). The COO business required traders to acquire a 

pool of assets, "structure" a new set of securities based on that pool, and then sell some or 

all of these newly structured securities to third parties. Creating and pricing the new 

securities required some expertise, but at its heart the COO business was a convoluted 

proprietary trade in which the traders acquired assets, held them as inventory and 

planned to resell them later at a higher price. 13 

These COO securities differed in their credit ratings, the rate of interest paid to 

investors and in their payment priority in the event of default The quantity and 

characteristics of each class of security were chosen by the Citigroup traders to maximize 

their profits. They found it profitable to create a class of "Super Senior" securities which 

were nominally highly-rated and which paid relatively low interest rates. Citi traders 

found that investors were unwilling to buy the Super Seniors. But instead of offering the 

securities at a lower price and higher interest rate - which would have required lowering 

the rates paid on the other COO securities and reduced their price - the Citigroup traders 

13 The securities comprising the COO asset pools were varied - including RMBS, high grade bonds, and 

tranches from other COOs. However, many of the underlying securities were constructed from subprime 

residential mortgages. The Office of the Controller of the Currency estimates that 70 percent of the assets 

underlying Citigroup COO's issued between 2003 and early 2006 were subprime-related. See U.S. Office 

of the Comptroller of the Currency (2008). Memo from John Lyons, Examiner-in-Charge, Citibank, N.A., 

Subject: Subprime COO Valuation and Oversight Review - Conclusion Memorandum, July 17, 5. Available 

at 

btt;p'l/fCic law stanford edu/resQurcelindex/SearchYideos'O/Search OQcuments·1/Search.endmonth·02 

/Search endyear' 20 12/Search Footnotes; 10,42 

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continued to create Super Seniors and to hold them. They would only have created and 

held unsalable Super Senior securities to maximize their overall returns.14 

To boost the return from holding the Super Senior positions, Citigroup relied on 

leverage. During 2003 and early 2006, Citigroup financed $25 billion in Super Senior 

securities through conduits. These special purpose vehicles rSPVs") issued asset-backed 

commercial paper, for which Citi provided "liquidity guarantees." The guarantees meant 

that Citi would buy the commercial paper issued by the conduit if no one else would.1s 

Liquidity guarantees meant that third party purchasers of the commercial paper faced 

default risk only if Citigroup itself failed to honor its guarantee, regardless of the market 

value of the Super Senior securities. 

Citigroup ceased to issue liquidity guarantees in early 2006. However, between 

early 2006 and August 2007 another $18 billion in Super Senior securities were added 

directly to Citigroup's trading book positions. Because the securities were held in the 

trading account,little or no capital was required to back them. 16 

In late 2007 it became clear that the Super Senior securities were worth far less 

than their face value. To avoid having to make good on its liquidity guarantees, Citigroup 

bought $25 billion of commercial paper that had been issued by the Super Senior 

conduits, and placed those Super Senior securities on the books of the Citigroup 

commercial bank. 

Beginning in November 2007, Citigroup was forced to recognize huge losses on 

the Super Senior securities and other positions.17 In a remarkably understated 2007 

annual inspection report on Citigroup, the Federal Reserve Bank of New York observed 

that "[m]anagement did not properly identify and assess its subprime risk in the COO 

trading books, leading to significant losses. Serious deficiencies in risk management and 

controls were identified in the management of Super Senior COO positions and other 

subprime-related traded credit products." 18 By the end of 2008, Citigroup had written 

,. The Comptroller of the Currency recognized this motive for the Citigroup trading strategy in its January, 

2008 review of Citigroup's COO-related losses, noting that "The hank built up [Super Senior] positions 

because they are hard to sell in the primary issuance market at the nominal spreads available for [Super 

Senior] once deals were completed (10-20bps) and the bank was unwilling to give up some of the 

inception profits. " See Ibid 

15 The amount ofleverage on the Citi conduits is not clear from available data. If the SPVs were entirely 

financed by commercial paper, the leverage was infinite. 

16 Financial Crisis Inquiry Commission (2011). Final Report of the Financial Crisis Inquiry Commission, U.S. 

Government Printing Office, 196-197. 

11 Citigroup, Inc. (2007). Press release, November 4 (announcing losses of approximately $S billion to $10 

billion), available at http'//www sec goylArchjyes/edear/data/S31001/Q00110465907079495/a07-

28417 1ex99d 1 htm 

18 Federal Reserve Bank of New York (200S). Summary of Supervisory Activity and Findings for Citigroup, 

January1, 2007 - December 31, 2007, 5, available at 

http;//fcic.\aw stanford edu /resourcelindex/Searcb keywords'fcic085390/Searcb Videos'O/Search Documents·l/Search.lntcrviews;O/Searcb endmonth'02lSearch endyea 

r;2.!ll.2. 

8 
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off $38.8 billion related to these positions and to ABS and CDO securities it held in 

anticipation of constructing additional CD05.19 

These losses reduced Citigroup's capital, helped to bring the company to the brink 

of failure, and made a massive federal rescue necessary. Indeed, Citigroup was the largest 

single recipient offederal emergency assistance and required a total of$476.2 billion, 

including capital injections, debt guarantees, and asset guarantees, to prevent it from 

failing. 20 

Citigroup was also the heaviest user of the Term Securities Lending Facility 

("TSLF"), and a very heavy user ofthe Primary Dealer Credit Facility ("PDCF"), two 

emergency lending facilities set up to halt a destabilizing collapse of broker dealers 

generally. Reliance on these facilities indicated that a broker dealer was having difficulty 

funding its positions in repo markets. So the fact that Citigroup went to the PDCF 279 

times for overnight loans averaging $7.2 billion each, and used the TSLF to execute 43 

swaps of "inv~stment grade" collateral averaging $3.7 billion each, are clear signs that its 

broker dealer was in a very difficult shape. (See attached Appendix 1, below). The 

debacle at Citigroup is merely illustrative of the harm that bank proprietary trading 

produced and threatened to produce. The heaviest users of TSLF and PDCF funds 

includes several other bank-based broker dealers, among them Bank of America, 

Deutsche Bank, Credit Suisse and Barclays. (See attached Appendix 2, below). Although 

they did not create wreckage on the scale of Citigroup, they were clearly on the brink of 

doing so. 

Other Too Big To Fail Banks High Risk Speculative Prop Bets Gone Wrong 

JP Morgan and Citigroup were not alone in making gigantic, high risk, highly 

leveraged proprietary bets. Indeed, as was made visible during the crisis, trading assets 

made up a large proportion of total assets at all of the large stand-alone securities firms 

and all came under extraordinary pressure as the crisis spread. A major source of that 

pressure was losses and conjectured losses on their proprietary trading positions. For 

example: 

• In June 2007, two Bears Stearns managed hedge funds - High-Grade Credit 

Fund and High-Grade Structured Credit Enhanced Leverage Fund - collapsed 

because of failed subprime mortgage trades. Bear was forced to rescue the 

funds by injecting more than $3 billion.21 As a result market participants 

became increasingly concerned about Bear's solvency, and its repo lenders, 

on whom Bear was increasingly dependent, began to require more collateral 

,. See Citigroup, Inc., Form 10K for the period ending December 31, 2007, 48; Form 10K for the period 

ending December 31,2008,68. 

20 See Special Inspector General for the Troubled Asset Relief Program (2011). Extraordinary Financial 

Assistance Proyjded to Cjtierm1p Inc .. January 13. 

21 htto:/Iwww nytimes.coml2007l06123/busjness/23bond htm(?pa~wanted-all. 

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for loans. In March 2008, there was a run by Bear's repo lenders and overthe-counter derivative counterparties, and the firm failed. 22 

• In October 2007, Morgan Stanley recognized a $9 billion loss on proprietary 

trades related to subprime mortgages. 23 That loss forced the firm to obtain 

an equity injection of $9 billion from Mitsubishi UFJ to prevent failure and 

bankruptcy. Ultimately Morgan Stanley had to seek safety net protection by 

becoming a bank holding company to avoid failure. 

• In mid-2008, Lehman Brothers began to publicly recognize significant losses. 

A major fraction of those losses came from proprietary positions Lehman had 

taken in subprime and Alt-A mortgages, in a belief that it would be able to 

securitize and sell them at a profit. Between the first quarter of 2007 and the 

third quarter of 2008 Lehman lost an estimated $7.4 billion on these 

proprietary positions.24 In September, Lehman's repo lenders and over-thecounter derivatives counterparties concluded that the firm was no longer 

solvent, and the resulting run caused Lehman to fail.25 

The Financial Crisis Inquiry Report summarizes role of proprietary trading at the standalone investment banks as follows: 

Lehman's collapse demonstrated weaknesses that also contributed to 

the failures or near failures of the other four large investment banks: 

inadequate regulatory oversight, risky trading activities (including 

securitization and over-the-counter (OTC) derivatives dealing), 

enormous leverage, and reliance on short-term funding. While 

investment banks tended to be initially more vulnerable, commercial 

banks suffered from many of the same weaknesses, including their 

involvement in the shadow banking system, and ultimately many 

suffered major losses, requiring government rescue.26 

Banks Haye Failed to Offer Empirical Eyidence - to Which They Haye Unique 

Ag;ess - To Support Their Claims about Marl«:t Makin". When They Are Also 

UniqUely Igceqtiylzed to Do So if that Evidence in fact supports Their Claims 

Banks have claimed that when they act as market makers they must hold 

substantial inventories of infrequently traded assets. Because these assets trade rarely, 

they say, continuous observable bid-ask spreads do not exist. In practice, they claim, 

market making in these assets is only possible because they can earn revenues from the 

22 National Commission on the Cause of the Financial and Economic Crisis in the United States, ~ 

Financial Crisis InQuhy Report (2011), New York: Public Affairs, 280-92. 

23 http'lfwww nytimes comlZ007ll2l20/busjnesslZOwalJ htm!?paeewanted=alJ. 

2. Report of Anton R Valukas, Examiner, In re Lehman Brothers Holdings Inc., et al., (2010), 84-94. 

2S National Commission ontbe Cause of the Financial and Economic Crisis in the United States, op. cit, 327-

333. 

26 Ibid, 343. 

10 
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price changes on the positions they hold. Therefore, using the existence of a bid-ask 

spread or revenue from the bid-ask spread as indices of market making will drive them 

from their market making role. 

For example, Morgan Stanley claims that because market makers must hold 

inventories of large or illiquid assets for "days, weeks or months," they must necessarily 

have "substantial revenues from market movements in their principal positions." 27 

Citigroup Inc. says that in "all but the most liqUid portions of the equity, rate and foreign 

exchange markets, profitability from bona fide market-making-related activity is 

significantly derived from price appreciation of inventory positions." 

If Morgan Stanley or other banks really wanted to inform us about how market 

making works, they would have presented verifiable data to answer some basic questions 

about their business. For example, with respect to corporate bonds, for which bonds are 

they market markers? Which of these bonds are infrequently traded, and which are 

frequently traded in the market as a whole? For which of these bonds do they typically 

hold inventories, and for which of them do they meet client demand by acting as agents 

or brokers? For those bonds in which they maintain positions, how large are their 

inventories? For which of the bonds in their inventory is there an observable bid-ask? 

How much of their trading revenue comes from frequently traded bonds for which there 

is an observable bid-ask? These and other relevant data are not forthcoming from the 

banks. 

When data are offered, they are often beside the point. Morgan Stanley, for 

example, in an appendix to its February 13, 2012 comment letter on the proposed rule, 

provides descriptive statistics on the frequency of bond trades during 2009. However, 

these data are derived from TRACE, a publicly available source. Such data tell us nothing 

about the actual market making activity of Morgan Stanley or any other large bond 

trader. 

These data provide no evidence that Morgan Stanley actually holds inventories of 

any of the infrequently traded bonds identified in the appendix, nor do they tell us 

anything about the availability of bids and asks for frequently traded bonds. The failure 

of the banks to provide meaningful data in their exclusive possession, and their focus on 

data that are irrelevant to the issues being discussed, leaves regulators with no data 

supporting their assertions. 

Given that they are self-interested market participants with the unique ability to 

support their claims with data, but chose not to, there is no defensible conclusion other 

than such data does not exist or, more likely, is not supportive. After all, if their claims 

27 Comment Letter on the Notice of Proposed Rulemaking Implementing the Volcker Rule - Proprietary 

Trading, from C. Kelleher, Co-President, Institutional Securities Group, and J. Rosenthal, Chief 

Operating Officer, Morgan Stanley. February 13, 2012, 4 ("Morgan Stanley Comment Letter"); 

Comment Letter on the Joint Notice of Proposed Rulemaking Implementing the Volcker Rule, from 

Brian Leach, Chief Risk Office, Citigroup. February 13, 2012, 4 ("Citigroup Comment Letter"). 

11 
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79694.028

were correct, it obviously would be in their interest to support their case empirically. 

They chose not to. Legislators, regulators and policymakers have no choice but to 

disregard such unsupported assertions and claims under such circumstances. 

Independent Eyidence Contradicts Bank Claims about Market Makinl for Corporate 

~ 

Claims made about the market for U.S. corporate bonds - a market which banks 

have cited in their arguments that large scale asset inventories and revenue from price 

appreciation are essential to market making 28 - are contradicted by independent 

academic research. 

A recent scholarly article, for example, suggests that dealers hold only small 

inventories of bonds that are frequently traded and no inventories of bonds that trade 

infrequently: 

"One argument against proposals to increase transparency in a dealer 

market is that dealers will become reluctant to enter trades as 

principals - that is, by themselves, purchasing bonds from customers 

or selling customers bonds owned by the dealer - and instead will 

only be willing to work orders on an "agency basis" - that is, they will 

search for potential counter parties (Genmill, 1996). In interviews, 

numerous corporate bond market participants voiced similar 

concerns. We were told that, post-TRACE, bond dealers no longer 

hold large inventories of bonds for some of the most active 

issues; for less active bonds, they now serve only as brokers. As 

noted, individual corporate bond issues trade on average only two or 

three times per day, and for illiquid issues even less often. With trade 

reporting, it may be possible to ascertain when a dealer may have 

taken a large position into inventory, and the price paid. Knowledge 

of the dealer's inventory may allow market participants to forecast 

upcoming trades the dealer will undertake to rebalance inventories, 

and these forecasts may in turn cause price movements adverse to the 

dealer." 29 [emphasis added] 

A second empirical study, using data from a sample of traded corporate bonds, 

also indicates that dealers avoid holding inventories of infrequently traded bonds.3o 

28 Comment Letter on Restrictions on Proprietary Trading and Certain Interests in and Relationships 

with Hedge Funds and Private Equity Funds, from /. F. W. Rodgers, Chief of Staff. Goldman Sachs 

Group, Inc., February 13, 2012, 12; Morgan Stanley Comment Letter, op. cit,4, appended Discussion 

Materials; Citigroup Comment Letter, op. cit. 

29 H. Bessembinder and W. Maxwell (2008). Transparency and the Corporate Bond Market. !l1lIrnill..of 

Economjc Peapectives Volume 22, Number 2, 217-234, 228. 

3. M. Goldstein et a!. (2007). Transparency and Liquidity: A Controlled Experiment on Corporate Bonds. 

The Revjew of Financial Studies Volume 20, Number 2,235-273. In the sample used in this study 

12 
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79694.029

Sample data show that when infrequently traded bonds are added to dealer inventory, 

they are held for shorter periods than frequently traded bonds, and the entire position is 

more frequently sold off to buyers. The authors conclude that for infrequently traded 

bonds" ... dealers may serve more of a search role, matching buyers and sellers, and 

not assuming the risk of holding bonds in their inventory." [emphasis added] 31 

It is important to emphasize that even after TRACE was introduced, post-trade 

bond prices became widely available, and bond traders reduced their inventories of 

infrequently traded bonds, the market for corporate bonds did not vanish. Between 

2002, when TRACE was introduced, and 2006, the average daily trading volume for 

corporate debt increased from $18.9 billion to $22.7 billion.32 Market makers continued 

to flourish, although their ability to extract rents from their counterparties was 

reduced. 33 

There are other recent examples, not directly related to market making, that 

illustrate how profit opportunities prompt rapid entry and adaptation in financial 

markets. When regulation NMS reduced regulatory barriers to entry for electronic 

market centers, there was rapid entry of new trading platforms and an increase in 

competition. As a recent academic study notes: 

Regulation NMS freed electronic trading platforms to compete with 

the NYSE. Subsequently, new entrants gained significant market 

share. The NYSE market share of volume in its listed stocks fell from 

80% at the beginning of 2003 to 25% by the end of 2009. NASDAQ 

matched share volume also increased, but later fell as volume traded 

through new entrants such as BATS and DirectEdge increased. 34 

Entry of new trading firms has been facilitated by technological and conceptual 

developments that have fostered the creation of high frequency trading ("HFT"). One of 

the distinguishing features of HFT is that is can be executed with relatively small amounts 

of capital. Positions are held for very short time periods, and the books ofHFT firms are 

typically flat at the end of the day.35 Because this overcomes the cost advantage of the 

frequently traded bonds are defined as those that trade at least once per week. Infrequently traded 

bonds trade less than once every two days, but at least once every two weeks. 

31 Ibid,267. 

32 Bessembinder, op. cit, 222. 

33 After the implementation of TRACE, transactions costs for corporate bond trades declined. See 

Bessemer and Maxwell, op. cit; Goldstein et al., op. cit; A. Edwards et aI. (2007) .. Corporate Bond 

Market Transparency and Transactions Costs. Iournal of Finance Volume 19, Number 1, 69-90. 

34 I. Angel et al. (2010). Equity Trading in the 21 "Century, USC Marshall Research Paper FBE 09-10, 

available at bttp'lIpapers ssmcom/so13lpapers cfin7abstract jd=1584026. 

35 Technical Committee of the International Organization of Securities Commissions (2011). Regulatory 

Issues Raised by the Impact of Technological Changes on Market Integrity and Efficiency, Consultation 

Report CR0211, luly, 21, available atwwwjoscoot;&lIjbralY/pubdocs/pdfllOSCOPD354.pd£ 

13 
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79694.030

established dealers, including those located in the LBHCs, numerous HFT firms have 

entered an activity in which bank dealers once played a more prominent role. 36 

Another classic example of competitive entry in response to newly created profit 

opportunities is the events following the passage of the Glass-Steagall Banking Act, 

passed in 1933 during the Great Depression. The Banking Act required commercial 

banks to exit from investment banking (including underwriting and trading) one year 

after enactment. Commercial banks divested their investment banking operations, 

thereby creating profit opportunities for new entrants. New investment banks were 

quickly formed, often employing the experienced personnel formerly located in the 

commercial banks. 

As Vincent Carosso notes in his historical study of investment banking: 

A major reorganization of the investment banking industry 

immediately resulted from the Banking Act. Affiliations were 

eliminated; the bond departments of commercial banks were cut in 

size and their activities greatly reduced; and private bankers were 

forced to choose between deposit and investment banking .... 

Implementation of the Banking Act also led to the organization of new 

investment firms. Most of these were officered and staffed by the 

individuals formerly associated either with security affiliates or with 

private banks that had decided to give up the security business. The 

First Boston Corporation, one of the largest and leading underwriting 

36 This example is an illustration of market entry when a profit opportunity presents itself. We do not here 

make a judgment regarding whether this particular entry, HIT, was good or bad for the markets, in whole 

or in part See, e.g., S. Arnuk, and J. Saluzzi (2012). Broken Markets, Pearson Education LTD: IT Press. 

See also, Comment Letters of Better Markets: "Requirements for Derivatives Clearing Organizations, 

Designated Contract Markets, and Swap Execution Facilities Regarding Mitigation of Conflicts of Interest" 

(November 15, 2010), 9,18, available at 

httP'llcomments cftc gOV/PublicComments/YiewCommentaspx?jd=26475&SearchText=, 

• Antidisruptive Practices Authority Contained in the Dodd-Frank Wall Street Refonn and Consumer 

Protection Act" (January 3, 2011), 2, 4, 7, 9-14, available at 

http://comments.cftc.gov/PublicComments/YiewCommentaspx?jd=26928&SearcbText=, "Reporting, 

Recordkeeping and Daily Trading Records Requirements for Swap Dealers and Major Swap Participants" 

(February 7, 2011), 1-2, available at 

httP'!lcomments cftc goy/PublicComments/YiewCommentaspx?jd=27630&SearchText-, "Core 

Principles and other Requirements for Designated Contract Markets" (February 22, 2011), 3-10, availablE 

at httP'lIcomments cftq:;ov IPubIicCommentslViewCommentaspx?jd=27994&SearchText=, "Core 

Principles and Other Requirement for Swap Execution Facilities" (March 8, 2011), 12-18, available at 

httP'lIcomments cftc W/PublicComments {VjewCommentaspx?jd=3123B&SearchText= , 

"Antidisruptive Practices" (May 17, 2011), 2-3, available at 

httP'l{comments cftc.lWy{PublicComments lYiewCommentaspx?jd=42710&SearchText=, "Reopening 

and Extension of Comment periods for Rulemaking Implementing the Dodd-Frank Wall Street Reform 

and Consumer Protection Act" (June 3, 2011), 7-8, available at 

httP'((comments cftc lWy/PublicComments/VjewCommentaspx?id=H711&SearchText=, "Clearing 

Member Risk Management" (September 30, 2011), 5, available at 

httP'llcomments cftc goy/PubIicComments/VjewCommentaspx?jd=48477&SearchText=. 

14 
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and bond-trading houses since its establishment, is a case in point 

Organized on June 16, 1934, as a publicly owned corporation, it was a 

rare phenomenon among investment banking firms. The First Boston 

grew out of the securities affiliate of the First National Bank of Boston, 

with some key personnel also coming from the old Harris, Forbes 

organization ... 

In September 1934 three Morgan partners and two from Drexel 

resigned and organized Morgan Stanley & Co., Inc., an investment 

banking corporation. They moved just at the time the securities 

business was starting to revive ... 

Numerous other similar changes occurred in 1934 and 1935, as 

former officials and associates of security affiliates and partners in 

private banking houses organized new firms or jOined existing 

ones .... 37 

Despite these rapid changes required by the change in regulation, which allowed 

just one year for total divestiture, the newly configured investment banking industry was 

able to handle a large increase in underwriting volume that occurred in 1935.38 

Precisely these types of entry and market adaptions have been happening 

routinely since the passage of the financial reform law. For example, the Financial Times 

reported recently that "the former head of proprietary trading at Citigroup," who is also 

the "former head of proprietary trading at Morgan Stanley," is launching "one of the 

largest hedge fund start-ups of 2012. "39 This is similar to what has already happened 

when proprietary traders left JP Morgan Chase and Goldman Sachs, which "has spawned 

the largest number of hedge fund start-ups in recent years."40 

Given these examples, there is little reason to believe that there will be a shortage 

of market making services, even if the Volcker Rule caused the large bank holding 

company dealers to cease providing them completely. That outcome, however, is 

unlikely given that the law specifically permits genuine "market making ... designed not 

to exceed the reasonably expected near term demands of cHents, customers, or 

counterparties." Any bank, including the largest banks, can engage in unlimited market 

making if, for example, it ran a flat book or a truly hedged book, with gains offsetting 

losses thus eliminating proprietary positions in connection with market making. 

Thus, • the market can be expected to adapt and the largest banks will provide 

many of the same services they do now, but in compliance with the law and at much 

37 V. Carosso (1970). !nyestmentBankin~inAmerjca' A History. Cambridge: Harvard University Press, 

372-374. (emphasis added) 

38 R Chernow (1990). The House of Morean. New York: Atlantic Monthly Press, 390. 

39 "Sharma to launch $500m London Hedge Fund: available at 

http'/lwww ft com/jntl/cms/s/0/94e28e48-b87Q-lle1-82c8-QQ144feabdcO,html#axzz1y6!Jj5ash . 

40 [d. 

15 
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79694.032

lower risk of failure and taxpayer bailouts, and new market entrants will provide the 

services that the largest banks choose not to provide. 

So contrary to the claims made by banks, the operation of the corporate bond 

market actually demonstrates that market making does not require that dealers hold 

significant inventories of infrequently traded assets. Effective implementation of the 

Volcker Rule, which requires tying permitted trading revenue and compensation to 

observable bid-ask spreads, will not bring an end to genuine market making by banks. 

Instead it wiIllimit the ability of banks to take proprietary positions in pursuit of large 

speculative profits. While banks may object, the banking system will become more stable 

as a result, which is the ultimate objective of the Volcker Rule. 

The Industry's Study is Expressly and Admittedly Incomplete and Should be 

Disreprded Entirely 

The industry has produced and relies on a paper by the consulting firm of Oliver 

Wyman. Given that the paper was purchased by one of the industry's top lobby and trade 

associations SIFMA on behalf of the industry, it is no surprise that it agrees with SIFMA's 

and the industry's position on the Volcker Rule. Like their other arguments, however, the 

paper is deeply flawed. Better Markets addressed these flaws in its comment letters 

(specifically in the April 16, 2012 and June 19, 2012 comment letters), but I will briefly 

address the primary flaw here: Oliver Wyman, without explanations or basis (and contrary 

to basic economics, facts and history), assumed that there would be no new entrants into 

the business of market making if the few biggest too big to fail banks stopped making 

markets as a result of the Volcker Rule (which itself is a highly dubious assumption because 

market making is an expressly permitted activity and would only require hedging if they 

wanted to do it or, as the data above suggests, get back to doing it). 

Specifically, the Oliver Wyman paper stated that "[w]e do not directly analyze a wide 

range of potential knock-on effects, including ... [t]he potential replacement of some 

proportion of intermediation currently provided by Volcker-affected dealers by dealers not 

so affected." As set forth in our comments letters of February 13. 2012, AP.ril..l2. 

2.Q.ll and June 19. 2012, there is, however, a great deal of historical and contemporary 

evidence that entry is the normal market response to profit opportunities like this, 

including recently in the corporate bond markets. 

This should come as no surprise to anyone. After all, the big dealer banks are 

not nonprofit organizations and do not make markets for free. They do it to make money 

and because there is money to be made. If they don't make that money, other market 

participants will move into the business to reap the profits. There is simply no basis to 

conclude otherwise. Self-serving industry claims contradicted by independent facts, 

research and history should be disregarded. 

16 
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79694.033

Swift:. Certain and Submntial Penalties Must be Publicly Irpposed on Traders and 

Management Alike for Any Violations oftbe Volcker Rule nnder a Strict LiabUity 

Standard. 

The regulatory system for the Volcker Rule cannot be constructed to require 

regulators to find a needle in a haystack when the "needle hiders" are extremely 

sophisticated, highly motivated and richly rewarded. Of course, they also have vastly 

more resources and much greater ability to hide and disguise their conduct than the 

regulatory agencies. 

The most senior operating, financial and compliance management at financial 

institutions must be responsible for full compliance with the Volcker Rule and they must 

be held accountable for such compliance. It has to be their job to ensure that potential 

"needle hiders" are supervised, monitored, caught and punished and, if they fail at their 

job, then management must be punished as well. 

This is what the statute contemplates in the "Anti-Evasion" provisions in Section 

13( e): the appropriate regulators "shall" issue regulations "regarding internal controls 

and recordkeeping, in order to insure compliance with this section," i.e., prohibition on 

proprietary trading. Because senior management is always the first line of defense, these 

regulations must require that the appropriate officers be directly involved in compliance 

and be held accountable. Among other things, one or more of these officers should be 

required to certify periodically that the banking entity has fully complied with the law or 

that it has promptly disclosed to the appropriate regulators each transaction or set of 

transactions which violated the law. 

Self-policing, self-correction and self-reporting have to be the cornerstone of any 

effective compliance regime, but that will only work if the most senior management is 

involved and explicitly accountable. 

Also, as contemplated by the statute, strict liability should be the standard 

imposed for violations of the Volcker Rule. The reason is obvious: anything less will 

inevitably result in unending disputes, encourage game playing and defeat deterrence. 

Indeed, not only does the statute contemplate strict liability, it also requires 

regulators to order the termination of the activity and/or disposition of the investment. 

For example. Section 13(e)(2) provides for the "Termination of Activities or Investments" 

on a strict liability basis: "whenever [a regulator] has a reasonable cause to believe that a 

banking entity or nonbank financial company supervised by the Board ... has made an 

investment or engaged in an activity in a manner that functions as an evasion of the 

requirements of this section (including through an abuse of any permitted activity) or 

otherwise violates the restrictions under this section ... shall order ... [the] terminat[ion 

of] the activity and. as relevant, dispose of the investment." (Emphasis added) 

This explicitly mandated action is in addition to all the other authority the 

appropriate regulatory agencies have to penalize violations of law. Thus, termination 

17 
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79694.034

and! or disposition ot the violating trade are me statutoruy mmlmum action regulators 

must take. -

However. such a sanction by itself would be grossly insufficient to obtain 

compliance with the law. Indeed. it might actually encourage violations because 

termination or disposition of the investment merely forfeits the upside. but has no 

meaningful downside. 

As is painfully obvious. financial institutions are populated with risk-takers and 

only by concretely affecting their riskjbenefit calculations before any violation occurs 

will there be any hope of compliance with the Volcker Rule. 

The Volcker Rule should include a sliding scale of very strong penalties to ensure 

that violating the Volcker Rule does not simply become a cost of doing business. There 

must be substantial fines and penalties for any violation of the rule and such penalties 

must be imposed swiftly. For example. if a regulator has reasonable cause to believe the 

rule has been violated then it must be empowered to impose immediately an 

administrative penalty of (1) 10 times the gross profit or loss from the trade. (2) a six 

month bar on the trader responsible for the trade. and (3) a cease and desist order to the 

firm. Ifthere is a second violation. then the penalties should double. a preliminary 

injunction should issue against the firm. and the responsible member of management 

should be barred for six months from being affiliated with any financial institution. 

To ensure compliance and obtain deterrence. while incentivizing a robust 

comprehensive internal compliance system supported by aggressive management 

oversight. a financial institution could avoid the penalties only if it detects. corrects and 

reports the violation to regulators promptly. The institution must also sanction all 

employees involved in the violation and those sanctions must be publicly reported. 

Without very significant sanctions and public reporting. there will be no 

deterrence and. without deterrence. there will be little compliance with the Volcker rule. 

Follow the Money; Bonus Pools and Other Already Collected. Readily Available Data 

Provide a Roadmap for How the Money is Made and Where the Risks Are. 

Financial institutions and their personnel already collect and precisely track. 

aggregate. analyze and disseminate every meaningful piece of information related to their 

business. including all trading. throughout the day and at the end of every day. week. 

month and quarter. Conveniently. it is all electronically gathered. sorted. stored and can 

be readily transmitted to any appropriate recipient. 

Just one example. in an interview with Bloomberg Business Week published in 

April 2010. Goldman Sachs' CFO said "I personally see the profit and loss statement of 

each orour 44 business units every single night." You can be sure that the finance officers 

below him do as well (and they also review every piece of information that gets rolled up 

into the P&L for their respective business units) because the CFO might call with a 

18 
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79694.035

question. And, you can be sure that the CFO's superiors are also routinely reviewing 

financial information. 

This data gathering is particularly true for any activity where the firm's own 

capital is at risk or might be at risk, which is the case with any proprietary trading. 

Financial institutions have robust and specific approval and monitoring procedures 

whenever the firm's capital is put at risk Importantly, all those processes have 

comprehensive record keeping requirements at the trade, desk and/or deal level, the 

business unit level, the finance department level, the management monitoring level and 

in compliance as well. 

Because regulators will be requesting information specific to an institution's 

businesses and activities, such information should be readily available as a routine 

matter. Therefore, any institution claiming not to have such requested data should be 

required to report that fact in writing to that institution's Board of Directors, Audit 

Committee, accountants and lawyers. 41 

Importantly, however, the regulators should not limit themselves to the traditional 

data gathered and reviewed. For example, one of the most important, and the most 

illuminating, data collections at every financial institution is the bonus pool as it is 

assembled month-by-month to quarter-by-quarter to annual finalization and distribution. 

Few items receive more or closer attention than the components of the bonus 

pool. It simply cannot be overstated the amount of time, effort and energy that is directed 

to assembling, analyzing, designating (prior to year-end) and allocating (at year end) the 

amounts and recipients of monies in the bonus pool. And, all of this information is 

gathered and tracked scrupulously by, among others, each person who will be fighting for 

the largest bonus possible based on their claimed contribution to the firm's profits 

(and/or other bonus components). 

Reverse engineering the bonus pool (as well as the P&L) will show regulators 

precisely where the money is being made (and lost), by whom and as a result of what 

activity. This is an invaluable roadmap. The famous saying is as true today as it was 

decades ago (albeit in a very different context): follow the money and it will lead you to 

most of the answers you need. 

Ending high risk speculative proprietary trading requires eliminating the 

unimaginably large compensation and bonuses that flow from it and that means 

aggressively monitoring the bonus pool. 

41 It is important to remember that the gathering and review of this data in a robust and nimble electronic 

system is already required by numerous rules, regulations and statutes as well as by compliance and 

outside auditors (not to mention the Audit Committee). In particular, the outside auditors must annually 

determine whether the company has an effective and comprehensive system of internal controls. 

19 
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79694.036

..... • ... 111 

Association 

Instit~tional 

INVESTORS· 

Testimony of Jeffrey Plunkett 

On behalf ofthe 

Association of Institutional INVESTORS 

Before the House Committee on Financial Services 

December 13, 2012 

Chairman Bachus, Ranking Member Frank, Members of the Committee, thank you for inviting 

me to testify today on behalf of the Association ofInstitutional INVESTORS (the 

"Association") regarding the Association's suggested changes to Section 619 of the Dodd-Frank 

Wall Street Reform and Consumer Protection Act ("Dodd-Frank Act"), which is commonly 

referred to as the Volcker Rule. 

My name is Jeffrey Plunkett, and I am the General Counsel and Executive Vice President for 

Natixis Global Asset Management, a founding member of the Association. The Association of 

Institutional INVESTORS is an association of some of the oldest, largest, and most trusted 

investment managers in the United States. Our members manage money on behalf of 

institutional investment entities that serve the interests of individual investors through public and 

private pension plans, foundations, and registered investment companies. Collectively, our 

member firms manage ERISA pension, 401 (k), mutual fund, and personal investments on behalf 

of more than 100 million American workers and retirees. Our clients rely on us to prudently 

manage participants' retirements, savings, and investments. This reliance is built, in part, upon 

the fiduciary duty owed to these organizations and individuals. We recognize the significance of 

this role, and the concerns we raise are intended to reflect not just the concerns of the 

Association, but also the concerns of the companies, labor unions, municipalities, families, and 

individuals we ultimately serve. 

The Association's Concerns with the Volcker Rule 

When the Volcker Rule was originally enacted, it was aimed at limiting high-risk proprietary 

trading strategies at a handful of very large banks. Since passage of the Dodd-Frank Act, 

Congress has urged regulators to draw clear lines limiting activities that are clearly proprietary 

trading, while still allowing banks to engage in permitted banking and market making activities. 

The regulators, however, have not found this objective easy to meet with the current statutory 

language, struggling to reach consensus nearly half a year after the deadline for implementation. 
82 


79694.037

We believe that congressional clarification in the form of a technical amendment bill would 

significantly help the regulators in their implementation efforts. 

Despite Congressional intent! that the Volcker Rule only affect the proprietary trading activities 

of large banks while continuing to allow banks to make markets, the proposed rule2 issued by the 

regulators in Octol:ler 2011 would have far-reaching consequences for investors. Asset managers 

and their clients rely on banks to execute trades. Anecdotal evidence suggests that in today's 

market well more than half of institutional investment adviser transactions consist of trades with 

banks, including foreign banks. In this role, banks are providing critical services for the 

functioning of the secondary market. 

The regulators' proposed rule may force bank dealers to stop facilitating transactions for 

customers because of compliance costs and uncertainty regarding the boundaries of permissible 

and impermissible activities. This is due, in part, to the rule's complex, after-the-fact tests for 

determining whether a bank is engaging in proprietary trading, which do not reflect the realities 

of financial markets. We believe the regulators are simply doing their best to implement the 

statute as written. However, unless changes are made to the proposed rule, there will be 

significant disruptions to both liquid and illiquid sectors of the market. 

Additionally, the Association understands the need to limit banking entities' relationships with 

hedge funds and private equity funds. The regulators' interpretation of the statute, however, is 

over-inclusive, and significantly and unnecessarily harms asset managers that are affiliated with 

banking institutions. Many of the covered fund restrictions could be drafted in a marmer that 

effectively addresses systemic risk to the financial system without creating a competitive 

disadvantage for asset managers that are affiliated with banking institutions. 

Mr. Chairman, we support your efforts to formulate a less burdensome Volcker Rule and we 

appreciate your request for industry input on suggested alternatives to the Volcker Rule. While 

we understand the underlying policy considerations for incorporating the Volcker Rule in the 

Dodd-Frank Act, we welcome opportunities to work with Congress and with the fmancial 

regulators to ensure that the ultimate restriction still permits markets to function efficiently and 

fairly. 

The Association submitted a comment letter on September 7, 2012, in response to the 

Chairman's request for industry comments, which discusses our specific concerns and offers 

suggested changes that would address each concern. The letter also offers legislative text that 

would implement each of the Association's suggestions. We would like to incorporate this letter 

and its recommendations by reference into the record and have attached this letter as Appendix 

! See e.g. 156 CONGo REG. S5906 (daily ed. July 15, 2010) (statement of Sen. Bayh (D-IN»: "With respect to the 

Voleker Rule, the conference report states that banking entities are not prohibited from purchasing and disposing of 

securities and other instruments in connection with underwriting or market making activities, provided that activity does 

not exceed the reasonably expected near term demands of clients, customers, or counterparties. I want to clarify this 

language would allow banks to maintain an appropriate dell!er inventory and residual risk positions, which are essential 

parts of the market making function. Without that flexibility, market makers would not be able to provide liquidity to 

markets," 

2 Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and Relationships With, Hedge Funds 

and Private Equity Funds, 76 Fed. Reg. 68846 (Nov. 7, 2011). 

2 
83 


79694.038

A. Additionally, many of the Association's concerns are further discussed in the Association's 

February 13,2012 comment letter submitted to the regulators in response to their proposed rule. 

This letter is also incorporated by reference and attached as Appendix B. 

Conclusion 

Mr. Chairman, as you and the Committee begin to consider draft legislation to amend the 

Volcker Rule, we hope our suggestions serve as a foundation for your efforts. Each of our 

suggestions is intended to mitigate unintended, adverse consequences that will ultimately affect 

the millions of American investors who rely on the continued vitality of their pension plans and 

401(k) accounts. We thank you and the Committee for considering our letter and for giving 

industry concerns with the Volcker Rule.the serious attention they deserve. As the Committee 

progresses toward making technical corrections to Section 619, we stand ready to provide useful 

guidance as a non-conflicted voice for investors. 

Thank you for the invitation to participate in today's hearing. 

3 
84 


79694.039

APPENDIX A 

Comments of the Association of Institutional INVESTORS 

In Response to Chairman Bachus' Public Request for Input on Volcker Rule Alternatives 

September 7,2012 

4 
85 


79694.040

The Honorable Spencer Bachus, Chairman 

House Financial Services Committee 

2129 Rayburn House Office Building 

Washington, D.C. 20515 

Association 

Institu~ional 

INVESTORS· 

Re: Public Request for Input on Volcker Rule Alternatives 

Dear Chairman Bachus: 

September 7,2012 

The Association ofInstitutional INVESTORS' (the Association) appreciates the opportunity to 

provide the House Financial Services Committee (HFSC) with specific legislative text and 

explanatory text that would amend certain provisions of Section 619 of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act (the Dodd-Frank Act)! 

The Association supports HFSC's efforts to formulate a less burdensome alternative to the Volcker 

Rule and appreciates HFSC's request for additional comments from those that would be directly 

affected by the rule. We believe the text of Section 619, and by extension the regulators' proposed 

rule (proposed Rule); will have resounding effects on the future of our industry, because it will 

1 The Association of InstitutioruU INVESTORS is an association of some of the oldest, largest, and most trusted 

investment advisers in the United States. Our clients are primarily institutioruU investment entities that serve the 

interests of individruU investors through public and private pension plans, foundations, and tegisteted investment 

companies. Collectively, our membet fu:ms manage ERISA pension, 401(k), mutual fund, and persoruU investments on 

behalf of mote than 100 million American workets and retieees. Our clients rely on us to prudently manage participants' 

retieements, savings, and investments. This reliance is built, in part, upon the fiduciary duty owed to tbese organizations 

and individuals. We recognize the significance of this role, and our comments are intended to reflect not just the 

concerns of the Association> but also the concerns of the companies, labo.r unions, municipalities, families, and 

individuals we ultimately serve. 

2 Sa Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010). 

3 Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and Relationships With, Hedge Funds 

and Private Equity Funds, 76 Fed. Reg. 68846 (Nov. 7, 2011). 
86 


79694.041

The Association ofInstitutional INVESTORS 

Response to HFSC Chainnan Bachus' Request for Volcker Alternatives 

Page 2 of14 

detennine whether banks will continue to serve as liquidity providers and counterparties to trades on 

behalf of our clients. Therefore, we welcome the opportunity to work with HFSC as it considers 

how best to make this provision workable, striking a balance between limiting risky behavior at 

banks and ensuring that banks can continue to serve the needs of our clients. 

OVERVIEW OF THE AsSOCIATION'S SUGGESTIONS 

The Association represents asset managers that work on behalf of institutional investors, such as 

pension funds and 401 (k) accounts. Although Section 619 of the Dodd-Frank Act, and by extension 

the Proposed Rule, is focused on the activities of banks, we believe that an inappropriately expansive 

Volcker Rule will have far reaching consequences for millions of American investors who rely on 

the continued vitality of these pension plans and 401 (k) accounts. 

Specifically, financial regulators have interpreted the language of Section 619 and drafted a Proposed 

Rule that reduces in the breadth of investment options available to American investors. The 

Proposed Rule could force bank dealers to stop facilitating transactions for customers in situations 

where the compliance costs and uncertainty about the boundaries of permissible and impermissible 

activities are too great, even though the banks are not engaging in "proprietary trading." Going 

forward, we also believe there will be diminished depth of both liquid and illiquid sectors of the 

market due to the complex nature and interplay of the factors and metrics that seem impracticable 

to implement. The Proposed Rule also has been subject to significant international criticism, as 

international bodies such as the G-20 have worked toward international coordination of financial 

regulatory reform. The Association believes that changes to the statute should be considered to 

foster international consensus regarding the provision. 

To address these harmful and unintended consequences, specific technical amendments must be 

made to Section 619 of the Dodd-Frank Act. By doing so, we believe it is possible to achieve the 

goal of limiting risky proprietary trading, while allowing banks to continue legitimate activity on 

behalf of institutional investors. The following sections of this memorandum discuss specific issues 

that we believe must be addressed within Section 619, including providing HFSC with a "blackline" 

of suggested legislative amendments. Appendix A to the document then provides a copy of the 

Association's suggested legislation to amend Section 619 and implement each of these changes. 

SPECIFIC LEGISLATIVE RECOMMENDATIONS WITH ExPLANATORY TEXT 

a. Proprietary Trading Restrictions 

i. Presumption of Proprietary Trading 

Although the Association does not believe it was the intent of Congress, under the Agencies' 

Proposed Rule, banks must meet a set of criteria to show that they are not engaged in proprietary 

trading. This creates the presumption that the activity is proprietary trading unless the banks prove 

otherwise. The Association believes this may result in banks being unwilling to take principal risk to 

provide liquidity services to institutional investors, because Agencies have the ability to second-guess 
87 


79694.042

The Association of Institutional INVESTORS 

Response to HFSC Chairman Bachus' Request for Volcker Alternatives 

Page 3 of14 

a bank's actions after it has completed trades, making it difficult or risky for the bank to assist asset 

managers in executing such trades. 

Although we recognize the desire to inhibit efforts to evade the prohibition that could result if the 

definition were to be drawn too nartowly, we believe these concerns are overshadowed by what may 

result from an overly broad or unclear definition. Further, given the anti-evasion provisions and 

significant oversight and reporting requirements, it is unnecessary to draft an over-inclusive 

definition for fear of atrempts to evade the prohibition. 

Suggested Change: Congress should clarify that the Agencies should focus on trading activities 

that "are conducted solely for the purpose of executing trading strategies that are expected to 

produce short-term profits without any connection to customer facilitation or intermediation," as 

described by Federal Reserve Governor Daniel Tarullo. This would limit proprietary trading to 

situations that are "not difficult to identify" and would be consistent with former Federal Reserve 

Chairman Paul Volcker's statements that it should be easy to recognize proprietary trading. 

Legislative Text: 

"(h) DEFINITIONS.-In this section, the following definitions shall apply: 

"(4) PROPRIETARY TRADING -The term 'proprietary trading', when used with respect to a 

banking entity or nonbank financial company supervised by the Board, means, subject to the 

folJowing sentence engaging as a principal for the trading account of the banking entity or nonbank 

financial company supervised by the Board in any transaction to purchase or sell, or otherwise 

acquire or dispose of, any security, any derivative, any contract of sale of a commodity for future 

delivery, any option on any such security, derivative, or contract, or any other security or financial 

instrument that the appropriate Federal banking agencies, the Securities and Exchange Commission, 

and the Commodity Futures Trading Commission may, by rule as provided in subsection (b)(2), 

determine. For pUqloses of thjs defipition the term 'proprietaty trading' is Urnited to principal 

transactions effected for the pumose of executing trading strategies that are gpected to produce 

shQrt-tepp profits without a dear connection to customer facilitation or iptennediatioo 

A. Market Making Exemption 

In particular, the market making test under Section 619 (d)(1 ) (B) is ambiguous and may lead to 

uncertainty as to whether the Agencies will interpret legitimate behavior as proprietary trading, and 

thus may make it difficult for banks to engage in market making activity. If banks are unwilling to 

continue intermediating trades for institutional investors because the Proposed Rule creates 

uncertainty as to whether such activity is market making, the ultimate harm will fall on individuals 

and families, who utilize pension funds and 401 (k) funds for their retirement savings. 

Suggested Change: The Association urges Congress to clarify that market making activities taken 

on behalf of customers fall within the market making exemption. The meaning of the phrase 

"reasonably expected near term demands of clients, customers, or counterparties" in Section 

619(d)(1)(B) should also be clarified to state that "near term" does not limit the market making 

trading activity in markets that are illiquid or have episodic liquidity. 
88 


79694.043

The Association of Institutional INVESTORS 

Response to HFSC Chainnan Bachus' Request for Volcker Alternatives 

Page 4 of14 

Legislative Text: 

"(d) PERMITTED ACTIVITIES.-

"(1) IN GENERAL.-Notwithstanding the restrictions under subsection (a), to the extent 

permitted by any other provision of Federal or State law, and subject to the limitations under 

paragraph (2) and any restrictions or limitations that the appropriate Federal banking agencies, the 

Securities and Exchange Commission, and the Commodity Futures Trading Commission, may 

determine, the following activities (in this section referred to as 'permitted activities') are permitted: 

"(B) The purchase, sale, acquisition, or disposition of securities and other instruments described in 

subsection (h)(4) in connection with underwriting or market-making related activities reasonably 

related to customer f.cilitaUon or inteqpedjarion, to the extent that any such activities permitted by 

this subparagraph are designed not to exceed the reasonably expected near term demands of clients, 

customers, or counterparties. For pumoses of thjs section the term "reaso~ably gpected near teon 

demands" sball be based on the specific liguidity characteristics of jndividual markets and products 

B. Risk Mitigating Hedging Exemption 

The Agencies' Proposed Rule also provides a number of requirements that firms must attain in 

order to rely on a risk-mitigating hedging exemption. According to the Proposed Rule, the criteria is 

intended to define the scope of permitted risk-mitigating hedging activities and to prohibit reliance 

on the exemption for proprietary trading that is mischaractenzed as permitted hedging activity. 

The Association agrees that hedging is an appropriate indicator of an entity's risk appetite, but 

believes that this indicator breaks down at the trade-by-trade level. In particular, this indication fails 

when gauging whether hedging activities are proper for illiquid markets, where perfect hedges are 

often not available. Further, members of the Association trade with market makers that use generally 

available hedges to bridge the gap between time and price with various traders in the market. The 

hedging exemption, therefore, must include a broad definition of what constitutes a "trading unit" 

(also known as an "aggregation unit") to permit banking entities to hedge adequately their trades 

with institutional clients. 

Suggested Change: Congress should clarify that the Agencies must allow coordinated aggregate 

risk-mitigating hedging activities that are implemented across trading units. Additionally, Congress 

should define the term 'trading unit' and the correlation to risk-mitigating hedging activities in the 

legislation to ensure that banking entities may continue to hedge adequately their trades with 

institutional clients. 

Legislative Text: 

"(d) PERMITTED ACTIVITIES.-

"(1) IN GENERAL-Notwithstanding the restrictions under subsection (a), to the extent 

permitted by any other provision of Federal or State law, and subject to the limitations under 

paragraph (2) and any restrictions or limitations that the appropriate Federal banking agencies, the 

Securities and Exchange Commission, and the Commodity Futures Trading Commission, may 

determine, the following activities (in this section referred to as 'permitted activities,) are permitted: 
89 


79694.044

The Association of Institutional INVESTORS 

Response to HFSC Chainnan Bachus' Request for Volcker Alternatives 

Page 50f14 

"(C) Risk-mitigating hedging activities in connection with and related to individual or aggregated 

positions, contracts, or other holdings of a banking entity that are designed to reduce the specific 

risks to the banking entity in connection with and related to such positions, contracts, or other 

holdings. In deyelqging apd issuing regulatioos pUrsuapt to this section the 3PJ2t9J2ria,ts federal 

bankipg agencies the Securities and Exchange Commission and the Cgmmgdity F1m1tes IpdiQg 

Commissiop shan consider coordipated aggregate risk-mitigating hedging- actiyiU,§ impJs;tQSipted 

across tradiog upits For put;poses of this section the feW "trading unit" means each discrete nojt 

engaged in a revenue generation strategy at a banking entity 

ii. Municipal Bond Market Exemption 

Section 619(d)(1)(A) permits the purchase, sale, acquisition, or disposition of obligations of the 

United States or any agency thereof, as well as obligations of any State or of any political subdivision 

thereof. While we support this exemption, the Association is concerned that the Agencies' 

Proposed Rule has been drawn too narrowly, prohibiting banks from trading in a significant portion 

of the current municipal bond activities, including securities issued by State agencies or 

instrumentalities. We also disagree with the Agencies' interpretation that its exemption is 

"consistent with the statutory language," because it does not extend the government obligations 

exemption to include "transactions in obligations of an aten!'} of any State or political subdivision 

thereof." Without clarification from Congress, the Agencies' current interpretation could have 

significant unintended consequences, such as limiting the funding availability for projects such as 

hospitals, affordable housing developments, airports, and universities that receive financing through 

municipal obligations. 

Suggested Change: Congress should clarify the exemption for proprietary trading in State or 

municipal agency obligations through adopting the definition of "municipal securities" already 

included in Section 3(a)(29) of the Securities Exchange Act of 1934. Utilizing such a definition in 

the exemption would provide a clearer line for banks to follow regarding what is covered under the 

municipal bond market exemption, pertnitting investors to continue investing in municipal debt at 

reasonable costs. 

Legislative Text: 

"(d) PERMITTED ACTIVITIES.-

"(1) IN GENERAL.-Notwithstanding the restrictions under subsection (a), to the extent 

pertnitted by any other provision of Federal or State law, and subject to the limitations under 

paragraph (2) and any restrictions or limitations that the appropriate Federal banking agencies, the 

Securities and Exchange Commission, and the Commodity Futures Trading Commission, may 

determine, the following activities (in this section referred to as 'permitted activities') are permitted: 

"(A) The purchase, sale, acquisition, or disposition of obligations of the United States or any agency 

thereof, obligations, participations, or other instruments of or issued by the Government National 

Mortgage Association, the Federal National Mortgage Association, the Federal Home Loan 

Mortgage Corporation, a Federal Home Loan Bank, the Federal Agricultutal Mortgage Corporation, 

or a Farm Credit System institution chartered under and subject to the provisions of the Farm 

Credit Act of 1971 (12 U.S.c. 2001 et seq.), aaa eeligatieas efftay 8ete ef effttty Ilelitieal 
90 


79694.045

'The Association of Institutional INVESTORS 

Response to HFSC Chainnan Bachus' Request for Volcker Alternatives 

Page 60f14 

stlBtlifl:sie6 l'hereef and 'mlmicigal seOlrities ' as defined in Section 3(a)(2Q) of the SeOlrities 

Exchange Act of 1934 (15 JJ S C 7Sc) 

b. Covered Funds 

i. Definition of "Covered Fund" 

Section 619(h)(2) of the Dodd-Frank Act defines "hedge fund" and "private equity fund" as: 

an issuer th~t would be an investment company, as defined in the Investment 

Company Act of 1940 (15 U.S.c. SOa-1 et seq.), but for section 3(c)(1) or 3(c)(7) of 

that Act, or such similar funds as the appropriate Federal banking agencies, the 

Securities and Exchange Conunission, and the Commodity Futures Trading 

Conunission may, by rule, as provided in subsection (b)(2), determine. 

The Financial Stability Oversight Council's (FSOC) study on the Volcker Rule acknowledged that 

the foregoing definition is over-inclusive, and includes funds that are not commonly understood to 

be either a "hedge fund" or a "private equity fund" and that do not present the same types of risks. 

It also acknowledged that the definition is under-inclusive and may not capture other vehicles that 

don't rely on the exemptions, but engage in the activities or share the characteristics of a traditional 

private equity fund or hedge fund. 

In drafting a definition, the FSOC study also recommended.that certain factors be considered in 

determining what funds should be included as "similar funds." Accordingly, the Association 

believes this language must be tightened up in order to provide the Agencies with better guidance 

regarding what types of funds should be identified as "similar funds." Under the Proposed Rule, 

given the lack of guidance, the Agencies have extended this section to other types of funds without 

actually identifying the characteristics or activities that make such funds problematic or 

demonstrating that these funds lack adequate regulation by foreign jurisdictions. 

For example, the Agencies have proposed to extend the definition of "covered fund" to cover any 

issuer organized or offered outside of the U.s. which would be a 3(c)(1) or 3(c)(7) fund if offered or 

organized inside the United States. Since most foreign funds could not meet all of the substantive 

regulatory requirements of a registered domestic investment company, they necessarily rely on the 

exemptions of Section 3(c)(1) or 3(c)(7). Thus, this definition captures a significant portion of 

foreign funds without adequate analysis of whether they share the same attributes as traditional 

hedge funds or private equity funds. 

Additionally, the Agencies proposed to include as similar funds all "commodity pools" (which 

broadly captures vehicles that trade in commodity interests), as well as the foreign equivalent of any 

commodity pool and treat them as a "covered funds." According to the Agencies, these entities 

would be included because they are generally managed and structured similar to a covered fund 

except that they are generally not subject to the Federal securities laws due to the instruments in 

which they invest or because they are not organized in the U.S. or one or more States. We do not 
91 


79694.046

The Association of Institutional INVESTORS 

Response to HFSC Chairman Bachus' Request for Volcker Alternatives 

Page 7 of 14 

believe it was Congress' intent to include these funds, because they do not have similar 

characteristics or activities of traditional hedge funds and private equity funds. 

Further, in the wake of the CFTC's recent repeal of the Ru1e 4.5 exemption for mutual funds from 

the definition of commodity pools, and the expansion of the types of instruments that constitute 

"commodity interests" (i.e., swaps), many mutual funds and other pooled vehicles are likely to fall 

under the definition of commodity pools even if they trade in relatively small amounts of 

commodity interests. This may now subject many otherwise exempt registered investments 

companies to the Volcker Ru1e because commodity pools are considered "covered funds." 

Suggested Change: Congress shou1d revise and narrow the definition of "hedge fund" or "private 

equity fund" to exclude all registered investment companies and specifically identify the factors (i.e., 

characteristics and/or activities) that must exist in other pooled vehicles before the regu1ators may 

designate them as "similar funds." Additionally, foreign funds that are not actively marketed to u.s. 

investors and non-U.S. regu1ated funds, such as UCITS funds.and other European regulated funds, 

which are subject to a degree of supervisory regulation in foreign jurisdictions (such as AIFMD), 

shou1d also be excluded from the definition. 

Legislative Text: 

"(h) DEFINITIONS.-In this section, the following definitions shall apply: 

"(2) HEDGE FUND; PRIVATE EQUITY FUND.-The terms 'hedge fund' and 'private equity 

fund' mean an issuer that wou1d be an investment company, as defined in the Investment Company 

Act of 1940 (15 U.S.c. 80a-l et seq.), but for section 3( c)(l) or 3( c)(7) of that Act, or such similar 

funds as the appropriate Federal banking agencies, the Securities and Exchange Commission, and 

the Commodity Futures Trading Commission may, by ru1e, as provided in subsection (h)(2), 

determine, provided that such fnnd demonstrates characteristics that are similar to traditional hedge 

funds and private egyity funds s11cb as being a managed portfoJio of investments that utilizes 

significant leveraging or high-risk strategjes snch as loni sbort and dsrivatiye positions that ipcrease 

risk or Joss to the fund The terms 'hedge 610d' and 'private equity Plod' shall not include" 

foreign fuods that ate not actively marketed to II S investors and PM-IJ S «gulated fimds when 

S11cb fUnds and their rukisers art s11biect to pnldeptia1 standards in 3 home country that are 

administered and enforced by a comBarable foreign sl!pervismy authority 

ii. Exemptions 

A. Naming Prohibition 

Section 619(d)(1)(G)(vi) provides that the banking entity may not share with the hedge fund or 

private equity fund, for corporate, marketing, promotional, or other purposes, the same name or a 

variation of the name. The Agencies' Proposed Ru1e expands upon this prohibition, stating that the 

covered fund may not share the same name or a variation of the same name with the banking entity 

(or an affiliate or subsidiary thereof) and also may not use the word ''hank'' in the name. 
92 


79694.047

The Association of Institutional INVESTORS 

Response to HFSC Chairman Bachus' Request for Volcker Alternatives 

Page 8 of14 

Under Section 619(d)(1)(G)(v), the banking entity may not, directly or indirectly, guarantee, assume, 

or otherwise insure the obligations or performance of the covered fund or of any covered fund in 

which such covered fund invests. This restriction is sufficient for ensuring that the entities are 

viewed separately in the market. We question the necessity for any naming prohibition beyond 

prohibiting the use of the word "bank" when a prohibition on bailing out funds is in place and 

where there is disclosure that investors bear the risk ofloss in any default. The prohibition on 

bailing out funds protects against the "too big to fail" problems of the financial ctisis and the 

disclosure requirements provide the necessary warning to investors of the risks involved. 

Suggested Change: Congress should amend this provision to prohibit the word "bank" from the 

names of hedge funds or private equity funds organized and offered by banking entities, without 

requiring that the fund not share the same name or a variation of the same name with the banking 

entity (or an affiliate or subsidiary thereof). As currently drafted, the naming prohibition burdens 

the industry without providing increasing safeguards to investors. Under the Volcker Rule, banking 

entities may not, directly or indirectly, guarantee, assume, or otherwise insure the obligations or 

performance of the fund or of any fund in which such covered fund invests, and this must be 

disclosed in writing to prospective and actual investors. This restriction is sufficient for ensuring 

that the entities are viewed separately in the market. 

Legislative Text: 

"(d) PERMITrED ACTIVITIES.-

"(1) IN GENERAL.-Notwithstanding the restrictions under subsection (a), to the extent 

permitted by any other provision of Federal or State law, and subject to the limitations under 

paragraph (2) and any restrictions or limitations that the appropriate Federal banking agencies, the 

Securities and Exchange Commission, and the Commodity Futures Trading Commission, may 

determine, the following activities (in this section referred to as 'permitted activities,) are permitted: 

"(G) Organizing and offering a private equity or hedge fund, including serving as a general partner, 

managing member, or trustee of the fund and in any manner selecting or controlling (or having 

employees, officers, directors, or agents who constitute) a majority of the directors, trustees, or 

management of the fund, including any necessary expenses for the foregoing, only if-

"(vi) the name of the eftfll~ efttity flaes fiat sRlire Mth the hedge fund or private equity fund, for 

corporate, marketing, promotional, or other purposes, tRe saffle fi!lffle at a'i'ftBfttfafi af the Sftffle 

flftffte:-tioes not include the word <bank;' 

B. Investments by Employees and Directors Providing Advisory 01 

Other Services 

Section 619 (d)(1)(G)(viJ.) prohibits any director or employee of the banking entity from taking or 

retaining an equity interest, partnership interest, or other ownership interest in the hedge fund or 

private equity fund, except for any director or employee of the banking entity who is directly 

engaged in providing investment advisory or other services to the hedge fund or private equity fund. 

Suggested Change: The Association believes that this prohibition on employee investment needs 

to be applied prospectively. Legislation should provide a grandfathering safe harbor for current 
93 


79694.048

The Association of Institutional INVESTORS 

Response to HFSC Chairman Bachus' Request for Volcker Alternatives 

Page 9 of14 

directors or employees to retain the interests already in their possession as of July 21, 2012, whether 

or not the directors or employees are currendy providing services to the hedge fund or private equity 

fund. To do otherwise would cause these investors to suffer potentially significant tax 

consequences, as well as cause the funds and these investors significant difficulties in situations 

where interests are currendy illiquid due to contractual redemption restrictions or the fund assets are 

illiquid. 

Legislative Text: 

"(d) PERMITIED ACTIVITIES.-

"(1) IN GENERAL.-Notwithstanding the restrictions under subsection (a), to the extent 

permitted by any other provision of Federal or State law, and subject to the limitations under 

paragraph (2) and any restrictions or limitations that the appropriate Federal banking agencies, the 

Securities and Exchange Commission, and the Commodity Futures Trading Commission, may 

determine, the following activities (in this section referred to as 'permitted activities,) are permitted: 

"(G) Organizing and offering a private equity or hedge fund, including serving as a general partner, 

managing member, or ttustee of the fund and in any manner sdecting or controlling (or baving 

employees, officers, directors, or agents who constitute) a majority of the directors, ttustees, or 

management of the fund, including any necessary expenses for the foregoing, only if-

"(vil) on or after the effective date no director or employee of the banking entity tftj.es Sf retftfs5 

~ an equity interest, partnership interest, or other ownership interest in the hedge fund or 

private equity fund, ~aeert fef !tsy ~director or employee of the banking entity whe-is 

direcdy engaged in providing investment advisory or other services to the hedge fund or private 

equity fund; and 

iii. Super 23A 

Section 619(£)(1) prohibits a banking entity that serves, direcdy or indirecdy, as the investment 

manager, investment adviser, or sponsor to a hedge fund or private equity fund, or that organizes 

and offers a hedge fund or private equity fund pursuant to Section 619(d)(1)(G), and no affiliate of 

such entity, to enter into a transaction with a fund, or with any other hedge fund or private equity 

fund that is controlled by such fund, that would be a covered transaction, as defined in Section 23A 

of the Federal Reserve Act, with the hedge fund or private equity fund, as if such banking entity and 

the affiliate thereof were a member bank and the hedge fund or private equity fund were an affiliate 

thereof. 

Under the additional restrictions created by this provision, banks and their affiliates would not be 

able to engage in limited types of covered transactions currendy permitted by the exclusions and 

restrictions under Section 23A when lending to affiliates. Unlike the regulations between banks and 

their affiliates, where limitations exist but banks are still able to lend, this provision would make it so 

that advisers are no longer permitted to lend money to funds in the same way as is available for 

banks to lend to operating affiliates. In practice, this provision would allow banks to engage in more 

extensive activities with affiliated entities (where the bank's capital is at greatest potential risk of loss) 

than would be permitted between a bank or its affiliate and an affiliated hedge fund (where the 

bank's risk of capital loss is less). 
94 


79694.049

The Association ofInstitutional INVESTORS 

Response to HFSC Chairman Bachus' Request for Volcker Alternatives 

Page 10 of14 

The Association also questions the necessity to restrict activity more tightly between banks and 

affiliates when the banks are engaged in the traditional functions of custodian banks. Custodian 

banks that also manage covered funds must be able to continue to provide custodian services, such 

as providing intraday and overnight credit in connection with routine security and currency 

deliveries of payment transactions. If custodian banks are unable to provide custodian services to 

affiliated funds in the same manner as unaffiliated funds, then more risk would be introduced into 

the settlement process for these affiliated funds, because they would have to introduce third party 

custodians or lending parties to offer intraday or overnight credit to provide the necessary liquidity 

for routine payment and settlement functions. TIlls would create more disconnect in the securities 

payment and settlement processing system, and will commensurately increase operational risk to 

these funds as well as the securities payment or settlement system. Ultimately, this would increase 

the potential risk to the fund sponsor. In other words, the fund may be more likely to suffer a loss 

that otherwise could have been anticipated and managed with an affiliated custodian because that 

custodian has a comprehensive view of the fund's activities and shares an interest to minimize risk 

of loss caused by disruptions in securities payment and settlements processing. 

Suggested Change: The Association suggests that the legislation should modify this provision to 

mirror the language of Section 23A of the Federal Reserve Act, permitting banks and their affiliates 

to engage in limited types of covered transactions permitted by the current exclusions and 

restrictions under the Federal Reserve Act when lending to affiliates. Additionally, the language 

should clarify that banks may continue to engage in the traditional functions of custodian banks. 

Legislative Text: 

"(f) LIMITATIONS ON RELATIONSHIPS WITH HEDGE FUNDS AND PRIVATE EQUITY 

FUNDS.-

"(1) IN GENERAL.-,a Ne banking entity that serves, directly or indirectly, as the investment 

manager, investment adviser, or sponsor to a hedge fund or private equity fund, or that organizes 

and offers a hedge fund or private equity fund pursuant to paragraph (d)(1)(G), and I!.!l fit} affiliate§ 

of such entity, f'l'Ilty ester iste It trliBSftet3:es -Mtfi ft funs, e£ Mtll. ftfty elher ll.e~e fuss e£ flmftte 

e~<y funs that is E6Btfeiles By stlell. fuss, that W6ti!S Be a ee. efes tfftftSltEt3:6S, ftS seasea ifl ~ 

abide by the restrictioos 00 trapsactioos with affiliates described in section 23A of the Federal 

Reserve Act (12 U.S.c. 371c) with the hedge fund or private equity fund, as if such banking entity 

ftBB the ltffiliftte thereefwere a member bank and the hedge fund or private equity fund were an 

affiliate thereof. 

iv. Limitations on Fund Investments 

Under Section 619(d)(4)(B)(ii)(I) of the Dodd-Frank Act, banking entities may take an ownership 

interest in a covered fund if the banking entity's investment is limited to no more than three percent 

of the total outstsnding ownership interests of such fund not later than one year after the date of 

establishment of the fund. The banking entity may also not invest more than three percent of its 

Tier 1 capital in covered funds in the aggregate. 
95 


79694.050

The Association of Institutional INVESTORS 

Response to HFSC Chairman Bachus' Request for Volcker Alternatives 

Page 11 of14 

Typically, bank asset managers will market affiliated funds that have at least a three-year 

performance record in order to attract institutional investors. In order to create such a longstanding 

record, the manager will typically seed a strategy for the initial three years with capital. Few asset 

managers or investors are willing to invest in a strategy that does not have a three-year perfonnance 

record. Because of the broad application of the Volcker Rule to bank-affiliated managers, the three 

percent restriction will severely curtail a bank-affiliated manager from investing its own money to 

create the three-year performance record, and effectively eliminate an adviser's ability to launch new 

strategies that are not 40 Act Funds. 

Suggested Change: The Association suggests that the legislation should modify the one-year 

deadline, instead requiting a three-year deadline to limit fund investment. By doing so, the 

Congressional goal of ensuring banks are not engaging in risky behavior will be met, while still 

allowing bank.asset managers who market affiliated funds to establish their perfonnance record 

needed in order to attract institutional investors. If appropriate, such three-year extension could be 

contingent on the per fund investment be subject to a dollar limit and otherwise be explicitly subject 

to the aggregate investment limit of 3% of Tier 1 capital of the banking entity. 

Legislative Text: 

"(d) PERMITTED ACTIVITIES.-

"(4) DE MINIMIS INVESTMENT.-

"(B) LIMITATIONS AND RESTRICTIONS ON INVESTMENTS.-

"(ii) LIMITATIONS ON SIZE OF INVESTMENTS.-Notwithstanding any other provision of 

law, investments by a banking entity in a hedge fund or private equity fund shall-

"(1) not later than + l,yeat'§ after the date of establishment of the fund, be reduced through 

redemption, sale, or dilution to an amount that is not more than 3 percent of the total ownership 

interests of the fund prODded that the appropriate Federal baoJsjng agencies may impose a doUar 

limit 00 the banking entity's ipyestment in an individual hedge fund or priyate SQllity 610d during jts 

injtial 3 year tenn to address potential lwdue risk to the banking eprity's capital· 

v. Definition ofIlliquid Fund 

Section 619(h)(7) of the Dodd-Frank Act defines illiquid fund as a hedge fund or private equity fund 

that "as of May 1,2010, was principally invested in, or was invested and contractually committed to 

principally invest in, illiquid assets, such as portfolio companies, real estate investments, and venture 

capital investments, and makes all investments pursuant to, and consistent with, an investment 

strategy to principally invest in illiquid assets." 

The Association believes this definition utilizes an arbitrary date that may unnecessarily exclude 

funds that otherwise should meet the definition of being an illiquid fund. While we recognize that 

the purpose of this definition is to ensure that people are unable to manipulate the system, this 

definition would exclude, for example, a fund that was entirely liquid on May 1, 2010, but ultimately 

found itself in an illiquid state due to reasons or factors beyond its control (for example, the 

illiquidity was not due to any changes in portfolio holdings but was due to market forces). Such a 

result would hann investors to such funds and cut against the Congressional intent in Section 619 of 
96 


79694.051

The Association of Institutional INVESTORS 

Response to HFSC Chairman Bachus' Request for Volcker Alternatives 

Page 120f14 

the Dodd-Frank Act. It would also not take into account liquidity factors that adversely affect the 

fund and are beyond the control or foresight of the fund sponsors. Ths could require sponsors to 

divest their fund ownership interest at inopportune times (i.e .. , when market liquidity is constrained) 

despite best efforts to reduce their ownership interests by the deadline. 

Suggested Change: The definition of illiquid fund should be based on assets rather than being 

solely based on contractual rights at a specific date in the past. The definition should also provide 

flexibility for regulators to implement a process for a banking entity to apply for an extension of 

time to divest its ownership interest in the fund in order to minimize the adverse impacts on, and 

conflicts of interest with, the fund and the investors, particularly where forcing the banking entity to 

divest prematurely could abrogate pre-existing contractual agreements or fundamental tenets of the 

fund's structure and operation. Such application process would allow the regulators to individually 

analyze whether a fund in existence prior to the statute's enactment has become illiquid through 

reasons beyond the fund or sponsor's control, and provide for a more tailored and orderly 

divestment based on the particular facts and circumstances. Further, the legislation should clarify 

that all funds that otherwise meet the definition of being principally invested in illiquid assets as of 

the date of implementation are grandfathered in as illiquid funds under the statute, rather than using 

the date of May 1, 2010. 

Legislative Text: 

"(h) DEFINITIONS.-In this section, the following definitions shall apply: 

"(J) ILLIQUID FUND.-

"(A) IN GENERAL.-The term 'illiquid fund' means a hedge fund or private equity fund that-

"(i) !IS sf MftY 1, 2019, ... as <a) on or prior to the enactment date was principally invested in, or was 

invested and contractually commitred to principally invest in, illiquid assets, such as portfolio 

companies, real estate investments, and venture capital investments; and 

"(iill) makes all investments pursuant to, and consistent with, an investment strategy to principally 

invest in illiquid assets;.Q,!; 

fjj) 00 or after the enactment date held Hgnid assets of which a siWifignt portiog became illiqyid 

due to market forces or factors beyond the individual or cQUeerlve control of such filpd its 

investment adviser and its sponsor In issuing rules regarding this subpatagraph, the Board shall take 

into consideration the terms of investment for the hedge fund or private equity fund, including 

contractual obligations, the ability of the fund to divest of assets held by the fund at a reasonable 

., whether the fund has become illiquid through factors or reasons beyond the individuaJ or 

collective control of the fimds its investment adviser or sponsor, and any other factors that the 

Board determines are appropriate. 

CONCLUSION 

The Association recognizes the challenges Congress and the Agencies have in attempting to draft 

legislation and regulations to limit potentially risky banking activities while permitting banks to 

continue to provide much needed liquidity. The Association thanks HFSC for the opportunity to 

provide our suggestions regarding how Section 619 of the Dodd-Frank Act could be improved. We 

would be happy to discuss these changes with you or the Committee at your convenience. Please 
97 


79694.052

The Association of Institutional INVESTORS 

Response to HFSC Chainnan Bachus' Request for Volcker Alternatives 

Page 13 of14 

feel free to contact me with any questions you may have at jgidman@1oomissayles.com or (617) 748-

1748. 

On behalf of the Association ofInstitutional INVESTORS, 

cc: Ms. Elizabeth M. Murphy, Secretary, Securities and Exchange Commission 

Ms. Jennifer J. Johnson, Secretary, Board of Governors of the Federal Reserve 

John Gidman 

President 

Mr. Robert E. Feldman, Executive Secretary, Federal Deposit Insurance Corporation 

Mr. David A. Stawick, Secretary, Commodity Futures Trading Commission 

Mr. Thomas J. Curry, Comptroller of the Currency, Office of the Comptroller of the 

Currency 
98 


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The Association ofInstitutional INVESTORS 

Response to HFSC Chairman Bachus' Request for Volcker Alternatives 

Page 140f14 

APPENDIX A 

SUGGESTED LEGISLATION TEXT 
99 


79694.054

112TH CONGRESS 

2ND SESSION 

H.R. 

To amend certain provisions in Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, and for other purposes. 

IN THE HOUSE OF REPRESENTATIVES 

___ ,,_2012 

Mr. Bachus introduced the following bill; which was referred to the House Financial Services Committee. 

A BILL 

To amend certain provisions in Section 619 of the Dodd-Frank 

Wall Street Reform and Consumer Protection Act, and for 

other purposes. 

Be it enacted by the Senate and House of Representatives of 

2 the United States of America in Congress assembled, 

3 SECTION 1. SHORT TITLE. 

4 (a) Short Title - This Act may be cited as the "Volcker Act". 

5 (b) Reference - Whenever in this Act an amendment or repeal is 

6 expressed in terms of an amendment to, or repeal of, a section or 

7 other provision, the reference shall be considered to be made to a 

8 section or other provision of the Dodd-Frank Wall Street Reform 

9 and Consumer Protection Act of2010. 
100 


79694.055

1 SECTION 2. PERMITTED ACTIVITIES 

2 (a) Section 619(d)(1)(A) (12 U.S.C. l851(d)(1)(A» is amended by 

3 striking "and obligations of any State or of any political subdivi4 sion thereof' and inserting "any 'municipal securities; as defmed 

5 in Section 3(a)(29) of the Securities Exchange Act of 1934 (15 

6 U.S.C.78c)." 

7 (b) Section 6l9(d)(1)(B) (12 U.S.C. 185 1 (d)(1)(B» is amended to 

8 read as follows: "(B) The purchase, sale, acquisition, or disposi9 tion of securities and other instruments described in subsection 

10 (h)(4) in connection with underwriting or market-making related 

11 activities reasonably related to customer facilitation or intermedia12 tion, to the extent that any such activities permitted by this sub13 paragraph are designed not to exceed the reasonably expected near 

14 term demands of clients, custom~rs, or counterparties. For pur15 poses of this section, the term "reasonably expected near term de16 mands" shall be based on the specific liquidity characteristics of 

17 individual markets and products." 

18 (c) Section 619(d)(1)(C) (12 U.S.C. 1851(d)(1)(C» is amended by 

19 inserting "In developing and issuing regulations pursuant to this 

20 section, the appropriate Federal banking agencies, the Securities 

21 and Exchange Commission, and the Commodity Futures Trading 

22 Commission shall consider coordinated aggregate risk-mitigating 

23 hedging activities implemented across trading units. For the pur24 poses of this section, the term ''trading unit" means each discrete 

25 unit engaged in a revenue generation strategy at a banking entity" 

26 after the period. 

2 
101 


79694.056

1 (d) Section 619(d)(l)(G)(vi) (12 U.S.C. 1851(d)(1)(G)(vi» is 

2 amended to read as follows: "(vi) the name of the hedge fund or 

3 private equity fund, for corporate, marketing, promotional, or 

4 other purposes, does not include the word 'bank;'" 

5 (e) Section 619(d)(I)(G)(vii) (12 U.S.C. 1851(d)(I)(G)(vii» is 

6 amended to read as follows: "(vii) on or after the effective date, no 

7 director or employee of the banking entity acquires an equity in8 terest, partnership interest, or other ownership interest in the hedge 

9 fund or private equity fund, unless the director or employee of the 

10 banking entity is directly engaged in providing investment advi11 sory or other services to the hedge fund or private equity fund; 

12 and" 

13 (1) Section 619(d)(4)(B)(ii)(I) is amended14 (1) by striking "1 year" and inserting "3 years"; and 

15 (2) by inserting before the semi colon the following: ", provided 

16 that the appropriate Federal banking agencies may impose a dollar 

17 limit on the banking entity's investment in an individual hedge 

18 fund or private equity fund during its initial 3 year tenn to address 

19 potential undue risk to the banking entity's capital". 

20 SECTION 3. LIMITATIONS ON RELATIONSHIPS WITH 

21 HEDGE FUNDS AND PRIVATE EQUITY FUNDS 

22 Section 619(1)(1) (12 U.S.C. 1851(1)(1» is amended to read as fol23 lows: "(1) IN GENERAL - A banking entity that serves, directly 

24 or indirectly, as the investment manager, investment adviser, or 

25 sponsor to a hedge fund or private equity fund, or that organizes 

26 and €lffers a hedge fund or private equity fund pursuant to para27 graph (d)(l)(G), shall abide by the restrictions on transactions with 

3 
102 


79694.057

1 affiliates described in section 23A of the Federal Reserve Act (12 

2 U.S.C. 371c) with the hedge fund or private equity fund, as ifsuch 

3 banking entity were a member bank and the hedge fund or private 

4 equity fund were an affiliate thereof." 

5 SECTION 4. DEFINITIONS 

6 (a) Section 619(h)(2) (12 U.S.C. 1851(h)(2» is amended by insert7 ing "provided that such fund demonstrates characteristics that are 

8 similar to traditional hedge funds and private equity funds, such as 

9 being a managed portfolio of investments that utilizes significant 

10 leveraging or high-risk strategies such as long, short, and deriva11 tive positions that increase risk or loss to the fund. The terms 

12 'hedge fund' and 'private equity fund' shall not include foreign 

13 funds that are not actively marketed to U.S. investors and non-U.S. 

14 related funds, when such funds and their advisors are subject to 

15 prudential standards in a home country that are administered and 

16 enforced by a comparable foreign supervisory authority" before 

17 the period. 

18 (b) Section 619(h)(4) (12 U.S.C. 1851(h)(4» is amended to read as 

19 follows: "(4) PROPRIETARY TRADING -The term 'proprie20 tary trading', when used with respect to a banking entity or non21 bank [mancial company supervised by the Board, means, subject 

22 to the following sentence, engaging as a principal for the trading 

23 account of the banking entity or nonbank financial company su24 pervised by the Board in any transaction to purchase or sell, or 

25 otherwise acquire or dispose of, any security, any derivative, any 

26 contract of sale of a commodity for future delivery, any option on 

27 any such security, derivative, or contract, or any other security or 

4 
103 


79694.058

1 financial instrument that the appropriate Federal banking agencies, 

2 the Securities and Exchange Commission, and the Commodity Fu3 tures Trading Commission may, by rule, as provided in subsection 

4 (b)(2), determine. For purposes of this definition, the term 'pro5 prietary trading' is limited to principal transactions effected for the 

6 purpose of executing trading strategies that are expected to pro7 duce short-term profits without a clear connection to customer fa8 cilitation or intermediation." 

9 (c) Section 619(h)(7)(A) (12 U.S.C. 1851(h)(7)(A» is amended to 

10 read as· follows: 

11 "(A) IN GENERAL - The term 'illiquid fund' means a hedge 

12 fund or private equity fund that -

13 "(i) (a) on or prior to the enactment date, was principally invested 

14 in, or was invested and contractually committed to principally in15 vest in, illiquid assets, such as portfolio companies, real estate in16 vestments, and venture capital investments; and 

17 "(b) makes all investments pursuant to, and consistent with, an in18 vestment strategy to principally invest in illiquid assets; or 

19 "(ii) on or after the enactment date, held liquid assets of which a 

20 significant portion became illiquid due to market forces or factors 

21 beyond the individual or collective control of such fund, its in22 vestment adviser and its sponsor. In issuing rules regarding this 

23 subparagraph, the Board shall take into consideration the terms of 

24 investment for the hedge fund or private equity fund, including 

25 contractual obligations, the ability of the fund to divest of assets 

26 held by the fund at a reasonable price, whether the fund has be27 come illiquid through factors or reasons beyond the individual or 

5 
104 


79694.059

collective control of the fund, its investment adviser or sponsor, 

2 and any other factors that the Board detennines are appropriate." 

3 

4 

5 

6 

7 

8 

9 

10 

11 

12 

13 

14 

15 

16 

17 

18 

19 

20 

21 

22 

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105 


79694.060

APPENDIXB 

Comments of the Association ofInstitutional INVESTORS 

In Response to the Financial Regulators Request for Comments on its Proposed Rule Titled: 

Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and Relationships 

With, Hedge Funds and Private Equity Funds 

February 13,2012 

5 
106 


79694.061

Ms. Elizabeth M. Murphy 

Secretary 

Securities and Exchange Commission 

100 F Street, N.E. 

Washington, D.C. 20549 

Mr. Robert E. Feldman 

Executive Secretary 

Federal Deposit Insurance Corporation 

550 17th Street, N.W. 

Washington, D.C. 20429 

Mr. David A. Stamek 

Secretary 

Commodity Futures Trading Commission 

Three Lafayette Centre 

1155 21st Street, N.W. 

Washington, D.C. 20581 

Association 

--of--

Institutional 

INVESTORS' 

Ms. Jennifer J. Johnson 

Secretary 

February 13,2012 

Board of Governors of the Federal Reserve 

20th Street and Constitution Avenue, N.W. 

Washington, D.C. 20551 

Mr. John G. Walsh 

Acting Comptroller of the Currency 

Office of the Comptroller of the Currency 

250 E Street, S.W. 

Washington, D.C. 20219 

Re: Prohibitions and Restrictions on PrqprietaJ;y Trading and Certain Interests in and 

Relationships With HeQge Funds and Private Eqyity Funds (SEC File Number S7-

41-11: FRS Docket No. R-1432 & RIN 7100 AD 82: FDIC RIN 3064-AD85: OCC 

Docket ID OCC-2011-14: CFTC RIN 3038-AD05). 

Dear Sirs and Madams, 

The Association of Institutional INVESTORS (the "Association")' appreciates the opportunity to 

provide comments related to the proposed rule tided, "Prohibitions and Restrictions on Proprietary 

Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds" 

(the "Proposed Rule,,).2 The Association recognizes the efforts undertaken by the Securities and 

1 The Association of Institutional INVESTORS is an association of some of the oldest, largest, and most trusted 

investment advisers in the United States. Ow: clients are primarily institutional investment entities that serve the 

interests of individual investors through public and private pension plans, foundations, and registered investment 

companies. Collectively, our member firms manage ERISA pension, 401(1<), mutual fund, and persoual investments on 

behalf of more than 100 million American workers and retirees. Ow: clients rely on us to prudently manage participants' 

retirements, savings, and investments. This reliance is built, in part, upon the fiduciary duty owed to these organizations 

and individuals. We recognize the significance of this role, and our comments are intended to reflect not just the 

concerns of the Association, but also the concerns of the companies, labor unions, municipalities, families, and 

individuals we ultimately serve. 

2 Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds 

and Private Equity Funds, 76 Fed. Reg. 68,846 (Nov. 7,2011). We recognize the CFTC did not join the other prudential 
107 


79694.062

Ms. Elizabeth Murphy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

February 13, 2012 

Page20f19 

Exchange Commission ("SEC"), Boaxd of Governors of the Federal Reserve C'Federal Reserve''), 

Federal Deposit Insurance Corporation ("FDIC''), Office of the Comptroller of the Currency 

("OCC''), and Commodity Futures Trading Commission ("CFTC" and together with the other 

agencies, the "Agencies") to implement rules regarding proprietary trading and restrictions on 

relationships with covered funds, as required under the Dodd-Frank Wall Street Reform and 

Consumer Protection Act (the "Dodd-Frank Act,,).3 However, the Association has some concerns 

with the Proposed Rule relating to both the proprietary trading restrictions and the restrictions on 

covered fund activity. 

The Association represents asset managers that work on behalf of institutional investors, such as 

pension funds and 401(k) accounts. Although this rulemaking is focused on the activities of banks, 

we believe that the Proposed Rule will negatively affect the clients of institutional asset managers, 

and therefore have consequences for millions of American investors who rely on the continued 

vitality of these pension plans and 401 (k) accounts. We are concerned that the implementation of 

the Volcker Rule as currently constructed will result in a reduction in the breadth of investment 

options available to the maxketplace, as bank dealers exit lines of business due to increased 

compliance costs and uncertainty about the boundaxies of permissible and impermissible activities. 

The Proposed Rule may also diminish the depth of both liquid and illiquid sectors of the maxket 

because the complex nature and interplay of the factors and metrics proposed in the rule axe 

impracticable to implement. 

The unintended consequences of this well intentioned Proposed Rule may be to deepen and extend 

the current economic downturn. 

I. PROPRIETARY TRADING RESTRICTIONS 

The Association is concerned that the Proposed Rule, as currently drafted, may funrlaxnentally 

change how, or whether, banks will be willing to serve as major liquidity providers. We believe that 

the Proposed Rule offers arbitrary and complex tests for determining whether a bank meets the 

exemptions from the proprietary trading restrictions, which do not adequately reflect the realities of 

the financial maxkets. We axe concerned that unless significant changes axe made to the Proposed 

Rule, our institutional investment clients will be negatively affected. 

regulators in issuing the Proposed Rule. However, because the Association pre1iminarily believes the CFfC's proposed 

rule, RIN 3038-AD05, which has not yet been published in the Federal Register, will be substantially similar to the 

Proposed Rule, we have determined that it is appropriate to provide the CFfC with the Association'. comments at this 

time. 'The Association believes that it is important for the CFfC to consider these comments because the prudential 

regulators must issue final joint regulations together. 

3 See Dodd-Frank Wall Street Refonn and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010). Further, 

although the Association appreciates the Agencies' efforts to implement Section 619 of the Dodd-Frank Act, we also 

recognize the arguments made by others, including Chainnan of the House Financial Services Committee Spencer 

Bachus (R-AL), who have called for Congress to reevaluate the provision, stating that Section 619 creates a "selfinflicted wound" on the U.S. markets and have noted that other efforts, such as implementing the Basel III capital 

requirements, may more properly address bank risk talting addressed by the Voleker Rule. See Examining the I11Ij>ad 'if the 

Vokker Rule on Marhts, Bmin,ues, Inmtors and Job Creation Befort the H. Sub",,,",,!. On Capital Marklt! and Go_tnt 

Spollfmd Enterprise! and Financial Instil1ltion! and Com"",,, C,.dit, 112th Congo (Jan. 18, 2012) (opening statement of Rep. 

Spencer Bachus, Chaii:man, H. Comm. on Financial Services). 
108 


79694.063

Ms. Elizabeth Murphy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

February 13, 2012 

Page 3 of19 

Asset managers and their clients rely on banks to execute trades. Anecdotal evidence suggests that 

in today's market well more than half of institutional investment adviser transactions consist of 

trades with banks, including foreign banks. In this role, banks are providing critical services for the 

functioning of the secondary market. While we understand that the regulators' intention is not to 

inhibit banks' legitimate market making functions, we remain concerned that unless changes are 

made to the Proposed Rule, market making activities will be curtailed, causing negative (though 

unintended) consequences for institutional and individual investors. 

In particular, the Proposed Rule's definitions relating to permitted activities do not recognize key 

differences between markets with continuous liquidity versus episodic liquidity. In markets with 

episodic liquidity, such as many fixed income markets, banks do not simply engage in agency trading 

without risk, only buying from a client or an investor seller when they already have counterparty 

demand and know the price that they will be able to sell the asset. Instead, traditional market 

making entails banks being able to hold inventory on their books, assuming the role of being a direct 

counterparty to the client or investor seller. In such a situation, banks will buy illiquid assets from 

sellers such as asset managers acting on behalf of their clients even if the bank has not yet found a 

buyer for such assets, agreeing to hold the assets until another buyer wishes to purchase them, which 

may occur quickly in some situations and slowly in others. 

The potential for the Proposed Rule to restrict a bank's ability to engage in principal-based trading 

and to cause a bank to convert to an agency trading model, where buyers and sellers must be 

matched before a trade is executed, may have devastating effects on an asset manager's ability to 

serve the needs of the institutional investors, such as ERISA pension and 401 (k) plans. A bank's 

willingness to take on this risk in order to facilitate customer transactions and hold assets in dealer 

inventory until a willing buyer is found is essential in less liquid markets because it allows an asset 

manager to choose which assets it wishes to sell to meet redemption requests from institutional 

investors. Without it, asset managers may be forced to do a "fire sale" of illiquid assets, or simply 

sell what assets it can sell, not what assets it wants to sell. TIlls will result not only in the loss of assets 

that the asset manager otherwise wanted to retain for the client, but also in the residual portfolio 

becoming increasingly illiquid. An increasingly illiquid portfolio is harmful to the remaining 

investors. As liquidity concerns rise, an asset manager may also have to carry additional cash to 

ensure that it can pay redemption orders at a customer's request. Alternatively, it may be necessary 

in some cases, where possible, for an asset manager to place additional restrictions on when 

investors can redeem their money out of a fund. In many cases it may also be difficult or impossible 

for an asset manager to amend restrictions on various types of funds, including ones established 

under the Investment Company Act of 1940 ("40 Act Funds"), which have regulations governing 

redemption requests. 

Even if dealers are still willing to make markets for institutional investment advisers, the Proposed 

Rule may also negatively affect investors by reducing market depth and raising costs. Currendy, 

banks provide investors with choice, offering securities with varying characteristics. The Proposed 

Rule may cause banks to limit the securities kept in inventory, depleting the pool of available 

securities for investors and affecting the ability of investors to efficiendy manage their portfolios. 

Further, we believe this Proposed Rule will significandy raise costs for investors, including 

institutional investors such as pension funds and 401 (k) accounts, because the compliance costs for 

banks will inevitably be passed on to investors. 
109 


79694.064

Ms. Elizabeth Muq>hy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

Februru:y 13, 2012 

Page40f19 

Bid-ask spreads will also widen, reducing the ultimate return investors will receive. By limiting when 

banks can engage in principal-based trading, the natural result will be that the difference between the 

price a buyer is willing to pay for a security, compared with the price in which a seller is willing to 

sell a security, will increase. These costs, coupled with a tightening of liquidity in the market, will 

negatively affect the ability of pension funds and 401 (k) accounts to function in the most effective 

manner. By taking on reasonable risk and principal positions, banks enable markets with otherwise 

episodic liquidity to operate in a vibrant and efficient way for millions of American investors! 

In addition to adversely affecting the secondary markets by decreasing liquidity and the depth of 

markets, the Proposed Rule also has the potential to distress primary markets. Without a vibrant 

secondary market for fixed income securities, for example, underwriters in the primary market will 

be less likely to underwrite debt offerings, resulting in fewer options for institutional investors, and 

U.S. companies will be forced to borrow direcdy from banks for their capital needs. Complicating 

this situation, since the economic downturn, many banks are unwilling or unable to lend, which will 

exacerbate American business's ability to access capital, grow the economy, and create jobs. 

To address these concerns, we believe the Agencies should focus on client activity when drafting a 

workable test for the markets, starting from a presumption that the bank is engaged in permitted 

activity, rather than presuming that the trading activity is proprietary unless the bank can meet one 

of the permitted activity tests. The Proposed Rule essentially characterizes banks as guilty until 

proven innocent, which the Association believes is an unwise and unsound position that will result 

in numerous negative consequences. As discussed in further detail below, the Association is 

particularly concerned with potential negative consequences that could result from the Agencies' 

narrow interpretations of: (1) the market maker exemption; (2) the risk mitigating hedging 

exemption; and (3) the municipal bond exemption. 

A. Presumption of Proprietary Trading 

The exemptions enumerated in the Proposed Rule require banks to meet a set of criteria to show 

that they are not engaged in proprietary trading, creating a presumption that the activity is 

proprietary trading unless the banks prove otherwise. This is inconsistent with congressional intent 

and may result in banks being unwilling to take principal risk to provide liquidity services to 

institutional investors. Unless this is changed, the Proposed Rule would allow the Agencies to 

second-guess a bank's actions after it has completed trades, making it difficult or risky for the bank 

to assist asset managers in executing such trades. This result may unnecessarily constrain liquidity in 

secondary markets and cause asset truinagers and others to look to alternative non-U.S. markets to 

service client needs. Such actions may also decrease transparency in the marketplace, in direct 

contrast to the Dodd-Frank Act's stated goals, and result in the U.S. losing market share, potentially 

hurting the still-fragile economy. 5 

4 In that regaro, we note that while retail investOlS genetally trade equity securities on exchanges (on a commission-basis 

through an agent), fixed-income markets are more commonly sold on a bid-ask spread through a principal intermediary, 

and thus, will be greatly impacted by the Proposed Rule. Further, even though a substantial portion of equity trading is 

conducted on an agency basis, a considerable amount of equity trades entered into by the funds and accounts managed 

by our members is traded on a principal basis and will, therefore, also be impacted. 

, See 156 CONGo REC. S5912-13 (daily ed. July 15, 2010) (statement of Sen. Leahy (D-V1): "The conference report we 

are voting on today goes directly to the heart of the Wall Street excesses that brought our economy to the brink. For far 

too long Wall Street finns made risky bets in the dark and reaped enormous profits. Then, when their bets went sour, 
110 


79694.065

Ms. Elizabeth Mutphy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

February 13, 2012 

Page 5 of19 

During the Dodd-Frank Act Conference Committee negotiations, Senator Jeff Merkley (D-OR) 

noted that the Agencies can distinguish proprietary trading from market making based on, "volume 

of trading, the size of the positions, the length of time that positions remain open, and the volatility 

of profits and losses.'" While we agree that these factors may generally help differentiate market 

making from proprietary trading, if implemented incorrectly, these same factors could unnecessarily 

consttict what a bank is willing, or even able, to accomplish and likely lead to liquidity drying up for 

the secondary market, which Congress was trying to avoid by including the market making 

exemption.7 

Under the Proposed Rule's market making exemption test, regulators will scrutinize behavior afterthe-fact and may "discover" proprietary trading, when banks were actually engaged in market 

making. Ambiguities in the test and uncettainty as to whether the Agencies will interpret legitimate 

behavior as proprietary trading may make it difficult for banks to remain in this role. Congress 

noted that market making is a "customer service," assisting customers in the "speedy acquisition or 

disposition of certain financial insttuments,"S If banks are unwilling to continue intermediating 

trades for institutional investors because the Proposed Rule creates uncertainty as to whether such 

activity is market making, the ultimate harm will fall on individuals and families, who utilize pension 

funds and 401 (k) funds for their retirement savings. 

This presumption will limit the tools available to asset managers to hedge and diversify their risk 

exposure, It will create problems not only for fixed-income markets, but also for equity markets, 

including millions of individuals invested through retail accounts and workplace retirement plans 

such as 401 (It) accounts. While retail investors and smaller institutional investors often trade equities 

using an agency-based "last sale" model, larger investors trade in a myriad of ways with covered 

banking entities in an effort to reduce execution costs, mitigate risk, and improve returns, It is 

they turned to America's taxpayers to bail them out. This bill is about changing the culture of rampant Wall Street 

speculation and doing what needs to be done to get our economy hack on track. We need more transparency and 

oversight of Wall Street. These improvements will increase transparency in and oversight of the financial sector ... It 

bas seemed to me that promoting transparency should be a vital element of Wall Street reform. Tnmsparency is a 

cleansing agent for healthy markets. Open infonnation helps investors make sound decisions. When infonnation is 

murky, market decisions must be based on guesses or rumors that corrode trust and that encourage fraud and 

deception." 

6 See 156 CONGo REc. S5896 (daily ed. July 15, 2010) (statement of Sen. Merkley (D-OR»: "Market-making is a customer 

service whereby a finn assists its customers by providing two-sided markets for speedy acquisition or disposition of 

certain financial instruments .. '. Academic literature sets out the distinctions between malting markets for customers and 

holding speculative positions in assets, but in general, the two types of trading are distinguishable by the volume of 

trading, the size of the positions, the length of time that positions remains open, and the volatility of profits and "'sses, 

among other factors. Regulations implementing this pennitted activity should focus on these types of factors to assist 

regulators in distinguishing between financial finns assisting their clients versus those engaged in proprietary trading." 

7 See 156 CONGo REc. 55906 (daily ed. July 15,2010) (statement of Sen_ Bayh(D-IN): "With respect to the Volcker Rule, 

the conference report states that banking entities are not prohibited from purchasing and disposing of securities and 

other instruments in connection with underwriting or market malting activities, provided that activity does not exceed 

the reasonably expected near term demands of clients, customers, or counterparties. I want to clarify this language would 

allow banks to maintain an appropriate dealer inventory and residua! risk positions, which are essential parts of the 

market malting function. Without that flexibility, market makers would not be able to provide liquidity to markets." 

8 See 156 CONGo REc. S5896 (daily ed. July 15, 2010) (statement of Sen, Merkley (D-OR». 
111 


79694.066

Ms. Elizabeth MU1"(>hy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

February 13, 2012 

Page 60fl9 

crucial for advisers to large institutional clients to have access to covered banking entities' traditional 

equity securities market making activities, including the ability to enter into block trades and hedge 

without undue restriction, so that end investors are not subject to unnecessary increased risk and 

costs. 

Similarly, the ability of institutional investors to continue to use over-the-counter (OTC) derivatives 

products to safely diversify their portfolios and effectively hedge or manage risks may also be 

impaired unless the presumption is changed. Activity in OTe derivatives markets can easily be 

misinterpreted as proprietary trading because market makers in this asset class usually act as 

principals who take positions in instruments with episodic liquidity in order to facilitate customer 

needs. Market making is also fundamental to OTe derivatives trading, as dealers use derivatives as 

part of their overall fixed income or equity trading to hedge out risk on a portfolio basis. Unless the 

market making exemption is sufficiently expanded to ensure that banks may continue to act as 

market makers with respect to OTe derivatives, the result for our investment funds, and ultimately 

our investors, will be diminished liquidity, less portfolio diversification, less ability to hedge, and 

increased costs. Also, in the event that banks limit their OTe derivatives trading as a result of the 

Proposed Rule, it would lead to less counterparty diversification, which increases counterparty risk 

for the funds and accounts managed by our members. 

We recognize that determining the exact criteria to be used in defining proprietary trading is 

difficult With that said, we agree with Federal Reserve Governor Daniel Tarullo that while some 

trades are "textbook examples" of proprietary trading or market making, the majoritY of trades 

include buyers and sdlers arriving "at different times, in staggered numbers, and often have 

demands for similar but not identical assets.'" Therefore, the Association suggests that the Agencies 

make the rule simpler; focusing on "trading activities that are organized within a discrete business 

unit, and that are conducted solely for the purpose of executing trading strategies that are expected 

to produce short-tenn profits without any connection to customer facilitation or intermediation," in 

defining proprietary trading, in a way which is, "not difficult to identify."lo By doing so, the 

Agencies would be consistent with fonner Federal Reserve ehainnan Paul Volcker's statements that 

it should be easy to recognize proprietary trading. II 

We are disappointed with Governor Tarullo's statement that the Agencies considered and rejected 

simpler tests to detertclne proprietary trading. We disagree that such tests would "fail to adequately 

capture the full range of activities that are prohibited under the [Dodd-Frank Act]," because, as 

stated previously, even fonner Chairman Voleker believed that true proprietary trading should be 

easy to spot. We are concerned that the Agencies are attempting to determine motive and intent 

under the Proposed Rule, and urge the Agencies to make the distinction as clear as possible.12 At a 

9 Set Examining th, Impod of the Volden RrJe on Mar;"ts, Busimssts, I"'ltdrm and Job CrraliDn Before the H. SW«J11I11Is. On CttpitaI 

Mar;"ts and Go"",,m,", Sponsored Entnprises and Financial Instit1ttions and C01lSTlmer Credit, 112th Congo (Jan. 18, 2012) 

(statement of Federal Reserve Governor Daniel Tarullo). 

10 Seeid. 

11 See '.g. Lauren Tam LaCapra, Paul VokJur Says IdetttiiJing SptaJa/ive Trading Is Eary, REUTERS, May 4, 2011, 

http://www.reuters.com/article/2011/OS/OS/us-volcker-idUSTRE74385W20110S05. 

12 House Financial Services Committee Chahman Spencer Bachus also noted concerns with the Agencies' attempt to 

determine motive and intent, stating "when we have to determine peoples' motive, we're on thin ice." See EXtlfIIinin,g the 

Impod of th, VokJur Rule on Mork.Its, Businems, Investors and Job CrraliDn Before the H. SlIhromms. On CapiJaI Mar;"ts and 
112 


79694.067

Ms. Elizabeth Murphy, Ms. Jennifer Johnson, Mr. Rohert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

February 13, 2012 

Page 7 of19 

minimum, we hope that the Agencies will meet the expectation noted by House Financial Services 

Committee Ranking Member Barney Frank (D-MA), who said that banks should not have to worry 

about getting "too close to the line," because the agencies will not be predisposed to considering 

such market making activities to be proprietary trading." 

B. Market Making Exemption 

As required under the statute, the Proposed Rule exempts market making activities." In order to 

satisfy the market making exemption under the Proposed Rule, a banking entity must be able to prove 

that the activity meets a list of seven criteria, including: (1) establishment of an internal compliance 

program; (2) the activity must meet bona fide market making requirements; (3) trades must match 

the reasonably expected near-term demands of clients, customers, and counterparties; (4) the 

banking entity relying on the exemption must be appropriately registered under securities or 

commodities laws; (5) market making-related activities must be designed to generate revenues 

primarily from fees, commissions, bid/ask spreads or other similar income; (6) compensation 

incentives must not be designed to reward proprietary trading activities; and (I) consistency with the 

commentary attached to the rule in Appendix B.'5 

While the Association understands that it was "particularly challenging"'· for the Agencies to 

determine how to distinguish permissible market making related activities from prohibited 

proprietary trading, the Proposed Rule's current exemption does not adequately fulfill the 

congressional goal of ensuring that legitimate market making activities remain permissible.'7 Instead, 

the market making exemptions' strict and complicated requirements, including: "(1) seven criteria 

that a banking entity's activities must meet to rely on the market making exception, including 

establishment of a compliance program; (2) six principles that the Agencies will use as a guide in 

distinguishing bona fide market making from prohibited proprietary trading; and (3) seventeen 

quantitative metrics that a banking entity with significant trading activities must report for each of its 

trading units at every level of the organization,"" will in fact jeopardize legitimate activity. Rather 

Go",",menl Sponsored Enlttprises tJ1td Fintm<ial Institutions and ConSlimer Credit, 112th Congo (Jan. 18, 2012) (statement of Rep. 

Spencer Bachus, Chainnan, H. Corom. on Financial Services). 

13 Ste Examining liN Impaa of liN Vokker Ruk on Markets, Busi1llSits, InvesIQrs tJ1td Job Creation Before the H SlIbcomms. On 

Capilal Markets and Govemmmt Sponsored Entttprises and Finausial Institutions and Co_mer Cm/it, 112th Congo (Jan. 18, 2012) 

(statement of Rep. Barney Frank, Ranking Member, H. Comm. on Financial Services). 

" Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and Relationships With, Hedge Funds 

and Private Equity Funds, 76 Fed. Reg. at 68,848. 

15 Itf. 

16 See Examining liN Impaa of liN Vokker Ruk on Markets, BusitIIsstJ, IntJtJlors and Job C,.ation Before tIN H Sltbcomms. On 

Capital Markets and Co"""m,,,t Sponso,.d Enlttprises and Finausial Institutions and Cons1t11ltr Cm/it, 112th Congo (Jan. 18, 2012) 

(statement of Acting Comptroller of the Currency John Walsh). 

17 S" 156 CONGo REc. 55896 (daily ed. July 15, 2010) (statement of Sen. Merkley (D-OR»: "Accordingly, while previous 

versions of the legislation referenced 'market-making,' the final version references "market- making-related" to provide 

the regulators with limited additional flexibility to incorporate those types of transactions to meet client needs, without 

unduly warping the common understanding of market-making." 

18 Ste Examining liN Impaa of /h, Vokker Ruk on Markets, Bminesses, I"",s/Qrs and Job Creation Before liN H. Sub,.m",s. On 

Capita! Markets and Covern",ent Sponsored Enlttprises and Financial Institutions and Co_mer Cf1!f/iI, 112th Congo Gao. 18, 2012) 

(statement of Acting Comptroller of the Currency John Walsh). 
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79694.068

Ms. Elizabeth Murphy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

Februaq 13, 2012 

Page 80f19 

than providing clear guidelines by which traders are encouraged to continue permissible trading, 

traders will likely restrict their activity out of fear of getting too close to the ambiguous line. 

The Association is particularly concerned that the criteria requiting that trades, "match the 

reasonably expected near-term demands of clients, customers, and counterparties," may be too 

ambiguous to be meaningful. The "reasonably expected near-term demands of clients, customers, 

and counterparties," means different things in different markets - for certain illiquid markets, the 

"near-term" may be much longer than in other, more liquid, markets. While we recognize. that this 

requirement is congressionally mandated, the Association urges the Agencies to construe it as 

narrowly as possible and define "near-term" in a way that considers the needs of markets that are 

illiquid or have episodic liquidity. 

Requiring banks to prove that their actiVIties are designed to "generate revenues from fees, 

commissions, bid-ask spreads or other similar income that is not related to proprietary trading"19 

does not adequately ensure that legitimate market making is protected because this test is an overinclusive indicator. Banks engaged in market making do not always have a matched trade ready when 

the assets must be purchased from the asset manager. A bank facilitating client demand may hold 

an asset that will appreciate in value as it remains on the books until a willing buyer is located. The 

Proposed Rule will create fear that this appreciation may be deemed proprietary speculation and 

result in banks refraining from the market making that is essential to maintain market liquidity, 

particularly in fixed income markets. The Agencies should focus on ensuring positions taken by a 

bank relate to the customer activity, regardless of the magnitude or length the positions are held 

open, or whether the bank is acting as an agent or ptincipal in the trade. As long as a bank's 

positions relate to customer activity, then its activities should be presumed to be market making, and 

not proprietary. 

Further, the Association appreciates the Agencies' desire to maintain legitimate market making 

activities, but believes this could be achieved in a manner that presumes that a bank's activity is not 

proprietary trading unless proven otherwise. Since the Dodd-Frank Act passed, some banks have 

already begun discontinuing proprietary trading desks.20 The industry has demonstrated, in advance 

of the Proposed Rule's effective date, that they understand and are willing to change their business 

models to comply with the purpose of the Proposed Rule. In light of these good faith efforts, we 

urge the Agencies to simplify the Proposed Rule to ensure that banks are able to continue those 

market making related activities that Congress intended to be protected, as our members rely on 

these activities for trading by the funds and accounts that they manage. 

C. Risk Mitigating Hedging Activity 

Section _.5 of the Proposed Rule, similar to the market making exemption, provides a number of 

requirements that firms must attain in order to rely on a risk-mitigating hedging exemption available 

19 Prohihitions and Restrictions on Proprietary Trading and Certain Interests In, and Relationships With, Hedge Funds 

and Private Equity Funds, 76 Fed. Reg. at 68,962. 

2" Liz Rappaport, Goldman to SimI Global Macro Trading Desk, WALL STREET JOURNAL, Feh. 15, 2011, 

http://online.wsj.com/article/SB1OOO1424052748704409004576146702013530680.html (Goldman Sachs closed its 

Global Macro Proprietary Trading desk "to comply with the Volcker Rule."). 
114 


79694.069

Ms. Elizabeth Murphy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

February 13, 2012 

Page 9 of 19 

under Section 13 of the Bank Holding Company Act ("BHC,,).21 According to the Proposed Rule, 

the criteria is intended to define the scope of permitted risk-mitigating hedging activities and to 

prohibit reliance on the exemption for proprietary trading that is mischaractenzed as permitted 

hedging activity.22 

The Association agrees that hedging is an appropriate indicator of an entity's risk appetite, but 

believes that this indicator breaks down at the trade-by-trade level. In particular, this indication fails 

when gauging whether hedging activities are proper for illiquid markets, where perfect hedges are 

often not available. Although we appreciate SEC Chairman Mary Schapiro'S assurances, in response 

to a question from Ranking Member Barney Frank at a House Financial Services Committee heating 

on the Volcker Rule, that the Agencies will not be looking at trading activity at the trade-by-trade 

level, we ask that the Agencies make this more explicit in the final rulemaking.23 Without making 

this explicit in the final rulemaking, we worry that trades will still be looked at on an individual basis, 

potentially finding proprietary trading in situations that are not, when considered overall.24 

Further, members of the Association work to reduce execution costs, mitigate risk, and improve 

returns for millions of investors in the funds and accounts that they manage. These goals are 

achieved by trading with market makers that use generally available hedges to bridge the gap 

between time and price with various traders in the market. The hedging exemption, therefore, must 

include a broad definition of what constitutes a "trading unit" (also known as an "aggregation unit") 

to permit banking entities to hedge adequately their trades with institutional clients. 

If the Agencies interpret "trading unit" too narrowly, or if the market making exemption is too 

restrictive, the ability of funds to enter into block trades with banking entities could be significandy 

diminished, to the detriment of funds and their investors. Block trading is traditionally used when 

the size of the trade would strain the market and potentially result in increased execution costs, as a 

result of adverse market movements, and increased risk, because the trade requires an extended time 

period for completion. In order for a banking entity to fill this need, it may gauge risk across its 

entire platform, rather than across one trading desk, and agree to take positions on its books until an 

appropriate buyer is available. In doing so, banking entities are effectively mitigating risk. 

If the Agencies look too narrowly at the hedging correlation, i.e., on a trade-by-trade basis, it may in 

actuality increase risk. It will disallow banking entities to continue to effectively hedge, thus limiting 

activity with funds and keeping the risk in the marketplace, but at the fund level, thereby exposing 

individual investors to this unhedged risk. Similarly, program risk trading, in which banking entities 

manage their risk across the entire trading organization, enables asset managers to swiftly and 

21 Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and Relationships With, Hedge Funds 

and Private Equity Funds, 76 Fed. Reg. at 68,875. 

22 Id. at68,874. 

23 S" EXtlI11ining tIN Impact of /he Volekef'RNk on Mar/em, BUJintsses, I11V11s/Qrr and Job O.ati011 Before the H. Subcomms. On 

Capitol Mark4ts and Co_t Sponsored Entnprises and Financial Insfil1ltions and Cons""", C",lit, 112th Congo Oan. 18, 2012) 

(statement of Securities and Exchange Commission Chairman Mary Schapiro). 

24 Indeed, House Financial Services Committee Chairman Spencer Bachus noted that he shared similar concerns, stating 

that although Chairman Schapiro says the SEC will not look at inclividual trades, he «doesn't know bow you enforce a 

rule without looking at inclividual trades." S" id. 
115 


79694.070

Ms. Elizabeth Mw:phy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

February 13, 2012 

Page lOof19 

efficiently trade multiple securities in a single transaction. It also allows asset managers to manage 

significant flows into and out of funds and accounts in a cost-efficient manner. Program risk trading 

would be significantly impaired if the proposed restrictive interpretation of hedging and trading units 

were adopted under the Proposed Rule. The result would be significantly reduced ability for funds 

and accounts to trade with banking entities and diminished market liquidity, as the elimination or 

substantial reduction of program risk trading would likely result in less trading in general. 

D. Municipal Bond Market Exemption 

Section _.6(a) of the Proposed Rule describes the government obligations in which a banking entity 

may trade, notwithstanding the prohibition on proprietary trading, including government obligations 

and U.S. State and municipal obligations.25 This exemption is too narrow because it prohibits banks 

from trading in a significant portion of the current municipal bond activities, including securities 

issued by State agencies or instrumentalities. We respectfully disagree with the Agencies' 

interpretation that its exemption is "consistent with the statutory language," because it does not 

extend the government obligations exemption to include "transactions in obligations of an agcnfY of 

any State or political subdivision thereof.,,26 

Further, the Association disagrees with the Agencies interpretation that statutory silence on State 

agencies is reason to not include State agency transactions within the exemption. Such an 

interpretation is inconsistent with legislative history. Congress did not intend to limit the funding 

availability for projects such as hospitals, affordable housing developments, airports, and universities 

that receive financing through municipal obligations, and in fact, the Dodd-Frank Act specifically 

permits trading with regard to "obligations of any State or of any political subdivision thereof.,,27 

Consistent with exercising its sovereign powers through agencies and other instrumentalities, States 

may authorize political subdivisions to finance a revenue-generating project through the issuance of 

municipal bonds backed by bond revenues, not taxes. Particularly since the same type of entity may 

have differing powers from State to State, it is simply unworkable for the Agencies to construct such 

a narrow interpretation of this exemption. 

If the Proposed Rule is implemented as currently drafted, it may have a significant impact on the 

municipal bond market, affecting not only institutional investors that regularly invest in these 

markets, but also the States and municipal agencies that will no longer have access to the capital 

provided by such investors. The municipal markets provide valuable tax-exempt tools for 

institutional investors. Despite the challenges that municipal issuers face in the current economy, 

municipal securities continue to have a lower risk of default than other types of debt and are also 

beneficial to States and municipalities.28 The result of the Volcker Rule may be the creation of an 

25 Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and Relationships With, Hedge Funds 

and Private Eqnity Funds, 76 Fed. Reg. at 68,877. 

26 Id. at 68,878 n.165 (emphasis in original). 

27 S" Dodd·Fmnk Wall Street Refonn and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376,1624 (2010). 

28 "In comparing the riskiness of municipal and corporate bonds, at least in terms of expected default, municipal bonds 

can be considered much safer than eqna11y rated corporate bonds. According to the rating agency Moody's, there have 

bern only 54 defaults by municipal bond issuers since 1970. Research finn Robini Global Economics estimates the size 

of the u.s. municipal bond market to be $2.7 trillion. On the other hand, there were 191 defaults by corporate bond 

issuers in 2009 alone. According the Fitch, the size of the US corporate bond market is about $4 trillion." Stephen J. 
116 


79694.071

Ms. Elizabeth Mutphy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

February 13, 2012 

Page 11 of19 

unnecessary bifurcation of the municipal securities market, which will impede the ability of taxexempt organizations to raise capital and negatively affect the liquidity of the municipal markets. 

Therefore, the Association urges the Agencies to expand its exemption for proprietary trading in 

State or municipal agency obligations under Section 13(d)(l)(J) of the BHC.29 This could be 

accomplished by adopting the definition of "municipal securities" already included in Section 

3(a)(29) of the Securities Exchange Act of 1934. Utilizing such a definition in the exemption would 

promote the financial stability of the U.S., providing a clearer line for banks to follow on what is 

covered under the municipal bond market exemption and permitring investors to continue investing 

in municipal debt at reasonable costs. 

II. COVERED FuNDS 

Section _.10(a) of the Proposed Rule implements Section 13(a)(l)(B) of the BHC Act and prohibits 

a banking entity from, as principal, direcdy or indirecdy acquiring or retaining an equity, partnership, 

or other ownership interest in, or acting as sponsor to, a covered fund, unless certain exemption 

criteria are met.30 The covered fund restrictions create a competitive disadvantage for asset 

managers that are affiliated with banking institutions. 

A. Definition of "Covered Fund" and Applicability to Covered Foreign Funds 

Although we recognize the Agencies need to address the potential for evasion from the Volcker 

Rule by capturing certain foreign funds and commodity pools, the approach taken is over-inclusive 

and should be refined. Currendy, the Proposed Rule defines "covered fund" as including both 

hedge funds and private equity funds." It also covers other funds that are not commonly 

understood to be either a "hedge fund" or a "private equity fund" by including issuers that are 

investment companies, as defined in the Investment Company Act, but for Section 3(c)(1) or 3(c)(7) 

of the Act.32 The "covered fund" definition includes an issuer organized or offered outside of the 

U.S. which would be a 3(c)(1) or 3(c)(7) fund if offered or organized inside the United States. 

Sections 3(c)(1) and 3(c)(7) are exclusions from the definition of "investment company" that are 

commonly relied on by a wide variety of entities that would otherwise be covered by the broad 

definition of "investment company." 

Additionally, the Proposed Rule incorporates the statutory application of the rule to cover "such 

similar funds as the Agencies may determine by rule as provided in Section 13(b)(2) of the BHC 

Act.,,33 Under this power, the Agencies propose to include commodity pools, as well as the foreign 

Huxley, Ph.D. and Brent Bums, SAFETY OF lNv!lsThiENT GRADE BONDS: EXAMINING CREDIT RATINGS AND DEFAULT 

RATES OF MUNICIPAL AND CORPORATE BONDS 5 (Asset Dedication 2011). 

29 12 U.S.c. § 1851(d)(1)0) (2006). 

30 Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and Relationships With, Hedge Funds 

and Private Equity Funds, 76 Fed. Reg. at 68,896. 

31 III. ot68,897. 

32 III. 

" III. 
117 


79694.072

Ms. Elizabeth Mutphy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

February 13, 2012 

Page 12 of19 

equivalent of any entity identified as a "covered fund."'"' According to the Agencies, these entities 

are included because they are generally managed and structured similar to a covered fund except that 

they are generally not subject to the Federal securities laws due to the instruments in which they 

invest or because they are not organized in the u.s. or one or more States.35 

Many asset managers operate funds outside of the U.S. that are registered and regulated in those 

foreign jurisdictions. The Proposed Rule is over-inclusive because it covers all such funds without 

actually identifying the characteristics that make such funds problematic for U.S. banks, or 

demonstrating that these funds lack adequate regulation by foreign jurisdictions. Such foreign funds 

are different from traditional hedge funds or private equity funds, and the Association suggests that 

the Agencies exclude from the Proposed Rules restrictions on funds that do not present the risks 

that the Volcker Rule is intended to address. We propose a number of suggested changes to this 

end: 

o As the scope of the Volcker Rule restrictions is intended to be limited to funds with U.S. 

resident investors, the Agencies should consider simply excluding all foreign funds that are 

not actively marketed to U.S. investors. This would have the additional benefit of clarifying 

that inadvertent sales of interests in foreign funds to persons who are or who become U.S. 

residents would not subject the fund to the restrictions of the Volcker Rule. 

o The Agencies should further consider excluding non-U.S. regulated funds, such as UCITS 

funds and other European regulated funds, that are subject to a degree of supervisory 

regulation in foreign jurisdictions that make it unlikely that they would pose significant risk 

to a banking entity or the United States. 

o In the alternative, we urge the Agencies to focus on specific characteristics rather than 

attempting to cover all foreign funds. The Agencies should consider adopting an exemption 

from the definition of covered funds using a system based on the characteristics suggested in 

Form PF. Form PF requires reporting of certain information by advisers to hedge funds and 

private equity groups. It focuses on these funds because they possess the type of risky 

trading strategies that typically concern regulators, which are also at the heart of the Volcker 

Rule prohibitions. Form PF also excludes funds that pose minimal systemic risk, while the 

Volcker Rule has no such exemptions. For example, State-registered advisers and "Exempt 

Reporting Advisers" are exempt from having to file Form PF with the SEC because they 

pose minimal systemic risk. Therefore, we suggest the Agencies consider covering only 

foreign funds, which exhibit several of the following attributes: (1) engaging in significant 

leverage; (2) having significant investment in derivatives and illiquid instruments; (3) not 

providing frequent liquidity rights of investors; and (4) incentivizing managers to engage in 

risky investments or techniques through performance fees. 

This scope should also be applied to covered funds and private equity funds in both the U.S. and 

foreign markets to create a logical and consistent approach for the Agencies to address the core 

aspects of the Volcker Rule, which is to reduce systemic risk without violating important market 

34 Id. 

35 Id. 
118 


79694.073

Ms. Elizabeth Murphy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

Febtuary 13, 2012 

Page 13of19 

functions. By establishing such a system, the Agencies would be excluding foreign funds regulated 

similarly to mutual funds and bank common and collective funds. This would exclude funds offered 

to retail investors that are substantively regulated, such as VCITS funds, where less risk exista. 

The Proposed Rule's extension to "commodity pools" may now include 40 Act Funds. Narrowing 

the commodity pool scope. to exclude those funds that invested in commodities for hedging 

purposes and otherwise cover their exposure consistent with SEC Release IC-I0666 and related noaction letters is a prudent approach. V nder SEC Release I C-l 0666 the SEC typically allows 

investments in commodities and derivatives among other financial instruments so long as assets are 

segregated from core exposure and are in amounts sufficient to cover all of the hypothetical 

borrowing.36 

Finally, the "covered funds" definition should be amended to exclude wholly owned subsidiaries, 

rather than exempting only those engaged in liquidity management. Since the definition of covered 

funds is so expansive it will cover wholly owned subsidiaries engaged in non-risky, permissible 

activity which was to be protected and ultimately hinder the ordinary course of business for holding 

companies. 

B. Exemptions 

Section _.11 of the Proposed Rule sets out the conditions that must be met in order for a banking 

entity to own an interest in a covered fund.'7 These conditions include: (i) the banking entity must 

provide bona fide trust, fiduciary, investment advisory, or commodity trading advisory services; (ll) the 

covered fund must be organized and offered only in connection with the provision of bona fide trust, 

fiduciary, inves tment advisory, or commodity trading advisory services and only to persons that are 

customers of such services of the banking entity; (Iii) the banking entity may not acquire or retain an 

ownership interest in the covered fund except as permitted under the Proposed Rule; (iv) the 

banking entity must comply with the restrictions governing relationships with covered funds under 

the Proposed Rule; (v) the banking entity may not, directly or indirectly, guarantee, assume, or 

otherwise insure the obligations or performance of the covered fund or of any covered fund in 

which such covered fund invests; (vi) the covered fund, for corporate, marketing, promotional, or 

other purposes, (A) may not share the same name or a variation of the same name with the banking 

entity (or an affiliate or subsidiary thereof), and (B) may not use the word "bank" in its name; (vii) 

no director or employee of the banking entity may take or retain an ownership interest in the 

covered fund, except for any director or employee of the banking entity who is directly engaged in 

providing investment advisory or other services to the covered fund; and (viii) the banking entity 

must (A) clearly and conspicuously disclose, in writing, to any prospective and actual investor in the 

covered fund (such as through disclosure in the covered fund's offering documents) the enumerated 

disclosures contained in the Proposed Rule, and (B) comply with any additional rules of the 

appropriate Agency or Agencies, designed to ensure that losses in such covered fund are borne 

solely by investors in the covered fund and not by the banking entity.38 While the Association agrees 

,. Investment Company Act Release No. 10666 (Apr. 18, 1979), 44 Fed. Reg. 25,128 (Apr. 27, 1979). 

37 Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and Relationships With, Hedge Funds 

and Private Equity Funds, 76 Fed. Reg. at 68,900. 

" It/. 
119 


79694.074

Ms. Elizabeth Murphy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

February 13, 2012 

Page 14of19 

with some provisions included in these exemptions, including the bona fide services provisions and 

the provisions on investments by employees and directors providing advisory or other services, we 

have concerns with the naming prohibition. 

1. Bona Fide Services 

The Association fully supports the bona fide services provisions included under Section _.11(a) of 

the Proposed Rule. The Association agrees that entities must have the ability to provide bona fide 

trust, fiduciary, investment advisory, or commodity trading advisory services to customers and 

supports the Agency's conclusion that the customer's relationship does not need to be pre-existing. 

When a bank is engaging in such bona fide services, the goal is to support the customer's needs, not 

to engage in risky behavior. Further, this exemption avoids a potential conflict of interest for asset 

managers that are affiliated with banks and may otherwise have difficulty continuing to provide 

advisory services to their clients without changing their business model. 

2. Naming Prohibition 

Section _.11(f) of the Proposed Rule provides that the covered fund, for corporate, marketing, 

promotional, or other purposes, (1) may not share the same name or a variation of the same name 

with the banking entity (or an affiliate or subsidiary thereof), and (2) may not use the word "bank" in 

its name.'" 

We believe the naming prohibition proposal over-reaches, and we urge the Agencies to interpret the 

congressional mandate as narrowly as possible. We note that at present, the Proposed Rule's 

language expands beyond the Dodd-Frank Act, which amends the BHC Act to include that a 

banking entity may not share with the hedge fund or private equity fund, for corporate, marketing, 

promotional, or other purposes, the same name or a variation of the same name.40 The Dodd-Frank 

Act does not require the Agencies' rulernaking to preclude the use of the name of investment 

management firms affiliated with banking institutions, and we therefore urge the Agencies to limit 

the definition of "banking entity" in this context to u.S.-insured depository institutions. 

As the Proposed Rule currendy stands, the naming prohibition burdens the industry without 

providing adequate corresponding benefits. Under Section _.11, the banking entity may not, 

direcdy or indirecdy, guarantee, assume, or otherwise insure the obligations or performance of the 

covered fund or of any covered fund in which such covered fund invests." This restriction is 

sufficient for ensuring that the entities are viewed separately in the market. We question the 

necessity for any naming prohibition when a prohibition on bailing out funds is in place and where 

there is disclosure that investors bear the risk ofloss in any default. The prohibition on bailing out 

funds protects against the "too big to fail" problems of the financial crisis and the disclosure 

requirements provide the necessary warning to investors of the risks involved. Further restricting 

the name of the fund, and in particular restricting the name of the fund beyond the name of the 

U.S.-insured depository institution, does not provide sufficient additional benefits. 

39 Id at 68,902. 

40 Id 

41 Id at 68,901. 
120 


79694.075

Ms. Elizabeth Murphy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

February 13, 2012 

Page 150f19 

It will be burdensome and expensive for funds currently affiliated with banks or bank-owned asset 

managers to change the name of the fund. Not only will the process be costly, but potential 

reputational costs also exist, as many of these funds have developed a solid reputation and good will 

within the marketplace that is affiliated with the fund's current name. Such actions will also 

inevitably lead to investor confusion, as many already associate certain fund names in the 

marketplace with certain characteristics. Ultimately, this restriction will place these funds affiliated 

with banking entities at a disadvantage and further hurt the financial condition of such funds and 

their bank-affiliated asset managers. 

3. Investments by Employees and Directors Providing Advisory or Other 

Services 

Section _.ll(g) of the Proposed Rule implements Section l3(d)(1)(G)(vii) of the BHC.42 The 

provision prohibits any director or employee of the banking entity from acquiring or retaining an 

ownership interest in the covered fund, except for any director or employee of the banking entity 

who is directly engaged in providing investment advisory or other services to the covered fund.43 

The Association generally supports the Agencies' approach and agrees it is essential that fund 

managers or advisers and support staff be permitted to have, "skin in the game." Indeed, many 

institutional investor clients require this as an additional check on the fund manager's or adviser's 

loyalty and diligence. 

The Proposed Rule also recognizes that director or employee investments in a covered fund may 

provide an opportunity for a banking entity to evade the limitations regarding the amount or value 

of ownership interests a banking entity may acquire or retain in a covered fund or funds contained in 

Section 13(d)(4) of the BHC Act and Section 1.12 of the Proposed Rule.44 To address this concern, 

the Proposed Rule would generally attribute an ownership interest in a covered fund acquired or 

retained by a director or employee to such person's employing banking entity, if the banking entity 

either extends credit for the purpose of allowing the director or employee to acquire such ownership 

interest, guarantees the director or employee'S purchase, or guarantees the director or employee 

against loss on the investment:5 Once again, the Association agrees that this solution adequately 

addresses the problem while still permitting such employees the ability to meet client needs. 

C. Sections 23A and 23B of the Federal Reserve Act 

The Dodd-Frank Act mandates additional restrictions on ttansactions between affiliates, amending 

Section 13(t)(1) of the BHC Act to generally prohibit a banking entity that, directly or indirectly, 

serves as an investment manager, investment adviser, commodity trading adviser, or sponsor to a 

covered fund from engaging in any transaction with a covered fund if the ttansaction would be a 

"covered transaction" as defined in Section 23A of the Federal Reserve (FR) Act, as if the banking 

42 Id. at 68,902. 

"Id. 

"Id. 

45 Id. 
121 


79694.076

Ms. Elizabeth Mwphy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

February 13, 2012 

Page 16 of19 

entity and any affiliate thereof were a member bank and the covered fund were an affiliate thereof.46 

Section 23A and Regulation W limit the aggregate amount of "covered transactions" between a bank 

and any single affiliate to 10 percent of the bank's capital stock and surplus, and limit the aggregate 

amount of covered transactions with all affiliates to 20 percent of the bank's capital stock and 

surplus:7 A "covered transaction" under 23A includes, for example, the extension of credit by a 

bank to an affiliate and the issuance by a bank of a guarantee on behalf of an affiliate.48 

Section _.16 of the Proposed Rule, consistent with the Dodd-Frank Act requirements, is more 

restrictive than Section 23A. Section _.16 generally prohibits a banking entity and any of its 

affiliates from entering into any such transaction, while Section 23A pennits covered transactions 

with affiliates so long as the transactions meet certain requirements:' Essentially, the Proposed Rule 

would prohibit all entities in a banking organization, and not merely the "bank," that act as an 

investment adviser or sponsor toa covered fund from engaging in certain transactions, including 

providing loans to or investments in a covered fund. Unfortunately, the Proposed Rule does not 

recognize certain standard exemptions available under Section 23A and Regulation W, whereby 

certain activities are recognized to not inhibit the goals of safety and soundness and allow for a 

functioning market to continue. 

Under the additional restrictions provided for in the Proposed Rule, banks and their affiliates would 

not be able to engage in limited types of covered transactions currently permitted by the exclusions 

and restrictions under Section 23A when lending to affiliates. Unlike the regulations between banks 

and their affiliates, where limitations exist but banks are still able to lend, the Proposed Rule would 

make it so that advisers are no longer pennitted to lend money to funds in the same way as is 

available for banks to lend to operating affiliates. In practice, this provision would allow banks to 

engage in more extensive activities with affiliated and unaffiliated entities than would be permitted 

between a bank or its affiliate and an affiliated hedge fund, creating an unequal playing field for 

affiliated funds and potentially increasing interconnectedness amongst major banks . 

.. Under Section 23A a member bank and its subsidiaries may engage in a covered transaction with an affiliate only if: 

(A) in the case of any affiliate, the aggregate amount of covered transactions of the member bank and its subsidiaries will 

not exceed 10 per centum of the capital stock and swplus of the member bank; and (B) in the case of all affiliates, the 

aggregate amount of covered transactions of the member bank and its subsidiaries will not exceed 20 per centum of the 

c.pital stock and swplus of the member bank. See 12 U.S.c. § 371c(a) (2006). 

47 12 U.S.c. § 371c(a)(I) (2006); 12 CFR §§ 223.11, 223.12 (2012). 

48 12 U.S.C. § 371(b)(7) (2006); 12 CFR § 223.3(b) (2012). 

4' For reference, under Section 23B of the FR Act. member bank and its subsidiaries may engage in: (A) Any covered 

transaction with an affiliate; (B)The sale of securities or other assets to an affiliate, including assets subject to an 

agreement to repurchase; (C) The payment of money or the furnishing of services to an affiliate under contract, lease, or 

otherwise; (0) Any transaction in which an affiliate acts as an agent or broker or receives a fee for its services to the 

bank or to any other person; or (E) Any transaction or series of transactions with a third party if an affiliate has a 

financial interest in the third party, or if an affiliate is a participant in such transaction or series of transactions, only in 

certain circumstances. A member bank and its subsidiary may engage in these activities only: (1) on terms and under 

circumstances, including credit standards, that are substantially the same, or at least as favorable to such bank or its 

subsidiary, as those prevailing at the time for comparable transactions with or involving other nonaffiliated companies; 

or (2) in the absence of comparable transactions, on terms and under circumstances, including credit standards, that in 

good faith would be offered to, or would apply to, nonaffiliated companies. See 12 U.S.c. § 371c-l (2006). 
122 


79694.077

Ms. Elizabeth Murphy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

February 13, 2012 

Page 17 of19 

The Association also questions the necessity to restrict activity more tightly between banks and 

affiliates when the banks are engaged in the traditional functions of custodian banks. Custodian 

banks that also manage covered funds must be able to continue to provide custodian services, such 

as providing intraday credit in connection with routine security and currency deliveries of payment 

transactions. While the Association acknowledges that lines of credit may create potentially risky 

situations, provisional liquidity services in connection with payment transactions merely facilitate the 

trade and ensure that delays caused by unavoidable situations, such as currency issues, do not derail 

the trade. Custodian banks need to continue this activity to provide at least some straight-thru 

processing for their managed funds. I f custodian banks are unable to provide custodian services, 

more risk would be introduced into the settlement process, because funds would have to ftnd third 

party custodians or others to offer intraday credit to provide the necessary liquidity. Turning to 

third parties for such intraday credit may create operational challenges and disrupt the settlement 

process without providing any beneftt to the market or end investor. It would also increase risk to 

the banking organization and markets without providing corresponding beneftt, as the bank may still 

perform the same role and engage in the same types of activities with unaffiliated funds. 

D. limitations on Fund Investments 

Section _.12 of the Proposed Rule describes one of the limited circumstances under which a 

banking entity may acquire or retain, as an inveslment, an ownership interest in a covered fund that 

the banking entity or its affiliates offer. 50 Banking entities may take an ownership interest in a 

covered fund if the banking entity's inveslment is limited to no more than three percent of the total 

outstanding ownership interests of such fund (after the expiration of any seeding period provided 

under the rule).5! The Proposed Rule also requires that the banking entity's inveslment in a covered 

fund may not result in more than three percent of the losses of the covered fund being allocable to 

the banking entity's inveSlment.52 Further, the banking entity may not invest more than three 

percent of its Tier 1 capital in covered funds in the aggregate. 53 

The Association believes this restriction will be harmful to bank-owned asset managers, by both 

eliminating the ability of these managers to launch non-40 Act Funds and also limiting the ability of 

bank-owned managers to launch innovative strategies that address the needs of institutional clients, 

such as large pension funds, if the fund may not meet all of the requirements of 40 Act Funds. This 

would harm investors generally, as well as bank-owned asset managers. 

Typically, bank asset managers will market affiliated funds that have at least a three-year 

performance record in order to attract institutional investors. In order to create such a longstanding 

record, the manager will typically seed a strategy for the initial three years with capital. Few asset 

managers or investors are willing to invest in a strategy that does not have a three-year performance 

record. Because of the broad application of the Volcker Rule to bank-affiliated managers, the three 

percent restriction will severely curtail a bank-affiliated manager from investing its own money to 

50 Prohibitions and Restrictions on Proprietary Trading and Certain Interests In, and Relationships With, Hedge Funds 

and Private Equity Funds, 76 Fed. Reg. at 68,903. 

51 Id. 

52 Id. 

13 Id. 
123 


79694.078

Ms. Elizabeth Murphy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

Februaty 13, 2012 

Page 180f19 

create the three-year perfonnance record, and effectively eliminate an advisor's ability to launch new 

strategies that are not 40 Act Funds. 

We acknowledge that the Agencies must adhere to the statutorily mandated restriction which 

includes a one-year time limit. However, we encourage the Agencies to implement a system 

whereby an additional two-year extension is available upon request for incubation of new and 

innovative products, as this would be "consistent with safety and soundness and in the public 

interest," particularly where separate capital of the manager is used and the fund does not utilize 

capital from the insured depository institution. 54 We worry that the factors required under the final 

rule on the Conformance Period for Entities Engaged in Prohibited Proprietary Trading or Private 

Equity Fund or Hedge Fund Activities create too high of a hurdle to meet, or at a minimum, create 

uncertainty as to whether a bank will qualify for the extension. 55 Rather than requiring an entity to 

essentially extinguish all other options, we argue an additional two years should be presumed to be 

granted in situations where a ban:k can establish that its actions are part of a legitimate product 

development program. 

III. AGENCY COORDINATION 

The Association also is concerned that the Agencies have not adequately clarified which Agency will 

be responsible for ensuring compliance with various components of the Proposed Rule. We worry 

that without the proper coordination, entities will be subjected to overlapping and potentially 

inconsistent regulation. Beyond wanting to ensure that our member firms fully understand how to 

comply with the final regulations, when issued, it would also be helpful to ensure that there is no 

disconnect between the Agencies that could translate into the same regulations being interpreted 

differently by different Agencies. Many of our members are regulated by more than one of the 

Agencies. For example, both the SEC and bank regulatory authorities regulate our members that are 

affiliated with banks. The Association requests that the final rulemaking articulate that the Agencies 

will coordinate oversight efforts and clarify which agency will supervise in various situations. 

IV. DELAY OF IMPLEMENTATION 

The Association agrees with House .Financial Services Oversight and Investigations Subcommittee 

Chairman Randy Neugebauer (R-TX) and the other House Financial Services Committee Members 

who urged the Agencies in a December 20, 2011, letter to consider comments to the Proposed Rule 

and then issue an interim final rule reflecting comments from affected stakeholders. 56 We commend 

the Agencies for including numerous questions and making public statements on their willingness to 

consider industry concerns with the Proposed Rule, and would appreciate the opportunity to further 

comment before the rulemaking is final. Further, although we understand that it may take 

54 See Dodd·Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010). 

55 Conformance Period for Entities Engaged in Prohibited Proprietary Trading or Private Eqnity Fund or Hedge Fund 

Activities, 76 Fed. Reg. 8,265 (Feb. 14,2011). 

56 Letter from Rep. Randy Neugebauer to Chairman Ben Bernanke, Fed. Reserve Bd., Chairman Gary Gensler, 

Commodity Futures Trading Comm'n, Acting Comptroller of the Currency John Walsh, Office of the Comptroller of 

the Currency, Chairman Mary Schapiro, Sec. and Exch. Comm'n, and Acting Chairman Martin Gruenberg, Fed. Deposit 

Insurance Corp. (Dec. 20, 2011), avaihble at http://randy.house.gov/uploads/Neugehauer%20House%20Vol 

cker%20Rule%20Ltrl.pdf. 
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Ms. Elizabeth Mutphy, Ms. Jennifer Johnson, Mr. Robert Feldman, Mr. John Walsh, and Mr. David A. Stawick 

February 13, 2012 

Page 19 of19 

congressional action to delay implementation of the final rule (as Section 619 becomes effective on 

July 21, 2012, even without a final rule), we note that there have been other situations where 

statutory deadlines were missed because of the comple,aty or challenges faced by the Agencies in 

implementing rules within the time frame established by Congress.$7 Therefore, we urge the 

Agencies to delay the time for compliance with this deadline in view of the many unsettled questions 

and issues they raise and the need for the industry to have final guidance before making significant 

investment of time and resources to modify their operations. It is important to ensure that 

regulators have the time necessary to re-propose the rulemaking, and market participants need time 

to adjust activities to comply with the final rulemaking. Although we recognize that covered 

banking entities have a two-year conformance period to bring existing activities and investments into 

compliance with Section 619 of the Dodd-Frank Act, we argue this does not adequately replace 

providing the Agencies with enough time to consider market concerns without worrying about an 

arbitrary deadline. 

V. CONCLUSION 

The Association recognizes the challenges the Agencies face in implementing these new 

requirements and appreciates the Agencies considering our concerns. We thank the Agencies for 

the opportunity to comment on the Proposed Rule. Please feel free to contact me with any 

questions you may have on our comments at jgidman@loomissayles.cQtnor(617) 748-1748. 

On behalf of the Association of Institutional INVESTORS, 

~!'~ 

" As of February 1, 2012, a total of 225 DQdd-Frank rulemaking requirement deadlines have passed. More than half of 

these deadlines have been missed. For example, last July the SEC and CFTC announced that they would miss deadlines 

on derivatives rulemalcings and suspend some new derivatives rules so that the Commission had time to consider what if 

any further action was required. Press Release, Serurities and Exchange Commission, SEC Proposes Exemptions from 

Registration Requirements for Serurity-Based Swaps Issued by Certain Clearing Agencies (June 10, 2011), aruiloblt at 

http://www.sec.gov/news/press/2011/2011-124.htm. 
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100 Years Standing Up for American Enterprise 

U.S. CHAMBER OF COMMERCE 

Statement 

of the 

U.S. Chamber 

of Commerce 

ON: "Examining the Impact of the Volcker Rule on Markets, Businesses, Investors 

and Job Creation, Part II" 

TO: The House Committee on Financial Services 

DATE: December 13, 2012 

The Chamber's mission is to advance human progress· through an economic, 

political and social system based on individual freedom, 

incentive, initiative, opportunity and responsibility. 

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The U.S. Chamber of Commerce is the world's largest business federation, 

representing the interests of more than 3 million businesses of all sizes, sectors, and 

regions, as well as state and local chambers and industry associations. 

More than 96 percent of the Chamber's members are small businesses with 

100 or fewer employees, 70 percent of which have 10 or fewer employees. Yet, 

virtually all of the nation's largest companies are also active members. We are 

particularly cognizant of the problems of smaller businesses, as well as issues facing 

the business community at large. 

Besides representing a cross-section of the American business community in 

terms of number of employees, the Chamber represents a wide management spectrum 

by type of business and location. Each major classification of American business --

manufacturing, retailing, services, construction, wholesaling, and finance - is 

represented. Also, the Chamber has substantial membership in all 50 states. 

The Chamber's international reach is substantial as well. It believes that global 

interdependence provides an opportunity, not a threat. In addition to the 

U.S. Chamber of Commerce's 115 American Chambers of Commerce abroad, an 

increasing number of members are engaged in the export and import of both goods 

and services and have ongoing investment activities. The Chamber favors 

strengthened international competitiveness and opposes artificial U.S. and foreign 

barriers to international business. 

Positions on national issues are developed by a cross-section of Chamber 

members serving on committees, subcommittees, and task forces. More than 1,000 

business people participate in this process. 

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Chairman Bachus, Ranking Member Frank and members of the House 

Financial Services Committee. My name is Tom Quaadman, Vice President for the 

Center for Capital Markets Competitiveness at the U.S. Chamber of Commerce. The 

Chamber is the world's largest business federation representing the interests of more 

than three million businesses and organizations of every size, sector and region. On 

behalf of the Chamber's membership, I appreciate the opportunity to testify on the 

impacts of the V olcker Rule upon markets, businesses, investors and job creation. 

America's businesses, in order to compete, grow and create jobs, need efficient 

capital markets. Efficient capital markets allow businesses to have the access to the 

resources needed to operate on a daily basis and strategically plan for long-term 

success. They give businesses large and small the means and confidence to plan, 

expand and create jobs. Effective regulators who understand these markets allow 

good actors to play on an even playing field while driving out bad actors and 

punishing them. 

There is a direct link between the strength and resiliency of the American 

economy and the fact that our capital markets are the deepest, broadest and most 

resilient in the world. 

While the intention of the V olcker Rule is to ban "proprietary trading" by 

financial institutions, the reality of the V olcker Rule is that it creates an ill-defined and 

ill-conceived standard that will impair the efficiency of American capital markets in a 

way that will harm businesses and investors who rely on those markets. 

The Chamber supports policies that will improve the efficiency of the capital 

markets and prevent another financial crisis. We do not believe that the V olcker Rule 

meets those goals. This is why the Chamber has supported higher capital 

requirements, instead of a unilateral ban on proprietary trading, as a pro-growth 

means of stabilizing the financial system. 

The Volcker Rule, as proposed, will not promote growth or stabilize the 

financial system. Indeed it will make U.S. capital markets less robust, U.S. businesses 

less competitive and ultimately hamper economic growth and the job creation that 

accompanies it. The lack of clarity in the proposed regulatory provisions and the 

vagueness of the term "proprietary trading" itself will cause financial institutions to 

scale back and even cease to offer some critical services they provide, reducing capital 

formation for non-fmancial businesses. 

Mr. Chairman, the Chamber is very appreciative of the letter that you and 

Representative Hensarling sent requesting a further delay in the completion of the 

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Volcker Rule. The Chamber also supports the introduction of H.R. 6524. This bill 

was introduced by Rep. Peter King, to stay enforcement of the Volcker Rule until 

other nations adopt similar restrictions. These efforts are important steps to preserve 

American competitiveness. 

Cumulative Impacts of the Vo1cker Rule and other Regulatory Initiatives 

The Volcker Rule cannot be viewed in a vacuum and must be examined in light 

of other major financial regulatory initiatives including potential new money market 

fund regulations, derivatives regulations and Basel III capital standards. Each has 

been proposed to address a perceived need to change a different segment of the 

financial system. 

However, each of these regulatory initiatives has unique and collective impacts 

upon the ability of a corporate treasurer to make sure that a business has the cash to 

pay the bills and grow: 

• The V olcker Rule impacts the ability of businesses to access the debt and 

equity markets. 

• New money market proposals affect the capacity of a business to sell 

commercial paper and use efficient cash management techniques. 

• Derivatives regulations shape the ability of businesses to manage risk 

and lock in prices for raw materials. 

• Basel III impinges on the ability of businesses to access commercial lines 

of credit and obtain bank loans. 

Each will impact treasury operations of American businesses and the 

cumulative impact of these efforts could be devastating. 

Companies doing business in the U.S. operate with approximately $2 trillion of 

cash reserves, which is a historically high number. That number represents 14% of 

U.S. gross domestic product, but in contrast, corporate cash reserves in the Euro zone 

is 21% ofEuro zone GDP. 

Highly liquid capital markets in the United States permit treasurers to keep less 

cash on hand and use a "just-in-time" financing system that allows companies to meet 

working capital needs and raise additional capital needed to expand and create jobs. 

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Should the Volcker Rule be enacted in its present form, capital efficiency will 

decline, resulting in the need to maintain increased corporate cash buffers. Were idle 

cash reserves to rise to the Euro zone level of 21 % of GDP, that new level would be 

$3 trillion. Higher cash reserves would not be an historic outlier; it will be the new 

normal. 

Stated differently, corporate Treasurers would need to set aside and idle an 

additional $1 trillion of cash. This would seriously slow the economy to the detriment 

of businesses and consumers alike. To raise this extra $1 trillion cash buffer, 

companies may have to downsize and layoff workers, reduce inventories, postpone 

expansion and defer capital investment. Obviously, the economic consequences 

would be huge if US. companies had to withdraw from productive use funding that 

dwarfs the stimulus bilL 

Specific Concerns with the Volcker Rule 

The ambiguity surrounding provisions of the Volcker Rule is likely to have a 

chilling effect on precisely those banking services that account for U.S. 

competitiveness, capital efficiency and financial stability. This is an issue for U.S. 

businesses, large and small. 

Some of the unintended consequences of the Volcker Rule include: 

• Impaired market liquidity and reduced access to credit 

• Higher costs and less certainty for borrowers 

• Restricted trading in proper and allowable businesses 

• Competitive disadvantage for U.S. businesses and financial institutions 

• Prohibitions on traditional investments mislabeled as "funds" 

• Increased compliance costs for non-financial businesses 

• Higher bank fees for consumers and businesses 

• Less access to capital for small business and start ups 

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• Shifting of risks to other sectors of the economy 

• Capital flows into offshore markets 

• Potential Trade Violations 

• Extension to joint ventures 

a. Impaired market liquidity and reduced access to credit 

The Volcker Rule may impair the ability of banks to function as market makers. 

Banks act as significant buyers and sellers of securities to ensure that borrowers can 

find investors and investors can find investments. 

As market makers, banks hold inventory. This could be inventory in various 

investment instruments, Treasury debt, customer securities and foreign currencies. 

However, the Voicker Rule will significantly constrain market making by dictating 

how banks should manage their inventory. This will reduce the depth and liquidity of 

our capital markets. 

For example, corporations, municipalities, healthcare providers and universities 

rely upon the "market making" activities of bank in order to secure affordable funding 

in the bond market. Bank trading activities are what create market liquidity and 

enable the market to provide an efficient clearing price. Thus, if banks can no longer 

hold inventory, it will be much more difficult for businesses, municipalities and 

schools to raise capital. 

Without these activities, markets could take a giant step backward. Many 

American businesses will have to rely solely on commercial loans. This will increase 

their financing costs and force them to hold greater idle cash reserves. 

b. Higher costs and less certainty for borrowers 

The Volcker Rule will increase the cost of capital for all companies. With 

reduced market liquidity, transaction spreads widen, risks increase and price changes 

become more volatile. To compensate for these new risks, investors will demand 

higher rates. 

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Because banks can currently underwrite a bond issue for a customer and hold 

any unsold bonds in inventory, credit worthy borrowers can be reasonably assured of 

timely access to credit. However, under the Volcker Rule in its current form, banks 

may not be able to hold that inventory. They therefore, may decide to defer or delay 

underwriting those bonds for their customers until buyers are found in advance. 

Imagine a municipality or a hospital facing a critical funding need. Under the 

V olcker rule, they may go bankrupt waiting for a bank to line up the funding. Or, 

they would end up paying a crippling rate. 

c. Restricted trading in proper and allowable businesses 

The Proposed Rule is inherently complicated and forces regulators to discern 

the intent ofa trade. Worse, they require banks to "prove" the intent of each trade. 

This cannot be done in any reliable and consistent way. One entity's proprietary trade 

is another entity's market making activity-the trades may look no different on paper. 

'Proprietary trading' defies a symmetrical definition. 

The complexity and vagueness of the Volcker Rule will force banks to adopt 

the most conservative interpretation of the rule and err on the side of prohibiting 

certain trades that have no proprietary "intent". With the burden of proof on the 

banks, the compliance costs become prohibitive. The net result will likely be the 

elimination of perfectly acceptable "market making' activities. This could result in 

banks exiting or scaling back such routine activities as commercial paper issuance, 

cash management sweep accounts and multi-currency trade finance. 

d. Competitive disadvantage for U.S. businesses and financial institutions 

The United States' major trading partners have rejected the Obama 

Administration's request to follow the Volcker Rule. This puts American businesses 

and financial institutions at a disadvantage. By eliminating a core revenue stream 

from U.S. banks, the Volcker Rule would effectively reduce the ability for U.S. banks 

to compete and continue to provide services that are essential to our nation's 

businesses. Additionally, in order to avoid the territorial jurisdiction of the Volcker 

Rule, foreign flnancial flrms may retreat from the U.S., further depriving American 

businesses of capital and degrading the ability of U.S. regulators to oversee and 

regulate financial activity. 

Finally, most companies will still have financial risks that need to be managed. 

U.S. business will increasingly tum to foreign banks in overseas markets to serve this 

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function. Perversely, this will simultaneously weaken U.S. banks while strengthening 

foreign banks. 

e. Prohibitions on traditional investments mislabeled as "funds" 

There has been wide recognition by the Financial Stability Oversight Council 

and industry members that the Volcker Rule's definitions of private equity funds and 

hedge funds are extremely overbroad, and could result in unintended prohibitions of 

legitimate and useful activities and investments. Unless corrected through regulation 

or legislation, this over-breadth could prohibit securitization vehicles, cash 

management entities, certain joint ventures and even internal holding companies 

simply because they meet a technical legal standard that is common among true 

investment funds. 

Prohibiting these investments would severely disrupt all businesses affected by 

the V olcker Rule, and would have ripple effects throughout the real economy as 

legitimate business activities such as securitization, cash management and joint 

venture business partnerships are disrupted. 

f. Increased compliance costs for non-financial businesses 

The reach of the Volcker Rule can extend to non-financial businesses, although 

they present no systemic risk whatsoever. Many businesses offer financing services to 

their customers to accommodate their commercial relationship. They may own a 

depository institution, have a commercial or consumer finance subsidiary or sponsor a 

credit card. These businesses will incur increased costs and higher compliance 

burdens. Some will pass these costs on to their customers. Others will simply 

discontinue these financial services. In any event, the result is higher cost credit for 

those willing to pay and less credit for most small businesses and consumers. 

g. Higher bank fees for consumers and businesses 

The cumulative effect of regulatory changes such as the Volcker Rule, and 

Basel III will be to reduce or eliminate core banking revenue. At the same time, the 

Volcker rule will materially increase the costs of regulatory compliance. In order to 

continue providing high quality technologically advanced banking services, U.S. banks 

will need to increase banking fees on a wide range of services. They may also need to 

become more selective in the customer segments they choose to serve, thereby 

reducing the general availability of banking services. 

h. Less access to capital for small business and start ups 

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As banks restrict the availability of their services and increase the price, an 

inevitable "crowding out" will occur. The largest corporations and those who transact 

in the highest denominations will still have access to credit and risk management 

products. However, the less credit worthy customers and start-ups will be left out 

Many traditional services will be no longer cost effective. Some may not be available 

to those segments at all. 

i. Shifting of risks to other sectors of the economy 

In the dynamic world of free enterprise, risk is neither created nor destroyed. 

It can only be transformed. A corporate CFO whose company imports a raw material 

from the Far East, for example, must manage currency risk, commodity price risk, 

interest rate risk and operational shipping risks. Simply precluding a bank from 

helping the company hedge those risks, the V olcker Rule does not make those risks 

go away. 

CFOs and Treasurers will undoubtedly conclude that some risk management 

techniques and some heretofore efficient transactions will no longer be cost effective. 

They will decide to "go naked" and retain that risk internally. The upshot of this is 

that they will hold even more precautionary cash on their balance sheets as a buffer. 

This will take money out of the real economy. 

j. Capital flows into offshore markets 

Corporate treasury is the fmancial nerve center of a company, daily facing and 

managing the complexities of the global markets. Most treasurers select a lead bank 

as their primary source of capital, information and advice. That bank must be one 

that cannot only give the company global visibility, but can seamlessly operate in 

markets far and wide. The Volcker Rule would virtually eliminate U.S. banks from 

contention for that important 'lead' role. 

Many U.S. multinational companies are already selecting lead banks for each 

region of the globe, eroding the dominance of the U.S. banks. Many companies are 

establishing regional treasury centers for functions traditionally housed in the U.S. All 

of this leads to capital flowing out of the U.S. and competitiveness declining. 

k. Potential Trade Violations 

Many nations including Canada, Japan, the United Kingdom, and Singapore 

have objected to the V olcker Rule, citing adverse consequences to their ability to issue 

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sovereign debt. The VoIcker Rule is discriminatory, as foreign sovereign debt is 

subject to the regulation, while U.S. Treasury debt instruments are exempt. This 

creates a discord in the G20 and invites foreign governments to retaliate at a time 

when we need those same regulators in foreign countries to support initiatives to 

liberalize trade in financial services. The Chamber has called for the U.S. Trade 

Representative ("USTR") to conduct a very close examination to ensure the VoIcker 

Rule does not violate any of our trade obligations. Ultimately it may not, but the 

VoIcker Rule's discriminatory provision certainly does, at a minimum, send the wrong 

message internationally and gravely complicates the long-standing U.S. goal of 

liberalizing trade in ftnancial services in addition to creating a potential problem for 

U.S. sovereign debt if foreign governments decide to retaliate. 

The Chamber believes it is important that USTR evaluate the VoIcker Rule in 

the context of our trade commitments and be an active voice in the inter-agency 

process so that regulators understand the costs to the American economy and 

potential retaliatory actions the United States faces if other nations treat the VoIcker 

Rule as a trade violation or choose to adopt similar restrictions on U.S. sovereign 

debt. 

1. Extension to Joint Ventures 

Joint Ventures are a means of companies and entities to band together and 

equally develop new business lines or assets. This is an important vehicle for 

companies to remain competitive, particularly overseas where partnership with a local 

business may be necessary to enter the market. Under the V oIcker Rule, if an entity 

involved in a Joint Venture is deemed to be part of a ''banking entity" and required to 

have a VoIcker Rule compliance program, then the Joint Venture itself would also be 

required to have a V olcker Rule compliance program and face all of the associated 

activity limitations under the Rule. This is an illogical overextension of the VoIcker 

Rule. Subjecting Joint Ventures to VoIcker Rule prohibitions and compliance 

programs will increase regulatory complexity for Joint Ventures and place American 

companies at a competitive disadvantage as compared to their foreign counterparts. 

Process Concerns with the Volcker Rule 

The VoIcker Rule, ftrst proposed in 2011, encompasses 298 pages and asks 

over 1,000 questions. This is an extremely complex regulation that could lead to 

oversight of the issuance and trading of bonds and stocks on an unprecedented scale. 

News reports have indicated that 1) regulators are reluctant to re-propose the rule and 

2) that the Securities and Exchange Commission and banking regulators may have 

some signiftcant differences. 

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We are troubled that there may not be a re-proposal of the Volcker Rule. This 

will deprive stakeholders of an opportunity to review the final rule and compare it to 

the proposed rule. Informed commentary of a re-proposal will give regulators 

important feedback to avoid unintended adverse consequences before the Volcker 

Rule is finalized. We believe that regulators may be missing an important opportunity 

to flx a flawed proposal. 

The Chamber is also concerned that the Volcker Rule has a fractured, 

incomplete and uncoordinated study of the economic impacts and costs and benefits 

associated with the proposed rule. Thus, stakeholders were not provided an analysis 

of the costs and benefits associated with the proposed rule to provide regulators with 

informed commentary. 

The Volcker Rule Proposal must follow the requirements of the Administrative 

Procedures Act (HAP A"). Additionally, the Federal Reserve, FDIC, OCC, SEC ,and 

CFrC each have differing legal standards and internal practices they must meet for 

economic analysis when promulgating a rule. There is a real question as to whether 

many of these agencies have satisfled these obligations as to the proposed Volcker 

Rule. Given this haphazard and uncoordinated analysis under existing practices, the 

Chamber a year ago proposed that all of the agencies involved in the Volcker Rule 

Proposal establish a common baseline for cost-beneflt and economic analysis by using 

the blueprint established by Executive Orders 13563 and 13579, in addition to other 

requirements they must follow. 1 This would allow meaningful, cumulative analysis 

that would result in a more coherent final rule with fewer harmful, unintended 

consequences for America's capital markets. 

Last year, the Chamber provided the regulators with examples of the significant 

costs to non-financial companies that we believe were not contemplated in the initial 

Volcker Rule release. The Chamber conducted a survey that uses 2010-2011 historic 

data of select U.S. financing companies that service non-financial businesses. Based 

on credible assessments that the V olcker Rule will impose a 5 basis point increase in 

bid-ask spreads, for just the 5 companies selected, the increased lending costs total 

nearly $150 million for just those companies. The survey also includes an analysis of 

switching transactions-the process whereby a financial institution buys back some of 

an issuer's older bonds as part of the process for a new issuance. A 10 basis point 

increase caused by the Volcker Rule would increase the costs of switching 

1 Executive Order 13579 requests that independent agencies follow the requirements of Executive Order 13563. Both 

executive orders were issued by President Bamek Obarna. 

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transactions by $2.8 million per billion issued while a 50 basis point increase would 

drive up costs by nearly $14 million per billion issued. 

Because there is ample reason to be1jeve that the costs that would be imposed 

by the proposed Volcker Rule to the economy, state and local governments are well 

over $100 million, the OCC should submit the proposed rule to an Office of 

Information and Regulatory Affairs ("OIRA") regulatory review process. The Federal 

Reserve, FDIC, SEC and CFTC should also voluntarily submit their portions of the 

Volcker Rule Proposal for an OIRA regulatory review process to ensure consistent 

and uniform analysis. 

Conclusion 

The Chamber continues to have serious concerns that the Volcker Rule, as 

currently constructed, will not reduce systemic risk nor improve economic well-being. 

We believe that it will make U.S. capital markets less robust, U.S. business less 

competitive and ultimately reduce underlying economic activity and the job creation 

that accompanies it We believe that the lack of clarity in the proposed rule and 

definition of "propriety" trading itself will cause financial institutions to scale back 

and even exit some of the critical services they provide. 

I am happy to discuss these issues further and answer any questions you may 

have. 

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1

'-'1 INVESTMENT f . COMPANY 

~ ~,# INSTITUTE 

STATEMENT OF 

PAUL SCHOTT STEVENS 

PRESIDENT AND CEO 

INVESTMENT COMPANY INSTITUTE 

BEFORE THE 

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ON 

"EXAMINING THE IMPACT OF THE VOLCKERRULE ON MARKETS, BUSINESSES. 

INVESTORS AND JOB CREATION, PART II" 

DECEMBER 13, 2012 
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79694.093

EXECUTIVE SUMMARY 

• Congress enacted the Volcker Rule to restrict banks from using their own resources to trade for 

purposes unrelated to serving clients and to address perceived conflicts of interest in certain bank 

transactions. The Volcker Rule was not directed at registered funds. Unfortunately, the regulatory 

proposal to implement the Volcker Rule ("Proposed Rule") nonetheless raises a number of serious 

concerns for u.s. mutual funds and other types of registered investment companies ("registered 

funds"). 

• Chief among our concerns is the fact that the Proposed Rule could treat many registered funds as 

hedge funds-a result that contradicts the plain language that Congress passed. Providing an 

express exclusion for registered funds would avoid this result. 

• Similarly, without an express exclusion, it is possible that some registered funds could be treated as 

"banking entities" and subject to all of the prohibitions and restrictions in the Volcker Rule. It is 

clear that Congress did not intend such a result, and providing this exclusion for registered funds 

would in no way thwart the policy goals of the Volcker Rule. 

• leI supports the overall goals of the Volcker Rule's proprietary trading prohibition, particularly the 

need to address systemic risk concerns surrounding truly speculative proprietary trading. We do 

not believe, however, that the Proposed Rule's proprietary trading restrictions, as currently drafted, 

will achieve these goals. Instead, they may adverSely impact the financial markets and the abiliry of 

registered funds and other investors to participate in the markets. 

• We are particularly concerned that the Proposed Rule would decrease liquidiry, especially for those 

markcts that rely most on banking entities to act as market makers, such as the fixed income and 

derivatives markets and the less liquid portions of the equities markets. A reduction of liquidity 

would have serious implications for registered funds, ultimately leading to the potential for higher 

costs for fund shareholders. 

• The proprietary trading provisions of the Proposed Rule call into question whether banking 

entities could continue to serve as Authorized Participants (" APs") and market makers for 

exchange-traded funds ("ETFs"), an increasingly popular form of registered fund that is structured 

to permit investors to buy and sell shares at market prices throughout the trading day. AP 

transactions and related ETF market making activity are critical to maintaining efficient pricing in 

the ETF marketplace and protecting ETF investors. We recommend making it clear that banking 

entities can continue to fulfill these important roles. 

• The Proposed Rule raises similar and additional concerns for the foreign counterparts to registered 

funds, i.e., funds that are publicly offered and substantively regulated outside of the United States 

("non-U.S. retail funds"). Without substantial changes, the Proposed Rule would unduly impede 

the ability of both U.S. and non-U.S. entities to organize, sponsor, and operate non-U.S. retail 
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funds and harm certain financial markers. market participants. and financial instruments. 

Providing an exclusion for non-U.S. retail funds would ensure that the Voleker Rule is not applied 

more restrictively outside the United States than within. and is con.sistent with Congressional 

intent to limit the extraterritorial impact of these requirements. 

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I. INTRODUCTION 

My name is Paul Schott Stevens. I am President and CEO of the Investment Company 

Institute ("ICI"). the national association of U.S. investment companies. including mutual funds. 

closed-end funds. exchange-traded funds ("ETFs"). and unit investment trusts ("UITs").' ICI seeks to 

encourage adherence to high ethical standards. promote public understanding. and otherwise advance 

the interests of registered funds. their shareholders. directors. and advisers. As of December 2012. 

members ofICI manage total assets of$13.8 trillion. 

I appreciate the opportunity to provide ICI's perspective on the impact of Section 619 of the 

Dodd-Frank Wall Street Reform and Consumer Protection Act-commonly known as the "Voleker 

Rule" -on markets. businesses. investors. and job creation. The registered fund industty has a unique 

perspective, because our funds are both issuers of securities and investors in domestic and international 

financial markets. 

As with the Dodd-FtankAct'more broadly. ICI has closely fullowed developments related to 

the implem~ntation of the Volcker Rule. actively engaging with policymakers during the 

implementation process. Our efforts are focused on ensuring that the implementing regulations do not 

have harmful or unintended consequences fur registered funds and their shareholders-or for the 

financial markets or the broader economy-;-and that any final regulations strike the right balance 

between costs and benefits. 

Congress enacted the Volcker Rule to restrict banks from using their own resources to trade fur 

purposes unrelated to serving clients and to address perceived conflicts of interest in certain bank 

transactions. As several members of Congress have expressly indicated, the Voleker Rule was not 

directed at registered funds. 2 Unfortunately. the regulatoty proposal to implement the Volcker Rule 

("Proposed Rule"p nonetheless raises a number of serious concerns fur the U.S. registered fund 

I For ease of referenee. this testimony refers to all types of US. registered investment companies-including mutual funds. 

closed-end funds. ETFs. and UITs-as "registered funds." unless the context requires otherwise. 

, See. e.g.. Letter from Reps. SCOtt Garrett (R-NJ). Shelley Moore Capito (R-WV). Gwen Moore (D-WI) and Gary C. Perers 

(D-MI) to Agencies. dated May 30. 2012. Similarly. in response to a question at a Congressional oversight heating. SEC 

Chairman Mary Schapiro acknowledged that Congress probably did not intend fur the Voleker Rule to restrict mutual fund 

trading and investment activities. Heating. Capital Markets and Government Sponsored EnterpriseS Subcommittee. House 

Financial Services Commlttee. on "Oversight of the U.S. Securities and Exchange Commission: April 25. 2012. 

, See Prohibitions and Restrictions on Proprietary Trading and Certain Interesrs In. and Relationships With. Hedge Funds 

and Private Equity Funds. 76 Fed. Reg. 68846 (Novembcr 7. 20 II). issued by the Office of the Comptroller of the 

Currency. Board of Governors of the Federal Reserve System ("Federal Reserve"). Federal Deposit Insurance Corporation 

("FDIC). and Securities and Exchange Commission ("SEC). The Commodity Futures Trading Commission ("CFTC) 

was not a patty to the Proposed Rule; instead. it issued a separate yet substantively similar proposal to implement the 

Vokker Rule. See Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, 
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79694.096

industry. ICIbelieves that the Agencies involved have the authoriry to address most of these concerns 

through the regulatory process. 

If adopted in its original form, the Proposed Rule would reach much farther than it seems 

Congress intended. For example, the Proposed Rule could treat many registered funds as hedge 

funds-a result that contradicts the plain language that Congress passed. The Proposed Rule also could 

restrict banks from acting as market makers buying and selling securities-despite the fact that 

Congress specifically deSignated "market making-related activiry" as a 'permitted activiry" for banks 

under the Volcker Rule. Ifbanks cannot provide these services, particularly in the fixed income and 

derivatives markets and the less liquid portions of the equity markets, registered funds and other 

investors likely would face higher transaction costs and diminished returns. The Proposed Rule also 

could greatly impair the U.S. financial markets by imposing stringent restrictions that go well beyond 

what is necessary to effectuate Congress' intent in enacting the Volcker Rule, potentially hurting our 

broader economy and impacting job creation and investments in U.S. businesses overall. Finally, the 

Proposed Rule, as issued, could limit investment opportunities fur registered funds and their 

shareholders. I CI' s comment letter on the Proposed Rule described these and other concerns in detail.' 

The Proposed Rule raises similar and additional concerns for funds that closely resemble 

registered funds but are publicly offered and substantively regulated outside of the United States ("nonU.S. retail funds"). Without subsrantial changes, the Proposed Rule would unduly impede the ability 

of both U.S. and non-U.S. entities to organize, sponsor, and operate non-U.S. retail funds and harm 

certain financial markets, market participants, and financial insttuments. Our global affiliate, ICI 

Global ("ICIG"), filed a detailed comment letter addresSing the concerns of non-U.S. retail funds.s 

Hedge Funds and Covered Funds, 77 Fed. Reg. 8332 (February 14.2012). Bdow. this testimony refers to the fOregoing 

regulators coUectivdy as the • Agencies." 

• See Letter from Paul Schott Stevens, President & CEO.lnvesttnent Company Institute, to Ms. Elizabeth M Murphy, 

Secretary, SEC. et Ill. dated February 13. 2012 ("ICI Voleker Comment Letter). available at 

http://www ici.org/pdf/2S909.pdf. See also Statement of the Investment Company Institute for Hearing on "'Examining 

the Impact of the Voleker Rule on Markets. Businesses, Investors and Job Creation." Subcommittee on Capital Markets and 

Government Sp·onsored Enterprises. Committee on Financial Services, United States House of Representatives Oanuary 18. 

2012). available ae httP'IISnanciaIservices.house,gov/UploadedFilesIHHRG-112-BA-WState-ICI-20!20118 pdf 

Statement of Thomas P. Lemke. General Connsd and Executive Vice President, Legg Mason & Coo. LLC. on behalf of the 

Investment Company Institute. before the Subcommittee on Capital Markets and Government Sponsored Enterprises. 

Committee on Financial Services. U.S. House: ofRcpresentatives. on "'The Impact ofDodd~Frank on Customers, Credit, 

and Job Creators" (July 10, 2012). available at http·IISnanciaIserviceshousegov/yploadedfiles/hbrg-1I2-baI6-wstate= 

clemke-201207IO.pd£ 

5 See Letter from Dan Waters. Managing Director. ICI Global ("ICIG"), to Ms. Elizabeth M. Murphy. Secretary, SEC, et Ill. 

dated February 13. 2012. available at http'IIWWWjCj or.g1pdf/12 icjg yolcker pdf ICIG is the global association of 

regulated fOnds publicly offered to investors in leading jurisdictions worldwide. ICIG seeks to advance the common 

interests and promote public understanding of global investment fOnds. their managers. and investors. Membcrs ofICIG 

manage tOtal assets inelOCcss of US $1 trillion. 

2 
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79694.097

My testimony highlights important ways in which the Proposed Rule could negatively impact 

U.S. registered funds and non-U.S. retail funds. After the close of the comment period for the 

Proposed Rule, Chairman Bachus invited interested parties to submit legislative recommendations for 

ways to make the Volcker Rule less burdensome. A copy of the proposed legislative changes ICI 

submitted to Chairman Bachus (revised as of December 12,2012) is attached as an Appendix to this 

testimony and several of our recommendations are mentioned herein. 

Before turning to those issues, however, I wish to note that some press reports have mentioned 

the possibility that the individual regulatory agencies charged with implementing the Volcker Rule 

might adopt final regulations that differ from each other in substance. Such a result, it seems to me, 

would violate the requirement in Section 619 that the Agencies coordinate their rulemaking so as to 

assur[ e j, to the extent possible, that such regulations are comparable and provide 

for consistent application and implementation of this section to avoid providing 

advantages or imposing disadvantages to the companies affected .... 

Such a result, moreover, would be particularly unworkable for firms that comprise multiple 

entities with different primary regulators. We accordingly urge the Committee to do all it can to ensure 

that any final rules will be consistent across all of the Agencies. Given the significant changes we believe 

are necessary to address our concerns and those of other commenters, ICI recommended in its 

comment letter, and still strongly urges, that the Agencies issue a revised proposal for comment befOre 

adopting any final rule. 

II. ORGANIZATION, SPONSORSHIP AND NORMAL ACTIVITIES OF REGISTERED 

FUNDS 

A. The Yolcker Rule Should Not Treat U,S. Registered Funds or Their Non-U.S. Counterparts as 

Hed~ Funds or Private Eqyity Funds 

The Dodd-Frank Act prohibits a banking entity from having an ownership interest in, or acting 

as sponsor to, a hedge fund or private equiry fund, The statute defines "hedge fund" and "private equity 

fund" as ·any issuer that would be an investment company, as defined in the Investment Company Act, 

budor Section 3(c)(1) or 3(c)(7) of that Act: or ·such similar funds" as the Agencies may determine 

by rule-collectively defined in the Proposed Rule as "covered funds." 

It is clear that Congress did not intend for the Volcker Rule to extend to U.S. registered funds. 

The statute applies to two types of investment funds that are explicitly excluded from regulation under 

the Investment Company Act and, as determined by the Agencies, to funds that are ·similar" to those 

excluded funds. Moreover, a registered fund is not remotely ·similar" to a hedge fund or private equity 

fund. Registered funds are subject to a comprehensive regulatory regime under the Investment 

Company Act that focuses first and foremost on investor protection, and such funds are designed to be 

publicly offered and sold to all investors. Hedge funds and private equity funds, on the other hand, are 

identified in Section 619 by the two sections of the Investment Company Act that keep those funds 

3 
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outside that Act's regulatory protections. In addition, shares of a hedge fund or private equiry fund 

cannot be sold publicly but rather only to a limited number of investors (in the case of a Section 3( c) (1) 

fund) or to a carefully defined set of sophisticated investors (in the case of a Section 3( c )(7) fund). 

The legislative history of the Dodd-Frank Act reflects the concern of the primary authors of the 

statute and other members of Congress that the Section 619 definition of hedge fund and private 

equity fund not be interpreted too broadly. Indeed, members engaged in colloquies to clarify that 

references to the Section 3( c)( 1) and Section 3( c)(7) exclusions under the Investment Company Act 

should not be read broadly to sweep in subsidiaries, joint ventures, venture capital funds and other 

structures that rely on those exclusions but "will not cause the harms at which the Volcker rule is 

directed."· It would pervert the intended scope of the Volcker Rule were the Agencies to take too broad 

a view of what constitutes a "similar fund." 

Unfortunately, the Proposed Rule would expand the reach of the Volcker Rule far beyond what 

Congress intended, even to the extent of sweeping in a number of registered funds. This is because the 

Proposed Rule includes within its definition of "covered fUnd" any investment vehicle that is 

considered a "commodity pool" under Section la( 10) of the Commodity Exchange Act. Section la(! 0) 

broadly defines" commodity pool" to include' any investment trust, syndicate or similar form of 

enterprise operated for the purpose of trading in commodity interests," including, among other things, 

any security futures product or swap. A registered fund might use security or commodity futures, 

swaps, or other commodity interests in varying ways to manage its investment portfolio, including for 

reasons wholly unrelated to providing exposure to the commodity markets.7 The broad CEA definition 

of" commodity pool" thus could bring such a registered fUnd into the Volcker Rule.' Providing an 

express exclusion for registered funds, either in the sratute or the implementing regulations, would 

avoid this result. 

Similarly. under the Proposed Rule as drafted, all non-U.S. retail fUnds (including ETFs) 

inappropriately are encompassed by the definition of" covered fUnd." As with U.S. registered funds, 

there should be an express exclusion from the Volcker Rule for non-U.S. retail fUnds. Like U.S. 

registered fUnds. non-U.S. retail funds are regulated in their home jurisdictions. As a condition of their 

being offered to retail investors. these funds are regulated with respect. for example, to how they may 

invest and operate. the disclosure they must provide to their investors, the means by which they value 

6 See, e.g., 156 Congo Rec. S5904 (daily cd. July IS, 20 I 0) (colloquy between Sens. Dodd and Boxer). 

7 Uses of these instruments U;clude,fur example, hedging positions, equitizing cash that cannot be immediatdy invested in 

direct equity holdings (e.g., when the Staclt market has a1teady closed ror the day), managing cash positions more generally, 

adjusting portfulio duration (e.g., seeking to maintain a stated duration of seven years as a fund's flxed income securities age 

or mature). managing bond positions in general (e.g., in anticipation of expected changes in monetary policy or the 

Treasury's auction schedule), or managing the fund's portfolio in accordance with the investment objective stated in the 

fund's prospectus (e.g., an S&P 500 index fund that melts the S&P 500 using. 'sarnplingalgorithm' that relies in part on 

S&P 500 or other futures). 

8 As explained in our comment letter, the Agencies may not have contemplated that the CEA definition of" commodity 

pool" could reach many registered funds. See ICI Voleker Comment Letter, supra note 4, at 8. 

4 
144 


79694.099

their portrolio securities, their corporate governance, and their use ofleverage. They are not managed 

or srructured like hedge funds or private equity funds and so should not be treated as ·similar funds" 

under the Voleker Rule. Providing an exclusion ror non-U.S. retail funds would ensure that the 

Voleker Rule is not applied more restrictively outside the United States than within, a result wholly 

consistent with Congressional intent to limit the extraterritorial impact of these requirements. 

B. The Definition of"Banldng Entity" Expressly Should Exclude All U.S. Rc;gistered Funds and 

Their Non-U.S. Counterparts 

The Voleker Rule's prohibition on proprietary trading, and its restrictions on activities 

involving hedge funds and private equity funds, apply to ·banking entities." A registered fund would 

fall within the definition of "banking entity" if it were considered an affiliate or subsidiary of a banking 

entity (e.g., its investment adviser). In that event, the registered fund itself would be subject to all the 

prohibitions and restrictions in the Voleker Rule as implemented by the Proposed Rule. 

There is no indication that Congress intended this result. It appears that the Agencies did not 

intend it either; the preamble to the Proposed Rule indicates that a registered fund generally would not 

be considered a subsidiary or affiliate of the banking entity that sponsors or advises it. Without an 

express exclusion, however, it remains possible that some registered funds nevertheless could be 

captured by the regulations as banking entities. 

For example, it is common industry practice for an investment adviser/sponsor to provide the 

initial "seed" capital necessary to launch a new registered fund. Dutingthe period following the launch 

of a new fund, when the banking entity adviser/sponsor may own all or nearly all of the shares of the 

fund as a result of its investment of seed capital, the registered fund could be considered an affiliate (as 

defined in the Bank Holding Company Act ("BHCA")) of the adviser/sponsor. If so, the fund would 

be captured by the proposed definition of "banking entity" and become subject to the Voleker Rule in 

its own right.lO This could have the effect of essentially barring banking entities from sponsoring the 

most highly regulated type of investment vehicle and, thereby, limiting investment options for 

investors. Further, it would. in effect, ban banking entities from engaging in an activity that is 

permitted under the BHCA and other federal banking laws and that was never intended to be affected 

'The Proposed Rule generally defines "banking entity" to include: (1) an insured depositoty institution; (2) • company that 

controls an insured depositoty institution; (3) • company that is tre.ted as a bank holding company fur purposes of Section 

8 of the International Banking Act ofl978; and (4) subject to certain exceptions. an affiliate or subsidiaty of any of the 

foregoing. "Affiliate" and "subsidiaty" are defined by reference to the dtfinitions of those terms in Section 2 of the Bank 

Holding Company Act. 

1. A similar result could arise in the ETF context. as wdl as fur other types of registered funds. including closed-end funds 

and unit investment trusts ("UITs"). In particular. there are instances in which a banking entity involved in the 

underwriting of a closed-end fund or UIT temporarily owns a controlling interest in that fund. We do not believe that 

Congress intended for the, Voleker Rule to interfere with the organization or operation of any type of registered fund. 

5 
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79694.100

by the Voleker Rule.l1 It also would put banking entity sponsors at a competitive disadvantage 

compared with their non-bank-affiliated peers, which have no limits on their ability to furnish seed 

capital. 

For some I CI member firms, the banking entity that triggers application of the Volcker Rule is 

an insured depositoty institution that is small in relation to the overall firm and does not constitute 

part of the firm's core line( s) of business. Ironically, the impracticality that results from applying the 

Proposed Rule could well cause these firms to discontinue their limited banking operations even 

though they do not engage in proprietaty trading and may not sponsor or have ownership interests in 

any hedge funds or private equity funds. 

Providing an express exclusion for all registered funds from the definition of "banking entity" 

either in the implementing regulations or the statute-would address all of the concerns described 

above without thwarting in any way the policy goals of the Volcker Rule. Even during the post-launch 

period, when a banking entity investment adviser may own all or nearly all of a fund's shares, the 

registered fund must be operated in accordance with the comprehensive regulatoty regime administered 

by the SEC under the Investment Company Act and other federal securities laws. Notably in this 

context, registered funds are subject to oversight by an independent board of directors, 12 strong conflict 

of interest protections through prohibitions on affdiated transactions, 13 and strict restrictions on 

leverage.l4 

To avoid the potential for serious and disruptive effects on their organization and operation, 

the definition of "banking entity" also should expressly exclude non-U.S. retail funds. The justifications 

for such an exclusion are largely the same as those outlined in Section ILA above with respect to the 

definition of "hedge fund" and "private equity fund." In particular, the highly regulated nature of nonU.S. retail funds and the intent of Congress to limit the extraterritorial impact of the Volcker Rule 

provide strong support for excluding these funds from the definition of "banking entity." 

II Under the BHCA, banking organizations generally may sponsor and "seed" registered funds so long as they (a.) do not 

exercise managerial control over the portfulio companies of funds. and (b) reduce their ownership stake in sponsored funds 

to below 25 percent within one year (or seek Federal Reserve Board approval for an extension). 12 CFR 225.86(b)(3). 

J2. See. e.g.~ Section lO(a) of the Investment Company Act (requiring a mutual fund or doscd~end fund to have a board of 

directors at least 40 percent of which must be independent directors. As afyear-end 2010, independent directors made up 

three-quarters of boards in more than 90 percent of fund complexes. Independent DirectOrs Council and Investment 

Company Institute, Overview o/Fund Governance Practices, 1994-2010 (October 2011). 

13 See Section 17(a) of the Investment Company Act; Section 23A of the Federal Reserve Act. 

14 See, e.g., Section 18 of the Investment Company Act {restrictions applicable to mutual funds and dosed-end funds}. 

6 
146 


79694.101

C. The V olcker Rule Should Not Limit the Ability of Banking Entities to Serve as Authorized 

Participants and Market Makers for Registered Exchange-Traded Funds 

The proprietary trading provisions of the Proposed Rule call into question whether banking 

entities could continue to serve as Authorized Participants (" APs") and market makers for ETFs 

registered under the Investment Company Act, as well as non-U.S. retail ETFs. ETFs are similar to 

mutual funds (the most common rype of registered fund) except that they list their shares on a 

securities exchange, thereby allowing retail and institutional investors to buy and sell shares throughout 

the trading day at market prices. Increasingly popular with investors, ETFs use a different process for 

offering their shares. APs alone transact in shares directly with ETF s, in large amounts (typically 

involving 50,000 to 100,000 ETF shares) based not on market prices but on the ETF's daily net asset 

value. AP transactions with an ETF are a unique and controlled form of arbitrage trading that, in the 

view of the SEC, is a critical component of maintaining efficient pricing in the ETF marketplace and 

protecting ETF investors. 

Some banking entities also may engage in traditional market making activities in ETFs. In this 

capaciry, they may provide seed capital, as well as temporatily hold inventory ofETF shares and the 

underlying securities or their economic equivalent in order to help maintain efficient pricing in the 

ETF marketplace. Although these are market making activities that should be permitted by the 

Proposed Rule, we are concerned that they may not be deemed to be "designed not to exceed the 

reasonably expected near term demands of clients, customers, or counterparties." We recommend 

making it clear, either in the implementing regulations or the statute, that banking entities can 

continue to fulfill these important roles. 

III. IMPACT ON THE FINANCIAL MARKETS 

Section 619 of the Dodd-Frank Act prohibits a banking entiry from engaging in proprietary 

trading of securities, derivatives, and certain other financial instruments for its own account. 

Notwithstanding this broad prohibition, the statute provides exemptions for a banking entiry to engage 

in certain "permitted activities.' Significantly, exemptions are provided for posirions taken in 

connection with market making-related activities, risk-mitigating hedging activities, and trading in 

certain U.S. government securities. 

ICI supports the overall goals of the Volcker Rule's proprietary trading prohibition, particularly 

the need to address systemic risk concerns surrounding truly speculative proprietary trading. We do 

not believe, however, that the Proposed Rule's proprietary trading restrictions, as currently drafred, will 

achieve these goals. Instead, they may adversely impact the financial markets and the abiliry of 

registered funds and other investors to participate in the markets. 

7 
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79694.102

A. LiQYid and Efficient Markets are Important for R<;gistered Funds 

For registered funds, the availability of liquidity is a critical element of efficient markets. 

Banking entities are key participants in providing this liquidity, promoting the orderly functioning of 

the markets as well as the commitment of capital when needed by investors to facilitate trading. 

Liquidity is particularly important in the everyday operations of mutual funds, which typically 

offer their shares on a continuing basis and are required by the Investment Company Act to issue 

"redeemable securities."15 Mutual funds must have efficient, orderly markets to invest cash they receive 

when investors purchase fund shares as well as to meet investor redemption requests on a daily basis. 

Registered funds also are dependent on adequate liquidity when making investment decisions 

and when trading the instruments in which they invest. Important invesrtnent criteria analyzed by 

portfolio managers at registered funds include a security's liquidity, i.e., whether a position can easily be 

sold in a timely and cost efficient manner. If registered funds cannot transact effectively in the financial 

markets due to a lack ofliquidity, they may be reluctant to invest in certain instruments altogether. 

We are concerned that the Proposed Rule would decrease liquidity, particularly for those 

markets that rely most on banking entities, such as the fixed income and derivatives markets and the less 

liquid portions of the equities markets. A reduction of liquidity would have serious implications for 

registered funds, ultimately leading to the potential for higher costs for fund shareholders. Non-U.S. 

retail funds similarly are apprehensive about the prospect of decreased liquidity in these markets, both 

in the United States, where many of these funds trade, and abroad (particularly with respect to 

obligations of foreign governments and international and multinational development banks). 

B. The Complexity of, and Difficulties of Complying with. the Proposed Rule Threaten Market 

Liquidity and May Adversely Impact Registered Funds 

Much of the concern surrounding the effect of the Proposed Rule on liquidity arises from the 

complexities of several provisions of the Proposed Rule and of the exemptions from the proprietary 

trading prohibition. We support recasting the rigid criteria that appear in the Proposed Rule as 

"guidance" to be incorporated into policies and procedures adopted by banking entities. These policies 

and procedures could be combined with a robust compliance progcam required to be employed by 

banking entities, the use of relevant quantitative metries to evaluate banking entity trading activity, and 

examinations by the Agencies to ensure that banks are not engaged in speculative proprietary trading. 

Together, these measures should accomplish the purposes of the V olcker Rule while permitting the sort 

of market making activity upon which registered funds and other investors rely. 

" See Section 2(.)(32) of the Investment Company Act (generally defining "redeemable security" as "any security ••• under 

the terms of which the holder. upon irs ptesentation to the issuer or to a person designated by the issuer. is entitled .•. to 

receive approximatdy his proportionate share of the issuer's current net assets, or the cash equivalent thereo£"). 

8 
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79694.103

1. The Presumption oJProhibitedActivitJ is Unwarranted 

The Proposed Rule generally presumes that a banking entity's short-term principal trading 

activity is prohibited proprietary trading. While the Proposed Rule provides a mechanism to rebut this 

presumption, doing so appears extremely complex and onerous. Inevitably, it would expose a banking 

entity to hindsight interpretations and second-guessing about key compliance decisions with respect to 

each individual financial position. 

This presumption of prohibited activity fundamenrally prejudices the analysis of a banking 

entity's trading activity from the outset. Given the difficulties of overcoming the presumption, banking 

entities understandably will be highly reluctant to make markets with respect to any instrument that 

might fall within the proprietary trading prohibition. 

2. The Conditions of the Exemptions Do Not Reflect the Operation ofthe Financial 

Markets as a Whole 

The Proposed Rule appears tailored primarily for the operations of the traditional trading of 

equities on an agency-based "last sale" model (i.e., on the securities exchanges), the operations of which 

differ substantially from how the fixed-income and other markets operate. In the majority of the 

financial markets, market makers provide liquidity by acting as principal, and not as agent. The 

Proposed Rule therefore does not reflect accurately the manner in which those other financial markets 

operate: fixed-income securities and derivatives are traded "over-the-counter" rather than on exchanges; 

their instruments are not as liquid as equities; and the markets and their instruments are more 

fragmented. As a result, the role of market makers in fixed-income securities and derivatives is more 

complex and more fundamental to how these markets operate. We are therefore concerned that the 

Proposed Rule will inhibit the ability of banking entities to conduct market making activities effectively 

across various asset classes and to supply needed liquidity by acting as principal in a transaction. 

The Proposed Rule also does not accord banking entities the flexibility they need as market 

makers to enter into transactions to build inventory, which is a significant element of making a market. 

As a result, the exemptions provided in the Proposed Rule from the proprietary trading prohibition, 

particularly the exemption for market making-related activities, likely will be of very limited utility fur 

banking entities. If that is the case, trading activity that registered funds rely on will be restricted, 

negatively impacting transaction costs, increasing shareholder risk, and ultimately impacting fund 

shareholder rerurns. 

3. The Conditions oJthe Pri!tJosed Exemptionj"or Market Making-Related Activities are 

Impractical 

The Proposed Rule's implementation of Section 619's exemption for market making-related 

activities contains numerous conditions that must be met by a banking entiry. We believe these 

9 
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79694.104

conditions, as currently drafted, make the exemption extremely complex and so difficult to comply with 

as to be effectively unworkable in a number of 6.nancial markets and fOr a significant number of 

6.nancial instruments. For example, the Proposed Rule would require banking entities to ensure that 

their market making activities generate revenues primatily from fees, commissions, bid/ask spreads or 

other income that is not attributable to appreciation in the value of covered 6.nancial positions held as 

inventory or hedging of such covered financial positions. As discussed above, market making in flxedincome and derivatives instruments simply does not function in that way, as market makers provide 

liquidity by acting as principal, and not as agent, in these markets. This condition ignores the fact that 

market makers holding inventoty may seek to generate revenue and profit from the appreciation, and 

avoid losses from the dep reciation, of the covered 6.nancial position during the time they hold the 

position in inventory. Similarly, in less liquid markets where trades are infrequent and customer 

demand is hard ro predict, it may be difficult fOr a market maker to satisfY the condition that irs activity 

be «designed not to exceed the reasonably expected near term demands of clients, customers, or 

counterparties .• 

4. The Risk-Mitigatin,gHedgirlgExemption Must be Flexible 

The ability of banking entities as market makers to hedge their positions and manage the risks 

taken in connection with their activities is a critical element of a liquid and efficient market. It is 

therefOre imperative to ensure that banking entities can hedge their positions appropriately to allow 

them effectively to provide needed services to registered funds. The Proposed Rule's risk-mitigating 

hedging exemption should not apply on a transaction-by-transaction basis. Rather, it should be flexible 

enough to allow banking entities to manage all possible risks and to facilitate hedging against overall 

portfOlio risk. 

S. The Proposed Government Obligations Exemption Should be Expanded to Cover All 

Municipal Securities and Foreign Sovereign Obligations 

The proposed exemption fOr trading in certain government obligations does not extend to 

transactions in obligations of an agency or instrumentality of any State or political subdivision. We 

submit that there is no rational basis upon which to exclude this particular class of municipal securities. 

These instruments represent one of the more conservative asset classes in the capital markets. and 

registered funds are significant investors in these securities. Excluding this class of municipal securities 

will restrict trading in these instruments and pose liquidity challenges fOr registered funds holding these 

securities. Moreover, it will impair the ability of many local government entities to raise capital, with 

significant adverse consequences fOr the finances of these entities. We therefOre recommend that the 

exemption be expanded. either in the statute or the implementing regulations. to include all municipal 

securities, which would be consistent with the current de6.nition of municipal securities under the 

Securities Exchange Act of 1934 ("Exchange Act"). We further recommend that there be an exemption 

for fOreign sovereign obligations. consistent with Congressional intent to limit the extraterritorial reach 

of the Volcker Rule and with the purposes of the Volcker Rule. 

10 
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79694.105

C. The Agencies' Proposed Implementation of the Proprietary T tadjng Prohibition Would 

Impact Capital Formation 

The Agencies' proposed implementation of the proprietary trading prohibition could have 

negative implications fOr capital fOrmation. Banking entities playa critical role in initial capital 

fOrmation. otten providing companies with the capital necessary to go public. Ifbanking entities find 

that the restrictions contemplated by the Proposed Rule prohibit or greatly impede their serving this 

role. they will be less willing to provide capital, adversely affecting registered funds and other investors. 

Similarly. ifissuers and dealers tace increased costs in the capital formation process .rue to the Proposed 

Rule. this could restrict access fOr registered funds to suitable investments. and the availabiliry of 

investments for registered funds overall will decline. 

Banking entities also may find it difficult to remain in the market making business, which could 

lead these activities to be perfOrmed by less regulated and less transparent institutions. We therefore 

believe the over-broad restrierions of the Proposed Rule, which go well beyond what is necessary to 

effectuate Congress' intent in enacting Section 619 of the Dodd-Frank Act. could hurt the broader 

economy. impaeringjob creation and investments in U.S. businesses overall. 

IV. LIMITING INVESTMENT OPPORTUNITIES FOR REGISTERED FUNDS AND 

THEIR SHAREHOLDERS 

A. The Foreign Trading Exemption Should Be Revised to Avoid Adyerse Effeers on Investments 

in Certain Foreign Securities by U.S. Registered Funds and Their Fore~ Counterparts 

Although Congress intended that trading outside of the United States be a "permitted activity" 

under the Volcker Rule, the Proposed Rule narrowly defines transaerions deemed to take place outside 

of the United States. In so doing, the Proposed Rule departs from an existing and well-understood U.S. 

securities regulation (Regulation 5 under the Securities Act of 1933) that governs whether an offering 

takes place outside of the United States. Iflett unaddressed, the discrepancy between the "fOreign 

trading exemption' in the Proposed Rule and the long-established Regulation S standard would have 

negative consequences for U.S. registered funds and their shareholders. 

Many registered funds invest in securities, such as sovereign debt securities denominated in 

fOreign currency. fOr which the primary and most liquid market is outside of the United States. These 

transaerions otten involve non-U.S. banking entities as counterparties. The narrow foreign trading 

exemption in the Proposed Rule may well cause some non-U.S. banking entities to avoid engaging in 

transactions with persons acting on behalf of U.S. registered funds. even when those transaerions would 

comport fully with Regulation S and related SEC interpretations. As a result. U.S. registered funds' 

access to non-U.S. counterparties could decrease significantly. 

As currently configured, the fOreign trading exemption also could reduce liquidity in some 

markets and lead to smaller or more fragmented markets fOr many securities. This would have adverse 

effects on investors in those markets including both U.S. registered funds and non-U.S. retail funds. 

11 
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79694.106

Revising the Proposed Rule (or the statute) to confurm to the existing approach under Regulation S 

would avoid these highly undesirable results. 

B. The Yolcker Rule Should Exempt Asset-Backed Commercial Paper and Municipal Tender 

Option Bond Programs 

The Proposed Rule would impair two particular types of securitization activities that are part of 

traditional banking activities-notes issued by asset-backed commercial paper (" ABCP") programs and 

securities issued pursuant to municipal tender option bond ("TOB") programs. This would have 

significant negative implications fur issuers of these financing vehicles and their investors. many of 

which are registered funds. There is no indication. however, that Congress intended to include ABCP 

or municipal TOB programs within the scope of the Volcker Rule; rather, Congress specifically sought 

to avoid interfering with longstanding, traditional banking activities. The provision of credit to 

companies to finance receivables through ABCP, as well as to issuers of municipal securities to finance 

their activities through TOBs, are both areas of traditional banking activity that should be 

distinguished from the types of financial activities that Congress sought to restrict under the Volcker 

Rule. Without liquid ABCP and TOB markets. credit funding fur corporations and municipalities 

would be unduly and unnecessarily constrained. It is therefore important that the statute or 

implementing regulations be revised to exempt ABCP and municipal TOB programs. 

V. CONCLUSION 

I appreciate the opportunity to share these views with the Committee. ICI looks furward to 

working with Congress and regulators as they continue to tackle these and other important issues. 

Attachment 

• Appendix: Proposed Amendments to Section 619 of the Dodd-Frank Wall Stree~ Refurm and 

Consumer Protection Act (the 'Volcker Rule") 

12 
152 


79694.107

Revised as of December 12, 2012 

APPENDIX 

Proposed Amendments to Section 619 of the Dodd-Frank Wall Street Reform and 

Consumer Protection Act (the "Volcker Rule") 16 

I. Amendments to CIari!Y that the Yolcker Rule Does Not Extend to U.S. Mutual Funds or 

Their Non-U.S. Counteqwts 

A. Amendment to Section 13(h)(2) of the Bank Holding Act of 1956. which defines the 

terms "hedge fund" and "private equity fund": 

Add the following language at the end of the paragraph: 

In no event shall the terms "hedge fund" or "private equity fund" Cindudjng any simyar fUnd as 

designared by rule) meanfA) an investment companY redstered under tbe Investment CgmpanyAct of 1940: 

(B) an iSSuer organized or formed under forsrign law tbat is authorized for public sale in the 

iurisdiction in wbicb it is formed and is regulated as a public inygtment company, qsgardless of 

the form oforganizatioQ, in that jurisdiction· Of 

fe) an issuer tbas is subject to contractua1or other restrictions tbat effectively limit its 

inycstment objectives, policies and strategies to those objectives. policies and strategies that 

would be permitted for investment companies reg;istsrs;d under tbe Investment Company Act 

~ 

EXPLANATION: 

• Section 619 of the Dodd-Frank Act prohibits a banking entity from having an ownership interest 

in, or acting as sponsor to, a hedge fund, ptivate equity fund, or 'similar fund" as the agencies 

charged with implementing the Volcker Rule may determine by rule. 

• Treating any mutual fund or other U.S. registered investment company as 'similar" to a hedge fund 

or ptivate equity fund is contrary to CongresSional intent. If the term 'similar fund" is interpreted 

broadly by the tegulators, however-as we have seen in the pending proposal to implement the 

Volcker Rule-some registered funds may become subject to the Voicker Rule prohibitions. 

Providing an express exclusion for mutual funds and other u.S. registered investment companies 

16 Section 619 added Section 13 (Prohibitions on Proptietary Trading and Certain Relationships with Hedge Funds and 

Private Equity Funds) to the Bank Holding Company Act of 1956. 
153 


79694.108

Revised as of December 12, 2012 

from the definition of "hedge fund" and "private equity fund" would avoid this result. 

• There likewise should be an express exclusion for non-U.S. retail funds from the definition of 

"hedge fund" and 'private equity fund" to treat them similarly to their U.S. mutual fund 

counterparts. Like U.s. registered investment companies. non-U.S. retail funds are regulated in 

areas such as how they may invest and operate. the disclosure they must provide to their investors. 

the means by which they value their portfolio securities. their corporate governance. and their use of 

leverage. in order to be widely offered to retail investors. They are not managed or structured like 

hedge funds or private ,equity funds and so should never be categorized as "similar funds." 

• Without such a corollary exclusion for non-U.S. retail funds. the Volcker Rule would be applied 

more restrictively outside the United States. Further, providing an express exclusion fOr non-U.S. 

retail funds from the definition of "hedge fund" and "private equity fund" is consistent with 

Congressional intent to limit the extraterritorial impact of the Volcker Rule. 

• The language of the proposed exclusion fOr non-U.S. retail funds is substantially similar to that used 

by the Securities and Exchange Commission in 2004. when it identified the types of non-U.S. funds 

that should not be treated as hedge funds.17 As in the SEC's rulemaking. the proposed exclusion 

should apply to any type of publicly offered fund otherwise meeting the requirements of the 

exclusion, whether in corporate, trust, contractual or other fOrm. 

• It also is unnecessary to apply the Volcker Rule prohibitions to funds that, because of contractual or 

other restrictions, effectively limit their investment objectives, policies and strategies to those that 

would be permitted for U.S. registered investment companies under the Investment Company Act 

of 1940 (e.g., limitations on leverage). These parameters are well understood by the investment 

management industry and by the SEC. which is the primary regulator of registered investment 

companies and advisers to certain hedge funds and private equity funds. 

• In addition, excluding the funds described in (C) above from the scope of Section 619 would be 

consistent with the Financial Stability Oversight Council's recommendation that the "similar fund" 

designation be reserved fOr funds that" engage in the activities or have the characteristics of a 

traditional private equity fund or hedge fund. "18 

17 SIte Registration under the Advisers Act of Cerraio Hedge Fund Advisers, Investment Advisers Act Release No. 2333 

(Dec. 2, 2004). This rulemaking was vacated by the u.s. Court of Appeals ror the District of Columbia Circuit on grounds 

unrelated to this particular provision. See Goldstein v. SIte. & Exch. Comm'n, 451 F.3d 873 (D.C. Cir. 2006). 

IS See Fioancial Stability Oversight Council, Study & Recommendations on Prohibitions on Proprietaty Tradiog & Certain 

Relationships with Hedge Funds & Private Equity Funds (jan. 2011), at 62. 

2 
154 


79694.109

Revised as of December 12, 2012 

B. Amendment to Section 13(h)(I) of the Bank Holding Company Act ofl956, which 

deSnes the term "banking entity": 

Add the fullowing language at the end of the paragraph: 

In no eyent shall the term "banking entity" mean 

(A) an investment company registered under the Investment Company Act of 19400 

fB) an issuer organized or formed under foreign law that is authorized for public sale in the 

jurisdiction in wbicb it is formed and is re,ulated as a public investment company regardless of 

the form of organization. in that jurisdiction· Qr 

CCl an iSSuer that is subject to contractual or other restrictions that effi;ctiyeIy limit irs 

inVestment objectives. noJickS and strategies t9 those objectives, polides and strategies that 

would be permitted for investment companjes registered under the Inyestment Company Act 

~ . 

EXPLANATION: 

• The Volcker Rule prohibits a "banking entity" from engaging in proprietary trading and from 

sponsoring or investing in hedge funds and private equity funds. The definition of "banking entity" 

includes an affiliate or subsidiaty of a banking entity. 

• A mutual fund generally is not considered an affiliate or subsidiaty of the banking entity that 

sponsors or advises it. Without an express exclusion, however, it is possible that some mutual funds 

or other U.s. registered investment companies could become subject to all of the prohibitions and 

restrictions in the Volcker Rule-a result not intended by Congress. For example, during the 

period following the launch of a new mutual fund by a bank-affiliated sponsor, when all or nearly all 

of the fund's shares are owned by that sponsor (the "seeding process" fur a new fund), the mutual 

fund could be considered an affiliate of the banking entity, and thus subject to the Volcker Rule in 

its own right. 

• Providing an express exclusion fur mutual funds (~d other U.s. registered investment companies) 

from the definition of "banking entity" would avoid this unintended result without thwarting in 

any way the policy goals of the Volcker Rule. 

• Consistent with Congress' intent to limit the extraterritorial impact of the Volcker Rule, the 

exclusion also should extend to non-U.S. retail funds (i.e., the non-U.S. counterparts to U.S. 

mutual funds). Like U.S. registered investment companies, non-U.S. retail funds are regulated in 

areas such as how they may invest and ·operate, the disclosure they must prOVide to their investors, 

3 
155 


79694.110

Revised as of December 12. 2012 

the means by which they value their portfolio securities. their corporate governance. and their use of 

leverage. in order to be widely offered to retail investors. 

• The language of the proposed exclusion for non-U.S. retail funds is substantially similar to that used 

by the SEC in 2004. when it identified the types of non-U.S. funds that should not be treated as 

hedge funds.19 As in the SEC's rulemaking. the proposed exclusion should apply to any type of 

publicly offered fund otherwise meeting the requirements of the exclusion. whether in corporate. 

trust. contractual or other form. 

• It also is consistent with Congressional intent to exclude from the definition of "banking entity" 

funds that. because of contractual or other restrictions. effectively limit their investment objectives. 

policies and strategies to those that would be permitted for U.S. registered investment companies 

under the Investment Company Act of 1940 (e.g.. limitations on leverage). Such funds do not 

present the risks at which the Volcker Rule prohibitions are directed. 

II. Amendment to Clarifr that the Yokker Rule Permits Market Makin,gActivity hy 

Authorized Participants in Exchange-Traded Funds 

Insert the following language as Section 13(d)(I)(C). (and redesignate successive subparagraphs (C) 

through 0) as (D) through (K»: 

(el The purchase, sale; acguisitiop, or di§positio9 of securities issued by Exchange-Traded Funds 

("ETF Shares") or underlying grudties held by an ETF (or other ipummsnts reasonably intended 

to provide substantially similar economic expospre) 

(n in connection with ErE market making-related gcWities, oc 

Oil by Authorized Participants in connection with the creation and redemption ofETF'Shares, 

EXPLANATION: 

• Exchange-traded funds ("ETPs") have over $1 trillion in assets under management. and are an 

important investment vehicle for a wide range ofinvestors. A robust trading environment is 

critical for the ETF market. 

• Banking entities play an important role in this market by acting as Authorized Participants 

(" APs") and market makers. An AP is an entity that enters into a contract with an ETF 

permirting it to purchase and sell shares directly with the ETP at the ETP's net asset value. 

19 See Registration under the Advisers Act of Certain Hedge Fund Advisers, Investment Advisers Act Release No. 2333 

(Dec. 2. 2004). This rulemaking was vacated by the U.S. Court of Appeals for the District of Columbia Circuit on grounds 

unrelated to this particular provision. See GolJsuin v. Sec. 6-Exch. Commn. 451 F.3d 873 (D.C. Cir. 2006). 

4 
156 


79694.111

Revised as of December 12,2012 

• In their role as APs and market makers, banking entities may, among other things: 

1. "Seed" new ETFs, by providing initial capital and holding shares of an ETF until a 

liquid trading market develops. 

2. Engage in short term arbitrage transactions, creating ETF shares when such shares trade 

at a premium (Le., when demand exceeds supply) and redeeming them when they trade 

at a discount (i.e., when supply exceeds demand); this activity helps to keep the market 

price for ETF shares close to their net asset value. The SEC views this arbitrage process 

as a critical component of maintaining efficient pricing in the ETF marketplace and 

protecting ETF investors from the risks of substantial and sustained deviations from 

net asset value.20 

3. Temporarily hold inventory ofETF shares and the underlying securities or their 

economic equivalent in order to maintain efficient pricing fur ETFs. 

• These activities may f.ill within the definition of "proprietary ~ing" in subsection (h)(4) of 

Section 13, and they do not clearly fit within the "permitted activities" exemptions enumerated 

in subsections (d)(l)(A) through (I) of Section 13. 

o Although the activities described above relate to market making in ETF shares, the 

existing exemption in subsection (d) (1) (B) for market making-related activities is too 

narrow because of its requirement that such activities be • designed not to exceed the 

reasonably expected near term demands of clients, customers, or counterparties." 

• These activities relating to ETF shares do nOt create the risks that the Volcker Rule was 

intended to address. 

• The proposed change would provide certainty to the ETF marketplace that banking entities 

can continue to act as APs and engage in market making-related activity with respect to ETF 

shares. Other ways to achieve this objective include: 

o Revising the definition of "proprietary trading" in Section 13(h)(4) to exclude trading 

in ETF shares and underlying securities held by an ETF (or other instruments 

reasonably intended to provide substantially similar economic exposure) 

20 A primary concern fur the SEC in its efforts to establish a regulatory framework fur ETFs was to ensure that the process 

fur this rype of trading could function effectivdy. See Part N.B of SEC Rde ... No. IC-25258 (November 17. 200 1). ETF 

exemptive orders contain conditions specifically designed to provide fur a sufficiently robust. but controlled. arbitragt 

process. See, e.g.. In the Matter ofPacmc Investment Management Company LLC. et al. SEC Rde ... Nos. IC-28949 

(October 20. 2009 (notice» and IC-28993 (November 10. 2009 ( order»: and In the Marter ofCl'¥IDore Excbange-Traded 

Fund Trust 3 et aI SEC Rde ... Nos. IC-29256 (April 23. 2010 (notice)) and IC-29271 (May 18, 2010 (order». 

5 
157 


79694.112

Revised as of December 12, 2012 

o Directing the agencies charged with implementation of the V olcker Rule to ensure that 

the activities permitted under the market making exemption in Section B( d)(l) (B) 

include the activities described herein. 

III. Amendment to &Panel the Government ObUgations Exemption 

Revise Section B( d)( 1 )(A) of the Bank Holding 'Company Act ofl956 as fullows: 

(A) The purchase, sale, acquisition, or disposition of obligations of the United States or any 

agency thereof, obligations, participations, or other instruments of or issued by the 

Government National Mortgage Association, the Federal National Mortgage Association, the 

Federal Home Loan Mortgage Corporation, a Federal Home Loan Bank, the Federal 

Agricultural Mortgage Corporation, or a Farm Credit System institution chartered under and 

subject to the provisions of the Farm Credit Act of 1971 (12 U.S.c. 2001 et seq.), and 

obligations of-, State or of an, politieal stthdhision thereof municipal securities as defined 

in section 3(a)(29) of the Securities Excha~ Act of 1934. 

EXPLANATION: 

• The Section 619 exemption fur trading in certain government obligations does not extend to 

transactions in obligations of an agency or instrumentality of any State or political subdivision. The 

exemption should be expanded to include these securities, which would be consistent with the 

current definition of municipal securities under the Securities Exchange Act of 1934. 

• Obligations issued by state agencies and instrumentalities represent one of the more conservative 

asset classes in the capital markets, and are estimated to account for almost half of the securities 

currently outstapding in the municipal securities market. 

• Banking entities currently playa significant role in underwriting and facilitating a secondary market 

for municipal securities of agencies and instrumentalities. Failure to include such trading as a 

permitted activity would impair the ability of many local government entities to raise capital, with 

significant adverse consequences fur the finances of these entities. 

IV. Amendment to Clarify the Swpe of the Permitted Activity Exemptions Involving 

Transactions and Activities Occurring Solely Outside the United States 

Add the fullowing paragraph as new subsection (i) of Section 13 of the Bank Holding Company Act of 

1956: 

6 
158 


79694.113

Revised as of December 12, 2012 

(0 For MWoSSS of4etsrminingwhich transactions and activities are considered' to be "permitted 

WOOd,s" within the meaning ofsubssgion Cd) or otherwise outdd, tbS §C9pe gfebe prohibitions in 

tbis Section any transNioQ or astiyity that takes place in accordance with Regulation Sunder tbe 

Securities Act of 1933. and igtergretations thereunder. shall be deemed to haye ocgtrrqi "solelyoutside 

the United States" In addition the term "resident pfthe United States" shall mean a·U 5, person" as 

defined jn Regulation Sunder tbe Securities Act of] 933, and inteQu'mtions thereunder 

EXPLANATION: 

• Congress expressly limited the extraterritorial application of the Volcker Rule through two 

"permitted activity" exemptions: (1) an exemption fur trading conducted by a non-U.S. 

banking entity solely outside the U.S. (known as the foreign trading exemption), and (2) an 

exemption for investment fund activities by a non-U.S. banking entity solely outside the U.S. 

(known as the foreign fund exemption). 

• For more than 20 years, Regulation S under the Securities Act of 1933 has been the global 

standard fur delineating the U.S. and non-U.S. securities markets. Regulation S governs 

whether a securities offering takes place outside of the U.S. and therefore is not subject to U.S. 

registration requirements. Market participants around the world, including U.S. registered 

investment companies, have built their compliance systems and processes based on 

Regulation S. 

• There is no indication that Congress intended to create a new or different standard for 

delineating U.S. and offshore securities activities fOr purposes of the Volcker Rule. 

UnfOrtunately, the pending proposal to implement the Volcker Rule would depart from the 

existing Regulation S standard, by narrowly defining the transactions that would be considered 

to take place outside the United States. Such an approach could have negative consequences fur 

U.S. registered funds and their shareholders. 

• For example, many U.S. registered funds with foreign subadvisers invest in securities, such as 

sovereign debt securities denominated in fureign currency, fur which the primary and most 

liquid market is outside of the United States. These transactions often involve non-U.S. 

banking entities as counterparties. If the Volcker Rule is interpreted too narrowly, some nonU.S. banking entities may avoid engaging in transactions with persons acting on behalf of U.S. 

registered funds. As a result, U.S. registered funds' access to non-U.S. counterparties could 

decrease significantly, and liquidity in some markets could be reduced. 

• Including an express statement in the statute that the foreign activity exemptions (and the 

Volcker Rule generally) should operate consistent with Regulation S and interpretations 

thereunder would avoid these highly undesirable results. 

7 
159 


79694.114

Revised as of December 12,2012 

V. Amendments to Clarify that the Volck;er Rule Does Not Extend to Asset-Backed 

Commercial Paper or Tender Qption Bond Proif'U!ls 

A. Amendment to Section 13(h)(2) of the Bank Holding Act of 1956, which deGnes the 

terms "hedge fund" and "private equity fund": 

Add the following language at the end of the paragraph: 

In no eyent shall tbe terms "hedge fund" or "private equity fund" (including anY similar fUnd as 

deSignated by rule) mean 

fA) an issuer that is a SpeCial PuQ?OSe Entity as defined in Rule 23-7 under the InYestment 

Company Act 0(1949 (17 CFR 2ZQ'2a-Z(al(3»), the assets or boldin~ ofwbicb are 

substantially comprised ofOualifYing Assets as defined in Rule 23 7 (17 eFR 27O.2a 

Zla)(3))· or 

CB) an issuer that is a trust, the assets or holdin~ of Wish are substantially comprised of 

municipal securities as that term is defined in Section 3(a')(29) of IDs Securities Exchange Act 

~ 

B. Amendment to Section 13(h)(1) of the Bank Holding Company Act ofl956, which 

deGnes the term "banking entity": 

Add the following language at the end of the paragraph: 

In no eyent shall the term "banking entity" mean 

(A) an issuer that is a Special Purpose Entity as defined in Rule 2a 7 under the Inyestment 

Company Act ofl940 (I? CFR 27o.2a-Z(al(3)), the assets or holding§ ofwhich are 

substantially comprised ofOualiMogAsset§ as defined in Rule 2a 7 (17 CFR 270 2a 

Z(i)(3)): or 

(B) an issuer that is a trnst the assets or holdings ofwbicb are substantially comprised of 

municinal securities as that term is defined in Section 3(a)(29) gEtbe Serurities Exchange Act 

cl..l2.34. 

EXPLANATION: 

• The Volcker Rule prohibits a "banking entity" from engaging in proprietary trading and from 

having an ownership interest in or sponsoring a "hedge fund" or a "private equity fund." The 

definition of "hedge fund" and ·private equity fund" includes an issuer that would be an 

investment company, as defined in the Investment Company Act ofl940, but for Section 3(c)(1) 

8 
160 


79694.115

Revised as of December 12,2012 

or 3(c)(7) of that Act. The definition of "banking entity" includes an affiliate or subsidiaty of a 

banking entity. 

• In enacting the Volcker Rule, Congress specifically sought to avoid interfeting with longstanding, 

traditional banking activities. Without further clarification, however, the Volcker Rule would 

impair two types of securitization activities that are part of traditional banking activities-notes 

issued by asset-backed commercial paper (" ABCP") programs and securities issued pursuant to 

municipal tender option bond ("TOB") programs. 

• Application of the Volcker Rule to ABCP and TOB programs would have significant negative 

implications for issuers of these financing vehicles and their investors, many of which are U.S. 

registered funds. The provision of credit to companies to finance receivables through ABCP, as 

well as to issuers of municipal securities to finance their activities through TOBs, are both areas of 

traditional banking activity that should be distinguished from the types of financial activities that 

Congress sought to restrict under the Volcker Rule. Without liquid ABCP and TOB markets, 

credit funding for corporations and municipalities would be unduly and unnecessarily constrained. 

• Although application of the Volcker Rule to these programs clearly was not intended by Congress, 

clarification is needed because ABCP and TOB issuers typically rely on Section 3( c)( 1) or Section 

3( c)(7) of the Investment Company Act. As a result, they would be captured by the definition of 

"hedge fund" or "private equity fund," despite the fact that they have none of the characteristics of 

a hedge fund or private equity fund. Similarly, an ABCP or TOB program would fall within the 

definition of "banking entity" ifit were considered an affiliate of a banking entity (e.g., because the 

banking entity is acting as sponsor of that ABCP or TOB program). To address these concerns, 

ABCP and TOB programs should be expressly excluded from the definition of "hedge fund" and 

"private equity fund" and from the definition of "banking entity." 

* 

The specilk recommendations outlined above address only a fraction of the vety significant concerns 

about the Volcker Rule that have been voiced by many stakeholders and that should be considered as 

part of any effort to develop a less burdensome alternative. As part of any such alternative, the 

Committee should include a conformance period of sufficient length that would begin to run upon 

adoption of final implementing rules by the various regulatoty agencies. It is imperative that banking 

entities and other market participants be given adequate time to understand the new regulatoty 

requirements and to adjust their business models and practices accordingly. Structuting the 

conformance period in this way would allow an orderly transition and minimize market disruptions. 

9 
161 


79694.116

Too big to fail looks on its way to being licked I Considered View I Breakingviews Page 1 of 1 

BREAKINGVIEWS 

Agenda-settirl9 flnandat insight 

Thursday, 13 December 2012 

Licking TBTF 

Too big to fail looks on its way to 

being licked 

12 December 2012 I By Rob Cox 

Has the too big to fail problem been licked? The Bank of England and 

Federal Deposit Insurance Corp sound pretty confiden1, declaring this 

week they're nearly in a position to resolve a systemic failure without 

inflicting losses on taxpayers. Ifs hard to know without a test case. But 

the signal from capital markets suggests watchdogs may be on to 

something. 

Though the wider public may still think big swinging bankers will get bailed 

out in a crisis, investors in U.S. bank debt are taking no chances. In fact, 

the nation's biggest financial institutions are paying more to fund their loan 

books on a relative basis in the credit default swaps market than are 

similarly rated industrial companies. More importantly, ~ costs them more 

than their smaller rivals. 

The top six U.S. banks and brokers, those with balance sheets larger than 

$750 billion, recenUy paid an average premium on their unsecured fiveyear debt of about 129 basis points above the risk-free rate, according to 

Credit Suisse's LiquidUS Corporate Index. Furthermore, the biggest 

banks paid more than the average of 15 regional and trust banks also 

analysed by Credit Suisse. Funding for these smaller institutions cost 12 

basis points less in the markets. 

The implication is that despite their size and that some of these banks 

were rescued in the 2008 panic, investors consider holding their debt a 

riskier proposition. That bolsters claims by regulators that new rules giving 

them the authority to shutler failing banks are sinking in. 

True, the bank deposit market may reflect lingering doubts. FDIC data 

show that since the crisis, banks with over $10 billion of assets pay less to 

depositors than smaller ones. In the second quarter, they paid 20 basis 

points less. This could be down to more extensive branch and A TM 

networks, higher marketing spending and a greater anay of products than 

any conscious decision by customers to keep savings in the vaults of 

institutions perceived as infallible. 

Until a major, failing bank is wound down by a govemment at the expense 

of bondholders as well as shareholders the verdict will be undecided on 

the fate of too big 10 fail. Ifs encouraging, however, to see inveslors finally 

recognising the possibility. 

Context News 

The Bank of England and the 

U.S. Federal Deposit Insurance 

Corp said in a joint paper 

released on Dec. 10 that .each 

country's plans for dealing with 

the types of cataclysmic 

financial failures that marked 

the 2007-2009 financial crisis 

would reduce risks to financial 

stability. 

"The FDIC and the Bank of 

England have developed 

resolution strategies that take 

control of the failed company at 

the top of the group, impose 

losses on shareholders and 

unsecured creditors - not on 

taxpayers - and remove top 

management and hold them 

accountable for their action: 

they said in the paper. 

The new authorities to seize 

and resolve so-called global 

systemically important financial 

institutions came in the United 

Stales from the 2010 DoddFrank financial refonn law, and 

in Britain from the anticipated 

approval by early 2013 of the 

European Union Recovery and 

Resolution Directive. 

http://www.breakingviews.com!too-big-to-fail-!00ks-on-its-way-to-being-lickedl2105839... 1211312012 
162 


79694.117

fACLI 

Financial Security .. Jor Life. 

American Council of Life Insurers (ACLI) Statement for the Record 

House Financial Services Committee 

Hearing entitled "Examining the Impact of the Volcker Rule on Markets, Businesses, 

Investors and Job Creation, Part II" 

December 13, 2012 

The American Council of Life Insurers (ACLI) is pleased to submit this statement for the hearing 

record expressing the concerns of the life insurance industry about the implementation of Section 

619 of the Dodd-Frank Act (DFA), commonly referred to as the Volcker Rule. ACLI strongly supports 

the business of insurance exclusion to the Volcker Rule that was explicitly authorized by Congress in 

the Dodd-Frank Act and believes it should not be diminished or undermined by rulemaking in any 

way. 

The American Council of Life Insurers is a Washington, D.C.-based trade association with more than 

300 legal reserve life insurer and fraternal benefit society member companies operating in the 

United States. ACLI advocates in federal, state and international forums. Its members 

represent more than 90 percent of the assets and premiums of the U. S. life insurance and annuity 

industry. In addition to life insurance, annuities and other workplace and individual retirement plans, 

ACLI members offer long-term care and disability income insurance, and reinsurance. Its public 

website can be accessed at www.acli.com. 

Insurer Investments Support Guarantees Made to Families, Savers, and Retirees 

Life insurers' financial products protect millions of individuals, families, retirees, and businesses 

through guaranteed lifetime income, life insurance, long-term care and disability income insurance. 

These products provide Americans with financial security through various stages of life and enable 

them to plan for their financial future, including retirement. Unlike nearly all other financial 

institutions, life insurers' obligations to policyholders are generally long-term, often extending for 

decades. In order to meet their obligations to policyholders, life insurers must acquire assets that 

match their liabilities. Accordingly, they are major institutional investors that provide a significant 

source of funding for issuers and liquidity for the financial markets in general. 

Insurance companies collect premiums from customers in return for a promise to pay benefits to 

those customers at some future point. During the time between the collection of premiums and the 

payout of benefits, the insurer takes ownership of those premium dollars and invests them in 

conservative yet sophisticated ways in order to ensure that sufficient funds exist in the future to pay 

benefits when they come due. Although insurance companies are most certainly not 'proprietary 

trading institutions', their fundamental business model requires them to invest the company's own 

money in order to ensure a healthy portfolio for paying customer benefits and prudently running the 

company. In addition, as is expected and desired from sophisticated investors, insurers regularly use 
163 


79694.118

2 

risk-mitigating hedging strategies to protect investment portfolios against interest rate risks, equity 

risks, credit risks and foreign exchange risks so that market movements do not endanger the health 

of the company or the company's ability to fulfill its promises to its policyholders. 

The Financial Stability Oversight Council, in its 2011 study on the Volcker Rule, recognized the 

unique nature of insurance company investment activity, stating, "The investment activity of 

[insurance] companies is central to the overall insurance business model and could be unduly 

disrupted if certain provisions of the Volcker Rule applied: 

Insurance Company Investments are Highly Regulated 

Insurance company investment activities are subject to rigorous oversight and examination by state 

insurance regulators. State regulators have comprehensive regulatory and reporting regimes for 

examining an insurer's investment activities and guarding against excessive risk in their investment 

portfolios. 

State insurance laws are specifically designed to promote the safe and sound operation of insurance 

companies inter alia by establishing limits and diversification requirements and by fostering 

investments in longer·term instruments that more appropriately correspond to the long-term liability 

structure of insurance companies. These laws directly impact prudent product design and help 

reduce the risk presented by the unique nature of insurance operations. 

State insurance laws and regulations address many other aspects of the business of insurance, 

including, importantly, financial matters such as standards of solvency, statutory reserves, 

reinsurance and capital adequacy. Each insurance company is required to file reports, generally 

including detailed annual financial statements, with state insurance regulators in each of the 

jurisdictions in which it does business, and its operations and accounts are subject to periodic 

examination by such authorities. Each insurance company is subject to risk-based capital 

requirements, and reports its risk-based capital based on a formula calculated by applying factors to 

various asset, premium and statutory reserve items, as well as taking into account the risk 

characteristics of the insurance company. The formula is used as an early warning regulatory tool to 

identity possible inadequately capitalized insurance companies for purposes of initiating regulatory 

action. Insurance laws provide state insurance regulators the authority to require various actions by, 

or take various actions against, insurance companies whose risk-based capital ratio does not meet 

or exceed certain levels. 

The Financial Stability Oversight Council, in its 2011 study on the Volcker Rule, recognized the 

existing constraints placed on insurer investments and the quality of supervision of these activities 

by state agencies, stating the following: 

• "Insurance company investment is subject to relevant state investment laws which, while n01 

uniform, are substantially similar and generally conform to standards set out in model laws 

and regulations developed by the National Association of Insurance Commissioners ("NAIC·). 

State investment laws aim at limiting the amount and type of investments insurers can make 

in order to limit their investment and counterparty risk exposure. For example, among other 

limitations, investment laws limit the amount of investment an insurer can make in equities, 

low-grade securities, or in the securities of anyone issuer: 
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3 

• "State insurance company investment laws and regulations govern the type of investment, 

and extent of such investments, an insurance company can include as "admitted" assets on 

their balance sheet for the purpose of determining whether the insurance company has the 

ability to discharge its obligations and meet capital and surplus requirements. Insurance 

companies can make otherwise prohibited investments, but such investments are not 

considered admitted assets and still have to be reported to state insurance regulators." 

• "State agencies monitor insurer investments, through reporting. valuation, and examination, 

to ensure that such investments are in compliance with state insurance investment laws, 

regulations, and guidance, and, even when insurers are otherwise in compliance to ensure 

that such investments do not threaten the solvency of the insurer." 

Congress Established the BusIness of Insurance Exclusion in DFA 

In recognition of the unique insurance business model and the existing investment safeguards 

enforced by state insurance supervisors, Congress expressly authorized a business of insurance 

exclusion to the Volcker Rule in the Dodd-Frank Act. Congress recognized the need to "appropriately 

accommodate the business of insurance within an insurance company, subject to regulation in 

accordance with the relevant insurance company investment laws: The specific reference to 

insurance company investment laws makes it clear that the accommodation required under the 

Volcker Rule relates both to the proprietary trading restrictions and the private equity and hedge 

fund investment restrictions. 

The Final Rule Must Follow Congressional Intent and Accommodate the Business of 

Insurance 

The business of insurance exclusion established by Congress applies to all insurance company 

investment activity. Rulemaking which prohibits an insurance company from engaging in any 

investment activity that is allowed under applicable insurance law would be inconsistent with the 

principle of accommodating the business of insurance. Therefore, the proposed rules should be 

revised and clarified to accommodate insurance investment activities. 

In addition to the above, life insurers are also concerned that the Volcker Rule could impair market 

making, liquidity and depth in the securities markets. If the proposed regulations impede an 

insurance company's ability to manage its fixed income portfolio and to enter into and manage 

hedging transactions, the direct and indirect costs of reduced liquidity could ultimately cause higher 

premiums for customers or reduced product options and features. To ensure the efficient operation 

of securities markets and prevent increases in transaction costs, the final rute should implement the 

market making exception in a less restrictive manner that would not constrain liquidity. 

Thank you for convening this important hearing and for your consideration of the views of ACLI and 

its member companies. 
165 


79694.120

BBVA Compass 

December 12. 2012 

The Honorable Spencer Bachus 

Chairman. Financial Services Committee 

US. House of Representatives 

2129 Rayburn House Office Building 

Washington. DC 20515 

Dear Chairman Bachus. 

Lawrence R Uhlick 

Chairman of the Board 

15 20th Street South, Suite 1902 

Birmingham, At 35233 

tany,uhliCk@bbvacompass.com 

We appreciate the oversight you and your colleagues on the House Financial Services Committee are 

conducting around the regulatory implementation of the Volcker Rule. In addition to this week·s hearing on 

this topiC. we applaud your efforts to encourage thoughtful improvements and coordinated finalization of the 

proposed rule by the federal financial regulators. including a two-year implementation period once the rule is 

finalized as expressed in your letter to those regulators on November 29th• 

We continue to believe that Congress and the federal financial regulators should seek to minimize the 

tremendous regulatory burden that the current Volcker Rule proposal would impose on the banking industry. 

The rule as proposed would have negative consequences on our ability to serve our customers. as well as on 

financial markets and economic growth. 

In our September 7" letter to you. we submitted a brief discussion of some of our major concerns with the 

proposed Volcker Rule and our recommendations for alternative approaches. As indicated in our letter. we 

believe the Volcker Rule as proposed would impose enormous burdens on regional banks. such as BBVA 

Compass. when our trading activities. or lack of certain trading activities. pose no risk to the Us. financial 

system. There would also be significant negative consequences from the extraterritorial reach of the rule 

which is contrary to the longstanding practice of deference to home country regulation. We have enclosed 

our September letter today and respectfully request that you considering including it in the record of the 

Commlttee's December 13th hearing. 

As always. please let me or Josh Denney know whenever we can be of aSSistance. 

With best regards. 

Lawrence R. Uhlick 

Chairman 

cc: The Honorable Barney Frank. Ranking Member. House Financial Services Committee 

Enclosure (1) 

BBVA Compass is a trade name of Compass Bank, a member of the 8BVA Group. Compass Bank Member FDIC 
166 


79694.121

• Compass 

The Honorable Spencer Bachus 

Chairman 

Committee on Financial Services 

U.S. House of Representatives 

September 7, 2012 

2129 Rayburn House Office Building 

Washington, DC 20515 

Dear Chairman Bachus: 

15 South 20th Street 

Birmingham, AL 35233 

BBVA Compass Bancshares, Inc. ("BBV A Compass") very much appreciates 

your request for input on how to formulate a less burdensome alternative to Section 13 of 

the Bank Holding Company Act of 1956, commonly known as the Volcker Rule. Wc 

strongly support and encourage over time a thorough exploration of possible legislative 

reforms and alternatives to the current statutory language. 

With the benefit of further Congressional input regarding the federal financial 

regulators' proposal to implement the Volcker Rule, we strongly urge that the final 

regulations address the many concerns that have been publicly expressed to both the 

agencies and Congress. We believe that Congress and the federal financial regulators 

should seek to minimize the tremendous regulatory burden that the current proposal 

would impose on the banking industry which would have negative consequences on our 

ability to serve our customers, as well as on financial markets and economic growth. 

We have set forth below a brief discussion of some of our major concerns with 

the proposed Volcker Rule and our recommendations for alternative approaches. 

Executive Summary 

• BBVA Compass supports regulation and reasonable monitoring of trading 

activities that bear a higher level of risk to a bank or banking system. We are 

concerned, however, that the proposal for implementation of the Volcker Rule 

would create costly and burdensome obligations on entities whose trading 

activities, or lack of trading activities, pose no risk to the U.S. financial system. 

Instead, community and regional banks like ours that do not engage in propriety 

trading should be able to simply certify to our regulators that we are not engaged 

in prohibited activities. 

• Additionally, the dollar threshold triggering the need for an extensive and 

prescriptive compliance program should be raised from $1 billion to at least $10 
167 


79694.122

billion in average trading assets and liabilities. This change would still require an 

extensive compliance program of the companies that control more than 97 percent 

of the total trading assets and trading liabilities in ail U.S. banking organizations. 

• Dodd-Frank's plain language exemption from the Volcker Rule for activities 

conducted outside the U.S. should not be interpreted to prohibit other connections 

to the United States, such as using an American exchange or transacting with an 

American counterparty. If the regulators' narrow interpretation of the exemptions 

for non-U.S. activities is left unchanged in fmal regulations, the result will be 

reduced liquidity in U.S. markets and securities and migration of trading activities 

to other jurisdictions, all of which will result in job losses in the U.S. 

• It appears that foreign banking entities engaged in activities entirely outside of the 

U.S. could still be subject to Volcker Rule compliance requirements. This would 

be contrary to the longstanding practice of deference to home country supervision 

and prudential regulation. Foreign entities engaged in proprietary trading and 

covered funds activities outside the U.S. should not be required either to refrain 

from those activities or institute the types of compliance programs and reporting 

systems required by the proposed regulations. 

• The proposed Volcker Rule permits trading of U.S. government securities but 

does not permit similar trading in non-U.S. sovereign securities. The final rule 

should allow trading in all government securities. Other supervisory authorities 

provide more appropriate and flexible ways for regulators to address any concerns 

regarding bank exposure to non-U.S. sovereign debt. 

Discussion ofVolcker Rule Alternatives 

I. Compliance Program Requirements 

The Volcker Rule generally prohibits banking entities, including foreign banking 

entities, from engaging in proprietary trading or sponsoring, acquiring or retaining an 

interest in covered hedge and private equity funds. BBVA Compass does not engage in 

proprietary trading nor does it sponsor or retain an interest in covered hedge and private 

equity funds. The same is true for our banking subsidiary, Compass Bank. Compass 

Bank is a regional bank that operates more than 700 branches in Alabama, Arizona, 

California, Colorado, Florida, New Mexico and Texas. Compass Bank ranks among the 

top 20 largest U.S. commercial banks based on deposit market share. 

BBV A Compass does not oppose sensible regulation of activities that pose risk to 

financial institutions, such as reasonable monitoring and risk control standards. 

However, BBVA Compass does have significant concerns about the excessive cost and 

complexity of complying with the proposed implementing regulations because BBV A 

Compass and its affiliates would expend significant resources to implement compliance 

plans that provide no meaningful benefits to customers, taxpayers or the U.S. financial 

system. Committing such resources would detract from our ability to serve customers. 

Resources used to prove that BBV A Compass or Compass Bank is not engaged in 

2 
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79694.123

proprietary trading or prohibited fund activities would be better deployed to lending and 

serving customers in general. 

A. Scope of Compliance Programs for Entities Not Engaged in Prohibited Trading 

The Volcker Rule was intended to prohibit proprietary trading and acquiring or 

holding interests in hedge funds or private equity funds. Nevertheless, the proposed 

implementing regulations would create elaborate and highly costly compliance 

obligations for banking entities that are not engaged in proprietary trading or covered 

fund activities. 

The proposed implementing regulations create a varied approach to implementing 

compliance with the regulations based on the level of proprietary trading activity of 

covered entities. First tier entities would be those not engaged in either proprietary 

trading or ownership/sponsorship of covered funds. Banking entities in the first 

compliance tier would be required to create and maintain a preventive compliance 

program. Essentially, a banking entity that is engaged in no proprietary trading would 

have to have both a program to prevent it from commencing prohibited activity and a 

compliance plan to cover it if it began to engage in prohibited activity. So, effectively, an 

entity in the first tier would likely be expected to adopt a compliance program similar to 

that of an entity engaged in prohibited trading. This is just one example of the overly 

burdensome approaches in the proposed implementing regulations. 

BBVA Compass sees little or no value in adoption of burdensome and costly 

compliance policies designed merely to prove a bank is not engaged in proprietary 

trading and then to develop comprehensive policies and procedures in case the bank later 

engages in such activities. 

Recommendation: Instead of requiring a costly new and burdensome compliance 

program, BBVA Compass advocates an approach whereby banks not engaged in 

proprietary trading or covered fond activity certifY to their regulators that they are not 

engaged in activities prohibited by the Volcker Rule. Certification would be subject to 

the existing supervisory and enforcement process. 

B. Compliance For Entities Engaged in Proprietary Trading 

Under the agencies' proposed implementing regulations entities engaged in any 

level of permitted proprietary trading will be required to adopt a mandated compliance 

program but the obligations under the compliance program vary with the level of trading. 

As proposed, banking entities engaged in limited proprietary trading (defined 

generally as trading assets and liabilities of less than $1 billion or less than 10% of total 

assets), would be in the second tier of compliance obligations. Banking entities in tier 

two would be required to have a compliance program that includes: written policies and 

procedures designed to document, describe and monitor trading activities; a system of 

internal controls designed to monitor and identify areas of noncompliance and to prevent 

occurrence of prohibited activities or investments; an appropriate management 

framework to create accountability for Volcker Rule compliance; independent testing of 

3 
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79694.124

the compliance program; training; and recordkeeping. Third tier entities, those engage in 

significant covered trading and covered fund activities (generally, covered trading or 

covered fund activity of $1 billion or more), would be required to comply with even more 

burdensome requirements. I 

Recommendation: The compliance program and reporting requirements for tier 

three are extensive and highly prescriptive. Given what BBVA Compass believes to be 

marginal benefit of the proposed compliance program and reporting requirements. along 

with what will likely be significant costs of implementing them. we think the requirements 

for entities engaged in limited proprietary trading should be streamlined Streamlining 

could be done without undermining the Volcker Rule. For example. if the tiered 

approach to compliance is retained, we recommend that the threshold for a tier three 

entity be raised to at least $10 billion. This would still cover U.S. banking organizations 

that control more than 97% of the total average trading assets and liabilities of all u.s. 

banking organizations. 

II. Economic and International Implications 

BBV A Compass is owned by BBV A, a financial services group headquartered in 

Spain with approximately $740 billion in total assets, 47 million clients, 7,400 branches 

and approximately 107,000 employees in more than 30 countries. As a wholly-owned 

subsidiary ofBBV A. BBVA Compass can offer a unique perspective on the international 

implications of the Volcker Rule and we have significant concerns about the international 

implications of the Volcker Rule and its proposed implementing regulations. 

A. Negative Economic Impact on the U.S. 

We are concerned that the Volcker Rule's requirements relating to foreign 

banking organizations, as they are currently interpreted by the federal financial 

regulators, will have a negative impact on the U.S. economy without offsetting benefits to 

safety and soundness of U.S. banks. Our specific concern is that the standing ofthe U.S. 

as a financial services center, with a vast infrastructure that facilitates international 

transactions of all types, may be harmed by the unduly narrow interpretation by the 

federal financial regulators of the Volcker Rule provision addressing trading outside the 

U.S. by foreign banking organizations. 

I A third tier entity would be one that: 

(i) engages in proprietary trading and has. together with its affiliates and subsidiaries, trading assets and 

liabilities the average gross sum of which (on a worldwide consolidated basis), as measured as of the last 

day of each of the four prior calendar quarters: (A) is equal to or greater than $1 billion; or (B) equals 10 

percent or more of its total assets; 

(ii) invests in, or has relationships with, a covered fund and: (A) the covered banking entity has. together 

with its affiliates and subsidiaries, aggregate investments in one or more covered funds, the average value 

of which is, as measured as of the last day of each of the four prior calendar quarters, equal to or greater 

than $1 billion; or (B) sponsors or advises, together with its affiliates and subsidiaries. one or more covered 

funds, the average total assets of which are, as measured as of the last day of each of the four prior calendar 

quarters. equal to or greater than $1 billion; or 

(iii) is determined to be tier 3 base on regulator discretion. 

4 
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79694.125

The Volcker Rule was intended to protect U.S. banks and the U.S. economy. 

Consequently, the Volcker Rule permits foreign banking entities to engage in proprietary 

trading and covered funds activity solely outside the U.S. The apparent intent ofthe 

provisions allowing otherwise prohibited activity "solely outside" of the U.S. was to limit 

activities of an entity as principal. The provisions do not refer to the location of 

counterparties or exchanges. Accordingly, the Volcker Rule should only be interpreted to 

prevent trading activity if the principal is in the U.S. Nevertheless, the federal financial 

regulators have interpreted the Volcker Rule to prohibit foreign banks from conducting 

transactions with nearly any U.S. connection thereby preventing transactions with a U.S. 

counterparty or involving a U.S. exchange. We are concerned that the unduly narrow 

interpretation proposed by the federal financial regulators would shift trading from U.s. 

infrastructure to infrastructure of other financial service centers without increasing the 

safety and soundness of U.S. banks or otherwise benefitting the U.S. financial system. 

As a consequence, U.S. exchanges and U.S. customers would lose out as transactions 

shift to other financial service centers. We are also concerned that such a reduction in 

U.S. activity could also result in U.S. job losses and access to capital. 

Recommendation: BBVA Compass does not believe that the Volcker Rule was 

intended to prohibit foreign banking organizations from using U.S. exchanges or 

engaging in transactions with U.s. counter parties. 

B. Extraterritorial Compliance Obligations 

As noted above, the proposed implementing regulations mandate detailed and 

prescriptive compliance requirements for banking entities engaged in permitted trading 

activities. Although the proposed implementing rules are not clear on this point, it 

appears that foreign banking entities engaged in such activities entirely outside of the 

U.S. would be subject to the compliance requirements. The proposed implementing 

regulations appear to propose that foreign banking organizations' proprietary or covered 

fund-related actions qualify as solely outside the U.S. and that such entities adhere to 

other subjective limitations as well as the compliance obligations discussed previously. 

We do not believe, and do not think Congress intended, that U.S. regulatory agencies 

should have authority to subject foreign banking entities operating pursuant to the laws of 

their home countries to requirements or supervision of U.S. regulators. To do so would be 

inconsistent with existing regulatory practice of deference to home country supervision 

and prudential regulation. 

Recommendation: Federal finanCial regulators should not impose compliance program 

and reporting requirements outside of the u.s. To do so would impose heavy burdens on 

entities and activities already subject to the regulatory purview of other countries' 

regulators without providing any meaningfol benefits to U.S. taxpayers or the U.S. 

financial system. The U.S. regulators' goals can be achieved by working more closely 

with foreign institutions' home country regulators by requesting information that will 

help the U.S. regulators monitor systemic risk while leaving regulators of foreign 

institutions to oversee banking activities in their country. 

5 
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79694.126

C. Non-U.S. Sovereign Securities 

Notwithstanding the general prohibition on proprietary trading, the Volcker Rule 

also pennits purchase, sale, acquisition or disposition of U.S. government securities but 

does not pennit similar trading in non-U.S. sovereign securities. Trading in securities 

issued by foreign governmental entities is crucial to non-U.S. economies. Many U.S. and 

non-U.S. banks playa role in the purchase and sale of such government debt, and the 

market-making and other exemptions in the Volcker Rule may not be broad enough to 

ensure necessary levels of Iiquidity for non-U.S. government securities. This adverse 

impact on liquidity would increase financing costs for virtually every country but the 

U.S. Reducing liquidity in such markets or limiting the trading capabilities on such 

bonds seems likely to increase, rather than decrease, systemic risk. 

Finally, we note that any concerns about bank exposure to non-U.S. sovereign 

securities can best be addressed by revising rules dealing with the regulation of bank 

capital. 

Recommendation: BBVA Compass advocates the creation of an exemption for 

non-US. government securities comparable to Us. government securities. 

* * * 

As always, Mr. Chainnan, we appreciate your leadership and stand ready to assist 

you and the Cornmittee as you address the VoIcker Rule and other important issues 

before you. Please contact either of the undersigned or Josh Denney in our Washington 

office (202-730-0952) if we can be of further assistance. 

Manolo Sanchez 

President and CEO 

BBVA U.S. Country Manager 

Very Truly Yours, 

6 

~ 

-. . ..Lb.:/ /' /A' ~ 

Lawrence R. Uhlick 

Chainnan of the Board 
172 


79694.127

BD\Bond . Dealers of 

Amenca 

21 Dupont Circle, NW. Suite 750 

Washington, DC 20036 

202.204.7900 

www.bdamerica.org 

Statement of Michael Nicholas 

Chief Executive Officer 

Bond Dealers of America 

Submitted for the Record Before the 

Committee on Financial Services 

United States House of Representatives 

Hearing Entitled, "Examining the Impact of the 

Volcker Rule on Markets, Business, Investors and 

Job Creation, Part II" 

2128 Rayburn House Office Building 

Thursday, December 13, 2012 
173 


79694.128

On behalf of the Bond Dealers of America ("BOA"), thank you for the opportunity to 

submittestimony for this hearing to examine the impact of the Volcker Rule on 

market participants. BOA represents middle market and regional banks and 

securities dealers focused on the US fixed income markets. 

The BOA would like to underscore that the Volcker Rule implementation, if not 

carefully crafted, could harm liquidity in the fixed income markets. This testimony 

sets forth recommended solutions to avoid this outcome. Any final Volcker rule 

must permit bank-affiliated broker-dealers to continue their essential role of 

facilitating fixed income trading for their customers. If the Volcker Rule does not 

appropriately consider the uniqueness of fixed income markets and principal 

trading. costs to issuers financing critical public infrastructure will increase; and 

retail investors seeking low-risk investments will be harmed. Equally urgent and 

more fundamentally, the rule must exempt municipal revenue bonds in addition to 

governmental bonds. Finally, the Rule should clarify the underwriting activities 

exception and Tender Option Bond Trusts should be excluded from the definition of 

a covered fund. 

The Volcker Rule Should Include An Exception for Principal Trading 

The Volcker proposal exempts market making activities, but only if the "trading 

desk or other organizational unit that conducts the purchase or sale holds itself out 

as being willing to buy and sell ... the covered financial position for its own account 

on a regular or continuous basis" (emphasis added). This exemption is too narrow 

and precludes the ability of bank-affiliated broker-dealers in the fixed income 

markets to facilitate trading among its customers. In order to support customer 

trading. a bank-affiliated broker-dealer must be permitted under the Rule to 

purchase a position for his or her own account until the broker is able to sell that 

position so that issuers have the assurance of a ready market for their bonds. A 

bank-affiliated broker-dealer cannot meet the test in the current proposal that 

requires it to hold itself out as continuously or regularly supporting specific 

positions; rather, the broker-dealer acts as a steady presence in the fixed-income 

markets to facilitate the customer trading by bridging buyers and sellers of bonds. 

Moreover, dealers support the markets by purchasing from other dealers, 

cooperating with each other to provide liquidity to the markets as a whole. If the 

market-maker exemption is too narrow and these activities are treated as 

proprietary trading. then an essential source of liqUidity will be eliminated from the 

fixed-income markets, harming both issuers and investors. 

The cure is to broaden the market-maker exemption to recognize the critical 

practice of "principal trading." in which bank-affiliated broker-dealers serve the role 

of facilitating trades for their customers. Because fixed income securities trade less 

frequently than eqUity securities, there may not be a buyer for a particular fixed 

income security at the precise pOint in time when a seller wants to sell it. Further, 

buyers tend not to target one specific security but will instead opt to purchase from 

a selection of bonds with characteristics meeting their investment objectives. 

2 
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79694.129

Therefore, the only way the fixed income markets work properly to match buyers 

and sellers is if broker-dealers are willing to purchase a bond into inventory with a 

view to re-sell that bond later to another customer. 

Such principal trading is substantially different from the risk taking of proprietary 

trading. Since the purpose of principal trading is to facilitate customer trades, banks 

are incentivized to limit the risks of principal trading and, therefore, to institute 

policies and procedures that mitigate potential risks. At the same time, principal 

trading adds enormous value to ordinary investors by providing them a place to sell 

their bonds. This provides the liquidity and stability that makes the markets 

function. 

BOA's recommendation is that the final Volcker Rule include in the market making 

exemption an additional exception that includes the purchases and sales of a 

"principal trading desk." A "principal trading desk" should be defined as having the 

purpose of facilitating trading among the bank's customers and clients. A safe 

harbor should be included in the definition based upon the presence of sales 

representatives in the desk's transactions. Essentially, BOA proposes that the Rule 

use the percentage of transactions a trading desk effects through sales 

representatives to determine when a trading desk clearly is -- and clearly is not -- a 

principal trading desk. 

This approach would provide a method to prove that a bank's trading desk exists for 

the purpose of facilitating trading among customers that provides certainty to banks 

and regulators alike. Sales representatives trade with the customers and clients of 

the bank. Their presence largely implies the substantial involvement of the trading 

desk with customers. Sales representatives eliminate the incentive for banks to 

maintain "proprietary books" because trades involving sales representatives require 

the trading desk to pay a commission. Further, the involvement of sales 

representatives is easily provable since the trade tickets need to record the 

involvement of the sales representative in order to properly credit the sales 

representative for sales commissions. 

Based on this certainty, BOA believes that the Agencies could create a safe harbor 

under which a trading desk would be deemed to be a principal trading desk if it 

effects more than 50% of its transactions through sales representatives. Conversely, 

the Agencies could deem a trading desk to "not be" a principal trading desk if it 

effects less than 25% of its transactions through sales representatives. While a 

principal trading operation with no "proprietary book" should ordinarily not 

experience trading activity with other broker-dealers that exceeds a majority of its 

trading activity, practices do vary. BOA recommends retaining the ability of a bank 

to establish that its principal trading desk is customer facing even if less than 50% 

(but more than 25%) of trades are through sales representatives, if other evidence 

can be produced to prove the customer-facing nature of the principal trading 

operations. 

3 
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79694.130

Providing more certainty to regulators, a trading desk (except for hedging 

transactions) could be required to make any covered financial position available for 

purchase to sales representatives through an electronic trading system if it is 

available to registered broker-dealers for purchase through an electronic trading 

system. The essence of a "proprietary book" is that its sales and trading inventory 

are not available for purchase by sales representatives. By making these covered 

financial positions available to both registered broker-dealers and sales 

representatives alike, it renders difficult any effort to maintain a "proprietary book" 

that effectively navigates the quantitative categories above. 

These suggestions, if incorporated, would provide regulators and fixed-income 

dealers more of the certainty they need so that issuers and investors are not 

damaged by the issuance of a Volcker Rule that destroys the important role of 

principal trading within the fixed-income markets. 

Municipal Securities Should Be Appropriately Pefined and Exempted 

The Volcker Rule, as currently proposed, recognizes that municipal securities are 

not the root cause of systemic risk and aims to exempt them from the prohibition on 

proprietary trading. The proposal, however, fails to exempt all state and local 

government securities - namely, those issued by agencies and authorities such as 

turnpike authorities and water and sewer districts. These issuances of municipal 

revenue bonds represent about 60% of the municipal securities market. They are 

indistinguishable from the 40% of municipal securities exempted from the proposed 

rule in that they do not present any more credit or systemic risk. The arbitrary 

distinction subjecting 60% of municipal securities to the Rule would interfere with 

the ability of broker-dealers to bridge gaps between buyers and sellers, immediately 

removing liquidity from the market that is necessary to keep issuance costs low and 

valuations stable. As the Securities and Exchange Commission ("SEC") and other 

agencies finalize the Volcker Rule, BPA urges the Agencies to exempt.all state and 

local government securities from the proprietary trading prohibitions. 

The Underwriting Activities Exception Should Be Clarified 

While underwriting activities are exempt from the Volcker Rule, more clarity is 

needed around this proposed exception. Regional bond dealers can serve as 

underwriters for municipal issuers in which the dealer purchases the bond from the 

issuer in order to distribute and sell the bonds to investors. In the fixed-income 

markets, underwriters frequently underwrite bonds knowing that at the sale of the 

bonds, they may need to temporarily retain unsold allotments within their 

inventories -- particularly since liquidity in the fixed income markets is not as deep 

as other markets. The Rule should clarify that just because bonds temporarily 

remain within a bank-affiliated broker-dealer's inventory, this does not change the 

regulator's perception that the purchase or sale was performed in connection with a 

view to distribute the securities. 

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79694.131

Tender Qption Bond Trusts Should Be Excluded from the Definition of a Covered 

EYru1 

As now drafted, the proposed Volcker Rule would treat tender option bond trusts 

(''TQB Trusts") as "covered funds," the same as hedge funds and private equity 

funds, thereby prohibiting banks from using them as investments. TQB Trusts, 

however, should be excluded from the definition of a covered fund because they 

usually hold municipal securities. They operate as a more efficient way for state and 

local governments to access the capital markets and for banks to participate in the 

issuance and financing of tax-exempt bonds. Banks frequently sponsor TQB Trusts, 

may own residual and other ownership rights in TQB Trusts, and may provide credit 

and liquidity enhancements that support securities issued by TQB Trusts. If banks 

were required to divest their holdings in TQB Trusts, this could lead to a massive 

sell-off of municipal securities holdings that could destabilize the municipal 

securities markets. 

The remedy is for the covered fund rules to borrow some of the principles of the 

proprietary trading rules of the proposed Volcker Rule. That is, if an asset is 

considered safe enough for a bank to purchase that asset directly under the 

proprietary trading rules, such as is the case with municipal securities, then there is 

no reason to prohibit a bank from creating a fund or trust to hold that asset 

indirectly. 

Thank you for the opportunity to present our views on the proposed V olcker Rule. 

The Volcker Rule as proposed must be modified to better accommodate the nature 

of fixed income markets. Developing a definition of and exception around principal 

trading is a critical component of these modifications. BDA stands ready to assist 

the Committee as you continue your important review ofthe Rule. 

5 
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79694.132

nle INSTITUTE OF INTERNATIONAL BANKERS 

Sarah A. Miller 

Chief Executive Officer 

E-mail: smiller@iib.org 

The Honorable Spencer Bachus 

Chairman 

Committee on Financial Services 

U.S. House of Representatives 

2129 Raybum House Office Building 

Washington, D.C. 20515 

Dear Chairman Bachus: 

299 Park Avenue, 17th Floor 

New York, N.Y. 10171 

Direct: (646) 213-1147 

Facsimile: (212) 421-1119 

Main: (212) 421-1611 

www.iib.org 

December 12, 2012 

We appreciate the Committee's continuing focus on Section 619 of the Dodd Frank Wall 

Street Reform and Consumer Protection Act ("Dodd Frank"), commonly known as the "Volcker 

Rule." In connection with tomorrow's hearing "Examining the Impact of the Volcker Rule on 

Markets, Businesses, Investors and Job Creation, Part II," the Institute of International Bankers 

("lID") would like to reiterate our views on this important topic. As we have previously testified 

before the Committee, the lID supports the goals of financial reform - namely, increased 

transparency; stronger capital and liquidity standards; and reduced risk to financial stability and 

to the taxpayer. At the same time, we have significant concerns regarding the negative effects on 

the U.S. and global economy if the Volcker Rule is implemented as currently proposed. 

The lID represents internationally headquartered financial institutions from over 35 

countries around the world doing business in the United States. The lID's members consist 

principally of international banks that operate branches and agencies, bank subsidiaries and 

broker-dealer subsidiaries in the United States. In the aggregate, our members' U.S. banking 

operations have more than $5 trillion in assets and provide 25% of all commercial and industrial 

bank loans made in this country and contribute to the depth and liquidity of U.S. financial 

markets. Our members also contribute more than $50 billion each year to the economies of 

major cities across the country in the form of employee compensation, contributions to local and 

national charities, tax payments to local, state and federal authorities, and other operating and 

capital expenditures. 

At the outset, it must be recognized that, as with U.S. banks, the U.S. operations of 

international banks are subject to the same statutory limitations set forth in the Volcker Rule. 

Notwithstanding this fact, properly limiting its application outside of the United States is of key 

importance, and it is these issues to which we address our attention in this letter. Specifically, 

we have focused our comments on the cross border issues and potential extraterritorial effects 

The Institute's mission is to help resolve the many special legislative, regulatory 

and tax issues confronting Internationally headquartered financial institutions 

that engage In banking, securities and/or insurance activities In the United States. 
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nle INSTITUTE OF INTERNATIONAL BANKERS 

raised by the VoIcker Rule that are of particular concern to internationally headquartered banks 

with u.s. banking operations ("international banks"), as well as to foreign governments and 

financial regulators. 

Any consideration of the extraterritorial scope of the Volcker Rule must be guided by the 

fundamental policy underlying the Volcker Rule: the protection of U.S. banks, U.S. financial 

stability and U.S. taxpayer funds from what Congress deems to be inappropriate risks. Simply 

put, there is no justification for the VoIcker Rule to limit transactions by international banks that 

do not put u.s. financial stability, the safety and soundness of U.S. banks or u.s. taxpayer 

dollars at risk. Inappropriately imposing U.S. limitations outside the United States would have 

significant adverse and unintended consequences for international banks, as well as the U.S. 

economy and U.S. investors. The flow of capital from foreign investors to U.S. companies 

would be restricted, and liquidity in U.S. markets would be reduced, without any corresponding 

benefit to U.S. financial stability, U.S. taxpayers or the safety and soundness of U.S. banks. 

While, as noted above, the U.S. operations of international banks are subject to the 

Volcker Rule to the same degree as U.S.-headquartered banks, Congress has already properly 

sought to limit the extra-territorial impact of the Volcker Rule by providing exemptions for 

certain activities conducted "solely outside of the United States" (the "SOTUS" exemptions). By 

providing this exemption, Congress recognized that if it were to do otherwise and regulate the 

trading practices of international banks and their non-U.S. affiliates, it would create unwarranted 

conflicts with foreign regulation and needlessly divert scarce U.S. regulatory resources to matters 

that do not implicate U.S. financial stability, the safety and soundness of U.S. banks or U.S. 

taxpayers. 

The proposed rules layer on additional limitations that make the exemptions too narrow, 

cutting off trade with U.S. investors and on U.S. exchanges without any corresponding benefit 

for U.S. financial stability. For example, under the proposed rules, a trade between a German 

bank in Frankfurt and a UK bank in London would apparently not qualify for the SOTUS 

exemptions if it were executed on a U.S. exchange. Similarly, a trade between a French bank 

and a U.S. manufacturing firm over a European trading platform would apparently subject the 

French bank to the full panoply of regulations under the proposed rules by virtue of having 

traded as principal with a single U.S. person. 

Similarly, while the Volcker Rule quite appropriately recognizes that U.S. publiclytraded mutual funds should not be subject to the Volcker Rule's funds prohibition, no similar 

recognition is given to comparable foreign investment companies, including funds that engage in 

public offerings outside of the u.S. For example, regulated investment funds in Canada could 

not be offered or sold by Canadian banks to Canadian residents while traveling on business or 

pleasure in the U.S. 

If the proposed rules' restrictions on permissible non-U.S. trading and funds activities are 

retained, they will reduce liquidity in U.S. markets and securities, contribute to the migration of 

trading and fund activities to other financial centers outside of the United States and spur the 

2 
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nle INSTITUTE OF INTERNATIONAL BANKERS 

development of alternative trading platforms outside of the United States, all of which are likely 

to cause job losses in the United States. This loss of jobs would come without any offsetting 

reduction in the risk to U.S. financial markets, U.S. taxpayers or the safety and soundness ofU.S. 

banks. 

Trading in non-U.S. government securities also should benefit from the same exemption 

from the proprietary trading prohibition as U.S. government securities. Liquidity in sovereign 

debt markets is vital to the functioning of national economies around the world. In light of the 

unique importance of trading in goveroment securities, both to sovereigns and to the treasury 

activities of banks in the jurisdictions where they operate, all government securities should be 

excluded from the Volcker Rule. Providing an exemption only for U.S. government securities 

would also be inconsistent with U.S. treaty obligations and principles of national treatment. 

Other regulatory frameworks (such as capital regulation) and supervisory authority 

provide more appropriate and flexible mechanisms for addressing any concerns regarding bank 

exposure to sovereign debt. The Vo1cker Rule is simply too blunt an instrument to address the 

many policy considerations and unique features of trading in government securities. 

In addition to the foregoing, in order to give those entities impacted by the Volcker Rule 

sufficient time to come into compliance with its requirements, it is imperative that the affected 

institutions be provided a two-year time period commencing with the issuance of final 

regulations. 

Thank you for considering our views. 

Sincerely, 

~ru.~Q.~' 

Sarah A. Miller 

Chief Executive Officer 

cc: The Honorable Bamey Frank 

3 
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99.9 Percent of Banks Would Be Unaffected by Volcker Rule 
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Acknowledgments 

This report was written by Bartlett Naylor, Financial Policy Advocate for Pubfic Citizen's 

Congress Watch division, and edited by Taylor Lincoln, Research Director for Congress 

Watch. . 

About Public Citizen 

Public Citizen is a national non-profit organization with more than 300,000 members and 

supporters. We represent consumer interests through lobbying. litigation, administrative 

advocacy, research, and public education on a broad range of issues including consumer 

rights in the marketplace, product safety, financial regulation, worker safety, safe' and 

affordable health care, campaign finance reform and government ethics, fair trade, climate 

change, and corporate and government accountability. 

PUBLICCITIZEN 

Public Citizen's Congress Watch 

215 Pennsylvania Ave. S.E 

Washington, D.C. 20003 

P: 202-546-4996 

F: 202-547-7392 

http://www.citizen.org 

© 2012 Public Citizen 
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For Congressman Brad Miller of North Carolina 

Whose service to America as a brilliant, loyal protector of 

average citizens in the U.S. House of Representatives will be 

missed 

June 2012 3 
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Contents 

I. INTRODUCTION: THE RIDE OF THE VOLCKER RULE, CAN BANKS UVE WITH IT? ..................... 5 

II. THE RISE OF CASINO BANKING ............................................................................................ 6 

III. THREE CASE STUDIES: SAFE AT ANY SIZE ............................................................................ 8 

IT's A WONDERFUL liFE; GENERATIONS BANK ....................................................................................... 8 

SWEET SPOT OF EFFICIENCY; M & T BANK .......................................................................................... 11 

WELLS FARGO: OLD SCHOOL BANKING ............................................................................................... 12 

IV. CONCLUSION: CLOSING THE CASINO ............................................................................... 16 

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I. Introduction: The Ride of the Volcker Rule 

Can Banks Live with It? 

There are 7,181 federally insured banks in the United States.1 After a new rule is 

implemented to prohibit banks from making risky trades, the business activities of 

7,175 of these banks will remain essentially unchanged. 

The Volcker Rule, among the most controversial aspects of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act, will prohibit federally insured banks from engaging 

in proprietary trading, which involves speculation through short-term trades in stocks, 

derivatives and other securities.2 

The financial crash, borne of reckless banking practices, cost the economy about $12 

trillion, give or take.3 But Wall Street lobbyists have succeeded in elevating concerns over 

the relatively minuscule costs of the Volcker Rule to a paramount position in the debate 

over how regulations should be crafted to implement it In reality, the Volcker Rule will 

mean no change, no closure of business divisions, no costs from foregone financial activity, 

for more than 99.9 percent of banks. 

What follows is an examination of how American banks will adapt to the Volcker Rule. We 

review three banks-one small, one medium-sized, and one giant-as case studies. This 

report examines the details of these banks' revenue and earnings, how the Volcker rule 

might alter them, and how the managers of some of the banks evaluate the effect that the 

rule will have on them. 

The nation's banking regulators are entering the last stages of finalizing the Volcker Rule 

this month, long after the July 21, 2012, deadline for completion imposed by Congress in 

Dodd-Frank. In all, 21 individuals nominated by the president and confirmed by the U.S. 

Senate (serving at the Federal Reserve, Federal Deposit Insurance Corp., Office of the 

Comptroller of the Currency, Commodity Futures Trading Commission, or Securities and 

Exchange Commission) must agree to the precise language of this rule. While the regulators 

undoubtedly understand the impact of the financial criSiS, they will inevitably consider the 

effects on the industry they regulate. These regulators have conducted 4,000 meetings with 

1 FDIC, Statistics at a Glance (Sept) 12, 2012), available at: 

http://wwwfdjc.goy/banklstatistical/statsI2012sejl/jndustry pdf These institutions include commercial 

banks as well as federally Insured savings and loan institutions. It does not include the 6.888 federally 

insured credit unions; none of these institutions engage in Volcker Rule-prohibited activity. 

2 The Volcker Rule is the informal name for Section 619 of the Dodd-Frank Wall Street Reform and Consumer 

Protection Act Federal officials at present are finalizing the rules. or regulations. to implement Section 619. 

3 See, e.g ... Cost o[the Crisis. BEITER MARKETS (Fall 2012), available at: httP; .. www.bettermarkets.com/costcrisis# UMYEZdSUrl4 

June 2012 5 
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outsiders, the overwhelming majority of which have been Wall Street" representatives.4 But 

these regulators must understand that the banking industry will thrive with a robust 

Volcker Rule. 

II. The Rise of Casino Banking 

The lure of astronomical profits from proprietary trading prompted a select group of large 

banks to deviate from sensible risk management practices. This sober account from the 

Group of 30, a non-profit international group consisting of private sector and academic 

leaders on financial issues,s recalls how the industry succumbed to a gambling ethos: 

Recent experience in the United States and elsewhere has demonstrated instances in which 

unanticipated and unsustainably large losses in proprietary trading, heavy exposure to 

structured credit products and credit default swaps, and sponsorship of hedge funds have 

placed at risk the viability of the entire enterprise ... These activities, and the "originate-todistribute" modeJ, which facilitated selling and reselling highly engineered packages of 

consolidated loans, are for the most part of relatively recent origin. In essence, these 

activities all step away from the general concept of relationship banking, resting on 

individual customer service, toward a more impersonal capital markets transaction-oriented 

financial system. What is at issue is the extent to which these approaches can sensibly be 

combined in a single institution, and particularly in those highly protected banking 

institutions at the core of the financial system.6 

Concerns over the activities outlined above prompted Congress to institute the Volcker 

Rule-informally named after Group of 30 member and former Federal Reserve Chairman 

Paul Volcker-to prohibit federally insured banks from engaging in proprietary trading or 

owning hedge funds of more than de minimis size. Opponents and proponents alike 

commonly observe that this provision promises the greatest change in American banking 

since the enactment in 1933 of the Glass-Steagall Act, which separated of commercial and 

investment banking. 

In prinCiple, the Volcker Rule aims to protect banking's core function of aggregating savings 

so that savings can be deployed in loans to consumers, homebuyers, and businesses. 

Federal deposit insurance protects the savers, which encourages them to accept lower 

returns (in this case, in the form of interest rates) than they would expect for higher-risk 

investments. Banks, in turn, are expected to pass on savings from their reduced cost of 

• Davis-Polk, Dodd-Frank Progress Report (November 2012), available at: 

htt\l:/lwww davispolk.com/files/Publication 19a99Ode9-911b-4e6b-b183-

OSb071d8b008/Presentation/PublicationAttachment/8363256a-524d-4<!65-8ebe096127dab2a3/Noy2012 Dodd.Frai1k.Proeress Re,vortpdf. 

S See Group of 30 Web site, available at: btt\l'/lwww group30 or~fabout.shtml. 

'Financial Reform, 0 Framework/or Financial Stability, Group o/Thirty Oan. 15,2009), available 

at: http'flwww,gToup30 org/images/PDFlFinancial Retorm-A Framework for Financial StabUitv pdf. 

June 2012 6 
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capital to their borrowers. The benefits that accrue from reduced costs of capital justify 

expectations that the banks abstain from high-risk activities. 

The Independent Community Bankers of America (lCBA), consisting of more than 5,000 

member banks,? articulated this view in a comment letter it submitted to federal regulators 

on the proposed regulations to implement the VoIcker Rule: "Banks are accorded access to 

federal deposit insurance and liquidity facilities because they serve a public purpose: 

facilitating economic growth by intermediating between savers and borrowers, i.e., taking 

deposits and making loans, and by maintaining liquidity in the economy throughout the 

economic cycle. These activities constitute the fundamental business of banking."8 

By its nature, a proprietary trade is a bet-a gamble. For every winner, there is a loser. A 

bank's gain from a proprietary trade results in a corresponding loss for the counterparty. 

No factories are financed, homes mortgaged, or cars purchased as a result of gambles won 

or lost by banks engaged in proprietary trading. 

Gambling can generate profits for institutions. Last decade, traders and bank managers 

pocketed mind-boggling sums in exchange for presiding over successful betting strategies. 

But when the traders' bets turned sour, wiping out the earlier gains and forcing their 

institutions to accept massive taxpayer-financed bailouts, the bankers retained the 

fortunes they had reaped in the previous years. Protecting the ability of bank executives 

and traders to command such bounties is a key reason that certain Wall Street leaders have 

intensely contested the VoIcker Rule. The debate over the Volcker Rule has arguably been 

the subject of more lobbying expenditures, regulatory meetings, congressional meetings, 

formally commissioned studies, and media coverage than any other regulation called for in 

Dodd-Frank. 

Public Citizen documented the scope of industry's obsession of the Volcker Rule earlier this 

year.9 Wall Street interests contributed $67 million to the campaigns of members of 

Congress who asked regulators to weaken the proposed regulations to implement the 

Volcker Rule. By contrast, members of Congress who pressed for a stronger regulations 

received a collective $1.9 million from Wall Street donors. However, a crucial fact is: More 

than 99.9 percent of banks' circumstances won't change because of the Volcker Rule. This 

rule is important to prevent a fraction of 1 percent of banks from putting our financial 

system-and, ultimately, our economy-at risk. 

71CBA Web Site, About Us, available at: httP'lIwwwicba omlaboutICBAljndex.cfm'ltemNumber-52Z. 

"ICBA comment letter on the Volcker Rule (Feb. 13,2012), available at: 

httn;//www federalreserve gov ISECRSI2012/MarchI20120305/R-1432/R1432 021312 104966 451638070183 1 pdf. 

9 NEGAH MOUZOON AND BARTLETINAYLOR, PUBLIC CITIZSN, Industry's Messengers (March 2012), available at: 

http·//www cjtizen,org/documents/industrvs-messengers-volcker-rule-report,pdf. 

June 2012 7 
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There are 7,181 banks in the United States. Of these, six account for 88 percent of all 

proprietary trading affected by the Volcker Rule.10 Four banks account for 93 percent of 

total derivatives holdings, a major venue in proprietary trading.ll "Proprietary trading in 

any real volume is c()nfined to a very few large, sophisticated U.S. banks: Volcker wrote in 

a letter to federal regulators.12 The nation's 6,888 credit unions are legally barred from 

using derivatives.13 In other words, of the 14,069 institutions that the average consumer 

would consider a "bank: the Volcker Rule means business as usual for 14,063 of them. 

It should be noted that banks do maintain investment accounts consisting oreasily sellable 

securities, and will be able to continue doing so after the Volcker Rule takes effect "Trading 

accounts: which may include U.S. Treasuries, corporate stocks and other securities, help 

banks meet unexpected cash demands, such as an unusual surge in withdrawals. Managers 

of trading accounts typical invest in conservative securities and retain their investments 

for a longer time than do proprietary traders. Under the Volcker Rule, trading accounts 

may not be a playground for short-term speculation. 

III. Three Case Studies: Safe at any Size 

The banking industry is composed of firms of various sizes, ranging from banks with only a 

single store front, to mid-sized regional firms, to a handful of mega-banks. How will the 

Volcker Rule apply, based on bank size? Examined here are three case studies: A smaller 

bank, Generations Bank of Seneca Falls, N.Y.; a mid-size bank, M&T Bancorp, of Buffalo, 

N.Y.; and a mega-bank, Wells Fargo Bancorp, headquartered in San Francisco. 

It's a wonderful Life: Generations Bank 

In the heartland of America, largely served by community bankers, the type of activity 

targeted by the Volcker Rule is unknown. 

One of the 7,181 American banks that will not be unaffected by the Volcker Rule is 

Generations Bank, of Seneca Falls, N.Y. 

10 GOVERNMENT ACCOUNTABILITY OFFICE, Proprietary Trading Ouly 2011), available at: 

iml':/1www gao goy/assets/3301321006 pdf. 

11 U.S. Comptroller of the Currency, acC's Quarterly Report on Bank Trading and Derivatives Activities Second 

Quarter 2012, available at: htl;p· IIwww.occ.gov/\:Qpjcs/capital-marketsltinandalmarkets/tradjnt:/derjvatjyes{dQ212 pdf. 

12 Paul Volcker, letter to regulators (Feb. 13, 2012), available at: iml':/Iwww.sec.goylcommentsls7-41-

111s74111-182 pdf. 

13 GOVERNMENT ACCOUNTABILITY OFFICE, Proprietary Trading, at 64 Oidy 2011), available at: 

http://www.gao.gov/assets/330/321006.pdf. The credit union industry is lobbying to remove restrictions on 

derivative use. For example, here is a letter from the Credit Union National Assodation from April 3, 2012: 

http://www.ncua goy/LegaI/CommentLetters/CL20120403DunnDerivatives,pdf. 

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"It's a Wonderful Life," Frank Capra's iconic Hollywood film about the travails of a small 

town banker, is set in mythical "Bedford Falls." Seneca Falls claims to be Frank Capra's 

inspiration. This real "Bedford Falls" features a museum dedicated to the film, and an 

annual "It's a Wonderful Life" festival. The Clarence Hotel was named in honor of the angel 

Clarence who talks banker George Bailey off the bridge of despair by reviewing the virtues 

of traditional banking. This year, the actress who played the daughter of the beleaguered 

banker joined the December festival,14 

Generations Bank, headquartered in Seneca Falls, founded in 1870, fits the description of 

George Bailey's bank to a tee: Folks in the community deposit their savings ($193 million) 

in one of the bank's nine branches, and then the bank loans out this money in mortgages to 

home buyers, in loans to car buyers, and credit to small business ($190 million).15 

The bank has reported rising net income: $476,000 in 2009, $1.1 million in 2010, and $1.3 

million in 2011. Through nine months of 2012, the bank reported $1.2 million in income.16 

Generations Bank has transformed, at least in name, over the 14 decades since its founding 

in 1870 as Seneca Falls Savings Bank17 Before the financial crash of 2008, the institution 

was called Seneca-Cayuga Bancorp. With the acquisition of other banks, the firm adopted 

Generations Bank as its umbrella name. CEO Menzo Case is the bank's largest single 

shareholder. IS 

The Volcker Rule will result in no substantial change of operations for Generations Bank. 

none of the bank's 85 employees are derivatives traders. None engage in market making or 

risky gambles. Generations Bank does hold some securities, in addition to its loans. In 

2009, for example, the bank held $1.7 million worth of securities, and earned a total of 

$1,000 from trades involving them.19 Because of the minimal nature of its trading, 

Generations will not be subject to reporting requirements of the Volcker rule will require of 

larger banks. 

B Web site for Seneca Falls town festival. Available at: http'lIwwwthereaJbedfordfalls comt. 

15 Generations Bank, Third quarter report, 2012. Available at: 

https://www.mygenbankcom/files/financial filings/Quarterly reportsf2012 3.pdf. 

10ld. 

17 Generations Bank, Annual Report, 2009, available at: 

https://www.rnygenbank.com(files/financial filings/annual reportsf2009 annual reportpdf. 

18 Generations Bank, Annual Report, 2010, available at: 

https·//www.mygenbankcom/files/finanCial filings/annual repO!1S/2010 annual reportodf. 

,. This was the last year the company reported its trading activity; it deregistered as a public company after 

that 

June 2012 9 
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Public Citizen Business As Usual 

ban ks perform based on 

enjoyed by larger b<Jnks. 

to manage. Is there 

2. Speech by Gov. Daniel TarulJo at Brookings Institution, Industry Structure and Systemic Risk Regulation 

(Dec. 4, ZOlZ), available at http·llwwwietieralreseryegoylnewseyentS/speech/!arulloZ0121Z04ahtm. 

21 Simon Johnson, Why Are the Big BanksSudden/y Afraid, THE NEW YORK TIMES (Aug. 30, 2012), available at: 

htt;p'lIeconomjx blo!:s nytjmes comI201ZI08/30/why-are=t:he-bj!:-banks-sudden)y-afraidl Identifying the 

sweet spot for efficiency and economies of scale has been compromised by vast changes In banking law. First, 

banks were allowed to branch across state lines only in the last three decades. Second, their powers were 

expanded, ultimately allOwing the kinds of activity that the Vo1cker Rule will prohibit Finally, major financial 

catastrophes cloud conclusions. Risky trading may have figured in the Z008 crash, but that led to problems at 

less culpable banks in the form of cascading housing prices and mortgage values. 

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"We have an [asset liability management] committee that reviews our position monthly, 

which includes consideration of whether we should purchase additional securities," Case 

explained. "If securities are to be purchased, either myself or the CFO will make the 

purchase."22 Generations devotes one employee to compliance. 

"Our Company has a history of conservative risk management-we don't 'reach' for yield. 

by entering into areas that we do not understand or for which the risk is not understood," 

Case wrote to shareholders.23 "I have yet to find an NY community bank that is actively 

trading securities. It's just not the way we operate," he wrote in e-mail to Public Citizen.24 

Sweet Spot of Efficiency: M & T Bank 

Will larger banks find··their business undermined by the Volcker Rule? An examination of 

M&T Bank, the nation's 31st largest with $77 billion in assets,25 shows that the Volcker 

Rule will cause no change to the bank's operations. M&T Bank believes it will continue to 

thrive. Its effiCiency ratio in the first quarter of 2011 ranked 83rd of the nation 6,900 bank 

holding companies on the American Banker list26 

"Based on the proposed rules, M&T does not currently anticipate that the Volcker Rule will 

have a material effect on the operations of M&T and its subsidiaries," the bank informed 

shareholdersP 

Founded in 1856 in western New York, the Buffalo-headquartered bank maintains 750 

branches in eight states and the District of Columbia. 

M&T employs 15,666 people, up from 13,869 in 2007 before the financial crash. M&T has 

grown by making acquisitions. Its largest acquisition, coincidentally, followed a proprietary 

trading fiasco at Allied Irish Bank's Baltimore-based division.28 Since the financial crash of 

2008, M&T has purchased Provident Bank of Baltimore, the failed Bradford Bank (seized by 

22 Menzo Case, CEO, Generations Bank, e-mail response to Public Citizen questions (Nov. 16,2012). On file 

with author. 

Z3 Generations Bank, Annual Report, 2010, available at: 

https'Uwwwmygenbankcom/files/finandal filings/annua! WlOrtsl2010 annual reoortpdf. 

2' Menzo Case, CEO, Generations Bank, e-mail response to Public Citizen questions (Nov. 16,2012). On file 

with author 

25 Banks and Thrifts with the Most Assets, AMERICAN BANKER (Second quarter 2012). 

26 Most Efficient Banks, AMERICAN BANKER (First quarter 2011). 

21 M&T Bank, Annual Report, 2011, available at: 

http·/Ifiles.shareholder com /downloads/MTB 12107851 053xOx546897/SCS92DAO-SA87 -4F46-8AF6-

8639E1 B8963612011 Annual Re])ortpdf. 

28 See Conor O'dery, PANIC AT THE BANK (2002). 

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Public Citizen Business As Usual 

the FDIC), Wilmington Trust, and Hudson City Bancorp. Berkshire Hathaway is its largest 

shareholder, owning 5.6 percent of its stock.29 

M&T has reported a profit in every quarter since 1970. Net income increased from $380 

million in 2009 to $736 mIllion in 2010, and $859 million in 2011.30 

M&T reported $27 million in trading account gains in 2011, in line with gains of $17million 

to $30 million from 2007 to 2010.31 Its trading profits represented 3 percent of its net 

income in 2011.32 

M&T did report a "gain on bank investment securitiesR of $150 million in 2011 that was not 

pursuant to its trading account. The bank explained that this stemmed from an agreement 

to boost its capital following its acquisition of Wilmington Trust. It booked the gain by 

selling slightly riskier securities, and then purchasing less risky securities. Capital, or the 

amount of investor funds in the bank, is measured against the relative risk of its assets. 

These assets include loans and securities. By holding less risky securities, its capital 

measure is considered stronger. 33 

The fact that M&T derives only 0.6 percent of its total income from trading reflects a 

conscious decision by the bank's leadership. CEO Robert Wilmers reported to shareholders: 

"Banks have traditionally played a clear, if limited, role in the economy: to gather savings 

and to finance industry and commerce. Trading and speculation were nowhere incJudednor should they be. "34 

Of his larger peers that engage in proprietary trading, Wilmers expresses little sympathy. 

"The Wall Street banks continue to fight against regulation that would limit their capacity 

to trade for their own accounts-while enjoying the backing of deposit insurance-and 

thus seek to keep in place a system which puts taxpayers at high risk.R35 

Wells Fargo: Old School Banking 

While the Volcker Rule essentially applies to only the largest banks with dedicated staff 

handling its trading account, mega-banks can remain large and profitable under the 

forthcoming restrictions on proprietary trading and hedge fund ownership. Wells Fargo 

proves this. 

2. M&T Bank, Annual Report, 2011, available at: 

btW'/lfiles sbareholder.com /downloads {MTB 12107851053xOx546897{SCS92DAO-SAB7 -4f46-8AF6-

8639E1B8963E{2011 Annual RellQrtlldf. 

30Id. 

3'Id. 

3l[d. 

33Id. 

3·ld. 

3sld. 

June 2012 12 
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Public Citizen Business As Usual 

Of the nation's 7,394 commercial banks, four institutions stand out in size: JP Morgan 

Chase, Bank of America, Citicorp, and Wells Fargo. Each of these banks holds roughly $1 

. trillion in deposits, ranging from $906 billion at Wells Fargo to $1.1 trillion at JP Morgan. 36 

Together, they account for nearly half of the nation's $9 trillion in total deposits.37 (The fifth 

largest depository is U.S. Bancorp, which holds $233 billion in deposits, about a fifth of the 

next largest.38) In the basic intermediation of savers and borrowers, these large four banks 

control about half of all deposits. How they deploy these dollars shapes the economy. Even 

a small diversion into proprietary trading of depositor savings is the equivalent to a 

wholesale decision by Generations, M&T, and hundreds of other like-sized banks to allocate 

all of their deposits to proprietary trading. 

--------------~--~~~~~~~~--~~~--

Government RePort Says ProMf~t~rv Tl'adirtgils Not a wi'riHel- fQ~ fJigBanks 

con~ress required the Go~ernm~ntA~~~~ntabilit~Off;~eto stu~.Vntbe· rOle~r!li~?rietary. tr~aillgat the largest banks.lnJuIY2011itl}eI~AO condud~~thateven:attheslx l1'l~jotbanks, 

proprietary trading idld. not generate ~oh~i.~~ell~ profits .. !·qle research~~s.examineQ~!he 13. 

quarters .. from 2006 to 2010;be!Qre,durirlg);~a~d. after thf,!!fjrancial~ash. \iVhiletMfirms. 

colle:ctillely posted', occasional . Winllin&s;ihey:.~!s~.suffertd substantiali;to5~~S,' Proprietary' 

trading .. resulted "in an?veralllossfr,Q~such~cti~ltj:e~ overthe~.s.yearperio~ or about $221 

million,"the governmentresearch~rs!CQncllld~d.~9 ::k:j' ... . . . . 

Citicorp and Bank of America received considerable taxpayer bailouts. Meanwhile, 

government leaders such as former FDIC chair Sheila Bair and even President Obama have 

called for the closure of one or both of these institutions. 

Citigroup does not object to the Volcker Rule. For example, in Citigroup's relatively brief 

10-page comment letter on the proposed rule to federal regulators, the firm states: "We 

stand firmly behind the Volcker Rule's core principles of re-focusing trading businesses on 

the needs of customers and markets, while reducing potential risk to financial institutions 

and our financial system."40 No representatives of Citigroup or Bank of America have 

testified in any of the congressional hearings on the Volcker Rule in the 112th Congress. In 

3. Research by SNL Advisers, available at: http://wwwsnI.comlInteractiveXfArtjcle aspx?cdid=A-1503173Sill.ll2. 

37 Federal Reserve statistics (Nov 7, 2012). Available at: 

http·lIwwwfederalreserve.goy/re\eases/hS/current/. 

3. Research by SNLAdvisers, available at: http'lIwwwsnlcomlInteractiyeX!ArticieaSDx?cdid-A-15031738-

ill.ll2. 

39 GOVERNMENT ACCOUNTABllJTY OFFICE, PROPRIETARY TRADING Ouly 2011), available at: 

http://www.gaogoy!assets/330/321006.pdf. 

4<l Letter from Brian Leach. chief risk officer, Citigroup (Feb. 13, 2012), available at: 

http·/lwww.federalreserve goy/SECRS/2012/MarchI20120307/R-1432/R1432 021312 104979 542079506624 1.pdf. 

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fact, former Citi Chairman John Reed counts as one of the Volcker Rule's earliest and most 

outspoken supporters. 41 

JP Morgan's opposition to the Volcker Rule is well known. The firm's proprietary trading 

became infamous in the spring of 2012 when it revealed a $5 billion to $7 billion loss from 

self-described "egregious' trades in London. 

And Wells Fargo? 

The name Wells Fargo derives from the 18505 entrepreneurs who profited from the traffic 

generated by the California gold rush. The bank itself served as a side business to the 

freight enterprise. Today's Wells Fargo is more accurately understood as Norwest Bank. a 

Minnesota branch-bank network, which bought the more familiar San Francisco-based 

·Wells Fargo in 1998.42 Norwest senior management has served in the top positions of Wells 

Fargo since the merger. 

Of the largest four American banks, Wells Fargo's business is decidedly old school. 

Summarized a New York Times columnist, "It focuses on plain-vanilla lending like 

mortgages, credit cards and corporate loans, and ... emerged relatively unscathed from the 

financial crisis."43 Wells Fargo boasts a high rating for its own debt. 44 

Will the Volcker Rule undermine this San Francisco-based giant's prospects? Proprietary 

trading generated the firm $2 million in profits in the third quarter of 2012, and $16 

million over the first nine months of the year.4S The $2 million in income represented 0.04 

percent of the Wells' $4.94 billion in net income. 46 Proprietary trading accounted for a $9 

million loss in the third quarter of 2011, and an $18 million loss for the first nine months of 

2011. Proprietary trading. concluded Wells Fargo CEO John Stumpf, is "almost zero for 

US:'47 

., Letter from John Reed to federal regulators (Feb. 13,2012), available at: 

htto;/fwww federa!reserve gov /SHCRS12012lMarch 120120301/R·1432/R· 

1432 021312 105359329612421677 1 pdf. 

42 Wells Fargo annual report, 2000, available at; http·/fsec.goylArchives/edgarldata/729Zl/0000912057· 

00·012168 txt 43 Peter Havis, Banks Tread a Fine Line in Trading, THE NEW YORK TIMBS (May 13,2012), available at; 

http·//dealbook.nvtimes.comI2012/05/13lbanks·tread·a·fine·!jne·jn·trading/ 

.. Wells Fargo Web site; https·//www.we!lsfargo.com!invest relations/debt! . 

• s Wells Fargo quarterly report, third quarter 2012, available at 

httos'/fwww wellsfargo com/down!oads/pdWnyest relations/3012 100.pdf. 

46 Wells Fargo quarterly report, third quarter 2012, available at 

https;lfwwwweUsfargo com /dQWnloadsfpdWnvest relations/3012 10Q,pdf. 

+7 Wells Fargo's Stump! on the Volcker Rule, CNBC (Feb. 17, 2012), available at: 

http;!tvideocnbc.com!gallerv/?video=3000073921. 

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The firm does engage in market-making, which the proposed Volcker Rule will allow. 

(Market making involves trading activities in which the bank aims to profit through 

commissions rather than through changing values of the underlying investments.) "We 

make active markets in.more than 400 issues and are recognized as a top 10 trader in 

convertible bonds," Wells Fargo says on its Web site.48 

Berkshire Hathaway-run by Warren Buffett, the nation's second wealthiest person,49 and 

Charles Munger-holds nearly 10 percent of Wells Fargo's stock,50 accounting for nearly 20 

percent of the value of Berkshire Hathaway's investment portfolio. 51 On why Berkshire 

Hathaway and others might find Wells Fargo "so attractive," Forbes observed: "Well, Wells 

Fargo is distinctive for what it doesn't do: rely on proprietary trading."52 

The one way the Volcker Rule could impact Wells Fargo is through the law's ban on hedge 

fund ownership. Wells Fargo fears federal regulators might bar its venture capital and 

merchant banking subsidiaries under the Volcker Rule. The funds largely fall under the 

name of Norwest, such as Norwest Equity Partners, Norwest Venture Partners, etc. 53 Wells 

Fargo lists 1,207 separate subsidiaries. 54 

Wells Fargo does not explicitly report the results of its venture and merchant capital 

subsidiaries. It does report various investment gains. In the latest quarter, Wells Fargo 

reported a gain of $167 million from the sale of debt and equity securities. That 

represented 1.5 percent of its total $10.5 billion in non-interest income, and 0.6 percent of 

its total interest and non-interest income of $21.5 billion for the quarter. Income from 

these sales represented 3.3 percent of its net income.55 

Despite the apparent lack of Significance ofVolcker Rule-prohibited activity for Wells Fargo 

and CEO Stumpfs dismissal of the importance of proprietary trading, Wells Pargo has 

joined the vigorous industry effort to contest robust implementation. The firm penned two 

... This assertion appears in the promotional material of a Wells Fargo Web site, available at: 

https·//www.wellsfargoeom!com!securities/equitv-sales . 

• 9 See FORBES (Sept 19,2012), available at: http://www,forbes.eom/forbes-4001. 

50 Wells Fargo, proxy statement 2012, 

http://see goylArchjyes/ed@r/data/72971/000119312512117239(d285202ddefl4a.htro. 

51 Buffett How Has 19.4% o/Portfolio in Wells Fargo: Why it's the Better Bank StJJck, FORBES (Nov. 25, 2012), 

http: Ilwww.forbes.eom/sjtes IychartsI2012/11125/buffett-hQW-has-19-4-of-portfolio-jn-wells-fargo-whyits-the-better-bank-stock/. 

52Td. Buffett discusses the Volcker Rule in this video: Buffett on Volcker rule: 

http://www valuewalkeom 12012/05 Iwarren-buffett-talks-about-volcker-rule-video/. 

53 Wells Fargo exhibit to annual report, 2012, available at: 

http'lIsee goy IArchjves/edgar/datalZ2971/000119312512084528/d280360dex21.htro. 

"'Id. 

55 Wells Fargo quarterly report, third quarter 2012, available at 

htt;ps· Ilwww.wellsfargocom/downloadsfpdflinvest relationsf3012 100.pdf. 

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letters to the federal agencies, and joined in endorsement of two others.56 Instead of a rule, 

Wells Fargo asks for special treatment: "We believe that a better approach would be to 

allow each covered banking entity to work with its primary federal regulator to tailor more 

general rules applicable to eac4 covered banking entity and its unique trading attributes. "57 

The Volcker Rule should portend minimal change for the company's business. Further, 

Wells Fargo's largest shareholder may be impatient with any attempts by management to 

violate the Volcker. Rule. Berkshire Hathaway's Munger commented, "Take the rapid 

trading by the computer geniuses [responsible for proprietary trading at banks]. Those 

people have all the social utility of a bunch of rats admitted to a grainery. I never would 

have allowed the rats to get in the grainery. I don't want the brilliant young men of America 

being rats in somebody else's grainery."58 

IV. Conclusion: Closing the Casino 

While large bank lobbyists and others who profit from bank proprietary trading vocally 

oppose the VoIcker Rule, Washington representatives of the vast majority of American 

banks endorse this reform. The Independent Community Bankers of America boasts 5,000 

members among the nation's 7,181 banks.59 While Wall Street lobbyists forecast grave 

harms from the Volcker Rule, here's what the trade association for the lion's share of the 

banking industry concludes: "ICBA generally supports the VoIcker Rule, which is an 

important step toward protecting the business of banking from the speculation inherent in 

proprietary trading and sponsoring or investing in hedge funds."60 The trade association 

explains: "The recent financial crisis and the ensuing government bailout show what 

happens when banks depart from the fundamental business ofbanking."61 

If the Volcker Rule affects relatively few players on Wall Street, why the storm and fury? 

M&T Bank CEO Wilmers speculates that personal compensation figures at the center of this 

public controversy, and that compensation undermines public perception of the social 

utility of banking. "Public cynicism about the major banks has been further reinforced by 

the salaries of their top executives, in large part fueled not by lending but by trading. At a 

5. Compilation of all letters to Federal Reserve on Volcker Rule. Available at: 

httll'llwww federalreserve iQy/apps/foja/YiewAllComments aspx?doc jd=R-1432&doc ver=l. 

57 Letter from Wells Fargo counsel James Strother (Feb. 13,2012), available at: 

httll:/lwww.federalreservegQvISECRSI2012/March/20120309/R-1432/R· 

1432 021312 104964 362706050221 l,pdf. 

5. Video interview of Charles Munger. available at: http://wwwwebcompactnetlindexphp/newsI29149-

charlie-munger-and-buffett-d;sagree-on-YQlc!rer-rule-video. 

5' ICBA Web site. available at: httll·llwww.ichagrg/abQutICBAfjndex.cfm7ItemNumber=529. 

60 ICBA comment letter on the Volcker Rule (Feb. 13. 2012). available at: 

http-lIwwwfedera1reserve.gov/SECRS/2012/MarchI201203QS/R-1432/R1432 021312 104966451638070183 1 pdf . 

• l/d. 

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time when the American economy is stuck in the doldrums and so many are unemployed or 

under-employed, the average compensation for the cWef executives of four of the six 

largest banks in 2010 was $17.3 million-more than 262 times that of the average 

American worker. Thus, it- is hardly surprising that the public would judge the banking 

industry harshly-and view Wall Street's executives and their intentions with skepticism ... 

The Wall Street banks continue to fight against regulation that would limit,their capacity to 

trade for their own accounts-while enjoying the backing of deposit insurance-and thus 

seek to keep in place a system which puts taxpayers at high risk."62 

The thousands of bankers unaffected by the Volcker Rule may not travel frequently to 

Washington to defend it Who petitions City Hall about a stop light on a street where one 

doesn't drive? But as Washington's rulemakers finalize this important regulation, they 

should be especially attuned to the silence of 7,000 banks. 

62 M& T Bank, Annual Report, 2011, available at: 

htl;\!: llfiles shareholder corn Idown!oads/MTB/2107851 053xOx546897/5C592DAO-5A87 -4F46-8AF6-

863,2EIB8963E/2011 Annua! RePQrtpdf 

June 2012 

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