When federal financial regulators last week adopted the massive Volcker Rule, it didn’t mean their work was finished. If anything, lawyers say the work is just beginning.
Legal challenges to the rule that bars banks from making risky bets with their customers’ money are a “virtual certainty,” said David Hooper, a corporate partner at Barnes & Thornburg. “The implications [for] banks are so widespread that it is highly likely there will be challenges to the final rule on a number of grounds.”
Financial regulatory specialist Keith Fisher, of counsel to Ballard Spahr, agreed. “There’s a very high likelihood somebody may try to test the entirety of the rule or specific aspects,” he said.
Regulators on Dec. 10 released the 71-page rule, plus another 882 pages of supporting documentation. It bars banks from making short-term proprietary trades, while exempting certain activities including market-making. The rule also requires new accountability from corporate chiefs.
A keystone of the Dodd-Frank Act, the final rule was jointly released by the board of governors of the Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, the Commodity Futures Trading Commission and the Securities and Exchange Commission.
“Our financial system will be safer and the American people are more secure” because of the rule, President Barack Obama said in a written statement.
Lawyers predicted that groups such as the U.S. Chamber of Commerce, the American Bankers Association or the Securities Industry and Financial Markets Association would be most likely to challenge the rule. Individual banks would hesitate to openly confront their regulators, said White & Case partner Ernest Patrikis, who served in senior positions including general counsel for 30 years with the Federal Reserve Bank of New York. “They’ll use a trade association,” he said.
A Chamber spokeswoman said in an email that the group “will carefully examine the final rule and take all options into account as we decide how best to proceed.”
A lawsuit might challenge the rule as a whole under the Administrative Pro­cedure Act or target specific provisions such as the CEO attestation requirement or the extension of regulation to foreign banks, lawyers said. Another tack would be to argue that regulators veered too far from the text of the Dodd-Frank Act in drafting the rule.
Sharply worded dissents from several agency commissioners spotlight some administrative vulnerabilities in the rulemaking process that could be used in a suit, said Venable partner Andrew Olmem, who recently finished a seven-year tenure at the Senate Banking Com­mit­tee, most recently as the Repub­li­can chief counsel. “Dissents can be very important in a lawsuit,” he said. “Courts can look to them and say, ‘Even your own principals did not agree that your agency complied with the law.’ “
A commissioner at the Commodity Futures Trading Commission, Scott O’Malia, blasted the agency for allegedly violating administrative procedures, writing that “the Commission seems to have forgotten the basics of agency rulemaking. I am deeply troubled by the egregious abuse of process in this rulemaking.” O’Malia alleged that chairman Gary Gensler excluded commissioners from negotiations, and he said the final rule lacked “due process and clarity in its enforcement procedures.”
SEC commissioner Daniel Gallagher dissented as well, saying that the rulemaking was rushed and that he was not given enough time to review the draft. “Under intense pressure to meet an utterly artificial, wholly political end-of-year deadline, this Commission is effectively being told that we have to vote for the final rule so we can find out what’s in it,” Gallagher said. He called the rule a “massive, untested governmental intrusion into a vital segment of our economy.”
A legal challenge might focus on whether the agencies gave stakeholders an opportunity to comment — and whether the agencies took the comments into account.
The agencies received about 18,000 comments, although all but roughly 500 were virtually identical form letters. The biggest problem, White & Case’s Patrikis said, is that the agencies subsequently made “many changes” and undertook “massive rewriting” between the draft version and the final rule. A key legal question is whether stakeholders had an adequate opportunity to comment on the final provisions, especially in instances in which the changes made the rules stricter. “I always felt that if you make a rule harsher, it should go up for comment again,” Patrikis said.
SEC commissioner Michael Piwowar voted against the final rule for this reason. “The final rule adopted today is substantially different from the rule that was proposed over two years ago. In my view, the extent of these changes necessitates a reproposal of the rule and an opportunity for public comment,” he wrote in his dissent.
Another avenue would be to challenge the agencies’ cost/benefit analysis — a popular tactic in suits against the SEC and other regulators. But given the nearly 900 pages of explanation accompanying the rule, “my gut tells me that it’s not too likely” such a challenge would succeed, Jones Day banking and finance partner Joel Telpner said.
Ellen Marshall, a banking, corporate and finance partner at Manatt, Phelps & Phillips, said in an email that lawsuits might take time to ripen.
“Applying these rules will involve line-drawing, such as when a hedge position is considered to be related to a specific asset or liability and when it is merely part of an overall portfolio management strategy,” she said. “Or when an investment, though held for longer than 60 days, is not held for investment. These sorts of line-drawing issues are likely to take years to develop.”
In the short term, Marshall said, the CEO attestation requirement could prove vulnerable to a challenge. The provision, not included in the original draft, would require bank executives to personally attest that their institutions have proper procedures in place to ensure compliance with the law. She also flagged the extension of regulation to foreign banks, which could be viewed as “beyond the scope of the statute.”
Still, Reed Smith partner Michael Bleier, a former assistant general counsel to the Federal Reserve Board who also served as the general counsel of Mellon Bank, predicted that any lawsuit would face “an uphill battle.”
“The statute gives lots of discretion to the agencies,” he said. “It was pretty clear what Congress wanted the agencies to do. The only issue is how it’s implemented.”
Venable’s Olmem said the outcome of any lawsuit is hard to predict, especially in this case, with three new judges nominated by Obama who are likely to soon join the U.S. Court of Appeals for the D.C. Circuit. Moreover, there’s no guarantee that if the rule were reversed and remanded, the final result would be more palatable. “The key question is: Can banks improve on the rule by suing?” Olmem said.
Banks have until July 2015 to comply with the rule — a one-year extension of the original target date. As a result, there’s “no all-fired rush to go to court,” Fisher of Ballard Spahr said. “I think people will wait until the compliance date is closer until they resort to judicial review.”
Contact Jenna Greene at firstname.lastname@example.org.