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Volcker Compliance: Spirit vs. Substance

Wall Street is innovative, well known for continuously developing new ways to make money through the financial markets.  In the early 2000s, Wall Street innovations allowed more Americans to become homeowners than ever before.  Those same innovations allowed the negative effects of the bursting housing bubble to permeate the entire financial system.   In the present, much of that innovative spirit must necessarily be aimed at discovering investment methods that comply with the post-financial crisis regulatory clampdown.   One such innovation can be seen in Goldman Sachs’ recent efforts to make private equity style investments without violating the Volcker Rule.  Of late, acquisitions by Goldman Sachs have drawn serious attention from regulators, and Goldman’s clients, for being in potential conflict with the “spirit” of the Volcker rule. 1  Yet, Goldman’s investments manage to stay within the letter of the law.

The Volcker Rule, a critical piece of the 2010 Dodd-Frank legislation, is aimed at two things: (1) eliminating the inherent conflict of interest that arises when insured depository institutions (banks) invest their own funds alongside or in place of their clients’ money and (2) discouraging the type of proprietary risk-taking that exacerbated the 2008 financial crisis. 2  The Volcker rule addresses excessive risk by prohibiting banks from engaging in “proprietary trading,” acquiring an equity, partnership, or other ownership interest in a hedge or private equity fund, or sponsoring its own hedge fund or private equity fund. 3  When introducing the Volcker Rule, President Obama articulated the spirit and purpose of the Rule stating, “We simply cannot accept a system in which hedge funds or private equity firms inside banks can place huge, risky bets that are subsidized by taxpayers and that could pose a conflict of interest.” 4  The Volcker rule calls for a drastic shift in banks’ strategy, mandating a shift of tens of billions of dollars out of investments that are now prohibited by the rule. 5

Since the passage of the Volcker Rule, Goldman Sachs and fellow banks have entered the long process of bringing their operations in line with the rule’s stipulations.  Major banks have eliminated proprietary trading desks that purely traded the banks’ own money.  Further, regulators imposed a July 2015 deadline for banks to reach compliance with the Volcker rule’s ban on private equity and Hedge Fund investments and sponsorships.6  The impending deadline poses a serious threat to banks like Goldman Sachs who have billions of dollars in Private Equity assets, many of which may be required to be sold at a loss in order to meet timing constraints.7 The potential losses to banks are so threatening that intense lobbying efforts may lead the Federal Reserve to extend the July deadline.

Meanwhile, moving in the entirely opposite direction, Goldman Sachs’ merchant banking arm has made a series of proprietary purchases, investing its own money in apartments in Spain, a mall in Utah, and a European ink company.  Further, in the second half of 2014, Goldman Sachs jointly acquired a series of British hotels alongside some of Goldman’s wealthiest partners. 8  Since the introduction of the Volcker Rule, the other major Wall Street banks have steered clear of investments of this sort, attempting to stay on the right side of the Volcker rule by complying with both the letter and spirit of the law.  Goldman recently articulated a different approach, stating “We are proud to invest alongside our clients in industries that create jobs and promote economic growth including major infrastructure projects, clean energy and technology companies and cutting-edge health care businesses.”9 Goldman further ensured that all of its investments comply with the Volcker Rule.10

While Goldman Sachs has pursued the type of proprietary risk that the Volcker Rule seeks to eliminate, its acquisitions comply with the letter of the law.  Under the Volcker Rule, Banks can purchase up to 3% of an asset with its own money. 11  The Volcker Rule prohibits banks from investing alongside its clients if the Bank itself takes anywhere from a 3% to a 99% stake in the asset, for this would violate the rule’s prohibitions on private equity and hedge fund investments.12 The rule’s prohibition of proprietary trading further restricts banks from taking a 100% stake in assets for anywhere between one and 60 days.  However, the Volcker Rule does not prohibit banks from making long-term acquisitions, when the bank acquires 100% of that asset.13 Thus, buying a series of apartment units or a mall outright is a perfectly legal acquisition under the Volcker Rule.

Goldman has even managed to circumvent the 100% ownership requirement by investing through “joint ventures.”  The Volcker Rule’s prohibition on sponsoring a private equity fund prevents Goldman from creating a fluid fund from which to pursue a series of investments. 14  However, section 10(c)(3) of the Volcker Rule exempts a “joint venture” of less than 10 unaffiliated co-venturers that does not hold itself as a fund. 15  If Goldman Sachs assembles a new joint venture for every acquisition, joint acquisitions with its partners, like its purchase of 144 British hotels, fall on the right side of the Volcker Rule.

In sum, while the Volcker rule, and in large part the entire Dodd-Frank act, was intended to discourage excessive risk-taking through private equity, hedge-fund investments, and proprietary trading, Goldman Sachs’ merchant banking arm has managed to make aggressive investments with the bank’s own money while still remaining within the letter of the law.  Wall Street has an uncanny knack for innovating ways to make a profit.   Such a culture is one that should not be expected to be confined by the “spirit” of the regulations that govern it.


  1. See Nathaniel Popper, Goldman Sachs Investments Test the Volcker Rule, DealBook N.Y. Times, Jan. 21, 2015, http://dealbook.nytimes.com/2015/1/21/goldman-investments-are-testing-volcker-rule/

  2. See Id

  3. Newsletter: The Volcker Rule, Skadden Arps, http://www.skadden.com/newsletters/FSR_The_Volcker_Rule.pdf

  4. Popper, supra note 1. 

  5. Jesse Hamilton, Ian Katz, & Cheyenne Hopkins, Goldman Needs Volcker Delay to Avoid Private-Equity Losses, BloombergBusiness, Dec. 5, 2014, http://www.bloomberg.com/news/articles/2014-12-05/goldman-may-dodge-private-equity-losses-with-volcker-reprieve

  6. See Id. 

  7. Id. 

  8. Popper, supra note 1. 

  9. Id. 

  10. Id. 

  11. Matt Levine, Goldman Sachs Actually Read the Volcker Rule, BloombergView, Jan. 22, 2015, http://www.bloombergview.com/articles/2015-01-22/goldman-sachs-actuall-read-the-volcker-rule

  12. Id. 

  13. Id. 

  14. Id. 

  15. Id. n. 7. 

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Robert Meyer

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