Even as five regulatory agencies prepared to vote Tuesday on a regulation that seeks to rein in risk-taking on Wall Street — an effort known as the Volcker Rule — lawyers and lobbyists were gearing up for another round of attacks against it.
In recent letters and meetings with financial regulators, lobbyists for Wall Street banks and business trade groups issued thinly veiled threats about challenging the Volcker Rule in court, people briefed on the matter said. The groups, including theU.S. Chamber of Commerce, are hinting that they could use litigation to either undercut or clarify the rule, which is intended to bar banks from trading for their own gain and limit their ability to invest in hedge funds.
The rule, a cornerstone of the 2010 Dodd-Frank Act and a barometer for the overall strength of the regulatory overhaul, is aimed at preventing future trading blowups on Wall Street. In July, Treasury Secretary Jacob J. Lew instructed the agencies drafting the Volcker Rule — the Federal Reserve, the Securities and Exchange Commission, the Commodity Futures Trading Commission, the Federal Deposit Insurance Corporation and the Comptroller of the Currency — to complete their work by year’s end.
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Timeline: Tracking the Volcker Rule
Over the past few months, the agencies overcame internal squabbling to draft identical versions of the rule, according to the people briefed on the matter, who were not authorized to speak publicly, and have scheduled votes for Tuesday. The agencies came together to write a tougher-than-expected final text despite two years of persistent prodding and pushing from Wall Street lobbyists to water down major provisions of an October 2011 draft version.
Wall Street also urged them to slow down, even as banks prepared to comply with the regulation. In a Dec. 4 letter to the heads of the five agencies, the U.S. Chamber of Commerce, the Business Roundtable and three other business trade groups wrote, “It is more important to get the Volcker Rule right than meet an artificially imposed deadline.”
But the Chamber is unlikely to rush into court. The Federal Reserve will delay the effective date of the rule to July 2015, the people briefed on the matter said, a move that will probably postpone any litigation for several months while bank lawyers study the rule’s nuances.
Still, Wall Street is wasting no time to find end runs. Come Tuesday, hundreds of lawyers will pore over the details of the final draft, searching for loopholes and outlining for banks how they can comply with the law while still taking risks. One big law firm is installing extra printers in its conference rooms to print out multiple copies of the rule.
Some banks like Goldman Sachs have already test-run certain strategies, such as putting together a separate investment vehicle to make loans to companies in the event the regulation limits the ability of bank-owned hedge funds to continue that business.
“Morgan Stanley and Goldman Sachs will go out and hire the best and brightest lawyers, and they will say, ‘How do we do this?’ ” said Bill Singer, a securities lawyer who represents individuals and brokerage firms in disputes with regulators and advises clients on regulatory compliance. “The mind-set,” he said, is “how do we get around it?”
That said, Wall Street is also throwing resources into compliance. Banks are writing new compliance manuals, training their traders and rewriting computer programs that effectively automate whether a trade is out of bounds under the Volcker Rule.
Even opponents of the rule, who question the benefit of a ban on trading by banks for their own gain — a practice known as proprietary trading — privately concede that banks will adjust to the vast majority of its requirements. Further smoothing the transition, banks like Citigroup, Goldman Sachs, JPMorgan Chase and Morgan Stanley have already complied with large swaths of the rule, shuttering stand-alone proprietary trading desks months or years ago after Dodd-Frank passed Congress.
But because there was a limit to what Wall Street could do without a completed rule, Tuesday’s vote will at least bring some finality to the behind-the-scenes discussions.
“Compliance will be daunting, but hopefully the waiting will have been the hardest part,” said Lisa M. Ledbetter, who said she was one of about 200 lawyers at Jones Day who will review the rule on Tuesday on behalf of the firm’s Wall Street clients. “The devil is in the details.”
With the Volcker Rule, which officials say is about 70 pages long with a preamble of nearly 900 pages introducing and interpreting the rule, the details will be numerous.
The rule is the brainchild of Paul A. Volcker, a former Federal Reserve chairman and adviser to President Obama who wanted to outlaw proprietary trading by banks that enjoy deposit insurance and other government support. Such a ban, Mr. Volcker reckoned, would curb risk-taking and avert future bailouts of Wall Street.
But there is not a bright line between proprietary trading and the legitimate practices that are allowed under the rule. For example, banks will still be allowed to buy stocks and bonds for their clients — a process known as market-making. They can also place trades that are meant to hedge their risks, a practice that is hard to distinguish from proprietary trading.
In recent weeks, according to the people briefed on the matter, the C.F.T.C. and Kara M. Stein, a Democratic commissioner at the S.E.C. who favors a strict Volcker Rule, pushed to close potential loopholes. Gary S. Gensler, the chairman of the C.F.T.C., argued for new language that would prevent banks from amassing large amounts of stock under the guise of market-making.
The final draft adopted many of their suggestions, the people said, requiring banks to meet tougher-than-expected measures for determining whether a trade is proprietary or market-making. Some require daily calculations from the banks. The measures, the people added, also force the banks to evaluate whether they are holding, say, thousands of shares in Facebook, based on “historical demand” from customers. If not, then regulators would deem the position proprietary and improper.
The rule will also require bank chief executives to attest that they are not doing proprietary trading, officials say, another victory for the rule’s supporters.
But it would still be up to the banks to police their compliance with the rule.
Representatives for Goldman Sachs and Morgan Stanley said it was premature to comment on a regulation that has yet to be approved.
A spokeswoman for the U.S. Chamber of Commerce, Lisa Burgess, said that the trade group had “deep concerns” about the process that led to the Volcker Rule but that it was too soon to say whether the organization would sue the regulators.
In pursuing courtroom battles against Dodd-Frank — federal agencies have been sued at least six times over recent rules — the Chamber and other trade groups have used a standard formula. They typically hire Eugene Scalia, a seasoned litigator at Gibson Dunn and the son of Justice Antonin Scalia, to lead the litigation. And to underpin the case, they scrutinize whether regulators fully weighed the costs and benefits of a rule.
The Volcker Rule is not expected to have a stand-alone cost-benefit section, the people briefed on the matter said, a decision that the Chamber might emphasize in a lawsuit. But regulators believed there was no need for such a section because they wove in cost considerations throughout the document and were drafting the rule under a federal statute — the Bank Holding Company Act — that does not require a cost-benefit analysis.
The Chamber might also seize on a provision in the Volcker Rule that would curtail the ability of banks to engage in portfolio hedging, a type of trading that critics say goes beyond normal hedging of positions for either the benefit of clients or mitigating the bank’s own risk. The provision is a response to the “London Whale” trading debacle that resulted in $6.2 billion in losses for JPMorgan Chase.
In a Nov. 25 letter to the regulatory agencies, a trade group with ties to the Chamber said that any provision aimed at restricting portfolio hedging would be improper since it was not included in the draft version of the Volcker Rule. The group argued that “expanding the Volcker Rule, to include portfolio hedging, without public comment, does not allow businesses to either consider the implications or communicate to regulators how capital formation will be affected.”
But Wall Street critics contend the banks and trade groups were put on notice that regulators might put restrictions on portfolio hedging because it was one of the nearly 400 questions regulators asked for comment on when they published the October 2011 draft.
Some bank lawyers also argue that with Wall Street working to meet the terms of much of the Volcker Rule, the most contentious issues in the measure will probably not take as much time to resolve as some suggest.
“Within a year or two, people will have a sense of how the regulators expect the rule to be implemented” said William J. Sweet Jr., a bank regulatory lawyer at Skadden, Arps, Slate, Meagher & Flom.
Jessica Silver-Greenberg contributed reporting.
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