November 1

Would the Volker Rule have prevented the collapse of MF Global?

A number of news articles suggest that a ban on all proprietary trading may have prevented MF Global from collapsing.** It certainly would have prevented it from collapsing as a result of a $6.3 billion bet on its own account.

(**Note that not even the current draft of the so-called Volker Rule would prohibit all proprietary trading by all entities. Some entities will be allowed to engage in proprietary trading and some prop trades will be allowed in specific instances, i.e. for hedging, to make a market, etc.)

There is no suggestion that the proprietary trading that MF Global engaged in was improper.  There is no suggestion that the bet that MF Global made on the European debt was contrary to the advice that it gave its clients or that MF Global improperly hid its investment position.

On the other hand, there have been reports that MF Global failed to segregate client funds from its own funds and may have used client funds to pay operating expenses. This conduct is unlawful. It may also be a red flag of other lax standards at MF Global. Maybe the firm would have failed even without taking large, risky proprietary bets.

UPDATE: Check out this recent article on the issue, which includes my thoughts on the MF Global collapse.

October 7

The Misguided, Exception-Laden Volker Rule

If you want people to follow a rule, (1) the rule needs to be clear and easily understood and (2) there must be a clear negative consequence if the rule is not followed.  Despite this fact of human behavior, the federal government has once again sought to solve the problem of lack of enforcement (no negative consequence) by introducing more dense and ambiguous regulations.


The new proprietary trading rule, the so-called “Volker Rule,” set to be unveiled soon, is an example of regulations run amok.  It is a knee-jerk response to a lack of enforcement of the clear, existing rules of fiduciary duty and conflict-of-interest.  Instead of encouraging the Securities & Exchange Commission to use the tools that it has to police improper trading on proprietary desks (and giving the S.E.C. the resources to do so), Congress has created a special rule that applies solely to proprietary trading.


But this new rule suffers from severe flaws. First, because there is nothing wrong per se with proprietary trading and, in fact, it is sometimes necessary in order to create a market for a client’s trade, the new rule does not ban all proprietary trading.  Thus, the new rule contains a list of exceptions that threaten to swallow the rule. Second, the new rule (at least in the draft that has been released), does not provide a clear definition of what type of trading is disallowed. For instance, although the rule is said to apply to any trading account that takes a position for the purpose of selling in the “near-term,” “near-term” is not a defined term. Neither is “short-term.”  Instead, three types of accounts, with certain exclusions, fall within the definition of a regulated account: (1) accounts used to take short-term positions or to hedge positions; (2) accounts already subject to Market Risk Capital Rules; or (3) any account used by a securities dealer, swap dealer, or security-based swap dealer.


Taken together, the litany of exceptions and the lack of definitions make it unlikely that many will understand what the Volker Rule allows and what it bans. In short, the regulation is likely to lead to intentional evasion, unintentional non-compliance, and years of litigation over its meaning. It is a jobs act for private corporate lawyers.


And it will be one more rule that the under-funded S.E.C. will be unable to enforce.