Corporate & Securities Law

By Jim Hamilton

House and Senate Reform Bills Take Different Approach to Volcker Rules

The House and Senate financial reform bills both have provisions banning financial institutions from proprietary trading. Proprietary trading is generally trading on behalf of the financial firm, rather than on behalf of a client. It is often considered high risk activity that contributed to the financial crisis. In fact, there is a growing consensus that proprietary trading is a riskier activity than other types of activities that financial institutions undertake, and therefore may require closer control.

The Senate bill prohibits proprietary trading by financial institutions and their subsidiaries. The bill exempts from the prohibition, State obligations, US obligations and federal agency obligations fully guaranteed by US, as well as obligations of government sponsored enterprises like Fannie Mae and Freddie Mac. Trading in foreign company activities is also exempt from the prohibition so long as the foreign company is not controlled by a US company.

The Senate bill defines proprietary trading to mean purchasing or selling, or otherwise acquiring and disposing of, stocks, bonds, options, commodities, derivatives, or other financial instruments by a financial institution for its trading book.

But proprietary trading does not include purchasing or selling, or otherwise acquiring and disposing of, stocks, bonds, options, commodities, derivatives, or other financial instruments on behalf of a customer, as part of market making activities, or otherwise in connection with or in facilitation of customer relationships, including hedging activities related to such a purchase, sale, acquisition, or disposal.

The Senate definition of proprietary trading is almost identical to the Treasury?s draft legislative language, which defines the term to mean purchasing or selling, or otherwise acquiring and disposing of, stocks, bonds, options, commodities, derivatives, or other financial instruments for the institution?s or company?s own trading book, and not on behalf of a customer, as part of market making activities, or otherwise in connection with or in facilitation of customer relationships, including related hedging activities.

The House bill defines proprietary trading to mean the trading of stocks, bonds, options, commodities, derivatives, or other financial instruments with the company's own money and for the company's own account. Unlike the Senate?s definition, the House bill does not specifically exempt proprietary trading in connection with market making and hedging.

However, the House bill allows the Fed to exempt proprietary trading ancillary to other corporate operations and that does not pose a threat to the safety and soundness of the company or to US financial stability, including making a market in securities issued by the company, hedging or managing risk, determining the market value of assets, and propriety trading for such other purposes allowed by the Board by rule. The House bill does not specifically exempt federal and state government and GSE obligations.

Full post as published by Jim Hamilton's World of Securities Regulation on April 12, 2010 (boomark / email).