More On Legal & Compliancefrom The Advisor's Professional Library
- Conducting Due Diligence of Sub-Advisors and Third-Party Advisors Engaging in due-diligence of sub-advisors isnt just a recommended best practice it is part of the fiduciary obligation to a client. An RIA should be extremely reluctant to enter a relationship with a sub-advisor who claims the firms strategy is proprietary.
- Client Communication and Miscommunication RIA policies and procedures must specify what type of communications should be retained. The safest course of action is for RIAs to retain all communicationsto clients, from clients, and about client accounts. To comply with fiduciary obligations, communications must be thorough and not mislead.
Those requirements, amendments to the Bank Holding Company Act of 1956 and other prior legislation, are meant to address the systemic risk issues that arose during the 2008-09 financial crisis and would, in the FDIC’s words, prohibit banks from executing transactions or engaging in “any activity that would:
1) involve or result in a material conflict of interest;
2) result in a material exposure to high-risk assets or high-risk trading strategies;
3) pose a threat to the safety and soundness of the banking entity; or
4) pose a threat to the financial stability of the United States."
Specifically, the rules are meant to prohibit banks and their subsidiaries from engaging in short-term proprietary trading for the bank’s own account and bank ownership of hedge funds or private equities; most of the details of the proposed Volcker rule were leaked last week to the media. The FDIC said it would accept comments on its proposed rulemaking until Jan. 13, 2012; the final rules are scheduled to be implemented by July 2012.
The rule, named for former Federal Reserve Chairman Paul Volcker, who proposed the ban on proprietary trading, arguing that it encouraged banks to take excessive risks, provides exemptions to those prohibitions, and is being issued in concert with the Federal Reserve (which approved the proposed rulemaking on Tuesday morning), the Office of the Comptroller of the Currency (OCC), and the SEC (which is scheduled to vote on the proposal on Wednesday). The FDIC said in formulating the proposed rulemaking it had consulted with the staff of the Commodity Futures Trading Commission (CFTC).
The rules would require banks to establish an internal compliance program “to ensure and monitor compliance with the statute's prohibitions and restrictions,” and that internal program “would be subject to oversight by the banking entity's board of directors and appropriate federal supervisory agency.”
The proposed rules would also require the banks with “significant trading operations to report to the appropriate federal supervisory agency certain quantitative measurements designed to assist the federal supervisory agencies and banking entities in identifying prohibited proprietary trading in the context of exempt activities.”
As with much of Dodd-Frank, the controversy will swirl around the details of the prohibitions and exemptions. The big banks, their representatives and at least one ratings agency quickly responded to the proposed rulemaking.
On Monday, Moody’s said the “complex” “Volcker rule” would be a “credit negative” for U.S. market-making banks. The New York Times’ DealBook quoted Moody’s as saying the rules would “diminish the flexibility and profitability of banks’ valuable market-making operations and place them at a competitive disadvantage to firms not constrained by the rule.”
SIFMA President and CEO Tim Ryan (left) released a statement Tuesday saying that “in trying to address the challenging problem of differentiating between market-making and proprietary trading, regulators have proposed a framework which may adversely impact market liquidity,” and that the “overly prescriptive and burdensome compliance requirements" could well depress the market-making functions of banks and their affiliated broker-dealers as well as the asset management alternative fund business.
Frank Keating, president and CEO of The American Bankers Association, released a statement lamenting that “the oversized nature and complexity of this proposed rule will make it unworkable and will further inhibit U.S. banks’ ability to serve customers and compete internationally.”
He further wondered, “How can banks comply with a rule that complicated, and how can regulators effectively administer it in a way that doesn’t make it harder for banks to serve their customers and further weaken the broader economy?”