The Volker Rule, Loan Shops, and the RIC

Law firm alerts often tell you just enough to confuse you into calling them. Cadwalader’s recent alert regarding the release of the proposed implementation of the Volker Rule is an exception.  The material, which focuses on the Rule’s restrictions on banks owning or sponsoring private funds, is dense material, but made bite-sized.  As we at Blue River often look for ways to help our fund manager clients navigate (read: avoid) regulation to the extent practical while still growing their businesses, our takeaway from the alert was:

Section 3(c)(5) funds (strict real estate, generally) and Rule 3a-7 funds (strict ABS, generally) are completely outside the scope of the Volker Rule.  Banks can, therefore, sponsor and own such funds without limitation.

– Section 3(c)(1) and 3(c)(7) funds, which make up the vast majority of privately placed funds, are subject to the Volker Rule and its bank ownership/sponsorship restrictions, unless they strictly contain loans and direct hedges of those loans (e.g. interest rate swaps, but no high yield).  If fund assets are thus restricted, Banks can own and sponsor them to their delight, but the banks would still carry the significant compliance obligation of the Volker Rule, including reporting various quantitative measures and having written policies and procedures, internal controls, management level compliance responsibilities, independent testing, employee training and record-keeping.

For managers and banks who want to avoid the ownership/sponsorship restrictions and still run the portfolio as they wish, we have suggested for some time they pursue the privately placed registered investment company (“RIC”).  While it carries some added administrative burdens (which we can perform for the manager) by virtue of its registered status, it’s completely outside of the scope of the Volker Rule, and carries the added benefits of (a) no limit on the number of investors as with 3(c)(1) and 3(c)(7) funds (100 and 500, respectively) and (b) the ability to take on ERISA investors (e.g. IRAs and private pensions) over the 25% limit that private funds can’t/shouldn’t cross.