SEC Staff Comment Letter Required Bank to Discuss Whether Foreign Currency Trading is Proprietary Trading under Volcker Rule

In what may be the first published SEC staff comments to a company regarding the Volcker rule, the staff asked Northern Trust Corporation to provide additional explanation of foreign currency trading on behalf of its clients. The Volcker rule is contained in Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act). The rule amends Section 13 of the Bank Holding Company Act of 1956 to prohibit most forms of proprietary trading by banks and nonbank financial institutions supervised by the Board. The Volcker rule generally prohibits a banking entity from engaging in proprietary trading, or from acquiring or retaining any equity, partnership, or other ownership interest in, or sponsoring a hedge fund or a private equity fund. (Bank Holding Company Act of 1956 Sec. 13(a)(1) as amended by Sec. 619 of the Dodd-Frank Act). "Proprietary trading" means engaging as principal for the trading account of a banking entity or nonbank financial company supervised by the Board in any transaction to buy or sell any security, derivative, contract of sale of a commodity for future delivery, any option on any such security, derivative, or contract, or any other security or financial instrument identified by federal regulators (Bank Holding Company Act of 1956 Sec. 13(h)(4) as amended by Sec. 619 of the Dodd-Frank Act). A "banking entity" is an insured depository institution, a company that controls an insured depository institution, or a company that is treated as a bank holding company, including any affiliates or subsidiaries. "Insured depository institution" does not include trust and fiduciary activities that meet specified criteria. (Bank Holding Company Act of 1956 Sec. 13(h)(1) as amended by Sec. 619 of the Dodd-Frank Act). The Volcker rule, however, permits some activities, including the buying and selling of securities for purposes of market-making-related activities, if the permitted activity is designed not to exceed reasonably expected near term demands of clients, customers, and counterparties (Bank Holding Company Act of 1956 Sec. 13(d)(1)(B) as amended by Sec. 619 of the Dodd-Frank Act). Even permitted activities, however, are subject to limits due to material conflicts of interest, material exposure to high-risk assets or trading strategies, safety and soundness concerns, and threats to U.S. financial stability (Bank Holding Company Act of 1956 Sec. 13(d)(2)(A) as amended by Sec. 619 of the Dodd-Frank Act). Permitted activities must satisfy any capital and quantitative limits established by rules (Bank Holding Company Act of 1956 Sec. 13(d)(3) as amended by Sec. 619 of the Dodd-Frank Act). Permitted activities also must not violate the anti-evasion provisions established by federal regulators (Bank Holding Company Act of 1956 Sec. 13(e) as amended by Sec. 619 of the Dodd-Frank Act). The SEC staff, upon reviewing the Form 10-K filed by Northern Trust Corporation, inquired whether foreign currency trading services provided by the bank to customers amounted to proprietary trading under the Volcker rule. Specifically, the staff observed that it was unclear how much of Northern Trust's foreign currency trades were for its own account and how much trading was conducted on behalf of clients. Thus, the staff asked the bank to separately quantify proprietary trading revenues (if material) to better inform investors of the significance of proprietary trading to the bank's overall results of operations. The staff requested that the bank explain the future impact of any proprietary trading limits imposed by the Volcker rule on its proprietary trading activities. The staff also asked Northern Trust to explain in its future filings how it intends to comply with the Volcker rule. Northern Trust replied that it does not engage in proprietary trading as defined in the Dodd-Frank Act. The bank noted that it acts as a foreign exchange market maker and principal in order to provide foreign exchange services to customers in the normal course of its business. The bank stated that it acts as market maker and as principal in transactions with third parties, investment managers of clients, and with some clients directly. As a result, Northern Trust trades currencies in the interbank market and may hold inventory positions in currencies to promote efficient trading. The bank described these interbank transactions in aid of its market making services as "trading for its own account" in its Form 10-K. The bank records aggregate revenues from such trades as foreign exchange trading income in its consolidated income statement. In addition, the bank observed that it had already disclosed in its Form 10-K regulatory section that it did not expect the Volcker rule to impact its foreign currency trading activities. [Editor's Note: Northern Trust did not discuss in its reply whether its activities may fall within in any of the permitted activities, including permitted market-making-related activities. However, the bank did discuss these permitted activities in Page 5 of its Form 10-K for the year ended December 31, 2010, filed February 25, 2011.] The bank further noted that it could not assess the full impact of the Volcker rule since multiple federal regulators must adopt rules and regulations over several years in order to fully implement the restrictions on proprietary trading. The staff subsequently indicated that it had completed its review. This post was provided by Mark S. Nelson, CCH Federal Securities Writer Analyst, Wolters Kluwer Incorporated.

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