Former Fed Chairman Paul Volcker At Senate Banking Hearing
Andrew Harrer/Bloomberg via Getty Images
By Douwe Miedema
and Sarah N. Lynch


WASHINGTON -- When U.S. regulators adopt the Volcker rule Tuesday, they will make good on a promise by politicians to rein in banks' ability to gamble with their own money.

The coordinated action by five separate regulatory agencies is seen sparking a court challenge as Wall Street tries once again to avoid one of the harshest elements of the post-financial crisis crackdown.

The rule, championed by former Federal Reserve Chairman Paul Volcker, was a last-minute addition to the 2010 Dodd-Frank Wall Street reform law and takes aim at a business that had been a big money spinner for banks before the crisis.

The measure bans banks from making bets for their own profits, an activity known as proprietary trading that regulators deemed too risky for banks that enjoy government backstops.

But banks argue the roughly 800-page rule will hurt markets because it is virtually impossible to distinguish profit-seeking trades from those needed to hedge against risks or trades executed on behalf of clients.

"For something of this magnitude and this controversial ... there will be somebody who will challenge it," said Brian Cartwright, an adviser at consultancy Patomak Global Partners and a former general counsel at the Securities and Exchange Commission, one of the agencies voting on the measure.

Banks had hoped the rule would be watered down from when it was proposed more than two years ago, but JPMorgan Chase's (JPM) $6 billion loss in 2012 -- named the London Whale after the giant trading bets the bank took -- put an end to that speculation.

The final rule is expected to tighten potential loopholes, and could trim billions of dollars in annual revenues from large banks including Goldman Sachs (GS), Morgan Stanley (MS) and JPMorgan.

Legal experts have identified three possible avenues of attack once the rule becomes final. Banks could challenge on procedural grounds,
including that they didn't have an adequate chance to comment on major new elements the final rule contains from when it was proposed two years ago.

They could also argue that certain regulators did not sufficiently analyze the costs and benefits of the rule. And lastly, they could argue that parts of the rule hammered out by the regulators contradicts the Dodd-Frank law.

The five agencies involved in Tuesday's final vote are the Federal Reserve, the Federal Deposit Insurance Corp., the Office of the Comptroller of the Currency, all bank regulators, plus the SEC and the Commodity Futures Trading Commission.

Costly Gamble

Few banks are expected to individually challenge their supervisors. Lawyers working on these issues said the likely candidates to sue were the industry groups that have done so against other Dodd-Frank rules.

These groups, such as the U.S. Chamber of Commerce and the Securities Industry and Financial Markets Association, have so far been coy about whether they will challenge the Volcker rule.

A hurdle for possible litigants is that regulators have in all likelihood blocked some of the most obvious routes for a lawsuit, these lawyers said, potentially making a lawsuit a risky and costly gamble.

"The agencies have been very attuned to the fact that there are many who would litigate about what comes out here," said Satish Kini, co-chair of the banking group of Debevoise & Plimpton, a law firm in Washington.

Banks could use procedural arguments under the Administrative Procedures Act, which bans regulators from writing rules that are "arbitrary and capricious."

If the final rule is tougher and contains substantially new elements, they could argue they didn't have a chance to comment on those elements, despite already having sent in 17,000 comment letters to regulators on the proposed rule.

"[Regulators] have to be quite careful that any changes are within the scope of the proposal," said Scott Cammarn, a partner at law firm Cadwalader, Wickersham & Taft. But the proposed rule was already very detailed, said another lawyer who asked not to be named, containing more than 350 questions the industry was asked to respond to.

Economic Test

Banks could also argue that some of the regulators failed to meet requirements to conduct proper cost-benefit analyses weighing the economic impacts of the rule.

Wall Street trade groups have already successfully used this tactic to defeat other Dodd-Frank rules from the CFTC and SEC, including one that would have made it easier for shareholders to nominate directors to corporate boards.

The OCC could be particularly vulnerable to this tactic.

Under a federal law known as the Unfunded Mandates Reform Act, the OCC must prepare a budgetary statement if a rule will cost either the government or the private sector more than $100 million, but it decided not to do so.

The Chamber of Commerce has already deemed that decision "clearly erroneous," in a November letter to regulators. But attacking an individual agency is a tricky strategy and the largest Wall Street banks are under Fed oversight.

"If you can't challenge the regulation that applies to bank holding companies [under the Fed], then it doesn't do you all that much good to succeed in a challenge against the other regulations," said Patomak's Cartwright.

Banks could also argue that the rule hammered out by the regulatory agencies contradicts the Dodd-Frank law, for instance if it restricts activities that Congress intended to permit such as hedging or market-making.

Judges could be wary about wading into complex trading matters, Cartwright said. "They need to be persuaded that they understand it well enough to know that what was done was arbitrary and capricious."


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