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1391Impact of Volcker Rule on RICs

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  • Baker, John
    Feb 21, 2014
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      As widely reported, the Volcker Rule restricts the ability of a banking entity to engage in proprietary trading and to have certain interests in covered funds. Although registered investment companies are excluded from the definition of "covered fund," it is possible under some circumstances for a RIC to be a banking entity subject to the Rule, which in many cases would make it impractical for the RIC to carry on business. RICs will need to revise their procedures to prevent this.

      In general, a "banking entity" is an insured depository institution or any company that controls, is controlled by, or is under common control with an insured depository institution. A RIC, therefore, would be a "banking entity" if it is controlled by a bank; if it is controlled by a bank holding company or financial holding company (and therefore is under common control with a bank); or if it controls a bank (directly or through a bank holding company or financial holding company). A company has "control" over another company if:

      (A) the company directly or indirectly or acting through one or more other persons owns, controls, or has power to vote 25% or more of any class of voting securities of the other company;

      (B) the company controls in any manner the election of a majority of the directors or trustees of the other company; or

      (C) the Federal Reserve Board determines, after notice and opportunity for hearing, that the company directly or indirectly exercises a controlling influence over the management or policies of the other company.

      12 U.S.C. § 1841(a)(2); 12 C.F.R. § 225.2(e).

      In the adopting release, the agencies stated that a financial holding company may own up to (but less than) 25% of the voting shares of a RIC for which the holding company provides investment advisory, administrative, and other services and has a number of director and officer interlocks, without controlling the fund. A bank holding company similarly may own up to 5% of the RIC's shares. A banking holding company may own up to (but less than) 25% of the voting shares of a RIC and perform similar services without controlling the fund, as long as the fund limits its investments to those permissible for the holding company to make itself. 79 Fed. Reg. at 5676.

      It should be straightforward for RICs to limit their investments in banking entities to noncontrolling positions. RICs will also need to track their investors to ensure that that no banking entity holds 25% or more of any class of voting security (e.g., a class of institutional shares). If the RIC has a bank holding company as an investment adviser, then the RIC will need to limit the banking holding company to 5% of any class of voting security, unless the fund limits its investments to those permissible for the holding company to make itself.

      The adopting release is at 79 Fed. Reg. 5536 (Jan. 31, 2014), and is available online at

      https://federalregister.gov/a/2013-31511


      John M. Baker, Esquire
      Stradley Ronon Stevens & Young, LLP
      1250 Connecticut Avenue, N.W., Suite 500
      Washington, DC 20036-2652
      p: 202.419.8413
      f: 202.822.0140
      FundLaw Listowner http://groups.yahoo.com/neo/groups/fundlaw/conversations/messages