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Regulators Get More Time to Respond to Volcker Rule Complaint

December 31, 2013

The SEC and three bank regulatory agencies are locked in a lawsuit with the banking industry over a rule that could force some small banks to sell securities in a fire sale and take $600 million in capital charges.Regulators appear somewhat willing to give the banks more flexibility in adopting the rule, but a definitive answer won’t be available before mid-January.

The U.S. Court of Appeals for the D.C. Circuit granted the SEC and three other regulatory agencies until January 17, 2014, to file their response to a lawsuit challenging a contentious provision within the Volcker Rule.

The parties to the complaint, which was filed by the American Bankers Association (ABA), were scheduled to convene before Judge Richard Leon of U.S. District Court on December 31.Along with the SEC, the ABA also named the Federal Reserve, the Federal Deposit Insurance Corp. (FDIC), and the Office of the Comptroller of the Currency as defendants.

The suit was prompted by a somewhat overlooked provision in Release No. BHCA-1,Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships with, Hedge Funds and Private Equity Funds,which the agencies issued to carry out a major reform from the 2010 Dodd-Frank Act.

The ABA’s December 24 complaint said the rule threatens an estimated 275 banks with capital charges of $600 million on $3.5 billion assets held in collateralized debt obligations (CDOs) backed by trust-preferred securities (TruPS) the community banks purchased in the years leading up to the financial crisis.The TruPS are a special class of hybrid instrument that has characteristics of both debt and equity.

The ABA’s complaint said the write-downs may have to be recorded in 2013 financial results because Release No. BHCA-1 required the securities to be sold before they could recover the losses they suffered in the crisis.

According to an exhibit the ABA filed with its compliant, because of the forced sales, the banks are required by FASB ASC 320-10-35-34B,Investments—Debt and Equity Securities—Overall—Subsequent Measurement,formerly FASB Staff Position (FSP) No. FAS 115-1 and FAS 124-1, to immediately take a charge against their 2013 earnings.The write-downs will automatically decrease the banks’ capital.

The agencies initially had until December 30 to respond, but a joint statement they issued late on December 27 said they would review the issue by January 15, 2014, which they said would give the banks that would be affected enough time to adjust their 2013 call reports they file with banking regulators.

After the regulators said they would reassess how the banks will apply the rule, the ABA agreed to allow the agencies extra time to file their response with the court.

In addition to fighting the regulators in court, the banking lobby is also drumming up support among members of Congress to press for changes to the Volcker Rule’s CDO requirement.

“I don’t think anyone on the Hill thought that the Volcker Rule would apply to CDO TruPS,” said Christopher Cole, senior vice president and senior regulatory counsel with the Independent Community Bankers of America, which is not a party to the ABA lawsuit.

According to Cole, the requirement in Release No. BHCA-1 that threatens to force banks to undertake what will amount to a fire sale of the CDOs conflicts with another provision in Dodd-Frank that lets banks count the securities as Tier 1 capital.

“It was congressional intent to grandfather them,” Cole said.