12 U.S.C. § 1851 — Prohibitions on proprietary trading and certain relationships with hedge funds and private equity funds

(a) General prohibition. (1) Unless this section provides otherwise, a banking entity may not (A) engage in proprietary trading, or (B) acquire or keep an equity, partnership, or other ownership interest in, or sponsor, a hedge fund or private equity fund. (2) A Board-supervised nonbank financial company that does either activity is subject by rule to extra capital requirements and quantitative limits as if it were a banking entity. Permitted activities under subsection (d) are not subject to those extra requirements and limits except as subsection (d)(3) provides. (b) Study and rules. (1) Within 6 months after July 21, 2010, the Financial Stability Oversight Council must study and recommend how to implement this section to: (A) improve banking entities’ safety and soundness; (B) protect taxpayers and consumers and improve financial stability by reducing the risk of unsafe activities by insured depository institutions and their affiliates; (C) limit improper transfers of Federal subsidies from institutions benefiting from deposit insurance and Federal liquidity facilities to unregulated entities; (D) reduce conflicts between the entities’ self-interest and their customers’ interests; (E) limit activities that caused or could reasonably be expected to cause excessive risk or loss; (F) accommodate insurance business under applicable insurance-investment laws while protecting affiliated banking entities and the United States financial system; and (G) set an appropriate time for selling illiquid assets affected by these prohibitions. (2)(A) Unless this section says otherwise, within 9 months after the study ends, the appropriate Federal banking agencies, the SEC, and the CFTC must consider the study and adopt rules under subparagraph (B). (B)(i) The appropriate Federal banking agencies jointly issue rules for insured depository institutions. The Board issues rules for companies controlling such institutions, companies treated as bank holding companies under section 8 of the International Banking Act, Board-supervised nonbank financial companies, and their subsidiaries unless another listed agency is the primary regulator. The CFTC issues rules for entities it primarily regulates, and the SEC issues rules for entities it primarily regulates. (ii) These agencies must consult and coordinate so rules are comparable and applied consistently, do not advantage or disadvantage affected companies, and protect covered entities’ safety and soundness. (iii) The Council Chair coordinates the rules. (c) Effective date and transition. (1) Except as paragraphs (2) and (3) provide, this section takes effect on the earlier of 12 months after final rules under subsection (b) are issued or 2 years after July 21, 2010. (2) A banking entity or Board-supervised nonbank financial company must comply within 2 years after the requirements take effect, or within 2 years after becoming such a nonbank company. The Board may extend that period by up to 1 year at a time if consistent with this section and not harmful to the public interest; total extensions may not exceed 3 years. (3) On application, the Board may extend the period for a banking entity to keep an ownership interest in, or provide capital to, an illiquid fund as needed to meet a contractual obligation existing on May 1, 2010. The Board may grant one extension of up to 5 years. (4) Except as subsection (d)(1)(G) provides, the entity may not continue the prohibited ownership activity after the earlier of the contract’s end or expiration of Board extensions. (5) When subsection (b)(2) rules are issued, the agencies must issue rules imposing appropriate extra capital requirements and other restrictions during the transition on a banking entity’s fund ownership or sponsorship. (6) Within 6 months after July 21, 2010, the Board must issue rules implementing paragraphs (2) and (3). (d) Permitted activities. (1) Subject to other Federal or State law, paragraph (2), and agency restrictions, these activities are permitted: (A) buying, selling, acquiring, or disposing of United States obligations, obligations or instruments of the listed housing, farm-credit, and Federal-home-loan entities, and obligations of a State or its political subdivisions; (B) securities and instruments described in paragraph (h)(4) used for underwriting or market-making, only to meet reasonably expected near-term client, customer, or counterparty demand; (C) hedging individual or combined positions, contracts, or holdings to reduce their specific risks; (D) transactions in those securities and instruments for customers; (E) investments in small business investment companies, investments primarily promoting public welfare of the kind allowed by 12 U.S.C. § 24(11), and qualified rehabilitation expenditures for qualified buildings or certified historic structures under 26 U.S.C. § 47 or a similar State credit program; (F) a regulated insurance company’s transactions, and an affiliate’s transactions solely for its general account, if they comply with the investment laws, regulations, and written guidance of the company’s home State or jurisdiction and the Federal banking agencies, after required consultation and notice and comment, have not jointly found that guidance insufficient to protect banking-entity safety or United States financial stability; (G) organizing and offering a hedge or private equity fund, including serving as general partner, managing member, trustee, or controller of fund management, only if the entity provides genuine trust, fiduciary, or investment-advisory services; offers the fund only with those services to its service customers; owns only a de minimis interest under paragraph (4); follows subsection (f)(1) and (2); does not guarantee, assume, or insure the fund’s obligations or performance; does not share its name with the fund except for the stated investment-adviser exception and conditions (the adviser cannot be an insured depository institution or covered holding company, cannot share its name with one, and the name cannot contain “bank”); its directors and employees do not own fund interests unless directly providing fund services; and gives investors a written disclosure that fund losses are borne only by investors, while following additional rules with that purpose; (H) proprietary trading under 12 U.S.C. § 1843(c)(9) or (13), solely outside the United States, by a banking entity not controlled directly or indirectly by a United States-organized banking entity; (I) such a banking entity’s fund ownership or sponsorship under those provisions, solely outside the United States, if no interest is offered or sold to a United States resident and the entity is not controlled by a United States-organized banking entity; and (J) another activity the three agencies determine by rule promotes and protects the entity’s safety and soundness and United States financial stability. (2)(A) None of these may be treated as permitted if it would create a material conflict of interest with clients, customers, or counterparties; materially expose the entity to high-risk assets or strategies; threaten its safety and soundness; or threaten United States financial stability. The terms “material conflict of interest,” “high-risk assets,” and “high-risk trading strategies” are to be defined by rule; this section does not define them. (B) The three agencies must issue implementing regulations. (3) The agencies must impose extra capital and quantitative limits, including diversification rules, on permitted activities if they determine those limits are needed to protect participating banking entities. (4)(A) An entity may invest in a fund it organizes and offers to establish it with enough initial equity to attract unaffiliated investors or to make a de minimis investment. (B)(i) It must actively seek unaffiliated investors to reduce or dilute its investment. (ii) Within 1 year after the fund is established, its interest must be reduced by redemption, sale, or dilution to no more than 3 percent of the fund’s ownership interests, and the investment must be immaterial under rules; all such fund interests together may not exceed 3 percent of the entity’s Tier 1 capital. (iii) For capital standards, the outstanding investment, including retained earnings, must be deducted from the entity’s assets and tangible equity, with the deduction increasing with fund leverage. (C) The Board may grant up to 2 extra years to meet the 3-percent fund-interest limit if consistent with safety and soundness and the public interest. (e) Anti-evasion. (1) The three agencies must issue rules on internal controls and recordkeeping to ensure compliance. (2) If an agency reasonably believes a covered entity made an investment or engaged in an activity to evade this section, including by abusing a permitted activity, or otherwise violated it, the agency must, after notice and a hearing opportunity, order the entity to stop the activity and, when relevant, dispose of the investment. This does not limit a Federal agency’s or State regulator’s inherent authority under otherwise applicable law to impose further limits. (f) Fund relationships. (1) A banking entity or affiliate that manages, advises, sponsors, or organizes and offers a covered fund may not enter into a transaction with that fund, or a fund it controls, that would be a “covered transaction” under 12 U.S.C. § 371c as if the entity were a member bank and the fund an affiliate. (2) Such an entity is subject to 12 U.S.C. § 371c–1 on the same assumed basis. (3) The Board may permit a prime-brokerage transaction with a fund in which a fund managed, sponsored, or advised by the entity owns an interest if the entity satisfies all subsection (d)(1)(G) limits, its chief executive or equivalent annually certifies in writing that the subsection (d)(1)(G)(v) condition is met (and updates a materially changed certification), and the Board finds the transaction consistent with safe and sound operation. The transaction is treated under section 371c–1 as if the counterparty were an affiliate. (4) The agencies must impose extra capital charges or other restrictions on Board-supervised nonbank financial companies to address the risks and conflicts described in paragraphs (1)–(3). (g) Construction. (1) Except as this section provides, its prohibitions and limits apply even when another law authorizes the activity. (2) It does not limit an otherwise lawful sale or securitization of loans. (3) It does not limit a Federal agency’s or State regulator’s inherent authority under otherwise applicable law. (h) Definitions. (1) “Banking entity” means an insured depository institution, a company controlling one or treated as a bank holding company under section 8 of the International Banking Act of 1978, and any affiliate or subsidiary of such an entity. “Insured depository institution” excludes an institution operating only in a trust or fiduciary capacity if substantially all deposits are trust funds received in a genuine fiduciary capacity, no FDIC-insured deposits are offered or marketed through an affiliate, it accepts no demand or check-withdrawable deposits and makes no commercial loans, and it does not obtain Federal Reserve payment services or exercise discount or borrowing privileges under the cited provisions. It also excludes an institution that does not have, and is not controlled by a company that has, more than $10 billion in consolidated assets and more than 5 percent of consolidated assets in trading assets and trading liabilities on its latest applicable regulatory filing. (2) “Hedge fund” and “private equity fund” mean an issuer that would be an investment company under the Investment Company Act of 1940 but for section 3(c)(1) or (7), or a similar fund the three agencies define by rule. (3) “Nonbank financial company supervised by the Board” means one supervised by the Board of Governors as defined in 12 U.S.C. § 5311. (4) “Proprietary trading” means acting as principal for the entity’s trading account in buying, selling, acquiring, or disposing of a security, derivative, futures commodity contract, or option on one of those, plus any other instrument the agencies define by rule. (5) To “sponsor” a fund means to be its general partner, managing member, or trustee; select or control, or provide people who make up, most of its directors, trustees, or managers; or share its corporate, marketing, promotional, or other name with it, except as subsection (d)(1)(G)(vi) allows. (6) “Trading account” means an account used mainly to take positions in the listed securities or instruments to sell soon or resell for short-term price profits, plus other accounts the agencies define by rule. (7) “Illiquid fund” means a hedge or private equity fund that, on May 1, 2010, was mainly invested, or contractually committed mainly to invest, in illiquid assets such as portfolio companies, real estate, and venture capital, and that makes all investments under a strategy mainly investing in illiquid assets. In making rules, the Board must consider fund investment terms, contractual obligations, ability to sell assets, and other appropriate factors. For this paragraph, “hedge fund” means a fund identified in paragraph (2) and does not include a private equity fund as that term is used in 15 U.S.C. § 80b–3(m).